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Sua Sponte

Cathy Pike, Chair
 Weber and Rose
cpike@weberandrose.com

Rules, Regulations, and Big Shoes

Most moments I am excited to assume the role of Chair of the Bankruptcy Section of the CLLA. Then there are moments when I am intimidated by all that lies ahead. Depending on one's attitude and perspective, this is an exciting time to be in bankruptcy. Our practice is going to change radically and yet, in many ways, stay the same.

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Case Analysis

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

SIXTH CIRCUIT RULES THAT TAX LIEN NOTICE WITH ERRONEOUS OR ABBREVIATED DEBTOR NAME MAY SUFFICE TO ESTABLISH LIEN PRIORITY

SUMMARY: In In re Spearing Tool and Manufacturing Co., Inc., 412 F.3d 653 (6th Cir. 2005), the United States Court of Appeals for the Sixth Circuit Court held that federal law dictates that an IRS tax lien notice provides adequate notice to establish priority over a secured lender's lien, even where the notice fails to use the precise legal name of the taxpayer/borrower. This case is significant as it likely signals a change in the way lenders must conduct their due diligence in connection with secured transactions.

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Case Law Update

Paula Lucas
Staff Writer, CLLA
plucas@clla.org

Payments Found Outside Ordinary Course of Business . Creditor sought to avoid and recover a single transfer made to creditor during 90 day preference period. Creditor argued that the payment was made within the ordinary course of business and sought to establish entitlement to the funds under a § 547(c) defense. Throughout their relationship the parties had engaged in seven transfers, one of which occurred during the preference period.

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Sua Sponte

Rules, Regulations, and Big Shoes

Most moments I am excited to assume the role of Chair of the Bankruptcy Section of the CLLA. Then there are moments when I am intimidated by all that lies ahead. Depending on one's attitude and perspective, this is an exciting time to be in bankruptcy. Our practice is going to change radically and yet, in many ways, stay the same. As I ponder how to best lead our Section as we confront the challenges of implementing the new law, I am comforted by the history of our Section and its past and current leadership.

Each year the Incoming Chair writes about the "big shoes" they have to fill. I don't know about you, but I'd rather have shoes that are comfortable and well worn, than small, too tight new shoes that pinch and bind. The "shoes" worn by the leadership of this Section have walked every step that this legislation has taken for the past eight years. They have provided excellent support to those before them and, gratefully, to those after them. In addition, the League has provided to Congress thoughtful insight and comments relating to the new legislation. So, in the end (or I guess, at the beginning), I'm much more excited than I am nervous.

Under the guidance of Alan Nahmias, Immediate Past Chair, and an impressive group of legislative experts, the Section has risen to new heights this past year. Through the tireless efforts of Jay Welford, Judy Miller, Cathy Vance, Peter Califano, David Goch and Sarah Jolie, as well as many others, the Bankruptcy Section lived up to its mission:

The purposes of this Section are to promote the highest standards in the practice of Bankruptcy and Insolvency Laws before the United States Bankruptcy Courts and other courts; to further aid and better understand the practices of Bankruptcy and Insolvency Laws; to conduct educational programs; to participate in the legislative process; to disseminate information not only to members of the Section, but to others engaged in Bankruptcy and Insolvency Law including the general public; and to formulate recommendations for the improvement of Bankruptcy and Insolvency Law and Procedures, all in conformity with the Constitution, Bylaws and Operative Resolutions of the League and subject to the approval of the Board of Governors.

I want to specifically highlight one achievement. The leadership of this Section made a key decision that the preparation of thorough and understandable educational materials was an absolute priority and that these materials needed to be available at no cost to anyone that needed them. These materials, available by clicking here, have been used from coast to coast, at large meetings and small ones, by judges and attorneys and everyone else. Our materials became the standard bearer. While other organizations have now produced their own materials and programming, YOUR Section set the bar. And with it, your membership became more valuable. More visitors came to clla.org, more people used the online member directory and more organizations looked for Section members to be their "expert." We intend to continue to be in the forefront as the new law and rules are implemented and applied.

