Collier Bankruptcy Case Update

The following case summaries appear in the Collier Bankruptcy Case Update, which is published by Matthew Bender & Company Inc., one of the LEXIS Publishing Companies.

April 15, 2002

CASES IN THIS ISSUE
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Collier Bankruptcy Case Summaries

Bankruptcy court's determination that obligation was not excepted from debtor's discharge was affirmed on appeal. B.A.P. 1st Cir. The creditor appealed the bankruptcy court's ruling that the chapter 7 debtor's obligation to the creditor was not excepted from discharge pursuant to section 523(a)(2)(A). The debtor subleased retail space from the creditor, a long-time friend and business associate, for his business. After falling behind several times with his rent, the debtor promised the creditor that he would pay the back rent. The debtor instead vacated the premises without paying the outstanding rent. The bankruptcy court ruled that the creditor established that the debtor knowingly made false representations regarding the payment of rent, with the intent to deceive the creditor, and the creditor suffered a loss as a result. The bankruptcy court, nevertheless, found that the creditor had not established actual or justifiable reliance on the debtor's promises because the creditor took no action against the debtor until almost two years after the debtor stopped paying rent. The creditor contended that the bankruptcy court did not take into consideration that the parties' friendship affected his perception regarding the debtor's promises to pay. The B.A.P. affirmed, holding that the creditor failed to establish that the bankruptcy court's findings of fact were clearly erroneous or the justifiable standard set forth in the lower court's decision was erroneous. The B.A.P. noted that the bankruptcy court's determination of justifiable reliance was one of mixed law and fact. The bankruptcy court properly considered the parties' relationship and concluded that the creditor did not really believe the debtor's continued promises to pay. The finding that the creditor did not actually rely on the debtor's promises precluded the need for any legal determination that any such reliance was justifiable. Lentz v. Spadoni (In re Spadoni), 2002 Bankr. LEXIS 26, 271 B.R. 703 (B.A.P. 1st Cir. January 9, 2002) (Deasy, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:523.08[1]

Debtor's motion for reconsideration of order entered two years earlier was denied. Bankr. E.D.N.Y. The chapter 13 debtor filed a motion pursuant to Rule 9024, requesting the bankruptcy court to vacate or modify the stipulation and order withdrawing with prejudice the debtor's objections to the proof of claim of the IRS. The IRS had filed a proof of claim asserting a secured claim, an unsecured priority claim and a general unsecured claim for federal income taxes owed by the debtor for various prepetition years. After the debtor objected to the claim, the IRS filed an amended proof of claim reducing and reclassifying some of the claims and responded that several of the debtor's objections should be denied. The court then approved a stipulation signed by the debtor's attorney and the IRS, whereby the debtor agreed that his objection to the claim was withdrawn with prejudice. Nearly two years after the order was entered, the debtor filed a pro se motion for reconsideration, claiming that his attorney mistakenly stipulated to withdraw his objection to the claim with prejudice. The IRS asserted that the debtor's motion was untimely because the order was not entered "without a contest" within the meaning of Rule 9024. The bankruptcy court denied the debtor's motion, holding that the debtor failed to meet the limitations period and the substantive requirements for obtaining relief from the order under Fed. R. Civ. P. 60(b)(1) or (3). The court noted that unless the order had been entered "without a contest" within the meaning of Rule 9024, the one-year limitations period applied, because the debtor was seeking relief under Fed. R. Civ. P. 60(b)(1) and (3). The objection to the claim was not unilaterally withdrawn, but was settled pursuant to a stipulation that expressly provided that the objection was withdrawn "with prejudice." The debtor's dissatisfaction in hindsight with his counsel's choice to withdraw the objection with prejudice was not grounds for finding the mistake, inadvertence, surprise or excusable neglect necessary to justify relief (citing Collier on Bankruptcy, 15th Ed. Revised). In re Clark, 2001 Bankr. LEXIS 1794, - B.R. - (Bankr. E.D.N.Y. December 7, 2001) (Craig, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 10:9024

