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Benchnotes Sep 1997

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Trustee's Ability to Reopen a Case

In re Ozer, 208 B.R. 630 (Bankr. E.D.N.Y 1997), Bankruptcy Judge Dorothy Eisenberg addressed a chapter 7 trustee's motion filed pursuant to 11 U.S.C. §350(b) to reopen a case after almost two years and seeking reappointment of the chapter 7 trustee to permit him to administer an asset consisting of a personal injury action. The trustee did not give creditors notice of a motion, and it was not filed pursuant to any request of any creditors. The personal injury action was scheduled by the debtors and subsequently abandoned by the trustee pursuant to 11 U.S.C. §554(c). Prior to closing, the trustee had obtained approval to employ special state court litigation counsel in order to pursue the personal injury claim. Approximately one year after retaining counsel, the trustee filed his Report of No Distribution and a Final Decree was subsequently entered. The debtors opposed the trustee's motion to reopen, arguing that the trustee lacked standing to seek to reopen and that the closing of the bankruptcy case with the filing of the report of no distribution resulted in abandonment of the personal injury claim such that it was no longer available for administration by the trustee. The court found that the trustee did not have standing to bring the motion to reopen. Further, the court distinguished in In re Neville, 192 B.R. 825 (D.N.J. 1996), where the debtors had failed to provide the trustee with additional information requested and, as a result, the trustee had insufficient information to determine whether to administer the case. The court found that in this case there were no allegations the debtors were "anything but truthful and candid" regarding the disclosure of their assets and liabilities.

Examining Tax Liens Under §724(b)

Matter of Owens, 208 B.R. 750 (Bankr. S.D. Ga. 1996), addressed various issues relating to 11 U.S.C. §724(b), which subordinates tax liens on property or proceeds of such property to certain §507 administrative claims. Bankruptcy Judge Lamar W. Davis Jr. noted that the tax lien subordination provision only provides for a method of distribution and does not grant a trustee a property right. Thus, §724(b) does not permit a chapter 7 trustee to extinguish tax liens against the debtor's property by accepting payment of the amount of those liens. The court then held that property of the chapter 7 estate did not include post-petition payments made by mortgage lenders to taxing authorities for satisfaction of unpaid ad valorem property taxes assessed against the chapter 7 debtors' property and thus were not recoverable by the trustee as post-petition transactions. Further, any power that a trustee may have under the tax lien subordination provision was waived upon the granting of relief from stay and extinguished when foreclosure occurs pursuant to that relief. Finally, the court held that the tax lien subordination provision would not govern distribution of proceeds from sale of debtors' property when a chapter 7 trustee did not elect to sell that property. However, (after sale of the debtors property free and clear of liens) a chapter 7 trustee could subordinate perfected post-petition tax liens in a matter similar to pre-petition tax liens.

Is a Consultant an Insider?

In In re Sullivan Haas Coyle Inc., 208 B.R. 239 (Bankr. N.D. Ga. 1997), Bankruptcy Judge Joyce Bihary addressed an issue of insider status in a preference action. The court noted the Bankruptcy Code list of specific relationships as insider relationships is not exhaustive but is only illustrative of insider relationships. In this case, the chapter 7 trustee sought to avoid certain payments made within the one year prior to the filing of the bankruptcy to a consulting firm. The consultant agreement was terminable at will by either party upon written notice. The firm acted as financial consultant to debtor for approximately two years, working with the debtor on a daily basis and giving advice on all financial matters. However, the evidence made it clear that the debtor and its principles always made the final decisions, while the firm created weekly "cash flows" including specific information as to debts, anticipated payables, receivables and timing of anticipated corrections. In addition, while the consultant spoke with the bank daily regarding the status of the accounts and the bank communicated with the consultant regarding potential overdraft situations, the principles of the debtor did not always follow the consultant's advice. The consultant could not sign checks, hire or fire employees or decide which new customers to accept. The consultant did not negotiate with printers, did not sign contracts, could not change bank accounts and had no role in supervising production. In addition, the consultant had no authority to alter or approve payables, could not approve any expense reimbursements for the principals of the company and could not attempt to collect moneys owed to the company. As a result, the court concluded that the consultant was not an insider for purposes of the one-year period for preferential payments.

