Risky Business: Distressed Companies and Payments in the Shadow of Bankruptcy
Doing business with a customer in the shadow of bankruptcy is risky.
A hallmark of bankruptcy law is equal treatment of similarly-situated creditors. The Bankruptcy Code frowns upon a debtor who, while insolvent, pays some creditors but not others in the run-up to bankruptcy – whether voluntarily or due to pressure. Under the Bankruptcy Code, payments by an insolvent debtor to creditors in the 90 days before bankruptcy, on account of an antecedent debt, are presumptively avoidable. That means if you get one of these “preference payments,” you may be forced to return it.
There are, however, defenses to a preference payment, one of which is the “ordinary course of business” defense. A recent decision from a bankruptcy court in Delaware provides an illuminating case study on behavior that will and won’t be considered “ordinary course.” In doing so, it educates companies on best practices in dealing with a customer headed towards bankruptcy and suggests the likelihood that a bankruptcy court would order you to disgorge preference payments you received.
The Delaware case involved Fred’s, a chain of retail stores like Dollar General. C.H. Robinson provided transportation and logistics to Fred’s under a $3 million credit line. Fred’s was required to pay invoices within 30 days. When Fred’s started closing stores and struggling to make payments, C.H. Robinson tightened the credit terms by reducing the credit line to $1.75 million and then $1 million. C.H. Robinson also warned Fred’s that it would not ship Fred’s product if Fred’s did not pay to catch-up on past-due invoices. C.H. Robinson also threatened to reduce the credit terms to a 14-day payment on invoices.
Fred’s ultimately filed bankruptcy and confirmed a liquidating plan. The court-appointed liquidating trustee sued C.H. Robinson to recover 15 payments totaling over $3.4 million it received from Fred’s during the 90-day preference period.
In defense, C.H. Robinson raised the “ordinary course” defense. They argued that it was standard practice in the transportation and logistics industry to tighten credit limits based on changes in a client’s financial status and predicted future performance, so any payments resulting from that tightening were in the “ordinary course of business.”
The Bankruptcy Code requires the recipient of a preference payment to show that the debt itself was incurred in the ordinary course of the business of both parties and that the payment of that debt was (a) made in the ordinary course of the business of both parties (what is sometimes described as the “subjective” test) or (b) made according to ordinary business terms (the “objective” test). The phrase “ordinary business terms” in the objective test looks to the general norms of the creditor’s industry.
The Court stressed that “ordinary course” and “ordinary business terms” mean conduct that is ordinary when dealing with a healthy company. “Ordinary course” does not apply to how either the defendant or the industry treats a distressed company. Thus, preference payments made under a payment plan are not “ordinary course,” nor are payments resulting from pressure tactics. The relevant yardstick is a healthy debtor, not a distressed one.
The upshot is that “ordinary course” means business as usual. A distressed debtor can pay you the way they always paid you. But if the distressed debtor singles you out as special among all his creditors and brings your past-due obligation current before bankruptcy, it might not be ordinary course. And if you resorted to a demand letter, threat, workout agreement, or full nelson to get the distressed debtor to cough up his payments, then it’s probably not ordinary course.
Doing business with a distressed debtor can pose a dilemma for companies. When faced with this situation, seek all the financial information you can get your hands on to understand the debtor’s situation. Continuing to provide the debtor credit or goods and services under ordinary terms may save it from bankruptcy. And if they stop paying you, you can do everything allowed under your contract to collect. But you need to be prepared for a preference claim if the debtor files bankruptcy.
Weekly Bankruptcy Alert February 17, 2025 (For the Week Ending February 16, 2025)
Covering reported business bankruptcy filings in Massachusetts, Maine, New Hampshire, and Rhode Island, and Chapter 11 bankruptcy filings in New York and Delaware listing assets of more than $1 million.
Chapter 11
Debtor Name
BusinessType1
BankruptcyCourt
Assets
Liabilities
FilingDate
Splashlight Holding LLC(New York, NY)
Not Disclosed
Manhattan(NY)
$50,000,001to$100 Million
$50,000,001to$100 Million
02/12/25
Chapter 7
Debtor Name
BusinessType1
BankruptcyCourt
Assets
Liabilities
FilingDate
Westford ILKB, LLC(Westford, MA)
Not Disclosed
Worcester(MA)
$0to$50,000
$100,001to$500,000
02/13/25
Camston Wrather LLC2(Fort Lauderdale, FL)
Remediation and Other Waste Management Services
Wilmington(DE)
$10,000,001to$50 Million
$100,000,001to$500 Million
02/13/25
1Business Type information is taken from Bankruptcy Court filings, which may include incorrect categorization by the debtor or others.
2Additional affiliate filings include: Camston Wrather Sub Co., LLC, Camston Wrather Plants Co., LLC, Camston Wrather Management Co., LLC, Camston Wrather Tech Co., LLC, Camston Wrather Lab Co., LLC, Stream Recycling Solutions, LLC, Stream Recycling Solutions of California, LLC, Camston Wrather (PA) LLC, Camston Wrather (TX) LLC, Three D Security, LLC, Camston Carlsbad, LLC, and Camston Carlsbad Asset I, LLC.
Independent Manager Consent Requirement Upheld
Recently, the Bankruptcy Court for the Northern District of Illinois issued an opinion in In re 301 W N. Ave., LLC, dismissing a debtor’s bankruptcy filing for lack of proper authority to file and discussing the considerations for enforcing a requirement that an Independent Manager approve a bankruptcy filing for a Delaware limited liability company. 2025 WL 37897 (Bankr. N.D. Ill. 2025). The opinion is consistent with “Authority to File” opinions regularly provided in structured finance transactions involving Delaware LLCs that have Independent Managers whose consent is required to file bankruptcy. Practitioners should be aware of the Bankruptcy Court’s analysis concerning LLC agreements and may want to update future Authority to File opinions to reference this case.
