Post-BAPCPA, Dairy Mart Retains its Frosty Goodness

Reclamation claims aren't something that practioners in smaller bankruptcy cases used to see every day. In the past, in order for reclamation to rear its head you needed a credit sale of goods to the debtor which was large enough to motivate the seller to seek immediate legal advice following a bankruptcy filing, within the short time period allowed to perfect the claim.

When BAPCPA rewrote 11 U.S.C. section 546(c), questions were raised as to how this expanded right would fit into the post-petition financing transactions which often occur in the big cases. Amended section 546(c) still says that the reclamation right is "subject to the prior rights of a holder of a security interest in such goods." What about the situation where a floating lien on the goods is released and replaced by a lien in favor of the DIP financer? Do you have to structure your new DIP financing as a assignment of the pre-existing lien? Does it matter that the pre-petition blanket lienholder was oversecured and would have remain adequately protected if the reclamation rights were honored?

These questions were answered in pre-BAPCPA days by the Southern District of New York in In re Dairy Mart Convenience Stores, Inc., 302 B.R. 128 (Bankr. S.D.N.Y. 2003). According to Dairy Mart, reclamation claimants have no marshaling rights vis a vis an oversecured floating lien creditor. Further, new DIP financing still trumps the reclamation creditor, on the theory that the reclaimed goods securing the prepetition lender's debt have been disposed in satisfaction of that debt by providing them as collateral to the DIP lender. For the contrary view, see In re Phar-Mor, Inc., 301 B.R. 482 (Bankr. N.D. Ohio 2003).

Last week the Southern District of New York issued its opinion in In re Dana Corporation, 2007 WL 1199221 (Bankr. S.D.N.Y. April 19, 2007). The decision holds that post-BAPCPA, Dairy Mart retains all of its frosty goodness (or badness, if you're a reclamation creditor). Enroute to disallowing any reclamation right, the Court was at pains to debunk the notion that BAPCPA had created a new federal right of reclamation.

Even practical problems aside, under the holding in Dairy Mart and now Dana Corporation, the right to actually receive back the reclaimed goods is not legally available in any case where a blanket lien is present (that is, all but the smallest cases). Dana Corporation does not deal with the reclamation claimant's alternative remedy, which under BAPCPA no longer depends on timely perfection or the absence of a blanket lien. Reclamation claimants get administrative claims. Trustees are going to be seeing a lot more of those as creditor attorneys catch on.

Chapter 7 With Your Fingers Crossed?

Debtors who file a chapter 7 petition without complying with the credit counseling requirements of BAPCPA are subject to dismissal of their cases under Bankruptcy Code section 109(h). But what if the Trustee discovers significant assets that can be liquidated for the benefit of creditors? In that case, it may be the debtor that wants to invoke section 109(h) and use the failure to obtain pre-petition credit counseling as an escape hatch.

In re Mendez, 2007 WL 1119891 (Bankr. App. 9th Cir. March 28, 2007) was such a case. In her motion to dismiss, the Debtor relied on several decisions which strictly enforced the credit counseling requirement against a debtor. These decisions rely on what seems like the clear language of section 109(h), that "an individual may not be a debtor " under chapter 7 unless he or she received pre-petition credit counseling. See, In re Fields, 337 B.R. 173 (Bankr. E. D. Tenn. 2005).

Nevertheless, the BAP has now held that section 109(h) is not jurisdictional, and that the requirement may be waived by a bankrutpcy court, at least in a case where the eligibility issue is invoked by the debtor.

Judge Tchaikovsky of the Northern District of California came to the same conclusion in February. See, In re Withers, 2007 WL 628078 (Bankr. N. D. Cal. 2007 ). Withers had the added feature that the Debtor had failed to file schedules, thus bringing him within the "mandatory dismissal" provision of 11 U.S.C. section 521(i). Judge Tchaivkovsky ruled that this requirement could also be waived.

