Bankruptcy Cases on the Supreme Courts October Term Part II

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Oct 2003

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This month's Supreme Court Update features Kontrick v. Ryan,<a href="#1" name="1a">1</a> in which the Court will decide whether a debtor's delay waives the deadline for objection to discharge, as the Seventh Circuit held. We also have
two short takes, cases the Court has agreed to hear on ERISA and partnership
tax issues arising in bankruptcy. The first of these is Yates v.
Hendon,<a href="#2" name="2a">2</a> where the Sixth Circuit held that ERISA does not cover working owners/sole shareholders of small businesses. In
bankruptcy, that means those debtors cannot rely on ERISA to exclude their
interests in employee benefit plans from the estate. Second is United
States v. Galletti,<a href="33" name="3a">3</a> where the Ninth
Circuit disallowed as time-barred IRS claims for partnership taxes against
individual partners because the IRS had not assessed or filed suit against the
partners within the three-year deadline.

<h3>Kontrick: The Dueling Doctors' Discharge Dispute</h3>

Bankruptcy Rule 4004 (a) requires objections to discharge
under Code §727 to be filed "no later than 60 days after the first
date set for the meeting of creditors," unless the court grants an
extension for cause before the time has expired. Kontrick v. Ryan,<a href="#4" name="4a">4</a> on appeal from the Seventh Circuit, raises a
fresh-start question impacting individual debtors, their creditors and
trustees. Suppose a discharge objection is filed late, but the debtor fails to
raise the time bar in his answer. Does the debtor get a discharge or is Rule
4004(a)'s deadline subject to waiver and other equitable defenses?

The Kontrick tale might be titled
"Slow and Slower;" the problem would not have arisen had counsel
been quick and quicker. Debtor Kontrick, a plastic surgeon, filed a chapter 7
petition. Creditor Ryan, a surgeon formerly in practice with debtor, held a
half-million dollar judgment against him. The creditor waited until the final
day of his third extension before finally filing an objection to discharge.
Four months later, with no further extension, the creditor amended his
complaint, adding the one count that eventually counted. The debtor answered,
but waited almost a year, until the creditor sought summary judgment, to raise
Rule 4004(a)'s time limit.

Prof.
Jeff Morris has suggested that the debtor's surname alone doomed his
discharge.<a href="#5" name="5a">5</a> All three courts, however, relied on other grounds. Judge John
Schwartz of the U.S. Bankruptcy Court for the Northern District of Illinois
agreed that the amended complaint was late, but held that the debtor's
own delay waived the time bar. Judge Schwartz then denied discharge based on
the late-added count. District Judge Harry Leinenweber, and then the Seventh
Circuit, in an opinion by Judge Ripple, affirmed.

On
appeal, Kontrick contended that Rule 4004(a)'s 60-day limit for objecting
to discharge is "jurisdictional" in the sense that "a court
has no authority to extend or alter [the deadline] with equitable exceptions
such as waiver." The courts below held that the time limits are instead
akin to statutes of limitations, which can be waived.

The
Seventh Circuit began by quoting the Supreme Court's statement in United
States v. Locke:<a href="#6" name="6a">6</a> "Statutory filing
deadlines are generally subject to the defenses of waiver, estoppel and
equitable tolling." Since, in the circuit's view, the text of the
rules in question "yields no definitive answer," it examined the <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=s…
and §28 U.S.C. 157</a> on core proceedings to decide that the time
limits are not jurisdictional. The Seventh Circuit followed the Second and
Fourth Circuits, as well as the Ninth Circuit BAP,<a href="#7" name="7a">7</a> in holding that deadlines
for objecting to discharge and dischargeability are affirmative defenses that
are waived if not timely raised.

Kontrick's
Supreme Court brief emphasizes the plain language of Rules 4004 and 4007 on
exceptions to discharge under §523. Rules 4004 and 4007 are both listed in
Rule 9006(b)(3), which allows a court to increase the time for filing under
[the listed rules] "only [as] stated in those rules." Further,
Kontrick relied heavily on <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=5…
v. Freeland & Kronz, 503 U.S. 638 (1992)</a>,
holding that Rule 4003's 30-day period for objecting to exemptions cannot
be extended even if the debtor's claim is in bad faith, and on <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=5…
v. United States, 517 U.S. 416 (1996)</a>,
denying authority to consider a motion for acquittal filed just one day late
due to attorney error. The Seventh Circuit said that Taylor did not hold
"that the debtor had an unlimited time" to raise time bars, and
that criminal appeals like Carlisle
require greater finality than discharge matters.

