The Aristophil Scandal: All that glitters…

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Rastignac? Grandet? Swindler? Arsène Lupin? Ponzi scheme concerning letters and manuscripts? The adventures of Gérard X, formidable businessman, founder and manager of the Aristophil company, were abruptly interrupted in November 2014, with the search of the company premises and its property by the judicial police.

The company was put into receivership on February 16 2015, and on 4 March of the same year Gérard X was indicted for deceptive marketing practices, organised fraud, laundering, breach of trust, and misuse of corporate assets. At that point, the Aristophil saga became a problem, if not a scandal.

The vast majority of 18,000 people who invested (usually through joint ownership) in the letters and manuscripts sold by the company risked losing a large part of the investment, in what might constitute a scam amounting to a loss of 1 billion Euros.

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Retail insolvency: consumer protection, pre-payments and changes to the Sale of Goods Act

Example Buy Now ButtonWe are yet to see the true impact of Christmas trading in the retail industry although HMV is already a victim of the tough conditions for retailers. Additionally, Boots has announced a fall in sales and the launch of a “transformational costs management program” to save more than $1 billion and Next has confirmed that profits in store have fallen and although online sales are up, the uncertainty about the UK economy after Brexit makes forecasting difficult. Only one thing is clear – consumers remain at risk in the event of a retail business entering administration.

There has been much talk of late about the failing UK high street, the change in consumer habits and how retailers are having to adapt and change their traditional business models to meet the evolving needs of consumers. However, what protections do consumers actually have if they have ordered and paid for goods online or paid a deposit but the business then fails? Continue Reading

State Marijuana Laws vs. Bankruptcy: The Tension Grows

In prior posts, we examined whether state-licensed marijuana businesses, and those doing business with marijuana businesses, can seek relief under the Bankruptcy Code.  As we noted, the Office of the United States Trustee (the “UST”) has taken the position that a marijuana business cannot seek bankruptcy relief because the business itself violates the Controlled Substances Act 21, U.S.C. §§ 801, et seq. (the “CSA”), notwithstanding their state licenses. The UST has also taken the position that those leasing commercial space to a state-licensed marijuana business are themselves precluded from accessing bankruptcy courts because the CSA makes no distinction between a seller or grower of marijuana and those renting space to the seller or grower.  Now, in an opinion issued on December 14, 2018, a bankruptcy court held that businesses selling horticultural supplies to both marijuana businesses and other customers is not eligible for bankruptcy protection.

In the case before the bankruptcy court in the District of Colorado, Way to Grow, Inc. and two affiliated companies were selling indoor hydroponic and gardening-related supplies. The debtors’ expansion plans were tied to the cannabis industry, although the debtors also had customers using the hydroponic products to grow other crops. A secured creditor moved to dismiss the cases, arguing that the debtors should be barred from bankruptcy relief because their business violated the CSA.  In considering the secured creditor’s argument, the bankruptcy court began by noting that bankruptcy courts “have consistently dismissed cases where debtors engaged in ongoing CSA violations, or where a debtor’s reorganization efforts depend on funds which can be considered proceeds of CSA violations.”  Thus, the question before the court was whether the debtors were engaged in ongoing violations of the CSA.

The court found no evidence that the debtors were directly violating the CSA.  The court also found that the debtors were not indirectly violating the CSA by either aiding and abetting a violation of the CSA, or by conspiring to violate the CSA.  The court held that the debtors’ business activities, i.e., selling hydroponic equipment, did not evidence a specific intent to assist their customers in violating the CSA.  Key to the court’s holding was the fact that the debtors were not selling exclusively to customers in the marijuana industry, but instead were also selling to commercial and individual horticulturists, growing a variety of legal crops.  The court also held that there was insufficient evidence of an actual agreement between the debtors and their customers to violate the CSA since the sale of the hydroponic supplies did not specifically contemplate, depend upon, or require any activity that is necessarily illegal.

Unfortunately for the debtors, however, the bankruptcy court held that they were violating Section 843(a)(7) of the CSA which makes it a federal crime to “manufacture” or “distribute” any “equipment, chemical, product or material which may be used to manufacture a controlled substance . . . knowing, intending, or having reasonable cause to believe, that it will be used to manufacture a controlled substance.”  The court pointed to substantial evidence that established that the debtors had reasonable cause to believe that the equipment they sold would be used, by at least some of their customers, to manufacture marijuana, finding:

Considering this abundant evidence, Debtors’ efforts to distance themselves from knowledge of their customers’ use of their products is simply not credible.  Even though the Court concludes Debtors do not share their customers’ specific intent to violate the CSA, Debtors certainly know they are selling products to customers who will, and do, use those products to manufacture a controlled substance in violation of the CSA.  Debtors tailor their business to cater to those needs, tout their expertise in doing so, and market themselves consistent with their knowledge.  There is no evidence this business model has materially changed post-petition.

