The two questions presented are, first, whether a debtor may include administrative expenses from a failed Chapter 11 case as part of the liquidation analysis in a hypothetical Chapter 7 liquidation to satisfy the best interest of creditors test confirmation standard; and,

The second question is whether a Chapter 11 plan’s proposed retention of earnings as a “cushion” post-confirmation by a non-profit corporation violates the absolute priority rule.

Neither question has enjoyed a lot of attention in published decisions, but the answer to the first question, while not definitive, seems to suggest it is possible to include post-petition pre-conversion administrative expenses in the liquidation analysis. [1]

The answer to the second question suggests a non-profit corporation cannot violate the absolute priority rule for the reason there are no equity interests to whom priority may be granted.

I. Liquidation Analysis and the Best Interest of Creditors Test

his discussion is limited to the propriety of including pre-conversion Chapter 11 administration expenses in the liquidation analysis involving a hypothetical post-conversion Chapter 7 liquidation.

Statutory Foundation:

Section 1129(a)(7)(A)(ii) sets out what has become known as the “best interest of creditors test” as follows:

(a)  The court shall confirm a plan only if all of the following requirements are met:…

(7) With respect to each impaired class of claims or interests—

(A) each holder of a claim or interest of such class—

(i) has accepted the plan; or

(ii) will receive or retain under the plan on account of such claim or interest property of a value, as of the effective date of the plan, that is not less than the amount that such holder would so receive or retain if the debtor were liquidated under chapter 7 of this title on such date. [Emphasis added.]

Also note the statutory treatment of administrative claims, except operational expenses, in post-conversion Chapter 7 cases found in § 726(b):

(b) Payment on claims of a kind specified in paragraph (1), (2), (3), (4), (5), (6), (7), (8), (9), or (10) of section 507(a) of this title, or in paragraph (2), (3), (4), or (5) of subsection (a) of this section, shall be made pro rata among claims of the kind specified in each such particular paragraph, except that in a case that has been converted to this chapter under section 1112, 1208, or 1307 of this title, a claim allowed under section 503(b) of this title incurred under this chapter after such conversion has priority over a claim allowed under section 503(b) of this title incurred under any other chapter of this title or under this chapter before such conversion and over any expenses of a custodian superseded under section 543 of this title.  [Emphasis added.]

Section 726(b) is compatible with § 348(d), providing, in pertinent part, as follows:

(d) A claim against the estate or the debtor that arises after the order for relief but before conversion in a case that is converted under section 1112, 1208, or 1307 of this title, other than a claim specified in section 503(b) of this title, shall be treated for all purposes as if such claim had arisen immediately before the date of the filing of the petition.

Section 503(b)(1)(A) provides that allowable administrative expenses include

the actual, necessary costs and expenses of preserving the estate including – (i) wages, salaries, and commissions for services rendered after the commencement of the case; and [NLRB wages and benefits not applicable here]. 

Accordingly, while operational expenses are relegated to general unsecured claims in a case converted from Chapter 11 to Chapter 7, traditional administrative expenses from the Chapter 11 case do not lose their character or priority as such in the converted Chapter 7 case, although they may be subordinated as a class in priority to the Chapter 7 administrative expenses in distribution priorities.[2]

Decisions:

In In re:  Adelphia Communications Corp., et al., 368 B.R. 140, 251 (USBC SDNY 2007), contains an analysis of the “best interest of creditor’s test” under § 1129(a)(7) as requiring a distribution “…that is no less than such holder would receive in a hypothetical chapter 7 liquidation of the debtor on such date.”  Id.  That court found the plan proponent must establish by a preponderance of the evidence that the plan “…meets the Best Interests test.”  Id., at 252. 

In determining whether the best interests standard is met, the court must measure what is to be received by rejecting creditors in the impaired classes under the plan against what would be received by them in the event of liquidation under chapter 7. In doing so, the court must take into consideration the applicable rules of distribution of the estate under chapter 7, as well as the probable costs incident to such liquidation.  [Emphasis added.]

Under chapter 7, a debtor’s estate is liquidated by a trustee appointed by the bankruptcy court. Here, substantially all of the Debtors’ businesses have been sold to Time Warner and Comcast, and the estates consist primarily of cash, TWC stock (which is not now freely marketable), and the value to be realized from the Contingent Value Vehicle. Accordingly, the determination of whether the Plan satisfies the Best Interests test here necessarily focuses on the incremental costs that may accrue in a chapter 7 that the estates need not absorb under the Plan, and, to the extent applicable, any incremental cost savings they might enjoy.  Id.

This language suggests the administrative costs being evaluated are those in addition to the administrative expenses incurred in the Chapter 11 case, rather than those that might have been incurred had the case been initiated as a Chapter 7 case. 

This interpretation is reinforced by the discussion in Adelphia Communications, at 254, noting there would be increased administrative costs in a hypothetical Chapter 7 due to trustee fees, and even though trustee fees are capped, even as to successor trustees, the trustee’s advisors’ and professionals’ fees are not capped.  That court goes on to note that if the plan is not confirmed, professional fees and expenses will continue to accrue.  This examination suggests, implicitly, the court is looking to a hypothetical “resulting” Chapter 7 post-conversion, not a hypothetical case initiated as a Chapter 7 instead of the actual Chapter 11 case.

Adelphia Communications, beginning at 255, also noted the likely delay in distribution in a resulting Chapter 7 case and the need to factor in the “time value” of distributions into the “best interests” analysis.  “Delayed distributions would be less valuable than the near-term distributions.”  Id. [3]

Lastly, see, In re Sierra–Cal, et al., 210 B.R. 168, 172 (USBC ED Ca. 1997) (“If a prompt chapter 7 liquidation would provide a better return to particular creditors or interest holders than a chapter 11 reorganization, then a reorganization is inappropriate and a chapter 11 plan should not be confirmed.”):

Applying the “best interests” test requires the court to conjure up a hypothetical chapter 7 liquidation that would be conducted on the effective date of the plan.

The hypothetical liquidation entails a considerable degree of speculation about a situation that will not occur unless the case is actually converted to chapter 7. It contemplates valuation according to the depressed prices that one typically receives in distress sales.  [Emphasis added.]  Id.

II.  Absolute Priority Rule and Non-Profit Corporate Debtors

Statutory Foundation:

The “absolute priority rule” is found in § 1129(b)(2)(B)(ii), providing  “…the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest…” 

Decisions:

This discussion of the absolute priority rule vis-à-vis non-profit corporate debtors in Chapter 11, principally relies on In re:  Save Our Springs (S.O.S.) Alliance, Inc., 388 B.R. 202 (USBC WD Tx. 2008) for the reason that SOS Alliance cites to the remaining decisions that preceded it in what is a rather sparse examination of this particular issue.

SOS Alliance dealt with a non-profit corporation involved with environmental issues, whose plan of reorganization did not pay all claims of all creditors and did not provide for equity holders to receive or retain an interest, because the debtor, as a non-profit corporation, had no equity holders.  Accordingly, the absolute priority rule was held inapplicable.  Id., at 245. [4]  Since there are no equity security holders in the non-profit, the absolute priority rule does not apply to non-profit corporations. 

[1] Many of the decisions involved the question of whether to confirm the plan or convert the case to Chapter 7, which is a common procedural posture to find at that stage of case administration. None of the decisions involved a direct examination as to whether a “hypothetical” Chapter 7 liquidation was one viewed in the context of a hypothetical Chapter 7 case originally filed as such, opposed to a post-conversion analysis involving Chapter 11 administrative expenses.

[2] See, In re:  Midway Airlines Corporation, et al., 406 F.3d 229, 241 (CA 4 2005) (“[I]f funds are insufficient to pay all [administrative expenses] they must individually suffer pro rata.”. Further, when a case is converted to chapter 7, a pre-conversion § 503(b) administrative expense claim is explicitly subordinated to a post-conversion § 503(b) claim. See 11 U.S.C. § 726(b).”  (Internal quotation marks, edits and citation omitted).

[3] See, also, In re Lason, Inc., et al., 300 B.R. 227, 232 (USBC, D Del. 2003) (“To measure value, the Court must contrive a hypothetical chapter 7 liquidation conducted on the effective date of the plan. [Emphasis added.]  Also, see, In re Sierra–Cal, 210 B.R. 168, 171–172 (Bankr.E.D.Cal.1997). Section 1129(a)(7)(A) requires a determination whether “a prompt chapter 7 liquidation would provide a better return to particular creditors or interest holders than a chapter 11 reorganization.” Id. The proponent of the plan bears the burden of showing that the best interest of creditors has been satisfied. In re Genesis Health Ventures, Inc., 266 B.R. 591 (Bankr.D.Del.2001) (citations omitted).”

[4] SOS Alliance, at 245, cited to  “In re General Teamsters, Warehousemen and Helpers Union, Local 890, 265 F.3d 869 (9th Cir.2001) (affirming bankruptcy court’s holding that a labor union, which was a non-profit entity, had no equity holders and that, therefore, the absolute priority rule was not applicable to its Chapter 11 plan); In re Wabash Valley Power Ass’n., Inc., 72 F.3d 1305 (7th Cir.1995) (holding that the absolute priority rule was not applicable to the Chapter 11 plan of a non-profit electric cooperative which had no equity holders), cert. denied sub nom. U.S. v. Wabash Valley Power Ass’n, Inc., 519 U.S. 965, 117 S.Ct. 389, 136 L.Ed.2d 305 (1996); In re Independence Village, Inc., 52 B.R. 715, 726 (Bankr.Mich.1985) (noting, in deciding the likelihood of an effective reorganization for purposes of § 362 stay relief litigation, that the Chapter 11 debtor, which operated a 252–unit life-care facility for the elderly, was “a non-profit corporation. It has no shareholders, hence there are no interests inferior to the unsecured creditors [and, t]hus there should be little difficulty with the absolute priority rule….”).”

This paper examines the history, development and argument often called “artificial impairment” in Chapter 11 plan confirmation under §§ 1124 and 1129(a)(10).   Most of the discussion of this issue involves single-asset chapter 11 bankruptcy cases, the single asset is secured to a single secured creditor, the collateral value is dwarfed by the claim, the secured creditor is at odds with the debtor, and there is little trade debt in the case. 

In re: Valley View Shopping Center, L.P., 260 B.R. 10 (Bankr. Ks.2001), apparently the only reported 10^th Circuit case directly on the subject, noted the “excellent discussion” on artificial impairment by Clemency & Saks in the ABI Journal, the latest of which, “Even an Act of Congress Can’t Stop the Fight Over Artificial Impairment,” 17-Nov. AmBankr.Inst.J. 18 (November, 1998) (hereafter referred to as “C&S”).  That article was the last and third in a series on the subject, but is apparently the only article still available on-line at the ABI.  The historical underpinnings of the issue must be understood to fully understand the issue, and that article provides a conceptual outline on the matter.  In all, the concept of artificial impairment typically involved paying a relatively small amount of unsecure claims in full shortly after the effective date of the plan.  C&S, note 2.

Even in the rare single-asset case where sufficient collateral value exists to pay 100% to all creditors over time, the DIP must still overcome the confirmation standard of § 1129(a)(10) requiring the acceptance of at least one impaired class of non-insider creditors.  Accordingly, what is “impaired?”  Valley View, at 31, simply states, without further analysis, that “under § 1124, a class of interests is impaired under a plan unless, the plan ‘leaves unaltered the legal, equitable, and contractual rights’ of the holders of such interests.”  See, also, L & J Anaheim Assocs. v. Kawasaki Leasing Int’l., Inc. (In re:  L & J Anaheim Assocs.), 995 F.2d 940 (9^th Cir. 1993)(even changes which, on balance, enhance creditor’s position cause impairment).  The concept of “impairment” is also discussed further below.

In 1994, Congress amended the Bankruptcy Code in an attempt to respond to complaints of abuse in single-asset chapter 11 cases (Bankruptcy Reform Act of 1994, Pub.L. 103-394, effective Oct. 22, 1994).  Prior to 1994, § 1124(3) allowed for a “cash out” option for debtors who wanted to “unimpair” certain creditors by providing a class of unimpaired claims when paid in full in cash on the effective date of the plan. Sub-§ 3 was deleted by the 1994 amendments in response to In re:  New Valley Corp., 168 B.R. 73 (Bankr. D.N.J. 1994), which applied the old § 1124(3), literally holding a class, paid in full in cash on the effective date, was unimpaired, could not vote for or against the plan, and was not entitled to receive post-petition interest despite the fact the debtor was solvent.  This result had the effect of creating a windfall for the debtor while disenfranchising certain creditors and denying them a voice.  Accordingly, § 1124(3) was deleted.  C&S concluded a plain reading of the changes to § 1124 was “…there would be no way that a class of claimants could be artificially impaired because even full cash payment to the class would constitute honest-to-goodness impairment under the Code.”

Prior to the 1994 amendments, the leading case on “artificial impairment” was In re:  Windsor on the River Associates, Ltd., 7 F.3d 127 (8^th Cir. 1993) in which the concept was adopted requiring an “economic” justification for impairment, although not specifically provided in § 1124.  (Note, Windsor preceded the 1994 amendments.)  Later, the 9^th Circuit BAP rejected Windsor in In re:  Hotel Associates of Tucson, 165 B.R. 470, 475 (9^th Cir. BAP 1994) where unsecured trade claims were paid in full 30 days after the effective date, finding them to constitute an impaired class for cramdown purposes, but injecting a good faith requirement into § 1129(a)(10).

Following the 1994 amendments, the debate continued among certain courts, largely while ignoring the 1994 amendments.   This led to the decision in In re:  Atlanta-Stewart Partners, 193 B.R. 79 (Bankr. N.D. Ga. 1996), that seized upon the ramifications of the 1994 amendments finding that “…a class of creditors which will receive payment in full upon the effective date of the plan is impaired within the meaning of the Bankruptcy Code.”  Id., at 82.  Atlanta-Stewart found the intentional removal of the language from § 1124 that a class paid in full at the effective date is unimpaired, left the creditor impaired, stating,

… the legislative history demonstrates that Congress intended to do away with the concept that a creditor receiving payment in full is unimpaired.

As a result of this change, if a plan proposed to pay a class of claims in cash in the full allowed amount of the claims, the class would be impaired entitling creditors to vote for or against the plan of reorganization. If creditors vote for the plan or reorganization, it can be confirmed over the vote of a dissenting class of creditors only if it complies with the “fair and equitable” test under section 1129(b)(2) of the Bankruptcy Code and it can be confirmed over the vote of dissenting individual creditors only if it complies with the “best interests of creditors” test under section 1129(a)(7) of the Bankruptcy Code. 

 140 Cong.Rec. H10752 (Oct. 4, 1994).  Id.

Atlanta-Stewart conceded it initially would seem illogical to treat a class of creditors receiving full payment as “impaired,” but noted such treatment provides advantages in avoiding litigation over artificial impairment with a resulting focus in confirmation on more important topics (e.g., “fair and equitable,” “best interest of creditors,” etc.).  Id.[1]

This brings us back to Valley View, which involved competing plans proposed by the debtor’s landlord/lessor, and the debtor.  Note, this is clearly a post-1994 amendments case involving a debtor with two primary assets, the largest being its operation of a shopping center under a long-term ground lease, and a limited partnership interest.  Valley View also looked at the history behind § 1124 as suggesting that even claims “cashed out” on the effective date can nevertheless be impaired within the meaning of § 1124.  Id., at 32.  It further concluded, following a brief discussion of Atlanta-Stewart, and noting the language of  In the Matter of Greate Bay Hotel & Casino, Inc., 251 B.R. 213, 240 (Bankr.D.N.J. 2000), in light of the 1994 amendment, “artificial impairment” is now more difficult to justify, and a claim need not and cannot be artificially impaired.

Also note, Judge Wedoff, in 203 N. LaSalle Street, also found that

Under current law, the debtor’s plan plainly does impair the class of general unsecured claims.  The creditors holding these claims are, at the very least, delayed in the right to payment that existed under their agreements with the debtor, and they were not provided interest to which they would otherwise be entitled.

The debtor’s bank in 203 N. LaSalle Street contended this impairment was artificial, since the debtor had the ability to pay these unsecured creditors in full, with interest, at the time of the confirmation hearing and the plan provided for full payment, without interest, 180 days following the effective date.   

Judge Wedoff examined Windsor and Hotel Assocs. of Tucson, commenting on how even cases finding Windsor somewhat persuasive found artificial impairment only where no reason for impairment existed other than to obtain compliance with § 1129(a)(10), resulting in his conclusion the better argument being that a plan was not proposed in good faith. 

Judge Wedoff brings us to the analysis of “good faith.”  At first blush, Judge Michael’s decision in In re:  Muskogee Environmental Conservation Company, 236 B.R. 57 (Bankr. Okla. 1999), might seem to play here, but that decision examined the good (or, as it turned out, bad) faith filing of the bankruptcy case.  While containing an excellent analysis of various factors used to make that determination, it has been held that the determination of “good faith” under § 1129(a)(3) is different than that under § 1112(b).  See, In re:  Boulders on the River, Inc., 164 B.R. 99, 103-104 (9^th Cir. BAP 1994); see also, In re:  Gillbertson Restaurants, LLC, 2005 WL 783063, *5 (Bankr. N.D. Iowa 2005); In re:  Gleason, 305 B.R. 464, 467 (U.S.D.C., N. Ill. 2004).

Rather, to be proposed in good faith for purposes of confirmation, a plan must fairly achieve results consistent with the Bankruptcy Code   See. Matter of Block Shim Development Company-Irving, 939 F.2d 289, 292 (C.A. 5 1991); In re Madison Hotel Assocs., 749 F.2d 410, 425 (7th Cir.1984); In re Resorts Int’l, Inc., 145 B.R. 412, 469 (Bankr.D.N.J.1990).  Also see, Greate Bay Hotel & Casino, Inc., supra, at 237, 238: 

“Courts have found a plan to be proposed in good faith where it: (1) fosters a result consistent with the Code’s objectives, In re:  Block Shim Dev. Company-Irving, id.; In re:  Madison Hotel Assocs., 749 F.2d 410, 425 (7^th Cir. 1984); In re:  Resorts Int’l., Inc. 145 B.R. 412, 469 (Bankr. D.N.J. 1990); (2) has been proposed with honesty and good intentions and with a basis for expecting that reorganization can be effected, In re:  Koelbl, 751 F.2d 137, 139 (2^nd Cir. 1984); In re:  Sound Radio, Inc., 93 B.R. 849, 853 (Bankr. D.N.J. 1988), aff’d in part, remanded in part, 103 B.R. 521 (D.N.J. 1989), aff’d, 908 F.2d 964 (3^rd Cir. 1990), or (3) is supportable based on the totality of the circumstances. In re:  Cajun Elect. Power Co-op., Inc. 150 F.3d 503, 519 (5^th Cir. 1998), cert. denied, 526 U.S. 1144, 119 S.Ct. 2019, 143 L.Ed.2d 1031 (1999); Beal Bank S.S.B. v. Waters Edge L.P., 248 B.R. 668, 688 (D.Mass. 2000); In re:  Holley Garden Aparts., ltd., 238 B.R. 488, 493 (Bankr. M.D.Fla. 1999).

Cases to consider/in anticipation of argument:

Bankruptcy court’s finding as to debtor’s good faith in proposing its Chapter 11 plan was not clearly erroneous, though debtor allegedly delayed paying certain claims that it had ability to easily satisfy in full in order to create an artificially impaired class and to “cram down” plan over creditors’ objection, given testimony of debtor’s financial consultant that the debtor needed at least $1 million in cash reserves in order to operate, and given evidence that immediate payment of these claims would cause debtor’s cash reserves to fall below this $1 million floor. In re:  Carolina Tobacco Co., 360 B.R. 702 (D.Or.2007), rehearing denied 2007 WL 927940.

Chapter 11 reorganization plan was made in good faith, even though effect of plan was to delay payments to unsecured judgment creditor, where plan appeared feasible and provided debtor with means to continue operating while paying off debts in orderly manner. Matter of National Paper & Type Co. of Puerto Rico, 120 B.R. 624 (D.Puerto Rico 1990).

Mere proposal of cram down over objections of secured creditors under Bankruptcy Code is not bad-faith proposal of Chapter 11 plan precluding confirmation; where there is reasonable likelihood that plan will achieve objectives and purpose of Bankruptcy Code by restructuring and payment of debt and preservation of economic units, plan is proposed in good faith. In re:  Elm Creek Joint Venture, 93 B.R. 105 (Banktcy. W.D. 1988).

[1] C&S also noted In re:  Duval Manor Associates, 191 B.R. 622, 626-699 (Bankr. E.D. Pa. 1996) (“providing a detailed analysis in rejecting the concept of artificial impairment and allowing intentional impairment of the ‘barest imaginable degree’”); and In re: 203 North LaSalle Street Ltd. Partnership, 190 B.R. 567, 592-93 (Bankr. N.D. Ill. 1995) (recognizing the split over Windsor, and suggesting the “developing consensus … that the ‘artificial impairment’ objection is best seen, not as a ground for finding non-compliance with § 1129(1)(10), but as an argument that a plan has not been proposed in good faith, a separate requirement for confirmation under § 1129(a)(3)”), aff’d., 126 F.3d 955 (7^th Cir. 1997), rev’d. on other grounds, 526 U.S. 434, 119 S.Ct. 1411, 143 L.Ed.2d 607 (1999).

The facts relied upon in this memorandum are as follows:

A limited partnership (LP), borrowed $3M from Bank, under a Revolving Credit Loan Agreement further evidenced by a promissory note in like amount (Revolving Loan). The Revolving Loan matured in September, 2010.  In conjunction therewith, LP pledged all of its assets to Bank to secure the repayment of the Revolving Loan.  At the time of the original loan, LP was generating $200K in income per month.

The Revolving Loan went into default, suit was filed by Bank to collect thereon and recover its collateral (Bank Lawsuit), Receiver was appointed as receiver by the court in the Bank Lawsuit over the assets of LP pledged to Bank, he was thereafter qualified and remained acting as such.  Following motion, hearing, approval of all parties to the litigation at that time, including, inter alia, separate and independent legal counsel for LP and an Intervenor, an agreed order was entered authorizing the receiver to enter into a Renewal Promissory Note and Amendment to the Revolving Credit Loan Agreement with Bank in the original principle amount of $3M with a maturity date in September, 2011 (Renewal Revolving Loan).  No new funds were advanced and no additional collateral was given, but no existing collateral was released.  The final paragraph of the Renewal Revolving Loan reads:  “This Note evidences and [sic.] extension and renewal of the $3,000,000 Promissory Note … payable by LP  to Lender [Bank].”

At some point in time, it was determined one or more spendthrift trusts, whose beneficiaries were the children of the LP’s principal (Principal, and the Trusts), were limited partners in the LP.  LP’s general partner was at all times material hereto a separate corporate entity controlled by the Principal. In essence, Principal controlled the activities of LP, its general partner, all related entities and business operations, and established the Trusts pursuant to his own terms.

The Trusts formally or informally intervened in the Bank Lawsuit, and for the first time, at a hearing, verbally indicated they challenged the validity of the Revolving Loan, and, for our purposes, the Renewal Revolving Loan, all documents and collateralization associated therewith (Bank Loan(s)), but without specifying the legal nature of that challenge.

Later in the deposition of one of the Trusts’ attorneys, the deponent was questioned as to the specifics of that challenge, replying the challenges to the Bank Loan(s) were based upon the fact “…that the bank fully knew that [LP] was owned by trusts that were spendthrift trusts and that [sic.] entered into these loan agreements in violation of the terms of those trusts and that was a violation I believe of their duty.”  When asked, the deponent identified that duty as Bank’s “…banking duty.” When asked as to whom the duty was owed, the deponent replied, “I believe the bank just as any other entity has a responsibility not to engage in actions which it knows are potentially in violation of trust agreements.  And I believe that the bank may have known that the [LP] properties should not have been mortgaged as they were.  I also believe that the bank may have known that the money that was being lent to [LP] was not intended to be used by [LP] but instead was intended for the operations of the [an affiliated entity]….” a separate entity from LP, its general partner, or the Trusts, but nevertheless controlled by Principal.

Accordingly, the questions addressed in this paper are as follows:

A.  What is the duty by a lending bank to its borrowing customer?

1.  Is there an obligation by the parties to act in good faith, and what does that obligation specifically entail?

2.  Is there a fiduciary relationship between a lending bank and its borrowing customer, or others?

3.  What interests do the Trusts possess, as limited partners, in the LP limited partnership?

B.  Under the allegations as they have been articulated to date, could Bank be found to have defrauded its borrower (LP) or the Trusts?

C.  Did the renewal Promissory Note, approved by the Court and all parties to the litigation at that time, novate the original revolving promissory note and what is the effect of such novation?

 A.  Duty of Lending Bank to its Borrowing Customer

1.  Duty to Act in Good Faith

It is well-settled law in Oklahoma, that banks, as well as all parties to a contract, have a duty or obligation to exercise good faith and fair dealing with its customers.  See, First Nat’l. Band & Trust Company of Vinita v. Kissee, 859 P.2d 502, 508, 1993 OK 96 (Okla. 1993).

The common law imposes this implied covenant upon all contracting parties that neither party, because of the purposes of the contract, will act to injure the parties’ reasonable expectations nor impair the rights or interests of the other to receive the benefits flowing from their contractual relationship.^FN25 However, … without ‘gross recklessness or wanton negligence on behalf of a party’ to a commercial contract, a breach of the implied covenant of good faith and fair dealing merely results in a breach of contract.

FN25. Western Natural Gas Co. v. Cities Service Gas Co., 507 P.2d 1236 (Okla.1972). See also 12A O.S.1991 § 1-203; Hall v. Farmers Ins. Exchange, 713 P.2d 1027 (Okla.1985).

FN26. 756 P.2d 1223, 1227 (Okla.1988).

Id.

“[T]he law presumes honesty and fair dealing, and fraud may not be inferred from acts which are consistent with honesty of purpose.” Madill Bank & Trust Co. v. Herrmann, 738 P.2d 567, 571 (Okla.Civ.App.1987).

 2.  Creditor-Debtor Relationship, Not A Fiduciary

Kissee continues, at 510, 511, by examining the relationship between a bank and its customer, in that case a guarantor to a loan transaction, finding

Oklahoma recognizes the common law rule that the relationship between a bank and its customer is not fiduciary in nature, but is that of creditor-debtor.^FN32 In all cases, the determination of the existence of a fiduciary relationship depends upon the factual circumstances, including the relationship of the parties involved, to each other and to the disputed transaction.^FN33

FN32. State Guar. Bank v. Doerfler, 99 Okla. 258, 226 P. 1054 (1924); Brown v. Eastman Natl. Bank, 291 P.2d 828 (Okla.1955); Ingram v. Liberty Natl. Bank & Trust Co., 533 P.2d 975 (Okla.1975).

FN33. Reeves v. Crum, 97 Okla. 293, 225 P. 177 (1924); Lewis v. Schafer, 163 Okla. 94, 20 P.2d 1048 (1933); Mahan v. Dunkleman, 205 Okla. 54, 234 P.2d 366 (1951).

In Conoco, Inc. v. J.M. Huber Corp., 148 F.Supp.2d 1157 (U.S.Dist.Ct.Ks. 2001), while applying Oklahoma law and examining Kissee, supra, the Kansas U.S. District Court found at 1172,

the Oklahoma Supreme Court held that no fiduciary relationship existed between a bank and its customer with respect to the customer’s business and private investments. [Internal citations omitted.]  Thus, while there would certainly be a fiduciary relationship between a bank and its customer if the customer entrusts money to the bank, no such relationship exists when the customer fails to ‘repose any special confidence’ in the bank in other situations. Cf. Mahan v. Dunkleman, 205 Okla. 54, 234 P.2d 366, 370 (Okla.1951) (finding the relationship was not sufficient to justify lowering the proposed beneficiary’s “sense of security”).

As further stated in Chapman v. Chase Manhattan Mortgage Corp., et al., 2007 WL 2815247 (U.S.Dist.Ct., N.D. Okla. 2007), beginning at *8,

The Oklahoma Supreme Court has recognized that a breach of contract claim and a tort claim may arise from the same set of facts when the contract serves as the “mere inducement creating the state of things that furnishes the occasion for a tort.” Finnell v. Seismic, 67 P.3d. 339, 344 (Okla.2003). However, in the commercial loan setting, Oklahoma appellate courts have refused to permit a tort claim arising out a customer’s contract with a bank:

The purpose of a commercial loan … is to provide the funds to facilitate the taking of a business risk. Where, as here, there is no special relationship, parties should be free to contract for any lawful purpose and upon such terms as they believe to be in their mutual interest. To impose tort liability on a bank for every breach of contract would only serve to chill commercial transactions. This is not to say that under every fact situation arising from a breach of contract that recovery may never lie. Gross recklessness or wanton negligence on behalf of a party to a contract may call for an application of the theory of tortious breach of contract.

***

Oklahoma law does not permit a bank customer to sue a bank in tort absent gross recklessness or wanton negligence committed by the bank. Mooring Capital Fund, LLC v. Phoenix Central, Inc., 2007 WL 2292462 (W.D.Okla. Aug. 7, 2007); Beshara v. Southern Nat. Bank, 928 P.2d 280, 288 (Okla.1996).

First National Bank of Durant v. Honey Creek Entertainment Corp.,54 P.3d 100, 2002 OK 11 stated, at 105,

In any action based on negligence, the first prerequisite must be to establish the existence of a legally cognizable duty. Wofford v. Eastern State Hosp., 1990 OK 77, 795 P.2d 516, 518. Duty is a question of law for the court in a negligence action although the existence of a duty often depends on the relationship of the parties. Delbrel v. Doenges Bros. Ford, Inc., 1996 OK 36, 913 P.2d 1318, 1320.

The evidence at trial established that the relationship of the Bank and Clancy was a debtor-creditor relationship, not a fiduciary relationship. *106Beshara v. Southern Nat. Bank, 1996 OK 90, 928 P.2d 280, 288 (a bank’s relationship to its customer is that of debtor-creditor).

In Honey Creek, the complaining party failed to establish the Bank owed her any duty to prevent a diminution in the value of the Honey Creek entity, finding she “…failed to identify any written agreement that imposed upon the Bank a duty to monitor the loan collateral for the benefit of Honey Creek, Clancy or Acme.”  Id.

Similarly, Bankers Trust Company v. Brown, 107 P.3d 609, 2005 OK CIV APP 1, at 613 (¶13), in finding no duty exists outside of the Home Ownership and Equity Protection Act, commonly known as “HOEPA” (15 U.S.C. § 1639(h) (1998), and not common law theories of negligence or tort, stated

Lenders have cited to numerous cases holding that a bank does not have a duty to ensure that its customer has the financial ability to repay a loan.^FN4

FN4. First Nat’l Bank in Durant v. Honey Creek Entm’t Corp., 2002 OK 11, ¶ 19, 54 P.3d 100, 105-06; Cogan v. Triad Am. Energy, 944 F.Supp. 1325, 1329 (S.D.Tex.1996); N. Trust Co. v. VIII S. Mich. Assocs., 276 Ill.App.3d 355, 212 Ill.Dec. 750, 657 N.E.2d 1095, 1102 (1995); Resolution Trust Corp. v. BVS Dev., Inc., 42 F.3d 1206, 1214 (9th Cir.1994); F.D.I.C. v. Smith, 848 F.Supp. 1053, 1057 (D.Mass.1994); Nelson v. Prod. Credit Ass’n of the Midlands, 930 F.2d 599, 605 (8th Cir.), cert. denied, 502 U.S. 957, 112 S.Ct. 417, 116 L.Ed.2d 438 (1991); In re Fordham, 130 B.R. 632, 646 (Bankr.D.Mass.1991); Nymark v. Heart Fed. Sav. & Loan Ass’n, 231 Cal.App.3d 1089, 283 Cal.Rptr. 53, 59 (1991); Commercial Nat’l Bank in Shreveport v. Audubon Meadow P’ship, 566 So.2d 1136, 1140 (La.Ct.App.1990); Prod. Credit Ass’n v. Croft, 143 Wis.2d 746, 423 N.W.2d 544, 548 (Ct.App.1988); and Wagner v. Benson, 101 Cal.App.3d 27, 161 Cal.Rptr. 516, 521 (1980).

And generally, the law is settled that a lender does not owe a borrower a duty of care arising simply from the lending of money. Russell v. Barnett Banks, Inc., 527 S.W.2d 25 (Ga.App. 1999). There are no duties owed by a lender to a borrower which are not specifically delineated in the written loan agreement. Roundtree Villas Association, Inc. v. 4701 Kings Corporation, 282 S.C. 415, 422, 321 S.E.2d 46, 50 (S.C. 1984) (holding that a lender does not owe a borrower any duty at common law to protect the borrower’s interests); Resolution Trust Corporation v. BVS Development, Inc., 42 F.3d 1206, 1214 (9th Cir. 1994) (even “[u]nder California law, a lender does not owe a borrower or third party any duties beyond those expressed in the loan agreement. First Union National Bank of Georgia v. Gurley, 431 S.E.2d 379, 381 (Ga. App. 1993) (“the law is clear that a Bank owes no legal duty to act as a customer’s legal or financial advisor”); Parker v. The Columbia Bank, 91 Md. App. 346, 604 A.2d 521 (1992) (borrower/lender relationship not sufficient to create duty of care to support claims of negligence, fraud, negligent misrepresentation or breach of fiduciary duty); Cahaba Seafood, Inc. v. Central Bank of the South, 567 So.2d 1304, 1305 (Ala. 1990) (“Central Bank owed no duty to (borrower) outside the confines of the (credit) agreement”); Commercial Nat. Bank v. Audubon Meadow Partnership, 566 So.2d 1136 (La. Ct. App. 1990) (to impose a duty on banks to investigate and analyze the feasibility of a loan would significantly alter the relationship between banks and borrowers); and Nymark v. Hart Federal Savings and Loan Association, 231 Cal.App.3d 1089, 283 Cal. Rptr. 53 (1991) (bank, acting within its role as a lender of money, owes no duty of care to the borrower). Furthermore, under the common law no duty is imposed upon a defendant to act to prevent a third party from causing injury to a plaintiff. Steinke v South Carolina Department of Labor, Licensing and Regulation, 336 S.C. 373, 388, 520 S.E.2d 142, 149 (1999). Moreover, at common law, there was no duty upon a defendant to act to prevent damage from a third party to a plaintiff even if the defendant could foresee that the plaintiff might be injured if the defendant did not act. South Carolina Ports Authority v. Booz-Allen & Hamilton, Inc., 289 S.C. 373, 376, 346 S.E.2d 324, 325 (1986); and Rice v. School Dist. of Farfield, 317 S.C. 87, 93, 457 S.E.2d 352, 355 (S.C. Ct.App. 1994).

Accordingly, in order to breach the duty of good faith, which is a bilateral duty that includes LP and the Principal, one must establish the breaching party acted with gross or wanton negligence, but such violation creates no independent tort liability.  Additionally, with nothing further, the only relationship created between a lending bank and its borrowing customer, absent the establishment of a fiduciary relationship, is that of a creditor and debtor.  In order to establish any type of a fiduciary relationship, requires a finding of a special confidence being placed in the bank by the customer.  Lastly, a lender owes no duty of care arising from the lending of money independently of the obligations specifically contained in the loan documents.

3.  Implications Existing and Arising from the Trust’s Status as Limited Partners

The Uniform Limited Partnership Act of 2010 (ULPA, §§ 500-101A, et seq., Tit. 54, Okla.Stat.2011) became effective on January 1, 2011.  As of yet, no reported decisions appear under Oklahoma’s ULPA, as recently enacted.  That said, however, § 500-110A.(a) provides the partnership agreement governs relations among the partners (statutorily defined to include both general and limited partners) and between the partners and the partnership; §500-302A. provides no limited partner has the right or power to act for or bind the limited partnership; § 500-402A. provides the limited partnership acts through and is generally bound by the general partner; § 500-403A. provides the limited partnership is liable for the general partner’s actionable conduct; and, § 500-406A.(a) provides the general partner may decide any matter relating to the activities of the limited partnership.  [It should be noted the UFTA 2011 replaced the UFTA 2008, which was ruled unconstitutional.  As a result, no cases appear in OSCN and Title 54 in printed form contains no decision in its annotations.]

Generally, however, under the Uniform Limited Partnership Act of 2001, a limited partner does not have the right or the power as a limited partner to act for or bind the limited partnership.[1] A limited partner has no right to participate in the management and operation of the business,[2] or to interfere in any manner with its conduct or control.[3] (59A AmJr 2d, § 864).

[FN1] Uniform Limited Partnership Act § 408(b)(3) (2001).

[FN2] Cromwell v. Commerce & Energy Bank of Lafayette, 450 So. 2d 1, 39 U.C.C. Rep. Serv. 625 (La. Ct. App. 3d Cir. 1984), writ granted, 456 So. 2d 1389 (La. 1984) and judgment aff’d in part, rev’d in part on other grounds, 464 So. 2d 721, 40 U.C.C. Rep. Serv. 1814 (La. 1985).

[FN3] Hirsch v. duPont, 396 F. Supp. 1214 (S.D. N.Y. 1975), judgment aff’d, 553 F.2d 750 (2d Cir. 1977) (applying New York law).

A limited partner does have the right to obtain records and information related to the limited partnership.  Tit. 54, Okla.Stat.2011, § 500-304A;  59A AmJur2d 865.

“A limited partner has no interest in,[1] or perhaps more correctly no title to,[2] the assets of the partnership. His or her interest is personal property, even if the partnership assets include[3] or consist solely of land,[4] and even if land is the only thing in which it deals.[5]  The Uniform Limited Partnership Act of 2001 provides that the only interest of a partner which is transferable is the partner’s transferable interest, and a transferable interest is personal property.[6]  59A AmJur2d § 863.

[FN1] Evans v. Galardi, 16 Cal. 3d 300, 128 Cal. Rptr. 25, 546 P.2d 313 (1976).

[FN2] Maxco, Inc. v. Volpe, 247 Ga. 212, 274 S.E.2d 561 (1981).

[FN3] Hirsch v. Equilateral Associates, 245 Ga. 373, 264 S.E.2d 885 (1980).

[FN4] McDermott v. McAdams, 273 Ark. 20, 616 S.W.2d 476 (1981).

[FN5] Reiter v. Greenberg, 21 N.Y.2d 388, 288 N.Y.S.2d 57, 235 N.E.2d 118 (1968).

[FN6] Uniform Limited Partnership Act § 701.

Accordingly, the only interest possessed by the Trusts was their limited partnership interest, whose rights are controlled by the limited partnership agreement, but which nonetheless gave them no right to participate in the management of the limited partnership or act on behalf thereof.

B.  Fraud

“Actionable fraud consists of a false material representation made as a positive assertion which is known either to be false, or made recklessly without knowledge of the truth [or falsity], with the intention that it be acted upon, and which is relied upon by a party to his/her detriment.” Tice v. Tice, 1983 OK 108, ¶ 7, 672 P.2d 1168, 1171 (footnote omitted). Constructive fraud is “the concealment of material facts which one is bound under the circumstances to disclose.” Varn v. Maloney, 1973 OK 133, ¶ 18, 516 P.2d 1328, 1332 (citation omitted); see also 15 O.S. 2001 § 59(1). However, “[a]n action for fraud may not be predicated on false statements when the allegedly defrauded party could have ascertained the truth with reasonable diligence.” Silver v. Slusher, 1988 OK 53, ¶ 6, 770 P.2d 878, n.8, 770 P.2d 878, 881 (citations omitted) (emphasis omitted).”  Bankers Trust v. Brown, supra, at 613, 614 (¶ 14).

“With limited exceptions, fraud cannot be predicated on misrepresentations of law or misrepresentations as to matters of law.”  See, Honey Creek, supra, at 104 (¶ 8).

 C.  Novation

Novation may be effected in three ways: (1) By the substitution of a new obligation between the same parties, with intent to extinguish the old obligations; (2) by the substitution of a new debtor in the place of the old one, with intent to release the latter; (3) by the substitution of a new creditor in the place of the old one, with intent to transfer the rights of the latter to the former.  See, State ex rel. Commissioners of Land Office v. Pitts, et al., 173 P.2d 923, 925, 197 Okla. 644, 1946 OK 303 (Okl.1946).

To meet the test of a novation there must be a mutual agreement among three parties the creditor, his immediate debtor and the intended new debtor by which liability is accepted in the place of the original debtor in discharge of the original debt. See, Poteau State Bank v. Denwalt, et al., 597 P.2d 756, 761, 1979 OK 201 (Okl.1981).

The requisites of a novation are: (1) the existence of an obligation; (2) commitment of obligor and obligee to a new, valid contract; and (3) mutual assent to extinguishment of original obligation.  Tulsa Ice Co. v. Tiley, 157 Okl. 86, 10 P.2d 1090 (1932); American Bank of Commerce v. Boger-Hare Mfg. Co., et al., 633 P.2d 1270, 1272, 1981 OK CIV APP 55.

Here, no novation could have occurred.  First, under Pitts, supra, there was no (1) substitution of a new obligation between the same parties, with intent to extinguish the old obligations (there was a Renewed Revolving Loan without extinguishment); (2) by the substitution of a new debtor in the place of the old one, with intent to release the latter (no release of LP was contemplated in the Renewed Revolving Loan); or (3) by the substitution of a new creditor in the place of the old one, with intent to transfer the rights of the latter to the former (again, this was a Renewed Revolving Loan).

Similarly, under Denwalt, there was no mutual agreement among three parties: the creditor, his immediate debtor and the intended new debtor by which liability was accepted in the place of the original debtor in discharge of the original debt.  See, also, Tulsa Ice and Boger-Hare and the lack of mutual assent to the extinguishment of the original obligation.

Overall, the reporting requirements for gamblers are quite easy. The gambler must report all his gambling winnings as “other income” on the first page of his IRS Form 1040. This includes winnings reported on IRS Form W-2G’s ($1,200 or more for slot machines) as well as any other amounts from any other gambling activities. Then, the gambler must separately report his gambling losses (not to exceed the amount won) on Schedule A. So for example, if a taxpayer over the course of a year won $8,000 in jackpots but spent $10,000 on lottery tickets, pull-tabs, playing blackjack and the slot machines, the taxpayer could only deduct $8,000 of his losses – just enough to offset the amount of his winnings. (Please refer to Internal Revenue Code Section 165(d) which states that “Losses from wagering transactions shall be allowed only to the extent of the gains from such transactions.”)

This separation of winnings and losses can have a serious side effect – the Gambler’s AGI Penalty. If a gambler has gambling winnings equal to the amount of his gambling losses, it will not affect his “Taxable Income.” However, it will inflate the gambler’s “Adjusted Gross Income” (commonly abbreviated AGI) which is frequently used as a multiplier and/or phase-out index for certain deductions, credits and exclusions. Some of the more common items include:

• Social Security
• IRA contributions
• Medical expense
• Mortgage interest
• Charitable contributions
• Casualty losses
• Miscellaneous deductions subject to the 2% limitation
• Child tax credit
• Earned income credit
• Adoption credit

Naïve, lazy or dishonest taxpayers will frequently try to cut corners and “net” together their wins and losses to avoid the Gambler’s AGI Penalty. Unfortunately, such action can easily trigger an audit when the IRS computers cannot match winnings reported by the casinos with a corresponding amount on the taxpayer’s return. And don’t think it won’t happen. The US Tax Court has numerous reported cases where the only change made, at the insistence of the IRS, was the “un-netting” of a gambler’s wins and losses. So what is a taxpayer to do?

Over the years, the Courts, IRS and tax professionals have developed the concept of a “Gambling Session.” Early on, the Courts recognized that it was impractical and onerous to even attempt to record every roll of the dice, spin of the wheel, draw of a card or pull of the handle. Essentially, a gambler is allowed to group a together a series of gambling activities when they can be identified by a specific action or activity and discrete, isolated time periods and/or locations.

So, if a gambler plays at one casino in the morning and another casino in the afternoon, then he has at least 2 gambling sessions. If a gambler starts off playing slot machines and then switches to blackjack, then he has at least 2 gambling sessions. But if a gambler enters a poker tournament, the tournament counts as just one session. And, every horse or dog race at a track is a separate gambling session.

In IRS Revenue Procedure 77-29, the IRS describes the information that should be recorded for each gambling session and type of wager. Furthermore, the IRS strongly recommends that a gambler contemporaneously use a “gambling diary” to record the required information. Yet, even after more than thirty years, gamblers are still reluctant to implement such record-keeping efforts.

Instead of relying upon Revenue Procedure 77-29, many gamblers choose to rely on bad advice, urban legends and just wrong information. Many people (gamblers and tax professionals alike) are under the mistaken impression that casino win/loss statements and player’s card reports will suffice. Nothing could be farther from the truth! The IRS has consistently and regularly rejected the use and reliance upon such information. The primary reason for the IRS belligerence is simply because the casinos explicitly state in their reports that the reports are inherently inaccurate and should not be used for accounting purposes.

In multiple court decisions, the judges frequently cry out for a gambling diary. The courts have relied upon all manner of evidence including napkins, calendars and other scraps of paper in an effort to recreate some type of a gambling diary in order to document a gambler’s losses. (In doing so, the court’s frequently rely upon Judge Learned Hand’s 1930 case of George M. Cohan v. Commissioner of Internal Revenue. Mr. Cohan was a Broadway producer and had very few records detailing the production costs of his plays.)

Most people are unaware of the hidden “sin tax” caused by the Gambler’s AGI Penalty. And the best bet (pun intended) is for the gambler to record their gambling sessions in a gambling diary. Don’t forget, prove it or lose it!

An expanded version of this article was published in the April 2011 edition of The Tulsa Lawyer, The Official Publication for the Tulsa County Bar Association, Inc. A PDF reprint of this article is available here.

TOP OF PAGE

1. REPRESENTING CLIENTS BEFORE IRS

Preparation is essential to successfully representing your client during audit.

Generally, any attorney or CPA may represent clients before the IRS.

Accountants who are not CPA’s may apply to the IRS for “enrolled” status which also enables them to practice before the IRS.

2. ESTABLISHING REPRESENTATION

A. A prospective client can be quite upset that the IRS intends to conduct an audit and looks to a professional such as you who can defend his interests. To many taxpayers, the IRS is feared rather than respected, and the client will often need the assurance that should come from a professional. Your goal during the initial contact should be to gain the taxpayer’s confidence and to make an appointment as quickly as possible for an initial interview prior to the audit. Frankly it is generally not that big of a deal and most likely to work out much better for the taxpayer than they think otherwise.

B. Initial Interview. Many tax controversies are better resolved sooner rather than later. Accordingly, it is often to your client’s advantage for you to begin work on the case promptly. Your first goal should be to accurately gather the necessary information. You must control this information gathering process. Otherwise, the client will often inundate you with reams of useless information while neglecting to hand over truly important documents. The initial interview with the client is an important step in your preparation for audit.

C. What Client Should Provide Prior to Interview. You should ask the client to provide the following items before your interview:

All correspondence, notices, reports, etc. from the IRS;
Tax returns for the relevant years;
All correspondence, etc., from taxpayer or previous representatives to the IRS; and
Issue related documentation such as receipts, books and records.

Examining correspondence from the IRS may enable you to spot the important issues facing your client. You should determine whether the matter is in audit, appeals or collection. One of the most significant pieces of information on some IRS correspondence is the name and telephone number of the IRS employee handling the file. It is always preferable to deal with a human as opposed to the error prone IRS Service Center. IRS correspondence can also alert you to important time deadlines such as a 30-day letter, 90 day letter or a Notice of Intent To Levy. Tax returns are, of course, absolutely necessary in most cases. Reviewing prior correspondence to the IRS can avoid nasty surprises such as unknown concessions, admissions or stipulations by the taxpayer. Prior correspondence is frequently useful in persuading the IRS to abate some penalties. Finally, you must ask for specific documents which relate to the taxpayer’s audit issues. For example, if the issue is substantiation of Schedule C expenses, ask the client for receipts or contempora neous records of expenses.

Many tax controversies have been won or lost depending upon the documents uncovered by a taxpayer’s representative.

D. What You Should Discuss with your Client. While the client is likely to complain about the IRS during your interview, other items for discussion might not come up unless you initiate the topic. These issues include:

Scope of representation;
The merits of your client’s position;
Fees for your services;
Power of Attorney or Declaration of Representative;
Additional documents you should obtain;
Document retention and destruction systems; and,
Contact between your client and the IRS.

E. Scope of Representation. You should agree with the client precisely what services you will provide. You should specify the type of tax or penalty involved and the tax year involved. Make it clear that you are not yet representing the client in other tax matters.

F. Merits of Your Client’s Position. Rule No. 1: Be honest with your clients! They already think that they are in trouble. Don’t compound their disappointment by giving them false hope of success. The client will appreciate an honest (and accurate) appraisal. Rule No. 2: Don’t be rushed! If the situation will require some research and thought before you can give an appraisal, tell them so! Admitting that you are uncertain doesn’t demonstrate weakness but is actually the mark of a professional.

G. Fees for Your Services. You must initiate the matter of fees. Most clients will be relieved if you broach the subject first. The client has the right to know the basis of your fees before you begin work. Several options are available:

Hourly rates for work done, plus disbursements;
Fixed prices for standard services; and
Minimum and maximum fees.

Hourly rates are most commonly used. You can adjust the hourly billing rate to reflect the expertise of the personnel performing the work. Hourly billing also protects you from grossly underestimating the amount of time a matter will take to resolve. If you agree to a fixed price, you may end up losing money on a case which takes longer than expected. Clients, however, often prefer a fixed price.

Suggestion: Give the client a “ball park” estimate of your fees and get this amount as a retainer but charge your time on an hourly basis.

H. Power of Attorney or Declaration of Representative. At the initial interview, you should get the client to sign a Power of Attorney or Declaration of Representative (Form 2848). The Power of Attorney allows you to contact the IRS on the taxpayer’s behalf. When received, the IRS enters the Power of Attorney into its nationwide computer system. IRS personnel are instructed not to talk to you about a client unless a Power of Attorney is on file. We generally fax the signed Power of Attorney to the Internal Revenue Service at 1-801-620-4249.

Suggestion: To avoid delays, always send a copy of the Power of Attorney to the IRS employee before your first contact with that person. Otherwise, the Power of Attorney may not have been entered into the computer system properly and you may be delayed.

I. Additional Documents You Should Obtain. One advantage of reviewing the client’s documents prior to your interview is that it enables you to locate any gaps in the records. For example, if the client produces a shoebox full of receipts for Schedule A itemized deductions but no mortgage interest statement is found, you will be able to ask your client to obtain one from his bank. Similarly, W 2′s and other information statements can be obtained from the employer. Audit reports, Revenue Agent Reports, Tax Returns, Information Document Requests and Notices of Deficiency can be obtained from the IRS Agent, employee or Service Center if the taxpayer failed to keep copies. All of these documents can contain vital information which you should examine thoroughly.

J. Document Retention and Destruction Systems. Most taxpayers destroy tax documents after a few years. Larger corporations establish document retention and destruction systems to regulate this process. Whether or not your client has such a system, you should sternly advise your client to immediately recover and retain any documents which might be even remotely relevant. It is your professional duty at an early stage to ensure that the client retains all potentially relevant documents.

K. Contact Between Your Client and IRS. Often the IRS will attempt to get information from your client even after a Power of Attorney is filed. This is improper and may damage your client’s case severely. Advise your client to simply refer the IRS to you and to volunteer nothing. You should decide if and when the IRS can interview your client. Under the Taxpayers Bill of Rights, the taxpayer need not appear unless a summons is issued. If an IRS employee continues to contact your client directly, call his manager to report the improper conduct.

3. CONTACTING IRS

A. Requesting Documents From IRS. The IRS possesses numerous documents which might be useful to your client. Your client might have been audited in prior years, or you may have been hired after the audit is already underway. Documents which you should obtain include:

• Tax returns or refund claims;
• The Initial Notice of Audit;
• Information Document Requests (IDRs) or Administrative Summonses;
• Notices of Proposed Adjustments;
• Agent workpapers;
• Audit letters, Audit Reports or Revenue Agents Reports (30 day letter);
• Notices of Deficiency (90 day letter);
• Tax Court petitions, documents or decisions; and
• Tax account information.

B. Administrative File. If your case is in Audit, Appeals or Tax Court, the Agent will usually have most of these documents, if they exist, in the administrative file. You can ask the Agent for copies of these documents, which will usually be provided. If the Agent withholds a critical document such as a tax return, speak to his manager and emphasize the importance of the document to your preparation of the client’s records for audit.

C. Service Center. You can also formally request relevant documents from the Service Center where the taxpayer filed his returns. This should be done as soon as possible since it may take months for the Service Center to copy the documents. For certain types of requests, the IRS has adopted specific formats.

D. Tax Returns or Refund Claims. Obviously, these are necessary documents in most tax controversies. Taxpayers have sometimes lost their copy or have kept only an unsigned draft copy. If at all possible, you should obtain a signed copy with the IRS date stamp indicating “FILED.” This date stamp is necessary in order to determine when the statute of limitations expires and whether certain penalties are appropriate.

E. Initial Notice of Audit. The initial audit correspondence between the IRS and your client might be useful in determining the goal of the audit. For example, a computer generated letter from the Service Center document matching program usually results in a single issue mail audit. A letter personally signed by a Revenue Officer or an Agent from the Criminal Investigation Division is a much more serious matter. The initial letter might also disclose whether this is a DIF audit or a full-blown, no holds barred TCMP audit.

F. IDRs or Administrative Summons. When an Agent wants specific information about the taxpayer, it can be to your advantage to request an IDR (Internal Revenue Service Document Request). The IDR will specify the information the Agent seeks and might alert you to the issues being investigated. The advantage of requesting an IDR is that you control the flow of information to the Agent. If you do not respond to an IDR, the Agent may have an Administrative Summons issued. Under most circumstances, you must comply with a summons.

G. Notice of Proposed Adjustment. When the Agent has made a tentative decision on an issue, he may issue a notice of proposed adjustment. An Agent is usually willing to change his mind on these notices if you provide an alternative in a timely fashion.

H. Agent Workpapers. If a prior audit took place, the Agent’s workpapers will allow you to see the positions and goals of the IRS. Contrary to popular opinion, these papers are often obtainable, either after audit or in the Tax Court.

I. Audit Letters, Audit Reports and Revenue Agents’ Reports (RARs). When the Agent has reached a definite conclusion, an audit report is issued. Depending upon the case, the client may receive anything from a simple letter to a very large RAR with numerous exhibits. These documents are also referred to as “30 day letters” since they grant the client 30 days in which to appeal the findings to the IRS Appeals Division.

J. Notices of Deficiency. If you do not appeal the 30 day letter, or if the appeal is unsuccessful, the IRS will issue a Notice of Deficiency. The Notice is also known as the 90 day letter, since it grants the client 90 days (150 days for taxpayers abroad) to file a petition in the Tax Court.5 Otherwise, the IRS will assess the tax at the end of 90 days and will attempt collection. The 90 day letter contains a description of the issues, but is not usually as complete as the RAR. You cannot file a Tax Court petition without attaching a Notice of Deficiency.

K. Tax Court Documents. These include petitions, briefs, stipulations and decisions. If your client has been involved in prior Tax Court litigation on the same or similar issues, you should obtain these documents from the Tax Court. You might also consider requesting documents from other Tax Court cases involving the same issues. They could alert you to the government’s strategy and provide other useful information.

L. Tax Account Information. In order to determine what taxes the client has paid and what taxes, interest or penalties are due, you need tax account information. The Agent should be able to provide you with a copy for the relevant years. Sometimes checks are posted to the wrong accounts or in the wrong amounts. The tax account can help locate those errors. If you cannot obtain the information from an Agent, write a letter to the appropriate Service Center.

M. Oral or Written Communications. Generally, frequent oral communication with the IRS employee handling the case is recommended. You will have many opportunities to get acquainted with the Agent and to understand the audit objectives. You can answer some questions or provide information quickly and informally. Many issues can be disposed of informally in this manner. Some issues will be incapable of oral settlement. In these cases the Agent may require documents to be provided. A cover letter should be sent with the documents, with a copy kept in your files. That way, you know exactly what information has been provided to the IRS.

Suggestion: You cannot rely in a court on the oral statements of an IRS employee. Advice by the IRS is binding only if it is in writing and certain other requirements are met. Nevertheless, most IRS Agents will uphold any oral agreements which they personally have made.

N. Finding Out What They Really Want. One primary goal of your pre-audit investigation is to find out what the IRS is looking for. This will help you prepare more effectively and will save your time and your client’s money. If the case is a simple one, a single issue mail audit, for example, you don’t need to prepare for a full blown audit. Conversely, you don’t want to be under prepared and surprised when the Agent arrives.

4. PREPARING FOR AUDIT INTERVIEW

A. Even though you have identified likely audit issues and have assembled the relevant records, you are not yet ready for the audit. Before the audit begins you should:

• Prepare document summaries;
• Examine the statute of limitations;
• Research the applicable law;
• Evaluation of the client’s position; and
• Discuss settlement with the client.

B. Prepare Document Summaries If the case involves a large number of documents, it is often advantageous to prepare summaries. For example, you can transform the proverbial shoebox of receipts into a legible schedule of itemized expenses. These summaries often help you to understand the strengths and weaknesses of your client’s case. In certain circumstances, you might want to provide these summaries to the IRS.

Suggestion: Be very careful about providing summaries to the IRS. You don’t want to provide a road map for the Agent’s audit. On the other hand, a well done summary could secure an early victory.

C. Examine Statute of Limitations. Generally, the IRS cannot assess a tax after three years have elapsed from the later of the due date of the return or the date the return was actually filed. Absent fraud, failure to file, substantial omissions or other similar circumstances, the IRS cannot assess tax after the three year statute of limitations has expired. The taxpayer can also agree to extend the period.

If the statute of limitations has expired, inform the Agent and in most cases the audit will be over once the fact is confirmed. If the statute is expiring soon, you are under no obligation to warn the Agent. If the Agent discovers the problem, he will request an extension of the statute of limitations.

D. Research Applicable Law. Once you have identified the likely audit issues, you can research the law. The Internal Revenue Code and Regulations are always good places to start, followed by one or more of the tax services (Mertens, CCH, RIA, or BNA Portfolios). Articles in various tax magazines might also prove useful. These sources can be used to identify leading cases and IRS pronouncements which discuss your issues.

5. REPRESENTATION DURING AUDIT

A. Evaluate Client’s Case. Weighing all the possibilities, what are the client’s chances of success? This evaluative skill comes mainly with experience, but there are some steps which can aid in the process:

• Determine dollar values for each issue in the case;
• Determine a percentage chance of success on each issue;
• Consider the costs and risks of contesting each issue; and
• Consider which issues the IRS is likely to concede.

With these considerations in mind, you can come to a reasoned judgment as to the probability of success on each issue facing your client and your client can determine whether the issue is worth fighting, given the costs and risks involved.

B. Discuss Settlement Possibilities With Client. You should discuss the probabilities of success on each issue with your client so that he will be inclined to settle certain issues if the need arises. Once you have settlement authority on an issue, you can negotiate appropriately with the IRS.

6. THE AUDIT

A. The Agent will schedule a time and a place for the audit. If the time or place is inconvenient, or if your preparations are incomplete, try to reschedule as soon as possible. The Agent will usually accommodate a reasonable request.

B. Should Taxpayer Be at Audit? Generally, no. The taxpayer is quite likely to volunteer additional information that you may or may not want to disclose. The Taxpayer Bill of Rights generally allows a taxpayer to send a representative to an audit in his place. If the IRS issues an Administrative Summons, the taxpayer must appear. In some situations, you may want to make your client available to the IRS to answer some questions.

C. Your Role in Audit. Your goal is to get your client through the audit process with the least possible cost. Any legitimate means to achieve that end should be considered. Your role is to coordinate the audit and to provide the necessary information to the Agent to achieve that goal. Your conduct during the audit is more a matter of personal style, some prefer a laid back approach, passively responding to the Agents’ questions. Others prefer an aggressive approach, persuasively arguing with the Agent the merits of your client’s position. The details hardly matter, as long as you choose a style which is natural and effective for you.

D. Establishing Trust and Competence. If the Agent trusts your integrity and believes you to be competent in your knowledge of taxes, then he is more likely to settle issues in the case in a mutually satisfactory manner. Facts should be carefully and honestly stated. Misrepresentations will earn the wrath of the Agent, a very dangerous proposition! Competence can be demonstrated by appropriate discussions of the legal and accounting requirements of the tax laws. Your goal is not to impress the Agent, but rather to establish yourself as a peer, a competent, honest tax professional.

E. Identification of Audit Issues. The Agent will often identify the audit issues. You should generally allow the Agent to identify the issues. Otherwise, you might unwittingly disclose a new issue to the Agent. The only exception to this rule is when you are aware of an issue which will entitle your client to a refund. In that case you must highlight this issue as a bargaining chip during the negotiation process.

F. Audit Plans. This is an excellent time to establish your control over the process. First, you should not allow the IRS to have direct access to a copying machine. Rather, they should give those documents to a designated person who will make two copies, one for you and one for the IRS. Second, you should agree upon the proper contact person from which the Agent may receive information. No other person should discuss the case with the Agent. The designated contact person should either be yourself or an employee or officer of the client who is sufficiently knowledgeable as to the tax issues involved and intelligent enough not to volunteer damaging information to the IRS. Preferably, any substantial questions and answers should be submitted in writing. Third, the IRS is often willing to establish a time limit for the audit, which can be a tremendous help to your client. Of course, other items may be included within an audit plan. The specifics are dictated by the nature of your client’s case.

G. Assistance In Fighting IRS. Some cases are so complex that experts need to be retained during the audit. For example, actuaries are often called in to examine the adequacy of insurance reserves during audits. Other issues which may require experts include valuation, depreciation, “ordinary and necessary” expenses, and legal terms derived from business practice. Experts are more commonly retained at the litigation stage, but in some cases an expert’s opinion during audit could settle an important issue.

H. Referral to Another Professional. At some point, you might need to refer the case to a law firm with specialists in tax litigation. Either way you should place your client’s interest above your own short term success. Understanding your limits and referring cases in appropriate situations will only enhance your professional reputation.

7. SETTLEMENT OF AUDIT ISSUES

A. You should attempt to settle audit issues whether or not you believe the settlement will succeed. Basis for settlements at audit include factual and legal disputes. The Agent is not authorized to settle audit issues based upon collectability and hazards of litigation. However, this rule is not strictly followed by IRS agents and their supervisors.

B. Initiating Settlement Discussions. Generally, you must initiate settlement discussions. IRS employees will usually wait for you to bring up the subject.

C. Settlement Methods. The actual method of settlement can vary. The simplest is issue trading: The IRS concedes one issue while you concede another. The IRS often concedes penalties in this manner. When a multiple year audit is being conducted, sometimes the same issue can be settled differently in separate years.

D. Settlement Offers. Once you or the IRS have mentioned a settlement offer, you have established a settlement range. Try to get the IRS Agent to make a settlement offer first, that way, you won’t offer less than the IRS is willing to accept.

E. Agreed and Partially Agreed Cases. On the RAR, the Agent will denote whether the taxpayer agreed, disagreed or partially agreed with the proposed adjustment. These notations should reflect whatever settlement you have negotiated on behalf of your client. It is important to realize that issues conceded by the IRS are often dropped forever while the taxpayer can contest continuing audit issues at a later date such as in Tax Court.

Suggestion: On an issue which you might want to litigate before the Tax Court, you might “agree to disagree” with the Agent. Allow the Agent to write up the issue, attempt to extract concessions on other issues, but prepare the issue for Tax Court. Experienced Agents are familiar with this process and should cooperate.

F. Closing Agreements. Any settlement of an audit issue does not legally bind either the taxpayer or the IRS unless a closing agreement is signed. Both the IRS and the taxpayer can raise “settled” issues in Tax Court and in refund suits. In most cases, however, the IRS does not do so. Nevertheless, the only sure way of foreclosing the possibility is a closing agreement. Closing agreements may be made on either Form 866, Form 906, or other closing agreement. The procedure is cumbersome and time consuming, but may be appropriate in certain cases. Absent fraud or misrepresentation of a material fact, closing agreements are absolutely binding upon both the IRS and the taxpayer.

Suggestion: An alternative to a closing agreement is to pay the tax shown on the RAR, wait almost two years (the length of the statute of limitations for refund) and then file a refund claim on the appropriate form. The statute of limitations for the IRS to assess new taxes would have expired, and yet the taxpayer is still able to file for a refund of the taxes paid on the issues he conceded. The refund will be limited in most cases to the amount of taxes paid within the last two years. If the IRS fails to allow the refund claim, a refund suit must be filed by an attorney in a federal district court or the United States Claims Court. If this procedure is followed, the taxpayer should not be liable for additional taxes for that year, claiming most of the advantages of a closing agreement with none of its disadvantages.

G. Group Manager’s Conference. After the Agent has made his final decision regarding an issue or the entire audit, you may request a conference with the Manager of his audit group. You may use this forum to appeal some of the adjustments which you feel are unfair. Be prepared to present detailed facts as to why the Group Manager should alter the Agent’s adjustments.

H. Revenue Agent’s Report (RAR). The RAR is the final report of an Agent after the audit. The length and detail of the RAR varies with the complexity of the case and the skills of the Agent. The RAR is also known as the “30 day letter” because you can appeal the findings to the Appeals Division of the IRS within 30 days after the issuance of the letter. In almost every case, an appeal would benefit your client. The Appeals Division rarely increases the taxes owed but in many cases reduces the adjustments made by the RAR. Furthermore, an appeal is necessary if you wish to file for professional fees from the IRS.

