Ninth Circuit Limits Section 502(b)(6) Cap on Claims by Landlord to Lost Rental Income, Does Not Extend This Cap to Collateral Claims by Landlord

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com


El Toro Materials Co. v. Saddleback Valley Community Church (In re El Toro Materials Co.)
Ninth Circuit Court of Appeals Case No. 05-56164
Filed October 1, 2007
Opinion by Judge Alex Kozinski
(subsequently appointed Chief Judge of the Ninth Circuit)

These Bulletins often present appellate opinions the day after they are released, but this Ninth Circuit opinion from last year is worth a look because 1) the holding and its rationale is quite straightforward, so it's easy to learn from; 2) the opinion involves, directly and indirectly two of the more interesting people living in the Ninth Circuit; and 3) because the subject in controversy is one million tons of mud. Even hard-
working bankruptcy attorneys every once in a while get to come out of the trenches and play in the mud.

The Two Personalities
The opinion's author, Alex Kozinski, who shortly after this opinion became the Chief Judge of the Ninth Circuit Court of Appeals. He became a U.S. Court of Appeals judge at 35, the youngest in the country. His opinions are common-sensical and humorous, reflecting fearless libertarian instincts. Emigrated from Romania at 12, his parents both Holocaust survivors, he still speaks, as he says, "with an accent close to [California Governor] Schwarzenegger's." (Please see my prior Bulletin featuring another opinion he authored: "Major New Student Loan Opinion: 9th Circuit Allows Chapter 13 Discharge of Student Loans WITHOUT Adversary Proceeding by Mere Inclusion in Plan."

The pastor of the successful appellant here, Saddleback Church, is Rick Warren, author of one of the best-selling books in history, "The Purpose-Driven Life," and "unquestionably the U.S.'s most influential and highest-profile churchman" in the opinion of a recent Time article on him His church was the venue for the "civil forum" last August featuring the two Presidential candidates, which he moderated. The event was affirmation of his stature. He is not named in the opinion.

The Simple Facts and the Interpreted Statute
This church is the landlord with the million tons of mud left by the debtor, El Toro Materials, upon its rejection of a lease under § 365(a) of the Code. It brought an adversary proceeding "claiming $23 million in damages for the alleged cost of removing the mess, under theories of waste, nuisance, trespass and breach of contract." § 502(b)(6) states that if an objection is made to a claim by a creditor the bankruptcy court

shall determine the amount of such claim . . . and shall allow such claim in such amount, except to the extent that--
(6) if such claim is the claim of a lessor for damages resulting from the termination of a lease of real property, such claim exceeds--(A) the rent reserved by such lease, without acceleration, for the greater of one year, or 15 percent, not to exceed three years, of the remaining term of such lease . . . .

That last subsection is a cap on the amount of the claim at either one year of rent on the remaining term of the lease, or, if it is greater, the rent for 15 percent of the remaining term of the lease, but at most three years of rent. The issue is whether that cap on a claim by "lessor for damages resulting from the termination" of a real estate lease caps not just future rent pegged to the periods stated in subsection (A), but also caps other damages owed by the lessee-debtor to the landlord. Such as the cost of removing two billion pounds of mud.

Judge Kozinski Explains
The holding was one of simple statutory construction supported by case law, but the judge presented it quite differently than most jurists. Instead of going right to the statute and case law, he starts by looking at the purpose of the cap for landlord-creditor claim amounts, its economic and historical context, with the help of a touch of legislative history: "The damages cap was 'designed to compensate the landlord for his loss while not permitting a claim so large (based on a long-term lease) as to prevent other general unsecured creditors from recovering a dividend from the estate.”

Then Judge Kozinski begins the core of his analysis with common sense:

The structure of the cap—measured as a fraction of the remaining term—suggests that damages other than those based on a loss of future rental income are not subject to the cap. It makes sense to cap damages for lost rental income based on the amount of expected rent: Landlords may have the ability to mitigate their damages by re-leasing or selling the premises, but will suffer injury in proportion to the value of their lost rent in the meantime. In contrast, collateral damages are likely to bear only a weak correlation to the amount of rent.

Then he moves to public policy:

One major purpose of bankruptcy law is to allow creditors to receive an aliquot share of the estate to settle their debts. Metering these collateral damages by the amount of the rent would be inconsistent with the goal of providing compensation to each creditor in proportion with what it is owed.

Only then does he seem to even look at the details of the statute at issue:

The statutory language supports this interpretation. The cap applies to damages “resulting from” the rejection of the lease. 11 U.S.C. § 502(b)(6). Saddleback’s claims for waste, nuisance and trespass do not result from the rejection of the lease—they result from the pile of dirt allegedly left on the property. . . . . The million-ton heap of dirt was not put there by the rejection of the lease—it was put there by the actions and inactions of El Toro in preparing to turn over the site.

He then returns back to common-sense public policy:

Interpreting the section 502(b)(6) cap to include damage collateral to the lease would also create a perverse incentive for tenants to reject their lease in bankruptcy instead of running it out: Rejecting the lease would allow the tenant to cap its liability for any collateral damage to the premises and thus reduce its overall liability, even if staying on the property would otherwise be desirable and preserve the operating value of the business

. . . .

This would both reduce the operating value of the business and deny recovery to a creditor—a lose-lose situation counter to bankruptcy policy

. . .

Further, extending the cap to cover any collateral damage to the premises wuold allow a post-petition but pre-rejection tenant to cause any amount of damage to the premises- either negligently or intentionally--without fear of liability beyond the cap.

