Bankruptcy Bulletin - Oct - Dec 2016

UPDATE V – OCTOBER-DECEMBER 2016

BANKRUPTCY SEMINAR -- HOLD THE DATE

We are now definitely set to hold the next seminar in Savannah, Georgia from Monday November 13 through Thursday November 16, 2017. The dates adjoin the Veterans’ Day Weekend, but the holiday will be celebrated on Friday, November 10, so the Monday will be a normal workday. We will be holding sessions at the Coastal Georgia Center, a conference facility operated by Georgia Southern University and will have room blocks at three surrounding “suites” hotels within easy walking distance of the Center. The rate at each hotel will be $129 per night ($146 with all taxes) and will include a full, hot breakfast so you’ll not only have a great rate and a great way to start your day but this will also help us keep conference registration rates down. We don’t have a final determination on what, if any, scholarship money will be available but we are hoping we will be able to provide assistance to a sizable group this year. There will be a Food and Wine Fest the weekend preceding the conference in Savannah which you may want to attend; we will have a limited number of rooms available at the same rate for those preceding days so if you’d like to come early make sure you register as soon as the official registration announcement goes out so that you will be able to claim one of those rooms.

If you are interested in being a speaker, or if you would like to see particular topics covered, please let Karen Cordry know (kcordry@naag.org) and we will do our best to work your thoughts into our conference planning. Hope to see everyone there!

SUPREME COURT ACTIONS:

The Court heard the argument in December in Czyzewski v. Jevic Holding Corp., No. 15-649. That case had to do with the notion of approval of settlements and/or “structured dismissals” that are based on agreements by some of the parties in the case to allocations of estate assets that do not correspond with the Code’s priorities. The Third Circuit had agreed that the parties could agree to a distribution of assets that skipped over the priority wage creditors because the net result provided more overall to creditors than would have occurred without the settlement and because the priority creditors might not, in any event, have been able to access those added funds if there had been no settlement. As such, the Circuit Court took the view that this was the “least bad” alternative, that it would be relatively rare, and that the absolute priority provisions that would apply to approving a plan did not literally apply in the case of a non-plan settlement.

At oral argument, the Debtor’s position met with a substantial degree of skepticism. It was perhaps most clearly expressed by Justice Breyer who said “It seems to me that you are arguing that Congress said pay claims 1, 2, 3, 4, 5 and you are saying you can pay them 5, 4, 3, 2, 1.” While there was some questioning of the employees’ counsel (and the Solicitor General who took their side in the argument) as to how far their arguments would extend with respect, for instance, to payment of priority claims under first day orders, the Justices appeared to be far more skeptical of the debtor’s arguments than those of the employees. In particular, several were openly doubtful that the scenario here was likely to be rare, at least once it had obtained the Court’s blessing. As of now, most predictions have been that there would be a reversal of the decision below with the question being how far would the opinion go in limiting settlements and dismissals.

SELECTED LOWER COURT CASE DECISIONS:

CLAIMS

In re Kupfer (Kupfer v. Salma), 2016 U.S. App. LEXIS 23385 (9th Cir. 12/29/16). Landlord’s claims for damages are limited by cap in Section 502(b)(6) only as to damages that would not exist if lease had been assumed.

Section 502(b)(6) limits the amount of damages a landlord may claim from the rejection or termination of a lease to a maximum of one year’s rent of 15% of the lease term up to 3 years. The court here agreed that the cap did not apply to damages that would have existed even if the lease had been assumed – such as tort damages to the property or attorneys’ fees relating to prepetition unpaid rent. Even if the debtor had assumed the lease, the prepetition rent would have been owed (and would need to be paid in order for the lease to be assumed) and the fees relating to that unpaid rent arose independent of the termination or rejection of the lease.

In re Lehman Brothers Holdings Inc. (344 Individuals v. Giddens), 2016 U.S. App. LEXIS 18288 (2nd Cir. 10/6/16). Arbitration of priority of claims not allowed.

While deferral of a claim to arbitration is not automatically precluded under the Code, the Second Circuit agreed that it was not warranted where the issue – determining whether to apply contractual subordination provisions to a possible alter ego entity – was a core proceeding, and the determination of the priority of claims was at the very heart of the bankruptcy court’s powers.

In re W.R. Grace & Co., 2016 Bankr. LEXIS 4478 (Bankr. D. Del. 12/28/16). Party that knew well before bar date of possibility of asbestos contamination of trees that it might seek to log was bound to file timely proof of claim.

W.R. Grace’s operated a mine in Libby, Montana that extracted vermiculite that was contaminated with asbestos. When the vermiculite was processed, it released dust that was similarly laden with asbestos and which dust wafted away and settled on nearby trees owned by Plum Creek. The EPA closed a road onto Plum Creek’s property, did preliminary testing on the contamination, and discussed the issues with Plum Creek. While it was not absolutely determined that the trees would be dangerous to harvest in light of asbestos dust falling on them and/or incorporated into their tissues, this was clearly a possibility that Plum Creek was aware of at the time. It also had notice of the case and the bar date – yet did not file a claim at that time. When it finally did file a claim seven years later, the court had little difficulty in determining that it had both a claim and adequate notice of the bar date to have allowed it to comply. The standard for a claim is not unquestioned certainty of harm; it is enough if there is a reasonable suspicion that there are damages. If so, the creditor cannot sit back and investigate at its leisure.

In re Chemtura Corp., 2016 Bankr. LEXIS 4056 (Bankr. S.D. N.Y. 11/23/16). Personal injury claims by persons unknown to debtor but exposed prepetition were prepetition claims and covered by discharge injunction.

