Illinois Bankruptcy Lawyer Blog

In the 7th Circuit Case of In re Porayko, appealed from the Bankruptcy Court for the Northern District of Illinois, a Citation to Discover Assets was served on a year before the Debtor filed bankruptcy, while a 3rd Party Citation was served on his bank the month he filed. The creditor moved for relief from the Automatic Stay to seize the $10,000 in the Debtor's bank account and the Trustee objected on the basis that the initial citation had not created a lien, while the 3rd Party Citation was avoidable pursuant to 11 USC 547.

The Law
Citations to Discover Assets are addressed in Illinois Statutes, Section 5/2-1402. According to Sec. 1402(m) a Citation to Discover Assets creates a lien on all

"nonexempt personal property including money, choses in action and effects of judgment debtor" as well as "personal property belonging to the judgment debtor in the possession or control of the judgment debtor or which may thereafter be acquired or come due..."

Illinois cases support the concept that a checking account is personal property to which a lien may attach. See Chicago v. Air Auto Leasing Co., 297 Ill. App. 3d 873, 878 (1st Dist. 1998), a problem for the Trustee.

The Argument
The Trustee in Porayko tried to distinguish Air Auto Leasing by pointing out that other Illinois Courts treated bank accounts as mere promises to pay rather than items of personal property that could be subject to a lien. The leading case of its kind, Citizens Bank of Maryland v. Strumpf, 515 US 16 (1995), dealt with whether a bank could offset a payment while the Debtor was in Bankruptcy. But the Porayko Court found the situation before it to be quite different, and concluded that the creditor's citation had created a secured interest in the checking account, so the relief from the Automatic Stay granted by the Bankruptcy Court was proper. 

Surprisingly, this meant that under the proper circumstances the lien of a pre-filing creditor could trump the interest of a Bankruptcy Trustee: a notion that would appear to stand the law of insolvency on its head.

The Takeaway
The takeaway from the Porayko case is that Debtors are wise to address debts before their creditors secure judgments that turn into liens. At a minimum, a Debtors ought to file soon enough so that creditors cannot perfect their judgment liens and trump the case Trustee.

These are dark times in the galaxy....

Unemployment is stubbornly high. The recovery has nearly stalled. People's savings are low. The housing market's so-called rebound has been uneven. Since June 2011 almost a million and a half people have sought bankruptcy protection. The number of filers keeps growing (so much for the salutary effect of BAPCPA).  Is there hope? 

A New Hope

One effective feature of Bankruptcy is the lien strip. Traditionally Chapter 7 debtors could not take advantage of a lien strip, which permits a debtor to treat unsecured mortgages and lines of credit the same way as other unsecured debts such as credit cards. If they could, those debts - previously treated as a "secured loan" or "mortgage" would really be discharged at the end of the case like a credit card debt. 

Instead, Courts have permitted lien strips to be employed only in connection with Chapter 13 reorganizations. Ironically this meant that the Chapter 7 debtors least able to keep their 2nd mortgage or HELOC could not get relief. And Courts have adhered to the Chapter 7 v. Chapter 13 distinction right up to the present - even as real estate values have plummeted.

But in a recent decision the 11th Circuit Appellate Court held that a Chapter 7 debtor could avoid a junior lien, in essence giving millions of Americans a new hope.

The Empire Strikes Back

So what makes Chapter 13 and 7 so different when it comes to the treatment of unsecured mortgages and home equity loans? Why let the Chapter 13 debtor to pursue a lien strip but deny it to the Chapter 7 debtor?

Chapter 7 of course is reserved for those who make less than the median income in their State or can demonstrate that letting them liquidate despite having an above the median income isn't an abuse of the Code. Chapter 7 cases move quickly- assets are liquidated or abandoned by the case Trustee within a short time-frame. 

Chapter 13 by contrast is the adjustment of debts by those with regular income who can meet their living expenses, but have fallen behind. The theory is they just need to catch up. Chapter 13 debtors are even their own trustees or Debtor in Possession and their repayment plans take up to 5 years to administer. 

