August/September 2004

ERISA
Supreme Court

Can a sole shareholder qualify as a participant in an ERISA pension plan?

The working owner of a business (here, the sole shareholder and president of a professional corporation) may qualify as a “participant” in a pension plan covered by ERISA. If the plan covers one or more employees other than the business owner and his or her spouse, the working owner may participate on equal terms with other plan participants. Yates v. Hendon, 124 S.Ct. 1330, 158 L.Ed.2d 40, 2004-1 USTC P 50,200, 50 Collier Bankr.Cas.2d 1603, 42 Bankr.Ct.Dec. 177, Bankr. L. Rep. P 80,056, 32 Employee Benefits Cas. 1097, Pens. Plan Guide (CCH) P 23987K (2004).

Supreme Court

Does ERISA § 204(g) prohibit a plan amendment expanding the categories of post retirement employment that triggers suspension of the payment of early retirement benefits already accrued?

The Supreme Court held that ERISA § 204(g) prohibits a plan amendment expanding the categories of post retirement employment that triggers suspension of the payment of early retirement benefits already accrued. Central Laborers’ Pension Fund v. Heinz, 124 S.Ct. 2230, 72 USLW 4441, 20041 USTC P 50,260, 32 Employee Benefits Cas. 2313, 4 Cal. Daily Op. Serv. 4841, 2004 Daily Journal D.A.R. 6651, 19 Fla. L. Weekly Fed. S 347 (2004).

Syllabus of Case

Respondents (collectively, Heinz) are retired participants in a multi-employer pension plan (hereinafter Plan) administered by petitioner. Heinz retired from the construction industry after accruing enough pension credits to qualify for early retirement payments under a “service only” pension scheme that pays him the same monthly benefit he would have received had he retired at the usual age. The Plan prohibits such beneficiaries from certain “disqualifying employment” after they retire, suspending monthly payments until they stop the forbidden work. When Heinz retired, the Plan defined “disqualifying employment” to include a job as a construction worker, but not as a supervisor, the job Heinz took. In 1998, the Plan expanded its definition to include any construction industry job and stopped Heinz’s payments when he did not leave his supervisor’s job. Heinz sued to recover the suspended benefits, claiming that the suspension violated the “anticutback” rule of the Employee Retirement Income Security Act of 1974 (ERISA), which prohibits any pension plan amendment that would reduce a participant’s “accrued benefit,” ERISA § 204(g), 29 U.S.C. § 1054(g). The District Court granted the Plan judgment on the pleadings, but the Seventh Circuit reversed, holding that imposing new conditions on rights to benefits already accrued violates the anticutback rule.

Held: ERISA § 204(g) prohibits a plan amendment expanding the categories of post retirement employment that triggers suspension of the payment of early retirement benefits already accrued. Pp. 2235-2239.

(a) The anticutback provision is crucial to ERISA’s central object of protecting employees’ justified expectations of receiving the benefits that they have been promised, see Lockheed Corp. v. Spink, 517 U.S. 882, 887, 116 S.Ct. 1783, 135 L.Ed.2d 153. The provision prohibits plan amendments that have “the effect of...eliminating or reducing an early retirement benefit.” 29 U.S.C. § 1054(g)(2). The question here is whether the Plan’s amendment had such an effect. Although the statutory text is not as helpful as it might be, it is clear as a matter of common sense that a benefit has suffered under the amendment. Heinz accrued benefits under a plan allowing him to supplement his retirement income, and he reasonably relied on that plan’s terms in planning his retirement. The 1998 amendment undercut that reliance, paying benefits only if he accepted a substantial curtailment of his opportunity to do the kind of work he knew. There is no way that, in any practical sense, this change of terms could not be viewed as shrinking the value of Heinz’s pension rights and reducing his promised benefits. Pp. 2235-2236.

(b) The Plan’s technical responses are rejected. To give the anticutback rule the constricted reading urged by the Plan - applying it only to amendments directly altering the monthly payment’s nominal dollar amount and not to a suspension when the amount that would be paid is unaltered - would take textual force majeure, and certainly something closer to irresistible than language in 29 U.S.C. § 1002(23)(A) to the effect that accrued benefits are ordinarily “expressed in the form of an annual benefit commencing at normal retirement age.” And the Plan’s argument that § 204(g)’s “eliminat[e] or reduc[e]” language does not apply to mere suspensions misses the point. ERISA permits conditions that are elements of the benefit itself but the question here is whether a new condition may be imposed after a benefit has accrued. The right to receive certain money on a certain date may not be limited by a new condition narrowing that right. P. 2236.

(c) This Court’s conclusion is confirmed by an Internal Revenue Service regulation that adopts the reading of § 204(g) approved here. Pp. 2236-2238.

