Top Developments in Bankruptcy Law and Litigation in 2006 by fsb96139

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									       NEW TWISTS AND TURNS UNDER THE NEW BANKRUPTCY LAWS:
                            A 2006 Update

                     Hon. Elizabeth Stong, Bankruptcy Judge, EDNY
                         William K. Zewadski, Esquire, Tampa

                                 December 1, 2006
            Fall Meeting, ABA Committee on Corporate and Business Litigation
                                 Washington, D.C.


I.      OVERVIEW – The new law and diminished filing statistics

II.     BUSINESS BANKRUPTCY

        ·       KERPs and other employee bonus programs
        ·       Creditor Committees: membership and disclosure
        ·       Prepackaged plans
        ·       Exclusivity limits
        ·       Small business cases
        ·       Single-asset real estate cases
        ·       International Chapter 15 cases
        ·       Health care debtors
        ·       Jurisdiction: Probate and divorce (Marshall v. Marshall); Sovereign
                immunity (Katz v. Community College); Direct appeals
        ·       Changes in Preferences and Defenses to Preferences
        ·       Utilities

III.    CONSUMER BANKRUPTCY

        ·       Eligibility: credit counseling and means testing, striking vs. dismissing an
                ineligible debtor’s petition
        ·       Automatic stay: the effect of refiling on the stay
        ·       The effect of nonperformance of statement of intentions on the stay
        ·       Exemptions, including homestead
        ·       Chapter 7: Amount: Disposable income, Means test
        ·       Individual Chapter 11 cases
        ·       Chapter 13: New requirements on confirmation – taxes and domestic
                support obligations; secured creditor cram-down; “910 lenders”; Payment
                period:
        ·       Debt relief agencies
        ·       Discharge
        ·       Financial management education and case closing
Bankruptcy Litigation
William Knight Zewadski, Co-Chair Subcommittee on Bankruptcy Litigation,
ABA Corporate and Business Litigation Committee, Business Law Section,
Trenam, Kemker, Scharf, Barkin, Frye, O'Neill & Mullis
101 E. Kennedy Boulevard, Suite 2700
Tampa, Florida 33601-1102
z@trenam.com
www.trenam.com
Tel: (813) 227-7484
Fax: (813) 229-6553


Michael D. Rubenstein, author of the section on Circuit Bankruptcy Updates
Liskow & Lewis,
(now in Houston after relocation from New Orleans following Hurricane Katrina)
Three Allen Center
333 Clay Street, Suite 3485,
Houston, Texas, 77002-4102
Tel: (713) 651-2953
Fax: (713) 651-2908
mdrubenstein@liskow.com
www.liskow.com
CHAPTER 4

Contents


§ 4.1 New Developments and a New Bankruptcy Law At Last!...................................
      § 4.1.1 Massive Last Minute Filings Before October 17, 2005.............................
              § 4.1.2 The New Bankruptcy Law Finally Passes and Becomes Effective

                  § 4.1.3 Other Federal Legislation of Moment Affecting Bankruptcy........

§ 4.2   Notable Business Changes Under the New Bankruptcy Law ..............................
        § 4.2.1 New Time Limits in Chapter 11 Cases – exclusivity is limited to 18 months,
                 under 1121, and lease assumptions and rejections are limited to 210 days, with
                 “cause” needed for an extension beyond the initial 120 days, under revised
                 365(d)(4).

                  § 4.2.2 Small Business Debtors’ cases are expedited for cases with under $2
                          million in unsecured claims. See 101(51C), 1116, 1121(c, e), 1129(e,
                          f, g).

                  § 4.2.3 Administrative Expense Priorities – goods received in the ordinary
                          course within 20 days prior to case filing are protected under
                          503(b)(9).

                  § 4.2.4 Reclamation claims expanded – 45 days after receipt of goods or 20
                          days after case is filed under revised 546(c).

                  § 4.2.5 Utility claims need cash or cash collateral under 366, not just priority
                          status.

                  § 4.2.6 Management retention bonuses and severance pay under 503(c) get
                          increased scrutiny.

                  § 4.2.7 Investment bankers do not have to be “disinterested” any more under
                          101 (14).

                  § 4.2.8 Health care cases get a “patient care ombudsman” under 333, and
                          patient records are cared for under 351.
                § 4.2.9 Exceptions to the automatic stay – evictions, failure to comply with
                        debtor’s statement of intent, Tax Court proceedings, repeat filers and
                        others. Comfort orders are available under new 362(j) saying the stay
                        is terminated.

                § 4.2.10 International insolvencies get new legal structures in new Chapter 15.

                § 4.2.11 More business changes in the new bankruptcy law worth noting:

                        Financial Contract Amendments for security dealers.
                        Appointment of Chapter 11 Trustees under 1104(a)(3), (e).
                        New grounds for conversion or dismissal under 1112.
                        Tax claims must be paid under Chapter 11 plans in regular cash
                        payments under 1129(a)(9)(c), not exceeding 5 years.
                        Assumed leases later rejected will be limited to 2 years rent under
                        505(h)(7).
                        The back pay administrative expense claims under 503(b)(1)(A)(ii)
                        and WARN Act notices.
                        Forward Contracts under 556 may be enforced.
                        FDCPA (Fair Debt Collections Practices Act) and HOEPA (Home
                        Ownership and Equity Protection Act of 1994) cases will be brought
                        by trustees.
                        More motions to dismiss will be brought and will result in litigation,
                        because of more statutory requirements (especially in individual
                        cases), under 707, 1112, and 1307.

§ 4.3 Rules, Fees, and Official Forms All Change

§ 4.4 Decisions in the Bankruptcy Arena in 2005
      § 4.4.1    Supreme Court Decisions in 2005
      § 4.4.2    Notable Circuit Court Bankruptcy Decisions, by Michael Rubenstein

§ 4.5 Fearless Predictions for Business Bankruptcy and Litigation in 2006
CHAPTER 4

Bankruptcy Litigation

§ 4.1     New Developments and a New Bankruptcy Law At Last!