Furthermore, the court held that the debtors could not make any changes to their business in order to cure the ongoing violations of the CSA since eliminating marijuana-related income “would be devastating to the Debtors.”  Therefore, the court found that it had no alternative but to dismiss the bankruptcy cases.

What makes this case interesting, or troubling from the standpoint of parties involved in a state legalized marijuana industry, is that the debtors did not grow or distribute marijuana, and did not lease space where the marijuana was produced or processed. Instead, the debtors sold equipment that was used to both grow marijuana as permitted under state law, as well as other crops.  This case puts those who derive income from the sale of product used by marijuana businesses at significant risk of being precluded from access to the bankruptcy courts.

The court’s ruling is now under appeal.  We are also awaiting the 9th Circuit Court of Appeals’ decision in the Garvin v. Cook Investments case.  It will be extremely helpful to get Circuit guidance on the question of whether those involved in a state-legalized marijuana industry can also access relief granted under the federal bankruptcy law.  We will continue to keep our readers up to date on all developments in these cases specifically and in marijuana-related bankruptcy cases more generally.

When is a decision to declare an interim dividend a decision?

It is often common practice for small businesses to structure payments to a director (who is also a shareholder) through a combination of dividend payments and salary, in order to minimize PAYE liabilities and reduce tax.  Consequently, rather than be paid a salary, a director is “remunerated” by dividend payments.  This works when the company declaring the dividend has sufficient distributable reserves – but when it does not, those payments are unlawful and can be clawed back under s847 of the Companies Act 2006.

It is also often the case that a director is paid by monthly interim dividend payments, albeit that at the time of payment it is not yet known whether there will be sufficient distributable reserves to justify the payment. If at the end of the financial year it turns out that the company did not have sufficient distributable reserves, the payment is re-characterised as salary and PAYE will be accounted for at that point.  This payment structure can work (although the original payment to the director is illegal), but what happens where there is an intervening insolvency that occurs before the payments are reversed? Continue Reading

Third Circuit Confirms There’s No Wiggle Room With Jurisdictional Limitations

A precedential decision issued on November 28, 2018 by the U.S. Court of Appeals for the Third Circuit highlights the limits of bankruptcy judges’ authority to transfer non-core proceedings to other courts.  The Third Circuit’s opinion in In re IMMC Corp. f/k/a Immunicon Corp., et al., Case No. 18-1177, also emphasizes the importance of choosing the right forum for filing post-confirmation litigation.

The facts of the eight-year long jurisdictional dispute are procedurally complex, but are crucial to understanding the potential significance of the Third Circuit’s ruling.  In 2008, IMMC Corporation (the “Debtor”) filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code in the U.S. Bankruptcy Court for the District of Delaware.  Roberto Troisio (the “Trustee”) was appointed liquidating trustee of the Debtor’s estate pursuant to the Debtor’s confirmed plan of liquidation.

In 2010, the Trustee filed an adversary proceeding in the bankruptcy court against the Debtor’s former officers and directors, alleging that these former officers and directors had breached their fiduciary duties by pursuing risky and costly litigation against a competitor of the Debtor.  The Trustee argued that the adversary proceeding was a core proceeding or, in the alternative, a non-core proceeding related to the chapter 11 case, but the bankruptcy court held that it lacked jurisdiction to hear the claims asserted in the adversary.  The bankruptcy court explained that after plan confirmation, a bankruptcy court’s “related to” jurisdiction is limited to matters that are closely connected to plan implementation, and the claims raised in the adversary proceeding did not have a sufficient nexus to implementation of the plan.

The Trustee did not appeal the bankruptcy court’s ruling, but instead moved to transfer the adversary proceeding to the U.S. District Court for the Eastern District of Pennsylvania pursuant to 28 U.S.C. § 1631.  Section 1631 provides:

Whenever a civil action is filed in a court as defined in section 610 of this title or an appeal, including a petition for review of administrative action, is noticed for or filed with such a court and that court finds that there is a want of jurisdiction, the court shall, if it is in the interest of justice, transfer such action or appeal to any other such court in which the action or appeal could have been brought at the time it was filed or noticed, and the action or appeal shall proceed as if it had been filed in or noticed for the court to which it is transferred on the date upon which it was actually filed in or noticed for the court from which it is transferred.

