Tag Archives: Tenth Circuit

March 1, 2016

Tenth Circuit Holds Default Judgments for Violations of Securities Laws Must be Given Preclusive Effect in Non-dischargeability Actions Under Section 523(a)(19)

The Tenth Circuit has in the past refused to give preclusive effect in bankruptcy non-dischargeability actions brought under § 523(a)(2) to pre-petition default judgments arising from claims of actual fraud. In re Jordana, 216 F.3d 1087 (10th Cir. 2000). However, the Tenth Circuit recently held that this refusal does not extend to pre-petition default judgments based on violations of securities laws where the claim for non-dischargeability is brought under § 523(a)(19), and that such judgments must be given preclusive effect for purposes of denying the dischargeability of the debt. Tripoldi v. Welch et al, 810 F.3d 761 (10th Cir. 2016).

Robert Tripoldi brought an action in the U.S. District Court for the District of Utah against Nathan Welch and others alleging violations of state and federal securities laws. Welch answered the complaint, but during the course of the litigation, his attorneys withdrew and Welch never retained new counsel. Eventually, the trial court issued a default judgment against Welch. Welch subsequently filed a chapter 7 bankruptcy petition, and then filed motions with the district court to set aside the default judgment and grant judgment on the pleadings in Welch’s favor. Tripoldi filed a motion with the district court to declare the pre-petition default judgment non-dischargeable under § 523(a)(19). The district court denied Welch’s motions and granted Tripoldi’s.

On appeal, after determining the district court did not abuse its discretion in entering the default judgment or in denying the motion to vacate it, the Tenth Circuit then turned to the issue of whether the default judgment could be the basis for a denial of discharge under § 523(a)(19). Welch argued that a default judgment should not be the basis for the denial of a discharge, relying on the Tenth Circuit’s prior opinion in Jordana. The Tenth Circuit disagreed, and noted what it considered to be significant differences between § 523(a)(2) and § 523(a)(19). The court stated that it declined to extend its reasoning in Jordana to default judgments based on violations of securities laws because § 523(a)(2) and § 523(a)(19) “have different requirements and different purposes.” The court placed great importance on the fact that § 523(a)(19) contains the specific requirement that the debt be memorialized in a “judgment, order, decree or settlement agreement” stemming from a violation of securities laws, whereas § 523(a)(2) contains no such requirement. The court also that Congress, in enacting § 523(a)(19) to include the requirement of a judgment, intended to close what it perceived to be a “loophole in the law.” The noted its decision was consistent with those of two other courts to rule on the issue: In re Pujdak, 462 B.R. 560 (Bankr. D. S.C. 2011) and Meyer v. Rigdon, 36 F.3d 1375 (7th Cir. 1994) (interpreting § 523(a)(11) which contained a similar requirement).

February 25, 2016

“Structured Dismissals” within the Tenth Circuit

  1. Introduction

The United States Bankruptcy Court for the District of Utah has published the first opinion within the Tenth Circuit analyzing and authorizing the “structured dismissal” of a chapter 11 case. See In re Naartjie Custom Kinds, Inc., 534 B.R. 416 (Bankr. D. Utah 2015) (Thurman, J.)  In Naartjie, Judge Thurman addressed two issues: first, whether the bankruptcy court has statutory authority to grant a “structured dismissal,” and second, whether the debtor met its burden of establishing cause for the court to grant such a relief.  Answering both of these questions in the affirmative, the court joined a growing number of jurisdictions, including the Third Circuit, where structured dismissals are now a viable alternative to traditional exit strategies from chapter 11 cases.  This article introduces the debate about the propriety of structured dismissals by comparing Naartjie to the Third Circuit’s decision in Jevic Holding Corp., 787 F.3d 173 (3rd Cir. 2015) decision – an opinion from the highest court to have weighed in on the debate.  It concludes with  ten “practice pointers” to consider when seeking or opposing an order authorizing a structured dismissal in the Tenth Circuit.

