Included Cases
(click on link to view case summary)
UNITED STATES COURT
OF APPEALS FOR THE SIXTH CIRCUIT
POST-PETITION CLAIMS FOR PATENT
INFRINGEMENT ARISE IN THE ORDINARY COURSE OF A DEBTOR MANUFACTURER’S
BUSINESS; ADMINISTRATIVE CLAIMS ARE NOT DISCHARGED BY A PLAN OF
REORGANIZATION - Caradon Doors and Windows, Inc. v. Eagle Picher
Industries, Inc. (Eagle Picher I)
COUNSEL’S ACTIONS BENEFIT THE ESTATE, RESULTING IN A FEE AWARD FOR
COUNSEL FOR THE COMMITTEE OF UNSECURED CREDITORS, EVEN WHEN NO
REALISITIC POSSIBILITY FOR DISTRIBUTION EXISTS - Kemp, Klein, Umphrey, Endelman and May v.
Bankruptcy Estate of Veltri Metal Products, Inc. (In re Veltri Metal
Products, Inc.)
SOLVENT DEBTOR REQUIRED TO PAY POST-PETITION INTEREST TO UNSECURED
CREDITORS AT CONTRACT (DEFAULT) RATE OF INTEREST - Official Committee
of Unsecured Creditors v. Dow Corning Corp. (In re Dow Corning Corp.)
POST-PETITION ASSIGNMENT OF PROMISSORY
NOTE AND PERFECTED MORTGAGE ON PROPERTY OF A DEBTOR DOES NOT INVOLVE
PROPERTY OF THE ESTATE AND IS NOT VIOLATION OF AUTOMATIC STAY - Rogan
v. Bank One, NA (In re Cook)
INSURER WITH ONLY SUBROGATION RIGHTS IS NOT AN AGGRIEVED PARTY WITH
RIGHT TO STANDING TO APPEAL COURT ORDER APPROVING DEBTOR’S SETTLEMENT OF
CONSTRUCTION DISPUTE - Lyndon Property
Insurance. Co. v. Katz
MONEY DUE FROM SUBROGATION RIGHTS IS NOT PROPERTY OF THE ESTATE, THUS
INSURERS ARE ENTITLED TO FULL SUBROGATION RIGHTS TO RECOVERY OBTAINED ON
ACCOUNT OF ACCIDENT INJURING DEBTOR - French v. Frey (In re Bergman)
REAL ESTATE LESSOR WHO FAILS TO NOTIFY
DEBTOR-LESSEE OF EXPECTATION THAT PREMISES BE RESTORED IS BARRED FROM
CLAIMING DAMAGES DUE TO FAILURE ON THE PART OF DEBTOR TO RESTORE
PREMISES - Queensgate Associates., LLC
v. Regal Cinemas, Inc. (In re Regal Cinemas, Inc.)
FRANCHISOR WHO TAKES OWNERSHIP OF FRANCHISES FROM
FAILING DEBTOR-FRANCHISEE AND PAYS DEBTS OF DEBTOR HAS NOT RECEIVED
FRAUDULENT TRANSFER - Congrove v.
McDonald’s Corp. (In re Congrove)
BANKRUPTCY APPELLATE PANEL FOR THE
SIXTH CIRCUIT
LAND INSTALLMENT CONTRACTS ARE EXECUTORY CONTRACTS
WITH UNPERFORMED OBLIGATIONS FOR BOTH PARTIES - O’Brien v. Ravenswood Apartments, Ltd. (In re
Ravenswood Apartments, Ltd.)
UNITED STATES DISTRICT COURTS WITHIN
THE SIXTH CIRCUIT
TRANSFER OF MALPRACTICE CLAIMS TO TRUST
PURSUANT TO PLAN OF REORGANIZATION IS A REASONABLE APPLICATION OF THE
“CATCH-ALL” POWERS GRANTED TO BANKRUPTCY COURT - Parrett v. National
Century Financial Enterprises, Inc.
CHAPTER 11 DEBTOR DOES NOT HAVE ABSOLUTE RIGHT TO
CONVERT CASE TO CASE UNDER CHAPTER 7 — CONVERSION MUST SATSIFY BEST
INTERESTS OF CREDITORS TEST - Monroe
Bank & Trust v. Pinnock
SOVEREIGN IMMUNITY IS NOT AN AVAILABLE
DEFENSE FOR TAXING AUTHORITIES TO PREVENT A DEBTOR FROM RECOVERING
OVERPAYMENTS OF SALES TAXES - Vermont Department of Taxes v. Quality
Stores, Inc. (In re Quality Stores, Inc.)
