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Bankruptcy ruling locks out insiders

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A recent bankruptcy appeal tossing an Indianapolis shopping center’s reorganization plan further establishes that the control of equity in Chapter 11 cases will be subject to competitive bidding and that insiders might be out of luck.

“This is a case that will be talked about by bankruptcy lawyers for a long time,” said Alan K. Mills, a Barnes & Thornburg LLP partner who successfully represented the chief creditor before the 7th Circuit Court of Appeals in In the matter of: Castleton Plaza LP; Appeal of: EL-SNPR Notes Holdings LLC, 12-2639.
 

plaza-15col.jpg Castleton Plaza in Indianapolis is at the center of a bankruptcy case that attorneys say will have broad implications for Chapter 11 reorganizations. (IL Photo/ Perry Reichanadter)

On Feb. 14, the 7th Circuit reversed a Southern District of Indiana bankruptcy court that had approved a Chapter 11 reorganization plan in which Castleton Plaza owner George Broadbent was to transfer equity in the property to his wife Mary Clare Broadbent, who was to invest $375,000 in new equity. Under the plan, Castleton Plaza secured lender EL-SNPR would be paid $300,000 on secured debt of $10 million, and the remainder would be written down to about $8.2 million of unsecured debt.

“Not only did the equity holder decide who it was going to be sold to, he also decided what it was going to be sold for,” Mills said of the original reorganization plan. “This has been sort of a nationwide maneuver by debtors’ lawyers in single-asset bankruptcy,” he said of reorganizations relying on infusion of new equity from insiders as 11 U.S.C. §101(31) defines that term.


mills_alan.jpg Mills

Mills said the 7th Circuit’s reversal was a vindication of the absolute priority rule that generally holds that a court will not confirm a plan in which dissenting creditors are not paid in full or given an opportunity to market test the value of equity.

“Competition is essential whenever a plan of reorganization leaves an objecting creditor unpaid yet distributes an equity interest to an insider,” 7th Circuit Chief Judge Frank Easterbrook wrote in remanding Castleton Plaza to the bankruptcy court to open the reorganization plan to competitive bidding.


deignan-paul-mug.jpg Deignan

Taft Stettinius & Hollister LLP partner Paul T. Deignan represented the Broadbent Company and Castleton Plaza. He said he and his clients are reviewing the ruling and might seek an appeal.

“It is of such a serious nature that it is getting serious attention,” Deignan said. “People including myself and other bankruptcy attorneys are going to have to think about this for a while. It’s a pretty dramatic change for those of us who represent family-owned businesses.”

Deignan said there is an exception or corollary to the absolute priority rule when substantial new equity is brought to the table, as was the case in Castleton Plaza. Bankruptcy courts have long recognized that new capital from insiders can be a key to a company’s recovery, he said.

“Part of the reason this is a very significant decision is, in our part of the country at least – Indiana, Illinois, Wisconsin in the 7th Circuit – many of the Chapter 11 reorganizations are of small businesses and family-owned businesses,” Deignan said. If creditors now can require an auction for new equity ownership in bankruptcy, “a consequence of that will be not a lot of incentive for family members to step up who might be able to save the family business,” he added.


georgakopulos-nicholas-mug Georgakopoulos

But Indiana University Robert H. McKinney School of Law professor Nicholas Georgakopoulos said the 7th Circuit decided correctly based on the U.S. Supreme Court precedent in Bank of America National Trust & Savings Association v. 203 North LaSalle Street Partnership, 526 U.S. 434 (1999). That ruling held that pre-bankruptcy equity holders may not contribute new capital on an exclusive basis over the objection of impaired creditors.

“I think the Supreme Court decision in 203 North LaSalle should be seen as trying to protect lenders,” said Georgakopoulos, whose article, “New Value, Fresh Start,” was cited in the high court’s opinion. “And if the 7th Circuit were to uphold the lower court’s opinion in Castleton, they would have created a huge loophole which would allow self-dealing and would allow essentially bankruptcies of closely held corporations to avoid the requirement of 203 North LaSalle.”

