Bankruptcy Bulletin - December 2015

QUARTERLY UPDATE

BANKRUPTCY SEMINAR -- Save the dates!

At this point, we are planning on being back in Santa Fe, New Mexico for the bankruptcy seminar for dates from September 25 through 28, 2016. Nothing firmed up yet, but those seem to be the dates that will not conflict with federal holidays, Jewish holidays, the National Conference of Bankruptcy Judges, and the general alignment of the stars. So, hold those dates and we’ll get back to you as we get more concrete information.

SUPREME COURT CASES

Czyzewski v. Jevic Holding Corp., 15-649 Amicus filed in support of grant of cert. petition.

Illinois, joined by Alaska, Arizona, Georgia, Hawaii, Louisiana, Maine, Montana, New Hampshire, New York, Ohio, Oregon, Pennsylvania, Rhode Island, Tennessee, Texas, Utah, Washington, and West Virginia filed an amicus brief in support of the Petitioners in this case. This was a good showing for a brief that circulated in mid-December when many decision-makers are out of the office.

The decision below, reported at 787 F.3d 173 (3rd Cir. 2015) had upheld a decision by the bankruptcy court that approved a settlement and a “structured dismissal” that resulted in an entire group of creditors, holding priority and general unsecured claims being skipped over while payments were made to lower priority creditors. The structure of the resolution of the case was concededly agreed to in order to protect one of the senior secured parties from ongoing litigation that might be supported by funding from the omitted class of creditors. The States argued that the Code should not be read to allow this, noting the States’ interest both in protecting other parties such as the priority employee claimants here, as well as the States’ own interests in protecting its priority tax claims from efforts by others to skip over them and pay lower-priority claims.

We’ll have to wait and see if the Court does decide to take the case in the coming weeks; if so, we’ll probably be back with a brief on the merits for the States to consider.

SELECTED LOWER COURT CASE HOLDINGS:

In re Caesars Entertainment Operating Company, Inc., (Caesars Entertainment Operating Company, Inc., (“CEOC”) v BOKF, N.A., 2015 U.S. App. LEXIS 22579 (7th Cir. 12/23/15) Suits between third parties suit can be enjoined if it interferes with debtor’s own claims to assets of one of those parties even if it the two suits involve different allegations.

CEOC was in bankruptcy; its parent, CEC, was not. CEC had guaranteed many loans issued by CEOC but had systematically tried to sell off assets of CEOC and eliminate its guarantee obligations. Many guarantee holders were suing CEC; in addition, CEOC had alleged that CEC had removed CEOC’s valuable assets and left it with only the liabilities thereby potentially engaging in fraudulent transfers. CEOC sought to use Section 105 to enjoin the guarantee litigation until its examiner issues his report on the fraudulent transfer actions that could be a basis to work out a three-party agreement dividing up CEC’s assets among the two sets of creditors. The Seventh Circuit held that such a suit was allowed and that the lower courts had overread its prior opinions when they concluded that Section 105 could not be used if the two competing suits did not arise out of the same set of facts. While the prior cases had involved such scenarios and provided the best case for use of Section 105, they did not so limit its use. The main concern was the competition over the assets, not the legal bases for the competition.

SEC v. Miller, 2015 U.S. App. LEXIS 22182 (2nd Cir. 12/18/15). SEC Asset freeze covered by police and regulatory exception

The District Court was allowed to issue its ruling on a pending motion for an asset freeze against both the debtors and various “relief defendants” (non-debtor parties) even after the debtors filed bankruptcy. The order was a temporary one that would expire once the bankruptcy court had assets scheduled and under its control. The case differed from SEC v. Brennan, 230 F.3d 65 (2d Cir. 2000), where the Court held a repatriation of assets order requiring deposit of assets into the court registry went too far and was part of an act to “collect” on the judgment. Here, there was no transfer of ownership, but only a freeze, and sufficient exceptions for necessary expenses so that defendants were not completely removed from control of funds. Further, action was at pre-judgment stage so it could not be collection action on a “judgment” yet. Moreover, there were no aspects of forum-shopping here where freeze was already being sought when debtors sought to circumvent by filing bankruptcy; moreover, bankruptcy court might not have full jurisdiction to limit transfers of property already in hands of relief defendants

Lazzo v. Rose Hill Bank (In re Schupbach Invs., L.L.C.), 2015 U.S. App. LEXIS 19175 (10th Cir. 11/3/15). Court approval must precede attorney engagement and retroactive approval of fees is appropriate only in “extraordinary circumstances.”

