Category: Property of the Estate

CAN SPOUSES NOW SAVE MARITAL PROPERTY BY FILING SEPARATE BANKRUPTCIES?

by Virginia Shea

The New Jersey Appellate Division has crafted a potential new avenue for debtor spouses to protect marital property.  The Appellate Division recently clarified that a creditor of one spouse cannot execute on marital real or personal property held by the spouses as tenants by the entirety, absent consent of both spouses.  Bankruptcy law holds that property held as tenants by the entirety is exempt property, unless state law holds to the contrary, which New Jersey law, now, clearly does not.  Accordingly, spouses may be able to protect marital property by filing separate bankruptcies, whereby consent may be denied by the respective non-debtor spouse.

The New Jersey Appellate Division recently ruled that a New Jersey Statute enacted in 1988 supersedes prior case law, such that there is no question that an unsecured creditor of one spouse cannot seek partition of property held by spouses as tenants by the entirety.  In Jimenez v. Jimenez, __A.3d __, 2018 WL 2106639 (App. Div. 2018), Raul and his wife Gwyn[1] owned undeveloped land in Mansfield, NJ (the “Mansfield Property”), as tenants by the entirety.  Plaintiffs, relatives of Raul, sought to enforce a consent judgment entered against Raul only, which judgment had been recorded as a lien.  Plaintiffs tried to enforce the judgment by way of other collection efforts but were unsuccessful.  Plaintiffs then moved under R. 4:59-1(d) to compel the partition and sale of the Mansfield Property.  Raul opposed the motion arguing that a forced sale and partition is prohibited by N.J.S.A. 46:3-17.4.  The motion judge agreed with Raul and denied the partition application.  The Appellate Division affirmed stating that N.J.S.A. 46:3-17.4 precluded one spouse’s unsecured creditor from obtaining a forced partition of property owned by both spouses as tenants by the entirety.

In 1988, new statutes were enacted in New Jersey, N.J.S.A. 46:3-17.2 to -17.4, pertaining to tenancies created on or after the 1988 enactment date.  Section 17.2 provides that a tenancy by the entirety is created when a husband and wife take title to “real or personal property under a written instrument designating both of their names as husband and wife.”  A tenancy by the entirety is a form of joint ownership of property only available to spouses, whereby each co-tenant is the owner of the entire property and each co-tenant has the right of survivorship after the death of the other.  Jimenez, 2018 WL 2106639 at *2.  A spouse can alienate his or her right of survivorship,[2]  but a spouse cannot force the partition of the property during the marriage.  Id.

Section 17.4 of N.J.S.A. 4:3 statute states, “[n]either spouse may sever, alienate, or otherwise affect their interest in the tenancy by entirety during the marriage or upon separation without the written consent of both spouses.”  Prior to the adoption of the 1988 statute, case law authorized courts to compel the partition and sale of a spouse’s interest in property held in a tenancy by the entirety, in the court’s discretion, where it would be equitable to do so.  Id. at *3.  In Jimenez, equity otherwise would have warranted partition as the Mansfield Property, because it was not used as the marital residence, some of the funds loaned to Raul by the plaintiffs related to development of the Mansfield Property, and plaintiffs had expended significant effort trying to execute from other sources, to no avail.  Id.  Nevertheless, the Appellate Division was constrained by the language of the 1988 statute to preclude partition since Raul and Gwyn owned the Mansfield Property as tenants by the entirety.  “Otherwise, a free-wheeling spouse, by amassing such individual debt, could detrimentally ‘affect’ the other spouse’s interest in their co-owned property.” Id. Moreover, “[t]here would have been little point for the Legislature to have enacted Section 17.4 if it only intended to continue established principles of case law regarding tenancies by the entirety ….”  Id.  The Appellate Division reached this conclusion in part, after reviewing In re Wanish, 555 B.R. 596 (Bankr. E.D. Pa. 2016).

