Category Archives: Tenth Circuit Court of Appeals

May 13, 2014

Tenth Circuit BAP Holds a Debtor may Exempt as “Tools of the Trade” Assets Used by the Debtor in a Side Business

In addition to their full-time jobs, many individuals have their own “side businesses” which generate some income but not enough to enable them to give up their “day job.”  Many of these side businesses require assets in order for the individual to deliver the goods or services to his customers.  When that individual has to file for bankruptcy, may he or she claim a “tools of the trade” exemption in the assets used in the side business?  The Tenth Circuit Bankruptcy Appellate Panel in held a debtor may assert such an exemption in appropriate circumstances, in its decision in Larson v. Sharp (In re Sharp), 2014 WL 1400073 (10th Cir. BAP April 11, 2014).

In Sharp, the debtor was employed full time in his proverbial “day job.”  However, his dream was to become an outdoor outfitter and guide and to spend his retirement years in that occupation, and in his effort to fulfill his dream the debtor started a part-time outdoor outfitting business, Aspen Place Outfitters.  The debtor attended trade shows, and used his vacation time from his main job to provide outfitting and guide services for his customers.  The debtor had acquired various assets (firearms, boats, a camper, an ATV, utility and horse trailers and fishing poles) which he used in his outfitting business and which he owned on the date he filed bankruptcy.  The debtor’s outfitting business generated some income but not enough to enable him to quit his full time job. Although the debtor’s side business was growing, it had not yet generated a net profit by the time the debtor filed bankruptcy.

The debtor asserted an exemption to his outfitting company assets as tools of the trade, under Colorado Rev. State § 13-54-102(1)(i), which allows an exemption in the “stock in trade, supplies, fixtures, maps, machines, tools, electronics, equipment, books, and business materials of any debtor used and kept for the purpose of carrying on any gainful occupation in the aggregate value of twenty thousand dollars.”  The trustee objected to the claim of the exemption, contending the Colorado statute’s use of the term “gainful occupation” requires the occupation to generate a net profit as of the petition date in order for a debtor to assert the exemption.  Consequently, the BAP’s analysis was focused on the term “gainful” in the statute. 

The court began its analysis by noting that the Constitution of the State of Colorado requires its exemption laws to be liberally construed.  See Beneficial Fin. Co. of Colo. V. Schmuhl, 713 P.2d 1294, 1298 (Colo. 1986).  The court also noted that the purpose of the exemption is to preserve to the debtor his means of support.  Taking these concepts in hand, the BAP next agreed with the bankruptcy court’s conclusion that the term “gainful” as used in the exemption statute, is ambiguous.  The bankruptcy court had found that the debtor’s outfitting business was “an entrepreneurial business that may become viable in the near future.”  The BAP agreed that this conclusion was supported by the record, and then went on to determine whether this finding supported the bankruptcy court’s conclusion that the side business was, therefore, a “gainful occupation” of the debtor.

The BAP noted that “virtually all dictionary definitions” of the work “gainful” list “profitable” as a synonym.  The BAP then stated that the Bankruptcy Code’s fresh start policy is served only when there is some element of profitability to the trade for which the debtor seeks to exempt his tools.  Consequently, the BAP concluded the term “gainful occupation” under Colorado’s exemption statute requires some aspect of profitability to the business.  However, the BAP held that the business in question need to actually be generating a profit at the time of the debtor’s bankruptcy.  Rather, the court held that a gainful occupation consists of two elements: a business (1) which is conducted with continuity and regularity and (2) which has a profit motive, meaning an expectation or anticipation of profit in the future. 

Taking the facts indicating that the debtor’s side business was on a trend toward profitability, with the debtor devoting regular efforts to the business, the BAP concluded the debtor could assert an exemption in the assets associated with his side business as tools of his trade.

April 29, 2014

The “No Harm No Foul” Rule is Alive and Well in the Tenth Circuit, and a Bankruptcy Trustee May Not Avoid Under Secs. 549 and 362 a Transfer if Recovery of the Transfer Does Not Benefit the Estate

The United States Court of Appeals for the Tenth Circuit recently ruled that a chapter 7 trustee may not avoid a post-petition transfer under either § 549 or § 362, where recovery of the transfer would not benefit the estate, even though the elements for avoidance under those sections are established by the evidence.

In In the Matter of C.W. Mining, Co., 2014 WL 1424526 (10th Cir. April 15, 2014), the debtor deposited cash with its bank, and the bank issued the debtor a certificate of deposit.  On the date that an involuntary petition was filed against it, the debtor still owned the certificate of deposit, but owed the bank a debt arising from three promissory notes which exceeded the amount of the certificate.  Following the entry of an order for relief, the bank liquidated the certificate of deposit and applied the proceeds to two of the three promissory notes which the debtor owed it and for which the certificate served as security.  The bank took this action without first seeking relief from the automatic stay or other approval from the bankruptcy court for the action.  Consequently, the bank’s conduct violated the automatic stay and was an unauthorized post-petition transfer.

