Strong-Arm on Steroids – Applying or Injecting ‘Rights and Powers' Under 11 U.S.C. § 544(a)
09/01/2005

Article originally appeared in Norton Bankruptcy Law Adviser on 09/01/05

If you have been a consumer debtor’s lawyer for any length of time you undoubtedly have had a client who needed a bankruptcy filing today, or first thing tomorrow morning, because a foreclosure sale was imminent. If you filed the case, you probably made some effort to notify the lender that a bankruptcy petition had been filed, perhaps by calling the phone number on your debtor’s payment coupons. But it is less likely that you immediately notified the trustee or sheriff who would actually conduct the sale, or that you could even find out who they were. You probably were not too worried that they would actually conduct the sale in ignorance of the bankruptcy filing, because you were confident that any such sale was void, or voidable, as a violation of the automatic stay. If you are similarly lackadaisical after October 17, 2005, you may be in for a big, ugly surprise, and possibly a malpractice suit from an angry, dispossessed former client who relied on you to save a home. Racing to the bankruptcy courthouse to beat a foreclosure sale may no longer be sufficient because you now must also race to the county recorder’s office to record the petition prior to the sale. Perhaps debtors’ counsels need a new practice protocol—to record the petition in the relevant real estate records immediately, whenever you file a bankruptcy case to stay a foreclosure. Why the sudden change? Does the Bankruptcy Abuse and Consumer Protection Act (“BAPCPA”) somehow permit foreclosure sales to be held, and be unavoidable, even after the filing of a bankruptcy case? BAPCPA was supposed to be all about credit card debt and a little about car lenders—who knew that real estate lenders, or perhaps vulture capitalists who purchase at foreclosure sales, were even at the secret kitchen table when BAPCPA was drafted? We may never know the answer to that second question, but the answer to the first is found in new Code § 362(b)(24), added by BAPCPA § 311. It provides a new exception to the automatic stay for any “transfer that is not avoidable under section 544 and that is not avoidable under section 549.” Section 544, of course, contains the strong arm clause empowering a trustee to assert creditors’ avoidance actions. Since those generally (perhaps only) apply to prepetition transfers, it is hard to understand how any such transfers ever would have been subject to the automatic stay anyway. What were the drafters thinking when they created a new exception from the automatic stay for prepetition transfers? The trap for the unwary comes in the reference to § 549, which of course permits trustees to avoid unauthorized post petition transfers. However, § 549(c) contains an exception: the trustee may not avoid a transfer of an interest in real property to a good faith purchaser who lacks knowledge of the bankruptcy case and who pays fair equivalent value, unless a copy or notice of the petition was recorded in the county recorder’s office prior to the transfer.

The new stay exception in § 362(b)(24) may mean that if a foreclosure sale is held post petition and the high bidder does not know of the filing of the bankruptcy case, the transfer to that high bidder is unavoidable under § 549, and the sale itself falls within the new exception to the automatic stay. The sale may be immunized even if the lender had some notice of the bankruptcy filing, because it is only the buyer who must lack knowledge to make the transfer unavoidable under § 549 and therefore an exception to the automatic stay under new § 362(b)(24). Third party purchasers are very likely to qualify for the “good faith purchaser” exception because they have no reason to check for bankruptcy filings, foreclosure sale auctioneers have no reason to tell them, and debtor’s lawyers have no ability to provide them notice in advance of the sale. Of course if the lender is the high credit bidder, then the lender’s knowledge of the filing might disqualify it from the § 549(c) exception. Even that conclusion is not solid because the phone call to the lender probably did not satisfy the lender’s designation of a person or subdivision for notice under the new notice requirements of amended § 342, and therefore § 342(g) may make that phone call notice not “effective.” Could BAPCPA have intended to permit lenders to commit knowing violations of the automatic stay, and yet render the sale to a third party bona fide purchaser unavoidable and immunize the lender against a damages claim under § 362(h) for knowingly proceeding with a trustee’s or sheriff ’s sale after a filing, because the purchase by a bona fide purchaser means there was no stay violation? Before attempting to answer that question, it is important to pause to emphasize a critical practice pointer. After BAPCPA, all debtor’s lawyers should make it a routine part of their filing procedures to immediately record the bankruptcy petition at the county recorder’s office. Failing to do so may permit a lender to complete a foreclosure without violating the automatic stay even after it has fully effective notice and knowledge of the filing, simply by the happenstance that unknowing, bona fide purchasers are available to bid. At a minimum, failure to record the petition invites expensive litigation and appeals if a foreclosure sale occurs post petition, either knowingly or innocently, and the purchaser lacked knowledge of the case. Not recording immediately is simply the road to malpractice. According to the Report of the House Committee on the Judiciary, the intent of BAPCPA § 311 in adding § 362(b)(24) was far more limited and benign than its potential application might suggest. H. Rep. on S.256, n.86 and accompanying text (109th Cong. April 2005). The House Report says its intent was merely to reverse the result in Thompson v.

Margen (In re McConville), 110 F.3d 47 (9th Cir. 1997).

In McConville, the debtor borrowed money post petition to conclude a prepetition contract to purchase property, and gave the lenders a deed of trust to secure the borrowing. This was done without bankruptcy court approval and without the lender’s knowledge that the debtor was even in bankruptcy. The trustee subsequently sought to avoid the deed of trust pursuant to § 549(a), and the lenders asserted the good faith purchaser defense under § 549(c). Earlier Ninth Circuit precedent had held that the creation of a lien is not a transfer of property for purposes of § 549. Phoenix Bond & Indemnity Co. v. Shamblin (In re Shamblin), 890 F.2d 123, 127 (9th Cir. 1989). In McConville, the Ninth Circuit first held that the § 549(c) defense was unavailable because the creation of a lien is not the kind of transfer to which § 549 applies. It then held that the creation of the lien was void in violation of the automatic stay. In re McConville, 97 F.3d 316 (9th Cir. 1996), opinion withdrawn and superseded, 110 F.3d 47 (9th Cir. 1997). Perhaps feeling that result to be unjust, the panel withdrew that opinion and replaced it with an opinion holding that because the unauthorized borrowing violated § 364(c)(2), the transaction should be rescinded and the lenders entitled to a lien against the property for the amount lent, but without interest because they “should get no benefit from their loan.” 110 F.3d at 50. New § 362(b)(24) probably does a fair job of reversing McConville, and the definition of “transfer” in § 101(54) has been amended by BAPCPA specifically to include “the creation of a lien.” If that is all these amendments accomplished, most bankruptcy folks would probably find the result to be unobjectionable. Indeed, most would probably agree that BAPCPA simply restored the original intent of § 549(a) and (c), to apply them to the unauthorized post petition creation of liens as well as to dispositions of fee title. Lenders and foreclosure sale purchasers will argue that the plain language goes much further. They will claim that the new stay exception in § 362(b)(24) also immunizes post petition foreclosure sales and reverses cases such as 40235 Washington Street Corp. v. Lusardi, 329 F.3d 1076 (9th Cir.), cert. denied, 540 U.S. 983, 124 S. Ct. 469, 157 L. Ed. 2d 374 (2003), and Value T Sales, Inc. v. Mitchell (In re Mitchell), 279 B.R. 839 (B.A.P. 9th Cir. 2002). The facts of these cases are similar and, indeed, the Ninth Circuit’s Lusardi opinion adopted the BAP’s analysis in Mitchell. In both cases there was a foreclosure sale shortly after the bankruptcy filing, apparently without knowledge of the filing, and in both cases a third party purchaser was the high bidder. When the debtors sought to void the sales as violations of the automatic stay, the purchasers defended that § 549(c) creates an exception to the automatic stay for innocent bona fide purchasers. Both courts held that § 549(c) is only a defense to an avoidance action brought by a trustee under § 549(a), and is not an exception to the automatic stay. Because the sale violated the stay and because under Ninth Circuit law a violation of the stay renders the action void, not voidable, the sale itself was automatically void. No avoidance action was needed, and certainly none under § 549, and therefore § 549(c) was not an available defense. Both courts went further to state that § 549 was intended to apply only to transfers initiated by the debtor, not to foreclosure sales: “The purpose of section 549, in contrast [to § 362], is to provide a just resolution when the debtor himself initiates an unauthorized postpetition transfer.” Lusardi, 329 F.3d at 1082. Section “549 protects the estate from unauthorized transfers by the debtor.” Mitchell, 279 B.R. at 843. New § 362(b)(24) certainly reverses some of the analysis of Lusardi and Mitchell. It now does make § 549(c) an exception to the automatic stay, but does it reverse either the essential analysis or the result of Lusardi and Mitchell? Perhaps not, in two important respects. First, § 549(c) merely provides that the trustee may not avoid the transfer to the bona fide purchaser. New § 362(b)(24) insulates that transfer from the automatic stay. Lusardi held that prior to the transfer to the bona fide purchaser there was another action—the foreclosure sale itself—and that action violated the stay: The post petition “tax sale, conducted to enforce the tax lien on the property, was void.... [T]herefore, Lusardi’s purchase of the property at the tax sale was without effect.” Lusardi, 329 F.3d at 1080. Wholly apart from the subsequent transfer to the high bidder (which in Arizona often occurs the next day when the bidder brings the purchase money to the trustee), the conduct of the sale by the lender was an act to enforce a lien against property of the estate, and an act to collect a debt, within the scope of § 362(a)(4), (5) and (6). It was that stay violation that rendered the sale void, and consequently voided the subsequent transfer to the high bidder. Neither opinion suggested there was a stay violation on account of the transfers to the purchasers, although the debtors might have so argued because the purchasers’ subsequent acts to obtain or exercise control over property of the estate could also be stay violations under § 362(b)(3). Nothing in either § 549(c) or new § 362(b)(24) makes the holding of the post petition foreclosure sale an exception to the automatic stay. If the intent of BAPCPA was to validate post petition foreclosure sales held in innocence of the bankruptcy filing, it would have referenced the foreclosure sale, and not just the subsequent transfer to the purchaser at the sale.

