The National Attorneys General Training & Research Institute
Bankruptcy Bulletin - July - Sept 2017
UPDATE III – JULY- SEPTEMBER 2017
The seminar recently held in Savannah Georgia in November went extremely well. Attendance was over 175, which was a great number with only the limited scholarship funds that were available. The city got rave reviews, as did the facility (except for some quirky sound system glitches from time to time), the breakfasts at the “suites” hotels, and the opening night reception. Now, we are just waiting to get the evaluations in so we can be sure the conference topics were all equally great. However, from the fact that we started early, went late and had people listening to speeches over their lunch hour – and still got great audience participation, I’m reasonably sure that the program was a success.
We are still looking into possible spots in the Midwest for next year’s seminar since we did the West (Santa Fe) last year and the East (Savannah) this year. The executive committee for the States’ Association of Bankruptcy Attorneys (“SABA”) is working with the meeting planner from NAAG to pick the spot with the best combination of reasonable hotel prices, good meeting space, interesting city to visit, and a large group of local potential conference attendees. We’ll let you know as soon as we settle on a city and a date (probably mid-October). Stay tuned.
SABA BOARD PICKS NEW MEMBERS; CREATES EMERITUS STATUS
If the names of the SABA Board members seem to have a lot of continuity over the years, it’s because that’s the fact. SABA began with a tax-only orientation that initially held its meeting every year in Santa Fe with the excellent assistance of that office’s attorney and clerical staff. NAAG’s conference, beginning in 1993, was separate and tried to cover both taxes and regulatory issues. It became clear that limited state budgets made it difficult for states to send people to two conferences a year and the issue came to a head after SABA’s 2001 conference had to be cancelled due to the events of 9/11. After much discussion, SABA and NAAG joined forces for the next year’s conference with NAAG taking on the logistical role and with the joint conference being held in the fall of the year as was the case with SABA’s conference.
Some of the original SABA board members (such as Zach Mosner (WA) and Jim Newbold (IL)) that began the seminars, dating back to the late 1980s and early 1990s are still working with the NAAG-SABA seminar programs. Others, such as Jonathan Alden (FL) and Margarita Padilla (CA) have been working with the NAAG side of the seminars for almost as long. And, whether they have been on the Board for the whole time or not, other current and recent Board members are reaching that age where the thought of not going into work begins to become increasingly attractive. As a result, at the most recent conference, we took two steps: we added four Board members, Elizabeth Gunn (VA), Steve Sakamoto-Wengel (MD), Trish Lazich (OH), and Jay Befort (KS). Some are new and some are returning. And Elizabeth gets special kudos for being selected as one of the American Bankruptcy Institute’s “Forty Under Forty” in recognition of a selection of up and coming potential stars in the bankruptcy field. Second, we created a position of Board Member Emeritus, which allows those who retire or at least want to retire off the Board, but who don’t want to stop helping with seminars and other activities, to stay active. Zach Mosner and Jim Holden (CO), who were both on the Board heading into this year’s seminar will be the first two to hold that status. Bottom line: we get to keep the gray (and bald) heads in the mix and we add some new folks to help us move things forward. We had a great exchange at our first planning discussion for next year, so stay tuned for news on that as well!
SUPREME COURT ACTIONS:
There are several pending cases in which the Supreme Court has granted certiorari on bankruptcy issues. They range from the important to esoteric. The first case heard was U.S. Bank National Association v. Village at Lakeridge, No. 15-1509 (reviewing decision below at 814 F.3d 993), which decides not what is the standard for determining “ non-statutory insider” status in bankruptcy cases, but the even narrower question of the appropriate standard of review of such decisions. The second was Merit Management Group, LP v. FTI Consulting, Inc., No. 16-784, reviewing whether the “safe harbor” in Section 546(e) would apply to transactions in which the financial institution was merely a conduit for the payments.
The third case, where certiorari was just granted is Upper Skagit Indian Tribe v. Lundgren, No. 17-387, 187 Wash. 2d 857 (2017). In that case, a tribe bought a piece of land in 2013. In 2015, their neighbor asserted that it had acquired a strip of land along that border based on adverse possession against the prior owner. The tribe disagreed and the neighbor sought to quiet title in itself in state court. The tribe argued that its tribal sovereign immunity precluded the suit from going forward. The state Supreme Court rejected that argument, based on the contention that an in rem action was not really one against the tribe, as tribe; rather it was just an action against the property. This argument appeared to have been roundly rejected by the U.S. Supreme Court up until the bankruptcy case decision in Tennessee Student Assistance Corp., 541 U.S. 440 (2004), which resurrected the in rem/in personam division with respect to state sovereign immunity. To the extent that issue is decided again in the Skagit Indian case, it can provide a vehicle for clarifying, limiting, and perhaps even reversing Hood vis-à-vis the States. Accordingly, this may be a case that the States may wish to consider for an amicus brief. If your state might be interested, please let Karen Cordry (firstname.lastname@example.org) know. Briefs would be due 52 days after certiorari was granted on December 8.
SELECTED LOWER COURT CASE DECISIONS:
United States Trustee v. Ste-Bri Enterprises, Inc., 2017 U.S. Dist. LEXIS 155428 (N.D. Ohio 9/22/17). U.S. Trustee fees in Chapter 11 cases are paid pro rata with Chapter 7 trustee expenses after case is converted.
Section 507 provides for second priority for claims under Section 503(b) (administrative expenses) and for claims for U.S. Trustee fees (among other expenses). Section 726 provides for payment pro rata of all claims at a given priority level, but then states that claims incurred under Section 503(b) in a case converted to Chapter 7 are paid before claims incurred under that same section in the original Chapter 11 case. The bankruptcy court here equated the Chapter 11 U.S. Trustee fees with the administrative expenses in that chapter and subordinated both to the Chapter 7 fees. The district court reversed, stating that the Trustee fees were dealt with separately under Section 507 and the subordination was limited to only the Section 503(b) costs.
Graybar Elec. Co., v. Brand (In re Brand), 2017 U.S. Dist. LEXIS 152409 (D. Md. 9/19/17). New obligations arising postpetition that would fall under the terms of a prepetition guarantee agreement were not discharged in guarantor’s bankruptcy.
Although the guarantee was entered into pre-bankruptcy, that created only a contingent right in the other party. The conduct that really created the enforceable right to payment was the later extension of credit based on the assumed continued existence of the guarantee. Just as dues that arise under a prepetition agreement after the petition date remain enforceable against a debtor that continues own and use the property postpetition, so too did the guarantee obligations. At least where the debtor has not given notice that it is revoking the guarantee, it cannot obtain the benefits of the continued inducement from that promise while failing to make the payments.
In re General Motors LLC Ignition Switch Litigation, 2017 U.S. Dist. LEXIS 123740 (S.D. N.Y. 8/3/17). On merits of successor liability litigation against new GM, court determined appropriate law to apply and held that, under Delaware law (applicable to 7 states), liability did not exist.
Following confirmation of old GM’s plan in 2009, pursuant to which new GM assumed some liability for certain personal injury claims but demanded protection from successor liability for most other claims, it was learned that old GM had hidden evidence of its defective ignition switches. The Second Circuit eventually ruled that, due to lack of notice, the provisions of the plan barring successor liability claims could not be applied against persons holding those claims. That still left the question though as to whether such liability existed under state law such that it could have been asserted absent the bankruptcy filing. That analysis is one that debtors usually try to circumvent by write ipse dixit pronouncements into their plans that they are not successors regardless of what state law would conclude. In fact, though, such provisions and the violence they due to factual and legal reality, are often unnecessary since the reality is that the state law usually provides only very limited successor liability to begin with. In this case, the court had to decide what law to apply to that issue and then determine if that law provided for such liability.
The court first concluded that the same due process violation that left the plaintiffs unbound by the plan terms also meant that the debtor could not assert that such claims belonged to it as a general matter, rather than to the plaintiffs individually. Since they were the only ones who could still bring such actions, compared to the rest of the creditor body that was bound by the plan, it would make no sense to continue to deprive them of the right to sue that they had lost by the debtor’s actions to conceal their claims. With respect to choice of law, the court held that it should apply the normal rules for diversity jurisdiction in a “multidistrict litigation” (MDL) action, since the rights at issue arose solely under state law (and the federal bankruptcy issues related at most to a defense that could have been asserted except for the due process violations. There were other complications here but the bottom line was that the court held that it must decide successor liability on a jurisdiction by jurisdiction basis. (One useful thing about this case is that it may, in the end, result in a neat compilation of successor liability rules for all 50 states so parties could simply work within those laws rather than trying to override them by fiat.) IN this case, the court found that a number of states would apply Delaware law (the law of the state of incorporation) despite the fact that the plaintiffs did not live there and the misconduct did not occur there. Rather, they focus solely on the issues relating to the change of corporate form as being the relevant issue for successor liability. That is bad news for the plaintiffs because Delaware (not surprisingly) has very stringent provisions on whether it will recognize successor liability and the court found they would not apply here. Thus, a corporation may be able to obtain favorable law for itself under the laws of many states merely by choosing to incorporate in Delaware even without any other connection of the case or its operations to that state. Other states, however, such as Maryland do choose to apply their own laws in situations such as this. Finally, on the merits, the court held that Delaware law does not generally recognize successor liability even for an entity that purchases all of another’s assets and continues its business except where the change is basically in one of name only and that the corporate entity is essentially continuing on. Here, the court found those factors were not satisfied and, accordingly, no successor liability could be imposed on the new entity. That is the case with many states as to general liabilities (although a different rule often applies with respect to employee labor issues under federal law) so again it would seem more appropriate for bankruptcy courts to reach that conclusion as a matter of legal analysis of the plan, rather than letting debtors simply impose it by fiat.
In re Lafemina, 2017 Bankr. LEXIS 3356 (Bankr. E.D.N.Y. 9/30/17). Injunctive sought for breach of non-compete agreement was not a claim; stay lifted for arbitration to conclude.
Section 101(5) defines a claim as both a direct “right to payment” and a right to an “equitable remedy for breach of performance if such breach gives rise to a right of payment.” While that might suggest that all equitable remedies if there could be a right to payment for the breach, the courts have not applied it that broadly. Rather, they look to see whether compliance with the obligation requires that money be spent, or whether payment would not be an adequate remedy, or whether the right to an injunction is treated as additional to and not necessarily in lieu of a right to payment. Under any of those standards, most courts have found noncompete agreements can be specifically enforced in bankruptcy and such enforcement is not a claim that can be discharged in the case. Enforcement is not merely an alternative to damages and, indeed, damages are often found to be an inadequate remedy (not least because failure to enjoin the conduct allows the damages to continue to accrue). The court also found that the equities weighed in favor of allowing the pending arbitration to be completed.
Orr v. Husch Blackwell LLP, 2017 U.S. Dist. LEXIS 142628 (D. Kan. 9/5/17); Trigee Foundation, Inc. v. Lerch, Early & Brewer, Chtd. (In re Trigee Foundation, Inc.), 2017 Bankr. LEXIS 3332 (Bankr. D.D.C. 9/28/17). Issues relating to competence of professionals in the case must be raised in connection with final rulings on their requested compensation, but failure to do so with regards to interim request is not binding.