8. EXTENDING AND SUSPENDING STATUTE OF LIMITATIONS

A. The IRS will sometimes ask you to sign a Form 872 or Form 872 A to extend or waive the statute of limitations for assessment of tax. You should not grant this request without careful consideration.

B. Extensions v. Waivers. An extension of the statute of limitations sets a fixed time limit within which the IRS must either: (a) issue a notice of deficiency; (b) decide not to assess tax; or (c) negotiate a new extension. Form 872 is used to extend the statute of limitations. Special versions of Form 872 have been designed for partnerships, S corporations and certain excise taxes.

C. Waivers (Form 872 A). A waiver of the statute of limitations is much broader. Form 872 A is usually the form used for waiver. A waiver is effective until the taxpayer gives the IRS proper, notice on Form 872 T or another appropriate form that the taxpayer is revoking the waiver. The issuance of a 90 day letter by the IRS also acts as a termination.

D. Extensions (Form 872). Practitioners generally prefer an extension on Form 872 rather than 872 A because it puts the IRS on a definite schedule which requires them to act relatively promptly. In some cases where a Form 872 A is signed, the audit is still going on (and the statute is still open) 12 years later!

Suggestion: If your client has signed a Form 872 A and the IRS is unreasonably delaying the process, issue a Form 872 T. This tactic has also been utilized when it appeared that the Agent had shifted the examination to issues of fraud.

E. When To Extend Statute of Limitations. The statute of limitations should be extended only when it is to your advantage to give the IRS extra time to audit your client. Form 872s are routinely signed by taxpayers when it is really not in their best interest to do so. Remember that you are doing the IRS a favor by extending the statute, so be sure that you are getting something valuable in return. One often cited benefit of extending the statute of limitations is that the IRS won’t be forced to issue a hasty notice of deficiency which might be more detrimental than a carefully negotiated RAR. On the other hand, with more time the Agent might uncover new issues which damage your client.

F. When Not To Extend Statute of Limitations. If the IRS has failed to discover potentially damaging issues, or if the IRS has not been diligent in its audit, you should seriously consider refusing to extend the statute of limitations. The Agent will issue a notice of deficiency but you can contest that finding before the Appeals Division and the Tax Court. If you plan not to extend the statute of limitations, let the Agent know as soon as possible so that he cannot claim to have been misled. You will also get a fairer RAR in the process.

G. Calculating Beginning of Statute of Limitations Period. The statute of limitations for assessment begins on the later of:

1. (1) the due date of the return; or
2. (2) the date the return was actually filed.

The due date of the return is the statuting due date, without regard to extensions of time to file. The best evidence of the date the return was actually filed is the date the IRS stamps “FILED” on the original return. You will find the original return in the Agent’s administrative file.

H. Length of Period. The statute of limitations for assessment is three years. The three years is calculated exclusive of the starting date and inclusive of the ending date. Thus, if a 1988 return was filed on April 15, 1989, the period would run from April 16, 1989 to April 15, 1992. Assessments for tax year 1988 made on or after April 16, 1992 would be invalid.

I. What Happens Once Period Has Run? If the statute of limitations for assessment has been completed and the IRS has not assessed any tax against your client, the IRS legally cannot attempt to collect the tax.

J. Exceptions. Several exceptions to this rule should be noted. First, some events temporarily suspend the statute of limitations, such as the issuance of a Notice of Deficiency, bankruptcy proceedings, or if the taxpayer is out of the country for an extended period. Second, the taxpayer could have agreed to suspend or modify the statute of limitations. Third, a longer statute applies if the taxpayer understated 25% or more of his gross income. Fourth, no statute of limitations applies to fraudulent returns, willful attempts to evade tax or failure to file returns. Finally, some penalties do not need to be assessed, typically penalties for failure to file information returns.

K. Discovering Assessment Date. The assessment date is found on Form 4340, Certificate of Assessments and Payments, which you should request from the Agent if you want to find out the taxes your client has paid or if you want to see if and when the IRS has assessed taxes.

9. PRESERVING AUDIT RECORDS FOR APPEAL OR LITIGATION

A. Retain Relevant Documents. You must act as soon as you are aware of a client’s tax controversy to retain relevant documents and to prevent their destruction. Innumerable tax cases have been needlessly lost at the audit, appeals or Tax Court stages due to inadequate retention of critical documents.

Suggestion: If you are in doubt as to the usefulness of retaining some documents, err on the safe side and keep the documents.

B. Privileged Documents. Some documents do not need to be turned over to the IRS. These documents are referred to as privileged documents. Examples of privileged documents include confidential communications between an attorney or an accountant and his client, such as a letter from an attorney to the client which outlined potential tax problems which might face the client. You would want to withhold this document. Not all such communication is privileged, however. If the document has been disclosed to outsiders, the privilege is usually waived. The books and records of a taxpayer are always subject to IRS discovery, even if prepared by an accountant.

C. Confidential Documents. Confidential documents contain trade secrets, business plans and the like. You must turn these over to the IRS if requested to do so, although you can ask for the copies to be returned in order to protect your client’s secrets. Generally, the IRS is very good about not revealing confidential documents to outsiders.

D. Nonresponsive Documents. When the IRS requests certain documents, the taxpayer could give the Agent access to all files and let the Agent find it himself. This is usually a terrible idea because while Agents are fishing through the files they often discover other audit issues as well. The proper alternative is for you to go through the files and to collect all documents which respond to the Agent’s request. All other documents (non responsive documents) are left in the files. The Agent is provided with only the responsive documents. When you are determining whether a particular document is responsive or not, it is your duty to interpret the Agent’s request fairly and consistently. Remember that the Agent can later expand the request. If it later is discovered that you withheld a requested document, then you have lost the confidence of the Agent and may face other serious consequences.

10. ANCILLARY CONCERNS

A. Aides and Abets Statute. IRC ‘ 7206(2) imposes criminal penalties for “any person who willfully aids or assists in, or procures, counsels, or advises the preparation or presentation under, or in connection with any matter assessing under, the internal revenue laws, of a return . . . which is fraudulent or is false as to any material matter.

B. Conspiracy Statute. 18 USC ‘ 371 imposes a maximum fine of $250,000 and imprisonment of up to five years where “. . . two or more persons conspire either to commit any offense against the U.S., or to defraud the U.S. . . ..” The government, in addition to the above statute, may convict a defendant for conspiracy to violate both IRC ” 7201 and 7206.

11. METHODS FOR PROTECTING YOURSELF AS PRACTITIONER

A. Unethical Clients. As a tax practitioner, you will find that not all of your clients areas honest and as ethical as you. Unfortunately, many clients try to cheat on their tax returns either convincingly or unconvincingly. As a practitioner, you must constantly be alert to the client who attempts to cheat during the preparation process and during the audit process. To make matters worse, if the client should be caught in a fraud, he may blame his preparer and/or tax practitioner for his misconduct.

B. Criminal Cases. Many fraud cases develop from routine examinations. An Agent and/or Auditor will note an extreme discrepancy during the audit process and prepare a referral to the Criminal Investigation Division. Should you determine that the Criminal Investigation Division has begun an investigation, cease all cooperation with the Internal Revenue Service. If you are not an attorney, secure the services of a competent criminal tax attorney immediately for your client. If you assisted the taxpayer in the preparation of the allegedly fraudulent return, you should immediately distance yourself from the client. If you believe that you may have committed a crime during that process, secure your own attorney.

C. Blame the Accountant Syndrome. One of the best defenses that a criminal tax attorney can make on behalf of his client charged with a criminal tax offense is to blame the accountant. It could take the guise of the statement “The accountant must have made a mistake.” Or it could take the more direct approach of “My accountant prepared the return wrong.” Practitioners should be aware it is the attorney’s job to defend the criminal defendant, not to protect the tax preparer. If it suits the purpose of the attorney and the client to blame the accountant for errors and omissions on the return, the attorney will certainly use that tactic. In such event, the practitioner should secure his own attorney to protect his interests.

12. PRACTITIONER’S ROLE AND ETHICAL CONCERNS

A. Disclosure of Taxpayer Information by Income Tax Return Preparer.  IRC Section 7216 prohibits the disclosure of return information by the preparer of the return without the taxpayer’s consent. This section applies to any person who, for compensation, aids another in the preparation of a return of tax imposed by Chapter 1 of the Internal Revenue Code. If that person knowingly or recklessly discloses or uses for any other purpose information furnished her in connection with the preparation of that return, that person may be prosecuted for a misdemeanor. Conviction under this section could result in a $1000 fine, a one year prison term or both.

B. Under the Regulations, you receive no compensation for preparation of the return. If, in the course of your business, you hold yourself out as a preparer of tax returns (whether that is your sole or principal business activity), you may be subject to this section regardless of whether you receive a fee for such Services. Additionally, you may be subject to this penalty even if you are not in the business of return preparation and don’t hold yourself out as such. Helping a friend, relative or acquaintance prepare a return on a casual basis may make you a preparer within the meaning of this section if you receive some sort of compensation for your services.

C. Consent for Release of Information. In order to avoid prosecution under this section a preparer must obtain a written consent from the taxpayer allowing her to disclose specified return information. Under the regulations, such written consent must contain the following in order to be effective:

• The name of the return preparer;
• The name of the taxpayer;
• The purpose of the consent;
• The date on which the consent is signed;
• A statement that disclosure can be made only for the purposes specified; and
• A statement by the taxpayer that he or she consents to the disclosure for the purposes specified.
• There are limited circumstances where a written consent is not necessary in order to make a legal disclosure. For example, disclosure pursuant to other provisions of the Internal Revenue Code is appropriate even without taxpayer consent. Also, consent is not necessary for disclosures made to a taxpayer’s fiduciary. For further instances where consent is not necessary, see Treasury Regulation ‘ 301.7216 2.

13. IRS’ POWER TO EXAMINE TAXPAYER DOCUMENTS

A. The IRS has incredibly broad powers to demand information from taxpayers. One of their most powerful weapons is the administrative summons. It is called an “administrative” summons because it is issued by an employee of the IRS rather than by a judge. This chapter will discuss how to defend against an administrative summons.

B. Informal Requests. During an audit, the Agent may ask to examine various documents, books and records. These first requests may be quite informal. The Agent may not specify the exact records but may ask for something like “all of your substantiation for these deductions.”

Suggestion: You have no obligation to respond to an informal IRS request for information. However, it is often in your client’s best interest to do so, as it may prevent the issuance of a broader administrative summons.

C. Information Document Requests (IDRs). When a taxpayer requests a written description of documents sought by the IRS, the Agent will often provide an Information Document Request. An IDR is a written, informal request for documents. Responding to an IDR is still voluntary. However, if you refuse, you are likely to anger the Agent and will probably receive an Administrative Summons.

Suggestion: If you want the Agent to ask for documents in writing, but want to avoid a summons, ask for an IDR.

D. Administrative Summons. An Administrative Summons is an official demand by the IRS that the taxpayers appear and produce certain documents. The scope of the summons may include any and all books, records and other data and may require testimony under oath on any relevant matter. The purpose of the summons may be any of the following:

• To ascertain a tax liability;
• To prepare a return where none was filed;
• To determine transferee or fiduciary liability;
• To determine the correctness of a filed return; or
• To collect any tax liability.

E. Summonses in Criminal Cases. Once the IRS has recommended a criminal prosecution or grand jury investigation (a “criminal referral” or “Justice Department referral”), no summons may be issued or enforced under the Internal Revenue Code for that tax year. However, if a Justice Department referral is made for a tax imposed under one chapter of the Internal Revenue Code (such as the FICA Social Security tax), a summons may still be issued or enforced for a tax under a different chapter (such as income taxes) or a different year. In addition, a summons is sometimes used when the investigation has turned criminal, but prior to a formal Justice Department referral.

Suggestion: The IRS may attempt to gather information with a summons immediately prior to a criminal referral. If you suspect a criminal investigation, have the client retain an attorney and delay any response to the summons until a court requires a response.

F. Service of Summons. A summons must be served in person or left at the taxpayer’s homes. A written certificate of service shall be evidence of service and will be sufficient unless the taxpayer establishes that the service was not made or was improper. Procedural objections to a summons should be made immediately.

G. Enforcement of Summons. The IRS may apply to a federal district court to compel the documents or testimony sought by the summons. Generally, only an attorney may appear on behalf of a taxpayer in district court. The district court will rule on the validity of the summons and can enforce the summons by fine or imprisonment. The IRS must meet four “good faith” requirements in order to enforce the summons:

The investigation is conducted for a legitimate purpose (i.e., it is not based upon racial, religious or other forms of discrimination);
The information sought is relevant;
The IRS does not already have the information; and
The procedural aspects of the summons have been satisfied (proper notice, proper service, etc.).

Suggestion: The client will have at least two opportunities to comply with the summons before any penalties are imposed. First, the government attorney handling the lawsuit will usually send a “last chance” letter prior to the filing of the suit. Second, the court will usually allow the taxpayer to comply before issuing an order or imposing sanctions.

H. Time and Place of Examination. The time and place of the summons must be “reasonable under the circumstances.” Generally, the summons must give at least 10 days’ notice prior to the date of appearance. For a “third party” summons, 23 days of notice must be given.

Suggestion: If the time or place of the summons is inconvenient, ask the IRS Agent to reschedule for a mutually convenient time. Most IRS Agents will agree to this procedure.

I. Fees and Costs. When third party record keepers (such as banks and return preparers) are summoned, they may be reimbursed for all reasonably necessary costs directly incurred in retrieving the information summoned.

J. Discovery Requests (During Tax Court Litigation). Once a petition is filed in Tax Court, the IRS cannot use the administrative summons. If an Agent attempts informal requests or IDR’s, do not respond and inform him that the case is docketed with the Tax Court. Once a petition is filed, the discovery rules of the Tax Court govern the exchange of information between the taxpayer and the IRS.

Suggestion: The discovery rules govern only what must be provided by or to the IRS. You may, of course, volunteer information which you are not required to provide. It is rarely to your advantage to volunteer information unless it is very helpful to your client. This is especially true in criminal cases.

14. STRATEGIES IN RESPONDING TO IRS REQUESTS

A. When To Respond to Informal Requests and IDRs. For the taxpayer, volunteering information to the IRS is likely to be detrimental unless one or more of the following factors are present:

• The IRS can successfully compel the information from you later with a formal summons;
• The sought information helps your client or substantiates the positions taken on her return; or
• The information is harmless but you wish to build goodwill with the IRS agent.

Suggestion: When the discovery of the information is inevitable and harmless, you might as well provide it. You will preserve goodwill and cooperation with the IRS and perhaps the Agent will not request something else.

B. When To Require Administrative Summons. The taxpayer could request that an administrative summons be issued if one or more of the following factors are present:

The information sought is privileged or not subject to discovery and you wish to challenge the request;
Your client does not want to appear too cooperative with the IRS and would prefer to be compelled to respond;
Your client’s expenses in responding will be significant and he desires reimbursement for those expenses; or
The risk of the IRS discovering other issues through an expanded formal request is low.

Suggestion: In order to preserve goodwill with the IRS Agent, explain that the client is willing to be fully cooperative but would prefer to respond under the compulsion of a summons. The IRS cooperates in these requests.

15. THIRD PARTY SUMMONS

A. Examples of Third Party Summons. In many cases the party receiving an informal request, IDR or summons is not the taxpayer being investigated. This is referred to as a “third party” request or summons. An example of a third party summons is a summons directed to the purchaser of property when the seller is being investigated for failure to report the income from the sale. Other examples of third parties which might receive a summons include:

• Banks;
• Savings and loans;
• Consumer reporting agencies;
• Persons extending bank card credit;
• Brokers;
• Attorneys;
• Accountants; and
• Barter exchanges

B. Hazards of Third Party Summons. One typical but unwarranted reaction upon receiving a third party sum mons is relief. The client is pleased that it is not the target of the IRS examination and lets down its guard. However, the third party summons may just be the first step in an examination which will eventually involve the taxpayer. Common cases include the following: Transferee liability; The 100% penalty; Lender liability for employment taxes; Third party liability for employment taxes; Surety liability for federal contractors; Withholding Agent cases; Partnerships; S Corporations; and Tax shelters.

These are just a few of the potential areas in which a third party summons may lead to an audit of your client. You should approach all summons with professional care, whether third party or not.

C. Intervening in Third Party Summons. Once a summons is served on a third party, the taxpayer being investigated has 20 days to sue in the United States District Court to prevent the third party from turning the documents over. Once the third party receives notice of the lawsuit, it is prohibited from turning over the documents until the lawsuit is completed.

Suggestion: You cannot intervene to prevent a third party from voluntarily disclosing information in response to an IDR or informal request. The IRS will often issue third party IDRs in order to collect information without the client’s knowledge. If you are under audit, you may want to ask your third party record keepers to demand a summons so that you may exercise your statutory right to intervene.

16. PRIVILEGED AND CONFIDENTIAL DOCUMENTS

A. Privileged Documents and Communications. Some matters are not subject to discovery, even if they are relevant to the case. These matters are referred to as “privileged.” Examples of privileged documents include letters from an attorney to his client discussing tax issues. Specific examples of privilege are discussed below.

B. Accountant Client Privilege. Essentially, the courts do not recognize an accountant client privilege in tax cases. It might be possible that a person admitted to practice before the IRS is the equivalent of an “attorney” for Tax Court purposes and should be afforded the protection of the attorney client privilege.

C. Attorney Client Privilege. Confidential communications between an attorney and a client may be protected from disclosure. The privilege must be claimed by the client and the communication must not be disclosed to outside parties. The purpose of the privilege is to encourage and protect open and frank dialogue between an attorney and the client.

D. Work Product Doctrine. Documents prepared in anticipation of litigation are not discoverable as a matter of right but require a showing of particular need. Protected documents would include memoranda outlining litigation strategy, notes from counsel, your opinions as to the case, etc. Work product should be protected whether or not it is actually prepared by an attorney. For example, a private report prepared by an accountant or expert solely for the attorney’s use in preparing for trial should not be discoverable. The privilege should be raised in this situation.

E. Fifth Amendment. A final privilege is the Fifth Amendment right against self-incrimination, which can be successfully asserted in some circumstances. An attorney should be retained in any case in which the Fifth Amendment might be involved.

F. Expert’s Reports. The Tax Court Rules require that any expert expected to testify at trial must prepare a report summarizing her testimony. That report must be provided to opposing counsel not later than 15 days prior to trial. If the report is not provided, the Tax Court might not allow the witness to testify at trial.

G. Protecting Privileged or Confidential Documents. Privileged or confidential documents must be protected or else privilege will be waived by the taxpayer. Once waived, a privilege can never be regained.

H. Asserting Privilege. The client may challenge a summons at an enforcement hearing on the basis of privilege. The client has the burden of proof to establish the existence of privilege. If the claim of privilege is not raised with the IRS Agent, the claim may be deemed to be waived. If the client allows the Agent to look at a privileged document, the privilege is also waived for that document.

Suggestion: Do not let the IRS Agent review any files which have not been examined in order to remove privileged documents. This will prevent accidental waiver of the privilege.

I. Preparing Privilege Log. The client must assert its claim of privilege on a document by document basis. The client must disclose to the IRS that documents are being withheld on the ground of privilege. The best way to assert the privilege is through a privilege log.

17. IRRELEVANT AND NON RESPONSIVE DOCUMENTS

A. Irrelevant Documents. The IRS cannot simply request every document in your client’s files. They may only examine those documents which are relevant to tax liability. The scope of what is considered “relevant” is very broad, so it is difficult to challenge a summons on this basis. The IRS considers a document “relevant” for summons purposes so long as it “might shed light” on the taxpayer’s correct tax liability.

B. Nonresponsive Documents A final category of documents that need not be provided to the IRS are those which are not “responsive” to the summons or other request. These documents need not be recorded in a privilege log since they are not being withheld.

18. WRITTEN PROTEST REQUIREMENT

A. 30 Day letters. The beginning of any tax appeal process, whether administrative or judicial, is triggered by the onset of what is commonly known as a “30 day letter”. These letters are generated by the Examination Division of the IRS, usually after the taxpayer has failed to agree with an agent or auditor regarding a deficiency. The 30 day letter puts the taxpayer on notice of an Agent’s determination of a deficiency or over assessment.

Suggestion: 30 day letters can generally be extended for an additional 30 days to allow you time to prepare a response. As far in advance as possible before the expiration of the initial 30 day period, verbally secure an additional extension of time and follow up with a written confirmation.

B. After receipt of the 30 day letter, the taxpayer may do a number of things:

• The taxpayer can bypass the Appeals process by paying the deficiency and subsequently contesting the determination in District Court or in the Claims Court;
• The taxpayer can ignore the letter and file his case in the United States Tax Court following the issuance of a 90 day letter, or the taxpayer can simply request the issuance of a 90 day letter and after its issuance, file a petition;
• The taxpayer can protest the 30 day letter and ask for further Administrative proceedings in the hope of settling the case with the Appeals Division.

C. Option (3) above is the one which the Service encourages and which underlies the Appeals Office’s mission. If the taxpayer elects to protest the 30 day letter or seeks Tax Court review following the issuance of a 90 day letter, he will have the ability to deal directly with the Appeals Office. In the case of a protest, these dealings are the taxpayer’s goal, and therefore are mandatory if he wants to proceed. In the event the taxpayer seeks Tax Court review, he will also have the option to deal with the Appeals Office. Clients should be aware of the fact that administrative appeals are entirely optional. If a client does choose to file a Tax Court petition, the Appeals Office will automatically obtain jurisdiction for a period of time. The taxpayer, however, is not required to deal with the Appeals Office in this situation.

Suggestion: It is the experience of practitioners that it is usually extremely wise to deal with the Appeals Office once the Tax Court petition is filed. District Counsel typically will be less likely to settle on favorable terms in that they enjoy litigation and desire the opportunity to take the case to court. Also, once the case leaves Appeals and the litigation phase begins, professional fees that are generated can often exceed the deficiency at issue! This turn of events will probably not result in return business for you.

D. Factors which Influence Protest Decision The main issue facing the client who has received a 30 day letter is whether to protest the 30 day letter and follow the protest procedure or bypass the protest procedure and file a Tax Court petition. As already mentioned, the Appeals Office will retain jurisdiction even if the Tax Court petition is filed. However, a number of considerations may affect the decision to pursue an administrative appeal.

E. Factors in Favor of Filing Protest.

A protest will avoid the expense of litigation through settlement procedures. Appeals Officers will weigh the “hazards of litigation” even when no case is actually pending. Hazards of litigation include costs involved both in financial terms and in manpower and the possibility of setting unfavorable precedent.
Appeals process allows the taxpayer to keep open the option of filing a petition in Tax Court or seeking district court or Claims Court review. This can prove advantageous to the taxpayer by allowing him to see how authority on the issue develops in the different forums. He may then be able to follow the most favorable avenue if settlement cannot be reached.
Protesting a 30 day letter allows for extended negotiations. When a case is docketed, and a trial status order has been issued by the Tax Court, Appeals cannot consider the case without District Counsel’s consent.
Protesting allows the taxpayer to defer payment of the deficiency for more time and delays collection proceedings such as levy and lien.

Suggestion: It may not always be advisable to put off the payment of the deficiency because of the compounding of interest. This cost should always be discussed with your client.

The taxpayer may use the appeals process to “feel out” the IRS’ position on a matter. The taxpayer may be able to prove the Agent or District was wrong, and avoid a court case entirely, so that for cost containment purposes this may be the preferred procedure.
An informal opportunity for discovery is inherent in the appeals process, which might not be available under the limited discovery rules of the Tax Court. (Remember that in tax cases, you control most information. Most discovery is done by the government against you.)
Protesting allows the taxpayer more time to prepare his case before the suit is started and provides him with an opportunity to judge the reactions of the Appeals Officer in order to evaluate which of his arguments are strongest.

In Whipsaw cases, there is more flexibility in resolving them before the Appeals Officer than if one of the taxpayers involved goes to court.

IRC ‘ 7430 may preclude a taxpayer from receiving attorneys’ fees even if he should prevail in Tax Count, if he has failed to exhaust his administrative appeals.

Suggestion: Each case involves different factors and different considerations and all the foregoing considerations should be weighed carefully before proceeding with a course of action.

F. Factors in Favor of Bypassing Appeals Process.

New issues and grounds are less likely to be raised if the taxpayer goes directly to Tax Court. Appeals Officers usually have more tax expertise than Revenue Agents; therefore the risk of new issues being raised by them upon their review is possible.
New issues raised by the Appeals Officer when the 90 day letter was issued by the Appeals Office (as opposed to the District Office) place the burden of proof on the taxpayer to disprove these issues. Therefore, if there is a substantial likelihood that new issues may be raised, the taxpayer may want to go to Tax Court where the IRS bears the burden on new issues or pursue refund litigation where new issues cannot be used affirmatively to collect any additional tax.
In smaller cases, the fact that a taxpayer has filed in Tax Court may indicate to the Appeals Officer that the taxpayer is convinced he is right. Psychologically, this may facilitate settlement. In cases involving larger amounts, however, the validity of this proposal is more questionable.
The taxpayer may wish to speed up the disposition of the case. Service procedures seem to encourage more expedited case hearings for docketed cases.
Settlements in docketed cases have more finality than settlements in non -docketed cases. Docketed case agreements are reflected in Tax Court decisions, while non docketed settlement agreements are by definition not binding where there is concealment, misrepresentation of material facts, fraud or malfeasance.
Where the Service is locked into a position on a particular matter which might preclude settlement, it might be more advantageous to fight the issue out in Tax Court if you believe the Service’s position is incorrect.
Appeals is generally a waste of time if the issue is coordinated against you (i.e., IRS is set on litigation and will not settle).

G. Choice of Forum Considerations. In evaluating the client’s case, all avenues should be examined, including not only the administrative and Tax Court routes, but also the alternative of pursuing a refund suit route in district court, the Court of Claims, or Bankruptcy Court. The following paragraphs will discuss factors will affect which forum will be most advantageous to the client:

H. Ability To Pay Asserted Deficiency. As a practical matter, the taxpayer is restricted at the outset by his ability to pay the asserted deficiency. If he is unable to do so, he can’t petition for a refund in the district court or the Claims Court where payment is required before suit can be instituted (except excise and employment tax cases).

I. Jurisdictional Factors. The type of tax involved also may limit the taxpayer’s choice of forum.

J. Interest Considerations. A taxpayer’s ability to file in Tax Court without paying the deficiency does not stop the running of interest on the deficiency if the taxpayer is unsuccessful. In refund cases, this interest will not build as it does in Tax Court cases, since the principal, at least, must be paid before the suit is instituted. Taxpayers can stop the running of interest in Tax Court cases by remitting the deficiency after the 90 day letter is received or post a bond. If he remits the entire deficiency prior to that date, the Tax Court will lose jurisdiction over the case. The taxpayer may wish to make an advanced payment of interest to obtain a current deduction of that amount. Also, a recent Tax Court decision allowed a taxpayer to deduct advance payments designated entirely to interest without paying the underlying tax.

K. Forum Shopping: Only the Tax Court exclusively hears tax cases, so its expertise must be considered in choosing a forum. Technical issues will receive different treatment in the Tax Court than issues with equitable appeal, for example, because the Tax Court has no “equitable” jurisdiction.

L. The Golsen Rule. Taxpayers choosing between Tax Court, district court and Claims Court must take into account the Golsen Rule. This rule requires the Tax Court to follow the rule adopted by the Court of Appeals to which the taxpayer would appeal an adverse decision. In effect, the Tax Court follows the same Circuit Court as the district court does. But the Circuit Court follows its own decisions. As a result, practitioners must know the law of the Circuit which may affect their client’s case. If the law in that Court of Appeals is against your client, perhaps it would be better to pay the deficiency and proceed to Claims Court instead.

M. Increased Deficiency. During the pendency of a Tax Court case, the statute of limitations on assessments is tolled, allowing the Commissioner to claim increased deficiencies so long as the Commissioner bears the burden of proof on these issues. This risk of this occurring is not insignificant. On the other hand, in district court or the Claims Court, once the statute of limitations has run, the government may only assert additional taxes to offset recoverable refunds.

N. Discovery Rules. Taxpayers may wish to avoid extensive discovery if they do not want the government to have equal knowledge of the facts and witnesses. They may also wish to avoid the expense of extensive discovery. If this is the case, taxpayers should avoid the district courts, where the Federal Rules of Civil Procedure govern and encourage extensive discovery. Discovery in the Claims Court, on the other hand, is somewhat more limited, while the Tax Court rules are the most restrictive and allow discovery through deposition only in very limited situations.

O. Jury Trial Considerations. Jury trials are not available in the Tax Court or Claims Court. Consequently, a taxpayer who feels his case presents an issue to which a jury may be sympathetic should file in district court. On the other hand, tax cases are often complex and may not present appealing jury issues. Furthermore, a wealthy client may have to face the possibility of unsympathetic jurors who are less wealthy, as the recent Leona Helmsley case shows.

P. Rules of Evidence. The Rules of Evidence are strict in jury trials, more relaxed in bench trials (United States District Court, Claims Court and Bankruptcy Court) and more relaxed in Tax Court.

Q. When Must Protests Be Filed? If the Taxpayer desires to settle his case with the Appeals Office after receiving a 30 day letter, he is required to protest the Examination Divisions determinations. Generally, this will be done in writing, unless:

A review is sought of an office examination case; or
It is a field examination case where the tax or over-assessment is less than $2500;

In which event the taxpayer or his representative may orally request a review by making a telephone call to the Agent and requesting that the matter be forwarded to Appeals.

Suggestion: Always follow up such a request with a written letter confirming what was said and promised.

R. Formalities of Written Protest. There is no strict form this written protest must take; however it must contain the following information:

• The name and address of the taxpayer;
• The date and symbols on the 30 day letter;
• The tax periods or years involved (note: a single protest is sufficient to cover all years and matters if they are covered in one 30 day letter);
• A statement the taxpayer wishes to appeal the determinations of the Examination Division to the Appeals Office;
• An itemized listing of the adjustments with which the taxpayers disagrees;
• A statement of facts supporting the taxpayer=s position in any contested factual issue;
• A statement outlining the law or other authority on which the taxpayer relies; and
• A declaration under penalties of perjury that the statement of facts is true to the best knowledge of the taxpayer. The following language is acceptable for this purpose: “Under penalties of perjury, I declare that the facts presented in my written protest, which are set out in the accompanying statement of facts, schedules, and attached statements, are to the best of my knowledge and belief, true, correct and complete”.

S. If a representative of the taxpayer prepares or files the protest, a duly executed power of attorney must be attached to the protest, as well as a declaration indicating whether the representative prepared it and whether the representative knows of his own knowledge, that the information contained in the protest is true.

T. Nature of Protest. The protest should be fact oriented. Facts of the case should be developed and carefully presented, because they will form the foundation for the legal discussion of the issues.

U. Documents and affidavits in support of the stated facts should be attached to the protest. This may gain the taxpayer a psychological advantage by showing the Appeals Officer the taxpayer is ready for trial.

V. The presentation of facts and law should be aimed at showing the issue is either hazardous or inappropriate for the IRS to litigate. In effect, a wise approach is to show that the IRS stands a substantial chance of losing on the issue in court and/ or that failure to settle might give other taxpayers the opportunity to obtain a windfall tax advantage. This can be done, for example, by showing that the Agent failed to consider or give appropriate weight to some fact or legal authority.

W. In preparing the protest, the preparer should be sensitive to defects and weaknesses in the examiner’s report. Omissions of information on the examiner’s report which are adverse to the government should be pointed out. The preparer should also highlight improperly framed issues and misstated facts.

X. All possible arguments in the taxpayer’s favor should be made, regard less of whether the preparer feels the argument is important or dispositive. The Appeals Officer may feel that such arguments have a cumulative effect in favor of the taxpayer.

Y. Since the taxpayer bears the burden of undercutting the determinations of the examination division, a “skeleton” protest which contains very few legal and factual arguments should probably be avoided. Such a protest may cause the Appeals Officer to dig in his heels on certain matters, particularly in light of the fact that a flimsy protest robs the Appeals Officer of the opportunity to be fully prepared for the settlement conference.

19. BASIC APPEALS PROCEDURES

A. Consents Extending Statutory Period of Assessment. The Appeals Office is also concerned about the statutory period of assessment expiring on the case. For this reason, District Offices are requested to send the case to Appeals at least 120 days before the statute of limitations will expire. The Appeals Office wants to ensure that there is enough time to negotiate toward a settlement. If it appears, therefore, that the time for appellate review is inadequate (usually, less than 60 days remaining), the taxpayer will be asked to consent to an extension of the statutory period on assessments. This is accomplished by Form 872 A, which extends the statutory period of assessment for an indefinite period of time and may restrict the extension only to assessments arising out of particular matters. Or signing Form 872 instead extends the period only for a specified time. Practitioners faced with the question of whether to consent to such an extension must analyze the pros and cons of such an extension on a case by case basis.

20. CONFERENCE PROCEDURE

A. Conference Proceedings. Appeals conferences are informal. They are conducted in a conference room at the Office of Appeals and normally only the Appeals Officer and the taxpayer’s representative attend, testimony is not taken under oath and discussions of the facts and law are not recorded by a stenographer. Facts which the taxpayer alleges, however, are generally required to be submitted in the form of an affidavit or declared to be true under penalties of perjury. It should be noted that the presentation of information at the Appeals Office which was withheld from the District Office, or is newly discovered may cause the Appeals Officer to transfer the case back to the District Office for reconsideration. Alternatively, the new information may be sent to the District for verification.

Suggestion: Practitioners should be aware of the practical reality that the Appeals Officer, while more experienced and capable of analyzing tax matters, may not simply conduct an objective review of the taxpayer’s case. He is, after all, a representative of the Service and will adhere to IRS policies in negotiating and considering settlement of the case. He will, of course, be arguing on behalf of the IRS. Do not be misled by his friendly and agreeable nature.

B. Requests for Additional Information. The Appeals Officer may ask for additional information at the conference if it is needed. Complex cases may require more than one conference with Appeals, but at some point, settlement will be discussed if the Appeals Officer feels the case can be settled. Generally, the Appeals Officer will ask for a settlement offer from the taxpayer or his representative. If the Appeals Officer does not accept the taxpayer’s offer, he will generally propose a settlement amount that he would consider. If the taxpayer and the Appeals Officer do reach a settlement agreement, the Appeals Officer prepares a report which sets out the settlement amount, the issues and evidence involved, and the reasons supporting the settlement. This report is then processed and the taxpayer is sent a bill for the agreed upon deficiency.

Suggestion: You should be very sure that you have authority to settle the case on behalf of your client before you get to the conference. If you are not able to agree to an offer on the spot, the Appeals Officer might change his mind. On the other hand, a common negotiation tactic is, “I have to clear that with the client.”

C. Failure To Reach Agreement. If the parties cannot reach agreement, the Appeals Officer prepares a report (called an Action/Transmittal memorandum) which discusses the taxpayer’s settlement offer and sets out the settlement range the Appeals Officer considers acceptable. It is at this point that the report is processed and the Appeals Office requests issuance of a 90 day letter. This request is reviewed by the Regional Counsel or District Counsel before issuance.

21. SETTLEMENT PRACTICE AND PROCEDURE

A. Hazards of Litigation Standard. The mission of Appeals is to reach a “fair and impartial” resolution of a controversy. What this means in practice is that the Appeals Office will work toward an outcome which takes into account what would probably happen if the case were litigated judicially. Thus, the Appeals Office considers what are known as the “hazards of litigation” when attempting to resolve a case before it. A “hazards of litigation” analysis involves consideration of how an issue (or issues) would be resolved if litigated, and the making or seeking of concessions, taking into account the strength of the parties’ positions. More specifically, the Appeals Officer will review the entire file to determine what a court might find, given the proof available and the effect of testimony. Additionally, the Appeals Officer will take into account judicial interpretation of relevant Code provisions in light of similar cases already decided. As a result, the taxpayer who desires to settle his case must show there is substantial uncertainty as to how the law would be applied to their case as a whole. Failure to make this showing prevents the Appeals Office from considering the relative merits of the opposing positions and the attendant hazards that would face them if those positions were litigated.

B. Judicial Attitude of Appeals Officer. The Taxpayer and his representative must be aware of the difference between the Appeals Officer’s approach when he is evaluating a case for settlement and when he is hearing the taxpayer’s appeal. He is not an impartial judge at the hearing; instead he is arguing the IRS’ position. When evaluating for settlement purposes, on the other hand, the Appeals Officer engages in a more objective analysis and looks at the case the way a court might.

C. Evidential Considerations. The Appeals Officer will consider a number of factors to evaluate settlement possibilities. Considerations include:

• how probative the evidence likely to be presented is;
• how credible the witnesses will be;
• whether the witnesses will be available;
• whether conclusions of law are doubtful.

A great deal of weight will therefore be given to the evidence which would be available at a trial. Hearsay evidence which might be excluded at trial, however, might be more influential to the Appeals Officer who is not comfortable applying rules of evidence.

D. Role of Legal Authority. The Appeals Officer may exercise independent judgment when settling cases, and may conclude that a court would decide a case differently than the IRS under one of its Revenue Rulings. The decision of a Tax Court on a particular issue will probably lead to agreement on that issue; however, the Appeals Officer can refuse to concede an issue if the Service wishes to re- litigate that issue in court. The law of the Circuit Court to which the taxpayer would appeal has greater weight for the Appeals Officer because the Tax Court must follow those precedents. Overall, however, the Appeals Officer is not bound by legal precedent if the IRS does not consider itself bound and desires to re litigate a particular issue or issues.

E. Settlement Offer. Practitioners who desire to settle their cases must make settlement offers which demonstrate a good faith effort to settle. Attempts to “bargain” with the Appeals Officer will be rejected. Therefore it will not be advantageous to point out the potential costs of litigation (also called the “nuisance value”) in tendering a settlement offer. The starting point for any settlement offer must be based on the hazards of litigation. An offer which the Appeals Officer believes is made in good faith may be rejected by the Appeals Officer. If that is the case, the Appeals Office will either state an acceptable settlement amount or be asked for one by the representative.

Suggestion: Representatives should initiate settlement proposals. Appeals Officers should accept such proposals if they are within the settlement range. Practitioners who fail to make a settlement offer will then have to work off the proposal made by the Appeals Officer and that proposal will normally be at the high end of the settlement range. As a result, a proposal at the low end of the settlement range, but made by the taxpayer, should be accepted and is to the taxpayer’s benefit.

Representatives should put their past dealings with the IRS behind them when they deal with Appeals. Hostility will not facilitate settlement, and the Appeals Officers are there to settle. So be open minded and willing to work with the Appeals Officer.

F. Types of Settlements. The IRS and practitioners have identified a number of ways in which to resolve cases, which are explained in the following Sections.

G. Mutual Concession Settlements. Mutual Concession settlements are made when there is substantial uncertainty about how a court would interpret and apply the law or about what facts the court would find if the case were litigated. Thus, neither side will completely concede the issue and both make concessions to reach a settlement.

H. Split Issue Settlements. Split issue settlements are reached on issues that would result in a decision completely for one of the parties if the issue were litigated. This type of settlement, then, recognizes the relative merits of both parties’ positions resulting in an intermediate solution which could not be reached in court.

I. Nuisance Value Settlements. Nuisance value settlements are concessions which are unrelated to the merits and issues of the case and are made only to eliminate the inconvenience or cost which would ensue if further negotiations or litigation were to take place.

22. PREPARATION FOR CONFERENCE

A. Preparing for Conference. Practitioners should not be lulled into “under preparedness” by the informality of a conference. Most of the staff assigned to the Office of Appeals have been promoted from the local area District Offices and are paid more than front line Revenue Agents. Many of them have advanced degrees, a few are attorneys (especially in estate tax) and some are CPAs. Still, many representatives are unprepared at the initial conference. This is dangerous in light of the fact that the adversary (the Appeals Officer) is also, in effect, the judge, who has a psychological edge with no vocal client to satisfy or fee to earn. Neither is he concerned with the time and expense involved should no settlement be reached. Preparation can offset these advantages. The Appeals Officer has not personally prepared the case and the Revenue Agent who did is more an auditor than an investigator of facts. Thus, preparation by the taxpayer and his representative will result in a better grasp of the facts than the Appeals Officer has.

B. Organization of Evidence and Research. To prepare for the case, the practitioner should first interview his client, searching hard for all details. The facts revealed should then be checked out. Complete reliance on the client is not advisable. The practitioner should also obtain whatever records or other evidence the client has. After researching the relevant legal standards which may apply, the argument or arguments can be formulated. All the elements which the taxpayer must prove should be outlined and the supporting documents and witnesses lined up. It is advisable to prepare both sides off the case, so that surprise is not an element at the conference. The practitioner may also need to determine if more evidence is needed, for example, third party affidavits. The evidence and exhibits should then be organized for presentation at the conference, and the entire presentation and file should be reviewed before the conference. Finally, the client should be consulted about settlement proposals before the conference.

Suggestion: A basis for settlement on all the issues raised must be presented by the taxpayer. Once an issue has been raised, it cannot be ignored by the taxpayer, regardless of how unimportant or meritorious the taxpayer may feel it is.

C. Interacting With Client. A settlement conference may be useless if the client has not granted permission for you to settle the case. It is advisable, therefore, that the representative gets specific settlement authority from his client prior to the conference. If the proposal of the Appeals Officer exceeds that settlement authority, the representative can defer acceptance of it until the client and the representative discuss the merits of the offer. Taxpayers may have very unrealistic views of the merits of their cases. One of the jobs of the representative during the preparation phase is to fully apprize the client of the strengths and weaknesses of his case. The client should also be fully apprised of the research which has been conducted with respect to the issues in the case. The only way a client may ever be satisfied that a settlement is in his best interest is if he participated in the decisions regarding that settlement. Don’t badger the client. If the client is unrealistic in his assessment of the case, perhaps it is wisest to direct a letter to the client setting forth the representative’s views and the risks inherent in trying the case. Even this may not satisfy the client, who may only be satisfied if the case is tried in court. Most cases, however, can be and are settled at the Appeals Office.

D. Presenting Client’s Case at Conference. At the conference, the parties will talk through the issues. Gradually, they will agree on some things and disagree on others. The representative will be asked to propose ways to dispose of unagreed issues. What will follow will either be settlement offers or arguments advancing the client’s position.

E. Presentation of Strongest Arguments. The representative should only make his strongest arguments at the conference or his credibility will be lessened. Tangible evidence is important, and should be used as support for arguments. Pointing out authority or facts that the examining Agent failed to disclose or consider is important. Only by presenting the strongest case for the taxpayer, both factually and legally, will the relative merits of the parties’ positions emerge. This is necessary as it will provide the Appeals Officer with a basis upon which to evaluate settlement offers. The Appeals Officer must justify his decision in writing, and the practitioner must give him the information with which to do so.

F. Guidelines for Preparing and Arguing Case. A number of things should be taken into account in preparing and arguing the client’s case at the conference:

The rules of evidence do not apply. All evidence should therefore be presented which is favorable to the client’s position;
Statements of fact or concessions made, either in the protest or at the conference, can be used as admissions at a trial if no settlement is reached. Evidence that the taxpayer offered to settle the case and the terms of that settlement are not admissible at a subsequent trial;
Legal authority on an issue its rarely dispositive and should therefore be emphasized in the protest, not at the conference; and
IRS pronouncements should be emphasized at the conference, since they will be given more weight by the Appeals Officer than court decisions.

G. Settlement Negotiations. Settlement negotiations will in large part be influenced by the success with which the taxpayer’s case was presented. The taxpayer’s case must create some doubt as to the probable result if the case was presented in court or a settlement offer will not even be considered. A number of strategies will aid the practitioner in negotiating a favorable settlement for his client apart from a well prepared case presentation. First, the practitioner should be aware of some of the situations in which reaching a settlement may be difficult, such as:

• where the taxpayer’s version of the facts is unclear;
• where the IRS wants a court decision on the issues for other cases (a “coordinated” issue);
• where the Commissioner’s policy conflicts with court law;
• where a case was poorly handled in the District Director’s Office, filling the case file with material which now has to be explained away.

Barring the above difficulties, a practitioner will be able to negotiate effectively if he keeps in mind some of the tenets of successful negotiation:

• Establish a reputation as a reasonable negotiator. Do not press beyond the merits of the case, but pursue a case to the bitter end if you are right. In this way you will earn respect;
• Assume the Appeals Officer handling the case is capable;
• Consider the governmental policy toward taxpayers and prepare a response to it;
• Know the governmental procedures and alternatives;
• Be completely prepared on the facts and the law, and know the strengths and weaknesses of the taxpayer’s as well as the government’s cases;
• Remember that almost everything can be negotiated. Be flexible and strive toward settlement, not winning;
• Be open minded. Don’t go in with ultimatums and final offers;
• Be persistent in negotiating toward a settlement, not in your position;
• Recognize that opposing interests may be genuinely felt and don’t insult your adversary or claim he is insincere;
• It might be advisable to leave your client at home; and
• Don’t misrepresent.

H. Proposal of Settlement by Taxpayer. An offer of 10% of the deficiency will generally be presumed not to be a good faith offer. The offer should be couched in terms which reflect the chances of success in court. This may result in offers which reflect the chance of success in court, or on the percentage of the amount of tax each issue involves. If the taxpayer’s initial offer is not accepted, the practitioner should ask the Appeals Officer what amount would be acceptable, if it is not offered. The Appeals conference is a horse trading session. Issues are traded. Risks are evaluated by the respective parties. Concessions must be made on the part of both parties to reach a settlement. Remember, if a settlement is not reached, the taxpayer still has the right to litigate the matter before the Tax Court.

23. SETTLEMENT AGREEMENTS

A. Settlement Agreements. Settlement of docketed Tax Court cases is reflected in a written stipulation of the parties, which then must be accepted by a Tax Court Judge. If it is signed and filed by the Judge, it becomes the judgment of the Tax Court.

RJS:BJB\Ron\Tax Seminar 2010

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REECE B. MORREL, J.D.; born Macomb, Oklahoma, March 20, 1940. Admitted to bar, 1966, Oklahoma; also admitted to practice before the U.S. District Court, Northern District of Oklahoma; U.S. Court of Appeals, Tenth Circuit; and U.S. Tax Court. Preparatory education: University of Central Oklahoma (B.S., 1961). Legal education: University of Tulsa (J.D., 1966); fraternity: Delta Theta Phi (Treasurer, 1964-66). Internal Revenue Agent, Internal Revenue Service, 1961-66. Trust Officer, Bank of Oklahoma, N.A., 1966-68. Member: Tulsa County Bar (Unlawful Practice of Law Committee, 1985; Taxation Section: Real Estate Committee, 1972-76). Oklahoma Bar. American Bar Assn. (Taxation Section). Recognition: Martindale-Hubbell “AV” Peer Review Rating. Areas of concentration: taxation, estate planning, oil and gas transactions, real estate transactions, and business law.

RONALD J. SAFFA, J.D., M.S., CPA; born Tulsa, Oklahoma, July 14, 1948. Admitted to bar, 1982, Oklahoma; also admitted to practice before the U.S. Supreme Court; U.S. Court of Appeals, Tenth Circuit; U.S. Court of Appeals, Federal Circuit; U.S. Claims Court; U.S. District Court, Northern and Eastern Districts of Oklahoma; and U.S. Tax Court. Preparatory education: Oklahoma State University (B.S., 1971; M.S., 1972). Legal education: University of Tulsa (J.D., 1981); fraternities: Phi Kappa Phi and Beta Alpha Psi. Certified Public Accountant, Oklahoma, 1974. Internal Revenue Agent, Internal Revenue Service, 1974-83. Editor: Research Institute of America. Member: Tulsa County Bar. Oklahoma Bar. Treasurer and Board of Directors Member, Morton Comprehensive Health Services. Author: “Oklahoma Income Taxes,” Research Institute of America, 1992. Lecturer: “Representing Small Businesses Before the Internal Revenue Service,” 1997. “Offers and Settlements with Tax Authorities,” Tulsa Chapter – Oklahoma Society of Certified Public Accountants, 2002. “Representation of Clients During IRS Audits and Collections,” Tulsa Chapter – Oklahoma Society of Certified Public Accountants, 2004. Recognition: Martindale-Hubbell “AV” Peer Review Rating. Areas of concentration: taxation, estate planning, business law, and civil litigation.

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Possibilities and Pitfalls

This paper will discuss some of the possibilities and pitfalls of Chapter 11 bankruptcy utilizing the Small Business provisions under 11 U.S.C. 1101 et seq. (commonly referred to as the Bankruptcy Code or, herein, simply as the Code). All statutory references herein are to sections of Title 11 of the United States Code unless otherwise stated. The revisions to the Code resulting from the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) impacting upon the provisions relevant to Chapter 11 are fairly extensive. As we will see, such revisions made significant changes to Chapter 11 insofar as Small Businesses and Individuals are concerned.

This paper is not intended as a comprehensive overview of Chapter 11 as such is far beyond the scope of a one hour presentation. Instead, this paper will focus on the sections of the Code primarily dealing with the utilization of Chapter 11 by a Small Business or an Individual.

The analysis of a Chapter 11 case for a Small Business or an Individual can be viewed in three parts: filing, case administration and plan. As an introductory matter, a few terms should be kept in mind:

Small Business Debtor: Any debtor that meets the definition in §101(51D)

Small Business Case: A Chapter 11 where the Debtor is a small business debtor

Big Business Debtor: Any Debtor that’s not a Small Business Debtor

Debtor: For this paper, the person filing Chapter 11

Individual Debtor: A living breathing human being that’s filed Chapter 11

Entity Debtor: Any legal entity that’s filed Chapter 11

The specific code sections applicable only to a Small Business Case are:

§101 (51D): Definition of Small Business Debtor

§308: Additional reporting requirements

§1116: Duties of a Small Business Debtor

§1121(e): Exclusivity

§1125(f): Plan and Disclosure Statement

§1129(a)(9)(b): Pre-petition DSOs

§1129(a)(14): Post-petition DSOs

§1129(a)(15): Disposable Income

§1129(b)(2)(B)(ii): Absolute priority rule repealed for Individuals

§1129(e): 45 days to confirm the Plan

§1141(d)(2): Plan Modification

§1141(d)(3): Discharge

Filing

Who is a Small Business Debtor?

Prior to BAPCPA, the Code provided for an option for qualifying Debtors to elect to be treated as a small business case. Such option was made at the discretion of the Debtor and was purely voluntary.

Post-BAPCPA, if the Debtor meets the definition of a Small Business Debtor, then the Chapter 11 case is administered under the provisions of the Code pertaining to a Small Business Case. There is no ability to choose otherwise.

The definition of a Small Business is found in 11 U.S.C. §101 (51D) which states:

The term “small business debtor” –

(A) subject to subparagraph (B), means a person engaged in commercial or business activities (including any affiliate of such person that is also a debtor under this title and excluding a person whose primary activity is the business of owning or operating real property or activities incidental thereto) that has aggregate non-contingent liquidated secured and unsecured debts as of the date of the petition or the date of the order for relief in an amount not more than $2,190,000 [FN1] (excluding debts owed to 1 or more affiliates or insiders) for a case in which the United States trustee has not appointed under §1102(a)(1) a committee of unsecured creditors or where the court has determined that the committee of unsecured creditors is not sufficiently active and representative to provide effective oversight of the debtor; and

(B) does not include any member of a group of affiliated debtors that has aggregate non-contingent liquidated secured and unsecured debts in an amount greater than $2,190,000 [FN1] (excluding debt owed to 1 or more affiliates or insiders).

[FN1] Dollar amount as adjusted by the Judicial Conference of the United States. See Adjustment of Dollar Amounts notes set out under this section and 11 U.S.C.A. §104.

The first part of this analysis is much like that one used for Chapter 13 eligibility set forth in 11 U.S.C.A. §109(e). Just like Chapter 13, only debts that are both non-contingent and liquidated count, except in here, the total of all debt is considered regardless of whether secured or unsecured.  Given the exact same wording is used in Chapter 13 as is used in this definition, resorting to well established Chapter 13 case law provides guidance as to the meaning of these terms.

A claim is “liquidated” for purposes of Chapter 13 eligibility only if it is capable of ready determination. Such occurs when the debtor’s liability and the amount of claim can be determined on the basis of agreed upon facts without need for evidentiary hearing. Neither a frivolous factual dispute, nor disagreement, concerning law as opposed to fact causes the claim to be unliquidated. In re Hustwaite, 136 B.R. 853 (Bkrtcy. D.Or., 1991). I use the calculator test: if the amount of the debt can be determined with a calculator, then the debt is liquidated. A good example of an unliquidated debt is a personal injury claim that has not been reduced to a judgment.

A debt is “non-contingent” for purposes of Chapter 13 eligibility limit on non-contingent, liquidated unsecured debts, if all events giving rise to liability occurred prior to filing of the bankruptcy petition. In re Loya, 123 B.R. 338 (9th Cir.BAP (Cal.) 1991).

The more problematic question is whether or not there is an active creditors committee. On the petition date, it is impossible to determine whether or not a committee will be appointed as such event typically does not occur until two or three weeks after the case is filed.  Even more of a dilemma is whether an appointed committee is “not sufficiently active and representative to provide effective oversight of the Debtor” as determined by the Court. Since the Court generally does not make determinations without being asked, then a finding that an appointed committee is inactive is not likely to occur until after the passage of several weeks or even months.  This situation presents an absurd administrative situation for the Debtor and the United States Trustee. General practice seems to be that if the total liquidated, non-contingent debts are under the dollar limit, then the case is treated as a small business case unless and until a committee is appointed. In addition, under the present Fed. R. Bankr. P. 1020, a Debtor that meets the dollar limitation may affirmatively elect to be treated as a Small Business Debtor.

In addition, a proposed change to Fed. R. Bankr. P. 1020 provides that the Debtor will be treated as a Small Business Debtor, or not, depending upon how it identifies itself in the petition until the Court rules otherwise. Specifically effective December 1, 2008, absent contrary Congressional action, Fed. R. Bankr. P. 1020 is amended to read as follows:

Rule 1020. Small Business Chapter 11 Reorganization Case

(a) Small business debtor designation

In a voluntary Chapter 11 case, the debtor shall state in the petition whether the debtor is a small business debtor. In an involuntary Chapter 11 case, the debtor shall file within 15 days after entry of the order for relief a statement as to whether the debtor is a small business debtor. Except as provided in subdivision (c), the status of the case as a small business case shall be in accordance with the debtor’s statement under this subdivision, unless and until the court enters an order finding that the debtor’s statement is incorrect.

(b) Objecting to designation

Except as provided in subdivision (c), the United States trustee or a party in interest may file an objection to the debtor’s statement under subdivision (a) no later than 30 days after the conclusion of the meeting of creditors held under §341(a) of the Code, or within 30 days after any amendment to the statement, whichever is later.

(c) Appointment of committee of unsecured creditors

If a committee of unsecured creditors has been appointed under §1102(a)(1), the case shall proceed as a small business case only if, and from the time when, the court enters an order determining that the committee has not been sufficiently active and representative to provide effective oversight of the debtor and that the debtor satisfies all the other requirements for being a small business. A request for a determination under this subdivision may be filed by the United States trustee or a party in interest only within a reasonable time after the failure of the committee to be sufficiently active and representative. The debtor may file a request for a determination at any time as to whether the committee has been sufficiently active and representative.

(d) Procedure for objection or determination

Any objection or request for a determination under this rule shall be governed by Rule 9014 and served on: the debtor; the debtor’s attorney; the United States trustee; the trustee; any committee appointed under §1102 or its authorized agent, or, if no committee of unsecured creditors has been appointed under §1102, the creditors included on the list filed under Rule 1007(d); and any other entity as the court directs.

ADVISORY COMMITTEE NOTES

1997 Amendments

This rule is designed to implement §§1121(e) and 1125(f), which were added to the Code by the Bankruptcy Reform Act of 1994.

GAP Report on Rule 1020. The phrase “or by a later date as the court, for cause, may fix” at the end of the published draft was deleted. The general provisions on reducing or extending time periods under Rule 9006 will be applicable.

2008 Amendments

[Effective December 1, 2008, absent contrary Congressional action.]

Under the Code, as amended in 2005, there are no longer any provisions permitting or requiring a Small Business Debtor to elect to be treated as a small business. Therefore, the election provisions in the rule are eliminated.

The 2005 amendments to the Code include several provisions relating to small business cases under Chapter 11. Section 101 includes definitions of “Small Business Debtor” and “Small Business Case.” The purpose of the new language in this rule is to provide a procedure for informing the parties, the United States Trustee, and the Court of whether the Debtor is a Small Business Debtor, and to provide procedures for resolving disputes regarding the proper characterization of the Debtor. Because it is important to resolve such disputes early in the case, a time limit for objecting to the Debtor’s self-designation is imposed. Rule 9006(b)(1), which governs enlargement of time, is applicable to the time limits set forth in this rule.

An important factor in determining whether the Debtor is a Small Business Debtor is whether the United States Trustee has appointed a committee of unsecured creditors under §1102, and whether such a committee is sufficiently active and representative. Subdivision (c), relating to the appointment and activity of a committee of unsecured creditors, is designed to be consistent with the Code’s definition of “Small Business Debtor.”

The new Fed. R. Bankr. P. 1020 resolves the threshold question of whether or not the Debtor is a Small Business Debtor, at least until a party in interest disputes the Debtor’s self-designation or a committee is appointed. If a committee is appointed, the case is no longer a Small Business Case unless at any time thereafter, the Court determines that the committee is or has become inactive. Therefore, the Debtor still faces the possibility that it will start out as a Small Business Case, then cease to be such a case upon the appointment of a committee, only to find itself once again a Small Business Case if the committee is lethargic.

Practically, committees are rarely appointed in small cases, so hopefully, if the Debtor starts out as a Small Business Case, then it will so remain despite the Gordian knot created by the provisions relating to committees.

For the remainder of this paper, we will assume the Debtor qualifies as a Small Business Debtor and continues to be so for the duration of the Chapter 11 case.

Given the obvious concern about the lack of an active committee in a Small Business Case, in the post-BAPCPA world, the U. S. Trustee now has specific duties in such cases set forth in 28 U.S.C.A. §586(a)(7). These duties include:

1.  Conduct an initial debtor interview before the first §341 meeting. The practice of the initial Debtor interview was already standard U. S. Trustee policy and is nothing new to Chapter 11 Debtor’s counsel in Oklahoma. However, the duties of the U. S. Trustee are now spelled out in detail in 28 U.S.C.A. §586(a)(7)(A)(i) to (iii).  This section mandates the U. S. Trustee to (i) begin to investigate the Debtor’s viability; (ii) inquire about the Debtor’s business plan; and (iii) explain the Debtor’s obligations to file monthly operating reports and other reports.

2.  Visit the appropriate business premises, and view the state of the books and records to determine the condition of such and verify if the Debtor has filed its tax returns, if it is appropriate and advisable to do so. Although the U. S. Trustee has no doubt always had the right to conduct an on-site review of a Debtor’s business operations if there was a good reason for such, it is not statutory. In reality, it seems likely that in most cases, the U. S. Trustee will find that is not appropriate or advisable to conduct such a visit to the Debtor’s premises because such a visit is not required in most cases to determine the state of the books and records or verify the filing of tax returns, so this probably doesn’t really change anything.

3. Review and monitor the Debtor’s activities to identify whether a plan will be forthcoming. Again, this is nothing new because the U. S. Trustee has always monitored cases to assess whether it is likely that the Debtor will confirm a plan, and, if not to file an appropriate motion to convert or dismiss the case.

The specific duties imposed upon U. S. Trustees in Small Business Cases are nothing new as they have been performing most creditors’ committee functions for years in small Chapter 11 cases.

Small Business Debtors also have several duties not imposed on Big Business Debtors to perform pursuant to Code §1116. These additional duties will be discussed in some detail, but generally include:

(1)  Filing substantial additional financial information with the petition that other Chapter 11 businesses are not required to file;

(2)  Maximum of 30-day extension of time to file schedules and a statement of affairs;

(3)  Senior management must be available for meetings scheduled by the Court or the U. S. Trustee;

(4)  All tax return filings and other government filings must be timely filed;

(5)  Allow the U. S. Trustee to inspect the Debtor’s business premises and books and records;

(6)  Exclusivity to file a plan is 180 days;

(7)  The plan must be filed within 300 days of petition date;

(8)  The plan must be confirmed within 45 days of its filing.

In addition, if the Debtor is an Individual Debtor they will find that some aspects of a Chapter 11 resembles a Chapter 13 regardless of whether their debts are primarily consumer or not. An Individual Debtor’s post-petition income is now part of the property of the estate and all their disposable income must be contributed to the Plan to obtain confirmation. Consumer Debtors with income levels that exceed the I.R.S. standards outlined in Code §707(b) and debts in excess of the Chapter 13 limit have to choose Chapter 11 or have no relief available.

Additional burdens imposed on individuals who find themselves in a Small Business Chapter 11 will find that upon obtaining confirmation that the Plan will operate like a Chapter 13 Plan in that the discharge is not entered until the Plan is substantially performed and its also subject to a request for post-confirmation modification by the U. S. Trustee or any unsecured creditors to increase the amount of the payments. Given the absence of a case trustee in most Chapter 11’s, the U. S. Trustee will have to monitor the case until the Plan is completed, which can take as long as five years. This means the Debtor’s counsel will also have to be engaged for the life of the Plan.

The benefits afforded a Small Business Debtor are few compared to the additional burdens. The primary benefit is a streamlined plan confirmation process by means of three statutory options whereby the Court may either:

(1)  determine that the plan itself provides adequate information and that a separate disclosure statement is not necessary;

(2)  approve a disclosure statement submitted on a standard form as approved by the Court or adopted under the bankruptcy rules;

(3)  conditionally approve a disclosure statement subject to final approval after a notice and a hearing (this practice was used in small business cases pre-BAPCPA).

In addition, in an Individual Debtor case, the Plan may be confirmed regardless of a rejecting class of unsecured creditors if it meets all 16 of the requirements for confirmation under §1129(a). This effectively eliminates the insurmountable hurdle of the Absolute Priority Rule in an individual case as discussed by the U. S. Supreme Court’s case of Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 198 (1988) which held  that the Debtor’s “promise of future services was intangible, inalienable, and, in all likelihood, unenforceable. Unlike “money or money’s worth” such promise cannot be exchanged in any market for something of value to the creditors today. No broader exception to the absolute priority rule than that suggested in Los Angeles Lumber’s dicta exists. The statutory language and §1129(b)’s legislative history bars any expansion of any exception to the absolute priority”. Revised §1129(b)(2)(B)(ii) effectively eliminates the Absolute Priority Rule in individual cases.

Some detailed discussion of these various items is worthwhile.

Duties Imposed Upon Small Business Debtors

The Code has an entire section devoted to the duties of Small Business Debtors found at §1116, which states:

In a small business case, a Trustee or the Debtor in Possession, in addition to the duties provided in this title and as otherwise required by law, shall –

(1) append to the voluntary petition or, in an involuntary case, file no later than 7 days after the date of the order for relief –

(A) its most recent balance sheet, statement of operations, cash-flow statement, and Federal income tax return; or

(B) a statement made under penalty of perjury that no balance sheet, statement of operations, or cash-flow statement has been prepared and no Federal tax return has been filed;

(2) attend, through its senior management personnel and counsel, meetings scheduled by the Court or the United States Trustee, including initial Debtor interviews, scheduling conferences, and meetings of creditors convened under §341 unless the Court, after notice and a hearing, waives that requirement upon a finding of extraordinary and compelling circumstances;

(3) timely file all schedules and statements of financial affairs, unless the Court, after notice and a hearing, grants an extension, which shall not extend such time period to a date later than 30 days after the date of the order for relief, absent extraordinary and compelling circumstances;

(4) file all post-petition financial and other reports required by the Federal Rules of Bankruptcy Procedure or by local rule of the District Court;

(5) subject to §363(c)(2) maintain insurance customary and appropriate to the industry;

(6)  (A) timely file tax returns and other required government filings; and

(B) subject to §363(c)(2) timely pay all taxes entitled to administrative expense priority except those being contested by appropriate proceedings being diligently prosecuted; and

(7) allow the United States Trustee, or a designated representative of the United States Trustee, to inspect the Debtor’s business premises, books, and records at reasonable times, after reasonable prior written notice, unless notice is waived by the Debtor.

In addition, there are additional reporting requirements specifically imposed upon a Small Business Debtor found in §308 which states:

(a) For purposes of this section, the term “profitability” means, with respect to a Debtor, the amount of money that the Debtor has earned or lost during current and recent fiscal periods.

(b) A Small Business Debtor shall file periodic financial and other reports containing information including –

(1) the Debtor’s profitability;

(2) reasonable approximations of the Debtor’s projected cash receipts and cash disbursements over a reasonable period;

(3) comparisons of actual cash receipts and disbursements with projections in prior reports;

(4) (A) whether the Debtor is –

(i) in compliance in all material respects with post petition requirements imposed by this title and the Federal Rules of Bankruptcy Procedure; and

(ii) timely filing tax returns and other required government filings and paying taxes and other administrative expenses when due;

(B) if the Debtor is not in compliance with the requirements referred to in subparagraph (A)(i) or filing tax returns and other required government filings and making the payments referred to in subparagraph (A)(ii), what the failures are and how, at what cost, and when the Debtor intends to remedy such failures; and

(C) such other matters as are in the best interests of the Debtor and creditors, and in the public interest in fair and efficient procedures under Chapter 11 of this title.

