Bankruptcy Beach

Concealed Assets and Exemptions

2007-10-29T19:26:00.000-07:00

In a post last week, I reported on the 9th Circuit BAP’s recent decision, In re Onubah, 2007 WL 2701336 (Bankr. App. 9th Cir. August 31, 2007), which surcharged the Debtor’s allowed homestead and household goods exemptions in the amount of the attorney fees and other costs incurred by the trustee as a result of the Debtor’s legal and extra-legal obstruction of the sale of his home.

In the Onubah opinion, the Court tries to explain why the result, which amounts in part to an award of the Trustee’s attorney fees against the debtor, did not violate the “American Rule” that the parties to litigation bear their own fees:

[T]he American Rule has three exceptions: (1) when a litigant preserves or recovers a fund for the benefit of others; (2) when a losing party acts in bad faith; and (3) in a civil contempt action for disobedience of a court order. Perry v. O'Donnell, 759 F.2d 702, 704 (9th Cir.1985). . . . Even a charitable view of Onubah's conduct in this case would characterize it as being undertaken in “bad faith” and as an abuse of the bankruptcy process. This implicates the second exception to the American Rule.

The Onubah decision is tantalizingly close to Ninth Circuit authority for the proposition that an exemption can be denied in its entirety for bad faith conduct in relation to the exempt asset. The paradigm case is one in which the debtor, intending to conceal an asset from the trustee, fails to list it on the schedules. After the trustee discovers the asset and spends time and money preparing to liquidate it, the Debtor seeks to amend Schedule C to claim the asset exempt. The Tenth Circuit has recently ruled that such an amendment will not be allowed. See, In re Ford, 492 F.3d 1148 (10th Cir. 2007), following In re Grogan, 300 B.R. 804 (Bankr. D. Utah 2003).

A debtor’s attorney could argue that denial of an exemption for bad faith conduct is already addressed by Bankruptcy Code section 522(g), which forbids the taking of an exemption in property recovered by the trustee using the avoiding powers, if the avoided transfer was voluntary. The argument would be that if Congress had wanted to deny exemptions as punishment for unsuccessfully attempting to conceal an asset from the trustee, it could have said so expressly in section 522. A debtor’s attorney in the 9th Circuit might also argue that denying an exemption for bad faith conduct, as opposed to carefully surcharging the exemption by the amount of the fees and costs occasioned by the debtor’s bad faith conduct, amounts to withholding an exemption to punish the debtor, which is forbidden by Latman v. Burdette, 366 F.3d 774 (9th Cir. 2004)

The key distinction supporting the result in Ford may be that in the concealed asset cases the debtor must seek to amend Schedule C, and that the allowance of an amendment is within the discretion of the Court.

The Tenth Circuit’s ruling in Ford is welcome. It imposes serious additional, real consequences on the debtor for concealing an asset. The loss of an exempt asset by an otherwise “judgment proof” debtor has more real-life impact than even a denial of the bankruptcy discharge. The loss of an exemption also may benefit creditors in dollars and cents, immediately.

Debtors: On Vacating the Premises, Take Your Goo With You!

2007-10-23T10:03:00.000-07:00

A landlord has successfully circumvented the “cap” on lease rejection damages imposed under Bankruptcy Code section 502(b)(6). In deciding a case with highly unusual (and sympathetic) facts, Ninth Circuit Judge Alex Kozinski has made some broad statements that will henceforth encourage landlords to structure their claims, and their leases, to try to “beat the cap.” The case is In re El Toro Materials Company, 2007 WL 2822019 (9th Cir., October 1, 2007).

You’ve got to love these facts: The debtor was a mining company which had leased land from the Saddleback Valley Community Church. The rent was $28,000 per month. The debtor rejected the lease and vacated the property, leaving (in Judge Kozinski’s words) “one million tons of its wet clay “goo,” mining equipment and other materials.” Saddleback claimed “$23 million in damages for the alleged cost of removing the mess, under theories of waste, nuisance, trespass and breach of contract.” The bankruptcy court held that this claim was not subject to section 502(b)(6), which limits in amount “the claim of a lessor for damages resulting from the termination of a lease of real property.” The BAP reversed, reluctantly concluding that it was bound by its own precedent in In re McSheridan, 184 B.R. 91 (Bankr. App. 9th Cir.1995). McSheridan contains a broad holding to the effect that any damages arising from breach of any lease covenant is subject to the cap.

Here’s how the Ninth Circuit opinion distinguishes the damages for the abandoned “goo” (which certainly was a breach of a lease covenant) from other damages which would be subject to the cap:

The cap applies to damages “resulting from” the rejection of the lease. 11 U.S.C. § 502(b)(6). Saddleback's claims for waste, nuisance and trespass do not result from the rejection of the lease-they result from the pile of dirt allegedly left on the property. Rejection of the lease may or may not have triggered Saddleback's ability to sue for the alleged damages. But the harm to Saddleback's property existed whether or not the lease was rejected. A simple test reveals whether the damages result from the rejection of the lease: Assuming all other conditions remain constant, would the landlord have the same claim against the tenant if the tenant were to assume the lease rather than rejecting it? . . . The million-ton heap of dirt was not put there by the rejection of the lease-it was put there by the actions and inactions of El Toro in preparing to turn over the site.

Are you persuaded? Well, as a landlord’s attorney I sure am! The opinion expressly overrules McSheridan to the extent that it holds that the cap is (to quote the El Toro opinion) “a limit on tort claims other than those based on lost rent, rent-like payments or other damages directly arising from a tenant's failure to complete a lease term.” Incidentally, in a footnote Judge Kozinski suggests that the BAP might amend its rules to allow for en banc hearings in order to address questionable precedent like McSheridan.

El Toro obviously will prompt landlords to express their claims not in terms of breach of contract but rather in terms of torts such as conversion, trespass and fraud. Drafters of leases may change language that used to characterize “restore to shell” and similar obligations on termination as rent. Instead, new lease forms may expressly reserve tort claims for these sorts of tenant obligations.

Trustees Can Take Hostages! – They’re Called “Exemptions”

2007-10-21T10:47:00.000-07:00

A few weeks ago the Bankruptcy Appellate Panel for the Ninth Circuit issued a decision which all chapter 7 trustees should welcome. The BAP upheld the decision of Bankruptcy Judge Kathleen Thompson, of the Central District of California, surcharging the Debtor’s homestead and household goods exemptions in the amount of the attorney fees and other costs incurred by the Trustee as a result of the Debtor’s refusal to vacate the home and related legal shennanigans aimed at frustrating the sale. In re Onubah, 2007 WL 2701336 (Bankr. App. 9th Cir. August 31, 2007).

