KEEP WHAT YOU EARNED FROM THE CLAWS OF THE BANKRUPTCY TRUSTEE 2017 Credit Professionals’ Conference and Expo THE BUSINESS CREDIT MANAGEMENT ASSOCIATION KEEP WHAT YOU EARNED FROM THE CLAWS OF THE BANKRUPTCY TRUSTEE

312-628-7193 | ccahill@lowis-gellen.com   Christopher M. Cahill Head of Bankruptcy and Restructuring Group 312-628-7193 | ccahill@lowis-gellen.com Chris advises businesses on relationships with vendors, customers, and lenders to maximize market share, return, and liquidity. He also represents secured creditors, trade creditors, and others with respect to litigation in chapter 11 cases and corporate restructuring more generally, including workouts, loan forbearance, assignments for the benefit of creditors, UCC Article 9 foreclosure sales, and avoidance litigation. Chris also publishes frequently and speaks regularly on commercial insolvency and commercial transaction issues. He is an Executive Editor of Commercial Bankruptcy Litigation, 2d Edition (Jonathan P. Friedland, Elizabeth Vandesteeg & Christopher M. Cahill eds., 2017), a comprehensive treatise that is updated annually and published by Thomson Reuters. Lowis & Gellen LLP 200 W. Adams St. Suite 1900 Chicago, Illinois 60606 312 364 2500 www.lowis-gellen.com Naperville, Illinois Joliet, Illinois Tempe, Arizona Orlando, Florida New York, New York London United Kingdom  

KEEP WHAT YOU EARNED FROM THE CLAWS OF THE BANKRUPTCY TRUSTEE Preference liability is not based on bad acts, but is a device to spread the pain more evenly among all creditors A key defense is based on keeping your terms and the customer’s payment behavior within your industry’s norms; another is based on keeping these things stable even as the customer’s troubles deepen Much better to make customer pay on delivery or in advance than to pressure customer to pay more quickly Retention of title terms are usually false gods, but can be useful; meanwhile selling commodities may get you off the hook Within a bankruptcy case, critical vendor payments or contract assumption can keep away the preference blues

AVOIDANCE AND RECOVERY SEQUENCE You get paid (or receive non-cash property, including a security interest) DIP/trustee/assignee sues you to invalidate (“avoid”) and claw back (“recover”) what you were paid If you do not pay or resolve the lawsuit (“adversary proceeding”), you cannot be distributed any property on your claim [section 502(d)] If the DIP/trustee/assignee prevails, you are not left empty-handed! You get a general unsecured claim for the amount clawed from you [section 502(h)]

BANKRUPTCY FUNDAMENTALS Payment Priorities: Secured Claims, then Administrative Claims, then General Unsecured Claims (champagne glass pyramid) In a chapter 11 plan, GUS may be paid less than 100%; in a distribution upon liquidation, GUS at bottom of water hole

WHO DOES THIS TO YOU, AND WHY? Debtor in possession (“DIP”) has the avoidance powers of a “trustee” of the debtor’s bankruptcy estate Chapter 11 trustees and chapter 7 trustees also have these powers Each has fiduciary duty to maximize the property of the bankruptcy estate for the benefit of creditors – in avoidance actions, general unsecured creditors as a whole (usually) Those powers can be acquired by a creditors’ committee, and can be assigned in a chapter 11 plan to a liquidation trustee

TYPES OF AVOIDANCE ACTIONS Section 549 avoidance: unauthorized post- petition transfer Section 548 avoidance: “fraudulent” transfers - [actually or constructively fraudulent] Section 544 avoidance: “fraudulent” transfers (under state law) – [Actually or constructively fraudulent] Section 547 avoidance: preferential transfers

Section 549 Avoidance – Unauthorized Post-Petition Transfers [NO BAD ACT NEED BE PROVED] (a) Except as provided in subsection (b) or (c) of this section, the trustee may avoid a transfer of property of the estate— (1) that occurs after the commencement of the case; and (2) (A) that is authorized only under section 303(f) or 542(c) of this title; or (B) that is not authorized under this title or by the court. DEFENSE? Authorization; ordinary course transaction for debtor’s estate

