The following case summaries appear in the Collier Bankruptcy Case Update, which is published by Matthew Bender & Company Inc., one of the LEXIS Publishing Companies.

August 26, 2002

CASES IN THIS ISSUE
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Collier Bankruptcy Case Summaries

Loan made to undercapitalized debtor, under which creditor never collected or exercised rights, was an equity interest which trustee could subordinate. Bankr. D. Mass. PROCEDURAL POSTURE: Plaintiff, the chapter 7 trustee, filed suit against defendant creditors, seeking a determination of whether loans made to the debtor by the creditors should be recharacterized as equity interests in the debtor corporation and whether the creditors’ claims should be equitably subordinated to all other secured and unsecured claims pursuant to 11 U.S.C. § 510(c). OVERVIEW: The trustee asserted that the debts owed to the creditors should be recharacterized as equity, arguing that although couched as secured debt the advances represented by the convertible promissory note and another note were more properly characterized as equity investments of capital. The trustee reasoned that the debtor was always grossly undercapitalized, the creditors never attempted to collect the convertible promissory note or exercise any rights under the security agreements, and the creditors bargained for and were given extraordinary rights to control the debtor’s actions. The creditors argued that their actions were consistent with those of a lender, and, therefore, recharacterization was improper. The creditors reasoned that each loan was fully documented, with fixed maturity dates and interest rates, and were secured by the debtor’s assets. With regard to one transaction, the court held that the transaction had the substance and character of an equity contribution while cast in the form of a loan. With regard to a second transaction, the court held that the trustee failed to sustain his burden of proving that the note should be recharacterized as equity. Atlanticrancher, Inc. v. Black, 2002 Bankr. LEXIS 706, 279 B.R. 411 (Bankr. D. Mass. June 21, 2002) (Freeney, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:510.05

Chapter 11 debtor utility provided adequate assurance of payment to its vendors through record of payment and allowance of postpetition administrative fees. Bankr. S.D.N.Y. PROCEDURAL POSTURE: In this chapter 11 contested matter, the debtors, providers of telecommunications services, moved for an order, under 11 U.S.C. § 366, determining that they had provided adequate assurance of payment to their utility vendors — overwhelmingly, other telecommunications providers. OVERVIEW: The debtors contended that the combination of their record of prepetition payment and the allowance to their utilities of an administrative expense for postpetition service was sufficient to provide those utilities with adequate assurance of payment. Four telecommunications providers contended that such was insufficient, and three of them argued that adequate assurance to them required payment of security deposits to them, in an aggregate amount in excess of $14 million. Two of the providers requested prepayment of their charges as well. While the court determined that the debtors’ proffered basis was insufficient to provide the adequate assurance that section 366 required, the court determined that adequate assurance did not, under the facts of this case, now require the deposits and prepayments requested by the objecting utilities. The court reasoned that this would drain the debtors of all of their cash, and be highly prejudicial to the interests of all of the other creditors in the case. In re Adelphia Bus. Solutions, Inc., 2002 Bankr. LEXIS 705, 280 B.R. 63 (Bankr. S.D.N.Y. June 25, 2002) (Gerber, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 3:366.01

Section 707(a) was improper basis for trustee’s motion to dismiss case and revoke discharge for debtors’ failure to cooperate. Bankr. D.N.J. PROCEDURAL POSTURE: The debtors filed a chapter 7 petition under the Bankruptcy Code and received a discharge. The trustee later filed a motion to dismiss the case and to revoke the debtors’ discharge, claiming a lack of cooperation. The debtors did not oppose the motion. OVERVIEW: The trustee wanted to revoke the discharge order based upon the debtors’ failure to respond to a request for information related to a personal injury claim. The court stated that a bankruptcy court could revoke a debtor’s discharge only on the grounds stated in 11 U.S.C. § 727(d). The court found that the trustee did not prove or allege that the debtors’ failure to cooperate was within the scope of section 727(d). On a separate procedural note, the court found that the trustee had not complied with Fed. R. Bankr. P. 7001(4), which required that an action to revoke a discharge must be commenced as an adversary proceeding. The court found that under the circumstances it was also inappropriate to dismiss the chapter 7 case pursuant to 11 U.S.C. § 707(a) based upon the debtors’ lack of cooperation. The debtors had received a discharge and there might have been assets available for any creditors. The court believed that there were other alternatives for persuading the debtors to cooperate with the trustee under the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure. In re Rodwell, 2002 Bankr. LEXIS 697, 280 B.R. 100 (Bankr. D.N.J. July 3, 2002) (Lyons, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 6:707.03

