Benchnotes Jun 2001

In In re Olympic Natural Gas Co., 258 B.R. 161 (Bankr. S.D.
Tex. 2001), Bankruptcy Judge William R. Geendyke addressed the issue of whether
payments made under certain contracts for the purchase and sale of natural gas could
be avoided as preferential or fraudulent conveyances. In 1996, Morgan Stanley began
entering into numerous contracts with the debtor (or its predecessors) to purchase and
sell natural gas in accordance with a contract that was characterized under its own
terms as a "forward contract" relating to the purchase and sale of natural gas. Morgan
Stanley asserted that pursuant to §546(e), a trustee could not avoid "settlement
payments" made to a "forward contract merchant." The initial question was whether Morgan
Stanley was a "forward contract merchant." The trustee admitted that Morgan Stanley's
business consisted "in part" of entering into forward contracts. However, relying on
a decision out of Canada, the trustee asked the court to make a distinction on the
grounds that Morgan Stanley does not produce or distribute natural gas, and thus was
not a forward contract merchant of natural gas. However, the court rejected this
argument and held that Morgan Stanley fell within the business of a forward contract
merchant. The second question was whether the payments between the debtor and Morgan
Stanley were "settlement payments." The court noted that §§741(8) and
101(51A) both define settlement payments for purposes of §546(e). While both
definitions are similar, the court held that §101(51A) is limited to a
definition of the types of payments commonly used in forward contract trades. In
interpreting §741(8), the court noted that the type of payments made and the
transactions at issue are "clearly not the type of settlement payments in the securities
industry that Congress intended to protect from the trustee's avoidance powers with the
definition provided by §741(8)." The court noted that the payments were for
natural gas actually purchased and that allowing avoidance of these transactions would
have no impact on the securities system. These were private transactions that did not
implicate the securities settlement process; no intermediaries or clearing agencies were
involved and there was no link between these transactions and the securities industry.
However, the court noted it must also entertain the definition provided in
§101(51A), which includes, for purposes of forward contract provisions, a "net
settlement payment." After taking into account the debtor's and Morgan Stanley's mutual
debt, all payments were made to the party with the net account receivables. The court
held that under the plain reading of §101(51A), these payments should be
characterized as payments commonly used in this forward contract trade and thus, a
settlement payment pursuant to §101(51A). As such, pursuant to §546(e),
the trustee may not avoid the payments made to Morgan Stanley.

Debt Repayment Avoided as Preferential Transfer

In In re McDowell, 258 B.R. 296 (Bankr. M.D. Ga. 2001),
Chief Bankruptcy Judge Robert F. Hershner Jr. addressed the distinctions between
the earmarking doctrine and an "implied trust." In this case, a chapter 7 trustee
brought an adversary proceeding to avoid, as alleged preference, the debtor's repayment
of a loan from his son-in-law. The loan was made for the specific purpose of
permitting the debtor to repay a debt to his ex-wife and thereby avoid being held
in contempt. The $80,000 borrowed from the son-in-law had been deposited into
an interest-bearing checking account, the sole purpose of which was to satisfy the
debtor's obligation to his ex-wife. The testimony was that the debtor understood he
could not use the loan for any purpose other than to satisfy the obligation to the
ex-wife. The debtor unexpectedly acquired other funds and did not find it necessary
to use the $80,000. He repaid the loan by issuing a check in the amount of
the $80,000 drawn on the account to which the check was originally deposited.
Between the initial deposit of the $80,000 and the repayment, the balance in
the bank account was never less than $80,000. After repayment, the bank account
was closed and the proceeds from the bank account were transferred to an account the
debtor maintained at another institution. The defendants argued that pursuant to the
earmarking doctrine, the transfer could be avoided since the $80,000 was
originally transferred with the clear agreement that the property is to be used by the
debtor to pay his ex-wife. The court noted that the application of the earmarking
doctrine is inherently fact-based, and it must determine the precise agreement between
the debtor and the transfer of property in order to determine whether the debtor ever
acquired an interest in the property that was transferred. Judge Hershner held that
three requirements must be met in the application of the earmarking doctrine: (1)
the existence of an agreement between the new lender and the debtor that the funds
would be used to repay a specific, specified unassumed debt, (2) the performance
of that agreement, according to its terms, and (3) the transaction viewed as a
whole, including the transfer in of the new funds and the transfer out to the old
creditor, does not result in any dimunation of the estate. In this case, the court
held that since the proceeds were actually repaid to the defendant in full, there was
the dimunition of the debtor's bankruptcy estate, rather than a substitution of one
creditor for another; thus, the earmarking doctrine did not apply. The defendant also
argued that the funds were loaned to be held in an implied trust. Implied trusts
were found to include circumstances where the parties intended that the person holding
legal title to the property would have no beneficial interest in the property. The
court looked to the state law of Georgia to determine the existence of a constructive
or implied trust, but looked to federal law to determine whether the funds at issue
could be traced to the constructive trust. The fact that the debtor deposited the loan
into a checking account that contained other funds did not destroy the characterization
of the loan as trust funds. The court held that it may hear parol evidence to
determine the true nature of the transaction, and based on the evidence before the
court, it held that the debtor held the funds in an implied trust. The funds were
loaned to the debtor "to be applied to a particular purpose" (to pay the ex-wife)
and were deposited into an account, the sole purpose of which was to satisfy the
obligation to the ex-wife. The uncontroverted evidence was that the debtor understood
that he could not use the loan for any purpose other than to satisfy this obligation.
Thus, the court held that the trustee did not establish that there was a "transfer
of any interest of the debtor in property" as that phrase is used in §547(b),
and thus, the loan repayment could be avoided as a preferential transfer.