Professionals in bankruptcy cases must have their fees approved before they can be paid. Normally, they receive an interim allowance of perhaps 80% of the fee request and the balance – and the final review of all fees – is deferred until the end of the case. Many decisions, including that in Orr, have held that a decision that is issued on a final review of a fee application is res judicata as to the merits of the professionals’ services and whether any challenges, such as a malpractice claim can be raised with respect thereto. Absent perhaps proof that the professional fraudulently concealed his misconduct, it is too late to raise such issues after the final order is entered. However, where fees have been approved on an interim basis but no final order has been entered as in Trigee, it is not too late to raise a malpractice claim since the professional can seek added fees and because the court is still free to revisit its prior order.
Hanawalt v. Hardesty (In re Hanawalt), 2017 Bankr. LEXIS 3437 (Bankr. S.D. Ohio 9/22/17). Amount received by debtor who was injured by product implanted prepetition but that did not manifest any harm until well after her case concluded did not have property right as of bankruptcy filing.
The debtor had an operation during which “transvaginal mesh” was implanted in 2005. She filed bankruptcy in 2007 and was discharged in 2008. It was not until 2011 that her physician determined that the mesh was causing injury and it was removed. She later sued and received an $80,000 settlement that the trustee in the 2007 case sought to claim for her prior estate and creditors (and of course for his fees as well). The court found that her claim was not sufficiently rooted in the prebankruptcy past as to warrant treating it as a property interest on the filing date. That criteria dates back to Segal v. Rochelle, 382 U.S. 375 (1966) which analyzed whether a loss-carryback received postpetition should be treated as relating back to the prepetition operations that generated it. The courts look to whether a viable cause of action has accrued for the debtor as of the petition date – if not, as here, where the debtor had no known injury or reason to assume a loss as of that date, then the eventual rights of recovery are not “sufficiently rooted” in the past to be part of the case. Interestingly, and as the court discusses, this standard is considerably different (and more stringent) than the standard when the debtor is the defendant and not the plaintiff. In those cases, the courts look to the nature of the debtor’s (mis)conduct as being determinative in most cases even if state law would not yet create a cause of action.
In re Spenlinhauer, 572 B.R. 18 and 573 B.R. 343 (Bankr. D. Mass. 9/8/17). Where debtor failed to file estate tax returns for which he was responsible as executor or list any claims with regard thereto in schedules, excusable neglect was shown for failure to file tax proofs of claim.
The debtor was the executor for his mother’s estate who died in 2005. While he obtained a federal tax ID number for her estate and obtained tax counsel, he never filed an estate tax return for the estate (nor did he pay the taxes owed thereon). Several years later, he filed personal bankruptcy and gave notice to the taxing authorities of the case and the bar date and they filed claims for certain amounts that he owed for his personal income taxes. Sometime later, he moved to sell some very valuable real property she had owned and that he had inherited from her. As a result of the motion and the information provided, the taxing authorities learned of the failure to file the estate return and pay taxes and filed amended claims against him (based on the devolution of the taxes onto him personally). They argued and the court agreed that there was excusable neglect for the failure to file earlier. Knowledge of the case and the bar date was not enough to provide notice of the need to file a claim as to the estate taxes when the agencies had no particular idea that a taxable estate existed, that taxes were not timely paid, or that the debtor now owed them. The mere fact that a tax ID number was obtained was not enough to require the taxing authorities to follow up back in 2005 to determine whether a return was needed, and certainly not enough to still be in their consciousness years later when the debtor filed personally. If there was any prejudice to the debtor from extending the bar date, it was based on his own failure to list the potential claims in his schedule so as to alert the agencies.
In re Gawker Media LLC, 2017 Bankr. LEXIS 2364 (Bankr. S.D. N.Y. 8/21/17). Defamation claims do not fall under “personal injury tort” provisions of 28 U.S.C. 157(b)(2)(B); special litigation provisions in California law for suits against media could not be enforced to extent inconsistent with federal rules.
After the onset of asbestos cases in the 1970s and 1980s, there was lobbying to restrict the jurisdiction of the bankruptcy courts to hear “personal injury tort” claim cases and that change was made in 1984. The amendment which limited claims for personal injury torts and wrongful death to the district courts (which would allow for jury trials) did not define what was meant by a personal injury tort. Based on the nature of the pressure for the changes and the association of “personal injury” with “wrongful death” in the statute, the court held the definition should be limited to claims of a physical nature and not to broader versions of “personal injury” that could include matters such as defamation or other intangible injuries. The court also concluded that the choice of law principles required it to apply California law to the creditor’s defamation law suit on a choice of law basis, and that would initially include such provisions as the “anti-SLAPP” provisions of that law. Those provisions were meant to provide additional protection to media entities among others against potentially frivolous litigation brought to interfere with their First Amendment activities. The court also found, though, that a number of the procedural aspects of how that law would apply were in conflict with the federal rules and that it was required to apply those in the case once the state case ended up in federal court due to the bankruptcy filing, even though it recognized that this could encourage forum shopping to benefit from those federal rules.
In re Purcell, 2017 Bankr. LEXIS 2074 (Bankr. D. Kan. 7/19/17). State law defines when a claim arises for purposes of it becoming “property of the estate;” under discovery rule, personal injury claim did not exist at time bankruptcy case was closed.
The Code provides a definition of when a claim arises for purposes of bringing suit against the debtor and uses a very broad standard. It does not have any similar language with respect to when the debtor obtains a claim for purposes of its being “property of the estate.” The court held that, in general, therefore, that issue, like any other question of what was “property” would be decided under state law. Here, the debtor had a medical device implanted after she received her discharge but before her case was closed. It eventually failed and was removed a year and a half later long after her case closed. Applicable state law used a “discovery” rule to determine when a personal injury cause of action accrued; under that standard, she had no property interest that could belong to the bankruptcy estate. Even using another test that looked to whether a claim was “sufficiently rooted in the pre-bankruptcy part,” the court found that there was no basis to include this lawsuit since the matter accrued long after her case was filed and indeed the initial cause of the claim was not even created until the case was virtually over.
Slater v. United States Steel Corp., 2017 U.S. App. LEXIS 17994 (11th Cir. 9/18/17). Debtor who omits mention of pending law suit from schedules is not automatically judicially estopped from proceeding with the case.
In an en banc opinion, the Eleventh Circuit decided to revise its prior holdings on when judicial estoppel should apply to a lawsuit or claim that a debtor knew of during its case but did not include on its schedules. It had originally concluded that, to avoid an abuse of the system, the debtor should be estopped where he or she intended to “make a mockery of the judicial system” and then further held that such an intent should be presumed as to any known claim where the debtor had the ability to benefit therefrom. After a number of years of working under that standard, the en banc court decided it was too stringent, in that it excluded any ability of the debtor to explain or minimize the omission or to show contrition by quickly correcting the problem. Moreover, while there were other means to penalize the debtor’s misconduct the automatic application of estoppel would harm innocent creditors who would lose the chance to gain an asset from which they could be paid. The court adopted a “totality of the circumstances” test that, in practice, has allowed substantially more cases to proceed.
In the Matter of Cowin (Cowin v. Countrywide Home Loans, Inc.), 864 F.3d 344 (5th Cir. 2017). Debts incurred by knowing co-conspirator in scheme to defraud were at least sufficient to except debt from discharge under Section 523(a)(4); did not decide if such liability sufficed for Section 523(a)(6) which requires action by debtor; filing action in bankruptcy court didn’t violate stay.
Where the lower court found that the debtor was a knowing and willing participant in a scheme to defraud his lenders, that was sufficient to except those debts from discharge under Section 523(a)(4) even if the wrongful acts were carried out by other parties where such liability would be imposed under nonbankruptcy law. The court noted, but did not decide whether co-conspirator status would suffice for purposes of Section 523(a)(6), since that section refers to willful and malicious injury “by the debtor.” The Court of Appeals rejected the debtor’s argument that the bankruptcy court violated the stay by entering judgment in an adversary proceeding that it had before it. The court concluded that there was an implicit exception to the stay for actions allowed by the Code that were brought in the bankruptcy court itself – not least because the court need only lift the stay to allow itself to do what it otherwise planned to do.
Easterling v. Progressive Specialty Ins. Co., 2017 Ala. LEXIS 93 (Ala. 9/15/17). Debtor’s discharge did not preclude suit against victim’s own insurer for uninsured motorist coverage.
There are many cases that hold that the discharge of a debtor does not preclude a lawsuit seeking to collect from the debtor’s insurer since nothing is being sought from the debtor personally and the discharge does not relieve third parties that have their own independent liability. This case dealt with a separate provision under state law that allows a victim to sue their own insurance company for coverage under a clause dealing with uninsured or underinsured motorists. That suit would in general be allowed under the same analysis dealing with the debtor’s insurance. The twist here was that the state law would not allow a claim under that clause if the victim could not have legally recovered from the victim. The insurer argued that, since the debtor was discharged, the victim could not legally recover from her and, thus, the insurer was also protected. The court rejected that argument, holding that the “legal recovery” provision went to the debtor/driver’s legal liability for the claim, not bars on the ability or right to collect on the claim. A debtor who has been discharged was still liable for the claim, the only limit was on being able to recover from her. As such, the insurer could be brought in to pay damages.
Georgia Lottery Corp. v. Tamri (In re Tamri), 2017 Bankr. LEXIS 3269 (Bankr. N.D. Ga. 9/26/17). Lottery seller that failed to properly deposit and account for funds was guilty of defalcation under Section 523(a)(4).
State law requires lottery sellers to hold proceeds in trust and, specifically, to create a segregated bank account into which proceeds are to be deposited. Those obligations were sufficient to make the debtor a fiduciary with respect to such funds and, when he failed to make those deposits or otherwise pay over the money, the debt was for defalcation and was nondischargeable.
Hattie v. McAlexander (In re McAlexander), 2017 Bankr. LEXIS 3115 (Bankr. W.D. Tenn. 9/12/17). Unlike the state in Tamri, workers who should be covered under Tennessee workers’ compensation statute are not protected if the employer defaults on its obligations.
The worker’s employer here apparently failed to follow any of his legal obligations, deducting taxes from his employees’ wages for Social Security and Medicare but not paying them to the government, and failing to follow the requirements for workers’ compensation. State law requires that an employer either obtain insurance or be certified from the state to self-insure. The latter certificate requires that the employer deposit substantial financial assurance funds with the state to cover costs for his employees. However, the courts have found that, while the failure to do so is a breach of the duty, there is accordingly no “trust fund” that is created by the breach as to which the defalcation can be traced. And, conversely, the court also concluded that the failure to maintain the fund was not a willful and malicious injury because it could not be shown that it was certain that any injury would occur that would go uncompensated. The courts focused only on the question of whether the injury itself was certain, and not on the question of whether harm was guaranteed to any injured party who could not be compensated. As a result, an employer who knowingly and intentionally violates his duty to protect his employees from on-the-job injury is completely insulated from any liability to them. It is unclear if the workers’ compensation statute restores the normal tort liability rights of an employee against his employer in those circumstances but, even if it does, that right itself is probably subject to discharge and is substantially more difficult to prove than the strict liability workers’ compensation approach.
