I. Recent Decisions:
1) Adelphia Recovery Trust v. Goldman, Sachs & Co., 2014 U.S. App. LEXIS 6211 (2d Cir. April 4, 2014):
Do avoidance powers under the Bankruptcy Code apply to funds that are not property of the bankruptcy estate?
After full repayment of unsecured creditors of Adelphia Communication Corp.’s (“ACC) 200 subsidiaries, a Trust was created in an effort to provide distributions to ACC’s own unsecured creditors through avoidance actions. The instant action alleged Goldman, Sachs & Co. (“Goldman”), received fraudulent transfers from ACC. Goldman moved to dismiss the Adversary Proceeding, in part because the payments were made out of a subsidiary’s account, not an account of the actual debtor ACC. The bankruptcy court and district court agreed and the matter was appealed to the Second Circuit.
The Second Circuit reiterated the commonly understood principal that avoidance power in Bankruptcy “applies only to transfers of property of the debtor.” As these payments came from the account of the Debtor’s subsidiary and not the Debtor itself, the funds in question cannot constitute property of the Debtor for purposes of 11 U.S.C. § 548. The Debtor’s Trust argued that the funds in the account were commingled and in were likely funds of the Debtor. This position, however, contradicted the Debtor’s own sworn bankruptcy schedules, disclosure statement, and plan which all identified the account as the subsidiaries. The Court, Debtor, Debtor’s subsidiaries, creditors and all parties-in-interest relied upon the accuracy of these Schedules throughout the Bankruptcy and confirmation of the Debtor’s Plan was based in part on this information. Through judicial estoppel, the Debtor’s Trust could not “alter their positions as to ownership of assets as they deem their litigation needs to change, leaving courts to unravel previously closed proceedings.” As such, the Second Circuit affirmed the District Court’s dismissal of the action.
2) Santiago-Moneverde v. Pereira (In re Santiago-Monteverde), 2014 U.S. App. LEXIS 5956 (2d Cir. March 31, 2014):
Is a NYC tenant’s rent-stabilized lease, or some portion thereof, exempt in bankruptcy as a “local public assistance benefit” under New York Debtor and Creditor Law § 282(2)?
§ 282. Permissible exemptions in bankruptcy
…an individual debtor domiciled in this state may exempt from the property of the [Bankruptcy] estate…the following property:
2. Bankruptcy exemption for right to receive benefits. The debtor’s right to receive or the debtor’s interest in: (a) a social security benefit, unemployment compensation or a local public assistance benefit…
The Chapter 7 Debtor was current on his monthly rent and included the apartment complex lease in Schedule G as an unexpired lease. The apartment was “rent-stabilized” and the lease protected under New York’s rent stabilization law of 1974. The landlord approached the Debtor’s Chapter 7 Trustee seeking to purchase the Debtor’s interest in the lease. The Trustee agreed and moved to assume and assign the lease to the landlord. The Debtor objected and claimed an exemption in the lease as a “local public assistance benefit” under section 282 of the Debtor and Creditor Law (see above). The Bankruptcy Court denied the exemption, determining the items listed in section 282(2) “are payments of one sort or another that a debtor has the right to receive or in which the debtor has an interest” and the “benefit of paying below market rent…is a quirk of the regulatory scheme in the New York housing market, not an individual entitlement.” The District Court affirmed.
As expected the Second Circuit received several amicus briefs on appeal, including in the subject matter was whether rent-stabilized tenant’s rights are statutory personal rights rather than property rights that can even be administered in the bankruptcy estate. While separate bankruptcy courts have permitted the assumption and assignment of rent-stabilized leases, neither decision confronted the exemption claim found here. Given the significance of the issue and the absence of clear authority, the Second Circuit certified the matter to the New York Court of Appeals for its review and determination.
3) In re Wrobel, 2014 Bank LEXIS 1194 / BK No. 12-13001 (Bankr. W.D.N.Y., Kaplan, J., March 28, 2014):
What must a creditor demonstrate to deny a debtor’s exemption rights under 11 U.S.C. §522(o)?