Unreported Income to Subsidized Housing a Breach of Contract

In In re Smith, 259 B.R. 901 (Bankr. 8th Cir. 2001), the
debtor resided in public housing and her rent was subsidized by the public housing
authority as the administrator of housing assistance funds. The housing authority directly
paid to the debtor's landlord a specific amount each month to rent an apartment. If
the debtor's benefits terminated, the housing authority would no longer pay the
subsidy, and the landlord, not receiving the rent, would have the right to evict
the debtor. Sometime in 1999, the housing authority discovered that the debtor had
failed to report income and, accordingly, sent a letter to the debtor advising that
it had discovered the unreported income and requested a payment of rent in accordance
with regulations. The debtor failed to make the required payments and filed a chapter
7 petition two days before the termination date. After receiving notice of the
chapter 7, the housing authority sent another letter to the debtor's attorney stating
that the benefits had terminated due to the debtor's failure to report income. The
housing authority thereafter filed a motion for relief from stay, which was granted.
The order was "specific and narrow," providing that the housing authority could
terminate the debtor from the housing program and discontinue making any payments to the
landlord for rent due and did not address the debtor's right to apply for future
benefits. On appeal, the debtor argued that §525 precluded the housing authority
from terminating her benefits on the grounds of non-payment. The court held that while
§525(a) protects debtors from acts of discrimination by housing authorities when the
discrimination is due solely to the fact the debtor has filed a bankruptcy petition,
was insolvent or failed to pay a discharged obligation, it does not affect termination
for fraud. Further, on appeal, the court held that even if the housing authority's
decision to terminate her benefits arose solely from the failure to pay a debt,
§525 does not prohibit termination of those benefits. The court noted that
pre-petition, the debtor had breached her contract with the housing authority, thereby
giving the housing authority cause to terminate the relationship. "Section 525 does
not operate to cure the [debtor's] contractual defaults and does not require the housing
authority to continue its contractual relationship with her."

In a similar case, Stoltz v. Brattleboro Housing Authority, 259 B.R.
255 (D. Vt. 2001), the court held the public housing authority qualified
as a "governmental unit" subject to §525's anti-discrimination provision. Thus, the
housing authority was barred from evicting a tenant from public housing on the basis
of an unpaid rental obligation that had been discharged in the tenant's bankruptcy.

Miscellaneous

• In re Maynard, 258 B.R. 91 (Bankr. D. Vt. 2001) (once a
  trustee determines not to proceed with objection to discharge, the trustee must seek
  to dismiss since compromise or settlement is not an option under §727(a));
• In re Burke, 258 B.R. 310 (Bankr. S.D. Ga. 2001) (the
  state of Georgia violated a discharge injunction when it sent a collection letter after
  entry of order of discharge demanding payment of past due tax that had been determined
  by the bankruptcy court to be a general unsecured claim);
• In re Carroll, 258 B.R. 316 (Bankr. S.D. Ga. 2001)
  (debtor has standing to pursue lien avoidance action asserting an impairment of an
  exemption in a reopened case notwithstanding that debtor no longer owned the property
  subject to the lien);
• In re Jercich, 238 F.3d 1202 (9th Cir. 2001)

  (debtor-employer's deliberate breach of employment contract in electing not to pay wages
  owed to employee, even though funds were available to do so, and instead choosing
  to use funds for a variety of personal investments was sufficiently "malicious" such
  that resulting indebtedness would be expected for discharge as one for willful and
  malicious injury);

• In re ICLNDS Notes Acquisition LLC, 259 B.R. 289 (Bankr. M.D.
  Ohio 2001) (limited liability company may not appear in court through a manager
  who is not an attorney but must be represented by counsel);
• In re Amos, 259 B.R. 317 (Bankr. C.D. Ill. 2001)
  (pre-petition acceleration of mortgage debt did not enable chapter 13 trustee to
  modify rights of creditor whose claim is secured only by interest in real property that
  is debtor's principal residence pursuant to §1322(b)(2));
• In re Armstrong, 259 B.R. 338 (E.D. Ark. 2001) (casino
  which was found to have sufficient knowledge to place it on inquiry notice as to
  debtor's possible insolvency was not entitled to the "good faith transferee for value"
  defense to fraudulent transfer claim brought by chapter 7 trustee); and
• In re Delash, 260 B.R. 4 (Bankr. E.D. Cal. 2000) (former
  trustee has no standing to file a motion to reopen a chapter 7 case in order to
  administer an asset, as such relief would infringe on the authority of a U.S.
  Trustee to decide whether former chapter 7 trustee should be reappointed).