Section 610 provides, in relevant part, that “courts includes the courts of appeals and district courts of the United States, the United States District Court for the District of the Canal Zone, the District Court of Guam, the District Court of the Virgin Islands, the United States Court of Federal Claims, and the Court of International Trade.”  The bankruptcy court denied the motion to transfer, reasoning that bankruptcy courts are not “courts” as defined by section 610 and therefore the bankruptcy court lacked authority under section 1631 to transfer the adversary proceeding.

The Trustee thereafter filed a motion to withdraw the reference in the U.S. District Court of Delaware.  Typically, a motion to withdraw the reference is a procedure that would permit matters that were automatically referred to a bankruptcy court pursuant to a general order to be returned to and heard by the district court.  The district court denied the motion, reasoning that “because the Bankruptcy Court lacked jurisdiction over the adversary proceeding, the action was never properly transferred to the Bankruptcy Court, and the District Court could not withdraw the reference of a proceeding that was never referred.”  Following the district court’s decision, the Trustee filed a new motion with the bankruptcy court to transfer the adversary proceeding to U.S. District Court for the Eastern District of Pennsylvania, which the court treated as an unsupported motion for reconsideration of its earlier order denying the motion to transfer, and denied the motion.

This time, the Trustee appealed the denial of the motion to transfer and the “renewed” motion to transfer to the district court.  Applying the same reasoning as did the bankruptcy court, the district court affirmed both orders, holding that bankruptcy courts are not “courts” as defined by section 610.  Thereafter, the Trustee appealed the district court’s order to the Third Circuit.

On appeal, the Trustee again argued that bankruptcy courts have authority to transfer proceedings pursuant to 28 U.S.C. § 1631 because they are “courts” as defined by section 610.  The Trustee cited the Third Circuit’s decision in In re Schaffer Salt Recovery, 542 F.3d 90 (2008), in which the court held that bankruptcy courts are “units” of the district court for purposes of 28 U.S.C. § 451, as precedential support for finding that bankruptcy courts are “courts” as defined by section 610 and are thereby authorized under section 1631 to transfer proceedings.  However, the Third Circuit rejected the Trustee’s arguments because in Schaffer, unlike here, it was undisputed that the bankruptcy court had jurisdiction over the bankruptcy petitions pursuant to 28 U.S.C. § 157.  Instead, the Third Circuit refocused the issue on the bankruptcy court’s ruling that it lacked jurisdiction to hear the case because the adversary proceeding was neither core nor related to the chapter 11 case.  The Court explained that if the bankruptcy court “[e]xercis[ed] jurisdiction over the adversary proceeding so as to transfer it under § 1631 [such action] would have been ultra vires, regardless of whether bankruptcy courts fall under § 610’s definition of courts.”

Although the question of whether bankruptcy courts are “courts” as defined under section 610 remains undecided, the Third Circuit’s decision reaffirms the well-established principle that bankruptcy courts are courts of limited jurisdiction and, more specifically, that the jurisdictional limitation includes a limitation on the courts’ authority to exercise jurisdiction simply to transfer adversary proceedings.  Going forward, bankruptcy attorneys should be very deliberate about where they file post-confirmation litigation since the bankruptcy court may not have jurisdiction over the case unless the case is connected to plan implementation.  At a minimum, this decision illustrates the various times during which the Trustee could and should have refiled the proceeding or appealed the bankruptcy court’s finding that the adversary proceeding was a non-core proceeding.

The Fifth Circuit Reminds Buyers To Beware Of Buying “Deemed Rejected” Contracts

The recent decision by the Fifth Circuit Court of Appeals in In re Provider Meds, L.L.C. is a stark reminder to chapter 7 trustees that they have an affirmative obligation to examine a debtor’s assets.  A trustee’s failure to conduct a sufficient and timely examination may deprive the estate of significant value.

