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 6, 2002

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

Collier Bankruptcy Case Summaries

Oversecured creditor entitled to prepetition and postpetition interest on claim. Bankr. D. Mass. The debtor filed her own chapter 13 petition. The petition was accompanied by incomplete schedules and an incomplete creditor matrix. One of several creditors not included on the debtor's creditor matrix was a Florida county, to whom the debtor owed property taxes. The debtor also failed to serve this creditor when she filed her proposed original plan. Additionally, although the debtor's proposed plan contained a provision to pay the creditor, the plan only provided for payment of the face amount of the creditor's scheduled claim and did not provide for any payment of interest on the taxes. After the debtor's plan was confirmed, several motions were brought, including a motion to dismiss, which was filed by the creditor. Following a hearing on the matter, the bankruptcy court denied the creditor's motion to dismiss the debtor's petition. However, the court ruled that the debtor's confirmed chapter 13 plan was not binding on the creditor to the extent that the confirmation order was entered in violation of the creditor's due process rights and that the creditor was entitled to full payment on its claim, plus interest. As to the amount of interest owed, the court found that the creditor was entitled to both prepetition and postpetition interest. Prepetition interest was to be at the rate provided for under nonbankruptcy law. Under Florida law, delinquent taxes were assessed at 18 percent interest; therefore, the court ordered that the prepetition portion of the creditor's claim be paid at this rate. Since the creditor's claim was oversecured, interest on the creditor's postpetition claim was determined based on two separate periods. First, under section 506(b), the court determined that the creditor was entitled to interest at the federal judgment interest rate from the chapter 13 petition date to the date of confirmation. Then, from the time of confirmation and until the debtor made her last plan payment, the creditor was entitled to the 'cram-down' interest rate as provided for in section 1325(a)(5)(B). The court determined that the cram-down interest rate should be determined by using the 'market rate plus' approach. Because the debt at issue involved real estate, the court took judicial notice of the annual rate of interest for a 30-year fixed-rate mortgage at the time of confirmation and added an additional 1 percent due to the debtor's default history, thus arriving at a cram-down interest rate of 8.135 percent. In re Chang, 2002 Bankr. LEXIS 170, 274 B.R. 295 (Bankr. D. Mass. March 1, 2002) (Rosenthal, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 8:1325.06[3]

Court denied debtor's motion to expunge claim filed by loan servicing company on behalf of mortgagee. Bankr. N.D.N.Y. The chapter 13 debtor objected to a proof of claim filed by a loan servicing company. The debtor argued that the proof of claim should be expunged because the company that filed the proof of claim did not own the mortgage on the debtor's residence and was not a creditor. The debtor did not dispute the loan servicing company's right, as a servicing agent, to file a proof of claim on behalf of the mortgagee. However, the debtor argued that the proof of claim was not valid because it failed to identify the actual owner of the claim. The bankruptcy court denied the debtor's motion seeking expungement of the claim. First, the court held that the loan servicing company was a party in interest because of its pecuniary interest in the mortgages it serviced (including the mortgage on the debtor's residence), and, as such, had standing to object to the debtor's motion to expunge the claim. Next, the court held that the loan servicing company was authorized to file the proof of claim as the agent of either the owner or the mortgagee, and to allow the debtor to expunge the claim based on the company's failure to disclose its principal would elevate form over substance. The court allowed the loan servicing company 15 days from the entry of its order to amend its proof of claim to identify the actual creditor. In re Viencek, 2002 Bankr. LEXIS 167, 273 B.R. 354 (Bankr. N.D.N.Y. February 15, 2002) (Gerling, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:502.02[2][c]

