Articles Posted in Chapter 7

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As a creditor, the news of a debtor who owes you a substantial sum of money filing bankruptcy is often the most alarming news you can learn—that is, until you seek advice of counsel and learn that payments the debtor made to you within 90-days prior to the bankruptcy will be the subject of a lawsuit and likely recoverable by the bankruptcy estate as a “preference.”  This is usually the point I offer soothing chamomile tea to the client.

Recovery of “preference” transfers in bankruptcy cases, though seemingly unfair to the individual creditor, serve an important role and offer a degree of protection to the creditors as a whole.  The primary elements of a preference transfer are relatively straightforward: a debtor who is insolvent, makes a payment or payments to a creditor, within 90 days[1] prior to the bankruptcy filing, to satisfy at least a portion of a pre-existing debt[2], and the creditor receives more than it would have had the debtor filed a chapter 7 (liquidation) bankruptcy case.  Though the “don’t rob Peter to pay Paul” concept appears clear enough, the Ninth Circuit has recently illustrated how complicated the matter can become in In re Tenderloin Health[3] where the court addressed the often overlooked final element to a preference—the “greater amount” test.

As the Ninth Circuit noted, the “greater amount test … ‘requires the court to construct a hypothetical chapter 7 case and determine what the creditor would have received if the case had proceeded under chapter 7’ without the alleged preferential transfer.” Id. at *7.  This task of creating a hypothetical chapter 7 liquidation grows ever more daunting as a case grows more complex, leading to uncertainty for a creditor client, especially when unresolved legal issues come up within the hypothetical bankruptcy.

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We asked some of our financial advisor colleagues to give us brief read outs on what they felt 2017 has in store for us now that we have gotten beyond the inauguration and into the first weeks of the Trump administration.  Their thoughts follow:

https://www.southerncaliforniabankruptcylawyersblog.com/files/2017/02/2012-03-31-10.05.15-214x300.jpgWe have been seeing a lot of highly leveraged deals that impact the performance of the business. These deals are leading to reduced spending on capital expenditure, marketing and even experienced management.  Once new ownership is in place, these strictures prevent the company from operating with the same efficiency as in the past, let alone growing.  Another scenario we have been encountering is companies getting beyond the management ability of the founder as the company increases revenues from $25M to $50M and then to $100M or more. In either case, increasing interest rates will cause dislocation, because it does not take much to push these companies into a zone where they are showing significant financial stress.

That being said, we are also seeing that lenders are still being lenient because it’s really hard to get a full recovery in a liquidation, and appraisal firms always seem to be the first to hedge on their ability liquidate inventory en masse.  Also, my sense is that lenders don’t really want to sell their loans to exit a credit as it hurts their reputation.  Still, we are finding that lenders keep getting surprised with over-advances for many reasons.  When we are called in to assist in such situations, we focus our efforts on trying to fix the operating issues of the businesses and make a reasoned re-allocation of limited resources.

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On December 1, 2016, something extraordinary happened. No, it was not president-elect Trump visiting another Carrier air conditioning factory in Indianapolis. It was an event that made no headlines and caused no stir.  The Federal Rules of Bankruptcy Procedure were silently amended to remove all references to “core” and “noncore” proceedings.

So what’s the big deal?

Besides eliminating one of the last tools I possessed to sound smarter than my non-bankruptcy colleagues, the change reflects the final chapter in a 34-year saga regarding bankruptcy court jurisdiction and the constitutional authority of bankruptcy judges.

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Inauguration is still about 2 months away, but it is not too early to begin thinking about what the Trump Administration will mean for commercial lawyers in general and bankruptcy lawyers in particular.

Bankruptcy Reform?

