In Their Opinion : Seventh Circuit Court of Appeals Commentary : Lawyer & Attorney Michael E. Rigney : Kelley Drye & Warren Law Firm

IN RE: MARCHFIRST (December 21, 2009)

CIT Communications Finance Corp. leased telephone equipment to marchFIRST beginning in 2000. After marchFIRST filed for bankruptcy in 2001, CIT sought the return of its equipment. The Trustee denied that marchFIRST held any CIT property. In 2002, CIT filed an administrative claim, asserting that the Trustee breached his fiduciary duty. In May of 2007, CIT filed a lawsuit against the Trustee for breach of fiduciary duty. The bankruptcy court, and the district court, both agreed that the suit was barred by the statute of limitations. CIT appeals.

In their opinion, Judges Bauer and Sykes and District Judge Simon affirmed. Everyone agreed that the claims were governed by the five-year statute of limitations -- they did not agree on when the claim accrued. The Court cited the general rule that tort claims accrue when a party sustains an injury but added that Illinois recognizes the discovery rule. That principle extends the time of accrual until the time when a party both knows he is injured and that the injury was wrongfully caused. Here, CIT begin demanding its equipment back as early as July of 2001 and the Trustee refused to return it as early as November of 2001. CIT was on notice of its injury and its claim. Even if the Trustee's breach of his fiduciary duty continued into the five-year period before the filing of the complaint, this is not the type of tort where a limitations period begins to run only after the cessation of the tortious conduct. When a tort arises out of a breach of contract, the statute begins to run at the time of the breach or its discovery.

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BOYER v. CROWN STOCK DISTRIBUTION, INC. (November 18, 2009)

Crown Unlimited Machine, Inc. ("Crown"), which designed and built custom machinery, was owned by the Stroup family. In 1999, the Stroups sold the company to Kevin Smith for $6 million. The $6 million consisted of $3.1 million that Smith borrowed, a $2.9 million note and only $500 directly from Smith. The Stroups split almost $600,000 in cash withdrawn from the company pre-closing as well as the $3.1 million in cash received at closing. Within about three years, the new Crown declared bankruptcy. The assets brought out $3.7 million. Most of the money was used to pay off the secured debt -- little was left to address over $1.5 million in unsecured debt. The Trustee in bankruptcy brought an action against the Stroups and the company, alleging a fraudulent conveyance. The bankruptcy court awarded over $3 million to the trustee. The district court affirmed. The Stroups appeal -- the Trustee cross-appeals, seeking the $600,000 pre-closing distribution.

In their opinion, Judges Posner, Rovner and Williams affirmed in part and reversed in part. Under the Uniform Fraudulent Transfer Act, a transfer is fraudulent if the corporation did not receive "reasonably equivalent value" and was therefore left with insufficient funds to be able to survive. Fraudulent conveyance law looks to substance rather than form -- the Court concluded that the form of the transaction was not important. Here, new Crown made payments and incurred obligations that threatened its ability to survive. It failed to receive "reasonably equivalent value" -- the bankruptcy court did not err in so finding. The Court disagreed with the bankruptcy court, however, with respect to the almost $600,000 dividend pre-closing. The evidence supported the conclusion that the dividend was part of the fraudulent conveyance rather than a normal distribution of profits. The Court reversed the bankruptcy court to the extent it denied recovery to the Trustee of the dividend.

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IN RE: ROSE (October 7, 2009)

Mercantile National Bank of Indiana sued Jasper- Newton Utility in state court for breach of contract and specific performance. Judgment was entered in Mercantile's favor for approximately $160,000. James Rose was a 50% shareholder in Jasper- Newton. A few weeks later, Rose and the other shareholder sold Jasper-Newton to WSCI. The shareholders indemnified WSCI for the liability to Mercantile. In proceedings to collect on the judgment, Mercantile sought leave to amend its complaint to add a claim under the Indiana Crime Victim Compensation Act. The court entered judgment in Mercantile's favor of almost $600,000. The state appellate court affirmed on the merits. The state Supreme Court reversed, holding that Mercantile could not assert a new CVCA claim in supplemental proceedings to collect the judgment. Rose filed a petition for bankruptcy in the meantime. Mercantile filed an adversary proceeding in the bankruptcy court challenging the dischargeability of its CVCA claim. The bankruptcy court granted Rose's motion to dismiss Mercantile's complaint, concluding that the CVCA claim was barred by the statute of limitations. The district court affirmed the bankruptcy court. Mercantile appeals. During the appeal, the state appellate court ruled that the CVCA claim was commenced within the appropriate limitations period.

