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When bankruptcy doesn’t work.

On Monday morning, August 1, 2011, Nick (my oldest) arrived at work to be told that he was being laid off immediately and would not be paid the last month’s salary of $8,000 which he had already worked very hard for and, of course, pretty much spent. His employer was Keeping Cash’n’Code, Inc. (a pseudonym), whose CEO was the Eskimo (also not his real name).

The first page of Nick's Employment Agreement with SquiggleChimp.

The first page of Nick’s Employment Agreement with Keeping Cash’n’Code.

Nick immediately moved in with me in the condo, which was a definite silver lining to a rather cloudy event. Love having him around! The other silver lining here is that the US Bankruptcy Code has a very real preference for employees laid off by a bankrupt company. The preference is so real that it places former employees ahead of most taxes: believe that?!

We settled down for the long fight to obtain his salary. He ran the first leg, before the State’s unemployment tribunal, obtaining his benefits over the objections of Keeping Cash’n’Code. Then when the company filed for bankruptcy in March 2012, I took over.

Ultimately, fifteen months later and nine months after Nick had returned to live and work in Paris (boo-hoo!), the bankruptcy court ordered the trustee to pay him 90% of his last month’s salary, but no other individual creditor received anything of substance. 

The second page, with highlights on some of the parts that confirmed his status as an employee.

The second page, with highlights on some of the parts that confirmed his status as an employee.

Nick’s finally getting paid for most of his last month’s is not the subject of this post. Willing to work for nothing to help my son out, I had an unusual perspective on the inner workings of the bankruptcy process and its rather troubling failings. They are the subject here.

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Bankruptcy is supposed to let off the hook the debtor, the person or entity which owes money to others, who are its creditors. The debtor does not have to pay those debts which it cannot meet: it is relieved of those repayment obligations. In return, all of the debtor’s assets are supposed to be distributed to those same creditors. It’s what they get out of losing the balance of what they are owed from the debtor. It is a simple bargain.

In the case of Keeping Cash’n’Code, that simple bargain did not work in two different ways. The company here kept a lot of the cash and a lot of the code! But most of its creditors got nothing.

 *        *        *

The email from Trustee Tom confirming that Keeping Cash’n’Code had made a significant sale of its intellectual property, and sending me the contract. Very thoughtful. The Eskimo’s summary of the use of the $13,000 was to pay the IRS, Franchise Tax Board and “other urgent claims.”

First, the cash. Nick shared a bush telegraph with his fellow coders, including those who had worked for Keeping Cash’n’Code, and before the company actually declared bankruptcy, the telegraph had informed him that there had been a big sale to a customer in San Francisco.

When we sat down at the initial creditors meeting in April 2012, Tom (again not his real name), the trustee appointed by the court, announced that he could not open a case to take care of the creditors because there was no cash available to distribute.

I gulped. What had happened to the San Francisco sale? But the bush telegraph isn’t proof, and so I waited until after the meeting to tell Trustee Tom and the Eskimo’s lawyer about the big deal with the San Francisco customer. They duly asked the Eskimo about it. He sent them, and Trustee Tom sent me, the Purchase Agreement with respect to the deal.

The first page of the San Francisco sale contract itself, showing that the customer had made a loan to Keeping Cash'n'Code in July, right before the company laid Nick off without pay.

The first page of the San Francisco sale contract itself, showing that the customer had made a loan to Keeping Cash’n’Code in July, right before the company laid Nick off without pay.

You’ll see one flaw in this procedure already. The Eskimo must have already told Trustee Tom that there was no cash, or Tom would not have told the creditors meeting the same thing. If the coders’ bush telegraph hadn’t worked and I hadn’t followed up, this game would already have been over, and no creditor would have received one cent, even though Keeping Cash’n’Code had taken in around $25,000 since it stopped paying its bills.

It gets worse. I duly sent this San Francisco Asset Purchase Agreement to Dick, the lawyer (not his real name either, but it does roll off the tongue!) retained by Tom after the creditors meeting. I pointed out that there was about $25,000 in proceeds paid to the company from this asset sale. The amount was important because the Eskimo had summarized in vague terms the company’s use of only the $13,000 that he admitted to receiving. In addition to checking what the Eskimo said that he had done with the $13,000, there was an additional $12,000 for Trustee Tom to follow up on.

The top of the second page of the IP sale contract, showing the components of the purchase price as well as the "Excluded Software." Squiggel Chimp was earning a decent chunk of change for just one piece of its intellectual property.

The top of the second page of the IP sale contract, showing the components of the purchase price as well as the “Excluded Software.” Keeping Cash’n’Code was earning a decent chunk of change for just one piece of its intellectual property.

I was pleased to have brought that serious piece of change within the protection of the bankruptcy court. But no, I hadn’t. Whoops! Trustee Tom never formally accounted for one cent of that money. In other words, as far as we know that money was never distributed to the people whom Keeping Cash’n’Code owed money to, its creditors.