The bankruptcy trustee brought suit seeking recovery of the transfer under § 549 as an unauthorized post-petition transfer and under § 362 as a violation of the automatic stay.  The trustee sought to recover the funds represented by the certificate of deposit for the benefit of the estate. The bankruptcy court entered summary judgment in favor of the bank under both claims asserted by the trustee.  On the trustee’s claim under § 549, the bankruptcy court held that § 502(h) would operate to restore the bank to its secured status, with a revival of its lien against the funds represented by the certificate.  The bankruptcy court also ruled that the trustee was not entitled to relief under § 362, reasoning that the goal of remedying violations of the automatic stay is to restore the status quo for both parties, also resulting in a return of the bank to its secured status and providing no benefit to the estate.  The BAP for the Tenth Circuit affirmed the bankruptcy court’s ruling.

On appeal the Tenth Circuit affirmed the grant of summary judgment to the bank.  Both the bankruptcy court and the BAP relied on the decision of the First Circuit Court of Appeals in Fleet Nat’l Bank v. Gray (In re Bankvest Capital Corp.), 375 F.3d 51, 66-68 (1st Cir. 2004) to reach their conclusions that avoidance of the post-petition transfer would revive the bank’s lien against the certificate of deposit under § 502(h).  The bankruptcy trustee argued that Bankvest was wrongly decided, but the Tenth Circuit was persuaded by its reasoning. Because the bank’s lien would be reinstated, avoidance would result only in the trustee having to pay the bank its fully secured claim.  Consequently, the court concluded there was no benefit to the estate in avoiding the transfer under § 549.

The court came to the same conclusion on the trustee’s contention that the bank’s conduct in offsetting the certificate against its pre-petition debt violated the automatic stay.  However, since the purpose of remedying stay violations is to return the parties to the status quo, and the status quo in this instance would mean the bank would receive its lien and be fully secured, the Tenth Circuit agreed with the courts below that the bank obtained no benefit from its violation of the stay and the estate suffered no damage. 

Thus, although the elements of avoidance under §§ 362 and 549 were established, the lack of damage to the estate from the bank’s conduct was sufficient to preclude the trustee’s recovery.  In short, no harm/no foul.

April 15, 2014

Tenth Circuit Solves Sec. 101(18)(A)’s Riddle and Gives the Definition of a Family Farmer

The definition of a family famer under § 101(18)(A) of the Bankruptcy Code is convoluted at best:  a family farmer is a farmer whose aggregate noncontingent, liquidated debts arising out of his farming operation make up not less than 50% of his debts; however, the farmer’s debt “for” his principal residence is excluded in making this calculation unless the debt also “arises out of” his farming operation, in which event it is included in making the calculation.    In its opinion in First National Bank of Durango v. Woods (In re Woods), 743 F.3d 689 (10th Cir. 2014), the Tenth Circuit tackled the question of when a debt “for” a principal residence does, and does not, “arise out of” the debtor’s farming operations.

The facts in Woods were straightforward.  The debtors purchased and operated a farm several years before filing chapter 12.  During that time the debtors incurred debts, some of which were related to their farming operations and some of which were not.  The debt in question involved a loan obtained from First National Bank of Durango, some of which was used to pay for the construction of the debtors’ principal residence located on the farmland.  The debtors and bank disagreed whether this construction loan “arose out of” the debtors’ farming operations.  If it did, then the debtors qualified to file a chapter 12 petition.  If it did not, then the debtors would likely have to proceed under chapter 11.

The Tenth Circuit decided that, in order for a debt to “arise out of” a farming operation for purposes of § 101(18)(A), there must be a “direct and substantial connection” between the debt and the farming operation.  In reaching its conclusion, the Tenth Circuit concluded the “direct and substantial connection” test as the most appropriate one to ensure that chapter 12’s protections are reserved for “true family farmers.”  Noting the general rule of statutory construction that exceptions to a rule are to be narrowly construed, the Tenth Circuit rejected the “but-for” test followed by some courts and the “some-connection” test followed by other courts, including the bankruptcy court in this case.  The “but-for” test provides that a debt arises out of a farming operation if but for the debt, there would be no farm.  See e.g., In re Reak, 92 B.R. 804, 805-06 (Bankr. E.D. Wis. 1988).  However, the Tenth Circuit believed the “but-for” test would eviscerate the exception relating to the debtor’s principal residence, and might make it more difficult for true family famers to qualify for chapter 12.  The “some-connection” test focuses on whether the purpose of the debt has “some connection” to the farming operations, and holds that a debt “arises out of” the farming operations if it has “some connection” to it.  The bankruptcy court in this case used the “some-connection” test and found that the construction loan arose out of the farming operation because the debtors maintained the farm’s books and records in the home, and the home was located in close proximity to the debtors’ farming operations.  The Tenth Circuit rejected the “some-connection” test also, finding that it would in many instances swallow the rule, thereby enabling debtors who were not “true family farmers” to take advantage of chapter 12.

The “direct-use” test adopted by the Tenth Circuit is “singularly focused on whether the loan proceeds were directly applied to or used in a farming operations.”  In re Douglass, 77 B.R. 714 (Bankr. W. D. Mo. 1987).  In other words, the loan proceeds must be directly used in the farming operation in order for the debt to be considered as arising in the farming operation. 

