Bankruptcy Law

Total news: 75
Last news: April 14, 2009 23:35:34

With bankruptcy filings up by more than 25% in the recent past, and with the promise of many more to come in the near future, an increasing number of businesses and individuals may find themselves listed amongst the largest unsecured creditors of a debtor and with much to lose in a bankruptcy case. As one of the largest creditors, these same businesses and individuals may also find themselves being solicited to serve on “official” unsecured creditors’ committees. While a creditor who is already owed significant amounts of money by a debtor may consider any further time or effort expended in connection with a debtor to be a waste of resources, serving on a creditors’ committee can often be a valuable opportunity to be involved in the direction a debtors case and reorganization (or ultimate liquidation) will take and to ensure the maximum recovery for all unsecured creditors, including itself. This article provides a brief overview of what a committee is, who may serve on a committee, what service entails, and some of the pros, cons and other considerations of and for serving on a creditors committee.

What is a committee?

The formation of an official committee of unsecured creditors is provided for under section 1102 of the U.S. Bankruptcy Code. Pursuant to section 1102, the U.S. Trustee is tasked with forming the unsecured creditors committee (and any other committees the U.S. Trustee may deem necessary) as soon as possible after a debtor files for chapter 11 relief. Accordingly, the process for choosing and appointing a committee will begin within days after the bankruptcy filing with the U.S. Trustee sending solicitation letters and questionnaires to the largest unsecured creditors identified by the debtor as part of its chapter 11 petition. The solicitation letters will designate a date, time and place for an organizational meeting at which the U.S. Trustee will review the completed questionnaires and choose a committee who represents the general unsecured creditor body in both type and amount. An unsecured creditors’ committee can be comprised of anywhere between three and eleven members, but is usually made up of no less than five and no more than seven members. On occasion, creditors hoping to garner a spot on the committee which were not originally contacted by the U.S. Trustee or listed among the ranks of the largest creditors of a debtor may be able to do so by exhibiting they have expertise and knowledge in the debtor’s particular industry, or by demonstrating that their claims are not adequately represented among the largest creditors designated by the debtor and solicited for committee membership. In some cases, an additional committee representing the debtors shareholders or bondholders may also be appointed if the U.S. Trustee and bankruptcy court sees a need and there is sufficient interest to do so.

Once formed, the committees has the right, subject only to bankruptcy court approval, to retain and consult counsel and other professionals of their own choosing to represent the committee as a whole (as opposed to the individual members and their individual interests). Committees will generally retain counsel and/or financial advisors immediately after formation through an expedited interview process. As a statutorily created entity, both the "reasonable" fees and expenses of the professionals selected to represent the committee, and the "reasonable" expenses (but not the fees) incurred by the committee members in serving on the committee, are paid and reimbursed out of the debtors estate. In this way, the committee members do not come out of pocket for their service on the committee.

It should be noted, however, that the fees and expenses for the attorneys and professionals retained by each individual member to represent its own specific interests, issues and claims in the bankruptcy case will not be paid for by the debtors estate and will be the sole responsibility of the individual member as a single creditor of the debtor (please also note that it is advisable to retain individual counsel in connection with the bankruptcy case even if serving on a committee, since the committee is representative of all creditors and not individual interests which may, from time to time, be adverse to a specific creditors interests).

What are the committees responsibilities?

Committees can play an integral role in shaping the course of a bankruptcy case. Although the ordinary day-to-day operations of a chapter 11 debtors business are normally determined by the debtors existing management, a committee can influence both the long-term strategy of the debtors business and affect any decisions it made out of the ordinary course of a debtors business and which may affect creditors generally.

As mentioned above, the committees purpose is to represent the interests of all unsecured creditors of the debtor, and to act as a watchdog for those interests while the bankruptcy case is pending.

In pursuing this purpose, the committee, through its professionals, will need to investigate and become knowledgeable about the debtors business and its background, and be involved in the debtors decision making. The committee will, therefore, be in a unique position to review the liabilities and assets of the estate and to influence or sometimes take action where necessary. For example, a debtor may not want to dispute a creditors claim if they are dependent on that business relationship in the debtors on-going business or may resist avoiding a transfer made to an insider. In these situations, the committee may be the only party willing and able to ask such questions or bring such actions derivatively to augment the estate for the benefit of all creditors.

In addition and most importantly, the committee will have the unique role of acting as advisor to the bankruptcy court in the bankruptcy process. For example, bankruptcy courts will often look to the committee any time a debtor seeks court approval to enter into an agreement outside the ordinary course of business or dispose of any assets. Ultimately, and through the discharge of these duties and actions, the committee is integral to the direction and success of a debtors bankruptcy case, and will assess and influence whether the debtor reorganizes or liquidates and the distribution that unsecured creditors will receive under either scenario.

The advantages and disadvantages of committee service.

Serving on a bankruptcy committee is a somewhat significant responsibility.

Time Commitment. Serving on a committee may require a considerable amount of time. The time commitment will vary depending on the complexity of the case; however, the typical committee may meet several times a month, usually via telephonic conference for minimum disruption. In any event, the time spent on the committee is going to take time away from other business activities, and in most cases will be time which would not have been spent on an insolvent party from whom you are likely to recoup on a fraction of what you are owed. In addition, since service is voluntary, committee members are not directly compensated for the considerable time they may expend (although committee members do receive reimbursement for expenses as described above).

Acting as a Fiduciary. The committee and its members have a fiduciary duty to act in the best interests of the unsecured creditors as a whole. As such, committee members have a duty they must discharge and for which they are accountable. Specifically, as a fiduciary, committee members are prohibited from using the confidential information gained in their service on the committee to their own advantage or from trading on their claims (or any securities held by such members in the debtor) based on such information. Practically speaking, this would prohibit any such member from taking any action which may appear to be in violation of this duty, including effectively prohibiting any securities or claims trading because of an assumption that such trading was based on insider information. Nevertheless, any committee member may pursue and defend its claim and defend against any claims brought against it by the estate, provided the committee member does not use any confidential information it learns as a member of the committee.

There are, however, significant advantages to serving on a committee:

Providing your opinion. The committee has a fiduciary responsibility to represent the interests of all similarly situated parties, i.e. all the unsecured creditors. As such, a bankruptcy judge relies heavily on the committees opinions and recommendations, as opposed to the self-interested view of one creditor. Being a member of the committee enables a creditor to influence how their own claim is treated and their recovery, along with the claims of all creditors.

