The National Attorneys General Training & Research Institute
Bankruptcy Bulletin - October - December 2017
UPDATE IV – OCTOBER-DECEMBER 2017
BANKRUPTCY SEMINAR 2018 – HOLD THE DATES!
We will be holding this year’s seminar in Columbus, Ohio from Tuesday afternoon to Friday, October 16-19 at the Sheraton on Capital Square. We’ll have more information coming later (including whether scholarships will be available) but we wanted you to know the dates early so you can keep the time slot clear. We will hold room nights before and after the main conference dates. If you’re a Buckeyes fan, the football team will be at home the weekend before and if you’re not, they will be away for the weekend after.
SELECTED LOWER COURT CASE DECISIONS:
United States Pipe & Foundry Co., v. Adams (In re United States Pipe & Foundry Co.), 577 B.R. 916 (Bankr. M.D. Fla. 2017). Fact that debtor had been discharging harmful chemicals long prior to bankruptcy was not enough, standing alone, to create dischargeable claims.
The debtor filed bankruptcy in 1992, gave mail notice to known creditors, and published notice in a number of newspapers. It confirmed its plan in 1995 with an order that discharged debts to the fullest extent allowed by Section 1141. In 2006, the debtor was sued for and settled (under seal) a number of tort claims. In 2009, the EPA began investigating the location as a Superfund site, in 2012, it was so designated, and, finally, in 2013, the debtor was named as a potentially responsible party. In 2015, state court complaints were filed against the debtor alleging personal injury from the effects of the debtor’s release of contaminants (beginning in 1911) but whose effects were not known until after the 1995 confirmation date.
The court noted that various tests have been used to deal with these claims where the debtor’s conduct occurred prepetition but the injury was only manifested later. The courts have rejected a test based on when a state law claim would accrue as being too narrow, but have also generally resisted a pure “conduct” test where the only question is when did the debtor do something that would eventually cause a liability. In In re Piper Aircraft Corp.58 F.3d 1573 (11th Cir. 1995) (dealing with injuries from planes built prepetition), the court held that, at a minimum, there must be some “prepetition relationship” between the parties such that the potential claimants could be identified. This test works reasonably well with torts from external mechanical things, where one often had no contact with the defective product until it blew up. It works less well with exposures to toxic chemicals where they may have been ingested prepetition but the party has no knowledge on the petition date of a potential for illness harm that may yet have even developed. The courts have long struggled with how to balance the desire to protect debtors by allowing them to bring in all possible claims against the due process rights of those who could not possibly know that they needed to file a claim. (A worker’s wife, for instance, who was diagnosed with cancer in 2015 was denied the right to file a claim because her husband’s exposure to asbestos (which led to her cancer) began before the debtor’s 1982 bankruptcy case.)
The bottom-line factor, the court here held, was the degree of knowledge the parties had of the “relationship” between them – either the debtor had to be able to identify the potential victims its conduct was creating or the future injury class had to have objective facts during the bankruptcy case to allow them to identify their claim against the debtor. The court noted this was based on both fairness and practicality – how could the court administer “claims” where the holder cannot articulate one and the debtor cannot identify who might have them? Some courts have used a further term – “fair contemplation” as a way to describe this additional issue. At a minimum, that term might go to address the point of whether it is possible to “provide for” these claims during the case. In asbestos cases, for instance, the plans typically identify a class of “future claimants” (whose individual identities are not known) but whose global damages can be actuarially estimated, and reserve a proportional share of funds for them to be paid out when a particular person does manifest disease from their exposure, which often occurs long after the confirmation date. Here, the court held, it could not be shown that any of these persons had claims at the time of the bankruptcy -- based on its view that it was not until at least some lawsuits were filed in 2006 (or more likely when the EPA began investigating in 2009) that the neighbors would have known of either the debtor’s conduct or its impact on them.
In re Houston Bluebonnet, LLC, 2017 Bankr. LEXIS 3520 (Bankr. S.D. Tex. 10/11/2017). Pleadings attached to debtor’s removal notice treated as informal proof of claim.
The debtor was a defendant in two long-pending suits over rights to proceeds dating back to a 1913 lease. The debtor filed bankruptcy in 2016, and immediately removed the lawsuits to the bankruptcy court, with the complaints and related documents attached to the removal notice. The plaintiffs were listed as (disputed) creditors in the debtor’s schedules but did not file actual proofs of claim. Several months after the bar date, they asked to have the removal filings treated as informal proofs of claim and the court agreed. An informal proof of claim is a document other than the formal claim form that serves a like purpose. To qualify, it must be filed with the bankruptcy court and demand that the pay a determinable amount. The court found that the removal attachments qualified even though they were not filed by the creditors themselves since the point of the informal proof of claim doctrine is to ensure notice to the debtor which occurred here. The court also held it was equitable to accept the informal claims but noted that, unlike a true proof of claim, the documents did not presumptively establish the validity of the claims so the creditors would bear the burden of proving up their rights.
Haler v. Boyington Capital Group, LLC (In re Haler), 2017 U.S. App. LEXIS 27034 (5th Cir. 12/29/17). Statements that a company is in “very fine financial shape” and has “plenty of cash to operate” are statement regarding financial condition and must be in writing to trigger Section 523(a)(2)(B).
Section 523(a)(2) distinguishes between false statements in general and those that are statements respecting the debtor’s “financial condition.” The latter must be in writing to trigger a discharge exception. The Code does not define, however, how to decide which statements meet that criterion. The courts are split as to whether any statement regarding assets or liabilities qualifies or whether the statement must be a broad analysis of the debtor’s overall status. The Fifth Circuit had previously held that a statement about a single asset (such as whether the debtor owned it or its value) was not a statement of “financial condition;” rather, the statement must go to the overall financial condition of the entity under a balance sheet type approach. However, the court here said these statements, while extremely bland and generic, were, in fact, description of the debtor’s overall finances as “very fine” and supplying the debtor with “plenty of cash.” The court held that was sufficient to fall under Section 523(a)(2)(B) and a formal balance sheet was not needed. (Perhaps a better reason to deny the discharge exception might be that, if one had a concern about the debtor’s finances, accepting such a glib oral statement might not have even risen to the level of justifiable reliance, but that is a different issue.) The Supreme Court will be taking up this issue this term in Lamar, Archer & Cofrin, LLP v. Appling.
Conard v. IRS (In re Conard), 2017 Bankr. LEXIS 4258 (Bankr. E.D. Va. 12/14/17). Tax debt is excepted from discharge under Section 523(a)(1)(C) where debtor consciously chose to buy discretionary luxury items rather than to meet his tax obligations.
Section 523(a)(1)(C) applies to a debt for a tax that a debtor has attempted to “willfully evade.” The test involves both the debtor’s conduct and his intent. Mere failure to pay taxes is not enough, standing alone, to trigger the section but failure to pay is still highly relevant. Other relevant factors are what the debtor spent his money on in lieu of paying taxes and whether the debtor complied with other aspects of the law including filing returns, timely or otherwise. Payment for discretionary items, particularly luxury items, is typically critical in applying the exception, even if, as here, the debtor claimed his work required a display of luxury to impress his clients. Where, the debtor had three cars costing $180,000, played golf once a week, and vacationed abroad, willful evasion had been shown and the taxes were not discharged.
TKC Aerospace, Inc. v. Muhs, 2017 U.S. Dist. LEXIS 170823 (E.D. Va. 10/16/17). Bankruptcy court could not use purported malpractice by debtor’s counsel to look behind state court ruling.
The debtor was allegedly part of a plot to sell trade secrets of his old employer to his new employer. The old employer won a judgment against the new employer in Arizona and that judgment was given preclusive effect in a separate action in Alaska against the employee. When the debtor filed bankruptcy, though, he sought to challenge the binding effect of that judgment based on his attacks on the competence of his trial counsel in the prior actions. The bankruptcy court allowed him to do that but the district court reversed. To begin with, the preclusive effect of the Arizona case on the Alaska case against the employee had already been addressed in that matter, so the bankruptcy court was seeking to ignore the decisions of two other courts. And, while a bankruptcy judge in deciding on a Section 523(a)(4) or (6) action can make his own legal analysis as to the dischargeability of a debt, he may not do so by discarding the underlying factual findings and conclusions of the prior courts. Where the district court had necessarily found that the debtor had engaged in willful and malicious conduct and defalcation by a fiduciary in order to impose the substantive liability that it did, the bankruptcy court was not entitled to simply substitute its own judgment for those findings.
Simon v. Boccarsi (In re Boccarsi), 2017 Bankr. LEXIS 4280 (Bankr. N.D. Ill. 12/14/17). Default judgment was sufficient to except debt from discharge under Section 523(a)(19).
While many states do not allow default judgments to be the basis of a finding of collateral estoppel for purposes of a discharge exception, the language in Section 523(a)(19) was added in 2002, after the collapse of Enron, as part of amendments intended to make it more difficult for securities law violators to walk away from their debts. In particular, securities law used a particular set of criteria and factors to find liability that overlapped to a substantial degree with those used in a run-of-the-mill fraud case but were not identical. In particular, reliance by each individual investor was not required to be shown in a securities case in the case of widely broadcast statements. The new exception was added to allow a decision made under securities law to stand on its own without needing to be reproven in bankruptcy court. The section also stated that “any” consent decree or settlement was covered, thereby creating a federal standard as to whether “actual litigation” was needed to give a document preclusive effect.
Thomas v. United States Dept of Education (In re Thomas), 2017 Bankr. LEXIS 4182 (12/8/17). Student loans are, basically, never dischargeable in the Fifth Circuit.
The judge started by saying that, under the Fifth Circuit’s standard, he had never, in 15 years, been able to discharge a student loan -- a conclusion that may be more stringent than the case law actually requires. The case cited by the judge, U.S. v. Gerhardt, 348 F.3d 89 (5th Cir. 2003) did say that the debtor must show a “total incapacity” to pay his debts but the debtor there was only 43, highly educated, in good health with no dependents, and likely to be able to find a job if he really wanted. The debtor here, by contrast was 62, with only a high school degree, and severe (and permanent) physical limitations that greatly limited her ability to work. She had lost a long-term job about a year before and had obtained, but could not retain, three temporary jobs due to her physical limitations. She had essentially no income except food stamps, no assets, was facing eviction, and did not qualify for Medicare or Medicaid. The court found that she could not show a total incapacity to pay the debt largely because it found she was not totally incapacitated to work (and had not applied for total disability). But inability to work is not the same as the inability to find work. One may well be capable of doing work but the jobs either not be available or may never be offered to someone such as the debtor here. And, as time goes on, the likelihood of finding gainful employment would likely only decline further. As such, the suggestion that she had not done enough by not going on an income contingent payment plan (under which she would pay nothing) proves little and accomplishes less for the government. Indeed, one wonders why a case was even brought for the $8,000 at stake here.
