11th Circuit – Creditor Cannot Pursue Pre-Petition Fraudulent Transfer Claims Against Debtor for Non-Dischargeable Debt; Establishes Standard of Review for In re Jet Florida.

By Scott Riddle Posted in Eleventh Circuit Cases

In SuVicMon Development, Inc. v. Morrison, __ F.3d __, 2021 WL 1136546 (11th Cir. March 25, 2021) (click here for .pdf), the plaintiffs are three corporations that sued the Debtor for fraud and securities violations in state court. Plaintiffs subsequently amended the complaint to include fraudulent transfer claims against Debtor and his two sons. Debtor then filed a Chapter 7 petition, and the Bankruptcy Court lift the automatic stay so the state court case could proceed to liquidation of the claims. A judgment was entered against Debtor on some claims and they were excepted from Debtor’s general discharge. Nevertheless, the Plaintiffs sought to continue the fraudulent transfer claims against the Debtor.

The first argument of Plaintiffs was that the suit was an action to collect the non-dischargeable debt (the securities fraud judgment), and because the debt was non-dischargeable the discharge injunction of 11 U.S.C. §524(a)(2) did not apply. The Circuit Panel disagreed.

The plaintiffs’ argument is incorrect. The reason is that a fraudulent transfer action is “not a mere ‘collection action,’ ”but “rather a claim that requires an independent adjudication of liability based on statutorily-defined elements.” Under the AUFTA, a creditor has a fraudulent transfer claim against a debtor for actual fraud whenever “the debtor made the transfer with actual intent to hinder, delay, or defraud any creditor of the debtor.”… A fraudulent transfer can also be found on the basis of constructive fraud, typically when the debtor makes the transfer without receiving “reasonably equivalent value,” under certain circumstances specified in the statute… Fraudulent transfer is a distinct cause of action, and, at least in the case of actual fraud, a tort…

The distinctness of a fraudulent transfer action is shown most clearly by the availability of damages specific to that action. While the remedy for fraudulent transfer may be avoidance of the transfer or execution directly on the transferred asset, see Ala. Code § 8-9A-7(a)(1), (b), under Alabama law it appears that a fraudulent transfer can in some instances result in an award of compensatory damages in addition to the value of the creditor’s underlying claim… It also appears that punitive damages may be available, at least in instances of actual fraud… The plaintiffs’ reasoning, accordingly, fails to distinguish between the different potential debts involved in this case…

A fraudulent transfer action differs in this respect from execution on a judgment. Modes of execution and associated proceedings, such as writs of execution, attachment, judgment liens, and garnishment, do not constitute a new claim against the debtor or give rise to a new debt distinct from the judgment being executed. The reason for this, however, is that execution and associated proceedings are unlike ordinary causes of
action against the debtor; they mostly are not causes of action at all. Because execution proceedings are ancillary to the prior judgment … they do not require any allegation of wrongdoing but are instead based simply on an executable judgment and the identification of property appropriately subject to execution. Modes of execution are generally in rem, in the sense that they “confer a property interest on the judgment creditor that satisfies the judgment”… Garnishment, by which a creditor may obtain property of the debtor or money due to the debtor from a third party, has been described as quasi in rem:… it typically both gives the creditor a lien on the property… and constitutes an action brought in personam against the garnishee. Another exceptional case is that of an action to enforce a foreign judgment, which is brought in personam against the debtor, but does not depend on any conduct of the debtor and merely makes the judgment effective and executable in the forum jurisdiction… A fraudulent transfer action is not an execution proceeding, and thus is not a ‘collection action’ in any sense helpful to the plaintiffs’ argument. Fraudulent transfer is a cause of action which can be brought against the debtor in personam…

The plaintiffs’ first argument, then, is unsuccessful: a fraudulent transfer action does not function as an execution proceeding, and the fact that the underlying claim is non-dischargeable does not compel the conclusion that the fraudulent transfer claim is non-dischargeable.

(Several citations omitted).