Mr. Onubah claimed a $75,000 homestead exemption in property which the Trustee ultimately contracted to sell for $2.3 Million. Onubah did not oppose the Trustee’s motion to sell, but he refused to vacate the property prior to close of escrow. The Trustee filed a turnover motion, but before the motion could be heard Onubah converted his chapter 7 case to chapter 11. Judge Thompson granted a re-conversion motion together with the turnover motion, but on the scheduled day of the turnover Onubah informed the Trustee that an involuntary bankruptcy petition had been filed against him. He refused to vacate, under color of the alleged new automatic stay. Judge Thompson later found that the petitioning creditors were colluding with Onubah. Apparently these petitioning creditors do this for a living in order to frustrate evictions. Ah, that wacky Central District! Onubah did not deny that all of these legal maneuvers were intended solely to frustrate the sale.

Ultimately, the Trustee was required to employ US Marshalls to evict Onubah, and the Trustee then had to store his household goods. The sale then closed. Judge Thompson then granted the Trustee’s motion to surcharge Onubah’s (presumably previously allowed without objection) homestead and household goods exemptions, in an amount representing the total of legal fees, storage charges, Marshall’s fees and locksmith charges.

In affirming, the BAP held that this result was mandated by the Ninth Circuit’s decision in Latman v. Burdette, 366 F.3d 774 (9th Cir. 2004). Still, the Onubah decision represents a significant extension of Latman. In Latman, the Court deducted from the debtor’s “wild card” exemption the amount of some pre-petition sale proceeds which the debtor had failed to account for. The opinion in Latman states that a surcharge of exemptions cannot be “punitive” in nature, and the Onubah opinion echoes this. The Latman surcharge passed muster because it prevented the debtor from shortchanging the estate by keeping money beyond the exempted amount, by subtracting that exact amount from the exemption.

In contrast, the decision in Onubah looks a bit more like sanctions (another word for “punishment”) imposed because of the Debtor’s improper litigation behavior. Onubah did not appeal this decision to the Ninth Circuit. For the time being, Trustees have a powerful new weapon against Debtors who fight wars of attrition to prevent assets from being liquidated for the benefit of creditors.

Bankruptcy Hearings Come to Your iPod

2007-10-20T21:45:00.000-07:00

Last summer we had news of a pilot project in which audio recordings of bankruptcy hearings were going to be posted online, as .mp3 files, so that those who didn’t attend a court hearing (either in person or telephonically) can listen to what went on. Its a pilot project now. Three bankruptcy courts and two district courts are supposed to be participating. Since getting the news, I have been checking to find an audio file for a hearing which has been posted on the internet.

The idea was championed by Bankruptcy Judge Rich Leonard of the Eastern District of North Carolina. The two other bankruptcy court participants are supposed to be the Northern District of Alabama and the District of Maine. The two district courts are Nebraska and the Eastern District of Pennsylvania.

I was so captivated by the notion of being able to listen to bankruptcy court hearings on my iPod that I trolled the recent chapter 11 filings in those courts and found an .mp3! If you have a few nickels to burn, get on ECF and visit the Bankruptcy Court for the Eastern District of North Carolina, the case of In re D & M Land Company, LLC No. 07-00054-5-ATS, Docket No. 130. This docket entry is a pdf with the .mp3 file as an attachment. Look down the left hand side of the screen as it displays the pdf and you will see a paperclip. Click it and you’ll have a chance to save the attachment to your computer. This and the other file I tried left something to be desired in terms of sound quality and volume, but it worked.

I hope that this catches on. For one thing, it lets you know what really transpired in court without ordering a transcript. Also, tone of voice tells us so much. I can’t help but think that lawyers and judges alike would be on their better behavior if they knew that audio recordings of the proceedings were publicly available. Also, this will help me tackle that unproductive time I previously wasted listening to music and podcasts. Another way to separate the true bankruptcy attorneys from the poseurs.

The 7th Circuit "Hangs" with the Minority - Or Does It?

2007-09-05T17:33:00.000-07:00

In the previous post, I covered In re Trejos, 2007 WL 2391184 (Bankr. App. 9th Cir. July 30, 2007), in which the Ninth Circuit BAP first considered BAPCPA’s infamous “hanging paragraph.” The language in issue is found in Bankruptcy Code section 1325(a):

For purposes of paragraph (5), section 506 shall not apply to a claim described in that paragraph if the creditor has a purchase money security interest securing the debt that is the subject of the claim, the debt was incurred within the 910-day [period] preceding the date of the filing of the petition, and the collateral for that debt consists of a motor vehicle as defined in section 30102 of title 49) acquired for the personal use of the debtor, or if collateral for that debt consists of any other thing of value, if the debt was incurred during the 1-year period preceding that filing.

In Trejos, the BAP rejected the Debtors’ argument that if section 506 does not apply to a “910 loan” then the auto lender cannot have an allowed secured claim in the chapter 13 case. In its ruling, the BAP stated that it is not section 506 that is the basis for a creditor’s security interest.

Trejos did not cite In re Wright, 492 F.3d 829 (7th Cir. 2007), published less than a month before. Wright was the first circuit decision on the “hanging paragraph.” Incidentally, the appeal reached the Seventh Circuit under BAPCPA’s new direct appeal provision, 28 U.S.C. § 158(d)(2)(A).

Unlike the Debtors in Trejos, the Wrights did not want to keep their car, but instead opted to return it. They claimed that the effect of the hanging paragraph was to disallow the lender’s unsecured claim for a deficiency. The Seventh Circuit adopted what it characterized as the “minority view” among bankruptcy courts, holding that the deficiency claim must be allowed. The opinion goes out of its way to debunk the argument (made by the National Association of Consumer Bankruptcy Attorneys in an amicus brief) that the hanging paragraph deprives the lender of even an allowed secured claim. The Court stated:

This line of argument makes the same basic mistake as the debtors' position: it supposes that contracts and state law are irrelevant unless specifically implemented by the Bankruptcy Code. Butner holds that the presumption runs the other way: rights under state law count in bankruptcy unless the Code says otherwise. Creditors don't need § 506 to create, allow, or recognize security interests, which rest on contracts (and the UCC) rather than federal law. Section 502 tells bankruptcy courts to allow claims that stem from contractual debts; nothing in § 502 disfavors or curtails secured claims. Limitations, if any, depend on § 506, which the hanging paragraph makes inapplicable to purchase-money interests in personal motor vehicles granted during the 910 days preceding bankruptcy (and in other assets during the year before bankruptcy).

Interestingly, the BAP in Trejos claimed to be siding with the substantial majority of published bankruptcy opinions in upholding the lender’s allowed secured claim against the hanging paragraph. In upholding the lender’s deficiency claim, the Seventh Circuit stated that it was adopting a minority view. That there should be a difference in result depending on the context is not surprising. In the Trejos situation, where the debtor wants to keep the car, the notion that the hanging paragraph was intended to deprive consumer lenders of a secured claim is absurd. However, it is less absurd (although implausible given the general tenor of BAPCPA) that Congress intended to relieve the Debtor of the burden of a deficiency claim in cases where the collateral is surrendered. It may also be argued that while section 506 may not be the origin of a secured claim, it may be the only basis for the creditor’s ability to bifurcate its claim.