Case Background
On January 6, 2025, the Bankruptcy Court dismissed a chapter 11 bankruptcy case, holding that the Debtor, which was organized as a Delaware LLC, lacked the requisite authority to file its bankruptcy petition under Delaware law. Prior to the bankruptcy filing, the Debtor entered into a $26 million secured Loan Agreement, which required the appointment of an Independent Manager. The Loan Agreement further required that the Debtor’s governing documents require the Independent Manager to consent to certain significant business decisions, including whether to authorize the Debtor to file bankruptcy. The Debtor’s LLC Agreement complied with the Loan Agreement’s requirements. The Debtor’s LLC Agreement also required the Independent Manager to consider the interests of the Debtor, including the Debtor’s creditors, when making any significant business decision, including any decision to file bankruptcy. Id. at *11. Nevertheless, the Debtor filed bankruptcy without the Independent Manager’s consent.
The Debtor’s lender filed a motion to dismiss the bankruptcy case, arguing that the Debtor lacked authority to file the bankruptcy petition because it failed to obtain the Independent Manager’s consent, as required by the LLC Agreement. The Bankruptcy Court agreed. The Bankruptcy Court first noted that under Delaware law, an LLC can act only through the authorization provided by its operating agreement, and that here, the LLC Agreement required the consent of the Independent Manager to file a bankruptcy petition. Id. at *7. As a result, the Bankruptcy Court concluded that the Debtor lacked the proper authority to file.
The Bankruptcy Court next considered whether the LLC Agreement impermissibly restricted the Debtor’s right to file bankruptcy. In this case, the LLC Agreement required the Independent Manager to consider only the interests of the Debtor, including the Debtor’s creditors, when deciding whether to file bankruptcy. Id. at *11. The LLC Agreement also expressly instructed the Independent Manager not to consider the interests of other third parties, including affiliates or groups of affiliates, when exercising its decision-making authority. Id. at *12. Although the Debtor argued that these provisions constituted an inappropriate restriction on the Debtor’s ability to file bankruptcy, the Bankruptcy Court concluded that restricting or eliminating the Independent Manager’s duties to the Debtor’s affiliates or groups of affiliates was “entirely consistent with Delaware law and cannot be construed to contravene public policy.” Id. at *12. After concluding that the LLC Agreement did not impermissibly restrict the Independent Manager’s obligation to consider the Debtor’s interests, and having already concluded that the Independent Manager did not consent to the bankruptcy, the Bankruptcy Court granted the motion to dismiss.
The Debtor appealed the Bankruptcy Court’s decision (appeal pending).
Potentially Updating Authority to File Opinions
Authority to File opinions are legal opinions provided in many structured finance transactions that address whether, under the terms of the applicable LLC agreement, the requirement that an Independent Manager consent to a bankruptcy filing of the LLC would be governed by state law, and not federal law. In other words, Authority to File opinions address whether a provision requiring an Independent Manager to consent to a bankruptcy filing would be preempted by federal law as an impermissible restriction. Authority to File opinions are only provided for LLCs because the law regarding corporations and partnerships is well settled.
The language in the 301W N. Ave Debtor’s LLC Agreement concerning what the Independent Manager should, and should not, consider is similar to language used in many LLC agreements that are subject to Authority to File opinions. In particular, since the In re General Growth Properties, Inc. bankruptcy case in 2009, many LLC agreements provide that Independent Managers should consider only the interests of the LLC, including its creditors, in deciding whether to consent to a bankruptcy, and should not consider the interests of affiliates or groups of affiliates. As the Bankruptcy Court here expressly analyzed such a provision, practitioners may want to update their Authority to File opinions to specifically reference 301 W N. Ave.
Conclusion
301 W N. Ave re-affirms the validity of LLC agreement provisions requiring an Independent Manager’s consent to file bankruptcy when the Independent Manager is required to consider the interests of only the LLC, including its creditors, and not the interests of the LLC’s affiliates or groups of affiliates. Accordingly, 301 W N. Ave also re-affirms the analysis used in Authority to File opinions in structured finance transactions.
Are you Making Progress? The Scottish Court Provides Helpful Pointers to English Administrators Seeking to Extend on the Content of Progress Reports
Although the case of Anthony John Wright and Alastair Rex Massey vs. Scottish Court of Session [2024] CSOH 105 is (as the name suggests) a Scottish decision, there are several takeaways from the case relating to the content of progress reports, which could usefully be applied and followed by English practitioners when making their own application. Not least, because of the words of warning from the judge:
“It is important that administrators and their advisers bear in mind that an extension of an administration should never be applied for, or granted, as a matter of formality. It is not uncommon for the court to encounter cases where serial applications have been made, often on (literally) the same grounds from 1 year to the next, with no discernible sign of progress being made; and of course, if there is an expectation that extensions will be granted without difficulty, there is a danger that administrators will not be incentivised into completing the administration within the existing deadline, confident that another one will be along in the fullness of time“
This case concerned an application to extend an administration that had originally commenced on 19 November 2020 and had been extended on three previous occasions. The court was keen to understand what progress had been made, that creditors had been informed of the application and given a chance to object and that the extension period was the appropriate length.
Despite the warning above the judge acknowledged that this administration was complex and did not fall into that category and was prepared to take at face value the assertion that further time was required to conclude the administration, despite some misgivings about the information in the progress reports.
Progress Reports
Typically, when making an application to extend, an administrator will rely on the last progress report to evidence what work has been undertaken and what additional work is still to be done.
However as noted by the judge it is not uncommon to see applications to extend made on the same grounds from one year to the next – and this is something which we also see in applications made before the English courts. That is not to say that an extension will not be granted where the reasons for the extension are the same, but there are some helpful lessons from this judgment which could usefully be utilised by English practitioners.
Evidence of progress following previous extensions
In this case the judge said that at the very least, when a previous extension has been granted on essentially the same grounds, the administrators should explain why they have been unable to complete the outstanding steps in the time available.