In their opinion, Judges Flaum and Williams and District Judge Kapala reversed. The Court looked to the various opinions of the state courts to decide whether Mercantile filed within the statutory period. Although the state Supreme Court reversed the trial court's order granting Mercantile leave to amend, it did so because it was improper to file the claim in supplemental proceedings. The court, in its opinion, specifically stated that Mercantile could pursue the claim in some other manner. After remand, the state Court of Appeals concluded that the claim was commenced when Mercantile moved to amend its complaint and was therefore filed within the limitations period. The Court concurred with the reasoning of the state appellate court in concluding that the claim was properly commenced within the limitations period.

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TIDWELL v. SMITH (September 23, 2009)

When Dr. Bruce Smith filed a bankruptcy petition in 2004, plaintiffs had separate lawsuits pending against him in state court. Smith listed neither of them on his creditors schedule, although he did list their attorney. That petition was dismissed, however, and a second petition filed a year later listed neither the plaintiffs nor their attorney. Plaintiffs' claims were potentially non-dischargeable because they were based on an alleged sexual assault. Plaintiffs never received notice of the petition. However, in late December, just a few weeks before the deadline for objecting to the discharge, Smith's lawyers in the state court cases filed motions asking for transfers to the bankruptcy calendar. The motions were received in plaintiffs' lawyer's office on December 23. He was out of town and did not actually see them until January 4 of the next year, five days before the deadline. The motions provided very little information about the bankruptcy, other than its filing. The deadline came and went. The bankruptcy court entered an order of discharge. Almost a year later, plaintiffs sought relief from the bankruptcy court. After taking testimony, the court concluded that plaintiffs could proceed against Smith in state court. In doing so, the court specifically found that the omission of plaintiffs from the schedule was deliberate and that the notice, albeit received before the final discharge, was too late. The district court affirmed the decision of the bankruptcy court. Smith appeals.

In their opinion, Judges Rovner and Evans and District Judge Van Bokkelen affirmed. The Court first declined to even consider Smith's challenge to the finding of deliberateness. The bankruptcy court declined to grant relief under section 727, which requires fraud. Instead, it granted relief under section 523, which only requires that the debt was unscheduled and the creditors did not have notice. With respect to the notice, the Court agreed that it was untimely. Notice must be reasonably calculated to inform an interested party of the action and provide a reasonable time to respond. Given the timing of the notice as well as its content, the Court concluded that the service of the state court motions was insufficient.

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UNITED STATES v. APEX OIL CO. (August 25, 2009)

Years ago, a corporate predecessor of Apex Oil Co. owned a refinery near Hartford, Illinois. According to the EPA, the operation of the refinery contributed to the contamination of the groundwater in the area. The United States brought an action, pursuant to the Resource Conservation and Recovery Act (RCRA), for an injunction to require Apex to clean up the site. Apex argued that its earlier discharge in bankruptcy relieved it of any cleanup obligation. The district court issued the injunction. Apex appeals.

In their opinion, Judges Cudahy, Posner and Kanne affirmed. The Court identified the principal issue on appeal as whether the government's claim for the injunction was discharged in bankruptcy. Under the bankruptcy laws, the Court stated that a debtor is discharged from any "liability on a claim." A "claim" is further defined as a "right to payment" or a "right to an equitable remedy for breach of performance if such breach gives rise to a right to payment." The Court concluded that the natural reading of the bankruptcy provision is that an equitable claim is dischargeable if the holder can obtain a money judgment in lieu of the injunction under certain circumstances. Here, however, the statute under which the government sought the injunction (RCRA) does not authorize any form of money judgment -- the only remedy available to the government is a cleanup order. The fact that the cleanup order would require a significant payment by Apex did not convert the injunction into a money judgment. The Court distinguished the Supreme Court's opinion in Kovacs. In Kovacs, the plaintiffs were seeking money from the debtor. Apex also challenged the injunction itself on vagueness grounds. The Court actually agreed that the injunction was vague and that it has in the past insisted on compliance with the requirement that an injunction describe in some reasonable detail the acts required. However, the Court concluded that that policy applies when compliance with the rule is feasible. Here, the subject of the injunction is a complicated refinery remediation. In such cases, more leeway is necessary.

