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.

July 8, 2002

CASES IN THIS ISSUE
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Collier Bankruptcy Case Summaries

Claim of investor who was beneficiary of fraud equitably subordinated to claims of unsecured creditors. Bankr. S.D.N.Y. PROCEDURAL POSTURE: In an action under the Securities Investor Protection Act of 1970 ('SIPA'), 15 U.S.C. §§ 78aaa through 78lll, plaintiff trustee for liquidation of debtor filed an adversary action against defendant investor, seeking equitable subordination of the investor's claim against debtor. The investor objected to the trustee's determination that denied the investor's customer claim status. The court consolidated the objection and adversary action. OVERVIEW: The investor formerly held an account at an introducing broker for which debtor served as the clearing firm. The investor was used by broker personnel as a 'nominee' for the broker in the broker's transactions for its own account, and investor knowingly permitted himself to be used as such. The trustee alleged that the investor was the single greatest beneficiary of illegal activity at the broker, which illegality ultimately led to the failure of both debtor and the broker. The court determined that the investor was the beneficiary of the fraud and other illegal conduct, and was a knowing beneficiary. Customer status was not proper for the investor, as the investor sought for the Securities Investor Protection Corporation and taxpayers to make him whole with respect to an account that plainly was the beneficiary of unlawful conduct. Equitable subordination to claims of unsecured creditors was proper. The investor was an 'insider,' due to a close personal relationship with a trader at the broker. Also, he engaged in the requisite unfair act, and circumstances were such that it was inequitable for him to assert a parity with the other creditors in the distribution of the estate.In re Adler, 2002 Bankr. LEXIS 453, 277 B.R. 520 (Bankr. S.D.N.Y. March 27, 2002) (Gerber, B.J ).

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

Transfer of essence of debtor's business to affiliate controlled by debtor's president held fraudulent. Bankr. D.N.J. PROCEDURAL POSTURE: The Chapter 7 trustee filed a complaint against defendant, debtor's affiliate, alleging fraudulent transfers under 11 U.S.C.S. §§ 548(a)(1)(A), 544(b), and the New Jersey Uniform Fraudulent Transfer Act, specifically, N.J. Stat. Ann. §§ 25:2-25(a), (b), 25:2-26. The court held the affiliate in contempt, struck its answer, and entered a default for the failure to comply with court orders. The trustee sought the entry of a default judgment. OVERVIEW: The court found that the affiliate had consistently refused to comply with court orders; it stymied discovery efforts and efforts to bring the case to trial. The debtor's president was the affiliate's president, and he and his family members were common directors and shareholders in both companies. After a state court judgment entered against the debtor, the affiliate began operating out of the debtor's premises and all employees began working for the affiliate. The affiliate completely took over the debtor's operations, as reflected in the debtor's quick loss in revenue and a corresponding increase in the affiliate's revenues. The affiliate's contumacious behavior did not shield it from judgment because the badges of fraud were established under 11 U.S.C. §§ 548(a)(1)(A), (B)(i), (ii)(I), 544(b). The essence of the debtor's business was transferred to the defendant with actual intent to hinder, delay, or defraud the judgment creditor. Given the presence of multiple badges of fraud, actual intent to defraud was established. The de facto merger rendered the affiliate liable for all claims against the debtor, and the affiliate's and the insiders' claims were disallowed. Dobin v. Taiwan Machinery Trade Center Corp. (In re Victor Int'l, Inc.), 2002 Bankr. LEXIS 530, 278 B.R. 67 (Bankr. D.N.J. May 24, 2002) (Stern, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 5:548.01

