The Intersection of Receiverships and Bankruptcy

Other Cases

The result in Bayou Group should be compared with several cases where the receivership order was not as well crafted as was the order in the Bayou Group receivership, or where there were other variants. For example, in Harder v. Premierwest Bank (In re Harder), 413 B.R. 827 (Bankr. D. Or. 2009), the bankruptcy court was presented with a request for a Section 105 Injunction by a guarantor of debts to enjoin enforcement actions by secured lenders on 250 SPEs that owned assisted living facilities. The order was denied but mediation was strongly encouraged. The bankruptcy court noted specifically that:

[t]he two federal judges that have been appointed as mediators, Ninth Circuit Judge Edward Leavy and District Court Judge Michael R. Hogan have settled some of the most contentious litigation in this state and around the country. Judges Leavy and Hogan are available immediately to work on a global settlement of what is a most complicated entanglement of economic relationships. Id. at 841.

The mediators had already begun their work and with respect to at least Judge Hogan, had strategy meetings about the mediation and overall settlement strategy with Harder's representatives prior to the bankruptcy filings and related mediations. These meetings, while somewhat unusual for initial meetings in a mediation, are not prohibited in that context. Nonetheless, despite the prospect of mediation, several bankruptcy cases were filed for the individual SPEs to stop foreclosure actions with respect to those properties.

The Harder Case

District Judge Hogan, although one of the mediators in the Harder case, subsequently had an SEC receivership for the equity sponsor and management company filed before him. SEC v. Sunwest Mgmt, Inc., No. 09-cv-06056 (D. Or. Filed Mar. 2, 2009). As the receivership court Judge Hogan issued an injunction essentially granting the relief that had been denied in the bankruptcy court by enjoining creditor action against the 250 SPEs even though the secured creditors were not parties to the receivership case. The district court then withdrew the reference of the bankruptcy cases that had been filed, suspended the filing of all stay relief motions, extended the exclusive periods in which to file plans (all without waiting for responses in opposition from creditors), and entered an order creating the Sunwest Unitary Enterprise, Stayton SW Assisted Living, LLC, as determined by the Oct. 2, 2009 Order in Sunwest Mgmt, Inc., No. 09-cv-06056 (D. Or. Oct. 2, 2009), and withdrawing the reference of In re Stayton SW Assisted Living, L.L.C., No. 08-36637 (Bankr. D. Or. Filed Dec. 1, 2008). The U. S. Trustee has moved to dismiss the bankruptcy case of the Sunwest Unitary Enterprise on the basis that a unitary enterprise is not a person and thus is not eligible to be a debtor. The next step in the cases is confirmation of a bankruptcy plan dealing with the treatment of the various creditor constituencies. Many of those will be consensual, at least with the secured lender. The appeal to the Ninth Circuit of the decisions not to disqualify Judge Hogan based on his pre-receivership role serving as a mediator was unsuccessful. On Dec. 29, 2009 the Ninth Circuit issued an unpublished decision in which it reasoned that the fact that the trial Judge was a pre-filing mediator on related issues in a bankruptcy case did not present an appearance of impropriety. SEC v. ING USA Annuity and Life Ins. Co., Case No. 09-35250 at *4 (9th Cir. 12/29/09).

In re Petters Co.

Another significant case is In re Petters Co., 401 B.R. 391 (Bankr. D. Minn. 2009), aff'd, 415 B.R. 391 (D. Minn. 2009), in which counsel that initially was contacted by “a criminal defense attorney retained by Tom Petters ' to represent the various entities of Tom Petter's business enterprise” was appointed federal receiver by the United States District Court. He then filed Chapter 11 cases for the entities for which he served as receiver, and was appointed as the Chapter 11 Trustee in those cases. 401 B.R at 396-401. Unlike the situation with Harder and Sunwest Management, the United States District Court “clarified ' that these Chapter 11 cases will go ahead fully governed by the substantive law of bankruptcy.” Id. at 408. The District Court in Petters Co. did not withdraw the reference of the bankruptcy cases from the Bankruptcy Court. Id. at 408. Also, unlike in Harder and Sunwest Management' the Bankruptcy Court in Petters Co. was careful to note that no orders granting relief would be summarily issued.

