CLLA Bankruptcy Section Newsletter

If you are having trouble navigating through the newsletter, the online version can be found here:
http://www.cllabankruptcy.org/bankruptcy/april2005.cfm

Like it or not, you have a new bankruptcy law. It impacts virtually every party of interest in any type of bankruptcy case. In order to provide your clients and prospects accurate advice you must at least become familiar with the fundamental changes. Although much of this legislation will not become effective until 180 days from now, there are many provisions that became immediately effective when President Bush signed the bill into law on April 20. The CLLA is offering three telephone seminars on the new bankruptcy law. Choose the ones that will benefit you the most.

May 4: Bankruptcy Reform Overview: Understanding the Radical Bankruptcy Code Changes - featuring The Honorable Eugene Wedoff, Judith Greenstone Miller, Jay Welford and Catherine Vance.

May 25: Business Bankruptcy Practice Under the New Code - featuring Judith Greenstone Miller, Jay Welford and Peter Califano.

June 23: Consumer Bankruptcy Practice Under the New Code - featuring The Honorable Eugene Wedoff, Catherine Vance as well as other speakers, providing an indepth discussion on how your practice will be affected by this new law.

Click here to register.

Sua Sponte

Case Analysis

Fifth Circuit Holds Administrative Expense Claims Are Not § 507 Claims under § 726(a)(1) in Chapter 7 Surplus Case

Summary: In Tarbox v. United States Trustee (In re Reed), 2005 U.S. App. LEXIS 5282 (5th Cir. April 1, 2005), the United States Court of Appeals for the Fifth Circuit held that because § 726's reference to § 507 claims did not include administrative expense claims, the trustee and other administrative claimants are not entitled to interest in a chapter 7 case in which there was a surplus of funds.

Case Law Update

Centralized Cash Management System Affects Amount of Quarterly Bankruptcy Fees. Court held that payments made on behalf of a debtor, whether made directly or indirectly through centralized disbursing accounts, constitute that particular debtor's disbursements for the purpose of quarterly fees calculations under 28 U.S.C. § 1930(a)(6). The Court reasoned that "holding otherwise would allow hundreds of affiliated debtors in Chapter 11 cases to avoid paying fees by having one debtor control disbursing accounts."

Sua Sponte

Having just returned from the Commercial Law League's Midwestern Chicago Meeting, and reflecting back upon last week's events, I find myself both proud and somewhat overwhelmed. Proud because of the outstanding educational programs which our Section sponsored, especially the two-hour update on the upcoming changes to the Bankruptcy Code. Because of the timing, the program was put together in virtually no time at all, but was so well done, one would think the participants, which included the Honorable Eugene Wedoff, United States Bankruptcy Judge, Jay Welford, Judy Miller, and Cathy Vance, had months to prepare. Not only was the program highly informative, covering vast amounts of information in the relatively short amount of time allotted, but the materials that accompanied the program were outstanding.

I am also proud because of the outstanding participation that our Section experienced with respect to its Future Planning Conference, which was held on Thursday, April 7th, prior to the formal start of the Conference. Our event was facilitated by Nancy Southern, and I believe was successful in accomplishing our primary objective of defining who we are as a Section now, and also in beginning the ongoing process of charting a course for what our Section will look like three to five years from now and beyond. Special thanks in that regard go out to Nancy, as well as our Co-Chairs Alan Ramos and Jay Welford, Sarah Jolie, and long-time advisor, Max Moses, all of whom worked extremely hard at ensuring that our agenda and objectives were properly defined and that a proper mix of members, new and old, were in attendance. Finally, to each of you who came and gave freely of your time, and more importantly your thoughts, I thank you.

My emotions also include being overwhelmed. I say this not only because of the outpouring of support you, our Section's members, but also at what remains to be done. The Future Planning Conference was but the first step in ensuring that our long-term objectives and goals will be reached. Accomplishing these will require the ongoing hard work and commitment of all who attended, along with all who were unable to attend but remain interested in participating in the process.

One of the goals for the Section, agreed upon by all in attendance at the Future Planning Conference, is to ensure that the Bankruptcy Section becomes the preeminent provider of education, legislative advocacy and business development opportunities to insolvency professionals. Along those lines, the Bankruptcy Section will be reprising its program on updates to the Bankruptcy Code via a telephonic call-in program on May 4, 2005 at 1:30 p.m. Eastern. The program, which will last two hours, will devote approximately one hour each to consumer changes and business or commercial changes. Separate programs will be held on May 25, 2005, and June 23, 2005, with the first program covering a more in-depth analysis to the business or commercial changes, and the June program focusing on the changes to the consumer side of the new law. All details can be found at www.clla.org.