In In re Wanish, a chapter 7 trustee in a Pennsylvania bankruptcy case, objected to a debtor’s claimed exemption in a mobile home owned with his non-debtor wife, which was located in New Jersey.  The Trustee conceded that New Jersey law applied in order to determine the exemption issue.  The bankruptcy court determined that based upon New Jersey’s 1988 statute, it was clear that creditors of one spouse could not levy or sell personal property held by a debtor as a tenant by the entirety, without the non-debtor spouse’s consent.  Id. 555 B.R. at 498.  Since it was clear under New Jersey law that creditors of the debtor were prohibited from levying on the mobile home without the consent of the non-debtor spouse, the debtor’s interest in the mobile home was exempt under 11 U.S.C. § 522(b)(3)(B).   Section 522(b)(3)(B) provides that a debtor may exempt as property “any interest in property in which the debtor had, immediately before the commencement of the case, an interest as a tenant by the entirety … to the extent that such interest as a tenant by the entirety … is exempt from process under applicable non-bankruptcy law.”  Here, New Jersey law no longer provides such “exempt[ion] from process,” such that property held as tenants by the entirety, is now clearly exempt under 11 U.S.C. § 522(b)(3)(B).

Along these lines, in 2012, the Bankruptcy Court for the Middle District of Florida, applied New Jersey law and determined that a trustee could not reach the sales proceeds generated by the sale of a debtor’s marital property.   In In re Montemoino, 491 B.R. 580 (2012), a married debtor, together with her non-debtor husband, sold real property held as tenants by the entirety, and deposited the net proceeds into a bank account titled solely in the non-debtor spouse’s name.   The trustee alleged that half the proceeds from the sale were property of the debtor and could be avoided as fraudulent, because the debtor transferred the proceeds to the non-debtor spouse for no consideration causing her to become insolvent as a result.  Id. at 583.  The debtor argued that the proceeds had originated from property held as tenants by the entirety,  and, as such, the proceeds maintained their tenant by entirety status, such that the proceeds were exempt.  The Florida bankruptcy agreed that New Jersey recognizes that personal property could be held as tenants by the entirety, and since the proceeds from the sale went to both spouses, the proceeds were presumed to be, under New Jersey law, held by the spouses as tenants by the entirety.  Id. at 586.  The bankruptcy court then held that although New Jersey common law prior to 1988 permitted creditors of a single spouse to execute on tenancy by the entireties property, “with the enactment of the tenancy by the entireties statutes, this Court concludes that creditors of just one spouse can no longer execute on entireties property.”  Id. at 588.  The court noted that the statute prevented a spouse from granting a mortgage on real property without the consent of the other spouse.  Id. at 589.  The court also pointed to a Third Circuit ruling that held “filing a bankruptcy petition does not sever a tenancy by the entirety and thus an individual spouse may be able to exempt the whole of entireties property from the bankruptcy estate in some circumstances.”  Id. (quoting In re O’Lexa, 476 F.3d 177 (3d Cir. 2007)).

Accordingly, Jimenez clarifies that with respect to creditors of a debtor who owns New Jersey property with a non-debtor spouse as tenants by the entirety, the entireties property is exempt under 11 U.S.C. § 522(b)(3)(B) because it is exempt from process under applicable non-bankruptcy law (absent a fraudulent conveyance).   A debtor may thus be able to protect marital property by filing for bankruptcy without his or her spouse, or by each spouse filing an indivi

[1] As plaintiffs and defendants surnames are “Jimenez,” all references will be to their first names.

[2] Presumably, by stepping into the debtor’s survivorship shoes, an unsecured creditor could acquire survivorship rights only such that the unsecured creditor could become owner of the entire property to the extent the debtor survives his or her non-debtor spouse after the marriage ends, whether by way of divorce or death.

