Benchnotes Dec/Jan 2001

Journal Issue

Dec/Jan 2001

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<h3>Property Transfers Amenable to Avoidance and Recovery</h3>

<p>In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Smoot,</i> 257 F.3d 401 (4th Cir. 2002)</a>, the Fourth
Circuit followed the majority of opinions that hold that transfers of property capable
of being exempt are amenable to avoidance and recovery actions by bankruptcy trustees.
In this case, the debtor transferred what otherwise would have been exempt property,
and the court found that the transfer was with the requisite intent to hinder, delay
and defraud creditors under §548. The Fourth Circuit held that §548 permits a
trustee to avoid any transfer of an interest of the debtor in property if that
transfer or obligation is entered into with the requisite intent.

</p><h3>"Reasonable Reliance" on False Statement</h3>

<p>In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Michael,</i> 265 B.R. 593 (Bankr. W.D. Tenn. 2002)</a>, the
court held that "reasonable reliance" is to be determined objectively by the fact finder
considering the totality of the circumstances. Further, the court held that a creditor
seeking to prove reasonable reliance on a materially false written statement under
§523(a)(2)(B)(iii) cannot ignore "red flags" contained on the written
statement. In the <i>Michael</i> case, the court found that the debtors' income was grossly
overstated, the debtors failed to list any expenses or personal property on the
financial statement, and the lender's actual knowledge of the debtors' inability to pay
their financial obligations detracted from the lender's position that its reliance on the
financial statement was reasonable under all of the facts and circumstances. The court
held that "[t]hese facts, known by the [lender], compel a commercial creditor to make
some threshold and independent inquiry or investigation into such glaring omissions and
inaccuracies, including the debtors' large annual income, in order to legitimately assert
reasonable reliance arising out of a false financial statement under
§523(a)(2)(B)(iii) when such 'red flags' are present." <i>Michael</i> at 600.
The court observed that "[d]espite the debtors' admissions and candors of difficult
financial circumstances expressed directly to the [lender], the [lender] made no such
inquiry or investigation into the debtors' annual income." Thus, the lender could not
have been said to have "reasonably relied" on the debtors' financial statement.

</p><h3>Social Security Benefits Exempt</h3>

<p>In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Radford,</i> 265 B.R. 827 (Bankr. W.D. Mo. 2000)</a>,
Chief Bankruptcy Judge <b>Arthur B. Federman</b> addressed <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C.A. §407</a> of
the Social Security Act, which provides that no benefits "paid or payable" under the
act are subject to execution, levy, attachment, garnishment or other legal process.
The court held that this provides an exemption for benefits already paid as well as
benefits to be received in the future, and such benefits do not lose their exempt
status once they are in the hands of the debtor. Further, a chapter 7 debtor is
entitled to exempt Social Security benefits without the need to show that these benefits
are necessary for continuing basic care or maintenance.

</p><h3>Chapter 7 Trustee Compensation</h3>

<p>In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re U-Can Rent Inc.,</i> 262 B.R. 147 (Bankr. M.D. Ga.
2001)</a>, Chief Bankruptcy Judge <b>Robert F. Hershner Jr.</b> addressed the issue of
chapter 7 trustee's compensation. Section 326(a) sets the statutory maximum
compensation payable to a bankruptcy trustee. However, while §326 sets the outer
limits, there is no entitlement to the maximum fee since §326(a) also provides
that the court may allow a trustee reasonable compensation under §330. Section 330
provides, in part, that the court may award a trustee reasonable compensation for
actual, necessary services, and reimbursement for actual, necessary expenses. The
court, in determining the amount of reasonable compensation, must consider the nature,
extent and value of the services, taking into account all relevant factors including
time spent on the services, the rates charged, and whether the services were
necessary, beneficial and reasonable. The court held that trustees at all times have
the burden of proving that they have earned the compensation and that the compensation
is reasonable. Further, the trustee's application must provide enough detail to allow
the court to reach some "conclusions regarding an award of reasonable compensation." In
accordance with Fed. R. Bankr. P. 2016, the court then went on to apply the
factors set forth in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Georgia Highway Express Inc.,</i> 488 F.2d
714 (5th Cir. 1974)</a>, noting that the <i>Johnson</i> factors may be adjusted if
the results obtained were of limited success, excellent or exceptional. After
consideration of all these factors, including the fact that the chapter 7 trustee had
hired his own firm as counsel in a successful adversary proceeding, the court awarded
the trustee $20,000, slightly less than half of the maximum amount of
compensation.