Road shows are also in the planning stages, and the authors of the bankruptcy reform program materials have agreed to allow our Section members to take the materials and use them at your various local bar meetings to present your own programs on the Code's updates. As all of you know, the changes are numerous, substantial, and in many ways rather complex. Reviewing the materials and becoming familiar enough with the changes, and thereafter putting on your own program at your local bar association will not only provide a valuable service to the legal community at large, but will increase your recognition within your professional community and hopefully result in more members joining our Section, when they come to recognize the benefits, such as this program, that membership has to offer. If you are interested in planning a program for your local bar association meeting, please contact Sarah Jolie at sjolie@clla.org.

Finally, please watch your emails for upcoming information on a "technical corrections" bill, which, according to David Goch, is already in the process of being drafted. As those of you who attended the program in Chicago are aware, the bankruptcy bill, which became law on April 20, contains numerous conflicts and other technical problems that must be resolved, or implementation of the bill's changes will be rendered difficult, if not impossible. David adds that it is the desire of Congress to have the technical corrections bill ready in time for the effective date of the new law, which will be on or around October 17. From what is generally acknowledged to be an unworkable and mean-spirited bill, we, both individually and as a Section, can be at the forefront of the changes, benefiting our clients, our firms and the Commercial Law League. Let's not miss this opportunity.

Alan I. Nahmias
Plotkin, Rapoport & Nahmias
16633 Ventura Boulevard, Suite 800,
Encino, CA 91436-1836
Phone: 818-995-2555
Fax: 818-907-9261

Case Analysis

Fifth Circuit Holds Administrative Expense Claims Are Not § 507 Claims under § 726(a)(1) in Chapter 7 Surplus Case

Summary: In Tarbox v. United States Trustee (In re Reed), 2005 U.S. App. LEXIS 5282 (5th Cir. April 1, 2005), the United States Court of Appeals for the Fifth Circuit held that because § 726's reference to § 507 claims did not include administrative expense claims, the trustee and other administrative claimants are not entitled to interest in a chapter 7 case in which there was a surplus of funds.

Facts: After administering the assets of the estate in a chapter 7 case, there was a surplus of some $10,000 and the trustee submitted to the Bankruptcy Court an Application for Compensation and Report of Proposed Distribution. In the application, the trustee proposed to pay interest on administrative claims, which comprised the fees and expenses of the trustee and his attorney and accountant. The trustee argued that § 726(a)(5) requires the payment of such interest, which accrues, according to the language of that statute, from the petition date.

The United States trustee objected, arguing that trustees and professionals in a case are entitled to interest only from the point at which the court awards them compensation, reasoning that, prior to the award, there is no claim on which interest can accrue.

The Bankruptcy Court rejected both arguments, holding instead that the applicable statutory language precludes interest in all events. The District Court affirmed and the trustee appealed the decision to the Court of Appeals for the Fifth Circuit.

Discussion: Two paragraphs of § 726(a), which sets forth the manner in which estate property is to be distributed, were at issue before the Court of Appeals. The relevant language of § 726(a) provides that property of the estate is to be distributed:

In affirming the Bankruptcy and District Courts and holding that this statutory language does not permit the payment of interest on § 507(a)(1) administrative claims, the Court noted that the Bankruptcy Court diverged from both the majority and minority views of the various courts that had dealt with the issue. The majority view, argued by the United States trustee and representing the position in the Ninth and Eleventh Circuits, is that interest is statutorily permitted, but limited in accrual from the point in time that the court awards compensation. The Eleventh Circuit in particular articulated concerns that to allow interest to accrue from the petition date would be contrary to the express limitation on trustee compensation in § 326 and create incentives for trustees to take actions that would frustrate the efficient liquidation and distribution of the estate for the creditors' benefit.

The minority view, which no Courts of Appeal have adopted, relies on a plain language rule. That is, § 726(a)(5) unambiguously allows for interest from the petition date on any claims paid under § 726(a)(1) without exception. Thus, even though the trustee and professionals in the case have no claim until sometime after the petition date, the plain language compels that interest be calculated from the petition date on the amount eventually awarded.

In the present case, the Court of Appeals agreed with the Bankruptcy and District Courts that the principal question is not the point at which interest should accrue under the statute, but whether interest on administrative expenses is proper at all. This is because of the manner in which § 726(a)(1) defines a claim, which is by reference to § 501 and the timely or tardily filing of a proof of claim. Section 501, in turn, speaks only to the filing of proofs of claims by creditors and equity security holders and the fact that § 501(a) specifically addresses proofs of claims by these two specific classes of interests "necessarily excludes trustees from recovering interest on their compensation and reimbursements." The Court further explained that a trustee cannot be a creditor as that term is defined in the Code because the trustee does not hold "a claim against the debtor that arose at the time of or before the order for relief concerning the debtor."