Almost as an afterthought, in his second-to-last paragraph, the judge refers to only one other court opinion, the only one in the entire body of his opinion that he deigns worthy of mention outside the ancient cases he refers to earlier for historical context, and mentions it only for the purpose of overruling it--a Ninth Circuit BAP opinion that the underlying BAP in this case relied on. He provides no explanation why this prior case was wrongly decided, other than to mention in a footnote that two concurring judges in the current case's BAP "expressed reservations" about it. Other than this, and a short footnote distinguishing a potentially contrary Ninth Circuit opinion from the issue in this case, Judge Kozinski's holding is supported in his opinion by no case law whatsoever, reflecting his usual audacity.

The Judge's Advice to the Entire Ninth Circuit BAP
Perhaps anticipating his ascension to the Chief Judge role, but more likely just reflecting his assertive personality, Judge Kozinski gave the following procedural recommendation to the Ninth Circuit's Bankruptcy Appellate Panel:

When the [BAP] believes that one of its precedents is wrongly decided or otherwise deserves reconsideration [as two of the three judges in the panel did in this case], the goal of judicial efficiency may be best served by allowing the BAP itself to overrule its own precedent. The BAP, promulgating its rules under supervision of the Ninth Circuit Judicial Council, has not yet implemented a rule creating an en banc procedure.[Citation excluded.] As this case suggests, the time may be ripe for the BAP to consider instituting such a procedure.

In other words, he's telling the BAP: don't waste the Ninth Circuit's time on cases relying on bad BAP precedent; instead come up with a procedure for dumping such bad BAP law on your own.

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

Please note that this writer is not licensed to practice law in Oregon. This means that he is not legally permitted to give any legal advice or provide and legal services. This Bulletin and the entire contents of this website is written only for attorneys. and is not intended for the public. If any non-attorney is reading this, you must consult an attorney about ANYTHING you read here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2008 Bankruptcy Litigation Support for Attorneys

Hedge Funds Scoff at Congress' Chapter 13 Mortgage Modification Threat: Funds Sue Countrywide and Jeopardize Its Huge Modification Settlement

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

A few weeks ago Congress directly warned two specific huge hedge funds, and the industry in general, not to undercut federal efforts at encouraging voluntary home mortgage modifications. These two hedge funds, Greenwich Financial Services and Braddock Financial Corporation, were apparently "instructing the servicers of their mortgages to defy this national program and to insist on further socially and economically damaging foreclosures."

This strong warning came specifically in the form of a very explicit statement by the chairman of the House Financial Services Committee and five of his pertinent subcommittee chairs (and in letters addressed personally to the presidents of Greenwich Financial and of Braddock Financial Corporation, and to the Managed Funds Association ("The Global Voice of the Alternative Investment Industry").) These influential members of Congress, albeit all Democrats, clearly threatened to "invoke the protection of the bankruptcy laws on single family residences" if these two particular hedge funds and the industry in general does not "reverse this policy."

But then this Monday (12/1/08), Greenwich Financial, whose president, William Frey, has been an outspoken critic of mortgage modifications, threw down its own gauntlet, in the form of a lawsuit filed in New York State Supreme Court in Manhattan, against Countrywide Financial Corp., now owned by Bank of America. This proposed class-action lawsuit seeks to require that Countrywide pays to the 374 securitization trusts involved the FULL VALUE of all the mortgage loans that Countrywide had sold to them, reflecting a total debt of about $80 billion. In October Countrywide had settled predatory lending charges by fifteen state attorneys general by agreeing to reduce mortgages by $8.4 billion through mandatory mortgage modifications. (See my 10/7/08 Bulletin on this settlement, called What You and Your Clients Need to Know About Yesterday's $8 Billion Countrywide/Bank of America Settlement).

The persistent Gordian Knot preventing solution of the mortgage meltdown has been the ownership of a large portion of mortgages not by single creditors but by multiple parties through the infamous mortgage backed securities.

At the outset, the mortgages backed by these securities include a disproportionate share of the troubled loans. As stated last month by James Lockhart, the head of the Federal Housing Finance Agency, in his own plea to the holders of these securities:

The performance of private label mortgage backed securities that were sliced and diced and sold to investors is just the opposite of Fannie Mae’s and Freddie Mac’s [which "only represent 20% of serious delinquencies".] Private label securities represent less than 20% of the mortgages but 60% of the serious delinquencies. As the regulator of the housing GSEs [Fannie Mae and Freddie Mac] that own over a quarter of a trillion dollars of private label securities, I ask the private label MBS [mortgage backed securities] servicers and investors to rapidly adopt this program as the industry standard. Not only will this streamlined program assist borrowers, but broad acceptance and effective implementation could stabilize communities and property values.

And for a variety of reasons, in part because of the multiple owners involved, convincing the holders of these private lable MBS's--often hedge funds and brokerage firms--to agree to mortgage modifications has been very difficult. This has greatly stymied the various much-ballyhooed federal mortgage modification initiatives of the last few months. With the major exception of the aggressive modification efforts by the FDIC at institutions that it has taken over--including IndyMac in July and Downey Federal Savings last month--the various governmental programs have all been voluntary on the part of the mortgage holders. Appeals to the common good, such as in the ones quoted above by the FHFA's Lockhart, or even Congressional threats have thus far not proved very effective.

The one major MANDATORY mortgage modification program has been the one agreed upon by Countrywide/Bank of America in the largest ever predatory lending settlement in history. It was scheduled to go into effect December 1, 2008. So Greenwich Financial's decision to target this program, or at least to try to draw a bright line in favor of investors' rights here, is fascinating. In some respects this week's lawsuit by Greenwich Financial against Countrywide could be seen as merely a strong ($8 billion!) message that it wasn't part of the settlement with the state attorneys general and so it refuses to share in the losses agreed to by Countrywide and its owner, Bank of America. As Greenwich's Frey said in written testimony in response to the Congressional ire referred to at the beginning of this Bulletin (oddly, he was not compelled to testify in person in spite of being invited to in the above letter from the Congresspersons): “These [residential MBE] investors are not only investment banks, college endowment funds, and sovereign wealth funds, but ordinary Americans in significant numbers.” And as he said in reference to Greenwich's lawsuit, "[Countrywide's] intention is to modify them, and they don't have the right to do that." Greenwich is merely seeking a declaratory judgment that it, and the other involved investors for whom it is seeking class action status, will not have to take any losses related to this massive settlement.