We are not hearing anything about a push for bankruptcy reform as part of the new administration’s agenda. Two potential exceptions are the fate of the proposed Financial Institution Bankruptcy Act of 2016, H.R. 2947, 114th Cong. (2016), which would add a new chapter to the Bankruptcy Code dealing with large financial institutions.  Another is the potential for the new administration to take a different position than the Obama administration on Czyzewski v Jevic Holding Corp., which is now pending before the United States Supreme Court.  To date, the Solicitor General has argued that the Third Circuit was wrong to affirm the Bankruptcy Court’s approval of the “structured settlement” which resolved that case.[i]  With so many other issues swirling about, it does not seem likely that bankruptcy reform per se is in the offing.  However, a number of other potential policies may impact bankruptcy practices.

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The additional “default interest” owed when a borrower defaults under a loan agreement is a technical but highly critical part of any lending arrangement. This important “default interest” was the subject of a recent Ninth Circuit decision in which the Circuit made a nearly 180 degree u-turn away from its prior precedent.  Earlier this month in a case called In re New Investments, Inc. the Ninth Circuit adopted a new rule which may significantly constrain the ability of distressed companies to reorganize by restructuring their debt.

In that case, two members of a three judge Ninth Circuit panel reversed a bankruptcy court’s decision, and ruled that the chapter 11 debtor could not cure a default under its loan agreement by paying only the contractual pre-default interest but instead must pay interest at the higher post-default rate. This ruling is contrary to the Circuit’s prior decision in In re Entz-White Lumber & Supply, Inc. 850 F. 2d 1138 (9th Cir. 1988), and represents a dramatic shift in the Bankruptcy Code’s balance of power away from debtors and towards secured creditors.  The decision makes it much more difficult for a debtor to cure a loan default as part of a plan of reorganization.

In 1988, in the Entz- White decision, the Ninth Circuit held that a debtor who proposes to cure a loan default through a plan of reorganization is entitled to avoid all consequences of the default including higher post-default interest rates.  At that time, the Court acknowledged that under the Bankruptcy Code, a plan of reorganization “shall provide adequate means for the plan’s implementation, such as curing or waiving of any default.”  The Court recognized that there was no definition of “cure” in the Bankruptcy Code, and adopted the following definition, which had been used by the Second Circuit:

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In my blog article on August 9, I focused on some of the issues that licensors need to be aware of as they license IP rights, including the concept of allowing distributors to include “damages only” clauses in the distribution agreements.

The second issue that often arises in distribution agreements related to DVD distribution rights is that the producer/licensor grants to the distributor/licensee the right to distribute a movie in various media, including, but not limited to DVD. The distributor will often pay for the cost of manufacturing the DVDs and then have the first right to recover the cost of manufacturing out of the first sales of those DVDs.  Sometimes the producer/licensor will pay for the cost of manufacturing the DVDs.  In either instance, however what happens when a distributor files a bankruptcy and holds on to the DVDs, the cost for which may have already been recouped through prior sales or which have actually been paid for by the producer.

The “automatic stay” which comes into being on the filing of a bankruptcy by the distributor, precludes the producer from immediately recovering those DVDs, and a significant question arises whether or not those DVDs become “property of the distributor’s bankruptcy estate”.

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Editor’s note: this post originally appeared in Law360.

In a recent decision, the United States Bankruptcy Appellate Panel of the Ninth Circuit resolved what it described as an issue of “first impression” in the Ninth Circuit — whether or not the two-year statute of limitations provided by Section 546(a) of the Bankruptcy Code “. . . preempts a state-law statute of repose such as California Civil Code § 3439.09(c).”  Rund v. Bank of America NA et al. (In re EPD Investment Co. LLC), 523 B.R. 680, 682 (B.A.P. 9th Cir. 2015).

The EPD Investment decision involved the application of the California Uniform Fraudulent Transfer Act (UFTA), set forth at Civil Code §§ 3439-3439.12, which allows a creditor to recover a fraudulent transfer from the transferee under various circumstances, including “actual fraud” and “constructive fraud.”  The statute of limitations provided in the UFTA, Civil Code § 3439.09, generally provides that claims must be brought within four years from the date of the transfer or in some cases, within one year of discovery of the claim.  The BAP found that despite the terms of Civil Code § 3439.09(c), if a claim existed under the UFTA on the date of the “order for relief,” the trustee had an additional two years to file a complaint with respect to that claim by reason of Sections 544(b) and 546(a) of the Bankruptcy Code.  EPD Investment, 523 B.R. 680 at 691-692.

