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Third Circuit Rejects Wait-and-See Valuation Approach and Accepts Lien Stripping in Section 506(a)

By: Andrew Richmond

St. John’s Law Student

American Bankruptcy Institute Law Review Staff
 
 
In In re Heritage Highgate, Inc.,[1] the Third Circuit held that the fair market value of property as of the confirmation date controls whether or not a lien is fully secured.[2]  Additionally, the court held that lien stripping is permissible in a chapter 11 reorganization.[3] The debtors, Heritage Highgate and Heritage-Twin Ponds II, were real-estate developers working on a project that was financed by a group of banks (the “Bank Lenders”) and other entities collectively known as Cornerstone Investors (“Cornerstone”).[4]  Both the Bank Lenders and Cornerstone secured their investments with liens on substantially all of the debtors’ assets but Cornerstone’s claims were contractually subordinated to the Bank Lenders’.[5] After selling a quarter of the project’s planned units, the debtors filed a chapter 11 petition.  The debtors’ joint proposed plan of reorganization proposed paying secured claims in full and paying 20% of the unsecured claims with funds obtained through the sale of the project’s remaining units.[6]  These estimated recoveries were based on the debtors’ appraisal, which valued the project at $15 million.[7] During the course of the case, the debtors continued to build and sell units and, with the consent of its secured lenders, used the sale proceeds to fund ongoing operating losses.[8] As a result, the fair market value of the project was reduced to approximately $9.54 million as of the time of plan confirmation, which was less than the Bank Lender’s $12 million secured claim.[9] Cornerstone argued their $1.4 million claim should still be fully secured and to hold otherwise would constitute impermissible lien stripping.[10] The bankruptcy court disagreed and determined that the proper method of valuing Cornerstone’s secured claim was the fair market value of the project as of the time of plan confirmation.[11]  Therefore, Cornerstone’s claim was unsecured.[12]
Bankruptcy Litigation, Real Estate

Can the Purchase of Groceries be in Furtherance of a Ponzi Scheme

By: Gabriella B. Zahn

St. John's Law Student

American Bankruptcy Institute Law Review Staff
 
 
Adopting a limited view of the “Ponzi scheme presumption,” the Bankruptcy Court for the Southern District of Florida[1] rejected the trustee’s contention that payments made for groceries were avoidable fraudulent transfers because the purchase of groceries was in furtherance of the Ponzi scheme.[2]  In In re Phoenix Diversified Investment, the debtor purchased $43,384.37 worth of groceries and other personal items over a four-year period from Publix – a grocery store chain.[3] The trustee sought to avoid the transfers under both state fraudulent transfer law[4] and section 548(a) of the Bankruptcy Code (the “Code”).[5] The trustee argued that the so-called “Ponzi scheme presumption” applied.[6]  The presumption allows the court to assume a transfer was made with the “actual intent to hinder, delay, or defraud” if the transfer was made in order to perpetuate a Ponzi scheme or was necessary to the continuance of the scheme.  In its classic application, the presumption allows the trustee to recover payments made to early investors in a Ponzi scheme on the theory that those payments kept the scheme hidden. Publix argued that the Ponzi scheme presumption was not applicable.[7]
Bankruptcy Litigation

Fourth Circuit Preserves Absolute Priority Rule Despite Challenge Through BAPCPA

By: Andrew Serrao

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

In the first appellate decision on the issue, the Fourth Circuit in In re Maharaj[1] held that the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”) did not abrogate the absolute priority rule’s applicability to individual Chapter 11 debtors.[2] Ganess and Vena Maharaj (the “Debtors”) accumulated a significant amount of debt while owning and operating an auto body repair shop.[3] The Debtors filed a voluntary petition under Chapter 11 in bankruptcy court, and subsequently filed a plan of reorganization (the “Plan”),[4] pursuant to section 1121(a).[5] The Plan provided that the Debtors would continue to own and operate their auto body business, using income from the business to pay general unsecured claims.[6] The Plan also separated creditors into four classes[7]. Class 3 (general unsecured claims) voted to reject the Plan,[8] and the Debtors sought a cram down.[9] If BAPCPA had abrogated the absolute priority rule, the Debtors could have retained their auto body business and crammed down the Plan.[10] However, the Fourth Circuit held that the absolute priority rule had not been abrogated by BAPCPA.[11]