Debtors’ breach of fiduciary duties to creditor and debtor’s corporation renedered related debt non-dischargeable.   4th Cir. PROCEDURAL POSTURE: A creditor brought an adversary proceeding in the United States District Court for the Southern District of West Virginia in the chapter 7 bankruptcy of two debtors. The bankruptcy court granted partial summary judgment for the creditor, finding that the debtors were liable on personal guarantees and declaring the indebtedness non-dischargeable under 11 U.S.C. § 523(a)(4). The debtors appealed. OVERVIEW: The debtors were officers, directors, and shareholders of a corporation that operated a travel agency. The corporation entered into an agreement with the creditor to facilitate airline ticket sales. The agreement required ticket payments to be deposited in a trust account for the benefit of the creditor. The debtors signed personal guarantees of the corporation’s performance. When financial difficulties arose, the debtors caused the corporation to fail to make required deposits. The appellate court agreed with the bankruptcy court that the resulting indebtedness was non-dischargeable under section 523(a)(4). Given the personal guarantees, the fact that the indebtedness arose from the corporation’s breach of a fiduciary duty to the creditor, the fact that the debtors brought about the corporation’s breach of duty, and the debtors’ resulting breach of their duty to the corporation, the debt arose from the debtors’ defalcation while acting in a fiduciary capacity. However, the contracts that set the ticket prices did not support the bankruptcy court’s damages calculation. The creditor’s claim that those contracts were invalid had yet to be addressed by the bankruptcy court. Airlines Reporting Corp. v. Ellison (In re Ellison), 2002 U.S. App. LEXIS 13918, 296 F.3d 266 (4th Cir. July 11, 2002) (Wilkinson, C.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:523.10

Debtor husband, who had treated payments to ex-spouse as alimony on tax returns, estopped from claiming same as dischargeable property payments. Bankr. N.D. Tex. PROCEDURAL POSTURE: Appellant husband sought review of a decision of the bankruptcy court, which granted summary judgment in favor of appellee wife and applied quasi-estoppel against the husband so that the husband could not claim that payments made pursuant to a divorce settlement were property payments that were dischargeable in bankruptcy. OVERVIEW: The husband and the wife entered into a separation agreement as part of a divorce proceeding, which provided that the husband would provide monthly payments to the wife until a mortgage was retired, regardless of whether the wife lived until the debt was retired. The husband deducted the payments as alimony on his tax returns and the wife treated the payments as income on her tax return. Thereafter, when the husband filed for bankruptcy, the bankruptcy court granted the wife’s request for quasi-estoppel to prevent the husband from asserting that the payments were property payments so that the would be dischargeable. The court affirmed the decision of the bankruptcy court. The court found that the husband had irrevocably received the benefit of the tax deductions, whether they were correct or not, because the statute of limitations had expired on prosecuting a tax action. As such, the bankruptcy court properly applied the doctrine of quasi-estoppel so that the husband could not now be heard to argue that the payments were actually property payments that would be dischargeable. In re Stebbins, 2002 U.S. Dist. LEXIS 12213, — B.R. — (Bankr. N.D. Tex. July 8, 2002) (Lynn, D.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:523.11