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The Beverly Hills Bar Association’s Bankruptcy Section recently held a program discussing the three recent bankruptcy-related Supreme Court decisions: Law v. Siegel (a case regarding surcharge, which was discussed on this blog in a previous post by Courtney Pozmantier), Executive Benefits Insurance Agency v. Arkison (In re Bellingham) (redux of Stern v. Marshall), and Clark v. Rameker (regarding inherited IRAs and exemptions).  The program was presented by Ken Klee and Dan Bussel and moderated by Greenberg Glusker’s own Brian Davidoff.

While the three cases that were discussed address different issues, the cases were linked by common themes.  All three cases were decided unanimously by the Supreme Court — no split decisions or plurality decisions here!  Also, all three opinions made use of textual analysis.  The panelists at the program speculated that perhaps unanimity came at the cost of squarely addressing key issues.  The Supreme Court’s grant of certiorari in the Wellness International case[1], in order to resolve issues left open by the Bellingham, supports this contention.  The panel also discussed the possibility that the use of textual analysis, which is advocated by some conservative Justices, may have been necessary for unanimity.  This is supported by the fact that Justice Sotomayor incorporated textual analysis into her opinion in Clark v. Rameker.

The program went on to address how these three cases will impact the practice of bankruptcy, including how courts will deal with Stern v. Marshall-type claims in the future.  A DVD of the program is available from the Beverly Hills Bar Association’s website.  By purchasing and viewing the DVD, attorneys can earn 1 hour of MCLE credit.

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On March 4, 2014, the Supreme Court issued a unanimous opinion in Law v. Seigel, Case No. 12-5196, 571 U.S. ___ (2014) holding that the bankruptcy court used its equitable powers in contravention of Bankruptcy Code section 522 by ordering the $75,000 protected by the debtor’s homestead exemption to be made available to pay the chapter 7 trustee’s attorney’s fees in light of the egregious misconduct of the debtor.  A full copy of the opinion can be reviewed at: http://www.supremecourt.gov/opinions/13pdf/12-5196_8mjp.pdf

The Debtor’s Fraud and Prolonged Litigation With Trustee

Stephen Law filed his chapter 7 bankruptcy petition in Los Angeles, California over 10 years ago, on January 5, 2004.  The case was assigned to the Honorable Thomas B. Donovan, United States Bankruptcy Judge.  The estate’s only significant asset was Law’s house in California, which Law valued at $363,348.  Law claimed a $75,000 homestead exemption in his bankruptcy schedules, and he listed two mortgages, totaling approximately $304,000, that exceeded the non-exempt value of the house.

Small Supreme Court Picture for Law v. Siegel ArticleAlfred H. Siegel, the chapter 7 Trustee, contended that one of the mortgages was a sham.  As detailed in the Supreme Court’s decision, the Trustee then spent almost five years proving that Law fabricated the second mortgage and deed of trust on the house – allegedly in favor of “Lili Lin” of China – to defraud his creditors and keep his equity in the house.  Ultimately, the Bankruptcy Court entered an order concluding that “no person named Lili Lin ever made a loan to [Law] in exchange for the disputed deed of trust,” and that the loan was a fiction meant to preserve [Law’s] equity in his residence beyond what he was entitled to exempt” by perpetrating “a fraud on his creditors and the court.”  In re Law, 401 B.R. 447, 453 (Bankr. C.D. Cal. 2009).  The Trustee apparently incurred more than $500,000 in attorney’s fees in the course of uncovering and litigating Law’s fraudulent misrepresentations. Continue reading