Fraud

On February 9, 2015 the Bankruptcy Court for the Northern District of Illinois, Eastern Division ruled in the case of Brandt vs. Rohr-Alpha, a case involving fraudulent transfers and whether certain debts can be avoided in Bankruptcy.

What is a “Fraudulent Transfer?”

A pre-petition payment is avoidable as constructively fraudulent according to 548(a)(1)(B) when the Debtor:

  1. Transfers property or an interest in property;
  2. Within the 2 years preceding its bankruptcy;
  3. Got less than reasonably equivalent value; and
  4. Was insolvent or rendered insolvent as a result.

Reasonably Equivalent Value

To determine whether reasonably equivalent value was exchanged the Court must determine:

  1. Whether at time of transfer the Debtor received value; and, if so,
  2. Whether that value was equivalent to what the debtor gave up.

Application to This Case

Plaintiff William Brandt, Plan Administrator for Debtor Equipment Acquisition Resources, Inc. (“EAR”), sought to recover transfers from EAR to car dealer Rohr-Alpha, Inc. (“Rohr-Alpha”) in exchange for 2 vehicles.

Checks were written by EAR to Rohr-Alpha for the purchase of a 2007 Jeep and a 2006 Jeep, which satisfied the first and second prongs of the analysis.

While EAR paid Rohr-Alpha $23,013.66 for the 2007 Jeep and $18,550.45 for the 2006 Jeep, records showed that the vehicles had been sold within months before the filing of the case to the father-in-law and mother-in-law of one of the Debtor’s officers – in other words, to “insiders.” This cast suspicion over the entire set of transactions.

Finally, an expert hired by the Plaintiff determined that EAR was running a type of Ponzi scheme and was therefore considered de facto insolvent. This satisfied fourth and final element of Section 548.

Ruling –Split Decision

Despite the nearly identical facts relating to these vehicles, the Court reached different conclusions:

2007 Jeep: The Court concluded that EAR was never an owner and therefore did not technically receive anything of value; so the transfer was constructively fraudulent and avoidable in bankruptcy.

2006 Jeep: The Court concluded that EAR was the owner, albeit for only two months, at the time of the transfer and therefore the $18,550.45 it received represented reasonable equivalent value.

The Upshot

The EAR case exemplifies the tendency of Courts to adhere stubbornly to established doctrines. It did not matter that both of the transfers in this case were almost identical; or that both went to non-employees of EAR. All that mattered was that one was “owned” by EAR before being sold, making it a fraudulent transfer.

Your Turn

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Foreclosure Notice

Today’s post features a pair of cases in which a foreclosure defense Attorney seems to have gone too far. Foreclosure defense has become a veritable cottage industry over the past decade and it is common for Clients to expect their lawyer to do more than fight. They want to delay “by any means necessary.” But the Courts still regard the law as a genteel profession. This means that what Clients see as run of the mill zealous lawyering comes off to the Judge as unprofessional or worse. This pair of cases highlights that point.

Case #1: In re Wendy A. Nora

Facts

Nora was known for using tactics to prolong her Clients’ cases. Here she had removed a matter to Federal Court based on what she called “recently uncovered research” to the effect that Freddy Mac was the true party in interest. The case was already 4 years old. But the District Court rejected her argument and remanded back to State Court, awarding PNC its Attorney’s fees and costs.

Nora moved for reconsideration. The Court did not change its position and called her pleading “frivolous” because she made “no good faith argument for changing existing law and offered no meritorious arguments for reconsidering the decision to award fees.” The Court went on to say that Nora “repeatedly used procedural feints to delay the foreclosure” and noted that she’d been suspended from practice in Minnesota for that very reason.

Back in State Court Nora continued her tactics: accusing the Judge and the Court Reporter of manipulating transcripts even as she asserted that the District Judge had pursued a campaign of libel and Opposing Counsel engaged in “civil fraud” and “racketeering.” Nora also made repeatedly references to rejected arguments from prior motions and stated that if she were given an evidentiary hearing she would be vindicated.

