A LEG UP FOR EQUITY?
Part II – Freeze Claims [1]
Equity security holders[2] or investors [3] (“Equity Holders”) in debtor entities are usually
subordinated to creditors’ claims in bankruptcy cases.[4] This need not always be so.
Two situations exist where Equity Holders’ claims may be equal or superior to general
unsecured creditors’ claims. The first are claims based on “fraudulent retention” (“Fraudulent
Retention Claims”). The second are claims based on debtors’ post-petition interfering with
Equity Holder’s rights to sell their investment, to benefit the debtors’ reorganization effort
(“Freeze Claims”).
Allowed[5] Fraudulent Retention Claims are treated equally to general unsecured creditors’
claims. Allowed[6] Freeze Claims may receive an administration priority[7] over general unsecured
claims. Allowed Fraudulent Retention Claims get available “bankruptcy dollars[8].” Allowed
Freeze Claims are entitled to full payment, subject to the bankruptcy estate’s resources.[9]
This blogtical is the second of two. The prior blogtical discussed the subordination or not
of Fraudulent Retention Claims, See. https://www.bankruptcystrategies.com/a-leg-up-for-equity-
fraudulent-retention-claims/. This blogtical concerns allowing Freeze Claims.
FREEZE CLAIMS
Preserving NOLs
A debtor’s net operating losses (“NOLs”) are a valuable asset.[10] The Internal Revenue
Code § 172 provides that corporations may carry forward their NOLs to reduce federal income
taxes on future income. However, that ability is significantly limited when by an “ownership
change.” [11] Ownership changes result from transfers of corporations’ shares.
To preserve NOLs, debtors seek orders, restricting transfers of equity interests or institute
notice procedures: Freeze Orders[12] Freeze Orders can be sought and entered as early as a case’s
filing.[13]
Freeze Orders may restrict trading of all or portions of a debtor’s equity. For example,
Freeze Order can restrict trading by “(a) holders of the equivalent of more than 449,390 shares of
Common Stock (e.g., 4.5 percent or more of outstanding Common Stock) and (b) parties who are
interested in purchasing sufficient Common Stock to result in such party becoming a holder of
4.5 percent or more of outstanding Common Stock.”[14] That restriction can run while a plan of
reorganization is being negotiated or confirmed.
During the Freeze Order’s effective period, share prices routinely drop. That creates
hardship enough when all equity security holders may not trade their shares. When the Freeze
Order affects only a portion of the Debtor’s shares, the harm is disproportionate. Then, Equity
Holders with frozen shares must wait as the share price slides while unfrozen shares sell. It’s
like waiting to escape the Titanic after all the life boats are gone.
This blogticle sees Freeze Claims[15] as “administration expenses.”[16] Claims for allowed
administration expenses[17] receive the second highest priority and seniority in distribution of
payments to unsecured creditors[18] in bankruptcy cases.[19]
Administration Claim Requirements
Bankruptcy Code § 503(b) (“§ 503(b)”) identifies allowable administration claims.
They include:
including— . . . .(D) a creditor, an indenture trustee, an equity security holder, or a committee
representing creditors or equity security holders other than a committee appointed
under section 1102 of this title, in making a substantial contribution in a case
under chapter 9 or 11 of this title;11 U.S.C. § 503(b)(1)(A) and (D)Debtors’ post-petition torts are allowable administration claims.[20]
What’s a Tort?
Torts are defined broadly as:
. . . .a civil wrong, other than breach of contract, for which the court will provide a
remedy in the form of an action for damages.” . . . . Indeed, one of the hallmarks
of traditional tort liability is the availability of a broad range of damages to
compensate the plaintiff “fairly for injuries caused by the violation of his legal
rights.” Carey v. Piphus, 435 U.S. 247, 257, 98 S.Ct. 1042, 1049, 55 L.Ed.2d
252 (1978). Although these damages often are described in compensatory terms,. .
. . in many cases they are larger than the amount necessary to reimburse actual
monetary loss sustained or even anticipated by the plaintiff, and thus redress
intangible elements of injury that are “deemed important, even though not
pecuniary in [their] immediate consequence[s].”[21]
Interfering with
Equity Holders’ Legal Rights
Equity Holders have a fundamental right to sell their shares.[22] Freeze Orders
interfere with that right by restricting and prohibiting the sale of equity security interests. Freeze
Orders are premised on the representation that they preserve debtors’ NOLs benefits.
Unfortunately for Equity Holders, once the freeze ends, the share price is reduced substantially.
Hence, Equity Holders are injured by Freeze Orders.
