Benchnotes Dec/Jan 2001

Benchnotes Dec/Jan 2001

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Property Transfers Amenable to Avoidance and Recovery

In Tavenner v. Smoot, 257 F.3d 401 (4th Cir. 2002), the Fourth Circuit followed the majority of opinions that hold that transfers of property capable of being exempt are amenable to avoidance and recovery actions by bankruptcy trustees. In this case, the debtor transferred what otherwise would have been exempt property, and the court found that the transfer was with the requisite intent to hinder, delay and defraud creditors under §548. The Fourth Circuit held that §548 permits a trustee to avoid any transfer of an interest of the debtor in property if that transfer or obligation is entered into with the requisite intent.

"Reasonable Reliance" on False Statement

In In re Michael, 265 B.R. 593 (Bankr. W.D. Tenn. 2002), the court held that "reasonable reliance" is to be determined objectively by the fact finder considering the totality of the circumstances. Further, the court held that a creditor seeking to prove reasonable reliance on a materially false written statement under §523(a)(2)(B)(iii) cannot ignore "red flags" contained on the written statement. In the Michael case, the court found that the debtors' income was grossly overstated, the debtors failed to list any expenses or personal property on the financial statement, and the lender's actual knowledge of the debtors' inability to pay their financial obligations detracted from the lender's position that its reliance on the financial statement was reasonable under all of the facts and circumstances. The court held that "[t]hese facts, known by the [lender], compel a commercial creditor to make some threshold and independent inquiry or investigation into such glaring omissions and inaccuracies, including the debtors' large annual income, in order to legitimately assert reasonable reliance arising out of a false financial statement under §523(a)(2)(B)(iii) when such 'red flags' are present." Michael at 600. The court observed that "[d]espite the debtors' admissions and candors of difficult financial circumstances expressed directly to the [lender], the [lender] made no such inquiry or investigation into the debtors' annual income." Thus, the lender could not have been said to have "reasonably relied" on the debtors' financial statement.

Social Security Benefits Exempt

In In re Radford, 265 B.R. 827 (Bankr. W.D. Mo. 2000), Chief Bankruptcy Judge Arthur B. Federman addressed 42 U.S.C.A. §407 of the Social Security Act, which provides that no benefits "paid or payable" under the act are subject to execution, levy, attachment, garnishment or other legal process. The court held that this provides an exemption for benefits already paid as well as benefits to be received in the future, and such benefits do not lose their exempt status once they are in the hands of the debtor. Further, a chapter 7 debtor is entitled to exempt Social Security benefits without the need to show that these benefits are necessary for continuing basic care or maintenance.

Chapter 7 Trustee Compensation

In In re U-Can Rent Inc., 262 B.R. 147 (Bankr. M.D. Ga. 2001), Chief Bankruptcy Judge Robert F. Hershner Jr. addressed the issue of chapter 7 trustee's compensation. Section 326(a) sets the statutory maximum compensation payable to a bankruptcy trustee. However, while §326 sets the outer limits, there is no entitlement to the maximum fee since §326(a) also provides that the court may allow a trustee reasonable compensation under §330. Section 330 provides, in part, that the court may award a trustee reasonable compensation for actual, necessary services, and reimbursement for actual, necessary expenses. The court, in determining the amount of reasonable compensation, must consider the nature, extent and value of the services, taking into account all relevant factors including time spent on the services, the rates charged, and whether the services were necessary, beneficial and reasonable. The court held that trustees at all times have the burden of proving that they have earned the compensation and that the compensation is reasonable. Further, the trustee's application must provide enough detail to allow the court to reach some "conclusions regarding an award of reasonable compensation." In accordance with Fed. R. Bankr. P. 2016, the court then went on to apply the factors set forth in Johnson v. Georgia Highway Express Inc., 488 F.2d 714 (5th Cir. 1974), noting that the Johnson factors may be adjusted if the results obtained were of limited success, excellent or exceptional. After consideration of all these factors, including the fact that the chapter 7 trustee had hired his own firm as counsel in a successful adversary proceeding, the court awarded the trustee $20,000, slightly less than half of the maximum amount of compensation.