Subordination of the breach of contract claims asserted by the debtor's shareholders was affirmed on appeal. 3d Cir. The chapter 11 debtor's shareholders appealed from an order of the district court that affirmed the bankruptcy court's order subordinating their claims against the estate pursuant to section 510(b). The shareholders sold assets of certain businesses to the debtor prepetition, in exchange for shares of the debtor's common stock. The stock purchase agreements required the debtor to use its best efforts to register its stock and ensure that the shares were freely tradeable by a date certain. The shareholders filed proofs of claim alleging that the debtor breached its agreement to use its best efforts to register the stock, and sought damages on the theory that, had the debtor performed its obligation under the contract, they would have sold their shares as soon as the stock became freely tradeable, thereby avoiding the losses incurred when the stock subsequently declined in value. Upon the debtor's objection, the bankruptcy court subordinated the claims, holding that because the shareholders' claims would not have existed but for their purchase of stock, the claims arose from that purchase for purposes of section 510(b). The district court affirmed. The Court of Appeals for the Third Circuit affirmed, holding that the shareholders' claims for breach of the provision in the stock purchase agreement requiring the debtor to use its best efforts to register its stock and ensure that the stock was freely tradeable "arose from" the purchase of the stock for purposes of section 510(b) and was properly subordinated. The court rejected the shareholders' contention that section 510(b) should have been construed narrowly, so that only claims for illegal conduct that occurred at the time of the purchase of the stock were deemed to arise from that purchase. The court considered the legislative history of the statute and the policies underlying the provision before concluding that section 510(b) required some nexus or causal relationship between the claims and the purchase of the securities, but was not limited to claims alleging illegality in the purchase itself. Baroda Hill Invs., Ltd. v. Telegroup, Inc. (In re Telegroup, Inc.), 2002 U.S. App. LEXIS 2415, 281 F.3d 133 (3d Cir. February 15, 2002) (Becker, C.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:510.04

Funds not considered "unclaimed" until debtor makes adequate attempt to notify creditors of availability of funds. Bankr. E.D. Va. The debtor filed for chapter 11 relief on February 26, 1992. Its plan of reorganization, which was confirmed on December 7, 1993, provided for periodic payments to the plan trustee, who was then responsible for distributing the payments to creditors. The bankruptcy court approved a compromise allowing the debtor to make a single payment of $1,075,000.00 to the plan trustee, rather than making the periodic payments called for under the plan. The payment was made on February 22, 1995. A final decree was entered in the case on March 8, 1996, reserving continuing jurisdiction in the bankruptcy court in order to allow the trustee to object to claims, file adversary proceedings and make a final disbursement. On March 23, 1995, the plan trustee objected to 19 proofs of claim. When the plan trustee made distributions, he withheld $364,675.47, which represented the disputed claims. Later, the plan trustee also came to be in possession of $23,122.05 in checks returned by the post office as undeliverable and $8,541.66 in outstanding checks that were not returned or cashed. The plan trustee took no significant action to resolve the disputed claims or to locate the missing creditors whose checks had been returned in the mail. Except for a change of address notification filed by the plan trustee in 1998, no papers were filed in the bankruptcy case from May 1, 1995 through June 21, 2000, when the debtor moved to reopen the case to seek an accounting and to claim the undistributed funds held by the plan trustee. In considering the debtor's motion, the court focused on whether the funds paid into the registry qualified as "unclaimed" funds under 11 U.S.C. § 347. After analysis, the court found that the funds represented by the checks returned in the mail did not qualify as "unclaimed" because it could not be presumed that the creditors who were to receive the checks were even aware of the availability of the distributed funds. The court found that the returned checks could only be considered "unclaimed" if there was no response after (1) a reasonable search to locate the creditors who were owed the funds; (2) reasonable notice (such as newspaper publication) was given to such creditors; and (3) the passage of a reasonable period of time, within which it would be expected that interested creditors would seek out the disbursement agent. The court also found that the funds set aside for disputed claims were not "unclaimed" funds. These disputed claims became allowed as a matter of law and should have been paid out when the final decree was entered because the plan did not confer jurisdiction on the court to hear the pending objections after the case was closed. As to the checks that were mailed but not cashed or returned, the court found that these checks were "stale" and constituted "unclaimed" funds that were returnable to the debtor. In re IBIS Corp., 2001 Bankr. LEXIS 1775, 272 B.R. 883 (Bankr. E.D. Va. October 5, 2001) (Mayer, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 3:347.03

