2017

A Miami, Florida District Court Judge recently ruled that a Chapter 13 debtor who is near retirement age may defer over $114,000 in voluntary retirement contributions during the life of his Chapter 13 plan, while paying general unsecured creditors a total of $12,000.00. This ruling follows the majority of Circuits, which allow a Chapter 13 debtor to exclude voluntary retirement contributions from the disposable income calculation, so long as the plan is filed in good faith. The Judge in RESFL Five LLC v. Ulysse, 16-62900 (S.D. Fla. Sept. 29, 2017), based her ruling on the majority view that 11 U.S.C. § 541(b)(7) does not limit a debtor’s ability to make voluntary contributions to a retirement account, whether they be made pre-or post-petition, because the exceptions of § 541(b)(7) are contained within the premise of section § 1306.

By contrast, the Sixth Circuit Bankruptcy Appellate Panel’s ruling in In re Seafort, 437 B.R. at 210, focused on Congress’s placement of the exclusion of voluntary contributions within § 541, as opposed to § 1306, and concluded that “§ 541(b)(7) does not exclude income which becomes available post-petition in order to start making contributions to a 401(k) plan.” The panel reasoned that this subsection’s placement within § 541 limited its application to pre-petition contributions. RESFL Five LLC v. Ulysse criticized the Sixth Circuit for relying on the placement of § 541, characterizing § 541 as being “outside” the scope of the Chapter 13 provisions. The Florida District Judge saw no statutory basis for allowing retirement contributions only if the debtor was making them before the bankruptcy started. Moreover, the Judge also considered the fact that the debtor making the voluntary contributions was close to retirement age, and therefore should be allowed to continue making voluntary contributions to his retirement account. To rule otherwise, would deprive the debtor of his fresh start.

This case is a reminder that Bankruptcy Courts are courts of equity, and that circuit splits such as this provide for significantly varied outcomes for debtors in otherwise similar situations.

The Ninth Circuit recently affirmed a District Court ruling that applied the “dominion test” instead of the “control test” to determine initial transferees of fraudulent transfers.

In the case, Henry v. Official Comm. of Unsecured Creditors of Walldesign, Inc. (In re Walldesign, Inc.), 872 F.3d 954 (9th Cir. 2017), Michael Bello served as the sole shareholder, director, and president of Walldesign, Inc., a California corporation. In 2002, Mr. Bello opened a bank account in the company’s name using Walldesign’s Federal Tax I.D. Number, a Statement by Domestic Stock Corporation, Walldesign’s Articles of Incorporation, a Unanimous Consent of Shareholder of Walldesign to Corporate Action, and a signature card granting him signing authority as Walldesign’s agent to open the secondary account. Mr. Bello funneled nearly $8 million of Walldesign funds into this account. He then used funds from the account to support a lavish lifestyle. Transfers out of this account included payments to Mr. and Mrs. Buresh and Ms. Henry, the appellants. All parties agreed that this account belonged to Walldesign, not to Mr. Bello. Mr. Bello never deposited the funds into a personal account before making payments to the Bureshes and Ms. Henry.

The Ninth Circuit addressed the distinction between initial transferees and subsequent transferees in the recovery of fraudulent transfers. Pursuant to 11 U.S.C. § 550(a), when there is an avoidable transfer, the trustee has an absolute right of recovery against the initial transferee and any entity for whose benefit such transfer was made. A trustee may recover from a subsequent transferee, but the law offers a safe harbor provision to subsequent transferees who accepted the property for value, in good faith, and without knowledge.

The Ninth Circuit first determined who could be considered a “transferee.” The Court adopted the “dominion test” and ruled that a transferee must have dominion over the money or asset such that he has legal title to the funds and the right to put the money to one’s own purposes. The Court rejected the more lenient “control test,” which requires the court to view the entire transaction as a whole to determine who truly had control of the money.

When applying the dominion test to cases involving corporate misappropriation, the Court adopted the majority, one-step transaction approach. Under this approach, the principal of a debtor corporation who misappropriates company funds to satisfy personal obligations is not an initial transferee. The funds in the Walldesign account remained under the dominion of Walldesign, Inc. Despite Mr. Bello’s de facto control over the account, he never had the legal authority to spend the money as he did. Therefore, Mr. Bello was never a transferee of these funds. Rather, he misappropriated corporate funds to the Bureshes and Ms. Henry. The Ninth Circuit considered this a classic one-step transaction which resulted in the Bureshes and Ms. Henry being strictly liable as initial transferees and Mr. Bello strictly liable as the party for whose benefit the transfers were made.

The Court noted that despite assigning responsibility to seemingly innocent initial transferees, as a matter of policy, the option to recover from all parties should be preserved where possible. Maintaining the possibility of recovering fraudulent transfers from “good guys” and “bad guys” alike is critical because recovering from the embezzling principal is difficult. The Committee was limited to seeking a single satisfaction from Mr. Bello, the Bureshes and Ms. Henry. 11 U.S.C. § 550(d).

An Illinois Appellate Court recently held that a senior lender that violated the terms of an intercreditor agreement partially relinquished its priority in collateral securing its loan. In Bowling Green Sports Center, Inc. v. G.A.G. LLC, 2017 IL App (2d) 160656, G.A.G. LLC financed the purchase of a bowling alley with loans from Gold Coast Bank and Bowling Green Sports Center, Inc. Gold Coast lent GAG $3.4 million and Bowling Green lent $405,000. Gold Coast and Bowling Green entered into an intercreditor agreement pursuant to which Gold Coast agreed not to amend or modify its loan to GAG without the consent of Bowling Green. In exchange, Bowling Green agreed not to pursue collection of its debt until Gold Coast was paid in full. Despite the agreement, Gold Coast subsequently increased its loan to GAG by $51,000 without notifying Bowling Green. Later, Bowling Green sued GAG to collect its debt and Gold Coast intervened, asserting that the complaint should be dismissed because the intercreditor agreement prohibited Bowling Green from pursuing its claims against GAG until the Gold Coast debt was paid in full.

The trial court agreed and held that Bowling Green’s complaint was premature and could not be brought until Gold Coast’s debt was repaid. On appeal, the appellate court affirmed the lower court’s ruling, but with the modification that the complaint was premature only until the amount of Gold Coast’s debt equaled $51,000. In support of its holding, the court cited numerous cases and the Restatement (Third) of Property for the proposition that a senior lender’s failure to obtain a junior lender’s consent results in a modification of the underlying loan documents being ineffective as to the junior lender and the senior lender relinquishing to the junior lender its priority with respect to the modified terms. The court did not, however, agree with Bowling Green’s assertion that Gold Coast should entirely forfeit its lien priority, as the additional $51,000 loan by Gold Coast "did not substantially impair Bowling Green’s security interest and rights as a junior lienholder."

The case is a reminder of the importance of carefully drafting intercreditor agreements and, more importantly, adhering to their terms.

The Sixth Circuit Court of Appeals recently affirmed a trial court’s decision to strike an affirmative defense alleging antitrust violations in a breach of contract case. In Hemlock Semiconductor Operators, LLC v. SolarWorld Industries Sachsen GmbH, 2017 U.S. App. LEXIS 15380 (6th Cir. 2017), the parties had entered into long-term supply agreements under which the plaintiff would sell to the defendant set quantities of polysilicon. The parties reached a temporary agreement to lower prices during a single year, but when that year expired, the defendant refused to revert back to the original pricing. The plaintiff sued for breach of contract. In response, the defendant asserted an affirmative defense alleging that the agreements at issue were illegal under antitrust laws and, therefore, the defendant was not responsible for lost profits. The district court struck the affirmative defense, and the Sixth Circuit Court of Appeals affirmed the decision.

Specifically, the Court of Appeals cited case law enforcing promises that were legal, even if the promise was part of an agreement containing a separate, illegal provision. The Court of Appeals expressed particular concern regarding defendants’ reliance on alleged violations of antitrust laws. “If buyers were allowed to broadly assert antitrust defenses, they would be able to unfairly obtain goods without paying for them. . . . [I]llegality defenses based on antitrust law are disfavored, especially when allowing the defense would ‘let the buyer escape from its side of a bargain’ after having received a benefit.”

The case is a reminder that illegality of a contract alone may not be sufficient to prevent enforcement of a contract’s terms.

In Giasson Aero. Sci., Inc. v. RCO Eng'g Inc., 2017 U.S. App. LEXIS 18165 (6th Cir. Sep. 20, 2017), the Sixth Circuit Court of Appeals held that a party seeking an independent action for relief from a final judgment under Rule 60(d)(1) must demonstrate a “grave miscarriage of justice” that is “several notches above” common law fraud. The case involves a settling party’s request to undo a settlement agreement executed nearly seven years ago on the basis that the opposing party misrepresented pricing information during settlement negotiations that led to a royalty-based settlement. In affirming the district court’s dismissal of the settling party’s complaint, the Sixth Circuit did not specifically define what a grave miscarriage of justice means, but it did state that it is something far greater than “recovery of less-than-ideal royalty payments” negotiated by sophisticated parties that were represented by legal counsel. This case reinforces the judicial policy in favor of settlement agreements, noting that independent actions under Rule 60(d)(1) should be granted only under unusual and exceptional circumstances.

The Ninth Circuit Court of Appeals recently split with the Seventh by holding that sovereign immunity does not prevent a bankruptcy trustee from avoiding a debtor’s federal tax payments to the Internal Revenue Service. In Zazzali v. United States (In re DBSI, Inc.), No. 16-35597, 2017 U.S. App. LEXIS 16817 (9th Cir. May 17, 2017), DBSI, Inc. and its affiliated entities operated an illegal Ponzi scheme that engaged in the acquisition, development, management, and sale of commercial real estate properties throughout the United States. While operating the scheme, DBSI paid the IRS a total of approximately $17 million on behalf its shareholders. DBSI subsequently filed for bankruptcy, after which DBSI’s liquidating trustee sought to avoid and recover the tax payments as fraudulent transfers under 11 U.S.C. § 544(b)(1) and Idaho’s Uniform Fraudulent Transfer Act. In defense, the IRS claimed that its sovereign immunity prohibited the trustee from recovering the payments.

Section 544(b)(1) provides that a trustee may avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim. The effect of this section is “to clothe the trustee with no new or additional right in the premises over that possessed by a creditor, but simply puts him in the shoes of the latter.” “If the actual creditor could not succeed for any reason-whether due to the statute of limitations, estoppel, res judicata, waiver, or any other defense-then the trustee is similarly barred and cannot avoid the transfer.” The effect of Section 544(b)(1) is that a trustee is normally subject to a government’s sovereign immunity defense. However, Congress expressly abrogated sovereign immunity “with respect to” Section 544(b)(1) under 11 U.S.C. § 106(a)(1). Given this express abrogation, and using well-settled canons of statutory interpretation, the Ninth Circuit found Congress’s waiver of sovereign immunity unequivocal, resulting in a split with the Seventh Circuit, which held otherwise.

In Gecker v. Estate of Flynn (In re Emerald Casino, Inc.), 2017 U.S. App. Lexis 14895 (7th Cir., August 11, 2017), the Chapter 7 trustee sued former casino officers, directors, and shareholders for, among other things, breaches of fiduciary duties in connection with the casino’s loss of its gaming license. The breach of fiduciary duty cause of action accrued in 2001, but the Chapter 7 trustee did not sue until 2008, well-beyond the five-year statute of limitation under Illinois law. The Chapter 7 trustee argued that the statute of limitations was tolled under the adverse-domination doctrine, which tolls the statute of limitations for claims by a corporation against its officers and directors when the corporation is controlled by the wrongdoing officers or directors. The district court held that the adverse-domination doctrine was rebutted because the Chapter 11 creditor’s committee had the knowledge, ability, and motivation to sue the directors and officers before the case was converted to Chapter 7, but elected not to do so.

On appeal, the Chapter 7 trustee argued that the creditor’s committee was unable to sue because it did not have derivative standing to assert the claims against the directors and officers. Further, the Chapter 7 trustee argued that the creditor’s committee was not motivated to pursue the lawsuit because a sale of the gaming license was pending during the same time period. The Seventh Circuit rejected both arguments and affirmed the district court’s decision. The fact that the bankruptcy court might have denied derivative standing to the creditor’s committee was not sufficient to demonstrate that the creditor’s committee was unable to sue. The Seventh Circuit also held that even if the creditor’s committee lacked the motivation to sue, it did not alter the outcome because “would-be plaintiffs must live with their choice” and a plaintiff does not lack motivation to sue “just because its chosen course of action proved to be unsuccessful in the end.”

A recent ruling by the Ninth Circuit Court of Appeals that a lessee’s possessory right did not survive a “free and clear” sale under section 363 of the Bankruptcy Code is a warning to tenants of a bankrupt landlord to be diligent.

The case, In the Matter of Spanish Peaks Holdings II, LLC (No. 15-35572), involved the Chapter 7 bankruptcy of a resort in Montana. The debtor had entered into two leases with insiders, one for 99 years for $1,000 per year in rent, and the other for 60 years for $1,285 per year in rent. The Chapter 7 trustee and the debtor’s secured lender agreed to a plan for liquidating the debtor’s real and personal property via sale “free and clear of any and all liens, claims, encumbrances and interests.” The sale excepted specified encumbrances, but the two leases were not among them.

The leases were not rejected before the sale, and the tenants had not requested adequate protection for their leasehold interests under Bankruptcy Code section 363(e) before the sale. The tenants objected to the sale, asserting that section 365(h) gave them the right to retain possession of the leased property notwithstanding the sale. The Bankruptcy Court authorized the sale without ruling on the tenants’ objection, deferring their claimed right to possession to the hearing on the motion to approve the sale. The winning bidder testified at the sale hearing that its bid was contingent on the property being free and clear of the leases. The Bankruptcy Court approved the sale free and clear of the tenants’ interests and approved the sale. The District Court affirmed.

The Ninth Circuit affirmed, acknowledging that it was adopting the “minority approach” to reconciling sections 363 and 365. The majority approach protects the lessee, holding that section 365 trumps section 363 under the canon of statutory construction that “the specific prevails over the general.” And, because section 365(h) gives lessees the right to retain possession of leased real property notwithstanding rejection of the lease, lessees may also retain possession following a sale under section 363 when the lease has not been rejected.

The court rejected this line of cases and instead held that the two statutory provisions – 363 and 365 – did not conflict here because the trustee had not rejected the leases. “A sale of property free and clear of a lease may be an effective rejection of the lease in some everyday sense, but it is not the same thing as ‘rejection’ contemplated by section 365.” In this case, there was a sale but no rejection. Therefore, the lessees’ possessory interest in the property was extinguished by section 363.

Importantly, the court noted that lessees have recourse in situations like this – by seek adequate protection of their leasehold interest under section 363(e). The tenants in this case had not done so.

The United States Bankruptcy Court for the District of Delaware recently denied a secured lender’s motion for partial judgment on the pleadings that the lender’s interest in certain goods took priority over a vendor’s interest in those same goods. In TSA Stores, Inc. v. M J Soffe, LLC (In re TSAWD Holdings, Inc.,), 565 B.R. 292 (Bankr. D. Del. 2017), M J Soffe, LLC sold nearly $5.5 million in goods to The Sports Authority on consignment pursuant to a Pay by Scan Agreement. After filing for bankruptcy, TSA initiated a lawsuit against Soffe seeking declaratory relief in connection with the goods.

TSA’s secured creditor, Wilmington Savings Fund Society, FSB, intervened in the lawsuit and filed a motion for partial judgment on the pleadings, arguing that its interest in the goods took priority over Soffe’s interest because Soffe failed to properly perfect its interest in the goods under the UCC. Under the UCC, consignments that satisfy the UCC’s definition must be perfected in accordance with the UCC, while consignments that fail to meet the UCC’s definition are governed by state common and statutory law. Wilmington argued that the relationship between TSA and Soffe constituted a consignment governed by the UCC because the agreement governing the parties’ relationship specifically stated that it was a “consignment” as defined by the UCC. Wilmington further argued that, as a result, its interest in the goods took priority over Soffe’s interest because Soffe failed to properly perfect its interest.

Soffe did not dispute that it did not properly perfect its interest. Rather, Soffe claimed that the agreement did not constitute a “consignment” within the meaning of the UCC because TSA’s creditors generally knew that TSA was substantially engaged in selling the goods of others and Wilmington had actual knowledge of the parties’ consignment arrangement. The court agreed with Soffe, holding that the Pay by Scan Agreement’s statement that the parties’ arrangement was a consignment under the UCC was not determinative. The court held that the UCC placed limits on the ability of contracting parties to define their legal relationship, and while parties could vary the effect of certain provisions of the UCC by agreement, they could not redefine otherwise defined terms, such as “consignment.” As a result, it remained an issue of fact as to whether the parties’ relationship constituted a “consignment” within the meaning of the UCC.

The Michigan Court of Appeals recently affirmed a trial court's decision to bar trial witnesses because a party failed to timely disclose them. In Roeder v. Global Express Services, LLC, 2017 Mich. App. LEXIS 947 (June 13, 2017), the trial court had entered a scheduling order setting dates for the parties to disclose witnesses. The defendant submitted its witness disclosures well past the deadlines, and the trial court excluded the witnesses' testimony at trial. The Court of Appeals affirmed the decision, stating, “Once a party has failed to file a witness list in accordance with the scheduling order, it is within the trial court's discretion to impose sanctions against that party. These sanctions may preclude the party from calling witnesses.” The Court noted that the defendant's failure to timely provide witness lists was likely accidental, but the defendant exhibited a history of failing to comply with discovery requests. The opinion is a strong reminder to all parties and their counsel that the consequences of failing to adhere to a court's deadlines may be fatal to their claims.

