Benchnotes May 1999
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In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Mid-American Waste Systems,</i> 228 B.R. 816 (Bankr. D. Del. 1999)</a>, Chief Bankruptcy Judge
<b>Peter J. Walsh</b> addressed objections to claims filed by former officers and directors of a reorganized chapter 11
debtor and underwriters on a sale of the debtor's stock. Claims had been asserted for indemnification of costs
associated with securities litigation. The former officers and directors also sought an administrative expense priority
for such claims. The court held that, to establish an administrative expense priority under §503(b)(1)(A), the officer
and director claimants must have demonstrated that the claimed expenses 1) arose out of a post-petition transaction
with the debtor-in-possession, and 2) directly and substantially benefited the bankruptcy estate. Under the facts of
this case, the court found that the claimants were all employed pre-petition by the debtor, the conduct that formed
the basis for the litigation all arose out of pre-petition activities, and the indemnification provisions were in place
during the pre-petition relevant period and covered the claimants throughout the pre-petition period during which the
conduct at issue occurred. Thus, the court found that the indemnification claims were not "on account of" services
rendered after the commencement of the case. Instead, they were claims for pre-petition compensation for services
rendered, not unlike salary or other benefits. The court then addressed the issue of whether the claims (including the
claims of the underwriter on the issuance of stock) should be subordinated pursuant to §510(b). The reorganized
debtor successfully argued the claims were for "reimbursement" within the contemplation of §510(b) and therefore
should be subordinated, with the court relying upon its understanding of the legislative history behind §510(b) and
cases interpreting the same.
</p><h3>Defining Abandonment</h3>
<p>In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Keller,</i> 229 B.R. 900 (Bankr. S.D. Ohio 1998)</a>, Bankruptcy Judge Donald E. Calhoun Jr.
again emphasized the irreversible effect of abandonment. The chapter 7 debtor had scheduled property of the estate
subject to a debt, the property was subsequently abandoned by the chapter 7 trustee and there was an unopposed order granting the creditor relief from the automatic stay.
After abandonment and entry of the order, the creditor discovered an inadvertent failure to describe all property in its
mortgage. In state court, the creditor sought to reform the mortgage to reflect the parties' intent. The debtors and the
chapter 7 trustee then reopened their bankruptcy case and attempted to avoid the reformed and refiled mortgages and
the lien on the previously unperfected parts of real property. The bankruptcy court noted that, while the arguments
on the effect of the trustee's status as a bona fide purchaser pursuant to §544 were "interesting," they unfortunately
failed to address the dispositive issue of the effect of abandonment. Finding without question that the property was
scheduled and that the lien against the property was not avoided during the pendency of the bankruptcy case
(therefore surviving the discharge), after abandonment there was no trustee to assert the rights of the hypothetical
lien creditor or bona fide purchaser, nor to challenge validity of the lien or include the reaffirmation of the mortgage.
The court noted in this case that the abandonment was by street address and not by legal description, and the issue
on the mortgage related to the legal description. If the abandonment had been the legal description, using the
description as attached to the recorded mortgage, this issue might not have been before the court.
</p><h3>Discovery Abuse Sanctions</h3>
<p>In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Rimsat Ltd.,</i> 229 B.R. 914 (Bankr. N.D. Ind. 1998)</a>, Bankruptcy Judge Robert B. Grant
addressed the difficulty of imposing sanctions for discovery abuse during a deposition, noting that the procedural
rules did not provide a completely satisfactory vehicle for adequately responding to counsel's sanctionable
conduct. Accordingly, the court found it necessary to supplement the rules by reliance upon §105(a). Judge Grant
noted that Rule 30 (which is made applicable pursuant to Rule 7030) provides a vehicle for recovering expenses that
have been needlessly imposed upon a litigant because a party does not proceed with the deposition as scheduled.