Texas District Court Finds Unclaimed Oil and Gas Royalties Are Not Property of the Estate

by Bradley Lehman

By: Bradley Lehman, Esquire

McElroy, Deutsch, Mulvaney & Carpenter, LLP

A recent opinion from the U.S. District Court for the Southern District of Texas, on appeal from the bankruptcy court in the District, is likely to have broad applicability in pending and future energy producer bankruptcy cases. In Oklahoma State Treasurer v. Linn Operating, Inc., 6:17-CV-0066, 2018 WL 1535354 (S.D. Tex., March 29, 2018), the Chapter 11 plan filed by Linn Operating LLC, an Oklahoma-based oil and gas producer, provided that the claims of owners of the approximately $1 million in unclaimed royalties held by the debtor would be discharged upon confirmation of the plan and the debtor would retain the funds. The bankruptcy court confirmed the plan, and the State of Oklahoma filed an adversary action against the debtor seeking turnover of the unclaimed royalties to the state. The bankruptcy court dismissed the complaint, finding that the adversary case was merely a post-confirmation collateral attack on the debtor’s plan.

Oklahoma appealed the dismissal of its adversary case to the Southern District of Texas, and Judge Kenneth M. Hoyt entered an opinion reversing the bankruptcy court’s decision. The District Court found that, as a matter of state law, unclaimed oil and gas royalties are held in trust by the producer for the owners of the royalties. Therefore, the unclaimed royalties were never property of the debtor’s bankruptcy and were not subject to the bankruptcy court’s jurisdiction or to confirmation of the debtor’s Chapter 11 plan.

The Hidden Chapter of the Financial Aid Handbook:Tuition Payments Subject to Fraudulent Transfer Liability

by Jason Angelo

By Jason D. Angelo

The cost of a college and professional education has, as most attorneys know all too well, skyrocketed over the course of the past few decades. Some students graduate with tens or even hundreds of thousands of dollars in student loan debt. Bankruptcy practitioners know the high hurdle of obtaining a discharge of student loan debt in a personal bankruptcy. But what happens when a student’s parents pay for their son’s or daughter’s tuition and then end up filing a chapter 7 or chapter 13 petition?

There is an emerging trend in bankruptcy cases across the country in which some trustees are attempting to recover pre-petition tuition payments made to educational institutions by debtors (parents) on behalf of their children (students). The Wall Street Journal reports that trustees have recovered over $276,000.00 from at least 25 educational institutions since 2014.1 The rationale is that the student, not the parents, received the reasonably equivalent value of the tuition payments – that is, the child, not the parents, received the actual benefit of the tuition payments, and so those payments are recoverable as fraudulent transfers. Some trustees have even attempted to recover payments made for private elementary and high school education, although with far less success.2

While educational institutions begin to battle these claims, many have opted to settle with trustees rather than see an adversary proceeding through to the end. Some students, however, have been hit with dire consequences: institutions, such as the University of Southern California – currently battling a lawsuit to recover nearly $200,000.00 in tuition payments – have threatened to withhold transcripts, refuse certification of a degree, recover the funds from the students themselves and bar them from registering for classes.3 Institutions also argue that allowing trustees to claw back such funds is inconsistent with the principles of federal financial aid and that, because the student will still owe the tuition to the institution (and the parents will still be on the hook for any loan they co-signed or guaranteed given the difficulty of discharging such loans), this is simply a windfall of funds to creditors – funds that they have no right to receive.

While some courts have agreed with the trustees’ position that the parents did not receive reasonably equivalent value, others have rejected the attempt to recover tuition, relying on a “moral obligation” of parents to pay for higher education. There is little consensus among bankruptcy courts on this issue. This post surveys some recent bankruptcy court decisions on this controversial tactic.

No Reasonably Equivalent Value Received?

The Michigan case of In re Leonard4 is significant because the Bankruptcy Court determined that the debtors did not receive reasonably equivalent value for the tuition payments made on behalf of their son. The Chapter 7 trustee sought to avoid and recover, as fraudulent transfers, four payments totaling $21,527.00 that the debtors made to Marquette University to pay for their 18–year old son’s tuition. The payments were made by checks from debtors’ joint checking account. However, the funds transferred were from a $35,000.00 private student loan from J.P. Morgan-Chase taken out by the student and his father. While the trustee argued that the transfers should be avoided, the University responded that the funds were never debtors’ property and instead had been held in trust for the education of their son. Relying on a theory that an express oral trust was created regarding the use of the loan proceeds, the University contended that debtors held legal, but not equitable, title in the funds, barring them from ever becoming property of the estate.