Halbert v. Dimas (In re Halbert), 576 B.R. 586 (Bankr. N.D. Ill. 2017). Amount owed to government as overpayment of domestic support was not, itself, a domestic support obligation.
The debtor was paid food stamp benefits for several years after which the government learned that she had not reported all her income and demanded repayment. It intercepted a tax refund but when she filed bankruptcy shortly thereafter, the trustee sought to reclaim the funds as a preference. The court rejected the government’s argument that the payments should fall under the exception for domestic support obligations (“DSOs”). The amount owed was not for any support the debtor was entitled to receive, rather, it was for an amount she was never entitled to. DSOs owed to the government are for matters such as where the government institutionalizes a child and is entitled to demand payment from the parents for the costs of that placement.
In re Cook Inlet Energy, LLC, 2017 Bankr. LEXIS 3973 (Bankr. D. Ak. 11/16/17). Right to offset mutual claims is not barred by discharge.
Section 1141 provides for the discharge of all prepetition claims. Section 553(a), however, states that, except as provided therein, nothing in the Code affects a party’s right to offset mutual debts – and nothing in Section 553 refers to the discharge provisions. Although the courts are split, the Ninth Circuit has come down squarely on the side of Section 553 being the governing provision. That setoff, however, only extends to a “defensive” right, i.e., an ability to deny payment to the debtor on any amount the creditor owes the debtor. It does not allow the creditor to pursue any affirmative recovery and only applies to mutual debts; i.e., ones between the same parties. Even in a substantively consolidated case, such as here, the creditor is not necessarily allowed to assert setoff against all of the debtors, depending on exactly what type of consolidation was ordered. The state was limited here to using its tax refunds only against the one debtor that incurred them.
In re Hansen, 576 B.R. 845 (Bankr. E.D. Wis. 2017). Amount charged debtor for failure to maintain worker’s compensation insurance was neither a tax nor a penalty.
Under state law, a business that does not maintain worker’s compensation insurance must not only reimburse the state for the cost it expends from the Uninsured Employers’ Fund, but also an additional payment of twice the cost the employer should have paid out in premiums. The debtor here had such a charge imposed on it and the state argued that it was nondischargeable either as an excise tax or a penalty. The court first held that the amount was not a tax because it was punitive in that it was imposed for the debtor’s misconduct and that it did not serve a compensatory purpose because the state does not purchase substitute insurance and so the payment did not serve to support governmental interests. The court then said the payment did not fall under the discharge exception for penalties because, although it was clearly “penal,” it was not for the benefit of the government because the funds all went into the uninsured fund and were used to benefit employees of uninsured employers and/or to buy reinsurance for those costs. So, on the one hand, the payment was not a tax because it did not serve a compensatory purpose such as to buy insurance and, on the other hand, it was not a penalty, because it provided a general benefit to the workers and was used to buy insurance. Perhaps on appeal, a district court can explain how this payment can fail both tests, this opinion does not make its logic clear.
Patterson v. United States, SSA (In re Patterson), 2017 Bankr. LEXIS 3423 (Bankr. N.D. Ga. 10/4/17). Application of postpetition sick leave to reduce prepetition advanced sick leave was recoupment and did not violate discharge.
The debtor used up all of his allotted sick leave under the employee benefit program as well as an additional 240 hours advanced to him; newly accruing sick leave was to be used to reduce that advance. When he filed bankruptcy, the court agreed with him that the government’s right to recover the advanced leave was a “claim,” but further held that the right to recover that amount arose out of the same transaction (the sick leave program) and allowed the government to recoup the overpayments. Recoupment is not a claim and is, accordingly, not discharged in bankruptcy.
AUTOMATIC STAY, POLICE AND REGULATORY POWERS, AND DISCHARGE INJUNCTION ISSUES
Mantiply v. Horne (In re Horne), 876 F.3d 1076 (11th Cir. 2017). Damages under Section 362(k) can include attorneys’ fees to end the violation and to defend appeals of the order.
Baker Botts LLP v. ASARCO LLC, 135 S. Ct. 2158 (2015) held that, in general, even in bankruptcy, the “American Rule” – that each side must pay its own attorneys’ fees – applied, absent explicit statutory authority. Section 362(k), though, does contain an explicit statement that damages for a violation include fees and costs where there has been a willful violation of the stay. Since nothing in that provision limits the fees to only those incurred in ending the stay, the Circuit Court held that the debtor was entitled to additional fee awards for the added costs incurred to defend the original award from the defendant’s repeated appeals. The Ninth Circuit had initially taken a contrary view but overruled that decision in an en banc decision, In re Schwartz-Tallard, 803 F.3d 1095 (9th Cir. 2015).
Blundell v. Home Quality Care Home Health Care, Inc., 2017 U.S. Dist. LEXIS 195765 (N.D. Tex. 11/29/17); Manchester CP v. Konstantinou, 2017 U.S. Dist. LEXIS 185934 (D. Vt. 11/16/17). Cases discussing standard for extending automatic stay to non-debtor parties.
It is not uncommon for a debtor in bankruptcy to have non-debtor affiliates or to be subject to liability on bases that also apply to other non-debtor parties. Either the debtor or those parties often seek to “extend” the automatic stay to those third parties or to use Section 105 to impose a discretionary stay on litigation between creditors and those parties. Because such cases can be so frequent and because imposing the stay extends the privileges of bankruptcy, but not its duties, to parties that have not filed themselves, courts are sparing in allowing such stays. In Manchester, the plaintiff sought to name non-debtor parties that it alleged were liable directly and as successors and/or alter egos to the individual debtor and one corporate debtor. While the bankruptcy court accepted the individual debtor’s arguments that funds from the non-debtor entities were needed to fund his plan and that defending the state court litigation would take too much of his time, the district court reversed. It noted that the Second Circuit had extended the stay only when the litigation would have an immediate adverse consequence on the debtor or where there was such an identity of interest that the debtor was the real defendant. The district court held there was no severe burden on the individual debtor to merely be a witness and it was not enough that an adverse result against the other parties might have some precedential effect. Any liability imposed on these parties, even as alter egos, would be satisfied out of their assets, not those owned by the debtors. The court also held that, although there was nothing that clearly precluded the use of a Section 105 stay in Chapter 13, there was no indication it had ever been used before and Section 1301 already provides a co-debtor stay in certain circumstances. As a result, it held Section 105 would not provide an alternative basis for a stay here.
In Blundell, on the other hand, the case involved a Fair Labor Standards Act case against the principals of a business who, the plaintiffs alleged, were also to be treated as employers and who could incur joint and several liability for the violations alleged against the debtor. The district court in which the litigation was pending held that the fact that the allegations were identical and that the results of litigation against one party might be available to use against the others was not necessarily enough to require the litigation to be stayed. However, the court decided, in its own discretion, that the possibility of duplicative litigation made severance inappropriate since it could either decide the issue for the absent parties or, alternatively, lead to inconsistent verdicts.
City of Chicago v. Marshall, 2017 U.S. Dist. LEXIS 193954 (N.D. Ill., 11/27/17); In re Walker, 2017 Bankr. LEXIS 4364 (Bankr. N.D. Ill. 12/20/17). Chicago may not obtain administrative status for postpetition traffic fines; Chicago may not maintain possession of vehicles seized prepetition for nonpayment of prepetition traffic fines.
Chicago apparently has a serious issue with unpaid traffic fines and has been working hard to collect them. It has, however, faced a number of setbacks when debtors with fines have filed bankruptcy. In Walker, the city had impounded the debtor’s car for failing to pay $10,000 in prepetition traffic fines; upon filing bankruptcy, she demanded the city release her car. The city refused, arguing that it had a possessory lien securing its claim that would be lost if the city turned over the car, and cited In re Avila, 566 B.R. 558 (Bankr. N.D. Ill. 2017) as holding that this would qualify for the stay exception under section 523(b)(3). In this case, however, the judge took the opposite view. He relief on Thompson v. GMAC, LLC, 566 F.3d 699 (7th Cir. 2009), which had held that a creditor that retained seized collateral had engaged in an “act” to violate Section 362(a)(3) of the stay and the creditor should, instead release the car, and seek adequate protection by filing an emergency motion post-release. The court here held that the judge had erred in Avila by holding that retention of the collateral was similarly an “act” for purposes of the stay exception. Thus, he held, while Thompson held passive retention of the car was an act of “exercising control” under Section 362(a)(3), that same retention was not an “act” for purposes of Section 362(b)(3), which seems a bit odd. Moreover, even if the city sought to follow his advice and file an emergency motion as Thompson suggested, that would not solve the city’s problem here. The lien there was consensual so the creditor could protect its secured status merely by receiving adequate protection payments. But, if the city returned the car here, the possessory lien would disappear, and any adequate protection motion would become moot. The city could presumably move to lift the stay but if the court would inevitably have to grant such a motion to protect the city’s interest, it’s not clear what the point of the exercise is. (The judge has now (reluctantly) withdrawn the opinion as moot, based on a settlement by the city, see In re Walker, 2018 Bankr. LEXIS 365 (Bankr. N.D. Ill. 2/8/18) but made clear that he had not changed his mind.) One can expect to see this issue again.
