By: Nicole Strout

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In Peterson v. Katten Muchin Rosenman LLP. , the Seventh Circuit held that the allegations in a legal malpractice complaint by the trustee for Lancelot Investors Fund and other entities in bankruptcy (collectively “the Funds”), was plausible on its face.[1] In Peterson , the trustee filed suit against the Funds’ law firm for failing to detect the peril and curtail the risks pertaining to the Funds.[2] The Funds loaned money to and invested in vehicles owned by Thomas Petters, which, in turn, was supposed to finance Costco’s consumer-electronics inventory.[3] The Funds’ advances were to be secured by deposits made by Costco, not Peters, into a lockbox bank account.[4] However, Costco never deposited money into the account.[5] All the money came from a Petters entity.[6] In reality, Petters never had any dealings with Costco, and the whole set up was a Ponzi scheme.[7] Once the scheme collapsed, the Funds also collapsed.[8] Consequently, the Funds filed for relief under chapter 7 of the Bankruptcy Code.[9] The chapter 7 trustee for the Funds brought a cause of action against Katten, the law firm which acted as transactions counsel for the Funds, claiming that the law firm had a duty to inform its clients that the actual arrangement posed a risk because Petters was not actually running a real business.[10] In granting the law firm’s motion to dismiss, the district court held the Funds “knowingly took the risk and cannot blame the firm for failing to give business advice.”[11] After the trustee appealed the motion to dismiss, the court of appeals reversed the district court decision, holding the firm was liable not for failing to provide business advice but for failing to inform its clients of “the different legal forms that are available to carry out the business and how risks differ with different legal forms.”[12] Clients do not have to take the advice of their attorneys, but attorneys need to advise clients.[13]

By: Maurice W. Sayeh

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re Dobbs , a Mississippi bankruptcy court held that it had the authority, to sanction and to permanently disbar an attorney from practicing in its district.[1] A debtor and his wife filed a joint chapter 13 bankruptcy petition in 2013 and hired an attorney (“First Attorney”) to represent them.[2] Following dismissal of the original 2013 case, the First Attorney filed a subsequent 2015 bankruptcy petition on behalf of the debtor but not the debtor’s wife[3]. The 2015 bankruptcy petition was accompanied with a Certificate of Credit Counseling (“First Certificate”) falsely reflecting that the debtor had attended a credit-counseling course on March 26, 2015,[4] as required by Section 109 of the United States Bankruptcy (“the Code”).[5] The 2015 bankruptcy petition listed the First Attorney as the debtor’s counsel and purportedly included the debtor’s electronic signature.[6] Following the court’s approval of the First Attorney’s request to withdraw as counsel, the debtor hired a new attorney (“Second Attorney”).[7] The Second Attorney filed another Certificate of Credit Counseling (“Second Certificate”) on behalf of the debtor, which indicated the debtor actually completed credit counseling on April 8, 2015.[8]

By: Matthew Repetto

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In Franklin v. Puerto Rico , the First Circuit held that Puerto Rico’s effort to restructure the debt of its public utilities through the enactment of its own municipal bankruptcy law, the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (“Recovery Act”), was preempted by Section 903(1) of the United States Bankruptcy Code.[1] Amid the most serious fiscal crisis in its history, Puerto Rico’s public utilities are currently at risk of becoming insolvent.[2] Unlike states, Puerto Rico is a territory and “may not authorize its municipalities . . . to seek federal bankruptcy relief under chapter 9 of the U.S. Bankruptcy Code.”[3] Thus, the Recovery Act was Puerto Rico’s attempt to “fill the gap” by providing relief on its own.[4] The Recovery Act was enacted to mirror chapter 9 and chapter 11 of the United States Bankruptcy Code.[5] Those in favor of the Recovery Act argued that preemption would leave Puerto Rico with no means of relief.[6] However, the First Circuit disagreed, and noted that Puerto Rico could, as it had already, seek relief directly from Congress.[7]

By: Todd Kingston Plummer

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re Medpoint Management , the United States Bankruptcy Court for the District of Arizona held that cause existed under Section 707(a) of the United States Bankruptcy Code (“Bankruptcy Code”) to dismiss an involuntary chapter 7 petition filed against a bankrupt medical marijuana distributor.[1] Although Arizona permits its Department of Health Services to register dispensaries “operated on a not-for-profit basis” for the legal sale of marijuana,[2] the drug remains a Schedule I substance under the federal government’s Controlled Substances Act (“CSA”).[3] Because Arizona law requires dispensaries to maintain a nonprofit nature, there has been a “proliferation of dispensary-management entities which serve as repositories of dispensary revenues.”[4] When Medpoint Management LLC, a marijuana dispensary, defaulted on several loans and obligations, a group of creditors filed an involuntary chapter 7 petition against Medpoint.[5] The petitioning creditors’ claims against Medpoint included unpaid amounts under two promissory notes, unpaid fees arising under two distinct consulting agreements, and over $500,000 in outstanding loans.[6] Medpoint moved to dismiss arguing that the “unclean hands doctrine” prevents not only any marijuana-related business but also any of their creditors from seeking relief from the federal bankruptcy courts.[7] At a hearing on Medpoint’s motion, the United States Trustee voiced staunch concern regarding a trustee’s ability to administer a bankruptcy estate consisting of substances that are illegal under federal law: “So, you’re going to ask a trustee to look at a management contract for illegal activities, essentially. So what is that trustee going to do?”[8] The court agreed with Medpoint and the United States Trustee and dismissed the involuntary petition.[9]

