St. John's Case Blog

By: Megan Kuzniewski

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

11 U.S.C. Section 523 lists certain debts that may not be discharged by a debtor’s bankruptcy.[1] In particular, 11 U.S.C. Section 523(a)(2)(A) (“Section 523(a)(2)(A)”) provides that a debtor who files a bankruptcy will not be discharged of debts that were obtained by “false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition.”[2] False representations, such as those described in Section 523(a)(2)(A), carry a scienter requirement which requires that it be shown that an individual knowingly made false statements or representations.[3] In In re Bocchino , the Court of Appeals for the Third Circuit found that gross recklessness satisfies the scienter requirement of Section 523(a)(2)(A).[4] In S.E.C. v. Bocchino , the Securities and Exchange Commission (the “SEC”) filed a lawsuit against Bocchino, a stockbroker, in the District Court of the Southern District of New York.[5] The district court found Bocchino civilly liable for “inducing investors via high pressure sales tactics and material misrepresentations” and entered a judgment against him totaling $178,967.55, including disgorgement of fees, interest, and civil penalties.[6] Thereafter, Bocchino filed for chapter 13 bankruptcy protection.[7] The SEC petitioned the bankruptcy court for a judgment declaring the judgments against Bocchino nondischargeable under Section 523(a)(2)(A).[8] The SEC argued that Bocchino had obtained the funds “by… false pretenses, a false representation, or actual fraud.”[9] Bocchino had sought investors for two ventures that turned out to be fraudulent.[10] He began seeking out investments without doing any independent research into the ventures, despite there being cause for suspicion.[11] The bankruptcy court found that, although “Bocchino did not knowingly make any false statements,” the scienter requirement of Section 523(a)(2)(A) “may be satisfied by grossly reckless behavior.”[12] The bankruptcy court discharged the civil penalty portion of the judgment but concluded that the remaining portions of the judgment were nondischargeable under Section 523(a)(2)(A).[13] Bocchino appealed this finding.[13] On appeal, the district court affirmed the bankruptcy court’s decision,[15] and thereafter, the Third Circuit also affirmed the lower court.[16]

By: Nicolas Berg

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In certain instances, a professional, such as a financial advisor, may contract the right to receive a “success fee” from a debtor in bankruptcy.[1] The courts have established different tests for awarding a success fee.[2] In In re Valence Technology , the United States District Court in the Western District of Texas held that KPMG was entitled to a success fee from Valence Tech for closing a $50 million dollar debt-equity conversion, but it was not entitled to a similar fee for closing a $20 million capital loan.[3] After filing for chapter 11 bankruptcy, Valence Tech hired KPMG to assist with necessary financial restructuring advice.[4] Pursuant to their agreement, if KPMG’s work resulted in “any consideration” from Valence Tech’s primary financier, Berg & Berg, KPMG would be entitled to a “success fee” of 1.25% of the value of that consideration or no less than $500,000.[5] Valence Tech received two payments from Berg & Berg: (1) a $50 million debt-to-equity conversion and (2) a $20 million capital loan.[6] While KPMG contended that it was entitled to the 1.25% success fee for both payments, Valence Tech argued that it should not have to pay the success fee for either payment.[7] The bankruptcy court concluded that under the agreement KPMG was entitled to the success fee for the debt-to-equity conversion.[8] The court, however, denied KPMG’s request for the success fee for the capital loan.[9] Valence Tech appealed the bankruptcy court’s ruling to the district court maintaining that KPMG was not entitled to a success fee for either transaction while KPMG cross-appealed to argue for payment of the success fee in connection with the capital loan.[10] To settle the dispute, the district court analyzed the agreement to determine whether the capital loan should be included in the meaning of “any consideration.”[11] Noting the sophistication of the parties, the district court found the contract described two potential scenarios: (1) a “Private Placement” coming from any party other than Berg & Berg resulting in a 2.5% fee for KPMG, and (2) a “Private Placement” coming from Berg & Berg reducing KPMG’s fee to 1.25%.[12] The district court reasoned that either way the contract defined “Private Placement” as having “Private Placement Value,” which necessarily included equity linked financing.[13] Therefore, according to the district court, the $50 million debt-equity conversion qualified as a “Private Placement,” which entitled KPMG to the agreed upon 1.25% “success fee.”[14] The $20 million capital loan did not qualify because it was not linked to any equity.[15]

By: Amanda Hoffman

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re Johns-Manville Corporation, the United States Bankruptcy Court for the Southern District of New York enforced orders it issued in 1986, confirming a plan (the “Plan”) of reorganization for Johns-Manville. Pursuant to the Plan, a settlement agreement was reached in which insurers contributed $770 million to a trust benefitting asbestos personal injury claimants. In exchange, the insurers of Johns-Manville, including long-time insurer Marsh USA (“Marsh”), were relieved of all liability related to their insurance of Johns-Manville and the insurers would be protected from claims via injunctive orders of the Bankruptcy Court. Marsh contributed $29.75 million to the trust in exchange for the injunction, which barred future claimants from bringing action against Marsh as an insurer of Johns-Manville. This settlement agreement was approved by the court, resulting in the court entering a confirmation order of the Plan (the “Confirmation Order), and an Insurance Settlement Order, together known as the “1986 Orders”. Under the 1986 Orders, Johns-Manville and its insurers were released from further liability, but present and future claimants could claim against the trust. Part of the settlement agreement included the appointment of a legal representative by the Bankruptcy Court, in order to ensure the rights of future claimants.

By: Anna Chen

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In Cantu v. Schmidt (In Re Cantu), the Court of Appeals for the Fifth Circuit held that malpractice claims that arise during chapter 11 reorganization but before chapter 7 liquidation belong to the bankruptcy estate. In Cantu, the debtors, the Cantus, filed for chapter 11 bankruptcy. The debtors hired an attorney, Ellen Stone, to represent them in the bankruptcy case. Upon the request of a group of creditors, the bankruptcy court converted the debtors’ chapter 11 case to chapter 7 and a trustee was appointed. Following conversion, the creditors filed a complaint seeking a judgment declaring that the debtors’ debts were not dischargeable. After a two-day trial, the bankruptcy court determined that the debtors’ debts would not be discharged. The court pointed out a number of “omissions, misstatements, and controversies” that plagued the chapter 11 bankruptcy, such as the Cantus’ failure to disclose significant assets and transactions, an improper transfer of $50,000 of what would have been estate property to a close friend during the bankruptcy case, and the Cantus’ lack of cooperation with the court and trustee. A few years later, the Cantus hired an attorney to investigate a possible legal malpractice claim against Stone for her representation during the Cantus’ bankruptcy. The trustee informed the new counsel that he believed the claims against Stone were “property of the estate and under the trustee’s sole authority to prosecute.” The bankruptcy court agreed with the trustee and authorized him to investigate the legal malpractice claims. After conducting his investigation, the trustee filed a malpractice suit against Stone in state court. After removal to federal court, Stone and the trustee settled for $281,710.54. The district court referred the case to the bankruptcy court to determine whether the settlement proceeds belonged to the debtors or the bankruptcy estate. The bankruptcy court held that the settlement proceeds belonged to the estate. On appeal, the district court and the Fifth Circuit affirmed the bankruptcy court’s decision, holding that the proceeds belonged to the debtors’ estate.