Bankruptcy Litigation

Bad Faith Constitutes Cause For Dismissal of a Bankruptcy Case

By: Kathleen Mullins

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

In In re Lee[1] the United States Bankruptcy Appellate Panel for the Sixth Circuit (the “BAP”) held that the bankruptcy court properly dismissed the debtor’s Chapter 11 bankruptcy petition because the debtor’s filing was abusive.[2] The debtor defaulted on her mortgage loan with Chase Home Finance (“Chase”) on one of her investment properties.[3] Chase sought to foreclose on the property, and the debtor filed bankruptcy, staying the foreclosure action.[4] This case was dismissed and Chase sought to foreclose a second time.[5] Once again, however, the debtor filed bankruptcy.[6] After the case was dismissed and Chase again attempted to foreclose, the debtor filed bankruptcy a third time.[7] This time Chase made a motion to dismiss the case, asserting that the debtor was acting in bad faith and was abusing the bankruptcy process in order to evade foreclosure by filing bankruptcy petitions whenever Chase made progress in the foreclosure action.[8] The bankruptcy court found that the debtor had been filing bankruptcy petitions “as a buffer to prevent the foreclosure proceedings from going forward” and it dismissed her case for acting in bad faith, which the court determined constituted sufficient “cause” under section 1112(b).[9]

Bankruptcy Litigation, Consumer Bankruptcy

Creditor Committees Concurrent Investigation Did Not Vitiate Need for Independent Examiner

By: Brendan A. Bertoli

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

The Bankruptcy Court for the Southern District of New York held that courts have discretion to appoint an independent examiner in cases where the debtor’s fixed debts exceed five million dollars, but the facts of In re Residential Capital, LLC[1] warranted appointment.[2] Berkshire Hathaway (“Berkshire”), joined by the Trustee, sought the appointment of an independent examiner to investigate certain pre-petition transactions between the debtor, GMAC, Ally and Cerebus Capital.[3] Berkshire claimed that appointment was mandatory pursuant to section 1104(c)(2) of the Bankruptcy Code.[4] The Official Committee of Unsecured Creditors (“the Committee”) objected to appointment, arguing that its own investigation obviated the need for an independent examiner.[5] The court held that appointment was not mandatory because section 1104(c)’s mandatory language is qualified by the phrase “as is appropriate.”[6] However, the court held that the Committee’s concurrent investigation, by itself, was not enough to render an independent examiner’s appointment inappropriate.[7]

Business Reorganization

Courts may Override 1111(a) and Require Proofs of Interest to be Filed

 By: Brett Joseph

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

In In re Greenwich Sentry, L.P.,[1] the Bankruptcy Court for the Southern District of New York held that section 1111(a) of the Bankruptcy Code did not prevent the court from requiring all interest holders to file proofs of interest.[2] In 2010, Greenwich Sentry Partners, L.P. (“the Debtor”) filed a petition for Chapter 11 relief.[3] The Debtor also filed its schedules and a statement of financial affairs,[4] which listed Christopher McLoughlin Keough, Quantum Hedge Strategies Fund, LP, and SIM Hedged Strategies Trust (the “Purported Limited Partners”) as interest holders. The Purported Limited Partner’s interests were listed on the Debtor’s schedules, but were not listed as disputed, contingent, or unliquidated.[5] The court issued an amended bar date order requiring all interest holders to file proofs of interest, even if their interests were not listed as disputed, contingent, or unliquidated.[6] Despite receiving a copy of the amended bar date order, the Purported Limited Partners did not file proofs of interest by the bar date. Nevertheless, the Purported Limited Partners sought a declaration from the court that they were holders of allowed limited partner interests, entitled to distribution.[7] The court denied the motion, holding that the Purported Limited Partners were required to submit proofs of interest in accordance with the amended bar date order and that they had failed to do so.[8]

Business Reorganization, Court Administration

Specific Intent is not Required to Establish a Willful Injury under Section 523(a)(6)

By: Robert Garafola

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

In Jendusa-Nicolai v. Larsen, the Seventh Circuit held that section 523(a)(6) of the Bankruptcy Code prevented the debtor, David Larsen, from discharging his debt from a civil judgment stemming from the attempted murder of his former wife, Teri Jendusa-Nicolai.[1] Larsen savagely beat Jendusa-Nicolai with a baseball bat, sealed her in a snow-filled trash can, and left her to die in a storage facility.[2] Jendusa-Nicolai miraculously survived, but she lost all of her toes to frostbite and suffered a miscarriage.[3]  Larsen was sentenced to life imprisonment for his crimes and lost a civil action to Jendusa-Nicolai and her family, who were awarded a judgment in excess of $3.4 million.[4] Larsen attempted to discharge the debt from the judgment by filing for bankruptcy under Chapter 7. Larsen argued that his debt should be discharged because he did not willfully injure his ex-wife within the meaning of section 523(a)(6) since he did not specifically intend to cause his ex-wife to lose her unborn child and toes.[5]  However, the court found that the statute did not require that the debtor intend to cause specific injuries and that a broader analysis of the debtor’s intended results is proper.[6]