The debtor was a chemical company that had absorbed a number of other companies over the years. When it filed it faced numerous personal injury claims that it sought to discharge. To meet some of the concerns about adequate notice to claimants that it did not have personal information on (and with respect to types of exposures that were just becoming known as being health risks), a robust publication notice was put into place that included specific reference to specific chemicals being used at specific facilities where known. A number of claimants sued after the plan was confirmed, arguing that their claims did not arise until postpetition because they had not been diagnosed prior to that date. The court first held that the general rule was that claims arose based on when exposure took place, not when symptoms manifested. To the extent that arguments were raised as to whether such an approach violated due process, they would be taken into account at the discharge stage, not at a “is there a claim” stage. The court also found serious questions as to whether the predecessor had even made the products at issue – and because the debtor had not previously been sued for such products or alerted to the plaintiffs’ contentions, it would have had no reason to try to learn employee names or to provide site-specific notices for those products. Moreover, any such effort would have been extremely burdensome in any event. The court rejected plaintiff’s attempt to analogize their situation to that in a class action, Amchem Products, Inc. v. Windsor, 521 U.S. 591 (1997) where the Court had been concerned about whether any notice could be effective for unmanifested victims. Finally, the court did not allow them to proceed solely against the debtor’s insurers because there was an agreement that made the debtors liable for part of the defense costs of any suits.

In re No Place Like Home, Inc., 559 B.R. 863 (Bankr. W.D. Tenn. 2016). Arbitration of merits of claims under Fair Labor Standards Act allowed,

The claims at issue related to the debtor’s treatment of its workers as independent contractors rather than employees pre-bankruptcy. Although the debtor had made the workers sign contracts containing arbitration provisions and demanded compliance with those provisions in lieu of allowing actions in federal district court to proceed, it changed course after it filed bankruptcy. At that time, rather than allowing the arbitrations to be completed, it argued that the court should instead rule on its objections to the claims filed by the employees. The Federal Arbitration Act generally requires enforcement of arbitration clauses even of statutory rights and the party opposing deferral must show that Congress intended to ensure continued access to a judicial forum such as where there is an inherent conflict between the two statutes. Even so, that only gives the court discretion to deny arbitration but does not mandate that it do so. Further, courts generally hold they have little or no discretion to refuse arbitration in non-core proceedings, but have greater powers in core matters particularly in light of the jurisdictional language in 28 U.S.C. § 1334. Here, though, while claim resolution is literally a core proceeding, it would have little effect on the case since the plan was already confirmed and no specifically Code-related provisions were at issue. As such there was no conflict and arbitration should be required.

DISCHARGE ISSUES

In re Behrends (Cooley-Linder v. Behrends), 2016 U.S. App. LEXIS 20395 (10th Cir. 11/14/16). A judgment in a securities fraud case does not need to satisfy an “actually litigated” requirement.

In view of the breadth of the exception in Section 523(a)(19), any judgment entered on a properly pled securities fraud complaint will be excepted from discharge even if the debtor defaults such that the case would not be found to have been “actually litigated.” As long as the complaint alleges sufficient facts to establish a violation of the law at issue, the default judgment will automatically be nondischargeable.

Rupp v. Pearson, 658 Fed. Appx. 446 (9th Cir. 2016) (unpublished). Intent to hinder creditors for purposes of discharge objection does not require proof of fraud as such.

The debtor had a long history of abortive and strategically timed bankruptcy filings. She filed a Chapter 13 case in 2012, 7 years after her last Chapter 7 filing, and promised to apply the bulk of her tax refund to the plan. Instead, she received the refund and spent all of it and shortly thereafter her case was dismissed. Two weeks later – on the day exactly 8 years after her Chapter 7 filing – she filed another Chapter 7 case. The Ninth Circuit held those facts stated a plausible case that the debtor was acting intentionally to pay the bare minimum possible to stave off her creditors until she could obtain another Chapter 7 discharge and pay them nothing. The court held the trustee need not negate any possible defense in his complaint or prove fraud.

U.S. v. Schmidt, 2016 U.S. Dist. LEXIS 173115 (E.D. Wash. 12/14/16). Return filed by tax protestor was not fraudulent where court found he sincerely believed his own arguments.

While the debtor’s arguments for why he did not believe various income items he received were plainly without merit, the court concluded that the IRS had not done enough to inform him as to why that was so. The IRS had only for several years sent him a form response that said that courts had denied his arguments (but without giving details). Once the IRS sent him specific court cases, he gave up on making the arguments so the court found his claims to a sincere belief in his own analysis up to that time to be credible. As such, the court refused to find that he had filed knowingly false returns. While it is not clear if other courts will follow this approach, it does suggest that taxing authorities may wish to brief up their form responses to tax protestors so they cannot claim to be unaware that their position is frivolous.

Citizens Bank v. Decena, 2016 U.S. Dist. LEXIS 165171 (E.D. N.Y. 11/29/16). Bank that did not receive proper service of adversary complaint under Rule 7004(h)(1) was not brought under court’s jurisdiction and was not obligated to respond; default should have been set aside.

Unlike the Mazius case below, the court held here, where the lender had not received the form of service that it was entitled to under Rule 7004(h)(1) but did eventually respond prior to the final entry of a default judgment, that the notice of default should have been vacated for cause. The court noted the general rule that failure of service means that jurisdiction has not been obtained over a party and it has no obligation to respond at all. Thus, the question of whether the defendant had actual or adequate notice is irrelevant. The case is in tension with the decision in Espinosa but can be reconciled to a degree by looking at the time that had lapsed. In Espinosa, the judgment had become final years prior to the challenge being raised unlike here where there had only been a relatively short delay. It is still the case though that Espinosa never addressed the point made here about whether improper service could impose jurisdiction on the defendant.