Second, Lusardi and Mitchell held that § 549 applies only to debtor-initiated sales, not to foreclosure sales. Nothing in BAPCPA or new § 362(b)(24) reverses that holding. To the contrary, the amendment is consistent with the interpretation that § 549 applies only to debtor-initiated transfers. Finally, it could also be argued that the legislative intent of § 362(b)(24) could not have been to reverse Lusardi because an identical amendment was proposed in § 311 of the 2000-2001 version of BAPCPA, H.R. 333 of the 107th Congress, long before Mitchell and Lusardi were decided. However, this argument from legislative history may not fare well in the face of plain meaning. So what is the appropriate scope and application of new § 362(b)(24)? It should apply in at least two circumstances, and perhaps in no others. First, it should apply to post petition, debtor initiated sales and creations of liens, to protect bona fide purchasers and lenders from stay violations. This protection is necessary, in addition to § 549(c), because § 549(c) only states that the trustee cannot avoid the transfer and recover the property. Because Lusardi holds that § 549(c) is not an exception to the automatic stay, but only a defense to a trustee’s avoidance action, it could still be argued that the debtor’s voluntary, unauthorized transfer violated the automatic stay. The purchase at a voluntary sale initiated by a debtor is an act to obtain possession and control of property of the estate for purposes of § 362(a)(3). Because § 549(c) provides no defense to that argument, it was necessary to add an exception from the automatic stay to fully protect the bona fide purchaser at an unauthorized postpetition sale initiated by a debtor. Thus new § 362(b)(24) performs an important function that remains consistent with the holding that § 549 only applies to debtor-initiated sales, not to foreclosure sales. Second, it may apply when there is a prepetition foreclosure sale but the transfer to the high bidder occurred after the petition. This issue has arisen in reported cases, some holding that the recording of the trustee’s deed is a ministerial act that merely gives notice to the world of what occurred prepetition and therefore does not violate the automatic stay. E.g., L. R. Partners LLC v. Steiner (In re Steiner), 251 B.R. 137 (Bankr. D. Ariz. 2000). The result may be different if the purchaser’s payment of the bid price and the delivery of the trustee’s deed also occurred post petition, because these essential acts are not ministerial. In that circumstance, the stay would prevent the completion of the sale, even though it was commenced prepetition, and the debtor may be able to cure the default under § 1322(c)(1). E.g., Capital Realty Servs. LLC v. Benson (In re Benson), 293 B.R. 234 (Bankr. D. Ariz. 2003). Perhaps § 362(b)(24) reverses cases such as Benson and validates a prepetition foreclosure sale that did not get concluded until after the filing. This analysis is consistent with its language that focuses only on the transfer to the purchaser, without mentioning the foreclosure sale itself. It is also consistent with the otherwise odd reference to § 544. The reference to § 544, which as noted above generally applies only to prepetition transactions, is probably there because the facts of McConville involved a prepetition purchase of property, financed in part by a postpetition borrowing secured by the deed of trust. Reading narrowly, new § 362(b)(24) might be limited to transactions that somehow straddle the petition date, part of which might be avoidable under § 544 and part of which might be avoidable under § 549. There was nothing essential to the result in McConville that the purchase began prepetition; the issue, analysis, and result would have been the same if the debtor had begun the purchase postpetition, but the dual reference to §§ 544 and 549 may indicate an intent to limit the application of § 362(b)(24) to transactions that occur on both sides of the petition. A prepetition foreclosure sale that is not concluded by transfer of the deed until postpetition would be one of the most common examples of a transaction to which new § 362(b)(24) might now apply. Thus postpetition foreclosure sales in violation of the automatic stay may remain avoidable, even as to bona fide third party purchasers. To avoid having to argue that, and to avoid having to convince a judge of the fine distinction between a foreclosure sale and the subsequent transfer to the successful bidder, the better lesson is to always, and immediately, record the petition at the county recorder’s office.

Research References: Norton Bankr. L. & Prac. 2d §§ 59:5, 100:1, 118:1, 118:2, 8 Norton Bankr. L. & Prac. 2d 11 U.S.C. §§ 362, 549; Bankr. Serv., L Ed §§ 35:102, 35:105, 35:106 West’s Key Number Digest, Bankruptcy ” 2558, 2701

A KNOCKOUT SUCCESS: TYSON’S BANKRUPTCY COUNSEL RESPONDS TO LOW BLOW

Robert J. Feinstein

Pachulski, Stang, Ziehl, Young, Jones &

Weintraub P.C.

New York, NY

Mr. Feinstein and Debra Grassgreen of Pachulski, Stang were the lead attorneys in the Tyson case. In August of 2003, boxer Mike Tyson filed for Chapter 11 relief in the Southern District of New York. My law firm, Pachulski, Stang, Ziehl, Young, Jones & Weintraub, P.C., served as debtor’s counsel. The case culminated in the Fall of 2004 with the confirmation of a consensual plan of reorganization supported by the debtor, the official creditors’ committee, Mr. Tyson’s ex-wife, the Internal Revenue Service, and Don King— an unlikely group of allies. After confirmation, we and other retained professionals filed applications for final allowance of compensation and reimbursement of expenses. At that point, Mr. Tyson hired an attorney who filed an omnibus objection to virtually all of the fee applications. Before a ruling was issued on our application, an article appeared in the February 2005 edition of the Norton Bankruptcy Law Adviser entitled Let’s Get Ready to Rumbllllllllllle! The Gloves Come Off in the Tyson Fee Fest, by Michael Schreiber, that all but convicted us of engaging in billing excesses. Indeed, the term “Fee Fest” in the title reflected a false factual premise—that our firm and others charged excessive fees for our services in the case. We have refrained until now from responding to the article because our final application was sub judice. On June 3, 2005, the Honorable Allan M. Gropper, the bankruptcy judge presiding over the case, issued an opinion on our final application calling the case a “knockout success” and awarding 100% of the fees and 100% of the expenses we requested. The court approved a settlement of the fee objections that included payment of a $50,000 fee enhancement to our firm. The confirmed plan, in Judge Gropper’s view, resulted in a meaningful return to unsecured creditors and a fresh start for Mr. Tyson after years of financial chaos. Rejecting the contention that our fees were excessive, the court had this to say about the value of our services: The real concern regarding Pachulski’s fees... is that top dollar was paid for first class counsel to handle a case that involved an individual with limited assets and estates that were unable to support a large distribution to unsecured creditors. In certain circumstances it might be appropriate to reduce... fees accordingly. The principal factor justifying... the awards here is that there might have been no distribution at all if less skilled counsel had been involved.... The Court will not rule on the basis that Tyson should have hired less expensive but less skilled professionals to assist in a critical endeavor that will hopefully help him straighten out his life. (Op. at 11.) Let’s Get Ready to Rumble was a slipshod effort to make a scholarly point relying on factual premises that do not withstand scrutiny, particularly in light of Judge Gropper’s ruling. Mr. Schreiber relied uncritically on unsubstantiated allegations in a pleading that was later partially disavowed in open court for factual accuracy and that otherwise misstated and distorted the facts. What Mr. Schreiber apparently did not know is that the objection was interposed in an effort to resolve a dispute over the magnitude of the fee enhancement Mr. Tyson agreed to pay the firm from his future boxing income, and that the reasonableness of our time charges was never seriously in dispute. Casting us as both avaricious and arrogant, the article mischaracterized the purpose to be served by the fee enhancement, which was to compensate for the assumption of enormous financial risk. At the time of the bankruptcy filing, Mr. Tyson had no liquid assets and faced myriad legal and financial problems. Because his bankruptcy estate consisted almost entirely of encumbered real estate and disputed litigation claims, the prospects for recovering professional fees as debtor’s counsel was dependent upon: (i) a successful resolution of Mr. Tyson’s pending litigation against Don King, a formidable and well funded adversary; and (ii) Mr. Tyson’s willingness and ability to resume his professional boxing career. It is an understatement that not every law firm would have taken on such a client in what would surely be a complicated, high-profile Chapter 11 case. The payment risk presented by such a client and case was so great that the firm requested, and Mr. Tyson agreed in writing, to the payment of a fee enhancement solely out of non-estate assets, i.e., future boxing income. In addition to taking on this risk, we also agreed to defer payment of a retainer of $250,000 (which was never paid) and wrote-off over $100,000 of prepetition fees incurred in preparing for the Chapter 11 filing. Mr. Schreiber made no mention of fee risk in his article. To advance his thesis that bankruptcy lawyers routinely gouge their clients, Mr. Schreiber implied that the fee enhancement was based on an arrogant assumption at the beginning of the case that the results would be exceptional. To quote Mr. Schreiber, “before the bankruptcy case was one day old, Tyson’s professionals had determined they were entitled to a 100% bonus for their services rendered.” He added caustically, “[w]ould that all firms representing insolvent debtors were entitled to such handsome rewards for not yet having done anything.” The article did not  the reason for the fee enhancement, nor the fact that when the article went to press this supposedly avaricious law firm had worked intensely for nearly a year-and-a-half in a complex case, and advanced over a quarter of a million dollars on Mr. Tyson’s behalf for expenses, without payment. Mr. Schreiber’s article is rife with factual errors. For example, repeating from the objection, the article states with alarm that the firm sent four attorneys to attend a negotiating session with Don King, which was untrue, as the author of the objection was forced to acknowledge in open court. Mr. Schreiber got it wrong when he expressed surprise that the proposed fee enhancement payable from future earnings was not questioned by the United States Trustee, the committee or any party in interest. In fact, at the outset of the case we conferred with the Office of the United States Trustee and the committee and, as a result of those discussions we submitted agreed-upon retention order providing that payment of any fee enhancement from Mr. Tyson’s future earnings would be subject to bankruptcy court approval, notwithstanding case authorities holding that a bankruptcy court may not have jurisdiction over an agreement by an individual debtor to use non-estate assets to pay fees. The tone and content of Mr. Schreiber’s article create the impression that our side of the story, which is never told, was not to be credited. The thrust of his article is not whether we engaged in misconduct, but whether this misconduct is endemic in the industry. He asserts, as if we had been convicted of billing abuses, that “[t]he Tyson case is a paradigm of what occurs daily in Chapter 11 cases throughout the country.” He asks the loaded question “[a]re the abuses alleged by the parties in this case an aberration or standard operating procedure?” While we are aware that Mr. Tyson, whom we continue to represent, has been routine fodder for sensationalized and sometimes inaccurate accounts in tabloid journals, we never thought we would see such fare targeting his counsel. Mr. Schreiber started out with a thesis to prove—that bankruptcy lawyers (like us, he thinks) routinely gouge their clients— and then produced a distorted rendition of the “facts” to prove his point. Starting with a conclusion and finding research to support one’s thesis—researching from a conclusion instead of to a conclusion—is an intellectually bankrupt endeavor. So is drawing wild conclusions from a faulty set of data. Similar criticism was leveled recently (and fairly so, in my humble opinion) against UCLA Professor Lynn LoPucki, whose book “Courting Corruption” scurrilously accuses bankruptcy judges sitting in the Southern  District of New York and Delaware of corruption, based on a questionable database of selected cases and the willingness to draw sensational but flawed conclusions from these “facts.” Given Mr. Schreiber’s sensational subject and tone, his populist resort to lawyer- bashing, and his rush to an incorrect judgment about our professionalism, one has to wonder whether Mr. Schreiber is just as guilty of academic excess as Mr. LoPucki. It is unfortunate that Mr. Schreiber would attempt to make his academic mark at the expense of our reputation.

