Bankruptcy Litigation

New Developments of Federal Preemption under Section 303 of the Bankruptcy Code

By: J. Tyler Mills

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In Rosenberg v. DVI Receivables XVII, LLC,[1] the Third Circuit held that an award of damages after the dismissal of an involuntary bankruptcy petition does not preempt a claim for tortious interference with contracts and business relationships brought against the petitioning creditors by injured parties who were not alleged debtors.[2] There, an involuntary bankruptcy was brought against a medical imaging company to collect on leases for various medical equipment.[3] After the involuntary petition was dismissed, the alleged debtor sued the petitioning creditors to recover costs, attorney’s fees, and damages for the bad faith filing of the involuntary petition.[4] The jury awarded the alleged debtor $1.1 million in compensatory damages and $5 million in punitive damages.[5]

Governmental Agency Can’t Foot the Bill by Repackaging its Claim

By: Christina Mavrikis

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re G-I Holdings, Inc., the Third Circuit of the United States Court of Appeals held that the New York City Housing Authority (“NYCHA”) could not repackage a claim for damages against G-I Holdings in the hopes of circumventing federal bankruptcy laws. G-I Holdings was the manufacturer of housing products containing asbestos. Seeking to address its asbestos related lawsuits, in 2001 GI Holdings filed for relief under Chapter 11 of the Bankruptcy Code in the Bankruptcy Court for the District of New Jersey. NYCHA submitted a half-billion dollar claim against G-I Holdings for property damage to its buildings. NYCHA claimed it had to take expensive measures to remove asbestos containing material from its buildings. In 2009, the District Court for the District of New Jersey and the Bankruptcy Court for the District of New Jersey approved a plan of reorganization that disposed all covered claims against G-I Holdings. Claim holders were also barred from reasserting such claims.

Foreign Representatives May Bypass The Recognition Process To Recover Debtor’s Property

By: Parm Partik Singh

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

A “foreign representative” must obtain recognition of a foreign proceeding pursuant to 11 U.S.C. § 1517 prior to “apply[ing] directly to a court in the United States.” However, under § 1509(f), a foreign representative may sue in a United States court “to collect or recover a claim which is the property of the debtor” without first obtaining recognition. The scope of this exception, however, is unclear.

Creditor’s Failure to File a Proof of Claim Inexcusable Where Potential Danger of Prejudice to Debtor Exists

By: Meghan Lombardo

St. John’s Law Student

American Bankruptcy Institute Law Review Staffer

In In re LMM Sports Management, the United States Bankruptcy Appellate Panel for the Ninth Circuit affirmed the bankruptcy court’s order disallowing a proof of claim that was filed after the deadline to file claims against the debtor (the “Bar Date”). Appellant Warner Angle Hallam Jackson & Formancek, P.L.C. (“Warner Angle”) filed proofs of claim against the debtor, LMM Sports Management (“LMM” or the “Debtor”), for legal services it provided to LLM in connection with a prior state court case against Your Source Pacific Fund I, LLP (“Your Source”). In the state court case, Your Source obtained a $2.4 million judgment against LLM, causing LLM to file for protection under chapter 11 of the Bankruptcy Code. The bankruptcy court approved a settlement of $1.5 million between Your Source and LMM (represented by new counsel) in full satisfaction of Your Source’s judgment over Warner Angle’s objection. Warner Angle filed its objection to the Debtor’s settlement motion on February 17, 2015, two months after the bar date. One day later, Warner Angle belatedly filed the proofs of claim. The Debtor objected to the proofs of claim arguing they should be disallowed as untimely. Warner Angle then filed a cross-motion requesting that the proofs be treated as timely because the late filing was the result of excusable neglect. The bankruptcy court rejected Warner Angle’s excusable neglect argument and denied its reconsideration motion. Warner Angle appealed.

