Georgia Bankruptcy Blog

It is not uncommon for financially distressed businesses to get behind on payroll taxes, especially when the company does not have a payroll service that handles the payment of all taxes and automatically deducts the full amount from the company's bank accounts.  Chapter 11 cases often have significant unpaid payroll taxes scheduled as a priority claim, after using the funds to pay other bills to stay afloat.

What happens when a company goes out of business (in or out of bankruptcy) and leaves behind unpaid federal withholding taxes (commpnly known as "trust fund taxes")?  The Fourth Circuit addressed that question in an opinion entered Wednesday.  See Erwin v. United States, No. 08-1564 (4th Cir. January 13, 2010) (click here for opinion). 

Mack Sperling has summarized this opinion in his North Carolina Business Litigation Blog.   He summarizes the situation where individuals can become liable for unpaid taxes:

• Employers are required to withhold social security and federal excise taxes from employee wages.
• Those withheld funds are held in trust for the United States, and are often referred to as "trust fund taxes."
• Once in the hands of the employer, those funds are held for the exclusive use of the government, not the employer.
• Even if the employer needs the withheld tax money to pay suppliers and vendors to keep the business operating as a going concern, it can't, because "the government cannot be made an unwilling partner in a floundering business."
• The Internal Revenue Code imposes personal liability for payroll tax on the officers and agents of an employer who are (1) responsible for "the employer's decisions regarding withholding and payment of the taxes" and (2) who willfully fail to see that the taxes are paid. 

You do not have to be an owner, officer or director to be a "responsible person" who has personal liability for these taxes.  If you have sufficient control over the company's payroll, which creditors to pay or not pay, the day-to-day business affairs and who to hire and fire, you could be liable. 

Click here to read Mack's detailed analysis of this opinion and individual liability for taxes.

Scott Riddle’s practice focuses on bankruptcy and litigation. Scott has represented Chapter 7 and 11 debtors, creditors, trustees and other interested parties in bankruptcy cases and bankruptcy litigation.  For more information, click here.

Section 529 Plans are tax advantaged savings plans intended to encourage saving for future college costs. There are two types of qualified tuition programs: a prepaid tuition plan or a college savings plan They are authorized under Section 529 of the Internal Revenue Code (26 U.S.C. § 529).  Click here for a basic summary of 529 Plans. Are funds in the Section 529 Plans property of the Bankruptcy Estate when the account-holder/owner (usually a parent or relative of the child) files a Bankruptcy petition?

Section 541 of the Bankruptcy Code provides that the Estate includes “all legal and equitable interests of the debtor in property as of the commencement of the case” except as provided in subsections (b) and (c)(2) of this section. 

Section 541(b)(6), added to the Code in October 2005 (the "BAPCPA" amendments) states that property of the estate does not include:

funds used to purchase a tuition credit or certificate or contributed to an account in accordance with section 529(b)(1)(A) of the Internal Revenue Code of 1986 under a qualified State tuition program (as defined in section 529(b)(1) of such Code) not later than 365 days before the date of the filing of the petition in a case under this title, but –

(A) only if the designated beneficiary of the amounts paid or contributed to such tuition program was a child, stepchild, grandchild, or stepgrandchild of the debtor for the taxable year for which funds were paid or contributed;

(B) with respect to the aggregate amount paid or contributed to such program having the same designated beneficiary, only so much of such  amount as does not exceed the total contributions permitted under section 529(b)(7) of such Code with respect to such beneficiary . . .;  and

(C) in the case of funds paid or contributed to such program having the same designated beneficiary not earlier than 720 days nor later than 365 days before such date, only so much of such funds as does not exceed $5,475[.]

 In In re Bourguignon, Ch. 7 Case No. 09-00766-TLM (Bankr. D. Idaho Sep. 23, 2009) (click here to download opinion), the Court discussed the application of these Code sections.  Debtor opened a Section 529 Plan for their daughter on March 10, 2009, and deposited an initial $14,500 into the account.  Debtor's Mother subsequently added $40,000 to the account.  Debtors filed a Chapter 7 petition two weeks later. Debtors did not list the account in Schedule B or on their Exemptions.

The Court found that the Debtors had a legal interest in the account as of the petition date, and it was property of the Estate. It was not excluded under § 541(c)(2): 

Debtors’ argument that § 541(c)(2) is applicable to the College Account fails. That exception deals with restrictions on transfer “of a beneficial interest of the debtor in a trust[.]” There is inadequate proof of a qualifying trust interest of Debtors. Debtors are not the “beneficiaries” of the College Account; Christian Bourguignon is, instead, the account owner. Debtors’ daughter is the designated beneficiary. Even if Debtors arguably have a contingent, beneficial interest in the College Account because either could potentially become a beneficiary the College Account does not contain the requisite anti-alienation and anti-assignment provisions required under nonbankruptcy law and recognized by § 541(c)(2).

The Court then addressed Debtors' primary argument that the account is excluded under Section 541(b)(2). 

Focusing on the term “not later than” and urging the Court to treat it as synonymous with “within,” Debtors contend that “not later than 365 days before the date of the filing” as found in § 541(b)(6) means that “if funds were put into a 529 account LESS THAN ONE YEAR before the petition day, they are NOT property of the estate.” ... Debtors’ interpretation of the Code lacks merit.

The natural reading of § 541(b)(6) provides an exclusion from property of the estate for 529 accounts on a sliding scale. Assuming the qualifying conditions of § 541(b)(6)(A) and (B) are met, any such contributions made to a 529 account more than 720 days prior to bankruptcy are fully excluded from property of the estate. Such  contributions made between 365 and 720 days prior to bankruptcy are excluded from property of the estate to the extent below $5,47513 but any such contributions over $5,475 in that same time frame remain property of the estate. Any amounts contributed within a year of bankruptcy are not excluded at all from property of the estate…

Thus, for funds to be excluded from property of the estate under § 541(b)(6), they must be contributed to a 529 account at least a year before the filing of the bankruptcy, and, even then, there is a monetary cap on the excluded funds contributed between 365 and 720 days prior to the filing. It is only those funds contributed more than 720 days before filing that are excluded without a monetary limit. ...In sum, Debtors’ desired construction is not supported by the language of the statute, plainly read; any plausible policy rationale; or their own account documents.

 In addition to the funds contributed by the Debtor being property of the Estate, the Court also held that the $40,000 contributed by Debtor's mother was also Estate property. 

Section § 541(b)(6) makes certain funds contributed into a 529 account property of the estate and excludes others, but that distinction is based on the timing of contribution, not the source of the contribution. Indeed, during the September 3 hearing, Debtors conceded the Code makes no distinction based on the source of the contributions.

Debtors instead rely on the language of their College Account’s plan description, which states that “Contributions . . . by an Account Owner” made within a year of filing bankruptcy are part of the account owner’s bankruptcy estate and are available to creditors, but which does not mention a third party’s contributions. See Ex. 201 at 13. The plan description’s silence on the subject of third party contributions does not suggest differential treatment under § 541(b)(6). More importantly, the description cannot alter the language and operation of the Code. The Court concludes that the source of the funds in the 529 account is immaterial.

This should be a warning to grandparents and other relatives who want to contribute to a Section 529 Plan.  If the account owner files a Chapter 7 within two years of the contribution, you risk losing all or part of your contribution.   

Scott Riddle’s practice focuses on bankruptcy and litigation. Scott has represented Chapter 7 and 11 debtors, creditors, trustees and other interested parties in bankruptcy cases and bankruptcy litigation.  For more information, click here.

Edited August 18 - Debtor Southeast Waffles has withdrawn its Plan of Reorganization and requests the Court take no further action on its plan.  As the Debtor's plan was to sell to Mickelson's group, it appears, at least for now, his bid is over.

Joe Guy Collier of the Atlanta Journal Constitution wrote an article for today's edition about the competing bids for the assets of a Waffle House franchisee that filed a Chapter 11 petition in Nashville.  The debtor company, Southeast Waffles, LLC, has proposed a plan whereby the assets would be purchased by a group including professional golfer Phil Mickleson.  Parent company Waffle House, Inc., based in Norcross has also filed a competing plan, along with a third bidder, MNM Waffles.

GS Acquisitions, a company that includes Mickelson as a principal, followed with a $20.2 million bid. Other GS principals include Steve Loy, CEO of Gaylord Sports Management, and Terry Pefanis, former chief operating officer of Big Idea, best known for its VeggieTales series.

Late last week, MNM Waffles submitted a $24.7 million bid. The CEO for the newly formed MNM Waffles is Maria Tangredi. Her husband and son are executives in M. Tangredi’s Restaurants, a Nashville restaurant firm that filed earlier this year for its own bankruptcy proceedings, according to NashvillePost.com.

Joe asked for a few comments about the competing plans:

The amount of the bid is only one factor, said Scott Riddle, an Atlanta bankruptcy attorney. The bidders have proposed making payments over several years.  The court and creditors will want to know if the bidders have sound financial backing and can successfully run the restaurants, Riddle said.  “I want to know who they are and I want to know what kind of experience they have,” he said. “It’s not just looking at the money.”

Henry Under of the AJC's Biz beat Blog also writes about the case:

 Can a Masters champ run a Waffle house? That’s what a bankruptcy court judge is going to decide...

GS Acquisitions includes Mickelson as a principal, as well as Steve Loy, CEO of Gaylord Sports Management; and Terry Pefanis, former chief operating officer of Big Idea, best known for its VeggieTales series. It submitted a bid of $20.2 million bid, Collier writes.

There are two other bidders competing with Mickelson’s team:

– Waffle House, the Norcross-based franchisor of the chain. It bid $21.4 million.

– MNM Waffles submitted a $24.7 million bid.

The amount of the bid is only one factor, Scott Riddle, an Atlanta bankruptcy attorney, told Collier. The court and creditors will want to know if the bidders have sound financial backing and can successfully run the restaurants, Riddle said.

Click for the documents: Chapter 11 Plan and Disclosure Statement of Debtor/GS Acquisitions; the Chapter 11 Plan and Disclosure Statement of MNM Waffles, LLC.  Interestingly, the MNM Waffles documents were filed without counsel.  Although a lawyer's name appears at the bottom of the documents, he had not been actually retained.  Maria Tangredi is filing documents on behalf of MNM. 

Finlay Enterprises Inc., the parent company of jewelry retailer Bailey Banks & Biddle, filed their petition in New York yesterday. There are three Bailey Banks & Biddle stores in Atlanta: Lenox Square Mall, Perimeter Mall and Mall of Georgia.

From the Atlanta Business Chronicle, the company announced plans to sell the business and assets at auction.

The Atlanta Business Chronicle is reporting that Ritz Camera, which operates as Wolf Camera in many locations (incl. Georgia), is giving up its reorganization efforts and will try to sell all remaining locations.  Click here for the article by Barton Eckert.

From the article:

In a court filing, Ritz Camera reported it is talking with two potential bidders, although neither has been willing to sign a contract. The company is hopeful at least some of the remaining 400 photo stores will be sold to a going-concern buyer. The other 400 stores already have been closed in going-out-of-business sales...

Ritz Camera also owned Boater’s World, a boating-and-fishing supply retailer. The bankruptcy court judge gave Ritz Camera permission on March 19 to hire Gordon Brothers to shut down the company's 130-store Boater’s World chain... Its retail brands today include Wolf Camera, Kits Cameras, Inkley’s and The Camera Shop.

Coincidentally, I stopped in the local Wolf Camera yesterday to take a look at two Canon lenses, and they did not have either in stock.  They did go through the effort to "check the system" to see when they might have them available, but I thought it was unusual they asked for no contact information to let me know what it arrived.  I probably do not need to check back in 1-3 weeks as suggested.  Unfortunately, Showcase, Inc., the other store in the area, also was out of stock for both so Amazon.com was the answer.

From the Wall Street Journal, Six Flags, Inc., which has three parks in metro Atlanta (Six Flags, White Water and American Adventures), has filed a Chapter 11 Bankruptcy petition this morning in the District of Delaware.  Click here for the company news release and here for an article that attaches the petition.

From the WSJ article -

The theme-park company, shouldering more than $2 billion in debt, had been racing to restructure outside of court, negotiating with lenders, selling parks and laying off staff. But it couldn't outrun the deteriorating economy and a looming $288 million payment due preferred shareholders this August, along with $31 million in unpaid dividends.

Six Flags, whose theme parks attract more than 25 million visitors a year, said it filed Chapter 11 with a prearranged reorganization plan that garnered unanimous approval from its lenders' steering committee. The plan would deleverage Six Flags' balance sheet by about $1.8 billion and eliminate more than $300 million in preferred stock obligations, the company said.

Low consumer confidence kept attendance down at Six Flags' 20 parks, which dot several cities across North America, including Chicago, San Antonio and Mexico City. Revenue fell and the company delayed certain debt payments.... A few months ago, Six Flags hired law firm Paul Hastings Janofsky & Walker LLP to prepare for a bankruptcy filing. It also hired Houlihan Lokey Howard & Zukin to negotiate with creditors.

Crunch Fitness, which has a location on Piedmont Road in Buckhead, filed a Chapter 11 petition in New York today. 

From Bloomberg -

Crunch Fitness, a gym operator with 73,000 members and clubs in six U.S. cities, filed for bankruptcy protection from creditors in New York, citing slowing membership and overpriced leases for some locations. The petition for Chapter 11 protection filed in Manhattan today listed up to $500 million in both assets and debts. AGT Crunch Acquisition LLC filed for court protection, along with affiliate clubs in New York, Miami, Chicago, Los Angeles, Atlanta and San Francisco.

The gym’s locations continue to operate, and Crunch is seeking bankruptcy court permission to continue “business as usual,” said Chief Financial Officer Michael Jacobs in a court filing... The case is In re AGT Crunch Acquisition LLC, 09-12889 U.S. Bankruptcy Court, Southern District of New York (Manhattan).

From Reuters, General Growth Properties, which owns Comberland, North Point, Perimeter and Southlake Malls in Metro Atlanta, field a Chapter 11 Bankruptcy petition in the Southern District of New York. 

General Growth Properties Inc, the second largest U.S. mall owner, filed for bankruptcy protection on Thursday in one of the biggest real estate failures in U.S. history. Ending months of speculation, the Chicago-based mall owner, which listed total assets of $29.56 billion and total debts of $27.29 billion, sought Chapter 11 bankruptcy protection from creditors along with 158 of its more than 200 U.S. malls, while it seeks to restructure some of its debt....General Growth's filing in the U.S. bankruptcy court in Manhattan makes it one of the largest nonfinancial companies to succumb to the financial crisis in the U.S...

The case is In re General Growth Properties Inc, U.S. Bankruptcy Court, Southern District of New York, No. 09-11977

Supermarket chain Bi-Lo  filed for Chapter 11 bankruptcy relief in the United States Bankruptcy Court, District of South Carolina.  According to its website, the chain has several stores in Georgia. 

From the Associated Press -

Details of the credit agreement terms were not immediately available but the company said it has met all the loan's terms so far.

Bi-Lo management said in a statement that in a normal credit environment it would expect to refinance the loan on "reasonable terms in the ordinary course of business" as its maturity date approaches. But the company determined it needed to file for bankruptcy protection to continue operating because of the current tight credit market.

"We intend to move through this process as quickly as possible, and we firmly believe that this course of action will better position Bi-Lo for continued growth and long-term success," Michael Byars, president and chief executive of Bi-Lo, said in a statement.

Six Flags Theme Parks, which includes Six Flags Over Georgia, Six Flags White Water, and American Adventures parks in the Atlanta area, is experience significant financial difficulties and there is speculation that a Chapter 11 Bankruptcy filing might be in its future.

From the Associated Press:

Shares of Six Flags Inc. fell in premarket trading Friday as worries grew that the theme park operator may have to file for Chapter 11 bankruptcy protection.  Six Flags shares lost 2 cents, or 10.5 percent, to 17 cents in early trading. The stock has traded between 16 cents and $2.50 during the past 52 weeks.  In its fourth-quarter earnings report on Tuesday, Six Flags said it does not expect to have enough cash to redeem its preferred income redeemable shares on their redemption date of Aug. 15...

The shares, known as PIERS, must be redeemed for $287.5 million plus accrued and unpaid dividends, which may total up to $31.3 million. The company has skipped paying the dividends since May of last year... In its annual report filed with the Securities and Exchange Commission on Wednesday, the company said it may be forced to file for Chapter 11 bankruptcy if it cannot negotiate an out-of-court restructuring agreement with its PIERS holders, common stockholder and creditors.  "Such a court filing would likely occur prior to the maturity of the PIERS or well in advance of such date, if we were to conclude at such time that an out-of-court solution is not feasible or advantageous," Six Flags said in the filing.

Meanwhile, another theme park has already filed a Chapter 11 petition.  From Andy Peters' Deal Watch Blog, Ghost Town in the Sky in Maggie Valley, N.C., filed a Chapter 11 petition in the Western District of North Carolina.  Ghost Town and nearby Frontierland were frequent destinations for those of us who grew up in western North Carolina in the 1970's.  There was even Ghost Town: The Movie. You can see a video of Ghost Town by clicking here.

As mentioned in this post, Ritz Camera, owner of Wolf Camera, filed a Chapter 11 petition last month.  Ritz also owns Boater's World stores, with two locations in Georgia.  According to the article, Ritz will liquidate Boater's World Stores and close half of its 800 camera stores.  Apparently they have not yet decided which camera stores to close.

From the Washington Post -

Ritz Camera, trying to raise cash to cover its mounting debt, received approval in bankruptcy court yesterday to begin the process of liquidating the assets at all 130 shops operated by its Boater's World Marine Centers.

Moreover, attorneys for the Beltsville-based company, the nation's largest photography retailer, said they will file a motion on Friday seeking to sell off half of its 800 Ritz camera stores.

The privately held company filed for Chapter 11 bankruptcy protection last month to cover more than $54 million in debt to such creditors as Fuji Photo Film, Nikon, Canon USA and Wachovia Bank. A U.S. bankruptcy judge in Wilmington, Del., where the case was filed, approved bidding procedures for the sale of the Boater's World assets...

"We will liquidate the assets in the less profitable retail stores," Walker said. The company, he added, has not specified which 400 camera stores would be closed...

Ritz Camera, the owner and operator of Boaters World and Wolf Camera, filed a Chapter 11 petition today in Delaware. Ritz bought Wolf in 2001 after Wolf filed a Chapter 11 in 2000.  Wolf had previously purchased Fox Photo.  Wolf has several stores in Atlanta, and Boaters World has two locations in Georgia.

From Reuters:

NEW YORK, Feb 23 (Reuters) - Ritz Camera Centers Inc, which said it is the largest U.S. specialty camera and imaging chain, on Monday filed for Chapter 11 bankruptcy protection, hurt by the recession and consumers' shift to digital photography... 

The Beltsville, Maryland-based company filed for protection from creditors with the U.S. bankruptcy court in Wilmington, Delaware. Ritz said it has between $100 million and $500 million of both assets and liabilities.

Ritz operates under such names as Ritz Camera, Wolf Camera, Kits Cameras, Inkley's and The Camera Shops, and also operates the 130-store Boater's World Marine Centers chain. It said it had nearly $1 billion of revenue in the year ended Nov. 30, 2008...

 

S&K Famous Brands., Inc., doing business as S & K Menswear, filed a Chapter 11 petition today.   The company has stores in Georgia and the Southeast.

From Reuters:

S & K Famous Brands Inc, which operates men's clothing stores mostly in mid-Atlantic states and the Carolinas, filed for Chapter 11 bankruptcy protection on Monday, hurt by sagging sales and the U.S. credit crunch, according to court documents...

The Richmond, Virginia-based company has about 1,095 full and part-time employees and operates about 136 stores in the United States under the name S&K Menswear. The case is In re S & K Famous Brands Inc., U.S. Bankruptcy Court, Eastern District of Virginia, Case No. 09-30805.

Spectrum Brands, Inc., the Atlanta-based manufacturer of Ray-o-vac, Remington, Spectracide, Cutter, Repel and other well-known brands, has filed a Chapter 11 petition in the Western District of Texas.

Click here for the company's press release:

ATLANTA--(BUSINESS WIRE)--Spectrum Brands (PINK SHEETS: SPCB - News) today announced that it has reached agreements with noteholders representing, in the aggregate, approximately 70% of the face value of its outstanding bonds, to pursue a refinancing that, if implemented as proposed, will significantly reduce the Company's outstanding debt and put the Company in a stronger financial position for the future. A refinancing on the agreed terms would enable Spectrum Brands to reduce the amount of debt on its balance sheet by approximately $840 million (or approximately one-third), eliminate approximately $95 million in annual cash interest payments for at least each of the next two years, and free up additional cash that can be reinvested in its business to support meaningful revenue and profit growth. The Company currently has outstanding indebtedness of approximately $2.6 billion.

To implement the refinancing in the most efficient manner and to take advantage of certain tax benefits, Spectrum Brands and its U.S. subsidiaries today filed voluntary petitions for reorganization under Chapter 11 in the U.S. Bankruptcy Court for the Western District of Texas, San Antonio Division. The Company's non-U.S. operations, which are legally separate, are not included in the Chapter 11 proceedings....

Click here for an article in the Atlanta Business Chronicle:

"Our businesses have attractive growth prospects that have been encumbered by the level of debt the parent company is carrying,” said Kent Hussey, CEO of Spectrum Brands, in a prepared statement. “After careful consideration, we decided that the approach announced today would be the most effective and expedient path for us to develop a more appropriate capital structure to support our long-term business objectives. We estimate that when this refinancing has been completed, the company will generate in excess of $100 million in annual free cash flow."...

Discount Clothing Retailer Goody's Family Clothing decided last week to liquidate and close its remaining stores, after emerging from Chapter 11 only a few months earlier.  Now it has filed Chapter 11 again.

