Spring 2013 • Issue 47, page 1

Recent Developments in Business Bankruptcy - Presented by Bay Area Bankruptcy Forum and SF Bar Commercial Law & Business Section - 2012 Highlights

By Montali, Honorable Dennis, Dumas, Cecily, Oliner, Ron, Clark, Robert, Brister, Peggy & Heaton, Geoffrey*

The panelists gratefully acknowledge the assistance of Peggy Brister, Law Clerk to the Hon. Dennis Montali; Robert E. Clark, Dumas & Clark LLP; and Geoffrey A. Heaton, Duane Morris LLP in the preparation of these materials.

It is once again the pleasure of the Receivership News to provide excerpts for our readers from the annual “Recent Developments in Business Bankruptcy” presentation of the Bay Area Chapter of the California Bankruptcy Forum and the Commercial Law and Business Section of the Bay Area Bar Association. Our thanks to the Hon. Dennis Montali, Ron Oliner and Cecily Dumas for allowing us to share in their work.


  1. Exempting Cash Surrender Values in Life Insurance Policies and Annuities

    In separate chapter 7 cases, a trustee objected to claims of exemption in cash surrender values of an insurance policy and an annuity contract, where each debtor had purchased the same for the benefit their adult, non-dependent children. The Bankruptcy Court overruled the trustee’s objections and the Bankruptcy Appellate Panel reversed. Here, the Ninth Circuit reversed again. These were both Arizona cases, and Arizona law excludes the federal exemption regime. Thus, Arizona law governs the question of what exemptions will apply. The relevant language under Arizona law provides an exemption for the cash surrender value of a life insurance policy and/or an annuity contract, where for a continuous unexpired period of two years the contract has been owned by a debtor and has named as a beneficiary “the debtor, the debtor’s surviving spouse, child, parent, brother or sister, or any other dependent family member” (emphasis added).

    The Ninth Circuit examined whether the word “other” operates as a word of differentiation or a connecting modifier. The Ninth Circuit ruled that the word “other” in the text of the statute was a word of differentiation, meaning that it did not apply to the child. The result is that the debtor can exempt these assets even where the child is no longer dependent.

    Tober v. Lang (In re Tober), 688 F.3d 1160 (9th Cir. 2012)

  2. Section 362(h) Applies to All Collateral Securing a Claim, Not Just Scheduled Collateral

    Following the appointment of a trustee in her converted case, the debtor filed amended schedules identifying the bank’s secured debt, but listing only part of the collateral securing the debt. The bank moved for stay relief under Bankruptcy Code § 362(h), which was added as part of the 2005 BAPCPA amendments. Section 362(h) provides that in the case of an individual debtor, the stay is terminated with respect to personal property of the estate or of the debtor securing in whole or in part a claim, if the debtor fails to timely file her statement of intention under Bankruptcy Code § 521(a)(2).

    The Ninth Circuit Court of Appeals affirmed the bankruptcy court’s ruling rejecting the trustee’s argument that the stay was lifted under § 362(h) only with respect to collateral that was listed in the debtor’s schedules.

    Samson v. Western Capital Partners, LLC (In re Blixseth), 684 F.3d 865 (9th Cir. 2012)

  3. Use Your Homestead Proceeds (Within Six Months) or Lose Them

    The debtor filed for chapter 7 to halt a judicial sale of her house initiated by a judgment creditor, and claimed a homestead exemption in the property under Cal. Civ. Proc. Code § 704.720. After the creditor obtained relief from stay, the sheriff sold the property at auction, and from the proceeds paid the debtor and her husband the amount of their homestead exemption. The debtor and her husband, however, failed to reinvest the homestead proceeds in a new homestead within six months, as required by § 704.720(b). The chapter 7 trustee filed suit against the couple, seeking, among other things, turnover of the homestead proceeds.

    Reversing the bankruptcy court and the BAP, the Ninth Circuit held that the proceeds were subject to turnover. While the so-called “snapshot” rule fixes exemptions at the petition date, the entire state law applicable on the petition date determines whether an exemption applies. Here, the entire state law included the reinvestment requirement. Once the six month reinvestment period lapsed, the debtor and her husband forfeited the exemption.

