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Bond Bankruptcy Report

Bordering on Unlucky – Gift Card Holders May Not File Late Claims

Don’t wait to spend those gift cards sitting in your junk drawer. The Second Circuit Court of Appeals held in an October 29, 2014 decision that gift card holders may be out of luck trying to file claims for unused gift cards if they wait too long, even if the card holder had no idea the company issuing the gift card had entered a bankruptcy proceeding.

In Beeman et al., v. BGI Creditors Liquidating Trust, Curtis R. Smith as Liquidating Trustee (In re BGI, Inc. f/k/a Borders Group, Inc.), the Second Circuit Court of Appeals upheld Southern District of New York Bankruptcy Judge Glenn’s ruling, and the subsequent District Court decision that an appeal of the bankruptcy court ruling was equitably moot, denying three gift card holders the right to file late proofs of claim.  The three gift card holders claimed they did not know Borders (the now-defunct book store chain) had filed a bankruptcy case. The Second Circuit also upheld the denial, as moot, of the gift card holders’ motion to certify a class.  By using the doctrine of “equitable mootness” the Second Circuit upheld the findings of the lower courts that allowing the gift card holders’ late claims would unravel the series of intricate transactions which resulted in an almost fully consummated liquidation plan under chapter 11.

Borders filed a voluntary petition for chapter 11 protections in the Bankruptcy Court of the Southern District of New York in February, 2011. The bar date order stated that prepetition creditors must file their claims by June 1, 2011. A notice of the bar date was published in the national edition of the New York Times.  The bar date order allowing for notice by publication to unknown creditors was never appealed.

On July 1, 2011, the Bankruptcy Court authorized Borders to close its stores and liquidate substantially all of its assets. On September 20, 2011, the last bricks and mortar Borders store was closed and, a week later, all online sales ceased. Many holders of unredeemed gift cards who were presumably aware of the chain’s closure took steps to ensure they were able to take advantage of the full value of the cards.  In fact, the Second Circuit noted that “[g]ift card redemptions constituted nearly one hundred percent of Borders’ net sales in the last month of the chain’s operations.”  A notice of the plan confirmation hearing was also published in the New York Times on November 16, 2011. The confirmation hearing was held December 20, 2011, with no objections filed or appearances made by the late claimants.

Two weeks later, however, two of the gift card holders moved for authorization to file an untimely proof of claim, saying the New York Times notice was insufficient and they did not have actual notice of the deadline to file a claim. A third gift card holder simply filed a late claim without prior authorization.

The gift card holders claimed that they were entitled to actual notice and that the constructive notice of the New York Times publication was insufficient. Judge Glenn held that gift card holders are unknown creditors to a debtor and therefore actual notice is not necessary. The constructive notice of the New York Times publication, as permitted by the Bankruptcy Rules and the Order setting the bar date, was sufficient. 

On appeal, the Court of Appeals in the Second Circuit held that the theory of “equitable mootness” applied to the gift card holders’ appeals of the denial of their requests to file late claims. The court applied a five factor test from Frito‐Lay, Inc. v. LTV Steel Co. (In re Chateaugay Corp.), 107 F.3d 944 (2d Cir. 1993), analyzing: (1) whether the court can still order effective relief; (2) whether such relief will affect the re-emergence of the debtor as a revitalized corporation; (3) whether such relief will unravel intricate transactions so as to knock the props out from under the authorization for every transaction that has taken place and create an unimaginable, uncontrollable situation for the bankruptcy court; (4) whether the adversely affected parties would have notice and an opportunity to participate in the proceedings; and (5) whether the appellant pursued with diligence all available remedies to obtain a stay of the execution of the objectionable order and, if the failure to do so creates a situation rendering it inequitable to reverse the orders on appeal.

The Court of Appeals stated that by applying these factors to the case at hand, “we have little difficulty in concluding that the District Court (which upheld the Bankruptcy Court’s ruling) did not abuse its discretion in dismissing the gift card holders’ appeals as equitably moot.” The plan had been substantially consummated, having distributed approximately half of the administrative and priority tax claims thus far, with approximately $90 million held to be distributed to over $800 million in priority and general unsecured claims. The court held that the gift card holders did not meet the Chateaugay 5-part test, in particular because they could not ensure adequate process for the parties that would be adversely affected by allowing late claims and could not demonstrate their diligence by obtaining a stay of execution.