Research References: Norton Bankr. L. & Prac. 2d §§ 26:7, 79:27; Bankr. Serv., L Ed §§ 16:683, 16:691, 16:1058 West’s Key Number Digest, Bankruptcy ” 3160, 3191 to 3201

STRONG-ARM ON STEROIDS— APPLYING OR INJECTING “RIGHTS AND POWERS” UNDER 11 U.S.C. § 544(a)?

Robert J. McKirgan

Scott K. Brown

Lewis and Roca LLP

Phoenix, AZ

rmckrigan@lrlaw.com

sbrown@lrlaw.com

I. Introduction

Steroids have captured the sports page headlines as recent revelations about rampant use by high profile athletes have scarred record books and destroyed reputations.1 There are short- and long-term health risks associated with steroids. In the short-term, new muscle mass develops faster than the ligaments can strengthen and adjust. Long-term effects can be worse—heart attacks, stroke, tumors, seizures and shrunken genitalia.2 There may be a similar “steroid” trend emerging in bankruptcy litigation. Of course, there is no “cheating” going on, but commentators have noted (and sometimes criticized) the increasing inclination of bankruptcy trustees and others to file bulked-up actions against third parties with deep pockets, asserting new theories of liability in “kitchen-sink” complaints. This trend is young and only time will tell whether the trustee’s new-found strength will help or harm the return of value to bankruptcy estates—and at what cost to the integrity of the bankruptcy process.4

II. Summary of Collins II

A recent bankruptcy court decision out of Arizona will certainly fuel this debate. In Collins v. Kohlberg & Co. (In re Southwest Supermarkets, LLC), 325 B.R. 417 (Bankr. D. Ariz. 2005) (Collins II), the bankruptcy court read the “rights and powers” clause in 11 U.S.C. § 544(a)(2) broadly to mean that a trustee may bring actions in the shoes of a hypothetical creditor, sidestepping common problems a trustee encounters in strong-arm proceedings, such as in pari delicto and statutes of limitations. The trustee’s second amended complaint in Collins II alleged breach of fiduciary duty and actual fraudulent transfer based on the following:

• The debtor made a $2.9 million tax overpayment to the defendants in 1996 that was never returned.

• The debtor paid $2.3 million in May 1997 to buy out the interest of the debtor’s CEO, far in excess of the value of his stockholdings in an insolvent corporation.

• The debtor paid $3.6 million from 1995 to 1999 as an “acquisition fee” and as “management fees.” The acquisition fee provided no apparent benefit to the debtor and the management fees were based on an earnings formula that disregarded the massive debt incurred to generate earnings. Collins II, 325 B.R. at 422.

The defendants moved to dismiss, citing the statute of limitations. They argued that the discovery rule did not apply “because the Debtor’s secured creditors (who assigned their claims to the trustee) had an opportunity to discover the Debtor’s true financial condition.” Collins II, 325 B.R. at 422.

The bankruptcy court found that the trustee adequately alleged self-dealing for profit by fiduciaries and concluded that limitations of such actions were tolled by Delaware law. Even if the creditors could have discovered the debtor’s true financial condition prior to the running of the statute of limitations, it was irrelevant—only “actual knowledge” would prevent equitable tolling under Delaware law and there was no actual knowledge in this case. The bankruptcy court then found support for the trustee’s position in § 544(a)(2). It held that the “rights and powers” of a “hypothetical creditor” vested in a trustee under § 544(a)(2) include standing to bring actions that could be brought by those who did not become creditors until after the wrong occurred. Further, the ability to stand in the shoes of a “hypothetical creditor” allowed the trustee to avoid common problems that arise when a trustee sues a third party in the shoes of the debtor—for example, piercing the corporate veil and in pari delicto. Finally, the court held that a trustee standing in the shoes of a hypothetical creditor “without regard to any knowledge of a trustee or any creditor” realized another advantage—there may be no statute of limitations for those actions.

III. Analysis

A. The Trustee’s Shoe Dilemma

There are many circumstances when it is advantageous for a trustee to stand in the shoes of a debtor. After all, that is how a trustee has the power to perform the duties in 11 U.S.C. §§ 1106 and 1108. It empowers a trustee to assert a debtor’s causes of action that belong to the estate pursuant to 11 U.S.C. § 541 and to avoid transfers of the debtor under 11 U.S.C. §§ 547 and 548. There are also occasions when it is important for a trustee to slip out of the shoes of the debtor and into the shoes of a hypothetical or actual creditor—this is the import of§ 544. Section 544(a) provides:The trustee shall have, as of the commencement of the case, and without regard to any knowledge of the trustee or any creditor, the rights and powers of, or may avoid any transfer of property by the debtor or any obligation incurred by the debtor that is voidable by... a creditor... whether or not such a creditor exists[.] 11 U.S.C. § 544(a).

This section is commonly called the “strong-arm” clause of the Bankruptcy Code because it empowers a trustee to step into the shoes of a “hypothetical creditor,” at the commencement of the case, and “avoid” certain transfers. Section 544(b), by comparison, gives a trustee the powers of an actual creditor with an allowable claim to “avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law.” There is a perceived gap in these statutes that creates a dilemma for a trustee. A trustee suing in the shoes of a hypothetical or actual creditor under § 544 is limited to “avoidance” actions. A trustee suing in the shoes of a debtor under § 541 is subject to all defenses available against the debtor. One such defense is the doctrine of in pari delicto. As one court explained:

The common-law defense of in pari delicto derives from the Latin “in pari delicto potior est conditio defendantis”; in other words, “where the wrong of the one party equals that of the other, the defendant is in the stronger position,” and a court will not “administer a remedy.”

Official Committee of Unsecured Creditors of Color Tile, Inc. v. Coopers & Lybrand, LLP, 322 F.3d 147, 158 (2d Cir. 2003) (quoting 34 TEX. JUR.3d Equity, at § 31 (2002)).

There are other problems for trustees that do not necessarily come with the debtor’s dirty shoes, such as piercing the corporate veil in states where only a creditor can pierce the corporate veil, the “insured versus insured” exclusion under D&O insurance policies, and ratification.5 Trustees are always searching for ways to bring a debtor’s causes of action without facing the difficult defenses that may be asserted when the trustee is suing in the shoes of a debtor.

B. Section 544(a)(2) May Allow a Trustee to Stand in the Shoes of a Hypothetical Creditor to Asserta Debtor’s Causes of Action

Collins II says that § 544(a)(2) solves the “shoe” dilemma, as least in part, and helps the trustee avoid the common problems noted above. It not only allows a trustee to step into the shoes of a hypothetical creditor to avoid certain transfers, but it also allows a trustee to step into the shoes of a hypothetical creditor to assert a debtor’s causes of action. In reaching this conclusion, Collins II focuses on the conjunction or in the language of § 544(a)—i.e., the “rights and powers” clause is separate from the “avoidance” clause—suggesting that § 544(a) gives the trustee more than just “avoidance” powers. It was this draftsmanship that caught the bankruptcy court’s attention and caused it to further analyze whether and to what extent the “rights and powers” of a hypothetical creditor differed from the “avoidance” powers of such a creditor. The court looked to two sources for an answer— the Bankruptcy Act and Western World. Section 70c of the Bankruptcy Act was the predecessor of § 544(a). In 1966, § 70c was amended to add what is now essentially § 544(a)(1)-(3). It read, in relevant part: The trustee shall have as of the date of the bankruptcy the rights and powers of:

(1) a creditor who obtained a judgment against the bankrupt upon the date of bankruptcy, whether or not such a creditor exists,

(2) a creditor who upon the date of bankruptcy obtained an execution returned unsatisfied against the bankrupt, whether or not such a creditor exists, and

(3) a creditor who upon the date of bankruptcy obtained a lien by legal or equitable proceedings upon all property, whether or not coming into possession or control of the court, upon which a creditor of the bankruptcy upon a simple contract could have obtained such a lien, whether or not such a creditor exists.

Notably, the word “avoid” is never used in the text of § 70c as it is in § 544(a). Instead, the “rights and powers” clause leads directly into subsections (1) to (3), indicating that the trustee held all the “rights and powers” of the aforementioned creditors, whatever they might include. The draftsman of that amendment later explained:

Those remedial rights which accrue to the judgment creditor with an execution returned unsatisfied were sheared off by the amendment of the subdivision in 1950. A creditor seeking equitable relief in connection with the avoidance of a transfer— discovery, injunction, receivership, levy on an equitable asset, or reformation or cancellation of a writing—may be required by state law to show that he had exhausted his remedy at law by obtaining a judgment with an execution returned unsatisfied.... [I]t was an inadvertence to deprive the trustee of any advantage given by nonbankruptcy law to a judgment creditor with an execution unsatisfied, and the amendment restores to him whatever rights inhere in this status.