UNITED STATES BANKRUPTCY COURTS WITHIN
THE SIXTH CIRCUIT
DEBTOR ABANDONING REAL PROPERTY MUST ENSURE COMPLIANCE WITH
ENVIRONMENTAL REGULATIONS — ESTABLISHING PROPERTY AS SAFE IS NOT ENOUGH
- In re Eagle Picher Holdings, Inc.
(Eagle Picher II)
ASSETS HELD IN NON-QUALIFIED RETIREMENT PLAN TRUSTS ARE AVAILABLE FOR
CREDITORS, THEREFORE SUCH ASSETS MUST BE TURNED OVER TO ESTATE - Collins & Aikman Corp. v. Northern Trust Bank
of California, NA (In re Collins & Aikman Corp.)
REAL PROPERTY OWNED BY DEBTOR SUBJECT TO
BUILDING RESTRICTIONS CAN BE SOLD FREE AND CLEAR OF SUCH RESTRICTIONS
UNDER SECTION 363(f)(5) - In re Signature Developments, Inc.
TRANSFER OF PROMISSORY NOTE CARRIES WITH IT
EQUITABLE OWNERSHIP OF MORTGAGE, EVEN IF MORTGAGE IS TRANSFERRED TO
THIRD PARTY - Gemini Services, Inc. v.
Mortgage Electronic Registration Systems, Inc. (In re Gemini Services,
Inc.)
PROVISIONS IN FINAL DIP FINANCING ORDER WAIVING
RIGHTS TO PURSUE AVOIDANCE AND OTHER CLAIMS AGAINST DIP LENDER UPHELD - Cobalt Ventures, LLC v. Bank of America
(In re Brooks Sand and Gravel LLC)
CASE SUMMARIES
UNITED STATES COURT OF APPEALS FOR THE
SIXTH CIRCUIT
POST-PETITION
CLAIMS FOR PATENT INFRINGEMENT ARISE IN THE ORDINARY COURSE OF A DEBTOR
MANUFACTURER’S BUSINESS; ADMINISTRATIVE CLAIMS ARE NOT DISCHARGED BY A
PLAN OF REORGANIZATION
Caradon Doors and Windows, Inc. v.
Eagle Picher Industries., Inc. (Eagle Picher I), 447 F. 3d 461 (6th Cir. May 5, 2006) (Sutton, J.)
A three judge panel for the Sixth Circuit
upheld (based upon a separate rationale) the ruling of the District
Court for the Southern District of Ohio, which overruled the Bankruptcy
Court for the Southern District of Ohio, in determining that a debtor’s
obligations to respond to and pay for post-petition patent infringement
claims must be considered liabilities arising in the ordinary course of
the debtor’s post-petition conduct, and thus properly payable as
administrative expenses pursuant to the confirmed debtor’s plan.
The debtor sought a ruling that its
responsibility for the patent infringement claims had been discharged
under its plan of reorganization that had been confirmed one month
before the patent infringement matter was settled on its substantive
merits. The plan of reorganization included blanket language
discharging certain post-petition obligations of the debtor that had not arisen in the ordinary course of the debtor’s business.
The Sixth Circuit reasoned that when a debtor/business is dealing in
patentable processes, a patent infringement suit must be considered to
arise in that debtor’s day-to-day business, making such an obligation per se ordinary course and an administrative expense that required
full payment to the appropriate third parties.
Practice Point: When advising
debtor clients, make certain the debtor understands the breadth of its
own business so that it can react to what types of actions are certain
to be considered ordinary course and what types of actions may or may
not be considered ordinary course.
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COUNSEL’S ACTIONS
BENEFIT THE ESTATE, RESULTING IN A FEE AWARD FOR COUNSEL FOR THE
COMMITTEE OF UNSECURED CREDITORS, EVEN WHEN NO REALISITIC POSSIBILITY
FOR DISTRIBUTION EXISTS
Kemp, Klein, Umphrey, Endelman and May
v. Bankruptcy Estate of Veltri Metal Products, Inc. (In re Veltri Metal
Products, Inc.), 2006 U.S. App. LEXIS 16171 (6th Cir.
June 22, 2006) (Cook, J.)
In a unanimous decision, a panel of the
Sixth Circuit reversed the ruling of the District Court for the Eastern
District of Michigan that disallowed fees for the counsel retained by
the Committee of Unsecured Creditors on the basis that the services
performed were not reasonably likely to benefit the estate solely
because creditors were unlikely to receive a distribution without really
considering other factors. In so holding, the Sixth Circuit held that
counsel’s actions may benefit the estate even when no reasonable
possibility of distribution exists.