Prepetition settlement of fraud and tort claims extinguished creditors' subsequent nondischargeability claims. 4th Cir. The creditors appealed the district court's order affirming the bankruptcy court's decision that upheld the chapter 7 debtor's affirmative defense to their nondischargeability action. The debtor and her husband had sold the assets of a corporation they owned to a corporation formed by the creditors. The creditors filed suit in state (North Carolina) court for fraud, intentional misrepresentation and intentional infliction of emotional distress due to the debtor's alleged misconduct arising out of the sale. The parties entered into a settlement agreement that released the claims against the debtor in exchange for $200,000 cash and a $100,000 promissory note. After the debtor defaulted on the note and sought bankruptcy protection, the creditors filed an adversary proceeding seeking a judgment for the amount due under the promissory note and a determination that such indebtedness was nondischargeable under sections 523(a)(2)(A) and (a)(6). The bankruptcy court upheld the debtor's affirmative defense that the releases and settlement agreement created a novation, substituting a dischargeable contract debt for a fraud-based tort claim, which may not have been dischargeable, and the district court affirmed. The Court of Appeals for the Fourth Circuit affirmed, holding that the prepetition settlement of claims involving alleged fraud and intentional tort extinguished the creditors' subsequent nondischargeability claim under section 523(a) when the debtor filed for bankruptcy without having paid the entire amount of the settlement. The court noted a split among the circuits and followed the novation theory, under which courts need only address the validity and completeness of the bargained-for agreement and release. The parties' prepetition settlement completely released the debtor from potential nondischargeability claims. Archer v. Warner (In re Warner), 2002 U.S. App. LEXIS 3678, 283 F.3d 230 (4th Cir. March 8, 2002) (Widener, C.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:523.06, .08[1]

Portion of debtor's student loan obligations spent on living and social expenses was nondischargeable. 5th Cir. The chapter 7 debtor appealed the ruling of the district court that affirmed the bankruptcy court's order barring him from discharging his student loans. The lender had disbursed the loans to the schools based upon the debtor's purported needs, and the schools withheld tuition and expenses and gave the debtor the remainder for discretionary spending. The debtor used the money to pay for a car, housing and food, as well as to pay fraternity dues and other ordinary living expenses. The debtor contended that the portion of the student loans spent on living expenses was nondischargeable. The bankruptcy court held that section 523(a)(8) barred the debtor from discharging any of the loans because he obtained them to finance his education and signed promissory notes reflecting that purpose, and the district court affirmed. The Court of Appeals for the Fifth Circuit affirmed, holding that because the student loans were made available for educational purposes, no part of the loans could be discharged, regardless of the actual use of the funds. It was the purpose, not the use, of the loans that controlled, and the debtor had taken out the loans to support his full-time attendance at school. Because Congress had defined living expense allowances as serving an educational purpose in the student loan statutes, the court assumed it also interpreted those living expense allowances as having an educational purpose in relation to the Bankruptcy Code. Murphy v. Pa. Higher Educ. Assistance Agency (In re Murphy), 2002 U.S. App. LEXIS 3415, 282 F.3d 868 (5th Cir. March 5, 2002) (Smith, C.J.).

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

Summary judgments in favor of law firm sued by debtor's shareholders and successor in interest were affirmed on appeal. 6th Cir. The chapter 11 debtor's successor in interest and its minority shareholders appealed the district court's grant of summary judgments in favor of a law firm they had sued for breach of fiduciary duty and legal malpractice. The firm had represented the debtor's majority shareholder and had successfully negotiated a settlement agreement and release of the debtor's claims against its client. The minority shareholders and successor alleged that the firm procured the settlement by fraud, and its actions contributed to the financial distress and resulting bankruptcy of the debtor. The district court held that their claims against the firm were barred by res judicata because they failed to raise or reserve their claims before the confirmation of the debtor's plan of reorganization. The Court of Appeals for the Sixth Circuit affirmed, holding that the district court did not err in concluding that the claims of the debtor's successor in interest and minority shareholders were barred by the res judicata effect of the confirmation order. The confirmation order was a final judgment for the purposes of res judicata. The court noted that the claims should have been raised or reserved prior to confirmation because they were 'related to' the bankruptcy case, since any recovery would have been available for the debtor's creditors and shareholders. The successor's blanket reservation of rights to enforce causes of action against any entity did not defeat the application of res judicata to its claims against the law firm. Browning v. Levy, 2002 U.S. App. LEXIS 3768, 283 F.3d 761 (6th Cir. March 12, 2002) (Gilman, C.J.).

