In National Energy & Gas Transmission, Inc. v. Liberty Electric Power, LLC (In re National Energy & Gas Transmission, Inc.),1 the Fourth Circuit held that, where an unsecured creditor receives payment from a non-debtor guarantor in partial satisfaction of a claim against the debtor, for purposes of the creditor's claim against the debtor, the creditor may not choose to allocate such payment to post-petition interest.

According to a recent decision by the United States District Court for the Southern District of New York,1 a claim sold post-petition is not subject to equitable subordination based solely on the original claimholder's conduct. Likewise, a claim sold post-petition cannot be disallowed based on the original claimholder's receipt of (and failure to repay) an avoidable transfer.

Background

While many amendments to bond indentures can be made without consent from all bondholders, “non-impairment” clauses provide that the indenture may not be amended or restructured in any way that will affect or impair a bondholder’s right to receive principal and interest when due without unanimous consent.

On August 9, 2006, Judge Burton R. Lifland of the United States Bankruptcy Court for the Southern District of New York entered a Final Order Establishing Procedures for Trading in Claims and Equity Securities of Dana Corporation (the “Dana NOL Trading Order”). The Dana NOL Trading Order is materially different from NOL trading orders that have been approved by other bankruptcy courts and, from the perspective of investors in claims and distressed securities, represents a material improvement.

Treatment of NOLs in Business Reorganizations

On the Friday before Labor Day, Judge James Peck of the United States Bankruptcy Court for the Southern District of New York shocked the distressed bond market by dismissing the preference and fraudulent transfer counts of Iridium LLC Creditors Committee’s $3.7 billion adversary proceeding against Motorola, Inc. Judge Peck found that the Committee had failed to prove that Iridium was insolvent at any time—even the day before bankruptcy. Iridium’s $1.6 billion in bonds dropped from the mid-20s to low single digits in days.

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.

Recently, in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., the U.S. Supreme Court resolved a conflict among the circuit courts of appeal by overruling the Ninth Circuit’s Fobian rule, which dictated that attorneys’ fees are not recoverable in bankruptcy for litigating issues “peculiar to federal bankruptcy law.” In reaching its decision, the Supreme Court reasoned that the Fobian rule’s limitations on attorneys’ fees find no support in either section 502 of the Bankruptcy Code or elsewhere.

A recent federal district court appellate decision issued in the Enron chapter 11 case1 has ruled that the postpetition transfer of a prepetition bankruptcy claim from one party to another may insulate the transferred claim against certain types of attack based solely on conduct by a prior holder of the same claim. Whether a particular claim is protected depends upon how the claim was transferred.

The United States Bankruptcy Court for the Southern District of New York granted preliminary injunctions ordering a directors and officers liability insurer to advance defense costs, despite the fact that the insurer had denied coverage, and without adjudicating the coverage defense. Axis Reinsurance Co. v. Bennett et al., Adv. No. 07-01712 (S.D.N.Y. Bankr. Aug. 31, 2007); Grant v. Axis Reinsurance Co., Adv. No. 07-2005 (S.D.N.Y. Bankr. Sep. 11, 2007). The bankruptcy court applied New York law and relied heavily on the case In re WorldCom, Inc.

Thinking about investing in a distressed company? If the company declares bankruptcy, your investment may be subject to equitable subordination, whereby your claim is subordinated to the claims of other creditors. One of the most crucial factors in determining whether your claim is equitably subordinated is whether you are deemed an insider as an insider’s actions undergo significantly more scrutiny than those of non-insiders. Of course, when investing in a distressed company, the more control over the entity’s, the better, right?