But Countrywide's response is that "[l]oan modifications have been occurring for decades without objections or challenges, so we are especially troubled at the timing of this complaint. . . . . We are confident any attempt to stop this program will be legally unsupportable.” In other words, we are being (forced to be) flexible--shouldn't the investors be as well?

The bottom line is that as policy makers seek ways to pressure and entice lenders to modify mortgages, the investors in the creative instruments backing up these mortgages are understandably asserting their contract rights, and now resorting to litigation. Given the phenomenal sums involved, this is not at all surprising. But if the investors and their agents refuse to be flexible about accepting reductions in value, while others in the financial chain are sharing in the pain, this reveals the continued intractability of the problem, and the severe limitations of voluntary solutions. And litigation delay is systemically dangerous because every passing month without efficient and workable solutions to the home mortgage meltdown causes ever broader economic fallout. Thus as the Congressional warning stated, these actions by the hedge funds are greatly undercutting the arguments of those "in the financial community" that mortgage modification through bankruptcy "would be damaging" and "would not be necessary to achieve the economically desirable result of reduced foreclosures." Given the bellicose behavior of Greenwich Financial and the general turf-protecting behavior of its industry, we shall see during this delicate transition to and beginning of a new Congress and new Administration whether the threatened "much tougher legislation," in the form of bankruptcy mortgage modifications or otherwise, will be forthcoming.


POSTSCRIPT: One of the most sadly entertaining items I have read in months came across my screen in researching for this story, testimony in 2003 by an attorney for Orrick, Herrington, and Sutcliffe, LLP, a "global law firm" with 21 offices on three continents, at a House subcommittee hearing on "Preventing Abusive Lending While Preserving Access to Credit," in which he argued against "[w]ell intended, but overly restrictive, regulation" in the securitization arena. In light of the events of the past few months, the following portions of his testimony will make you both laugh and cry:

Securitization reflects innovation in the financial markets at its best.

Virtually all ... MBS [mortgage backed securities] are rated by independent rating agencies whose analyses is watched closely by investors as a guide to the credit quality of the securities. In almost all cases, rating agencies monitor the performance of the securities on an ongoing basis.

Securitization reallocates risk at many levels. By shifting the credit risk of the securitized assets (for a price) to ... MBS [mortgage backed securities] investors, financial institutions can reduce their own risk. As the risk level of an individual institution declines, so does systemic risk, or the risk faced by the financial system overall.

Good to see that "systemic risk" and "the risk faced by the financial system" has been reallocated so seamlessly.

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

Please note that this writer is not licensed to practice law in Oregon. This means that he is not legally permitted to give any legal advice or provide and legal services. This Bulletin and the entire contents of this website is written only for attorneys. and is not intended for the public. If any non-attorney is reading this, you must consult an attorney about ANYTHING you read here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2008 Bankruptcy Litigation Support for Attorneys

The Best of the Nov. '08 Bulletins: Stories on BAPCPA's Unintended Economic Consequences, Effect of Decrease in Credit on B'cy Filings, & More

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Here is a list with which to easily access some of the best recent Bulletins from this website. Just click on the title to link to that story. I have two kinds of daily "Practice-Critical Bankruptcy Bulletins" on this website: 1) summaries of court opinions--mostly from the 9th Circuit Court of Appeals, the Bankruptcy Appellate Panel of the 9th Circuit, and the Oregon U.S. District Court and Bankruptcy Court, with occasional especially noteworthy ones from elsewhere; and 2) stories about the local and national economy, legislation, bankruptcy statistics and other areas of interest to bankruptcy professionals. The following list is from this second category of Bulletins, and includes all Bulletins published last month of this category. A short excerpt follows each title.

Please feel free to comment on any story--just click on the blue word "COMMENTS" immediately after the body of that Bulletin. I respond to all comments.


At the Extreme of BAPCPA's Unintended Consequences: Did Arcane Provisions of BAPCPA Contribute to the Bear Stearns, Lehman Bros. & AIG Collapses?
Excerpt: "So how could mere bankruptcy code changes designed to protect financial institutions, and pushed by knowledgeable organizations like the Securities Industry & Financial Markets Association and the International Swaps & Derivatives Association, lead to the demise of some of the most venerable of these institutions? By newly exempting credit default swaps and mortgage repurchase agreements from the automatic stay, instruments which Bear Sterns and Lehman Brothers used extensively, creditors of these institutions--such as hedge funds and other financial institutions--no longer had the disincentive that the institutions could file bankruptcy and freeze their transactions and their collateral if they were pushed too hard."
Posted: November 3, 2008

The Effect of a Decrease in Credit Availability on the Number of Future Bankruptcy Filings
Excerpt: "According to The Paradox of Consumer Credit, by Robert M. Lawless, a professor at the University of Illinois College of Law, empirical data supports the . . . inclination that, in the short-run, decreases in credit availability increase bankruptcy filings. But in the long-run, bankruptcy filing rates increase with greater credit availability. Does that mean that potential long-term reductions in credit availability mean long-term reductions in bankruptcy filings?"
Posted: November 5, 2008

Will President-Elect Obama Now Make Chapter 13 Mortgage Modification Part of His First-100-Days Economic Plan?
Excerpt: "Here is a sampling of what the blogosphere is saying about the current prospects for bankruptcy law reform and specifically Chapter 13 mortgage modifications."
Posted: November 7, 2008

