Circuit Splits

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Another solid opinion from the Bankruptcy Court for the Northern District of Illinois, this time in In re Mid-City Parking, Inc., 2005 WL 2857728 (Bankr.N.D.Ill, 10/31/05). In this case, Mid-City (the debtor in possession or “DIP”) filed a petition for relief under chapter 11. Subsequent to the filing, the DIP appealed a judgment that had been entered against it prepetition in favor of Clark Polk Land, LLC (“Clark Polk”). Notably, the DIP did not seek to modify the stay under section 362(d) in advance. Clark Polk shrewdly filed a motion in the state court to dismiss debtor’s appeal, arguing that the appeal violated the automatic stay. The Illinois Appellate Court granted Clark Polk’s motion. Not satisfied leaving well enough alone, Clark Polk then filed a motion in the DIP’s bankruptcy case seeking costs and attorneys’ fees related to the effort to seek dismissal of the appeal. The Bankruptcy Court undertook an extensive analysis of two central unsettled questions which have generated significant splits among the circuits:

1. Does a bankruptcy court have exclusive jurisdiction over whether a state court proceeding is subject to the automatic stay?
2. Can the trustee or debtor in possession unilaterally waive the protections of the automatic stay “with acts of estate administration that would otherwise violate 11 U.S.C. § 362(a) if performed by anyone else”?

After an extensive review of applicable law, Judge Jacqueline Cox answers the first question by choosing the first of three distinct approaches taken by various courts (including an earlier case from the same district that had selected the second of the three alternative approaches):

(A) the bankruptcy and state courts have concurrent jurisdiction to determine jurisdiction, with the bankruptcy court having the final say;
(B) the bankruptcy court has exclusive jurisdiction (and thus the state court ruling has no legal effect);
(C) the bankruptcy and state courts have concurrent jurisdiction to determine jurisdiction, but a prior state court ruling strips the bankruptcy courts of jurisdiction under the Rooker-Feldman doctrine. [Ed. Note: Though the Bankruptcy Court did not raise this, consider whether another ground for rejecting this third approach is the US Supreme Court’s unanimous ruling last term in Exxon Mobil Corp. v. Saudi Basic Indus. Corp., 125 S.Ct. 1517 (2005), which held that the Rooker-Feldman doctrine could not be invoked in cases involving concurrent or parallel state and federal court proceedings.]

The Court answered the second question in the affirmative, stating:

A Chapter 11 debtor-in-possession or case trustee may waive the protections afforded by § 362(a) when the actions that would otherwise violate the stay are in furtherance of his statutory duties of administering the bankruptcy estate, including appealing judgments against the debtor’s estate in nonbankruptcy forums. In so holding, this Court approves the result reached by the U.S. Court of Appeals for the Tenth Circuit and the Indiana Supreme Court rather than that reached by the First Circuit and the Ninth Circuit. Until a debtor-in-possession or trustee takes affirmative action showing an intent to prosecute the appeal of a judgment claim, however, an appeal from a judgment against the debtor’s estate is stayed pursuant to § 362(a)(1).

In support of this conclusion, the Court provides a thoroughly researched analysis, much of which follows:Continue Reading Illinois Bankruptcy Court Addresses Circuits’ Split Regarding a State Court’s Jurisdiction Over the Automatic Stay’s Applicability and a Debtor’s Right to Unilaterally Waive the Automatic Stay’s Protections

In Allen v. J.K. Harris & Co, LLC, 2005 WL 2600205 (E.D. Pa., 10/12/05), a state court consumer class action seeking damages based on unfair trade practices was removed by the defendants to federal district court following the plaintiff/debtor’s filing of a chapter 13 petition for relief. The plaintiff/debtor then moved to remand the case back to state court.
The district court considered whether abstention is mandatory under 28 U.S.C. § 1334(c)(2), which says that courts “shall abstain” from exercising jurisdiction over an adversary proceeding where a party timely moves for abstention based on a state law claim that does not arise in the bankruptcy case and could be “timely adjudicated” in the state forum.
In noting the split among the circuits as to whether the doctrine of mandatory abstention can be applied to an already removed case, the Court (indicating that the Third Circuit has not decided the matter) sided with the majority view that the doctrine of mandatory abstention may be applied to a removed proceeding. The Court stated:Continue Reading Mandatory Absention of a Removed State Court Action: A New Case Reviews the Split Among the Circuits

