Republicans Propose Allowing States to File Bankruptcy
Newt Gingrich and Texas Senator John Cornyn are advocating allowing states, such as California and New York, to file bankruptcy. At present, only cities and other municipal entities can file bankruptcy under chapter 9 of the Bankruptcy Code. Allowing a state to utilize some form of bankruptcy protection would likely shift losses from taxpayers to public sector union employees and pension plans. In fact, Newt Gingrich's proposal would prohibit any tax increases as part of a reorganization. In addition to public employees, bondholders are likely to take a loss in a state bankruptcy, and adding a chapter of the Bankruptcy Code for states will certainly upset the government bond market. Nevertheless, University of Pennsylvanie law professor David. A. Skeel argues that state bankruptcy will make it easier for states to negotiate with unions and that the alternative of a federal bailout is unattractive. Skeel also notes that, although the bond market will be unhappy, California bondholders are already accounting for a potential default. - Reno Fernandez
Justice Kagan's First Opinion Tightens Automobile Ownership Cost Determination Under the Means Test
In her first opinion on the United States Supreme Court, Justice Elena Kagan reports the Justices' 8-1 ruling that a consumer debtor cannot deduct the IRS standard automobile ownership costs from his or her disposable monthly income under the means test if the automobile is free and clear. In Ransom v . FIA Card Services, N.A., 11 C.D.O.S. 459 (U.S. Supr. Ct. No. 09–907 January 11, 2011), Justice Kagan explained that the means test, which is used for determining eligibility for chapter 7 and is related to the calculation of plan payments under chapter 13, includes deductions from disposable monthly income for vehicle “Ownership Costs” and vehicle “Operating Costs” pursuant to certain IRS standards. The Ownership Costs include only loan or lease payments, and they are deemed to be $471 per month based on national automobile financing data. Operating Costs, on the other hand, can include the expenses of driving and maintaining a vehicle.
In Ransom, the chapter 13 debtor claimed the full Ownership Cost as well as Opweating Costs of $388 per month for a car that the debtor owned free and clear. A creditor, namely FIA Card Services, objected to the claim of Ownership Costs and argued that the payments to creditors proposed in the plan should be increased in light of the resulting higher disposable monthly income. The bankruptcy court agreed and denied confirmation of the plan. The Ninth Circuit Bankruptcy Appellate Panel and the Ninth Circuit Court of Appeals affirmed.
The Supreme Court focused on the language of 11 U.S.C. § 707(b)(2)(A)(ii)(I), which provides that: “The debtor’s monthly expenses shall be the debtor’s applicable monthly expense amounts specified under the National Standards and Local Standards, and the debtor’s actual monthly expenses for the categories specified as Other Necessary Expenses issued by the Internal Revenue Service for the area in which the debtor resides.” Specifically, the Justices ruled that the term "applicable" means that the debtor must have actually incurred the expense. In other words, the Ownership Costs do not apply if there are in fact no loan or lease payments. The opinion further notes that the Ownership Costs do not include the expenses of driving or maintaining an automobile, which are covered by the separate Operating Costs deduction.
The Justices did not discuss the debtor's policy argument or alternative interpretation of the term "applicable." These may be similar to the arguments advanced in a recent Credit Slips article. The article argues that: "[W]e also can think of the 'ownership expense' as the cost of saving up to replace an existing car. In addition, if we deny an ownership expense to a debtor who owns a car free and clear, we create an incentive to buy a new car on credit just before filing bankruptcy so that there is an actual out-of-pocket 'ownership expense' the debtor can deduct."
Justice Scalia filed a dissenting opinion, arguing that the term "applicable" does not do as much work as the majority thinks. "A House of Lords opinion holds, for example, that in the phrase ‘in addition to and not in derogation of ’ the last part adds nothing but emphasis. Davies v. Powell Duffryn Associated Collieries , Ltd. , [1942] A. C. 601, 607." Specifically, Justice Scalia argues that the phrase simply makes the IRS tables applicable to the means test. The tables have entries for "one car" and "two cars," but not "no car." In other words, the first two entries are applicable of the debtor has a car, and the last is applicable if the debtor has no car, regardless of whether there are any loan or lease payments.