From Reuters -

Goody's LLC, a privately held family apparel retailer that emerged from bankruptcy in October, has filed for Chapter 11 protection again, and said it plans to liquidate its remaining 282 stores.

A "significant downturn in the national economy caused severe and unexpected financial pressures," and led to "unexpectedly poor" sales in the holiday season, Goody's said in a Tuesday filing with the U.S. bankruptcy court in Wilmington, Delaware. ... Several retailers have filed for bankruptcy protection in recent months, including Boscov's Inc, Circuit City Stores Inc and KB Toys Inc.The case is In re Goody's LLC, 09-10124, U.S. Bankruptcy Court, District of Delaware (Wilmington).

From Reuters:

 Nortel Networks, the maker of telephone equipment, filed for bankruptcy protection on Wednesday, a day before it was scheduled to make an interest payment of about $107 million. Nortel and a number of its affiliates filed for Chapter 11 bankruptcy protection in federal bankruptcy court in Delaware.

“Based on this filing, the board of directors must believe that not only is the fourth quarter bad, but that the first quarter is going to be just as bad or worse,” said Duncan Stewart, an analyst at DSAM Consulting in Toronto.

Although they have cash in the short term, even the medium-term outlook is not enough to make the company viable as a going concern.” ...

Shane Company, a jewelry retailer with four locations around Atlanta according to its website, filed a Chapter 11 petition in the U.S. Bankruptcy Court for the District of Colorado.  Chapter 11 Case No. 09-10367.   Hear the announcement from Tom Shane himself.

From Reuters:

Shane Co, a privately held jewellery retailer, filed for Chapter 11 bankruptcy protection in a Colorado court on Monday and said it appointed Kevin Regan of FTI Consulting as interim chief restructuring officer. ..The company also said it has about 6,000 creditors including trade vendors, customers and employees.

The company owes more than $26 million to its top 20 unsecured creditors, according to court filings and it listed Dison Gems as its top unsecured creditor.

From the Rocky Mountain News:

Now you have a bankrupt friend in the diamond business...

Tom Shane has been the public face of the company for much of that time, earnestly delivering he company's tag line "Now you have a friend in the diamond business" in advertisements that tout the company's "no-middle man markup" approach to buying diamonds and other gems.

Shane owes as much as $26.2 million to its 20 biggest unsecured creditors, according to court papers. The largest unsecured creditor is New York- based Dison Gems Inc., with a $4.7 million claim, the company said. Among Shane's 6,000 creditors are 4,600 customers who placed special orders or made layaway deposits on future purchases...

In a 2002 interview with the Atlanta Business Chronicle, he called the ads "the longest-running continuous campaign in the history of radio" and said he writes them himself.

"A lot of owner-spokesmen are really pitchmen, and I'd like to think that's not how we position ourselves," Shane was quoted as saying. "We try to be credible and sincere. Most people don't know much about jewelry. They want to be assured that they're not going to be ripped off."

Update: KB Toys to close and quickly liquidate for the Christmas rush, according to a Court filing and this Wall Street Journal article:

The company plans to quickly start going-out-of-business sales at hundreds of its stores, "in order to take advantage of the last two weeks of the holiday selling season," KB Toys said in a filing with the U.S. Bankruptcy Court in Wilmington, Del.

From Bloomberg:

KB Toys Inc., the 86-year-old toy retailer, filed for bankruptcy three years after leaving court protection, blaming a cash crisis caused by a “sudden” drop in sales at its 277 stores...  “The liquidity crisis is directly attributable to a sudden and sharp decline in consumer sales,” Controller Raymond Borst said in court documents filed in U.S. Bankruptcy Court in Wilmington, Delaware...  The case is In re KB Toys Inc., 08-13269 U.S. Bankruptcy Court, District of Delaware (Wilmington).

 

From the Wall Street Journal -

Tribune Co. filed for bankruptcy protection Monday, in a sign of worsening trouble for the newspaper industry.  In recent days, as Chicago-based Tribune continued talks with lenders to restructure its debt, the newspaper-and-television concern hired investment bank Lazard Ltd. as its financial adviser and law firm Sidley Austin to advise the company on a possible trip through Chapter 11 bankruptcy, people familiar with the matter say.

Tribune owns eight major daily newspapers, including the Los Angeles Times, Chicago Tribune and Baltimore Sun, plus a string of local TV stations....

Even as its financial performance worsens, Tribune has some options. A sale of its Chicago Cubs baseball team is under way, and Tribune owns valuable stakes in businesses including the cable-TV channel Food Network.

See the petition here.

Alan Judd at the Atlanta Journal has an article about Michael Vick's spending in the time leading up to his imprisonment, including millions of dollars transferred just before his incarceration.  This information was contained in pleadings filed in his Bankruptcy case.   Click here for the article.

Among the highlights from Alan's article:

• The day he went to jail, Michael Vick bought a $99,000 Mercedes.  He cashed four checks that totaled $24,900. He gave $28,000 to the mother of his oldest child. He paid a public relations firm $23,000 and gave a friend $16,000.  Altogether on Nov. 19, 2007, Vick spent $201,840. But for the former Atlanta Falcons quarterback, the day was most remarkable for how it ended: behind bars .. From Aug. 27, 2007, the day he pleaded guilty in a Richmond federal courthouse, until Nov. 19, the day he bought the new Mercedes before reporting to jail, Vick shelled out $3,627,291.

• During his last weeks of freedom, though, Vick also spent $85,000 on a fish pond and $48,257 for landscaping. He bought a $31,000 Ford pickup and a $33,100 Chevrolet. Vick’s financial records suggest he was hemorrhaging money. In the weeks before he went to jail, he made 48 cash withdrawals for a total of $325,945. The largest was on Sept. 19, for about $67,000. Using three cashier’s checks, he withdrew an additional $90,000.

• Vick seems to have relied heavily on cash.  In 2007, documents show, he used cashier’s checks to withdraw $908,500 from his bank accounts. During a two-year period, he wrote checks payable to “cash” totaling almost $1.1 million.

• Not long after joining the Falcons, Vick bought his first house: a $918,000 mini-mansion behind the gates that guard the Sugarloaf Country Club in Duluth. Two years later, in April 2005, he upgraded to a larger house in the same neighborhood, for almost $3.8 million.  He bought four more houses, all in Virginia, and began building another.He bought a condominium in Miami Beach.He bought interests in two farms — one in Virginia, one in Rockdale County, east of Atlanta. He bought six Paso Fino horses, worth about $450,000. He bought two boats, one for $100,000, the other for $125,000. He bought cars: a Bentley, two Land Rovers, Cadillacs, an Infiniti sport utility vehicle and an Infiniti sedan, two Ford pickup trucks, a Dodge, a Chevrolet, the $99,000 Mercedes. And he bought as much as $450,000 in jewelry.
  

Tweeter Home Entertainment, the parent of HiFi Buys (which had several locations in Atlanta), first filed a Chapter 11 petition in June 2007 (click here).  It was bought by an investment firm and operated as Tweeter Opco, LLC, but that entity filed another Chapter 11 in November 2008 (click here).  This week, however, it abruptly closed all of its remaining stores and fired employees on Monday and sought conversion to Chapter 7 (see Reuters article here), wh ich was granted.

I purchased electronics from Stereo Sound in Chapel Hill (another chain purchased by Tweeter) while in college and law school at UNC, and HiFi Buys in Atlanta for several years, but over the years Best Buy, Amazon, H.H. Gregg, Brandsmart, etc., moved in to take the market share from specialty electronics retailers (and Circuit City). 

It appears possible that some stores may reopen for liquidation (see article here).  However, there are a few issues:

The conversion will free up cash, allowing Tweeter to continue liquidating its inventory and real estate, and will provide for a $900,000 fund from which employees are to be immediately paid accrued wages and commissions.

TWICE has received reports from Tweeter workers who were either told to return to work tomorrow or received inquiries about their availability. Whether the stores will reopen remains unclear, however, as the headquarters office has essentially ceased operations and Tweeter’s liquidators have filed an objection to the Chapter 7 conversion, demanding immediate payment of about $1.8 million for services rendered.  All parties reportedly were back in the United States Bankruptcy Court in Delaware this afternoon to hammer out an accord.

Bally Total Fitness has filed Chapter 11 for the second time in a little over a year. The website lists eight clubs in Metro Atlanta.

From Reuters:

NEW YORK, Dec 3 (Reuters) - Bally Total Fitness Holding Corp, which operates 347 health clubs serving more than 3.1 million customers, filed for bankruptcy protection for the second time in 17 months, and put itself up for sale.

The Chicago-based company and more than 40 affiliates filed for Chapter 11 protection with the U.S. bankruptcy court in Manhattan on Wednesday. Bally said it has more than $1 billion of both assets and debts, and in excess of 100,000 creditors.

Chief Executive Michael Sheehan in a statement said, "The burden of Bally's long-term indebtedness, coupled with the lack of refinancing options in today's constrained credit markets," left no alternative other than a bankruptcy filing, despite "marked improvement" in Bally's operating results.

Bally first filed for bankruptcy protection on July 31, 2007, and emerged two months later after receiving $233.6 million from hedge fund Harbinger Capital Partners. It later defaulted under a credit agreement it obtained when it emerged, according to a resolution adopted by Bally's board.

From the press release at Marketwatch:

CHICAGO, Dec 03, 2008 /PRNewswire via COMTEX/ -- Bally Total Fitness Corporation ("Bally") today announced that it has filed for voluntary chapter 11 bankruptcy protection. The chapter 11 petition was filed today in the U.S. Bankruptcy Court for the Southern District of New York. Bally intends to use the chapter 11 process to significantly reduce debt from its balance sheet while streamlining and strengthening its core operations. It expects to accomplish these goals through either a sale of the business as a going concern or through a chapter 11 plan of reorganization.

Bally has received strong indications of interest from a number of prospective purchasers and is engaged in active and advanced negotiations with certain of its lenders regarding an agreement to purchase the Company's assets as a going concern. The Company seeks to complete these sale negotiations and enter into a definitive agreement as promptly as possible, subject to Bankruptcy Court approval of the sale transaction.

From the Atlanta Business Chronicle -

Chicken processor Pilgrim’s Pride Corp., which in 2007 acquired Atlanta-based Gold Kist Inc., confirmed Monday it has filed a voluntary petition for Chapter 11 bankruptcy protection. The filing, which was made in the U.S. Bankruptcy Court for the Northern District of Texas, if approved, will enable the company to restructure under a Chapter 11 bankruptcy reorganization plan.

Citing the company’s difficulty weathering tough economic cycles, the challenges of high feed prices, unbalanced chicken inventory, weak market pricing and falling demand, Pilgrim’s Pride (NYSE: PPC) said it filed for bankruptcy protection after determining a Chapter 11 reorganization is the best solution to address the company’s short-term operational and liquidity difficulties.

From the Wall Street Journal (sub. req'd)

Pilgrim's Pride vaulted over Tyson to become the market leader with its $1.1 billion acquisition of rival Gold Kist Inc., only to be squeezed by over-production at home and abroad as well as rising commodity costs. The company was also left exposed by loss-making corn-futures contracts purchased when feed costs were spiraling.

Bank of Montreal has lined up to provide $450 million in debtor-in-possession funding, subject to approval by the bankruptcy court in the northern district of Texas.

The company's Mexican operation – ranked No. 2 in poultry sales – wasn't included in the filing, and could emerge as a potential target for Tyson or Sanderson Farms, though analysts estimate it would generate net proceeds of just $100 million

Another well-known business feels the crunch.  Fine China and collectible manufacturer Lenox Group, Inc. filed a Chapter 11 petition in the Southern District of New York.

From Yahoo (AP):

The Eden Prairie, Minn., company will continue to conduct "business as usual," Chief Executive Marc Pfefferle said in a statement. Lenox was called Department 56 until 2005 when it changed its name after buying Lenox Inc., a fine-china maker, to offset declining demand for its collectibles. Debt stemming from the acquisition and the weakening financial markets lead to the filing, Lenox Group said.

"Our business has been significantly impacted by economic conditions and excessive debt levels incurred at the time Department 56 purchased Lenox Inc. in 2005," he said. "After exhausting all other possibilities and considering the current state of credit markets and the economy, we determined that the best way to complete a restructuring of the balance sheet and protect our franchise value was to pursue a sale of the Company under Court approval in a Chapter 11 proceeding."

Lenox trades on an over-the-counter bulletin board. It expects trading in its shares will be temporarily halted until the exchange receives more information about the company's financial condition.

The company filed with the U.S. Bankruptcy Court in the Southern District of New York. Its bankruptcy attorney is Weil, Gotshal & Manges LLP and its financial adviser is Berenson & Co.

From the Detroit Free Press:

BH S&B Holdings, an entity formed to buy bankrupt retailer Steve & Barry's LLC out of bankruptcy for $163 million, sought court protection itself, citing the deteriorating U.S. economy.  BH S&B Holdings, created by hedge funds and former owners of Steve & Barry's, filed for bankruptcy protection today in Manhattan federal court.

The petition for Chapter 11 reorganization listed $100 million to $500 million in debt and assets. BH S&B Holdings, formed to purchase the retailer in August, includes Bay Harbour Management LC and York Capital Management, with Steve & Barry's co-founders Steve Shore and Barry Prevor as investors...

Update September 2009 - Unfortunately, this story has taken an unfortunate turn, as the CEO of Land Resources, J. Robert Ward, was arrested for killing his wife.  Click here for the story.

Land Resource, LLC, and related entities filed Chapter 11 Petitions in the Middle District of Florida on October 30, 2008.  See bottom of post for case information.  

A description of the entities and facts can be found in the Declaration in Support of First Day Pleadings by J. Robert Ward, the Chairman, President and Secretary of Land Resource Group, Inc., which is the Managing Member of Land Resource, LLC.  Click here for the 20 Largest Unsecured Creditors, which includes the Atlanta Braves (owed $50,000).

Land Resource is the developer of Cumberland Harbour on Cumberland Island. An Atlanta Journal article by Stacy Shelton discusses the company and filing:

Ward said his company fell victim to the real estate downturn, fueled by the credit crisis and low consumer confidence. He was not making enough money on sales to complete the promised projects.  “The banks stopped making loans to our customers,” Ward said in an e-mail. “It just doesn’t seem fair that the banks can put us into bankruptcy because of their failure to lend and then get a federal bailout, but then chase me personally and ruin a very good company and put 250 people out of work and affect thousands of property owners and leave them with uncompleted lots.” ... The company’s assets include 128 unsold lots in Cumberland Harbour in St. Marys, where the largest marina complex on the Georgia coast has been proposed. According to Land Resource, 936 lots have been sold. They asked from $150,000 to $750,000 for lots

Former Atlanta Falcons Quarterback, and current resident of a federal prison, Michael Vick is selling his house in Sugarloaf in Gwinnett County.  See the Deal Watch Blog for the report.

The disclosure statement and plan of reorganization filed with the Bankruptcy Court also assume that creditors will be paid, at least in part, by Vick's future earnings in the National Football League.  "The Debtor has every reason to believe that upon his release, he will be reinstated into the NFL, resume his career and be able to earn a substantial living," Vick's attorneys wrote in a disclosure statement filed before a hearing Thursday in U.S. Bankruptcy Court in Norfolk (see AP article).

 If you are interested in the 8 bedroom house, listed at $4.1 million, see the listing here. The site includes several photographs of the house.  Apparently, the list price is down from $4.5 million.  If you buy it, you can live among other successful and interesting people and activities.

It is certainly not a surprise that Circuit City filed a Chapter 11 petition in the Eastern District of Virginia.  See the press release here. Last week the company announced it was closing many stories, and pulling out of Atlanta entirely.  According to this article, the company hired Skadden Arps a few weeks ago.

The parent of Creative Loafing, the alternative newspaper/magazine, filed a Chapter 11 petition today.

From the company -

September 29, 2008 at 1:11 pm by John F. Sugg in Inside CL, News

Creative Loafing Inc. — which owns alternative weekly newspapers in Chicago, Washington, Tampa, Charlotte and Sarasota, as well as Atlanta — today filed for bankruptcy protection. Prompting the move was a debt load of more than $40 million.
“The company owned more money than it can pay back right now,” CEO Ben Eason said in a conference call with company managers. The bankruptcy petition was filed in Tampa, where the company’s based, and was timed to preclude a interest payment that was owed lenders on Wednesday.
The company will ask federal bankruptcy Judge Caryl Delano to stay any attempt by creditors to liquidate the assets or take control of the company.
“We’re doing the right things,” Eason said. “This will give us a fresh start. It is a reorganization, not a liquidation. Everybody gets paid.”
The debt load was substantially increased last year when Creative Loafing purchased the Chicago Reader and the Washington City Paper. Since then, advertising revenues for the print editions of the papers has deteriorated, as they have for newspapers nationwide. Over the same period last year, revenues were down between 10 and 15 percent.
Among the largest unsecured creditors is Fayetteville Publishing Co., which prints the Atlanta paper and some of the other papers in the group. The Georgia Department of Labor, the Georgia Department of Revenue and the IRS are also among the creditors.
Creative Loafing was founded in 1972 by Debby Eason in Atlanta and later opened several other papers in the Southeast. Her son, Ben, who owned the Tampa paper, acquired the rest of the family newspapers in 2000.

On September 28, 2008, late on Sunday evening, Bill Heard Chevrolet filed Chapter 11 Bankruptcy in the United States Bankruptcy Court for the Northern District of Alabama.  As discussed in this prior post, the dealership closed its locations last week.

The debtor companies filed a Motion for Joint Administration under the name of "In re Bill Hard Enterprises, et al,: Chapter 11 Case No. 08-83029-11.  The debtors have also filed a motion to authorize post-petition financing by GMAC.  Ironically, it was having their credit cut by GMAC that, in part, led to Bill Heard's demise.

Bill Heard is represented in the cases by Derek Meek and Mark Solomon of the Birmingham office of Burr Forman.

The several related entities that filed are listed below.  

The university's lawyers seem to think so, and have said so in court!  For background, go to the comprehensive post on the N.C. Business Litigation Blog, and the follow-up post here, but I'll summarize.

The University of Louisville filed suit against Duke University in Kentucky state court because Duke backed out of a contract to play a four game series against Louisville (read the complaint).  Duke defended  based on a provision in the contract which stated that it had to pay a fee of $150,000 per game only if Louisville was unable to find a replacement opponent of "similar stature" to Duke.  In discovery, Louisville asked Duke what the term meant and Duke responded that every other team in Division 1 was of "similar stature" (or better) than Duke, except junior varsity teams:

Duke states that any and all college varsity teams in the Football Bowl Subdivision (formerly Division I-A) are teams of a 'similar stature' to Duke. . . . Additionally, Duke states that any and all college varsity football teams in the Football Championship Subdivision (formerly Division I-AA) that would be considered as good or better than Duke in football. . . are teams of a 'similar stature' to Duke. . . . [J]unior varsity programs of any of the aforementioned teams would not be teams of a 'similar stature' to Duke's varsity college football team.

The evidence was good for the Judge, as Duke won in summary judgment (see order here).  

The term 'team of similar stature' simply means any team that competes at the same level of athletic performance as the Duke football team. At oral argument, Duke . . . persuasively asserted that this is a threshold that could not be any lower. Duke's argument on this point cannot be reasonably disputed by Louisville. Duke won only one football game, and lost eleven, during the 2007 football season.

In its latest post, the N.C. Business Litigation Blog includes a link to the video and transcript of the oral arguments.  It includes these gems from Duke's counsel:

 Duke's Lawyer: "I think the Court can absolutely positively take judicial notice that Duke is probably the worst football team in Division I football. Everybody knows that. That’s no secret. The longest losing streak, the inability to ever win games. Everybody knows about it. That’s well documented. We certainly don’t have to go out and take six months of discovery to establish that for you."

Duke's Lawyer:  "So the bottom line is how much discovery, if any, should anyone have to take, want to take or need to take to make the simple analysis of whether or not that was a team of similar stature? It’s judicial notice that they got beat by Utah. Maybe that’s part of the dispute – that they wish they’d played somebody weaker, like Duke which would have been an automatic W."

 

 

Duke's Lawyer: "I think again you can take judicial notice of the fact that the Louisville-Utah game ended up on TV. I don’t know, I don’t have the discovery on it, but I’ll guarantee they made more money playing a team that there was some interest in in Utah than they ever would of in playing Duke who no one would televise in their right mind."  (As pointed out later in the hearing by Louisville's lawyer, that's not exactly right. Duke was on national television last year playing Notre Dame, and is frequently televised in ACC games).

 

From law.com,  Winstead Ordered to Disgorge up to $500,000 in Bankruptcy Case:

A 5th U.S. Circuit Court of Appeals opinion that one former bankruptcy judge calls "scary" for lawyers requires Dallas-based Winstead to disgorge up to $500,000 in attorney fees the firm received for its work on the restructuring of a restaurant chain that filed for bankruptcy.

In an Aug. 28 decision in Wooley v. Faulkner, a three-judge panel of the 5th Circuit concluded that the doctrine of equitable mootness did not apply to attorneys representing clients in a Chapter 11 bankruptcy… Under the equitable mootness doctrine, appeals courts typically recognize that there is a point at which they cannot order fundamental changes in a debtor's reorganization plan approved by a bankruptcy court once that plan has been consummated…

The Wooley case stems from the August 2004 filing for Chapter 11 bankruptcy protection by Schlotzsky's Inc., a chain of sandwich restaurants... Citing the 9th U.S. Circuit Court of Appeals' 2004 decision in Focus Media Inc. v. National Broadcasting Co., the 5th Circuit reasoned in Wooley II that an order compelling disgorgement of attorney fees and expenses would not unravel a complicated bankruptcy plan but instead "would require only that one party disgorge the money it has received, money that would then be distributed pursuant to the bankruptcy court's final decree." …

[R. Glen] Ayers, the former bankruptcy judge, says the 5th Circuit's opinion in Wooley leaves open the possibility that a lawyer's fees in a Chapter 11 bankruptcy case are subject to recapture for an indefinite period.  Notes Ayers, "This is scary, because it leaves you in the dark as to when a Chapter 11 case is finally over."
 