The Court determined that, because the check for the loan proceeds from J.P. Morgan-Chase was actually made payable to both the student and the father, no express oral trust could be created as to half of the funds. Further, the deposit of the funds into debtors’ joint checking account created a rebuttable presumption under state law that the money was debtors’ property, and cast further doubt upon the claim that an express trust was created given the commingling of the funds. The Court rejected the notion that a constructive trust had been created and hence was not property of the estate. Ultimately, the matter came down to who received reasonably equivalent value for the transfers: the debtors’ son, or the debtors who received value in the form of intangible benefits, such as: (1) the son’s education “bestowed peace of mind” on the debtors in that their son “will be afforded opportunities” in life that would not have come but for the education; and (2) debtors “anticipate that they will not remain financially responsible” for their son. The Court rejected Marquette’s argument and found that the debtors received no economic value in exchange for the transfers. However, the trustee’s summary judgment motion was ultimately denied because there was a still a genuine issue of material fact regarding the creation of an express oral trust and whether the loan proceeds were ever property of the estate.

Recovery of Federal Loan Proceeds

 In a case pending in the District of Connecticut5, the Chapter 7 trustee sought disgorgement of tuition payments from Johnson & Wales University. Slated for trial this year, the trustee seeks to claw back $46,909.00 in payments made from March 2011 to December 2013. According to the University and the amici curiae, the trustee’s argument essentially transforms federal loans into a government subsidy to pay off the debtors’ creditors, leaving educational institutions, which are not able to protect themselves from parents who apply for Federal Loans and later file a bankruptcy petition, incredibly vulnerable.

The key issue here is the source and control of the payments: while the tuition payments were federal dollars, they were never in the debtors’ possession or control. Rather, the government made payments directly to the university for restricted purposes. Thus, according to the University, the funds never were and never could have been property of the estate; the funds were not “fungible cash” that could actually have been utilized by the debtors to pay their creditors. Moreover, as the amici curiae point out, diversion of federal PLUS Loan funds to the debtors’ estate would be deemed “misuse” of the funds, causing the loans to be accelerated and made immediately due. The proper relief, according to the University, is to avoid the debtors’ obligations to repay the loans for which they are solely liable rather than claw back the funds from an educational institution.

In response, the trustee asserts that the debtors are liable as the sole obligor on the master promissory note related to the funds, thereby providing debtors a clear and unequivocal interest in the funds. Where there is a direct transfer to a third party resulting in an increase in a debtor’s liability and no increase in a debtor’s assets, the trustee argues that there has clearly been a transfer of the debtor’s interest in property. The trustee further claims that, had Congress intended to exempt federal loan proceeds as property of the estate, they would have done so when passing BAPCPA – in which they exempted Education IRAs (529 plans), and that this omission demonstrates an intent that proceeds of federal loans be available for recovery. See 11 U.S.C. § 541(b)(5) and (6). By incurring nearly $50,000 in new debt and receiving no corresponding benefit, the trustee believed the transfers to be fraudulent and thus recoverable. The Bankruptcy Court has not ruled yet on these issues, and the case is scheduled for trial later this year.

A “Moral Obligation” As Reasonably Equivalent value

In two separate cases6 in the Western District of Pennsylvania, the bankruptcy court determined that debtors did in fact receive reasonably equivalent value for tuition payments. Specifically, the courts held that undergraduate expenses fit within the definition of “necessities” under Pennsylvania’s Uniform Fraudulent Transfer Act.