February 4, 2014

Tenth Circuit BAP Clarifies Creditors’ Rights to File Plans in Small Business Chapter 11 Cases

Section 1121(e)(1) of the Bankruptcy Code provides a 180-day exclusive period for a small business debtor to file a plan, unless this period is extended by the court.  Section 1121(e)(2) provides “the” plan and a disclosure statement (if any) shall be filed no later than 300 days after the order for relief.  Section 1121(e)(3) provides that the deadlines in 1121(e)(1) and (e)(2) may be extended only if the debtor demonstrates that it is more likely than not that the court will confirm a plan within a reasonable period of time. These time periods in section 1121(e), and any extension of them, differ from the times periods in sections 1121(b) and (c) and the procedure in section 1121(d) for extending them. 

In the context of a small business chapter 11 case, then, is a creditor prohibited from filing a plan more than 300 days following the order for relief (the deadline contained in sec. 1121(e)), or may the creditor still file a plan if it otherwise meets the provisions of section 1121(c)?  In ruling that the provisions of section 1121(e) apply only to small business debtors, the Tenth Circuit BAP held that creditors of a small business debtor may file plans of reorganization more than 300 days following the order for relief.  Thurner Industries, Inc. v. Gunnison Energy Corporation (In re Riviera Drilling & Exploration Company), 2013 WL 6623647 (10th Cir. BAP 2013). 

In Riviera Drilling the debtor filed a plan but was unsuccessful in obtaining confirmation.  The bankruptcy court then ordered the appointment of a chapter 11 trustee, who unsuccessfully sought to sell the debtor’s assets through a section 363 sale.  When the trustee thereafter sought to have the case converted to a chapter 7 proceeding.  Gunnison Energy, a creditor of the estate, opposed the trustee’s motion to convert and filed a liquidating plan.  Thurner Industries objected to confirmation of Gunnison Energy’s plan in part on the ground that it was filed after the 300-day deadline of section 1121(e)(2), and the 300-day deadline had not been extended.  The bankruptcy court concluded that the 300-day deadline applies only to plans filed by a debtor and confirmed the plan.  The Bankruptcy Appellate Panel affirmed that ruling.

The BAP held that the provisions of section 1121 should be read as a whole in determining the extent of section 1121(e)’s reach.  First, the court noted that section 1121(b) provides a 120-day exclusive period for a debtor to file a plan and, if the debtor does so, section 1121(c) extends this exclusive period an additional 60 days to enable the debtor to obtain confirmation of its plan.  If the debtor fails to meet these deadlines, or if a chapter 11 trustee is appointed, the debtor’s exclusive period ends, and creditors may file plans.  These deadlines may be extended in some respects by means of a request under section 1121(d) filed by a party in interest.  However, if the debtor is a small business, the deadlines in sections 1121(b) and (c) a replaced by section 1121(e)(1) and (2), and the procedure for extending the small business deadlines is found in sections 1121(e)(1)(A) and (B) and section 1121(e)(3).  Importantly, the court noted that in the small business context, extension of the 180-day and 300-day deadlines depends on affirmative action by the debtor with no right by creditors or other parties in interest to seek an extension. 

In addition, the BAP looked to changes made to section 1121(e) in the 2005 BAPCPA amendments.  Previously, the deadline for filing a plan could be requested by a party in interest, whereas the amendments removed this language and placed complete power to seek an extension in the debtor.  In addition, the prior section 1121 required “all plans” to be filed within 160 days from the order for relief, whereas the amendment speak in terms of “the” plan must be filed within 300 days from the order for relief.

The BAP then reviewed other court decisions dealing with section 1121(e) and the effect of its deadlines on untimely filed plans.  All but one reported decision dealt with plans filed only by the debtor.  One, the decision of the Bankruptcy Court for the Southern District of Florida in In re Florida Coastal Airlines, Inc., 361 B.R. 286 (Bankr. S.D. Fla. 2007), involved competing plans by the debtor and a creditor, with the debtor’s plan being timely filed and the creditor’s plan falling outside the 300-day deadline.  The court in Florida Coastal Airlines determined that, since only the debtor may file “a” plan until the exclusive period expires, and since “the” plan must be filed not later than 300 days after the order for relief, the phrase “the plan” in section (e)(2) referred only to “a plan” filed by the debtor. 361 B.R. at 291.  In addition, because extension of the section 1121(e) deadlines can be accomplished only through the affirmative action of the debtor, the Florida Coastal Airlines court found it absurd to bind creditors to a deadline that only the debtor could seek to extend. 

The Tenth Circuit BAP found the reasoning of the Florida Coastal Airlines case persuasive.  The BAP agreed that applying the 300-day deadline of section 1121(e) to defeat a result that may otherwise be beneficial to creditors made no sense, and that it is absurd to hold creditors to the 300-day deadline when only the debtor may seek its extension.  Reading section 1121(e) in harmony with the rest of section 1121 lead the court to conclude that the deadlines contained in section 1121(e) apply only to the small business debtor, and the deadlines contained in sections 1121(c) apply to creditors and parties in interest, even in small business cases.

