The Trail of Bankruptcy, Collections and Bad Debt for the Tennessee Valley Public Power Association 2011 Accounting and Finance Conference October 19-21,

The Trail of Bankruptcy, Collections and Bad Debt

for theTennessee Valley Public Power Association 2011 Accounting and Finance Conference

October 19-21, 2011

byNicholas W. Whittenburg

Miller & Martin PLLC

832 Georgia Ave., Suite 1000

Chattanooga, TN 37402

Phone: (423) 756-6600

Facsimile: (423) 785-8480

[email protected]

Bankruptcy Issues and Trends

1. Post-bankruptcy termination of service

2. Assuring payment for post-bankruptcy service

3. Collecting pre-bankruptcy invoices:a. Automatic Stay

b. Setoff vs. Recoupment

c. Recovery under LC or Bond

d. Liquidating and filing a Proof of Claim

e. Prosecuting Administrative Claims

4. Electricity: A Product or Service

5. Defending Preferential Transfer Litigation

Post-Bankruptcy Service

The Bankruptcy Code (§366(a)) precludes a utility from altering, refusing or discontinuing service or discriminating against a debtor or trustee solely on the basis of the filing of bankruptcy or non-payment of a pre-bankruptcy debt.

When May Service Be Terminated?

1. If the debtor/trustee fails to pay for post-petition service. In re Robinson, 918 F.2d 579 (6th Cir. 1990); In re Begley, 760 F.2d 46 (3d Cir. 1985).

2. If debtor/trustee fails to timely provide “adequate assurance of future payment.”

3. Termination must be consistent with the customer’s contract, regulations, and applicable non-bankruptcy law.

Adequate Assurance in Chapter 7, 12 and 13 Cases

1. Debtor/Trustee required to furnish “adequate assurance” within 20 days of the commencement of bankruptcy. 2. Form of “Adequate Assurance” - May be a security deposit or “other security.”3. Amount of “Assurance” – Within the discretion of the Bankruptcy Court. Courts consider whether pre-bankruptcy security deposit was paid, payment history,applicable regulations, and debtor’s financial condition.

Adequate Assurance in Chapter 11 Following BAPCPA of 2005

1. Debtor required to furnish adequate assurance “satisfactory to the utility” within 30 days.2. Form of “Adequate Assurance” - (i) cash deposit; (ii) LC; (iii)

CD; (iv) surety bond; (v) prepayment; (vi) or any other form agreed to by utility.- BAPCPA overturned In re Caldor, 117 F.3d 646 (2nd Cir.

1997) (holding that administrative priority afforded post-bankruptcy providers was “adequate assurance.”)

- Practice developing in large cases of establishing a segregated utility deposit account containing

50% of the debtor’s estimated average monthly utility costs.

3. Absence of prior deposit and payment history irrelevant in Chapter 11.

4. Procedural Burdens:a. Venue – Often New York or Delawareb. First Day Motions – Inadequate notice and expedited hearings)

Judicial Decisions

1. In re Lucre Inc., 333 B.R. 151 (Bankr. W.D. Mich 2005) Held that, “as a condition to continuing the injunction” prohibiting utility from discontinuing service and any modification of “adequate assurance”, the debtor must first provide a deposit or other security “satisfactory” to utility.

2. In re Syroco Inc., 374 B.R. 60 (Bankr. D. Puerto Rico 2007) a. Held that utilities’ failure to respond to debtor’s offer to post a deposit equal to average cost of 2 weeks of service is a tacit acceptance of the debtor’s offer of adequate assurance. b. Court declined to follow Lucre.

Court Decisions Cont.

3. In re Bedford Town Condominium, 427 B.R. 380 (Bankr. D. Md. 2010); In re Circuit City Stores, Inc., 2009 W.L. 484553 (Bankr. E.D. Va. 2009); In re Beach House Property, LLC, 2008 W.L. 961498 (Bankr. S.D. Fla. 2008)a. All rejected as absurd the Lucre decision.b. Held that the court may modify the amount of adequate assurance demanded by a utility even though the debtor has not yet paid that amount.

Court Decisions Cont.

4. In re Viking Offshore (USA) Inc., 2008 W.L. 782449 (Bankr. S.D. Tx 2008)a. Debtor proposed no adequate assurance. Instead, proposed a procedure whereby utilities must request adequate assurance.b. Court held that the court’s authority to modify the

amount of adequate assurance may not be used to eliminate entirely the requirement in section 366(c) that a debtor provide adequate assurance of payment.c. Court agreed with Lucre decision noting that it lacks the power to reverse the statutory framework for

provision of adequate assurance.

Court Decisions Cont.

5.In re New Rochelle Telephone Corp., 397 B.R. 633 (Bankr. E.D. N.Y. 2008)a. “Adequate assurance . . . is not a guarantee of payment; rather, it is intended to guard against the utility assuming an unreasonable risk of non-payment.”b. Required debtor to post a 1 month security deposit ($150,000).

