The National Attorneys General Training & Research Institute
Bankruptcy Bulletin - August 2015
Bos v. Bd. of Trustees., 2015 U.S. App. LEXIS 13272 (9th Cir. 7/30/15) -- Section 523(a)(4) defalcation by fiduciary did not apply to unpaid pension plan contributions.
A fiduciary for purposes of the Code must act with respect to already existing trust assets; if the fiduciary status is imposed due to wrongdoing (i.e., by a constructive trust), then that debt does not qualify for a discharge exception under Section 523(a)(4). The debtor employer was held not to be a fiduciary with respect to contributions not yet made to benefit funds, even if pension plan purported to establish those contributions as plan assets. Essentially, the court held that the Code preempted this effort to make him a trustee for funds that would otherwise be treated as simply a breach of a contractual payment obligation.
United States SEC v. Bocchino (In re Bocchino), 2015 U.S. App. LEXIS 12685 (3rd Cir. 7/123/15). Standard of liability for stockbroker in soliciting client investments
The debtor solicited his brokeage clients to invest in two private placement offerings without any meaningful effort to investigate their merits or their suitability for the clients; when both turned out to be fraudulent ventures, the debtor was charged with securities violations for promoting the investments through high pressure sales tactics and essentially vouching for stocks when he had no basis for doing so. The court held that his behavior was grossly negligent and that was sufficient to find the securities violation and make the debt nondischargeable even if he did actually believe the statements he was making. The criminal behavior of the operators of the underlying stocks was irrelevant since part of the duty of a broker is to check for that possibility.
In re McLean, 2015 U.S. App. LEXIS 12736 (11th Cir. 7/23/15) – Filing a proof of claim for discharged claim violates discharge injunction
Violations of an injunction issued by a bankruptcy judge in a given district may be enforced by contempt proceedings initiated before any other judge within that district in the same or a different case. Section 524(a)(2) prohibits the filing of a proof of claim for a discharged debt where the objective effect of the claim is to pressure the debtor to pay the debt. Although the automatic stay is not violated by the filing of an invalid claim, Section 524 applies to any attempt to pressure a party to pay a discharged debt and the filing of a claim has that objective effect; stay is merely procedural breathing space; discharge cuts off the debt altogether; certain noncompensatory sanctions were punitive and could not be imposed absent use of criminal protections
Loveridge v. Hall (In re Renewable Energy Dev. Corp.),2015 U.S. App. LEXIS 11957 (10th Cir. 2015) – bankruptcy court does not have jurisdiction to hear Stern issue just because it is “intertwined” with bankruptcy case
A long and folksy dissertation and discussion about the limits, rationale, history, and application of the doctrines underlying the decision in Stern v. Marshall, 131 S. Ct. 2594 (2011) holding that, whatever else it may cover or not cover, it does not allow a suit that is based on state law, that will not be resolved in any claims allowance proceedings, and that does not directly involve the debtor to be determined by a bankruptcy court over a party’s objections. That is true even if the court is properly in federal court on other grounds (i.e., diversity) and even if there is some basis to argue that it was “intertwined” with the bankruptcy proceedings (in this case because it involved the trustee’s in with various non-debtor parties that eventually crated conflicts with his position as trustee). The court discussed the history of the public rights doctrine and how it coincided and differed from the old summary/plenary jurisdiction division of authority prior to 1978 and whether that division might be more easily explained and applied.
Franklin Cal. Tax-Free Trust v. Puerto Rico, 2015 U.S. App. LEXIS 11594 (1st Cir. 7/6/15) – Puerto Rico bankruptcy act is preempted.
The Puerto Rico Public Corporation Debt Enforcement and Recovery Act, which expressly provided different protections for creditors than did the federal Chapter 9, was preempted by 11 U.S.C.S. § 903(1), which ensured the uniformity of federal bankruptcy laws by prohibiting state municipal debt restructuring laws that bound creditors without their consent. Prior to 1984 Puerto Rico had the ability to authorize its municipalities to file Chapter 9 cases but the amendments took it out of a definition of a “state” for that purpose, while still leaving it subject to the prohibition in Section 903(1) on enacting its own equivalent of a bankruptcy law that binds unconsenting creditors. As a result, Puerto Rico’s only option is to seek relief directly from Congress. (That same limitation also applies to the District of Columbia – when it was in financial straits some time ago it was put under financial control board rather that itself, or any subentities thereof seeking to file bankruptcy.)
Ellmann v. Baker (In re Baker), 2015 U.S. App. LEXIS 11437 (6th Cir. 7/2/15) – bad faith or fraud cannot be used to deny any exemption claim.