No fraudulent transfer established where successor trustee failed to present sufficient evidence that stock given was not fair consideration for loan proceeds. N.D. Tex. In 1983, the debtor company sought to borrow $10 million from Bank A for use as working capital. As collateral for the loan, the debtor agreed to give Bank A 900 shares of common stock in one of the companies controlled by the debtor's principal. Another bank, Bank B, had been holding 468 shares in this same company to secure defaulted loan obligations of the debtor's principal and certain of his companies. In order to provide the collateral required for the loan with Bank A, the debtor arranged for Bank B to transfer the 468 shares it held to Bank A in exchange for the debtor paying $4 million to Bank B to cover the defaulted loan obligations. The loan transaction with Bank A was completed, and the debtor paid Bank B $4 million to cover the defaulted loans, including $1.1 million to cover the defaults of entities unrelated to the debtor. The debtor failed to repay the $10 million loan from Bank A and filed for bankruptcy in 1986. The successor trustee filed an adversary proceeding seeking to avoid the $1.1 million transfer on the basis that the payment constituted constructive fraud under Texas' fraudulent transfer law. The bankruptcy court determined that the trustee failed to establish the elements of constructive fraud, based on the court's finding that the trustee had failed to prove that the transfer was made without fair consideration. Specifically, the trustee failed to establish that on the date of the transfer, the transferred stock was valued at less than the $1.1 million given to repay the overdue interest owed by the unrelated companies. On appeal, the district court found that the bankruptcy court did not err in determining that the successor trustee failed to prove adequate consideration was not received for the loan proceeds. The district court then denied the successor trustee's motions to amend his complaint to conform to the evidence and affirmed the bankruptcy court's final judgment.Nordberg v. Cont'l Bank, N.A. (In re Topcor, Inc.), 2002 U.S. Dist. LEXIS 2220, - B.R. - (N.D. Tex. February 13, 2002) (Lynn, D.J.).

Collier on Bankruptcy, 15th Ed. Revised 5:544.09

State court judgment obtained after commencement of debtor's bankruptcy case merely voidable. Bankr. S.D. Ohio The debtor filed for chapter 7 relief on June 23, 1998. Three weeks later, the state (Ohio) court entered a judgment in favor of the creditor and against the debtor based on a magistrate's decision in an embezzlement case brought by the creditor. Because the judgment involved more than a ministerial act, it was entered in violation of the automatic stay. However, despite the apparent invalidity of the state court judgment, the debtor did not take any steps to avoid the judgment and the creditor did not seek to have the stay annulled in order to give retroactive effect to the judgment. The creditor later filed an adversary proceeding against the debtor, seeking to have the judgment deemed nondischargeable under section 523(a)(4). After reviewing the entire record for the case, the bankruptcy court concluded that the creditor had established the elements of embezzlement as to one of the checks misappropriated by the debtor. In considering whether the state court judgment could be used to establish the amount of this debt, the bankruptcy court found that it was required to give the state court judgment the same preclusive effect that the judgment would have under Ohio law. The court then found that the judgment was not void, but merely voidable, because the state court had jurisdiction to enter its order. Since the voidable judgment was entitled to res judicata effect, the bankruptcy court also found that the state court judgment could be used to establish the amount of the debt owed to the creditor. Helfrich v. Thompson (In re Thompson), 2001 Bankr. LEXIS 1766, 273 B.R. 143 (Bankr. S.D. Ohio September 28, 2001) (Sellers, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 3:362.03[3]

District court rejected creditor's request for mandatory abstention of an action initiated in state court. N.D. Ill. The plaintiff creditor filed a motion to remand its action to the state (Illinois) court or, in the alternative, for mandatory abstention. The creditor had filed a class action complaint for tort and for equitable relief against the secured lender in state court. The creditor, an owner of a small retail beverage business, had entered into a merchant processing agreement with the chapter 11 debtor prepetition, allowing the installation of an automatic teller machine on his business premises. Pursuant to the agreement, the creditor's class of merchants was entitled to receive 85 percent of all surcharged transactions as revenue on the terminal. The creditor contended that the debtor had no rights in 85 percent of the fees and had improperly remitted the funds to its secured lender prior to the commencement of its case. The lender filed a separate adversary proceeding to determine the extent of its liens and removed the creditor's action to the district court. The district court denied the creditor's motion, holding that mandatory abstention was not warranted because the creditor failed to present any evidence that the matter could be timely adjudicated in the state court. Factors the court considered in determining the timely adjudication element of mandatory abstention included the backlog of the state court's calendar, the status of the bankruptcy proceedings, the complexity of the issues and whether the state court proceeding would have prolonged the administration or liquidation of the estate. Whether the fees were property of the estate or subject to a constructive trust were traditional subjects within the expertise of the bankruptcy court, which had already provided for a fast-track resolution of the dispute. Janazzo v. FleetBoston Fin. Corp., 2002 U.S. Dist. LEXIS 451, - B.R. - (N.D. Ill. January 9, 2002) (Andersen, D.J.).