    Wolfe v. Jacobson (In re Jacobson), 676 F.3d 1193 (9th Cir. 2012)


  1. Even Post-Stern, Bankruptcy Court Has Authority to Liquidate Amount of Nondischargeable Debt

    Creditor homebuyers filed a nondischargeability action against debtor contractor. The bankruptcy court entered a judgment awarding a money judgment in favor of creditors and declaring the debt nondischargeable under § 523(a)(2). The BAP affirmed, holding that notwithstanding Stern v. Marshall, 131 S. Ct. 2594 (2011), the bankruptcy court had authority to not only finally adjudicate dischargeability of chapter 7 debtor’s obligation to homebuyers, but also to liquidate the amount of that nondischargeable debt. The BAP also held that the bankruptcy court did not clearly err in finding (1) that the debtor-contractor had acted with intent to deceive in falsely representing to prospective clients who were interested in hiring him to build home that he was licensed general contractor in good standing; and (2) that the homebuyers had justifiably relied on debtor’s representations, as required by fraud-based dischargeability exception.

    Deitz v. Ford (In re Deitz), 469 B.R. 11 (9th Cir. BAP 2012)


  1. Credit Bid Can’t Be Used in Calculating Trustee’s Fee Cap

    In a court-approved sale, the chapter 7 trustee sold real property of the estate to secured creditor in exchange for secured creditor’s $1.5 million credit bid, as authorized by § 363(k). In his final report, the trustee represented that he made a total of $2,720,000 in disbursements to creditors, inclusive of the credit bid amount. Based upon the $2,720,000 figure, the trustee sought $109,293 in compensation, the maximum available under § 326(a). The U.S. Trustee objected to the trustee’s fees, contending that a credit bid does not qualify as “moneys disbursed” for purposes of calculating the § 326(a) cap. Notably, the U.S. Trustee did not dispute that the trustee’s fees were reasonable, only that the amount exceeded the cap. The bankruptcy court approved the full amount of the fees, and the BAP reversed. Looking to the dictionary, the BAP determined that “money” is a “medium of exchange,” or “something commonly accepted in exchange for goods and services and recognized as . . . a standard of value”–namely, cash, currency, or its equivalent. “Disbursement,” in turn, means to “pay out or expend money.” The BAP concluded that a credit bid does not qualify as “money disbursed” because it is not commonly accepted as a medium of exchange used in the purchase and sale of goods or services; rather, it is “strictly a creature of the Bankruptcy Code, having a single application . . . under § 363(k).” The BAP noted that its holding was in accord with the legislative history of § 326(a), the meaning of the term “money” in other provisions of the Bankruptcy Code, and published circuit-level authorities addressing the issue.

    United States Trustee v. Tamm (In re Hokulani Square, Inc.), 460 B.R. 763 (9th Cir. BAP 2011)

  2. Chapter 7 Trustee’s Capped Fees Presumed Reasonable - No Time Records Necessary

    BAPCPA added § 330(a)(7), which provides that “[i]n determining the amount of reasonable compensation to be awarded to a trustee, the court shall treat such compensation as a commission, based on section 326.” Here, the chapter 7 trustee provided a narrative summary of services and time records in connection with his final fee request, which was calculated based upon the § 326(a) cap. The bankruptcy court cut the trustee’s fees in half, finding they were unreasonable in light of the “routine, simple administrative tasks” required of the trustee.

    In a detailed and scholarly decision, the BAP parsed § 330(a)(7) clause by clause, focusing on the term “commission,” which commonly means a form of compensation set as a fixed percentage of the amount involved in a transaction. Notably, the BAP found that chapter 7 trustees are not subject to § 330(a)(3) (containing a list of six factors used to determine the reasonableness of fees), as it is applicable by its terms only to chapter 11 trustees.

    After considering a variety of bankruptcy and non-bankruptcy sources, as well as Congress’s “clearly expressed intent to fix trustee commission rates for the vast majority of cases,” the court concluded that absent “extraordinary circumstances,” chapter 7 (and 12 and 13) trustee fees should be presumed reasonable if they are requested at the statutory rate (i.e., the § 326 cap), and should be approved “without any significant additional review” - noting that the U.S. Trustee’s office has indicated that it will not object if a trustee fails to keep time records. If, however, extraordinary circumstances exist, a court may, but does not have to, take into account the § 330(a)(3) factors and a lodestar analysis. Accordingly, since the fees at issue were for routine services, the bankruptcy court erred in reducing the trustee’s fees below the commission set by § 326.