As a result, the Court of Appeals affirmed the lower courts’ equitable mootness findings, and also held that certifying the class would subsequently be moot as well.

The Chateaugay 5-part test confirms that Bankruptcy Courts may take into account the significant work that goes into confirming a chapter 11 case in order to prevent creating an “unimaginable, uncontrollable situation” for the court to administer.  Ultimately, the gift card holders were left with gift certificates so worthless that, ironically, they could not even be used to buy a copy of the New York Times. And so, with the holidays fast approaching, it is time to open that junk drawer and dust off those old gift cards – spend them now before you miss the chance.

The Jewel Unfinished Business Doctrine Loses its Luster

On November 15 and December 2, 2013, the Second Circuit Court of Appeals, in In re Thelen LLP and In re Coudert Brothers LLP, certified to the New York Court of Appeals the question of whether a client matter, billed on an hourly basis, constituted property of the law firm such that upon dissolution, the law firm is entitled to the profit earned on such matters as the ‘unfinished business’ of the firm.

On July 1, 2014, the New York Court of Appeals answered that question in the negative.  In In re Thelen LLP, the chapter 7 bankruptcy trustee had relied upon the unfinished business doctrine, as set forth in Jewel v. Boxer, a 1984 California state court appellate decision, in an attempt to recover the value of the Thelen LLP law firm’s unfinished business for the benefit of the bankruptcy estate’s creditors.

Although the facts in Jewel are convoluted, that court found that “several courts in other states have held that after dissolution of a law partnership, income received by former partners from cases unfinished at the time of dissolution is to be allocated on the basis of the partners’ respective interests in the dissolved partnership.…” The Jewel defendants argued, among other things, that this interfered with a client’s absolute right to the attorney of his or her choice.  The Jewel court reached the opposite conclusion: that the client’s right to an attorney of his or her choice “was irrelevant to the rights and duties between the former partners with regard to income from unfinished partnership business… Once a client’s fee is paid to an attorney, it is of no concern to the client how that fee is allocated among the attorney and his or her former partners.”

In the New York Court of Appeals’ unanimous decision in In re Thelen, the Court took a view quite different from that of the Jewel court.

The Court of Appeals rejected the premise upon which the unfinished business doctrine was based.  Instead, the Court of Appeals reasoned that because a client has an ‘unfettered right’ to hire and fire legal counsel, no law firm has a property interest in hourly legal fees.  In other words, “a client’s legal matter belongs to the client, not the lawyer.”  With the firm having no property interest in an hourly legal fee matter, the Jewel unfinished business doctrine appears to have lost its relevance in New York and perhaps elsewhere.

The Court of Appeals noted that although the Appellate Division sometimes refers to a contingency fee case as an “asset” subject to distribution, a former partner is entitled only to the value of his interest in the contingency case as of the date of dissolution; the lawyer must remit to her former firm the settlement value, less the amount attributable to the lawyer’s efforts following the firm’s dissolution.

The Court of Appeals also noted in In re Thelen that a ruling to the contrary would have perverse public policy considerations.  For example, if a dissolved firm’s hourly fee matters were to be considered partnership property, former partners of a dissolved firm could profit from work they did not perform.  Also, such a policy would encourage partners to leave a troubled law firm well before it neared dissolution, thus discouraging lawyers from remaining with troubled firms in an attempt to bolster their firms’ odds of surviving.

As noted in this blog in May of 2012, the Trustee in In re Thelen had, at that point, reached settlements with several firms to which former Thelen partners had fled.  These settlements, in excess of $700,000, were reached based on the Trustee’s assertion of claims under the unfinished business doctrine against the new firms and partners of the dissolved firms.

With the Court of Appeals’ decision in In re Thelen, trustees will no longer be able to extract such tribute from firms that have hired lawyers from dissolved firms.  In fact, in reaching its holding, the Court even cited to public policy encouraging “attorney mobility.”

If there is a tag line that will emerge from the New York Court of Appeals’ decision in In re Thelen, it may be the one resurrected by Judge Read (the author of the unanimous In re Thelen decision) from a 1943 New York County Lawyers’ Association opinion:

“Clients are not merchandise, [and] lawyers are not tradesmen.”

