Section 503(b)(9) Claims and Bar Dates: Creditors Must Be Vigilant,  ABI Journal, Vol. XXVII, No. 6, July/August 2008.  Authored by: Carl N. Kunz, III

The publishers of Chambers USA:  America’s Leading Lawyers for Business recently launched the 2008 Client’s Guide.  Morris James partners Stephen M. Miller and Carl N. (“Chuck”) Kunz, III have been recognized by Chambers this year in the area of bankruptcy.  Mr. Miller appears in Chambers for the 4th time.

In its description of the Morris James Bankruptcy and Creditors’ Rights Group, Chambers USA notes that “this ‘persuasive and innovative’ team has also carved itself a niche in the representation of commercial landlords in bankruptcy proceedings across the country. The attorneys here are known for their quiet reliability and diligence, which is a great help for their clients: ‘I can rely on them to work independently when I’m tied up on other matters.’ Group chair Stephen Miller ‘does a wonderful job’ on the creditors side, and is rated for his ‘smart, diligent and solid approach.’  Carl Kunz makes his first appearance in these rankings this year, and does so thanks to a growing band of followers who affirm that ‘his practice is really taking off.’ He is building a reputation for the representation of secured and unsecured creditors in Chapter 11 and Chapter 7 bankruptcies in Delaware and beyond, and his background in litigation is an obvious asset to his clients. Collectively, Miller and Kunz are highlighted for their ability to ‘handle matters in a cost-efficient manner’ - an attention to value which is exemplified by the team’s willingness to ‘keep me informed about the status of matters,’ according to one client - and their proactivity with regard to dealing with ‘what may be coming up later in a case.’”

Chambers USA ranks law firms and attorneys in particular areas of law based upon the results of more than 14,000 interviews conducted during a six-month period.  The qualities assessed during the interviews are those most valued by the client: technical legal ability, professional conduct, client service, commercial awareness, diligence, and commitment.

On April 1, 2008, Brett D. Fallon, a Partner in Morris James' Bankruptcy and Creditors' Rights group, was appointed as Chair of the Claims and Priorities Subcommittee of the American Bar Association Business Bankruptcy Committee.  Mr. Fallon's three (3) year term will begin at the committee's fall meeting.  The Business Bankruptcy Committee operates through 33 subcommittees and consists of approximately 1,200 members, and is the largest group in the world made up exclusively of bankruptcy lawyers, professors and judges.

The Business Bankruptcy Committee is affiliated with the Business Law Section of the American Bar Association.  It offers educational programs, develops and reviews proposed bankruptcy legislation, and is an important participant in United Nations Commission on International Trade Law's Insolvency and Secured Transactions Working Group.

JELD-WEN, Inc. v. Brunt (In re Grossman’s, Inc.), Nos. 97-00695, Adv. No. 07-51602 (Bankr. D. Del. June 9, 2008) (Judge Peter J. Walsh)

The Bankruptcy Court confirmed Grossman’s chapter 11 plan for reorganization in December 1997 in which all claims against Grossman’s were discharged.  Approximately ten years later, Mary and Gordon Van Brunt sued JELD-WEN, as successor in interest to Grossman’s, for injuries allegedly caused by materials sold by Grossman’s that contained asbestos.  JELD-WEN contended that these state court claims were discharged by the confirmed plan and commenced an adversary proceeding against the Van Brunts seeking (i) a permanent injunction enjoining defendants’ prosecution of claims against JELD-WEN; (ii) a determination that these claims were discharged; and (iii) an award of damages.

Grossman’s was a retailer of home improvement and building products.  Grossman’s filed for protection under chapter 11 of the Bankruptcy Code in April 1997.  The deadline for filing proofs of claim was August 4, 1997.  At the time of this chapter 11 case, Grossman’s was unaware of any potential products liability lawsuits.  However, Grossman’s was apparently aware that it sold products containing asbestos and was aware of the health risks associated with asbestos.  Mary Van Brunt allegedly purchased home improvement products containing asbestos from Grossman’s in 1977.  The Van Brunts did not file a proof of claim in the bankruptcy case.  Thirty years after purchasing the products, Mary Van Brunt was diagnosed with mesothelioma.  She did not exhibit symptoms of the disease until late 2006.  As a result of the diagnosis, the Van Brunts filed a products liability suit in New York State Court against JELD-WEN.  JELD-WEN subsequently commenced this adversary proceeding in the Bankruptcy Court for the District of Delaware.

