Benchnotes Jun 2004

Journal Issue

Jun 2004

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<h3>Section 501(b) Subordination Provisions Read Broadly</h3>

In In re PT-1 Communications Inc., 304 B.R. 601 (Bankr. E.D.N.Y. 2004), Chief Bankruptcy Judge Conrad B. Duberstein held that the mandatory subordination provisions of §501(b) are not limited to claims that flow
directly from a securities transaction, but may include claims where the securities transaction is part of the causal
link leading to the alleged injury. Further, §501(b) is not limited as to a type of claimant but rather relates to the
type of claim. Thus, the claim does not necessarily have to belong to a shareholder. Finally, §501(b) is not limited
to claims that "sound in fraud," but includes claims "based upon contract law and other actions." As a result, the
court held that claims of creditors who contributed capital to a corporate debtor's predecessor, but who were
allegedly deprived of their ownership interest by surreptitious issuance of stock to other principal in predecessor
company, who then sold the stock to a third party, should be subordinated under §501(b).

<h3>Bankruptcy Court Cannot Liquidate Medical Malpractice Claims</h3>

In re Santos, 304 B.R. 539 (Bankr. D. N.J. 2004), involved an objection to dischargeability of a medical
malpractice claim pursuant to §523(a)(2)(A) as a debt incurred by "false pretenses, a false representation or actual
fraud." The claims arose out of the debtor's allegedly false representations relating to the quality of low-cost plastic
surgery that was going to be provided in the Dominican Republic. The representations included (a) that the
techniques, equipment and facilities would be the same as in the United States, (b) that the surgeons were "up to
American standards using American techniques," (c) a failure to disclose the debtor's malpractice insurance had
lapsed, (d) that the debtor would be the primary surgeon, and (e) that the multiple plastic surgery techniques could
be safely performed in one session. Unlike the claims in In re Cohen, 185 B.R. 171 (Bankr. D. N.J. 1994), and
other cases, the personal injury claims had not been liquidated prior to the bankruptcy. As a result, Bankruptcy
Judge Morris Stern held that the bankruptcy court could not liquidate the personal-injury aspects, including
damages for mental anguish, of the claim, but any judgment entered by the state court would be non-dischargeable.

<h3>Fraudulent Conduct Nondischargeable Under §§523(a)(2)(A) and 523(a)(6)</h3>

In re Houston, 305 B.R. 111 (Bankr. M.D. Fla. 2003), also involved a claim under §523(a)(2)(A) involving fees
and expenses awarded to a defendant arising from a pre-petition personal injury action brought by the debtor. The
action was dismissed on the basis that the debtor made "several misrepresentations and false statements during
discovery regarding prior similar injuries." The defendant asserted that the fees and costs were nondischargeable
under §523(a)(2) because prosecution of the action constituted a fraud, and nondischargeable under §523(a)(6)
because prosecution also constituted a willful and malicious injury. Relying on In re Auffant, 268 B.R. 689
(Bankr. M.D. Fla. 2001), Chief Bankruptcy Judge Paul M. Glenn agreed that the fees and costs were a "debt" that
resulted from the debtor's fraudulent conduct and were nondischargeable pursuant to both §§523(a)(2)(A) and
523(a)(6).

<h3>Trustee May Waive Attorney/Client Privilege in Certain Situations</h3>

In In re Eddy, 304 B.R. 591 (Bankr. D. Mass. 2004), Bankruptcy Judge Henry J. Boroff ventured into the area left
unanswered by Commodity Futures Trading Commission v. Weintraub, 471 U.S. 343 (1985)—the issue of a
chapter 7 trustee's ability to waive the attorney/client privilege of an individual debtor. Recognizing that courts have
struggled with the issue, the court held that at least under some circumstances, a trustee may waive the privilege.
However, that power is limited to post-petition, pre-conversion communications that related to the administration of
property of the estate. Under the facts of this case, the court found that any privileged communications related to a
claim that the estate assets were transferred and/or dissipated, and to a potential malpractice claim, could be waived.

<h3>Adversary Proceeding Does Not Change Filing Date</h3>

In In re Farmland Industries Inc., 305 B.R. 490 (Bankr. W.D. Mo. 2003), Bankruptcy Judge Jerry W. Venters was required to "delve into the muddy waters of bankruptcy procedure, a generally uncharted area that is all too
often given irreverent acknowledgement by the courts and practitioners alike." A chapter 7 trustee filed a proof of
claim in the Farmland case asserting preferential transfers to Farmland. The trustee filed the proof of claim within
two years, but did not initiate any adversary proceeding. Farmland objected to the claim, arguing that the trustee
was not entitled to recover money or property, which under the express provisions of Fed. R. Bank. P. 3007
converted the claim objection into an adversary proceeding. Farmland was equally unsuccessful arguing that the
adversary proceeding was banned because it had not been timely commenced. The court noted that §546(a) contains
an "or," indicating that commencement of an "action" can be different from commencement of a proceeding. The
court found that the filing of the proof of claim commenced a "proceeding," and the objection that converted the
action to an adversary proceeding did not change the initial filing date.