In Marshall, the issue concerned what steps the city could take to enforce postpetition traffic sanctions. Although, in Chapter 11, costs arising from postpetition operations of the debtor are given priority over payments to prepetition creditors – and that is reinforced by 28 U.S.C. 959(b) – the court here upheld the bankruptcy court’s conclusion that those principles did not apply in Chapter 13. Because the debtor is allowed to unilaterally decide whether to have newly acquired property (i.e., postpetition wages) revest in the debtor personally after confirmation or remain property of the estate, the debtor can, effectively ensure that all of his funds remain subject to the automatic stay throughout his case. That is what occurs in Chapter 11, but the standard there is that such funds have to be used to pay expenses accruing during the case. Here, though, the district court held that the policy of the “fresh start” is that expenses occurring prepetition are dealt with during the case, but those accruing postpetition are not. (That is true, to be sure, in Chapter 7, where the case typically only takes up a few months, but is certainly not the case, as noted, in Chapter 11.) In the court’s view, it was sufficient that the debtor remained liable for payment of those claims after the case expired, finding that treating them as postpetition expenses would benefit the debtor at the expense of the prepetition creditors. The court viewed the debtor’s individual existence as different from the continued corporate existence in Chapter 11 that operated for the benefit of creditors (but also, of course, for the benefit of its shareholders who could be viewed as being akin to the debtor personally). The court suggested that the city could move to lift the stay to allow it to seek to seize the debtor’s vehicle or to have the bankruptcy dismissed. While those options would seem more harmful to debtors and creditors than the relief the city sought, it will await a further appeal to see if the Seventh Circuit concurs.
In re Vazquez, 2017 Bankr. LEXIS 4440 (Bankr. C.D. Cal. 12/29/17). An “in rem” stay relief order could be issued against a borrower even if he had not (yet) filed bankruptcy.
A new kind of scam involves two financially troubled individuals – a debtor already in bankruptcy and another party at risk of foreclosure but not yet in bankruptcy. An unscrupulous broker will tell the non-bankrupt party, as here, that he can save his house by making payments to the broker. The broke just pockets the payments, and then forges a deed that places at least part ownership of the property in the name of the already-filed debtor. That party doesn’t know that property has been put in his name, and the borrower doesn’t know his property is not being paid for, but the broker uses the data from the filed bankruptcy to stay foreclosure on the non-debtor’s home while he keeps taking payments from that party. In this case, when the facts emerged, the lender on the non-debtor party’s house sought an in rem order in the debtor’s case, lifting the stay on the house not only in the existing debtor’s case but also as any case to be filed by the non-debtor party so foreclosure could take place without hindrance. The court agreed that it had the power to do so based on the fact that the property had been transferred under its jurisdiction, even if improperly. Moreover, it held, it was appropriate to include the broad stay relief (which would make it unavailing for the non-debtor party to file a case) even if the non-debtor was an innocent victim. He was the one that had dealt with the unscrupulous broker and had the greater ability to have barred the whole transaction from taking place.
In re Morgan, 2017 Bankr. LEXIS 4221 (Bankr. N.D. N.Y. 12/12/17). Private entity does not violate discharge injunction by refusing to do business with debtor unless all debts paid in full.
The discharge injunction (unlike the protections in Section 525) only protects a debtor from coercive efforts to collect the debt. A statement that a creditor will not deal with a party with delinquent accounts does not coerce such payments, at least where the creditor does not provide some service that is so uniquely beneficial that the debtor feels that it must do business with that entity, even if that means repaying the debt. The debtor might prefer to keep doing business with the credit union, but it is by no means unique in terms of the services it can provide and the debtor can go elsewhere if it does not wish to pay.
Marks Family Trucking, LLC v. U.S. (In re Marks Family Trucking, LLC), 2017 Bankr. LEXIS 4084 (Bankr. E.D.Wi. 12/1/17). Civil forfeiture action against truck owned by debtor not stayed.
Since 1998, Section 362(b)(4) has included Section 362(a)(3) among the provisions subject to the police power exception, meaning that such actions can “exercise control” over property of the estate. As such, a debtor contesting a civil forfeiture action must go back to the district court and cannot seek assistance from the bankruptcy court.
In re GEO Specialty Claims, Ltd., 577 B.R. 142 (Bankr. D. N.J. 2017); In re Liquid Aluminum Sulfate Antirust Litigation, 2017 U.S. Dist. LEXIS 115294 (D. J.J. 7/20/17). Claims of antitrust victims were not discharged in prior bankruptcy cases where debtor at time was still participating in and concealing unlawful conspiracy.
The debtors filed bankruptcy and received discharges in 2003 and 2004. At the time they were active participants in an antitrust conspiracy to raise prices that did not end until 2011. Not surprisingly, as part of that conspiracy, their bankruptcy cases did not involve any issues relating to those antitrust violations not did they give notice to those doing business with them that they were being overcharged. The district court, in somewhat abbreviated fashion, and the bankruptcy court, in a longer discussion, stated that, to discharge a claim, there must be not only prepetition conduct by the debtor and a relationship with the creditor, but also a showing that the creditor had received sufficient notice to satisfy due process. Where a debtor’s conduct was obvious and known to all, then notice of the bankruptcy itself could suffice. But, where the gravamen of the claims was that the debtors had concealed their criminal liability for antitrust violations, the potential creditors could not have known of their claims or the need to file them. By the same token, the debtors’ knowledge of its own misconduct meant that it knew that these parties were all potential claimants and were entitled to actual notice as known creditors since the debtors certainly knew who their customers were. Accordingly, the court held, these parties had not received adequate notice and were not bound by the discharge injunction. (Another interesting substantive basis for postdischarge liability is that, under antitrust law, each party is jointly and severally liable for all acts of the conspiracy, even for time periods when the party was not part of the conspiracy. Under that analysis, the debtors’ continued participation in the conspiracy for years after the bankruptcy left it liable for all claims against all co-conspirators including those taking place in the bankruptcy and before.)
United States v. Busch, 2017 U.S. Dist. LEXIS 215577 (E.D. Tex. 12/4/17). Form 4549s do not qualify as Section 6020(a) returns for purposes of qualifying as late returns.
The taxpayer failed to file and/or pay his taxes for many years. He finally did come to the IRS under the impetus of a pending criminal case and signed a number of Form 4549 (Income Tax Examination Change) documents in 2006. He later filed actual 1040s in 2007, and then in 2010 filed a bankruptcy case which, he argued, allowed for discharge of the taxes on those returns. The court denied his arguments finding, first, that the Fifth Circuit had already decided that the “one-day-late” rule applied to federal returns and would bar any of his filings from being treated as “returns” for discharge purposes. It also rejected his attempt to rely on the IRS’ 2010 notice in which it attempted to define which returns it concluded should be treated as allowable for discharge purpose, noting that the IRS Notice was not binding on it, nor did it purport to apply in the scenario of a criminal case. Finally, the court also rejected the debtor’s argument that its Form 4549 filings could be treated as tax returns. An assessment (to which the debtor confesses by signing the Form 4549) can be issued without a tax return being filed so it is not inherently a tax return. Nor would the Form qualify as a Section 6020(a) return. In later 2005, after the passage of BAPCPA and its reference to such returns, the IRS changed its position on whether such a form would be treated as Section 6020(a) return. Its new guidance stated that it would no longer treat Form 4549s as being filed under Section 6020(a), since they did not purport to be returns and were not signed under penalty of perjury. Moreover, the debtor did not disclose information for purposes of preparing a return but rather in order to comply with an order in his criminal case. Accordingly, the debtor was not entitled to discharge of those debts.
Shek v. Mass. Dept. of Revenue (In re Shek), 2017 Bankr. LEXIS 4444 (Bankr. M.D. Fla. 12/21/17). Court refused to apply First Circuit’s “one-day-late” rule to Florida debtor who filed about seven months late during a divorce proceeding where the debtor claimed he needed to know what his ex-wife was doing before he could file his return.
The BAPCPA included a new definition of what is a “return” for discharge purposes. The First Circuit adopted the “one-day-late” rule which holds that meeting a filing deadline is part of a requirement for a filing to be a return. The judge here, though, held that she was not bound by that decision since she was sitting in Florida. The Eleventh Circuit has applied the Beard test, which looks to whether a late filing was an “honest and reasonable attempt to comply.” Filings made post-assessment, presumptively, do not meet the test but in this case, the filing was before the assessment date. The judge viewed the Eleventh Circuit as likely to adopt the view of the dissent in the First Circuit which she viewed as more logical. The opinion appears to be a bit confused in suggesting that a Section 6020(a) return (which is allowed to count as a return even if filed late) can only be filed after the assessment date such that there would be an incentive for debtor sot delay in filing until after an assessment issues. There is nothing, though, that limits Section 6020(a) returns from being filed prior to that date, so that part of the analysis is not necessarily correct. In any event, the opinion reflects the raging debate going on in the courts.
Petersen v. IRS (In re Petersen), 2017 Bankr. LEXIS 3685 (Bankr. E.D. Cal. 10/23/17). Tax document filed after assessment date could not be a “return” for discharge purposes.
After the death of his wife, in 1999, the debtor failed to file timely tax returns for the tax years 1999 through 2002. He apparently prepared the returns in 2007 but did not actually file them until 2011. In the meantime, the IRS had completed assessments on all of those years and filed various tax liens. When he filed bankruptcy, he sought to have those years discharged in that the documents were filed more than two years before the bankruptcy case. The court agreed with the IRS, however, that the documents were not “returns” pursuant to the language added in 2005. Without needing to decide on the “one-day-late” rule, these returns plainly did not meet the Beard test for what was needed to be an “honest and reasonable attempt” to satisfy the tax laws. In general, that test uses the assessment date as a cut-off point with a possibility of showing some excuse for failing to file. Here, the debtor’s grief over his wife was not sufficient to justify the long delay since he was able to function otherwise and even to negotiate with the IRS over the unpaid taxes.
Henry v. Off. Cmte. of Unsecured Creditors of Walldesign, Inc. (In re Walldesign, Inc.), 872 F.3d 954 (9th Cir. 2017). Recipients of payments made from funds of debtor at (mis)direction of corporate principal were initial transferees of payments.
The debtor’s president set up a secret bank account into which funds owed to the debtor were deposited and he then made transfers from that account for his personal expenses. The recipients of the payments argued that he should be treated as the initial transferee and they should be subsequent transferees, which would allow them more defenses to an avoidance action. The court denied that argument, holding that it was required to use the control and dominion test to determine when one was a transferee and the president never had such dominion over those funds in his personal capacity. That is, while he did direct they be put into an account that only he knew, the fund was still maintained in the name of the company and the funds never devolved into his control in a personal capacity. Thus, his misdirection of the funds was not functionally different than if he had directed the corporation’s normal funds be used to pay his expenses. While the result was hard on the recipients, they could at least see that they were being paid from a corporate account and that could have raised red flags for them. As such, it was more equitable for them to be forced to repay the funds than for the wholly innocent creditors to lose out.
