Recent Bankruptcy Decisions from the Appellate Courts - September/October 2007

Reprinted from the Norton Bankruptcy Law Adviser, with permission of Thomson/West. For more information about this publication please visit http://www.west.thomson.com/.

SECOND CIRCUIT

Krys v. Official Committee of Unsecured Creditors of Refco, Inc. (In re Refco, Inc.)
--- F.3d ----, 2007 WL 2893370 (2d Cir. Oct. 5, 2007)
Holding:  Defendant's investors did not have standing in preference action as a party in interest under § 1109(b) to object to settlement of the preference action.  An internal dispute between a creditor and that creditor's investors does not belong in bankruptcy court, and the bankruptcy court does not have the obligation to ensure that a creditor's representatives are honoring their fiduciary duties.

Cadle Co. v. Mangan (In re Flanagan)
--- F.3d ----, 2007 WL 2915812 (2d Cir. Oct. 9, 2007)
Holding:  (1) Pre-petition judgment creditor was not entitled to constructive trust or equitable lien encompassing debtor's interest in certain stock.  Creditor argued the trust or lien should be imposed based on debtor's pre-petition conduct concealing the stock so creditor could not execute against it.  Pre-petition, debtor was found in contempt for refusing to produce information concerning the stock.  In a bankruptcy case, a constructive trust burdens creditors since a constructive trust takes property out of the estate.  Trust was inappropriate because creditor failed to prove that other creditors would be unjustly enriched by the estate's continued ownership of the stock.  (2) During preference period, family member loaned debtor  funds to satisfy creditor's judgment.  This loan was secured by the stock.  Debtor's payment of the proceeds of the family loan to satisfy the judgment was subject to the earmarking doctrine and, thus, not a voidable preference except to the extent that the debtor encumbered previously unencumbered property by granting a security interest in the stock.

SIXTH CIRCUIT

Al Perry Enterprises, Inc. v. Appalachian Fuels, LLC
--- F.3d ----, 2007 WL 2791126 (6th Cir. Sept. 27, 2007)
Holding:  Debtor's sale of assets and assumption and assignment of executory contracts "free and clear of any and all liens, claims, interests and encumbrances" except those specifically listed did not obligate assignee of executory contract to pay commissions under assumed contract when those commissions were not listed.  Debtor had pre-petition coal supply contract with another party, and debtor paid commissions to plaintiff sales agent based on sales of coal under the contract.  After a dispute arose concerning the commissions, a pre-petition judgment was entered in favor of the sales agent that the debtor was required to continue paying the commissions.  In the bankruptcy case, the coal supply contract was assumed and assigned, and the order provided that sale of assets and assumption and assignment of contracts was free and clear of any claim of creditors against the debtor.  Plaintiff had notice of and an opportunity to object to this order but failed to do so.  As a result, the assignee took the coal supply contract free of the plaintiff's claim for commissions.

EIGHTH CIRCUIT

In re Frederickson
--- F.3d ----, 2007 WL 2752769 (8th Cir. Sept. 24, 2007)
Holding:  Above-median Chapter 13 debtor whose disposable income is negative is not required to propose a plan with a duration of five years.  To be confirmed under § 1325(b)(1)(B), a plan must provide that all the debtor's projected disposable income will be applied to make payments to unsecured creditors.  Debtor's Form 22C, calculated using IRS standards, showed no disposable income, so there was no applicable commitment period.

In re Morgan
--- F.3d ----, 2007 WL 2752767 (8th Cir. Sept. 24, 2007)
Holding:  Order entered in one case removing Chapter 13 trustee from that case was affirmed, but order entered in second case removing the trustee from all cases in which she was serving was reversed because adequate notice of the conduct constituting cause for removal under § 324 was not provided.  Notice that the court is considering removing a trustee must set forth specific facts that would form the basis for removal.  The notice in the first case met this requirement.  The notice in the second case did not meet this requirement because it only included a general statement that the findings of fact and conclusions of law entered in the first case constituted the basis for the notice.  As to the first case, the bankruptcy court's finding that the trustee had testified falsely was not clearly erroneous.  Additionally, the bankruptcy court correctly concluded that a conflict of interest arose when an adversary proceeding with apparent merit was filed against the trustee in a case where she was serving as trustee.