The
National Association of Consumer Bankruptcy Attorneys (NACBA), in its amicus brief, avoids characterizing the rules as
jurisdictional. Instead, NACBA argues that the plain language of Rule 4004
provides that lack of a timely objection to discharge entitles the debtor
forthwith to a discharge. NACBA emphasizes the importance of finality in the
fresh start, as well as the burden on bankruptcy courts of late-filed
complaints and consequent arguments for equitable extension of time limits.

Respondent
Ryan denies that the time limits are jurisdictional, and emphasizes the long
history of statutes of limitation as affirmative defenses, waived if not timely
asserted. He also cites the Supreme Court's decision in Young v.
United States,<a href="#8" name="8a">8</a> finding the three-year look-back
for discharge of tax claims tolled by a prior chapter 13. The Court there said
bankruptcy courts are courts of equity, and bankruptcy time limits may be
extended by equitable defenses. The Executive Office of the U.S. Trustee filed
an amicus brief supporting the
creditor's arguments.

The
moral of the story is this: File those complaints and raise those affirmative
defenses on time. Don't let time play a Kontrick on your client.

<h3>Yates: May an Employer Shelter His Own Assets Under ERISA?</h3>

Another
doctor-debtor on the docket is Tennessee physician Raymond Yates, sole
shareholder of a professional corporation. Three weeks before an involuntary
chapter 7 petition was filed against him, Yates repaid $50,000 borrowed years
earlier from the corporation's profit-sharing plan. When Trustee William
Hendon sought to recover the payment as a preference, Yates argued that the
funds were excluded from the estate under Code §541(c)(2) by ERISA and Patterson
v. Shumate.<a href="#9" name="9a">9</a> The trustee relied on Sixth
Circuit precedent, holding that business owners, such as sole proprietors and
sole shareholders, are not employees under ERISA10 and may not enforce its
anti-alienation rules on their own behalf if they participate in employee
benefit plans. The bankruptcy court granted summary judgment to the trustee
allowing recovery of the payment. The district court<a href="#11" name="11a">11</a> and the Sixth Circuit,
bound by Sixth Circuit precedent, affirmed, and rehearing en banc was denied. The Supreme Court granted certiorari on the interpretation of ERISA.

Debtor
Yates urged that working owners are eligible ERISA plan participants, provided
the plan covers non-owner employees as well. The Sixth Circuit, he argued,
misconstrues a regulation intended only to determine if a plan covers such
non-owner employees as instead totally excluding owners from ERISA protection.
That holding, he says, sets up an unworkable two-tiered system with regular
employees protected by ERISA but limited by its preemption of state remedies,
while owners can access state law remedies for their interests in the same
plan.

The
United States, as amicus, urges
reversal. The solicitor general seconds Yates's interpretation of ERISA
and Department of Labor (DOL) regulations. In addition, he points out that in
1998, more than 600,000 ERISA pension plans, covering millions of workers,
included at least one working owner. Allowing owners to participate is a
powerful incentive for them to offer pension and other benefit plans to their
employees, an incentive undermined by the Sixth Circuit holding. Disability
insurer UNUMProvident, another amicus urging reversal, emphasized congressional intent to regulate ERISA
plans under uniform federal law, not inconsistent state law.

The
Supreme Court briefs do not directly address bankruptcy, but affirmance would
mean that small-business owners could exclude their interests in employee
benefit plans from the estate only if and as state trust and exemption law
allowed. Non-owner employees, on the other hand, could completely exclude their
interests under ERISA's anti-alienation rules and Code §541(c)(2).