Post Petition Torts are Part of the
Debtors’ Post Petition Operations
Whether post-petition torts occurred as part of debtors’ operations is sometimes
considered in determining if there is an allowable administration claim.[23]
Motions for Freeze Orders may represent:
“Implementation of the Procedures is necessary and appropriate to enforce the
automatic stay and, critically, to preserve the value of the Tax Attributes for the
benefit of the Debtors’ estates. . . . For the reasons discussed herein, the relief
requested is necessary in order for the Debtors to operate their businesses in the
ordinary course and preserve the ongoing value of the Debtors’ operations and
maximize the value of their estates for the benefit of all stakeholders.[24]
The injuries to Equity Holders cause by Freeze Orders are foreseeable. This foreseeable
injury is apparently incorporated into those debtors’ operations.
Understandably, “if you want to make an omelet, you have to break some eggs.”[25]
However, if you break someone else’s eggs to make your omelet, they are entitled to
compensation for their loss.[26]
Freeze Order Injuries Preserve
Debtors’ Assets
Bankruptcy Code § 503 includes as administration expenses the “actual, necessary costs and expenses of preserving the estate.” Freeze Orders’ purpose is to preserve the debtor’s NOLS. Debtors’ NOL’s are property of their estates.[27]
Motions seeking Freeze Orders may represent, among other things:
– Notably, the Debtors have limited the relief requested herein to the extent
necessary to preserve estate value.
– By establishing and implementing such Procedures, the Debtors will be in
a position to object to “ownership changes” that threaten their ability to
preserve the value of their Tax Attributes for the benefit of the estates.
– The Procedures . . . ensure preservation of the Tax Attributes.
– . . . . Implementation of the Procedures is necessary and appropriate to enforce
the automatic stay and, critically, to preserve the value of the Tax Attributes for the benefit of
the Debtors’ estates. The termination or limitation of the Tax Attributes could be materially
detrimental to all parties-in-interest. Thus, granting the relief requested herein will preserve the
Debtors’ flexibility in operating their businesses during the pendency of these chapter 11 cases
and also implementing an exit plan that makes full and efficient use of the Tax Attributes,
maximizing the value of their estates.
– The Debtors seek to establish procedures . . . to preserve the Debtors’
ability to seek substantive relief if it appears that a proposed transfer could
jeopardize the Debtors’ utilization of the Tax Attributes. . . .
– For the reasons discussed herein, the relief requested is necessary in order for the
Debtors to operate their businesses in the ordinary course and preserve the
ongoing value of the Debtors’ operations and maximize the value of their
estates for the benefit of all stakeholders.
Disclosure statements for plans of reorganization, for cases using Freeze Orders may
include NOLs among that debtor’s tax attribute, discuss the importance of NOLs and the Freeze
Order’s role in preserving NOLs.[28]
More importantly, the Freeze Orders will probably include a statement that:
. . . and this Court having found that the relief requested in the Motion is in the
best interest of the Debtors’ estates, their creditors, and other parties in interest; . .
. .; and this Court having reviewed the Motion and having heard the statements
in support of the relief requested therein at a hearing before the Court (the
“Hearing”); and this Court having determined that the legal and factual bases
set forth in the Motion and at the Hearing establish just cause for the relief
granted herein . . .[29]
Thus, debtors getting Freeze Orders are “judicially estopped” from claiming the Freeze Order did not benefit the bankruptcy estate and case. They cannot backtrack from those representations.[30]
Calculating the Allowable Claim
If the Freeze Claim is allowable, the amount of the allowed claim is determined next. If
the basis for the claim being allowed is “post petition tort,” determining the amount of the claim
should follow tort law: dollar value of the injury.
The calculation is more complex for “substantial contribution” claims. The creditor must
show the value the debtor received as the result of the creditor’s injury.[31] Calculating that figure
first entails determining the dollar amount of NOLs the creditor’s losses preserved. Then
anticipate the claim objector requiring the creditor to show the dollar value to the debtor of those
NOLs’ preservation.
The creditor lacks the information to answer those questions. Discovery about the debtor
will be required from a contentious estate administrator. Then, comes the quantitative analysis.
This exercise is not cheap. However, both sides must do it and there is risk to both sides. So,
settlement discussions can occur before there is a trial on the issues.
Public equity security holders have always had to claw their way to recover anything in
bankruptcy cases. With the advent of “zombie corporations” and “ponzi financing,” other parties
in interest exclude equity security holders from a place at the bargaining table.[32] The view is the
debtors lack any equity for equity security holders to share in.
However, as the foregoing shows, equity security holders who have been wronged,
independently of merely losing their investment through a debtor’s failure, may have recourse in
a bankruptcy case. Securing recourse will be a struggle. But, that’s not new for equity security
holders.