There is a national form for the extra reporting:

Form B26: “Periodic Report Regarding Value, Operations and Profitability of Entities in Which the Debtor’s Estate Holds a Substantial or Controlling Interest”

Free, downloadable PDF and text versions are available at (Please note, in December 2008 the form was renumbered to B26 from B25.):
http://www.uscourts.gov/FormsAndFees/Forms/BankruptcyForms.aspx

The majority of these duties were more or less customarily imposed on most Chapter 11 Debtors in one form or another by the reporting requirements requested by the U. S. Trustee’s guidelines and reporting requirements. The difference now is that requirements are now statutory, the time limits more strict and the failure to comply is a statutory basis for dismissal of the case. The Code now contains specific grounds for dismissal of a case for failure to comply with the various statutory obligations in §1112(b)(4)(F) and (H). Although there are few cases discussing these issues, one case I did find with a good discussion of the issues involved in these reporting requirements in the context of a motion to dismiss is found in the case of In re Franmar, Inc., 361 B.R. 170 (Bankr.D.Colo., 2006) wherein Judge Sidney Brooks concluded in his decision denying the motion of the U. S. Trustee to dismiss a small business case that:

For the reasons stated above, the Court finds that the failure to append the documents required pursuant to 11 U.S.C. §1116(1) to a small business voluntary Petition does not mandate automatic dismissal of the underlying case. The failure to attach the Small Business Documents at the time of filing the Petition, in this case, did not constitute an “unexcused failure” pursuant to 11 U.S.C. §1112(b)(4)(F). Nor does the failure to attach the small business documents at the time of filing the Petition, or Debtor’s counsel’s delay in contacting the UST, in this case, rise to the level of failure to timely provide information pursuant to 11 U.S.C. §1112(b)(4)(H).

The Court finds Debtor’s delay in this case in filing the required documents listed in 11 U.S.C. §1116(1) was reasonable and justified based on the particular circumstances. This case is relatively simple and involves few creditors. The delay was caused solely by Debtor’s dependence on its accountant and its accountant’s busy schedule during the height of the tax season. Debtor’s counsel took reasonable steps to file the missing small business documents as soon as possible and filed them prior the April 18, 2006, initial debtor’s interview.

The initial debtor’s interview and the creditor’s meeting both took place with no delay from the dates established by the UST. None of the deadlines for filing and confirming Debtor’s plan pursuant to 11 U.S.C. § 1121(e) or 11 U.S.C. § 1129(e) will be impacted. The delay was minimal and did not prejudice any party involved in this case.

Small Business Debtors then must file more papers at the inception of the case and also file monthly reports containing more information than required by Big Business Debtors. Given the inherent lack of internal staff resources a small company (or worse, an individual) will have, it is imperative that a qualified bankruptcy accountant or financial advisor be engaged to assist with the preparation of these reports. This will also result in more professional fees in the context of a Small Business Case, which will in turn make it more difficult to successfully navigate such a case to a successful conclusion.

Case Administration Issues

There are no significant differences in a Small Business Case and a Big Business Case when it comes to traditional case administration issues. The Small Business Debtor must still deal with many of the same issues facing any other Chapter 11 Debtor such as:

1. Cash Collateral, §363

2. Payment of accrued pre-petition wages coming due shortly after filing. §507

3. Obtaining Post-Petition Credit. §364

4. Assumption and/or rejection of Executory Contracts and Unexpired Leases. §365

5. Valuation of Collateral. §506

6. Sales of Assets. §363

7. Stay Relief. §362(d)

8. Retention of Professionals and Allowance of Fees

9. Utility Providers

Many of these traditional Chapter 11 matters are present in most Small Business Cases and must be dealt with in the same manner as in any other Chapter 11 case.

Plan Issues

There are some potentially significant differences in a Small Business Case when one gets to the main event in a Chapter 11 case, i.e., the Plan. There are three main areas which we will discuss under this subdivision. First, is exclusivity and timing; second, disclosure statement and plan forms; and finally, plan confirmation.

Exclusivity And Timing

A Small Business Debtor faces different rules when it comes to the exclusive right to file a plan. In a Small Business Case prior to BAPCPA, §1121(e) limited exclusivity to 100. Thereafter, any party could file a plan, provided “all plans shall be filed within 160 days after the date of the Order for Relief”. This requirement was different from the 180-day requirement under Code §1121(c)(3), in that it established a termination date upon which any party may file a plan. §1121(e)(2). The Court had discretion to extend the 100-day exclusivity period but not the 160-day period (pre-2005 §1121(e)(3)). In effect, there was a 160 day absolute deadline for filing a plan. This time constraint was a disincentive for Debtors to elect to be treated under the small business provision.

Incentives are no longer relevant because now a Small Business Debtor has no choice but to administer their case as a Small Business Case subject to the small-business provisions, however, there is some relief on the restrictive exclusivity rules. The now amended §1121(e) provides:

(e) In a small business case –

(1) only the Debtor may file a plan until after 180 days after the date of the order for relief, unless that period is –

(A) extended as provided by this subsection, after notice and a hearing; or

(B) the Court, for cause, orders otherwise;

(2) the plan and a disclosure statement (if any) shall be filed not later than 300 days after the date of the order for relief; and

(3) the time periods specified in paragraphs (1) and (2), and the time fixed in §1129(e) within which the plan shall be confirmed, may be extended only if –

(A) the debtor, after providing notice to parties in interest (including the United States trustee), demonstrates by a preponderance of the evidence that it is more likely than not that the court will confirm a plan within a reasonable period of time;

(B) a new deadline is imposed at the time the extension is granted; and

(C) the order extending time is signed before the existing deadline has expired.

This section then extends the initial exclusivity period to 180 days (60 days longer than the 120 day period for Big Business Cases) and extends the deadline for all Plans to 300 days. There is no absolute maximum time limit, but extensions appear to be available only to the Debtor if:

1. Notice is given to parties in interest;

2. Proves by preponderance of evidence that a plan is likely to be approved within a reasonable time; and

3. The order granting the extension:

(a) imposes a new deadline; and

(b) is signed BEFORE the existing deadline expires.

It is clear from this section that an evidentiary hearing is required to be held after notice is given to “parties in interest”. It is suggested that an application for hearing be filed requesting the order setting the hearing to specify the parties to whom notice is given to avoid notice issues and requesting a specific date for the hearing to be “on or before” to make sure that the hearing date is sufficiently in advance of the deadline to conduct the hearing and get the order signed.

Disclosure Statement And Plan

Format and Forms

One of the benefits of a Small Business Case is that the disclosure statement and plan process is streamlined in two ways. First, the disclosure statement can be approved without the two-hearing procedure used in big business cases and second, the format and form of the disclosure statement and plan can be greatly simplified from what is typically encountered in a big business cases. This process is governed by §1125(f) which states:

(f) Notwithstanding subsection (b), in a small business case –

(1) the court may determine that the plan itself provides adequate information and that a separate disclosure statement is not necessary;

(2) the court may approve a disclosure statement submitted on standard forms approved by the court or adopted under §2075 of title 28; and

(3) (A) the court may conditionally approve a disclosure statement subject to final approval after notice and a hearing;

(B) acceptances and rejections of a plan may be solicited based on a conditionally approved disclosure statement if the debtor provides adequate information to each holder of a claim or interest that is solicited, but a conditionally approved disclosure statement shall be mailed not later than 25 days before the date of the hearing on confirmation of the plan; and

(C) the hearing on the disclosure statement may be combined with the hearing on confirmation of a plan.

Single Document Option: The first option is to use a combined plan and disclosure statement into one single document. Then, file an application requesting the Court to find that such document is conditionally approved as the disclosure statement, with a final approval hearing to be conducted at the same time as the confirmation of the plan is considered and that a separate disclosure statement is not required. This practice has been utilized since the advent of the small business case provisions in the early 90’s and is fairly common. Attached is a form of an order conditionally approving the disclosure statement and setting a combined hearing to finally approve the disclosure statement as well as consider confirmation of the plan and a combined plan and disclosure statement that I have used in several cases.

Standard Form Option: A second new option is now found in §1125(f)(2). This provision allows for standardized forms to be created by the particular Court or by adoption of a national form. To my knowledge, none of the Oklahoma Bankruptcy Courts have adopted a local standardized form. There are now proposed national forms B25A and B25B that will be effective December 1, 2008. Copies are attached. Downloadable PDF and Rich Text versions of both these forms are available for free at:
http://www.uscourts.gov/FormsAndFees/Forms/BankruptcyForms.aspx

It appears that if one uses these forms, then files the same sort of application described for the Single Document Option, then the Court may in the same manner conditionally approve the standard form disclosure statement, with a final approval hearing to be conducted at the same time as the confirmation of the standard form plan is considered.

The standard form plan is only 6 pages and is considerably simpler that the plans that I typically used for my debtor cases or that I encounter when representing creditors in Chapter 11 cases. The standard form disclosure statement is 24 pages, although by the time you finish editing and filling in the blanks, it will be considerably longer. Regardless, with some work, it does appear that the professional time required to draft a standard form plan and disclosure statement should be somewhat less than is now typically required in smaller Chapter 11 cases.

Note that under either option, there is a minimum 25 days notice required for the combined hearing to consider both the final approval of the disclosure statement and confirmation of the plan. This should shorten the time between filing the plan and disclosure statement and the hearing by several days.

That’s good, because there is a 45 day deadline for the Court to confirm a plan in a Small Business Case found in §1129(e) which states:

(e) In a small business case, the court shall confirm a plan that complies with the applicable provisions of this title and that is filed in accordance with §1121(e) no later than 45 days after the plan is filed unless the time for confirmation is extended in accordance with §1121(e)(3).

This 45 day deadline starts running when the plan is filed and may only be extended in the same manner as described above to extend exclusivity under §1123(e)(3). Hopefully, this streamlined process should save some money on both professional fees and expenses for copies and postage as well as speeding up the process to get to the confirmation hearing.

Confirmation Considerations

The hearing to consider confirmation of the plan is the main event in any Chapter 11 case. Entity Debtors are treated the same as Big Business Corporations under §1129. The good news is that even though you are essentially forced to get to a confirmation hearing faster in a Small Business Case for a legal entity, once you get to the hearing, you don’t have to learn anything new.

On the other hand, if the Small Business Debtor is an Individual Debtor,  there are some significant revisions to the confirmation requirements under §1129, some of which are beneficial to the Debtor and afford a better chance of obtaining confirmation of a Plan that the Debtor can successfully perform; and others of which are not so beneficial.  The provisions are:

§1129(a)(9)(b) “You must pay the DSO to pass go”:

(9) Except to the extent that the holder of a particular claim has agreed to a different treatment of such claim, the plan provides that –

(B) with respect to a class of claims of a kind specified in §§507(a)(1), 507(a)(4), 507(a)(5), 507(a)(6), or 507(a)(7) of this title, each holder of a claim of such class will receive –

(i) if such class has accepted the plan, deferred cash payments of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or

(ii) if such class has not accepted the plan, cash on the effective date of the plan equal to the allowed amount of such claim.

Given that §507(a)(1) grants a first in priority claim to all prepetition Domestic Support Obligations (DSO), then unless the Individual Debtor can negotiate a payment of DSO over time, such claims are entitled to be paid in cash in full at confirmation.  This gives a substantial bargaining position to a class of creditors almost always populated by former spouses (often with minor children), a class of individuals not typically known for being “easy” negotiators.

§1129(a)(14) “DITTO”

If the debtor is required by a judicial or administrative order, or by statute, to pay a domestic support obligation, the debtor has paid all amounts payable under such order or such statute for such obligation that first become payable after the date of the filing of the petition.

This section is the post-petition counter-part to §1129(a)(9)(b) and requires that all post-petition DSOs be paid up prior to the confirmation hearing.

§1129(a)(15) Living the Means Test Lifestyle.

In a case in which the debtor is an individual and in which the holder of an allowed unsecured claim objects to the confirmation of the plan –

(A) the value, as of the effective date of the plan, of the property to be distributed under the plan on account of such claim is not less than the amount of such claim; or

(B) the value of the property to be distributed under the plan is not less than the projected disposable income of the debtor (as defined in §1325(b)(2)) to be received during the 5-year period beginning on the date that the first payment is due under the plan, or during the period for which the plan provides payments, whichever is longer.

Except in cases of a 100% Plan, this section is the same as the familiar disposable income test used in Chapter 13 cases and indeed, makes specific reference to §1325(b)(2) which states:

(2) For purposes of this subsection, the term “disposable income” means current monthly income received by the debtor (other than child support payments, foster care payments, or disability payments for a dependent child made in accordance with applicable non-bankruptcy law to the extent reasonably necessary to be expended for such child) less amounts reasonably necessary to be expended –

(A)(i) for the maintenance or support of the debtor or a dependent of the debtor, or for a domestic support obligation, that first becomes payable after the date the petition is filed; and

(ii) for charitable contributions (that meet the definition of “charitable contribution” under §548(d)(3) [FN1] to a qualified religious or charitable entity or organization (as defined in §548(d)(4)) in an amount not to exceed 15 percent of gross income of the debtor for the year in which the contributions are made; and

(B) if the debtor is engaged in business, for the payment of expenditures necessary for the continuation, preservation, and operation of such business.

(3) Amounts reasonably necessary to be expended under paragraph (2), other than subparagraph (A)(ii) of paragraph (2), shall be determined in accordance with subparagraphs (A) and (B) of §707(b)(2), if the debtor has current monthly income, when multiplied by 12, greater than –

(A) in the case of a debtor in a household of 1 person, the median family income of the applicable State for 1 earner;

(B) in the case of a debtor in a household of 2, 3, or 4 individuals, the highest median family income of the applicable State for a family of the same number or fewer individuals; or

(C) in the case of a debtor in a household exceeding 4 individuals, the highest median family income of the applicable State for a family of 4 or fewer individuals, plus $575 [FN2] per month for each individual in excess of 4.

For purposes of determining the expense component of the disposable income calculation, §1325(b)(2) makes further reference to §707(b)(2)(A) and (B) if the Debtor’s income is above the state median for their size of household. §707(b)(2)(A) and (B) is the expense side of the Means Test, a subject far beyond the scope of this paper. There is a significant body of case law already developed (and continuing to develop) around this life style litigation.

Since it seems highly unlikely anyone with income below the state median would ever consider filing Chapter 11, this section will apply to virtually all Individual Chapter 11 Debtors. The short answer is that an Individual Debtor in a Chapter 11, regardless of whether it’s a Small Business Case or a Big Business Case, will have to live on a Means Test budget for 5 years.

§1129(b)(2)(B)(ii) Abolished Absolute Priority Rule.

(2) For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements:

(B) With respect to a class of unsecured claims –

(i) the plan provides that each holder of a claim of such class receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or

(ii) the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property, except that in a case in which the debtor is an individual, the debtor may retain property included in the estate under §1115, subject to the requirements of subsection (a)(14) of this section.

As we discussed in the early part of this presentation, the Absolute Priority Rule is essentially repealed in all Individual Debtor Cases, although it is effectively replaced with the Disposable Income/Means Test requirement above. Whether this is a net gain or loss is hard to determine, however, given the holding of Ahlers, it is virtually impossible to cram down an individual case where the Debtor seeks to retain any property, whereas, it is at least theoretically possible to live on a Means Test Budget as Chapter 13 debtors do it all the time.

§1127(e) “If your income changes, so can your payments.”

If the debtor is an individual, the plan may be modified at any time after confirmation of the plan but before the completion of payments under the plan, whether or not the plan has been substantially consummated, upon request of the debtor, the trustee, the United States Trustee, or the holder of an allowed unsecured claim, to –

(1) increase or reduce the amount of payments on claims of a particular class provided for by the plan;

(2) extend or reduce the time period for such payments; or

(3) alter the amount of the distribution to a creditor whose claim is provided for by the plan to the extent necessary to take account of any payment of such claim made other than under the plan

Somewhat like in Chapter 13 cases the payments under the Plan can be modified anytime before they are paid in full. The language of this sub-section is identical to Chapter 13 so the well developed body of case law dealing with plan modifications and partial-payment discharge should be equally applicable to this subsection. See §1329 and the 35 pages of head notes thereunder.

Contrast this to an Entity Debtor case, a confirmed Plan cannot be modified after substantial consummation has occurred. §1127(b). Substantial consummation occurs upon commencement of payments. See In re Scotland Guard Services, Inc., 139 B.R. 264, 266 (Bankr.D.Puerto Rico, 1991) and cases cited therein. Since payments typically commence shortly after confirmation, then a confirmed Plan in an entity Debtor case usually is subject to post-confirmation modification for a relatively short period of time. Whether that’s good or bad depends on the circumstances.

This means that the Individual Debtor faces the possibility of their payments to their unsecured creditors going up if the Debtor’s financial picture improves for a period of 5 years. On the plus side, it also means that if the Debtor’s income goes down, they are not stuck with Plan payments that they cannot make. At least this sword cuts both ways.

§1141(d)(2) It’s the same discharge everyone else gets.

A discharge under this chapter does not discharge a debtor who is an individual from any debt excepted from discharge under §523 of this title.

The discharge of an Individual Debtor is the same as the discharge in a Chapter 7, 12 or 13. Individual Debtors get the same discharge in any chapter of bankruptcy relief.

§1141(d)(3) “You cannot have a discharge until you pay (almost) all your payments.”

The confirmation of a plan does not discharge a debtor if –

(A) the plan provides for the liquidation of all or substantially all of the property of the estate;

(B) the debtor does not engage in business after consummation of the plan; and

(C) the debtor would be denied a discharge under §727(a) of this title if the case were a case under Chapter 7 of this title.

(4) The court may approve a written waiver of discharge executed by the debtor after the order for relief under this chapter.

(5) In a case in which the debtor is an individual –

(A) unless after notice and a hearing the court orders otherwise for cause, confirmation of the plan does not discharge any debt provided for in the plan until the court grants a discharge on completion of all payments under the plan;

(B) at any time after the confirmation of the plan, and after notice and a hearing, the court may grant a discharge to the debtor who has not completed payments under the plan if –

(i) the value, as of the effective date of the plan, of property actually distributed under the plan on account of each allowed unsecured claim is not less than the amount that would have been paid on such claim if the estate of the debtor had been liquidated under Chapter 7 on such date; and

(ii) modification of the plan under §1127 is not practicable; and

(C) unless after notice and a hearing held not more than 10 days before the date of the entry of the order granting the discharge, the court finds that there is no reasonable cause to believe that –

(i) §522(q)(1) may be applicable to the debtor; and

(ii) there is pending any proceeding in which the debtor may be found guilty of a felony of the kind described in §522(q)(1)(A) or liable for a debt of the kind described in §522(q)(1)(B).

Once again, Chapter 13 concepts are grafted onto Chapter 11. Unlike entity Debtors who receive a discharge upon confirmation of the Plan, Individual Debtors do not receive their discharge until they make all or substantially all of their payments. The language of this sub-section is identical to Chapter 13, so the well developed body of case law dealing with plan modifications and partial-payment discharge should be equally applicable to this subsection. See §1328 and the 30 pages of head notes thereunder.

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I. A. INTRODUCTION

The purpose of this part of the seminar is to provide a basic approach to the impact of bankruptcy on a landlord in the process of an eviction. All references to the term “lease” herein refer to an “unexpired lease” of real property, unless otherwise specified. This section assumes little or no working knowledge of the Bankruptcy Code.

B. INTRODUCTION TO THE BANKRUPTCY CODE

All Bankruptcy Cases are governed by the provisions of 11 U.S.C. §101 et seq, referred to herein after as the Bankruptcy Code or simply, “the Code.” All statutory citations in this paper refer to specific sections of the Code unless otherwise stated.  This paper deals with the Code as it has been amended to date, including the most recent amendments of the Bankruptcy Abuse and Consumer Protection Act of 2005 (the “Reform Act”). The Reform Act was signed by the President on April 20, 2005; however, the majority of its provisions did not become effective until October 17, 2005.  This paper will assume that the Bankruptcy Case was filed after October 17, 2005 and that such case is subject to all provisions of the Reform Act.

The Code creates 6 different types of bankruptcy cases which may be filed. Specifically, Chapters 7, 9, 11, 12, 13 and 15 all create different types of relief available to various different types of debtors. Chapter 7 is what is known as liquidation bankruptcy, although, the actual liquidation of an asset only occurs in about 5% of such cases filed in Oklahoma.

Chapters 9, 11, 12 and 13 are all referred to as “reorganizations” because they all contemplate a continuation of the debtor in some form subject to debts which have been modified by a device known as a plan. A plan is really nothing more than a court enforced loan modification agreement wherein the debtor rewrites the terms of all their debt on a global basis.

Chapter 9 is a municipal reorganization which is a very specialized type of bankruptcy case and is far beyond the scope of this seminar.

Chapter 11 is designed for public corporations, but almost any type of entity or individual may file such a case.

Chapter 12 is a very powerful, but also a very limited reorganization which may only be utilized by family farmers. There are very few Chapter 12 cases filed and therefore, such matters are beyond the scope of this seminar.

Chapter 13 is a sort of individual reorganization which may only be used by natural persons.

Finally, Chapter 15 is limited to what are referred to as “Cross-border insolvency cases” wherein the primary insolvency proceeding is filed in a foreign country and such company has assets located within the United States. Such cases are far beyond the scope of this seminar.

Each reorganization chapter has subchapters which define the administration of the estate under rules which are unique to the particular chapter and which define the various rules related to each unique chapter.

The Bankruptcy Code as we know it today was passed in 1978 as a complete overhaul of the then existing Bankruptcy Act. It has been amended several times, but none of the amendments really made sweeping types of changes and were mostly limited to smaller adjustment types of amendments. Most recent of these amendments is the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Reform Act”) The Reform Act made substantial changes to many aspects of the Code.

II. INITIAL CONSIDERATIONS

The first notice of bankruptcy that a creditor will receive is known commonly as the “341 notice.” This notice will be received in the mail and involves several important pieces of information. One of the initial reactions to the receipt of a 341 notice, especially if litigation is pending, is anger. However, creditors are not without defense to a bankruptcy. However, more so than any other area of the law which I have encountered, you must actively participate in the case before any relief may be received. Anyone who stands by and does nothing upon receiving a bankruptcy notice generally will get out of it exactly what they put into it. Upon receipt of the 341 notice, you should calendar the dates for the initial meeting of creditors, 30 days thereafter to object to exemptions, 60 days thereafter to object to the discharge or file a complaint to determine an exception to discharge, and any bar date for filing proofs of claim.

Also, you must determine what chapter the debtor is filing. This is simply a matter of reading the notice. If the case is a “reorganization” chapter, i.e. Chapter 11, 12, or 13, the considerations for creditor’s counsel are far more complex than in a Chapter 7. It is recommended that if you have never been involved in such a case before, that you associate with someone who has experience in such matters.

Throughout this paper, you will see references to objections and court hearings. It is important to remember that while the Bankruptcy Code grants specific and meaningful special rights to landlords, that “The Bankruptcy Court is a court of equity and will do equity in this case. The court does not favor granting a windfall to landlords in derogation of the purposes of bankruptcy reorganization.” See, In re Huntington Ltd., 654 F.2d 578, 584 (9th Cir.1980); In re Queens Blvd. Wine & Liquor Corp., 503 F.2d 202, 205 (2d Cir.1974).” In re Prime Motor Inns, Inc., 166 B.R. 993, 997 (Bankr.S.D.Fla., 1994). To put it another way, while pigs tend to get fat, hogs tend to get slaughtered.

As with most bankruptcy issues there is a specific section of the Code applicable to unexpired leases. 11 U.S.C. § 365 provides in relevant parts related to real property leases:

(a) Except as provided in sections 765 and 766 of this title and in subsections (b), (c), and (d) of this section, the trustee, subject to the court’s approval, may assume or reject any executory contract or unexpired lease of the debtor.

(b)(1) If there has been a default in an executory contract or unexpired lease of the debtor, the trustee may not assume such contract or lease unless, at the time of assumption of such contract or lease, the trustee –

(A) cures, or provides adequate assurance that the trustee will promptly cure, such default other than a default that is a breach of a provision relating to the satisfaction of any provision (other than a penalty rate or penalty provision) relating to a default arising from any failure to perform nonmonetary obligations under an unexpired lease of real property, if it is impossible for the trustee to cure such default by performing nonmonetary acts at and after the time of assumption, except that if such default arises from a failure to operate in accordance with a nonresidential real property lease, then such default shall be cured by performance at and after the time of assumption in accordance with such lease, and pecuniary losses resulting from such default shall be compensated in accordance with the provisions of this paragraph;

(B) compensates, or provides adequate assurance that the trustee will promptly compensate, a party other than the debtor to such contract or lease, for any actual pecuniary loss to such party resulting from such default; and

(C) provides adequate assurance of future performance under such contract or lease.

(2) Paragraph (1) of this subsection does not apply to a default that is a breach of a provision relating to –

(A) the insolvency or financial condition of the debtor at any time before the closing of the case;

(B) the commencement of a case under this title;

(C) the appointment of or taking possession by a trustee in a case under this title or a custodian before such commencement; or

(D) the satisfaction of any penalty rate or penalty provision relating to a default arising from any failure by the debtor to perform nonmonetary obligations under the executory contract or unexpired lease.

(3) For the purposes of paragraph (1) of this subsection and paragraph (2)(B) of subsection (f), adequate assurance of future performance of a lease of real property in a shopping center includes adequate assurance –

(A) of the source of rent and other consideration due under such lease, and in the case of an assignment, that the financial condition and operating performance of the proposed assignee and its guarantors, if any, shall be similar to the financial condition and operating performance of the debtor and its guarantors, if any, as of the time the debtor became the lessee under the lease;

(B) that any percentage rent due under such lease will not decline substantially;

(C) that assumption or assignment of such lease is subject to all the provisions thereof, including (but not limited to) provisions such as a radius, location, use, or exclusivity provision, and will not breach any such provision contained in any other lease, financing agreement, or master agreement relating to such shopping center; and

(D) that assumption or assignment of such lease will not disrupt any tenant mix or balance in such shopping center.

(4) Notwithstanding any other provision of this section, if there has been a default in an unexpired lease of the debtor, other than a default of a kind specified in paragraph (2) of this subsection, the trustee may not require a lessor to provide services or supplies incidental to such lease before assumption of such lease unless the lessor is compensated under the terms of such lease for any services and supplies provided under such lease before assumption of such lease.

(c) The trustee may not assume or assign any executory contract or unexpired lease of the debtor, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties, if –

(1)(A) applicable law excuses a party, other than the debtor, to such contract or lease from accepting performance from or rendering performance to an entity other than the debtor or the debtor in possession, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties; and

(B) such party does not consent to such assumption or assignment; or

(2) such contract is a contract to make a loan, or extend other debt financing or financial accommodations, to or for the benefit of the debtor, or to issue a security of the debtor; or

(3) such lease is of nonresidential real property and has been terminated under applicable nonbankruptcy law prior to the order for relief.

[(4) Repealed. Pub.L. 109-8, Title III, § 328(a)(2)(C), Apr. 20, 2005, 119 Stat. 100]

(d)(1) In a case under Chapter 7 of this title, if the trustee does not assume or reject an executory contract or unexpired lease of residential real property or of personal property of the debtor within 60 days after the order for relief, or within such additional time as the court, for cause, within such 60-day period, fixes, then such contract or lease is deemed rejected.

(2) In a case under Chapter 9, 11, 12, or 13 of this title, the trustee may assume or reject an executory contract or unexpired lease of residential real property or of personal property of the debtor at any time before the confirmation of a plan but the court, on the request of any party to such contract or lease, may order the trustee to determine within a specified period of time whether to assume or reject such contract or lease.

(3) The trustee shall timely perform all the obligations of the debtor, except those specified in section 365(b)(2), arising from and after the order for relief under any unexpired lease of nonresidential real property, until such lease is assumed or rejected, notwithstanding section 503(b)(1) of this title. The court may extend, for cause, the time for performance of any such obligation that arises within 60 days after the date of the order for relief, but the time for performance shall not be extended beyond such 60-day period. This subsection shall not be deemed to affect the trustee’s obligations under the provisions of subsection (b) or (f) of this section. Acceptance of any such performance does not constitute waiver or relinquishment of the lessor’s rights under such lease or under this title.

(4)(A) Subject to subparagraph (B), an unexpired lease of nonresidential real property under which the debtor is the lessee shall be deemed rejected, and the trustee shall immediately surrender that nonresidential real property to the lessor, if the trustee does not assume or reject the unexpired lease by the earlier of –

(i) the date that is 120 days after the date of the order for relief; or

(ii) the date of the entry of an order confirming a plan.

(B)(i) The court may extend the period determined under subparagraph (A), prior to the expiration of the 120-day period, for 90 days on the motion of the trustee or lessor for cause.

(ii) If the court grants an extension under clause (i), the court may grant a subsequent extension only upon prior written consent of the lessor in each instance.

(5) The trustee shall timely perform all of the obligations of the debtor, except those specified in section 365(b)(2), first arising from or after 60 days after the order for relief in a case under Chapter 11 of this title under an unexpired lease of personal property (other than personal property leased to an individual primarily for personal, family, or household purposes), until such lease is assumed or rejected notwithstanding section 503(b)(1) of this title, unless the court, after notice and a hearing and based on the equities of the case, orders otherwise with respect to the obligations or timely performance thereof. This subsection shall not be deemed to affect the trustee’s obligations under the provisions of subsection (b) or (f). Acceptance of any such performance does not constitute waiver or relinquishment of the lessor’s rights under such lease or under this title.

(e)(1) Notwithstanding a provision in an executory contract or unexpired lease, or in applicable law, an executory contract or unexpired lease of the debtor may not be terminated or modified, and any right or obligation under such contract or lease may not be terminated or modified, at any time after the commencement of the case solely because of a provision in such contract or lease that is conditioned on –

(A) the insolvency or financial condition of the debtor at any time before the closing of the case;

(B) the commencement of a case under this title; or

(C) the appointment of or taking possession by a trustee in a case under this title or a custodian before such commencement.

(2) Paragraph (1) of this subsection does not apply to an executory contract or unexpired lease of the debtor, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties, if –

(A)(i) applicable law excuses a party, other than the debtor, to such contract or lease from accepting performance from or rendering performance to the trustee or to an assignee of such contract or lease, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties; and

(ii) such party does not consent to such assumption or assignment; or

(B) such contract is a contract to make a loan, or extend other debt financing or financial accommodations, to or for the benefit of the debtor, or to issue a security of the debtor.

(f)(1) Except as provided in subsections (b) and (c) of this section, notwithstanding a provision in an executory contract or unexpired lease of the debtor, or in applicable law, that prohibits, restricts, or conditions the assignment of such contract or lease, the trustee may assign such contract or lease under paragraph (2) of this subsection.

(2) The trustee may assign an executory contract or unexpired lease of the debtor only if –

(A) the trustee assumes such contract or lease in accordance with the provisions of this section; and

(B) adequate assurance of future performance by the assignee of such contract or lease is provided, whether or not there has been a default in such contract or lease.

(3) Notwithstanding a provision in an executory contract or unexpired lease of the debtor, or in applicable law that terminates or modifies, or permits a party other than the debtor to terminate or modify, such contract or lease or a right or obligation under such contract or lease on account of an assignment of such contract or lease, such contract, lease, right, or obligation may not be terminated or modified under such provision because of the assumption or assignment of such contract or lease by the trustee.

(g) Except as provided in subsections (h)(2) and (i)(2) of this section, the rejection of an executory contract or unexpired lease of the debtor constitutes a breach of such contract or lease –

(1) if such contract or lease has not been assumed under this section or under a plan confirmed under Chapter 9, 11, 12, or 13 of this title, immediately before the date of the filing of the petition; or

(2) if such contract or lease has been assumed under this section or under a plan confirmed under Chapter 9, 11, 12, or 13 of this title –

(A) if before such rejection the case has not been converted under section 1112, 1208, or 1307 of this title, at the time of such rejection; or

(B) if before such rejection the case has been converted under section 1112, 1208, or 1307 of this title –

(i) immediately before the date of such conversion, if such contract or lease was assumed before such conversion; or

(ii) at the time of such rejection, if such contract or lease was assumed after such conversion.

Please note there are specific provisions in the Code related to shopping center leases and various other specialized topics. Because this seminar deals with evictions, it is assumed that the lease in question was breached prior to the bankruptcy being filed.

It is important to remember that a lease may not be permanently modified by the Bankruptcy Court. A Debtor does not have the right to extend or vary terms of assumed executory contracts, and the court has no authority to vary terms of a contract assumed under provisions of law. In re Rigg, 198 B.R. 681(Bankr.N.D.Tex.1996). However, there are certain exceptions to this general rule. For example, the statutory prohibition against any modification of an unexpired lease based on debtor’s assumption or assignment thereof was prohibition that could be waived by those for whose benefit it was enacted. In re J.F. Hink & Son, 815 F.2d 1314 (9^th Cir.1987). Also, it was held in one case that the anti-assignment and subletting provisions in Chapter 11 debtor’s shopping mall lease that were not unreasonable on their face, would not be permanently excised from lease, but would be set aside merely to allow debtor to assign property to its proposed assignee, with assignee thereafter being subject to provisions for purposes of its subletting efforts. In re Rickel Home Centers, Inc., 240 B.R. 826 (D.Del.1998).

It has become very common practice in large retail bankruptcy cases such as Goody’s Family Clothing, Inc., Case No. 08-11133-CSS Bankr. Ct. Delaware and locally, in Harold’s Stores, Inc., Case No. 08- 15027, Bankr. Ct. Western District of Oklahoma, to see pleadings filed wherein the Debtor proposes to sell a large number of retail leases at a public auction. To facilitate such sales you will often see a motion filed very early in the case wherein the Debtor seeks approval what are innocuously called a something like:

DEBTORS’MOTION FOR ORDER (A) AUTHORIZING DEBTORS TO ENTER INTO STALKING HORSE AGREEMENT IN CONNECTION WITH STORE CLOSING SALES (B) APPROVING PAYMENT OF TERMINATION FEE IN CONNECTION THEREWITH (C) APPROVING BIDDING PROCEDURES IN CONNECTION THEREWITH (D) SETTING AUCTION AND HEARING DATES AND ESTABLISHING NOTICE PROCEDURES (E) APPROVING STORE CLOSING SALES PURSUANT TO BANKRUPTCY CODE SECTIONS 105 AND 363

Attached to the Motion will be an agreement with a real estate marketing company commonly referred to as a “liquidating agent” and attached to the agreement will be yet another document the “closing sales guidelines” or some similar name. Typically buried in this large pile of documents, you will file a store sale and closing “guideline” which will very commonly give the liquidating agent to effectively ignore many of the restrictive covenants founds in most commercial shopping center leases such as the use of a large going out of business sale banners hung on the outside of the mall; the use of “sign walkers,” persons wearing “sandwich boards,” or carrying placard signs advertising the sales in the shopping center common areas, parking lots, or on any of the streets or access ways immediately adjacent to any of the Landlords’ shopping center premises and other similar types of relief that any Landlord will rightly consider a modification of the terms of its lease. You must carefully review such motions and timely file an objection to the relief requested. It is very common in Delaware to see such motions file on the very first day of the case and to see a hearing set 3 or 4 days later. In such cases, you must move very quickly to protect your client’s rights.

III. RESIDENTIAL OR NON-RESIDENTIAL?

In the context of a landlord-tenant dispute, you must determine if the lease is residential or non-residential in nature. The Bankruptcy Code, found in 11 U.S.C. §101 et seq., and hereinafter referred to as the “Code,” makes a significant distinction between leases of real property which are residential and those which are not. Though these terms are not defined in the Code, nor by any real clear case law, it is apparent that “residential” means an individual person’s home as opposed to a business or other non-homestead type of use. Thus, the first analysis you must do is determine this point.

IV. PROPERTY OF THE ESTATE

As with all other property interests owned by a debtor, a debtor’s interest in a lease of real estate becomes property of the Bankruptcy Estate. A leasehold interest is “property of estate,” which the debtor may assume or reject, only if the debtor is lessee of property at time that bankruptcy petition is filed. In re Arizona Appetito’s Stores, Inc. 893 F.2d 216 (9^th Cir. 1990). Thus, the debtor’s rights in a lease of real property is based on the facts and circumstances that existed on the day the bankruptcy case was filed (the “Petition Date”). The filing of a petition for relief in bankruptcy results in a direct impairment of a creditor’s ability to effect or control any property of the estate, so upon receipt of any actual notice of the filing of a bankruptcy petition means you must generally cease prosecution of the eviction case in whatever non-bankruptcy forum it is pending and move your fight to the Bankruptcy Court, although as you will see there is one possible exception to this general rule.

V. A. AUTOMATIC STAY

The impediment to the actions of a creditor or landlord is the referred to as the “Automatic Stay” which comes into existence upon the filing of the bankruptcy case. The Court will issue and the clerk of the court will mail out a notice of the filing of a bankruptcy case known as the “§341 notice” which provides for notice of the imposition of the automatic stay.  It is beneficial to conceptualize a bankruptcy case as a request for an injunction. The issuance of the automatic stay amounts to an ex parte temporary restraining order, which ultimately ripens into a permanent injunction upon the issuance of the discharge. Thus, the Automatic Stay remains in effect from the moment in time when the bankruptcy petition is filed until such time the discharge is entered, the case is dismissed, or an order is entered modifying or terminating the stay. The automatic stay is governed by §362. Essentially, this injunction enjoins all creditors (including landlords) from taking any action against the debtor or any property of the estate. Since all unexpired leases are property of the estate, then the Automatic Stay generally enjoins any action to evict a tenant who has filed bankruptcy.

B. EXCEPTION TO STAY FOR RESIDENTIAL LEASES WHEN JUDGMENT FOR POSSESSION HAS BEEN OBTAINED PRE-PETITION

There are several exceptions to the Automatic Stay are set forth in §362(b), one of which was added by BAPCPA and is specifically directed at the residential eviction proceedings. A new subsection (b)(22) provides:

(b) The filing of a petition under section 301, 302, or 303 of this title, or of an application under section 5(a)(3) of the Securities Investor Protection Act of 1970, does not operate as a stay –

(22) subject to subsection (l), under subsection (a)(3), of the continuation of any eviction, unlawful detainer action, or similar proceeding by a lessor against a debtor involving residential property in which the debtor resides as a tenant under a lease or rental agreement and with respect to which the lessor has obtained before the date of the filing of the bankruptcy petition, a judgment for possession of such property against the debtor;

§362(l) provides an exception to the newly added first new exception discussed immediately above for landlords in new §362(b)(22) as follows:

(l)(1) Except as otherwise provided in this subsection, subsection (b) (22) shall apply on the date that is 30 days after the date on which the bankruptcy petition is filed, if the debtor files with the petition and serves upon the lessor a certification under penalty of perjury that –

(A) under nonbankruptcy law applicable in the jurisdiction, there are circumstances under which the debtor would be permitted to cure the entire monetary default that gave rise to the judgment for possession, after that judgment for possession was entered; and

(B) the debtor (or an adult dependent of the debtor) has deposited with the clerk of the court, any rent that would become due during the 30-day period after the filing of the bankruptcy petition.

This provision provides that the stay would be in effect for 30 days post-petition if at the time the debtor files the bankruptcy petition, they also file a certification under penalty of perjury that there are circumstances recognized by applicable nonbankruptcy law that would permit the debtor to cure “the entire monetary default that gave rise to the judgment for possession.” In addition, the debtor must deposit with the clerk of the court sufficient money to pay any rent becoming due during the 30-day post-petition period. The debtor accomplishes both of these requirements, then the new exception to the stay for eviction judgments is delayed for 30 days. Thereafter, if during this 30-day post-petition period the debtor (or an adult dependant of the debtor) can obtain a further extension if they comply with §362(l)(2) which states:

(2) If, within the 30-day period after the filing of the bankruptcy petition, the debtor (or an adult dependent of the debtor) complies with paragraph (1) and files with the court and serves upon the lessor a further certification under penalty of perjury that the debtor (or an adult dependent of the debtor) has cured, under nonbankrupcty law applicable in the jurisdiction, the entire monetary default that gave rise to the judgment under which possession is sought by the lessor, subsection (b)(22) shall not apply, unless ordered to apply by the court under paragraph (3).

In effect, the debtor must put up the money for the 30-day post-petition period with the petition, then pay the additional money required to fully cure any monetary defaults that gave rise to the eviction judgment. This section requires two certifications under penalty of perjury to be filed with the Court Clerk certifying such payments. In such certifications are filed, but the landlord disputes the truthfulness of either or both, then the landlord may obtain relief under §362(l)(3) which provides:

(3)(A) If the lessor files an objection to any certification filed by the debtor under paragraph (1) or (2), and serves such objection upon the debtor, the court shall hold a hearing within 10 days after the filing and service of such objection to determine if the certification filed by the debtor under paragraph (1) or (2) is true.

Assuming the debtor meets all of these requirements, then the stay enjoins the eviction and continues in effect until the court ordered otherwise, but if the landlord objects to the certification, a hearing must be held within 10 days of the objection.

This new exception to the stay give substantial relief to residential landlords because the tenant cannot the filing of a bankruptcy case to stop a residential eviction when a judgment has been obtained unless they have the cash to pay the rent coming due and cure all of the back rent. All of this seems unlikely to apply in very many cases in Oklahoma given the lack of rent controlled leases found in places like New York City and the fact that if the debtor had the money required to make the payments needed to obtain this relief, they probably would not be in a fight with the landlord in the first place.

C. EXCEPTION FOR ENDANGERMENT OF SUCH PROPERTY OR THE ILLEGAL USE OF CONTROLLED SUBSTANCES

Another new exception to the automatic stay is §362(b)(23) which excludes from the stay, except as provided in new subsection 362(m) as follows:

(b) The filing of a petition under section 301, 302, or 303 of this title, or of an application under section 5(a)(3) of the Securities Investor Protection Act of 1970, does not operate as a stay –

(23) subject to subsection (m), under subsection (a)(3), of an eviction action that seeks possession of the residential property in which the debtor resides as a tenant under a lease or rental agreement based on endangerment of such property or the illegal use of controlled substances on such property, but only if the lessor files with the court, and serves upon the debtor, a certification under penalty of perjury that such an eviction action has been filed, or that the debtor, during the 30-day period preceding the date of the filing of the certification, has endangered property or illegally used or allowed to be used a controlled substance on the property;

For this section to apply, the eviction action must be related to residential property in which the debtor resides as a tenant and the basis for the if the eviction action must be is based on an endangerment of such property or the illegal use of controlled substances on such property.  This exception is not automatic, but requires the landlord to file with the clerk of the bankruptcy court a certification under penalty of perjury wherein the landlord’s must assert that an eviction proceeding has begun or that the necessary endangerment or illegal use has occurred within 30 days of the bankruptcy filing.

If this landlord complies with §362(b)(23), the also new §362(m) provides an avenue for the debtor to obtain relief if they object to the “truth or legal sufficiency” of the landlord’s certification within 15 days of the filing of the landlord’s certification.  If both the landlord and the debtor comply with their respective filing obligations, then the stay continues in effect until the Court holds a hearing which must be within within 10 days of the debtor’s objection. At the hearing, the debtor has the burden of satisfying the court that the conditions complained of by the landlord did not exist or have been remedied, the stay will continue in effect until the discharge is entered.  On the other hand, if the debtor fails to meet their burden, then stay is terminated without any further filings by the landlord.

In the alternative, if the debtor fails to file the 15 day objection under §362(m), then the exception under §362(b)(23) “shall apply immediately upon such failure and relief from the stay provided under subsection (a)(3) shall not be required to enable the lessor to complete the process to recover full possession of the property.”  In either case, the clerk of the bankruptcy court must “immediately serve upon the lessor and the debtor” either a certified copy of the court’s order upholding the lessor’s certification or a “certified copy of the docket” indicating the debtor failed to file the 15 day objection to the lessor’s certification. Thus, the landlord who faces a tenant running a meth lab or other illegal or dangerous use of the property has a new and expeditious way to obtain relief from the stay.

D. NO EXCEPTIONS FOR COMMERCIAL LEASES OR LANDLORDS WHO DO NOT HAVE AN EVICTION JUDGMENT

None of these new exceptions apply to commercial leases in any manner nor do they apply to residential landlords who do not yet have an eviction judgment. Actions in all such cases are NOT exempt from the stay.  In these more common situations, it is critical that all collection and eviction actions be stopped upon receipt of notice of the filing of the case. If you discover that for some reason such activities have not ceased, take corrective measures to stop them at once.  Section 362(h) creates a cause of action for damages, both actual and punitive, attorney’s fees and costs, for any creditor who willfully violates the provisions of §362. Bankruptcy Judges take a very dim view of creditors who intentionally violate the Automatic Stay after they have been asked to stop, and usually require such creditors to pay for such transgressions. You can’t win this one, so don’t try it.

Any “willful” act taken in violation of the Automatic Stay, after receipt of the actual notice of the stay, justifies award of actual damages, which includes attorneys fees. If there are additional findings of maliciousness or bad faith on part of the creditor, then the imposition of punitive damages is appropriate. In re Crysen/Montenay Energy Co., 902 F.2d 1098 (2d Cir. 1990). For example, in one local case, Judge Terrance Michael awarded $2,850.00 in actual damages, $15,000.00 in attorney fees, plus $40,000.00 in punitive damages against a creditor who repossessed a debtor’s car in violation of the stay in a Chapter 13 case. In re Diviney, 211 B.R. 951, (Bankr.N.D.Okla. 1997). It is a very risky course to assume that the stay does not apply to you. Unless the debtor/tenant has already vacated the premises and you have taken affirmative actions to terminate the lease prior to the Petition Date, then the Automatic Stay applies. If there is any doubt, err on the side of caution, because if you are wrong, then you will have to pay any damages which result from your acts. The best course is to obtain relief from the stay.

E. OBTAINING RELIEF FROM THE STAY

Relief from the stay in such cases may only be obtained by the filing of a motion for relief from the stay pursuant to §362(d). The motion must be filed with the Court after paying the filing fee (presently $60.00) and providing notice to appropriate parties. The debtor generally cannot successfully oppose, unless the property sought by the creditor may be retained by assumption of the lease. Section 362(d) provides for relief from the stay when there is no equity in the property and the property is not necessary for an effective reorganization. Clearly, in a Chapter 7 there is not ever going to be a reorganization, since the purpose of Chapter 7 is liquidation and not reorganization, so the creditor is almost always going to be entitled to relief from the stay. The Chapter 7 Trustee may oppose relief from the stay only if the unexpired lease is related to residential property that is not the Debtor’s home since a Trustee is only interested in property not claimed as exempt that has value in excess of the encumbrances upon such property.

In the case of a lease, the Trustee would typically only be interested if the market value of the leasehold were significantly in excess of the contractual rent. In such a case, the Trustee may try to extract the “equity” in the unexpired lease or sell and assign the lease to a third party to obtain money to be distributed to unsecured creditors. If this occurs, the Trustee may only sell the lease and assign it to a new lessor if the lease is assumed as discussed below. This situation is highly unlikely in the context of a residential property due to the homestead rights of the debtor, but you should be aware of this point when advising your client about the likelihood of obtaining relief from the stay.

The leasehold also should be abandoned from the estate pursuant to §554. The legal effect of such is to remove the leasehold from the Bankruptcy Estate. If this is not accomplished, then you must give notice to the Trustee of any subsequent action taken. The abandonment of property is accomplished through a motion to compel abandonment under §554, and the only real issue is value of the leasehold to the estate. If the property is burdensome to the Trustee and has no value, the Court will determine it to be abandoned. This is the same issue that will arise with the Trustee in a motion for relief from the stay. Consequently, most Courts do not have a problem with a combined motion for relief from stay and to compel the trustee to abandon the property.

If you are successful in obtaining an order granting relief from the stay and determining that the leasehold has been abandoned from the bankruptcy estate, then you may proceed with the eviction as if there were no bankruptcy except for the enforcement of any claims for an in personam money judgment against the tenant/debtor.

VI. CREDITORS MEETING

After the filing of the petition, the next major event to occur in a Chapter 7 case is the first meeting of creditors pursuant to §341. The debtor’s attendance at the creditors meeting is mandatory, §343. The creditors meeting is attended and presided over officially by the United States Trustee, but typically by the panel trustee who has been appointed in a particular case. Any creditor who wishes to attend may do so and inquire of the debtor.  f you have any real issues, make sure you get the testimony of both debtors if its a joint case. See In Re Osborn, supra.

Creditors meetings are conducted under oath by the Trustee, but interestingly enough the Court is expressly prohibited from presiding over any creditors meeting. §341(c). The meeting is taped, but there is no court reporter unless you bring one.  If you expect a serious contest in the case, it is a good idea to take a reporter with you to the meeting so you will have a reliable record of the proceedings.

In representing a landlord at creditor’s meetings, the basic preparation should include a review of the schedules, the statement of financial affairs, and the documentation of the claim. The Trustee is usually interested in assets since that’s how trustees get paid. The Trustee will inquire if the debtor has listed all their assets on the schedules and if any particular asset is of interest to the Trustee, questions will be presented regarding such asset. Also, the Trustee may have questions of the debtor regarding perfection of various creditors’ security interests in certain assets. Additionally, the question of exempt property may be covered at the creditors meeting. Essentially, the creditors meeting is a period of discovery wherein the Trustee and the creditors have a chance to interview and effectively take the deposition of the debtor regarding potential assets of the estate.

The creditors meeting is a good time to get issues resolved in the case since all of the real parties in interest are typically present. If you have already filed a motion for relief from the stay or to compel rejection of the lease, but such has not yet been heard by the Court, then many times such motions can be resolved at this meeting, so it may be worth your time to attend. It is no secret that a face to face meeting with all the real players often results in a resolution of a disputed issue, particularly when there may not be any real legal dispute, but merely an effort by the Debtor to delay the an evitable eviction.

If you believe there is some basis for challenging the discharge, then you should appear and inquire about the conduct of the debtor preparatory to the commencement of a complaint pursuant to §523 or §727.  The benefit to this is that most of the time the debtor is not as well prepared to testify as they will be in a deposition setting since they really don’t know what you are going to do..

VII. ASSUMPTION OR REJECTION OF THE LEASE

The central issue when dealing with any lease in the context of a bankruptcy filing is typically the assumption or rejection of the lease. If you file a motion for relief from stay requesting you be permitted to continue an eviction action on a lease, then the only real objection you are likely to draw is that the debtor or the Trustee wants to assume the lease. In such situations, then they will likely object to a stay relief motion by arguing that they has such intention and that therefore, you should not be permitted to continue the eviction action. Therefore, it is important to discuss the issue of the assumption and rejection of a lease.

First of all, what do these terms mean and what is the legal effect of each? Conceptually, the rejection of the lease is nothing more than a statutorily authorized breach of the lease. If the Trustee/Debtor/Tenant rejects a lease, then they must vacate the premises and the lease is terminated.  Conversely, the assumption of the lease means that it continues in full force and effect and the Trustee/Debtor/Tenant is legally obligated to perform all of the provisions of the lease post-petition despite the filing of the bankruptcy petition. This paper will first discuss basic issues related to the assumption of a lease then it will deal with rejection to the lease.

VIII. ASSUMPTION

Who is entitled to assume a lease? The bankruptcy debtor, or its trustee, is allowed, with permission of bankruptcy court, to assume an executory contract, or contract on which performance remains due to some extent on both sides, and thereby prevent other contracting party from terminating contract. In re Ionosphere Clubs, Inc., 85 F3d 992 (2d Cir.1996). The real party in interest with standing to assume a lease depends upon the chapter under which relief has been sought. A Chapter 7 debtor, who did not have standing to assume or reject his unexpired lease, likewise did not have standing to ask for extension of time to assume or reject; question of whether to seek extension was one for Chapter 7 trustee. In re Gatea, Bankr. 227 B.R. 695 (S.D.Ind.1997). A Chapter 7 debtor does not have standing to assume unexpired lease of residential real property, as Bankruptcy Code provides for assumption of lease by debtor only in reorganization chapters and provides for automatic rejection upon trustee’s failure to act. In re Rodall, Bankr., 165 B.R. 506 (M.D.Fla.1994). Thus, in a Chapter 7, it is clear the Debtor/Tenant has no rights to assume a lease, nor ask for any extension of time on the automatic rejection of a lease (discussed below).

In a Chapter 11 case, the debtor in possession is the party with standing to assume a lease.  With certain exceptions, a debtor-in-possession under Chapter 11 exercises the rights and powers of a Chapter 11 trustee and, therefore, a debtor-in- possession may reject executory contracts. In re Rovine Corp., 5 B.R. 402 (Bankr.W.D.Tenn.1980).  See also, In re Devlin, 185 B.R. 376 Bankr.M.D.Fla.1995). This is true since the debtor in possession statutorily endowed with the powers of a trustee, unless a Chapter 11 trustee has been appointed.

Although Chapter 13’s always have a trustee, most courts have held that the debtor nonetheless has standing to assume a lease.  While the Bankruptcy Code expressly permits rejection or assumption of debtor’s executory contracts or unexpired leases only by trustee, a Chapter 13 debtor could properly reject tenancy-at-will rental agreement. In re Brewer, 233 B.R. 825 Bankr.E.D.Ark.1999).  See also, In re Jackson,105 B.R. 418 (Bankr.S.D.Ohio 1989).

IX. LEASE TERMINATION

When is it too late for the debtor to assume a lease? When considering a motion to assume or reject lease, the Bankruptcy Court must first determine whether there is any lease to assume or reject, or whether lease expired by its own terms before bankruptcy petition was filed.  In re Kong, 162 B.R. 86 (Bankr.E.D.N.Y.1993). When making this determination, it should be noted that the provisions of the Bankruptcy Code allowing unexpired leases to be assumed requires the Bankruptcy Court to consider whether the lease has ended under state law.  Robinson v. Chicago Housing Authority, 54 F.3d 316 (7^th Cir. 1995). So, one must look to the law of the state that controls the rights of the parties to the lease for the answer to the question of whether the debtor had any rights remaining in the lease to allow an assumption of such lease.

It also matters whether the lease terms have lapsed or not. “Termination at the expiration and expired by its own terms have been held to encompass leases ended by a default based termination prior to a lease running to the end of its initially set term.” Robinson v. Chicago Housing Authority, 54 F.3d 316, 320 (7th Cir.1995) (“Hence we conclude that federal law draws no meaningful distinction between ‘expired’ and ‘terminated’ residential leases and does not provide greater federal protection for lessees under residential leases, the stated terms of which have not run, even though they have been otherwise terminated. Instead, the federal law allowing ‘unexpired’ leases to be assumed calls for a determination whether a lease has ended under state law.”  In re Moore, 290 B.R. 851, 884 (Bankr.N.D.Ala., 2003).

In addition, the answer depends upon whether the leasehold is the debtor’s home or not. Here is one place where it matters whether or not the lease is residential or not. Because while “§ 365(c)(3), which provides that nonresidential leases cannot be assumed if they have been ‘terminated under applicable nonbankruptcy law.’, the same is not true for residential leases.” Robinson v. Chicago Housing Authority, supra.316. The reported cases show a definite bias in favor of residential property, no doubt because its usually the debtor’s home. A Chapter 13 debtor retained right to cure and assume residential lease when she filed bankruptcy petition after landlord obtained judgment for immediate possession of leasehold premises in forcible entry and detainer aaction, but before she was served with writ of assistance; execution of writ of assistance was point in eviction process under Oklahoma law, as predicted by Bankruptcy Court, that debtor’s rights in leased property would have been extinguished, and therefore debtor’s rights had not yet “expired,” for purposes of Bankruptcy Code’s assumption of unexpired lease provisions, at time petition was filed. In re Mims, 195 B.R. 472 (Bankr.W.D.Okla.1996). For a Chapter 13 Debtor/Tenant to assume unexpired residential lease that has been terminated prepetition under state law, debtor must retain some leasehold interest, even after termination, which may be only a possessory interest.  Matter of DiCamillo, 206 B.R. 64 (Bankr.D.N.J.1997) For purposes of application of Chapter 13 debtor’s right to cure default and maintain payments under residential lease, “expired” did not equate to default or terminated, nor did it require that original contract term had passed, but rather, lease was not “expired,” until execution of writ of possession by service upon tenant debtor. In re Talley, 69 B.R. 219(Bankr.M.D.Tenn.1986). Finally, in the most extreme case I found, one court held that a lease which has been terminated under nonbankruptcy law may, despite that fact, be an “unexpired lease” under the bankruptcy statute governing assumption of executory contracts and unexpired leases, and, ipso facto, may be an “unexpired lease” of residential real property which may be assumed by Chapter 13 debtor even though lease may have been terminated under nonbankruptcy law prior to bankruptcy. In re Morgan, 181 B.R. 579 (Bankr.N.D.Ala.1994). The bottom line on a debtor’s home is that you are never free of worry about the intervention of a bankruptcy filing unless you have actually evicted the debtor. This was the intention of Congress in adopting the provisions of §365; “The application of these provisions is limited to non-residential leases in order to avoid depriving residential tenants of whatever consumer protection they may have under applicable non-bankruptcy law.” S. Rep. No. 65, 98th Cong., 1st Sess., 37 (1983)

On the other hand, in the case of a non-residential lease, the standard is much lower. Where debtor defaulted on rental payments, landlord elected to terminate the lease in accordance with its provisions and applicable state law, and debtor did not thereafter cure the default within the grace period provided, the lease was terminated prior to the filing of the bankruptcy petition, and thus the lease was “expired” for purposes of this section, providing that debtor may assume any unexpired lease of the debtor, and may cure the default or provide adequate assurance that it will promptly cure the default; therefore landlord was entitled to termination of automatic stay to proceed with eviction proceedings. In re Foxfire Inn of Stuart Florida, Inc., 30 B.R. 30 (Bankr.S.D. Fla.1983). A Debtor may not assume a lease that has been validly terminated prior to filing for bankruptcy. In re Gateway Investors, Ltd., 113 B.R. 564 (Bankr.D.N.D.1990). A Debtor may not assume a lease once it has expired. Matter of Escondido West Travelodge, 52 B.R. 376 (S.D.Cal.1985). See also, In re Consolidated Pier Deliveries, Inc., 53 B.R. 523 (Bankr.D.N.J.1985). See also,  In re Crabb, 48 B.R. 165 (Bankr.D.Mass.1985) and In re Victory Pipe Craftsmen, Inc., Bankr., 8 B.R. 635 (N.D.Ill.1981).

X. WHEN MUST THE LEASE BE ASSUMED?

The Code provides that a lease is deemed rejected if not timely assumed. The time frames for assumption are set forth in §365(d). It matters a lot under which chapter the case is filed and whether the property is residential and non-residential.

A. RESIDENTIAL PROPERTY

In the case of residential property, a Chapter 7 case, the Trustee must assume a lease of residential property within 60 days post-petition. §365(d)(1).

Pursuant to §362(d)(2), in a case under any other chapter except Chapter 7, the lease must be assumed prior to confirmation of the Plan which means that the assumption/rejection in such chapters generally is part of the plan confirmation process.  However, the landlord has the right to request a shorter period of time. The reported decisions generally hold the debtor/trustee “is entitled to a reasonable time to make a careful and informed evaluation as to possible burdens and benefits of an executory contract,” quoting from 6 Collier on Bankruptcy (14th Ed.) 576-80 and citing is In re American National Trust, 426 F.2d 1059, 1064 (7 Cir.1970). See Matter of Whitcomb & Keller Mortg. Co., Inc., 715 F.2d 375, 378 (7^th Cir. 1983). “What constitutes a reasonable time is left to the bankruptcy court’s discretion in the light of the circumstances of each case.” Theatre Holding Corp. v. Mauro, 681 F.2d 102, 105 (C.A.N.Y., 1982).

B. NON-RESIDENTIAL PROPERTY

When the lease pertains to non-residential property, §365(d)(4) allows a longer period of time for the assumption to occur.  Specifically, this BAPCAP revised section provides

(4)(A) Subject to subparagraph (B), an unexpired lease of nonresidential real property under which the debtor is the lessee shall be deemed rejected, and the trustee shall immediately surrender that nonresidential real property to the lessor, if the trustee does not assume or reject the unexpired lease by the earlier of –

(i) the date that is 120 days after the date of the order for relief; or

(ii) the date of the entry of an order confirming a plan.

(B)(i) The court may extend the period determined under subparagraph (A), prior to the expiration of the 120-day period, for 90 days on the motion of the trustee or lessor for cause.

(ii) If the court grants an extension under clause (i), the court may grant a subsequent extension only upon prior written consent of the lessor in each instance.

Any lease not timely assumed is deemed rejected. The term “deemed rejected” has been interpreted to mean that section 365(d)(4) is self-executing. That is, the rejection of a lease occurs automatically without the need for court approval. Once statutory rejection of a lease has occurred, the rejection is conclusive. In re Sonora Convalescent Hosp. Inc., 69 B.R. 134, 137” In re Arizona Appetito’s Stores, Inc. 893 F.2d 216 (9^th Cir. 1990).

As discussed above, the Code specifically provides that the time frame for assumption may be modified upon application to the Court. It will generally always be necessary for you to seek a Court order shortening the time period to compel a decision on this issue, because at least one Court has held that as long as bankruptcy trustee remains undecided on whether to affirm or to reject executory contract and decision remains in his discretion, trustee has no duty to creditors to tell them he is entitled by law to reject that contract. In re Cochise College Park, Inc., 703 F.2d 1339 (9^th Cir. 1983). Given the fairly rigid limitations on the ability to obtain an extension of time to assume or reject a lease of non-residential property, the ability to shorten such periods seems less likely post-BAPCPA.

The Code specifically provides that the party with standing to assume the lease may seek to extend the time period within which such lease must be assumed. In this regard, it is critical to note that the pleading filed with the Court seeking such extension of time must be filed before the time period expires, but the order extending the time may be outside such period.  In re Southwest Aircraft Services, Inc., 831 F.2d 848 (9^th Cir. 1987)  The Northern District of Oklahoma’s Judge Michael recently penned a decision on this point in the case of In re Beautyco, Inc. Case No. 03-07621-M. Slip. Op. dated March 30, 2004 wherein the Court agreed with the holding of the Southwest Aircraft case and gave a thoughtful discussion of this issue.

Along the same lines, there are also many cases holding that the order approving the assumption of a lease need not be entered within the time period so long as the pleading seeking such an order was timely filed. Although an assumption of a lease under the statute governing executory contracts and unexpired leases requires express approval of court, it is not necessary to obtain court approval within the time limit for assumption of nonresidential lease of real property. In re Aneiro, 72 B.R. 424 (Bankr.S.D.Cal. 1987).

Also, keep in mind that between the filing of the petition and the assumption or rejection of the lease, §365(d)(3) requires the estate representative to timely perform the obligations under the unexpired commercial leases and requires an estate representative to make immediate payment of debtor’s nonresidential lease obligations, where the estate representative can meet those obligations consistent with its obligations to others. In re Valley Media, Inc., 290 B.R. 73 (Bankr.D.Del.2003). “If an estate representative does not comply with its obligations under § 365(d)(3), the lessor is not without a remedy.” Dieckhaus Stationers, 73 B.R. at 974.  The lessor may: (1) file a motion seeking an order compelling the estate representative to immediately pay the rental obligations before rejection, see Granada, 88 B.R. at 374; (2) move for an order requiring the estate representative to immediately surrender the premises, Orvco, 95 B.R. at 727; (3) file a motion for relief from stay to have the estate representative evicted from the premises, Dieckhaus Stationers, 73 B.R. at 974; or (4) move for an order to convert the case to one under Chapter 7 for failure to comply with § 365(d)(3). An estate representative who defaults under § 365(d)(3) will run the risk that the automatic stay will be terminated, its right of possession of the premises will be terminated, or that its case will be converted to one under Chapter 7.”  In re J.T. Rapps, Inc., 225 B.R. 257, 263 (Bankr.D.Mass.1998).

XI. ASSUMPTION ISSUES

First of all, what does a debtor or trustee have to do to assume a lease? Assumption may not be implied, but is only effective when approved by a duly entered order of the Bankruptcy Court. Assumption of a lease cannot be implied; it requires specific court approval. In re Spencer, 139 B.R. 562 (Bankr.M.D.Fla.1992). See also, In re Condominium Administrative Services, Inc., 55 B.R. 792 (Bankr.M.D.Fla.1985). Consequently, there must be a timely filed motion seeking the Court’s approval, notice of such motion must be given to the proper parties in interest, and an order must be entered granting such motion. If you represent the landlord, you must timely file a written objection to such a motion. The Court will set a hearing at which you must appear and present evidence to support the objection that you filed after which the Court will rule on the motion.

What are the issues related to the assumption of a lease? Recall the statutory provision relevant to this discussion is §365(b)(1), which states:

(b)(1) If there has been a default in an executory contract or unexpired lease of the debtor, the trustee may not assume such contract or lease unless, at the time of assumption of such contract or lease, the trustee –

(A) cures, or provides adequate assurance that the trustee will promptly cure, such default other than a default that is a breach of a provision relating to the satisfaction of any provision (other than a penalty rate or penalty provision) relating to a default arising from any failure to perform nonmonetary obligations under an unexpired lease of real property, if it is impossible for the trustee to cure such default by performing nonmonetary acts at and after the time of assumption, except that if such default arises from a failure to operate in accordance with a nonresidential real property lease, then such default shall be cured by performance at and after the time of assumption in accordance with such lease, and pecuniary losses resulting from such default shall be compensated in accordance with the provisions of this paragraph;

(B) compensates, or provides adequate assurance that the trustee will promptly compensate, a party other than the debtor to such contract or lease, for any actual pecuniary loss to such party resulting from such default; and

(C) provides adequate assurance of future performance under such contract or lease.