From the Federal Civil Practice Bulletin, the Third Circuit has held that a court may use Federal Rule of Civil Rule 60(b) to overturn the judgment of another court.  While this is not a bankruptcy case, it could be applicable to Bankruptcy Courts via Federal Rule of Bankruptcy Procedure 9024.  

Budget Blinds, Inc. v. White, --- F.3d ----, 2008 WL 2875349 (3d Cir. July 28, 2008) (click here for .pdf).

In this appeal, we consider whether a federal district court properly relied on Federal Rule of Civil Procedure 60(b)(6) to vacate a default judgment entered by another district court. We conclude that it did not, and we will remand so that it may consider whether to set aside the default judgment under Federal Rule of Civil Procedure 60(b)(4)...

We are persuaded by the reasoning of the First, Second, Fifth, Seventh, Ninth, and Tenth Circuits to the extent that they conclude that Rule 60(b) motions (other than motions under
Rule 60(b)(4)) should generally be raised in the rendering court. Nonetheless, we decline to hold that registering courts lack the power in all situations to invoke Rule 60(b)(6) to set aside judgments.9 Rule 60(b)(6) exists so that courts may “vacate judgments whenever such action is appropriate to accomplish justice,” Klapprott v. United States, 335 U.S. 601, 614 (1949), in situations that are not addressed by the other five clauses of Rule 60(b). The drafters of Rule 60(b)(6) apparently recognized that a catch-all provision would be necessary, since it would be impossible to specify all of the scenarios in which justice might require vacatur of a judgment. Given the catch-all nature of Rule 60(b)(6), we do not think that it would be wise to adopt a rule that categorically forbids district courts from vacating the judgments of other district courts under this provision....

We decline to establish a categorical rule stating that registering courts lack the power to use Rule 60(b)(6) to vacate the judgments of rendering courts, but we emphasize that registering courts should exercise this power only under very limited circumstances. Even when a court is considering its own judgment, “extraordinary circumstances” must be present to justify the use of the Rule 60(b)(6) catch-all provision to vacate the judgment. See, e.g., Gonzalez v. Crosby, 545 U.S. 524, 535-36, 125 S.Ct. 2641, 162 L.Ed.2d 480 (2005) (citing Ackermann v. United States, 340 U.S. 193, 199, 71 S.Ct. 209, 95 L.Ed. 207 (1950)). When a court is considering whether to vacate another court's judgment under Rule 60(b)(6), these circumstances must be even more “extraordinary” because of the additional interest in comity among the federal district courts. We need not decide exactly how “extraordinary” a circumstance must be to justify the vacatur of another court's judgment.

From Bloomberg.com

 Barbeques Galore Inc., a closely held retailer of barbeque grills and accessories in the U.S. and Australia, filed for bankruptcy, citing a decline in home sales, a ``trigger'' for its grill sales.  The petition for Chapter 11 protection, filed Aug. 15 in U.S. Bankruptcy Court in California listed assets and debts of $10 million to $50 million each. Barbeques Galore estimated it has from 1,000 to 5,000 creditors and said that it plans to sell the company or form ``a consensual liquidating plan'' with its bank lenders.

According to its website, the company has stores in Duluth, Alpharetta and on Roswell Road in Atlanta.

Steve Jakubowski has a post at the Bankruptcy Litigation Blog entitled Delaware's Judge Kevin Gross Rules That, Absent Adequate Protection, Whitehall's Asset Sale May Not Include Consigned Jewels.  Steve discusses the case of  In re Whitehall Jewelers Holdings, Inc., 2008 WL 2951974 (Bankr. D. Del. July 28, 2008) (click here for pdf),  in which the issue was whether the debtor could sell consigned goods and, if so, under what circumstances.

Bridgeport Holdings Inc. Liquidating Trust v. Boyer (In re Bridgeport Holdings, Inc.), 2008 WL 2235330 (Bankr. D. Del. May 30, 2008).

Summary:  Liquidating trust brought adversary proceeding against Chapter 11 debtors' former officers and directors and restructuring professional appointed to position of chief operating officer (COO), asserting claims for breach of fiduciary duty and lack of good faith and corporate waste. Defendants moved to dismiss.

Gibson, Dunn & Crutcher has summarized this case in a publication entitled Delaware Bankruptcy Court Expounds on Directors' Duties in Financially Distressed Situations June 30, 2008.  They conclude with the following advice for officers and directors:

To limit such claims, directors and officers of financially distressed companies should:

• assume all actions will be scrutinized and second guessed;
• avoid actions that could cause loss of protection of business judgment rule (e.g., conflicts of interest or conflicting loyalties; insider issues; preferential treatment of certain stakeholders, failing to keep informed);
• act with care after obtaining all necessary information (directors, members and managers can rely in good faith on reports prepared by officers or outside experts);
• obtain adequate professional and expert advice on a timely basis;
• in consultation with the company’s advisors, establish and follow a deliberate decision-making process;
• document the decision-making process;
• disclose all material facts;
• in connection with potential transactions, hire investment bankers, obtain fairness opinions and/or seek offers from potential purchasers;
• do not freeze up—no decision is a decision and will likely lead to an argument that duties were abdicated. 

This is post is obviously way off-topic, but the United States Supreme Court held, for the first time, that the Second Amendment includes an individual's right to bear arms, at least to some extent.  Although most people believe the right was already there, it really was not according to many lower court cases over the years because of the reference to the militia:  A well regulated Militia, being necessary to the security of a free State, the right of the people to keep and bear Arms, shall not be infringed.

The Supreme Court finally answered the question, in a 5-4 decision in District of Columbia v. Heller.  Read the analysis at the Supreme Court Blog.

By: Scott B. Riddle, Esq.

In Schultz v. United States, 2008 WL 2229495 (6th Cir. June 12, 2008) (pdf opinion here), the debtor argued that the Means Test violates the United States Constitution because the test is reliant on state and local income standards and deductions.

Because of these deductions, eligibility under the new regime is calculated at least in part based on the state and county where the debtor resides. The housing expense deduction, for example, is governed by the county where the debtor resides. Id. § 5.15.1.7(4)(A). Although the national standards, which identify amounts for “food, housekeeping supplies, apparel and services, and personal care products and services,” and a fixed miscellaneous” amount, id. § 5.15.1.7(3), are mostly uniform throughout the United States, the local standards, which define amounts for housing and transportation, vary greatly. 

...the Schultzes brought a separate suit against the United States, which challenges the five sections of the BAPCPA that employ the “means test”-Sections 707(b)(7), 707(b)(2), 704(b), 1325(b)(3), and 1325(b)(4)-under one central theory: because median-income calculations are based, at least in part, on the state and county in which the debtor resides, the BAPCPA is not a “uniform Law[ ] on the subject of Bankruptcies throughout the United States.” U.S. Const. art. 1, § 8, cl. 4   

The District Court granted the United States' summary judgment motion and the debtor appealed. The Sixth Circuit affirmed.

We turn to the central issue in this case: Is the BAPCPA a uniform law on the subject of bankruptcy? The Bankruptcy Clause of the Constitution grants Congress the power to “establish ... uniform Laws on the subject of Bankruptcies throughout the United States.” U.S. Const. art. I, § 8, cl. 4. What distinguishes these “peculiar terms” from the other Article I powers is the concept of uniformity, which, as Chief Justice Marshall noted nearly two centuries ago, “deserve[s] notice. Congress is not authorized merely to pass laws, the operation of which shall be uniform, but instead to establish uniform laws on the subject throughout the United States.”

Over the last century, the Supreme Court has wrestled with the notion of geographic uniformity, ultimately concluding that it allows different effects in various states due to dissimilarities in state law, so long as the federal law applies uniformly among classes of debtors. In Moyses, one of the first cases dealing with the validity of a bankruptcy statute, the Court upheld the incorporation of varying state exemptions into the 1898 Bankruptcy Act. 186 U.S. at 189-90, 22 S.Ct. 857. Geographic uniformity in this context, the Court observed, was satisfied “when the trustee takes in each state whatever would have been available if the bankrupt law had not been passed. The general operation of the law is uniform although it may result in certain particulars differently in different states.” Id. at 190, 22 S.Ct. 857. In 1918, the Court reaffirmed the Moyses principle in a case involving the Bankruptcy Act's incorporation of varying state fraudulent conveyance statutes, despite the fact that the laws “may lead to different results in different states.” Stellwagen v. Clum, 245 U.S. 605, 613, 38 S.Ct. 215, 62 L.Ed. 507 (1918). See also Vanston, 329 U.S. at 172, 67 S.Ct. 237 (explaining that the Bankruptcy Clause “does not mean wiping out the differences among the forty-eight States” and holding that state tort and contract law may determine the validity of creditors' claims).

Nearly sixty years later, the Supreme Court, applying Moyses, held that Congress may enact non-uniform laws to deal with geographically isolated problems as long as the law operates uniformly upon a given class of creditors and debtors. Blanchette v. Connecticut General Ins. Corps., 419 U.S. 102, 95 S.Ct. 335, 42 L.Ed.2d 320 (1974). ...The Court ultimately concluded that the “uniformity provision does not deny Congress power to take into account differences that exist between different parts of the country, and to fashion legislation to resolve geographically isolated problems,” id. at 159, 67 S.Ct. 237, so long as the law “appl[ied] equally to all creditors and debtors,” id. at 160, 67 S.Ct. 237. See also Leidigh Carriage Co. v. Stengel, 95 F. 637, 646 (6th Cir.1899) (holding that the Bankruptcy Clause “imposes no limitation upon congress as to the classification of persons who are to be affected by such laws, provided only the laws shall have uniform operation”).

From the Atlanta Business Chronicle -

Discount clothing retailer Goody's Family Clothing Inc. has filed for Chapter 11 bankruptcy protection blaming pressures from tightening credit markets, strain on merchandise flow and dozens of underperforming stores in the chain.

Knoxville, Tenn.-based Goody's said it will close 69 underperforming stores, consolidate distribution centers by closing one facility in Russellville, Ark., which will shrink expenses.

Goody's has 17 stores in Georgia, but will close stores in Kennesaw, Conyers, Newnan, Austell, Cumming, Gainesville, Hiram, Tucker and South Augusta.

The Chapter 11 cases (including 19 related cases)  was filed in the District of Delaware.  The New York Post also has an article about the filing.

Obviously not bankruptcy related, but former North Carolinians will be interested in Cheerwine coming back to Atlanta (the article incorrectly says it is making its debut - it was sold in Atlanta grocery stores a few years ago).

Tar Heels, rejoice! Cheerwine, one of our state's indigenous delicacies, is now available in the ATL."Our first ship date to Atlanta was early to mid-May. It's now starting to appear on shelves," said Tom Barbitta, vice president of marketing for the Salisbury, N.C.-based company. "We're thrilled we're going to be moving into Atlanta."

Even though this is Coca-Cola's back yard, the brand's hoping Atlantans will be thrilled right back at welcoming the cherry-flavored soft drink into their midst. Founded in 1917 and still family-owned, the brand has a quirky, devoted following. Nothing bonds two Cackalacky transplants like a cold Cheerwine — especially one cracked open next to a barbecue sandwich with vinegar-based sauce and slaw on top. And road trips north often involve a stop to stock up.
...

Barbitta, who's a New Yorker but sounds pleasant enough nonetheless, says the nectar of the Old North State is being stocked in metro Atlanta Wal-mart, Kroger, Publix, Ingles, and Food Lion stores, with plans to roll out in smaller convenience stores next. Cheerwine is available in 20 states, including California but mostly east of the Mississippi, Barbitta said.

 

From the Delaware Bankruptcy Blog, comes the case of  Miller v. McCown De Leeuw & Co., Inc. (In re Brown Schools), No. 05-10841, Adv. No. 06-50861 (Bankr. D. Del. April 24, 2008).

Duty of care violations more closely resemble causes of action for deepening insolvency because the alleged injury in both is the result of the board of directors’ poor business decision. To defeat such an action, a defendant need only prove that the process of reaching the final decision  was not the result of gross negligence. Therefore, claims alleging a duty of care violation could be viewed as a deepening insolvency claim by another name. 

For breach of the duty of loyalty claims, on the other hand, the plaintiff need only prove that the defendant was on both sides of the transaction. Weinberger v. UOP, Inc., 457 A.2d 701, 710 (Del. 1983) (“When directors of a Delaware corporation are on both sides of a transaction, they are required to demonstrate  their utmost good faith and the most scrupulous inherent fairness of the bargain.”). The burden then shifts to the defendant to prove that the transaction was entirely fair. Id. This burden is greater than meeting the business judgment rule inherent in 5 MDC cites Paragraph 65 of the Second Amended Complaint which reads: “During the period that Defendants wrongfully perpetuated [the Debtors’] operations and existence, the insolvency of [the Debtors] increased by more than $22 million.” (Second Am. Compl. ¶ 65.) MDC also cites Paragraph 71 which reads: “As a result of the Defendants’ breach of their fiduciary duties, [the Debtors] suffered the damages previously alleged.” (Id. at ¶ 71.)  duty of care cases. Further, duty of loyalty breaches are not  indemnifiable under the Delaware law. 8 Del. C. § 102(b)(7). 

Therefore, the Court concludes that the Trustee’s claims for  breach of the fiduciary duty of loyalty in the form of self dealing are not deepening insolvency claims in disguise.  Consequently, the Trenwick and Radnor decisions are not  controlling.

The opinion also addresses deepening insolvency as a measure of damages, fraudulent transfers, aidding and abetting fraudulent transfers, and the in pari delicto defense.

By: Scott B. Riddle, Esq.

From Conglomerate (and now the Wall Street Journal) comes the recent decision in National City Bank v. Hill (In re Hill), Adv No. 07-4106, Ch. 7 Case No. 07-41137 (Bankr. C.D. Ca. May 23, 2008) (click here for .pdf of opinion).  Here, the debtors had previously submitted a materially false loan application to the Bank in order to obtain a secured residential loan.  The false representations at issue included fairly significant inflated income for both of the debtors.  However, the loan program was a "stated income" loan, or "liar loan," which was not subject to independent verification by the lender, as long as other conditions were met.  After default and foreclosure by a senior lender, the Bank filed a complaint to determine dischargeability, arguing that the debt was nondischargeable pursuant to §523(a)(2)(B)  based upon the false representations made by debtors in the loan applications.

Here are the basic facts:

• Debtors joint income was modest - at most, $65,000 combined.
• Debtors owned their home almost 20 years, frequently refinancing first and second mortgages  as the value increased.  As of the petition date, total secured debt was $683,000.
• For several years, Debtors had used the services of a mortgage broker.  In April 2006 the Broker assisted Debtors in getting a $200,000 equity line from the Bank.  The application signed by Debtors falsely indicated they had combined income of $145,716.  The Broker testified he obtained this information from Debtors to place in the application, and he sent the application for the Debtors to sign.  Debtor Mrs. Hill testified she did not provide the figures and that Debtors had never read this, or any other, loan application.
• In October 2006, Debtors needed more cash and contacted the Bank directly.  The new application signed by Debtors reflected a combined income of $190,800, or about triple the actual number.  Again, Debtors denied providing this number.
• The Loans made by the Bank were stated income loans, which  required verification of employment, but not income.  However, the guidelines entered as evidence did reveal that there should be an evaluation of the reasonableness of the stated income based on the type of job, tenure, location, etc.  There was no evidence of such a review by the Bank.  The last loan was also apparently supported by an inaccurate appraisal, but that was apparently conducted by, or on behalf of, the Bank.
• After foreclosure by the senior lender, the Bank filed the adversary proceeding against Debtors, arguing the debt should be determined nondichargeable based upon the materially false financial statements signed and submitted by Debtors.

 The Court ruled against the Bank, stating it had not met it burden under §523(a)(2)(B).

• For reasons more thoroughly discussed in the Opinion, the Court did find that Debtors knew that the representation concerning income was false when made, and that the Debtors made the representation with the intent to deceive the Bank.  Basically, the Court apparently did not find Debtors to be credible on any issue about which they testified.  This is something that should not be lost in the holding. 
• Conversely, the Court held that the Bank did not meet its burden of proving that it reasonably relied on the false representations when making the loan.  Its own guidelines were not followed as far as employment verification and self-employment verification, and it ignored a "red flag" as far as the disparity in stated income for the April and October 2006 loans. The appraisal performed on behalf of the Bank was apparently inflated, and thus the Bank's reliance was in part on its own vendor.

I do not find this opinion particularly remarkable.  The Court starts off by stating that the proceeding is "a poster child for some of the practices that have led to the current crisis in the housing market."   That is probably correct, and notably, the opinion does not distinguish which face is on that poster.  It appears that the Court simply applied the evidence to the statute in a rather straightforward manner, and aptly held that the Bank did not meet the burden of proof on one of the elements.   It certainly could be a big problem for lenders who choose to object to discharge when they have not followed their own guidelines and standards, or have otherwise acted "unreasonably."

Since drafting this, I have already seen a couple of other posts in other bankruptcy forums touting this as a "victory" for debtors over the lenders, or "restoring the balance to the equation."  It is not.  It is a loss for a lender that did not make its case, and should have lost.   The Debtors fortuitously escaped liability as the Court obviously thought they were inherently dishonest and had the intent to deceive the Bank. 

The problem with Nelson's claims is that he is seeking a second chance to win the same game.Nelson made the same arguments he raises in this case to the Bankruptcy Court for the Northern District of Illinois when he sought to have Repository's bankruptcy filing dismissed as being filed in bad faith or, alternatively, due to gross mismanagement of the Company. The Bankruptcy Court, despite dismissing Repository from Bankruptcy because it could not reorganize
successfully, explicitly found that “the bankruptcy filing cannot be held to be in bad faith” and that there had not been “any mismanagement of [Repository's] assets and business.” Satisfied with the dismissal of  Repository's bankruptcy, but unhappy with the Bankruptcy Court's ruling that the bankruptcy had not been brought in bad faith, Nelson appealed to the District Court for the Northern District of Illinois and
argued that the Bankruptcy Court's findings on the bad faith issue were dicta. In essence, Nelson was attempting to preserve his ability to present his bad
faith argument to another tribunal in the hope that a new court might find the argument more substantial. The District Court rejected Nelson's argument, ruling
that the bad faith determination was an essential part of the Bankruptcy Court's holding because Nelson himself had advanced the argument that the bankruptcy filing was made in bad faith.

From the Wall Street Journal Legal Blog -

Tax firm Caplin & Drysdale was appointed national counsel for the asbestos claimants’ committee in the bankruptcy of Babcock & Wilcox, a maker of boilers and generators. The firm sought about $6.3 million in fees and costs for it services, and charged its full hourly-rate for travel time. The bankruptcy trustee objected to paying the full hourly rate for travel time not spent working, and the bankruptcy judge agreed, awarding attorney’s fees at 50% for those hours — trimming $135,685.80 from Caplin & Drysdale’s tab. The district and appellate courts agreed.

In re Babcock & Wilcox, Inc., Case No. 07-30377 (5th Cir. May 1, 2008).

A warning for firms that have unpaid pre-petition fees  when they represent a Chapter 11 debtor.  From Law.com - 

In a stinging 38-page decision, Southern District of New York Bankruptcy Judge Arthur J. Gonzalez denied Windels Marx Lane & Mittendorf any compensation for its work on the bankruptcy of hip-hop media company Source Enterprises Inc.

The New York firm had sought around $526,000 in fees for the five months from September 2006 to February 2007 it acted as debtor's counsel to Source, publisher of The Source magazine. But Gonzalez said the "manner in which Windels represented the Debtor and the firm's eventual singular concentration on fees, as opposed to its role as counsel, caused harm to the Debtor sufficient to support a denial of all fees sought."

The judge said Windels Marx had a conflict of interest in representing Source in its bankruptcy proceeding because the law firm was itself a creditor and had a bill outstanding with the debtor company of as much as $200,000 even before the bankruptcy filing.

"Simpson's continued representation of the Debtor under this strained relationship was at odds with his ethical obligations and was detrimental to the estate," the judge wrote in In re Source Enterprises Inc., 06-11707. "Rather than seeking to rectify his concerns regarding the Debtor, Simpson turned his efforts to securing an avenue for getting his firm's legal fees paid despite having agreed to defer them." ...

The judge said Windels Marx's desire to be paid may have influenced the proceeding in other ways. Noting that the firm had taken no steps to include affiliated entities of Source in the bankruptcy, Gonzalez said he found it compelling that Windels Marx was a creditor of at least one of these affiliates, whose debt it intended to pursue.

From the Bankruptcy Prof Blog -

Miller v. Cameron (In re Miller)  ---- B.R. ----, 2008 WL 754809 (10th Cir. Mar. 2008) (click here for opinion). 

Issue: Is a debtor's pay stub containing year-to-date income totals “other evidence of payment” sufficient to meet the filing requirements of payment advices for the previous 60 days?

Holding: Yes 

Under the bankruptcy court's interpretation, a debtor would not only need to provide a separate piece of documentary evidence for each pay period during the sixty days prepetition, he would also have to ensure that each piece of evidence was created by his employer.” “[T]he bankruptcy court's interpretation makes the ‘other evidence of payment’ option effectively non-existent. This stretches the statutory language too far.” “[Y]ear-to-date payment information may be credible ‘other evidence of payment received,’ even though the evidence is not technically in the form of separate payment advices for each relevant pay period.” “In reaching this conclusion, it is important to emphasize that we are not holding that year-to-date income information per se satisfies the filing requirements of § 521(a)(1)(B)(iv). Whether year-to-date figures or some ‘other evidence of payment’ presented by a debtor satisfies the statute will depend on the particular facts and circumstances of any given case.”