The judge extracted a few examples from the progress reports where it was not obvious (without further explanation) why it had taken the administrators more than four year to complete the work:
reconcile issues with a small number of trade suppliers,
interrogate the company’s records,
continue investigations into the affairs and transactions of the company, as well as the conduct of directors,
continue liaising with the purchaser’s finance and property teams,
review and deal with any third-party assets.
Each time an extension had been requested the progress reports had listed much of the same work that needed to be completed and the same, or similar wording appeared in the reports.
That is not to say that an extension won’t be granted when the reasons for an extension are the same, but the court was critical of the fact that year on year the same statements were used in the progress report to explain what work was still to be done. For example, this statement was repeatedly given:
“The Administrators’ trading account is not yet complete due to unreconciled positions with several of the cash processing providers and trade suppliers alike. It is envisaged that all these matters will be finalised in the next reporting period“
The same or similar wording appeared in multiple reports and the judge said that repeating the expression that it was envisaged that “these matters” will be finalised in the following reporting period was starting to sound “somewhat hollow”.
The underlying message was that a progress report should evidence what progress had been made in the last period and simply tweaking a report without giving meaningful updates and explanations is unsatisfactory – becoming more so, the longer the administration continues.
Statutory Tasks
In this case multiple reasons were given to support the extension including finalising “all costs associated with the administration” and attending to and completing “all statutory and administrative matters necessary for completion of the administration”. The judge noted that those tasks are applicable in any administration, and to say that they are outstanding does not really go any way towards explaining why an extension is necessary.
Regardless of whether an application is made before an English or Scottish court it would be unusual to rely on these as the only reasons for an extension, but clearly as the judge’s comments indicate, more is required to justify an extension than statutory tasks that a practitioner can be expected to undertake as a matter of course.
Information to creditors
The process and expectations of the Scottish courts in dealing with an administration extension are different, compared to English practice and procedure – the Scottish courts expect unsecured creditors to be notified of the application and to be given an opportunity to object even where they are not expected to get a return. Actively inviting objections is not, as a rule of thumb, something that English courts expect practitioners to do.
However, English practitioners will, as standard, notify all creditors of their intention to seek an extension and their reasons for doing so in a progress report. The Insolvency Service has previously suggested (see Dear IP October 2010) that this should be done only where there is a realistic expectation that an application for an extension will be made within three or four months of the progress report. This is a much shorter period than that mentioned by the judge in this Scottish case who said that it was likely to be acceptable for administrators to rely on a report that was 6 months old, where creditors had been told that an extension was required.
There isn’t, in our view, a hard and fast rule about the age of a progress report, the key question must be whether at the time of the report the administrator knew and could give reasons why an extension was required. Where a creditor portal is being used, informing creditors is much easier and if circumstances have changed or the progress report is a bit older updating creditors with a letter via the portal seems a sensible thing to do – the court can then be satisfied that creditors are informed.
However, there was no suggestion by the Insolvency Service in Dear IP October 2010 that English administrators should actively invite objections – this seems to be a long-standing practice confined to the Scottish Courts and we are sure that English administrators will hope it stays that way!
Key Takeaways
Although this decision is not binding on the English courts, the below takeaways are sensible and would undoubtedly assist English practitioners with an application to extend given that an English court will also want to understand why an extension is required and what progress has been made:
Simply saying that more time is required, for the same task without more detail is unlikely to be viewed favourably especially so where the task appears on the face of it to be something that can be completed within the extended period.
If a prior report says that the administrators expect/hope that a task will be completed in the next reporting period, but it hasn’t, explain why that hasn’t been possible.
Ensure reports contain ‘meaningful’ and sufficient information. Avoid simply repeating or regurgitating the same statements in successive progress reports as a matter of course. A progress report should evidence progress.
If using a previous version of a progress report to produce the next one, review the statements given previously and add an update.
If the circumstances have changed since a progress report was produced or it is becoming a bit old, consider updating creditors with a letter via the creditor portal (if there is one).
Requiring an extension to complete statutory tasks is unlikely on its own to be sufficient justification for an extension.
Separately, the court was required to consider the length of the extension having agreed to extend. The secured creditor had consented to an extension (but only for a 6-month period) the administrators wanted a 12-month extension. The judge confirmed that there isn’t a policy of granting year long extensions and that granting an extension for a year should not therefore be presumed. He also referenced instances of where administrators had asked for 12 months but when pressed they had accepted a shorter period.
As noted at the outset, administrators have to be incentivised to conclude an administration, and countless extensions are unlikely to do achieve that. But there is a balance between imposing a realistic deadline so that the tasks which need to be done, can be, and not giving enough time such that further cost will be incurred in having to come back to court to extend again. Each case will be considered on its own merits, and we have seen the English courts grant long extensions where administrators have been able to justify why a long period is required, but as with any application to extend practitioners should not assume that these will be rubber stamped without full explanation and justification for the extension as this case also demonstrates.
Bankruptcy Dollar Amounts Set to Rise Significantly on April 1, 2025
Every three years on April 1, the dollar amounts in the Bankruptcy Code are adjusted to account for inflation. The April 1, 2025, increase will be approximately 13.2%, even larger than the nearly 11% increase three years ago.
Bankruptcy Code section 104 requires the Judicial Conference of the United States to publish the changes at least a month before they take effect. On February 4, 2025, the Judicial Conference published this year’s increase in the Federal Register.[1] The planned 13.2% increase in statutory dollar limits will affect nearly everything in bankruptcy that has a dollar limit, including
the amount of property that a debtor may exempt from the estate,
the maximum amount of certain “priority” claims, such as for employee wages and for deposits for certain undelivered products and services,
the minimum aggregate claims needed to file an involuntary bankruptcy petition, and
the aggregate debt limits used to determine which debtors qualify to file cases under chapter 13 or subchapter V of chapter 11.
Anyone who relies on specific dollar limits in the Bankruptcy Code should note these changes.
