Banking and Finance Law Report : Banking & Finance Lawyer & Attorney : Porter Wright Morris & Arthur Law Firm : Bankruptcy, Commercial Lending

As Ohio enjoys its latest boom in oil and gas exploration, it is important to understand how oil and gas leases are treated in bankruptcy.  The importance of these issues are underscored by the frequency with which the courts confront them; hence we visit again this unsettled area and consider further the question of the ownership of unextracted oil and gas in a bankruptcy context.

In the recent case of In re Cassetto, 475 B.R. 874 (Bankr. N.D. Ohio 2012), a bankruptcy court for the Northern District of Ohio examined whether a bankruptcy trustee charged with administering the assets of an individual chapter 7 debtor could enter into an oil and gas lease despite the debtor’s objections, and, if so, whether the debtor’s homestead exemption would apply to the signing bonus for such lease.

The lease the trustee sought to enter into had a five year term and would permit the extraction of oil and gas in exchange for a $3,900 per acre signing bonus and royalties of 17.5% of the value of any oil and gas produced from the property.  The trustee sought to enter into the lease, receive the signing bonus and thereafter abandon the lease to the debtor such that the debtor would be entitled to any royalty payments under the lease.

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As Ohio enjoys its latest boom in oil and gas exploration, it is important to understand how oil and gas leases are treated in bankruptcy. Unsettled Ohio law regarding whether a debtor owns unextracted oil and gas as part of the debtor's real property can make this a difficult issue. 

In In re Loveday, No. 10-64110, 2012 WL 1565479 (Bankr. N.D. Ohio May 2, 2012), the Northern District of Ohio examined whether a Chapter 13 debtor had properly included in his bankruptcy schedules his interest in unextracted oil and gas relating to the debtor’s real property. Whether the debtor’s oil and gas rights were properly scheduled was a significant factor in determining whether the debtor could retain the proceeds of the sale of his oil and gas rights. But more importantly, for the companies who sought to purchase the debtor's oil and gas rights, knowing whether such rights were properly scheduled was necessary to determine whether the debtor had unfettered authority to sell his oil and gas rights without court approval.

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Secured creditors of borrowers holding Federal Communications Commission ("FCC") broadcasting licenses, as well as such borrowers seeking credit, will be reassured by a recent decision of the United States Court of Appeals for the Tenth Circuit, In re: Tracy Broadcasting Corporation, released October 16, 2012. The Tenth Circuit has joined other courts in upholding the priority of a creditor's security interest over that of unsecured creditors in the post-bankruptcy sale proceeds of an FCC broadcasting license. The decision reversed the decisions of lower courts and held that "a security interest in the proceeds of a license attaches when the licensee enters into the security agreement, regardless of whether a sale [of the license] is contemplated at that time."

In 2008, Tracy Broadcasting (the "Debtor") issued a promissory note in favor of Valley Bank & Trust Company (the "Secured Creditor") and secured such obligations with various assets, including its general intangibles and the proceeds of such collateral. In 2009, the Debtor filed a Chapter 11 petition in the U.S. Bankruptcy Court for the District of Colorado. An unsecured creditor of the Debtor brought an adversary action to determine the extent of the Secured Creditor's security interest in the proceeds of the sale of the Debtor's license.

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This article is Part Seven in a seven-part series on how to structure sales and what to do when your customer fails to pay. You can find previous articles in this series here: Structuring Sales to Ensure Payment; Signs of Trouble Before Payment Default; Default by a Customer: Knowledge is Power; What to Consider When Non-Payment Leads to Litigation and Post-Judgement Remedies. Please subscribe to this blog by entering your email in the box on the left, or check back weekly for additional articles in the series.

This posting will provide a general overview of bankruptcy law for the non-lawyer, including what it means to be "bankrupt," the types of bankruptcy, and bankruptcy issues for creditors, particularly for sellers of goods or services.