§ 522. Exemptions
(o) For purposes of subsection (b)(3)(A)1, and notwithstanding subsection (a), the value of an interest in—
(1) real or personal property that the debtor or a dependent of the debtor uses as a residence;
(2) a cooperative that owns property that the debtor or a dependent of the debtor uses as a residence;
(3) a burial plot for the debtor or a dependent of the debtor; or
(4) real or personal property that the debtor or a dependent of the debtor claims as a homestead;
shall be reduced to the extent that such value is attributable to any portion of any property that the debtor disposed of in the 10-year period ending on the date of the filing of the petition with the intent to hinder, delay, or defraud a creditor and that the debtor could not exempt, or that portion that the debtor could not exempt, under subsection (b), if on such date the debtor had held the property so disposed of (emphasis added).
In a lengthy decision on a matter of first impression in New York, Judge Kaplan tackled the BAPCPA added section 522(o) of the Bankruptcy Code (copied above). Pre-petition, the Debtor was being represented by the law firm of Hogan Willig in her lengthy divorce proceeding. At the time, the Debtor was residing in one of her husband’s apartment complexes. Likely following the receipt of the Firm’s $100,000 legal bill, the Debtor terminated them as counsel and hired a new divorce attorney who successfully settled the proceeding. The settlement included the Debtor becoming owner of the apartment complex where she was living.
The Firm eventually earned a $90,000 judgment against the Debtor for its outstanding fees and the Debtor eventually filed a grievance against the Firm for its performance. Prior to the Firm’s judgment, the Debtor sold the Apartment Complex for roughly $100,000. The Firm twice moved in State Court to either enjoin the sale or the Debtor’s use of the sale proceeds; both requests were denied. The Debtor then used $75,000 of those proceeds toward the purchase of a condominium from her son-in-law. A year later she filed Chapter 13. Citing section 522(o), the Firm objected to the Debtor’s $75,000 homestead exemption, claiming the Debtor’s use of $75,000 in non-exempt cash toward exempt real property was a disposition that was “intended to hinder, delay, or defraud the Firm.”
Judge Kaplan began by noting the basis for Congress’ addition of 522(0) in 2005 – that (particularly in states with unlimited homestead exemptions) wealthy persons were fraudulently converting sizeable non-exempt savings into an exorbitant and fully protected homestead. The Firm here looked to a broad reading of 522(o) and its use of the term “or” to claim the Debtor’s conversion of $75,000 from non-exempt to exempt was with intent to “hinder” or “delay” its collection efforts. By its very language, nothing more is necessary to deny the Debtor’s exemption under section 522(o). Judge Kaplan agreed with Debtor’s counsel that the Firm position “in this case as being that of one who complains that the Debtor ‘did not hold non-exempt property securely in a fashion to facilitate collection by Hogan Willig’” (emphasis in original). Judge Kaplan disagreed with such a broad reading of section 522(o), finding that “although the phrase is written in the disjunctive, it must be read in the whole because many things that simply ‘hinder’ or ‘delay’ a creditor cannot reasonably be viewed as warranting the severe consequence of loss of one’s home.”2 The Court agreed that the interpretation of section 522(o) is informed by the “badges of fraud” or “smell test” developed under sections 548(a)(1)(A)3 and 727(a)(2)4.
In applying these “badges” to the instant facts, the Court did find a couple items worthy of further review. First, the Court offered the Firm 30 days to undertake an appraisal of the condominium unit to ensure the purchase price was fair and reasonable. Second, the Court required some type of demonstrating that the Debtor’s son-in-law has not returned any portion of the purchase price to the Debtor.