Collateral Estoppel Effect

In In re Hallmark Builders Inc., 205 B.R. 971 (Bankr. N.D. Fla. 1996), the issue before the court was whether the bankruptcy court should give collateral estoppel effect to factual findings from an arbitration proceeding. Bankruptcy Judge Arthur B. Briskman noted that the arbitration was properly commenced under the terms of the contract in question; the issue before the bankruptcy court was identical to that before the arbitrators; the issue was actually litigated and the determination of issue in prior litigation was a critical and necessary part of arbitrators' judgment. The court then held that an arbitration decision can have res judicata or collateral estoppel effect when the proceeding supports the basic elements of an adjudicatory procedure such as opportunity for presentation of evidence. Further, he held that a determination of issues in an arbitration proceeding should, as a general rule, be treated as conclusive in subsequent proceedings just as determination of court would be treated.

Bidding Procedures

In In re Food Barn Stores Inc., 107 F.3d 558 (8th Cir. 1997), the court addressed issues arising out of a sale and assignment of a shopping center lease. The debtor had entered into a purchase agreement with the ultimately successful bidder which was subject to court approval and provided that the debtor would receive $1.5 million as the purchase price for the lease and certain equipment, fixtures and inventory. The purchase agreement also contained two "bid protection" features. Specifically, the contract granted the bidder the right to match any rival offers for the property and precluded the debtor from recommending another proposal unless any competing bidder agreed to reimburse the bidder no less than $10,000 for its "actual" legal and accounting expenses. At the hearing on the sale motion, the debtor informed the court that another bidder had offered $1.6 million for the lease. However, due to the debtor's desire for immediate consummation, it "expressed a willingness to honor the original purchase agreement," over the objections of various parties including the creditors' committee. After some deliberation, Frank W. Koger, the Chief U.S. Bankruptcy Judge for the Western District of Missouri, orally declared his preliminary intention to authorize the original deal. "Within seconds" the new bidder announced that it was raising its offer to $2.1 million. At that time, Judge Koger granted the debtor's request for a recess stating, "I think we all better have a recess for a half a million dollars." When the hearing reconvened, the debtor proposed that the court compel the new bidder to extend its best and final offer which the original bidder would be allowed to equal. The original bidder then volunteered to go forward under one of two courses of actions: 1) it would offer $2.1 million but reserve the right to appeal the bankruptcy court's insistence that it pay any amount in excess of the original $1.5 million purchase price, or 2) it would not appeal but would close without reservations on the original lower bid. Judge Koger selected the first option and subsequently approved the sale of $2.1 million. The debtor placed $600,000 of the purchase price into an escrow account pending resolution of the appeal. The decision addresses a number of policy issues involving the sale of assets. To begin with, the 8th Circuit rejected any "intimation that a bankruptcy court should pre-qualify bidders before conducting a sale of the estate's property. Adoption of this custom would, in our view, needlessly divert the court's time and resources to matters that are true issues only in the most speculative sense." The court also noted that a pre-qualification requirement may have an adverse effect on the bidding process and it would almost certainly require a bidder to hire an attorney and prepare for a hearing without any assurance that it would have the "triumphant offer." Thus, in the absence of evidence that the second bidder was "patently unqualified or an insincere bidder" the 8th Circuit found that there is no abuse of discretion by entertaining the second bidder's overtures. The court then noted that while a number of elements are "at play" during bankruptcy sales, a very important one is the requirement for stability and finality. "A time must come when a fair bid is accepted and the proceedings are ended." However, the court must also remain mindful of the desires of the unsecured creditors, and a primary objective of the Code, which is to enhance the value of the estate. Noting that this is a "tightrope" that the bankruptcy judge must navigate when presiding over judicial sales, the court finally held that "we think that the important notions of finality and regularity in judicial auctions are appeased if the court acts consistently with the rules by which the particular sale is conducted and in compliance to the bidder's reasonable expectations."