Bankruptcy Structure
Bankruptcy Code is federal law- it was created by, and is amended by the U.S. Congress. In theory, the same laws and rules apply wherever you file bankruptcy in this country, however it does happen that different Bankruptcy Courts around the country interpret the same statute differently. When this happens, the cases are appealed. If the U. S. Courts of Appeals reach different conclusions about the same statute, it is possible that the U.S. Supreme Court will resolve the controversy. 

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This article is Part Two in a seven-part series on how to structure sales and what to do when your customer fails to pay. You can find Part One of this series here: Structuring Sales to Ensure Payment. Please subscribe to this blog by entering your email in the box on the left, or check back weekly for additional articles in the series. 

With the recent economic slowdown in many sectors and the parade of corrupt corporate executives on the evening news, corporate managers are more sensitive than ever to signs of troubled business practices and how those practices affect outstanding receivables.  Many distressed businesses display early warning signs of impending trouble, including some or all of the following:

• Lack of a sound business plan- The company may not have a plan or may have expanded past the vision of it original business plan.

• Ineffective management style- The management of a small company that has experienced rapid growth may not be able to delegate authority effectively. 

• Poor lender/vendor relationships- The company may not respond quickly or fully to its vendor’s request for financial information or may actively hide information from its vendors.

• Change in market conditions- The market for the company’s product may have changed, leaving the company with a shrinking market share and lower sales. The company’s technology or marketing may be obsolete to compete in the current marketplace (remember 8-track tapes?).

• Over-diversification of products- The company may enter non-traditional markets too quickly in an effort to increase flagging sales but without the necessary resources or knowledge to compete successfully in the new market.

• Geographic expansion- The company expands its footprint too quickly, straining managerial and financial resources. These signs should alert the vendor that the company may be a candidate for default on existing obligations.  The prudent vendor should heed these signs and take immediate action to protect its interests in the event the company defaults on its obligations or seeks protection from its creditors under the Bankruptcy Code.  Consider shortening payment terms, going to credit card payment or cash on delivery, a consignment sale format or taking a security interest in the customer's assets of obtaining a guaranty from a financially reliable insider.

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Health care lenders and others evaluating or relying on the financial strength of a healthcare provider need to think about the potential recoupment and setoff of claims against Medicare/Medicaid receivables of the provider. 

RECOUPMENT

Recoupment, which is the netting of two related claims which is the function of a single, unitary transaction between the parties, occurs in the normal course of business and is not stayed by the automatic stay in a bankruptcy proceeding. For example, if Party A sells 100 widgets to Party B, and Party B discovers that four of the widgets were not delivered, Party B will deduct (recoup) the invoice amount of each unit in making payment to Party A.

In dealing with Medicare/Medicaid recoupment issues in bankruptcy, two general approaches have been taken by the Circuit Courts of Appeal with respect to the netting of overpayments against accounts due to the provider.

In the Third Circuit, which includes Delaware, the Court has applied an integrated transaction test, which means generally that any recoupment of Medicare/Medicaid payments is viewed as yearly payments and therefore the government can only recoup overpayments against payments due for a single year. Most of the Circuit Courts have adopted a “logical relationship test” in which Medicare/Medicaid overpayments and any payments due are all part of the same transaction even if they are not in the same year or the services are not rendered to the same patients. States are also permitted to recoup amounts owed for hospital and bed taxes by withholding certain Medicare/Medicaid payments otherwise due. Some courts have gone so far as to provide that Medicaid recoupments can be made across service categories, such as nursing service overpayments being recouped from payments due for laboratory services.

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Breaking with the Third Circuit and the Fifth Circuit, on June 28, 2011, the Seventh Circuit held that a debtor's plan of reorganization that provides for the sale of the debtor's assets free and clear of an existing security interest may only be confirmed over the objection of its secured creditor if the plan's sale procedure permits the secured creditor to credit bid its secured debt for the assets being sold. River Road Hotel Partners, LLC v. Amalgamated Bank, -- F.3d --, Nos. 10-3597 & 10-3598 (7th Cir. June 28, 2011).

