Benchnotes Nov 1998

Journal Issue

Nov 1998

Column Name

Benchnotes

Journal HTML Content

<h3>Collateral Surcharge</h3>

In re Lockwood Corp., 223 B.R. 170 (Bankr. 8th Cir. 1998), addressed an appeal denying an insurance company's

attempt to surcharge collateral for unpaid worker's compensation insurance premiums incurred by the debtor. The

lender was a post-petition debtor-in-possession (DIP) lender with no pre-petition relationship with the debtor. The

final order authorizing DIP financing had "immunized" the lender and its collateral from surcharge claims arising

under §506(c). Relying upon In re Hen House Interstate Inc., 150 F.3d 868 (8th Cir. 1998), which voided such a

provision in an agreement between a pre-petition secured creditor and a debtor, the court found that any attempt to

immunize is unenforceable. The court also noted that such an interpretation, while compelled by an Eighth Circuit

precedent, raises new and significant obstacles for debtors seeking post-petition lending and makes it difficult for

DIPs to negotiate cash collateral agreements with their pre-petition lenders. Further, the court expressed concern that

this decision will hinder courts from allowing the use of cash collateral, "as such rulings must be based upon

findings that a post-petition replacement lien will constitute adequate protection. Under the current precedent, this

has now become...an exceedingly difficult task to accomplish." As noted in this month's "Last in Line" column,

Hen House has been vacated and is set for an en banc rehearing.

<h3>Attorney's Fees for Post-petition Services</h3>

In In re Hines, 147 F.3d 1185 (9th Cir. 1998), the court addressed a "small dollars but large issue" involving the

status of fees attributable to post-petition services rendered in a chapter 7. The underlying case involved a chapter 7

attorney's post-petition cashing of two post-dated personal checks and other actions to collect previously

agreed-upon attorney's fees. The debtor, through new counsel, sought a motion for contempt against the original

counsel for willful violation of §362(a)(6) as an act to collect a pre-petition claim. It was undisputed that there was a

pre-petition employment agreement and that the services were rendered after the filing of the bankruptcy petition.

Further, the source of payment for the fees was not the estate, but the debtor. Noting that Congress has "been

delinquent in failing to deal expressly with the always-present problem of arranging in advance for the payment of

services to be rendered after the filing of the bankruptcy," the court recognized that chapter 7 debtor's attorneys have

normally resorted to working under one of two fee arrangements, both of which are potentially subject to disruption.

In the first approach, the attorney receives full payment from the chapter 7 debtor, in advance of the bankruptcy

filing, for all of the work anticipated to be required in the case. As a technical legal matter, that pre-paid right to

future legal services becomes property of the bankruptcy estate, and the right to legal services should be liquidated to

satisfy creditor's claims against the estate. This could be accomplished by a trustee rejecting the contract with the

attorney, and demanding a refund of the unearned fees. In the second type of arrangement, which is like the one in

question, the chapter 7 debtor's attorney receives a minimal advance payment, plus an agreement that the debtor

will pay the attorney for work done in the bankruptcy from the debtor's post-petition earnings. (The BAP had held

that such an arrangement gives the attorney a pre-petition claim for payment attributable to the pre-petition services,

which claim is discharged.) The Ninth Circuit noted there were several technically correct solutions to this void.

One would be to have the attorney contract initially only to provide pre-petition bankruptcy service and accept

payment only for those services. The attorney could later enter into a separate post-petition agreement to provide any

necessary post-petition services. However, the court noted that "in addition to the patent artificiality of any such

arrangement, it faces difficulties because of the ethical obligations that are typically imposed on any attorney who

files a bankruptcy including, without limitation, the need to seek court approval before withdrawing from such

representation." Similarly, a post-filing reaffirmation by the debtor is complicated by the requirements of §524(c)(3),

which includes the need to provide an affidavit from the debtor's attorney, thus creating an obvious conflict of

interest. The court found that in light of the unsettled state of the law, there was no violation of the automatic stay

arising from the post-petition efforts to collect fees attributable to the post-petition services. Further, the court found

that the attorney had an undischarged claim for any fees earned in excess of that already paid for services rendered

post-petition, but the value of the claim was to be determined under a quantum meruit theory of recovery—not the

remaining balance under the contract.