Attorney Misconduct

In Trulis v. Barton, 107 F.3d 685 (9th Cir. 1997), the 9th Circuit issued its amended opinion addressing the question of "how much attorney misconduct a court should tolerate before imposing sanctions." In the underlying case, a bankruptcy plan was confirmed that resulted in the release of certain principals of a country club. Noting that once a bankruptcy plan is confirmed, it is binding on all parties and that all questions that could have been raised concerning the plan are entitled to res judicata, the court found that in the bankruptcy court order confirming the plan each plaintiff in this case released all claims against the defendants. "Since the bankruptcy court order confirming the plan applied to the same claims and parties involved in this litigation, this suit is barred by res judicata and summary judgment was appropriate." The court then turned to a perhaps more important issue of "attorney misconduct and the district court's failure to impose sanctions" under 28 U.S.C. §1927, Fed. R. Civ. P. 11 and the inherent powers of the court. In the case before the court, counsel for the plaintiffs continued to prosecute litigation against named defendants who were released in the plan. The 9th Circuit found that the lawyer "vexatiously continued" the suit after the order confirming the plan explicitly barred such suit and found that the district court abused its discretion by denying the defendants motion for sanctions in regard to this issue. The court noted that some of the plaintiffs explicitly demanded out of the lawsuit and the lawyer apparently disregarded such instructions. The court found that the lawyer's "intentional disregard of his client's expressed instructions and his continued insistence that he represented persons who he was not authorized to represent is reckless as a matter of law" which vexatiously increases the scope of litigation in violation of §1927. As a result, the failure to award sanctions for disregarding the client's instructions was also held to be an abuse of discretion.

Creditor's Qualification to Vote on Trustee

In In re Centennial Textiles Inc., 209 B.R. 31 (Bankr. S.D.N.Y. 1997), Bankruptcy Judge Burton R. Lifland evaluated a creditor's ability to qualify for inclusion for the 20 percent threshold required by §702 for voting and requesting the election of a trustee. Section 702 provides that a creditor may vote for a candidate for trustee (and request an election for trustee) if a creditor holds "an allowable, undisputed, fixed, liquidated, unsecured claim and…does not have an interest materially adverse…to the interest of creditors entitled to distribution and is not an insider." Centennial involved jointly administered but not consolidated estates. The U.S. Trustee questioned whether the petitioning creditors met the §702 requirements. The court noted that in 1991, Rule 2003(b)(3) was amended to delete the provision which gave the court authority to make provisional allowance of claims for voting purposes. As a result, any claims that did not meet the §702 requirements would not be counted. The court then went on to address a number of situations, including a claimant who was the recipient of a potential preferential transfer. The court held that, if it appears that the dispute is grounded "on more than mere suspicion" and even if the recipient has valid defenses to a preference action, a creditor who is a recipient of a potential preference transfer is both "materially adverse" and the holder of a claim which is not "allowable" within the meaning of §502(d) (unless the creditor returns the preferential transfer) and thus is not "allowable" within the meaning of §702(a). The court then addressed the eligibility of a creditor, a portion of whose claim is in dispute in an adversary proceeding, where the claim was cross guaranteed by the two jointly administered debtors. Under those facts, the claims were held to be unliquidated in both cases, distinguishing the situation where a creditor may resort to non-debtors (as opposed to separate estates being jointly administered). Next, he noted that where a creditor claims a security interest in assets of the estate that creditor's "interest is in maximizing the collateral that can be applied to the secured portion of its claim, not in maximizing recovery for the unsecured creditors of the estate." A guaranteed and allegedly secured debt is both unliquidated and materially adverse to the unsecured creditors and thus could not be included in the 20 percent threshold of unsecured creditors requesting an election, or be counted in such election. As a result, Judge Lifland found that the requests for election of a trustee in both cases were not made by the eligible creditors holding 20 percent of eligible claims, nor were the creditors eligible to vote such claims. Accordingly, pursuant to the provisions of §702, the court found that the interim trustee would succeed as permanent trustee in both cases.