(d) ERISA § 203(a)(3)(B), 29 U.S.C. § 1053(a)(3)(B) which provides that the right to an accrued benefit “shall not be treated as forfeitable solely because the plan” suspends benefit payments when beneficiaries like respondents are employed in the same industry and the same geographic area covered by the plan is irrelevant to the question here. Section 203(a) addresses the entirely distinct concept of benefit forfeitures. And read most simply and in context, § 203(a)(3)(B) is a statement about the terms that can be offered to plan participants up front, not as an authorization to adopt retroactive amendments. Pp. 2238-2239.

303 F.3d 802, affirmed.

Bankruptcy
Supreme Court

What is the interest rate for installments in a chapter 13 cram down?

The Supreme Court held that the formula approach, requiring adjustment of prime national interest rate based on risk of non-payment, was the appropriate method for determining adequate rate of interest on a chapter 13 cram down loan. Till v. SCS Credit Corporation, 124 S.Ct. 1951, 43 Bankr.Ct.Dec. 2, Bankr. L. Rep. P 80,099, 4 Cal. Daily Op. Serv. 4224, 2004 Daily Journal D.A.R. 5841, 17 Fla. L. Weekly Fed. S 282 (2004).

When it is recognized that the purpose of including interest as part of the installment payments is to place the secured creditor in the same economic position as if the debtor had surrendered the collateral to the secured creditor, the issue of how the applicable interest rate is to be calculated becomes essentially an economic one.

The lower courts grappled with the appropriate formulation. See, In re Colegrove, 771 F.2d 119 (6th Cir. 1985) (prevailing market rate of interest on similar types of secured loans at the time of allowance of the creditor’s claim and the confirmation of the plan in bankruptcy with a maximum limitation of the underlying contract rate of interest); In re Gincastro, 48 B.R. 662, 665 (Bankr. D. R.I. 1985) (rate at which creditor earns interest); In re Thorne, 34 B.R. 428, 431 (Bankr. E.D. Tenn. 1983) (contract rate); In re Spader, 66 B.R. 618 (W.D. Mo. 1986) (disapproved of by, In re Amerson, 143 B.R. 413 (Bankr. S.D. Miss. 1992)) (state statutory rate instead of the contract rate); In re Wilkinson, 33 B.R. 933 (Bankr. S.D. N.Y. 1983) (current market rate for U.S. Treasury Bonds). Some courts pick a set rate, such as the 9 percent judgment rate, and justify the use of a set rate as being an administrative convenience and of benefit to the parties. In re Callahan, 158 B.R. 898, 902 (Bankr. W.D. N.Y. 1993) (Interest rate to cure arrearages, whether fully secured or undersecured).

In this case Till, a case involving a used truck as collateral, the Supreme Court held that the formula approach, requiring adjustment of prime national interest rate based on risk of nonpayment, was the appropriate method for determining adequate rate of interest on a cram down loan. Both the plurality and the dissent agree that debtor’s promise of future payments is worth less than an immediate payment of the same total amount because the creditor cannot use the money right away, inflation may cause the value of the dollar to decline before the debtor pays, and there is always some risk of nonpayment. Thus, the plurality and the dissent agree that the proper method for discounting deferred payments to present value should take into account each of these factors, but disagree over the proper starting point for calculating the risk of nonpayment. ¹

Justice Stevens writing for the plurality rejected the coerced loan, presumptive contract rate, and cost of funds approaches. Instead, he chose the “formula approach.” The approach begins by looking to the national prime rate reported daily in the press, which reflects the financial market’s estimate of the amount a commercial bank should charge a creditworthy commercial borrower to compensate for the opportunity costs of the loan, the risk of inflation, and the relatively slight risk of default. The Court did not decide the proper scale for the risk adjustment. The Bankruptcy Court in this case approved a risk adjustment of 1.5%. The Supreme Court noted that other courts have generally approved adjustments of 1% to 3%, and cited In re Valenti, 105 F.3d 55, 64(CA2) (collecting cases), abrogated on other grounds by Associates Commercial Corp. v. Rash, 520 U.S. 953, 117 S.Ct. 1879, 138 L.Ed.2d 148 (1997). The Court stated that the appropriate size of the risk adjustment depends on such factors as the circumstances of the estate, the nature of the security, and the duration and feasibility of the reorganization plan. The court must therefore hold a hearing at which the debtor and any creditors may present evidence about the appropriate risk adjustment. The Court recognized that starting from a concededly low estimate and adjusting upward places the evidentiary burden squarely on the creditors, who are likely to have readier access to any information absent from the debtor’s filing.