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IN RE: TURNER (July 20, 2009)

Joel Turner had monthly mortgage payments of $1500 when he filed a Chapter 13 petition for bankruptcy. In computing his "projected disposable income" under the bankruptcy law, he deducted the mortgage payments. He stated in his plan, however, that he intended to stop making his mortgage payments and turn his home over to the mortgagee. The trustee objected. The $1500 monthly deduction from Turner’s disposable income would make that much unavailable to the unsecured creditors. The bankruptcy court rejected the trustee’s objection. The trustee appealed under a since superseded process for direct appeal to the court of appeals. The process required: a) the trustee to file a notice of appeal in the bankruptcy court within 30 days, b) the bankruptcy court to certify that the ruling satisfied certain statutory criteria, and c) the trustee had to petition the court of appeals for leave to appeal within 10 days of the certification. The trustee filed his notice of appeal and the court certified. The trustee never filed a petition -- but the clerk of the court transmitted the request for certification and the certification order. The Court docketed the appeal.

In their opinion, Judges Posner, Sykes (dissenting) and Van Bokkelen (concurring in part and concurring in judgment) accepted the appeal and reversed. Each of the three judges had a different approach to the jurisdictional issue. Judge Posner emphasized that the clerk of the court transmitted to the appellate court everything that a petition for review would have contained. Therefore, the filing was complete and timely. Its only possible defect was that it was transmitted by the clerk rather than by the appellant. Because it served all the purposes behind the procedural requirements, Judge Posner concluded that it fell within the "functional equivalent" test. Alternatively, Judge Posner allowed the appeal pursuant to Rule 2 of the Federal Rules of Appellate Procedure, which allows the Court to suspend appellate rules for good cause. On the merits, the Court concluded that considering what the debtor's projected income will be at the time of plan approval was more consistent with the statutory language than considering it at the time of filing. The Court emphasized that it was not approving an exercise in speculation about the future income of the debtor -- it was considering only a fixed debt that all agreed would disappear.

Judge Van Bokkelen agreed that the Court could hear the appeal, but based his decision on Judge Posner's alternative Rule 2 holding, and concurred on the merits.

Judge Sykes dissented. She concluded that the petition was a statutory jurisdictional requirement. Since the trustee never filed a petition, she would dismiss for lack of appellate jurisdiction.

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IN RE: GALLO (July 20, 2009)

In 2004, a state court entered a dissolution order in the divorce proceedings of Frank Gallo and Gillian Emery. Gallo had a bankruptcy proceeding pending at the time. The divorce court awarded a Sanibel Island, Florida property to Emery but required her to pay $125,000 to the bankruptcy trustee. Gallo transferred his interest in the Sanibel Island property to Emery but Emery made no payments to the trustee. Gallo filed a lis pendens against the Sanibel Island property. Several months later, Emery obtained an order quieting title and sold the property for $490,000. In a subsequent Gallo bankruptcy proceeding, Emery filed a proof of claim for slander of title, alleging that she lost an opportunity to sell the Sanibel Island property because of the lis pendens notice. The bankruptcy court denied Emery's proof of claim and issued an order directing her to pay the amount of the state court dissolution order. Emery appeals.

In their opinion, Judges Posner, Ripple and Wood affirmed. The issues presented on appeal were whether Emery had a valid slander of title claim and whether the bankruptcy court erred in not considering her inability to pay. In order to establish slander of title under Florida law, one must establish a falsehood. A lis pendens is proper if there is a connection between an equitable interest in the property and a lawsuit. The Court did find that Gallo had an equitable interest in the property because the same order granted the property to Emery and required her to pay the trustee. It was less certain that Gallo could meet the litigation requirement of Florida law, since there was only a possibility of future litigation. The Court did not decide the issue, however, because it found the record established a good faith affirmative defense and absence of actual malice on the part of Gallo. The Court also rejected Emery's argument that the bankruptcy court should have considered her ability to pay. The bankruptcy court had no obligation to ensure her ability to pay before issuing its order, which was based on the final order of the state court. If later proceedings attempt to hold Emery in contempt for failure to pay, she may then present evidence of her financial situation.