Findings

In her defense, Nora characterized her comments as mere rudeness. The Court disagreed, stating that her repeated and factually baseless accusations of criminal conduct were “unacceptable.” It then found that:

  • Nora’s actions were meant solely to delay her Clients’ foreclosure; and that
  • Her outbursts  were “unbecoming a member of the bar” in violation of Rule 38 of the Rules of Federal Appellate Procedure.

Holding

The Court Imposed sanctions of $2,500 on Nora and ordered she be suspended from practicing before it. The holding was forwarded to the Office of Lawyer Regulation of the Wisconsin Supreme Court, where a disciplinary case is underway.

Case #2: Nora v. HSBC Bank USA, N.A.

Facts

HSBC initiated a Wisconsin foreclosure against the Rinaldis, who counterclaimed alleging that certain paperwork had been fraudulently altered and that HSBC lacked standing to enforce the mortgage. The Rinaldis lost at summary judgment and did not appeal. HSBC later agreed to modify its mortgage and the Court vacated the Judgment of Foreclosure. The Rinaldis filed a new suit reasserting their counterclaims. Before the Court could rule on HSBC’s motion to dismiss, the Rinaldis filed Bankruptcy. HSBC filed a Proof of Claim in the Bankruptcy, but the Rinaldis objected and filed Adversary claims alleging fraud, abuse of process, tortious interference, breach of contract, and violations of RICO and the Fair Debt Collection Practices Act.

Holding

The Bankruptcy Court recommended denial of the Adversary action and the District Court agreed.The Court also warned the Rinaldis that if they filed additional frivolous claims they would be sanctions due to the “vexatious and time and resource-consuming” nature of their “nigh-unintelligible” filings.

Did that deter the Rinadldis? Perish the thought. Following several additional filings of the same type the Rinaldis voluntarily dismissed their Bankruptcy but their Attorney, Nora, filed additional motions. Consequently the Court ordered a sanction of $1,000 against Nora, which the 7th  Circuit upheld on appeal.

The Upshot

Lawyers are asked to be advocates, but how zealous is too zealous? While cases such as the ones above could answer that question, it is not clear that they do. Was Nora too zealous in this case or just too rude? Should she not have stepped into a Courtroom to begin with? Should she have done more diligence or tossed out her Client because they were asking for too much? Sadly, the simple fact is that even if an Attorney is prepared to draw the line, they can bet there is another lawyer around the corner that won’t.

No wonder Shakespeare wrote “The first thing we do, let’s kill all the lawyers.”

Your Turn

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Kmart

In Kmart v. Footstar and Liberty Mutual the 7th Circuit Court of Appeals was presented with 2 primary issues:

  • Is an indemnification clause triggered when an employee acts outside the scope of his duties?
  • Does an insurance company have a duty to defend the lawsuit arising from such an incident?

The Facts

Footstar operated the footwear department at various Kmart locations. Footstar employees could only work in shoe department unless they had written permission from Kmart. The agreement between the two stores provided that Footstar was to “reimburse, indemnify, defend and hold [Kmart] harmless” in the event of an accident. Footstar also bought insurance from Liberty Mutual.

In 2005 a Kmart customer asked for assistance retrieving a stroller. Both a Kmart and Footstar employee attempted to secure the stroller, which fell out of the box and hit the customer in the face. The accident took place well outside the Footstar department. The customer sued Kmart in negligence. Kmart in turn sued Footstar and Liberty Mutual, alleging that they owed a duty to defend and indemnify it.

The Opinion

First, the 7th Circuit ruled that Footstar and Liberty Mutual did not have a duty to indemnify Kmart: for such a duty to arise the injury would have to arise “pursuant to” or “under” the agreement between the stores. But that agreement in this case prohibited Footstar employees from taking action outside the footwear department. The Court also noted that the duty to indemnify arises only where the insured’s activity and resulting damages fall within the policy’s coverage terms. Since the Footstar employee here was acting in an extra-contractual manner, there was no indemnification requirement.