In In re Cohen, the trustee challenged a total of $102,573.00 in tuition payments, including $46,059.97 for their son’s undergraduate education, $7,562 for their daughter’s undergraduate education, and $39,205 for their daughter’s graduate education. The Court refused to accept the trustee’s argument that because Pennsylvania law does not require parents to pay for post-secondary education, it is not a necessity and is therefore avoidable. The Court held that post-secondary educational expenses are reasonable and necessary for the maintenance of the debtor’s family for purposes of the fraudulent transfer statutes only. However, the ruling was limited to undergraduate expenses only, with the Court expressly noting that “children in graduate school are well into adulthood.” Similarly, in In re Oberdick, the trustee challenged $82,536.22 used to pay for the college education of debtors’ children at the University of Chicago and Robert Morris University. Citing to Cohen, the Court relied on debtors’ testimony that “they viewed college tuition and related educational expenses for the children as a family obligation” to deny the trustee’s claim.

Willing to Settle

Unlike Johnson and Wales, Marquette and the University of Chicago, other institutions have elected to settle these fraudulent transfer actions rather than incur the costs of litigation. The University of Hartford, Quinnipiac University7, the University of Bridgeport, Pace University, Post University, the University of Arizona and the University of Michigan8 each paid more to the trustee to avoid the risks of litigation.  According to the trustee’s attorney, many similar adversary proceedings have settled, and there are “about a dozen pending” in the Connecticut bankruptcy courts as of May 2, 2016.9

A Potential Solution?

In response to the willingness of some trustees to go after tuition dollars, Congressman Chris Collins (R-NY) introduced H.R. 2267 – PACT (Protecting All College Tuition) Act of 2015. The legislation would amend Section 548 of the Bankruptcy Code to explicitly provide that “payment of tuition by a parent to an institution of higher education . . . for the education of that parent’s child is not a transfer” that is recoverable as fraudulent. While seemingly supported by legislators on both sides of the aisle, including Rep. Blake Farenthold (R-Tex.) and Sen. Richard Blumenthal (D-Conn.), the legislation has been languishing in the House Judiciary Committee’s Subcommittee on Regulatory Reform, Commercial and Antitrust Law since June 1, 2015.10 In the meantime, as educational institutions continue to settle these fraudulent transfer actions, expect to see more filings from trustees across the country in an attempt to claw back tuition payments for distribution to creditors.          

Jason D. Angelo is an Associate in McElroy, Deutsch, Mulvaney & Carpenter, LLP’s Bankruptcy, Restructuring & Creditors’ Rights Practice Group and is admitted to practice in Delaware and New Jersey.

[1] http://www.ctlawtribune.com/id=1202756519162/Bankruptcy-Attorneys-Sue-Colleges-to-Demand-Return-of-Tuition-Payments?slreturn=20160418124233; http://www.wsj.com/articles/bankruptcy-trustees-claw-back-college-tuition-paid-for-filers-kids-1430869820.

[2]               See, e.g., In re Akanmu, 2013 WL 6283582 (Bankr. E.D.N.Y. Dec. 4, 2013) (Debtors legally obligated under New York Law to provide their minor children with an education, and the fact that they chose to do so by sending their children to private or parochial school, rather than public school, did not render the tuition payments avoidable. Debtors received reasonably equivalent value by satisfying their legal obligation to educate their children and because parents and children are viewed as a single economic unit for purposes of a constructive fraudulent conveyance analysis).

[3]                    http://blogs.wsj.com/bankruptcy/2015/11/17/usc-in-tuition-battle-former-students-will-face-consequences/

[4]               In re Leonard, 2011 WL 1344732 (Bankr. E.D. Mich. Apr. 8, 2011)

[5]               Roumeliotis v. Johnson & Wales Univ., No. 15-03011 (Bankr. D. Conn. Apr. 8, 2015)

[6]                  In re Cohen, 2012 WL 5360956, at *9-10 (Bankr. W.D. Pa. Oct. 31, 2012), aff’d in part, vacated in part, remanded sub nom. Cohen v. Sikirica, 487 B.R. 615 (W.D. Pa. 2013); In re Oberdick, 2013 WL 1289152 (Bankr. W.D. Pa. Mar. 27, 2013).

