Creditors Beware: A Restrictive Approach to the Criminal Prosecution Exception to the Automatic Stay

By Kirk B. Burkley

and Daniel R. Schimizzi

Bernstein-Burkley, P.C.

Pittsburgh, PA

                 A recent decision from the United States Court of Appeals for the Sixth Circuit will likely chill certain collection practices employed by aggressive creditors.  In the case of Weary v. Poteat, No. 15-5159, 2015 WL5712191 (6th Cir. Sept. 30, 2015), the Sixth Circuit reviewed the criminal prosecution exception to the automatic stay and upheld the bankruptcy court’s award of actual and punitive damages to the debtor for the creditor’s violation of the stay. 

            In Weary, after the Debtor defaulted on her rent payments and moved out of the rental property, her landlord commenced a civil action, claiming $24,999.99 in damages.  The Debtor then filed a chapter 7 bankruptcy petition with the United States Bankruptcy Court for the Eastern District of Tennessee.  After receiving notice of the bankruptcy, the landlord sent letters to the Debtor’s bankruptcy attorney and her mother threatening to pursue criminal charges against the Debtor.  As a result of the letters, the Debtor moved the bankruptcy court to hold the landlord in contempt for violating the automatic stay.  In defense, the landlord invoked the criminal prosecution exception, claiming that the letters communicated his intent to pursue criminal prosecution and fell within the exception. 

 

            The automatic stay prohibits creditors from engaging in any act to collect, assess or recover a claim against the debtor that arose before the commencement of the case.  See 11 U.S.C. §362(a). The automatic stay does not operate as a bar to “the commencement or continuation of a criminal action or proceeding against the debtor.”  11 U.S.C. §362(b)(1).  The bankruptcy court found that the landlord’s motivation for sending the letters was to threaten, harass and intimidate the Debtor in an effort to coerce her into making a payment.  More importantly, the letters were not in the nature of, or in furtherance of any, criminal prosecution; rather, the letters communicated the landlord’s threat to pursue criminal prosecution.  Finding that the landlord willfully acted to harass and coerce the debtor into paying him, the bankruptcy court awarded the Debtor with actual damages, including costs and attorneys’ fees, and punitive damages of $7,500.00. 

            The United States District Court for the Eastern District of Tennessee and the Sixth Circuit affirmed the bankruptcy court.  The Sixth Circuit noted that the landlord failed to challenge the bankruptcy court’s fact findings, or its exercise of discretion in imposing punitive damages.  The landlord also did not challenge the bankruptcy court’s finding of his intent underlying the letters, or of his knowledge of the bankruptcy case.  Since the letters were not in furtherance of any criminal prosecution and were intended to coerce payment from the Debtor, the plain language of Section 362(b)(1) prevented the letters from falling within the criminal prosecution exception.  The Sixth Circuit affirmed the bankruptcy court’s findings that the criminal prosecution exception to the automatic stay did not apply.  The Sixth Circuit also affirmed the award of actual and punitive damages, as the landlord did not challenge these findings.

            The practice point to take from this opinion is that the criminal prosecution exception to the automatic stay does not safeguard the threat of criminal prosecution.  Don’t take the risk:  if you have grounds to pursue criminal charges against a debtor, just do it.  Threatening to do so may run afoul of the automatic stay. 

 

Supreme Court to Hear Dischargeability Case

The Supreme Court has agreed to hear its first bankruptcy case of the current term.     On November 6, the Court granted certiorari in  Case No. 15-145, Husky Electronic, Inc. v. Ritz.   The case involves whether a non-dischargeability case under 11 U.S.C. Sec. 523(a)(2)(A) requires a false representation or can be satisfied by conduct.   The Fifth Circuit ruled against the creditor, holding that a fraudulent transfer of assets was not actionable under Sec. 523(a)(2)(A).    I previously wrote about the Fifth Circuit decision here.  

Bankruptcy Court Resolves Social Media Showdown

By Stephen W. Sather

Barron & Newburger, P.C.

Austin, TX

This is a story about guns and bankruptcy and social media in Texas.   When the dust had cleared, the gun shop's social media accounts had been pried out of the former owner's hands, having been found to be property of the estate.   In re CTLI, Inc., 528 B.R. 359 (Bankr. S.D. Tex. 2015). 