Hurt v. HUD (In re Hurt), 2017 Bankr. LEXIS 4403 (Bankr. W.D. Va. 12/27/17). Setoffs are not governed by the preference section; the only applicable limits are in Section 553.
The debtor owed about $20,000 on a loan from HUD; he was notified in August 2016 that HUD would seek to intercept any tax returns. On February 23, 2017, the Treasury processed a efund for the debtor of some $5,300 and turned the funds over to HUD. The debtor filed his petition a few weeks later and sought to avoid the intercept as a preference under Section 547 so he could claim the funds as exempt. The court rejected the debtor’s arguments, noting first that the term “transfer” is defined in Section 101(54) without reference to a “setoff” and the legislative history makes clear that was done deliberately. Rather than treating setoff under the general Section 547 provisions, special rules are applied in Section 553. That section, in turn, makes clear that it governs over any section not explicitly listed therein, such as Section 547. In turn, it states that a creditor may not use setoff to improve its position from before the 90-day prepetition period begins – or from the date where there is an “insufficiency” – to the date of the petition. An “insufficiency;” i.e., a point where the claim against a debtor exceeds the claim owed to a debtor, only exists where mutual debts exist. Here, on the 90th day prepetition, the government did not owe the debtor anything but the debtor owed HUD some $20,000. On December 31, a mutual debt arose when the tax year ended and the right to a refund of $5,300 was created, which then created the $15,000 insufficiency. That same insufficieny persisted, without change, throughout the preference period until the case was filed so there was no improvement during that period.
In re Health Diagnostic Laboratory, Inc., 2017 Bankr. LEXIS 4148 (Bankr. E.D. Va. 2017). Right to elect whether or not debtor shall retain its status as “Subchapter S corporation” is not property of the estate and revocation of status is not avoidable transfer.
The debtors were established as so-called “S corporations,” i.e., their income was passed through to their shareholders and reported on their tax returns, thereby ensuring that the income was only taxed once and not at both the corporate and personal levels. As a corollary, distributions are normally made to shareholders in the amount needed to pay the taxes accruing on that income. When the debtors filed bankruptcy, the trustee sought to recover those distributions as being fraudulent transfers since the income on which the tax is being paid is, on paper, the income of the shareholders, not the debtor. As such, and as the parties with deeper pockets, the trustee may well seek recovery of the distributions from the taxing authorities who received the tax payments. (This was the scenario in DBSI in which the IRS and a number of states were sued.)
The wrinkle here was that the shareholders revoked the S Corporation status in the year of the bankruptcy filing (foiling the trustee’s plan to demand that they take the net operating losses from that year and carry them back to prior years, obtain refunds, and then turn those refunds over to the estate for payment to creditors). The trustee sued the shareholders, the United States and a number of states to try to force the IRS to revoke the revocation and restore the S corporation status, arguing that the right to make that choice was property of the estate and he should be able to control the debtor’s status. There were numerous other problems with his position but the court focused first on the property of the estate issue. If that right did not belong to the debtor, then the decision to revoke the status was not one that could be avoided because there was no “property” to return to the estate. The court adopted the Third Circuit’s analysis and held that, as a functional matter, the right to adopt or revoke that status rested under IRS law with the shareholders, not the debtor. As such, their decision could not be altered by the trustee. The trustee chose not to appeal the decision (or to try to assert other theories against the taxing authorities) so this is the final decision on this matter.
Gunsalus v. Ontario County, 576 B.R. 302 (Bankr. W.D. N.Y. 2017). Properly conducted tax sale cannot be avoided as fraudulent conveyance no matter how low the price received.
In BFP v. Resolution Trust Corp., 511 U.S. 531 (1994), the Court barred attacks on properly conducted foreclosure sales based on the alleged insufficiency of the consideration received at the auction. It held that respect for state law and the stability of the real estate market precluded intrusive review of such sales and that a property subject to a forced sale was simply worth less than one without such constraints. In recent years, many cases have considered whether the same principles should apply to tax sales, since some do not involved competitive bidding at all and, in other cases, the process is not structured to try to obtain the full value of the property. Rather, they are often set to ensure that the amount the debtor must pay to redeem the property is the lowest amount possible after the government is paid in full. As such, it is practically axiomatic that the amount paid by the buyer is nowhere near any sort of reasonable market value for the property. Moreover, under New York law, the county is allowed to seize the property after certain procedures are followed and then it may sell the property at auction, and keep not only the taxes owed but the entire auction price – thereby conclusively showing that even in that forced-sale scenario, the house is worth far more than the taxes. (Here, for instance, one house sold for $22,000 with delinquent taxes of $1,200; in another case, the debtors had a house appraised at $87,000 that sold at auction for $27,000 of which only $5200 was owed for taxes.)
The court here had initially focused on the lack of competitive bidding and viewed that as a basis to distinguish tax sales from BFP’s holding, particularly since the Court had noted that other types of sales “may be different” from the result it reached in BFP. The court, now though, concluded that the only binding aspect of BFP was the requirements for notice, opportunity to cure, and compliance with state law. Once those aspects are met, the party’s only recourse is to hope that there is some provision in state law for a “shock the conscience” review of the adequacy of the payment. And, since the Supreme Court had previously rejected constitutional challenges to foreclosure actions for unpaid utility bills (with likely an even worse price-to-debt ratio) where the government retained the entire price. As such, there was no basis to treat a tax lien foreclosure any differently. If the statute is too harsh, the recourse is to seeking help in the state legislature, not the bankruptcy courts.
ASSET SALES AND PROPERTY OF THE ESTATE
IDEA Boardwalk, LLC v. Polo North Country Club, Inc., 2017 U.S. Dist. LEXIS 180076 (D. N.J. 10/31/17). A sale of a property with current tenant leases must satisfy both Section 363 and 365; tenant is entitled to continue to exercise recoupment against rent due.
The debtor sold a building in which it had a number of valid tenant leases under the “free and clear” provisions of Section 363 and also sought to reject the leases of those tenants pursuant to Section 365. The court allowed the sale and the rejection but noted that Section 365(h) protects the rights of the tenants. Rejection is not treated as a termination of the lease but merely a breach by the landlord of its obligations thereunder to provide services or other benefits. Section 365(h) provides, though, that regardless of any other breach, the landlord-debtor is not allowed to breach the tenant’s right of quiet enjoyment of the lease or to change the terms of the rent payments. Moreover, if the debtor does fail to perform its other obligations under the lease, the tenant is allowed to offset against the rent any damages caused by that nonperformance. Those same consequences applied to the purchaser based on a prior decision of the court. Those rights also included, according to the bankruptcy court, the right to continue applying certain recoupment rights that had already accrued under the lease and that were tied into the calculation of the rent. The district court agreed that this was allowed and the essence of the tenant’s action was the assertion of a right of recoupment – a right that would survive the entry of the debtor’s discharge of prior debts.
Brandon v. Sherwood (In re Sann), 2017 U.S. Dist. LEXIS 171729 (D. Mt. 10/17/17). Funds held pursuant to FTC asset freeze order were property of estate and could not be used by debtor.
The debtor agreed to a stipulated injunction in an FTC case freezing his funds but allowing his attorney to hold them and release a set amount per month for living expenses. After he filed bankruptcy, the attorney continued making payments to him from those funds despite being advised by the debtor’s bankruptcy attorneys that he should not do so. The Chapter 7 trustee sued the attorney for turnover of the balance of the funds being held and for the postpetition payments to the debtor. The district court affirmed the bankruptcy court’s ruling that the funds were property of the estate and that the “spendthrift trust” exception under Section 541(c)(2) did not apply. That exception excluded funds held in a valid trust that includes a restriction on transfer enforceable under federal or state law from inclusion in the estate. The court found that, while the latter two factors applied, the funds were not held in “trust,” but rather were simply being retained as part of a temporary litigation order. The funds were not being held for the benefit of the debtor (as would normally be the case for a spendthrift trust) nor, conversely, was there any indication that the FTC wanted to allow the debtor to have any control over the funds as a trustee for them. As such, the lawyer was obligated to have turned over the funds on request and could be liable for failing to do so without any authority from the court.
In re Zullo, 2017 Bankr. LEXIS 4198 (Bankr. D. N.J. 12/8/17). Debtor may not use Section 522(f)(1) to avoid a judicial lien that was already fixed on the property before he acquired it.
Section 522(f)(1) allows a debtor to avoid the fixing of a judicial lien to the extent that the lien would impair the debtor’s exemption. This provision, however, does not apply when the debtor acquires a property to which the lien has already attached (so as not to allow the debtor to destroy an existing creditor’s rights merely by transferring the property). Rather, it is meant to ensure that existing exempt property does not lose that status if a judgment later issues that imposes a lien. The limit applies even if the debtor had held the property by the entireties with his wife (who incurred the debt) before she transferred it to him in fee simple. That was a new status so when he took the property as such (for a dollar), it was already encumbered.
In re Mejia, 576 B.R. 464 (Bankr. S.D. N.Y. 2017). Debtor may sell property after it has been abandoned, but trustee’s mere statement of “no assets” and “no distribution” did not do so.
The trustee reviewed the debtor’s assets in his Chapter 7 case and determined he had no equity in his home above his mortgage and homestead exemption. The trustee declared the case to be a “no asset” filing, stated there would be no distributions, and then stated that she was abandoning the property. The debtor thereafter obtained a purchase offer that would pay off the mortgage and the broker’s commission and still leave him with some funds towards his exemption rights. The court held a debtor could sell property “outside the case” without retained professionals or the like (and without paying the trustee a fee), but only after the property was abandoned in accordance with section 554. Property can be automatically abandoned at the end of the case but to do so while the case is open, either the debtor or trustee must move for authority to do so and give notice to other parties (so they can challenge the sale if appropriate). Here, the court treated the trustee’s objection to the debtor’s motion as more akin to providing the required notice of a desire to abandon the property and allowed that to be done. The court did hold, though, that the sale was taking place outside the bankruptcy and would receive protection under Section 363(b).
