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.

May 27, 2002

CASES IN THIS ISSUE
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Collier Bankruptcy Case Summaries

Bankruptcy court's judgment that creditor violated the automatic stay by imposing conditions on reaffirmation agreement was reversed. 1st Cir. The credit union appealed the B.A.P.'s order affirming the bankruptcy court's finding that it had violated the automatic stay. The indebtedness to the credit union consisted of a promissory note secured by a first mortgage on the chapter 7 debtors' residence, as well as unsecured personal loans and credit cards. When the debtors sought to reaffirm the mortgage obligation, the credit union responded that it would not enter into a reaffirmation agreement unless the debtors agreed to reaffirm their unsecured indebtedness. The debtors then commenced an adversary proceeding charging the credit union with a violation of the automatic stay. The bankruptcy court concluded that the credit union's efforts to condition reaffirmation of the mortgage debt upon the simultaneous reaffirmation of other unsecured debts violated the automatic stay. The bankruptcy court determined that the credit union's insistence upon linkage constituted an impermissible coercive attempt to 'strong-arm' the debtors into reaffirming their separate, unsecured obligations and that the credit union had engaged in prohibited conduct by threatening to foreclose on the debtors' home. The bankruptcy court compelled reaffirmation of the mortgage debt on its original terms and awarded attorney's fees and costs to the debtors. The B.A.P. affirmed the judgment. The Court of Appeals for the First Circuit reversed, holding that the credit union did not violate the automatic stay by conditioning reaffirmation of the mortgage indebtedness upon the reaffirmation of separate, unsecured obligations. The court rejected the lower courts' rulings that a creditor's refusal to reaffirm a secured debt unless the debtor simultaneously agrees to reaffirm additional, unsecured debts constitutes a per se violation of the automatic stay. Because the record did not support the additional findings that the credit union engaged in impermissibly coercive conduct, the bankruptcy court lacked the power to modify the reaffirmation agreement or award monetary sanctions (citing Collier on Bankruptcy, 15th Ed. Revised). Jamo v. Katahdin Fed. Credit Union (In re Jamo), 2002 U.S. App. LEXIS 4987, 283 F.3d 392 (1st Cir. March 26, 2002) (Selya, C.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:524.04; 3:362.03[8]

Proceeds from the sale of merchandise sold pursuant to a licensing agreement deemed property of the estate. Bankr. S.D.N.Y. In 1987, the debtor licensed a shoe company to operate shoe departments within its department stores. The shoe company owned all of the shoes and related merchandise sold in the debtor's stores. Under the agreement, all shoe sales were to be processed through the debtor's cashiers and the sale proceeds were to be processed through the regular channels of the debtor's business. The debtor was to keep separate books and records of all of the shoe company's sales and was to maintain the sale proceeds in a separate account. The debtor was to provide weekly statements of sales and pay the shoe company the balance after deducting commissions and other charge-backs. In practice, the debtor's sale proceeds and the shoe company's proceeds were placed in the same cash registers and bank accounts. In 1990, the debtor filed for chapter 11 relief and assumed the contract with the shoe company. The assumption did not change the way the debtor prospectively handled funds from the shoe company's sales. In February 2001, and with the debtor's consent, the shoe company assigned the license agreement to the creditor. In August 2001, the debtor and certain of its affiliates again filed for chapter 11 relief. In September 2001, the creditor commenced an adversary proceeding against the debtor seeking the return of $8.9 million related to the creditor's shoe sales. The creditor argued that the $8.9 million was the creditor's property and was not property of the estate based on contract, agency, trust and constructive trust principles. The debtor defended against the action, arguing that the creditor was merely an unsecured creditor and that the use of the words 'trust' or 'agent' in the licensing agreement did not create a valid trust or agency where the debtor was allowed to commingle monies and was not required to pay over funds immediately or on demand. As to the creditor's contract theory, the bankruptcy court found that the creditor failed to rebut the presumption that title and ownership of the net sales proceeds vested in the debtor upon deposit in the debtor's bank accounts. The court further found that the creditor and its assignee had ample opportunity to address any concerns over the debtor's treatment of the net sales proceeds but had failed to do so. On the agency theory, the court found that the original parties to the licensing agreement did not contemplate that the net sales proceeds would be placed into a segregated bank account and that the debtor was not the creditor's agent because the creditor had no right to control the debtor's collection or remittance of the net sales proceeds. On the theory of express trust, the court similarly found that no trust relationship existed because the licensing agreement did not require that the net sale proceeds be maintained in a separate account and, indeed, the funds were commingled with the debtor's other income. The creditor's argument for a constructive trust and for equitable subrogation also failed because the court found that the debtor owed no fiduciary duty to the creditor. Accordingly, the court ruled that the funds at issue were property of the debtor's bankruptcy estate. LFD Operating, Inc. v. Ames Dep't Stores, Inc. (In re Ames Dep't Stores, Inc.), 2002 Bankr. LEXIS 226, 274 B.R. 600 (Bankr. S.D.N.Y. March 8, 2002) (Gonzales, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 5:541.06, .09