 In 2005, the specter of the new bankruptcy law, effective for most purposes on October 17,
 2005, drove an astonishing record number of individuals, and some big corporations as well,
 to file bankruptcy petitions under the previous law. The changes created by the Bankruptcy
 Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) will take years to sort out
 and have precipitated a range of unintended consequences.




§ 4.1.1   Massive Last Minute Filings Before October 17, 2005

 After a 2.6 per cent decline in FY2004 to “only” 1,618,987 bankruptcy cases, the new statute
 pushed a record number of individuals to file bankruptcy before it became effective, as widely
 predicted. In the second quarter of calendar year 2005 a quarterly-filing record was set with
 467,333 bankruptcy cases being filed, of which only 8,736 were business cases. ABI Update
 Highlights, Aug. 29, 2005. In the three months to September 30, 2005, a new record was set
 with 542,002 cases filed. BCD Weekly New & Comment, December 20, 2005, p. A-1.

    The Associated Press reported statistics for the calendar year 2006 on January 11, 2006 as
    follows:

             “Significant increases in consumer bankruptcy filings occurred in
             every region, according to the data released Wednesday [January
             11, 2006] by Lundquist Consulting Inc., a financial research firm
             based in Burlingame, Calif. It tallied 2,043,535 new filings last
             year, up 31.6 percent from 1,552,967 in 2004 – meaning that
             one in every 53 households filed bankruptcy petitions,
             according to the company.” (emphasis added).


    Business cases fell, with FY2005 business filings dropping 36 per cent from 10,368 in
    FY2004 to only 6,637 in FY2005. BCD Weekly New & Comment, December 20, 2005,
    p. A-1.
Amazingly, a reported estimate of 500,000 bankruptcy cases were filed in the two weeks
before the new law became effective on October 17, 2005, heralded by headline after
headline. See e.g., Liz Pulliam Weston, “Bankruptcy law backfires on credit card issuers,”
MSN Money, Dec. 30, 2005. This surge will push the totals for the year to over 2 million
cases, far more than ever before.

The provisions of the new law, with its mandate of preliminary credit counseling and a
convoluted “means test,” which is designed to push some individual debtors into a
payment plan under Chapter 13, have increased the uncertainty of the bankruptcy process
and made its shelter less available by creating new hurdles of forms, due diligence, and
expense. It was estimated that between 4 and 20 per cent of Chapter 7 filers under the old
law would be forced into Chapter 13 under the new law. Nedra Pickler, “Bush Signs Big
Rewrite of Bankruptcy Law, AP, April 21, 2005. Generally speaking, individuals with an
income above their state’s median income who can pay $6,000 over five years will have to
resort to Chapter 13 cases for a bankruptcy discharge.

As a result of this prospect, double digit increases of filings occurred in the six months
before the effective date, contrasted with a year or more of relatively flat filings just before
the new law was signed. “Debtors in Rush to Bankruptcy as Change Nears,” read a front
page headline in the New York Times for Aug. 21, 2005. The article also noted that filings
had increased “eightfold over the last 30 years,” from 200,000 in 1978 to 1.6 million cases
in 2004, marking a sea change in the social and legal acceptance of bankruptcy nationally.
Divorce, loss of jobs, and medical costs were primary reasons for the filings, not the abuse
of credit cards, despite the focus of the corrective provisions of the new law.

Among the unintended consequences of the new law was an ironically adverse effect on
the major lobbying force behind the change, namely that credit card defaults soared. “Size
of Bankruptcy Bubble Surprises Banks,” New York Times, Oct. 25, 2005, accompanied
with a photo of a long line of filers waiting in the rain with umbrellas outside the
bankruptcy courts in New York City. A 30 per cent increase in credit card write-offs was
predicted, totaling well over a billion dollars by the end of 2005. ABI Update Highlights,
Nov. 18, 2005, citing the Credit agency Fitch Ratings. Some bankruptcy clerk’s offices
had only just been able to digest the October glut of filings by the end of the year.

Similarly, the new law’s strictures on extensions of exclusivity, limits on other judicial
discretion, and limits on the debtor’s ability to assume or reject commercial land leases
drove several major corporations to file before the law changed. Northwest and Delta
Airlines both filed in September 2005, after a long struggle and with new pressures of
pensions and fuel increases. They were the second and third largest airline bankruptcies
ever, with assets of $14 billion and $21 billion respectively, according to
BankruptcyData.com, September 15, 2005. In 30 districts, the corporate filings increased
twenty per cent in the last quarter before the new law became effective. ABI Update
Highlights, Oct. 12, 2005. Among these was the October 8, 2005 filing of Delphi Corp.,
which supplied components for car manufacturers, affecting over 50,000 of its employees,
and at the last minute, Refco Inc., a large financial services organization. The Southern
District of New York appears to have landed most of the new big corporate cases, in
    contrast to Delaware and other states used in recent years as the favored forum for such
    cases.

    The earlier cases of the largest airline to file, UAL Corp. ($25 billion in assets) and US
    Airways Group, Inc, ($8 billion in assets) which filed in 2002 and 2004, continued to make
    news. The other major corporate cases of recent years, Worldcom, Inc., which filed in
    2002, Enron Corp., 2001, Conseco, Inc., 2002, Global Crossing, 2002, and Pacific Gas and
    Electric Co., 2001, continued to generate new precedents and headlines and formed a
    chorus singing from the bank of last resort.