After the event, the Benevolent Judge let that happen. At a hearing in June 2013, he explained that in a voluntary bankruptcy such as this the debtor (Keeping Cash’n’Code, the entity which owed everybody money) could game the system, for which there was no real remedy. In other words, the Eskimo could choose the time when he filed for bankruptcy protection, as well as the time when he brought in money. Depending on the timing, maybe he allocated what he brought in among the company’s creditors. Or maybe not.

This portion of the transcript of the June Hearing in Bankruptcy Court includes the Benevolent Judge's explanation of why the proceeds of the San Francisco asset sale were not accounted for by Trustee Tom: because they were not in Keeping Cash'n'Code's bank account when the Trustee took charge of it. It had "apparently" been spent on taxes "and other expenses." How can that be apparent when the Trustee has not accounted for those expenses? The court found "ludicrous" my suggestion that the money should have been included in the bankruptcy estate and accounted for.

This portion of the transcript of the June Hearing in Bankruptcy Court includes the Benevolent Judge’s explanation of why the proceeds of the San Francisco asset sale were not accounted for by Trustee Tom: because they were not in Keeping Cash’n’Code’s bank account when the Trustee took charge of it. These proceeds had “apparently” been spent on taxes “and other expenses.” How can that be apparent when the Trustee has not accounted for those expenses? The court found “ludicrous” my suggestion that the money should have been included in the bankruptcy estate. Really?!

But, said the Benevolent Judge, the Trustee had a duty to investigate where the proceeds of that sale went. The judge suggested that another time I should have asked more questions. Wait a minute!

I had informed Trustee Tom and Dick his lawyer about that $25,000, underlining the difference between that amount and the $13,000 which the Eskimo admitted to receiving, but didn’t ask enough questions about it: give me a break! Didn’t the Trustee have the duty to account to the court where that money went? What’s his job, if not that?

Dick’s portrayal of what had happened here in his firm’s invoice to Trustee Tom basically dissimulated this San Francisco sale, not from the trustee but from the judge. That suggested to me that Dick thought that there was a problem with how his client, Trustee Tom, had handled that sale.

Dick believed that “the debtor’s activity in the months before (March 15, 2012) . . .  revolved around an effort to sell the business. . . . (A)fter  . . .  Keeping Cash’n’Code . . . failed to find a buyer for its business or a buyer for its intellectual property, Trustee Tom undertook the effort, and with the generous assistance of the Eskimo, succeeded in finding a buyer for the intellectual property.” I added the bold text. This refers to a second buyer for Keeping Cash’n’Code’s intellectual property, or IP, but the quoted language made it sound like the first.

The portion of Dick's firm's invoice referred to in the accompanying text. Note that his fees, by far the highest payment from this bankruptcy estate, far exceed Nick's last month's salary.

The portion of Dick’s firm’s invoice referred to in the accompanying text. Note that his fees, by far the highest payment from this bankruptcy estate, significantly exceeded Nick’s last month’s salary.

The Eskimo had not failed! He had found a buyer in San Francisco for a valuable chunk of the company’s intellectual property. Why was Dick telling the judge that the Eskimo had failed?

*        *        *

With the Eskimo’s able assistance, Trustee Tom had now found a second buyer for another chunk of Keeping Cash’n’Code’s IP. Congratulations guys! I mean it.

But if there were two buyers for big chunks of the company’s IP, couldn’t others have been found?  I think that the answer is yes, and this raises the second troubling issue here: the source code, the debtor’s principal asset, still exists on a server somewhere and was never distributed to any creditor. That source code could be at the core of other valuable chunks of IP, in existence or to be created.

This was the email sent to Dick alerting him to the cash to be located. In all of these documents, the mess is attributable to not wanting to name names. This is not a vendetta.

This was the email sent to Dick alerting him to the cash to be located. In all of these documents, the mess is attributable to not wanting to name names. This is not a vendetta.

I first exposed this issue too during that initial creditors meeting in April 2012. “Even if there is no cash now,” I told Trustee Tom when he informed us that there was none, “the source code is still on a server somewhere, and if you do nothing it will remain in the control of Keeping Cash’n’Code’s management.” The company’s software was based on servers which its customers accessed, what they call “software as a service” or SaaS: the code was not at the customer’s site.

I asked Trustee Tom then and again in June 2013 to take possession of that code and make it available to the people Keeping Cash’n’Code owed money to. In my mind, that was what a bankruptcy trustee was supposed to do, locate the bankrupt entity’s assets for the benefit of its creditors.

Tom never did that here.

Mini course in contract interpretation: part 1. This page of the New York Asset Purchase Agreement makes a convincing case that all the intellectual property was being sold this time by the trustee. The "Purchased Assets" include "all of the Seller's assets . . . except the Excluded Assets." These are cash, office furniture and equipment, receivables and claims. Open and shut: all the intellectual property is being sold.