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IN RE: MARCHFIRST (July 17, 2009)

When MarchFIRST filed for Chapter 7 bankruptcy, it sent a notice to its creditors. The notice stated that the original of a proof of claim had to be received by 4 p.m. on October 11. It also provided that the proof of claim could be submitted by hand or by mail. Avnet, a MarchFIRST creditor, faxed its proof of claim. The claims agent received the fax at 4:43 p.m. on October 11. The original of the claim was delivered the following morning. The trustee treated the original as the claim and objected to it on the grounds that it was not received until October 12. The bankruptcy court sustained the trustee's objection -- the district court affirmed. Avnet appeals.

In their opinion, Judges Ripple, Evans and Sykes affirmed. The Court concluded: a) transmission of a proof of claim by facsimile is improper when the notice clearly states that the original must be submitted and that submissions can be made by hand or mail, b) Rule 5005 (c) of the Federal Rules of Bankruptcy Procedure applies only when a document is sent to the wrong recipient, not when it is sent by the wrong method, and c) in any event, the facsimile itself was untimely.

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JAFARI v. WYNN LAS VEGAS, LLC (June 17, 2009)

Robert Jafari, a Wisconsin resident, liked to gamble. In September, 2005, Wynn Las Vegas and Caesar’s Palace extended him credit in the total amount of $1,250,000. Each of the credit agreements contained a Nevada choice-of-law provision. After Jafari failed to repay the credit advance and his bank denied payment, Wynn and Caesar’s sued Jafari. Jafari later filed an individual bankruptcy proceeding in Wisconsin. Wynn and Caesar’s filed proofs of claim. Jafari and the bankruptcy trustee objected to the claims on the grounds that gambling debts are unenforceable in Wisconsin. The bankruptcy court applied Wisconsin choice-of-law rules, which led it to apply Wisconsin substantive law, which led it to conclude that the gambling claims were unenforceable under Wisconsin law. On appeal to the district court, the court concluded that both federal and Wisconsin choice-of-law rules would require the application of Nevada substantive law. On remand, the bankruptcy court applied Nevada substantive law and upheld the claims. Jafari and the trustee appeal.

In their opinion, Judges Flaum, Evans and Williams affirmed. The Court noted a tension surrounding whether a bankruptcy court should apply the choice-of-law principles from federal law or from the forum state. Since neither the Supreme Court nor the Seventh Circuit has decided the issue, the Court asked itself whether the question mattered. The parties agreed both that federal common law would apply Nevada substantive law and that Nevada would allow the claims. Therefore, the Court undertook an analysis of Wisconsin choice-of-law principles to see if it would end up elsewhere. Wisconsin courts apply a "grouping of contacts" rule in contract cases. Under that rule, the law of the forum state is applied unless contacts with a non-forum state are greater. Here, the Court concluded that the relevant contacts (place of negotiation, place of contracting, place of performance, location of the subject matter, domiciles of the parties) are undoubtedly greater for Nevada than they are for Wisconsin. Therefore, Wisconsin would apply the substantive law of Nevada and also uphold the claims. The Court rejected Jafari’s argument that notwithstanding the "grouping of contacts" rule, a Wisconsin court would apply its own law if applying the law of another state would contravene Wisconsin public policy. Having decided that an application of either federal common law or Wisconsin choice-of-law principles would lead to the same conclusion, the Court declined to resolve the choice-of-law issue.

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THOMPSON v. GENERAL MOTORS ACCEPTANCE CORP. (May 27, 2009)

Theodore Thompson financed his purchase of a 2003 Chevy with General Motors Acceptance Corp. ("GMAC"). After he defaulted, GMAC repossessed the Chevy. A few weeks later, Thompson filed for bankruptcy. GMAC refused his request to return the vehicle to the bankruptcy estate. Thompson claimed that GMAC willfully violated the automatic stay and moved for sanctions. The bankruptcy court denied the motion, holding that a creditor need not return property absent adequate security. Thompson appeals.

