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Collier Bankruptcy Case Update

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.

March 11, 2002

CASES IN THIS ISSUE
(scroll down to read the full summary)

Collier Bankruptcy Case Summaries

2d Cir.

United States trustee's motion for penalties and disgorgement of fees was denied. Bankr. D. Vt. The United States trustee filed a motion seeking an order imposing penalties upon the chapter 7 debtors' bankruptcy petition preparer. The petition identified the nonattorney petition preparer and disclosed that the debtors had paid him $300 to prepare the documents. The United States trustee contended that the preparer obtained an excessive fee for his services, failed to make adequate disclosure of the fee paid to him by the debtors and engaged in the unauthorized practice of law. The preparer denied giving legal advice, and stated that he employed only the federal exemption statute and filed only chapter 7 cases and that by choosing to hire him, the debtors themselves chose chapter 7 and the federal exemptions. At the time they employed the preparer, the debtors executed disclaimers indicating that they made all of the decisions pertaining to their petition and schedules. The bankruptcy court denied the United States trustee's motion, holding that because the petition preparer did not provide legal advice to the debtors and did not charge an excessive fee, he did not negligently or fraudulently prepare the debtors' petition. The court concluded that the legal decisions requisite to the completion and filing of the debtors' petition and related documents were made exclusively by the debtors. In re Schneider, 2002 Bankr. LEXIS 35, 271 B.R. 761 (Bankr. D. Vt. January 4, 2002) (Brown, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 2:110

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Discharged debtor could not seek indemnification because it did not suffer any out-of- pocket losses. S.D.N.Y. The bank moved to dismiss a fourth-party complaint filed against it by the former chapter 11 debtor on the grounds that the indemnification claim did not state a cause of action. After the bank refused to issue letters of credit to the debtor, the debtor was unable to supply goods to its affiliate. The affiliate defaulted on its own debt and it was sued by its lender. The affiliate, in turn, filed a third-party action against the debtor, alleging that the debtor's failure to supply goods caused the affiliate's default. The debtor filed the fourth-party complaint against the bank, seeking indemnification in the event that it was found liable to its affiliate. After the debtor filed its petition, it consented to entry of judgment against it for damages to the affiliate's business, and the debtor's confirmed plan provided that the affiliate would receive the net proceeds of any recovery in the fourth-party action. The bank moved to dismiss the fourth-party complaint, arguing that the debtor's indemnification claim was barred by the confirmation of the plan and the debtor's discharge under chapter 11. The district court granted the motion to dismiss, holding that section 524(e) did not permit the indemnification action to continue. Pursuant to state (New York) law, a claim for indemnification did not accrue prior to actual payment of a judgment. Since section 524(e) did not permit execution against the debtor's assets and the debtor could not be forced to pay the affiliate's judgment, the debtor had no indemnification claim against the bank. Bank of India v. Trendi Sportswear, Inc., 2002 U.S. Dist. LEXIS 894, - F. Supp.2d - (S.D.N.Y. January 17, 2002) (Martin, Jr., D.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:524.05

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District court refused to grant leave to appeal from an interlocutory order. S.D.N.Y. A minority shareholder of a company that was part of the chapter 11 individual debtor's estate filed a motion for leave to appeal an interlocutory order issued by the bankruptcy court. The bankruptcy court had issued a preliminary injunction against the shareholder in an adversary proceeding initiated by the liquidating trustee. The injunction was issued to prevent the shareholder from obstructing the trustee's implementation of the plan of reorganization. The district court denied the shareholder's motion, holding that an appeal would not materially advance the termination of the litigation between the trustee and the shareholder. The preliminary injunction also did not involve a controlling question of law, as to which there was a substantial ground for differences of opinion. Gibson v. Kassover (In re Kassover), 2002 U.S. Dist. LEXIS 1179, - B.R. - (S.D.N.Y. January 23, 2002) (Baer, Jr., D.J.).

Collier on Bankruptcy, 15th Ed. Revised 1:5.07

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3d Cir.