The panel held that the lower courts did
not fully apply the standards set forth in Section 330 for compensation
of professionals. Section 330 provides that compensation for
professionals is not to be allowed for services that are not (i)
reasonably likely to benefit the estate or (ii) necessary to the
administration of the estate. The lower courts only applied the first
prong of the test, and further equated the concept that distribution to
creditors was necessary to find that a benefit to the estate had been
conferred. The Sixth Circuit found this decision to be in error
because, although distribution to creditors appeared unlikely, the
committee counsel had provided administration services during the case,
and that the benefits to the estate need not be direct and economic.
The Sixth Circuit recognized the flexibility provided in the Section 330
of the Bankruptcy Code. The case was remanded to the Bankruptcy Court
for a determination of what administrative benefits the law firm
provided.
Practice Point: This case can
be useful to estate professionals practicing within the Sixth Circuit in
overcoming objections to their fees when other parties question the
value of the contributions to the estate of the professionals seeking
the fee award. The statutory application used in this case can be
particularly persuasive.
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SOLVENT DEBTOR
REQUIRED TO PAY POST-PETITION INTEREST TO UNSECURED CREDITORS AT
CONTRACT (DEFAULT) RATES OF INTEREST
Official Committee of Unsecured
Creditors v. Dow Corning Corp. (In re Dow Corning Corp.), 456
F. 3d 668 (6th Cir. July 26, 2006) (Cole, J.)
The Sixth Circuit reversed the District
Court for the Eastern District of Michigan when it determined that a
debtor who is determined to have been solvent must pay post-petition
interest to unsecured creditors at the rate provided in any such
contract with such unsecured creditors, including default rates of
interest (the District Court had approved application of non-default
contract rates of interest). Where default interest rates were
specified, non-default contract rates of interest were held to be
insufficient to give the creditor the “benefit of its bargain.”
The Chapter 11 debtor entered into
Bankruptcy in an effort to avoid liability from, and ultimately settle,
certain mass-tort lawsuits. While in Chapter 11, the debtor did, in
fact, resolve the mass-tort litigation, and as a result, it was found
that the debtor was solvent after considering all other asserted
obligations. In applying the absolute priority rule, the Court held
that when a debtor is found to be solvent, there is no reason creditors
should suffer any impairment from the actual benefit of their bargains
with the debtor, and honoring such bargain must include payment of
post-petition interest at whatever rate would be applicable under the
conditions agreed to between the debtor and each individual creditor —
including the application of any post-petition default rates of
interest, where such rates were agreed to pre-petition between the
parties.
Practice Pointer: Although
“solvent” debtors are rare, to prepare for this situation, it is
important to make certain creditor clients, especially unsecured
creditor clients, inform the Court, in their proof of claim or
otherwise, of all remedies and escalated interest formulas available to
them under their specific transaction documents.
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POST-PETITION ASSIGNMENT OF PROMISSORY NOTE AND PERFECTED MORTGAGE ON
PROPERTY OF A DEBTOR DOES NOT INVOLVE PROPERTY OF THE ESTATE AND IS NOT
VIOLATION OF AUTOMATIC STAY
Rogan v. Bank One, NA (In re Cook),
457 F. 3d 561 (6th Cir. Aug. 9, 2006) (Gilman, J.)
A panel of two Circuit Court judges and a
District Court judge sitting by designation for the Sixth Circuit
affirmed the holding of the District Court for the Eastern District of
Kentucky that a lender’s mortgage interest in real estate of the debtor
is only an equitable interest in such real property and not property of
the estate that is subject to the automatic stay. Accordingly, so long
as no greater rights in the debtor’s real estate were created, the
lender was free to transfer its interest to a third party who was
equally free to record such interest without violating the automatic
stay. Further, the panel held that such transfers were not subject to
avoidance, even if recording occurred post-petition.
Pre-petition, the debtor obtained secured
financing for the purchase of its real estate, granting its initial
lender a mortgage in the real estate. The initial lender recorded its
mortgage interest in the real estate. Subsequently, the note and
mortgage were transferred to other lenders on the secondary mortgage
market. The final transfer included an indorsement in blank of the
mortgage because the purchaser was unknown to the seller at the time of
the transfer. The indorsement in blank created bearer paper, which
ultimately flowed into the hands of the lender buying the debtor’s loan
debt. This final lender neglected to file documents recording its
mortgage interest in the debtor’s real estate, but held the mortgage
indorsed in blank. Further, the debtor was aware of the identity of
this lender on the date they filed for protection in Bankruptcy. The
final lender sought to record its mortgage post-petition and the Chapter
7 Trustee objected claiming his rights as a judgment lien creditor were
superior to the lender’s. The panel held that, under Kentucky law, the
transfer of documents in blank indorsement constituted a transfer of
property that is not part of the estate, and that notice of the mortgage
interest in the real estate had been established by constructive notice
through the proper recording by the initial lender. Accordingly, the
recording of a mortgage interest in the debtor’s real estate after the
debtor filed for Bankruptcy relief was both proper and not a violation
of the automatic stay.