Debtor who had made good faith efforts to pay was entitled to have several of her student loans discharged for undue hardship. Bankr. S.D. Ohio PROCEDURAL POSTURE: In this chapter 7 adversary proceeding, plaintiff debtor sought the dischargeability of student loans pursuant to 11 U.S.C. § 523(a)(8). OVERVIEW: The debtor was married and lived with her husband and nine children. She had three children from a prior marriage ages 11, 14, and 16. There were five children from the husband’s prior marriage ages 8, 10, 12, 13, and 14. The 8 year old child had cerebral palsy and a seizure condition. The court noted that whether there was an analysis of the parties’ joint income and debts, or an analysis of the individual debtor’s separate income and debts, there was a present inability to pay the total amount of the existing student loan without the undue hardship and this inability would continue to persist into the foreseeable future. The court was persuaded that the debtor had made a good faith effort to repay the claimed student loans consistent with her past, and her now present, financial resources. The court concluded that it would be an undue hardship for the debtor to repay several of the student loans. However, the court also held that the debtor did have the ability to repay, without undue hardship, as partially discharged and modified, several of the loans. Meyers v. Fifth Third Bank (In re Meyers), 2002 Bankr. LEXIS 698, 280 B.R. 416 (Bankr. S.D. Ohio July 9, 2002) (Waldron, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:523.14

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Permissive nature of 28 U.S.C. 1409(a) allowed for enforcement of forum selection clause in contract. Bankr. N.D. Ill. PROCEDURAL POSTURE: Defendant debtor and company moved to dismiss the breach of contract and unjust enrichment claims for improper venue, arguing that the forum selection clause in the purchase order contracts between plaintiff and defendants required dismissal as the contracts made a German court the sole court of competent jurisdiction for any disputes resulting directly or indirectly from the contractual relationship. OVERVIEW: The debtor was in bankruptcy, and the automatic stay was lifted for a determination of liability. Plaintiff acknowledged that it issued invoices requiring litigation related to the invoices be conducted in Germany, but argued that enforcement of the forum selection clause would contravene strong public policy set forth in 28 U.S.C. § 1334(a) that vested original and exclusive jurisdiction for all cases under the bankruptcy code in the district court. Plaintiff further argued that enforcing the forum selection clause would result in piecemeal litigation. However, to the extent that there was a public policy in favor of providing a single forum to preserve, protect and distribute the assets of a bankruptcy estate, that forum was not a single judicial district, but the bankruptcy court where the bankruptcy case was pending. In the face of the permissive nature of 28 U.S.C. § 1409(a), the fact plaintiff obtained relief from the stay to proceed outside the bankruptcy court, and the absence of any cases cited to the contrary, the court could not say enforcement of the forum selection clause would violate a strong public policy in the bankruptcy related matter. Gruner AG v. KG Components, Inc., 2002 U.S. Dist. LEXIS 12385, — B.R. — (Bankr. N.D. Ill. April 16, 2002) (Reinhard, D.J.).

Collier on Bankruptcy, 15th Ed. Revised 1:4.02[1]

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Appeal of adversary proceeding prior to entry of final judgment remanded. Bankr. N.D. Ind. PROCEDURAL POSTURE: The United States Bankruptcy Court for the Northern District of Indiana, Hammond Division at Lafayette, signed a written order dismissing appellant debtor’s adversary proceeding against appellee insurer. Although a final judgment had not issued pursuant to Fed. R. Bankr. P. 9021, the debtor appealed. The insurer moved to dismiss. The debtor moved for entry of a final judgment. The bankruptcy court declined to entertain either motion. OVERVIEW: The insurer filed the motion to dismiss and the debtor filed the motion for entry of a final judgment in the bankruptcy court. The bankruptcy court held that it lacked subject matter jurisdiction to entertain those motions. Before the instant court, the insurer argued that the appeal was untimely and, thus, the instant court lacked subject matter jurisdiction over it. The debtor argued that the appeal either was timely because a final judgment had not yet been entered pursuant to Fed. R. Bankr. P. 9021 or, in the alternative, that an extension of time to file the appeal should be granted because the debtor had shown 'excusable neglect.' The court noted that it could consider the technically premature appeal on the merits. However, the court believed that the better course was to remand the case to the bankruptcy court for entry of a judgment on a separate document in accordance with the bankruptcy rules; the purpose of Rule 9021 was to give the parties notice of the applicable time periods for filing an appeal. Enodis Corp. v. Employer Ins. (In re Consolidated Indus. Corp.), 2002 U.S. Dist. LEXIS 12514, 279 B.R. 831 (Bankr. N.D. Ind. June 5, 2002) (Sharp, D.J.).

