Tuesday, January 24, 2012

Nice Explanation of Excusable Neglect

Print Page

There is nothing quite like the horror of realizing that a deadline has been missed. As the heart pounds at the thought of notifying client and carrier, the mind should shift to damage control. Was this a deadline which could be extended after the fact based on excusable neglect? O'Brien v. Harnett, Adv. No. 11-5010 (Bankr. W.D. Tex. 1/19/12), which can be found here, is a nice addition to the jurisprudence of excusable neglect.
The point is that the notion of “excusable neglect” of necessity presumes that someone has made a mistake, someone has been careless, someone has been negligent. It is no answer, then, to a request for mercy that the party making the request should not have made the mistake. Hindsight always affords the clarity that confirms that, had the person simply been paying strict attention, no mistake would have been made. The reality is that human beings often are not paying strict attention all the time. Not even lawyers.


Of course it was a mistake for counsel not to then go back to the docket to confirm the entry of the order itself. Hindsight, as we have seen, makes us all perfect (or seem that we should have been). But his secretary was out of the office, it was the week between Christmas and New Years, and thus counsel, as most people in that time period tend to be, was more distracted than usual. (emphasis added).
Opinion, p. 4.

This opinion is not only a handy resource to use in making pleas for mercy in the case of inadvertently missed deadlines, but is also a good commentary on human nature. Anyone can be perfect in hindsight. However, the reality is that we don't always pay attention as well as we could and that condition is magnified during the holidays. Thank you, Judge Clark, for saying it.

Friday, January 20, 2012

Yet Another Hanging Paragraph Creates a Taxing Situation

Print Page

A pair of new opinions suggests that dischargeability of taxes is even more complicated subsequent to BAPCPA. In Matter of McCoy, No. 11-60146 (5th Cir. 1/4/12), which can be found here, the Fifth Circuit found that, under Missisippi law, late filed returns did not constitute "returns" at all and thus were not subject to being discharged. In In re Hernandez, Adv. No. 11-5126 (Bankr. W.D. Tex. 1/11/12), which can be found here, Judge Leif Clark found that returns filed after the IRS made its own assessment on unfiled returns were not subject to discharge either. While these decisions may be consistent with the prevailing sentiment, they are not necessarily rooted on solid legal reasoning.

The Other Hanging Paragraph

One of BAPCPA's legacies will be the hanging paragraph, a piece of text hanging by itself which is not part of a specific subsection. We are reasonably familiar with the hanging paragraph of Section 1325(a)(*) which has to do with the valuation of vehicles in chapter 13 cases. Now, six years after BAPCPA took effect, a new hanging paragraph has been discovered, Section 523(a)(*), having to do with dischargeability of taxes. While dischargeability of taxes is dealt with in Section 523(a)(1), which would have been a logical place to put the additional language, Congress saw fit to add a codicil to Section 523(a)(1) at the end of Section 523(a). The new language states:

For purposes of this subsection the term "return" means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to ajudgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law.
Why do we care about the definition of return? Section 523(a)(1)(B) states that a debt is not dischargeable "with respect to which a return . . . was not filed or given; or" was filed "after two years before the date of the filing of the petition."

Prior to BAPCPA, a return could be filed late but at least two years before bankruptcy and still be dischargeable.

However, under the new jurisprudence, some late returns, even if filed more than two years before the date of the petition, are not returns at all.

Going to Mississippi

Linda McCoy, a resident of Mississippi, filed bankruptcy. Mississippi is one of those states that are not Texas which have a state income tax. (While most states have state income taxes, it is an unwritten law here in Texas that proposing a state income tax is a sacrilege on the same level as urinating on the Alamo). Linda McCoy did not file her state income tax returns for 1998 and 1999 when they were due. She did ultimately file her returns, but she filed them after the date they were due.

The Fifth Circuit held that under Mississippi law, a "return" meant a timely filed return. Therefore, a late return constituted an unfiled return and could not be discharged.