Collecting Pre-Bankruptcy Invoices

• A. Customer NOT in Bankruptcy– Terminate Service– Demand Payment– Apply security deposit– Enforce LC or Bond– Collection Agency– File SuitB. Customer in Bankruptcy- Automatic Stay (11 U.S.C. § 362)- May not terminate service (11 U.S.C. § 366)- File Proof of Claim

Automatic StayA. Scope – Proscribes any action (formal or informal) to:

- collect a pre-bankruptcy debt- enforce a lien or right of setoff - exercise control over property of the estate- exercise control over property of the debtor

B. Setoff v. Recoupment- Setoff includes any right to reduce or deduct from a competing

claim- Recoupment not subject to the automatic stay- Recoupment is a right of setoff arising from the same

transaction or contract giving rise to the competing claim. In re McMahon, 129 F.3d 93 (2d Cir. 1997) (holding that utility company’s application of prepetition security deposit to debtor’s prepetition utility obligation was recoupment not subject to the automatic stay)

C. Relief From Stay. Court may grant relief from automatic stay “for cause.”

The Bottom Line for UtilitiesA. Upon commencement of bankruptcy by a customer:

- Stop all billing for pre-bankruptcy service and any other collection devices (e.g. termination notices, litigation, garnishments);- Don’t terminate service because of bankruptcy or failure to pay pre-bankruptcy charges or fees;- Liquidate pre- and post-bankruptcy debt;- Recoup pre-bankruptcy security deposit; and- Draw on Letter of Credit/Surety Bond

B. Upon commencement of bankruptcy by an employee:- Cease withholding of garnishment excepting for “Domestic Support Obligations” and Pension Loans;- Comply with Chapter 13 Wage Order.

C. Promptly file Proofs of Claim in Bankruptcy- Chapter 7, 12 and 13: Deadline is 90 days after first date set for the meeting of creditors- Chapter 11: Deadline set by the Bankruptcy Court

Collecting Pre-Bankruptcy Invoices

A. Secured Claim 1. Right of setoff = secured claim (11 U.S.C.§ 506)2. Setoff subject to automatic stay3. Recoupment not stayed4. Recovery of LC or Surety Bond not stayed

B. Unsecured Claim (Balance after liquidation of collateral)1. Balance owing for pre-bankruptcy service 2. File proof of claim3. Probable low or no distribution4. Delayed distribution

C. Administrative Priority Claim1. Section 503(b)(1)(A) – Administrative Expenses

defined as “actual, necessary costs and expenses of preserving the [bankruptcy] estate …”a. Entitled to payment prior to general unsecured creditors. § 507b. Applies to post-petition service beneficial to the bankruptcy estate.c. Requires filing of a motion with the Bankruptcy Court seeking allowance.

2. Section 503(b)(9) – Affords administrative status to claims for the “value” of “goods” received by the debtor within 20 days of a bankruptcy.

Electricity – A Good or Service

1. Whether electricity is classified as a “product” or “good” is legally important because :

a. Strict Liability Statutes;

b. Laws and Regulations governing the sale of “goods” (e.g. Art. 2 UCC);

and

c. Bankruptcy provisions affording priority treatment to providers of “goods.”

Strict Liability Exposure

a) If electricity is a “product,” then the utility may be subject to applicable state laws imposing strict liability for personal

injuries.

b) Judicial decisions are not uniform.

Under Restatement (Second) of Torts § 402A, Strict Liability applies to:

(1) One who sells any product in a defective condition unreasonably dangerous to the user or to his property is subject to liability for physical harm thereby caused to the ultimate user or consumer, or to his property, if

(a) the seller is engaged in the business of selling such a product, and

(b) it is expected to and does reach the user or consumer without substantial change in the condition in which it is sold.

Three legal questions must be answered when analyzing whether strict liability applies to electricity:

• Is electricity a “product”?

• If it is a product, when is it “sold”?

• When does electricity contain a “defect” that renders it “unreasonably dangerous”?

Jurisdictions holding that Electricity is NOT a Product:

a. Bowen v. Niagara Mohawk Power Corp., 590 N.Y. S. 2d 628 (N.Y. App. Div. 1992)

b. Otte v. Dayton Power & Light Co., 523 N.E. 2d 835 (Ohio 1988)

c. Wyrulec Co. v. Schutt, 866 P. 2d 756 (Wyo. 1993)

d. G&K Dairy v. Princeton Elec. Plant Bd., 781 F. Supp. 485 (W.D. Ky. 1991)

This is the minority view. Courts that have held that electricity is a

service and not a product have reasoned that

“Electricity is the flow of electrically charged particles along a conductor” and the utility company “does not manufacture electrically charged particles, but rather, sets in motion the necessary elements that allow the flow of electricity.”

Otte v. Dayton Power & Light Co., 523 N.E. 2d 835, 838 (Ohio 1988).

The majority of courts have held that electricity IS a “product” and subject to strict liability laws.

a. Monroe v. Savannah Electric & Power Co., 471 S.E. 2d 854 (Ga. 1996)

b. Bryant v. Tri-County Electric Membership Corp., 844 F. Supp. 347 (W.D. Ky. 1994)

c. Houston Lighting & Power Co. v. Reynolds, 765 S.W. 2d 784 (Tex. 1989)

d. Butler v. City of Peru, 733 N.E. 2d 912, (Ind. 2000).