Collier on Bankruptcy, 15th Ed. Revised 10:9021.01

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Totality of circumstances justified discharge of student loans for 'undue hardship.' Bankr. N.D. Iowa PROCEDURAL POSTURE: A student loan creditor appealed the bankruptcy court’s determination that the debtor’s two student loans should be discharged, because excepting the loans from discharge would impose an 'undue hardship' on the debtor and the debtor’s dependents. The debtor asserted that the bankruptcy court’s ruling should be affirmed in all respects. OVERVIEW: The creditor challenged: (1) the findings regarding the debtor’s present and reasonably predictable future income and financial resources; (2) the bankruptcy court’s alleged failure to require the debtor to explore options for refinancing her loans; (3) its finding that the debtor had made strenuous efforts to maximize her income, in light of her failure to work full-time or to seek larger child support payments from the fathers of her dependents; and (4) its alleged failure to conduct a separate dischargeability analysis as to each of two educational loans. The debtor bore the burden of proving 'undue hardship' under 11 U.S.C. § 523(a)(8) by a preponderance of the evidence. The court applied the Andrews test, which required a totality of the circumstances inquiry with special attention to the debtor’s current and future financial resources, the debtor’s necessary reasonable living expenses for her and her dependents, and any other unique circumstances. Under the facts, the court could not find that the bankruptcy judge’s conclusions were clearly erroneous. The debtor had established 'undue hardship' as to each of her loans, whether considered separately or together. Cheney v. Educ. Credit Mgmt. Corp. (In re Cheney), 2002 U.S. Dist. LEXIS 12478, — B.R. — (Bankr. N.D. Iowa July 8, 2002) (Bennett, D.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:523.14

Sanctions against debtor and attorney for bad faith, serial filing and removals of state court case were warranted under section 105(a). B.A.P. 9th Cir. PROCEDURAL POSTURE: Appellants, an attorney and a debtor, appealed from a United States Bankruptcy Court for the Northern District of California order that awarded sanctions to a state court plaintiff under Fed. R. Bankr. P. 9011(c)(1)(B), 28 U.S.C. § 1927, and 11 U.S.C. § 105, including attorneys’ fees and costs, plus a penalty. The appellants argued that the bankruptcy court exceeded its authority and violated due process. OVERVIEW: The appellate panel found that the appellants deserved the sanctions awarded against them for their bad faith conduct, serial bankruptcies, and removals of the plaintiff’s state court action. But, Fed. R. Bankr. P. 9011 was applied in error, because the sanction was ordered on the court’s own motion, and the plaintiff’s attorney’s fee statement, filed at the court’s request, was not the functional equivalent of such a motion. While sanctions could be ordered sua sponte, they had to be payable to the court. The sanction of attorneys’ fees and costs was sustained under the inherent authority of 11 U.S.C. § 105(a), on the finding that the appellants used an overall scheme to harass, delay, and increase the plaintiff’s costs. The bankruptcy court’s second order to show cause specifically addressed lack of good faith and manipulation of the bankruptcy system. The appellants had an opportunity to respond in writing, and to appear and testify. The notice satisfied due process. The penalty was authorized, and was appropriate in amount, but it had to be reversed because a Fed. R. Bankr. P. 9011(c)(2) penalty had to be paid into court, instead of to the plaintiff as had been ordered. DeVille v. Cardinale (In re DeVille), 2002 Bankr. LEXIS 720, 280 B.R. 483 (B.A.P. 9th Cir. November 29, 2001) (Marlar, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 2:105.05