In re Young (Commonwealth of Virginia ex rel. Virginia State Board v. Young), 2017 Bankr. LEXIS 2452 (Bankr. W.D. Va. 8/30/17). Restitution ordered by State Bar as condition for reinstatement of license was excepted from discharge under Section 523(a)(7).
The debtor, a lawyer, was ordered to repay the state client protection fund for amounts that it had laid out to cover injuries to his clients due to his ethical violations. When he filed bankruptcy, the bar asked that those amounts be treated as nondischargeable penalties. The court had little difficulty in finding that they were intended to act as penalties and to be part of the disciplinary and rehabilitative sentence imposed on his to protect the public. To be excepted from discharge, the penalty must also be “not for compensation for actual pecuniary loss.” The court found that criteria was also met, even though the amount of the restitution ordered was in the same amount as the funds the fund had laid out, based primarily on the nature and reasons for the imposition. Thus, because the restitution was meant to serve the purpose of protecting the public, the court held that was enough to exempt the fines from the “pecuniary loss” limitation.
In re Pruitt (Georgia Dept. of Labor v. Pruitt), 2017 Bankr. LEXIS 2275 (Bankr. N.D. Ala. 8/14/17). State did not provide sufficient information about debtor’s false statements with respect to unemployment benefits to tell if her statement was one about her “financial condition.”
Section 523(a)(2)(A) deals with false statements generally; Section 523(a)(2)(B) deals with those made by the debtor regarding her “financial condition,” but the section does not define that term. That category of false statements must be in writing. Here the debtor represented in some fashion (the opinion does not even state how the representations were made) that she was not working when, in fact, she was. The state found out and sought to have the benefits returned – and made nondischargeable in a bankruptcy she filed. The court found that the facts alleged by the state were all admitted by the debtor but still denied summary judgment because it said the state had not adequately described the totality of information provided by the debtor so that it would be possible to assess whether her statement was one about her financial condition. While most courts would say that a statement about a single fact, such as whether one was working or not, would not possibly be a statement of financial condition (which those same courts generally say refers to the debtor’s entire financial status and usually requires something akin to a balance sheet or a full financial statement), the court here looked at In re Appling, 848 F.3d 953 (11th Cir. 2017) which took a much broader view. In that case, the debtor had convinced a lawyer to pursue his case by stating that he was expecting a tax refund and would turn it over to the lawyer. He did receive a refund (albeit somewhat less than expected but still enough to pay the fees) but did not pay the lawyer, spent it on other items, and lied to the lawyer again to keep him working. The court there concluded that a statement about the existence of even a single asset could be a statement respecting the debtor’s financial condition and, hence, since these statements were not in writing, the debt was dischargeable. There is a considerable split in the courts on this issue – and, after the creditor petitioned for certiorari on this point, the Supreme Court requested the view of the Solicitor General as to whether it should grant the petition. That request is usually a sign that the Court is strongly considering taking the issue; if it does take the case, it should, at a minimum, provide clarity to parties as to what they need to do. It is not clear how much more the state here could have shown to the court, but presumably it could at least show that it did not ask about the debtor’s general finances or its solvency or anything beyond the fact of whether she was working or not. Since unemployment compensation is paid based on work history, not need, per se, it would presumably not be proof of any sort of financial status.
In re Chestnut (U.S. v. Chestnut), 2017 Bankr. LEXIS 2053 (Bankr. W.D. Ark. 7/21/17). Approval of a Chapter 13 plan that provides for partial payment of nonpriority taxes does not, without more, serve to discharge unpaid balance of those taxes.
In United Student Aid Funds, Inc. v. Espinosa, 559 U.S. 260 (2010), the Court held that a plan that specifically (albeit improperly) provided for the discharge on interest on student loans -- without providing for proof of undue hardship was binding if the creditor did not object. The court here held that the debtor could not extend that principle to tax claims. The court emphasized that the type of tax claims at issue were not dischargeable under any circumstance but, what seems to be more critical is that the plan did not explicitly purport to discharge the unpaid taxes (unlike the plan in Espinosa). As such, the mere fact that the debtor obtained a general discharge did not change the nondischargeable nature of these particular taxes.
In re Palmeroni (N.V.E., Inc. v. Palmeroni), 570 B.R. 144 (Bankr. M.D. Penn. 2017). Objection to plan that clearly spelled out elements of nondischargeability claim could be treated as timely complaint objecting to discharge.
While clearly not a best practice, the court allowed a creditor that had filed an objection to confirmation of the debtor’s Chapter 13 plan based on an assertion that the debtor was trying to discharge a nondischargeable debt, and which objection spelled out in reasonable detail the nature of the alleged misconduct and cited to the relevant discharge sections, to recharacterize the objection as a discharge complaint. As a result, the creditor was able to salvage its right to challenge discharge of its debt despite not filing a timely formal complaint.
In re Holzheuter (Holzheuter v. Groth), 2017 Bankr. LEXIS 1983 (Bankr. W.D. Wis. 7/18/17). Where multiple parties had securities lawsuits pending in different courts when petition was filed, court did not need to abstain from hearing the merits of those suits and discharge issues.
Approximately 60 persons had allegedly been defrauded by the debtor as part of a securities scam. Six of those persons had filed suit in three different counties. The SEC filed an action in federal district court that encompassed the entire scheme; the court in that case stayed the state court actions and appointed a receiver. During the same time, the debtor filed bankruptcy and the six state court litigants asked the bankruptcy court to abstain from hearing the merits of their litigation as well the decision on whether a verdict in their favor would result in a debt that was excepted from discharge under Section 523(a)(19). They conceded, however, that the issues relating to whether the debt was excepted from discharge under Section 523(a)(2) and (6) would have to be decided by the bankruptcy court. The court found that most factors weighed against abstention – these claims were only a small portion of the total number, they were scattered in several courts, and none were ready to go to trial as compared to the bankruptcy court being ready to hold a hearing in only a few months. Moreover, the facts would also be relevant to deciding the other discharge issues that would be limited to the bankruptcy court.
The one issue that might have forced the court to abstain would be if Section 523(a)(19) required that the decision on liability be heard by a non-bankruptcy court. Although nothing in that section explicitly bars bankruptcy courts from deciding such matters (indeed, the section says that the existence of the debt can be determined in any federal or state court judicial or administrative tribunal and the bankruptcy court is certainly a federal judicial body), some courts have (mis)read the language to preclude bankruptcy courts from deciding the liability issues. The court here reviewed the history of the language at issue and concluded that it did not by its own terms, or by logical implication impose any such bar. Absent any such limitation, the vast majority of the factors supported having the bankruptcy court retain jurisdiction to try the matter.
AUTOMATIC STAY, POLICE AND REGULATORY POWERS, AND DISCHARGE INJUNCTION ISSUES
In re Partida (Partida v. United States), 862 F.3d 909 (9th Cir. 2017). Collection of criminal restitution under federal law is not subject to automatic stay.
The Mandatory Victims Restitution Act, 18 U.S.C. § 3613(a) allows the government to act, “notwithstanding any other federal law.” That language was broad enough, the court held, to exempt collection actions under the MVRA during the bankruptcy case despite the existence of the automatic stay. That language is reinforced by the scope of the criminal exception in Section 362(b)(1) which other courts have held is sufficient to justify allowing collections to continue.
In re Spencer (Missouri Dept. of Social Services v. Spencer), 868 F.3d 748 (8th Cir. 2017). Action to recover disallowed part of claim for child support did not violate discharge injunction.
The debtors’ plan provided for payment of only the original amount of the state’s claim and not the much larger amount stated in its amended claim. The debtors claimed that the state had waived the higher amount and the bankruptcy court granted the motion to disallow the increased claim amount. After the debtors completed their Chapter 13 plan, the state resumed collection activity. The debtors contended this violated the discharge injunction – the bankruptcy court agreed but the district court reversed, and the Ninth Circuit affirmed. As with the Chestnut case below, the Ninth Circuit relied on language from United Student Aid Funds, Inc. v. Espinosa, 559 U.S. 260 (2010) stating that such support obligations are not dischargeable under any circumstances and held that mere disallowance of the claim did not change that fact. On appeal, the debtors changed their argument to assert that the state was trying to collect an amount the bankruptcy court had determined was not owed, but the Eighth Circuit did not accept that argument, noting that it had not been raised below. Inasmuch as there was no specific plan provision barring collection of the additional amount, the court held that the state had a reasonable basis to believe that the disallowed portion could be collected as a nondischargeable debt. Even if the state were wrong on the merits, the court held, that mistake did not rise to the level of sanctionable conduct (although it might leave the state obligated to return the funds).
United States v. Greenlight Organic, Inc., 2017 Ct. Intl. Trade LEXIS 127 (Ct. Intl. Trade 9/15/17). Court may determine applicability of stay; fraudulent importation action not stayed.
The Court of International Trade like other judicial bodies has the power to decide for itself whether the automatic stay applies to its proceedings. The action here was to decide whether the importer had engaged in fraudulent conduct in filling out its customs reports in an effort to reduce the duties owed. Available remedies included the imposition of penalties – up to the full amount of the merchandise – and “restoration” (i.e., payment) of the lawful duties owed. The court agreed with the United States that the action was not stayed and met the pecuniary purpose test even though all of the remedies were purely monetary. The purpose of these provisions was to ensure that importers accurately completed the forms that Customs relied upon, and tying the amount of the penalty to the culpability of the importer indicated that deterrence, not just compensation, was the primary point of the provision. As such, the action to determine and obtain a judgment for the amounts owed was not a violation of the stay.
Williams v. Sentry Insurance A Mutual, 2017 U.S. Dist. LEXIS 132506 (W.D. La. 8/17/17). Deciding motion to remand does not violate stay.
The debtor removed a pending state case to district court after filing bankruptcy. The plaintiffs moved to remand the case using a non-bankruptcy removal statute. The debtor then filed a suggestion of bankruptcy and argued that the automatic stay precluded the district court from reviewing the remand motion. The court rejected that argument stating the stay did not, by its own terms, apply to the sort of decision being made on the remand motion. A court has power to determine its own jurisdiction and to refuse to retain a case where it does not have such jurisdiction. Taking such steps which do not, in and of themselves, serve to assist a plaintiff in collecting a claim does not violate the stay. The court also concluded that it could allow limited discovery in order to resolve issues relating to the remand motion without violating the stay. (The court, somewhat oddly, said the stay didn’t apply but then also stated that it was “lifting” the stay which it does not have the power to do. Since its initial conclusion was correct, that added language can presumably be disregarded.)
In re Taylor, 2017 Bankr. LEXIS 2392 (Bankr E.D. N.C. 8/24/17). Action brought by non-profit groups to enforce environmental laws was not excepted by stay because they were not brought by governmental unit.
