Concealed Assets and Exemptions

In a post last week, I reported on the 9th Circuit BAP’s recent decision, In re Onubah, 2007 WL 2701336 (Bankr. App. 9th Cir. August 31, 2007), which surcharged the Debtor’s allowed homestead and household goods exemptions in the amount of the attorney fees and other costs incurred by the trustee as a result of the Debtor’s legal and extra-legal obstruction of the sale of his home.

In the Onubah opinion, the Court tries to explain why the result, which amounts in part to an award of the Trustee’s attorney fees against the debtor, did not violate the “American Rule” that the parties to litigation bear their own fees:

[T]he American Rule has three exceptions: (1) when a litigant preserves or recovers a fund for the benefit of others; (2) when a losing party acts in bad faith; and (3) in a civil contempt action for disobedience of a court order. Perry v. O'Donnell, 759 F.2d 702, 704 (9th Cir.1985). . . . Even a charitable view of Onubah's conduct in this case would characterize it as being undertaken in “bad faith” and as an abuse of the bankruptcy process. This implicates the second exception to the American Rule.

The Onubah decision is tantalizingly close to Ninth Circuit authority for the proposition that an exemption can be denied in its entirety for bad faith conduct in relation to the exempt asset. The paradigm case is one in which the debtor, intending to conceal an asset from the trustee, fails to list it on the schedules. After the trustee discovers the asset and spends time and money preparing to liquidate it, the Debtor seeks to amend Schedule C to claim the asset exempt. The Tenth Circuit has recently ruled that such an amendment will not be allowed. See, In re Ford, 492 F.3d 1148 (10th Cir. 2007), following In re Grogan, 300 B.R. 804 (Bankr. D. Utah 2003).

A debtor’s attorney could argue that denial of an exemption for bad faith conduct is already addressed by Bankruptcy Code section 522(g), which forbids the taking of an exemption in property recovered by the trustee using the avoiding powers, if the avoided transfer was voluntary. The argument would be that if Congress had wanted to deny exemptions as punishment for unsuccessfully attempting to conceal an asset from the trustee, it could have said so expressly in section 522. A debtor’s attorney in the 9th Circuit might also argue that denying an exemption for bad faith conduct, as opposed to carefully surcharging the exemption by the amount of the fees and costs occasioned by the debtor’s bad faith conduct, amounts to withholding an exemption to punish the debtor, which is forbidden by Latman v. Burdette, 366 F.3d 774 (9th Cir. 2004)

The key distinction supporting the result in Ford may be that in the concealed asset cases the debtor must seek to amend Schedule C, and that the allowance of an amendment is within the discretion of the Court.

The Tenth Circuit’s ruling in Ford is welcome. It imposes serious additional, real consequences on the debtor for concealing an asset. The loss of an exempt asset by an otherwise “judgment proof” debtor has more real-life impact than even a denial of the bankruptcy discharge. The loss of an exemption also may benefit creditors in dollars and cents, immediately.

Debtors: On Vacating the Premises, Take Your Goo With You!

A landlord has successfully circumvented the “cap” on lease rejection damages imposed under Bankruptcy Code section 502(b)(6). In deciding a case with highly unusual (and sympathetic) facts, Ninth Circuit Judge Alex Kozinski has made some broad statements that will henceforth encourage landlords to structure their claims, and their leases, to try to “beat the cap.” The case is In re El Toro Materials Company, 2007 WL 2822019 (9th Cir., October 1, 2007).

You’ve got to love these facts: The debtor was a mining company which had leased land from the Saddleback Valley Community Church. The rent was $28,000 per month. The debtor rejected the lease and vacated the property, leaving (in Judge Kozinski’s words) “one million tons of its wet clay “goo,” mining equipment and other materials.” Saddleback claimed “$23 million in damages for the alleged cost of removing the mess, under theories of waste, nuisance, trespass and breach of contract.” The bankruptcy court held that this claim was not subject to section 502(b)(6), which limits in amount “the claim of a lessor for damages resulting from the termination of a lease of real property.” The BAP reversed, reluctantly concluding that it was bound by its own precedent in In re McSheridan, 184 B.R. 91 (Bankr. App. 9th Cir.1995). McSheridan contains a broad holding to the effect that any damages arising from breach of any lease covenant is subject to the cap.