(2) Paragraph (1) of this subsection does not apply to a default that is a breach of a provision relating to –

(A) the insolvency or financial condition of the debtor at any time before the closing of the case;

(B) the commencement of a case under this title;

(C) the appointment of or taking possession by a trustee in a case under this title or a custodian before such commencement; or

(D) the satisfaction of any penalty rate or penalty provision relating to a default arising from any failure by the debtor to perform nonmonetary obligations under the executory contract or unexpired lease.

(3) For the purposes of paragraph (1) of this subsection and paragraph (2)(B) of subsection (f), adequate assurance of future performance of a lease of real property in a shopping center includes adequate assurance –

(A) of the source of rent and other consideration due under such lease, and in the case of an assignment, that the financial condition and operating performance of the proposed assignee and its guarantors, if any, shall be similar to the financial condition and operating performance of the debtor and its guarantors, if any, as of the time the debtor became the lessee under the lease;

(B) that any percentage rent due under such lease will not decline substantially;

(C) that assumption or assignment of such lease is subject to all the provisions thereof, including (but not limited to) provisions such as a radius, location, use, or exclusivity provision, and will not breach any such provision contained in any other lease, financing agreement, or master agreement relating to such shopping center; and

(D) that assumption or assignment of such lease will not disrupt any tenant mix or balance in such shopping center.

(4) Notwithstanding any other provision of this section, if there has been a default in an unexpired lease of the debtor, other than a default of a kind specified in paragraph (2) of this subsection, the trustee may not require a lessor to provide services or supplies incidental to such lease before assumption of such lease unless the lessor is compensated under the terms of such lease for any services and supplies provided under such lease before assumption of such lease.

Conceptually, the trustee/debtor/tenant must make the landlord whole such that the assumption does not result in economic loss to the landlord, and also give the landlord some degree of comfort that there will be no further defaults in the future.  This idea is nothing more than would be required if a landlord and tenant were to reach a settlement outside of bankruptcy to reinstate a defaulted lease and pay all of the damages incurred by the landlord associated with the default.  Congress’ intent in imposing cure and adequate assurance conditions on ability of bankruptcy debtor to assume a lease contract was to ensure that contracting parties receive full benefit of their bargain if they are forced to continue performance. In re Ionosphere Clubs, Inc., supra.

Assumption of an unexpired lease requires curing any default or providing adequate assurance of prompt cure, compensating for any losses resulting from default or providing adequate assurance of prompt compensation therefore, and providing adequate assurance of future performance. In re Larson, 128 B.R. 257 (Bankr. D.N.D.1990). The Code specifically requires that as a prerequisite to assumption upon a lease where there has been a default that the trustee or debtor must:

(A) cure, or provide adequate assurance that the trustee will promptly cure, such default;

(B) compensate, or provide adequate assurance that the trustee will promptly compensate a party other than the debtor to such contract or lease, for any actual pecuniary loss to such party resulting from such default; and

(C) provides adequate assurance of future performance under such contract or lease.

It’s important to note that if you receive a motion wherein the assumption of a lease is sought, that if it is alleged that no default exists, then the burden is upon you to timely object and be prepared to appear in Court to prove up the default.  Since the Code requires the allegation of any default existing in the lease and if such default is not alleged, then the entry of order approving the contract necessarily determines that no default exists. In re Diamond Mfg. Co., Inc., 164 B.R. 189 (Bankr.S.D. Ga.1994).  If you receive such a motion, then you must carefully read the motion and file a response to assert the amounts of unpaid rent and any other economic loss  as a monetary cure cost claim.  Such claims generally are paid as part of the assumption of the lease by the purchaser of the lease.

XII. PROMPT CURE OF DEFAULTS

The landlord will typically demand immediate cash payments for all monetary defaults under the lease prior to assumption, but such is not required by the Code.  First, “the “cure” or “compensation” contemplated by § 365(b)(1)(A) and (B) allows for something other than immediate cash payment. 2 Collier on Bankruptcy ¶ 365.04 at 365-38 (15th ed. 1987).”  In re Carlisle Homes, Inc., 103 B.R. 524, 538 (Bankr.D.N.J.1988). So, it’s wide open to whatever a creative debtor or trustee can convince the Court will get the lease current. Typically, the trustee/debtor will seek to pay the amounts to cure monetary defaults, but they will want to make such payments over some extended period of time. The Code merely requires “prompt” payment. There is no clear cut answer because “the period of time that is considered ‘promptly’ may vary in accordance with the circumstances on a case by case basis.” In re Lawrence, 11 B.R. 44, 45 (Bankr.N.D.Ga.1981). There are cases all over the board on how long is “prompt.”

The following cases are examples of proposed cures found to be “not prompt:” 6 months. In re Urbanco, Inc., 122 B.R. 513 (Bankr.W.D.Mich.1991); 18-months, In re Reed, 226 B.R. 1 (Bankr.W.D.Ky.1998); 29 months;  In re Embers 86th Street, Inc., 184 B.R. 892 (Bankr S.D.N.Y.1995); or ten years In re Flugel, 197 B.R. 92 (Bankr.S.D.Cal.1996). But prompt may be “slightly less” than a two-year period, In re Whitsett, 163 B.R. 752 (Bankr.E.D.Pa.1994).  What is apparent for these cases is that any time frame may be proposed and if the Court finds that such proposal is reasonable under the circumstances, then such may be approved. Since there is no bright line here, you must be prepared to carefully review the Motion to Assume the lease, timely file any objections your client may have and then appear in Court to present your case.

What about attorney fees incurred by the landlord pre-petition? Assuming the landlord is entitled to an award of fees under non-bankruptcy law, most cases have held that such fees are part of the “cure amount”,  “Entitlement to attorneys’ fees, however, is dependent on the terms of the lease and on state law; § 365(b)(1)(B) does not create an independent right to an award of attorneys’ fees. See, e.g., In re Ryan’s Subs, Inc., 165 B.R. 465, 467 (Bankr.W.D.Mo.1994); In re Child World, Inc., 161 B.R. 349, 353 (Bankr.S.D.N.Y.1993); In re F & N Acquisition Corp., 152 B.R. at 308; In re Hillsborough Holdings Corp., 126 B.R. at 898; In re Joshua Slocum, Ltd., 103 B.R. 601, 607-08 (Bankr.E.D.Pa.1989); In re Westview 74th Street Drug Corp., 59 B.R. 747, 756-57 (Bankr.S.D.N.Y.1986); In re Tech Hifi, Inc., 49 B.R. 876, 881 (Bankr.D.Mass.1985).”  In re Mid American Oil, Inc. 255 B.R. 839, 841 (Bkrtcy.M.D.Tenn.,2000) Attorney’s fees incurred in adversary proceeding should be paid as part of curing default under §365(b)(1)(A) of this section and in compensation for actual pecuniary loss under §365(b)(1)(B) of this section. In re Bullock, 17 B.R. 438 (9th Cir.BAP (Cal.) 1982). But see In re J.W. Mays, Inc., 30 B.R. 76 (Bankr.S.D.N.Y.1995), wherein it was held that the Landlord was not entitled to recover attorney fees from Debtor/Tenant as part of debtor’s curing of default where there was no express agreement by tenant to pay attorney fees as additional rent.

In addition, if there is a valid legal basis for claiming interest on the unpaid rent, then such may be part of the “cure amount.”  In re Eagle Bus Mfg., Inc., 148 B.R. 481 (Bankr.S.D.Tex.1992).  If you have any basis in law or fact to back you up as to any particular item of money, then you should always argue that the payment should be included in the “cure amount.”

XIII. NON-MONETARY DEFAULTS

Pre-BAPCAP, there was no specific code guidance and divergent case law over exactly what types of non-monetary defaults must be timely cured as part of the assumption process. §365(b)(1)(A) now specifically addresses non-monetary defaults by requiring the Trustee (or Debtor under a reorganization chapter) to cure or provide adequate assurances that such party will cure any non-monetary default unless it is “impossible for the trustee to cure such default by performing nonmonetary acts at and after the time of assumption.”  There is a further exception to this exception if the non-monetary default arises from a “failure to operate in accordance with a nonresidential real property lease,” whereupon the default shall be cured by performance at and after the time of assumption “in accordance with such lease,” and the landlord must be compensated for any pecuniary losses resulting from such default.

XIV. ADEQUATE ASSURANCES

The landlord is also entitled to “adequate assurance of future performance” when there is a proposed assumption of an unexpired lease. The phrase “adequate assurance of future performance,” for purposes of Section 365(b)(1)(C), “is to be given a practical, pragmatic construction based upon … the circumstances of [the] case.” In re Carlisle Homes, Inc., 103 B.R. 524, 538 (Bankr.D.N.J.1988); Accord In re Westview 74th Street Drug Corp., 59 B.R. 747, 754 (Bankr.S.D.N.Y.1986); In re Sapolin Paints, Inc., 5 B.R. 412, 420 (Bankr.E.D.N.Y.1980). The assurance of future performance is adequate if performance is likely (i.e. more probable than not). The degree of assurance necessary falls considerably short of an absolute guaranty. In re Prime Motor Inns, Inc., supra. at 997. This again is an issue that is determined on a case by case basis depending upon the facts and circumstances of the particular situation.  You must carefully review any pleading filed seeking to assume a lease.  If the motion to assume alleges that adequate assurances are provided by a particular means and your client disagrees, the burden is upon you to file a timely objection and be prepared to appear in Court to prove up your case.

XV. ASSIGNMENT OF ASSUMED LEASES

A lease may only be assigned if it has been timely assumed as provided above. The Code permits assignment of an assumed lease in §365(c) and (f) which provide:

(c) The trustee may not assume or assign any executory contract or unexpired lease of the debtor, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties, if –

….

(3) such lease is of nonresidential real property and has been terminated under applicable nonbankruptcy law prior to the order for relief;

(f)(1) Except as provided in subsections (b) and (c) of this section, notwithstanding a provision in an executory contract or unexpired lease of the debtor, or in applicable law, that prohibits, restricts, or conditions the assignment of such contract or lease, the trustee may assign such contract or lease under paragraph (2) of this subsection.

(2) The trustee may assign an executory contract or unexpired lease of the debtor only if –

(A) the trustee assumes such contract or lease in accordance with the provisions of this section; and

(B) adequate assurance of future performance by the assignee of such contract or lease is provided, whether or not there has been a default in such contract or lease.

(3) Notwithstanding a provision in an executory contract or unexpired lease of the debtor, or in applicable law that terminates or modifies, or permits a party other than the debtor to terminate or modify, such contract or lease or a right or obligation under such contract or lease on account of an assignment of such contract or lease, such contract, lease, right, or obligation may not be terminated or modified under such provision because of the assumption or assignment of such contract or lease by the trustee.

Section (f) was added by BAPCPA and codified existing case law. A general discussion of assumptions is found in In re Howe, 78 B.R. 226 (Bankr.D.S.D.,1987) at page 231. Consequently, the Trustee may assign virtually any commercial lease as long as it has been properly assumed. This includes the requirement of adequate assurances for future performance discussed above. “It is not possible under Section 365 of the Bankruptcy Code to simply “sell” a lease or executory contract. It must first be assumed, and then assigned, with a showing of adequate assurance of future performance.  Section 365(f)(2)(B).” In re Dartmouth Audio, Inc., 42 B.R. 871, 877 (Bankr.N.H.,1984). Also, landlord may require a new deposit from an assignee under §365(l).

XVI. REJECTION OF LEASES

Since this seminar deals with eviction, the rejection of a non-residential lease will typically mean the tenant will have to move out thereby achieving the desired result. Specifically, in the case of a non-residential lease, upon rejection the “the trustee shall immediately surrender such nonresidential real property to the lessor.” §365(d)(4).  Further, the Bankruptcy Court can issue order granting surrender of leased premises to lessor once the lease is rejected. In re Kong, 162 B.R. 86 (Bankr.E.D.N.Y.1993).

However, in the case of a residential property, there is no similar corresponding provision in the Code. Its is important to keep in mind the legal effect of the “rejection” of lease as discussed in: In re Henderson, 245 B.R. 449, 453 (Bankr.S.D.N.Y.,2000) beginning at page 453:

“The effect of rejection is one of the great mysteries of bankruptcy law. As a rule, the rejection of a lease gives rise to a pre-petition breach, 11 U.S.C. § 365(g)(1), but does not terminate the lease. See Medical Malpractice Ins. Ass’n v. Hirsch (In re Lavigne), 114 F.3d 379, 386-87 (2d Cir.1997) (discussing the effect of rejection on executory contracts). This broad rule is nonetheless subject to a significant exception. Where the trustee rejects a non-residential real property lease, he must immediately surrender the property to the lessor. 11 U.S.C. § 365(d)(1). In such a case, rejection is tantamount to termination.”

Where, as here, the lease is residential in nature, the general rule applies. Thus, rejection, without more, does not terminate the lease or immediately divest the estate of its interest in the lease. In this regard, property of the estate ceases to be property of the estate when it is abandoned, and abandonment can occur in one of three ways. First, the trustee can abandon the lease during the pendency of the case by serving a notice of abandonment, and if necessary, obtaining an order of abandonment. Fed.R.Bankr.P. 6007(a); see 11 U.S.C. § 554(a). This is a common practice where the value of the lease is inconsequential, and poses a risk of future liability to the estate.  Second, a party in interest can seek to compel the trustee to abandon the lease. See 11 U.S.C. § 554(b); Fed.R.Bankr.P. 6007(b). Third, the trustee can abandon a lease through inaction, analogous to the “deemed rejection” provisions of the Bankruptcy Code. This form of abandonment depends on whether the debtor has identified the lease in her schedules. If the lease is scheduled, and the trustee does not administer it, the lease is deemed abandoned to the debtor when the case is closed. 11 U.S.C. § 554(c). If it is not scheduled, it is not abandoned. Id., § 554(d).  In either case, the court can order a different result. See Id. § 554(c) and (d).

Here, the lease has not been directly or formally abandoned through the notice or motion procedures described above. Further, since the case is still open, the lease has not been deemed abandoned. It is true that the debtor’s Schedule “G” identifies the lease, and the trustee has filed a “no asset” report on July 9, 1999, signaling that he will not administer the lease for the benefit of the creditors. As a result, the lease will be deemed abandoned to the debtor when the case is closed, unless the court orders otherwise. However, this has not yet occurred, and accordingly, the lease remains property of the estate. The landlord must, therefore, obtain relief from the stay to terminate the lease and obtain control of the premises. FN 14. (all footnotes except for number 14 are omitted).

FN 14. In this regard, the automatic stay protects the lease until it is no longer property of the estate, and without regard to whether the discharge has issued. See 11 U.S.C. § 362(c). Further, the pre-petition termination of the lease does not alter the conclusion that a landlord seeking to evict a debtor must obtain relief from the stay. The debtor and estate inevitably have personal property on the premises, and the termination of the lease does not affect those interests.  Any act by the landlord that interferes with or exercises control over the estate’s property violates the automatic stay. See 11 U.S.C. § 362(a)(3). In addition, any attempt to collect a pre-petition claim from property of the estate or property of the debtor violates the stay. See Id., § 362(a)(2), (6).

Thus, in the case of residential property, rejection will not result in the immediate surrender, so you must still file a motion for relief from the stay to continue your eviction unless you want to wait until the discharge is entered some 90 or so days after the petition is filed.

Although, as discussed above, court approval is required for the assumption of a lease, the converse if not true. Court approval of rejection of lease is not required in case of automatic statutory rejection due to the failure of the Trustee to timely assume the lease within the timeframes discussed above.  In re Southwest Aircraft Services, Inc., supra. Rejection may be accomplished by a duly entered order of the Court, but most often, it occurs by operation of law due to the failure to timely assume the lease as discussed above.

XVII. REJECTION DAMAGES CLAIMS

If a lease is rejected, the landlord may file a proof of claim for any damages resulting from the rejection. §365(g) specifically provides that rejection is tantamount to a breach of the lease, as discussed above, the landlord’s claim in the bankruptcy case is treated as a breach of contract and is therefore entitled to file proof of claim for such damages. In re Federated Dept. Stores, Inc., 131 B.R. 808 (S.D.Ohio 1991)  The calculation of the claim for “rejection damages” was discussed in detail in the case of Third Nat. Bank v. Winner Corp., 29 B.R. 383 (M.D. Tenn, 1982) beginning at page 386:

…There is no definition in the Bankruptcy statutes as to what constitutes “damages”; and neither counsel nor the Bankruptcy Court refer to any provision defining damages. On a fundamental level, obviously total damages equal “past” damages plus “future” damages. FN

Under the test used in Aristo Foods to determine “actual damages”, the Court merely (1) subtracted the present value for the term remaining under the lease from (2) the rent reserved under the lease for the term remaining under the lease. 1 B.C.D. at 350. If the difference was greater than the § 353 ceiling, the Court awarded the ceiling as damages; otherwise, the “actual damages” were awarded. Id. Under this test the Court failed to consider any past damages in the calculations of “actual damages.”  It is true that the Court considered the unpaid accrued next in setting the § 353 damages, but it then failed to consider unpaid accrued rent in its calculations of actual damages. In drafting § 353, Congress obviously intended the Court to consider unpaid accrued rent (“past” damages) in establishing the ceiling damages. If the Congress intended that unpaid accrued rent be included in ceiling on damages, this Court feels that it is highly unlikely that Congress intended to exclude such claims from actual damages. Exclusion of past damages in the determination of actual damages for rejected leases has no basis in the Bankruptcy laws. Therefore, the Court rejects the Aristo Foods test and proffers the following test:

(1) determine the rent due (reserved value) for the term remaining under the lease, discounted to present worth,

(2) determine the present fair rental value for the term remaining under the lease, discounted to present worth,

(3) subtract (2) from (1) (this difference is the lessor’s “future” damages),

(4) determine “past” damages (including unpaid accrued rent, etc.),

(5) add (4) to (3) (this sum equals “actual” total damages),

(6) determine the § 353 ceiling,

(7) the lesser of (6) or (5) will be the maximum allowable damages.

The “§353 ceiling” referred to is the statutory limitation of rejection damages found in §502(a)(6). which provides that a claim for lease rejection damages is allowed as follows:

(A) the rent reserved by such lease, without acceleration, for the greater of one year, or 15 percent, not to exceed three years, of the remaining term of such lease, following the earlier of –

(i) the date of the filing of the petition; and

(ii) the date on which such lessor repossessed, or the lessee surrendered, the leased property; plus

(B) any unpaid rent due under such lease, without acceleration, on the earlier of such dates;

The time period for calculation of an administrative rent claims begins at the petition date and ends upon the rejection of the lease or the vacation of the premises, which ever occurs later. The Chapter 7 estate was liable to lessor for administrative rent up to and including date that leased premises were surrendered.  In re Sporting Way, Inc., 126 B.R. 110 (Bankr.M.D.Fla.1991).

FN: The Court acknowledges that the use of the terms “past damages” and “future damages” is not an artful way to express the question of actual damages; nevertheless the Court finds that this use of terms most clearly expresses the argument of the Court. As used herein, “past” damages are damages incurred prior to abandonment; “future” damages are damages anticipated after abandonment.

Rejection damages claims must be presented by means of filing a proof of claim. The proof of claim form is basically a “fill in the blank” type of form which is fairly self-explanatory.  Copies of supporting documents should be attached to the proof of claim and the proof of claim must be filed timely filed with the court clerk, a copy mailed to the trustee and to the debtor’s counsel.

The primary difference between a rejection damages claim and an administrative expense claim is that if there is any money available in the bankruptcy estate, then such funds must first be used to pay allowed administrative expense claims, whereas, a claim for rejection damages is treated as an unsecured claim to be paid pro rata with all other allowed unsecured claims of the estate.

XVIII. DISCHARGE

The issuance of the discharge permanently enjoins all parties to the bankruptcy, and anyone who had actual notice of the case, from taking any action to collect the debt as a personal liability of the Debtor. The discharge is the objective which is sought by all debtors in bankruptcy. This section of the discussion will provide an overview of two primary Code sections which deal with the discharge. The first is 11 U.S.C. §727, which provides the grounds under which a discharge may be denied entirely. Second is 11 U.S.C. § 523, which provides various exceptions to the discharge. An overall discussion of the discharge is covered elsewhere in this seminar. This section focuses on the section usually utilized by creditors.

A. Denial of Discharge, §727:

A.1 §727(A)(2) Property of the Estate

11 U.S.C. §727(A)(2) provides the Court shall grant the debtor a discharge unless:

[t]he debtor, with the intent to hinder, delay or defraud a creditor or officer of the estate charged with custody of property under this title [11 U.S.C. §101 et seq.], has transferred, removed, destroyed, mutilated or concealed or has permitted to be transferred, removed, destroyed, mutilated or concealed:

(A) property of the debtor within one year before the date of filing of the petition; or

(B) property of the estate, after the filing of the petition.

The most obvious means by which a debtor may violate this provision is the failure to disclose either the transfer or ownership of any property of the estate in the statement of financial affairs required to be filed by a debtor in a case under Title 11. The statement of financial affairs requires the debtor to disclose transfers of property for the one year period immediately preceding filing of the original petition in a case. The statement of financial affairs also requires the debtor to disclose any other persons holding anything of value which might constitute property of the estate.

Likewise, the debtor is required to aver under penalty of perjury that the various schedules are completed truly and correctly. The schedules require the debtor to disclose the debtor’s interest in any type of property, whether real, personal, or “any kind not otherwise scheduled.”

A debtor may violate this provision by knowingly and fraudulently failing to truthfully answer any of the above inquiries. The intent of the statute is to condemn the transfer or concealment of property of the estate. United States v. Shapiro, 101 F.2d 375, cert. den. 306 U.S. 657 (7th Cir., Wis. 1939). 11 U.S.C. §548 provides the trustee may avoid a transfer of property made within one year of the filing if the same is made for less than adequate consideration while the debtor was insolvent, or with the actual intent to hinder, delay or defraud a creditor. The debtor may be denied a discharge with the intent to “hinder, delay or defraud a creditor or officer of the estate” property was transferred either within one year prior to filing or after the filing of the petition.

Look carefully at the debtor’s pre-petition conduct. Has there been extensive pre-bankruptcy planning? May the debtor transfer property from non-exempt assets to exempt assets? The cases are fairly uniform that the conversion of assets into exempt property does not by itself constitute fraud absent extrinsic evidence of fraud. In Re: Johnson, 880 F.2d (8th Cir., 1989); Northwest Bank Nebraska, N.A. v. Tventen, 848 F.2d 871 (8th Cir., 1988); In Re: Carey, 96 B.R. 336, 18 B.C.D. 1501, (BC, W.D. Ok. 1989), Aff’d. 112, B.R. 401 (W.D. Ok. 1989); In Re: Chastant, 873 F.2d 89 (5th Cir., 1989); In Re: Oliver, 819 F.2d 550, (5th Cir., 1987); In Re: Smiley, 864 F.2d 562, (7th Cir. 1986). However, it was held in In re Spoor-Weston, 139 B.R. 1009 (B.C. N.D. Ok 1992) that the Chapter 7 trustee was entitled to $21,000 equitable lien against debtors’ homestead where, before filing their bankruptcy petition, debtors had paid $21,000 from a nonexempt checking account on the mortgage on their homestead for the admitted purpose of removing property from the reach of creditors.

While the actual act of conversion of non-exempt property into exempt property is not in and of itself a violation of 11 U.S.C. §727, if you can prove that the debtor did the same with the intent to defraud the estate or a creditor, then the debtor may be denied a discharge. What constitutes fraudulent intent? The Courts have held that such is determined by a “factor” test which includes “conduct intentionally designed to mislead or deceive creditors about the debtor’s position; conveyances for less than fair value; or the continued retention, benefit or use of property allegedly conveyed, together with evidence that the conveyance was for inadequate consideration.” Northwest Bank of Nebraska, N.A. v. Tventen, supra. Ask the debtor why they transferred the property. If the answer doesn’t pass the “smell test”, you may be able to prevail on this issue. Consider how much the value of the property transferred was, when the transfer took place, to whom it was transferred, and if the transfer is disclosed in the filings.

A.2 §727(A)(3) Records And Information

The provision of 11 U.S.C. §727(A)(3) provides:

“[The court shall grant the debtor a discharge unless] the debtor has concealed, destroyed, mutilated, falsified or failed to keep or preserve any recorded information, including books, documents, records and papers from which the debtor’s financial conditions or business transactions might be ascertained, unless such act or failure to act were justified under all the circumstances of the case.”

This provision may be violated by the mere negligent failure of the debtor to keep necessary financial records. Has the debtor destroyed their records to prevent your finding out what they did? If so, this section can provide some relief.

A.3 §727(A)(4) Truthfulness

11 U.S.C. §727(A)(4) provides:

“[The court shall grant the debtor a discharge, unless] the debtor knowingly and fraudulently, in or in connection with the case:

(A) made a false oath or account;

(B) presented or used a false claim;

Omissions of information concerning the existence or disposition of property from the debtor’s schedules constitutes a false oath. In Re: Calder, 907 F.2d 953 (10th Cir., 1990). A false oath would include any omission from the schedules, a false answer given at a creditors meeting or in open court. Testimony given at the first meeting of creditors is a proceeding in bankruptcy and is subject to penalties for false oath. 18 U.S.C. §152, In Re: Slokum, 22 F.2d 282 (2nd Cir., 1927).

However, to be a basis for denial of the discharge, such omission from the schedules or incorrect statements at creditors meetings must be made with knowing and fraudulent intent. An oath may be considered to have been made with knowing and fraudulent intent when it was made by a person who states matters which are not believed to be true, willfully and contrary to the oath taken. In Re: Hale, 206 F.2d 856 (DC, NM 1913). The proof of knowing and fraudulent intent is generally made up by the facts and circumstances surrounding the false oath. Cases on this issue are in fact specific. In one case the evidence was sufficient to establish the defendant had not innocently transferred an automobile to his fiancé where it was shown that his company had been in increasing financial trouble since the death of his father, at the meeting with the secured creditor the debtor brought up the subject of bankruptcy, during the same month as the meeting with the creditor, the debtor transferred the automobile to his fiancé without consideration, several weeks subsequent to the transfer, the debtor filed a bankruptcy petition in which he stated he had not made any gifts other than ordinary and usual presents to family members, and subsequently the debtor continued to use the automobile. In Re: Cadarette, 601 F.2d 648, 5 B.C.D. 444, (2nd Cir., 1979).

If the debtor makes a false statement, the false statement must be material. United States v. Phillips, 606 F.2d 884, cert. den. 444 U.S. 1024, (9th Cir., 1979); United States v. Jackson, 836 F.2d 324 (7th Cir., 1987). Although materiality is not specifically set forth in the statutes, the cases cited above consistently hold the same to be an element. Materiality generally relates to property of the estate. However, one court has held that every statement required to be made in the schedules was material. United States v. Lake, 129 Fed. 499 (DC Ark. 1904).

It is apparent upon an examination of the above authorities that the debtor has an absolute obligation to be truthful in the completion of the schedules and statement of affairs. If the debtor is not being truthful, most Bankruptcy Judges will not tolerate such conduct.

A.4 §727(A)(5) Loss of Assets

This section provides the Court shall grant the debtor a discharge unless:

“The debtor has failed to explain satisfactorily, the before the determination of denial of discharge under this paragraph, any loss of assets or deficiency of assets to meet the debtor’s liability.”

The key inquiry here is the loss of assets. If the debtor never had the assets to satisfy relations which creditors were willing to extend, that is primarily the creditor’s problem unless there has been some fraud in convincing creditors otherwise.  However, if the debtor did at one time have substantial assets and at the time of filing the bankruptcy, the assets have disappeared, this section constitutes a valid basis for challenging the debtor’s ability to receive a discharge.

Upon the creditor making a prima facia case for the loss of assets, the burden shifts to the debtor to explain what happened.  Failure to offer any explanation for the loss of assets is clearly a basis for denial of discharge.  Minella v. Phillips, 245 F.2d. 687 (5th Cir., 1957).  The adequacy of the explanation hinges on the facts of a particular case. In Re: Brown, 56 B.R. 63 (D.C.N.H. 1985).  There must be much more than vague generalities.  In Re: Sperling, 74 F.2d 259 (2nd Cir. 1934).  The standard by which an explanation is measured is one of reasonableness and credibility.  In Re: Cohen, 47 B.R. 871 (B.C.S.D. Fla. 1987).

Essentially, the debtor’s explanation must pass the “smell test”. Is the debtor’s explanation one which really makes sense and is credible or does it lead one to the conclusion that the debtor probably has transferred some assets or made other disposition in an irresponsible manner?

There are several other grounds for denial of the discharge which are available. You should become familiar with the entire section.  However, most of the other situations are rare enough to be beyond the scope of this discussion.

B. Exceptions to Discharge, §523

11 U.S.C. §523(a) provides there are eleven specific categories of claims which are excepted from the discharge. 11 U.S.C. §523(c) provides that debts which are non-dischargeable pursuant to 11 U.S.C. §523(a)(2), (4), (6), or (15) are presumed discharged unless a creditor brings a timely complaint to have the same determined to be non-dischargeable. The remainder of the subdivisions are presumed non-dischargeable unless the debtor brings a complaint to have them determined to be dischargeable. This discussion will only deal with those which require affirmative action by the creditor because none of the automatic exceptions will typically apply to a landlord-tenant dispute.

11 U.S.C. §523(c)(1) provides that claims which are non-dischargeable under §§(2), (4), (6) or (15) are in fact discharged unless a creditor brings a timely complaint pursuant to Fed.R.Bankr.P. 4004. Such section provides that claims must be filed 60 days after the first date set for a creditors’ meeting. The time for filing a complaint to determine dischargeability may be extended upon the motion of a party if such motion is made before the time for filing a complaint has expired. Fed.R.Bankr.P. 4004(B). If the time limit is approaching and you have not yet made an adequate determination as to whether or not to pursue such a claim, it is wise to seek an extension of time and conduct a further investigation before pursuing such a claim. If the creditor pursues a complaint to determine dischargeability and the claim relates to a consumer debt, if the debt is discharged the Court may grant attorney’s fees and costs against the creditor if the position of the creditor was not “substantially justified”. 11 U.S.C. §523(d).

There are basically three categories of claims which the creditor must bring complaints to have determined to be dischargeable, but only two of these will typically apply to a landlord-tenant dispute.

B.1 (A) Fraud – §523(a)(2)

11 U.S.C. §523(a)(2) provides that debts are non-dischargeable to the extent they relate to the obtaining of money, property or services, or the extension, renewal or refinancing of such credit to the extent such is obtained by false pretenses, a false financial statement or for luxury goods or services.

B.1 (A.1) Actual Fraud – 11 U.S.C. §523(a)(2)(a)

11 U.S.C. §523(a)(2)(a) provides that if the debtor obtained money, property or services by actual fraud, then such is not dischargeable. Such representations generally are not made in writing. In Re: Reader, 60 B.R. 529 (B.C.N.D. Minn. 1986). The creditor must show that the loss was proximately caused by the fraud of the debtor. In Re: Smith, 61 B.R. 742 (B.C. Mont. 1986). The fraud must be actual and not implied or express. In Re: Hunter, 780 F.2d. 1577 (11th Cir. 1986). If actual fraud can be shown, a non-disclosure may result in non-dischargeability if the debtor allows the creditor to proceed upon what it assumes to be the truth when the debtor in fact knows the same is not true.  In Re: Van Horn, 823 F.2d. 185 (5th Cir. 1987). However, most Courts require there to be some actual affirmative act which causes fraud to be visited upon the creditor. Additionally, the creditor must rely upon the misrepresentations and such reliance must be “justifiable.” The fraud exception to discharge requires justifiable, but not reasonable, reliance. Field v. Mans 116 S.Ct. 437, 133 L.Ed.2d 351(1995).

There has been some question about whether or not claim for punitive damages is subject to discharge since it was sometimes argued such is not really a debt. It was held in Cohen v. Cruz, 118 S.Ct. 1212 (1998), that the discharge exception for actual fraud prevented discharge of all liability arising from debtor’s fraud, including treble damages assessed on account of fraud under state law as well as award of attorney fees and costs.

B.1 (A.2) Fraudulent Financial Statements, 11 U.S.C. §523(a)(2)(B)

If the debtor obtains a lease or other economic value from the landlord by use of a fraudulent financial statement, then the claim is not dischargeable if the following elements are present, to-wit:

(1)  The statement is in writing;

(2)  It is materially false;

(3)  It regards the debtor or an insider’s financial condition;

(4)  The creditor reasonably relies upon the statement; and

(5)  The debtor caused the same to be made or published with the actual intent to deceive.

This is probably one of the most common bases for creditors seeking to have their debt determined to be non-dischargeable, however not all landlords require financial statements are a part of the lease negotiations. If your client did obtain a written financial statement, then should carefully review the financial statements given by the debtor to see if the elements may be met. The statement must be in writing and signed by the debtor. In Re: Howard, 73 B.R. 694 (B.C.N.D. Ind. 1987); Blackwell v. Dabney, 702 F.2d. 490 (4th Cir. 1983); and Ingler v. Van Steinburg, 744 F.2d. 1060 (4th Cir. 1984).

The statement must be materially false.  The debtor makes a materially false statement when (1) The debtor makes no effort to verify the truth or validity of the statements; (2) The debtor has no reasonable grounds to believe the truth of the statements; (3) The inaccuracies are inexcusable, such as exaggerated income and significant understatements of debt. In Re: Bradford, 22 B.R. 899 (B.C.W.D. Ok 1982). However, minor discrepancies are insufficient to cause the creditor’s debt to be non-dischargeable. In Re: Anderson, 29 B.R. 184 (B.C.N.D. Ia. 1983).

The financial statement must be respecting a debtor or an insider’s financial condition. Obviously, if the debtor’s financial statement is about themselves, it relates to the debtor’s financial condition. However, insiders may also be determined to be non-dischargeable, as in a corporate officer or president who participates in the obtaining of a loan for the corporation by having the corporation publish a financial statement which meets the various elements of this subdivision, may have the debt determined to be non-dischargeable as against such corporate officer individually. In Re Long, 774 F.2d 875 (8th Cir 1985). Thus, corporate officers, agents and other individuals who would be insiders as that term is defined in 11 U.S.C. §101(31) may also have claims to be determined to be non-dischargeable against them individually if they should file an individual Chapter 7.

The reliance of the landlord must be reasonable. A landlord/creditor must make some reasonable inquiry based on the sophistication of the particular party. It is a question of fact as to whether or not the creditor did in fact reasonably rely on the creditor considering all the facts and circumstances of a particular case. Nonetheless, the creditor must in fact rely upon the statement in extending the credit. In Re: Hampfner, 52 B.R. 1020 (B.C.W.D. Va. 1985). Partial reliance upon the statement is sufficient if the financial statement constitutes a substantial part of the collective financial information upon which the creditor relied. In Re: Harms, 53 B.R. 1134 (B.C.D.C. Minn. 1985).

Finally, the statement must be published with the intent to deceive. Intent requires actual intent or reckless disregard for the truth. In Re: Liming, 797 F.2d. 895 (10th Cir. 1986) and In Re: Ruben, 875 F.2d 775 (9th Cir. 1989).  The burden is upon the creditor to prove that the debtor had the actual intent to deceive.  However, the fact that the intent to deceive will certainly be able to be proven by circumstantial evidence.

B.1 (C)

Willful or Malicious Injury, 11 U.S.C. §523(a)(6)

This section provides that willful or malicious injury to the property of another constitutes a basis for denial of a discharge. In the context of a landlord-tenant dispute, this would typically apply where the tenant intentionally damaged the leasehold premises. The recent U.S. Supreme Court cases of debts arising from recklessly or negligently inflicted injuries do not fall within compass of willful and malicious injury exception to discharge. Kawaauhau v. Geiger, 118 S.Ct. 974 (1998). Rather, the creditor must prove that the debtor had the intent to cause a deliberate or intentional injury, not merely a deliberate or intentional act that leads to injury. The most recent decision which has addressed this issue in the context of conversion of collateral was In re Kidd, 219 B.R. 278, *285 (Bankr. D. Mt.1998), wherein the court opined:

“Thus, following the aforementioned reasoning and pursuant to the Supreme Court’s holding in Kawaauhau, a creditor, in order to prevail under §523(a)(6), must demonstrate by a preponderance of the evidence, that the debtor desired to cause the injury complained of, or that the debtor believed that the consequences were substantially certain to result from the debtors acts. In other words, in the case of a conversion, a creditor must show that a debtor, when converting collateral, did so with the specific intent of depriving the creditor of its collateral or did so knowing, with substantial certainty, that the creditor would be harmed by the conversion. This subjective test focuses on whether the injury was in fact anticipated by the debtor and thus insulates the innocent collateral conversions from non-dischargeability under §523(a)(6).”

Based upon this case, it appears the creditor’s burden under §523(a)(6) is substantially more difficult that under previous case law.

B.2 Burden of Proof

If the creditor brings a complaint to determine the dischargeability of a debt pursuant to 11 U.S.C. §523(a)(2), (4), or (6), the creditor has the burden of proving that the debt is non-dischargeable. A recent Supreme Court case of Grogan v. Garner, 111 S.Ct. 645 (1991) has clearly established that the standard by which dischargeability claims are judged is a preponderance of the evidence.  Prior to the Grogan case being decided there was a split of authority as to whether or not dischargeability must be proven by preponderance of the evidence or by clear and convincing evidence.

The Grogan case also establishes clearly that if the parties have litigated issues in a non-bankruptcy forum to a judgment, such litigation is issue preclusive on dischargeability issues; however, the Bankruptcy Court reserves final jurisdiction to determine dischargeability of claims pursuant to 28 U.S.C. §157. It is not necessary to include dischargeability type claims in a non-bankruptcy litigation. For example, if a creditor has a claim against a debtor on a promissory note which also involves a fraudulent financial statement, the creditor probably should not litigate the financial statement claim in the non-bankruptcy forum. If the debtor subsequently files bankruptcy, the creditor still has the opportunity to litigate this claim before the Bankruptcy Court. It should be noted, as you all remember from law school, that a default judgment is not a litigation on the merits, and thus is not issue preclusive of anything in the bankruptcy.

XIX. CONCLUSION

The representation of a landlord in a Chapter 7 consumer case can appear to be deceptively simple. However, as can be seen from the above, there are several fairly detailed issues which must be considered by a landlord’s counsel. Most of the issues will not arise in most of the cases which will be processed.  However, the same analysis must be made in each case in order to insure that the landlord is receiving proper representation.

TOP OF PAGE

I. Introduction

The purpose of this part of the seminar is to provide a basic approach to Chapter 7 bankruptcy from the perspective of the creditor. This section assumes little or no working knowledge of the Bankruptcy Code and will assume the debtor to be an individual consumer debtor for the greater part of this discussion.

This paper provides an analysis of the impact of the Bankruptcy Abuse and Consumer Protection Act of 2005 (the “Reform Act”) on creditor’s rights under the Bankruptcy Code. The Reform Act was signed by the President on April 20, 2005 and became fully effective on October 17, 2005. The Bankruptcy Code is found at Title 11 of the United States Code and is referred to in this article as the “Code”.

II. Initial Considerations

The first notice of bankruptcy that a creditor will receive is known commonly as the “341 notice”. This notice will be received in the mail and involves several important pieces of information. One of the initial reactions to the receipt of a 341 notice, especially if litigation is pending, is anger. Creditors are not without defense to a bankruptcy. However, more than any other area of the law which I have encountered, you must take an aggressive stance in the case before any relief may be received. Anyone who stands by and does nothing upon receiving a bankruptcy notice generally will get out of it exactly what they put into it. Upon receipt of the 341 notice, you should diary the dates for the initial meeting of creditors, 30 days thereafter to object to exemptions, 60 days thereafter to object to the discharge or file a complaint to determine dischargeability, and any bar date for filing proofs of claim.

Also, you must determine what chapter the debtor is filing. This is simply a matter of reading the notice. If the case is a “reorganization” chapter, i.e., Chapter 11, 12, or 13, the considerations for creditor’s counsel are far more complex than in a Chapter 7. It is recommended that if you have never been involved in such a case before, that you associate with someone who has experience in such matters. The discussion herein is focused only on Chapter 7 as the others are far beyond the scope of this discussion.

III. New Rules For Dismissal Of Abusive Chapter 7 Cases

The Reform Bill makes significant changes to this area.

The heart of the Reform Bill as it relates to consumer Chapter 7 cases is a set of new, strict rules for determining when a case should be dismissed as an abusive filing. The concept is that if a person has the financial ability to pay a meaningful amount of money to their unsecured creditors, then that person should not be allowed to file a Chapter 7 case, but rather, if they want relief under the Bankruptcy system, they must typically resort to a Chapter 13 filing. The mechanism by which Congress implemented this concept is what is commonly being referred to as the “Means Test”.

Under pre-BAPCPA law, the test was commonly referred to as “substantial abuse”. Substantial abuse is discussed herein below and may be raised only by the U. S. Trustee’s office or by the Court sua sponte. In the past few years, few Courts have raised this issue.

Under the “Old” Code §707(b) contained what is generally referred to as the “substantial abuse” provision. This section generally provides that if the debtor’s debts are primarily consumer debts and the case would constitute a “substantial abuse”, then the Court may dismiss the case. Substantial abuse generally is determined to be present when the debtor’s disposable income is significant. Under existing law, there is no definition of the terms “substantial abuse” and cases are generally determined on a case by case basis. The test is generally stated that if a person can pay a “significant” amount under a Chapter 13, then a §707(b) filing is appropriate. It is important to note that this concept remains in the Code after the Reform Act. In talking with the U.S. Trustee personnel, they intend to use this as sort of a catch-all for Debtors who figure out some way to “get around” the Means Test, but still are abusing Chapter 7. However, even this concept has been altered somewhat by the new §707(b)(3) which provides that the Court “shall” consider whether the petition was filed in bad faith or whether the totality of circumstances involving the debtor’s financial situation demonstrates an abuse. Interestingly, under the “totality of circumstances” inquiry, the Court is directed consider “whether the debtor seeks to reject a personal services contract and the financial need for such rejection as sought by the debtor”.

One other very significant point, none of these provisions apply to entity debtors (i.e., corporations, LLCs, partnerships) or individuals whose debts are more than 51% non-consumer debt. It’s also important to note that Judge Rasure has held that a debtor’s income tax obligations were not “consumer debts” within meaning of §707(b). In re Brashers, 216 B.R. 59 (Bkrtcy.N.D.Okla.,1998).

Also, under the “Old” Code, no one except for the U. S. Trustee had standing to bring a motion for affirmative relief under this section. Under the Reform Bill, the rules are substantially changed. The most significant changes are that generally any party may raise issue by filing a Motion to Dismiss and a strict set of formulary type rules are now in place to determine if a case is simply “an abuse” as opposed to a “substantial abuse” under the existing law.

New §707(b)(1) has been amended to expand the standing under the provision to include creditors in some cases. Standing to file abuse motions is found first in the general language of §707(b)(1). In addition to the U. S. Trustee, and the Court, now the case trustees, as well as creditors, are also allowed to file a motion to dismiss. To determine standing, one must utilize the actual, current monthly income of the debtor multiplied by 12. If this “annualized income” is equal to or less than the state median family income of the debtor’s domicile state for a similar size family, then only the Court, U. S. trustee, or bankruptcy administrator may bring a motion under §707(b)’s general abuse standard. 11 U.S.C.A. §707(b)(6). Note that the income of the debtor’s spouse is used only if such spouse is a joint debtor but such may be excluded if (i) debtor and their spouse are separated, and (ii) the debtor certifies to such separation under penalty of perjury. This is true whether both or just one of the couple files bankruptcy. 11 U.S.C. §707(b)(7)(B). Thus, in a lower income case, the standing is the same as the “Old” law.

This seems rather a strange way of determining standing, particularly in light of the fact that the definition of “current monthly income” for all other purposes excludes the income of the other spouse unless they both file for bankruptcy relief.  QUERY: Why should the Court consider the non-debtor spouse’s income at all under the current monthly income definition?

The place to start then is to examine whether the particular debtor’s income is above or below the median family income for Oklahoma. If it’s below this amount, then you do not have standing to file the Motion to Dismiss since it remains restricted as with the present law. If it’s more, then you as a creditor do have standing.

In addition, if the “annualized” income is equal to or less than the same median family income, then the new §707(b)(2) “presumption of abuse” does not apply at all and the Debtor is not required to do the means test calculation. If it is over, then the Debtor(s) must complete the Means Test calculation. The official form for the Means Test is “Official Form B22A,” which may be obtained at the following website:

http://www.uscourts.gov/FormsAndFees/Forms/BankruptcyForms.aspx

The Means Test is the heart of the so-called “need-based” bankruptcy reform contained in the Reform Act. The concept is that an individual consumer debtor(s) will be permitted to file for Chapter 7 relief if such is not an “abuse” determined by an analysis of whether the debtor can repay a specific amount or percentage to unsecured creditors. In very basic terms, the “presumption of abuse” arises if the debtor’s current monthly income, after allowance of specific “standardized” expenses (not based on actual expense), multiplied by 60 is not less than the lesser of (i) $10,000 or (ii) 25% of the debtor’s non-priority unsecured creditors or (iii) a minimum of $6,000 if that’s less than 25% of the non-priority unsecured creditors. At a minimum, if the debtor’s calculated and adjusted monthly income provides at least $100 monthly to unsecured creditors over 60 months, then the debtor has presumptively failed the means test. Using the $10,000 standard, if it happens to be the “lesser” measure, then if the debtor has $166.67 in disposable income the presumption of abuse exists. Once this new “presumption of abuse” arises under the formula, then unless the debtor can rebut the presumption with documented special circumstances or expenses, the case will be dismissed. The Debtor retains the right to convert to an appropriate reorganization Chapter, i.e., 11, 12, or 13.

As you can see by looking at the form, the application of the Means Test is very technical and complex. The practical aspect of this is that the Debtor’s lawyer must screen every prospective Chapter 7 case by applying the Means Test because if they fail to do so and the case is ultimately dismissed, then the lawyer may personally be liable for the fees and costs associated with the prosecution of the Motion to Dismiss.

In addition, the Reform Act now includes in the Code the provision that the signature of the debtor’s attorney on the petition constitutes a certification that the attorney has “performed a reasonable investigation into the circumstances that gave rise to the petition, pleading, or written motion” and that the attorney determined that the petition or other pleading is “well grounded in fact” and warranted under the law, and that the petition or pleading is not an abuse under §707(b)(1). See 11 U.S.C.A. §707(b)(4)(C). This is a broad certification by the debtor’s attorney, one seemingly requiring some level of inquiry into why the debtor needs to file for Chapter 7 relief. The certification that the petition is not an abuse is broadly worded to include that it is not an abuse under either the general bad faith or the means-testing standard. A separate certification is called for by §707(b)(4)(D): “The signature of an attorney on the petition shall constitute a certification that the attorney has no knowledge after an inquiry that the information in the schedules filed with such petition is incorrect”. Thus the debtor’s attorney is certifying both that the debtor has good cause to file for Chapter 7 relief and that the attorney has no knowledge of incorrect information in the schedules.

Many questions arise under these certification rules. How much inquiry must the attorney make into the reasons for the bankruptcy filing and to what extent must the attorney inquire into accuracy? An obvious question is how willing attorneys are going to be to make this certification and how rigidly the Rule 9011 implications will be applied. Other questions are how this requirement for attorneys will impact the fees that they will charge for Chapter 7 work and how the broad certification will impact their professional liability insurance coverage and rates.

Given the possibility of personal sanctions being imposed upon the lawyer for a debtor who files an abusive Chapter 7 case, it seems likely that few should be filed.

In addition, there is a second level of scrutiny in that every case will be reviewed under the Means Test by the U. S. Trustee’s office. New §704(b) mandates the U. S. Trustee file with the Court Clerk a statement of whether a case is or is not “presumed abusive” within 10 days of the creditors’ meeting. Within five days thereafter, the Clerk of the Court is directed to provide a copy of the statement to “all creditors”. Then, within 30 days of the creditors’ meeting, U. S. Trustee is further obligated to either file the §707(b) motion to dismiss based upon abuse or, in the alternative, file a statement of why the case is not presumed abusive. So, the U. S. Trustee must also review and scrutinize the Means Test calculation submitted by the debtor in every consumer case, then file a statement saying that they essentially agree or disagree with such calculation. If they disagree, they must file a Motion to Dismiss or explain why they are not doing so.

Since this is a government agency specifically charged with enforcing the Means Test and with certifying whether or not a case falls within the presumptive abuse rules discussed above, it is submitted that few cases will fall to you as creditors to enforce the Means Test.  In addition, the prospect of a creditor filing a Motion to Dismiss when the USTE has declined to do so also exposes you to a possible award of fees to the debtor if you lose.

Given the duties imposed upon debtor’s counsel, complete with personal liability for fees and costs, coupled with the fact that the USTE is obligated to perform a Means Test analysis on every case and certify the same, it seems that you as a creditor may not have many opportunities to use this tool. Moreover, when you factor in the cost of prosecuting a Motion to Dismiss and the exposure to fees if you lose, the bottom line is that for the most part, the Means Test will be a self-executing rule that you really don’t have to worry about very much.

IV. Exemptions

An examination of the debtor’s claim of exemption is important. Exemptions are simply those assets which the debtor may keep in spite of the filing of bankruptcy. Exemptions under the Bankruptcy Code are governed under 11 U.S.C. §522. Pursuant to 11 U.S.C. §522(b)(1), Oklahoma has elected to require the debtor to utilize the exemptions under Oklahoma law as are specifically set forth in 31 O.S. §1. Note that Oklahoma also amended its exemption statutes effective August 26, 2005. The specific statutory provisions are:

Title 31. Homestead and Exemptions (Refs & Annos)

§ 1. Property exempt from attachment, execution or other forced sale — Bankruptcy proceedings

A. Except as otherwise provided in this title and notwithstanding subsection B of this section, the following property shall be reserved to every person residing in the state, exempt from attachment or execution and every other species of forced sale for the payment of debts, except as herein provided:

1. The home of such person, provided that such home is the principal residence of such person;

2. A manufactured home, provided that such manufactured home is the principal residence of such person;

3. All household and kitchen furniture held primarily for the personal, family, educational or household use of such person or a dependent of such person, including a personal computer and related equipment;

4. Any lot or lots in a cemetery held for the purpose of sepulcher;

5. Implements of husbandry necessary to farm the homestead and tools, apparatus and books used in any trade or profession of such person or a dependent of such person, not to exceed Ten Thousand Dollars ($10,000.00) in aggregate value;

6. All books, portraits and pictures that are held primarily for the personal, family or household use of such person or a dependent of such person;

7. The person’s interest, not to exceed Four Thousand Dollars ($4,000.00) in aggregate value, in wearing apparel that is held primarily for the personal, family or household use of such person or a dependent of such person;

8. The person’s interest, not to exceed Three Thousand Dollars ($3,000.00) in aggregate value, in wedding and anniversary rings;

9. All professionally prescribed health aids for such person or a dependent of such person;

10. Five milk cows and their calves under six (6) months old, that are held primarily for the personal, family or household use of such person or a dependent of such person;

11. One hundred chickens that are held primarily for the personal, family or household use of such person or a dependent of such person;

12. Two horses and two bridles and two saddles, that are held primarily for the personal, family or household use of such person or a dependent of such person;

13. Such person’s interest, not to exceed Seven Thousand Five Hundred Dollars ($7,500.00) in value, in one motor vehicle;

14. Guns, not to exceed Two Thousand Dollars ($2,000.00) in aggregate value, that are held primarily for the personal, family or household use of such person or a dependent of such person, provided that nothing in this subsection shall be construed to allow a person to exempt guns which are used mainly as an investment or non-personal, family or household use;

15. Ten hogs that are held primarily for the personal, family or household use of such person or a dependent of such person;

16. Twenty head of sheep that are held primarily for the personal, family or household use of such person or a dependent of such person;

17. All provisions and forage on hand, or growing for home consumption, and for the use of exempt stock for one (1) year;

18. Seventy-five percent (75%) of all current wages or earnings for personal or professional services earned during the last ninety (90) days, except as provided in Title 12 of the Oklahoma Statutes in garnishment proceedings for collection of child support;

19. Such person’s right to receive alimony, support, separate maintenance or child support payments to the extent reasonably necessary for the support of such person and any dependent of such person;

20. Subject to the Uniform Fraudulent Transfer Act, Section 112 et seq. of Title 24 of the Oklahoma Statutes, any interest in a retirement plan or arrangement qualified for tax exemption or deferment purposes under present or future Acts of Congress; provided, any transfer or rollover contribution between retirement plans or arrangements which avoids current federal income taxation shall not be deemed a transfer which is fraudulent as to a creditor under the Uniform Fraudulent Transfer Act. “Retirement plan or arrangement qualified for tax exemption purposes” shall include without limitation, trusts, custodial accounts, insurance, annuity contracts and other properties and rights constituting a part thereof. By way of example and not by limitation, retirement plans or arrangements qualified for tax exemption or deferment purposes permitted under present Acts of Congress include defined contribution plans and defined benefit plans as defined under the Internal Revenue Code (“IRC”), individual retirement accounts, individual retirement annuities, simplified employee pension plans, Keogh plans, IRC Section 403(a) annuity plans, IRC Section 403(b) annuities, Roth individual retirement accounts created pursuant to IRC Section 408A, educational individual retirement accounts created pursuant to IRC Section 530 and eligible state deferred compensation plans governed under IRC Section 457. This provision shall be in addition to and not a limitation of any other provision of the Oklahoma Statutes which grants an exemption from attachment or execution and every other species of forced sale for the payment of debts. This provision shall be effective for retirement plans and arrangements in existence on, or created after April 16, 1987;

21. Such person’s interest in a claim for personal bodily injury, death or workers’ compensation claim, for a net amount not in excess of Fifty Thousand Dollars ($50,000.00), but not including any claim for exemplary or punitive damages;

22. Funds in an individual development account established pursuant to the provisions of Section 251 et seq. of Title 56 of the Oklahoma Statutes;

23. Any amount received pursuant to the federal earned income tax credit; and

24. Any interest in an Oklahoma College Savings Plan account established pursuant to the provisions of Section 3970.1 et seq. of Title 70 of the Oklahoma Statutes.

B. No natural person residing in this state may exempt from the property of the estate in any bankruptcy proceeding the property specified in subsection (d) of Section 522 of the Bankruptcy Reform Act of 1978, Public Law 95-598, 11 U.S.C.A. 101 et seq., except as may otherwise be expressly permitted under this title or other statutes of this state.

An examination of 31 O.S. §1 reveals a “laundry list” of various items which may be claimed as exempt. In any creditor case, the schedules filed by the debtor must be examined to see if the exemptions claimed are valid exemption claims. If you believe that something claimed is not a valid exemption, then you must file an objection to the claim of exemption. If no objection is filed then the exemption is deemed allowed §522(l). Objections must be filed within 30 days of the conclusion of the creditors meeting held pursuant to §341.

If for some reason you fail to file an objection to the exemption in a timely fashion, then the item claimed as exempt is conclusively deemed to be exempt even if there is no good faith basis for the claimed exemption. Taylor v. Freeland & Kronz, 112 S.Ct. 1644, 503 U.S. 638, 118 L.Ed.2d 280, 60 USLW 4333, 26 Collier Bankr.Cas.2d 487, 22 Bankr.Ct.Dec. 1396, Bankr. L. Rep. (U. S.1992). It is critical to diary the objection date at the opening of the file and make a conscious decision to file or not after examination of the schedules. Anything the debtor claims as exempt is exempt unless an objection is filed regardless of whether or not there is any legal basis for the item claimed. The following are some potential areas which creditor’s counsel should be particularly careful to look for in any case.

Homestead – 31 O.S. §1(A)(1) and 31 O.S. §2

Homestead exemptions are governed under 31 O.S. §2. The homestead within a city or town is limited to one acre; however, outside of a city, town or village the homestead may be up to 160 acres. If there is no equity in the homestead, then look no further. If the homestead is mortgaged the exemption really doesn’t mean very much since the debtor must keep the payments on the mortgage current, otherwise, the mortgage holder may foreclose the mortgage notwithstanding the exemption. The debtor’s equity in the homestead over and above any encumbrances is, of course, exempt from all creditors except the IRS.

If the homestead is located within the limits of a city, town or village and is used for both a dwelling place and for a commercial enterprise then one must look to the amount of square footage used for business and non-business purposes. Specifically, “at least seventy‑five percent (75%) of the total square foot area of the improvements for which a homestead exemption is claimed must be used as the principal residence in order to qualify for the exemption. If more than twenty‑five percent (25%) of the total square foot area of the improvements for which a homestead exemption is claimed is used for business purposes, the homestead exemption amount shall not exceed Five Thousand Dollars ($5,000.00)”. If there is significant equity in the home, look first at the petition to see if the debtor claims to be engaged in business, then look at Schedule “I” to find the debtor’s means of gain. Are they self-employed? Where do they carry on their primary business activity?  If it’s in their home, then look at their tax returns to see if they claimed any deduction. This may be a source of substantial funds to repay creditors.

If it looks like you may be able to successfully attack the homestead exemption claim, make sure that you get testimony from both of the debtors if there is a marriage. Testimony from one debtor as to homestead issues may not be used to estop the other, and may result in neither being estopped. In re Osborn, 24 F.3d 1199(10^th Cir. (Okla.) 1994).

The Reform Act added several limitations to the homestead exemption. Although the Reform Bill generally became effective on October 17, 2005, some of its provisions became effective upon its signing. The following provisions affecting the homestead exemption became effective immediately on April 20, 2005.

All of the following Code sections are new:

New §522(a)(3)(A) provides restrictions on the applicable exemption law for debtors who have moved from one state to another within 730 days pre-petition. If your debtor has moved within this period of time, then you must determine how long they have been in the State of residence as of petition date. If they have not been in such State for at least 730 days (approximately 2 years), then you must inquire as to which State they were in for “180 days immediately preceding the 730-day period or for a longer portion of such 180-day period than in any other place”. What this seems to say is that you look back past the 730 days and determine where the debtor was for the greatest portion of the 180 days prior to the 730 days, and that is the State whose exemption laws apply. This can make a difference in a situation where a debtor moves to Oklahoma from say, Missouri, which has a $15,000.00 limit on the personal residence. See V.A.M.S. 513.475. In such a case, the debtor’s Oklahoma home would be subject to the $15,000 cap imposed under Missouri law. The specific language of the statute is:

(A) subject to subsections (o) and (p), any property that is exempt under Federal law, other than subsection (d) of this section, or State or local law that is applicable on the date of the filing of the petition at the place in which the debtor’s domicile has been located for the 180 730 days immediately preceding the date of the filing of the petition, or for a longer portion of such 180-day period than in any other place or if the debtor’s domicile has not been located at a single State for such 730-day period, the place in which the debtor’s domicile was located for 180 days immediately preceding the 730-day period or for a longer portion of such 180-day period than in any other place;

Section 522(o) reduces the homestead exemption to the extent that value is attributable to any portion of non-exempt property that the debtor disposed of within 10 years of filing bankruptcy, if the disposition was made with intent to hinder, delay, or defraud creditors. This section essentially overrules cases like In re Carey, 938 F.2d 1073 (10^th Cir. 1991) which allowed debtor’s pre-bankruptcy planning in converting non-exempt to exempt assets.

Section 522(p) generally places a $125,000 cap on the homestead acquired within 1,215 days of filing bankruptcy. Here, it is important to know when the debtor acquired their homestead. Note that this limitation does not include a “roll-over” of the debtor’s previous homestead. §522(p)(2)(B). Also, this limitation does not apply to family farmers (what about family fisherman?). The specific Code language of §522(p)(2)(A) is:

(p)(1) Except as provided in paragraph (2) of this subsection and sections 544 and 548, as a result of electing under subsection (b)(3)(A) to exempt property under State or local law, a debtor may not exempt any amount of interest that was acquired by the debtor during the 1215-day period preceding the date of the filing of the petition that exceeds in the aggregate $125,000 in value in –

(A) real or personal property that the debtor or a dependent of the debtor uses as a residence;

(B) a cooperative that owns property that the debtor or a dependent of the debtor uses as a residence;

(C) a burial plot for the debtor or a dependent of the debtor; or

(D) real or personal property that the debtor or dependent of the debtor claims as a homestead.

(2)(A) The limitation under paragraph (1) shall not apply to an exemption claimed under subsection (b)(3)(A) by a family farmer for the principal residence of such farmer.

(B) For purposes of paragraph (1), any amount of such interest does not include any interest transferred from a debtor’s previous principal residence (which was acquired prior to the beginning of such 1215-day period) into the debtor’s current principal residence, if the debtor’s previous and current residences are located in the same State.

Section 522(q) extends that $125,000 cap to situations involving a felony criminal conviction or other violations specified in the section.

(q)(1) As a result of electing under subsection (b)(3)(A) to exempt property under State or local law, a debtor may not exempt any amount of an interest in property described in subparagraphs (A), (B), (C), and (D) of subsection (p)(1) which exceeds in the aggregate $125,000 if –

(A) the court determines, after notice and a hearing, that the debtor has been convicted of a felony (as defined in section 3156 of title 18), which under the circumstances, demonstrates that the filing of the case was an abuse of the provisions of this title; or

(B) the debtor owes a debt arising from –

(i) any violation of the Federal securities laws (as defined in section 3(a)(47) of the Securities Exchange Act of 1934), any State securities laws, or any regulation or order issued under Federal securities laws or State securities laws;

(ii) fraud, deceit, or manipulation in a fiduciary capacity or in connection with the purchase or sale of any security registered under section 12 or 15(d) of the Securities Exchange Act of 1934 or under section 6 of the Securities Act of 1933;

(iii) any civil remedy under section 1964 of title 18; or

(iv) any criminal act, intentional tort, or willful or reckless misconduct that caused serious physical injury or death to another individual in the preceding 5 years.

(2) Paragraph (1) shall not apply to the extent the amount of an interest in property described in subparagraphs (A), (B), (C), and (D) of subsection (p)(1) is reasonably necessary for the support of the debtor and any dependent of the debtor.

It is unclear what is meant by the phrase in §522(q)(1)(A) “a felony (as defined in §3156 of title 18)” as such section states:

(3) the term “felony” means an offense punishable by a maximum term of imprisonment of more than one year;

This definition does not refer to any particular felony nor does it relate to a Federal vs. State criminal statute. So, does this mean that anyone who has ever been convicted of a felony would fall within this statute? If so, then what does “circumstances, demonstrate that the filing of the case was an abuse” mean? It is not certainly a specific standard, which in turn would leave the door open for creditor’s lawyer to argue a creative case. The other specific criminal acts relate to securities violations and are clearly a result of the Enron/Worldcom/Tyco fiascos.

Each of these situations give a creditor who has some history with the debtor an opportunity to utilize such knowledge by informing the Trustee or filing your own objection.

Household Goods and Furniture – 31 O.S. §1(A)(3)

Furniture is defined to mean those things necessary to furnish a house as opposed to just things which you may sit on and the like. Security Building & Loan Association of Oklahoma City v. Ward, 50 P.2d 651 (Okl. 1935). About the only thing of interest here is whether or not the debtor has any expensive antiques. Look at the financial statement given to your client to see if they have listed any antiques or other valuable personal property which might be “lumped in” with the debtor’s furniture.

Wearing Apparel – 31 O.S. §1(A)(8)

The debtor’s wearing apparel is exempt and usually is not subject to much question since used clothing does not have much value. This exemption is nonetheless limited to $4,000.00. However, the question of jewelry arises under this context. Jewelry is not specifically exempt however if it is wearing apparel it may be exempt. Items of jewelry which are held as investments and which are not part of the debtor’s normal attire are not exempt. In Re: Goldberg, 59 B.R. 201 (NDBC OK, 1986).

Implements of Husbandry & Tools of Trade – 31 O.S. 1(A)(5) & (6)

Oklahoma provides that any apparatus used in a trade or profession may be a tool of the trade. In Re Wineland, 3 F.Supp. 796 (D.C. 1933). Implements of husbandry are those items which are “necessary” to farm the homestead. Implements which are actually used on the homestead may be claimed as exempt implements. There is a new, increased dollar limitation of $10,000 on implements and tools of the trade. This area is particularly important to creditor’s counsel because this is one area where the debtor may avoid a non-purchase money lien. If your client has such a lien, be extra careful to review the tools of the trade exemptions claimed. You may be able to get a tactical advantage by objecting to the exemption before the debtor files their lien avoidance. Further, if you don’t object to the exemption timely, the debtor will argue that the property is by definition exempt due to your failure to object to the exemption claim. In Re Towns 74 B.R. 563 (BC SD Iowa, 1987). However, there is case law to the contrary. In Re Caruthers 87 B.R. 723 (BC ND Ga, 1988).

Retirement Plans – 31 O.S. §1(A)(20)

The United States Supreme Court has held that ERISA qualified retirement plans are not property of the estate, and thus may not be attacked in bankruptcy. Patterson v. Shumate, 112 S.Ct. 2242 (U.S. 1992). Any other types of retirement plan to which contributions are tax deductible are exempt under Oklahoma law.