Public Policy Necessitates Penetration of § 363’s Liability Shield

By: Julie Lavoie

St. John’s Law Student

American Bankruptcy Institute Law Review Staffer

In In re Motors Liquidation Co., the Second Circuit reversed the Bankruptcy Court of the Southern District of New York’s holding that the “free and clear” provision in the sale order barred plaintiff’s claims against New GM arising out of ignition switch defects. The Second Circuit acknowledged that the bankruptcy court was correct in concluding that even though the cars were not recalled for ignition switch defects until 2014, five years after the § 363 sale, there was ample evidence that Old GM knew or should have known about the ignition switch defect prior to bankruptcy. Therefore, due process dictates that claimants were entitled to notice of the sale by direct mail or an equivalent means. Unlike the bankruptcy court, the Second Circuit found that ignition switch claimants were prejudiced by this lack of notice. The Second Circuit could not confidently say that, given the circumstances, the outcome of the § 363 sale motion would have been the same if the claimants were notified and thus afforded the opportunity to be heard and partake in the negotiation.

Finding a Safe Harbor After the Storm

By: William Accordino

St. John’s Law Student

American Bankruptcy Institute Law Review Staffer

In In re Lehman Brothers Holdings Inc. (“Lehman”), Judge Shelley C. Chapman of the United States Bankruptcy Court for the Southern District of New York dismissed a complaint filed by Lehman Brothers Holding Inc. (“LBHI”) and Lehman Brothers Special Financing Inc. (“LBSF”) challenging the early termination of forty-four credit default swap agreements.[1] The complaint alleged the subsequent liquidation of the collateral underlying those agreements after the early termination and the distribution of those proceeds violated the Bankruptcy Code (“Code”) despite LBSF’s default.[2] Of the forty-four swap agreements, the court found five contained provisions that “effected an ipso facto modification of LBSF’s rights . . . .”[3] However, the distributions from those transactions were protected by the Code’s safe harbor provision.[4] Judge Chapman found the priority provisions in the other thirty-nine swap agreements did not operate as ipso facto clauses because they did not modify any rights of LBSF.[5] The payment priority for those agreements was not set at any time prior to the termination of the swap, thus no right to payment priority could be modified by a termination.[6] As a result, all nineteen counts of the complaint were dismissed for failure to state a cause of action.[7]

Exposing the Lack of Uniformity in U.S. Bankruptcy Law: Puerto Rico’s Own Municipal Bankruptcy Law Preempted by Chapter 9

By: Matthew Repetto

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In Franklin v. Puerto Rico , the First Circuit held that Puerto Rico’s effort to restructure the debt of its public utilities through the enactment of its own municipal bankruptcy law, the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (“Recovery Act”), was preempted by Section 903(1) of the United States Bankruptcy Code.[1] Amid the most serious fiscal crisis in its history, Puerto Rico’s public utilities are currently at risk of becoming insolvent.[2] Unlike states, Puerto Rico is a territory and “may not authorize its municipalities . . . to seek federal bankruptcy relief under chapter 9 of the U.S. Bankruptcy Code.”[3] Thus, the Recovery Act was Puerto Rico’s attempt to “fill the gap” by providing relief on its own.[4] The Recovery Act was enacted to mirror chapter 9 and chapter 11 of the United States Bankruptcy Code.[5] Those in favor of the Recovery Act argued that preemption would leave Puerto Rico with no means of relief.[6] However, the First Circuit disagreed, and noted that Puerto Rico could, as it had already, seek relief directly from Congress.[7]

Discretionary Automatic Stays “Pave” Way for More Litigation

By: Joanna Matuza

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In Pavers & Road Builders District Council Welfare Fund v. Core Contracting of NY, LLC, the Eastern District Court of New York exercised its discretion with regard to automatic stays in its holding that a corporation’s alter ego status does not permit an automatic stay for non-debtors. In Pavers & Road Builders District Council Welfare Fund, administrators of an Employee Retirement Income Security Act (“ERISA”) pension fund brought suit against four related corporate defendants for “delinquent contributions and shifting of assets to avoid having to pay workers.” Canal Asphalt, the defendant-debtor, filed a voluntary petition for chapter 11 relief in the Southern District of New York. Thus, the cause of action was automatically stayed against the debtor, pursuant to section 362(a)(1) of the Bankruptcy Code. The other defendants argued in a letter to the District Court of Eastern District of New York that because they are alter egos of one another, the automatic stay arising in the debtor’s case should prevent the action from proceeding against all defendants. The Eastern District court disagreed, and instead, issued an order stating that the automatic stay only enjoined actions against debtors or their property.