The Chapter 11 debtor in In re Arm Ventures, LLC, 564 B.R. 77 (Bankr. S.D. Fla. 2017) owned a commercial building. The debtor repeatedly maneuvered in state and federal court to stop foreclosure sales by the bank. Ultimately, the debtor filed Chapter 11 bankruptcy to prevent the third attempted foreclosure sale. The bank moved to dismiss the bankruptcy case as having been filed in bad faith or, in the alternative, for relief from the automatic stay to complete foreclosure proceedings. The debtor opposed the motion and filed a plan of reorganization that relied upon lease income from an entity that sold medical marijuana. The bank argued that the plan was not confirmable because income derived from selling marijuana was not legal under state and federal law. The debtor argued that the proposed tenant was applying for all of the appropriate licenses under state and federal law to sell medical marijuana. The bankruptcy court held that the plan was not confirmable because the prospect of the tenant being approved to sell medical marijuana under federal law was “highly unlikely” and “an extremely remote possibility.” The bankruptcy court further held that the fact that the debtor proposed a plan that depended on income derived from selling medical marijuana was bad faith under the bankruptcy code that permitted the court to dismiss the case. Ultimately, although the bankruptcy court held that the case was “ripe for dismissal,” the court did not dismiss the case due to significant unsecured debt and instead lifted the automatic stay in favor of the bank.

The Sixth Circuit Court of Appeals recently held in a 2-1 decision that an “insured-versus-insured” exclusion found in a directors’ and officers’ liability insurance policy applied to a breach of fiduciary duty claim brought by a liquidating trustee against a debtor company’s former officers and directors. In Indian Harbor Insurance Company v. Zucker, 2017 U.S. App. LEXIS 10821 (6th Cir. June 20, 2017), “Capitol Bancorp went bankrupt. After negotiations between Capitol’s officers and the company’s creditors during the bankruptcy process, Capitol created a Liquidating Trust to pursue the estate’s legal claims.” The liquidating plan permitted the liquidating trustee to sue Capitol’s former officers; however, the plan limited any recovery on claims arising from pre-petition conduct to amounts recovered under Capitol’s liability insurance policy. The trust subsequently sued Capitol’s officers for $18.8 million for breaches of fiduciary duties. At the same time, Capitol’s insurance company filed a declaratory action seeking a judgment that the trustee’s lawsuit fell within the “insured-versus-insured” exclusion under the insurance policy. If applicable, the exclusion would prevent the trustee from recovering from the insurance company in the event a judgment were rendered against the officers.

In holding that the exclusion applied to the trustee’s lawsuit, the Sixth Circuit noted that “the terms of the contract are a good place to start.” Under the contract, the exclusion applied to claims “by, on behalf of, or in the name or right of, the Company or any Insured Person” against an Insured Person. The court noted that the exclusion undoubtedly applied to claims brought by Capitol against its officers. Yet, this outcome remained the same for a liquidating trustee because as a voluntary assignee, the trustee stood in Capitol’s shoes and possessed the same rights subject to the same defenses as Capitol. Moreover, the court held that, for purposes of the policy, Capitol as a debtor in possession and Capitol pre-bankruptcy were not legally distinct entities. Indeed, “[e]ven if settings remain in which it makes good sense to treat the debtor and debtor in possession as legally distinct, this is not one of them.” Thus, the court held that the “contract itself, together with core principles of bankruptcy law,” confirmed that the exclusion applied to the trustee’s lawsuit.

In a dissent, Judge Bernice B. Donald asserted that the definition of “Company” in the policy did not include a debtor or debtor in possession. Judge Donald further argued that a pre-bankruptcy debtor and debtor in possession are legally distinct entities and cited cases in which courts have held that an insured-versus-insured exclusion does not extend to successors or assigns. Accordingly, Judge Donald stated that "there is no reason that the assigned trustee in this case should trigger the insured-versus-insured exclusion."

In Frank v. Linkner, decided on May 15, 2017, the Michigan Supreme Court made several important rulings involving limited liability company member oppression claims. First, the Court held that member oppression claims accrue under MCL 450.4515 when a plaintiff incurs a harm that is actionable, not when a plaintiff incurs a calculable financial injury. Therefore, if events giving rise to member oppression have occurred, the claim accrues regardless of when monetary damages result. Further, if additional damages resulting from the same harmful conduct occur, the additional damages do not reset the plaintiff’s accrual date.

The Court also held that MCL 450.4515 is a three-year statute of limitations and not a statute of repose, reasoning that there was no indication that the Michigan Legislature intended this statute to be a statute of repose. Finally, despite the three-year statute of limitations, a plaintiff bringing a claim for damages has only two years to bring a claim after plaintiff discovers the claim because the language of the statute requires the claim to be brought within three years of accrual or two years after discovery of the claim, whichever occurs first. In other words, the two year period commences once a plaintiff discovers or reasonably should have discovered the cause of action.

The United States Supreme Court recently held that the filing of a time-barred proof of claim "is not a false, deceptive, misleading, unfair, or unconscionable debt collection practice within the meaning of the Fair Debt Collection Practices Act." In Midland Funding, LLC v. Johnson, 581 U.S. ___ (2017), Aleida Johnson filed for bankruptcy under chapter 13 of the bankruptcy code in March 2014. Midland Funding, LLC subsequently filed a proof of claim relating to a credit-card debt in the amount of $1,879.71. In the claim, Midland stated that the last charge made on Johnson’s account was in May 2003, well outside the six year statute of limitations in Alabama. Johnson thus objected to the claim as being time barred, and it was disallowed. Johnson then filed suit against Midland seeking to recover damages against Midland for violation of the Fair Debt Collection Practices Act, which prohibits a debt collector from asserting any "false, deceptive, or misleading representation," or using any "unfair or unconscionable means" to collect, or attempt to collect, a debt. The district court ruled that the Act did not apply to the filing of a time-barred proof of claim. The Eleventh Circuit Court of Appeals reversed, adding to the growing split among the circuits on the issue. The Supreme Court then granted certiorari.

In overturning the Eleventh Circuit, the Court held that Midland had a "claim," or right to payment, within the meaning of the bankruptcy code, regardless of whether the claim had expired. Because Midland had a claim within the meaning of the bankruptcy code, Midland was entitled to file a proof of that claim. Simply put, "[t]he law has long treated unenforceability of a claim (due to the expiration of the limitations period) as an affirmative defense, and there is nothing misleading or deceptive in the filing of a proof of claim that follows the Code’s similar system." The Court further held that the proof of claim was not "unfair" or "unconscionable" because "[t]he audience in a Chapter 13 bankruptcy case includes a trustee," meaning its "considerably more likely that an effort to collect upon a stale claim in bankruptcy will be met with resistance, objection, and disallowance." Thus, the Court held that Midland’s filing of a time-barred proof of claim does not violate the Act.

The Michigan Supreme Court recently held that a plaintiff waived her right to a jury regarding the award of attorney fees. In Barton-Spencer v. Farm Bureau Life Ins. Co. of Michigan (Mich. April 14, 2017), the plaintiff had signed an agreement stating that if the defendants were successful in future litigation, the plaintiff "agrees to reimburse [the defendants'] attorney fees and costs as may be fixed by the court in which suit or proceeding is brought" (emphasis added). All parties demanded a jury trial, and the jury subsequently found for defendants on their counterclaim and a portion of the plaintiff's breach of contract claim. The court later granted defendants' postjudgment motion seeking contractual attorney fees. The Court of Appeals reversed the trial court's decision to grant defendants contractual attorney fees because it found that the contractual language did not clearly show that the plaintiff waived her right to a jury regarding attorney fees. The Supreme Court disagreed and reversed the Court of Appeal's decision, stating, "The phrase 'fixed by the court' is not ambiguous. When the parties agreed to this provision, they agreed that the amount of attorney fees and costs would be fixed by a judge rather than a jury. In ordinary parlance, the word 'court' refers to judges."

Contracting parties would be well-served by reviewing their boilerplate agreements in light of this decision and determining whether they adequately define jury rights.

Resolving conflicting holdings in the Eastern District of Michigan, the Sixth Circuit recently held that an assignment of rents is a transfer of ownership under Michigan law and the assignor retains no residual property rights in the assigned rents. The case is Town Center Flats, LLC v. ECP Commercial II LLC, Case No. 16-1812. The case involved a 53-unit residential complex in Shelby Township, Michigan. The debtor had agreed to assign its rents to the creditor in the event of a default under its loan documents. Before filing bankruptcy, the creditor took the necessary steps to record notice documents against the debtor. When the debtor filed bankruptcy, it argued that the assignment of rents merely created a security interest in favor of the creditor, not a transfer of ownership, and that the rents were available assets in its bankruptcy proceeding. The debtor further argued that since it was a single asset real estate entity and rents were its only source of income, an adverse ruling on this issue would doom its chances of reorganization. While acknowledging the policy implications of the debtor’s argument, the Sixth Circuit held that Michigan law is clear that the assignment of rents is a transfer of ownership and that the debtor retains no residual property interest in the assigned rents after the transfer has been accomplished.

In Planet Bingo, LLC et al. v. VKGS, LLC, the Michigan Court of Appeals recently held that not all common-law unfair competition claims are preempted by the Michigan Uniform Trade Secrets Act (“MUTSA”). While holding that MUTSA preempts claims related to misappropriation of a trade secret, the Court also held that Michigan common-law has long recognized that unfair competition claims may encompass more than misappropriation and that such claims are not preempted by MUTSA. Specifically, the defendant’s alleged sale of software based on its similarity to plaintiff’s software and the defendant’s allegedly false representation to a customer that a third-party was using its software are both viable claims that are unrelated to misappropriation of a trade secret and therefore not preempted by MUTSA. This case serves a reminder that while the legislature may abrogate the common law by enacting legislation, the legislature must “speak in no uncertain terms” in order for preemption to apply.

The United States Supreme Court recently held that “[a] distribution scheme ordered in connection with the dismissal of a Chapter 11 case cannot, without the consent of the affected parties, deviate from the basic priority rules that apply under the primary mechanisms the [Bankruptcy] Code establishes for final distributions of estate value in business bankruptcies.” In Czyzewski v. Jevic Holding Corp., 580 U.S. ___ (2017), a group of truck drivers held a $12.4 million judgment against their former bankrupt employer, Jevic Transportation Company. In accordance with the Bankruptcy Code’s distribution scheme, approximately $8.3 million of the judgment was entitled to priority payment after Jevic’s secured creditors, but before Jevic’s unsecured creditors. Jevic’s unsecured creditors’ committee, however, agreed to a settlement under which the bankruptcy court would, among other things, dismiss Jevic’s bankruptcy case and make distributions to Jevic’s general unsecured creditors without any payment to the truck drivers. The truck drivers objected, arguing that the proposed settlement violated the Bankruptcy Code’s priority distribution scheme by failing to pay priority creditors before general unsecured creditors.

In analyzing the permissibility of the settlement, the Court held that the chapter 11 process foresees three outcomes: (1) the confirmation of a plan; (2) the conversion of the case to a chapter 7; or (3) a dismissal that returns the former debtor to the prepetition financial status quo. Instead of dismissing a case outright, bankruptcy courts—as the court did here—have increasingly utilized “structured dismissals.” In a structured dismissal, a bankruptcy court dismisses a case, but may also approve distributions to creditors, grant third-party releases, enjoin certain conduct by creditors, and not necessarily vacate orders or unwind transactions undertaken during the case. In this instance, the proposed settlement called for a structured dismissal that made distributions in violation of the Bankruptcy Code’s priority distribution scheme. The Court, however, flatly held that a bankruptcy court cannot order such a structured dismissal. Simply put, no provision in the Bankruptcy Code permits priority-violating distributions via a dismissal, and the Court would expect such a provision if Congress truly intended to permit them.

The Michigan Court of Appeals recently reiterated that the burden of proof shifts to a fraudulent transfer defendant to establish that a transaction was “in all respects bona fide” when a plaintiff establishes the elements of a fraudulent conveyance against a judgment debtor defendant.

In Burke v. Maurer (Mich. Ct. App. February 21, 2017), Plaintiffs filed a complaint alleging that the judgment debtors’ transfers of property were fraudulent because they were intended to render the judgment debtors uncollectible. Plaintiffs filed a motion for summary disposition arguing that the defendants had failed to rebut plaintiff’s prima facie case by failing to produce evidence that the transfers were bona fide transactions. The Court of Appeals held that, although badges of fraud are not conclusive evidence of fraud and may be overcome by evidence establishing the bona fides of a transaction, “a concurrence of several badges will always make out a strong case.” The reason the burden of proceeding shifts to a fraudulent transfer defendant once badges of fraud have been demonstrated is that “the defendant . . . is supposed to be in a better position to show the facts.” Defendants failed to establish that the transactions were made in good faith, therefore “the presumption created by the statute did not dissolve” and Plaintiff was properly granted summary disposition.

The Bankruptcy Court for the District of Delaware recently upheld the terms of a pre-petition intercreditor agreement by ruling that the first lien rights of an asset based lending group were not impacted by the pre-petition restructuring of the lenders’ debt. In Salus Capital Partners, LLC v. Std. Wireless Inc. (In re Radioshack Corp.), 550 B.R. 700 (Bankr. D. Del. 2016), two groups of lenders provided Radioshack $835 million in financing before Radioshack filed for bankruptcy, comprised of $250 million provided by a term loan lender group and $585 million provided by an asset based lending group. As part of the financing, the two groups entered into an intercreditor agreement that provided the asset based lenders a first priority lien on the liquid assets of Radioshack up to the “Maximum ABL Facility Amount,” which was defined as “the combined Revolving Loan Commitments . . . which shall initially be in the amount of $535,000,000, as such amount may be reduced from time to time.”

A separate group of lenders purchased the asset based loans and restructured them into a term loan, a letter of credit facility, and a revolving loan facility. After Radioshack liquidated its assets, it paid the asset based lenders $232 million. The term loan lenders objected, alleging that as a result of the restructuring of the revolving loans, the Maximum ABL Facility Amount was reduced. The bankruptcy court held otherwise, ruling that the terms of the intercreditor agreement allowed the original asset based loan debt to be refinanced and the terms to be modified. As a result, the obligations, as modified, fit “squarely within the definition of Maximum ABL Facility Amount,” meaning the asset based lenders were still entitled to priority. Additionally, the court held that the term loan lenders failed to show that their position was unfairly changed “either as a matter of economics or contract law” as a result of the loan restructuring.

In Meoli v. Huntington Nat'l Bank, the Sixth Circuit affirmed a multi-million judgment against The Huntington National Bank stemming from a bankruptcy trustee’s lawsuit seeking to recover fraudulent transfers from a debtor company’s operation of a Ponzi scheme. The opinion discussed several aspects of fraudulent transfer and recovery law, including the following: (i) that the dominion-and-control test is used to determine transferee liability for both an initial transferee and subsequent transferee; (ii) a bank account holder’s right to withdraw money from a deposit account prevents a bank from exercising dominion-and-control; (iii) in evaluating a fraudulent transferee’s defenses, a court should perform a “holistic factual determination of whether a reasonable person, given the available information, would have been alerted to the transfer voidability;” and (iv) the Court refused to articulate whether the standard for measuring “good faith” is a subjective or objective standard. The case citation is 2017 U.S. App. LEXIS 2248 (6th Cir. Feb. 8, 2017).

The Michigan Court of Appeals recently continued its trend of enforcing settlements despite the absence of a signed settlement agreement. In Trevino v. Siler, et al., case no. 330120 (Mich. Ct. App. January 17, 2017), the plaintiff's counsel called defendants' counsel and indicated that the plaintiff would settle his claims for $100,000. Defense counsel responded with an e-mail that confirmed the conversation and attached a settlement agreement for the plaintiff to execute. But the plaintiff never signed the agreement, later claiming that he did not give his attorney authority to settle the claims. Nevertheless, the Court of Appeals held that a binding settlement agreement existed. "[I]f an agreement to settle pending litigation satisfies the elements of MCR 2.507, it is binding even if a party subsequently denies that his or her attorney had authority to settle the suit." The agreement must be evidenced in writing and "subscribed by the party against whom the agreement is offered or by that party's attorney" (emphasis added). Therefore, the plaintiff's only remedy was to sue his attorney for professional malpractice.

The opinion is another reminder that a binding settlement does not necessarily require a signed agreement.

In In re Tuscan Energy LLC, 16-100398 (Bankr. S.D.Fla. Dec. 30, 2016), a bank objected to a fee application of Debtor’s counsel on the grounds that the pre-petition retainer paid to counsel constituted the bank’s cash collateral that should not be used to pay counsel’s fees. The court overruled the objection, holding that the bank had no interest in the pre-petition retainer held by Debtor’s counsel and, if the bank had an interest, that interest was trumped by counsel’s first-priority perfected security interest in the retainer.

In reaching its decision, the court cited U.C.C. Article 9, section 9-332 for the proposition that a transferee of money from a deposit account takes free of any security interest “unless the transferee acts in collusion with the debtor in violating the rights of the secured party.” The bank did not assert collusion, and the court held that the bank had no interest in the pre-petition retainer held by counsel. Therefore, the bank had no cash collateral interest that was entitled to adequate protection. And, even if the bank could somehow claim a continuing security interest in the pre-petition retainer, that interest would be junior to the perfected security interest held by counsel, which was perfected by counsel’s possession of the funds.