Note, subchapter V of chapter 11 previously had a debt limit of $7,500,000, but as we reported earlier, this debt limit reverted on Friday, June 21, 2024, to $3,024,725. The subchapter V debt limit will rise to $3,424,000 on April 1, 2025, as part of this triennial adjustment.
Michigan has dollar limits for its own set of state-specific bankruptcy exemptions, and its dollar limits increase every three years as well. They increase on a different three-year cycle, though. They were last increased March 1, 2023, and are not set to increase again until 2026.
[1] Adjustment of Certain Dollar Amounts Applicable to Bankruptcy Cases, 90 FR 8941-01.
Weekly Bankruptcy Alert February 10, 2025 (For the Week Ending February 9, 2025)
Covering reported business bankruptcy filings in Massachusetts, Maine, New Hampshire, and Rhode Island, and Chapter 11 bankruptcy filings in New York and Delaware listing assets of more than $1 million.
Chapter 11
Debtor Name
BusinessType1
BankruptcyCourt
Assets
Liabilities
FilingDate
7 Wales Street, LLC(Dorchester, MA)
Not Disclosed
Boston(MA)
$500,001to$1 Million
$100,001to$500,000
2/3/25
SBF Ventures, LLC(Boston, MA)
Not Disclosed
Boston(MA)
$1,000,001to$10 Million
$1,000,001to$10 Million
2/3/25
Zmetra Land Holdings, LLC(Webster, MA)
Lessors of Real Estate
Worcester(MA)
$1,000,001to$10 Million
$1,000,001to$10 Million
2/4/25
MMK Subs, LLC(Westbrook, ME)
Not Disclosed
Portland(ME)
$50,001to$100,000
$500,001to$1 Million
2/4/25
MMK Family Investments, Inc.(Biddeford, ME)
Not Disclosed
Portland(ME)
$50,001to$100,000
$500,001to$1 Million
2/4/25
York Beach Surf Club LLC(York, ME)
Traveler Accommodation
Portland(ME)
$10,000,001to$50 Million
$10,000,001to$50 Million
2/6/25
Omega Therapeutics, Inc.(Cambridge, MA)
Pharmaceutical and Medicine Manufacturing
Wilmington(DE)
$100,000,001to$500 Million
$100,000,001to$500 Million
2/10/25
Orispel V LLC(New York, NY)
Not Disclosed
Manhattan(NY)
$10,000,001to$50 Million
$10,000,001to$50 Million
2/7/25
Xinergy Corp.2(Knoxville, TN)
Mining, Quarrying and Oil and Gas Extraction
Wilmington(DE)
$10,000,001to$50 Million
$50,000,001to$100 Million
2/7/25
Chapter 7
Debtor Name
BusinessType1
BankruptcyCourt
Assets
Liabilities
FilingDate
JPKS Management LLC(Manchester, NH)
Restaurants and Other Eating Places
Concord(NH)
$0to$50,000
$1,000,001to$10 Million
2/5/25
Bruneau Antiques Inc.,d/b/a Bruneau & Co Auctioneers(North Scituate, RI)
Retail Trade
Providence(RI)
$0to$50,000
$500,0001to$1 Million
2/6/25
1Business Type information is taken from Bankruptcy Court filings, which may include incorrect categorization by the debtor or others.
2Additional affiliate filings include: Brier Creek Coal Company, LLC, Bull Creek Processing Company, LLC, Raven Crest Contracting, LLC, Raven Crest Leasing, LLC, Raven Crest Minerals, LLC, Raven Crest Mining, LLC, Shenandoah Energy, LLC, South Fork Coal Company, LLC, White Forest Resources, Inc. and Xinergy of West Virginia Inc.
Michelle Pottle also contributed to this article.
Valuing Real Estate Assets in Bankruptcy: Ethical Considerations and Practical Insights
Real estate bankruptcies present intricate legal and ethical challenges, particularly concerning asset valuation. Accurate valuations are pivotal as they influence negotiations, creditor recoveries, and court proceedings. Ensuring that all parties—attorneys, lenders, property owners, and appraisers—adhere to ethical standards is crucial for maintaining transparency, fairness, and compliance within the bankruptcy process.
The Importance of Valuation in Real Estate Bankruptcy
David Levy, Managing Director for Keen-Summit Capital Partners and Summit Investment Management, notes that valuations play a pivotal role in bankruptcy cases, influencing everything from cash collateral motions to asset sales and plan confirmation. Whether dealing with declining or appreciating property values, parties must navigate competing interests and ethical obligations. Ethics in real estate bankruptcy encompasses adherence to professional obligations, legal requirements, and moral principles to ensure integrity in all dealings. Ethical lapses can lead to significant legal consequences, reputational damage, and financial losses.
Key Ethical Rules Relevant To Real Estate Bankruptcy
Robert Richards, chair of Dentons’ Global Restructuring, Insolvency and Bankruptcy practice group, emphasizes that attorneys and valuation professionals must adhere to the American Bar Association (ABA) Model Rules throughout the valuation process. Several ABA Model Rules are pertinent when navigating real estate bankruptcy cases, including:
Rule 1.3 (Diligence): Attorneys must act with reasonable diligence and promptness in representing their clients, ensuring that cases progress efficiently and clients’ interests are adequately pursued. This includes the proper investigation and verification of valuation reports.
Rule 3.3 (Candor Toward the Tribunal): Lawyers are required to ensure that all statements to the court are truthful and complete, avoiding material omissions that could mislead the tribunal. In bankruptcy valuations, attorneys are obligated to provide truthful information and avoid misrepresenting asset values.
Rule 3.4 (Fairness to Opposing Parties and Counsel): Attorneys must not unlawfully obstruct another party’s access to evidence or alter, destroy, or conceal material with potential evidentiary value. This requirement includes ensuring transparency and fairness when presenting valuation data in negotiations.
Rule 4.1 (Truthfulness in Statements to Others): In the course of representing a client, a lawyer shall not knowingly make a false statement of material fact or law to a third person.