JELD-WEN contended that the Van Brunts’ state court claims were barred by the Confirmation Order entered in the Grossman’s bankruptcy case.  The Confirmation Order contained an injunction provision that barred claims arising before the effective date.  The Bankruptcy Court concluded that the threshold question in this case was whether the Van Brunts’ claim arose before or after the Plan’s effective date.

The Bankruptcy Court utilized the holding of In re Frenville Co., Inc., 744 F.2d 332 (3d Cir. 1984), to determine that a bankruptcy court must examine state law to determine when a claim or interest arises.  The Van Brunts’ filed their products liability claim in New York state court and no party disputed that New York state law governed these claims.  Under New York law, asbestos injury claims do not arise until the injury manifests itself.  Thus, the Van Brunts’ claims did not arise until after the plan’s effective date.

However, JELD-WEN contended that the majority of courts have concluded that a claim arises when the acts giving rise to the claim were performed.  The cases cited by JELD-WEN for this proposition were located outside the Third Circuit.  Additionally, JELD-WEN argued that Frenville was one of the “most criticized and least followed precedence” decided under the Bankruptcy Code and suggested that the Bankruptcy Court ignore it.  The Bankruptcy Court refused to ignore Frenville and noted that another Third Circuit case, Jones v. Chemetron Corp., 212 F.3d 199, 206 (3d Cir. 2000), reaffirmed Frenville as the law of this circuit, despite contrary authority in other circuits.

The Bankruptcy Court further observed that the Third Circuit decided the question of when an asbestos claim arises in  Schweitzer v. Consol. Rail Corp., 758 F.2d 936 (3d Cir. 1985).  The Third Circuit held in the Schweitzer case that a claim for asbestos related injuries does not arise until the injuries manifest themselves.  In doing so, the court reasoned that an injury that has not manifested itself would have damages insufficient to sustain a cause of action under tort law.  Further, requiring a person who has no idea that he would be harmed by a product produced or sold by the debtor to file a claim in a debtor’s bankruptcy case would be absurd.  Thus, the Third Circuit concluded that a claim for an asbestos-related injury does not arise until the injuries manifest themselves.

The Bankruptcy Court relied on this precedent and held that the Van Brunts’ claims did not arise until Mary Van Brunt began to exhibit symptoms of her injuries.  As a result, the Confirmation Order did not bar the Van Brunts’ state court claims against JELD-WEN.

Plassein Int’l Corp. v. B.A. Capital Co. LP (In re Plassein Int’l Corp.), No. 03-14489, 2008 WL 2073495 (D. Del. May 15, 2008) (Judge Joseph J. Farnan, Jr.)

The Debtors’ Chapter 7 Trustee (the “Trustee”) commenced an adversary proceeding against B.A. Capital Co. LP alleging that a series of fraudulent transfers rendered the Debtors insolvent or with unreasonably small capital for its businesses. The Bankruptcy Court had dismissed the Complaint because the court concluded (i) the transfers were settlement payments, pursuant to 11 U.S.C. § 546(e) and thus, not subject to avoidance under 11 U.S.C. § 544(b); (ii) the Complaint failed to state a claim upon which relief could be granted because it failed to assert that Plassein or any of the related Debtors made the allegedly fraudulent transfers; and (iii) the allegations within the Complaint could not be collapsed because neither the intent to defraud nor bad faith was alleged. The District Court affirmed.

On appeal, the Trustee first asserted that the prohibition on avoiding transfers listed in 11 U.S.C. § 546(e) only applied to publicly traded securities. On the other hand, Appellees asserted that the plain language of 11 U.S.C. § 546(e) and applicable Third Circuit case law demonstrated that the applicability of section 546(e) is not limited to publicly traded securities. The District Court concluded that the Bankruptcy Court correctly held that 11 U.S.C. 546(e) is not limited to publicly traded securities. Rather, the Court noted, Third Circuit case law, including In re Resorts Intl., Inc., 181 F.3d 505 (3d Cir. 1999) demonstrated that the phrase “settlement payment” should be broadly construed. 