Frank R. Kennedy, The Bankruptcy Amendments of 1966, 1 GA. L. REV. 149, 169 (1967). Professor Kennedy’s initial description of the trustee’s powers under § 70c indicates that a trustee’s powers are limited to those instances where relief is being sought “in connection with the avoidance of a transfer.” Thus, a trustee may have rights and powers over and above “avoidance” powers, but those powers may only be used as procedural tools to enable the trustee to avoid transfers. However, his final comment—that § 70c gives the trustee “any advantage” and “whatever rights” a § 70c creditor has—is very broad indeed and would presumable entail more than mere avoidance powers. At least one court, Western World, has recognized a trustee’s broad powers under § 544(a). Henderson v. Buchanan (In re Western World Funding, Inc.), 52 B.R. 743, 773 (Bankr. D. Nev. 1985). In that case, the trustee sued the defendants for breach of fiduciary duty. The defendants argued that state law did not permit creditors to sue for breach of fiduciary duty and that the court should dismiss the action because the trustee did not hold greater rights than a creditor acting under state law. The court agreed, but said that the cases cited by the defendants were not applicable for two reasons: (1) those cases only held that a single creditor may not bring a breach of fiduciary duty action on his own behalf, i.e., such an action leaves the defendants vulnerable to multiple liability; and (2) to avoid these problems, such actions must be brought in the name of the corporation for the benefit of all those who were wronged. This, the court said, is exactly thenature of the trustee’s action: “In his capacity as a creditor under § 544(a), he [the trustee] may bring a ‘creditors’ bill’ to reach choses in action belonging to the debtor.” 52 B.R. at 773.

Collins II adopts the reasoning of Western World that a trustee can in fact stand in the shoes of a hypothetical creditor under § 544(a) to bring a creditors’ bill asserting a cause of action belonging to the debtor.

Collins II said: “A receiver appointed on such a creditors’ bill may assert damage actions against those who harmed the corporation. A creditors’ bill is an appropriate remedy for shareholder ‘milking’ of a corporation.” 325B.R. at 425. This holding is significant in and of itself, but it did nothing for the trustee in Collins II—he had previously brought causes of action belonging to the debtor in Collins I for breach of fiduciary duty, but those actions were dismissed because the court determined that the fiduciary duties were owed to the parent corporation and not to the debtor subsidiary corporation. Collins v. Kohlberg & Co. (In re Southwest Supermarkets, L.L.C.), 315 B.R. 565 (Bankr. D. Ariz. 2004) (Collins I). Thus, a creditors’ bill to reach a chose in action “belonging to the debtor” was of little use to the trustee in Collins II.C. Section 544(a)(2) May Allow a Trustee to Stand in the Shoes of a Hypothetical Creditor to Asserta Hypothetical Creditor’s Causes of Action

Having recognized that the trustee in Collins II does not want to be re-saddled with the debtor’s causes of action that were dismissed in Collins I, the bankruptcy court said: “[T]he intent behind § 544(a)(2) tomake a creditors’ bill available to trustees is nevertheless very significant because it demonstrates that some kind of affirmative damages can be asserted under § 544(a)(2), not just avoidance of secret liens.” Collins II, 325 B.R. at 425. The question, of course, is what “some kind of affirmative damages” entails. To this point, the court says: Probably most kinds of affirmative relief that a trustee might seek would not be available under § 544(a)(2), because a creditor who extends credit on the date of petition will always have become a creditor after the wrong complained of. Consequently, the kinds of actions that trustee might be able to bring under § 544(a)(2) will always be limited to those for which remedies are available to subsequent creditors, and these may be rare.

Collins II, 325 B.R. at 426.6 Put more plainly, Collins II holds that a trustee may not only stand in the shoes of a hypothetical creditor under § 544(a) to assert a debtor’s causes of action, but a trustee may also assert a hypothetical creditor’s causes of action under § 544(a), whatever they may be. This interpretation of § 544(a) may run into some historical problems simply because it involves a “trustee” suing on a “creditor’s” action. 7 In drafting the Bankruptcy Code, the House of Representatives Committee of the Judiciary included a subparagraph to section 544 that would have allowed the trustee to enforce a claim that any individual creditor or class of creditors had against a third party. See H.R. REP. NO. 95-595, at 370-71 (1977). This was added in response to the Supreme Court’s comment in Caplin v. Marine Midland Grace Trust Co. of New York, 406 U.S. 416, 92 S. Ct. 1678, 32 L. Ed. 2d 195 (1972), that Congress should decide the standing of a trustee in bankruptcy reorganizations to bring claims against an indenture trustee on behalf of debenture holders. In explaining this history, one circuit court observed: As originally proposed by the House, Section 544 was to contain a subsection (c), which was intended to overrule Caplin. It is extremely noteworthy, however, that this provision was deleted before promulgation of the final version of Section 544. Because subsection (c), as a part of Section 544, would have applied to both reorganization and liquidation trustees, and because Congress refused to enact subsection (c), we believe Congress’ message is clear—no trustee, whether a reorganization trustee as in Caplin or a liquidation trustee as in the present case, has power under Section 544 of the Code to assert general causes of action, such as the alter ego claim, on behalf of the bankrupt estate’s creditors.

Mixon v. Anderson (In re Ozark Rest. Equipment Co., Inc.), 816 F.2d 1222 (8th Cir. 1987) (emphasis in original); see also

Williams v. California 1st Bank, 859 F.2d 664 (9th Cir. 1988); Moore v. Kumer (In re

Adam Furniture Indus., Inc.), 191 B.R. 249 (Bankr. S.D. Ga. 1996). This interpretation of Caplin and the legislative history of § 544 casts some doubt on whether § 544(a) was intended as a vehicle to bring general causes of action on behalf of the estate’s “hypothetical creditors.” See Ozark, 816 F.2d at 1230 n.12 (questioning the validity of the Western World holding based on § 544(a)(2)).

However, many courts have rejected this narrow interpretation of Caplin, holding that a trustee still retains the “right to bring a general action on behalf of all creditors rather than a personal one on behalf of only some.” See, e.g., Koch Refining v. Farmers Union Cent. Exchange, Inc., 831 F.2d 1339 (7th Cir. 1987); Dana Molded Products, Inc. v. Brodner, 58 B.R. 576, 578 (N.D. Ill. 1986) (claims by creditors for corporate mismanagement or breach of fiduciary duty are “enforceable solely by the trustee, and may not be asserted by any one creditor”);
Hassett v. McColley (In re O.P.M. Leasing Servs., Inc.), 28 B.R. 740, 759 (Bankr. S.D.N.Y. 1983) (same). This seems to be exactly the case in Collins II, not to mention that there had been a complete assignment by creditors of their claims to the trustee, Collins. Moreover, Collins II never claims to be a way to side step Caplin, though the court acknowledges that its decision may help a trustee avoid in pari delicto problems (as discussed above). Nevertheless, there may be some who will think that Collins II runs afoul of Caplin. Assuming Caplin can be managed, a trustee must also ensure that the § 544(a) cause of action can be brought by a “future” creditor within the paradigm set forth by the court. Fortunately, at least for the trustee in Collins II, the court said that the trustee’s two primary actions—actual fraudulent transfer and breach of fiduciary duty—both fit into this paradigm. Another important cause of action (not at issue in Collins II) may be a RICO claim. It should be noted that each of these actions has its own quirks, particularly if § 544(a) is the governing statute:Actual fraudulent transfer. If a trustee’s best action is an actual fraudulent transfer claim, it faces a long, uphill battle, particularly when the fraud happened years before the lawsuit is filed and tried. A trustee is expressly given authority to bring just such an action under § 544(b). It seems unlikely that Congress intended § 544(a) to have the exact same effect minus the burdens a trustee faces under § 544(b), which forces the trustee into the shoes of an actual creditor with an allowable claim. Breach of fiduciary duty: Most courts agree that the nature of the “fiduciary duty” changes upon insolvency. See, e.g., Ed Peters Jewelry Co. v. C & J Jewelry Co., 124 F.3d 252, 276 (1st Cir. 1997); Askanase v. Fatjo, 130 F.3d 657, 666 (5th Cir. 1997); In re Sharon Steel Corp., 871 F.2d 1217, 1228 (3d Cir. 1989). See also Myron M. Sheinfeld & Judy Harris Pippitt, Fiduciary Duties of Directors of a Corporation in the Vicinity of Insolvency and After Initiation of a Bankruptcy Case, 60 BUS. LAW. 79 (2004). This appears to be the case in Arizona.8 The important question for purposes of Collins II, however, is whether such a breach of fiduciary duty claim is available to those creditors whose debt arose after the point of insolvency, “and hence to the creditors that extended credit on the date of the petition.” Collins II, 325 B.R. at 426. The bankruptcy court thought that it would, but it does not cite any authority. In the context of a shareholder bringing a derivative action against a corporation for a breach of fiduciary duty before the shareholder bought into the company, some courts have held that this cannot be done. See, e.g., Midland Food Servs., LLC v. Castle Hill Holdings V, LLC, 792 A.2d 920 (Del. Ch. 1999). This may be why Collins II said that “[s]uch claims may also be available to those who became creditors after the point of insolvency.” Collins II, 325 B.R. at 426 (emphasis added). Another important question is whether the parent’s manager-defendants in Collins II owed a fiduciary duty to the debtor’s creditors. The bankruptcy court previously said that the managers owed their fiduciary duties to the parent and not the debtor subsidiary. If this is the case, then the duty, if it did shift upon insolvency, may have shifted to the parent’s creditors and not those of the debtor. RICO. The trustee in Collins II did not bring a cause of action based on RICO, but it has been discussed by other courts in the context of § 544(a). In Lumbard v. Maglia, the court allowed the trustee to bring a RICO action against the principal officers and director of the debtor corporation, apparently relying on § 544(a). Lumbard v. Maglia, Inc., 621 F. Supp. 1529 (S.D.N.Y. 1985) (“Section 544, the ‘strong arm’ provision, provides ample statutory authority for a chapter 7 trustee’s asserting of creditor’s claims against third parties.”). Another court agreed that a trustee could bring such an action, relying on public policy grounds, but it expressly said that a trustee’s § 544 avoidance powers “do not include the right to bring RICO and fraud claims for pre-petition injury to creditor.”