Complaint to avoid any transfer of interest under unrecorded mortgage that purported to operate as lien on debtor's residence stated valid cause of action. Bankr. E.D. Pa. The debtor and the chapter 13 trustee filed an adversary complaint against a bank that held a mortgage on both a residential property and a second property owned by the debtor and her husband. The complaint alleged that because the bank failed to index the mortgage under the address or parcel number for the residence or under the debtor's name, the mortgage was not properly recorded or otherwise perfected as of the date that the debtor's bankruptcy case was filed. Thus, according to the debtor and trustee, a bona fide purchaser would have acquired the residence free of any security interest held by the bank. The debtor and the trustee sought to use the bona fide purchaser status granted to the trustee under section 544(a)(3) to avoid any transfer of interest under the mortgage to the extent that it purported to operate as a lien upon the residence. The bank moved to dismiss the complaint, and argued that any flaw in its security interest alleged by the debtor and trustee was irrelevant as a matter of law because the bank held a separate judicial lien against the residence. The basis of the separate asserted lien was a state court default judgment that was entered against the debtor and her husband after a civil complaint for mortgage foreclosure was filed against them. The bankruptcy court denied the bank's motion to dismiss. The court held that the fact that the unrecorded mortgage was the subject of a foreclosure action and default judgment did not change the nature of the bank's security interest; thus, the complaint stated a valid cause of action. The court explained that while a mortgage foreclosure judgment terminates the mortgage, (i.e., the parties' contractual relationship), the security interest created by the mortgage continues to exist. Thus, the bank had no more of a security interest under the foreclosure judgment than it did under the mortgage itself, and it was this underlying security interest that the complaint sought to invalidate under section 544(a)(3). The court also held that the bank's argument, that there was a separate and independent judicial lien as a result of the foreclosure judgment, had no merit under state (Pennsylvania) law. Suy v. St. Edmond's Fed. Sav. Bank (In re Suy), 2001 Bankr. LEXIS 1701, - B.R. - (Bankr. E.D. Pa. December 6, 2001) (Sigmund, B.J.).

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

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Bankruptcy court's dismissal of successor corporation's avoidance action was reversed. D. Del. The successor corporation to the related chapter 11 debtors appealed the bankruptcy court's dismissal of its avoidance action against the creditor. Pursuant to the plan, the successor made a substantial payment that was issued directly to the unsecured creditors and assumed liability for various other types of claims. In return, substantially all of the debtors' assets, including the right to pursue avoidance actions, were transferred to the successor corporation. The bankruptcy court subsequently dismissed the successor's suit seeking to avoid and recover preferential transfers made to the creditor, on the ground that it lacked standing because any recovery from the proceeding would provide no benefit to the estate. The district court reversed, holding that because the successor corporation was assigned the avoidance actions pursuant to the confirmed plan and the estate benefited from such assignment, the successor had standing to bring the action against the creditor. The court concluded that the estate previously benefited from the voluntary, mutual exchange, and the successor was also entitled to receive the benefit of that bargain. Burlington Motor Carriers, Inc. v. Comdata Network, Inc. (In re Burlington Motor Holdings, Inc.), 2002 U.S. Dist. LEXIS 805, - B.R. - (D. Del. January 18, 2002) (Sleet, D.J.).

Collier on Bankruptcy, 15th Ed. Revised 5:550.02[2]

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4th Cir.

Bankruptcy court erred in partially discharging debtor's student loan obligation. W.D. Va. The student loan creditor appealed the bankruptcy court's decision that partially discharged the debtor's loan obligation. The debtor was 49 years old, held a master's degree in management and was employed as a claims examiner for an insurance company. She earned a modest income and never made any voluntary payments on her student loan. Although the bankruptcy court found that the debtor had not made a good faith effort to repay the loan, the court held that it had the general equitable power under section 105 to partially discharge the debt because the debtor did not have the present ability to pay the entire debt. The district court reversed, holding that the debtor's refusal to minimize her expenses and maximize her income precluded a hardship discharge of any portion of the loan. The bankruptcy court's factual findings were correct, but in the absence of good faith, it was error to discharge any portion of the debt. Tenn. Student Assistance Corp. v. Mort (In re Mort), 2002 U.S. Dist. LEXIS 1123, 272 B.R. 181 (W.D. Va. January 18, 2002) (Jones, D.J.).

