Message from the Chair:

Dear Colleagues and Friends:

Welcome to our Winter 2017 edition of The Business Advisor, featuring articles and general updates on our financial restructuring and creditors’ rights practice. In the first article, Brett S. Theisen addresses the conflict that arises under an operating agreement governing a limited liability company (“LLC”) between a lender’s asserted contractual right to control the LLC-borrower’s ability to file a bankruptcy petition and the public policy that eschews such control. In our second article, Mark B. Conlan and Nicholas A. Falcone analyze an important recent decision of the Second Circuit Court of Appeals in MPM Silicones, L.L.C., addressing chapter 11 confirmation issues of cramdown interest rates, contractual subordination, and “make-whole” premiums raised by indenture trustees for three groups of appealing noteholders. In our third article, Corporate Director Lawrence A. Goldman highlights a recent decision following the minority view that “S corporation” status is not a property right in bankruptcy. Finally, in our Litigation Update, Dale E. Barney writes about a recent success of the Gibbons’ trial team in a valuation phase of a fraudulent transfer lawsuit being litigated in the United States Bankruptcy Court for the District of Idaho on behalf of DBSI Estate Litigation Trustee James R. Zazzali.

Please also read about recent and upcoming Professional Activities of our attorneys and recent Firm News that reflects noteworthy professional achievements about the workplace we enjoy. It is hard to believe that 2017 is coming to a close. On behalf of all our attorneys, we wish all of our readers a happy, healthy New Year and look forward to continued camaraderie and professionalism in our future dealings.


Karen A. Giannelli, Esq.
Chair, FR&CR Department

ARTICLES & CLIENT ALERTS

Public Policy Prohibits Contractual Restrictions on an LLC’s Right to File Bankruptcy
By: Brett S. Theisen

Generally, public policy prohibits attempts to contract away the right to file bankruptcy, and a string of recent decisions confirms this principle in the context of limited liability company (“LLC”) operating agreements. In September, the United States Bankruptcy Court for the Eastern District of Kentucky held that provisions of an LLC operating agreement, added incidental to the closing of a commercial loan, served no purpose other than to frustrate the LLC’s ability to commence a bankruptcy case, and were thus unenforceable. In re Lexington Hosp. Grp., LLC, 2017 WL 4118117 (Bankr. E.D. KY, Sept. 15, 2017). In short, the applicable provisions gave the lender the ability to block a filing. Notwithstanding state law policy of freedom of contract in LLC agreements, the bankruptcy court observed that enforceability of bankruptcy restrictions is a matter of federal law. The Court’s holding follows two other recent decisions similarly voiding restrictions on bankruptcy rights. See In re Intervention Energy Holdings, LLC, 553 B.R. 258 (Bankr. D. Del. 2016); In re Lake Michigan Beach Pottawattamie Resort, LLC, 547 B.R. 899 (Bankr. N.D. Ill. 2016).

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Second Circuit Adopts Two-Step Market-Based Approach to Chapter 11 Cramdown Interest Rates and Affirms Bankruptcy Court’s Subordination of Certain Notes and Denial of “Make-Whole” Premium
By: Mark B. Conlan and Nicholas A. Falcone

The Second Circuit Court of Appeals recently released its decision in In the matter of MPM Silicones, L.L.C. (MPM). In the consolidated appeals, certain noteholders argued, among other issues, that the cramdown provisions of the confirmed chapter 11 plan of Momentive Performance Materials Inc. (MPM) improperly eliminated or reduced the value of their notes. The Court of Appeals affirmed plan confirmation, but remanded the case to the bankruptcy court to employ a two-step analysis to establish interest rates under the cramdown plan. Under the Second Circuit’s ruling, bankruptcy courts must first determine whether an efficient market exists, and, if so, use the market rate of interest for replacement notes. Second, only if no efficient market exists, the court employs the formula method used in Till v. SCS Credit Corp., a United States Supreme Court decision in a chapter 13 case.

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Virginia Bankruptcy Court Holds that S Corporation Status is Not “Property” for Purposes of the Bankruptcy Code
By: Lawrence A. Goldman

Confronted with conflicting precedent, a Bankruptcy Court in Virginia held that “S corporation” status under federal income tax law does not constitute “property” for purposes of Sections 544(b) and 548 of the United States Bankruptcy Code. In In re Health Diagnostic Laboratory, Inc., et al., 2017 WL 6061579 (Bankr. E.D. VA, Dec. 6, 2017), a liquidating trustee alleged that the shareholders’ vote to terminate S corporation status prior to the corporation’s commencing a bankruptcy case was a fraudulent transfer subject to being voided, thereby creating value for the estate by generating tax refunds which could be claimed by the liquidating trustee. The issue was one of first impression within the Fourth Circuit. Only the Third Circuit had concluded that S corporation status does not constitute a property right in bankruptcy. In re Majestic Star Casino, LLC, 716 F.3d 736 (3rd Cir. 2013), with several lower courts having held to the contrary. The court reasoned that federal tax law governs any purported property tax right and that in applying an “essential property rights” analysis of the Fourth Circuit, the Court determined that S corporation status is not a property right under federal tax law.

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Trial Team Update: Zazzali v. Goldsmith (In re DBSI Inc.)
By: Dale E. Barney

In early September 2017, a trial team consisting of Dale E. Barney, Mark B. Conlan, and Brett S. Theisen successfully tried to conclusion the valuation phase of the fraudulent transfer lawsuit of Zazzali v. Goldsmith in the U.S. Bankruptcy Court for the District of Idaho in Boise. This last of the DBSI fraudulent transfer actions commenced by the firm on behalf of DBSI Estate Litigation Trustee James R. Zazzali involves a 177-acre parcel of development land located in Meridian, ID known as Tanana Valley. The DBSI group of companies were controlled by majority owner Douglas Swenson, who, along with two of his sons and DBSI’s general counsel, were convicted in the U.S. District Court for the District of Idaho on multiple counts of securities fraud and related charges in 2014; and affirmed by the Ninth Circuit Court of Appeals. The criminal defendants have until January 18, 2018 to seek further appellate review by the U.S. Supreme Court.