[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

Last night, the Chicago White Sox swept the World Series, bringing great joy to much of Chicago (except for Cub fans, whose Cubbie blue is turning a shade of pale-green from all the jealousy). Even the most dogged Cub fan has to admit that the White Sox played incredible baseball. Congratulations to the entire organization and to all the long-suffering White Sox fans!
© Steve Jakubowski 2005
Speaking of long-suffering… In a recent post, I noted the inequity of the “all or nothing” rule of Moore v. Bay, 284 U.S. 4 (1931), which provides that a transfer avoidable by a bankruptcy trustee as to a single creditor (even as to just a nickel), is avoidable to the entire extent of the transaction (even if the transaction is worth millions). Unlike today’s weighty US Supreme Court opinions, Moore v. Bay is only one page. It’s author was none other than Justice Oliver Wendell Holmes, Jr., who wrote the opinion at the end of his rich life, while in his last term on the bench. You can’t say much in one page; and Justice Holmes didn’t, to be sure. Still, the rule of Moore v. Bay staunchly remains the law of the land.
Having brought up the case only in passing in my previous post, I said that my discussion of Moore v. Bay will have to await another day. With the Bankruptcy Court from the Northern District of Illinois in In re Unglaub, (2005 WL 2740595) (Bankr. N.D. Ill., 10/24/05), reminding us recently that the rule of Moore v. Bay remains the law of the land, it looks like today is that day. In Unglaub, the Bankruptcy Court stated matter of factly:

In a case under § 544(b)(1), the trustee has the rights of an unsecured creditor to avoid transactions that can be avoided by such creditor under state law. In re Image Worldwide, Ltd., 139 F.3d 574, 576-77 (7th Cir. 1998). The trustee need not identify the creditor, so long as an unsecured creditor exists. Id. at 577; In re Leonard, 125 F.3d 543, 544 (7th Cir. 1997). The transaction can be avoided completely even if the trustee cannot produce creditors whose liens total more than the value of the property. Leonard, 125 F.3d at 544-45.

Though the Bankruptcy Court did not expressly cite Moore v. Bay, it effectively did so by citing to Leonard, where the Seventh Circuit said this about Moore v. Bay:

Section 544(b) of the Bankruptcy Code of 1978 gives the Trustee the power to “avoid any transfer of an interest of the debtor in property … that is voidable under applicable law by [an unsecured creditor]”. 11 U.S.C. § 544(b). In other words, if any unsecured creditor could reach an asset of the debtor outside bankruptcy, the Trustee can use § 544(b) to obtain that asset for the estate. As part of the estate, that asset is then divided among all the unsecured creditors, not just the creditor who could have reached the asset outside bankruptcy. Barker and Lieblich complain that the Trustee has not articulated the specific creditor who could set aside Zach’s gift, but a trustee need not do so. Thirteen unsecured claims have been filed; the Trustee can assume the position of any one of them. Unless the claims of Barker and Lieblich are secured, any unsecured creditor may pursue a fraudulent-conveyance action under Illinois law. Even if he cannot point to creditors whose claims total more than the value of the land, the Trustee can avoid the transaction entirely. Moore v. Bay, 284 U.S. 4, 52 S.Ct. 3, 76 L.Ed. 133 (1931). The whole value of the asset then is distributed among creditors of the estate. 11 U.S.C. § 551. The wisdom of this approach has been questioned, see Douglas G. Baird, The Elements of Bankruptcy 104 (2d ed. 1993); Thomas H. Jackson, The Logic and Limits of Bankruptcy Law 79-83 (1986), but this entrenched rule is the source of the dilution that Barker and Lieblich want to escape.

