Bankruptcy Court's Interpretation of Reorganization Plan It Confirmed Receives Deferential Treatment

IN RE: AIRADIGM COMMUNICATIONS, INC. (August 4, 2010)

Airadigm Communications' principal assets when it petitioned for bankruptcy in 1999 were fifteen mobile phone service licenses issued by the FCC. Pursuant to regulation, the FCC revoked the licenses and Airadigm's 2000 reorganization plan treated them as if they were not part of the bankruptcy estate. It did, however, petition for reinstatement of the licenses. The plan provided alternative treatment for the claims of two major creditors (Oneida and Ericsson), depending on whether the licenses were reinstated. Payment of both claims was going to be financed by loans from Telephone and Data Systems, Inc. ("TDS") -- and the claims have since been assigned to TDS. TDS also advanced additional funds directly to Airadigm pursuant to three loans. Each of the loans was to be repaid by collateral surrender. Several years after the reorganization plan was confirmed, the Supreme Court held that the FCC's license revocation rule was invalid. The FCC then denied Airadigm's motion for reinstatement as moot. Airadigm filed a new petition for bankruptcy protection in 2006. The FCC objected, arguing that the 2000 reorganization plan should be modified instead. The parties entered into a stipulation pursuant to which the new petition was recognized. Among other things, the stipulation provided that the 1999 "Allowed Claim(s)" of the FCC, TDS as assignee, and TDS would be allowed in the 2006 bankruptcy. The bankruptcy judge thought the stipulation was unclear and invited the parties to make the intent of the stipulation more clear, but they did not. TDS filed three claims in the 2006 bankruptcy (one each for the direct loans, the Oneida assigned claim, and the Ericsson assigned claim). The FCC objected to them all. The bankruptcy court allowed the claims based on the direct loans and the Ericsson assignment, and disallowed the claim based on the Oneida assignment. Judge Crabb (W.D. Wis.) reversed with respect to the Oneida assignment and allowed all of TDS's claims. The FCC appeals.

In their opinion, Circuit Judges Kanne and Evans and District Judge Dow affirmed in part and reversed in part. The Court first addressed the standard of review. It noted that it would consider matters of law de novo, but that it would grant much deference to the bankruptcy court's interpretation of the 2000 plan. It treated the interpretation of the plan like a court’s interpretation of its own order. On the merits, the Court turned to the claim on the direct loans. First, it concluded that the FCC did not preserve its argument that the claim should be disallowed because the financing arrangement was an asset sale agreement, not a loan. Next, it concluded that the parties' stipulation barred the FCC from proceeding on its argument that the advances should be recharacterized as equity. Although the stipulation was subject to multiple readings, the Court concluded that the best reading, particularly in light of the "last antecedent rule," allowed the FCC to contest only the amount of the loan and the interest calculation. Particularly in light of the FCC's failure to bring forth any extrinsic evidence that supported its interpretation of the stipulation, the Court affirmed the allowance of the direct loans claim. Alternatively, even if the FCC's challenge were allowed, the Court noted that the record did not support a claim for recharacterization. The Court next addressed the Oneida assignment claim. It agreed with the bankruptcy court that the FCC's objection to this claim should be sustained for two reasons. First, it concluded that the bankruptcy court's interpretation of the "thorny" issues presented by the plan and the Supreme Court's decision was not an abuse of discretion. Second, it concluded that TDS was judicially estopped from arguing otherwise. In earlier proceedings, TDS had successfully defeated Oneida's motion to fund its claim. Its later position is diametrically opposed to its successful argument at that time and there is no reasonable justification for their change in position. Finally, with respect to the Ericsson assigned claim, the Court affirmed the allowance of the claim. Unlike the Oneida claim, the 2000 plan did not extinguish Ericsson's rights. In fact, the plan specifically provided that Ericsson retained its liens on terminated licenses. That right survived the 2000 plan and supports a claim in the 2006 bankruptcy.

Pro-Rata Calculation Of Pre-Petition Portion Of Tax Refund Was Reasonable

IN RE: MEYERS (August 2, 2010)

Andrea Meyers filed a Chapter 7 petition for bankruptcy relief on September 25, 2007. Months later, she received federal and state tax refunds for the 2007 tax year totaling $3,538. The bankruptcy Trustee moved for the turnover of the pre-petition share of the refunds. Since September 25 was 73.42% into the year as a whole, the Trustee asked for 73.42% of the refunds (or $2597.60). After a reduction related to Illinois' wild-card exemption, the Trustee sought $973.60. Meyers objected. The bankruptcy court sided with the Trustee and the district court affirmed. Meyers appeals.