Second Circuit Court Of Appeals: “We Said What We Said” About Brunner Test And Student Loans

By Scott Riddle Posted in Consumer Bankruptcy Guide, Miscellaneous Cases

In In re Tingling, __ F3d __, 2021 WL 922448 (2nd Cir. March 11, 2021) (click for .pdf), the Debtor filed an adversary proceeding seeking discharge of her student loans. The Bankruptcy Court determined that the debtor failed to meet the Brunner Test, and the District Court affirmed. The Debtor appealed to the Second Circuit, arguing that the lower courts abused their discretion in finding that she would not face an “undue hardship” if her loans were not discharged. The Debtor also argued that the Brunner Test has, over time, become too high a burden for debtors to satisfy. The Second Circuit disagreed, and affirmed. It is probably relevant that the Debtor was pro se for the latter part of the adversary proceeding and appeals. I do not really find this to be a close call on the Brunner Test, so perhaps the Second Circuit took the opportunity to let everyone know the test is still the test.

Section 523(a)(8) provides:

(a) A discharge under section 727, 1141, 1192, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt—

(8) unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for—

(A)(i) an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or (ii) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or

(B) any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual;

Pursuant to Brunner v. N.Y State Higher Educ. Servs. Corp., 831 F.2d 395 (2nd Cir. 1987) – the infamous “Brunner Test” –

[A] debtor who claims “undue hardship” to defeat the statutory presumption against a student loan discharge must make the following specific factual showing by a preponderance of the evidence:

(1) that the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for herself and her dependents if forced to repay the loans;

(2) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and

(3) that the debtor has made good faith efforts to repay the loans.

Eleventh Circuit Allows Individual Chapter 11 Debtor To Argue Appointment Of Trustee Violated Thirteenth Amendment

By Scott Riddle Posted in Eleventh Circuit Cases

In In re Breland, __ F.3d __ , 2021 WL 910657 (11th Cir., March 10, 2021) (click here for .pdf) the individual Debtor filed a voluntary Chapter 11 petition. After it was determined that he was transferring assets and defrauding his creditors a Chapter 11 Trustee was appointed.

[Debtor] protested that the trustee’s appointment violated his Thirteenth Amendment right to be free from “involuntary servitude”— because, he said, under the trustee’s direction, all of his postpetition earnings would be put into the bankruptcy estate for the benefit of his creditors. The bankruptcy court dismissed [Debtor’s] Thirteenth Amendment claim as unripe, and, on review, the district court similarly held that [Debtor] couldn’t show an injury-in-fact sufficient to confer Article III standing…

The Eleventh Circuit panel disagreed with the District Court, finding that “[Debtor’s] loss of authority and control over his estate, which he suffered as a result of his removal as the debtor-in-possession, constitutes an Article III-qualifying injury-in-fact that is both traceable to the bankruptcy court’s appointment of the trustee and redressable by an order vacating that appointment...” Accordingly, the Panel held that Debtor had standing to pursue his Thirteenth Amendment arguments.

The Thirteenth Amendment to the United States Constitution provides the following:

Neither slavery nor involuntary servitude, except as a punishment for crime whereof the party shall have been duly convicted, shall exist within the United States, or any place subject to their jurisdiction.

Of course, this Amendment is most notable for abolishing slavery rather than protecting individuals who have filed voluntary Bankruptcy petitions. Nevertheless, the Panel left a small opening for the Debtor to make his case.

Both the bankruptcy court and the district court held that [Debtor’s] Thirteenth Amendment claim was nonjusticiable in the absence of a reorganization plan requiring [Debtor] to work and devote his income to paying off his creditors —the bankruptcy court because the claim wasn’t ripe, and the district court because Debtor had suffered no injury-in-fact. Whatever the merits of [Debtor’s] Thirteenth Amendment challenge—and we are skeptical—we hold that the appointment of the trustee sufficiently diminished [Debtor’s] ability to control the assets in his own bankruptcy estate to satisfy Article III’s standing requirements…

Before the appointment of a trustee—i.e., while he remained the debtor-in-possession—[Debtor] could, even without the bankruptcy court’s approval, hire professionals whose work is “necessary in the operation” of his business, id. § 327(b); use, sell, or lease the property of the estate in the ordinary course of business, id. § 363(c)(1); and obtain unsecured credit in the ordinary course of business, id. § 364(a). Likewise, before the
trustee’s appointment, [Debtor] could do any of the following, so long as he obtained the bankruptcy court’s approval: hire professionals to assist in the reorganization, id. § 327(a); use, sell, or lease estate property or obtain unsecured credit outside the ordinary course of business, id. §§ 363(b)(1), 364(b); accept and reject executory contracts and unexpired leases to which he was a party, id. § 365(a); and bring most avoidance actions on his own behalf, id. § 544, 548.