[1] © Wayne Greenwald 2022
[2] See 11 U.S.C. § 101 (16) and (17)
(16) The term “equity security” means—
(A) share in a corporation, whether or not transferable or denominated “stock”,
or similar security;
(B) interest of a limited partner in a limited partnership; or
(C) warrant or right, other than a right to convert, to purchase, sell, or
subscribe to a share, security, or interest of a kind specified in
subparagraph (A) or (B) of this paragraph.
(17) The term “equity security holder” means holder of an equity security of the debtor.
[3]See, In re Montgomery Ward Holding Corp., 272 B.R. 836, 842 (Bkrtcy.D.Del.,2001).
[4]See, 11 U.S.C. § 510(b)(Subordination) and 11 U.S.C. § 1129(b)(2)(B)’s “absolute
priority rule” which “generally requires that all unsecured creditors be paid in full before equity
security holders are allowed to retain any ownership interest in the debtor.” In re Brotby, 303
B.R. 177, 195 (9th Cir.BAP 2003).
[5]Allowed claims give the creditor holding that claim a right to payment of a specified
sum of money pursuant to 11 U.S.C. § 502(b), usually enforceable against the debtor’s
bankruptcy estate. See, In re Ayers Bath (U.S.A.), Co., Ltd., 2021 WL 4317321, at *41
(Bkrtcy.C.D.Cal., 2021). A “claim becomes allowed in one of three ways: first, a proof of claim
is filed or deemed filed and no party objects; second, a claim is allowed by the court after an
objection is filed; and third, a claim is estimated by the Court under the provisions of section
502( c ). In re Rowe, 342 B.R. 341, 348 (Bkrtcy.D.Kan.,2006).
[6]See, Id.
[7] 11 U.S.C. § 503(b).
[8]“Bankruptcy Dollars” are the percentage recoveries by creditors holding unsecured
claims. Paying 10¢ on the $ 1.00 is probably above average in most chapter 7 cases.
In re Rappaport, 517 B.R. 518, 538 (Bkrtcy.D.N.J., 2014)
[9] See 11 U.S.C. § 507. Priorities. Regulating the priorities in distributing the bankruptcy
estate’s assets.
[10]In re Feiler, 218 B.R. 957, 962 (Bkrtcy.N.D.Cal.,1998), In re Wilson-Seafresh, Inc.,
263 B.R. 624, 629 (Bkrtcy.N.D.Fla.,2001) First-Day Issues (Payment of Critical Vendors;
Abuses of DIP Financing; Cash Management), 091203 ABI-CLE 23
[11]Id., IRC §§ 382 and 383
[12]See, In re Intelsat S.A., No. 20-32299 (KLP) (Bankr. E.D. Va. June 9, 2020)
(establishing notification and hearing procedures related to certain stock transfers and
declarations of worthlessness); In re Pier 1 Imports, Inc., No. 20-30805 (KRH)
(Bankr. E.D. Va. Mar. 19, 2020) (same); In re Toys “R” Us Inc., No. 17-34665 (KLP) (Bankr.
E.D. Va. Oct. 25, 2017) (same); In re Penn Virginia Corp., No. 16-32395 (KLP) (Bankr. E.D.
Va. June 9, 2016) (same).
[13]First-Day Issues (Payment of Critical Vendors; Abuses of DIP Financing; Cash Management), 091203 ABI-CLE 23
[14]See, Ascena Retail Group, Inc., et al., Case No. 20-33113 (KRH), United States
Bankruptcy Court For the Eastern District of Virginia, Richmond Division (“Ascena”).
[15]U.S.C. § 101(5) defines a “claim” as a:
(A) right to payment, whether or not such right is reduced to judgment,
liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed,
undisputed, legal, equitable, secured, or unsecured; or
(B) right to an equitable remedy for breach of performance if such breach
gives rise to a right to payment, whether or not such right to an equitable
remedy is reduced to judgment, fixed, contingent, matured, unmatured,
disputed, undisputed, secured, or unsecured
[16]11 U.S.C. § 503(b)(1)(A) defines administrative expenses as “the actual, necessary
costs and expenses of preserving the estate. . .”
[17]Administration claims become “allowed” through a “notice and a hearing,” 11 U.S.C. §
503(b), which determines whether and how much that claim may receive from the
bankruptcyestate. 11 U.S.C. § 541 (Defining bankruptcy estate.)
[18]An secured creditor is a creditor whose claim lacks collateral to secure its payment.
[19] See, 11 U.S.C. § 507(a)(2).