Second, the Trustee contended that the record established that the transferor, Plassein Packaging, was a debtor or the same entity as the Debtors. The Trustee asserted that the court should have looked to the public record to conclude that Plassein Packaging and Plassein International were the same entity. Appellees conversely argued that the Trustee failed to allege such a relationship in the Complaint. The District Court affirmed the Bankruptcy Court’s dismissal of the Complaint for failure to state a claim upon which relief could be granted. The District Court concluded that the Complaint failed to state such an allegation and this deficiency could not be cured by subsequent briefing or affidavits. Further, the Court determined that the Bankruptcy Court’s decision not consult the public record was not erroneous.

Finally, the Trustee argued that actual intent to defraud was not a required element to collapse the transactions. The Trustee sought to avoid the implication that Plassein Packaging was not a debtor by arguing that the transactions were a single integrated plan. Appellees countered, arguing that Third Circuit precedent requires a showing of bad faith or intent to defraud to collapse otherwise separate transactions. The District Court held that the allegations within the Complaint did not support collapsing the transactions. The court noted that collapsing otherwise separate transactions requires proof of bad faith or intent to defraud.

Thus, the District Court affirmed the Bankruptcy Court’s order.

Miller v. McCown De Leeuw & Co., Inc. (In re Brown Schools), No. 05-10841, Adv. No. 06-50861 (Bankr. D. Del. April 24, 2008) (Judge Mary F. Walrath)

The Bankruptcy Court reaffirmed that Delaware does not recognize a deepening insolvency cause of action. However, the Court determined that a breach of the duty of loyalty claim could still be asserted. Unlike a breach of the duty of care, a breach of the duty of loyalty is not a disguised deepening insolvency claim. Further, damages based on deepening insolvency could be used in the damages calculations. Finally, a claim for aiding and abetting fraudulent transfers is not a recognized cause of action in Delaware.

Defendant McCown De Leeuw & Co., Inc. (“MDC”) acquired more than 65% of Brown School, Inc.’s stock in 1997 and 1998. MDC, through subsidiaries, also entered into an Advisory Services Agreement (“ASA”) with the Debtors and pursuant to the ASA, received the greater of $400,000 or 0.3% of the Debtors’ net revenues (maximum of $800,000) as compensation. Debtors subsequently received loans from various institutions including MDC. The MDC notes were unsecured and subordinate to the other loans. In April 2003, the Debtors owed roughly (i) $47 million to Credit Suisse First Boston (“CSFB”), (ii) $18.4 million to Teachers Insurance and Annuity Association of America (“TIAA”), (iii) $12.5 million to MDC, and (iv) $22 million to other creditors. That same month, Debtors sold all of their residential treatment centers for $64 million. The proceeds satisfied the CSFB debt and were also used to pay fees and other costs including $1.7 million to MDC. The Trustee alleged that this payment to MDC unlawfully preferred MDC over the Debtors’ other creditors because MDC provided no compensable services related to this transaction beyond those services for which it was already being compensated for under the ASA. In July 2004, Debtors restructured their debt and granted TIAA first lien position and gave MDC a second lien on substantially all of its assets. On March 25, 2005, the Debtors filed voluntary petitions for relief under chapter 7 of the Bankruptcy Code and George Miller was appointed trustee (the “Trustee”).

The Trustee alleged various claims in his Second Amended Complaint (the “Complaint”) against the MDC defendants. The claims for deepening insolvency, breach of fiduciary duty and aiding and abetting fraudulent transfers by the MDC defendants are addressed in this summary.  The first asserted claim included a claim for deepening insolvency. The Delaware Supreme Court in Trenwick Am. Litig. Trust v. Billett, 2007 LEXIS 357, at *1 (Del. 2007), held that Delaware does not recognize a cause of action for deepening insolvency. Hence, the Bankruptcy Court summarily held that this count of the Trustee’s Complaint was dismissed.