Turning to Texas

A few days later Judge Leif Clark interpreted the hanging paragraph of section 523(a)(*) in the context of federal taxes in Texas. (Have you ever noticed that "taxes" and "Texas" contain most of the same letters. It seems subversive since Texans hate taxes--just ask Rick Perry). The Hernandez decision involved a lot of years of taxes. The Debtor did not file timely returns for 1999 through 2006, although he eventually got them all filed. For the seven years in question, the IRS assessed liability for three years before the Debtor got around to filing returns. For the other four years, the IRS either did not get around to making assessments before the returns were filed or no taxes were due.

The IRS did not contest dischargeability for the years in which the Debtor filed his returns prior to taxes being assessed or where it acknowledged that no taxes were due. However, for the three years in which assessments preceded returns, it contended that the taxes could not be discharged--and the court agreed.

The Rationale

Prior to BAPCPA, the term "return" was not defined. Case law held that "a late filed return that required the government to assess the tax without the tax payer's assistance would not be treated as a return for section 523 purposes." McCoy, at 5. In order to constitute a "return" under prior law, it had to satisfy four requirements:

1. It had to purport to be a return;
2. It had to be executed under penalty of perjury;
3. It must contain sufficient information to allow calculation of the tax; and
4. It must represent an honest and reasonable attempt to satisfy the requirements of the tax law.

The new hanging paragraph replaced the old test with three guidelines:

1. The return must be a "return that satisfies the requirements of applicable nonbankruptcy law (including filing requirements);"
2. It would include a return "prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal; and
3. It would not include "a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law.

The Mississippi State Tax Commission argued that under the first factor an untimely return was not "a return that satisfies the requirements of applicable bankruptcy law (including filing requirements)." The Debtor argued that MSTC's construction would read the reference to section 6020(a) out of the statute. As acknowledged by the Fifth Circuit, returns under section 6020(a) involve cases in which the Debtor fails to file an actual return but nevertheless provides the IRS with all of the information necessary to calculate the liability.

The Fifth Circuit adopted MSTC's reasoning stating:

We find MSTC''s interpretation of section 523(a)(*) more convincing. We have previously explained that "the plain language of the [Bankruptcy] Code should rarely be trumped. Although the Code at times is 'awkward, and even ungrammatical . . . that does not make it ambiguous." (citation omitted). The plain language interpretation of section 523(a)(*) comports with this admonition.
McCoy at 8-9. The Court went on to find that returns prepared under section 6020(a) constituted a narrow exception to the rule that late filed returns were not returns. It also referred to other courts which have reached the same result.

The Hernandez Court did not significantly expand upon the Fifth Circuit opinion, stating:

Anticipating consistency on the part of the circuit court, this court concludes that late-filed returns cannot be treated as filed, for purposes of section 523(a)(1), save for returns that comport with the requirements of section 6020(b)(sic) of title 26. The exception is a narrow one, and does not apply on the facts of the case sub judice. [Ed. The correct statutory reference was section 6020(a). The court corrected the cite in an errata to the opinion].
Hernandez at 9.

If Every Other Court Jumped Off a Building Would You Join Them?

The Courts following the majority interpretation of section 523(a)(*) show a lemming-like ability to follow the crowd without careful thought. Section 523(a)(1)(B) provides that taxes are not dischargeable in two instances:

1. Where a return was not "filed or given;" or
2. Where the return "was filed or given after the date on which such return, report, or notice was last due, under applicable nonbankruptcy law or under any extension, and after two years before the date of the filing of the petition.

Thus, section 523(a)(1)(B) has two components to it: a substantive one and a temporal one. If no return was filed, then the tax cannot be discharged. However, if the return was filed at least two years before bankruptcy, even if it was not timely filed, it could be discharged (assuming that the other requirements for dischargeability are met).

The McCoy decision does not state when the returns were actually filed. However, In Hernandez, the Court's finding of fact explicitly recite that the returns for 1999, 2003 and 2004 were each filed more than two years before the petition date. Thus, Hernandez raises the Catch-22 situation in which a return filed at least two years before bankruptcy may be subject to discharge but a return filed one day late is not a return at all.

