By: Amanda Hoffman

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re Johns-Manville Corporation, the United States Bankruptcy Court for the Southern District of New York enforced orders it issued in 1986, confirming a plan (the “Plan”) of reorganization for Johns-Manville. Pursuant to the Plan, a settlement agreement was reached in which insurers contributed $770 million to a trust benefitting asbestos personal injury claimants. In exchange, the insurers of Johns-Manville, including long-time insurer Marsh USA (“Marsh”), were relieved of all liability related to their insurance of Johns-Manville and the insurers would be protected from claims via injunctive orders of the Bankruptcy Court. Marsh contributed $29.75 million to the trust in exchange for the injunction, which barred future claimants from bringing action against Marsh as an insurer of Johns-Manville. This settlement agreement was approved by the court, resulting in the court entering a confirmation order of the Plan (the “Confirmation Order), and an Insurance Settlement Order, together known as the “1986 Orders”. Under the 1986 Orders, Johns-Manville and its insurers were released from further liability, but present and future claimants could claim against the trust. Part of the settlement agreement included the appointment of a legal representative by the Bankruptcy Court, in order to ensure the rights of future claimants.

By: Arielle Cummings

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

With certain limited exceptions, an individual debtor may have his debts discharged in bankruptcy. Debts resulting from a debtor’s fraud, however, are generally not dischargeable. In In re Glenn, the United States Court of Appeals Seventh Circuit affirmed the lower court’s holding that if a debt is the result of fraud, the court can discharge the debt in bankruptcy if the debtor was not complicit in the fraud and that the court can still discharge the debt even if the fraud was created by the debtor’s agent, provided, again, that the debtor was not complicit in it. In Glenn, the defendants, the Glenns, asked a loan broker, Karen Chung to get them a short-term “bridge” loan of $250,000. Chung told the Glenns that a bank had agreed to give the Glenns a $1 million line of credit, but that the line for credit would not be available for a few weeks—hence the need for the “bridge” loan. Brian Sullivan, a lawyer and friend of Chung, agreed to lend the Glenns the $250,000. The loan was never repaid and the $1 million line of credit was never approved because Chung never applied for it in the first place. The Glenns declared bankruptcy and the lower court found that neither of the Glenns had committed fraud and refused to impute Chung’s fraud to either of them under an agency theory. The court granted the Glenn’s discharge. The court reasoned that “[p]roof that a debtor’s agent obtains money by fraud does not justify the denial of discharge to the debtor, unless it is accompanied by proof which demonstrates or justifies an inference that the debtor knew or should have known of the fraud.”

By: Anna Chen

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In Cantu v. Schmidt (In Re Cantu), the Court of Appeals for the Fifth Circuit held that malpractice claims that arise during chapter 11 reorganization but before chapter 7 liquidation belong to the bankruptcy estate. In Cantu, the debtors, the Cantus, filed for chapter 11 bankruptcy. The debtors hired an attorney, Ellen Stone, to represent them in the bankruptcy case. Upon the request of a group of creditors, the bankruptcy court converted the debtors’ chapter 11 case to chapter 7 and a trustee was appointed. Following conversion, the creditors filed a complaint seeking a judgment declaring that the debtors’ debts were not dischargeable. After a two-day trial, the bankruptcy court determined that the debtors’ debts would not be discharged. The court pointed out a number of “omissions, misstatements, and controversies” that plagued the chapter 11 bankruptcy, such as the Cantus’ failure to disclose significant assets and transactions, an improper transfer of $50,000 of what would have been estate property to a close friend during the bankruptcy case, and the Cantus’ lack of cooperation with the court and trustee. A few years later, the Cantus hired an attorney to investigate a possible legal malpractice claim against Stone for her representation during the Cantus’ bankruptcy. The trustee informed the new counsel that he believed the claims against Stone were “property of the estate and under the trustee’s sole authority to prosecute.” The bankruptcy court agreed with the trustee and authorized him to investigate the legal malpractice claims. After conducting his investigation, the trustee filed a malpractice suit against Stone in state court. After removal to federal court, Stone and the trustee settled for $281,710.54. The district court referred the case to the bankruptcy court to determine whether the settlement proceeds belonged to the debtors or the bankruptcy estate. The bankruptcy court held that the settlement proceeds belonged to the estate. On appeal, the district court and the Fifth Circuit affirmed the bankruptcy court’s decision, holding that the proceeds belonged to the debtors’ estate.