<h3>Medicare Overpayment Recoupment</h3>

In In re Ahn Home Care, LLC, 222 B.R. 804 (Bankr. N.D. Tex. 1998), the chapter 11 debtor, a health care

provider participating in the Medicare program, brought an adversary proceeding against the U.S. Department of

Health and Human Services (HHS), seeking a determination of the amounts owing between the debtor and the

federal government in connection with alleged overpayments by the government, as well as a recovery of damages

from the government for violation of the automatic stay arising from the government's attempt to recoup the alleged

overpayments from interim payments that were owing to the debtor for post-petition services provided to Medicare

patients. After analyzing the relevant provisions of the Medicare Act, 42 U.S.C. §405(h) and 11 U.S.C. §362, the

court found that the dispute did not "arise under" the Medicare Act for purposes of the Act's restriction on federal

court jurisdiction to hear actions arising under the Act. Therefore, the court found that it had subject matter

jurisdiction to decide the dispute regarding the alleged overpayments and the recoupment. The court then found that

the alleged overpayments that previously had been made to the chapter 11 debtor arose from the same transaction as

the interim payments owed to the debtor for services that it had subsequently provided to Medicare patients. The

court found that the amounts sought to be recouped by the agency came from the same transaction as the previous

overpayments, followed the Fifth Circuit ruling in Matter of Holford, 896 F.2d 176 (5th Cir. 1990) and held that

the right of recoupment, and that the exercise of that right, did not violate the automatic stay. Finally, the court

declined to consider the matter of determination of the amounts owed to the debtor by the HHS and the amounts

owed by HHS to the debtor, finding that it lacked jurisdiction to hear that matter since it is one "arising under" the

Medicare Act, and 42 U.S.C. §405(h) denies the court jurisdiction to consider the matter.

<h3>Jurisdiction</h3>

In the case of Pereira vs. First North American Nat. Bank, 223 B.R. 28 (Bankr. N.D. Ga. 1998), the court

considered a claim of alleged violations of 11 U.S.C. §524. A chapter 7 debtor filed a separate, independent case in

U.S. District Court against a bank, as a class action for himself and all others similarly situated, complaining of the

bank's use of a reaffirmation agreement which the debtor had signed and the bank had successfully moved to

dismiss. The court held that 11 U.S.C. §524 does not create a separate, private cause of action for a creditor's failure

to comply with the statutory requirements and that any action the debtor might have must be brought in the

bankruptcy court that originally issued the automatic stay in debtor's case. The court further held that the provisions

of the Bankruptcy Code pre-empt the former chapter 7 debtor's state law claims grounded upon unjust enrichment

and accounting.

<h3>Cash Collateral Authorization</h3>

In In re America's Hobby Center Inc., 223 B.R. 275 (Bankr. S.D.N.Y. 1998), the court entered an agreed-upon cash

collateral order which provided, among other things, that "the pre-chapter 11 notes and other loan and security

agreements...entered into between [the bank] and the debtor...together with the security interests provided for

thereunder, be and the same, are affirmed, ratified and adopted, without defense or offset, by the debtor, except that

the committee of unsecured creditors shall have 30 days from the date of entry of this Order to object to the

validity of [the bank's] security interests." Thereafter, without seeking court approval, the creditors' committee filed

an adversary proceeding seeking to equitably subordinate the bank's claims to those of the unsecured creditors,

among other allegations and complaints. The court ruled that the agreed-upon cash collateral order did not provide

prior authorization and that the committee should have sought authorization prior to filing its adversary complaint.

However, the court went on to hold that retroactive relief is available and found that appropriate circumstances were

present to approve the filing by the committee, although the better practice is to obtain prior approval, citing In re

Spalding Composites Co. Inc., 207 B.R. 899, 905 (9th Cir. Bankr. 1996).