When the bankruptcy court appointed a trustee, and thereby deposed [Debtor] as the debtor-in-possession, it stripped him of the ability to do—or to seek permission to do— any of those things. The consequent loss of authority over his estate constitutes an Article III-qualifying injury-in-fact. And to round out the standing analysis, [Debtor’s] injury is “fairly traceable” to the appointment of the trustee, and it is “redress[able],” in the sense that an order removing the trustee would have the effect of restoring him to debtor-in-possession status, with all its attendant rights and responsibilities. [See Friends of the Earth, Inc. v. Laidlaw Envtl. Servs., Inc., 528 U.S. 167, 180–81, 120 S.Ct. 693, 145 L.Ed.2d 610 (2000)]. We thus hold that [Debtor] has Article III standing to pursue his Thirteenth Amendment challenge.

The Panel not-so-subtly expressed skepticism about the Debtor’s 13th Amendment challenge in the Order and concluded:

It’s oh-so tempting to forge ahead and address the merits of [Debtor’s] Thirteenth Amendment claim, but our hands are tied. It’s true, of course, that we can affirm a district court’s judgment based on any ground supported by the record… But when the district court here held that [Debtor] lacked standing to sue, it dismissed his claim for lack of subject-matter jurisdiction—and thus without prejudice… Were we to range beyond the jurisdictional issue here and reject [Debtor’s] claim on the merits, we would, in effect, be directing a dismissal with prejudice—and thereby altering the district court’s judgment. That, we cannot do.

Reversed and remanded. Perhaps we will see this case again.

Scott Riddle’s practice focuses on bankruptcy and reorganization. Scott has represented businesses and other parties in Chapter 11 cases for almost 30 years. You can contact Scott at 404-815-0164 or scott@scottriddlelaw.com. For more information, click here.

Georgia Bankruptcy Judge Paul Bonapfel Lowers Boom On Chapter 7 Trustee and Counsel Fees

By Scott Riddle Posted in Northern District Cases

In what certainly will be one of most important and talked-about orders to come out of the Northern District of Georgia in some time, Judge Paul Bonapfel eviscerated a fee application filed by a Chapter 7 Trustee and counsel. The case is In re McConnell, Case No. 19-67128-pwb, 2021 WL 203331 (Bankr. N.D.Ga. October 28, 2019). The local panel trustees and their attorneys are very concerned about the impact of the case, and other Bankruptcy judges in the district have already referenced the Order in other hearings. The Orders discussed below strongly indicate that the issues have been brewing among the local judges for some time. The Trustee has appealed the Order to the District Court (Case No. 1:21-cv-00304-AT (N.D. Ga)) and the United States Trustee and perhaps the National Association of Bankruptcy Trustees are expected to appear. It is important to read the full, very detailed opinions – the initial twenty-four page Order and Notice (click here for .pdf) and the seventy-three page Final Order (click for .pdf or the Westlaw link). Otherwise, here is a not-so-brief summary:

The Debtor filed a Chapter 7 case in October 2019 and scheduled ownership of his residence at a value of $117,962.00 and secured debt totaling $105,566.00. Debtor claimed an exemption for the equity in the amount of $12,126.00. His schedules reflected net monthly income of $2,988.00 and expenses in the same amount. The Trustee believed, based on sources regularly used by trustees, the property could be worth $215,000.00, and the Debtor testified at the creditor meeting that he really did not know the true value. Based on these facts, the Trustee filed an application to employ a real estate agent to market and sell the property. In turn, the Debtor filed a motion to convert the case to Chapter 13 to retain his interest and equity in the residence. It is important to note going forward that the parties and Judge apparently assumed that there was significant equity in the property and unsecured creditors, totaling less than $20,000.00, would be paid in full in either a Chapter 7 or confirmed Chapter 13 plan.