But for these loose ends, the Court found the Firm failed to meet its burden of establishing and intent to defraud necessary to deny the Debtor’s exemption under section 522(o). The Court held that “proving that the conversion of non-exempt property into an exempt homestead ‘without proving something more’ does not sustain the burden of proof imposed upon one objecting to the Debtor’s claim of a homestead exemption under § 522(o)” (emphasis in original). Under certain circumstances the “something more” may be the fact the Debtor knew that she was being sued for a very significant dollar amount, but not here. Judge Kaplan took considerable notice of the fact that as the Debtor’s divorce attorney, the Firm had full knowledge of the Debtor’s finances and financial transactions – including the sale of the apartment complex and purchase of the condominium. “The badges of fraud bespeak of ‘hiding,’ ‘absconding,’ ‘avoiding,’ ‘sharp dealing,” but the Debtor here “hid nothing from anyone, Hogan Willig least of all.” In fact, based on this knowledge, the Firm twice attempted to legally block the Debtor’s sale of the apartment complex – failing both times. The Court therefore, denied the Firm’s 522(o) objection.
1 (b)(3) In a case in which State law that is applicable to the debtor–
(A) permits a person to voluntarily waive a right to claim exemptions under subsection (d) or prohibits a debtor from claiming exemptions under subsection (d); and
(B) either permits the debtor to claim exemptions under State law without limitation in amount…
2 The Court wrote later in the Decision “the phrase ‘hinder, delay or defraud’ is a statutory whole, not to be parsed and severed to a point of absurdity.” Judge Kaplan offered several examples of such hypothetical absurdity, such as a debtor’s use of a non-exempt $1,000 refund for food and shelter rather than payment on a creditor’s $20,000 judgment. Could this too be an act to “hinder” the creditor’s ability to collect?
3 “The trustee may avoid any transfer…if the debtor voluntarily or involuntarily–made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted.”
4 “The court shall grant the debtor a discharge, unless…the debtor, with intent to hinder, delay, or defraud a creditor or an officer of the estate charged with custody of property under this title, has transferred, removed, destroyed, mutilated, or concealed, or has permitted to be transferred, removed, destroyed, mutilated, or concealed.”
4) Jordan v. D’Amico (In re D’Amico), 2014 Bankr. LEXIS 1367 (Bankr. W.D.N.Y, Kaplan, J., April 4, 2014):
Can a plaintiff amend his adversary proceeding when it was mistakenly filed in the debtor’s dismissed but still open chapter 13 rather then the debtor’s current chapter 7?
In a unique set of facts the Debtor’s Chapter 13 was voluntarily dismissed to allow him to file Chapter 7 jointly with his wife. The very same day the Order Dismissing the Chapter 13 was filed, the Debtors filed Chapter 7 – resulting in two separate open bankruptcies on the docket for a short time-period. A creditor filed what the Court termed a “well-pled” adversary proceeding seeking the denial of discharge under sections 523 and 727. Unfortunately, the Complaint was filed under the Chapter 13 index number rather than in the newly filed Chapter 7 case. The Debtors answered the Complaint and at the pre-trial the Debtors pointed out to the Court that the Adversary Proceeding was improperly filed. Moreover, the deadline to object to discharge in the Chapter 7 had now passed. Based on the foregoing, the Debtors objected to the Plaintiff’s Rule 15 Motion to amend the caption of the Complaint to reflect the new Chapter 7 case number. The Debtors argued both that the deadline had passed as well as that Rule 15 could not be used to move an adversary proceeding into a different bankruptcy case.
Judge Kaplan began by noting that had the filing occurred pre-CM/ECF the clerk would have noticed the irregularity and advised Plaintiff’s counsel prior to filing. In addition, in District Court the Complaint would have been filed without any numbers in the caption, allowing the Clerk to assign the number. With these notions of equity in mind, the Court found the Plaintiff’s pleading did “conform substantially to the appropriate Official Form” for purposes of Rule 7010 of the Federal Rules of Bankruptcy Procedure. The Debtors’ case law was also not on point, as it dealt with a plaintiff’s attempt to amend a caption where they failed to even name the correct debtor – this was the correct debtor, only the wrong bankruptcy number. Based on the foregoing and in accordance with FRCP 15, the Plaintiff was allowed to amend the Complaint nunc pro tunc to be deemed to have been timely filed in the Debtors’ Chapter 7 case.