Nevertheless, both Trejos and Wright are based on exactly the same, persuasive reasoning. Perhaps some future opinion will better explain why that reasoning should apply in one situation and not the other.

How's It Hanging?

2007-09-03T17:25:00.000-07:00

The Ninth Circuit BAP has spoken on the “hanging paragraph” issue, siding with consumer lenders. Ever since the enactment of BAPCPA, some have claimed that poor legislative drafting must be read as substantially liberalizing the treatment of certain consumer loans in chapter 13.

In re Trejos, 2007 WL 2391184 (Bankr. App. 9th Cir. July 30, 2007) interprets the following language which was added to Bankruptcy Code section 1325(a) but left “hanging” without inclusion in any of its subparagraphs:

For purposes of paragraph (5), section 506 shall not apply to a claim described in that paragraph if the creditor has a purchase money security interest securing the debt that is the subject of the claim, the debt was incurred within the 910-day [period] preceding the date of the filing of the petition, and the collateral for that debt consists of a motor vehicle as defined in section 30102 of title 49) acquired for the personal use of the debtor, or if collateral for that debt consists of any other thing of value, if the debt was incurred during the 1-year period preceding that filing.

The Debtors first asserted that because their vehicle finance contract was assigned by the dealer to VW Credit, the assignee did not have a “purchase money security interest.” The BAP disposed of this argument, holding that “under the assignment, VW Credit simply stepped into the Dealer's shoes.”

The Debtors next argued that because under the language of the hanging paragraph, section 506 did not apply , VW credit could not have an allowed secured claim. In support of this position they cited the following passage in Colliers:

It is possible that [the “Hanging Paragraph”] was intended to prohibit the use of section 506(a) to bifurcate a secured claim into an allowed secured claim and an allowed unsecured claim as part of the cramdown permitted by section 1325(a)(5)(B) and, therefore, that such claims should be treated as fully secured claims regardless of the value of the collateral. But, even if that was the intent, because [the “Hanging Paragraph”] renders entirely inapplicable for some creditors the only section, section 506(a), that gives those creditors allowed secured claims, it does not to [sic] carry out such intent.

The assumption made by Colliers is that it is section 506 that “gives” creditors an allowed secured claim. In holding otherwise, the BAP quoted In re Brown, 346 B.R. 868, 873 (Bankr.N.D.Fla.2006): “Just because § 506 does not apply does not mean that there is no secured claim. Section 506(a) simply provides for bifurcation of claims into secured and unsecured portions in accordance with the value of the collateral; it does not form the basis for a secured claim.”

Trejos was not one of those cases in which the Court was invited to interpret the “plain language” of BAPCPA to reach an absurd result. In order to sustain the Debtors’ position, one was required to make basic assumptions about bankruptcy law that go far beyond the tinkering of BAPCPA. A creditors’ lien is not a privilege created by the Bankruptcy Code. It is a constitutionally protected property interest that the Bankruptcy Code can affect within limits. This opinion may be quoted for that much broader and significant holding long after the “hanging paragraph” issue has been finally resolved.

None of Your Business, Trustee!

2007-08-12T09:18:00.000-07:00

A recent decision by Judge Montali denied a bankruptcy trustee’s bid to capture a piece of the sole proprietorship business of a non-filing spouse. A lawyer reading this decision may be: (i) intrigued by the idea of applying its principles in the right case; (ii) puzzled by how the end game might have been played had the trustee succeeded.

In re Duggan, 2007 WL 2155704 (Bankr.N.D.Cal. July 26, 2007) was a bankruptcy case commenced by the wife of an insurance agent whose practice was a sole proprietorship. The agency had “negligible” personal property. The opinion doesn’t mention that there was any agreement between these long-time spouses that the practice, which existed prior to the marriage, would remain the husband’s separate property. Although the brief opinion provides no details, it appears that the debtor wife made “efforts to enhance, maintain and grow” the business during the marriage.

The opinion explains the applicable legal principal as follows:

Where a spouse has a separate property business in which he is employed and the business increases in value, the enhanced value and profits are attributable in part to the original capital (the separate property) and in part to the spouse's labor and skill (community property). . . . To allocate the proper portion of the enhanced value and profits to the separate and community interests, California courts typically choose between two approaches. . . . The first, the approach set forth in Pereira v. Pereira, 156 Cal. 1, 103 P. 488 (1909), is generally applied where, as here, profits are attributable to community effort. . . . Under Pereira, the court allocates a fair return on the separate property as separate income and allocates the rest to the community property.

In Duggan, Judge Montali found (in the absence of any contrary showing by the Trustee) that the sole proprietorship business had a value of $100,000, which had not increased at all in value since 1979, and that therefore the proprietorship was the separate property of the non-filing husband.

If instead the Court had applied the formula explained above and concluded that, say, 20% of the value of the practice was community property, the Trustee might have faced an uphill struggle in liquidating that interest if the husband had been unwilling to cooperate by paying a settlement. It would require an adversary proceeding to sell an unincorporated professional practice free and clear of the non-cooperating professional’s interest. The trustee would be without the ability to deliver a covenant not to compete to a buyer. Not impossible, maybe, but a row to hoe. Perhaps the most likely candidate might be a dental practice, but it would have to be an awfully good one to justify the legal effort.

Getting Off the Omnibus: Fair Notice of Claims Objections

2007-07-25T21:45:00.000-07:00

Everyone who has represented a general unsecured creditor in a big chapter 11 case has had this experience. After the proof of claim has been filed, and usually after the plan has been confirmed, you receive in the mail the “Reorganized Debtor’s First Omnibus Objection to Claims.” Attached to the objection is an exhibit listing, in very small type, literally hundreds of claims. The grounds for objection may be something like “required documentation not attached.” Unless a timely response is submitted, all of these claims will be disallowed.

Counsel for unsecured creditors in a large case are subjected to this kind of notice constantly. In one in which I am currently involved, the liquidating trust is up to its 31st omnibus objection. Its bad for clients, but worse for lawyers in some ways. A lawyer who has actually appeared for a client in one of these cases gets electronic service of all the papers. In the case I’m speaking of the 31st Omnibus Objection was docket entry No. 3189.

Lawyers have been let off the hook for missing their client’s claim in the list and failing to file a timely response to an omnibus objection. It took an appeal to the District Court to accomplish this is in In re Inacom Corp., 2004 WL 2283599 (D. Del. 2004). As the opinion describes it: “The Objection contests approximately 412 claims spread over 96 pages of exhibits. The exhibits are lettered A through H, with some exhibits containing multiple alphabetical listings of objections.” This hapless creditor’s name appeared on one of the alphabetical lists included in Exhibit E. The law firm’s mistake in failing to respond to the objection was not discovered until the expected distribution under the confirmed plan was not received.