Kozlowski v. Mich. Unemp. Ins. Agency, 2016 U.S. Dist. LEXIS 149745 (E.D. Mich. 10/28/16). Penalty that is imposed as part of fraud determination is included in fraud discharge exception even in Chapter 13.

The debtor fraudulently received unemployment benefits while he was working; he was ordered to both pay back the benefits and pay a penalty. The penalties were excepted from discharge in his Chapter 13 filing, because they were based on fraud. While penalties as such are not excepted in Chapter 13, a debt may fall under two discharge exceptions simultaneously. Since all aspects of a debt for fraud (including penalties) are excepted under Section 1328(a)(2), it is irrelevant that non-fraud penalties are discharged in Chapter 13 cases.

In re Engen, 2016 Bankr. LEXIS 4251 (Bankr. D. Kan. 12/12/16). Under unique facts of case, court held separate classification of student loans was appropriate.

The court has an extended discussion of the nature of the student loan burden on debtors, their treatment under the Code in being able to obtain a discharge, and the provisions in Chapter 13 for allowing separate classification of claims. The latter provisions allow discrimination among creditors that is not “undue,” without ever defining that term. The court concluded here that, at least where debtors had worked diligently to greatly pay down what they owed to other creditors prior to the filing and all creditors were receiving as much overall as they would in Chapter 7 that the preferential payment of student loans in the plan was acceptable.

In re Novak (Sabatina v. Novak), 2016 Bankr. LEXIS 3928 (Bankr. D. N.J. 11/7/16). Debtor is affirmatively required to maintain adequate records; failure to do is basis to deny discharge.

While destroying or concealing records that were created is an obvious basis of fraud that warrants denial of a discharge, Section 727(a)(3) imposes an affirmative burden on a debtor to maintain adequate records for creditors to ascertain his financial status and affairs. The failure to do so can also be a basis to deny the discharge even if the debtor never destroyed anything because he never kept records to begin with. The debtor may justify the absence of records based on factors such as his lack of sophistication or their accidental destruction but a person that has operated a significant business for decades such as the debtor here will not be excused.

Financial Casualty & Surety Co., Inc. v. Thayer, 559 B.R. 102 (D.N.J. 2016). Debt of bail bondsman to surety who paid forfeiture liability to state and then sued bondsman was excepted under Section 523(a)(7) as a “forfeiture.”

In Dobrek v. Phelan, 419 F.3d 259 (3rd Cir. 2005), the court held that a forfeiture judgment against a commercial bail bondsman fell under Section 523(a)(7). The court here held that there was no meaningful difference when a surety paid the forfeiture and was then subrogated to the state’s right to collect the amount paid from the bondsman. Public policy concerns to ensure that the incentives in the bail bond system have teeth mean that the debts must not be discharged. Moreover, when the bondsman used premiums he was receiving from other defendants to pay his operating expenses rather than remitting them to the surety (as to whom he had fiduciary duties to hold the funds in trust), he also violated Section 523(a)(4) – defalcation by a fiduciary. It was irrelevant that he was using them to operate his business and not just spending them on himself.

In re Hobbs (Hobbs v. State of Arizona), 2016 Bankr. LEXIS 3714 (9th Cir. BAP 10/13/16). Bankruptcy court has no power to look behind state penalty judgment for discharge purposes.

The state court judgment clearly on its face held the debtor liable for the full amount of the penalties awarded in the case and the BAP agreed with the bankruptcy court that the Rooker-Feldman doctrine precluded the federal courts from looking behind the judgment to determine if it were correct or warranted. The court did so, even while imploring the state to voluntarily correct the judgment to meet the concerns the debtor had raised, because it did appear that the judgment had not been properly drafted.

In re Fagan, 559 B.R. 718 (Bankr. E.D. Cal. 11/14/16). Section 523 is not the only source of discharge exceptions; other federal statutes may except additional debts from the discharge.

Although Section 523 appears all-inclusive, a number of federal statutes, including laws applicable to those receiving enlistment bonuses for joining the armed services have other provisions that specifically reference and override the bankruptcy discharge section. The court held that such provisions, which were enacted well after the 1978 Code, are controlling. The court did note that the provision at issue here was time-limited and could be waived if it imposed undue hardship on the debtor.

In re Meier (Shrock v. Meier), 2016 Bankr. LEXIS 3711 (Bankr. N.D. Ill. 10/11/16). Majority stockholder and manager of business owed fiduciary duty to minority stockholder; deliberate actions to withhold and divert profits violated that duty and caused willful and malicious injury.

A majority stockholder has general fiduciary obligations to the minority stockholders under state law and, in this case, by the parties’ contract. By virtue of his controlling ownership interest and management of the company he did hold a position of “ascendency” over the other owner. As such, his actions to “willfully and wantonly” violate his obligations were sufficient to show both that he had engaged in defalcation by a fiduciary and willful and malicious conduct.

AUTOMATIC STAY, POLICE AND REGULATORY POWERS, AND DISCHARGE INJUNCTION ISSUES

In re Silva (Silva v. MBB Properties, LLC), 2016 U.S. App. LEXIS 22312 (9th Cir. 12/15/16). Section 362(b)(24) excepts recording a deed during the case by a good faith purchaser of property without notice of the filing.

Although the actual facts are far more complicated, the case can be treated as involving a sale of a foreclosed property to a buyer and a later recording of the deed to the property at a time when the original owner had filed bankruptcy. The buyers paid a fair equivalent value for the property and did not have knowledge, actual or constructive, of the bankruptcy filing when the deed was recorded. Section 549(c) provides that a postpetition transfer (which would include the recording of the deed) to a good faith purchaser without knowledge of the bankruptcy is not avoidable. Section 362(b)(24), in turn, provides that the stay does not apply to a sale that is “not avoidable under Section 549” and, since this sale was excepted from Section 549, it was equally excepted from the stay.