Mills said the 7th Circuit decision in Castleton Plaza appears to be the first Circuit-level ruling to apply the LaSalle holding. He said the opinion goes a long way toward resolving a split among bankruptcy courts regarding whether equity owners can avoid the absolute priority rule through transfers to insiders.

He believes the ruling may have a wider impact, even if insiders are not involved in a reorganization plan. “Whenever you have an equity piece that is going to be sold, I think many bankruptcy courts after this will see if there’s a market for it to determine its true value.”

Bose McKinney & Evans LLP partner James E. Carlberg chairs the Bankruptcy and Creditors’ Rights Section of the Indiana State Bar Association. He also believes the ruling will have profound ramifications for Chapter 11 reorganizations.

“What the court really said was no one knows for sure what the right to make a contribution to become the new equity owner is worth,” Carlberg said. “And in all cases that has to be put up, in essence, for bids and the creditor allowed to bid for it as well.

“What the court is saying is we should put that up for auction to safeguard against it being undervalued at the outset.”

Carlberg explained that many bankruptcies don’t involve assets earning sufficient income to service debts. That doesn’t appear to be the case with Castleton Plaza, which boasts leases with at least 20 retail tenants including such anchor stores as Sam Ash, West Marine, Dollar Tree and Formosa Seafood Buffet.

Easterbrook’s ruling made clear that when a Chapter 11 bankruptcy creditor doesn’t buy into a reorganization plan involving insiders, that plan won’t pass muster.

“This appeal presents the question whether an equity investor can evade the competitive process by arranging for the new value to be contributed by (and the new equity to go to) an ‘insider,’” Easterbrook wrote. “The bankruptcy judge answered yes; our answer is no.”•

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  1. I have been on this program while on parole from 2011-2013. No person should be forced mentally to share private details of their personal life with total strangers. Also giving permission for a mental therapist to report to your parole agent that your not participating in group therapy because you don't have the financial mean to be in the group therapy. I was personally singled out and sent back three times for not having money and also sent back within the six month when you aren't to be sent according to state law. I will work to het this INSOMM's removed from this state. I also had twelve or thirteen parole agents with a fifteen month period. Thanks for your time.

  2. Our nation produces very few jurists of the caliber of Justice DOUGLAS and his peers these days. Here is that great civil libertarian, who recognized government as both a blessing and, when corrupted by ideological interests, a curse: "Once the investigator has only the conscience of government as a guide, the conscience can become ‘ravenous,’ as Cromwell, bent on destroying Thomas More, said in Bolt, A Man For All Seasons (1960), p. 120. The First Amendment mirrors many episodes where men, harried and harassed by government, sought refuge in their conscience, as these lines of Thomas More show: ‘MORE: And when we stand before God, and you are sent to Paradise for doing according to your conscience, *575 and I am damned for not doing according to mine, will you come with me, for fellowship? ‘CRANMER: So those of us whose names are there are damned, Sir Thomas? ‘MORE: I don't know, Your Grace. I have no window to look into another man's conscience. I condemn no one. ‘CRANMER: Then the matter is capable of question? ‘MORE: Certainly. ‘CRANMER: But that you owe obedience to your King is not capable of question. So weigh a doubt against a certainty—and sign. ‘MORE: Some men think the Earth is round, others think it flat; it is a matter capable of question. But if it is flat, will the King's command make it round? And if it is round, will the King's command flatten it? No, I will not sign.’ Id., pp. 132—133. DOUGLAS THEN WROTE: Where government is the Big Brother,11 privacy gives way to surveillance. **909 But our commitment is otherwise. *576 By the First Amendment we have staked our security on freedom to promote a multiplicity of ideas, to associate at will with kindred spirits, and to defy governmental intrusion into these precincts" Gibson v. Florida Legislative Investigation Comm., 372 U.S. 539, 574-76, 83 S. Ct. 889, 908-09, 9 L. Ed. 2d 929 (1963) Mr. Justice DOUGLAS, concurring. I write: Happy Memorial Day to all -- God please bless our fallen who lived and died to preserve constitutional governance in our wonderful series of Republics. And God open the eyes of those government officials who denounce the constitutions of these Republics by arbitrary actions arising out capricious motives.