Sharing costs and cutting down costs. Because the committee will hire its own attorneys and financial advisors, a creditor serving on the committee may often find that its interests are, necessarily, aligned with the entire committee in taking action or objecting to an action. Asserting those positions through the singular voice of the committee and its professionals saves costs to the individual creditor in taking or opposing action on its own. Moreover, while payment from the debtors assets will decrease the amount of the estate available to pay creditors in the long run, the cost of those professionals is disbursed evenly among all the creditors which the committee is formed to benefit.

Networking opportunities. Participating on a committee provides a unique opportunity to work with other individuals involved in the same industry. Due to the committees access to confidential information and heightened knowledge of case developments, many members view committee service as a way to sustain or strengthen the existing business relationship with the debtor and other committee members, who may provide vital business to the creditor.

Conclusion

While bankruptcy may connote worry and fear, the actual process can provide significant opportunities for the creditor solicited to serve on a committee. Although committee service requires a considerable time commitment accompanied with extensive responsibility, a creditor may find that they have excerpted more control in an environment where creditors often find themselves feeling somewhat helpless. Committee service should be seriously considered in consultation with counsel to discuss the advantages and disadvantages of committee service in a particular situation, but should always be considered.


Authored By:

Malani J. Cademartori

212.332.3847

mcademartori@sheppardmullin.com

On February 17, 2009, President Obama signed the American Recovery and Reinvestment Tax Act of 2009 ("ARRTA").  ARRTA contains significant potential Federal income tax relief for businesses.  Some of the more important provisions are summarized in the remainder of this article.

• Delayed Recognition of Debt Cancellation Income for Debt Repurchased, Replaced or Modified During 2009 or 2010. A corporation or business recognizes cancellation of debt income ("COD") when the taxpayer or a related party repurchases its debt for less than the amount outstanding or modifies or replaces the debt so it has a lower issue price.  ARRTA allows the COD to be deferred until 2014 and recognized over the next five years through 2019.  If deferral is elected, deductions for original issue discount ("OID") on direct or indirect replacement debt are similarly deferred.  COD so deferred is accelerated into income upon cessation of business, liquidation, or sale of all or substantially all the assets of the business (or the day before it files a bankruptcy petition) or, in the case of an S corporation or partnership, upon sale, exchange or redemption of an interest or death of a shareholder or member.
• Temporary Allowance of Deductions for OID on Modification or Exchanges Into High-Yield Discount Obligations.  Corporations cannot deduct unpaid OID representing a yield higher than six percentage points over the applicable federal rate on debt with a term of 5 years or more.  ARRTA temporarily suspends this disallowance for exchanges or modifications after September 1, 2008 and before December 31, 2008, provided the old debt itself was not a high-yield discount obligation, does not have contingent interest, and is not held by a person related to the issuer.  Thus, such publicly traded debt can be exchanged without COD arising as a result of trading at a discount in the secondary market, and privately held debt can be modified debt so it has substantial OID without COD (such as due to deferring payments of interest).  IRS can temporarily use higher rates to determine high-yield discount status.
• Extension of Bonus Depreciation and Increase in Small Business Expensing. Businesses can deduct for regular and alternative minimum tax ("AMT") purposes 50% of the cost of most depreciable tangible personal property, computer software, qualified leasehold improvements and certain other property acquired and placed in service during 2009 as well as during 2008.  Also, taxpayers can write-off immediately up to $250,000 of tangible personal property and computer software purchased during 2009, subject to phase out if such purchases exceed $800,000.
• Extension of Election to Accelerate Pre-2006 AMT and Research Credits In Lieu of Bonus Depreciation. As under prior law, instead of bonus depreciation a corporation may elect to increase its limits on use of pre-2006 AMT and research credits up to the lesser of 6% thereof or $30 million.  Different elections for 2008 and 2009 are allowed.
• Preservation of NOLs Following Ownership Changes Pursuant to Loans Under EESA. The limitation on using net operating losses ("NOLs") of a corporation after a more than 50% ownership change does not apply to a change required under a loan agreement or commitment with Treasury under the Emergency Economic Stabilization Act of 2008 to rationalize costs, capitalization and capacity with respect to manufacturing workforce of, and supplies to, the corporation, or to certain later ownership changes, provided the corporation is not more than 50% held by one or related persons (other than a voluntary employees benefit association).  IRS Notice 2008-83 is overturned for post‑January 16, 2009 deals not previously committed (Notice 2008-83 granted similar relief to banking institutions).
• 5-Year Carryback of NOLs for Smaller Business. A business with average gross receipts up to $15,000,000 for its prior three years may elect to carry back five years any NOL for its taxable year beginning or ending in 2008.
• Temporary Suspension of S Corporation 10-Year Built-In Gain Rule. S corporations that have not been C corporations for more than seven years can sell built-in gain assets during 2009 or 2010 without incurring corporate-level tax, rather than having to wait until more than 10 years after electing S corporation status.
• Expansion of Qualified Small Business Stock Rule for Investments Before 2012. For qualified small business stock acquired after enactment and before 2012 and held five years, 75% rather than 50% of gain will be excluded.
• Numerous Other Business Incentives. ARRTA includes numerous other incentives for business investment and activity, including credits for hiring veterans and disconnected youth, expansion of industrial development and other tax-exempt bond provisions, credits for renewable energy products and projects, and many other new tax benefits.

Authored by:

John R. Bonn

(978) 594-0170

jbonn@sheppardmullin.com

Pursuant to applicable Treasury Regulations, we notify you that the information in the foregoing flyer does not constitute legal or tax advice, cannot be used for the purpose of avoiding any tax penalties that may be imposed on any person, and may not be used or referred to in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement to any person. No limitation is hereby imposed on disclosure of tax treatment or structure of any transaction.

Most maritime shipping companies were operating profitably through the summer of 2008 until the "perfect storm" of the credit crisis and the worldwide recession struck, leading to the collapse of both the commodity and freight markets.  The resulting upheaval has affected trade credits, shipbuilding deliveries, orders, chartering, and sales-and-purchases, among other things, for shipping companies worldwide.  Reports of bankruptcy, insolvency, liquidation and complex debt restructurings of shipping and other maritime industry companies have begun surfacing in the trade press, with more to come.

As a result of the turmoil in the shipping industry, actions seeking attachments under Supplemental Admiralty Rule B of the Federal Rules of Civil Procedure have risen dramatically, further exacerbating the problems facing cash-strapped shipping companies.  As the recent U.S. bankruptcy filings of Armada (Singapore) Pte. Ltd. and Atlas Shipping A/S demonstrate, Chapter 15 bankruptcy proceedings under the U.S. Bankruptcy Code may provide struggling shipping companies with a powerful tool for protecting their assets from Rule B Attachments.