</p><h3>Administrative Claim for Attorney's Fees</h3>

<p><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Jack/Wade Drilling Inc.,</i> 258 F.3d 385 (5th Cir. 2001)</a>,
involved a prevailing party in a suit brought by a chapter 7 trustee pursuant to
a contract that provided that the prevailing party was entitled to attorney's fees.
The defendant/prevailing party filed an administrative claim for attorney's fees, costs
and expenses. The Fifth Circuit held that in order to establish an administrative
expense claim, and thus qualify as an "actual and necessary" cost, the claim must
(1) have arisen post-petition and (2) be the result of an action of the
trustee that actually benefited the estate. An exception to this two-prong test is
found in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Co. v. Brown,</i> 391 U.S. 471 (1968)</a>, which
recognized an administrative claim for damages inflicted on innocent third parties
through a trustee's operation of the estate. However, the court held that while
<i>Reading</i> survived congressional amendment and has been recognized and applied by nearly
every court of appeal, it has never been extended to cover debts incurred by a
non-wrongful post-petition action to liquidate a chapter 7 bankruptcy estate. Thus,
the court found that <i>Reading</i> was not intended to grant priority to a post-petition
claim resulting from a trustee's good-faith attempt to liquidate the debtor's estate
by bringing suit on a pre-petition contract. The court then evaluated the claim
under the traditional standard, beginning with the assumption that all creditors "are
equally innocent victims in this bankruptcy." Thus, the question identified by the
Fifth Circuit was "not whether the [claimant] deserves to get paid, but whether
[the claimant] deserves to get paid at the expense of existing unsecured creditors."
The answer to the question was that in a chapter 7 liquidation where the trustee
is not operating the business and where the actions were taken in the course of
responsibly carrying out the duties of a chapter 7 trustee, there was no claim for
administrative priority.

</p><h3>Debtor Fraud While Acting as Fiduciary</h3>

<p>In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Detrano,</i> 266 B.R. 282 (E.D.N.Y. 2001)</a>, District
Judge Amon addressed the issue of whether a settlement agreement precludes an action
against the debtor for fraud while acting in a fiduciary capacity. Pre-petition, an
action was brought against the debtor, who had been appointed as a trustee to manage
certain financial affairs pursuant to an Inter Vivos Trust Agreement, alleging that
the debtor had fraudulently converted funds. The parties subsequently entered into a
settlement agreement pursuant to which the debtor agreed to pay in full claims totaling
$480,000 plus interest. The settlement agreement further provided that the parties
shall exchange general releases. The debtor defaulted after making minimum payments, and
an action was commenced in state court seeking to enforce the settlement agreement.
A judgment was entered for the dollar amount then owing under the settlement agreement
plus specific performance of non-monetary obligations under the settlement agreement. The
debtor then filed chapter 7, and a complaint was filed seeking a determination that
obligations owed pursuant to state court judgment were not dischargeable pursuant to
§523(a)(4). The bankruptcy court ruled that regardless of the underlying nature
of the claims encompassed in the settlement agreement, the obligation was dischargeable
because the judgment was based on the contractual debt contained in the settlement
agreement. On appeal, the district court undertook a review of cases addressing the
issue of whether a bankruptcy court should look beyond a settlement agreement to
determine whether a debt was in fact based on fraud. After reviewing such decisions,
the court followed the "better-reasoned" majority and concluded that a discharge
proceeding in bankruptcy is fundamentally different from a tort action seeking damages.
Thus, under the facts of this case, the settlement did not prevent an inquiry into
whether the debtor in fact committed fraud or breached his fiduciary duties as alleged
for purposes of determining the dischargeability of the debt. The court also held that
it could not "discern any valid reason why it would make a substantial difference here
that, in addition to resolving the state court actions, the settlement agreement at
issue also contains a general release," agreeing with <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…. v. Spicer,</i> 57 F.3d
1152 (D.C. Cir. 1995), <i>cert. denied,</i> 516 U.S. 1043
(1996)</a>, that a debtor should not be allowed to "escape non-dischargeability,
imposed as a matter of public policy by Congress...merely by altering the form of
his debt through a settlement agreement, whether or not the agreement includes an
express release or waiver of the fraud claim."

</p><h3>Rule 2004 and Subpoenas</h3>

<p>In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Fred Ayers Co. Inc.,</i> 266 B.R. 557 (Bankr. M.D.
Ga. 2001)</a>, Bankruptcy Judge <b>John T. Laney III</b> addressed whether a subpoena
issued in connection with a court order in or pursuant to a Rule 2004 exam must
be issued from the court for the district in which the bankruptcy case is pending or
from the court for the district in which the Rule 2004 examination was to take
place. The court reviewed Rule 2004(c), which provides that attendance may be
compelled "in the manner provided in Rule 9016 for the attendance of witnesses at
a hearing or trial." The court then noted that Rule 9016 incorporates Rule 45
of the Federal Rules of Civil Procedure, which provides that a subpoena commanding
attendance shall issue from the court for the district in which the hearing or trial
is to be held. However, a subpoena for attendance at a deposition shall issue from
the court for the district designated by the Notice of Deposition as the district in
which the deposition is to be taken. The starting point for interpreting the statute
is the language of the statute itself, and parties must look to the entire statutory
context. The court noted that a Rule 2004 examination is broader in scope than
a deposition. The court also noted that the second and third sentences of Fed. R.
Civ. P. 45(a)(2) are inapplicable to a Rule 2004(c) examination. Thus,
interpreting the first sentence of Fed. R. Civ. P. 45(a)(2), the court
disagreed with the decision in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Texas International Co.,</i> 97 B.R. 582
(Bankr. C.D. Cal. 1989)</a>, and held that a subpoena issued by the court
for Rule 2004 examination need not be issued from the district court where the
examination is to be taken.