In their opinion, Judges Cudahy, Williams and Tinder reversed and remanded. The Court first addressed whether GMAC "exercised control" over the property of the bankruptcy estate. GMAC argued that something more than the passive act of possession was required to meet the "exercise control" prohibition of the Bankruptcy Code. The Court, relying principally on the plain meaning of the Code, concluded that GMAC exercised control over the Chevy when it refused to return it. The Court next addressed whether GMAC's entitlement to adequate protection of its interests allowed it to retain the property until such protection was afforded. The Court identified a split of authority on this issue, a question of first impression in the Seventh Circuit. Most district courts in Illinois follow the same precedent relied on by the bankruptcy court below -- that a creditor need not return property to the bankruptcy estate absent adequate protection. Several other circuits have held that a creditor must return the property to the estate and move to protect its interests. The Court relied on a plain reading of the Bankruptcy Code, the Supreme Court’s holding in Whiting Pools in the corporate reorganization context, and policy considerations in concluding that a Chapter 13 creditor must first return property in which the bankruptcy estate has an interest and then seek protection of its interests in the bankruptcy court. The Court remanded for a determination of whether GMAC willfully violated the automatic stay and was thus subject to sanctions.

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UNITED AIRLINES, INC. v. REGIONAL AIRPORTS IMPROVEMENT CORPORATION (May 5, 2009)

When United Airlines reorganized in bankruptcy, several issues remained unresolved. One of those issues involved $60 million of secured loans to United for terminal improvements at Los Angeles International Airport. United is under an obligation to pay to the lenders the full value of the secured asset, up to the $60 million. The bankruptcy court used a discounted-cash-flow analysis to value the asset, mainly because there was little evidence in the record on the market value of improved airport terminal space. The court's analysis resulted in a value of approximately $35 million. The lenders appeal.

In their opinion, Chief Judge Easterbrook and Judges Bauer and Manion reversed and remanded. The Court addressed two aspects of the court's analysis -- the appropriate annual rental rate and the appropriate discount rate. With respect to the rental rate, the Court rejected the court's use of a $17 per square foot rental rate. The Court noted that the evidence of the $17 rate represented unimproved airport terminal space. The security for the $60 million loan, however, is improved airport terminal space. There is evidence in the record that improved space at Los Angeles International Airport is rented for as much as $63 a foot. The Court recognized that the United space may not be worth as much as $63 because of several factors that distinguish it from the actual space rented. The Court noted that any rental revenue in excess of $30 would result in a full repayment of the $60 million loan. The Court concluded that the space could be leased for at least $30 a foot. With respect to the discount rate, the Court also took issue with the bankruptcy court’s approach. The court simply averaged the rate suggested by the lenders and the rate suggested by United. Relying on the fact that Los Angeles International Airport is currently operating at full capacity and can itself raise money at 8%, the Court concluded that the discount rate should not exceed 8%. The reduced discount rate also reduced the rental amount at which the lenders would fully recover the amount of their loans to $23 a foot. The Court concluded that the lenders were entitled to that full recovery.

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IN RE: TEKNEK, LLC (April 29, 2009)

Systems Division, Inc. ("SDI") sought and obtained a judgment for patent infringement against Teknek LLC (“Teknek”) and Teknek Electronics “(Electronics”). During the pendency of the patent infringement suit, the shareholders of Teknek and Electronics created Teknek Holdings ("Holdings") and transferred the assets of Teknek and Electronics into Holdings. Following the judgment, SDI added Holdings and the shareholders as defendants under an alter ego theory. Meanwhile, Teknek filed for bankruptcy. SDI filed a notice of its claim in the bankruptcy court. The bankruptcy trustee filed an adversary proceeding against the alter egos, alleging fraudulent transfers and breach of fiduciary duty. The complaint also sought relief against the shareholders personally for Teknek's obligation to SDI. The bankruptcy court enjoined SDI from attempting to collect its judgment outside of bankruptcy. The district court vacated the injunction. The shareholders paid SDI in full on the judgment. The trustee appeals.