The decision in Law v. Siegel, 134 S. Ct. 1188 (2014) applies across the board whether a case has been closed or reopened and precludes the court from denying an exemption that might otherwise be available based on the bad faith or fraudulent conduct of the debtor related to that exemption. Other sanctions may be available for such conduct, but denial of the exemption is not one of them.
Sauer Inc. v. Lawson (In re Lawson), 2015 U.S. App. LEXIS 11366 (1st Cir. 7/1/15) – “fraud” in Section 523(a)(2) does not always require false statement.
Joining the Seventh Circuit in McClellan v. Cantrell, 217 F.3d 890 (7th Cir. 2000), the First Circuit concluded that Section 523(a)(2)’s “actual fraud” prong could include debts that did not involve a direct false statement. In particular, as in McClellan, the First Circuit concluded that a debt owed by a person who knowingly accepted a fraudulent conveyance (i.e., one that was made to hinder the transferor’s creditors) was nondischargeable. Thus, while a fraudulent transfer can be found even if the bad motives exist only on the part of the transferor, this case deals with the subset of cases where the recipient is well aware of what is going on and knowingly accepts the transfers and participates in the fraud. The result is important in that, although the recipient could be ordered to return the funds as a subsequent transferee, that obligation is meaningless if the person can discharge it in their own bankruptcy filing. The court noted that the “actual fraud” language was typically defined as including a false statement element but in all of those cases that was, in fact, the nature of the actual fraud alleged. Citing those elements in that context was not intended to foreclose the possibility of other forms of fraud that did not involve an actual statement. The common law, that is the assumed foundation for the Code’s provision is summarized in the Restatement of Torts, which clearly discusses forms of fraud that extend beyond false statements and explicitly include fraudulent conveyances. There must be actual knowledge and intent on the part of the recipient to defraud (i.e., the constructive fraud branch of fraudulent transfers will not suffice) but, if proven, it need not involve any statements made to the creditor or any reliance on such statements. Since the Code lists both actual fraud and false representations, the former must have some different meaning than the latter. The court also discusses aspects of prior case law and legislative history that support this broader reading.
While finding that this conduct might also be covered by Section 523(a)(6), the court refused to exclude it from Section 523(a)(2) (particularly since doing so would allow a debtor to escape liability for the debt by filing in Chapter 13, which does not include intentional property torts within its exceptions to discharge.
Janvey v. Golf Channel, Inc., 2015 U.S. App. LEXIS 11268 (5th Cir. 6/30/15) – certification to Texas Supreme Court on how to determine if “value” has been received.
The Fifth Circuit, upon a petition for rehearing of its decision at 780 F.3d 641 (5th Cir. 2015), decided to certify a question to the Texas Supreme Court. The issue concerned what could be a recurring fact pattern – the debtor contracts with some third party entity to provide services that the debtor uses to further its Ponzi scheme (in this case, it bought advertising on the Golf Channel to lure well-heeled investors to invest in the funds that were carrying out the Ponzi scheme). The Golf Channel provided the services that were contracted for, the rates charged were presumably appropriate for the ads presented – but the Ponzi scheme investors received no benefit from those services. Indeed, they could argue they were harmed because it was used to pull them into the fraudulent scheme. The Fifth Circuit initially analyzed the issue from the perspective of the victimized investors; the Golf Channel (and other defendants) asked the court to reconsider whether that was the way Texas would actually apply its law (since it would leave innocent service providers at great risk). The Fifth Circuit agreed that Texas did not appear to have dispositive law on the issue and agreed to certify to the Texas Supreme Court the question of whether the services provided by the third party were sufficient to satisfy the “reasonably equivalent value” standard.
Charbono v. Sumski (In re Charbono), 2015 U.S. App. LEXIS 10053 (1st Cir. 6/15/15) – court’s power to impose punitive “inherent power” sanctions.
A bankruptcy court may impose an “inherent power” sanction to vindicate its authority where a party has failed to timely comply with its orders without needing to meet the standard for a showing of criminal contempt. This is true even if the sanction is punitive in that the party had already complied by the time the sanction was ordered. That could affect the amount of the sanction but it does not meant the bankruptcy court has no means to punish the original delay (in this case, the failure to meet the deadline for filing a required tax return). Similarly, the sanction may be implied even without a showing of bad faith (i.e., even good-faith, negligent conduct can trigger a sanction, albeit that factor would likely suggest that the sanction should be modest such as the $100 fine imposed here).