Rule B Attachments

Under Rule B, a party may obtain security for a maritime claim that has not yet been reduced to judgment or arbitral award.  Rule B Attachments can be issued by the court where the action on the merits is pending or by any court where the defendant has assets so long as the defendant itself is not located or otherwise found in that jurisdiction.  Thus, while the type of claim must be within that courts admiralty jurisdiction (i.e., arising from a maritime tort or contract), the underlying dispute need not have any connection to the particular courts geographical district or even the United States.  In addition, a claimant can obtain a Rule B Attachment on an ex parte basis, without notifying its opponent in advance.  In fact, many shipping companies only learn their funds have been attached when a puzzled business partner inquires about a payment not received.

Rule B Attachments are popular because they are effective.  In Winter Storm Shipping, Ltd. v. TPI, the Court of Appeals for the Second Circuit held a Rule B Attachment can intercept and attach an electronic funds transfer (EFT) in the hands of an intermediary bank, including the New York Clearing House banks in Manhattan that process virtually all transfers of U.S. currency (or USD transfers) made worldwide.  Because shipping industry transactions are generally in U.S. currency and usually pass through one of the New York Clearing House banks, Rule B Attachment proceedings have become exceptionally popular in the Southern District of New York (which includes Manhattan) where they now comprise approximately 30% of all new cases filed.

Relief under U.S. Bankruptcy Law

Foreign shipping companies facing financial difficulties or the threat of Rule B Attachment can protect themselves through the United States bankruptcy laws.  When a company files for bankruptcy certain automatic protections are triggered.  First, in most cases, the filing will act to suspend a debtors past, pending and current liabilities and obligations, providing the debtor with opportunity and time to reorganize its business operations and financial arrangements, while allowing the debtor to continue to manage its business and maintain control of its assets and corporate governance, subject only to certain restrictions and the supervision of the bankruptcy court.  Second, upon a bankruptcy filing, the law imposes an automatic, statutory stay, which suspends the continuation or commencement of any action, proceeding or any other formal or informal attempt to recover claims against the debtor or its assets – anywhere in the world.  There are certain exceptions to the automatic stay and a creditor can request the court to grant relief from the stay.  Generally though, the protections of the automatic stay under the U.S. Bankruptcy Code will provide a debtor with breathing room and the ability to protect its assets during the proceeding, giving it time to catch its breath and, perhaps, chart a new course.

Foreign companies can protect themselves through Chapter 15 of the Bankruptcy Code.  Although Chapter 15 does not commence a full-blown bankruptcy case within the United States, it can provide a foreign debtor in an insolvency proceeding outside of the United States with certain protections, including the automatic stay, to protect assets in the United States.  Specifically, a foreign shipping company that has commenced an insolvency proceeding abroad, may be able to stay all actions against it, including pending Rule B Attachments, by filing a Chapter 15 case soon after the commencement of its foreign proceedings.  The Board of Directors of Armada (Singapore) Pte. Ltd. recently filed a chapter 15 petition in the Bankruptcy Court for the Southern District of New York for recognition of the companys insolvency proceeding in Singapore, for exactly that reason – to protect its assets against potential Rule B Attachments.

To qualify for protection under Chapter 15 of the Bankruptcy Code, a foreign debtors authorized foreign representative must file a petition for recognition of the foreign insolvency proceeding, meet certain statutory requirements, notify all relevant parties and attend a hearing for approval of such recognition.  A foreign representative can also seek provisionally to stay any execution or action against the debtors assets from the time it files a petition for recognition through the time when the Bankruptcy Court makes its decision whether or not to approve the recognition of the foreign proceeding.  If approved, the Bankruptcy Court will enter an order recognizing the foreign proceeding either as a "foreign main proceeding," if the foreign proceeding is pending in the country where the debtor has its main interests, or as a "foreign non-main proceeding," if the foreign proceeding is pending in a country where the debtor has a place of operations to carry out non-transitory economic activity.  The scope of protections afforded to a foreign debtor will differ depending on whether the court determines the foreign proceeding to be a main or non-main proceeding.  Specifically, the automatic stay against all proceedings applies only upon the recognition of a foreign main proceeding.  Alternatively, while the recognition of a foreign non-main proceeding does not trigger the general automatic stay, it does grant the Bankruptcy Court the power to stay the commencement or continuation of individual or specific actions against the debtors assets, and to suspend the right to transfer, encumber or otherwise dispose of the debtors property and assets within the United States. 

No one is yet certain where the shipping industry is headed or the extent of the damage that has been done.  In the midst of this uncertainty, United States bankruptcy law may provide some needed relief to enable shipping companies to reorganize.

Authored by:

Edward H. Tillinghast, III
(212) 332-3529 - etillinghast@sheppardmullin.com

Greggory B. Mendenhall
(212) 332-3825 - gmendenhall@sheppardmullin.com

Charles S. Donovan
(415) 774-2994 - cdonovan@sheppardmullin.com

Elizabeth Rotenberg-Schwartz
(212) 332-3800 - erotenberg-schwartz@sheppardmullin.com

Malani J. Cademartori
(212) 332-3847 - mcademartori@sheppardmullin.com

Blanka Wolfe
(212) 332-3822 - bwolfe@sheppardmullin.com

A common strategy for acquiring the business of a troubled company is to purchase assets rather than acquire all outstanding capital stock of the target, based on the general principle that a purchaser of assets is not responsible for liabilities of its seller absent an express or implied assumption.  Does the strategy work?  Depending on the liability and circumstances, the answers are "No" and "Maybe," and sometimes a qualified "Yes."  In troubled economic times, buyers may reconsider whether they are willing to rely upon indemnity by the seller or its owners, particularly since doctrines of public policy may render such an indemnity unenforceable in certain situations.

