Bankruptcy, Antitrust and Aircraft Leases – An Interesting Combination
 
June 29, 2005
 

One of the more common frustrations of representing a creditor in a chapter 11 case is litigating against a debtor whose back is against the wall. The bankruptcy court knows that if the creditor wins, the debtor’s prospects of reorganizing may be considerably reduced or even eliminated. The court may, therefore, be inclined to do whatever the court can to preserve the debtor’s prospects of reorganizing. This tendency can only be exacerbated when the creditor is relying on one of those so-called “special interest” provisions that Congress has added to the Bankruptcy Code from time to time that are designed to favor a particular creditor constituency to the detriment of the debtor and, presumably, other creditors.

Often, when that occurs, the only source of relief for the creditor is appellate review. However, part of the creditor frustration is that it may be extraordinarily difficult to obtain appellate relief. After all, the bankruptcy court need not actually make a decision in the debtor’s favor, often a non-decision may have the same effect.

The recent decision of the Seventh Circuit in United Airlines Inc. v. U.S. Bank, N.A., 406 F.3d 918 (7^th Cir. 2005) illustrates these themes well while also embodying important decisions on two significant issues of law. As the title of the decision suggests, it arose out of the United Airlines (UAL) chapter 11 case.

When UAL entered bankruptcy in 2002, the airline operated about 460 aircraft. Some 175 of the aircraft had been acquired via financing leases subject to section 1110 of the Bankruptcy Code. Section 1110 contains provisions specifically designed to protect lessors of aircraft. In substance, that section requires a debtor lessee who wishes to keep the leased equipment to timely pay the entire rent due the lessor. If the debtor fails to make the required payments, the lessor may exercise its legal and contractual rights without the need to obtain relief from the automatic stay of section 362 of the Bankruptcy Code. Furthermore, except as otherwise provided in section 1110, the lessor’s rights “[are] not limited or otherwise affected by any other provision of [the Bankruptcy Code] or by any power of the court.” 11 U.S.C. § 1110(a)(1). The only significant exception to this protection is what may be consensually agreed to by the parties. Subject to approval of the bankruptcy court, the debtor and the lessor may negotiate an agreement permitting the debtor to retain the aircraft under different terms. When UAL filed for bankruptcy, the airline endeavored to negotiate reduced rates with equipment lessors. Initially, many lessors went along. However, as the bankruptcy case dragged on, some equipment lessors began to have second thoughts. In November 2004, the banks serving as indenture trustees for three of the aircraft leases demanded that UAL return 14 of the leased aircraft unless the airline cured all defaults under the leases and resumed the full rental payments promised under the contracts.

UAL responded by filing an adversary proceeding accusing the banks of antitrust violations under the Sherman Act, 15 U.S.C. § 1, by coordinating their efforts to preserve their collateral and collect the promised payments. In order to prevent the lenders from repossessing the airplanes, the debtor also filed a motion for a preliminary injunction seeking to maintain possession of the aircraft until the adversary proceeding was decided. In conjunction with the preliminary injunction motion, UAL sought a temporary restraining order (TRO) pending resolution of the preliminary injunction motion. The bankruptcy court granted the TRO. In so doing, the court rejected the banks’ argument that the provision of section 1110 quoted above precludes the use of “any power of the court” to prevent repossession on the ground that this provision did not affect the court’s right to provide injunctive relief under non-bankruptcy law.

Under Federal Rule of Civil Procedure 65(b) and Federal Rule of Bankruptcy Procedure 7065, TROs cannot be extended for more than 20 days. The bankruptcy court, therefore, scheduled the preliminary injunction hearing during that 20-day period. In the meantime, the bankruptcy court authorized expedited discovery. Thereupon, UAL issued an extremely broad discovery demand that, among other matters, sought all of the banks’ communications with their attorneys. When the banks objected on the ground that the materials sought were covered by the attorney-client and work-product privileges, the bankruptcy court overruled their objections on the ground that UAL’s antitrust claim was strong enough to override such privileges because such privileges cannot be used to shield ongoing crimes, and a violation of the Sherman Act is a felony.

Seeking to establish an opportunity for appellate review, the banks respectfully declined to comply with the discovery order. However, rather than draw an adverse inference and enter a preliminary injunction that would be subject to appeal or hold the banks in criminal contempt, which would also be subject to appeal, the bankruptcy court simply declared the banks to be in contempt without imposing any sanction. 406 F.3d at 922-23. The bankruptcy court then adjourned the scheduled preliminary injunction hearing until such time as the banks produced the requested materials.