In re Packard Square LLC, 575 B.R. 768 (Bankr. E.D. Mich. 2017). Discussion of standard for allowing receiver to remain in control of case.
Under Section 543, a prepetition “custodian” of the debtor’s property must turn over the assets to a bankruptcy trustee (or the debtor) upon a petition filing, but that “turnover” obligation can be excused if the interests of creditors are better served by leaving the assets with the receiver. In this case, the debtor was trying to manage a large renovation project without a great deal of success. The lender had obtained appointment of a receiver in state court some 10 months before the bankruptcy who had done substantial work on the project (and determined the debtor had seriously underestimate the cost). The debtor filed bankruptcy to try to wrest back control of the project, but the bankruptcy court concluded that it would not be helpful to change course yet again or to put the debtor back in control of a project that it had not succeeded with before and that it had no funds to complete since the court would not approve the terms of a DIP loan that it sought to take out. Accordingly, the court not only denied the turnover motion but also used its powers under Section 305 to abstain entirely from hearing the matter and dismissed the case.
CHAPTER 7 ISSUES
In re McCray, 578 B.R. 403 (Bankr. E.D. Mich. 2017). Debtor only has three options in Chapter 7 with respect to personal property subject to a security interest – redeem, reaffirm, or surrender. The “ride through” option is not available; failure to perform chosen option lifts the stay.
Section 521(a)(2) only provides a debtor with three options as to how to deal with personal property that secures a debt – redeem, reaffirm, or surrender. While courts prior to BAPCPA sometimes allowed a fourth option – having the debt simply ride through the bankruptcy with the debtor continuing to pay, but not formally reaffirming the debt – the court here concluded that, after BAPCPA, it was clear that that option was not available. What BAPCPA also clarified was the obligation of the debtor to choose and the consequences of failing to do so or to perform the choice. Section 362(h) automatically terminates the stay after a period of time if the debtor either does not state his intention or fails to carry out the intention. In addition, Section 521(a)(6) reiterates that the debtor is to “not maintain possession of” the property at issue, and if it does so, the stay is again terminated and a creditor is free to use any of its nonbankruptcy enforcement rights. (This is another reason to find that the “stay and pay” fourth option is not allowed.) What those sections do not provide is what the creditor wanted – to keep the debtor in bankruptcy with the court ordering the debtor to comply with its intention (on pains of contempt sanctions) to avoid the costs and burdens of enforcing its rights under nonbankruptcy law.
In re Arndt, 2017 Bankr. LEXIS 3834 (Bankr. N.D. Ohio 11/6/17). Very extensive discussion of whether debtor may count payments for assets to be surrendered for purposes of the Section 707(b)(2) means test, and noting contrary analysis under Section 707(b)(3) substantial abuse test.
In this opinion that was both exhaustive and exhausting discussion, the court reviewed every case and every argument with respect to whether a debtor should be able to deduct expenses on the means test for secured debts that he had indicated he planned to surrender to the creditors. The court lists literally dozens of cases supporting the majority view – that such payments may be deducted for purposes of the mechanical means test under Section 707(b)(2) – and then dissects and rebuts at equally great length every argument raised by any case that had suggested a contrary view. Finally, in only a few pages, the court quickly notes that Section 707(b)(3) provides a fall back that allows for dismissal of a case for “substantial abuse.” While imposing a stricter standard, this section does allow for a more particularized analysis and courts have readily concluded that they could take these payments as evidence of abuse if the debtor seeks to deduct them while also conceding that it does not intend to pay them going forward. In this case, the debtor’s actual expenses would allow her to pay $30,000 in a Chapter 13 plan, well in excess of the abuse threshold. Accordingly, she was ordered to convert her case or have it dismissed.
CHAPTER 11 ISSUES
Apollo Global Mgmt., LLC v. Bank of America, NA (In re MPM Silicones, LLC), 874 F.3d 787 (2nd Cir. 2017). In a Chapter 11 case, court should use market-rate approach to determine proper interest rate to pay on notes under a plan.
In Till v. SCS Credit Corp, 541 U.S. 465 (2004), the Court held that the appropriate rate for interest payments under a Chapter 13 plan to provide a secured creditor with the total “value, as of the effective date of the plan” of its claim should be based on a formula that starts with a risk-free rate, such as the national prime rate, and then adds a 1-3% margin based on the risk of the debtor not completing the plan. This result is very helpful to debtors since it often results in a rate far below what the debtor had contracted to pay. (In Till, the debtor was paying 21%; under the formula, he would start with the then 8% prime rate and apply no more than 3% thereto). Here, though, the issue was whether the same process should be used with Chapter 11 debtors, particularly since the Court had stated in Till that the result might be different where there was an “efficient market” for the type of loan at issue. Here, the court found, there was a viable market for lenders willing to offer post-confirmation debtor financing and that there was testimony that loans would have been available, but at a rate about 1 to 1.5% higher than the bankruptcy court was prepared to apply under its version of the formula. (Actually, had the bankruptcy court merely applied the full 3% risk factor, it would have reached a result close to what the “efficient market” would produce.) In any event, the Second Circuit remanded the issue for the lower courts to reconsider using the market approach.
JD Holdings LLC v. John Q. Hammons Fall 2006, LLC (In re John Q. Hammons Fall 2006, LLC), 2017 Bankr. LEXIS 4426 (10th Cir. BAP 12/28/17). Debtor allowed to reject executory contracts while creditor’s motion to dismiss case due to debtor’s alleged ineligibility to file was pending; eligibility limitations in Section 109 are not jurisdictional.
This case raises issues similar to those in the Pratola case below in Chapter 13 – namely, what can/should the court do while a timely challenge to the debtor’s eligibility to file bankruptcy is pending. A creditor in this case asked that the case be dismissed for several reasons, including the alleged ineligibility of the debtor to file in Chapter 11. At about the same time, the debtor filed a motion to allow it to reject a contract with that same creditor that was the subject of the exact litigation that the bankruptcy had been filed to forestall. The bankruptcy court approved the rejection motion without deciding the dismissal motion (which it did not rule on until October 2017). In doing so, the court held (and the BAP affirmed) that the eligibility of the debtor was not a jurisdictional criteria and it could act on other issues prior to resolving that question. The BAP only cited one case for that proposition which made the statement in dicta, but other cases do appear to conclude that the requirements in Section 109 do not implicate the bankruptcy court’s subject matter jurisdiction (which is stated in 28 U.S.C. 1334). The BAP’s main point appeared to be that, as a practical matter, a debtor has to be able to continue to operate even if a creditor initially raises an eligibility dispute. That may be true and the court may have to assume its right to proceed on normal issues while it is determining the debtor’s eligibility. It is distinctly problematic, though, to allow months to go by and major decisions to be made in a case (particularly one such as here that gave the debtor the relief it had been denied in the state court litigation) without deciding whether the debtor was even eligible to assert those rights. It is perhaps poetic justice that, in the end, the debtor was unable to propose a viable plan, lost exclusivity, and ended up agreeing to support a creditor-filed plan that largely approximated what would have resulted from the state court litigation in any event.
In re Archdiocese of St. Paul & Minneapolis, 2017 Bankr. LEXIS 4424 (Bankr. D. Minn. 12/28/17; In re SunEdison, Inc., 576 B.R. 453 (Bankr. S.D. N.Y. 2017); In re Midway Gold US, Inc., 575 B.R. 475 (Bankr. D. Col. 2017). Discussions of scope of allowable releases in Chapter 11 plans.
Debtors routinely seek to include release and exculpation provisions in their plans, not only for themselves and their employees, but often for third parties, such as banks funding the plan, non-debtor parties who may be co-liable with the debtors, and many other scenarios. Creditors and the U.S. trustee just as often oppose some or all of such provisions. This trio of decisions from different circuits discuss the applicable standards and the different approaches that have been taken to the issues. There are typically three types of proposals – releases for the debtor and affiliated persons for prepetition conduct; releases for non-debtor, separate third parties for their own non-bankruptcy conduct, and “exculpation” provisions which is used to describe provisions protecting parties for their postpetition conduct in negotiating the plan. The latter typically is the least controversial type of release and the allowed scope the most settled – generally, if the provision excludes willful misconduct, fraud, gross negligence and the like and applies only with responsibility for those negotiations, it will be allowed. The general rationale is somewhat akin to provisions dealing with immunity for actors in the judicial process – i.e., if parties involved in negotiating a plan could be sued by disgruntled creditors, few would ever choose to participate. It also is tied to the treatment of creditors’ committees under Section 1103(c), which is generally viewed as entitling them to a form of qualified immunity.
As to the other types of releases, the first level of analysis is that Section 524(e) provides that the statutory discharge only applies to the debtor itself and does not affect the liability of any other party. (This is why an insurance company remains liable, for instance, to pay a claim for a tort debt that the debtor has been discharged from.) The Fifth, Ninth and Tenth Circuits relied on that language as a basis for generally denying third party releases. Other circuits, though, have treated that language as only prohibiting a “discharge,” – i.e., an automatic release of liability upon confirmation of a plan, but not as necessarily precluding the granting of a “release,” which is usually defined as some form of consensual agreement with the creditors. Alternatively, the issue is also often analyzed in terms of whether the non-debtor party has paid sufficient value so as to have “bought” a release of its liability. (An insurance company that tendered the full value of its policy to the court might seek to be released from any further involvement in the case on that basis.) Under either rationale, at least some degree of non-debtor release has become commonplace (at least in the bankruptcy centers of New York and Delaware) despite ritual recitations that such relief is proper only in “rare” circumstances.
The court in Midway viewed the Tenth Circuit decision as only applying to third party releases for entities that were co-liable with the debtor for a debt it was being discharged from, but not as applying to separate liability that the third party might bear. In considering the request for a release, the courts that allow them typically look at several factors including how closely the third party’s status is intertwined with the debtor’s (so as to determine whether the third-party action will have an impact on the debtor’s assets), whether the third party has made a substantial contribution to the case such that the injunction is critical to the reorganization, whether the affected class has supported the plan and whether all or most of their claims are being paid. There is also a difference between a debtor deciding to release its claims against third parties (which is just another form of settlement of a claim to a potential asset which debtors do all the time) versus the debtor seeking to release claims between two sets of non-debtor parties.
