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Breach of the Covenant of Good Faith Leads to Equitably Subordinated Debt and the Possibility of Losing Millions

By: Lauren Casparie

St. John’s Law Student

American Bankruptcy Institute Law Review Staff


In In re LightSquared, Inc.,[i] a bankruptcy court recently equitably subordinated the claim of an entity that the founder, chairman of the board, and controlling shareholder of a competitor of the debtor created in order to circumvent a credit agreement’s restrictions on transferring the debt to certain parties. In particular, the LightSquared court determined that the entity breached the implied covenant of good faith by effectively acquiring the debt on behalf of the competitor’s controlling shareholder.[ii] In LightSquared, the debtor entered into a credit agreement that restricted transferring the debt to certain disqualified companies and all natural persons.[iii] When a competitor company inquired about purchasing the debt, it discovered that the agreement’s schedules listed competitor as a disqualified company.[iv] Since the competitor could not purchase the debt directly, its controlling shareholder formed an investment vehicle for the exclusive purpose of buying the debt, thereby circumventing the credit agreement’s restrictions on transferring the debt, in order to give the competitor effective control over the debtor’s reorganization.[v] The investment vehicle was under capitalized, resulting in the creditor funding multiple purchases by transferring money from his personal account.[vi] Eventually, the investment entity purchased enough debt to give it a blocking position and the power to enforce certain rights during the debtor’s subsequent bankruptcy.[vii] After this purchase, rumors started to circulate that the controlling shareholder of the competitor was behind the purchasing.[viii] After hearing of these rumors, the debtor’s management strongly suspected that the controlling shareholder was behind the investment vehicle’s acquisition of the debt but never inquired into this suspicion.[ix] A month after obtaining a blocking position, the controlling shareholder made presentations to the competitor’s board of directors, informed them that he was behind the purchases of the debt, and proposed that the competitor submit a bid seeking to acquire the debtor’s assets.[x] Later, without informing the board of directors, the controlling shareholder submitted a bid on the competitor’s behalf for the debtor’s assets.[xi] This bid would have resulted in the investment entity being paid in full on the debt with an additional $140 million profit.[xii] Subsequently, the debtor filed for bankruptcy under chapter 11 of the Bankruptcy Code.[xiii]

A Non-Attorney Can Be Subject to Bankruptcy Code’s Requirements for Both a Bankruptcy Petition Provider and a Debt Relief Agency

By: Sharon Basiratmand

St. John’s Law Student

American Bankruptcy Institute Law Review Staff


Recently, in Jonak v. McDermott,[i] a federal district court in Minnesota affirmed a bankruptcy court’s ruling that an individual and his companies functioned as bankruptcy petition preparers, regardless of what they actually called themselves.[ii] In particular, the district court affirmed the bankruptcy courts order enjoining the individual and his companies from “providing any bankruptcy assistance within the meaning of section 101(4A) to an assisted person for compensation, without giving all disclosures required by sections 527 and 528(a).”[iii] The district court also held that the bankruptcy court’s order disgorging the fees paid to the individual and his companies was proper.[iv] In Jonak, Edward Jonak was sole shareholder, president, and operating principal of Affordable Legal Services (“ALC”). [v] He advertised ALC as providing “low cost legal aid,” including services by “program attorneys.”[vi] Acting through ALC, he provided forms for clients to complete, assisted in preparing bankruptcy petitions on their behalf, answered questions about how to complete forms, and provided completed firms to a service to type into completed bankruptcy petitions and schedules.[vii] After investigating Mr. Jonak’s conduct in the underlying bankruptcy cases the United States Trustee (the “UST”) filed a complaint against Jonak and his companies, alleging that Mr. Jonak violated five provisions of section 110 of the bankruptcy code, all of which are applicable to petition preparers.[viii] The complaint also alleged that Mr. Jonak violated section 527 by failing to provide required notices and section 528 by failing to identify his company as a debt relief agency.[ix] In response, Mr. Jonak denied that section 110 applied, asserting that he did not physically prepare the bankruptcy documents and therefore was not a bankruptcy petition preparer.[x] He further contended that sections 526 to 528 did not apply, arguing that his company, ALC, was not a debt relief agency.[xi] After the UST moved for summary judgment, the bankrupty court found that Jonak and ALC functioned as bankruptcy petition preparers and that ALC qualified as a debt relief agency.[xii] Therefore, the bankruptcy court enjoined him from committing any future violations of section 110, ordered forfeiture and turnover of fees received, and awarded the UST liquidated damages.[xiii] On appeal, the district court affirmed.[xiv]

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An Oversecured Creditor’s Post-Petition Attorneys’ Fees: Determined by Federal Law or State Law?

Charles Lazo

St. John’s Law Student

American Bankruptcy Institute Law Review Staff


Recently, in Wells Fargo Bank, N.A. v. 804 Congress, L.L.C. (In re 804 Congress, L.L.C.),[i] the Fifth Circuit held that federal law governs an oversecured creditor’s recovery of post-petition attorneys’ fees from the proceeds from the sale of the creditor’s collateral.[ii] In In re 804 Congress, L.L.C., a bank financed the debtor’s purchase of an office building.[iii] The loan was secured by a deed of trust.[iv] The deed of trust provided, among other things, that the debtor was required to pay the bank it attorneys’ fees following a foreclosure of the property.[v] After the bank scheduled a foreclosure sale of the property, the debtor filed for bankruptcy.[vi] Subsequently, the bankruptcy court granted the bank’s motion for relief from the automatic stay in order to complete the non-judicial foreclosure sale.[vii] Following the sale, the bankruptcy court exercised jurisdiction over the sales proceeds, and therefore, the bank filed proofs of claim for the amount it was owed under the deed of trust.[viii] The debtor objected to the bank’s proofs of claims and moved to require the trustee under the deed of trust to distribute the principal and interest due the bank and a second-lien holder and to pay the remaining amount to the debtor pending resolution of the claims against those funds.[ix] The bankruptcy court ruled that (1) the second-lien holder was entitled to be paid in full, (2) the bank was entitled to full payment except for the attorneys’ fees because the bank did not file the “proper application for [the] fees” and “provided no supporting documentation or testimony that the fees were reasonable”[x] under section 506(b),[xi] and (3) the trustee was entitled to a fee in the amount equal to twenty hours at her hourly rate instead of five percent of the total sale price.[xii] On appeal, “[t]he district court remanded ‘for further proceedings with instructions that [trustee] disburse the foreclosure-sale proceeds in accordance with Texas law and the [d]eed of [t]rust.’”[xiii] On appeal to the Fifth Circuit, the bank argued that state law governed its recovery of attorneys’ and other fees from the sale proceeds or, in the alternative, that the attorney fees should be recoverable under section 502.[xiv] The Fifth Circuit reversed the district court, concluding that “[b]ased on this record, [the court could not] say that the bankruptcy court erred in finding under [section] 506(b) that the amount of attorneys’ fees [the bank] sought [were] not substantiated and therefore [were] not shown to be reasonable.”[xv] Further, since it was unclear whether the issue had been raised below, the Fifth Circuit remanded the case to the bankruptcy court to determine whether the bank was entitled to an unsecured claim for its attorneys’ fees under section 502.[xvi]

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