New Streamlined Home Mortgage Modification Program: Making Sense of Yet Another Federal Effort to Rescue Homeowners
Excerpt: "On November 11, 2008 the federal government announced another major home mortgage modification program. It is being presented by the Federal Housing Finance Agency (FHFA), which was established by the Housing and Economic Recovery Act of 2008 signed into law on July 30, 2008, the same agency which took control of Fannie Mae and Freddie Mac in September by authority of that Act. This Bulletin focuses on the bankruptcy aspects of this story ... ."
Posted: November 12, 2008

New Oregon Employment Data: The Trends Behind the News
Excerpt: "Yesterday (11/17/08) the Oregon Employment Department released statewide employment data for October 2008, highlighted by an unusually large 0.9% one-month increase in the unemployment rate to 7.3%. Even though the national average unemployment rate also went up--from 6.1% to 6.4%--this increase took the state in one month from slightly worse to significantly worse than the national average."
Posted: November 18, 2008

New Chapter 13 Mortgage Modification Bill Introduced During Lame-Duck Session
Excerpt: "Earlier this week Senator Richard Durbin introduced another Chapter 13 mortgage modification bill, S.3690, during this lame-duck session of Congress. It is called the Homeowner Assistance and Taxpayer Protection Act."
Posted: November 20, 2008

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

Please note that this writer is not licensed to practice law in Oregon. This means that he is not legally permitted to give any legal advice or provide and legal services. This Bulletin and the entire contents of this website is written only for attorneys. and is not intended for the public. If any non-attorney is reading this, you must consult an attorney about ANYTHING you read here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2008 Bankruptcy Litigation Support for Attorneys

Bankruptcy Courts to Be Hit by Wave of Chapter 11 Reorganizations, Right? Think Again

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

A series of recent articles and blogs have highlighted yet another extremely adverse consequence of our current credit debacle, as it leaps down the economic food chain into corporate bankruptcies: Chapter 11's have quickly become much less favorable vehicles with which to reorganize businesses. This is because 1) the credit squeeze is also greatly diminishing the availability of debtor-in-possession financing, upon which reorganizing Chapter 11's depend, and 2) BAPCPA's Chapter 11 amendments have had some (surprise, surprise) highly detrimental unintended consequences. The resulting radical reduction in the ability of Chapter 11 to keep businesses relatively intact will add to the cycle of business closings, layoffs, and reduced consumer and commercial purchasing power.

Here are summaries of some of the better recent articles and blogs on this issue, with links to them:

A New York Times article of a couple of weeks ago with the headline, "Advantage of Corporate Bankruptcy is Dwindling," cited the examples of Chapter 11's by Linens 'n Things and Mervyns having to go the liquidation route because of the lack of debtor-in-possession financing, with the recent filing by Circuit City anticipated by many to go in the same direction. The problem is aggravated by the fact that in recent years the large DIP lenders have tended to be hedge funds and private equity investors, whose ranks have been thinned, and the survivors often now do not have money to lend, and if they do they want a quick return to assuage their own skittish investors, thus forcing liquidations instead of reorganizations.

"In the (Red): the Business Bankruptcy Blog" has recently had a couple of related stories:

"The Credit Crisis and DIP Financing" refers to the unavailability AND the greater expense of DIP (Debtor-in-Possession) financing when it is available, and the reality that more companies are more deeply leveraged, such as with "second liens, that many companies took on over the past few years when financing was easier to get," leaving these companies with "little or no unencumbered assets to offer a DIP lender as collateral." (So it's not just homeowners who were getting easy second mortgages!)

"The 2005 Bankruptcy Law Changes and Their Impact on Retail Reorganizations" focused on testimony in September 2008 by some bankruptcy professors and a Chapter 11 practitioner, Lawrence C. Gottlieb of the law firm Cooley Godward Kronish LLP, before the U.S. House of Representative's Subcommittee on Commercial and Administrative Law, of the Committee on the Judiciary, about "The Disappearance of Retail Reorganization in the Post-BAPCPA Era" . This testimony (the link is specifically to the testimony of Mr. Gottlieb) is a fascinating story of the perfect storm of "the credit crunch, the subprime lending crisis, the slowdown of the housing market and eroding value of retail commercial leases," all contributing to the near impossibility for retailers to emerge from Chapter 11 without liquidation. But notwithstanding these unprecedented economic forces, the testimony pinned much of the blame squarely on BAPCPA:

It is our experience that BAPCPA, with its numerous provisions impacting corporate insolvencies, has made it nearly impossible for retailers to emerge from Chapter 11 under any economic conditions. BAPCPA’s amendment to, and introduction of, some of the more crucial Bankruptcy Code sections affecting the retailer’s ability to meet its liquidity needs and obtain necessary postpetition financing – the lynch pin to any successful retail reorganization effort –has had a devastating effect on the retailer’s ability to reorganize.

The testimony reviews many changes to the Code which in combination, and particularly in the context of this unprecedented economic whirlwind, has had consequences that could not have been intended. By way of illustration, the changes to Section 365(d)(4) of the Bankruptcy Code now give DIP's an absolute maximum of 210 days from the date of filing to assume or reject a commercial real estate lease (without lessor's consent), instead of the prior 60 days PLUS "for cause" extensions routinely granted when the DIP was continuing to perform on the lease obligations.

