Business Bankruptcy Basics

Learn about business bankruptcy basics and earn CLE credit valid in ten states with this video, available here.  The provider, namely LexVid, should give you one video for free.  Here is the course description:

There are a number of complex issues to consider when representing a business client in a bankruptcy.  Join Reno Fernandez, San Francisco commercial bankruptcy attorney, as he covers all the basics of a business bankruptcy case.  The program will focus mostly on corporate Chapter 11 cases, which allows the business to continue to operate with the goal or reorganizing and paying creditors.  Mr. Fernandez will also cover business Chapter 7 cases, which are an effective way to dissolve and wind up if the business does not require a reorganization.  Other topics include discharge, the automatic stay, trustees, and many more.

Mandatory Subordination Does Not Compel Claim Disalowance and Does Not Apply to Individual Debtors

In Khan v. Barton (In re Khan), CC-14-1021-TaDKi, CC-14-1041-TaDKi, CC-14-1062-TaDKi (9th Cir. BAP Dec. 9, 2014), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit (the "BAP") held that mandatory subordination of a claim under Bankruptcy Code Section 510(b) does not compel disalowance of the claim and does not apply to individual debtors.

In Khan, a creditor obtained judgment against the debtors and their corporation for conversion, fraud, breach of fiduciary duty and loss of common stock shares.  Thereafter, each of the debtors filed a chapter 13 bankruptcy petition.  The creditor filed proofs of claim in both cases. The creditor also commenced adversary proceedings to render the judgment nondischargeable.  The debtors responded by filing adversary proceedings for mandatory subordination of the creditor's claims under Section 510(b) and for disallowance of the claims.

The bankruptcy court ruled in favor of the creditor and dismissed the debtors' adversary proceedings with prejudice. On appeal, the BAP affirmed.

The court held that subordination of a claim does not compel disallowance because it impacts only the order of distribution among creditors, not the validity of the claim itself.  Moreover,  Section 510(b) does not apply to individual debtors; it applies only to claims against corporate debtors.

Discharging Student Loans

A recent opinion, namely In re Hedlund, 718 F.3d 848 (9th Cir. 2013), may make it easier to discharge student loans.  In Hedlund, the debtor borrowed approximately $85,000 for college and law school.  He failed the bar examination three times and took a job as a youth counselor.  The debtor was 33 years old and married with one child.  The debtor filed bankruptcy and sued for a declaration that his student loan debts were dischargeable.

The court applied the tough "undue hardship" standard for discharging student loans in an unusually lenient way.  The undue hardship standard requires that (1) the borrower and his or her defendants cannot maintain a minimal standard of living, (2) this is likely to be the case for a significant portion of the repayment period, and (3) he or she made a good faith effort to repay the loan.

The bankruptcy court determined that the debtor's family expenses were reasonable - including two cell phones, an automobile lease and cable television - notwithstanding the fact that his wife worked only one day per week and could work three and the debtor turned down a repayment plan he contended was itself unaffordable.  Accordingly, the court entered a partial discharge, discharging all but $32,080 of the student loans.

On appeal, the district court reversed.  However, the United States Court of Appeals for the Ninth Circuit reversed the district court and affirmed the bankruptcy court's original ruling.

The Ninth Circuit held that the district court erred by reviewing the bankruptcy court's finding of good faith de novo rather than under the "clear error" standard.  This gives bankruptcy courts significant leeway in determining whether the facts at hand support a finding of good faith, but it may be a double edged sword for debtors with unsympathetic facts.

The Ninth Circuit also held that bankruptcy court's application of the undue hardship standard was supported by substantial evidence that the debtor had maximized income, minimized expenses and attempted to negotiate repayments.  This holding is likely to provide significant help to former students attempting to discharge student loans.

Also seen on Legal By the Bay, the blog of the Bar Association of San Francisco.

Discharging Trust-Related Claims in Bankruptcy

Check out our article on Bankruptcy Code Section 523(a)(4) in this month's Bar Association of San Francisco Bulletin.  This is a self-study article providing one hour of MCLE credit.  Read the article here.

Under Washington Law, Marriage Establishes No Express or Technical Trust With Respect to the Exception from Discharge Provided in Bankruptcy Code Section 523(a)(4)

In In re Mele, 13 C.D.O.S. 12737, No. WW-13-1173-DTaKu (November 25, 2013), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit held that a property allocation judgment arising from marital dissolution proceedings in Washington is dischargeable in a chapter 13 case notwithstanding Bankruptcy Code Section 523(a)(4), which excepts from discharge debts "for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny...."

In Mele, the separated husband spent the spouses' $274,000 retirement savings, including spending hundreds of dollars on comic books and related expenses, and stopped paying child support, all apparently in violation of a court order.  Accordingly, the family court awarded the wife a judgment for return of her interest in the funds.  The husband commenced a chapter 13 bankruptcy case, and the bankruptcy judge ruled in favor of the wife in her nondischargeability action.