Although the private entities had standing under the environmental laws to try to enforce them against the debtor, that did not convert their action into one brought “by” a governmental unit, particularly where the relevant governments were aware of the issues and the pending private suit but had never chosen to intervene or pursue it themselves. The court was also not sufficiently convinced of the merits of the action to agree to lift the stay to allow the entities to try to pursue their injunctive litigation against the debtor while the bankruptcy case was pending.
In re JSS of Albuquerque, LLC, 2017 Bankr. LEXIS 2255 (Bankr. D. N.M. 8/10/17). Court (incorrectly) held that action seeking to determine rights of individual consumers to money damages, rescission, and restitution were not matters of public interest and were barred by stay.
The bankruptcy court, largely led astray by decisions dealing with a different issue (namely when was the state bound, for state law collateral estoppel purposes, by a decision in litigation brought by the consumer), held that the state’s consumer protection action was barred by the stay to the extent that it sought to determine damages owed to individual consumers. There are numerous cases holding to the contrary (including ones from the Tenth Circuit), based among other things, on the express legislative history for this Code provisions that talks about the right of the state to litigate liability and fix damages for consumer protection actions. The state is appealing the decision and hopefully it will be reversed on appeal.
In re Chestnut (U.S. v. Chestnut), 2017 Bankr. LEXIS 2053 (Bankr. W.D. Ark. 7/21/17). Approval of a Chapter 13 plan that provides for partial payment of nonpriority taxes does not, without more, serve to discharge unpaid balance of those taxes.
In United Student Aid Funds, Inc. v. Espinosa, 559 U.S. 260 (2010), the Court held that a plan that specifically (albeit improperly) provided for the discharge on interest on student loans -- without providing for proof of undue hardship was binding if the creditor did not object. The court here held that the debtor could not extend that principle to tax claims. The court emphasized that the type of tax claims at issue were not dischargeable under any circumstance but, what seems to be more critical is that the plan did not explicitly purport to discharge the unpaid taxes (unlike the plan in Espinosa). As such, the mere fact that the debtor obtained a general discharge did not change the nondischargeable nature of these particular taxes or create a violation by the United States in seeking to collect those taxes.
In re Haynes, 569 B.R. 733 (Bankr. N.D. Ill. 2017). Court refused to extend analysis in Reading Co. v. Brown, 391 U.S. 471 (1968) which gave administrative priority to tort claims against debt during case to imposition of liability on debtor for parking and red light tickets during the case.
Administrative claims usually require a showing of “benefit to the estate.” In Reading, the Court extended the same priority to costs incurred by the estate when it was sued in tort for damages to a neighboring building from a fire starting on the debtor’s property. The Court held that the reorganization was operated for the benefit of the creditors and they had to take the good with the bad – not only the profits from operations but also the costs that were ordinarily incident to the operation of the business must be treated as administrative costs as well. The holding has been extended to many other aspects of post-petition operations but the court here found ways to distinguish those cases and to treat the liability as not accruing to the debtor. It noted among other factors that although the violations had occurred, the city had not suffered “losses” (suggesting that maintaining public safety and the proper use of public parking were not similar concerns. The court also held there was no proof the debtors were trying to “flout” the law since the city hadn’t proven they were personally operating the vehicle at the time of the violations (although there is nothing in the opinion that suggests they denied doing so). And, further the court held that debtors had lesser obligations in Chapter 13 than in Chapter 11. Instead, the court suggested the city should ask to have the stay lifted to impound the car or perhaps seek to have the case dismissed or converted (all of which arguably are considerable overkill for a simple desire to have the tickets paid). The court came up with a number of other technical reasons that it suggested would preclude a violation here but it is far from clear that they actually would be applicable particularly under the actual facts (i.e., the tickets are issued to the person to whom the car is “registered,” which could be someone other than the owners, i.e., the debtors here). Yet, there is again, clearly no dispute that the debtors are both the owners and the parties who registered the car so the court’s distinctions here appear highly forced. In any case, it will be interesting to see what happens to this case on appeal.
In re Garcia (Layng v. Garcia), 569 B.R. 480 (Bankr. N.D. Ill. 2017). Bankruptcy court need not stay objection to discharge adversary even though debtor was also facing criminal investigation.
Although a court may choose to stay civil litigation while parallel criminal matters are being investigated, it is not required to do so. A defendant can be put to the choice of invoking her Fifth Amendment rights or answering questions in the civil proceeding even if those answers may be relevant to and implicate her in the criminal matter. The Fifth Amendment protects one from being forced to incriminate oneself; it does not guarantee that one can avoid consequences that follow from demanding that right. So long as the action was not brought solely to obtain evidence for the criminal case or without notice to the defendants of the potential for criminal charges, putting the defendants to an unpleasant choice was not unconstitutional. The court, though, may stay the action if it believes the interests of justice so warrant. The court considered a number of relevant factors to decide where the balance would fall. It noted that no actual indictment had issued which suggested that the risk was less clear – and that it was difficult to determine the degree of overlap between the two proceedings. Indeed, any proceeding under Section 727 could potentially lead to a criminal case in light of the overlap of the provisions there with those in the bankruptcy fraud language in 18 U.S.C. 152. If that mere possibility were enough, one could never proceed on those charges. On the other hand, the court did agree that the fact that both matters were brought by the government raised the possibility of the use of evidence from one matter to advance the litigation of the other. The court noted the interests of the parties to the bankruptcy system in having the mater promptly resolved and completing discovery while memories were still relatively fresh. It also noted that the debtor had delayed bringing the stay month for almost a year. On balance, the court held no stay was warranted.
In re Gardens Regional Hospital & Medical Center, Inc., 573 B.R. 811 (Bankr. C.D. Cal. 9/25/17). “Health Quality Assurance (HQA) Fees” imposed on hospitals are not taxes because they are primarily for the benefit of the hospital, not the general public.
Under a state program, all hospitals are assessed a HQA Fee whether or not they participate in the Medi-Cal program (which provides health assistance to patients). The funds collected are used by California to obtain additional matching funds from the federal government which are then distributed back to hospitals based on a different formula based on what they need to provide care. Thus, this is income redistribution among California hospitals along with a method to obtain federal subsidization. The court had to decide whether these were non-tax “fees” or a tax that could be given priority in the case. Fees are generally thought of as amounts paid for some specific benefit to the debtor, such as costs of water, or a license fee, while taxes are used for the general public good. The court noted that, in light of the heavy involvement of government in the health care field, most aspects of the system presented a hybrid focus, costs and benefits could both serve a public purpose and the vitality of the hospitals. The court then concluded that, although the issue was close, that it would find that the payments were more intended to strengthen the hospitals’ balance sheets (which he found to be a private purpose even while conceding that, absent financially viable institutions, the health care could not be provided). He based this on a) the fact that the fee was used initially to obtain additional federal funds so he viewed this as being akin to an “investment” by the hospitals as a way of gathering income (while leaving aside the involuntary nature of this “investment” program and the fact that it is determined by the government), b) the fact that the state was directed to work with the hospitals and could waive the fee if financial hardship was shown (i.e., if the hospital would not be able to perform the health functions the state wished to support if the fee were charged), c) the fact that some of the funds must be used to reimburse hospitals for uncompensated care (which one might think is more likely to be viewed as a way of funding that service to the public rather than a mere benefit to the hospital). And, finally, the court looked to the fact that state law required emergency care for all regardless of ability to pay and viewed that as showing that the hospitals had that obligation regardless of whether the act existed. (That, of course, ignores the question of whether that law would be modified if the costs of such care began to overwhelm the hospitals). In any event, this is one of many cases that attempt to answer the thorny question of what is a “fee” versus what is a “tax.” Many such decisions, including this one, are far from satisfactory on the question and it will be interesting to see what the result is on appeal.
In re Forrester (Forrester v. IRS), 2017 Bankr. LEXIS 2338 (Bankr. S.D. Ala. 8/18/17). “Returns’ filed after IRS completes “substitute returns” under Section 6020(b) do not qualify under Code to start time running for dischargeability.
The debtor did not file tax returns for tax years 2005, 2006, and 2007. The IRS prepared Section 6020(b) substitute returns for those years in 2008 and 2009. The debtor eventually filed returns himself, but not until 2012, a year after the petition was filed. As such, even assuming the late-filed returns could have been considered returns (which most courts would not allow in any case), they were not filed within two years prior to the bankruptcy and, hence, did not count either. As such, the taxes were excepted from discharge based on Section 523(a)(1)(B)(ii).
In re Ridgecrest Healthcare, Inc., 2017 Bankr. LEXIS 2380 (Bankr. C.D. Cal. 8/24/17). Quality assurance fee imposed by state on skilled nursing home operations that was used to provide supplemental assistance to certain facilities was an excise tax, but because it was measured based on income, the court held it was not a tax “on a transaction” so it was not entitled to priority.
The bankruptcy court had initially determined that this fee was not a tax at all, but the district court reversed the opinion holding that the court had failed to correctly analyze and apply the Ninth Circuit’s test. On remand, the bankruptcy court concluded that it did meet all the requirements to be a tax including that it was imposed involuntarily on all similarly situated parties and was used for general public purposes. However, even after determining that it could qualify as an “excise tax,” the court pointed to the fact that the statute referred to the tax being “on a transaction,” and held that the tax failed that test. Since it was no imposed or calculated on a singular act, such as admitting a patient, or deciding to engage in the business of being a nursing home, but rather was based on the facility’s revenues, the court said that was too general of a criteria to be a “transaction.” Accordingly, the court held, the state still was not entitled to priority for the claim. It would seem, though, that if the problem was that this was viewed as a tax on income, rather than on a transaction, that there is no reason the state could not ask that it be treated as a priority income tax, rather than trying to fit under the excise tax section. In any case, it seems likely this is one that will be going back up on appeal. That is particularly true in that on the original appeal, the district court had noted and rejected the bankruptcy court’s insistence that an excise tax must relate to a “single act” as a basis for not finding it to be a tax. It seems quite possible that the district court will not agree that finding it to be a tax but still denying priority because it was not on a single transaction is a meaningful difference.
Zazzali v. United States (In re DBSI, Inc.), 2017 U.S. App. LEXIS 16788 (9th Cir. 8/31/17). United States was not automatically protected from liability to pay trustee in avoidance action amounts that it had already refunded to the tax payer.
In a companion case discussed below under Sovereign Immunity, the Ninth Circuit held that payments the United States received from the debtor corporations in estimated payments of the taxes owed on income passed through to its shareholders could be avoided under Section 544(b). Of the amounts paid in, about 20% had been refunded to the shareholders based on the final returns which showed overpayments. The district court had adopted the Eleventh Circuit’s view that the IRS was not the initial transferee of those funds and had served as mere conduit, receiving and holding them in essence until the final tax returns were filed. The Ninth Circuit held that the Eleventh Circuit test was too loose and remanded the action to the lower court to determine in the IRS should be liable to pay to the trustee the amounts it had already paid out once to the shareholders.
In re Veltre (Veltre v. Fifth Third Bank), 2017 U.S. Dist. LEXIS 128540 (W.D. Penn. 8/14/17). Foreclosure sale cannot be attacked as preferential transfer based on BFP v. Resolution Trust Corp., 511 U.S. 531 (1994).