• State and Local Taxes.  At least 25 of the 50 states impose successor liability on a purchaser of assets with respect to unpaid taxes of the seller, unless the purchaser either (i) withholds the taxes from the purchase price or (ii) obtains a clearance certificate from the government.  Usually, but not always, the transaction must involve substantially all the assets of the business or a termination of business by the seller.
• Bulks Sales Act.  Failure to comply with a state bulk sales act, if applicable, generally results in liability for the purchaser to creditors of the seller.
• Certain Product Liabilities.  A buyer may inherit seller product liabilities pursuant to judicial doctrine.
• Collective Bargaining Agreements.  A purchaser of assets may be required to recognize and bargain with a union that represented the sellers employees
• Certain Underfunded Pensions. If the seller participates in an underfunded multiemployer union pension plan, a sale of its assets results in immediate withdrawal liability.  Some courts hold a buyer liable for a sellers delinquent contributions and withdrawal liability despite disclaimer in the asset purchase agreement.
• Environmental Liabilities. A buyer may be liable for seller liabilities under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 or other environmental laws.
• Regulated Industries. If the seller engages in a business subject to special governmental regulation, then additional issues arise concerning potential exposure of an asset purchaser to seller liabilities.
• De Facto Merger or "Mere Continuation" of Seller. Pursuant to common law developed by the courts, a seller and buyer may be considered to have undergone a "de facto merger" or the buyer may be considered a "mere continuation" of the seller, with the result that the buyer is liable to creditors of the target.
• Fraudulent Transfers. Obviously an actually fraudulent sale can create successor liability.  However, both state and federal law may treat a transfer as "fraudulent" -- and thereby expose the buyer to liabilities of its seller –in various circumstances, most commonly where the seller is insolvent before or after the transfer.

Authored by:

John R. Bonn

(978) 594-0170

jbonn@sheppardmullin.com

Bankruptcy filings are skyrocketing as more and more companies are going deep into the red.  For retailers or their landlords holding leases in commercial property, there are special considerations to keep in mind.  This post will provide some basic information on the rights of non-debtor tenants and landlords under unexpired non-residential property leases when a debtor–landlord or –tenant, respectively, files a chapter 11 bankruptcy petition.

Assuming or Rejecting the Lease.  When a debtor files for bankruptcy and seeks to reorganize its business under chapter 11, the debtor will generally retain possession of its property and continue to manage its business as a debtor in possession.  The debtor has broad rights to either assume, assume and assign, or reject commercial leases (and other contracts and leases to which it may be a party), subject only to court approval.  By assuming a lease, the debtor is choosing to continue under the terms of the lease and accepts all burdens and obligations related to the lease.  If rejected, however, the debtor will be relieved of its obligations under the lease, leaving the non-debtor with an unsecured claim for damages based on a breach of the lease.

When the chapter 11 debtor is the tenant:

• Before a tenant-debtor may assume an unexpired lease of non-residential real property, it must: (1) cure any monetary defaults, or provide adequate assurance that any monetary defaults under the lease will be promptly cured; and (2) provide adequate assurance that all obligations under the lease will be satisfied in the future.  For tenant-debtors seeking to assume a lease in a shopping center, additional showings are required for adequate assurance of future performance, including evidence of the source of rent and assurances that any percentage rent due will not decline substantially.
• If the tenant-debtor rejects the lease of non-residential real property, the tenant will be required to immediately vacate the premises.  In addition, the rejecting tenant-debtor will still be required to address any claims made against it for past due and unpaid rental and other monetary obligations, and may be exposed to damages for rejection of such lease, including future rent.

When the chapter 11 debtor is the landlord:

• Similarly, if a landlord-debtor assumes an unexpired lease of non-residential real property, it must first: (1) cure any monetary defaults, or provide adequate assurance that any monetary defaults under the lease will be promptly cured; and (2) provide adequate assurance that all obligations under the subject lease will be satisfied in the future.
• However, if a landlord-debtor rejects an unexpired lease of non-residential real property, the non-debtor tenant will have the option to treat the lease as terminated or retain its rights under the lease for the duration of the lease and any renewal or extension periods thereof.  The landlord-debtor must allow the tenant to exercise its rights, including with respect to the amount and timing of payment of rent and any other amounts due, and to possession, use, quiet enjoyment, subletting, assignment and hypothecation.  If the non-debtor tenant opts to remain, the landlord-debtor is not required or obligated to actively perform their duties and responsibilities under such lease.  The tenant, however, is entitled to offset any damages incurred by the tenant by virtue of the landlord-debtors non-performance of its obligations under the lease against the rental or other payments it is required to make.  Rejection of a lease of non-residential real property in a shopping center where the non-debtor tenant opts to continue its use of the premises will not affect the enforceability of any provision pertaining to radius, location, use, exclusivity, tenant mix or balance within the shopping mall.
• In the event that either a tenant-debtor or landlord-debtor seeks to assume and assign a lease of non-residential real property to a third party: (1) the debtor party must still first cure any monetary defaults, or provide adequate assurance that any monetary defaults under the lease will be promptly cured; and (2) the proposed third-party assignee must provide adequate assurance of its future performance under such lease from and after assignment.  In addition, before a shopping center lease is assigned to a third party, the proposed assignee must provide adequate assurance that it is able to perform under the lease, including compliance with all restrictive covenants and the ability to maintain the tenant mix or balance within the shopping center will not be disturbed.

Timeframe.  In 2005, Congress reduced the time in which a tenant-debtor may assume, assume and assign, or reject an unexpired lease of non-residential real property to 120 days of the bankruptcy filing.  The debtor may be granted one 90-day extension of this 120-day period, however, if the tenant-debtor wishes to seek further extensions thereafter, it must first attain written approval of the non-debtor landlord.  If assumption has not occurred within the required time period, the unexpired lease is deemed rejected.

This 210 day cap has significant implications for retail debtors.  Prior to this change the time to make a decision for assumption or rejection was often virtually unlimited (and remains virtually unlimited for landlord-debtors), allowing a retailer to evaluate sales at a particular store for one, if not two, holiday seasons.  Now, the decision must be made within seven months.

Assignment of Leases.  Many leases have provisions purporting to restrict or prohibit assignment (as well as provisions which state that the lease will terminate upon bankruptcy).  There are, however, specific Bankruptcy Code sections which render such provisions generally unenforceable in the bankruptcy context.

The ability to assign a non-residential real property lease can provide a significant opportunity to retail debtors who hold leases below market rates and are able to find third-party buyers to purchase the rights under, and thereby take over, these leases.  This not only provides proposed assignees with an opportunity to step into the shoes of the debtor on below-market unexpired commercial leases, but also provides the retail tenant-debtors with additional capital with which to administer their estates.  Note that with respect to shopping center leases, limitations such as radius, location, use, or exclusivity will continue to be enforceable, even in the bankruptcy context.