By: Naffie Lamin

St John’s University Law Student

American Bankruptcy Institute Law Review Staff

In In re Nortel Inc. , the Bankruptcy Court denied a motion filed by former Canadian employees of the debtor Nortel Networks’ Canadian affiliates (the “Canadian Employees”) seeking leave to file proofs of claim after the expiration of the final date to file a proof of claim in the United States (the “Bar Date”).[1] On January 14, 2009, the United States Nortel affiliates (the “U.S. Debtors”) filed voluntary petitions of relief under chapter 11 of the Bankruptcy Code.[2] On the same day, the Canada affiliates (the “Canadian Debtors”) filed insolvency proceedings under Canada's Companies' Creditors Arrangement Act (“CCCAA”).[3] Pursuant to the rules of the CCCAA, the Ontario Superior Court appointed Ernst & Young Inc. (the “Monitor”) as monitor and Koskie Minsky, LLP (“Koskie Minsky”) as the law firm to represent the interests of all former employees of the Canadian Debtors, including the Canadian Employees.[4]

By: Corey Trail

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re Monticello Real Estate Investments, LLC, a bankruptcy court held that a creditor did not act in bad faith when it purchased unsecured debt from another creditor in order to have the votes necessary to veto a debtor’s reorganization plan. In Monticello, the debtor was a realty investor that took out a $1.185 million loan to finance the purchase of an office center. After the debtor failed to satisfy the loan by its five year maturity date, the bank and the debtor entered into two loan modifications that extended the maturity date of the loan. The debtor soon failed to adhere to the loan modifications and the bank began foreclosure proceedings. In response, the debtor filed a chapter 11 bankruptcy petition and requested authority to use cash collateral. The court granted the debtor’s request and instructed the parties to submit an agreed upon order authorizing the use of cash collateral that set forth a tentative agreement to restructure the bank’s debt. As part of the agreement, the bank required the debtor to sign two promissory notes that it claimed contained “standard loan documents.” However, the debtor rejected the standard loan forms and responded with a modified loan agreement, which the bank rejected. The debtor filed the new agreement (“the Plan”) without the required new loan documents. The court issued a second cash collateral order, which was again dependent on the execution of new loan documents. Subsequently, the court scheduled a hearing to confirm the Plan. Both the bank and a credit card company filed claims against the debtor. In order to ensure that the debtor’s Plan was not able to acquire the requisite amount of votes, the bank purchased the claim from the credit card company to obtain enough votes to block the Plan’s confirmation. The bank explained that had the Plan been confirmed, the FDIC would negatively rate the debt. The debtor moved to have the bank’s ballots designated pursuant to 11 U.S.C. section 1126(e), stating that the bank’s desire to dictate the terms of the new loan documents, the cessation of negotiation on the new terms before the expiration deadline, and the purchasing of other claims exhibited a lack of good faith required by the statute. The court however, disagreed, finding that because the execution of a new loan agreement on the bank’s terms was crucial to protecting the bank’s interests, the purchase of other claims to ensure that the Plan would not receive the necessary votes was not in bad faith.

By: Joanna Matuza

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In Pavers & Road Builders District Council Welfare Fund v. Core Contracting of NY, LLC, the Eastern District Court of New York exercised its discretion with regard to automatic stays in its holding that a corporation’s alter ego status does not permit an automatic stay for non-debtors. In Pavers & Road Builders District Council Welfare Fund, administrators of an Employee Retirement Income Security Act (“ERISA”) pension fund brought suit against four related corporate defendants for “delinquent contributions and shifting of assets to avoid having to pay workers.” Canal Asphalt, the defendant-debtor, filed a voluntary petition for chapter 11 relief in the Southern District of New York. Thus, the cause of action was automatically stayed against the debtor, pursuant to section 362(a)(1) of the Bankruptcy Code. The other defendants argued in a letter to the District Court of Eastern District of New York that because they are alter egos of one another, the automatic stay arising in the debtor’s case should prevent the action from proceeding against all defendants. The Eastern District court disagreed, and instead, issued an order stating that the automatic stay only enjoined actions against debtors or their property.