  1. Structured Dismissals Generally

Generally, “structured dismissals are simply dismissals that are preceded by other orders of the bankruptcy court (e.g., orders approving settlements, granting releases, and so forth) that remain in effect after dismissal.” Jevic Holding, 787 F.3d at 181.   “Unlike old-fashioned one sentence dismissals order – ‘this case is hereby dismissed’ – structured dismissal orders often include some or all of the following additional provisions: ‘releases’ (some more limited than others), protocols for reconciling an paying claims, ‘gifting’ of funds to unsecured creditors and provisions providing for the bankruptcy court’s continued retention of jurisdiction over certain post-dismissal matters.’” In re Strategic Labor, Inc., 467 B.R. 11, 18 (Bankr. D. Mass. 2012) (quoting Norman L. Pernick & G. David Dean, Structured Chapter 11 Dismissals: a Viable and Growing Alternative After Asset Sales, 29 Am. Bankr.Inst. J. 1, 56 (June 2010)).  The most contentious features of some structured dismissals are provisions that authorize distribution of funds outside the priority scheme prescribed by § 507 of the Bankruptcy Code. 

III.       Structured Dismissals in Practice: Jevic and Naarjie

The recent decisions of the Third Circuit in Jevic and the Utah Bankruptcy Court in Naartjie illustrate the nature of and issues surrounding structured dismissals.

  1. Jevic and Structured Dismissals that Deviate from Section 507’s Priority Scheme

As of December of 2015, the Third Circuit was the highest court to have opined on the propriety of “structured dismissals” under the Code. In Jevic, the Third Circuit upheld the bankruptcy court’s order authorizing a dismissal of a Chapter 11 case pursuant to a settlement agreement that, among other things, included broad exculpatory clauses and authorized the distribution of estate assets outside the priority scheme of § 507 of the Code.

Jevic was a typical case with an atypical outcome.  In 2006, CIT Group financed Sun Capital Partners’ leveraged buyout of Jevic Transportation, Inc. See Jevic, 787 F.3d at 175.  Jevic was a trucking company in decline, and as part of the acquisition, CIT advanced an $85 million revolving credit facility to Jevic secured by substantially all of Jevic’s assets. Id. The acquisition did not alter Jevic’s fate, and by May of 2008, the company had been forced to enter into a forbearance agreement with CIT, which also required a $2 million guarantee from Sun. See id. On May 19, 2008, Jevic ceased business operations and notified employees that they would be terminated.   See id. at 175-176.  The next day, the company filed a petition for protection under Chapter 11 of the Code in Delaware. See id. at 176.  As of the petition date, Jevic owed $53 million to CIT and Sun.   See id. It owed also over  $20 million in tax and general unsecured claims. See id.

The court appointed a committee of unsecured creditors, which filed an adversary proceeding asserting fraudulent and preferential transfer claims against CIT and Sun. See Jevic, 787 F.3d at 176.  In essence, the committee alleged that “Sun, with CIT’s assistance, acquired Jevic with virtually none of its own money based on baseless projections of almost immediate growth and increasing profitability.” Id. Meanwhile, a group of truck drivers filed a class action against Jevic and Sun, alleging that the defendants had violated the Worker Adjustment and Retraining Notification (“WARN”) Act by failing to give the workers 60 days’ written notice of their layoffs. See id.

By March of 2012, the estate’s sole remaining assets consisted of $1.7 million in cash and the committee’s action against CIT and Sun. See Jevic, 787 F.3d at 176.  The $1.7 million were subject to Sun’s lien, and although the committee had partially succeeded in defeating a motion to dismiss the fraudulent and preferential transfer claims, it had concluded that the estate lacked sufficient funds to finance prosecution of its action.  Accordingly, the committee, Sun, Jevic, CIT and Sun reached a settlement agreement whereby: (1) all parties would exchange releases, (2) the committee’s fraudulent and preferential transfer action would be dismissed with prejudice, (3) CIT would deposit $2 million into an account earmarked to pay the estate’s administrative expenses, including the fees of the committee’s and the debtor’s professionals, (4) Sun would assign its lien in the remaining $1.7 million to a trust for the payment of tax and administrative creditors first, and the remainder to unsecured creditors on a pro rata basis, and (5) the chapter 11 case would be dismissed. See id. at 177.  Although the truck drivers participated in the settlement discussions, the parties could not agree on a settlement of the WARN Act claims, which the drivers valued at $12.4 million, inclusive of 8.3 million entitled to priority under § 507(a)(4) of the Code. See id. Consequently, the drivers were not included in the settlement presumably because Sun, who remained a defendant in their WARN Act lawsuit, did not want to fund litigation against itself. See id. The effect of the drivers’ exclusion from the settlement would be that the drivers would receive nothing from the estate, even on the $8.3 million wage claim, but all other general unsecured would receive about four percent of their claims. See id. at 177, 177 n.1.