How Long Is Too Long to Reopen A Bankruptcy Case?

By Judith K. Fitzgerald,

Shareholder at Tucker Arensberg, P.C. and

Professor of Practice, University of Pittsburgh School of Law

In a per curiam opinion that is not precedential but of interest to lenders who take mortgages as security, the Court of Appeals for the Third Circuit decided that the Debtor’s effort to reopen her bankruptcy case was too late. 

The basic facts were stated by the court as follows:

In 1997, Scheib filed a Chapter 13 bankruptcy petition in the United States Bankruptcy Court for the Western District of Pennsylvania. The petition was converted to Chapter 7 and in 1998, the Bankruptcy Court granted a motion by Mellon Bank, N.A. (now The Bank of New York Mellon and BNY Mellon, N.A.) for relief from the automatic stay to pursue foreclosure of Scheib's property in state court. Scheib received a discharge releasing her from her dischargeable debts and her bankruptcy case was closed on October 14, 1998. Scheib was evicted from the property that was the subject of the state foreclosure action in 1999. Scheib has since filed, without success, numerous actions in state and federal court seeking to challenge the foreclosure. 

In 2013, Scheib filed a motion in Bankruptcy Court to reopen her case. Although the motion is far from clear, Scheib appears to allege that she paid her mortgage in full and that Mellon Bank committed fraud in the foreclosure action and the bankruptcy proceeding. . . .

In re Scheib, 2015 WL 6685714, at *1 (3d Cir. Nov. 3, 2015).

The Last Screen: A Cautionary Tale

By Judith Fitzgerald

Bankruptcy Judge (Ret.)

Tucker Arensberg, P.C.

University of Pittsburgh School of Law

Pittsburgh, PA

The United States Court of Appeals for the Second Circuit issued an opinion on October 30, 2015, that should be of interest to everyone who files pleadings electronically.  In Luther Franklin v. John McHugh,  Docket No. 14‐4096‐cv,[1] the Court of Appeals dismissed an appeal for lack of jurisdiction due to a failure to complete the filing under CM/ECF.  The attorney did everything CM/ECF requires, including paying the $505 filing fee, but then missed the last step, so the document was never actually submitted to the court. 

Commercial Law League Presents Webinar on New Rules and Forms

The Commercial Law League of America will present Changes in the Bankruptcy Rules and Forms--Know the Changes Before They Go Into Effect on November 20, 2015 from 2:00-3:00 pm CST.    The webinar will feature Bankruptcy Judges Eugene Wedoff from the Northern District of  Illinois and Arthur Harris from the Northern District of Ohio, who served on the Rules Committee, and Ray Obuchowski, who was the liason for the National Association of Bankruptcy Trustees to the Committee.   The program will be moderated by Ronald Peterson from Jenner & Block.

The program will explain the rules process, discuss Amended Rule 1007, provide an overview of the extensive changes to the forms, discuss the substantive changes to the forms, will discuss transition issues and explain the consequences of not knowing about or using the new forms.   The new rule and forms go into effect on December 1, 2015 so that the webinar is very timely.   This is an opportunity to learn about the rule and forms before they go into effect from the people involved in creating them.

The cost of the webinar is $80 for CLLA members and members of affiliated groups and $100 for non-members.     Registration information is available here.

First Ever Young Lawyers Blogging Contest

The CLLA Bankruptcy Blog announces the first ever young lawyers' blogging contest.    The contest is intended to encourage younger members of the League to show off their writing talents and up their involvement in League activities.    According to CLLA Bankruptcy Blog editor Steve Sather, "Young members have grown up with blogging and social media so this should be a natural fit for them."  

Third Circuit Upholds Secured Creditor's "Gift" to Unsecured Creditors in Process Pioneered by CLLA Leader

By Louis Robin

Law Offices of Louis S. Robin

Longmeadow, MA

            The Third Circuit recently entered a decision regarding sales of assets and payment of funds to unsecured creditors over other priority creditors.  It provides additional support for these sales, and enhances the possibility of unsecured creditors gleaning some return for its claims in an otherwise hopeless situation.  It also has some personal significance for me and others as it forces us to revisit an old friend of the CLLA who recently passed. 