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

<ul>
<li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Altman,</i> 265 B.R. 652 (Bankr. D. Conn. 2002)</a>
(creditors do not have an automatic right to intervene in contested matters just as
they do not have an automatic right to intervene in an adversary proceeding);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Reeves,</i> 265 B.R. 766 (Bankr. N.D. Ohio 2002)</a>
(ex-employer did not violate discharge injunction by deducting from severance payments
payable to debtor under the employment agreement sums sufficient to satisfy debtor's
obligations pursuant to the same employment agreement to reimburse employer for charges
on company credit card);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Radford,</i> 265 B.R. 827 (Bankr. W.D. Mo. 2000)</a> (42
U.S.C.A. §407 of the Social Security Act, which provides that no benefits
"paid or payable" under the act are subject to execution, levy, attachment,
garnishment or other legal process, provides an exemption for benefits already paid
as well as benefits in the future; said benefits did not lose their exempt status
once they were in the hands of the debtor and were capable of being exempted without
the need to show that these benefits were necessary for continuing basic care or
maintenance);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Reardon,</i> 265 B.R. 533 (Bankr. E.D. Pa. 2002)</a> (upon
the filing of the debtor's chapter 7 case, the debtor had no standing to remove a
pending state court action to the bankruptcy court as the chapter 7 trustee succeeded
to whatever interest the debtor had in his pending, pre-petition personal injury
action);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Craig,</i> 265 B.R. 624 (Bankr. M.D. Fla. 2002)</a>
(provision in engagement letter that provided that the attorneys could move to dismiss
or convert the bankruptcy case if the debtor-client became delinquent in payment of
attorneys' fees was held to create a clear conflict of interest);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Swallen's Inc.,</i> 266 B.R. 807 (Bankr. S.D. Ohio 2000)</a>
(relying upon <i>In re Kaypro,</i> 218 F.3d 1070 (9th Cir. 2000))
(existence of a "pre-petition restructuring agreement is not <i>ipso facto</i> determinative
of whether payments were made in the ordinary course of business");

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Southern Industrial Mechanical Corp.,</i> 266 B.R. 827 (W.D.
Tenn. 2001)</a> (chapter 7 debtor's knowing and voluntary contractual waiver of right
to trial by jury is binding upon the chapter 7 trustee);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Philip Services (Delaware) Inc.,</i> 267 B.R. 62 (Bankr. D.
Del. 2001)</a> (§547(c) does not limit the defenses that may be raised in
preference actions, and other affirmative defenses such as latches, unclean hands and
setoff may be raised);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Altman,</i> 265 B.R. 652 (Bankr. D. Conn. 2001)</a>
(creditors do not have an automatic right to intervene in contested matters or in
adversary proceedings);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Reeves,</i> 265 B.R. 766 (Bankr. N.D. Ohio 2001)</a>

(ex-employer did not violate discharge injunction by deducting, from severance
payments payable to the debtor under an employment agreement, an amount sufficient
to satisfy the debtor's obligation pursuant to the same employment agreement to
reimburse employer for charges on company credit card);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Sand & Sage Farm and Ranch Inc.,</i> 266 B.R. 507 (Bankr.
D. Kan. 2001)</a> (under Kansas law, center pivot irrigation system was a fixture
and not equipment);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Coleman Enterprises Inc.,</i> 266 B.R. 423 (Bankr. D. Minn.
2001)</a> (creditors may seek removal of a debtor from "fast-track" status for a
small business reorganization);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Indian Motorcycle Co. Inc.,</i> 261 B.R. 800 (B.A.P. 1st
Cir. 2001)</a> (§502(c) may not be used to estimate debtor's post-petition tax
liability);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Asset Recovery Group Inc.,</i> 261 B.R. 825 (Bankr. W.D.
Pa. 2001)</a> (as a matter of law, a party may recoup regardless of whether there
was some sort of over-payment);

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Transport Associates Inc.,</i> 263 B.R. 531 (Bankr. W.D. Ky.
2002)</a> (while the trustee's objection to insurance company's claim was subject to
mandatory arbitration under the arbitration clause contained in the insurance contract,
the equitable subordination claim under §510(c) was not subject to arbitration);
and

</li><li><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Cybernetic Services Inc.,</i> 252 F.3d 1039 (9th Cir.
2002)</a> (while the Patent Act requires all "ownership interests" to be recorded with
the Patent Office, the Patent Act does not pre-empt the filing and perfection
provisions of the UCC, as a security interest does not represent "ownership" of a
patent and is perfected by the filing requirements of Article 9 of the UCC).
</li></ul>

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Journal Authors

Deborah D. Williamson

Ronald Hornberger

Journal Date

Saturday, December 1, 2001 - 12:00

Bankruptcy Rule

2001