Benchnotes Oct 2002

Benchnotes Oct 2002

Journal Issue: 
Column Name: 
Journal Article: 

Mortgage Servicing Rights and Sales Agreements

In In re DMR Financial Services Inc., 274 B.R. 465 (Bankr. E.D. Mich. 2002), Bankruptcy Court Judge Walter Shapero addressed a sale agreement for mortgage servicing rights. Prior to filing bankruptcy, the debtor entered into a sales agreement with the purchaser concerning the sale of "servicing portfolios." After filing chapter 11, the debtor took the position that the contract was a contract to employ the purchaser as a broker and interim servicer of the mortgages and argued that the "sale agreement" was an executory contract that could be rejected. The debtor attempted, through rejection of the contract, to regain possession and ownership of the servicing rights without returning the purchase price to the purchaser, thus leaving the purchaser as a general unsecured creditor for $4 million. After analyzing the contract between the parties, the court held that the sales agreement transferred ownership of the servicing rights prior to the filing of the bankruptcy case and that the agreement was not an executory contract that could be rejected by the debtor.

Priority for Severance Claims

In a case of first impression for the Fifth Circuit, In re Phones For All Inc., 288 F.3d 730 (5th Cir. 2002), addressed the issue of whether an employee was entitled to an administrative priority claim based on a severance clause contained in an employment contract. The employment contract was executed several months prior to the bankruptcy, and the employee was terminated three weeks after the petition was filed. The employee argued that his contractual right to severance was an administrative claim. The Fifth Circuit held that a claim arising under a pre-petition severance agreement is not entitled to post-petition administrative priority status, agreeing with the Tenth Circuit (In re Commercial Financial Services Inc., 246 F.3d 1291, 1294 (10th Cir. 2001)). "To attain such status, a severance claim 'must have arisen from a transaction with the debtor in possession' and must then confer a benefit on the debtor's estate." The Fifth Circuit found the bankruptcy court's reasoning persuasive, noting that "while the general wage priority section of the Bankruptcy Code clearly specifies and limits priority treatment of severance payments...the provision according first-priority status to administrative claims does not.... Congress's omission of severance pay from administrative priority status must therefore have been deliberate." In addition, the court said that the employee "earned" the severance pay when he entered into the contract and that the employee's claim did not represent services that conferred a benefit on the estate. Thus, under all theories asserted by the former employee, the severance claim was not entitled to administrative priority.

Chapter Conversion Does Not Restart Objection Period

In a case of apparent first impression in the Ninth Circuit, In re Rogers, 278 B.R. 201 (Bankr. D. Nev. 2002), Bankruptcy Court Judge Linda B. Riegle held that the conversion of a chapter 13 case to one under chapter 7 does not restart the 30-day period for objections to the debtor's claimed exemptions. Relying on the Ninth Circuit's opinion in In re Smith, 235 F.3d 472 (9th Cir. 2000), that conversion from a chapter 11 case to a chapter 7 case does not create a new 90-day period for objections under Bankruptcy Rule 4003(b), the court concluded that there is no reason for treating conversion of a case from chapter 11 to 7 any differently than the conversion of a case from chapter 13 to 7.

General Partner Liable for Debts

In In re Sewickley Hospitality Ltd., 278 B.R. 127 (Bankr. S.D. Tex. 2002), Bankruptcy Judge Richard S. Schmidt addressed issues concerning the liability of limited partners on debts incurred by a general partner, acting on behalf of itself, under Texas partnership law. The debtor, a Texas limited partnership, contracted with its general partner (K&B) for the management of a hotel property owned by the debtor. The agreement gave K&B both the sole responsibility and the sole right to manage the hotel property. K&B failed to pay employee withholding taxes. In addition to asserting liability against K&B, the IRS claimed that the debtor was also liable for the unpaid taxes. The court found that K&B was the sole employer of the employees and undertook its actions as an independent hotel management company, not in its capacity as the general partner of the debtor. The court also found that under the Texas Revised Limited Partnership Act, when K&B contracted with the debtor to be the independent hotel management company, it had the same rights and obligations as a management company that was not a partner. Since K&B's employment of the hotel employees was as a non-partner, its retention of these employees was not an act of the debtor and did not obligate the debtor for any of the tax liabilities. The court held that the resulting debt for non-payment of the employee withholding taxes was not an obligation owed by the debtor.

Fiduciary Duties Owed by Debtors' Counsel

In In re ICM Notes Ltd. v. Andrews & Kurth LLP, 278 B.R. 117 (S.D. Tex. 2002), District Judge David Hittner addressed issues concerning the fiduciary duties owed by a debtor's counsel. The debtor-in-possession (DIP)entered into a purchase agreement to sell the assets of the corporation, the debtor subsequently breached the purchase agreement when additional attorney's fees were included in the final purchase price, and the purchaser terminated the purchase offer. The debtor's secured creditor sued the DIP's counsel for breach of fiduciary duties related to the inclusion of the additional attorney's fees in the purchase agreement. The court held that "whereas an attorney for a DIP may owe a general fiduciary duty to preserve the bankruptcy estate, this duty cannot be extended to justify the imposition of a fiduciary duty running from counsel for the DIP directly to a particular creditor that would support a separate civil action for breach..." under the circumstances of the case. The court cited Scheffner vs. Foster (In re Dieringer), 132 B.R. 34 (Bankr. N.D. Cal. 1991), for the proposition that the attorney for the debtor-in-possession generally owes no fiduciary duties directly to creditors. The opinion contains an extensive review of cases concerning the duties of counsel for the DIP. As the court concluded, a "finding that debtor's counsel owes a particular duty to an individual creditor in a chapter 11 bankruptcy proceeding would prevent counsel from representing his client in accordance with the provisions of the Bankruptcy Code." Further, the court observed that a "ruling that counsel of a DIP owes a fiduciary duty to a particular creditor is contrary to the tenet of the Bankruptcy Code mandating that debtor's counsel be disinterested."


Journal Date: 
Tuesday, October 1, 2002