Recent Bankruptcy Decisions from the Appellate Courts - August 2005



as published in the Norton Bankruptcy Law Advisor


In re Merrimac Paper Co., Inc.
--- F.3d ----, 2005 WL 2037416 (1st Cir. Aug. 25, 2005)
Holding:  Bankruptcy Court’s equitable subordination of stock repurchase note claim pursuant to § 510(c) was improper because equitable subordination must be decided on a case-by-case basis, and subordination in this case was based on the premise that all claims based on stock redemption notes must be subordinated.  The First Circuit further held that the individual circumstances did not warrant subordination because the claim was for a note for stock that had accrued as a retirement benefit.

Gitto v. Worchester Telegram & Gazette Corp. (In re Gitto Global Corp.)
--- F.3d ----, 2005 WL 2089973 (1st Cir. Aug. 31, 2005)
Holding:  Section 107(b)(2) provides an exception to the general rule of public access to information for “scandalous or defamatory” material.  Material that is potentially untrue and would cause a reasonable person to alter his opinion of an interested party falls within the exception only if the material is irrelevant or included within a bankruptcy filing for an improper end.  In this case, an examiner had been appointed to investigate pre-petition conduct of the debtor.  Some principals in the debtor company objected to the public filing of the examiner’s report, claiming that allegations of wrongdoing therein were general in nature and not supported by evidence.  The Court held that this made the report potentially untrue, but the report should still be available to the public because the material was relevant to the case and no improper purpose was shown. 

Liberty Mut. Ins. Co. v. Greenwich Ins. Co.
417 F.3d 193 (1st Cir. 2005)
Holding:  Section 365(e)(1) prohibition against ipso facto  clauses did not prevent debtor’s bankruptcy filing from triggering surety bond default and resulting liability of third-party bond issuer.


In re Siemon
--- F.3d ----, 2005 WL 2050108 (2d Cir. Aug. 26, 2005)
Holding:  Former debtor’s pro se  appeal of bankruptcy court’s denial of motion to reopen Chapter 13 case was proper because time limit for filing appeal pursuant to Bankruptcy Rule 8002(a) is jurisdictional.

Universal Oil, Ltd. v. Allfirst Bank (In re Millenium Seacarriers, Inc.)
--- F.3d ----, 2005 WL 1907016 (2d Cir. Aug. 11, 2005)
Holding:  A Bankruptcy Court may extinguish maritime liens on a vessel that was not voluntarily within the Court’s jurisdiction if the lien holders submit to the Court’s jurisdiction.  Admiralty law allows lienors to voluntarily submit to the equitable jurisdiction of a non-admiralty court.  The lien holders in this case submitted to the Bankruptcy Court’s equitable jurisdiction by filing proofs of claim, objecting to the sale of the vessel free and clear of their liens and actively litigating their liens in an adversary proceeding. 

O’Brien v. First Marblehead Educ. Res., Inc. (In re O’Brien)
--- F.3d ----, 2005 WL 1939704 (2d Cir. Aug. 15, 2005)
Holding:  Student loan debt guaranteed by a non-profit corporation is nondischargeable under § 523(a)(8) as a debt “made under any program funded in whole or in part by a . . . nonprofit institution.”  Although the guarantor did not provide any of the funds that were advanced to the borrower, it nonetheless “funded” the program through its commitment of its financial resources to support the program. 

Midland Cogeneration Venture Ltd. P’ship v. Enron Corp. (In re Enron Corp.)
--- F.3d ----, 2005 WL 1950271 (2d Cir. Aug. 16, 2005)
Holding:  Bankruptcy Court did not abuse its discretion in finding inexcusable creditor’s failure to file an amended claim before the bar date.  The creditor filed a timely claim but requested permission to amend its claim six months after the bar date.  The Bankruptcy Court found that the reason given for the delay – the heavy focus of creditor’s counsel on negotiations with debtor’s counsel concerning other issues – was not a genuine reason for delay.  Although a plan of reorganization was not submitted until several months later and a plan was not confirmed for more than a year after the creditor’s motion, the Court concluded that the amendment of the claim would disrupt the reorganization process.  Finally, even though the amended claim was outweighed 72,000 to 1 by other claims in the bankruptcy, the Court found that allowing the claim could prejudice the debtor by opening the floodgates for other late-filed claims given that 26% of creditors potentially held claims similar to those of this creditor.