The Trustee objected to the Debtor’s motion to convert to Chapter 13 on three primary grounds: 1) a Chapter 13 would not be feasible because Debtor had no net monthly income to fund a plan according to his schedules, 2) conversion would not be in the best interests of creditors, and 3) the motion was filed in bad faith because Debtor undervalued the property in his schedules and could not propose a feasible Chapter 13 plan. The Trustee also argued that creditors would be prejudiced by the delay in getting paid. The Court ultimately granted the Debtor’s motion and converted the case to a Chapter 13, noting that debtors often make adjustments to their budgets to make plan payments and there was no real evidence of bad faith. If Debtor could not propose a confirmable plan that paid all unsecured creditors in full, based on the equity in the property, the case would likely be re-converted back to Chapter 7 and the Trustee could sell the property. (The Debtor’s Chapter 13 was ultimately confirmed in November 2020).

The Trustee filed an Applications for compensation for himself, as Trustee, and his law firm as counsel for the Trustee. The Trustee requested compensation of $1,915.00 based on his hourly fee and 30 cents of expenses. He also requested $13,304.00 in fees and $210.50 in expenses for his law firm as counsel for the Trustee. No objections to the Application were filed. Judge Bonapfel specifically pointed out in the Order and Notice discussed below that “[n]either the United States Trustee (whose duties include supervising Chapter 7 trustees and reviewing applications for compensation, 28 U.S.C. §586(a)(1), (3)), nor the debtor (who must bear the burden of payment of allowed fees given the value of nonexempt in this case) objected.”

Why Are Large Chapter 11 Cases Dismissed, Leaving Small Creditors Out of Luck? Judge Bonapfel Explains.

By Scott Riddle Posted in News and Comments, Northern District Cases

“It has been said that, in many bankruptcy cases, there are no good alternatives, only less bad ones. As financial realities in this case took hold, it became clear that, for most creditors, including the objectors, there were not even “less bad” alternatives. The Court is saddened that it can offer only an explanation for what happened and why.” Judge Paul Bonapfel.

National fast food chain The Krystal Company (and several related entities) filed Chapter 11 Bankruptcy petitions on January 19, 2020 in the Northern District of Georgia. It was ultimately determined that the largest secured creditor, Wells Fargo, had a secured claim of $51 million and it was secured by a lien on virtually all of the Debtor’s assets. The Debtor, Creditors Committee and Wells Fargo agreed that the best way to pay creditors was to sell the Debtor’s assets as a going concern. After significant marketing efforts and failed proposals, the parties proposed a sale of the Debtor’s assets to DB KRST Investors, LLC, a sub-agent for Wells Fargo. The consideration paid for the Debtor’s assets included:

(1) reduction of the amount of the Wells Fargo debt by $ 27 million (leaving an unpaid claim of about $ 24 million); (2) assumption by DB KRST Investors of postpetition debts incurred in the ordinary course of business, including attorneys and other professionals employed by the Debtor and the Committee for their work in the case; (3) assumption of liabilities under certain leases and other agreements; and (4) use of cash to pay expenses necessary to pay postpetition obligations the Debtor had incurred during the case and to “wind down” the chapter 11 case.

Notably, there was essentially no money left for general unsecured creditors after the sale. After resolving some other matters in the case the Debtor filed a Motion to Dismiss the Chapter 11 case because there were no remaining assets and nothing more to do that could lead to payments to creditors. After notice of the Motion to all creditors the Court received several objections to the dismissal. Most were from individuals or small businesses who experienced hardship from the loss of their claim:

One person has lost the ability to feed poor people and help a high school student attend college because gift cards and a scholarship that the Debtor is obligated to provide under the terms of a settlement agreement for wrongful termination of employment will not be honored. Another individual has not been paid for services rendered in good faith in December 2019, right before the bankruptcy filing. A small business has lost about $ 18,700 for services rendered and expenses incurred that will not be paid. A customer injured at a Krystal restaurant has not received compensation for his injuries. Four workers who were laid off due to the Coronavirus pandemic are struggling to make ends meet for their families and have had difficulty receiving unemployment compensation. There are a lot of other people and companies with valid debts that the Debtor has not paid, and it is likely that many of them are suffering similar financial hardship…