In their opinion, Circuit Judges Flaum and Wood and District Judge St. Eve affirmed. Allocation of assets and liabilities is generally fairly simple in a bankruptcy context. Pre-petition assets satisfy pre-petition debts. Post-petition assets are generally not at risk and post-petition liabilities are not discharged. Tax refunds, however, do not fit neatly into this generalization. Courts have long recognized that tax refunds can be pre-petition assets. The sometimes difficult question can be how to allocate a single tax refund into pre-and post-petition shares. The Court recognized that reasonable people can identify any number of methods to do so. Here, the Trustee proposed the pro-rata approach -- 73.42% of the year had passed when Meyers filed her petition so 73.42% of the refund belongs to the bankruptcy estate. Meyers, on the other hand, proposed a formula under which the Trustee received a portion of the refund but only to the extent that the taxes withheld before the petition was filed exceeded the entire year's tax liability (a formula that was adopted by a bankruptcy court in Texas in 2006). In order to select from the competing proposals, the Court turned its attention to the Trustee's burden. It adopted the approach that had been used under the old Bankruptcy Act. The Trustee first has the burden of a prima facie case. Assuming a prima facie case, the debtor has the opportunity to challenge that case. The ultimate burden of persuasion rests with the Trustee. Applying that approach to the facts of the case, the Court concluded that the Trustee had made its prima facie showing. It identified the refund, the established that Meyer's income and withholding grew relatively steadily throughout the year without any spikes, and properly calculated the estate's pro-rata share. Turning to Meyer's challenge, the Court found it wanting. She offered no evidence that suggested a pro-rata approach was unreasonable. All she did was propose an approach that had been used once before -- and used in a case where the debtors' income and withholding did not grow steadily throughout the year. The Court conceded that the pro-rata approach might not be appropriate in every case, but concluded that it was reasonable in Meyer’s case.

Internal Revenue Code § 7433(e) Is The Exclusive Taxpayer Remedy For IRS' Willful Violation Of A Discharge Injunction

KOVACS v. UNITED STATES OF AMERICA (July 29, 2010)

Nancy Kovacs accumulated some federal income tax liability in the early 1990s. She entered into an agreement with the IRS in 1996 to resolve those liabilities. The agreement required her to pay her tax liabilities on time for the ensuing five years. She was unable to do so. The IRS terminated the agreement and reinstated the tax liability in 2001. Several months later, Kovacs filed for bankruptcy. In late 2001, she received a bankruptcy discharge. The discharge included her tax liabilities. Notwithstanding the discharge, the IRS continued to demand payment. It even applied some overpaid taxes to the obligation. Kovacs' attorney originally misunderstood the impact of the discharge, thought she still owed taxes, and attempted to reach another agreement with the IRS. The IRS continued to demand payment until August of 2003, when it informed Kovacs’ attorneys that the tax liability had indeed been discharged. Remarkably, the IRS sent two more letters -- in September of 2003 -- indicating that the taxes were still owed. Kovacs brought an adversary complaint in bankruptcy seeking damages for the attorneys’ fees she incurred. The bankruptcy court denied the IRS' motion to dismiss on jurisdictional grounds and the case was tried. The bankruptcy court awarded $25,000 in damages. The district court remanded for a determination of the timeliness of the suit under § 7433 of the Internal Revenue Code, which has a two year statute of limitations. It did not address the bankruptcy court's alternative holding that it had authority under §§ 105 and 106 of the bankruptcy code, which has no limitations period. On remand, the bankruptcy court concluded that the cause of action accrued in July 2002 and dismissed her claim for failure to bring it within the two year statute of limitations. Judge Stadtmueller (E.D. Wis.) affirmed. Kovacs appeals.