The truck drivers and the United States Trustee objected to the proposed settlement, arguing, in part, that the proposed distribution violated the priority scheme prescribed by § 507 of the Code. See Jevic, 787 F.3d at 178.[1]   The drivers argued that the Code does not authorize “structured dismissals,” but rather only three ways for the debtor to exit chapter 11: (1) confirmation of a plan, (2) conversion to chapter 7, or (3) “plain dismissal with no strings attached.” See id. at 180.  The Third Circuit addressed these objections in reverse.

First, the Third Circuit affirmed the district court and bankruptcy court’s conclusion that while structured dismissals are not expressly authorized by the Code, they are not prohibited by the Code either. See Jevic, 787 F.3d at 181.  Specifically, the Third Circuit held that “though § 349 of the Code contemplates that dismissal will typically reinstate the pre-petition state of affairs by revesting property in the debtor and vacating orders and judgments of the bankruptcy court, it also explicitly authorizes the bankruptcy court to alter the effect of dismissal ‘for cause’ – in other words, the Code does not strictly require dismissal of a Chapter 11 case to be a hard reset.” Id.

Second, the Third Circuit rejected the argument that “even if structured dismissals are allowed, they cannot be approved if they distribute estate assets in derogation of the priority scheme of § 507 of the Code.” See Jevic, 787 F.3d at 182.  In essence, the drivers argued that § 103(a) required settlements in Chapter 11 cases to comply with § 507’s priority scheme. See id.[2] Although the Third Circuit acknowledged “some tacit support in the caselaw for the [d]river’s position,” it concluded that “neither Congress nor the Supreme Court has ever said that the [absolute priority rule] applies to settlements in bankruptcy.” Id. at 182-83.  The Third Circuit noted that the Fifth and Second Circuits “had grappled with whether the priority scheme of § 507 must be followed when settlement proceeds are distributed in Chapter 11 cases.” Id. (citing Matter of AWECO, Inc., 725 F.2d 293, 295-96 (4th Cir. 1984) (declining to approve a settlement agreement because unsecured creditor would be paid ahead of senior claims); In re Iridium Operating LLC, 478 F.3d 452, 463-64 (2nd Cir. 2007) (rejecting the AWECO ruling as too rigid because and finding that the absolute priority rule is not necessarily implicated in settlements outside of plans of reorganization)).  The Third Circuit agreed with the Second Circuit’s approach, and held that “bankruptcy courts may approve settlements that deviate from the priority scheme of § 507 of the Bankruptcy Code only if they have specific and credible grounds to justify the deviation.”   Id. at 184 (citation and quotation omitted). 

Having concluded that the bankruptcy court had authority to grant structured dismissals, and that the “structure” could include distributions outside the priority scheme of § 507, the Second Circuit found that although it was a “close call,” the bankruptcy court had “sufficient reasons” to approve the settlement in Jevic and overrule the Trustee’s and the truck drivers’ objections. See Jevic, 787 F.3d at 184-85.  The court emphasized that there was “no evidence calling into question the Bankruptcy Court’s conclusion that there was ‘no realistic prospect’ of a meaningful distribution to Jevic’s unsecured creditors apart from the settlement under review.”   Id. at 185.  Instead, it was apparent that if the court did not approve the proposed settlement, the unsecured creditors would not receive anything at all because the estate lacked sufficient funds to prosecute the fraudulent claims against Sun and CIT, both of which claimed they would not enter into the same settlement with a trustee were the case converted to chapter 7.  Thus, the court concluded, the movants had shown cause for approval of a structured dismissal that deviated from § 507, “[a]lthough this result is likely to be justified only rarely.”   Id. at 186.[3]

  1. Naartjie – a Simple Structure

Naartjie was a much narrower decision than Jevic. See Naartjie, 534 B.R. 416. 