Practice Pointer: Although
this case indicates that secured creditor clients can move forward with
conveying mortgage debt instruments originally issued by a borrower that
is now a Bankruptcy debtor without obtaining relief from stay, it is
possible that some Courts may consider this ruling “aggressive,” and
still expect lenders to seek relief from stay in order to transfer a
mortgage interest in property owned by a debtor.
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INSURER WITH ONLY
SUBROGATION RIGHTS IS NOT AN AGGRIEVED PARTY WITH RIGHT TO STANDING TO
APPEAL COURT ORDER APPROVING DEBTOR’S SETTLEMENT OF CONSTRUCTION DISPUTE
Lyndon Property Insurance Co. v. Katz,
2006 U.S. App. LEXIS 21883 (6th Cir. Aug. 24, 2006) (Gibbons,
J.)
The Sixth Circuit affirmed the District
Court for the Eastern District of Kentucky upholding the long standing
rule that in order to appeal a Bankruptcy court order, such party
seeking appeal must be a “party aggrieved.” To be a “party aggrieved”
with appeal rights, one must show that the order in question diminishes
its property, increases its burdens or impairs its rights. In Lyndon,
the Sixth Circuit held that an insurer with only subrogation rights to
sale proceeds was not a “party aggrieved” when a settlement proposed by
the debtor purported to settle claims with a contractor with funds from
the debtor’s general account.
The Chapter 11 debtor was a building
owner building a university bookstore. In order to complete its
building obligations, it obtained a surety bond from the insurer to
protect the university’s interests. The debtor also contracted with a
contractor to perform specific work on the project. After the debtor
filed its Bankruptcy petition, the contractor proceeded to file liens on
the property and the insurer made claims to the proceeds stemming from
any sale of property from the building project. The debtor sold certain
property to a third party and the sale proceeds were held in escrow
pending a resolution of the contractor’s claims. This dispute was
resolved and the contractor agreed to receive one-half of its original
contract fee.
Initially, payment of the settlement
amount was to be paid to the contractor from the sale proceeds, in which
the insurer asserted a superior, subrogation interest. To get around
this hurdle, the debtor and the contractor proposed that the funds for
their settlement would be paid from general funds held by the debtor, in
which the insurer presumably had no interest. The insurer objected
anyway, and the Panel affirmed that payment from the debtor’s general
funds did not diminish resources available for the insurer to recover
from, did not increase the insurer’s burdens, and did not further impair
the insurer in any way because it had no interest in such funds.
Accordingly, the insurer had no right to appeal the lower court ruling.
Practice Pointer: Creativity
in how settlements are structured and how funds may flow from one party
to another can be paramount in achieving your clients’ goals, including
how to extricate your client from other parties’ issues and problems
present in the smorgasbord created by Chapter 11.
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MONEY DUE FROM
SUBROGATION RIGHTS IS NOT PROPERTY OF THE ESTATE, THUS INSURERS ARE
ENTITLED TO FULL SUBROGATION RIGHTS TO RECOVERY OBTAINED ON ACCOUNT OF
ACCIDENT INJURING DEBTOR
French v. Frey (In re Bergman),
467 F. 3d 536 (6th Cir. Oct. 27, 2006) (Merritt, J.)
A three judge panel (including one
District Court judge sitting by designation) affirmed the holding of the
District Court for the Northern District of Ohio in deciding that an
insurer who is entitled to subrogation reimbursement rights to payments
made to its insureds has acquired actual property rights to payment
separate from the debtor’s rights in the property.
The Chapter 7 Trustee asserted that an
insurer who had paid pre-petition medical expenses for its insured
(resulting from an auto accident) was entitled to only a pre-petition
general unsecured claim on account of its outlay of cash, and not funds
“off the top” from the Trustee’s suit against the party who injured the
debtor. The insurer claimed under the policy in place, it had
subrogation rights to be reimbursed dollar for dollar from the
tortfeasor. The panel agreed with the insurer holding that when a
policy provides subrogation rights for an insurer and the insurer makes
payments under the policy, the property interest in those reimbursement
funds has been transferred to the insurer and the estate no longer has a
claim to those funds. Accordingly, the Trustee was instructed to
reimburse the insurer from his recovery against the tortfeasor dollar
for dollar rather than on a pro-rata basis with other general unsecured
creditors.
Practice Pointer: When working
with insurers or other entities who make outlays of cash in return for
subrogation rights to reimbursement, make certain that they understand
that such subrogation rights may not need to be relegated to a general
unsecured claim if the party from whom reimbursement is sought enters
Bankruptcy.