January 21, 2014

Tenth Circuit Finds the Plain Language of Sec. 548(a)(2) Not So Charitable and Holds an Entire Religious Tithing Avoidable if it Exceeds 15% of Debtor’s Gross Annual Income

In a case of first impression at the circuit level, the Tenth Circuit Court of Appeals has held a debtor’s entire religious tithing is avoidable if it exceeds 15% of the debtor’s gross annual income, and the court did so based on its perception of the plain language of the Religious Liberty and Charitable Donation Protection Act which codified the “safe harbor” provisions of sec. 548(a)(2).[1]  Wadsworth v. The Word of Life Christian Center (In re McGough), 2013 WL 6570853 (10th Cir. 2013). 

In McGough, in each of the two years prior to their bankruptcy filing, the debtors, through numerous payments each year, contributed more than 15% of their gross annual income to their church.  No single payment exceeded the 15% threshold, but the total payments each year did.  The bankruptcy trustee asserted that the term “contribution” in sec. 548(a)(2)(A) should be read to apply to the aggregate of all religious contributions made during the year, and sought to avoid the contributions in their entirety because they exceeded the threshold.  In defense the church brought forward two arguments:  (1) the term “contribution” in the statute applies to each contribution individually and not to all contributions in the aggregate and, since no single contribution exceeded 15% of the debtors’ gross annual income, none of the contributions was avoidable and (2) if the term “contribution” under the statute was read as applying to the entire years’ contributions in the aggregate, the trustee could avoid only the amount that exceeded 15% of the debtors’ gross annual income.

The bankruptcy court held that, for purposes of applying the safe harbor provisions of the statute, the contributions made in any year must be considered in the aggregate.  However, the bankruptcy court decided that the statute empowered the trustee to recover only the amount of the aggregate contributions that exceeded 15% of the debtor’s gross annual income.  The BAP affirmed the bankruptcy court, and the trustee perfected an appeal to the Tenth Circuit on the issue of whether section 548(a)(2)(A)’s safe harbor protected the debtors’ contributions up to the 15% threshold.[2]

Determining that the plain language of the safe harbor provisions of section 548(a)(2)(A) mandated a contrary finding, the Tenth Circuit reversed, and held that a trustee may avoid the entirety of a debtor’s religious contributions if they exceed the 15% threshold of the sum total of all contributions made during the year in question, unless the transfer is consistent with the debtor’s practice.[3]  The Tenth Circuit based its conclusion on the plain language of section 548(a)(2)(A):

                A transfer of a charitable contribution to a qualified religious or charitable entity or organization shall not be [avoidable by the Trustee under sec. 548(a)(1)(B)] in any case in which

(A)   the amount of that contribution does not exceed 15  percent of the gross annual income of the debtor for the year in which the transfer of the contribution is made; or

(B)   the contribution made by a debtor exceeded the percentage amount of gross annual income specified in subparagraph (A), if the transfer was consistent with the practices of the debtor in making charitable contributions.

The court stated that its interpretation of the statute begins “where all such inquiries must begin: with the language of the statute itself.”  Ransom v. FIA Card Servs., N.A., 131 S. Ct. 716, 723 (2011).  Noting that “courts must presume that a legislature says in a statute what it means and means in a statute what it says,” and when the words of a statute are not ambiguous, resort to legislative history for interpretation of the statute is unnecessary.   The church argued the phrase “in any case in which” should be interpreted as equivalent to the phrase “to the extent,” with a result that the statute should be interpreted as protecting contributions up to the 15% level and exposing only those above that threshold to the trustee’s avoidance powers.  The court rejected this argument, noting that the phrase “in any case in which” is used synonymously with “if” or “when”  in several federal statutes.  Because the statute contains no language limiting the amount of the transfer to be avoided to amounts above the 15% threshold, the court held that in those instances where the contribution exceeds 15% of the debtor’s gross annual income, the trustee may avoid the entire contribution. 

The church also raised the absurdity doctrine, contending that allowing the trustee to recover the entire transfer if the threshold is exceeded but nothing if the threshold is not met lead to a result not intended by Congress.  The Tenth Circuit noted that the absurdity doctrine is an exception to the rule that the plain meaning of a statute controls, and is used when an interpretation of a statute on its plain language would lead to a result not intended by its drafters.  However, the court stated that there is a “heavy presumption” meant what it said when it used plain and clear language, and the absurdity exception is to be applied only when the court is convinced that Congress could not have intended such a result:

[w]e cannot reject an application of the plain meaning of the words of a statute on the ground that we are confident that Congress would have wanted a different result.  Instead, we can apply the doctrine only when it would have been unthinkable for Congress to have intended the result commanded by the words of the statute—that is, when the result would have been so bizarre that Congress could not have intended it.

The court saw no absurdity, and instead determined that Congress intended to create a bright-line rule under which donations not exceeding 15% of gross annual income are protected but donations exceeding that limit are not.  The court stated that the bright-line rule was not absurd if viewed as a policy protecting excess contributions if they are consistent with prior practice but allowing recovering of the entire fraudulently transferred donation where it exceeds the threshold and was inconsistent with the debtor’s prior practice.