    Hopkins v. Asset Acceptance LLC (In re Salgado Nava), 473 B.R. 911 (9th Cir. BAP 2012)


  1. Trustee Strikes Out on Fraudulent Transfer Claims Against Bank

    The debtor, a convicted felon and fugitive from justice, operated a Ponzi scheme using various accounts at a bank, assisted by a branch vice-president of the bank. In addition to investing in a bakery and building custom sports cars with the Ponzi proceeds, the debtor used over $1 million to purchase stock of the bank’s parent company. The chapter 7 trustee filed an adversary proceeding against the bank, its parent, and another subsidiary of the parent, asserting various fraudulent transfer claims. The bankruptcy court dismissed the trustee’s complaint with prejudice.

    Affirming the bankruptcy court, the BAP held that the trustee’s claims under §§ 548(a)(1)(A) and 544(b) failed because the bank defendants did not qualify as transferees under the Ninth Circuit’s “dominion test,” whereby a transferee must have legal authority over money and the right to use the money however it wishes. Here, the complaint reflected that the debtor had dominion over the funds, not the defendants. Moreover, the BAP found that the trustee lacked standing to assert a claim for aiding and abetting fraudulent transfers, since this claim was held by (and derivative of) the injured investors, not the estate. Finally, the BAP held that the trustee could not avoid the $1 million transfer for the purchase of the parent’s stock, since the transfer occurred outside of § 548(a)(1)(A)’s two-year reach back period, and otherwise fell within the safe harbor for stockbrokers and financial institutions set forth in § 546(e).

    Hoskins v. Citigroup, Inc. (In re Viola), 469 B.R. 1 (9th Cir. BAP 2012)


  1. Unpaid Unemployment Insurance Taxes Are Dischargeable

    Taxing authority filed adversary proceeding to except tax debt from discharge. The bankruptcy court entered judgment in favor of debtors on ground that unpaid unemployment insurance taxes at issue did not qualify for priority treatment as “taxes required to be collected” and thus did not give rise to nondischargeable tax debt. The BAP affirmed. Unpaid unemployment insurance taxes that

    are to be paid directly to taxing authority without first collecting them from employees are not withholding taxes. They are therefore not entitled to priority treatment and are not excepted from discharge.

    State of Cal. Emp. Dev. Dept. v. Hansen (In re Hansen), 470 B.R. 535 (9th Cir. 2012).

  2. BAP Narrows the Definition of a “Statement Respecting the Debtor’s Financial Condition”

    Section 523(a)(2)(B)(ii) excepts from discharge debts incurred through the use of a statement in writing respecting the debtor’s or an insider's financial condition. Plaintiff filed a nondischargeability action, alleging various oral misrepresentations by the debtor regarding his monthly salary, rent, and profit from refinancing. The bankruptcy court dismissed the adversary proceeding, determining that the alleged misrepresentations were oral statements “respecting the debtor's financial condition.” The BAP reversed, holding on an issue of first impression that the phrase “statement respecting the debtor's financial condition” should be interpreted narrowly to mean those statements that purport to present a picture of the debtor's overall financial health, and not statements that are about a specific asset or liability.

    Barnes v. Belice (In re Belice), 461 B.R. 564 (9th Cir. BAP 2011)


  1. No Use Crying to the Bankruptcy Court After Plan Confirmation

    Two years ago, the Ninth Circuit held that following plan confirmation, the bankruptcy court did not have jurisdiction over a state-law breach of contract action against the debtor, even though the action was based on a sale that had been approved by the bankruptcy court, because it did not have the “close nexus” required for post-confirmation “related-to” jurisdiction. See Battle Ground Plaza, LLC v. Ray (In re Ray), 624 F.3d 1124 (9th Cir. 2010). Here, the BAP applied Ray’s holding in the context of a chapter 9 case. The debtor, a local healthcare district, had sold substantially all of its assets in connection with its plan of adjustment. Plaintiffs were participants in the debtor’s retirement plan, for which the debtor had been discharged of any responsibility. They sought a writ of mandamus in state court to enforce their rights under the plan. The debtor removed the petition to the bankruptcy court and from there had it dismissed. But the BAP held that under Ray, the bankruptcy court lacked jurisdiction over the removed action. Though the respondent might assert bankruptcy-based defenses, the petition itself was based only on state law. The fact that the plan was not yet consummated was irrelevant, as were the plan’s broad jurisdiction-retention provisions. The state court was able to determine whether the petition was precluded by the debtor’s bankruptcy. The fact that it represented a collateral attack on the bankruptcy court’s confirmation order did not give it the “close nexus” to the bankruptcy case required for post-confirmation jurisdiction.