Collier on Bankruptcy, 15th Ed. Revised 7:1123.02[3]

Secured creditor entitled to reconsideration of claim. Bankr. C.D. Ill. The chapter 11 debtor's liquidating agent moved for approval of an interim distribution and for disallowance of various claims. Among the claims at issue was a claim held by a secured creditor that the liquidating agent acknowledged as valid, but contested in amount. The court file reflected that the liquidating agent's objection to the secured creditor's claim was mailed to the secured creditor, and was ultimately sustained based upon the secured creditor's failure to file a response. The secured creditor objected to the liquidating agent's proposed distribution. The creditor alleged, among other things, that it did not receive entry of the order that denied its claim, and that it had numerous contacts with the liquidating agent after the denial of its claim, and no mention was ever made of the claim's disallowance. The bankruptcy court sustained the secured creditor's objection to the proposed distribution, recharacterized the relief sought by the secured creditor as reconsideration of a claim under section 502(j), and held that the claim was entitled to reconsideration. The court noted that the length of the creditor's delay in seeking relief in this case was tempered by its continued contact with the liquidating agent and his attorney during the relevant period, that the liquidating agent had not alleged any prejudice and the court could discern none, and that there was no evidence of the secured creditor's lack of good faith. The court also noted that since the liquidating agent objected to other claims in his proposed distribution, the claims allowance/disallowance process was not yet complete. The deciding factor for the court, however, involved the secured creditor's assertion that it never received notice of the liquidating agent's objection to its claim or the court order that disallowed its claim. In re Van Dyke, 2001 Bankr. LEXIS 1808, - B.R. - (Bankr. C.D. Ill. July 24, 2001) (Altenberger, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:502.11

Lien held by class of unsecured creditors was subordinated to secured creditor's lien. Bankr. W.D. Mo. A secured creditor filed an adversary proceeding to determine, among other things, the priority of its lien on equipment owned by the chapter 11 debtor vis-a-vis a class of unsecured creditors. The specific issue before the court was whether the secured creditor's security interest, which remained attached to the equipment even though it became unperfected under state (Missouri) law upon the lapse of the creditor's financing statements, retained its priority against the junior lien of the unsecured creditor class. The bankruptcy court held that the lien held by the class of unsecured creditors was subordinated to the secured creditor's lien. The court noted that the trustee had full knowledge of the secured creditor's lien and did not extend new credit to the debtor based on the lapse of perfection. In addition, both the secured creditor and the unsecured creditor class participated in the plan confirmation process and agreed, as participants, that the secured creditor would have a secured interest and that the unsecured creditor class would have a secured interest subordinated to that of the secured creditor. The court concluded that as between the parties, the plan was controlling. Thus, no perfection was necessary, and the secured creditor held a security interest in the equipment that was prior to that of the unsecured creditor class. The court also found that the debtor was in default to both the unsecured creditors and the secured creditor; thus, the unsecured creditor class had the right to foreclose its interest as long as it satisfied the secured creditor's claim. Gen. Elec. Cap. Corp. v. Dial Bus. Forms, Inc. (In re Dial Bus. Forms, Inc.), 2002 Bankr. LEXIS 158, 273 B.R. 594 (Bankr. W.D. Mo. February 5, 2002) (Federman, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:506.01

ABI Members, click here to get the full opinion.

Unanimity rule applied to removal action where federal subject matter jurisdiction was based on related-to jurisdiction. S.D. Iowa After a state court action was filed against several defendants, one of the defendants removed the action to federal court based on federal question jurisdiction and related-to jurisdiction because one of the other defendants had already petitioned for bankruptcy. Several other defendants joined the notice of removal within the allowed 30-day joinder period. However, two defendants joined after their 30-day window had expired and three defendants did not join the notice of removal. Some other defendants were excused from the joinder as the record reflected that they were not served at the time the moving defendant filed its notice of removal. Following the filing of the notice of removal, the plaintiffs in the action filed a motion to remand the case back to state court, arguing that the district court lacked personal and subject matter jurisdiction over the matter. After a hearing, the district court ruled that the defendants claiming federal subject matter jurisdiction based on related-to jurisdiction had the burden of establishing that the joinder requirement for removal had been satisfied. Focusing on the unanimity rule, the court noted that all defendants were required to join the removal petition in order to effect removal, unless one of three exceptions applied. Based on the facts, the court determined that it lacked subject matter jurisdiction over the case because none of the exceptions to the unanimity rule applied to the three nonjoining defendants and, accordingly, granted the plaintiffs' motion to remand the case to state court. Ross v. Thousand Adventures of Iowa, Inc., 2001 U.S. Dist. LEXIS 22965, 178 F. Supp.2d 996 (S.D. Iowa September 20, 2001) (Longstaff, D.J.).