Barnett v. Stern, 93 B.R. 962 (N.D. Ill. 1988), rev’d, 909 F.2d 973 (7th Cir. 1990).

D. Section 544(a)(2) May Help a Trustee Indefinitely Toll the Statute of Limitations

Another import of § 544(a)(2) is the ability of a trustee to stand in the shoes of a hypothetical creditor “without regard to any knowledge of the trustee or of any creditor” as of the petition date. “Consequently, if the limitations on such an action is subject to a discovery rule, such as the discovery rule for actual fraudulent transfers, the action is assertable on behalf of the hypothetical creditor who is hypothesized to have had no knowledge of the wrongdoing.” Collins II, 325 B.R. at 426-27. This means that the secured creditor’s ability to have known the debtor’s true financial condition is irrelevant because a “hypothetical creditor” is not burdened with such knowledge. Presumably this is true even if actual creditors had actual knowledge, thus tolling the statute of limitations indefinitely. Some courts have interpreted the term “knowledge” under § 544(a) more narrowly than Collins II. In the context of avoiding transfers, it has been said that “knowledge” refers only to actual and not to constructive knowledge that a trustee (via the debtor) or a creditor possesses. In other words, even though a trustee is relieved of any actual knowledge relating to a lien, vulnerability remains to a charge of constructive knowledge.

See, e.g., Mosello v. Ali, Inc. (In re Mosello),

190 B.R. 165 (Bankr. S.D.N.Y. 1995), aff ’d,

193 B.R. 147 (S.D.N.Y. 1996), aff ’d, 104 F.3d

352 (2d Cir. 1996); National Bank of

Alaska, N.A. v. Erickson (In re Seaway Exp.

Corp.), 912 F.2d 1125 (9th Cir. 1990);

McCannon v. Marston, 679 F.2d 13 (3d Cir.

1982).

These decisions have little effect on Collins II, though, because the court also held that constructive notice was not sufficient to stop the tolling of the statute of limitations under Delaware law.

E. Section 544(a)(2) May Not Help a Trustee Recover Damages

Another issue—left untouched by this opinion because it was not yet ripe—is damages. When the trustee sues in the shoes of a known creditor or a known debtor, the harm is quantifiable. When the trustee sues in the shoes of an unknown creditor that may or may not exist, the harm is much harder to measure. It is, perhaps, in this context, that the trustee is most like the steroid user who finds new strength, but limited ability to use it. A simple approach to this issue is that the trustee is asserting the corporation’s causes of action through a hypothetical creditor— approximately what happens on a creditors’ bill. The amount of the particular creditor’s claim does not matter. Instead, the trustee is asserting the corporation’s causes of action through the hypothetical creditor, recovering whatever amount the corporation is entitled to recover, and all that comes into the estate gets distributed according to the priorities. This approach, though, may be letting the trustee have his cake and eat it, too, especially, as in Collins II, when the court has expressly forbidden the trustee to pursue certain claims that belong to the debtor. In other words, it would allow the trustee to stand in the shoes of creditors to assert claims and avoid dismissal problems, but then step into the shoes of the debtor for purposes of recovering damages.

It may also be that the kinds of claims that can be brought on behalf of a hypothetical creditor may be limited to those where damages or the resulting judgment would be something other than based on the amount of the hypothetical creditor’s claim. For example, in the context of piercing the corporate veil, the parent is liable for all of the debts of the subsidiary and the amount of the plaintiff’s claim is irrelevant. Deepening insolvency may be similar if the defendant owes the estate “x” amount of dollars based on how much more insolvent the debtor became after it should have been put into bankruptcy. Again, the amount of damages would be unrelated to the hypothetical creditor’s claim.

Another possibility is the rule of Moore v. Bay, 284 U.S. 4, 52 S. Ct. 3, 76 L. Ed. 133, 76 A.L.R. 1198 (1931), which says that the

rights of the trustee under § 70e(1)—the predecessor to 11 U.S.C. § 544(b)—were not limited to those of the creditor whose rights were asserted by the trustee. The Second Circuit has held that a creditor owed a relatively small amount enabled the trustee to avoid and recover or the benefit of all creditors a mortgage securing $65,000. Zamore v. Goldblatt, 194 F.2d 933 (2d Cir. 1952). The Sixth Circuit likewise held that a trustee was able to assert the rights of a single creditor having a claim of $10 to avoid a mortgage on property worth $2,300. Sears, Roebuck & Co. v. Bissell (In re Plonta), 311 F.2d 44 (6th Cir. 1962). Congress continued the rule of Moore v. Bay in § 544(b). See Gerald K. Smith, Avoiding Powers of Trustee, in Practicing Under the Bankr. Reform Act 121 (Brody et al. eds, CRR Pub. Co. 1977). The problem, of course, is that the hypothetical creditor under § 544(a) is just that— hypothetical, and it does not have a claim, not even $1. Another problem is that if the trustee is relying on the amount of a specific claim of a specific creditor, then the trustee may run afoul of Caplin. A potentially more complicated question is whether and to what extent a trustee is entitled to prejudgment interest when a hypothetical creditor’s credit is not extended under § 544(a) until “the time of the commencement of the case.” It may be that a trustee is not entitled to prejudgment interest in that situation, or it may be that a trustee is able to make out some sort of unjust enrichment claims that allow recovery of interest.

III. Conclusion

Relying on § 544(a)’s predecessor, § 70c, comments from § 70c’s draftsmen, and the “intent” behind § 544(a) to make creditors’ bills available to a trustee, Collins II outlines new ways trustees can assert claims. It is appropriately limited to claims that a creditor could bring after it becomes a creditor and after the wrong has been committed. But absent that restriction, the trustee may be free from common problems that arise when the trustee sues in the shoes of a debtor or an actual creditor. One possible drawback to this approach may be the issue of damages, since  a “hypothetical creditor” suffers no real harm. At the end of day, the conflicting interpretations

of § 544(a)’s “rights and powers” clause suggest that Congress should address the “rights and powers” riddle. In the meantime, bankruptcy trustees can look to Collins

II for fertile ideas about bulking up actions to enhance the bankruptcy estate.

Research References: 8 Norton Bankr. L. & Prac. 2d 11 U.S.C. § 544; Bankr. Serv., L Ed §§ 31:42, 31:81, 31:111, 31:112

West’s Key Number Digest,

Bankruptcy ” 2512 to 2516

Notes

1. The steroid saga in baseball was revealed by TomVerducci, Baseball’s Worst Kept Secret, SPORTS ILLUSTRATED(May 28, 2002) (“Steroids are changing the game and making a mockery of the record book.”).

2. Tom Verducci, Baseball’s Worst Kept Secret, Sports Illustrated (May 28, 2002); see also Anita Manning, Steroids Can Build Muscles, Shrink Careers, USA TODAY (July 7, 2002) at http:// www.usatoday.com/sports/baseball/stories/2002- 07-08-steroids-focus.htm#more.

3. See, e.g., William Bates III, Deepening Insolvency: nto the Void, 24-2 AM. BANKR. INST. J. 1 (2005); see also Jo Ann J. Brighton, Deepening InsolvencySecured Creditors and Professionals Beware: It Is Not Just for Officers and Directors Anymore, 23-3 AM. BANKR. INST. J. 34 (2004) (hereinafter “Brighton, Deepening Insolvency”); Jo Ann J. Brighton, Secured Creditors Beware: Latest Tool in the Creditors’ Committee Toolbox: Aiding and Abetting in the Breach of Fiduciary Duty, 23-8 AM. BANKR. INST. J. 36 (2004).

4. See, e.g., Brighton, Deepening Insolvency (suggesting that if the current trend continues, secured creditors become conservative about working with borrowers to reorganize their businesses).

5. See, e.g., Collins II, 325 B.R. at 426 (addressing the problem of piercing the corporate veil) (citations omitted); David M. Hillman and Jeffrey S. Sabin, Will D&O Insurance Be Available When Angry Creditors Come Calling?, 44-10 BANKR. CT. DEC. (Mar. 29, 2005) (addressing the problems relating to the “insured v. insured exclusion”); Henderson v. Buchanan (In re Western World Funding, Inc.), 52 B.R. 743, 775 (Bankr. D. Nev. 1985), aff ’d in part, rev’d in part on other grounds, 131 B.R. 859 (D. Nev. 1990), rev’d, 985 F.2d 1021 (9th Cir. 1993).

6. Western World recognized this limitation as well, but was not too troubled by it: “The fact that the trustee becomes a creditor subsequent to the misconduct complained of, does not impair his standing, for the creditor may complain of past misconduct which impaired the corporation’s assets.” 52 B.R. at 774 n.10.

7. A thorough review of this history was provided by Gerald K. Smith, Avoiding Powers of Trustee, in Practicing Under the Bankr. Reform Act 113 (Brody et al. eds., CRR Pub. Co. 1977). This history does not indicate in any way that a trustee could assert affirmative actions on behalf of hypothetical creditors under § 544(a).

8. The bankruptcy court relied on A.R. Teeters & Associates, Inc. v. Eastman Kodak Co., 172 Ariz. 324, 333, 836 P.2d 1034, 1043 (Ct. App. Div. 1 1992) (“When a corporation becomes insolvent, its directors and officers become fiduciaries of the corporate assets for the benefit of creditors.”), for this proposition. It should be noted that A.R. Tetters never says that duty actually shifts to the creditors.

