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New York Courts Split on Jewel Unfinished Business Claims

By: Guillermo Martinez

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Two recent New York District Court cases disagree whether the principle established in the famous California Jewel v. Boxer[1] case applies to hourly matters upon the dissolution of New York law firms.

In Development Specialists, Inc. v. Akin Gump Strauss Hauer & Feld, LLP, et al.,[2] the United States District Court for the Southern District of New York held that unfinished client matters pending on the date of law firm’s, Coudert Brothers LLP (the “Firm”), dissolution remain property of the estate.[3] The Firm dissolved on August 16, 2005 and the remaining equity partners authorized the Firm’s executive board to sell all of its assets.[4] A number of the Firm’s partners were hired by other law firms, and subsequently took their unfinished hourly matters with them.[5] Development Specialists, Inc., the administrator of the Firm’s bankruptcy estate (the “Administrator”), sued a number of firms that had hired ex-Coudert Brothers partners in an attempt to recover the profits those firms made on unfinished Coudert client matters.[6] The court agreed with the Administrator and ordered the defendant law firms to turnover profits earned on old Firm matters.

Brunner Test Reexamined in Western District of New York

By: Shane Malone

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Despite failing to apply for an income-based loan repayment plan, the Bankruptcy Court for the Western District of New York (the “Court”) held in In re Bene[1], that Donne Bene (the “Debtor”) satisfied the “undue hardship”[2] test and discharged her student loans. The Debtor was an elderly Chapter 7 debtor who owed $57,298.70 to Educational Credit Management Corp., a student loan lender (the “Lender”), for loans she took out between 1981 and 1987. The Debtor voluntarily withdrew from school in 1987 before earning a degree or any professional license in order to care for her incapacitated parents.[3] Although she had recently received a termination notice from her employer,[4] at the time of her discharge, she worked—as she had for the last 12 years—on an assembly line earning $10.67 per hour.[5] Her impending job loss and minimal level of education left her with little hope of improving her financial situation.[6] The Debtor had no other debts, and had made good faith efforts to repay her student loans, but those payments only totaled $2,400.[7] The Lender argued that the Debtor should be ineligible for a discharge of her student loan debt because she had not enrolled in income-based repayment plans for which she was eligible, such as the William D. Ford Program (the “Program”).[8]

Court Focuses on Policy Rather Than Formality in Approving Key Employee Plans

By: Erin Dempsey

St. John's Law Student

American Bankruptcy Institute Law Review Staff

Rejecting the technical arguments of the United States Trustee (the “UST”), the Bankruptcy Court focused on the policies behind the restrictions on employee retention plans to approve the debtor’s key employee incentive plan (“KEIP”) in In re Velo Holdings[1]. The Velo Holdings Court approved the KEIP because it was incentive-based rather than retentive-based and was a valid exercise of the debtor’s sound business judgment.[2]

Exempt Assets May Be Surcharged to Remedy Debtor Misconduct

By: Elizabeth H. Shumejda

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Broadly construing section 105(a) of the Bankruptcy Code (the “Code”), the First Circuit, in Malley v. Agin, upheld a surcharge against the value of an otherwise exempt asset as an appropriate remedy for a chapter 7 debtor’s fraudulent concealment of assets.[1] The debtor intentionally failed to disclose $25,000 in assets, which violated his specific disclosure obligations under section 521 of the Code, as well as his general obligation to be forthright and honest with the court.[2] The bankruptcy court sanctioned the debtor by denying the debtor’s discharge pursuant to section 727 of the Code.[3] In addition, the bankruptcy court used its general equitable powers under section 105(a) to surcharge the concealed amount, plus the cost of untangling the fraud, against the value of an otherwise exempt asset—a truck used in the debtor’s business.[4] On direct appeal to the First Circuit, the debtor challenged the bankruptcy court’s surcharge order on the grounds that it exceeded the court’s equitable power under section 105(a).[5]

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Third Circuit Rejects Wait-and-See Valuation Approach and Accepts Lien Stripping in Section 506(a)

By: Andrew Richmond

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re Heritage Highgate, Inc.,[1] the Third Circuit held that the fair market value of property as of the confirmation date controls whether or not a lien is fully secured.[2] Additionally, the court held that lien stripping is permissible in a chapter 11 reorganization.[3] The debtors, Heritage Highgate and Heritage-Twin Ponds II, were real-estate developers working on a project that was financed by a group of banks (the “Bank Lenders”) and other entities collectively known as Cornerstone Investors (“Cornerstone”).[4] Both the Bank Lenders and Cornerstone secured their investments with liens on substantially all of the debtors’ assets but Cornerstone’s claims were contractually subordinated to the Bank Lenders’.[5] After selling a quarter of the project’s planned units, the debtors filed a chapter 11 petition. The debtors’ joint proposed plan of reorganization proposed paying secured claims in full and paying 20% of the unsecured claims with funds obtained through the sale of the project’s remaining units.[6] These estimated recoveries were based on the debtors’ appraisal, which valued the project at $15 million.[7] During the course of the case, the debtors continued to build and sell units and, with the consent of its secured lenders, used the sale proceeds to fund ongoing operating losses.[8] As a result, the fair market value of the project was reduced to approximately $9.54 million as of the time of plan confirmation, which was less than the Bank Lender’s $12 million secured claim.[9] Cornerstone argued their $1.4 million claim should still be fully secured and to hold otherwise would constitute impermissible lien stripping.[10] The bankruptcy court disagreed and determined that the proper method of valuing Cornerstone’s secured claim was the fair market value of the project as of the time of plan confirmation.[11] Therefore, Cornerstone’s claim was unsecured.[12]