In their opinion, Circuit Judges Flaum and Wood and District Judge St. Eve affirmed in part and reversed in part. The Court conceded that § 105 of the Bankruptcy Code has no statute of limitations and grants broad power to a bankruptcy court, including the power to issue any order necessary to carry out the provisions of the code. Nevertheless, § 7433 of the Internal Revenue Code provides that "notwithstanding [§ 105]", it "shall be the exclusive remedy for recovering damages" resulting from the IRS' willful violation of a discharge injunction. The Court concluded that the language of § 7433 was "exceedingly clear" and was thus the only section under which Kovacs could proceed. The Court therefore applied to the section's two year statute of limitations to Kovacs' claims. Her claims accrued when she had a reasonable opportunity to discover the elements of her claim. The Court agreed with the bankruptcy court that Kovacs had that opportunity when she received six notices of intent to levy in July of 2002. The result does not change because of the mistake of her counsel. The Court therefore affirmed the dismissal of the claims based on the July communications. There were two other communications, however, that did occur within the limitations period. The Court found that each of the September letters was a discreet violation of the discharge injunction. They both stated that Kovacs still owed the full amount of her discharged tax liabilities. The Court rejected Kovacs' continuing violation theory because the September letters were not part of a series of acts that resulted in an injury -- they were discrete acts themselves. Kovacs' claims based on those two September letters are not time barred.

Taxbuyer's Interest In Property Is Not "Perfected" Under Fraudulent Transfer Statute Until Deed Is Recorded

SMITH v. SIPI, LLC (July 27, 2010)

Keith and Dawn Smith lived in their Joliet, Illinois home for years. When Dawn inherited title to the home in 2004, it was subject to a state tax lien. Pursuant to Illinois law, it was auctioned off at a tax sale in late 2001. SIPI, LLC was the successful bidder and received a certificate of purchase. Under Illinois tax sale procedure, the sale is followed by a redemption period, during which the owner may redeem the property. If it is not redeemed, the buyer can obtain a tax deed to the property. The tax deed must be recorded within one year after the expiration of the redemption period. The Smiths' redemption period expired on November 1, 2004. SIPI acquired the deed in April of 2005 and recorded the deed in May of 2005. In April 2007, the Smiths petitioned for bankruptcy and filed an adversary complaint against SIPI to avoid the tax sale as a fraudulent transfer under § 548 of the Bankruptcy Code. The bankruptcy court concluded that the tax sale did not occur within the two year "look back period" because the sale was perfected when the redemption period expired in November 2004. Judge Guzman (N.D. Ill.) affirmed. The Smiths appeal.

In their opinion, Judges Williams, Sykes, and Tinder reversed and remanded. The Court noted that the only real issue in the case was whether the buyer’s interest in the property was "perfected" under bankruptcy law before or after the outer limit of the look back period -- April 13, 2005. The redemption period expired four months earlier but the tax deed was issued two days later and recorded 36 days later. Under § 548, a buyer’s interest is perfected when the owners can no longer convey a superior interest to a bona fide purchaser. The Court looked to the Illinois Property Tax Code for guidance, since the issue was one of first impression for the Court. The Court concluded that the statute considers the time of recording to be the point where the buyer's rights are superior to a bona fide purchaser. The Court did express some concern whether a bona fide purchaser could even exist after a tax sale, given the extensive public proceedings associated with tax sales and the "without notice" requirement of a bona fide purchaser. Ultimately, the Court was comfortable in rejecting the notion that a bona fide purchaser could never prevail after a tax sale.

Bankruptcy Court's Order Denying A Plan Objection Is Not Appealable

IN RE: MCKINNEY (June 23, 2010)

When Lonnie McKinney fell behind on the property taxes for his Peoria County duplex, the county sold the tax debt to Salta Group. McKinney had two years within which to pay the debt after the sale. He did not and was notified that the property had been sold. He still had several months to redeem the property before Salta Group would receive a tax deed to the property. One day before the end of the redemption period, McKinney filed for bankruptcy. He proposed a bankruptcy plan that allowed an additional five years to pay off the tax debt. Salta Group filed an objection to the plan. The bankruptcy court denied the objection and Judge McDade (C.D. Ill.) affirmed. Salta Group appeals.

In their opinion, Chief Judge Easterbrook and Judges Rovner and Tinder dismissed for want of jurisdiction. The Court first addressed its -- and the district court's -- jurisdiction. The jurisdictional statute grants jurisdiction over "final" decisions and orders of the bankruptcy court. The Court conceded that the concept of finality is murkier in the bankruptcy arena than it is elsewhere because of the frequent existence of numerous discrete disputes within a single bankruptcy case. The test the Court applied was whether the order resolves a dispute that, but for the bankruptcy, would have been a discrete lawsuit. It concluded that Salta’s claim was not such a dispute. The order did not resolve any part of Salta's claim -- it merely resolved one issue.