WHEN A SOLVENT DEBTOR FILES FOR REORGANIZATION, IS THE FILING “PER SE” BAD FAITH?

Larry D. Simons

SulmeyerKupetz

Los Angeles, CA

lsimons@sulmeyerlaw.com

In their article, Courts Reign in Solvent Debtor Bankruptcies by Handing Landlords Significant Victories, 5 NORTON BANKR. L. ADVISER 3 (2005), John D. Fredericks and Eric E. Sagerman argue that In re Liberate Technologies, 314 B.R. 206 (Bankr. N.D. Cal. 2004), and NMSBPCSLDHB, L.P. v. Integrated Telecom Express, Inc. (In re Integrated Telecom Express, Inc.), 384 F.3d 108 (3d Cir. 2004), cert. denied, 2005 WL 544094 (June 6, 2004), reflect a trend away from prior cases that allowed solvent debtors to reorganize. As explained here, these recent decisions depart from a long line of cases holding that a debtor’s good faith should be determined from a “totality of circumstances”—including solvency of thedebtor—but not determined exclusively by the debtor’s solvency. Further, this excessive focus on the debtor’s solvency creates an additional eligibility requirement not found in 11 U.S.C. § 109(d) or (e). It is too soon to declare that the courts have shifted away from or abandoned the “totality of circumstances” approach and instead adopted the holdings in Liberate and Integrated.

Good Faith in the Code

The requirement that a plan be filed in “good faith” is mentioned in both § 1129 and § 1325 of the Bankruptcy Code (Chapter 12 also has a good faith requirement in § 1225(a)(3) that is identical to § 1325(a)(3)). Section 1129(a) states in part that a courtshall confirm a plan only if, among otherthings, “the plan has been proposed in goodfaith and not by any means forbidden by law.” 11 U.S.C. § 1129(a)(3). Section 1325(a)(3) similarly provides that plan confirmation requires that the plan be proposed in good faith and not by any means forbidden by law. Lack of good faith is conspicuously absent from the Code sections describing appropriate “cause” to dismiss or convert a Chapter 13 or Chapter 11 filing. See 11 U.S.C. §§ 1112(b) and 1307(c). Courts have generally found that a petition must be filed in good faith whenever a debtor is seeking the rehabilitative goals of Chapter 11, and require that a debtor show that its filing presupposes a “valid reorganizational purpose.” In re SGL Carbon Corp., 200 F.3d 154, 164 (3d Cir. 1999). Even though “good faith” is not listed n § 1112 or § 1307, courts have found an implicit requirement that petitions be filed in good faith and that a court may use its equitable power to prevent a misuse or abuse of the rehabilitative provisions of Chapters 11 and 13. Alt v. United States (In re Alt), 305 F.3d 413 (6th Cir. 2002); In re Adell,310 B.R. 460, 465 (Bankr. M.D. Fla. 2004). (There are several cases which have found that Chapter 7 does not have a similar good faith requirement. See Neary v. Padilla (In re Padilla), 222 F.3d 1184, 1193 (9th Cir. 2000).) Courts have generally employed a “totality of circumstances” test when determining whether a petition has been filed in good faith. See generally Leavitt v. Soto (In re Leavitt), 171 F.3d 1219 (9th Cir. 1999) (Chapter 13); Finney v. Smith (In re Finney), 992 F.2d 43 (4th Cir. 1993) (Chapter

11); In re Love, 957 F.2d 1350, 1357 (7th Cir. 1992) (rejected by, In re Lilley, 91 F.3d 491 (3d Cir. 1996) (Chapter 13)); Winslow v. Williams Group (In re Winslow), 949 F.2d 401 (10th Cir. 1991) (Chapter 11).

Two recent courts have dismissed petitions not based on a “totality of circumstances” analysis, but instead dismissed petitions as bad faith filings on the sole ground that a debtor is solvent. Are these decisions creating a “per se” rule that a solvent debtor is precluded from filing a good faith petition for reorganization, creating an additional eligibility requirement for reorganization under

Chapter 11 or Chapter 13?

Chapter 11 Cases—A Differing View on Solvency

It is well established that a debtor need not be insolvent before filing for bankruptcy protection. SGL Carbon, 200 F.3d at 163. The Code does not require specific evidence of insolvency for a voluntary Chapter 11 filing. In re Mid-Valley, Inc., 305 B.R. 425, 430 (Bankr. W.D. Pa. 2004). In the past, courts have considered a debtor’s solvency as a factor in determining whether or not a petition is filed in good faith. See, e.g., SGL Carbon, 200 F.3d at 163. Recently, two courts have abandoned the “totality of circumstances” test and focused on a debtor’s solvency exclusively to determine whether or not a petition is filed in good faith.

Liberate and Integrated TelecomSolvency Precludes a Finding of Good Faith

In the case of Liberate Technologies, the debtor had over $212 million of unrestricted cash on hand at the time it filed its Chapter 11 petition. The debtor sought to cap a landlord’s claim at $8 million from the $45 million scheduled claim pursuant to  § 502(b)(6). The court, analyzing whether the petition was filed in good faith, stated that the most conspicuous prerequisite for obtaining Chapter 11 bankruptcy relief is that the debtor need Chapter 11 relief. Liberate, 314 B.R. at 211. It further held that a case could not be found to have been filed in good faith if the sole purpose of the solvent debtor’s filing was to take advantage of a particular section of the Code (here, § 502(b)(6)).

Liberate, 314 B.R. at 216.

The Third Circuit reached a similar conclusion in Integrated Telecom. In that case, the debtor had over $105 million in cash which exceeded its liabilities by over $70 million. Again, the debtor sought to cap a landlord’s claim under § 502(b)(6), reducing the claim from $26 million to $4.3 million. The Third Circuit found that the bankruptcy filing was in bad faith because the debtor did not have any financial distress; it was solvent.

Integrated Telecom, 384 F.3d at 122. The court further based its conclusion on the fact that the filing of the petition did not maximize value for creditors as a whole, but instead facilitated dissolution on terms favorable to equity interests. Integrated Telecom, 384 F.3d at 126. Lastly, the court stated “[t]o be filed in good faith, a petition must do more than merely invoke some distributional mechanism in the Bankruptcy Code. It must seek to create or preserve some value that would otherwise be lost—not merely distributed to a different stakeholder— outside of bankruptcy.” Integrated Telecom, 384 F.3d at 129.Solvency is a Factor in Determining Good Faith, but Not a Bar to Filing The Liberate and Integrated Telecom decisions remain the minority decisions, with other courts continuing to allow solvent debtors to seek bankruptcy protection to reorganize under the Code.

In the case of In re Chameleon Systems, Inc., 306 B.R. 666, 672 (Bankr. N.D. Cal. 2004), the court held that a solvent debtor with enough cash to cover its liabilities) could file a bankruptcy petition to cap a landlord’s claim under §502(b)(6), notingthat “there is no reason [the debtor] should remain in operation for the sole purpose of servicing this lease.”

The court in Solow v. PPI Enterprises (U.S.), Inc. (In re PPI Enterprises (U.S.), Inc.), 324 F.3d 197 (3d Cir. 2003) discussed the relevancy of the solvency of a Chapter 11 debtor that sought to limit a landlord’s claim under § 502(b)(6). The Third Circuit, which later decided Integrated Telecom, found in this case that a debtor’s solvency was not relevant to an application of § 502(b)(6) and that there was no requirement in the Code that a debtor be insolvent. The court affirmed the bankruptcy court’s decision that it is not bad faith for debtors to file for bankruptcy in order to take advantage of a particular provision of the Code. In re PPI Enterprises (U.S.), Inc., 228 B.R. 339, 345 (Bankr. D. Del. 1998), aff ’d, 324 F.3d 197 (3d Cir. 2003). The bankruptcy court further held that the debtor was using § 502(b)(6) for exactly its intended purpose. PPI, 228 B.R. at 345. The PPI court relied on a “totality of the circumstances” test and found that in evaluating a debtor’s good faith, the court’s only inquiry is to determine whether the debtor seeks to abuse the bankruptcy law by employing it for a purpose for which is was not intended. PPI, 228 B.R. at 345. In In re Federated Dep’t Stores, Inc., 131 B.R. 808, 813 (S.D. Ohio 1991), the court did not prohibit a debtor from filing Chapter 11, instead finding that a “debtor’s duty to unsecured creditors who happen to be lessors does not include the performance of an otherwise act for the sole purpose of helping the lessor to avoid the statutory cap of § 502(b)(6).”

Other Chapter 11 Cases Raising Solvency of the Debtor

Cases discussing a solvent Chapter 11 debtor’s good faith are not limited to instances where the debtor seeks to utilize § 502(b)(6). The Ninth Circuit in Platinum Capital, Inc. v. Sylmar Plaza, L.P. (In re Sylmar Plaza, L.P.), 314 F.3d 1070 (9th Cir. 2002), cert. denied, 538 U.S. 1035, 123 S. Ct. 2097, 155 L. Ed. 2d 1065 (2003), ruled in favor of a debtor and held it was not per se bad faith to file a bankruptcy plan solely to use the cure and reinstatement provisions of § 1124(2).The debtor owned a shopping center that was subject to a secured loan. The debtor ultimately defaulted on the loan. The debtor sold the shopping center free and clear of the bank’s lien. The secured lender objected to the debtor’s plan that allowed the debtor to pay the lender’s claim at the nondefault interest rate. The Ninth Circuit found that insolvency is not a prerequisite to a finding of good faith, and that a creditor’s contractual rights are adversely affected by a bad faith filing. Sylmar Plaza, 314 F.3d at 1074-75.