Naartjie was a children clothing retailer that filed Chapter 11 intending to reorganized using pre-arranged financing. See id. at 418.  The financing fell through shortly after the petition date, and the debtor shifted to an orderly liquidation. Id. Over the next six months, the court approved multiple orders authorizing the debtor to sell significantly all of its assets pursuant to § 363 of the Code. See id. Following the proof of claim deadline, four principal creditor constituencies emerged: (1) a group of secured noteholders claimed a senior lien against virtually all of the debtor’s assets in the amount of $8.8 million; (2) a trade creditor of the debtor – Target Ease – asserted a $7 million claim, of which $2.1 was entitled to administrative priority and $2.6 million consisted of a reclamation claim;(3) a shipping company asserted a claim secured by a maritime line in the amount of $339,923.47; and (4) general unsecured creditors. See id.at 418-19.

The parties sought and obtained approval of a settlement agreement to distribute the estates’ assets as follows: (1) payment of all allowed administrative claims subject to a negotiated budget, and priority claims up to $382,000; (2) payment of $140,000 to the shipping company in satisfaction of its claim; (3) all remaining funds to be distributed among the secured creditors (45%), the trade creditor Target Ease (30.5%), and the unsecured creditors excluding Target Ease (24.5%). All parties agreed to mutual releases and to seek dismissal of the case or confirmation of a plan. See id. at 419. No one objected to the settlement proposal, and the court approved it pursuant to Rule 9019 and the factors set out in In re Kopexa Realty Venture Co., 213 B.R. 1020 (BAP 10th Cir. 1997).

After liquidating all assets, and consummating much of the settlement agreement, the debtor moved for approval of a structured dismissal under §§ 305(a) and 349 of the Code, whereby (1) all of the court’s orders would remain in full force; (2) the court would retain jurisdiction over the approval of professional fees and any disputes arising from the interpretation and implementation of an order approving the dismissal; (3) the court’s dismissal order would incorporate the exculpation clauses and releases negotiated through the settlement agreement; and (4) the debtor and committee of unsecured creditors would distribute all funds pursuant to the terms of the settlement agreement. See Naartjie, 534 B.R. at 420. 

No party with an economic interest in the estate objected, and the senior secured creditors, the committee and Target Ease supported the motion for approval of the structured dismissal. See Naartjie, 534 B.R. at 521.  The U.S. Trustee objected, however, arguing that the Code does not authorize the approval of “structured dismissals” because “there are only three ways to exit a Chapter 11 case: (1) by  confirmation of a plan pursuant to § 1129; (2) by dismissal of the case pursuant to § 1112(b); or (3) by conversion of the case pursuant to §1112(b).” See id.  

The court granted the debtor’s motion, holding that §305(a) authorized dismissals of any case if the interest of creditors and the debtor would be better served by such dismissal or suspension. Naartjie, 534 B.R. at 422.  The court then turned to the determinative question: “may the Court alter the effect of dismissal?”  Id.  Quoting § 349(b), the court held that “[t]his subsection describes the effect of dismissal, but it qualifies the effect by providing that the Court may, for cause, order otherwise.  It follows that, if cause is shown, a bankruptcy court may alter the effect of dismissal.  The statute is clear and unambiguous on this point.” Id. at 422-23.  Furthermore, analyzing § 349’s legislative history, the court concluded that “[t]he effect of dismissal is to put the parties, as much as practicable, back in the positions they occupied pre-bankruptcy.” Id. at 423.  “But, if cause is shown, such as when a structured dismissal will better serve the interests of the creditors and the debtor, the bankruptcy court may order otherwise and alter the effect of dismissal.” Id.