Valuation Challenges in Bankruptcy Proceedings
Valuation plays a critical role in real estate bankruptcy cases, affecting negotiations, creditor recoveries, and court proceedings. A proper valuation framework helps determine whether secured creditors are adequately protected, ensures that distressed assets are sold at fair market value, and establishes creditor claims appropriately.
Common Valuation Methods
Several methods are used to determine real estate asset values in bankruptcy. Mark Silverman, a partner at Troutman Pepper Locke, highlights the two most common valuation approaches used in bankruptcy cases:
Appraisals: A professional opinion of value based on market trends, property conditions, and comparable sales.
Broker Opinion of Value (BOV): A more market-driven estimate from real estate brokers who understand local conditions.
Valuations should be supported by thorough documentation and clear methodologies to avoid challenges and ensure credibility.
Ethical Considerations in Valuation Practices
Real estate bankruptcies can present various ethical dilemmas related to valuation. Withholding material facts or misrepresenting valuations can lead to legal and reputational consequences. Overstating or understating property values to influence negotiations or court decisions can violate ethical guidelines and legal regulations. Professionals must also be cautious when representing multiple parties with potentially conflicting interests, ensuring that their duties remain aligned with ethical standards.
Transparency in Asset Valuation
Transparency is a fundamental principle in real estate bankruptcy proceedings. All stakeholders, including creditors, courts, and potential buyers, rely on accurate and complete information to make informed decisions. Ethical obligations require full disclosure of all material facts, including pending offers, financial conditions, and market trends. A lack of transparency can lead to mistrust, legal complications, and potential accusations of fraud.
Attorneys and financial advisors must ensure that their clients provide truthful and comprehensive disclosures. This includes being candid about property conditions, occupancy rates, and market comparables. Ethical rules such as ABA Model Rule 3.3 require attorneys to disclose any material information that may impact the court’s decision-making process. Failure to do so can result in sanctions and reputational damage.
Managing Conflicts of Interest
Avoiding conflicts of interest is a prevalent concern in real estate bankruptcy cases, particularly when professionals have relationships with multiple stakeholders. For example, an attorney representing a property owner may have financial ties to other business interests of the client, which could compromise their ability to provide objective advice.
Ethical guidelines emphasize the need for attorneys to avoid representing conflicting interests without full disclosure and informed consent. When conflicts arise, attorneys and financial advisors must take steps to address them appropriately. This may involve withdrawing from representation, seeking independent valuations, or ensuring that their recommendations align with the best interests of creditors and other stakeholders.
Manipulation of Valuation Data
Manipulating property valuation data is an ethical pitfall that can have severe legal and financial consequences. Stakeholders may be tempted to overstate property values to secure more favorable loan terms or misrepresent financial conditions to minimize creditor recoveries. Such practices violate ethical obligations and can lead to litigation or regulatory scrutiny.
Common tactics of valuation manipulation include using inappropriate comparables, omitting key expenses, and inflating projected income. Ethical compliance requires professionals to use reliable valuation methodologies, such as third-party appraisals, BOVs, and comparable sales analysis. ABA Model Rule 4.1 prohibits the making of false or misleading statements, emphasizing the need for honesty in all financial representations.
Regulatory Developments Impacting Valuation Practices
Recent regulatory developments have introduced additional considerations for ethical valuation practices:
Automated Valuation Models (AVMs): On June 24, 2024, six federal agencies finalized a rule to create safeguards for automated valuation models in the real estate industry. The rule requires companies that utilize AVMs to implement quality control standards to ensure data accuracy, protect against data manipulation, and prevent discriminatory impacts.
Addressing Discrimination in Appraisals: The Federal Financial Institutions Examination Council (FFIEC) has emphasized the importance of mitigating risks arising from potential discrimination or bias in real estate appraisals. Examiners are encouraged to evaluate appraisal practices to ensure compliance with consumer protection laws and promote credible valuations.
Best Practices for Ethical Compliance in Bankruptcy Valuation
Matt Christensen of Johnson May notes that adhering to best practices can ensure ethical and effective valuation processes. To navigate valuation challenges effectively, professionals involved in real estate bankruptcies should adhere to the following best practices:
Maintain Transparency: Ensure all stakeholders, including creditors and the court, have access to accurate and complete information.
Engage Independent Valuations: Avoid conflicts of interest by using reputable third-party appraisers or brokers.
Document Communications: Keep records of all discussions and disclosures to prevent disputes over what was shared.
Adhere to Fiduciary Responsibilities: Focus on acting in the best interests of creditors when insolvency is a factor.
Understand the Legal Implications: Legal counsel should stay updated on ethical obligations and ensure compliance with jurisdiction-specific rules.
Conclusion
Ethical considerations in real estate bankruptcy, particularly regarding asset valuation, are critical to fair and effective resolution processes. Whether representing borrowers, lenders, or stakeholders, professionals must ensure they act with integrity, transparency, and adherence to established legal and ethical guidelines.
To learn more about this topic view Valuing Real Estate Assets. The quoted remarks referenced in this article were made either during this webinar or shortly thereafter during post-webinar interviews with the panelists. Readers may also be interested to read other articles about real estate-focused bankruptcy cases.
This article was originally published on DailyDAC.
©2025. DailyDAC TM. This article is subject to the disclaimers found here.
4 Lease Auction Tips for Landlords
During a retail bankruptcy, commercial landlords often face challenges when their tenants try to maximize the value of the bankrupt estate by holding lease auctions. Despite lease provisions that may restrict or prohibit a lease sale, courts have generally allowed retail debtors to conduct such sales. This is because lease clauses that attempt to limit or prohibit a lease sale are often disregarded as “ipso facto” clauses, which are unenforceable in bankruptcy.
Smart landlords have shifted their focus from trying to prohibit lease sales to influencing how these sales are conducted and what information the landlord may request for “adequate assurance” of future performance by the potential new tenant.
Here are four tips for the next time your lease is part of a lease auction.
