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LeClairRyan

LeClair Ryan helps kickoff Richmond Legal Diversity Alliance
As one of the founding members of the Richmond Legal Diversity Alliance, LeClair Ryan is playing an integral role in helping promote the Richmond area as a city of choice for new law school graduates and laterals from other metropolitan areas. The RLDA was created support the efforts of all the major law firms in recruiting and retaining attorneys, in particular women and minorities.

The first summer social was a great success in introducing the participating firms to summer interns, law school students and even new attorneys in the area as well as sharing with newcomers what's available in Richmond from a cultural and ethnic perspective. More events are in the planning for the RLDA. The Richmond Times-Dispatch article link on the Summer Social is below.

08-01-2006

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LeClairRyan

May Fox Appointed to VHCF Board of Trustees
May H. Fox has been appointed to the Virginia Health Care Foundation's Board of Trustees. A public-private partnership initiated in 1992 by the Virginia General Assembly and its Joint Commission on Health Care, the Virginia Health Care Foundation works to improve the lives and health of Virginia’s uninsured. Whether helping children obtain health insurance, providing seniors and the chronically ill with medicines they need, or bringing more health professionals to underserved areas, VHCF touches the lives of thousands of Virginians everyday.

08-01-2006

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Stites & Harbison PLLC

Deadly Double Discounting
Assume that your client, Lender A, and another lender, Lender B, each loan XYZ Inc. $100 million on an unsecured basis on June 1, payable in installments over ten (10) years, plus ten percent (10%) interest. On June 2, the next day, XYZ Inc. defaults on both loans. Lender A does not accelerate its loan on June 2 (its lawyer is playing golf that day), but Lender B does. On June 3, XYZ Inc. files bankruptcy. XYZ Inc. then asserts that Lender B's allowed claim is $100 million and that Lender A's allowed claim is $61.4 million, or the present value of the installment payments to Lender A under the non-accelerated loan. XYZ Inc.'s assertion is based on its argument that § 502(b) of the Bankruptcy Code requires that any post-petition interest be disallowed and that principal payments due in the future to Lender A as of the petition date must be reduced to their present value. Is XYZ Inc. correct?

The answer to the above question may lie in In re Oakwood Homes Corporation, 449 F.3d 588 (3d Cir. 2006), a June 9, 2006 opinion.

Background
Oakwood Homes Corporation and its various subsidiaries (""Oakwood"") manufactured and sold prefabricated homes and financed the purchase of the homes with installment paper, which was sold to various trusts (""Trusts""). The Trusts then issued certificates to investors (""Trust Certificates""), to whom the Trust made periodic payments of principal and interest that were funded by the installment payments from the installment paper owned by the Trusts. This financing is called ""securitization."" JP Morgan Chase Bank (""JP Morgan"") was the indenture trustee for various holders of Trust Certificates. One non-typical feature of at least part of the Oakwood securitization was that Oakwood guaranteed payments to the investors in some of the Trusts (""Oakwood Guaranty""), with the guaranty issued to JP Morgan as trustee. At least some of the Trust Certificates did not have an acceleration feature, so that JP Morgan as trustee could not accelerate the payments due from the Trusts or the payments due under the Oakwood Guaranty.

The Trusts failed to make payments to investors, and eventually it was established that the income to be received from the installment paper would result in no further distributions to certain classes of investors represented by JP Morgan as trustee. Oakwood filed a Chapter 11 bankruptcy on November 15, 2002 (""Petition Date""). JP Morgan filed proofs of claim as trustee based on the Oakwood Guaranty. The proofs of claim included all unpaid principal and interest owed under the certificates for the entire term.

U.S. Bank National Association, as trustee for another group of Oakwood creditors (""US Bank""), objected to the JP Morgan claims. US Bank's arguments included the following: (1) JP Morgan's claims should not include postpetition interest and (2) JP Morgan's claims for principal payments should be discounted to present value as of the Petition Date.

Bankruptcy Court
The United States Bankruptcy Court for the District of Delaware ruled in favor of US Bank, disallowing postpetition interest and discounting $116,370,915 in principal shortfalls to $30,491,930. Oakwood, 449 F.3d at 591. Additionally, even though Oakwood�s confirmed plan of reorganization created an interest-bearing distribution trust for unsecured creditors (""Distribution Trust"") and required that amounts be reserved by the Distribution Trust to pay disputed claims, the bankruptcy court required JP Morgan to post a substantial bond (the ""Bond"") to prevent a distribution of funds from the Distribution Trust. Oakwood, 449 F.3d at 592.