If the Debtor is a Sublandlord.  If you are a tenant under a sublease and the sublandlord files for bankruptcy, your right to occupy the property will likely be terminated if the sublandlord rejects the master lease (the lease between the ultimate landlord and your sublandlord).  You may retain your rights to possess the property, however, if you have a non-disturbance agreement with the ultimate landlord or if you are a third party beneficiary of a non-disturbance clause in the master lease.

Get prompt legal advice. Whether the debtor is a tenant or a landlord, commercial leases will be affected by any bankruptcy proceeding. The above discussion provides only a brief snapshot of the complexities involved when a business holding commercial leases as either a landlord or debtor files for bankruptcy. In order to protect your rights, get prompt legal advice any time bankruptcy proceedings are involved.

Authored by:

Richard Brunette

(213) 617-4174

rbrunette@sheppardmullin.com

and

Kristy E. Young

(415) 774-3153

kyoung@sheppardmullin.com

In Burkhart v. Coleman, (In re Tippett) --- F.3d ---, 2008 WL 4070690 (9th Cir. Sept. 4, 2008), the Ninth Circuit held that an unauthorized post-petition sale of real property may be upheld where: 1) the bankruptcy trustee failed to record the bankruptcy petition with the county recorder; and 2) a bona fide purchaser thereafter bought and recorded title in the property.  As welcome as this news is to bona fide purchasers in California, the opinion raises interesting issues pertaining to acts arguably taken in violation of the automatic stay under section 362 of the Bankruptcy Code by holding that the automatic stay may not apply to sales or transfers of property initiated by the debtor under certain circumstances.

Mr. and Mrs. Tippett filed a Chapter 7 petition in May of 2001.  On their schedules, the Tippetts listed their homestead as having a value of $140,000, with two liens against it totaling approximately $135,000.  The bankruptcy Trustee did not abandon the bankruptcy estates interest in the residence, but did not record the Tippetts petition with the county recorder.  

Without obtaining bankruptcy court approval, in November of 2002, the Tippetts sold their home to Seitu Coleman for $225,000.  This sale resulted in the receipt by the Tippetts of over $75,000 after payment of all liens on the property.  To purchase the property, Coleman signed purchase money notes in favor of two mortgage companies.  These notes were secured by deeds of trust that were duly recorded.  It was undisputed that Coleman was a bona fide purchaser of the property. 

The Trustee filed an adversary proceeding against the Tippetts, Coleman, and the lenders seeking to recover the sale proceeds under 11 U.S.C. § 542, avoid the lenders liens, and quiet title to Coleman.  The bankruptcy court, however, ruled in favor of the Trustee, and held that the Tippetts grant deed and the lenders liens were void ab initio as violations of the automatic stay under 11 U.S.C. § 362.  On appeal, the Bankruptcy Appellate Panel reversed and entered judgment in favor of Coleman, concluding that the Tippetts unauthorized transfer of the residence to Coleman did not violate the automatic stay.

The Ninth Circuit affirmed the BAP decision and held that the Bankruptcy Code does not preempt Californias bona fide purchaser status as it applied to the foregoing transaction.  Additionally, the Court held it was "adher[ing] to the established proposition that the automatic stay triggered by a debtors bankruptcy petition does not void transfers of estate property initiated by the debtor." 

Preemption

The Ninth Circuit found that Californias Bona Fide Purchaser Statute was not preempted by the Bankruptcy Code.  In making this determination, the Court found that Chapter 7 of the Code embodies two ideals: 1) giving a debtors a fresh start, and 2) equitably distributing a debtors assets among competing creditors.  The Court found that Californias bona fide purchaser statute was "wholly consistent" with the second goal, and thus there was no federal preemption. 

The Automatic Stay

The Trustee also contended that the automatic stay rendered the transfer of the real property to Coleman a nullity pursuant to 11 U.S.C. § 362.  This argument would appear to persuasive as the Ninth Circuit has consistently stated that violations of the automatic stay are void, not merely voidable.  However, the Court in In re Tippett concluded otherwise. 

The Courts rationale was as follows: section 549 of the Bankruptcy Code, allows (but does not mandate) a trustee to avoid a transfer of property of the estate that occurs post-petition and without authorization.  According to the Bankruptcy Court, the expansive definition of "transfer" in section 549 means that sections 362 and 549 of the Bankruptcy Code, at times, govern the same transactions.  In addition, section 549 of the Bankruptcy Code implies that some transactions will be valid unless challenged by a trustee.  Thus, the Court noted that some have argued section 362 of the Bankruptcy Code cannot be interpreted to void these overlapping transactions, for doing so would render section 549 of the Bankruptcy Code moot. 

The Court also found that there was a key difference between section 549 and section 362: section 362 protects the debtor, not creditors, while section 549 is designed to protect creditors against unauthorized transfers by the debtor.  Moreover, the Court cited Schwartz v. United States (In re Schwartz), 954 F.2d 569, 574 (9th Cir. 1992), for the proposition that in most circumstances, section 549 applies to transfers in which the debtor is a willing participant; in contrast, the automatic stay under section 362 does not apply to sales or transfers of property initiated by the debtor.  As a result, the transfer from the Tippetts to Coleman was not rendered void by the automatic stay. 

Unfortunately, the Court does not provide any analysis as to why section 362 does not apply to sales or transfers of property initiated by the debtor.  Rather, the Court found itself bound by the principles of stare decisis, and concluded that "there is no question that the analysis and conclusion in Schwartz that the automatic stay did not apply to transfers by debtors was an important and focused part of the panel’s reasoning."  The "analysis" in Schwartz, however, is non-existent, and Schwartz fails to include a single case in support of this proposition. 

As a result, the few short paragraphs in the opinion that discuss the automatic stay add a further wrinkle to the well established Ninth Circuit authority that renders actions taken in violation of the automatic stay as "void," at least when the debtor is the one initiating the action.  Although it is clear from reading the opinion that the automatic stay does not apply to transfers by debtors, at least under certain circumstances, the rationale for this proclamation is uncertain. As a result, it is unclear how future cases will apply section 362 if it involves transfers by the debtor. 

If In re Tippett is held to its facts, the potential impact on the Ninth Circuits interpretation of the automatic stay may be quite limited.  However, the possibility that In re Tippett could be extended beyond its particular facts is one that creditor and debtor attorneys should be aware of.