Know What to Request as Adequate Assurance
Adequate assurance refers to a guarantee or proof provided to a landlord in a potential new lease demonstrating the ability to continue fulfilling future contractual obligations of the lease. Basically, it helps convince the landlord that this new tenant will meet the lease commitments.
At a minimum, landlords should request information from the exact proposed assignee of the lease, including:
The exact name of the entity which is going to be designated as the proposed assignee;
The proposed assignee’s and any guarantor’s tax returns and audited financial statements (or un-audited, if audited financials are not available) and any supplemental schedules for the last calendar or fiscal years;
If there was a guarantor on the original lease, then identify a guarantor on this lease;
The number of other retail stores the proposed assignee operates and all trade names that the proposed assignee uses;
A statement setting forth the proposed assignee’s intended use of the premises;
The proposed assignee’s business plans, including sales and cash flow projections; and
Any financial projections, calculations, and/or financial pro-formas prepared in contemplation of purchasing the
Demand Payment of Cure Costs
As a function of any assignment, a landlord should demand that they be brought current with all liabilities, payments, and other covenants. Sometimes an assignee may request a waiver of cure costs. This is a business decision for the landlord. However, the landlord should not feel like it can’t say no. Sometimes, a request to waive these costs is just another attempt to sweeten a deal. Meaning the potential tenant may still assume the lease even if you say no.
Consider Bidding on Your Own Lease
Sometimes, a landlord may want to control the space for its own financial reasons. For instance, potential new tenant, whom the landlord really wants in the center, may approach the landlord to lease the space. Or, the landlord may be looking to sell the center. In both instances, having control of the space is essential. However, the Bankruptcy Code provides a debtor the right to continue the lease unless it is rejected or sold. The debtor has up to 210 days to assume or reject the lease. So waiting the debtor out may not be a viable option. As such, it may be advantageous for a landlord to buy back its own lease to ensure certainty.
If this is the case, it’s important to assert your rights to credit bid, when the Debtor files the initial motion to sell leases. Your credit bid may allow you to assert all prepetition claims, as well as avoid placing a deposit, as is common with new bidders. Further, you may want to attend the auction but not bid. Generally, if a landlord asserts this right during the bidding procedures motion process, the debtor will allow them to attend. But again, it needs to be asserted before the order is entered. Also, if the lease is not listed to be sold in the initial motion, nothing stops a landlord from reaching out to the debtor to make an offer to buy back the lease.
Review Your Lease for Restrictions
Lease assignments during bankruptcy can be contentious. Landlords may object to the assignment of leases to new tenants, but these objections are often overruled unless the landlord can demonstrate that the new tenant would disrupt the tenant mix and balance of the shopping center. For instance, is there a lease restriction that would violate another lease? If so, you want to argue that point now.
Commercial landlords may have to navigate the complexities of bankruptcy law, which often favors the debtor’s ability to assign leases. However, landlords can still seek to impose reasonable restrictions on the conduct of auctions and assert their lease rights.
If you are a landlord or trade creditor in a retail bankruptcy, it is vital to know your rights now. Stark & Stark’s Shopping Center and Retail Development Group can help. Our bankruptcy attorneys regularly represent landlords throughout the country, including the Eastern District of Missouri, District of New Jersey, Southern District of New York, District of Delaware, District of Minnesota and the Western and Eastern Districts of Pennsylvania regarding a variety of issues. Most recently, our Group has represented landlords and trade creditors in the Party City, Big Lots, Tijuana Flats, Rite Aid, Blink Fitness, Express, JOANN’s and Sports Authority chapter 11 bankruptcy cases.
A BIG LOTS Chapter 11 Lesson: Caution Needed When Doing Business with Chapter 11 Debtors
Vendors, landlords, and other creditors often feel a sense of security when doing business with Chapter 11 debtors. The Bankruptcy Code, and even court orders entered at the outset of a bankruptcy case, seemingly provide a myriad of protections to those engaging in business with a company reorganizing under Chapter 11.
Indeed, Chapter 11 debtors often induce continued business by suggesting that they are “required” to pay all post-bankruptcy obligations in full. Nevertheless, these protections and assurances often prove to be optical illusions, leaving creditors holding the bag with significant unpaid post-petition obligations at the end of a bankruptcy case.
The recent Big Lots Chapter 11 bankruptcy filing is a massive warning signal that exposes the significant risks of doing business with Chapter 11 debtors.
Landlord Protections
The Bankruptcy Code provides heightened protections to landlords when dealing with Chapter 11 debtors. Pursuant to section 365(d)(3) of the Bankruptcy Code, a tenant debtor is required to “timely perform all the obligations of the debtor… arising from and after the petition date” under any unexpired lease. This means they must continue to fulfill lease obligations that come due after the bankruptcy filing until the lease is either assumed or rejected by the debtor.
Essentially, a landlord is entitled to receive post-petition rent payments as a high-priority administrative expense claim if the tenant does not pay in a timely manner.
Pursuant to the Bankruptcy Code, shopping center landlords are entitled to additional protections when a lease is assumed and assigned. In such circumstances, a Chapter 11 debtor must cure any defaults and provide “adequate assurance” of future performance under the lease.
If the lease qualifies as “a lease for real property in a shopping center,” a landlord is entitled to “adequate assurance” for certain specific obligations. “Adequate assurance” is intended to protect a landlord from a decline in the value of the subject premises if a lease is assumed. The assurances include requirements that:
the financial condition and operating performance of any assignee be similar;
percentage rent does not decline substantially;
all other provisions of the lease apply, such as exclusive use clauses; and
the tenant mix or balance at the shopping center not be disrupted.
“Adequate assurance” that a landlord will be compensated for any pecuniary loss is a condition to the assumption of a lease of real property in a shopping center. With such protections, landlords may feel a false sense of confidence when dealing with Chapter 11 debtors.