            In In re ICL Holding Company, Inc. No. 14-2709, (3rd Cir. 9/14/15), the Third Circuit reviewed the decision of the Bankruptcy Court approving a sale for substantially all the debtor's assets for $320 million to the secured creditor who was owed at least $350 million (the purchase was a credit bid).  There were two objections: first, by the creditors' committee which was resolved when it agreed to accept $3.5 million to be paid into a trust for the benefit of unsecured creditors; and, second, by the U.S. Government which maintained that the funds being paid to the unsecured creditors avoided the priority position of the IRS as the IRS was entitled to an administrative claim based upon capital gains incurred as a result of the sale. 

            There were various technical and substantive arguments made and discussed.  In short, the Third Circuit, after resolving the technical arguments, resolved the substantive issues by relying on the structure of the payment to the trust for the benefit of unsecured creditors – these funds were from the secured creditor, not the bankruptcy estate.

            This case provides a path for unsecured creditors in otherwise hopelessly under-secured cases.  True, the amount may be minor – I would estimate the return in ICL could be less than 5% (and maybe less) – I have had two such cases in the past, one with a dividend of less than 5% and one that may have exceeded 40%.  The later I would consider an anomaly, although garnering anything should be considered a small victory in such cases.

            In the First Circuit, these cases are common.  They were pioneered by Eugene Berman, a past president of the CLLA, in In re SPM Manufacturing Corp., 984 F.2d 1305 (1^st Cir. 1993).  This was a novel concept, accepted by no courts at the time.  Indeed, the Bankruptcy Court and District Court rejected the proposed distribution scheme, which made the Circuit Court decision even more of an accomplishment.  Eugene passed away on September 14, 2015, the day that the Third Circuit issued its decision.  Eugene would have taken great pride that the Third Circuit adopted the concept and procedure that he spearheaded.

            Eugene was an attorney with an immense personality and perseverance.  He accumulated many accomplishments as a creditors’ attorney and as a leader in the CLLA.  Over the years I have heard many accolades for him, although it should not be ignored that he had his share of detractors (something he would have taken pride in also). 

            I understand that Eugene last words were “Massachusetts should enact a judicial foreclosure statute, and that they should name it the 'Eugene Berman Judicial Foreclosure Act'”.  That Eugene, anew, focused on this new issue in the last seven years speaks volumes for his intellect, perspective, and personality.  And I understand that this issue is not over in the Commonwealth of Massachusetts, as some will continue this fight – I hope that I (with my debtor's counsel's hat on) can provide some assistance, although I would add that there is much for both sides to work together to benefit debtors, mortgage holders, and commerce if both sides take a fresh perspective.

Does A U.S. Bankruptcy Court Have Jurisdiction Over a Beis Din, or Jewish Religious Court?

By Michael R. King

Gammage & Burnham, P.C.

Phoenix, AZ

 

QUESTION:  DOES A U.S. BANKRUPTCY COURT HAVE JURISDICTION OVER A BEIS DIN, OR JEWISH RELIGIOUS COURT?

ANSWER:         AT LEAST IN THIS VELT, THE BANKRUPTCY COURT HAS ASSERTED ITS JURISDICTION OVER A BEIS DIN RELIGIOUS
COURT.

Would a Bankruptcy Judge really have the chutzpah to enjoin a Jewish Rabbinical Court and issue sanctions against it?

Congregation Birchos Yosef filed a Chapter 11 reorganization bankruptcy. In re: Congregation Birchos Yosef, Case No. 15-22254 (Bankr. S.D.N.Y.). After filing the Chapter 11 petition, Congregation Birchos Yosef filed an adversary lawsuit in bankruptcy court against Bais Chinuch L'Bonois, Inc. ("Bais Chinuch") and others alleging claims for fraud, breach of fiduciary duty and "looting" of assets of Congregation Birchos Yosef.

Religious Proceeding Violates Automatic Stay

By Jeff Sayer

Scorpion Legal Services, LLC

Roswell, GA

 

The Honorable Robert Drain of the United States Bankruptcy Court for the Southern District of New York issued an opinion on August 24, 2015 in a case which raised a conflict between bankruptcy law and Jewish religious proceedings.