On April 30, the United States Supreme Court approved changes to Federal Rule of Bankruptcy Procedure 3007. Absent Congressional action, the new rule will take effect on December 1, 2007. The new rule limits the grounds for an omnibus objection. Even where such objections are allowed, the new rule requires that the objection “list claimants alphabetically, provide cross references to claim numbers and, if appropriate, list claimants by category of claims.” The rule also contains an absolute limit of 100 claims which may be joined in an omnibus objection.

The practicalities of the mega case mean that application of the new rule will result in similar claims objections being spread over more omnibus notices, 100 at a time. Even so, the new rule will make things easier on everyone who needs to find a name on one of those lists.

Adbox Redux: Who Must Prove and Disprove Earmarking

2007-07-23T16:24:00.000-07:00

In the previous post, I commented on In re Adbox, Inc., 2007 WL 1584582 (9th Cir. June 4, 2007), a case which explains the maybe not so obvious – why can’t creditors counterclaim in an avoidance action and offset their claims against their disgorgement liability?

I omitted to mention in that post, which was already long enough, that Adbox also contains a good, practical groundrule on who has the burden of proof to establish the “earmarking” defense to a preference claim. To quote the Court, “the ‘earmarking doctrine’ is a court-made exception [to preference liability] that applies when a third party advances funds to the debtor subject to an agreement requiring the debtor to use the funds to pay off another creditor.” This would be the case, for example, when a bank makes a loan subject to covenants that the loan proceeds will be used to make particular payments.

Does the trustee have the burden to disprove earmarking, because an element of preference liability is a transfer of property of the debtor (and not property in effect held in trust for another)? Or is earmarking an affirmative defense which must be proved by the creditor? The Ninth Circuit adopted the holding of an earlier BAP decision, In re Sierra Steel, Inc., 96 B.R. 271, 274 (Bankr. App. 9th Cir. 1989), holding that the Trustee must make a preliminary showing that the payment “was from one of the debtor's accounts over which the debtor ordinarily exercised total control.” Once that showing is made, “the burden then shifts to the defendant in the preference action to show that the funds were earmarked.”

Counterclaims in Avoidance Actions? Are We Sure We Know Why Not?

2007-07-21T17:58:00.000-07:00

If you have defended a few preference actions, I’ll bet that you’ve heard this one from your client more than once: “Can I countersue them for what they owe me?" The obvious (to a bankruptcy lawyer) and correct response is “no,” but you might not have been 100% glib if called upon to explain why. Now the Ninth Circuit has come to your rescue, and you can just say “In re Adbox, Inc., 2007 WL 1584582 (9th Cir. June 4, 2007).

Adbox was a preference action by a chapter 7 trustee. The Metcalfs as defendants filed a counterclaim seeking damages for pre-petition torts by the debtor. The Ninth Circuit ruled that this was impermissible because a counterclaim may only be brought against an “opposing party” under Federal Rule of Civil Procedure 13. The Court reasoned:

The question presented here, however, is whether the trustee is an “opposing party” when he has brought a preference action that belongs to the bankruptcy estate and not to the debtor, but the counterclaim alleges causes of action that could have been brought against the debtor prior to its bankruptcy filing. We hold that he is not. The Metcalfs styled their counterclaim as against Golden “in his capacity as Chapter 7 trustee for the estate of Adbox,” but their allegations concerned the conduct of . . . Adbox prior to Adbox's bankruptcy filing. While the Metcalfs presumably sought to recover from Adbox's assets in bankruptcy, the trustee would have to stand in the shoes of the debtor to defend against the counterclaim. This would be a representative capacity different from the representative capacity in which a trustee brings a preference action, because a preference action belongs specifically to the bankruptcy trustee and could not have been brought by the debtor prior to its bankruptcy filing.

To me, this explanation sort of begs the question. After all, isn’t the pre-petition claim a liability of the bankruptcy estate? Or at least, I thought that the bankruptcy estate "stands in the shoes of the debtor." Another way of looking at this is that the creditor is prevented by the automatic stay from bringing a counterclaim, and is required to proceed via a proof of claim unless relief from stay is granted. But wait, that argument doesn’t dispose of the setoff issue, which isn’t directly addressed by Adbox. Is the only reason that a creditor can’t offset a claim against preference liability the prohibition of 11 U.S.C. §502(d), which prohibits allowance of claim until the preference is repaid? See, e.g., In re Allegheny Health, Education and Research Foundation, 292 B.R. 68, 94-95 (Bankr. W.D.Pa. 2003). What if the creditor doesn’t file a claim and just asserts offset?

Does it ever strike you that the more obvious a proposition seems to be to you, the harder it is to find authority for it? Sometimes its also hard to come up with reasons for these obvious rules when we are forced to go beyond our own peremptory judgments or innate sense of bankruptcy logic. I have little doubt that I’m missing something here, so please help me out. That’s what Comments are for.

No Need to Bother the Bankruptcy Judge – Continuing a Personal Injury Case After the Discharge to Reach Insurance

2007-07-17T09:20:00.000-07:00

Bankruptcy Judge Lee of the Eastern District of California probably doesn’t think that it should be necessary to remind litigants that a personal injury plaintiff need not obtain relief from the post-discharge injunction in order to commence or continue a lawsuit against the debtor, so long as it is clear that the plaintiff will resort only to insurance coverage to pay the claim.

In re Zagala, 2007 WL 1772171(Bankr. E.D. Cal. June 19, 2007) is an unpublished Memorandum Decision on a motion to modify the post-discharge injunction to allow a peronal injury lawsuit to continue. Judge Lee ruled that the motion was “procedurally inappropriate and unnecessary.” The opinion cites an earlier BAP decision In re Beeney, 142 B.R. 360, 363-64 (Bankr. App. 9th Cir. 1992) in which the court ruled that a bankruptcy case need not be reopened, nor did the section 524 injunction need to be modified, for this purpose.

An interesting aspect of the ruling in Zagala is Judge Lee’s observation that “the bankruptcy court may enforce, or define the scope of the discharge injunction, but it may only do so through a declaratory judgment in a properly filed and served adversary proceeding.” I thought that at least the post-discharge injunction could be enforced via contempt proceedings. Question: In order to file such an adversary proceeding, must the underlying bankruptcy case be reopened? If so, then wouldn’t a contested matter in the reopened bankruptcy case be more efficient given the limited issues which are likely to be involved?

Aiieeee!! Phantom Expenses Haunt Means Testing

2007-07-15T08:21:00.000-07:00

Bankruptcy Judge Jury of the Central District has joined the majority of courts across the land in holding that a chapter 7 debtor may deduct, for purposes of means testing, expenses which the debtor has sworn elsewhere in her bankruptcy papers she has no intention of paying. The case is In re Wilkins, 2007 WL 1933591 (Bankr. C.D.Cal.).

Ms. Wilkins owned property in Georgia which she indicated in her Statement of Intention that she would surrender to the secured creditor, Ameriquest Mortgage. The payment to Ameriquest was $1,994.07 per month. If Ms. Wilkins was not allowed to deduct the amount of that payment, she flunked the means test.