To be blunt, McCoy and Hernandez obliterate section 523(a)(1)(B)(ii) by stating that late-filed returns, much like disgraced party members in the former Soviet Union, are non-returns. (In the Soviet Union, party members who had fallen from favor would be erased from photographs and treated as though they had never existed). Why would the statute allow for returns filed more than two years prior to bankruptcy to be considered when all late filed returns would necessarily be considered non-returns? The obvious answer is that the hanging paragraph was meant to address the question of whether the document submitted was sufficient to constitute a return rather than whether it was a timely return. The reference to "filing requirements" in the hanging paragraph is best understood as a reference to whether the document was filed rather than when it was filed.

The language of the hanging paragraph reinforces the interpretation that it was meant to be a substantive rather than a temporal requirement. Under the hanging paragraph, "a written stipulation to a judgment or final order entered by a nonbankruptcy tribunal" would constitute a return. Thus, if a Debtor who filed nothing and waited for the taxing authority to initiate suit , but then agreed to the assessment would have been deemed to have filed a return. On the other hand, if the debtor filed his return one day late and the ever-vigilant taxing authority made its assessment in the intervening hours, the return would cease to exist. This makes no sense.

I may be missing something profound or obvious. However, these decisions appear to be just plain wrong.

Hat tip to Michael Baumer who got the word out on these decisions on the State Bar of Texas Bankruptcy Section listserve. Michael is a smart guy and caught the importance of these opinions before I did.

Sunday, January 01, 2012

Best of the Rest

Print Page

LinkEvery year, I read more cases than I have time to blog about. Here are some cases that I meant to write about but didn't have the time. My inability to get to these cases is demonstrated by the fact that I am concluding my year-end clean-up on January 2nd, two days into the new year.

Philadelphia Newspapers:

River Road Partners v. Amalgamated Bank, 651 F.3d 642 (7th Cir. 2011), cert granted, RadLAX Gateway Hotel, LLC v. Amalgamated Bank, No. 11-166 (2011). The Supreme Court has granted cert to resolve the Philadelphia Newspapers issue of whether a debtor can deny a creditor's right to credit bid in a plan by offering the creditor the "indubitable equivalent." The Third Circuit said yes. The Seventh Circuit said no. You can access all the relevant documents at SCOTUS Blog here.

Gifting and Bad Faith:

In re DBSD, North America, Inc., 634 F.3d 79 (2nd Cir. 2011). The Second Circuit held that "gifting" where a senior class of claims gives up property in favor of a junior class violates the absolute priority rule where an intervening class of claims is skipped. The Court also held that votes of a competitor could be designated as cast in bad faith.

Collateral Attacks on Plans:

Matter of Davis Offshore, LP, No. 09-41294 (5th Cir. 7/16/11), which can be found here.

Chapter 11 cases are frequently criticized for languishing in the courts. However, this prepackaged chapter 11 case proceeded to confirmation in less than a week, resulting in a sale to a group which included a member of the family which owned the companies. Unfortunately, that is when the bickering began. Although no party appealed the confirmation order, one of the former shareholders filed a motion to revoke confirmation under 11 U.S.C. §1144. The bankruptcy court determined that no fraud had taken place. The district court vacated the bankruptcy court’s order but dismissed the appeal due to equitable mootness. Rather than appealing this decision, the former shareholder then sued the purchasers for fraud. The bankruptcy court found that the fraud suit was an impermissible collateral attack on the confirmation order. A direct appeal to the Fifth Circuit was authorized.

The Fifth Circuit, in an opinion by Chief Judge Edith Jones affirmed the bankruptcy court. The following passage captures the essence of the opinion:
The principal question posed on appeal is whether the Plan and confirmation order bar the assertion of fraud claims against the defendants/appellees. This is an issue of perennial importance in bankruptcy procedure. Bankruptcy cases must be and often are resolved in haste to prevent the continuing depletion of a debtor’s value and assets. Haste, however, creates the danger that inadequate supervision of deals, valuations, and participants in the process may occur, leaving a fertile field for fraud. To this extent, the demands for finality and integrity in the process may be in tension. In some situations, fraud and related claims may outlive the bankruptcy process. (citation omitted).

We conclude that in this case, in the context of reorganizing a family owned company all of whose shareholders had access to sophisticated financial and legal assistance, and where the releases and exculpatory provisions in the Plan and confirmation order were essential to a reorganization that no party appealed, those provisions bar the (Appellant’s) current claims.
Opinion, pp. 3-4. This case goes to show that when you push to get a deal done quickly, you may be stuck with results that you don’t like.