A Delaware Bankruptcy Court recently held that an unsecured creditors’ committee’s legal fees were not subject to a pre-confirmation cap contained in a financing order. In In re Molycorp, Inc., Case No. 15-11357 (Bankr. D. Del. Jan. 5, 2017), the unsecured creditors’ committee’s attorneys filed an application seeking $8.5 million in fees for services performed in investigating and prosecuting certain causes of action on behalf of the debtors. The committee filed the application after confirmation of the debtors’ plan. Before confirmation of the plan, however, the court entered a financing order capping the committee’s legal fees at $250,000. Thus, the issue before the court was whether the pre-confirmation cap applied to the committee’s application.

In analyzing the application, the court noted that, as a general rule, administrative expenses must be satisfied from assets of the estate not subject to liens. Put another way, "where there are insufficient unencumbered assets with which to pay administrative expenses, professionals employed by the debtors or by creditors’ committees may not ordinarily look to secured creditors’ collateral for payment." To facilitate the chapter 11 process and induce professionals to represent a committee, the secured lender usually enters into an agreement under which it subordinates its liens and claims to a limited amount of professional fees. In the event a plan is not confirmed and the case is administratively insolvent, the professionals’ fees are capped at that limited amount. According to the court, however, this changes after the plan is confirmed, as 11 U.S.C. § 1129(a)(9) requires that each holder of an administrative claim receive full payment of their claim. The court went on to hold that "if the secured parties desire confirmation, the administration claims must be paid in full in cash at confirmation even if it means invading their collateral." Thus, while professional fees may be capped prior to plan confirmation, they must be paid in full post-confirmation to comply with the bankruptcy code.

In the personal bankruptcy of a husband and wife, a bankruptcy trustee sought to avoid an allegedly fraudulent transfer between two third-party corporations. Debtors entered into a purchase agreement to purchase a farm, then assigned the purchase agreement to an LLC Debtors had formed. The LLC obtained a loan, guaranteed by Debtors, to purchase the farm. Debtors operated a horse farm and bed and breakfast on the property for the next three years.

In November 2010, Debtors made a large payment on the LLC’s mortgage for no consideration, then, a month later, the Debtors’ LLC sold to the property to a third-party LLC, Beads and Steeds Inns, for roughly half of what Debtors’ LLC paid three years earlier. Debtors continued to operate the horse farm and bed and breakfast under a significantly below-market lease. Debtors filed for bankruptcy two years later. The bankruptcy trustee filed an adversarial action against Beads and Steads, asserting that the transfer from Debtors’ LLC to Beads and Steeds was fraudulent, done to evade Debtors’ creditors. Beads and Steeds moved for judgment on the pleadings, arguing that the bankruptcy trustee failed to state a claim because a fraudulent transfer requires a transfer of an interest of the debtor in property – while here the transfer was of an interest of the Debtors’ LLC in property. The bankruptcy trustee asserted that she could pierce the corporate veil in reverse and thereby treat Debtors’ LLC and the Debtors as a single entity. She also asserted that the Debtors’ LLC should be substantively consolidated with Debtors, such that they should be treated as one.

The Sixth Circuit Court of Appeals ruled against the bankruptcy trustee. First, the court held that veil piercing under Kentucky law does not consolidate a debtor and its alter ego into a single entity; rather, Kentucky employs veil piercing as a form of vicarious liability, shifting liability from the debtor to its alter ego. "Because Kentucky veil piercing does not transform the alter ego’s property into the property of the debtor, but rather simply allows a creditor to pursue the alter ego under a vicarious liability theory, the trustee has not stated a claim under § 544 and § 548, both of which require that the debtor have an interest in the transferred property."

The court also rejected the bankruptcy trustee’s substantive consolidation arguments. The court employed the In re Owens Corning test to evaluate the bankruptcy trustee’s substantive consolidation claim because that was the test the parties propounded in the lower court, but, in a footnote, the court noted that the Sixth Circuit "has not adopted a test for evaluating a substantive consolidation claim." The Owens Corning test requires that either (1) prepetition the entities sought to be consolidated disregarded separateness so significantly their creditors relied on the breakdown of entity borders and treated them as one legal entity; or (2) postpetition their assets and liabilities are so scrambled that separating them is prohibitive and hurts all creditors. The court held that the bankruptcy trustee’s proposed amended complaint did not contain sufficient factual allegations under either standard.

The case is Phaedra Spradlin v. Beads and Steeds Inns, LLC (In re Howland), Case No. 16-5499 (6th Cir. January 3, 2017), which the court indicated was not recommended for publication.

2016

The Supreme Court of Texas recently held that the transfer of $5.9 million from Stanford International Bank Ltd. to the Golf Channel for media-advertising services was not recoverable as a fraudulent transfer, even though Stanford used the services to promote its Ponzi scheme. In Janvey v. Golf Channel, Inc., 487 S.W.3d 560 (Tex. 2016), R. Allen Stanford used Stanford International Bank Ltd. to perpetrate a multi-billion dollar Ponzi scheme for nearly two decades. To that end, Stanford paid the Golf Channel approximately $5.9 million to advertise its services and activities. After Stanford was put into receivership, a court-appointed receiver sought to recover the payments Stanford made to the Golf Channel under Texas’s Uniform Fraudulent Transfer Act ("TUFTA") as fraudulent transfers. TUFTA, however, prohibits the recovery of a fraudulent transfer if the transferee took the transfer in good faith and for a reasonably equivalent value. While the Golf Channel argued that its advertising services provided value in exchange for the transfers, the receiver claimed otherwise, arguing that there is no "value" unless the transaction leaves the transferor’s estate with a tangible asset on which creditors can levy execution.

On cross-motions for summary judgment, the federal district court held in favor of the Golf Channel. On appeal, the Fifth Circuit reversed the district court’s ruling and held that the media-advertising services "provided zero value to a Ponzi scheme’s creditors." The Fifth Circuit, however, later vacated its opinion and asked the Texas Supreme Court to determine what constitutes "value" under TUFTA’s good faith affirmative defense. In answering the Fifth Circuit’s question, the Texas Supreme Court held that the reasonably equivalent value requirement can be satisfied with evidence that the transferee (1) fully performed under a lawful, arm’s-length contract for fair market value, (2) provided consideration that had objective value at the time of the transaction, and (3) made the exchange in the ordinary course of the transferee’s business. The court further held that it was not necessary that the consideration provided preserve the debtor’s estate, just that it had an objective value, and that the standard does not differ in the context of a Ponzi scheme. Accordingly, the court ruled that the media-services provided by the Golf Channel had an objective value at the time of the transfer, ultimately leading to the Golf Channel’s victory.

The Michigan legislature, at the recommendation of the Uniform Law Commission, is considering replacing the Uniform Fraudulent Transfer Act with the Uniform Voidable Transactions Act. The proposed legislation would, according to the Senate Fiscal Agency, amend the Uniform Fraudulent Transfer Act to do the following:

  • • Refer to transactions that can be avoided as "voidable" transactions, instead of "fraudulent" transactions.
  • • Specify that a creditor making a claim for relief to avoid a transaction would have the burden of proving the elements of the claim by a preponderance of the evidence.
  • • Provide that a claim for relief would be governed by the law of the jurisdiction where the debtor was located when the transfer was made, and prescribe rules for determining a debtor's location.
  • • Identify the party that would have the burden of proving certain matters, and establish a preponderance of the evidence standard.
  • • Make an exception to a provision under which a transfer is not voidable if it results from the enforcement of a security interest under the Uniform Commercial Code.
  • • Preclude the entry of a judgment against an immediate or mediate good-faith transferee of a good-faith transferee who took for value.
  • • Specify that a debtor that was not paying debts as they became due other than as a result of a bona fide dispute would be presumed to be insolvent.
  • • Delete a provision that specifies when a partnership is insolvent.
  • • Specify that a series organization and each of its protected series would be considered a separate person for purposes of the Act.

The bill also would rename the Act as the “Uniform Voidable Transactions Act”. The bill passed the in the Michigan Senate 37-0 on October 20, 2016, and was received in the Michigan House of Representatives on November 9, 2016, where it was referred to the House Judiciary Committee.

If the bill becomes law, the sections it would amend or add would apply to a transfer made or obligation incurred on or after the bill’s effective date. Those sections would not apply retroactively, nor would they apply to a right of action that accrued before the bill’s effective dated.

In Blixseth v. Brown, et al. (In re Yellowstone Mount Club, LLC), No. 14-35363 (9th Cir. November 28, 2016), the Ninth Circuit Court of Appeals held that the Barton doctrine applies to members of an Unsecured Creditors’ Committee and, therefore, a plaintiff must obtain authorization from the bankruptcy court before initiating an action against a member. Prior to this ruling, the Barton doctrine traditionally applied to actions against receivers and bankruptcy trustees. The plaintiff argued that the doctrine should not extend to members of a UCC because such members owe no duty to the bankruptcy estate; they represent creditors seeking payment from the estate. The Court of Appeals disagreed, finding that this interpretation of the UCC’s duties is too narrow. "The UCC can only maximize recovery for the creditors by increasing the size of the estate. . . . Because creditors have interests that are closely aligned with those of a bankruptcy trustee, there’s good reason to treat the two the same for purposes of the Barton doctrine." The Court further noted that UCC members are statutorily obliged to perform tasks related to the estate’s administration, and that a lawsuit could interfere with these duties.

In extending the Barton doctrine to UCC members, the Court adopted the recommendation of the Commission to Study the Reform of Chapter 11. The Ninth Circuit’s decision will likely have an impact in other courts across the country.

In Jones v. CitiMortgage, Inc., et al., Case No. 15-14853, the plaintiff filed suit in federal district court to stop the foreclosure sale of his home. One of his allegations was that the foreclosure violated a the bankruptcy discharge injunction of Section 524 because the defendants were attempting to hold him personally liable for the mortgage debt. The Eleventh Circuit Court of Appeals held that the federal district court lacked jurisdiction to rule on an alleged violation of the bankruptcy discharge injunction because the federal district court had not issued the discharge order. While acknowledging that the district court had original subject matter jurisdiction related to bankruptcy cases, the Eleventh Circuit noted that the discharge order had been issued by the United States Bankruptcy Court for the Northern District of Georgia and that court, not the district court, “possessed the power to enforce compliance with the discharge injunction and ‘punish contempt of that order.’”

In Ochadleus v. City of Detroit (In re City of Detroit), Nos. 15-2194, 2337, 2353, 2371, 2379 (6th Cir. Oct. 3, 2016), the Sixth Circuit Court of Appeals affirmed an order prohibiting Detroit pensioners from challenging cuts to their pensions under the equitable mootness doctrine. The appeal arose out of the City’s bankruptcy, in which "the City crafted a complex network of settlements and agreements with its thousands of creditors and stakeholders, memorialized those agreements in a comprehensive Plan, and obtained the bankruptcy court’s ratification of that Plan in a final Confirmation Order." One aspect of the plan involved the reduction of certain municipal-employee pension benefits under the City’s General Retirement System. At the time of Detroit’s bankruptcy filing, the pension plan was underfunded by $1.879 billion, therefore forcing the City to reduce the plan by 27% during the bankruptcy. In an effort to prevent such drastic cuts, the City reached a settlement with pensioners under which the City obtained outside funding, including from the City, the State of Michigan, and certain philanthropic organizations, totaling $816 million in exchange for a release of all claims. Overall, the settlement reduced pensions by 4.5% and eliminated cost-of-living increases; reduced retiree health coverage and eliminated dental, vision, and life insurance; and set out a mechanism for the partial recoupment of excess annuity savings funds distributions. The pensioners settlement, in addition to numerous other settlements, eliminated approximately $7 billion in debt and freed approximately $1.7 billion in revenue for reinvestment into City services and infrastructure.

While 73% of the City’s pensioners voted in favor of the settlement, resulting in the plan’s confirmation, the remainder appealed, arguing that their pensions should be exempt from reduction under the plan. The Sixth Circuit held otherwise due to the equitable mootness doctrine. Equitable mootness is "a prudential doctrine that protects the need for finality in bankruptcy proceedings and allows third parties to rely on that finality by preventing a court from unscrambling complex bankruptcy reorganizations when the appealing party should have acted before the plan became extremely difficult to retract." In deciding whether an appeal is equitably moot, the court examines: (1) whether a stay has been obtained; (2) whether the plan has been "substantially consummated;" and (3) whether the relief requested would significantly and irrevocably disrupt the implementation of the plan or disproportionately harm the reliance interests of other parties not before the court. In this instance, the Sixth Circuit held, "all three factors favor the application of equitable mootness: the appellants did not obtain a stay; the Plan has been substantially consummated, inasmuch as numerous significant—even colossal—actions have been undertaken or completed, many irreversible; and the requested relief of omitting the bargained-for (and by majority vote agreed-upon) pension reduction would . . . unravel the entire Plan and adversely affect countless third parties, including . . . the entire City population." Overall, the court’s decision was "not a close call," as "the doctrine of equitable mootness was created and intended for exactly this type of scenario."

The Michigan Court of Appeals recently upheld a trial court’s ruling that the sale of real estate by a receiver free and clear of all liens, claims, and encumbrances, including mortgages in favor of a subcontractor, was a proper exercise of the trial court’s authority under MCL § 570.1123(2). At issue in Stock Building Supply, LLC v. Crosswinds Communities, Inc., 2016 Mich. App. LEXIS 1685 (2016) was whether the sale by a receiver of four condominium units “free and clear of all claims, liens, and encumbrances” extinguished mortgages placed on those units by Church & Church, Inc. Church was a subcontractor on the Eton Street Station II condominium project in Birmingham, Michigan, which was funded by a $13,201,800 loan from Citizens Bank and secured by a mortgage.

After the developer defaulted, Citizens sought and was granted a receiver over the condominiums. The receiver sold four units, with court approval, “free and clear of all liens, claims, and encumbrances.” Church objected to the sales three years after the close of the receivership, arguing that it still maintained mortgages on the units because the trial court did not have the authority to approve the sale of them free and clear of Church’s interests. The Michigan Court of Appeals disagreed, holding that MCL § 570.1123(2), which permits a receiver to “petition the court for authority to sell the real property interest under foreclosure for cash or on other terms as may be ordered by the court,” permitted the trial court to sell the properties free and clear of Church’s mortgage. Specifically, the court held that the phrase “on other terms” gave the trial court the authority to approve the sale of the units free and clear of all liens, including Church’s mortgage.

The Sixth Circuit Court of Appeals recently held that a party can be bound to a mutual release of claims in a settlement agreement despite failing to sign it. In Baker Hughes, Inc. v. S&S Chemical LLC, et al., case no. 15-2413 (6th Cir. September 2, 2016), a former employee sued his employer in Oklahoma, alleging he did not receive his full compensation. The employer sent the employee a draft settlement agreement proposing to resolve the case. The draft agreement indicated that the employer would pay the employee $10,000 in exchange for a mutual release of claims. The employee signed the settlement agreement, but the employer never did. The employer later filed suit against the former employee in Michigan and alleged that the employee was using the employer's trade secrets in his new business. The employer argued that, at the very least, a genuine issue of material fact existed regarding whether the mutual release of claims in the settlement agreement applied because the employer never signed the draft. The Sixth Circuit Court of Appeals disagreed, affirming the trial court's decision that the release was enforceable against the employer. "[T]he transmission of the Settlement to [the employee] constituted an offer . . . ." The offer was accepted when the former employee "signed the draft of the Settlement" and "communicated his acceptance to [the employer]" when the signed draft was faxed to the employer's counsel. The Court noted that "nothing in the record suggests that [the employer's] offer was expressly conditioned upon [the employer] later signing the Settlement."

The case is a strong reminder to clients and attorneys alike to be cautious when exchanging multiple drafts of settlement agreements. A party may be bound by a draft's terms regardless of whether the draft has been signed. If a party's attorney is transmitting a draft settlement agreement but does not yet have his or her client's approval regarding specific language, the attorney should expressly state that the settlement is conditioned on the client's signature.

In Bash v. Textron Financial Corporation (In re Fair Finance Company), the Sixth Circuit Court of Appeals reversed a district court’s dismissal of a chapter 7 trustee’s civil conspiracy claim. The chapter 7 trustee had sued Textron Financial Corporation, alleging that Textron assisted in the debtor company’s concealment and perpetuation of a Ponzi scheme. Textron filed a motion to dismiss the chapter 7 trustee’s civil conspiracy claim, arguing that the in pari delicto (in a case of equal or mutual fault, equity favors the position of the defending party) defense barred the trustee’s claim. The Sixth Circuit reversed, holding that a plaintiff is not required to plead facts necessary to defeat an affirmative defense. The Sixth Circuit went on to hold that the Ohio Supreme Court, if faced with the issue, would adopt the "innocent insider" exception as it relates to the in pari delicto defense. In other words, in pari delicto may bar a trustee’s actions against third parties who participated in or facilitated wrongful conduct of the debtor. An exception to the in pari delicto defense is the adverse interest exception, which arises if a person is committing an independent fraudulent act on her own account. The adverse interest exception also has an exception known as the sole actor doctrine that arises if agents responsible for adverse conduct dominate and control the principal. And, finally, the adverse interest exception also has an exception, which is known as the innocent insider exception. This exception arises if an innocent person inside a company has the power to stop the fraud.