Northbay Wellness Group, Inc. v. Beyries, 2015 U.S. App. LEXIS 9397 (9th Cir. 6/515) – “unclean hands” doctrine does not allow attorney to steal from medical marijuana client.
While marijuana sales remain illegal under federal law and the bankruptcy courts have tended to find this does not allow them to provide relief to such entities, the Ninth Circuit held that such a limitation could not extend so far as to give an attorney for such an entity a free pass to steal from that client with impunity. While the doctrine of “unclean hands” may limit the relief available to a party that itself is not operating in strict accordance with the law, the doctrine is an equitable one and is applied under a balancing test. It would not be applied where doing so would violate public policy – i.e., by allowing an attorney to violate his fiduciary obligations to his clients by misappropriating funds entrusted to him.
In re Pinnacle Airlines Corp., 2015 U.S. Dist. LEXIS 97873 (S.D. N.Y. 7/27/15). Consumer priority.
One defunct company operated a flight training school that held itself out as being partnered with an airline and suggested that its program was designed for that airline. A number of students paid it the fees but never received the flight training they were promised. While that would normally qualify as a scenario fitting the consumer priority, the court held that it would not apply to Pinnacle’s bankruptcy, because the defunct company had never paid over any of the monies received to Pinnacle and Pinnacle had never made any arrangements directly with the creditors. Even assuming there was a partnership or a “holding out,” the court held that the usual strictness applied to granting priority status argued against according it to claims for money Pinnacle had never received and, accordingly, had no ability to give back even if it were solvent.
Goodman v. Gorman, 2105 U.S. Dist. LEXIS 95621 (E.D. Va. 7/21/15). Inheritances in Chapter 13 are property of estate.
Although Chapter 7 limits the debtor’s obligation to turn over inheritances to those received within 180 days postpetition, no such limitations applies in Chapter 13. Such receipts will become part of the estate whenever received and will be an appropriate basis to consider modifying the plan to capture the additional funds for the creditors. Where the debtor was able to make the payments under her existing plan without difficulty, there was no basis to find that she should be able to modify her plan by increasing her expenses so as to capture the additional funds for herself, rather than her creditors.
In re Ferris Properties, Inc., 2015 Bankr. LEXIS 2554 (Bankr. D. Del. 7/30/15). Section 363 sale – attempt to sell free and clear of liens.
The debtor’s proposed sale of several properties to a third party for less than the value of the lender’s liens was not authorized under Section 363(f). Section 363(f)(5) would not apply because there was no legal proceeding that could actually force the lender to accept a monetary satisfaction. While some courts look to a Section 1129(b)(2) cramdown, the court noted that the debtor must be able to show that a plan with a cramdown could actually remove a lender’s liens if it did not receive the full value of its claim – which that section does not do. The court also rejected the argument that a state law provision allowing for a sale of a property for unpaid taxes could suffice. Such a sale would allow the mortgage holder to pay the taxes itself or to redeem the properties if they were sold, neither of which rights would be afforded under the Section 363 sale proposed. Accordingly, the court denied approval of the sale.
In re Hawk (Res-TX One, LLC v. Hawk), 2015 Bankr. LEXIS 2445 (Bankr. S.D. Tex. 7/23/15). Transfer of exempt assets as fraudulent transfer.
Even the transfer of exempt assets can be attacked as a fraudulent conveyance if the transfer is made with the requisite fraudulent intent. Where the debtor liquidated exempt IRAs and transferred the funds not to accounts held in his own name but to an account held by a defunct corporate entity in order to avoid garnishment of his own accounts, transfer was held to be fraudulent even if debtor asserted funds were merely being used for normal household expenses. The initial transfer of the funds with the intent to evade creditor action was the fraudulent transfer; the later uses are irrelevant. In any event, debtor did not satisfactorily account for payments from that account.
In re Howard, 2015 Bankr. LEXIS 2441 (Bankr. S.D. Miss. 7/23/15). Abandonment of environmentally contaminated property.
The debtors filed a Chapter 13 case in 2000; although they inherited certain property during the case and were the executors with respect to one debtor’s father’s estate, none of those transactions were reported during the case. The property was environmentally contaminated and suits had been pending with respect to the land since 1996, which the debtors continued to pursue during and after their bankruptcy. The defendants eventually learned of the bankruptcy and successfully convinced the bankruptcy court to hold that the trustee could pursue the actions but only to the extent of obtaining funds to pay the debtor’s creditors but not to provide any funds to the debtors who were judicially estopped from being compensated. The trustee sought to abandon the property to the debtors as burdensome to the estate and to accept a settlement from the defendant of enough cash ($2700) to pay off the creditors. The court agreed over the debtors’ objections.