Chapter 13 Cases

Chapter 13 debtors may also take advantage of particular Code sections that may adversely  a single creditor. Consider the following hypothetical. A Chapter 13 debtor owns real estate which is not his primary residence. He is current on the mortgage obligation on the property and has no other debt either secured or unsecured). The value of the property is less than the amount of the mortgage. The debtor files Chapter 13 for the sole purpose of bifurcating his mortgageunder § 506(a) into secured and unsecured portions with the intent of paying the secured portion and paying a percentage of the unsecured portion over the  of the Chapter 13 plan. Would this filing be a good faith filing? Under the holdings of PPI, Chameleon and Sylmar Plaza, the hypothetical casewould survive a good faith inquiry because the debtor was using the Code “for a purpose for which it was intended.” The Liberate and Integrated Telecom courts would reach a different result. Which result is correct? As stated previously, courts have held that solvency is not a prerequisite to filing either a Chapter 11 or 13 petition. The Liberate and Integrated Telecom courts have become gatekeepers, preventing a certain class of debtors, namely those that are solvent, from filing petitions to reorganize. However, it is unclear what section of the Code these courts rely on to reach a determination that solvency is a barrier to a good faith filing and why they have abandoned a “totality of the circumstances” test. Clearly, they are not relying on § 109 that governs a debtor’s eligibility. Eligibility Under § 109 Section 109(d) states: Only a railroad, a person that may be a debtor under Chapter 7 of this title (except a stockbroker or a commodity broker), and an uninsured State member , or a corporation organized under section 25A of the F ederal Reserve Act, which operates, or operates as, a multilateral clearing organization pursuant to section 409 of the Federal Deposit Insurance Corporation Improvement Act of 1991 may be a debtor under  11 of this title. 11 U.S.C. § 109(d). Section 109(e) states: Only an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $307,675 and noncontingent, liquidated, secured debts of less than $922,975, or an individual with regular income and such individual’s spouse, except a stockbroker or a commodity broker, that owe, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts that aggregate less than $307,675 and noncontingent, liquidated, secured debts of less than $922,975 may be a debtor under Chapter 13 of this title. 11 U.S.C. § 109(e). Solvency is conspicuously absent as a factor to determine a debtor’s eligibility under Chapter 11 or 13. By requiring a debtor to be insolvent, the Liberate and Integrated Telecom courts are adding an additional re quirement of eligibility that is not found in the Code. If Congress had intended solvency to be a requirement for filing Chapter 11 or Chapter 13, it would have written it into § 109(d) or (e). Indeed, Chapter 9 eligibility requires that a debtor under that chapter be insolvent. 11U.S.C. § 109(c)(3).

Conclusion

Based upon a literal reading of the Code, if a debtor meets the eligibility requirements found in § 109, it should be able to attempt to propose a plan of reorganization. Courts should employ a “totality of the circumstances” test to each case to determine whether a particular debtor has filed its petition in bad faith, considering a debtor’s solvency as a factor (not the only factor). As stated earlier, Fredericks and Sagerman’s article which heralded a shift from the “totality of circumstances” may be premature. Further, the holdings in Liberate and Integrated Telecom ignore the plain language of § 109(d) and (e) which allow a solvent debtor to file a petition to reorganize. As the Supreme Court has held in United States v. Ron Pair Enterprises, Inc., 489 U.S. 235, 109 S. Ct. 1026, 103 L. Ed. 2d 290 (1989), when a statute is unambiguous on its face, it must be read literally.

The mere fact that a debtor is solvent should not cause a case to lack good faith “per se.” A debtor may file for the sole purpose of taking advantage of certain Code sections such as § 502(b)(6) or § 506(a). To preclude a solvent debtor from filing for reorganization when it seeks to take advantage of certain sections of the Code creates an additional requirement of eligibility. If Congress had intended that debtors seeking reorganization be insolvent, it would have drafted such language into § 109(d) or (e), as it did in § 109(c). In its present form, that language is not included in § 109 and this author believes that the courts seeking to add this additional eligibility requirement are thwarting congressional intent by limiting Chapter 11 or Chapter 13 filings to insolvent debtors.

RECENT DECISIONS

FROM THE APPELLATE

COURTS

John W. Lamb, Jr.

Austin L. McMullen

Boult, Cummings, Conners & Berry, PLC

Nashville, TN

FIRST CIRCUIT

Boston Reg’l Med. Ctr., Inc. v. Reynolds

(In re Boston Regional Medical Center,

Inc.), 410 F.3d 100 (1st Cir. 2005). In the context of a liquidating plan of reorganization, court’s related-to jurisdiction does not diminish postconfirmation to the same degree it would in a viable, reorganized debtor case.

Research References: Norton Bankr. L. & Prac. 2d § 95:6

West’s Key Number Digest, Bankruptcy ” 3570

Hannigan v. White (In re Hannigan), 409 F.3d 480 (1st Cir. 2005). Debtor cannot amend schedules to take full advantage of homestead exemption when debtor intentionally undervalued his home.

Research References: Norton Bankr. L. & Prac. 2d § 46:33; Bankr. Serv., L Ed §§ 26:380, 26:1050

West’s Key Number Digest, Bankruptcy ” 2796, 2798

SECOND CIRCUIT

Pereira v. Farace, 413 F.3d 330 (2d Cir. 2005). Standing in the shoes of the debtor corporation, Chapter 7 trustee cannot maintain “due care” claim against debtor’s directors, when exculpatory language in the corporate charter would preclude the debtor from bringing such claims. Trustee argued un successfully that the claim was brought on behalf of creditors, not the corporation. Research References: Norton Bankr. L. & Prac. 2d §§ 23:12, 77A:5; Bankr. Serv., L Ed §§ 2A:1, 2A:48 to 2A:50 West’s Key Number Digest, Bankruptcy ” 3009

JP Morgan Chase Bank v. Altos Hornos De Mexico, S.A. De C.V., 412 F.3d 418 (2d Cir. 2005). A bona fide dispute regarding ownershipof property that is the subject of a foreign bankruptcy case may be heard in a U.S. court despite principles of comity, because ownership must be determined before distribution of the property can be addressed in the foreign court (the Koreag comity exception). Because bona fide dispute existed regarding ownership of funds in a collection account, the district court properly dismissed the creditor’s U.S. litigation to determine ownership, in deference to the debtor’s pending bankruptcy case in Mexico.

Research References: Bankr. Serv., L Ed §§ 14:28, 14:32, 14;33

Dairy Mart Convenience Stores, Inc. v.

Nickel (In re Dairy Mart Convenience

Stores, Inc.), 411 F.3d 367 (2d Cir. 2005). Eleventh Amendment immunity was not implicated by the tolling, pursuant to 11 U.S.C. § 108, of the debtor’s deadline for filing an application for reimbursement from the State of Kentucky for environmental cleanup costs.

Ex parte Young entitled debtor to injunctive relief against state agents to compel them to accept the application as timely filed, because the injunction did not directly cause disbursement of state funds.

THIRD CIRCUIT

Sovereign Bank v. Schwab (In re Kirby), 414 F.3d 450 (3d Cir. 2005). Rent was not property= of the estate because creditor had foreclosed, taken title to the rental properties and notified tenants that it would begin directly collecting rent pre-petition. That a state court had appointed the creditor as receiver of the properties as part of the foreclosure did not change the analysis because § 543 requires only the turnover of property that belongs to the debtor; here the rents belonged to the creditor.

Joubert v. ABN AMRO Mortgage Group, Inc. (In re Joubert), 411 F.3d 452 (3d Cir. 2005). Neither § 105(a) nor § 506(b) of the Bankruptcy Code entitled debtor to private right of action for secured creditor’s allegedly improper assertion of postpetition attorney’s fees.

Research References: Norton Bankr. L. & Prac. 2d §§ 123:14; Bankr. Serv., L Ed §§ 24:323, 52:315

West’s Key Number Digest, Bankruptcy ” 2877, 3204, 3705

FOURTH CIRCUIT

Logan v. JKV Real Estate Servs. (In re Bogdan), 414 F.3d 507 (4th Cir. 2005). Bankruptcy trustee, as assignee of creditors victimized by debtor’s fraudulent scheme, has standing to sue debtor’s co-conspirators for the benefit of the estate. Court rejected the coconspirators’ in pari delicto defense because

the trustee stood in the shoes of the victimized creditors, not the wrongdoing debtor.

Hall v. Chrysler Credit Corp. (In re JKJ Chevrolet, Inc.), 412 F.3d 545 (4th Cir. 2005). Creditor lost new value defense to preference

claim when debtor made subsequent payments on account of the new value, even though trustee did not seek to avoid subsequent payments. Although the statute of limitations had run on avoidance of the subsequent payments, the trustee nonetheless could have avoided the payments, so they are “otherwise unavoidable” under § 547(c)(4)(B). The court also held that § 547(b)(5) refers to state law to determine whether a creditor was paid out of the creditor’s collateral and, thus, contains no “tracing” requirement unless one exists in state law.

Research References: Norton Bankr. L. & Prac. 2d § 57:20; Bankr. Serv., L Ed §§ 33:629, 33:639, 33:640

West’s Key Number Digest, Bankruptcy ” 2613(4)

FIFTH CIRCUIT

Baker Hughes Oilfield Operations, Inc. v. Cage (In re Ramba, Inc.), No. 04-20807, 2005 WL 1581076 (5th Cir. July 7, 2005). Payment to a petitioning creditor in an involuntary bankruptcy case to obtain an agreed dismissal of the case was an avoidable preference when, two months later, debtor filed avoluntary Chapter 7. Dismissal of the involuntary case was not a recognized category of new value under § 547(a)(2).

Jethroe v. Omnova Solutions, Inc., 412 F.3d 598 (5th Cir. 2005). Debtor was judicially estopped to pursue Title VII claim against former employer because she failed to mention the claim in her previous Chapter 13 case. The judicial estoppel requirement that the omission not be inadvertent was satisfied because she knew of the claim. Debtor’s assertion that the omission was an innocent error was irrelevant.

Research References: Bankr. Serv., L Ed §§ 15:66, 29:605, 29:607

West’s Key Number Digest, Bankruptcy ” 2552, 2557

Cadle Co. v. Pratt (In re Pratt), 411 F.3d 561 (5th Cir. 2005). Bankruptcy court did not err in overruling creditor’s objections to discharge when it found insufficient evidence that the debtor’s failure to disclose assets was the result of fraudulent intent.