The issue before the Court in Provider Meds was whether the assumption and assignment of an intellectual property license agreement (the “License Agreement”) conveyed any intellectual property rights since the Agreement had not been timely assumed by the trustee.  The facts were not in dispute.  Multiple related debtors filed chapter 11 cases, and those cases were later converted to chapter 7.  None of the debtors listed the License Agreement in their bankruptcy schedules.  The License Agreement had been executed as part of a settlement of a 2010 patent litigation in which Tech Pharmacy Services, LLC (“Tech Pharm”) had alleged that multiple defendants, including several of the debtors (pre-petition), had infringed its patent.  Under the License Agreement, all but one of the debtors obtained a non-exclusive perpetual license to use Tech Pharm’s patent.  Following conversion of their cases to chapter 7, RPD Holdings, L.L.C. (“RPD”) purchased all of the assets of three of the debtors under section 363 of the Bankruptcy Code.  The orders approving the sales provided that to the extent that any of the subject property was an executory contract, the contract was assumed by the estate and immediately assigned to RPD under section 365 of the Bankruptcy Code.

RPD’s problems began shortly thereafter, when Tech Pharm sued for patent infringement.  In its defense, RPD argued that the License Agreement had been assigned to RPD under the terms of the sale orders.  Unfortunately for RPD, a chapter 7 trustee has a limited period of time in which to assume an executory contract before that contract is deemed rejected.  Specifically, pursuant to section 365(d)(1) of the Bankruptcy Code, after a chapter 7 case is filed, or after a case is converted to chapter 7, the trustee has only 60 days in which to assume an executory contract.  Failure to timely assume an executory contract leads to the contract being automatically rejected (i.e., deemed rejected).

Here, the sale orders were entered after the 60-day time period had run, and the chapter 7 trustee had not assumed the License Agreement within the 60-day period provided for by section 365(d)(1).  Tech Pharm therefore argued that RPD had acquired no rights to Tech Pharm’s patent under the License Agreement.  In response, RPD argued that the License Agreement was not executory, and that even if it was, the time limits established by section 365(d)(1) should not apply when the debtors failed to list the License Agreement in their bankruptcy schedules and when the trustee was therefore unaware of its existence.

The Fifth Circuit began its analysis by holding that the License Agreement was executory.  In order to be executory, parties to the contract must both, at the time of the bankruptcy filing, have some performance obligations remaining which if not completed would constitute a material breach of the contract.  Here, the License Agreement was executory since (a) Tech Pharm had certain continuing obligation to refrain from suing its counterparties for patent infringement, and (b) the licensees under the License Agreement had continuing reporting obligations and had to refrain from making statements about the settled lawsuit.

The Court also rejected RPD’s argument that it should read an implicit exception in section 365(d)(1) for when a debtor fails to include an executory contract in its bankruptcy schedules and when the trustee is unaware of the contract within the 60-day period.  The Court approved an earlier Ninth Circuit opinion decided under the Bankruptcy Act where that court had held that “a trustee has an affirmative duty to investigate for unscheduled executory contracts” and that the “statutory presumption of rejection by the trustee’s nonaction within the sixty day period following his qualification is a conclusive presumption.”  According to the Fifth Circuit, section 365(d)(1) does not impose an actual or constructive notice requirement for the 60-day period.  Therefore, because the License Agreement had not been assumed within 60 days of conversion to chapter 7, the License Agreement was deemed rejected and was not part of the bankruptcy estate.  This meant that the License Agreement could not be sold under section 363, which permits a trustee to sell only “property of the estate.”  The fact that the trustee had no knowledge of its existence was irrelevant for purposes of section 365(d)(1).

Importantly, the Court did not reach the question of whether the 60-day deadline applies where a debtor intentionally conceals the existence of an executory contract from a trustee.  As noted by the Fifth Circuit, some courts have refused to hold that the executory contract is deemed rejected in such circumstances.

The Court’s decision in Provider Meds is a wake-up call to chapter 7 trustees.  Chapter 7 trustees have an affirmative obligation to thoroughly investigate a debtor’s assets, including those assets that may not be scheduled.  If the trustee suspects that the debtor is hiding assets, he or she can seek an extension of the 60-day period, but they cannot let the period run without ensuring that all executory contracts have been identified.  Failure to do so could deprive the estate of value, since the trustee could not then assume and assign an executory contract which may have value.  Further, the Provider Meds decision reminds parties acquiring executory contracts under section 365 in chapter 7 cases to ensure that the contracts have been timely assumed by the chapter 7 trustee.  Otherwise, they run the risk that they will have paid value for a contract that no longer exists.

Did Jevic Doom Future Chapter 11 Recovery Efforts By Unsecured Creditors?

Can a senior secured creditor, who credit bid for substantially all of a debtor’s assets, contribute non-estate property to a litigation trust for the benefit of general unsecured creditors without following the absolute priority rule?  In the recent Constellation Enterprises case, the Bankruptcy Court for the District of Delaware ruled that, as a result of the Supreme Court’s Jevic decision, it cannot and on that basis refused to approve a settlement which would have provided a significant recovery to unsecured creditors. The court’s decision resulted in a multi-million dollar windfall for the senior secured creditors with whom the creditors’ committee in that case had negotiated a favorable settlement.

