Articles Posted in Supreme Court

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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: 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 Thursday I published a blog article entitled Will “Wellness Make Us Better?, in which I posed the question of whether or not the U.S. Supreme Court would finally rule on whether or not bankruptcy courts can, in Stern type cases, enter a final judgment with the consent of the parties.

Yesterday the Supreme Court, in a 6-3 decision authored by Justice Sotomayor, answered the question in the affirmative and provided us all a good measure of relief.  In the case of Wellness International Network, Ltd., et al. v. Shariff (“Wellness”), Richard Shariff tried to discharge a debt he owed to Wellness International Network, Ltd.  After a series of procedural rulings on discovery, the bankruptcy court eventually entered a default judgment against Shariff.  While Shariff’s appeal was pending in the District Court, the U.S. Supreme Court held in Stern v. Marshall, 131 S. Ct. 2594 (2011) that Article III forbids bankruptcy courts from entering final judgments on claims that seek only to “augment” the bankruptcy estate and would otherwise “exist without regard to any bankruptcy proceeding.”  Thereafter in Wellness, the 7th Circuit Court of Appeals held that the judgment entered by the bankruptcy court against Shariff could not stand because the bankruptcy court lacked the constitutional authority to enter a final judgment on the claim.

The Supreme Court disagreed with the 7th Circuit and, consistent with the 9th Circuit holding in Bellingham, 702 F.3d 553 (9th Cir. 2012), held that Article III permits bankruptcy judges to adjudicate Stern claims with the parties’ knowing and voluntary consent.

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The United States Supreme Court will hand down its decision in the next few weeks in the case of Wellness Int’l Network, Ltd. v. Sharif (“Wellness”), 727 F.3d 751 (7th Cir. 2013) regarding bankruptcy courts’ jurisdiction.  The jurisdictional quagmire is a major and growing virus in the bankruptcy courts, increasing exponentially the costs of bankruptcy litigation.  Hopefully the Wellness decision will eventually provide a belated prescription on bankruptcy courts’ jurisdiction, and make us all feel just peachy.

A little background:

In Stern v. Marshall (“Stern”) 131 S.Ct. 2594 (2011), the Supreme Court granted certiorari to resolve whether a bankruptcy court had authority to enter a final judgment on a debtor’s counterclaim for tortious interference.  Chief Justice Roberts held that 28 U.S.C. § 157, which gives bankruptcy judges core authority to determine counterclaims that are not necessary to the allowance of claims (so-called “Stern type claims”), unconstitutionally delegated the judicial power of the United States to non-Article III bankruptcy judges.  The Court looked at earlier decisions for its holding that only decisions regarding “public rights” can be delegated to a non-Article III judge, while decisions involving private rights “subject to suit at common law, or in equity or admiralty” require Article III jurisdiction.  The Court held that actions which “augment” the bankruptcy estate may not be within the “public rights” exception and thus a bankruptcy judge does not have the authority to make a final decision, whereas actions to determine a creditor’s right to receive “a pro rata share in the bankruptcy estate” are matters over which the bankruptcy judge does have the authority to finally decide.

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Baker Botts L.L.P. et al. v. ASARCO L.L.C., currently pending before the Supreme Court of the United States, is of particular interest to bankruptcy practitioners because this decision will have far-reaching effects regarding attorney’s fees in bankruptcy.  Specifically, the Supreme Court will determine whether Section 330(a) of the Bankruptcy Code grants bankruptcy judges the discretion to award compensation for the defense of fee applications.

The dispute arose after law firm Baker Botts L.L.P. filed a fee application with the Bankruptcy Court for work related to mining company ASARCO’s bankruptcy, including the firm’s work in obtaining a fraudulent transfer judgment in excess of $6 billion.  Baker Botts’ fee application was challenged, and the firm incurred additional fees in its successful defense of the fee application.  Ultimately, the Bankruptcy Court awarded Baker Botts $113 million in fees for its work on the case, plus a $4.1 million merit enhancement, as well as $5 million in fees for its successful defense of the fee application.

However, on appeal, the Fifth Circuit held that the bankruptcy code “does not authorize compensation for the costs counsel or professionals bear to defend their fee applications.”  In re ASARCO, L.L.C., 751 F.3d 291, 299 (5th Cir.) cert. granted sub nom. Baker Botts, L.L.P. v. ASARCO, L.L.C., 135 S. Ct. 44 (2014).  This ruling created a circuit split with a decision by the Ninth Circuit in In re Smith, 317 F.3d 918 (9th Cir. 2002).  Baker Botts appealed the Fifth Circuit’s ruling to the Supreme Court, which granted certioriari earlier this year.

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As we all know, on June 9 of this year, the Supreme Court issued its long awaited decision in Executive Benefits Ins. Agency vs. Arkison, 134 S. Ct. 2165, 189 L. Ed. 2d 83 (2014), which we had hoped would resolve the open questions arising from Stern v. Marshall, 131 S. Ct. 2594, 180 L.Ed 2d 475 (2011).

In Stern v. Marshall, the U.S. Supreme Court held that even though bankruptcy courts are statutorily authorized to enter final judgments on a class of bankruptcy-related claims, Article III of the Constitution prohibits bankruptcy courts from finally adjudicating certain of those claims.  Stern however did not decide how bankruptcy courts should proceed when a “Stern type” claim is identified.

In Executive Benefits the Court went through some of the history of the case law that determines which claims may be adjudicated by a bankruptcy court and which may not be.  The Court distinguished between cases involving so-called “public rights,” which may be removed from the jurisdiction of Article III courts, and cases involving “private rights,” which may not.  Public rights are those related to the restructuring of the debtor-creditor relations, which is at the core of the federal bankruptcy power and which must be distinguished from the adjudication of state-created private rights that belong to an Article III court.

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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:

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