The Midway case has a good analysis of several types of releases and exculpations, pointing out the subtle ways in which they may apply more broadly than appropriate when closely parsed. Among other things, it held that exculpation provisions only properly applied to entities that had fiduciary duties in the case (such as the committees) and not to every party that had any involvement in agreements that went into the plan. It also discussed what options had to be allowed to creditors in order to validate third-party releases. In order to rely on the view that the release is a voluntary waiver by the creditors, courts have, in many cases, required opt-out provisions for creditors. The problem, of course, is that, if opting out is painless, every creditor will likely to do so. So, plans often only provide a benefit to those who opt-in or attempts to “deem” that a release has been granted unless the creditor takes affirmative steps to opt out. Plans may seek to deny any right to opt out to creditors that are “deemed” to accept the plan, but, conversely, require creditors that are “deemed” to have rejected the plan to take further action to opt out. The court here noted first the jurisdictional problem caused by an attempt to release claims between third parties that were not related to the debtor and held that the court had no power to release those in any event. The fact that the third party might have contributed financial support to the case did not give the court power to release all claims against it even if the payments might allow the debtor to provide additional funding for the creditor claims against it. The court did not rule specifically on the merits of the opt-out provisions, noting only that they could not confer jurisdiction on it that did not otherwise exist.
Sun Edison, on the other hand, did concentrate on issues relating to the “deemed approving” provisions of the plan with respect to non-voting creditors. The court held that, even in the face of language in the disclosure statement that said the debtor would ask the court to bind non-voting creditors to the release, it would not treat those creditors as having approved the release. The debtor cannot convert silence into consent (which the court viewed as required, not merely the absence of affirmative opposition) unless a party has a duty to speak. The creditors did not have such a duty to speak (or vote), had done nothing to mislead the debtor, and could not be forced to act merely because of the debtor’s warnings as to its own proposed course of action. The court then held that it would not be appropriate to impose the release on creditors absent their consent, even if third parties had contributed to the case. The language used went far beyond the court’s possible power to enjoin cases that would involve the debtor’s indemnity obligations. As such, the court held the debtor must propose an amended, much narrower release before approval might be considered.
In the Archdioecse case, the court discussed the standards used in various courts and the relevant factors that could justify a release. In that case, the court found that the third parties at issue (primarily insurers to the debtor who sought a “channeling injunction” to have all claims against them and their coverage directed to a fund they were paying into) had satisfied the criteria of being critical to the reorganization and supplying a substantial contribution. However, they had not shown that there was a substantial majority in support of the plan (which he defined as at least a majority) – to the contrary, the class of victims had overwhelmingly rejected the plan. Accordingly, the judge denied confirmation on that basis.
Fifth Third Bank v. Circulatory Centers of America, LLC, 2017 Bankr. LEXIS 4292 (Bankr. W.D. Penn. 12/15/17). Trustee warranted where corporate principals structured transaction so as to protect their own interests, not those of creditors.
The same parties owned a number of affiliated entities, some of which were liable on a large debt and had filed bankruptcy, as well as at least one that was not liable and that remained outside the case. The owners investigated a number of potential sales of the entire business and received offers on that basis. They then decided thought to structure the transaction to allocate a “wildly disproportionate” amount of the total price to the non-debtor affiliate. That would, in turn, allow them to use funds received by that affiliate to pay a debt to the government that they would otherwise owe personally. The court concluded that the combination of these factors meant that the owners were ignoring their fiduciary duties to other creditors in order to help themselves and this was sufficient to warrant displacing them from management of the companies.
In re Ultra Petroleum Corp., 2017 Bankr. LEXIS 3746 (Bankr. S.D. Tex. 10/26/17). Case certified for direct appeal to Fifth Circuit on issue of what constituted impairment of claim.
Section 506 sets a number of limits on how much of a nonbankruptcy claim can be “allowed” for payment under Title 11. The limits are generally intended to limit how much of particular claims (such as for rent under a long-term lease, where the landlord can presumably re-rent the property after a time)) can be put into the payment pool so as not to overwhelm the amounts owed to others. In turn, Section 1124 defines when a claim is “impaired” for several purposes under the Code (including whether the creditor is conclusively deemed to support the plan). The question for direct appeal was whether “impairment” is analyzed in terms of the creditor’s nonbankruptcy rights or only against the “claim” that the creditor is allowed under Section 506. The Third Circuit took the latter position, the court here suggested that it viewed the former view as correct.
In re Energy Future Holdings Corp., 575 B.R. 616 (Bankr D. Del. 2017). Court reconsidered grant of termination fee based on its misunderstanding that fee could be earned even if estate did not benefit therefrom.
Energy Futures entered into a purchase agreement that required regulatory approval. The sale agreement included a $275 million termination fee that was to be paid if the transaction did not close for certain reasons. The court sought to ensure that the fee would not be owed if the buyer chose for its own reasons, including the lack of regulatory approval, not to go through with the sale, although it would be owed if the debtor was able to find a “higher and better” deal. The court viewed the fee as acceptable under those terms, but later when the regulators did, in fact, condition approval of the sale on terms the buyer found unacceptable, it became clear that the buyer could simply refuse to terminate the sale and force the debtor to do so in order to sell to someone else. Doing so, though, would trigger the payment but provide no benefit to the estate. The court held that it fundamentally misunderstood the terms of the payment and that warranted reconsideration of its order. The court noted some reasons a break-up fee might be warranted, but payment of a fee when regulators made legitimate choices was not proper and would unduly pressure their judgment. As such, the payment would not benefit the estate and was not justified.
CHAPTER 13 ISSUES
Gorman v. Cantu, 2017 U.S. App. LEXIS 25487 (4th Cir. 12/18/17). Where debtor sought to resume making retirement contributions after his 401(k) loan was paid off, his established pattern of contributions and relatively modest amount of contributions showed he acted in good faith.
Courts have used several approaches with respect to whether debtors are allowed to contribute to their 401(k) accounts during their Chapter 11 case – i.e., not at all; only if they were contributing before and only to the same extent; or at any time subject to a showing of good faith. Here, though, the trustee argued that, regardless of the approach, the debtor was not acting in good faith here where he was only 38, was earning an above median income salary, was only going to pay creditors about a third of what they were owed, and only included the payments after the trustee challenged his plan calculations. The Fourth Circuit, though, focused on the fact that the debtor had been making the contributions since 2000, had stopped only when he was barred from making them due to having taken out loans from his account, and proposed to use only the amount freed up after one loan was paid off ($268 a month) to resume contributing. That amount is well below the maximum allowed for such contributions and was the debtor’s only form of retirement benefits. As such, the court held, he was acting in good faith. (One might also note that a one-third payment ratio is actually fairly high for a Chapter 13 case and that, while he was young, retirement planners emphasize how beneficial it is to save at an early age.)
Max v. Northington (In re Northington), 876 F.3d 1302 (11th Cir. 2017); Encore Assets, LLC v. Woodley (In re Woodley), 2017 Bankr. LEXIS 4299 (Bankr. N.D. Ga. 12/18/17); In re Robinson, 577 B.R. 294 (Bankr. N.D. Ill. 12/5/17); In re Alexander, 2017 Bankr. LEXIS 3896 (Bankr. N.D. Georgia 11/13/17); In re Keisler, 2017 Bankr. LEXIS 3617 (Bankr. D. S.C. 10/16/17); In re LaPorta, 2017 Bankr. LEXIS 4155 (Bankr. N.D. Ill. 12/5/17). Discussion of whether and how a debtor may use Chapter 13 rather than redemption to pay amount owed to a secured creditor.
All of these cases (except LaPorta, which is a Chapter 11 case, but reasons by analogy to Chapter 13) deal with whether a debtor holding property which is collateral for a debt to which a right of redemption applies is subject to the time limits in Section 108, or whether the debtor may use the full time allowed under a plan to pay off that debt. Encore, Robinson, and Alexander all dealt with debtors who sought to be able to use a Chapter 13 plan to retain property that had been sold at a tax sale and where the redemption period was still open when the case was filed. Each proposed to use the plan to pay off the claim over a period that would extend long past both the original deadline and the extension granted in Section 108(b) (i.e, up to 60 days). Keisler dealt with a similar issue involving a loan on a truck owned by a company of which the debtor was the sole member and so to which he had personally guaranteed the debt. LaPorta dealt with a Chapter 11 case which has somewhat less restrictive language regarding being able to restructure a loan and extend its terms. In each of those cases, the courts held that the debtor was not actually seeking to exercise a right to “redeem” its debt, but rather was utilizing the provisions of Section 1322 (or 1125) that allowed it to “modify” the terms of a secured claim. Courts taking that view consider Section 1322 to be the more specific provision that controls over the general language in Section 108. They view the debtor as holding all rights to the asset subject solely to the rights of the lender as a secured creditor – and those rights are, in turn, subject to modification in a plan. Some of the courts also suggest that allowing the modified form of payment is simply “redemption” in another form, i.e., payment by installment. (It is not clear why any party would ever opt to perform a lump sum redemption under that analysis since it would always be in the debtor’s interest to retain funds for as long as possible. It would also appear that this view of “redemption” as allowing installment payments is contrary to the view of other courts that the “fourth option” in Chapter 7 or “retain assets and pay over time” is not redemption within the meaning of the Code.) In any case, under this view, the debtor can use this method of “redemption” as least so long as the period had not expired on the petition date.
Indeed, Robinson holds that the debtor may make payments under a Chapter 13 plan even after the redemption period for a tax sale has expired until the point at which a tax deed was entered and recorded. At least in the context of a tax sale as opposed to a mortgage foreclosure, the taxpayer still held significant rights under state law after the sale was held and continued to be the title holder until the new deed was issued and recorded. As such, the court held, the buyer merely held a secured claim against the property and that claim could be modified outside the time limits for redemption, not least because once the bankruptcy was filed, the creditor was barred by the stay from obtaining or recording a deed. Again, the court noted the debtor was not actually redeeming the property – but, again, one might ask why would any debtor ever redeem property if this option was available? Encore took much the same approach, noting that Georgia law treats the original owner as continuing to hold title to the property at least until the right of redemption expired and, as such, the buyer only held a secured claim that could be modified. The case does note that other decisions in Georgia have taken the view that Section 108(b) is the only basis for extending a deadline but that here no foreclosure notice had actually issued yet so no deadline had been set that had to be extended.