Mini course in contract interpretation: part 1. This page of the New York Asset Purchase Agreement makes a convincing case that all the intellectual property was being sold this time by the trustee. The “Purchased Assets” include “all of the Seller’s assets . . . except the Excluded Assets.” These are cash, office furniture and equipment, receivables and claims. Open and shut: all the intellectual property is being sold.

The second buyer of Keeping Cash’n’Code’s intellectual property, this time in New York, was again focused in its purchase. It wanted the patent application owned by Keeping Cash’n’Code.

Most software is protected as a trade secret (in other words, the source code is kept confidential) or copyrighted. In this case, the Eskimo believed that he had come up with a patentable invention, and this New York buyer’s focus on the patent application meant that what it really wanted out of the deal was the exclusive right to use the software application protected by the patent.

Source code like that owned by Keeping Cash’n’Code can be used with any number of software applications, almost. The limits on this are limits to the creativity of the coders working with and developing the source code. Because of its focus on the patent application, and the peculiarities of an asset purchase from a bankruptcy estate, the New York buyer effectively did not buy all of the company’s source code.

Mini course in contract interpretation: part 2. Existing "originals and copies of source code" will be delivered to the buyer "to the extent available from" Keeping Cash'n'Code. The company held on to what it felt like here.

Mini course in contract interpretation: part 2. Existing “originals and copies of source code” will be delivered to the buyer “to the extent available from” Keeping Cash’n’Code. The company held on to what it felt like here.

That’s where review of key provisions of the Asset Purchase Agreement comes in handy. At first sight, it does look as if all of the intellectual property of Keeping Cash’n’Code was purchased, an impression which Trustee Tom and Dick, his lawyer, were eager to foster. But delivery of the source code is at the discretion of the seller. So long as the buyer was properly assigned the patentable software application that it cared about, which it was, it did not care how many copies of the source code it received, or even if it received the original.

This conformed to bankruptcy procedure generally. While the buyer in a normal M&A deal will reserve itself the right to pursue the seller if all that it buys is not as the seller promised, there’s no-one to pursue after sale of a bankrupt’s assets, because there’s nothing and no-one left. The case has been closed. So the trustee makes no guarantees. Which played right into the hands of the Eskimo here. Trustee Tom could not guarantee that all copies the source code were sold, and the buyer did not care so long as it obtained the patent application at issue. The source code sat basically untouched by the bankruptcy proceeding.

In April 2012, I asked Trustee Tom to take possession of the source code. By June 2013, when I again raised the issue, he had never done so. That source code is still out there on a server somewhere, I believe under the control of the Eskimo. Nobody took the source code away from him. He may have held on to it, or delegated it, or disposed of it in such a way that the San Francisco and New York purchasers’ software applications were not included. All that he can’t do from an M&A perspective is use those two software applications. The rest of the source code is now basically unrestricted.

The page in the New York Asset Purchase Agreement which repeats in several different ways that the buyer has no recourse if it does not get what it wants. Added to the page which says that the bankruptcy estate will only deliver the source code which it feels like, this page allowed the source code to remain physically untouched by the bankruptcy. I found this on the USPTO site when Tom and Dick did not respond to me request for a copy.

The page in the New York Asset Purchase Agreement which repeats in several different ways that the buyer has no recourse if it does not get what it wants. Added to the page which says that the bankruptcy estate will only deliver the source code which it feels like, this page allowed the source code to remain physically untouched by the bankruptcy. I found this on the USPTO site when Tom and Dick did not respond to me request for a copy.

Why does this get my goat? Investors in Keeping Cash’n’Code were individual creditors of the company, as were the coders (all but Nick were independent contractors who did not have the benefit of his employee preference in the bankruptcy) who turned their capital into code. Yet investors and independent coders got nothing from the source code which they collectively contributed. Frankly, that stinks. 

*        *        *

Here’s why I bothered writing this down. Tom, Dick and Harry, the trustee’s accountant, were paid over $16,000 out of this bankruptcy estate, more than twice Nick’s last month’s salary. They paid themselves so much that they shaved about $850 off of the top of that last month: those administering a bankrupt’s estate are its most preferred creditors. They then blamed me for this shaving, which did not improve my mood!

That was the point when I formally raised to the Benevolent Judge the “missing” cash and the untouched source code. I was a perfect storm for Tom, Dick and Harry. Not only was I prepared to put in substantial legal time without payment to help out my swindled son, I am also by trade an M&A lawyer, and can read and understand subtle nuances in Asset Purchase Agreements like this New York one.

The reason that I am more understanding of the judge is because having these issues thrown at him for the first time late in the bankruptcy process put him in a very difficult position. But if Tom and Dick had been doing their job, as a bankruptcy outsider like me understands that job, he should never have been put in that position.