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

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5th Cir.

Chapter 13 debtors could not modify plan to provide for surrender of collateral with any resulting deficiency to constitute unsecured claim. Bankr. N.D. Tex. The chapter 13 debtors sought to modify their confirmed plan to provide for surrender of their vehicle to a credit union in satisfaction of their obligation to make payments on the credit union's secured claim. The debtors and the credit union agreed that the vehicle's current value was less than the amount of the credit union's secured claim. The debtors argued that to the extent that any deficiency that existed upon foreclosure by the credit union, the credit union was entitled to nothing more than an unsecured deficiency claim to be paid along with other unsecured creditors under the terms of the modified plan. The bankruptcy court held that the debtor's proposed plan modification could not provide for surrender of collateral with any resulting deficiency after foreclosure constituting an unsecured claim. The court explained that the credit union's lien was already stripped down under the confirmed plan, and concluded that the modification, which would cause the credit union's unsecured claim to increase by the amount of any deficiency, would alter the nature of the credit union's secured claim and, if allowed, stretch the language of section 1329(a) beyond its plain meaning. The court further stated that even if section 1329(a) was construed to allow consideration of the debtors' proposed modification, the proposed modification was unfair and the debtors' should bear the burden of depreciation. Finally, upon the facts presented, the court rejected the debtors' argument that the proposed modification was allowed by section 502(j). In re Coffman, 2002 Bankr. LEXIS 29, 271 B.R. 492 (Bankr. N.D. Tex. January 10, 2002) (Jones, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 8:1329.04

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6th Cir

Insurer did not violate automatic stay by making payments to debtor's directors under officers' and directors' liability insurance policy. Bankr. N.D. Ohio The chapter 11 debtor filed an adversary complaint against its directors that alleged breaches of fiduciary duties, negligence hiring, supervision and retention, fraud, misappropriation, conspiracy and related claims. In addition, the debtor filed a motion to enforce the automatic stay against an insurer that issued an officers' and directors' liability policy to the debtor. The debtors argued that the insurer could not make payments under the policy to the directors without violating the automatic stay. The bankruptcy court held that based on the language of the officers' and directors' liability policy issued to the debtor, the policy proceeds were not property of the debtor's estate, and any payments made by the insurer to the directors pursuant to their claims under the policy did not violate the automatic stay. The court explained that while the debtor was the named insured on the policy, the policy was for the benefit of the debtor's directors and officers. Thus, although the debtor owned the policy, it did not own the proceeds at issue. The court rejected the debtor's argument that it had a pecuniary interest in the policy, which provided indemnity coverage, because no claim was made against indemnity coverage. The court noted that the debtor had not paid any of the directors' defense costs, so it was not entitled to any reimbursement. The court also noted that the debtor had no 'entity coverage' with the insurer that would directly insure the debtor. Youngstown Osteopathic Hosp. Ass'n v. Ventresco (In re Youngstown Osteopathic Hosp. Ass'n), 2002 Bankr. LEXIS 30, 271 B.R. 544 (Bankr. N.D. Ohio January 4, 2002) (Bodoh, B.J.).

Collier on Bankruptcy, 15th Ed. Revised3:362.01

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Debtor's obligation to pay half of ex-wife's mortgage was not in the nature of spousal support. Bankr. S.D. Ohio The chapter 7 debtor's former wife filed a complaint to determine the dischargeability of the debtor's obligation to pay one-half of her monthly mortgage payment. Pursuant to the parties' divorce decree, the debtor and his former wife were equally liable for the mortgage debt on the marital residence. The state (Ohio) court specifically determined that the former wife was not entitled to spousal support, but it also concluded that requiring her to sell the house to pay the debt would very likely increase her need for spousal support. The former spouse argued that the mortgage obligation was, in effect, a support payment because the divorce decree was structured to permit her and her children to remain in the property. The bankruptcy court rejected the spouse's argument, holding that the debtor's mortgage obligation was not excepted from discharge by section 523(a)(5). The record failed to establish clearly and unequivocally that the parties intended to create a support obligation. The court concluded that the state court's express finding that the former spouse was not entitled to support was entitled to due deference. Hammermeister v. Hammermeister (In re Hammermeister), 2001 Bankr. LEXIS 1704, 270 B.R. 863 (Bankr. S.D. Ohio December 14, 2001) (Hoffman, Jr., B.J.).