Encore’s last point is interesting, since it fails to even mention the Northington case despite that decision having issued from the Eleventh Circuit a week earlier. The latter case dealt with a somewhat different fact pattern – namely a “pawn” transaction in which the debtor pledged his car in exchange for a loan. But, like the others, he defaulted on repaying the title loan, and filed a Chapter 13 petition just prior to the expiration date of the redemption period. As the court phrased it, even assuming the car and the right of redemption become part of the estate on the petition date, did the filing freeze the lender’s status as the mere holder of a secured claim? Or did the pawn statute continue to run so that, at some point, the car was “automatically forfeited” to the pawnbroker such that there was no longer a bankruptcy claim to be redeemed. Contrary to the analyses above, the Eleventh Circuit held that the state law provisions did continue to operate in the background and that, at the prescribed moment (taking into account the Section 108(b) extension), the car “dropped out of the bankruptcy estate” so the pawnbroker no longer had just a claim, he now had the car itself. A pawn transaction does, in fact, result in the borrower signing over the title to the broker, so that may be a relevant difference, but as a whole the analysis is at odds with most of the reasoning of the cases above. The majority in the case concluded that, based on the automatic nature of the pawn statute, any right to regain title passed by operation of law at the moment the redemption period expired. This would, arguably, be the equivalent of the title deed being recorded in the cases above – an affirmative act that could not take place during the case because of the automatic stay, but was not needed here where the title was already in the hands of the broker, subject to the conditional rights of the debtor. The court also held that the stay would not indefinitely “toll” a redemption period since there was already a tolling provision in Section 108 – and, moreover, the running of a time limit is not an “act” by a creditor. Nor does the fact that something is property of the estate on the petition date preclude it from disappearing during the case – i.e., if a debtor does not exercise an option in a contract that right will disappear without violating the stay or the definition of property. It will be interesting to see if this case only presents an unusual fact pattern or if it portends a broader limitation on using Chapter 13.
Sharkey v. Stevenson & Bullock, PLC (In re Sharkey), 2017 U.S. Dist. LEXIS 188689 (E.D. Mich. 11/15/17). Creditors in Chapter 13 can receive a “substantial contribution” payment in unusual circumstances, even though Section 503(b)(3)(D) only refers to Chapters 9 and 11 cases.
This case had originally been filed in Chapter 7 and the trustee’s law firm had incurred significant fees challenging certain claims of the debtor to exemptions in annuities. When the case was converted to Chapter 13, the firm (then simply a creditor for its unpaid fees) continued to contest the exemptions and was eventually successful in having the exemptions denied. (The Chapter 13 trustee concurred in that objection but apparently did not do the work thereon). The bankruptcy court granted the law firm’s motion to be given a substantial contribution payment, relying on the Sixth Circuit’s decision in a case involving a somewhat similar issue in a Chapter 7 case. In that case, the original trustee had been grossly negligent in conducting an adversary proceeding and three creditors successfully moved to replace him. He was sued by the successor trustee and paid a substantial sum of money. The creditors sought payment for their costs and fees incurred in the removal of the trustee, arguing that they had, thereby made a substantial contribution to the case. The Sixth Circuit agreed they could be paid, even though Section 503(b)(3)(D) only refers to Chapters 9 and 11 cases. The court found that the section used the term “including,” which is not a term of exclusivity. Moreover, the court held, the structure of Chapter 7 meant that outside parties were not normally needed to run the case but that did not apply when it was the trustee himself that was the party to be sued. Accordingly, it held that an administrative expense award could be given for the same reasons as in the other chapters. The court here held that the same reasoning could apply in Chapter 13 at least where, as here, the Chapter 13 trustee did not actively challenge the exemptions. leaving that entirely to the creditors. While it might be better for the creditor to affirmatively ask to be substituted for the trustee, the court did not require that.
Va. v. Beskin, 2017 U.S. Dist. LEXIS 173197 (W.D. Va. 10/19/17). Payments that are to be returned to debtor under Section 1326 cannot be garnished from the trustee first.
Under Section 1326(a)(2), if the debtor’s case is dismissed, the trustee is required, in general to return payments received, but not distributed, to the debtor. In a number of cases, creditors have argued that this sets up a debtor-creditor relationship between the trustee and the debtor and, like any other party, it should be possible to garnish the trustee for the funds he owes to the debtor. Since, under that argument the debtor still owes the funds to the debtor, this is no different from garnishing the debtor’s employer, for instance, and results in the funds being functionally paid to the debtor since they serve to reduce the debtor’s obligations. Most courts, though, including the court here, read the statute literally and say it only allows the payment to be made to the debtor directly, leaving the creditor to try to scramble quickly to catch up to the debtor and seize the funds through some other method before they are spent and dissipated.
In re Pratola, 578 B.R. 414 (Bankr. N.D. Ill. 2017). Court was not required to dismiss a case filed by a debtor with student loan debts that made the debtor ineligible to file in Chapter 13.
The debtor incurred $375,000 in student loans for degrees in interdisciplinary studies and cinema and television production. He has worked since 2013 at an Apple store making about $40-45,000 while paying on that debt under an income-based plan that was nowhere close to reducing the debt. After paying for several years, he now owes $570,000 and sought to file a Chapter 13 case to help deal with the debt. The trustee, though, moved to dismiss on the basis that his liquidated debts greatly exceeded the eligibility limit for a Chapter 13 debtor under Section 109. The court noted that the section only defines eligibility and Section 1307 is the section that provides for dismissal or conversion. That section states a number of circumstances that are included within “cause” but does not expressly refer to eligibility. The court concluded that, since the debt limits were placed into the Code at the time that it was drafted to include small businesses, they should basically be read to only be concerned with such debt and it should be assumed Congress did not intend to exclude debtors with large student loans. He also noted a number of reasons why it would be beneficial to have student loan debtors file in Chapter 13, particularly in light of the high costs of Chapter 11 and the skyrocketing levels of student debt. Based on all of that, he held that not being an eligible debtor was not necessarily cause for dismissal and he could allow an ineligible debtor to remain in Chapter 13. He cited no cases, however, for that proposition – the closest he came was a case that barred a trustee from belatedly raising the issue post-confirmation. The problem is that, no matter how worthy his points, it is unclear what it means to say one is ineligible to be a debtor in a particular chapter if the court can itself decide to allow that person to be a debtor in the face of a timely objection.
In re Kindle, 2017 Bankr. LEXIS 3796 (Bankr. D.S.C. 11/1/17). Student loans can be separately classified and paid in that discrimination was not “unfair.”
Section 1322(b) allows a debtor to separately classify and pay claims as long as discrimination between the classes is not “unfair.” That language, the court held, implicitly indicates that some degree of discrimination can be fair. In this case, where the debtors agreed to pay in an amount in excess of the projected disposable income calculated under the means test and would pay creditors about a third of their claims, it was not “unfair” for them to continue paying their student loan debt at the established rate outside the plan in order to stay on track with the debt and avoid increasing the interest and unpaid balance beyond what they owed when they started the case. While the student loan debt would receive about 44% of what was owed versus 33% for other claims, placing the claims in one class would only raise the payment to non-student loan debtors by about 3% or less than $3,000 over the course of the plan. The court did not find those differences to be sufficiently stark to bar confirmation of the debtor’s plan.
In re Mendenhall, 2017 Bankr. LEXIS 3600 (Bankr. D. Idaho 10/17/17). Arguably time-barred debts still count against the eligibility limits for Chapter 13.
Under Midland Funding, LLC v. Johnson, 137 S.Ct. 1407 (2017), even a time-barred debt is still a claim because it is still owed even if it cannot be enforced in court. As such, it is still counted in the eligibility limits for Chapter 13, since they require inclusion of all debts owed, even if the debt is disputed, as long as it is liquidated, which these student loans clearly were. As such, the debtor could not use Chapter 13 to resolve his debts even if, on objection to the claims, they would not need to be paid and he might well have a viable plan.
CHAPTER 9 AND 15 ISSUES
In re Lombard Pubic Facilities Corp., 2017 Bankr. LEXIS 4169 (Bankr. N.D. Ill. 12/6/17). An entity separately incorporated to operate a public facility for a county was not a governmental entity for purposes of whether it must file under Chapter 11 versus Chapter 9.
The case discusses how to analyze the status of hybrid entities that are created by a governmental entity and that serve quasi-public purposes but that also operate in competition with other private entities. The court looked at a number of factors including whether the government was actively involved in the management, whether the entity was performing a “core” government function, how it was taxed, and the like. Based on all of the factors, the court held this corporation was a private entity, not a pure instrumentality of the governmental entity that could file in Chapter 9.
Montana Dept. of Rev. v. Blixseth, 2017 U.S. Dist. LEXIS 206513 (D. Nev. 12/15/17). After 2005 amendments, any bona fide dispute over the value of a claim precludes the creditor from being a petitioner for purposes of an involuntary bankruptcy.
Filing an involuntary bankruptcy requires a specified number of creditors with undisputed claims above a specified minimum. Prior to the 2005 amendments, the courts were split as to whether a creditor whose claim was conceded up to a certain level (which would satisfy that minimum), but was disputed as to its total value, would qualify. Many courts agreed that, if the minimum were $10,000, for instance, and the debtor admitted that the claim was worth $12,500 but denied that it was worth the $50,000 the creditor was seeking, the creditor would still qualify. In 2005, the BAPCPA, however, was amended to provide that any bona fide dispute over the value of a claim would disqualify the creditor. Here, Montana claimed to be owed taxes arising from a number of issues – at least one of which (in an amount far in excess of the minimum) was not challenged by the debtor. However, the court agreed with the debtor that, under Montana law, there was an arguable basis to claim that the state could not break up the issues and seek payment on only one, at least not without taking other steps that it had not done. Thus, the court held, that was enough to make even the undisputed portion of the claim, disputed for purposes of the test. Other decisions suggest that, if a single party has several separable claims, the creditor can isolate a single, undisputed claim and rely on that as a basis to qualify. But, that quirk of state tax law apparently precluded that approach here.
