A recent opinion from the United States Bankruptcy Court in Baton Rouge, Louisiana shows that even experienced lenders and developers may not always understand how Louisiana’s Private Works Act applies to their project, and how much leverage a properly filed notice of contract can provide to a general contractor.  Tuscany Reserve, LLC (“LLC”) was formed by sophisticated developers for the purpose of developing a new apartment complex in Baton Rouge. LLC obtained acquisition and construction financing from a bank (1st Bank), which properly recorded its mortgage on the project before work commenced. LLC hired “Contractor” to build the complex; Contractor recorded its notice of contract in the parish mortgage records.  As often happens, a dispute developed between LLC and Contractor regarding the work performed and lack of payment.  Contractor stopped work and filed a lien on the property under the Louisiana Private Works Act for $1.17 million.  Contractor eventually agreed to cancel its lien in exchange for a promissory note and guarantees from LLC’s principals and collateral provided by an LLC affiliate.  Once the lien was cancelled, 1st Bank funded two draw requests on the construction loan.  LLC needed more money for the project and turned to a new lender (2nd Bank) for additional financing.   2nd Bank secured its loan with a collateral mortgage on the immovable property for the project; there were no liens in the property records when 2nd Bank recorded its mortgage.  The relationship between LLC and Contractor soon soured, again, and Contractor filed two liens on the project, one for the original claim amount, plus interest, and another for $250,000.00.  Contractor sued LLC and its principals on the matured promissory note, and also sued LLC based on its rights under the recorded construction contract and the Louisiana Private Works Act. LLC eventually filed for chapter 11 bankruptcy in the Middle District of Louisiana.

2nd Bank made several arguments for why Contractor’s liens should not relate back to the date the notice of contract was filed. 2nd Bank argued that Contractor’s agreement to take a promissory note in lieu of payment after the first lien was filed, and Contractor’s subsequent cancellation of its lien, was a novation of Contractor’s claims and transformed those claims “from a construction contract claim secured by Private Works Act liens into an unsecured claim” based on the promissory note.  The Bankruptcy Court disagreed.  The Court found that the parties’ agreement did not expressly state that a novation was intended, so no novation occurred. The original debt and related rights remained in place.

The Court also rejected 2nd Bank’s argument that Contractor abandoned its privilege by cancelling its initial lien and accepting LLC’s promissory note and other consideration in payment of that debt. The Court noted that there is no authority for 2nd Bank’s proposition that a contractor is barred from filing a second lien for the same work referenced in an earlier lien that the Contractor cancelled.  So long as a notice of contract is on file, the contractor has the right to file a lien on the project, and that lien will outrank any mortgage put on the project after the notice of contract was filed.  See Shreve Land Constructors, LLC v. Tuscany Reserve, LLC, et al. (In re Tuscany Reserve, LLC), Adv. No. 10-1042 (Bankr. M.D. La., March 3, 2011).

How can a lender considering a new loan on an existing project avoid the same fate that befell 2nd Bank?  First and foremost, thoroughly review the mortgage records before advancing funds.  The absence of liens on the project does not necessarily mean that all is clear. If there is a notice of contract for the project in the mortgage records, the new lender should require the contractor to terminate that contract or subordinate its rights to the new lender as a condition of advancing funds.
 

Does a tenant’s failure to expressly assume a commercial lease within 120 days of filing bankruptcy give its landlord the right to immediate possession of the leased premises? Yes, according to several recent court decisions. The bankrupt tenant’s landlord is entitled to immediate possession of the leased premises, without going through the time and expense of moving to lift the automatic stay and pursuing an eviction in state court, or commencing an adversary proceeding in the bankruptcy court.

For more information about the bankruptcy process from a landlord’s perspective, see additional information here. 

