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Benchnotes Jul/Aug 2000

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Day-trading Debt Dischargeability

n In re Rea, 245 B.R. 77 (Bankr. N.D. Tex. 2000), the creditor-investors brought an adversary proceeding against a chapter 7 debtor-securities broker, seeking determination that debt arising from the debtor's day-trading losses was excepted from discharge. Relying on In re Jordon, 927 F.2d 221 (5th Cir. 1991), Bankruptcy Judge Steven A. Felsenthal held that the plaintiffs could recover reasonable attorneys' fees necessary to establish their claim, to the extent authorized by non-bankruptcy law. However, the debtor conceded the debt including the damages, and thus the litigation concerned only the dischargeability of that debt. Relying on Alyeska Pipeline Services Co. v. Wilderness Soc'y., 421 U.S. 240 (1975), Judge Felsenthal held that the Bankruptcy Code does not provide for the recovery of attorneys' fees for dischargeabalty litigation.

Enjoined Guarantor Actions

In re Mendez, 246 B.R. 141 (Bankr. D. P.R. 2000), involved review of a confirmed plan of reorganization that provided that actions against a guarantor or co-obligor were enjoined. The plaintiffs continued their efforts to collect the judgment against such guarantor/co-obligor by filing an action in state court to attach to the sale of certain realty. The debtors opposed the state court action, claiming that the plaintiffs were bound by the terms of the confirmed plan, which meant they were enjoined from prosecuting such a claim as long as the plan was in effect. The state court judge "paralyzed" the plaintiffs' execution of the judgment. The plaintiffs did not appeal that state court ruling, but instead filed a suit for declaratory judgment in bankruptcy court stating they were not bound by that provision of the plan. The bankruptcy court held that it did not have jurisdiction because the state court had already determined the issue. Under the Rooker-Feldman Doctrine, the court concluded that the relief requested, if granted, would void the state court's decision or would require the bankruptcy court to determine that the decision was wrong, which is prohibited under the Rooker-Feldman Doctrine.

State Exemption Provisions

In In re Stewart, 246 B.R. 134 (Bankr. D. N.H. 2000), Chief Bankruptcy Judge Mark W. Vaughn addressed significant legal issues at the "intersection" of New Hampshire law and federal bankruptcy law regarding exemptions. The court examined the newly enacted New Hampshire exemption provision that provides that certain assets are exempt from attachment without limitation. The "vexing wrinkle" is that the statute explicitly provides that there is no exemption from debts arising on or before Jan. 1, 1999. In Stewart, it was undisputed that most of the debtor's unsecured debts arose before Jan. 1, 1999. The debtor filed bankruptcy Jan. 29, 1999, after the effective date of the statute. The question before the court was whether the debtor could elect the state exemption and protect assets from creditors whose claims arose prior to Jan. 1, 1999. The court conducted a detailed examination of In re Weinstein, 164 F.3d 677 (1st Cir. 1999), cert. denied, 119 S.Ct. 2394 (1999). Weinstein involved a Massachusetts homestead that was designated by the debtor after the recordation of a judgment. Under Massachusetts law, the homestead would not be effective against that judgment. Weinstein sought to avoid the judgment lien pursuant to §522(f). As §522(f) allows the avoidance of a lien only to the extent that such a lien impairs an exemption the debtor would otherwise be entitled to, the Weinstein court had to decide whether Weinstein was entitled to the exemption under the Massachusetts Homestead Statute. The Weinstein court held that the Massachusetts Homestead Statute was pre-empted by §522, which prohibits exempt property from liability for debts other than those expressly enumerated under §522(c)(1)-(3). Also relying on In re Leicht, 222 B.R. 670 (1st Cir. Bankr. 1998), the court held that although states can determine the nature and amount of the property that can be exempted, states may not determine the types of debt to which the exemption applies as that right has been expressly pre-empted by Congress pursuant to §522.