Of course, your Section provided excellent educational programming with the top speakers in the country including The Honorable Eugene Wedoff, The Honorable Bruce Markell and those mentioned above. If you did not have a chance to attend these programs, they are available via CD Rom and will provide the information you need to be ready for October 17!

As I said at the beginning, this is an exciting time to be in the bankruptcy profession. I promise you, the next few months will not be dull. We are in the process of finalizing a position paper on the technical amendments we think need to be made to the new law. We will probably ask your assistance in disseminating this to your representatives in Congress.

The Judicial Conference is currently in the process of adopting new Interim Rules. New forms are being drafted and tested. We will continue to be your resource for the "breaking news" on the new Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.

Cathy S. Pike
Weber and Rose, PSC
2400 Aegon Center
400 West Market Street,
Louisville, KY 40202

Phone: 502-589-2200
Fax: 502-589-3400
cpike@weberandrose.com

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Case Analysis

SIXTH CIRCUIT RULES THAT TAX LIEN NOTICE WITH ERRONEOUS OR ABBREVIATED DEBTOR NAME MAY SUFFICE TO ESTABLISH LIEN PRIORITY

Summary: In In re Spearing Tool and Manufacturing Co., Inc., 412 F.3d 653 (6th Cir. 2005), the United States Court of Appeals for the Sixth Circuit Court held that federal law dictates that an IRS tax lien notice provides adequate notice to establish priority over a secured lender's lien, even where the notice fails to use the precise legal name of the taxpayer/borrower. This case is significant as it likely signals a change in the way lenders must conduct their due diligence in connection with secured transactions.

Facts: Crestmark Bank and Crestmark Financial Corporation (collectively, "Crestmark") entered into financing agreements with Spearing Tool and Manufacturing Co. ("Spearing") in April 1998 and April 2001. Under these agreements, Crestmark obtained a security interest in all of Spearing's assets. Crestmark timely filed UCC financing statements, each time using Spearing's exact legal name, as registered with the Michigan Secretary of State: "Spearing Tool and Manufacturing Co."

In October 2001, the IRS filed two notices of federal tax lien against Spearing with the Michigan Secretary of State; both identified Spearing as "SPEARING TOOL & MFG. COMPANY INC." Subsequently, Crestmark periodically requested lien searches from the Secretary of State using Spearing's exact legal name. Because Michigan's electronic search technology only picks up liens matching the exact name searched The IRS liens were not located

In February 2002, Crestmark received its search results accompanied by a handwritten note from the Secretary of State's office indicating that: "You may wish to search using Spearing Tool & Mfg. Company Inc." Crestmark never conducted that search and, having not learned of the tax liens, lent additional funds to Spearing between October 2001 and April 2002.

Crestmark became aware of the tax liens only after Spearing filed a Chapter 11 bankruptcy petition in April 2002. Crestmark filed a complaint in Spearing's bankruptcy case to determine lien priority. The bankruptcy court granted summary judgment in favor of the government. The district court reversed.

Analysis: The three-judge panel of the Sixth Circuit agreed with the bankruptcy court, and ruled that (1) federal law determines the sufficiency of IRS tax lien notices and (2) the IRS notices in this case sufficed to give the IRS liens priority.

The Court's reasoning behind its first ruling was both perfunctory and clear. Federal law prescribes that tax lien notices must be filed on IRS Form 668. Federal statutes and regulations provide for the validity of the form "notwithstanding any other provision of law regarding the form or content of a notice of lien." See 26 U.S.C. § 6323(f)(3); 26 C.F.R. § 301.6323(f)-1(d)(1). Relying on the plain language of federal statutory and regulatory law, the Court concluded that notice using Form 668 will suffice regardless of state law.