But are those really fair characterizations of Chapter 7 and 13 debtors?  These days a sudden job loss, illness, drop in property value, or plain old economic malaise can transform a wage earner into a deadbeat. So why not offer the same benefit to both types of debtors? Why not permit Chapter 7 lien strips?

Return of the Jedi

Speaking of lien strips, what is a lien exactly? Answer: it's a security interest in real property given or taken in return for value. Typically, a bank lends the money to buy your house and in return you grant a lien in the property. But not all liens are created equal, since only some are perfected. Holders of perfected liens get paid before the holders of unperfected liens. 

That's where McNeal v. GMAC Mortgage comes into play. In McNeal the 11th Circuit Court of Appeals concluded that Chapter 7 debtors had as much right as Chapter 13 debtors to strip unsecured junior liens. The Court's reasoning rested largely on a linguistic choice - "stripping down" versus "stripping off." In fact, policy considerations drove the decision and reversed a long line of precedent.

The facts were these: McNeal, a Chapter 7 debtor, had two mortgages. The amount due as to the first mortgage was $176,413, the amount due as to the second loan was $44,444 and the debtor's house was wroth only $141,416. This would have qualified the debtor to perform a lien strip in Chapter 13. But this was a Chapter 7. 

The Bankruptcy Court cited a long line of precedent, including a Supreme Court case, all of which pointed in a single direction: Chapter 7 debtors could not 'strip down' junior liens. But the 11th Circuit went a different way. It applied the U.S. Supreme Court case of Dewsnup v. Timm which concluded that a Chapter 7 debtor could "strip down" a partially unsecured lien even though the debtor could not 'strip it off' altogether. The result was essentially the same - the debtor got out of paying the entire value of the lien.

Boom goes the dynamite!

Epilogue: Yes, There is Hope

Okay, was the 11th Circuit really persuaded by the distinction between a "stripping down" and "stripping off?" Probably not. But for years consumer groups had called for a vehicle by which debtors could strip liens in Chapter 7 and escape crushing debt without losing their house and home. Many of the Circuits criticized Dewsnup too because it seemed to declare once and for all that only Chapter 13 debtors could employ lien strips then stopped just short of overturning the practice altogether. 

So is this an unconditional victory for Chapter 7 debtors? Not exactly. The rest of the Federal Circuits, including the 7th Circuit, have recently reaffirmed their allegiance to Dewsnup and the narrow reading of the practice of lien stripping. But the circuit split means the Supreme Court may yet have to address the issue in its next term. But until then, all bets are once again off.

Want to learn more about qualifying for a lien strip? Read about it on our website and feel free to reach us at 630-378-2200 or at mhedayat@mha-law.com.

Alan J. Mandel Law Offices had been representing a Debtor in Possession (DIP) in Chapter 11 and sought final payment for Attorneys' fees as well as expenses. Ultimately Mandel received only part of the requested compensation due to its overly broad reading of the Bankruptcy Code and the resulting attempt to fit a square peg into a round hole.

Officially "No" ... Unofficially "Yes"
Multiut, an Illinois Corporation, filed a Chapter 11 Petition on May 14, 2009 due largely to litigation between it and Dynegy Marketing and Trade. Mandel, who was eventually retained with Court approval, served as outside general counsel to Multiut during the litigation and even acted as Bankruptcy Counsel. But Mandel was not hired by Multuit until January 22, 2010 and was not "officially" retained until February 1, 2010; at which point it sought payment for fees and costs retroactive to the Petition Date via a legal technique known as nunc pro tunc (Latin for 'now, for then').

But as a creditor of Multuit's with a stake in the outcome of its Chapter 11 reorganization, Dynegy fought back by voicing its displeasure at the apparent conflict of interest between Mandel the litigator and Mandel the bankruptcy attorney. Due in part to those objections, Multiut's Plan of Reorganization failed and the case was converted to a Chapter 7 liquidation - ensuring that almost nobody got anything.