Collier on Bankruptcy, 15th Ed. Revised 1:3.05[2]

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Debtor's failure to obtain stay pending appeal prevented appellate court from ruling on the merits of the appeal. B.A.P. 8th Cir. The chapter 13 debtor appealed the bankruptcy court's order lifting the automatic stay to allow the creditors' foreclosure sale to proceed, as well as the order denying the debtor's motion for reconsideration. As grounds for the creditors' motion for relief from the stay, they alleged that the debtor had not filed a chapter 13 plan, had not filed his schedules and had no means of income with which to fund a plan. The debtor failed to obtain a stay pending appeal and the property was sold. The B.A.P. for the Eighth Circuit affirmed, holding that because no effective relief could be granted the debtor, the issues raised on appeal pertaining to relief from the automatic stay were moot. The sale was not subject to modification by the appellate court absent a stay pending appeal. The court further noted that it was not empowered to give an opinion on moot questions or declare rules of law that could not affect the matter at issue in the case before it. Dudley v. Powers (In re Dudley), 2002 Bankr. LEXIS 106, 273 B.R. 197 (B.A.P. 8th Cir. February 15, 2002) (Schermer).

Collier on Bankruptcy, 15th Ed. Revised 3:362.07; 10:8005

Former attorney found in civil contempt for improper preparation of bankruptcy schedules. Bankr. D. Colo. The debtors filed a chapter 7 petition. Their petition and schedules did not list any attorney or law firm representation, and did not list any nonattorney petition preparer. Similarly, the debtors' statement of financial affairs did not list any payments for debt counseling or bankruptcy. However, at a reaffirmation, the debtors testified that they thought that a man named Mr. Lamberson was their attorney and that he had filed the bankruptcy on their behalf. The debtors further testified that it was not until the meeting of creditors that they discovered they were not represented by counsel. As a result of the debtors' testimony at the reaffirmation hearing, the bankruptcy court entered an order directing Mr. Lamberson to show cause why (1) his conduct was not in violation of 11 U.S.C. § 110; (2) his actions did not constitute civil contempt; and (3) his conduct should not be sanctioned. Although Mr. Lamberson did not appear at the show cause hearing, the debtors appeared and testified. Their testimony indicated that they had retained Mr. Lamberson, who at that time was still admitted to practice law, and paid him $2,500 to file their chapter 7 bankruptcy petition. After Mr. Lamberson was disbarred, the debtors paid him an additional $900 for the bankruptcy filing. Also, the debtors had saved $4,500 for taxes and, upon Mr. Lamberson's advice, gave him the money to shelter from the trustee. Following this testimony, the bankruptcy court issued another show cause order. The United States Marshall service was eventually able to locate and serve Mr. Lamberson with the second show cause order. When Mr. Lamberson was brought before the court, he testified that he had received the court's two show cause orders. After a hearing on the matter, the bankruptcy court concluded that Mr. Lamberson had violated section 110(b) by rendering legal advise after he was disbarred and, at a minimum, was a bankruptcy petition preparer and, at worst, was practicing law without a license. The court then ordered a disgorgement of the total fee paid to Mr. Lamberson by the debtors for the purpose of filing their chapter 7 petition. The court also ordered that Mr. Lamberson pay fines in the amount of $1,000 for civil contempt and pay over to the court's registry the amounts being held for the debtors' taxes. The court further certified the matter to the district court for consideration of the violation of the court's local rules and for consideration of criminal contempt. The decision and judgment were also to be sent to the state's Unauthorized Practice of Law Committee and the Committee on Conduct for the United States District Court for review and appropriate action. In re Seehusen, 2001 Bankr. LEXIS 1774, 273 B.R. 636 (Bankr. D. Colo. December 20, 2001) (Brooks, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 2:110.03

Equitable title to property remained fully with the debtor after purchaser defaulted and trustees under deed of trust elected to pursue resale of property. Bankr. D.C. Before filing her chapter 13 petition, the debtor held equitable title to real property located in the District of Columbia subject to a deed of trust that secured repayment of a promissory note held by a creditor. The deed of trust gave the trustees a power of sale in the event of a default in its terms. Due to a default in the terms of the deed of trust, the creditor caused the trustees to sell the property at a prepetition foreclosure sale. However, the successful bidder at the sale failed to settle on its purchase in accordance with the terms of sale. As a result, the substitute trustees elected to notice a resale of the property, and the property was sold. The debtor's chapter 13 case was commenced one minute before the resale began. Thereafter, the creditor filed a motion in the bankruptcy court seeking a determination that the automatic stay did not apply to the postpetition resale of the property. Alternatively, the creditor sought an annulment of the stay if the stay was held to bar the resale. The bankruptcy court denied the creditor's motion. The court held that upon the first purchaser's default and the election of the trustees under the deed of trust to pursue a resale of the property, the equitable title to the property remained fully in the debtor; thus, the automatic stay applied to the postpetition resale. The court also found that no grounds existed to warrant an annulment of the automatic stay. In re Cooper, 2002 Bankr. LEXIS 123, 273 B.R. 297 (Bankr. D.C. February 5, 2002) (Teel, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 3:362.03[6]