Having concluded that it had statutory authority to authorize a structured dismissal, the court found that the debtor had shown cause for dismissal under § 305(a) because (1) “it [was] clear that the proposed structured dismissal [was] the most efficient and economic[cal] way to administer” the case; (2) the parties’ rights were protected and preserved since the court’s orders would remain in full force and effect; (3) the parties would have access to a forum where they could enforce those orders (i.e, the bankruptcy court); and (4) the settlement agreement was an out-of-court workout that equitably distributed the assets of the estate. See Naartjie, 534 B.R. at 426 (applying factors adopted in In re Zapas, 530 B.R. 560, 572 (Bankr.E.D.N.Y. 2015), In re AMC Investors, LLC, 406 B.R. 478, 488 (Bankr.D.Del. 2009), In re RCM Global Long Term Capital Appreciation Fund, Ltd., 2000 B.R. 514, 525 (Bankr.S.D.N.Y. 1996), In re Picacho Hills Util. Co., No. 11-13-10742 TL, 2013 WL 1788298, at *9 (Bankr.D.N.M. Apr. 26, 2013)). 

The court found that the debtor had also met the standard for altering the effect of dismissal under § 349. Naartjie, 534 B.R. at 426.  In addition to the bases discussed above, it found that despite receiving notice of both the settlement motion and the motion for approval of a structured dismissal, “no economic stakeholder [] objected.”  Moreover, there was little for the debtor to do in the case, other than distributing the assets.  The court concluded that the motion was “not an attempt to work around the protections of § 1129; it is simply the rare case where cause is shown to alter the effect of dismissal.” Id. Thus, the court concluded, the movants had shown cause for alternating the effect of dismissal under § 349.

  1. Ten Factors to Consider When Proposing or Opposing a Structured Dismissal

As Judge Thurman noted in Naartjie, that case was part of a “growing trend of structured dismissals.” Naartjie, 534 B.R. at 421.  Given their perceived or actual benefits, including speed and lower cost, structured dismissals are likely to become more common over the next few months or, at least, are highly likely to be litigated more frequently.  In seeking approval of or opposing structured dismissals, practitioners should consider the following:

  1. Statutory Relief: Consider whether dismissal should be or is sought under §§ 305(a) or 1112(b). As Judge Thurman noted in Naartjie, “[s]ection 305(a)(1) is a narrower provision for dismissing a Chapter 11 case than § 1112(b).” Naartjie, 534 B.R. at 422. Under § 305(a), a court may dismiss a case if “the interests of creditors and the debtor would be better served by” the dismissal. 11 U.S.C. § 305(a)(1). By contrast, under § 1112(b), the court may appoint a trustee, convert or dismiss a chapter 11 case, “whichever is in the best interest of creditors and the estate.” 11 U.S.C. § 1112(b). Courts are less likely to grant relief under § 305(a) than 1112(b) particularly because the court’s decision under § 305(a) is not subject to appellate review pursuant to § 305(c) of the Code. Nevertheless, movants may be tempted to seek relief under § 305(a) over § 1112(b) to limit the range of potential relief – i.e., to avoid the possibility that the court may appoint a trustee or convert the case rather than dismiss it. Section 305(a) is particularly attractive where all parties with an economic interest in the outcome of the case have reached a settlement.
  2. Focus on “Cause” Under § 349: At this point, the debate on whether the court has statutory authority to grant a structured dismissal is largely academic. Even the courts that have denied motions for approval of structured dismissals have recognized that they have the statutory authority to alter the effect of dismissal under § 349(b) of the Code. Although “cause” for altering the effect of § 349 is a developing concept, the Naartjie opinion provides some guidance on factors that may be considered when determining whether the movant has met this burden. See Naartjie, 534 B.R. at 426 (considering the notice provided to the parties, objections filed, and whether movant was attempting “work around the protections of the Bankruptcy Code”).
  3. Anticipate the U.S. Trustee’s Objection: In virtually every reported opinion, the U.S. Trustee has objected to motions seeking approval of structured dismissals. The reasons for the U.S. Trustee’s distaste for structured dismissals are articulated in an article by the Associate General Counsel for Chapter 11 Practice at the Executive Office for the U.S. Trustee titled Structured Dismissals, or Cases Dismissed Outside of the Code’s Structure, 30 Am. Bankr. Inst. J. 20 (March 2011). Practitioners proposing or opposing structured dismissals can anticipate the U.S. Trustee’s position and address, to the extent possible, the concerns raised in this article.
  4. Timing: Movants should seek relief under § 349(b) as soon as it becomes significantly likely that confirmation of a plan is not a viable option, but after resolution of as many preliminary matters as possible. Correspondingly, opponents should highlight loose ends that may affect negatively the rights of creditors or other stakeholders. For example, the court may reject a structured dismissal motion where claim disputes are outstanding.
  5. Consider sub rosa Jurisprudence: Strictly speaking, a proposal constitutes a sub rosa plan where it dictates the terms of a reorganization plan. See Jevic, 787 F.3d at 188 (Scirica, J., dissenting); see also, In re Shubh Hotels Pittsburgh, LLC, 439 B.R. 637, 644-45 (Bankr. W.D. Penn. 2010) (“a transaction would amount to a sub rosa plan or reorganization if it: (1) specifies the terms of any future reorganization plan; (2) restructures creditors’ rights; and (3) requires that all parties release claims against the Debtor, its offices and directors, and its secured creditors”). Structured dismissals, by definition, do not implicate the confirmation of a plan, and thus are distinguishable from sub rosa plans. Structured dismissals, however, implicate the same policy concerns as sub rosa plans. Accordingly, practitioners should consult case law analyzing sub rosa plans and may rely on it by analogy particularly when opposing structured dismissals motions.
  6. 9019 Settlements and Asset Sales: Most successful structured dismissals follow approval of a settlement under Rule 9019, the sale of substantially all assets of the debtor under § 363, or both. The practical reason for this sequence is that by the time the court has to determine whether there is cause for altering the effect of § 349, all other major disputes in the case have been resolved. This is particularly true in cases like Naartjie, where all constituents with an economic interest in the case reach a settlement (or, at least, are represented during settlement discussions). Thus, in seeking structured dismissals, movants increase the likelihood of succeeding if they first obtain relief, were applicable, under § 363 and seek consensus from stakeholders in the form of a settlement under Rule 9019.
  7. But if no Consensus, Invoke Jevic: Failure to obtain consensus from all stakeholders with an economic interest in the case, however, is not a dispositive post Jevic. The effect of that opinion appears to be that so long as objecting creditors like the truck drivers in Jevic can vindicate their rights elsewhere or against another party, the court may approve a structured dismissal that violates the absolute priority rule. In other words, movants should seek consensus, but if they must, then they should abandon only creditors who can fend for themselves.
  8. Remain Vigilant: Opponents of structured dismissal motions should object to any Rule 9019 or §363 motion that sets up the dismissal motion. For example, in Naartjie, the Rule 9019 Motion that predated the structured dismissal motion contemplated a filing of the latter. In dismissing the case, the court noted that no party had objected to the earlier motion. See Naartjie, 534 B.R. at 426.
  9. Prove Efficiency: One of the primary justifications for granting a structured dismissal motion is the movant’s ubiquitous proffer that the structured dismissal will save the estate significant resources over an expensive plan confirmation process. Typically, however, the estate is not fully administered as of the date the court enters an order approving a structured dismissal. Thus, part of the “structure” will likely include process for wrapping up the case. Practitioners should be careful not to surprise the court with professional fees or administrative expenses incurred post-approval of a structured dismissal that disprove its professed efficiency.

10.       Equitable Mootness: The Jevic dissent points out that the doctrine of equitable mootness was not applicable to a court’s order approving a structured dismissal because that doctrine applies only where a plan of reorganization is confirmed. See Jevic, 787 F.3d at 186 (Scirica, J., dissenting) (citing In re Semcrude, L.P., 728 F.3d 314 (3d. Cir. 2013). It is unclear, however, whether Judge Scirica’s rationale holds true in the Tenth Circuit, specially when the structured dismissal is approved pursuant to a rule 9019 motion, or where the court dismisses the case under § 305(a). See e.g., Rindlebach v. Jones, 532 B.R. 850, 856-58 (Bankr. D. Utah 2015) (appeal from order approving settlement equitably moot).  Opponents of structured dismissal motions should therefore consider whether and when to ask a court to stay an order pending post-ruling motions.