[1]  The Religious Liberty and Charitable Donation Protection Act added secs. 548(a)(2)(A) and (B) to the Code.  These sections protect transfers to qualified religious organizations if the amount of the contribution does not exceed 15% of the debtor’s gross annual income for the year in which the transfer was made, or is consistent with the debtor’s tithing practice if the contribution does exceed this threshold.

[2] The church did not appeal the bankruptcy court’s holding that contributions are to be determined by the aggregate of the contributions made during the year in question.

[3] No contention was made by the church that the McGough’s exceptional contributions in the years in question were in keeping with their prior practice.

January 7, 2014

Tenth Circuit Holds that a Claim for Overpayment of Spousal Support is Dischargeable Under Sec. 523(a)(5) but Non-Dischargeable Under Sec. 523(a)(15)

The Tenth Circuit recently analyzed the interplay between sections 523(a)(5) and 523(a)(15) of the Bankruptcy Code in connection with a judgment obtained by a former husband for overpayment of his spousal support obligations.  Eloisa Taylor, the debtor in In re Taylor, 2013 WL 6404952 (10th Cir. 2013) had divorced Matthew Taylow and was awarded spousal support, with the divorce decree providing that Matthew’s obligation to pay spousal support would terminate on Eloisa’s remarriage.  Several years later, Matthew moved to terminate his spousal support obligations on the ground that Eloisa was cohabiting with another man in a marriage-like relationship.  Applicable Virginia law provided that cohabitation for one year in a relation analogous to marriage constitutes grounds for termination of spousal support under a decree that provides for termination on remarriage.  Not only did the Virginia state court terminate Matthew’s obligation to pay spousal support, it did so retroactively and awarded him a judgment of $40,660 against Eloisa for overpaid spousal support.

Eloisa filed bankruptcy in the District of New Mexico seeking to discharge the judgment.  Matthew filed an adversary proceeding asserting the judgment was non-dischargeable under either section 523(a)(5) or 523(a)(15).  The bankruptcy court held that the judgment was not “spousal support” and, therefore, did not qualify for denial of discharge under section 523(a)(5).  However, the bankruptcy court further held that the judgment was an obligation in connection with a divorce proceeding within the plain language of section 523(a)(15) and denied a discharge of the judgment.  The BAP affirmed, and the appeal was then brought to the Tenth Circuit, which also affirmed.

The Tenth Circuit first analyzed whether the judgment in Matthew’s favor was “spousal support” within the meaning of section 523(a)(5).  The court first noted that, while the Bankruptcy Code favors a debtor’s “fresh start,” it does not do so over the policy of enforcing familial support obligations.  First, the court looked to the statutory definition of “domestic support obligation” as a debt “owed to. . . . a spouse. . . in the nature of alimony, maintenance or support.”  11 U.S.C. sec. 101(14A).  The court affirmed the conclusion of the bankruptcy court and the BAP that the judgment did not qualify under section 523(a)(5) for a denial of discharge, because it did not create a support obligation as to Matthew as the creditor spouse.  The Tenth Circuit held that, to be non-dischargeable under section 523(a)(5), the spousal support obligation had to be owed to the creditor spouse.  In this case, Matthew was the one who owed spousal support.  The judgment in question was not one where Eloisa was ordered to pay spousal support to Matthew, but instead to compensate Matthew for his overpayment of spousal support to Eloisa.  Consequently, the court held that Matthew could not obtain a denial of discharge of the judgment under section 523(a)(5).

The Tenth Circuit, however, held that Matthew’s judgment was non-dischargeable under section 523(a)(15).  Section 523(a)(15) provides that debts owed to a former spouse incurred in the course of a divorce decree or other court of record, which are not of the kind described in section 523(a)(5), are not dischargeable.  There was no dispute in this instance that Matthew was Eloisa’s former spouse, and the Tenth Circuit held the debt did not constitute spousal support for purposes of section 523(a)(5).  The state court retained jurisdiction over the parties under the divorce decree and entered the judgment in connection with the prior divorce decree.  Thus, under the plain language of section 523(a)(15), the judgment was not dischargeable. 

Eloisa attempted to avoid this result by asserting the “absurdity doctrine,” under which the plain language of a statute is to “yield to the legislative intent of the Bankruptcy Code drafter,” and where enforcement of a statute’s plain language will yield a result demonstrably at odds with the drafters’ intent.  See United States v. Ron Pair Enterprises, 489 U.S. 235, 242-43 (1989).  However, the Tenth Circuit noted that the absurdity doctrine applies “in only the most extreme of circumstances,” where the result of enforcing the statute’s plan language will lead to “results so gross as to shock the general moral or common sense.”  (citing United States v. Husted, 545 F.3d 1240, 1245 (10th Cir. 2008)).  The court concluded that the bankruptcy court’s determination that Matthew’s judgment was not dischargeable under section 523(a)(15) did not shock the general moral or common sense, and was not at odds with the intent of the Bankruptcy Code’s drafters.  Congress amended section 523(a)(15) in 2005 to remove the provisions which required a court to balance the debtor spouse’s ability to pay the debt in question against the merits of the creditor spouse’s needs, leaving the court to conclude that Congress intended such debts to be non-dischargeable regardless of the debtor spouse’s ability to pay.  In addition, nothing in the statute indicated Congressional intent that the statute was enacted solely for the protection of the dependent spouse.  Based on this reasoning, the Tenth Circuit held the judgment non-dischargeable under section 523(a)(15).