V. Reaffirmation

Unless a lien is avoidable the debtor really only has three options with regard to a secured creditor. Either the debtor must surrender the property subject to the lien, continue to make the payments in accordance with the terms of the contract or redeem the property.  If the debtor chooses to retain the asset and enter into an arrangement with the creditor to continue making payments, the parties must contend with a reaffirmation agreement. Reaffirmation agreements are governed by 11 U.S.C. §524(c). Section 524 has been amended to add a new subsection (k) that specifically sets forth the mandatory disclosures that must be in all reaffirmation agreements. The new mandatory disclosures required to be included in all reaffirmation agreements include an expanded explanation regarding the rescission of such agreements, the financial obligations created by signing the agreement, and a panoply of specific language mandated for all reaffirmation agreements. A national form which complies with these new requirements has been developed by the Administrative Office of the U. S. Courts. It is Form B 240A (copy attached) and may be downloaded from the website:

http://www.uscourts.gov/FormsAndFees/Forms/BankruptcyForms.aspx

Some of the new disclosures established by §524(k) are not applicable to reaffirmations with credit unions. It is critical to be careful in utilizing the official forms (when such come to exist). Until such time, I recommend parroting the statute. This is critical because not only is a non-conforming form likely to be held invalid, but the Reform Act amends Title 18 of the Code to require both the United States attorneys and the FBI to designate a specific person to be responsible for investigating and addressing abusive reaffirmation practices as well as materially fraudulent statements made in bankruptcy schedules. Although such designated person is not specifically directed to actually conduct an investigation, the fact that such a person exists should give all parties reason to pay closer attention to the new rules.

The new provision found in §524(c) adds a tremendous amount of specific language which must be utilized in a reaffirmation agreement. The text of §524(k) is set forth below:

(c) An agreement between a holder of a claim and the debtor, the consideration for which, in whole or in part, is based on a debt that is dischargeable in a case under this title is enforceable only to any extent enforceable under applicable nonbankruptcy law, whether or not discharge of such debt is waived, only if –

(1) such agreement was made before the granting of the discharge under section 727, 1141, 1228, or 1328 of this title;

• “(2)(A) such agreement contains a clear and conspicuous statement which advises the debtor that the agreement may be rescinded at any time prior to discharge or within sixty days after such agreement is filed with the court, whichever occurs later, by giving notice of rescission to the holder of such claim; and”

“(B) such agreement contains a clear and conspicuous statement which advises the debtor that such agreement is not required under this title, under nonbankruptcy law, or under any agreement not in accordance with the provisions of this subsection;”

(2) the debtor received the disclosures described in subsection (k) at or before the time at which the debtor signed the agreement;

……….

(k)(1) The disclosures required under subsection (c)(2) shall consist of the disclosure statement described in paragraph (3), completed as required in that paragraph, together with the agreement specified in subsection (c), statement, declaration, motion and order described, respectively, in paragraphs (4) through (8), and shall be the only disclosures required in connection with entering into such agreement.

(2) Disclosures made under paragraph (1) shall be made clearly and conspicuously and in writing. The terms ‘Amount Reaffirmed’ and ‘Annual Percentage Rate’ shall be disclosed more conspicuously than other terms, data or information provided in connection with this disclosure, except that the phrases ‘Before agreeing to reaffirm a debt, review these important disclosures’ and ‘Summary of Reaffirmation Agreement’ may be equally conspicuous. Disclosures may be made in a different order and may use terminology different from that set forth in paragraphs (2) through (8), except that the terms ‘Amount Reaffirmed’ and ‘Annual Percentage Rate’ must be used where indicated.

(3) The disclosure statement required under this paragraph shall consist of the following:

(A) The statement: ‘Part A: Before agreeing to reaffirm a debt, review these important disclosures:’;

(B) Under the heading ‘Summary of Reaffirmation Agreement’, the statement: ‘This Summary is made pursuant to the requirements of the Bankruptcy Code’;

(C) The ‘Amount Reaffirmed’, using that term, which shall be –

(i) the total amount of debt that the debtor agrees to reaffirm by entering into an agreement of the kind specified in subsection (c), and

(ii) the total of any fees and costs accrued as of the date of the disclosure statement, related to such total amount.

(D) In conjunction with the disclosure of the ‘Amount Reaffirmed’, the statements –

(i) ‘The amount of debt you have agreed to reaffirm’; and

(ii) ‘Your credit agreement may obligate you to pay additional amounts which may come due after the date of this disclosure. Consult your credit agreement.’.

(E) The ‘Annual Percentage Rate’, using that term, which shall be disclosed as —

(i) if, at the time the petition is filed, the debt is an extension of credit under an open end credit plan, as the terms ‘credit’ and ‘open end credit plan’ are defined in section 103 of the Truth in Lending Act, then—

(I) the annual percentage rate determined under paragraphs (5) and (6) of section 127(b) of the Truth in Lending Act, as applicable, as disclosed to the debtor in the most recent periodic statement prior to entering into an agreement of the kind specified in subsection (c) or, if no such periodic statement has been given to the debtor during the prior 6 months, the annual percentage rate as it would have been so disclosed at the time the disclosure statement is given to the debtor, or to the extent this annual percentage rate is not readily available or not applicable, then

(II) the simple interest rate applicable to the amount reaffirmed as of the date the disclosure statement is given to the debtor, or if different simple interest rates apply to different balances, the simple interest rate applicable to each such balance, identifying the amount of each such balance included in the amount reaffirmed, or

(III) if the entity making the disclosure elects, to disclose the annual percentage rate under subclause (I) and the simple interest rate under subclause (II); or

(ii) if, at the time the petition is filed, the debt is an extension of credit other than under an open end credit plan, as the terms ‘credit’ and ‘open end credit plan’ are defined in section 103 of the Truth in Lending Act, then –

(I) the annual percentage rate under section 128(a)(4) of the Truth in Lending Act, as disclosed to the debtor in the most recent disclosure statement given to the debtor prior to the entering into an agreement of the kind specified in subsection (c) with respect to the debt, or, if no such disclosure statement was given to the debtor, the annual percentage rate as it would have been so disclosed at the time the disclosure statement is given to the debtor, or to the extent this annual percentage rate is not readily available or not applicable, then

(II) the simple interest rate applicable to the amount reaffirmed as of the date the disclosure statement is given to the debtor, or if different simple interest rates apply to different balances, the simple interest rate applicable to each such balance, identifying the amount of such balance included in the amount reaffirmed, or

(III) if the entity making the disclosure elects, to disclose the annual percentage rate under (I) and the simple interest rate under (II).

(F) If the underlying debt transaction was disclosed as a variable rate transaction on the most recent disclosure given under the Truth in Lending Act, by stating ‘The interest rate on your loan may be a variable interest rate which changes from time to time, so that the annual percentage rate disclosed here may be higher or lower.’.

(G) If the debt is secured by a security interest which has not been waived in whole or in part or determined to be void by a final order of the court at the time of the disclosure, by disclosing that a security interest or lien in goods or property is asserted over some or all of the debts the debtor is reaffirming and listing the items and their original purchase price that are subject to the asserted security interest, or if not a purchase-money security interest then listing by items or types and the original amount of the loan.

(H) At the election of the creditor, a statement of the repayment schedule using 1 or a combination of the following –

(i) by making the statement: ‘Your first payment in the amount of $XXX is due on XXX but the future payment amount may be different. Consult your reaffirmation agreement or credit agreement, as applicable.’, and stating the amount of the first payment and the due date of that payment in the places provided;

(ii) by making the statement: ‘Your payment schedule will be:’, and describing the repayment schedule with the number, amount, and due dates or period of payments scheduled to repay the debts reaffirmed to the extent then known by the disclosing party; or

(iii) by describing the debtor’s repayment obligations with reasonable specificity to the extent then known by the disclosing party.

(I) The following statement: ‘Note: When this disclosure refers to what a creditor ‘may’ do, it does not use the word ‘may’ to give the creditor specific permission.The word ‘may’ is used to tell you what might occur if the law permits the creditor to take the action. If you have questions about your reaffirming a debt or what the law requires, consult with the attorney who helped you negotiate this agreement reaffirming a debt. If you don’t have an attorney helping you, the judge will explain the effect of your reaffirming a debt when the hearing on the reaffirmation agreement is held.’.

(J)(i) The following additional statements:

Reaffirming a debt is a serious financial decision. The law requires you to take certain steps to make sure the decision is in your best interest. If these steps are not completed, the reaffirmation agreement is not effective, even though you have signed it.

1. Read the disclosures in this Part A carefully. Consider the decision to reaffirm carefully. Then, if you want to reaffirm, sign the reaffirmation agreement in Part B (or you may use a separate agreement you and your creditor agree on).

2. Complete and sign Part D and be sure you can afford to make the payments you are agreeing to make and have received a copy of the disclosure statement and a completed and signed reaffirmation agreement.

3. If you were represented by an attorney during the negotiation of your reaffirmation agreement, the attorney must have signed the certification in Part C.

4. If you were not represented by an attorney during the negotiation of your reaffirmation agreement, you must have completed and signed Part E.

5. The original of this disclosure must be filed with the court by you or your creditor. If a separate reaffirmation agreement (other than the one in Part B) has been signed, it must be attached.

6. If you were represented by an attorney during the negotiation of your reaffirmation agreement, your reaffirmation agreement becomes effective upon filing with the court unless the reaffirmation is presumed to be an undue hardship as explained in Part D.

7. If you were not represented by an attorney during the negotiation of your reaffirmation agreement, it will not be effective unless the court approves it. The court will notify you of the hearing on your reaffirmation agreement. You must attend this hearing in bankruptcy court where the judge will review your reaffirmation agreement. The bankruptcy court must approve your reaffirmation agreement as consistent with your best interests, except that no court approval is required if your reaffirmation agreement is for a consumer debt secured by a mortgage, deed of trust, security deed, or other lien on your real property, like your home.

Your right to rescind (cancel) your reaffirmation agreement. You may rescind (cancel) your reaffirmation agreement at any time before the bankruptcy court enters a discharge order, or before the expiration of the 60-day period that begins on the date your reaffirmation agreement is filed with the court, whichever occurs later. To rescind (cancel) your reaffirmation agreement, you must notify the creditor that your reaffirmation agreement is rescinded (or canceled).

What are your obligations if you reaffirm the debt? A reaffirmed debt remains your personal legal obligation. It is not discharged in your bankruptcy case. That means that if you default on your reaffirmed debt after your bankruptcy case is over, your creditor may be able to take your property or your wages. Otherwise, your obligations will be determined by the reaffirmation agreement which may have changed the terms of the original agreement. For example, if you are reaffirming an open end credit agreement, the creditor may be permitted by that agreement or applicable law to change the terms of that agreement in the future under certain conditions.

Are you required to enter into a reaffirmation agreement by any law? No, you are not required to reaffirm a debt by any law. Only agree to reaffirm a debt if it is in your best interest. Be sure you can afford the payments you agree to make.

What if your creditor has a security interest or lien? Your bankruptcy discharge does not eliminate any lien on your property. A ‘lien’ is often referred to as a security interest, deed of trust, mortgage or security deed. Even if you do not reaffirm and your personal liability on the debt is discharged, because of the lien your creditor may still have the right to take the security property if you do not pay the debt or default on it. If the lien is on an item of personal property that is exempt under your State’s law or that the trustee has abandoned, you may be able to redeem the item rather than reaffirm the debt. To redeem, you make a single payment to the creditor equal to the current value of the security property, as agreed by the parties or determined by the court.

(ii) In the case of a reaffirmation under subsection (m)(2), numbered paragraph 6 in the disclosures required by clause (i) of this subparagraph shall read as follows:

6. If you were represented by an attorney during the negotiation of your reaffirmation agreement, your reaffirmation agreement becomes effective upon filing with the court.

(4) The form of such agreement required under this paragraph shall consist of the following:

Part B: Reaffirmation Agreement. I (we) agree to reaffirm the debts arising under the credit agreement described below.

Brief description of credit agreement:

Description of any changes to the credit agreement made as part of this reaffirmation agreement:

Signature: Date:

Borrower:

Co-borrower, if also reaffirming these debts:

Accepted by creditor:

Date of creditor acceptance:.

(5) The declaration shall consist of the following:

(A) The following certification:

Part C: Certification by Debtor’s Attorney (If Any).

I hereby certify that (1) this agreement represents a fully informed and voluntary agreement by the debtor; (2) this agreement does not impose an undue hardship on the debtor or any dependent of the debtor; and (3) I have fully advised the debtor of the legal effect and consequences of this agreement and any default under this agreement.

Signature of Debtor’s Attorney: Date:.

(B) If a presumption of undue hardship has been established with respect to such agreement, such certification shall state that in the opinion of the attorney, the debtor is able to make the payment.

(C) In the case of a reaffirmation agreement under subsection (m)(2), subparagraph (B) is not applicable.

(6)(A) The statement in support of such agreement, which the debtor shall sign and date prior to filing with the court, shall consist of the following:

Part D: Debtor’s Statement in Support of Reaffirmation Agreement.

1. I believe this reaffirmation agreement will not impose an undue hardship on my dependents or me. I can afford to make the payments on the reaffirmed debt because my monthly income (take home pay plus any other income received) is $XXX, and my actual current monthly expenses including monthly payments on post-bankruptcy debt and other reaffirmation agreements total $XXX, leaving $XXXX to make the required payments on this reaffirmed debt. I understand that if my income less my monthly expenses does not leave enough to make the payments, this reaffirmation agreement is presumed to be an undue hardship on me and must be reviewed by the court. However, this presumption may be overcome if I explain to the satisfaction of the court how I can afford to make the payments here: XXX.

2. I received a copy of the Reaffirmation Disclosure Statement in Part A and a completed and signed reaffirmation agreement.

(B) Where the debtor is represented by an attorney and is reaffirming a debt owed to a creditor defined in section 19(b)(1)(A)(iv) of the Federal Reserve Act, the statement of support of the reaffirmation agreement, which the debtor shall sign and date prior to filing with the court, shall consist of the following:

I believe this reaffirmation agreement is in my financial interest. I can afford to make the payments on the reaffirmed debt. I received a copy of the Reaffirmation Disclosure Statement in Part A and a completed and signed reaffirmation agreement.

(7) The motion that may be used if approval of such agreement by the court is required in order for it to be effective, shall be signed and dated by the movant and shall consist of the following:

Part E: Motion for Court Approval (To be completed only if the debtor is not represented by an attorney.). I (we), the debtor(s), affirm the following to be true and correct:

I am not represented by an attorney in connection with this reaffirmation agreement.

I believe this reaffirmation agreement is in my best interest based on the income and expenses I have disclosed in my Statement in Support of this reaffirmation agreement, and because (provide any additional relevant reasons the court should consider):

Therefore, I ask the court for an order approving this reaffirmation agreement.’.

(8) The court order, which may be used to approve such agreement, shall consist of the following:

Court Order: The court grants the debtor’s motion and approves the reaffirmation agreement described above.

(l) Notwithstanding any other provision of this title the following shall apply:

(1) A creditor may accept payments from a debtor before and after the filing of an agreement of the kind specified in subsection (c) with the court.

(2) A creditor may accept payments from a debtor under such agreement that the creditor believes in good faith to be effective.

(3) The requirements of subsections (c)(2) and (k) shall be satisfied if disclosures required under those subsections are given in good faith.

(m)(1) Until 60 days after an agreement of the kind specified in subsection (c) is filed with the court (or such additional period as the court, after notice and a hearing and for cause, orders before the expiration of such period), it shall be presumed that such agreement is an undue hardship on the debtor if the debtor’s monthly income less the debtor’s monthly expenses as shown on the debtor’s completed and signed statement in support of such agreement required under subsection (k)(6)(A) is less than the scheduled payments on the reaffirmed debt. This presumption shall be reviewed by the court. The presumption may be rebutted in writing by the debtor if the statement includes an explanation that identifies additional sources of funds to make the payments as agreed upon under the terms of such agreement. If the presumption is not rebutted to the satisfaction of the court, the court may disapprove such agreement. No agreement shall be disapproved without notice and a hearing to the debtor and creditor, and such hearing shall be concluded before the entry of the debtor’s discharge.

(2) This subsection does not apply to reaffirmation agreements where the creditor is a credit union, as defined in section 19(b)(1)(A)(iv) of the Federal Reserve Act.

Thus, one must meet several requirements in order to effectively reaffirm a debtor’s obligation to a particular creditor. Everyone will need to completely revise the forms they use for reaffirmation agreements and incorporate all of the new, additional language into such agreements. Note that credit unions have special treatment under this section. The mandatory language required for inclusion in all reaffirmation agreements is significantly less wordy if the creditor is a credit union and if the debtor is represented by an attorney. Note that everyone has to provide the Disclosure Statement. Also, the presumption of abuse provision does not apply to credit unions.

Note that it is absolutely critical that the reaffirmation agreement be properly executed and filed PRIOR to the entry of the discharge. There has been significant litigation recently against creditors who obtained signed reaffirmation agreements, but failed to file the same. Ultimately, such creditors had to refund all of the money they collected on these invalid reaffirmation agreements. See In re Latanowich, 207 B.R. 326 (Bkrtcy.D.Mass. 1997), which held, (1) a reaffirmation agreement which was never filed with or approved by Bankruptcy Court, was void; (2) the creditor’s attempt to collect a pre-petition debt pursuant to agreement violated discharge injunction; (3) the debtor was entitled to compensatory damages; (4) the creditor’s conduct warranted punitive damages; and (5) the creditor was permanently enjoined from taking any action to enforce its alleged security interest in items debtor acquired pre-petition. This case has spawned a number of class action suits against the particular creditor. Moral of the story, be sure to file your reaffirmation agreements prior to the entry of the discharge. Given the new deadlines imposed upon debtors, this normally should not be a problem.

The timing of the reaffirmation agreement is important in that it must be entered before the discharge. If a timing problem arises it is advisable to file a motion requesting that the discharge not be entered until such time as the reaffirmation is filed. However, it is a better practice to get the reaffirmation agreements done early in the case and signed before the creditors’ meeting in order to avoid this problem. With the new provisions of §521(a) requiring the debtor to perform their intentions within 30 days, the job of the secured creditor will be considerably easier. The sanction for failure to perform the stated intention within 30 days is the termination of the automatic stay. An additional discussion of how this works is found below, but the short answer is that the debtor has to do what they say they are going to do within 30 days or in most cases, the stay will terminate thereby allowing you to exercise your State law rights of repossession.

In addition, if your loan was in part or in whole a purchase money loan, then the debtor only has 45 days to reaffirm or redeem the property, otherwise the stay terminates. There is a conflict between the 30 and 45 day periods. The primary difference seems to be that the 30 day period applies to non-purchase money security interests while the 45 day period applies to purchase money loans. Although it seems incongruous that a purchase money lender would have to wait longer than a non-purchase money lender, this seems to be the case.

Only the Trustee may obtain an extension of either of these time limits, which normally will only occur if the Trustee believes there is some defect in the perfection of one’s security interest.

The reaffirmation agreement by its terms will generally mirror the terms of the original contractual agreement between the debtor and the creditor. The debtor does not have any means of forcing a change in the terms of a pre-petition contract in Chapter 7 without the creditor’s consent. However, the parties may agree to any legal arrangement which can be arrived at. Many times reaffirmation agreements may be negotiated which modify the terms of the agreement if such is an intelligent business decision.

If the debtor is represented by an attorney, then there is no court involvement in the reaffirmation process. Note that under certain circumstances, the new mandatory language now requires the Debtor’s lawyer to aver that “in the opinion of the attorney, the debtor is able to make the payment”. This language is required when there is a presumption of a hardship as calculated in §524(k)(6) Part D, which essentially requires the debtor to show that they have sufficient disposable income to pay the monthly payments being reaffirmed. If the calculation shows that there is not sufficient income, then the agreement is presumed abusive. In this situation there must be an explanation provided as to how the payments are going to be made and the debtor’s lawyer must sign off on the document expressing their opinion that the debtor can make the payments. Query: Can the creditor receiving such an agreement sue the debtor’s lawyer when the debtor defaults? I personally have no intention of ever signing such a document.

If the debtor has no attorney, then 11 U.S.C. §524(d) provides for a hearing at which the debtor is required to appear and the Court to inform the debtor: (1) that the reaffirmation agreement is not required by law and (2) the legal effect and consequences of entering into such reaffirmation agreement and the effect of default under such agreement. Additionally, the Court is required to determine that the agreement which the debtor desires to make complies with all of the provisions of 11 U.S.C. §524(c).

If the Code requires a §524(d) hearing, is a reaffirmation agreement valid without such a hearing?  Answer: In an unreported case, Judge Stephen Covey has held a reaffirmation agreement without a §524(d) hearing is unenforceable. If the debtor has no attorney, it’s up to you to make sure the debtor attends this hearing. Write them a letter and remind them to attend.

The best practice is to get the reaffirmation agreements negotiated prior to the creditors’ meeting and appear at the creditors’ meeting, have everyone sign off on the agreement and be done with your labors when you leave. If there is any question about the equity in a non-exempt asset which the debtor seeks to reaffirm, you may have the trustee sign a document giving notice of the trustee’s intent to abandon at the creditors’ meeting as well.

The new provisions providing for the automatic termination of the automatic stay 45 days after the creditors meeting should also help a lot in getting these agreements signed in a timely manner.

Now, what about the ride through?  We are all familiar with the Tenth Circuit case of Lowry Federal Credit Union v. West, 882 F.2d 1543 (10^th Cir. 1989) which holds that a debtor’s failure to file notice of election to redeem collateral or reaffirm debt does not give a secured creditor the automatic right to repossess its collateral, and that bankruptcy court’s have the discretionary authority to permit debtors to retain a secured creditor’s collateral without either redeeming collateral or reaffirming debt. So, is this fourth option dead?  The answer is a definite “maybe”. Although it is clear that unless the debtor either surrenders, redeems or reaffirms within the 45 day deadline, then the stay is automatically terminated; what is not clear is whether a debtor who is not otherwise in default as of the petition date, would be in default by such failure.  Although the holding of Lowry was not specifically overruled by the Reform Act, it appears that every Court which has addressed this issue has found that the Reform Act eliminated the ride through option.  “BAPCPA appears to have eliminated simple retention and “ride through” as an option for debtors.” In re Blakeley, — B.R. —-, 2007 WL 674712 (Bankr.Utah 2007), citing Stern, Reaffirmation Under BAPCPA: Did Ride-Through Survive?, 2007 Norton Bankr.L Advisor No. 1 at p. 6.  See also, Jean Braucher, Rash and Ride-Through Redux: The Terms for Holding on to Cars, Homes and Other Collateral Under the 2005 Act, 13 Am. Bankr.Inst. L.Rev. 457, 474-81 (2005). In re Rowe, 342 B.R. 341 (Bankr.D.Kan.2006) and In re Laynas, 345 B.R. 505 (Bankr.E.D.Pa.,2006)

VI. Lien Avoidance

There are certain circumstances under which the debtor may retain property subject to a lien without paying the creditor. This is generally known as a lien avoidance and is governed by 11 U.S.C. §522(f). The practical effect of lien avoidance is to remove whatever encumbrance is present on the property without any compensation being paid to the creditor. The lien avoidance is an extremely powerful tool, albeit one which is somewhat limited in scope. If the debtor wants to avoid a lien, they must file a motion and get an order entered by the Court. If a motion to avoid your client’s lien is filed, you must object within the time frame required by the local rules, which is generally about two weeks.

First, examine the type of lien you hold. There are two types of liens which may be avoided under §522(f). Section 522(f)(1)(A) provides for the avoidance of a judicial lien. The nature of the judgment does not affect its avoidability, except for Domestic Support Obligations, which are not avoidable. This generally applies to judgment liens which have been filed of record thereby encumbering the homestead real property of the debtor. As long as the exemption on the real estate is valid, there is no defense to an effort to avoid this type of lien.

The other type of avoidable lien is under §522(f)(1)(B). This type of lien is avoidable provided it is a non-possessory, non-purchase money security interest which encumbers certain types of exempt property. The fact that a creditor has repossessed property under a security agreement pursuant to the self help provisions of the Uniform Commercial Code may or may not create a possessory security interest. In Re: Medows, 75 B.R. 357 (W.D. Va. 1987) (holding repossession does not create possessory security interest.) Contra: In Re: Sanders, 61 B.R. 381 (Bankr. Kan. 1986). Before the lien is a possessory lien, it must have been a possessory lien at its creation.

Also, the security interest must be a non-purchase money security interest. Purchase money security interests are defined in 12A O.S. §9-107(b) as security interests which enable the debtor to obtain an interest in the item which is pledged as collateral. An interesting question arises here as to what effect the refinancing of a debt and the execution of a new security agreement granting a new security interest in the particular item of collateral creates. The Oklahoma Courts have generally held that funds retain their purchase money nature on a first-in, first-out basis. In Re: Russell, 29 B.R. 270 (B.C. W.D. Ok., 1983). If the lien of your client is not of the type discussed above, then the debtor may not avoid same and you should file a timely objection.

If the lien is of the type which may be avoided, then one must analyze whether or not the collateral is the type of exempt property which is subject to the lien avoidance procedure. Section 522(f)(1)(B)(i), (ii) and (iii) describe the types of property which are subject to lien avoidance.  The analysis which must take place is that first you must determine whether or not the goods are exempt under Oklahoma law and, secondly, if the exempt goods also fit within one of the categories set forth in §522(f)(1)(B)(i), (ii) and (iii).

In addition, the Reform Act imposes additional limitations upon the avoidance rights under §522(f)(1)(B) by imposing a statutory definition on the term “household goods”. The new §522(f)(4)(A) restricts the term “household goods” to the following specific list:

(i) clothing;

(ii) furniture;

(iii) appliances;

(iv) 1 radio;

(v) 1 television;

(vi) 1 VCR;

(vii) linens;

(viii) china;

(ix) crockery;

(x) kitchenware;

(xi) educational materials and educational equipment primarily for the use of minor dependent children of the debtor;

(xii) medical equipment and supplies;

(xiii) furniture exclusively for the use of minor children, or elderly or disabled dependents of the debtor;

(xiv) personal effects (including the toys and hobby equipment of minor dependent children and wedding rings) of the debtor and the dependents of the debtor; and

(xv) 1 personal computer and related equipment.

A further restriction is also found in §522(f)(4)(B) to exclude certain items as follows:

(B) The term “household goods” does not include –

(i) works of art (unless by or of the debtor, or any relative of the debtor);

(ii) electronic entertainment equipment with a fair market value of more than $500 in the aggregate (except 1 television, 1 radio, and 1 VCR);

(iii) items acquired as antiques with a fair market value of more than $500 in the aggregate;

(iv) jewelry with a fair market value of more than $500 in the aggregate (except wedding rings); and

(v) a computer (except as otherwise provided for in this section), motor vehicle (including a tractor or lawn tractor), boat, or a motorized recreational device, conveyance, vehicle, watercraft, or aircraft.

If the property is not within both the Oklahoma and Federal definitions, the debtor may not avoid the lien. If, on the other hand the lien is avoidable, the collateral meets all of the various statutory definitions, then the lien is avoidable and no objection should be filed.

Note that even though the failure to object to a claim of exemption results in the property claimed being conclusively determined to be exempt, Taylor v. Freeland & Kronz, supra, such failure to object does not preclude the secured creditor from defending a lien avoidance on the ground that the property upon which the lien is sought to be avoided is not exempt despite the failure to timely object to the claim of exemption. In Re Maylin, 155 B.R. 605 (Bkrtcy. Me. 1993).However, if you have a non-purchase money security interest which may be subject to avoidance, you should carefully review the claimed exemptions to see if your collateral is improperly claimed as exempt. If so, a timely objection should be filed to preserve your position.

One other issue to consider is when a motion to avoid a lien may be filed. The Bankruptcy Code nor the bankruptcy rules proscribe when such a motion must be filed. Thus, the debtor may file a motion to avoid the lien any time during which the case is open. It is even permissible to reopen a case and file a motion to avoid a lien provided the creditor whose lien is being avoided has not taken any action in reliance upon the debtor’s inaction to the creditor’s detriment. In Re: Peterson, 8 C.B.C. 2d 215, 24 B.R. 942 (B.C. D. MN 1983) and In Re: Yazzie, 9 C.B.C. 2d 62, 24 B.R. 576 (BAP-9, 1982). Just because the debtor doesn’t move to avoid your lien while the case is open doesn’t mean you’re safe. However, if you have repossessed the property and otherwise taken some actions based upon the failure to avoid the lien after the bankruptcy case is closed, then you may be able to defeat the attempt to re-open the case and avoid the lien.

VII. Redemption

There is one other procedure by which the debtor may retain property subject to a creditor’s lien. This is known as redemption and is governed under §722. This section only relates to consumer debts on personal property of the debtor. It provides the debtor may redeem property subject to the creditor’s lien by paying the fair market value of the asset sought to be redeemed to the creditor. In the event the debtor and the creditor cannot agree upon the value of the property sought to be redeemed, the Court may, after proper notice and hearing, determine the fair market value of the property which may then be redeemed by the debtor. The primary limitation to this proceeding is that the debtor must redeem the property in cash and may not compel the creditor to take an installment payout of the redemption value. There is no detriment to the creditor in this procedure, and in fact as long as the values are protected, the creditor is actually better off with the cash value of the property than to have to deal with repossession.

The Reform Act made no changes to this provision, but keep in mind that if the debtor seeks to redeem property, they must accomplish such before 45 days after the creditors meeting to avoid the automatic termination of the automatic stay.

VIII. Automatic Stay

If the debtor chooses not to retain the property, then you must take steps to recover it. The impediment is the Automatic Stay which comes into existence upon the filing of the bankruptcy case. The Court will issue the §341 notice which provides the notice of the imposition of the automatic stay. It is beneficial to conceptualize a bankruptcy case as really a request for an equitable injunction. The issuance of the automatic stay amounts to an ex parte temporary restraining order which ultimately ripens into a permanent restraining order upon the issuance of the discharge. The automatic stay is governed by §362. Essentially, this injunction enjoins all creditors from taking any action against the debtor or their property.

Exceptions to the automatic stay are set forth in §362(b); however, most creditor’s claims will not be exempt from the stay. It is critical that all collection actions be stopped upon being given notice of the filing of the case. If you discover that for some reason such activities have not ceased, take corrective measures to stop them at once. Section 362(k)(1) creates a cause of action for damages, both actual and punitive, attorney’s fees and costs, for any creditor who willfully violates the provisions of §362. Bankruptcy Judges take a very dim view of creditors who intentionally violate the stay after they have been asked to stop and usually require such creditors to pay for such transgressions. You can’t win this one, so don’t try it.

Any deliberate act taken in violation of automatic stay, which violator knows to be in existence, justifies award of actual damages which includes attorney’s fees. If there are additional finding of maliciousness or bad faith on part of the creditor, then the imposition of punitive damages is appropriate. In re Crysen/Montenay Energy Co., 902 F.2d 1098 (2d Cir. 1990). For example, in one local case in Tulsa, Judge Terrance Michael awarded $2,850.00 in actual damages, $15,000.00 in attorney’s fees, plus $40,000.00 in punitive damages against a creditor who repossessed a debtor’s car in violation of the stay in a Chapter 13 case. In re Diviney, 211 B.R. 951, (Bkrtcy.N.D.Okla. 1997). It is a very risky course to assume that the stay does not apply to you. If you are wrong, then you will have to pay any damages which result from your acts. The best course is to obtain relief from the stay.

As will be discussed below, new section in §362(h) provides for automatic termination of the stay. If a creditor violates the stay in the mistaken, good faith belief that the stay was automatically terminated under new §362(h), the damages are limited to actual damages, NOT including attorney’s fees.

Automatic Termination of the Automatic Stay

Failure to file and perform statement of intention

New §362(h) provides for the automatic termination of the stay and for abandonment of the property if the debtor fails to timely perform their intentions under §521(a)(2) unless they attempt to reaffirm based on the original contract terms and the creditor refuses to agree to such reaffirmation. Specifically, §521(a)(2)(A) requires the debtor to file a statement of intention within earlier of 30 days after the petition date or the date set for the creditors’ meeting (unless extended by an order of the Court). Thereafter, §521(a)(2)(B) requires the debtor to perform their stated intention within 30 days after the creditors’ meeting (unless such time period is extended by a court order obtained before the 30 day period expires).

The statement of intention is not changed. There is no statutory “ride through” option as discussed above. The statement of intention provides the debtor must either surrender, reaffirm, redeem, avoid the lien under §522(f)(1)(B) or assume an unexpired lease of personal property under §365(p).

New §362(h)(A) provides debtor must timely file the statement of intention and §362(h)(B) requires that such stated intentions must be performed within the time frames established by §521(a)(2). If the debtor fails in any of these obligations, then the stay automatically terminates. No motion, notice or order is required.

Note that the Trustee (and only the Trustee) may obtain relief from the automatic termination of the stay by filing a motion, upon notice and opportunity, before the stay automatically terminates as provided in §362(h)(2) as follows:

Paragraph (1) does not apply if the court determines, on the motion of the trustee filed before the expiration of the applicable time set by §521(a)(2), after notice and a hearing, that such personal property is of consequential value or benefit to the estate, and orders appropriate adequate protection of the creditor’s interest, and orders the debtor to deliver any collateral in the debtor’s possession to the trustee. If the court does not so determine, the stay provided by subsection (a) shall terminate upon the conclusion of the hearing on the motion.

This section would likely only be used when there is significant equity in non-exempt property, or if the Trustee believes the creditor’s lien is defective in some manner so that such lien is avoidable. It is important to note that the automatic provisions also provide for automatic abandonment of the property in question from the Bankruptcy Estate. Thus, if the Trustee fails to timely seek relief from the automatic termination of the stay, then the Trustee’s avoidance claims under §544 are also terminated.

In the event you are feeling somewhat uneasy about whether the stay is in effect, new §362(j) provides that “On request of a party in interest, the court shall issue an order under subsection (c) confirming that the automatic stay has been terminated”. Note that this provision does not provide for notice and opportunity for a hearing, so apparently, it is intended that obtaining such an order is to be done on ex parte application. In re Record, 347 B.R. 450, 453 (Bankr.M.D.Fla.,2006) held:

In order to obtain relief requested pursuant to §362(j), whether ex parte or not, the party must prove that all conditions are satisfied under §362(h)(1)(A) or (B). To wit, the party will have to prove: 1) the specific date when time ran on the debtor’s statement of intention, so that he could not have amended the ambiguity; 2) that the debtor did not, in fact, amend his statement of intention to more accurately reflect what he intended to do with the secured property; and 3) that the trustee did not, in fact, file a motion to determine that the property is of consequential value or benefit to the estate. The aforementioned information need not be certified.

Serial Filings

For years, creditors have been frustrated by debtors who file multiple cases, particularly Chapter 13 cases which allow for instanter dismissals with no prohibition to re-filing an unlimited number of sequential cases (i.e., “Serial Filing”). Each filing creates an automatic stay, thereby delaying recovery of collateral for what sometimes seems like eternity at the cost of thousands of dollars to the creditor.  §362 has been amended to stop this practice.

New §362(c)(3) and (4) specifically address Serial Filings. §362(c)(3) automatically terminates the stay 30 days post-petition in the case of an individual debtor who files a second case under Chapter 7, 11 or 13, within one year after the dismissal of the first case, unless the second case is not a Chapter 7 and the first case was a Chapter 7 that was dismissed under §707(b). An extension of the automatic termination is possible only if the second case is filed in good faith and the order granting such extension must be entered BEFORE the 30 day period expires. The standard for good faith is also statutory and requires the moving party must comply with the following sections:

(C) for purposes of subparagraph (B), a case is presumptively filed not in good faith (but such presumption may be rebutted by clear and convincing evidence to the contrary) –

(i) as to all creditors, if –

(I) more than 1 previous case under any of Chapters 7, 11, and 13 in which the individual was a debtor was pending within the preceding 1-year period;

(II) a previous case under any of Chapters 7, 11, and 13 in which the individual was a debtor was dismissed within such 1-year period, after the debtor failed to –

(aa) file or amend the petition or other documents as required by this title or the court without substantial excuse (but mere inadvertence or negligence shall not be a substantial excuse unless the dismissal was caused by the negligence of the debtor’s attorney);

(bb) provide adequate protection as ordered by the court; or

(cc) perform the terms of a plan confirmed by the court; or

(III) there has not been a substantial change in the financial or personal affairs of the debtor since the dismissal of the next most previous case under Chapter 7, 11, or 13 or any other reason to conclude that the later case will be concluded—

(aa) if a case under Chapter 7, with a discharge; or

(bb) if a case under Chapter 11 or 13, with a confirmed plan that will be fully performed; and

(ii) as to any creditor that commenced an action under subsection (d) in a previous case in which the individual was a debtor if, as of the date of dismissal of such case, that action was still pending or had been resolved by terminating, conditioning, or limiting the stay as to actions of such creditor;

It is also very important to note that the automatic termination of the stay provided for above is only a termination of the stay as to the debtor and not to any property which is property of the estate. In re Jumpp, 356 B.R. 789, *791 -792 (1st Cir.BAP (Mass.),2006) held in overruling the only lower court to come to a contrary decision, that “The majority of courts that have considered the issue have concluded that the automatic stay does not terminate with respect to property of the estate”. See also In re Pope, 351 B.R. 14 (Bankr.D.R.I.2006); In re Murray, 350 B.R. 408 (Bankr.S.D.Ohio 2006); In re Brandon, 349 B.R. 130 (Bankr.M.D.N.C.2006); In re Gillcrese, 346 B.R. 373 (Bankr.W.D.Pa.2006); In re Williams, 346 B.R. 361 (Bankr.E.D.Pa.2006); In re Harris, 342 B.R. 274 (Bankr.N.D.Ohio 2006); In re Jones, 339 B.R. 360 (Bankr.E.D.N.C.2006); In re Moon, 339 B.R. 668 (Bankr.N.D.Ohio 2006); In re Johnson, 335 B.R. 805 (Bankr.W.D.Tenn.2006); see also In re Baldassaro, 338 B.R. 178 (Bankr.D.N.H.2006) (discussing the issue but disposing of the case on other grounds); In re Paschal, 337 B.R. 274 (Bankr.E.D.N.C.2006) (same).  It is my understanding that Judge Rasure has also ruled on this section in a manner consistent with the majority position.

If the Debtor files a case and there were 2 pending within the previous year that were dismissed unless the third case is not a Chapter 7 and the other cases were Chapter 7s that was dismissed under §707(b), then there is NO STAY upon the filing of the 3rd case. §362(c)(4)(A)(i). There is also the right to a comfort order under §362(c)(4)(A)(ii) just like §362(j) above, although this seems redundant.

Unlike the restricted automatic relief under §362(c)(3)(A), the relief provided for under §362(c)(4)(A) is not limited. This issue was discussed in the recent case of In re Pope, 351 B.R. 14, 16 (Bankr. R.I.,2006)

Some Courts have referenced §362(c)(4)(A) to support the limiting interpretation of §362(c)(3)(A), noting that the former statute deals with termination of the stay when the debtor has more than two bankruptcy filings in the preceding year, and that “the stay under subsection (a) shall not go into effect upon the filing of the later case.” While the statute in question exhibits the same mediocre draftsmanship as the bulk of the BAPCPA of 2005, in this instance it does accomplish its intended purpose, i.e., to terminate the stay for all purposes in two filing cases, but is equally clear in drawing a distinction for other classes of repeat filers. See In re Moon, 339 B.R. at 672; See also In re Paschal, 337 B.R. at 278-79 (holding that the difference in the language signaled that the scope of the automatic stay termination under §362(c)(3)(A) is narrower and more limiting than that of §362(c)(4)(A)); In re Jones, 339 B.R. 360, 364 (“if Congress had intended that the automatic stay would terminate under §362(c)(3)(A) as to property of the estate, it would have specifically said so, as it did in §521(a)(6)”). “Where Congress includes particular language in one section of a statute but omits it in another it is generally presumed that Congress acts intentionally and purposely in the disparate inclusion or exclusion.” Keene Corp. v. U.S., 508 U.S. 200, 208, 113 S.Ct. 2035, 124 L.Ed.2d 118 (1993); In re Ground Systems, Inc., 213 B.R. 1016, 1019 (9th Cir.BAP1997).

As with §363(c)(3)(B) above, §363(c)(4)(B) provides for obtaining a stay in the third serial filing case only by compliance with the following:

(B) if, within 30 days after the filing of the later case, a party in interest requests the court may order the stay to take effect in the case as to any or all creditors (subject to such conditions or limitations as the court may impose), after notice and a hearing, only if the party in interest demonstrates that the filing of the later case is in good faith as to the creditors to be stayed;

(C) a stay imposed under subparagraph (B) shall be effective on the date of the entry of the order allowing the stay to go into effect; and

(D) for purposes of subparagraph (B), a case is presumptively filed not in good faith (but such presumption may be rebutted by clear and convincing evidence to the contrary) –

(i) as to all creditors if –

(I) 2 or more previous cases under this title in which the individual was a debtor were pending within the 1-year period;

(II) a previous case under this title in which the individual was a debtor was dismissed within the time period stated in this paragraph after the debtor failed to file or amend the petition or other documents as required by this title or the court without substantial excuse (but mere inadvertence or negligence shall not be substantial excuse unless the dismissal was caused by the negligence of the debtor’s attorney), failed to provide adequate protection as ordered by the court, or failed to perform the terms of a plan confirmed by the court; or

(III) there has not been a substantial change in the financial or personal affairs of the debtor since the dismissal of the next most previous case under this title, or any other reason to conclude that the later case will not be concluded, if a case under Chapter 7, with a discharge, and if a case under Chapter 11 or 13, with a confirmed plan that will be fully performed; or

(ii) as to any creditor that commenced an action under subsection (d) in a previous case in which the individual was a debtor if, as of the date of dismissal of such case, such action was still pending or had been resolved by terminating, conditioning, or limiting the stay as to such action of such creditor.

It is important to note that under both §§362(c)(3) & (4), any creditor who obtained an order “terminating, conditioning, or limiting the stay as to such action of such creditor” or who had an unresolved, pending motion for such relief, is essentially exempt from any  continuation or imposition of the stay in a second or third serial case.  So, despite all of these automatic terminations of the stay, it still may be good practice to file a Motion for relief from stay and obtain an order to essentially immunize the creditor from serial filings.

An order granting relief from the stay still requires the filing of a motion for relief from the stay pursuant to §362(d). The debtor generally cannot successfully oppose unless the property sought by the creditor may be retained by lien avoidance or redemption. Section 362(d) provides for relief from the stay when there is no equity in the property and the property is not necessary for an effective reorganization. Obviously in a Chapter 7 there is not ever going to be a reorganization so the creditor is almost always going to be entitled to relief from the stay. The trustee may oppose relief from the stay on the basis that the property not claimed as exempt has value in excess of the creditor’s secured claim. If this becomes an issue consider having the trustee sell the property pursuant to §363. This will avoid most of the problems which will arise. Be sure to get a deadline for the sale since most trustees are very busy and your collateral can easily get lost in the crowd.

The sale of the property by the trustee is a good alternative in some cases. The trustee may sell any non-exempt property on 20 days notice. Be sure to determine the tax basis of any business property to be sold.  If the debtor has depreciated the property, the estate will be liable for any gain on the sale, and the trustee will want to take the taxes out before turning over the proceeds to the creditor.  If the tax basis is low, get the stay modified, and sell the property outside of the bankruptcy estate.

One other issue is the trustee’s fee based upon a percentage of the disbursements made by the trustee. Specifically, 11 U.S.C. §326(A) provides:

(A) In a case under Chapter 7 or 11, the court may allow reasonable compensation under §330 of this title of the trustee for the trustee’s services, payable after the trustee renders such services, not to exceed 25 percent on the first $5,000 or less, 10 percent on any amount in excess of $5,000 but not in excess of $50,000, 5 percent on any amount in excess of $50,000 but not in excess of $1,000,000, and reasonable compensation not to exceed 3 percent of such moneys in excess of $1,000,000, upon all moneys disbursed or turned over in the case by the trustee to parties in interest, excluding the debtor, but including holders of secured claims.

This statute provides for the maximum amounts a trustee may be paid, but the reality is that unless you negotiate a specific agreement with the trustee, you are probably going to wind up paying the maximum. If the property is worth a substantial amount of money, this could be significant.  Strike a deal with the trustee in advance and save money. Objections to the fees after the trustee has done the work rarely yield good results.

If the property is real estate, the property also needs to be abandoned from the estate pursuant to §554. If it is not, you must give notice to the trustee of any subsequent action taken. The abandonment of property is accomplished through a Motion to Compel Abandonment under §554,  the issue is value to the estate. If the property is burdensome to the trustee and has no value, the Court will determine it to be abandoned. This is the same issue which will arise with the trustee in a motion for relief from the stay. Consequently, most Courts do not have a problem with a combined motion for relief from stay and to compel the trustee to abandon the property. If the collateral is real property, abandonment is a very important issue as a subsequent title examination will require this before the property’s title will meet the title standards. In fact, it is a good idea to review the title examination standards before moving for relief to make sure you comply with what the title examiners will be looking for. The title standards are found at 16 O.S. Ch 1. App. Std 20.1.

IX. Creditors Meeting

After the filing of the petition the next major event to occur in a Chapter 7 case is the first meeting of creditors pursuant to §341. The debtor’s attendance at the creditors meeting is mandatory, §343. The creditors meeting is attended and presided over officially by the U. S. Trustee, but typically by the panel trustee who has been appointed in a particular case. Any creditor who wishes to attend may do so and inquire of the debtor. If you have any real issues, make sure you get the testimony of both debtors if it’s a joint case. See In Re Osborn, supra.

The only change to this topic in the Reform Act is that the Code now specifically authorizes a creditor to appear at the meeting without counsel. See §341(c) which states in relevant part:

a creditor holding a consumer debt or any representative of the creditor (which may include an entity or an employee of an entity and may be a representative for more than 1 creditor) shall be permitted to appear at and participate in the meeting of creditors in a case under Chapter 7 or 13, either alone or in conjunction with an attorney for the creditor

Creditors’ meetings are conducted under oath by the trustee, but interestingly enough the Court is expressly prohibited from presiding over any creditors’ meeting. §341(c). The meeting is taped, but there is no court reporter unless you bring one. If you expect a serious contest in the case, it is a good idea to take a reporter with you to the meeting so you will have a reliable record of the proceedings.

In representing a creditor at creditors’ meetings, the basic preparation should include a review of the schedules, the statement of affairs and the documentation of the claim. The trustee is usually interested in assets since that’s how trustees get paid.  The trustee will inquire if the debtor has listed all their assets on the schedules and if any particular asset is of interest to the trustee, questions will be presented regarding such asset. Also, the trustee may ask questions of the debtor regarding perfection of various creditors’ security interests in certain assets. Additionally, the question of exempt property may be covered at the creditors’ meeting. Essentially the creditors’ meeting is a period of discovery wherein the trustee and the creditors have a chance to interview and effectively take the deposition of the debtor regarding potential assets of the estate.

The creditors’ meeting is a good time to get reaffirmation agreements signed and out of the way if such are appropriate in the case. If the debtor is not going to reaffirm, then you can make arrangements to pick-up the collateral and save yourself a replevin action.

If you believe there is some basis for challenging the discharge, then you should appear and inquire about the conduct of the debtor preparatory to the commencement of a complaint pursuant to §523 or §727. The benefit to this is that most of the time the debtor is not as well prepared to testify as they will be in a deposition setting since they really don’t know what you are going to do.

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X. Discharge

The issuance of the discharge permanently enjoins all parties to the bankruptcy, and anyone who had actual notice of the case, from taking any action to collect the debt. The discharge is the objective which is sought by all debtors in bankruptcy. This section of the discussion will provide an overview of two primary Code sections which deal with the discharge. The first is 11 U.S.C. §727, which provides the grounds under which a discharge may be denied entirely. Second is 11 U.S.C. §523, which provides various exceptions to the discharge. This section focuses on the section usually utilized by creditors.

A. Denial of Discharge, §727:

A.1. §727(A)(2)

Property of the Estate

The Reform Bill has no impact on the following concepts, so these are provided as a refresher.

11 U.S.C. §727(A)(2) provides the Court shall grant the debtor a discharge unless:

[t]he debtor, with the intent to hinder, delay or defraud a creditor or officer of the estate charged with custody of property under this title [11 U.S.C. §101 et seq.], has transferred, removed, destroyed, mutilated or concealed or has permitted to be transferred, removed, destroyed, mutilated or concealed

(A) property of the debtor within one year before the date of filing of the petition; or

(B) property of the estate, after the filing of the petition;

The most obvious means by which a debtor may violate this provision is the failure to disclose either the transfer or ownership of any property of the estate in the statement of financial affairs required to be filed by a debtor in a case under Title 11. The statement of financial affairs requires the debtor to disclose transfers of property for the one year period immediately preceding filing of the original petition in a case. The statement of financial affairs also requires the debtor to disclose any other persons holding anything of value which might constitute property of the estate.

Likewise, the debtor is required to aver under penalty of perjury that the various schedules are completed truly and correctly. The schedules require the debtor to disclose the debtor’s interest in any type of property, whether real, personal, or “any kind not otherwise scheduled”.

A debtor may violate this provision by knowingly and fraudulently failing to truthfully answer any of the above inquiries. The intent of the statute is to condemn the transfer or concealment of property of the estate.  United States v. Shapiro, 101 F.2d 375, cert. den. 306 U.S. 657 (7th Cir., Wis. 1939). 11 U.S.C. §548 provides the trustee may avoid a transfer of property made within one year of the filing if the same is made for less than adequate consideration while the debtor was insolvent, or with the actual intent to hinder, delay or defraud a creditor. The debtor may be denied a discharge if there was an intent to “hinder, delay or defraud a creditor or officer of the estate” and property was transferred either within one year prior to filing or after the filing of the petition.

Look carefully at the debtor’s pre-petition conduct. Has there been extensive pre-bankruptcy planning?  May the debtor transfer property from non-exempt assets to exempt assets? The cases are fairly uniform that the conversion of assets into exempt property does not by itself constitute fraud absent extrinsic evidence of fraud.  In Re: Johnson, 880 F.2d (8th Cir., 1989); Northwest Bank Nebraska, N.A. v. Tventen, 848 F.2d 871 (8th Cir., 1988); In Re: Carey, 96 B.R. 336, 18 B.C.D. 1501, (BC, W.D. Ok. 1989), Aff’d. 112, B.R. 401 (W.D. Ok. 1989); In Re: Chastant, 873 F.2d 89 (5th Cir., 1989); In Re: Oliver, 819 F.2d 550, (5th Cir., 1987); In Re: Smiley, 864 F.2d 562, (7th Cir. 1986).

However, Judge Mickey Wilson, who sat in Tulsa, Oklahoma, held in In re Spoor‑Weston, 139 B.R. 1009 (B.C. N.D. Ok 1992) that the Chapter 7 trustee was entitled to $21,000 equitable lien against debtors’ homestead where, before filing their bankruptcy petition, debtors had paid $21,000 from a non-exempt checking account on the mortgage on their homestead for the admitted purpose of removing property from the reach of creditors. Even though this was done on the advice of counsel, Judge Wilson condemned the actions as fraudulent holding, “that the deliberate conversion of substantial non‑exempt property into exempt property in contemplation of bankruptcy was fraudulent and abusive and ought not to be tolerated”. The Court determined Judge Phelps’ letter also made it clear that advice of counsel is no excuse for such conduct, but rather may be considered part of the essence of the offense.

While the actual act of conversion of non-exempt property into exempt property is not in and of itself a violation of 11 U.S.C. §727, if you can prove that the debtor did the same with the intent to defraud the estate or a creditor, then the debtor may be denied a discharge. What constitutes fraudulent intent? The Courts have held that such is determined by a “factor” test which includes “conduct intentionally designed to mislead or deceive creditors about the debtor’s position; conveyances for less than fair value; or the continued retention, benefit or use of property allegedly conveyed, together with evidence that the conveyance was for inadequate consideration”.  Northwest Bank of Nebraska, N.A. v. Tventen, supra. Ask the debtor why they transferred the property.  If the answer doesn’t pass the “smell test” you may be able to prevail on this issue. Consider how much the value of the property transferred was, when the transfer took place, to whom it was transferred, and if the transfer is disclosed in the filings.

A.2. §727(A)(3) — Records And Information

The Reform Bill has no impact on the following concepts, so these are provided as a refresher.

The provision of 11 U.S.C. §727(A)(3) provides:

[The court shall grant the debtor a discharge unless] the debtor has concealed, destroyed, mutilated, falsified or failed to keep or preserve any recorded information, including books, documents, records and papers from which the debtor’s financial conditions or business transactions might be ascertained, unless such act or failure to act were justified under all the circumstances of the case.

This provision may be violated by the mere negligent failure of the debtor to keep necessary financial records. Has the debtor destroyed their records to prevent your finding out what they did? If so, this section can provide some relief.

A.3.  §727(A)(4) — Truthfulness

The Reform Bill has no impact on the following concepts, so these are provided as a refresher.

11 U.S.C. §727(A)(4) provides:

[The court shall grant the debtor a discharge, unless] the debtor knowingly and fraudulently, in or in connection with the case

(A) made a false oath or account;

(B) presented or used a false claim;

Omissions of information concerning the existence or disposition of property from the debtor’s schedules constitute a false oath. In Re: Calder, 907 F.2d 953 (10th Cir., 1990). A false oath would include any omission from the schedules, a false answer given at a creditors’ meeting or in open court. Testimony given at the first meeting of creditors is a proceeding in bankruptcy and is subject to penalties for false oath.  18 U.S.C. §152, In Re: Slokum, 22 F.2d 282 (2nd Cir., 1927).

However, to be a basis for denial of the discharge, such omission from the schedules or incorrect statements at creditors’ meetings must be made with knowing and fraudulent intent. An oath may be considered to have been made with knowing and fraudulent intent when it was made by a person who states matters which are not believed to be true, willfully and contrary to the oath taken. In Re: Hale, 206 F.2d 856 (DC, NM 1913). The proof of knowing and fraudulent intent is generally made up by the facts and circumstances surrounding the false oath. Cases on this issue are in fact specific. In one case the evidence was sufficient to establish the defendant had not innocently transferred an automobile to his fiancé where it was shown that his company had been in increasing financial trouble since the death of his father, at the meeting with the secured creditor the debtor brought up the subject of bankruptcy; during the same month as the meeting with the creditor, the debtor transferred the automobile to his fiancé without consideration, several weeks subsequent to the transfer the debtor filed a bankruptcy petition in which he stated he had not made any gifts other than ordinary and usual presents to family members, and subsequently the debtor continued to use the automobile. In Re: Cadarette, 601 F.2d 648, 5 B.C.D. 444, (2nd Cir., 1979).

If the debtor makes a false statement, the false statement must be material. United States v. Phillips, 606 F.2d 884, cert. den. 444 U.S. 1024, (9th Cir., 1979); United States v. Jackson, 836 F.2d 324 (7th Cir., 1987). Although materiality is not specifically set forth in the statutes, the cases cited above consistently hold the same to be an element.  Materiality generally relates to property of the estate. However, one Court has held that every statement required to be made in the schedules was material. United States v. Lake, 129 Fed. 499 (DC Ark. 1904).

It is apparent upon an examination of the above authorities that the debtor has an absolute obligation to be truthful in the completion of the schedules and statement of financial affairs. If the debtor is not being truthful, most Bankruptcy Judges will not tolerate such conduct.

A.4. §727(A)(5) — Loss of Assets

The Reform Bill has no impact on the following concepts, so these are provided as a refresher.

This section provides the Court shall grant the debtor a discharge unless:

The debtor has failed to explain satisfactorily, the before the determination of denial of discharge under this paragraph, any loss of assets or deficiency of assets to meet the debtor’s liability.

The key inquiry here is the loss of assets. If the debtor never had the assets to satisfy relations which creditors were willing to extend, that is primarily the creditor’s problem unless there has been some fraud in convincing creditors otherwise. However, if the debtor did at one time have substantial assets and at the time of filing the bankruptcy, the assets have disappeared, this section constitutes a valid basis for challenging the debtor’s ability to receive a discharge.

Upon the creditor making a prima facia case for the loss of assets, the burden shifts to the debtor to explain what happened. Failure to offer any explanation for the loss of assets is clearly a basis for denial of discharge. Minella v. Phillips, 245 F.2d. 687 (5th Cir., 1957). The adequacy of the explanation hinges on the facts of a particular case. In Re: Brown, 56 B.R. 63 (D.C.N.H. 1985). There must be much more than vague generalities.  In Re: Sperling, 74 F.2d 259 (2nd Cir. 1934). The standard by which an explanation is measured is one of reasonableness and credibility. In Re: Cohen, 47 B.R. 871 (B.C.S.D. Fla. 1987).

Essentially, the debtor’s explanation must pass the “smell test”. Is the debtor’s explanation one which really makes sense and is credible or does it lead one to the conclusion that the debtor probably has transferred some assets or made other disposition in an irresponsible manner?

There are several other grounds for denial of the discharge which are available. You should become familiar with the entire section. However, most of the other situations are rare enough to be beyond the scope of this discussion.

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A.5. §727(a) — Time Between Filing of Cases

The Reform Bill makes significant changes to this area.

§727(a)(8) has been amended to extend the time between the receipt of an individual discharge under Chapter 7 or 11 and the right to receive a discharge in a subsequent case filed eight years rather than the current six years.

New §1328(f) has been added to deny the right to a discharge in a subsequent filing under Chapter 13 after receipt of a discharge under Chapter 7, 11, or 12 within four years before the filing of the current Chapter 13 case or if the debtor has received a Chapter 13 discharge in a case filed within two years of the current case filing.

Although this provision is sometimes erroneously referred to by the phrase, “A debtor can only file once every six years” this is not correct. A debtor can file, but may not receive a discharge for 2, 4 or 8 years, depending upon which chapters a discharge was received and under which chapter the subsequent case was filed.

Like many other provisions of the Reform Bill, if the debtor files sequential Chapter 7 cases within the eight year time limitation, the Chapter 7 Trustee or the USTE will most likely file the objection to the entry of the discharge.

A.6. §727(a)(11)

Delay in Granting Discharge

The Reform Bill adds this completely new concept to the Code.

New §727(a)(11) has been added to provide that the court shall not grant a discharge when the debtor has failed to complete the instructional course in personal financial management unless the Debtor complies with §109(h)(4), which states:

4) The requirements of paragraph (1) shall not apply with respect to a debtor whom the court determines, after notice and hearing, is unable to complete those requirements because of incapacity, disability, or active military duty in a military combat zone. For the purposes of this paragraph, incapacity means that the debtor is impaired by reason of mental illness or mental deficiency so that he is incapable of realizing and making rational decisions with respect to his financial responsibilities; and ‘disability’ means that the debtor is so physically impaired as to be unable, after reasonable effort, to participate in an in person, telephone, or Internet briefing required under paragraph (1).

This prohibition also does not apply if there are no approved educational courses available within such person’s home federal district.

An additional new §727(a)(12) now requires denial of the discharge if the Court finds that there is “reasonable cause to believe” either that the new §522(q)(1) applies or that there is a pending proceeding in which the debtor may be found guilty of a felony or liable for damages under the new §522(q)(1)(A) or (B). This section seems to provide for denial of a discharge when certain types of criminals seek bankruptcy relief.  Interestingly, the procedural basis for this narrow type of relief only requires that the Court find reasonable cause to believe such facts are present “after notice and a hearing held not more than 10 days before the date of the entry of the order granting the discharge”.

Similar changes are made to Chapter 11 by adding §1141(d)(C); to Chapter 12 by adding §1228(f); and to Chapter 13 by adding §1328(h). These provisions seem to be self-executing for the most part. Again, special knowledge you may have can play an important role here.

B.  Exceptions to Discharge

11 U.S.C. §523

The Reform Bill makes significant changes to this area.

11 U.S.C. §523(a) provides there are eleven specific categories of claims which are excepted from the discharge.  11 U.S.C. §523(c) provides that debts which are non-dischargeable pursuant to 11 U.S.C. §523(a)(2), (4), or (6) are presumed discharged unless a creditor brings a timely complaint to have the same determined to be non-dischargeable. The remainder of the subdivisions are presumed non-dischargeable unless the debtor brings a complaint to have them determined to be dischargeable. This discussion will only deal with those which require affirmative action by the creditor.

11 U.S.C. §523(c)(1) provides that claims which are non-dischargeable under §§(2), (4), or (6) are in fact discharged unless a creditor brings a timely complaint pursuant to F.R.B.P. 4004. Such section provides that claims must be filed 60 days after the first date set for a creditors’ meeting. The time for filing a complaint to determine dischargeability may be extended upon the motion of a party if such motion is made before the time for filing a complaint has expired. F.R.B.P. 4004(B). If the time limit is approaching and you have not yet made an adequate determination as to whether or not to pursue such a claim, it is wise to seek an extension of time and conduct a further investigation before pursuing such a claim. If the creditor pursues a complaint to determine dischargeability and the claim relates to a consumer debt, if the debt is discharged the Court may grant attorney’s fees and costs against the creditor if the position of the creditor was not “substantially justified”. 11 U.S.C. §523(d).

There are basically three categories of claims which the creditor must bring complaints to have determined to be dischargeable.

B.1. (A)

Fraud – §523(a)(2)

11 U.S.C. §523(a)(2) provides that debts are non-dischargeable to the extent they relate to the obtaining of money, property or services, or the extension, renewal or refinancing of such credit to the extent such is obtained by false pretenses, a false financial statement or for luxury goods or services.

B.1.(A.1)

Actual Fraud – 11 U.S.C. §523(a)(2)(a)

The Reform Bill has no impact on the following concepts, so these are provided as a refresher.

There is no change to existing §523(a)(2)(a) which provides that if the debtor obtained money, property or services by actual fraud, then such is not dischargeable. Such representations generally are not made in writing. In Re: Reader, 60 B.R. 529 (B.C.N.D. Minn. 1986). The creditor must show that the loss was proximately caused by the fraud of the debtor.  In Re: Smith, 61 B.R. 742 (B.C. Mont. 1986). The fraud must be actual and not implied or express. In Re: Hunter, 780 F.2d. 1577 (11th Cir. 1986). If actual fraud can be shown, a non-disclosure may result in non-dischargeability if the debtor allows the creditor to proceed upon what it assumes to be the truth when the debtor in fact knows the same is not true. In Re: Van Horn, 823 F.2d. 185 (5th Cir. 1987). However, most Courts require there to be some actual affirmative act which causes fraud to be visited upon the creditor. Additionally, the creditor must rely upon the misrepresentations and such reliance must be “justifiable”. The fraud exception to discharge requires justifiable, but not reasonable, reliance. Field v. Mans 116 S.Ct. 437, 133 L.Ed.2d 351(1995).

There has been some question about whether or not a claim for punitive damage is subject to discharge since it was sometimes argued that it is not really a debt. It was held in Cohen v. Cruz, 118 S.Ct. 1212 (1998), that the discharge exception for actual fraud prevented discharge of all liability arising from debtor’s fraud, including treble damages assessed on account of fraud under State law as well as an award of attorney’s fees and costs.

B.1.(A.2)

Fraudulent Financial Statements, 11 U.S.C. §523(a)(2)(B)

The Reform Bill has no impact on the following concepts, so these are provided as a refresher.

There is also no change to the exception for fraudulent financial statement. If the debtor obtains money, property or services by use of a fraudulent financial statement, then the claim is not dischargeable if the following elements are present, to-wit:

(1) The statement is in writing;

(2) It is materially false;

(3) It regards the debtor or an insider’s financial condition;

(4) The creditor reasonably relies upon the statement; and

(5)  The debtor caused the same to be made or published with the actual intent to deceive.

This is probably one of the most common bases for creditors seeking to have their debt determined to be non-dischargeable. Virtually all financial arrangements made by institutional lenders involve the furnishing of financial statements to the lender as a part of the loan-making process.  Creditors’ counsel should carefully review the financial statements given by the debtor to see if the elements may be met. The statement must be in writing and signed by the debtor. In Re: Howard, 73 B.R. 694 (B.C.N.D. Ind. 1987); Blackwell v. Dabney, 702 F.2d. 490 (4th Cir. 1983); and Ingler v. Van Steinburg, 744 F.2d. 1060 (4th Cir. 1984).

The statement must be materially false. The debtor makes a materially false statement when the following are true:

(1) The debtor makes no effort to verify the truth or validity of the statements;

(2) The debtor has no reasonable grounds to believe the truth of the statements;

(3) The inaccuracies are inexcusable, such as exaggerated income and significant understatements of debt. In Re: Bradford, 22 B.R. 899 (B.C.W.D. Ok 1982). However, minor discrepancies are insufficient to cause the creditor’s debt to be non-dischargeable.  In Re: Anderson, 29 B.R. 184 (B.C.N.D. Ia. 1983).

The financial statement must be respecting a debtor or an insider’s financial condition. Obviously, if the debtor’s financial statement is about themselves it relates to the debtor’s financial condition. However, insiders may also be determined to be non-dischargeable. A corporate officer or president who participates in the obtaining of a loan for the corporation by having the corporation publish a financial statement which meets the various elements of this subdivision, may have the debt determined to be non-dischargeable as against such corporate officer individually. In Re Long, 774 F.2d 875 (8th Cir 1985). Thus, corporate officers, agents and other individuals who would be insiders as that term is defined in 11 U.S.C. §101(31) may also have claims to be determined to be non-dischargeable against them individually if they should file an individual Chapter 7.

