Because of Winn-Dixie? SDNY Bankruptcy Court Looks Beyond Literal Compliance with Venue Statute and Transfers Patriot Coal Cases to Eastern District of Missouri

[authors: Sharon J. Richardson, David E. Kronenberg, Thomas Curtin]

On November 27, 2012, in a ruling that undoubtedly will impact the choice of venue for many large corporate bankruptcies in the future, Judge Shelley C. Chapman of the United States Bankruptcy Court for the Southern District of New York transferred venue of the chapter 11 cases of Patriot Coal Corporation and ninety-eight of its affiliates to the Eastern District of Missouri. Drawing on an array of jurisprudence regarding venue, Judge Chapman found that notwithstanding literal compliance with the applicable statute, the New York domicile of two of the debtors was insufficient to establish venue for all ninety-nine cases in the Southern District of New York when the two debtors were formed on the eve of the commencement of the chapter 11 cases admittedly for the sole purpose of establishing venue. In re Patriot Coal Corp., 12-12900-SCC (Bankr. S.D.N.Y. Nov. 27, 2012) [docket no. 1629]. The Patriot decision is the latest in a line of recent decisions by courts in the Southern District of New York and the District of Delaware granting motions to transfer venue to other districts. The decision is notable in that it strongly discourages the practice of “bootstrapping” a corporate bankruptcy case to the case of a recently formed affiliate in New York when the debtor has no meaningful presence in the jurisdiction, change of venue is requested by economic parties in interest, and moving the case is unlikely to inflict demonstrable economic harm to the estate.

Transfer of Venue of Bankruptcy Cases

Venue of bankruptcy cases is governed by 28 U.S.C. § 1408, which provides that venue may lie in the district where: (1) the debtor has a domicile, (2) the debtor has a residence, (3) the debtor has a principal place of business, (4) the debtor has principal assets, or (5) there is a pending bankruptcy case concerning the debtor’s affiliate, general partner, or partnership. Often, debtors seeking to file their cases in New York or Delaware, despite no meaningful contacts with these states, would form a subsidiary in the jurisdiction and then rely upon section 1408(5) to “bootstrap” their case to the pending case of the newly-formed affiliate.

Although such bootstrapping permits a debtor seeking to file for bankruptcy protection to technically comply with the requirements of 1408, the debtor’s choice of venue may nevertheless be challenged under 28 U.S.C. § 1412, which provides that a court may transfer a case or proceeding for the “convenience of the parties” or in the “interest of justice.”

Though a debtor’s choice of venue is given considerable deference, it appears that courts may be becoming more receptive to challenges. For example, the U.S. Trustee successfully moved to transfer venue in the Houghton Mifflin case (covered here). Although the debtor’s prepackaged plan had been confirmed with unanimous support from its creditors, the cases were projected to conclude within 30 days of filing, and the debtors’ primary creditor constituencies supported venue in New York, the court transferred venue because none of the debtors were incorporated in New York and their principal assets were located elsewhere. See In re Houghton Mifflin Harcourt Publ’g Co., 474 B.R. 122 (Bankr. S.D.N.Y. 2012). Likewise, in In re Cordillera Golf Club, the Delaware bankruptcy court transferred the case to Colorado pursuant to section 1412 and held that, even though the debtor was incorporated in Delaware, Colorado was a more appropriate venue because the debtor’s ability to reorganize would depend on the involvement of the golf club’s members, all of whom spent time in Colorado.  In re Cordillera Golf Club, LLC, No. 12-11893 (CSS) (Bankr. D. Del. July 16, 2012).

Background

Patriot Coal Corporation (“PCC”) and its affiliates (collectively with PCC, “Patriot”), which are among the nation’s largest coal companies, were formed in 2007 as part of spin-off from Peabody Energy Corporation. PCC and the majority of its subsidiaries are incorporated in Delaware, West Virginia, Virginia, and Kentucky. Patriot operates in various states, including Missouri (where the company is headquartered), West Virginia (where nine of Patriot’s mines are located) and Kentucky (where three of Patriot’s mines are located). Patriot also owns and leases coal reserves located in Illinois, Indiana, Kentucky, Missouri, Ohio, Pennsylvania, and West Virginia. New York law governs much of Patriot’s major contracts, including its debt instruments, spin-off agreements, coal supply agreements, master leases, and surety indemnity agreements.