December 23, 2013

Tenth Circuit Holds the Recording of a Lis Pendens is not a “Transfer” Under Colorado Law Within the Meaning of Sec. 101(54)(D)(ii)

The Tenth Circuit Court of Appeals recently concluded that, under Colorado law, the recording of a lis pendens is not a “transfer” within the meaning of 11 U.S.C. Sec. 101(54)(D)(ii).  The question was presented to the Court in the case of Ute Mesa Lot 1, LLC v. First-Citizens Bank & Trust Company (In re Ute Mesa Lot 1, LLC), No. 12-1134, —F.3d— (10th Cir. 2013). 

In Ute Mesa, the bank’s predecessor in interest recorded a trust deed in connection with a loan made to the debtor.  However, due to an error in the trust deed, the recording was ineffective to give the bank’s predecessor a lien against the debtor’s property.   Before the debtor filed bankruptcy, the bank commenced an action in Colorado state court seeking to reform the trust deed and recorded a lis pendens in connection with the action.  Shortly thereafter, the debtor filed bankruptcy and commenced an adversary proceeding against the bank seeking to avoid the lis pendens as a preferential transfer under sec. 547(b).  The bankruptcy court held, under Colorado law, the recording of a lis pendens only serves the limited purpose of providing notice of an action and does not create a lien or otherwise result in the transfer of an interest in property, and dismissed the debtor’s adversary proceeding.  Both the district court and the Tenth Circuit affirmed.

The debtor argued that the recording of the lis pendens diminished the value of its property and rendered it virtually impossible to sell, the recording of the lis pendens was voidable under sec. 547(b).  The Tenth Circuit disagreed.  First, it noted that sec. 547(b) provides that a trustee “may avoid any transfer of an interest of the debtor in property, to or for the benefit of a creditor.”  The Court stated that fundamentally, the “keystone of a preference is a transfer of the debtor’s property.”  (citing 5 Collier on Bankruptcy ¶ 547.05).  Because property interest are defined by state law, the Court looked to Colorado law to ascertain whether the recording of a lis pendens constitutes a transfer of a property interest.  Colo. Rev. State. §38-35-110(1) provides that a party may record a lis pendens against real property after initiating an action” wherein relief is claimed affecting the titel to real property.”  The statute also states a lis pendens provides notice to any person subsequently acquiring the property that the acquired interest may be subject to the action described in the notice of lis pendens. 

The Tenth Circuit noted that Colorado courts have construed the statute to make clear that a “lis pendens does not constitute a lien against real property.”  Hewitt v. Rice, 154 P.3d 408, 412 (Colo. 2007).  Further, until judgment is recorded, “no new interest is created by the existence of a lis pendens notice.”  Kerns v. Kerns, 53 P.3d 1157, 1164 n. 6 (Colo. 2002).  Although the Court agreed with the debtor that federal law determines what constitutes a transfer for purposes of section 547, state law governs the transfer was of an interest in property.  While the Court noted that a lis pendens likely renders the property unmarketable, its purpose under Colorado law is only to provide notice and it does not transfer an interest in property from the debtor to the party recording the notice.  In addition to the Colorado Supreme Court’s decision in Kerns v. Kerns, the Tenth Circuit noted that specific holding of the Colorado Supreme Court in Hammersley v. District Court in and for Routt County, 610 P.2d 94, 96 (Colo. 1980) that, while the recording of a lis pendens clouds title and impairs marketability, it “harms no legitimate interest of the owner.” 

Based on these clear rulings from the Colorado Supreme Court, the Tenth Circuit held that the recording of the lis pendens by the bank did not result in a transfer of any interest of the debtor in its real property for purposes of section 547(b).

December 10, 2013

Tenth Circuit BAP Holds Debt Incurred for New Operating Procedures can be “Ordinary” for Purposes of Section 547(c)(2)(A)

The Tenth Circuit BAP recently addressed a case which presented the question “how ordinary is ordinary?”  In its decision in Rushton v. SMC Electrical Products, Inc. (In re: C.W. Mining Company), 500 B.R. 635 (10th Cir. BAP 2013), the BAP addressed an appeal from a claim by a chapter 7 trustee asserting a preference action against an equipment vendor who defended the action asserting the incurring and payment of the debt was in the ordinary course of business under 11 U.S.C. sec. 547(c)(2)(A). 

The debtor, C.W. Mining, had operated a mine using a process known as the “continuous mining” process.  Prior to filing bankruptcy, the debtor contracted with SMC Electrical Products for the purchase and installation of a longwall electrical system.  Longwall electrical mining is a different process of mining from the continuous mining process, so the acquisition of the longwall electrical system from SMC enabled the debtor to change its historical method of operations.  SMC issued a purchase order to the debtor for the longwall system, and the agreement between the debtor and SMC provided that the debtor would make progress payments as it received invoices from SMC.  The last invoice issued before the debtor was placed into involuntary bankruptcy exceeded $800,000.  This invoice was paid through five payments from three different sources, including at least one payment from an affiliate of the debtor.  The payment by the debtor which the trustee sought to avoid had been made 28 days after the invoice was issued.  SMC introduced evidence showing that it customarily received payments of large invoices over the course of several payments, payments from affiliates of its customer and payments utilizing the same timing as was the case with the debtor.