By: Alana Friedberg

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in Royal v. First Interstate Bank (In re Trierweiler), the Tenth Circuit held that a mortgage granted in favor of the private electronic database Mortgage Electronic Registration Systems, Inc. (“MERS”), which records transfers of notes and mortgages, was enforceable as to a bankruptcy trustee even though the promissory note was held by a third-party. In Trierweiler, the debtors took out a loan from and granted a mortgage to First Interstate Bank (“First Interstate”) in order to purchase real property. The mortgage identified First Interstate as the “lender,” and MERS as both the “mortgagee” and the “nominee for the lender and lender’s successors and assigns.” Sometime thereafter, First Interstate assigned the note to Fannie Mae, but remained as the servicer for the loan. The debtors subsequently defaulted on the loan and filed for bankruptcy under chapter 7 of the Bankruptcy Code. The chapter 7 trustee then sought to avoid the mortgage, using his “strong arm” powers under section 544(a). In particular, the chapter 7 trustee claimed that MERS “was powerless to foreclose on the property” because it did not hold the note and instead was merely the mortgagee. The trustee also claimed that while Fannie Mae held the note, it “had no ability to enforce the mortgage because it was not listed as the mortgagee in the land records . . . .” Therefore, the trustee asserted that this “combination rendered the mortgage unenforceable and void as to [him].” The bankruptcy court, however, rejected the trustee’s arguments and ruled that the mortgage was a properly recorded and enforceable security interest that could not be avoided in bankruptcy.[13] On appeal, the Bankruptcy Appellate Panel of the Tenth Circuit and the United States Court of Appeals for the Tenth Circuit both affirmed.

By: Michael Rich

St John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in In Re Matson, the court held that a same-sex couple who filed for bankruptcy as joint debtors were “spouses” for the purpose of the Bankruptcy Code even though the petition was filed in a state that did not recognize their same-sex marriage. In Matson, the debtors were legally married in Iowa but resided in Wisconsin, which does not recognize same-sex marriages. Upon the filing of the case, a creditor moved to dismiss the bankruptcy case or, in the alternative, to bifurcate the case. The creditor argued that a joint bankruptcy case could only be commenced “by an individual that may be a debtor under such chapters and such individual’s spouse.” Further, the creditor claimed that “the definition of marriage and the regulation of marriage . . . has been treated as being within the authority and realm of the separate States.” Thus, the creditor argued that since Wisconsin did not permit or recognize same sex marriages, the debtors should not be deemed “spouses” for the purpose of a joint bankruptcy petition. In the response, the debtors relied on the Supreme Court’s holding that the federal Defense of Marriage Act, which defined marriage as a union between one man and one women, was unconstitutional because it “violate[d] basic due process and equal protection principles applicable to the Federal Government.” In particular, the debtors argued that following Windsor, the definition of marriage could no longer be restricted to “a union between one man and one woman.” Therefore, the debtors claimed that Wisconsin did not have the authority to deny a lawfully wedded couple any federal benefits, which would include same-sex couples right to file as spouses in a joint bankruptcy case. Ultimately, the Matson court denied the creditor’s motion to dismiss or, in the alternative, bifurcate the case because the court found that it was required to give full faith and credit to the Iowa marriage.

By: Arthur Rushforth

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in In re Hoffman, a bankruptcy court denied confirmation of the joint debtors’ plan after the chapter 13 trustee objected to the plan, which had a three-year applicable commitment period, holding that the debtors improperly deducted ordinary and necessary business expenses when calculating their current monthly income. Instead, the court held that the debtors should have used the gross receipts from the business. In Hoffman, a married couple filed a joint petition under chapter 13 of the Bankruptcy Code. The husband was self-employed, and pursuant to Official Bankruptcy Form 22C, the debtors deducted the husband’s ordinary and necessary business expenses from his gross receipts when they calculated their current monthly income. Based on these calculations the debtors’ annualized current monthly income was lower than the applicable median family income of in Minnesota, where they resided. Accordingly, the debtors proposed a plan that provided for them to pay $175.00 for thirty-six months. The chapter 13 trustee objected, arguing that the debtors improperly deducted business expenses when calculating the husband’s current monthly income and that the debtor’s current monthly income was above-median after eliminating that deduction, thereby triggering a five-year applicable commitment plan rather than the three-year period proposed by the debtors. In particular, the trustee argued the plain language of section 1325 did not provide for the deduction of ordinary and necessary business expenses when calculating current monthly income. The debtors responded by claiming their applicable commitment calculation conformed to the calculation scheme provided for by Official Form 22C. The court ultimately agreed with the trustee and denied the confirmation of the debtor’s plan.

