Delaware and Business Insolvency

Delaware continues to be a venue of choice for parties seeking a consistent and sophisticated jurisdiction to file an insolvency proceeding, whether the case is a large bankruptcy or a midmarket bankruptcy.  Companies can file in the Delaware courts because they can file bankruptcy in any jurisdiction that one of its affiliates is incorporated or where it has a principal place of business or principal asset.  Delaware has a long history as the state of incorporation of choice, since the early 1900s, and has gained even more popularity because of its innovation in alternative entities, such as limited liability companies.  Litigants who enter Delaware quickly gain the same appreciation that the members of the bar and their partners from outside the state have for the Delaware legal community.

Small is Good

The Delaware bar exam is only given once a year as opposed to the norm in most states in the U.S. which is twice a year.  The number of lawyers admitted each year is modest, and the bar difficult, with about 150 lawyers entering the bar most years (by comparison, California has about 6300 lawyers a year entering the profession). 

The intimacy of living and working in a small community leads to a very close and cordial bar in which incivility is not tolerated.(1)  This doesn’t mean that the lawyers aren’t tough or smart; they are just not allowed to take advantage of the strife inherent in a business dispute for their own gain.  Many clients figure out soon enough that a litigation fueled by anything other than the facts and the law, like emotion, leads to a result where often the only parties who gain anything are the lawyers.  Legal practice, whether Federal or State, is heavily influenced by the legal culture of the Delaware Supreme Court and the Delaware Court of Chancery, the preferred trial court for the resolution of corporate business disputes in the U.S. and neither court tolerates unprofessional behavior. 

The District Court for the District of Delaware (“District Court”), of which the United States Federal Bankruptcy Court for the District of Delaware (“Bankruptcy Court”) is a part, also require that Delaware lawyers be retained as attorney of record in Delaware cases, though admission for out of state lawyers who work with a Delaware lawyer is freely allowed.  At the same time, parties who are pulled into a bankruptcy case as creditors, and, thus, might not have immediate need for a Delaware lawyer, have thirty days after filing papers in the case, or when their case is transferred to Delaware, to associate with a Delaware lawyer.  This allows for the parties to negotiate before having to litigate an issue in the Delaware Courts.  Once a Delaware lawyer is engaged, both Federal and State Courts in Delaware require that the lawyer be a member of the bar, maintain an office in Delaware and regularly transact business with the Court.  The procedural rules in both the Bankruptcy Court and the District Court are almost identical in how they address this issue. 

The Bankruptcy Local Rules note that claims can be handled without a Delaware lawyer until the point that it appears there will be extensive discovery or trial time, at which point the court may direct the party to consult with a Delaware lawyer.  Other exceptions that relieve parties from having to use Delaware counsel exist for government lawyers and pro se litigants.  The rules also allow the Bankruptcy Judge discretion to approve admission to a non-Delaware lawyer to practice before them without Delaware counsel, under the appropriate circumstances.

Delaware is Just Right – Both Flexible and Consistent

Much of Delaware state court practice and procedure has shaped practice in the Delaware Bankruptcy Court, whether by design or simply because the lawyers who have drafted the Bankruptcy Court’s rules and procedures themselves have been influenced by the Delaware legal culture.  The Chancery Court(2) and the Delaware Legislature, through the Delaware General Corporation Law (“DGCL”), influences(3) the Bankruptcy Court in two ways. 

The first is a combination of procedural efficiency and the accommodating manner in which Delaware Judges allow parties to avail themselves of the state court.  The Clerk and the Judges of the Bankruptcy Court have taken to heart the practices of the Delaware state courts(4)when structuring their local procedures.  The second is the flexibility and sophistication that the DGCL and other applicable corporate laws, including the law of contract under Delaware common law,(5)that leads to consistency in the judge’s decisions, while implementing the law in a flexible and pragmatic fashion.  Delaware law is particularly helpful in this vein to support the powers already granted under Chapter 11 to a debtor-in-possession. 

Bankruptcy Courts in Delaware have made it a priority to accommodate corporate bankruptcy filings, pioneering the concept of first day relief and providing access to its judicial officers and courts, moving quickly to accommodate technology, working with the bar to create consistent and uniform local rules and Chambers Procedures, leading in the way in the innovation of fair and accessible claims procedures, and in requiring transparency and consistency in disclosure of important terms in the often complex financing documents related to the funding of the bankruptcy process. 

Emergency Relief and Access to the Court

It is not uncommon for a Bankruptcy Judge to put aside travel plans and adjourn a hearing for a few hours in the hope of allowing the parties to reach a settlement or “get a deal done.”  The accommodation of these judges to the litigants is something that is often unavailable in many other Courts and is truly to be commended.

The access by litigants to the Court is also institutionalized.  The Delaware Bankruptcy Court and its Clerk have made filing an emergency Chapter 11 within two business days notice the standard and provide for leave to file a case in shorter time if the circumstances warrant it. It is notable that the Office of the United States Trustee in Delaware, the arm of the Justice Department responsible for overseeing several aspects of the bankruptcy process, also adheres to this schedule and works diligently and tirelessly on behalf of creditors until such time as an Official Committee of Unsecured Creditors can step in and watch out for the unsecureds interests. 