The ordinary course defense provides that a trustee may not set aside a payment of a debt that of a “debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor.”  11 U.S.C. sec. 547(c)(2).  The trustee argued that, because the debt was incurred by the debtor in order to effect a complete change of its mining system from continuous mining to longwall mining, the debt would not be considered as having been incurred in the ordinary course of the debtor’s business.  The BAP disagreed.  The BAP stated that the purpose of the preference statute is to “prevent creditors from exerting undue pressure on struggling debtors” and to “discourage ‘unusual action’ that might ‘favor certain creditors or hasten bankruptcy by alarming other creditors and motivating them to force the debtor into bankruptcy to avoid being left out.’” (citing Milk Palace Dairy, LLC v. L&N Pump, Inc. (In re Milk Palace Dairy LLC), 385 B.R. 765, 771 (10th Cir. BAP 2008)).  The BAP further stated that the purpose of the ordinary course defense is “’to leave undisturbed normal financial relations, because it does not detract from the general policy of the preference section to discourage unusual action by either the debtor or his creditors during the debtor’s slide into bankruptcy.’” (citing In re M&L Business Machine Co., 84 F.3d at 1339-40). 

The BAP further noted that the fact that the debtor and the creditor had no prior dealings before the transaction in question does not preclude application of the ordinary course defense.  The term “incurred” for purposes of section 547(c)(2) focuses on whether the debt was incurred in a typical, arms-length commercial transaction that occurred in the marketplace, or whether it is atypical, fraudulent or not consistent with an arms-length commercial transaction.  (citing 5 Collier on Bankruptcy ¶ 547.04[2][a][i]).  Consequently, the fact that the transaction between the debtor and SMC was one under which the debtor effected a significant change to its business operations was not determinative.  Instead, focusing on the fact that the underlying transaction was a typical arms-length transaction in the marketplace, the court concluded that the debt arising from the transaction was incurred by the debtor in the ordinary course of its business.   In short, the transaction need not be common, just ordinary.  (citing Huffman v. New Jersey Steel Corp. (In re Valley Steel Corp.), 182 B.R. 728 (Bankr. W.D. Va. 1995)).

August 26, 2013

Tenth Circuit Set Parameters of Application of UFTA Statute of Limitations on SEC Equity Receiver’s Claims for Fraudulent Transfer

In a recent opinion, the Tenth Circuit Court of Appeals addressed several issues relating to the application of the statute of limitations in the Uniform Fraudulent Transfer Act on fraudulent transfer
claims asserted by an equity receiver appointed in an SEC civil enforcement action.  The decision was rendered in Wing v. Buchanan (Tenth Circuit No. 12-4123, August 9, 2013). 

Wing was appointed receiver for VesCor Capital, Inc. and a number of its affiliates in connection with a civil enforcement action brought by the SEC.  Prior to the filing of the SEC action, VesCor Capital, Inc. filed a voluntary bankruptcy petition under chapter 11 of the Bankruptcy Code.  However, the affiliates involved in the receivership proceeding did not file bankruptcy petitions.  The bankruptcy court ordered the appointment of a chapter 11 trustee approximately seven months before the SEC action was commenced and ten months before the receiver was appointed. 

Wing filed an action against Buchanan seeking to recover payments made by VesCor Capital and several of its affiliates under the UFTA, alleging that VesCor operated a Ponzi scheme and, therefore, these payments were “by definition, made to hinder, delay or defraud creditors and/or investors of VesCor.”  The timing of the filing of the receiver’s complaint was a critical fact in the dispute:  it was filed more than four years after the transfers in question, more than one year after the appointment of the bankruptcy trustee, but within one year of the receiver’s appointment.  Buchanan alleged that the complaint was barred by the statute of limitations found at Utah Code § 25-6-10.  That statute provides that an action seeking to recover transfers based on allegations of actual fraud must be filed within four years after the transfer was made or, if later, within one year after the transfer was or could reasonably have been discovered by the claimant.  The district court rejected Buchanan’s argument and entered summary judgment in favor of the receiver.

The Tenth Circuit began its analysis by concluding that Utah would adopt the adverse domination theory so that the discovery period for such transfers would not begin to run until the bad actors controlling the entity were removed.  The adverse domination theory recognizes that control of the transferor by its bad actors precludes the possibility of filing suit because these individuals would have no motivation to reveal their fraud by filing suit to claw back fraudulent transfers.  The Tenth Circuit ruled that limitations did not begin to run until Val Southwick, the bad actor controlling
the VesCort entities, was removed from control.