Third Circuit Finds Limited Partners’ “Direct” Claims to be Masked Derivative Ones

By: Kristen Lasak

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re SemCrude L.P., the U.S Court of Appeals for the Third Circuit found that the claims of breach of fiduciary duty, negligent misrepresentation, and fraud set forth by limited partners against the co-founder and former President and CEO of SemCrude L.P. were derivative of the claims held by SemCrude’s Litigation Trust. SemCrude L.P. is an Oklahoma-based oil and gas company co-founded by Thomas Kivisto, who allegedly drove the company into bankruptcy due to self-dealing and speculative trading strategies. In July 2008, SemCrude, along with its parent company and certain subsidiaries, filed petitions for relief under chapter 11 with the United States Bankruptcy Court for the District of Delaware. On October 28, 2009, the bankruptcy court issued an order confirming SemCrude’s plan of reorganization, which established a Litigation Trust. The plan specifically transferred the claims belonging to SemCrude’s bankruptcy estate to the Litigation Trust and authorized the Litigation Trust to pursue SemCrude’s claims and distribute any money attained to SemCrude’s creditors. The Litigation Trust asserted thirty claims, including breach of fiduciary duty, breach of contract, fraudulent transfer, and unjust enrichment, against Kivisto and certain Semcrude officers. On November 19, 2010, the bankruptcy court approved a $30 million settlement agreement, which also incorporated a mutual release of all claims. Particularly, the Litigation Trust released Kivisto and the other officers from being accountable to any party for “contribution or indemnity relating to the released claims.”

A Showing of Gross Recklessness Satisfies Section 523(a)(2)(A): Denying Deceivers the Ability to Discharge Debts Related to Fraudulently Obtained Funds

By: Megan Kuzniewski

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

11 U.S.C. Section 523 lists certain debts that may not be discharged by a debtor’s bankruptcy.[1] In particular, 11 U.S.C. Section 523(a)(2)(A) (“Section 523(a)(2)(A)”) provides that a debtor who files a bankruptcy will not be discharged of debts that were obtained by “false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition.”[2] False representations, such as those described in Section 523(a)(2)(A), carry a scienter requirement which requires that it be shown that an individual knowingly made false statements or representations.[3] In In re Bocchino , the Court of Appeals for the Third Circuit found that gross recklessness satisfies the scienter requirement of Section 523(a)(2)(A).[4] In S.E.C. v. Bocchino , the Securities and Exchange Commission (the “SEC”) filed a lawsuit against Bocchino, a stockbroker, in the District Court of the Southern District of New York.[5] The district court found Bocchino civilly liable for “inducing investors via high pressure sales tactics and material misrepresentations” and entered a judgment against him totaling $178,967.55, including disgorgement of fees, interest, and civil penalties.[6] Thereafter, Bocchino filed for chapter 13 bankruptcy protection.[7] The SEC petitioned the bankruptcy court for a judgment declaring the judgments against Bocchino nondischargeable under Section 523(a)(2)(A).[8] The SEC argued that Bocchino had obtained the funds “by… false pretenses, a false representation, or actual fraud.”[9] Bocchino had sought investors for two ventures that turned out to be fraudulent.[10] He began seeking out investments without doing any independent research into the ventures, despite there being cause for suspicion.[11] The bankruptcy court found that, although “Bocchino did not knowingly make any false statements,” the scienter requirement of Section 523(a)(2)(A) “may be satisfied by grossly reckless behavior.”[12] The bankruptcy court discharged the civil penalty portion of the judgment but concluded that the remaining portions of the judgment were nondischargeable under Section 523(a)(2)(A).[13] Bocchino appealed this finding.[13] On appeal, the district court affirmed the bankruptcy court’s decision,[15] and thereafter, the Third Circuit also affirmed the lower court.[16]

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