Sells v. Porter (In re Porter)
--- F.3d ----, 2007 WL 2736541 (8th Cir. Sept. 21, 2007)
Holding: Pre-petition jury verdict that debtor engaged in retaliation against employee unlawful under 42 U.S.C. § 2000e-3(a) collaterally estopped debtor from arguing in adversary proceeding that the debt was not for willful and malicious injury.  Debtor's retaliatory actions against employee were willful because the debtor purposefully took action against the employee based on her report of sexual harassment by debtor's business partner.  Debtor's actions were malicious because he intended to harm the employee when he retaliated against her.  Accordingly, bankruptcy court properly granted employee summary judgment that the debt was non-dischargeable under § 523(a)(6).

NINTH CIRCUIT

Saddleback Valley Community Church v. El Toro Materials Co., Inc. (In re El Toro Materials Co., Inc.)
--- F.3d ----, 2007 WL 2822019 (9th Cir. Oct. 1, 2007)
Holding:  Landlord's claim for collateral damage to leasehold caused by debtor is not limited by the § 502(b)(6) cap.  Debtor left one million tons of wet clay "goo," mining equipment and other materials on landlord's property when debtor rejected lease.  The cap applies to damages "resulting from" the rejection of the lease, but the harm to the property existed whether or not the lease was rejected.

Suter v. Goedert
--- F.3d ----, 2007 WL 2822023 (9th Cir. Oct. 1, 2007)
Holding:  District court erred in dismissing as moot debtor's appeal of bankruptcy court order permitting trustee to sell debtors' interest in legal malpractice lawsuit.  Trustee sold the lawsuit to the attorneys accused of malpractice, and the bankruptcy court denied debtors' request to stay the sale.  The attorneys dismissed the malpractice lawsuit, which was then pending before the Nevada Supreme Court.  On the appeal of the sale order, the district court erred when it did not require the attorneys to prove that the debtors could not obtain relief from the Nevada court.  Under Nevada procedure, the debtors would have an extraordinary writ available to them under which the Nevada court might reinstate the appeal of the malpractice lawsuit.

Sigma Micro Corp. v. Healthcentral.com (In re Healthcentral.com)
--- F.3d ----, 2007 WL 2743497 (9th Cir. Sept. 21, 2007)
Holding:  (1) In preference action, bankruptcy court erred when it granted summary judgment in favor of Chapter 11 trustee.  When defendant transferee filed declaration showing that payments made during preference period conformed to the payment cycle established before the preference period, an issue of fact arose as to the ordinary course of business defense under § 547(c)(2)(B).  Even though debtor changed its cash flow management system pre-petition to only pay critical vendors, this was but one non-exclusive factor for the court to consider.  Defendant's declaration also created an issue of fact as to ordinary business terms under § 547(c)(2)(C).  The declaration included testimony concerning typical business terms in the industry and evidence that the payments between debtor and defendant were within those terms.  (2) Bankruptcy court's local rule allowing bankruptcy court to withdraw the jurisdictional reference from the district court when a party demands a jury trial is invalid because it is inconsistent with 28 U.S.C. § 157(d) and Fed. R. Bankr. P. 5011(a), which state that only a district court may withdraw the reference.  Additionally, when a party requests a jury trial, the bankruptcy court may still handle discovery matters, pre-trial conference and motions, including dispositive motions.

TENTH CIRCUIT

In re Mersmann
--- F.3d ----, 2007 WL 2833218 (10th Cir. Sept. 24, 2007)
Holding:  Tenth Circuit overruled precedent allowing student loans to be discharged without proving undue hardship in an adversary proceeding.  The previously allowed "discharge by declaration" procedure, where the student debtor could establish undue hardship by submitting language in a proposed Chapter 13 plan, which, if no creditor objected and the court approved, would later be uncontestable, violated § 523(a)(8) and Fed. R. Bankr. P. 7001(6).