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The Earmarking Doctrine’s Viability as a Defense to Preference Actions Involving Home-Loan Refinancing Transactions

By: Michael Benzaki

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in In re Flannery,[i] the bankruptcy court held that the earmarking doctrine was not an appropriate defense to a preference action seeking to avoid a late-filed mortgage that was granted as part of a home-loan refinancing.[ii] In Flannery, the debtors financed the purchase of their home through an initial home-mortgage loan, which was secured by a mortgage. Further, within a year of granting the first mortgage, the debtors also granted a second-priority mortgage to secure a home equity line of credit. Subsequently, a new bank acquired both loans and mortgages from the initial lender.[iii] In 2012, the debtors refinanced the initial loan with the new bank through the Home Affordable Refinancing Program (“HARP”).[iv] In connection with the refinancing loan, the debtors granted the new bank a new mortgage against their property and the new bank executed a subordination of mortgage, subordinating the home equity mortgage to the new mortgage.[v] The proceeds from the refinancing loan were used to pay off the initial loan on January 25, 2012, and a discharge of the initial mortgage was recorded on February 21, 2012.[vi] However, the new mortgage was not recorded until April 18, 2012.[vii] Subsequently, on June 28, 2012, less than ninety days later, the debtors filed for bankruptcy under chapter 7 of the Bankruptcy Code. Since the mortgage was recorded within ninety days of the bankruptcy filing, the chapter 7 trustee for the debtors sought to avoid the refinance mortgage as a preference pursuant to section 547 of the Bankruptcy Code.[viii] Ultimately, the court rejected the new bank’s argument that, given the facts of the case at hand, the earmarking doctrine successfully defended the transaction in question from being designated an avoidable preference.[ix]

Pay Me, Maybe? Creditors’ Superior Claim to Undistributed Funds After a Conversion from Chapter 13 to Chapter 7

By: Rosa Aliberti

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, the Fifth Circuit held, in Viegelahn v. Harris (In re Harris),[i] that any funds held by a chapter 13 trustee at the time of conversion to chapter 7 should be distributed to creditors in accordance with the chapter 13 payment plan.[ii] In In re Harris, the debtor filed for bankruptcy under chapter 13 of the Bankruptcy Code.[iii] The chapter 13 plan required the debtor to make monthly payments to a trustee for distribution to secured creditors and unsecured creditors.[iv] The debtor also was required to make monthly mortgage payments directly to Chase, his mortgage lender. After failing to do so, the bank foreclosed on his home.[v] The debtor did not modify the plan and continued making the required monthly payments to the trustee for approximately a year before converting his case to chapter 7.[vi] Since Chase no longer had a claim against the debtor, the funds that were allocated for Chase under the plan began to accumulate.[vii] After the debtor converted to chapter 7, the chapter 13 trustee distributed the funds in her possession to pay the debtor’s attorneys’ fees, the remaining secured creditor, the six unsecured creditors, and her commission.[viii] The debtor moved to compel the chapter 13 trustee to return those funds, arguing that the trustee was not authorized to distribute the funds once he converted the case to chapter 7.[ix] The bankruptcy court ordered the chapter 13 trustee to return the funds to the debtor,[x] and on appeal, the district court affirmed.[xi] The trustee appealed again, and the Fifth Circuit reversed,[xii] concluding that the creditors’ claim to the undistributed funds was greater than that of the debtor.[xiii]

Going Concern Sale Liquidations and the Termination of Collective Bargaining Agreements under Chapter 11

By: Cecilia Ehresman

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re Chicago Construction Specialties, Inc.,[i] the United States Bankruptcy Court for the Northern District of Illinois recently held that the debtor must satisfy the requirements of section 1113 of the Bankruptcy Code, even though the debtor was liquidating under chapter 11 instead of reorganizing.[ii] In Chicago Construction, debtor, a demolition construction company, ceased operations, sold substantially all its assets outside of bankruptcy, and sent the union representing its workers a notice that it intended to reject a collective bargaining agreement[iii] before the company filed for bankruptcy.[iv] Subsequently, the debtor filed for bankruptcy under chapter 11 of the Bankruptcy Code and moved to reject its CBAs pursuant to section 1113 of the Bankruptcy Code.[v] The union objected, arguing that the debtor had unilaterally rejected the CBA by providing an ultimatum rather than a proposal for modification.[vi] The Chicago Construction court ruled in favor of the debtor, finding that there was no good reason not to allow the debtor to reject the CBA because the debtor had already liquidated and the only effect of not allowing the debtor to reject the CBA would be to elevate the union’s claims over those of the debtor’s other creditors.[vii]