It determined that the Chapter 13 trustee had no inherent obligation to clean up the property for the debtors’ behalf. While he might do so if it would produce a net benefit to creditors, it would not likely do so here and would produce nothing more than he could obtain from the defendants without difficult. Further, he concluded that the decision in Midlantic National Bank v. New Jersey Dept. of Envt’l Prot., 474 U.S. 494 (1986) and particularly its footnote 9 (one of the times where a footnote controls over the rest of the text) only precluded abandonment where there was an “imminent and identifiable harm” from the property in its current state. Here, he noted, that the lawsuits had been going on for almost 20 years with no claimed actual harm, the property was remote, and the environmental reports, while identifying the contamination, did not directly comment on the likelihood of harm to the public. Finally, he noted that the state had been aware of the property and the litigation since 2006 but had not issued any clean-up orders or given any clear indications that it viewed the property as dangerous. Accordingly, the court allowed the property to be abandoned and returned to the debtors who would bear the obligation going forward for a clean-up.
Shefa, LLC v. Oakland Cnty. Treasurer (In re Shefa LLC), 2015 U.S. Dist. LEXIS 95101 (Bankr. E.D. Mich. 7/22/15). Fees v. taxes for purposes of Section 502(b)(3)
Section 502(b)(3) limits taxes assessed against property of the estate to the value of the property itself; the water and sewerage charges imposed by the county, though, did not fall under this section because they are not a “tax.” Only ad valorem taxes fall under that limit. The charges here are a fee for the water and sewerage service received and are direct compensation for the benefit, albeit the statute allows them to be collected in the same manner as a tax.
In re Hoberg, 2015 Bankr. LEXIS 2407 (Bankr. D. N.D. 7/22/15). Derivative liabilities are nondischargable on same basis as primary liability.
Where state law imposed derivative liability on the owner of an entity for workers compensation premiums not paid by the entity, and such liabilities were treated as taxes, the derivative liability was subject to the same discharge standards as if the owner had direct liability for the taxes.
In re Oakey, 2015 Bankr. LEXIS 2431 (Bankr. D. N.J. 7/22/15). Setoff of taxes against benefits.
As a “unitary creditor” the U.S. is entitled to setoff overpayments of prepetition income taxes owed to the debtor against its prepetition claim against the debtor for overpayments of social security benefits. However, it is required to receive relief from the automatic stay to do so and violated the stay when it failed to obtain that relief. The two payments are not closely enough related to be treated as recoupment. The actions taken by the government were also sufficiently final to be treated as an actual setoff, not just a temporary administrative freeze, pursuant to Citizens Bank of Md. v. Strumpf, 516 U.S. 16 (1995). Section 362(b)(26) does except setoffs from the stay, but only setoffs of other income tax liabilities, not all debts owed to the United States. In terms of remedy, the court found that the setoff was appropriate (once properly requested) but that the government was liable for reasonable attorneys’ fees for the debtor’s efforts to correct the original improper setoff. The court did note that the amount of the fees would be limited in terms of the prompt corrective actions taken by the government.
In re Trump Entertainment Resorts, Inc., 2015 Bankr. LEXIS 2415 (Bankr. D. Del. 7/21/15). Norris-LaGuardia Act (anti-injunction provision) versus automatic stay.
Although the court approved the debtor’s request to reject its collective bargaining agreement with its unions, that power under Section 1113 and the automatic stay did not trump (pun intended!) the anti-injunction provisions of the Norris-LaGuardia Act (“NLA”), which is a long-standing law limiting the ability of federal courts to interfere in and enjoin labor union activity. In this case, the unions had been contacting customers to urge them to support the union’s position and/or to boycott the hotel because of the labor dispute – all of which would be protected by the NLA outside of bankruptcy. In determining the scope of Section 362(a)(3) and (6), and the interaction of competing federal statutes and policies, the court held that it was required to balance the interests of each side. Where allowing the automatic stay to be applied to normal union activities would dramatically tip the balance of negotiating power between the two parties with respect to ongoing negotiations for future contracts, the court held it could not be held to override the protections of the NLA.
Bradford v. United States, Dep’t of the Treasury, 2015 U.S. Dist. LEXIS 2374 (Bankr. M.D. Ga. 7/19/15). 10% tax imposed on early withdrawals from IRA accounts is a noncompensatory penalty, not a tax, and is not entitled to priority.