Where the attorney failed to file for employment approval until a month after the case was filed, later, and did not disclose that request was for retroactive approval until three more months later, he had not shown justification for approval of fees; “substantial compliance” was not the test even if failure to file application was inadvertent.

Weinman v. Walker (In re Adam Aircraft Indus.), 805 F.3d 888 (10th Cir. 10/15/15). Definition of “insider” for purposes of avoidance action deadline.

Insider lost that status once told he was terminated; challenges to severance pay he negotiated after that notice had to be brought within normal 90-day period where he was dealt with at arms-length after termination notice given.

America's Servicing Co. v. Schwartz-Tallard (In re Schwartz-Tallard), 803 F.3d 1095 (9th Cir. 10/14/15). Fees incurred to pursue damages remedy for stay violation are recoverable damages.

Reversing Sternberg v. Johnston, 595 F.3d 937 (9th Cir. 2010), the court held, en banc, that fees incurred to pursue a damages remedy for a stay violation were recoverable. The prior decision had held that only the fees incurred to stop the stay violation were proper damages and that other fees should be treated under the “American Rule,” i.e., that each party bears its own fees. The court here reversed and held that Section 362(k) had no such limitation and the need to protect a debtor that had been harmed by the stay violation extended to the fees needed to adequately obtain recompense for the violation.

Brandt v. Horseshoe Hammond, LLC (In re Equip. Acquisition Resources), 803 F.3d 835 (7th Cir. 10/13/15). Casino not required to return payments received from debtor’s owner (who was using money taken from debtor) in that it took payments in “good faith.”

The debtor, which was engaged in a large-scale fraudulent operation, made substantial payments to its owners who used them to gamble with. The owners made false statements on their creditor applications which the casino did not try to verify; it also had reason to believe that some of the funds it was accepting were coming from business accounts. When the debtor’s trustee later sued, the casino argued that it was protected under Section 550 because it had acted in good faith without knowledge of the voidability of the transfers when it took them. The recipient cannot be liable unless a reasonable inquiry would have divulged culpable knowledge and, if the inquiry would have shown that the transfer was made with proper authorization that would be enough. The only inquiry is as to the recipient’s knowledge of fraud in the initial transfer; if a subsequent recipient has no reason to have knowledge of the facts about that transfer that is enough. Even if there was knowledge that money came from debtor, that would not suggest anything when the recipient is an owner who normally would be able to control debtor’s assets and draw from them and when any fraud in operations was not immediately apparent to outsiders.

Revel AC, Inc. v. IDEA Boardwalk LLC, 802 F.3d 558 (3rd Cir. 9/30/15). Discussion of how to weigh “four-factor test” in deciding whether to grant stay pending appeal; where lessee would be totally dispossessed by sale that did not recognize lease, stay was warranted.

Court endorsed balancing test between various factors and use of “sliding scale” where stronger the party’s claim on the merits, the less a showing of irreparable harm and the like it needed to make. Where party was probably protected by rights under Section 365(h) (that had to be adequately protected under Section 363(e)) and debtor had not raised any bona fide contention that there was valid dispute as to existence of lease, stay was warranted.

Mediofactoring v. McDermott (In re Connolly N. Am., LLC), 802 F.3d 810 (6th Cir. 2015). Creditors making “substantial contribution” in Chapter 7 may be given administrative expense status for such payments despite absence of such language in Section 503(b)(3)(D).

Although ordinarily, a Chapter 7 creditor does not need to take extensive action to deal with misfeasance by the Chapter 7 trustee (since the U.S. Trustee and/or the court should step in and deal with complaints), the broad language in the opening provision of Section 503(b) is enough to allow compensation to a creditor who is forced to take such action even though there is no specific provision for this in Section 503(b)(3)(D). The panel majority held that the general policies of the Code warranted granting such status to the payment, unless the Code specifically disallowed payment of such expenses in Chapter 7. The dissent asserted that the Code’s language was drawn to say what it included and that the term “includes” that was used in the opening language was not repeated in Section 503(b)(3), unlike other subsections. Neither side cited a similar issue with respect to compensation of lawyers for individual creditors serving on the creditors’ committee in Lehman where the bankruptcy court used similarly broad reasoning to allow the fees and the district court reversed and rejected the award.