  3. From back in the day before secularism got a stranglehold on Hoosier jurists comes this great excerpt via Indiana federal court judge Allan Sharp, dedicated to those many Indiana government attorneys (with whom I have dealt) who count the law as a mere tool, an optional tool that is not to be used when political correctness compels a more acceptable result than merely following the path that the law directs: ALLEN SHARP, District Judge. I. In a scene following a visit by Henry VIII to the home of Sir Thomas More, playwriter Robert Bolt puts the following words into the mouths of his characters: Margaret: Father, that man's bad. MORE: There is no law against that. ROPER: There is! God's law! MORE: Then God can arrest him. ROPER: Sophistication upon sophistication! MORE: No, sheer simplicity. The law, Roper, the law. I know what's legal not what's right. And I'll stick to what's legal. ROPER: Then you set man's law above God's! MORE: No, far below; but let me draw your attention to a fact I'm not God. The currents and eddies of right and wrong, which you find such plain sailing, I can't navigate. I'm no voyager. But in the thickets of law, oh, there I'm a forester. I doubt if there's a man alive who could follow me there, thank God... ALICE: (Exasperated, pointing after Rich) While you talk, he's gone! MORE: And go he should, if he was the Devil himself, until he broke the law! ROPER: So now you'd give the Devil benefit of law! MORE: Yes. What would you do? Cut a great road through the law to get after the Devil? ROPER: I'd cut down every law in England to do that! MORE: (Roused and excited) Oh? (Advances on Roper) And when the last law was down, and the Devil turned round on you where would you hide, Roper, the laws being flat? (He leaves *1257 him) This country's planted thick with laws from coast to coast man's laws, not God's and if you cut them down and you're just the man to do it d'you really think you would stand upright in the winds that would blow then? (Quietly) Yes, I'd give the Devil benefit of law, for my own safety's sake. ROPER: I have long suspected this; this is the golden calf; the law's your god. MORE: (Wearily) Oh, Roper, you're a fool, God's my god... (Rather bitterly) But I find him rather too (Very bitterly) subtle... I don't know where he is nor what he wants. ROPER: My God wants service, to the end and unremitting; nothing else! MORE: (Dryly) Are you sure that's God! He sounds like Moloch. But indeed it may be God And whoever hunts for me, Roper, God or Devil, will find me hiding in the thickets of the law! And I'll hide my daughter with me! Not hoist her up the mainmast of your seagoing principles! They put about too nimbly! (Exit More. They all look after him). Pgs. 65-67, A MAN FOR ALL SEASONS A Play in Two Acts, Robert Bolt, Random House, New York, 1960. Linley E. Pearson, Atty. Gen. of Indiana, Indianapolis, for defendants. Childs v. Duckworth, 509 F. Supp. 1254, 1256 (N.D. Ind. 1981) aff'd, 705 F.2d 915 (7th Cir. 1983)

  4. "Meanwhile small- and mid-size firms are getting squeezed and likely will not survive unless they become a boutique firm." I've been a business attorney in small, and now mid-size firm for over 30 years, and for over 30 years legal consultants have been preaching this exact same mantra of impending doom for small and mid-sized firms -- verbatim. This claim apparently helps them gin up merger opportunities from smaller firms who become convinced that they need to become larger overnight. The claim that large corporations are interested in cost-saving and efficiency has likewise been preached for decades, and is likewise bunk. If large corporations had any real interest in saving money they wouldn't use large law firms whose rates are substantially higher than those of high-quality mid-sized firms.

  5. The family is the foundation of all human government. That is the Grand Design. Modern governments throw off this Design and make bureaucratic war against the family, as does Hollywood and cultural elitists such as third wave feminists. Since WWII we have been on a ship of fools that way, with both the elite and government and their social engineering hacks relentlessly attacking the very foundation of social order. And their success? See it in the streets of Fergusson, on the food stamp doles (mostly broken families)and in the above article. Reject the Grand Design for true social function, enter the Glorious State to manage social dysfunction. Our Brave New World will be a prison camp, and we will welcome it as the only way to manage given the anarchy without it.

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