Authored by:

Stephanie M. Seidl

(213) 617-4177

sseidl@sheppardmullin.com

In a recent decision, the United States Supreme Court ruled that asset sales in bankruptcy that occur after plan confirmation will be exempt from certain and often potentially costly state taxes, whereas sales that occur before plan confirmation will not be so exempt. In so ruling, the Court resolved a circuit split regarding the meaning of the statutory phrase "under a plan confirmed under [Chapter 11] of the bankruptcy Code," as codified in 11 U.S.C. § 1146(a).

The case arose from the bankruptcy of Piccadilly Cafeterias, Inc.  At one time among the nations most successful cafeteria chains, Piccadilly had fallen on hard financial times.  In 2003, Piccadilly filed for Chapter 11 bankruptcy protection in the Southern District of Florida.  As the centerpiece of its reorganization efforts, Piccadilly sought court authorization to sell virtually all of its assets in a § 363(b)(1) sale pursuant to a settlement agreement reached with creditors.  The bankruptcy court granted this authority.  In authorizing the sale, the bankruptcy court further ruled Piccadillys transfer of assets would be "exempt from stamp taxes under § 1146(a)."  (Maj. Slip Op. at 2.)  Piccadilly closed its sale on March 16, 2004.

Months after the successful sale, Piccadilly filed a plan of reorganization.  On July 31, 2004, Piccadilly filed its second amended (and final) plan of reorganization.  The plan duly called for a transfer of assets "in a manner consistent with" the sale that had closed in March.

The Florida Department of Revenue objected to the plan.  Seeking payment of $39,200 in stamp taxes it had assessed against some of Piccadillys transferred assets, Florida argued the transfer had not been "under a plan confirmed."  11 U.S.C. § 1146(a).  Floridas argument was simple.  The statutory term "confirmed," because it is a past participle, refers exclusively to something that has already happened.  But at the time of the transfer, plan confirmation had not yet occurred.  Therefore, the transfer had not been "under a plan confirmed" and thus fell outside the scope of the § 1146(a) tax exemption.  Piccadilly countered that "under a plan confirmed" imposed no such temporal requirement.  According to Piccadilly, the most natural reading of the statute extended the exemption to all transfers that complied with the terms of a plan, regardless of whether that plans confirmation happened before, or after, the transfer.

On cross-motions for summary judgment, the bankruptcy court ruled in favor of Piccadilly.  The District Court for the Southern District of Florida affirmed.  The Court of Appeals for the Eleventh Circuit also affirmed in a per curiam opinion.  Noting a circuit split, the Supreme Court granted certiorari.

In a vote of 7-2, with Thomas, J., speaking for the majority and Breyer, J., writing in dissent, the Court reversed and remanded:

The most natural reading of § 1146(a)s text, the provisions placement in the Code, and applicable substantive canons of all lead to the same conclusion: Section 1146(a) affords a stamp-tax exemption only to transfers made pursuant to a Chapter 11 plan that has been confirmed.  Because Piccadilly transferred its assets before its Chapter 11 plan was confirmed by the Bankruptcy Court, it may not rely on § 1146(a) to avoid Floridas stamp taxes.

(Maj. Slip Op. at 19.)  To reach its conclusion, the Court relied principally on the text.  Section 1146(a) provides, in its entirety:

The issuance, transfer, or exchange of a security, or the making or delivery of an instrument of transfer under a plan confirmed under section 1129 of this title, may not be taxed under any law imposing a stamp tax or similar tax.

11 U.S.C. § 1146(a).  Acknowledging the variability of the term "under," the Court nevertheless found the statutes meaning was plain.  "Confirmed," the Court observed, is a past participle.  As such, it is most naturally interpreted as referring to something that has already occurred.  Therefore, the plain terms of § 1146(a) extends the stamp tax exemption only to transfers made under a plan that has already been confirmed.

The Court then continued on to hold that even if § 1146(a)s text was ambiguous, nothing suggested the Court should resolve that ambiguity in favor of Piccadilly.  Indeed, the Court held that in the event of ambiguity, the interpretive "canon" of California State Bd. of Equalization v. Sierra Summit, Inc., 490 U.S. 844 (1989), required it to construe the provision narrowly in favor of state taxing authorities.

Writing in dissent, Breyer and Stevens, JJ., set forth a three-step critique.  First, the dissent argued, the notoriously variable term "under"—past participles notwithstanding—rendered the statute ambiguous.  Second, the dissent doubted the applicability of the Sierra Summit canon.  Specifically, the dissent wondered how this so-called canon could logically apply to a provision "the express point of which is to exempt some category of state taxation?"  (Dissent Slip Op. at 3.)  Third, the dissent concluded that because the statute was ambiguous, and because Sierra Summit should not apply, the Court should construe the statute in light of Chapter 11s basic objectives: (1) preserving going concerns and (2) maximizing property available to satisfy creditors.

These objectives, the dissent urged, militate in favor of the exemption.  For one thing, the Chapter 11 plan confirmation process "takes time" (Dissent Slip Op. at 5), whereas asset sales are sometimes most successful when the debtor closes them relatively early.  Among other things, restricting the tax exemption to only those debtors who close a sale after confirmation would potentially reduce the incentive to engage in a timely sale process and may have a chilling effect on the ability of a debtor to market its assets and maximize their value, thus subverting the purposes of Chapter 11 to the detriment of the bankruptcy estate and creditors.

Authored by:

Timothy C. Perry

(415) 774-3215

tperry@sheppardmullin.com

In a recently-issued Revenue Procedure (Rev. Proc. 2008-28), the IRS states that the modification of certain mortgage loans under foreclosure prevention programs involving, for example, interest rate reductions, principal forgiveness, extensions of maturity and alterations in the timing of changes in an interest rate generally will not cause the IRS either to challenge the tax status of certain securitization vehicles that hold the loans or to assert that those modifications create a liability for tax on a prohibited transaction. This relief is granted to real estate mortgage investment conduits (REMICs) and investment trusts where the mortgage loan meets all of the following conditions:

(1) The real property securing the mortgage loan is a residence that contains fewer than 5 dwelling units.

(2) The real property securing the mortgage loan is owner-occupied.

(3) If a REMIC holds the mortgage loan, then as of either the startup day or the end of the 3-month period beginning on the startup day, no more than 10% of the stated principal of the total assets of the REMIC was represented by loans the payments on which were then overdue by 30 days or more; and if an investment trust holds the mortgage loan, then as of all dates when assets were contributed to the trust, no more than 10% of the stated principal of all the debt instruments then held by the trust was represented by instruments the payments on which were then overdue by 30 days or more.

(4) The holder or servicer reasonably believes that there is a significant risk of foreclosure of the original loan based on guidelines developed as part of a foreclosure prevention program similar to that described in the Revenue Procedure or may be based on any other credible systematic determination.