The United States Bankruptcy Court for the District of Delaware recently permitted a creditor to set off its allowed post-petition administrative expense claim against its preferential liability. In Official Committee of Unsecured Creditors of Quantum Foods, LLC v. Tyson Foods, Inc., No. 15-50254 (Bankr. D. Del. July 25, 2016), the Official Committee of Unsecured Creditors of Quantum Foods, LLC, after being granted derivative standing, filed suit against Tyson Foods, Inc. and Tyson Fresh Meats, Inc. seeking to avoid and recover preferential and fraudulent transfers totaling $13,747,933. In response, Tyson asserted, among other defenses, a right to set off a previously-allowed post-petition administrative expense claim in the amount of $2,603,841.09 against its preferential liability. The Committee subsequently filed a motion for judgment on the pleadings with respect to Tyson’s assertion of a setoff right.

Section 553(a) of 11 U.S.C. preserves the "right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case . . . against a claim of such creditor against the debtor that arose before the commencement of the case." Although the Code seemingly only preserves the right of a creditor to setoff mutual prepetition obligations, "[t]he judicial consensus is that setoff is available in bankruptcy when the opposing obligations arise on the same side of the bankruptcy petition date." Thus, a creditor may set off a debt owing to and from the debtor if the debts both arose either pre-petition or post-petition. In this instance, the court held, the administrative expense clearly arose post-petition. Moreover, even though a preference claim concerns pre-petition facts, the court held, a preference claim "necessarily arises only post-petition." Accordingly, the court denied the Committee’s motion.

A Bankruptcy Court recently voided an operating agreement provision requiring the consent of a secured lender-placed "special member" for a Michigan LLC to file a bankruptcy petition.

In In re Lake Michigan Beach Pottawattamie Resort LLC, 547 B.R. 899 (Bankr. N.D. Ill. 2016), the "blocking director" provision was inserted as an amendment to the debtor’s operating agreement in connection with a forbearance agreement. The provision granted the special member the right to approve or disapprove various LLC actions, including filing a bankruptcy petition. The amendment was clear that the blocking director provision was for the express benefit of the lender, and that the special member was relieved of any fiduciary duties to the debtor and its members.

The debtor filed a voluntary bankruptcy petition without the consent of the special member, and the secured lender moved to dismiss the filing as unauthorized. The court held that the blocking director provision was void under both bankruptcy and Michigan law, and that the bankruptcy was authorized because the remaining members voted in favor of the filing.

The Superior Court of Rhode Island recently granted a motion for replevin in favor of an unperfected secured creditor, Pet Food Experts, Inc., and against another unperfected secured creditor, Greenwood Credit Union, to partially satisfy obligations owing from Alpha Nutrition, Inc. d/b/a Doggiefood.com to Pet Food Experts. In Pet Food Experts, Inc. v. Alpha Nutrition, Inc., 2016 R.I. Super LEXIS 58 (R.I. Sup. Ct. May 10, 2016), two secured creditors were competing over their security interests in a 2015 Cadillac Escalade. Pet Food Experts previously made a $700,000 loan to Alpha Nutrition in September 2014 that was secured by all of Alpha’s existing and after acquired assets. Pet Food Experts perfected its security interest by filing a UCC financing statement. Alpha Nutrition later purchased an Escalade using financing it received from Greenwood. While Greenwood received a security interest in the vehicle in exchange for the financing, Greenwood failed to note its interest on the vehicle’s certificate so as to perfect its interest in accordance with Rhode Island law. Alpha Nutrition subsequently defaulted on its payments to Pet Food Experts and Pet Food Experts filed a replevin action for the vehicle. The Court, after describing the steps to perfect an interest in a titled vehicle, held that while both secured parties’ interests attached to the vehicle at the same time, neither noted their lien on the title, and thus both were unperfected. As a result, the Court could not look to either the title statute’s or the UCC’s priority rules, but rather had to use its equitable powers to determine priority. In holding that Pet Food Experts had priority, the court stated that the subsequent lender providing the financing to the debtor was in a better position to perfect its interest and that a creditor with an after-acquired property clause was "at a severe disadvantage when the after-acquired property is an automobile financed by a subsequent creditor." The Court thus granted the replevin motion in favor of Pet Food Experts.

The Michigan Court of Appeals recently held that a party to a mortgage can take advantage of equitable subrogation. In Albace v. RAAW Enterprises, et al., case no. 326435 (Mich. Ct. App. June 21, 2016), the defendants owed the plaintiff $300,000 for the purchase of property under a land contract. Defendants executed a promissory note to a bank in order to obtain $200,000 to pay to the plaintiff. The plaintiff was not a party to the promissory note, but granted a mortgage to the bank on the property as collateral. When defendants defaulted under the loan, the plaintiff paid the amount owing to the bank in order to protect his interest in the property, and later attempted to recover this amount against defendants under the theory of equitable subrogation. The defendants argued that equitable subrogation was inappropriate in this case because the plaintiff was liable for the debt to the bank as a party to the mortgage. The Michigan Court of Appeals disagreed because the mortgage did not expressly obligate the plaintiff to pay the indebtedness. "[A] mortgage can set forth the terms of indebtedness . . . But this one does not. The mortgage contains no promise to make payments on the underlying debt." Therefore, because the mortgage did not expressly create a payment obligation for the plaintiff, the mortgage was "mere security of the money debt" and the plaintiff could recover under equitable subrogation.

General Products Corporation, a full service supplier of engineered, complex, and precision machine components and assemblies for the automotive and heavy-duty truck markets, filed Chapter 11 bankruptcy on June 27, 2016 in the United States Bankruptcy Court for the Eastern District of Michigan. The case is pending in Detroit before Judge Thomas J. Tucker. General Products identified the cause of its filing as declining demand for products and increased capital requirements. A motion to sell substantially all of General Products’ assets has been filed, requesting a sale closing on or before August 22, 2016. The case is In re General Products Corporation, Case No. 16-49267.

In Intervention Energy Holdings, LLC, Case No. 16-11247, the United States Bankruptcy Court for the District of Delaware recently held that a provision inserted into a limited liability company’s operating agreement to restrict the filing of a bankruptcy is void as contrary to federal public policy. As part of a forbearance agreement with its lender, Debtor IE Holdings agreed to an amendment of its operating agreement whereby authorization to file bankruptcy required the unanimous approval of all holders of common unit interests and one common unit interest was sold to its lender for $1.00. Debtor IE Holdings filed bankruptcy absent the approval of its lender and the lender moved to dismiss the bankruptcy, arguing that the filing was unauthorized. In denying the lender’s motion to dismiss IE Holdings’ bankruptcy case, the bankruptcy court held that the amendment of the operating agreement was “tantamount to an absolute waiver” of the right to file bankruptcy, which, even if permitted by state law, contravenes federal public policy and is void.

In In re Sabine Oil & Gas Corp., 548 B.R. 674 (Bankr. S.D.N.Y. 2016), a New York bankruptcy court recently refused to apply the divestiture doctrine to stay confirmation proceedings pending an appeal. The court had previously denied a request by the official committee of unsecured creditors to derivatively pursue certain causes of action on behalf of the estate. The committee then appealed the court’s decision and sought a stay. At the time of the appeal, the debtors had already filed a plan of reorganization that released the same causes of action the committee sought to pursue. Thus, if the plan were confirmed pending the committee’s appeal, it would effectively moot the appeal. This result, the committee argued, violated the divestiture doctrine because it would divest the appeals court of its ability to allow the committee to pursue the claims.

The bankruptcy court held the divestiture doctrine inapplicable to the committee’s request. “The divestiture doctrine, in its simplest terms, provides that the filing of an appeal divests the lower court of its control over the issue or matter that is on appeal. . . . During the pendency of an appeal of a bankruptcy court order, however, the bankruptcy court is not divested of jurisdiction to enforce or implement the order being appealed, nor is the bankruptcy court divested of jurisdiction to decide issues and proceedings different from and collateral to those involved in the appeal.” Here, the court held, confirmation of the proposed plan containing releases would not alter the court’s order denying the committee derivative standing. Further, the court held, “[i]f the divestiture doctrine were to be applied in a way that divests bankruptcy courts of jurisdiction over all issues relevant to confirmation on which the court has previously ruled and are the subject of a pending appeal, this would lead to an absurd result—courts would likely decline to rule on any issues that could be implicated at confirmation for fear of interfering with a debtor’s ability to emerge from chapter 11. Moreover, it would effectively cede control of the conduct of a chapter 11 case to disappointed litigants. This cannot be, and is not, the law.” Accordingly, the committee’s request was denied.

On May 16, 2016, the United States Supreme Court held in Husky International Electronics, Inc. v. Ritz, 578 U.S. ___ (2016), that the term "actual fraud" in a bankruptcy non-discharge section encompasses fraudulent conveyance schemes, even when those schemes do not involve a false representation. The Bankruptcy Code prohibits debtors from discharging debts "obtained by . . . false pretenses, a false representation, or actual fraud." Debts of this type pass through the bankruptcy and creditors continue to be able to seek and enforce judgments arising from those claims.

In Ritz, Husky International Electronics sold goods to Chrysalis Manufacturing, and Chrysalis incurred a debt to Husky of approximately $164,000. During the same period, defendant Daniel Lee Ritz, Jr. served as a director of Chrysalis and owned at least 30% of Chrysalis’s stock. He drained Chrysalis of assets it could have used to pay its debts to creditors like Husky by transferring large sums of Chrysalis’s funds to other entities Ritz controlled.

Husky filed a lawsuit seeking to hold Ritz personally liable for Chrysalis’s debt. Ritz then filed for Chapter 7 bankruptcy. Husky brought an adversary proceeding against Ritz seeking to hold Ritz personally liable to Husky and to hold the debt non-dischargeable because Ritz’s intercompany-transfer scheme constituted "actual fraud" under the Bankruptcy Code’s exemption to discharge in 11 U.S.C. 523(A)(2)(A). In a split with other Circuit Courts, the Fifth Circuit held that a debt is "obtained by . . . actual fraud" only if the debtor’s fraud involves a false representation from the debtor to the creditor. The Supreme Court reversed, holding that the term "actual fraud" encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without a false representation.

The Court of Appeals of Texas held that the written words in loan documents prevail over contradictory numerals. In Charles R. Tips Family Trust v. PB Commercial LLC, 459 S.W.3d 147 (Tex. App. 2015), Patriot Bank loaned $1,700,000 to Charles R. Tips Family Trust and Hazel W. Tips Family Trust pursuant to a note, a deed of trust, and a guaranty agreement. Each document described the principal amount of the loan as “ONE MILLION SEVEN THOUSAND AND NO/100 ($1,700,000.00) DOLLARS.” Id. at 150. The borrowers failed to repay the entire amount of the loan prior to maturity. Patriot Bank sought to collect the unpaid principal and interest. PB Commercial acquired the loan and documents from Patriot Bank and sold the property securing the note for $874,125. PB Commercial then sued the borrowers for the remaining deficiency and was granted an $815,214.50 judgment. The borrowers appealed the deficiency judgment.

On appeal, the appellate court held that the deficiency judgment was improper because the principal balance owing under the loan documents was $1,007,000, not $1,700,000, citing the Uniform Commercial Code’s provision that “words prevail over numbers.” Tex. Bus. & Com. Code § 3.114. The court refused to consider extrinsic evidence regarding the amount of money that Patriot Bank actually provided to the borrowers because the loan documents were not ambiguous after application of all relevant rules of construction. Id. at 156. As a result, the court reversed the trial court’s deficiency judgment for PB Commercial, rendered a judgment that the principal amount of the loan was $1,007,000, and remanded the case to the trial court for further proceedings.

The Michigan Court of Appeals recently held that the circuit court did not have jurisdiction over a claim and delivery action because the complaint included allegations of a failure to follow procedures for abandoned vehicle reporting. In Ford Motor Credit Company v. Haggen, case no. 325889 (Mich. Ct. App. March 15, 2016), Ford Credit filed a complaint in Wayne County Circuit Court alleging a claim and delivery action and claim for conversion regarding a vehicle in a towing company's possession. Ford Credit later amended the complaint to include other counts and defendants. The court granted Ford Credit's motion for partial summary disposition, but the Court of Appeals reversed the decision on the grounds that the circuit court did not have subject-matter jurisdiction. Despite the fact that the original complaint never alleged that the vehicle was "abandoned," the Court of Appeals found that all claims stemmed from the contention that the towing company failed to comply with abandoned vehicle processing requirements under MCL 257.252e(1). That statute indicates that the district court, not circuit court, has jurisdiction over such claims. Ford Credit argued that the statute's requirements were not at issue because the towing company admitted that it failed to allow Ford Credit to redeem the car, but the Court of Appeals found those admissions irrelevant for jurisdictional purposes. "[T]he issue of whether the circuit court had subject-matter jurisdiction over the case was based on the pleadings in the case, rather than subsequent admissions of the opposing party."

The opinion is a strong reminder to plaintiffs that a single allegation can change the location where a complaint may be filed.

In Southwest Sec., FSB v. Segner (In re Domistyle, Inc.), 811 F.3d 691, (5th Cir. 2015), the trustee attempted to sell property believed by all parties to be worth more than the secured debt. Once he was unable to sell the property for an amount acceptable to the secured creditor, he abandoned the property to the secured creditor and sought to surcharge the property under 11 U.S.C. § 506(c) for expenses incurred during the sale process related to preserving the value of the property. These expenses included security, repairs to the roof and electrical system, mowing, landscaping, utilities, and insurance premiums. The Bankruptcy Court granted the surcharge and the secured creditor appealed.

The Fifth Circuit began its analysis by noting the general rule in bankruptcy that administrative expenses cannot be satisfied out of collateral property but must be borne out of the unencumbered assets of the estate. Section 506(c) provides a “narrow” and “extraordinary” exception to this general rule by allowing a trustee to “surcharge” a secured creditor’s collateral to recover the reasonable and necessary expenses preserving and disposing of the collateral “to the extent of any benefit” to the secured creditor. The rationale for surcharge is to prevent a secured creditor being unjustly enriched.

The Fifth Circuit rejected the secured creditor’s arguments that the trustee had failed to carry his burden of proving entitlement to surcharge. It held that the bankruptcy court did not clearly err in finding that the secured creditor received a direct and quantifiable benefit from the trustee’s stewardship of the property, based on testimony of the trustee’s real estate broker that the value preserved was at least as much as the amount expended.

The United States Court of Appeals for the Seventh Circuit recently held that a debtor’s termination of two commercial leases constituted transfers subject to avoidance and recovery. In Official Committee of Unsecured Creditors of Great Lakes Quick Lube, LP v. T.D. Investments I, LLP (In re Great Lakes Quick Lube LP), No. 15-2093, 2016 U.S. App. LEXIS 4560 (7th Cir. Mar. 11, 2016), Great Lakes Quick Lube LP (“Great Lakes”) leased numerous oil change stores from entities throughout the Midwest. Fifty-two days before filing for bankruptcy, Great Lakes negotiated the termination of two of its leases with T.D. Investments I, LLP (“T.D.”). After filing for bankruptcy, Great Lakes’s unsecured creditors committee (“Committee”) filed an adversary proceeding against T.D. seeking to avoid and recover the value of the cancelled leases as preferential and fraudulent transfers. The bankruptcy court denied the Committee’s request, holding that the terminations were not “transfers” subject to avoidance and recovery.

The Seventh Circuit reversed the bankruptcy court’s ruling on a direct appeal, holding that a transfer, as defined by the Bankruptcy Code, includes “each mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with—(i) property; or (ii) an interest in property.” When Great Lakes terminated the leases, the Seventh Circuit ruled, it transferred an interest in property—the leases—to T.D., thus making the terminations “transfers” subject to avoidance and recovery. The Seventh Circuit also noted that 11 U.S.C. § 365(c)(3), which prohibits a trustee from assuming a commercial lease that is terminated before the order for relief is entered, was inapplicable because the Committee was seeking to recover only the value of the leases, not the leases themselves. Accordingly, the Seventh Circuit remanded the case to the bankruptcy court to determine the value of the transfers to T.D.

In J&N Koets, Inc. d/b/a Advanced Restorations, v. Onemarket Properties Lake Point LLC, et al., case no. 324007 (Mich. Ct. App. January 12, 2016), the owners of a condominium complex asked the plaintiff restoration company to address water damage within the building. The owners signed a contract listing the “Client” as the condominium but the space labeled “Company” was left blank. The restoration company issued an invoice afterwards that stated a different name than the plaintiff. The owners argued that the plaintiff was not the real party in interest because of this name difference, but the Court disagreed, stating, “A real party in interest is the one who is vested with the right of action on a given claim, although the beneficial interest may be in another.” The Court noted that there was uncontroverted evidence that only the plaintiff’s employees were involved in the formation of the contract and the relevant services. Moreover, the entity that the owners claimed was the real party in interest assigned their claims to the plaintiff.

The opinion is further evidence that courts may look beyond documents’ labels when the substantive facts of the dispute are clear.