By: Brianna Walsh

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in In re 56 Walker LLC, a bankruptcy court overruled a debtor’s objection a secured creditor’s proposed order providing for the distribution of the proceeds from the sale of real property that was the debtor’s sole asset pursuant to the debtor’s confirmed plan of reorganization even though the secured creditor “gifted” a portion of its recovery to a junior class because, among other reasons, the court found that the distribution scheme would not violate the absolute priority rule. In 56 Walker, the debtor pledged a six-story mixed-use building, its sole asset, as security for an $8 million mortgage loan. After the debtor defaulted one year later, the bank that had acquired the mortgage loan from an FDIC receivership commenced a foreclosure action in New York state court. Subsequently, the debtor filed for bankruptcy under chapter 11 of the Bankruptcy Code in order to stay the foreclosure proceeding. This first case was ultimately dismissed. Following dismissal of the debtor’ first chapter 11 case, the bank resumed the foreclosure action in state court and moved for summary judgment. The debtor then crossed-moved for summary judgment, arguing that the bank had not provided adequate proof that it was the assignee of the mortgage or the note and that the bank was liable for certain lender-liability claims. The state court granted the bank’s motion for summary judgment of foreclosure and denied the debtor’s cross-motion. The debtor timely filed a notice of appeal. Prior to the state court entering the bank’s proposed judgment of foreclosure, the debtor filed a second chapter 11 case. Ultimately, the debtor confirmed a consensual plan of reorganization and sold the property for $18 million. After selling the property, the debtor objected to, among others, the bank’s claim. In its decision, the court overruled the debtor’s objection and directed the bank to settle an order to provide for the distribution of the sales proceeds. The bank then filed a proposed order, providing that (i) the bank would have a distribution in the amount of $15.1 million, (ii) another mortgage lender would have a distribution in the amount of $150,000, (iii) a mechanic’s lien holder would have a distribution in the amount of $400,000, (iv) another mechanic’s lien holder would have a distribution of $350,000, (v) the debtor’s counsel would have an administrative claim for fees and expenses capped at $250,000, and (vi) the remaining funds would be distributed to the debtor’s unsecured creditors. Equity would not receive a distribution under the proposed order. The debtor objected to the proposed order, arguing, among other things, that the proposed distribution to a mechanic’s lien holder was premature because the debtor’s previous objection to the mechanic’s lien holder’s claim was still pending. The court, however, overruled the debtor’s objection to the proposed order, noting that the only reason the mechanic’s lien holder would receive anything was the bank’s willingness to forgo part of its claim and “gift” it to the junior secured creditors.

By: Sally A. Profeta

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in In re Abraham, a bankruptcy court held that debtors living in Iran could not claim the federal homestead exemption for their real property located in New Jersey because the property did not qualify as their “residence” under section 522(d)(1) of the Bankruptcy Code. In Abraham, the married debtors moved to Tehran, Iran from New Jersey in 2011, seeking employment after the husband’s business income started to decline. Their children, however, continued to occupy the debtor’s New Jersey home, making payments for the mortgage, utilities, and the general maintenance of the property. In 2012, the debtors filed for bankruptcy in New Jersey and claimed an exemption for the New Jersey property. In their original Schedule C, the debtors claimed a $10,505.76 exemption in the New Jersey property. Subsequently, the debtors amended their Schedule C and claimed a $43,250 exemption in the property. The chapter 7 trustee objected to the debtors’ proposed exemption. The trustee argued that the property did not qualify as their residence, and the debtors filed their amended exemption in bad faith. In the husband’s certification, he indicated that, while the debtors lived and worked in Iran, they intended to return to the New Jersey property in the future. Yet this assertion contradicted the debtors’ previously filed certification in support of a motion to compel abandonment of the property, where they stated they did not intend to return to the United States in the near future. In addition to the husband’s certification, the husband offered his New Jersey driver’s license as proof of residency during a section 341 meeting of creditors. Therefore, the debtors argued that the New Jersey property was their “residence” under section 522(d)(1) of the Bankruptcy Code. Ultimately, the bankruptcy court agreed with the trustee and denied the homestead exemption.

By: Ashraf Mokbel

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in National Heritage Foundation Inc. v. Highbourne Foundation, the Fourth Circuit held that a non-debtor release provision in a chapter 11 reorganization plan was not warranted by the circumstances of the case because the court found that the bankruptcy case would not be adversely affected if the provision was not included in the plan.

By: Christopher J. Pedraita

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Reversing the bankruptcy court, in In re City of San Bernardino, a district court recently held that the Eleventh Amendment barred a chapter 9 debtor’s claims against certain state agencies. In San Bernardino, the City of San Bernardino (the “City”) sought to protect funds, which the State of California (the “State”) demanded that the City remit to the State. The funds at issue in San Bernardino had been parceled out to the City’s redevelopment agency (“RDA”) and earmarked for redeveloping urban neighborhoods. In light of the fiscal emergency experienced by State in 2011, however, its legislature supplanted the existing RDAs with “successor agencies” to conclude all remaining matters of the RDAs, including returning the funds to the county auditor-controller that the RDAs had not already been committed to a project. As part of this process, the State ordered the City’ successor agency to return millions of dollars in tax revenues to the State’s Department of Finance (the “DOF”). If the successor agency failed to remit the funds to the DOF, the State warned that it could withhold tax revenue from the successor agency or the City. The warning prompted the City to commence adversary proceedings against the various state agencies seeking injunctive and declaratory relief to, among other things, prevent the State agencies from withholding tax revenue from the successor agency (and the City itself). The State agencies moved to dismiss the City’s complaint on several grounds, including that claims were barred under the Eleventh Amendment. While the bankruptcy court granted the State agencies’ motion to dismiss with leave to amend, believing that the City could show imminent injury if the state agencies withheld the tax money, the court rejected the state agencies’ Eleventh Amendment defense. In particular, the bankruptcy court ruled that when the subject of litigation was unquestionably within the court’s control state sovereign immunity could not prevent the adversary proceeding. On appeal, the district court reversed the bankruptcy court holding the Eleventh Amendment to apply in order to protect the State’s rights to run its own finances.