(5) The terms of the modified loan are less favorable to the holder than were the unmodified terms of the original mortgage loan.

(6) The holder or servicer reasonably believes that the modified loan presents a substantially reduced risk of foreclosure, as compared with the original loan.

The Revenue Procedure applies generally to loan modifications that are effected on or before December 31, 2010.

Authored by:

D. Matthew Richardson

(213) 617-4222

mrichardson@sheppardmullin.com

In a recently-issued Revenue Procedure (Rev. Proc. 2008-28), the IRS states that the modification of certain mortgage loans under foreclosure prevention programs involving, for example, interest rate reductions, principal forgiveness, extensions of maturity and alterations in the timing of changes in an interest rate generally will not cause the IRS either to challenge the tax status of certain securitization vehicles that hold the loans or to assert that those modifications create a liability for tax on a prohibited transaction. This relief is granted to real estate mortgage investment conduits (REMICs) and investment trusts where the mortgage loan meets all of the following conditions:

(1) The real property securing the mortgage loan is a residence that contains fewer than 5 dwelling units.

(2) The real property securing the mortgage loan is owner-occupied.

(3) If a REMIC holds the mortgage loan, then as of either the startup day or the end of the 3-month period beginning on the startup day, no more than 10% of the stated principal of the total assets of the REMIC was represented by loans the payments on which were then overdue by 30 days or more; and if an investment trust holds the mortgage loan, then as of all dates when assets were contributed to the trust, no more than 10% of the stated principal of all the debt instruments then held by the trust was represented by instruments the payments on which were then overdue by 30 days or more.

(4) The holder or servicer reasonably believes that there is a significant risk of foreclosure of the original loan based on guidelines developed as part of a foreclosure prevention program similar to that described in the Revenue Procedure or may be based on any other credible systematic determination.

(5) The terms of the modified loan are less favorable to the holder than were the unmodified terms of the original mortgage loan.

(6) The holder or servicer reasonably believes that the modified loan presents a substantially reduced risk of foreclosure, as compared with the original loan.

The Revenue Procedure applies generally to loan modifications that are effected on or before December 31, 2010.

Authored by:

D. Matthew Richardson

(213) 617-4222

mrichardson@sheppardmullin.com

In a recently-issued Revenue Procedure (Rev. Proc. 2008-28), the IRS states that the modification of certain mortgage loans under foreclosure prevention programs involving, for example, interest rate reductions, principal forgiveness, extensions of maturity and alterations in the timing of changes in an interest rate generally will not cause the IRS either to challenge the tax status of certain securitization vehicles that hold the loans or to assert that those modifications create a liability for tax on a prohibited transaction. This relief is granted to real estate mortgage investment conduits (REMICs) and investment trusts where the mortgage loan meets all of the following conditions:

(1) The real property securing the mortgage loan is a residence that contains fewer than 5 dwelling units.

(2) The real property securing the mortgage loan is owner-occupied.

(3) If a REMIC holds the mortgage loan, then as of either the startup day or the end of the 3-month period beginning on the startup day, no more than 10% of the stated principal of the total assets of the REMIC was represented by loans the payments on which were then overdue by 30 days or more; and if an investment trust holds the mortgage loan, then as of all dates when assets were contributed to the trust, no more than 10% of the stated principal of all the debt instruments then held by the trust was represented by instruments the payments on which were then overdue by 30 days or more.

(4) The holder or servicer reasonably believes that there is a significant risk of foreclosure of the original loan based on guidelines developed as part of a foreclosure prevention program similar to that described in the Revenue Procedure or may be based on any other credible systematic determination.

(5) The terms of the modified loan are less favorable to the holder than were the unmodified terms of the original mortgage loan.

(6) The holder or servicer reasonably believes that the modified loan presents a substantially reduced risk of foreclosure, as compared with the original loan.

The Revenue Procedure applies generally to loan modifications that are effected on or before December 31, 2010.

Authored by:

D. Matthew Richardson

(213) 617-4222

mrichardson@sheppardmullin.com

In a recently-issued Revenue Procedure (Rev. Proc. 2008-28), the IRS states that the modification of certain mortgage loans under foreclosure prevention programs involving, for example, interest rate reductions, principal forgiveness, extensions of maturity and alterations in the timing of changes in an interest rate generally will not cause the IRS either to challenge the tax status of certain securitization vehicles that hold the loans or to assert that those modifications create a liability for tax on a prohibited transaction. This relief is granted to real estate mortgage investment conduits (REMICs) and investment trusts where the mortgage loan meets all of the following conditions:

(1) The real property securing the mortgage loan is a residence that contains fewer than 5 dwelling units.

(2) The real property securing the mortgage loan is owner-occupied.

(3) If a REMIC holds the mortgage loan, then as of either the startup day or the end of the 3-month period beginning on the startup day, no more than 10% of the stated principal of the total assets of the REMIC was represented by loans the payments on which were then overdue by 30 days or more; and if an investment trust holds the mortgage loan, then as of all dates when assets were contributed to the trust, no more than 10% of the stated principal of all the debt instruments then held by the trust was represented by instruments the payments on which were then overdue by 30 days or more.

(4) The holder or servicer reasonably believes that there is a significant risk of foreclosure of the original loan based on guidelines developed as part of a foreclosure prevention program similar to that described in the Revenue Procedure or may be based on any other credible systematic determination.

(5) The terms of the modified loan are less favorable to the holder than were the unmodified terms of the original mortgage loan.

(6) The holder or servicer reasonably believes that the modified loan presents a substantially reduced risk of foreclosure, as compared with the original loan.

The Revenue Procedure applies generally to loan modifications that are effected on or before December 31, 2010.

Authored by:

D. Matthew Richardson

(213) 617-4222

mrichardson@sheppardmullin.com

In a recently-issued Revenue Procedure (Rev. Proc. 2008-28), the IRS states that the modification of certain mortgage loans under foreclosure prevention programs involving, for example, interest rate reductions, principal forgiveness, extensions of maturity and alterations in the timing of changes in an interest rate generally will not cause the IRS either to challenge the tax status of certain securitization vehicles that hold the loans or to assert that those modifications create a liability for tax on a prohibited transaction. This relief is granted to real estate mortgage investment conduits (REMICs) and investment trusts where the mortgage loan meets all of the following conditions:

(1) The real property securing the mortgage loan is a residence that contains fewer than 5 dwelling units.