However, in a case before the court, the deposition did indeed commence, although nothing in the substantive sense
was accomplished. Improper discovery requests, responses and objections are governed by Rule 26(g), made
applicable pursuant to Bankruptcy Rule 7026. The standard for imposing sanctions pursuant to Rule 26(g) is much
the same as the standard for imposing sanctions under Rule 9011. However, the sanctions contemplated by those
rules can only be imposed upon the individual attorney who actually signed the notice of deposition and the client
on whose behalf it was submitted, and not the counsel who attended the deposition at which the abusive discovery
occurred. The court then turned to <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §1927</a>, which gives the court authority to require an attorney who
"multiplies proceedings in any case, unreasonably and vexatiously" to pay the excess costs, expenses and reasonable
attorney's fees incurred because of such conduct. Although the counsel's conduct violated §1927, the court found
that bankruptcy courts do not have authority to impose such sanctions pursuant to that statute, <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… of Voltert,</i>
110 F.3d 494, 497 (7th Cir. 1997)</a>. However, that decision recognizes that bankruptcy courts do possess the
authority to sanction such conduct under §105(a). In addition, recognizing that it was a "harsh sanction," the court
found that counsel's unthinking "file and litigate anything we can think of, just for the sake of doing so" approach
to the case justified revocation of the authorization to appear <i>pro hac vice.</i>
</p><h3>Original Issue Discounts</h3>
<p>In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re ICH Corp.,</i> 230 B.R. 88 (Bankr. N.D. Texas 1999)</a>, District Judge Fitzwater addressed the
issue of whether the bankruptcy court had erred in holding that a debenture did not, as a matter of law, include an
Original Issue Discount (OID). An OID results when an entity issues a debt instrument for consideration that is less
than its face value. The discount equals the difference between the debt instrument's face value (also called the stated
principal amount or the redemption value) and the proceeds received by the issuer. This discount compensates for a
submarket interest rate, and therefore is in the nature of additional interest. As OID is in the nature of interest, a
creditor may not recover unamortized OID in a bankruptcy case. The court noted that the Bankruptcy Code does not
provide guidance concerning how to determine the existence of an OID in a debt-for-stock transaction, and that the
two circuits that have addressed OID issues have done so in a specific context of a debt-for-debt exchange in a
consensual, out-of-court workout. Thus, absent a guiding precedent, the court noted that bankruptcy policy
mandates that the court determine the existence of OID—which would never exist if the parties stated in the contract
that the debt and the property given in exchange had the same value—by considering evidence outside the parties'
agreement. The court determined that the Parol Evidence Rule, which would arguably permit creditors to make
interest appear to be principal and then collect the unearned interest in contradiction to the policy underlining
§502(b), would not bar extrinsic evidence of OID due to specific provisions contained in the debenture that was part
of the overall contract, which must be viewed as a whole. The court also stated that the contract language was
ambiguous, and thus the Parol Evidence Rule would not bar extrinsic evidence as to the value of the stock, as the
parties' statement of the stock's aggregate price is a recitation of fact that may be contradicted by extrinsic evidence,
not evidence of an agreement.
</p><h3>Miscellaneous</h3>
<ul>
<li><a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Pilavis,</i> 228 B.R. 808 (Bankr. D. Mass. 1999)</a> (there is no right to a jury trial in an action for the
avoidance of an alleged fraudulent conveyance);
</li><li><a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Whitmer,</i> 228 B.R. 841 (Bankr. W.D. Va. 1998)</a> (earned income credit that the chapter 7 debtor received
in the tax year in which its bankruptcy case commenced was "property of the estate" and subject to turnover as
pro-rated to the date on which the bankruptcy petition was filed);
</li><li><a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Williamson,</i> 228 B.R. 910 (Bankr. N.D. Ill 1999)</a> (§722 allows redemption of the debtor's automobile
from a wholly unsecured second lien by payment of a nominal amount);
</li><li><a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Baird,</i> 229 B.R. 361 (Bankr. D. S.C. 1997)</a> (debt that was to be secured by a debtor's crop was
non-dischargeable based on the debtor's false representation that he intended to plant crops that were not planted);
</li><li><a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Blue Cactus Post L.P.,</i> 229 B.R. 379 (Bankr. N.D. Tex. 1999)</a> (county appraisal district that was a
political subdivision created by the state to appraise property within the county for <i>ad valorem</i> tax purposes was not
the arm of the state and not entitled to 11th Amendment sovereign immunity);
</li><li><a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Rimsat Ltd.,</i> 229 B.R. 914 (Bankr. N.D. Ind. 1998)</a> (pursuant to §726(a)(6), any estate property
remaining after all creditors have been paid in full is distributed to the debtor, not to the debtor's shareholders);
</li><li><a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Long John Silver's,</i> 230 B.R. 29 (Bankr. N.D. Del. 1999)</a> (Perishable Agriculture Commodities Act
does not apply to french fries that were enhanced by a batter that was engineered to improve texture and allow fries
to retain heat rather than to preserve the fries or to prepare them for freezing) (<i>See</i> "Last in Line," p. 32, for a full
discussion); and
</li><li><a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Trans-End Technology Inc.,</i> 230 B.R. 101 (Bankr. N.D. Ohio 1998)</a> (prior to seeking recovery from a
subsequent transferee, the initial transfer must be first be avoided rather than merely proven to be avoidable).
</li>
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