<h3>Willful Stay Violation</h3>

In In re Novak, 223 B.R. 363 (Bankr. M.D. Fla. 1997), the debtor filed a chapter 7 case and listed a bank as having

a general unsecured claim. In due course, notice of the bankruptcy was sent to the bank, which did not file a

complaint objecting to the debtor's discharge or to the dischargeability of the debt owed to the bank. The debtor's

discharge was entered and the debt to the bank was discharged. Several months later, the debtor went to cash a check

made payable to him from a third party's account at the bank. The bank advised the debtor that it would retain the

funds represented by the check and offset them against the debt owed to the bank. The bank had not made a notation

on the debtor's old account to reflect the notice of bankruptcy. The bank's officers determined that the debt the

debtor owed to the bank was non-dischargeable regardless of the discharge in bankruptcy and offset the funds. These

deliberate actions to obtain partial satisfaction in the face of a bankruptcy filing, notice of the filing, and entry of a

discharge order yielded an award of actual damages, attorney fees and $20,000 in punitive damages.

<h3>Court Lacks Jurisdiction to Release Claims Against Non-debtor</h3>

In re Digital Impact Inc., 223 B.R. 1 (Bankr. N.D. Okla. 1998) is an exhaustive discussion of the issues related to

plan releases of a non-debtor. The court held that it lacked jurisdiction to confirm a plan that contained a release of

claims against the plan proponent, who was a non-debtor third party. The plan also provided for a permanent

injunction enjoining claims against the non-debtor third parties. Further, the court would not retain

post-confirmation jurisdiction to enforce the release.

<h3>Miscellaneous</h3>

<ul>

<li> In re Aboody, 223 B.R. 36 (Bankr. 1st Cir. 1998) (Fed. R. Bankr. P. 9006(b) does not apply in chapter 7s to

extend the time for filing a proof of claim for "excusable neglect");

</li><li> In re Santa Clara County Child Care Consortium, 223 B.R. 40 (Bankr. 1st Cir. 1998) (State court proceedings to

determine validity and enforceability of guarantee between two creditors were not sufficiently "related to" debtor's

case to confer subject matter jurisdiction upon bankruptcy court);

</li><li> In re Mishler, 223 B.R. 17 (Bankr. M.D. Fla. 1998) (IRS successfully levied funds held by chapter 13 trustee

where case was dismissed, although court had earlier entered order that required the trustee to return the funds to the

debtor. An intervening IRS levy was challenged by the debtor.)

</li><li> In re Melancon, 223 B.R. 300 (Bankr. M.D. La. 1998) (Debtor's inability to resist the gambling tables resulted in

a finding of non-dischargeability of credit card cash advances pursuant to 11 U.S.C. §523(a)(2)(A).)

</li><li> In re Howard Furniture Inc., 222 B.R. 795 (Bankr. N.D. Miss. 1998) (11 U.S.C. §724(b) permits a chapter 7

trustee to subordinate a pre-petition tax lien to the payment of enumerated priority claims when insufficient funds

exist with which to pay administrative and priority claims [citing In re Dowco Petroleum Inc. 137 B.R. 207

(Bankr. E.D. Tex. 1992) and Collier's 15th Edition, 724.03[3][b] (1997)].)

</li><li> In re Detrano, 222 B.R. 685 (Bankr. E.D.N.Y. 1998) (Bankruptcy court refused to enforce pre-petition settlement

agreement which provided that obligations under the agreement would be non-dischargeable in bankruptcy, as the

settlement agreement that was a contract and the clause regarding non-dischargeability was unenforceable against

federal bankruptcy policy.)

</li><li> In re LaBRUM & Doak L.L.P., 222 B.R. 749 (Bankr. E.D. Pa. 1998) (Chapter 11 debtor partnership's adversary

proceeding seeking declaratory judgment to approve proposed allocation of the tax recapture liabilities among its

existing and former partners is a core matter.)

</li><li> In re Litton, 222 B.R. 788 (Bankr. W.D. Va. 1998) (Chapter 11 plan had not been substantially consummated

where the debtor had made one payment to the secured lender under the plan but had not made any other payments

to other secured creditors, unsecured creditors or priority creditors, and the debtor that had suffered substantial

change in circumstances and that had not transferred all or substantially all of the property proposed to be transferred

by the original plan could modify plan.)

</li></ul>

<hr>

</td>
<td valign="top" width="125">

Journal Authors

Deborah D. Williamson

Ronald Hornberger

Journal Date

Sunday, November 1, 1998 - 12:00