Petters Co. is also significant in that it discussed some aspects inherent in dealing with the receiver as bankruptcy trustee, particularly in dealing with a multi-debtor case, and ultimately concluded that the efficiencies associated with a single fiduciary outweighed concerns about potential conflicts, at least until the potential conflicts between and among debtors materialized into actual conflicts.

Aggressive Use of a Receivership

Bayou Group, Petters Co., Harder, and Sunwest Management are not the only examples of cases where receivers have been appointed as trustees or otherwise remained in control. Harder and Sunwest Management are an example of the most aggressive use of a receivership to pre-empt, or at least delay, the procedures and protections of the statutory structure of bankruptcy in favor of a mechanism that does not have any apparent restriction other than the discretion of the presiding judge. Bayou Group and Petters Co. are examples of the practical interpretation and application of the bankruptcy laws to facilitate continuing a receiver in possession while obtaining the benefits of many provisions of the bankruptcy laws including, among others, the automatic stay, centralized jurisdiction, and potentially expanded avoiding powers. Another potential benefit of the receiver wearing the dual hat of receiver and bankruptcy trustee is possible limitation and mitigation of the in pari delicto defense that generally applies to bankruptcy trustees but not receivers,

Additional Cases

Two other cases that merit comments are International Management Associates and Rothstein Rosenfeldt Adler PA. In re International Management Associates. LLC, No. 06-62966 (Bankr. N.D. Ga. Filed Mar. 16, 2006) is another example of a SEC receiver filing bankruptcy cases for each of the various International Management Associates entities for whom he was receiver, and then, after the bankruptcy cases were filed, the receiver was appointed to be the Chapter 11 Trustee. In re Rothstein Rosenfeldt Adler, PA, No. 09-34791 (Bankr. S.D. Fla. Filed Nov. 10, 2009) is another recent Ponzi case where a law firm was the alleged fraudulent actor. In Rothstein, an involuntary petition in bankruptcy was filed after the state court receivership had been filed and a state court receiver had been appointed. Ultimately, the state court receiver consented to the entry of an order for relief and was also appointed to serve as the Chapter 11 Trustee.

Conclusion

As noted earlier, the foregoing examples reflect a pattern of allowing a fiduciary appointed either in state court or federal court to continue in a similar fiduciary role as the trustee in bankruptcy. The unusual circumstance present in the Harder/Sunwest Management case reflects an extension of an SEC receivership to essentially displace a bankruptcy court and separate bankruptcy cases with a result oriented approach. They all reflect creative lawyering, creative judging, and sometimes reasonable compromise, leading to desired and usually practical results.

Grant T. Stein, a member of this Newsletter's Board of Editors, is a senior partner in Alston & Bird's Bankruptcy, Reorganization and Workouts Group, resident in the firm's Atlanta office. He is a Fellow in the American College of Bankruptcy, President of the Association of Insolvency and Reorganization Advisors, and Chair of the Southeastern Bankruptcy Law Institute. R. Todd Neilson is a Director in LECG, an international consulting firm. He is a Fellow in the American College of Bankruptcy and a former FBI Agent specializing in accounting fraud matters such as Ponzi schemes.

The intersection of bankruptcy and federal and state receiverships has become a fairly regular occurrence around the country. Cases from Florida, Georgia, Minnesota, New York and Oregon evidence that such incidents are taking place all across the country. There is a tension reflected in some of the cases between the primacy of the orderly and well-developed bankruptcy structure as compared with the much less structured alternative of receivership proceedings. There is also a disinterestedness issue raised by the retention of the receiver as the management of the Debtor in Possession or as the trustee in the bankruptcy. The tendency of the cases favors proceeding in the Bankruptcy Court, as well as the appointment of the receiver as bankruptcy trustee. One might also argue that there is an underlying conflict present between differing arms of the U.S. Department of Justice (DOJ) when the Office of the United States Trustee disagrees with the approach, or results, of actions taken by U.S. Attorneys and the receivers they have caused to be appointed.