While the application of Moore v. Bay didn’t appear to affect the outcome of the case before the Bankruptcy Court in Unglaub, it surely could have. Which leads to a simple question, why should a transaction that is not voidable as to certain creditors become avoidable in its entirety merely because the debtor happens to be in bankruptcy?
It’s always easier to follow a rule then to work to change it, but this law needs to be changed. Perhaps someday the rule of Moore v. Bay will become a relic of the past, just as the “no-World-Series-win-in-my-lifetime” is now, happily, a thing of the past on Chicago’s south side. Go Sox!
Steve Jakubowski

Bankruptcy Code section 1109(b) gives a “party in interest” the right to raise, and appear and be heard on, any issue in a chapter 11 case. Two recent cases involving insurers of debtors in mass tort asbestos-related bankruptcies came to different conclusions as to whether insurers have standing to object to issues arising in the bankruptcies of their insureds. In In re Congoleum Corp., (2005 WL 2559715) (3d Cir., 10/13/05),the Third Circuit held that a debtor asbestos-manufacturer’s insurers had standing to challenge the retention of Gilbert, Heintz & Randolph, LLP as special insurance counsel under Bankruptcy Code section 327(e). Conversely, in In re A.P.I., Inc., (2005 WL 2630662) (Bankr. D. Minn., 10/15/05), the Bankruptcy Court found that the insurers lacked standing to object to confirmation of the debtor-insured’s asbestos-related plan because plan confirmation would not have any material collateral impact on pending state court insurance coverage litigation between the insurer and the debtor-insured.
It’s not easy to reconcile these two cases: the insurers in Congoleum are granted standing; the insurers in A.P.I. are not. Still, both opinions seemingly yielded the “better” result. In A.P.I., by denying standing to the insurers, 83 thorny objections to the plan were eliminated, thus clearing the way to confirmation. Conversely, in Congoleum, granting the insurers standing enabled them to expose cozy relationships among law firms on opposite sides of the table, thus giving the Third Circuit an opportunity to deliver a stern message regarding professional responsibilities in bankruptcy. Still, the A.P.I. case is so strong for asbestos debtors trying to prevent insurers from gaining standing in bankruptcy that one has to wonder whether this case will lead to Minnesota’s bankruptcy court becoming the “Delaware” (i.e., the preferred venue) of asbestos bankruptcies.
Summaries of these two cases follow:

Continue Reading An Insurer’s Standing in Mass Tort Bankruptcy Cases: Finding the Right Rule and/or Reaching the Right Result

Here’s our weekly roundup of significant recently decided cases involving complex bankruptcy disputes for the week ended 10/23/05.
In re Safety-Kleen, (2005 WL 2656399) (Bankr. D. Del., 10/19/05)
Illinois Department of Revenue v. Hayslett/Judy Oil, Inc., (2005 WL 2649994) (7th Cir., 10/18/05)
Boyer v. Gildea, (2005 WL 2648673) (N.D. Ind., 10/17/05)
SEC v. Great White Marine & Recreation, Inc., (2005 WL 2604454) (5th Cir., 10/14/05)
Dunlap v. Friedman’s, Inc., (2005 WL 2561470) (S.D. W. Va., 9/30/05)
In re American Tissue, Inc., (2005 WL 2574014) (Bankr. D. Del., 9/27/05)
In re XO Communications, Inc., (2005 WL 2319155) (Bankr. S.D.N.Y., 9/23/05)

Continue Reading Notable Reported Cases for the Week Ended 10/23/05

Many lawyers and clients unfamiliar with the upside-down world of avoidance litigation tend to think that traditional rules of setoff should govern the resolution of avoidance action litigation: “the debtor’s entitled to “x”; the creditor’s entitled to “y”; net-net….” As the Fourth Circuit reminds us in In re Coleman, (2005 WL 2665798) (4th Cir., 10/20/05), avoidance litigation often starts with a more “all or nothing” approach.
The case reminds me of another classic “all or nothing” type case that often trips people up: Moore v. Bay, 284 U.S. 4 (1931). Unlike today’s weighty US Supreme Court opinions, Moore v. Bay is only one page. Apparently that’s all Justice Oliver Wendell Holmes (then about 90 and one year from retirement) had the strength to say about the topic. Subject to some important nuances, that case is generally understood to mean that a transfer avoidable by a bankruptcy trustee as to a single creditor (even as to just a nickel), is avoidable to the entire extent of the transaction (even if the transaction is worth millions). This is as inequitable a result as one gets in bankruptcy, and if any bankruptcy case deserves to be reviewed again by the US Supreme Court it’s Moore v. Bay, but that’s a discussion for another day.
In the Fourth Circuit’s Coleman case, a bank initiated foreclosure proceedings against a debtor’s home, which was stayed by the debtor’s chapter 11 filing on the day before the planned foreclosure sale. The Fourth Circuit described the interesting procedural posture of the case as follows:

Continue Reading Avoidance Actions Are All or Nothing, the Fourth Circuit Rules

Summers v. UAL Corporation, et al., (2005 WL 2648670) (N.D. Ill., 10/12/05), pitted the United Airlines ESOP participants against the plan trustee, State Street Bank and Trust Company, among others. In their complaint, the plaintiffs claimed that when UAL’s stock prices declined prior to UAL’s filing for bankruptcy, the UAL ESOP Committee, State Street Bank (the plan trustee), and others failed to take appropriate action to protect plan assets (e.g., by diversifying the ESOP’s stockholdings and shedding UAL shares). All defendants except State Street Bank settled.
Plaintiffs and State Street filed cross-motions for summary judgment, and State Street Bank moved to strike or exclude the opinions and testimony of Plaintiffs’ expert witness, Lucian Morrison (“Morrison”), who opined that “UAL’s bankruptcy was imminent in October 2001, and that Defendants failed to act prudently by neglecting to sell the UAL stock to protect the interests of the Plan participants.” United’s bankruptcy imminent in October, 2001? Doesn’t sound too unreasonable if you were in the bankruptcy or turnaround business at the time, does it? Now just try and prove it!
In granting State Street’s motion to exclude the Morrison’s opinion, Judge Deryeghiayan reminded us that “the district court acts as a ‘gatekeeper with respect to testimony proffered under Rule 702 to ensure that the testimony is sufficiently reliable to qualify for admission,’ ” and opined:

Continue Reading Expert’s “Half-Baked” Opinions Thrown Out in Action Against UAL’s ESOP Trustee

As people in the oil & gas business know, some wells never go dry. The IPO allocation shareholder litigation, which spawned hundreds of shareholder suits against investment banks who had improperly allocated shares in hot IPO’s to favored investors, is one such well that is now yielding tangible benefits for bankruptcy estates. In In re Quintus Corp, (2005 WL 2594600) (Bankr. D. Del. 10/13/05), the Bankruptcy Court for the District of Delaware, recently refused to dismiss a chapter 11 trustee’s complaint against Donaldson, Lufkin & Jenrette Securities Corporation. In Quintus, the trustee’s complaint alleged that DLJ caused the stock issued in Quintus’ 1999 IPO to be underpriced because it was simultaneously allocating the underpriced shares to favored clients who, in exchange, would share part of their profits with DLJ through side agreements. Notably, the Court in Quintus refused to dismiss any counts of the Complaint, which alleged not only breach of fiduciary duty, but also breach of the covenant of good faith and fair dealing, breach of contract, fraud and fraudulent concealment, negligence, and unjust enrichment.
This case represents another recent victory for bankruptcy estates in actions against securities underwriters who underpriced and misallocated an issuer’s IPO shares during the high-tech boom of the late 1990’s. Recently in EBC I Inc. v. Goldman Sachs & Co., (2005 WL 1346859) (N.Y., 6/7/05), for example, the New York Court of Appeals, in a case of first impression, held that a valid claim for breach of fiduciary duty had been asserted against Goldman Sachs, the lead underwriter in eToys’ IPO. There, the Court stated that when Goldman set the IPO price of eToys’ stock, it had a duty to advise eToys of conflicts of interest stemming from an alleged scheme that resulted in Goldman netting millions of dollars in kickbacks from clients who had flipped the debtor’s discounted stock into the market at a windfall. This case, brought by the Creditors’ Committee in the eToys bankruptcy case, is also notable because the New York Court of Appeals held that the complaint failed to state a claim for breach of contract, professional malpractice, or unjust enrichment. As such, unlike the Bankruptcy Court in Quintus, the Court in EBC I narrowed the complaint to a single breach of fiduciary duty count based on Goldman’s role as adviser in setting the IPO price, while simultaneously failing to disclose its relationships with clients to whom it had allocated the discounted shares.
© Steve Jakubowski 2005