5) In re Sheehan Memorial Hospital, BK No. 12-12663 (Bankr. W.D.N.Y., Bucki, C. J., March 21, 2014):
Should a late filed claim of the New York State Department of Labor be expunged or allowed as a tardily filed claim?
NYS filed its $242,000 priority claim within the Debtor’s Chapter 11 Bankruptcy two months following the claims bar date. The Debtor moved to expunge the claim, to which the Court found excessive and overly broad. Under section 1129(a)(7) of the Bankruptcy Code, confirmation of the Debtor’s eventual plan requires that each impaired class receive no less under the plan than it would have in a chapter 7 liquidation. Under section 726(a), distribution is first required to priority claims “timely filed under section 501 of this title or tardily filed on or before the earlier of (A) the date that is 10 days after the mailing to creditors of the summary of the trustee’s final report; or (B) the date on which the trustee commences final distribution under this section.” Because no trustee has filed a final report or commenced a final distribution here, tardily filed priority claims would still be entitled to a distribution under section 726(a) and thus NYS might still retain rights under section 1129(a)(7). In addition, tardily filed claims of any sort may still be entitled to a distribution under Chapter 7 if there is a surplus. Based on the forgoing, the proper relief under this set of facts is to allow the claim as a tardy rather than complete expungement.
6) In re Radzikowski, BK No. 12-13484 (Bankr. W.D.N.Y., Bucki, C.J., March 20, 2014):
What factors are considered in cross-motions to terminate and extend a chapter 11 debtor’s exclusivity period?
Prior to the voluntary dismissal of the Debtors’ Chapter 13 Bankruptcy (and prior to the confirmation of any Plan), the Chapter 13 Trustee had collected $3,700 through a wage order. Before the Chapter 13 Trustee could release the funds to the Debtors, the Debtors’ counsel made a motion seeking $2,000 of the funds for outstanding legal fees. The Debtors objected.
Under section 349(b)(3) of the Bankruptcy Code property that had vested immediately before the commencement of a case revests to the Debtor upon dismissal. This however, was not property that vested immediately upon the petition date, but during the bankruptcy. As such, it was governed by section 1326(a) that states a payment made to the trustee during a bankruptcy:
…shall be retained by the trustee until confirmation or denial of confirmation. If a plan is confirmed the trustee shall distribute any such payment in accordance with the plan as soon as practicable. If a plan is not confirmed, the trustee shall return any such payments not previously paid and not yet due and owing to creditors pursuant to paragraph (3) to the debtor, after deducting any unpaid claim allowed under section 503(b).
It was the position of Debtors’ counsel that his unpaid fee qualified under section 503(b) and, therefore, must be paid prior to the release of any funds to the Debtors. The Court disagreed. First, the Debtors’ counsel had never been relieved from its duty of representing the Debtors. Until the firm is removed as counsel they “must represent not themselves but their clients” and “are here appropriately estopped from seeking a diversion of funds that the trustee must otherwise release to the debtors.”
Even if the firm was not estopped from its argument, the Court went on to articulate why they would still be precluded from payment. Section 1326(a) only allows for payment of “any unpaid claim allowed under section 503(b).” The law firm has made no application for allowing its claim. Moreover, it is the Debtors’ contention the fee would only be paid through a confirmed Plan – something that did not exist. Nothing in the retainer agreement clearly contradicted the Debtors’ interpretation of payment and the plan itself read “payment of legal fees to counsel for the debtor shall be made on a monthly basis from funds remaining after payment of trustee compensation, adequate protection payments, and equal monthly installment payments to creditors holding allowed secured claims against personal property.” This arrangement, according to Chief Judge Bucki, “follows the custom and practice for Chapter 13 cases in this district, namely that unless paid in advance of bankruptcy, legal fees are recoverable only under the terms of a confirmed plan.” As such, the law firm could not meet its burden of proof to demonstrate an entitlement to compensation and the funds were released back to the Debtors.