The United States Court of Appeals for the Third Circuit recently ruled that payments made by a secured creditor to unsecured creditors and their professionals were not property of the estate and, thus, not subject to the Bankruptcy Code’s priority scheme. In In re LCI Holding Co., 802 F.3d 547 (3rd Cir. 2015), lenders to an operator of long-term acute care hospitals credit bid $320 million of the $355 million of secured debt that they had lent to the debtor. In connection with the bid and to resolve objections, the lenders agreed to pay the debtor’s unsecured creditors $3.5 million and the unsecured creditors committee’s professional fees. The bankruptcy court approved the sale over the United States Government’s objection that the payments made to the unsecured creditors and their professionals violated the Code’s priority scheme. The bankruptcy court held that the funds placed in escrow by the secured lenders were not property of the estate and not subject to distribution to the debtor’s creditors. The Government appealed the decision. The 3rd Circuit affirmed the bankruptcy court’s decision, holding that the funds were not property of the estate or proceeds of the lenders’ collateral, but were instead the lender’s property. As a result, the Bankruptcy Code’s priority scheme was not violated.

The Seventh Circuit Court of Appeals recently voided Bank of New York Mellon’s ("BNYM") security for its $312 million dollar loan to Sentinel Management Group because the bank was aware of suspicious facts that should have led it to investigate whether Sentinel had authority to pledge securities to the bank. The case is Grede v. Bank of New York Mellon Corp. and Bank of New York (In re Sentinel Management Group, Inc.), Case No. 15-1039 (7th Cir. January 8, 2016).

Sentinel was a cash management firm, investing cash which had been lent to it in liquid, low-risk securities. Sentinel also traded on its own account using money borrowed from BNYM to finance the trades. To secure its loan from BNYM, Sentinel pledged securities that it had bought for its customers with their money even though Sentinel’s loans from BNYM were used to trade on Sentinel’s own account. Sentinel was forbidden to pledge these securities to BNYM as security for BNYM’s loans to it.

Sentinel experienced trading losses that prevented it from maintaining its collateral with BNYM and meeting the demands of Sentinel’s customers for redemption of the securities that Sentinel had bought with their assets. Sentinel used its line of credit with BNYM to meet redemption demands. When Sentinel declared bankruptcy, it owed BNYM $312 million.

BNYM notified Sentinel that, because of Sentinel’s inability to repay BNYM’s loan, the bank planned to liquidate the collateral that Sentinel had pledged to secure the loan. Sentinel’s trustee refused to classify BNYM as a secured creditor with respect to the $312 million Sentinel owed it, asserting that Sentinel’s transfers of customer accounts to BNYM to collateralize Sentinel’s loans were fraudulent transfers under 11 U.S.C. § 548(a)(1)(A).

The Seventh Circuit noted that the bank would have been in the clear had it accepted the pledge of assets "in good faith" under 11 U.S.C. § 548(c), but BNYM would not have been acting in good faith had it had "inquiry notice." Inquiry notice is "knowledge that would lead a reasonable, law-abiding person to inquire further – would make him in other words suspicious enough to conduct a diligent search for possible dirt." The Court held that BNYM was on inquiry notice to further investigate whether Sentinel could pledge the securities because the evidence showed that the bank, before it accepted the collateral, questioned whether Sentinel could pledge the securities. Therefore, BNYM was an unsecured creditor with respect to the $312 million Sentinel owed it.

Great Lakes Comnet, Inc., an owner and operator of a 6,500 mile fiber network serving Michigan and neighboring states, and Comlink, L.L.C., a provider of dedicated ultra-high-speed bandwidth data transmission, filed for bankruptcy on January 25, 2016 in the United States Bankruptcy Court for the Western District of Michigan. Debtors’ secured lender, CoBank, ACB, is owed more than $25 million. Debtors state that the prime cause of their bankruptcy filings is an on-going payment dispute with AT&T Services, Inc. and AT&T Corp. Debtors’ first-day filings suggest a motion to sell assets will be filed quickly, with a stalking horse price estimated at approximately $32.6 million. The cases are In re Great Lakes Comnet, Inc., Case No. 16-00290 and In re Comlink, L.L.C., Case No. 16-00292.

A Bankruptcy Court in the Middle District of Pennsylvania recently held that proceeds of a D&O policy owned by a Chapter 7 debtor were not property of the estate. In Brothers v. Neblett (In re Valley Forge Composite Techs., Inc.), 2015 Bankr. LEXIS 4296 (Bankr. M.D. Pa. Dec. 21, 2015), two of the Debtor’s officers filed a motion for relief from the automatic stay to allow the advancement of their defense costs under the D&O policy and, in the alternative, sought a declaratory judgment that the automatic stay does not apply to bar the advancement of defense costs.

The Bankruptcy Court cited precedent from the Third and Fifth Circuits and the District Court for the Southern District of New York in holding that proceeds payable to directors and officers under a D&O policy are not property of the Debtor’s estate. “The automatic stay, therefore, does not apply, and the Movants need not obtain this Court’s permission to seek payment under the policy.”

2015

The Bankruptcy Appellate Panel (BAP) of the Sixth Circuit recently held that a Bankruptcy Court did not err by granting a motion for relief from stay to continue litigation against a Chapter 7 individual debtor. In In re Martin (6th Cir. BAP Dec. 16, 2015), creditors who were plaintiffs in a state court fraud case against Debtor and others and who were also plaintiffs in a non-dischargeability proceeding against debtor stemming from the same state court litigation, sought relief from the automatic stay to continue the state court litigation. The Bankruptcy Court granted the motion and stayed the non-discharge proceeding.

Debtor asserted that the Bankruptcy Court was improperly allowing a state court judge to decide the issue of dischargeability in contradiction to the exclusive jurisdiction of the Bankruptcy Court because a judgment rendered by the state court is likely to have preclusive effect in the adversary proceeding.

The BAP affirmed the Bankruptcy Court’s decision to allow the state court litigation to continue, holding that the dischargeability of a debt is a matter separate from the merits of the debt itself, and that giving a state court judgment preclusive effect does not mean that the Bankruptcy Court is deferring to the state court to determine dischargeability. “Accordingly, the bankruptcy court does not improperly abdicate its role by holding an adversary proceeding to determine the dischargeability of a potential debt in abeyance in order to allow completion of on-going state court litigation regarding the cause of action giving rise to the potential debt.”

The City of Detroit filed lawsuits today in the United States Bankruptcy Court seeking to recover millions that the City paid to its creditors before it filed for protection under Chapter 9 of Bankruptcy Code. Each lawsuit seeks to recover payments ranging from the low hundreds of thousands to millions of dollars. The City retained the New York law firm of Togut, Segal & Segal LLP to file and litigate the lawsuits.

The City seeks to recover the payments as preferential transfers. Under section 547 of the Bankruptcy Code, the City may recover payments it made to creditors within 90 days before the City filed for bankruptcy if the City can show the payments allowed the creditor to receive more than it would have received in a Chapter 7 liquidating bankruptcy case, and that the payments were made on account of an antecedent debt and while the City was insolvent. The creditors being sued, in turn, may raise a number of defenses, the most common of which are that (i) the payments were made in the ordinary course of business, (ii) the creditor provided valuable goods or services, known as “new value,” contemporaneously with the payment, or (iii) the creditor continued to provide new value after receiving the payment.

The United States Bankruptcy Court of Appeals for the Seventh Circuit ruled that a lender could defeat an avoidance action because its agreement to forbear exercising its rights provided sufficient value. In 1756 W. Lake St. LLC v. Am. Chartered Bank, 787 F.3d 383 (7th Cir. 2015), the bank lent the borrower $1.5 million secured by a mortgage on real property. The borrower was not able to repay the loan, and the bank entered into several forbearance agreements. Under one of the agreements, the borrower gave a deed to the mortgaged property to an escrow agent for the bank’s benefit in the event of a default. The borrower later defaulted and the bank recorded the deed. The borrower subsequently filed for bankruptcy and sought to avoid the recording of the deed by claiming it was a fraudulent transfer. The borrower argued that it did not receive reasonably equivalent value because the property was worth $1.7 million, $200,000 more than the $1.5 million loan that it satisfied. The Court ruled in favor of the bank by holding that the forbearance agreements themselves had value. Specifically, the Court found that the borrower was able to generate over $400,000 in gross income during the term of the forbearance agreements, thereby receiving sufficient value to defeat any fraudulent transfer claim.

The Michigan Court of Appeals recently held that a contract purporting to grant a party exclusive rights to transport motor fuel was unenforceable. In Armada Oil Company LLC d/b/a AOG Trucking v. Barrick Enterprises, Inc., (No. 321636, September 22, 2015), a motor fuel hauling company claimed it entered into a written contract with a wholesale distributor to serve as the "exclusive fuel hauler" for certain supply agreements. The hauler further claimed that the parties agreed to split the resulting profits. The Court of Appeals held that even if it accepted the hauler’s claims as true and assumed there was a meeting of the minds on the material terms, the contract was unenforceable for lack of consideration. Specifically, the agreement did not require the fuel hauler to do anything. "Plaintiff incurred no obligation or legal detriment that was bargained for and exchanged for defendant’s alleged promises . . . . Because plaintiff made no legally enforceable promise to defendant, defendant would have no cause of action for breach of contract against plaintiff."

The case is a reminder that parties must closely examine contracts that grant “exclusive” rights to ensure there is mutuality of obligation.

In Mediofactoring, et al. v. McDermott, creditors applied for administrative claims seeking payment of attorneys' fees and costs on the basis that they had substantially contributed to a Chapter 7 bankruptcy case. The creditors argued that their successful removal of the original Chapter 7 trustee for misfeasance and resulting settlement by the new Chapter 7 Trustee against the former significantly increased the amount of funds available for distribution. Both the bankruptcy court and district court agreed that the creditors had contributed substantially to the settlement. However, the bankruptcy court held that the statutory language of 11 U.S.C. 503(b)(3)(D), which authorizes an administrative claim related to a "substantial contribution in a case under chapter 9 or 11" of the Bankruptcy Code, did not apply in a Chapter 7 case. The Sixth Circuit disagreed, holding that the prefatory language of Section 503(b) permitted the claim and explained that the enumerated subsections of Section 503(b) are non-exhaustive examples of expenses warranting administrative treatment.

Postpetition financing is usually crucial to a debtor’s chapter 11 success. Once an order is entered authorizing postpetition financing, however, creditors and other interested parties are generally powerless to reverse the order’s effects. In In re Health Diagnostic Lab., Inc., No. 15-32919-KRH, 2015 Bankr. LEXIS 2731 (Bankr. E.D. Va. Aug. 17, 2015), for instance, a prepetition lender’s request for a stay pending appeal of a court’s interim order authorizing postpetition financing was denied. In the case, a secured prepetition lender loaned the debtor over $13 million, but was unwilling to provide postpetition financing, forcing the debtor to take out a loan from a different lender for $12,000,000 in exchange for a security interest in all of the debtor’s assets and superiority status. The court subsequently approved the financing on an interim basis and set a date for a hearing on a final order. The debtor’s prepetition lender appealed the interim order and sought a stay pending appeal.

In denying the prepetition lender’s request, the court examined whether: (1) the prepetition lender was likely to prevail on the merits of its appeal; (2) the prepetition lender would suffer irreparable injury if the stay was denied; (3) the other parties would be substantially harmed by the stay; and (4) the public interest would be served by granting the stay. The prepetition lender argued primarily that a stay should be issued because the lender would be successful on appeal. Specifically, the prepetition lender argued that the court improperly found that the lender had a 100% equity cushion due to valuing the debtor’s assets at a going concern, rather than at a liquidation. The court disagreed by holding that the use of the going concern value was appropriate because liquidation did not seem likely in the future. As for the other factors, the court held that the balance of hardships and the public interest weighed in favor of the debtor because the lender had an adequate equity cushion and because the debtor could continue to operate its business with the financing. Accordingly, the court denied the prepetition lender’s request.

Health Diagnostic yet again demonstrates that creditors and interested parties are limited in attacking a financing order. Such parties should therefore attempt to negotiate the terms of a proposed financing order before, rather than after, it is entered.

The United States Bankruptcy Court for the District of Delaware recently held that the Trademark License Agreement between Trump AC Casino Marks, LLC (“Trump AC”) and Trump Entertainment Resorts, Inc. and certain of its affiliates (“Trump Entertainment”) was not assignable without Trump AC’s consent, and that cause existed to allow Trump AC to lift the automatic stay to proceed with its state court breach action. In In re Trump Entm’t Resorts, Inc., 526 B.R. 116 (Bankr. D. Del. 2015), Trump AC entered into a Trademark License Agreement with Trump Entertainment under which, in connection with the operation of three hotel casinos located in Atlantic City, Trump Entertainment was granted a royalty-free license to use Donald and Ivanka Trump’s names, likenesses, and other marks. The Trademark License Agreement was not assignable without the consent of Trump AC. Trump AC entered into a Consent and Agreement (“Consent Agreement”) with Trump Entertainment’s pre-petition lender under which Trump AC consented to the transfer of Trump Entertainment’s rights under the Trademark License Agreement after an “Enforcement Action.” In August 2014, Trump AC filed a state court lawsuit seeking to terminate the Trademark License Agreement for breaches of the agreement by Trump Entertainment.

On September 9, 2014, Trump Entertainment filed for relief under Chapter 11 of the Bankruptcy Code. This resulted in a stay of Trump AC’s state court action. Trump AC filed a motion seeking relief from the automatic stay to allow it to proceed with the state court action. While the Court found that the Trademark License Agreement was an executory contract, its assumption was subject to the limitation contained in Section 365(c)(1) of the Bankruptcy Code. Under this section, a contract may not be assumed if “applicable law excuses a party, other than the debtor, to such contract . . . from accepting performance from or rendering performance to an entity other than the debtor.” The Court found that the applicable law was federal trademark law, and that under federal trademark law, “trademark licenses are not assignable in the absence of some express authorization from the licensor.” Because the Trademark License Agreement expressly prohibited assignment, Trump AC was entitled to relief from the automatic stay under Section 362(d)(1) of the Bankruptcy Code. The Court further found that because Trump Entertainment’s lender had not commenced an “Enforcement Action” before the bankruptcy filing, the lender was not entitled to the benefits of the Consent Agreement entered into with Trump AC, and actions taken by the lender in the bankruptcy proceedings were not tantamount to an “Enforcement Action” as defined in the Consent Agreement.

The Michigan Court of Appeals recently addressed the bankruptcy estate of Borman’s, the company connected with the now defunct Farmer Jack grocery store chain. In Ashley Livonia A&P v. The Great Atlantic & Pacific Tea Co., et al. (Case No. 319288, June 16, 2015), Borman’s asserted that the security deposit and rent payment it collected from its subtenant was part of its bankruptcy estate and, therefore, beyond the reach of the property’s owner. The Court disagreed, noting that Borman’s collected these payments after the landlord had already evicted Borman’s. "Because Borman’s could not legally provide its subtenant, Mastronardi, with possession and quiet enjoyment of the property, its right to receive rent was terminated." Therefore, the proceeds could not be part of Borman’s bankruptcy estate.

In Ellmann v. Baker (In re Baker), 2015 U.S. App. LEXIS 11437 (6th Cir. 2015), the Sixth Circuit Court of Appeals held that Law v. Siegel, 134 S. Ct. 1188 (2014), limits a bankruptcy court’s power to disallow claimed exemptions. The debtors had failed to disclose a cause of action in their bankruptcy schedules until years after the close of their case. The bankruptcy trustee moved to reopen the case to pursue the cause of action and the debtors filed an amended exemption of the cause of action. The trustee objected, claiming the exemption was fraudulent and asserted in bad faith. Affirming the district court, the Sixth Circuit held that Law v. Siegel prohibits a bankruptcy court from disallowing the debtors’ claimed exemptions because of their alleged bad faith and fraudulent conduct. Further, the Court affirmed the district court’s finding that the trustee had waived his objection to the timeliness of the exemption amendment.

In Baker Botts v. Asarco, 576 U.S. __ (2015), the United States Supreme Court held that Section 330(a)(1) of the Bankruptcy Code does not permit a bankruptcy court to award attorney’s fees for work performed in defending a fee application in court. Debtor-in-possession’s law firms had prosecuted a fraudulent-transfer claim against Debtor’s parent company and obtained a judgment against it worth between $7 and $10 billion. The law firms were awarded $120 million for their work plus a $4.1 million fee enhancement. Post-bankruptcy, the Debtor was again controlled by its judgment-debtor parent, which objected to the law firms’ fees. The bankruptcy court rejected the fee challenge following extensive discovery and a 6-day trial. The court also awarded the law firms over $5 million for time spent litigating in defense of their fee applications.

The Supreme Court reversed this award, holding that Congress did not expressly depart from the American Rule – that each litigant pays its own attorney’s fees, win or lose – to permit compensation for fee-defense litigation by professionals hired to assist trustees in bankruptcy proceedings. The Court noted that Section 330(a)(1) does not authorize the award of fees for defending a fee application, and that is the end of the matter.  "Our job is to follow the text even if doing so will supposedly undercut a basic objective of the statute." (internal quotations omitted).

In Bank of America, N.A. v. Caulkett, 575 U.S. __ (2015), the United States Supreme Court overruled the longstanding ability of a debtor to void a junior mortgage under 11 U.S.C. § 506(d) when the debt owed on a senior mortgage exceeds the value of the secured property. Section 506(d) allows a debtor to void a lien on property "[t]o the extent that [the] lien secures a claim against the debtor that is not an allowed secured claim." Typically, and as was the case in Caulkett, debtors use § 506(d) to void, or "strip," wholly-underwater junior mortgages, or ones in which the junior mortgagor will receive nothing in the event of a sale of the collateral. Because the amount of the senior debt exceeds the value of the property, only a senior mortgagor is entitled to payment from any sale proceeds, rendering the junior mortgagor essentially unsecured.

