Recent Bankruptcy Decisions from the Appellate Courts - July 2007



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


In re Applied Theory Corporation
--- F.3d ----, 2007 WL 1965012 (2nd Cir. July 9, 2007)
Holding: Section 510(c) does not give a creditor’s committee the unrestricted right to bring an equitable subordination claim without court approval.  The Committee unsuccessfully argued that pursuant to § 510(c), an equitable subordination claim is a “direct” claim and not a derivative claim brought on behalf of the trustee or debtor-in-possession, and that as a result no court approval is required to bring such a claim.  The Second Circuit ruled that where the purpose of a creditors committee claim is to preserve the interests of the estate as a whole, allowing the committee to pursue the claim would improperly usurp the trustee’s role as a representative of the estate.  In light of the fact that the trustee properly declined to pursue the equitable subordination claim, the bankruptcy court properly prohibited the Committee from bringing that same claim.


In re National Energy & Gas Transmission, Inc.
--- F.3d ----, 2007 WL 1978004 (4th Cir. July 10, 2007)
Holding:  Creditor recovered, from a non-debtor surety, the full amount of the creditor’s principal claim against the bankrupt debtor.  The creditor applied the funds to interest first and then attempted to recover the remaining portion of the claim in the bankruptcy as unpaid principal.  The claim was barred as a collection of interest pursuant to § 502(b)(2).  Although the creditor could apply and classify the payment differently under non-bankruptcy law, the Bankruptcy Code could deem it to be an impermissible interest claim against the debtor by looking to the circumstances of the claim, which in this case was increased only due to the accrual of interest.


Board of Trustees v. Bucci (In re Bucci)
--- F.3d ----, 2007 WL 1891736 (6th Cir. July 3, 2007)
Holding:  Debtor’s obligation to make employee pension and fringe benefit contributions was dischargeable because it was not a debt for fraud or defalcation while acting in a fiduciary capacity under § 523(a)(4).  Debtor’s collective bargaining agreement with employees provided that unpaid contributions were assets of the pension fund.  Although this may have made the debtor an ERISA fiduciary, “fiduciary capacity” under § 523(a)(4) is defined more narrowly than in other contexts.  There was no fiduciary capacity under § 523(a)(4) since the debtor was not the trustee of the contributions, and a simple breach of contract is not enough to make a debt non-dischargeable.


Fehribach v. Ernst & Young LLP
--- F.3d ----, 2007 WL 2033734 (7th Cir. July 17, 2007)
Holding:  Defendant waived its § 108(a) statute of limitations defense by raising it for the first time before the Seventh Circuit.  Absent waiver, the underlying adversary proceeding for professional negligence and breach of contract would have time-barred, because it was filed by the trustee more than three years after the bankruptcy filing and also after the expiration of the statute of limitations under state law.  Defendant had erroneously assumed that the suit was timely because the state-law statute of limitations had not expired as of the bankruptcy filing.

In re Wright
--- F.3d ----, 2007 WL 1892502 (7th Cir. July 3, 2007)
Holding:  Creditor holding security interest in Chapter 13 debtor’s automobile purchased within 910 days before the filing of the petition is entitled to collect deficiency amount if allowed under state law or contract.  Section 1325(a)’s hanging paragraph, added by BAPCPA, provides that § 506 does not apply to such a creditor’s claim.  By knocking out § 506, the hanging paragraph leaves the parties to their state law and contractual entitlements.  Since the debtor’s agreement with the creditor allowed the creditor to seek a deficiency judgment after liquidating the collateral, the bankruptcy court properly refused to confirm debtor’s plan that would surrender the car and pay nothing on account of the deficiency. 


In re Benn
--- F.3d ----, 2007 WL 1976071 (8th Cir. July 10, 2007)
Holding:  Missouri statute implementing opt-out from the federal scheme of Bankruptcy Code exemptions pursuant to § 522(b)(2) does not create additional substantive exemptions of property.  The proper interpretation of the statute’s provision of an exemption for “any property that is exempt from attachment and execution” pursuant to non-bankruptcy law refers to existing exemption schemes.  Despite the debtor’s “plain meaning” argument to the contrary, the provision does not mean that property not subject to attachment and execution in general, such as the debtor’s unclaimed tax refund being held by the IRS, is exempt from the bankruptcy estate.


In re Sweeney
--- F.3d ----, 2007 WL 1991069 (10th Cir. July 11, 2007)
Holding:  Chapter 13 debtor adult could discharge a restitution obligation arising from his juvenile delinquent record for second-degree arson.  Juvenile delinquency is an adjustment of status but does not constitute a crime under either the federal Juvenile Justice and Delinquency Protection Act or Colorado state law, and thus the crime-related non-discharge provisions of § 1328(a)(3) do not apply.

Eastman v. Union Pacific R.R. Co.
--- F.3d ----, 2007 WL 1954031 (10th Cir. July 6, 2007)
Holding: Chapter 7 debtor was judicially estopped from pursuing personal injury claim not disclosed in bankruptcy case.  Debtor initiated personal injury litigation nine months before filing Chapter 7 petition but did not schedule the action or disclose it at §341 meeting.  Post-discharge, trustee learned of the litigation, reopened the bankruptcy case, settled with two of the defendants and paid all allowed claims in full.  Debtor was then resubstituted as the real-party-in-interest in the personal injury litigation, and the remaining defendants sought dismissal.  Although the debtor claimed that his failure to disclose was the result of ignorance, the court found that the debtor knew of the litigation and had a motive for non-disclosure, making the application of judicial estoppel appropriate.