Court of Appeals affirmed district court order that affirmed bankruptcy court's dismissal of involuntary petition. 3d Cir. A petitioner appealed from a district court order that affirmed the bankruptcy court's dismissal of an involuntary chapter 7 petition filed against two entities. The bankruptcy court dismissed the petition because it found that it did not satisfy the statutory requirements and was filed in bad faith. The Court of Appeals for the Third Circuit affirmed. The court held that the bankruptcy court properly dismissed the involuntary petition under section 303(h) after it correctly concluded that the claim was the subject of a bona fide dispute. The court noted that the claim at issue had been seriously contested in many rounds of state court litigation. The court also found that the bankruptcy court was justified in dismissing the involuntary petition under Third Circuit case law that permitted dismissal when petitions were filed in bad faith, which was specifically found in this case. Finally, the court found that the bankruptcy court properly exercised its discretion to impose reasonable attorney's fees and costs under section 303(i). Shinko v. Miele, 2002 U.S. App. LEXIS 4556, - F.3d - (3d Cir. March 19, 2002) (per curiam).

Collier on Bankruptcy, 15th Ed. Revised 3:303.14[c]

Creditor's adversary proceeding and activities during debtors' bankruptcy case served as informal proof of claim. Bankr. D.S.C. A creditor filed a motion seeking to file a late claim in the debtors' chapter 7 case. The creditor alleged that he was not listed in the debtors' initial filing with the court and did not receive notice to file a claim. The creditor also asserted that his filing of a late claim should be permitted because he participated extensively in the debtors' bankruptcy case, as evidenced, in part, by his timely filing of a dischargeability adversary proceeding. The bankruptcy court held that it lacked discretion to allow the creditor to file a late claim, but that the creditor's adversary proceeding, as well as his activities during the debtors' bankruptcy case, served as an informal proof of claim. The court also held that the creditor's informal proof of claim could be amended. The court found that the creditor affirmatively acted to alert the debtors, the chapter trustee and other parties of his claim even though he did not file a formal proof of claim within the proper time period. The court noted the following elements sufficient to establish a claim as an informal proof of claim: (1) the claim must be in writing; (2) the writing must contain a demand by the creditor on the debtor's estate; (3) the writing must evidence an intent to hold the debtor liable for such debt; (4) the writing must be filed with the bankruptcy court; and (5) based upon the facts of the case, allowance of the claim must be equitable under the circumstances. In re Delacruz, 2002 Bankr. LEXIS 218, - B.R. - (Bankr. D.S.C. January 23, 2002) (Waites, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:502.02[1][b]