In re Erie Forge & Steel, Inc.
418 F.3d 270 (3rd Cir. 2005
Holding:  Employees were bound by stipulation agreed to by their union, even if a letter from the union’s counsel to the employees implied that the union did not represent them.  The plain language of § 1114(c)(2) provides that a union’s status as an authorized representative cannot be changed except upon motion, notice, and a hearing, none of which occurred.

In re Schick
418 F.3d 321 (3rd Cir. 2005)
Holding:  New Jersey Motor Vehicles Commission’s surcharge and interest lien was a statutory lien and not a judicial lien because the lien arose solely by statute, and the function of the Clerk of the Superior Court in recording the lien as required by statute was insufficient to constitute a judicial process or proceeding pursuant to § 101(36).  As a statutory lien as opposed to a judicial lien, it could not be avoided pursuant to § 522(f)(1).

In re Thompson
418 F.3d 362 (3d Cir. Aug. 11, 2005)
Holding:  Despite the contrary result required by a literal reading of § 523(a)(7), the Bankruptcy Court properly held as nondischargeable a state criminal restitution debt requiring payment to the victim.  The judicial tradition which supports such a departure from the text of the Code in favor of federalism has been endorsed by the Supreme Court in Kelly v. Robinson and by Congress in its acquiescence.

In re Owens Corning
--- F.3d ----, 2005 WL 1939796 (3d Cir. Aug. 15, 2005)
Holding:  District Court erred in granting substantive consolidation of eighteen debtor entities and three non-debtor entities.  There was no pre-petition disregard of corporate separateness nor any hopeless commingling of assets post-petition.  Moreover, the proposed “deemed” consolidation – in which the assets and liabilities of the separate entities are treated, for plan purposes, as if the entities were merged but in fact remain separate – was nothing more than a stratagem to use consolidation offensively to eliminate certain guarantees and favor certain creditors.

Dobrek v. Phelan
--- F.3d ----, 2005 WL 1963036 (3d Cir. Aug. 17, 2005)
Holding:  The bail bond debts of a commercial surety are nondischargeable.  The debtor was an agent for insurance companies that underwrote the obligations of bail bondsmen.  Bail bondsmen agree to pay the bail of criminal defendants in the event those defendants do not appear.  State law prevents agents from writing future bonds until existing bail forfeiture judgments are satisfied.  The Court held that the debtor could be prohibited, under this rule, from writing future bonds based on pre-petition bail forfeiture judgments.  Such judgments are “forfeitures” and, thus, are nondischargeable under § 523(a)(7).


Brown v. Chesnut (In re Chesnut)
--- F.3d ----, 2005 WL 1995385 (5th Cir. Aug. 19, 2005)
Holding:  Creditor willfully violated the automatic stay when it foreclosed on property knowing of the debtor’s bankruptcy and the debtor’s assertion that the property belonged to the estate.  At the time the petition was filed, the debtor scheduled the property as community property because it had been bought with community funds.  The debtor’s rights in the property were unclear because it was titled solely in the name of the debtor’s spouse.  Even though a court later determined that the property did not belong to the estate, the creditor nonetheless was required to pay a fine and attorney’s fees because the property was “arguable property” at the time of the foreclosure.


In re American Homepatient, Inc.
--- F.3d ----, 2005 WL 1949548 (6th Cir. Aug. 16, 2005)
Holdings: (1) The Sixth Circuit upheld a cram-down interest rate of 6.785% because the rate was what the market rate of interest would be, and because the 12.16% rate proposed by the lenders was too high on its face, at nearly eight percentage points higher than prime.  The Sixth Circuit took the position that in a Chapter 11 case, Till  requires a cram-down rate to be determined in accordance with the market rate for similar loans, or if there is no efficient market, by the formula approach endorsed by the plurality in Till.  (2) Prior to reaching the merits, the Sixth Circuit denied the appellee’s motion to dismiss the appeal as equitably moot.  In doing so, the Court adopted the Fifth Circuit equitable mootness test regarding an appeal of a bankruptcy plan.  The factors are whether the appellant obtained a stay pending appeal, whether the plan has been substantially consummated, and whether the relief requested would affect either the rights of parties not before the court or the success of the plan, with the last factor being the most important.  Despite the fact that appellant had not obtained a stay and that the plan had been substantially consummated, the appeal would not be dismissed as moot, because appellant raised a plausible argument that the relief requested would not affect the success of the plan. 

