Sua Sponte

Midwest Chicago Conference a Success . . . Plans For Future Under Way

Judith Greenstone Miller
Raymond & Prokop, P.C.
jmiller@raypro.com

With all of the advance planning and time that goes into the creation of and the actual meeting, it seems hard to believe that the Midwest Regional Conference held in Chicago has already taken place and concluded just two short weeks ago. It represented a wonderful opportunity to meet, greet and network with old friends and colleagues and to develop new prospects.

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Case Analysis

Supreme Court Rules that Debtor Obligations under Pre-bankruptcy Settlement of Fraud Claim May be Nondischargeable

Jesse Mainardi
Cooper, White & Cooper LLP
jmainardi@cwclaw.com

SUMMARY: In Archer v. Warner, ___ U.S. ___, 123 S. Ct. 1462, 71 U.S.L.W. 4249 (2003), the United States Supreme Court held that a creditor may prove in bankruptcy proceedings that a debtor's obligation pursuant to a pre-petition settlement arose out of false pretenses, a false representation, or actual fraud and thus is nondischargeable under 11 U.S.C. § 523(a)(2)(A).

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Case Law Update

Catherine E. Vance, Esq.
vance76@earthlink.net
(614) 336-3861

Assignment of Rights under ERISA. Court declined to read into ERISA an anti-alienation provision that would prevent assignments of enforcement rights of employee welfare plans; assignee of a health care provider who has a valid assignment from the plan participant or beneficiary has derivative standing to bring cause of action to recover benefits from ERISA governed employee welfare plan. Tango Transp. v. Healthcare Fin. Servs., LLC, 322 F.3d 888 (5th Cir. 2003).

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Sua Sponte

Midwest Chicago Conference a Success . . . Plans For Future Under Way

With all of the advance planning and time that goes into the creation of and the actual meeting, it seems hard to believe that the Midwest Regional Conference held in Chicago has already taken place and concluded just two short weeks ago. It represented a wonderful opportunity to meet, greet and network with old friends and colleagues and to develop new prospects. The Chicago Conference also provided tremendous educational programs from an in-depth analysis of bankruptcy ethics from prominent Chicago attorneys Melanie Rovner Cohen and Will Kohn, and Dean Nancy Rapoport of the Houston School of Law, to the intricacies associated with out-of-court workouts from the financial professionals’ perspective. Moreover, this year, Commercial Law League of America and Bankruptcy Section members got the ability to attend an extra inexpensive and high quality program offered through the DePaul University College of Law that took place just before the commencement of the conference. The DePaul University College of Law, in conjunction with the CLLA, hosted the First Annual Symposium (“Symposium”), focusing on issues arising in mega-bankruptcy cases. Five panel discussions took place at the Symposium on issues ranging from forum selection, case management, critical vendors, director and officer liabilities, ethical concerns, re-characterizations and asset securitizations, DIP financing and lock up agreements. The panels participating in the Symposium were Martin Bienenstock, Richard Cieri, Mark Kieselstein, David Fisher, Professor Douglas Baird, Judge Judith Fitzgerald and me. It provided a great chance for the experienced practitioner to brush up on the recent, hot and emerging issues in large, complex commercial bankruptcy cases. We hope that you will consider attending the Symposium next year.

The Bankruptcy Section Executive Council met during the Chicago Conference on Thursday afternoon and Sunday morning. Attendance at the meetings was excellent. The Council has approved a new publication entitled “Bankruptcy Section Practice Alert.” It will be distributed via email as and when necessary to provide the members with the hottest and most important news available. It also provides another added benefit for members. If you submit a news item of interest (whether it be a new case decision, a new affiliation or honor received, a new statute or amendment to a current statute that impacts bankruptcy and creditors’ rights issues), the item, when published, will be attributed to the member who has provided the information. Therefore, it represents a wonderful opportunity to get P.R. and your name out across the country. Please note that the Section retains the right to not publish an item that it receives based on it not being “newsworthy.” We hope that you will start to supply us with items of interest so that members can be kept current and on the cutting edge of developments affecting their practice. New items should be sent to the Practice Alert Editor. Please help us make the Bankruptcy Section Practice Alert a success!

The Nominating Committee of the Section met at the Conference. The slate for the next year will be published soon. If you are interested in getting more involved in the leadership of the Section, please contact Harry Greenfield, this year’s chair of the Nominating Committee. The Long Range Planning Committee of the Section, chaired by Mary Whitmer, also met at the Conference and is considering strategic planning and ways to enhance the Section’s membership and stature. Please contact Mary Whitmer if you have any suggestions.

I hope that you will take advantage of the programs and benefits that CLLA and the Bankruptcy Section membership provide to you. If you haven’t attended a meeting lately, or gotten involved in Section activities, we encourage and welcome your participation.