Collier on Bankruptcy, 15th Ed. Revised 1:3.07[4]-[5]

ABI Members, click here to get the full opinion.

Bankruptcy court's denial of chapter 11 trustee's requested surcharge was upheld on appeal. B.A.P. 9th Cir. The chapter 11 trustee appealed the bankruptcy court's denial of his motion to surcharge a secured creditor's collateral under section 506(c). The creditor had obtained notices of levy and writs of execution against the debtor's parcels of real estate, but the debtor filed his petition before the execution sale. The trustee disputed the validity of the creditor's lien and subsequently sold the parcels free and clear of encumbrances. The bankruptcy court granted the creditor's counterclaim for turnover of the sale proceeds, and the trustee filed a surcharge motion, asking for fees and costs, as well as attorney's fees and costs, that he incurred in preserving and selling the parcels. The bankruptcy court denied the motion on the grounds that the services and costs of the trustee and his counsel did not provide a quantifiable benefit to the creditor. The B.A.P. affirmed, holding that the trustee failed to prove that his services provided a benefit to the secured creditor. Although the trustee argued that the creditor benefited from the sale of the properties because it did not have to incur any of the costs of sale, he failed to prove what it would have cost the creditor to restart the sheriff's sales and dispose of the properties. Without proof of what the creditor's disposal costs would have been, the benefit to the creditor was merely hypothetical. Golden v. Chicago Title Ins. Co. (In re Choo), 2002 Bankr. LEXIS 159, 273 B.R. 608 (B.A.P. 9th Cir. February 8, 2002) (Brandt, B.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:506.05

IRS allowed to submit a Summary Record of Assessment in support of proof of claim. D.N.M. After the debtor filed for bankruptcy relief, the IRS filed a proof of claim for unpaid taxes for various years. The proof of claim was supported by several 'Summary Record of Assessments' or '4340' computer data reports, which were certified and showed the assessment or '23C' dates. The debtor objected to the IRS's proof of claim, arguing that the claim was invalid absent production of the actual, signed underlying '23C' forms. The bankruptcy court overruled the debtor's objection and allowed the proof of claim to stand. The debtor appealed, arguing that the 4340 forms submitted by the IRS could not be used as substitutes for the 23C forms because the 4340 reports were not 'duly certified by the seal of the district director' as required by 26 C.F.R. Part 301.7514. The magistrate court found that the debtor's argument was without merit because, in addition to being waived because it had not been raised before the bankruptcy court, the copies of the certification pages for the 4340 exhibits contained the required seal. The magistrate court then recommended that the bankruptcy court's ruling be affirmed and the appeal be dismissed. March v. IRS (In re March), 2002 U.S. Dist. LEXIS 3448, - B.R. - (D.N.M. January 2, 2002) (Molzen, M.J.).

Collier on Bankruptcy, 15th Ed. Revised 4:502.03[1]

Court halted local custom which violated Code provisions regarding professional compensation. Bankr. M.D. Ala. Eight professionals employed by the chapter 11 debtor in possession billed and received over $200,000 for services without applying for approval or disclosing the payments. When the bankruptcy court issued an order to show cause, the bankruptcy attorney returned the funds to the debtor, but argued that so long as an 'award' of fees was ultimately made, receipt during the case was proper. The attorney also argued that local custom permitted billing and receipt of funds during the case without court approval. Following an in-depth discussion of the policies and obligations set forth in the Code and Rules, and in an effort to halt the apparently widespread 'local custom,' the bankruptcy court held that sanctions for violation of numerous fee disclosure and application procedures were warranted. Even if a local custom existed by which professionals could, without court approval, bill and receive payments from debtors, the custom could not override the Code. Moreover, the attorneys hired for a special purpose pursuant to section 329(e) had an independent duty to comply with the Code and could not merely claim reliance upon the advice of the bankruptcy attorney. Their assertion, however, could be considered in the sanctions phase of the proceeding. To rectify the purported custom, the court required that all funds paid to professionals without court approval be turned over to the clerk of the court; full disclosure be made; and the professionals properly apply for payment whereupon the court would consider, on a case-by-case basis, appropriate sanctions. In re Tri-State Plant Food, Inc., 2002 Bankr. LEXIS 118, 273 B.R. 250 (Bankr. M.D. Ala. February 6, 2002) (Sawyer, B.J.).

Collier on Bankruptcy, 15th Ed. Revised