    Kirton v. Valley Health System (In re Valley Health System), 471 B.R. 555 (9th Cir. BAP 2012)

  2. Bankruptcy Court Cannot Order Chapter 9 Debtor Not to Reduce Retiree Benefit Payments

    In a thorough and reasoned opinion, the bankruptcy court in the City of Stockton chapter 9 case rejected the request of certain retired employees for an order compelling the City to maintain payments for their vested health benefits during the pendency of the City’s chapter 9 case.

    Plaintiff employees filed an adversary proceeding for a declaration and injunctive relief, alleging that the City’s plan to discontinue healthcare payments as part of balancing its annual budget violated the Contracts Clause of the United States Constitution and 42 U.S.C. § 1983. The court first rejected the application of the Contracts Clause to the City’s action, observing that while the Contracts Clause bars the states from enacting laws that impair contracts, it did not bar Congress from enacting federal bankruptcy laws. The court next discussed the history of federal legislation governing municipal bankruptcies, noting the tension between federal bankruptcy law and states rights in the context of the enactment of Bankruptcy Code § 904 and predecessors to that statute. Based on the court’s interpretation of the legislative history, the court held that Bankruptcy Code § 904 was intended by Congress to be read expansively to preclude bankruptcy courts from employing any power granted under the Bankruptcy Code, including its general equitable powers, to interfere with the bankrupt municipality’s “property or revenues.” Accordingly, the court held that § 904 prohibited it from granting the relief plaintiffs requested.

    The court was also careful to distinguish the order entered by the court in the Orange County bankruptcy pursuant to which the Orange County court issued a temporary restraining order requiring the debtor to treat certain permanently-laid-off employees as temporarily-laid-off during the debtor’s process of rejecting its collective bargaining agreements. In that case, the debtor’s “property or revenues” were not being interfered with during the pendency of the TRO, and the parties settled their disputes before any monetary consequence ensued.

    Finally, the court held that the adversary proceeding was not the proper forum for resolution of the former employees’ disputes, and entered an order of dismissal. The former employees, as creditors holding claims against the debtor, should instead participate in the formulation of the debtor’s plan of adjustment.

    Association of Retired Employees of the City of Stockton v. City of Stockton (In re City of Stockton), 478 B.R. 8 (Bankr. E.D. Cal. 2012)


  1. You Can’t Deprive a Secured Creditor of the Right to Credit-Bid by Saying That It Will Nevertheless Get the “Indubitable Equivalent” of its Claim

    Section 1129(b)(2)(A) provides three ways for a plan to be “fair and equitable” as to an objecting secured creditor: (i) make a series of deferred payments and let the creditor keep its lien; (ii) sell the property free and clear with the lien attaching to the proceeds; and (iii) provide the creditor with the “indubitable equivalent” of its claim. In a sale under clause (ii), the Code specifically allows the creditor to credit-bid its claim. Here, the debtor asked the court to approve sale procedures that precluded the secured creditor from credit-bidding. It argued that although the procedures would not meet the credit-bid requirement of clause (ii), they could nevertheless be approved as giving the creditor the “indubitable equivalent” of its claim under clause (iii).

    The bankruptcy court and the court of appeals rejected this argument, and the Supreme Court affirmed. The Court based its analysis on the canon of statutory construction that “the specific governs the general.” With § 1129(b)(2)(A)(ii), Congress provided a specific set of criteria that must be met for a free-and-clear sale to be deemed fair and equitable for cramdown purposes. These are the criteria that should be applied, even though strictly speaking such a sale might be encompassed by the more general “indubitable equivalent” requirement of § 1129(b)(2)(A)(iii). The Court rejected the idea that the clauses provide parallel avenues for establishing fairness and equitability, one procedural and the other substantive. Nor was it relevant that the debtor was not yet seeking plan confirmation but only approval of bid procedures. Where the requirements of clause (ii) are applicable, they must be applied. And where nonconforming procedures would ultimately lead to an unconfirmable plan, those procedures must be rejected.

    RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065 (2012)

  2. Each Subsidiary of a Real Estate Business Enterprise is a SARE

    MMP operated a complex real estate development business in which each project was held through a subsidiary. MMP and its subsidiaries used a consolidated cash management system in which money was deposited in a single account and used by MMP to pay operating expenses of itself and its subsidiaries. The group filed consolidated financial reports with the SEC and consolidated tax returns with the IRS.

    MMP and 53 subsidiaries filed chapter 11 petitions and requested joint administration, but not substantive consolidation of the cases. One subsidiary filed a motion for a determination that neither it nor the other operating subsidiaries were subject to the single asset real estate provisions of the Bankruptcy Code. A secured creditor filed a cross-motion seeking a determination that the property owned by the moving party was single asset real estate, thereby triggering the creditor’s rights under Bankruptcy Code § 362(d)(3). The bankruptcy court decided not to apply the SARE provisions because of the interrelated nature of the business operations of MMP and its subsidiaries. The district court reversed, and the Ninth Circuit affirmed. Since the definition of SARE in Bankruptcy Code § 101(51B) does not contain a “whole enterprise exception,” and the asset owned by each subsidiary otherwise met the criteria for single asset real estate, the court was not inclined to create such an exception.

    Meruelo Maddux Properties–760 S. Hill Street, LLC v. Bank of America, N.A. (In re Meruelo Maddux Props., Inc.), 667 F.3d 1072 (9th Cir. 2012)

  3. A Plan’s Bare Claim of “Insurance Neutrality” Does Not Deprive Insurers of Standing to Object

    Section 524(g) of the Code contains detailed provisions allowing a court, when confirming a plan involving asbestos liaibility, to require that asbestos-related claims, both present and future, be paid from a trust and to enjoin claimants from seeking recovery against the debtor or its insurers. Here, most of the insurers had settled and were on board, but there were a few that wished to object to the proposed plan, maintaining that it was insufficiently funded and that its assignment of insurance rights to the trust violated their policies’ anti-assignment clauses. Unfortunately for them, the bankruptcy court agreed with the debtor's characterization of the plan as “insurance neutral,” as it purported to preserve coverage issues for resolution outside of the bankruptcy. The court therefore denied the non-settling insurers standing to object. See, e.g., In re Fuller-Austin Insulation, 1998 WL 812388 (D. Del. Nov. 10, 1998) (asbestos insurers not “parties in interest” with standing to object to plan confirmation).

    After the district court affirmed confirmation, the insurers appealed and sought a stay, which was denied. With the trust established and payments already underway, the appeals court first considered whether the appeal was equitably moot, concluding that it wasn’t: the insurers had not been lax in seeking a stay, and remedies less drastic than completely undoing the plan were available to address concerns about its funding and the effects on non-settling insurers. Those effects included the possibility of being bound by the trust’s determination of claimant liability, increased liability if the trust were to run dry, and the elimination of contribution rights against the settling insurers. The plan was therefore not “insurance neutral” and the non-settling insurers had standing to object. The appeals court agreed, however, with the district court’s conclusion that the insurers’ anti-assignment rights were preempted, both expressly under § 541(c)(1)(A), under which the debtor’s property enters the estate despite any provision that restricts or conditions its transfer, and implicitly, since the enforcement of such clauses would make it impossible to fund an asbestos trust without every insurer’s consent and would thus render § 524(g) unworkable.

    Motor Vehicle Casualty Co. v. Thorpe Insulation Co. (In re Thorpe Insulation Co.), 677 F.3d 869 (9th Cir. 2012).