The Court was called upon to interpret 11 U.S.C. §707(b)(2)(A)(iii), which states that for purposes of means testing: “The debtor's average monthly payments on account of secured debts shall be calculated as the sum of-(I) the total of all amounts scheduled as contractually due to secured creditors in each month of the 60 months following the date of the petition.”

The US Trustee took the position that “scheduled” refers to the bankruptcy schedules, and that since the schedules in that case reflected that the payment would not be made, it should not be deducted. Judge Jury followed the reasoning of the majority of the courts in ruling that “scheduled” has the Webster’s dictionary meaning, and that those mortgage payments were, indeed, scheduled to be made under the mortgage contract.

Does the phrase “scheduled as contractually due” seem clear and unambiguous in this context? Wilkins is part of a crowded field of cases in which “plain language” reasoning is applied to reach a result which seems contrary to the purposes of BAPCPA.

Involuntary Bankruptcy Is Even Riskier Than You Thought

2007-07-11T20:09:00.000-07:00

We all know that per 11 U.S.C. § 303(i), when an involuntary bankruptcy petition is unsuccessful, the court may grant judgment against the petitioning creditors for attorney fees, and may also award damages and punitive damages if the petition was filed in bad faith. The Bankruptcy Appellate Panel has sharpened those tools in a recent decision: In re Macke International Trade, Inc., 2007 WL 1845519 (Bankr. App. 9th Cir. June 8, 2007).

Macke manufactured pet care products. The single petitioning creditor, one Lawrence Weschler, was a competitor of the debtor who also happened to be a patent lawyer. Weschler won a $650,000 infringement judgment, then on appeal. The other two major creditors were lawyers who had represented Macke in the patent litigation. During the pendency of the appeal, the debtor made a general assignment for the benefit of creditors. The assignee liquidated Macke’s assets for $10,500. Weschler decided not to participate in the assignment, and did not file a claim.

Six months after the assignment, Weschler filed an involuntary bankruptcy petition against Macke. Macke moved to dismiss under the abstention provision, 11 U.S.C. §305(a), on the grounds that “the interests of creditors and the debtor would be better served” by dismissal (quoting the statute). The Bankruptcy Court agreed and decided to abstain, a decision which is “not reviewable by appeal or otherwise” under 11 U.S.C. § 305(c). That’s where the fun really began.

The Bankruptcy Court, having decided to abstain, did not abstain from awarding attorney fees against Weschler, relying on the language in section 303(a) which allows such an award “if the court dismisses a petition under this section other than on consent of all petitioners and the debtor. . . .”

To add insult to injury, the Court then ruled that the attorney fee award could not be offset against Macke’s indebtedness on the judgment. In so holding, the BAP followed the reasoning of In re Schiliro, 72 B.R. 147 (Bankr.E.D.Pa.1987), and quoted that decision as follows:

If the petitioning creditor could suffer no other recourse except a reduction in his probably-uncollectible judgment as a penalty for requiring a debtor to defend an unjustified case, and Congress has specifically stated should result in such a penalty, the disincentive built into the system to discourage such actions would evaporate. The rule sought by [the petitioning creditor] would surely be a boon to creditors who seek to wear down to submission small debtors such as the Debtor here.

To summarize: A creditor can file a completely meritorious involuntary bankruptcy petition, but the bankruptcy court can exercise its non-reviewable discretion to decline jurisdiction over the case. On its way out the door, however, the bankruptcy court can award attorney fees against that creditor for taking the wrong position on whether the “interest of creditors and the debtor” would be better served by bankruptcy. And the bankruptcy court can override the law of setoff by concluding on public policy grounds that the debt for attorney fees has greater dignity than a judgment for damages rendered by a United States District Court. Ouch!

Bankruptcy More of a Girl Thing

2007-07-09T14:49:00.000-07:00

A major new source of fresh, meaningful bankruptcy statistics has come to my attention. The Institute for Financial Literacy is based in Portland, Maine. To quote from the IFL website:

The Institute for Financial Literacy is a non-profit organization whose mission is to make effective financial literacy education available to all American adults. The Institute accomplishes its mission by developing financial literacy education programs, partnering with non-profit, educational and governmental organizations, and publishing the National Standards in Adult Financial Literacy Education. The Institute is funded by program fees, private donations, and grants from public and private foundations.

The Institute is an educational organization focused on presenting unbiased, neutral information to its clients. The Institute does not create debt repayment plans or negotiate debts for its clients.

Recently, the IFL published what promises to be an annual study, entitled “Who Went Bankrupt in 2006.” This 22 page white paper is full of unbiased information about the causes of consumer bankruptcy, and the demographics of consumer debtors. The study draws no conclusions but identifies the “areas of growing concern”: (i) bankruptcy filing rates for seniors; (ii) the role of identity theft; (iii) women filing bankruptcy at higher rates then men; and (iv) what role education plays in financial management.

Consistent with earlier studies, IFL found that bankruptcies in 2006 were distributed between women and men at roughly 53.6% to 46.4%, respectively, as compared to the 51% to 49% ratio existing in the general population. The study wonders why this is, but it seems to me that any family lawyer could help you understand that one. Also, it is still the case that women are underemployed and underpaid compared to their male counterparts.

But how about this? While the percentage of white and black debtors roughly mirrors their shares of the general population, hispanic debtors file at a rate less than half of their share of the general population, topping the asians as the least bankruptcy prone ethnicity.

A Back Door to Chapter 7 for Means-Challenged Debtors?

2007-07-07T10:45:00.000-07:00

There is now a difference of opinion in the published cases about whether means testing applies to determine chapter 7 eligibility in a case converted from chapter 13. Last month, Bankruptcy Judge Burns of the District of New Jersey decided In re Fox, 2007 WL 1576140 (Bankr. D. N.J. June 1, 2007).

In Fox, the debtor was a processing supervisor making $57,000 per year. Her chapter 13 plan was confirmed, but she lost her job a month later, and she successfully obtained a suspension of chapter 13 payments. After several months, her unemployment benefits and her payment suspension ran out at the same time. She finally got a job as a medical biller at $13.00 per hour, $30,000 per year less than previously. The debtor converted her case to chapter 7 a few days before starting her new job. She refused to file Official Form B22A, the Statement of Monthly Income and Means test, and the US Trustee filed a motion to dismiss the bankruptcy case. The Court denied the motion, ruling that means testing does not apply to the debtor in a chapter 7 case which was converted from chapter 13.

The rationale of Fox is simple and based on the “plain language” of BAPCPA. 11 U.S.C. § 707(b)(1) which provides authority for courts to dismiss a case, “filed by an individual debtor under this chapter . . . if it finds that the granting of relief would be an abuse of the provisions of this chapter.” Since the case wasn’t “filed under” chapter 7, the Court reasoned that it wasn’t subject to dismissal under section 707(b).