Consumer Bankruptcy

Failure to Apply for Income Based Repayment Does Not Bar Discharge of Student Loans

By: Gabriella Formosa

St. John’s Law Student

American Bankruptcy Institute Law Review Staff
 
In In re Krieger,[1] the Bankruptcy Court for the Southern District of Illinois permitted a discharge of federal student loans despite the debtor’s failure to apply for an Income Contingent Repayment Plan (“ICRP”).[2] Under an ICRP, a borrower’s annual loan payments can be reduced after applying a formula that takes into account poverty guidelines and the borrower’s adjusted gross income.[3] However, if the borrower has no discretionary income, the monthly payment due will be zero.[4] Here, the debtor, a twice divorced, fifty-two year old woman had been unemployed for over ten years despite countless attempts to secure employment.[5] She lives with her elderly mother and her sole income is a monthly government assistance check for $200.[6] She is unable to afford health or dental care, a cellular phone, or her car payments.[7] The court held that application for an ICRP would be nothing more than a formality because the debtor was currently destitute, and was likely to remain that way for rest of her life.[8] As such, application was not dispositive of a good faith attempt to repay her loans.[9]
Consumer Bankruptcy

Developing Consensus Among Delaware Bankruptcy Courts to Narrowly Construe Stern v. Marshall Concerning Avoidance Claims

By: Joseph P. Donnelly IV

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 
Adopting a narrow interpretation of the holding of Stern v. Marshall,[1] the Bankruptcy Court for the District of Delaware, in In re DBSI,[2] held that Stern does not preclude a bankruptcy court from adjudicating avoidance claims.[3] In November 2008, DBSI Inc. and several of its affiliates (the “Debtors”) filed for Chapter 11 bankruptcy protection.[4] Following confirmation of the Debtors’ liquidating plan, a litigation trustee commenced several adversary proceedings relating to, inter alia, preferential or fraudulent transfer claims.[5] Certain defendants (the “Movants”) sought to have these adversary proceedings dismissed, arguing that the bankruptcy court lacked jurisdiction under 28 U.S.C. § 157 and the United States Supreme Court’s decisions in Stern v. Marshall and Granfinanciera, S.A. v. Nordberg,[6]to adjudicate causes of action sounding in preference or fraudulent conveyance.[7]
Bankruptcy Litigation, Court Administration

Definition of Reasonably Equivalent Value Narrowed as Pool of Potential Litigants is Expanded in Fraudulent Transfer Context

By: Steve Traditi

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

In In re TOUSA, Inc.,[1] the Eleventh Circuit held that subsidiaries of a parent company did not receive “reasonably equivalent value” in exchange for liens granted to secure the obligations of the parent company in an attempt by the group to avoid bankruptcy.[2] The court also held that third party beneficiaries could be liable as parties “for whose benefit” the transfer was made.[3] In 2005, TOUSA, Inc., a large homebuilding company, entered into a joint venture in order to acquire homebuilding assets from Transeastern Properties, Inc., using monies borrowed from the so-called “Transeastern Lenders” to fund the acquisition.[4] When the housing market took a downturn in 2006, TOUSA defaulted and the Transeastern Lenders sued for more than $2 billion.[5] TOUSA agreed to settle the case for $421 million with money borrowed from a collection of lenders (the “New Lenders”). The New Lenders secured their loans by taking liens on the assets of certain of TOUSA’s subsidiaries (the “Conveying Subsidiaries”).[6]  After TOUSA and its subsidiaries, including the Conveying Subsidiaries, went into bankruptcy, TOUSA sought to avoid the New Lenders’ liens as fraudulent transfers arguing that the Conveying Subsidiaries did not receive reasonably equivalent value.[7] In addition, TOUSA sought to recover from the Transeastern Lenders by claiming that the Transeastern Lenders were the entities for whose benefit the transfer was made.[8]  The bankruptcy court agreed with TOUSA, but the district court reversed.[9] TOUSA then appealed to the Eleventh Circuit.

Bankruptcy Litigation