As Oil Prices Fall, Oil & Gas Bankruptcies Rise

While a new report from the Administrative Office of the U.S. Courts shows a 46% decline in chapter 11 filings from 2010 to 2014, there appears to be an uptick in energy related filings, especially by Texas-based companies.

The report from the Administrative Office shows that chapter 11 filings decreased from 14,191 in fiscal year 2010 to 7,658 in fiscal year 2014, a decline of 46% in just four years.    A separate report from the U.S. Energy Information Administration shows the price of West Texas Intermediate Crude dropping from over $100 per barrel in July 2014 to just over $50 per barrel in January 2015.  While bankruptcy is typically a lagging indicator in the economy, oil and gas related bankruptcy filings appear to be on the rise with at least three publicly traded companies filing this month.   

I was able to locate eleven energy-related filings with aggregate debt of $4.9 billion in the past few months.   While all of the American debtors were Texas-based, they included filings in Delaware, Utah and the Southern and Western Districts of Texas.   Calgary, Canada has also received two filings, including one which resulted in a Chapter 15 in the Western District of Texas.

Date	Court	Case #	Case Name	Debts
10/10/14	DE	14-12308	Endeavour Operating Corporation (Houston, TX)	$1.2B
10/31/14	UT	14-31632	Marion Energy, Inc. (McKinney, TX)	$171M
11/9/14	DE	14-12514	KiOR, Inc. (Pasadena, TX)	$242M
1/14/15	Alberta, Canada	15001-00396	Gasfrac Energy Services, Inc. (Calgary)	$88.7M CDN + $10M USD
1/15/15	WDTX	15-10003	WBH Energy, LP (Austin, TX)	$49M
1/15/15	WDTX	15-50161 Ch. 15	Gasfrac Energy Services, Inc.(Calgary)	$88.7M CDN + $10M USD
1/27/15	SDTX	15-60003	Royalty Partners, LLC  (Houston, TX)	$1.6M
2/20/15	Alberta, Canada	25-1963517	Ivanhoe Energy Inc. (Calgary)	$103M CDN
3/3/15	DE	15-10458	Cal Dive International, Inc. (Houston, TX)	$286M+
3/8/15	WDTX	15-10336	Dune Energy, Inc. (Houston, TX)	$105M+
3/9/15	SDTX	15-60016	BPZ Resources, Inc. (Houston, TX)	$229M+
3/17/15	DE	15-10585	Quicksilver Resources, Inc. (Fort Worth, TX)	$2.35B

Fifth Circuit Report: February 2015

February's bankruptcy opinions revolve around the common theme of not doing things right.   There is the case of an attorney who didn't pay a sanctions order and incurred more liability, an assignee from a bankruptcy debtor who wasn't in existence at the time and a buyer who didn't read his title commitment.    They did not find any satisfaction at the Court of Appeals.

Garrett v. Coventry II DDR/Trademark Montgomery Farm, LP (Matter of White-Robinson), No. 14-10525 (5th Cir. 2/6/15).   This case involved a bankruptcy court which sanctioned a law firm and then imposed a contempt order against them when they did not pay the sanction.   The District Court and the Fifth Circuit both affirmed the contempt order.   Attorney Garrett represented Nina White-Robinson in her bankruptcy.    She represented the Debtor in a suit against DDR.   The Bankruptcy Court ordered that Garrett and her firm pay sanctions totaling $25,000 for discovery abuse and for filing a frivolous motion for contempt.   Garrett appealed the sanctions orders and lost.  Garrett did not obtain a stay pending appeal nor did she pay the sanctions.   As a result, DDR brought a motion for contempt against Garrett and her firm.   The Bankruptcy Court ordered Garrett to pay an additional $6,454.50 in expenses to DDR and ordered that they pay an additional $100.00 per day for each additional day that they did not pay the sanctions.   (There is an irony here in that the attorneys started the ball rolling with a motion for contempt only to have one granted against themselves.).