By: Melanie Lee

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

At the Constitutional Convention, the States agreed not to assert any sovereign immunity defense “in proceedings pursuant to ‘Laws on the subject of Bankruptcies.’”[1] The agreement was made to “prevent competing sovereigns’ interference with discharge[ing]…” debts. [2] The Seventh Circuit, in In re Bulk Petroleum , held that Kentucky could not assert sovereign immunity as a defense to a debtor’s request to an excise tax refund.[3] There, Bulk Petroleum Corp., prior to filing its chapter 11 petition, had lost its license as a “gasoline and special fuels dealer” in the state of Kentucky.[4] As a gasoline and special fuels supplier, the debtor, pre-petition, was entitled to a refund for the excess fuel taxes it paid.[5] The loss of the license did not require the debtor to cease business in Kentucky or permit the debtor to ignore its tax obligations.[6] However, according to the Kentucky Department of Revenue (“KDOR”), only a “taxpayer” within the meaning of the statute was entitled to a refund.[7] The KDOR refused to refund the fuel taxes to the debtor because the debtor “was unlicensed” and therefore, not a ’taxpayer.’[8] The Seventh Circuit disagreed and found that while the debtor was unlicensed, the debtor was still required to pay the fuel taxes to its upstream suppliers.[9] The suppliers were authorized to add the fuel tax to the debtor’s invoices because of their capacity as “trust officer[s] of the state” under Kentucky Revised Statute 138.280.[10] Because this statute required suppliers to collect, hold, and turn over the tax collected to Kentucky, the court held that the debtor had paid the fuel tax, via its suppliers, despite being unlicensed.[11] Consequently, the debtor was entitled to any excess tax paid on the gasoline, which ended up being sold outside of Kentucky.[12] Despite having not been raised by either party, the Seventh Circuit considered the possibility of Kentucky asserting sovereign immunity, under the Eleventh Amendment, as a defense to the state having to issue the refund.[13] According to the Seventh Circuit, that defense would have failed because the States “agreed in the plan of the [Constitutional] Convention not to assert any sovereign immunity defense they might have had in proceedings brought pursuant to ‘Laws on the subject of Bankruptcies.’”[14]

By: Aaron Z. Leaf

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

For over a decade, courts have struggled with how to reconcile sections 363 and 365(h) of the United States Bankruptcy Code (the “Code”). While neither statute working alone in bankruptcy cases presents much challenge, when invoked together some courts have found them to be incompatible. A court cannot simultaneously allow a trustee to sell property “ free and clear of any interest in such property” and allow a lessee to retain all rights that are “appurtenant to the real property for the balance of the term.” The United States Bankruptcy Court for New Jersey recently addressed sections 363 and 365(h) in In re Reval. After years of poor financial performance, Revel AC, Inc. and its partners, filed petitions under chapter 11 of the Code. Debtors subsequently filed a motion under section 365(a) to reject lease agreements with its tenants. In response, IDEA Boardwalk and other lessees gave a notice of their intent to continue to exercise their “possessory leasehold rights under section 365(h).” Upon the debtor’s request, the court thereafter approved a sale of the debtors’ property to Polo North under section 363 of the Code. After finding that the agreement between the Debtors and Tenants were true leases, the court addressed how the sale would affect Tenants section 365(h) possessory rights. The court held that the tenants possessory rights under section 365(h) eviscerates a debtor’s right under section 363of the Code to sell its property free and clear of any interest.

By: Kristen Lasak

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re SemCrude L.P., the U.S Court of Appeals for the Third Circuit found that the claims of breach of fiduciary duty, negligent misrepresentation, and fraud set forth by limited partners against the co-founder and former President and CEO of SemCrude L.P. were derivative of the claims held by SemCrude’s Litigation Trust. SemCrude L.P. is an Oklahoma-based oil and gas company co-founded by Thomas Kivisto, who allegedly drove the company into bankruptcy due to self-dealing and speculative trading strategies. In July 2008, SemCrude, along with its parent company and certain subsidiaries, filed petitions for relief under chapter 11 with the United States Bankruptcy Court for the District of Delaware. On October 28, 2009, the bankruptcy court issued an order confirming SemCrude’s plan of reorganization, which established a Litigation Trust. The plan specifically transferred the claims belonging to SemCrude’s bankruptcy estate to the Litigation Trust and authorized the Litigation Trust to pursue SemCrude’s claims and distribute any money attained to SemCrude’s creditors. The Litigation Trust asserted thirty claims, including breach of fiduciary duty, breach of contract, fraudulent transfer, and unjust enrichment, against Kivisto and certain Semcrude officers. On November 19, 2010, the bankruptcy court approved a $30 million settlement agreement, which also incorporated a mutual release of all claims. Particularly, the Litigation Trust released Kivisto and the other officers from being accountable to any party for “contribution or indemnity relating to the released claims.”