In In re: Congregation Birchos Yosef, the Debtor was a debtor in possession of a Jewish School in a case filed under Chapter 11. The issue arose when the Debtor asserted an adversary proceeding against Bais Chinuch L’Bonois (“Bais”), another Jewish School asserting claims of breach of fiduciary duty and looting of the Debtor’s assets. Upon the filing of the adversary proceeding, Bais invoked a religious proceeding to hear the case, in which a Jewish religious court, a Beis Din, would allow the principals of the Debtor to dispute the charges brought by the Bais. If the principals of the Debtor did not participate in the Jewish court hearing, the result would be at a minimum a shunning by their religious community, a Sirov, and potentially all Orthodox Jews. 

The Million Dollar Typo

By Michael R. King

Gammage & Burnham

Phoenix, AZ

QUESTION:    HOW DID THE BANK LOSE OVER $1 MILLION WORTH OF COLLATERAL DUE TO A PETTY TYPOGRAPHICAL ERROR? ANSWER:  A BANKRUPTCY TRUSTEE ACTS AS A HYPOTHETICAL SECURED CREDITOR THAT CAN IGNORE THE REALITIES OF THE FACTS! What a difference two days makes! The State Bank of Toulon lost its collateral securing a loan of $1,100,000 because its security agreement had the number “13” for a date instead of the number “15.”  Really!  David L. Duckworth borrowed $1.1 million from the State Bank of Toulon (the “Bank”) on December 15, 2008.  The loan transaction was documented with a promissory note dated and signed on December 15, 2008.  The document creating the lien against the collateral was an Agricultural Security Agreement (“Security Agreement”) dated December 13, 2008.  The Security Agreement granted a security interest in crops and farm equipment belonging to Mr. Duckworth.  In re Duckworth, 776 F.3d 453 (7th Cir., 2014)

Three Recent Supreme Court Cases--None Concerning Jurisdiction

By Louis S. Robin

Law Offices of Louis S. Robin

Longmeadow, MA 

As we return from our summer respites (if any of us consider the few moments we may be able to steal as a summer respite), some discussion of three recent Supreme Court cases might quicken our return to our the struggles we endure in our legal practices.  They may have some effect on our practices.  I will also provide some suggestions and comments.

Harris v. Viegelahn

            This case provides guidance regarding payments (usually based upon earnings) to a Chapter 13 trustee for the plan but not yet distributed, followed by the Chapter 13 case being converted to Chapter 7.  I would suggest similar guidance applies to Chapter 13 cases which have been dismissed (a circumstance that is unfortunately common). 

Debtor Not Allowed to Claim Exemption on Proceeds Created By Trustee's Carve-out Agreement

By Beau Hays

Hays, Potter & Martin, LLP

Peachtree Corners, GA

Judge Margaret Murphy of the Bankruptcy Court for the Northern District of Georgia recently handed down a victory for Trustees (and creditors) in a case involving a carve-out negotiated with secured lenders to allow for a short sale and create a fund for unsecured creditors. In re Diener,  No. 11-83085-MHM (Bankr. N.D.Ga. 7/6/15; docket #88) The Opinion can be found here.

 What Happened

Debtors filed Chapter 7 case with three security deeds on their home, totaling about $350,000.00.  As everyone acknowledged that the property was underwater, the Trustee sought to negotiate a carve-out with Wells Fargo, holder of the second- and third-priority liens on the house, offering to pay $9,000.00 in satisfaction of the second and third positions in exchange for finding a buyer and keeping the property from being foreclosed by the first mortgage holder.  A buyer was eventually found at market value; the first lien was paid off, Wells Fargo got its $9,000 and the balance was paid to the Trustee – allowing the Trustee to pay administrative expenses in the case and ultimately providing for about $6000 to go to the unsecured creditor pool.

What Does Gay Marriage Mean for Bankruptcy?

By Stephen W. Sather

Barron & Newburger, P.C.