The judge overseeing Chrysler LLC’s bankruptcy entered an order on June 1, 2009 approving Chrysler’s motion seeking permission to sell substantially all of its assets to a new company.  The procedure by which this sale was accomplished, and by which a similar sale in the GM bankruptcy will likely be accomplished, is known in the bankruptcy and finance worlds as a “363 Sale,” after the relevant provision of the U.S. Bankruptcy Code.

(For those well-versed in 363 Sales, see Stephen Sather’s thoughtful post about practical and ethical concerns with the Chrysler sale here. )

Companies outside of bankruptcy that have strong cash reserves or access to capital should look for opportunities to acquire new product lines, expand their footprint, or strengthen their intellectual property portfolio when reading headlines about troubled firms.  363 Sales are not just for multi-billion dollar bankruptcies; businesses of any size in any type of industry can sell all or part of themselves through a 363 Sale.  There are no restrictions on the type of assets that can be sold through a 363 Sale.  Inventory, equipment, patents, trademarks, customer lists, trade secrets, accounts receivable, and other rights to payment are all possibilities for a 363 Sale.  There are limitations, however, on the sale of a Debtor’s assets in which a third party has an interest.  If a third party has an interest in a particular asset, whether a security interest, lien, etc., then that particular asset may only be sold in a 363 Sale if the third party’s claim is satisfied from the proceeds, or if other criteria are met.  

Generally, the purchaser at a 363 Sale acquires only the Debtor’s rights in the asset.  For example, if the Debtor was a co-owner of an asset, then the purchaser would only obtain the Debtor’s co-ownership interest.  In some instances, however, a 363 Sale can deliver outright ownership of an asset to the purchaser even when the Debtor has only a partial ownership interest in the particular asset.  This is often an appealing solution to resolve a dispute where a joint venture sours and the partners cannot agree on price or terms to move on.  The purchaser can acquire the entire asset—including an entire operating business or just a part of one—outright instead of merely owning the Debtor’s partial ownership interest in the asset.
 

The number of businesses seeking bankruptcy protection hit its highest level in more than two years in March, as the recession sends more companies into financial crisis, according to a story today in the Dow Jones Daily Bankruptcy Review. The 7,843 commercial bankruptcy filings in March 2009 represent a 23.2% jump from the 6,365 filings the previous month. It's also the highest monthly total of business filings since at least 2006, according to Automated Access to Court Electronic Records, or AACER.

Other data from AACER, a private firm that tracks bankruptcy filings, shows a 52.4% increase in business bankruptcy filings during Q1 of 2009 over the number of filings in Q1 of 2008. One expert predicts a record number of public companies to file bankruptcy this year.

Read the entire story here.

In the current economy, corporate officers and directors face an increased risk of derivative suits and other litigation against them from frustrated shareholders and other stakeholders in a corporation. Should officers and directors also be concerned about claims brought against them by their company’s creditors? The answer may depend on what state’s law applies to the creditors’ claims.

Delaware dramatically curtailed zone-of-insolvency liability litigation in 2007. In North American Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007), the Delaware Supreme Court announced that the officers and directors of Delaware corporations do not owe fiduciary duties to the corporation’s creditors, regardless of how close the firm is to insolvency. Directors and officers owe fiduciary duties to the corporation and its shareholders only. The Court held that the only actions individual creditors may assert against officers or directors are derivative claims on behalf of the corporation and, “any other direct nonfiduciary claim.” Id. at 103.

The “zone of insolvency” theory of fiduciary duties to creditors may still be viable in Louisiana and other states, however, despite being rejected by Delaware. In 2008, after the Gheewalla decision, the Eastern District of Louisiana decided that the manager of a Louisiana limited liability company owed fiduciary duties to one of the company’s creditors because the company was within the zone of insolvency. 3 Point Holdings, L.L.C. v. Gulf South Solutions, L.L.C., Civ. No. 06-10902 (E.D. La. Mar. 13, 2008). The court cited Carrieri v. Jobs.com, Inc. for a legal proposition that was important to its holding: “Officers and directors who are aware that the entity is within the ‘zone of insolvency’ have expanded fiduciary duties which include the creditors, not just equity holders.” The 3 Point Holdings court made no reference to Gheewalla.