That holding lead to the next question—whether Southwick was “removed” for purposes of the statute when the bankruptcy trustee was appointed in the VesCor Capital bankruptcy case, or whether it began running when the receiver was appointed in the SEC action.  Because some of the transfers were likely made by entities that had not been included in the bankruptcy proceedings, the Tenth Circuit vacated the summary judgment in favor of the receiver and remanded the case to the district court to determine which of the transfers could reasonably have been discovered by the bankruptcy trustee, thereby triggering the statute of limitations on the trustee’s appointment.

The receiver raised two arguments before the appellate court which were rejected.  First, he asserted that limitations could not begin running on the trustee’s appointment because the
receiver is the “claimant” for purposes of the UFTA.  The court rejected that argument, ruling that
it is the companies in receivership and their creditors who are claimants that benefit from the discovery rule, and if their claims are barred by limitations, a subsequent appointment of a receiver will not resurrect otherwise stale claims.  The court also noted that such an interpretation would enable receivers to manipulate the statute by causing a receivership entity to file a bankruptcy petition and thereby gain the commencement of a new statute of limitations on claims that may be barred in the receiver’s hands.  Wing also asserted that the district had equitable discretion to disregard the statute of limitations altogether, citing the Tenth Circuit’s statement in SEC v. VesCor Capital Corp., 599 F.3d 1189, 1194 (10th Cir. 2010) that a “district court has broad powers and wide discretion to determine relief in an equity receivership.”  The court stated that the receiver had
misinterpreted this prior language. The court explained that a district court sits in equity when determining the distribution of assets already in a receiver’s control, but that a district court does not sit in equity when adjudicating a receiver’s claims against third parties to recover property.

May 23, 2013

Tenth Circuit Holds that Property Transferred by the Debtor Pre-petition and Subject to Avoidance is not Protected by the Automatic Stay

Section 541(a)(1) defines “property of the estate” to include all legal or equitable interests of the debtor in property as of the commencement of the case.  Although this broad definition brings into the estate many assets to which the debtor may claim entitlement, the Tenth Circuit Court of Appeals held in Rajala v. Gardner, 709 F.3d 1031 (10th Cir. 2013) that it is not so broad as to include property transferred by the debtor pre-petition and which is subject to avoidance, but not yet recovered by the trustee. 

The debtor in Rajala owned several wind-generated power projects and entered into a Memorandum of Understanding with Edison Capital to sell three of those projects to Edison.  The debtor’s insiders formed a new entity (“Newco”) which received an alleged fraudulent transfer of the three projects, and which then concluded an agreement with Edison for the sale of the projects.  Eventually Newco brought suit against Edison in federal court in Pennsylvania seeking to recover the last installment due under the contract. 

The debtor was placed into bankruptcy in Kansas after Newco’s Pennsylvania suit was commenced. 
The bankruptcy trustee brought suit in federal district court in Kansas against Newco and the insiders alleging that the transfer of the power projects to Newco was a fraudulent transfer.  The trustee requested the Kansas court to stay Newco and the insiders from pursuing the Pennsylvania litigation, asserting that the proceeds from any judgment would be property of the debtor’s bankruptcy estate and that the automatic stay precluded Newco and the insiders from prosecuting the Pennsylvania action.  The Kansas court denied the motion, and the trustee prosecuted an appeal.

On appeal the Tenth Circuit stated that “the underlying issue we must decide is whether a bankruptcy estate includes fraudulently transferred property that the Trustee has not yet recovered.”  The Tenth Circuit held that such property does not become property of the estate until such time as the trustee recovers it. 

The court arrived at its conclusion by analyzing the plain language of sections 541(a)(1) and 541(a)(3) of the Bankruptcy Code.  The former defined property to include “all legal or equitable interests” the debtor has as of the date the petition is filed, while the latter brings into the estate “interest in property that the trustee recovers under section . . . 550.”  Section 550 empowers a trustee recover transferred property if the transfer is voidable under section 548.  The Tenth Circuit noted a dispute between the Fifth and Second Circuits over whether fraudulently transferred property constitutes property of the estate before it is recovered.  The Fifth Circuit has determined that it is and that the automatic stay protects such property, Am. Nat’l Bank of Austin v. MortgageAmerica Corp. (In re Mortgage America Corp.), 714 F.2d 1266 (5th Circ. 1983), whereas the Second Circuit has determined that it is not and that the automatic stay does not protect such property, Fed. Deposit Ins. Corp. v. Hirsh (In re Colonial Realty Co.), 980 F.2d 125 (2nd Cir. 1992). 

The Tenth Circuit found that the plain language of the statute supported the Second Circuit’s holding in Colonial Realty, and agreed with it.  The court determined that “equitable title” under section 541(a)(1) is such as will give the holder the right to acquire formal legal title. However, interpreting “equitable title” to include an interest in property that has been allegedly fraudulently transferred goes too far and violates concepts of equity.  Further, the court held that interpreting section 541(a)(1) to include property which is recovered by the trustee would render meaningless the provisions of section 541(a)(3).  In addition, because Fed. R. Civ. P. 65 and Fed. R. Bankr. P. 7065 provide a mechanism for a trustee to obtain injunctive relief prohibiting a transfer of property pending the outcome of a fraudulent transfer action, there was no policy reason to justify extending the automatic stay to property which is alleged to have been fraudulently transferred but has not yet been recovered.