Austin, TX

 

The recent Supreme Court decision requiring states to recognize same-sex marriages has generated substantial controversy in the political world, but what does it mean for bankruptcy courts?   The obvious answer is that more people will be able to file joint bankruptcy petitions than before.   However, going from a system where some marriages were legally recognized in certain jurisdictions but not others to one where they must be permitted everywhere is likely to result in confusion for practitioners and courts alike for years to come.    This post will attempt to point out some of the issues involved.

A Short History of Same-Sex Marriage in the United States

For most of the nation’s history, marriage was limited to couples of different genders.   In 1996, Congress passed the Defense of Marriage Act which prohibited the United States government from recognizing any marriage other than one between a man and a woman.   In 2003, the Massachusetts Supreme Court entered a ruling which made that state the first in the nation to recognize same sex marriage.    As a few other states followed suit, it became possible to have a marriage which was sanctioned by a particular state but not by the federal government.

Growing Marijuana Can Be Problematic Both In Bankruptcy and Out

By Judith K. Fitzgerald

Tucker Arensberg, P.C.

Pittsburgh, PA

Frank Arenas is licensed in Colorado to grow and dispense medical marijuana.  He and his wife own a building, half of which is used for the cultivation and the other half of which is leased to a marijuana dispensary.  These activities are legal in Colorado, but, despite then Attorney General Eric Holder’s expressed willingness to work with Congress[i] to reschedule marijuana and remove it from the Schedule I (high potential for abuse) drug list[ii], 21 U.S.C.  §856(a) has not been amended.  Thus, knowingly opening, renting, using or maintaining any place, even temporarily, for the purpose of manufacturing, distributing or using any controlled substance is a federal crime.  Similarly, 21 U.S.C. §841(a)(1) makes it unlawful for any person knowingly or intentionally to manufacture, distribute, or dispense or possess with intent to do so, a controlled substance.

When Mr. Arenas tried to evict his tenant and lost the effort, resulting in a judgment that Arenas could not pay, he and his wife filed Chapter 7.[iii]  They listed their nonexempt marijuana plants with a value of $6,250 and their building as worth $262,725 but over-encumbered with liens.  The trustee initially filed a notice of no distribution but withdrew that notice after he received some indication that a purchaser would take the property.  He consulted with the United States Trustee (“UST”) to determine whether he could administer the property.  The UST said no and filed a motion to dismiss the case for cause because the property could not be administered without violating federal law.  In response, the Debtors moved to convert their case to Chapter 13.  The bankruptcy court denied the motion to convert and dismissed the case.  Debtors appealed to the Tenth Circuit Bankruptcy Appellate Panel (“BAP”).

Bankruptcy Court Considers When an Attorney Is an “Initial Transferee” of Funds That Were Deposited Into a Trust Account

By Michael Riela

Vedder Price

New York, NY

In Horwitz v.Montroy (In re Select Tree Farms, Inc.), A.P. No. 15-1014, 2015 WL 4594076 (Bankr. W.D.N.Y. July 17, 2015), the United States Bankruptcy Court for the Western District of New York held that an attorney was not an “initial transferee” for purposes of Section 550(a) of the Bankruptcy Code with respect to funds that were deposited into the attorney’s trust account and later used to pay the debtor’s creditors.  However, the bankruptcy court also held that the attorney was an “initial transferee” with respect to funds that were deposited into the trust account and later used to pay the attorney’s own fees.

This case highlights some of the circumstances under which funds that are deposited into a trust or escrow account may be subject to recovery claims in a bankruptcy case.

Facts

George A. Schichtel was the president of Select Tree Farms, Inc. and managed its operations.  Shortly before it commenced its Chapter 11 case on March 7, 2012, Select Tree Farms issued six checks that were payable to three creditors.  Those checks were signed by Mr. Schichtel.  The drawee bank dishonored those checks because of insufficient funds, and the three creditors subsequently filed complaints that resulted in the prosecution of criminal charges against Mr. Schichtel under New Jersey law.