In an interesting twist, the Credit Slips article criticized the Office of the US Trustee for having published guidelines on the means test that stated, without qualification, that the Ownership Costs could not be deducted if the automobile is free and clear; in other words, the US Trustee decided the Ransom case before the Supreme Court did.
By Reno F.R. Fernandez III
In Ransom, the chapter 13 debtor claimed the full Ownership Cost as well as Opweating Costs of $388 per month for a car that the debtor owned free and clear. A creditor, namely FIA Card Services, objected to the claim of Ownership Costs and argued that the payments to creditors proposed in the plan should be increased in light of the resulting higher disposable monthly income. The bankruptcy court agreed and denied confirmation of the plan. The Ninth Circuit Bankruptcy Appellate Panel and the Ninth Circuit Court of Appeals affirmed.
The Supreme Court focused on the language of 11 U.S.C. § 707(b)(2)(A)(ii)(I), which provides that: “The debtor’s monthly expenses shall be the debtor’s applicable monthly expense amounts specified under the National Standards and Local Standards, and the debtor’s actual monthly expenses for the categories specified as Other Necessary Expenses issued by the Internal Revenue Service for the area in which the debtor resides.” Specifically, the Justices ruled that the term "applicable" means that the debtor must have actually incurred the expense. In other words, the Ownership Costs do not apply if there are in fact no loan or lease payments. The opinion further notes that the Ownership Costs do not include the expenses of driving or maintaining an automobile, which are covered by the separate Operating Costs deduction.
The Justices did not discuss the debtor's policy argument or alternative interpretation of the term "applicable." These may be similar to the arguments advanced in a recent Credit Slips article. The article argues that: "[W]e also can think of the 'ownership expense' as the cost of saving up to replace an existing car. In addition, if we deny an ownership expense to a debtor who owns a car free and clear, we create an incentive to buy a new car on credit just before filing bankruptcy so that there is an actual out-of-pocket 'ownership expense' the debtor can deduct."
Justice Scalia filed a dissenting opinion, arguing that the term "applicable" does not do as much work as the majority thinks. "A House of Lords opinion holds, for example, that in the phrase ‘in addition to and not in derogation of ’ the last part adds nothing but emphasis. Davies v. Powell Duffryn Associated Collieries , Ltd. , [1942] A. C. 601, 607." Specifically, Justice Scalia argues that the phrase simply makes the IRS tables applicable to the means test. The tables have entries for "one car" and "two cars," but not "no car." In other words, the first two entries are applicable of the debtor has a car, and the last is applicable if the debtor has no car, regardless of whether there are any loan or lease payments.
In an interesting twist, the Credit Slips article criticized the Office of the US Trustee for having published guidelines on the means test that stated, without qualification, that the Ownership Costs could not be deducted if the automobile is free and clear; in other words, the US Trustee decided the Ransom case before the Supreme Court did.
By Reno F.R. Fernandez III
Anchor Blue Files Chapter 11
Today, Anchor Blue Holding Corp. and Anchor Blue, Inc. commenced a chapter 11 bankruptcy case in Delaware. Anchor Blue is a clothing retailer known for its denim wear. The company is based in Corona, California, and operates 117 stores and employs approximately 1446 employees in Arizona, California, Colorado, New Mexico, Oregon, Texas, Utah and Washington. - Reno Fernandez
Event Update: Alternative Strategies in Assisting Distressed Companies
On Thursday, January 13, 2010, John Seeley of Acrius Capital will be giving a talk entitled "Alternative Strategies in Assisting Distressed Companies" to the Barrister's Club Business, Commercial and Bankruptcy Section. We look forward to getting the inside scoop on turnaround financing and other issues. The program is from 12:00 to 1:00 pm, and all are welcome. For more information and to sign up, click here. - Reno Fernandez
Buyer (and Lender) Beware! Court Rules Bank May Have Acted as Financial Advisor and Wrongfully Refused to Fund All Phases of Condominium Project
In Errico vs. Pacific Capital Bank, N.A., ___ F.Supp.2d ___, 2010 Westlaw 4699394 (N.D. Cal.), William and Loretta Errico allege that in 2005 they applied for three loans to finance and develop a single parcel of real property they had owned for about 25 years. The loan was obtained through Niraj Maharaj, a vice president of Pacific Capital Bank, with whom the Errico's had previously done business. The bank orally agreed to finance at least 75% of the appraised value of the project.