The Fifth Circuit found that the Bankruptcy Court had authority to issue the civil contempt order.  It found that it was a core proceeding for the Bankruptcy Court to enforce its own orders and that the pending appeal did not deprive the court of jurisdiction.   The Fifth Circuit also rejected the argument that the Contempt Order improperly allowed imprisonment for failure to pay a debt.    However, the Contempt Order did not provide for imprisonment.   Rather, it just increased the amount of money she owed.   The Fifth Circuit also rejected the argument that the contempt order was an abuse of discretion.  

The first moral here is that when appealing an order for payment of money, you should always request a stay pending appeal.   The second one is that if you don't get a stay pending appeal, you should be prepared to get your checkbook out.   Bankruptcy Courts don't like it when their orders are ignored.

Superior MRI Services, Inc. v. Alliance Healthcare Services, Inc., No. 14-60087 (5th Cir. 2/18/15). This case involves rights supposedly acquired from a debtor that filed bankruptcy.     We start with P & L Incorporated.   It filed chapter 7 bankruptcy on January 19, 2012.   In its statement of financial affairs, it referenced an assignment of MRI service agreements to Superior MRI Services.   However, Superior was not incorporated with the State of Mississippi until November 28, 2011.   Superior then sued Alliance Healthcare Services for allegedly interfering with the MRI service agreements it acquired from the Debtor.   Each of the incidents happened prior to Superior's incorporation.    Alliance moved to dismiss for lack of prudential standing.  It provided public records showing that Superior was not incorporated at the time of the alleged assignment.   Furthermore, Superior was not able to provide evidence of the alleged assignment other than the statement in P & L's statement of financial affairs.    The District Court dismissed the complaint.   The District Court rejected the argument that P & L and Superior had merged and that Superior had ratified the assignment after it was incorporated.   The Fifth Circuit affirmed.    

The principal bankruptcy interest here is what doesn't appear in the record.    Apparently Alliance also argued that any cause of action belonged to the bankruptcy trustee since the alleged wrongs occurred prior to bankruptcy.   Superior sought leave to join the trustee as a party but the court dismissed the case before that could happen.    There is certainly a hint here that P & L sought to transfer assets to a third party on the eve of bankruptcy to keep them out of the estate.   If that was the case, the plan failed due to the fact that the assignee didn't exist at the time and no evidence of the assignments was ever produced.    Assuming that there ever was a valid cause of action, it should have been pursued by the bankruptcy trustee.    However, we don't know what the chapter 7 trustee thought about the case or whether he ever knew it existed.   If this were a Sherlock Holmes mystery, it would be the case of the trustee who didn't bark.    

 

Baker v. Baker (In re Baker), No. 14-10569 (5th Cir. 2/20/15)(unpublished).    This is the case of Joe, Joan and John and the missing mineral interest.   Joe and Joan were married.   When they got divorced, Joan was supposed to convey all of her interest in a property known as Poppies to Joe.  However, when she signed the deed, it contained an exclusion for her mineral interest in the property.   At some point Joe sued Joan in state court to compel her to convey the mineral interest to him.    Joe filed chapter 12.  Under his plan, he sold all of the estate's interest in Poppies to John.   The sale order provided for John to receive all of the estate's interest, both mineral and surface to the Poppies property.   John received a title commitment showing a reservation for the mineral interests and accepted a deed with this reservation as well.   Eight months later, he filed a motion to compel, seeking to force the bankruptcy estate to convey the mineral interest to him.   Finding that the estate had already conveyed all of the interest that it had, the Bankruptcy Court denied the motion.   On appeal, John contended that the Bankruptcy Court exceeded its jurisdiction by determining the extent of the estate's interest.   Apparently John was afraid that the Bankruptcy Court's order could be interpreted to foreclose Joe's suit against Joan to get the mineral interests back.   The Fifth Circuit said that yes, the Bankruptcy Court had authority to interpret its own orders and that no, the Bankruptcy Court did not rule upon the state law issue between Joe and Joan.   

