Creditors often compromise disputed claims against debtors and their guarantors. In connection with the settlement of claims against a debtor and its guarantor, the creditor may give the debtor and the guarantor written releases from further liability in exchange for a settlement payment. But what if the creditor later surrenders a portion of the payment in settlement of a preference recovery action? Can the creditor revive the guarantee notwithstanding the release?

The United States Bankruptcy Court for the Southern District of New York recently awarded an oversecured lender post-petition interest on the full amount of its secured claim at the default rate set forth in the lender’s contract (19%) plus compound (PIK) interest up to the aggregate rate of 25% (the maximum rate allowable under New York State usury laws). In re Urban Communicators PCS Limited Partnership, et al., 2007 Bankr. LEXIS 4062 (Bankr. S.D.N.Y. 12/11/07) (Gerber, B.J.).

The Bankruptcy Code facilitates asset sales in chapter 11 by offering incentives to buyers and flexibility in structuring and timing the sale. A buyer can acquire assets free and clear of liens and is permitted to "cherry-pick" the debtor's contracts and leases to select only those it wants to keep. The assets and sale process can be structured in many ways, including auctions, private sales, lot or bulk sales, and going concern transactions.

The Key Parties

Lease Payments. It is not uncommon for a retailer with financial problems to be past due on lease payments. Filing for bankruptcy often gives a debtor “breathing room” to evaluate its financial condition, including profitability (or not) of non-residential real-property leases. Depending on the applicable law, this “breathing room” may also free up some cash flow for the debtor.

Late last year, government responses to the subprime mortgage crisis proliferated but most attention focused on those measures that could be, and in some cases were, rapidly implemented — measures like the Treasury Department’s urging holders of certain subprime adjustable rate mortgages (ARMs) to freeze interest rates temporarily or the Federal Reserve’s proposed tightening of lending requirements.

Editor’s note: Success in the restructuring and insolvency arena requires more than an understanding of the law—it requires the ability to address issues specific to a debtor’s industry and business. Below, two Reed Smith partners with extensive experience representing health care institutions and creditors discuss issues unique to hospitals facing financial distress.

In UPS Capital Business Credit v. Gencarelli (In re Gencarelli),1 the First Circuit Court of Appeals addressed the issue of whether a secured creditor is entitled to collect a prepayment penalty from a solvent debtor. The Court found that the secured creditor could collect the penalty, whether or not it is reasonable, so long as the penalty is enforceable under state law. The Court reasoned that any other holding would leave open the possibility that an unsecured creditor could recover more from a solvent estate than a secured creditor.

Background

The next time you negotiate a settlement payment with a financially troubled party, you may want to keep in mind an ancient term related to livestock herding: earmarking. The concept may be somewhat antiquated, but the Second Circuit has recently confirmed that it is still viable – and can help you keep the settlement payment if the other party later files for bankruptcy.

The United States Bankruptcy Court for the Southern District of New York has held that a severance payment made to an executive who worked for both Enron Corp. (“Enron”) and various affiliates of Enron prior to Enron’s filing for bankruptcy was a preferential transfer that could be avoided by the Official Committee of Unsecured Creditors (the “Committee”).1 In reaching this conclusion, the Bankruptcy Court rejected the argument that the severance payment was an “ordinary course” transaction that was protected from avoidance.

In an important recent decision of the United States Court of Appeals for the Second Circuit, testing the outer reaches of a bankruptcy court’s jurisdiction, In re Johns Manville Corp., 06-2099 (2d Cir. Feb. 15, 2008), the court considered whether claims that are not derivative of a debtor’s liability, but rather seek to recover directly from an insurer for its own alleged misconduct, can be enjoined by the “channeling” mechanism developed by the bankruptcy court.