Sunday, October 08, 2006

Administrative Expenses: Direct and Substantial Benefit to the Estate

In In re Korn, a creditor made a § 503(b)(1)(A) request for administrative expenses. There, a debtor-in-possession sold real property to the creditor. The creditor planned to develop the property as a mall, and required the debtor to vacate the property expeditiously. Complicating the matter was the fact debtor housed a business dealing with exotic animals on the property. Debtor needed to relocate the animals before he could vacate the property. To facilitate the move, creditor funded a trust with $50,000.00, to reimburse actual expenses incurred while moving. Because the creditor needed the debtor to vacate the property in order to deliver on an agreement to a mall tenant, when the debtor delayed moving off the property, the creditor provided additional funds to the trust account and made numerous direct disbursements to facilitate the move. The creditor now claims an administrative expense of $157,074.64 administered from trust account, and $437,712.53 in direct expenditures in relocating the animals. The original sale agreement only provided for the funding of $50,000.00 to the trust account, and did not provide for the payment of direct expenditures. Additionally, the sale agreement provided remedies to the creditor if the debtor failed to vacate the property timely. Those remedies were not pursued by the creditor. The court was required to determine, whether the creditor was entitled to an administrative priority for animal relocation costs.

Under § 503(b)(1)(A), administrative expenses are allowed for “the actual, necessary costs and expenses of preserving the estate . . . rendered after the commencement of the case.” The court said, in order to establish an administrative expense, “the claimant must show the debt it incurred (1) arose from a transaction with the debtor-in-possession as opposed to the preceding entity, and (2) directly and substantially benefitted the estate.”

In this case, the creditor argued its claims were necessary for the execution of the terms of the Sale Order. However, the court found contrary. The court observed the funds spent for animal relocation did not directly and substantially benefit the estate. The debtor argued the estate benefitted from the payment of additional expenses, by preventing the debtor from breaching the sale agreement. But, the court held, “because neither the Sale Agreement nor its implementing Sale Order obligated [the creditor] to advance any money to Debtor, for any purpose, beyond the initial $50,000.00, there can be no breach of contract claim under the Sale Agreement regarding a failure to repay those additional amounts.”

Saturday, September 16, 2006

Ride Through Severly Limited In The District of Idaho

The District of Idaho recently weighed in regarding the validity of a “ride-through” under BAPCPA. In In re Steinhaus, the court held a debtor’s ability to retain property secured by consumer debt was severely limited under the new bankruptcy act.

In Steinhaus, the debtors filed a Form 8 with their petition that allowed the debtors to indicate, as to each creditor or lessor and each item of secured or leased property, whether they intend to surrender the property, claim the property as exempt, redeem the property under § 722, or reaffirm the debt under § 524(c). Instead of making use of the form, the debtor’s inserted their own language stating their intention was to retain the vehicle and continue to make regular payments. The court held the automatic stay was terminated 30 days after the filing of the petition because the debtors never indicated in their statement of intention whether they intended to surrender or retain the property by redemption or reaffirmation agreement.

Prior to BAPCPA, under § 521(2)(A), the Ninth Circuit allowed a debtor to maintain current payments on property secured by consumer debt without redeeming or reaffirming the debt against the property. As long as the debtors maintained current payments to the secured creditor, the debtor could retain the collateral and discharge any unsecured liability associated with the debt.

In Steinhaus, the court held that BAPCPA did not eliminate the ride through provision in §521, but § 362(h) significantly impacted its applicability. Section 362(h) provides for the termination of the automatic stay under certain circumstances. One of those circumstances occurs if the debtors fail to file a timely statement of intention under § 521(a)(2), or to indicate in the statement that the debtor will either surrender the personal property or retain it and, if retaining the personal property, either redeem the property pursuant to § 722, enter into a reaffirmation agreement under § 524(c). This approach is consistent with other courts around the country. See In re Boring, 346 B.R. 178, 180 (Bankr. N.D. W. Va 2006); In re Rowe, 342 B.R. 341, 346-47 (Bankr. D. Kan. 2006); In re Craker, 337 B.R. 549, 551 (Bankr. M.D.N.C. 2006).