Research References: Norton Bankr. L. & Prac. 2d §§ 74:3 to 74:5; Bankr. Serv., L Ed §§ 17:329, 39:352

West’s Key Number Digest, Bankruptcy ” 2557, 3314, 3314.1

SIXTH CIRCUIT

Bank of Montreal v. American HomePatient, Inc. (In re American HomePatient, Inc.), 414 F.3d 614 (6th Cir. 2005). Damages for breach of executory stock purchase contract were properly calculated as of the bankruptcy petition date pursuant to §§ 365(g)(1) and 502(g). Plain language of § 502(g) that the claim be “determined” as if it had arisen prepetition defeated creditor’s argument that claim could arise prepetition but be calculated postpetition.

Made in Detroit, Inc. v. Official Comm. of Unsecured Creditors (In re Made in Detroit, Inc.), 414 F.3d 576 (6th Cir. 2005). Debtor’s appeal of confirmation of creditor’s liquidating plan was moot because stay pending appeal was denied and debtor’s property was sold to a good faith purchaser. A finding that a purchaser did not take in good faith requires proof of the purchaser’s fraud or collusion or an attempt by the purchaser to take grossly unfair advantage of other bidders. No such proof existed in this case.

Ruehle v. Educational Credit Mgmt. Corp. (In re Ruehle), 412 F.3d 679 (6th Cir. 2005).

Chapter 13 debtor’s discharge of student loans was obtained in violation of the creditor’s substantial due process rights and was illegal and void. Student loan creditor was entitled to relief under Rule 60(b)(4). Debtor did not initiate an adversary proceeding to determine undue hardship, as required by Rule 7001(6). Instead, debtor filed a “discharge by declaration” reciting the undue hardship language found in § 523(a)(8). The student loan creditor did not object to the discharge, but there was no evidence that the creditor received notice of the plan or had an opportunity to be heard before confirmation. Research References: Norton Bankr. L. & Prac. 2d § 120:1; Bankr. Serv., L Ed §§ 27:1930, 50:162

West’s Key Number Digest, Bankruptcy ” 3351, 3351.1

Tirch v. Pennsylvania Higher Educ. Assistance

Agency (In re Tirch), 409 F.3d 677

(6th Cir. 2005). The debtor did not establish an undue hardship that would allow discharge of student loans. The debtor did not prove that her current lack of income would continue long-term; her evidence of physical and psychological problems was unaccompanied by any evidence that these problems prevented her from working or that these problems would persist. The debtor had not made a good faith effort to repay the loans; she had not applied for an Income Contingent Repayment Plan and, in almost 20 years, she had repaid only 5% of the amount owed while earning more than $27,000 in some years.

Research References: Norton Bankr. L. & Prac. 2d §§ 47:52; Bankr. Serv., L Ed §§ 27:1920

West’s Key Number Digest, Bankruptcy ” 3351.10 to 3351.10(3)

SEVENTH CIRCUIT

United Airlines, Inc. v. HSBC Bank USA,

N.A. (In re United Airlines, Inc.), Nos. 04-

4209, 04-4315, 04-4321, 2005 WL 1743787

(7th Cir. July 26, 2005). The agreement in this case was not a lease under § 365 because:

(1) the debtor’s “rent” was not measured by the market value of the subject property but by the amount the debtor had borrowed;

(2) the debtor owed the rent even if it lost possession or use of the property;

(3) the repayment schedule includes a balloon payment, which is a common feature of secured credit but not leases;

(4) at the end of the “lease” the creditor’s interest in the property would terminate and the debtor would receive its full interest in the property without additional payment; and (5) if the debtor prepays, the creditor’s interest in the property would terminate and the debtor would receive its full interest in the property.

Belda v. Marshall (In re Belda), No. 04- 3820, 2005 WL 1743791 (7th Cir. July 26, 2005). An appeal to determine the validity of a Chapter 13 plan was moot. While the appeal to the circuit court was pending, the bankruptcy court dismissed the case because the debtor was in substantial default on his required payments and there was no replacement plan before the bankruptcy court.

In re UAL Corp., 411 F.3d 818 (7th Cir. 2005). United’s unilateral mistake in miscalculating amounts owed on aircraft leases, leading to a misinformed decision to retain the leases, constituted “excusable neglect” justifying relief pursuant to Rule 60(b).

Research References: Norton Bankr. L. & Prac. 2d § 39:25; Bankr. Serv., L Ed §§ 5E:56, 59:721

West’s Key Number Digest, Bankruptcy ” 3111, 3112, 3117

In re UAL Corp., 412 F.3d 775 (7th Cir. 2005).

Bankruptcy court’s injunction against sale of debtor’s stock by Employee Stock Ownership Plan should have provided stockholders adequate protection of their interests or required debtor to post a bond against lossin stock value. No party requested this security, and none was provided. When the Internal Revenue Service changed the rules governing ESOPs and the debtor terminated the ESOP, the ESOP trustee distributed the ESOP’s shares to the stockholders, who then became entitled to sell the shares. On appeal, the trustee of the terminated ESOP sought damages on behalf of the stockholders for the loss in stock value between the date of the injunction and the date of the distribution of the shares. The court held that the appeal was moot based on the dissolution of the ESOP and held that the trustee could not recover damages in the absence of an injunction bond.

Research References: Norton Bankr. L. & Prac. 2d § 156:13; Bankr. Serv., L Ed § 12:375, 23:702, 27:1051

West’s Key Number Digest,Bankruptcy ” 2958, 2961

EIGHTH CIRCUIT

Clauss v. Church (In re Church), No. 05-

6010SI, 2005 WL 1719838 (8th Cir. July 26,

2005). Debtor’s prepetition attorney seeking to have fee owed for legal services held nondischargeable under § 523(a)(2)(A) failed to show that his reliance on the debtor’s false statements was justifiable. Debtor had promised not to request discharge of the debt, and the attorney claimed that he provided services based on this promise. In light of the attorney’s knowledge and expertise, the attorney failed to prove that he could justifiably rely on this promise. Moreover, the attorney failed to prove that he provided anyof his services after the promise.

NINTH CIRCUIT

AMB Property, L.P. v. Official Creditors for

the Estate of AB Liquidating Corp. (In re AB

Liquidating Corp.), No. 03-16979, 2005 WL

1668683 (9th Cir. July 19, 2005). Debtor’s $1

million security deposit was applied to the landlord’s $2 million claim as capped by § 502(b)(6), and not to the landlord’s $5 million gross breach of lease claim. The Ninth Circuit rejected the landlord’s argument that this result, dictated by the Second Circuit in Oldden, contravenes the plain language of § 502. Section

502 is ambiguous as to the application of security deposits, yet Congress explicitly embraced Oldden in the legislative history. Pilate v. Burrell (In re Burrell), 415 F.3d 994 (9th Cir. 2005). A creditor’s appeal of a dischargeability judgment became moot when the bankruptcy trustee obtained a separate determination of the debt’s nondischargeability on other grounds.

Scott v. United States Trustee (In re Doser), 412 F.3d 1056 (9th Cir. 2005). Document preparer franchisee engaged in deceptive practice in violation of 11 U.S.C. § 110 by advertising the availability of an attorney who was not authorized to render legal advice and by offering printed booklets explaining bankruptcy law erroneously. The court did not reach the question whether the franchisee engaged in the unauthorized practice of law. Court rejected multiple constitutional challenges to § 110.

Research References: Norton Bankr. L. & Prac. 2d §§ 18A:1, 18A:2; Bankr. Serv., L Ed §§ 12:1534

West’s Key Number Digest, Bankruptcy ” 3030.5, 3030.8, 3030.10

Cossu v. Jefferson Pilot Sec. Corp. (In re

Cossu), 410 F.3d 591 (9th Cir. 2005). The debtor’s undisclosed moonlighting resulted in indemnification obligation to former employer that was nondischargeable under § 523(a)(2)(A).

Research References: Norton Bankr. L. & Prac. 2d §§ 47:14, 47:19 ; Bankr. Serv., L Ed §§ 27:859

West’s Key Number Digest, Bankruptcy ” 3353(1.40)

Muegler v. Bening, 413 F.3d 980 (9th Cir. 2005). Prebankruptcy determination in federal district court that debtor committed intentional fraud under Missouri law collaterally estops debtor from re-litigating fraud in § 523(a)(2) proceeding.

Research References: Norton Bankr. L. & Prac. 2d § 47:72; Bankr. Serv., L Ed §§ 27:185, 27:186

West’s Key Number Digest, Bankruptcy ” 3363(6)

TENTH CIRCUIT

Lang v. Lang (In re Lang), 414 F.3d 1191

(10th Cir. 2005). Bankruptcy court properly determined that the failure to comply with the deadline for the filing of a notice of appeal due to the press of other business was not excusable neglect and, thus, properly denied Rule 8002(c) motion for extension of time.

Jaurdon v. Cricket Commc’ns., Inc., 412 F.3d 11567 (10th Cir. 2005). Plaintiff ’s race discrimination and retaliation claim against Chapter 11 debtor was discharged upon confirmation of plan.

Research References: Norton Bankr. L. & Prac. 2d §§ 91:19, 156:16; Bankr. Serv., L Ed §§ 23:338

West’s Key Number Digest, Bankruptcy ” 3568, 3568(3)

Alderete v. Educational Credit Mgmt. Corp.

(In re Alderete), 412 F.3d 1200 (10th Cir. 2005). Debtors did not establish undue hardship that would allow discharge of student loans, and bankruptcy court does not have equitable power to partially discharge student loans in the absence of undue hardship.

Research References: Norton Bankr. L. & Prac. 2d §§ 47:52; Bankr. Serv., L Ed §§ 27:1859 to 27:1861

West’s Key Number Digest Bankruptcy ” 3351, 3351.1

Click here for a PDF of original article

Authors

Related Attorneys