Administrative Claim for Attorney's Fees

In re Jack/Wade Drilling Inc., 258 F.3d 385 (5th Cir. 2001), involved a prevailing party in a suit brought by a chapter 7 trustee pursuant to a contract that provided that the prevailing party was entitled to attorney's fees. The defendant/prevailing party filed an administrative claim for attorney's fees, costs and expenses. The Fifth Circuit held that in order to establish an administrative expense claim, and thus qualify as an "actual and necessary" cost, the claim must (1) have arisen post-petition and (2) be the result of an action of the trustee that actually benefited the estate. An exception to this two-prong test is found in Reading Co. v. Brown, 391 U.S. 471 (1968), which recognized an administrative claim for damages inflicted on innocent third parties through a trustee's operation of the estate. However, the court held that while Reading survived congressional amendment and has been recognized and applied by nearly every court of appeal, it has never been extended to cover debts incurred by a non-wrongful post-petition action to liquidate a chapter 7 bankruptcy estate. Thus, the court found that Reading was not intended to grant priority to a post-petition claim resulting from a trustee's good-faith attempt to liquidate the debtor's estate by bringing suit on a pre-petition contract. The court then evaluated the claim under the traditional standard, beginning with the assumption that all creditors "are equally innocent victims in this bankruptcy." Thus, the question identified by the Fifth Circuit was "not whether the [claimant] deserves to get paid, but whether [the claimant] deserves to get paid at the expense of existing unsecured creditors." The answer to the question was that in a chapter 7 liquidation where the trustee is not operating the business and where the actions were taken in the course of responsibly carrying out the duties of a chapter 7 trustee, there was no claim for administrative priority.

Debtor Fraud While Acting as Fiduciary

In In re Detrano, 266 B.R. 282 (E.D.N.Y. 2001), District Judge Amon addressed the issue of whether a settlement agreement precludes an action against the debtor for fraud while acting in a fiduciary capacity. Pre-petition, an action was brought against the debtor, who had been appointed as a trustee to manage certain financial affairs pursuant to an Inter Vivos Trust Agreement, alleging that the debtor had fraudulently converted funds. The parties subsequently entered into a settlement agreement pursuant to which the debtor agreed to pay in full claims totaling $480,000 plus interest. The settlement agreement further provided that the parties shall exchange general releases. The debtor defaulted after making minimum payments, and an action was commenced in state court seeking to enforce the settlement agreement. A judgment was entered for the dollar amount then owing under the settlement agreement plus specific performance of non-monetary obligations under the settlement agreement. The debtor then filed chapter 7, and a complaint was filed seeking a determination that obligations owed pursuant to state court judgment were not dischargeable pursuant to §523(a)(4). The bankruptcy court ruled that regardless of the underlying nature of the claims encompassed in the settlement agreement, the obligation was dischargeable because the judgment was based on the contractual debt contained in the settlement agreement. On appeal, the district court undertook a review of cases addressing the issue of whether a bankruptcy court should look beyond a settlement agreement to determine whether a debt was in fact based on fraud. After reviewing such decisions, the court followed the "better-reasoned" majority and concluded that a discharge proceeding in bankruptcy is fundamentally different from a tort action seeking damages. Thus, under the facts of this case, the settlement did not prevent an inquiry into whether the debtor in fact committed fraud or breached his fiduciary duties as alleged for purposes of determining the dischargeability of the debt. The court also held that it could not "discern any valid reason why it would make a substantial difference here that, in addition to resolving the state court actions, the settlement agreement at issue also contains a general release," agreeing with U.S. v. Spicer, 57 F.3d 1152 (D.C. Cir. 1995), cert. denied, 516 U.S. 1043 (1996), that a debtor should not be allowed to "escape non-dischargeability, imposed as a matter of public policy by Congress...merely by altering the form of his debt through a settlement agreement, whether or not the agreement includes an express release or waiver of the fraud claim."

Rule 2004 and Subpoenas

In In re Fred Ayers Co. Inc., 266 B.R. 557 (Bankr. M.D. Ga. 2001), Bankruptcy Judge John T. Laney III addressed whether a subpoena issued in connection with a court order in or pursuant to a Rule 2004 exam must be issued from the court for the district in which the bankruptcy case is pending or from the court for the district in which the Rule 2004 examination was to take place. The court reviewed Rule 2004(c), which provides that attendance may be compelled "in the manner provided in Rule 9016 for the attendance of witnesses at a hearing or trial." The court then noted that Rule 9016 incorporates Rule 45 of the Federal Rules of Civil Procedure, which provides that a subpoena commanding attendance shall issue from the court for the district in which the hearing or trial is to be held. However, a subpoena for attendance at a deposition shall issue from the court for the district designated by the Notice of Deposition as the district in which the deposition is to be taken. The starting point for interpreting the statute is the language of the statute itself, and parties must look to the entire statutory context. The court noted that a Rule 2004 examination is broader in scope than a deposition. The court also noted that the second and third sentences of Fed. R. Civ. P. 45(a)(2) are inapplicable to a Rule 2004(c) examination. Thus, interpreting the first sentence of Fed. R. Civ. P. 45(a)(2), the court disagreed with the decision in In re Texas International Co., 97 B.R. 582 (Bankr. C.D. Cal. 1989), and held that a subpoena issued by the court for Rule 2004 examination need not be issued from the district court where the examination is to be taken.


Journal Date: 
Saturday, December 1, 2001