In their opinion, Judges Bauer, Cudahy and Williams affirmed. The Court recognized that both claims were valid but only one could be satisfied – should the trustee or SDI be permitted to pursue the judgment. The Court discussed the law regarding a trustee’s rights to bring actions and the distinction between general claims that can be brought by a trustee and personal claims that can be brought by individual creditors. In the end, however, the Court concluded that those principles apply when the parties seek to recover for an injury inflicted on the debtor. Here, SDI is not seeking to recover from the alter egos for their misconduct directed toward Teknek, the debtor. SDI is seeking recourse for the injury suffered by Electronics. Electronics’ injury is separate from Teknek’s. The Court compared the situation to one in which a creditor brings an action against an insurer or guarantor, which can proceed outside the bankruptcy process. The Court agreed that the injunction was properly vacated by the district court.

While the appeal was pending, both SDI and the trustee sought relief of various sorts from the bankruptcy court, in violation of the rule that lower courts lose their jurisdiction while a matter is on appeal. The Court imposed sanctions on both.

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IN RE: KUEHN (April 16, 2009)

Stephanie Kuehn completed all the coursework necessary for a master's degree at Cardinal Stritch University. She did not, however complete her obligation with respect to tuition. When the university awarded her a degree, she still owed $6,000 in tuition. When she requested a transcript in order to qualify for a salary increase, the university refused. Kuehn filed for bankruptcy. The university continued to refuse to provide her a transcript, both while the bankruptcy case was pending and even after the discharge order. The bankruptcy court ordered the university to provide a transcript and pay damages and attorneys fees. The district court affirmed. The university appeals.

In their opinion, Chief Judge Easterbrook and Judges Ripple and Wood affirmed. The Court recited the Bankruptcy Code provisions that prohibit a creditor from taking "any act to collect" a claim during the bankruptcy proceeding or after a claim has been discharged. The Court determined that whether the university was acting to collect a debt depended on whether Kuehn had a right, or property interest, in obtaining a transcript. Since the Wisconsin Supreme Court has never addressed the issue, The Court was forced to predict what the court would do. The Court concluded that the Wisconsin Supreme Court would hold that students are joint owners of the data reflecting their grades. Relying on the Wisconsin Supreme Court’s reasoning in Hirsch as well as established university custom, the Court concluded that a right in one’s grades would be meaningless without a right to a transcript. The university’s refusal to provide the transcript was therefore an act to collect a debt and violated the automatic stay and the discharge injunction.  

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IN RE: INGERSOLL, INC. (April 15, 2009)

Winthrop Ingersoll founded the Ingersoll Cutting Tool Company (ICTC) in the late 1800s. It remained a family- owned leader in its industry through the year 2000. In 2001, Iscar, Ltd. acquired ICTC. The then-owners and descendents of Winthrop Ingersoll, the Gaylords, alleged that they never intended to sell but were duped into it by outside directors. They contacted attorney Marshall Miller to assist them in blocking the sale. He agreed to do so and enlisted the help of David Margules. The Gaylords reached an agreement to pay Miller and Margules $100,000 for the representation. The litigation proceeded apace. Miller soon asked for an retainer increase to $250,000. The litigation was unsuccessful, the sale was consummated and the Gaylords paid the $250,000. Then things got interesting: a) the attorneys sent invoices totaling $390,000, b) Miller and the Gaylord's submitted their fee dispute to arbitration, c) the arbitrator apparently ruled that the Gaylords did not owe any more to Miller and didn't decide whether they owed anything to Margules, d) the D. C. Superior Court ordered the Gaylords to pay an additional $83,000 to Miller (which they did), and e) Margules brought an action in Delaware to recover the $60,000 he claimed he was owed, which was denied. In the meantime ICTC's parent, Ingersoll International Inc., petitioned for bankruptcy. Although the Gaylords were not debtors in that case, the bankruptcy court confirmed a liquidation plan that released the Gaylords from claims "arising from" or "relating to" their original case to enjoin the sale of the company. The Gaylords sought relief in the bankruptcy court from another claim filed in the D. C. Superior Court by Miller. Although recognizing that the Gaylords were not debtors and that Miller was not a creditor, the bankruptcy court held that the release was valid because it was key to the ultimate negotiation and success of the plan. The district court, after a remand for clarification, affirmed the bankruptcy court. Miller appeals.