The Supreme Court, however, overruled this practice. While other Code provisions might suggest otherwise, the Court followed Dewsnup v. Timm, 502 U.S. 410 (1992) in construing § 506(d) to prohibit lien stripping. In Dewsnup, the Court held that a "secured claim" for purposes of § 506(d) means "a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim." The Dewsnup definition, the Court held, therefore mandated the result that § 506(d) can be used to void a lien only to the extent the claim is not a secured allowed claim. Accordingly, "[t]he reasoning of Dewsnup dictates that a debtor in a Chapter 7 bankruptcy proceeding may not void a junior mortgage lien under § 506(d) when the debt owed on a senior mortgage lien exceeds the current value of the collateral."

The United States Bankruptcy Court for the Western District of New York recently held that a collateral description in a UCC financing statement was not "seriously misleading," even though it was "needlessly convoluted." In Ring v. First Niagara Bank, N.A. (In re Sterling United, Inc.), 519 B.R. 586 (Bankr. W.D.N.Y. 2014), First Niagara Bank, N.A. loaned $1.2 million to United Graphics, Inc. To secure the loan, the bank took a security interest in all of United’s assets and filed a UCC financing statement with a collateral description that arguably limited the collateral to assets located at the debtor’s business address. United moved its operations, and, although the UCC financing statement was amended to change the debtor’s address, the collateral description still referred to assets located at the prior address. Just before United’s involuntary bankruptcy petition, First Niagara modified the collateral description to eliminate the limiting language. The Chapter 7 Trustee later initiated an adversary proceeding to avoid the amended financing statement.

The Court denied the Chapter 7 Trustee’s request by following the ruling of ProGrowth Bank, Inc. v. Wells Fargo Bank, N.A., 558 F.3d 809 (8th Cir. 2009), in which the Eighth Circuit Court of Appeals ruled that notice filings are sufficient if they alert subsequent creditors of the possibility that a debtor’s assets are covered by the financing statement. The Court disagreed with the idea that a "Court must consider whether a hypothetical creditor could have been misled." Rather, the Court held that it "must presume a certain level of sophistication" of the hypothetical downstream creditor and that there "must be a degree of diligence" employed by that creditor when examining the collateral description, similar to how other courts have held downstream creditors “to a standard of 'reasonableness' or 'prudence'" when searching a debtor’s name. Accordingly, the Court saw "no basis for setting the bar higher for a secured creditor against a bankruptcy trustee" and held that a bankruptcy trustee is not granted "a special status" when it comes to what is a seriously misleading financing statement.

A bankruptcy court recently held that a business’s Facebook and Twitter accounts were property of the estate. In In re CTLI, LLC, Case No. 14-33564 (S.D. Texas April 3, 2015), a former owner of a Chapter 11 corporate debtor refused to relinquish control of the debtor’s social media accounts. The former owner claimed that the Facebook and Twitter accounts were his personal accounts, but the Court disagreed and pointed out the numerous posts related to the business’s operations. "[B]usiness social media accounts are property interests. Like subscriber lists, [they] provide valuable access to customers and potential customers." The Court further noted that its ruling did not deny the former owner his personal goodwill because any followers representing such goodwill are free to follow the former owner to his other social media pages.

In an unpublished opinion, the Sixth Circuit Court of Appeals held in Waldman v. Stone that a district court is not required to receive additional evidence when reviewing a bankruptcy court’s proposed findings of fact and conclusions of law. Waldman had argued that, under Fed. R. Bankr. P. 9033(d), the district court was required to receive additional evidence when conducting a de novo review of the bankruptcy court’s findings. The Sixth Circuit disagreed, holding that the language of the rule is permissive and that the district court may, but is not required to, accept additional evidence when conducting a de novo review. The Sixth Circuit also held that a de novo review by a district court may be accomplished by either a review "upon the record" or "after additional evidence" and that the choice of method to employ is left to the discretion of the district court. The case citation is: Waldman v. Stone, 2015 U.S. App. LEXIS 4668 (6th Cir. 2015).

The court in In re Headlee Mgmt. Corp., 519 B.R. 452 (Bankr. S.D.N.Y. 2014) refused to order disgorgement of interim fees paid to Chapter 11 professionals where the debtor’s estate was insolvent on conversion to Chapter 7. The Chapter 11 professionals were paid interim fees before the case was converted to Chapter 7. The Chapter 7 trustee moved to disgorge those interim fees, relying solely on the administrative insolvency of the Chapter 7 estate. The United States Trustee supported the disgorgement motion.

The court noted that the Bankruptcy Code has a comprehensive system for the recovery of assets by the trustee, including specific provisions for the recovery of postpetition transfers and for the recovery of interim fees. Finding that the professional fees at issue were both postpetition transfers and interim fees, the court held that disgorgement of the interim Chapter 11 professional fees was not authorized by the Bankruptcy Code. The court disagreed with the Sixth Circuit’s statutory analysis in Specker Motor Sales Co. v. Eisen, 393 F.3d 659 (6th Cir. 2004) (finding disgorgement of interim fees in similar circumstances mandatory), questioned Specker Motor’s continuing validity in light of recent Supreme Court precedent, and noted that "the absolute pro rata distribution contemplated by Specker Motors is not even possible." Id. at 459

The Seventh Circuit Court of Appeals held that the First Amendment and the Religious Freedom Restoration Act (RFRA) do not protect religious organizations from avoidance actions brought by unsecured creditors’ committees. Listecki v. Official Committee of Unsecured Creditors, Nos. 13-2881 et al, 2015 U.S. App. LEXIS 3669 (7th Cir. 2015). Before the Archdiocese of Milwaukee filed its Chapter 11 bankruptcy petition, it transferred $55 million from the Archdiocese’s general accounts to a trust earmarked for maintaining Milwaukee area cemeteries. After the bankruptcy filing, the Archbishop, as trustee, filed a declaratory judgment action seeking to protect the trust funds from avoidance actions. The Archbishop argued that any claim by the Debtor or Committee to recover the trust funds would impose a substantial burden on his religious beliefs in violation of his free exercise rights under the First Amendment and the RFRA. The Bankruptcy Court granted a motion brought by the Committee and dismissed the First Amendment and RFRA claims. The District Court reversed, finding that recovery claims would substantially burden the Archbishop’s free exercise of religion under the First Amendment and RFRA, and that the Committee was acting under color of law for purposes of the RFRA.

On appeal, the Seventh Circuit first determined that the RFRA is not applicable if the government is not a party. The Seventh Circuit then reversed the District Court’s finding that the Committee was acting as the government under color of law under the RFRA. Although the Committee is formed by the United States Trustee’s Office and is subject in some ways to oversight by both the U.S. Trustee and the Bankruptcy Court, the Seventh Circuit determined that the Committee represents and owes a fiduciary duty to private unsecured creditors, not to any governmental actor. For the same reason, the Committee is not performing a traditional public function – the Committee can be adverse to the U.S. Trustee when representing the creditors’ interests. Similarly, the Committee did not become a public actor by obtaining derivative standing to bring avoidance actions on behalf of the Debtor-in-possession – prosecution of avoidance actions is not traditionally a government function whether performed by a debtor or a committee. Because the Committee is not a governmental actor, the RFRA does not apply.

The Seventh Circuit also dismissed the Archbishop’s claims that the First Amendment’s Free Exercise clause protected the funds from Committee actions even if the Committee was not acting under color of law. The Court agreed that the Free Exercise Clause applies, but that it did not protect the trust funds because the bankruptcy code’s avoidance provisions serve a compelling government interest and are sufficiently narrowly tailored to achieve that interest. Even if the avoidance provisions impose an undue burden on the Archbishop’s religious practice, the Committee’s compelling governmental interest in protecting creditors overcomes that burden under the Seventh Circuit’s balancing test. Therefore, neither the First Amendment nor the RFRA apply to protect transfers by religious institutions from avoidance actions under the Bankruptcy Code.

The Michigan Court of Appeals recently addressed the obligations of guarantors in connection with a bankruptcy discharge. In Talmer West Bank v. Stewart, Nos. 316678; 317420 (Mich. Ct. App. December 11, 2014), the bankruptcy court had confirmed a reorganization plan discharging the debtor of certain loan repayment obligations. The lender later filed a complaint in Kalamazoo County Circuit Court against the guarantors on the loan seeking repayment. The trial court entered a judgment against the guarantors for the full amount of the repayment obligations, and the Court of Appeals affirmed the judgment. The Court stated, "Generally, ‘[t]he discharge of a debtor in bankruptcy does not discharge the obligations of guarantors.'" The guaranty is only discharged if the guarantor’s discharge is "accepted and confirmed as an integral part of reorganization." The Court found nothing in the plain language of the reorganization plan expressly indicating the guaranties were discharged and, therefore, the obligations remained intact.

The Court’s opinion is a strong reminder that guarantors’ silence during bankruptcy proceedings may have consequences long after plan confirmation.

The United States Bankruptcy Court for the Western District of Tennessee held that the mere fact a secured creditor’s right to credit bid had a potential chilling effect on third-party bids was not, without more, sufficient cause to justify denying its right to credit bid in a sale of collateral under § 363(k) of the Bankruptcy Code. In In re RML Development, Inc., No. 13-29244, 2014 Bankr. LEXIS 3024 (Bankr. W.D. Tenn. July 10, 2014), the debtor, RML Development, Inc., attempted to sell two residential apartment complexes in a § 363 sale. The secured creditor, SPCP Group III CNI 1, LLC (Silverpoint) filed a motion to allow it to credit bid, asserting that it had a valid first mortgage security interest in these properties. Under § 363(k) of the Bankruptcy Code, holders of secured allowed claims have the right to bid at § 363 sales and to offset the purchase price by their secured claim. RML Development countered that Silverpoint's credit bidding rights should be limited due to a dispute over the amount of Silverpoint’s claim.

The Court found sufficient cause to limit Silverpoint's credit bidding rights to the undisputed portion of its claim because of allegations asserting a Ponzi scheme and breaches of fiduciary duty. The Court explained that credit bidding rights should be modified or denied only when equitable concerns give it cause, and because the Bankruptcy Code does not define cause, courts have the discretion to determine cause on a case-by-case basis. The Court held that modifying or denying credit bidding rights should be the "extraordinary exception" and not the norm.

In Official Committee of Unsecured Creditors of Motors Liquidation Co. v. JP Morgan Chase Bank, N.A. (In re Motors Liquidation Co.), No. 13-2187 (2d Cir. Jan. 21, 2015), the Second Circuit Court of Appeals held that a clerical error rendered a syndicate of lenders, including JP Morgan, unsecured on a $1.5 billion loan to GM. A syndicate of lenders made loans to GM in two transactions: one in which GM was given $300 million in exchange for liens on twelve pieces of real estate, and another in which GM was given $1.5 billion in exchange for security interests in a large number of GM’s assets, including all of GM’s equipment and fixtures at forty-two facilities throughout the U.S. As the $300 million loan reached maturity, GM contacted Mayer Brown, GM’s counsel, and JP Morgan, the secured party of record, and explained that GM sought to repay the loan and release the liens on its property. Mayer Brown drafted a release. The release also mistakenly terminated JP Morgan’s security interests under the $1.5 billion loan. Mayer Brown, JP Morgan, and its counsel, Simpson Thacher & Bartlett LLP, did not notice the error, and the release was filed with the authorization of JP Morgan.

When GM filed for chapter 11 relief, its official committee of unsecured creditors brought an action to determine whether the release effectively terminated JP Morgan’s interests under the $1.5 billion loan. The Second Circuit ruled that it did, holding that even though JP Morgan did not subjectively intend to release its interests under the $1.5 billion loan, the objective act of filing the release with JP Morgan’s authorization was sufficient to terminate JP Morgan’s interests. This error terminated JP Morgan’s interests in GM’s equipment and fixtures at forty-two facilities throughout the U.S., rendering JP Morgan an unsecured creditor in GM’s bankruptcy case.

In In re Derma Pen, LLC, the United States Bankruptcy Court for the District of Delaware dismissed a chapter 11 bankruptcy that lacked a good faith attempt to reorganize or preserve value for creditors and was determined to have been filed as a litigation tactic. The debtor, a provider of micro needling and skin treatment devices and systems, had commenced a chapter 11 bankruptcy following entry of adverse summary judgment orders against it in Utah District Court. The United States Trustee and the defendants in the Utah District Court litigation filed motions to dismiss Derma Pen’s bankruptcy, claiming that it was commenced as a litigation tactic. In dismissing the case, the Bankruptcy Court held that debtor was not in financial distress at the time of its filing, the filing was actually an improper attempt to re-start litigation with the Utah District Court defendants related to contract and trademark claims, and that Derma Pen’s desire to take advantage of an 11 U.S.C. § 363 asset sale and 11 U.S.C. § 365 contract rejection were not sufficient justifications to transform Debtor’s bad faith filing into a good faith filing.

2014

In Dillard v. Schlussel, No. 315485, 2014 Mich. App. LEXIS 1985, at *1 (Mich. Ct. App. Oct. 21, 2014), the Michigan Court of Appeals held that "a debtor’s transfer of assets for the purpose of paying the debtor’s ordinary household expenses [did not] immunize the transfers from challenge under the MUFTA." Dillard stemmed from a creditor’s efforts to collect on a judgment rendered against Schlussel. During discovery, the creditor learned that Schlussel endorsed approximately $1,540,000 worth of checks to his wife, who would deposit the checks into a personal account and use the funds to pay for living expenses. The creditor subsequently sued Schlussel under the Michigan Uniform Fraudulent Transfer Act for actual and constructive fraud. Citing Sixth Circuit precedent, the circuit court granted summary disposition in favor of Schlussel, holding that the use of the funds to pay for living expenses provided reasonably equivalent value to Schlussel and thus barred the creditor’s claims.

On appeal, the Michigan Court of Appeals reversed. In addition to holding that the creditor’s actual fraud claim should be decided by a jury, the appellate court held that the payments from Schlussel to his wife for household expenses did not automatically trump the creditor’s constructive fraud claim. "If it did, the MUFTA would be a useless waste of ink and paper, as every debtor would simply transfer any cash in his possession to a covert account, spend it freely, and thereby avoid liability on a court-entered judgment." Id. at *40. Yet, while not a complete defense, the appellate court also held that the finder of fact would have to decide whether Schlussel received reasonably equivalent value when his wife made the payments. Accordingly, the case was remanded for further proceedings.

In Anderson v. Fisher (In re Anderson), No. 14-08007, 2014 Bankr. LEXIS 3908 (B.A.P. 6th Cir. Sept. 15, 2014), the Sixth Circuit Bankruptcy Appellate Panel upheld a Tennessee bankruptcy court’s decision entitling a state court "penalty" default judgment to preclusive effect. The decision stemmed from a Tennessee state court order granting a default judgment as a penalty against the debtors for repeated refusals to comply with court orders regarding discovery. After the debtors filed for chapter 7 relief, the prevailing party in state court sought a non-dischargeability determination of the state court judgment, arguing, through a motion for summary judgment, that the state court order was entitled to preclusive effect under the doctrine of collateral estoppel.

The Sixth Circuit Bankruptcy Appellate Panel, in upholding the bankruptcy court’s decision, first noted that whether to give preclusive effect to a state court default judgment depends on state law. Tennessee state courts have not addressed whether a penalty default judgment is entitled to preclusive effect. However, "true" default judgments are given preclusive effect by Tennessee state courts. Furthermore, the panel held, the amount of participation in the state court case by the debtors was similar to an earlier Sixth Circuit case in which a Tennessee default judgment was given preclusive effect. Thus, the panel reasoned that—if presented with the issue—a Tennessee state court would likely give a penalty default judgment preclusive effect.

The United States Bankruptcy Court for the Eastern District of Virginia held that a secured creditor’s right to credit bid was capped because of, among other things, its aggressive tactics. The case involved the purchase of a $50 million secured loan originally made by Branch Banking and Trust to Free Lance-Star, a family-owned publishing, newspaper, radio and communications company. DSP Acquisition, LLC was formed by a Sandton Capital Partners, a private equity fund, to execute on its loan-to-own strategy. After finding that DSP did not have lien on all of the assets it proposed to credit bid on, and that DSP’s “overly zealous loan-to-own strategy” had a negative impact on the auction process, the In re Free Lance-Star Publ'g Co., 2014 Bankr. LEXIS 1611 (Bankr. E.D. Va. Apr. 14, 2014) court capped DSP’s right to credit bid at $13.9 million, significantly less than the $39 million that DSP claimed. In its analysis, the court recognized the important safeguard provided to secured creditors by 11 U.S.C. § 363(k), but also stated that credit bidding was "not an absolute right." The combination of DSP’s inequitable conduct and less than fully-secured lien status led the court to conclude that limiting its credit bid would best serve the bidding process and ultimately increase the realized value for the assets.