[T]he fixing of an immutable deadline for the assumption or rejection of commercial real estate leases has dealt a knockout blow to prospective retail reorganizations. From a lender’s perspective, a retailer’s ability to routinely obtain extensions of the assumption/rejection period provided two critical protections. First, a lender could be assured that the retailer was provided with sufficient time to analyze the value of each individual store lease before making the critical decision to assume or reject the lease. Second, lenders were also assured that they would be provided with enough time to conduct a “going-out-of-business” (“GOB”) sale on the premises in the event a decision was subsequently made to terminate the reorganization process. Although both protections play important roles in a lender’s decision to provide postpetition financing, it is the latter protection which is most crucial. Absent the ability to conduct a GOB sale from the debtor’s store locations, a lender is deprived of the most commercially viable location to liquidate the collateralized inventory.
... .
Prior to BAPCPA, lenders were far more willing to finance a debtor’s reorganization, partly because the Bankruptcy Code essentially provided them with an indefinite period of time to assign the debtor’s below-market commercial leases to third parties at a premium in the course of a subsequent liquidation. Revised section 365(d)(4) appreciably lessens the residual value of a debtor’s commercial leases because lenders are left without sufficient time to market those leases in the event the reorganization stalls.

Sounds like the perennial "whipping boy," BAPCPA, deserves some more whipping.

by: Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

Please note that this writer is not licensed to practice law in Oregon. This means that he is not legally permitted to give any legal advice or provide and legal services. This Bulletin and the entire contents of this website is written only for attorneys. and is not intended for the public. If any non-attorney is reading this, you must consult an attorney about ANYTHING you read here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2008 Bankruptcy Litigation Support for Attorneys

Judge Perris Denies Discharge to Chapter 7 Debtors Under Section 727(a)(4)(A) for Making "a False Oath or Account"

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

U.STrustee v. Killian and Lesser (In re Killian and Lesser)
Case No. 07-33641-elp7
November 17, 2008
Unpublished

This opinion, in which debtors were denied a Chapter 7 discharge for making a series of written and oral false oaths, is a painful-to-read story about very difficult debtors and their attorney and legal assistant, with a lot of pointing of fingers back and forth among them. It is a lesson in the kind of clients for debtors' attorneys to avoid, or else to educate very thoroughly at the beginning of representation. It also seems to be a lesson, admittedly from the perspective of the "Monday morning quarterback," of a number of important ways the attorney could have done a better job avoiding this situation.


Judge Perris' Holding

Given the egregiousness of the debtors' behavior as described in Judge Perris' factual findings, Judge Perris' decision to deny discharge is not surprising. She recited the four elements of a violation of § 727(a)(4)(A):

(1) the debtor made a false oath in connection with the case; (2) the oath related to a material fact; (3) the oath was made knowingly; and (4) the oath was made fraudulently.

The judge indicated that the first two elements were easily met as she recited a series of false oaths about debtors' assets and business affairs: 1) woefully incomplete original schedules signed under oath, 2) oral false oaths at the meetings of creditors (three meetings were needed), and 3) continued false oaths in amended schedules which still lacked significant information. These written and/or oral false oaths involved omitting numerous significant real estate transactions, continued ownership in significant items of jewelry, nondisclosure of multiple business ownerships, their disposal of jewelry and household furnishings recently purchased for many tens of thousands of dollars, and large amounts of undisclosed income. In the judge's words, debtors "omitted a breathtaking amount of significant financial information."

The key section of the opinion, on the last two elements, was introduced with: "The only remaining question is whether the false oaths were knowingly and fraudulently made." The judge determined as follows:

1) As to debtors' testimony that they were only presented by their attorney's legal assistant with the signature pages of the original bankruptcy documents, it was enough that their signatures represented that the information on them was true when it was not true: "That was a lie." Furthermore, debtors had access to the other pages and had the opportunity to review them before signing. Thus the false oath signatures on the original bankruptcy documents were knowingly and fraudulently made.
2) As to the amended bankruptcy documents, these were also false oaths knowingly and fraudulently made in that the debtors had been warned by the trustee at the original meeting of creditors of the inadequacy of the documents, a draft of the amended documents were emailed to clients, their attorney advised them to review them carefully, and yet they were still signed with a "continued failure to include anywhere near complete information."
3) And as to the debtors' testimony at the various meetings of creditors, the judge did not believe debtors "that their lawyer told them to lie under oath," and in any event "[i[t was the debtors . . . who were under oath" and '[i]t was debtors' obligation to tell the truth, regardless what their counsel may have said." So the oral false oaths were also knowingly and fraudulently made.

In sum, the debtors exhibited "a shocking level of disregard for the obligation to assure accuracy in the information provided in a bankruptcy case." "They utterly disregarded their obligation to tell the truth." The US Trustee met the four elements of

Because the justification for denial of discharge was so strong under § 727(a)(4)(A), Judge Perris did not see a need to go into three other potential statutory bases for denial of discharge.


The Monday Morning Quarterback's Areas of Improvement for Debtors' Counsel

This is a website for bankruptcy attorneys, authored by someone who spent seventeen years first as a creditors' and then mostly debtors' attorney, and then has spent the last eight years working as a paralegal for many attorneys, as an employee and on a contract basis,for those who run a tight ship and for those barely afloat. From these 25 years of varied experience, I have perhaps a better perspective on these kinds of situations than those who have primarily seen this situation from only one angle. And because I have lots of past experience in representing very difficult clients, poorly chosen and perhaps insufficiently "educated," contributing to very difficult ethical problems, I have both sympathy and strong warnings for attorneys who allow themselves and their staff to get sloppy.