In their opinion, Judges Bauer, Evans and Williams affirmed. First, the Court agreed with the lower court that the release was broad enough to cover Miller's claim. Since the claim related to a breach of the arbitration award, which arose out of a fee dispute in the identified litigation, the Court concluded that it was clearly covered. As for the validity of the release, the Court noted that releases of non-debtors should rarely be approved. Here, however, the release was narrowly tailored, only covered claims relating to two cases, and was, according to the bankruptcy court, essential to the success of the plan. Although the Court approved the use and validity of the release in this case, it warned that releases like it will usually not pass muster.

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ILLINOIS INVESTMENT TRUST NO. 92-7163 v. AMERICAN GRADING CO. (April 8, 2009)

Resource Technology Corp. ("RTC") collected methane gas at landfills and converted the gas into energy. In 1995, RTC entered into a ten-year lease at the McCook landfill. RTC was to install and operate a methane collection and conversion system in exchange for royalties. Although the actual royalties were computed on the sale of electrical energy, the lease required RTC to pay a $100,000 royalty advance at the beginning of each year. RTC entered bankruptcy in 1999. The bankruptcy proceeded for several years. When the 2006 royalty advance payment became due, the trustee did not pay it. A few weeks later the owner of the landfill requested that the trustee refrain from entering the premises. In March of 2006, the trustee entered into a settlement agreement with some of RTC's creditors. Illinois Investment sought an order under the agreement compelling the estate to assume the McCook lease. The lessor objected, asserting that the ten-year lease term had expired. The court ruled that the lease had been extended for a five-year term. The lessor then sent a notice of termination of the lease. The bankruptcy court determined that the lessor validly terminated the lease as a result of RTC's failure to make the royalty payment. Illinois Investment appeals.

In their opinion, Judges Manion, Wood and Williams affirmed. The Court ruled that the failure to pay the advance royalty was a material breach and allowed the lessor to terminate the lease. Even if no royalties were generated during the year, as Illinois Investment argued, the Court concluded that the advance royalty was still required, as security for RTC's performance under the lease.

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IN RE: GOLDBLATT'S BARGAIN STORES (March 18, 2009)

Before its bankruptcy, Goldblatt's operated six stores in the Chicago area. In January 2003, Great American Group agreed to buy the inventory at two of the stores at a deep discount. Shortly thereafter, Great American agreed to do the same with the inventory at the other four stores. Both sales were contingent on the independent appraisal of the inventories. Both sales were approved by LaSalle Bank, Goldblatt's principal creditor. Before the sales, Great American learned that inventory purchased for $450,000 had been moved from the four stores to the two stores. Great American did not advise the Bank of that fact. The independent appraisal of the first sale confirmed that the inventory was worth at least as much as it had been represented. The appraisal of the inventory from the four other stores, however, indicated that the inventory was worth at least $2 million less than Goldblatt's had estimated. The results of the second appraisal entitled Great American to a refund of approximately $1 million from Goldblatt's. LaSalle Bank, although required by contract to pay, refused to do so. The bankruptcy court, after a trial, concluded that Great American was legally obligated to disclose the movement of the inventory to LaSalle. The court concluded, however, that LaSalle would not have acted any differently had it known and that LaSalle had not shown that it incurred any loss from the movement. On appeal, the district court reversed. The district court agreed that Great American owed a duty of disclosure to LaSalle. However, it held that the fraud excused LaSalle Bank from any obligation to perform. Great American appeals.

In their opinion, Chief Judge Easterbrook and Judges Sykes and Tinder reversed. The Court agreed that a victim of fraud is typically entitled to rescission. Here, however, LaSalle does not seek rescission. It simply wants to be excused from having to pay the deficiency based on the overestimation of the second inventory. Before LaSalle is entitled to a remedy, it must establish reliance and injury. The Court agreed with the bankruptcy judge that LaSalle had not proven neither reliance nor loss.