Fool Them Once, That's Enough - Inherited Dischargeability Claims

In re Boyajian, 2007 WL 1119910 (Bankr. App. 9th Cir. March 30, 2007) will prove useful to assignees of debts obtained by fraud. The Debtor was the President of the Blue Diamond Straw & Toothpick Company. She gave a personal guaranty and a false personal financial statement to Epic Funding Co. to obtain an equipment lease. After payments under the lease were delayed by Blue Diamond's cash flow problems, Epic sold the lease to Cupertino National Bank. After the lease defaulted the Bank obtained a judgment against Blue Diamond and Boyajian, then sold the judgment to Stornawaye Capital LLC, which conducted judgment debtor exams and then resold the judgment to New Falls Corporation. Boyajian then filed a chapter 7 petition.

The Debtor hung her hat on the "plain language" of 11 USC section 523(a)(2)(B), which excepts from discharge debts obtained by the use of a financial statement "on which the creditor to whom the debtor is liable . . . reasonably relied. . . ." The Debtor pointed out that New Falls purchased the debt after default, judgment and judgment debtor examination had all taken place, and obviously did not reasonably rely on her financial statement. She cited a number of cases requiring proof of reliance by the assignee, including In re Bui, 188 B.R. 274 (Bankr. N.D. Cal. 1995), followed by In re Whitenack, 235 B.R. 819 (Bankr. D. S.C. 1998); and In re Hurley, 285 B.R. 871 (Bankr. D. N. J. 2002).

In Boyajian the BAP disapproves these cases and holds that it is sufficient to prove reasonable reliance by the original creditor. In reversing Bankrutcy Judge Thompson of the Central District, the opinion nevertheless quotes her sceptical question to the Debtor's counsel:

"Really what you're saying to me it's okay to lie ... in order to get the credit because if you're really lucky somebody else will come along and purchase this debt...."

Whoever sells a debt after default, judgment and unsuccessful efforts to collect a judgment will be taking a pretty deep discount. But maybe not quite as deep as the result of this ruling. Although this one arose in a commercial context, you can see that it will also be used by purchasers of consumer debt.

No Wage Garnishment After Bankruptcy? Aw, Geez . . .

On April 11, 2007 Judge Montali discouraged an over-aggressive judgment creditor who wanted to garnish the debtor's wages over 13 years after her bankruptcy discharge was entered (!). The case, In re Kimmel, 2007 WL 1111248 (Bankr. N. D. Cal. 2007) gave me some food for thought.

The creditor sues husband and wife in 1991. Wife files chapter 7 in 1993 and receives her discharge. The suit continues against husband and in May, 1995 a judgment is obtained. In July, 1995, husband and wife enter into a postnuptial agreement under which husband transfers to wife all his community property interest in her future wages. More than 7 years later (that being the absolute maximum extension of the statute of limitations under the Uniform Fraudulent Transfer Act) creditor sues to avoid the post-nuptial agreement so that he can garnish wife's wages to recover husband's community property share. In the meantime, husband filed chapter 7 and receives a discharge.

First, its nice to see a case which assumes (too bad it couldn't simply and expressly hold) that a creditor holding a discharged claim can still sue post-discharge to reach property fraudulently transferred by the debtor. Although Kimmel doesn't need to discuss this (because the transfer was post-petition), there would still be an issue as to whether property fraudulently transferred pre-petition which was not referred to in the schedules remains property of the bankruptcy estate even after case closing. 11 USC section 554(c) states that only scheduled property is deemed abandoned at case closing, so query whether property recovered as the result of a creditor's post-petition avoidance of a concealed pre-petition transfer would be estate property. There is even a split of authority as to whether the UFTA lawsuit itself might be subject to the automatic stay because it is an effort to obtain control over estate property. See, Klingman v. Levinson, 158 B.R. 109 (N.D.Ill.1993).

It is also good to be reminded that the community property interest of a spouse in wages can be the subject of a fraudulent transfer. See, State Board of Equalization v. Woo, 82 Cal.App.4th 481 (2000). But there would seem to be no reason for non-filing spouses to take such a step, since 11 USC section 524(a)(3) enjoins future collection activity against the non-filing spouse's share of the community property. Judge Montali found that this creditor's actions violated the post-discharge injunction. Oh, yes, the action was barred by the seven year UFTA limitations, too.
No sanctions against the creditor were imposed, remarkably in my view since the import of section 524(a)(3) seems so clear.