The “Law’s” Limits On The Bankruptcy Court’s Ability To Impose Sanctions For Debtor Misconduct

In the first six months of 2014 the Supreme Court has already issued two opinions concerning the authority of the bankruptcy courts.  The first opinion, Law v. Siegel, 134 S. Ct. 1188 (2014), was issued in March.  In Law, Justice Antonin Scalia delivered a unanimous opinion of the Supreme Court holding that a bankruptcy court may not “order that a debtor’s exempt assets be used to pay administrative expenses incurred as a result of the debtor’s misconduct.”  And in Executive Benefits Insurance Agency v. Arkison, 573 U.S. ___ (2014), which was issued earlier this week, Justice Clarence Thomas delivered another unanimous opinion of the Court holding that “when . . . the Constitution does not permit a bankruptcy court to enter final judgment on a bankruptcy-related claim, the relevant statute nevertheless permits a bankruptcy court to issue proposed findings of fact and conclusions of law to be reviewed de novo by the district judge.”   The subject of this post is Law, but an analysis of Executive Benefits will follow shortly on the Bond Bankruptcy Report.

Under Chapter 7 of the Bankruptcy Code, a debtor may liquidate assets to pay creditors, and the filing of the Chapter 7 petition creates an “estate” that, with limited exceptions, is comprised of all of the debtor’s property.  11 U.S.C. §§ 541(a)(1), 704(a)(1), 726, 727.  Certain assets, however, may be “exempt” from the bankruptcy estate, and the debtor may keep those assets after he emerges from bankruptcy.  11 U.S.C. § 522(b)(1).  The Code lists a number of exemptions that may be used unless prohibited by state law.  11 U.S.C. § 522(d).  A debtor, however, may choose to use the exemptions provided by his state or local laws by foregoing the federal exemptions.  11 U.S.C. § 522(b)(3)(a).

The debtor in Law owned a house in California, and the house was the estate’s only significant asset.  He valued it at approximately $360,000.00, but he claimed that $75,000.00 of the house’s value fell under California’s homestead exemption.  The debtor further claimed that the house was subject to two liens, and that the two liens exceeded the house’s nonexempt value.  Thus, he “represented that there was no equity in the house that could be recovered for his other creditors.”

The bankruptcy trustee commenced an adversary proceeding, alleging that the lien held by “Lili Lin,” as reflected on the deed of trust, was fraudulent.  Two individuals claiming to be Lili Lin responded to the complaint.  One of the individuals was from California.  Although she knew the debtor, she denied loaning him money, and said the debtor had tried, on multiple occasions, “to involve her in various sham transactions relating to the disputed deed of trust.”  She then “entered into a stipulated judgment disclaiming any interest in the house.”  The other “Lili Lin” was “supposedly living in China and [spoke] no English,” but she managed to engage in protracted and costly litigation to contest the avoidance of the deed and the sale of the house.

Five years after the bankruptcy proceeding was commenced, the bankruptcy court entered an order finding that “the loan was a fiction, meant to preserve [the debtor’s] equity in his residence beyond what he was entitled to exempt.”  The trustee had incurred more than half a million in attorney’s fees throughout the litigation, and thus, the court granted his “motion to ‘surcharge’ the entirety of [the] $75,000 homestead exemption, making those funds available to defray [the trustee’s] attorney’s fees.”  Both the Ninth Circuit Bankruptcy Appellate Panel and the Ninth Circuit Court of Appeals affirmed the bankruptcy court’s order.

The Supreme Court, however, reversed the order because the “‘surcharge’ was unauthorized [as] it contravened a specific provision of the Code.”

Although bankruptcy courts may “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of the Bankruptcy Code,” 11 U.S.C. § 105(a), and hold the “inherent power . . . to sanction ‘abuse litigation practices,’” the bankruptcy courts “may not contravene specific statutory provisions.”

In imposing a surcharge to be drawn from the exempt portion of the estate, the bankruptcy court violated the provision of the Code stating that “exempt” property “is not liable for payment of any administrative expense,” with two limited exceptions that did not apply in Law.