Second, the Court noted that under Illinois and New Jersey law Footstar and Liberty Mutual were liable for defense costs incurred following notice of the lawsuit because an insurer may be required to defend its insured even when there will ultimately be no obligation to indemnify. In other words, an insurer has a duty to defend unless the complaint in issue simply did not involve its insured.

In summary, the Court concluded that the actions of the Footstar employee were “potentially covered” and arose out of his performance under the agreement between the stores.

The Upshot

This case reminds us that even in this day and age contract drafting is a nuanced but critical part of what lawyers do. Here, the Agreement and the Policy were both deemed ambiguous by the Court, which left them open to competing interpretations. Had they been better written, the issue may not have come up at all.

 

Erasing Debt

For Debtors, Chapter 7 Liquidation is the ultimate relief, while Chapter 13 and 11 Reorganization offers an opportunity to reduce their Debtor’s payments in light of their income. In either type of case however, the Creditor is not entitled to anything until it has filed is Proof of Claim.

What Is a Proof of Claim?

The Proof of Claim or “PoC” is the means by which Creditors state:

  • How much they are owed by this Debtor;
  • Why they are owed that much to begin with; and
  • Whether debt is secured by property of the Estate.

Different types of cases contain strict deadlines for filing a PoC, and each PoC should be accompanied by supporting documentation such as a calculation of sums due, a copy of a Judgment Order, etc.

Will The Claim Be Paid?

Once filed, the Creditor’s PoC represents what could be paid to it, presuming:

  • The Debtor has sufficient assets to liquidate in order to pay the Creditor’s Claim; or
  • The Debtor’s Reorganization provides for full payment of creditors – a “100% Plan.

But in the overwhelming number of cases the reality is:

  • The Debtor has few if any assets to liquidate, resulting in a “No Asset” finding; or
  • The Debtor’s Plan of Reorganization involves paying only a small fraction of debts.

What If The PoC Is Wrong?

If a Debtor believes that a Creditor filed a materially false or inflated Claim, that Debtor may file an Objection to Proof of Claim. The Objection will require the Creditor to support, clarify, or defend its Claim. Creditors that fail to do so may lose their Claim altogether. As in the case of the PoC, there is a strict time limit in which to file Objections. Failure to do so is fatal to the Objection and permits the Creditor to pursue whatever amount it seeks.

The Upshot

For Creditors whose Debtors file Bankruptcy, the key to collecting is diligence and proactive planning. For Debtors whose Creditors continue to pursue them even past a Bankruptcy filing, it is critical to know what a Creditor can legitimately seek, what it cannot, once a Bankruptcy has been filed.

Your Turn

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SmashBurgerThe Issue

On December 30, 2014 the Delaware Chancery Court decided the case of Prokupek v. Consumer Capital Partners LLC, C.A. 9918-VCN (December 30, 2014), which resolved the following issue: Can  a terminated LLC member enforce “inspection rights” in the company’s Operating Agreement and the Delaware LLC Act? The short answer: “No.” Here’s why.

The Facts

David Prokupek, Chairman and CEO of Smashburger, owned a substantial amount of company stock, with roughly 2/3’s of it unvested. He also held options that would vest when certain performance milestones were met.
Despite being told in November 2013 that he was being terminated, Prokupek remained with Smashburger until February 2014. In April and May 2014 Smashburger told Prokupek how much of his holdings had vested and the fair market value of those holdings. Those sums were paid to him, with the notices from the company.

Prokupek, who disagreed with Smashburger’s valuation and calculation of the number of shares that had vested, demanded to see business and financial records based on the company’s Operating Agreement as well as the Delaware’s LLC Act.

The Opinion

Applying settled law, the Court of Chancery ruled that by its plain language the Delaware LLC Act “confers inspection rights only on current members of the LLC” meaning that a member’s right to inspect books and records terminates upon his firing. Since Prokupek was no longer a member of Smashburger when he made his demand, he had no inspection rights.