Time-Barred Proof of Claims Violate FDCPA

By: Garam Choe

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in Crawford v. LVNV Funding, LLC, the Eleventh Circuit held that the creditor violated the Fair Debt Collection Practices Act (“FDCPA”) by filing a proof of claim to collect a debt that was unenforceable because the statute of limitations had expired.[i] In Crawford, a third-party creditor acquired a debt owed by the debtor from a furniture company.[ii] The last transaction on the account occurred in October 2001.[iii] Accordingly, under Alabama’s three-year statute of limitations, the debt became unenforceable in October 2004.[iv] On February 2, 2008, the debtor filed bankruptcy under chapter 13 of the Bankruptcy Code.[v] The third-party creditor then filed a proof of claim for the time-barred debt during the debtor’s bankruptcy proceeding.[vi] Neither the debtor nor the bankruptcy trustee objected the claim.[vii] Rather, the trustee distributed the pro rata portion of the claim from the plan payments to the creditor.[viii] In May 2012, the debtor commenced an adversary proceeding against the third-party creditor alleging that the third-party creditor filed a proof of claim for a time-barred debt in violation of the FDCPA.[ix] The bankruptcy court dismissed the adversary proceeding in its entirety, and district court affirmed.[x] In affirming the bankruptcy court’s dismissal, the district court found that the third-party creditor did not attempt to collect a debt from the debtor because filing a proof of claim is “merely ‘a request to participate in the distribution of the bankruptcy estate under court control.’”[xi] Furthermore, the district court found that, even if the third-party creditor was attempting to collect the debt, the third-party creditor did not engage in abusive practices.[xii] On appeal, the Eleventh Circuit reversed, holding that the third-party creditor violated the FDCPA by filing a stale claim in the bankruptcy court.[xiii]

Funds Transferred From a Client Trust Account Can Be Property of the Debtor That Is Subject to a Fraudulent Transfer Claim

By: Adam C.B. Lanza

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re Dayton Title Agency, Inc., where a title company’s bankruptcy estate sued a paid-off lender to recover a fraudulent transfer,[1] the Sixth Circuit Court of Appeals held that the funds paid out of the debtor’s trust account constituted property of the debtor at the time of transfer for purposes of avoiding a fraudulent transfer.[2] In Dayton Title, the chapter 7 trustee (“trustee”) commenced an adversary proceeding to avoid, as a constructively fraudulent transfer, a payment the debtor had made to its client’s lender from the trustee’s client trust account without waiting for a forged check to clear.[3] The funds used to make the payment were from a provisional credit that the debtor’s bank extended to it.[4] In response to the fraudulent transfer action, the lender argued, among other things, that the transfer was not constructively fraudulent because the money that the lender received was not property of the title agency, as the money was being held in trust for a third party.[5] The bankruptcy court entered summary judgment in favor of the trustee, holding that majority of the payment was constructively fraudulent.[6] On appeal, the district court held that only a small portion of the payment was fraudulent.[7] However, the Sixth Circuit reversed the district court and affirmed the bankruptcy court’s ruling.[8]

Should Post-Confirmation Review of the Debtors Disposable Income Analysis Be a Basis for an Upward Modification

By: Steven Ching

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Joining the majority of courts, in In re Salpietro, the United States Bankruptcy Court for the Eastern District of New York held that a post-petition review of the debtor’s net disposable income was not required under the Bankruptcy Code and did not provide the basis for an upward modification under section 1329(a).[1] There, the debtors confirmed joint chapter 13 plan that provided that the “future earnings of the debtor [were to be] submitted to the supervision and control of the trustee.”[2] After making timely payments for five years, the debtors moved to approve a loan modification that would essentially reduce their monthly mortgage expenses by approximately $970.[3]In response, the chapter 13 trustee cross-moved to increase the debtors' payments under their plan on the grounds that the decrease in the debtors’ expenses constituted “future earnings,” and therefore, under the plan, were to be “submitted to the supervision and control of the trustee.”[4] However, the court disagreed and denied the trustee’s motion for upward modification, holding that: (1) section 1325(b)’s projected disposable income test does not apply to modifications under section 1329, and (2) section 1322(a)(1) did not provide a basis for upward modification because the reduction of the debtor’s mortgage expenses did not constitute additional income or earnings.[5]

A Pre-Conversion Superpriority Claim Has Priority Over Post-Conversion Administrative Expenses

By: Michael Foster

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Following the conversion of the bankruptcy case from chapter 11 to chapter 7, the Bankruptcy Court for the Southern District of Florida, in In re National Litho, LLC, recently held that a DIP lender’s pre-conversion superpriority claim had priority over any and all post-conversion administrative expenses.[1] In National Litho, the debtor initially filed its bankruptcy case under chapter 11 of the Bankruptcy Code. In its motion to approve the post-petition financing, the debtor requested the authority to grant the DIP lender a superpriority claim under section 364(c)(1), which would have priority over “any and all administrative expenses.”[2] Two days after the court approved the DIP financing, the court converted the case from chapter 11 to chapter 7. [3] The chapter 7 trustee subsequently objected to the DIP lender’s motion to allow its superpriority claim.[4] The court found that the phrase “any and all administrative expenses” included any and all chapter 7 administrative expenses.[5] Therefore, the court opined that the conversion of a bankruptcy case under chapter 7 did not impact the priority of a pre-conversion superpriority claim granted under section 364(c)(1).[6] Accordingly, the court held that the DIP lender’s claim had priority over the post-conversion administrative expenses.[7]