United States Trustee Is A "Party In Interest" Under Bankruptcy Code § 1129(d)

IN RE: SOUTH BEACH SECURITIES (May 19, 2010)

South Beach Securities, Inc. is controlled by Leon Greenblatt and was once a registered securities dealer. In the early 2000s, Greenblatt orchestrated a number of financial transactions among South Beach and other companies, including Scattered Corporation, which he controlled in whole or in part. At the time, South Beach's only potential assets were net operating losses. As a result of the transactions, Scattered became South Beach's only creditor. South Beach filed a Chapter 11 petition and submitted a plan of reorganization. The U.S. Trustee opposed confirmation of the plan. The bankruptcy court refused confirmation and dismissed the petition. Judge Lefkow (N.D. Ill.) affirmed. Scattered and South Beach appeal.

In their opinion, Judges Posner, Flaum, and Wood affirmed and issued a show-cause order. The Court first addressed the argument that the U.S. Trustee was not even authorized to oppose confirmation of the plan on the ground that its primary purpose was to avoid taxes. Although the Court thought the Internal Revenue Code's guidance is a ”mishmash," it concluded that the Trustee was a "party in interest" under § 1129(d) and authorized to oppose the plan. The Court specifically relied on § 307's grant of authority to the Trustee to "be heard on any issue." On the merits, the Court not only concluded that the proposed plan would not confer the desired tax consequences, it found at least three reasons why the plan could not be confirmed. First, a plan cannot be confirmed if its principal purpose is to avoid taxes. Second, a plan must be rejected if it is not proposed in good faith. Here, the lack of good faith is illustrated by the absence of any outside creditors or any real debt. Finally, a plan cannot be confirmed without the approval of the non-inside owners of at least one class of impaired claims. Because of Scattered's insider status, no such owners exist in this case. The Court concluded that the appeal was frivolous, invited the Trustee to apply for sanctions, and issued an order for the appellants and their lawyers to show cause why they should not be sanctioned.

Reorganization Plan's Definition Of A Term Need Not Coincide With The Statutory Definition Of The Same Term

IN RE: ALTHEIMER & GRAY (April 15, 2010)

Mark Berens practiced law at Altheimer & Gray, a Chicago-based international law firm. He was a capital partner at the firm -- he invested capital, he voted, he was listed on the articles of partnership, and his compensation was based on the firm's profits. He qualified as a partner under the definition of the Uniform Partnership Act. In 1999, he withdrew from the partnership and signed a contract pursuant to which he gave up any right to the profits of the firm. In lieu, he agreed to a salary. Under the practice at the law firm at the time, he was still called a "partner." In 2003, the firm, which had been in existence for almost 100 years, entered involuntary bankruptcy. The firm and its creditors agreed to a liquidation plan under which any firm debt to a "partner" was subordinated to other debts. The plan defined "partner" to include both the firm's "unit partners" and the "non-unit partners." Within the firm, "unit partners" were those who shared in the profits. "Non-unit partners" were the salaried, or contract, partners. Berens filed a claim for over $300,000 that he claimed was owed to him by the firm. When the trustee failed to pay the claim, Berens filed a motion in the bankruptcy court for relief. The bankruptcy court denied the motion and the district court affirmed. Berens appeals.

In their opinion, Chief Judge Easterbrook and Judges Bauer and Hamilton affirmed. The question presented to the Court was whether Berens was a "partner" under the liquidation plan and therefore subordinate to other creditors. The Court agreed with Berens that his position with the firm after 1999 did not qualify as a "partner" under the Uniform Partnership Act. The plan of dissolution, however, had its own definition of "partner" and did not adopt or refer to the definition contained in the Uniform Partnership Act. There is nothing in the bankruptcy law that requires a dissolution plan to adopt any particular definition of a term. In fact, as Chief Judge Easterbrook pointed out in his opinion, the plan could have used a word from a nonsense poem (can you say “borogrove”?) instead of “partner” as long as it defined it properly. Berens was clearly a partner as that term is defined in the dissolution plan -- therefore his claim is subordinate to the claims of other creditors.