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Exemption for truck that was necessary to chapter 13 debtor’s business met the 'best-interest' test. Bankr. D. Colo. PROCEDURAL POSTURE: The debtor filed for chapter 13 relief under the Bankruptcy Code. The debtor claimed his truck as an exempt asset pursuant to Colo. Rev. Stat. § 13-54-102(1)(i) (2000). The trustee and a creditor objected to the claim. The creditor also objected to confirmation of the debtor’s chapter 13 plan. OVERVIEW: The debtor owned a truck clear of encumbrances and used the truck primarily in his business as a self-employed building contractor. The court found that the truck was necessary in order for the debtor to conduct his business. The court believed that a motor vehicle could be exempted under section 102(1)(i), separate and apart from Colo. Rev. Stat. 13-54-102(1)(j). The court found that the debtor’s truck qualified as a machine or equipment of the debtor used for carrying on a gainful occupation. The mere use of a vehicle for transportation to and from work was not use for carrying on a gainful occupation, as intended by the exemption of section 102(1)(i). The court held that a truck driver’s use of his rig was use for carrying on a gainful occupation. For purposes of applying the best-interest test of 11 U.S.C. § 1325(a)(4), the debtor’s claim to an exemption for his truck for use in his trade or business met the test. In re Black, 2002 Bankr. LEXIS 707, 280 B.R. 258 (Bankr. D. Colo. May 10, 2002) (Campbell, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 8:1325.05

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Claim by debtor against former employee who formed a competing entity did not give rise to 'related to' jurisdiction. Bankr. D. Colo. PROCEDURAL POSTURE: Defendants filed a third party complaint against plaintiff debtor’s principal in which it sought damages against the debtor and the principal. Before the court were the parties’ arguments on the question of whether the court had jurisdiction over defendants’ claims against the principal. OVERVIEW: The debtor originally brought an action against defendants in connection with defendants’ conduct in leaving the employ of the debtor and forming a competing entity. The debtor and the principal argued that defendants’ claims against the principal were non-core over which the court could assert jurisdiction pursuant to 28 U.S.C. § 157(c). The court noted that defendants’ claims were, at best, 'related to' a case under Title 11. The court determined that unless the outcome of the litigation between the nondebtor would have precluded the debtor by way of res judicata or collateral estoppel in other litigation, the bankruptcy court did not have jurisdiction over the litigation between the nondebtors. Defendants’ request for injunctive relief and attorney fees against the principal, individually, related to their claims against her in connection with her alleged intentional conduct prior to and after their leaving the employ of the debtor. Because there could be no collateral estoppel or res judicata effect on the debtor by any ruling against the principal in a separate proceeding against her, such claims were not 'related to' the bankruptcy. Prof’l Home Health Care, Inc. v. Complete Home Health Care, Inc., 2002 Bankr. LEXIS 695, — B.R. — (Bankr. D. Colo. July 2, 2002) (Campbell, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 1:3.03

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Bifurcation and cramdown of undersecured short-term mortgages permitted (Case of first impression). 11th Cir. PROCEDURAL POSTURE: Plaintiff creditor appealed the bankruptcy court’s confirmation of defendant debtors’ plan to the United States District Court for the Middle District of Georgia, which rejected the creditor’s arguments and affirmed the bankruptcy court’s decision. The creditor filed a timely notice of appeal. OVERVIEW: The case presented an issue of first impression in the United States Court of Appeals for the Eleventh Circuit: does 11 U.S.C. § 1322(c)(2) permit chapter 13 debtors to bifurcate undersecured, short-term home mortgages into secured and unsecured claims, with the unsecured claim subject to 'cramdown' pursuant to 11 U.S.C. § 1325(a)(5)? The bankruptcy court, in confirming the debtors’ chapter 13 plan, held that section 1322(c)(2) did indeed permit the debtors to modify undersecured, short-term home mortgages through bifurcation and 'cramdown.' The bankruptcy court’s interpretation of section 1322(c)(2) was the correct one. The provision plainly permitted the modification of the creditor’s claim through the bifurcation and 'cramdown.' The bankruptcy court did not err in confirming the debtors’ plan, based upon such a construction of section 1322(c)(2), and the district court correctly affirmed the bankruptcy court’s decision. The creditor’s claims that the bankruptcy court’s confirmation ruling was based on a misapplication of several basic principles of contract law was meritless. Am. Gen. Fin., Inc. v. Paschen (In re Paschen), 2002 U.S. App. LEXIS 13853, — F.3d — (11th Cir. July 10, 2002) (Wilson, C.J.).

Collier on Bankruptcy, 15th Ed. Revised 8:1322.01

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