Patriot employs over 4,000 people. Forty-two percent of Patriot’s employees are unionized and are members of the United Mine Workers of America (“UMWA”). Patriot also provides insurance and health benefits to 11,860 retirees, 10,388 of whom are UMWA members. The retirees mostly reside in West Virginia and the Illinois Basin (which includes Illinois, Indiana, and Kentucky).

On July 9, 2012, PCC and 98 of its subsidiaries commenced chapter 11 cases in the Bankruptcy Court for the Southern District of New York The filings were precipitated by a number of factors, including a reduced demand for coal, increased regulation, substantial legacy labor costs, and Patriot’s inability to refinance its capital structure.

According to the debtors’ petitions, 54 of the entities are domiciled in West Virginia; 40 entities are domiciled in Missouri; 3 entities are domiciled in Kentucky; and 2 entities are domiciled in New York. The New York entities – PCX Enterprises, Inc. and Patriot Beaver Dam Holdings LLC – were formed in New York one month prior to the commencement of Patriot’s cases. The debtors stipulated to the fact that they were formed for the sole purpose of establishing New York as the venue of their chapter 11 cases. Neither subsidiary had any employees, any offices, or any business operations in New York. In addition, neither subsidiary had any substantial assets in New York, other than a bank account with $97,985 and a certificate evidencing an equity interest in one of Patriot’s other subsidiaries. The remaining 97 debtors also had no meaningful contacts with New York, as none were incorporated in the state, nor did they have principal assets, offices, or employees in the state. In addition, the remaining 97 debtors conducted their business operations and generated their revenues from their mining activities in West Virginia and the Illinois Basin. Despite these de minimis contacts with the state, the debtors commenced their cases in the Southern District of New York, bootstrapping 97 of the cases to the cases filed by the newly-formed New York entities.

Shortly after the debtors commenced their cases, the UMWA and several surety insurance companies filed motions pursuant to section 1412 seeking to transfer Patriot’s chapter 11 cases to the Southern District of West Virginia.  Several parties joined the UMWA and insurance company motions, including the West Virginia Attorney General. In addition, on August 22, 2012, the U.S. Trustee filed a separate motion seeking to transfer venue to a district where venue is proper in the interest of justice. Unlike the UMWA’s motion, the U.S. Trustee’s motion did not seek to transfer the case to any specific district. Certain UMWA health and pension funds and an ad hoc group of holders of Patriot’s common stock joined the U.S. Trustee’s motion.

The debtors objected to the motions to transfer venue, arguing that the convenience of parties and administrative efficiency warranted retaining venue of the cases in the Southern District of New York. Among other things, the debtors contended that the benefits of remaining in the district (namely the access to capital markets and chapter 11 professionals, as well as its function as a “global transportation hub”) demonstrated that the district was the most convenient for all parties. Moreover, the debtors argued that upholding their choice of venue would preserve costs and maximize the value of the estate. Their objection was joined by thirty-five of the debtors’ unsecured creditors, including the unsecured creditors’ committee.

The Court’s Analysis

The Bankruptcy Court ultimately granted the U.S. Trustee’s motion and transferred the cases to the Eastern District of Missouri, notwithstanding the debtors’ technical compliance with the venue requirements of section 1408.

As a preliminary matter, the Court found that the debtors’ cases were not filed in bad faith. To the contrary, the Court found that filing the cases in New York was consistent with the debtors’ fiduciary duties to preserve the value of their estates for the benefit of their stakeholders. At trial, the UMWA alleged that the debtors chose New York because the district would be empathetic to the debtors’ needs and demands. The UMWA also alleged that New York was chosen by the debtors due to the perceived ease of rejecting collective bargaining agreements in New York as compared to other districts. However, the Court rejected those arguments.