Judith Greenstone Miller
Raymond & Prokop, P.C.
26300 Northwestern Highway
4th Floor - P.O. Box 5058
Southfield, MI 48086-5058
Phone: 248-357-3010
Fax: 248-357-2720
jmiller@raypro.com
www.raypro.com

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Case Analysis

Supreme Court Rules that Debtor Obligations under Pre-bankruptcy Settlement of Fraud Claim May be Nondischargeable

Summary: In Archer v. Warner, ___ U.S. ___, 123 S. Ct. 1462, 71 U.S.L.W. 4249 (2003), the United States Supreme Court held that a creditor may prove in bankruptcy proceedings that a debtor's obligation pursuant to a pre-petition settlement arose out of false pretenses, a false representation, or actual fraud and thus is nondischargeable under 11 U.S.C. § 523(a)(2)(A). This case is significant because it resolves a split in the circuits and permits a bankruptcy court to look beyond the parties' settlement agreement to determine a fraud issue originally raised in a pre-petition state court action.

Facts: Elliott and Carol Archer bought the Warner Manufacturing Company from Leonard and Arlene Warner, but later sued the Warners in North Carolina state court for fraud in connection with that sale. The parties entered into a settlement agreement in 1995 pursuant to which the Warners executed a promissory note for $100,000 payable to the Archers. In return, the Archers executed releases "discharging" the Warners from all claims arising out of the litigation other than claims on the note. The releases specifically stated that no party was admitting to any liability or wrongdoing. After the Warners failed to make their first payment under the note, the Archers sued in state court. The Warners subsequently filed for bankruptcy. The Archers filed an adversary proceeding asking the Bankruptcy Court to find the debt under the note to be nondischargeable and to order the Warners to pay the full amount due. Leonard Warner agreed to a consent order holding his debt nondischargeable, but Arlene Warner contested the nondischargeability issue. In response, the Archers argued that the $100,000 debt was nondischargeable since it was for "money . . . obtained by . . . fraud." The Bankruptcy Court found that the promissory note debt was dischargeable and that decision was subsequently affirmed by both the District Court and the Court of Appeals for the Fourth Circuit. The Fourth Circuit Court of Appeals reasoned that the settlement agreement and releases constituted a "novation." The "new" debt, according to the Fourth Circuit, was not for money obtained by fraud and as a result was dischargeable in bankruptcy.

Analysis: A seven-justice majority of the Supreme Court agreed that the settlement agreement and releases may have constituted a kind of novation, but ruled that the Archers were not barred from showing that the settlement debt arose out of false pretenses, a false representation, or actual fraud and was thus nondischargeable under 11 U.S.C. § 523(a)(2)(A). The Court based its ruling entirely on Brown v. Felsen, 442 U.S. 127 (1979), a case which dealt with a similar factual scenario. In Brown, plaintiff Brown sued Felsen in state court for money allegedly obtained through fraud. The state court entered a consent decree that embodied a stipulation that Felsen would pay Brown a specified amount but that did not indicate that the payment was for fraudulent actions. After Felsen failed to pay the debt and entered into bankruptcy, Brown asked the Bankruptcy Court to hold that the debt was nondischargeable because it was money obtained by fraud. The Supreme Court in that case held that claim preclusion did not prevent the Bankruptcy Court from looking beyond the record of the state court proceeding and the stipulation and consent judgment to decide whether the debt was for money obtained by fraud.

In Archer, the Supreme Court stated that the Brown holding was determinative in three respects. First, the Court stated that the consent decree in Brown constituted the same type of novation as the settlement agreement in the present case. Thus, the Court's ruling in Brown that a Bankruptcy Court should look behind the stipulation for evidence of fraud in the original action was contrary to the Fourth Circuit's view that a settlement definitively changed the type of debt for purposes of dischargeability. Second, the Court referred to specific language in Brown: "the mere fact that a conscientious creditor has previously reduced his claim to judgment should not bar further inquiry into the true nature of the debt." Substituting "settlement" for "judgment," the Archer Court found this language to support its ruling. Finally, the Court cited as persuasive the Brown decision's reference to the Congressional intent to permit the fullest possible inquiry to ensure that all debts arising of fraud are excepted from discharge regardless of form. The Court refused to address Arlene Warner's argument that the Archers were barred from making their claim on grounds of collateral estoppel since that argument had not been raised before the Fourth Circuit which therefore did not determine its merits.

In his dissent, Justice Thomas found relevance in the distinction between a blanket release and a consent judgment. Justice Thomas contended that, unlike in Brown, the only remaining debt at the time of the bankruptcy in Archer was a debt obtained through the voluntary agreement of the parties, not by fraud. The parties had intended to replace an "old" fraud debt with a "new" contract debt which was dischargeable. Ultimately, however, the majority found the distinction between a settlement and a consent judgment to be insignificant and stated that "[a] debt embodied in a settlement of a fraud case 'arises' no less 'out of' the underlying fraud than a debt embodied in a stipulation and consent decree." As a result, the Supreme Court reversed the Fourth Circuit and remanded the case for further proceedings.