The problem with the Reed decision is that the Fifth Circuit's holding is not limited to payment of interest on administrative claims in surplus cases, which was the specific issue presented. Although the Court's analysis begins with § 726(a)(5), which deals only with interest, the Court's reasoning turns on defining the type of § 507 claim that may receive distribution from the estate under § 726(a)(1). One could argue that under Reed not only are trustees and professionals not entitled to be paid interest in surplus cases, they are similarly not entitled to an estate distribution for their fees and expenses at all because their claims are not the kind for which a proof of claim is filed or allowed under § 501.

The Court acknowledged the possibility of this outcome but concluded that there was no reason for concern. According to the Court, § 503 provides the means for allowance of fees and expenses in bankruptcy proceedings and for their payment. However, if one views § 726 as the exclusive means by which a person may lay claim to estate property, the Reed case could be construed as creating the rather perverse rule that administrative claimants are excluded from estate distributions altogether.

Catherine E. Vance
Development Specialists, Inc.
6375 Riverside Dr.
Suite 200
Dublin , OH 43017
(614) 734-2717

Case Law Update

Centralized Cash Management System Affects Amount of Quarterly Bankruptcy Fees. Court held that payments made on behalf of a debtor, whether made directly or indirectly through centralized disbursing accounts, constitute that particular debtor's disbursements for the purpose of quarterly fees calculations under 28 U.S.C. § 1930(a)(6). The Court reasoned that "holding otherwise would allow hundreds of affiliated debtors in Chapter 11 cases to avoid paying fees by having one debtor control disbursing accounts." The Court further found that the obligation for US Trustee quarterly payments under § 1930(a)(6) continued after confirmation of the debtors' Joint Plan of Reorganization ("Joint Plan"). While the Joint Plan provided that the debtors are deemed consolidated for certain purposes, there was not sufficient evidence to determine that substantive consolidation had occurred. The Court based this finding on the fact that 1) debtors did not seek substantive consolidation, 2) the Bankruptcy Court did not order substantive consolidation, 3) the deemed consolidation provisions of the Debtors' Joint Plan did not result in de facto substantive consolidation, and 4) all pre-confirmation cases continued as separate cases post-confirmation. Genesis Health Ventures, Inc. v. Stapleton (In re Genesis Health Ventures, Inc.), 2005 U.S. App. LEXIS 5154 (3d Cir. Mar. 31, 2005).

Minnesota Homestead Exemption Given Extraterritorial Effect. A family sold their Minnesota residence in June 2003 and purchased a home in Arizona. Subsequently, in July 2003 the family filed for bankruptcy. They claimed their unencumbered Arizona property was exempt from the bankruptcy estate under the Minnesota homestead exemption. The Trustee, basing his argument on state choice of law principals, argued that the Minnesota homestead exemption should not be given extraterritorial effect since it is a statute relating to the ownership of real property. Court found that Congress did not invoke state choice of law rules with the homestead exemption. "Instead, Congress used state-defined exemptions as part of a federal bankruptcy scheme, while limiting the application of state policies that impair those exemptions." Thus, the Court looked to the language of the Minnesota exemption to determine if the exemption could be applied to an Arizona homestead. It found that the statute itself does not preclude use of the homestead exemption for an out-of-state property. Drenttel v. Jensen-Carter (In re Drenttel), 2005 U.S. App. LEXIS 5131 (8th Cir. Mar. 31, 2005).

Court Denies Motion to Compel Arbitration. The Court affirmed the bankruptcy court's denial of a motion to compel arbitration, refusal to stay an adversary proceeding, and injunction of participation in the arbitration because the arbitration would have "seriously interfered with the debtor's efforts to reorganize." Court found that arbitration is inconsistent with the centralized decision making process Congress intended in the bankruptcy courts. Permitting an arbitrator "to decide a core issue would make debtor-creditor rights â€˜contingent upon an arbitrator's ruling' rather than the ruling of the bankruptcy judge assigned to hear the debtor's case." White Mountain Mining Co. v. Congelton (In re White Mountain Mining Co.), 2005 U.S. App. LEXIS 5240 (4th Cir. Apr. 1, 2005).

Pre-Petition Attorney Fees are Dischargeable. Joining the Second, Seventh, and Ninth Circuits, the Sixth Circuit ruled that pre-petition attorney fees are dischargeable due to the plain meaning of § 523(a). The Court rejected appellant's argument that "unless pre-petition debts for legal services are held to be non-dischargeable, the provisions of § 329, governing attorney fees, will conflict with the general discharge provisions of § 727(b) and that § 329 is meaningless with respect to Chapter 7 bankruptcies unless pre-petition attorney fees are non-dischargeable." Court ruled that § 329 has "plenty to do in Chapter 7 cases." The Court did note, however, that while appellant's argument may have merit, it raises a public policy question that should be directed to Congress, not the Court. Rittenhouse v. Eisen, 2005 U.S. App. LEXIS 5600 (6th Cir. Apr. 7, 2005).