The Court then turned to case law and public policy arguments finding the IRS' imprecise identification of Spearing on its Forms 688 sufficient to give priority to its liens. In this respect, the applicable standard is whether a "reasonable and diligent search would have revealed the existence of the notices of the federal tax liens" under an erroneous or abbreviated name. The Court referred to factual scenarios from earlier cases, but noted that these scenarios were inapplicable since Michigan no longer maintained a physical lien index (as in the earlier cases) and instead employed an electronic search system for location of liens.

The Court noted that "Mfg." and "&" are very common abbreviations, both known to be used by Spearing, and that the Michigan Secretary of State had recommended that Crestmark use such abbreviations in future searches. Taken together, the Court concluded that "a reasonable, diligent search by Crestmark of the Michigan lien filings for this business would have disclosed Spearing's IRS tax liens." In response to Crestmark's arguments that it is unreasonable to require numerous lien searches for businesses with many potential name variations, the Court stated that it was "express[ing] no opinion about whether creditors have a general obligation to search name variations. Our holding is limited to these facts."

The Court found its ruling to be consistent with the IRS policy of ensuring prompt and effective revenue collection. The Court refused to require the IRS to meet the precise name identification requirement under the UCC, noting that the UCC provisions apply only to security interests created by contract. Moreover, the Supreme Court has held that the United States, "as an involuntary creditor of delinquent taxpayers, is entitled to special priority over voluntary creditors," and thus its interest in effective tax collection trumps a bank's interest in the convenience of loan collection.

Comment: Despite the Court's contention that its holding was limited to the facts in this case, the Spearing Tool decision appears to impose a general obligation on creditors to search multiple name variations in applicable states in order to find any imprecise IRS lien notices that may be otherwise "hidden" when in a state's UCC index. To do otherwise might risk the loss of lien priority, at least to the extent a state's search engine uses a very strict search logic like Michigan and ignores certain "noise words" and their abbreviations, like "Incorporated" and "Company," but not "Manufacturing" or "and." The potential breadth and unreasonableness of this obligation is illustrated by Crestmark's example of a business name that apparently could be abbreviated 288 different ways: "ABCD Christian Brothers Construction and Development Company of Michigan, Inc." Alternatively, lenders might also consider implementing (albeit burdensome) the requirement that debtors provide the front pages of tax returns for past years, so that lenders might limit their lien searches to the names which have appeared on debtor tax returns.

Jesse Mainardi
Cooper, White & Cooper, LLP
201 California Street, 17th Floor,
San Francisco, CA 94111

Phone: 415-433-1900
Fax: 415-433-5530

pcc@cwclaw.com
http://www.cwclaw.com

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Case Law Update

Payments Found Outside Ordinary Course of Business . Creditor sought to avoid and recover a single transfer made to creditor during 90 day preference period. Creditor argued that the payment was made within the ordinary course of business and sought to establish entitlement to the funds under a § 547(c) defense. Throughout their relationship the parties had engaged in seven transfers, one of which occurred during the preference period. All seven of the prior invoice payments had been made on average, 69 days late. The payment in question was paid four days prior to the due date with a check written five days prior to that. Reasoning that "there is no precise legal test which can be applied in determining whether the payments by the debtor…were made in the ordinary course of business," the Court held that a creditor needs to demonstrate some consistency with other business transactions between the debtor and creditor to establish grounds for a § 547(c) defense. The payment was found to be a preference. In re TWA, Inc., 2005 Bankr. LEXIS 1384 (Bankr. D. Del. June 28, 2005).

Rejection of Non-Debtor Release under Reorganization Plan . Court ruled that a non-debtor release under the plan of reorganization shall not occur absent "unusual circumstances." Debtor sought to enjoin of creditors from suits against third parties and argued that the relief was key to the success of the reorganization plan. The Court found non-debtor releases to be proper only in "rare cases" where the injunction was material to the plan's success. Metromedia Fiber Network, Inc. v. Metromedia Fiber Network, Inc., 2005 U.S. App. LEXIS 14817 (2d Cir. July 21, 2005).