It's the Latin, Stupid
In its ruling, the Court noted that under Sec.330 of the Bankruptcy Code, as well as case law on the subject from the 7th Circuit, an Attorney not retained in accordance with the Code is ineligible for compensation regardless of whether its work benefited the bankruptcy estate. In other words, the Bankruptcy Court would not go out of its way to avoid stiffing a lawyer: if an Attorney failed to plan it looked like they might as well have planned to fail. As for the nunc pro tunc argument, the Mandel Court noted that other courts had considered it and concluded that nunc pro tunc retention ought to be permitted only in "extraordinary circumstances," whatever that meant. That said, the Court granted Mandel compensation in this case. So all's well that ends well, right? Well not exactly ...

Game of Counsels
The decision to grant some fees and costs to Mandel was not the end of the inquiry. After looking into the facts, the Court noted that many of the services recorded by Mandel were compensable only under Sec. 327(a) of the Bankruptcy Code: not Sec. 327(e). The latter section, which was the basis of the Mandel Application for Compensation, was narrower in scope and did not include the same activities.

So, did Mandel go too far? To the Court there was no question in this case. "General Chapter 11 Administrative" services were not within the purview of 327(e), which explicitly states that services must be for a specific purpose other than the Bankruptcy case itself. The kinds of "day to day activities" recorded by Mandel were clearly connected with the Bankruptcy case and thus not payable under 327(e). What's more, the Debtor had already obtained 327(a) Counsel to handle the Bankruptcy case, so Mandel should have known it could not take on "day to day" activities and expect to be paid.

A Man's Got to Know His Limitations
The upshot of the Mandel decision is simple: respect the Bankruptcy Code or face the consequences. Get compensated the right way, or expect to go back to the office at least partially empty-handed.

If you enjoyed this post feel free to contact M. Hedayat & Associates today. The firm has been expertly handling Bankruptcy cases of all kinds for nearly twenty years.

IN RE MULTIUT CORPORATION, Bankr. Court, ND Illinois 2012

While Bernie Madoff serves out his 150-year sentence, the fight over how to satisfy his creditors rages on. Now, an infamous 2011 ruling by the Supreme Court limiting the power of bankruptcy courts may have a bizarre and unintended affect: many of the investors that recovered money when Madoff was first exposed may lose it (again) because the Bankruptcy Court may have overstepped its bounds by giving it to them in the first place. Confused yet?

Collateral Damage

Here's the problem. Irving Picard, Trustee in the Madoff Bankruptcy, is now attempting to recoup funds lost to Madoff's Ponzi schemes by means of fraudulent transfer suits. A Ponzi scheme is an illegal investment scheme that involves investors getting returns on their investment not based on profits but by subsequent investors. The enticement for new investors is usually short-term investments that offer an unnaturally high rate of return. Because it is not based on actual profits, it is destined for collapse. Madoff, on his way to becoming the largest financial fraud in U.S. history, created a Ponzi scheme that defrauded investors of billions of dollars. A fraudulent transfer suit is when in an effort to mislead creditors, the debtor transfers assets he knows he does not have. This is a fraudulent conveyance. The "suit" part is when a creditor, or a Bankruptcy Trustee, sues the recipients of the fraudulent conveyances demanding the funds back. In the case of Madoff and his Bankruptcy Trustee Picard, Picard is trying to augment the bankruptcy estate by suing people who originally invested in Madoff's Ponzi scheme and received a "return" on that investment from Madoff. Picard wants the investors' funds back, despite it being Madoff who created the fraudulent scheme in the first place. So if you are one of those investors, what do you do?