The circuit split centers on the Bankruptcy Code's provisions that only permit the confirmation of a plan of reorganization over the objection of a creditor class (a so called "cram down") where the plan's treatment of such class is "fair and equitable." When the objecting class consists of secured creditors, the Bankruptcy Code requires that such fair and equitable treatment include provisions whereby either: (A) the secured creditor retains its liens in its collateral whether such collateral is retained by the debtor or transferred to another party and the secured creditor receives a specified level of cash payments under the plan, 11 U.S.C. § 1129(b)(2)(A)(i); (B) the secured creditor "realiz[es] … the indubitable equivalent" of its claim, id. § 1129(b)(2)(A)(iii); or (C) the secured creditor's collateral is sold subject to the secured creditor's right to credit bid for such property, the secured creditor retains a lien in the proceeds of the sale and the treatment of this new lien is in accordance with (A) or (B) above. Id. § 1129(b)(2)(A)(iii). Because the Bankruptcy Code does not define "indubitable equivalent" the courts, in providing their own definition have struggled over whether these three alternative "fair and equitable" treatments are mutually exclusive such that the only method for selling property free and clear is in an auction that permits credit bidding, or whether indubitable equivalent alternative is broad enough to encompass a free and clear sale that would not otherwise be "fair and equitable" because it did not honor credit bidding.

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The ability of a single asset real estate debtor in a bankruptcy case to utilize a non-consenting secured creditor's cash collateral has been limited by a recent decision from the Bankruptcy Appellate Panel of the Sixth Circuit in In re Buttermilk Towne Center, LLC, 2010 FED App. 0010P (B.A.P. 6th Cir. 2010).

Under 11 U.S.C. § 552(a)(2), a pre-petition security interest in rents extends to rents generated by a debtor post-petition. Further, 11 U.S.C. § 363 provides that a debtor can only use the cash collateral of a non-consenting secured creditor if the creditor is deemed to be "adequately protected." Prior to Buttermilk, the Sixth Circuit Court of Appeals issued the unpublished decision of Stearns Bldg. v. WHBCF Real Estate (In re Stearns Bldg.), 165 F.3d 28 (6th Cir. 1998), in which the Sixth Circuit held that a secured creditor was not adequately protected when a single asset real estate debtor only offered to provide the creditor with a replacement lien on post-petition rents that were encumbered by the secured creditor's pre-petition lien. Many courts in the Sixth Circuit have failed to follow the unpublished decision of Stearns Building, and rather have held that a pre-petition secured creditor is adequately protected when a single-asset real estate debtor provided a replacement lien on rents that were already encumbered by the creditor's pre-petition lien.

In Buttermilk, the Debtor was the owner and operator of a commercial real estate development. Bank of America was the Debtor's primary pre-petition secured lender and had a pre-petition security interest in all of the rents and profits derived from the property. Upon filing its bankruptcy petition, the Debtor sought to use the rents to pay for the administrative costs of its bankruptcy, including to pay for the post-petition legal fees of the Debtor. While Bank of America argued that the Debtor should not be able to utilize its cash collateral to fund its bankruptcy estate since it was not adequately protected due to a replacement lien on assets that it already had encumbered, the bankruptcy court concluded that Bank of America was adequately protected. In reliance on Stearns, the Bankruptcy Appellate Panel reversed the bankruptcy court and held that a non-consenting secured creditor was not adequately protected when a Debtor provided a security interest in rents that were already encumbered by the secured creditor's pre-petition lien. Therefore, going forward, in a single-asset real estate case, Buttermilk affirms the proposition that a non-consenting secured creditor must receive more than a replacement lien on rents that are already encumbered by the secured creditor's pre-petition lien in order for a debtor to be able to utilize the creditor's cash collateral to pay the administrative expenses of the bankruptcy case.
 

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