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December 2014 Archives

Too Early to Dismiss? BAP Overturns Order Dismissing Chapter 11 Case as Bad Faith Filing

In Sullivan v. Harnisch (In re Sullivan), CC-14-1225-TaDKi (9th Cir. BAP December 9, 2014), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit (the "BAP") reversed a bankruptcy court order dismissing a chapter 11 bankruptcy case as having been filed in bad faith.The case was commenced by filing a skeletal bankruptcy petition.  The debtor filed a status report eight days later.  Six days later, the debtor filed schedules and a statement of financial affairs.  The next day, the creditor (who held judgments and judgment liens) moved to dismiss the case as a bad faith filing, contending that the bankruptcy case amounted to a two-party dispute and was filed solely to delay collection attempts.  The creditor further contended that confirmation of a chapter 11 plan was unlikely because the creditor would vote against it.The hearing on dismissal was scheduled simultaneously with a scheduling conference as well as the debtor’s motions to employ counsel and approve a budget.  The bankruptcy court called the motion to dismiss first.  After argument, but without testimony or other evidence, the court took the motion under submission and continued the remaining hearings. Thereafter, the court dismissed the case, finding bad faith and no possibility of confirming a plan.  The debtor appealed.The BAP ruled that the bankruptcy court abused its discretion by considering to consider the interests of the creditor who moved for dismissal and not the best interests of creditors in general.  It is also important to note the speed of the proceedings and the fact that dismissal came before the first steps of the case.Creditors and bankruptcy judges favor early dismissal if a case was clearly files in bad faith as delay causes harm.  However, in future cases, bankruptcy judges and attorneys may ask themselves:  "Is it too soon for dismissal?"

Mandatory Subordination Does Not Compel Claim Disalowance and Does Not Apply to Individual Debtors

In Khan v. Barton (In re Khan), CC-14-1021-TaDKi, CC-14-1041-TaDKi, CC-14-1062-TaDKi (9th Cir. BAP Dec. 9, 2014), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit (the "BAP") held that mandatory subordination of a claim under Bankruptcy Code Section 510(b) does not compel disalowance of the claim and does not apply to individual debtors.
In Khan, a creditor obtained judgment against the debtors and their corporation for conversion, fraud, breach of fiduciary duty and loss of common stock shares.  Thereafter, each of the debtors filed a chapter 13 bankruptcy petition.  The creditor filed proofs of claim in both cases. The creditor also commenced adversary proceedings to render the judgment nondischargeable.  The debtors responded by filing adversary proceedings for mandatory subordination of the creditor's claims under Section 510(b) and for disallowance of the claims.
The bankruptcy court ruled in favor of the creditor and dismissed the debtors' adversary proceedings with prejudice. On appeal, the BAP affirmed.
The court held that subordination of a claim does not compel disallowance because it impacts only the order of distribution among creditors, not the validity of the claim itself.  Moreover,  Section 510(b) does not apply to individual debtors; it applies only to claims against corporate debtors.

Bankruptcy Judges Luncheon 2015

Reno Fernandez will introduce Chief Judge Alan Jaroslovsky and Judge Stephen L. Johnson as well as the incoming chair of the Bar Association of San Francisco's Commercial Law and Bankruptcy Section at the annual Bankruptcy Judges Luncheon on Tuesday, January 13, 2015, at noon at the City Club in San Francisco. We expect an excellent program and discussion, as in past years. This program ordinarily sells out, and we encourage you to RSVP.

BANKRUPTCY JUDGES LUNCHEON 2015

If You Are A Spendthrift (Trust), Go To Hawaii

A valid spendthrift trust is entitled to certain protections in bankruptcy, especially in Hawaii.  In In re Zukerkorn, 500 B.R. 598 (9th Cir. BAP 2013), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit (the "BAP") upheld the decision of California Bankruptcy Judge Alan Jaroslovsky ruling that a Hawaii spendthrift trust was valid and entitled to full protection under Hawaii law.
A spendthrift trust is used to transfer the beneficial interest in assets, often to children or grandchildren, with restrictions on spending.  Because the beneficiary's use of funds is restricted, the trust is entitled to certain protections from execution by creditors.  For example, in California, creditors generally can reach only 25% of distributions to the target beneficiary under California Probate Code Section 15306.5.  Under Hawaii law, by contrast, the distributions are fully protected.
In Zukerkorn, the debtor and his mother lived in Hawaii, and the mother held assets in Hawaii.  The debtor's mother set up a spendthrift trust, with a Hawaii choice of law clause, for the benefit of her two sons.  After the death of his mother and brother, the debtor became the trustee and moved to California with his two children, also beneficiaries under the trust.
The debtor filed bankruptcy in California. The bankruptcy trustee sought turnover of 25% of the debtor's future distributions and raised traditional choice of law arguments, including that California has a more substantial interest in the matter and Hawaii's full protection of spendthrift trusts violates a fundamental policy of California law.
The bankruptcy court ruled that the trust was governed by Hawaii law and fully protected.  The trustee appealed, and the BAP affirmed.
The BAP held that Hawaii has a substantial relationship to the dispute.  Moreover, the BAP held that Hawaii's full protection for spendthrift trusts does not violate a fundamental policy of California law.  Accordingly, the BAP held that Hawaii law applies.
It will be interesting to see whether this opinion encourages foreign choice of law provisions in spendthrift trusts in California and throughout the Ninth Circuit.  The fact that there was a clear, concrete connection to Hawaii in this case, and the fact that this is a decision of the BAP and not the Ninth Circuit, may discourage a mass migration toward foreign choice of law provisions.

Discharging Student Loans

A recent opinion, namely In re Hedlund, 718 F.3d 848 (9th Cir. 2013), may make it easier to discharge student loans.  In Hedlund, the debtor borrowed approximately $85,000 for college and law school.  He failed the bar examination three times and took a job as a youth counselor.  The debtor was 33 years old and married with one child.  The debtor filed bankruptcy and sued for a declaration that his student loan debts were dischargeable.
The court applied the tough "undue hardship" standard for discharging student loans in an unusually lenient way.  The undue hardship standard requires that (1) the borrower and his or her defendants cannot maintain a minimal standard of living, (2) this is likely to be the case for a significant portion of the repayment period, and (3) he or she made a good faith effort to repay the loan.
The bankruptcy court determined that the debtor's family expenses were reasonable - including two cell phones, an automobile lease and cable television - notwithstanding the fact that his wife worked only one day per week and could work three and the debtor turned down a repayment plan he contended was itself unaffordable.  Accordingly, the court entered a partial discharge, discharging all but $32,080 of the student loans.
On appeal, the district court reversed.  However, the United States Court of Appeals for the Ninth Circuit reversed the district court and affirmed the bankruptcy court's original ruling.
The Ninth Circuit held that the district court erred by reviewing the bankruptcy court's finding of good faith de novo rather than under the "clear error" standard.  This gives bankruptcy courts significant leeway in determining whether the facts at hand support a finding of good faith, but it may be a double edged sword for debtors with unsympathetic facts.The Ninth Circuit also held that bankruptcy court's application of the undue hardship standard was supported by substantial evidence that the debtor had maximized income, minimized expenses and attempted to negotiate repayments.  This holding is likely to provide significant help to former students attempting to discharge student loans.

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