Delaware Business Bankruptcy Report: Morris James LLP Lawyers and Attorneys

In re Truong, 513 F.3d 91 (3d Cir. 2008) (per curiam) (Precedential)

The debtors in this Chapter 7 case filed a motion in the Bankruptcy Court to hold a hearing on whether the Chapter 7 Trustee should be removed under 11 U.S.C. § 324 (a) because of a conflict of interest. The Bankruptcy Court denied the motion, and the District Court dismissed the debtors’ appeal. The Third Circuit held that the appeal was from an interlocutory appeal, and that it therefore lacked jurisdiction under 28 U.S.C. § 158(d).

In this Chapter 7 case, the debtors filed a motion to hold a hearing to determine whether there was cause to remove the Chapter 7 trustee because of the debtors’ allegations that there was a conflict of interest between the trustee and the assets of the bankruptcy estate. The United States Bankruptcy Court for the District of New Jersey denied the debtors’ motion for a hearing. The District Court dismissed the debtors’ appeal from the order because the debtors failed to follow the procedural requirements of Fed. R. Bankr. P. 8001(a). The debtors also filed a motion for reconsideration, which the District Court denied. The debtors then filed a timely notice of appeal to the United States Court of Appeals for the Third Circuit. The threshold question before the Third Circuit was whether the Bankruptcy Court order was a final order over which the District Court and Third Circuit possessed jurisdiction under 28 U.S.C. § 158.

Under section 158(d), a United States Circuit Court of Appeals only possesses jurisdiction over an appeal from a final order; the Court lacks jurisdiction over appeals from interlocutory orders. The inquiry, therefore, was whether the Bankruptcy Court order was final.

The Third Circuit held that the Bankruptcy Court order was interlocutory because it did not dispose of any discrete claim or cause of action. Instead, it related only to the conduct of litigation before the Court, and was therefore not a final, appealable order. Accordingly, the Court held that it lacked jurisdiction under section 158(d), and dismissed the appeal on that basis.

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In re Seven Fields Dev. Corp., 505 F.3d 237 (3d Cir. 2007) (Circuit Judge Morton I. Greenberg)

This opinion arises out of a bankruptcy case filed in 1986. A group of corporations engaged in real estate development in Seven Fields, Pennsylvania sold investment shares to raise capital. The debtors promised their investors an annual return on their investments. As the debtors became unable to make their payments to the investors, they filed Chapter 11 petitions in the United States Bankruptcy Court for the Western District of Pennsylvania. The Court approved the appointment of Arthur Young & Company (a predecessor of Ernst & Young) to serve as accountants. Young determined that the debtors were insolvent, and that the vast majority of their debt was owed to the investors. The Court approved a plan of reorganization that merged the debtors into a single successor entity, Seven Fields Development Corporation. The plan provided for payment in full to secured and trade creditor claims. The investor class of unsecured creditors received common stock in Seven Fields at a par value equal to 5% of their allowed claims, with the remaining 95% classified as unsecured nondischargable debt. Under the plan, the purpose of Seven Fields was to manage the real estate and seek to achieve maximum returns for the investors. After confirmation of the plan, Seven Fields liquidated its real estate holdings, but did not realize sufficient proceeds to the investors in full. The bankruptcy case later closed.

In 2004, the shareholders filed a complaint against Ernst & Young in the Court of Common Pleas of Butler County, Pennsylvania alleging professional negligence, fraud and deceit and negligent misrepresentation. The complaint alleged that, based upon Young’s advice, a plan was approved and implemented that caused the investors to suffer losses.

Ernst & Young filed a notice of removal of the Butler County action with the clerk of the Bankruptcy Court, removing the case to the United States Bankruptcy Court for the Western District of Pennsylvania. Ernst & Young also filed a motion to dismiss. The shareholders then moved to remand the case back to the state court, or in the alternative, to abstain from exercising jurisdiction.

The Bankruptcy Court, sua sponte, reopened the bankruptcy case and dismissed the case on various substantive grounds. The shareholders appealed, challenging the Bankruptcy Court’s jurisdiction.

The Bankruptcy Court held that it had jurisdiction, under 28 U.S.C. § 1334(b), over the shareholders’ claims because they arose in the bankruptcy case. The claims asserted professional malpractice by a professional approved by and subject to the supervision of the Bankruptcy Court. The Bankruptcy Court further held that it did not need to apply the “close nexus” test set forth in the Third Circuit’s Resorts International case because, in this case, Young was a court-appointed professional providing services during the bankruptcy case, whereas the professionals in Resorts provided post-confirmation services to a litigation trust, not to the debtor. The district court affirmed the Bankruptcy Court’s decision.