§ 4.1.2   The New Bankruptcy Law Finally Passes and Becomes
          Effective
 When the President signed the BAPCPA on April 20, 2005, a few of its provisions became
 effective immediately, such as a homestead limitation, reduction of the exemption for fraud,
 the reversal of the DiPrezio doctrine on insider preferences, and the creation of some much-
 needed bankruptcy judgeships. Most of the law’s sweeping changes became effective October
 17, 2005 for cases filed on or after that date.

     After the new law became effective, few cases of any type put their toe into the frigid
     waters of the bankruptcy court, but, nevertheless, the occasional major corporate filing
     did occur. Notably the December 2005 filing of Calpine, the biggest owner of natural-
     gas fired power plants, with assets of $26.6 billion, making it the sixth largest bankruptcy
     case of all time. Its many issues of junk bonds and a complex system of borrowings will
     make for a field day for the reorganization specialists and vulture capitalists in the
     coming years as it winds its way through the process. The buoyant economy may give the
     process some breathing room to sort out what the major new contours of the process will
     be.

     As surveyed below, the new law created a flurry of new rules, new forms, increased fees,
     and the predictable uncertainty in the meaning of the new provisions, as courts scrambled
     to implement the Congressional intent, which was sometimes not clear. A useful and
     recommended blog, discussing the changes of the new law, sponsored by Miami’s
     Kozyak Tropin & Throckmorton, P.A., is at http://bapcpa.blogspot.com/ .


§ 4.1.3 Other Federal Legislation of Moment Affecting Bankruptcy
 Aid for Asbestos victims was much discussed in Congress in 2005, with a proposal to create a
 fund of $140 billion to pay those claims over fifty years. A study by the Congressional
 Budget Office suggested the proposed fund might not be adequate. ABI Update, Highlights,
 Sept. 9, 2005. Some 77 companies have been forced into bankruptcy by the magnitude of the
 numbers and aggregate size of these claims. The proposed fund is to come from industry and
 insurance sources and is intended to end suits and bankruptcies for such victims. However,
 legislation had not been passed by year’s end. ABI Update, Dec. 21, 2005.
        Although some discussion and some proposed legislative changes to soften the new law’s
        harsh effects occurred after the Hurricane Katrina devastation, it is predicted that
        Congress is unlikely to change the new law anytime soon. “No relief from BAPCPA on
        horizon,” BCD, Oct. 25, 2005, at p. A-2. Representative Sensenbrenner, Chair of the
        House Judiciary Committee announced his intention not to revisit bankruptcy reform.
        Reuters, Sept. 13, 2005, cited in a report for Congress, Robin Jeweler, “Bankruptcy
        Relief and Natural Disaster Victims,” Sept. 14, 2005.

        Other laws affecting bankruptcy are always in the hopper. One, for instance, the Federal
        Judgeship and Administrative Efficiency Act of 2005, is intended to create 24 more
        permanent or temporary bankruptcy judgeships, as well as other judges at the circuit and
        district levels. ABI Update, Oct. 28, 2005. Funding for the Pension Benefit Guaranty
        Corp. for pension terminations is likely also to be the subject of new legislation this year,
        notably as part of the Deficit Reduction Act of 2005. ABI Update, Dec. 21, 2005. A
        proposal to split the Ninth Circuit Court of Appeals has been dropped for now. Id.




§ 4.2       Notable Business Changes Under the New Bankruptcy Law


 Noted here as a checklist for business practitioners are some of the important business changes
 under the new bankruptcy law:


§ 4.2.1      New Time Limits in Chapter 11 Cases - Exclusivity for the
             debtor to propose a plan is limited to 18 months, under 1121
             and ease assumptions and rejections are limited to 210 days,
             with “cause” needed for an extension beyond the initial 120
             days, under revised 365(d)(4).

§ 4.2.2      Small Business Debtors’ cases are expedited for cases with
             under $2 million in unsecured claims. See 101(51C), 1116,
             1121(c, e), 1129(e, f, g).



§ 4.2.3      Administrative Expense Priorities – Goods received in the
             ordinary course within 20 days prior to case filing are
             protected under 503(b)(9).
§ 4.2.4   Reclamation claims expanded – 45 days after receipt of
          goods or 20 days after case is filed under revised 546(c).



§ 4.2.5   Utility claims need cash or cash collateral under 366, not just
          priority status.

§ 4.2.6   Management Retention bonuses and severance pay under
          503(c) get increased scrutiny and become very difficult
          under the new law.



§ 4.2.7   Investment bankers do not have to be “disinterested” any
          more under 101 (14).



§ 4.2.8   Health care cases get a “patient care ombudsman” under
          333, and patient records are cared for under 351.



§ 4.2.9   Exceptions to the automatic stay – evictions, failure to
          comply with debtor’s statement of intent, Tax Court
          proceedings, repeat filers and § 4.3.6 Management retention
          bonuses and severance pay under 503(c) get others. Comfort
          orders are available under new 362(j) saying the stay is
          terminated.


§ 4.2.10 International insolvencies get new legal structures in new
         Chapter 15.


§ 4.2.11 More business changes in the new bankruptcy law worth
         noting:
  Financial Contract Amendments for security dealers.

     Appointment of Chapter 11 Trustees under 1104(a)(3), (e).
        New grounds for conversion or dismissal exist under 1112.

        Tax claims must be paid under Chapter 11 plans in regular cash payments under
        1129(a)(9)(c), not exceeding 5 years.

        Assumed leases later rejected will be limited to 2 years rent under 505(h)(7).

        The back pay administrative expense claims under 503(b)(1)(A)(ii) and WARN Act
        notices need to be given or claims will result.

        Forward Contracts under 556 may be enforced.

        FDCPA (Fair Debt Collections Practices Act) and HOEPA (Home Ownership and Equity
        Protection Act of 1994) cases will be brought by trustees.

        More motions to dismiss will be brought and will result in litigation, because of more
        statutory requirements (especially in individual cases), under 707, 1112, and 1307.