Here’s how the Ninth Circuit opinion distinguishes the damages for the abandoned “goo” (which certainly was a breach of a lease covenant) from other damages which would be subject to the cap:

The cap applies to damages “resulting from” the rejection of the lease. 11 U.S.C. § 502(b)(6). Saddleback's claims for waste, nuisance and trespass do not result from the rejection of the lease-they result from the pile of dirt allegedly left on the property. Rejection of the lease may or may not have triggered Saddleback's ability to sue for the alleged damages. But the harm to Saddleback's property existed whether or not the lease was rejected. A simple test reveals whether the damages result from the rejection of the lease: Assuming all other conditions remain constant, would the landlord have the same claim against the tenant if the tenant were to assume the lease rather than rejecting it? . . . The million-ton heap of dirt was not put there by the rejection of the lease-it was put there by the actions and inactions of El Toro in preparing to turn over the site.

Are you persuaded? Well, as a landlord’s attorney I sure am! The opinion expressly overrules McSheridan to the extent that it holds that the cap is (to quote the El Toro opinion) “a limit on tort claims other than those based on lost rent, rent-like payments or other damages directly arising from a tenant's failure to complete a lease term.” Incidentally, in a footnote Judge Kozinski suggests that the BAP might amend its rules to allow for en banc hearings in order to address questionable precedent like McSheridan.

El Toro obviously will prompt landlords to express their claims not in terms of breach of contract but rather in terms of torts such as conversion, trespass and fraud. Drafters of leases may change language that used to characterize “restore to shell” and similar obligations on termination as rent. Instead, new lease forms may expressly reserve tort claims for these sorts of tenant obligations.

Trustees Can Take Hostages! – They’re Called “Exemptions”

A few weeks ago the Bankruptcy Appellate Panel for the Ninth Circuit issued a decision which all chapter 7 trustees should welcome. The BAP upheld the decision of Bankruptcy Judge Kathleen Thompson, of the Central District of California, surcharging the Debtor’s homestead and household goods exemptions in the amount of the attorney fees and other costs incurred by the Trustee as a result of the Debtor’s refusal to vacate the home and related legal shennanigans aimed at frustrating the sale. In re Onubah, 2007 WL 2701336 (Bankr. App. 9th Cir. August 31, 2007).

Mr. Onubah claimed a $75,000 homestead exemption in property which the Trustee ultimately contracted to sell for $2.3 Million. Onubah did not oppose the Trustee’s motion to sell, but he refused to vacate the property prior to close of escrow. The Trustee filed a turnover motion, but before the motion could be heard Onubah converted his chapter 7 case to chapter 11. Judge Thompson granted a re-conversion motion together with the turnover motion, but on the scheduled day of the turnover Onubah informed the Trustee that an involuntary bankruptcy petition had been filed against him. He refused to vacate, under color of the alleged new automatic stay. Judge Thompson later found that the petitioning creditors were colluding with Onubah. Apparently these petitioning creditors do this for a living in order to frustrate evictions. Ah, that wacky Central District! Onubah did not deny that all of these legal maneuvers were intended solely to frustrate the sale.

Ultimately, the Trustee was required to employ US Marshalls to evict Onubah, and the Trustee then had to store his household goods. The sale then closed. Judge Thompson then granted the Trustee’s motion to surcharge Onubah’s (presumably previously allowed without objection) homestead and household goods exemptions, in an amount representing the total of legal fees, storage charges, Marshall’s fees and locksmith charges.

In affirming, the BAP held that this result was mandated by the Ninth Circuit’s decision in Latman v. Burdette, 366 F.3d 774 (9th Cir. 2004). Still, the Onubah decision represents a significant extension of Latman. In Latman, the Court deducted from the debtor’s “wild card” exemption the amount of some pre-petition sale proceeds which the debtor had failed to account for. The opinion in Latman states that a surcharge of exemptions cannot be “punitive” in nature, and the Onubah opinion echoes this. The Latman surcharge passed muster because it prevented the debtor from shortchanging the estate by keeping money beyond the exempted amount, by subtracting that exact amount from the exemption.

In contrast, the decision in Onubah looks a bit more like sanctions (another word for “punishment”) imposed because of the Debtor’s improper litigation behavior. Onubah did not appeal this decision to the Ninth Circuit. For the time being, Trustees have a powerful new weapon against Debtors who fight wars of attrition to prevent assets from being liquidated for the benefit of creditors.

Bankruptcy Hearings Come to Your iPod

Last summer we had news of a pilot project in which audio recordings of bankruptcy hearings were going to be posted online, as .mp3 files, so that those who didn’t attend a court hearing (either in person or telephonically) can listen to what went on. Its a pilot project now. Three bankruptcy courts and two district courts are supposed to be participating. Since getting the news, I have been checking to find an audio file for a hearing which has been posted on the internet.

The idea was championed by Bankruptcy Judge Rich Leonard of the Eastern District of North Carolina. The two other bankruptcy court participants are supposed to be the Northern District of Alabama and the District of Maine. The two district courts are Nebraska and the Eastern District of Pennsylvania.