In that spirit, here are some attorney-client problems Judge Perris' opinion highlights, all the more important as bankruptcy work heats up and the temptation to cut corners rears its head:

[This portion being edited--please return in a few minutes. Thanks for your interest. Please feel free to comment--I respond to all comments.]

by: Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

Please note that this writer is not licensed to practice law in Oregon. This means that he is not legally permitted to give any legal advice or provide and legal services. This Bulletin and the entire contents of this website is written only for attorneys. and is not intended for the public. If any non-attorney is reading this, you must consult an attorney about ANYTHING you read here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2008 Bankruptcy Litigation Support for Attorneys

Ninth Circuit Overturns BAP in Preserving Creditor's Non-Dischargeability Claim Against Embezzling Debtor After Creditor's Payment of Preference

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Busseto Foods, Inc. v. Laizure (In re Laizure)
Ninth Circuit Court of Appeals, Case No. 06-16857
November 17, 2008

In this opinion released on Monday, the Ninth Circuit overturned both the bankruptcy court and the BAP (Bankruptcy Appellate Panel) in holding that a creditor which paid the trustee a preference preserved its right to pursue the debtor on its nondischargeability claims. The lower courts had ruled that the creditor could not pursue the debtor for nondischargeability because at the time the debtor filed the bankruptcy case he owed nothing to the creditor; having paid off the creditor during the preferential period, the debt only arising again post-petition after that creditor paid back the preferential payment to the trustee. This was strictly a case of statutory construction, focusing on the meaning of § 502(h) of the Bankruptcy Code, apparently the first time this issue has been addressed by any Circuit Court.

The Crucial Facts
Debtor embezzled from his employer while he was its controller and CFO, and after leaving employment arranged to repay the employer. Within 90 days after his final payment of about $39,000, debtor and his wife filed a Chapter 7 bankruptcy, and trustee demanded employer pay the $39,000 to the estate. While in negotiations with trustee about this and just before the filing deadline, employer filed an adversary proceeding alleging the nondischargeability of the debt under § 523(a)(4) of the Code. Employer then paid trustee $34,000 in settlement of the preference matter. It filed a proof of claim for that amount, but all of the Chapter 7 estate assets went to pay debtor's priority tax claims and the trustee's fees so employer received nothing through the estate. On debtor's motion, the bankruptcy court dismissed the employer's nondischargeability complaint on the basis that the debtor owed employer nothing on the date of the bankruptcy filing. The BAP affirmed; employer appealed.

The Statute
"Generally, § 502(h) allows claims arising from recovery of property by the trustee under § 550 the same as if the claim had arisen before the filing date of the bankruptcy petition."

§ 502(h) states in full:

A claim arising from the recovery of property under section 522, 550, or 553 of this title shall be determined, and shall be allowed under subsection (a), (b), or (c) of this section, or disallowed under subsection (d) or (e) of this section, the same as if such claim had arisen before the date of the filing of the petition.

Primarily at issue was whether the "claim" which "shall be allowed" was a claim against the estate or against debtor personally.

The Ninth Circuit's Rationale
The Court couched the issue as follows: "whether the trustee's action in requiring [employer] to pay to the bankruptcy estate the amount it received from [the debtor] deprived [the employer] of its nondischargeability claim."

Its statutory analysis focused on the word "determined," stating that "[t]here would be no reason to require a § 502(h) determination if it were subsumed by allowability, so the plain language of § 502 demonstrates that the determination is an independent inquiry." Also, "the statute's use of the word 'and' shows Congress' intent to reinstate both determined and allowed claims."

Then the Court noted that the "phrase 'determination of dischargeability' appears twice in § 523" (regarding exceptions to discharge). The Court found this important because § 523(a) introduces the list of exceptions to discharge by speaking of not discharging "an individual debtor from any debt," and this term "any debt" the Court found to be "certainly broad enough to apply to personal claims," so "if a § 550 claim is determined to be nondischargeable under § 502(h), § 523 permits that reinstated claim to be brought against the debtor personally."

The Ninth Circuit concluded with a public policy argument. "Here, allowing [the debtor] to avoid repaying the funds he embezzled from [the employer] would only encourage debtors to pay outstanding debts that are nondischargeable and later file for bankruptcy protection, thus avoiding the nondischargeability of their debt under the veil of our bankruptcy laws." The Court remanded the case back to the bankruptcy court to resolve the employer's nondischargeability complaint against the debtor.

The Bottom Line
Creditors who are paid in full before debtor files a bankruptcy case, and so are not owed anything by the debtor as of the date of filing, may nevertheless pursue the debtor on a nondischargeability complaint if the creditor ends up returning some of the payments to the trustee on a preference claim. Therefore, if a creditor has reason to believe it will be pursued on a preference claim, that creditor should file a nondischargeability complaint against the debtor if it has grounds to do so, even if the creditor was owed nothing on the date of filing the case. The seeming lack of a debt at the date of filing of the petition will no longer preclude creditor from pursuing debtor on nondischargeability as to any preference funds it pays to the trustee.

by: Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

Please note that this writer is not licensed to practice law in Oregon. This means that he is not legally permitted to give any legal advice or provide and legal services. This Bulletin and the entire contents of this website is written only for attorneys. and is not intended for the public. If any non-attorney is reading this, you must consult an attorney about ANYTHING you read here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2008 Bankruptcy Litigation Support for Attorneys

New Chapter 13 Mortgage Modification Bill Introduced During Lame-Duck Session

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Earlier this week Senator Richard Durbin introduced another Chapter 13 mortgage modification bill, S.3690, during this lame-duck session of Congress. It is called the Homeowner Assistance and Taxpayer Protection Act. Here is the full text of the bill in the Congressional Record for 11/17/08, with Senator Durbin's introductory speech. In truth this bill is highly unlikely to pass during this short session--which is expected to be over with in a matter of days, but in light of all the political and financial upheavals since last spring when a somewhat similar bill was narrowly defeated in committee, this new version merits at least a few moments of attention. The bill is very likely to be reintroduced early in the next Congress.

The Proposed Modification Language

We have all heard much talk about a Chapter 13 mortgage modification amendment to the Bankruptcy Code during the last year or so, with this issue and other bankruptcy law reform proposals even getting into the campaign speeches and website of candidate Obama. See my Bulletin from late August entitled Prospects for Amendments to BAPCPA Under an Obama-Biden Administration.