The reliance of the creditor must be reasonable. A creditor must make some reasonable inquiry based on the sophistication of the creditor. If the creditor is a bank, the creditor must take steps to verify the information and ask the debtor for supporting statements of value. In re: Bagstad, 799 F.2d 377 (7th Cir. 1989). However, if the creditor is not sophisticated, such as an individual who has never made a loan before, then the creditor is going to be held to a much lesser standard of reasonableness. It would be a question of fact as to whether or not the creditor did in fact reasonably rely on the creditor considering all the facts and circumstances of a particular case.

Nonetheless, the creditor must in fact rely upon the statement in extending the credit. In Re: Hampfner, 52 B.R. 1020 (B.C.W.D. Va. 1985). Partial reliance upon the statement is sufficient if the financial statement constitutes a substantial part of the collective financial information upon which the creditor relied.  In Re: Harms, 53 B.R. 1134 (B.C.D.C. Minn. 1985).

Finally, the statement must be published with the intent to deceive. Intent requires actual intent or reckless disregard for the truth. In Re: Liming, 797 F.2d. 895 (10th Cir. 1986) and In Re: Ruben, 875 F.2d 775 (9th Cir. 1989). The burden is upon the creditor to prove that the debtor had the actual intent to deceive. Direct evidence of intent to deceive is of course almost never available therefore proof of intent to deceive may be able to be proven by circumstantial evidence.

B.1.(A.3)

Consumer Credit – 11 U.S.C. §523(a)(2)(C)

The Reform Bill makes significant changes to this area.

Congress has established a very narrow category of consumer debts which are presumed non-dischargeable. Under existing law, if the debtor purchases more than $1,000 worth of luxury goods or services within 60 days prior to the filing of the case or obtains cash advances aggregating more than $1,000 by an extension of consumer credit under an open-ended credit plan within 60 days prior to the filing of the case, such claims are “presumed to be non-dischargeable”. For purposes of this subsection, luxury goods or services do not include goods or services required for the support and maintenance of the debtor or a dependent.

The Reform Bill modifies this provision as follows:

§523(a)(2)(C) has been amended to change the amount of luxury goods from the current $1,225 to $600 and change the 60-day measuring period for their acquisition to 90 days. Cash advances under an open end credit plan are changed from the current $1,225 to $875 and the current 60-day measuring period is expanded to 70 days. This change generally expands the number of claims that fall within this exception^. These dollar amounts are set to periodically adjust.

An additional change has been made to create an exception to this change which eliminates goods acquired for the support and maintenance of dependents of the debtor.

You should review the credit activity of the debtor immediately prior to the filing of the case to see whether or not the debtor has gone “credit card crazy” shortly before the filing of the case. If such is the case, the creditor must still file the complaint timely but the debt will be presumed non-dischargeable. If the creditor’s claim falls within 11 U.S.C. §523(a)(2)(C) but the creditor does not pursue a complaint to determine dischargeability, then the debt will be discharged.

B.1.(B)

Fraud or Defalcation by Fiduciary, 11 U.S.C. §523(a)(4)

The Reform Bill has no impact on the following concepts, so these are provided as a refresher.

The Reform Bill makes no changes to this section which provides that certain acts by fiduciaries are non-dischargeable. The first question which must be answered is whether or not a fiduciary capacity actually exists.  Fiduciary capacity contemplated by this section must be an express technical trust created by contract or statute. In Re: Tooks, 76 B.R. 162 (B.C.D.C. Cal. 1987) and In Re: Salomone, 78 B.R. 74 (B.C.E.D. Pa. 1987). The fiduciary capacity may not be the result of a constructive or implied trust or a trust which comes into existence as a result of some act of the debtor. In Re: Ayers, 25 B.R. 762 (B.C.M.D. Tenn. 1982) and In Re: Schultz, 46 B.R. 880 (B.C.D.C. Nev. 1985). The lead case in this Circuit is In re Young, 91 F.3d 1367, 1371 -1372 (10^th Cir. 1996), which held:

For purposes of §523(a)(4), Mr. Young and Fowler Brothers did not have a fiduciary relationship. The existence of a fiduciary relationship under §523(a)(4) is determined under federal law. See Carlisle Cashway, Inc. v. Johnson (In re Johnson), 691 F.2d 249, 251 & n. 2 (6th Cir.1982) (analyzing § 17(a)(4) of the Bankruptcy Act, §523(a)(4)’s predecessor); Ball v. McDowell (In re McDowell), 162 B.R. 136, 139 (Bankr. N.D.Ohio 1993) (analyzing 11 U.S.C. §523(a)(4)); Ducey v. Doherty (In re Ducey), 160 B.R. 465, 469 (Bankr.D.N.H.1993) (analyzing 11 U.S.C. §523(a)(4)); Gore v. Kressner (In re Kressner), 155 B.R. 68, 73 (Bankr.S.D.N.Y.1993) (analyzing 11 U.S.C. §523(a)(4)); Neal v. United States (In re Neal), 156 B.R. 529, 533 (N.D.Tex.1993) (analyzing 11 U.S.C. §523(a)(4)); Purcell v. Janikowski (In re Janikowski), 60 B.R. 784, 788 (Bankr.N.D.Ill.1986) (analyzing 11 U.S.C. §523(a)(4)).  However, State law is relevant to this inquiry. In re Johnson, 691 F.2d at 251; In re McDowell, 162 B.R. at 139; In re Ducey, 160 B.R. at 469; In re Kressner, 155 B.R. at 73; Clarendon National Ins. Co. v. Barrett (In re Barrett), 156 B.R. 529, 533 (Bankr.N.D.Tex.1993); In re Janikowski, 60 B.R. at 788. Under this circuit’s federal bankruptcy case law, to find that a fiduciary relationship existed under §523(a)(4), the court must find that the money or property on which the debt at issue was based was entrusted to the debtor. See Allen v. Romero (In re Romero), 535 F.2d 618, 621 (10th Cir.1976) (interpreting “fiduciary capacity” as used in §17(a)(4) of the Bankruptcy Act, §523(a)(4)’s predecessor, to require a relationship “of trust or confidence, which … arises whenever one’s property is placed in the custody of another”); Van De Water v. Van De Water (In re Van De Water), 180 B.R. 283, 289-90 (Bankr.D.N.M.1995) (explaining that in cases where discharge has been denied under §523(a)(4) for breach of fiduciary obligations, “the debtor had been entrusted with property of another and then abused that trust”). Thus, an express or technical trust must be present for a fiduciary relationship to exist under §523(a)(4). In re Romero, 535 F.2d at 621 (interpreting § 17(a)(4) of the Bankruptcy Act to apply only to technical trusts); Evans v. Pollard (In re Evans), 161 B.R. 474, 477 (9th Cir.BAP 1993) (limiting “fiduciary capacity” as used in §523(a)(4) to “ ‘express or technical trust relationships’ ” (citation omitted)); *1372 Kayes v. Klippel (In re Klippel), 183 B.R. 252, 259 (Bankr.D.Kan.1995) (“In this circuit, 11 U.S.C. §523(a)(4) applies only to a fiduciary relationship arising from a technical or express trust….”); In re Van De Water, 180 B.R. at 289 (requiring a fiduciary relationship under §523(a)(4) to “arise from an express or technical trust”); Kartchner v. Kudla (In re Kudla), 105 B.R. 985, 990 (Bankr.D.Colo.1989) (“In bankruptcy, the meaning of fiduciary is limited in application to an express or technical trust.”). Neither a general fiduciary duty of confidence, trust, loyalty, and good faith, see In re Evans, 161 B.R. at 477, nor an inequality between the parties’ knowledge or bargaining power, see In re Klippel, 183 B.R. at 260, is sufficient to establish a fiduciary relationship for purposes of dischargeability. “Further, the fiduciary relationship must be shown to exist prior to the creation of the debt in controversy.” In re Romero, 535 F.2d at 621; see also In re Evans, 161 B.R. at 477.

If the debtor is in fact in a fiduciary capacity, then the claim is non-dischargeable if the debtor acted to misappropriate some funds by an intentional or reckless act. In Re: Boyle, 819 F.2d 583 (5th Cir. 1987). This particular element requires the showing of actual or constructive intent by means of a reckless act.

The broad category includes defalcation by the fiduciary. Defalcation generally involves misappropriation of funds. Defalcation does not require fraudulent intent to be shown. Thus, there is in fact a way to have a debt discharged when the debtor was merely negligent. In Re: Waters, 20 B.R. 277 (B.C.W.D. Tex. 1982); In Re: Anderson, 64 B.R. 331 (B.C.N.D. Ill. 1986).

If the debtor is guilty of embezzlement, the claim is non-dischargeable although a criminal conviction is not necessary. Embezzlement does not require the debtor to be acting in a fiduciary capacity, but rather constitutes a separate category of non-dischargeable debt. In Re: Black, 787 F.2d 503 (10th Cir. 1986).

B.1.(C)

Willful & Malicious Injury, 11 U.S.C. §523(a)(6)

The Reform Bill has no impact on the following concepts, so these are provided as a refresher.

The Reform Bill makes no changes to this section which provides that willful and malicious injury to the property of another constitutes a basis for denial of a discharge. The most common application of this section is in the conversion or sale of mortgaged property by a debtor. This would involve the sale of property subject to a security interest such as the disposition of livestock, inventory subject to a floor plan-type security interest or other type of disposition of encumbered assets which do not have a title type of lien.

The recent U. S. Supreme Court case of debts arising from recklessly or negligently inflicted injuries do not fall within the compass of willful and malicious injury exception to discharge. Kawaauhau v. Geiger, 118 S.Ct. 974 (1998).  Rather, the creditor must prove that the debtor had the intent to cause a deliberate or intentional injury not merely a deliberate or intentional act that leads to injury. The most recent decision which has addressed this issue in the context of conversion of collateral was In re Kidd, 219 B.R. 278, 285 (Bankr. D. Mt.1998), wherein the Court opined:

Thus, following the aforementioned reasoning and pursuant to the Supreme Court’s holding in Kawaauhau, a creditor, in order to prevail under §523(a)(6), must demonstrate by a preponderance of the evidence, that the debtor desired to cause the injury complained of, or that the debtor believed that the consequences were substantially certain to result from the debtors acts. In other words, in the case of a conversion, a creditor must show that a debtor, when converting collateral, did so with the specific intent of depriving the creditor of its collateral or did so knowing, with substantial certainty, that the creditor would be harmed by the conversion. This subjective test focuses on whether the injury was in fact anticipated by the debtor and thus insulates the innocent collateral conversions from non‑dischargeability under §523(a)(6).

Based upon this case, it appears the creditor’s burden under §523(a)(6) is substantially more difficult than under previous case law.

B.1.(D)

Non-Support Domestic Relations Claims

The Reform Bill makes significant changes to this area.

If the claim is a monetary obligation arising from a decree of divorce or legal separation, it may be excepted from the discharge. A timely complaint is no longer required. This is a fairly new provision and is related only to inter-spousal matters. Creditors cannot assert this basis for exception to discharge. Since this seminar is limited to collection matters and a full discussion of this provision is beyond the scope of this presentation. The Reform Bill essentially makes all financial obligations arising under a divorce decree automatically non-dischargeable.

B.1.(E)

Loans For Taxes Exception

The Reform Bill creates a new exception to discharge for loans taken out by debtors to pay their taxes as follows:

A new exception from discharge is added for debts “incurred to pay a tax to a governmental unit, other than the United States, that would be non-dischargeable under paragraph (1)”.  11 U.S.C.A. §523(a)(14A). Thus, if the debtor borrows money for the purpose of paying a state or local tax, that debt would be non-dischargeable provided that the underlying tax is also non-dischargeable under §523(a)(1). The new exception does not include debts incurred for the payment of taxes owed to the United States.

This section is NOT one of those whereby the creditor must timely file an adversary proceeding to avail themselves of this exception. That is to say, this is an automatic exception to the discharge. This section could have an impact on consumer lenders if the loans are made to pay off taxes. It is suggested that one may want to add a question in the loan application asking if the purpose of the loan is to pay off a tax liability. If you suspect this exception applies, then it is suggested that you should at least write a letter to the Debtor’s counsel advising them of your position. Like the automatic exceptions to the stay, if you sue a debtor to collect on a loan under the theory that it is not discharged because the loan was to pay taxes but you are wrong, then you could be open for a claim of damages for violation of the discharge.

B.1.(F)

Pension Loan Exception

The Reform Bill creates a new exception to discharge for loans owed to pension plans as follows:

New §523(a)(18) creates an exception to discharge for all debts for loans from pension, profit-sharing, stock bonus, or other tax-sheltered plans. This provision contains some rather unusual language stating that the fact that the loan is excepted from discharge is not to be construed to mean the holder of such a claim has a claim or a debt. This is contrary to the typical definitions of “debt” and “claim”. In addition, §523(a) begins with the notion only “debts” are excepted from discharge. No doubt these new and different concepts will be the subject of litigation.

This section is another one where the creditor is not required to timely file an adversary proceeding to avail themselves of this exception. It is yet another automatic exception to the discharge. This section will definitely impact on pension plan administrators, but probably no one else.

B.2.

Burden of Proof

The Reform Bill has no impact on the following concepts, so these are provided as a refresher.

If the creditor brings a complaint to determine the dischargeability of a debt pursuant to 11 U.S.C. §523(a)(2), (4), or (6), the creditor has the burden of proving that the debt is non-dischargeable. A recent Supreme Court case of Grogan v. Garner, 111 S.Ct. 645 (1991) has clearly established that the standard by which dischargeability claims are judged is a preponderance of the evidence. Prior to the Grogan case being decided there was a split of authority as to whether or not dischargeability must be proven by preponderance of the evidence or by clear and convincing evidence.

The Grogan case also establishes clearly that if the parties have litigated issues in a non-bankruptcy forum to a judgment, such litigation is issue preclusive on dischargeability issues; however, the Bankruptcy Court reserves final jurisdiction to determine dischargeability of claims pursuant to 28 U.S.C. §157. It is not necessary to include dischargeability type claims in a non-bankruptcy litigation. For example, if a creditor has a claim against a debtor on a promissory note which also involves a fraudulent financial statement, the creditor probably should not litigate the financial statement claim in the non-bankruptcy forum. If the debtor subsequently files bankruptcy, the creditor still has the opportunity to litigate this claim before the Bankruptcy Court. It should be noted, as you all remember from law school, that a default judgment is not a litigation on the merits and thus is not issue preclusive of anything in the bankruptcy.

XI. Proof Of Claim

The second thing which you must do upon receiving a notice of bankruptcy after having diaried the appropriate dates is to examine your client’s claim. The vehicle by which you may accomplish this is to fill out the proof of claim form and attach the appropriate supporting documentation. The proof of claim form is basically a “fill in the blank” type of form which is fairly self-explanatory. A generic, fillable proof of claim form may be obtained at:

http://www.uscourts.gov/FormsAndFees/Forms/BankruptcyForms.aspx

It is important if your client has a security interest, mortgage or lien upon some particular piece of property to include evidence of perfection. Generally, this will be a copy of the UCC-1, filed in the proper filing office, copy of the lien entry form or a file-stamped copy of the real estate mortgage. Copies of these documents should be attached to the proof of claim and the proof of claim should be filed with the Court Clerk, a copy mailed to the trustee and to the debtor’s counsel. The trustee is interested in reviewing the proofs of claim to determine whether or not the property which the debtor has is, in fact, subject to properly perfected liens.

If your lien is not properly perfected, you should consider the potential consequences of an avoidance proceeding by the trustee pursuant to 11 U.S.C. §544 or §547. If the claim was not properly perfected timely but was subsequently perfected, it may be subject to avoidance as a preference pursuant to 11 U.S.C. §547. On the other hand, if the claim is not perfected at all, the trustee may prevail over the unperfected secured creditor pursuant to 11 U.S.C. §544(a)(1) wherein the trustee takes on the character of a “hypothetical” lien creditor who has executed upon the property as of the date of the petition. Such creditors will prevail over unperfected security interests. If in fact your claim is unperfected, the best course of action is to do nothing and hope the trustee overlooks perfection problems. However, this is fairly unlikely since trustees always look to see if they can get property from the debtor since that is how trustees make money. If the trustee attacks your client’s claim as being unperfected, most of the time the creditor can settle out with the trustee for less than the value of the collateral, thus providing an economic benefit to your client.

If the claim is under secured or unsecured, any payments received will be avoidable as a preferential transfer pursuant to 11 U.S.C. §547 for 90 days prior to the filing of the case. If the creditor is an “insider” 11 U.S.C. §101(31), then the time limit is extended to one year. A detailed discussion of the intricacies of avoidance proceedings is far beyond the scope of this paper.

The creditor should carefully consider the possibility of having to litigate preferences, fraudulent conveyances or other types of avoidance proceedings within the context of a bankruptcy proceeding. If such appears likely and if it does not appear that there is any reasonable likelihood of recovery of assets from the estate, then a proof of claim should not be filed in the case. The filing of a proof of claim in a bankruptcy waives the creditor’s right to a jury trial. In Re: Gran Financiera, 492 U.S. 33, 109 S.Ct. 2782, 106 L.Ed.2d 26. If, on the other hand, there appears to be a likelihood of assets being distributed, you should weigh whether or not you want to have a jury trial against the likelihood of receiving proceeds from the bankruptcy estate.

It is now possible to conduct jury trials in the Bankruptcy Court. Until the Bankruptcy Reform Act of 1994, the Bankruptcy Courts did not have the constitutional power to conduct jury trials. Now they do, but only if all parties to the matter being litigated consent. This provides yet another tactical consideration to the process which must be considered. Usually, the trial in the Bankruptcy Court will be faster than in the District Court, but the Bankruptcy Courts have little, if any experience in conducting jury trials, whereas, the District Courts do them all the time.

Note that the debtor always waives their right to a jury trial because the filing of a voluntary case is a submission to the jurisdiction of the Bankruptcy Court, thus waiving the right to a jury trial on discharge issues.

Creditors are entitled to a jury trial in Bankruptcy Court, if they have not waived it by submitting to the Bankruptcy Court’s authority, any time they would otherwise be entitled to a jury trial.  In Re: Gran Financiera. The discussion of a jury trial right in Bankruptcy Court is a matter which is yet unsettled by the Courts, and greatly exceeds the scope of this discussion.

After having completed the proof of claim, you should have a firm grasp upon whether or not your claim is subject to some priority pursuant to 11 U.S.C. §507 or whether the claim is unsecured, secured or under secured. If the claim is secured, the following analysis is appropriate.

XII. Conclusion

The representation of a creditor in a Chapter 7 consumer case can appear to be deceptively simple. However, as can be seen from the above, there are several fairly detailed issues which must be considered by a creditor’s counsel. Most of the issues will not arise in most of the cases which will be processed. However, the same analysis must be made in each case in order to insure that the creditor is receiving proper representation.  From the creditor’s perspective, bankruptcy represents a common occurrence in the ordinary course of any institutional lender. Consequently, a basic knowledge of bankruptcy is both important to anyone who extends credit. The use of this knowledge by active participation in the bankruptcy system will effectively limit the losses occasioned by the inevitable filings which occur and thereby increase the profitability of any creditor.

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This section of the seminar deals with issues which typically arise when the record title holder of the property subject to the mortgage you are foreclosing upon (the “Mortgagee” or “Debtor”) files for relief under the Bankruptcy Code. This section assumes little or no working knowledge of the Bankruptcy Code. It is not intended to be an exhaustive study of all possible issues which may arise in this context, but rather is intended to provide an overview of the primary issues which typically arise. This paper assumes that a foreclosure is pending at the time the mortgagor files a voluntary petition for relief under the Bankruptcy Code and that your client is the holder of the mortgage (the “Mortgagee” or “Creditor”). Is it not the intention of this paper to educate you on every possible issue that may arise in every type of bankruptcy case, but rather to give you the basic tools to deal with such event. Many times, bankruptcy cases turn into very complex matters which are far beyond the scope of this paper and in such event, it is highly recommended you associate with experienced Bankruptcy counsel.

I. INTRODUCTION TO THE BANKRUPTCY CODE

All Bankruptcy Cases are governed by the provisions of 11 U.S.C. §101 et seq, referred to herein after as the Bankruptcy Code or simply, “the Code.” All statutory citations in this paper refer to specific sections of the Code unless otherwise stated. This paper deals with the Code as it has been amended to date, including the most recent amendments of the Bankruptcy Abuse and Consumer Protection Act of 2005 (the “Reform Act”). The Reform Act was signed by the President on April 20, 2005; however, the majority of its provisions did not become effective until October 17, 2005. This paper will assume that the Bankruptcy Case was filed after October 17, 2005 and that such case is subject to all provisions of the Reform Act.

The Code creates 6 different types of bankruptcy cases which may be filed. Specifically, Chapters 7, 9, 11, 12, 13 and 15 all create different types of relief available to various different types of debtors. Chapter 7 is what is known as liquidation bankruptcy, although, the actual liquidation of an asset only occurs in about 5% of such cases filed in Oklahoma.

Chapters 9, 11, 12 and 13 are all referred to as “reorganizations” because they all contemplate a continuation of the debtor in some form subject to debts which have been modified by a device known as a plan. A plan is really nothing more than a court enforced loan modification agreement wherein the debtor rewrites the terms of all their debt on a global basis.

Chapter 9 is a municipal reorganization which is a very specialized type of bankruptcy case and is far beyond the scope of this seminar.

Chapter 11 is designed for public corporations, but almost any type of entity or individual may file such a case.

Chapter 12 is a very powerful, but also a very limited reorganization which may only be utilized by family farmers. There are very few Chapter 12 cases filed and therefore, such matters are beyond the scope of this seminar.

Chapter 13 is a sort of individual reorganization which may only be used by natural persons.

Finally, Chapter 15 is limited to what are referred to as “Cross-border insolvency cases” wherein the primary insolvency proceeding is filed in a foreign country and such company has assets located within the United States. Such cases are far beyond the scope of this seminar.

Each reorganization chapter has subchapters which define the administration of the estate under rules which are unique to the particular chapter and which define the various rules related to each unique chapter.

The Bankruptcy Code as we know it today was passed in 1978 as a complete overhaul of the then existing Bankruptcy Act. It has been amended several times, but none of the amendments really made sweeping types of changes and were mostly limited to smaller adjustment types of amendments. Most recent of these amendments is the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Reform Act”) The Reform Act made substantial changes to many aspects of the Code.

II. INITIAL CONSIDERATIONS

The first notice of bankruptcy that a creditor will receive is known commonly as the “341 notice”. This notice will be received in the mail and involves several important pieces of information. One of the initial reactions to the receipt of a 341 notice, especially if litigation is pending, is anger. Creditors, and in particular mortgagees, are not without defense to a bankruptcy. However, more so than any other area of the law which I have encountered, you must take an aggressive stance in the case before any relief may be received. Anyone who stands by and does nothing upon receiving a bankruptcy notice generally will get out of it exactly what they put into it. Upon receipt of the 341 notice, you should diary the dates for the initial meeting of creditors, 30 days thereafter to object to exemptions, 60 days thereafter to object to the discharge or file a complaint to determine dischargeability and any bar date for filing proofs of claim.

Also, you must determine what chapter the debtor is filing. This is simply a matter of reading the notice. If the case is a “reorganization” chapter, i.e., Chapter 11, 12 or 13, the considerations for creditor’s counsel are far more complex than in a Chapter 7. It is recommended that if you have never been involved in such a case before, that you associate with someone who has experience in such matters.

III. AUTOMATIC STAY

Most of the time, the mortgagee will prefer to simply continue with its foreclosure action. The impediment to this preferred course is the Automatic Stay which comes into existence upon the filing of the bankruptcy case. The Automatic Stay comes into existence upon the filing of the petition in virtually every case, hence the term “Automatic”. The Court will issue an initial document known as “the §341 notice” which provides for notice of the imposition of the Automatic Stay. It is beneficial to conceptualize a bankruptcy case as really a request for an equitable injunction. The issuance of the Automatic Stay amounts to an ex parte temporary restraining order which ultimately ripens into a permanent restraining order upon the issuance of the discharge. The automatic stay is governed by §362. Essentially, this injunction enjoins virtually all creditors from taking any action against the debtor or their property.

Exceptions to the automatic stay are set forth in §362(b); however, most mortgagee’s claims will not be exempt from the stay. It is critical that all foreclosure and collection actions be stopped upon being given notice of the filing of the case. If you discover that for some reason such activities have not ceased, take corrective measures to stop them at once. §362(k)(1) creates a cause of action for damages, both actual and punitive, attorney’s fees and costs, for any creditor who willfully violates the provisions of §362. Bankruptcy Judges take a very dim view of creditors who intentionally violate the stay after they have been asked to stop and usually require such creditors to pay for such transgressions. You can’t win this one, so don’t try it.

Any act taken in violation of automatic stay, which violator knows to be in existence, justifies award of actual damages which includes attorney’s fees. If there are additional finding of maliciousness or bad faith on part of the creditor, then the imposition of punitive damages is appropriate. In re Crysen/Montenay Energy Co., 902 F.2d 1098 (2d Cir. 1990). For example, in one local case in Tulsa, Judge Terrence L. Michael awarded $2,850.00 in actual damages, $15,000.00 in attorney’s fees, plus $40,000.00 in punitive damages against a creditor who repossessed a debtor’s car in violation of the stay in a Chapter 13 case.  In re Diviney, 211 B.R. 951, (Bankr.N.D.Okla. 1997). It is a very risky course to assume that the stay does not apply to you. If you are wrong, then you will have to pay any damages which result from your acts. The best course is to obtain relief from the stay.  The Reform Act created a few limited situations where you may be able to proceed without seeking relief from the stay.

As will be discussed below, the Reform Act created a new section in §362(h) which provides for automatic termination of the stay. If a creditor violates the stay in the mistaken, good faith belief that the stay was automatically terminated under new §362(h), the damages are limited to actual damages, NOT including attorney’s fees.

A. Automatic Termination of the Automatic Stay

There are several provisions under the Code which effectuate an automatic termination of the automatic stay. In essence, if these situations apply to your case, you don’t have to do anything but wait the appropriate period of time for the automatic stay to simply “go away”.

1. Failure to File and Perform Statement of Intention

If the Bankruptcy Case is one under Chapter 7, then §362(h) provides for the automatic termination of the stay and for abandonment of the property if the debtor fails to timely perform their intentions under §521(a)(2) unless they attempt to reaffirm based on the original contract terms and the creditor refuses to agree to such reaffirmation. Since we are assuming a foreclosure is pending at the time the Bankruptcy Case is filed, then this narrow exception would virtually never be true because the debtor in a Chapter 7 case has no ability to compel a cure of a default under a mortgage and almost no way to come up with the cash to effect such a cure.

Specifically, §521(a)(2)(A) requires the debtor to file a statement of intention within earlier of 30 days after the petition date or the date set for the creditor’s meeting (unless extended by an order of the Court). Thereafter, §521(a)(2)(B) requires the debtor to perform their stated intention within 30 days after the creditor’s meeting (unless such time period is extended by a court order obtained before the 30 day period expires). Therefore, in the vast majority of foreclosure cases, the Debtor will have no practical ability to reaffirm the debt and thus, in most typical Chapter 7 cases, the Automatic Stay will automatically terminate in no more than approximately 60 days.

The statement of intention provides the debtor must either surrender, reaffirm, redeem, avoid the lien under §522(f)(1)(B) or assume an unexpired lease of personal property under §365(p). §362(h)(A) provides the debtor must timely file the statement of intention and §362(h)(B) requires that such stated intentions must be performed within the time frames established by §521(a)(2). If the debtor fails in any of these obligations, then the stay automatically terminates. Also, note that not only does the stay terminate, but also, the property in question is abandoned from the Bankruptcy Estate. No motion, notice or order is required.

Note that the Chapter 7 Bankruptcy Trustee (and only the Trustee) may obtain relief from the automatic termination of the stay by filing a motion, upon notice and opportunity, before the stay automatically terminates as provided in §362(h)(2) as follows:

Paragraph (1) does not apply if the court determines, on the motion of the trustee filed before the expiration of the applicable time set by §521(a)(2), after notice and a hearing, that such personal property is of consequential value or benefit to the estate, and orders appropriate adequate protection of the creditor’s interest, and orders the debtor to deliver any collateral in the debtor’s possession to the trustee. If the court does not so determine, the stay provided by subsection (a) shall terminate upon the conclusion of the hearing on the motion.

This section would likely only be used when there is significant equity in non-exempt property, or if the Trustee believes the creditor’s lien upon such non-exempt property is defective in some manner so that such lien is avoidable. It is important to note that the automatic provisions also provide for automatic abandonment of the property in question from the Bankruptcy Estate. Thus, if the Trustee fails to timely seek relief from the automatic termination of the stay, then the Trustee’s avoidance claims related to the liens upon the property under §544 are also terminated.

In the event you are feeling somewhat uneasy about whether the stay is in effect, new §362(j) provides that “On request of a party in interest, the Court shall issue an order under subsection (c) confirming that the automatic stay has been terminated”. Note that this provision does not provide for notice and opportunity for a hearing, thus is appears it is intended that obtaining such an order is to be done on ex parte application. The new and revised Federal Rules of Bankruptcy Procedure were adopted and became effective December 1, 2007. The specific rule related to stay relief is Fed. R. Bankr. P. 4001, which states:

(a) Relief from stay; prohibiting or conditioning the use, sale, or lease of property

(1) Motion

A motion for relief from an automatic stay provided by the Code or a motion to prohibit or condition the use, sale, or lease of property pursuant to § 363(e) shall be made in accordance with Rule 9014 and shall be served on any committee elected pursuant to § 705 or appointed pursuant to § 1102 of the Code or its authorized agent, or, if the case is a Chapter 9 municipality case or a Chapter 11 reorganization case and no committee of unsecured creditors has been appointed pursuant to § 1102, on the creditors included on the list filed pursuant to Rule 1007(d), and on such other entities as the court may direct.

(2) Ex parte relief

Relief from a stay under § 362(a) or a request to prohibit or condition the use, sale, or lease of property pursuant to § 363(e) may be granted without prior notice only if (A) it clearly appears from specific facts shown by affidavit or by a verified motion that immediate and irreparable injury, loss, or damage will result to the movant before the adverse party or the attorney for the adverse party can be heard in opposition, and (B) the movant’s attorney certifies to the court in writing the efforts, if any, which have been made to give notice and the reasons why notice should not be required. The party obtaining relief under this subdivision and § 362(f) or § 363(e) shall immediately give oral notice thereof to the trustee or debtor in possession and to the debtor and forthwith mail or otherwise transmit to such adverse party or parties a copy of the order granting relief. On two days notice to the party who obtained relief from the stay without notice or on shorter notice to that party as the court may prescribe, the adverse party may appear and move reinstatement of the stay or reconsideration of the order prohibiting or conditioning the use, sale, or lease of property. In that event, the court shall proceed expeditiously to hear and determine the motion.

(3) Stay of order

An order granting a motion for relief from an automatic stay made in accordance with Rule 4001(a)(1) is stayed until the expiration of 10 days after the entry of the order, unless the court orders otherwise.

As you can see, there is nothing in the new and improved Bankruptcy Rules to address relief under §362(j). Although neither the Western nor Eastern Districts of Oklahoma have any local rule specifically addressing this issue, the Northern District has adopted a specific local rule addressing this point NDOK L.R. 4001(G) states:

G. Confirmation that Automatic Stay is Terminated. A request for an order under 11 U.S.C. § 362(j), confirming that the automatic stay has been terminated, may be made by application. An application pursuant to 11 U.S.C. § 362(j) shall provide the following information, as appropriate in the circumstances for each prior case: (1) if the prior filing was in this Court, the complete case caption, date of filing and date of dismissal; and/or (2) if the prior filing was in any other court, then, in addition to the requirements of (1), the movant shall also file relevant copies of all court records reflecting the information provided in subsection (1).

In any event, it seems clear that you should be able to get this statutory “comfort order” quickly. Just how quick remains to be seen depending upon which court you find yourself.

2. Serial Filings

For years, creditors have been frustrated by debtors who file multiple cases, particularly, Chapter 13 cases which allow for instanter dismissals with no prohibition to re-filing an unlimited number of sequential cases (i.e., “Serial Filing”). Each filing creates an automatic stay, thereby delaying recovery of collateral for what sometimes seems like eternity at the cost of thousands of dollars to the creditor. §362 was amended to stop this practice.

§§362(c)(3) and (4) specifically address Serial Filings. §362(c)(3) automatically terminates the stay 30 days post-petition in the case of an individual debtor who files a second case under Chapter 7, 11 or 13 within one year after the dismissal of the first case, unless the second case is not a Chapter 7 and the first case was a Chapter 7 that was dismissed under §707(b). An extension of the automatic termination is possible only if the second case is filed in good faith and the order granting such extension must be entered BEFORE the 30 day period expires. The standard for good faith is also statutory and requires the moving party must comply with the following sections:

(C) for purposes of subparagraph (B), a case is presumptively filed not in good faith (but such presumption may be rebutted by clear and convincing evidence to the contrary) –

(i) as to all creditors, if –

(I) more than 1 previous case under any of Chapters 7, 11, and 13 in which the individual was a debtor was pending within the preceding 1-year period;

(II) a previous case under any of Chapters 7, 11, and 13 in which the individual was a debtor was dismissed within such 1-year period, after the debtor failed to –

(aa) file or amend the petition or other documents as required by this title or the court without substantial excuse (but mere inadvertence or negligence shall not be a substantial excuse unless the dismissal was caused by the negligence of the debtor’s attorney);

(bb) provide adequate protection as ordered by the court; or

(cc) perform the terms of a plan confirmed by the court; or

(III) there has not been a substantial change in the financial or personal affairs of the debtor since the dismissal of the next most previous case under Chapter 7, 11, or 13 or any other reason to conclude that the later case will be concluded—

(aa) if a case under Chapter 7, with a discharge; or

(bb) if a case under Chapter 11 or 13, with a confirmed plan that will be fully performed; and

(ii) as to any creditor that commenced an action under subsection (d) in a previous case in which the individual was a debtor if, as of the date of dismissal of such case, that action was still pending or had been resolved by terminating, conditioning, or limiting the stay as to actions of such creditor;

If the debtor files a case and there were 2 pending within the previous year that were dismissed unless the third case is not a Chapter 7 and the other cases were Chapter 7’s that were dismissed under §707(b), then there is NO STAY upon the filing of the 3rd case. §363(c)(4)(A)(i).  There is also the right to a comfort order under §363(c)(4)(A)(ii) just like §363(j) above, although this seems redundant.

As with §363(c)(3)(B) above, §363(c)(4)(B) provides for obtaining a stay in the third serial filing case only by compliance with the following:

(B) if, within 30 days after the filing of the later case, a party in interest requests the court may order the stay to take effect in the case as to any or all creditors (subject to such conditions or limitations as the court may impose), after notice and a hearing, only if the party in interest demonstrates that the filing of the later case is in good faith as to the creditors to be stayed;

(C) a stay imposed under subparagraph (B) shall be effective on the date of the entry of the order allowing the stay to go into effect; and

(D) for purposes of subparagraph (B), a case is presumptively filed not in good faith (but such presumption may be rebutted by clear and convincing evidence to the contrary) –

(i) as to all creditors if –

(I) 2 or more previous cases under this title in which the individual was a debtor were pending within the 1-year period;

(II) a previous case under this title in which the individual was a debtor was dismissed within the time period stated in this paragraph after the debtor failed to file or amend the petition or other documents as required by this title or the court without substantial excuse (but mere inadvertence or negligence shall not be substantial excuse unless the dismissal was caused by the negligence of the debtor’s attorney), failed to provide adequate protection as ordered by the court, or failed to perform the terms of a plan confirmed by the court; or

(III) there has not been a substantial change in the financial or personal affairs of the debtor since the dismissal of the next most previous case under this title, or any other reason to conclude that the later case will not be concluded, if a case under Chapter 7, with a discharge, and if a case under Chapter 11 or 13, with a confirmed plan that will be fully performed; or

(ii) as to any creditor that commenced an action under subsection (d) in a previous case in which the individual was a debtor if, as of the date of dismissal of such case, such action was still pending or had been resolved by terminating, conditioning, or limiting the stay as to such action of such creditor.

It is important to note that under both §§362(c)(3) and (4), any creditor who obtained an order “terminating, conditioning or limiting the stay as to such action of such creditor” or who had an unresolved, pending motion for such relief, is essentially exempt from any  continuation or imposition of the stay in a second or third serial case. So, despite all of these automatic terminations of the stay, it is still good practice to file a motion for relief from stay and obtain an order to essentially immunize the creditor from serial filings.

3. In Rem Enforcement Exception

A new subsection 362(b)(20) is added to exclude from the automatic stay actions to enforce liens or security interests following entry of an in rem order described in the new §362(d)(4), unless the debtor in the subsequent bankruptcy case successfully reinstates the automatic stay under the provisions of (d)(4).

Code §362(d)(4) provides that, as to real property, if the court finds that the bankruptcy case was filed as part of a “scheme to delay, hinder, and defraud creditors”, either by the transfer of all or part of an interest in the realty without the secured creditor’s consent or by multiple bankruptcy filings that affect the realty (presumably stopping foreclosure actions, for example), the court may grant in rem relief from the automatic stay. While this may seem to be a good avenue in cases of serial filing, early cases imposed an obligation to prove traditional common law fraud which is virtually impossible. More recent cases have defined fraud much more broadly and now permit such to be inferred from a series of filings with no good faith effort to prosecute such cases. As of July 6, 2010, a search for cases decided under §362(d)(4) found:

Granted:

In re Young, 2007 WL 128280, 10 -11 (Bankr.S.D.Tex.,2007)

In re Wilke, 2010 WL 2384836, 6 (Bankr.N.D.Ill.) (Bkrtcy.N.D.Ill.,2010)

In re Montalvo, 416 B.R. 381, 387 (Bkrtcy.E.D.N.Y.,2009)

In re Blair, 2009 WL 5203738, 4 (Bankr. E.D.N.Y.,2009) (unreported).

Denied:

In re Duncan & Forbes Development, Inc., 368 B.R. 27, 32 (Bankr.C.D.Cal.,2006)

In re Abdul Muhaimin, 343 B.R. 159, 167 (Bankr.D.Md.,2006)

In re Gould 348 B.R. 78, *80 -81 (Bankr..D.Mass.,2006)

In re Van Eck, 425 B.R. 54, 71 (Bankr.D.Conn.,2010)

In re Poissant, 405 B.R. 267, 273 -274 (Bankr.N.D.Ohio,2009)

In re Russell, 2010 WL 1740643, 1 (Bkrtcy.E.D.N.C.,2010)

In the opinions wherein relief under §362(d)(4) was denied, the Court focused on each element of scheme to delay, hinder, and defraud, requiring the moving creditor to prove each “delay,” “hinder,” AND “defraud” as independent elements requiring separate proof and required proof of “fraud” under a traditional common law standard. For example, In re Poissant, held:

While the serial filings reflect a delay in allowing the Bank to foreclose on the property, there is nothing before the Court to prove that the Debtor intended to defraud the Bank. See, In re Gould, 348 B.R. 78, 80 (Bankr.D.Mass.2006); In re Abdulla, 2009 WL 348365, at 1 (Bankr.D.Mass. Feb.6, 2009); In re Young, 2007 WL 128280, at 8-9 (Bankr.S.D.Tex. Jan.10, 2007); In re Smith, 395 B.R. 711, 719 (Bankr.D.Kan.2008); and In re Lemma, 394 B.R. 315, 325 (Bank.E.D.N.Y.2008).

The elements of fraud are: i) false representation of a material fact; ii) knowledge of or belief in its falsity by the person making it; iii) belief in its truth by the person to whom it is made; iv) intent that it should be acted upon; and v) detrimental reliance upon it by the person claiming to have been deceived. In re Meridia Products Liab. Litig., 328 F.Supp.2d 791, 819 (N.D.Ohio 2004).

Some of the recent decisions cited above granting relief have digressed from this position, thereby breathing life into this section. The case of in In re Wilke, offers some hope for creditors as it defined “fraud” as “not limited to misrepresentation, but may encompass “any deceit, artifice, trick or design involving direct and active operation of the mind, used to circumvent and cheat another.” Citing McClellan v. Cantrell, 217 F.3d 890, 893 (7th Cir.2000). The decision in In re Blair shows a line of cases which trend away from the initial strict standard requiring proof of traditional, “actual fraud” as follows:

As this Court also noted in Montalvo, Courts have varied on whether a bankruptcy court can infer an intent to hinder, delay, and defraud creditors from the fact of serial filings alone. Compare In re Poissant, 405 B.R. 267, 273 (Bankr.N.D.2009); In re Abdulla, No. 08-16802, 2009 WL 348365 at *1 (Bankr.D.Mass. Feb. 6, 2009); and In re Smith, 395 B.R. 711, 719-20 (Bankr.D.Kan.2008) (several filings alone are not adequate to find intent to hinder, delay and defraud, which requirements are in the conjunctive and must all be demonstrated); with In re Hendersen, 395 B.R. 893, 902 (Bankr.D.S.C.2008); and In re Johnson, No. 07-33312, 2008 WL 183342 (Bankr.E.D.Va. Jan. 18, 2008) (finding multiple, strategically timed bankruptcy filings can be basis for inference of debtor’s intent to hinder, delay and defraud). In Montalvo, this Court joined those courts which hold that the mere timing and filing of several bankruptcy cases is an adequate basis from which a court can draw a permissible inference that the filing of a subsequent case was part of a scheme to hinder, delay, and defraud creditors.

It is also noteworthy that your author has personal knowledge that Judge Michael followed the analysis of the courts that denied relief under §362(d)(4), although the case was dismissed. See In Re Light of the World Interdenominational Deliverance, Case No. 06-10583-M, Docket Entry 61. There is no order or opinion in the case as such was a telephonic bench ruling. Judge Michael used the a traditional common law fraud standard. To the knowledge of this author, the alternative and more relaxed definition of fraud has not been presented to the Courts in Oklahoma.

In the event one chooses this approach, counsel must be prepared to somehow prove that the bankruptcy filing was part of a scheme to defraud creditors arguing that the series of cases filed and not prosecuted in good faith are sufficient factual basis for the court to infer a scheme to hinder, delay and defraud. Whether Oklahoma Bankruptcy Courts will follow this line of reasoning remains to be seen.

If on manages to obtain relief under this section, such relief from the stay has a binding effect in any other bankruptcy case that might be filed within two years of the entry of the order, provided that the order was also recorded in compliance with state real estate noticing laws. A debtor in a subsequent case who may be affected by this in rem order could move for relief from the order to reinstate a stay, provided that the debtor must show a change of circumstances since entry of the order or other good cause. The subsection specifically provides that federal, state, or local governmental units must accept a certified copy of the in rem order for “indexing and recording”.

The sad reality of this section is that although Congress attempted to provide a form of relief that would be very helpful in the context of mortgage foreclosures, the use of the conjunctive word “AND” rather than the time honored, traditional disjunctive “OR” renders this provision problematic.

4. Single Asset Real Estate

The Reform Act modified the procedure for stay relief in single asset real estate cases. The definition “single asset real estate” is found in §101(51)(B).

The term “single asset real estate” means real property constituting a single property or project, other than residential real property with fewer than 4 residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental.

Essentially, the stay is automatically modified 90 days post petition unless a plan is filed or monthly cash payments are commenced “in an amount equal to interest at a current fair market rate on the value of the creditor’s interest in the real estate”. See §362(d)(3)(B). which states:

(3) with respect to a stay of an act against single asset real estate under subsection (a), by a creditor whose claim is secured by an interest in such real estate, unless, not later than the date that is 90 days after the entry of the order for relief (or such later date as the court may determine for cause by order entered within that 90-day period) or 30 days after the court determines that the debtor is subject to this paragraph, whichever is later –

(A) the debtor has filed a plan of reorganization that has a reasonable possibility of being confirmed within a reasonable time; or

(B) the debtor has commenced monthly payments that –

(i) may, in the debtor’s sole discretion, notwithstanding section 363(c)(2), be made from rents or other income generated before, on, or after the date of the commencement of the case by or from the property to each creditor whose claim is secured by such real estate (other than a claim secured by a judgment lien or by an unmatured statutory lien); and

(ii) are in an amount equal to interest at the then applicable nondefault contract rate of interest on the value of the creditor’s interest in the real estate; or

In the context of a Chapter 11 case, this provision gives mortgage holders additional leverage to obtain payments of money fairly early on in the case. Creditors may want to negotiate for an agreement that the debtor is in fact a single asset real estate case.  Debtors will want to have a provision that the payments made under the cash collateral order are “equal to interest at a current fair market rate on the value of the creditor’s interest in the real estate”. Note that this particular automatic modification of the Automatic Stay does not effect an abandonment of the Property.

In the context of a Chapter 7, this provision may provide assistance to mortgage holder in an entity bankruptcy where the Trustee thinks there may be some value in the single item of real property, but where such property is not generating income. This provision mandates relief from the stay if actual monthly payments in real money do not start within 90 days.

5. Motion for Relief from Stay

An order granting relief from the stay requires the filing of a motion for relief from the stay pursuant to §362(d). Although this is often referred to as “lifting the stay” it should be noted that the Code refers only to termination, modification, annulling or conditioning the stay. In a Chapter 7, the debtor generally cannot successfully oppose a motion for relief from stay. §362(d) provides for relief from the stay when there is no equity in the property and the property is not necessary for an effective reorganization. Obviously in a Chapter 7 there is not ever going to be a reorganization so the creditor is almost always going to be entitled to relief from the stay. Even if there is equity in the property, unless the Trustee gets involved, most Bankruptcy Courts are not sympathetic to a Debtor’s resistance of a Motion for Relief from Stay based solely upon alleged equity particularly if the property is the Debtor’s homestead.

The trustee may oppose relief from the stay on the basis that the property not claimed as exempt has value in excess of the creditor’s secured claim. If this becomes an issue consider having the trustee sell the property pursuant to §363. This will avoid most of the problems which will arise. Be sure to get a deadline for the sale since most trustees are very busy and your collateral can easily get lost in the crowd.

The sale of the property by the trustee is a good alternative in some cases. The trustee may sell any non-exempt property on 20 days notice. Be sure to determine the tax basis of any business property to be sold. If the debtor has depreciated the property, the estate will be liable for any gain on the sale, and the trustee will want to take the taxes out before turning over the proceeds to the creditor. If the tax basis is low, get the stay modified, and sell the property outside of the bankruptcy estate. The creation of a tax liability from the sale of the property has a direct impact on the benefit to the Estate from such a sale. Sometimes, the tax liability will off set any equity in the property so that there is no real benefit to the Estate.

One other issue is the Trustee’s fee based upon a percentage of the disbursements made by the trustee. Specifically, 11 U.S.C. §326(A) provides:

(A) In a case under Chapter 7 or 11, the court may allow reasonable compensation under §330 of this title of the trustee for the trustee’s services, payable after the trustee renders such services, not to exceed 25 percent on the first $5,000 or less, 10 percent on any amount in excess of $5,000 but not in excess of $50,000, 5 percent on any amount in excess of $50,000 but not in excess of $1,000,000, and reasonable compensation not to exceed 3 percent of such moneys in excess of $1,000,000, upon all moneys disbursed or turned over in the case by the trustee to parties in interest, excluding the debtor, but including holders of secured claims.

This statute provides for the maximum amounts a trustee may be paid, but the reality is that unless you negotiate a specific agreement with the trustee, you are probably going to wind up paying the maximum. If the property is worth a substantial amount of money, this could be significant. Strike a deal with the trustee in advance and save money. Objections to the fees after the trustee has done the work are usually difficult to win.

In the case of a motion for relief related to a foreclosure action, it is also important the property is abandoned from the estate pursuant to §554. If it is not, you must give notice to the trustee of any subsequent action taken. The abandonment of property is accomplished through a motion to compel abandonment under §554 and the issue is value to the estate. If the property is burdensome to the trustee and has no value, the Court will determine it to be abandoned. This is the same issue which will arise with the trustee in a motion for relief from the stay. Consequently, most Courts do not have a problem with a combined motion for relief from stay and to compel the trustee to abandon the property. In the case of mortgaged real property, abandonment is a very important issue as a subsequent title examination will require this before the property’s title will meet the title standards.  In fact, it is a good idea to review the title examination standards before moving for relief to make sure you identify issues important to the title examiners. The title standards are found at 16 O.S. Ch 1. App. Std 20.1. The combined motion for relief from stay and for abandonment of the property is hereinafter referred to as the “Motion”.

Notice is an area where many inexperienced counsel err. It is my recommendation that you give notice of the Motion to all creditors listed on the matrix. If the Court determines the notice of the Motion is defective, then it may be denied on a technical basis and you will get to do it over again, usually at your expense!

If the creditor matrix has a large number of creditors so that giving notice to all of them is too expensive, then you are permitted to file an application to limit the notice under Federal Rules of Bankruptcy Procedure Rule 9029 and the corresponding local rule. Such an application must allege cause for limiting the notice. Language such as the following will usually suffice:

There are approximately 125 creditors and other parties in interest in this case. Providing full notice to all such parties of the Motions in this case is very costly and not necessary to provide due process in this case. The limited notice proposed herein is sufficient to serve the constitutional requirement of fair and reasonable notice in this case. Debtor proposes to limit the notice of the Motions to the parties identified in paragraph 4. Debtor will mail the Notice of the Sale which also contains notice of the hearing and notice to file objections to all parties on the matrix. Debtor submits all notices should be limited to the United States Trustee, all attorneys requesting notice, any committees appointed, all parties claiming

If you have an order limiting the notice to a specific group of parties, then make sure you give notice to that group and file a certificate of service reflecting such.

The pivotal issue in all Motions for relief from stay is value, i.e., what is the property worth if it’s sold? In a Chapter 7 case, value is typically the only issue. If the Trustee believes there is significant equity in the property, you will undoubtedly draw an objection to the Motion. In this case, since the property is by definition real property, then the issue of value is really a question of fact. There are only two types of witnesses competent to testify as to the value of real property: (1) the owner. “An owner of real property is competent to testify as to its value. III Wigmore on Evidence § 714; Arkansas Louisiana Gas Company v. Ackley, 410 P.2d 35 (Okl.1965).” In re Ferris, 415 F.Supp. 33, 40 (D.C.Okl. 1976); and (2) an expert who is an appraiser. “As the owner of real estate, the debtor is entitled to render his opinion as to the fair market value of the property. With that one exception, only the testimony of a qualified expert, such as an experienced appraiser, would be admissible on the issue.” In re Donoway, 139 B.R. 156, 158 (Bankr.D.Md.,1992).  Real Estate brokers are not appraisers. Oklahoma now requires a license for real estate appraisers, so don’t waste your time on any expert who is not a licensed appraiser. Finally, make sure that you tell the appraiser you hire that they will most likely have to testify in court. Many appraisers will refuse the engagement if they know they will have to go to Court. After all, a reluctant expert is really not much help to your case.

Get the property appraised and then show the appraisal to the Trustee. Many times, this will resolve the issue. Otherwise, get ready to go to court and prove your case. 11 U.S.C. §362(g)(1) specifically provides that the burden of proof as to the issue of value is upon the Movant. That’s you.

IV. CASH COLLATERAL

A. What is Cash Collateral?

Cash collateral seems to be an area of a good deal of “floundering” by many Debtors’ counsel. The appropriate handling of cash collateral issues is vital to the success of any business reorganization. Consequently, you must first consider what precisely is cash collateral.  Fortunately, the Code provides a good deal of guidance in this area. The primary Code section for consideration is 11 U.S.C. §363.  §363(a) provides a definition of cash collateral:

Cash collateral means cash, negotiable instruments, documents of title, securities, deposit accounts or other cash equivalents whenever acquired in which the estate and an entity other than the estate have an interest and includes the proceeds, products, offspring, rents or profits of the property subject to a security interest as provided in §552(b) [11 U.S.C. §562(b)] whether existing before or after the commencement of a case . . .

The case law reveals that virtually anything arising from encumbered property could be considered cash collateral. For example, rents from real estate have been considered cash collateral by various courts. In Re: Village Properties Ltd., 723 F.2d. 441 (5th Cir. 1984); In Re: Casebeer, 793 F.2d. 1436 (5th Cir. 1986); Virginia Beach Federal Savings & Loan v. Wood, 901 F.2d. 894 (10th Cir. 1990). Whether or not rents from real estate are cash collateral is generally determined by state law.  See Village Properties and Virginia Beach, supra. The Reform Act clarifies that hotel rents from mortgages premises are in fact cash collateral. 11 U.S.C. §363(a).

B. Use of Cash Collateral

It is critical to remember that the use of cash collateral is not authorized unless the Court enters an order providing for such use. This means the Debtor-In-Possession or Trustee will not be able to continue what probably had been the ordinary course of their business by using income from the real property to pay current operating expenses. Conceptually, the DIP or Trustee is using funds that, but for the filing of the bankruptcy, the creditor(s) would have taken through a state court action anyway. In effect, the DIP or Trustee is using funds they would not otherwise be able to use but for the bankruptcy filing. 11 U.S.C. §363(c)(2) provides:

The trustee may not use, sell or lease cash collateral under paragraph 1 of this section unless:

(A)  Each entity that has an interest in such collateral consents; or

(B)  The court, after notice and a hearing authorizes such use, sale or lease in accordance with the provision of this section.

Regardless of the party’s pre-petition conduct, the filing of a petition for relief imposes immediate restrictions on the use of cash collateral. In Re: Pine Lake Village Apartment Co., 16 B.R. 750 (B.C.S.D. NY 1982). The DIP/Trustee is thus subject to the same restrictions on the use of cash collateral as is the trustee. The DIP/Trustee is absolutely prohibited from using cash collateral unless the parties consent or unless an order is entered. In Re: Kain, 86 B.R. 506 (B.C.W.D. Mich. 1988). Consequently, in any case where there is a question regarding cash collateral, this issue must be dealt with immediately.

The best course of action is to reach an agreement with the various creditors prior to filing the bankruptcy. Upon filing the case, file a stipulation with the Court and circulate the same to the interested parties to the case. It is the opinion of this author that since the unsecured creditors may actually have some indirect claim to cash collateral, that all parties to the case should ultimately be noticed regarding an agreement to allow the use of cash collateral. This is particularly true in light of the expanded period for the assertion of reclamation claims, discussed below. If an agreement cannot be reached, a motion to use cash collateral should be prepared and filed with the petition or immediately thereafter and a hearing date should be obtained immediately. Fed. R. Bankr. P. 6004 controls the setting and noticing of hearings under this section.

The question arises as to what notice must be given of the hearing. Cases reveal that the bankruptcy courts are willing to fashion remedies to meet this need in accordance with the particular facts and circumstances of the case. While it has been held that one day notice by mailgram was not sufficient, In Re: Center Wholesale, Inc., 759 F.2d. 1440 (9th Cir. 1985), one court has held that appropriate telephonic notice of the hearing was sufficient. In Re: James A. Phillips, 29 B.R. 391 (S.D. NY 1983). Other courts have held that 72 hours notice was sufficient in a case where the need for cash was immediate to preserve the property of the estate. In Re: Sheehan, 11 B.D.C. 835 (Bankr. D.C. S.D. 1984). The courts may shorten the notice period required for hearings as set forth in Fed. R. Bankr. P. 6004, et seq., where the facts and circumstances of a case necessitate such action. In Re: Plaza Family Partnership, 95 B.R. 166 (E.D. Cal. 1989).

C. Basic Concepts of Adequate Protection

The key issue in obtaining an order allowing the DIP or Trustee to use cash collateral or retain property in the face of a Motion for relief from stay is adequate protection. This concept is also one way that a party opposing a Motion for Relief from Stay can prevail. The concept of adequate protection in a Chapter 11 is governed by a specific Code section. 11 U.S.C. §361 provides:

When adequate protection is required under §§362, 363 or 364 of this title of an interest of an equity in property, such adequate protection may be provided by

(1)  requiring the trustee to make a cash payment or periodic cash payments to such entity to the extent that the stay under §362 of this title, use, sale or lease under §363 of this title, or any grant of a lien under §364 of this title results in the decrease in the value of such entity’s interest in such property;

(2)  providing to such entity an additional or replacement lien to the extent that such stay, use, sale, lease or grant results in a decrease in the value of such entity’s interest in such property; or

(3)  granting such other relief, other than entitling such entity to compensation allowable under §503(b)(1) of this title as an administrative expense, as will result in the realization by such entity of the indubitable equivalent of such entity’s interest in such property.

What may be determined to provide adequate protection is a matter of significant litigation. A creditor is entitled to maintain its secured position as of filing and a DIP/Trustee may not do anything to diminish a creditor’s secured position. However, creditors are not entitled to better their positions or receive a windfall. In Re: Texlon Corp., 596 F.2d. 1092 (2nd Cir. 1979).

Precisely what is sufficient for adequate protection is limited only by the facts and circumstances of a particular case and the imagination of a good lawyer. Anything the bankruptcy court finds will protect the creditor’s secured position may serve as adequate protection. On appeal, whether or not a particular concept actually provides adequate protection will be a question of fact subject to review only under the clearly erroneous standard. In Re: O’Connor, 808 F.2d. 1393 (10th Cir. 1987).  The basic analysis of whether or not the matter offered as adequate protection is appropriate in a particular case is determined by:

(1)  The value of the secured creditor’s interest;

(2)  A determination of the risks to that value that will result from the debtor’s use of the property; and most importantly;

(3)  A determination of whether the adequate protection proposed protects the creditor’s value from the risk to which it is being exposed.

The primary inquiry is whether the proposed use of the collateral places the creditor’s interest at risk despite the offer of adequate protection. In Re: Mangus, 50 B.R. 241 (B.C.D.C. ND 1985). The various types of adequate protection, considered as proposed by §361 above, are essentially limited only by the attorney’s imagination.

D. Methods of Providing Adequate Protection

One of the best means of providing adequate protection is to provide for cash payments to the creditor to compensate them for any diminution in value as a result of the debtor’s use of the property. Adequate protection payments made should be applied to compensate a secured creditor for any diminution in value of collateral resulting from the use, depreciation, destruction or other caused reduction in value. In Re: Kain, 86 B.R. 506 (B.C.W.D. Mich. 1988). This concept is reinforced by the Reform Act in its amendment to §362 when the bankruptcy case is a single asset real estate case. In such instances, the stay will terminate unless a plan which has a reasonable probability of success is filed within 90 days or cash payments of interest accruing upon the value of the real property are commenced. This new concept is discussed in more detail below.

The second method of providing adequate protection is by granting a replacement lien. While 11 U.S.C. §552 limits liens on after-acquired property, if the creditor has a valid and enforceable contractual provision providing for liens on after-acquired property due to proceeds, replacement liens offered are not sufficient, In Re: Bohne, 57 B.R. 461 (B.C.N.D. 1985). In other words, the debtor was denied the use of cash collateral since the replacement lien tendered as adequate protection was for a lien the creditor already had an interest in. The test of whether the creditor’s cash collateral is adequately protected is whether the debtor has provided a method of ultimately giving creditor the value of their cash collateral. In Re: Johnson, 87 B.R. 204 (B.C.W.D. Wis. 1985).

The Code also provides a “catch-all” provision in 11 U.S.C. §361(3) by providing for the “granting of such other relief as will result in the realization of such entity of the indubitable equivalent of such entity’s interest in such property”. This gives lawyers the ability to propose anything which passes the “smell test” and appears reasonable. Consequently, the guaranty by a third party, whether secured or unsecured, has been held to serve as adequate protection. In Re: Diaconx Corp., 69 B.R. 333 (B.C.E.D. Pa. 1987), see later proceedings, 69 B.R. 343, (B.C.E.D. Pa. 1987). In one Chapter 11 case, it has been held that adequate protection was provided by the debtor’s continued use of dairy cows, the milking of cows and exerting his best efforts toward effectuating a plan of reorganization. In Re: Underbakke, 60 B.R. 705 (B.C.N.D. Iowa 1986). However, this is probably the most extreme case found.

The courts have held that if the parties are unable to reach an agreement as to what constitutes adequate protection, the court itself may decide what constitutes appropriate adequate protection under the circumstances. In Re: Kielhafner, 69 B.R. 51 (B.C.E.D. Mo. 1986). However, counsel for the debtor certainly would not want to merely ask the court to order whatever adequate protection it felt was appropriate without articulating one or more reasonable scenarios.

The providing of an equity cushion may be sufficient for adequate protection, In Re: THB Corp., 94 B.R. 797 (B.C.D. Mass. 1988). However, mere administrative priority is not sufficient. 11 U.S.C. §361(3).

E. Valuation and Superpriority Administrative Claims

It is important that whatever the method of providing adequate protection be truly adequate. If the collateral becomes diminished in value as a result of its use and the secured creditor becomes less secured, the creditor is entitled to a super priority administrative claim. 11 U.S.C. §507(b). This section provides that when adequate protection has been given to a secured creditor and later proves to be inadequate, the creditor becomes entitled to a super priority administrative expense claim to the extent that the proffered adequate protection was insufficient. In re Carpet Center Leasing Co., Inc., 991 F.2d 682 (11th Cir. 1993) and Grundy Nat’l Bank v. Rife, 876 F.2d 361, 363 (4th Cir.1989). Such a claim has priority over attorney’s fee claims for counsel, as well as all other administrative claims. Claims such as this can be an unwelcome guest at a confirmation hearing as the creditor may demand cash payment in full as of confirmation, which could defeat the entire reorganization if not placed in the budget, see 11 U.S.C. §1129(a)(9)(A). Creditors should be aware of their ability to assert such claims as it is a way to help insure that the creditor’s secured position is not diminished during the case.

This also once again raises the question of value. From the secured creditor’s perspective, should there be a value of the collateral determined at the time the order is entered? If a stipulation can be reached, then this is not too difficult. However, many times, the value of the collateral is a hotly disputed issue to which no stipulated resolution can obtained. If the property is valued at this point, then a baseline is established for later determination as to potential §507(b) super priority administrative claims. Since it is very common not to have current appraisals early in the case, how can this be resolved quickly? One suggestion is that a value be agreed upon which does not prejudice the parties’ right to seek a judicial determination of the value at a later date. If no agreement can be reached and, as is almost always the case, the entry of a cash collateral order cannot be delayed for 30 to 60 days, then put a provision in the order which reserves your right as a secured creditor to have a determination of the value as of the entry of the cash collateral order date made at a later time. Remember to have your appraiser make such a determination at the time of the appraisal, put this into evidence and ask the court for a finding in the §506 order. This will be of great assistance in a case which lasts a long time and, in particular, where there is a risk of devaluation in the collateral.

Practical considerations also dictate that certain control features be part of any negotiated cash collateral order. Counsel for creditors will want to insure that appropriate monitoring mechanisms are in place, otherwise the cash collateral may “evaporate”. Such control features include monthly, or even in some cases, weekly reporting on the levels of collateral, income and expenses. Periodic actual inspections of the collateral, coupled with accounting controls and independent verification of the debtor’s expenditures are very useful in protecting a creditor’s interest. Also, a budget for the debtor’s expenditures should be presented to the court along with the cash collateral motion. Creditors may want to impose other restrictions on the use of cash in order to properly control the debtor’s use of the money.

F. Property Taxes

Another issue is an exception to the automatic stay for post-petition property taxes. “Both the property owner and any mortgage holder recognize that their interest in real property is subject to the local government’s right to collect such property taxes. However, several circuit courts have held that the automatic stay prevents local governments from attaching a statutory lien to property taxes accruing subsequent to a bankruptcy filing. See, e. g., In re Paar Meadows, 880 F.2d 1540 (2d Cir. 1989), cert. denied, 110 S.Ct. 869 (1990); Makaroff v. City of Lockport, 916 F.2d 890 (3d Cir. 1990). These decisions create a windfall for secured lenders, who would otherwise be subordinated to such tax liens, and significantly impair the revenue collecting capability of local governments. This section overrules these cases and allows local governments to utilize their statutory property tax liens in order to secure the payment of property taxes.” House Judiciary Committee, “Section by Section Analysis”, 1994. Mortgagees should include a provision in the cash collateral order which requires the debtor to pay all of the property taxes as they come due in order to prevent such taxes from becoming a lien which has priority over the claim secured by the mortgage. Debtors must be aware that they cannot protect their property from property tax liens by the automatic stay.

V. PROOF OF CLAIM

The second thing which you must do upon receiving a notice of bankruptcy after having diaried the appropriate dates is to examine your client’s claim. The vehicle by which you may accomplish this is to fill out the proof of claim form and attach the appropriate supporting documentation. The proof of claim form is basically a “fill in the blank” type of form which is fairly self-explanatory. It is important if your client has a security interest, mortgage or lien upon some particular piece of property to include evidence of perfection. Generally, this will be a copy of the UCC-1 filed in the proper filing office, copy of the lien entry form or a file-stamped copy of the real estate mortgage. Copies of these documents should be attached to the proof of claim and the proof of claim should be filed with the Bankruptcy Clerk, a copy mailed to the trustee and to the debtor’s counsel. The trustee is interested in reviewing the proofs of claim to determine whether or not the property which the debtor has is, in fact, subject to properly perfected liens.

If your lien is not properly perfected, you should consider the potential consequences of an avoidance proceeding by the trustee pursuant to 11 U.S.C. §544 or §547. If the claim was not properly perfected timely but was subsequently perfected, it may be subject to avoidance as a preference pursuant to 11 U.S.C. §547. On the other hand, if the claim is not perfected at all, the trustee may prevail over the unperfected secured creditor pursuant to 11 U.S.C. §544(a)(1) wherein the trustee takes on the character of a “hypothetical” lien creditor who has executed upon the property as of the date of the petition. Such creditors will prevail over unperfected security interests. If in fact your claim is unperfected, the best course of action is to do nothing and hope the trustee overlooks perfection problems. However, this is fairly unlikely since trustees always look to see if they can get property from the debtor since that is how trustees make money. If the trustee attacks your client’s claim as being unperfected, most of the time the creditor can settle out with the trustee for less than the value of the collateral, thus providing an economic benefit to your client.

