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A Showing of Gross Recklessness Satisfies Section 523(a)(2)(A): Denying Deceivers the Ability to Discharge Debts Related to Fraudulently Obtained Funds

By: Megan Kuzniewski

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

11 U.S.C. Section 523 lists certain debts that may not be discharged by a debtor’s bankruptcy.[1] In particular, 11 U.S.C. Section 523(a)(2)(A) (“Section 523(a)(2)(A)”) provides that a debtor who files a bankruptcy will not be discharged of debts that were obtained by “false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition.”[2] False representations, such as those described in Section 523(a)(2)(A), carry a scienter requirement which requires that it be shown that an individual knowingly made false statements or representations.[3] In In re Bocchino , the Court of Appeals for the Third Circuit found that gross recklessness satisfies the scienter requirement of Section 523(a)(2)(A).[4] In S.E.C. v. Bocchino , the Securities and Exchange Commission (the “SEC”) filed a lawsuit against Bocchino, a stockbroker, in the District Court of the Southern District of New York.[5] The district court found Bocchino civilly liable for “inducing investors via high pressure sales tactics and material misrepresentations” and entered a judgment against him totaling $178,967.55, including disgorgement of fees, interest, and civil penalties.[6] Thereafter, Bocchino filed for chapter 13 bankruptcy protection.[7] The SEC petitioned the bankruptcy court for a judgment declaring the judgments against Bocchino nondischargeable under Section 523(a)(2)(A).[8] The SEC argued that Bocchino had obtained the funds “by… false pretenses, a false representation, or actual fraud.”[9] Bocchino had sought investors for two ventures that turned out to be fraudulent.[10] He began seeking out investments without doing any independent research into the ventures, despite there being cause for suspicion.[11] The bankruptcy court found that, although “Bocchino did not knowingly make any false statements,” the scienter requirement of Section 523(a)(2)(A) “may be satisfied by grossly reckless behavior.”[12] The bankruptcy court discharged the civil penalty portion of the judgment but concluded that the remaining portions of the judgment were nondischargeable under Section 523(a)(2)(A).[13] Bocchino appealed this finding.[13] On appeal, the district court affirmed the bankruptcy court’s decision,[15] and thereafter, the Third Circuit also affirmed the lower court.[16]

The Great Euro Siphoning Stratagem: In re Hellas Telecommunications (Luxembourg) II SCA

By: Peter Collorafi

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In August 2015, the United States Bankruptcy Court for the Southern District of New York determined, inter alia, that the Joint Compulsory Liquidators for Hellas Telecommunications (Luxembourg) II SCA (“Hellas II”) could amend their original complaint to include a foreign fraudulent transfer claim under Section 423 of the United Kingdom Insolvency Act of 1986 (“Section 423”) against certain United States defendants. The plaintiffs filed their initial complaint seeking to avoid and recover an initial transfer of approximately €1.57 billion made by Hellas II to its parent entity and a subsequent series of transfers totaling €973.7 million made to several named defendants and an unnamed class of transferees. The plaintiffs’ initial complaint contained actual and constructive fraudulent transfer claims under New York law in addition to an unjust enrichment claim under unspecified law. The court dismissed the plaintiffs’ New York law fraudulent transfer claims for lack of standing and, consequently, the plaintiffs sought to amend their complaint.