Other Courts holding that electricity is a product:

a. Travelers Indem. Co. of America v. Connecticut Light and Power Co., 2008 WL 2447351 (Conn.Super. 2008)

b. Mancuso v. Southern Cal. Edison Co., 232 Cal.App.3d 88, (Cal.App. 2 Dist.1991)

c. Smithbower v. Southwest Cent. Rural Elec. Co-op., Inc., 374 Pa.Super. 46, (Pa.Super.,1988)

d. Smith v. Home Light and Power Co.  734 P.2d 1051 (Colo.1987)e. Public Service Indiana, Inc. v. Nichols, 494 N.E.2d 349 (Ind.App. 4

Dist.1986) f. Pierce v. Pacific Gas & Electric Co., 166 Cal.App.3d

(Cal.App.3.Dist.1985)g. Carbone v. Connecticut Light and Power Co., 482 A.2d 722,

723 (Conn.Super.1984)h. Aversa v. Public Service Elec. and Gas Co., 186 N.J.Super. 130

(N.J.Super.L.,1982)i. Ransome v. Wisconsin Elec. Power Co., 275 N.W.2d 641 (Wis. 1979)j. Petroski v. Northern Indiana Public Service Co., 354 N.E.2d 736,

747 (Ind.App. 1976)

 Courts have held that electricity is a product

because it can be:

• Confined• Controlled • Transmitted• Distributed into the stream of commerce• measured • bought and sold• changed in quantity or quality• delivered wherever desired;  and • subject to larceny standards

Defenses for when electricity is held to be a product:

• The electricity must have been “sold” in order for the utility to be strictly liable– The majority of courts hold that electricity is not “sold” until it passes

through a customer’s meter. Harm caused by electricity which has not yet passed through the meter is governed by negligence principles.

– Bryant v. Tri-County Electric Membership Corp., 844 F. Supp. at 351.

• Plaintiff has the burden to prove that the electricity was “defective” and “unreasonably dangerous.”– Many courts have held that electric voltage is dangerously defective

when it is “far in excess of the level intended by the utility and expected by the consumer.”

– Comer v. American Elec. Power, 63 F.Supp.2d at 939 (N.D.Ind.,1999).

UCC Definition of “Goods”

1. UCC § 2-105 – Defines “goods” as “all things. . .which are movable at the time of identification to the contract for sale…”

2. Is electricity a good?a. Puget Sound Energy, Inc. v. Pacific Gas & Elec. Co., (In re Pacific Gas & Electric Co.), 271 B.R. 626 (N.D. Cal. 2002) (holding that electricity is a movable “good” under the UCC definition)b. In Re Pilgrim’s Pride Corp. 421 B.R. 231 (Bankr. N.D. Tex. 2009) (holding that electricity is not a “good” because it is consumed at time of identification at the meter); In re Samaritan Alliance, LLC, 2008 W.L. 2520107 (Bankr. E.D. Ky. 2008)

Electricity as a “Good” and Bankruptcy

Bankruptcy Code Section 503(b)(9) – Allows administrative expense priority for the “value of any goods received by the debtor within 20 days before the commencement of a case. . . in the ordinary course of such debtor’s business.” a. Electricity is a “Good” – GFI Wisconsin, Inc. v.

Reedsburg Utility Com., 440 B.R. 791 (W.D. Wis. 2010) (held that electricity received from utilities within 20

days prior to bankruptcy qualified as a “good” for which utilities could assert administrative claim); In re Erving Industries, Inc., 432 B.R. 354 (Bankr. D. Mass. 2010) (held that electricity supplied by a supplier (not a utility) is

a “good” entitling provider to an administrative expense for electricity supplied within 20 days of the petition

date)b.Electricity is not a “Good” – In Re Pilgrim’s Pride

Corp., 421 B.R. 231 (Bankr. N.D. Tex. 2009) (held that electricity was not a “good” under 503(b)(9))

Elements of an Avoidable Preferential Transfer

• a. Transfer of an interest of the debtor’s property;

• b. to or for the benefit of a creditor;• c. for or on account of any antecedent debt;• d. made while the debtor was insolvent;• e. made on or within 90 days before the filing

of the petition; and• f. that enables the creditor to receive more

than it would receive in a liquidation if the transfer had not been made.

Defenses to Avoidance

• a. Ordinary Course of Business

• b. New Value

• c. Transfers aggregating less than $5,850 in cases involving a debtor whose debts are not primarily consumer debts.

To be excepted from avoidance under the “ordinary course of business” defense the creditor must establish:

a. That the debt was incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the creditor; and

b. That the transfer was made –• In the ordinary course of business of the debtor and

creditor; or• Made according to ordinary business terms.

New Value Exception

A transfer is excepted from avoidance to the extent that:

a. After the transfer the creditor gave “new value” to or for the benefit of the debtor;

b. on an unsecured basis; andc. on account of such new value the debtor did

not make an otherwise unavoidable transfer.“New Value” means “money or money’s worth in goods, services, or new credit…” 11 U.S.C. § 547(a)(2)

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