Articles Posted in Law Firm Bankruptcies

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As we learned during the downturn in 2008, the economic climate can change rapidly. When things are going well, many businesses forget the lessons of the past. No matter what industry your business is in, there may be occasions when you are asked to enter into a relatively long-term contract, i.e. longer than three years. Such agreements are sometimes favorable because of the stability and predictability they can provide. However, before entering into such an agreement, you should consider that the longer the contract, the greater the risk of a change in the contract counterparty’s financial situation. A safe credit risk in 2017 might find itself filing for bankruptcy by 2020.

If your response is: “I am not concerned about the other party filing bankruptcy. I had my attorney include a bankruptcy termination clause in our agreement,” then you may want to think again. The U.S. Bankruptcy Code has a lot to say about the rights of both the debtor and the non-debtor party once a bankruptcy is filed – often to the chagrin of the non-debtor party.

It is true that many business agreements contain clauses which provide that a party filing bankruptcy is deemed to have breached the agreement, and the other party may terminate the agreement (a “Right to Terminate” clause). Or the provision might say that if one party files bankruptcy, that party’s rights terminate automatically (an “Automatic Termination” clause).

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We asked some of our financial advisor colleagues to give us brief read outs on what they felt 2017 has in store for us now that we have gotten beyond the inauguration and into the first weeks of the Trump administration.  Their thoughts follow:

https://www.southerncaliforniabankruptcylawyersblog.com/files/2017/02/2012-03-31-10.05.15-214x300.jpgWe have been seeing a lot of highly leveraged deals that impact the performance of the business. These deals are leading to reduced spending on capital expenditure, marketing and even experienced management.  Once new ownership is in place, these strictures prevent the company from operating with the same efficiency as in the past, let alone growing.  Another scenario we have been encountering is companies getting beyond the management ability of the founder as the company increases revenues from $25M to $50M and then to $100M or more. In either case, increasing interest rates will cause dislocation, because it does not take much to push these companies into a zone where they are showing significant financial stress.

That being said, we are also seeing that lenders are still being lenient because it’s really hard to get a full recovery in a liquidation, and appraisal firms always seem to be the first to hedge on their ability liquidate inventory en masse.  Also, my sense is that lenders don’t really want to sell their loans to exit a credit as it hurts their reputation.  Still, we are finding that lenders keep getting surprised with over-advances for many reasons.  When we are called in to assist in such situations, we focus our efforts on trying to fix the operating issues of the businesses and make a reasoned re-allocation of limited resources.

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Any property owner which has experienced the bankruptcy of a tenant is doubtless keenly aware of the limitation on damages which the Bankruptcy Code imposes on the landlord. A new decision by the Ninth Circuit bolsters the position of landlords in this long-running tussle.

Section 502(b)(6) Cap Refresher

Before getting to the Ninth Circuit’s recent opinion, here is a quick review for those who have not confronted the issue recently: Bankruptcy Code section 502(b)(6) generally “caps” a landlord’s claim for “damages” against a bankrupt tenant when a lease is terminated before or during the bankruptcy case to (a) the greater of the next year of rent due, or 15% of all the remaining rent due up to 3 years of the remaining term, and (b) any unpaid rent owing as of the date of the bankruptcy, or the date the tenant lost possession of the premises if prior to bankruptcy.  Fairly or not, the policy justification for the cap is that large claims of landlords, which are by their nature long-term and hard to calculate, should not overwhelm the claims of other trade creditors.

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In my blog article on August 9, I focused on some of the issues that licensors need to be aware of as they license IP rights, including the concept of allowing distributors to include “damages only” clauses in the distribution agreements.

The second issue that often arises in distribution agreements related to DVD distribution rights is that the producer/licensor grants to the distributor/licensee the right to distribute a movie in various media, including, but not limited to DVD. The distributor will often pay for the cost of manufacturing the DVDs and then have the first right to recover the cost of manufacturing out of the first sales of those DVDs.  Sometimes the producer/licensor will pay for the cost of manufacturing the DVDs.  In either instance, however what happens when a distributor files a bankruptcy and holds on to the DVDs, the cost for which may have already been recouped through prior sales or which have actually been paid for by the producer.

The “automatic stay” which comes into being on the filing of a bankruptcy by the distributor, precludes the producer from immediately recovering those DVDs, and a significant question arises whether or not those DVDs become “property of the distributor’s bankruptcy estate”.

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The Issue

There has been written a plethora of articles about Bankruptcy Code §365(n) regarding the rights of parties to license agreements when the licensor files a bankruptcy and rejects a license agreement. Generally, Code Section 365(n) allows the licensee to “accept” a rejection of a license agreement by the licensor or “reject” the rejection of a license agreement and retain its rights.

However, what has not been addressed, and what seems to be of frequent concern in recent years, are the issues that affect producer/licensors when their distributor/licensees file bankruptcy. We have seen these issues arise in a significant way in the recent bankruptcy filings by Relativity which filed in the Southern District of New York, and the more recent bankruptcy filing by Our Alchemy in the District of Delaware.

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Bankruptcy Judge Dennis Montali in San Francisco said last week that he will allow a direct appeal to the Ninth Circuit from one of his rulings in the bankruptcy of Howrey LLP, skipping an intermediate appeal to the U.S. District Court.  The judge relied on Jewel v. Boxer — a California state law case which holds that profit earned on unfinished business after dissolution belongs to the “old” firm, not to a newly-formed firm that completed the work.

The case is of intense interest to attorneys who move to other firms when their existing firms go out of business.  Judge Montali had allowed the Howrey trustee to sue several law firms including Jones Day and Seyfarth Shaw LLP for profits they made on work that began at the now-defunct firm.

The New York Court of Appeals recently ruled to the contrary in response to a question by the New York-based Second Circuit Court of Appeals in litigation involving the failed law firms Thelen and Coudert Brothers.  The New York Court of Appeals stated:  “We hold that pending hourly fee matters are not partnership ‘property’ or ‘unfinished business’ within the meaning of New York’s Partnership Law.  A law firm does not own a client or an engagement, and is only entitled to be paid for services actually rendered.”