Another creditor believed that failing to require the Debtor to pay it’s debts was a form of corporate welfare:

… Krystal [should] be required to pay its debts to us for this project. There has been too much corporate welfare in this country this summer to the gross detriment of small businesses and the American people. Krystal should not be a part of that – their marketing team and other high pay level execs still have jobs, their restaurants are still open. They should not be released from their moral and legal responsibilities when they still have the means to pay the debts to the small businesses who have worked hard and spent their own money for them. The small businesses who make this country what it is and without whom there would be no large corporations.

Judge Bonapfel discussed, in layman’s terms, why the case was dismissed without making the company pay creditors. Continue Reading

Small Business Reorganization After Covid-19 Pandemic: Better and Cheaper Options

By Scott Riddle Posted in Small Business Bankruptcy

In a recent article the New York Times, citing a poll, rather pessimistically stated that more than 40% of the small businesses in the country could close permanently in the next six months because of the coronavirus pandemic. Hopefully this not come to pass as the economy is opened up and we are able to control further outbreaks of Covid-19. For small businesses that are able to struggle through and survive the pandemic, some relief may be available through the Small Business Reorganization Act of 2019 (also known as “Subchapter 5”) that became effective for cases filed in February 2020. The cost of Chapter 11 has always been an impediment for small businesses seeking to reorganize. Many of the same requirements for large commercial cases also applied to small businesses and Bankruptcy lawyers typically have to get an upfront retainer to protect them for the first few months of the case. This alone leads many businesses to continue struggling or close entirely. The new procedures will probably save many small businesses needing to reorganize.

The first question is what “small businesses” qualify for the new procedures. The primary qualification is the level of current debt. Initially, the debt limit for Subchapter 5 was total debt (secured and unsecured) of $2,725,625.00 but it was raised to $7.5 million under the Coronavirus Aid, Relief and Economic Security Act (“CARES” Act). Although the initial limit was a significant amount, consider a small business in metro Atlanta that may have an SBA Loan, a multi-year lease, equipment and inventory loans and other trade debt. It would be relatively easy for even a “small” local business to exceed the initial limit.

There are several potential benefits for small businesses in the new Chapter 11, Subchapter 5, including:

A case trustee is appointed to monitor the case and, hopefully, assist the business and creditors in reaching a workable plan of reorganization and keeping the case on track. Unlike in larger Chapter 11 proceedings the trustee does not take over the operations of the company. In addition, there is no creditors committee. Although a committee may provide beneficial oversight in larger cases it is often an unnecessary burden in smaller cases and it can be very expensive.
A plan of reorganization must be filed within 90 days and the term must be between three and five years. Recent cases indicate that the 90 day deadline can be extended for cause. For example, an extension may be warranted as the pandemic continues and it is difficult for the business to forecast income and expenses in the short term. The business does not have to file a separate disclosure statement. The new rules also make it easier to get the plan confirmed even with objecting creditors.
There are no United States Trustee fees.
The owners of the business can retain their ownership and, therefore, do not need to meet the “absolute priority rule.”
If the business makes all plan payments it receives a discharge of remaining debt.

With the favorable changes discussed above many small business should be able to survive through the pandemic and reorganize their debts.

Bankruptcy and Reorganization for Small Businesses After Covid-19.

By Scott Riddle Posted in Small Business Bankruptcy

If you own a small business you are most likely very concerned about making it through the next few months. Unfortunately, one of the inevitable consequences of the ongoing Covid-19 crisis is the increase in business closings – temporarily or permanently. We have already seen a long list of large, well-known businesses close permanently or file Chapter 11 Bankruptcy petitions. That list will get longer every day. We also expect to get a large number of small and mid-sized businesses who have to file for Chapter 11 in the coming months. Landlords may start to lose patience over past-due rent, courts open back up for evictions, and other creditors generally lose patience as they face their own financial issues.