While I’ve spent quite of bit of time bashing BAPCPA, it’s not all bad. One change, for example, that was long overdue was an amendment to the Bankruptcy Code that addressed the so-called “Deprizio problem,” a problem the drafters of the Code’s amendments in 1994 thought they had resolved once and for all.
In In re ABC-Naco, (2005 WL 2649305) (Bankr. N.D. Ill., 10/13/05), Judge Wedoff, Chief Judge of the Bankruptcy Court for the Northern District of Illinois, in addressing a challenge to the constitutionality of BAPCPA’s Deprizio amendment, first succinctly summarized the purpose of the amendment, and then affirmed its constitutionality.
For those contemplating constitutional challenges to BAPCPA based on violations of the Takings and Due Process Clauses of the US Constitution, this case is worth reading as it well demonstrates the challenges facing the litigant who contests garden variety amendments to BAPCPA like the “Deprizio amendment.” (See also, Erwin Chemerinsky, Constitutional Issues Posed in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, 79 Am. Bankr. L. J. 571 (2005) (“identify[ing] the constitutional issues most likely raised by BAPCPA”)).
Excerpts from the Court’s opinion follow:

Continue Reading Bankruptcy Court Affirms Constitutionality of BAPCPA’s Deprizio Amendment

In the first case to address who is (or is not) a “debt relief agency” under BAPCPA, an important question given the “new and significant restrictions on the activities of debt relief agencies,” Judge Lamar W. Davis, Chief Bankruptcy Judge of the Bankruptcy Court for the Southern District of Georgia, ruled sua sponte on October 17, 2005, BAPCPA’s effective date, that attorneys who are members of the bar of that court, as well as those admitted pro hac vice, are not “debt relief agencies” within the meaning of BAPCPA, so long as their activities fall within the scope of the practice of law and do not constitute a separate commercial enterprise. In re Attorneys at Law and Debt Relief Agencies, (2005 WL 2626199) (Bankr. S.D. Ga. 10/17/05). The matter raises interesting “case or controversy” issues, as it’s not exactly clear what specific situation(s) the Court was addressing, other than the obvious theoretical ones. Still, it’s hard to imagine anyone challenging or disagreeing with this opinion and order. You have to wonder whether this Court’s proactive style will catch on elsewhere.
Without explicitly casting aside “plain meaning” canons of statutory construction, the Court drew support from a wealth of current critical commentary on the topic in rejecting the plain meaning of BAPCPA’s relevant provisions (which seemingly include attorneys within BAPCPA’s definition of “debt relief agencies”), stating:

Continue Reading Georgia Bankruptcy Court Rules Sua Sponte that Attorneys Admitted to Practice in the District are Not “Debt Relief Agencies” Under BAPCPA

Multi-Year Litigation Seeking $17 Million in Damages Ends With $150,000 Settlement

FRIEDRICHSDORF, Germany, Oct. 17, 2006 (PRIMEZONE) — AM GmbH, a privately held German company, today announced that a federal bankruptcy court in Chicago has approved a settlement between the bankruptcy litigation trust of Chinin USA, Inc. and the company concerning financing services provided by AM GmbH to Chinin between 1992 and 1997. AM GmbH paid $150,000 in the settlement in exchange for a complete release of all possible claims against the company and its founders. The bankruptcy court order approving the settlement is now final and non-appealable, and the case was dismissed with prejudice yesterday by stipulation of the parties.

 

"Our position since the beginning has been that the litigation lacked merit. This settlement provides a resolution to a matter that had become a significant nuisance over a several-year period and we look forward to more productive use of management’s time," said Arnold Mattschull, chairman and president of AM GmbH.

Steve Jakubowski of The Coleman Law Firm, based in Chicago, represented AM GmbH in the litigation.

About AM Group

The AM Group produces "ready-to-wear" clothing from designs with modern machinery, trained skilled employees, and effective logistics with a total capacity of more than one million garments per month. The AM Group currently operates four state-of-the-art production facilities in India, Sri Lanka, and China with more than 2,400 employees. Additional information is available at www.AM-Fashion.com

CONTACT:  Maier & Company, Inc.
Gary S. Maier/Crystal Warner
(310) 442-9852

© Steve Jakubowski 2005