But have you ever looked at the terms of any of these mortgage modification proposals? Frankly, the details are quite interesting.The core language would amend section 1322 of the Code ("Contents of plan") so a chapter 13 plan would be able to modify a secured claim secured solely by the debtor's principal residence, as follows:

(A) modify an allowed secured claim secured by the debtor's principal residence, as described in subparagraph (B), if, after deduction from the debtor's current monthly income of the expenses permitted for debtors described in section 1325(b)(3) of this title (other than amounts contractually due to creditors holding such allowed secured claims and additional payments necessary to maintain possession of that residence), the debtor has insufficient remaining income to retain possession of the residence by curing a default and maintaining payments while the case is pending, as provided under paragraph (5); and

(B) provide for payment of such claim--


(i) in an amount equal to the amount of the allowed secured claim;
(ii) for a period that is not longer than 40 years; and
(iii) at a rate of interest accruing after such date calculated at a fixed annual percentage rate, in an amount equal to the most recently published annual yield on conventional mortgages published by the Board of Governors of the Federal Reserve System, as of the applicable time set forth in the rules of the Board, plus a reasonable premium for risk."

So if Chapter 13 debtors would be able to work their budget into the calculations indicated, they would be permitted to reduce their mortgage claim down to the value of their residence, change the interest rate as indicated, and increase the term for up to 40 years.

Other Noteworthy Provisions of the Homeowner Assistance and Taxpayer Protection Act

• A Chapter 13 plan would also be able to provide for the waiver of any prepayment penalty.
• The credit counseling requirement would be waived for any debtor who files a certification that her principal residence has been scheduled for a foreclosure.
• The recent Emergency Economic Stabilization Act would be amended to require instead of merely encourage the Department of the Treasury, the Federal Reserve, the FDIC and FHFA to restructure mortgage loans which these entities now own or have a controlling interest in.
• Loan servicers would be required to restructure mortgage loans that qualify for the Hope for Homeowners program, rather than simply be encouraged to do so.
• Creditors would be required to go through a noticing procedure to add any post-petition contractual fees or costs to a claim secured by a principal residence, thereby avoiding the addition of hidden costs.
• The Bankruptcy Code amendments would apply to cases filed on or after the date of enactment, as well as cases pending on that date.
  

The "Taxpayer Protection" Portion of the Bill

Senator Durbin's website's news release contains the following summary of the remaining non-bankruptcy provisions of the bill:

"The financial rescue bill also failed to put in place enough taxpayer protections. Congress meant for banks to use the money provided by the Treasury to lend to qualified borrowers, rather than enriching their shareholders and executives. Recent reports indicating that AIG will lavish more than a half billion dollars on its employees at the same time that it receives an even larger $152 billion taxpayer bailout than originally announced speaks loudly to this problem.

"Durbin’s bill would add additional taxpayer protections by:

• Baring banks participating in the Capital Purchase Program, authorized by the Emergency Economic Stabilization Act, from increasing common share dividends as long as the government owns preferred shares; and by
• Requiring participating banks to reduce the next year's dividends in an amount equal to the compensation paid to the top five executives in excess of $500,000."

by: Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

Please note that this writer is not licensed to practice law in Oregon. This means that he is not legally permitted to give any legal advice or provide and legal services. This Bulletin and the entire contents of this website is written only for attorneys. and is not intended for the public. If any non-attorney is reading this, you must consult an attorney about ANYTHING you read here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2008 Bankruptcy Litigation Support for Attorneys

New Oregon Employment Data: The Trends Behind the News

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Yesterday (11/17/08) the Oregon Employment Department released statewide employment data for October 2008, highlighted by an unusually large 0.9% one-month increase in the unemployment rate to 7.3%. Even though the national average unemployment rate also went up--from 6.1% to 6.4%--this increase took the state in one month from slightly worse to significantly worse than the national average. Next month will give a better idea of the trend, particularly compared to the national average, but this large monthly unemployment rate increase is certainly troublesome considering the continued negative economic indications locally and nationally.

The news reports focus on a few items of that most grab the public's attention, but here I'll instead 1) provide easy access to the direct sources for this news, and 2) then give some valuable yet less publicized information gleaned from these sources.

The Sources

a) Here is the basic News Release from the State of Oregon Employment Department, a two-page summary of the employment and unemployment data for the month, broken down by industry.

b) A much more detailed 8-page report from the same source entitled Oregon’s Employment Situation: October 2008, which includes a number of tables and graphs, including a table of data comparing October 2008, September 2008, & October 2007 employment data broken down by industry and sub-industry.

c) The increase in the unemployment rate has triggered an Extended Benefit program for Oregon unemployment benefits, beginning the week of December 7, 2008. This is in addition to the usual 26-week program and the previously implemented 13-week Emergency Unemployment Compensation program. Here is a FAQ's sheet about this.

d) And here is a long Oregonian article on the story, although largely a re-hash of the Employment Department's data it also includes some noteworthy observations from some knowledgeable people such as Oregon's state economist Tom Potiowsky, Oregon Senate President Peter Courtney, and John McGrath, owner of McGrath's Fish House, a 20-restaurant chain.


Important, Less Publicized Analysis

1) The Oregon Unemployment Rate Trend
The seasonally adjusted unemployment rate from January through June of 2008 had hovered between 5.4 and 5.6%, but has generally been climbing since then, with July at 5.9%, August at 6.5%, September at 6.4%, and now October at 7.3%.

2) Longer-Term Oregon Unemployment History
Although the unemployment rate has climbed steeply in the last few months, it has not (yet?) reached the early 2002 high point of about 7.9% or the highest point of the decade at about 8.5% in mid-2003. However, Tom Potiowsky, the state economist is saying that the rate could reach or exceed 8%, and others are predicting it will hit double-digits.