Subsequently, Maharaj advised the Errico's that, due to a declining market, they should construct the project in phases, which would result in delayed financing. The Errico's agreed that the financing would be staggered in three separate loans for three phases: (1) construction of 140 condominium units; (2) construction of a commercial plaza; and (3) construction of off-site improvements (typically roads and utility trenches). Simultaneously, the bank assured the Errico's that it would provide the promised minimum financing for the entire project. However, as of approximately August, 2007, the bank secretly determined not to fund the condominium phase.
After the other two phases were funded, the bank advised the Errico's that the condominium construction costs should be reduced and that the units should be initially leased as apartments, and the Errico's agreed. Thereafter, the bank approved certain expenditures for the condominium phase, additional appraisals were obtained and additional information was provided to the bank. The prevailing economic crisis intervened, and in July, 2009, the bank informed the Errico's that it would not fund the condominium project.
The bank moved to dismiss the complaint, and the court ruled that the allegations of fraud and promissory estoppel were sufficient to state a cause of action. Specifically, the court ruled that the allegations could support findings that the bank orally promised to finance the entire project, and that the bank acted as financial adviser to the Errico's, who reasonably relied upon the promise.
The ruling that the bank might have acted as a financial adviser may be subject to criticism because no fiduciary relationship arises in a loan transaction absent special circumstances. Perlas v. GMAC Mortgage, LLC, 187 Cal.App.4th 429, 436 (2010). Whether the facts of this case give rise to a fiduciary duty is likely to be an issue at trial and possibly on appeal. In any case, this case is a reminder to both borrowers and lenders against going too far on a handshake.
By Reno F.R. Fernandez III
Subsequently, Maharaj advised the Errico's that, due to a declining market, they should construct the project in phases, which would result in delayed financing. The Errico's agreed that the financing would be staggered in three separate loans for three phases: (1) construction of 140 condominium units; (2) construction of a commercial plaza; and (3) construction of off-site improvements (typically roads and utility trenches). Simultaneously, the bank assured the Errico's that it would provide the promised minimum financing for the entire project. However, as of approximately August, 2007, the bank secretly determined not to fund the condominium phase.
After the other two phases were funded, the bank advised the Errico's that the condominium construction costs should be reduced and that the units should be initially leased as apartments, and the Errico's agreed. Thereafter, the bank approved certain expenditures for the condominium phase, additional appraisals were obtained and additional information was provided to the bank. The prevailing economic crisis intervened, and in July, 2009, the bank informed the Errico's that it would not fund the condominium project.
The bank moved to dismiss the complaint, and the court ruled that the allegations of fraud and promissory estoppel were sufficient to state a cause of action. Specifically, the court ruled that the allegations could support findings that the bank orally promised to finance the entire project, and that the bank acted as financial adviser to the Errico's, who reasonably relied upon the promise.
The ruling that the bank might have acted as a financial adviser may be subject to criticism because no fiduciary relationship arises in a loan transaction absent special circumstances. Perlas v. GMAC Mortgage, LLC, 187 Cal.App.4th 429, 436 (2010). Whether the facts of this case give rise to a fiduciary duty is likely to be an issue at trial and possibly on appeal. In any case, this case is a reminder to both borrowers and lenders against going too far on a handshake.
By Reno F.R. Fernandez III
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