In Madugula v. Taub, 2014 Mich. LEXIS 1281 (Mich. July 15, 2014), the Michigan Supreme Court held that parties do not have a right to a jury trial in actions for shareholder oppression; rather, such claims must be heard by a court sitting in equity. The court reached its decision by determining that neither the shareholder oppression statute, MCL § 450.1489, nor the Michigan Constitution provides for the right. Indeed, the statute itself does not explicitly mention jury trials, but instead permits a court to "make an order or grant of relief as it considers appropriate." Although such relief may come in the form of money damages—a remedy normally awarded by a jury—the broad discretion of the circuit court to fashion any relief reflects the equitable nature of the claim: claims of which are normally decided by a judge.

Like the statute, the Michigan Constitution also precludes the right to a jury trial in shareholder oppression actions. While Article 1, § 14 states that "[t]he right of trial by jury shall remain," the provision only extends to claims that are similar to claims that were traditionally tried before a jury at the time the 1963 Constitution was adopted. A shareholder oppression action, according to the court, is comparable to a shareholder derivative claim and a corporate dissolution claim, both of which are equitable in nature and decided by judges. Thus, without a statutory or constitutional basis granting the right, the court concluded that the right to a jury trial does not exist in shareholder oppression actions and that such claims must be heard by a court sitting in equity.

The Fourth Circuit Court of Appeals, in National Heritage Foundation v. Highbourne Foundation, 2014 U.S. App. LEXIS 12144 (4th Cir. June 27, 2014), recently held a Chapter 11 plan’s non-consensual, third party release of non-debtors invalid because the release lacked adequate factual support. The court applied the Sixth Circuit’s test for non-debtor releases from Class Five Nevada Claimants v. Dow Corning Corp. (In re Dow Corning Corp), 280 F.3d 648, 658 (6th Cir. 2002) and struck the release of the debtor’s officers and directors.

Finding that only one Dow Corning factor – the identity of interests between the debtor and the Released Parties due to an expansive indemnity provision – had been met, the Fourth Circuit held that the debtor had not established "exceptional circumstances" justifying the non-debtor release. "[A]n indemnity obligation is not, by itself, sufficient to justify a non-debtor release. If it were, third party releases would be the norm, not the exception, in Chapter 11 cases." The court advised that a debtor need not demonstrate that every Dow Corning factor weighs in its favor to obtain approval of a non-debtor release, but warned that adequate factual support must be shown to warrant such "exceptional relief."

The Michigan Court of Appeals recently held that courts may create a "gap filler" that reaches a result contrary to a contract's terms. In Martlew v. City of Benton Harbor, et al. (Case No. 311897, May 1, 2014), the plaintiff entered into a contract with the City of Benton Harbor for the provision of services related to building inspections. The contract indicated that the plaintiff would receive payment only upon the completion of specific milestones. The contract also authorized the city to terminate the contract upon 30 days' notice at any time. The city terminated the contract in accordance with this provision before the plaintiff had reached any of the milestones triggering payment. The Court of Appeals found that the contract's terms were unambiguous; no payment was required under the plain terms. Nevertheless, it held that the plaintiff was entitled to the prorated value of work performed despite failing to reach any of the payment triggers outlined in the contract. The court reasoned that the contract was "incomplete" because it failed to describe how the city would pay plaintiff if it terminated the contract before a milestone was reached. "[W]hen a contract is incomplete because it fails to provide for a contingency, courts . . . may supply constructive conditions or 'gap fillers' to avoid failure for indefiniteness."

Parties drafting commercial contracts should be mindful of this decision; it is possible for a court to create new terms outside of the contract’s plain language. Courts are less likely to add such "gap fillers" if the parties expressly address foreseeable contingencies in the contract’s terms.

In Exec. Benefits Ins. Agency v. Arkison, Chapter 7 Tr. of Estate of Bellingham Ins. Agency, Inc., 573 U.S. ___, (2014), the United States Supreme Court held that claims designated for final adjudication in the bankruptcy court as a statutory matter, but prohibited from proceeding in that way as a constitutional matter (i.e., Stern claims), may be adjudicated by a bankruptcy court subject to district court review. Peter Arkison, the trustee for Bellingham Insurance Agency, filed a complaint against Executive Benefits Insurance Agency alleging fraudulent conveyance of assets from Bellingham to Executive Benefits. The parties agreed that this was a Stern claim, and the Court held this type of claim may be heard by a bankruptcy court issuing proposed findings of fact and conclusions of law subject to district court de novo review. The Court held that the fraudulent conveyance claims at issue in Bellingham were granted appropriate review by an Article III court when a district court reviewed the case de novo and entered a judgment separate from the bankruptcy court’s order.

In an unpublished opinion, the Michigan Court of Appeals in Shaya v. Karam, et. al, Case No. 308905, refused to allow plaintiffs to enforce a promissory note because plaintiffs possessed only a photocopy of the note. Plaintiffs had taken their interest in the promissory note via an allonge from the original holder of the promissory note, but the Court of Appeals held that the allonge was not a valid endorsement of a negotiable instrument because it was not affixed to the original note (only a photocopy of the original note) as required by MCL § 440.3204(1). Further, plaintiffs were not holders in due course of the note under MCL § 440.3301 because there was no evidence that the original note was transferred to plaintiffs’ possession.

The United States Court of Appeals for the Sixth Circuit in Westfield Ins. Co. v. Talmer Bancorp, 545 Fed. Appx. 402 (6th Cir. Oct. 30, 2013) held that a secured party’s insurance coverage rights under a loss payee provision are derivative of its borrower, and thus were extinguished when the borrower admitted fraud. The secured lender, Talmer Bancorp, Inc. (successor to People’s State Bank), made a loan to Milan 2000 Furnishings, Ltd. that was secured by real estate and business inventory. In March 2008, Milan stated that burglars had vandalized the real property and stolen the business’s inventory. Milan made a claim with its insurance carrier, Westfield Insurance Company, and submitted a fraudulent proof of loss when it failed to divulge that the inventory was subject to a security interest in favor of Talmer. Westfield paid the proceeds of the inventory loss to Milan. Talmer requested that the check be reissued to include Talmer as a joint payee. Westfield refused to reissue the check and filed a declaratory judgment action. The district court ruled in favor of Westfield, and Talmer appealed. On appeal, the Sixth Circuit held that Milan voided its coverage under the policy’s terms when it falsified the proof of loss. The court also held that Talmer’s rights were derivative and that Talmer had no independent right of recovery. Because of Milan’s breach of the terms of its insurance policy, Talmer was foreclosed from receiving any of the insurance proceeds.

In a direct appeal from the bankruptcy court, the Sixth Circuit reversed the bankruptcy court’s confirmation of an individual’s chapter 11 plan of reorganization and held that the plan must satisfy the absolute priority rule. Ice House Am. v. Cardin, ___ F.3d ___, 2014 U.S. App. LEXIS 8882, Case No. 13-5764 (May 13, 2014). The absolute priority rule, as applied in an individual chapter 11 case, requires that the debtor may retain property of the estate after confirmation of a plan only if all classes of unsecured creditors consent, or if all non-consenting classes are to be paid in full under the plan. 11 U.S.C. § 1129(b)(2)(B)(ii).

The Court determined that a 2005 revision to section 1129 of the Bankruptcy Code does create an exception to the absolute priority rule, but ruled that this exception is limited to the debtor’s post-petition earnings referenced in section 1115 and does not extend to any assets the debtor owned before the bankruptcy filing. The Sixth Circuit now joins the Fourth, Fifth, and Tenth in holding that individual chapter 11 debtors remain subject to the absolute priority rule. The Sixth Circuit acknowledged that this ruling places individual chapter 11 debtors at a disadvantage compared to chapter 13 debtors who are not subject to the absolute priority rule, but refused to permit this policy argument to influence its interpretation of Congress’ language.

In Hart v. Southern Heritage Bank, Case No. 13-6188 (April 28, 2014), the United States Court of Appeals for the Sixth Circuit held that a Bankruptcy Court for the Eastern District of Tennessee had constitutional authority to enter a final monetary judgment in a case under 11 U.S.C. section 523. The decision addressed the parameters of the U.S. Supreme Court's decision in Stern v. Marshall, 131 S. Ct. 2594 (2011).

The Court distinguished the case from Stern in two ways. First, the Court held that the Bank's claim against the Debtor arises specifically in bankruptcy (the discharge of a particular debt), and second, the Bank's non-discharge claim was resolvable by ruling on the Bank's proof of claim.

On March 26, 2014, the Michigan Supreme Court approved amendments to MCR 2.621 and MCR 2.622 regarding receiverships in Michigan. Court Rule 2.622 was amended to specifically set forth the process for the appointment of a receiver, selection of a receiver, and how the court must address objections to the appointment of a proposed receiver, receiver disqualifications, the specific requirements of an order appointing a receiver, the duties of a receiver, the powers of a receiver, the compensation and expenses of a receiver, and the bond of a receiver. If an objection is made to the person or entity appointed receiver, or if the court makes a determination that a different receiver should be appointed, the court must state its rationale for the selection of the receiver in consideration of six enumerated factors, which include the receiver’s experience in the operation and/or liquidation of the asset being administered and the receiver’s relevant legal, business, and receivership knowledge. A full text copy of the amendments can be found here.

The Michigan Court of Appeals recently issued a rare opinion refusing to enforce a contract on public policy grounds. In Ammori v. Nafso (Case No. 312498, January 28, 2014), the parties entered into an otherwise valid oral agreement to divide ownership of a limited liability company in an effort to avoid the obligations of a separate non-compete agreement. The Court of Appeals quoted an 1877 court decision stating, "When parties associate for an unlawful purpose, they must calculate in advance the probabilities of bad faith towards each other, and must expect no assistance of the law against each other’s frauds." The Court held that the parties' contract represented an agreement to defraud a third party, and was, therefore, unenforceable as a matter of public policy.

This decision is a strong reminder to contracting parties and third parties to look beyond an agreement's terms in some circumstances and consider whether the contract's objectives are enforceable.

The Michigan Court of Appeals reversed a circuit court judgment on tortious interference and remanded for entry of a judgment of no cause of action. In Datam Manufacturing v Magna Powertrain USA(Case No. 306202, February 13, 2014), Magna competed with plaintiff Datam to purchase a supplier’s inventory of unsold parts. Magna had asserted in 2007 that the supplier was contractually bound to ship the residual inventory parts to Magna, but supplier refused. The supplier then offered to sell the residual inventory parts to Datam, who in turn entered into a contract with a Magna tier one supplier who would supply the parts to Magna. Magna issued a purchase order to its tier-one supplier for the parts.

In the meantime, Magna continued to negotiate directly with the supplier for the purchase of the parts, ultimately reaching an agreement with the supplier to release the parts directly to Magna. The supplier then released the parts to Magna and declined to fulfill its purchase order for the parts with Datam. Datam sued Magna for tortious interference with contract and for tortious interference with a business relationship or expectancy.

The court focused on the element of the tortious interference claims requiring either a per se wrongful act that can never be justified under any circumstances or a specific, affirmative act that corroborates an unlawful purpose for the interference, noting that, "[w]here the defendant’s actions were motivated by legitimate business reasons, its actions would not constitute improper motive or interference." "Mere interference for the purpose of competition is not enough." "In other words, liability may not be predicated on the fact that the defendant ‘outbid and outmaneuvered’ the plaintiff in purchasing an item from a third party. Rather, the defendant must have done something illegal, unethical, or fraudulent."

The court held that Magna did not commit an inherently wrongful act or an affirmative act corroborating an unlawful purpose for its actions. "At most, Magna ‘outbid and outmaneuvered’ Datam in purchasing the parts from [supplier]; such conduct by itself fails to corroborate an improper motive." Simply put, competition does not establish tortious interference.

The United States Bankruptcy Court for the Southern District of New York, in Official Committee of Unsecured Creditors of Motors Liquidation Company v. JPMorgan Chase Bank, N.A., 486 B.R. 596 (Bankr. S.D.N.Y. 2013), ruled against a creditors’ committee when the court granted summary judgment in favor of the secured parties and found that a UCC financing statement termination was not effective because the termination was unauthorized. The mistake occurred when General Motors Corporation paid off a synthetic lease and a UCC-3 termination statement was mistakenly filed terminating a UCC-1 financing statement for an unrelated $1.5 billion term loan. JPMorgan Chase Bank, N.A., agent for a syndicate of lenders for the term loan, sought summary judgment and argued that the UCC termination statement was not authorized. The court found that, although JPMorgan was provided a copy of the erroneous UCC-3 termination before the termination was filed, JPMorgan did not intend to terminate the UCC financing statement and, equally important, GM did not believe it was authorized to terminate the financing statement.

2013

A debtor in bankruptcy is required to submit a list of his or her creditors with the creditors’ names and addresses under Fed. R. Bankr. P. 1007(a). In Lampe v. Kash , 2013 U.S. App. Lexis 22704 (6th Cir 2013), the debtor (Kash) filed his bankruptcy schedules listing the notice address of a creditor (Lampe) as the creditor’s former attorney. Lampe’s attorney had stopped working for her eight years before Kash filed his bankruptcy. Lampe did not participate in Kash’s bankruptcy case and Lampe’s $25,000 judgment against Kash was discharged in the bankruptcy. Lampe appealed to the Sixth Circuit, arguing that the notice sent to her former attorney was not reasonably calculated to reach her and deprived her of her due process rights. The Sixth Circuit agreed, holding that a search for Lampe’s residential address to include on Kash’s list of creditors did not present an undue burden, and that the bankruptcy court could not discharge Lampe’s judgment because she never received adequate notice of Kash’s bankruptcy.

The United States District Court for the District of New Jersey upheld the Bankruptcy Court’s ruling that a junior creditor’s assignment of voting rights to a senior creditor under an intercreditor agreement is enforceable in bankruptcy. In In re Coastal Broadcasting Systems, Inc., 2013 U.S. Dist. Lexis 91469 (June 28, 2013), the junior creditors, who were debtor’s former shareholders, argued that their Subordination and Intercreditor Agreement’s grant of voting rights to Sturdy Savings Bank was not enforceable, and the plan of reorganization should not be confirmed under 11 U.S.C. § 1129(a). The Court found that the agreement was enforceable in accordance with its terms under applicable nonbankruptcy law, and thus enforceable under 11 U.S.C. § 510(a).

The court also held that the assignment of voting rights did not violate public policy, dismissing appellant’s analogy to a debtor’s pre-petition waiver of the automatic stay. Finally, the Court dismissed the argument that the assignment conflicted with Bankruptcy Rule 3018, reasoning that Sturdy was a "creditor" for voting purposes, and, even if it did not qualify as a creditor, Sturdy would qualify as an authorized agent. Based upon this reasoning, and Sturdy’s deemed acceptance of the plan of reorganization, the Court affirmed the Bankruptcy Court’s confirmation of the plan under 11 U.S.C. § 1129(a).

The Michigan Court of Appeals, in a 2-1 panel decision, gave some clarity to a question bank lawyers have litigated in Michigan trial courts for years: whether a garnishee bank can trump the garnishing creditor of a bank’s borrower by claiming – versus actually taking – a setoff against funds held on deposit. The court held that claiming the right of setoff in response to the garnishment is sufficient.

The case is Ladd v. Motor City Plastics Co., 2013 Mich. App. Lexis 1773 (October 31, 2013). The court held that the garnishee-bank was not required to exercise its right of setoff or to seize the funds in the defendant's deposit accounts to deny the release of funds under the plaintiff's writ of garnishment. In reaching its decision, the court focused on the language of the Michigan Court Rule governing garnishments and the rule’s requirement that a garnishee file a disclosure setting forth "any setoff that the garnishee would have against the [judgment debtor] . . . ." (Emphasis in original).

The court also held that the bank did not waive its right to a setoff or its perfected security interest in the deposit accounts by authorizing defendant to continue to withdraw account funds.

Groeb Farms, Inc., a honey processor and producer of industrial sweeteners headquartered in Onsted, MI, filed a Chapter 11 bankruptcy petition on October 1, 2013. The U.S. Department of Justice accused Groeb Farms of evading anti-dumping duties on honey imported from China. Although Groeb Farms was able to settle these allegations through payment of a $2 million fine and other penalties, related class action lawsuits along with more than $12 million in losses in 2011 and 2012 forced Groeb Farms to seek bankruptcy court protection.

Before the bankruptcy filing, Groeb Farms agreed to a purchase agreement with Honey Financing Company, an affiliate of Peak Rock Capital. Groeb Farms also reached pre-filing agreements with its secured lenders (which included the purchase of senior secured debt by Honey Financing) and with counsel for the class action plaintiffs.

On the first day of the bankruptcy case, in addition to all the typical first day motions, Groeb Farms filed its Disclosure Statement attaching a proposed Plan of Reorganization. Under the Plan, Honey Financing would receive 100% of the equity of Groeb Farms by a partial conversion of debt to equity. The Plan proposes paying unsecured trade creditors forty percent recovery of their unsecured claims over time, but only if Groeb Farms and the creditor enter into a continuing trade agreement subject to Groeb Farms’ terms. The Plan proposes establishing a trust to pursue lawsuits with initial seed money of $50,000. All general unsecured creditors, and any trade creditor that does not receive a continuing trade agreement, would share the net proceeds, if any, from the trust.

Groeb Farms and Peak Rock Capital are seeking expedited approval of the sale and related agreements through confirmation of the Plan by the Bankruptcy Court – they have requested that the confirmation hearing be held before the end of 2013. The Bankruptcy Court has accommodated the debtor’s request for expedited proceedings, scheduling expedited hearings, and entering a November 4, 2013 bar date for all proofs of claims and motions for payment of pre-petition administrative expense claims.