Retirement Annuity Account Not Exempt . Debtor appealed judgment denying retirement annuity account exemption under Chapter 7. Debtor was required to make 53 monthly alimony payments, which were secured by assignment of funds from Debtor's Optional Retirement Program Account. Debtor filed its Chapter 7 petition claiming an exemption for the retirement fund. The Bankruptcy Court deemed the pledged amount received by Debtor a distribution from the annuity account no longer part of the qualified plan. Applying Texas law, the Bankruptcy Court found that the payment was not exempted under Texas law. The district court affirmed. Debtor argued that the assigned portion of the account is a "retirement account" under Texas law and 11 U.S.C. § 522(b), which incorporates exemptions authorized by state law. Debtor attempted to distinguish deemed distributions, which are exempted, and actual distributions which are not exempted. Looking to the tax consequences of the distribution and finding the integrity of the plan still intact the court deemed the distribution to be an actual distribution. The plan was therefore not exempt under debtor's bankruptcy plan. In re Joseph C. Coppola, 2005 U.S. App. LEXIS 15225 (5th Cir. July 25, 2005).

Student Loans Classified as Long Term Debt under § 1322(b)(5). Debtor filed for Chapter 13 and under an amended reorganization plan proposed to make payments toward his student loan throughout the 60 month term of the reorganization plan, with the final payments to be made at the end of the plan's term. Trustee objected claiming the special student loan classification to be a violation of 11 U.S.C. § 1322(b)(1) as an unfair discrimination against a class. Debtor argued that § 1322(b)(1) did not apply, but rather the student loans should be classified as long-term debt under § 1322(b)(5). The lower court affirmed the proposed plan, finding that §§ 1322(b)(1) and (b)(5) were non-conjunctive and that the long-term debt provision was not subject to the anti-discrimination provision. The Trustee appealed, the district court reversed the order and confirmed the reorganization plan. Following debtor's appeal the Trustee filed a motion to dismiss as the Debtor was in substantial default on required payments and no replacement plan was in place. An order dismissing the bankruptcy case was entered while Debtor's appeal was pending. Debtor did not appeal that order. The Trustee argued the Debtor's motion to be moot as having been dismissed in the prior hearing. A bankruptcy court retains jurisdiction over cases before it throughout the term of the plan to allow protection of the rights of the various interested parties via enforcement of the debtor's performance under the reorganization plan and ensuring proper administration of the plan by the trustee. Debtor contended that the exception to the mootness doctrine is issues that are "capable of repetition, yet evading review." Where the challenged action was too short to be fully litigated prior to expiration and there was a reasonable expectation that the same complaining party would be subjected to the same action again there was an exception to the mootness doctrine. Ronald Belda v. Marilyn O. Marshall, 2005 LEXIS 15250 (7th Cir. July 26, 2005).

United Leases Determined to be Financing Devices.   The Seventh Circuit Court of Appeals reversed the District Court and determined that the transaction was not a true lease, but rather it was a financing device. The Court followed the same course as every other appellate court that has evaluated the nature of a true lease determination under § 365 and found that substance controls over form. Furthermore, the Seventh Circuit affirmed the standard utilized by the District Court -- state law applies as to the determination of a true lease, however it reached a different conclusion regarding the nature of the transaction. Under California law, there was no true lease because (i) there was a lack of connection between the rental value of the property and United's financial obligation; the rent was not based upon market value, but rather upon the amount United had borrowed; (ii) at the end of the lease full tenancy reverted to United for no additional charge, which is characteristic of the granting of secured credit under the Uniform Commercial Code; (iii) United was entitled to make a payment to retire the principal at the conclusion of the lease, another characteristic of secured financing as opposed to true leases; and (iv) if United prepays the amount due under the agreements, the lease and sublease terminate immediately; whereas in a true lease scenario prepayment would secure the tenant's right to occupy the property for an additional period of time. United Airlines, Inc. v. HSBC Bank USA , 2005 WL 1743787 (7th Cir. July 26, 2005).