[7]              Roumeliotis v. Univ. of Hartford, No. 15-03006 (Bankr. D. Conn. Mar. 11, 2015); Roumeliotis v. Quinnipiac Univ., No. 15-03017 (Bankr. D. Conn. Apr. 15, 2015).

[8]                       http://www.wsj.com/articles/bankruptcy-trustees-claw-back-college-tuition-paid-for-filers-kids-1430869820.

[9]                       http://www.ctlawtribune.com/id=1202756519162/Bankruptcy-Attorneys-Sue-Colleges-to-Demand-Return-of-Tuition-Payments?slreturn=20160418124233

[10]             http://www.ctlawtribune.com/id=1202756519162/Bankruptcy-Attorneys-Sue-Colleges-to-Demand-Return-of-Tuition-Payments?slreturn=20160418124233; http://blogs.wsj.com/bankruptcy/2015/05/12/bill-proposes-ban-on-tuition-clawbacks-in-bankruptcy/.

Third Circuit Approves Payment by Creditor/High Bidder to Unsecured Creditors and Bankruptcy Professionals – Leaving Government in the Cold

by Nicole Leonard

In In re ICL Holding Co., Inc.[i], the Third Circuit Court of Appeals (the “Court”) addressed whether a bankruptcy sale and related settlement that resulted in (1) paying some administrative claimants (i.e. the case professionals) and not others (i.e. the government) and (2) paying unsecured creditors, while not paying creditors higher on the priority scheme, violated the Bankruptcy Code’s distribution requirements.  The Court found that following the sale and related settlement (neither of which the government was successful in staying), the government’s arguments against distribution were neither constitutionally, statutorily nor equitably moot.  Nevertheless, the Court affirmed the decisions of the lower courts approving distributions to both administrative creditors at the same priority as the government and junior creditors–while not paying the government – because such transfers were not made from property of the bankruptcy estate and were thus not subject to the Code’s distribution scheme.

Facts:

Debtor LifeCare Holdings, Inc. (“LifeCare” or “Debtor”) was in the business of operating long term acute care hospitals.  Following devastation of some its facilities after Hurricane Katrina, a post-Katrina environment of increased regulation and a debt load that thwarted obtaining new capital, LifeCare explored a sale of its assets.  After LifeCare entered into an asset purchase agreement with its secured lenders (the “Lender Group”), LifeCare and its 34 subsidiaries filed for chapter 11 protection.  The asset purchase agreement involved a credit bid by the Lender Group of about 90% of the debt owed to it   for the transfer of all of the Debtor’s assets and cash.  The agreement further provided that the Lender Group would pay for the legal and accounting costs of the Debtor and the (to-be-formed) unsecured creditors’ committee  (the “Committee”) as well as Debtor’s wind down costs.  These funds were to be held in escrow and any remaining funds after the aforementioned payments were made would go back to the Lender Group.

Following initial sale approval and an auction, the Lender Group bid was determined best.  But, the Committee and the government objected.   The Committee argued that the transaction was really a “veiled foreclosure” that would leave the estate administratively insolvent.  The government argued that the sale improperly provided for payment to certain administrative creditors, namely the case professionals, but did not provide for payment of the government’s administrative claim – described as an approximately $24 million capital gains tax claim resulting from the sale.

The Lender Group and the Committee worked out a deal that would provide $3.5 million to unsecured creditors and the Committee would thus withdraw its objection.  But removal of the Committee’s objection added to the government’s objection since the settlement resulted in unsecured creditors junior in priority to the government’s tax claim being paid ahead of (and instead of) the tax claim.  Despite the government’s objections, the settlement and the sale were approved in separate hearings. The government appealed both decisions and sought a stay pending appeal which was denied.  The district court affirmed denial of the stay and dismissed the government appeal.  The Third Circuit affirmed.