In a post on February 29, 2008, I discussed the adversary complaint filed against Countrywide by the United States Trustee in the Northern District of Georgia.  Since then, others have picked up on the case, including the New York Times.

Countrywide now faces more troubles.  On Wednesday, April 2, 2008, Judge Thomas Agresti of the Bankruptcy Court for the Western District of Pennsylvania entered this Opinion and Order in the case of In re Countrywide Home Loans, Inc., Misc. No. 07-00204 TPA.  In this case, the U.S. Trustee sought, via a Rule 2004 examination and subpoena, information from Countrywide.  (See the broad list by clicking here).

Several months ago the Chapter 13 Trustee for this District filed substantially identical motions entitled Trustee’s Motion to Compel Countrywide Home Loans, Inc./ f/k/a Countrywide  Funding Corp. to Provide Loan Histories and for Sanctions in 293 separate cases in which Countrywide was a creditor. On October 18, 2007, the Court entered a consolidation order which consolidated all of these separate motions for administrative purposes at Misc. No. 07-00203. 

Subsequently, in 10 of those 293 cases the UST (“context cases”) filed substantially identical documents entitled Notice of Examination Under Fed.R.Bankr.P. 2004 and Service of Subpoena  (Duces Tecum) (“Notice of Examination”).3 In each of these 10 cases, the UST identified actions engaged in by Countrywide that she claims were questionable or raised issues going to the integrity of the bankruptcy system.  On November 2, 2007, the Court entered another consolidation order, this one  consolidating the 10 cases in which the UST had filed the Notices of Examination under Misc. No. 07-00204. Since the 10 Notices of Examination were substantially identical, the Court further  ordered the UST to file a single Notice of Examination (with an attached Subpoena Duces Tecum (“Subpoena”)) by November 7, 2007, with such single Notice of Examination to then have effect in all of the context cases....

The Notice of Examination, which the UST says was filed pursuant to Fed.R.Bankr.P.
2004(c) and 9016, indicates that the UST seeks to examine the “corporate representative” of Countrywide regarding “its bankruptcy procedures as they relate to the Debtors’ financial affairs, the administration of their estate, and the impact of Countrywide’s bankruptcy procedures on the integrity of the bankruptcy process in the Western District of Pennsylvania.” The Subpoena Duces Tecum (“Subpoena”) component of the Notice of Examination directs Countrywide to produce a variety of documents,and Countrywide is further directed to produce an authorized representative  of the company to be examined on a variety of topics.

 (bold emphasis added).

 The Court's Opinion reviews the history of the U.S. Trustee's office, the statutory language, and case law supporting a broad view of the US Trustee's authority.

The Court has little difficulty concluding that the UST has met her initial burden of
sufficient “good cause” to proceed with the Countrywide Rule 2004 exam and obtain receipt of the documentation sought by her in advance of the examination in Categories 5-12. There are a number  of reasons for this conclusion. Most importantly, the UST has shown sufficient proof of a “common  thread” running throughout the context cases sufficient to at least raise the possibility of a systemic  problem worthy of the UST’s attention. That is to say, the UST has not simply randomly chosen  cases and demanded documentation from Countrywide.

As an initial matter, the documents at issue relate very precisely to the specific debtors’ loans, the interaction between Countrywide and each debtor, and the interaction between  Countrywide and this Bankruptcy Court. These are not documents that will implicate any private  business affairs or strategies of Countrywide, and there is no question that they would be discoverable  in traditional litigation between the debtor and Countrywide over the respective loan if the proceeding  had been brought as an adversary proceeding or contested matter. Thus, because turning over the documents will not subject Countrywide to an unfair intrusion into its private business affairs, the UST’s burden of demonstrating good cause to obtain them is a modest one....

More broadly and as noted, the UST has sufficiently identified a common thread among the context cases to warrant some inquiry on her part. Viewed collectively as a group, the  context cases appear to reflect a common pattern, thread, or theme that runs through them involving  the manner in which Countrywide, generally, calculates and determines the extent of its bankruptcy  claims....

Questions surely arise as to why Countrywide fails to honor the terms of the respective discharge orders or the orders approving the Trustee’s final account which, in this District, specifically state that all payments are current as of the date of the Trustee’s last distribution payment. How is notice of these particular orders handled internally by the staff person(s) receiving the notice? How are they posted on the respective accounts? It might be argued that many of these same questions will also arise in and most likely be answered in the Hill contested matter....

It has certainly not been proven that Countrywide did anything wrong in any of these cases and the Court specifically is not making any finding in that regard by this Opinion. The Court merely finds that the UST has made a showing of a common thread of potential wrongdoing in each of the cases that is sufficient to meet the general standard of good cause necessary for her to proceed under Rule 2004.

Jonathan Hayes at the BankruptcyProf Blog discusses the employment applications in the Sharper Image Chapter 11 case filed recently in Delaware.   

The Weil Gotshal firm disclosed that it received a $400,000 retainer of which about $376,000 was used up prepetition.  (Sharper Image had $700,000 in the bank the day it filed the petition)  The hourly rates for the Weil firm run from $650 to $950 per hour for partners and $355 to $595 for associates ($595 per hour for an associate?).  The Womble, Carlyle firm, the local Delaware lawyers, received a $40,000 prepetition retainer.  The new chief executive, Robert P. Conway and his firm will receive $150,000 per month plus 1% of any new money or any sales of assets.

I have never been a Sharper Image shopper, but apparently not as many other people are these days.  The company filed a Chapter 11 petition in Delaware. 

Litigation involving Sharper Image's Ionic Breeze air purifiers resulted in ``negative publicity'' and a decrease in total revenue, according to court papers. The company has lost money in 11 of the past 13 quarters. Sales plunged 11 percent in comparable store sales and 23 percent in total company sales for the month of January versus 2007.

The company plans to close about 90 non-performing stores. Sharper Image said it is currently in negotiations for the sale of the stores and inventory.

The Womble Carlyle Construction Industry Blog reports a landmark decision in North Carolina, in which the N.C. Supreme Court held that arbitration clauses in consumer loan agreements are unconscionable and unenforceable.  The case is Tillman et al v. Commercial Credit Loans, Inc. et al, No. 360A06 (January 25, 2008).

From the Womble Blog -

Specifically, the Court was troubled by findings that the provision:

1. Allowed the credit companies to bring certain claims in court while precluding customers from bringing any claims in court;

2. Contained a cost-shifting/loser pays provision that is triggered after the first eight hours of arbitration (because the cost of the second day of an arbitration proceeding could exceed most or all of disputed amount);

3. Effectively precluded the customer from obtaining a lawyer to pursue a claim in arbitration because lawyers would not agree to represent individual customers in an arbitration setting where the amount in controversy is so low (e.g. an average of $4,500); and

4. Precluded consumers joining their claims together for arbitration and precluded class actions.

The Blog also describes the analysis of the Court -

The principal opinion adopted a new approach, contemplating that a party claiming unconscionability must prove both procedural unconscionability, a/k/a “bargaining naughtiness,” and substantive unconscionability, arising from oppressiveness or one-sidedness in the terms. The Court also institutes a new “sliding scale” approach in which the more one-sided the clause is, the less bargaining naughtiness is required to establish unconscionability. The disagreeing Justices criticize this approach because the facts relied upon in the principal opinion to demonstrate “bargaining naughtiness” (e.g. being rushed through the closing process and not specifically discussing the arbitration provision) are not particularly unique. Thus, while superficially appearing to raise the bar, the new analysis in the principal opinion probably lowers the hurdle that plaintiffs must clear to avoid arbitration and bring class actions in court.

 While this opinion does not bind Georgia Courts, it likely does apply to any consumer loan agreements that are governed by North Carolina law. 

The Delaware Corporate and Commercial Litigation Blog discusses the case of Fogel v. U.S. Energy Systems, Inc., 2008 WL 151857 (Del. Ch., Jan. 15, 2007) -

The Chancery Court cited to a decision of the U.S. Court of Appeals for the Second Circuit--which in turn relied on a Delaware Supreme Court decision, that asserted the "well-settled rule that the right to compel a shareholders' meeting for the purpose of electing a new board subsists during reorganization proceedings." Moreover, the Chancery Court relied on a U.S. Supreme Court decision for the principle that: "a corporation in Chapter 11 reorganization continues to owe duties to its shareholders and that 'the passage into bankruptcy does not sound the death knell for the shareholders' role in corporate governance.'"

You can download a copy of the decision from the Delaware Litigation Blog.

For a case where Judge Mullins in the Northern District of Georgia refused to compel a shareholders meeting until the debtor company complied with SEC regulations, see this post about the case of In re Allied Holdings, Inc, et al., Case No. 05-12525, 2007 Bankr. LEXIS 1598 (Bankr. N.D. Ga. April 20, 2007)(Mullins)

In a prior post, I discussed the Supreme Court case Travelers Casualty & Surety v. Pacific Gas & Electric (05-1429), (opinion available here) wherein the Supreme Court reversed the Ninth Circuit and held that the Bankruptcy Code does not forbid a claim for attorneys fees where such fees are provided for in a contract, even where the fees were generated in litigating Bankruptcy issues.

Left open was the question of whether unsecured creditors could recover, as part of their unsecured claims, post-petition attorney's fees incurred during the bankruptcy case.  The 9th Circuit BAP has recently answer the question with a "yes," in the case of In re SNTL Corp., BAP No. 06-1350-MoDK, 2007 WL 4625246 (9th Cir. BAP December 19, 2007) (pdf. available here).

Bob Eisenbach has written a thorough analysis of the SNTL on the Business Bankruptcy Blog, so please head over there to read his summary and comments.  

The bottom line of these cases is that unsecured creditors will (and probably should) include attorneys fees as part of their claim, at least until the other Circuit Courts rule on the issue.

By: Scott B. Riddle, Esq.

The latest casualty in the subprime world is Delta Financial, which filed a Chapter 11 petition in Delaware yesterday. 

Delta stopped originating loans and fired 1,300 of its 1,350 workers since August, according to papers filed with the U.S. Bankruptcy Court in Delaware.

Delta will consider reorganization but will likely end up liquidating its assets, the papers say. ...

This year's panic over mortgage-related assets caused Delta's key source of financing -- institutional investment in bumdled mortgages -- to dry up. In September, chief executive Hugh Miller writes in his affidavit, Delta resold $900 million of mortgage loans but took a $56.2-million loss.

Still, Delta, continued originating loans -- albeit fewer than before. It wasn't until November that the company laid off half of its remaining workers and further scaled back lending.

That month, the company's lenders began demanding repayment of some of its debts. Delta responded by negotiating "standstill agreements" while it attempted to secure additional financing.

On Nov. 21, Delta "tested the securitization market" by trying to resell the $534.3 million of loans still on its books. When that didn't work, the lenders terminated standstill atgreements and declared Delta to be in default of its agreements.

It is common for corporate lawyers in Georgia (and all other states) to provide legal advice to entities incorporated in Delaware.  Often that advice leads to corporate documents being filed with the Delaware Secretary of State.  Does that advice lead to the out of state lawyer being subject to personal jurisdiction in Delaware? The answer may be "yes."

See Francis Pileggi's analysis of the case of Sample v. Morgan, 2007 WL 4207790 (Del. Ch., Nov. 27, 2007), decided by the Chancery Court.

By: Scott B Riddle, Esq.

Thompson v. Greenwood, 2007 Fed. App. 0445P,  2007 WL 3286743 (6th Cir. Nov. 8, 2007).  "This case presents a single issue on appeal: whether a bankruptcy court may retain a case filed in an improper venue under 28 U.S.C. § 1408 over a timely objection by an interested party, if it determines that retention is in the interests of justice or for the convenience of the parties."  The Court of Appeals held that it cannot.

Venue in a Title 11 case is governed by 28 U.S.C. § 1408, which reads, in pertinent part:

[A] case under title 11 may be commenced in the district court for the district ... in which the domicile, residence, principal place of business in the United States, or principal assets in the United States, of the person or entity that is the subject of such case have been located for the one hundred and eighty days immediately preceding such commencement....

28 U.S.C. § 1408 (2006). Under this standard, the debtors concede that venue is not proper in the Western District of Tennessee, or, at least, not “technically” proper. Appellants' Br. at 9. Improperly venued cases are governed by 28 U.S.C. § 1406, which is headed “Cure or waiver of defects” and instructs:

(a) The district court of a district in which is filed a case laying venue in the wrong division or district shall dismiss, or if it be in the interest of justice, transfer such case to any district or division in which it could have been brought.

(b) Nothing in this chapter shall impair the jurisdiction of a district court of any matter involving a party who does not interpose timely and sufficient objection to venue.

...  Although this section does not specifically mention Title 11 bankruptcy cases, its broad language plainly encompasses all improperly venued cases of whatever variety. Presumably, since bankruptcy judges “constitute a unit of the district court,” 28 U.S.C. § 151 (2006), this includes Title 11 cases.  Therefore, under § 1406, if a case is brought in an improper venue and an interested party FN3 timely objects, a district court has only two options: (1) dismiss the case, or (2) transfer the case to a jurisdiction of proper venue, if it be in the interest of justice.

The Court cited Judge Drake's opinion in In re Sporting Club of Illinois Center, 132 B.R. 792 (Bankr. N.D. Ga. 1991), in support of the majority position. 

The statute which governs change of venue for bankruptcy proceedings is 28 U.S.C. § 1412. FN11 As is evident, this statute does not expressly address cases in which venue is improper. Pick, 95 B.R. at 715. However, when Rule 1014, which does address improperly venued cases, was amended in 1987, the advisory committee added an explanation:

FN11. 28 U.S.C. § 1412 states:
A district court may transfer a case or proceeding under title 11 to a district court for another district, in the interest of justice or for the convenience of the parties.

Both paragraphs 1 and 2 of subdivision (a) are amended to conform to the standard for transfer in 28 U.S.C. § 1412. Formerly, 28 U.S.C. § 1477 authorized a court either to transfer or retain a case which had been commenced in a district where venue was improper. However, 28 U.S.C. § 1412, which supersedes 28 U.S.C. § 1477, authorizes only the transfer of a case. The rule is amended to delete the reference to retention of a case commenced in the improper district. Dismissal of a case commenced in the improper district as authorized by 28 U.S.C. § 1406 has been added to the rule. If a timely motion to dismiss for improper venue is not filed, the right to object to venue is waived.

Fed.R.Bankr.P. 1014 (Advisory Committee Note 1987). Section 1477(a),  which was superceded by § 1412, was similar to the current § 1412, except that it expressly applied to improperly venued cases. Thus, when § 1477 was not enacted, there was no statute which dealt specifically with improperly venued cases. Pick, 95 B.R. at 715. This Court agrees with the court in Pick that when Congress failed to enact § 1477, they intended that improperly venued cases be treated the same as all other federal civil actions under § 1406, and that upon the motion of a party in interest, the case must either be dismissed or transferred. Id. This view is consistent with both Rule 1014(a) and the advisory committee notes..... Thus, the only situation in which the Court may retain an improperly venued case is where no party in interest files a timely objection. 

FN12. 28 U.S.C. § 1477, enacted in 1978, but later superseded, stated in pertinent part:   (a) The bankruptcy court of a district in which is filed a case or proceeding laying venue in the wrong division or district may, in the interest of justice and for the convenience of the parties, retain such case or proceeding, or may transfer, under section 1475 of this title, such case or proceeding to any other district or division.

The Court is aware that other courts have reached the opposite conclusion. Lazaro, 128 B.R. at 175; In re Leonard, 55 B.R. 106 (Bankr.D.D.C.1985); In re Boeckman, 54 B.R. 110 (Bankr.D.S.D.1985). However, this Court respectfully disagrees with the holdings of these cases. Accordingly, since venue in this case is improper, the only alternatives are to dismiss the proceedings or transfer them to the proper district.

Two interesting points about the Sporting Club case, which was before the Court during my clerkship with Judge Drake.  Debtor and the secured lender moving for transfer were represented by future Bankruptcy Judges.  Second, the case was one of clear venue shopping -

The only connection that either of the Clubs has in this district is a lease for office space in Peachtree City, Georgia, the address stated on the petitions of both the Illinois and Boca Raton Clubs. However, the evidence strongly indicates that this space was leased by the Illinois and Boca Raton Clubs, along with the Atlanta Club, for the sole purpose of obtaining venue in this district. The office space was jointly leased, on a month-to-month basis, on May 6, 1991, or shortly before the bankruptcy petitions were filed. No records of any value were kept in the office, and little, if any, business was conducted from the office. Additionally, the only mail received at the office was bank statements for accounts set up concurrently with the lease.

In re Perrotta, 2007 WL 3307256 (Bankr. D. N.H., November 7, 2007).  The United States Trustee sought a Rule 2004 Order in order to determine, through an "informed decision," whether the debtor's case should be "presumed abuse" pursuant to §707(b).  The Court denied the request, concluding that the UST should rely upon existing information (i.e., pay advice, tax returns, schedules, etc.) to make the initial determination under §704. 

As stated by Chief Judge Gregory F. Kishel of the United States Bankruptcy Court for the District of Minnesota,

There is no reference [in the Bankruptcy Code] to materials to be obtained from the debtor or third-party sources via formal discovery, informal exchange, or independent investigation. There is certainly no newly-created right in the UST to compel the production of documents or any other information from a debtor on an expedited basis, or to obtain them in any way other than those under generally-applicable law. So, in doing the statutorily-mandated early evaluation of a case for the prospect of a presumption of abuse, the UST ultimately is relegated to relying on what the debtor “filed” in the case. The statute seems to contemplate that this will present sufficiently-reliable information on which to make an evaluation-at least when the debtors and their counsel have complied with the newly-heightened duties of verification as to accuracy that BAPCPA has imposed.

BAPCPA put in place very short time limits for the UST to make a determination as to whether a debtor's case should be presumed to be an abuse and then to file a motion seeking dismissal under § 707(b)(2). BAPCPA further instituted new requirements that debtors produce additional financial information including pay advices and tax returns as well as the information set forth in the Means Test Form. 11 U.S.C. § 521(a)(1)(B)(iv), (a)(1)(B)(v), and (e)(2)(A)(i). Taken together, this Court concludes that Congress could not have contemplated that the UST would undertake exhaustive research or discovery before filing a motion to dismiss. Rather, the UST would only be required to review the information filed with the Court as contemplated by § 704(b)(1)(A). Thus, BAPCPA did not place any burden on the UST to engage in extensive discovery in order to determine whether a debtor's case is a substantial abuse and thus subject to dismissal.FN2 The UST is required to file a statement of her determination of abuse under § 707(b). If she finds the filing to be presumptively abusive, she must then file a motion to dismiss within thirty days or file a statement as to why dismissal is not being sought. Upon the filing of the motion, the formal discovery rules of Part VII of the Federal Rules of Bankruptcy Procedure are then applicable pursuant to the contested matter rule of Rule 9014(c). The statutory framework and deadlines can only lead to the conclusion that Congress intended the UST to file first and investigate beyond the documents submitted by the debtor later. In the context of the statutory mandate, the UST can satisfy her obligations under Rule 9011 by making the determinations required under § 704(b)(2) on the documents in the file and provided to the chapter 7 trustee and, if a motion is filed, by pursuing discovery as contemplated by Rule 9014 in prosecuting such motion.

FN2. Of course, nothing prevents the UST from engaging in informal discovery or making requests to a debtor's counsel in order to clarify one or more points which may bear on the filing of a motion to dismiss under § 704(b)(2). However, the BAPCPA amendments to the Bankruptcy Code do not require such efforts, formally or informally.

From the Wall Street Journal Law Blog, The Legal Implications of Throwing Eggs -

• Theft: Stealing candy from another person, or a location, is classified as “robbery.” Use a real or fake weapon in the commission of this robbery, and the stakes get even greater with possible felony-level re-classification as a “violent” crime for which penalties get gravely serious. So, trick-or-treaters should wield that pirate’s sword judiciously.
• Vandalism: Throwing eggs or any other item at cars, homes or other personal property, smashing mailboxes, putting shaving cream on cars or garage doors can all cause permanent damage, and are considered more than just a prank by police. Retribution can include community service or repaying monetary damages that can add up to thousands of dollars.
• Criminal Mischief: “Toilet papering” trees or other personal property, smashing pumpkins and other seemingly innocuous pranks are also unlawful, and can result in fines to cover property damages and other forms of civil law punishment.
  

In In re Lilliefors, 2007 WL 2903803* (E.D. Va. October 3, 2007), the debtor certified, under oath, that he had obtained the credit counseling prior to filing his Bankruptcy petition, as required by §109(h)(1). In fact, he had not obtained the counseling.  However, the Court applied judicial estoppel and prohibited the debtor from taking an inconsistent position in his pleadings to obtain a benefit or advantage.  Thus, the debtor could not falsely claim that he had obtained counseling, then seek a dismissal on the grounds that the requirement was not met.  The Court commented that Congress enacted §109(h)(1) to prevent abuse, and not create another avenue of abuse by debtors.   The debtor was, therefore, deemed to have satisfied the credit counseling requirement and the case was not dismissed.

The Court relief heavily on Judge Diehl's opinion in In re Parker.

* I am doing a trial with Westlaw, hence the WL citations. 

By: Scott B. Riddle, Esq.