If the claim is under secured or unsecured, any payments received will be avoidable as a preferential transfer pursuant to 11 U.S.C. §547 for 90 days prior to the filing of the case. If the creditor is an “insider”, 11 U.S.C. §101(31), then the time limit is extended to one year. A detailed discussion of the intricacies of avoidance proceedings is far beyond the scope of this paper.

The creditor should carefully consider the possibility of having to litigate preferences, fraudulent conveyances or other types of avoidance proceedings within the context of a bankruptcy proceeding. If such appears likely and if it does not appear that there is any reasonable likelihood of recovery of assets from the estate, then a proof of claim should not be filed in the case. The filing of a proof of claim in a bankruptcy waives the creditor’s right to a jury trial. In Re: Gran Financiera, 492 U.S. 33, 109 S.Ct. 2782, 106 L.Ed.2d 26. If, on the other hand, there appears to be a likelihood of assets being distributed, you should weigh whether or not you want to have a jury trial against the likelihood of receiving proceeds from the bankruptcy estate.

It is now possible to conduct jury trials in the Bankruptcy Court. Until the Bankruptcy Reform Act of 1994, Bankruptcy Court’s did not have the constitutional power to conduct jury trials. Now they do, but only if all parties to the matter being litigated consent. This provides yet another tactical consideration to the process which must be considered. Usually, the trial in the Bankruptcy Court will be faster than in the District Court, but the Bankruptcy Courts have little, if any experience in conducting jury trials, whereas, the District Courts do them all the time.

Note that the debtor always waives their right to a jury trial because the filing of a voluntary case is a submission to the jurisdiction of the Bankruptcy Court, thus waiving the right to a jury trial on discharge issues.

Creditors are entitled to a jury trial in Bankruptcy Court, if they have not waived it by submitting to the Bankruptcy Court’s authority, any time they would otherwise be entitled to a jury trial. In Re: Gran Financiera. The discussion of a jury trial right in Bankruptcy Court is a matter which is yet unsettled by the courts, and greatly exceeds the scope of this discussion.

After having completed the proof of claim, you should have a firm grasp upon whether or not your claim is subject to some priority pursuant to 11 U.S.C. §507 or whether the claim is unsecured, secured or under secured. If the claim is secured, the following analysis is appropriate.

VI. ISSUES COMMON TO REORGANIZATION CHAPTERS

This last section discusses the additional issues related to Chapter 13 and 11 cases, both of which are reorganization chapters. The more common of the two is Chapter 13. This is even more so since the Reform Act became effective, as one of the major goals of Congress in passing the Reform Act was to cause more debtor to file Chapter 13 as opposed to Chapter 7. Therefore, this paper will now discuss some selected Chapter 13 issues and contrast such issues with the similar issues in a Chapter 11 case.

A. Valuation of Property

Once again, the issue of value comes to the forefront. All secured creditors must be paid at least the present value of their allowed secured claims under either chapter. The provisions relating to secured creditor treatment in Chapter 13 is §1325. The corresponding provision in Chapter 11 is §1129(b)(2)(A)(i).  Under either Chapter 13 or under Chapter 11, the value of the collateral is always going to be an issue, because either chapter in essence requires the lesser value of the collateral or the amount of the creditor’s claim to be paid in full with interest. As discussed below, the ability to “strip down” a secured claim does not apply to the Debtor’s primary residence. Under either chapter, the valuation will be determined under §506(a), which in a Plan where the Debtor proposes to keep the property and repay the secured creditor over time, has been interpreted by the U.S Supreme Court to mean replacement cost for the same type of asset in like condition. Associates Commercial Corp. v. Rash, 138 L.Ed.2d 148, 65 USLW 4451, 37 Collier Bankr.Cas.2d 744, 30 Bankr.Ct.Dec. 1254, Bankr. L. Rep. P 77,409, 97 Cal. Daily Op. Serv. 4527, 97 Daily Journal D.A.R. 7497, 97 CJ C.A.R. 905, 11 Fla. L. Weekly Fed. S 4 117 S.Ct. 1879, 65 USLW 4451, (1997). Once again, it is incumbent upon you as counsel for the Mortgagee to obtain an appraisal of the property. Such matters take some time, so it is recommended you engage an appraiser early on in the case.

This is also where the Reorganization Chapters diverge from Chapter 7, because in addition to the issue of value is the issue of whether or not the real property in question is “necessary for an effective reorganization”. Even if the property in question has no equity, if the Debtor can show that the retention of such property is important to their overall restructuring plan, then the Court will deny your Motion. Therefore, it is important to review the overall case to see if an effective reorganization is likely. As a result, this paper will discuss some of the major issues related to reorganization cases, with a primary focus upon Chapter 13 cases.

VII. CHAPTER 13 ISSUES

A. Restrictions on the Form of the Entity

There are certain types of debtors that may not file under various chapters of the code. For example, if the business is a family farm, then it may file a Chapter 12 in addition to Chapter 11 or 13. Usually, Chapter 12 is the choice for a farmer, but only family farmers may file a Chapter 12. If the business is a political subdivision, it has to file a Chapter 9, but only political subdivisions may file Chapter 9. Are there similar restrictions in Chapter 13? Yes.

The restrictions upon Chapter 13 debtors are found in 11 U.S.C. §109(e), which provides:

Only an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $336,900 and noncontingent, liquidated, secured debts of less than $1,010,650, or an individual with regular income and such individual’s spouse, except a stockbroker or a commodity broker, that owe, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts that aggregate less than $336,900 and noncontingent, liquidated, secured debts of less than $1,010,650 may be a debtor under Chapter 13 of this title.

Keep in mind that the dollar amounts in this section are adjusted annually, so always check the current version of the statute to verify the amounts applicable to the particular case.

Only individuals with regular income may file a Chapter 13. This term is defined in §101(30), which provides:

“individual with regular income means individual whose income is sufficiently stable and regular to enable such individual to make payments under a plan under Chapter 13 of this title, other than a stockbroker or a commodity broker.”

Although the Code does not define individual, §101(41) defines “person” to include individuals, corporations and partnerships. The case law makes it clear that persons include individuals and entities. In Re: Clem, 29 B.R. 3 (Bkrtcy.D.Idaho 1982). Consequently, it is generally accepted that the term “individual” means a human being and does not include any entities which are not natural persons. Thus, if the debtor is a corporation or partnership, it may not file Chapter 13. A partnership may not file Chapter 13 and the assets of the partnership entity are not property of the individual’s bankruptcy estate. In Re: Ross, 173 B.R. 943 (Bankr. E.D. Okla. 1994).

B. Dollar Amount of Debt

Only debtors who have debt under the debt limitation may file Chapter 13. The dollar limitations in 11 U.S.C. §109(e) are subject to periodic adjustment based on the consumer price index. See 11 U.S.C. §104. Note that such debt must be “non-contingent, liquidated” debt. A claim is “liquidated” for purposes of Chapter 13 eligibility only if it is capable of ready determination. Such occurs when the debtor’s liability and the amount of claim can be determined on basis of agreed upon facts without need for evidentiary hearing. A frivolous factual dispute, nor disagreement, concerning law as opposed to fact causes the claim to be unliquidated. In Re: Hustwaite, 136 B.R. 853 (Bkrtcy.D.Or.1991). An estimated tax claim is not a liquidated claim for eligibility purposes. In Re: Elrod, 178 B.R. 5 (Bankr. N.D. Okla. 1995).

A debt is “non-contingent” for purposes of Chapter 13 eligibility limit on non-contingent, liquidated unsecured debts, if all events giving rise to liability occurred prior to filing of bankruptcy petition. In Re: Loya, 123 B.R. 338 (9th Cir.BAP (Cal.) 1991). A claim is not contingent if no future event occurs prior to the filing of the petition for the transaction to constitute a liability as of the petition date. In Re: Jordan, 166 B.R. 201 (Bankr. D. Me. 1994). See also In Re: Knight, 55 F.3d 231 (7th Cir. 1995) and In Re: Solomon, 166 B.R. 832 (Bankr. D. Md. 1994).

If a creditor’s claim is scheduled as a “secured” claim, but in fact the lien which secures the claim is an avoidable lien because it is a preferential transfer, then the claim is in fact an unsecured claim for purposes of determining eligibility. In Re: Toronto, 165 B.R. 746 (Bankr. D. Conn. 1994). The unsecured portion of an undersecured claim is counted toward the debt limitation of §109(e). Ficken v. United States, (In Re: Ficken), 2 F.3d 299 (8th Cir. 1993).

C. Regular Income

The individual must have regular income. The Code defines this to mean the debtor has “stable and regular” income to make the payments under the Plan. §101(30). Chapter 13 contemplates some form of regular periodic payments which must begin within 30 days of the plan being filed. §1326. The debtor must have some form of regular income and must start making payments quickly after the case is filed.

D. Automatic Stay Issues Unique to Chapter 13

As we all know, one of the reasons people file bankruptcy is to receive the immediate benefit of the automatic stay. 11 U.S.C. §362 creates the stay in a Chapter 7 case. However, under Chapter 13, there is an additional element which provides protection for certain limited classes of individuals who are not debtors under bankruptcy. This is the co-debtor stay provision of §1301, which provides:

(a)  Except as provided in Subsections (b) and (c) of this Section, after the order for relief under this chapter, a creditor may not act, or commence or continue any civil action, to collect all or any part of a consumer debt of the debtor from any individual that is liable on such debt with the debtor, or that secured such debt, unless —

(1)  such individual became liable on or secured such debt in the ordinary course of such individual’s business;  or

(2)  the case is closed, dismissed, or converted to a case under Chapter 7 or 11 of this title.

(b)  A creditor may present a negotiable instrument, and may give notice of dishonor of such an instrument.

(c)  On request of a party in interest and after notice and a hearing, the court shall grant relief from the stay provided by Subsection (a) of this Section with respect to a creditor, to the extent that ‑‑

(1)  as between the debtor and the individual protected under Subsection (a) of this Section, such individual received the consideration for the claim held by such creditor;

(2)  the plan filed by the debtor proposes not to pay such claim; or

(3)  such creditor’s interest would be irreparably harmed by continuation of such stay.

“The purpose of this provision is to protect a debtor operating under a Chapter 13 individual repayment plan case by insulating him from indirect pressures from his creditors exerted through friends or relatives that may have co-signed an obligation of the debtor. The protection is limited, however, to ensure that the creditor involved does not lose the benefit of the bargain he made for a cosigner. He is entitled to full compensation, including any interest, fees, and costs provided for by the agreement under which the debtor obtained his loan. The creditor is simply required to share with other creditors to the extent that the debtor will repay him under the Chapter 13 plan. The creditor is delayed, but his substantive rights are not affected. 11 USCA §1301, Stay of action against co-debtor.” 1984 Act. Statements by Legislative Leaders, see 1984 U.S.Code Cong. and Adm.News, p. 576.

When is relief appropriate from the co-debtor stay? The first question is whether or not the co-debtor received consideration for the claim. The stay may be modified as against co‑obligor not filing for bankruptcy relief, on ground that such co‑obligor “received consideration for claim”, only where such consideration ran exclusively to co‑obligor. In Re: Rhodes, 85 B.R. 64 (Bkrtcy.N.D.Ill.1988). In a recent case of In Re: Motes, 166 B.R. 147 (Bankr. E.D. Mo. 1994), the Court held it would not grant relief from the co-debtor stay if the debtor received no consideration for the loan in question. What constitutes consideration? It doesn’t have to be money. At least one Court has held that the education, meals, and books received by the daughter of debtor under this chapter were the entire consideration for a debt owed to a college, consequently, the creditor was entitled to relief from the co-debtor stay as to the non-debtor daughter. In Re: Brown, 12 B.R. 885 (Bkrtcy.N.D.Ga.1981).

The second issue is whether or not the debt is a consumer debt. Another way to ask the question is “was this a business loan”?  The following cases are illustrative of this issue. Where joint debtors made a bank loan and the proceeds were used for training for a business opportunity, the debt owed to the bank was a business obligation and not a consumer debt. Therefore, the bank was entitled to relief from the co-debtor stay. In Re: Chrisman, 27 B.R. 648 (Bkrtcy.S.D.Ohio 1982).  In another case, where it was admitted by one debtor that the primary reason for loan was for a business purpose and the funds were in fact primarily used for business purposes, the debt was not a consumer debt subject to the co-debtor stay. In Re: Demaree, 27 B.R. 1 (Bkrtcy.D.Or.1982). A debt was a consumer debt for purposes of the co-debtor stay even though funds representing proceeds of loan found their way into debtor’s automobile dealership business in a case where the note was a personal obligation only of the debtor and the endorsement by the co-debtor was done as a simple accommodation act of friendship having no relationship whatsoever to a business venture or ventures of the debtor. In Re: Lindamood, 21 B.R. 473 (Bkrtcy.W.D.Va.1982).

Note that the co-debtor does not receive a discharge, so if the debt in question is an unsecured, non-priority debt, the co-debtor will ultimately have to face the creditor. If such a debt is not going to be paid in full by the plan, the creditor can obtain relief from the co-debtor stay and immediately proceed against the co-debtor. This is really only meaningful if the debt in question is a priority or secured debt, which will be paid in full by the plan, thus avoiding yet another bankruptcy by the co-debtor. In the right case, this can be a very useful tool, although its’ benefit is somewhat limited.

What is the effect of confirmation of a plan upon the stay?  The stay continues in effect post-confirmation even if the creditor is not provided for in the plan, although such omissions would constitute a basis for relief from the stay. Honesdale National Bank v. Mordenti (In Re: Mordenti), 164 B.R. 37 (Bankr. M.D. Pa. 1993). Thus, a motion for relief from stay is necessary prior to the creditor taking any action against the debtor post-confirmation even if the plan is in default. The confirmation of the plan bars relief from the stay where the ground for relief is an objection to confirmation which could have been asserted before confirmation. In Re: Arkell, 165 B.R. 432 (Bankr. M.D. Tenn. 1994). See also, In Re: Lee, 167 B.R. 417 (Bankr. S.D. Miss. 1992).
If an analysis of the issues reveals that relief from the co-debtor stay is appropriate, then a motion for relief from the stay should be filed seeking permission to pursue the co-debtor notwithstanding the proceedings pending on the debtor who has filed bankruptcy.

E. The Debtor Must File A Plan

The debtor shall file a plan. §1321. Only the debtor may propose a plan under Chapter 13, not the court, the creditors, or the trustee. In Re: Higgins, 43 B.R. 391 (Bkrtcy.N.D.Ala.1984). What is a plan? It was held that a plan had indeed been filed by the debtor, where debtors filed printed form entitled “Chapter 13 plan” with their petition and the form disclosed duration of plan, the amount to be paid to trustee each week, the secured creditors were listed along with percentage of secured claims to be paid under the plan, and the percentage of unsecured claims to be paid was also disclosed, as well as executory contracts which had been rejected. In Re: Purdy, 10 B.R. 902, affirmed 16 B.R. 847 (Bkrtcy.N.D.Ga.1981).
Fed. R. Bankr. P. 3015(b) requires the debtor to file a plan within 15 days of the case being commenced under Chapter 13. If there is some real reason that the plan cannot be timely filed, Fed. R. Bankr. P. 9006(b) permits the court to enlarge the time required to act as if a motion requesting such is filed within the time limit for the act in question. The failure to file a timely plan may be grounds for dismissal of the case, particularly where the case is merely a delaying tactic. In Re: Maurice, 167 B.R. 114 (Bankr. N. D. Ill. 1994) and In Re: Spurgeon, 166 B.R. 150 (Bankr. D. Neb. 1993).

F. Plan Provisions

The plan is the main issue in most Chapter 13 cases. The real issue in the plan has to do with the extent to which a debtor can modify the terms of payment to a particular creditor. In essence, the confirmation of the plan creates a new contract between the debtor and their creditors. Conceptually, the plan is a global loan modification agreement. The key difference is that it does not require the agreement of any creditor for its approval. There is no requirement in Chapter 13 that any creditor affirmatively accept the plan nor is there anything like the absolute priority rule and its’ new value exception which is found in Chapter 11 cases. “The secured creditor’s consent is not required — a Chapter 13 plan is through and through a “cram-down” plan (it is crammed down the throats of the unconsenting creditors).” In re Henry, 266 B.R. 457,471 (Bankr.C.D.Cal.,2001).

In a Chapter 13 the issue is one of statutory compliance. The plan must comply with all of the provisions of §§1322 and 1325. If it does, then the court must confirm the plan, otherwise, confirmation is denied. What are the requirements for confirmation of a plan?

G. Length Of Plan

Existing law for Chapter 13 requires the claims to be paid in full over the term of the plan which may not exceed 60 months. Under the Reform Act, the Debtor must perform a “reduced form of means testing, therefore, whether a Chapter 13 debtor’s plan must last for three or five years is determined by current monthly income measured against the median income for a family of like size”. A more detailed discussion is beyond the scope of this paper. This fairly complex analysis will most likely be something you as a creditor will not need to get involved with in most cases. As with the Means Test for Chapter 7, in a Chapter 13, the Debtor’s counsel will have to perform this analysis to determine the length of the plan and then the Chapter 13 Trustee will perform it again to verify the term of the Plan is appropriate.

H. Claims Secured By Real Property

The primary secured claim which can effectively be dealt with in a Chapter 13 case is the debtor’s home mortgage. This is the most common issue you are likely to encounter in a Chapter 13 case in the context of a foreclosure. Many mortgagors do not want to lose their homes and Chapter 13 offers them a possible way to keep it despite the mortgagee’s desires to the contrary.

While the underlying mortgage contract may not be modified if the property is the Debtor’s primary residence, any defaults may be cured by the plan. The typical means of accomplishing this is to pay any arrearage over time. This is restricted to 60 months in a Chapter 13. The required treatment for secured claims in Chapter 13 is set out in §1325(a)(5).

The protected class of secured claims is not determined by whether or not the loan is a long or short term debt, but rather whether or not it is secured solely by the debtor’s principal residence. In Re: Reeves, 164 B.R. 766 (Bankr. 9th Cir. 1994). If the claim is secured by property other than the principal residence, then it is not protected from modification. For example, a duplex or triplex where part of the property is rented to third parties. See In Re: Legowski, 167 B.R. 711 (Bankr. D. Mass. 1994) and In Re: Adebanjo, 165 B.R. 98 (Bankr. D. Conn. 1994). Contra. In Re: Guilbert, 165 B.R. 88 (Bankr. D.R.I.1994). It is fairly uniformly held that the assignment of rents and other such rights do not exclude the creditor’s claim for protection under §1322(b)(2). In Re: Hammond, 27 F3d. 325 (3rd Cir. 1994).  See also, In Re: Harris, 167 B.R. 813 (Bankr. D.S.C. 1994) and In Re: Tallo, 168 B.R. 573 (Bankr. M.D. Pa. 1994).

As discussed above, if the real property is not the Debtor’s primary residence, then the Debtor may seek to reduce the claims to the value of the property. This is the process known as bifurcation of the claim, claim splitting, and lien stripping or sometimes “cramming down” a secured claim. For example, if the Debtor’s rent house is subject to a mortgage claim totaling $10,000, but the rent house is only worth $6,000, then the mortgagee’s claim is a secured claim equal to $6,000 and an unsecured claim equal to the difference in the total claim ($10,000) and the secured claim ($6,000) or $4,000. Because of the protection afforded to home mortgages, this process is not permitted as to such secured claims, but all other secured creditors are fair game under existing law. In Re: Lee, 162 B.R. 217 (D. Minn 1993); In Re: Cook, 169 B.R. 662 (Bankr. W.D. Mo. 1994); and In Re: Ross, 162 B.R. 785 (Bankr. N.D. Ill. 1993).

What if the claim is secured by a second mortgage upon the debtor’s principal residence and there is no value at all to support the secured portion of the claim, can such a claim be bifurcated? There is authority that such is not permitted, In Re: Johnson, 160 B.R. 800 (S.D. Ohio 1993), but the majority of the courts have held that such claims are not protected. In Re: Williams, 166 B.R. 615 (Bankr. E.D. Va. 1994); In Re: Sette, 164 B.R. 453 (Bankr. E.D. N.Y. 1994) and In Re: Moncrief, 163 B.R. 492 (Bankr. E.D. Ky. 1993). One recent reported local case on this point is In Re: Lee, which holds that such claims are not protected. 161 B.R. 271 (Bankr. W.D. Okla. 1993).  See additional cases to the contrary: In re Barnes, 207 B.R. 588 (Bankr.N.D.Ill.1997); In re Tanner, 223 B.R. 379, 33 Bankr.Ct.Dec. 57 (Bankr.M.D.Fla. 1998); American General Finance, Inc. v. Dickerson, 229 B.R. 539, 41 Collier Bankr.Cas.2d 700 (M.D.Ga. 1999); In re Bauler, 215 B.R. 628, 39 Collier Bankr.Cas.2d 285, 31 Bankr.Ct.Dec. 1112 (Bankr.D.N.M. 1997).

If there is an arrearage on the home mortgage claim, such arrearage is not entitled to be paid interest on such arrearage unless such is permitted by local law and is specifically provided for in the contract. §1322(e). This provision of the Bankruptcy Reform Act of 1994 overruled Rake v Wade, 113 S.Ct. 2187 (1993). In that case, the court held that the Bankruptcy Code required that interest be paid on mortgage arrearage paid by debtors curing defaults on their mortgages.  Notwithstanding State law, this case has had the effect of providing a windfall to secured creditors at the expense of unsecured creditors by forcing debtors to pay the bulk of their income to satisfy the secured creditors’ claims. This had the effect of giving secured creditors interest on interest payments, and interest on the late charges and other fees, even where applicable law prohibits such interest and even when it was something that was not contemplated by either party in the original transaction. This provision will be applicable prospectively only, i.e., it will be applicable to all future contracts, including transactions that refinance existing contracts. It will limit the secured creditor to the benefit of the initial bargain with no court contrived windfall. It is the committee’s intention that a cure pursuant to a plan should operate to put the debtor in the same position as if the default had never occurred. House Committee Report to the Bankruptcy Reform Act of 1994. However, the mortgage holder is entitled to add reasonable attorney’s fees and other charges to the amount of its arrearage. In Re: Henson, 182 B.R. 588 (Bankr. N.D. Okla. 1995).

The case must be filed prior to the sale of the property at the sheriff’s sale if the debtor seeks to cure the mortgage arrearage and keep their home. §1322. The Committee Report, (supra) discusses the reasoning and impact of this provision:

§1322(b)(3) and (5) of the Bankruptcy Code permit a debtor to cure defaults in connection with a Chapter 13 plan, including defaults on a home mortgage loan. Until the Third Circuit’s decision in Matter of Roach, 824 F.2d 1370 (3d Cir. 1987), all of the Federal Circuit Courts of Appeal had held that such right continues at least up until the time of the foreclosure sale.

See In Re: Glenn, 760 F.2d 1428 (6th Cir. 1985), cert. denied, 474 U.S. 849 (1985); Matter of Clark, 738 F.2d 869 (7th Cir. 1984), cert. denied, 474 U.S. 849 (1985). The Roach (supra) case, however, held that the debtor’s right to cure was extinguished at the time of the foreclosure judgment, which occurs in advance of the foreclosure sale. This decision is in conflict with the fundamental bankruptcy principle allowing the debtor a fresh start through bankruptcy.

This Section of the bill safeguards a debtor’s rights in a Chapter 13 case by allowing the debtor to cure home mortgage defaults at least through completion of a foreclosure sale under applicable non-bankruptcy law. However, if the State provides the debtor more extensive “cure” rights (through, for example, some later redemption period), the debtor would continue to enjoy such rights in bankruptcy. This issue is not controversial in Oklahoma as discussed in In re Faulkner, 240 B.R. 67, 68 (Bankr.W.D.Okla.,1999):

For over half a century, Oklahoma decisional law has held that a foreclosure sale is not complete, in fact not a sale, until it is confirmed by a Court. In State Comm’rs of Land Office v. Schneider, 198 Okla. 697, 181 P.2d 975, 978 (1947), the Oklahoma Supreme Court wrote: “A foreclosure sale is not fully a sale until confirmed by a court order.” Since then, the state’s high court has repeatedly reaffirmed that proposition: “[A] judicial sale on foreclosure is neither conclusive nor binding in the sense of transferring legal title to the purchaser until it is effectively confirmed.” Sooner Fed. Savs. and Loan Assoc. v. Oklahoma Central Credit Union, 790 P.2d 526, 529 (1989).

The changes made by this Section, in conjunction with those made in §305 of this bill, would also overrule the result in First National Fidelity Corp v. Perry, 945 F.2d 61 (3d Cir. 1991) with respect to mortgages on which the last payment on the original payment schedule is due before the date on which the final payment under the plan is due. In that case, the Third Circuit held that subsequent to foreclosure judgment, a Chapter 13 debtor cannot provide for a mortgage debt by paying the full amount of the allowed secured claim in accordance with Bankruptcy Code §1325(a)(5), because doing so would constitute an impermissible modification of the mortgage holder’s right to immediate payment under §1322(b)(2) of the Bankruptcy Code.

I. Conversion and Dismissal

One additional strategy which may be employed to oppose a Bankruptcy is to seek the dismissal or conversion of the case. Keep in mind that under the Reform Act, serial filings have a direct impact upon the stay, so that if the case is dismissed and the Debtor re-files within a year, the Automatic Stay is only in place for 30 days. Thus, dismissal may be a viable tactic.

If the case has not been converted under §706, 1112 or 1208 at any time, then the debtor has an absolute right to dismiss a Chapter 13 petition under §1307. See In re Nash, 765 F.2d 1410 (9^th Cir. (Cal.) 1985) and In re Barbieri, 199 F.3d 616 (2^nd Cir. (N.Y.) 1999). §1307 does not require notice and opportunity for a hearing therefore, the Court may dismiss the case instanter upon request from the Debtor. The Debtor may also convert the case to a case under Chapter 7 at anytime.

A creditor or the Trustee may move to dismiss under §1307(c) which provides:

Except as provided in subsection (e) of this section, on request of a party in interest or the United States trustee and after notice and a hearing, the court may convert a case under this chapter to a case under Chapter 7 of this title, or may dismiss a case under this chapter, whichever is in the best interests of creditors and the estate, for cause, including –

(1) unreasonable delay by the debtor that is prejudicial to creditors;

(2) non-payment of any fees and charges required under Chapter 123 of title 28;

(3) failure to file a plan timely under §1321 of this title;

(4) failure to commence making timely payments under §1326 of this title;

(5) denial of confirmation of a plan under §1325 of this title and denial of a request made for additional time for filing another plan or a modification of a plan;

(6) material default by the debtor with respect to a term of a confirmed plan;

(7) revocation of the order of confirmation under §1330 of this title, and denial of confirmation of a modified plan under §1329 of this title;

(8) termination of a confirmed plan by reason of the occurrence of a condition specified in the plan other than completion of payments under the plan;

(9) only on request of the United States trustee, failure of the debtor to file, within fifteen days, or such additional time as the court may allow, after the filing of the petition commencing such case, the information required by paragraph (1) of §521; or

(10) only on request of the United States trustee, failure to timely  file the information required by paragraph (2) of §521.

The Reform Bill added two new, additional bases for dismissal of a case, both of which seem likely to be enforced by someone other than the typical institutional creditor:

§1307(c)(11) is amended to add as cause for dismissal or conversion of a Chapter 13 case the “failure of the debtor to pay any domestic support obligation that first becomes payable after the date of the filing of the petition.” The same amendment is made in Chapter 12. See the discussion of domestic support obligation.

§1307(e) requires the court to either dismiss or convert the case upon the failure of the debtor to file a tax return as required under new § 1308, to be discussed below. A party in interest or the U.S. trustee may move for dismissal or conversion, and the court “shall” dismiss or convert the case, “whichever is in the best interest of the creditors and the estate.”

Note that the best-interest analysis does not include consideration of the debtor’s personal interest.

The most common grounds are failure to timely file a Plan or get a Plan confirmed and the failure to make the Plan payments. Usually, the Chapter 13 trustee will file the Motion on these grounds, but the creditor may do so also.

You can also move to convert the case to a case under Chapter 7, which often times is a good idea if you are dealing with a dishonest or highly combative debtor. The basis for conversion or dismissal is based on the best interest of the creditors. “…under subsection (c) the Court may involuntarily dismiss a Chapter 13 case or convert it to a Chapter 7 case only “for cause.” Furthermore, §1307(c) requires that, in selecting between conversion and involuntary dismissal, the Bankruptcy Court must consider “whichever is in the best interests of creditors and the estate….” In re Gaudet, 132 B.R. 670, 676 (D.R.I.,1991).

The final argument which may be advanced by a creditor opposing a Chapter 13 case is to object to the plan and move to dismiss the case on the grounds of bad faith. The leading case in this circuit is In Re: Robinson, 987 F.2d 665 (10^th Cir. 1993). It is very common to see debtors file a Chapter 13 case seeking to discharge a debt which would not be subject to discharge in a Chapter 7 case. If such is the case, then the only real attack is to attempt to prevent the confirmation of the plan based on bad faith. Whether a Chapter 13 plan has been proposed in good faith is a question of fact subject to the clearly erroneous standard of review. Noreen v. Slattengren, 974 F.2d 75, 77 (8th Cir.1992); In Re: Love, 957 F.2d 1350, 1354 (7th Cir.1992); Society Nat’l. Bank v. Barrett (In Re: Barrett), 964 F.2d 588, 591 (6th Cir.1992); Jim Walter Homes, Inc. v. Saylors (In Re:  Saylors), 869 F.2d 1434, 1438 (11th Cir.1989); Downey Sav. & Loan Ass’n v. Metz (In Re: Metz), 820 F.2d 1495, 1497 (9th Cir.1987). A determination of good faith must be made on a case by case basis, looking at the totality of the circumstances.  Pioneer Bank v. Rasmussen (In Re: Rasmussen), 888 F.2d 703, 704 (10th Cir.1989). In evaluating whether a debtor has filed in good faith, courts should be guided by the eleven factors set forth in Flygare v. Boulden, 709 F.2d 1344, 1347-48 (10th Cir.1983), as well as any other relevant circumstances. In Re: Rasmussen, 88 F.2d 703, 704 (10th Cir.1989). A detailed discussion of this issue is beyond the scope of this paper.

VIII. COMPARISON

This final section of the paper will contrast and compare some of the Chapter 13 issues discussed above with similar issues in a Chapter 11 case. The real issue in the Plan has to do with the extent to which a Debtor can modify the terms of payment to a particular creditor. As will be seen, there are significant differences which make a major difference in the chapter of choice for a particular debtor. We have discussed the primary Chapter 13 plan issues above. This final portion of the paper will compare and contrast Chapter 13 cases with Chapter 11 cases to illustrate some of the basic issues involved. Keep in mind that Chapter 11 is very complex and therefore, a complete discussion of the many issues involved in such cases is far beyond the scope of this presentation.

A. Timing Issues

A plan must be filed under either Chapter 13 or Chapter 11. After all, the Plan is the means by which the debt structure of the debtor is modified and is the reason for filing the case in most instances. In essence, a confirmed Plan is a new contract which is binding upon the debtors and all of their creditors. In re: Vandy, Inc., 89 B.R. 342 (Bkrtcy.E.D.Pa.1995). See also, Gerson v. Booth Lumber Co., 230 F.2d 631 (C.A.9 (Cal.) 1955). There are time limits imposed under either chapter, but those in Chapter 13 present more of an obstacle than they do under Chapter 11.

1. Chapter 13

Fed. R. Bankr. P. 3015(b) requires the debtor to file a plan within 15 days of the case being commenced under a 13. However, if the case is a business case, this is really not practical given that there are usually more hotly disputed matters involving value since there are usually more dollars at stake in a business case. This reveals one of the biggest obstacles for a business case in 13. Chapter 13 has long been a consumer based system. When a business case is placed into a consumer system, there are going to be some difficulties because it is different than the usual case. Although it appears on its face that small businesses operated by sole proprietors should be able to utilize Chapter 13, the fact is that the vast majority of such efforts fail.

2.  Chapter 11

The debtor has the exclusive right to file a Plan under Chapter 11 for 120 days. §1121(b). However, this time limit may be modified upon order of the Court upon request of a party in interest for good cause shown. §1121(d). If the debtor files a plan within 120 days, then they also have 180 days exclusive right to get the plan confirmed. These periods may be extended for cause if a motion requesting such is filed prior to the lapse of such time period. §1121(d). Under the Reform Act, an absolute outside limit has been set so that the exclusive period to file and confirm a plan may be not be extended beyond 18 and 20 months respectively.

If the Debtor is subject to the small business provisions of 11 U.S.C. §101(51D), then the 120 day exclusive period becomes 180 days and all plans must be filed within 300 days. 11 U.S.C. §1121(e). The time limits for small business cases may only be extended under fairly extreme cases. See 11 U.S.C. §1121(e)(3). Further, the debtor’s exclusive right terminates if a trustee is appointed.

These time limits do not mean that the case will be dismissed or converted automatically if no plan is filed and confirmed with them, but it does permit any other party to the case to file a plan of their own. Most courts will consider the debtor’s failure to file a plan within the exclusive period reason to take sua sponte action in the case, such as a status conference or show cause hearing as to why the case should not be dismissed. Also, if a creditor moves to dismiss or convert the case, such failure is one of the statutory “causes” for relief. §1112(b)(4).

B. Secured Claims

First, do not forget there is a limit on secured debts in Chapter 13 of $750,000.00, while there is no limit in Chapter 11. The different chapters have significant differences in the ability of the debtor to restructure their secured debt.

Chapter 11 has the same restriction on modification of home mortgages as Chapter 13. The debtor’s home mortgage may not be restructured at all; however, any defaults may be cured by the plan. The typical means of accomplishing this is to pay any arrearages over time. This is restricted to 60 months in a Chapter 13, while Chapter 11 only requires they be cured. The Chapter 11 seems to permit the debtor to cure the arrearage over a term longer than 60 months.

The required treatment for other types of secured claims in Chapter 13 is set out in §1325(a)(5), while in Chapter 11 the requirements for such claims are found in §1129(b)(2)(A). Chapter 13 requires the claims to be paid in full over the term of the plan which may not exceed 60 months due to the restriction of §1322(d), which provides:

(d) The plan may not provide for payments over a period that is longer than three years, unless the court, for cause, approves a longer period, but the court may not approve a period that is longer than five years.

The only exception to this rule is “cure” provisions for long term debt found in §1322(b)(5), which provides:

(b)(5) notwithstanding paragraph (2) of this subsection, provide for the curing of any default within a reasonable time and maintenance of payments while the case is pending on any unsecured claim or secured claim on which the last payment is due after the date on which the final payment under the plan is due;

This permits long terms debts to be cured and maintained in accordance with the pre-petition contract of the parties, but no modification of the terms of repayment is permitted. If the collateral for the debt is solely the debtor’s residence, then the claim may not be modified at all with the exception of the curing and reinstatement. If the claim is secured by property other than the debtor’s residence, it is possible to reduce the principal balance on the claim by bifurcation of the claim into its secured and unsecured parts under §506 and still reinstate the contract. In re Johns, 37 F.3d 1021 (3rd Cir. 1994). However, in no event may the long term contract payments be modified if the payments extend beyond the term of the plan. In re Richards, 151 B.R. 8 (Bkrtcy.D.Mass.1993). Be advised this procedure is not well settled law.

By contrast, Chapter 11 has no specific limit on length of time for repayment comparable to those in Chapter 13. The Bankruptcy Courts may “cram down” feasible plans of reorganization under reorganization provisions of this title where such plans seek to achieve restructuring of mortgaged debts secured by real estate. Such restructuring may include any of the following: the terms of any mortgage debt may be extended; the payments required by mortgage debt of either principal or interest may be postponed; and deferred or reduced payments of principal or interest may be added to mortgage balance. In re Hollanger, 15 B.R. 35 (Bkrtcy.W.D.La.1981). Long-term payouts are not prohibited under a plan under this chapter, notwithstanding that secured lender’s normal lending practice or policies may be only to make short-term loans. In re White, 36 B.R. 199( Bkrtcy.D.Kan.1983). It may even be possible to set up the secured creditor’s repayment treatment in a negative amortization. It has been held that although negative amortization is not per se inequitable in considering whether a bankruptcy plan meets cramdown requirements, negative amortization is highly suspect when evaluating the plan’s compliance with cramdown requirements. In re Club Associates, 107 B.R. 385, appeal decided 956 F.2d 1065 (Bkrtcy.N.D.Ga.1989). But it has been held that a negative amortization plan which provided the impaired mortgagee with at best a market rate of interest, while dramatically altering terms of mortgage agreement, was not “fair and equitable” to the mortgagee, and could not be confirmed over mortgagee’s objection under cramdown provisions. In re 8315 Fourth Ave. Corp., 172 B.R. 725 (Bkrtcy.E.D.N.Y.1994). Typically, the secured creditor can be crammed down if they are paid a market rate of interest over a commercially reasonable repayment term considering the character of the collateral and other market considerations.

This is where Chapter 11 has a big advantage on real estate based debt. Since the commercial market for real property mortgage loans is generally longer than 60 months, a Chapter 11 debtor can get a much longer repayment term than a Chapter 13 debtor. This reality was one of the major deviations from Chapter 13 in Chapter 12, which specifically allows secured debts to be paid out beyond the 60 month term. See §1222(b)(9).

Also, although confirmation of a Chapter 11 plan is consensual to some degree, as discussed below, if the only rejecting class is a secured creditor, the confirmation notwithstanding such rejection is not particularly difficult. In fact, the requirements for confirmation over the objection of a secured creditor are virtually the same for 13 and 11. Compare §1129(b)(2)(A) and §1325(a)(5). In essence, both require the payment in full of the allowed secured claim with interest. The main difference is the time over which such payments may be made. In 13, the maximum is 60 months, while under 11, it’s whatever the market is for similar claims, which may well be in excess of 60 months. In the case of real property secured claims, it will almost certainly be much longer.

Chapter 11 also has what is know as the §1111(b)(2) election. If an undersecured creditor whose claim has been bifurcated under §506 makes this election in writing prior to the conclusion of the hearing on the disclosure statement, then their lien is not avoided. Also, this provision requires creditors whose debts are non-recourse to be treated as if they had recourse notwithstanding a contract to the contrary. A detailed discussion of §1111 is far beyond the scope of this paper. It does give certain types of secured creditors more rights than they have in Chapter 13, which has no comparable section.

C. Confirmation Issues

Chapter 13 confirmation is governed by §1325 and has in essence 7 requirements to confirm a plan. In larger contrast is Chapter 11, which has 16 requirements to confirm a plan, found in §1129(a).

In the case of an individual, all of the confirmation requirements of Chapter 13 are present in Chapter 11 including the disposable income requirement. There are in essence 8 more hurdles to jump to get a plan confirmed in 11 than are present in 13. The major difference is that Chapter 11 requires a majority of the creditors to vote for the plan to obtain confirmation unless the debtor has the ability to “cram down” the plan under §1129(b). It is very difficult to obtain confirmation by cram down when the rejecting class is an unsecured class since the Debtor is required to give up ownership by cancellation of the pre-petition equity. A notable exception under the Reform Act has been created for individuals. Such Debtors may retain their pre-petition equity if they pay their disposable income to the creditors.

A complete discussion of the confirmation of Chapter 11 is far beyond the scope of this paper. In the event a comparison of the plans leads one to the conclusion that a plan can be confirmed under either chapter based on the matters already discussed, be sure to look at the addition requirements to confirm a Chapter 11 plan. Most of them are not too meaningful in an individual case, but sometimes there are issues which are barriers to Chapter 11 which are not present in Chapter 13.

Because of the voting aspect of Chapter 11, there is also the requirement that the Debtor prepare and obtain approval of a disclosure statement prior to any solicitation of binding acceptance of the proposed plan. §1125. This is an informational document which requires a lot of time and effort to prepare. If there is a confirmable plan, then it is almost always possible to obtain approval of the disclosure statement even if a creditor objects, since the only real issue is the adequate information in the disclosure statement.

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REAL ESTATE AND TITLE INSURANCE

This section of the seminar deals with issues which typically arise when the record title holder (the “Owner”) of the real property upon which title insurance is proposed to be issued (the “Property”) is a debtor under the Bankruptcy Code. This section assumes little or no working knowledge of the Bankruptcy Code. It is not intended to be an exhaustive study of all possible issues which may arise in this context, but rather is intended to provide an overview of the primary issues which typically arise. This paper assumes that an order for relief under the Bankruptcy Code has been entered regarding the Owner and that title to the Property in the context of the issuance of a title insurance policy on the Property (the “Policy”) is being considered. The Policy could be either an owner’s policy where the insured under the Policy seeks to acquire marketable title to the Property or a mortgagee who seeks to loan money secured by a mortgage upon the Property that is insured under a mortgagee’s title policy. Under either scenario, the insured under the Policy is referred to as the “Insured.” Is it not the intention of this paper to educate you on every possible issue that may arise in every type of bankruptcy case, but rather to give you the basic tools to deal with such event. Many times, bankruptcy cases turn into very complex matters which are far beyond the scope of this paper and in such event, it is highly recommended you associate with experienced Bankruptcy counsel.

I. INTRODUCTION TO THE BANKRUPTCY CODE

All Bankruptcy Cases are governed by the provisions of 11 U.S.C. §101 et seq, referred to herein after as the Bankruptcy Code or simply, “the Code.” All statutory citations in this paper refer to specific sections of the Code unless otherwise stated. This paper deals with the Code as it has been amended to date, including the most recent amendments of the Bankruptcy Abuse and Consumer Protection Act of 2005 (the “Reform Act”). The Reform Act was signed by the President on April 20, 2005; however, the majority of its provisions did not become effective until October 17, 2005. This paper will assume that the Bankruptcy Case was filed after October 17, 2005 and that such case is subject to all provisions of the Reform Act.

The Code creates 6 different types of bankruptcy cases which may be filed. Specifically, Chapters 7, 9, 11, 12, 13 and 15 all create different types of relief available to various different types of debtors. Chapter 7 is what is known as liquidation bankruptcy, although, the actual liquidation of an asset only occurs in about 5% of such cases filed in Oklahoma.

Chapters 9, 11, 12 and 13 are all referred to as “reorganizations” because they all contemplate a continuation of the debtor in some form subject to debts which have been modified by a device known as a plan. A plan is really nothing more than a court enforced loan modification agreement wherein the debtor rewrites the terms of all their debt on a global basis.

Chapter 9 is a municipal reorganization which is a very specialized type of bankruptcy case and is far beyond the scope of this seminar.

Chapter 11 is designed for public corporations, but almost any type of entity or individual may file such a case.

Chapter 12 is a very powerful, but also a very limited reorganization which may only be utilized by family farmers. There are very few Chapter 12 cases filed and therefore, such matters are beyond the scope of this seminar.

Chapter 13 is a sort of individual reorganization which may only be used by natural persons.

Finally, Chapter 15 is limited to what are referred to as “Cross-border insolvency cases” wherein the primary insolvency proceeding is filed in a foreign country and such company has assets located within the United States. Such cases are far beyond the scope of this seminar.

Each reorganization chapter has subchapters which define the administration of the estate under rules which are unique to the particular chapter and which define the various rules related to each unique chapter.

Any individual or entity that is subject to an order for relief under the Code is defined as a “Debtor” until such time as the case is dismissed or closed. 101(13). All Bankruptcy Cases begin or “commence,” with the filing of a Petition. The day the petition is filed is called the “petition date.” The order that grants the petition is called the “Order for Relief.”

A Bankruptcy case may be a voluntary case, wherein the Debtor filed the case voluntarily on their own behalf. In a voluntary case, the order for relief is automatically granted and the petition date is simultaneous. Virtually all bankruptcy cases are voluntary cases.

On rare occasion, bankruptcy cases are filed by creditors of the Owner as Involuntary Bankruptcy Cases. See §303. In such cases, the Petition Date is different than the date of the entry of the Order for Relief and is not an automatic event.  Once the Order for Relief is entered, then the title considerations are the same as a voluntary case.  However, if your examination of title is during the time between the petition date and the order for relief, known as the “gap period,” then different rules apply because although there is an automatic stay, there is no estate. In such cases, the only safe procedure is to require a duly entered order of the Bankruptcy Court.

The filing of a petition for relief almost always results in the automatic creation of a stay order known as the “Automatic Stay” which is discussed below.

This leads to the next general principal regarding bankruptcy cases. Any time you find the Owner is also a Debtor, the safest route is to require the proposed transaction be the subject of a duly entered order of the Bankruptcy Court. The specifics of such orders are discussed below. Most orders entered by the Bankruptcy Court are as a result of a Motion being filed and notice of such motion being provided to the appropriate parties as required by the local rules of the particular court. There are three Federal Districts in Oklahoma, each of which has its own Bankruptcy Court with its own unique set of local rules governing procedure related to Motions. There are also national rules of Bankruptcy procedure which do not vary between Courts known as the Federal Rules of Bankruptcy Procedure “FRBP.” Generally, Motions are granted only after notice of the filing of the Motion is given and the appropriate time period lapses without any responsive pleading being filed.

Anytime real property is involved notice should be given to all parties listed on the official mailing list in the case known as the “Matrix.”  There are some types of Motions, but not all, whereupon the Court may limit the parties to whom notice is given upon application and order as provided in FRBP 2002. As a title examiner, you need to review the certificate of mailing that will be filed by the party filing the particular Motion to make sure that proper notice of the motion that resulted in the order was given. In the discussion below, I will discuss the specifics of notice related to the various types of Motions that may be filed regarding real property.

The Debtor is required by file numerous documents listing all of their assets, commonly referred to as the “Schedules.” The Debtor is under an absolute obligation to list any and all interests in any and all real property on the Schedule of Real Property without any exception. The Schedule of Real Property is found in Schedule “B-1″ for cases filed prior to August 1, 1991, or Schedule “A” for cases filed on or after August 1, 1991. One of the first things to check in any bankruptcy case is the Schedule of Real Property to make sure that the Property is reflected thereon.

The Bankruptcy Code as we know it today was passed in 1978 as a complete overhaul of the then existing Bankruptcy Act. It has been amended several times, but none of the amendments really made sweeping types of changes and were mostly limited to smaller adjustment types of amendments. Most recent of these amendments is the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Reform Act”) The Reform Act made substantial changes to many aspects of the Code.

Documents to review and process:

1. The Petition and Order for Relief.

1. The Schedule of Real Property (Schedule “B-1″ for cases filed prior to August 1, 1991, or Schedule “A” for cases filed on or after August 1, 1991) showing that the debtor(s)’ interest in the property was disclosed.

If the Property is not shown on the Schedule of Real Property or any amendment to such schedule, the further curative measures are required.

C. If the case is a Chapter 7, then there will always be a Trustee and you must look for evidence of the qualification of the case trustee to serve in that capacity. Such evidence shall consist of either:

1. Evidence that the trustee has filed with the bankruptcy court a bond in favor of the United States conditioned on the faithful performance of the trustee’s official duties and transmitted notice of the acceptance of the office to the court and to the United States trustee within five (5) days of receipt of the notice of selection; or

2. If the trustee has filed a blanket bond pursuant to Fed.R.Bankr.P. 2010, evidence that the trustee did not reject the appointment within five days of receipt of notice of the appointment; or

D. If the case is a Chapter 11 case, then there will be no trustee unless one is appointed by Court Order. In such cases, you must review the docket to determine that no trustee has been appointed in the case. If there is an order appointing a trustee, then such trustee must be qualified as stated above.

II. TITLE STANDARDS AND BANKRUPTCY CASES

There are specific Oklahoma title standards pertaining to Bankruptcy Cases. The title standards are found at 16 O.S. Ch 1. App. Standard 20.1. The specific title standard related to bankruptcy cases is T. 16, Ch. 1, App., Standard 34.2 which provides:

EXEMPT ASSETS

Under Section 522 of the Bankruptcy Code a debtor may claim certain property as being exempt from forced sale for the benefit of its creditors. Therefore, a claim of exemption is a tool by which the debtor may retain property and exclude it from administration by the bankruptcy court.

Where the property under examination is claimed as exempt, the abstract being examined should contain, or the examiner should review certified copies of, the following:

A. The Petition and Order for Relief. 11 U.S.C. §§ 301, 302 or 303.

B. The Schedule of Real Property (Schedule “B-1″ for cases filed prior to August 1, 1991, or Schedule “A” for cases filed on or after August 1, 1991) showing that the debtor(s)’ interest in the property was disclosed. 11 U.S.C. § 521(1) and Fed. R. Bankr. P. 1007(b) & 4002(3).

C. The Schedule of Exempt Property (Schedule “B-4″ for cases filed prior to August 1, 1991, or Schedule “C” for cases filed on or after August 1, 1991), showing that the subject property was claimed as exempt by the debtor(s). 11 U.S.C. §§ 522(b) & (l). Fed. R. Bankr. P. 4003(a).

D. The docket sheet indicating whether the claim of exemption was subject to an objection by any party in interest.

NOTE: An objection to the claim of exemption must be filed within thirty (30) days of the conclusion of the meeting of creditors held pursuant to 11 U.S.C. § 341 and Fed. R. Bankr. P. 2003(a). Fed. R. Bankr. P. 4003(b).

1. If the docket sheet indicates that no objection was timely filed, the property is deemed exempt. 11 U.S.C. § 522(l) and Taylor v. Freeland & Kronz, 503 U.S. 638 (1992).

2. If the docket sheet indicates that an objection was timely filed, the examiner should review a copy of the bankruptcy court’s order disposing of the objection.

E. Judgment Liens in Bankruptcy.

1. Judgment Liens Before November 1, 1997

a. Judgment liens perfected before November 1, 1997, do not attach to homestead property and do not constitute a lien against such property. 12 O.S. § 706; Gerlach Bank v. Allen, 51 Okla. 736, 152 P. 399 (1915) and Finerty v. First Nat. Bank, 92 Okl. 102, 218 P. 859 (1923).

b. When a lien does not attach to real property, there is no need for avoidance proceedings. David Dorsey Distrib., Inc. v. Sanders (In re Sanders), 39 F.3d 258, 262 (10th Cir. 1994).

2. Judgment Liens On or After November 1, 1997

a. Judgment liens perfected on or after November 1, 1997, attach to homestead property and constitute a lien against such property. 12 O.S. § 706.

b. Any liens or charges that were properly perfected prior to the instigation of bankruptcy proceedings will survive those proceedings unless specifically avoided pursuant to 11 U.S.C. § 522(f) and Fed. R. Bankr. P. 4003(d). 11 U.S.C. §§ 522(c) and (f); Long v. Bullard, 117 U.S. 617, 6 S.Ct. 917, 29 L.Ed. 1004 (1886); Johnson v. Home State Bank, 111 S.Ct. 2150 (1991); Farrey v. Sanderfoot, 111 S.Ct. 1825 (1991); and Owen v. Owen, 111 S.Ct. 1833 (1991).

c. For the title to real property passing through bankruptcy proceedings to be free and clear of a pre-petition judgment lien, the abstract being examined should contain, or the examiner should review certified copies of, the motion requesting that the lien be avoided pursuant to 11 U.S.C. § 522(f) and Fed. R. Bankr. P. 4003(d) and the order granting said motion. Id. and Coats v. Ogg (In re: Ogg), __ F.3d __, BAP No. EO-98-028 (10th Cir. 1999).

ABANDONMENT

Abandonment of an asset can take place at any time during the pendency of the bankruptcy proceedings. The procedure can be initiated by a debtor-in-possession or case trustee via the filing a notice of abandonment with the bankruptcy court and the service of a copy of the notice on each of the parties in interest in the case.

Abandonment is also a creditor’s remedy. Any creditor holding an interest in the subject property has the right to file a motion with the bankruptcy court requesting that its collateral be abandoned from the estate. Once its collateral is abandoned from the estate, and the automatic stay imposed by 11 U.S.C. § 362 is lifted, the creditor is free to pursue any of the remedies available to it in accordance with applicable law.

Where the property under examination is abandoned from the bankruptcy estate, the abstract being examined should contain, or the examiner should review certified copies of, the following:

A. The Petition and Order for Relief. 11 U.S.C. §§ 301, 302 or 303.

B. The Schedule of Real Property (Schedule “B-1″ for cases filed prior to August 1, 1991, or Schedule “A” for cases filed on or after August 1, 1991) showing that the debtor(s)’ interest in the property was disclosed. 11 U.S.C. § 521(1) and Fed.R.Bankr.P. 1007(b) & 4002(3).

C. If a trustee has been appointed in the case, evidence of the qualification of the case trustee to serve in that capacity. Such evidence shall consist of either:

1. Evidence that the trustee has filed with the bankruptcy court a bond in favor of the United States conditioned on the faithful performance of the trustee’s official duties and transmitted notice of the acceptance of the office to the court and to the United States trustee within five (5) days of receipt of the notice of selection. 11 U.S.C. § 322(a) and Fed.R.Bankr.P. 2008; or

2. If the trustee has filed a blanket bond pursuant to Fed.R.Bankr.P. 2010, evidence that the trustee did not reject the appointment within five days of receipt of notice of the appointment. 11 U.S.C. § 322(a) and Fed.R.Bankr.P. 2008;or

D. If no trustee has been appointed in the case, evidence of that fact.

NOTE: The elements indicated above regarding the qualification of a trustee to act in a particular case may be conclusively evidenced through a certificate from the clerk of the bankruptcy court in which the proceedings are pending certifying that either: 1) the debtor is acting as a debtor-in-possession, and thus retains the powers, duties and obligations of a trustee, or 2) that a trustee has qualified. Fed.R.Bankr.P. 2011(a).

E. If the property was affirmatively abandoned by either the case trustee or a debtor-in-possession:

1. The notice of intent to abandon required by Fed.R.Bankr.P. 6007(a).

NOTE: The notice of intent to abandon property of the estate may be contained within the notice of the meeting of creditors (the “341 meeting”) which is mailed to each party in the case at the outset of the proceedings. If the court file contains an order of abandonment, but no pleading specifically labeled as being a notice of abandonment, the examiner should review the notice of meeting of creditors to determine if it contains a general notice of the trustee’s ability to abandon property at the 341 meeting.

2. Evidence that there was no objection to the notice of abandonment filed within 18 days of the date of mailing of the notice. Fed.R.Bankr.P. 6007(a) and 9006(f);or

3. The bankruptcy court’s order abandoning the property.

F. If the abandonment is by virtue of a motion filed by a creditor having an interest in the subject property:

1. The motion filed pursuant to 11 U.S.C. § 554(b) and Fed.R.Bankr.P. 6007(b) requesting that the subject property be abandoned from the estate;

2. The bankruptcy court’s order ruling on the motion.

G. If the subject property is disclosed on the schedule of real property filed in conjunction with the Petition, but is not otherwise disposed of during the pendency of the bankruptcy proceedings, it is deemed abandoned to the debtor upon the closing of the case. 11 U.S.C. § 554(c). In that event, the examiner should review the order discharging the trustee, if one has been appointed, and closing the estate. Fed.R.Bankr.P. 5009 and 11 U.S.C. § 350(a).

NOTE: If the subject property is not disclosed on the schedule of real property filed in conjunction with the Petition, it remains unadministered property of the estate upon the closing of the case. 11 U.S.C. § 554(d). In that event, the examiner should require that the bankruptcy proceedings be re-opened in accordance with 11 U.S.C. § 350(b) so that the property can be scheduled and administered by the bankruptcy court.

SALES

Sales of realty held by a bankruptcy estate are governed by Section 363 of the Bankruptcy Code and Rules 2002 and 6004 of the Federal Rules of Bankruptcy Procedure. In the event a bankruptcy trustee is selling an interest in realty that is subject to an ownership interest by someone that is not a debtor, the sale may be conducted only after the successful prosecution of an adversary proceeding within the bankruptcy case. See, Fed.R.Bankr.P. 7001(3). In the event an examiner encounters such a situation, the entire adversary proceedings should be reviewed.

Where the property under examination is sold by a bankruptcy trustee or a debtor-in-possession (other than in the ordinary course of business), the abstract being examined should contain, or the examiner should review certified copies of, the following:

A. The Petition and Order for Relief. 11 U.S.C. §§ 301, 302 or 303.

B. The Schedule of Real Property (Schedule “B-1″ for cases filed prior to August 1, 1991, or Schedule “A” for cases filed on or after August 1, 1991) showing that the debtor(s)’ interest in the property was disclosed. 11 U.S.C. § 521(1) and Fed.R.Bankr.P. 1007(b) & 4002(3).

C. If a trustee has been appointed in the case, evidence of the qualification of the case trustee to serve in that capacity. Such evidence shall consist of either:

1. Evidence that the trustee has filed with the bankruptcy court a bond in favor of the United States conditioned on the faithful performance of the trustee’s official duties and transmitted notice of the acceptance of the office to the court and to the United States trustee within five (5) days of receipt of the notice of selection. 11 U.S.C. § 322(a) and Fed.R.Bankr.P. 2008; or

2. If the trustee has filed a blanket bond pursuant to Fed.R.Bankr.P. 2010, evidence that the trustee did not reject the appointment pursuant to Fed.R.Bankr.P. 2008; or

D. If no trustee has been appointed in the case, evidence of that fact.

NOTE: The elements indicated above regarding the qualification of a trustee to act in a particular case may be conclusively evidenced through a certificate from the clerk of the bankruptcy court in which the proceedings are pending certifying that either: 1) the debtor is acting as a debtor-in-possession, and thus retains the powers, duties and obligations of a trustee, or 2) that a trustee has qualified. Fed.R.Bankr.P. 2011(a).

E. Evidence that the debtor, the trustee, all creditors and indenture trustees, any committees formed pursuant to Sections 705 or 1102 and the United States trustee received at least twenty (20) days notice of the proposed sale. Fed.R.Bankr.P. 2002(a)(2), (i) and (k).

F. Evidence that the notice of sale served upon each of the parties delineated above contained at least the following information regarding the transaction:

1. Either

a. The time and place of any public sale; or

b. The terms and conditions of any private sale;

2. The time fixed for filing objections to the proposed sale; and

3. A description of the property being sold. Fed.R.Bankr.P. 2002(c)(1).

G. Evidence that either:

1. No objection to the proposed sale was filed and served more than five (5) days before the date set for the proposed action or within the time fixed by the court. Fed.R.Bankr.P. 6004(b); or

2. If an objection was filed, the order of the bankruptcy court disposing of the objection.

H. A properly executed conveyance from either:

1. The debtor-in-possession; or

2. The duly appointed and acting trustee in his capacity as trustee of the bankruptcy estate. Fed.R.Bankr.P. 6004(f)(2).

SALES FREE AND CLEAR OF LIENS

Section 363(f) of the Bankruptcy Code allows a movant to conduct a sale of estate property free and clear of certain specified interests that may encumber the interest being sold. In a Chapter 12 case, that authority is supplemented by Section 1208. If a sale free and clear of interests is encountered, in addition to the materials indicated in the immediately preceding section, the abstract being examined should contain, or the examiner should review certified copies of, the following:

A. The notice of sale discussed in TES 34.2.III.E. and F. should also contain the date of the hearing on the motion and the time within which objections may be filed and served on the debtor-in-possession or trustee. Fed.R.Bankr.P. 6004(c).

B. Evidence that the motion filed with the bankruptcy court requesting that the subject property be sold pursuant to Section 363(f) was properly served on the parties who held liens or other interests in the property to be sold. Fed.R.Bankr.P. 6004(c).

C. The order of the bankruptcy court disposing of the motion.

TRANSFERS PURSUANT TO A CONFIRMED CHAPTER 11 PLAN

In the Chapter 11 context transfers of interests that are part of the bankruptcy estate may be effectuated through the provisions of a confirmed Chapter 11 plan of reorganization. Where the property under examination is transferred through the terms of a confirmed plan of reorganization, the abstract being examined should contain, or the examiner should review certified copies of, the following:

A. The Plan and court approved Disclosure Statement.

1. The Plan and Disclosure Statement are filed concurrently. Fed.R.Bankr.P. 3016(c).

B. Approval of the Disclosure Statement

1. When the Plan and Disclosure Statement are filed, in accordance with Fed.R.Bankr.P. 2002(b) a hearing for approval of the Disclosure Statement should be set on not less than 25 days notice. Fed.R.Bankr.P. 3017(a).

2. Notice of the hearing must be served on:

a. the debtor;

b. the trustee;

c. the creditors and indenture trustees;

d. any equity security holders;

e. the United States Trustee; and

f. all other parties in interest, including:

1. any committees appointed pursuant to 11 U.S.C. §§ 1102 and 1114;

2. the S.E.C. [Fed.R.Bankr.P. 2002(j)(1)];

3. the I.R.S. [Fed.R.Bankr.P. 2002(j)(3)];

4. the U.S. Attorney [Fed.R.Bankr.P. 2002(j)(4)]

5. the department, agency, or instrumentality of the U.S. through which the debtor became indebted to the U.S. Id.; and

6. the Secretary of the Treasury. Id.
See, Fed.R.Bankr.P. 3017(a).

3. Copies of the Plan and Disclosure Statement only need to be served on:

a. the debtor;

b. any trustee or committee that has been appointed;

c. the S.E.C.; and

d. any party that has filed an Entry of Appearance. Fed.R.Bankr.P. 3017(a).

4. Following the hearing, the Court shall determine whether the Disclosure Statement should be approved. Fed.R.Bankr.P. 3017(b).

5. If the Disclosure Statement is approved, the Court shall fix a time within which:

a. the holders of claims and interests may accept or reject the plan; and,

b. fix a date for the confirmation hearing. Fed.R.Bankr.P. 3017(c).

6. When the Disclosure Statement is approved, the Debtor must mail:

a. a copy of the plan, or a court approved summary;

b. a copy of the approved Disclosure Statement;

c. a ballot

d. notice of the time established to file acceptances to, or rejections of, the plan and of the confirmation hearing;

e. a copy of the order approving the Disclosure Statement; and

f. such other information as required by the Court to

1. all creditors;

2. all equity security holders; and

3. the U.S. Trustee. Fed.R.Bankr.P. 3017(d).

C. Confirmation of the Plan

1. Notice of the confirmation hearing and the time fixed for filing objections to the plan and a ballot must be mailed to:

a. all creditors;

b. all equity security holders. Fed.R.Bankr.P. 3017(d).

2. An acceptance or rejection of the Plan must:

a. be in writing;

b. identify the plan or plans accepted or rejected;

c. be signed by the creditor or equity security holder, or an authorized agent; and

d. conform to the Official Form. Fed.R.Bankr.P. 3018(c).

3. Objections must be filed and served on the plan proponent within the time fixed by the Court. Fed.R.Bankr.P. 3020(b)(1).

4. An objection to confirmation is governed by Fed.R.Bankr.P. 9014. Id.

5. The Court shall rule on confirmation of the Plan after notice and hearing as provided by Fed.R.Bankr.P. 2002(b). Fed.R.Bankr.P. 3020(b)(2).

6. If no objection is filed, the Court may rule that the Plan has been proposed in good faith and not by any means forbidden by law without receiving evidence on such issues. Id.

NOTE: Prior to the entry of an order confirming the Plan, the Court may order the debtor to deposit with the trustee or debtor-in-possession all consideration required to be paid on confirmation. If the Court so orders, those funds must be placed in a special account established for the exclusive purpose of making the distribution. Fed.R.Bankr.P. 3020(a).

D. The Confirmation Order

1. Must conform to the Official Form. Fed.R.Bankr.P. 3020(c).

2. Notice of entry thereof must be mailed to:

a. the debtor;

b. the trustee;

c. all creditors;

d. all equity security holders;

e. the U.S. Trustee; and,

f. all other parties in interest. Fed.R.Bankr.P. 3020(c).

E. Post-Confirmation Matters

1. Distributions Under the Plan

a. After confirmation of the Plan, distribution shall be made to creditors whose claims have been allowed. Fed.R.Bankr.P. 3021.

b. After the estate is fully administered, the court, on motion of a party in interest, shall enter a final decree closing the case. Fed.R.Bankr.P. 3022.

As you can see from a review the this title standard, it provides a good outline of the documents that you must review to make the various determinations necessary to deal with a bankruptcy matter. This presentation will attempt to fill in the concepts and some details on these various items.

III. INITIAL CONSIDERATIONS

The first notice of bankruptcy that creditors of the Owner will receive is known commonly as the “341 notice”. This notice will be received in the mail and involves several important pieces of information. As counsel reviewing the bankruptcy case proceedings, you must determine what chapter the debtor is filing.  This is simply a matter of reading the notice. If the case is a “reorganization” chapter, i.e., Chapter 11, 12 or 13, the considerations for creditor’s counsel are far more complex than in a Chapter 7. It is recommended that if you have never been involved in such a case before, that you associate with someone who has experience in such matters.

III.A THE ELECTRONIC COURTHOUSE

All Bankruptcy Courts are now subject to mandatory electronic filing using a system electronic filing and case management known as “CM/ECF.” [1] CM/EFC utilizes a system of internet and email based protocols for filing and receiving notices of items filed in bankruptcy cases. Only attorneys may utilize the CM/ECF system and must be authorized by each Bankruptcy Court wherein such system is to be utilized. For more details on the CM/ECF system, go to http://pacer.psc.uscourts.gov/cmecf/.