Bricklayers and Trowel Trades Int’l Pension Fund v. Wasco, Inc., 2015 U.S. Dist. LEXIS 171192 (M.D. Tenn. 12/23/15). Standard for dismissing case filed in bad faith.

Where debtor filed case and structured plan concededly as way to avoid paying liability for single primary creditor (union pension funds) while leaving virtually all other creditors largely untouched (and, in fact, paying them off before case was filed) and while paying large additional bonuses to insiders, court held those and other facts were sufficient to find case and plan were filed in bad faith. District court rejected bankruptcy court’s view that it could find such facts but use them only as basis to impose more stringent “new value” obligation on debtor; if bad faith existed, debtor was not entitled to buy its way into a confirmed plan.

In re Chaban, 2015 U.S. Dist. LEXIS 112191 ( E.D. Mich. 8/25/15). Imposing sanctions for vexatious litigation was protected by police and regulatory exception.

Court imposed sanctions to discourage frivolous litigation and protect judicial resources so goal was to protect public interest; sanctions awarded to other side so they were not imposed to serve the government’s own pecuniary interests.

In re Martin (U.S. v. Martin), 2105 Bankr. LEXIS 4237 (9th Cir. BAP 12/17/15) Standard for determining whether a late filed tax returns qualifies as a “return.”

The BAP rejected the views of several Circuit Courts which have read the hanging language in Section 523(a) as excluding all late-filed returns (except those prepared under Section 6020(a)), and held that the language was meant, instead, to codify the Beard test that used several factors to assess whether a late-filed return would qualify. It also rejected, however, the bankuptcy court’s view that the only issue was whether the return was properly completed and objectively correct such that it was irrelevant whether and why the return was late, and the reasons for the delay. On the other hand, it also rejected the IRS’ argument that the issuance of an assessment should create a bright-line for determining whether a return qualified.

In re Ogden (GT Contracting Corp. v. Ogden), 2015 Bankr. LEXIS 4300 (Bankr. E.D. N.C. 12/21/15). Preclusive effect of default judgment; state contractor law setting fiduciary duties.

While federal law generally requires “actual litigation” to allow a default judgment to have collateral estoppel effect, many state laws take a broader view and do give preclusive effects to such judgment. In bankruptcy, if the underlying issue arises under state law, the state law view of preclusion must be applied. The case here involved a violation of the state law that requires general contractors to treat funds received for a particular job as being held in trust for the subcontractors working on the job. That law does create a fiduciary relationship for purposes of Section 523(a)(4) and will except those debts from discharge in the bankruptcy of a general contractor who fails to apply the funds appropriately.

In re Bennett (Bennett v. Morton Buildings, Inc.), 2105 Bankr. LEXIS 4108 (Bankr. N.D. Ohio 12/7/15). When does fraud claim arise?

Court test often used for environmental and mass tort cases – when did conduct occur and was it within “fair contemplation” of creditor during bankruptcy case – can also be applied to question of whether creditor had pre or postpetition claim against debtor for fraud; actions were prepetition but issue is whether creditor knew or should have known of facts prior to discharge that would have put him on notice of fraudulent acts by debtor; if debtor’s fraud was sufficient to conceal creditor’s injury, claim will not yet have arisen and, therefore, will not be discharged.

In re Williams, 2015 Bankr. LEXIS 4055 (Bankr. D. Kan. 12/2/15). Chapter 13 debtor cannot vest property in secured creditor over creditor’s objections.

Section 1325(a)(5) allows a debtor to satisfy a secured claim by “surrendering” the property to the secured lender, but it does not address the “vesting” of the property. “Surrender” means to relinquish one’s rights and make the property available, but “vesting” generally means an actual transfer of ownership. That is, “surrender” means “come and take it,” vesting” means “I have come and taken it and acquired ownership. The difference is meaningful for underwater properties where the lender does not yet wish to take ownership and acquire the attendant liabilities. While vesting may be accomplished by a plan if the creditor does not object, most courts holds that the creditor cannot be forced to accept vesting. Others have relied on separate provisions to allow debtors to force vesting over objections but the court here disagreed and sided with those that do not allow forced ownership. While Section 1322(b)(9) allows a plan to propose vesting, that does not mean that such a provision will satisfy the confirmation standards in Section 1325(a) – particularly when the result would alter state law rights.