Bates v. Citimortgage, Inc., 2016 U.S. App. LEXIS 22215 (1st Cir. 12/14/16). Sending an IRS 1099 form reflecting discharge of indebtedness is not an attempt to collect the claim.

While some forms of communications by creditors can constitute efforts to collect a claim that violate the discharge injunction, merely sending the IRS Form 1099 to reflect the reportable “income” from the discharge of indebtedness through the bankruptcy case is not a violation. The form itself is purely information and there were no other related efforts to convince the debtor to pay. The fact that the debtors may have thought (incorrectly) that the form itself imposed some liability on them did not change the reality of the form. Nor did the fact that the debtor allegedly checked a box indicating the debtors were still personally liable constitute an “effort to collect.”

Parkview Adventist Medical Center v. U.S., 842 F.3d 757 (1st Cir. 2016). Termination of a Medicare provider agreement because debtor no longer met definition of a “hospital” was excepted from stay as police and regulatory action.

The debtor advised Medicare that it would be shutting down its facility and no longer taking inpatients and expected to close entirely within 2 to 3 months after the petition date. It apparently thought it would be able to maintain is provider agreement and bill Medicare while it was going through the shutdown process but Medicare terminated the agreement immediately based on the fact that the debtor no longer qualified as a “hospital.” The First Circuit agreed that the actions of Medicare were covered by the police and regulatory exception so it had no need to decide whether it was barred from reviewing Medicare’s action by virtue of the debtor’s failure to exhaust its administrative remedies. Termination based on that analysis was clearly regulatory even if there was a dispute about the merits of Medicare’s position. Moreover, since the decision was based on the definition of a “hospital,” it did not appear that Medicare was acting based on the debtor’s decision to file bankruptcy so there was no violation of Section 525.

Wernick v. United States, 2016 U.S. Dist. LEXIS 171962 (N.D. Ill. 12/13/16). Reducing future social security benefits to recover overpaid social security benefits obtained by fraud is recoupment and is not subject to automatic stay.

Because the provisions for reducing future benefits to recover overpaid benefits is part and parcel of the process for determining the amount of payments owed, the court concluded that that process was part of a single overall transaction. As such, it was recoupment that was not subject to the automatic stay. The court rejected the view of the Third Circuit that the provision of Social Security benefits was purely a social welfare program and could not be treated as an integrated contractual transaction. Since Congress explicitly provided for recoupment as part of the process of determining benefits, it must have intended that those provisions be applied.

In re Taggart (Emmert v. Taggart), 548 B.R. 275 (9th Cir. BAP 2016). Party does not violate stay by asking state court for ruling with respect to whether its actions are covered by stay.

The creditor’s request for a ruling in state court was the equivalent of a request for a declaratory judgment and was the correct procedure to follow. Thereafter, where both the state court and the bankruptcy court agreed that the creditor’s action was not covered by the stay, the creditor could not be sanctioned for proceeding even if the BAP later reversed that decision on the merits. Based on that history, the creditor could not be said to have known that the discharge injunction applied to its acts in order to prove it acted willfully.

In re Cary, 2016 Bankr. LEXIS 4623 (Bankr. E.D. N.C. 12/13/16). Debtor that chose to allow state court to determine effect on discharge of debt owed unlisted creditor was bound by result.

The courts are split as to the effect under Section 523(a)(3) of the debtor’s failure to list a creditor in a non-asset case where no bar date was set for filing claims. Some find that the omission makes the debt at least presumptively nondischargeable; others hold that, in the absence of a bar date, it can never be too late to file a claim. In this case, though, after the unlisted creditor pursued the debt in state court, the debtor did not seek to bring the matter back to the bankruptcy court but, rather, raised the issue in the state court action and the court at least implicitly rejected the argument. As such, the bankruptcy court held, it was bound to accept that resolution under the Rooker-Feldman doctrine, regardless of what it might have done had the matter been brought to its attention initially.

In re Bender, 2016 Bankr. LEXIS 4161 (Bankr. E.D. N.Y. 12/6/16). Stay termination for serial filer under Section 362(c)(3)(A) is limited to actions to continue prepetition actions with respect to specific debts or assets.

The courts are split as to whether Section 362(c)(3)(A) applies to property of the estate or only to the debtor and property of the debtor. The majority view limits it to the latter categories (even though “property of the debtor” is not referred to in the statute); the minority view includes all assets, but only as to the serial filing debtor if there is a joint case and only one debtor had prior filings. The court here viewed both readings as incorrect, holding that the reference to the “stay under Section 362(a)” clearly refers to all aspects of the stay, which includes provisions that apply to property of the estate. However, other portions of Section 362(c)(3) limit the stay termination provisions to those that affect “actions taken” – which the court held to refer to pending administrative or judicial proceedings – with respect to particular debts or property. Thus, the section is meant to allow creditors, particularly secured creditors who were proceeding on an enforcement action prepetition to have the stay lifted as to that particular action if the debtor files a second petition within a year. As such, this complements the other “in rem” protections that the 2005 amendments created for secured lenders.

In re Otero County Hospital Association, Inc. (Landrum v. Otero County Hospital Association, Inc.), 560 B.R. 551 (Bankr. D. N.M. 2016). Discharge of hospital held to bar actions against doctors employed there even though no attempt made to sue hospital and doctors contributed nothing to plan.