The other aspect of the case that seems somewhat unusual is that the debtor was allowed to claim that he had 12 total creditors based on the fact that he had a number of ongoing parties with which he dealt and that, although he had timely paid the last bill he owed them, there was some amount that had accrued between the billing date and the petition date, so they were creditors too. However, it does not appear from the court’s discussion that they had billed the debtor for those services yet, much less that he had not paid an invoice that was due. Thus, it seems at least questionable that those amounts should be treated as claims or debts at all. See, for instance, In re Colon, 474 B.R. 330 (Bankr. D. P.R. 2012), which looked at those factors in evaluating which debts counted for purposes of determining the number of creditors the debtor had.
Jones v. Samson Res. Corp. (In re Samson Res. Corp.), 2017 U.S. Dist. LEXIS 174925 (D. Del. 10/23/17). Time for appeal is jurisdictional since rule is incorporated into statute.
The Supreme Court has clarified its position on whether time limits are “jurisdictional,” i.e., not waivable and violations not excusable, by focusing on whether the limit is set by statute or by rule. In this case, the time limits are set by a bankruptcy rule – but the rule is expressly incorporated into the statue and, as such, is treated as a statutory provision. The court also rejected the argument that the time started from the day after the order was dated when the order was issued electronically after hours or that the rule incorporated a 3-day “mailbox” provisions. Rule 9006(f), which has that mailbox language only applies it when the time period is calculated from the date of “service” of an order. Here, though, the time limit ran from the date of “entry” of the order, regardless of the means by which the appellant learned of the entry.
In re Bird, 577 B.R. 365 (10th Cir. BAP 2017). The BAP strongly affirmed a bankruptcy court’s view that a Chapter 7 trustee should not seek to sell fully encumbered property, even if it could obtain a carve-out from a secured party.
In two cases a trustee dealt with debtors whose homes were substantially overencumbered with both mortgage and tax liens. The trustee objected to the debtors’ claim of exemptions because the properties were substantially underwater but then obtained carve-out agreements with the IRS to allocate a portion of the funds it would receive from sale of the homes to the estate. Armed with those agreements, the trustee then sought to sell the debtors’ homes and leave them with nothing, while the trustee (and his counsel) would end up with substantial billings to the estate. The trustee was later able to obtain offers that would have exceeded the face value of the liens but would not have covered the various fees and costs of a sale, much less left anything for the debtors’ exemptions. The bankruptcy court allowed the debtors to convert their cases to Chapter 13 and then considered – and denied – the fee applications of the Chapter 7 trustee and his firm for their efforts in trying to make the sales. It held, and the BAP affirmed, that, unless a sale is likely to produce value for the unsecured creditors there is no basis for the trustee to seek to sell an asset rather than abandon it. Even if there is a carve-out, any rights so created must still go first to the debtor’s exemptions The point of the exemption statutes is to protect debtors’ rights in their homestead, not to allow a trustee to skip over those rights and direct the funds elsewhere. (The case is akin to Czyzewski v. Jevic Holding Co., 137 S.Ct. 973 (2017) which barred the debtor from skipping over the Code’s priorities.) Nor does the trustee owe any duty to the secured creditors to sell assets for their benefit; they have their own legal rights and are capable of enforcing them without adding on the costs of a trustee. As such, none of the fees generated benefitted the estates.
In re Gibbs, 2017 Bankr. LEXIS 4322 (Bankr. D. Hi 12/19/17); In re Rapid-American Corp., 2017 Bankr. LEXIS 4266 (Bankr. S.D. N.Y. 12/15/17); Robbins v. Delafield (In re Williams), 2017 Bankr. LEXIS 4183 (Bankr. W.D. Va. 12/8/17). Section 107, which allows sealing of confidential commercial information has a very limited scope; disclosure is the norm.
In each of these cases, the debtor sought to place information in the case under seal and the courts discussed the applicable standards. Robbins did allow some material to be sealed, the other two denied the request entirely. Each noted that disclosure was the normal baseline in a bankruptcy case and a motion to seal was not presumptively valid. Robbins had to do with a suit brought by the U.S. Trustee against several debt relief agencies and documents that were submitted there as potential exhibits and temporarily marked confidential. At the end of the trial, the agencies sought to maintain their scripts, employee training, partner manuals, and tax returns as confidential noting they contained commercial information, the agencies sought to keep them confidential even when used at trial, and only portions had been referred to. The court deferred judgment on them until it ruled on the merits of the case. On the other hand, newsletters were required to be available with only limited redactions. In Rapid-American, the debtor sought to conceal the amount it was being paid for two claims it was selling, and in Gibbs, a bank sought to have sealed the amount it was willing to pay to settle a claim of improper foreclosure. In both cases, the court refused – “commercial confidential information” has been defined as information that would give competitors an unfair advantage by advising them about the debtor’s operations. The sales price of a claim has nothing to do with the debtor’s operations and could not benefit competitors. Nor does a defendant’s desire not to let other potential plaintiffs know what it would settle for provide any advantage to the competitors of the debtor or the bank. Accordingly, the courts in both cases refused the request to seal the agreements.
In re Rupari Holding Corp., 2017 Bankr. LEXIS 4095 (Bankr. D. Del. 11/28/17). Debtor allowed to reject separation agreements to resolve discrimination complaints signed just prior to bankruptcy filing; treated as executory based on non-compete agreements despite debtor’s plan to immediately file bankruptcy and sell company.
The court noted these facts (with no sense of concern): the debtor, a meat products manufacturer, signed separation agreements to resolve age discrimination claims with two employees. The agreements included no-compete and no-solicitation clauses for the employees for six and twelve months, respectively; provided that the employees would be paid through their separation dates a few weeks later; and provided for additional payments to be made in installments. However, four days after signing the agreement with the second employee, the debtor filed a pre-packaged bankruptcy that provided for the sale of its assets to a company that chose not to assume these contracts. The court accepted the debtor’s argument that the employees still had materially unperformed obligations in the form of their no-compete and no-solicit agreements – although the debtor was clearly no longer going to be operating when it filed its case so it was unclear how it would benefit from such agreements. (Nor did the purchaser care since it rejected the agreements.) The employees, though, apparently did not make an effective argument that a breach by them of those clauses would have no material effect on the debtor (although it is difficult to imagine how it would), so the court concluded that the harm to them (losing their right to payment of the amounts owed to them) was not disproportionate to the harm that a (defunct) company might suffer if those provisions were breached. And, since rejection of the contract would benefit the estate by allowing it to not pay these employees that clearly satisfied the other criteria for rejection. Perhaps what the case most clearly illustrates is the problems caused by the overly broad use of these type of clauses with respect to employees generally. Not only can it harm them in obtaining future employment but can cut off their payment rights if their employer then files bankruptcy.
In re Dickson, 2017 Bankr. LEXIS 4030 (Bankr. E.D. Ky. 11/22/17). Filing a petition by a solvent party solely to avoid the consequences of being unable to obtain a supersedeas bond, with no intent of reorganizing, is for an improper purposes and warrants sanctions.
In a case involving a very dysfunctional family, the debtor, the 81-year-old mother of the primary creditor, was found guilty of interfering with the daughter’s inheritance, and inflicting emotional distress on the daughter. She was ordered to pay over $3 million, with $405,000 of that amount being for punitive damages. Although she was unemployed and on Social Security, she had assets of over $5 million. For reasons that are not clear, she was unable to obtain a supersedeas bond while she appealed the judgment. She then filed a Chapter 11 bankruptcy and the court found the filing was made in bad faith since it was done just to have the stay substitute for the bond. The debtor was solvent, it was a two-party case, she had no business to reorganize and did not want to liquidate her assets any pay the judgment.
Rule 9011 normally allows time to correct a violation but not when the violative act is the filing of a petition since the filing itself causes damage. The court noted that the dismissal of a petition for bad faith did not automatically require assessment of sanctions but it was warranted here where there was no bankruptcy purpose to be served and the debtor was dilatory about pursuing her state remedies or moving towards a plan. In terms of sanctions, though, the court gave credence to the debtor’s statement that she was following her counsel’s advice – and noted that the daughter had studiously avoided naming the mother’s counsel in her motion. Accordingly, it only imposed a $5,000 fine on on the mother, pointedly noting that the firm bore primary blame.
Glass v. Miller & Martin, PLLC (In re Hutcheson Med. Ctr., Inc.), 2017 Bankr. LEXIS 3523 (Bankr. N.D. Ga. 10/6/17). Law firm allowed to enforce forum selection clause in retention agreement to take malpractice suit out of bankruptcy forum.
Prior to its bankruptcy filing, the debtor obtained a loan for working capital and agreed to have part of its property put up as collateral. Its retained counsel, however, drafted the deed to secure debt (i.e., the lien document) in a way that included all of its property – which did not become known until a few years later when it was unable to close a loan for additional financing because of the overly broad lien filing. It filed bankruptcy not too long after and, in that case, was required to pay more to the first lender because of the latter’s (overly)secured position. When the trustee sought to bring a malpractice claim against the firm, it insisted that the matter had to be heard in Tennessee based on forum selection language in its retention agreement. The court agreed that the trustee’s suit was a non-core matter and, as such, forum selection clauses, like arbitration agreements were generally enforceable. Venue could be transferred under either 28 U.S.C. 1404(a) (the general statute) or 1412 (the bankruptcy-specific provision) and there was insufficient basis to deny the motion. The clause had been agreed to by sophisticated parties, was not ambiguous, and was not unduly inconvenient to the debtor. Moreover, this was true, even though the case was wholly centered in Georgia, had no connection with Tennessee – and could result in application of a Tennessee statute of limitations that might bar the trustee’s case altogether. The presumed moral is that one should be careful what one signs and not just treat venue and arbitration provisions as mere boilerplate.
Wonders v. United Tax Grp., LLC, 2017 U.S. Dist. LEXIS 166224 (S.D. Fla. 10/5/17). If debtor does not remove actions within the first 90 days, it must have stay lifted in underlying state court action in order to later remove matters.
28 U.S.C. 1452(a) allows the debtor to remove any pending (non-police and regulatory) civil action, and Rule 9027 determines the time when such removal may take place. Any action may be removed for the first 90 days after the petition date; if it is not done then, such an action is presumably dormant due to the automatic stay, so the debtor (or the creditor) may not later remove the action until the stay is lifted. The Rule then allows a party 30 days to make the removal. This is presumably meant to give the bankruptcy court discretion as to whether it wishes to allow anymore matters to be added to the bankruptcy itself at a belated date.