Disgorgement of Previously Paid Administrative Claims

In re Anolik, 207 B.R. 34 (Bankr. D. Mass 1997), involved a potentially administratively insolvent chapter 7 estate. Bankruptcy Judge Henry J. Boroff addressed the issue of whether to order disgorgement of previously paid administrative claims. The court noted that disgorgement must be considered on a case by case basis, after consideration of factors such as whether the parties facing disgorgement had a reasonable expectation that payment was final and whether any party who would suffer if there was no disgorgement had objected to the trustee's proposed final distribution. Judge Boroff was "somewhat troubled by a double standard prevalent in administratively insolvent cases," noting that a literal interpretation of §726(b) would mandate disgorgement by all who had asserted claims and received payments in administratively insolvent cases, but he had found only one case where a non-professional was ordered to disgorge. The court then held that where disgorgement is ordered, such disgorgement should not exceed the amount that would be required to achieve a pro rata distribution, assuming that all parties subject to disgorgement were ordered to relinquish funds, regardless of whether the court actually so ordered. In other words, a claimant required to disgorge should not suffer disproportionately simply because the court equitably waived disgorgement for another administrative claimant, disagreeing with In re Lockmiller Industries Inc., 178 B.R. 241 (Bankr. S.D. Cal. 1995) and In re Kearing, 170 B.R. 1 (Bankr. D.D.C. 1994). As a result, consideration of the disgorgement motion was premature in that the amount, if any, of administrative insolvency had not been finally determined.

Miscellaneous

  • In re Marshall, 208 B.R. 690 (Bankr. D. Minn. 1997), (sexual harassment claim is not exempt under Minnesota statute exempting claims for "injuries to the person")
  • In re Bryan, 208 B.R. 162 (Bankr. W. D. Tenn. 1997), (a missing car battery, a tear in the upholstery, a detached console lid and 37,000 miles averaged a month does not constitute a "willful and malicious" injury to the collateral of bank);
  • Denmon v. Runyon, 208 B.R. 225 (D. Kan. 1997), (obligation is to provide notice to the creditor, not to creditor's counsel, even if counsel is known, although notice to parties' attorney can serve as constructive notice to the creditor);
  • In re Pintlar Corp., 205 B.R. 945 (Bankr. D. Idaho 1997), (while "insured versus insured" in D & O policy would exclude coverage for claims brought by debtor-in-possession, it did not exclude coverage brought by litigation trustees pursuant to confirmed plan of reorganization);
  • In re Montaldo Corp., 209 B.R. 40 (Bankr. M.D.N.C. 1997), (general bar date applicable to lessor's lease rejection claim where lease was rejected prior to such general claims' bar date);
  • In re Jodoin, 209 B.R. 132 (Bankr. 9th Cir. 1997), (debtor has the burdens of proof under §523(a)(15)(A) and (B) as to the inability to pay test and the detriment test);
  • In re C-TC 9th Avenue Partnership, 113 F.3d 1304 (2nd Cir. 1997), (New York partnership in dissolution was not eligible "person" under chapter 11);
  • Southern Blvd. Inc. v. Martin Paint Stores, 207 B.R. 57 (S.D.N.Y. 1997), (tenant engaged in same retail businesses as proposed assignee of debtor had no standing to object to an assumption and assignment of lease);
  • In re Montaldo Corp., 207 B.R. 112 (Bankr. M.D.N.C. 1997), (pre-petition premium claim for group health and life insurance coverage is not entitled to priority as "contribution to an employee benefit plan" under §507(a)(4));
  • Pritchard v. U.S. Trustee, 207 B.R. 138 (N.D. Tex. 1997), (chapter 7 trustee's constructive disbursements of unencumbered property to unsecured creditors in satisfaction of claims is properly included in calculating trustee's fees); and
  • In re Smith, 207 B.R. 888 (Bankr. 9th Cir. 1996), (whether life insurance premium is "a necessary expense" for a chapter 13 plan must be determined on a case-by-case basis).
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Monday, September 1, 1997
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