Debtor could not dismiss adversary proceeding that was ready for trial. Bankr. S.D. Tex. After the debtor filed for chapter 13 relief, the IRS filed a proof of claim asserting claims for unpaid federal income taxes for the years 1995 through 1999. The debtor objected to the proof of claim, arguing that the taxes assessed for the tax years 1996 and 1997 were not priority claims, but were only unsecured claims. However, the debtor did not address the amount of the claims or the allocation of any payments made by the debtor. The IRS responded to the objection and filed a motion requesting invocation of the bankruptcy rules applicable to adversary proceedings. The court issued a written scheduling order setting a discovery cutoff date, requiring a pretrial order and setting a trial date of March 5, 2002. The scheduling order also required a separate listing of stipulated and disputed facts. According to the bankruptcy court, in a very professional and competent way, counsel for the debtor and the IRS defined the dispute and limited the hearing to matters that were actually disputed. Specifically, the IRS contended that the taxes due for the tax years 1996 and 1997 were priority taxes because the three-year look-back period was tolled by the debtor's prior bankruptcies. The debtor contended that tolling did not apply as a matter of law and that the facts did not support equitable tolling. The day prior to trial, the Supreme Court decided Young v. United States, 122 S. Ct. 1036 (2002), holding that tolling applied as a matter of law and that the factual circumstances, such as the good faith or intent of the debtor, are inconsequential. Given the facts of the debtor's case and the ruling in Young, the bankruptcy court was prepared to render a decision in favor of the IRS, but counsel for the debtor asked the court to withhold entry of an order to allow him additional time to consider the decision in the Young case. The court denied the request, and counsel for the debtor then moved to withdraw the debtor's objection to the IRS claim, rather than have the court adjudicate it. Counsel for the debtor also indicated that, if allowed to withdraw his existing objection to the IRS's claim, he might file another objection that would challenge the application of tax payments made by the IRS. Because such an objection would contradict facts and conclusions to which the debtor had stipulated in the joint pretrial order, the IRS objected to the debtor's request to withdraw the claim objection and requested issuance of an order adjudicating the allowance and amount of its claim. After consideration, the bankruptcy court found that Rule 7041, which adopts Fed. R. Civ. P. 41 in adversary proceedings, required that, after a response had been filed, the debtor's objection to the IRS's claims could be withdrawn without order of the court and could only be withdrawn upon such terms and conditions as the court deemed proper. Accordingly, the court denied the debtor's request to withdraw the objection after finding that it would be inequitable to allow the debtor to withdraw the objection at the commencement of trial merely to avoid adverse adjudication. The court then adjudicated the debtor's objection to the claims and ruled that the IRS's claims were allowed in the amount specified in its proof of claim. In re Wotkyns, 2002 Bankr. LEXIS 220, 274 B.R. 690 (Bankr. S.D. Tex. March 5, 2002) (Steen, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 10:7041.01
 

Bankruptcy court's order permitting creditors to proceed with late-filed complaint was reversed. B.A.P. 6th Cir. The debtor appealed the bankruptcy court's order permitting two creditors to proceed with their complaint to determine the dischargeability of a debt, despite the fact that the complaint was filed two days late. The bankruptcy court invoked section 105(a) and its equitable powers to extend the deadline by two days, finding that the creditors' attorney had mailed the complaint by regular mail to the office of the bankruptcy court clerk in what should have been sufficient time to assure its arrival on the filing deadline. The bankruptcy court further found that counsel's expectation of a timely filing was reasonable and that she did not intend any delay. The B.A.P. reversed, holding that the bankruptcy court erred in allowing the creditors to file their dischargeability complaint two days past the deadline provided for in Rule 4007(c). The B.A.P. concluded that the Supreme Court's discussions of the strict operations of Rule 4003(b) in Taylor v. Freeland & Kronz, 503 U.S. 638 (1992), and Fed. R. Crim. P. 29(c) in Carlisle v. United States, 517 U.S. 416 (1996), applied to Rule 4007(c). The only recognized exception to the time limitation in Rule 4007(c), where the court itself made an error that resulted in the untimely action of a creditor, was inapplicable. Ohio Farmers Ins. Co. v. Leet (In re Leet), 2002 Bankr. LEXIS 232, 274 B.R. 695 (B.A.P. 6th Cir. March 26, 2002) (Cook, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 9:4007.04