Revocation of Discharge Allowed under Bankruptcy Rule 9024. Bankruptcy court acted properly in revoking debtor's discharge, issued through routine administrative procedures, pursuant to Rule 9024 even where the specific grounds for revocation under § 727(d) are not met. The bankruptcy court did not abuse its discretion because it was taking corrective action based on facts learned through creditor's prosecution of dischargeability complaint. The Court did abuse its discretion was abused, however, in invoking § 105(a) as an alternative authorization for revocation. Disch v. Rassmussen, 2005 U.S. App. LEXIS 16592 (7th Cir. Aug. 9, 2005).

Paula Lucas
Commercial Law League of America
70 East Lake Street, Suite 630
Chicago , IL 60601

Phone: 312.781.2000
Email: plucas@clla.org

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Washington Hot News

August 25: IRS Argues Universal Fidelity should not impact new Debt-Collection process

On August 12th, the IRS asked a federal claims court to drop the lawsuit brought by Universal Fidelity LLP challenging the IRS's limiting the cancelled debt-collection initiative to certain vendors. IRS said the Houston debt collection agency is attempting to shape the terms of a new solicitation. On August 4th, Judge Robert Hodge, Jr. said he has no particular interest in dismissing the case. Universal has not said what it intends to do.

August 16: New York Enacts Data Breach Notification Law

It is believed that on August 10th, Gov. Pataki (R) signed legislation requiring businesses and state agencies to notify consumers when here is a security breach of their personal information (A. 4254-A).

The law, effective 120 days after signature, requires notification to consumers by writing, telephone, e-mail in certain cases, when unauthorized acquisition or acquisition without valid authorization" of private information that "compromises the security, confidentiality, or integrity of personal information" occurs.

The law defines "private information," as "any information concerning a natural person which, because of name, number, personal mark, or other identifier, can be used to identify such natural person" in conjunction with one or more data elements including: Social Security number, driver's license number, or credit card numbers, bank account information, or other financial account number with codes or passwords allowing access.

Covered entities are required under the new law to inform the state attorney general, state Office of Cybersecurity and Critical Infrastructure and the state Consumer Protection Board of breaches.

Although patterned after California's law, New York's law, unlike other state laws enacted to date, does not:

  • Limit its scope to the release of unencrypted data
  • Include a risk threshold provision to allow a covered entity to avoid disclosure if there is little risk of harm to individuals as the result of a breach (creating the potential for "over-notification" and desensitization)
  • Contain a safe harbor from notification for a covered entity with its own consumer breach notification policy that is at least as strong as the State's
  • Provide a safe harbor or exemption for entities that are governed by federal regulators and already are subject to data security and consumer notification requirements of federal laws, such as GLB or HIPAA

The law does contain a substitute notice provision. If a breach involves more than 500,000 names or if the cost of notifying individual consumers would exceed $250,000, consumers can be notified by e-mail, if their e-mail addresses are known, and by posting announcements in statewide media and on the entity's Web site.

Just over the river, New Jersey's legislature passed a breach notice bill June 23 that is awaiting transmission to the governor, who has indicated he will sign.

August 10, 2005 : Senate Passage of Data Breach Notification Bill Likely In Spring 2006

Looking into the "legislative crystal ball", while Senate committees (namely, the Senate Banking Committee and the Judiciary Committee) will continue to work on data security breach notification legislation, the entire Senate is not likely to pass comprehensive privacy legislation until spring 2006.

It is believed that many hurdles still lie ahead this year: a short legislative calendar (only 30 scheduled days remaining in 2005), committee jurisdictional disputes, not to mention the increased attention to at least one U.S. Supreme Court nomination.

However, it is also believed that whatever finally emerges will be fairly comprehensive and include not only data security, notification to consumers in cases of security breaches, fraud alerts; but the regulation of data brokers (specifically attempting to provide "transparency" by giving consumers the right to examine data broker's records and allow them to correct inaccuracies); as well as access to and use of social security numbers. Although this is good news regarding any final passage, it should not be considered a "break" from plans to comment on pending legislation, etc., since, as stated above, committee work will be continuing.

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