State Law Conspiracy And Tortious Interference Claims Were Properly Removed Because They "Arose In" Bankruptcy

IN RE: REPOSITORY TECHNOLOGIES, INC. (April 12, 2010)

Repository Technologies, Inc. ("RTI") was a software supplier. When it needed additional financing, William Nelson, a minority shareholder, offered to help. He eventually loaned almost $2 million to RTI. Once he sent a notice of default, however, RTI filed for Chapter 11 reorganization. In the bankruptcy proceeding, RTI attempted, unsuccessfully, to recharacterize the entire Nelson debt as equity. Although the bankruptcy court refused to dismiss the case on the ground it was filed in bad faith, it did dismiss it on the ground that RTI was unable to reorganize. The district court affirmed the bankruptcy court and denied Nelson's request to strike, as dictum, the finding that the case had not been filed in bad faith. Nelson appeals -- RTI cross appeals. (Meanwhile, Nelson also filed a complaint in federal court seeking damages for the breach of the loan agreement. The district court froze RTI's assets pending resolution of the case, but not before RTI paid $100,000 to its bankruptcy lawyers. The court also appointed a receiver who transferred all of RTI's assets to Nelson as the successful bidder at a UCC sale. The court approved the sale and dismissed the claims without prejudice.)

Nelson also brought suit, in state court, against RTI's lawyers. He alleged that the lawyers conspired with RTI to file the bankruptcy case to enrich themselves, that they tortiously interfered with his loan agreement with RTI, and that they abused the bankruptcy process. The defendants removed. The district court denied remand, even after Nelson withdrew his "abuse of the bankruptcy process" count. The court then, relying on the district court’s finding in the bankruptcy case that the bankruptcy case was not filed in bad faith, dismissed the abuse of process claim with prejudice. The defendants moved to dismiss the rest of the complaint on the grounds that the entirety of the complaint was based on an abuse of the bankruptcy process. The district court, however, concluded that some state claims remained and remanded to state court. The defendants appeal.

In their opinion, Chief Judge Easterbrook and Judges Ripple and Tinder vacated and remanded with instructions to dismiss in the bankruptcy court appeal and reversed and remanded in the district court appeal. First addressing the appeal of the bankruptcy court decision, the Court concluded that the case was moot. The district court, in an order not appealed, approved the sale of all of RTI's assets. An appellate review of the bankruptcy court's decision could therefore not provide any meaningful relief. Although the Court agreed with Nelson that the bankruptcy court's statement about the good faith filing was dictum, it declined to entertain the argument since one cannot appeal dictum. The Court therefore vacated the judgment of the district court and remanded with instructions to dismiss the appeal from the bankruptcy court as moot.

With respect to the appeal of the district court case, the Court also began with a discussion of its jurisdiction. The defendants had removed on three alternate grounds: bankruptcy jurisdiction, diversity jurisdiction, and complete preemption. The district court relied on its bankruptcy jurisdiction to keep the case. The Court noted that district courts have original jurisdiction of proceedings "arising in or related to" cases under title 11. The Court agreed with the district court that the claims in the case were predicated on the lawyers' participation in the bankruptcy case and therefore met the "arising in" jurisdiction. Even the pre-petition conduct alleged in the complaint was related to the claims of abuse of process. Before reaching the merits of the remand, however, the Court concluded that it also had to address the existence of jurisdiction under the alternate grounds argued -- diversity jurisdiction and complete preemption – since the existence of any federal jurisdiction ground would prohibit a remand. As to the former, the defendants earlier conceded that diversity jurisdiction could not be a basis for the original removal because of the "forum defendant rule." The defendants did not preserve the argument that diversity jurisdiction could be used to keep the case in federal court, notwithstanding the “forum defendant rule, since the original removal was on other, proper grounds that have now been eliminated. The court therefore did not reach that "interesting question." With respect to complete preemption, the Court noted that complete preemption requires the existence of a federal cause of action that can substitute for the state action and provide recovery. Here, the lack of a federal claim that could substitute for Nelson's civil conspiracy and tortious interference claims illustrates the absence of complete preemption. The district court therefore did not have an independent ground of federal jurisdiction and had discretion to remand the supplemental state claims. On the merits of the remand, the Court recognized the usual practice to dismiss supplemental state claims if federal claims are dismissed before trial and conceded that it rarely interferes with a district court's discretion in this area. However, the discretion is not absolute. Here, the state claims are based on the defendants' participation in the bankruptcy case and are inseparable from the dismissed federal claims. When state claims are so entangled with the dismissed federal claims, the district court should retain supplemental jurisdiction. The fact that the claims are so interrelated and entangled might suggest that the state law claims should be dismissed as well. Although conceding the logic of that point, the Court added that the district court's reliance on the bankruptcy court's dictum in dismissing the federal claim was flawed. Dictum has no preclusive effect. The state claims should be resolved, said the Court, without reference to that dictum.