Section 548/544 Avoidance: Fraudulent Transfers [EXCEPT FOR ACTUALLY FRAUDULENT TRANSFERS, NO BAD ACT NEED BE PROVED] 11 U.S.C. § 548 (a) (1) The trustee may avoid any transfer (including any transfer to or for the benefit of an insider under an employment contract) of an interest of the debtor in property, or any obligation (including any obligation to or for the benefit of an insider under an employment contract) incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of the petition, if the debtor voluntarily or involuntarily— (A) made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted; or (B) (i) received less than a reasonably equivalent value in exchange for such transfer or obligation; and

Section 548/544 Avoidance: Fraudulent Transfers 11 U.S.C. § 548, continued: (ii) (I) was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation; (II) was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was an unreasonably small capital; (III) intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor’s ability to pay as such debts matured; or (IV) made such transfer to or for the benefit of an insider, or incurred such obligation to or for the benefit of an insider, under an employment contract and not in the ordinary course of business. Defense? You gave “reasonably equivalent value”; debtor was not insolvent

Section 547 Avoidance: Preferential Transfers [NO BAD ACT NEED BE PROVED] (b) Except as provided in subsections (c) and (i) of this section, the trustee may avoid any transfer of an interest of the debtor in property— (1) to or for the benefit of a creditor; (2) for or on account of an antecedent debt owed by the debtor before such transfer was made; (3) made while the debtor was insolvent; (4) made— (A) on or within 90 days before the date of the filing of the petition; or (B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and (5) that enables such creditor to receive more than such creditor would receive if— (A) the case were a case under chapter 7 of this title; (B) the transfer had not been made; and (C) such creditor received payment of such debt to the extent provided by the provisions of this title.

Defenses to Section 547 Preference Avoidance Actions Negating an element, e.g., “antecedent debt” or “insolvency” Contemporaneous Exchange for New Value Ordinary Course of Business (plus ca change, plus la meme chose, entre nous) Ordinary Business Terms (reasonably within industry norms) New Value (you shipped or performed at some point after having received a preferential transfer)

Take-Away for Pre-Bankruptcy Pressure on Fading Customer NO HALF MEASURES CIA or COD are fine; shortening terms from 90 to 10 days not fine

CLAWBACK POWER Section 550: The trustee may recover the value of the property transferred from . . . (a)(1) the immediate or initial transferee, and (a)(2) the “intermediate or mediate transferee” of the initial transferee NOTE: (a)(2) transferees have the defense of having given value, having taken in good faith, and having taken without knowledge of the voidability of the transfer

Special Topic 1: Critical Vendor status If your product or service is critical to the debtor’s operations in bankruptcy – e.g., you are a sole source provider – the debtor may offer you “critical vendor” status, including: Payment to you of some or all of your pre-petition claim Your agreement to supply or otherwise perform in the case, on certain conditions Your agreement to DIP’s right to clawback the payment on your claim, if you breach conditions You can negotiate DIP’s acknowledgement that you face no avoidance liability for pre-petition transfers, provided no clawback is effected

Special Topic 2: Assumption of Executory Contract Under section 365 of the Bankruptcy Code, a trustee may assume (or reject) an “executory contract” An executory contract has continuing material obligations on both parties Assumption of an executory contract requires the trustee to “cure” all defaults, which includes paying you an amount equal to your pre-petition claim Negotiate a trustee acknowledgment that you face no avoidance liability

Special Topic 3: Retention of Title A valid retention of title arrangement would result in payment to you shortly after debtor’s sale of the goods to a third party or debtor’s incorporation of your goods into other ordered goods (supports and ordinary course f business defense) Problem: retention of title arrangements are disfavored

Special Topic 4: COMMODITIES!! Congress passed amendments to the bankruptcy Code to exempt transactions involving securities from avoidance These amendments were broadly worded and defined Many transfers in connection with “forward contracts” and “swap agreements” are exempt Those terms have been construed to include physically- settled commodities supply agreements See Hutson v. E.I. DuPont de Nemours & Co. (In re National Gas Distribs. LLC), 556 F.3d 247 (4th Cir. 2009); Williams v. Morgan Stanley Capital Group Inc. (In re Olympic Natural Gas Co.), 294 F.3d 737 (5th Cir. 2002); and Lightfoot v. MXEnergy Electric (In re MBS Management Services), 690 F.3d 352 (5th Cir. 2012)