§ 4.3       Rules, Fees and Official Forms All Change

 The Federal Rules of Civil Procedure were amended effective in December 1, 2005 as to rules
 6, 27, and 45 in minor ways.

        The Federal Rules of Bankruptcy Procedure likewise were amended, effective also on
        December 1, 2005, as to rules 1007, 2002, 3004, 3005, 7004, 9001 9006, and 9036,
        including changes as to notice, proof of claims filings, reaffirmation agreements, and
        other minor provisions.

        Notably, Interim Rules were adopted by all districts to implement BAPCPA’s new
        changes and many applicable official forms and filing fees have changed. See
        www.uscourts.gov/rules/index.html.

        As always in prior years, consult local bankruptcy rules for other changes and procedural
        announcements, such as http://www.flmb.uscourts.gov/.




§ 4.4       Court Decisions in the Bankrupty Arena in 2005
§ 4.4.1     Supreme Court Decisions in 2005


The Supremes decided only three case of notable impact on bankruptcy law in 2005.
The first, Rousey v. Jacoway, 544 U.S. ---, 125 S. Ct. 1561 (2005), resolved a circuit spit, and it
held an IRA qualifies for the section 522(d)(10)(E) exemption to the extent necessary for the
support of the debtor and his dependents. This view was carried forward into the new
bankruptcy provisions of section 522(b)(3)(C) and (d)(12).

      The second, Household Credit Services, Inc. v. Pfening, 541 U.S. 232, 124 S.Ct. 1741
      (2004), held a finance charge disclosure need not disclose over-limit fees.

      The third, Koons Buick Pontiac GMC, Inc. v. Nigh, 125 S. Ct. 460 (2004), held the
      damages available under 15 U.S.C. section 1640(a)(2)(iii) are $2,000 for violations only
      for loans secured by real property.

      Coming up on the United State Supreme Court’s bankruptcy agenda for 2006 are those
      appeals where certiorari has been granted, including the Anna Nicole Smith case, another
      In re Howard Delivery Service, 44 BCD 122 (4th Cir. 2005), a workers’ compensation
      case, and the sovereign immunity case, Central Virginia Community College v. Katz, No.
      04-885, argued and awaiting a decision.

§ 4.4.2     Notable Circuit Bankruptcy Decisions

First Circuit


Prior to the commencement of the case, the debtor transferred assets to a spendthrift trust
established in favor of himself in order to avoid the claims of creditors. The debtor thereafter
filed a petition under Chapter 7. The debtor was not forthcoming in his schedules and attempted
to conceal assets. After questioning by the Chapter 7 trustee, the debtor filed notice of his intent
to convert the case to one governed by Chapter 13. The trustee opposed conversion.

      The debtor claimed an absolute right to convert his case to one under Chapter 13, noting
      that Section 706 (a) provides that the debtor “may convert a case under this chapter to a
      case under chapter 11, 12, or 13 of this title at any time, if the case has not been converted
      . . . . Any waiver of the right to convert a case under this subsection is unenforceable.”
      The First Circuit held that the language of the statute did not confer an absolute right and
      that “a bankruptcy court sitting in equity is duty bound to take all reasonable steps to
      prevent a debtor from abusing or manipulating the bankruptcy process.” The Court noted
      that Congress knew how to deprive the bankruptcy court of this discretion and pointed to
      the near absolute right of a debtor to have his Chapter 13 case dismissed. The court also
      noted that the bankruptcy court “has unquestioned authority to dismiss a chapter 13 case . .
      . based upon a showing of ‘bad faith’ on the part of the debtor.” Marrama v. Citizens
      Bank (In re Marrama), 430 F.3d 474 (1st Cir. 2005).
Prior to the commencement of the case, appellant retired as an executive of the debtor.
Pursuant to the debtor’s employee stock ownership plan (the “ESOP”), the appellant
exercised his right to exercise a put option with respect to the stock he owned pursuant to
the ESOP. In exchange for the shares of stock held in the ESOP, the debtor gave the
appellant a promissory note. Approximately two years later and while the debtor was still
obligated to pay the promissory note, the debtor filed for protection under Chapter 11 of
the Code. The debtor then initiated an adversary proceeding seeking to equitably
subordinate the appellant’s claim. The debtor also filed its proposed plan, which sought to
pay general unsecured creditors in priority to the claims of stock redemption claimants
(meaning that such claimants, like the appellant, would receive nothing). The bankruptcy
court subordinated the appellant’s claim.

On appeal, the debtor argued that First Circuit precedent supported subordination of stock
redemption claims as a class. These cases stem from the principle that equity is not
entitled to any distribution until the corporation’s creditors have been paid in full. These
precedents antedated the adoption of the Code in 1978. While pre-Code jurisprudence
regarding equitable subordination was not necessarily overruled by the adoption of the
Code, the First Circuit found that more recent Supreme Court cases reject the notion that
the a bankruptcy court must impose equitable subordination on a categorical basis. These
cases, according to the court, established that categorical subordination was a legislative
rather than a judicial function. For a court to equitably subordinate a claim, it must make a
case-by-case analysis of the claim. The First Circuit, therefore, abrogate the categorical
rule of its prior cases. Nonetheless, the court held that claims arising out of stock
redemption plans should generally be regarded as suspect, but that the court sitting in
equity must then determine whether a particular claim should be subordinated based on the
totality of the circumstances. Turning to the facts of the case and the fact that the note
arose out of an ESOP transaction, the court found no evidence of any misconduct on the
appellant’s part and no equitable basis for subordination. The court expressly declined to
address whether the lack of creditor misconduct is itself dispositive. Merrimac Paper Co.
v. Harrison (In re Merrimac Paper Co.), 420 F.3d 53 (1st Cir. 2005).