Another 2008 case from the Eastern District of Louisiana reached a different result on a similar question when it applied Delaware law. In Torch Liquidating Trust v. Stockstill, the court relied on the Gheewalla decision to hold that creditors of an insolvent corporation have no right to assert direct claims for breach of fiduciary duty against corporate directors. Civ. No. 07-133 (E.D. La. Mar. 13, 2008). The Torch Liquidating Trust decision noted that the parties agreed that Delaware substantive law applied to the creditors’ claims because the corporation was organized in Delaware. The 3 Point Holdings decision, in contrast, presumably applied Louisiana substantive law because the limited liability company at issue was organized in Louisiana.

While the law appears settled in Delaware, it appears uncertain in Louisiana and possibly elsewhere within the Fifth Circuit. Officers and directors of corporations operating in or near “the zone of insolvency” would be wise to contact their outside counsel or their D&O insurer to discuss steps they can take to avoid being the test case for whether this theory is still a viable cause of action outside of Delaware.
 

In today’s distressed retail market, the possibility of a tenant’s bankruptcy is a top concern for managers and owners of retail centers. Owners of commercial office buildings in many parts of the country are becoming increasingly concerned about tenant bankruptcies, too. Landlords need to know the options available when a tenant files for bankruptcy and should anticipate a tenant/debtor’s likely maneuvers in bankruptcy. This article provides a summary of relevant law and key strategic considerations to help landlords minimize losses and protect their interests when a tenant files bankruptcy.

Leases & “Executory Contracts”

Section 365 of the Bankruptcy Code allows a debtor (i.e., an entity that has filed for bankruptcy) to either assume or reject an executory contract or unexpired lease. This way, a debtor may decide to assume any valuable contracts and reject any burdensome ones. If a bankruptcy tenant decides to assume an unexpired lease, the lease will remain in effect through and after completion of a Chapter 11 reorganization. Assuming the lease does not mean the tenant gets to stay in the space free of charge. The tenant must cure any outstanding defaults and perform all pending obligations in the lease.
 

When a tenant files bankruptcy, its unexpired lease, as well as the tenant’s other executory contracts, remain in existence and enforceable by, but not against, the tenant-debtor. This remains so until the tenant decides to assume or reject the lease. If the tenant remains in possession of the lease space pending a decision to assume or reject the contract, the tenant must pay for that privilege. Bankruptcy courts may adjust the lease’s rent price to a new “reasonable value” payment in certain circumstances.

Time Period for Assumption/Rejection

The 2005 amendments to the Bankruptcy Code shortened the time limit for a commercial tenant to decide whether to assume or reject a lease. This change is welcome news for landlords who were frustrated with the prior law, which many people thought gave bankrupt tenants an almost endless right to remain in place without paying rent. Under current law, a tenant in bankruptcy is deemed to have rejected its lease unless it formally assumes the lease within 120 days of the date bankruptcy is filed. The court may order only one 90-day extension; any subsequent extension requires the landlord’s consent.

Procedure for Assumption or Rejection

If your bankrupt tenant indicates that it wants to assume the lease, get it in writing. Moreover, get court approval. Best practices require the landlord and tenant to agree in writing on all back-rent, late charges, and other fees to be brought current; any changes to the lease’s terms; and any side agreements. This written agreement should be submitted to the bankruptcy court for approval, either as part of the tenant’s reorganization plan or by a separate motion.

The Easier Path: Terminate the Lease Before Bankruptcy

One way to avoid the uncertainty of whether your tenant is going to assume or reject its lease is to terminate the lease before the tenant files for bankruptcy. Most retail tenants will send signals of their financial distress before filing for bankruptcy: late rent payments, requests to make payment in installments rather than on the date it is due, inquiries from the tenant’s lender or trade creditors asking if you have had any problems with the tenant, to name a few. If you receive a percentage of sales in rent, a quick historical analysis might show how the tenant’s current sales compare to historical periods; a significant decline in revenue should prompt you to review the lease. News reports about your tenant or your tenant’s industry may also be an indication of trouble on the horizon.