Section 502(b)(6):

In re Dronebarger, No. 10-10889 (Bankr. W.D. Tex. 1/31/11), which can be found here. This case is significant as the maiden opinion from Judge H. Christopher Mott, who took the bench in October 2010. The issue was whether the guarantor of a lease could take advantage of the cap on damages resulting from lease termination under section 502(b)(6). In a forty page opinion, the Court said no. The Court's primary reasoning was that section 502(b)(6) was limited to damages arising from termination of a lease. Here, the damages arose from failure to repair the property during the pendency of the lease, not from termination of the lease. As a result, he distinguished the case from In re Mr. Gatti's, Inc., 162 B.R. 1004 (Bankr. W.D. Tex. 1994), where the damages resulted from rejection of the lease in bankruptcy. He also ruled that a guarantor could not take advantage of the cap because his liability arose under a guaranty rather than under the lease. The opinion has an excellent discussion of section 502(b)(6) and should be must reading for any party litigating under that section.

Disclosure: My firm became co-counsel to the Debtors subsequent to the court's opinion. We were not involved in the claims issue. Another interesting historical note is that Eric Taube represented the landlord in both Mr. Gatti's and Dronebarger. I represented the Debtor in Mr. Gatti's.

Fraudulent Transfers:

In re Wren Alexander Investments, LLC, No. 08-52914 (Bankr. W.D. Tex. 2/17/11). You can find the opinion here. This case goes to show that not all second acts are for the better. Charles Pircher is a former banker who went to prison during the bank scandal of the 1980s. After prison, he managed a series of professional employee organizations which minimized workers compensation costs by forming new entities to take advantage of lower rates given to new companies. The PEOs were supposed to pay wages and remit taxes to the government. They failed to accomplish the latter, resulting in a large IRS tax liability.

One of the PEOs acquired a ranch in Medina County, Texas. It proved to be a good investment because it was purchased for $630,000 in 1999 and was sold for $5,250,000 in 2009. Pircher used money from the PEOs to build a 10,000 square foot house, a 12,000 square foot horse stable and a 39,000 square foot quarter horse arena. While Pircher said that he had an informal agreement to pay the money back at some point, no documents were drafted and he paid no rent.

The first owner of the property, United Capital Investment Group, Inc., took out a hard money loan to pay off the original purchase price, to build improvements on the property and to pay Pircher's criminal restitution obligations. When the IRS started filing tax liens against the PEOs, Pircher transferred the property to Medina Heritage, Ltd., an entity he controlled. While the deed was dated prior to the filing of an IRS tax lien, it was not recorded until afterwards. The consideration for the transfer was assumption of the existing liabilities on the property.

The property was then transferred to Wren Alexander Investments, Ltd., the debtor in this case. Wren Alexander was controlled by a close business associate of Pircher's. The purchase price was the amount necessary to pay off the existing liens (although not the tax lien). Pircher's stated intent in selling the property was to get it out of his name while retaining control. The IRS filed a nominee lien against Wren Alexander Investments, Ltd.

Wren Alexander filed chapter 11 and the property was sold. The Debtor filed an objection to the claim of the IRS. The principal issue was whether the tax lien was valid against the transferee of the property. Judge Ronald King has an excellent discussion of Texas fraudulent transfer law. Judge King found that the transfer from United Capital to Medina Heritage was a fraudulent transfer because the property was sold for less than reasonably equivalent value while insolvent. The found that this provision could not be used to avoid the second transfer because the IRS was not an existing creditor of Wren Alexander. However, he did find that the transfer could be avoided as one made with actual intent to hinder, delay or defraud. The result was that the IRS received the remaining proceeds in the amount of approximately $1.2 million.

Avoiding a Foreclosure Sale:

Munoz v. James S. Nutter & Co., Adv. No. 10-3039 (Bankr. W.D. Tex. 2/22/11), found here.