This case, like the Hackler case next, deals with whether the Court’s BFP decision can be applied to preferential transfer actions as well as fraudulent conveyance actions. The court noted that the standard in a preference action was somewhat different than in a fraudulent conveyance action; i.e., whether the creditor received more than in a Chapter 7 liquidation rather than whether “reasonably equivalent” value had been obtained. However, at least in the context of a traditional foreclosure sale where the goal is to obtain the highest and best price for the property, the court here held that the sale could not be avoided. Absent very limited exceptions, there was a well-established presumption that the price at the sheriff’s sale was the best price obtainable. As such, then, by definition, it would match the best price that could be obtained in Chapter 7 liquidation, so there was no preference involved. The sale in Hackler, by contrast, was a tax sale which is frequently structured in ways that does not produce the highest price. The court there did find that a challenge could, therefore, be raised.
Boscarino v. Board of Trustees of Conn. State. Univ. (In re Knight), 2017 Bankr. LEXIS 3324 (Bankr. D. Conn. 9/29/17). Payment of college tuition for child is fraudulent transfer.
Paying college tuition for a child that has reached the age of majority so there is no legal support obligation is a constructively fraudulent transfer. The payment provides no benefit to the estate for the use of creditors and satisfaction of a moral obligation to one’s children does not provide “reasonably equivalent value” for creditors. One must be “just before one is generous.” The court also rejected the concerns of some courts about the value of supporting a “societal expectation” or the policy implications of a perhaps unwise choice by Congress. If those concerns are sufficient, Congress can change the law as it did to protect charitable contributions. The court also viewed the idea that the benefit to the parent to produce an economically self-sufficient child was sufficiently concrete to serve as the necessary “value” for creditors – not to mention that any such value would be well into the future and would do nothing for current creditors even if the parents extracted a promise of future support from their 19 year-old-student.
Geltzer v. Trey Whitfield School (In re Michel), 573 B.R. 46 (Bankr. E.D.N.Y. 2017) and Geltzer v. Lawrence Woodmere Academy (In re Michel), 572 B.R. 463 (Bankr. E.D.N.Y. 2017). Payments made to private school for minor children’s tuition were not fraudulent.
The trustee here made much the same arguments as in Knight, but with respect to the tuition paid for education of three minor children. While conceding that state law required that the children be educated, he argued there was no benefit to creditors and the estate for paying private school tuition where a free public school education was available. The court disagreed, holding that the issue was whether value was provided to the debtor, not whether that value could be collected upon by creditors or some other criteria. Nor is up to the court or the trustee to decide the wisdom of a particular expenditures prepetition, at least as long as it represented a bona fide payment for something that was of value. That is, attending an expensive concert might not be a good idea for a financially stressed individual but that does not mean that the debtor did not receive value for the price paid for the ticket – even if creditors have no ability to seize her good memories and sell them for their own benefit. It is not entirely clear from this particular form of analysis why the same could not be said about the college tuition issue, but at least for school costs, the legal requirement to pay for one’s child’s education clearly provides a “value” that the parent (and not just the child) is receiving.
In re Hackler (Hackler v. Arianna Holdings Company, LLC), 2017 Bankr. LEXIS 2437 (Bankr. D. N.J. 8/28/17). Unlike a fraudulent transfer action under Section 548, a preferential transfer action under Section 547 with regards to a tax sale does not violate BFP v. Resolution Trust Corp., 511 U.S. 531 (1994).
BFP held that, for reasons of comity, the amount received at a properly conducted foreclosure sale would be conclusively presumed to be the “reasonable equivalent” of the value of the property, reasoning that property subject to forced sale was not worth the same as property that was being sold voluntarily. It also noted that the process normally includes a competitive bidding process that is meant to achieve the highest price Courts have concluded, however, that the same does not necessarily apply to sales of properties for unpaid taxes that use a myriad of systems and, in any event, do not purport to try to obtain full value. The court here applied much the same reasoning to the question of whether a tax sale could be attacked as a preferential transfer. The question there is not equivalent value but rather where the creditor received more than he would have in a Chapter 7 case. There was no reasonably plausible scenario in which the trustee would not have been able to take the property as a whole and sell it for more than what the creditor was owed in back taxes. So, when the creditor was able to keep the entire property (and those excess amounts), it was fair to say he had received more than he would in Chapter 7. As such, the preference language was satisfied.
In re NewPage Corp. (Pirinate Consulting Group, LLC v. Kadant Solutions Division), 569 B.R. 593 (D. Del. 2017). Prepayment made under a contract is not a preferential payment.
A preference, by statutory definition, is a payment made on an “antecedent debt.” Where a prepayment is made in advance of when the binding obligation is incurred, it cannot, by virtue of that definition, be with respect to an antecedent debt. Here, for instance, the parties signed a contract under which the debtor was required to make a down-payment of 60% of the purchase price before the counter-party would start the manufacturing process. Conversely, the debtor could have canceled the contract without penalty prior to making that payment. On that scenario, the court said no binding agreement existed that could have imposed a debt or created a claim for the creditor. That is, it had no “right to payment” prior to when the payment was made. The contract gave it a right to retain the payment once voluntarily made, but nothing bound the debtor to make the payment. The mere fact that the contract contemplated an ongoing transaction did not create a present debt where the agreement could be revoked at will.
In re Grooms, 2017 Bankr. LEXIS 2357 (Bankr. W.D. Penn. 8/22/17). Restitution payment made by defendant in criminal investigation prior to actual imposition of sentence was not protected from avoidance action by Mandatory Victim Restitution Act (MVRA) nor could U.S. enforce rights against trustee after payments were avoided.
The MVRA provides that it applies “notwithstanding any other federal law” and a number of courts have held that that language trumps the bankruptcy code. In this case, though, the sequence was that the debtor was investigated and his lawyer conveyed a restitution offer to the government as part of a possible plea deal before the charges were actually filed. A partial payment was made after a draft plea agreement was prepared but before it was finalized or presented to the district court for approval. The debtor obtained the funds for that payment primarily from a loan from a bank and promptly after executing the plea filed bankruptcy. The district court did later approve the plea preliminarily and later on a final basis and stated that it assumed that the funds could not be recovered in a bankruptcy case. The trustee did sue the creditor, though, asserting that the payment was a preference. With reluctance, the bankruptcy court agreed, noting that the MVRA’s provision only applied to a payment pursuant to a criminal judgment and that judgment was not entered prior to payment being made. As such, despite the obvious integrated process of moving from investigation to plea discussions to agreement to judgment, the court held the MVRA would trump a preference action only after the judgment was actually entered. Since that did not occur prior to bankruptcy, the trustee could avoid the payment and, thereafter, the court found that the payments became part of the property of the estate, not the property of the debtor. As such, the court held, they could not be recovered by the U.S. after the bankruptcy was filed. The net result was that the payments had to be returned by the initial victim and distributed generally to all of the debtor’s creditors. The court noted that both the original victim and the bank would have nondischargeable debts so they could still try to collect and that the avoidance action provided a more equitable distribution to all (which is the goal of the preference provisions).
In re Rollaguard Security, LLC et al. (Furr. v. TD Bank, N.A.), 2017 Bankr. LEXIS 2101 (Bankr. S.D. Fla. 7/27/17). Deposit of debtor’s own money into an unrestricted bank account is not a
“transfer,” banks are not transferees liable to trustee for amount of withdrawals from accounts.
While, technically, the deposit of funds into a bank account creates a debtor-creditor relationship between the bank and the depositor (as opposed to a trustee relationship where the bank holds the funds in trust), the court held, based on Eleventh Circuit law, that the bank would not be treated as a “transferee.” Rather, because it has no control over the account or rights to do anything but follow a depositor’s directives as to the use of the funds, the court held that the banks were mere “conduits” who could not be held liable to the trustee for the fact that they followed those directions of the debtor and paid out the funds in the accounts. (The result might be different if the banks were actually aware of, or conspired with the debtors in their use of the accounts as part of the process of their fraudulent schemes, but banks do not have an affirmative duty to investigate their clients.) The court noted that the trustee’s position while it might provide a recovery here would be disastrous in other cases. If the bank is always considered an initial transferee, then all payments by a debtor to a third party by virtue of checks drawn on that bank account would no longer be payments to an initial transferee (with essentially strict liability) but would be payments from the initial transferee (the bank) to a subsequent transferee, which would have much broader defenses. The court accordingly dismissed the trustee’s complaint.
In re King Center Corp. (King Center Corp. v. City of Middletown), 2017 Bankr. LEXIS 1895 (Bankr. E.D. N.Y. 7/7/17). Party that failed to timely challenge city in rem tax foreclosure was barred from later doing so; involuntary action not covered by state fraudulent transfer statute.
The case deals with a somewhat typical action whereby the city acted under its charter to transfer a delinquent taxpayer’s real property to itself after the taxpayer did not respond to several notices to satisfy the taxes. The amount of the taxes was much less than the general value of the property and it is possible the taxpayer could have contested the tax deed under the provisions of the city charter. It failed to do so within the 2-year limitation period in the charter, though, and, as a result, the court agreed with the city that the action was time-barred. The debtor later filed bankruptcy and sought to challenge the action as a fraudulent transfer. Because the two-year period for Section 548 had already run, the debtor tried to use Section 544 to challenge the transfer under applicable state law. That law, which is similar to most similar state laws, speaks of a conveyance “made by” the debtor and the city successfully argued that such phrasing refers to a voluntary transfer made by the party, not an involuntary transfer made by the city itself (without the involvement of the party) as part of a tax collection effort. While Section 548 is not applied in that fashion, the debtor waited too long to file its bankruptcy to be able to use that section to challenge the tax deed the city executed to itself.
ASSET SALES AND PROPERTY OF THE ESTATE
In the Matter of Spanish Peaks Holdings II, LLC (Pinnacle Restaurant at Big Sky, LLC v. CH SP Acquisitions, 862 F.3d 1148 (9th Cir. 2017). Debtor may sell properties free and clear of liens (if a provision of Section 363(f) applies) without complying with Section 365 rejection provisions.
A proposed sale of a property with existing leases can potentially be subject to both Section 363 dealing with sales and Section 365 dealing with lease rejections. If Section 365 applies, a tenant has the right to demand to remain in possession of the property during the term of the lease despite its being rejected. The proposed buyer of the property did not want to allow that since the leases were sweetheart deals between the owner and the related tenants and the rent was far below market value. Although the majority view is that Section 365 as the “more specific” section should govern, the court here followed the lead of the Seventh Circuit and held that the section would only if the lease were, in fact, rejected. If the debtor did not reject the lease, it could sell free and clear if another provision (such as the state foreclosure laws would allow a lease to be terminated in such an action). The lessor’s proper course of action in that scenario would be to invoke Section 363(e) and demand “adequate protection” for whatever state law rights it retained.
United States v. Calle Serna, 2017 U.S. Dist. LEXIS 139923 (E.D. N.Y. 8/29/17). Funds that were forfeited to the United States in criminal action were not property of debtor’s estate.