On June 12, defendants in the fraudulent transfer proceedings filed a brief arguing that the bankruptcy judge cannot rule or recommend rulings on fraudulent transfer suits by Picard, the liquidator of Madoff's brokerage. The defendants, many of whom after receiving original returns from Madoff invested again only to eventually see that investment vanish, argued that attempts to "augment" a bankrupt estate are based on common law and must be heard in district court. In May, US District Judge Jed S. Rakoff ruled bankruptcy courts could not issue final rulings on claims of fraudulent transfers or unjust enrichment, but they could make recommendations or reports to federal district judges, citing the recent Supreme Court decision Stern v. Marshall. The defendants argued such recommendations by bankruptcy judges are not allowed, as Congress has "considered and rejected bankruptcy judges serving as magistrates, who would issues reports and recommendations."

TMZ Meets the Supreme Court

Oddly enough, the fate of the fraudulent transfer suits and the collateral damage of Bernie Madoff rest with the fortunes of an ill-fated and questionably famous starlet, whose case ended at the doorstep of the supreme law of the land. The case of Stern v. Marshall, decided June 23, 2011, involved the estate of the late Anna Nicole Smith and her late husband. Her husband's estate, worth a modest 1.6 billion, resulted in a protracted legal battle. The case, which outlived many of the original players, was in 2006 compared to "a Harlequin romance novel. It's part Knots Landing, and part Shakespearean filial betrayal...the protagonists, shall we say, are not without flaws." Ouch.

The Supreme Court's ruling issued a stern warning to Congress not to leave judicial duties to anyone other than the judicial branch. With Chief Justice John Roberts writing the majority opinion, the court held unanimously that under a 1984 law, Congress had given the bankruptcy court the power to issue a final ruling in the debtor's claim, but ruled 5-4 that Congress violated Article III by creating such power in the bankruptcy courts, thus shutting out Smith. The infamous, flaw-filled celebrity diva went home empty-handed. Tragic.

Roberts argued Congress had grossly overstepped its authority by creating such power in the bankruptcy courts. The ruling states bankruptcy judges cannot constitutionally decide debtor's claims that are based solely on state law. Bankruptcy judges can still decide cases that are based on federal law or related to a federal regulatory scheme. According to the Court, issuing such decisions from a non-Article III court threatens the entire separation of powers, "...Article III would be transformed from the guardian of individual liberty and separation of powers we have long recognized into mere wishful thinking." But why do the Madoff victims care about this?

Fight (in Bankruptcy Court) or Flight (out of Bankruptcy Court)

In response, hundreds of former Madoff investors, many of whom were unaware of Madoff's unapologetic fraud, and facing fraudulent transfer suits in bankruptcy court, are trying to get their case before a federal judge and not a bankruptcy judge, arguing their claim is based solely on state law. Unclear in Stern v. Marshall is whether or not a bankruptcy court can issue recommendations to the relevant federal judges as Rakoff argued in May. Rakoff argued that the specialized expertise of bankruptcy court judges make them better suited to handle such claims and thus should issue recommendations to less experienced federal judges.

If you are concerned that you are a victim of a Ponzi scheme, or could be facing a fraudulent transfer suit, contact the offices of M. Hedayat & Associates. The firm has been expertly handling Bankruptcy proceedings of all kinds for nearly twenty years.

The SEC filed a complaint. The court appointed a receiver to handle defendants' assets for distribution among victims of the $31 million fraud. Assets included oil and gas leases. SonCo filed a claim. The parties came to terms; the court entered an agreed order that required SonCo to pay $580,000 for assignment of the leases. The wells were unproductive, because of freeze orders entered to prevent dissipation of assets; the lease operator, ALCO, had posted a $250,000 bond with the Texas Railroad Commission. The bond was, in part, from defrauded investors. SonCo was ordered to replace ALCO as operator and to obtain a bond. More than a year later, SonCo had not posted the bond or obtained Commission authorization to operate the wells, but had paid for the assignment. The judge held SonCo in contempt and ordered it to return the leases, allowing the receiver to keep $600,000 that SonCo had paid. SonCo returned the leases. The Seventh Circuit affirmed that SonCo willfully violated the order, but vacated the sanction. The judge on remand may: reimpose the sanction, upon demonstrating that it is a compensatory remedy for civil contempt; impose a different, or no sanction; or proceed under rules governing criminal contempt.