Estate owed attorney's fees only for services rendered prior to conversion from Chapter 11 to Chapter 7. 4th Cir. PROCEDURAL POSTURE: The attorney for appellee/appellant debtor corporation applied to the bankruptcy court for the payment of his legal fees incurred pre-petition, during the Chapter 11 proceeding, and after conversion to a Chapter 7 proceeding. The United States District Court for the Western District of Virginia, at Abingdon, awarded the attorney all his requested fees. The debtor and appellant/appellee United States Trustee filed cross-appeals. OVERVIEW: The debtor retained the attorney to prepare a voluntary petition for relief under Chapter 11 of the Bankruptcy Code. The debtor paid the attorney a $6,000 retainer, of which $1,000 was used to pay the fees of filing the Chapter 11 petition. The attorney deposited the remainder in his client escrow account. The Chapter 11 proceeding was converted into a Chapter 7 proceeding. The attorney filed an application with the bankruptcy court and sought approval of attorney's fees. The trustee objected and argued that 11 U.S.C.S. § 330(a) made no provision for counsel of the debtor to be compensated by the estate in a Chapter 7 proceeding. The bankruptcy court awarded the attorney the requested fees. The district court affirmed. The parties cross-appealed. The court found that under 11 U.S.C. § 330(a), the debtor's attorney was not authorized to be paid funds from the bankruptcy estate for services rendered after the case was converted to a Chapter 7 proceeding. Of the $6,000 retainer held by the attorney, $1,000 was properly paid to him for pre-petition work, $1,328.85 was payable to him for work performed during the Chapter 11 proceeding, and $3,617.15 belonged to the estate. U.S. Trustee v. Equipment Services, Inc. (In re Equipment Services, Inc.), 2002 U.S. App. LEXIS 10563, 290 F.3d. 739 (4th Cir. May 31, 2002) (Niemeyer, C.J.).

Collier on Bankruptcy, 15th Ed. Revised 3:330.04

Debtors' claim of a homestead exemption for property held by family limited partnership denied. Bankr. W.D. Tex. PROCEDURAL POSTURE: Debtors filed a Chapter 7 bankruptcy. The trustee objected to debtors' claim of an urban homestead in property owned by a family limited partnership. OVERVIEW: Debtors claimed as their exempt urban homestead 10.33 acres of land in El Paso County, Texas, upon which were located a dwelling and horse sheds. Debtors never held fee simple title to the property. When it was acquired in 1992, title was taken in a family limited partnership but debtors lived on the property continuously since 1992. The court held that when debtors filed their petition in bankruptcy, all of their property, including their interests in the partnership, became part of the bankruptcy estate and, therefore, subject to the control of the trustee. Debtors did not claim their interests in the partnership as exempt; thus, the partnership remained in the estate and subject to the control of the trustee. Debtors did not own the partnership and, thus, could not claim an exemption in specific partnership property, even if the court should decide that the older Texas partnership cases, which held that a partner in a solvent partnership could designate his interest in partnership realty as a part of his homestead, applied in the matter. In re Monsivais, 2002 Bankr. LEXIS 470, 274 B.R. 263 (Bankr. W.D. Tex. January 29, 2002) (Akard, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 5:541.04-11

Creditor's lien entitled to priority over subsequent tax lien which was not considered in avoidance calculation. Bankr. W.D. Ky. PROCEDURAL POSTURE: Debtor moved to avoid the judgment lien of creditor lienholder. At issue was whether a state tax lien against the subject real property, but lower in priority that the creditor's lien, should be counted in determining the debtor's avoidance of the lien under 11 U.S.C. § 522(f)(2)(A). The creditor argued the tax lien should not be so considered. OVERVIEW: Debtor owned real property that was valued at $250,000. In order of priority, there were an ad valorem tax lien for real estate taxes of $15,000, a first mortgage of $180,000, the creditor's judgment lien of about $112,000, and a state tax lien of about $57,000. The debtor argued that all the liens on the property plus the debtor's exemption totaled about $370,000, which exceeded the stipulated $ 250,000 value of the property, and that the creditor's judgment lien should be avoided in its entirety. Debtor based his argument on the plain language of 11 U.S.C. § 522(f)(2)(A). The court rejected that logic as violative of the Fifth Amendment takings clause. The creditor was entitled to have the priority of its lien over the state tax lien, and only the encumbrances having priority over the creditor's interest were used in the calculations, resulting in avoidance of $48,400 and a retained lien of $64,000 for the creditor. In re Radcliffe, 2002 Bankr. LEXIS 538, 278 B.R. 426 (Bankr. W.D. Ky. May 24, 2002) (Stosberg, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:522.01