In re Moorman, 2007 Bankr. LEXIS 3269 (Bankr. C.D. Illinois, September 28, 2007).  The issue before the Court was -

... whether Chapter 13 debtors, calculating their disposable income pursuant to §1325(b)(2) and (b)(3) and §707(b)(2), may claim an ownership deduction for a vehicle they own free and clear of liens and for which they make no secured debt payment. This issue, which arises under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"), has divided courts. At least 41 courts have issued written opinions on this issue or on the related issue involving the availability of the deduction under similar facts for the Chapter 7 means test calculation. Twenty-four courts have allowed the deduction while 17 courts, including two district courts, have denied the deduction. After considering many thoughtful, well-reasoned, and well-written opinions on both sides of the issue, this Court finds that the deduction should be allowed.

 The conclusions is as follows -

In view of these cases, this Court finds that a debtor's "applicable" deductions are those that correspond to the debtor's date of filing, family size, geographic location, number of vehicles, or other factors set forth in the Standard tables. In determining whether a debtor has properly claimed his "applicable" deductions, a Court must determine whether the debtor has correctly navigated through the tables. How a debtor's actual expenditures correspond to the amount of a Standard deduction is not relevant in determining whether such Standard deduction is "applicable."

If Congress had wanted to limit vehicle ownership deductions to the amount actually expended for secured debt payment as the IRS does, albeit with a cap, it could have done so by allowing the secured debt payment in full and eliminating the ownership deduction altogether. But, Congress did not do that. Instead, the statute specifically provides for the deduction of both a secured debt payment and the balance of the related Standard to the extent that the secured debt payment does not exceed the Standard. A debtor can deduct a minimal secured debt payment - presumably as little as $ 1.00 - from the Standard vehicle ownership deduction, and then still receive the balance of the Standard as a deduction. Thus, with even the smallest of secured debt payments, the Standard deduction is still "applicable" regardless of a debtor's actual ownership expenses. It does not logically follow that, if a debtor has no secured debt payment to deduct from the Standard, the Standard, for some reason, becomes no longer "applicable." In re Wilson, B.R. , 2007 Bankr. LEXIS 2530, 2007 WL 2199021 *5 (Bankr. W.D. Ark.). To the contrary, following the statutory formula, a debtor with no secured debt payment should receive the entire Standard deduction.

This Court is cognizant of the concerns expressed in In re Ross-Tousey, 368 B.R. 762 (E.D. Wis. 2007). There, the district court opined that, if a full ownership deduction is available to a debtor who has no secured debt payment on a vehicle, a debtor could claim the deduction even for an old, inoperable vehicle rusting away in the backyard. Id. at 768. This leads to the concern that a debtor might purchase such a vehicle for a few dollars for the purpose of qualifying for the deduction. Although that is certainly possible, it may be just as likely that a debtor faced with receiving no ownership deduction for a vehicle owned free and clear of liens would obtain a modest loan against the vehicle solely for the purpose of qualifying for the Standard deduction. Both scenarios are problematic, but that is the challenge of the required use of a Standard expense deduction rather than the actual, provable vehicle ownership expenses of a debtor. The remedy, if any is needed for this perceived problem, is legislative, not judicial.

Bob Eisenbach at the Business Bankruptcy Blog discusses the recent 9th Circuit case of In re El Toro Materials Company, wherein the Court held that the cap on a landlord's damages for lease rejection does not apply to the landlord's tort claims. Bob summarizes the facts  - "the debtor was a mining company that leased property from the Saddleback Community Church, paying $28,000 per month in rent. After the lease was rejected, Saddleback brought an adversary proceeding against El Toro for $23 million in damages alleging that El Toro left a million tons of wet clay "goo," mining equipment, and other materials on the property. "

The Court commented -

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? Here, Saddleback would still have the same claim it brings today had El Toro accepted the lease and committed to finish its term: The pile of dirt would still be allegedly trespassing on Saddleback’s land and Saddleback still would have the same basis for its theories of nuisance, waste and breach of contract. 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.

Head over to Bob's post for a thorough discussion of the case, and a copy of the opinion, that he believes changes the landscape of landlord/tenant relations in Bankruptcy in the 9th Circuit.

As an aside, the landlord in the case, Saddleback Community Church, is the home church of Rick Warren, author of the popular best-seller, "The Purpose Driven Life."

By: Scott B. Riddle, Esq.

Thanks to the Fresno Bankruptcy Blog for noting this.

In Jones v. Wells Fargo Home Mortgage, Adv. No. 06-01093 (Bankr. E.D. La. August 29, 2007) (click here for pdf. of opinion), the Court found Wells Fargo guilty of violating the automatic stay by improperly assessing post-petition charges in a Chapter 13 case, and diverting payments made by the Chapter 13 trustee to satisfy claims not authorized by the Chapter 13 plan or the Court.  Further, the Court found that this conduct was the normal court of business for Wells Fargo in perhaps thousands of consumer cases.

The Court awarded attorneys fees and expenses of $67,202.45 and considered a multi-million dollar punitive damages award due to the apparent widespread misconduct.  However, Wells Fargo proposed changes (noted below, after the jump) in the way it does business in lieu of sanctions.  Further, Wells Fargo agreed to memorialize its proposal into an order of the Court, "enforceable in any case pending or subsequently filed before any court in the country."

The Court agreed that this was an appropriate result and would enter an order setting forth this agreement, such that the Court could continue oversight over Wells Fargo's implementation of the agreement.

The agreement Wells Fargo proposed is as follows  (after the jump)--

By: Scott B. Riddle, Esq.

Bob Eisenbach at the Business Bankruptcy Blog summarizes the 9th Circuit case of Sigma Micro Corp. v. Healthcentral.com,  No. 04-17565 (9th Cir. Sep. 21, 2007), which involves the right to a jury trial in a preference action. Although the issue at hand involves the interpretation of a local rule in California, Bob provides a good general summary of the right to jury trial in preference actions, and the opinion may be relevant in other districts.

The theory of deepening insolvency as a separate tort has had mixed results.  It has never been truly recognized in Georgia, as noted by a Texas court.  Other courts have held that it is a theory of damages rather than a cause of action.

In a big strike against its viability, the Delaware Chancery Court said it was not even a "coherent concept."  What would the Delaware Supreme Court say?  We just found out.  Apparently, they also agreed that it was not a coherent concept so they entered a two page order affirming the Chancery Court decision, and the reasons therefore. Trenwick America Litigation Trust v. Billett, No. 495, 2006 (Del. August 14, 2007).

Thanks to Bob Eisenbach at the Business Bankruptcy Blog for the tip, and some additional analysis. 

On July 5, 2007, the Seventh Circuit held that the "hanging paragraph" of 11 U.S.C. §1325 meant that the secured creditor may assert a deficiency claim after the surrender and liquidation of a "910 vehicle."  This is generally known as the minority position (and the one followed in the ND Ga). See this post for the discussion of In re Wright, and also see Steve Jakubowski's take at the Bankruptcy Litigation Blog.  

It seems that on the same day, the 10th Circuit Bankruptcy Appellate Panel decided to go the other way, following the majority position that the surrender of the 910 vehicle constitutes full satisfaction of their claim.  See In re Quick; In re Ballard,  BAP No. 07-025, No. 07-026, 2007 Bankr. LEXIS 2175 (10th Cir. BAP June 5, 2007) (opinion not yet available on the court's website).

The BAP initially concluded that §1325 was not ambiguous -

Chrysler urges this Court to adopt the minority position allowing under-secured creditors to assert unsecured claims for deficiencies resulting from sales of collateral. ... However, such a holding would require this Court to first determine that the hanging paragraph is ambiguous, thereby necessitating an examination of legislative history. This we decline to do.

Although Chrysler asserts that the purpose behind enactment of the hanging paragraph must be examined in order to interpret it, the cases relied upon do not support its position. For example, in Griffin v. Oceanic Contractors, Inc., 458 U.S. 564 (1982), the Court first acknowledged that "[t]here is, of course, no more persuasive evidence of the purpose of a statute than the words by which the legislature undertook to give expression to its wishes," and then noted that "in rare cases the literal application of a statute will produce a result demonstrably at odds with the intentions of its drafters, and those intentions must be controlling." Id. at 571 (emphasis added; internal quotation marks omitted). Moreover, an unambiguous statute may not be "interpreted" to match a court's determination of what Congress "meant" to say. Bracewell v. Kelley (In re Bracewell), 454 F.3d 1234, 1243 (11th Cir. 2002), cert. denied, 127 S. Ct. 1815 (2007).

In this case, the language of the hanging paragraph is neither ambiguous, nor does literal application of its terms lead to a result that is demonstrably at odds with the apparent intentions of its drafters. Significantly, this Court is not persuaded that the sparse legislative history of the amendment of § 1325 supports Chrysler's assertion that the hanging paragraph was enacted solely for the benefit of secured creditors. In any event, Congress easily could have specified that the hanging paragraph applies only to §1325(a)(5)(B), but it did not.

 The Court then held as follows:

We therefore hold that the hanging paragraph unambiguously precludes application of 11 U.S.C. 506 to the entirety of  §1325(a)(5) and no bifurcation of allowed secured claims may be effected in the exercise of any of a 910 debtor's three options under §1325(a)(5). The effect of this elimination of bifurcation in 910 cases has been described as follows:

The effect of the hanging paragraph is that a debtor no longer has this bifurcation tool at his or her disposal. If a creditor files a secured claim relating to 910 property and that claim is allowed under § 502, the debtor must treat the claim as fully secured. In a sense, a fiction arises that the 910 collateral is worth the exact amount of the proof of claim. So when a debtor proposes to retain the collateral, the debtor must propose to pay the entire claim as filed. Likewise, where the debtor proposes to surrender the collateral, the fiction created by the hanging paragraph serves to render the secured claim completely satisfied.

In re Durham,361 B.R. 206, 209 (Bankr. D. Utah 2006) Thus, post-BAPCPA, 910 debtors may no longer retain collateral and cram down their loans, and 910 creditors may not recover deficiencies when collateral is surrendered.

The Court expressly declined the state law argument that the Seventh Circuit found persuasive in Wright (after the jump)-

In In re Racing Services, Inc., 363 B.R. 911, 47 Bankr. Ct. Dec. 246 (8th Cir. BAP, March 9, 2007) (No. 06-6058), the Eighth Circuit Bankrptcy Appellate Panal addressed the issue of who may have derivative standing to act on behalf of a Bankruptcy estate.  Thanks to Split Circuits Blog for the tip.

The Court left some wiggle room by holding that a party other than the trustee requires court approval to pursue the §548 claims on behalf of the estate, and that was not done in this case. However, it was clear that the BAP did generally approve of derivative standing.

Every circuit, including the Eighth Circuit, which has addressed the issue has recognized the possibility of derivative standing to pursue avoidance actions on behalf of a bankruptcy estate under certain circumstances. Nangle v. Lauer (In re Lauer), 98 F.3d 378, 388 (8th Cir. 1996); Scott v. Nat’l Century Fin. Enter. Inc. (In re Baltimore Emergency Services II Corp.), 432 F.3d 557 (4th Cir. 2005); Official Comm. of Unsecured Creditors of Cybergenics Corp. v. Chinery, 330 F.3d 548 (3rd Cir. 2003); Commodore Int’l Ltd v. Gould (In re Commodore Int’l Ltd.), 262 F.3d 96 (2nd Cir. 2001); Fogel v. Zell, 221 F.3d 995 (7th Cir. 2000); Avalanche Maritime, Ltd. v. Parekh (In re Parmetex, Inc.), 199 F.3d 1029 (9th Cir. 1999); Canadian Pac. Forest Prod. Ltd. v. J.D. Irving, Ltd. (In re Gibson Group, Inc.), 66 F.3d 1436 (6th Cir. 1995); Louisiana World Exposition v. Fed. Ins. Co., 858 F.2d 233 (5th Cir. 1988); Unsecured Creditors Committee v. Noyes (In re STN Enter.), 779 F.2d 901 (2nd Cir. 1985).

The Eighth Circuit Court of Appeals concluded that creditors cannot bring avoidance actions under Section 548 of the Bankruptcy Code absent evidence that the trustee cannot be relied upon to assert such claims. Nangle v. Lauer (In re Lauer), 98 F.3d 378, 388 (8th Cir. 1996). In order for a creditor to assert standing under Section 548, the creditor must establish that the trustee was unable or unwilling to pursue the claims on behalf of the bankruptcy estate. Id.

 The Court continued -

In a case that was a direct appeal to the Seventh Circuit Court of Appeals, pursuant to 28 U.S.C. §158(d)(2)(A), the Court held that the "hanging paragraph" of 11 U.S.C. §1325 left lenders with a deficiency claim after surrender of the "910 vehicle."   The Court rejects the majority (?) view that Congress "accidentally gave debtors a break" in §1325 (see the bottom of the post for the audio of the oral argument).

In In re Wright, (click for .pdf), Case No. 07-1483, 2007 U.S. App. LEXIS 15843 (7th Cir. July 5, 2007), the Chapter 13 debtors proposed a plan that would result in surrendering their "910 vehicle," but making no provision for paying the difference in the value of the vehicle and the amount of their debt.

The question we must decide is what happens when, as a result of the hanging paragraph, §506 vanishes from the picture. The majority view among bankruptcy judges is that, with §506(a) gone, creditors cannot divide their loans into secured and unsecured components. Because §1325(a)(5)(C) allows a debtor to surrender the collateral to the lender, it follows (on this view) that surrender fully satisfies the borrower’s obligations. If this is so, then many secured loans have been rendered nonrecourse, no matter what the contract provides. See, e.g., In re Payne, 347 B.R. 278 (Bankr. S.D. Ohio 2006); In re Ezell, 338 B.R. 330 (Bankr. E.D. Tenn. 2006); In re Kenney, 2007 Bankr. LEXIS 1646 at *16-17 (Bankr. E.D. Va. May 11, 2007) (collecting cases). The minority view is that Article 9 of the Uniform Commercial Code plus the law of contracts entitle the creditor to an unsecured deficiency judgment after surrender of the collateral, unless the contract itself provides that the loan is without recourse against the borrower. See, e.g., In re Particka, 355 B.R. 616 (Bankr. E.D. Mich. 2006); In re Zehrung, 351 B.R. 675 (W.D. Wis. 2006). That unsecured balance must be treated the same as other unsecured debts under the Chapter 13 plan.

Like the bankruptcy court, we think that, by knocking out §506, the hanging paragraph leaves the parties to their contractual entitlements. True enough, §506(a) divides claims into secured and unsecured components...Yet it is a mistake to assume, as the majority of bankruptcy courts have done, that §506 is the only source of authority for a deficiency judgment when the collateral is insufficient. The Supreme Court held in Butner v. United States, 440 U.S. 48 (1979), that state law determines rights and obligations when the Code does not supply a federal rule. See also, e.g., Travelers Casualty & Surety Co. v. Pacific Gas & Electric Co., 127 S. Ct. 1199 (2007); Raleigh v. Illinois Dep’t of Revenue, 530 U.S. 15 (2000). ...

By surrendering the car, debtors gave their creditor the full market value of the collateral. Any shortfall must be treated as an unsecured debt. It need not be paid in full, any more than the Wrights’ other unsecured debts, but it can’t be written off in toto while other unsecured creditors are paid some fraction of their entitlements.

(emphasis added)

Hechinger Investment Company of Delaware, Inc. v. Universal Forest Products, Inc., Nos. 06-2166, 06-2229, 2007 U.S. App. LEXIS 13155 (3rd Cir. June 7, 2007).   The issue was whether preferential transfers may be protected by the contemporaneous exchange defense of §547(c)(1).  Bob Eisenbach comments on the case at the Business Bankruptcy Blog, so I will just include a couple excerpts from the opinion.

The Bankruptcy Court found that the disputed transfers were not intended by the parties to be contemporaneous exchanges because the transfers were credit transactions. In reaching this result, the Court relied upon several factually distinguishable cases, none of which stand for the proposition that parties can never intend credit transactions to be contemporaneous exchanges under § 547(c)(1)(A). We disagree with the Bankruptcy Court’s conclusion. Indeed, it  would appear that § 547(c)(1) covers little other than credit transactions. The § 547(c)(1) defense applies only to transfers that the debtor has shown are payments on an “antecedent debt” under § 547(b). See 11 U.S.C. § 547(b)(2) (definition of  avoidable transfers). If there is no delay between when the debt arises and payment of the obligation, then the transfer is outside the scope of § 547(b), and § 547(c)(1) is not implicated. The existence of a delay between the creation of a debt and its payment is a hallmark of a credit relationship, which is, by definition, a relationship in which the creditor entrusts the debtor with goods without present payment. OXFORD ENGLISH DICTIONARY (2d ed. 1989) (defining “credit” as “[t]rust or confidence in a buyer’s ability and intention to pay at some future time, exhibited by entrusting him with goods, etc. without present payment.”). ...

The inquiry still remains: even if a credit relationship was intended, was it nonetheless their intent that the ongoing payments would be contemporaneous exchanges for new value? A court may find the parties intended a contemporaneous exchange for new value even when the transaction is styled as a “credit” transaction. See In re Payless Cashways, Inc., 306 B.R. 243 (8th Cir. BAP 2004), aff’d, 394 F.3d 1082 (8th Cir. 2005). The question is one of intent, and although a delay between the incurrence of the debt and its payment can evidence that the exchange was not intended to be contemporaneous, the passage of time does not necessarily negate intent. In In re Payless Cashways, for example, the debtor generally paid the creditor for specific shipments some time after the goods were shipped, but before or at the time that the shipments arrived at the debtor’s facility. Id. at 247. The court concluded that the parties intended the transfers to be part of a contemporaneous exchange for new value. The court noted that the debtor and creditor agreed to credit terms that would match up the date of the actual delivery of the goods purchased by the debtor with the date of the debtor’s obligation to wire payment for the goods to the creditor. Id. at 246. The court also put great weight on the fact that the contracts were “destination contracts,” meaning that the creditor could have refused to deliver the goods if the debtor had failed to make payment before the delivery arrived. Id. at 250, 254.

This case comes courtesy of an email from Jennifer Gronwaldt of the Media Relations firm of Hellerman Baretz Communications LLC, apparently sent to other bankruptcy blogs as something of a press release (it apparently worked!).

The case is In re Cygnus Oil and Gas Corp., f/k/a Coffee Exchange, Inc., f/k/a Touchstone Resources, LLC, Case No. 07-32417 (Bankr. S.D. Texas).  The issue is whether the law firm of Bracewell & Giuliani is "disinterested" pursuant to §101(14) and §327 of the Code, notwithstanding the fact that a member of the firm was a shareholder of the debtor, held an unsecured claim against the debtor, and served as a director until about three months before filing.

Sounds like an easy call, right?  No....  Judge Marvin Igsur, in this opinion, ruled that the firm was disinterested in spite of the lawyer's interest --

Although this case involves a Chapter 11 debtor as a party, the issue is not based upon Bankruptcy law.  However, it is an interesting holding for lawyers who practice in federal court.

In Saltire Industrial, Inc., f/k/a Scovill, Inc. v. Waller, Lansden, Dortch & Davis, PLLC (click for opinion), No. 06-5949, 2007 U.S. App. LEXIS 14347 (June 19, 2007), the issue was whether a plaintiff's lawyers may make a secret agreement with an in-state co-defendant such that the co-defendant is kept in the case only to defeat diversity.  In a prior lawsuit, Saltire was sued in state court for causes of action related to toxic torts, and it removed the case to federal court. However, it was remanded to state court because of the presence of an in-state defendant.  The case lasted 10 years, and was ultimately settled.

After Saltire filed a Chapter 11 petition, it filed a lawsuit against the law firm that represented the plaintiffs in the prior case, contended that the law firm committed common law fraud by having a secret agreement with the non-diverse co-defendant. 

The Sixth Circuit affirmed the District Court's dismissal --

In the present case, the theory of Saltire’s fraud claim is based on Waller Lansden’s failure
to disclose the secret agreement. Although a third party injured by fraudulent conduct has a right to recover from the party committing fraud, see Arcata Graphics Co. v. Heidelberg Harris, Inc., 874  S.W.2d 15, 23 (Tenn. Ct. App. 1993), a tort must first be committed. There simply is no tort in the  present case unless Waller Lansden had a duty to disclose. 

Although the Tennessee courts have recognized that a duty to disclose can arise even where  a fiduciary relationship did not exist, there has always been a contractual or other type of business  relationship between the parties underlying the fraud claim. See, e.g., Simmons v. Evans, 206  S.W.2d 295, 297 (Tenn. 1947) (holding that the seller of a residence had a duty to disclose material  facts to the buyer “unless common observation or such inquiry as the exercise of ordinary prudence  required would have furnished such information”); Arcata, 874 S.W.2d at 23 (allowing a claim of  fraud by the seller of printing presses even though the misrepresentation at issue was not made  directly to the seller but to a parent company of the buyer who was not party to the original contract  of sale); Macon County Livestock Mkt.,Inc. v. Ky. State Bank, Inc., 724 S.W.2d 343, 350-51 (Tenn.  Ct. App. 1986) (holding that a bank had no duty to disclose material facts to a depositor or other  customer relating to the shaky financial condition of the depositor’s business partner unless the bank  “knows or has reason to know that the customer is placing his trust and confidence in the bank and is relying upon the bank so to counsel and inform him”). In the absence of either a fiduciary, contractual, or other business relationship in the present case, we conclude that Waller Lansden had
no duty under Tennessee law to disclose the alleged secret agreement. Thus no fraudulent
concealment occurred. ...

What Waller Lansden’s actions boil down to, in our view, is litigation strategy. Litigation
strategy cannot, without more, support an action for fraud. See Jerome-Duncan, Inc. v. Auto-By-Tel, L.L.C., 176 F.3d 904, 907 (6th Cir. 1999) (holding that the “burden of proving fraudulent joinder” is on the alleging party and that the defendant’s “motive in joining [the nondiverse party] is immaterial to our determination regarding fraudulent joinder”)....