Comment: The Archer decision is potentially problematic in its practical implications. The inability of parties to negotiate a release of fraud claims that resolves any nondischargeability exposure, despite their desire to do so, might discourage pre-petition settlements. However, the Archer opinion notes that there was no indication that "the parties meant to resolve the issue of fraud . . . for purposes of a later claim of nondischargeability in bankruptcy." This language may suggest that a settlement agreement and release which specifically absolve a party of any liability for fraud might give rise to a dischargeable claim.

In any case, the Supreme Court rightly favored substance over form by permitting a bankruptcy court to determine whether a debt under a pre-petition settlement agreement arose out of fraud. The decision promotes the Congressional policy of providing relief to honest debtors but preventing the fraudulent debtor from avoiding nondischargeability by changing the form of his or her debt via settlement agreement. The Court correctly rejected the Fourth Circuit's holding which would have rendered most settled fraud claims dischargeable even if the parties had not considered the bankruptcy implications of settlement.

Jesse Mainardi
Cooper, White & Cooper LLP
201 California Street
17th Floor
San Francisco, CA 94111
415-433-1900
jmainardi@cwclaw.com

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Case Law Update

Assignment of Rights under ERISA. Court declined to read into ERISA an anti-alienation provision that would prevent assignments of enforcement rights of employee welfare plans; assignee of a health care provider who has a valid assignment from the plan participant or beneficiary has derivative standing to bring cause of action to recover benefits from ERISA governed employee welfare plan. Tango Transp. v. Healthcare Fin. Servs., LLC, 322 F.3d 888 (5th Cir. 2003).

Successor Liability in Section 363 Sales. An “interest in property” under § 363(f) includes obligations that are connected to or arise from the property being sold. Therefore, airline’s sale of assets free and clear of successor liability extinguished unsettled employment discrimination claims and liability on travel voucher program awarded in settlement of prior sex discrimination class action lawsuit. In re Trans World Airlines, Inc., 322 F.3d 283 (3d Cir. 2003).

Attorney Compensation. Court approved employment of attorney to pursue claim against debtor’s husband and contingency fee of one-third of amount recovered. Attorney commenced suit, which was resolved on summary judgment, and defendant promptly remitted full amount due. Bankruptcy court reduced attorney’s compensation, determining the ease with which attorney resolved claim demonstrated that approved fee arrangement was improvident in light of developments not capable of being anticipated at time compensation terms were fixed under § 328(a). Court of Appeals reversed; despite excessive character of actual amount of compensation for minimal work performed, all factors relied on by bankruptcy court were reasonably foreseeable at the time compensation was initially approved. Daniels v. Barron (Matter of Barron), 2003 U.S. App. LEXIS 6440 (5th Cir. Apr. 4, 2003).

Separate Classification of Nondischargeable Claims. Acknowledging difficulty in developing test for determining whether separate classification amounts to unfair discrimination, Court of Appeals affirmed bankruptcy court’s rejection of plan that would have shifted two-thirds of debtor’s nondischargeable debt to other unsecured creditors and would pay nothing on general unsecured claims. In re Crawford, 2003 U.S. App. LEXIS 6276 (7th Cir. Apr. 1, 2003) aff’g Crawford v. Chatterton (In re Crawford), 268 B.R. 832 (W.D. Wis. 2001).

Impairment of Claims. Where § 502(b)(6), which imposes a cap on damages arising from termination of real property leases, alters a creditor’s nonbankruptcy claim, there is no alteration of the claimant’s legal, equitable, and contractual rights for the purposes of impairment under § 1124(1). Solow v. PPI Enters. (In re PPI Enters.), 2003 U.S. App. LEXIS 5937 (3d Cir. Mar. 28, 2003).

Equitable Subordination. Claimant’s misconduct, arising from covert purchase of claims at discounted amount while acting as a fiduciary to the debtor, was sufficiently egregious to warrant subordination of not only amount paid for claims but also amounts reflecting damage inflicted on non-selling creditors including professional fees incurred in litigating against claimant. Citicorp Venture Capital, Ltd. v. Committee of Creditors Holding Unsecured Claims, 2003 U.S. App. LEXIS 4939 (3d Cir. Mar. 19, 2003).

Critical Vendor/Doctrine of Necessity. Bankruptcy court had neither statutory nor equitable power to authorize pre-plan payment of prepetition claims. Such claims, though useful and practical in minimizing business disruptions, are not authorized by the Bankruptcy Code. Capital Factors, Inc. v. Kmart Corp., 2003 U.S. Dist. LEXIS 5937 (N.D. Ill. Apr. 8, 2003).

Catherine E. Vance, Esq.
Columbus, Ohio
614-336-3861
vance76@earthlink.net


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