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ROSS-TOUSEY v. NEARY (December 17, 2008)

Marvin Ross-Tousey and his wife Deborah (the “debtors”) filed a Chapter 7 bankruptcy petition. Because their household income was above the median income level, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) subjected their petition to a means test. The means test is used to distinguish those debtors who can repay a portion of their debts from those who cannot. A debtor who has enough disposable income to pay at least $166.67 per month to his creditors is expected to file under Chapter 13. A Chapter 7 filing is presumptively abusive in that circumstance. The debtors claimed a vehicle ownership expense allowance of over $800, although they had no debt or lease payments. With that deduction, they had no disposable income and met the means test. The United States Trustee (“UST”) moved to dismiss their petition for abuse. The UST first asserted abuse based on a totality of the circumstances. The UST later amended the motion to include presumptive abuse on the grounds that they should not have taken the vehicle ownership allowance. The bankruptcy court denied the motion. The district court reversed, holding that a debtor cannot claim a vehicle ownership allowance for vehicles he owns outright. The district court remanded for proceedings to determine whether the debtors could rebut the presumption. The debtors appealed. The UST moved to dismiss for absence of finality because the bankruptcy court had not ruled on whether the presumption could be rebutted. The debtors conceded that they could not rebut the presumption.

In their opinion, Judges Flaum, Rovner and Williams reversed and remanded. The Court first considered two jurisdictional issues: whether there was a “final order” to review and whether the time period for the UST’s amendment of the motion to dismiss was jurisdictional. On the first issue, the Court found that both the bankruptcy court’s order and the district court’s order were final. In the case of the bankruptcy order, the only remaining act was to distribute the debtors’ assets. In the district court’s reversal and remand, the only obligation of the bankruptcy court was to either dismiss the petition or convert it to a Chapter 13 proceeding, at the option of the debtors. The presence of these continued ministerial acts did not divest the Court of jurisdiction. On the timing issue, the Court stated that the statute set a deadline for filing a motion to dismiss. The UST’s original motion met the deadline but the amendment to add the presumptive abuse ground did not. The Court appreciated that the Supreme Court’s decision in Bowles seems to say that filing deadlines found in statutes are jurisdictional, while those found elsewhere are not. Nevertheless, relying on the Supreme Court’s later decision in John R. Sand & Gravel and the fact that much case law would be overturned by such a reading of Bowles, the Court found a different path. In John R. Sand & Gravel, the Supreme Court distinguished between statutes of limitations designed to protect defendants from stale claims from those that that sought to achieve a “system-related goal,” with only the latter classified as jurisdictional. Since the bankruptcy deadline existed principally to protect a debtor from delay and not to achieve some broader system goal, the Court held that it was not jurisdictional and any objection was waived by the debtors.

The Court proceeded to the merits. The means test in the BAPCPA includes, in the definition of monthly expenses, “applicable" monthly expenses specified by the National and Local Standards found in the Internal Revenue Manual (“IRM") and “actual" monthly expenses for other defined expenses. The vehicle ownership allowance at issue is one of two transportation components found in the Local Standards. The Court noted that the issue it faced has been litigated frequently but never decided by a circuit court. Two approaches have emerged, depending on the treatment of the word “applicable” in the statute. The IRM approach treats “applicable” as meaning “relevant” and concludes that a debtor with no lease or debt payment on a vehicle has no “relevant” cost of ownership. The Plain Language approach, on the other hand, treats “applicable” as that number “applied” by the Local Standards for the debtors’ region and number of vehicles. The Court was persuaded by the Plain Language approach. It decided that, to give effect to all the words of the statute, “applicable” could not mean the same as “actual.” Since it could not refer to the debtors’ actual expense, it must refer to the deductions listed in the Local Standards. The Court found additional support for its holding in: a) the inconsistency in the statute’s disallowance of debt as an expense and the IRM approach’s conditioning the transportation allowance on debt, b) Congress’ specific language throughout other sections of the means test to describe allowable deductions, c) an absence of any indication that Congress intended the IRM methodology to be used in the means test, d) the avoidance of an unfair result if the allowance is limited to debtors with car payments, and e) the recognition that allowing the deduction only avoids a presumption of abuse – abuse can be shown independently.  

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