 

[1] The drivers also claimed that the committee of unsecured creditors violated its fiduciary duties to the estate because the settlement it negotiated excluded the drivers. See Jevic, 787 F.3d at 178.

[2]               Section 103(a) provides, “[e]xcept as provided in section 1161 of this title, chapters 1, 3, and 5 of this title apply in a case under chapter 7, 11, 12, or 13 of this title, and this chapter, sections 307, 362(0), 554 through 557, and 559 through 562 apply in an case under chapter 15.” 11 U.S.C. § 103(a).

[3] Judge Scirica dissented, arguing that it was not clear that the only alternative to the settlement was a chapter 7 liquidation. See Jevic, 787 F.3d at 186. He emphasized that the settlement at bar was not substantially distinguishable from sub rosa plans, and emphasized that this was not a “gifting” case because the assets to be distributed were assets of the estate since the settlement resolved the estate’s fraudulent transfer claims. See id. at 187-88.

December 15, 2015

Tenth Circuit Hits Debtor’s Counsel With a Double Whammy—Denying Fees Incurred Prior to Formal Appointment and After Confirmation of Plan

In its decision in Lazzo v. Bank (In re Schupach Investments, L.L.C.), 2015 WL 6685416 (10th Cir. 2015), the Tenth Circuit sent a clear message to attorneys representing debtors-in-possession: make sure you have authority to represent the debtor if you want to be compensated from the estate.

In this case, Mark Lazzo, debtor’s counsel, failed to file an application seeking appointment as counsel for the debtor-in-possession until about one month after the case was filed. Lazzo stated that his application “got lost in the shuffle” of other first day motions which he had filed. In addition, Lazzo did not specifically request post facto approval of his appointment when he did get around to filing the application. He claimed his failure to timely file the application was the result of excusable neglect.

Several of the debtor’s secured creditors filed a plan of liquidation which provided for the transfer of the debtor’s secured property to the secured creditors, the cancellation of members’ interests, the dissolution of the debtor, and the transfer of the debtor’s unencumbered assets to a liquidating trust. The plan also required the debtor to cooperate post-confirmation in effecting various administrative tasks required by the plan. The debtor consented to the creditors’ plan, and the bankruptcy court confirmed it. Although the plan empowered the liquidating trustee to retain counsel, and the liquidating trustee did not retain Lazzo, Lazzo continued to perform services for the debtor after confirmation. Lazzo filed fee applications seeking payment of his fees, including fees incurred before the bankruptcy court approved his appointment as and after confirmation of the creditors’ plan of liquidation. The bankruptcy court allowed these fees, but the Bankruptcy Appellate Panel reversed. The Tenth Circuit affirmed the decision of the BAP, agreeing that Lazzo was not entitled to fees for services performed before his appointment was approved or after the plan was confirmed.

In connection with the issue of entitlement to fees for services performed before Lazzo’s retention as debtor’s counsel was approved by the bankruptcy court, the Tenth Circuit revisited its prior decision in Land v. First Nat’l Bank of Alamosa (In re Land), 943 F.2d 1265 (10th Cir. 1991). In Land the court assumed that a bankruptcy court may approve an attorney’s employment post facto, thereby entitling him to seek fees for work performed prior to approval. In Land, the court held that retroactive approval of an attorney’s employment “is only appropriate in the most extraordinary circumstances” and that “[s]imple neglect will not justify pro tunc approval.” Land 943 F.2d at 1267-68. Lazzo argued that this language in Land was dicta and that the appropriate standard for post facto approval of employment applications should be excusable neglect. The Tenth Circuit noted the minority view, as set out in the Seventh Circuit’s opinion in Matter of Singson, 41 F.3d 316, 319 (7th Cir. 1994), that excusable neglect is the proper standard. The Tenth Circuit panel, however, reaffirmed its language in Land, stating that it was not dicta and further represented the prevailing approach among the circuits. The court went on to state that the reasons provided by Lazzo for failing to timely seek appointment as debtor’s counsel did not rise to the “extraordinary circumstances” required to support post facto approval.

