Recent Bankruptcy Decisions from the Appellate Courts - June 2007



Reprinted from the Norton Bankruptcy Law Adviser, with permission of Thomson/West. For more information about this publication please visit


In re Capitol Food Corp. of Fields Corner
--- F.3d. ----, 2007 WL 1616646 (1st Cir. June 6, 2007)
Holding:  Bankruptcy court's denial of motion to dismiss Chapter 11 petition on the ground that it was not filed in good faith was appropriate.  Landlord filed a motion pursuant to § 1112(b) to dismiss Chapter 11 case, alleging that solvent lessee filed voluntary Chapter 11 petition in bad faith, expressly to avoid forfeiture of a below-market rate lease.  Lease permitted landlord to terminate lease if lessee stopped operating a business on the premises for 30 days.  Sublessee closed business, and lessee was unable to reopen business before expiration of 30 day period.  Lessee filed Chapter 11 petition on 31st day.  Even though the debtor was solvent, this did not establish bad faith or cause under § 1112(b).  Debtor need not be insolvent before filing a bankruptcy petition, so long as it is experiencing "some type of financial distress."  The continuation of debtor's below-market rate lease was vital to the debtor's continuation as a going concern, and the two primary purposes of Chapter 11 relief are the preservation of businesses as going concerns, and the maximization of assets recoverable to satisfy unsecured claims.  The § 1112(b) inquiry often centers around the debtor's bona fide need for a "breathing spell" to reorganize, and there is often a considerable gap between delaying creditors on the eve of foreclosure and the concept of abuse of judicial purpose.  Debtor's petition was necessary to serve a valid reorganization purpose, and the continuation of the lease benefited not only the debtor, but the landlord as well as unsecured creditors.


In re Hechinger Investment Company of Delaware, Inc.
--- F.3d ----, 2007 WL 1630004 (3d Cir. June 7, 2007)
Holding:  In ruling for the plaintiff in a preference action, the bankruptcy court erred in holding that a creditor-debtor relationship precludes the possibility that the parties intended for certain transfers to be contemporaneous exchanges for new value pursuant to § 547(c)(1).  In regard to the ordinary course defense of § 547(c)(2), the bankruptcy court correctly ruled that preference-period payments were not made in the ordinary course of business between the debtor and the creditor, where just prior to the preference period, the creditor had imposed stricter credit terms, a lower credit limit, and required wire payments, and the debtor made payments made according to these new terms.  Because the new terms were "extreme" and "out of character with the long historical relationship between these parties," the payments made according to those terms were not in the ordinary course.  The Third Circuit remanded the issue of prejudgment interest pursuant to § 550(a), because prejudgment interest must be awarded unless there is a sound reason not to do so, and no reason was given for the denial of prejudgment interest.

In re Myers
--- F.3d ----, 2007 WL 1775125 (3d Cir. June 21, 2007)
Holding:  Dismissal of Chapter 13 petition and retroactive annulment of automatic stay were appropriate based on debtor’s bad conduct.  State court fraudulent transfer action was pending pre-petition against debtor and corporation of which she was the only shareholder, and state court judge announced that he would issue his judgment in open court in two days.  In the interim, debtor filed Chapter 13 petition.  The state court was notified of the petition but, at the insistence of the state court plaintiff, entered a judgment against debtor in her “in her corporate capacity.”  The state court also froze all assets of debtor’s company.  The following day, debtor withdrew funds from the company’s account in violation of the state court order.  The state court then held debtor in contempt and incarcerated her.  (1) On the motion of the state court plaintiff, the bankruptcy court properly dismissed the petition under § 1307(c) and refused to convert it to a Chapter 7 case pursuant to § 1307(a).  Appropriate factors for a finding of bad faith included the suspicious timing of the petition in relation to the state court action, the fact that the vast majority of the debtor’s debt was the fraudulent transfer that was at issue in the state court action, that the debtor acted with knowledge or deliberate ignorance of the state court’s order when she transferred funds from her company’s bank account and that debtor did not qualify as a Chapter 13 debtor under § 109(e).  (2) The bankruptcy also properly annulled the automatic stay, and this annulment had the effect of ratifying the state court actions that were voidable as violations of the automatic stay.  Whether a petition is filed in bad faith is relevant to whether the bankruptcy court should annul the stay, and the only effect of refusing to ratify the state court action in this case would be to reward the debtor for her attempted abuse of the bankruptcy system.  The court noted, however, that both the debtor and the state court plaintiff engaged in inequitable conduct and advised that § 362(h) damages may be appropriately imposed on parties that violated the automatic stay even if those violations are later ratified by annulment of the stay.


In re J.A. Jones, Inc.
--- F.3d ----, 2007 WL 1816612 (4th Cir. June 26, 2007)
Holding:  Estate of motorists killed in a highway accident in a construction zone was a known creditor of construction firm debtor and, thus, entitled to actual notice of proof of claim bar date.  Debtor knew of the accident, participated in news accounts of it and knew the identify of the deceased motorists.  Debtor reported the accident to its insurer and participated in its insurer’s investigation.  Notice of the claims bar date was not sent to the decedents’ estate.  No one associated with the decedents’ estate saw published notices of the bar date or had actual knowledge of the bankruptcy case or filing deadlines.  The decedents’ estate was a known creditor because the identity of the deceased motorists was actually known to the debtor or was reasonably ascertainable.  Known creditors are entitled to actual notice, even if they have not asserted a claim pre-petition and even if it is possible that they will not assert a claim against the debtor.  Bankruptcy court, thus, correctly authorized the estate’s late-filed proof of claim and granted the estate relief from the stay to pursue state court litigation. 