 

The Bankruptcy Code makes clear that the attorney’s fees that the trustee incurred were, without a doubt, “administrative expenses.”  Section 503(b)(2) states that “administrative expenses,” include “compensation and reimbursement awarded under” § 330(a), which authorizes “reasonable compensation for actual, necessary services rendered” by a “professional person employed under” § 327.  Section 327 (a) allows the trustee to “employ one or more attorneys . . . to represent or assist the trustee in carrying out the trustee’s duties under this title.”  The Supreme Court rejected the trustee’s argument that while attorney’s fees may be “administrative expenses” under § 503(b), attorney’s fees were not administrative expenses” under § 522(k).  The trustee, however, did not provide the Court with any “reason to depart from the ‘normal rule of statutory construction’ that words repeated in different parts of the same statute generally have the same meaning.”

The trustee also argued that the surcharge did not exceed the scope of the Bankruptcy Court’s statutory authority.  He submitted that while § 522 permits exemptions, the Code does not require judicial recognition of exemptions in every circumstance, and thus, the court, in response to misconduct, may deny an exemption through a surcharge on the exempt property.  The United States, as amicus curiae, supported the trustee’s position.  The Supreme Court, however, rejected those arguments because if the surcharge were treated as a denial, then the trustee’s objection was untimely, and “a trustee’s failure to make a timely objection prevents him from challenging an exemption.”

In another attempt to support his position, the trustee argued “that because § 522(b) says that a debtor ‘may exempt’ certain property, rather than that he ‘shall’ be entitled to do so, the court retains discretion to grant or deny exemptions when the statutory criteria are met.”  (Emphasis in original).  The Court rejected that argument, noting that “the subject of ‘may exempt’ in § 522(b) is the debtor, not the court, so it is the debtor in whom the statute vests discretion.”

“A debtor need not invoke an exemption to which the statute entitles him; but if he does, the court may not refuse to honor the exemption absent a valid statutory basis for doing so.”

Finally, the Supreme Court noted that the Bankruptcy Code and Federal Rules of Bankruptcy Procedure already give bankruptcy courts the authority to sanction debtor misconduct, including subjecting the debtor to criminal prosecution.  Bankruptcy courts, however, may not exceed the scope of their statutory authority:

“[W]hatever other sanctions a bankruptcy court may impose on a dishonest debtor, it may not contravene express provisions of the Bankruptcy Code by ordering that the debtor’s exempt property be used to pay debts and expenses for which that property is not liable under the Code.”

In Law, the Court appeared to express a unanimous concern about expanding the power of the bankruptcy courts beyond what Congress intended.  This concern may stem from the bankruptcy judges’ status as Article I judges that do not enjoy the same constitutional benefits as Article III judges (i.e. lifetime tenure and protection from salary diminution).  The bankruptcy courts, like other Article I courts, derive their authority entirely from laws passed by Congress, and thus, the scope of their authority may be limited by Congress in every respect.  But Article III courts derive their authority from the Constitution itself, and under the Constitution, Congress may only limit the Supreme Court’s appellate jurisdiction.  As will be discussed in a subsequent post on the Bond Bankruptcy Report, the distinctions between Article I and III courts, and the implications of those distinctions, were also at issue in Executive Benefits.

UPDATE: Leaving Las Vegas (but What is Filed in Delaware Stays in Delaware)

On Thursday, May 22, 2014, Judge Sontchi upheld the Energy Futures Holdings debtors’ chosen venue in Delaware, denying the second-lien holders’ motion to transfer the bankruptcy case to Texas.  In arriving at this decision, Judge Sontchi accepted the Debtor’s argument that the bankruptcy case was primarily a “financial restructuring” and would thus impact mostly investors and banking institutions based in New York, and not employees, trade creditors and customers based in Texas.  Additionally, the Texas Attorney General filed a 2-page statement prior to the hearing, confirming that “the Texas Regulatory Authorities take no position on the Motion to Change Venue.”

In issuing his bench ruling, Judge Sontchi also noted that the request for a transfer of venue to Texas came from a Delaware entity, Wilmington Savings Fund Society, as trustee for second-lien notes, and that none of the Texas-based Energy Futures employees or customers requested a change of venue to Texas.

Leaving Las Vegas (and Wilmington, too?)