Energy Resources Remains Viable for Allocation of Tax Payments

Twenty-five years ago, the Supreme Court held that a Bankruptcy Court had the authority to order the IRS to allocate payments made "voluntarily" by a Debtor when necessary to effectuate a successful reorganization.    United States v. Energy Resources Co., 495 U.S. 545 (1990).   Left to its own devices, the IRS will generally allocate payments to the oldest taxes first, or, in the case of payroll taxes, to non-trust funds taxes first.   If the Debtor can require the IRS to allocate payments differently, it can greatly impact the overall amount the Debtor will be required to pay.   A recent decision out of Fort Worth illustrates how Energy Resources continues to provide a valuable tool for Debtors with tax obligations.    In re Fielding, 522 B.R. 888 (Bankr. N.D. Tex. 2014).  

Fielding was a chapter 13 case where the Debtors owed $539,885.26 to the IRS.    The debt was secured by a lien against all of the Debtors' real and personal property.    The Debtors filed a motion to sell their homestead.   After paying superior obligations, there was approximately $128,000 available to pay on the IRS claim.    The Debtors sought to apply the payment to the base tax amounts but not to interest or penalty.    The IRS, on the other hand, wanted to apply the payments to the oldest taxes first, including penalties and interest.    This could have resulted in paying priority and unsecured claims prior to secured claims.   

The IRS argued that it could not be compelled to allocate the proceeds and that payments from a bankruptcy sale were not "voluntary" payments which could be designated by the taxpayer.    The Court held that Energy Resources could be applied in a chapter 13 case.    In doing so, it noted that other courts and commentators had been hesitant to limit the case to its facts.    (One of the authorities it cited was a law review article that I wrote).    

However, having found that the designation doctrine could be applied to a chapter 13 case, the Court raised the issue of whether it could be done in the absence of a confirmed plan.   The Court noted that:

(J)ust as a debtor in a chapter 11 case must make payments in accordance with its chapter 11 plan upon confirmation, a chapter 13 debtor must make payments in accordance with its proposed plan even prior to confirmation.

Opinion at *15.   Based on this distinction between chapter 11 and chapter 13, the court found that payments could be designated in chapter 13 even prior to confirmation.

Next, the court found that the designation was necessary to effectuate the reorganization.   The Court stated:

In the case at bar, to achieve success through the reorganization, Debtors must be capable of complying with Amended Plan provisions.   To do so, Debtors rely on the sale of assets to reduce the debt owed to the IRS.   If the IRS is permitted to apply the Proceeds to unsecured or priority portions of the debt as requested, then the lien held by the IRS for the secured claim would continue to attach to Debtors' property.   thus, any reduction in the IRS secured claim would not sufficiently correspond with the assets being sold.  Debtors would also continue to incur the interest and penalties on the unpaid, secured portion of the debt, further decreasing the plan's feasibility.

Opinion, at *18.

 Finally, the Court rejected the IRS's argument that payments made in bankruptcy proceedings could never be considered to be voluntary.   It noted that the Supreme Court rejected this position in Energy Resources and there was no basis for limiting the case to its facts.   The Court found that chapter 13 itself was a voluntary process and that the case involved the voluntary sale of exempt property.   As a result, the Court found that the payment was voluntary and could be designated by the Debtors.

The Court's 28-page opinion is very thorough which makes at times for difficult reading.  It has a lot of good discussion of bankruptcy policy in general and chapter 13 in particular.  The main lessons that I picked up are that:   1) it is possible to use chapter 13 creatively and 2) it pays to dust off old precedents you haven't thought about in a while.   

Exemptions Continue to Feel Frost's Bite

The rift in the bankruptcy universe created by Viegelahn v. Frost (Matter of Frost), 744 F.3d 384 (5th Cir. 2014) continues to widen, drawing more exemptions into its vortex in seeming disregard of Supreme Court precedent.   The latest opinion to come down is  In re Hawk, 2015 Bankr. LEXIS 309 (Bankr. S.D. Tex. 1/30/15) which holds that the Debtor in a chapter 7 proceeding forfeited his IRA exemption when he liquidated the account after the deadline to object had expired.   