The case has a very extensive discussion of differences between a tax and a penalty and what criteria separate them. The court rejects the view that a penalty can only apply to illegal conduct; rather it is enough that it is imposed primarily to deter particular, undesirable conduct rather than to produce revenue growth for general governmental purposes. Here, the goal was to deter removal of funds that were intended to be retained for retirement; the added revenue from the “tax” was not tied in any meaningful way to any actual revenue losses by the government or any desire to raise more funds.
Addison v. U.S. Dep't of Agric. (In re Addison), 2015 Bankr. LEXIS 2306 (Bankr. W.D. Va. 7/13/15) – tax overpayments are subject to automatic stay so using them to pay other liabilities (particularly non-tax liabilities violates automatic stay; exemptions trump set-off rights.
The two issues decided here continue to split the courts. Based in large part of the addition of Section 362(b)(26), which protects setoff of prepetition tax claims and refunds against each other, the court held that this supported the view that the federal “Tax Overpayment Program” does not sub silentio serve as another exception to the stay for all applications of tax overpayments. That is particularly true, the court held, when the overpayment is applied to another prepetition non-tax debt. The court also concluded that the exemption rights in Section 522 overrode the language in Section 553, despite the absence of any reference to Section 522 in the otherwise sweeping “notwithstanding” language in Section 553. As a result, the debtor was able to demand payment of his tax overpayments and to exempt them despite the existence of other debts owed to the United States.
Gonzalez v. P.R. Treasury Dep't (In re Gonzalez), 532 B.R. 1 (Bankr. D. P.R. 6/19/15). Tax notices that threatened property seizure not covered by Section 362(b)(9).
The case has a good discussion of the extent to which tax notices, assessments, etc. are protected from the stay under the Section 362(b)(9) exception for determinations of liability, and when they go too far and threaten to actually enforce and collect upon such liability determinations. The latter communications fall outside the tax auditing and assessment exception.
Maitland v. New Jersey, Div. of Taxation (In re Maitland), 531 B.R. 516 (Bankr. D. N.J. 6/10/15). Late-filed return is still a “return” for purpose of triggering two-year discharge period.
Contrary to the decisions of the First, Fifth, and Tenth Circuits, the court here sided with the lower court decisions that have found that a late-filed return will still qualify as a “return” under the language in the “hanging paragraph” in Section 507(a)(8). As such, it will trigger the running of the two-year period that will allow debts owed under such a return to be discharged. The court also found that, when she filed a late return on day X, and subsequently filed an even later amendment to that late return that reduced the amount of tax owed, the two-year period for the discharge ran from the date of the originally filed return.
Buchwald Capital Advisors, LLC v. Papas (In re Greektown Holdings, LLC, 2015 U.S. Dist. LEXIS 64509 (E.D. Mich. 6/9/15). Section 106(a) does not unequivocally apply to Indian tribes.
Section 106(a) abrogates immunity of all governmental units, and Section 101(29) defines a governmental unit as including the United States, states, their subdivisions, and other foreign and domestic governments. Concededly tribes are domestic entities, and they concededly are recognized as having governmental powers and structures. A number of courts have, accordingly, held that they are a “domestic government” within the meaning of the Section 101 definition – not least because those courts notes there is no other entity in the United States that would fall into that category that is not covered elsewhere in the definition. The court below agreed with that analysis but the court here noted that that particular phraseology had not been one of the usual ways in other statutes of referring to tribes and that the trustee here was unable to point to another law that successfully abrogated tribal immunity with using the words tribe or Indian as part of that abrogation. Accordingly, the court held it could not say with “perfect confidence” that the term “other domestic government” was meant to apply to tribes, particularly in light of the special relationship between the federal government and tribes. Accordingly, it held tribes were not subject to the Section 106(a) abrogation.
Kelley v. Opportunity Fin., LLC (In re Petters Co.), 532 B.R. 100 (Bankr. D. Minn. 2015). Charitable contributions excluded from state fraudulent transfer law
Although this case is very lengthy and complex due to the nature of the way payments that were asserted to be “contributions” were made to the charities at issue, the most interesting point is the state’s decision, in view of efforts by trustees to use state Uniform Fraudulent Transfer Acts (“UFTAs”) to claw back payments made to charities by Ponzi scheme operators many years before the bankruptcy petition was filed, to amend the state UFTA to exclude contributions from the definition of a “transfer” to which the UFTA could apply. The language used paralleled in some respects but expanded upon the language in Section 548(a)(2) that excludes some charitable contributions from the definition of a fraudulent transfer under that section. The case has a good discussion of the competing equities. The issues in the case are similar to those being discussed in the Janvey case above – when should an innocent third party be required to return funds that it accepted in good faith from a Ponzi scheme operator.