Spring 2008 • Issue 28, page 6

Bay Area Bankruptcy Forum & San Francisco Ban Assn. Review 2007's Key Business Bankruptcy Case Decisions

By Montali, Honorable Dennis, Dumas, Cecily & Oliner, Ron*

(This is the first of a two-part article – Ed.)

“Recent Developments in Business Bankruptcy” was the subject of panel presentations by the Bay Area Bankruptcy Forum and the San Francisco Bar Association Commercial Law and Business Section for attorneys from throughout the greater Bay Area and San Jose in November 2007.

The authors, panelists and presenters at the annual evening programs – The Honorable Dennis Montali, United States Bankruptcy Judge; Cecily A. Dumas, Esq., (a partner in the firm Friedman Dumas & Springwater LLP); and Ron Mark Oliner, Esq. (a partner in the firm Duane Morris LLP) – have excerpted the facts and law from some of the most important cases reported on for readers of the Receivership News.

Chapter 7 Debtors Do Not Have an Absolute Right to Convert their Cases to Chapter 13.
Section 706(a) of the Bankruptcy Code gives debtors who file under chapter 7 an unwaivable right to convert their cases to chapters 11, 12, or 13 at any time, subject to the condition (expressed in subsection (d)) that the debtor is eligible to be a debtor under the new chapter. In Marrama, the Supreme Court held that this right to convert, though it may not be waived, may be forfeited through bad faith. The debtor had made a number of misleading or inaccurate statements about his principal asset; when he later invoked his right to convert to chapter 13, the bankruptcy court denied his request. The Supreme Court affirmed, reasoning that the debtor’s eligibility under chapter 13 was vitiated by the court’s finding of bad faith, which is grounds for dismissal or conversion under section 1307. In dissent, Justice Alito opined that the majority’s imposition of a good faith condition on the debtor’s conversion right was inconsistent with the clear terms of section 706(a).
Marrama v. Citizens Bank of Mass., ___ U.S. ___, 127 S. Ct. 1105, 166 L. Ed. 2d 956 (2007).

Section 502(b)(6) Does Not Cap Tort Claims for Damage to Rented Property.
Bankruptcy Code § 502(b)(6) limits a landlord’s claim for damages from the termination of a real property lease by a debtor tenant, based on the amount of rent still owed. Here, the landlord was stuck not only with a terminated lease, but also with approximately a million tons of dirt and debris that its tenant, a mining company, had allegedly left behind. The cleanup cost was $23 million—several orders of magnitude greater than the cap would allow. But the Ninth Circuit held (reversing the BAP) that the § 502(b)(6) cap applies only to claims for damages resulting from the rejection of the lease itself, not to claims for collateral damage to the rented property. Overruling Kuske v. McSheridan (In re McSheridan), 184 B.R. 91 (9th Cir. BAP 1995).
Saddleback Valley Community Church v. El Toro Materials Co. (In re El Toro Materials Co.), 504 F.3d 978 (9th Cir. 2007).

Property of the Estate Includes the Debtor’s Right to Future Tax Reductions.
James and Beverly Nichols were entitled to federal and state tax refunds for the year 2001, but instead they elected to apply the overpayments to their future tax liabilities. A few weeks after making this irrevocable election, the couple filed for bankruptcy. The court held that the money left on deposit with the taxing authorities was property of the estate subject to turnover from the debtors under Bankruptcy Code § 542. Cf. In re Feiler, 218 F.3d 948 (9th Cir. 2000) (holding that a debtor’s waiver of the right to a present tax refund based on previous years’ net operating losses was a fraudulent transfer). It didn’t matter that the money was in the government’s hands and out of the debtors’ reach, the illiquidity of an asset being no barrier to its becoming property of the estate. See Bankruptcy Code § 541(c)(1).
Nichols v. Birdsell, 491 F.3d 987 (9th Cir. 2007).