7) In re Iannopollo Associates, BK No. 14-20045 (Bankr. W.D.N.Y., Warren, J., April 17, 2014):
What factors are considered in cross-motions to terminate and extend a chapter 11 debtor’s exclusivity period?
11 U.S.C. § 1121. Who may file a plan
(a) The debtor may file a plan with a petition commencing a voluntary case, or at any time in a voluntary case or an involuntary case.
(b) Except as otherwise provided in this section, only the debtor may file a plan until after 120 days after the date of the order for relief under this chapter.
(c) Any party in interest, including the debtor, the trustee, a creditors’ committee, an equity security holders’ committee, a creditor, an equity security holder, or any indenture trustee, may file a plan if and only if–
(1) a trustee has been appointed under this chapter;
(2) the debtor has not filed a plan before 120 days after the date of the order for relief under this chapter; or
(3) the debtor has not filed a plan that has been accepted, before 180 days after the date of the order for relief under this chapter, by each class of claims or interests that is impaired under the plan.
(d) (1) Subject to paragraph (2), on request of a party in interest made within the respective periods specified in subsections (b) and (c) of this section and after notice and a hearing, the court may for cause reduce or increase the 120-day period for the 180-day period referred to in this section.
(2) (A) The 120-day period specified in paragraph (1) may not be extended beyond a date that is 18 months after the date of the order for relief under this chapter.
(B) The 180-day period specified in paragraph (1) may not be extended beyond a date that is 20 months after the date of the order for relief under this chapter.
Just 68 days into the Debtor’s Chapter 11 Bankruptcy, its largest secured creditor moved to terminate the Debtor’s 120 day exclusivity period pursuant to section 1121(d)(1). By cross motion, the Debtor, a single asset golf course that remained closed during these winter months, sought an extension of the 120 day exclusivity period pursuant to the same section of the Bankruptcy Code.
Judge Warren found the decision to extend or terminate exclusivity for cause was within the discretion of the Bankruptcy Court. Citing Adelphia Communications Corp., 352 B.R. 578 (Bankr. S.D.N.Y. 2006), the Court found nine factors typically weighed in that discretionary decision:
(1) the size and complexity of the case;
(2) the necessity for sufficient time to permit the debtor to negotiate a plan of reorganization and prepare adequate information;
(3) the existence of good faith progress toward reorganization;
(4) the fact that the debtor is paying its bills as they become due;
(5) whether the debtor has demonstrated reasonable prospects for filing a viable plan;
(6) whether the debtor has made progress in negotiations with its creditors;
(7) the amount of time which has elapsed in the case;
(8) whether the debtor is seeking an extension of exclusivity in order to pressure creditors to submit to the debtor’s reorganization demands; and
(9) whether an unresolved contingency exists.
In applying those factors to the instant facts, Judge Warren found neither party met its burden to terminate or extend exclusivity. For the Creditor, the Court found the second, fourth and seventh Adelphia Factors most relevant and all weighted against termination. In addition, “cause to reduce the exclusivity period…should only be found in extraordinary circumstances” and the party seeking such relief bears a heavy burden of proof. The Creditor here cited no mismanagement or “troubling conduct” to warrant such relief. “The mere fact that NYBDC wants to file a competing plan is not sufficient to establish cause to terminate the exclusivity period.”
By contrast the Court found the first, third, fifth and sixth Adelphia Factors most relevant to the Debtor’s motion and all weighed against the extension of the exclusivity period. In general, the Court found the Debtor failed to meet its burden of demonstrating that an extension at this time was necessary to “significantly improve progress toward an effective reorganization.”
Based on the foregoing, the Court denied both motions.