Fraudulent Inducement To Forbear Collection Of Loan Results in Non-Dischargeable Debt Under Section 523(a)(2)(A)

OJEDA v. GOLDBERG (March 25, 2010)

Gail and Ronald Goldberg were in the business of making high risk loans. They made such a loan in the amount of $600,000 to Ernest and Beverly Ojeda. The Ojedas provided stock valued at $800,000 as collateral. The original loan agreement was executed in August of 1998, with an original maturity date of October of 1998. The maturity date was extended many times, and the Ojedas continued to pay monthly interest until January of 2006. In late 1999, the company whose stock secured the original loan executed a reverse stock split, significantly reducing the number of shares and value of the collateral. At the time of one of the loan extensions in late 2001, two entities owned by the Ojedas, both of which owned McDonald's restaurants, guaranteed the note. Another maturity date came and went – and the Ojedas continued to make the monthly interest payments. In 2004, the Ojedas sold their interest in the McDonald's restaurants and used the proceeds to pay off creditors and to buy a pizza franchise. The Ojedas ultimately defaulted on the note in January of 2006, the pizza franchise failed a month later, and the Ojedas entered bankruptcy. In the bankruptcy proceeding, the Goldbergs asserted that the Ojedas’ liability on the $600,000 loan should be non-dischargeable pursuant to 11 U.S.C. § 523(a)(2)(A). The bankruptcy court concluded that the Goldberg's were not justified in relying either on the value of the stock or the ownership in the restaurants and further concluded that, if there was reliance, the only amount excluded from discharge would be attorney's fees and unpaid interest. The district court reversed, concluding that reliance on the restaurant ownership was justified and that the entire amount was excepted from discharge. The Ojedas appeal.

In their opinion, Judges Kanne, Rovner, and Williams affirmed. The Court first set forth the elements of a discharge exception under § 523(a)(2)(A): a debtor’s false representation, the debtor's knowledge of the falsity or reckless disregard for the truth, an intent to deceive, and justifiable reliance. The first three elements were not seriously contested. With respect to justifiable reliance, the Court noted that it is a lower standard than reasonable reliance, and only requires that one not rely "blindly" on a false representation if the falsity would have been obvious upon cursory investigation. Applying that test, the Court found no clear error in the bankruptcy court's determination that the Goldberg's reliance on the stock shares was not justified. Ronald Goldberg was an experienced businessman and he was aware of the company's troubles. He therefore should have made inquiry before continuing to extend the note. The Court found error, however, in the bankruptcy court's conclusion that the Goldberg's reliance on the Ojeda’s restaurant ownership was not justifiable. The Court concluded that the Goldbergs had no information that would have alerted them to the sale of the restaurants. Even though the restaurants did not secure the debt, the companies that owned the restaurants did guarantee the note. The sale of the restaurants materially affected each company's ability to perform as guarantors. Next, the Court concluded that the fraudulently induced forbearance fit within the definition of an "extension" or "renewal" of credit under § 523. Finally, the Court addressed the issue of the extent to which the forbearance was obtained by false pretenses. The test is whether the creditor: a) had collection remedies at the time of the false representation, b) did not take advantage of the remedies because of the false representation, and c) the remedies lost value during the extension period. The Court concluded that the Goldbergs met the test since the Ojedas had significant assets in 2004 that no longer existed at the time of default. Since the Goldberg's forbearance applied to the entire debt, the Court concluded that the entire debt was excepted from discharge, notwithstanding that the original loan involved no deception.

