Benchnotes Dec/Jan 1999

Journal Issue

Dec/Jan 1999

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<h3>Fee Application Reduced</h3>

<p>In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Northeast Express Regional Airlines Inc.,</i> 235 B.R. 695 (Bankr. D.
Me. 1999)</a>, Bankruptcy Judge <b>James A. Goodman</b> addressed the final fee application of
counsel employed by a chapter 7 trustee to pursue certain claims against a third-party airline.
An adversary proceeding had settled for a net recovery to the estate of $650,000, a waiver by
the defendant of a $1.2 million claim for administrative expenses and a waiver of a $2 million
unsecured claim. Noticing that the waiver of the unsecured claim was essentially a waiver of a
worthless claim and that the waiver of the administrative claim only benefited administrative
claimants such as the law firm seeking the payment, the court found that the fee application
sought a recovery of $15,000 more than the net recovery from the adversary proceeding.
While counsel are not required to guarantee success, the court said, "They must still exercise
reasonable judgment in the positions they take." The court reached the conclusion that it was
unreasonable to spend almost 4,000 hours on the litigation, particularly after the defendant
filed a "suggestion of fraud" that, if true, would have hampered the trustee's case because of the
lack of requisite "clean" hands. The court also noted that some months earlier it had granted a
motion for summary judgment that severely eroded the foundation on which the trustee's
"monumental" claims were founded. The applicant asserted that the decision in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re National
Gypsum Co.,</i> 123 F.3d 861 (5th Cir. 1997)</a>, was pertinent to the application. Judge Goodman
disagreed, stating that all applications and pleadings filed with the court specifically noted that
all fees were subject to court approval. Thus, having considered all of the elements of the
lodestar factors, the court approved fees through mediation as well as those incurred in
connection with the settlement, and disallowed all other fees. The court also noted that the
cumulative effect of this ruling was that the applicant received more than 70 percent of the net
recovery from the litigation.

</p><h3>Special Counsel Disgorgement Fees</h3>

<p>In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Chute,</i> 235 B.R. 700 (Bankr. D. Mass. 1999)</a>, the chapter 7 trustee had a
case that became administratively insolvent and sought to compel disgorgement fees that had
been paid to special counsel retained to prosecute a legal malpractice claim on behalf of the
estate. Counsel had been engaged on a contingency-fee basis, successfully brought $12,500 into
the estate and received a payment of $4,409.67. The trustee also had employed a second set of
counsel to pursue a personal injury action on a contingency-fee basis. However, this suit was
unsuccessful. In fact, significant discovery and experts' expenses totaled $29,160.20, and the
defendants had an administrative expense claim in the amount of $4,254.98 for total allowed
administrative expense claims exceeding $36,000. However, the estate had less than $8,000,
the net recovery from the legal malpractice action pursued by the first counsel. The court
agreed that it was within its power to order disgorgement in order to achieve <i>pro rata</i>
distribution to administrative claimants in administratively insolvent cases, but circumstances
did not warrant such disgorgement. The court noted that perhaps the trustee was "improvident"
when it sought and obtained approval of fees and expenses immediately following resolution of
the first litigation, further noting that a potential disgorgement might have a chilling effect on a
chapter 7 trustee's ability in the future to retain special counsel to prosecute claims on behalf
of the estate.

</p><h3>Constructive Trusts</h3>

<p>In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re U.S. Lan Systems Corp.,</i> 235 B.R. 847 (Bankr. E.D. Va. 1999)</a>,
Bankruptcy Judge Stephen S. Mitchell addressed a claim by former employees asserting that
amounts withheld from their salary that should have been (but were not) paid into a 401(k)
plan created an express statutory trust pursuant to 29 U.S.C. §§1104 and 1106. Relying on <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…
re College Bound,</i> 172 B.R. 399 (Bankr. S.D. Fla. 1994)</a>, the court held that the funds held in
the debtor's operating account on the filing date were held in trust for the benefit of the
employees to the extent of the plan contributions withheld from the employees' salaries. The
court then went on to address the issue where, during the bankruptcy case, the debtor's
operating account had become completely depleted. The debtor had subsequently sold all of its
assets and the cash proceeds of the sale were being held in escrow subject to various liens and
claims that, if allowed, would entirely consume the proceeds of the sale. The former employees
argued that a constructive trust should be imposed upon the escrowed funds. The court noted that
in a normal situation, in order to impose a constructive trust, the funds must be "distinctly
traced" into the fund or the property that is to remain the subject of the trust. While troubled
with the imposition of a constructive trust on assets of the debtor other than traceable proceeds,
the court nonetheless followed <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Cardian Mortgage Corp.,</i> 122 B.R. 255 (Bankr. E.D. Va.
1990)</a>, and held that the necessity for tracing ends when the bankruptcy petition is
filed‹provided, however, that the constructive trust could not attach to encumbered assets.