The Munoz case involved the situation of a bankruptcy being filed after a foreclosure sale had been conducted but before the deed was recorded. The Court found that the debtors could not use the strong arm powers under section 522(h) because the recorded deed of trust would have placed a prospective purchaser on inquiry notice. The opinion is memorable for the following passage:
What a difference a day can make. This case presents a regrettable situation where Plaintiffs’ bankruptcy petition, for whatever reason, was filed one day late and Plaintiffs’ home was foreclosed upon before the bankruptcy. Thankfully these occurrences are infrequent, as the result can be disastrous to a debtor who can lose the opportunity to save their home. With the right set of facts and proof, the bankruptcy laws can provide relief to “undo” a pre-bankruptcy foreclosure, but the mountain that must be climbed is very technical and extremely steep. Few debtors have been successful in reaching the summit of this mountain and setting aside a foreclosure sale that occurred prior to the bankruptcy filing. Although this Court is extremely sympathetic to Plaintiffs’ plight, in this case it is unable to “reverse” the foreclosure and give Plaintiffs back their home.

Plaintiffs’ attempt to set aside the foreclosure sale under the “strong-arm power” of §544 must be denied as a hypothetical purchaser on the date of Plaintiffs’ bankruptcy filing would not have “bona fide purchaser” status under §544(a)(3) of the Bankruptcy Code and Texas state law. Plaintiffs also did not meet their burden of proof under §544, and for these reasons and those set forth in this Opinion, Plaintiffs may not avoid the foreclosure sale transfer of the Property to Navar under §544(a)(3).
Opinion, pp. 36-37.

Homestead Exemption on a Golf Course:

In re Schott, No. 10-54276 (Bankr. W.D. Tex. 3/15/11), found here.

Many golf widows may feel that their husbands live at the golf course. However, in this case involving a Texas homestead exemption, the debtor literally did live in the clubhouse (at least for a period of time.). When he filed bankruptcy, he claimed the golf course as his homestead and a creditor objected.

The court found that the property was rural and that the debtor had not abandoned the homestead. Therefore, the question was whether he could claim some of all of the property as homestead. The property consisted of two tracts separated by a county road.

Judge Leif Clark noted that under Texas law, where a rural homestead consists of two noncontiguous tracts, one tract must be used as a residence and the other tract must be used for the “comfort, convenience or support of the family.” The tract containing the clubhouse qualified as a residence. However, the tract containing the golf course did not fit within the definition of a homestead.

The court found that the debtor “does not play or even enjoy golf,” that he sometimes likes to take walks on the golf course and that he had intended to develop the property as a resort. While the term “comfort, convenience or support of the family” is a broad one, taking occasional walks on the property was not sufficient.

Non-Dischargeability Among Friends:

Turbo Aleae Investments, Inv. v. Borschow, Adv. No. 09-3005 (Bankr. W.D. Tex. 4/8/11), which can be found here. Judge Mott succinctly described the dispute in this case when he stated:
This case illustrates what can happen when a friend loans money to another friend, and then the relationship turns sour when the friend cannot repay the loan.
Opinion, p. 1.

The opinion contains a lengthy recitation of the conflicting narratives of the parties, highlighting that many of the critical terms were never reduced to writing.

The court distinguished between false pretenses and actual fraud, noting that earlier cases considered these two grounds for nondischargeabiilty under section 523(a)(2)(A) to have separate elements, while more recent Fifth Circuit cases pointed to a single test. The court rejected a claim of false pretenses on the basis that, if it still existed as a separate ground for nondischargeability, it required a false statement about current or past facts, not actions to be performed in the future.

The opinion is a good case study in how to prove or defend a non-dischargeability case. There were two main contentions made: 1. that the debtor lied about intending to use the loan proceeds to pay off a prior secured debt; and 2. that the debtor lied about intending to use the loan proceeds to pay off a debt owed to a related party to the lender.

In the case of the first representation, the court found insufficient evidence that the representation was made. The first time the representation was mentioned in writing was in an email after the fact. Although the stated reason for wanting the prior debt paid off was to obtain a security interest in the company's equipment, the loan documents did not provide for a security interest. Additionally, the lender did not inspect the equipment or attempt to determine its value. Finally, the lender acted inconsistently by referring the debtor to Chase Bank to get a loan to pay off the prior debt. As Judge Mott concluded:
While the Court is sympathetic to Turbo and believes that Omar and Ernest likely thought Allen should have used the money to pay off the SNB loan, after weighing the evidence and testimony, the Court concludes that Turbo has failed to show that Allen obtained the loan proceeds through actual fraud by falsely representing he would use the loan proceeds to pay off the SNB loan.
Opinion, p. 27.