In re Zair, 535 B.R. 15 (Bankr. E.D. N.Y. 2015). Chapter 13 debtor could confirm plan that vested property in secured creditor over its objections.

This case takes the opposite view from Williams and holds that the debtor can vest property in a lender and force it to take ownership of the property even if it objects. Court relies on authority given in Section 1322(b)(9) to vest property in various entities, not just the debtor, and holds that debtor complied with Section 1325 confirmation requirement by providing for surrender of property as its option under that section. Debtor must be allowed to complete process of severing connection with property so that “surrender” does not leave the debtor still saddled with the property.

In re Petersburg Regency LLC, 2015 Bankr. LEXIS 3756 (Bankr. D. N.J. 11/2/15). Structured dismissal that was supported by all creditors could be approved over debtor’s objections.

Unlike In re Jevic, 787 F.3d 173 (3rd Cir. 2015), the settlement and structured dismissal here was supported by all creditors and did not include any “priority skipping” provisions although some parties may have compromised their rights. The fact that the debtor’s owners did not support the plan did not preclude the court’s approval, particularly when they had previously argued that a prior involuntary bankruptcy served no purpose and were now estopped from arguing to the contrary. Dismissal is not required to be in best interests of equity and debtors could not confirm plan in any event.

In re Princeton Paper Products, Inc. (Liscinski, Jr. v. Freeport Paper, Inc.), 2015 Bankr. LEXIS 3831 (Bankr. D. N.J. 11/6/15). Revision of accounting treatment of intercompany transfers held to be fraudulent transfer where action released viable entity from being required to make payment to debtor even if they could be considered alter egos.

Where debtor traded a tax loss to an affiliated entity so that entity’s president could deduct it on his returns (based on the entity’s income that was passed through to him) in return for a promise by the affiliate to make a payment to the debtor, the decision to reverse those actions was fraudulent transfer since the tax loss could not benefit the debtor, and it was conversely losing the right to collect on the account payable. Even if consolidation between affiliates might normally be allowed, the actual result here barred it from being done.

In re Horstmeyer (horstmeyer v. Internal Revenue Service), 2015 Bankr. LEXIS 3814 (Bankr. D. S.C. 11/4/15). Anti-Injunction Act (“AIA”) bars act to limit IRS levy.

The AIA bars the court from enjoining the IRS from levying on funds held in the debtor’s retirement account as there was no exception in the AIA for bankruptcy and no explicit provision in the Code that would preclude application of the AIA to this situation. And, while courts may consider a judicial exception to the AIA where a party can show irreparable injury and a certainty of success on the merits, neither factor was present here.

In re JCP Properties, Ltd., 540 B.R. 596 (Bankr. S.D. Tex. 2015). Limits on filing second Chapter 11 when it effectively serves to modify first case that was substantially consummated but not completed.

Where debtor confirmed a plan that required payments over time to several different groups and made at least one payment under the plan provisions as well as making whatever property transfers were called for under plan, it had done enough to constitute “substantial consummation,” since that required only the “commencement of distribution” under the plan. At that point, Section 1127 precludes modification of the plan. A failure to live up to the plan by completing payments cannot be resolved by modifying the plan, nor should the debtor in most circumstances be able to reset the process by dismissing his case and refiling a new Chapter 11 case. Filing in second case will be treated as being made in bad faith and warrant dismissal of that case.

In re Guerrero, 540 B.R. 270 (Bankr. S.D. Tex. 2015). Section 109(g)(2) language should be read literally (i.e., chronologically) when applying refiling bar

Section 109(g)(2) bars refiling for 180 days where a debtors voluntarily dismiss case “following” the filing of a creditor’s motion to lift stay; while some courts use “following” to require a causal relationship between the stay motion and the dismissal motion (and do not apply the refiling bar where the events are widely separated in time and not linked by causation), court here held that “following” should be given the normal meaning of one event following another in time and nothing more need be shown; if result were truly unfair, court could invoke “absurd consequences” rule on case by case basis.