On appeal to the Third Circuit, the shareholders argued that the Bankruptcy Court erred by finding that the close nexus test did not apply, based on the Court’s determination that the state law claims arose during the bankruptcy case. The shareholders argued that what mattered was not when the actions occurred, but when the state law claims were asserted. They asserted that the close nexus test applies whenever a state lawsuit is removed to federal court on the basis of a bankruptcy case that was already closed when the state law action was filed. The appellants also contended that the Bankruptcy Court erred when it found that the state law action was a core proceeding under 28 U.S.C. § 157(b).

The Third Circuit affirmed, holding that the “close nexus” test applies only to determine whether a federal court has jurisdiction over a non-core “related-to” proceeding under 28 U.S.C. § 1334(c)(2). It does not apply where the federal court possesses “arising in” jurisdiction. The relevant inquiry is not into when the state law action was commenced, but instead when the underlying events took place.

The Third Circuit also affirmed the finding that the Bankruptcy Court possessed “arising in” jurisdiction. The investors alleged that their claims against Ernst & Young arose out of the work conducted during the course of the bankruptcy case. Moreover, the investors’ allegations implicated the integrity of the entire bankruptcy process. The investors alleged that Young’s work led the Bankruptcy Court to the conclusion that the debtors were insolvent, and the resulting formation of Seven Fields to achieve the goal of full payment of claims. This was a significant factor in bringing about confirmation of the plan. The Third Circuit concluded, therefore, that a malpractice action against an accountant for misconduct during the bankruptcy case, on which the judge relied in confirming a plan and approving fees, is a core proceeding, “arising in” the bankruptcy and subject to bankruptcy jurisdiction.

The Court then went on to address a question that it did not need to resolve, but that was the subject of division in the courts within the Third Circuit. That question was, “in analyzing a court’s “related-to” jurisdiction, is pre-confirmation conduct alleged in a complaint that is filed post-confirmation evaluated under the Pacor test or the Resorts “close nexus” test? The Bankruptcy Courts in Delaware in New Jersey have reached inconsistent results on this question, with at least one opinion in each court holding that the proper inquiry is into when the conduct occurred or the cause of action arose, and another set of decisions in each court stating that when the cause of action was filed is the starting point. The Third Circuit concluded that, under Resorts, the “close nexus” test is applicable to “related to” jurisdiction over any claim filed post-confirmation regardless of when the underlying conduct occurred.

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In re Shenango Group Inc., 501 F.3d 338 (3d Cir. Sept. 6, 2007) (Circuit Judge D. Brooks Smith)

In this precedential opinion, the United States Court of Appeals for the Third Circuit, in a case of first impression, adopted a standard for reviewing a bankruptcy court’s interpretation of its own order. If the appeal concerns a bankruptcy court’s interpretation its own order, the Court held that an abuse of discretion standard should be applied. If the issue under review presents only a question of law, that review will be de novo.

The debtor, Shenango Group, filed a Chapter 11 petition on December 14, 1992, and confirmed a plan of reorganization on March 2, 1994. 

Section 4.04 of the Reorganization Plan addressed the Class 4 retirees’ rights to medical benefit coverage, life insurance, and pension benefits. The introductory clause of this subsection stated that “[n]either Debtors nor any member of the Aloe Controlled Group[, Shenango’s Holding Company,] shall have any funding obligations to the Pension Plan as a result of this section 4.04(h), other than the obligations which exist without regard thereto.” Subsection (h) concerned the interest of a subclass of retirees, known as the Class 4B retirees, in the allocation of any Pension Plan surplus. Paragraph (x) of subsection 4.04(h) pertained to certain conditions regarding amending the Pension Plan. It specified that the Pension Plan shall be amended to provide that none of the assets of the Pension Plan would revert back to the Pension Plan sponsor until all liabilities to Class 4B Claimants had been satisfied by either a distribution of any surplus or a benefit enhancement. Paragraph (x) also specified that until the Class 4B Claimants received their maximum entitlement, no benefit increases could be provided for Pension Plan participants other than Class 4B retirees, except under certain conditions.