Granting of debtors' discharge was reversed on appeal. 7th Cir. A lien creditor appealed the decision of the district court that affirmed the bankruptcy court's judgment granting the chapter 7 debtors' discharge. After the creditor was granted costs for demolishing the debtors' condemned real estate, as well as a lien on the debtors' property, the debtors conveyed several lots that they owned, by quitclaim deed, for $1 and love to their grandchildren. The creditor filed a supplemental motion in state (Illinois) court to set aside the transfers under the Uniform Fraudulent Transfer Act, and the debtors filed their petition the following month. Although the debtors disclosed the transfers in their petition, they only testified about the transfers at the meeting of creditors after the trustee specifically inquired about the lots. After the creditor filed an objection to the debtors' discharge under section 727(a)(2), the debtors' grandchildren reconveyed the lots back to the debtors. The bankruptcy court granted the discharge, finding that the debtors' subsequent remedial conduct of disclosing and recovering the properties negated the prepetition conduct, and the district court affirmed. The Court of Appeals for the Seventh Circuit reversed, holding that the debtors' attempts to remedy their fraud by disclosing the prepetition transfers and reconveying the transferred property postpetition did not cure their intent to hinder, delay or defraud the creditor under section 727(a)(2). The court noted that the debtors recovered the property well after the creditor discovered the transfers and filed an action to set them aside. Village of San Jose v. McWilliams, 2002 U.S. App. LEXIS 5057, 284 F.3d 785 (7th Cir. March 27, 2002) (Bauer, C.J.).

Collier on Bankruptcy, 15th Ed. Revised 6:727.02

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Seventh Circuit affirmed denial of debtors' discharge for failure to keep adequate records. 7th Cir. In 1994, the debtors took out two lines of credit with the creditor, a bank. The credit lines had a limit of $19 million. Over the next year, the debtors borrowed an additional $9 million from the bank. The loans, which were used to fund the purchase of three businesses and a $4 million house, were secured with 2.5 million shares of stock in a casino. At its high point, the shares of stock sold for $36 per share, but by 1997, the stock had fallen to under $3 per share. The creditor sold the shares and obtained a lien on almost all of the debtors' property. It also demanded repayment of the outstanding loans, which were then at $12 million. After the debtors' filed for chapter 7 relief, the creditor filed an objection to discharge, arguing that the debtors had failed to provide enough information for the creditor to ascertain the debtors' financial condition and track their financial dealings with substantial completeness and accuracy for a reasonable period. At a hearing on the matter, the debtors admitted that they did not keep many records of their financial transactions and that they had disposed of other financial records when they moved. The bankruptcy court granted the creditor's objection to discharge, holding that the debtors failed to keep adequate records as required by section 727(a)(3). The district court affirmed and the debtors appealed, arguing that the equities favored a discharge because they would otherwise face more than $15 million in debt and there was no evidence that they intended to defraud their creditors. After reviewing the record and noting that a discharge in bankruptcy is a privilege and not a right, the Seventh Circuit found that the bankruptcy court did not abuse its discretion in denying the debtors' discharge and affirmed the rulings of the lower courts. Union Planters Bank, N.A. v. Connors, 2002 U.S. App. LEXIS 4564, 283 F.3d 896 (7th Cir. February 21, 2002) (Flaum, C.J.).
Collier on Bankruptcy, 15th Ed. Revised 6:727.03