The BAP reversed.  First, there was a subsequent change in the law when the Supreme Court of the United States decided Bullock v. BankChampaign, N.A., 133 S.Ct. 1754 (2013), in which the Court rule that "defalcation" includes "a culpable state of mind requirement akin to that which accompanies application of the other terms in the same statutory phrase.  We describe that state of mind as one involving knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior." The former standard was very low and was triggered by even the most minor failure to observe fiduciary duties.  The bankruptcy court did not apply the new, higher standard.

More fundamentally, the BAP determined that a marital relationship under Washington law does not constitute an express or technical trust, which is a requirement that courts have long ascribed to the words "while acting in a fiduciary capacity."  An express trust is one created by expressly by the parties by words or agreement.  A technical trust arises from statute or at law.  In re Lewis, 97 F.3d 1182 (9th Cir. 1996).

Crucial to the BAP's ruling is that Washington has a statute governing when and how a trust is created, which was not applicable to marriages in general.  Revised Code of Washington Section 11.98.008.  Although there is Washington case law describing the fiduciary duties of spouses as arising from a confidential relation of trust, the court found no authority actually holding that a marriage constitutes an express or technical trust.  It will be interesting to see how this ruling is used in the context of other states' marital property regimes.

Also seen on Legal By the Bay, the Bar Association of San Francisco's New Blog.

Bank of America Fined $10,000 Per Month for Violations of Discharge Injunction

On Tuesday, United States Bankruptcy Judge Rober Drain ordered Bank of America to pay $10,000 plus attorney's fees for every month that the bank attempts to collect from Edwin and Michelle Ramos, who previously received a discharge in their chapter 7 bankruptcy case.  Although liens and mortgages were not discharged in their case, their personal liabilities were discharged, including their personal liability to to the bank.  The court stated that the ruling was intended to "send a message."

Contractor's Withdrawal Liability for Unpaid Pension Contributions Dischargeable in Bankruptcy

In Carpenters Pension Trust Fund for Northern California v. Moxley, 13 C.D.O.S. 9503, No. 11-16133 (9th Cir. August 20, 2013), the United States Court of Appeals for the Ninth Circuit ruled that a construction contractor's withdrawal liability for unpaid pension fund contributions is dischargeable in bankruptcy.

Contractors who stop working under collective bargaining agreements but stay in business must continue to fund the amount necessary to ensure payment to vested pension beneficiaries under ERISA.  29 U.S.C. §§ 1381, 1391.  In this case, Michael Moxley's obligations under a California carpenters multiemployer collective bargaining agreement lapsed but he continued in business without making pension contributions.  He filed bankruptcy owing the pension fund more than $170,000, and the fund brought an adversary proceeding to except it's claim from Moxley's discharge under Bankruptcy Code Section 523(a)(4).

Section 523(a)(4) excepts from discharge "any debt . . . for fraud or defalcation while acting in a fiduciary capacity . . ."  Although the pension fund is arguably a trust, the court determined that Moxley did not act in a fiduciary capacity with respect to the fund because, among other things:  (1) he did not administer the fund; and (2) the unpaid funds did not become an asset of the pension fund.

Section 523(a)(4) issues frequently arise in contractor cases, and this opinion should provide a valuable tool in determining how pension obligations are treated.

Actions Against Non-Debtor Spouse May Violate Discharge Injunction

In Lumb v. Cimenian, 2009 WL 427836 (1st Cir. BAP Feb. 23, 2009), the First Circuit Bankruptcy Appellate Panel (“BAP”) held that post-discharge actions against a non-debtor spouse of a chapter 7 debtor can violate the discharge injunction of Bankruptcy Code Section 524.

In this case, the debtor had entered into a business transaction with a creditor which did not substantially involve the debtor’s wife. The debtor later filed a voluntary chapter 7 petition. Thereafter, the creditor sent a letter to the debtor’s lawyer threatening to take legal action against the debtor’s wife. The creditor subsequently sued the debtor’s wife, who successfully defended the lawsuit. The creditor appealed, and the Supreme Court of Main affirmed, observing that the lawsuit was devoid of “even the slightest merit” and awarding $50,000 in attorney fees to the wife.

The debtor brought an adversary proceeding against the creditor in bankruptcy court, alleging that the creditor’s lawsuit against his wife amounted to a violation of the discharge injunction of Bankruptcy Code Section 524 in that the creditor’s actions were an effort to coerce him into paying the discharged debt. The bankruptcy court ruled in favor of the creditor, holding that the discharge offered no protection to the wife because she had not filed the bankruptcy.

The debtor/husband appealed, and the BAP reversed the bankruptcy court, ruling that: “Although we are not aware of any case in which a creditor was found to have violated the discharge injunction by virtue of actions taken against a third party, we note that the prohibition in section 524(a)(2) is not limited to actions by creditors against the debtor to collect on a discharged debt."