The topic of transfer of bankruptcy venue continues to percolate.  There were panels on the topic at both the summer 2013 American Bankruptcy Institute Mid-Atlantic Conference, and the May 2014 annual American Bankruptcy Institute New York City Conference.  Both of these recent panels featured U.S. Bankruptcy Judge Shelly Chapman’s Patriot Coal decision, in which the Patriot Coal cases were transferred from their original venue in the Southern District of New York to the venue of Patriot Coal’s headquarters in the Eastern District of Missouri.  Judge Chapman’s analysis and holding were based, in part, on the formation of certain subsidiaries in New York shortly before the chapter 11 filing.  While certainly not the first transfer of venue decision issued by a Southern District Bankruptcy Judge, Patriot Coal seems to have left a substantial impression upon both bar and bench.

Two recent motions for transfer of venue, one granted by Bankruptcy Judge Landis in the District of Nevada and one pending before Delaware Bankruptcy Judge Christopher Sontchi, do not expressly rely upon the analysis in Patriot Coal.  However, the Patriot Coal decision lurks in the background, and informs many practitioners’ and judges’ approach to venue motions.

In re Telexfree, LLC Transferred From Nevada to Massachusetts

Venue was recently transferred in the case of Telexfree, LLC, a limited liability company that had been formed under the laws of the state of Nevada.  On April 13, 2014 (a Sunday), Telexfree, LLC and two affiliates filed chapter 11 petitions in the Bankruptcy Court for the District of Nevada, which is located in Las Vegas; a fairly unremarkable event on its face.  However, Telexfree, LLC and its two non-Nevada affiliates did the vast majority of their business from Marlborough, Massachusetts.  And the business they did there was of the type that attracted a considerable amount of unwanted attention from the Securities Division of the Massachusetts Office of the Secretary of the Commonwealth, the Securities and Exchange Commission, and the Department of Homeland Security.  This unwanted attention culminated in the Department of Homeland Security and the local sheriff executing a search warrant on the companies’ headquarters on April 15, 2014, and the SEC obtaining a TRO and freeze of all the companies’ assets from the United States District Court for the District of Massachusetts on April 16.  By all accounts, these events did not constitute a propitious start to the debtors’ chapter 11 reorganization.  Apparently all three companies had been engaged in conducting an extensive and longstanding Ponzi scheme, which the authorities had been watching for some time.

It appears that the Telexfree debtors had hoped that the automatic stay in a bankruptcy case filed in another jurisdiction would render portions of the Massachusetts district court TRO obtained postpetition void ab initio, and permit the companies to continue to use their assets in the ordinary course of business.

On April 23, 2014, the SEC moved the Nevada Bankruptcy Court to transfer venue of the Telexfree cases to the Bankruptcy Court for the District of Massachusetts.  The Debtor objected to the motion to change venue, pointing out, among other things, that it had installed new management, and was in the process of changing its business model.  Although these are the types of institutional changes that could be used to avoid the appointment of an 1104 trustee or examiner, they could not prevent the continuation of the TRO obtained by the Massachusetts Securities Division.  On May 6, 2014, Bankruptcy Judge August B. Landis issued an Order Granting the SEC’s Motion to Transfer Venue.  The cases are now before Bankruptcy Judge Melvin S. Hoffman of the Bankruptcy Court for the District of Massachusetts.

Energy Future Pending Motion to Transfer Venue from Delaware to Texas

Another transfer of venue motion was argued on May 22, 2014, in the Energy Future Holdings Corp. case, before Bankruptcy Judge Christopher Soncthi in Delaware.  Energy Future Holdings has been deemed the eighth largest Chapter 11 filing in history.  Energy Future Holdings Corp. and over 70 of its affiliates (“EFH” or the “EFH Debtors”) filed their chapter 11 petitions on April 29, 2014.  EFH, with over 9,000 employees, is the largest generator and retail provider of electricity in Texas, and is subject to regulation by the Public Utility Commission of Texas.  The stated reason for EFH’s filing was the prolonged and significant decrease in natural gas prices caused by Congress’ 2005 lifting the ban on fracking as a means of extracting natural gas.

Pre-petition restructuring discussions with creditors began in July 2012.  From these discussions, a consenting group of creditors emerged which supported EFH’s prearranged plan for restructuring its debt.  The EFH Debtors entered bankruptcy with a pre-arranged plan, or “restructuring support agreement,” to restructure approximately $42 billion in debt.  Ongoing negotiations with those creditors not agreeable to the prearranged plan were cut short by EFH’s rapidly declining liquidity situation in early 2014.  EFH also faced sizeable impending debt maturities in late 2014, and an expected “going concern qualification” to EFH’s 2013 audited financial statements.