3) Total Payroll Employment Trends
Since mid-2003, Oregon nonfarm payroll employment had climbed from about 1,580,000 to a high of about 1,740,000 in very early 2008, but has fallen off sharply since especially this summer, with a reduction of 24,500 jobs since October 2007, and 3,100 of those between just September and October 2008.

4) Employment in the Legal Services Sub-industry
This sub-industry of the "Professional and business services" industry has continued to stay quite stable in the last year, with about 12,800 employees, no indicated change from last month, and about an increase of 100 since October of 2007. Compare this, for example, with one of the other sub-industries in the same industry, with a similar size employee base, "Architectural and engineering services," which lost about 300 positions in the last month and 1,700 in the last year.

The Next Shoe to Drop
The state economist, Tom Potiowsky, issues his quarterly economic forecast on Wednesday, 11/19/08.

by: Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

Please note that this writer is not licensed to practice law in Oregon. This means that he is not legally permitted to give any legal advice or provide and legal services. This Bulletin and the entire contents of this website is written only for attorneys. and is not intended for the public. If any non-attorney is reading this, you must consult an attorney about ANYTHING you read here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2008 Bankruptcy Litigation Support for Attorneys

Debtor's Error in Social Security Number on Petition Results in Failure to Discharge Tax Debt

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Ellett v. Goldberg (In re Ellett)
Ninth Circuit Court Case No. 05-16677
October 29, 2007


In this case of first impression for the Ninth Circuit, indeed for any Circuit, the Court held that if a debtor prepares a bankruptcy petition with an inaccurate social security number, containing one inaccurate digit, the bankruptcy notice with that inaccuracy sent to a creditor does NOT put the creditor on sufficient notice to protect its rights, even if that notice included the debtor's accurate name and address. Accordingly, more than $21,000 of otherwise dischargeable tax liabilities were left not discharged after this debtor's Chapter 13 case.

The Facts
This individual debtor filed his Chapter 13 case before BAPCPA (when FRBP Rule 1005 required that the bankruptcy petition include the debtor's entire social security number not just its last four digits). His petition was filed with an inaccurate last digit in his security number. So a tax creditor, the California Franchise Tax Board (FTB) received a bankruptcy notice with the inaccurate social security number, and did not file a proof of claim or participate in any other way in the Chapter 13 case because its records showed no debt owed by the person with that social security number. The FTB's usual procedure when a social security number did not match the name on the petition was to put this information into a special list, and FTB's policy provided "an alternative procedure for an FTB employee to investigate further and attempt to match the name of the debtor to the correct SSN. This procedure, however, was used infrequently, if at all, due to resource limitations." The creditor here did not attempt to match the debtor with an accurate social security number, and so did not connect this taxpayer to his Chapter 13 case filing until after the claims bar date had passed.

After the completion of the Chapter 13 case and entry of discharge, the FTB contacted debtor to attempt to collect the debt, and debtor filed an adversary proceeding to determine dischargeability of the debt. The bankruptcy court held that the tax debt was not discharged because the erroneous social security number left FTB without proper notice, the U.S. District Court affirmed, and debtor appealed.

The Ninth Circuit's Rationale
The Court weighed the debtor's obligation to provide accurate identifying information--the social security number--against the creditors' obligation to identify the debtor from the other accurate information--name and address--it had received. Its rationale was that a § 1328(a) discharge covers "all debts provided for by the plan or disallowed under section 502" of the Code, and that a debt is not "provided for" if it does not receive adequate notice of the case. But what is adequate notice? Although this was a case of first impression, the Court spent most of its analysis reviewing its own and other related case law in answering this question. It concluded that, in spite of the fact that FTB had readily accessible information, between its records and the accurate information on the petition, to identify the debtor, and indeed had a policy and procedure to do so:

[the debtor] was in the best position to list the correct SSN on his petition and comply with the additional requirements of Rule 1005 of the Federal Rules of Bankruptcy Procedure. Requiring a creditor to ferret out a debtor’s correct identity when incorrect identifying information is provided would be overly burdensome and inappropriate. . . . . Here, due to [the debtor’s] negligence in listing an erroneous SSN on his bankruptcy petition and § 341(a) notice, proper notice was not provided to the FTB. Consequently, [debtor's] Chapter 13 plan did not “provide for” the FTB taxes. The FTB should not be punished because [debtor] failed to provide proper notice including his correct SSN.

Observation
The Court came to this conclusion in spite of the tax creditor having sufficient information very readily available to connect the bankruptcy notice it had received to the correct taxpayer. The Court is close to saying that if there is ANY inaccuracy in the petition information, the creditor has no duty to investigate, no duty to look at the other, accurate, information provided to it by the debtor or at the creditor's own records, to identify the debtor. The Court is being very solicitous of the governmental agency's administrative burden, perhaps recognizing both their limited personnel resources and contemporary realities of computer automation requiring that such information be completely accurate in order to be efficiently found in creditors' databases.

The Clear Bottom Line
Clearly debtors' attorneys must take extreme care to ensure that all of debtors' identifying information is accurate as shown on their bankruptcy petitions, including adding to their client disclosure forms a place for clients to sign or initial that the clients verify the accuracy of that petition information. Otherwise, the Professional Liability Fund will be paying off such nondischarged debt.


by: Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

Please note that this writer is not licensed to practice law in Oregon. This means that he is not legally permitted to give any legal advice or provide and legal services. This Bulletin and the entire contents of this website is written only for attorneys. and is not intended for the public. If any non-attorney is reading this, you must consult an attorney about ANYTHING you read here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

©2008 Bankruptcy Litigation Support for Attorneys