The banks nevertheless appealed the bankruptcy court’s ruling to the district court, which has discretionary authority to review non-final decisions of the bankruptcy court. The banks filed one appeal from the TRO and a second appeal from the declaration of contempt. The district court dismissed both appeals ruling that neither order was “final” and declining to exercise jurisdiction to review the interlocutory (non-final) orders. The situation was concisely summarized by the Seventh Circuit:

The upshot is that the lessors are enjoined from repossessing the aircraft, without either review by an Article III judge or any prospect of such review – for the bankruptcy judge will not hold a hearing on the motion for injunctive relief until the trustees cough up the privileged documents, which they do not plan to do until they obtain the appellate review that has been denied to them.

Id. at 923.

Because appellate courts have jurisdiction to review only “final” decisions, the banks then sought a writ of mandamus from the Seventh Circuit but asked that the appellate court treat the writ as a notice of appeal in the event that the appellate court determined that jurisdiction existed.

At this point, the banks’ fortunes took a sharp turn for the better. The Seventh Circuit first determined that the appellate court did indeed have jurisdiction over the appeal on the ground that the TRO became a preliminary injunction when it extended past 20 days no matter what the rendering judge may have called the order, so that both the district court had jurisdiction and the appellate court had jurisdiction over the issuance of the injunction.¹

The Seventh Circuit then considered whether the bankruptcy court had the power, based on non-bankruptcy law, to enjoin the banks from exercising their legal right to repossess the aircraft notwithstanding the apparently clear language of Section 1110. The appellate court rejected UAL’s position, pointing out that section 1110 states that courts may not limit the lessor’s right based on either “any other provision of this title or by any power of the court,” thus making clear that a court may not enjoin the exercise of a lender’s right to repossession under any source of law. The appellate court also rejected UAL’s argument that this result would effectuate a “repeal” of the Sherman Act by pointing out that the debtor could still seek damages and the government could still initiate a criminal prosecution. Instead, section 1110 only “curtails a particular remedy”. Id. at 924.

The Seventh Circuit then turned to the antitrust claim, describing it as “thin to the point of invisibility.” Id. at 924-25. UAL conceded that creditors are generally entitled to negotiate jointly in bankruptcy without running afoul of the Sherman Act. UAL contended, however, that this case was different because the lenders “colluded with one another with respect to the future terms and prices on which they would make aircraft available to UAL.” Id. (emphasis in original). The appellate court interpreted this allegation to mean that the collusion concerned “how much less than the contract price the lessors and lenders are willing to accept to forbear from repossessing planes now in United’s hands.” Id.

The Seventh Circuit rejected the contention that such conduct violated the Sherman Act:

Negotiating discounts on products already sold at competitive prices is not a form of monopolization. Negotiations on reductions to be taken in bankruptcy, when the buyer cannot pay all of its debts, are common and lawful, under the Noerr-Pennington doctrine if nothing else ... collaboration among creditors to formulate a position about how much of a haircut to accept has no effect unless the court approves the restructuring.

Id. at 925 (emphasis in original).

Accordingly, the Seventh Circuit remanded the case to the bankruptcy court with instructions to vacate the preliminary injunction and permit the repossessions to proceed unless UAL immediately cured all defaults and resumed payment of full rent due.²

The United decision demonstrates how useful it may be for a creditor to obtain access to appellate review, while also demonstrating some of the difficulties that must be overcome when attempting to do so. The specific holding of the case – that section 1110(a) of the Bankruptcy Code means precisely what it says – is, of course, important in airline cases and should give lessors some comfort in future cases, but the holding is relatively narrow in scope. Whether the Seventh Circuit’s obvious discomfort with the bankruptcy court’s efforts to facilitate UAL’s goals at the banks’ expense will have any long-term impact remains to be seen.

Although the discussion of the Sherman Act was strictly speaking dictum (since it was unnecessary to the decision to vacate the injunction), the antitrust discussion may turn out to be the most significant aspect of the case. Such a result is possible because there are surprisingly few decisions concerning the application of the antitrust laws to collective action by creditors of a defaulting debtor.

The only case discussed by the Seventh Circuit in United was Sharon Steel Corp. v. Chase Manhattan Bank, N.A., 691 F.2d 1039 (2d Cir. 1982), cert. denied mem., 460 U.S. 1253, 103 S.Ct. 1253 (1983), which was cited for the proposition that “creditors are entitled to negotiate jointly in bankruptcy.” Id. at 924-25. Interestingly enough, Sharon Steel did not involve either a bankruptcy or an insolvent debtor. In that case, shareholders of the obligor, UV Industries, Inc. (UV), had approved a liquidating plan. Pursuant to that plan, UV sold its remaining assets to Sharon Steel Corp. (Sharon). As part of that transaction, Sharon assumed UV’s obligations to debentureholders on various trust indentures. The indenture trustees contended that under the indentures, UV was required to pay off its debt obligations and was prohibited from assigning such obligations to Sharon. In the ensuing litigation, Sharon contended, among other things, that the indenture trustees conspired to force UV and Sharon to redeem the outstanding debentures. The Second Circuit disagreed, holding that it was perfectly proper for creditors to act jointly when facing a borrower since absent such collective efforts “creditors … would be compelled to resort to the most extreme action available in order to protect its individual interest.” Sharon Steel, 691 F.2d at 1052.