If the rent is late or you perceive that your tenant is in distress, review the lease’s terms regarding tenant defaults. Is the tenant in default? If so, provide notice of the default and wait any required cure period. If the default is not cured, or if no cure period is required, consider terminating the lease.

Landlords are sometime hesitant to terminate a lease because they would rather have a slow-paying tenant than dark space. Keep in mind that terminating the lease is different than evicting the tenant. Most leases allow for a tenant to remain in possession of the leased space after the lease is terminated on a month-to-month basis. If the tenant files Chapter 11, it is much easier to evict a month-to-month tenant than it is to evict a tenant whose lease is in effect and enjoys all the lease-related protections afforded by the Bankruptcy Code. Even if you prefer not to evict the tenant, the fact that you have the legal right to do so will help you in negotiations for new lease terms.

Chapter 11 bankruptcies are on the rise, and many expect that trend to continue. In the third quarter of 2008 there were 70% more Chapter 11 filings than in the third quarter of 2007, according to Automated Access to Court Electronic Records, a company that tracks bankruptcy statistics.

Experts are predicting a record number of corporate bankruptcies – from large public companies to small local-only businesses – in 2009, and possibly beyond. With corporate bankruptcies becoming more common, businesses leaders across all industries are wondering: What exactly is a Chapter 11 bankruptcy, and how does it affect my business when a customer/vendor/competitor files for bankruptcy? This post and future posts on the Louisiana Law Blog are intended to help you understand the Chapter 11 process and answer some of your business bankruptcy questions.

In brief, Chapter 11 is a tool that companies facing financial distress may use to hold their creditors at bay – at least temporarily – and to reduce and restructure their outstanding debt. (The name, “Chapter 11,” comes from the chapter within the federal bankruptcy laws that applies to corporations and other businesses that go into bankruptcy and seek to continue operating through the process.) A Chapter 11 case starts with the company, generally referred to as “the Debtor,” filing a petition for relief or “Petition,” in a federal bankruptcy court. The Petition is analogous to a lawsuit entitled, “Debtor v. All of Its Creditors.” It initiates a legal proceeding that brings all of the Debtor’s creditors into one forum where all the creditors’ claims against the Debtor can be addressed. One important difference between a bankruptcy petition and a regular lawsuit is that the Debtor receives immediate relief from its creditors after filing the Petition. (In a regular civil case, a plaintiff has to prove its case before getting any relief from the judicial system.) This immediate relief is commonly known as “the Automatic Stay,” or simply “the Stay,” among bankruptcy practitioners.

Management of the Debtor:

In a Chapter 11 case, the Debtor’s current management remains in place after the Debtor files its Petition. Contrary to popular belief, the Court does not appoint a trustee to take over the Debtor’s business when a Chapter 11 is filed. Management continues to run the day-to-day operations of the Debtor and to plan the Debtor’s long-term business strategy. Management of a closely held company is probably not accustomed to the kind of outside scrutiny and public disclosures required by the Chapter 11 process. For example, a Debtor must file operating reports in the public record that show its monthly revenues and expenditures – including salary information for key employees. The Debtor also has to disclose information about its business plan. Importantly, the Debtor’s management will periodically be asked to justify why the Debtor should continue as a going concern instead of having its assets sold to the highest bidder and using the sale proceeds to pay its creditors.

If you would like to learn more about the Chapter 11 process or legal terms and issues that are common to Chapter 11 bankruptcies, please continue to visit www.louisianalawblog.com. The Kean Miller Louisiana Law Blog will contain several general-use, educational articles that may be helpful, but that do not constitute legal advice. Please consult an experienced bankruptcy attorney for advice about how best to address particular situations your business is currently facing, or may soon face.