The Court also rejected Prokupek’s argument that he retained member status because the proposed price for his holdings was too low; stating that it did not matter whether Smashburger had unreliable figures or even whether the performance hurdles had been met. This was the case, said the Court, even if Prokupek’s allegations that he was intentionally undercompensated were true. All that mattered was that Prokupek was no longer of a member of Smashburger when he demanded his inspection. Of course this decision did not leave Prokupek without a remedy.

The Court pointed out that the recourse for a former shareholder was to assert a breach of contract action against the company.

The Upshot

This case tells us that the rights of former LLC member are not unlimited: and are certainly much more limited than those of a member. The moral of the story may therefore be that shareholders or members who feel insecure about their position should take action before they get the ax.

Your Turn

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Sleazy Lawyer

Gasunas vs. Yotis, 14-321 (Nov.24) ND IL ED (J. Schmetterer)

The Facts

Yotis, a former Illinois Attorney, borrowed over $50,000 from his Client Gasunas using various tricks and subterfuge: from outright lies to misrepresentations and material omissions of fact designed to manipulate his “friend” and benefactor. Once he had the money, Yotis filed a Chapter 13 Bankruptcy.

The Adversary Complaint

Gasunas fought back against the Bankruptcy by filing a 4-count Adversary Complaint challenging Yotis’ Chapter 13 discharge under a variety of statutory fraud theories under 11 U.S.C. 523(a) including

  • Fraudulent Pretenses;
  • False Representations;
  • Actual Fraud; and
  • Fraud While a Fiduciary

Yotis, in turn, brought a Motion to Dismiss the Adversary Complaint sounding in 11 U.S.C. 12(b)(6) in an effort to have his case confirmed over the objections of his former Client.

The Opinion

In a carefully written and exhaustive Opinion, Judge Schmetterer of the Bankruptcy Court for the Northern District of Illinois, Eastern Division, evaluates each of the arguments in the Motion to Dismiss and applies them to all 4 counts of the Adversary Complaint. Ultimately the Court dismissed Counts I and II without prejudice and with leave to re-plead, while Counts III and IV are allowed to stand without any changes.

Aside from the precise way in which it examines everything from the Federal Rules of Civil and Bankruptcy Procedure to the substantive law of Bankruptcy Fraud and the Relation-Back Doctrine, the Opinion is notable for its recitation of the truly underhanded things that Yotis is alleged to have done in order to weasel money from his Client, including:

+ Crying about his wife and daughter leaving
+ Claiming to need money to pay his mortgage
+ Lying about visiting his sister in an institution
+ Cajoling even while professing false friendship
+ And many other examples of how not to behave

 The Upshot

This Opinion is a solid primer and review concerning the types of Bankruptcy Fraud available through 523(a) – a mainstay of Bankruptcy litigation. Here, the fact that the Debtor was an Attorney and the Plaintiff/Creditor was his former Client simply makes the case that much more of an object lesson.

Your Turn

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Mortgage Application

We represent many consumers in Bankruptcy, and getting our Clients back on their feet afterwards is a big part of what we do. Often, cases are driven by upside-down home loans or even reasonable loans in which payments have become too high because the homeowner lost their job or had to take a lower paying job as a result of the Great Recession. One option for those who’ve gone through Bankruptcy and are looking to borrow again is the FHA Loan.

Before the housing bubble burst in 2008 FHA loans were considered the choice for buyers with little credit or bad credit; or an option for those with low incomes. But since everyone’s home value began falling – often taking their credit standing with it – FHA mortgages have become more widely appealing, especially when compared to conventional loans that require private mortgage insurance (“PMI”). PMI is the mortgage lender’s way of ensuring it gets paid following default. It is insurance for which the borrower pays the premium, adding to the cost of the loan.