</p><p><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Leitner,</i> 236 B.R. 420 (Bankr. D. Kan. 1999)</a>, also involved the imposition of a
constructive trust. In this case, there was a pre-petition, pre-judgment attachment entered by
the state court less than 90 days prior to the commencement of the debtor's chapter 7 case.
Post-petition, the stay was lifted to allow the state court action to proceed. The state court
entered a final judgment imposing a constructive trust against a home that the
debtor/ex-employee had purchased with funds he had embezzled from his employer. The chapter
7 trustee unsuccessfully sought to avoid the constructive trust. Bankruptcy Judge <b>John T.
Flannagan</b> held that the fact that the pre-judgment attachment was entered less than 90 days
prior to the bankruptcy did not create an avoidable transfer or permit use of strong-arm
powers to bring the property back into the estate since the debtor had no equitable interest in
the home as a result of the constructive trust. While the trust was formally imposed by the state
court post-petition, it arose on the date of the debtor's "bad act." Therefore, it was not an asset
of the estate as of the date of the filing of the bankruptcy.

</p><h3>Patent License Assignment</h3>

<p>In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Access Beyond Technologies Inc.,</i> 237 B.R. 32 (Bankr. D. Del.
1999)</a>, Bankruptcy Judge Mary F. Walrath held that a chapter 11 trustee has the standing to
seek court approval of the debtor's assumption and assignment of a patent license agreement,
and that the patent owner has standing to object to such assignment. In the case before the court,
the patent license was silent on the question of assignability, and thus, under federal law, the
court held that the license was non-transferable because applicable non-bankruptcy
law‹federal patent law‹would bar the chapter 11 debtor/licensee's assignment of the rights
and patent license to a third-party over the patent owner's objection. In reaching this
conclusion, the court rejected the "actual test" approach, which reasons that where the
contract is "merely being assumed by the debtor," the <i>policy</i> behind the non-bankruptcy law
that prohibits assignment is still upheld. The court noted that the majority of the circuit courts
that have addressed this issue have concluded that the plain language of §365(c)(1) requires
the application of a hypothetical test that provides that a debtor-in-possession (DIP) may not
assume an executory contract over the non-debtor's objection if applicable law would bar
assignment to a hypothetical third-party, even where the DIP has no intention of assigning the
contract in question to any such third party, citing <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Catapult Entertainment Inc.,</i> 165 F.3d
747, 750 (9th Cir. 1999)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re James Cable Partners L.P.,</i> 27 F.2d 534, 537, <i>reh'g denied,</i>

38 F.3d 575 (11th Cir. 1994)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re West Electronics Inc.,</i> 852 F.2d 79 (3rd Cir. 1998)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…
re Pioneer Ford Sales Inc.,</i> 729 F.2d 27 (1st Cir. 1984)</a>; and <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Braniff Airways Inc.,</i> 700
F.2d 935, 943 (5th Cir. 1983)</a>.

</p><h3>Post-petition Patent Infringement</h3>

<p>In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Telegroup Inc.,</i> 237 B.R. 87 (Bankr. D. N.J. 1999)</a>, Bankruptcy Judge
William F. Tuohey addressed the ability to pursue an action against a DIP, irrespective of the
automatic stay, pursuant to <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §957(a)</a>, which generally provides that trustees,
"including debtors-in-possession, may be sued, without leave of the court appointing them,
with respect to any other acts or transactions in carrying on business connected with such
property" in the context of an alleged post-petition patent infringement action by the debtor.
The court held that to the extent a party is merely seeking to liquidate a post-petition claim for
damages arising out of the debtor's alleged patent infringement, and where a proof of interest
for an administrative claim arising out of such patent infringement has been filed, the court
may exercise its discretion to prohibit litigation from going forward to liquidate such claim.

</p><h3>Miscellaneous</h3>

<ul>
<li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Williams,</i> 235 B.R. 795 (Bankr. D. Md. 1999)</a> (capital gains exclusion from income
available to the individual taxpayer when its principal residence is sold may be utilized by the
trustee during the bankruptcy case to the same extent that the individual could have utilized the
exclusion);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re TechturnBench Systems Corp.,</i> 235 B.R. 857 (Bankr. E.D. Va. 1999)</a> (anti-assignment act founded on <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §15</a> prohibited an assignment of a chapter 11
debtor's government contracts and thus assumption by the debtor of those contracts over the
government's objection, even when the debtor did not intend to assign);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Lan Associates XI L.P.,</i> 237 B.R 49 (Bankr. D. N.J. 1998)</a> (value of the property
transferred pursuant to a credit bid sale will not be used to calculate the maximum allowable
amount of trustee compensation).
</li></ul>

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Journal Authors

Deborah D. Williamson

Ronald Hornberger

Journal Date

Wednesday, December 1, 1999 - 12:00