The United State obtained forfeiture orders against defendants in the illegal drug trade in Columbia. That petition was applied to $2.7 million that had been paid to a debtor in bankruptcy as part of a sales transaction. The trustee in that case sought to participate in a proceeding with respect to the forfeiture pursuant to which the United States allows third parties to assert that they have superior rights in the forfeited assets. That process takes place under 21 U.S.C. 853(n), which allows the party to petition the court to assess the parties’ relative rights in the assets. To do so, it must either show that he had a prior vested superior interest or that it was a bona fide purchaser of the asset. The difficulty is that the third party must show that its rights existed prior to the time of the criminal activity that created the right of forfeiture because the government’s rights are created automatically at the time of the misconduct, pursuant to 21 U.S.C. 853(c). The trustee’s rights here were not created, at the earliest until confirmation of the plan providing for the sale of the assets. Since the assets here were traceable back to the criminal activity (and were not merely some other assets held by the defendant that the government sought to seize), they were subject to forfeiture retroactive to the criminal activity date.
In re Briar Hill Foods, LLC, 2017 Bankr. LEXIS 3342 (Bankr. N.D. Ohio 9/29/17). While receiver generally cannot be left in place during bankruptcy, court excused turnover for short period to allow sales to take place.
The debtor and its lenders had worked through a receivership process prebankruptcy to work towards having various stores sold. They then decided, though, that they wanted the sales to be run through a bankruptcy process to obtain the stronger protections available under Section 363 – but didn’t want to have the debtor in charge or to go to the bother of having the receiver appointed as a trustee. Thus, they asked the court to allow the receiver to be excused from turnover and to continue the sale process. The court grumbled about the lack of any provision under the Code for such a process – noting that the Code only allows for a debtor in possession or a trustee but not a retained receiver, and that “It is the Bankruptcy Code, not the Bankruptcy Suggestions.” Nevertheless, the court did allow the receivers to be excused under Section 543 from turning over the property for a month to allow the negotiated sales to be completed.
In re W.O.L.F., 2017 Bankr. LEXIS 2279 (Bankr. D. Col. 7/25/17). Section 1141(c) eliminates “claims and interests” of “creditors” in property dealt with by plan, not rights of asserted co-owners.
The debtor was determined in the case to be a 50% co-owner of a piece of property with a third party. After the plan was confirmed, the third party requested partition of the property in state court. The debtor argued that confirmation the plan terminated all “interests” in the property, which included the right to seek partition. The court rejected that argument holding that, while the right to partition is an interest, it was not held in that case by a creditor, but rather by a co-owner. Section 363 has somewhat broader application – and it also has a specific section – 363(h) – that allows a trustee to seek partition of property. It is not applicable here. The court also refused to direct the state court in how to carry out such a partition to meet the debtor’s concerns that the division of the land would not impair its ability to operate since the bankruptcy did not allow the debtor to perpetually be protected from other parties’ suits.
In re OGA Charters, LLC (Schmidt v. Villarreal), 2017 Bankr. LEXIS 2056 (Bankr. S.D. Tex. 7/24/17). Proceeds of a liability policy that are payable only to victims are still property of estate if claims exceed policy limits; court certified decision for direct appeal to Fifth Circuit.
The treatment of insurance policies is a complicated issue. While the ownership of the policies themselves that are issued to the debtor plainly makes the policies property of the estate, the more difficult issue is how to analyze the status of the proceeds of the policies. In a vehicle insurance policy, for instance, the collision damage benefit is payable directly to the vehicle owner (i.e., the debtor) and allows the debtor to use those payments for its own benefit in fixing damage. But, benefits for those injured by a debtor vehicle normally cannot be obtained and held by the debtor for its own benefits; rather, they are either paid directly to the victim or are held by the debtor only as a conduit for payment to the victim. In a simple case where the amount of claims does not exceed the policy limits, the courts generally agree that the proceeds are, therefore, not property of the estate. As a practical matter, this means that other non-victim creditors cannot access them and that the debtor is free to go ahead and pay them out to the victim without forcing those funds to go through the whole estate allocation process in the bankruptcy case. For victims, it is essential to ensure that their payments do not come into the debtor’s estate unencumbered so that they can be used to pay all claimants rather than those who injuries triggered the payments. The other question is where the claims collectively exceed the policy limits. In those cases, the court here concluded, based on its analysis of Fifth Circuit law, the secondary impacts on the estate and similarly situated creditors (some of whom may have settled early and were set to be paid in full, while others who were injured later might find the policy exhausted with nothing for them) were enough to treat the proceeds as property of the estate. Doing so would allow the debtor to propose a pro rata allocation of the proceeds among all similar creditors so none would receive a windfall while others were excluded. It does not appear, though, that the court believed that this would allow non-victim creditors to share in the proceeds; i.e., these funds would be functionally segregated for victims. The court certified its opinion since it believed it had correctly applied the prior cases but there was some uncertainty.
CHAPTER 7 ISSUES
In re Edwards, 2017 Bankr. LEXIS 2358 (Bankr. E.D. N.C. 8/2/17). High income debtors’ case may be dismissed as bad faith even where means test does not literally apply.
The “means test,” which imposes a numerical calculation on debtors with primarily “consumer debt” does not literally apply to those individuals whose debts arise in connection with business ventures. Nevertheless, the court held, it could look at ability to pay as part of the indicia of whether the debtors’ filing was made in bad faith. Where the debtors made over $300,000, but were seeking to discharge all of their debts in Chapter 7 – leaving them to fall solely on their business partner – while simultaneously raising their charitable contributions from $200 to $1500 a month, providing thousands a month to support one debtor’s father, and buying new cars and similar factors, the court held the facts were sufficient to show the debtors were attempting to abuse the system. As such, there was cause to dismiss their case.
CHAPTER 11 ISSUES
In re Cook Investments NW, SPNWY, LLC v. Geiger, U.S. Dist. LEXIS 136129 (W.D. Wash. 8/24/17). Plan need not avoid every remote possibility of violation of law in order for confirmation to be proper.
The courts have struggled in recent years with whether they can authorize activities of a debtor that involve the use of marijuana in ways that are legal in the state, but still illegal under federal law. In this case, the debtor had a lease with an entity that grew marijuana – but agreed to reject the lease and show that its plan was still financially viable in order to affirm confirmation. Nevertheless, the trustee still insisted that the debtor’s plan might have some lingering taint of illegality (it is not clear if the marijuana operation would be staying in place albeit without a lease) and, accordingly, could not be confirmed under Section 1129(a)(3). The court first took a very narrow view of that section and held that it only applied to actions relating to confirmation that were themselves illegal, not to any actions that the confirmed debtor planned to engage in as part of its approved plan that might be illegal going forward. The court then held that, even if it took a broader view there nothing about the debtor’s plan that involved it in any illegal activity relating to a former tenant.
In re Nuverra Environmental Solutions, Inc. (Hargreaves v. Nuverra Environmental Solutions, Inc.), 2017 U.S. Dist. LEXIS 122317 (D. Del. 8/3/17). Without mentioning Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017), court found that gifting plan (whereby secured creditors diverted some of their recovery so trade creditors got 100% of their claims while general unsecured creditors received only 4-6% was legal.
The courts have long struggled with whether “gift plans” that pay creditors out of the normal order of priority by virtue of a “gift” from the buyer or from secured creditors from their collateral are allowed. Jevic barred class-skipping plans in the context of a dismissal of the case; here, on the other hand, the unequal treatment was part of a proposed plan. The bankruptcy court allowed it based on its conclusion that the unsecured creditors were totally out of the money so that anything they received from the secured creditors was a pure gift – and one that the secured creditors need not distribute equally. By referring to this as a reallocation of funds, the court just defined away the asserted discrimination between the two classes – even if the funds being diverted are initially property of the estate. Previous cases seems to have suggested that the gift had to come from non-estate property, i.e., from a buyer, but this case brushes away that distinction. The court suggests that the only alternative was a return to a strict enforcement of normal priorities while ignoring the possibility that the other parties when faced with resistance might try another plan allocation that would either equate all of the unsecured creditors or at least reduce the stark difference in percentages so that even a relatively disfavored group might choose to consent to the plan.
In re Wagle, LLC, 570 B.R. 725 (Bankr. W.D. Penn. 8/16/17). “New value” contribution held not to be sufficient to warrant allowing owners to retain equity.
The debtors operated a locksmith business and filed a plan under which they would pay off the secured lenders over time (with the second lien holder being paid on only a portion of the loan), would pay about 2% to unsecured creditors, and would retain the ownership of the business. The debtors proposed to make an $8,000 payment into the plan based on a donation from family members and argued that this was a sufficient “new value” contribution to overcome the effects of the absolute priority rule. (Although it is not clear, it appears this payment is probably the amount being used to make the 2% payment to unsecured creditors.) One of those creditors objected and the court agreed that the debtor had not made its case. While it was an appropriate form of new value, the court held that the debtors had not clearly shown that the contribution was necessary for the plan where it was not being used to satisfy some immediate need as opposed to merely funding a token payment to unsecured creditors. And, in any case, the debtors had failed to allow competitive bidding on the business or otherwise established what the value of the business was as a going concern. As a result, the court had no basis to determine whether what was being offered was a fair equivalent of the value of the equity being retained.
In re Penn Virginia (Koropey v. Penn Virginia Corp.), 2017 Bankr. LEXIS 2031 (Bankr. E.D. Va. 7/21/17). Complaints seeking revocation of a plan confirmation are untimely if filed on the 180th day.
Section 1144 allows a party to file a complaint to vacate a confirmation order at any time “before” 180 days after the confirmation date. Read literally, that means the complaint must be filed not on, but rather “before” the 180th day; i.e., the bar date for such complaints is only 179 days. That language is the converse of the usual phrasing that an action must be taken within “x days after” a particular event. Had that language been used in Section 1144, the creditor would have had the full 180 days.
In re Motors Liquidation Company, 2017 Bankr. LEXIS 1930 (Bankr. S.D. N.Y. 7/12/17). Plaintiffs could not obtain punitive damages from new GM because court held they could never have gotten them from old GM.
The plaintiffs in the ignition switch litigation argued that they could hold new GM liable as a successor for punitive damages that might have been incurred by old GM in view of old GM’s concealment of the defective switches. The court held that could not happen because old GM would never have had to pay any punitive damages because it was insolvent and unable to pay its compensatory damages. That analysis – which treats punitive damages as being automatically fully subordinated in Chapter 11, because they are subordinated in Chapter 7 is used by many courts, but is not necessarily correct. The only requirement in Chapter 11 is that parties get as much in that chapter as in a Chapter 7 liquidation. The issue then is a mathematical calculations – the addition of punitive damages clearly increases the denominator but it is always argued in disclosure statements that the Chapter 11 plan will create much more for creditors than a straight liquidation in Chapter 7, thus increasing the numerator. As a result, one must do a mathematical calculation to determine whether creditors will actually receive as much if penalties are included. (As an example, if the Chapter 7 pie is $100 to be applied against $500 of claims, a creditor with a $50 claim will get $10. If the Chapter 11 pie expands to $150 but $100 of punitive damages are added, the result will be a 25% payout, leaving the creditor with a $12.50 payment so there is no violation of the best interests test). The court here made no such calculation – nor did it take into account that a plan that was negotiated with knowledge of the switches might have included a limited amount of punitive damages that could have still met the best interests test.