The Lender Group credit bid $320 million which was 90% of its $355 million secured claim. Following the credit bid, the Lender Group had an approximately $35 million remaining secured claim against any property of the estate.  The Debtor and Committee argued that the government’s claim for a $24 million tax liability was moot.  However, the Court disagreed and found that (a) the government’s claim, though remote, was not impossible and therefore not constitutionally moot; (b) Section 363(m) did not bar review so the claim was not statutorily moot; and (c) since the matter was not being addressed in the plan context it was not equitably moot.  Having determined the government’s claims were not moot, the Court turned to whether the funds escrowed for case professionals and placed in trust for the unsecured creditors were paid from property of the Debtor’s estate.

Settlement Payment to Unsecured Creditors

The Court found that “the settlement sums paid by the purchaser [Lender Group] were not proceeds from its liens, did not at any time belong to LifeCare’s estate, and will not become part of its estate even as a pass-through.”[ii] Further, the Court was not persuaded that language in the motion seeking approval of the Committee settlement, which described the settlement as an allocation of the “proceeds of the sale”, was evidence that the settlement proceeds served as consideration for the purchased assets.[iii]

Payment to Case Professionals

The Court found more difficult the analysis of whether the funds set aside for payment to professionals were property of the estate.  The asset purchase agreement described the funds as part of the purchase price for the Debtor’s assets.  Despite that description, the Court found it could not “ignore the economic reality of what actually occurred.”[iv] The Court explained that in the sale the Lender Group took all of the Debtor’s assets, including their cash, “[t]hus, once the sale closed, there technically was no more estate property.”[v] Further, any residual funds in the escrow account set aside for professionals would be returned to the Lender Group. The Court acknowledged the following:

All that said, we recognize that, in the abstract, it may seem strange for a creditor to claim ownership of cash that it parted with in exchange for something. . But in this context it makes sense. Though the sale agreement gives the impression that the secured lender group agreed to pay the enumerated liabilities as partial consideration for LifeCare’s assets, it was really “to facilitate … a smooth … transfer of the assets from the debtors’ estates to [the secured lenders]” by resolving objections to that transfer. …. To assure that no funds reached LifeCare’s estate, the secured lenders agreed to pay cash for services and expenses through escrow arrangements.[vi]

The Court distinguished this arrangement from a standard carve-out from a secured creditor’s cash collateral because in that circumstance, the cash collateral used for the carve-out is property of the estate where, as here, the funds escrowed were property of the Lender Group.

Key Take Aways:

  • This sale involved the Lender Group credit bidding part of its claim for all of the Debtor’s assets, including cash. Thus, the sale effectively removed all property from the estate. An important distinction made by the Court was that the funds to be distributed to the case professionals and unsecured creditors were not “cash collateral” and arguably part of the Debtor’s estate, but were rather funds of the Lender Group.       If the sale did not go through, the funds would not go to the Debtor but back to the Lender group.       Thus – this opinion does not address the distribution scheme in a typical carve-out scenario. However, this case does give a very useful roadmap on how to provide value for professionals and unsecured creditors outside of the plan context – although such value may come at the expense of other creditors similarly situated or even superior to those receiving the value.
  • This Court read substance over form in terms of the language in the sale documents even though the funds in question were specifically described as part of the purchase price. But, attention should be paid to drafting motions and asset purchase agreements in case another court is less inclined to divine the substance from the form.
  • An issue raised but not determined by the Court is whether the priority requirements apply in the 363 sale context “even if textually most (save for § 507) are limited to the plan context.”[vii] The Court found that “ even assuming the rules forbidding equal-ranked creditors from receiving unequal payouts and lower-ranked creditors from being paid before higher ranking creditors apply in the § 363 context, neither was violated here.”[viii] Thus the issue as to whether the priority scheme applies in the 363 context is left open.

[i] In re ICL Holding Co., Inc., No. 14–2709,  2015 WL 5315604 (Sept. 14, 2015 3d Cir.)

[ii] Id. at *7.

[iii] Id.

[iv] Id. at *8.

[v] Id.

[vi] Id. (internal citation omitted).

[vii] Id. at *6.

[viii] Id. at *9.