Court had no discretionary power to relieve debtor from previously ordered refinancing requirement. Bankr. E.D. Wis. PROCEDURAL POSTURE: After finding that the debtor had failed to obtain refinancing as required under a previous court order as a condition for not converting the Chapter 11 case to a Chapter 7, the court denied the debtor relief from the previous court order and converted the case to a Chapter 7. Asserting Fed. R. Civ. P. 60(b), 59(a), the debtor filed an emergency motion for relief from the order converting the case. OVERVIEW: The court held it had not based its decision denying relief from the previous order exclusively, or even primarily, on Fed. R. Civ. P. 60(b). The previous order requiring the refinancing mandated strict compliance. The debtor admitted he did not obtain the refinancing. He had not complied with the order, whether it was a final order or not. The debtor was in default, and accordingly, the case had to be converted. Even if the court were to 'rethink' its earlier order, it would impose the same conditions and would rule the same way. The refinancing was a major condition imposed in the previous order. There had been no changed circumstances, no unforeseen events, nor any new evidence which would support removing the refinancing from the conditions. The debtor had repeatedly defaulted on court directives and had afterward offered another excuse, an additional explanation, and a new promise, with little progress. There was no reason justifying relief from the operation of the previous order. The court could not find, based any inherent discretionary power under 11 U.S.C. § 105(a), that the debtor was entitled to be relieved from the refinancing requirement. In re Malmgren, 2002 Bankr. LEXIS 487, 277 B.R. 755 (Bankr. E.D. Wis. May 16, 2002) (Eisenberg, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 2:105.01

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Mere issuance of bad check does not except discharge of related debt for fraud. Bankr. N.D. Ill. PROCEDURAL POSTURE: Plaintiff creditor brought this adversary proceeding objecting to the dischargeability of a debt under the fraud exception of 11 U.S.C. § 523(a)(2)(A). After the debtor failed to appear at a scheduled status hearing, the creditor sought a judgment by default that its debt was nondischargeable because it arose from the debtor's issuance of a bad check. OVERVIEW: The creditor argued that the debtor could not discharge its debt because, when he caused his business check to issue, the debtor knew or should have known that there were not sufficient funds to cover the check and his other obligations. The creditor contended that the debtor's issuance of the check constituted conventional fraud and therefore its debt was nondischargeable under 11 U.S.C. § 523(a)(2)(A). The court held that the creditor had not offered any circumstantial evidence to establish that the debtor intended to defraud it. The creditor had not shown that the debtor had no intent to honor the check, or that the dishonor of it was not the result of some financial difficulties that drove the debtor into bankruptcy. Thus, the court held that the creditor could not except its debt from discharge merely by showing that it was derived from a bad check. New Austin Roosevelt Currency Exchange, Inc. v. Sanchez (In re Sanchez), 2002 Bankr. LEXIS 497, 277 B.R. 904 (Bankr. N.D. Ill. May 20, 2002) (Schmetterer, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:523.08[1]

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IRA under which debtor could withdraw with only a ten percent penalty not entitled to an exemption under § 522(d)(10)(e). Bankr. W.D. Ark. PROCEDURAL POSTURE: Debtors, husband and wife, filed a Chapter 7 case. Among the property of the debtors were two individual retirement accounts ('IRAs'), which they claimed as exempt property. The Chapter 7 trustee filed an objection to claim of exemptions and motion for turnover. OVERVIEW: The bankruptcy court found, based on the debtors' testimony and the language of the IRA agreements, that the debtors had a right to withdraw from the IRAs at any time, subject only to a 10 percent excise tax penalty. Based on this right of withdrawal, the court concluded that the IRAs were not 'similar plans or contracts' within the meaning of 11 U.S.C. § 522(d)(10)(E). Because of the right of withdrawal, the debtors' right to payment under the IRAs was not conditioned on account of illness, disability, death, age, or length of service. Accordingly, the debtors' right to payment under the IRAs was not entitled to an exemption under 11 U.S.C. § 522(d)(10)(E). However, the court found that debtors were entitled to their 'wildcard exemption' in the total amount of $10,681.00 pursuant to 11 U.S.C. § 522(d)(5). In re Rousey, 2002 Bankr. LEXIS 466, 275 B.R. 307 (Bankr. W.D. Ark. February 12, 2002) (Fussell, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 4: 522.09 [10]