On the other hand, the plaintiff's did show that the debtor committed fraud with regard to the second representation. The lender initially wanted to withhold the funds and pay them directly to the related party. The debtor said that he needed to receive the funds directly "for accounting purposes." However, when he received the funds, his business account was so far overdrawn that there were no funds left to repay the related party.

The differing outcomes between the two claims demonstrates that parties are rarely completely honest or completely devious, but that the truth is largely a combination of shades of gray.

In a very brief passage, the Court denied attorney's fees to the plaintiffs, noting that:
The Court also determines that each party shall bear their own attorneys fees and expenses. Specifically, the Court finds that the loan at issue is not primarily consumer debt, and that the positions of parties in this proceeding were substantially justified. Thus, awarding attorney fees is not appropriate in this case. See 11 U.S.C. §523(d).
Opinion, p. 37. Section 523(d) allows the court to award attorney's fees against a creditor who unsuccessfully seeks a determination of nondischargeability on a consumer debt and asserts a position that is not substantially justified. In this case, the debts involved were business debts so that the debtor could not have recovered attorney's fees. However, the court appears to be using the principles of section 523(d) by analogy to deny recovery of attorney's fees in a business dispute where each side offered positions that were substantially justified. I would have preferred to see the Court invoke the American Rule that each side pays its own fees in the absence of specific authority for fee-shifting. However, the court's ruling roughly adheres to this standard.

The take-away from this case is don't loan money to friends if you can't afford to lose the money or the friendship.


Legal Xtranet, Inc. v. AT&T Management Services, LP, Adv. No. 11-5042 (Bankr. W.D. Tex. 5/24/11), which can be found here. This was a case involving a motion to remand. The Court found that state law contract disputes were non-core proceedings subject to mandatory abstention and that disputes over the tax liability of AT&T did not qualify for even "related to" jurisdiction. The most interesting part of the opinion is the Court's lament over AT&T's successful attempt at forum shopping. Judge Leif Clark wrote:

The court is reluctant to reward AT&T’s blatant forum shopping in this case. AT&T filed a jury demand and refused to consent to a jury trial in this court in an effort to bolster its argument that the parties’ dispute could be timely adjudicated in state court: AT&T’s refusal to consent to a jury trial here meant that even if the court retained jurisdiction over the parties’ dispute, the case would have to be tried in the federal district court, assuring AT&T that it would have a different judge to hear the case. That would also almost certainly mean that the case would not likely be heard for quite some time. Furthermore, it is not entirely clear that the parties’ dispute, as it currently stands, involves any factual issues for a jury to decide – the request of declaratory relief will not go beyond the terms of the contract itself unless there is ambiguity in the agreement (or unless the contract itself is found to point outside itself for the determination or application of its terms). Thus, AT&T’s jury demand machinations appear to be nothing more than an effort to forum shop. Nonetheless, as noted above, the question is not whether the case can be more timely adjudicated in state court than in the bankruptcy or district court; the question is simply whether it can be timely adjudicated in state court. AT&T established that it could be timely adjudicated in state court, and the court’s determination to that effect did not depend upon a finding that the case could not be timely adjudicated in the district court. And there is nothing in section 1334(c)(2) that permits a court to deny relief on grounds that the effort is motivated by a desire to forum shop. Indeed, the sad truth is that the structure of bankruptcy jurisdiction actually encourages and rewards forum shopping strategies. There is little this court can about that, other than to encourage Congress to consider the consequences that seem to flow from the current structure.

Opinion, at p. 17. It seems unlikely that Congress will be moved to change section 1334(c)(2).

Till Interest Rate:

In re Village at Camp Bowie I, LP, No. 10-45097 (Bankr. N.D. Tex. 8/4/11), found here. In this single asset real estate case, the court considered, among other things, artificial impairment and
the proper interest rate for cramdown of a secured creditor.