In re Bayou Group, LLC

One of the recent cases to address the overlap between bankruptcy and receiverships was the Second Circuit's decision in Adams v. Marwil (In re Bayou Group, LLC)'564 F.3d 541 (2d Cir. 2009). In Bayou Group, the United States District Court appointed a receiver in a Ponzi scheme case for a series of hedge funds. The order of appointment was very well crafted and was summarized by the Second Circuit as follows:

authoriz[ing], empower[ing], and direct[ing]” Marwil [the receiver] to perform a number of “duties and responsibilities,” including the responsibility for “Corporate Governance.” Order 7(e). Marwil [the receiver] was directed to be “the sole and exclusive managing member and representative of each of the Bayou Entities [,] [possessing] ' without limitation, the authority to petition for protection under the Bankruptcy Code, 11 U.S.C. ” 101 et seq.” Id. The Order specified that the appointment was “warranted under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 thereunder, state law claims of fraud and breach of a fiduciary duty, Federal Rule of Civil Procedure 66, and the facts and circumstances of this case.” Id. at Introduction, 3 [emphasis added]. The Order further stated that the district court's authority to appoint Marwil was “[p]ursuant to 28 U.S.C. ” 754 and 959, Federal Rule of Civil Procedure 66 and [the] [c]ourt's inherent authority.” Id. 1. 564 F.3d at 544.

Following his appointment as receiver, Marwil filed a bankruptcy case for each of the entities for which he was the receiver. The U.S. Trustee then moved to have a bankruptcy trustee appointed reasoning that the receiver was a custodian under Section 543 of the Bankruptcy Code in whom post-petition management and control could not be vested. Ultimately, the Second Circuit determined that the appointment of a trustee and removal of the receiver from post-bankruptcy control was not required as a matter of law.

Other Cases

The result in Bayou Group should be compared with several cases where the receivership order was not as well crafted as was the order in the Bayou Group receivership, or where there were other variants. For example, in Harder v. Premierwest Bank (In re Harder), 413 B.R. 827 (Bankr. D. Or. 2009), the bankruptcy court was presented with a request for a Section 105 Injunction by a guarantor of debts to enjoin enforcement actions by secured lenders on 250 SPEs that owned assisted living facilities. The order was denied but mediation was strongly encouraged. The bankruptcy court noted specifically that:

[t]he two federal judges that have been appointed as mediators, Ninth Circuit Judge Edward Leavy and District Court Judge Michael R. Hogan have settled some of the most contentious litigation in this state and around the country. Judges Leavy and Hogan are available immediately to work on a global settlement of what is a most complicated entanglement of economic relationships. Id. at 841.

The mediators had already begun their work and with respect to at least Judge Hogan, had strategy meetings about the mediation and overall settlement strategy with Harder's representatives prior to the bankruptcy filings and related mediations. These meetings, while somewhat unusual for initial meetings in a mediation, are not prohibited in that context. Nonetheless, despite the prospect of mediation, several bankruptcy cases were filed for the individual SPEs to stop foreclosure actions with respect to those properties.

The Harder Case

District Judge Hogan, although one of the mediators in the Harder case, subsequently had an SEC receivership for the equity sponsor and management company filed before him. SEC v. Sunwest Mgmt, Inc., No. 09-cv-06056 (D. Or. Filed Mar. 2, 2009). As the receivership court Judge Hogan issued an injunction essentially granting the relief that had been denied in the bankruptcy court by enjoining creditor action against the 250 SPEs even though the secured creditors were not parties to the receivership case. The district court then withdrew the reference of the bankruptcy cases that had been filed, suspended the filing of all stay relief motions, extended the exclusive periods in which to file plans (all without waiting for responses in opposition from creditors), and entered an order creating the Sunwest Unitary Enterprise, Stayton SW Assisted Living, LLC, as determined by the Oct. 2, 2009 Order in Sunwest Mgmt, Inc., No. 09-cv-06056 (D. Or. Oct. 2, 2009), and withdrawing the reference of In re Stayton SW Assisted Living, L.L.C., No. 08-36637 (Bankr. D. Or. Filed Dec. 1, 2008). The U. S. Trustee has moved to dismiss the bankruptcy case of the Sunwest Unitary Enterprise on the basis that a unitary enterprise is not a person and thus is not eligible to be a debtor. The next step in the cases is confirmation of a bankruptcy plan dealing with the treatment of the various creditor constituencies. Many of those will be consensual, at least with the secured lender. The appeal to the Ninth Circuit of the decisions not to disqualify Judge Hogan based on his pre-receivership role serving as a mediator was unsuccessful. On Dec. 29, 2009 the Ninth Circuit issued an unpublished decision in which it reasoned that the fact that the trial Judge was a pre-filing mediator on related issues in a bankruptcy case did not present an appearance of impropriety. SEC v. ING USA Annuity and Life Ins. Co., Case No. 09-35250 at *4 (9th Cir. 12/29/09).