In re Thru, Inc., 2017 Bankr. LEXIS 1902 (Bankr. N.D. Tex. 7/10/17). Creditor whose claim arose out of its position as competitor with debtor could be separately classified.
Where the debtor’s primary creditor was a competitor whose claim arose out of their dispute over the ownership of a trademark and who, it could be inferred, was more interested in the debtor’s demise than in payment of its claim, it was not improper to separately classify that creditor. Its interests were different than those of the other trade creditors who did support the debtor’s reorganization. The plan did promise full payment of the claim albeit on somewhat slower terms than the other parties. The court also found, in the absence of evidence of a more appropriate rate, that the federal judgment rate (currently a little over 1%) was a fair rate to use during the period of time that payments were being made.
CHAPTER 13 ISSUES
RESFL Five, LLC v. Ulysse, 2017 U.S. Dist. LEXIS 161751 (S.D. Fla. 9/29/17). Debtors are entitled to make qualified retirement contributions to the maximum amount allowed by law during their case even if this is substantially more than is paid to creditors.
As with much of the BAPCPA, the language used with respect to whether retirement savings contributions are to be treated as disposable income is less than clear. Some courts have disallowed them entirely; others have allowed them only to the extent consistent with what was being done prebankruptcy (and would often require that payments that were used to pay off loans from retirement accounts must be dedicated to creditor payments after the loans are paid off, not converted to contributions), but the majority, subject to a general showing of good faith, find that the debtor may make contributions to the maximum amount allowed by law. Accordingly, the debtor, who in this case was near or above normal retirement age and was supporting a grandchild, was allowed to contribute $114,000 to his account over the five-year plan, while only paying $12,000 to his creditors.
Nomellini v. IRS (In re Nomellini), 2017 U.S. Dist. LEXIS 145230 (N.D. Cal. 9/7/17). IRS lien remained viable under Chapter 13 plan where debtor neither avoided lien or included plan terms explicitly limiting its value.
The debtor filed Chapter 13 at a time when his real property, valued at $950,000 was under water with respect to the first mortgage of $980,000. There were two junior mortgage lenders as well as an IRS lien. The IRS filed as secured only with respect to some personal property in the case. The debtor moved to value and avoid the mortgage liens but took no such action with respect to the IRS lien. The confirmed plan stated that secured claims in general would be paid up to the value of the collateral and the rest would be an unsecured claim. About halfway through the plan, real estate values had apparently recovered and the house was eventually listed for sale and sold for almost $2.2 million. The sale order was the first notice given to the IRS of the increased value of the home and it moved to amend its claim to list the full value of its debt as secured. The debtor then filed an adversary seeking to determine the extent of the IRS lien to be only the original $10,000 but the bankruptcy court disagreed, and the district court affirmed. Under In re Brawders, 503 F.3d 856 (9th Cir. 2005), confirmation of the plan standing alone was not enough to affect the IRS’ in rem rights where there had been no explicit valuation of its claim or avoidance of its lien. While res judicata can bind a party to even an illegal plan term, the burden is on the debtor to show that its plan clearly and unequivocally was intended to have that effect. The creditor is entitled to due process both as to the substance of the proceeding to treat its claim and to the need for adequate notice. This is particularly true with respect to secured claims that normally pass through bankruptcy unaffected. Here, the plan did not deal with the IRS as it had with the other lenders and was not sufficiently clear to wipe out the IRS’ normal lien rights.
Kohout v. Nationstar Mortgage, LLC, 2017 U.S. Dist. LEXIS 146647 (N.D. Tex. 9/11/17). Like Nomellini, failure to defend validity of filed claim did not serve to void underlying lien.
Like Nomellini, the debtor here filed a plan that provided for payment of allowed claims and he completed the plan and resolved all claims filed in the case. The debtor objected to the claim of a secured lender but based only on procedural issues about the documentation of the claim without really disputing that an amount was owed and that the lender was secured. The lender did not object and the claim was disallowed in the case but the lender later said the disallowance did not affect its in rem rights. The court held the issue was close but, because the disallowance was not on the merits, the court viewed this as not being a case where the court had previously held – in a matter that the lender had initiated by filing a proof of claim – that the claim itself had no validity. As such, the court held it would not treat the lender worse than if it had filed no claim at all.
In re Manzo, 2017 U.S. Dist. LEXIS 136448 (N.D. Ill. 8/25/17). Failure to apply social security income to paying secured claims does not bar confirmation of plan.
The Code’s means test excludes social security income as a source of disposable income. The Code also allows a debtor to strip a wholly unsecured lien in some circumstances. If the debtor does exactly what the Code allows, he cannot be held to be acting in bad faith. Here, the debtor had received a lump sum payment from Social Security that was in addition to the positive (albeit small) result of his means. The bankruptcy court held that he had to show his good faith by using at least part of that lump sum to make payment towards the lien that he was stripping. The district court disagreed, holding that there was no bad faith in doing what the law allowed.
In re Escarcega, 573 B.R. 219 (9th Cir. BAP 2017). Chapter 13 debtor has obligation to review and object to plans where appropriate; refusing to object so as not to trigger obligations that arise upon objection is improper; debtors cannot use provision that overrides commitment periods.
The Ninth Circuit made clear that the applicable commitment periods for the length of a plan must be abided by if there are any objections. The trustee worked out an arrangement with debtors’ counsel under which she informally notified them of any problems so they could change their plans but never filed formal objections that would trigger the commitment period obligation. Indeed, when they proposed nonstandard plan provisions that would allow them to terminate their “zero payment” plans whenever administrative and priority claims had been paid, without notifying other parties or giving them a chance to object or to seek a review of whether the debtors’ income had changed, she also did not object to those provisions. The bankruptcy courts held that the provisions and her failure to object both violated the Code’s terms; the Code clearly envisioned that debtors would remain in a plan for a minimum period of time specifically so there would be a chance to see if their finances would approve so as to be able to make some payment to unsecured creditors. The proposed plans would have not placed any such duty on the debtors and could have been ended without notice to objecting creditors. The BAP affirmed the lower court’s view that such provisions were not allowed.
In re Sorenson, 2017 Bankr. LEXIS 4040 (Bankr. D. Col. 9/29/17). Debtor could not have two Chapter 13 cases pending for extended period of time.
While the Code does not explicitly preclude a debtor from having more than one case pending at a time, virtually all courts find that scenario improper except for very limited periods of overlap. If, for instance, a debtor files a Chapter 7 case and obtains a discharge, but the case has not yet been closed, he is not necessarily precluded from filing a Chapter 13 case to start to deal with payments for nondischarged debts or secured claims where the lender could assert in rem rights. There may be other reasons why a very short overlap might occur. But, because of all of the complications that may arise from having two different cases dealing with the same debtor assets and wages, courts have generally barred any long-term filings. Here, the debtor still had more than a year to go on his initial Chapter 13 plan at a time when he incurred additional liabilities from his activities as a broker that could cost him his license unless he dealt with them in a bankruptcy. The court held that, while there was some appeal to his argument, the problems were still too great to allow him to file a second case to include the new debts. Among the issues were that the new debts would be paid a greatly different percentage and that the combination of debts in the two cases would exceed the Chapter 13 eligibility limits.
In re Ortiz-Peredo, 2017 Bankr. LEXIS 2003 (Bankr. W.D. Tex. 7/18/17). “Disposable income” in Chapter 13 includes exempt income.
While Section 522(c) provides that exempt property is not to be used to satisfy the debtor’s prepetition obligations, Section 1325(b) provides that all disposable income (i.e., that above what is needed to satisfy the debtor’s living obligations) must be applied to satisfy creditor’s claims. To the extent the two provisions are contradictory, the substantial majority of courts, including the court here, have concluded that Section 1325(b) governs in Chapter 13 cases since it makes no reference to Section 522(c) nor does it indicate that there is any limits to its application. The definition of “current monthly income” in Section 1325, which is the starting point for “disposable income,” does exclude certain types of exempt income (most notably Social Security payments), but, by negative implication, all other forms of exempt income (such as payments for personal injury claims) remains subject to Section 1325.
In re Kalesnik (Kalesnik v. HSBC Bank USA), 2017 Bankr. LEXIS 1908 (Bankr. D. Mass. 7/11/17). Chapter 13 debtor does not have standing to pursue avoidance actions.
Although avoidance actions and the recoveries therefrom are part of the chapter 13 debtor’s estate, there is nothing in Chapter 13 that explicitly gives the debtor the right to pursue such actions. The Code gives the case trustee the right to bring avoidance actions and, in Chapters 11 and 12, there is a specific reference to the debtor being able to exercise those powers of the trustee. There is no similar language contained in Chapter 13; accordingly, the difference between the two provisions indicates that the language allocating such authority to the trustee should be read literally.
In re DBSI, Inc. (Zazzali v. United States), 869 F.3d 1004 (9th Cir. 2017). Contra to the Seventh Circuit, Ninth Circuit holds that Section 106(a) allows trustee to bring suit under Section 544(b) even though no nonbankruptcy creditor exists who could bring such suit.
Section 544(b) allows the trustee to step into the shoes of an actual, not merely a hypothetical, creditor as is allowed under Section 544(a) who could have brought an avoidance action under state law. In the case here, there was concededly no creditor who could bring such an action because state law could not authorize suit against the United States nor would the United States’ immunity allow it to be sued in state court without its consent. Section 106(a)(1) abrogates sovereign immunity with respect to a number of provisions including “Section 544,” but Section 106(a)(5) says that it is not intended to create any causes of action not existing outside of bankruptcy law. The Seventh Circuit concluded that the combination of those provisions meant that there was no creditor that the trustee could act in place of, and, accordingly, the suit could not proceed. The Ninth Circuit rejected that view and affirmed the decisions below and those of some (but by no means all) lower courts that concluded that Section 106(a) could reach out and abolish the sovereign immunity limitations within state law as well so as to, in essence, create a creditor who could sue the United States in bankruptcy (but could not do so outside bankruptcy). The United States had requested rehearing en banc request and, if unsuccessful there, a petition for certiorari is likely in light of the clear circuit split with the Seventh Circuit.
In re Odom (Odom v. Philadelphia Parking Authority), 2017 Bankr. LEXIS 2240 (Bankr. E.D. Penn. 8/10/17).
The court agreed with the debtor that Section 106(a) and the decision in Central Virginia College v. Katz, 546 U.S. 356 (2006)precluded the city from relying on its statutory immunity under state law to protect it from a charge of violating the automatic stay, noting that the debtor could not assert Eleventh Amendment immunity since it was not the state and that Katz had made Section 106(a) largely irrelevant for liability purposes. It also found, however, that the limitations in Section 106(a)(3) with respect to available damages (barring punitive damages, for instance) remained viable since Congress was free to grant or deny immunity as it chose. The court also found that Section 106(a)(4), which speaks of collecting a judgment in accordance with the means prescribed under nonbankruptcy law, only went to limiting enforcement options (i.e., not putting a lien on the Capitol building, for instance), not to recognizing the substantive immunity provisions in state law.