The court found that artificial impairment standing alone was not enough to prevent a finding of good faith.
Indeed, at least one court has persuasively suggested that the drafters of the Code did not intend to create a system in which – even in a single asset real estate case – a lender could use its overwhelming share of the claims in a case to divest other creditors and equity owners of their economic interests. (citation omitted). Yet the only way around control of the reorganization by a debtor’s lender in a case like that at bar is through impairment and an affirmative vote of a class of unsecured creditors who will typically have small claims that could be readily satisfied through full payment with interest. For a debtor to have any leverage at all in such a case – e.g., in negotiations – it must be possible to look to those unsecured creditors to satisfy section 1129(a)(10).
Opinion, p. 10.

The Court also had an interest take on applying Till v. SCS Corporation, 541 U.S. 465 (2007). The court noted that under Till, the court left open the issue of whether a market rate could be set in the case where there was an efficient market for loans of the type proposed by the debtor in its plan. Because there was no such efficient market, the court determined to apply a formula approach. However, rather than using the Prime + 1-3% formula suggested by the Till Court, the Bankruptcy Court went through an elaborate approach of valuing different tranches of debt and adjusting for risk.

One of the experts (it is not clear whose) started with the five year treasury bill rate of 1.71% as a risk free rate. He then adjusted it for several factors and concluded that the rate for the first 65% of the collateral's value would be between 4.76%-5.01%. He concluded that the mezzanine rate for 65-85% of collateral value would be 13.02-14.88%. Finally, he concluded that the appropriate rate for amounts in excess of 85% of collateral value would be 18.63%. Taking all of these tranches into account and making other adjustments, he somehow came up with a blended rate of 6.25-7.75%.

The court adopted his methodology but tinkered with the assumptions to come up with a rate of 6.27-6.59%. Because the Debtor had proposed a rate of 5.83%, the Court denied confirmation with leave to file a plan providing for an interest rate of 6.4%.

Camp Bowie was a case involving a property valued at $34 million. Therefore, it might have been able to support the cost for the type of expert witness testimony used here. However, I have two concerns here. The first is that Till was supposed to provide an inexpensive and simple method for determining value. Most chapter 11 cases are small business cases which cannot afford the cost of an expert. Second, unless the Court has an advanced degree in finance (which several of the Texas bankruptcy judges do), it is likely that the competing experts will bamboozle the court which will be forced to split the difference.

In the Camp Bowie case, the Court could just as easily said prime + 3 and arrived at 6.25%, which is within .15% of the rate it reached through the elaborate calculations.

Recently, I was at a CLE seminar in New York sponsored by the Commercial Law League of America. Judge Robert Drain from the Southern District of Texas polled the room as to who represented debtors and who represented creditors. He then offered a hypothetical with choices between a prime rate + approach, a tranche approach and a there is no rate high enough approach. When only one hand went up for the prime + approach, he said, I see we've found the debtor's lawyer in the room (which was me). He then offered a very thoughtful analysis of why he thought the Supreme Court would adopt the prime + approach in a chapter 11 case.

This just goes to show that even after Till, there is still a lot of debate over how to select the cram-down interest rate.

Stern and Fraudulent Conveyances:

Kirschner v. Agoglia, Adv. No. 07-3060 (Bankr. S.D. N.Y. 11/30/11), found here. (Link will take you to the Southern District of New York Bankruptcy website. Go to opinions, then to Judge Drain to find the case).

During the past six months, practitioners have heard a lot of volume about Stern v. Marshall without getting a lot of clarity. (I plead guilty there since I have been on multiple panels and I am still trying to figure it out). Judge Robert Drain from the Southern District of New York has recently penned a very thoughtful opinion about the "firmly established historical practice" doctrine suggested by Justice Scalia in his concurrence. He noted that "the pursuit of avoidance claims has been 'a core aspect of the administration of bankruptcy estates since the 18th century.'" Opinion, at 9. He then offered a very thorough history of the ability of Article I judges to enter final judgments in fraudulent transfer cases. After all that, he found that the complaint did not state a cause of action and dismissed it as to one defendant.

The analysis that I would like to see (and would like to write some day if I had the time) would trace the origin of bankruptcy as a device to punish debtors who made fraudulent transfers. I suspect that it would show that bankruptcy law and fraudulent transfer law have been bound together since the very beginning.