Maryland  Port Admin. v. Premier Auto. Servs., Inc. (In re Premier Auto. Servs., Inc.)
--- F.3d ----, 2007 WL 1721951 (4th Cir. June 15, 2007)
Holding:  Bankruptcy court properly dismissed as a bad faith filing a chapter 11 petition filed by a solvent entity for the purpose of forestalling eviction on an obviously expired lease of real property.  The expired lease was not property of the estate under § 541(b)(2) and was expressly excluded from the protections of the automatic stay under § 362(b)(10).  Debtor asserted that its reorganization strategy was, through litigation, to require its landlord to negotiate more favorable terms for a new lease covering the same premises as the expired lease.  This was not a reorganization strategy, the court concluded, but, instead, an effort to hold an asset hostage through endless, fruitless litigation. 


In re Barrett
--- F.3d ----, 2007 WL 1649102 (6th Cir. Jun. 8, 2007)
Holding:  In an action to discharge student loan debt on the ground of “undue hardship” pursuant to § 523(a)(8), expert testimony is not necessarily required to prove the second prong of the Brunner test, namely, that the particular circumstances of hardship are likely to persist for a significant portion of the repayment period of the student loans.  Testimony of the debtor, who had a medical background, was sufficiently credible to establish his medical history, diagnosis, surgeries, and ability to work.  The validity of the debtor’s testimony was further supported by a letter from his treating position and the creditor’s failure to offer any evidence in opposition.  Debtor’s failure to enroll in the Income Contingent Repayment Program (“ICRP”) did not per se indicate the lack of a good-faith effort to repay – Brunner’s   third prong for two reasons.  First, the debtor credibly explained his analysis that repayment under IRCP would be impractical, given the low amount of his income and the severe tax consequences upon completion.  Second, if failure to enroll in IRCP were a per se requirement of Brenner, the undue hardship discharge would effectively be eliminated.

In re Glance
--- F.3d ----, 2007 WL 1574392 (6th Cir. June 1, 2007)
Holding:  Bankruptcy court properly dismissed Chapter 13 petition where mortgage liens exceeded debt limit found in § 109(e).  A security interest in a debtor's property is a noncontingent, liquidated, secured debt for the purposes of § 109(e).  Mortgage liens qualify under this definition as well, as they are "debts" within the meaning of the Code, they are liquidated and thus readily ascertainable,  they are secured, and they are noncontingent because they immediately give the creditor a secured claim on the debtor's property.  Even though debtor did not sign the notes secured by the mortgage liens, he consented to the liens and would have been required to satisfy them if he wanted to sell the properties.


In re American Wagering, Inc.
--- F.3d ----, 2006 WL 2846373 (9th Cir. June 28, 2007)
Holding:  A claim for nonpayment of services provided to the debtor could not be subordinated as a claim for damages arising from a purchase or sale of security pursuant to § 510(b), even though the compensation for the services was based on the debtor’s stock price.  The claimant had obtained a money judgment for the nonpayment long before the bankruptcy case was filed, and the claim was not based on the issuance or nonissuance of stock, but rather the failure to pay for services provided.

In re Adbox, Inc.
--- F.3d ----, 2007 WL 1584582 (9th Cir. June 4, 2007)
Holding: (1) In adversary proceeding brought by Chapter 7 trustee to assert a preference claim, bankruptcy court properly dismissed creditor's counterclaim asserting debtor's liability for pre-petition conduct.  Preference actions belong to the bankruptcy estate, not the debtor, and cannot be brought by the debtor prior to filing for bankruptcy, so bankruptcy trustee is not an "opposing party" for purposes of Rule 7013, since the trustee would have to stand in the shoes of the debtor to defend against the counterclaim.  (2)  The defense of "earmarking" is not an affirmative defense required to be specifically pled under Rule 7008, but is rather a challenge to the trustee's claim that particular funds are part of the estate under § 547.  If the trustee in a preference action makes a preliminary showing of an avoidable transfer from an account over which the debtor ordinary exercised total control, then the burden of proof of establishing an earmarking defense lies with the defendant.


Morris v. Hicks (In re Hicks)
--- F.3d ----, 2007 WL 1810102 (10th Cir. June 25, 2007)
Holding:  Trustee’s status as a hypothetical lien creditor under § 544(a)(1) allowed the trustee to avoid a creditor’s unperfected lien against the debtor’s vehicle.  The lien was not perfected pursuant to state law at the time the petition was filed, and post-petition efforts to perfect the lien were not effective to obtain priority ahead of the trustee.

Rupp v. United Security Bank (In re Kunz)
--- F.3d ----, 2007 WL 1600429 (10th Cir. June 5, 2007)
Holding:  In preference action, "director emeritus" is not an insider for purposes of § 101(31)(A).  Debtor at one time was an active director, but his status as emeritus was purely honorary, as Debtor had not attended any board meetings, had no right to attend any board meetings, had no voting rights or any other authority.  To include "director emeritus" as used in this context in the definition of "director" would do violence to the thrust of the statute and would clearly be against Congress' intent.