For those considering an FHA Loan, keep these points in mind:

1) FHA Loans are Private, But Backed by the Government

FHA loans start like any other – with an application at your local bank or mortgage brokerage. Once you qualify, the loan is made by a private entity and guaranteed (i.e. insured) by the FHA. Like PMI, this is a hedge against default. In turn the FHA charges an up-front premium as well as an annual premium – both paid by the borrower. To find a list of FHA approved lenders, search the website maintained by the Department of Housing and Urban Development.

2) FHA Loans Do Nearly Everything Conventional Loans Do

Despite the popular misconception that FHA Loans can only be used to purchase modest homes, they can actually be employed for everything from buying a $600,000+ house or multifamily building to remodeling, refinancing, upgrading, and property rehab. They even come in fixed-rate and variable-rate varieties, including ARM’s.

3) Down Payments Are Lower

No-money-down financing, once the standard in real estate transactions, was welcomed at virtually every Bank before disappearing overnight in 2008. Panicked Banks quickly overreacted by putting a virtual freeze one mortgage lending altogether. When they finally did start lending again, Banks demanded 20% down or more. By contrast, an FHA loan can be arranged with as little as 3.5% down.

4) Perfect Credit Not Needed

One thing that was true about FHA Loans before the housing crash, and remains true, is this: they are still easier to obtain than conventional loans. With a credit score as low as 580 a borrower can put only 3.5% down on the purchase of a home and qualify for a mortgage. A borrower with a lower score can still get financed if they are willing to put down about 10%. And of course FHA Loans are a great choice for those who’ve filed Bankruptcy or undergone a Foreclosure in the past few years. Borrowers just need to re-establish their credit and meet other program requirements first.

5) Property Renovations Using FHA Loans

If a borrower is interested in a home that needs a little work, they can borrow enough to cover both the purchase and the rehab using a special product known as an FHA 203(k) Loan. Likewise, the FHA’s Energy Efficient Mortgage program is aimed at upgrades that lower utility bills and make the house more energy efficient. The cost of new appliances, for instance, can be part of the loan.

6) Help With Closing Costs Available

Buying property involves several inevitable out-of-pocket expenses such as Loan Origination fees, Attorneys’ fees, Appraisal costs, etc. It is often not possible for the seller, builder, or lender to pay these costs with a conventional loan: but with an FHA loan they can. For instance, a motivated seller can offer to cover closing costs like these without running afoul of the underwriting standards of an FHA lender.

7) Which Way To Go

Despite the benefits of going FHA, borrowers could still end up paying more to borrow this way compared to a conventional loan plus PMI. Of course that assumes the FHA borrower qualifies for a conventional loan. Either way, these days the premium charged by FHA in lieu of PMI is 1.75% of the loan value up-grant, plus an annual premium of up to 1.35% of the loan amount. Borrowers should talk to their mortgage adviser before deciding which way to go on this.

The Upshot

An FHA mortgage is something that many borrowers don’t even consider. If you have experienced a Bankruptcy or Foreclosure, put FHA loans on your list of ways to consider getting back into home ownership, or just as a way to improve your living conditions.

Your Turn

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Divorce

In re Meier (Ch. 11) )(Nov.24) 14-10105 ND IL ED (J.Schmetterer)

The Facts

Bob and Martha Meier divorced and entered into a Marital Settlement Agreement (“MSA”) that provided for $4 million in maintenance payable in monthly installments over 10 years; plus a $400,000 property settlement. Bob filed for Chapter 11 sometime later and Martha filed a proof of claim (“PoC”) in the case seeking the rest of her $4 Million as well as the $400K as a “priority as a domestic support obligation” per 11 U.S.C. §507(a)(1)(A).

The Issue

Of course domestic support obligations are exempt from discharge in Bankruptcy, and entitled to priority payment in a plan of reorganization. The tricky part however, is determining just what constitutes a “domestic support obligation” entitled to special treatment, and what does not. For instance, would a spouse’s Attorneys’ Fees be entitled to special treatment? How about interest on unpaid sums? Court sanctions for unpaid support?