In connection with the issues of entitlement to fees for services performed post-confirmation, the court looked to both the provisions of the Bankruptcy Code and the provisions of the confirmed plan. As the court noted, because termination of a debtor’s status as a debtor-in-possession also terminates debtor’s counsel’s authorization under § 327 to provide service as an attorney for the debtor-in-possession, Lamie v. U.S. Tr., 540 U.S. 526, 532 (2004), the Tenth Circuit framed the question as “whether the Debtor retained its status as debtor-in-possession after confirmation of the Creditors’ Plan.” The court held that § 1101(1) of the Bankruptcy Code eliminates the debtor-in-possession’s ability to perform the functions and duties of a trustee where a qualified trustee has been appointed and is serving those functions. The court stated that § 1101(1) “serves the salutary purpose of avoiding the logistical difficulties inherent in having two different and possibly conflicting trustees serving simultaneously.” Although the plan trustee in the case was not qualified under § 322 of the code, the court found that § 1101(1) does not entitle permanent debtor-in-possession status in those instances where a trustee is appointed pursuant to a plan. In addition, the court noted well-settled case law holding that debtor-in-possession status terminates on confirmation of a plan. In the present case, the plan provided that all of the debtor’s unencumbered assets vested on confirmation in the liquidating trust, and vested the trustee of the liquidating trust with all rights and powers of a trustee under the Bankruptcy Code. Further, the plan dissolved the debtor as of the confirmation date. The court believed the plan’s provisions obligating the debtor to cooperate with the plan trustee in connection with various ministerial and administrative aspects of the plan “fell far short of encompassing the responsibilities of a debtor-in-possession.” Because the debtor lost its debtor-in-possession status when the plan was confirmed, Lazzo had no authority to seek compensation from the post-confirmation trust for services he performed post-petition.

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.

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.

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.

May 9, 2013

Tenth Circuit Holds that BAPCPA did not Abrogate the Absolute Priority Rule in Individual Chapter 11 Cases

In a case of first impression, the Tenth Circuit Court of Appeals has held that the amendments to the Bankruptcy Code in BAPCPA did not abrogate the Absolute Priority Rule in Individual Chapter 11 Cases.  Its decision in Dill Oil Company, et al v. Arvin Stephens, et al (In re Stephens), 704 F.3d 1279 (10th Cir. 2013) agreed with the reasoning of the Fourth Circuit Court of Appeals in In re Maharaj, 681 F.3d 558 (4th Cir. 2012).  In its opinion, the court addressed the differing interpretations courts have provided to sections 1115(a)(1) and 1129(b)(2)(B)(ii) of the Bankruptcy Code.

Section 1129(b)(2)(B)(ii) provides that, in order for a plan to be fair and equitable as against a dissenting class, “the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on acct of such junior claim or interest any property, except that in a case in which the debtor is an individual, the debtor may retain property included in the estate under section 1115, subject to the requirements of subsection (a)(14) of this section.”  Section 1115(a)(1)(a)(1) provides that “in a case in which the debtor is an individual, property of the estate includes, in
addition to the property specified in section 541—(1) all property of the kind specified in section 541 that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13. . . “.

The noted that two views of interpretation of section 1115(a)(1) have arisen:  (1) the “broad” view, which interprets section 1115 as subsuming and replacing section 541 and, therefore, abrogating
the absolute priority rule for individual chapter 11 debtors, and (2) the “narrow” view, which interprets section 1115 as supplementing section 541 and, therefore, not abrogating the absolute priority rule for individual chapter 11 debtors.  The court noted that proponents of the broad view tend to point to the similarities between chapter 11 and chapter 13 cases for individual debtors as supporting their interpretation.  However, the court agreed with the Fourth Circuit’s opinion in Maharaj that, if Congress had intended to make individual chapter 11 cases more like chapter 13, it could have just as easily raised the debt limits for chapter 13 cases.  The court also placed great
emphasis on the presumption against implied repeal in reaching its decision—because of the longstanding existence of the absolute priority rule, the court determined that Congress would have explicitly repealed it had that been the result it intended in passing BAPCPA.