Second Circuit

A chapter 13 debtor filed a motion to reinstate the automatic stay. The bankruptcy court
denied the motion and the debtor sought to appeal. However, the notice of appeal was not
filed within the ten-day period prescribed by the bankruptcy rules. Deciding a matter of
first impression in the Second Circuit, the court of appeals held that the ten-day limit is
jurisdictional that cannot be extended, even in the context of excusable neglect. This
decision is in accord with the decisions of the Third, Fifth, Sixth, and Ninth Circuits.
Siemon v. Emigrant Savings Bank (In re Siemon), 421 F.3d 167 (2d Cir. 2005).

Creditors appealed the bankruptcy court’s order confirming the debtor’s plan of
reorganization. They complained, inter alia, that the plan improperly bars suits against
certain nondebtor parties. The sole argument presented regarding the nondebtor releases
was that the releases were not authorized by the Code. The Second Circuit had previously
held that a court may enjoin a creditor from suing a third-party as long as the injunction
plays an important part of the reorganization plan. The court noted that other circuits have
held that nondebtor releases are prohibited by the Code, except in certain asbestos cases.
Noting the problems created by allowing nondebtor releases, the court found that only
unique cases warrant approval of such third-party releases. In this case, the court held that
the bankruptcy court’s findings were insufficient. The bankruptcy court had held that the
third parties had made a material contribution to the estate, but had not found that the
third-party release itself was important to the estate. The court rejected the argument that
the enjoined creditor must be paid good and sufficient consideration. Yet the court also
noted that the mere fact the creditors were allocated a plan distribution did not constitute
sufficient consideration. Although the court found the nondebtor releases to be
unwarranted, the creditors had failed to seek a stay and relief was denied on grounds of
equitable mootness. Thus, although the court could have permitted the creditors to pursue
their claims without unraveling the plan, the court considered it unfair to carve out a
portion of the plan and allow the remainder to stay in place. Deutsche Bank AG v.
Metromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F.3d 136 (2d
Cir. 2005).

Third Circuit

A commercial bail bondsman brought an action against a clerk of court. The clerk had
removed the bondsman’s name from the court’s bail registry following the bankruptcy
discharge of his bail bond debts. The bondsman claimed the clerk violated the discharge
injunction. The Third Circuit began its analysis by considering the scope of the Chapter 7
discharge. It noted that, pursuant to Section 523 (a)(7) of the Code, a discharge in
bankruptcy does not extend to debts for fines, penalties, or forfeitures payable to a
governmental unit and is not compensation for an actual pecuniary loss. The court
concluded that the appellant’s bail bond debts were clearly within the plain meaning of
“forfeiture.” Thus, the court held the debt was nondischargeable. This holding is in
conflict with decisions of the Fourth and Fifth Circuits. The circuit split is worth noting as
Judge Alito was a member of this Third Circuit panel. Dobrek v. Phelan, 419 F.3d 259
(3rd Cir. 2005).

A Chapter 13 debtor moved to avoid a lien held by the New Jersey Motor Vehicle
Commission for certain unpaid motor vehicle surcharges and interest. In the instant case,
the MVC filed a certificate of debt with the local clerk of court in order to obtain its lien.
The bankruptcy court avoided the liens as judicial liens, pursuant to Section 522 of the
Code. The Third Circuit was called upon to decide whether the lien was a judicial or
statutory lien. The court began by noting that a statutory lien arises automatically and is
not based on an agreement (a consensual lien) or judicial action. Lower courts had
reached differing results with regard to the New Jersey liens in question. The Third
Circuit held that the MVC’s lien was not obtained by any legal process or proceeding and
that the docketing of the lien by the clerk upon the filing of a certificate was merely a
ministerial act. The lien itself arose solely by force of statute and was, therefore, not
avoidable. In re Schick, 418 F.3d 321 (3rd Cir. 2005).

Fourth Circuit
A principal of the Chapter 11 debtor brought an adversary proceeding against another
equity owner seeking a determination that funds he had provided to the debtor were loans
and not capital contributions. The other equity owner moved to compel the principal to
submit his claims to arbitration already pending in London. The principal was American
while the other equity owner was British. The agreements between the parties contained a
mandatory arbitration clause. The bankruptcy court denied the motion to compel
arbitration and enjoined the parties from pursuing the pending arbitration. Because the
question involved whether the debtor owed money to one of its owners, the court
concluded the proceeding was core and that it, therefore, took precedence over the
arbitration.

The Fourth Circuit concluded that although arbitration is particularly favored in the area of
international commerce, Congress intended to permit a bankruptcy court to enjoin even
international arbitrations. The court found an inherent conflict between arbitration and the
underlying purpose of bankruptcy, which is centralized decision making regarding the
respective rights of debtors and creditors. As a result, the Fourth Circuit affirmed the
bankruptcy court’s decision to enjoin the London arbitration. Phillips v. Congelton, L.L.C.
(In re White Mountain Mining Co.), 403 F.3d 164 (4th Cir. 2005).

Fifth Circuit

A trustee of the Chapter 11 debtor’s liquidating trust brought an adversary proceeding
against debtor’s lessor. The lessor had drawn down a letter of credit that had been
provided as security for the debtor’s leasehold obligations. Among other complaints, the
trustee objected to the lessor retaining funds drawn from the letter of credit in excess of the
Code’s cap on a claim arising from the termination of a lease. The bankruptcy court held,
inter alia, that the lessor was not entitled to retain an amount in excess of the statutory cap.