Finally, Saltire was not without a remedy in the present case if it believed that Waller
Lansden had engaged in improper litigation tactics in order to secure a more favorable forum for its clients. As the district court noted, Saltire could have sought sanctions pursuant to Rule 11 of the Federal Rules of Civil Procedure against Waller Lansden after the latter disclosed the 2002 letter in support of the plaintiffs’ second motion to remand. It chose not to do so.

In re Moustafi (click for opinion), Ch. 7 Case No. 4-07-00407-EWH, 2007 Bankr. LEXIS 1925 (Bankr. D. Ariz. June 4, 2007.  The Chapter 7 debtor stated her intention to reaffirm the debt secured by her vehicle. She timely executed the reaffirmation agreement pursuant to §521, and it was accepted by the lender.  However, the court found that debtor's income could not support the payments and declined to approve the reaffirmation.  The question thus arose as to whether the lender could repossess the vehicle.

If disapproval of the Reaffirmation Agreement means that the Debtor has failed to perform her intention as required by § 521(a)(2)(B), then § 521(d) would apply, permitting Vantage to enforce its ipso facto clause. Post-discharge, Vantage would be able to repossess the Nissan because the Debtor's bankruptcy filing is an event of default under the Vantage Security Agreement.

In In re Husain, 2007 Bankr. LEXIS 768, 2007 WL 709302 (Bankr. E.D. Va. March 5, 2007), the court addressed this issue and found:

The Debtors' timely act of entering into mutually satisfactory reaffirmation Agreements with their creditors must be viewed as sufficient to satisfy the performance standards of § 521(a). Those performance requirements should not be read as a mandate for debtors to entirely consummate their stated intentions. . . . Section 521(a) of the Bankruptcy Code merely requires the debtor to "take steps to act on an intention to either retain or surrender.". . . . The Debtors in the case at bar did everything in their capacity to perform.

2007 Bankr. LEXIS 768, 2007 WL 709302, at *5 (citations omitted in text). This court agrees. The consequences of § 362(h)(1) and § 521(d) -- lifting the automatic stay and making ipso facto default clauses enforceable -- are only caused by a debtor's failure to timely file a statement of intention and/or to timely enter into a reaffirmation agreement, "not by the court's disapproval of the agreement or by its determination that the agreement is unenforceable." Id.; see also In re Blakeley, 2007 Bankr. LEXIS 538, 2007 WL 674712, at *6 (Bankr. D. Utah Feb. 21, 2007) ("It is not necessary for the Court to approve the reaffirmation agreement in order for the Debtor to comply with § 521 or § 362(h).").

Out of the soaps of celebrity news comes an interesting Bankruptcy issue.  Last week, Judge Cristol of the Southern District of Florida found that the debtor company that owned the rights to OJ Simpson's book, "If I Did It" was a sham corporation.  The rights of the book were essentially awarded to the Goldman family. 

The trustee now contends in this Motion that the debtor and its counsel represent that they do not have any copies of the manuscript.  However, the trustee further contends that the manuscript was made available for download, free of charge and in .pdf format, by the gossip website TMZ.com (sorry, no link here) for two hours on June 19, 2007. 

The trustee filed the emergency motion against TMZ.com (owned by Time-Warner and AOL) seeking an order holding TMZ in contempt for violating the automatic stay of 11 U.S.C. §362(a), for turnover of any manuscripts, and to appear at a 2004 examination.  Fred Goldman filed a joinder to the motion, and the trustee filed a supplement.  The trustee states in his supplement that his office did a google search mere minutes after the manuscript was posted on TMZ, and the number of other websites on which it was available was "staggering."  (To save you the trouble - the search term was "If I Did It Leaked").

A hearing was scheduled for yesterday, June 20, 2007.  The more skeptical may believe that someone gave away estate property before the trustee and Goldmans could get to it.  How does a trustee seek turnover of all copies of copyright material that has already been electronically transmitted to thousands of people?  How much money has been lost by the Goldmans and estate?

Update 

At an emergency hearing Wednesday, U.S. Bankruptcy Judge A. Jay Cristol said he would schedule a hearing later on whether to hold TMZ in contempt and suggested that the company -- a joint venture between America Online Inc. and a Time Warner Co. subsidiary -- could eventually be held financially liable for any violation.

"This may be a good thing rather than a bad thing," Cristol said, noting that the parent firms have "deep pockets."

In re Fox, Case No. 06-12410 (Bankr. N.J. June 1, 2007)(GMB) .

The debtor filed a Chapter 13 petition, including the required Form B22C for means testing in a Chapter 13 case. The debtor subsequently lost her job and converted to a Chapter 7 case, but did not file Form B22A, Statement of Monthly Income and Means Test required for Chapter 7 cases. The debtor filed a motion for determination that means testing does not apply to conversions to Chapter 7 and the United States Trustee opposed. 

The holding --

This Court holds that the Debtor, having converted her case from one under chapter 13 to
one under chapter 7, is not subject to the means test under the plain language of § 707(b)(1) and is, thus, not required to file a Form B22A under Rule 1007(b)(4).

Some excerpts -

Section § 707(b)(1) provides authority for courts to dismiss a case, “filed by an individual
debtor under this chapter . . . or, with the debtor’s consent, convert such a case to a case under chapter 11 or 13 of this title, if it finds that the granting of relief would be an abuse of the provisions of this chapter.” 11 U.S.C. § 707(b)(1) (emphasis added). The language is explicit that the authority of the courts to dismiss or convert extends to debtors who “file[]” cases under “this chapter,” which plainly means chapter 7. This Court cannot find ambiguity in such clear and explicit language. There is nothing in the language of § 707(b)(1) that indicates that this section was meant to apply to debtors who convert a case under either chapter 13 or chapter 11 to chapter 7.

By: Scott B. Riddle, Esq.

 I have previously posted (follow the link to the Delaware Litigation Blog) on the subject of whether creditors have a direct action against directors of a corporaton that has entered the zone of insolvency.  Chief Justice Steele's comments were prophetic.  Yesterday, in an opinion that will likely have a far reaching affect (even if we only consider Delaware corporations), the Delaware Supreme Court ruled that creditors of an insolvent corporation do not have a direct action against directors (and presumably officers?) for breach of fiduciary.  Note that while Chief Justice Steele participated in the case, he did not write the opinion. Thanks to Ideoblog for the tip.

In North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, et al, No. 521,2006, 2007 Del. LEXIS 227 (Del. May 18, 2007), the issue before the court - one of first impression for the Delaware Supreme Court - was whether creditors of an insolvent corporation may bring a direct action (as opposed to a derivative action) against directors for breach of fiduciary duty. The Court said no.

 This Court has never directly addressed the zone of insolvency issue involving directors' purported fiduciary duties to creditors that is presented by NACEPF in this appeal. That subject has been discussed, however, in several judicial opinions and many scholarly articles.   ...

Direct Claims For Breach of Fiduciary Duty May Not Be Asserted by Creditors

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. 
 

By: Scott B. Riddle, Esq.

Bob Eisenbach at the Business Bankruptcy Blog discusses the case of  Wood v. Stratos Product Development, LLC (In re Ahaza Systems, Inc.), 2007 U.S.App. LEXIS 7607 (9th Cir. April 3, 2007), wherein the Ninth Circuit held that even first-time transactions between the parties can come within the ordinary course defense to preference claims.  Bob provides the following excerpt from the opinion -

[W]hen we have no past debt between the parties with which to compare the challenged one, the instant debt should be compared to the debt agreements into which we would expect the debtor and creditor to enter as part of their ordinary business operations. Consistent with Food Catering [971 F.2d 396 (9th Cir. 1982)], however, this analysis should be as specific to the actual parties as possible. Thus, we hold that to fulfill § 547(c)(2)(A), a first-time debt must be ordinary in relation to this debtor’s and this creditor’s past practices when dealing with other, similarly situated parties. Only if a party has never engaged in similar transactions would we consider more generally whether the debt is similar to what we would expect of similarly situated parties, where the debtor is not sliding into bankruptcy.

In a prior post entitled Partial Payment of Note Was Within "Ordinary Course" Defense Even Where It Was the First Transaction Between Parties, I discussed Judge Diehl's opinion in Ogier, Chapter 7 Trustee for Express Factors, Inc. v. Trautman, 2005 Bankr. LEXIS, Adv. No. 04-6076 (Bankr. N.D. Ga. September 30, 2005).   I have a vague memory that Judge Drake also issued an opinion holding that first time transactions could be within the ordinary course, but that was many years ago. 

By: Scott B. Riddle, Esq.

There is a school of thought that says that Chapter 7 debtors can still "pass" the Means Test if the expense that would otherwise cause them to "fail" is a house payment more than the allowable housing deduction.  It is unclear where that arose, or how often it worked, but the case of In re Delunas, 2007 Bankr. LEXIS 803 (Bankr. E.D. Mo., March 6, 2007), illustrates the fallacy of that argument.

Debtors' annual income for a family of five raised the presumption of abuse.  However, on the Means Test they attempted to include an expense for "special circumstances" in the amount of $813 per month. In fact, this amount was the portion of their monthly mortgage payment over and above the allowable housing allowance of $1012 per month.  Debtors claimed this was an educational expense because they wanted each child (including an adult daughter) to have their own room, and it allowed the children to stay in the same school they had been attending.  The court noted that there was no evidence that the allowed housing expense priced them out of the district; it just priced them out of the relatively expensive home they wanted to keep at creditors' expense.  Finally, the Court found that the Debtors could not provide their adult daughter, who was working and not in school, with free room and board on the backs of their creditors.  The Chapter 7 case was dismissed.  

The court also dismissed the debtors' claim that one daughter's depression was an excuse to stay in the house.  Finally, the Court noted that even if the additional mortgage expense could be classified as an educational expense, it would be subject to the ceiling of $1500/year in 707(b)(2)(A)(ii)(IV).    

By: Scott B. Riddle, Esq.

This opinion is courtesy of Greg Hays, CPA, who acts as a receiver in several cases (including this case).

S. Gregory Hays, as Receiver for Mobile Billboards of America, Inc. v. Adam, et al., Case 1:05-cv-2705-CAP (N.D. Ga. March 1, 2007). 

The basic facts, as alleged in the Complaint and taken as true for the motion, are as follows -

From 2001  through 2004, Mobile Billboards of America, Inc. (“MBA”) used a network of sales agents to sell more than $60 million in bogus  mobile billboard investments to investors as part of a massive Ponzi scheme. The sales agents, including the defendants in this case, were members of organizations assembled by “master sales agents.” MBA typically paid a 27% commission per billboard sale to one of the master sales agents, who in turn made a commission payment to the individual within his or her organization that actually made the sale. The agents received sales commissions and bonuses for their participation in the mobile billboard scheme. These high commission rates were not disclosed to investors during the sales process. The plaintiffs claim that the fraudulent billboard investments
sold by the sales agents were unregistered securities. The agents sold the unregistered securities and received commissions from the sales even though they were not registered securities dealers. The Ponzi scheme was dependent upon the sales agents’ efforts in
soliciting investors. Agents were compensated with more than $19 million in commission payments....

The Receiver filed this action on October 18, 2005, seeking an accounting and recovery of the commissions and bonuses paid to the defendants pursuant to the investment scheme. The defendants filed the motion to dismiss now under consideration on October 9, 2006.

 The defendants argue that the Receiver’s complaint should be dismissed pursuant to Federal Rule of Civil Procedure 12(b)(6) based on the doctrine of in pari delicto. Essentially, the defendants argue that because MBA and its affiliated entities perpetrated the fraud, the Receiver lacks standing to bring claims against the defendants. As this court has already held in Hays v. Paul, Hastings, Janofsky & Walker LLP, No. 1:06-CV-754-CAP [Doc.No. 31, at 25-27] (N.D. Ga. Sept. 14, 2006), however, this argument  fails.

The court held that the doctrine of in pari delicto was inapplicable as a defense -

By: Scott B. Riddle, Esq.

This opinion could by very important in Chapter 11 (or 13) cases that are nearing their two-year anniversary and in danger of conversion.

In Singer, Trustee v. Franklin Boxboard Co. (In re American Pad & Paper, Co.), No. 05-1379, 2007 Bankr. LEXIS 4792 (3rd Cir. March 2, 2006), the Chapter 11 Order for Relief for the Debtor was entered on January 14, 2000 (via voluntary petitions filed after involuntary petitions).  The case was converted to a Chapter 7 case on January 3, 2002. On the same date, an interim Chapter 7 trustee was appointed pursuant to 11 U.S.C. § 701. (note that the first sentence on p. 8 of the opinion contains an error stating that the appointment date was January 14, 2002; obviously, that sentence only makes sense if the correct date of January 3, 2002 is assumed).

The Section 341 meeting was scheduled for February 13, 2002.  At the meeting, certain creditors requested the appointment of a "permanent" Chapter 7 trustee under 11 U.S.C. §702(b).  A new trustee was, accordingly, appointed.  Importantly, this was more than two years after the Order for Relief was entered on January 14, 2000.

The Trustee subsequently filed approximately 150 avoidance actions under §547 of the Code, and several defendants sought dismissal based upon the statute of limitations set forth in 11 U.S.C. §546(a), which provides the following:

An action or proceeding under section 544, 545, 547, 548, or 553 of this title may not be commenced after the earlier of--

(1) the later of--

(A) 2 years after the entry of the order for relief; or

(B) 1 year after the appointment or election of the first trustee under section 702, 1104, 1163, 1202, or 1302 of this title if such appointment or such election occurs before the expiration of the period specified in subparagraph (A); or

(2) the time the case is closed or dismissed.

The Bankruptcy Court and District Court dismissed some proceedings based upon the statute of limitations.  The issue, a question of law of first impression in the Circuit, was whether the Trustee's actions were barred because the Order for Relief was entered more than two years before the election of the Trustee.  The Third Circuit said yes --

Posted By: Scott B. Riddle, Esq.

In Kaye v. Dupree, et al. (In re Avado Brands, Inc.), Adv. No. 05-3823, 2006 Bankr. LEXIS 3631 (Bankr. N.D. Tex. December 28, 2006), the Trustee of the Debtor's Litigation Trust filed a post-confirmation suit against the Debtor's former officers and directors.  The causes of action included preferential transfers, breach of fiduciary duty, fraud and deepening insolvency.  The defendants filed motions to dismiss and motions for summary judgment. The court addressed several matters raised by the motions, not all of which are addressed in this post. 

The court first determined that it did have post-confirmation jurisdiction over the proceeding as the claims arose pre-petition, were provided for under the plan, and transferred to the trust for prosecution by the Trustee.

The Court next addressed whether O.C.G.A. §14-2-202, the exculpation provision, protected the directors of Debtor (a Georgia corporation) from liability for breach of fiduciary duty. The statute states the following -

(b) The articles of incorporation may set forth:
* * *
(4) A provision eliminating or limiting the liability of a director to the corporation or its shareholders for monetary damages for any action taken, or any failure to take any action, as a director, except liability:
* * *
(B) For acts or omissions which involve intentional misconduct or a knowing violation of law; or
(D) For any transaction from which the director received an improper personal benefit, provided that no such provision shall eliminate or limit the liability of a director for any act or omission occurring prior to the date when such provision becomes effective. 

This provision (for which there are no reported cases in Georgia) was adopted by Debtor, but the Trustee argued that the Directors are still liable for intentional, wrongful, and grossly negligent conduct, as alleged in the Complaint. The Court agreed with the Trustee -

Georgia's statute is similar but not identical to Delaware's. One provision found in Delaware's exculpation statute specifically limits the ability of a corporation to absolve directors from breaches of the duty of loyalty; however, they both contain limitations on conduct that is intentional or knowing. In Delaware, this has been extended by case law to intentionally reckless acts and acts taken in bad faith. ...

A recent decision by the Delaware Chancery Court in In re Walt Disney Co. Derivative Litigation, 825 A.2d 275, 289 (Del. Ch. 2003), stated that where the facts of the complaint, taken as true, "suggest that the defendant directors consciously and intentionally disregarded their responsibilities, adopting a 'we don't care about the risks' attitude," they sufficiently allege claims of intentional misconduct that fall outside of the exculpatory statutes. Id. (emphasis original). "Knowing or deliberate indifference by a director to his or her duty to act faithfully and with appropriate care is conduct . . . that may not have been taken honestly and in good faith to advance the best interests of the company" and, thus, constitutes intentional misconduct. Id. "Put differently, all of the alleged facts, if true, imply that the defendant directors knew that they were making material decisions without adequate information [or] deliberation, and that they simply did not care." Id.

The Court finds this rationale instructive in interpreting the similar provisions in Georgia's exculpatory statute. The Complaint alleges that the Outside Directors breached their fiduciary duties of care, good faith and loyalty to Avado through their intentional, wrongful and/or reckless conduct. At this early stage of the litigation, reviewing the Outside Director's Motion to Dismiss against the Trustee's Complaint and accepting the facts pled in the Complaint as true, the Court finds that the Exculpation provisions in Avado's articles of incorporation do not protect the Outside Directors from liability

The Defendant Directors also sought dismissal of the Trustee's claims for the tort of deepening insolvency.   The court granted the motion, finding --

Section 546 of the Bankruptcy Code was amended with the enactment of the BAPCPA.  The new provisions provide sellers of goods with a 45-day window for reclamation, instead of incorporating the 10 day window in the Uniform Commercial Code, require that the goods be sold in the ordinary course of the seller's business, requires the reclamation demand must be made in writing, etc.  See the In the Red Blog for a more thorough summary of the new provisions.

The first case interpreting the new provision is out - Simon & Schuster, Inc. v. Advanced Marketing, Inc. (In re Advanced Marketing, Inc.), Adv. No. 07-50004 (Bankr. D. Del. Jan. 22, 2007). Bob Eisenbach, Esq.  at the In the Red Blog has analyzed the opinion and new Code section, and provided links to pleadings.  In summary, the Court denied the seller's request for a Temporary Restraining Order, finding that the secured creditor's pre-petition and post-petition rights were superior to the seller's right of reclamation. As Bob states, this opinion is important because it is the first one (that we know of) on the subject. 

Several blogs reported last year on the order entered in the Florida case of Avista Management v. Wausau Underwriters Insurance Co. (June 6, 2006), in which the Judge ordered the lawyers to play a game of "rock, paper, scissors" to resolve a discovery dispute. 

Judge Marvin Shoob threatened the same in an order entered in the case of Holmes v. Trauner, Cohen & Thomas, PC. Case No. 1-06-cv-1806-MHS (N.D. Ga.).  From the Fulton County Daily Report -

In the Atlanta case, attorney Lisa D. Wright sought a protective order on behalf of plaintiff Kelly Holmes, claiming that defense lawyer Louis R. Cohan had previously deposed one of her other clients “in an abusive, annoying, harassing and oppressive manner.” 

As a result, Wright asked Shoob to order that Holmes’s deposition be held either at her office, a court reporter’s office or federal court. Cohan objected and sought his own protective order to bar plaintiff’s counsel from taking depositions from the defense anywhere other than his own law office or the offices of his client, Trauner, Cohen & Thomas.

Shoob denied both motions, and named “Rock, Paper, Scissors” as the future means by which counsel should resolve their differences. “The parties,” Shoob ordered, “shall each bear their own costs of bringing these silly motions.”

By: Scott B. Riddle, Esq.

Deutsche Bank A.G. London Branch v. Worldcom, Inc. (In re Worldcom, Inc.), 2006 U.S. Dist. LEXIS 92729 (S.D.N.Y. December 21, 2006).

The plaintiff filed proofs of claim in Worldcom's Bankruptcy case for pre-petition dividends that were announced, but never paid. The issue before the District Court, on appeal from the Bankruptcy Court, was whether Worldcom was insolvent at the time the dividend was to have been paid. The applicable statute was O.C.G.A. 14-2-640(c), which provides the following:

 (c) No distribution may be made if, after giving it effect:

(1) The corporation would not be able to pay its debts as they become due in the usual course of business; or

(2) The corporation's total assets would be less than the sum of its total liabilities plus (unless the articles of incorporation permit otherwise) the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution.

Worldcom defended on the grounds that it was insolvent when it refused to pay the dividend.  The Bankruptcy Court agreed in an oral ruling, finding that Worldcom was insolvent on the relevant dates.  The plaintiff argued that the Bankruptcy Court was required to "make and articulate a number of determinations, including both tests articulated by the statute."  The Court disagreed, finding that the Bankruptcy Court needed only to find insolvency under one of the two tests in the statute. While the Bankruptcy Court could have been more explicit, it was not reversible error to not do so.   Therefore, there was no requirement that the dividend be paid - in fact, it would have been improper to pay it - and summary judgment was affirmed.

By: Scott B. Riddle, Esq.

The Split Circuits Blog reviews the case of For Play Limited v. Bow to Stern Maintenance, Inc., Slip Copy, 2006 WL 3662339 (S.D. Fla. Nov. 06, 2006). An excerpt from the opinion -

There is a split of authority regarding whether clerical or secretarial work is compensable. Compare, e.g., Walker v. United States Dep't of Housing and Urban Development, 99 F.3d 761, 770 (5th Cir.1996) ("Clerical work, however, should be compensated at a different rate from legal work."), with, e.g., Surge v. Massanari, 155 F.Supp.2d 1301, 1307 (M.D.Ala.2001) ("requests for . . . non-compensable clerical tasks [are] inappropriate").

Consistent with what appears to be the great majority of courts within the Eleventh Circuit that have considered that issue, this Court concludes that Plaintiff is not entitled to any reimbursement for clerical or secretarial tasks that Plaintiff's counsel performed.