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REAL ESTATE
LESSOR WHO FAILS TO NOTIFY DEBTOR-LESSEE OF EXPECTATION THAT PREMISES BE
RESTORED IS BARRED FROM CLAIMING DAMAGES DUE TO FAILURE ON THE PART OF
DEBTOR TO RESTORE PREMISES
Queensgate Associates, LLC v. Regal
Cinemas, Inc. (In re Regal Cinemas, Inc.), 2006 U.S. App. LEXIS
29509 (6th Cir. Nov. 29, 2006) (Rogers, J.)
A panel of three judges for the Sixth
Circuit affirmed both the District Court for the Middle District of
Tennessee and the Bankruptcy Court holding that an assertion by a
landlord in its proof of claim asserting a claim for “physical damages”
is insufficient to put a debtor on notice that the lessor intended to
exercise its lease rights to have the debtor restore the premises to a
pre-lease condition after the debtor’s rejection of the lease.
The lessor claimed that, post-rejection,
it was entitled to damages stemming from the debtor’s failure to adhere
to a lease provision requiring restoration of the real property to a
pre-lease condition. The lease also provided that the lessor had an
obligation to put the debtor-lessee on notice that such restoration was
expected. In an earlier appeal from the Bankruptcy Court, the District
Court had already decided that such damages are not subject to the real
property lease rejection caps imposed by Section 502(b)(6). However,
the lessor, in this case, merely asserted, in its proof of claim, its
claim for these “damages” as “damages to the premises” without any
mention of what or how the lessor was calculating or asserting these
claims for payment. Further, no specific notice was provided to the
debtor-lessee of any restoration expectation. Due to this lack of
notice of expectation, the Sixth Circuit affirmed the disallowance of
the lessor’s claim for damages resulting from the debtor’s failure to
restore the premises.
As an aside, the panel also determined,
contrary to the position of the lessor, that providing notice of
enforcement of lease provisions, such as restoration, to a debtor who
has rejected a lease, would not have been and is not a violation of the
automatic stay.
Practice Pointer: When working
with lessor and executory contract holder clients, instruct them to be
very specific in completing their proofs of claim, especially taking
time to include all special provisions and special recovery rights the
client may want to later assert. Also, a detailed review of all
relevant documents by an attorney is advisable so no notices or other
issues are overlooked.
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FRANCHISOR WHO
TAKES OWNERSHIP OF FRANCHISES FROM FAILING DEBTOR-FRANCHISEE AND PAYS
DEBTS OF DEBTOR HAS NOT RECEIVED FRAUDULENT TRANSFER
Congrove v. McDonald’s Corp. (In re
Congrove), 2007 U.S. App. LEXIS 764 (6th Cir. Jan. 10,
2007) (Griffin, J.)
A three judge panel for the Sixth Circuit
affirmed the holding of both the BAP and the Bankruptcy Court for the
Southern District of Ohio holding that a franchisor who re-takes control
over franchises surrendered by the franchisee and then settles and/or
pays certain debts of the franchisee in order to maintain operations of
the franchises has not benefited from a fraudulent transfer.
The franchisee asserted that the
“volunteer doctrine” applied to payments made by the franchisor. The
franchisee claimed such payments were “cherry picked” by the franchisor,
solely to benefit the ongoing operations of the franchises for the
benefit of the franchisor. The end result was that payments made by the
franchisor to the franchisee’s creditors totaled over $750,000 in cash.
Further evidence was adduced wherein the franchisor and franchisee
agreed that the franchises were worth $700,000. Accordingly, the Panel
held that the “volunteer doctrine” did not apply to the payments the
franchisor was forced to pay to “clean up” the title and property, and
that the debt reduction received by the franchisee represented
reasonably equivalent value for the transfer of the franchises.
Practice Pointer: Franchisees
who are in distressed situations need to consider, well in advance, the
ramifications that will result from turning over their franchises to the
franchisors. In such instances, many unexpected results can, and often
will, occur.
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BANKRUPTCY APPELLATE PANEL FOR THE
SIXTH CIRCUIT
LAND
INSTALLMENT CONTRACTS ARE EXECUTORY CONTRACTS WITH UNPERFORMED
OBLIGATIONS FOR BOTH PARTIES
O’Brien v. Ravenswood Apartments, Ltd.
(In re Ravenswood Apartments, Ltd.), 338 B.R. 307 (B.A.P. 6th Cir. Feb. 17, 2006) (Gregg, J.)
The Bankruptcy Appellate Panel for the
Sixth Circuit reversed the Bankruptcy Court for the Southern District of
Ohio in stating that, applying the Countryman definition of
executory contracts, a land installment contract is an executory
contract, subject to assumption and cure or rejection by a debtor.