Back in the early to mid-1990’s, while Conseco’s profligate CEO, Steve Hilbert, was on his way to becoming America’s highest paid CEO (with a whopping $277 million between 1991 and 1996), Hilbert was (forever?) smitten with the lovely 25 year old Indy stripper Tomisue Tomlinson as she jumped out of a cake at his stepson’s bachelor party.
Unlike Hilbert’s five previous marriages, this one has survived the test of time (and loss of money). Conseco’s bankruptcy appears to have joined them at the hip (or maybe the prepetition asset transfer to Tomisue did), as evidenced by a recently decided case in Conseco’s post-confirmation bankruptcy saga, here involving the rights of the Hilberts’ “irrevocable trusts” to four “split-dollar” life insurance agreements established in 1998. In re Conseco, 2005 WL 2737507 (N.D. Ill., 10/18/05).
Under these self-dealt policies, Conseco agreed to pay annual premiums owing under the policies (worth between $12.5 million and $25 million each). The Hilberts were also required to pay a portion of the policy premiums (presumably the minimum required to maximize tax benefits). If the Hilberts failed to pay their portion, the trusts could pay on their behalf. The Court noted that the Agreements had early termination provisions if Conseco went bankrupt, or if the Hilberts or their trusts failed to pay Conseco a share of the premiums. Upon termination, the trusts could repurchase the policy from Conseco by reimbursing Conseco for premium payments made. If, within 60 days, the trusts did not exercise this repurchase option, Conseco could either become the owner of the policy or surrender the policies and get its premium payments back.
In December 2001, Conseco stopped making payments on the insurance policies, believing the Hilberts owed Conseco millions of dollars in defaulted D&O loans. Apparently, after Conseco stopped making payments, the trusts responded by converting the policies into paid-up policies with lower death benefits so that no further payments were due under the insurance policies.
One year later, Conseco filed for bankruptcy, and on September 10, 2003, it’s reorganization plan went effective. Notably, neither the Hilberts nor their trusts exercised their option to purchase the policies from Conseco within 60 days of the bankruptcy filing, but rather filed claims against Conseco in the bankruptcy case seeking damages for alleged breach of the Agreements. (Perhaps they were thrown off by the ipso facto clauses in the Agreements that provided for termination in the event of bankruptcy, which every bankruptcy lawyer knows will not alone terminate an executory contract.)
The trusts asserted in their proofs of claims that Conseco’s bankruptcy filing did not terminate the Agreements. Conseco objected to the claims, smartly asserting that the Agreements were not executory, and thus were terminated because neither the Hilberts nor the trusts exercised their option to purchase the policies from Conseco within 60 days of the bankruptcy filing (the ipso facto clause notwithstanding). In September 2004, Conseco’s attorneys advised the trusts that the Agreements were terminated and that Conseco intended to enforce its rights to recoup the premium payments made. Counsel for the trusts responded that the trust “would consider your taking of the cash value of the policies not only to be an additional breach of the [Agreements], but also to be conversion as well.”
The Bankruptcy Court, however, disagreed with the trust counsel’s assessment, holding that the Agreements were not “executory contracts” under Bankruptcy Code section 365, and thus were automatically terminated when Conseco filed for bankruptcy in December 2002. The Bankruptcy Court also found that “because Conseco was not attempting to enforce a contract, its material breach of the Agreements in December 2001, when it stopped making premium payments, was of no consequence.”
The District Court, reviewing the bankruptcy court’s rulings and conclusions of law de novo, ruled that the bankruptcy court correctly adopted the “Countryman definition” of an exectuory contract as one in which “the obligation of both the bankruptcy and the other party are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance by the other.” (Citing Vern Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn L. Rev. 439, 460 (1973)). The District Court also concurred with the Bankruptcy Court’s logical extension of the Countryman definition in concluding that “if any of the parties’ duties is deemed immaterial, then the contract is deemed not executory.”
As regards whether a contract is “executory,” the District Court noted the split in the circuits between the majority Countryman “material breach” test and the minority “functional test” (with the Seventh Circuit following the Countryman definition), stating as follows:Continue Reading What Makes a CEO Perk Executory and the Circuits’ Split Over the Definition of an Executory Contract

[This is the first of many posts highlighting cases that touch on the splits among the federal circuit courts on various topical bankruptcy issues.]
“Hell hath no fury like a lover scorned” is a well-known epithet that comes to mind when reading the Tenth Circuit’s recent opinion in Cadwell v. Joelson (In re Joelson), (2005 WL 2722891) (10th Cir., 10/24/05). The case recounts how Stan Cadwell (a retired single man from Casper, Wyoming) met Joelene Joelson (a waitress) in a Casper “cafe” where Joelene worked. Stan took out a mortgage on his house for $50,000 for the benefit of his erstwhile lover, but not until after he had performed some due diligence of his own into Joelene’s claims to ownership of a sizable, though illiquid, estate. When the affair ended, and Joelene didn’t repay her debt, Stan sued Joelene in Wyoming state court on the $50,000 he had given her. Joelene demurred, saying it was but a gift from her former lover, but the state court disagreed, and entered judgment against Joelene. She later filed a petition for chapter 7 relief.
Stan proved that “hell hath no fury like a [Cadwell] scorned” and filed an adversary proceeding in the bankruptcy court seeking to bar the discharge of all of Joelene’s debts (or, at a minimum, his state court judgment). The bankruptcy court would not deny the discharge of all of her debts, but did agree that Stan’s claim was non-dischargeable under Bankruptcy Code section 523(a)(2)(A). This section states that a debt obtained by “false pretenses, a false representation, or actual fraud” is nondischargeable, subject to this important exception: if a debt is obtained by a false oral “statement respecting the debtor’s … financial condition,” the debt is dischargeable. Conversely, under Bankruptcy Code section 523(a)(2)(B), a debt obtained by a false written statement “respecting the debtor’s … financial condition” is nondischargeable, provided certain conditions are met.
In finding the debt to Stan nondischargable, the bankruptcy court found actionable Joelene’s misrepresentations to Stan that she owned “residences in both Casper and Glendo, a motel in Glendo, and a number of antique vehicles stored in Glendo.” On appeal, the BAP affirmed the ruling of the bankruptcy court, holding that some of Joelene’s misrepresentations to Stan were not statements “respecting [her] financial condition,” thus rendering her debt to Stan nondischargable.
The case is notable for its exceptional analysis of the roots of § 523(a)(2) (whose origins are found in the Bankruptcy Act of 1898) and the prevailing split in the circuits on the meaning of the phrase “respecting the debtor’s … financial condition.” In affirming the ruling of the lower courts, the Tenth Circuit outlined the respective legal positions of Stan and Joelene, and concluded that Stan’s “strict interpretation” of the phrase was “most consistent with the text and structure of the Bankruptcy Code, Congress’s intent as expressed in the legislative history of 11 U.S.C. § 523(a)(2)(A) and (B), and case law,” stating:Continue Reading Hell Hath No Fury Like a Lover Scorned: Stan, Joelene, and the Circuits’ Split Over the Section 523(a)(2) Discharge