In footnote 14, the Court contrasts chapter 13 and chapter 11 cases. Till v. SCS Credit Corporation, 124 S.Ct 1951, 2004 U.S. LEXIS 3385 (2004), at *28-29 (Justice Scalia, dissenting)(ruling that appropriate market rate for chapter 13 cramdown plan is prime rate plus an additional 1 % to 3 % to compensate for element of risk, but leaving open possibility that market-driven interest rate may be more appropriate in chapter 11 context because efficient market exists for financing chapter 11 debtors in possession).

Supreme Court

Can the IRS obtain a ten-year statute of limitations for collection of taxes by assessing only against partnership?

Respondents were general partners of a partnership that failed to pay federal employment taxes. The Supreme Court held that in order for Internal Revenue Service to avail itself of ten-year increase in statute of limitations for collection of tax debt, it had to assess taxes only against partnership that was directly liable for debt, and not against each individual partner who might be jointly and severally liable for debts of partner-ship; proper assessment of tax against partnership sufficed to extend statute of limitations for collection of tax from general partners who were liable for payment of partnership’s debts. 26 U.S.C.A. §§ 6203, 6501(a), 6502(a), 7701(a)(1, 14); West’s Ann.Cal.Corp.Code § 16306. United States v. Galletti, 124 S.Ct. 1548, 158 L.Ed.2d 279, 72 USLW 4252, 93 A.F.T.R.2d 2004-1425, 2004-1 USTC P 50,204 (2004).

Supreme Court

Can a sale-and-leaseback arrangement with a fixed rate of return be an “investment contract” within the meaning of the federal securities laws?

The Supreme Court held that a sale-and-leaseback arrangement with a fixed rate of return can be an “investment contract” within the meaning of the federal securities laws. Securities and Exchange Commission v. Edwards, 124 S.Ct. 892, 157 L.Ed.2d 813, 72 USLW 4111, Fed. Sec. L. Rep. P 92,656 (2004).

Respondent/debtor in bankruptcy was the chairman, chief executive officer, and sole shareholder of ETS Payphones, Inc., which sold payphones to the public via independent distributors. The pay-phones were offered with an agreement under which ETS leased back the payphone from the purchaser for a fixed monthly payment, thereby giving purchasers a fixed 14% annual return on their investment.

Second Circuit

Are preconversion fees discharged in subsequent bankruptcy?

The Second Circuit followed the Seventh Circuit in holding that preconversion attorney’s fees are discharged in subsequent chapter 7. In re Fickling, 361 F.3d 172, 42 Bankr.Ct.Dec. 188, Bankr. L. Rep. P 80,059 (2nd Cir. 2004).

This appeal turns on whether the discharge provision of chapter 7, 11 U.S.C. § 727, applies to fees earned and expenses incurred by a debtor’s attorney after the filing of a chapter 11 petition, but before the conversion of the chapter 11 case to a chapter 7 case. Section 727 of the Bankruptcy Code provides that a Chapter 7 debtor may be discharged from all debts, except for those specified in 11 U.S.C. § 523, “that arose before the date of the order for relief under this chapter...” 11 U.S.C. § 727(b). Reading §§ 727(b) and 348(b) together, then, all debts that arose after the filing of the chapter 11 petition, but before the conversion (except those listed in § 523) are treated as pre-petition debts, and are therefore dischargeable.

Nonetheless, the law firm offered two reasons why the Court should not apply the plain language of § 727(b) and § 348(b): (1) the debt is an “administrative expense” under 11 U.S.C. § 503(b) and therefore exempt from discharge pursuant to 11 U.S.C. § 348(d); and (2) to treat the debt as dischargeable under chapter 7 would be to ignore the implications of 11 U.S.C. § 329, which gives the bankruptcy court the power to review claims for attorneys’ fees.

The Court rejected the argument that § 348(d) creates an exception to discharge for administrative expense claims. Section 348(d) may give administrative expense claims priority of payment upon distribution, but it says nothing about their susceptibility to discharge. See also 3 Collier on Bankruptcy, ¶ 348.05[3], at 348-20 (15th ed. rev.2003).

The Court disagreed with the premise of the law firm’s second argument. No portion of § 329 is rendered superfluous by according § 727(b) its plain meaning. The Court agreed with the Seventh Circuit that “ § 329 has plenty to do in Chapter 7 cases,” even if pre-petition claims for legal fees are subject to discharge. Bethea v. Robert J. Adams & Assocs., 352 F.3d 1125, 1127 (7th Cir.2003) (emphasis in original). At the very least, the supposedly superfluous language (“compensation...agreed to be paid...for services...to be rendered”) covers not just pre-petition attorneys’ fees, but also post-petition attorneys’ fees, which are not dischargeable under chapter 7. See 11 U.S.C. §§ 348(b), 727(b); see also In re Sanchez, 241 F.3d 1148, 1150-51 (9th Cir.2001) (post-petition fees are not dischargeable).