Trade Creditor Post-Bankruptcy Protections
The Bankruptcy Code also provides various protections to vendors that provide goods and services to Debtors after a bankruptcy is filed. Claims for such services are generally entitled to administrative expense priority status over other unsecured creditors. Further, vendors who deliver goods to debtors within twenty days before the bankruptcy filing are also entitled to administrative expense status under Section 503(b)(9) of the Bankruptcy Code.
Additionally, in many cases, Debtors seek orders allowing certain vendors to be treated as critical vendors. Based upon the doctrine of necessity, Debtors not only commit to paying critical vendors for post-petition goods, but must pay critical vendors for pre-bankruptcy claims.
Finally, to confirm a Chapter 11 bankruptcy plan, a debtor must show that it can pay all its administrative claims in full. Similar to landlords, trade creditors may also feel a false sense of post-petition security, given all of these purported protections.
Big Lots Chapter 11 Bankruptcy Leaves Administrative Creditors Massively Exposed
The recently filed Big Lots Chapter 11 bankruptcy case provides a stark illustration of the risks of doing business with a debtor post-bankruptcy. Big Lots’ proposed creditor protections proved to be mirages leaving post-petition claims substantially exposed to non-payment.
Immediately upon filing for bankruptcy protection, Big Lots provided certain assurances to its landlord and vendor community. To secure its Debtor in Possession financing, Big Lots’ Chapter 11 plan committed to a budget that included payment of landlord stub rent claims. Big Lots also commenced a critical vendor program, offering payment of pre-bankruptcy claims in return for continued open credit terms.
Big Lots also commenced a sale process that proposed to sell its business as a going concern, including over 800 stores, to Nexus Capital Partners (“Nexus”). With representations that a continued going concern business was in process, creditors were induced into continued business with Big Lots.
How the Big Lots Chapter 11 Plan Failed
As part of the sale to Nexus, Big Lots was required to deliver certain inventory value. To achieve the necessary asset value, Big Lots used its post-petition trade credit and incurred over $215 million in debt to build up its post-petition inventory. This was in addition to $38 million in 503(b)(9) twenty-day vendor claims, as well as additional post-bankruptcy landlord claims. Simply put, Big Lots exposed its trade credit and landlord constituents to well over $250 million of post-petition credit to close the deal with Nexus.
Due to Big Lots’ inability to deliver its asset value obligations under the Asset Purchase Agreement (APA) – despite pumping up over $200 million in trade credit – Nexus would not close the sale. This left Big Lots exposed to a complete fire-sale liquidation and a massive administratively insolvent estate, with little, if any, of the post-petition obligations to be paid.
GBRP Saves the Day, Sort Of
“Luckily,” total catastrophe was averted by a last-minute sale transaction with Gordon Brothers Retail Properties (“GBRP”) where between 200 and 400 stores will be saved. However, the GBRP transaction only provides minimal hope for recovery to post-bankruptcy vendors and landlords.
As part of its APA, GBRP will pay select post-petition creditors, leaving most vendors and landlords in the cold. GBRP’s APA protects professionals, certain landlords, and go-forward trade creditors without covering the post-petition obligations accrued to date. The proposed APA terms created categories of preferred administrative claimants, with the balance remaining prejudiced by the sale.
For example, Big Lots’ Chapter 11 wind-down budget increased a prior fee reserve for professionals by $13,438,000 for two months of continued service. In addition, certain landlords will be paid $17 million in satisfaction of unpaid administrative rent and Debtors will purportedly remain current on their rent going forward. This, while the $250 million in other post-bankruptcy claims remains largely unpaid.
Big Lots and GBRP carved out approximately $19 million in assets (tax refunds, litigation proceeds, and a percentage of real estate sales), which will remain behind to pay a paltry dividend to administrative claimants.
The creditor community raised concern that the GBRP sale violated the priority scheme of the Bankruptcy Code, by allowing Big Lots to pick and choose among its creditors. The court overruled the creditor community’s cries that proceeds of the GBRP sale be escrowed with distributions and priority to be decided post-closing. The Bankruptcy Court allowed the transaction to proceed per the terms mandated by GBRP.
Avoiding the Big Lots Chapter 11 Outcome
In sum, while numerous trade vendors and landlords engaged with Big Lots after the bankruptcy was filed, feeling secure that their post-petition claims would be paid, they are now left with over $200 million in post-petition debt, with only nominal distributions on the horizon.
Big Lots’ Chapter 11 provides a harsh lesson that no matter what protections or assurances are assumed, creditors must be vigilant in enforcing their post-petition rights and be wary when extending post-petition credit, or otherwise engaging in business with a Chapter 11 debtor.
Weekly Bankruptcy Alert February 4, 2025 (For the Week Ending February 2, 2025)
Covering reported business bankruptcy filings in Massachusetts, Maine, New Hampshire, and Rhode Island, and Chapter 11 bankruptcy filings in New York and Delaware listing assets of more than $1 million.
Chapter 11
Debtor Name
BusinessType1
BankruptcyCourt
Assets
Liabilities
FilingDate
Twenty Eight Hundred Lafayette, Inc.(Portsmouth, NH)
Not Disclosed
Concord(NH)
$50,001to$100,000
$1,000,001to$10 Million
1/29/25
iM3NY LLC(Endicott, NY)
Engine, Turbine and Power Transmission Equipment Manufacturing
Wilmington(DE)
$50,000,001to$100 Million
$100,000,001to$500 Million
1/27/25
Imperium3 New York, Inc.(Endicott, NY)
Engine, Turbine and Power Transmission Equipment Manufacturing
Wilmington(DE)
$50,000,001to$100 Million
$100,000,001to$500 Million
1/27/25
Liberated Brands LLC2(Costa Mesa, CA)
Apparel Accessories and Other Apparel Manufacturing
Wilmington(DE)
$100,000,001to$500 Million
$100,000,001to$500 Million
2/2/25
Chapter 7
Debtor Name
BusinessType1
BankruptcyCourt
Assets
Liabilities
FilingDate
Lunchpail Productions, Inc.(Lynnfield, MA)
Not Disclosed
Boston(MA)
$0to$50,000
$100,001to$500,000
1/31/25
271 West 11th Street LLC(New York, NY)
Not Disclosed
Manhattan(NY)
$10,000,001to$50 Million
$10,000,0001to$50 Million
1/27/25
16EF Apartment LLC(Southampton, NY)
Not Disclosed
Manhattan(NY)
$10,000,001to$50 Million
$10,000,001to$50 Million
1/29/25
1Business Type information is taken from Bankruptcy Court filings, which may include incorrect categorization by the debtor or others.