District Court
JP Morgan appealed to the district court both the order disallowing the JP Morgan claims and the order requiring the Bond. On appeal, with no bond posted, the district court temporarily stayed distributions by the Distribution Trust, but it eventually affirmed both of the bankruptcy court's orders and lifted the stay. Oakwood, 449 F.3d at 592. Relying on the bankruptcy court's previous holding in In re Loewen Group Int'l, Inc., 274 B.R. 427 (Bankr. D. Del. 2002), the district court found that § 502 unambiguously mandated disallowance of interest and discounting of the principal portion of the claim to present value, regardless of whether the principal was interest-bearing, thus precluding any resort to the legislative history or economic factors. Oakwood, 449 F.3d at 591-92.

Third Circuit
JP Morgan appealed to the Third Circuit, but it did not appeal the disallowance of unearned interest, only the discounting of principal to present value and the Bond requirement. It also sought a stay by the Third Circuit so that moneys would remain in the Distribution Trust to pay its claims if the appeal were successful. The Third Circuit declined to put a stay in effect that protected JP Morgan through the appeal.

The Third Circuit, in a 2-1 decision, reversed the bankruptcy court's and the district court's rulings that the principal portion of the interest-bearing JP Morgan claims must be reduced to present value. The Third Circuit determined that the JP Morgan claims involved separate interest and principal components, and ""not merely a single future liability."" Oakwood, 449 F.3d at 593. It then examined § 502(b) of the Bankruptcy Code. The court stated: ""we express no view on whether the bankruptcy court correctly disallowed post-petition interest pursuant to 11 U.S.C. § 502(b)(2). We must decide only the narrower issue before us, whether further reduction of the claims by discounting is required or allowed by the Bankruptcy Code."" Oakwood, 449 F.3d at 595.

The Third Circuit recognized that § 502 ""speaks in terms of determining the 'amount' of a claim 'as of' the petition date. However, given that the remainder of the Bankruptcy Code uses the terms, 'value, as of' to signify discounting to present value, and 'amount' and 'value' are not synonymous, we cannot say that § 502(b) clearly and unambiguously requires discounting to present value in all situations."" Oakwood, 449 F.3d at 595. The Third Circuit rejected the district court's finding that § 502 is unambiguous and followed the Supreme Court�s admonition to ""view the Bankruptcy Code holistically, instead of in isolated sections."" Oakwood, 449 F.3d at 596, citing United Sav. Ass'n of Texas v. Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 365, 371, 108 S. Ct. 626, 98 L. Ed. 2d 740 (1988). ""We do not hold here that 11 U.S.C. § 502(b) never authorizes discounting a claim to present value but instead that the statute does not clearly and unambiguously require it for all claims evaluated under § 502."" Oakwood, 449 F.3d at 598. With respect to the case before it, the Third Circuit stated: ""Once the Bankruptcy Court disallowed post-petition interest pursuant to § 502(b)(2), the legislative history of the provision, the economic reality of the transaction, and fundamental tenets of bankruptcy law do not permit further discounting of the principal."" Oakwood, 449 F.3d at 599. The court continued:

By its terms, 11 U.S.C. § 502 applies only to claims involving interest in additional to principal. A note providing for payments of principal plus interest is fundamentally more valuable than note involving the same principal payments, but no interest. A buyer of a note that includes interest surely knows he is bargaining for a more valuable instrument, as does the seller. Contrary to the District Court's assertion, then, ""the distinction between interest-bearing and non-interest-bearing claims"" is highly significant. U.S. Bank could not cite the Court to a single case from any court that applied discounting to an interest-bearing instrument after the post-petition interest had been disallowed under § 502(b)(2).

Oakwood, 449 F.3d at 599.
The Third Circuit cited the following legislative history, which the lower courts refused to consider because of their determination that § 502 was unambiguous:

A proof of claim or interest is prima facie evidence of the claim or interest. Thus it is allowed under subsection (a) unless a party in interest objects. The Rules and case law will determine who is a party in interest for purposes of objection to allowance . . .

Subsection (b) prescribes the grounds on which a claim may be disallowed. The court will apply these standards if there is an objection to a proof of claim. The burden of proof on the issue of allowance is left to the Rules of Bankruptcy Procedure . . .