Collateral Estoppel - Not a Rule, An Option

California judgment debtors who want to relitigate dischargeability issues (like fraud and willful and malicious injury) got a boost from the BAP. On March 27, 2007 the Bankruptcy Appellate Panel for the Ninth Circuit decided In re Lopez, 2007 WL 1128811. The Plaintiff, Emergency Service Restoration, had already obtained a judgment for damages for misappropriation of trade secrets in California Superior Court. The Superior Court judge entered a written statement of decision finding that the debtor’s conduct was willful and malicious. After the judgment became final for purposes of appeal, the Debtor’s chapter 7 petition was filed.

Sounds like an easy and obvious case to apply collateral estoppel, or "issue preclusion" on summary judgment in a dischargeability action. That’s just what Central District Bankruptcy Judge Thompson did. The problem was, the BAP concluded from the record, that Judge Thompson thought that she was compelled to apply collateral estoppel in order to give full faith and credit to the Superior Court judgment under the Rooker-Feldman doctrine. That’s the holding of cases like In re Williams, 280 B.R. 857 (Bankr. App. 9th Cir 2002), and In re Audre, Inc., 216 B.R. 19 (Bankr. App. 9th Cir. 1997). Williams and Audre have now been expressly overruled by Lopez.

The BAP believes that its earlier Rooker-Feldman decisions were disapproved by the Supreme Court in Exxon Mobil Corp. v. Saudi Basic Indus. Corp., 125 S.Ct. 1517 (2005), The Lopez opinion observes that Exxon "severely constrained" the Rooker-Feldman doctrine, and made clear that it has nothing to do with issue preclusion. Now, according to the BAP, dischargeability cases are independent federal claims, which can be decided in a manner inconsistent with a state judgment based on exactly the same facts.

The BAP held in Lopez that application of collateral estoppel is a matter of discretion in California. It remanded the case so that the Bankruptcy Court could consider the Debtor’s arguments which mitigated against applying collateral estoppel. For example, the Debtor contended that he had been improperly denied a jury trial, and that his lawyer had gotten into a “screaming match” with the Superior Court judge.

Whither comity with the state courts? We now are going to be re-examining the judgments of state courts based on the fairness of the proceedings. Did the debtor have the effective assistance of counsel in the state court case? Was the debtor out of money at the time so that the case could not be properly defended? Lopez even invites the Bankruptcy Court to assess the decorum of the Superior Court case and to revisit rulings on issues like the right to a jury trial. Bankruptcy judges: if you decline on the record to consider matters like this then you may get reversed. Consider it all and you won’t get reversed except for abuse of discretion, whatever that might be in this context.

All in the Ordinary Course of a Desperate Struggle to Survive

Back in pre-BAPCPA days, creditors defending a preference action using the "ordinary course" exception of 11 USC §547(c)(2) had to show both that: (i) the debt was incurred and the payment was made in the ordinary course of the business or financial affairs of the debtor and the transferee and that (ii) the payment was made according to ordinary business terms.

Creditors defending preference actions in the 9th Circuit got a boost awhile back from In re Jan Weilert, RV, Inc., 315 F.3d 1192 (9th Cir. 2003). Jan Weilert held that the meaning of “ordinary business terms” cannot be limited to “the average transaction.” According to the opinion, such a standard fails to take into account the broad range of terms that encompasses the practices employed by 'similarly situated debtors and creditors facing the same or similar problems. . . ' These were said to include "terms that are ordinary for those under financial distress" i.e., "similarly situated" can mean similarly broke and similarly trying to keep creditors at bay.

Jan Weilert made the "ordinary business terms" prong much easier to assert although still a little difficult in the proof department. Then BAPCPA helped out more by amending the “ordinary course” exception to make it an alternative test – the exception now applies if the defendant can show either "ordinary course of business" or "ordinary business terms."

On April 3, the 9th Circuit decided In re Ahaza Systems, Inc., 2007 WL 968386, still a pre-BAPCPA case, interpreting the first, "ordinary course of business" prong. The specific issue in Ahaza was – Can the "ordinary course of business" prong ever be satisfied in a case where there was only one transaction between the debtor and the creditor? The Court held "when we have no past debt between the parties with which to compare the challenged one, the instant debt should be compared to the debt agreements into which we would expect the debtor and creditor to enter as part of their ordinary business operations. . . . [H]owever, this analysis should be as specific to the actual parties as possible."