2Additional affiliate filings include: Boardriders Retail, LLC, Liberated AX LLC, Liberated Brands International, Inc., Liberated Brands USA LLC (DE), Liberated-Spyder LLC, Volcom Retail Outlets, LLC, Valcom Retail, LLC and Valcom, LLC.
(UK) Revolution Bars: When is a Meeting Really a Meeting?
In his judgment to sanction the restructuring plan (“RP”) of Revolution Bars[1], Justice Richards proceeded on the basis that the Class B1 Landlords and the General Property and Business Rate Creditors were dissenting classes, notwithstanding that they approved the Plan by the statutory majority. This is because they did not approve the Plan at “meetings”, since only one person was physically present at each “meeting” even though the chair held proxies from other creditors.
Pursuant to Part 26A of the Companies Act 2006, to agree a RP, at least 75% in value of a class of creditors, present and voting either in person or by proxy at the meeting, must vote in favour (section 901F). This is repeated when considering the cross-class cram down (“CCCD”), which can be applied “if the compromise or arrangement is not agreed by a number representing at least 75% in value of a class of creditors… present and voting either in person or by proxy at the meeting” (section 901G).
Applying various case law on the subject, we now have the following guidance in relation to a “meeting” for the purposes of RPs:
The ordinary legal meaning of a meeting requires there to be two or more persons assembling or coming together[2];
If there is only one shareholder, creditor or member of a relevant class, that would constitute a “meeting” by necessity, but a meeting in this instance would be considered an exception to the ordinary legal meaning[3];
An inquorate and invalid “meeting” does not preclude the court from exercising its discretion to apply a CCCD to those “dissenting” classes[4].
To ensure a proper “meeting”, there must be two or more creditors physically present (where two or more creditors exist in a class). The physical presence of only one person voting in two capacities – as creditor and as proxy for another – will not suffice, nor will it suffice if the chair holds proxies and there is only one creditor in attendance. Only in cases where there is one creditor in a class, will a meeting of one be valid. If there is no valid meeting, the creditors of that class will be treated as dissenting, and potentially subject to CCCD (assuming the RP has also met the relevant voting threshold and CCCD is engaged).
It does beg the question – if the circumstance were to arise where there were no valid meetings, then what? It seems likely that the RP would fall at the first hurdle.
In this case, the judge sanctioned the CCCD of all “dissenting” classes, and the RP.
Notably, in Re Dobbies Garden Centre Limited[5] the Scottish court took a different approach. Here, only one creditor attended the meeting of the only “in the money” class which approved the plan. If the court had adopted the approach in Revolution Bars, that meeting would be considered invalid, the class categorised as dissenting and the plan would not have been sanctioned.
Focusing on the words “either in proxy or by person” as a qualifier to being “present and voting”, the Scottish court found that a meeting may be quorate where two or more creditors were in attendance or represented in person, or by proxy, or by a combination, and one person can act in two capacities; therefore the meeting was valid.
[1] [2024] EWHC 2949 (Ch)
[2] Sharp v Dawes (1876) 2 Q.B.D. 26
[3] East v Bennett Bros Ltd [1911] 1 Ch. 163; Re Altitude Scaffolding [2006] BCC 904
[4] Revolution Bars
[5] [2024] CSOH 11
Weekly Bankruptcy Alert January 29, 2025 (For the Week Ending January 26, 2025)
Covering reported business bankruptcy filings in Massachusetts, Maine, New Hampshire, and Rhode Island, and Chapter 11 bankruptcy filings in New York and Delaware listing assets of more than $1 million.
Chapter 11
Debtor Name
BusinessType1
BankruptcyCourt
Assets
Liabilities
FilingDate
491 Bergen St. Corporation2(New York, NY)
Single Asset Real Estate
Manhattan(NY)
$10,000,001to$50 million
$10,000,001to$50 million
1/22/25
New London Pharmacy Inc.(New York, NY)
Grocery and Convenience Retailers
Manhattan(NY)
$1,000,001to$10 million
$1,000,001to$10 million
1/23/25
Eleni International Inc. DBA New London Specialty Pharmacy(New York, NY)
Grocery and Convenience Retailers
Manhattan(NY)
$1,000,001to$10 million
$1,000,001to$10 million
1/23/25
KCT, Inc.3(Yonkers, NY)
Single Asset Real Estate
White Plains(NY)
$10,000,001to$50 million
$10,000,001to$50 million
1/23/25
Chapter 7
Debtor Name
BusinessType1
BankruptcyCourt
Assets
Liabilities
FilingDate
Renal and Transplant Associates of New England, P.C.(Springfield, MA)
Health Care Business
Springfield(MA)
$100,001to$500,000
$1,000,00to$10 million
1/24/25
North Shore Financial 1 Inc.(Tarrytown, NY)
Lessors of Real Estate
White Plains(NY)
$1,000,001to$10 million
$1,000,001to$10 million
1/23/25
1Business Type information is taken from Bankruptcy Court filings, which may include incorrect categorization by the debtor or others.
2Additional affiliate filings include: 471 Amsterdam Ave Realty Corp., T.J.F. Holding Corp., 139-141 Franklin Street Realty Corp., Sofia Bros., Inc., Peter F. Reilly Storage Inc.
3Additional affiliate filings include: 1060 Nepperhan Ave LLC