While third party releases are not uncommon in plans and are typically hotly contested, this case illustrates a drafting issue that may or may not be intentional but is highly problematic. The injunction language in the plan provided that it applied to anyone who have been or may be the “the holder of a claim against the hospital.” The court held this included the plaintiff because she could have sued both the doctor and his employer, the hospital, for his medical malpractice. In turn, the injunction then barred anyone who had a claim against the hospital from suing any of the hospital’s employees with respect thereto. (The case says such suits had to relate to the unfiled claims against the hospital although the quoted portion of the release does not have that requirement.) Even if the suit did relate to the hospital, the release barred any action against all employees of the hospital, with no indication that there was any of the normal showing for a third party release (including that their release was critical to the plan or that they had made any contribution to the plan). Since the doctor was an employee of the hospital, the court held he was automatically covered by the release even though the creditor did not seek to sue the hospital and it was too late for her to contest the release after plan confirmation. (She had not objected before because she had assumed, incorrectly, that the debtor was an independent contractor.) This type of provision illustrates how easy it is for third party releases to slip into plans through use of overly broad language.

In re York, 2016 Bankr. LEXIS 3795 (Bankr. E.D. Wash. 10/21/16). Automatic stay does not toll running of redemption periods for assets.

The debtor pawned items pre-bankruptcy and filed his case during the redemption period but took no further steps to redeem the property. Section 541(b)(8) explicitly provides that property of the estate does not include pledged assets that have not been timely redeemed. In this case, Section 108(b) provides a debtor with an additional 60 days to take such an action after the case is filed, but then terminates. As a result, the pawned assets would automatically cease to be property of the estate at the end of that time period, if not redeemed, unless the automatic stay imposes an indefinite extension of the redemption period. The court held that it did not, since such a provision would make both Sections 108(a) and Section 541(b)(8) largely superfluous. The court noted that a filed plan might be able to make provisions for payment of the creditor’s secured claim over the course of the case but that was not proposed here.

In re McOuat, 2016 Bankr. LEXIS 3698 (Bankr. E.D. N.C. 10/13/16). Actions under the False Claims Act are covered by the police and regulatory exception to the stay.

Actions brought to stop fraud and determine liability therefor are expressly recognized in the legislative history as falling within the police and regulatory exception. It is irrelevant that such actions may seek a money judgment since it is only the enforcement of such a judgment that is limited by the stay.

AVOIDANCE ACTIONS

In re Lyondell Chemical Co. (Weisfelner v. Hofmann), 554 B.R. 635 (S.D. N.Y. 2016). Knowledge of debtor’s CEO that income figures were being artificially inflated to create higher value in leveraged buyout could be attributed to company to show intentional fraud.

The debtor’s CEO was charged with knowingly inflating income projections in order to obtain a higher price for the debtor in LBO discussions. The complaint also asserted that the Board knew the projections were inflated, unreasonable, and unachievable but approved them anyway (not least in order to receive payouts to them from the buyout). The district court reversed the bankruptcy court’s dismissal of the complaint which held that the CEO’s guilty knowledge could only be imputed to the Board if he was in a position to control their actions. Instead, the district court held, the proper rule was that the wrongful actions of an agent who was acting within the general scope of his authority can still be imputed to the employer. There is an exception where the officer is acting solely in his own interests and not that of the corporation but that was not alleged here to avoid the imputation. And, once the CEO’s knowledge was imputed to the Board, its decision to act in the face of the clear issues with the projections was sufficient to sustain a complaint alleging intentional fraud.

A motion for reconsideration was denied at In re Lyondell Chemical Co., 2016 U.S. Dist. LEXIS 138449 (S.D. N.Y. 10/5/16).

ASSET SALES AND PROPERTY OF THE ESTATE

In re Failla (Failla v. Citibank, N.A.), 838 F.3d 1170 (11th Cir. 2016). Debtor that agrees to “surrender” house, pursuant to Section 521(a)(2), may not contest state court foreclosure action,

The term “surrender” applies to both the trustee and the creditor if the trustee abandons the property because it is overencumbered. “Surrender” is an alternative to the options to “redeem” or “reaffirm,” both of which are actions that must be taken with the creditor, so it makes sense that surrender equally applies to the creditor. “Surrender,” moreover, should be given a meaning congruent with its context; while it may not go as far as to require an affirmative action – the term “deliver” is usually used for such a duty – it is appropriate to use the definition of “giving up a right or a claim.” That describes a legal relationship which is consistent with the other options of exemption, redemption, and reaffirmation. As such, at a minimum, the debtor may no longer contest the foreclosure action that will allow the creditor to secure its rights in the property. The reservation of rights language in the hanging paragraph in Section 521(a)(2) only applies to rights under title 11 (i.e., in the bankruptcy case), not to rights accruing under state law. The debtor is estopped to do otherwise, and the bankruptcy court may enjoin him from continuing such opposition. It is not limited to simply lifting the stay (which would occur at the end of the case in any event.)

In re Perl (Eden Place v. Perl), 811 F.3d 1120 (9th Cir. 2016). Party illegally staying in property after foreclosure sale and entry of illegal detainer order had no property interest that automatic stay would protect.

The debtor’s property was sold prepetition at a foreclosure sale and the deed timely recorded. When he refused to move out, the state court entered an unlawful detainer order and a writ of possession. Pursuant to those, the sheriff’s office proceeded to evict the debtor despite his having filed bankruptcy after issuance of the writ. While the lower courts agreed that the debtor had no legal right to be in the home, they held that his mere physical “squatting” on the property was a property interest that was protected by the stay. The Ninth Circuit disagreed: property interests are decided under state law and the law had already fully adjudicated the issue of who had the “better title” to the property including the right to possession thereof. Inasmuch as the debtor had no remaining interest, there was nothing for the stay to attach to.

In re Maizus, 2016 U.S. Dist. LEXIS 165337 (D. N.J. 11/30/16). Sale subject to protections of Section 363(m) cannot be vacated merely because service did not precisely follow Rules.