In analyzing this issue, the Fifth Circuit first noted that the lessor had not filed a proof of
claim (the need to do so having been obviated by the security available). The Code’s
limitation on leasehold damages is couched in terms of allowance of claims. In this case,
the lessor was proceeding against a letter of credit, which the Fifth Circuit has repeatedly
held to not be property of the estate. The Court held that the claim of a lessor against the
assets of the estate is “an essential precondition to applying the damages cap at all.” Since
the lessor had not made such a claim, the damages cap was inapplicable. The court
rejected the argument that the letter of credit was a security deposit and that the Code
limited the ability of a lessor to retain a deposit in excess of the cap. It is not clear whether
the court’s ruling would be different if the lessor had filed a proof of claim, but still
proceeded separately against the letter of credit. EOP-Colonnade of Dallas Ltd.
Partnership v. Faulkner (In re Stonebridge Tech.), 430 F.3d 260 (5th Cir. 2005).

Prior to the commencement of the bankruptcy case, the debtor made a substantial payment
to a creditor. The trustee sought to avoid the payment as a preferential transfer. The
creditor asserted, inter alia, that the payment not on account of an antecedent and that it
was a contemporaneous exchange for new value and was, thus, unavoidable. The creditor
conceded that the transfer was made on account of a preexisting debt. Yet the creditor
argued that because the payment was made after a prior involuntary bankruptcy
proceeding was commenced and in exchange for the creditor’s agreement to dismiss that
proceeding, its claim was transformed into something different and, therefore, not a
payment on account of an antecedent debt. The Fifth Circuit held that whatever else the
payment might have been, it was clearly made on account of an antecedent debt.

The court then turned to the creditor’s argument that because the payment was made in
exchange for dismissal of the involuntary bankruptcy proceeding, it fit within the Code’s
exception for contemporaneous exchanges for new value. Although the dismissal did
enable the debtor to sell assets that could not have been sold while the involuntary
bankruptcy was pending, the court found that to be insufficient. The new value required
by the Code must be given as part of the contemporaneous exchange. All that was
contemporaneously exchanged was the dismissal, which the Court held was not itself new
value. Baker Hughes Oilfield Operations, Inc. v. Cage (In re Ramba), 416 F.3d 394 (5th
Cir. 2005).

A former employee brought a claim for employment discrimination. The employer moved
for summary judgment urging a theory of judicial estoppel based on the employees
statement in her bankruptcy schedules that she no other contingent or unliquidated claims
of any nature. Because the assertion of the discrimination claim was plainly inconsistent
with the former employee’s legal position in the bankruptcy case and because she was
under an affirmative duty to disclose that claim to the bankruptcy court, the Fifth Circuit
held that she was estopped from later pursuing the undisclosed claim. The court rejected
the argument that the failure to disclose was inadvertent as the test was not whether the
debtor knew of the legal duty to disclose but whether she was unaware of the facts giving
rise to her claim at the time she filed her bankruptcy petition. Jethroe v. Omnova
Solutions, Inc., 412 F.3d 597 (5th Cir. 2005).

Sixth Circuit

A Chapter 7 debtor sought to convert his case to one under Chapter 13. The bankruptcy
court denied the motion having found the debtor was acting in bad faith. For more than
nine years, the debtor had “taken evasive action to avoid paying his ex-wife . . . amounts
she was awarded under [their] divorce decree.” The bankruptcy court found a number of
serious false statements in the schedules the debtor filed and in his trial testimony. On
appeal, the debtor urged an absolute right to convert. The Sixth Circuit noted that the
bankruptcy courts were divided on the question. One line of cases holds that the debtor
has an absolute right to convert a case from Chapter 7 to Chapter 13, if the debtor is
otherwise eligible for relief under that chapter. Other cases hold that the right to convert is
not absolute and that, in extraordinary cases of bad faith, conversion can be denied. The
Sixth Circuit found the latter line of cases to be better reasoned. Copper v. Copper (In re
Copper), 426 F.3d 810 (6th Cir. 2005).

A Chapter 13 debtor’s plan was confirmed. The plan established the value of the
creditor’s collateral. After confirmation, the debtor failed to make the required payments
and the creditor obtained relief from the stay and sold the collateral. The creditor
requested that any deficiency balance (the unpaid portion of the previously allowed
secured claim less the proceeds from the sale of collateral) be paid as a secured claim in
accordance with the plan. Interpreting its own precedent, the Sixth Circuit held that the
confirmation of a plan is preclusive as to all issues addressed during plan confirmation.
Because the valuation of collateral for purposes of claim allowance is determined at
confirmation, the parties are precluded from relitigating the question. Once the amount of
the secured claim is determined, it must be paid in full. Allowing a reclassification
following repossession and sale would shift the burden of depreciation to the secured
creditor. Accordingly, the deficiency balance should be treated as secured. The Sixth
Circuit noted that other circuits disagree. Ruskin v. DaimlerChrysler Services, L.L.C. (In
re Adkins), 425 F.3d 296 (6th Cir. 2005).

Seventh Circuit

The debtor sought a declaratory judgment that its obligations for various airport
improvements were not leasehold obligations. The Seventh Circuit was called upon to
decide what is a lease for purposes of bankruptcy law. The question was, in essence, when
is a lease a lease and when is a lease merely a security device. The treatment of the
obligation depends on the answer to that question. The court of appeals, like every other
appellate court that has considered the issue, held that substance, not form, governs; thus,
only a “true lease” is a lease for bankruptcy purposes. The Seventh Circuit held that if
state law looks to form over substance, then it is in conflict with federal law and is
preempted. If state law looks to substance over form, then state law provides the rule as to
whether the lease in question is substantively a “true lease.” In this case, state law (that
of California) looked to substance over form. Applying California law, the court held that
because the rent was not measured by the value of the leased property but by the amount
borrowed, it was not a true lease. To help explain its decision, the court constructed an
analytical model whereby a true lease is distinguished by the fact that rental payments are
made for current consumption, whereas a security device disguised as a lease calls for rent
that represents the cost of funds for capital assets or past operations. United Airlines, Inc.
v. HSBC Bank USA, N.A., 416 F.3d 609 (7th Cir. 2005).