However much satisfaction may lie in literally interpreting the words of the poorly drafted, mean-spirited BAPCPA, the ruling of Fox may not wind up the majority rule. For one thing, Interim Bankruptcy Rule 1007(b)(4) requires that the statement be filed “in a chapter 7 case,” not just in a “case filed under” chapter 7. Also, there is already one published decision to the contrary, In re Perfetto, 361 B.R. 27 (Bankr. D.R.I. 2007). Perfetto was a case where the debtor converted her chapter 13 case within 2 weeks after the petition, and did not allege any change in circumstances. The Court required the debtor to file FormB22A, reasoning that it was the intent of Congress to apply the means test in all chapter 7 cases.

Neither of these decisions discusses the impact of the Supreme Court’s decision in Marrama v. Citizens Bank of Massachusetts, 127 S.Ct. 1105 (2007), which I blogged in February. Marrama holds that despite the “plain language” of 11 U.S.C. §706(a), there is no absolute right to convert a case from chapter 7 to chapter 13, and conversion could be denied based on bad faith. Perhaps a bad faith conversion standard could have been employed to achieve the same result in both cases?

The Disconnect Between Foreclosures and Bankruptcies

2007-06-17T19:03:00.000-07:00

Recently, the American Financial Services Association posted a blurb on their website “Spotlight on Financial Services” noting a continuing “disconnect between rising foreclosures in the subprime mortgage market and the statistics on personal bankruptcy filings.” Personal bankruptcy filings in 2007 continue to poke along at rates a bit above the same period in 2006, but far below the rate of filings in 2002-2004.

The post suggests that bankruptcy filings lag behind as borrowers attempt to absorb the changes in ARM rates, and due to the length of the foreclosure process itself. As consumer practitioners know, summer is a time when bankruptcy filings typically dip. Whether or not we feel the dip this summer, the post maintains that increased foreclosures must eventually result in increased bankruptcy filings, especially under chapter 13 by borrowers who want to save their home by repaying mortgage arrearages.

I question whether ARM foreclosures will cause much of a spike in chapter 13 filings. Chapter 13 is a cure for foreclosures that resulted from changes in the borrowers’ circumstances, like a layoff. You can’t rewrite an ARM under chapter 13. The only borrowers that can succeed in solving their ARM woes are those who can make their new, higher mortgage payments by not paying their old unsecured debt and not incurring new unsecured debt along the road to recovery.

R-E-S-P-E-C-T or Mr. Smith Goes to McDonald's

2007-05-30T14:57:00.000-07:00

Last week, an incident was reported in Above the Law, that most entertaining blawg which calls itself “A Legal Tabloid.” William P. Smith, head of the bankruptcy department at the huge international firm of McDermott, Will & Emery, appeared before Bankruptcy Judge Laurel Isicoff of the Southern District of Florida. Judge Isicoff appears to be newly appointed, but a veteran of 20 years of sophisticated insolvency practice. In arguing whether a transaction in escrow would probably close, Smith told Judge Isicoff: “I suggest to you with respect, your honor, that you’re a few french fries short of a happy meal in terms of what’s likely to take place.”

With respect????

In my experience, United States Bankruptcy Judges seem to get less respect from the bar than a United States District Judge receives. If this is true, why should it be? Is it that their courtrooms are smaller and less impressive? Is the standard of practice at the bar lower in the Bankruptcy Court than in the District Court? Is it that bankruptcy lawyers are likely to have appeared before the same judge many times, and may even have known the judge before his or her appointment? In other words, might familiarity breed contempt? Is it because a Bankruptcy Judge may appear to the world not as an enforcer of promises and dispenser of justice but as the facilitator of broken promises? Is it that because so many decisions of the Bankruptcy Judges are discretionary, they are seen as making arbitrary rulings?

In any case, Smith will get a chance to explain himself on June 25, at the hearing on the Order to Show Cause why he shouldn’t be suspended from practice before the United States Bankruptcy Court, Southern District of Florida. I’m sure that he’ll say that he did not intend to disparage the judge. However, I suspect that if Smith had held in his heart true respect for the institution of the Court (or perhaps just an ounce of humility) he wouldn’t have said what he did.

Maybe Smith will be suspended down in Florida, or (more likely, I would guess) his apology will suffice. In any case, the blawgs have already held him and his firm up to worldwide ridicule. I would be lying if I said it didn’t brighten my day – in a sort of a dismayed “what is the world coming to” kind of way, of course.

Deepening Insolvency: Reports of Its Death Were Greatly Exaggerated

2007-05-29T10:42:00.000-07:00

On May 18, the Delaware Supreme Court issued a major ruling on so-called “deepening insolvency” liability of corporate officers and directors. For those of you who haven’t heard of this by now, “deepening insolvency” is shorthand for a question that presents itself in many forms, both before and after bankruptcy. In an insolvent company, the shareholders have no equity and nothing to lose. In the past, the law has told us that the responsibility of corporate officers and directors was to the shareholders only. Do officers and directors face liability to creditors by running that company into deeper debt?

In North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 2007 WL 1453705 (Del. May 18, 2007), the Delaware Supreme Court ruled that no direct cause of action exists which would permit creditors of an insolvent company to sue directors. However, the Court held that creditors could sue derivatively for damages suffered by the insolvent corporation. The Court stated:

It is well settled that directors owe fiduciary duties to the corporation. When a corporation is solvent, those duties may be enforced by its shareholders, who have standing to bring derivative actions on behalf of the corporation because they are the ultimate beneficiaries of the corporation's growth and increased value. When a corporation is insolvent, however, its creditors take the place of the shareholders as the residual beneficiaries of any increase in value.

Consequently, the creditors of an insolvent corporation have standing to maintain derivative claims against directors on behalf of the corporation for breaches of fiduciary duties. The corporation's insolvency “makes the creditors the principal constituency injured by any fiduciary breaches that diminish the firm's value.” Therefore, equitable considerations give creditors standing to pursue derivative claims against the directors of an insolvent corporation. Individual creditors of an insolvent corporation have the same incentive to pursue valid derivative claims on its behalf that shareholders have when the corporation is solvent.

In the Ninth Circuit, bankruptcy trustees already had the green light to sue officers and directors who run a failing corporation into the ground for their own ends. See, Smith v. Arthur Andersen LLP, 421 F.3d 989 (9th Cir. 2005). The Gheewalla case now makes clear that “deepening insolvency” is a harm suffered by the corporation, not by shareholders or by any individual creditor. The trick in these cases will be to find the conflict of interest that takes the case outside the aegis of the business judgment rule.

Bankruptcy Landscape is Turning Grey

2007-05-28T10:17:00.000-07:00

This will come as no surprise to practitioners in the trenches of consumer bankruptcy law, but . . . . the face of America’s debtor population is acquiring wrinkles. According to a study just released by the Administrative Office of the U.S. Courts, the average age of debtors in bankruptcy is increasing at a much faster rate than the age of the general population.

During the 8 year period from 1994 to 2002, the segment of our population aged 45 to 54 increased by 19.9%. The percentage of bankruptcy filers aged 45 to 54 increased by 43.9%.