<h3>Galletti: What Must the IRS Do to Collect Partnership Taxes from Individual Partners?</h3>

That does it for doctors in debt, but we're not done with deadlines. United
States v. Galletti<a href="#12" name="12a">12</a> will determine what the
IRS must do to collect partnership tax deficiencies from individual general
partners. The debtors, two married couples, were general partners in a business
that failed to pay federal employment taxes from 1992-95. The IRS timely
assessed the taxes against the partnership, but did not individually assess or
sue the general partners. Instead, when the partners filed chapter 13 cases in
1999 and 2000, the IRS just filed proofs of claim. The debtors objected that
the claims should be disallowed as time-barred, and Bankruptcy Judge Ernest
Robles agreed. Judge Virginia Phillips of the Central District of California
affirmed,<a href="#13" name="13a">13</a> as did the Ninth Circuit, in an opinion by Judge Graber.

To
collect tax deficiencies from a taxpayer, the IRS must either make an assessment
or file suit against that taxpayer within three years after a return for the
taxes was due. After a timely assessment, the IRS has 10 years to collect from
the taxpayer.<a href="#14" name="14a">14</a> The Galletti partners filed chapter 13 petitions more than
three years after the partnership taxes were due, but less than 10 years after
assessment against the partnership. Before the Ninth Circuit, the IRS claimed
that assessment of the partnership is enough to allow collection from
individual partners.<a href="#15" name="15a">15</a> In the IRS's view, partners are not separate
taxpayers from the partnership under the relevant statutes. The courts below
all disagreed, holding that the individuals are taxpayers distinct from the
partnership, and that the IRS's right to enforce their liability ended
when the three-year period expired without assessment or civil suit against
them. Since the three years expired before the debtors filed chapter 13, the
tax claims were properly disallowed under Code §502(b)(1) as
"unenforceable...under applicable law." Stay tuned to see if the
IRS can persuade the Supreme Court to see it their way.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
v. Ryan (In re Kontrick), 295 F. 3d 724 (7th Cir. 2002), cert. granted, 123 S.Ct.
1899 (2003)</a>. <a href="#1a">Return to article</a>

<a name="2">2</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
v. Yates (In re Yates), 287 F. 3d 521 (6th Cir.
2002)</a>, cert. granted sub nom, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
v. Hendon, 123 S.Ct. 2637 (2003)</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…
States v. Galletti, 314 F.3d 336 (9th Cir.
2002), cert. granted, 123 S.Ct. 2606
(2003)</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…; note 1</a>. <a href="#4a">Return to article</a>

<a name="5">5</a> Morris, Jeff, "Recent Case Developments," 8, 2003 ABI Annual Spring Meeting. <a href="#5a">Return to article</a>

<a name="6">6</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=4…
U.S. 84 (1985)</a>. <a href="#6a">Return to article</a>

<a name="7">7</a> See
<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9…
American Bank v. Benedict, 90 F.3d 50 (2d Cir.
1996)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
v. Emirates Bank Int'l. Ltd., 14 F.3d 244
(4th Cir. 1994)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
re Santos, 112 B.R. 1001 (9th Cir. BAP 1990)</a>.

See, also, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=%…
v. Maughan (In re Maughan), ___ F.3d ___</a> (6th Cir. 8/14/03) (bankruptcy court may use equitable power to extend time for filing objection to discharge). <a href="#7a">Return to article</a>

<a name="8">8</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=5…
U.S. 42 (2002)</a>. <a href="#8a">Return to article</a>

<a name="9">9</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=5…
U.S. 753 (1992)</a>. <a href="#9a">Return to article</a>

<a name="10">10</a> See,
e.g., <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
v. Paul Revere Life Ins. Co., 205 F.3d 297 (6th
Cir. 2000)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9…
v. Hartford Life & Acc. Ins. Co., 969 F.2d
178 (6th Cir. 1992)</a>. <a href="#10a">Return to article</a>

<a name="11">11</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…,
supra note 2</a>. The opinions of the bankruptcy and district courts are not reported. <a href="#11a">Return to article</a>

<a name="12">12</a> See note 3, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9…; <a href="#12a">Return to article</a>

<a name="13">13</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Galletti, 2001 WL 752652 (C.D. Cal.)</a>. <a href="#13a">Return to article</a>

<a name="14">14</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… U.S.C. §§6203, 6501(a)</a> and 6502(a). <a href="#14a">Return to article</a>

<a name="15">15</a> The Supreme Court briefs in this case were not available online when this article was prepared. <a href="#15a">Return to article</a>

Journal Authors

Marianne B. Culhane

Journal Date

Wednesday, October 1, 2003 - 12:00

Bankruptcy Rule

2003