Download the Opinion in .pdf format.

Justia.com Opinion Summary

Defendant owned companies forced into Chapter 11 bankruptcy, but was not a debtor in the proceedings. The plan was confirmed and prohibited suits against the bankruptcy professionals and certain litigation against pre-bankruptcy creditors. Years later defendant sued plaintiff, pre-judgment creditors, and the bankruptcy professionals in an Indiana state court, based on Indiana law. The creditors removed the suit to bankruptcy court (28 U.S.C. 1452(a)) rather than asking the bankruptcy judge to enforce his order. The statute authorizes removal of any claim of which that court would have jurisdiction under 28 U.S.C. 1334, which confers on the district courts original jurisdiction of all civil proceedings arising under the Bankruptcy Code, or "arising in or related to cases under" the Code. The bankruptcy judge determined that the suit against the bankruptcy professionals was barred. Defendant filed an amended complaint eliminating all defendants except plaintiff and stating that the only claims arose from alleged violations of confidentiality agreements. The bankruptcy judge ruled that, as amended, the complaint was unrelated to the bankruptcy and ordered the suit remanded to the state court. The district judge affirmed. The Seventh Circuit concluded that the dismissal was not subject to review.

Receive FREE Daily Opinion Summaries by Email

7th Circuit Opinion Summaries courtesy of Justia.com

United States v. Rogan

Bankruptcy, Criminal Law, Government, White Collar Crime

River Road Hotel Partners, LLC v. Amalgamated Bank

Bankruptcy

Bloomfield State Bank v. United States

Bankruptcy, Real Estate & Property Law, Tax Law

Costello v. Grundon

Bankruptcy, Commercial Law, Securities Law

CDX Liquidating Trust v. Venrock Assocs., et al

Bankruptcy, Business Law, Securities Law

Reedsburg Util. Comm'n v. Grede Foundries, Inc.

Bankruptcy, Utilities Law

Kimbrell v. Brown

Bankruptcy, Injury Law

In re: Exide Technologies, 08-1872

Issued June 01, 2010

Heard in U.S. 3rd Circuit Court of Appeals

Summary In a Chapter 11 case, the District Court's affirmance of the Bankruptcy Court's grant of Debtor's motion to reject an agreement to sell substantially all of its industrial battery business on the ground that the agreement was an executory contract, subject to rejection under 11 U.S.C. section 365(a), and that rejection terminated the debtor's obligations under it, is vacated and remanded as: 1) the agreement is not an executory contract because it does not contain at least one ongoing material obligation for the other party; and 2) because the agreement is not an executory contract, the debtor cannot reject it. Read More

In re Robinson v. Tyson Foods, Inc., 08-14991

Issued February 8, 2010

Heard in U.S. 11th Circuit Court of Appeals

Summary In an employment discrimination action brought by plaintiff during her Chapter 13 proceedings, summary judgment for defendant on the ground of judicial estoppel is affirmed where plaintiff failed to disclose her employment discrimination suit to the bankruptcy court, and thus took inconsistent positions under oath with the intent of misleading the court.

Source: FindLaw.com

In re TransTexas Gas Corp, 08-41128

Issued February 10, 2010

Heard in U.S. 5th Circuit Court of Appeals

Summary In two related cases involving a bankrupt corporate debtor, rulings rejecting (i) a claim by corporate debtor's former CEO that the severance payments he received from the company were not fraudulent transfers, and (ii) a claim by a trustee in a related matter that the estate was covered under a policy issued by appellee-insurer, are affirmed where: 1) the severance payments made to the CEO after his dismissal were obligations incurred by debtor within two years of its petition date and thus constituted fraudulent transfers; 2) debtor did not receive reasonably equivalent value for the payments to the CEO; and 3) the CEO's repayment of the amounts received did not constitute an insurable "Loss" under the insurance policy.