In Edgewater Growth Capital Partners LP v. H.I.G. Capital, Inc., 68 A.3d 197 (Del. Ch. 2013), the Delaware Court of Chancery upheld the sale of a borrower’s assets to an entity related to borrower’s secured creditor, finding that the assets were sold via a public auction under Article 9 of the Uniform Commercial Code and not a private sale. The court also found that all aspects of the sale were commercially reasonable.

Pendum LLC, an ATM repair and servicing company, was a borrower under a $70 million syndicated loan secured by a lien on all of Pendum’s assets. Edgewater was a limited guarantor of Pendum’s obligations. Following Pendum’s default, Pendum and the lending syndicate led by HIG Capital entered into a foreclosure sale agreement ("Foreclosure Agreement"). The Foreclosure Agreement allowed Pendum 55 days to find a buyer for its assets and provided funds for a financial advisor to assist Pendum in Pendum’s sale efforts. Despite contacting over 60 potential suitors, Pendum was unable to find a buyer. HIG Capital proceeded to conduct a public auction under Section 9-610 of the UCC and complied with Article 9’s notice requirements. The only bidder was an affiliate of HIG Capital who bid $41 million and agreed to assume $50 million of Pendum’s liabilities. HIG Capital then demanded payment under Edgewater’s guaranty in the amount of $4 million.

Edgewater objected and sued HIG Capital claiming that, because Pendum had entered into the Foreclosure Agreement, the sale was an impermissible private sale that violated Section 9-610(c) of the UCC. Edgewater also argued that, even if the sale were held public, the sale was not performed in a commercially reasonable manner because there was limited advertising and only a form notice was sent to potential bidders.

The Delaware Court of Chancery rejected the private sale claim, reasoning that, if the court deemed this sale – where the secured party entered into an agreement that was designed to give the debtor a better chance to market itself and to find a buyer – "private," the court would be creating counterproductive incentives for secured creditors to exercise their rights under the Uniform Commercial Code to the detriment of debtors. The court also found that the Foreclosure Agreement and Pendum’s efforts were part of the overall sale process. As a result, the court held that sale process was commercially reasonable because the process gave third parties notice and a meaningful opportunity to bid on the assets, and because HIG Capital had performed the sale in accordance with practices of financial advisors who sell distressed entities. Accordingly, the Court upheld the public sale and ordered that Edgewater pay HIG Capital under its guaranty.

The Sixth Circuit Court of Appeals recently held that a district court’s denial of a Chapter 11 reorganization plan in bankruptcy proceedings is not a "final appealable order." The Court began its analysis by reaffirming the general principle that a district court order remanding a case to a bankruptcy court is not final for appellate purposes unless the remand is "ministerial." The Court then noted, "Far more than a few ministerial tasks remain to be done" after a court rejects a confirmation plan. The debtor may propose another confirmation plan or abandon the petition entirely. Additionally, any new plan may require further fact finding, and the creditors may accept the revised plan without further litigation. No order can be considered "final" before some of these decisions are made. The court also stated that if a debtor prefers immediate appellate review, the debtor may seek certification of the interlocutory order rejecting the plan.

The Sixth Circuit joins four other federal circuits holding that denial of a reorganization plan is not a final order, while three other circuits have held the opposite. A widening divide among the circuits may increase the likelihood of forum shopping, and correspondingly increase the likelihood that the United States Supreme Court may eventually decide the issue.

The case is In re William Edwin Lindsey (Lindsey v. Pinnacle National Bank, et al.), Case No. 12-6362 (E.D. Mich. August 13, 2013).

The United States Bankruptcy Court for the Eastern District of Wisconsin held that a pre-petition stay waiver in favor of debtor’s lender is a factor to be considered in determining "cause" for relief from the automatic stay under 11 U.S.C. 362(d)(1). The case is In re 4848, LLC, 490 B.R. 343 (Bankr. E.D. Wis. 2013). Debtor 4848, LLC was a single asset real estate debtor that had filed a Chapter 11 bankruptcy. Pre-petition, debtor entered into a forbearance agreement with its lender that included a stay waiver in favor of lender in the event that 4848, LLC filed for bankruptcy protection. Following debtor’s bankruptcy filing and the filing of a proposed plan of reorganization, debtor’s lender moved for relief from the automatic stay to continue foreclosure proceedings. In granting the lender’s motion for relief from the automatic stay, the Court held that while the pre-petition stay waiver is not the only consideration in determining "cause" for relief from stay, it is a factor to be considered, especially where, as here, the debtor had gained a "considerable advantage from the forbearance agreement and the waiver . . . ."

On August 13, 2013, the Bankruptcy Court entered Mediation Order [Docket No. 322] in the City of Detroit Bankruptcy Case. The Mediation Order appoints Judge Rosen, the Chief Judge of the United States District Court for the Eastern District of Michigan, mediator. The Order authorizes Judge Rosen to designate additional mediators. While mediation is non-binding, participation in the mediation process can be compulsory. The Mediation Order permits the Bankruptcy Court to refer any matter to Judge Rosen for mediation, and Judge Rosen may direct the disputing parties to engage in the mediation process.

On July 18, 2013, the City of Detroit filed the largest municipal bankruptcy in the history of the United States. Since the filing, the Bankruptcy Court has entered 22 orders, including orders (a) affirming that challenges to the City’s authorization to file bankruptcy may be brought only in the Bankruptcy Court, (b) establishing dates and procedures for challenges to the City’s eligibility under Chapter 9 of the United States Bankruptcy Code, (c) setting a deadline for the City to file a plan for the adjustment of the City’s debts, (d) directing the appointment of a committee of retired employees, and (e) appointing as mediator the Chief Judge of the District Court for the Eastern District of Michigan.

The following are some of the most critical of the many issues that will be decided in the City of Detroit’s Chapter 9 bankruptcy case:

1. Eligibility – Under Section 109(c) and 921(c) of the Code, the Bankruptcy Court may dismiss the Chapter 9 bankruptcy petition if the City did not file in good faith or if the petition does not meet the requirements of the Code. Several creditors are asserting that the Chapter 9 case should be dismissed because the City of Detroit (a) did not negotiate with creditors in good faith before the bankruptcy filing, (b) is not actually insolvent, and (c) was not properly authorized to file the Chapter 9 bankruptcy petition. The Bankruptcy Court has set an expedited timetable for determining eligibility issues, with trial scheduled to begin on October 23, 2013. In comparison, the eligibility of the City of Vallejo, CA was not finally determined until over a year after Vallejo’s Chapter 9 bankruptcy filing.

2. Retiree obligations – The City of Detroit estimates its unfunded pension liabilities at $3.5 billion, plus another $5.7 billion in other post-employment benefits. The City plans to treat these obligations as general unsecured debts subject to adjustment. The Bankruptcy Court has directed the United States Trustee’s Office to appoint a Committee of Retired Employees. The Michigan Attorney General, pension funds, and unions are also likely to oppose any cuts to the City’s pension obligations and have argued that the Michigan Constitution prohibits the City from taking any action to impair the City’s pension obligations.

3.Rejection of union contracts – The Bankruptcy Code permits the City to reject its collective bargaining agreements in bankruptcy. While collective bargaining agreements are granted heightened protection in corporate bankruptcy cases, Section 901 of the Code excludes these protections in Chapter 9 municipal cases.

4.General Obligation (“GO”) Bonds – The City owes approximately $530 million in GO Bond liabilities. GO Bonds are backed by the full faith, credit, and resources of the City of Detroit and are supported by the City’s taxing authority. The City has indicated that it will treat GO Bonds as general unsecured debts.

5.Sale of assets held by the Detroit Institute of Arts (“DIA”) – The City of Detroit has retained Christie’s Appraisals, Inc. to value the holdings of the DIA. While the City has not indicated that it plans to sell art work held by the DIA, the DIA has retained a law firm and has indicated that it would litigate in bankruptcy court to protect its holdings. The City may also be evaluating other City-owned cultural assets, including Belle Isle and the Detroit Zoo. Although a bill that sought to safeguard the DIA and other cultural assets did not pass the Michigan Legislature, the Michigan Attorney General issued an opinion before the Chapter 9 filing stating that the DIA art collection is held in a charitable trust for the people of Michigan and cannot be sold to satisfy Detroit’s debts.

6.Confirmation of a Plan of Adjustment – Section 941 requires that the City file a plan for the adjustment of the City’s debts at the time fixed by the Bankruptcy Court. The Bankruptcy Court has set March 1, 2014 as the deadline for the City to file its plan. If the plan is confirmed, creditors will be bound by the terms of the plan and the City will emerge from Chapter 9 bankruptcy with reduced debt obligations. To be confirmed, the City must propose a plan that complies with the requirements of the Code, including requirements that the plan must be (a) fair and equitable with respect to each class of creditors that have not accepted the plan, (b) feasible, and (c) in the best interests of creditors.

The Michigan Supreme Court recently held that account stated and open account actions are subject to the six-year limitations period provided by MCL § 600.5807(8), even when the actions are based on a debt stemming from the sale of goods. In Fisher Sand & Gravel Co. v. Neal A Sweebe, Inc., Case No. 143374 (Mich. Sup. Ct. July 30, 2013), Fisher sought payment for concrete supplies it provided to Sweebe on account. Sweebe countered that the Michigan Uniform Commercial Code’s four-year limitations period barred Fisher’s claims. The trial and appeals courts agreed with Sweebe and dismissed Fisher’s claims.

The Michigan Supreme Court reversed, holding that the actions did not fall within the scope of the UCC. According to the court, the UCC’s limitations period applies only to breach of contract claims involving the sale of goods. An action on an account stated is an action to enforce a subsequent promise to pay an account. Similarly, an open account claim "is an action to collect on the single liability stemming from the parties’ credit relationship regardless of the underlying transactions comprising the account." Neither involves the sale of goods. Accordingly, the UCC’s four-year period of limitations did not bar Fisher’s claims.

The first step in the bankruptcy process requires the City to prove that it is eligible for Chapter 9 protection. Eligibility requirements include the City of Detroit proving that it is insolvent and that it has negotiated in good faith with creditors but failed to obtain an agreement to effect a plan of adjustment. If Detroit is found ineligible to have filed a Chapter 9 bankruptcy, the bankruptcy court must dismiss the case.

The Michigan Court of Appeals recently held that Michigan courts may exercise jurisdiction over businesses that have engaged in a single past transaction in the state and that subsequently ceased doing business here. In Larsen Services, Inc v. Nova Verta USA Inc., Case No. 306280 (Mich. Ct. App. May 14, 2013), the trial court dismissed a plaintiff's complaint for lack of jurisdiction because the defendant was located in another state, was not registered in Michigan, did not regularly conduct business in Michigan, had no employees or property in the state, and the last significant contact with Michigan occurred in 2004.

However, the Michigan Court of Appeals reversed, holding that a Michigan court may exercise jurisdiction over a business that transacts any business within the state. "[T]he use of the term 'any' by our Legislature 'establishes that even the slightest transaction is sufficient to bring a corporation within Michigan's long-arm jurisdiction.'" In this case, two transactions with a company headquartered in Michigan several years ago allowed the court to exercise jurisdiction over the defendant.

The case indicates that courts are maintaining their long jurisdictional reach in an environment with increasingly mobile business models.

The Sixth Circuit recently held that a trustee and his attorneys were protected by quasi-judicial immunity from claims of malicious prosecution and abuse of process. In Grant, Konvalinka & Harrison, PC v. Banks (In re McKenzie), Case No. 12-5874 (6th Cir. May 24, 2013), the trustee unsuccessfully brought turnover and avoidance actions against GKH. After the actions were dismissed, GKH sued the trustee, arguing that the trustee’s earlier actions were wrongfully filed and lacked a reasonable legal basis. The bankruptcy court disagreed and dismissed GKH’s claims citing immunity.

On appeal, the Sixth Circuit ruled that a trustee is entitled to quasi-judicial immunity for actions taken on behalf of the estate that are within the scope of the trustee’s authority. Although the trustee may have filed the actions without a reasonable legal basis, he was acting on behalf of the estate and exercising his statutory authority when he brought the claims. Accordingly, the court affirmed the bankruptcy court’s decision.

The City of Detroit’s Emergency Manager, Kevyn D. Orr, submitted his Financial and Operating Plan on May 12, 2013. The Plan provides that its objectives are to ensure that Detroit is able to provide governmental services essential to the public health, safety, and welfare of its citizens and to assure the fiscal accountability and stability of the City. The report, which can be accessed through the following link, City of Detroit Financial and Operating Plan May 12, 2013 (00012913).pdf, states that Detroit "is clearly insolvent on a cash flow basis" (p. 26), and that "the City has effectively exhausted its ability to borrow" (p. 3).

While Mr. Orr indicates that he "has a solid foundation from which to build a comprehensive restructuring plan for the City" (p. 1), he has previously indicated that a Chapter 9 bankruptcy filing is a possibility.

In re Managed Storage International, Inc., 2012 WL 5921723 (Bankr. Del. 2012), the Delaware Bankruptcy Court held that a release given by a debtor in connection with a sale under § 363 of the Bankruptcy Code was binding upon a subsequently appointed Chapter 7 bankruptcy trustee. Managed Storage International, Inc. and affiliates ("Debtors") sold all of their assets free and clear of liens in a sale under § 363 of the Bankruptcy Code. The Debtors agreed to segregate proceeds of the sale of the collateral of one of its creditors, Avnet, Inc. When the Debtors failed to segregate the proceeds, Avnet filed a motion seeking turnover of its collateral from the purchaser of the assets.

Debtors settled with Avent and gave Avnet a general release. After Debtors’ cases were converted to chapter 7, the bankruptcy trustee filed a complaint against Avnet to avoid and recover over $5 million in preferences. Bankruptcy Judge Mary F. Walrath dismissed the complaint against Avnet. She held that the release given by the Debtors was binding on the chapter 7 trustee because (a) there was no "fraud, coercion, or mutual mistake" asserted by the trustee in connection with the release, (b) there was valid consideration given for the release, and (c) adequate notice of the release was provided

The Sixth Circuit has recognized a cause of action under Michigan law for aiding and abetting tortious conduct. In El Camino Resources Ltd v. Huntington National Bank, Case No. 12-1254 (6th Cir. April 8, 2013), the court addressed a claim for aiding and abetting a conversion. The Sixth Circuit held that, if faced with the opportunity to do so, the Michigan Supreme Court would adopt the approach of aiding and abetting as set forth in § 876(b) of the Restatement (Second) of Torts. That section requires (1) knowledge of wrongful conduct by the aider/abettor – which may be proven by circumstantial evidence – and (2) substantial assistance of the wrongful conduct by the aider/abettor.

The court affirmed the district court’s grant of summary judgment for Huntington Bank on the aiding and abetting a conversion claim, finding that Huntington had, at best, a strong suspicion of wrongdoing by its borrower, but no actual knowledge of its borrower’s fraud.

The United States District Court for the Eastern District of Michigan granted Wolfson Bolton’s client’s motions to dismiss two bankruptcy appeals. Following relief from the automatic stay in bankruptcy court, Debtor filed appeals to the District Court but never obtained a stay of proceedings. The Bank foreclosed on Debtor’s real properties and requested dismissal of the appeals on the grounds of mootness. The District Court agreed, dismissing Debtor’s two appeals because the Debtor’s failure to obtain a stay of proceeding and the Bank’s foreclosures eliminated the possibility of the District Court granting effective relief to Debtor on appeal. The case is In re: Asmar, Inc.Read a Copy of the Opinion Here

The court affirmed the district court’s grant of summary judgment for Huntington Bank on the aiding and abetting a conversion claim, finding that Huntington had, at best, a strong suspicion of wrongdoing by its borrower, but no actual knowledge of its borrower’s fraud.

The Bankruptcy Court for the Eastern District of Michigan recently issued an opinion restricting the use of 11 U.S.C. § 502(d) to object to and delay payment of administrative expense claims. In re Energy Conversion Devices, Inc., 2013 Bankr. LEXIS 536 (Bankr. E.D. Mich. Feb. 11, 2013). After confirmation of a liquidating plan, Ameri-Source Specialty Products filed a motion requesting allowance and immediate payment of an administrative expense under 11 U.S.C. § 503(b)(9) for steel delivered to the debtor within 20 days before the bankruptcy filing. The Liquidation Trustee objected, arguing that Ameri-Source had received pre-petition preferential payments avoidable under 11 U.S.C. § 547 and, therefore, the expense must be disallowed by application of 11 U.S.C. § 502(d) until resolution of the preference avoidance action and payment by Ameri-Source of any resulting judgment. The Trustee further argued that, even if section 502(d) did not strictly apply to bar Ameri-Source’s administrative claim, the Bankruptcy Court should still exercise its discretion to delay payment of the administrative expense until resolution of the preference action for the purpose of protecting the liquidating bankruptcy estate from any failure or inability by Ameri-Source to pay a future judgment.

Noting a split among courts, the Bankruptcy Court determined that Congress did not intend to limit allowance and payment of administrative expenses. Accordingly, the Bankruptcy Court held that section 502(d) does not bar any administrative expense, including pre-petition expenses arising under section 503(b)(9). The Bankruptcy Court also held that it had no discretion to delay payment of the administrative expense because payment was required both by the terms of the confirmed plan and by section 1129(a)(9)(A). The opinion leaves open the question whether a bankruptcy court would have discretion to delay payment of an administrative expense if there had been no confirmed plan.