In an article published in the Journal of Corporate Renewal, the official publication of the Turnaround Management Association, entitled “Did Jevic Doom Future Chapter 11 Recovery Efforts by Unsecured Creditors?,” Squire Patton Boggs Restructuring & Insolvency Group partners Norman Kinel and Nava Hazan examine Constellation Enterprises and its potential ramifications on efforts by creditors’ committees to obtain recoveries for their constituents in the chapter 11 cases of highly overleveraged companies.

Black Friday- risks and opportunities for UK retailers

You may have noticed from the emails flooding into your inbox (even in this post-GDPR world) that this Friday 23 November is “Black Friday”. The event, originating in the US, takes place the day after Thanksgiving and is now synonymous with heavy discounting by retailers, especially those online.

Less than a decade ago, this would have been an utterly unremarkable shopping day in the UK. The UK’s shoppers understood that, whilst the retailers were fiercely competing with each other to secure consumers’ spending in the run-up to Christmas, November and December were not months in which retailers would slash their prices as a means to generate sales. The UK public had to wait until Boxing Day for the retailers to cut prices in order to sell their excess Christmas stock, with the leading news story on Boxing Day often consisting of shoppers (both from the UK and overseas) flocking to the UK’s department stores to try to obtain the best bargains.

That changed with the increased adoption of Black Friday discounting by the UK’s retailers approximately five years ago, (although Amazon had offered UK consumers Black Friday deals from 2010). Black Friday firmly came on the UK’s radar in 2014, when the headlines featured shoppers at several UK supermarkets coming to blows in a bid to purchase heavily discounted televisions.

So what will be the effect of Black Friday on the retail sector in 2018, in the context of the current challenging market, with a number of well-known retailers releasing profit warnings and others proposing CVAs and/or entering administration? In recent years, Black Friday has undoubtedly had an impact on consumers’ shopping habits during the key trading period prior to Christmas, meaning that retailers have had to react. Continue Reading

The Supreme Court May Finally Give Guidance On Trademark Protections In Bankruptcy

In prior posts, we discussed the perplexing issue of how and whether a trademark licensee is protected when the trademark owner/licensor files a bankruptcy petition and moves to reject the trademark license in accordance with section 365 of the Bankruptcy Code.

In January of this year, the First Circuit Court of Appeals issued its ruling in Mission Product Holdings, Inc. v. Tempnology, LLC, 879 F.3d 389 (2018), holding that a trademark licensee was not permitted to continue to utilize the trademark after the rejection of the license agreement. In so holding, the First Circuit disagreed with the Seventh Circuit Court of Appeals’ decision in Sunbeam Prods. v. Chicago Am. Mfg., LLC, 686 F.3d 372 (2012), where the Seventh Circuit held that a non-debtor’s right to continue to use a trademark license is based upon section 365(g) of the Bankruptcy Code which provides that a rejection of an executory contract (such as a trademark license agreement) simply constitutes a prepetition breach of that contract — it neither acts as a contract rescission nor termination.  Instead, the court held that rejection leaves in place the licensee’s right to continue to use the licensed trademark notwithstanding the contract’s rejection.

In what could only be considered as good news for trademark licensees and licensors, as well as bankruptcy professionals advising them, on October 26, 2018, the U.S. Supreme Court granted certiorari in the Mission Product Holdings, Inc. v. Tempnology, LLC case.  This means that parties may finally get guidance as to what happens to a trademark license when the trademark licensor rejects the trademark license agreement. Do trademark licensees have any protections like those afforded licensees of intellectual property under section 365(n)?  Is the Seventh Circuit’s approach in Sunbeam appropriate, or, as held by the First Circuit, is it up to Congress to clarify the status of trademark rights post-rejection? Only time will tell. 

We will keep our readers informed as to all developments in this incredibly important case.

HMRC, Insolvency and Post-Budget Preferential Status

Following the Enterprise Act 2002, the preferential status which HMRC had enjoyed in an insolvency was abolished, rendering HMRC the same as any other unsecured creditor. The effect of this was to swell the pot of assets available to be applied to all unsecured creditor claims.U Turn Sign

Philip Hammond announced in Monday’s budget that HMRC’s preferential status is to be restored. What does this mean for HMRC and unsecured creditors? Continue Reading