In re Petters Co.

Another significant case is In re Petters Co., 401 B.R. 391 (Bankr. D. Minn. 2009), aff'd, 415 B.R. 391 (D. Minn. 2009), in which counsel that initially was contacted by “a criminal defense attorney retained by Tom Petters ' to represent the various entities of Tom Petter's business enterprise” was appointed federal receiver by the United States District Court. He then filed Chapter 11 cases for the entities for which he served as receiver, and was appointed as the Chapter 11 Trustee in those cases. 401 B.R at 396-401. Unlike the situation with Harder and Sunwest Management, the United States District Court “clarified ' that these Chapter 11 cases will go ahead fully governed by the substantive law of bankruptcy.” Id. at 408. The District Court in Petters Co. did not withdraw the reference of the bankruptcy cases from the Bankruptcy Court. Id. at 408. Also, unlike in Harder and Sunwest Management' the Bankruptcy Court in Petters Co. was careful to note that no orders granting relief would be summarily issued.

Petters Co. is also significant in that it discussed some aspects inherent in dealing with the receiver as bankruptcy trustee, particularly in dealing with a multi-debtor case, and ultimately concluded that the efficiencies associated with a single fiduciary outweighed concerns about potential conflicts, at least until the potential conflicts between and among debtors materialized into actual conflicts.

Aggressive Use of a Receivership

Bayou Group, Petters Co., Harder, and Sunwest Management are not the only examples of cases where receivers have been appointed as trustees or otherwise remained in control. Harder and Sunwest Management are an example of the most aggressive use of a receivership to pre-empt, or at least delay, the procedures and protections of the statutory structure of bankruptcy in favor of a mechanism that does not have any apparent restriction other than the discretion of the presiding judge. Bayou Group and Petters Co. are examples of the practical interpretation and application of the bankruptcy laws to facilitate continuing a receiver in possession while obtaining the benefits of many provisions of the bankruptcy laws including, among others, the automatic stay, centralized jurisdiction, and potentially expanded avoiding powers. Another potential benefit of the receiver wearing the dual hat of receiver and bankruptcy trustee is possible limitation and mitigation of the in pari delicto defense that generally applies to bankruptcy trustees but not receivers,

Additional Cases

Two other cases that merit comments are International Management Associates and Rothstein Rosenfeldt Adler PA. In re International Management Associates. LLC, No. 06-62966 (Bankr. N.D. Ga. Filed Mar. 16, 2006) is another example of a SEC receiver filing bankruptcy cases for each of the various International Management Associates entities for whom he was receiver, and then, after the bankruptcy cases were filed, the receiver was appointed to be the Chapter 11 Trustee. In re Rothstein Rosenfeldt Adler, PA, No. 09-34791 (Bankr. S.D. Fla. Filed Nov. 10, 2009) is another recent Ponzi case where a law firm was the alleged fraudulent actor. In Rothstein, an involuntary petition in bankruptcy was filed after the state court receivership had been filed and a state court receiver had been appointed. Ultimately, the state court receiver consented to the entry of an order for relief and was also appointed to serve as the Chapter 11 Trustee.

Conclusion

As noted earlier, the foregoing examples reflect a pattern of allowing a fiduciary appointed either in state court or federal court to continue in a similar fiduciary role as the trustee in bankruptcy. The unusual circumstance present in the Harder/Sunwest Management case reflects an extension of an SEC receivership to essentially displace a bankruptcy court and separate bankruptcy cases with a result oriented approach. They all reflect creative lawyering, creative judging, and sometimes reasonable compromise, leading to desired and usually practical results.

Grant T. Stein, a member of this Newsletter's Board of Editors, is a senior partner in Alston & Bird's Bankruptcy, Reorganization and Workouts Group, resident in the firm's Atlanta office. He is a Fellow in the American College of Bankruptcy, President of the Association of Insolvency and Reorganization Advisors, and Chair of the Southeastern Bankruptcy Law Institute. R. Todd Neilson is a Director in LECG, an international consulting firm. He is a Fellow in the American College of Bankruptcy and a former FBI Agent specializing in accounting fraud matters such as Ponzi schemes.