Source: FindLaw.com

From the ABA Journal article

Written by Debra Cassens Weiss

In Republic v. Doyle, 3D09-2405, the Florida 3rd District Court of Appeal ruled that "benevolence and compassion" are not grounds for delaying a foreclosure sale and stated that the decision byMiami-Dade Circuit Judge Valerie Manno Schurr to delay a foreclosure sale long enough to allow the owners of the house to file bankruptcy and attempt to save their interest was "an abuse of discretion." To quote the Appellate Court

Although granting continuances and postponements are, generally speaking, within the discretion of the trial court, the "ground' of benevolence and compassion ... does not constitute a lawful, cognizable basis for granting relief to one side to the detriment of the other.

Just one more reason I'm glad I don't live in Florida. Yikes.

cir 1

In Re Weaver, 08-8046 [Sep. 17, 2008]
In a decision involving an attempted appeal from a decision under the BAPCPA, a petition for leave to appeal is denied and appeal is terminated where 1) without resolving the jurisdictional question the court exercised its discretion under section 158(d)(2)(A) to deny leave to appeal; and 2) allowing the appeal to proceed may not have served the purposes of section 158(d)(2), i.e. a rapid and definitive resolution of the underlying legal question.

Richmond v. NH S.Ct. Comm. on Prof. Conduct, 07-2671 [Sep. 19, 2008]
In a bankruptcy case involving an underlying obligation relating to attorney disciplinary proceedings, the holding that an order to pay costs of bringing disciplinary proceedings cannot be discharged in Chapter 7 bankruptcy is affirmed because the award of costs qualified as a non-dischargeable discretionary penalty under the terms of 523(a)(7).

5th cir

Kane v. Nat'l Union Fire Ins. Co., 07-30611 (Jul 14)

A finding of summary judgment in a PI suit, as well as judicial estoppal of the plaintiffs/debtors due to their failure to list the suit in their Chapter 7 schedules, and denial of trustee's motion to be substituted in the case as the real party in interest, are reversed and the case is remanded because

+the PI claim became an asset of the estate upon filing of the petition

+the trustee is the real party in interest and never abandoned his right

+the debtors only benefit if a PI judgment yields a surplus to the estate

The Appellate Court also found that a prior circuit court determination in the case did not control in bankruptcy court, and the district court (which ruled that the circuit court decision controlled as a matter of law) abused its discretion.

6th cir

Phar-Mor, Inc. v. McKesson Corp., 05-4525, 05-4526 (Jul 17)

Vendor's administrative-expense priority on a reclamation claim is not extinguished when the goods to which that claim applies are sold and the proceeds used to satisfy a secured creditor's claim. The vendor retains it's priority in those proceeds of the estate that remain after secured creditors are satisfied.

10th cir

In re Tri-Valley Distrib., Inc., 06-4279, 06-4280 (Jul 15)

In suit alleging state claims for fraudulent transfer and negligent lending, the parties' motions to dismiss each other's appeals for lack of jurisdiction are granted where:

+ bankruptcy appellate panel's order was not final and appealable

+ denial of defendant's motion to dismiss was not a final collateral order entitled to review

+ bankruptcy appellate panel acted within its authority

+ there was no jurisdiction to review the merits of a section 1334(c)(1) abstention issue

In re: US Med., Inc., 07-1259 (Jul 15)

Creditor is not a non-statutory insider of the debtor for purposes of 547(b)(4)(B) and a transaction between that creditor and the debtor will not be avoided where

+ the transactions at issue were at arm's length

+ there is no undue influence or control by creditor

In sum, while creditor is only a "non-statutory insider" when its transaction of business with the debtor is not at arm's length or there is undue influence; no such requirements are needed if the creditor qualifies as an insider per statute ("statutory insider").