This expediency does not sacrifice the rights of other parties.  All orders entered into on an emergency basis are subject to final approval, often being approved on only an interim basis and only to the extent necessary to assist the debtor between the emergency hearing date, the “first days”, and the next available hearing.  Parties get a second chance even beyond the final hearing to object to any emergency relief, as relief granted on an emergency basis is subject to reconsideration after thirty days except for motions for post petition financing under Del. Bankr. L.R. 9013-1 (v).

The Delaware Bankruptcy Judges are also quick to remind a debtor that while the standards for emergency relief are a little easier on the first day, if other parties demand a further showing at a final hearing, the standards will be a lot tougher.  The practice of critical vendor payments,(6)for example, has come under pressure in recent years. 

Debtors will often petition the Bankruptcy Court to make payments to certain essential suppliers or service providers for prepetition debts in exchange for continued provision of goods or services after the bankruptcy is filed, on the condition that the terms, or better, that existed pre-bankruptcy are continued.  Critical vendor motion relief allows flexibility and ability to preserve the going concern value of debtors and free up much needed cash flow by eliminating the number of vendors who demand C.O.D. or prepayment.  Critical vendors are often credited with helping to keep the business operating so that value can be preserved for all creditors.  However, allowing the practice is criticized or forbidden in other jurisdictions because it violates the distribution system in bankruptcy known as the absolute priority scheme, in which higher priority creditors, such as secured lenders, are paid in full before any junior classes, like unsecured creditors, are paid.  Additionally unsecured creditors who are not chosen to participate in the Debtors critical trade program also, arguably, do not get equal treatment with similarly situated unsecured critical trade vendors.

Delaware Courts have balanced the virtues of allowing the debtor a pragmatic approach to preserving its business while not ignoring the rights of objecting parties, allowing objecting parties to contest and require the debtors to justify the aggregate amounts claimed in emergency filings.  Parties have been able to demand that final approval of such payments be supported with a detailed evidentiary showing at the hearing.  Debtors still get emergency relief, but are not allowed unmitigated authority to spend estate funds on unsecured trade claims that could arguably be paid to other higher priority parties.  In several high profile cases, this compromise approach has lead to voluntary reductions by Debtors in the amount requested for critical trade once their situations have stabilized post filing, balancing creditor rights with the debtors need for cash flow and emergency relief. 

Innovators in Technology and Procedure

Bankruptcy courts across the country began implementing electronic filing in 2001 before the Federal District Courts or Federal Appellate Courts and Delaware was an early adopter.  Commercial entities in Delaware began creating virtual dockets for the Delaware legal community in 1998, but the Delaware Superior Court is credited with having the first electronic case filing system in the U.S. in 1991 with the development of the Complex Litigation Automated Docket or CLAD.  Electronic filing made it possible to file around the clock to accommodate the breadth of litigants from around the world.  The Bankruptcy Court also freely grants both telephonic and video appearances so that creditors, other interested parties, and lawyers from all parts of the globe can participate.  The Bankruptcy Court still requires, in most circumstances, that should a hearing require live testimony; the parties appear in person so that the lawyers can conduct a proper cross examination.  Exceptions have been made, however, when parties are simply unable to travel the great distances involved.  The Bankruptcy Court’s requirements, especially in dealing with very large cases has caused an evolution in private companies that assist the Bankruptcy Court when a case reaches a certain size(7)and these private companies are further advancing technology in the insolvency process that opens and facilitates access to participants in the legal process in Delaware.

A criticism of many other jurisdictions outside of Delaware is that the judges have varied judicial Chambers procedures and the local rules are limited in scope or out of touch with the practice as it evolves.  The Delaware Bankruptcy judges have all agreed to use a uniform set of chambers procedures with some few small exceptions dealing with limited elements of trial practice.  These, and other permanent procedural rules, are located conveniently, and updated often, on the website for the Bankruptcy Court.  The bar and the court also moved to incorporate several standing orders and existing local practice into one set of local rules about a decade ago.  Many Courts in other jurisdictions do not have uniform rules that govern case procedures, which results in disjointed case by case procedural orders.  Delaware sets the standard in this respect, with a vibrant set of local rules that cover the depth of most procedural issues and having a local rules committee that is not limited to Delaware Judges and lawyers, but also includes prominent and frequent practitioners who often practice in Delaware. 

Two area of notes are the claims objection process in Delaware, which was drafted in order to provide a consistent treatment of claims, the most likely time that a creditor would need to appear in Delaware, and how a case is financed through either debtor-in-possession financing or requests for use of available cash flow, or cash collateral, as it is known to bankruptcy professionals. 