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Debtor's interest in ERISA-qualified retirement plan was not property of estate. B.A.P. 8th Cir. Prior to filing for chapter 7 relief, the debtor was awarded an interest in his former spouse's ERISA-qualified retirement plan in the approximate amount of $71,000, pursuant to a divorce decree and domestic relations order. The debtor filed for bankruptcy before receiving any distributions from the retirement plan. In his bankruptcy case, the debtor asserted that his interest in the plan was either not property of the estate or, alternatively, that it was exempt under section 522. The bankruptcy court ruled that the interest was property of the estate and not exempt, except in the amount of $4,525.00, which was the remaining sum available under the debtor's wildcard exemption. The debtor appealed the ruling that his interest in the plan was property of the estate, arguing that the Supreme Court's holding in Patterson v. Shumate, 504 U.S. 753 (1992) (which held that a debtor's interest in an ERISA-qualified retirement plan excluded from the bankruptcy estate pursuant to section 541(c)(2) should be extended to an interest in such a plan when the interest is acquired pursuant to a marital dissolution proceeding). The B.A.P. for the Eighth Circuit agreed with the debtor, ruling that the debtor's interest in the retirement plan fell under the protective umbrella of the Supreme Court's Patterson decision and was excluded from the bankruptcy estate since the debtor was a beneficiary of the ERISA-qualified plan and his beneficial interest was subject to the antialienation provisions of ERISA. Nelson v. Ramette (In re Nelson), 2002 Bankr. LEXIS 221, 274 B.R. 789 (B.A.P. 8th Cir. March 21, 2002) (Koger, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 5:541.07[1]

Bankruptcy court's use of section 105 to deny debtor's discharge was abuse of discretion. B.A.P. 9th Cir. The chapter 7 debtor appealed the bankruptcy court's sua sponte denial of his discharge under section 105(a). The creditor's complaint objecting to the debtor's discharge consisted mainly of quotations of the pertinent subsections of section 727, with some sparse factual allegations that the debtor transferred property, including assets of a business, for less than reasonable value. The sufficiency of the complaint was not questioned by motion or otherwise before trial, and the debtor did not object to the trial evidence as being beyond the scope of the pleadings. The evidence adduced at trial revealed, among other things, that the debtor had lied under oath about his interest in real estate, filed schedules and statements that were not accurate and had no records of income and multiple refinancing of the real property. The bankruptcy court concluded that although the creditor demonstrated at trial that the debtor was not entitled to a discharge under section 727, the complaint was too conclusory in nature to support such a judgment. The bankruptcy court instead denied the discharge under section 105(a). The B.A.P. vacated the order and remanded the proceedings, holding that the denial of the debtor's discharge under section 105(a) was in error. It was neither necessary nor appropriate to use section 105 to trump section 727, especially in view of the straightforward alternatives available under the Federal Rules of Civil Procedure to amend the pleadings. The B.A.P. pointed out that Fed. R. Civ. P. 15(b) permitted the pleadings to be amended to conform to the evidence upon the express or implied consent of the parties. Yadidi v. Herzlich (In re Yadidi), 2002 Bankr. LEXIS 231, 274 B.R. 843 (B.A.P. 9th Cir. February 26, 2002) (Klein, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 2:105.01, .05

Bankruptcy court did not err in not accepting expert's testimony on his definition of 'ordinary course of business.' D. Utah After the debtor filed for chapter 11 relief, the creditor sought administrative expense priority for certain expenses. The matter was set for trial and the creditor sought to introduce testimony of its former principal concerning his personal business practices. The creditor also sought to offer expert testimony of a nonlawyer on his definition of 'ordinary course of business.' The bankruptcy court declined to hear the testimony of both individuals, and the creditor appealed the bankruptcy court's evidentiary rulings. On appeal, the district court found that the rulings were within the court's discretion and that they were sound based on the reasons articulated by the court in its decision. Specifically, as to the testimony regarding the definition of 'ordinary course of business,' the district court found that the proffered opinion was based on the meaning of the law and that the bankruptcy court was free to recognize that the 'expert' was not a legal expert. The district court also found that it would not have been proper for the court to accept expert legal testimony in its proceedings, when such testimony should have come from the creditor's attorneys in the course of the normal adversarial process. Because the legal conclusions of the proffered expert would not have been useful or appropriate for the bankruptcy court to hear, the district court affirmed the bankruptcy court's ruling denying administrative expense priority to the creditor. In re Husting Land & Dev., Inc., 2002 U.S. Dist. LEXIS 4092, 274 B.R. 906 (D. Utah January 30, 2002) (Benson, D.J.)
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Collier on Bankruptcy, 15th Ed. Revised 3:364.02