(2) The real property securing the mortgage loan is owner-occupied.

(3) If a REMIC holds the mortgage loan, then as of either the startup day or the end of the 3-month period beginning on the startup day, no more than 10% of the stated principal of the total assets of the REMIC was represented by loans the payments on which were then overdue by 30 days or more; and if an investment trust holds the mortgage loan, then as of all dates when assets were contributed to the trust, no more than 10% of the stated principal of all the debt instruments then held by the trust was represented by instruments the payments on which were then overdue by 30 days or more.

(4) The holder or servicer reasonably believes that there is a significant risk of foreclosure of the original loan based on guidelines developed as part of a foreclosure prevention program similar to that described in the Revenue Procedure or may be based on any other credible systematic determination.

(5) The terms of the modified loan are less favorable to the holder than were the unmodified terms of the original mortgage loan.

(6) The holder or servicer reasonably believes that the modified loan presents a substantially reduced risk of foreclosure, as compared with the original loan.

The Revenue Procedure applies generally to loan modifications that are effected on or before December 31, 2010.

Authored by:

D. Matthew Richardson

(213) 617-4222

mrichardson@sheppardmullin.com

In a recently-issued Revenue Procedure (Rev. Proc. 2008-28), the IRS states that the modification of certain mortgage loans under foreclosure prevention programs involving, for example, interest rate reductions, principal forgiveness, extensions of maturity and alterations in the timing of changes in an interest rate generally will not cause the IRS either to challenge the tax status of certain securitization vehicles that hold the loans or to assert that those modifications create a liability for tax on a prohibited transaction. This relief is granted to real estate mortgage investment conduits (REMICs) and investment trusts where the mortgage loan meets all of the following conditions:

(1) The real property securing the mortgage loan is a residence that contains fewer than 5 dwelling units.

(2) The real property securing the mortgage loan is owner-occupied.

(3) If a REMIC holds the mortgage loan, then as of either the startup day or the end of the 3-month period beginning on the startup day, no more than 10% of the stated principal of the total assets of the REMIC was represented by loans the payments on which were then overdue by 30 days or more; and if an investment trust holds the mortgage loan, then as of all dates when assets were contributed to the trust, no more than 10% of the stated principal of all the debt instruments then held by the trust was represented by instruments the payments on which were then overdue by 30 days or more.

(4) The holder or servicer reasonably believes that there is a significant risk of foreclosure of the original loan based on guidelines developed as part of a foreclosure prevention program similar to that described in the Revenue Procedure or may be based on any other credible systematic determination.

(5) The terms of the modified loan are less favorable to the holder than were the unmodified terms of the original mortgage loan.

(6) The holder or servicer reasonably believes that the modified loan presents a substantially reduced risk of foreclosure, as compared with the original loan.

The Revenue Procedure applies generally to loan modifications that are effected on or before December 31, 2010.

Authored by:

D. Matthew Richardson

(213) 617-4222

mrichardson@sheppardmullin.com

In a recently-issued Revenue Procedure (Rev. Proc. 2008-28), the IRS states that the modification of certain mortgage loans under foreclosure prevention programs involving, for example, interest rate reductions, principal forgiveness, extensions of maturity and alterations in the timing of changes in an interest rate generally will not cause the IRS either to challenge the tax status of certain securitization vehicles that hold the loans or to assert that those modifications create a liability for tax on a prohibited transaction. This relief is granted to real estate mortgage investment conduits (REMICs) and investment trusts where the mortgage loan meets all of the following conditions:

(1) The real property securing the mortgage loan is a residence that contains fewer than 5 dwelling units.

(2) The real property securing the mortgage loan is owner-occupied.

(3) If a REMIC holds the mortgage loan, then as of either the startup day or the end of the 3-month period beginning on the startup day, no more than 10% of the stated principal of the total assets of the REMIC was represented by loans the payments on which were then overdue by 30 days or more; and if an investment trust holds the mortgage loan, then as of all dates when assets were contributed to the trust, no more than 10% of the stated principal of all the debt instruments then held by the trust was represented by instruments the payments on which were then overdue by 30 days or more.

(4) The holder or servicer reasonably believes that there is a significant risk of foreclosure of the original loan based on guidelines developed as part of a foreclosure prevention program similar to that described in the Revenue Procedure or may be based on any other credible systematic determination.

(5) The terms of the modified loan are less favorable to the holder than were the unmodified terms of the original mortgage loan.

(6) The holder or servicer reasonably believes that the modified loan presents a substantially reduced risk of foreclosure, as compared with the original loan.

The Revenue Procedure applies generally to loan modifications that are effected on or before December 31, 2010.

Authored by:

D. Matthew Richardson

(213) 617-4222

mrichardson@sheppardmullin.com

In a recently-issued Revenue Procedure (Rev. Proc. 2008-28), the IRS states that the modification of certain mortgage loans under foreclosure prevention programs involving, for example, interest rate reductions, principal forgiveness, extensions of maturity and alterations in the timing of changes in an interest rate generally will not cause the IRS either to challenge the tax status of certain securitization vehicles that hold the loans or to assert that those modifications create a liability for tax on a prohibited transaction. This relief is granted to real estate mortgage investment conduits (REMICs) and investment trusts where the mortgage loan meets all of the following conditions:

(1) The real property securing the mortgage loan is a residence that contains fewer than 5 dwelling units.

(2) The real property securing the mortgage loan is owner-occupied.

(3) If a REMIC holds the mortgage loan, then as of either the startup day or the end of the 3-month period beginning on the startup day, no more than 10% of the stated principal of the total assets of the REMIC was represented by loans the payments on which were then overdue by 30 days or more; and if an investment trust holds the mortgage loan, then as of all dates when assets were contributed to the trust, no more than 10% of the stated principal of all the debt instruments then held by the trust was represented by instruments the payments on which were then overdue by 30 days or more.

(4) The holder or servicer reasonably believes that there is a significant risk of foreclosure of the original loan based on guidelines developed as part of a foreclosure prevention program similar to that described in the Revenue Procedure or may be based on any other credible systematic determination.

(5) The terms of the modified loan are less favorable to the holder than were the unmodified terms of the original mortgage loan.

(6) The holder or servicer reasonably believes that the modified loan presents a substantially reduced risk of foreclosure, as compared with the original loan.

The Revenue Procedure applies generally to loan modifications that are effected on or before December 31, 2010.

Authored by:

D. Matthew Richardson

(213) 617-4222

mrichardson@sheppardmullin.com