Mistake in Understanding not an Intent to Deceive under § 523. The Court found that debtor's actions did not amount to an intent to deceive under § 523(a)(2)(A). "An honest belief, even if unreasonable, that a representation is true and that the speaker has information to justify it does not amount to an intent to deceive." In this case, debtor personally guaranteed the creditor's preferred ship mortgage to a corporation, of which the debtor was secretary. After default occurred on the mortgage, debtor filed bankruptcy under Chapter 7. Creditor filed an adversary proceeding claiming that the guarantee was non-dischargeable. Creditor argued that debtor's actions amounted to "an intent to deceive" because he did not disclose a prior mortgage or the maintenance claim of a captain injured on the ship. The Court rejected this argument giving significance to the fact that the debtor honestly, although mistakenly, believed that the mortgage was extinguished by a memorandum of agreement between the corporation and prior lender, which was confirmed by the absence of an encumbrance in the Coast Guard records, or that the personal injury claim could not prime the creditor's mortgage. Appellant also argued that the bankruptcy court's ruling that appellant failed to satisfy § 523(a)(2)(B) was erroneous. However, the Court found that appellants waived appeal of this issue because while it listed the waiver ruling as an issue in its statement of the issues and statement of the case, it failed to argue the point in the body of its opening brief. General Electric Capital Corp. v. Acosta (In the Matter of: Acosta), 2005 U.S. App. LEXIS 5703 (5th Cir. Apr. 8, 2005).

Paige E. Barr
Kenneth B. Moll & Associates
Three First National Plaza, 50th Floor
Chicago, Illinois 60602

Washington Hot News

In March, Rep. Markey (D-Mass.) introduced H.R. 1078, a bill to strengthen the authority of the federal government to protect individuals from certain acts and practices in the sale and purchase of Social Security numbers and Social Security account numbers; referred jointly to Energy & Commerce and Ways & Means.

On the same day, Markey also introduced H.R. 1080, the Information Protection and Security Act, which directs the Federal Trade Commission to promulgate regulations governing the conduct of information brokers and the protection of personally identifiable information held by such brokers. States that such regulations shall include rules: (1) requiring procedures for maximum data accuracy, confidentiality, user authentication and tracking, the prevention and detection of illegal or unauthorized activity, and mitigation of potential harm to individuals; (2) allowing individuals to obtain disclosure of such information pertaining to them held by an information broker, to be informed of each entity that procured such information, and to request and receive prompt correction of errors; and (3) prohibiting brokers from engaging in activity that fails to comply with FTC regulations.

Senators Schumer (D-NY) and Nelson D-FL) on April 12th introduced S. 768, the Comprehensive Identity Theft Prevention Act (the "Act").

The bill establishes the Office of Identity Theft (the "Office") within the Federal Trade Commission and would provide the FTC with broad authority to prevent identity theft and establish limitations on businesses that collect, maintain, sell or transfer sensitive personal information of individuals.

The FTC would have civil jurisdiction over all commercial organizations that collect, maintain, sell or transfer sensitive personal information. Sensitive personal information includes an individual's:

The FTC is to promulgate regulations to enable the Office to protect consumers' sensitive personal information that is collected, maintained, sold or transferred by commercial organizations. The FTC is given authority to regulate data merchants. The term "data merchant" is defined broadly as a person that engages in collecting, assembling or selling sensitive personal information in a significant manner or as a significant part of the organization's operations. As a result, many companies that share information with others may be regarded as data merchants. The FTC's rules must require data merchants to register with the FTC. Data merchants will be required to authenticate third parties who have access to the data merchant's database and to track who has accessed what records containing sensitive personal information and for what purpose. Consumers will have the ability to request a report from data merchants holding the consumer's sensitive personal information which includes what information is maintained, to whom the information was provided and the purpose of the disclosure.

The Act provides that a person may not request an individual's social security number unless it is necessary for the normal course of business and no other identifying number can be used. It also prohibits the sale, purchase or display of social security numbers to the general public. The Act provides for civil penalties of up to $1,000 per violation, depending upon the nature of the violation. The FTC and state attorneys general are authorized to enforce the Act.

On February 23rd South Dakota Gov. Rounds (R) signed a bill that prohibits Social Security numbers from being displayed on state driver's licenses and non-driver identification cards. It will take effect with licenses and identification cards issued after June 30 this year.

Legislation (H.B. 2470) which would create civil penalties for violating Social Security number confidentiality restrictions, passed the Arizona House in March.