The creditor had filed a claim with a designated address and the debtor served it thereafter at that address and at its attorney’s address. The debtor eventually moved for and obtained permission for a short sale of their home and again served the designated address and the attorney (although the attorney later claimed to no longer represent the creditor). Although the notice was technically deficient because it was not addressed to an “officer or agent” under Rule 7004, the creditor would have to show a violation of constitutional due process in order to overcome the sale protection in Section 363(m). Technical deficiencies are not necessarily enough if the notice was “reasonably calculated” to reach the party at issue.

In re Ryan, 560 B.R. 339 (Bankr. D. Haw. 2016). “Surrender” simply means that debtor is not exercising other options under Section 521; may still contest “wrongful foreclosure.”

Contrary to Failla, the court held that ‘surrender” should only be read to mean that the debtor is not exercising the other options under Section 521 but did not imply a waiver of rights to contest a wrongful foreclosure action. By the same token, the court held that the “savings provision” in Section 521 was not merely limited to protecting the debtor’s rights under the automatic stay but also applies to other rights such as challenging the secured creditor’s rights under nonbankruptcy law as well. As such, the court held, Section 521 is merely a notice provision and does not limit the debtor’s rights to proceed (or give any substantive advantages to the creditor).

Reed v. Nathan, 558 B.R. 800 (E.D. Mich. 2016). Bankruptcy court has the constitutional power to adjudicate which assets constitute property of estate and enter final turnover orders.

The case has a lengthy discussion of jurisdictional issues relative to a bankruptcy court’s powers as an Article I court to adjudicate issues relating to whether an ostensibly independent entity is actually an alter ego of the debtor such that it would be appropriate to treat those assets as property of the estate and subject to a turnover order. The court began with a historical review of the authority of courts under the 1898 Act which gave the courts full power over property within the “possession” (actual or constructive) of the court, including the power to adjudicate rights of adverse claimants. Constructive possession was deemed to include situations where the claim of the third party that actually held the property was merely “colorable” but not substantial. A mere alter ego was not deemed to have a substantial claim of right to assets it held. The order here followed the same line of analysis: the bankruptcy court could use a turnover motion to gather in assets held by an alter ego entity, particularly when the entity was used to deny creditors access to those assets. The decision on what is property of the estate is, under current law, a core proceeding, and the subsequent order to turn over that property is likewise core. The court distinguished case law that had held that bona fide disputes over title were not core proceedings, under the same distinction between merely “colorable” and “substantial” disputes noted above.

In re Christensen, 2016 Bankr. LEXIS 4312 (Bankr. D. Utah. 12/14/16). Trustee cannot agree with IRS to have tax liens reduced solely in order to allow trustee to recover costs of selling overencumbered property for benefit of secured creditors.

The case covers a number of issues but at bottom it deals primarily with an apparently growing practice of the IRS and the trustee agreeing that the IRS will waive a portion of its tax liens to provide funds for the trustee to sell the debtor’s property on its behalf even where this would provide no other benefit to unsecured creditors in the case – and where it would leave the debtors both without their homestead and with no protection for their exemptions. The court also held that the primary effect of this approach would be for funds from the sale of the house to go to pay unneeded administrative costs of the trustee rather than paying down the nondischargeable debts owed to the IRS.

In re Revel, AC, Inc. (IDEA Boardwalk, LLC v. Polo North Country Club, Inc.), 2016 Bankr. LEXIS 3805 (Bankr. D. N.J. 10/21/16). Sale of property under Section 363 does not allow debtor to avoid obligations to existing tenants under Section 365(h); debtor/purchaser need not provide services to tenant but failure to do may allow tenant to recoup costs by rent reduction.

The debtor sought to sell its property and reject a lease with its tenants. The court allowed both the rejection and the sale but made clear that the sale could not eliminate the tenants’ rights under Section 365(h)(1)(B) to remain in possession of the property for the balance of the lease term. Rejection is not a termination of the lease and it leaves the lease terms in place with the exception that the debtor is excused from performing obligations under the lease unless they would preclude the tenant from maintaining “quiet enjoyment” of the premises. If performance is not required, the tenant may be able to require on its rights under the contract to adjust the rent if it takes on duties otherwise to be performed by the debtor under the doctrine of equitable recoupment. The court also held those recoupment rights applied against the purchaser.

In re Spoverlock, LLC, 560 B.R. 358 (Bankr D. N.M. 2016). Debtor allowed to reject settlement agreement (that it had been ordered by court to comply with) that required transfer of land.

Section 365 does not specifically define the effect of “rejecting” a contract apart from stating that rejection is treated as a prepetition breach of the contract (which has the effect of making any damages prepetition claims rather than administrative expenses). It does not discuss what is the effect of rejection on a contract that can be specifically enforced prepetition, except for providing specific remedies in two circumstances. A majority of courts draw the negative conclusion from those provisions that in all other circumstances, the section, sub silentio, requires conversion of all specific performance remedies into money damages. Other courts conclude that the statute does not go that far and look to the remedies available under state law. The court here agreed with the majority and held the debtor could refuse to abide by either a settlement that it had agreed to that found that it had already transferred certain property to another party or a court order enforcing that settlement. The court held that an actual specific performance judgment could not be rejected but this order did not rise to that level. Accordingly, the debtor held the debtor could take the property (which the other party wished to keep undeveloped), and proceed to develop it so long as it paid damages for the rejection (which damages would be paid only a pro rata amount as a prepetition bankruptcy claim.)

CHAPTER 7 ISSUES

In re Palmer (Palmer v. Laying), 559 B.R. 746 (D. Col. 11/15/16). Student loans incurred by debtor to obtain employment or better one’s job prospects were incurred for “profit motive” and were not “consumer debts.”