Administrative Claimant Who Failed To Appear And Object To Bankruptcy Court Dismissal Order Lacked Standing To Appeal

IN RE: RAY (March 8, 2010)

Mark Ray and Berwick Black Cattle Company bought, sold, and raised cattle until involuntary Chapter 11 bankruptcy petitions were filed against them. A committee was formed to represent their creditors. The Committee retained Becker & Poliakoff (“Becker”) as litigation counsel. Even after most of their assets were liquidated, unsecured claims remained. Becker represented the Committee in adversary complaints seeking recovery of preferences and fraudulent transfers. Becker filed an interim fee application in September of 2008. The next month, the Becker lawyer responsible for representing the Committee left the firm and his new firm substituted for Becker as Committee counsel. In December of 2008, the bankruptcy court conducted a hearing to consider a number of pending motions, including a motion to dismiss filed by the debtors. Becker neither appeared at the hearing nor responded to any motions. In January 2009, the court dismissed the case. Becker filed two emergency motions seeking reconsideration of the court's ruling, which were denied. The firm appealed to the district court. Although the district court concluded that Becker had standing, it affirmed the dismissal order. Becker appeals.

In their opinion, Circuit Judges Ripple and Rovner in District Judge St. Eve vacated the judgment and remanded with instructions to dismiss for lack of standing. Before reaching the merits of the dismissal, the Court had to determine if Becker had standing. Before it reached the merits of standing, it had to determine if the lack of a cross-appeal resulted in a waiver. Unlike Article III standing, bankruptcy (or "prudential") standing may be waived by a failure to raise the issue. Even if waived, however, a court may raise bankruptcy standing on its own -- and the Court chose to do so here. On the merits of the standing issue, the Court stated that bankruptcy standing lies only with one who is affected pecuniarily by a court order and has attended and objected at a court proceeding. Becker concedes that it did not appear and object until it filed its motion to reconsider. Nevertheless, it claims that it met this requirement either because Committee counsel represented its interest at the hearing directly, or because it actually qualified as an administrative claimant and was therefore represented by Committee counsel at the hearing, or because of its motions to reconsider. The Court found no evidence of the first or second and rejected the third as a matter of law.

Automobile's Negative Equity Is Included In The Purchase Money Security Interest And Not Subject To Cramdown in Chapter 13

IN RE: HOWARD (March 1, 2010)

Aubrey Howard purchased a $30,000 car. He made a down payment of $4,500 and traded in his old car. Although his old car was worth $14,500, he still owed $22,500. He therefore financed $35,500 (the purchase price minus the down payment plus the $8,000 in negative equity plus $2,000 in taxes and fees). Later (within 910 days), he filed for Chapter 13 bankruptcy. An issue presented to the bankruptcy court was whether the $8,000 in negative equity was subject to the court's cramdown power. The bankruptcy court ruled that negative equity is included in a purchase money security interest and is therefore not subject to the court's cramdown power. Howard appeals.

In their opinion, Judges Posner, Flaum, and Williams affirmed. The Court began its opinion with a short lesson on bankruptcy. "Cramdown" refers to the bankruptcy court practice of determining the value of secured collateral, allowing the debtor to force the creditor to accept a payment schedule equal to the determined value, and converting any excess loan balance to an unsecured claim. Cramdown favors the debtor to the disadvantage of the creditor. In addition, cramdown creates another payment obligation and exposes the creditor to a possible second default. In response to creditors' complaints, Congress amended the bankruptcy law. The law now prohibits a cramdown in Chapter 13 cases to reduce a purchase money security interest in an automobile acquired for personal use, if the debt was incurred within 910 days of the bankruptcy filing. The Court looked to state law for the definition of a purchase money security interest. As defined in the UCC, a purchase money security interest includes the price of an item and also "obligations for expenses incurred" in connection with the acquisition of the item. For example, the Court noted that a loan could provide for the payment of attorney's fees in the event of default. In that case, the fees would be included in the purchase money security interest. The Court also cited to the Illinois Motor Vehicle Retail Installment Sales Act which, although it does not purport to prescribe what is or is not included in a purchase money security interest, does define "amount financed" as including negative equity. The inclusion of negative equity in "amount financed" was evidence to the Court that negative equity was common in automobile purchases. Finally, the Court considered what effect including negative equity in purchase money security interests would have on other creditors. Concluding that purchase money security interests need not be narrowly defined to protect other creditors and that including negative equity in purchase money security interest was important to the automobile sales market, the Court held that negative equity is not subject to cramdown power.