The Split Circuits Blog discusses the case of In re Moore, --- B.R. ----, 2006 WL 3692640 (Bkrtcy.E.D.Tenn. Dec. 14, 2006), wherein the issue was the validity of credit counseling done the day of filing.

Resolution of the motions to dismiss turns on the interpretation of 11 U.S.C. § 109(h)(1), which was enacted by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"), Pub.L. No. 109-8, § 106, 119 Stat. 23, 37. This provision states in part:

[A]n individual may not be a debtor under this title unless such individual has, during the 180-day period preceding the date of filing of the petition by such individual, received from an approved nonprofit budget and credit counseling agency described in section 111(a) an individual or group briefing (including a briefing conducted by telephone or on the Internet) that outlined the opportunities for available credit counseling and assisted such individual in performing a related budget analysis.

The court, noting the split of authority, held that counseling received the same day was valid --

[T]he "180-day" phrase must be read in context with the clause that proceeds it: "an individual may not be a debtor under this title unless such individual has, during the 180-day ...." This language is instructive because it reminds us that this is an eligibility provision, just like other eligibility requirements in § 109 of the Bankruptcy Code, defining who is eligible for bankruptcy relief. Eligibility is determined as of the filing of the petition. See, e.g., In re Global Ocean Carriers Ltd, 251 B.R. 31, 37 (Bankr.D.Del.2000) ("The test for eligibility is as of the date the bankruptcy petition is filed."). . . .

Thus, considered in its context of § 109's eligibility requirements, the more likely plain meaning of "date" as used in § 109(h)(1) appears to be the less common, but still often used definition, that of moment or specific time. . . . Similarly, the now infamous "hanging paragraph" at the end of 11 U.S.C. § 1325(a) refers to debts "incurred within the 910-day [period] preceding the date of the filing of the petition." . . .

Furthermore, although this court believes that the appropriate reading of § 109(h)(1) is ascertainable from both its language and context, the sparse legislative history to the provision also supports the determination that rather than mandating an artificial time frame period during which credit counseling must occur, Congress' focus in § 109(h)(1) was on imposing a new eligibility requirement which must be satisfied at the bankruptcy filing deadline.

Sorry for the length of this post, but rather than attempt to summarize this case I am posting lengthy excerpts from the opinion.  Scroll to the bottom of the post for links to the briefs filed in the case. Thanks to Katie Porter at Credit Slips for notice of the case.

Milavetz, Gallop & Milavetz v. United States, Case No. 05-cv-2626 (D. Minn. December 7, 2006) (Click here for a copy of the opinion.

In a case filed by a law firm and "unnamed members of the public," the United States District Court for the District of Minnesota struck down, in an Order denying the United States' Motion to Dismiss, Sections 526(a)(4) and 528(a)(4) as unconstitutional as applied to attorneys.

 11 U.S.C. § 526 provides as follows -

A debt relief agency shall not . . . advise an assisted person or prospective assisted person to incur more debt in contemplation of such person filing a case under this title or to pay an attorney or bankruptcy petition preparer fee or charge for services performed as part of preparing for or representing a debtor in a case under this title.

The first issue was the appropriate standard to apply to the analysis.  Plaintiffs contended that the Court should apply a "strict scrutiny" standard, while the US argued for a more lenient standard that balanced the First Amendment rights of lawyers with the government's legitimate interest in regulating the activity in question. 

When fairly viewed, the Court finds § 526(a)(4) to be a content-based regulation of attorney speech --it restricts attorneys from giving particular information and advice to their clients. Attorneys are forbidden to advise their clients concerning an entire subject – incurring more debt in contemplation of filing for bankruptcy. This is a plain regulation of speech.
Beyond this, the forbidden speech trenches on two other important areas of concern.

First, the lawyer’s advice to take on certain additional financial obligations in contemplation of bankruptcy may well be in the client’s best interest. A lawyer’s highest duty is to the client, and the statute’s forbidden advice may indeed be helpful to the client. Secondly, this statute does not restrict false statements – arguably implicating some “ethical” precept – it forbids truthful and possibly efficacious advice. If this is the government’s view of legal ethics, it is a form of ethics unfamiliar to the Court.

As the United States Supreme Court has explained, “[g]overnment action that stifles speech on account of its message, or that requires the utterance of a particular message favored by the Government, contravenes th[e] essential [First Amendment] right[s]” of private citizens. Turner Broad. Sys. v. FCC, 512 U.S. 622, 641 (1994). For this reason, “governmental control over the content of messages expressed by private individuals” is unconstitutional except in narrow circumstances. Id.

As the Court finds § 526(a)(4) to be a content-based restriction on protected speech, it is subject to strict scrutiny. Id. Such a restriction can only survive if (1) narrowly tailored to achieve (2) a compelling state interest. United States v. Playboy Entm’t Group, Inc., 529 U.S. 803, 813 (2000). The Court finds the government has failed to meet its burden on the first point – § 526(a)(4) is not narrowly tailored.

In In re Tubular Technologies, LLC, Chapter 11 Case No. 06-00228 (Bankr. D. S.C. June 21, 2006) (click here for the opinion), the debtor filed a Chapter 11 petition on January 20, 2006.  On May 12, 2006, 112 days after the petition date, the debtor moved, pursuant to 11 U.S.C. §365(d)(4), for an extension of time within which to assume or reject a lease of non-residential real property. The debtor did not seek an expedited hearing on the motion, and no order was entered prior to the 120 day time set forth in the statute. The lessor objected to the extension.

The court denied the motion for an extension of time.  Section 365(d)(4) provides the following --

The court may extend the period determined under subparagraph (A), prior to the expiration of 120 day period, for 90 days on the motion of the trustee or lessor for cause.

The Court stated the following --

Section 365(d)(4), as revised by the BAPCPA, appears to be self-executing like the previous version of § 365(d)(4). ... Debtor timely act under §365(d)(4)(A) and failed to timely obtain an extension under §365(d)(4)(B).  The Court therefore finds that Debtor's Motion should be denied as a matter of law because ther elief requested cannot be provided to the Debtor after the lapse of the applicable deadline pursuant to the plain language of §365(d)(4)(B)(i).  This result is consistent with other changes to the Bankruptcy Code where Congress enacted self-executing provisions that deny a debtor relief if a debtor does not timely act. 

Finally, the Court rejects Debtor's excusable neglect argument.  The Court is not aware of any case in this jurisdiction that applies an excusable neglect standard, which is primarily used for obtaining relief from a judgment, to extend what is essentially a statute of limitations preclusion for Debtor... The Court rejects Debtor's excusable neglect argument, assuming it could apply, because §365(d)(4)(B)(i) provides that Debtor is required to obtain an order before the lapse of the deadline and it is Counsel's responsibility to ensure that hearings are timely scheduled before the deadline lapses.

The Debtor subsequently moved for a stay pending appeal, and the Court again addressed the issue in In re Tubular Technologies, LLC, 348 B.R. 699 (Bankr. D.S.C. July 18, 2006) (click here for opinion) , stating as follows --

Francis G.X. Pillegi, in the Delaware Litigation Blog, discusses the case of Bryan v. Doar, (Del. Supr., Nov. 6, 2006), in which the Delaware Supreme Court held that the Bankruptcy Trustee of the Creditor Trust did not have standing to appeal a Chancery Court decision when he failed to seek substitution under Rule 25(c) or intervention at the trial level.  Francis has discussion about the case, and a link to the opinion.  Head over there to read the summary and the opinion.

The case is a lesson to Trustee's to jump in quickly in any inherited cases, or risk waiving any right to contest the outcome.

In Nisselson v. Lernout, 2006 U.S. App. LEXIS 27562 (1st Cir. November 8, 2006), (click here for opinion) the Trustee of a Litigation Trust filed suit against several parties for securities fraud, fraud, unfair trade practices, negligent misrepresentation and conspiracy.  The claims arose from a failed merger.

The basic, relevant facts are relatively straightforward. "Old Dictaphone" was a successful corporation in the telecommunications industry.  L&H  was also a purported leader in the industry and began courting Old Dictaphone.  In the process, "it described in glowing terms its financial stability and the profitable synergies that a merger could generate."  "Old Dictaphone conducted extensive due diligence investigations into L&H's fiscal health. During the course of that review, L&H's senior officers, investment bankers, attorneys, and auditors touted its financial prowess. Against this rose-colored backdrop, Old Dictaphone agreed to a stock-for-stock merger."

As part and parcel of the transaction, Old Dictaphone merged into Dark Acquisition Corp. (Dark), a wholly-owned subsidiary of L&H created under Delaware law for the express purpose of effectuating the merger. L&H's chief executive officer, defendant-appellee Gaston  Bastiaens, doubled in brass as Dark's chief executive and lone director. He also signed the merger agreement on its behalf.

Under the terms of the merger agreement, Dark inherited Old Dictaphone's assets (including any existing legal claims) and assumed Old Dictaphone's liabilities. This arrangement corresponded to the dictates of Delaware law. See Del. Code Ann. tit. 8, § 259(a). Dark survived the merger and Old Dictaphone ceased to exist. Dark then changed its name to Dictaphone Corporation (New Dictaphone).

The honeymoon was brief. Shortly after the merger had been consummated, L&H announced that the financial picture it had painted and displayed was not an accurate portrayal. As matters turned out, nearly two-thirds of L&H's reported revenue from 1998 through mid-2000 had been improperly recorded, so that an apparent $ 70,000,000 net profit for that period was in fact a net loss of a similar magnitude. The price of L&H shares plummeted and, on November 29, 2000, L&H and New Dictaphone filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code.

We fast-forward to New Dictaphone's approved plan of reorganization. As part of that plan, the corporation conveyed its interest in any claims arising out of the merger to the Dictaphone Litigation Trust (the Trust). That assignment galvanized this suit: acting on behalf of the Trust, the trustee filed a civil action in federal district court seeking damages to compensate for the "loss or diminution of [Old Dictaphone's] value as a going concern."

Zelotes v. Martini, 2006 U.S. Dist. LEXIS 81385 (D. Conn. November 7, 2006).  The plaintiff, a bankruptcy lawyer, filed a lawsuit to declare Section 526(a)(4) unconstitutional. This section provides --

A debt relief agency shall not . . . advise an assisted person or prospective assisted person to incur more debt in contemplation of such person filing a case under this title or to pay an attorney or bankruptcy petition preparer fee or charge for services performed as part of preparing for or representing a debtor in a case under this title.

The defendant United States Trustee moved to dismiss.  The court first disposed of the standing issue, and moved to the substance of the subsection at issue --

2. Limitations on Lawyers' Speech

Rather than changing the bankruptcy system by closing the loopholes, eliminating the incentives for opportunistic action or enacting penalties for those who take on such debt prior to filing for bankruptcy, Congress enacted § 526(a)(4), a prophylactic rule which prohibits attorneys from advising their clients to take on any additional debt in contemplation of bankruptcy, even when doing so would be lawful. As Plaintiff argues, and as both the Hersh and Olsen courts found, there are instances whereby taking on more debt in contemplation of bankruptcy would not constitute abuse of the bankruptcy system. Without delving too deep into the complexities of bankruptcy law, it is clear that the prohibition in § 526(a)(4), while addressing opportunistic abuses, could also ensnare lawful, financially prudent actions. The Hersh and Olsen courts noted examples where the prohibition could reach lawful and beneficial actions, including (1)"refinancing at a lower rate to reduce payments and forestall or even prevent entering bankruptcy," (2) "taking on secured debt such as [a] loan on an automobile that would survive bankruptcy and also enable the debtor to continue to get to work and make payments," (3) "taking out a loan to obtain the services of bankruptcy attorney, to pay the filing fee in a bankruptcy case or the conversion of a non-exempt asset to an exempt asset which is still allowed under the Bankruptcy code," and (4) "refinanc[ing] a mortgage that allows a debtor to pay off the mortgage and other debts, such as credit card debt, in a chapter 13 where failure to refinance may only allow the debtor sufficient funds to pay off one or the other but not both." Hersh, 347 B.R. at 24; Olsen, 2006 U.S. Dist. LEXIS 56197, at *20. Plaintiff cited these and other examples of lawful, financially prudent actions, including: (1) borrowing money from friends and family or taking out a secured loan to obtain the services of a bankruptcy attorney or to pay a filing fee, in order to (a) prevent a wage garnishment or attachment, (b) prevent a home foreclosure, repossession or associated costs or (c) avoid a preferential payment or fraudulent transfer to insiders; and (2) borrowing from friends and family or taking out a secured loan to finance the purchase of a new vehicle in order to (a) purchase a less expensive vehicle with lower monthly payments in order to maintain transportation, (b) obtain transportation and secure employment, (c) avoid the higher rate of interest--and therefore, potentially higher likelihood of default--which the debtor would face after filing for bankruptcy, (d) obtain a more economical and/or reliable vehicle in order to reduce average monthly expenses. n8

By prohibiting lawyers from advising clients to take a course of action that is lawful and in the client's best financial interest, albeit a counterintuitive one, § 526(a)(4) prevents lawyers from giving clients the best and most complete advice. n9 As Plaintiff argues, "[s]ection 526 chills the attorney's very exercise of the advice and counsel function that is the defining feature of our profession." (Pl.'s Opp. 11.) By prohibiting lawyers from advising clients to take lawful, prudent actions as well as abusive ones, § 526(a)(4) is overbroad and restricts attorney speech beyond what is "narrow and necessary" to further the governmental interest. Gentile, 501 U.S. at 1075; Hersh, 347 B.R. at 25 (citing IN RE R. M. J., 455 U.S. 191, 203, 102 S. Ct. 929, 71 L. Ed. 2d 64 (1982) (Even under intermediate scrutiny, "[s]tates may not place an absolute prohibition on certain types of potentially misleading information . . . if the information also may be presented in a way that is not deceptive."); Conant v. Walters, 309 F.3d 629, 638-39 (9th Cir. 2002) (finding that government could not justify [*20] policy that threatened to punish a physician for recommending to a patient the medical use of marijuana on ground that such a recommendation might encourage illegal conduct by the patient)); Olsen, 2006 U.S. Dist. LEXIS 56197, at *21. Accordingly, the Court finds 11 U.S.C. § 526(a)(4) facially unconstitutional.

 

In re Greater Southeast Community Hospital Corp., (Alberts v. Tuft), 2006 B.R. 2419 (Bankr. D.C. September 21, 2006).

The Trustee for the Liquidating Trust filed suit against former officers and directors, and the debtors’ former law firms, alleging that the defendants furthered a Ponzi scheme. One of the claim asserted by the trustee was deepening insolvency, which the court had already concluded was not a viable separate tort. In re Greater Southeast Cmty. Hosp. Corp. I, 333 B.R. at 516-17. Given the recent cases on the subject (See discussion about Lafferty and CitX), the court revisited the issue.

Since the court issued its opinion in October, the Third Circuit has had occasion to reflect on its ruling in Lafferty. In CitX, the Third Circuit considered whether an accountant for an internet company could be held liable for the deepening insolvency of the company where the accountant was allegedly negligent in his review of the company's finances. 448 F.3d at 674. The Third Circuit clarified that, notwithstanding its descriptions of deepening insolvency as a "type" or "theory" of injury in Lafferty, id. at 677 (quoting Lafferty, 267 F.3d at 349), it had never held that deepening insolvency was "a valid theory of damages for an independent cause of action." Id. at 677. The court also concluded that "a claim of negligence cannot sustain a deepening [] insolvency cause of action." Id. at 681.

These conclusions give the court serious pause. Although CitX involved different facts, n9 and although the decision is not binding on this court, the Third Circuit's reinterpretation of Lafferty contradicts the conclusions reached by this court in its earlier opinion, thereby calling into question the court's reliance on that case in that opinion. The court has therefore been especially careful in its review of the CitX decision.

n9 In CitX, the debtor company's accountant supposedly deepened the debtor's insolvency by approving financial statements that allowed the debtor to solicit funds from investors despite its financial distress, which allowed the struggling company to continue operating and, through the subsequent machinations of its management, acquire more debt. The Third Circuit found this theory of harm too attenuated to state a claim for negligence, concluding that "[a]ny increase in insolvency (i.e., the several million dollars of debt incurred after the $ 1,000,000 investment) was wrought by CitX's management, not by [the defendant]." CitX, 448 F.3d at 677. In contrast, Alberts alleges that the D & O Defendants, with the assistance of the Law Firm Defendants, directly increased the debt load of the debtors.

Francis G.X. Pillegi  at the Delaware Litigation Blog discusses the case of Stone v. Ritter, (Del. Supr., Nov. 6, 2006), in which the Delaware Supreme Court "clarified its position on whether "good faith" is a separate stand-alone duty, in the same way as loyalty and due care are."  Francis also has a link to the opinion,  comments from Professor Gordon Smith, and additional discussion. 

From the opinion (credit to Professor Smith at his Conglomerate Blog for the relevant excerpt) --

It is important, in this context, to clarify a doctrinal issue that is critical to understanding fiduciary liability under Caremark as we construe that case. The phraseology used in Caremark and that we employ here—describing the lack of good faith as a "necessary condition to liability"—is deliberate. The purpose of that formulation is to communicate that a failure to act in good faith is not conduct that results, ipso facto, in the direct imposition of fiduciary liability. The failure to act in good faith may result in liability because the requirement to act in good faith "is a subsidiary element[,]" i.e., a condition, "of the fundamental duty of loyalty." It follows that because a showing of bad faith conduct, in the sense described in Disney and Caremark, is essential to establish director oversight liability, the fiduciary duty violated by that conduct is the duty of loyalty.

This view of a failure to act in good faith results in two additional doctrinal consequences. First, although good faith may be described colloquially as part of a "triad" of fiduciary duties that includes the duties of care and loyalty, the obligation to act in good faith does not establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty. Only the latter two duties, where violated, may directly result in liability, whereas a failure to act in good faith may do so, but indirectly. The second doctrinal consequence is that the fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary conflict of interest. It also encompasses cases where the fiduciary fails to act in good faith. As the Court of Chancery aptly put it in Guttman, "[a] director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation's best interest."

No more "triad" of fiduciary duties? Read more at the Delaware Litigation Blog. 

In Trenwick America Litigation Trust v. Ernst & Young, LLP, et al, 906 A.2d 168, 2006 Del Ch. LEXIS 139 (Del. Ch. August 10, 2006), the Chancery Court firmly held that deepening insolvency is not a valid cause of action under Delaware law. It will be interesting to see how the Delaware Supreme Court rules on this matter, if and when the issue is before that Court.

 The Trust created by the Chapter 11 Plan filed suit against former subsidiary directors for, inter alia, deepening insolvency. Specifically, the Court identified the following allegations that supported the claim --

• From 2000 until 2003, these [Trenwick America] Defendants fraudulently concealed the true nature and extent of [Trenwick America's] financial problems by expanding the amount of debt undertaken by [Trenwick America].
• The [Trenwick America] Defendants knew that [Trenwick America] would not be able to repay this increased debt, but fraudulently represented to creditors and other outsiders that the debt would be repaid.
• By these actions, [Trenwick America's] officers and directors prolonged the corporate life of [Trenwick America] and increased its insolvency, until [Trenwick America] was forced to file for bankruptcy on August 20, 2003.
• As a result of [those] actions, [Trenwick America] suffered damages to be proven at trail, which [the Litigation Trust] is entitled to recover.

The Court, in the introductory section, told readers where it was going, finding that deepening insolvency was not even a “coherent concept” --

In the complaint, the Litigation Trust also has attempted to state a claim against the former subsidiary directors for "deepening insolvency." As noted, however, the complaint fails to plead facts supporting an inference that the subsidiary was insolvent before or immediately after the challenged transactions. Equally important, however, is that Delaware law does not recognize this catchy term as a cause of action, because catchy though the term may be, it does not express a coherent concept. Even when a firm is insolvent, its directors may, in the appropriate exercise of their business judgment, take action that might, if it does not pan out, result in the firm being painted in a deeper hue of red. The fact that the residual claimants of the firm at that time are creditors does not mean that the directors cannot choose to continue the firm's operations in the hope that they can expand the inadequate pie such that the firm's creditors get a greater recovery. By doing so, the directors do not become a guarantor of success. Put simply, under Delaware law, "deepening insolvency" is no more of a cause of action when a firm is insolvent than a cause of action for "shallowing profitability" would be when a firm is solvent. Existing equitable causes of action for breach of fiduciary duty, and existing legal causes of action for fraud, fraudulent conveyance, and breach of contract are the appropriate means by which to challenge the actions of boards of insolvent corporations.

The Electronic Discovery Blog discusses the case of In re Quintus Corp., 2006 WL 3072982 (Bankr. D. Del. Oct. 27, 2006), wherein the Delaware Bankruptcy Court entered summary judgment in favor of a Bankruptcy Trustee based upon the adverse party's destruction of documents. See  $1.888 Million Judgment Entered in Favor of Bankruptcy Trustee Based on Adverse Party's Spoliation of Financial Records.  The post includes a link to download the opinion.

Note that the electronic documents were destroyed before the Trustee was even appointed, and before an adversary proceeding was filed.  The court concluded that the party should have anticipated litigation.

Bankruptcy lawyers, as much as general litigation lawyers, need to be familiar with Electronic Discovery rules.   

In In re CITX Corp. (Seitz v. Detweiler Hershey & Assoc., PC), 448 F.3d 672, 2006 U.S. App, LEXIS 13141 (3rd Cir. May 26, 2006), the debtor was also alleged to have been an illegal Ponzi scheme. The Chapter 7 Trustee filed suit against the accounting firm for, inter alia, deepening insolvency. The District Court granted summary judgment to the defendants.