Resulting Trusts/Bankruptcy
First Circuit / Eleventh Circuit

Do 11 U.S.C.A. §§ 510 (a) & (c) extinguish the Rule of Explicitness in construction of subordination agreements?

Section 510(a) states that a subordination agreement “is enforceable in a case under [title 11] to the extent that such agreement is enforceable under applicable nonbankruptcy law.’’ Some courts have relied on a federal common law equitable doctrine known as the Rule of Explicitness to deny postpetition interest to undersecured senior creditors even in the face of valid and enforceable subordination agreements.² In its simplest form, this equitable doctrine, called the Rule of Explicitness, required that a subordination agreement show clearly that the general rule that interest stops on the date of the filing of the petition is to be suspended. For purposes of this case, the Court stated “the Rule of Explicitness is a dead letter.” In re Bank of New England, 364 F.3d 355, 42 Bankr.Ct.Dec. 243, Bankr. L. Rep. P 80,079 (1st Cir. 2004). The decision partially contradicts the decision of the only other court of appeals to have addressed the same set of questions, see Chem. Bank v. First Trust of N.Y. (In re Southeast Banking Corp.), 156 F.3d 1114 (11th Cir.1998), and to that extent creates a circuit split.

The Court held that the Rule of Explicitness, which provides that only unequivocal language in a subordination agreement can overcome the generic bar on recovery of postpetition interest, was not part of New York’s general contract law outside the bankruptcy context and, thus, could not be applied in construing subordination clauses contained in debt instruments issued by Chapter 7 debtor.

The Court held that the Rule of Explicitness has no application in the context of bankruptcy where, as here, the state has not adopted the rule as one of general applicability. Consequently, the Court turned to generic principles of state law to interpret the contractual provisions at issue. Applying those principles, the Court found that the subordination provisions are ambiguous as to whether they provide for the priority payment of post-petition interest. This finding necessitated an examination into the intent of the parties --an inquiry which, in the circumstances of this case, entails questions of fact that must in the first instance be addressed by the bankruptcy court. The Court therefore vacated the decision of the district court and remanded with instructions that the district court vacate the judgment of the bankruptcy court and remand the matter to that tribunal for further proceedings.

Fraudulent transfers
Fourth Circuit

Is the Uniform Fraudulent Transfer Act the exclusive route for recovery of fraudulently transferred assets?

The Fourth Circuit held that Rhode Island’s version of the Uniform Fraudulent Transfer Act (“UFTA”) did not preempt all common-law remedies relating to fraudulent transfers. In re Valenti, 360 F.3d 256, 42 Bankr.Ct.Dec. 199 (4th Cir. 2004).

Courts in other contexts have also rejected UFTA preemption of existing remedies. See, e.g., Macedo v. Bosio, 86 Cal.App.4th 1044, 1051, 104 Cal.Rptr.2d 1 (Cal.Ct.App.2001) (“[T]he UFTA is not the exclusive remedy by which fraudulent conveyances and transfers may be attacked. They may also be attacked by, as it were, a common law action.”); Cortez v. Vogt, 52 Cal.App.4th 917, 929, 60 Cal.Rptr.2d 841 (Cal.Ct.App.1997) (“[T]he remedies of the UFTA...are cumulative to the remedies applicable to fraudulent conveyances that existed before the uniform laws went into effect.”); Freitag v. McGhie, 133 Wash.2d 816, 947 P.2d 1186, 1189-90 (1997) (observing that the purpose of the UFTA was to “discourag [e] fraud” and that “within the UFTA itself lies a mandate to apply the common law to the extent it is not inconsistent with the provisions of the act”); Bill Nay & Sons Excavating v. Neeley Constr. Co., 677 P.2d 1120, 1123 (Utah 1984) (imposing a resulting trust after concluding that the creditor did not satisfy the requirements for relief under the UFTA). But see Moore v. Browning, 203 Ariz. 102, 50 P.3d 852, 858 (App.2002) (concluding that the UFTA preempted the common law use of the statute of limitations regarding fraudulent actions).

Endnotes

1 Bankruptcy Code 11 U.S.C. §1325(a)(5)(B), does not mention the term “discount rate” or the word “interest.” Rather, it simply requires bankruptcy courts to ensure that the property to be distributed to a particular secured creditor over the life of a Bankruptcy plan has a total “value, as of the effective date of the plan,” that equals or exceeds the value of the creditor’s allowed secured claim

2 4-510 Collier on Bankruptcy - 15th Edition Revised P 510.03 (2004).

Professor Dunaway, professor emeritus, School of Law, Pepperdine University.

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