Residency for the Purposes of Applying State Exemption Laws Must Be Analyzed as it Existed on the Petition Date

By: Christopher McCune

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in In the Matter of Willis, the Bankruptcy Court for the Western District of Wisconsin decided that under section 522(b)(3) of the Bankruptcy Code, a debtor must be domiciled in a given state at the time of filing a bankruptcy petition in order to access—or be bound by—that state’s exemption laws.[1] In Willis, the debtors claimed the federal exemptions in their bankruptcy petitions, rather than attempting to assert any state exemptions.[2] The debtors resided in two different states during the 730-day period immediately preceding the filing of their bankruptcy petitions; they were domiciled in Illinois first, and then moved to Wisconsin.[3] Going back further, the debtors were domiciled solely in Illinois (an “opt out” state) during the 180 days prior to the aforementioned 730-day period.[4] However, the debtor’s were domiciled in Wisconsin at the time that they filed their petitions. Due to that fact, the court ruled that Illinois’ exemption laws did not apply, notwithstanding all of the time the debtors spent domiciled there.[5] However, since the debtors also had not been domiciled in Wisconsin for the requisite number of days prior to filing the petition, they also could not invoke the state exemption laws of their current residence, even if they wished to.[6] Faced with no applicable state law exemptions, the Willis court found that the debtors were therefore necessarily entitled to claim the federal exemptions.[7]

Translating Section 362(c)(3) What Gets Terminated

By: Michael C. Aryeh

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Adopting the majority approach, in In re Williford, the Bankruptcy Court for the Northern District of Texas held that the plain meaning of the phrase “with respect to the debtor,” found in section 362(c)(3)(A) of the Bankruptcy Code, limits the termination of the automatic stay to the debtor and the debtor’s property, and the automatic stay does not terminate the stay with respect to the property of the estate.[1] In Williford, the debtor and his wife executed a deed of trust to a secured creditor, placing a lean on their real property.[2] At some point, the debtor defaulted on the note, the secured creditor served the debtor with a notice of acceleration and foreclosure.[3] In response, the debtor filed for bankruptcy under chapter 7, but the case was subsequently dismissed due the debtor’s failure to file certain information with the bankruptcy court.[4] Following the dismissal, the creditor again began serving the debtor with foreclosure notices.[5] The debtor then filed for bankruptcy under chapter 11 within a year of the dismissal of his previous chapter 7 case. [6] The debtor, however, failed to file a motion to extend the automatic stay within the 30-day window provided for in section 362(c)(3)(A).[7] Thirty-five days after the debtor filed his second case, the creditor moved to confirm that the automatic stay was “terminated.”[8] The next day the debtor moved to extend the stay.[9] The court denied the debtor’s motion.[10] The court, however, agreed with the debtor that section 362(c)(3) did not terminate the entire automatic stay and, instead, only terminated the stay with respect to the “debtor’s property.”[11]

Self-Settled Trusts Choice-of-Law Difficulties under Restatement 270

By: Christian Corkery

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Applying Washington law, the United States Bankruptcy Court for the Western District of Washington in In re Huber held that prepetition transfers of the debtor’s assets to a self-settled trust created under Alaska state law were void under Washington law.[1] The matter before the court involved a debtor who created a self-settled trust in Alaska to protect his assets from creditors. Because Washington state law does not recognize self-settled trusts, the debtor created the trust in Alaska under Alaska state law, which permits self-settled trusts. The trust agreement included a choice-of-law provision which stated that Alaska state law would govern all legal disputes.[2] After the trust was created, the debtor filed for bankruptcy.[3] The chapter 7 trustee brought an adversary proceeding seeking to recover the assets that the debtor transferred to the self-settled trust and to deny the debtor a discharge.[4] The court declined to apply Alaska law because Washington had a public policy interest against self-settled trusts, and Alaska did not have a substantial relation to the trust.[5] The debtor was not domiciled in Alaska, his assets were not located in Alaska, and the trust’s beneficiaries were not domiciled in Alaska.[6] The court found that Alaska’s only connections were that it was the location of where the trust was to be administered and the location of one of the trustees.[7] As such, the court applied Washington state law which states that transfers made to self-settled trusts are void as against existing or future creditors, and therefore, the trustee was able to recover the assets.[8]

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