[20]See, In re Baseline Sports, Inc., 393 B.R. 105, 130 (Bkrtcy.E.D.Va.,2008) (“Baseline”),
([Reading Co. v. Brown, 391 U.S. 471, 88 S.Ct. 1759, 20 L.Ed.2d 751 (1968), makes] post-
petition torts committed by the debtor-in-possession while acting in the furtherance of the
operation of the business satisfy the second or “burden” prong of the administrative expense test,
and claims for such torts may be accorded priority as an administrative expense. See id. at
477–85, 88 S.Ct. 1759; Pa. Dep’t of Envtl. Res. v. Tri–State Clinical Labs., Inc., 178 F.3d 685,
691 (3d Cir.1999) (“The Supreme Court held that the tort judgment was entitled to priority as an
administrative expense under § 64a(1) of the Bankruptcy Act, even though the expense was not
technically a cost of preserving the estate.”); Ala. Surface Mining Comm. v. N.P. Mining Co., 963
F.2d 1449, 1453 (11th Cir.1992) (“Reading … held that tort claims against a bankruptcy trustee
were payable as administrative expenses even though they were not beneficial to the estate.”);
Kapernekas v. Continental Airlines, Inc. (In re Continental Airlines, Inc.), 148 B.R. 207, 213
(D.Del.1992) (stating that Reading held that certain costs may be treated as administrative
expenses if those costs were incurred as a result of the debtor committing a post-petition tort);
4–503 Collier on Bankruptcy ¶ 503–06[2][c] [i]–[iv] (15th ed.2008). See also, In re Krisu
Hospitality, LLC, 2021 WL 1186483, at *6 (Bkrtcy.N.D.Tex., 2021), citing, Baseline
[21]U.S. v. Burke, 112 S.Ct. 1867, 1870–71, 504 U.S. 229, 234–35 (1992) (Emphasis
supplied).
[22]Williams Companies Stockholder Litigation, 2021 WL 754593, at *20 (Del.Ch.,
2021)(“Modern corporate law recognizes that stockholders have three fundamental, substantive
rights: to vote, to sell, and to sue.”, citing, Strougo v. Hollander, 111 A.3d 590, 595 n.21 (Del.
Ch. 2015), See also, J, Velesco, the Fundamental Rights of the Shareholder, 40 U.C. Davis Law
Review 407.
[23]See, Baseline 393 B.R. at 130.
[24]See Ascena Freeze Order motion
[25]Oregon Natural Resources Council v. Marsh, 1986 WL 13440, at *4
(D.Or.,1986)(“Congress ordered the [Army Corps of Engineers] to make an omelet [build a
dam]; Congress knew full well that one must break the eggs [harm the environment] to cook an
omelet. State v. Cummings, 647 S.E.2d 869, 879, 220 W.Va. 433, 443 (W.Va.,2007)(The
dissent’s “basic argument is that you have to break a few eggs to make an omelet. A few innocent
people have to go to jail to make sure we get as many guilty people in there as possible”).
[26]See, Baseline 393 B.R. at 130.
[27] See, In re A.H. Robins Co., Inc., 251 B.R. 312, 315 (Bkrtcy.E.D.Va.,2000).
[28]See, Ascena, Disclosure Statement.
[29]See, Ascena, Freeze Order.
[30] Bresler v. Wilmington Trust Company, 348 F.Supp.3d 473, 490 (D.Md., 2018), citing
New Hampshire v. Maine, 532 U.S. 742, 749, 121 S.Ct. 1808, 149 L.Ed.2d 968 (2001)(Judicial
estoppel “generally prevents a party from prevailing in one phase of a case on an argument and
then relying on a contradictory argument to prevail in another phase.”).
[31]See, Ford Motor Credit Co. v. Dobbins, 35 F.3d 860, 866 (C.A.4 (Va.), 1994)Dobbins,
(4th Cir. 1994) (“[t]he court’s administrative expense inquiry centers upon whether the estate has
received an actual benefit, as opposed to the loss a creditor might experience by virtue of the
debtor’s possession of its property.”) (emphasis in original) (citations omitted); accord Broadcast
Corp. v. Broadfoot, 54 B.R. 606, 611 (N.D. Ga. 1985) (“administrative expense scheme does not
focus in the first instance on whether a creditor sustained a loss during this period, but on
whether the estate has received an actual benefit”), aff’d, In re Subscription Television, 789 F.2d
1530, 1532 (11th Cir. 1986).
[32]See, In re Eastman Kodak Company, 2013 WL 4413300 (Bkrtcy.S.D.N.Y., 2013),
In re SunEdison, Inc., 556 B.R. 94, 102 (Bkrtcy.S.D.N.Y., 2016)(“. . .stockholders of a
“hopelessly insolvent” estate have no economic interest in the case.”)