Paragraph (2) requires disallowance to the extent that the claim is for unmatured interest as of the date of the petition. Whether interest is matured or unmatured on the date of bankruptcy is to be determined without reference to any ipso facto or bankruptcy clause in the agreement creating the claim. Interest disallowed under this paragraph includes postpetition interest that is not yet due and payable, and any portion of prepaid interest that represents an original discounting of the claim, yet that would not have been earned on the date of bankruptcy . . . .[3rd Circuit footnote omitted]

Section 502(b) thus contains two principles of present law. First, interest stops accruing at the date of the filing of the petition, because any claim for unmatured interest is disallowed under this paragraph. Second, bankruptcy operates as the acceleration of the principal amount of all claims against the debtor. One unarticulated reason for this is that the discounting factor for claims after the commencement of the case is equivalent to [the] contractual interest rate on the claim. Thus, this paragraph does not cause disallowance of claims that have not been discounted to a present value because of the irrebutable presumption that the discounting rate and the contractual interest rate (even a zero interest rate) are equivalent.

Oakwood, 449 F.3d at 599-600, quoting H.R. Rep. No. 95-595, at 352-54 (1977) (emphases added), see also S. Rep. No. 95-989, at 62-65 (1978) (same).

Relying on this history, the court concluded with an apparently absolute rule: ""To the extent that the Code in any way contemplates discounting to present value, such discounting is not permitted where the claim is for principal plus interest, and the interest has already been disallowed pursuant to § 502(b)(2)."" Oakwood, 449 F.3d at 600.

With respect to the economic reality of the transaction, the Court stated:
We emphasize that our holding in this case in no way yields a windfall for creditors such as JP Morgan. Instead, the interplay between section 502(b) and section 502(b)(2), as reflected in both the legislative history and basic economics, acknowledges that once unmatured interest has been disallowed, discounting the remainder of the claim to present value would inequitably twice penalize the creditor for the time value of money. We wholeheartedly agree that future liabilities must be reduced in some way to reflect the time value of money, but doing so twice is the ""double discounting"" complained of by JP Morgan in this case.

Oakwood, 449 F.3d at 601.
The Third Circuit also addressed the issue of whether, as suggested by the legislative history, the filing of the case causes an acceleration of the debt, thus negating any need to present value a claim. Rejecting that approach, the Third Circuit determined that even though acceleration occurs for the purpose of filing a claim, it does not resolve the issue of whether a claim not accelerated prior to filing should be discounted to present value under a holistic interpretation of § 502(b). Oakwood, 449 F.3d at 602 & n.18.

Dissent
The dissent concluded that the payments to be made under the Oakwood Guaranty were not properly characterized as interest-bearing principal or interest. Oakwood, 449 F.3d at 614. The dissent apparently accepted the proposition that principal payments on an interest-bearing loan should not be discounted when the interest is disallowed, but because the dissent concluded that the payments were neither interest-bearing principal nor interest, the dissent concluded that: (i) none of the income stream to be paid under the Oakwood Guaranty should be disallowed; (ii) the entire income stream should be discounted to present value; and (iii) because JP Morgan did not appeal the disallowance of what was improperly characterized as interest, the decision of the lower courts should stand. Oakwood, 449 F.3d at 614-15. The dissent also concluded that for interest-bearing claims under § 502(b)(2), the principal would be deemed accelerated and not subject to present value discounting, but that non-interest-bearing claims, which are not subject to § 502(b)(2), can be deemed not accelerated and subject to present value discounting. Oakwood, 449 F.3d at 610. The dissent stated:

The courts in turn should apply the Bankruptcy Code, including § 502 and § 502(b)(2), in light of the actual economic bargains defined by such financial instruments. Only then can the courts carry out one of the core purposes of the Bankruptcy Code—to reliably and fairly distribute the bankrupt's assets among its creditors.

Oakwood, 449 F.3d at 615.