<h3>Miscellaneous</h3>

<ul>
<li> U.S. Ex Rel. Goldstein v. P & M Draperies Inc., 303 B.R. 601 (Bankr. D. Md. 2004) (a qui tam relator/plaintiff
asserting a claim against a debtor under the False Claims Act is not a "governmental unit" and does not fall within
the parameters of 11 U.S.C. §362(b)(4), permitting the continuance of a governmental action to enforce police
powers under the circumstances where the government had declined to intervene in the qui tam action.);

</li><li> In re Bren, 303 B.R. 610 (8th Cir. BAP 2004) (debtors that falsely declared under penalty of perjury that they had
read their statement of affairs and bankruptcy schedules and that they were accurate were denied a discharge pursuant
to 11 U.S.C. §727(a)(4)(A) for making a false oath. "To allow debtors to ignore the seriousness of their oath,
submit documents to the court which contain numerous material inaccuracies, and, when the inaccuracies are
discovered, excuse their behavior because they claim they failed to read the documents before signing them under
oath, would undermine the whole structure of the system.");

</li><li> In re Tarbuck, 304 B.R. 718 (Bankr. W.D. Pa. 2004) (if the bankruptcy set-off provisions are equitable in nature,
and permissive rather than mandatory, set-off cannot be invoked if unsupported by equity);

</li><li> In re Callahan, 304 B.R. 743 (W.D. Pa. 2004) (in a matter of apparent first impression, premiums owed by
debtor corporation under Coal Industry Retiree Health Benefit Act, which accrued post-conversion to chapter 7, were
entitled to administrative expense treatment as chapter 7 expenses);

</li><li> In re Midwest Mobile Technologies Inc., 304 B.R. 787 (Bankr. S.D. Ohio 2003) (direct obligee was not
indispensable party to preference action brought against guarantors pursuant to §550(a)(1));

</li><li> In re Donahue Securities Inc., 304 B.R. 797 (Bankr. S.D. Ohio 2003) (in pari delicto doctrine precludes SIPA
trustee from recovering from debtor's employees for alleged breach of duty of care);

</li><li> In re Laspina, 304 B.R. 814 (Bankr. S.D. Ohio 2004) (payments to a debtor under a severance agreement signed
post-petition but negotiated pre-petition were not excluded from the chapter 7 estate pursuant to §541(a)(6));

</li><li> In re Outboard Marine Corp., 304 B.R. 844 (Bankr. N.D. Ill. 2004) (summary judgment cannot be based on
statement made "on information and belief");

</li><li> In re Villarreal, 304 B.R. 882 (8th Cir. BAP 2004) (debtor has no right to bankruptcy counsel);

</li><li> In re Lickman, 304 B.R. 897 (Bankr. M.D. Fla. 2004) (judicial assistants to federal bankruptcy judge also have
judicial immunity);

</li><li> In re Wilson, 305 B.R. 4 (N.D. Iowa 2004) (direct commodity program payments received under the Farm
Security and Rural Investment Act were exempt as "public assistance benefit" under Iowa statute);

</li><li> In re Electrical Contracting Services Co., 305 B.R. 22 (Bankr. D. Colo. 2003) (a collective bargaining
agreement's "favored nations clause" cannot provide good cause for a union's rejection of a debtor's proposals);

</li><li> In re Sullivan, 305 B.R. 809 (Bankr. W.D. Mich. 2004) (liability for usurpation of business opportunity held
nondischargeable as a claim for "willful and malicious injury");

</li><li> In re Hughes Living Trust, 305 B.R. 59 (Bankr. W.D. Okla. 2004) (trust that conducted business but which was
established for estate-planning purposes had no board of directors or officers and where there were no issued
transferable certificates did not qualify as a "business trust");

</li><li> In re Higgins, 305 B.R. 63 (Bankr. N.D. Ala. 2003) (debtor, but not chapter 7 trustee, was judicially estopped
from pursuing copyright infringement claim that was intentionally not disclosed on schedules);

</li><li> In re Hovis, 356 F.3d 820 (7th Cir. 2004) (when chapter 11 plan provides for post-confirmation adjustments to
size of claim, doctrine of "law of the case" did not prevent debtor from objecting to claim post-confirmation);

</li><li> In re Chi-Chi's Inc., 305 B.R. 396 (Bankr. D. Del. 2004) (equity does not require immediate payment of stub
period rent);

</li><li> In re Mid-Valley Inc., 305 B.R. 425 (Bankr. W.D. Pa. 2004) (debtors' insurers were not creditors and thus did not
have standing to seek dismissal of bankruptcy case or to assert lack of disinterestedness on part of proposed future
claims representative);

</li><li> In re Phoenix Group Corp., 305 B.R. 447 (Bankr. N.D. Tex. 2003) (counsel to debtor may rely on its
professional judgment and will not be penalized for failing to comply with directives of debtor's management if
they require counsel to act illegally, unintentionally or contrary to fiduciary debtors);

</li><li> In re Wagner, 305 B.R. 472 (8th Cir. BAP 2004) (it is not appropriate to deny discharge pursuant to
§727(a)(2)(A) where the property transferred did not belong to the debtors);

</li><li> Oliner v. Kontrabecki, 305 B.R. 510 (N.D. Cal. 2004) (district court does not have jurisdiction to hear appeal of
coercive civil contempt order against chapter 11 debtor); and

</li><li> In re Mungo, 305 B.R. 762 (Bankr. D. S.C. 2005) ("ghost-writing" pleadings for individuals violates Federal
Rules of Civil Procedure, South Carolina Rules of Professional Conduct and local bankruptcy rules).
</li>

Journal Authors

Deborah D. Williamson

Ronald Hornberger

Journal Date

Tuesday, June 1, 2004 - 12:00

Bankruptcy Rule

2004