Excusable Neglect

In In re D.A. Elia Const. Corp., 246 B.R. 164 (Bankr. W.D.N.Y. 2000), Bankruptcy Judge Michael J. Kaplan addressed the parameters of "excusable neglect" in connection with the late filing of claims. The court noted that Pioneer Investment Services Co. v. Brunswick Assoc. Ltd. Partnership, 507 U.S. 380 (1993), stands for three major propositions: (1) clients may be held accountable for the acts and omissions of their chosen counsel; (2) excusable neglect is not limited strictly to omission caused by circumstances beyond the control of the movant; and (3) if the court finds that there was "neglect," then the question of whether the neglect was "excusable" is an equitable one involving a number of factors. What is also clear is that if someone chooses to "flout" a deadline, that is not "neglect." The court noted that while neglect may take the form of an omission, not all omissions are the result of neglect. Omissions may be the result of choice, mistake, ignorance, naivete, incompetence, accident, coercion, etc. Further, "while one might 'neglect' to read one thing carefully, or neglect to respond to it properly, one may not 'neglect' a whole sequence and system designed to inform him." The evidence in this case was that counsel (a) ignored every opportunity and every safeguard that the court, the Code and the Rules set up; (b) obtained erroneous "understandings" or "beliefs" from someplace else, when all the true answers were available in the public record or in open court; and then (c) claimed that all of it was "excusable neglect" because admittedly a key provision in a key notice of a hearing to be held in open court was inconspicuous. The court found that the argument of excusable neglect was mere pretext, noting that counsel's declaration "pretends that this court's tireless attention to the notice requirements of the Rules, and perpetual insistence on the conveying of meaningful information to creditors, is all to be ignored if the court fails to 'catch' a caption—and typeface—deficiency in what is, admittedly, an important order."

Termination Premiums

In Foothill Capital Corp. v. Midcom Communications, 246 B.R. 296 (E.D. Mich. 2000), the court addressed what appeared to be two issues of first impression in that jurisdiction: (1) whether, as a matter of law, a debtor terminates a pre-petition contract for line of credit when it files its chapter 11 petition, since §365(c)(2) prohibits a debtor-in-possession or trustee from assuming a contract to provide financial accommodations; and (2) whether the lender's right to receive a premium for early termination was accelerated, either as a matter of law as an allowable contingent claim under §506(a) or as an allowable charge under §506(b). Analogizing to the rejection of a lease, District Court Judge Cook affirmed the bankruptcy court's holding that rejection of a loan contract does not, without more, terminate the agreement and thereby trigger the right to an early termination premium. Further, although the chapter 11 filing constituted a default that gave the lender the right to terminate the contract, it was undisputed that "no explicit, outward act of termination ever occurred." As a result, the bankruptcy court held that the lender did not have the right "to silently terminate the contract." The district court found that the terms of the contract itself did not authorize termination "amid silence" and affirmed. The court then addressed the argument of whether the premium should be paid as a contingent, secured claim or secured charge. The court rejected the argument that the claim was contingent, but held in the alternative that the lender had an obligation to prove the claim along with a reasonable estimation of its value, and the lender had failed to establish such a right. As to the argument under §506(b), the court held that there was "little doubt that the premium had the potential to be a charge, which would be payable under §506(b) if it were reasonable," however, as no termination had taken place, the charge had not matured and its payment was not proper.

Unreasonable Conduct of Counsel

In In re Engel, 246 B.R. 784 (Bankr. N.D. Pa. 2000), Bankruptcy Judge John J. Thomas addressed the U.S. Trustee's request for sanctions under Bankruptcy Rule 9011 against a chapter 7 debtor's attorney for omission and underevaluation of assets on the debtors' bankruptcy schedules. The court noted that the plain reading of Rule 9011 appears to exclude bankruptcy schedules and statement of affairs from its provision. However, the court accepted the argument that §105 gives the court separate, inherent powers to address the complained of conduct. The court noted that sanctions under Rule 9011 merely require a showing of "objectively unreasonable conduct," a comparatively light burden. In contrast, the court found that "relying on the inherent authority of a court requires a finding of bad faith." A finding of bad faith implies the conscious doing of a wrong because of its dishonest purpose or moral obliquity. The court noted that counsel was a "busy and capable practitioner whose zealous advocacy and 'seat of the pants' representation has pushed the envelope far beyond the ethical limits that can be tolerated by this court." The court then examined a lawyer's responsibility in drafting accurate schedules. Applying the Model Rules of Professional Conduct, the court found that counsel was given ample reason to question the documents that he filed of record, that counsel had a corresponding obligation to reasonably and expeditiously investigate the accuracy and to tender amendments if necessary, and finally, if his clients declined to cooperate in the disclosure, counsel would have had cause to withdraw from the case. The court fined counsel $2,500 in each of the two cases payable to the Clerk of the Bankruptcy Court and required reimbursement to the U.S. Trustee for time and expense in bringing the cases to the court's attention.

Miscellaneous

Journal Date: 
Saturday, July 1, 2000

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