Creditor waived sovereign immunity by filing claim for costs of administration. Bankr. D. Or. PROCEDURAL POSTURE: Debtors filed an adversary complaint alleging that the creditor railroad's fees, charged for the debtors' permits for fiber optic cables under Alaska Stat. § 42.40.010 et seq., were anti-competitive and violated § 253 of the Federal Telecommunications Act of 1996. The railroad, and the railroad's president, officer, and board members, moved to dismiss for lack of jurisdiction based on sovereign immunity under the Eleventh Amendment. OVERVIEW: The railroad had previously been held to be an arm of the state, but the court found it had waived the defense of sovereign immunity with respect to the issues in the adversary proceeding. The railroad had filed objections to the debtors' motions regarding the use of cash collateral and an extension of the time to assume or reject executory contracts. It invoked the bankruptcy court's jurisdiction specifically to require the debtors to make payments due and owing under the permits both as a condition to granting the motion to extend and as required to comply with 11 U.S.C. § 365(d)(3). It further invoked the courts' jurisdiction to require the debtors to make the scheduled payments under the permits as adequate protection. The railroad had characterized unpaid rent or fees under the permits as costs of administration entitled to preferred administrative expense treatment upon confirmation of any plan or liquidation in the Chapter 11. The claims stated in the adversary complaint arose with respect to the same transactions: the payment obligations of the debtors under the permits, concerning which the railroad had invoked the court's jurisdiction in the objections. WCI Cable, Inc. v. Alaska RR Corp. (In re WCI Cable, Inc.), 2002 Bankr. LEXIS 488, 274 B.R. 529 (Bankr. D. Or. February 1, 2002) (Dunn, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 7:1129.03[9]

Trustee may avoid mortgage that appeared to be released as of record as a bona fide purchaser. Bankr. D. Kan. PROCEDURAL POSTURE: Plaintiff, a Chapter 7 bankruptcy trustee, sued defendant bank to avoid a mortgage lien on real estate owned by the debtors. The trustee moved for summary judgment as a bona fide purchaser under 11 U.S.C. § 544(a)(3). OVERVIEW: The bank recorded a mortgage on the property with the appropriate county register of deeds, but two years later recorded a satisfaction and discharge of the mortgage debt. When the trustee examined the record and saw that the mortgage had been satisfied, he sought to avoid the mortgage lien. The court concluded that the trustee was entitled to avoid the mortgage as a bona fide purchaser because to a purchaser examining the record after the release, the mortgage no longer appeared valid since there was no constructive notice of a defect in title. Since the trustee was a bona fide purchaser on the date of commencement of the bankruptcy case by virtue of 11 U.S.C. § 544(a)(3) and Kansas law, he was entitled to avoid the mortgage lien. Moreover, the debtors' knowledge of the mortgage was not imputed to the trustee because the trustee was a new entity that came into existence with the filing of the bankruptcy case without knowledge of past events. Finally, the bank was not entitled to reinstatement of the mortgage on equitable grounds because the trustee was an intervening third party whose presence negated the Kansas equitable rule for reinstatement of mistakenly released mortgages. Clark v. Banc One Mortgage Corp. (In re Gilbert), 2002 Bankr. LEXIS 498, 274 B.R. 541 (Bankr. D. Kan. March 6, 2002) (Flannagan, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 5:544.08