Contract Interpretation Governs Success Fee Dispute

By: Nicolas Berg

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In certain instances, a professional, such as a financial advisor, may contract the right to receive a “success fee” from a debtor in bankruptcy.[1] The courts have established different tests for awarding a success fee.[2] In In re Valence Technology , the United States District Court in the Western District of Texas held that KPMG was entitled to a success fee from Valence Tech for closing a $50 million dollar debt-equity conversion, but it was not entitled to a similar fee for closing a $20 million capital loan.[3] After filing for chapter 11 bankruptcy, Valence Tech hired KPMG to assist with necessary financial restructuring advice.[4] Pursuant to their agreement, if KPMG’s work resulted in “any consideration” from Valence Tech’s primary financier, Berg & Berg, KPMG would be entitled to a “success fee” of 1.25% of the value of that consideration or no less than $500,000.[5] Valence Tech received two payments from Berg & Berg: (1) a $50 million debt-to-equity conversion and (2) a $20 million capital loan.[6] While KPMG contended that it was entitled to the 1.25% success fee for both payments, Valence Tech argued that it should not have to pay the success fee for either payment.[7] The bankruptcy court concluded that under the agreement KPMG was entitled to the success fee for the debt-to-equity conversion.[8] The court, however, denied KPMG’s request for the success fee for the capital loan.[9] Valence Tech appealed the bankruptcy court’s ruling to the district court maintaining that KPMG was not entitled to a success fee for either transaction while KPMG cross-appealed to argue for payment of the success fee in connection with the capital loan.[10] To settle the dispute, the district court analyzed the agreement to determine whether the capital loan should be included in the meaning of “any consideration.”[11] Noting the sophistication of the parties, the district court found the contract described two potential scenarios: (1) a “Private Placement” coming from any party other than Berg & Berg resulting in a 2.5% fee for KPMG, and (2) a “Private Placement” coming from Berg & Berg reducing KPMG’s fee to 1.25%.[12] The district court reasoned that either way the contract defined “Private Placement” as having “Private Placement Value,” which necessarily included equity linked financing.[13] Therefore, according to the district court, the $50 million debt-equity conversion qualified as a “Private Placement,” which entitled KPMG to the agreed upon 1.25% “success fee.”[14] The $20 million capital loan did not qualify because it was not linked to any equity.[15]

A Sublessee’s Rights in the Face of A Debtor-Sublessor’s Rejection of an Unexpired Lease Under Chapter 11

By: Adam Lau

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re Overseas Shipholding Group, Inc., a bankruptcy court held that rejection of a lease by a debtor constituted a pre-petition breach of the lease and was not a termination of the lease. The debtor, Overseas Shipholding Group, Inc., entered into a lease agreement with TST/Commerz East Building (“TST”) that was set to expire on December 31, 2020. Two years into the lease, debtor subleased a part of the space to Maritime Overseas Corporation (“Maritime”). After filing voluntary petitions under chapter 11, the debtor and Maritime entered into a stipulation with the assignee of TST whereby the debtor and Maritime agreed to reject the lease and the sublease. Maritime then vacated the premises and proceeded to file a claim against debtor for $30,788.32 for return of its security deposit under the sublease, but amended its claim, adding $367,858 for damages from rejection of the sublease, including moving expenses, increased rent, electricity, and legal fees relating to Maritime’s relocation. The debtor objected to the amended claim, and asked the court to disallow the claim for rejection damages and to limit the recovery to the amount of the security deposit. The debtor argued that the rejection of the lease constituted a termination of the lease, which would, under Clause 2 in the sublease, preclude Maritime from recovering rejection damages. Clause 2 provided that, “this Sublease shall terminate (in whole or in part, as applicable) on the date of such termination as if such date had been specified in this Sublease as the Expiration Date and Tenant shall have no liability to Subtenant with respect to such termination.” The debtor relied on Chatlos Systems, Inc. v. Kaplan, where the court held that a debtor’s rejection of a non-residential lease resulted in termination of the lease. In response, Maritime argued the Bankruptcy Code establishes that the rejection of the overlease was not a termination of the lease but merely a pre-petition breach. The court was not persuaded by the debtor’s argument, finding that the Chatlos case was not applicable because that case involved a lessee of the debtor who chose to remain in possession of the property, whereas Maritime did not elect to remain on the premises. However, while the bankruptcy court agreed with Maritime’s argument that the rejection of the lease constituted a breach and not termination, Maritime was still precluded from claiming rejection damages because Clause 22(j) in the sublease provided that the “subtenant shall look solely to Tenant's interests in the Lease to enforce Tenant's obligations hereunder and shall not seek any damages against Tenant or any of the Tenant's Related Parties.”

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