The Opinion

Regardless of how much of Martha’s PoC was entitled to priority, one thing was for certain: it would definitely put a crimp in Robert’s Plan of Reorganization. So it is no surprise that Ed Shrock, one of Bob’s creditors under the Plan, objected to Martha’s PoC. According to Shrock, in order for Martha’s claim to be valid, all the domestic support obligations would have to be due at once – not the case here. By contrast, domestic support obligations due in the future like the installments here are NOT allowable claims in Bankruptcy. In response to the Ojection, Martha amended her PoC to reflect $2,333,333 as a “domestic support obligation” and $400,000 as a “property settlement.” Apprently, that amendment did not satisfy Shrock, who believed that none of Martha’s claim was entitled to priority over the debt owed to him.

Following a thorough discussion about jurisdiction, whether the disputed amount constitutes a domestic support obligation in whole or part, whether a Proof of Claim is a “judicial admission,” and the proecess by which PoC’s can be amended under Federal Law, the Court ultimately sustained Shrock’s objection as the amended $2.3 Million domestic support claim – rather than the original $2.7 Million claim – but overruled it as to the property settlement. Ultimately, Martha was left with a claim for the $400K and in potential future claims that would not mature until they were due and owing.

The Upshot

While the numbers in the Meier divorce are large and impressive, the facts and reasoning in this case apply accross the board. Domestic support is still the #1 source of exempt claims in Bankruptcy, as well as a persistent source of confusion to Family Law practitioners and their Clients.

Your Turn

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Bankruptcy Court Seal

Skavysh v. Katsman, No. 12 C 3807
Appeal from District Court, ND IL ED
Decided: November 19, 2014

If a Debtor intends to pay people back following discharge, are they “creditors”? Put another way: Who is a creditor in Bankruptcy?

The Issue

That was the issue in Skavysh v. Katsman, which started out as a simple Chapter 7 before Judge Wedoff in the Northern District of Illinois, Eastern Division, worked its way through the District Court, and eventually ended up before the 7th Circuit Court of Appeals. The central question revolved around when a Debtor’s omission rises to a level that is sufficient to justify denying Discharge.

The Facts

The Debtor/Appellant was an immigrant with limited knowledge of English who omitted members of her family from Schedule “F” of her Petition – unsecured creditors. These people had supported her through a nasty divorce and she fully intended to pay them back. When her step-son challenged her Discharge based on those omissions, the matter went to trial before Judge Wedoff.

In her testimony at trial the Debtor said that since she intended to pay the omitted people back they weren’t really creditors.  It isn’t hard to understand why she might think that: mom, grandma, and uncle Ed aren’t the same as Visa and American Express, after all. And they’re the real “creditors” as the Debtor  saw it.

Judge Wedoff ruled that the Debtor’s omissions were not material enough in value, and did not rise to the level of “fraud” necessary, to deny Discharge. The District Court disagreed. The matter was eventually taken up on appeal to the 7th Circuit.

The Opinion

The Bankruptcy Judge had the benefit of hearing the Debtor’s testimony and deemed her credible: he knew her approach was wrong but thought she was sincere in her beliefs.  By contrast, the Appellate Court focused on the telltale signs that the Debtor had not been sincere: her Attorney did not represent her on appeal, the Attorney did not testify on her behalf at trial, one of the omitted creditors was the Plaintiff here, despite the Debtor’s claim that she had only excluded “friends and family.” In other words the 7th Circuit reasoned that it could not trust her: there were just too many loose ends and inconsistencies.

The Upshot

Taken literally, this Opinion could be taken to mean that no lie in a sworn Federal document is de minimus. They’re all deal killers, because all it takes to undermine the Bankruptcy system is for a Debtor to lie and others to stand silently by.

But does that mean that mistakes or unintentional omissions in a Bankruptcy Petition can result in a denial of Discharge or worse? I would say that is going too far. This Opinion does not depart from the spirit of the Bankruptcy Code by that much. All it really does is to reinforce the fact that intentional misrepresentations will not be overlooked, no matter how minor they appear to be in the big picture.

Your Turn

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