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

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7th Cir.

Debtor's motion to reopen his case was denied because the court was without authority to extend deadline for filing a reaffirmation agreement. Bankr. S.D. Ind. The chapter 7 debtor moved to reopen his case so that he could file a reaffirmation agreement. The debtor had filed a statement of intention with his petition, wherein he indicated that he intended to reaffirm his debt with the creditor, which was secured by a lien on his mobile home. The debtor, however, failed to file the reaffirmation agreement before receiving a discharge, and his case was closed. The bankruptcy court denied the motion, holding that the debtor's failure to file his reaffirmation agreement prior to receiving his discharge could not be cured by reopening the case and submitting the agreement. The court noted that reaffirmation agreements entered into after entry of the discharge were unenforceable and had no legal significance (citing Collier on Bankruptcy, 15th Ed. Revised). In re Pettet, 2002 Bankr. LEXIS 34, 271 B.R. 855 (Bankr. S.D. Ind. January 16, 2002) (Coachys, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:524.04

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8th Cir.

Attorney's fee received for representation of debtor during sale of asset in contemplation of bankruptcy filing was properly disgorged. 8th Cir. The chapter 7 debtor's attorney appealed an order of the B.A.P. affirming the bankruptcy court's order to disgorge a portion of the fee paid by the debtor. Because he failed to disclose a prepetition tax-free exchange of property, the debtor was denied a discharge. The debtor's attorney represented him in the land transaction, which had been effectuated in contemplation of the bankruptcy filing. A portion of the real estate proceeds was paid to the attorney for services related to the transaction both prepetition and postpetition. The bankruptcy court concluded that the land transaction was a sham and ordered disgorgement of the portion of the fee which was not deemed to be reasonable. On appeal, the attorney argued that the bankruptcy court lacked jurisdiction to order him to disgorge the fee and that since his fee was fully earned prepetition, it was not part of the debtor's estate. The Court of Appeals for the Eighth Circuit affirmed, holding that the bankruptcy court acted within its sound discretion in ordering the attorney to return to the estate a portion of the fee paid to him. The bankruptcy court had jurisdiction to review the reasonableness of the attorney's fees and did not clearly err in finding that the representation related to a transaction in contemplation of the bankruptcy filing. The attorney also failed to prove that he was entitled to retain any fees for postpetition services because he did not seek court approval to be paid from assets of the estate. Brown v. Luker (In re Zepecki), 2002 U.S. App. LEXIS 972, 277 F.3d 1042 (8th Cir. January 25, 2002) (per curiam).

Collier on Bankruptcy, 15th Ed. Revised 3:329.03, .04

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Bankruptcy court did not have jurisdiction over postdischarge claim objection proceeding. 8th Cir. The chapter 13 debtor appealed the B.A.P. order reversing the bankruptcy court's enforcement order. After completing his plan payments and receiving a discharge, the debtor filed an objection to the student loan creditor's claim, arguing that the collection costs were excessive. The creditor did not respond and the bankruptcy court entered a default order holding that the creditor could recover only the unpaid principal and interest. When the creditor continued to attempt to recoup the collection costs, the debtor reopened his case and filed an adversary proceeding seeking enforcement of the default order. The bankruptcy court issued an order permanently enjoining the creditor from taking any action to recoup the collection costs the court had previously disallowed in its default order. The B.A.P. reversed on the basis that the bankruptcy court lacked subject matter jurisdiction over the dispute. The Court of Appeals for the Eighth Circuit affirmed the B.A.P., holding that because the debtor's challenge to the propriety of the claimed collection costs came after his discharge, the bankruptcy court did not have jurisdiction. The claim could no longer have been against the estate, and thus did not involve a right created by bankruptcy law or arising only in bankruptcy. The claim objection proceeding was not related to the bankruptcy either, because at the time the debtor objected to the claim there was no longer a plan to be confirmed, or an estate, and therefore the proceeding could not conceivably have affected his estate. McAlpin v. Educ. Credit Mgmt. Corp. (In re McAlpin), 2002 U.S. App. LEXIS 1108, 278 F.3d 866 (8th Cir. January 28, 2002) (per curiam).