The twist in CITX, a case under Pennsylvania law, was that the deepening insolvency claim was based upon allegations of negligence (the complaint “barely makes out, and his evidence completely fails to support, any allegation of fraudulent conduct on [Defendant’s] part”). The issue before the Court, therefore, was whether a cause of action for deepening insolvency could be based upon negligence, as opposed to fraudulent conduct? The Court answered “no.”

First, let’s review the Lafferty case, in which the Court held that “Deepening Insolvency” was a valid cause of action under Pennsylvania law. In Official Committee of Unsecured Creditors v. R.F. Lafferty & Co., Inc., 267 F.3d 340 (3rd Cir. 2001), the debtor corporations were alleged to have been Ponzi schemes” and the Committee filed suit against third-parties for, inter alia, fraudulently inducing the debtors to issue debt securities, thereby “deepening their insolvency.” At issue (for purposes of this post) was “whether ‘deepening insolvency’ is a valid theory that gives rise to a cognizable injury under [Pennsylvania] state law. The Court found that the Pennsylvania state courts had not addressed the issue, and there were no other state or federal cases on point.

… [W]e conclude that, if faced with the issue, the Pennsylvania Supreme Court would determine that "deepening insolvency" may give rise to a cognizable injury. First and foremost, the theory is essentially sound. Under federal bankruptcy law, insolvency is a financial condition in which a corporation's debts exceed the fair market value of its assets. 11 U.S.C. § 101(32). Even when a corporation is insolvent, its corporate property may have value. The fraudulent and concealed incurrence of debt can damage that value in several ways. For example, to the extent that bankruptcy is not already a certainty, the incurrence of debt can force an insolvent corporation into bankruptcy, thus inflicting legal and administrative costs on the corporation. … When brought on by unwieldy debt, bankruptcy also creates operational limitations which hurt a corporation's ability to run its business in a profitable manner. …. Aside from causing actual bankruptcy, deepening insolvency can undermine a corporation's relationships with its customers, suppliers, and employees. The very threat of bankruptcy, brought about through fraudulent debt, can shake the confidence of parties dealing with the corporation, calling into question its ability to perform, thereby damaging the corporation's assets, the value of which often depends on the performance of other parties. … In addition, prolonging an insolvent corporation's life through bad debt may simply cause the dissipation of corporate assets.

In In re Southwest Florida Heart Group, P.A. (Amato v. Southwest Florida Heart Group, P.A), 2006 Bankr. LEXIS 1556 (Bankr. M.D. Fla. July 7, 2006), Judge Paskay, with no discussion, held that "there is no cognizable, viable claim based on a theory of deepening insolvency."

I was involved in a case earlier this year where the Superior Court appointed a Receiver to take control of the assets and management of a corporation. Notwithstanding the appointment of a Receiver, the owners filed a Chapter 7 petition. The Bankruptcy Court ultimately abstained and dismissed the case based upon the equities of the case and because the petition was filed without the approval of the directors. The court did not need to reach the issue of whether the officers and directors had authority to file the petition after the Receiver was appointed, but intimated in the hearing that the Receiver could not prevent the filing.

The issue was recently addressed by an Arizona Bankruptcy Court. In In re Corporate and Leisure Event Productions, Inc., 2006 Bankr. LEXIS 2074 (Bankr. D. Ariz. September 5, 2006), the State Court appointed a Receiver and expressly authorized the Receiver to remove the officers, directors and any other persons from the management of the debtor (which the Receiver concluded was a multi-million dollar Ponzi scheme). The State Court also expressly enjoined the defendants therein from filing a Bankruptcy petition or taking any other action to interfere with the Receivership. Nevertheless, the principal of the debtor filed Chapter 11 petitions on behalf of the debtor and related corporations and removed the State Court proceedings to Bankruptcy Court. The Receiver filed an Emergency Motion to Dismiss Unauthorized Chapter 11 Petition.

The Court denied the Motion to Dismiss.  Rather than summarize, I have included several excerpts from the opinion

This dispute is not governed by the Bankruptcy Code. Indeed, the complaining creditors and their Receiver cannot point to any provision of the Bankruptcy Code that has even allegedly been violated by these filings. But while intracorporate disputes would ordinarily be governed by the law of the state of incorporation, this particular kind of creditor-driven intracorporate dispute is governed instead by federal common law, as will be seen.

There have been several recent stories about on-the-field or on-the-court incidents during sporting events.  See Youth Coach Attacks Opposing Player; Temple Coach John Chaney Sends "Goon" To "Send A Message," Miami v. Florida International, etc. 

In Brokaw v. McSorley, Adv. No. 05-31213, 2006 Bankr. LEXIS 2728 (Bankr. S.D. Iowa October 18, 2006), the debtor was a high school basketball player who, according to game films, through a haymaker fist or elbow on an opposing player during the course of a game.  The film showed that before this incident, the debtor had also undercut an opposing player during a layup, and threw an elbow that missed at another opposing player.  In the incident at issue in the case, both players were away from the action, and the debtor's move was not, the Judge found, an attempt to get free from the defense or otherwise a part of the game.

The injured player sued, and the debtor filed his Bankruptcy petition.  The Judge reviewed the game films and held that the debtor's actions were maliciously targeted at the injured player and certain to cause him harm.  In reaching this conclusion, the court considered the prior conduct of the debtor during the game and the fact that the debtor's team was losing badly.  While not required, the Court also found that the actions showed the presence of "spite, ill will or personal animosity." 

The Court concluded that any damages awarded b the state court (after the stay was lifted) would be non-dischargeable pursuant to §523(a)(6).

What happens when a creditor who is owed a non-dischargeable debt (such as a fraud judgment) receives a payment during the preference period and later has to return the voidable preference to the estate?  May the creditor seek an exception to discharge for the amount of the voided preference?  According to the Ninth Circuit BAP, the answer may be "no."

The Sheppard Mullin Blog discusses this case in an article:  Return Of Preferential Payment Arising From Fraud Settlement Does Not Revive Creditor's Nondischargeability Claim.

Section 1328(f) of the Bankruptcy Code, by the BAPCPA,  provides the following concerning discharges granted (or denied) in Chapter 13 cases--

Discharge

Notwithstanding subsections (a) and (b), the court shall not grant a discharge of all debts provided for in the plan or disallowed under section 502, if the debtor has received a discharge--

(1) in a case filed under chapter 7, 11, or 12 of this title during the 4-year period preceding the date of the order for relief under this chapter, or

(2) in a case filed under chapter 13 of this title during the 2-year period preceding the date of such order.

In In re West, 2006 Bankr. LEXIS 2562 (Bankr. E.D. Ark. October 10, 2006), the issue was exactly when the two year period started - the date of filing of the prior case, or the date of any discharge in the prior case.  The court found that it is the date of filing of the prior case that is referenced by the statute --

A plain reading of the statute supports this interpretation. The statute states that discharge is denied if  the prior case was "filed [under the relevant chapter] during the [2- or 4-year] period preceding the date of the order for relief." (Emphasis added.) What makes this code section so unclear is the impracticality of it. As recognized by William Houston Brown (former Bankruptcy Judge for the Western District of Tennessee),

This provision obviously has a potential chilling effect for those debtors who receive a quick discharge in a prior case but who then encounter a new cause for filing another case. This provision seems to ignore the realization that debtors who filed for Chapter 13 relief within two years of filing another case are unlikely to have obtained a discharge in that prior case. Rarely is a Chapter 13 debtor able to propose and obtain a confirmation of a less-than-two-year plan.

William Houston Brown, Taking Exception to a Debtor's Discharge: The 2005 Bankruptcy Amendments Make it Easier, The American Bankruptcy Law Journal, 79 A.M. BANKR. L.J. 419, 449 (2005) (emphasis added).

The court also found that this interpretation was supported by the legislative history -

To the Court's knowledge, the only available legislative history on this new Code section is found in House Report, § 312 which provides that BAPCPA amends:

section 1328 to prohibit the issuance of a discharge in a subsequent chapter 13 case if the debtor received a discharge in a prior chapter 7, 11, or 12 case within four years preceding the filing of the subsequent chapter 13 case. In addition, it prohibits the issuance of a discharge in a subsequent chapter 13 case if the debtor received a discharge in a chapter 13 case filed during the two-year period preceding the date of the filing of the subsequent chapter 13 case.

H.R. 31, 109th Cong. § 312 (1st Sess. 2005). Examining the first sentence of § 312, the court in Capers concluded that § 1328(f) was intended to lengthen the time between the discharges a debtor may receive. There, the Court stated:

Adoption of Debtor's mechanical reading of § 1328(f) would frustrate the policy that Congress sought to implement through the provisions of the section. Clearly, Congress sought to lengthen the time between the discharges debtors receive under chapters 7, 11, 12, and 13 and subsequently filed chapter 13 cases. Just as clearly, Congress determined that the length of time between discharges should be greater for debtors who had received a discharge in a previous chapter 7, 11, or 12 case than for debtors who previously received a chapter 13 discharge.

However, with respect to a previous chapter 13 case, § 312 clearly refers to the filing of the prior case and not when the discharge was received. Accordingly, the legislative history supports a plain language interpretation.

A recent case in the Middle District of Florida provides an opportunity to remind business owners and upper level managers of their personal liability of payroll taxes that should have been withheld by the business and paid to the IRS.  See In re Paris, Case No. 06-cv-1084, 2006 U.S. Dist LEXIS 73795 (M.D. Fla. October 10, 2006), although I will not focus on the particular facts of this case.

The general rule for personal liability for these taxes is --

Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall . . . be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over. . . .

 26 USC §6672(a).  Thus, "Section 6672 imposes liability upon (1) a responsible person (2) who has willfully failed to perform a duty to collect, account for, or pay over federal employment taxes." Thosteson v. United States, 331 F.3d 1294, 1298 (11th Cir. 2003)."

In this case, the court noted some factors in finding that the party was responsible --

Thus, he had the authority to hire, fire and manage the employees of the corporation, had the authority to direct the payment of the corporation's bills, and had the authority to determine the financial policy of the corporation. Appellant could negotiate on behalf of the corporation in its dealings with its suppliers, clients, and customers.  He also had the authority to open and close corporate bank accounts, sign the checks of the corporation, and to make deposits and authorize deposits to the corporate bank accounts.

Once it is established that a taxpayer is a responsible person, he assumes the burden of proving lack of willfulness. George v. United States, 819 F.2d 1008, 1011 (11th Cir 1987).   Although the Supreme Court has ruled that Section 6672 precludes the imposition of trust fund recovery penalties without personal fault, the willfulness requirement of Section 6672 has been interpreted by courts to broadly encompass a range of actions by responsible persons. Id. (citing Slodov v. United States, 436 U.S. 238, 255 (1978)). In Mazo v. United States, 591 F.2d 1151, 1155 (5th Cir. 1979), the predecessor court to the Eleventh Circuit defined "willfully" as "meaning, in general, a voluntary, conscious and intentional act." It does not require a fraudulent or other bad motive on the part of the responsible person. Id. The willfulness requirement of Section 6672 is satisfied where there is evidence that the responsible person had knowledge of payments to other creditors after he became aware of the failure to remit withholding taxes. Smith v. United States, 894 F.2d 1549, 1553 (11th Cir. 1990). Even if the responsible person is unaware that withholding taxes have gone unpaid in past quarters, one who becomes aware that taxes have gone unpaid in past quarters in which he was also a responsible person is under a duty to use all unencumbered funds available to the corporation to pay those back taxes. Thosteson v. United States, 331 F.3d 1294, 1301 (11th Cir. 2003).

 In Paris, the individual who was the responsible party for the payment of taxes, filed an individual Chapter 7, and the Bankruptcy Court and District Court found that the trust fund penalties were excepted from discharge pursuant to 11 U.S.C. § 523(a)(1).

These cases are a warning to business owners, managers and other employees that meet the definition of "responsible party" to make sure that payroll taxes are collected and paid to the IRS.  If you think you fall into this category, and you know taxes are not being paid, it may or may not make a difference that you personally are not the final decision-maker.  

(g) Notwithstanding any other provision of this section, no individual or family farmer may be a debtor under this title who has been a debtor in a case pending under this title at any time in the preceding 180 days if  . . . .  (2) the debtor requested and obtained the voluntary dismissal of the case following the filing of a request for relief from the automatic stay provided by section 362 of this title.

(3)  In considering under paragraph (1) whether the granting of relief would be an abuse of the provisions of this chapter in a case in which the presumption in subparagraph (A)(i) of such paragraph does not arise or is rebutted, the court shall consider--

(A) whether the debtor filed the petition in bad faith; or

(B) the totality of the circumstances (including whether the debtor seeks to reject a personal services contract and the financial need for such rejection as sought by the debtor) of the debtor's financial situation demonstrates abuse.

As for the possibility of malfeasance, it is impossible to legislate or rule in such a way as to preclude the eventuality of bad faith actions completely. The Court believes that the measures suggested by this opinion will go a long way toward preventing manipulation of the striking of petitions -- where a petition is obviously filed for improper purposes, and credit counseling requirements are being strategically used to avoid the provisions of the BAPCPA, the Court can use its inherent powers to impose preclusive relief. It must also be noted that the outcome proposed by the proponents of dismissal could also lead to malfeasance -- an individual may file a petition without credit counseling, invoke the protection of the stay, sit back and do virtually nothing, secure in the knowledge that creditors may not proceed until dismissal or stay relief is granted, and enjoying the delay that such action will involve. Presumably, persons who file bankruptcy on one or even multiple occasions, precipitated by a lack of financial savvy rather than an attempt to deliberately forestall creditors, are not "bad faith" filers -- they are just ignorant of the law or inept in financial matters. Those who wish to circumvent the system will find a means of doing so, regardless of whether the petition is ultimately stricken or dismissed. The Court may use its inherent powers to prevent abuse of the Bankruptcy Code, and if the Court does determine that bad faith exists, due to, e.g., serial filings or skeletal filings, the Court can strike a case, with prejudice to future filings if necessary, after undertaking a case-by-case analysis of the circumstances.

I do not like dismissal automatic,
It seems to me to be traumatic.
I do not like it in this case,
I do not like it any place.

As a judge I am most keen
to understand, What does it mean?
How can any person know
what the docket does not show?

The puzzle of 521(i) leads Judge Cristol to plead:
What does automatic dismissal mean?
And by what means can it be seen?
Are we only left to guess?
Oh please Congress, fix this mess!
Until it's fixed what should I do?
How can I explain this mess to you?

1. A $5000 tractor (secured by $5,000 loan, so there was no equity).
2. A cabin worth $14,000 with, at best, $4,000 of equity and probably closer to little or no equity.
3. Pre-petition inheritance income of $36,000, which had purportedly been spent, perhaps properly,  prior to filing for bankruptcy.
4. Gambling income of $1,400 within 2 years of filing, all of which had been purportedly spent prior to filing.

In papers filed with the U.S. Bankruptcy Court in Manhattan Tuesday, Delphi's creditors blamed the spin-off for much of Delphi's current financial troubles. Delphi has made the same contention in court papers, but the creditors said it has lately shown signs of wanting to let GM off the hook.

Under the circumstances, Delphi's creditors committee asked a judge to authorize it to pursue GM on Delphi's behalf. The committee said they saw "means of recovering from GM billions of dollars in payments" potentially owed to Troy, Mich.-based Delphi as a result of the spin-off. It said it identified those means to Delphi more than six weeks ago and was reluctant to let much more time go by.

The defendants argue that the directors do not owe any duties to the subsidiary itself. In support of this, the defendants rely principally on Southwest Holdings, L.L.C. v. Kohlberg & Co. (In re Southwest Supermarkets, L.L.C.), 315 B.R. 565 (Bankr. D. Ariz. 2004), in which the court interpreted Delaware corporate law to the effect that "Delaware law appears to hold that when a subsidiary is wholly owned, its officers and directors owe their fiduciary duties solely to the single shareholder, and not to the subsidiary corporation itself" and that "there is nothing to suggest this law changes when the corporation becomes insolvent." Id. at 575-76. I respectfully do not agree with that interpretation, however. In my view, Delaware law would recognize that the directors and officers of an insolvent wholly-owned subsidiary owe fiduciary duties to the subsidiary and its creditors. This view is supported by a number of courts that have addressed the issue.

The Southwest court relied on the Delaware Supreme Court's decision in Anadarko Petroleum Corp. v. Panhandle Eastern Corp., 545 A.2d 1171 (Del. 1998) for the proposition that the directors of a wholly-owned insolvent subsidiary owe fiduciary duties to the parent but not the subsidiary corporation. I do not believe that Anadarko advances this position.

Rather, the issue in Anadarko involved "whether a corporate parent and directors of a wholly-owned subsidiary owe fiduciary duties to the prospective stockholders of the subsidiary after the parent declares its intention to spin-off the subsidiary." Anadarko, 545 A.2d at 1172. The Delaware Supreme Court concluded "that prior to the date of distribution the interests held by Anadarko's prospective stockholders were insufficient to impose fiduciary obligations on the parent and the subsidiary's directors." Id. Thus, Anadarko did not address the situation addressed here.

For a "generally serviceable modern foundation," the court turned to Edward J. Imwinkelried, "Evidentiary Foundations" §4.03[2], which suggests the following 11-step foundation for authenticating computer records:

The business uses a computer.
The computer is reliable.
The business has developed a procedure for inserting data into the computer.
The procedure has built-in safeguards to ensure accuracy and identify errors.
The business keeps the computer in a good state of repair.
The witness had the computer read out certain data.
The witness used the proper procedures to obtain the readout.
The computer was in working order at the time the witness obtained the readout.
The witness recognizes the exhibit as the readout.
The witness explains how he or she recognizes the readout.
If the readout contains strange symbols or terms, the witness explains the meaning of the symbols or terms for the trier of fact.

Although § 521(e)(2) uses the word "shall" twice, at least one bankruptcy court has held that trustees' prosecutorial discretion allows them the authority to decline to file a motion to dismiss despite untimely filings under § 521(e)(2)(A). In re Duffus, 339 B.R. 746, 748 (Bankr. D. Or. 2006) (holding trustee has discretion to waive untimely filing under § 521(e)(2)(A) by declining to file a motion to dismiss); cf. Rooney v. Thorson (In re Dawnwood Properties), 209 F.3d 114, 117 (2d Cir. 2000) (indicating trustee has discretion to pursue malpractice claims, let them lie, or abandon them in order to allow the debtor to proceed with an action); Society Bank v. Sinder (In re Sinder), 102 B.R. 978, 984 (Bankr. S.D. Ohio 1989) (holding trustee has discretion to decline to pursue avoidance actions); In re V. Savino Oil & Heating Co., Inc., 91 B.R. 655, 656 (Bankr. E.D.N.Y. 1988) (indicating commencement of avoidance litigation by a trustee is permissive and not mandatory); In re Airlift Intern., Inc., 18 B.R. 787, 788 (Bankr. S.D. Fla. 1982) (stating the decision to cease operation of a business is within the discretion of the trustee). The Duffus court reasoned that Congress did not intend that § 521(e)(2) require mandatory dismissal because the language in § 521(e)(2) differs from the language in other sections of BAPCPA that do require mandatory dismissal. Duffus, 339 B.R. at 748. "Where the Congress intended that a case be dismissed automatically, and without need for a motion, it said as much." See § 521(i)(1). n2 Nothing in § 521 suggests that the Trustee's motion was required." Id.

If the Trustee has no discretion to waive an untimely filing under § 521(e)(2)(A), then dismissal would be automatic upon the Trustee's motion coming to the Court's attention, unless the debtor can satisfy § 521(e)(2)(B). Congress simply did not impose such a requirement. There is nothing in the language of § 521(e)(2) that suggests that Congress intended to limit the discretion traditionally exercised by trustees in performing their duties under federal bankruptcy law. This Court will not limit such discretion by implication. If anything, the language of § 521(e)(2)(B) was likely intended to limit the Court's discretion regarding the dismissal of a case for failure to timely deliver tax returns to the trustee as required under § 521(e)(2)(A). If a trustee or other party in interest brings a debtor's failure to timely comply with § 521(e)(2)(A) to the Court's attention, the Court must dismiss the case, unless the debtor can establish that such failure is excused as being due to circumstances beyond the debtor's control within the meaning of § 521(e)(2)(B).

It was a good try by the trustee, and would have been great for professionals and creditors other than the IRS --

In Reed v. United States, 2006 U.S. Dist. LEXIS 25040 (N.D. Tex. May 2, 2006), the Chapter 7 Trustee came up with a novel theory to reduce the estate's tax liability. Pre-petition, the debtor was in the business of transporting medical specimens between doctors' offices and laboratories. After conversion to a Chapter 7, the Trustee settled an adversary, resulting in real property being transferred to the debtor's estate. The property was subsequently sold by the Trustee.

The Trustee claimed an ordinary loss, rather than a capital loss, on the sale of the property. Without getting bogged down in the Tax Code, the treatment of the sale as an ordinary loss resulted in substantial tax benefits to the estate. The basis for the Trustee's position was that, at the time of the acquisition and sale of the property, the "business" of the debtor was "liquidating assets for the benefit of the creditors." At no time, the Trustee argued, did she acquire or hold the property for investment as a capital asset.

The Bankruptcy Court and District Court disagreed, finding that the trustee "really can be in no other position than the debtor" and the debtor was not in the business of selling real estate. Further, the trustee did not have the authority to unilaterally operate or alter the nature of the debtor's pre-petition business.

Had the Trustee prevailed, the tax consequences for business debtors would potentially be drastic. The liquidation of factories, machinery, and equipment could be characterized as ordinary losses, potentially leading to massive refunds for current and past tax years. Would capital assets simple "disappear" insofar as the IRS is concerned? Would trustees have to obtain specific authority under § 721 to operate the "liquidation business?" Would portions of § 363 go out the window?