Discharge Does Not Moot Appeal From Denial of Motion to Dismiss.
Last year, the Ninth Circuit held that the SEC, by virtue of a disgorgement judgment it held against the debtor, was a “creditor” with standing to move for dismissal of a chapter 7 case. Although the bankruptcy court had discharged the debtor’s debts by the time the appeal was heard, the Ninth Circuit considered the appeal not moot because the bankruptcy court had no jurisdiction to enter its discharge order while the appeal of its order denying the motion to dismiss was pending. The Ninth Circuit has now amended its opinion to explain that the appeal did not in fact divest the bankruptcy court of its jurisdiction to enter the discharge order—as would, for example, an appeal from an order granting a motion to dismiss—because the court could enter the discharge order without altering or expanding upon the appealed order. Nevertheless the appeal was still not moot, given that the SEC, if it prevailed on appeal, could obtain relief from the discharge order under Fed. R. Civ. P. 60(b).
Sherman v. SEC (In re Sherman), 491 F.3d 948 (9th Cir. 2007).

Counter-Claim Against a Trustee in Preference Litigation.
Chapter 7 trustee sued to recover a preference. Defendants filed a counter-claim against the trustee. Question presented was whether the trustee is an “opposing party” when he brings a preference action on behalf of the estate, but where a counter-claim alleges causes of action that could have been brought against the debtor (not the estate). Ninth Circuit rules that trustee is not an opposing party under these circumstances, affirming Bankruptcy Court’s dismissal of counter-claim. See generally FRBP 7013 and FRCP 13 (governing the proprietary of counter-claims).
Metcalf v. Golden (In re Adbox, Inc.), 488 F.3d 836 (9th Cir. 2007).

Even a Single Transaction Can Create “Ordinary Course” Exception in Preference Litigation.
Under pre-BAPCPA Bankruptcy Code § 547(c)(2), payment for a debt incurred in the ordinary course of business is exempt from avoidance as a preference if the payment is also made in the ordinary course of business and according to ordinary business terms. The ordinariness of a transaction is generally to be determined relative to past practices between the debtor and the creditor. See In re Food Catering & Hous., Inc., 971 F.2d 396, 398 (9th Cir. 2002). In this case, the debt arose from the first-time dealing between the debtor and the creditor, so there were no past practices to be considered. The Ninth Circuit held that in such a circumstance, the debt can be considered to have arisen in the ordinary course of business if it is ordinary relative to the debtor’s and creditor’s past dealings with other, similarly situated parties. If a party has never engaged in similar transactions, courts may consider more generally what would be expected of similarly situated parties. The court also held that when an original debt was later restructured, both the original debt and the restructuring must be considered to determine whether the transaction was within the ordinary course of business.
Wood v. Stratos Product Development, LLC (In re Ahaza Systems, Inc.), 482 F.3d 1118 (9th Cir. 2007).

Bankruptcy Schedules Do Not Give Constructive Or Inquiry Notice To Defeat Trustee’s BFP Status Under 544(a)(3).
In the infamous case of Briggs v. Kent (In re Professional Investment Properties), 955 F.2d 623 (9th Cir. 1992), a creditor holding an unperfected security interest invited disaster by filing an involuntary petition. That would normally result in avoidance of its interest by the trustee, wielding the powers of a hypothetical bona fide purchaser (a “bfp”). The creditor was saved by the Ninth Circuit’s surprising holding that the involuntary petition itself listed enough information about the creditor’s claim to put the trustee on constructive or inquiry notice, preventing the trustee from qualifying as a bfp. The BAP, however, narrowed Professional Investment Properties to its highly unusual facts, reversing a bankruptcy court’s holding that the debtor’s schedules and statement of financial affairs gave the trustee constructive or inquiry notice, since logically those documents cannot be filed until after the petition is filed, whereas the trustee’s bfp powers arise as of the moment the petition is filed.
Taxel v. Chase Manhattan Bank, USA, NA (In re Deuel), 361 B.R. 509 (9th Cir. BAP 2006).

*The Hon. Dennis Montali is a United States Bankruptcy Judge sitting in the San Francisco Division of the Northern District of California.

*Cecily A. Dumas, Esq. is a partner in the firm Friedman Dumas & Springwater LLP.

*Ron Mark Oliner, Esq. is a partner in the firm Duane Morris LLP.