Collier on Bankruptcy, 15th Ed. Revised 1:3.02, .03

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9th Cir.

Landlord was granted relief from stay to evict debtor from premises in which debtor retained a possessory interest. Bankr. C.D. Cal. The chapter 7 debtor's landlord filed a motion for relief from the automatic stay in order to remove the debtor from her apartment. The debtor had previously defaulted on her rent payments and the landlord obtained a prepetition unlawful detainer judgment against the debtor. The landlord moved for relief upon reliance of a state (California) statute that allowed it to enforce a valid writ of possession against a tenant in possession of residential property notwithstanding the tenant's bankruptcy filing. The bankruptcy court rejected the landlord's position, holding that the debtor had an equitable possessory property interest that was protected by section 362(a)(3) even after the landlord obtained an unlawful detainer judgment. Nevertheless, the landlord properly requested relief from the stay and met its burden of proof. The court further concluded that the state statute which operated in contravention of the automatic stay was preempted by section 362 and was unconstitutional. Westside Apts., LLC v. Butler (In re Butler), 2002 Bankr. LEXIS 44, 271 B.R. 867 (Bankr. C.D. Cal. January 9, 2002) (Russell, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 3:362.03[5]; 5:541.05[3]

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Order granting relief did not constitute abandonment of property. 9th Cir. The Commissioner of Internal Revenue appealed the tax court's allowance of the chapter 11 debtor's interest deduction. After the bankruptcy court lifted the automatic stay to allow foreclosure of the debtor's condominium, the property was sold for less than the outstanding balance owed to the secured creditor. The debtor reported the foreclosure sale on his own tax return for that year and claimed a deduction for interest that had accrued on the loan but had not been paid at the time of the sale. The IRS disallowed the deduction and determined a deficiency in the debtor's income tax. The tax court ruled in favor of the debtor and concluded that the lifting of the automatic stay resulted in an abandonment of the property by the estate. The tax court allowed the interest deduction because the amount realized upon the sale of property subject to nonrecourse debt included both the principal amount of the indebtedness and any accrued interest. The Court of Appeals for the Ninth Circuit reversed, holding that the order granting relief from the stay did not, as a matter of law, constitute property abandonment. The lifting of the automatic stay, without explicitly providing for abandonment, did not extinguish the estate's interest in the property and all tax consequences of the sale fell upon the estate. Therefore, the tax court's decision to allow the debtor's interest deduction was founded on an incorrect legal premise. Catalano v. Commissioner of Internal Revenue, 2002 U.S. App. LEXIS 1125, 279 F.3d 682 (9th Cir. January 28, 2002) (Thomas, C.J.).

Collier on Bankruptcy, 15th Ed. Revised3:362.07; 5:554.02

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Debtors retained the right to exempt property only up to the statutory maximum. B.A.P. 9th Cir. The chapter 11 individual debtors appealed the bankruptcy court's grant of preliminary injunction precluding them from selling shares of stock they had claimed exempt under state (California) law. On their schedules, the debtors stated their intention to exempt as many shares of a closely held company as possible, pursuant to the allowable statutory maximum. The trustee did not object to the debtors' exemption, but reserved the right to challenge the valuation of the stock. After the debtors failed to comply with the trustee's requests for financial information to verify their valuation of the shares, the trustee filed a complaint for turnover of estate property and injunctive relief. The debtors argued that the trustee could no longer challenge the value of the shares because she had not timely objected to their exemption, and as such, the shares were no longer property of the estate. The bankruptcy court granted the injunction on the grounds that the trustee had a strong probability of prevailing on the merits of the turnover complaint. The B.A.P. affirmed, holding that although the trustee was required to object to the value of the property subject to the exemption within the time constraints of Rule 4003(b), the trustee still had the right to sell the property that the debtors had claimed exempt. The exemption laws did not provide the debtors with an unassailable ownership interest in the exempt property, and their exemption in the proceeds from a sale of the shares was restricted to the statutory maximum. Since the trustee was likely to prevail on the merits, the bankruptcy court did not abuse its discretion in granting the injunction.Morgan-Busby v. Gladstone (In re Morgan-Busby), 2002 Bankr. LEXIS 38, 272 B.R. 257 (B.A.P. 9th Cir. January 7, 2002) (Ryan, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 9:4003.03

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10th Cir.