I was so captivated by the notion of being able to listen to bankruptcy court hearings on my iPod that I trolled the recent chapter 11 filings in those courts and found an .mp3! If you have a few nickels to burn, get on ECF and visit the Bankruptcy Court for the Eastern District of North Carolina, the case of In re D & M Land Company, LLC No. 07-00054-5-ATS, Docket No. 130. This docket entry is a pdf with the .mp3 file as an attachment. Look down the left hand side of the screen as it displays the pdf and you will see a paperclip. Click it and you’ll have a chance to save the attachment to your computer. This and the other file I tried left something to be desired in terms of sound quality and volume, but it worked.

I hope that this catches on. For one thing, it lets you know what really transpired in court without ordering a transcript. Also, tone of voice tells us so much. I can’t help but think that lawyers and judges alike would be on their better behavior if they knew that audio recordings of the proceedings were publicly available. Also, this will help me tackle that unproductive time I previously wasted listening to music and podcasts. Another way to separate the true bankruptcy attorneys from the poseurs.

The 7th Circuit "Hangs" with the Minority - Or Does It?

In the previous post, I covered In re Trejos, 2007 WL 2391184 (Bankr. App. 9th Cir. July 30, 2007), in which the Ninth Circuit BAP first considered BAPCPA’s infamous “hanging paragraph.” The language in issue is found in Bankruptcy Code section 1325(a):

For purposes of paragraph (5), section 506 shall not apply to a claim described in that paragraph if the creditor has a purchase money security interest securing the debt that is the subject of the claim, the debt was incurred within the 910-day [period] preceding the date of the filing of the petition, and the collateral for that debt consists of a motor vehicle as defined in section 30102 of title 49) acquired for the personal use of the debtor, or if collateral for that debt consists of any other thing of value, if the debt was incurred during the 1-year period preceding that filing.

In Trejos, the BAP rejected the Debtors’ argument that if section 506 does not apply to a “910 loan” then the auto lender cannot have an allowed secured claim in the chapter 13 case. In its ruling, the BAP stated that it is not section 506 that is the basis for a creditor’s security interest.

Trejos did not cite In re Wright, 492 F.3d 829 (7th Cir. 2007), published less than a month before. Wright was the first circuit decision on the “hanging paragraph.” Incidentally, the appeal reached the Seventh Circuit under BAPCPA’s new direct appeal provision, 28 U.S.C. § 158(d)(2)(A).

Unlike the Debtors in Trejos, the Wrights did not want to keep their car, but instead opted to return it. They claimed that the effect of the hanging paragraph was to disallow the lender’s unsecured claim for a deficiency. The Seventh Circuit adopted what it characterized as the “minority view” among bankruptcy courts, holding that the deficiency claim must be allowed. The opinion goes out of its way to debunk the argument (made by the National Association of Consumer Bankruptcy Attorneys in an amicus brief) that the hanging paragraph deprives the lender of even an allowed secured claim. The Court stated:

This line of argument makes the same basic mistake as the debtors' position: it supposes that contracts and state law are irrelevant unless specifically implemented by the Bankruptcy Code. Butner holds that the presumption runs the other way: rights under state law count in bankruptcy unless the Code says otherwise. Creditors don't need § 506 to create, allow, or recognize security interests, which rest on contracts (and the UCC) rather than federal law. Section 502 tells bankruptcy courts to allow claims that stem from contractual debts; nothing in § 502 disfavors or curtails secured claims. Limitations, if any, depend on § 506, which the hanging paragraph makes inapplicable to purchase-money interests in personal motor vehicles granted during the 910 days preceding bankruptcy (and in other assets during the year before bankruptcy).

Interestingly, the BAP in Trejos claimed to be siding with the substantial majority of published bankruptcy opinions in upholding the lender’s allowed secured claim against the hanging paragraph. In upholding the lender’s deficiency claim, the Seventh Circuit stated that it was adopting a minority view. That there should be a difference in result depending on the context is not surprising. In the Trejos situation, where the debtor wants to keep the car, the notion that the hanging paragraph was intended to deprive consumer lenders of a secured claim is absurd. However, it is less absurd (although implausible given the general tenor of BAPCPA) that Congress intended to relieve the Debtor of the burden of a deficiency claim in cases where the collateral is surrendered. It may also be argued that while section 506 may not be the origin of a secured claim, it may be the only basis for the creditor’s ability to bifurcate its claim.

Nevertheless, both Trejos and Wright are based on exactly the same, persuasive reasoning. Perhaps some future opinion will better explain why that reasoning should apply in one situation and not the other.