II. Interesting Cases from Across the Country:
a) McNeal v. GMAC Mortgage, LLC (In re McNeal), 735 F.3d 1263 / 477 Fed. Appx. 562 (11th Cir. 2012):
The Eleventh Circuit reversed the bankruptcy and district court by holding that a Chapter 7 debtor can utilize sections 506(a) and 506(d) to “strip off” (rather then “strip down”) a wholly unsecured junior mortgage. The Court relied upon its earlier decision of Folendore v. United States Small Bus. Admin., 862 F.2d 1537 (11th Cir. 1989). Folendore, however, predated Dewsnup v. Timm, 502 U.S. 410 (1992). In Dewsnup, the Supreme Court determined that a Chapter 7 debtor could not “strip down” a partially unsecured lien under section 506(d). Many courts have interpreted Dewsnup to further hold that a Chapter 7 debtor cannot “strip off” a wholly unsecured junior lien. The Eleventh Circuit found Dewsnup limited “expressly to the precise issue raised by the facts of the case.” “Obedience to a Supreme Court decision is one thing, extrapolating from its implications a holding on an issue that was not before that Court in order to upend settled circuit law is another thing.”
Thanks to Deb Schaal who advised that the Supreme Court refused to hear Bank of America’s appeal of McNeal v. GMAC Mortgage, LLC (In re McNeal). What are the implications?
• See also, In re Saric, 2013 Bankr. LEXIS 5220 (Bankr. N.D.N.Y. Dec. 12, 2013); In re Grano, 422 B.R. 401, 402 (Bankr. W.D.N.Y., Bucki, C.J., 2010) (Both holding Dewsnup prohibits a Chapter 7 debtor from stripping off wholly unsecured liens under section 506. Such actions are only allowed for Chapter 13 Debtors under section 1322(b)(2) and In re Pond).
b) Martin v. Internal Revenue Service, BK No. 11-62436 (Bankr. E.D.Ca., March 31, 2014):
The Debtors failed to file their federal income tax returns for the 2004, 2005, and 2006 tax years when those returns became due. In March 2009, the IRS made assessments of the Martins’ tax liability for those years. In June 2009, the Debtors finally signed and mailed to the IRS their tax returns for those three years. Two years later, the Debtors (who have not paid any of the taxes in question) filed Chapter 7 Bankruptcy. The IRS objected to the potential discharge of these taxes, despite the fact they were over two years due, because of section 523(a)(1)(B)(i): No discharge for a tax “to which a return…was not filed or given.” In other words, a debtor cannot discharge a tax liability debt if: (1) the tax underlying the liability required a return; and (2) the debtor failed to file the required return. In 2005 Congress added a hanging paragraph to 523 through BAPCPA to help define the term “return” as:
For purposes of this subsection, the term “return” means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law.
Here, the IRS argues that the Debtors did not file their tax returns until after the IRS made its assessment and began collection efforts. It does not matter that a return was subsequently filed, because the assessment already created a legally enforceable debt’ carrying the force of a judgment. Immediately after the IRS makes its assessment, any document the debtor may file, including as here, the official Form 1040, loses its identity as a tax return for dischargeablity purposes.
The Bankruptcy Court disagreed. It noted the IRS’ position “essentially puts the dischargeability ‘trigger’ entirely in the hands of the creditor.” “It puts the IRS in complete control of the issue of timeliness and the ultimate result of nondischargeability. To simply tie the definition of a tax return to the timing of the IRS’ assessment would yield totally arbitrary and potentially unconscionable results.” Instead the Court sided with the minority that puts no time limit on when a return is filed (so long as it was filed before the two year cutoff under section 523).
Based on the foregoing, the Court found the Debtors’ Form 1040 tax returns for the years 2004, 2005, and 2006 were “returns” within the meaning of § 523(a)(1)(B)(i) and § 523(a)’s hanging paragraph and the underlying debt dischargeable in the Debtors’ Chapter 7 Bankruptcy.