The debtor had defaulted on the land
installment contract and the vendor was pursuing its state court
remedies when the debtor filed its petition for protection under Chapter
11. The BAP held that the Countryman definition of executory
contract — that an executory contract exists when performance under the
contract is still required by each side to the contract — applied in
this instance. Applying this definition, the BAP found that the debtor
had an obvious obligation to pay and the vendor, holding legal title to
the real estate, had an undeniable duty to transfer title to the real
property upon payment in full, thus continuing the executory nature of
the land installment contracts. This holding overruled the Bankruptcy
Court’s application of Ohio statutes that led to a determination that
land installment contracts in Ohio do not require performance by both
parties and are therefore non-executory.
Practice Pointer: Based on
this case, it appears that in situations involving installment contracts
the law is going to fluctuate wildly between states and between state
court and federal court. When working with a vendor of land installment
contracts, one needs to carefully examine the applicable law and be
prepared for changes in how a case will be handled dependant upon in
which jurisdiction the case ultimately is filed.
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UNITED STATES DISTRICT COURTS WITHIN
THE SIXTH CIRCUIT
TRANSFER OF
MALPRACTICE CLAIMS TO TRUST PURSUANT TO PLAN OF REORGANIZATION IS A
REASONABLE APPLICATION OF THE “CATCH-ALL” POWERS GRANTED TO BANKRUPTCY
COURT
Parrett v. National Century Financial
Enterprises, Inc., 2006 U.S. Dist. LEXIS 16982 (S.D. Ohio Mar. 23,
2006) (Graham, J.)
The District Court for the Southern
District of Ohio affirmed the Bankruptcy Court in holding that the
Bankruptcy Court had authority, under Section 105 of the Bankruptcy
Code, to allow the transfer of legal malpractice claims held by a debtor
to a post-confirmation trust, even though such transfer was contrary to
applicable state law.
The debtor, through its plan of
reorganization, sought to create a post-confirmation trust containing
certain assets of the debtor, including claims of legal malpractice.
Ohio law generally prohibits the assignment of claims of legal
malpractice to parties who were not aggrieved by the alleged
malpractice. In creating a tacit exception to the Ohio rule, the Court
held that the trust was really a continuation of the debtor and that the
trust’s pursuit of the legal malpractice claims would benefit the same
parties (the debtor’s creditors) as if the debtor itself brought the
claims. Based on this ascribed legal reality, the Court found this
opportunity presented an appropriate use of the catch all powers of the
Bankruptcy Court.
Practice Pointer: Many
Bankruptcy Court judges are loathe to look to Section 105 as a basis to
confer substantive guidance and justify rulings. This case presents a
situation where Section 105 provided the Court the flexibility it needed
to accomplish a very practical result. Not all Bankruptcy Court judges
would have reached this conclusion.
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CHAPTER 11
DEBTOR DOES NOT HAVE ABSOLUTE RIGHT TO CONVERT CASE TO CASE UNDER
CHAPTER 7 — CONVERSION MUST SATISFY BEST INTERESTS OF CREDITORS TEST
Monroe Bank & Trust v. Pinnock, 349 B.R. 496 (E.D. Mich. Aug. 15, 2006) (Duggan, J.)
The District Court for the Eastern
District of Michigan held, in a case of first impression within the
Sixth Circuit, that a debtor’s right to convert a Chapter 11 case to a
case under Chapter 7 is not absolute, and remains subject to the Court
finding that cause exists and that conversion is in the best interests
of the creditors.
The Court took a literal reading of
Section 1112(b) to find that the word “may” modifying conversion creates
a circumstance where a court may allow a debtor to convert its Chapter
11 case to Chapter 7. The Court rejected a reading of the statute
giving deference to the debtor’s choice of path once it had entered
Chapter 11. In the reported case, the debtor was unable to confirm
its proposed plan of reorganization. Further, the debtor had
accumulated significant post-petition assets that would be used to make
payments under an alternative plan of reorganization, such assets would
not be considered assets of a similarly positioned Chapter 7 estate.
For these reasons, among others, the Court ruled that a Chapter 11
debtor must show that cause exists to convert its case to Chapter 7 and that
such cause must be in the best interests of creditors.
Practice Pointer: This case is
highly applicable at the onset of a business debtor case. Debtor
clients need to be advised that a long standing expectation that a
debtor could wield the “club of conversion” may not be such a true
statement anymore, especially within the Sixth Circuit.
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SOVEREIGN
IMMUNITY IS NOT AN AVAILABLE DEFENSE FOR TAXING AUTHORITIES TO PREVENT A
DEBTOR FROM RECOVERING OVERPAYMENTS OF SALES TAXES
Vermont Department of Taxes v. Quality
Stores, Inc. (In re Quality Stores, Inc.), 2006 U.S. Dist. LEXIS
72572 (W.D. Mich. Oct. 4, 2006) (Bell, C.J.)
