Bankruptcy Practice: A 2014 Overview

We have identified several ongoing trends in our practice area impacting retailers, healthcare providers, and pharmaceutical patent licensees, as well as a growing number of suits against bankrupt companies’ directors and officers. Retail bankruptcy filings have been on the rise for many years. The Mid-Atlantic region’s dense population and suburban landscape have driven robust retail businesses for decades. Many retailers expanded during the second half of the 20th century from local storefronts to regional chains with dozens, if not hundreds, of retail locations. Auto parts retailers, discount clothiers, supermarkets, electronics vendors, video rental outlets, and sporting goods stores are representative market segments that have historically grown through expansion. However, the rise of internet and digital retailing has displaced the demand for many “brick and mortar” retail locations. Remember Blockbuster? Big box stores have displaced smaller, independent merchants. Add to all of that the effect of several recessions, the chapter 11 filings of many of these retail merchants was inevitable. Most of these chapter 11 cases have ultimately been resolved through asset sales in bankruptcy followed by liquidations.

In a similar vein, the healthcare industry has faced significant financial challenges in the past 20 years. Reimbursements by public and private insurers have decreased. Even with the closure of hospitals, overcapacity remains. The increase in ambulatory care centers providing imaging services, chemotherapy, and outpatient surgical procedures has drained previously profitable business segments away from hospitals. Healthcare reform, spurred by the Patient Protection and Affordable Care Act of 2010 and non-governmental efforts to improve healthcare in the United States, have resulted in increasing pressure on healthcare providers to deliver services more efficiently and effectively.

One result has been the increase in healthcare-related, particularly hospital, bankruptcies. In the past, a bankruptcy filing by a hospital was followed the closure of the debtor-hospital. More recently, hospital bankruptcies have resulted in the sales of debtor-hospitals to other hospital operators. The latest and perhaps the most significant development in hospital bankruptcies has been the acquisition out of bankruptcy of nonprofit hospitals by for-profit hospital systems. This development is a sharp break from the historical domination of the hospital market by nonprofit (often religious) hospitals. Given recent events, the acquisition of nonprofit hospitals by for-profit hospital systems will continue.

Intellectual property rights relevant to the pharmaceutical industry have also been at issue in recent bankruptcies. It is not uncommon for the holders of pharmaceutical patents to license patent rights to third parties. A bankruptcy filing by the patent holder can be devastating to a non-debtor patent licensee holding rights in the debtor’s patent. In bankruptcies in the United States, debtors enjoy significant (although not absolute) discretion in determining whether to reject certain pre-petition contracts. However, if the non-debtor counterparty can demonstrate that it has a right to intellectual property, including a license to exploit a patent, the Bankruptcy Code provides the licensee with the ability to elect to retain its rights under such license, including the right to enforce any exclusivity provisions.

Finally, we have identified D&O insurance disputes as a growing trend in bankruptcy litigation. Directors and officers of bankrupt companies are often subject to suit for negligence and breach of fiduciary duty by creditors and trustees seeking to augment recoveries from the liquidation of a debtor’s assets. Such actions typically allege that directors and officers failed to exercise appropriate care in executing strategic decisions, mergers and acquisitions, and general management of enterprises. Most of these actions are defended under liability policies specifically designed to insure directors and officers from such claims. Powerful defenses to such claims exist. For example, many Mid-Atlantic based companies are formed under Delaware law, which provides that no direct breach of fiduciary duty claim lies in favor of creditors. The business judgment rule likewise insulates directors and officers from liability under such claims. Nevertheless, creditors and trustees of debtors have pursued these claims aggressively in recent years in light of otherwise minimal distributions to creditors resulting from the sale and liquidation of the assets of bankrupt companies.