The New York Times recently published an article about the small business bankruptcies that are expected to be filed. The article gave particular attention to the “Small Business Restructuring Act” that, very fortuitously, became effective in February of this year. The intent of the new law, also known as “Subchapter 5 Bankruptcy,” is to reduce the normally high costs of reorganization proceedings for small businesses. Initially, the debt limit for qualifying for the new Subchapter 5 was $2.72 million but Congress raised the debt limit to $7.5 million as part of the recent stimulus programs. This new debt limit significantly increases the number of small business that will qualify for, and benefit from, Subchapter 5.

If you have a small or mid-size business facing financial difficulties there are a few steps you can take now to prepare for a possible reorganization. The most important first step is to speak with a good business bankruptcy and reorganization lawyer in your area. Most lawyers will be glad to speak with you and meet with you, when appropriate, at no initial cost. It is important to make sure you speak with lawyers who have significant experience in business bankruptcy and reorganization cases rather than lawyers who my gravitate to the practice due to the crisis. The lawyers who advertise “no money down” cases on television may do a fine job with personal bankruptcies, but they typically do not handle business cases.

One of the first questions a lawyer usually asks is for a brief summary of your current debts so it is often helpful to start gathering this information. This includes the general amount and status of secured debt, such as bank or real estate loans, lease obligations, unsecured loans and credit card debt, and trade debt owed to key suppliers. This is also a good time to note any business debts that have been personally guaranteed by the owner.

What you should not do is wait until a real emergency, such as an eviction suit, getting cut off by a key supplier or getting behind on employee wages and taxes. Contacting a lawyer sooner than later is by no means a guarantee that a small business will survive but the chances are much greater by planning as well in advance as possible.

The Krystal Company Files for Chapter 11 Bankruptcy in Northern District of Georgia

By Scott Riddle Posted in Northern District Cases

The Krystal Company files Chapter 11 Bankruptcy Petition in the Northern District of Georgia on January 19, 2020. Case No. 20-61065. The company is represented by King & Spalding. According to pleadings, the company owns 182 Krystal restaurant locations.

Can Debtor’s Counsel Also Represent A Non-Filing Spouse (Or Other Party) In A Rule 2004 Examination? Maybe.

By Scott Riddle Posted in Northern District Cases

This is an issue that comes up fairly often, although normally no objections are made for a Rule 2004 examination. As long as the lawyer is not obstructive, it is usually not worth the additional time and expense of filing an objection. In In re Craig, Ch. 7 Case No. 16-59582, 2017 WL 713572 (Bankr. N.D. Ga. February 21, 2017) (click here for .pdf), Judge Diehl addressed the issue of whether a debtor’s attorney can represent an non-filing spouse in a Rule 2004 exam. The United States Trustee was the party moving for the examination in this case as part of their investigation into possible bad faith or whether an objection to discharge is appropriate. The U.S. Trustee moved for disqualification of the debtor’s counsel after he informed them that he would be representing the debtor’s spouse at the examination, but before the examination took place.

The U.S. Trustee contends that Debtor and his non-filing spouse have divergent and conflicting interests relating to their marital property, and by representing both, [counsel] would be violating conflict of interest ethics rules, warranting disqualification. At the hearing, the U.S. Trustee provided numerous examples of potential conflicts that may arise but failed to allege any actual, current conflicts.

N.D. Ga. – Judge Sacca Holds Interest Rate Paid Pursuant To 11 U.S.C. §726(a)(5) Is Federal Judgment Rate.

By Scott Riddle Posted in Northern District Cases

It is the rare Chapter 7 case that ends up with sufficient estate assets to pay all claims in full, plus interest as required by 11 U.S.C. §726(a)(5). The question addressed by Judge Sacca in In re Robinson, Ch. 7 Case No. 15-51556, 2017 WL 713571 (Bankr. N.D. Ga. February 22, 2017) (click here for .pdf) concerned the interest rate to be paid pursuant to this statute.

The issue before the Court is what does “interest at the legal rate” mean under Section 726(a)(5) of the Bankruptcy Code for purposes of a distribution on unsecured claims in a Chapter 7 case if the estate has sufficient assets to pay post-petition interest on those claims. Does the phrase mean interest at the federal judgment rate or does it mean the applicable nonbankruptcy rate on the unsecured claim that existed prepetition?