Can the Purchase of Groceries be in Furtherance of a Ponzi Scheme

By: Gabriella B. Zahn

St. John's Law Student

American Bankruptcy Institute Law Review Staff

Adopting a limited view of the “Ponzi scheme presumption,” the Bankruptcy Court for the Southern District of Florida[1] rejected the trustee’s contention that payments made for groceries were avoidable fraudulent transfers because the purchase of groceries was in furtherance of the Ponzi scheme.[2] In In re Phoenix Diversified Investment, the debtor purchased $43,384.37 worth of groceries and other personal items over a four-year period from Publix – a grocery store chain.[3] The trustee sought to avoid the transfers under both state fraudulent transfer law[4] and section 548(a) of the Bankruptcy Code (the “Code”).[5] The trustee argued that the so-called “Ponzi scheme presumption” applied.[6] The presumption allows the court to assume a transfer was made with the “actual intent to hinder, delay, or defraud” if the transfer was made in order to perpetuate a Ponzi scheme or was necessary to the continuance of the scheme. In its classic application, the presumption allows the trustee to recover payments made to early investors in a Ponzi scheme on the theory that those payments kept the scheme hidden. Publix argued that the Ponzi scheme presumption was not applicable.[7]

Fourth Circuit Preserves Absolute Priority Rule Despite Challenge Through BAPCPA

By: Andrew Serrao

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In the first appellate decision on the issue, the Fourth Circuit in In re Maharaj[1] held that the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”) did not abrogate the absolute priority rule’s applicability to individual Chapter 11 debtors.[2] Ganess and Vena Maharaj (the “Debtors”) accumulated a significant amount of debt while owning and operating an auto body repair shop.[3] The Debtors filed a voluntary petition under Chapter 11 in bankruptcy court, and subsequently filed a plan of reorganization (the “Plan”),[4] pursuant to section 1121(a).[5] The Plan provided that the Debtors would continue to own and operate their auto body business, using income from the business to pay general unsecured claims.[6] The Plan also separated creditors into four classes[7]. Class 3 (general unsecured claims) voted to reject the Plan,[8] and the Debtors sought a cram down.[9] If BAPCPA had abrogated the absolute priority rule, the Debtors could have retained their auto body business and crammed down the Plan.[10] However, the Fourth Circuit held that the absolute priority rule had not been abrogated by BAPCPA.[11]

Bad Faith Constitutes Cause For Dismissal of a Bankruptcy Case

By: Kathleen Mullins

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re Lee[1] the United States Bankruptcy Appellate Panel for the Sixth Circuit (the “BAP”) held that the bankruptcy court properly dismissed the debtor’s Chapter 11 bankruptcy petition because the debtor’s filing was abusive.[2] The debtor defaulted on her mortgage loan with Chase Home Finance (“Chase”) on one of her investment properties.[3] Chase sought to foreclose on the property, and the debtor filed bankruptcy, staying the foreclosure action.[4] This case was dismissed and Chase sought to foreclose a second time.[5] Once again, however, the debtor filed bankruptcy.[6] After the case was dismissed and Chase again attempted to foreclose, the debtor filed bankruptcy a third time.[7] This time Chase made a motion to dismiss the case, asserting that the debtor was acting in bad faith and was abusing the bankruptcy process in order to evade foreclosure by filing bankruptcy petitions whenever Chase made progress in the foreclosure action.[8] The bankruptcy court found that the debtor had been filing bankruptcy petitions “as a buffer to prevent the foreclosure proceedings from going forward” and it dismissed her case for acting in bad faith, which the court determined constituted sufficient “cause” under section 1112(b).[9]

Developing Consensus Among Delaware Bankruptcy Courts to Narrowly Construe Stern v. Marshall Concerning Avoidance Claims

By: Joseph P. Donnelly IV

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Adopting a narrow interpretation of the holding of Stern v. Marshall,[1] the Bankruptcy Court for the District of Delaware, in In re DBSI,[2] held that Stern does not preclude a bankruptcy court from adjudicating avoidance claims.[3] In November 2008, DBSI Inc. and several of its affiliates (the “Debtors”) filed for Chapter 11 bankruptcy protection.[4] Following confirmation of the Debtors’ liquidating plan, a litigation trustee commenced several adversary proceedings relating to, inter alia, preferential or fraudulent transfer claims.[5] Certain defendants (the “Movants”) sought to have these adversary proceedings dismissed, arguing that the bankruptcy court lacked jurisdiction under 28 U.S.C. § 157 and the United States Supreme Court’s decisions in Stern v. Marshall and Granfinanciera, S.A. v. Nordberg,[6]to adjudicate causes of action sounding in preference or fraudulent conveyance.[7]

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