In re Kuhnel
--- F.3d. ----, 2007 WL 2122062 (10th Cir. July 25, 2007)
Holding:  After secured creditor consensually released its late perfected security interest in debtor's truck, trustee objected to the debtor's claim of an exemption in the truck, but failed to do so within the 30-day window prescribed by Rule 4003(b).  The bankruptcy court allowed the objection under § 522(g), and the appellate court affirmed, noting that Rule 4003(b) is "uncompromising and inflexible" but that § 522(g) allowed the trustee to file what would be an untimely objection under Rule 4003(b).  The court pointed out that a trustee will "rarely be able to recover property within the thirty-day period of Rule 4003(b)" and that the "nature of § 522(g) is such that is precludes exemptions in recovered property even beyond the time limit imposed by Rule 4003(b).  The court said that a trustee acting under § 522(g) is "not contesting the exemption per se, but rather is asserting the fact that he or she has set aside a debtor's voluntary transfer."  The court agreed with the trustee's contention that the debtor voluntarily transferred an interest in the truck by granting a purchased money security interest, and it did not matter that the trustee did not commence formal proceedings to recover the property under § 522(g) so long as the trustee "took some action resulting in the reconveyance of the property to the estate," and thus allowed the objection to the exemption. 

In re Woody
--- F.3d. ----, 2007 WL 2110808 (10th Cir. July 24, 2007)
Holding:  Department of Justice appealed BAP's affirmation of bankruptcy court's discharge of debtor's Health Education and Assistance Loan (HEAL Loan).  The Tenth Circuit adopted the framework used by the Fourth and Sixth Circuits to determine when discharge of a HEAL loan is permitted under 42 U.S.C. § 292f(g)'s "strict language."  The framework adopted by the Tenth Circuit involves application of a "totality of the circumstances" approach.  Noting that HEAL loans may only be discharged when the "nondischarge of such debt would be unconscionable," the factors to examine when determining unconscionability include 1) debtor's income, earning ability, health, educational background, dependents, age, accumulated wealth, and professional degree; 2) debtor's claimed expenses and standard of living; 3) whether debtor's current situation is likely to continue or improve, including whether the debtor has attempted to maximize his income by seeking or obtaining employment commensurate with his education and abilities; 4) if the debtor's dependents are, or could be, financially independent; 5) the amount of the debt and the rate at which interest accrues; and 6) debtor's good faith, including his prior repayment efforts and undertaking of new debts despite knowledge of his HEAL debts.  The court pointed out that this list is not exclusive and that additional pertinent factors could be considered.  After applying each of the above factors to debtor's circumstances, the court overturned the decision of the BAP and overruled the discharge of the HEAL loan.      


In re Citation Corp.
--- F.3d. ----, 2007 WL 2128165 (11th Cir. July 26, 2007)
Holding:  Debtor hired investment banker to provide financial advisory and investment banking services necessary for potential restructuring prior to filing for bankruptcy.  Debtor subsequently filed for bankruptcy, and the bankruptcy court approved the retention of the investment banker but specifically reserved the right to review the overall fee subject to the reasonableness standard in § 330.  Debtor objected to investment banker's final fee application, arguing that investment banker had a conflict of interest with debtor.  Debtor also argued that the services provided by investment banker were much less extensive than originally expected and sought to have the fee reduced.  The bankruptcy court first found that there was no conflict of interest, and then reduced investment banker's fee, pursuant to § 330, after thoroughly reviewing the 16 factors in the statute, including the "lodestar," which requires a court to find a reasonable rate and then multiply that by the amount of hours actually expended that benefited the estate. The appellate court affirmed the holding of the bankruptcy court's reduction of the fee, saying that § 330 instructs a court to "look at: 'the nature, the extent, and the value of such services,' as well as the time spent on such services, and the cost of comparable services in other cases."  The appellate court also noted that it is appropriate, but not required, for a bankruptcy court to use the lodestar analysis to review an investment bank's fees for reasonableness, because part of the intent of § 330 and the Code as a whole is "an overriding concern for keeping administrative expenses to a minimum so as preserve as much of the estate as possible for the creditors."  As for the conflict of interest issue, the appellate court remanded the matter to the bankruptcy court for a determination of whether or not investment banker violated Rule 2014's disclosure requirements. 

United States  v. Jacobs (In re Jacobs)
--- F.3d ----, 2007 WL 1859701 (11th Cir. June 29, 2007)
Holding: Debtor’s tax debts were non-dischargeable under § 523(a)(1)(C) based on debtor’s willful attempts to evade or defeat the taxes.  This finding was supported by the following facts: (1) debtor titled real property solely in spouse’s name even though spouse had no income or assets, and debtor made all of the mortgage payments; (2) debtor caused his income to be characterized as officer compensation not subject to tax withholding and then failed to pay estimated taxes on those earnings; (3) debtor used his business entities to purchase numerous luxury vehicles that he used for personal purposes; (4) debtor made large discretionary expenditures while debtor knew of his tax liabilities, was capable of paying them but chose not to; and (5) debtor made substantial loans to his spouse for no documented consideration.  The fact that debtor filed returns, paid a portion of his tax liability and regretted not paying his taxes did not defeat the finding of non-dischargeability.