Schilling v. Hearvin (In re Triple S Restaurants, Inc.)
--- F.3d ----, 2005 WL 2076636 (6th Cir. Aug. 30, 2005)
Holding:  Bankruptcy Court did not err in avoiding debtor company’s transfer of ownership of life insurance policy to a trust created by the company co-founder.  The insurance policy proceeds had been assigned to a lender but ownership of the policy remained with the company until it was transferred to the trust.  After the death of the co-founder, the trust beneficiaries negotiated with the lender to receive a portion of the policy proceeds.  The beneficiaries argued that the transfer of policy ownership was not a fraudulent transfer because the company never had the right to receive any policy proceeds, so unsecured creditors were not defrauded by the transfer.  The Court found contradictory evidence consisting primarily of the payment of some policy proceeds to the trust, which suggested that the lender was not unconditionally entitled to all policy proceeds.  The Court also held that the Bankruptcy Court did not err in shifting the burden of proof to the trust beneficiaries based on badges of fraud – the beneficiaries being children of the company co-founder and one beneficiary being a company insider.

Bear Stearns Gov’t Sec., Inc. v. Dow Corning Corp. (In re Dow Corning Corp.)
--- F.3d ----, 2005 WL 2000376 (6th Cir. Aug. 22, 2005)
Holding:  Liquidated damages that are uncollectible under state law may not be recovered as a claim in bankruptcy.


Disch v. Rasmussen
417 F.3d 769 (7th Cir. 2005)
Holding:  Bankruptcy Court did not abuse its discretion in allowing creditor to amend its § 523 discharge exception complaint to include a § 727 nondischarge claim, despite the passage of the deadline for filing a § 727 complaint pursuant to Bankruptcy Rule 4004 and the entry of an order granting the debtor a general discharge.  The Bankruptcy Court had authority to vacate its prior discharge order pursuant to Bankruptcy Rule 9024 and Fed. R. Civ. Proc. 60, regardless of the grounds for revocation of discharge under § 727(d).  The Court had authority to allow the late-filed § 727 claim pursuant to Bankruptcy Rule 7015 and Fed. R. Civ. Proc. 15, because the relevant issues had already been raised in § 523 complaint.


Integrated Health Services of Cliff Manor, Inc., et al. v. THCI Company, LLC
417 F.3d 953 (8th Cir. 2005)
Holding:  Transfer of a removed state court action to the District of Delaware and denial of motion to enjoin Delaware litigation were not abuses of discretion by the Western District of Missouri when the lease obligations at issue in the Missouri action were already at issue in a bankruptcy appeal pending before the District of Delaware.  The Eighth Circuit retained jurisdiction over the appeal despite the transfer because the appellant filed its Notice of Appeal before the Delaware court physically received the file.


Beck v. Fort James Corp. (In re Crown Vantage, Inc.)
--- F.3d ----, 2005 WL 2077551 (9th Cir. Aug. 30, 2005)
Holding:  Leave of the bankruptcy court must be obtained before an action can be initiated in another forum against the trustee of a liquidating trust created as part of a plan of reorganization.

Smith v. Arthur Andersen LLP
--- F.3d ----, 2005 WL 2077679 (9th Cir. Aug. 30, 2005)
Holding:  Trustee has standing to assert against debtor’s officers, directors, securities underwriters and auditors claims for breach of contract and fiduciary duty on behalf of company.  The trustee’s claims were based on a theory of deepening insolvency, and the Court held that these claims were being asserted on behalf of the company, not creditors.