The District Court for the Western
District of Michigan held that Section 106 of the Bankruptcy Code
provides for the express abrogation of sovereign immunity enjoyed by
states with respect to the turnover of state tax refunds to a Bankruptcy
estate.
Although the doctrine of sovereign
immunity protects states from attack on a vast expanse of topics, the
Court held that Congress has the authority to remove such protections
when it deems appropriate. In upholding that ultimate legislative duty
of Congress, the Court further held that the enactment of Section 106 of
the Bankruptcy Code was one such instance where Congress acted to allow
debtors to, among other things, collect and force turnover of
overpayments for taxes remitted to states.
Practice Pointer: As an aside,
Congress has overriding authority to change, modify or abrogate portions
or the entire Bankruptcy Code at any time, although unlikely. With this
in mind, when working with clients active in distressed markets,
encourage them to consider options and lobbying efforts to introduce to
Congresspeople and Senators, as Congress’ word will always trump.
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UNITED STATES BANKRUPTCY COURTS WITHIN
THE SIXTH CIRCUIT
DEBTOR ABANDONING
REAL PROPERTY MUST ENSURE COMPLIANCE WITH ENVIRONMENTAL REGULATIONS —
ESTABLISHING PROPERTY AS SAFE IS NOT ENOUGH
In re Eagle Picher Holdings, Inc.
(Eagle Picher II), 345 B.R. 860 (Bankr. S.D. Ohio June 13, 2006)
(Aug, J.)
The Bankruptcy Court for the Southern
District of Ohio held that when a debtor is proposing to abandon real
property, it is incumbent upon the abandoning debtor to ensure that the
property is compliant with Federal environmental protection regulations
and guidelines. Abandonment of real property that is “safe” but not
technically compliant is not appropriate.
In this case, the debtor was the owner of
significant plats of contaminated real property that it was proposing to
abandon as burdensome. Two sites were in question as to whether the
debtor had allocated significant funds to “clean up trusts” that would
pay to remedy the contaminated sites. With regard to the two sites in
question, the debtor proposed funding the trusts with $45,000 for site
one and $900,000 for site two. The EPA countered stating that
compliance would require $1.84 million and $5.8 to $9.3 million,
respectively. The issue was framed in the context of an objection to
plan confirmation, the EPA asserting that the debtor was proposing a
plan that was contrary to applicable law. Although the Court agreed
with the EPA’s reading of the law that compliance was needed, it did not
agree with the EPA’s calculations and approved the trust funded with
$45,000 and required a 20% increase in the funding to a separate
$900,000 trust.
Practice Pointer: Clients who
have property with environmental concerns always require the assistance
of competent environmental counsel and professionals. Such retention
will aid in dealing with federal and state environmental authorities,
and often serve to reduce the mitigation costs incurred by clients.
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ASSETS HELD IN
NON-QUALIFIED RETIREMENT PLAN TRUSTS ARE AVAILABLE FOR CREDITORS,
THEREFORE SUCH ASSETS MUST BE TURNED OVER TO ESTATE
Collins & Aikman Corp. v. Northern
Trust Bank of California, NA (In re Collins & Aikman Corp.), 2006
Bankr. LEXIS 1724 (Bankr. E.D. Mich. Aug. 9, 2006) (Rhodes, C.J.)
The Bankruptcy Court for the Eastern
District of Michigan applied the long standing rule that assets held in
trust for non-qualified benefit plan purposes (deferred from taxation)
remain assets of the company and are subject to the claims of creditors,
even if the debtor company has entered a Bankruptcy proceeding. The
Court ordered the turnover of a rabbi trust corpus to the debtor so such
assets could be used by the Chapter 11 debtor.
Although the trust was made up of an
annuity that was purchased by the trust with deferred compensation from
executives and management of the debtor, such funds had never been
subject to taxation and remained subject to the claims of the debtor
company’s creditors, both in and out of Bankruptcy. Accordingly, the
Court held that these assets were most certainly property of the estate
within Section 541 of the Bankruptcy Code and subject to turnover to the
estate.
Practice Pointer: If a debtor
client has a non-qualified plan, and the distress situation appears to
have significant lead time, a “long range” plan to amend the plan and
distribute non-qualified plan assets may work to the advantage of
management and could assist in making up for the general prohibitions on
Key Employee Retention Plans imposed by BAPCPA.
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REAL PROPERTY
OWNED BY DEBTOR SUBJECT TO BUILDING RESTRICTIONS CAN BE SOLD FREE AND
CLEAR OF SUCH RESTRICTIONS UNDER SECTION 363(f)(5)
In re Signature Developments, Inc.,
348 B.R. 758 (Bankr. E.D. Mich. Aug. 24, 2006) (Shapero, J.)
The Bankruptcy Court held that building
restrictions are property interests and not contract claims, and
therefore, the real property to which they are attached may be sold,
pursuant to Section 363(f)(5), free and clear of these building
restrictions because the interest holder can be compelled to accept
money satisfaction in return. Naturally, the party benefiting from the
building restriction is entitled to assert its claim(s) to money from
the proceeds resulting from the sale.