Second Circuit Holds That a Chapter 11 Plan May Extinguish a Lien When the Lienholder “Participates in the Bankruptcy Proceedings”

By Michael Riela

Vedder Price

New York

 In City of Concord v. Northern New England Telephone Operations LLC (In re Northern New EnglandTelephone Operations LLC), No. 14-3381, 2015 WL 4619576 (2d Cir. Aug. 4, 2015), the Second Circuit considered the circumstances under which a Chapter 11 plan extinguishes a lien.  Notably, although the general rule is that liens may pass through a bankruptcy unaffected, the Second Circuit held that a Chapter 11 plan can extinguish a lien when the lienholder had participated in the bankruptcy proceedings (by, for instance, filing a proof of claim in the bankruptcy case).  This case is an important reminder that if you are a secured creditor, there is a risk to simply filing a proof of claim in a Chapter 11 case and not diligently defending your lien rights thereafter.

Texas Judge Fires Shots on Venue

By Stephen W. Sather
Barron & Newburger, P.C.
Austin, TX

Come back to Texas
It's just not the same since you went away
Before you lose your accent
And forget all about the Lone Star State
There's a seat for you at the rodeo
And I've got every slow dance saved
Besides the Mexican food sucks north of here anyway

--Ohio (Come Back to Texas) by Bowling for Soup


Texas Bankruptcy Judge Russell Nelms has authored a thoughtful opinion on venue and a challenge to Texas companies who file in far off forums.  No. 15-41545, The Crosby National Golf Club, LLC (Bankr. N.D. Tex. 8/3/15).

The Case At Hand

The case in front of Judge Nelms involved a San Diego golf course that was having difficulties with the gated communities which surrounded it.   The company's management was based in Ft. Worth which is where the case was filed.   One of the homeowners' associations moved to transfer venue while the Debtor and its Texas-based bank sought to keep the case in Texas.

Taxpayers Request Cert to Determine Whether IRS Entitled to Special Status in Alter Ego Determination

George Orwell famously said that, "all animals are equal, but some animals are more equal than others."   A petition for writ of cert filed on July 20, 2015 challenges the 9th Circuit's ruling upholding a District Court which found that the IRS was more equal than other creditors when it came to an alter ego determination.    The case is No. 15-102, Robert A. Polittle, et al v. United States of America.

 The Polittes owned several Midas franchises in California through two corporations.   According to the Polittes, their CFO stopped paying employment taxes for one of their companies in 1998 and used his background as a CPA to conceal this fact from them.   The IRS did not detect the non-payment until 2005.    By this time, taxes of $5.3 million had accrued.   After selling all of the assets of the company, the tax debt managed to grow to $11.7 million.   The IRS then filed nominee liens against the Polittes and a second corporation which they owned.    The IRS collected about $1.7 million from sale of two condominiums owned by the Polittes and all of the assets of their other corporation.   The Polittes filed a refund suit against the IRS in U.S. District Court.

Seventh Circuit Delivers Split Decisions for Trustee

By Ron Peterson and Landon Raiford

Jenner & Block, LLP

Chicago, IL 

 

On July 7, the Seventh Circuit delivered two opinions involving trustee Ronald Peterson.   In one case, the Trustee's claim was dismissed under the doctrine of in pari delicto, while in the second, the trustee's malpractice claim against a law firm stated a plausible claim.   In both cases, the trustee for Lancelot Investors Fund, Ltd. had sued professionals for contributing to the debtor's demise.   (Click on the style of the case for a link to the decison).

Peterson v. McGladrey LLP, No. 14-1986 (7^th Cir. July 7, 2015)

In McGladrey, the Seventh Circuit recently expanded on an earlier decision (also in the same litigation) that the doctrine of in pari delicto may apply to a bankruptcy trustee if the doctrine otherwise would apply under the relevant state law.  In McGladrey, the trustee alleged that McGladrey negligently committed its audit of the debtor, and that if McGladrey had not done so, it would have discovered that the debtor was actually investing in a Ponzi scheme thereby saving the debtors millions of dollars lost through further investments in that scheme.  McGladrey argued that even if the trustee’s contentions were correct, McGladrey could not be liable because the debtors committed their own fraud by giving false information to its investors regarding certain safeguards the debtors stated they had put in place but which were not.  The question before the Seventh Circuit was whether the in pari delicto doctrine only applies if the plaintiff and defendant commit the same misconduct.