In re Wilcox, 539 B.R. 137 (Bankr. S. D. Tex. 2015). “Cause” for dismissal under Section 707(a) can include abuse of system by debtor with ability to pay.

A debtor that was paid $250,000 a year, plus a housing and car allowance, but who claimed no ability to pay anything at all towards some $16 million in business debts was found to have created “cause” for his case to be dismissed. He had failed to tighten his belt at all, had spent huge amounts on obvious luxury items and trips, had stopped paying creditors after he consulted with bankruptcy counsel, and had used his wife’s bank account to avoid garnishment. After analyzing the two main approaches to Section 707(a) cause, the court rejected the view that such cause could only be shown by actions after the petition date such as filing fraudulent schedules or the like. A debtor cannot engage in flagrantly abusive behavior prior to the bankruptcy and then get a free pass merely by obeying the rules once the case was filed.

In re Old Carco LLC (f/k/a Chrysler LLC), 538 B.R. 674 (Bankr. S.D. N.Y. 2015). Use of experience ratings of debtor to determine purchaser’s liability is an “interest” that may be sold “free and clear” of.

Following a line of cases that were not decided until four years after the Chrysler plan was confirmed, the court concluded that experience ratings applicable to purchasers are “interests” in the debtor’s property that can be sold free and clear of under a Section 363 sale at least if no objection is raised. The court further concluded that the states could be bound by the order because they did not object to the standard language regarding interests as including such ratings even though no case had so held before 2013 based on other decisions that had used broad readings of the term “interest” in other contexts – and despite the fact that new Chrysler itself did not raise the issue until after those new cases had issues. This reiterates the point that a) states need to object to such language in every plan and b) demand, if the court purports to overrule their objection that they be given adequate protection from the debtor for a payment that is owed by the buyer (which may help to explain the reason why these decisions are wrong). The one remaining issue in the case is whether the language in the plan retaining the ongoing application of police and regulatory powers can be deemed to apply to this language.

In re Smith (Loucks v. Smith), 537 B.R. 1 (Bankr. M.D. Ala. 2015) Discharge violation for willful and malicious injury can never be based on vicarious liability.

Employer who was made fully aware of his employee’s sexual harassment of other employees and did nothing to stop it could not have the debt imposed on him for his supervisory liability excepted from discharge because he did not personally carry out the harassment. Analysis is based on the view that the debtor’s liability was purely vicarious but it seems one could argue that it was the violation of his own duty to maintain a nondiscriminatory workplace that was the violation and that the violation was done with knowledge of the certainty of harm.

In re Andrews (Michigan Unemployment Insurance Agency v. Andrews), 2015 Bankr. LEXIS 3372 (Bankr. E.D. Mich. 10/2/15). Penalties imposed in connection with fraud debt were dischargeable in Chapter 13.

While, in general, Section 523(a)(2)’s language on fraud is given a broad construction with respect to the various costs arising from the fraud, the court held that the more specific language contained in Section 523(a)(7) governed with respect to the limited scope of debts that were excepted from discharge in Chapter 13. In view of its exclusion of penalty debts, the court held that was sufficient to exclude all penalties, including those arising from fraud debts.

In re Licking River Mining, LLC, 2015 Bankr. LEXIS 3194 (Bankr. E.D. Ky 9/22/15). Firm holding administrative expense claims is not “creditor” and may be “disinterested party” in later Chapter 7 case.

Section 327 requires general bankruptcy counsel to be disinterested persons and, in general, those holding prepetition claims against a debtor do not meet that test. However, the definition of a “creditor” is limited to those with prepetition claims so a firm that was still owed funds for its postpetition administrative work was not barred from working for the Chapter 7 trustee after conversion of the case. The court did not find any actual conflict of interest in the present case.

§ 522(h)

Holloway v. VA (In re Holloway), 2015 Bankr. LEXIS 4072 (Bankr. W.D. Ky. December 3, 2015) (Lloyd, B.J.)

Veterans Administrations' recoupment of allegedly exempt disability overpayments within 90 days prior to petition date was not an avoidable preference.

 

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