Debtor's pattern of nondisclosure resulted in denial of discharge. Bankr. N.D. Okla. The judgment creditor filed a complaint objecting to the chapter 7 debtor's discharge. The debtor failed to disclose funds received within a year of his petition from a former business associate and the coowner of his business, and failed to list his associates as creditors. The debtor also failed to list worthless stock as an asset, failed to provide information pertaining to a bank account closed within one year of his filing date, failed to disclose the foreclosure of his home and inflated his monthly expenses by listing nonexistent monthly payments. The debtor asserted that he did not list the funds received as income because the transfers were either loans or gifts from friends that were intended to help him through a difficult financial period. The debtor further claimed that he was not obligated to disclose other information because it was immaterial. The bankruptcy court denied the debtor's discharge, holding that the debtor made material statements under oath that he knew to be false, with the intent to defraud his creditors. The court applied the Tax Code's definition of 'gross income' to the debtor's disclosures in his statement of affairs and schedules, and concluded that the payments were neither loans nor gifts. The court noted that the transfers were made at fairly regular intervals in similar deposits in the debtor's bank account. The additional omissions and misstatements made by the debtor evidenced a pattern of nondisclosure or falsehood that indicated the debtor's fraudulent intent (citing Collier on Bankruptcy, 15th Ed. Revised). The Cadle Co. v. King (In re King), 2002 Bankr. LEXIS 43, 272 B.R. 281 (Bankr. N.D. Okla. January 16, 2002) (Michael, B.J.).

Collier on Bankruptcy, 15th Ed. Revised6:727.04

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11th Cir.

United States trustee's motion to dismiss chapter 7 case as 'substantial abuse' denied. Bankr. M.D. Fla. The United States trustee moved to dismiss the debtor's chapter 7 case on the grounds that granting relief to the debtor would be a 'substantial abuse' of the provisions of chapter 7. The bankruptcy court denied the United States trustee's motion. The court held that ability to pay is the primary, but not conclusive, factor in determining whether there is a substantial abuse of chapter 7; where a debtor has the ability to pay something (either because her income exceeds her expenses or because her expenses are excessive), the following factors should be considered to determine whether they militate against or in favor of dismissal: (1) whether unforeseen or catastrophic events (such as sudden illness, disability or unemployment) propelled the debtor into bankruptcy; (2) whether the debtor's standard of living has substantially improved as a result of the bankruptcy filing; (3) the debtor's age, health, dependents and other family responsibilities; (4) the debtor's eligibility for chapter 13 relief and whether creditors would receive a meaningful distribution in a chapter 13 case; (5) the age of the debts for which the debtor seeks a discharge and the period over which they were incurred; (6) whether the debtor incurred cash advances and made consumer purchases far in excess of her ability to repay; (7) whether the debtor made any payments toward her debts or attempted to negotiate with her creditors; (8) the accuracy of the debtor's schedules and statement of current income and expenses; and (9) whether the debtor filed her petition in good faith. The court also noted that it defined substantial abuse as 'that which shocks the conscience of the court.' Applying the foregoing considerations, the court found that although the debtor could likely pay something into a chapter 13 plan, granting her relief would not be a substantial abuse of the provisions of chapter 7 because a discharge would not substantially improve her standard of living, she had a chronic heart condition, her creditors would not receive a meaningful distribution in a chapter 13 case, her debts were incurred between five and ten years ago, she had made substantial payments on the debts, her schedules and statement of income and expenses were accurate, and she filed her petition in good faith. In re DeGross, 2001 Bankr. LEXIS 1694, 272 B.R. 309 (Bankr. M.D. Fla. October 22, 2001) (Funk, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 6:707.04

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