Similarly, during the same 8 years the segment of our population aged 55 and over increased by 3.1%. The percentage of bankruptcy filers aged 55 and over increased by 45.8%.

We’ve all been anticipating the time when veterans of the credit economy who haven’t saved for retirement begin facing declining incomes in their declining years. The bankruptcy courts may be full of these folks for the next two decades. Will they organize? American Association of Retired Debtors (AARD)?

Some good news from the study: Bankruptcy filers aged under 25 declined by 60.4% during that same period, at a time when the spiraling cost of higher education has put huge economic pressure on kids. Credit education like the CARE program (Credit Abuse Resistance Education) may deserve part of the credit.

Its Not Final Until Its Over

2007-05-27T18:12:00.000-07:00

A little understood aspect of the automatic stay is the effect of a bankruptcy filing on a judgment debtor’s appeal rights. Contrary to what you might think, when a judgment is entered in a pre-bankruptcy action against the debtor, prosecution of the debtor’s appeal of that judgment is subject to the automatic stay. This is on the rationale that the appeal is a “continuation of an action” against the debtor. See, Parker v. Bain, 63 F.3d 1131, 1135-36 (9th Cir. 1995).

I’ve used this a few times on behalf of judgment creditors, and its proved handy. If the debtor wants to continue a pending appeal, relief from stay is required. If the judgment creditor can make a deal with the trustee in the meantime, the expense of defending an appeal can possibly be avoided.

In re Ingeniero, 2007 WL 1453132 (Bankr. N.D. Cal. 2007) points out the flipside of this otherwise salutary rule, as far as judgment creditors are concerned. If a judgment debtor files a petition before the appeal period runs, the debtor is stayed from taking an appeal and the judgment can’t become final until the automatic stay is dissolved, for example by closing of the case. Bankruptcy Judge Jellen of the Northern District of California rejected the judgment creditor’s argument that the appeal period was merely extended under 11 U.S.C. §108(b).

A New Kind of Tax Shelter That Also Doesn’t Work, and Why Do Molehills Turn Into Mountains?

2007-05-13T10:21:00.000-07:00

James and Beverly Nichols filed their 2001 federal income tax return on January 20, 2002. The return showed that they were entitled to a refund in the amount of $2,231.57. They checked the box on their return, making the irrevocable election to apply that amount to payment of future taxes, pursuant to 26 U.S.C. § 6513(d). Sixteen days later, the Nichols filed their chapter 7 petition.

More than five years after these events, the Ninth Circuit has ruled that “the pre-petition application of the right to the tax refund was an asset as of the petition date, and that the Debtors must therefore deliver to the trustee the value of the property under section 542(a).” In re Nichols, 2007 WL 1344219 (9th Cir. May 09, 2007). This is one of those results that seems obviously correct in effect, but a little difficult to lawyer your way into.

The Ninth Circuit’s opinion omits any mention of the amount in dispute. I had to mine the Bankruptcy Court docket for that. Over my years practicing bankruptcy law, I have seen many published decisions at the appellate level that do reveal that the underlying dispute is over a tiny amount of money. At least tiny in relation to the cost of filing a lawsuit in the bankruptcy court, prosecuting an appeal to the US District Court, and then briefing and arguing the case in San Francisco before the Ninth Circuit.

Why did the Trustee file the lawsuit? As far as I can tell, no other assets were administered in the Nichols’ case, so assuming that certiorari is denied (that was meant to be a joke but I wouldn’t be surprised . . . ) the Trustee will get to administer a $2,231.57 estate, plus some interest and costs. Does this come up all the time? Why did the Debtor mount two unsuccessful appeals? Was their lawyer trying to establish a legal principle for the benefit of his own practice and the debtors’ bar? Was it a grudge match? Or do they both just love it so?

I’m going to send a copy of this post to all of the combatants and invite them to comment. I will probably be ashamed in the presence of their diligence and public spirit. Check back to see what they have to say.

Chapter 11 Plan Feasibility and the Judgment on Appeal - Its Either the Long Wait Or the Educated Guess

2007-05-06T14:27:00.000-07:00

Chapter 11 filings are often precipitated by the entry of a judgment against the debtor which is appealed. The parties must then argue about whether a chapter 11 plan is feasible and otherwise confirmable in the light of uncertainty over the amount of what might be the debtor's biggest liability.

Bankruptcy Code section 502(c) provides a solution to this dilemma by stating that the bankruptcy court "shall" estimate a contingent or unliquidated claim, "the fixing or liquidation of which, as the case may be, would unduly delay the administration of the case." This power was restricted early on by an amendment to 28 U.S.C. section 157, which expressly withholds jurisdiction to estimate an unliquidated personal injury claim. This jurisdictional limitation is a major factor which shapes mass tort chapter 11 cases, such as the Archdiocese case now pending in my hometown of San Diego.

Athough lawyers in a sense have a professional duty to estimate claims as they advise clients to litigate and settle them, bankruptcy judges seem reluctant to estimate claims, at least expressly under section 502(c). Its sort of like getting a doctor to guess out loud. In fact, up until very recently, the BAP's decision in In re Audre, Inc., 216 B.R. 19 (Bankr. App. 9th Cir.1997), barred bankruptcy judges from estimating claims represented by state court judgments that were on appeal. The rationale was that: (i) these claims really aren't contingent or unliquidated; and (ii) estimating them was to allow a collateral attack contrary to the Rooker-Feldman doctrine.

In an earlier post, I reported on In re Lopez, 2007 WL 1128811 (March 27, 2007), in which the 9th Circuit BAP abrogated Audre, on the basis of recent Supreme Court decisions which reminded us that Rooker - Feldman was a doctrine of narrow applicability.

The Ninth Circuit has taken another lick at the dead horse of Rooker-Feldman. In re Harbin, 2007 WL 1203545, (April 25, 2007) was a case in which a state court jury had entered a big verdict against the debtor, the trial judge had granted JNOV, and the defense judgment was on appeal. The Bankruptcy Court had confirmed a plan which provided for 100% payment to creditors except for the claim on appeal. The confirmation order apparently provided that if the appeal were successful the claim could be reopened as in In re Cobe, 229 B.R. 15, 18 (Bankr. App.9th Cir. 1998). A basis for this decision was the bankruptcy court's conclusion that Rooker-Feldman "precluded the court from taking into consideration the possibility" that the appeal would be successful.

In a split decision, the Ninth Circuit upheld a District Court judgment reversing the confirmation order, holding that a bankruptcy court "must evaluate the possible effect of a debtor's ongoing civil case with a potential creditor" in determining the feasibility of a chapter 11 plan.

Oh, incidentally, it looks like the JNOV was reinstated by the California Court of Appeal a long time ago in an unpublished decision, a fact not mentioned in the Ninth Circuit's opinion. See, Sherman v. Harbin, 2004 WL 1843288 (2004). Guess that's why the Ninth Circuit appeal wasn't moot.