Wilmington Savings Fund Society (“WSFS”), indenture trustee for certain secured second lien lenders to the EFH Debtors, was one of the creditors that opposed the pre-arranged plan.  On the same day the EFH Debtors filed for chapter 11, WSFS filed (among other things) its Motion to Transfer Cases to the U.S. District Court for the Northern District of Texas. WSFS argued in its Transfer of Venue Motion that, although some of the Debtors were formed under Delaware law, the EFH Debtors (i) have substantially all of their assets, customers, employees and trade creditors located in Texas; (ii) are subject to numerous Texas regulatory regimes; (iii) have potentially significant environmental cleanup obligations in Texas; and (iv) are parties to over 175 legal proceedings in state and federal courts in Texas.  WSFS also pointed out that (a) the Delaware bankruptcy docket is much more congested that that of the Northern District of Texas, even on a per judge basis; and (b) several Delaware Bankruptcy courts have ruled that Delaware is not a per se superior jurisdiction for restructuring.

In response, the EFH Debtors argued that their cases should remain venued in Delaware, first citing the usual reasons: (i) the debtor’s choice of venue should be accorded significant deference; and (ii) because venue is proper, WSFS did not meet its burden of overcoming the strong presumption of maintaining venue where the cases are pending.  Interestingly, the EFH Debtors sought to minimize WSFS’ arguments about location of assets, employees, pending litigation and trade creditors in Texas, by contending that the purpose of EFH Debtors’ chapter 11 cases was “to restructure their balance sheets.”  Thus, the real parties in interest are comprised of major creditors and professionals, the vast majority of which are located in New York, not Texas.

The EFH Debtors also pointed to other major bankruptcy debtors whose headquarters, employees and assets were located far from their bankruptcy venues – (a) AMR Corp., Enron, and Lyondell, which were venued in New York although the debtors were located in Texas; (b) Calpine Corp., venued in New York although located in California; (c) Washington Mutual, venued in Delaware although located in Seattle, and (d) Delta Airlines, venued in New York, although headquartered in Georgia.

The EFH Debtors even quarreled with WSFS’s congested docket argument, contending that WSFS did not include the 14,353 chapter 7, 12, and 13 cases handled by Bankruptcy Judges in the Northern District of Texas during 2013 (although the Debtors did not complete the argument by counting the number of chapter 7, 12, and 13 cases handled by Delaware Bankruptcy Judges during the same period).

The hearing on the venue transfer motion in the EFH cases took place on May 22, 2014, before Judge Sontchi.  Two previous venue decisions made by Judge Sontchi may shed some light on the analysis he may undertake in the EFH cases.

In re Cordillera

A prior case transferred by Judge Sontchi from Delaware to Colorado involved a 700 acre high-end residential golf development consisting of over 500 privately owned residences and three golf courses.  In re Cordillera Golf Club, LLC, Case No. 12-11893 (CSS) (Bankr. D. Del. 2012). Starting in late 2010, disputes arose between residents of the residential development and Cordillera.  This led to litigation in Colorado state courts.  Cordillera filed a chapter 11 petition in the Bankruptcy Court for the District of Delaware in June of 2012.  Motions to transfer venue to Colorado were filed by several parties in interest, including the Debtor’s secured lender. On July 16, 2012, the motions to transfer venue were argued before Judge Sontchi, who issued a ruling from the bench.

Judge Sontchi, applying the six-factor Innovative Communication Co. LLC, 358 B.R. 120 (Bankr. D. Del. 2006) test and the twelve-factor test set forth in In re Hays Lemmerz Int’l, Inc., 312 B.R. 44 (Bankr. D. Del. 2004), ruled that the Cordillera case would be transferred to Colorado.  Judge Sontchi’s primary rationale was that the money used to run the case would come from Cordillera’s existing members, as well as future members, the vast majority of whom would be solicited from the Colorado area.  It is also possible that the Court was swayed, to some extent, by the creditor’s argument that this was a “valuation case,” making Colorado a more suitable venue.