The Debtors filed their chapter 7 proceeding on December 15, 2013.   On this date, they held an IRA in the amount of $164,902.   Over the period from December 11, 2013 to July 14, 2014, the Debtors withdrew the funds from the IRA. The Trustee filed a no asset report on April 3, 2014.  The deadline to object to exemptions expired on April 28, 2014.  No party filed an objection.

A creditor objected to the Debtors' discharge.   At a deposition on November 18, 2014, the creditor learned of the liquidated IRA in a deposition.   The Trustee then made demand for the Debtors to turn over the IRA proceeds because they had not been reinvested within sixty days.   The Trustee then filed a motion for turnover of the funds.

The Bankruptcy Court granted the Trustee's motion for turnover, finding that the failure to file a timely objection was not material.   The Court stated:

(T)he Court finds that the pertinent threshold question is whether property deemed exempt under state law loses its statutory protection at any point during the pendency of a Chapter 7 case. Here, the Liquidated IRA Funds lost their exempt status under state law while the Debtors' bankruptcy case was open. Once the Liquidated IRA Funds became non-exempt, the Funds automatically became property of the estate and the Chapter 7 Trustee was immediately entitled to them.

Opinion, at *9.    The Court emphasized the Fifth Circuit's language in Frost that

a change in the character of the property that eliminates an element required for the exemption voids the exemption, even if the bankruptcy proceedings have already begun.

Frost at 388.   The Court found that it was significant that the IRA exemption under the Texas Property Code included a provision allowing proceeds to retain their exempt character if reinvested within sixty days.   As explained by the Court:

(A)pplication of the 60-day rule here is merely applying the entire IRA exemption statute and should not turn on whether a party in interest lodged an objection to the claimed IRA exemption In fact, the imposition of an objection condition when applying either the Texas homestead or IRA exemption statute would violate state law. There is no objection requirement in either sections 41.001 or 42.0021. Construing an extratextual objection requirement would preclude application of the reinvestment provisions--thereby contravening the intent of the Texas legislature.  (emphasis added).

Opinion, at *20-21.   Thus, according to the Court, in order to give effect to the intent of the Texas legislature, proceeds from an IRA must be timely reinvested to retain their exempt status.

While the Court may be correct as to the intent of the Texas legislature, why is this relevant?   Exemptions in bankruptcy are a matter of federal law.  When a Debtor claims exemptions under Texas law, he does so as a matter of federal law.    In re Dyke, 943 F.2d 1435 (5th Cir. 1991).  Federal bankruptcy law very definitely does contain an objection requirement.  Under bankruptcy law, any property claimed by the Debtor as exempt leaves the estate absent a timely objection.   According to this term's opinion in Law v. Siegel, 134 S.Ct. 1188 (2014), "a trustee's failure to make a timely objection prevents him from challenging an exemption."   Under the previous Supreme Court opinion in Taylor v. Freeland & Kronz, 503 U.S. 638 (1992), a clearly invalid claim of exemption could not be challenged once the objection period had passed.    According to the Court:

We reject Taylor's argument. Davis claimed the lawsuit proceeds as exempt on a list filed with the Bankruptcy Court. Section 522(l), to repeat, says that "unless a party in interest objects, the property claimed as exempt on such list is exempt." Rule 4003(b) gives the trustee and creditors 30 days from the initial creditors' meeting to object. By negative implication, the Rule indicates that creditors may not object after 30 days "unless, within such period, further time is granted by the court." The Bankruptcy Court did not extend the 30-day period. Section 522(l) therefore has made the property exempt. Taylor cannot contest the exemption at this time whether or not Davis had a colorable statutory basis for claiming it.

 Taylor, at 643-44. 