Amendments that took effect on December 1, 2007 to the Federal Rules of Bankruptcy Procedure included limits on the use of omnibus claim objections under Rule 3007 which restricts omnibus objections to certain situations and imposes formatting standards on the motions that can be filed.  The Delaware Judges opted out of the new rules because they already had their own omnibus objection procedures and the new rule seemed to be modeled on the Delaware rules.  The new rules were too restrictive in some discrete areas.  The main aspects of Rule 3007 and the existing Delaware rules that are consistent focus on keeping the form of the objections simple enough for claimants to follow, such as limited the types of objections that can be combined, and limiting the total number of objections that could be filed under one document, which often contained hundreds of objections and were mystifying to laypersons and professionals alike. 

Another area of concern, both in terms of judicial efficiency and transparency for litigants was in there area of requests for DIP financing.  Delaware Bankruptcy Judge Peter J. Walsh was frustrated with the density and lack of clarity in the debtor in possession financing requests he reviewed, especially as they often came in on an emergency basis.  As a result, he wrote a carefully prepared request to the bar to highlight certain provisions in any request so that both the judge and parties reviewing the crucial financing requests could adequately analyze the papers.  His letter was adopted almost entirely and incorporated in the local rules under Del. Bankr. L. R. 4001-2. 

The Delaware Bankruptcy Local Rules require transparency in cross collateralization requests, findings of fact that bind the estate as to the validity of any secured lien, wavier of rights to surcharge a secured creditors collateral, any liens on estate causes of action, provisions that convert prepetition secured debt to post petition secured debt, conditions that prime (make senior) post petition debts to the detriment of existing liens, and provisions that treat creditor committee professionals different from debtors professionals in terms of financing available to pay their fees. 

Highlighting these provisions for the Court and the other parties provides necessary clarity that balances the needs of a debtor in an emergency need of financing with the rights of various parties that will not appear until later in the case, allowing the Court to deny or make temporary the relief requested until a creditors’ committee can come into the case and address the relevant issues.  Delaware Bankruptcy Local Rule 6004-1 follows suit in requiring the same type of transparency when filing a motion to sell the debtor’s assets.

State Law Insolvency

Interestingly enough Vice Chancellor Travis Laster wrote an article on the viability of the Delaware state receivership drawing many parallels to the Bankruptcy practice thriving a few short blocks from the Chancery Court.  He wrote:

The Delaware Court of Chancery can be flexible in administering a receivership proceeding. Particularly, under Delaware Court of Chancery Rule 148, the court has the power to relieve the receiver from “complying with all or any of the duties and procedures” set forth in the Court of Chancery Rules. Unlike bankruptcy cases, where parties must rigorously comply with a fairly exhaustive set of reporting requirements and procedures, the Court of Chancery may tailor the rules to the realities of the case and needs of the parties-in-interest.  This can produce great savings in the cost of administering a receivership case as compared to the cost of administering a bankruptcy case.(8)

He further discussed the powers of the Chancery Court to reject contracts and to sell property free and clear of liens under 8 Del. C. §297, assuring readers that the state law receivership can accomplish many of the same goals as a bankruptcy filing, especially for the case with circumstances that can’t sustain the costs of a Chapter 11.  His article demonstrates that the state judges in Delaware are constant innovators and problem solvers and follow the market and their brother and sister judges in the federal courts just as much as federal judges in Delaware look to guidance from the history and long tradition of the Chancery Court.  The continuing evolution and flexibility of the Delaware courts, whether state or federal, all have the same thing in common, dedicated judges and lawyers unified in continuing to producing one of the best court system in the U.S.(9)if not the world.

Rafael X. Zahralddin-Aravena is a shareholder and a member of Elliott Greenleaf’s board of directors.  He is the Chair of the firm’s Commercial Bankruptcy and Restructuring Practice and works almost exclusively as a corporate restructuring lawyer and commercial litigator.  He has extensive experience in representing debtors and creditor’s committees and as special litigation counsel in large chapter 11 cases. Active in distressed mergers and acquisitions; he has been involved in multiple sales, with unique expertise in the sale of foreign subsidiaries, representing foreign buyers and sellers and in cases filed under chapter 15.  He also represents creditor clients nationwide in complex bankruptcy and commercial litigation.  Rafael can be contacted on +1 302 545 2888 or by email at rxza@elliottgreenleaf.com.

Shelley A. Kinsella is counsel to Elliott Greenleaf.  She has significant experience in complex chapter 11 reorganization and liquidation cases, and practices in many aspects of bankruptcy, representing debtors, unsecured creditors’ committees, equity committees, trustees, and secured and unsecured creditors. Ms. Kinsella represents reorganized debtors, committees, and trusts in bankruptcy related litigation, including preference actions and fraudulent conveyance actions.  Ms. Kinsella is also a mediator in the United States Bankruptcy Court for the District of Delaware.  Ms. Kinsella practices in the healthcare industry and in employment law both within and outside of bankruptcy.  Shelley can be contacted on +1 302 384 9403 or by email at sak@elliottgreenleaf.com