Contrary to Robinson, below, the district court read prior cases discussing the concept of whether a student had a “profit motive” in incurring student loan debt as determining whether it consumer debt as requiring a far looser standard. Essentially any student loans taken out by the student as an “investment in himself” and his own earning potential would suffice and would not require any showing of a tie to current job requirements. Indeed, the court said that even education acquired for purely “humanitarian” goals and not to profit would also be excluded from “consumer debt.” Under this view, apparently only loans taken out by a dilettante would qualify as consumer debts. As such, this largely excepts most students from the means test in Chapter 7.

In re Robinson, 560 B.R. 352 (Bankr. D. Col. 2016). Student loans for debtor to advance herself and not just satisfy current job duties were “consumer debts” for substantial abuse analysis.

Student loans for courses that allowed debtor to take on different and higher job duties, not just meet her present occupational requirements, were consumer debtor because they were not incurred to benefit an existing business or job requirement. Since the debtor had the ability to pay 100% of her debts in a five-year plan, her filing was an abuse under Section 707(b)(2) or(3).

CHAPTER 11 ISSUES

In re New Investments, Inc. (Pacifica L 51 LLC v. New Investments, Inc.), 840 F.3d 1137 (9th Cir. 2016). Plan that proposes to cure default on loan must include payment of default interest rate.

Section 1123(a)(5)(G) allows a plan to include a measure to “cure” a default. In In re Entz-White Lumber & Supply, Inc., 850 F.3d 1338 (9th Cir. 1988), the court held that a “cure” meant that all consequence of the default had been wiped away, including the use of a default interest rate. The court now returned to that question in light of a later provision in Section 1123(d) that stated that, in order to cure a default, the necessary amount was to be “determined in accordance with the underlying agreement and applicable nonbankruptcy law.” In a 2-1 decision, the court held that this meant that a “cure” could no longer avoid the payment of the default rate of interest. (Notably, in Entz-White the cure took place at confirmation; i.e., the default was to be paid in full at confirmation and the only question was what interest rate had to be used. The plan did not provided for the debtor to be able to further spread out cure by way of post-confirmation payments at a non-default interest rate, which some courts have allowed) In any event, the facts here were the same as in Entz-White, i.e., what interest rate would be paid up through confirmation. Since the contract required use of a default rate, the majority held Section 1123(d) would now require its use during the bankruptcy. After that was done and the debtor was no longer in default, it could then return to the lower interest rate going forward. This also makes the provision consistent with Section 1124(2)(E), which provides that a creditor is not “unimpaired” unless all of its rights are left intact. The dissent did not view Section 1123(d) as overruling Entz-White since it was enacted to deal with a different problem.

In re Theodore, 2016 Bankr. LEXIS 4439 (Bankr. D. Vt. 12/22/16). Mortgage modifications made in confirmed plan were not binding after plan was competed because parties did not follow procedures to reaffirm debt.

The court held that, notwithstanding the issues relating to the mortgage modifications had been litigated and approved by the bankruptcy court, they could not be enforced against the debtor after the plan was completed because, to the extent they imposed further personal liability on the debtor, they were the equivalent of having the debtor reaffirm the debt without completing the proper procedures. The law is clear that any re-entry into an agreement imposing personal liability on the debtor based on the prepetition debt must be done through a reaffirmation – even if there is a new agreement and new consideration (i.e., forbearance on a lender’s right to foreclose). This is a potential trap for those dealing with debtors in Chapter 11 (or 13) cases.

In re Schwarz (Americorp Financial L.L.C. v. Schwarz), 2016 Bankr. LEXIS 4432 (Bankr. E.D. N.C. 12/22/16). Forbearance of creditors to accommodate debtors’ payment circumstances postdischarge violated discharge injunction.

This case presents a similar problem. The debtor’s business was party to various equipment finance leases on which he gave a personal guaranty. That guaranty obligation was discharged in the bankruptcy but the business wished to keep the equipment and continue paying thereon. Three years later, the business defaulted and the business and the debtor executed a forbearance agreement with the lender easing the terms of payment for the equipment and renewing the debtor’s personal guaranty. For reasons that are not clear, the lender later sought a declaratory judgment that its conduct was not illegal, but the court held that its actions did violate the discharge injunction because the forbearance agreement reinstated the debtor’s personal liability. It is not entirely clear from the opinion but the lender presumably had a security interest in the equipment so that it could have repossessed the equipment for the failure to pay but chose not to do so to accommodate the debtor but would not do so without the guaranty. While it is clear that this line of cases seems to follow the letter of the discharge provisions, it does leave lenders – and debtors – with few options. The lender is protected if it simply seizes the equipment and puts the debtor out of business – but not if it attempts to accommodate the debtor in a way that gives the lender some protections as well. It is less than clear how this is a benefit to debtors.

CHAPTER 13 ISSUES

In re Barker (Spokane Law Enforcement Credit Union v. Barker), 839 F.3d 1189 (9th Cir. 2016). Even parties listed in debtor’s schedules must file claim, failure to do so bars payment on claim.

A creditor listed in the debtor’s schedules did not file a proof of claim (assertedly because of dereliction by a disgruntled employee) despite receiving adequate notice. The court rejected all of the creditor’s arguments for being excused from failing to do so. The Code and Rules clearly required that an actual proof of claim be filed (unlike in Chapter 11). The schedules would not serve as an informal proof of claim, a judicial admission, or a debtor-filed proof of claim; rather the Code and Rules clearly required an affirmative act by the creditor and the court had no leeway to make equitable allowance for the creditor.