To me, the really interesting thing about Ahaza is still this "ordinary distressed debtor" angle. The creditor defendant in Ahaza was a supplier. The Court described the transaction this way:

Stratos threatened to sue Ahaza for breach of contract and other causes of action. Instead of heading to court, Stratos and Ahaza in 2001 entered into a Settlement Agreement . . .[which] provided that Ahaza would pay to Stratos $380,000 immediately, and $35,000 per month for the following year. . . . If Ahaza failed to pay within ten days of receiving notice of payment due, the entire remaining balance would immediately become due.

Ahaza makes clear that delinquent debts that are restructured under threat of lawsuit may still be regarded as having been incurred and paid in the ordinary course of business. Aggressive trade creditors can negotiate draconian payment plans which have the practical effect of preferring their delinquent debts over debts owing to others, and maybe not lose those payments in a later bankruptcy. But there’s still the problem of those recidivist debtors who make their workout payments late!

Raising the Stakes in Dischargeability Litigation

Everybody, including me, has been blogging over the Supreme Court’s Travelers decision, which overruled the Ninth Circuit case of In re Fobian, 951 F.2d 1149 (9th Cir. 1991). Fobian held that attorney fees are not recoverable in bankruptcy for litigating issues “peculiar to federal bankruptcy law.” In Travelers, 2007 WL 816795, the Supremes went out of their way to overrule Fobian, but ducked an issue which was inexplicably raised late by the Debtor: is recovery of attorney fees by an unsecured creditor barred anyway by implication under the Code? Section 506(b) only allows attorney fees to oversecured creditors, right?

It will therefore remain unclear for now whether unsecured creditors can add attorney fees to their claims when they successfully litigate bankruptcy issues, and if so whether those fees will have administrative priority. In the meantime, the holding in Travelers will impact another area – dischargeability litigation. Section 506(b) governs the allowability of attorney fees as a component of a bankruptcy claim It shouldn’t have any effect on whether these fees can be recovered against an individual debtor, as opposed to the bankruptcy estate.

In re Baroff, 105 F.3d 439 (9th Cir. 1997) applied the Fobian rule in a dischargeability case, leading to a strange result in which the Debtor was awarded fees for successfully defending a fraud claim under §523(a)(2)(a) (fraud in the inducement) but not for defending a breach of fiduciary duty claim under §523(a)(4). The Ninth Circuit later stated in Renfrow v. Draper, 232 F.3d 688 (9th Cir. 2000): “The rule we announced in In re Baroff does not permit a bankruptcy court to award a party attorney's fees for litigating federal law issues in a bankruptcy court whenever state law is ‘integral’ to determining dischargeability. Instead, we held that attorney's fees should be awarded solely to the extent they were incurred in litigating state law issues.”

The Bankruptcy Appellate Panel had already backed away from Baroff following the Supreme Court’s decision in Cohen v. de la Cruz, 118 S.Ct. 1212 (1998), which upheld an award of attorney fees and treble damages in favor of a landlord under a New Jersey statute. In re Pham, 250 B.R. 93 (Bank. App. 9th Cir. 2000) held:

We agree that, after Cohen, the determinative question in cases under §523(a)(2) is whether the successful plaintiff could recover attorney's fees in a non-bankruptcy court. The Ninth Circuit's holdings in Baroff . . . were premised on the view that, under California law, fees in a fraud action for damages could not be recovered via a contractual fee agreement. These holdings were arguably undercut by Santisas v. Goodin, 17 Cal.4th 599, 608, 71 Cal.Rptr.2d 830, 836, 951 P.2d 399 (1998), in which the Supreme Court of California concluded that, depending on the wording of the fee provision, there may be a contractual right to recover attorney's fees in litigating tort claims.

On the issue of attorney fees in dischargeablity cases, Travelers demolishes Ninth Circuit law, but leaves Pham intact. It now seems likely that attorney fee claims in dischargeability litigation will be made with increasing frequency, and that the legal issue will be whether the contractual attorney fee provision involved is broad enough to include fees incurred in litigating tort claims. Adding attorney fee liability to dischargeability cases is a greater problem for creditors than for debtors. Chapter 7 debtors are judgment proof by definition. Creditors are not, and they may begin to think twice before filing a questionable dischargeability claim in the often unfriendly confines of the Bankruptcy Court.