In previous editions of the Business Restructuring Review, we reported on a pair of highly controversial rulings handed down in late 2005 and early 2006 by the New York bankruptcy court overseeing the chapter 11 cases of embattled energy broker Enron Corporation and its affiliates. In the first, Bankruptcy Judge Arthur J. Gonzalez held that a claim is subject to equitable subordination under section 510(c) of the Bankruptcy Code even if it is assigned to a third-party transferee who was not involved in any misconduct committed by the original holder of the debt.

Organizations that acquire claims in bankruptcy should acquire such claims by a sale without knowledge of the debtors’ claims against the original holder or prior transferees, and obtain an indemnification from the transferor of such claims.

In 1991, a decision of the Delaware Chancery Court helped popularize the term "zone of insolvency.”[1] In the intervening 16 years, numerous courts and commentators have cited this decision as standing for the proposition that the directors of a Delaware corporation that is either insolvent or in the zone of insolvency owe fiduciary duties to the creditors, as well as to the shareholders, of the corporation.

The Court of Appeals for the First Circuit recently held that an oversecured lender holds at least an unsecured claim for contractual prepayment penalties against a solvent debtor. UPS Capital Business Credit v. Gencarelli (In re Gencarelli), 2007 BL 91656 (1st Cir., Aug. 30, 2007). As the court explained, "[t]his is a difficult question that has significant ramifications for the commercial lending industry." Id. at 16.

A company attempting to reorganize its affairs in bankruptcy may seek to enjoin its creditors or other third parties from suing members of the company's senior management team during the course of the reorganization proceedings, so that the senior management members can devote their time and resources to the reorganization effort without distraction. Courts throughout the country have applied differing standards in determining when the granting of an injunction of proceedings against a non-debtor is appropriate.

The Delaware Supreme Court’s recent decision in North American Catholic Educational Programming Foundation, Inc. v. Gheewalla1 addresses the fiduciary duties of corporate directors in Delaware. In affirming a lower court decision by the Delaware Court of Chancery,2 the Delaware Supreme Court held that creditors of a Delaware corporation that is insolvent or in the “zone of insolvency” have no right to bring direct claims for breach of fiduciary duty against directors.

A fundamental premise of chapter 11 is that a debtor’s prebankruptcy management is presumed to provide the most capable and dedicated leadership for the company and should be allowed to continue operating the company’s business and managing its assets in bankruptcy while devising a viable business plan or other workable exit strategy. The chapter 11 “debtor-in-possession” (“DIP ”) is a concept rooted strongly in modern U.S. bankruptcy jurisprudence. Still, the presumption can be overcome.

The power to alter the relative priority of claims due to the misconduct of one creditor that causes injury to others is an important tool in the array of remedies available to a bankruptcy court in exercising its broad equitable powers. However, unlike provisions in the Bankruptcy Code that expressly authorize a bankruptcy trustee or chapter 11 debtor-in-possession (“DIP ”) to seek the imposition of equitable remedies, such as lien or transfer avoidance, the statutory authority for equitable subordination—section 510(c)—does not specify exactly who may seek subordination of a claim.

In an issue the court notes is one of first impression, a Bankruptcy Appellate Panel for the U.S. Court of Appeals for the Ninth Circuit has held that a bankruptcy court could grant an administrative priority to a claim which also may be secured. Brown & Cole Stores, LLC v. Associated Grocers, Inc., 375 B.R. 873 (9th Cir. BAP, Aug. 17, 2007).

Determining a question of first impression within its circuit, the U.S. Court of Appeals for the First Circuit recently held that an oversecured creditor is entitled to collect a bargained-for pre-payment penalty from a solvent debtor, regardless of the penalty’s “reasonableness” under section 506(b) of the Bankruptcy Code.

In so holding, the First Circuit reversed the decisions of the U.S. Bankruptcy and District Courts for the District of Rhode Island. Gencarelli v. UPS Capital Business Credit, 50 F.3d 1 (1st Cir., Aug. 30, 2007).