The Court did take issue with the debtors’ formation of the New York subsidiaries on the eve of filing for the purpose of manufacturing venue, which it viewed as the exploitation of “loopholes” in section 1408. The Court held that although Patriot complied literally with section 1408, Patriot’s conduct nevertheless conflicted with the plain intent of the venue statute, which is to ensure fairness and convenience to all of the parties and witnesses involved in a case. The Court noted that Patriot’s course of conduct was factually analogous to the debtors’ actions in Winn-Dixie, in which the debtors incorporated an entity in New York shortly before commencing their chapter 11 cases and admittedly did so to establish venue. See In re Winn-Dixie Stores, Inc., Case No. 05-11063 (RDD) (Bankr. S.D.N.Y. Apr. 12, 2005). In Winn-Dixie, the Bankruptcy Court determined that a transfer of the debtors’ cases to another district would be in the interests of justice given that the debtors’ formed the entities to solely “exploit a loophole in the statute to obtain venue.” Winn Dixie, Hr’g Tr. at 167.

Similar to the debtors in Winn-Dixie, Patriot created the two New York subsidiaries solely to comply with section 1408. The Court held that permitting the debtors’ cases to remain in the district under these circumstances would not serve the interests of justice because it would “all but render the venue statute meaningless.” The Court found that allowing the debtors’ venue choice to stand solely on the creation of the New York subsidiaries “would elevate form over substance in [a] way that would be an affront to the purpose of the bankruptcy venue statute and the integrity of the bankruptcy system.” In re Patriot Coal Corp., 12-12900-SCC, at 38.  Such a ruling, according to the Court, would encourage and permit a debtor to forum shop.

The Court found that the efficient administration of the case could not be given the most weight in every case because doing so would unfairly allow a forum, such as the Southern District of New York, to trump other venues by virtue of the district’s access to capital markets and its concentration of leading chapter 11 practitioners.

The Court cautioned that its decision to transfer venue should not be viewed as a categorical rule for venue transfers and that the result might well have been different if the U.S. Trustee was the only party requesting a change of venue. In such a scenario, the Court noted, it would be difficult to square the interests of justice with the “purposeful infliction of economic harm on a debtor’s creditors.” Id. at 51. Here, however, the debtors’ choice of venue lacked the unanimous support of Patriot’s creditors, and thus, the Court found that it would be in the interests of justice to transfer the case to another district.

Finally, the Court addressed which district would best handle the debtors’ cases. The Court rejected the UMWA and surety insurers’ arguments that the Southern District of West Virginia was an appropriate venue, finding that it would not be “in the interest of justice to merely swap one party’s perceived home field advantage for another.” Id. at 53. Noting that the case was not a two-party dispute between the UMWA and the debtors, the Court found that transferring the case to a forum more empathetic to the concerns of the UMWA (which represents only 40% of the debtors’ employees) would amount to “forum-shopping that is just as inappropriate as the forum selection strategy employed by the debtors.” Id. at 56.

The Court ultimately found that the Eastern District of Missouri would be the most appropriate forum because the debtors’ headquarters, books and records, and key employees are all located in that district.

Conclusion

The Patriot Coal decision joins other recent decisions, including the Cordillera Golf Club and Houghton Mifflin decisions, in which bankruptcy courts have granted motions to transfer venue to districts from New York or Delaware. The administrative efficiency of a particular jurisdiction and its access to capital markets and leading chapter 11 professionals likely will not, without more, suffice to overcome a motion to transfer venue by economic parties of interest.

The Patriot Coal decision demonstrates that for the purposes of a section 1412 analysis, the interests of justice includes upholding the letter of the law and the integrity of the bankruptcy system. Technical compliance with the venue requirements of section 1408 is not dispositive to a court’s analysis regarding choice of venue. Where, as here, a debtor forms subsidiaries in a district in which there are no meaningful contacts, solely for the purpose of satisfying the statutory predicates, a court could transfer the case to another district.