The debtor real estate developer entered
into Chapter 7 and a Trustee was appointed to administer the estate. A
third party entity (also a real estate developer), owned in part by
equity interest holders of the debtor, purchased all but two plats of
land held by the Chapter 7 debtor. The covenants attached to each of
these plats (including two plats not sold to this third party) included
language that forced the landowner to have all property improvements
completed by the debtor (or its successor – the third party). The
Trustee sought to sell the remaining two plats to the bank that held a
mortgage on the respective real property free and clear of all
encumbrances, including the building restrictions. The Court held such
result was possible and appropriate because the third party could
reasonably determine the value, in money, that should be attributed to
the building restriction and that such party could recover such monetary
sum from the sale proceeds derived from the Trustee’s property sale to
the bank.
Practice Pointer: Section
363(f) is very broad. Courts can and often will find ways to make
debtor property liquid, especially if the dollars can fund a recovery
for creditors. Practitioners should be encouraged, when appropriate, to
use this creativity to their clients’ advantage.
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TRANSFER OF PROMISSORY NOTE CARRIES WITH IT EQUITABLE OWNERSHIP OF
MORTGAGE, EVEN IF MORTGAGE IS TRANSFERRED TO THIRD PARTY
Gemini Services, Inc. v. Mortgage
Electronic Registration Systems, Inc. (In re Gemini Services, Inc.), 350 B.R. 74 (Bankr. S.D. Ohio Aug., 29, 2006) (Waldron, J.)
The Bankruptcy Court for the Southern
District of Ohio held that, in Ohio, a mortgage is not a property
interest separate and apart from the note it secures. Rather, in Ohio,
the mortgage is incident to the debt owed to the noteholder. Because of
this status, when a note is transferred with the mortgage being
transferred to a second, agent party, the noteholder retains equitable
ownership in the mortgage and the protections it provides.
In this case, the debtor executed a note
and granted a mortgage securing repayment of the note to a lender.
Subsequently, this lender sold the note to one party and assigned the
corresponding mortgage to another party – the noteholder’s undisputed
agent. Prior to the debtor filing Bankruptcy, a state court foreclosure
proceeding took place and the state court found that the noteholder, by
virtue of the note and the mortgage held by its agent, held the first
and best lien on the property. Using the strong arm powers of a trustee
in Bankruptcy, this Chapter 11 debtor sought to avoid the noteholder’s
lien due to the bifurcation. For the reasons stated above, this effort
was rebuked by the Court, and the Court held that the noteholder’s lien
was, in fact, first and best on the incident property.
Practice Pointer: The use of
mortgage agents is a growing practice in Ohio, and other states. It is
reasonable to expect confusion to continue with respect to these types
of relationships. This case may be used as a guide to your debtor and
lender clients to illustrate how Ohio treats mortgages that have been
bifurcated from the incident debt.
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PROVISIONS IN
FINAL DIP FINANCING ORDER WAIVING RIGHTS TO PURSUE AVOIDANCE AND OTHER
CLAIMS AGAINST DIP LENDER UPHELD
Cobalt Ventures, LLC v. Bank of
America (In re Brooks Sand and Gravel LLC), 2007 Bankr. LEXIS 353 (Bankr.
W.D. Ky. Feb. 13, 2007) (Lloyd, J.)
The Bankruptcy Court for the Western
District of Kentucky upheld and enforced provisions of the
debtor-in-possession financing order that barred parties from
challenging the validity, extent and priority of the lender’s liens in
property of the debtor. In so holding, the Court found that when an
order is final it must have binding and preclusive effect so all parties
can know what to expect.
The Court held that final orders resolve
and dispose of discreet issues and disputes within the context of a
Chapter 11 Bankruptcy case. This protection is afforded to all parties
that are subject to the specific order — in this case a financing order
that bound all parties involved in the case, due in part to the fact
that all parties had notice of the request and hearing. The objecting
party was seeking to avoid certain interests of the lender months after
the Court entered the order confirming the waiver of claims against the
lender. In reaching its decision, the Court reasoned that finality is
an important concept to Bankruptcy cases, and its beneficial effect
should not be minimized.
Practice Pointer: In Chapter
11, obtaining financing is often the most important early “win” for the
parties. When working with a lender, make certain the terms of the
financing are negotiated and include every caveat and perk your lender
client will need to see their way cleanly to the end of the case. This
case illustrates just how powerful the front-end thinking can be.
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