Additionally, the court held under § 521(a)(6), chapter 7 debtors must either redeem or reaffirm property in which a creditor holds a purchase money security interest. The statute provides no other options, including a ride through. The court further held the use of “allowed” claims in §521(a)(6) does not preclude creditors who have not filed a proof of claim from obtaining relief under the statute. Also, creditors qualify for protection under § 521(a)(6) even if their claim is less than the full purchase price. As a remedy for creditors, this section provides “the stay under section 362(a) is terminated with respect to the personal property of the estate or of the debtor which is affected, such property shall no longer be property of the estate, and the creditor may take whatever action as to such property as is permitted by applicable nonbankruptcy law[.]” The effect of this remedy, is that creditors are free to pursue any remedy available under state law, with respect to the collateral.

Saturday, August 26, 2006

Compromises, Distributions, and Constructive Trusts

Compromises are regularly used in bankruptcy cases. They can be an effective tool for trustees to maximize the proceeds of assets distributed by the estate. In In re Olson, the District of Idaho recently published an opinion that laid out the general requirements for both compromises and distributions. Additionally, the court addressed the applicability of constructive trusts in a compromise and distribution.

A compromise must be fair and equitable, and supported by an adequate factual foundation. In determining the fairness, reasonableness and adequacy of a proposed settlement agreement, the court must consider:

(a) The probability of success in the litigation;
(b) the difficulties, if any, to be encountered in the matter of collection;
(c) the complexity of the litigation involved, and the expense, inconvenience and delay necessarily attending it;
(d) the paramount interest of the creditors and a proper deference to their reasonable views in the premises.
In re Marples, 266 B.R. 202, 206, (Bankr. D. Idaho 2001); Martin v. Kane (In re A & C Properties), 784 F.2d 1377, 1381-83 (9th Cir. 1986).

Distributions are usually made in a combined motion with the compromise. Like a compromise, the factual and legal basis for all distributions must be made in the motion. Distributions are generally of two kinds: subrogation, and payments to alleged lienors, secured creditors or others. To show a sufficient factual and legal basis for distributions sought under subrogation, the trustee must document the source and extent of the insurers subrogation right, and the claims paid by the insurer. For payments to other creditors, the trustee must have adequate proof of the distributee’s entitlement, a sufficient record must be laid with that proof, and the motion must explain why the creditor is entitled to payment.

In Olson, the trustee was seeking court approval to pay two post-petition medical creditors. These obligations were not subject to discharge under § 524(a) and § 727(b), and not entitled to receive compensation from the bankruptcy estate. Therefore the trustee claimed the settlement proceeds were held in constructive trust for the post-petition medical creditors. Under § 541, property held in trust by a debtor for another, is excluded from property of the estate. See Mitsui Mfrs. Bank v. Unicom Computer Corp. (In re Unicom Computer
Corp.), 13 F.3d 321, 324 (9th Cir. 1994).

To be valid, a constructive trust must be (1) recognized by applicable state law, (2) applied in a manner consistent with federal bankruptcy law, and (3) at the time of filing the case the debtor’s interest in the trust property was only legal and lacking an equitable interest. This is a pre-petition date analysis for a legal interest in the trust property. In re Hiatt, 00.3 I.B.C.R. 131, 132 (Bankr. D. Idaho 2000). In Olson, the creditors were post-petition medical creditors, and therefore had no legal interest in the settlement proceeds at the time the case was filed.

Section 1141 Discharge - Applicable To Claims Arising Prior To The Date of Confirmation, or The Date Plan Becomes Effective?

After a Chapter 11 reorganization plan was confirmed and went into effect, three plaintiffs brought an action against ZiLOG alleging employment discrimination stemming from an offer to pay retention bonuses, that was subsequently revoked. The bankruptcy court granted summary judgment to ZiLOG and held that the discrimination claims arose pre-discharge. The Ninth Circuit reversed. In re Zilog, Inc., 450 F.3d 996 (9th Cir. 2006).

Pursuant to 11 U.S.C. § 524(a)(2), confirmation of a plan “operates as an injunction against the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the debtor.” See also § 1141(d)(1). However, this only bars the continuation of claims that have accrued under the bankruptcy code at the time the plan is confirmed. The Ninth Circuit held that the plaintiffs’ claims may not have been within their fair contemplation until after the confirmation order on April 30th, and therefore were outside the bankruptcy process.

The bankruptcy court below held that the employment discrimination claims were within plaintiffs’ fair contemplation when the plan became effective on May 13th, and therefore were subject to discharge. This rational would allow a bankruptcy court to discharge all claims arising from the time of confirmation until the plan became effective, even though no provision was made for their presentation and payment. The Ninth Circuit recognized there would be manifest injustice in discharging claims that arose after the date of the confirmation order, without allowing for the presentation of such claims. Therefore, only claims that arise prior to an order for confirmation are discharged under § 1141.

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