The debtor proposed to terminate its pension plans and transfer the liabilities to the
Pension Benefit Guaranty Corporation. The plans’ independent fiduciary sought to
participate in a hearing held regarding rejection of certain collective bargaining
agreements (“CBAs”). The bankruptcy court held that the fiduciary was not an interested
party within the meaning of Section 1113 of the Code, which provides that all interested
parties may appear and be heard at such a hearing regarding rejection of a CBA. The
fiduciary appealed. The Seventh Circuit rejected the fiduciary’s claim that the term
interested party is equivalent to the Code’s use, in Section 1109, of “party in interest,”
which would have included any person with a financial stake in the performance of the
collective bargaining agreement. To adopt this definition would render proceedings
concerning rejection of CBAs “unmanageable.” The court concluded that interested
parties for purposes of Section 1113 must be a subset of those parties in interest under
Section 1109. The court found this position to be consistent with the concept of collective
bargaining: “[l]abor and management are free to change their agreements without any
complaint by individual workers or pensioners – or for that matter by other third party
fiduciaries, including pension fiduciaries.” The court concluded there was no need to
include in a Section 1113 hearing any party whose consent would not be needed for a
voluntary change in the agreement. In re UAL Corp., 408 F.3d 847 (7th Cir. 2005).

The debtor, an issuer of private label credit cards, was the target of numerous lawsuits that
sought both compensatory and punitive damages.                 These lawsuits led to the
commencement of the bankruptcy case. The debtor’s confirmed plan of reorganization
rejects all claims to punitive damages and enjoins suits against the debtor’s corporate
parent. Certain creditors objected to the disallowance of their claim for punitive damages
and the injunction in favor of the parent company. The Seventh Circuit held that if state
law allows a claim for punitive damages against an insolvent defendant, then federal law
would not bar such a claim. However, the court further held that whether such an award
should be equitably subordinated would need to be analyzed on a case-by-case basis in
accordance with the provisions of the Code. The Seventh Circuit read the bankruptcy
court’s decision as favoring equitable subordination and the appellate court did not
disagree.

With regard to the injunction against the corporate parent, the circuit court concluded that
the creditors had no claim of their own to pursue and could only hope to assert a claim
belonging to the debtor. Accordingly, the injunction did not harm the creditors. The
decision was, therefore, affirmed. In re A.G. Financial Serv. Ctr., Inc., 395 F.3d 410 (7th
Cir. 2005).

Eighth Circuit

The debtors claimed a Minnesota homestead exemption in their newly acquired Arizona
residence. The Chapter 7 trustee objected. Because the Code restricts the debtors to the
exemptions provided by federal law or the law of the state in which the debtors were
domiciled for the 180 days immediately preceding the date of the filing of the petition (or
for a longer portion of that period than any other place), only the federal or Minnesota
exemptions were available to the debtors. The trustee argued that the Minnesota
exemption was only applicable to a homestead located in the state. The trustee premised
this argument on state choice-of-law principles (arguing that Minnesota courts would not
apply Minnesota law to such a question). The Eighth Circuit rejected this approach,
concluding that Congress did not adopt state choice-of-law principles in this context.
Instead, the court held that federal choice-of-law principles dictated the application of
Minnesota substantive law (i.e., Minnesota exemption law). Because Minnesota courts
have liberally construed that state’s homestead exemption, the court concluded that
Minnesota law did not preclude application of the Minnesota homestead exemption to
property located in Arizona (and the statute itself did not preclude such a result). Drenttel
v. Jensen-Carter (In re Drenttel), 403 F.3d 611 (8th Cir. 2005).

Ninth Circuit
A commercial landlord filed a proof of claim for damages arising from rejection of a lease.
The creditors’ committee objected and argued that the security deposit, in the form of a
letter of credit, held by the landlord reduced the allowable claim. The question for the
court of appeals was whether the security deposit should be deducted from the gross
damages or from lesser amount allowed by the Code. The Ninth Circuit held that the
statutory language did not provide guidance on the question and the Code was, therefore,
ambiguous. Looking to pre-Code jurisprudence and the legislative history, the Court
concluded that the deposit must be deducted from the capped amount and not the gross
damages. AMB Property, L.P. v. Official Creditors for the Estate of AB Liquidating Corp.
(In re AB Liquidating Corp.), 416 F.3d 961 (9th Cir. 2005).

A Montana bankruptcy court awarded attorney’s fees in favor of a Montana debtor and
against a Washington debtor, who had filed a proof of claim in the Montana case. After
the objection to the proof of claim had been litigated, but before the fee award had been
rendered, the Washington debtor filed her own bankruptcy petition. The Montana
bankruptcy court found that the automatic stay resulting from the Washington case was
inapplicable. While the automatic stay does not apply to proceedings initiated against the
debtor in the same bankruptcy court where the case is pending, the Ninth Circuit held that
the stay does apply to any action brought against the debtor in any other bankruptcy court.
It concluded that the automatic stay does not contain a general bankruptcy court exception.
Snavely v. Miller (In re Miller), 397 F.3d 726 (9th Cir. 2005).

The assignee of a general assignment for the benefit of creditors brought a state court
action against a transferee of the assignor as being preferential. The action was thereafter
removed to federal court where the transferee argued that the state law action was
preempted by the Code. The Ninth Circuit noted that Chapter 7 has two goals: (i) a fresh
start for the debtor and (ii) an equitable distribution of the debtor’s assets among the
competing creditors. The court further noted that it is settled law that state laws purporting
to provide a fresh start or discharge of indebtedness are preempted by federal law. The
court concluded that the second goal of bankruptcy is equally preemptive and that state
laws aimed at providing for such an equitable distribution are invalid. The court was
particularly concerned that a state preferential transfer action might preclude a federal one,
if a bankruptcy case were to later be filed. The court distinguished actions brought by
individual creditors, which are presumably not preempted. The dissenting judge, however,
noted that the decision calls into question many other state laws governing voluntary
assignments for benefit of creditors. Sherwood Partners, Inc. v. Lycos, Inc., 394 F.3d
1198 (9th Cir.), cert. denied, 126 S. Ct. 397 (2005).