Hawk v. Englehart (In re Hart), 871 F.3d 287 (5th Cir. 2017). On rehearing, Fifth Circuit reverses position on whether funds removed from an exempt IRA would remain exempt under the Code where state law required that they be rolled over into another exempt account to retain that status.
The Fifth Circuit had originally followed state law and held that the funds lost their exempt status after the time limit for reinvesting them had passed. In the opinion on rehearing, it held that such a rule could apply in Chapter 13, where the “conditionally exempted” property lost that status during the case when the funds were not reinvested and became a new property interest that, under Section 1306, entered the estate when it was created. In a Chapter 7 case, on the other hand, such as this one, the court held that the situation was different. At least when the proceeds did not exist when the case was filed – and the trustee failed to object in a timely fashion – the court held that it would not find that the new property interest could be brought into a Chapter 7 case where there is no statutory provision similar to Section 1306.
In re Gordon (Gordon v. Tese-Milner), 2017 U.S. Dist. LEXIS 131466 (S.D.N.Y. 8/17/17). Sanctions in the form of attorney’s fees may be imposed on debtor in discharge litigation where it engages in bad faith litigation tactics and there is not a colorable basis for its opposition.
This case is the flip side of cases that discuss when a creditor might be liable for acting with respect to debts that are arguably not discharged. While, concededly, if the issue is disputed and the creditor loses, it must correct the violation, the question becomes whether sanctions in the form of attorneys’ fees and the like should be awarded automatically. While some courts appear to think so, the better answer is that they should not be awarded if the creditor has taken a position in good faith that is objectively reasonable. This case upheld sanctions on a debtor that engaged in numerous improper actions in defending an objection to discharge – and the court held that, where he was acting in bad faith without a colorable claim of merit to his arguments that an award of the other party’s attorneys’ fees was justified. It defined “colorable
as whether there was some legal and factual support, considered in light of the reasonable beliefs of the party making the claim.
In re Play Membership Golf, Inc., 2017 Bankr. LEXIS 3828 (Bankr. D. Col. 9/29/17). Discussion of post-confirmation jurisdiction with respect to failures to meet plan payment obligations.
Bankruptcy court jurisdiction is established in 28 U.S.C. 1334 and includes jurisdiction over matters “related to” the bankruptcy. While that standard is quite broad prior to the confirmation date (taking in any matter with a “conceivable effect” upon the estate, the scope of the court’s power narrows considerably after confirmation. At a minimum, the plan normally must provide for the bankruptcy court to retain jurisdiction, but even if that is done, the court still loses much of its authority once the “estate” disappears upon confirmation of the plan. At that point, even though the court does have some power to continue to help implement the plan, it is not expected to maintain a continuing power of oversight over everything the parties do in carrying out the transactions and the payment obligations contemplated by the plan. Thus, to the extent the debtor had disputes about the actions of the management company it hired to operate the facilities that were expected to generate funds needed to make plan payments, those disputes did not implicate the bankruptcy case anymore than any other ongoing business dispute. Bankruptcy is not intended to create a party with a never-ending protected status in federal court.
In re Pustejovsky, 2017 Bankr. LEXIS 2500 (Bankr. W.D. Tex. 9/1/17). Chapter 13 debtor who requested dismissal in bad faith could be forced to convert to Chapter 7 instead.
Section 1307(b) says a case shall be dismissed on the debtor’s motion. Section 1307(c) says the court may convert a case to another chapter for a variety of reasons constituting “cause.” In this case, the debtor moved to dismiss her case in bad faith at a time when she knew doing so would allow us to retain funds that should have been paid into the estate and used to satisfy creditors. The court found that allowing a debtor’s dismissal motion to be absolutely controlling, no matter what the circumstances, would make the conversion provisions in Section 1307(c) meaningless when the debtor is acting in bad faith. A number of courts, though, find that, regardless of the policy implications, the different wording of Section 1307(b) and (c) suggest that even a debtor acting in bad faith can still dismiss his case even in the face of a pending conversion motion.
In re Haddad, 572 B.R. 661 (Bankr. E.D. Mich. 2017). Debtor who received large settlement during case and failed to report it could still have case dismissed but dismissal order would require retention of sufficient funds to pay creditors in full.
The debtor was in an auto accident during her Chapter 13 case and eventually recovered more than $750,000 – an amount vastly in excess of the roughly $25,000 exemption amount and the $40,000 needed to pay her creditors. She did not report the amount at any time but it was brought to the Chapter 13 trustee’s attention by her personal injury attorney. The trustee sought to modify her plan to provide for payment of the creditors and the debtor moved, before his motion was heard, to dismiss her case. The bankruptcy court did dismiss the case, holding that even if Section 1307 provided him an option to do so the debtor’s conduct was not so extreme as to warrant that remedy, noting that she claimed not to have known that she was obligated to disclosure the funds. However, it also relied on Section 349 as giving him authority to condition that order with respect to revesting undistributed estate funds in the debtor. The court held that, while Section 349 may not literally apply to funds that were not in the debtor’s hands prior to the commencement of the case, the general policies underlying it warranted applying it to property that came into the estate after confirmation (pursuant to Section 1327). Relying on the overall equities, including the fact that the debtor would still receive a very large sum even after paying creditors in full, the court held that it could use Section 349(b)(3) to withhold $40,000 from the amount that would otherwise revest in her upon dismissal.
In re Grand Dakota Partners, LLC, 2017 Bankr. LEXIS 2442 Bankr. W.D.N.C. 8/28/17). While venue was not improper in North Carolina, court agreed to transfer case to North Dakota where business was located and virtually all creditors and assets existed.
The debtors’ owners were located in North Carolina and they incorporated the businesses there, making North Carolina the “principal place of business” as a matter of law. As a result, venue in North Carolina was proper under 28 U.S.C. 1408. However, as a matter of pragmatic reality, the debtors’ entire business was located in North Dakota, all employees worked there, all of the assets were there, and all of the creditors were there. Further, while the executive-level decisions were made by the owners, all of the day-to-day operational decisions were made by management in North Dakota. Based on those factors, the court held it was proper to transfer the venue to North Dakota under 28 U.S.C. 1412 for the “convenience of the parties” and in the “interests of justice” so parties other than the debtors and their owners could participate in the case.
In re Zamora-Quezeda, M.D., 2017 Bankr. LEXIS 2208 (Bankr. S.D. Tex. 8/7/17). Conduct that would warrant converting or dismissing a Chapter 11 case for “cause” can be sufficient grounds for denying a motion to convert from Chapter 7 to Chapter 11.
After the individual debtor filed a Chapter 7 and a trustee was appointed that began exploring various avoidance actions against the debtor, the debtor began seeking to try to convert its case to Chapter 11. While claiming that doing so would allow him to pay more to creditors and avoid the high costs of the trustee, the evidence suggested that his main concern was to place himself in control of the case so he could escape being called to account in the avoidance actions and other pre-petition litigation. The court noted that the case of In re Marrama, 549 U.S. 365 (2007), the Supreme Court had held that the debtor’s bad faith could preclude a conversion to Chapter 13 where the facts would readily justify forcing the case out of Chapter 13 as soon as the change was made. So too, here, the court held, it needed to look at the reasons for the debtor’s proposed conversion and whether the debtor was acting in good faith and in the interests of creditors. The court found that the debtor had engaged in bad faith activities before and during the case such as misstating his financial condition, filing for bankruptcy as a litigation tactic and transferring millions of dollars of assets to affiliated entities. The bad faith continued after the petition date by virtue of the debtor’s wildly inaccurate schedules. Based on all of those factors, the court found ample grounds for reconverting the case were the debtor’s conversion request to be granted. As such, there was no basis to waste the parties’ time and resources on that change.
In re Corbett (Calif. Correctional Peace Officers Association Benefit Trust Fund v. Corbett), 2017 U.S. Dist. LEXIS 108925 (E.D. Cal. 7/13/17). Agreement between debtor and Trust Fund was sufficiently definite and specific so as to allow equitable lien to be asserted by Trust Fund against reimbursements debtor received on her workers’ compensation claim.
The Trust Fund provides advances to its members if they are injured on the job and are seeking workers’ compensation awards. The member is required to sign an agreement to reimburse the Trust Fund if, and to the extent that, such an award is made. Where the debtor did eventually receive such an award, the court held that the agreement with the debtor was adequate to both require the reimbursement and to grant the Trust Fund with an equitable lien against the worker’s compensation award that would trump any exemption claim in those funds.
In re Black, 2017 U.S. Dist. LEXIS 111222 (E.D. La. 7/17/11). Failure to follow provisions for Rule 11 sanctions does not bar use of court’s “inherent powers” to sanction counsel.
Rule 11 (and its bankruptcy counterpart, Rule 9011) set up specific timelines under which parties are to first serve the offender with the proposed sanctions motion and then give that party 21 days to correct the offending pleading. If that is done, then sanctions are not allowed. Parties seem to rarely actually follow those steps, but most courts find that they still retain “inherent authority” to impose sanctions for the exact same conduct. That analysis, while helpful for those seeking to impose sanctions, may be somewhat problematic if the goal of the fairly balanced provisions in Rule 9011 are routinely bypassed. There is little incentive to correct a challenged, but debatably valid, pleading if one will be sanctioned in exactly the same way whether one does or does not withdraw it.
In re Hardy, 2017 Bankr. LEXIS 2086 (Bankr. D. D.C. 7/26/17). Debtor’s failure to perform duties under Code may be grounds for denial of discharge, but do not automatically warrant dismissal of case.
The debtor failed to perform several of her duties under the Code and then sought to have her case dismissed. The court held that those duties were imposed for the benefit of creditors not so debtors could have an automatic ability to drop out of a case without consequences whenever she chose to do so. It was up to the trustee to decide between dismissal and/or denial of a discharge.
In re Hoover, 2017 Bankr. LEXIS 1987 (Bankr. D. Mass. 7/17/17). Even if trustee alleges claim of exemption was fraudulently made, exemption cannot be denied.
The debtor initially filed exemption schedules listing a personal injury claim but valuing it at $0. After the trustee negotiated a settlement that would provide enough to pay medical claims, the trustee’s attorney costs, and leave some surplus for creditors, the debtor then moved to amend his exemptions to amounts that would cover the entire balance of the settlement. The trustee argued that his actions were fraudulent (presumably on the basis that, had the debtor claimed the same exemptions earlier, the trustee might not have bothered trying to settle the case), but the court held that such a challenge was precluded by Law v. Siegel, 134 S. Ct. 1188 (2014), which held that the courts could not use any equitable concerns or general provisions in the bankruptcy rules, to bar exemptions that were statutorily provided for without any such exception. The court here held that Law applied even if Rule 40003(b)(2) appeared to create a specific basis to object based on fraud, and without the need to rely on the generalized language in Section 105. While the court was clearly concerned, it found that it had no discretion to allow the trustee’s objection.