The Complaint also alleged a claim for breach of fiduciary duty against the MDC defendants. The Trustee contended that the MDC defendants’ conduct constituted self-dealing and that they had prolonged the Debtors existence for their own profit. The Trustee pointed to the $1.7 million MDC received for the sale of Debtors’ residential treatment centers as an example of the breach of loyalty. The Trustee also asserted that the July 2004 restructuring was done to prefer MDC over non-insider creditors. Further, the Trustee asserted a claim for aiding and abetting a breach of fiduciary duty against any MDC defendants that would be found not to have a fiduciary duty to the Debtors.

The MDC defendants argued that the Trustee’s claims for breach of fiduciary duty were merely disguised deepening insolvency claims and therefore, they should be dismissed. The Trustee countered, arguing that while Trenwick rejected an independent cause of action for deepening insolvency, it did not prevent holding directors of insolvent corporations responsible under fiduciary duty causes of action. The Trustee identified language in the Chancery Court’s opinion in Trenwick wherein the court noted that directors of an insolvent corporation owed fiduciary duties to its creditors. 906 A.2d 168, 205 (Del. Ch. 2006). Thus, the Trustee asserted that his claims were more than simply deepening insolvency claims. The Bankruptcy Court agreed with the Trustee’s arguments holding that Trenwick could not be so broadly construed as to require dismissal of all breach of fiduciary duty and aiding and abetting a breach of fiduciary duty claims. 

The Bankruptcy Court also rejected the argument that the In re Radnor Holdings Corp., 353 B.R. 820 (Bankr. D. Del. 2006) case required dismissal of the Trustee’s claims. The Radnor court dismissed causes of action for breach of fiduciary duty and aiding and abetting breach of fiduciary duty because such claims were merely a deepening insolvency cause of action. The Bankruptcy Court in this case distinguished Radnor on the basis that Radnor dealt only with alleged duty of care violations, not breaches of the duty of loyalty as asserted in this case. The Court reasoned that duty of care violations more closely resemble deepening insolvency claims because they both relate to a board of director’s business decisions. Such decisions are generally protected by the business judgment rule. Thus, the Court concluded claims asserting a breach of the duty of care could be considered a disguised deepening insolvency claim.

The Bankruptcy Court contrasted a breach of the duty of loyalty claim because it merely requires proof that the defendant was on both sides of the transaction. Once such proof is demonstrated, the burden shifts to the defendant to show that the transaction was entirely fair. Thus, the requirements for demonstrating a cause of action for breach of the duty of loyalty are much less than those for a breach of the duty of care. The Court further distinguished duty of care violations from duty of loyalty violations by noting that duty of loyalty violations are not indemnifiable under 8 Del. C. § 102(b)(7). Consequently, the Bankruptcy Court held that the breach of the fiduciary duty of loyalty claims were not disguised deepening insolvency claims and would not be dismissed.

The MDC defendants also argued that deepening insolvency could not be used to measure damages for a claim of breach of fiduciary duty. In response, the Trustee asserted that his damage calculations did not rely exclusively on the amount by which Debtors’ insolvency was deepened. The Trustee also argued that even if it did rely solely on the amount by which the insolvency deepened, the damages should still be recoverable. The Trustee relied on the Alberts v. Tuft (In re Greater Southeast Cmty. Hosp. Corp. I), 353 B.R. 324 (Bankr. D.C. 2006) case where the court held that deepening insolvency could be used to calculate damages in a breach of fiduciary duty claim. The Bankruptcy Court agreed with the reasoning of the Tuft court and rejected the MDC’s defendants’ argument that the damages calculations were impermissible.

The MDC defendants also contended that the Trustee’s claim for aiding and abetting fraudulent transfers should be dismissed. The MDC defendants argued that the Third Circuit has never recognized a cause of action for aiding and abetting a fraudulent transfer. Further, they argued that Delaware Courts have held that such a cause of action does not exist. The Bankruptcy Court agreed with the MDC defendants, and held that aiding and abetting fraudulent transfers is not a cause of action that exists under Delaware law.