Tenth Circuit

The Tenth Circuit was called upon to decide whether a debt was nondischargeable because
of the debtor’s fraudulent misrepresentations made in order to obtain the loan. The court
began by noting that Section 523 (a)(2)(A) of the Code provides that debts obtained by
false pretenses, false representations, or actual fraud are not dischargeable. The court went
on to note that there is an exception to rule of nondischargeability for oral false statements
respecting the debtor’s financial condition. Such false statements do not bar a discharge.
Whereas, written statements respecting the debtor’s financial condition that are false do
bar discharge. To determine the effect of these differing rules, the court was required to
interpret the phrase “respecting the debtor’s . . . financial condition.” Some courts have
adopted a broad interpretation and held that such a statement is any communication that
has a bearing on the debtor’s financial condition. Other courts adopt a strict interpretation
and hold that the phrase only encompasses those communications that present an overall
picture of the debtor’s financial condition. The Tenth Circuit found that the strict
interpretation was most consistent with the text and structure of the relevant provision of
the Code, which was corroborated by the legislative history. Turning to the facts of the
instant case, the false oral representations at issue concerned the debtor’s ownership of
specific assets and the debtor’s ability to repay the debt and were not made with regard to
his overall financial condition. Thus, the underlying debt was not dischargeable. Cadwell
v. Joelson (In re Joelson), 427 F.3d 700 (10th Cir. 2005).

Eleventh Circuit

An action was brought in the district court to recover damages for a violation of the
automatic stay. The district court dismissed the action for lack of subject-matter
jurisdiction. The district court concluded the action should have been brought in the
bankruptcy court. The Eleventh Circuit held that while a district court may refer all cases
under Title 11 and all cases arising under Title 11 to the bankruptcy court, the explicit
grant of original jurisdiction is to the district court. Thus, it was clear that the conclusion
that the district court lacked subject-matter jurisdiction was wrong. The court of appeals
noted that the Second Circuit has held to the contrary. Justice Cometh, Ltd. v. Lambert,
426 F.3d 1342 (11th Cir. 2005).

Prior to the commencement of the case, the debtor leased personal property to certain third
parties. Thereafter, the debtor assigned the leases to third-party finance companies. At
some point, the debtor encountered financial difficulties and entered Chapter 11. The
debtor filed a plan of reorganization that purported to modify all of its leases without
limiting that modification to leases that had not expired. The lessees did not appear at the
confirmation hearing nor did they object to confirmation. Following confirmation, the
assignee of the leases sought to enforce them as modified. Ultimately, an adversary
proceeding brought the parties before the court. Some of the lessees argued that their
leases had expired before the filing of the bankruptcy case and that the confirmed plan
could not have modified a lease that was no longer in effect. The Eleventh Circuit began
its analysis by stating that a confirmation order is a judgment of the court and has the
preclusive effects that accompany a final judgment. It then found that the confirmed plan
clearly modified all leases that were in effect on a date prior to the commencement of the
case (without regard to whether they were in effect at the time of confirmation). This
language clearly established that the plan modified leases that might have expired before
the debtor filed for bankruptcy. Any objection that the lessees had should have been raised
at the time of confirmation. The lessees were barred from collaterally attacking the
confirmation order and the bankruptcy court was bound to enforce the terms of the plan as
written, including its modification of leases that expired prior to the commencement of the
      case. Finova Capital Corp. v. Larson Pharmacy Inc. (In re Optical Techs., Inc.), 425 F.3d
      1294 (11th Cir. 2005).




§ 4.5       Fearless Predictions for Business Bankruptcy and Litigation
            in 2006

In the coming year, airline bankruptcies will continue to evolve, asbestos claims and asbestos
cases will persist, and pension obligations will be important in every major case.

      Big bankruptcy cases will continue to migrate to New York and Wilmington, and
      interpretative surprises will assuredly unfold under the new law.

      Electronic filings will become routine nationwide, and total bankruptcy cases, which fell
      off sharply after October 17, 2005, will begin to rebound in late 2006. There will be the
      intended shift to more use of Chapter 13 for individual cases under the new law in 2006,
      but a large number of Chapter 7 cases will continue. Whether the norm in recent years of
      1.5 million filings will occur is doubtful for 2006, but the numbers will grow as experience
      under the new law increases.

      Changes will be proposed in Congress for asbestos and other mass tort claims, pension
      reforms and general bankruptcy law aspects.

      Large legal and other professional fees will continue to be approved in major cases.

      Bankruptcy planning for individuals will continue to present difficult ethical and legal
      issues.

      Chapter 11 will continue as the “bank of last resort” for troubled companies.

      The ABA and the ABI will continue to present educational programs and meetings,
      important to every bankruptcy practitioner.

      Consumer confidence and consumer spending will take their places along with interest
      rates, inflation, international trade and investment, and other, as factors influencing
      bankruptcies.

      Global events like war, terrorism, hurricanes and bird flu will have their inevitable impact
      on economies in general. Major floods, fires or droughts may likewise impact the
      economy in particular areas. In this connection it is noted that bird flu – of only casual
      economic interest in 2005 – may pose a significant threat to the economy, especially as to
      areas of tourism, travel, retailing and entertainment. One study by the Congressional
      Budget Office estimates a five per cent drop in the gross domestic product in the year of a
      pandemic outbreak, amounting to 675 billion dollars. The projection estimated 30 percent
       of the work force in urban areas would become infected (90 million over all) and two per
       cent or more would die (some two million persons). Lumkin, “Study: Flu Pandemic Could
       Hurt Economy, “ AP, December 8, 2005.




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