Conclusion
In Loewen, the bankruptcy court had before it the issue of whether non-interest-bearing principal should be discounted to present value, and the bankruptcy court said ""yes."" Although the result in Loewen is not troubling on the facts of that case, the means of achieving it are troubling, as became apparent when the bankruptcy court used its prior Loewen analysis to disallow over $60 million in principal claims after disallowing postpetition interest. When it resolved Loewen by determining under § 502 that the word ""amount"" is synonymous with the word ""value,"" despite Congress' use of the word ""amount"" and the word ""value"" in different code sections with the apparent intention that the words are not interchangeable, the bankruptcy court erroneously and unnecessarily created an inflexible rule not mandated by § 502. The Third Circuit in Oakwood recognized the inequity of this rule and the lack of a statutory basis for it. The Third Circuit approached this issue more flexibly and more cautiously than the bankruptcy and district courts. The Third Circuit statement that ""we do not hold that 11 U.S.C. § 502(b) never authorizes discounting a claim to present value, but instead that the statute does not clearly and unambiguously require it for all claims evaluated under § 502"" allows for a ""holistic approach"" that will require a case-by-case examination of the myriad of fact patterns that may arise. The Third Circuit opinion contains two absolutes: (i) interest-bearing principal, whether or not accelerated prior to filing, is never to be discounted if the interest is disallowed, and (ii) § 502 allows but does not mandate the discounting of non-interest-bearing principal to present value.

At the same time, however, the Third Circuit's ""holistic approach,"" although seemingly necessitated by the language of § 502 and in keeping with the dissent's admonition ""to carry out one of the core purposes of the Bankruptcy Code"" may prove a Pandora�s Box. For example:

(i) Are all interest-bearing principal obligations, whether accelerated or not at the time of filing, equal as claims in bankruptcy, notwithstanding that the interest rates may be drastically different, e.g., are the respective holders of a $10,000 note maturing in twenty years earning 15% interest and of a $10,000 note maturing in twenty years earning 1% interest both $10,000 claimants in bankruptcy?

(ii) Does it matter that one note holder in the above hypothetical actually advanced $10,000 to the debtor and the other took the note in settlement of a tort dispute?

(iii) What about the disparity in treatment between the person who has 1% interest and the person who has a non-interest-bearing obligation? The discounted present value of $10,000 in twenty years is $1,486.44, assuming a 10% discount rate, so the effect of having 1% interest, and thereby avoiding any discounting of principal, is to avoid having the $10,000 claim reduced by $8,513.56.

(iv) If Lender A and Lender B both hold non-interest-bearing notes due in twenty five years and Lender A accelerates the day before bankruptcy but Lender B does not, does Lender A now have a much higher claim than Lender B?

08-01-2006

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Ruden McClosky Smith Schuster & Russell, PA

RUDEN MCCLOSKY NAMED TO MULTICULTURAL LAW MAGAZINE TOP 100 LAW FIRMS FOR DIVERSITY
The Ruden McClosky law firm has been named to Multicultural Law magazine’s 2006 Top 100 Law Firms for Diversity for the second year in a row. Ruden McClosky was #68 in the Top 100, #16 in the Top 50 Law Firms for Partners, #37 in the Top Law Firms for Associates, and #7 in the Top 25 Law Firms for Hispanic Americans.

Ruden McClosky is committed to increasing and maintaining diversity at all levels. With the guidance of a national diversity consulting group, Ruden McClosky has designed programs to increase and retain minority attorneys and developed minority scholarships to promote diversity in law schools.

08-01-2006

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McGuireWoods LLP

Brian Bernhardt Speaks on Pro Bono Tax Representation Opportunities
Brian Bernhardt (Richmond) spoke on pro bono tax representation opportunities for tax lawyers and hot topics in tax controversy and tax litigation, before the D.C. Bar Tax Section Tax Audits and Litigation Committee on Jun 29 in D.C.

08-01-2006

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Richards, Spears, Kibbe & Orbe, L.L.P.

RSKO Changes Name to RK&O
It is our pleasure to announce that the new name of our firm is Richards Kibbe & Orbe LLP. Our domain address has changed to www.rkollp.com. Our New York, DC and London offices are at the same addresses and contact numbers.

08-01-2006

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Katten Muchin Rosenman LLP

Partner Kenneth Davis Quoted in Diagnostic Imaging Intelligence Report on Imaging Joint Ventures and the Stark Law
W. Kenneth Davis, a partner in the Firm's Health Care Practice, was quoted extensively in a Diagnostic Imaging Intelligence Report article discussing strategies for unwinding or restructuring imaging joint ventures in the face of recent modifications to the Stark Law (Strategies for Restructuring Imaging Joint Ventures, August 2006).

08-01-2006

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