Hilex Poly Co. LLC, which touts itself as the word's largest manufacturer of plastic bags, has filed a petition for relief under Chapter 11 of the United States Bankruptcy Code.  The debtor filed the petition on May 6, 2008 in the United States Bankruptcy Court for the District of Delaware.  The Honorable Kevin J. Carey is presiding over this case.

At the first day hearings in the case, Judge Carey granted interim approval of over $140 million in debtor-in-possession financing from prepetition lenders who include GE Capital Corp., Morgan Stanley Senior Funding, Inc. and others.  Judge Carey set a final hearing on this financing plan for May 27, 2008.

The debtor is proposing a prepackaged plan of reorganization under which existing equity would be wiped out.  Under the proposed plan, a new company, to be called Hilex Poly Investors Corp., would be created, with all equity in the new entity divided among the debtor's first and second lien holders.  While first lien holders will be made whole under the proposed plan, second lien holders will realize forty  (40) cents on each dollar.  General unsecured claims are anticipated to pass through the case unaffected, and are proposed to be paid in the ordinary course by the new company.  On May 7, 2008, Judge Carey scheduled a plan confirmation hearing for June 12, 2008 at 10:00 a.m.

Home furnishings retail giant Linens 'n Thing has filed a Chapter 11 petition in the United States  Bankruptcy Court for the District of Delaware, where the Honorable Christopher S. Sontchi is presiding over the cases.  Linens 'n Things operated 589 retail stores in the United States and Canada.


According to the affidavit that the debtors' Chief Financial Officer filed in support of their first day motions, a number of external factors led to a steep decline in the debtors' profitability and liquidity that has prevented the debtors from continuing their plans to turn around the retailer.  The chief factors cited were the decline in the housing market and tightening of credit markets that have led to a decline of discretionary spending in the housewares and home furnishing sector.

The cases comprise thirteen (13) debtors with approximately 120,000 creditors.  The debtors have sought permission to pay pre-petition wages and benefits to their approximately 15,900 U.S. employees.

Rampant Internet-based rumors in recent months urged customers to use gift cards from Linens 'n Things amid speculation that the chain would declare bankruptcy.  However, the debtors sought permission from the Court to honor gift card and certain other customer obligations in the ordinary course.  The Court has approved this request.

Spyrus Inc. and two subsidiaries - Terisa Systems Inc. and Blue Money Software Inc. - sought Chapter 11 protection Monday in the United States Bankruptcy Court for the District of Delaware.  Spyrus develops and sells software and other products for the electronic information security market.

The debtors are proposing DIP financing of $2 million to be obtained from John Miller, a current investor in the debtors, in exchange for a corresponding equity interest in the reorganized debtors.  The debtors are requesting that the Court set a hearing to approve a pre-packaged plan of reorganization.

The Honorable Christopher S. Sontchi has scheduled a hearing on the debtors' first day motions for today, Wednesday, March 12, 2008, at noon at the United States Bankruptcy Court in Wilmington, Delaware.

Leiner Health Products Inc., a manufacturer of store brand vitamins, minerals, and nutritional supplements, today filed a voluntary Chapter 11 petition in the United States Bankruptcy Court for the District of Delaware.  The Honorable Kevin J. Carey is presiding over the case.

According to the website the debtor has set up to disseminate information about its case, “Leiner intends to use the Chapter 11 process to restructure its debt obligations and explore the sale of the business.”  

Related entities filing petitions today include LHP Holding Corp., Leiner Health Products, LLC and Leiner Health Services Corp.

UPDATED ON MARCH 11, 2008:
The debtors have filed a motion seeking approval of debtor-in-possession financing in the amount of $74 million.  The proposed maturity date of this DIP facility is the earlier of July 31, 2008, or other possible events in the case including the closing date of a sale of all or substantially all the debtor's assets under section 363 of the Bankruptcy Code, the conversion of the case to a case under Chapter 7, the effective date of a plan of reorganization, the date on which all the loans have been repaid in full or the date of the termination of all of the commitments under the DIP facility.

The first day hearing in this case is scheduled for March 12, 2008 at 11:00 a.m.