In re Allied Systems Holdings

On the other hand, however, Judge Sontchi denied transfer of venue of a case with affiliated bankruptcy cases pending in Georgia in In re Allied Systems Holdings, Inc., Case No. 12-11564 (CSS) (Bankr. D. Del. 2012).  Allied was an involuntary case; the petitioning creditors chose Delaware.  Allied had been incorporated in Delaware, but was headquartered in Georgia; it sought to transfer the case (although an order for relief had not yet been entered) to the Northern District of Georgia.  Among its strongest arguments for transfer of venue was the fact that an affiliate of the alleged debtor was still in the final stages of a bankruptcy case venued in that district.  The petitioning creditors argued (as do the debtors in EFH) that the debtors’ major creditors and professionals on both sides are located in the northeast, rather than in Georgia.

Judge Sontchi was not swayed by the open bankruptcy case in the Northern District of Georgia, stating that it was, for all intents and purposes, closed.  The Court found that an application of the six and twelve factor tests essentially resulted in a “wash”, which in Judge Sontchi’s view meant that “the movant loses.”  The Allied case remained venued in Delaware.

Given the Court’s reasoning in these two cases, one would have to surmise that Judge Sontchi would be reluctant to transfer venue of the EFH cases to Texas.  This may be especially so because Judge Sontchi has already approved an interim $2.3 billion DIP facility for the EFH Debtors.  Moreover, many of the EFH Debtors are incorporated in Delaware.  Also, in neither Cordillera nor Allied Systems did Judge Sontchi seem to regard the location of employees as persuasive.  If the Judge does respond to the creditors’ argument that other cases, such as Enron, AMR,  Lyondell, Calpine Corp., Washington Mutual, and Delta Airlines (among many others, to be sure), were reorganized in either Delaware or New York despite having headquarters, employees and primary assets in faraway districts, the EFH cases may well remain in Delaware.

Stern Revisited, Testing the Jurisdictional Authority of the Bankruptcy Courts and Beyond

In January, the Supreme Court heard oral argument in Executive Benefits Insurance Agency v. Arkison. Executive Benefits is viewed by many as the sequel to Stern v. Marshall, 131 S. Ct. 2594, 180 L. Ed. 2d 475 (2011).  In Stern, the Court held that bankruptcy courts lacked the constitutional authority to enter final judgment in a claim based exclusively on state law.  Writing for the majority, Chief Justice Roberts stated that “Article III protects liberty not only through its role in implementing the separation of powers, but also by specifying the defining characteristics of Article III judges.”  These characteristics include lifetime tenure and protection from salary diminution.  Unlike Article III judges, bankruptcy judges are appointed to fourteen-year terms, and their salaries are subject to diminution from Congress.  See 28 U.S. Code §§ 152(a)(1), 153(a)Stern “involve[d] the most prototypical exercise of judicial power: the entry of a final, binding judgment by a court with broad substantive jurisdiction, on a common law cause of action.”  The claim, however, “neither derive[d] from nor depend[ed] upon any agency regulatory regime.”  The Chief Justice warned:  “If such an exercise of judicial power may nonetheless be taken from the Article III Judiciary simply by deeming it part of some amorphous ‘public right,’ then Article III would be transformed from the guardian of individual liberty and separation of powers we have long recognized into mere wishful thinking.” Continue Reading

Just When Secured Creditors Thought it Was Safe to Credit Bid Again . . . .

The ability of a secured creditor to credit bid at a bankruptcy sale was recently called into question (again) in a January 17, 2014 decision by Bankruptcy Judge Kevin Gross in the In re Fisker Automotive Holdings, Inc. chapter 11 liquidation cases (“In re Fisker”) in Delaware. Continue Reading

Revisiting the Concept of Prudential Standing: In re Ampal-American Israel Corp.