Middleton Factors Support Conclusion That Statutory Amendment Is Clarifying

MILLER v. LASALLE BANK (February 19, 2010)

In 2001, individuals entered into a mortgage on an Indiana property with LaSalle Bank's predecessor. The mortgage was recorded -- but the acknowledgment had a technical defect. In 2007, the individuals petitioned for Chapter 13 bankruptcy. The Trustee initiated an adversary proceeding against La Salle to avoid the mortgage. Indiana law provides that a "properly acknowledged" mortgage is constructive notice of the mortgage to later bona fide purchasers (BFPs). Prior to 2007, Indiana courts held that a mortgage with a technical defect in the acknowledgment did not amount to constructive notice. The Indiana legislature amended the statute in 2007 to overrule the case law and allow constructive notice even with certain technical defects. The legislature amended the statute again in 2008 to provide that the statute applied to all mortgages, regardless of the date of recording. The dispute in the adversary proceeding centered on whether, prior to the 2008 amendment, the 2007 amendment applied to mortgages recorded prior to 2007. The bankruptcy court concluded that the 2007 amendment applied only to mortgages recorded after its effective date. The district court reversed. The Trustee appeals.

In their opinion, Judges Cudahy, Wood, and Evans affirmed. The Court began with the statute and the Indiana rules of statutory construction. Concluding that both parties' constructions of the language of the statute were reasonable, the Court held that the statute was ambiguous and proceeded to apply rules of interpretation. One such rule is the presumption that an amendment to a statute is intended to change the meaning of the statute unless it is clear that the legislature intended to clarify its original intent. The Court applied the factors set forth in Middleton (intheiropinion.com post) to determine whether the 2008 amendment amended or clarified the 2007 amendment. It concluded that the 2008 amendment was a clarifying amendment under Middleton because: a) they were enacted in the same legislative session and sponsored by many of the same legislators, b) the 2007 amendment was ambiguous, and c) the bankruptcy trustees were actively seeking to avoid mortgages on technical grounds after the 2007 amendment.

Statute Of Limitations For Tort Arising Out Of Breach Of Contract Accrues At The Time Of The Breach

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.

Corporate Transfer Is Fraudulent If Corporation Does Not Receive "Reasonably Equivalent Value"

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.

Filing Claim, Albeit In Improper Proceeding, Is Nevertheless Commencement Of Action For Limitations Purposes

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.

Late And Incomplete Notice Of Bankruptcy Filing Is Insufficient To Bar Creditor

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.

Government's Equitable Claim For A Cleanup Remedy Was Not Discharged In Bankruptcy

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.

Direct Appeal From Bankruptcy Court Is Allowed When Court Clerk, Rather Than Petitioner, Transmitted The Documents

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.

Bankruptcy Court Properly Denied Proof Of Claim For Slander Of Title When Record Established Good Faith Of Debtor And Lack Of Actual Malice

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.

Transmission Of A Proof Of Claim By Facsimile Was Improper When The Notice Clearly Stated That An Original Was Required And That It Could Be Submitted By Hand Or Mail

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.

Court Declines To Decide Issue Of Whether Federal Or State Choice-Of-Law Principles Apply In Bankruptcy

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.

A Chapter 13 Creditor In Possession Of Property Of The Bankruptcy Estate Must First Return The Property And The Move To Protect Its Interest

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.

Bankruptcy Court's Use Of Unimproved Airport Terminal Space's Value As A Guide To Improved Space's Value Was Error

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.

Joint And Several Judgment Against Debtor and Non-Debtor May Be Pursued Against Non-Debtor Outside Of Bankruptcy

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.

School's Refusal To Provide Transcript To Graduate Because After Her Tuition Debt Was Discharged In Bankruptcy Violated The Automatic Stay And Discharge Injunction

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.  

In The "Unique Circumstances" Of The Case, Court Approves Release In Bankruptcy In Favor Of Non-Debtor From Claim By Non-Creditor

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.

Lessee's Failure To Make Advance Royalty Payment Is A Material Breach Of The Lease, Even If No Royalty Payment Is Ultimately Due

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.

Bank's Remedy For Fraud Is Limited By Its Inability To Show Reliance Or Injury

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.

Statutory Filing Deadline That Does Not Seek a "System-Related Goal" is Not Jurisdictional - Debtors May Claim a Car Allowance in a Chapter 7 Means Test Even if They Owe No Debt on the Car

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.