Another reported decision addressing the issue of joint creditor activity is Falstaff Brewing Corp. v. New York Life Ins. Co., 513 F. Supp. 289 (N.D. Cal. 1978). Falstaff Brewing Corp. (Falstaff) was party to various loan agreements with four banks and two insurance companies. Although Falstaff continued to make the payments due under the agreements, it was in violation of various covenants for which Falstaff sought and obtained waivers. In order to shore up its business, Falstaff obtained a new investor who was prepared to invest $10 million to be used to repay a portion of the outstanding loans. The insurance companies became concerned that, because the interest rates on the bank loans were higher than the rates on the insurance company loans, Falstaff would use all of the new money to pay down the bank loans. Accordingly, the insurance companies insisted, as a condition of granting an extension of their waiver, that Falstaff agree that any payments be pro rata among all the lenders. Falstaff did so agree but later attempted to extricate itself from the agreement by claiming that the agreement constituted an illegal restraint of trade in that it “fixed” the interest rates for its indebtedness. The district court disagreed:

[The insurance companies] were not competing with the banks or other institutions to offer or to supply Falstaff with more credit, but were attempting to secure that credit which they had already extended, the terms of which had already been negotiated. This is the very opposite of price fixing.

513 F. Supp. at 293.

The United decision echoes the arguments provided by Sharon Steel and Falstaff as to why collective action by creditors to protect their existing exposure to a debtor should be encouraged, not discouraged. The Seventh Circuit also relied on a separate rationale that is not applicable to out-of-court workouts, but is applicable to bankruptcy cases, namely the Noerr-Pennington doctrine of anti-trust immunity for collective actions taken by competitors in litigation and regulatory proceedings. Further, as the United court pointed out, any agreement between creditors and the debtor is subject to bankruptcy court scrutiny whether pursuant to a plan or otherwise.

But one should consider what creditor actions would not be protected from antitrust liability. The Seventh Circuit in United contrasted the case before the court to one in which “would-be lessors” conspired “to set the price to be charged for new planes,” id. at 924-25, which would be the basis for “a good antitrust theory … .” Id. This seems straightforward, but one may wonder about a situation in which creditors are being called upon to both restructure existing debt and provide additional credit for new purchases. For example, a retailer may need to restructure its existing debt with suppliers, but to survive, the retailer must also have the ability to continually replenish its existing inventory. Clearly, the United, Sharon Steel and Falstaff decisions all would support such hypothetical suppliers collectively discussing the terms on which the repayment of existing debt would be paid. However, the terms of new credit may be as important or, even more important, to the retailer’s survival. One wonders whether new credit terms could be discussed among the suppliers without such discussions constituting antitrust violations. Presumably, discussions of future credit would be protected if they took place in connection with the negotiation of a chapter 11 plan that is subject to bankruptcy court approval. In fact, the terms under which creditors will provide credit following reorganization are frequently the subject of plan negotiations. It would appear, however, based on a fair reading of the United decision, that any such discussions in the context of an informal workout could prove to be dangerous for the creditors if the negotiations fail and the debtor commences litigation.

In summary, United is an important decision that will give creditors comfort that collective action to protect existing obligations will be safe from anti-trust scrutiny, particularly if such action occurs in a formal bankruptcy proceeding. However, creditors must still be careful, particularly in an out-of-court restructuring, to limit discussion to existing obligations and not to discuss terms of new credit or other arrangements.

For more information, e-mail David J. Mark at david.mark@hklaw.com or call toll free, 1-888-688-8500.

¹ UAL had argued that the banks had consented to the extension, and the district court had agreed. However, the Seventh Circuit determined that the banks consented only to an extension until the bankruptcy court ruled on the privilege issue, which it did the following day. 406 F.3d at 923-24.

² The Seventh Circuit did not direct the dismissal of the complaint, presumably because a motion to dismiss the complaint was not before it. On May 27, 2005, after the district court failed to comply with the Seventh Circuit’s ruling, the appellate court granted the banks’ writ of mandamus, directing the district and bankruptcy courts to vacate the preliminary injunction immediately, and stayed the injunction pending entry of the formal orders by the lower courts. United Air Lines, Inc., et al. v. U.S. Bank N.A., et al., 2005 WL 1265851, *1 (7^th Cir. May 27, 2005).