It is well recognized that there are penalties for violating the automatic stay.  It does not follow, however, that any entity may seek to enforce the automatic stay.  Recently, the United States Bankruptcy Court for the Southern District of New York rendered a decision that serves as a reminder to litigants that an entity seeking to enforce the automatic stay must have standing – both Article III standing and prudential standing.  The decision is In re Ampal-Am. Israel Corp., 2013 Bankr. LEXIS 5240; 2013 WL 6576500 (S.D.N.Y. December 16, 2013). Continue Reading

Undue Hardship? Part II: The Eighth Circuit’s Totality-Of-Circumstances Test

In July, this blog explored the Second and Ninth Circuit’s application of the “undue hardship” test under 11 U.S.C. § 523(a)(8), which states that student loan debt is presumptively non-dischargeable.  To refresh, in those circuits, a debtor claiming “undue hardship” must show, by a preponderance of evidence:  (1) that the debtor cannot maintain, based on current income and expenses, a minimal standard of living for herself and her dependents if forced to repay the loans; (2) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and (3) that the debtor has made good faith efforts to repay the loans.  Hedlund v. Educational Resources Institute, No. 12-3258, 2013 WL 2232325, at *2-3 (9th Cir. May 22, 2013); In re Traversa, 444 F. App’x 472, 474, (2d Cir. Oct. 28, 2011).  As discussed in the prior post, Hedlund may represent a shift by the courts toward applying the undue burden standard less stringently.

A recent opinion from the Bankruptcy Appellate Panel for the Eighth Circuit appears to follow that shift.  In re Conway, 495 B.R. 416 (B.A.P. 8th Cir. 2013).  There, the appellate panel reversed and remanded the bankruptcy court’s determination that a debtor’s student loan debt was not dischargeable.  The Eighth Circuit, however, uses a “totality-of-circumstances” test to determine whether a debtor has shown undue hardship:

Reviewing courts must consider the debtor’s past, present, and reasonably reliable future financial resources, the debtor’s reasonable and necessary living expenses, and “any other relevant facts and circumstances.”  The debtor has the burden of proving undue hardship by a preponderance of the evidence.  The burden is rigorous.  “Simply put, if the debtor’s reasonable future financial resources will sufficiently cover payment of the student loan debt—while still allowing for a minimal standard of living—then the debt should not be discharged.”

In re Conway, 495 B.R. at 419 (citing Educ. Credit Mgmt. Corp. v. Jesperson, 571 F.3d 775, 779 (8th Cir. 2009)).

The debtor in Conway had fifteen separate student loans with National Collegiate Trust (“NCT”).  She owed a total of $118,579.66, which included interest, to NCT.  After graduating from college in 2005, the debtor worked as a loan sales analyst, but she lost her job two years later.  She then took various temporary office positions for five months before finding permanent employment.  She lost that job after nine months and then found work as a part-time waitress and at a bank.  At the time of the appellate panel’s decision, the debtor worked two part-time jobs as a restaurant server, and earned a monthly income between $1,379.97 and $2,040.36, which fluctuated with the seasons.  The bankruptcy court had found that her reasonably reliable future financial resources were sufficient to repay her debt because she possessed well-developed writing and reasoning skills, and that she had “at least 30 years left to navigate the job market.”

The appellate panel, however, concluded that courts could not rely on assumptions or speculation.  Courts must rely instead on the facts in the record.  In the eight years following the debtor’s graduation from college, her annual income never exceeded $25,000.00.  The appellate panel further found that the debtor was not intentionally underemployed.  Indeed, the debtor sent out over 200 applications, was laid off twice for no fault of her own, and was never unemployed for a significant period of time.  With respect to the debtor’s disposable income, the appellate panel concluded that it fluctuated between $300.00/month to negative $357.00/month, both of which were well below the $846.16/month she owed to NCT.  The appellate panel also rejected the bankruptcy court’s finding that the debtor could reduce her out-of-pocket medical expenses by finding a job with medical benefits because courts cannot engage in speculation.

The debtor’s indebtedness to NCT, however, was not a single obligation.  Rather, the debtor owed a total of $118,579.66 across fifteen separate student loans, with the monthly obligations on each loan ranging from $39.63 to $98.58.  Where multiple loans are involved, each loan must be analyzed separately.  The appellate panel concluded that the bankruptcy court erred by failing to conduct a loan-by-loan analysis.  Accordingly, the appellate panel remanded the case for the bankruptcy court to make that determination.

Since the decision was rendered less than a month ago, it is unclear if the appellate panel’s decision will survive any potential appeal.  But the appellate panel’s decision in Conway and the Ninth Circuit’s decision in Hedlund may reflect a shift by the federal courts to apply the undue burden less stringently in order to alleviate the burden of high student loan debt.