One of the benefits of such a system is that it facilitates internet based public access to all bankruptcy and federal district court proceedings to anyone via a companion system known as “PACER.”[2] Anyone with a credit card may obtain a PACER account which provides you with a login and password to then enable you to search any bankruptcy court for a particular Debtor, review the court docket for the case and then download a PDF image of any document or pleading filed in the case.  For more information about PACER and to sign up for an account, go to http://pacer.psc.uscourts.gov/.

To locate a particular bankruptcy court, there is a parent website http://www.uscourts.gov/ which has links to each Bankruptcy Court (as well as all other Federal Courts). This website will allow you to link directly to the homepage for any Bankruptcy Court.

There is another internet based system known as the USCPI[3] found at http://pacer.uspci.uscourts.gov/. This system will allow you to search virtually all federal courts, including bankruptcy courts, for a particular Owner by name.

If you need a certified copy, you will still have to request an old fashioned piece of paper from the Bankruptcy Court Clerk’s Office.

IV. PROPERTY OF THE ESTATE

Concept: When the Owner of the Property becomes a Debtor as a result of an order for relief, title to the Property is transferred to the Estate. The title to the Property must then be transferred out of the estate to maintain the chain of title.

The entry of an order for relief case creates a new, separate legal entity pursuant to §541(a), usually referred to as the “Bankruptcy Estate” or just the “Estate.” All references to the term “estate” in this paper are to the Bankruptcy Estate. Under this provision, the estate is comprised of all legal or equitable interest of the debtor in property, wherever located, as of the commencement of the case with a few exceptions, none of which apply to real property. “The United States Supreme Court addressed the issue of the breadth of the scope of “property of the estate” in United States v. Whiting Pools, Inc., 462 U.S. 198, 103 S.Ct. 2309, 76 L.Ed.2d 515 (1983). The Court determined that a debtor’s property, although seized by the federal Internal Revenue Service (“the IRS”) prior to the bankruptcy filing, was “property of the estate” of the debtor.” In re Shapiro, 124 B.R. 974, 980 (Bankrt.E.D.Pa.,1991).

There are special rules for community property states, but since Oklahoma is generally not a community property state, such rules are beyond the scope of this paper. The estate’s rights in the Property are based on the facts and circumstances that existed on the Petition Date.

Another commonly used phrase is “property of the estate,” which merely refers to all property to which the estate holder legal and equitable title.  Record title to real property often does not reflect the estate’s interest in the Property. However, if the title examiner has any actual notice that the Owner was a Debtor at any time prior to the current examination of title, then inquiry into the Bankruptcy Case is necessary to determine whether the estate has an interest in the Property.

Generally, the scope of what is included in the estate is determined by whether or not the Owner held title to the Property on the petition date, with a few exceptions. One exception to this rule which could apply to real property is §541(a)(5) which states:

(5) Any interest in property that would have been property of the estate if such interest had been an interest of the debtor on the date of the filing of the petition, and that the debtor acquires or becomes entitled to acquire within 180 days after such date –

(A) by bequest, devise, or inheritance;

(B) as a result of a property settlement agreement with the debtor’s spouse, or of an interlocutory or final divorce decree; or

(C) as a beneficiary of a life insurance policy or of a death benefit plan.
Thus, if the Owner’s predecessor in title to the Property died within 180 days AFTER the petition date, then the Owner’s interest in the Property is property of the estate.

It is very important to note that a Debtor’s interest in Property becomes property of the estate regardless of whether or not such Property is listed on the Schedule of Real Property and such Property remains property of the estate until it is removed from the estate by one of the methods described herein. “Property that was not correctly scheduled remains property of the estate forever (until administered or formally abandoned by the trustee), regardless of whether it is scheduled after the case is reopened.” In re Lopez, 283 B.R. 22, 31 (9th Cir.BAP (Cal.),2002).

The filing of a petition for relief in bankruptcy results in a direct impairment of a Owner’s ability to effect or control any property of the Estate, so upon receipt of any actual notice of the filing of a bankruptcy petition means you must make further inquiry to determine whether or not the Property is or is not part of the Estate. This is particularly true for real property as none of the exceptions to inclusion of the Owner’s interest in the Property apply.

How does the Property get out of the Estate? Property may be removed from the Estate by a duly entered Order or by operation of law. Sometimes there is a formal order of the Court, sometimes there is a deed from the estate representative (which can be the Trustee or the Debtor In Possession) and other times, the removal from the estate is by operation of law.

IV.A. DISMISSAL OF THE CASE

Concept: Any type of bankruptcy case may be dismissed by order of the Court, which results in all property of the estate being re-vested in then Owner.

Any type of bankruptcy case may under appropriate circumstances be dismissed. Dismissal of a case is always accomplished by an order of the Court, usually after the filing of a Motion to Dismiss by a party in interest, but not always. There are now provisions in Chapter 7 cases wherein automatic dismissal of cases can occur. However, such is always accomplished by an order of the Court.  S.E.C. v. Great White Marine & Recreation, Inc., 428 F.3d 553, 556 (5^th. Cir. (Tex.),2005)

..the district court dismissed with prejudice the bankruptcy proceeding. Therefore, there is no bankruptcy estate. See In re Herberman, 122 B.R. 273, 278 (Bankr.W.D.Tex.1990) (“An estate is a separate legal identity, created on (and by) the filing of a bankruptcy petition, and continuing until confirmation, conversion, or dismissal of the case.”). Without a bankruptcy estate, there can be no property of a bankruptcy estate. See 11 U.S.C. § 349(b)(3) (a dismissal “revests the property of the estate in the entity in which such property was vested immediately before the commencement of the case under this title”).

Dismissal of the case terminates the estate and returns all property of the estate to the Owner.

Documents to review and process:

1. The hearing on the Docket will show if the case is dismissed.

2. Order of Dismissal shown on Docket.

3. Case Dismissed, property removed from Estate.

IV. B. EXEMPTION OF REAL PROPERTY

Concept: The Property may be removed from the Estate by means of Exemption, ie the Property is included on the Debtor Schedule of Exemption Property. Upon the approval of the claim of exemption (referred to as the “allowance”), the Property is removed from the Estate. The allowance of exemption can be by operation of law, or by Court order.

Exempt assets are simply those assets which the individual Debtor may keep in spite of the filing of bankruptcy. There are no exemptions for entities such as corporations or limited liability companies, so if your Owner now Debtor is not a natural person, then skip to the next section.  Exemptions under the Bankruptcy Code are governed under 11 U.S.C. §522. Pursuant to 11 U.S.C. §522(b)(1), Oklahoma has elected to require the debtor to utilize the exemptions under Oklahoma law as are specifically set forth in 31 O.S. §1. Note that Oklahoma also amended its exemption statutes effective August 26, 2005. The specific statutory provisions related to real property are:

Title 31. Homestead and Exemptions (Refs & Annos)

§ 1. Property exempt from attachment, execution or other forced sale– Bankruptcy proceedings
A. Except as otherwise provided in this title and notwithstanding subsection B of this section, the following property shall be reserved to every person residing in the state, exempt from attachment or execution and every other species of forced sale for the payment of debts, except as herein provided:
1. The home of such person, provided that such home is the principal residence of such person;

B. No natural person residing in this state may exempt from the property of the estate in any bankruptcy proceeding the property specified in subsection (d) of Section 522 of the Bankruptcy Reform Act of 1978, Public Law 95-598, 11 U.S.C.A. 101 et seq., except as may otherwise be expressly permitted under this title or other statutes of this state.

If a party to the bankruptcy case believes that something claimed is not a valid exemption, then they must file an objection to the claim of exemption. If no objection is filed then the exemption is deemed allowed §522(l). Objections to a claimed exemption must be filed within 30 days of the conclusion of the creditors meeting held pursuant to §341. The date for the first meeting of creditors is found in the §341 Notice, but such meetings may be continued, so one must look at the docket sheet to find then the meeting was concluded.

If there are no objections filed to the exemption in a timely fashion, then the item claimed as exempt is conclusively deemed to be exempt even if there is no good faith basis for the claimed exemption. Taylor v. Freeland & Kronz, 112 S.Ct. 1644, 503 U.S. 638, 118 L.Ed.2d 280, 60 USLW 4333, 26 Collier Bankr.Cas.2d 487, 22 Bankr.Ct.Dec. 1396, Bankr. L. Rep.  (U. S.1992).

The only exemption available under Oklahoma law pertaining to real estate is the Homestead exemption authorized under 31 O.S. §2. The homestead within a city or town is limited to one acre; however, outside of a city, town or village the homestead may be up to 160 acres. If the homestead is located within the limits of a city, town or village and is used for both a dwelling place and for a commercial enterprise then one must look to the amount of square footage used for business and non-business purposes. Specifically, “at least seventy‑five percent (75%) of the total square foot area of the improvements for which a homestead exemption is claimed must be used as the principal residence in order to qualify for the exemption. If more than twenty‑five percent (25%) of the total square foot area of the improvements for which a homestead exemption is claimed is used for business purposes, the homestead exemption amount shall not exceed Five Thousand Dollars ($5,000.00)”. If there is significant equity in the home and the Debtor is using their home to conduct a business, then there may well be a challenge to the claim of exemption a source of substantial funds to repay creditors.

The Reform Act added several limitations to the homestead exemption. Although the Reform Bill generally became effective on October 17, 2005, some of its provisions became effective upon its signing. The following provisions affecting the homestead exemption became effective immediately on April 20, 2005.

All of the following Code sections are new:

New §522(a)(3)(A) provides restrictions on the applicable exemption law for debtors who have moved from one state to another within 730 days pre-petition. If the Debtor has moved within this period of time, then a party seeking to challenge the claim of exemption must determine how long they have been in the State of residence as of petition date. If they have not been in such State for at least 730 days (approximately 2 years), then further inquiry must be made as to which State they were in for “180 days immediately preceding the 730-day period or for a longer portion of such 180-day period than in any other place”. What this seems to say is that one must look back past the 730 days and determine where the debtor was for the greatest portion of the 180 days prior to the 730 days, and that is the State whose exemption laws apply. This can make a difference in a situation where a debtor moves to Oklahoma from say, Missouri, which has a $15,000.00 limit on the personal residence. See V.A.M.S. 513.475. In such a case, the debtor’s Oklahoma home would be subject to the $15,000 cap imposed under Missouri law. The specific language of the statute is:

(A) subject to subsections (o) and (p), any property that is exempt under Federal law, other than subsection (d) of this section, or State or local law that is applicable on the date of the filing of the petition at the place in which the debtor’s domicile has been located for the 180 730 days immediately preceding the date of the filing of the petition, or for a longer portion of such 180-day period than in any other place or if the debtor’s domicile has not been located at a single State for such 730-day period, the place in which the debtor’s domicile was located for 180 days immediately preceding the 730-day period or for a longer portion of such 180-day period than in any other place;

Section 522(o) reduces the homestead exemption to the extent that value is attributable to any portion of non-exempt property that the debtor disposed of within 10 years of filing bankruptcy, if the disposition was made with intent to hinder, delay, or defraud creditors. This section essentially overrules cases like In re Carey, 938 F.2d 1073 (10^th Cir. 1991) which allowed debtor’s pre-bankruptcy planning in converting non-exempt to exempt assets.

Section 522(p) generally places a $125,000 cap on the homestead acquired within 1,215 days of filing bankruptcy. Here, it is important to know when the debtor acquired their homestead. Note that this limitation does not include a “roll-over” of the debtor’s previous homestead. §522(p)(2)(B).  Also, this limitation does not apply to family farmers (what about family fisherman?). The specific Code language of §522(p)(2)(A) is:

(p)(1) Except as provided in paragraph (2) of this subsection and sections 544 and 548, as a result of electing under subsection (b)(3)(A) to exempt property under State or local law, a debtor may not exempt any amount of interest that was acquired by the debtor during the 1215-day period preceding the date of the filing of the petition that exceeds in the aggregate $125,000 in value in–

(A) real or personal property that the debtor or a dependent of the debtor uses as a residence;

(B) a cooperative that owns property that the debtor or a dependent of the debtor uses as a residence;

(C) a burial plot for the debtor or a dependent of the debtor; or

(D) real or personal property that the debtor or dependent of the debtor claims as a homestead.

(2)(A) The limitation under paragraph (1) shall not apply to an exemption claimed under subsection (b)(3)(A) by a family farmer for the principal residence of such farmer.

(B) For purposes of paragraph (1), any amount of such interest does not include any interest transferred from a debtor’s previous principal residence (which was acquired prior to the beginning of such 1215-day period) into the debtor’s current principal residence, if the debtor’s previous and current residences are located in the same State.

Section 522(q) extends that $125,000 cap to situations involving a felony criminal conviction or other violations specified in the section.

(q)(1) As a result of electing under subsection (b)(3)(A) to exempt property under State or local law, a debtor may not exempt any amount of an interest in property described in subparagraphs (A), (B), (C), and (D) of subsection (p)(1) which exceeds in the aggregate $125,000 if –

(A) the court determines, after notice and a hearing, that the debtor has been convicted of a felony (as defined in section 3156 of title 18), which under the circumstances, demonstrates that the filing of the case was an abuse of the provisions of this title; or

(B) the debtor owes a debt arising from –

(i) any violation of the Federal securities laws (as defined in section 3(a)(47) of the Securities Exchange Act of 1934), any State securities laws, or any regulation or order issued under Federal securities laws or State securities laws;

(ii) fraud, deceit, or manipulation in a fiduciary capacity or in connection with the purchase or sale of any security registered under section 12 or 15(d) of the Securities Exchange Act of 1934 or under section 6 of the Securities Act of 1933;

(iii) any civil remedy under section 1964 of title 18; or

(iv) any criminal act, intentional tort, or willful or reckless misconduct that caused serious physical injury or death to another individual in the preceding 5 years.

(2) Paragraph (1) shall not apply to the extent the amount of an interest in property described in subparagraphs (A), (B), (C), and (D) of subsection (p)(1) is reasonably necessary for the support of the debtor and any dependent of the debtor.

It is unclear what is meant by the phrase in §522(q)(1)(A) “a felony (as defined in §3156 of title 18)” as such section states:

(3) the term “felony” means an offense punishable by a maximum term of imprisonment of more than one year;
This definition does not refer to any particular felony nor does it relate to a Federal vs. State criminal statute. So, does this mean that anyone who has ever been convicted of a felony would fall within this statute? If so, then what does “circumstances, demonstrate that the filing of the case was an abuse” mean?  It is not certainly a specific standard, which in turn would leave the door open for creditor’s lawyer to argue a creative case. The other specific criminal acts relate to securities violations and are clearly a result of the Enron/Worldcom/Tyco fiascos.

For the title examiner, there will either be an objection to the claim or exemption filed or not.  If an objection is filed, then there will be an order entered which either allows or disallows the claim of exemption.

If no objection is filed, then the exemption is conclusively allowed for all purposes upon the expiration of the objection deadline of 30 days after the conclusion of the creditors’ meeting. Either way, the allowance of the claim of exemption removes the Property from the Estate, whereas, the disallowance of such means the Property remains in the Estate and one must look further to determine its disposition.

Documents to review and process:

1. Schedule of Real Estate. Is the Property is listed?
   1. No.  Stop and require additional action to cure.
   2. Yes. Next step.
2. Schedule C, Claim of Exemption. Is the Property is listed?
   1. No. Go to Abandonment.
   2. Yes. Next step.
3. Was there an objection to the Exemption?
   1. No. Exemption allowed, Property removed from estate.
   2. Yes. Next step
4. Review the Court order related to the objection to the Exemption.
   1. Objection denied, exemption allowed, Property removed from estate.
   2. Objection granted, exemption NOT allowed, Property remains in estate, go to next inquiry, Abandonment.

IV. C. ABANDONMENT OF PROPERTY OF THE ESTATE

Concept: Property is no longer property of the estate if it is abandoned. Abandonment may occur by: Court order; Trustee affirmative action by filing report of no distribution or notice of intent to abandon; or by the closing of the case.

The legal effect of abandonment under 554 was discussed in the case of In re Renaissance Stone Works, L.L.C., 373 B.R. 817, 820 -821 (Bankr.E.D.Mich.,2007):

By definition, then, the effect of a trustee abandoning property of the estate under § 554 is simply that whatever legal or equitable interests the debtor may have had in the property are no longer included in the property of the bankruptcy estate. Abandonment does not and cannot convey to any third party any of the estate’s (or the debtor’s) legal or equitable interests in property. And abandonment of estate property under § 554 is different than a sale of estate property under Code § 363.

Many cases hold that abandoned property reverts nunc pro tunc to its prepetition status as if no bankruptcy had been filed. See, e.g., Morlan v. Universal Guar. Life Ins. Co., 298 F.3d 609, 617 (7th Cir.2002)(“[W]hen property of the bankrupt is abandoned, the title ‘reverts to the bankrupt,*821 nunc pro tunc, so that he is treated as having owned it continuously.’ ”)(quoting Wallace v. Lawrence Warehouse Co., 338 F.2d 392, 394 n. 1 (9th Cir.1964)); Mason v. Commissioner of Internal Revenue, 646 F.2d 1309, 1310 (9th Cir.1980)(“When the court grants a trustee’s petition to abandon property in a bankrupt’s estate, any title that was vested in the trustee is extinguished, and the title reverts to the bankrupt, nunc pro tunc.”); Bergeron v. Ross ( In re Ross), 367 B.R. 577, 580 (Bankr.W.D.Ky.2007)(quoting Dewsnup v. Timm ( In re Dewsnup), 908 F.2d 588, 590 (10th Cir.1990), aff’d, 502 U.S. 410, 112 S.Ct. 773, 116 L.Ed.2d 903 (1992)), (“ ‘[P]roperty abandoned under [section 554] ceases to be part of the estate. It reverts to the debtor and stands as if no bankruptcy petition was filed.’ ”); 3 Norton Bankruptcy Law and Practice 2d § 53:1 (William L. Norton, Jr., ed., June 2007)(same).[footnotes omitted]

The abandonment of property is governed under 554.  It may be accomplished through a Notice of abandonment, 554(a); duly entered order as a result of a Motion to Compel Abandonment, §554(b); or by operation of law, 554(c) or §362(h).

The Trustee or Debtor In Possession may affirmatively abandon Property by giving a Notice of Abandonment if the Trustee determines that such Property has no economic value to estate. This process is authorized by 554(a) and the procedure is regulated by FRPB 6007(a). Property is abandoned if a formal notice of abandonment is filed by the Trustee or Debtor In Possession and no pleading responsive to such notice is filed within 15 days.  If a pleading responsive to such notice is filed, then the Court will set a hearing and either approve the abandonment or deny such.

The Trustee may also abandon property by filing formal document in the case called a “Report of No Distribution” wherein the Trustee states that they do not intend to administer any thing. “Upon entry of the Trustee’s Report of No Distribution, the trustee effectively abandoned any interest of the estate in the [property]. 11 U.S.C. § 554(c). Accordingly, the property, having been abandoned, the automatic stay is no longer in effect as to the [property]. 11 U.S.C. § 362(c)(1).”  American Nat. Bank & Trust Co. v. DeJournette, 222 B.R. 86, 91 (W.D.Va.,1998).

The Trustee can under some circumstances withdraw a Report of No Distribution. If this occurs, then you cannot rely upon such to accomplish abandonment. You must always review the entire docket to ensure that such a report was not subsequently withdrawn. If it was withdrawn, then you must look to some other means by which the Property was removed from the estate.

In a Motion for abandonment, if the property is burdensome to the trustee and has no value, the Court will determine it to be abandoned. This is the same issue which will arise with the trustee in a motion for relief from the stay. Consequently, most Courts allow a combined motion for relief from stay and to compel the trustee to abandon the property.

Whether by Trustee’s Notice or by Motion for abandonment, 15 days notice is required. Notice may be reduced or limited by proper application and order under FRBP 9006(c). If such a Notice or Motion is filed, then look to see if a response was filed. If there was none, then an order will be entered granting the Motion, but not so as to the Notice. The Notice of Intent to Abandon is self-effectuating after 15 days in absence of any response.

Scheduled Property is abandoned if it is still in the estate when the case is closed, unless there is a specific order of the Court to the contrary.  554(c). “It recognized that the closing of a bankruptcy case normally results in a technical abandonment to the debtor of all unadministered property under § 554(c)…” In re Wick, 276 F.3d 412, 414 (8^th. Cir. (Minn.),2002).

Documents to review and process:

1. Schedule of Real Estate. Property is listed and not claimed exempt on Schedule C.

2. Motion for abandonment filed?

a. Yes.

i. Order granting. Property is removed from estate.

ii. Order denying. Go to next step.

b. No. Go to next step.

3. Notice of Intent to Abandon filed?

a. Yes.

i. Objection filed?

1. Yes.

a. Order granting. Property is removed from estate.

b. Order denying. Go to next step.

2. No. Property is removed from estate.

b. No. Go to next step.

4. Report of No Distribution?

a. Yes. Property is removed from estate.

b. No. Next Step.

5. Case Closed.

a. Property is removed from estate.

V. AUTOMATIC STAY

Concept: The Automatic Stay enjoins actions by creditors or other parties to enforce their lien claims against the Property. The stay must be terminated or modified before a creditor may take action to transfer title to Property.

The Automatic Stay comes into existence upon the filing of the petition in virtually every case, hence the term “Automatic”. The §341 notice provides for notice of the imposition of the Automatic Stay. It is beneficial to conceptualize a bankruptcy case as a request for an injunction. The issuance of the Automatic Stay amounts to an ex parte temporary restraining order which ultimately ripens into a permanent restraining order upon the issuance of the discharge.  The automatic stay is governed by §362. Essentially, this injunction enjoins virtually all creditors from taking any action against the debtor or the Property.

In any situation where there is some legal action pending regarding the Property, such as a foreclosure, the stay must be modified before such action may continue.

The Tenth Circuit Court of Appeals held in the case of Ellis v. Consolidated Diesel Elec. Corp. , 894 F.2d 371, 372 -373 (10^th Cir. (Okl.),1990) that actions taken in violation of the stay are void:

According to the automatic stay provisions of section 362, all proceedings against a debtor are stayed upon the debtor’s filing of a petition for bankruptcy. 11 U.S.C. § 362(a)(1). It is well established that any action taken in violation of the stay is void and without effect. Kalb v. Feuerstein, 308 U.S. 433, 438, 60 S.Ct. 343, 346, 84 L.Ed. 370 (1940) (“the action of the … court was not merely erroneous but was beyond its power, void, and subject to collateral attack”); Meyer v. Rowen, 181 F.2d 715, 716 (10th Cir.1950); In re Sambo’s Restaurants, Inc., 754 F.2d 811, 816 (9th Cir.1985); Borg-Warner Acceptance Corp. v. Hall, 685 F.2d 1306, 1308 (11th Cir.1982); 2 Collier on Bankruptcy § 362.11 (15th ed. 1989).[Footnotes omitted].

The Title Examination Standards make reference to the fact that the automatic stay is effective regardless of whether or not notice of such is filed in the land records in T. 16, Ch. 1, App., Standard 30.14, which states:

The automatic stay of a federal bankruptcy proceeding is not subject to the requirements of Title 28 U.S.C.A. § 1964. The automatic stay is generally effective without filing notice and regardless of where the bankruptcy is filed, 11 U.S.C.A. § 362(a);

Exceptions to the automatic stay are set forth in §362(b); however, virtually all actions related to the Property claims will not be exempt from the stay. It is critical that all foreclosure and other actions pertaining to the Property be stopped upon being given notice of the filing of the bankruptcy case by the Owner. If you discover that for some reason such activities have not ceased, take corrective measures to stop them at once.  §362(k)(1) creates a cause of action for damages, both actual and punitive, attorney’s fees and costs, for any creditor who willfully violates the provisions of §362. Bankruptcy Judges take a very dim view of creditors who intentionally violate the stay after they have been asked to stop and usually require such creditors to pay for such transgressions.

V. A. Automatic Termination of the Automatic Stay

There are several provisions under the Code which effectuate an automatic termination of the automatic stay. In essence, if these situations apply to your case, you don’t have to do anything but wait the appropriate period of time for the automatic stay to simply “go away”. Although the “automatic” termination of the “automatic stay” its not dealt with in the Title Standard and appears to cause some consternation among title examiners and insurers.

V. A.1. Failure to File and Perform Statement of Intention

If the Bankruptcy Case is one under Chapter 7, then §362(h) provides for the automatic termination of the stay and for abandonment of the property if the debtor fails to timely perform their intentions under §521(a)(2) unless they attempt to reaffirm based on the original contract terms and the creditor refuses to agree to such reaffirmation. Specifically, §521(a)(2)(A) requires the debtor to file a statement of intention within earlier of 30 days after the petition date or the date set for the creditor’s meeting (unless extended by an order of the Court). Thereafter, §521(a)(2)(B) requires the debtor to perform their stated intention within 30 days after the creditor’s meeting (unless such time period is extended by a court order obtained before the 30 day period expires). Therefore, in the vast majority of foreclosure cases, the Debtor will have no practical ability to reaffirm the debt and thus, in most typical Chapter 7 cases, the Automatic Stay will automatically terminate in no more than approximately 60 days.

With regard to real property, the statement of intention provides the debtor must either surrender or reaffirm the debt secured by a lien upon the real property. §362(h)(A) provides the debtor must timely file the statement of intention and §362(h)(B) requires that such stated intentions must be performed within the time frames established by §521(a)(2).  If the debtor fails in any of these obligations, then the stay automatically terminates. Also, note that not only does the stay terminate, but also, the property in question is abandoned from the Bankruptcy Estate. No motion, notice or order is required.

If the Debtor’s intention is to surrender the Property, then there will not be any further documentation in the record to provide evidence that such actions were taken. If the Debtor states they intend to surrender the Property and one finds no further pleadings in the record, then the only conclusion is that the Property was surrendered. If the Debtor fails to surrender the Property, then you will probably see a motion filed by the creditor, but since such is not required, you cannot rely upon such occurring.

If the Debtor’s intention is to reaffirm the debt secured by the Property, then there will be a filed reaffirmation agreement reflected on the docket. Reaffirmation of a debt may ONLY be accomplished by a timely filed reaffirmation agreement.

Quandary: The problem is that performing the stated intention DOES NOT cause an automatic abandonment, whereas failure to do so DOES result in automatic abandonment. If the Debtor does perform the stated intention, then you must look for some other evidence of abandonment as stated above. If the Debtor does not perform the stated intention, then you face a difficult situation because the Title Standards do not appear to address this situation at all. To be safe, I would recommend you require a Comfort Order as provided below.

Note that the Chapter 7 Bankruptcy Trustee (and only the Trustee) may obtain relief from the automatic termination of the automatic stay by filing a motion, upon notice and opportunity, before the automatic stay automatically terminates as provided in §362(h)(2) as follows:

Paragraph (1) does not apply if the court determines, on the motion of the trustee filed before the expiration of the applicable time set by §521(a)(2), after notice and a hearing, that such personal property is of consequential value or benefit to the estate, and orders appropriate adequate protection of the creditor’s interest, and orders the debtor to deliver any collateral in the debtor’s possession to the trustee. If the court does not so determine, the stay provided by subsection (a) shall terminate upon the conclusion of the hearing on the motion.

This section would likely only be used when there is significant equity in non-exempt property, or if the Trustee believes the creditor’s lien upon such non-exempt property is defective in some manner so that such lien is avoidable. It is important to note that the automatic provisions also provide for automatic abandonment of the property in question from the Bankruptcy Estate. Thus, if the Trustee fails to timely seek relief from the automatic termination of the stay, then the Property is automatically removed from the estate.

V.A.2. Serial Filings

For years, creditors have been frustrated by debtors who file multiple cases, particularly, Chapter 13 cases which allow for instanter dismissals with no prohibition to re-filing an unlimited number of sequential cases (i.e., “Serial Filing”). Each filing creates an automatic stay, thereby delaying recovery of collateral for what sometimes seems like eternity at the cost of thousands of dollars to the creditor. §362 was amended to stop this practice.

§§362(c)(3) and (4) specifically address Serial Filings. §362(c)(3) automatically terminates the stay 30 days post-petition in the case of an individual debtor who files a second case under Chapter 7, 11 or 13 within one year after the dismissal of the first case, unless the second case is not a Chapter 7 and the first case was a Chapter 7 that was dismissed under §707(b). An extension of the automatic termination is possible only if the second case is filed in good faith and the order granting such extension must be entered BEFORE the 30 day period expires. The standard for good faith is also statutory and requires the moving party must comply with the following sections:

(C) for purposes of subparagraph (B), a case is presumptively filed not in good faith (but such presumption may be rebutted by clear and convincing evidence to the contrary) –

(i) as to all creditors, if –

(I) more than 1 previous case under any of Chapters 7, 11, and 13 in which the individual was a debtor was pending within the preceding 1-year period;

(II) a previous case under any of Chapters 7, 11, and 13 in which the individual was a debtor was dismissed within such 1-year period, after the debtor failed to –

(aa) file or amend the petition or other documents as required by this title or the court without substantial excuse (but mere inadvertence or negligence shall not be a substantial excuse unless the dismissal was caused by the negligence of the debtor’s attorney);

(bb) provide adequate protection as ordered by the court; or

(cc) perform the terms of a plan confirmed by the court; or

(III) there has not been a substantial change in the financial or personal affairs of the debtor since the dismissal of the next most previous case under Chapter 7, 11, or 13 or any other reason to conclude that the later case will be concluded—

(aa) if a case under Chapter 7, with a discharge; or

(bb) if a case under Chapter 11 or 13, with a confirmed plan that will be fully performed; and

(ii) as to any creditor that commenced an action under subsection (d) in a previous case in which the individual was a debtor if, as of the date of dismissal of such case, that action was still pending or had been resolved by terminating, conditioning, or limiting the stay as to actions of such creditor;

If the debtor files a case and there were 2 pending within the previous year that were dismissed unless the third case is not a Chapter 7 and the other cases were Chapter 7’s that were dismissed under §707(b), then there is NO STAY upon the filing of the 3rd case. §363(c)(4)(A)(i). There is also the right to a comfort order under §363(c)(4)(A)(ii) just like §363(j) above, although this seems redundant.

As with §363(c)(3)(B) above, §363(c)(4)(B) provides for obtaining a stay in the third serial filing case only by compliance with the following:

(B) if, within 30 days after the filing of the later case, a party in interest requests the court may order the stay to take effect in the case as to any or all creditors (subject to such conditions or limitations as the court may impose), after notice and a hearing, only if the party in interest demonstrates that the filing of the later case is in good faith as to the creditors to be stayed;

(C) a stay imposed under subparagraph (B) shall be effective on the date of the entry of the order allowing the stay to go into effect; and

(D) for purposes of subparagraph (B), a case is presumptively filed not in good faith (but such presumption may be rebutted by clear and convincing evidence to the contrary) –

(i) as to all creditors if –

(I) 2 or more previous cases under this title in which the individual was a debtor were pending within the 1-year period;

(II) a previous case under this title in which the individual was a debtor was dismissed within the time period stated in this paragraph after the debtor failed to file or amend the petition or other documents as required by this title or the court without substantial excuse (but mere inadvertence or negligence shall not be substantial excuse unless the dismissal was caused by the negligence of the debtor’s attorney), failed to provide adequate protection as ordered by the court, or failed to perform the terms of a plan confirmed by the court; or

(III) there has not been a substantial change in the financial or personal affairs of the debtor since the dismissal of the next most previous case under this title, or any other reason to conclude that the later case will not be concluded, if a case under Chapter 7, with a discharge, and if a case under Chapter 11 or 13, with a confirmed plan that will be fully performed; or

(ii) as to any creditor that commenced an action under subsection (d) in a previous case in which the individual was a debtor if, as of the date of dismissal of such case, such action was still pending or had been resolved by terminating, conditioning, or limiting the stay as to such action of such creditor.

It is important to note that under both §§362(c)(3) and (4), any creditor who obtained an order “terminating, conditioning or limiting the stay as to such action of such creditor” or who had an unresolved, pending motion for such relief, is essentially exempt from any  continuation or imposition of the stay in a second or third serial case.  So, despite all of these automatic terminations of the stay, it is still good practice to file a motion for relief from stay and obtain an order to essentially immunize the creditor from serial filings.

This is particularly important because §§362(c)(3) and (4) do not provide for automatic abandonment of property.

A.3. In Rem Enforcement Exception

A new subsection 362(b)(20) is added to exclude from the automatic stay actions to enforce liens or security interests following entry of an in rem order described in the new §362(d)(4), unless the debtor in the subsequent bankruptcy case successfully reinstates the automatic stay under the provisions of (d)(4).

Code §362(d)(4) provides that, as to real property, if the court finds that the bankruptcy case was filed as part of a “scheme to delay, hinder, and defraud creditors”, either by the transfer of all or part of an interest in the realty without the secured creditor’s consent or by multiple bankruptcy filings that affect the realty (presumably stopping foreclosure actions, for example), the court may grant in rem relief from the automatic stay. If an order for relief under this section has been duly entered, then the automatic stay simply does not apply to a lienholder’s right to enforce its lien rights to the particular Property subject to such an order in any bankruptcy case filed after the entry of such an order. However, such an order does not prevent the real property from becoming property of the estate nor does it effect an automatic abandonment of such property.

While this may seem to be a good avenue in cases of serial filing, upon deeper analysis, such is probably not the case most of the time. The problem with this section is that it requires the Bankruptcy Court to make findings of fact that are very difficult to prove. As of the February 18^th, 2008, a search for cases decided under §362(d)(4) found:

Granted:

In re Young, 2007 WL 128280, 10 -11  (Bankr.S.D.Tex.,2007)

Denied:

In re Duncan & Forbes Development, Inc., 368 B.R. 27, 32 (Bankr.C.D.Cal.,2006)

In re Abdul Muhaimin, 343 B.R. 159, 167 (Bankr.D.Md.,2006)

In re Gould 348 B.R. 78, *80 -81 (Bkrtcy.D.Mass.,2006)

In the three opinions wherein relief under §362(d)(4) was denied, the Court focused on each element of scheme to delay, hinder, and defraud, requiring the moving creditor to prove each “delay,” “hinder,” AND “defraud” as independent elements requiring separate proof. The one reported decision cited above where relief was granted provides little hope for creditors as the court did not engage in any real analysis of the issues.

It is also noteworthy that your author has personal knowledge that Judge Michael followed the analysis of the courts that denied relief under §362(d)(4), although the case was dismissed. See In Re Light of the World Interdenominational Deliverance, Case No. 06-10583-M, Docket Entry 61. There is no order or opinion in the case as such was a telephonic bench ruling.

In the event one chooses this approach, counsel must be prepared to somehow prove that the bankruptcy filing was part of a scheme to defraud creditors. Just how one proves such a thing remains to be seen.

If on manages to obtain relief under this section, such relief from the stay has a binding effect in any other bankruptcy case that might be filed within two years of the entry of the order, provided that the order was also recorded in compliance with state real estate filing rules. A debtor in a subsequent case who may be affected by this in rem order could move for relief from the order to reinstate a stay, provided that the debtor must show a change of circumstances since entry of the order or other good cause. The subsection specifically provides that federal, state, or local governmental units must accept a certified copy of the in rem order for “indexing and recording”.

The sad reality of this section is that although Congress attempted to provide a form of relief that would be very helpful in the context of mortgage foreclosures, the use of the conjunctive word “AND” rather than the time honored, traditional disjunctive “OR” renders this provision essentially worthless in all but the rare case.

This type of automatic relief does not result in an abandonment of the Property from the Estate.

V. A.4. Single Asset Real Estate

The Reform Act modified the procedure for stay relief in single asset real estate cases. The definition “single asset real estate” is found in §101(51)(B).

The term “single asset real estate” means real property constituting a single property or project, other than residential real property with fewer than 4 residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental.

Essentially, the stay is automatically modified 90 days post petition unless a plan is filed or monthly cash payments are commenced “in an amount equal to interest at a current fair market rate on the value of the creditor’s interest in the real estate”. See §362(d)(3)(B). which states:

(3) with respect to a stay of an act against single asset real estate under subsection (a), by a creditor whose claim is secured by an interest in such real estate, unless, not later than the date that is 90 days after the entry of the order for relief (or such later date as the court may determine for cause by order entered within that 90-day period) or 30 days after the court determines that the debtor is subject to this paragraph, whichever is later –

(A) the debtor has filed a plan of reorganization that has a reasonable possibility of being confirmed within a reasonable time; or

(B) the debtor has commenced monthly payments that –

(i) may, in the debtor’s sole discretion, notwithstanding section 363(c)(2), be made from rents or other income generated before, on, or after the date of the commencement of the case by or from the property to each creditor whose claim is secured by such real estate (other than a claim secured by a judgment lien or by an unmatured statutory lien); and

(ii) are in an amount equal to interest at the then applicable nondefault contract rate of interest on the value of the creditor’s interest in the real estate; or

In the context of a Chapter 11 case, this provision gives mortgage holders additional leverage to obtain payments of money fairly early on in the case. Creditors may want to negotiate for an agreement that the debtor is in fact a single asset real estate case. Debtors will want to have a provision that the payments made under the cash collateral order are “equal to interest at a current fair market rate on the value of the creditor’s interest in the real estate”. Note that this particular automatic modification of the Automatic Stay does not effect an abandonment of the Property.

In the context of a Chapter 7, this provision may provide assistance to mortgage holder in an entity bankruptcy where the Trustee thinks there may be some value in the single item of real property, but where such property is not generating income. This provision mandates relief from the stay if actual monthly payments in real money do not start within 90 days.

V. B. Court Orders Regarding the Automatic Stay

Most of the time, a prudent title examiner should require a duly entered order stating that the stay has been modified.

V. B.1 Comfort Orders

Under any of the automatic termination provisions discussed above, §362(j) provides that “On request of a party in interest, the Court shall issue an order under subsection (c) confirming that the automatic stay has been terminated”. Note that this provision does not provide for notice and opportunity for a hearing, thus is appears it is intended that obtaining such an order is to be done on ex parte application. The new and revised Federal Rules of Bankruptcy Procedure were adopted and became effective December 1, 2007. The specific rule related to stay relief is Fed. R. Bankr. P. 4001, which states:

(a) Relief from stay; prohibiting or conditioning the use, sale, or lease of property

(1) Motion

A motion for relief from an automatic stay provided by the Code or a motion to prohibit or condition the use, sale, or lease of property pursuant to § 363(e) shall be made in accordance with Rule 9014 and shall be served on any committee elected pursuant to § 705 or appointed pursuant to § 1102 of the Code or its authorized agent, or, if the case is a Chapter 9 municipality case or a Chapter 11 reorganization case and no committee of unsecured creditors has been appointed pursuant to § 1102, on the creditors included on the list filed pursuant to Rule 1007(d), and on such other entities as the court may direct.

(2) Ex parte relief

Relief from a stay under § 362(a) or a request to prohibit or condition the use, sale, or lease of property pursuant to § 363(e) may be granted without prior notice only if (A) it clearly appears from specific facts shown by affidavit or by a verified motion that immediate and irreparable injury, loss, or damage will result to the movant before the adverse party or the attorney for the adverse party can be heard in opposition, and (B) the movant’s attorney certifies to the court in writing the efforts, if any, which have been made to give notice and the reasons why notice should not be required. The party obtaining relief under this subdivision and § 362(f) or § 363(e) shall immediately give oral notice thereof to the trustee or debtor in possession and to the debtor and forthwith mail or otherwise transmit to such adverse party or parties a copy of the order granting relief. On two days notice to the party who obtained relief from the stay without notice or on shorter notice to that party as the court may prescribe, the adverse party may appear and move reinstatement of the stay or reconsideration of the order prohibiting or conditioning the use, sale, or lease of property. In that event, the court shall proceed expeditiously to hear and determine the motion.

(3) Stay of order

An order granting a motion for relief from an automatic stay made in accordance with Rule 4001(a)(1) is stayed until the expiration of 10 days after the entry of the order, unless the court orders otherwise.

As you can see, there is nothing in the new and improved Bankruptcy Rules to address relief under §362(j). Although neither the Western nor Eastern Districts of Oklahoma have any local rule specifically addressing this issue, the Northern District has adopted a specific local rule addressing this point NDOK L.R. 4001(G) states:

G. Confirmation that Automatic Stay is Terminated. A request for an order under 11 U.S.C. § 362(j), confirming that the automatic stay has been terminated, may be made by application. An application pursuant to 11 U.S.C. § 362(j) shall provide the following information, as appropriate in the circumstances for each prior case: (1) if the prior filing was in this Court, the complete case caption, date of filing and date of dismissal; and/or (2) if the prior filing was in any other court, then, in addition to the requirements of (1), the movant shall also file relevant copies of all court records reflecting the information provided in subsection (1).

In any event, it seems clear that you should be able to get this statutory “comfort order” quickly. Just how quick remains to be seen depending upon which court you find yourself.

Since the Title Standards do not address these situations, then I would require a Comfort order in any of the automatic termination situations.

V. B.2. Motion for Relief from Stay

In other cases where there is no automatic termination of the automatic stay, an order granting relief from the stay requires the filing of a motion for relief from the stay pursuant to §362(d). Although this is often referred to as “lifting the stay” it should be noted that the Code refers only to termination, modification, annulling or conditioning the stay. In a Chapter 7, the debtor generally cannot successfully oppose a motion for relief from stay. §362(d) provides for relief from the stay when there is no equity in the property and the property is not necessary for an effective reorganization. Obviously in a Chapter 7 there is not ever going to be a reorganization so the creditor is almost always going to be entitled to relief from the stay. Even if there is equity in the property, unless the Trustee gets involved, most Bankruptcy Courts are not sympathetic to a Debtor’s resistance of a Motion for Relief from Stay based solely upon alleged equity particularly if the property is the Debtor’s homestead.

The trustee may oppose relief from the stay on the basis that the property not claimed as exempt has value in excess of the creditor’s secured claim. If this becomes an issue consider having the trustee sell the property pursuant to §363.

In the case of a motion for relief related to a foreclosure or other action effecting title to real property, it is also important the property is abandoned from the estate pursuant to §554 as discussed above. If it is not, notice must be given to the trustee of any subsequent action taken. The abandonment of property is accomplished through a motion to compel abandonment under §554 and the issue is value to the estate. If the property is burdensome to the trustee and has no value, the Court will determine it to be abandoned. This is the same issue which will arise with the trustee in a motion for relief from the stay. Consequently, most Courts do not have a problem with a combined motion for relief from stay and to compel the trustee to abandon the property. In the case of mortgaged real property, abandonment is a very important issue as a subsequent title examination will require this before the property’s title will meet the title standards. The combined motion for relief from stay and for abandonment of the property is hereinafter referred to as the “Motion”.

Notice is an area where many inexperienced counsel err. Anytime real property is involved, notice of the Motion must be given to all creditors listed on the matrix. If the creditor matrix has a large number of creditors so that giving notice to all of them is too expensive, then the movant is permitted to file an application to limit the notice under Federal Rules of Bankruptcy Procedure Rule 9029 and the corresponding local rule. Such an application must allege cause for limiting the notice. Language such as the following is fairly typical:

There are approximately 125 creditors and other parties in interest in this case. Providing full notice to all such parties of the Motions in this case is very costly and not necessary to provide due process in this case. The limited notice proposed herein is sufficient to serve the constitutional requirement of fair and reasonable notice in this case. Debtor proposes to limit the notice of the Motions to the parties identified in paragraph 4. Debtor will mail the Notice of the Sale which also contains notice of the hearing and notice to file objections to all parties on the matrix. Debtor submits all notices should be limited to the United States Trustee, all attorneys requesting notice, any committees appointed, all parties claiming

If there is an order limiting the notice to a specific group of parties, then make sure notice was provided to that group and file a certificate of service reflecting such.

Anytime there is a court proceeding which ultimately results effects the title to the Property and if the Owner files bankruptcy before such proceeding is concluded, then relief from the stay must be obtained before the proceeding may continue.

Documents to review and process:

1. Motion for relief from stay or Motion for Comfort Order filed.
2. Yes.
3. Order entered.
   1. Granting. Stay is terminated.
   2. Denied. Stay not terminated.
   3. No.

i. Property abandoned?

1. Yes. Stay is terminated as to Property.

ii. No. Stay is not terminated.

VI. SALE OF PROPERTY

Concept: If the Property has not been removed from the Estate by means of Exemption or Abandonment, then the only other way it can be removed from the Estate is by a sale. All bankruptcy sales require affirmative Bankruptcy Court approval by Court Order.

The Estate cannot hold Property indefinitely. Therefore, ALL non-exempt property that is not abandoned must be sold. The determining factor is whether or not there is value over and above any liens or mortgages. If the Property is does not have sufficient value to justify the costs of a sale and still garner funds to benefit the estate, then it will be abandoned. Otherwise, it will be sold.

Only the Trustee or the Debtor has authority to seek permission from the Court to sell the Property. 363(b)(1). Such authority must be requested by a Court Order granting a Motion after proper notice has been provided. Creditors have no basis to seek authority to sell property of the estate.  The determination of whether the moving party in the case is the Trustee or the Debtor depends upon the Chapter under which the case is filed:

Chapter 7: Only Trustee.

Chapter 11: Debtor In Possession, UNLESS Trustee has been appointed by Court Order.

Chapter 12: Debtor In Possession, UNLESS power supplanted by Trustee by Court Order.

Chapter 13: Only the Debtor UNLESS power supplanted by Trustee by Court Order.

The party with the authority to sell is hereinafter referred to as the “Estate Representative” or “ER.”

The ER may only sell property of the estate Sales after a properly noticed Motion seeking authority to sell is filed under §363 and an order is entered granting such Motion. The Motion will almost always seek to sell the Property “free and clear of liens, claims and encumbrances” under §363(f). Generally, the Motion should provide the legal description of the Property and request that the ER be authorized to sell the Property free and clear at a public or private sale describing the terms and conditions of the proposed sale. Such sales are generally referred to as “363 Sales.”

The Court may authorize the ER to sell real property that is encumbered by virtually any sort of lien, mortgage, judgment, claim or other encumbrance “free and clear” of such encumbrances. In such cases, there will not be any formal release of such encumbrances, rather the Order granting the Motion will substitute for the release as it will specifically state that the conveyance of the estate’s interest in the Property is free and clear of encumbrances. Such a sale is conceptually no different that a sheriff sale in a foreclosure action. It is very important that the Motion and Order granting such identify the parties claiming liens upon the Property and that notice of the pleadings and sale be given to all such parties.

363 Sales may be a public auction or private sale under an agreement negotiated prior to the filing of the Motion. The Bankruptcy Code does not provide any specific process or procedure for conducting the sale under §363, therefore, the Motion must set for the procedures, terms and conditions of the sale. Notice of the Motion to sell must be given to the debtor, the trustee, all creditors and indenture trustees, any committees formed pursuant to Sections 705 or 1102 and the United States trustee unless the Court orders otherwise upon application. Motions to sell may be granted after notice and an opportunity for objections without a hearing is no objection is filed.  If an objection is file, then a hearing will be held whereupon the Court will either grant or deny the Motion.  In order to proceed with the sale, there must be an order authorizing the ER conduct the sale.

In addition to the Motion, there must also be a Notice of Sale. At least 20 days in advance of the sale, a copy of the Notice of sale must also be provided to debtor, the trustee, all creditors and indenture trustees, any committees formed pursuant to Sections 705 or 1102 and the United States trustee (the “Parties”) unless such period is shortened by an Order of the Court under FPRB 2002(a)(2). It is very important to note that although the TIME for notice of the filing of objections to the Motion, the hearing and the sale may be shortened to less than 20 days by an order of the Court, the EXTENT of the Notice of the Sale may not be limited MUST be always be given to ALL Parties. Certificate of Service must be filed showing that proper notice of the sale was provided.  It is very common to see the Motion, Notice and Certificate of Service contained in the same pleading. The Notice of the sale must state:

1. Either

a. The time and place of any public sale; or

b. The terms and conditions of any private sale;

2. The time fixed for filing objections to the proposed sale; and

3. A description of the property being sold. Fed.R.Bankr.P. 2002(c)(1).

If the sale is a “free and clear,” then the notice must also state the date of the hearing on the motion and the time within which objections may be filed and served on the debtor-in-possession or trustee.

The Certificate of Service must show that notice was properly served on the parties who held liens or other interests in the property to be sold.

After the entry of an Order approving the sale is filed and after proper notice has been given, the ER must also sign a deed conveying the Property. Such deeds are always a without any warranty of title. Who would want such a warranty? The estate is virtually always insolvent and is by its very nature, a temporary creature.

Documents to review and process:

1. Motion to Sell filed.

a. Verify authority of ER.

b. Cert. of Service reflecting proper notice Motion.

2. Objection to Motion filed?

a. Yes.

i. Hearing set.

ii. Cert. of Service reflecting proper notice of time to file objections hearing

iii. Order Entered.

1. Granting Motion.  Next, check for notice of sale.

2. Motion Denied.  NO sale.

b. No.

i. Cert. of Service reflecting proper notice of time to file objections and hearing.

ii. Order Entered. Next, check for notice of sale.

3. Notice of Sale filed.

a. Yes.

i. Check Content of Notice.

ii. Cert. of Service reflecting proper notice.

a. Private Sale: The terms and conditions of any private sale.

b. Public Sale: The time and place of any public sale.

c. Description of property and other terms of sale.

b. No. No sale can occur.

2. Conveyance of Property properly executed by ER.

VII. REORGANIZATION CHAPTERS

Concept: A confirmed Plan under Chapters 11, 12, or 13 may authorize or directly affect the transfer of Property from the Estate.

This last section discusses the additional issues related to Chapter 11, 12 and 13 cases, all of which are reorganization chapters. Each of these types of cases may result in entry of a Court Order confirming a Plan. The Plan may contain provisions which authorize the ER to transfer the Property, either by a sale similar to a 363 Sale or by conveyance to the Debtor or a third-party as a means to implement the Plan.

VII. A. AUTHORITY TO TRANSFER TITLE IN THE PLAN

Each of the three different reorganization chapters has different provisions which MAY be included in a plan that will upon confirmation result in the transfer of title to the Property. The following Code provisions specify that a Plan under the various chapters may authorize or provide for transfer of title to the Property.

Chapter 11:

§ 1123. Contents of plan.
(a) Notwithstanding any otherwise applicable nonbankruptcy law, a plan shall –

(5) provide adequate means for the plan’s implementation, such as –

(A) retention by the debtor of all or any part of the property of the estate;

(B) transfer of all or any part of the property of the estate to one or more entities, whether organized before or after the confirmation of such plan;

(C) merger or consolidation of the debtor with one or more persons;

(D) sale of all or any part of the property of the estate, either subject to or free of any lien, or the distribution of all or any part of the property of the estate among those having an interest in such property of the estate;

(b) Subject to subsection (a) of this section, a plan may –

(4) provide for the sale of all or substantially all of the property of the estate, and the distribution of the proceeds of such sale among holders of claims or interests;

Chapter 12:

(b) Subject to subsections (a) and (c) of this section, the plan may –

(7) provide for the payment of all or part of a claim against the debtor from property of the estate or property of the debtor;

(8) provide for the sale of all or any part of the property of the estate or the distribution of all or any part of the property of the estate among those having an interest in such property;

(10) provide for the vesting of property of the estate, on confirmation of the plan or at a later time, in the debtor or in any other entity;

Chapter 13:

§ 1322. Contents of plan

(b) Subject to subsections (a) and (c) of this section, the plan may –

(8) provide for the payment of all or part of a claim against the debtor from property of the estate or property of the debtor;

(9) provide for the vesting of property of the estate, on confirmation of the plan or at a later time, in the debtor or in any other entity;
§ 1303. Rights and powers of debtor

Subject to any limitations on a trustee under this chapter, the debtor shall have, exclusive of the trustee, the rights and powers of a trustee under sections 363(b), 363(d), 363(e), 363(f), and 363(l), of this title.

To determine if a particular Plan authorizes the ER to transfer title, you must read the Plan and the Order confirming the Plan. The provisions will typically specify the procedure and authority for the transfer of title. This can be one of several modalities:

1. Sale. The Plan may provide for the sale of the Property by public or private sale the same as under a 363 Sale. Typically, the Plan will set for the procedure and process to be utilized to accomplish the sale. You must read the Plan and insure that the process provided was followed. The ER should sign a deed to convey title.

2. Surrender to a creditor. The Plan may provide for the surrender or transfer of all or any portion of the Property to a creditor as payment of the debt owed to such creditor. Typically, the Plan will set for the procedure and process to be utilized to accomplish the sale. You must read the Plan and insure that the process provided was followed. The ER should sign a deed to convey title.

3. Transfer to a Trust or other entity for subsequent sale. The Plan may provide for the transfer of all or any portion of the Property to a trust for the benefit of the creditors. The trustee of this trust is then responsible for the administration of the Property as provided by the terms of the trust. The Plan will set for the procedure and process to be utilized to facilitate the trust. Thereafter, the trustee will administer the property as provided under the terms of the trust. Sometimes, the Property will remain in the estate so that the trustee may utilize the powers of a 363 Sale to liquidate the Property, but not always. You must read the Plan and the trust to determine the process set up thereby and insure that it was followed.

VII. B. Plan Confirmation

The plan is the main issue in any reorganization case. In essence, the confirmation of the plan creates a new contract between the debtor and their creditors. Conceptually, the plan is a global loan modification agreement.

In any case, a Plan must be approved by the Court, a process known as “Confirmation.” The key difference between Chapter 11 and Chapter 12 & 13 cases is that Chapter 12 & 13 do not require the agreement of any creditor for its approval.  There is no requirement in Chapter 12 or 13 that any creditor affirmatively accept the plan nor is there anything like the absolute priority rule and its’ new value exception which is found in Chapter 11 cases. “The secured creditor’s consent is not required — a Chapter 13 plan is through and through a “cram-down” plan (it is crammed down the throats of the unconsenting creditors).” In re Henry, 266 B.R. 457,471 (Bankr.C.D.Cal.,2001).

In a Chapter 12 & 13 confirmation the issues are statutory compliance. The plan must comply with all of the provisions of §§1322 and 1325 for Chapter 13 and §§1222 and 1225 for Chapter 12. If it does, then the court must confirm the plan, otherwise, confirmation is denied.

In Chapter 11 cases, there is a requirement that creditors consent to the Plan by voting. Creditors are “classified” in to groups. At least one Class must vote to accept the Plan. Typical classes and their respective voting rights are:

1. Administrative Claims, Non-voting.

2. Priority Claims, Non-Voting.

3. Secured Claim, voting.

4. Unsecured Claims, voting.

5. Post-petition claims, non-voting.

6. Bond & debenture claims, voting.

7. Owner interests, ie Stockholders etc., voting.

A class of claims otherwise entitled to vote on the plan may lose their voting rights if such class is “unimpaired” only if the rights of the member of such class are totally unaffected by the Plan. Otherwise, the voting class is impaired.

Votes on the Plan are counted on a class by class basis. If all voting Classes vote to accept the plan, then if the Plan meets the other 14 statutory requirement for confirmation, the Court will enter an order confirming the Plan. At least one impaired voting class votes to accept the Plan, but other do not, then the Court may still confirm the Plan under what is commonly referred to as “cram-down.”

VII. C. Confirmation Issues

Chapter 13 confirmation is governed by §1325 and has in essence 7 requirements to confirm a plan. In larger contrast is Chapter 11, which has 16 requirements to confirm a plan, found in §1129(a).

In the case of an individual, all of the confirmation requirements of Chapter 13 are present in Chapter 11 including the disposable income requirement. There are in essence 8 more hurdles to jump to get a plan confirmed in 11 than are present in 13. The major difference is that Chapter 11 requires a majority of the creditors to vote for the plan to obtain confirmation unless the debtor has the ability to “cram down” the plan under §1129(b). It is very difficult to obtain confirmation by cram down when the rejecting class is an unsecured class since the Debtor is required to give up ownership by cancellation of the pre-petition equity. A notable exception under the Reform Act has been created for individuals. Such Debtors may retain their pre-petition equity if they pay their disposable income to the creditors.

A complete discussion of the confirmation of Chapter 11 is far beyond the scope of this paper. In the event a comparison of the plans leads one to the conclusion that a plan can be confirmed under either chapter based on the matters already discussed, be sure to look at the addition requirements to confirm a Chapter 11 plan. Most of them are not too meaningful in an individual case, but sometimes there are issues which are barriers to Chapter 11 which are not present in Chapter 13.

Because of the voting aspect of Chapter 11, there is also the requirement that the Debtor prepare and obtain approval of a disclosure statement prior to any solicitation of binding acceptance of the proposed plan. §1125. This is an informational document which requires a lot of time and effort to prepare. If there is a confirmable plan, then it is almost always possible to obtain approval of the disclosure statement even if a creditor objects, since the only real issue is the adequate information in the disclosure statement.

VII. D. Confirmation Process

Chapter 12 & 13:

To obtain an order confirming a Plan in Chapter 12 & 13 cases, the Plan must be filed. Only the Debtor may file the Plan. The Court will set a hearing on the Plan by means of a separate notice of hearing that will also set forth the deadline for filing objections to the Plan. The Plan and the Notice of Hearing must be mailed to ALL parties and a Certificate of Service reflecting such must be filed in the case. At the hearing, the Court will either confirm or deny confirmation of the Plan. If the Order confirms the Plan, then the Order must be mailed out to the all Parties.

20 days notice of the Confirmation Hearing is required in Chapter 12 cases. FRBP 2002(a)(8). Whereas, 25 days notice of the Confirmation Hearing is required in Chapter 11 & 13 cases. FRBP 2002(b)(2). These time limits may be modified by duly entered Court Order.

Chapter 11:

Chapter 11 Plans are semi-consensual in nature as discussed above. As a result, there is voting on the Plan. Typically, the Plan and Disclosure Statement are filed concurrently by the Debtor, although under certain circumstances, other parties may file their own Plan and Disclosure Statement. If more than one Plan and Disclosure Statement are filed, they are usually referred to as “Competing Plans.” The party filing a particular Plan and Disclosure Statement is called the “Plan Proponent.”

Before the parties are allowed to vote on the Plan, the Court must approve the sufficiency of the Disclosure Statement. Upon the filing of the Plan and Disclosure Statement, a notice of hearing on the Disclosure Statement will be issued which must be served upon all parties at least 25 days prior to the hearing unless limited by Court Order. Generally, notice of the hearing on the Disclosure Statement must be sent to:

a. the debtor;

b. the trustee;

c. the creditors and indenture trustees;

d. any equity security holders;

e. the United States Trustee; and

f. all other parties in interest, including:

1. any committees appointed;

2. the S.E.C.;

3. the I.R.S.;

4. the U.S. Attorney;

5. the department, agency, or instrumentality of the U.S. through which the debtor became indebted to the U.S. (if any) and

6. the Secretary of the Treasury.

Note that the actual Disclosure Statement is not mailed out to this rather long list of parties, but only to a smaller list which includes:

a. the debtor;

b. any trustee or committee that has been appointed;

c. the S.E.C.; and

d. any party that has filed an Entry of Appearance.

Smaller Chapter 11 cases may proceed as a small business Chapter 11. “Small” in this case means the Debtor has “aggregate noncontingent liquidated secured and unsecured debts as of the date of the petition or the date of the order for relief in an amount not more than $2,190,000” §101(51D). Note that this number is subject to COLA type adjustments on an annual basis. In such cases, the Court will automatically approve the Disclosure Statement on a conditional basis without notice to any party, then set both the Plan and Disclosure Statement for hearing at the same time.

Either way, look for an order approving the Disclosure Statement, setting deadlines for ballots and objections and setting the Plan for hearing (the “DS Order”). Upon the entry of the DS Order the following mailings must occur:

a. the plan, or a court approved summary;

b. the approved Disclosure Statement;

c. a ballot

d. the DS Order;

Mailed to:

1. all creditors;

2. all equity security holders;

3. all committees; and

4. the U.S. Trustee.

In order for the votes to court, the voting creditors typically return the Ballots to the attorney for the Plan Proponent, or as otherwise instructed in the DS Order by the deadline stated in DS Order. Note that Ballots are virtually never mailed to the Court Clerk. The party receiving the Ballots will court the votes, will then file a pleading setting forth the results of the voting, typically styled “Ballot Report.” The Ballot Report will usually have the Ballots attached thereto.  Note that the filing of the Ballot Report is not specified in Bankruptcy Code nor the FRBP, so practices may vary widely among different Bankruptcy Courts.

Parties may file objections to the confirmation of the Plan which the Court will consider at the confirmation hearing at the time set forth in the DS Order. It is very common for the parties filing objections and the Plan Proponent to negotiate a revision to the Plan to resolve the objection resulting in the filing of a Plan Modification. It is not uncommon to see multiple modifications filed to a Plan.

After the confirmation hearing, the Court will either approve or deny the Plan, as modified by any Plan Modifications that are filed and enter a formal Order Confirming the Plan (the “Confirmation Order”). It is also not uncommon to see the Confirmation Order made additional revisions to the Plan. Although it is good practice to file a amended and re-stated Plan after the confirmation hearing which incorporates into one document all of the Plan Modifications, such is not required by the Code nor the FRBP. It is unfortunate, but sometimes one must look through several different documents to ascertain the terms of the confirmed Plan. Despite the fact that the Title Standard 34.1 states: “Must conform to the Official Form. Fed.R.Bankr.P. 3020(c),” the fact is that such orders many times do not so conform.

Notice of the entry of the Conformation Order must be mailed to:

a. the debtor;

b. the trustee;

c. all creditors;

d. all equity security holders;

e. the U.S. Trustee; and,

f. all other parties in interest.

A certificate of mailing should be filed reflecting all of the required mailings.

If the Plan provides for the transfer of title to the Property, then the ER should execute a good and sufficient deed to accomplish such transfer, against without any warranty of title.

Keep in mind that Plan in Chapter 12 and 13 cases may be amended or modified anytime after confirmation until the case is closed. Chapter 11 Plan may only be amended or modified until “substantial consummation” occurs.

11 U.S.C. § 1101(2) provides:

“substantial consummation” means –

(A) transfer of all or substantially all of the property proposed by the plan to be transferred;

(B) assumption by the debtor or by the successor to the debtor under the plan of the business or of the management of all or substantially all of the property dealt with by the plan; and

(C) commencement of distribution under the plan.

Pretty much any event taken to commence fulfillment of the Chapter 11 Plan will constitute substantial consummation. Therefore, very few changes to a Chapter 11 Plan will be approved AFTER it is confirmed.

Any post-confirmation changes to the Plan must be approved by a Court Order after proper notice. All references to the term “Plan” include any and all amendments or modifications approved by Court Order.

Documents to review and Process:

Chapter 12 & 13:

Is there a deed from the ER?

YES: Review Plan for terms authorizing transfer.

No: Curative Measures required.

YES: Review notice/order re confirmation hearing and COS

a. Was the Plan and notice of confirmation hearing properly mailed?

No: Curative Measures required.

Yes: Was the Plan confirmed?

No: Curative Measures required.

Yes: Property is out of Estate.

Chapter 11:

Is there a deed from the ER?

YES: Review Plan for terms authorizing transfer.

No: Curative Measures required.

YES: Review notice/order re Disclosure Statement hearing and COS

a. Was the Disclosure Statement and notice of hearing properly  mailed?

No: Curative Measures required.

Yes: Review notice/order re confirmation hearing and COS

b. Was the Plan and notice of confirmation hearing properly mailed?

No: Curative Measures required.

Yes: Was the Plan confirmed?

No: Curative Measures required.

Yes: Property is out of Estate.

X. Appeals

A complete discussion of appeals of bankruptcy orders is far beyond the scope of this presentation. Not all orders are immediately appealable because of their interlocutory nature. The most important thing to look for when relying upon a particular order is whether or not such order was appealed. Generally, appeals must be filed within 10 days after the order is entered on the court docket. FRBP 8002(a).

The filing of an appeal does not stay the effectiveness of the Order unless a stay is obtained under FRBP 8005. If the Order results in the ER being authorized to convey Property, most Courts will require a bond as a condition of entering a stay pending appeal.

Order authorizing a sale under §363 are subject to a specific savings provision which insulates the buyer under such an order. §363(m) provides:

(m) The reversal or modification on appeal of an authorization under subsection (b) or (c) of this section of a sale or lease of property does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale or lease were stayed pending appeal.

Most other Orders authorizing the ER to convey the Property will likely be dismissed if the conveyance occurs after an appeal is filed due to the absence of a stay pending appeal under the equitable doctrine of “mootness.” The Tenth Circuit discussed this doctrine in the case of Phelps v. Hamilton, 122 F.3d 885, 891(10^th Cir. (Kan.),1997):

The constitutional mootness doctrine is grounded in Article III’ s requirement that federal courts only decide “actual, ongoing cases or controversies.” Lewis v. Continental Bank Corp., 494 U.S. 472, 477, 110 S.Ct. 1249, 1253, 108 L.Ed.2d 400 (1990). “Generally an appeal should be dismissed as moot when events occur that prevent the appellate court from granting any effective relief.” Thournir v. Buchanan, 710 F.2d 1461, 1463 (10th Cir.1983). The central question in determining whether a case has become moot is whether “the issues presented are no longer ‘live’ or the parties lack a legally cognizable interest in the outcome.” Powell v. McCormack, 395 U.S. 486, 496, 89 S.Ct. 1944, 1951, 23 L.Ed.2d 491 (1969).

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