  1. Flexible Finality Part I: Flexible Finality Standard Does Not Apply to Decisions Rendered by District Court Acting as Bankruptcy Court

    Creditors moved for sanctions against debtors and debtors’ counsel for filing. The district court, sitting as the bankruptcy court after withdrawal of the reference of the underlying case, granted the motion. The sanctioned parties appealed. The Ninth Circuit dismissed the appeal for lack of
    jurisdiction, as the sanctions order was interlocutory and not a “final decision” under 28 U.S.C. § 1291, which governs appeals of judgments of a district court. The appellants argued that because the district court was acting as the bankruptcy court, the Ninth Circuit’s principle of flexible finality should apply. See, e.g., Benny v. England (In re Benny), 791 F.2d 712, 718 (9th Cir. 1986) (recognizing that “the general standards for appealability of bankruptcy orders are broader and more flexible than those that apply to ordinary civil cases.”). The Ninth Circuit disagreed, stating that “[t]his argument overlooks the fact that the order in this case was issued by a district court sitting in bankruptcy. Our more flexible standard for interlocutory appeals in the bankruptcy context applies only to appeals from orders issued by a bankruptcy appellate panel or by a district court hearing an appeal from a bankruptcy court.”

    The court noted the distinction in its statutory jurisdiction: “We have jurisdiction to hear appeals from district courts sitting in bankruptcy under § 1291, but have jurisdiction to hear appeals from district courts reviewing bankruptcy court decisions under 28 U.S.C. § 158(d)(1), as well as § 1291. While § 1291 gives us jurisdiction only over ‘final decisions,’ the scope of § 158(d) is broader: it gives appellate courts the authority to hear appeals from ‘final decisions, judgments, orders, and decrees’ entered by district courts.” Section 158’s jurisdictional grant gives the circuit court greater “flexibility in asserting jurisdiction over interlocutory orders, because ‘certain proceedings in a bankruptcy case are so distinct and conclusive either to the rights of individual parties or the ultimate outcome of the case’ that their resolution should be immediately appealable, even if such resolution does not end the entire litigation on the merits.”

    Klestadt & Winters, LLP v. Cangelosi, 672 F.3d 809 (9th Cir. 2012)

  2. Flexible Finality Part II: A Bankruptcy Court’s Denial of Motion to Remove Trustee Is Interlocutory

    The chapter 11 trustee took possession of documents that the appellants had left at the debtor’s office. Appellants alleged
    that the trustee had acted illegally in taking possession of the documents, and that the trustee and his counsel should be removed. The bankruptcy court denied relief, and the district court affirmed. The Ninth Circuit dismissed the appeal pending before it, holding that both the bankruptcy court order and the district court affirmance were not final and thus appellate jurisdiction did not exist.

    The Ninth Circuit repeated the general principles governing bankruptcy appeals: that it only has appellate jurisdiction over final orders of a district court, and that to determine whether the district court order is final, it must look to the nature of the underlying bankruptcy court order. “If the underlying bankruptcy court order is interlocutory, so is the district court order affirming or reversing it. Although the district courts have discretion to consider interlocutory appeals, we do not.” Because of the nature of bankruptcy cases, the Ninth Circuit will apply a pragmatic or flexible finality standard in evaluating the nature of the bankruptcy court order. “A bankruptcy court order is considered final ‘where it 1) resolves and seriously affects substantive rights and 2) finally determines the discrete issue to which it is addressed.’ ” An order denying removal of a trustee does not satisfy either prong of the test. Neither does an order denying disqualification of counsel. “If a party could file an interlocutory appeal every time he tried unsuccessfully to remove a trustee, he could bring the litigation to a never-ending standstill. . . . Where the underlying bankruptcy court order involves the appointment or disqualification of counsel, courts have uniformly found that such orders are interlocutory even in the more flexible bankruptcy context.”

    SS Farms, LLC v. Sharp (In re SK Foods, L.P.), 676 F.3d 798 (9th Cir. 2012)

Recent Developments – 2012 continues in the next Receivership News with summaries related to consumer bankruptcy cases.

*Hon. Dennis Montali is a United States Bankruptcy Judge sitting in the San Francisco Division of the Northern District of California.

*Cecily Dumas is a partner in the San Francisco firm of Dumas & Clark LLP.

*Ron Mark Oliner is a partner at the San Francisco office of Duane Morris LLP.

*Robert E. Clark
is a partner in the firm of Dumas & Clark LLP.

*Peggy Brister is the law clerk to the Hon. Dennis Montali.

*Geoffrey A. Heaton is Special Counsel at the San Francisco office of Duane Morris LLP.