The problem with Harbin, at least in cases not involving personal injury claims: Section 506(c) says that a claim shall be estimated. It doesn't authorize a bankruptcy court to decline to estimate a claim and then to consider the uncertain status of the claim in determining feasibility.

BAPCPA For Your Viewing Pleasure

2007-05-02T20:18:00.000-07:00

On Tuesday the House Committee on the Judiciary held a day long hearing on the second anniversary of the enactment of BAPCPA. Before I assumed the responsibilities of a blogger, I didn't know that Congressional hearings were given snappy titles. The title of this hearing asked the question (no, I'm not making this up) "Are Consumers Really Being Protected Under the Act?"

The real bankruptcy lawyers were separated from the poseurs when they stayed home to watch this event on CSPAN. Coming in a distant second were those who Tivo'ed the action. If you weren't even in this group, why would you be reading my blog? Anyway, you still have a chance to watch the hearings video online at the Committee website.

Not surprisingly, the witnesses gave differing explanations of the indisputable fact that consumer bankruptcy filings are down drastically so far in 2007, over a year removed from the effective date of BAPCPA. Steve Bartlett, President of the Financial Services Roundtable, testified that eligibility restrictions and credit counseling have resulted in lower filings. Yes, he really was serious about the credit counseling. Henry Sommer, President of the National Association of Consumer Bankruptcy Attorneys, testified that increased costs "and the widespread misperception that bankruptcy is no longer available (aggravated by collection agent misrepresentations to consumers) are the primary reasons that bankruptcy case filings have declined so precipitously. "

Well, we're going to see. If the decline in bankruptcy filings proves permanent over the next couple of years, during a period when the housing bust should be causing more filings, its going to be hard to maintain the NACBA position.

The real question that few seem interested in answering is "are less bankruptcy filings good for the economy?" I assume that "good for the economy" means the same as "good for the consumer." Is there an economist out there who has figured this out?

Doesn't matter, really. There is no politically potent pro-bankruptcy consitutency. Envision a Congress full of Democrats and its still hard to imagine most of BAPCPA being rolled back. The future of bankruptcy reform for the forseeable future is nibbling around the edges. And sorry, NACBA, that may mean plugging loopholes as much as relaxing BAPCPA's more silly provisions.

The only thing that we can all agree on was neglected at the hearings: When are the front line troops (the chapter 7 trustees) going to be taken care of? BAPCPA drastically increased their responsibilities and has cut their income. The compensation for no asset chapter 7 cases needs to go to $100 now. Could that bill possibly pass without becoming hostage to the political football of bankruptcy reform?

Security Is More Than A Feeling

2007-05-02T20:03:00.000-07:00

Section 101(37) of the Bankruptcy Code defines “lien” as a “charge against or interest in property to secure payment of a debt . . . .” and section 101(51) defines “security interest” as a “lien created by an agreement.” Most of us who get hired to enforce homemade loan documents have encountered a promissory note or other contract that clearly contemplates the application of specific property to pay the debt in the event of a default, but which doesn’t exactly say “Joe grants a security interest to Bob.”

A source of confusion for the non-lawyer is that “security” also has a common meaning – according to Merriam Webster: “Freedom from fear or anxiety” Real commercial lawyers hate it when someone says that a loan is “secured by a personal guaranty.” The guaranty may make the lender feel more “secure” but it doesn’t give the lender a security interest as either the UCC or the Bankruptcy Code defines it. It is sometimes hard to make an unsophisticated client understand that having lots of promises from a borrower doesn’t help much once the major promise – the promise to repay the debt – has been broken.

In re Ryalls, 2007 WL 1228789 (Bankr. N.D. Cal. April 23, 2007) interpreted the following language in a homemade loan agreement:

Borrowers agree to repay Lender the entire principal of $18,000 on or before April 1st, 2005. If Borrower cannot refinance their current mortgage to cover this amount, or, if another source of funds is unavailable, Borrowers agree to sell their mobile home in order to repay Lender.

After the debtor received a chapter 7 discharge the secured creditor sent a “Notice of Default” and then filed a lawsuit in the Superior Court to foreclose on the mobile home. Bankruptcy Judge Jaroslovsky, without wasting time citing a lot of readily available authority, held that “the Loan Agreement does not objectively indicate the intent to create a security interest. Specifying when a loan is to be repaid and promising to sell an asset if necessary is not the same thing as granting a security interest in the asset.”

On behalf of all lawyers everywhere: God bless all do it yourselfers. What makes them secure may help to make us secure.

Post-BAPCPA, Dairy Mart Retains its Frosty Goodness

2007-04-29T18:53:00.000-07:00

Reclamation claims aren't something that practioners in smaller bankruptcy cases used to see every day. In the past, in order for reclamation to rear its head you needed a credit sale of goods to the debtor which was large enough to motivate the seller to seek immediate legal advice following a bankruptcy filing, within the short time period allowed to perfect the claim.

When BAPCPA rewrote 11 U.S.C. section 546(c), questions were raised as to how this expanded right would fit into the post-petition financing transactions which often occur in the big cases. Amended section 546(c) still says that the reclamation right is "subject to the prior rights of a holder of a security interest in such goods." What about the situation where a floating lien on the goods is released and replaced by a lien in favor of the DIP financer? Do you have to structure your new DIP financing as a assignment of the pre-existing lien? Does it matter that the pre-petition blanket lienholder was oversecured and would have remain adequately protected if the reclamation rights were honored?

These questions were answered in pre-BAPCPA days by the Southern District of New York in In re Dairy Mart Convenience Stores, Inc., 302 B.R. 128 (Bankr. S.D.N.Y. 2003). According to Dairy Mart, reclamation claimants have no marshaling rights vis a vis an oversecured floating lien creditor. Further, new DIP financing still trumps the reclamation creditor, on the theory that the reclaimed goods securing the prepetition lender's debt have been disposed in satisfaction of that debt by providing them as collateral to the DIP lender. For the contrary view, see In re Phar-Mor, Inc., 301 B.R. 482 (Bankr. N.D. Ohio 2003).

Last week the Southern District of New York issued its opinion in In re Dana Corporation, 2007 WL 1199221 (Bankr. S.D.N.Y. April 19, 2007). The decision holds that post-BAPCPA, Dairy Mart retains all of its frosty goodness (or badness, if you're a reclamation creditor). Enroute to disallowing any reclamation right, the Court was at pains to debunk the notion that BAPCPA had created a new federal right of reclamation.

Even practical problems aside, under the holding in Dairy Mart and now Dana Corporation, the right to actually receive back the reclaimed goods is not legally available in any case where a blanket lien is present (that is, all but the smallest cases). Dana Corporation does not deal with the reclamation claimant's alternative remedy, which under BAPCPA no longer depends on timely perfection or the absence of a blanket lien. Reclamation claimants get administrative claims. Trustees are going to be seeing a lot more of those as creditor attorneys catch on.