There seems to be a clear conflict here.   The Supreme Court has stated that once property becomes exempt, it remains exempt.   It has now said this for over twenty years.   However, under Frost, as interpreted by Judge Bohm, property must retain its exempt character at all times during the pendency of the case or be subject to turnover.    It does not seem possible to reconcile the Supreme Court opinions in Taylor and Law with Frost and Hawk.  If property could be claimed by the trustee at any time that it lost its exempt character, then property which was never exempt could be challenged at any time.    However, the Supreme Court expressly rejected that proposition.   To reiterate, if we protect property claimed as exempt with no colorable basis, as the Supreme Court did in Taylor, how can we fail to protect property which was legitimately exempt on the date of filing?

With any luck, this issue will eventually make its way back to the Fifth Circuit, or if necessary, the Supreme Court.   Until then, the watchword is debtors beware:  your exemptions are less secure than you might think.

Hat tip to Steve Roberts.

Recovering Attorneys' Fees in Dischargeability Litigation

A new opinion from Judge Tony Davis answers some interesting questions about recovery of attorneys' fees in dischargeability litigation.   Schwertner Backhoe Services, Inc. v. Kirk (In re Kirk), Adv. No. 11-1239 (Bankr. W.D. Tex. 1/28/15), which can be found here.    The Court concluded that a prevailing plaintiff could recover attorneys' fees allowable under state law but could not recover for litigating pure issues of dischargeability.   

The case involved a dischargeability complaint brought under 11 U.S.C. Sec. 523(a)(4) based on the Texas Construction Trust Fund Act.   The Debtor owned a homebuilding company which did not pay one of its subcontractors.   The Debtor's answer was ambiguous as to whether the creditor's underlying debt was owed.   However, when the Debtor's deposition was taken, about two years into the litigation, the Debtor acknowledged that the debt was owed.   Prior to trial, the Debtor stipulated that the underlying debt was non-dischargeable but disputed that the creditor could recover attorneys' fees.

The Court reached several conclusions.   First, it concluded that if a debt includes pre-petition attorneys' fees and is determined to be non-dischargeable, the attorneys' fees are part of the non-dischargeable debt.   Second, the Court concluded that "(s)ince the Bankruptcy Code does not address whether creditors can recover attorney’s fees in nondischargeability cases, they can only do so if allowed by another statute or by contract."    Opinion, p. 6.    

The Court clarified that the recovery of attorneys' fees depended on the specific language of the contract or statute.   In discussing prior Texas bankruptcy cases, the Court noted that where a contractual debt was determined to be non-dischargeable based on fraud, the attorneys' fees were not included in the non-dischargeable debt.   On the other hand, where the contract allowed recovery of fees for "all costs of collection and enforcement," the cost of prosecuting the non-dischargeability action "contributed directly" to the effort to collect and enforce the notes.  

In the specific case, the Court concluded that the Texas Construction Trust Fund Act did not allow for recovery of attorney's fees.   In doing so, the Court was required to choose between competing lines of state court precedent.    However, it did find that under the Texas Civil Practices and Remedies Code, fees could be imposed for fees incurred in establishing the liability for labor and materials provided.    As a result, the Court concluded that the creditor could recover reasonable attorneys' fees for amounts incurred prior to the Debtor's admission that his company was liable for the underlying debt but not afterwards.  

The Court explained:

(F)ees cannot be awarded for litigating defalcation in this case because doing so is essentially the same as establishing Kirk’s liability under the Texas Construction Trust Fund Act; both determinations are predicated on the same facts – that Kirk was a fiduciary, and that he failed to handle funds properly. Put another way, this aspect of what Schwertner Backhoe had to prove is an action for which the Texas legislature has not shifted fees. Cohen renders properly awarded fees nondischargeable; it does not provide an independent basis for awarding fees.

Opinion, p. 14.    As a result, the Court awarded the creditor approximately half of the attorneys' fees that it requested.

The practice point here is that the Debtor should be cautious about disputing liability on the underlying claim asserted in the dischargeability action.    If the Debtor had admitted liability for the underlying debt from the beginning, the creditor could not have recovered its attorneys' fees.

Note:  This is a case which I took over from another attorney.   However, I can't sure that I would have caught the importance of admitting liability on the underlying debt if I had represented the Debtor from the outset.