CHAPTER 9 AND 15 ISSUES

In re City of Detroit (Lyda v. City of Detroit), 841 F.3d 684 (6th Cir. 2016). Limits on bankruptcy court’s power under Section 904 are so sweeping that they override anything else in Code.

The plaintiffs sought to challenge the actions of the City with respect to its provision of water and sewer services based on a variety of theories. The Sixth Circuit held that Section 904 bars any action by the court to interfere with any of the political or governmental powers of the debtor, any of its revenues, or its use of any income-producing property. Whatever the merits of the various causes of action raised by the plaintiffs, it was clear their action would run afoul of each of those limitations. Chapter 9 is modeled on Chapter 11 but it gives bankruptcy courts none of the powers of control over the debtor that the court has in Chapter 11. It is meant to assist the governmental entity, not to allow its decisions to be second-guessed. Even if the government was arguably violating the citizens’ constitutional rights to due process in a way that exceeded its governmental powers, that did not mean that Section 904 allowed the bankruptcy court to remedy that violation in light of its other limits on controlling the use of revenues and property.

In re City of Detroit (Ochadleus v. City of Detroit), 838 F.3d 792 (6th Cir. 2016). Equitable mootness applies in Chapter 9 cases and can bar appeals from being granted.

In its plan, Detroit required employees to accept reduced pensions and associated benefits and to allow recoupment of a portion of overpayments that were made into their 401(k)-type accounts. The reductions were part of a “Grand Bargain” that used contributions from the state and charitable organizations to mitigate the full impact of the reductions that would otherwise have been imposed. The plan, as implemented, also included numerous other payments for city services and to creditors and made many changes to city operations. While 73% of employees accepted the plan, a number of the dissenters appealed the confirmation order, but the courts below held the appeal was “equitably moot,” and the Sixth Circuit agreed. That doctrine is meant to protect the finality of bankruptcy proceedings by limiting when an appeal can try to unscramble the extremely complex results of an implemented plan. Even if the court could grant relief, the doctrine may preclude it in order to protect the reliance interests of other parties and to ensure that plans can be agreed to in the future. The court found the appeals here fell under the doctrine since granting the required relief would void the “Grand Bargain.” Nothing about a Chapter 9 case warranted taking a different approach than in Chapter 11. A dissent argued that the Supreme Court had placed increased emphasis on the need for federal courts to exercise the jurisdiction they held, that the result here left creditors with the possibility that an Article III judge would never hear their issues (although that also applies to a Chapter 11 case) and that the doctrine’s shaky roots in Chapter 11 should not be extended to Chapter 9.

CONSUMER ISSUES

Bednar v. Pierce & Associates, P.C., 2016 U.S. Dist. LEXIS 156032 (N.D. Ill. 11/10/16) Action under state consumer protection law suit based on stay violation was preempted.

Where the debtor sought to remedy an alleged violation of the stay by filing suit in federal district court based on a state consumer protection law, the court held that the suit was preempted. There was no violation apart from the alleged violation of the Code and the Code already provides a full remedy for such violations. As such, other suits are preempted.

SOVEREIGN IMMUNITY

Hunsaker v. United States, 2016 U.S. Dist. LEXIS 145460 (D. Ore. 10/20/16). Sovereign immunity is not clearly waived for emotional distress damages under Section 362(k).

Section 106(a) abrogates immunity with respect to the provisions of Section 362. Section 362(k), in turn, allows for recovery of “actual damages.” The court concluded that, at least as to the United States, the degree to which “emotional” damages are “actual” damages remained ambiguous. In a case involving the Privacy Act, the Supreme Court had found that they were not included, which suggested the issue was similarly unclear here. As such, immunity remained.

In re Patriot Coal Corp. (Davis v. West Virginia State Tax Dept.), 2016 Bankr. LEXIS 4039 (Bankr. E.D. Va. 11/22/16). Use of Section 505(a) to adjudicate disputed right to tax refund is not turnover action and does not fall within in rem exception under Katz.

The Fourth Circuit held in 1997 that the Supreme Court’s decision in Seminole Tribe v. Florida, 517 U.S. 44 (1996) applied to bankruptcy cases. In the Katz case, decided in 2006, the Court essentially took an end run around Seminole, holding that, at least where an action was based on the bankruptcy court’s in rem authority to distribute the estate, the states had agreed in ratifying the Constitution to forego asserting such immunity. However, the court here concluded, the converse was also true – where an action did not involve the allocation of the property of the estate, Katz was not applicable and Seminole still governed. While a true turnover action would be a part of the in rem gathering of estate property, the court also held that, a “turnover” action is normally only allowed for undisputed property of the estate. (See related issues in Reed, above.) Where a turnover action is proper, it will be in rem and covered by Katz (as well as by Section 106(a)(1)); but, where there is a substantial dispute over the rights being asserted by the debtor, the action is neither a turnover action nor excepted from the state’s sovereign immunity claim. Rather, it is akin to a direct affirmative suit by the debtor seeking to recover additional assets that would be property of the estate only under Section 541 – which was deliberately not included in the abrogation language of Section 106(a)(1). While the state might have given the court the power to adjudicate 505 issues had it filed a claim with respect to those taxes, it did not do so.

MISCELLANEOUS

In re Yellowstone Mountain Club, LLC (Blixseth v. Brown), 841 F.3d 1090 (9th Cir. 2016). Barton doctrine applies, by extension to preclude suits against chair of creditors’ committee.

Although the Barton doctrine (which bars suits against court-appointed trustees without the court’s permission) does not literally apply to the creditors’ committee, the court held the same principles would apply by analogy so as to include the chair of the committee within its protection. However, the court held, the doctrine does not apply to actions of the chair that took place prior to the bankruptcy filing.

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