In 2000, the debtor and the United Steelworkers of America agreed to a retirement window pension for fourteen (14) persons. In 2001, a second window pension was under consideration. A member of the Pension Board objected because the first window pension had not yet been funded. The second window pension was approved nonetheless. The Class 4B retirees asserted that full funding was required under the terms of § 4.04(h) of the Reorganization Plan at the time the determination was made to grant this second window pension to non-Class 4B retirees, and they demanded that Shenango tender the requisite funding at that point in time. When their demands were not met, the Class 4B retirees’ representative filed a motion to reopen the bankruptcy case. The representative simultaneously filed a motion to compel compliance with the Reorganization Plan. Shenango argued that the Bankruptcy Court lacked jurisdiction over this dispute.

The Bankruptcy Court concluded that it possessed “related to” jurisdiction over the proceeding, and held that the plan of reorganization was unambiguous, requiring that Shenango fund the window benefits at the amount of their valuation, plus interest, and that Shenango be enjoined from granting future benefits without fully funding such increases.

On appeal, the Third Circuit had to decide what standard to apply to a bankruptcy court’s review of its own plan confirmation order. After review of the standards in other circuits, the Court adopted the majority view that, if the appeal concerns a bankruptcy court’s interpretation its own order, an abuse of discretion standard should be applied. If the issue under review presents only a question of law, that review will be de novo.

The initial query into whether the plan was ambiguous was subject to de novo review. If the Court found that it was ambiguous, it would defer to the Bankruptcy Court’s interpretation, unless that interpretation was unreasonable. The Third Circuit agreed that the Plan obligated Shenango to fully fund any increase in pension benefits to participants in the Pension Plan other than the Class 4B retires. However, the Plan did not address the timing of the funding obligations. To that extent, it was ambiguous.

However, the Third Circuit held that it did not have to vacate and remand to decide this issue because the bankruptcy court’s analysis included findings of fact in support of its conclusion that immediate funding was required, and these findings of fact were not in dispute. Therefore, there was no abuse of discretion. Accordingly, the Third Circuit affirmed.

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Hechinger Inv. Co. of Del. v. Universal Forest Prods., Inc. (In re Hechinger Inv. Co. of Del.), 489 F.3d 568 (3d Cir. 2007) (Circuit Judge Marjorie O. Rendell)

The Third Circuit reversed a Bankruptcy Court decision in an avoidance and recovery action brought by debtors Hechinger Investment Company of Delaware against Universal Forest Products, Inc. that held that the contemporaneous exchange for new value defense to a preference cause of action was not available where the parties intended a credit relationship. Instead, the Third Circuit found that this defense applies to little other than a credit relationship, and remanded to the Bankruptcy Court for a determination of whether the parties intended that the payments in question were intended by the parties to be contemporaneous exchange for new value.

This matter arose out of the bankruptcy of Hechinger Investment Company of Delaware, which filed a petition for relief under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware on June 11, 1999. In 2001, Hechinger commenced this adversary proceeding by filing a complaint to avoid and recover $16,703,604.57 in payments under sections 547 and 550 of the Bankruptcy Code. Before trial in the Bankruptcy Court, the debtor conceded that $6,576,603.36 of these payments were advance payments, and therefore not avoidable as preferences. The parties also stipulated that the remaining amount at issue was $1,004,216.03, potentially subject to UFP’s contemporaneous exchange for new value and ordinary course of business defenses under 11 U.S.C. § 547(c)(1) and (2).

Prior to trial, the Bankruptcy Court denied, without discussion, UFP’s spoliation motion that asked the Bankruptcy Court to draw an adverse inference from Hechinger’s destruction of documents that might have helped UFP prove that Hechinger intended its preference period payments to be contemporaneous exchange for new value.

Subsequent to a February 25, 2005 trial, the Bankruptcy Court entered judgment in favor of the debtor in the amount of $1,004,216.03, holding that the payments were not protected by the contemporaneous exchange for new value defense because “the nature of a credit relationship is inconsistent with the intent which is required in order to sustain the § 547(c)(1) defense.” The Bankruptcy Court also rejected UFP’s ordinary course of business defense, finding that the payments were not made in the ordinary course between the parties and were not made according to ordinary business terms in UFP’s industry. The Bankruptcy Court also rejected, without discussion, the debtor’s request for prejudgment interest.

The parties then appealed to the District Court, which affirmed.

On appeal, the Third Circuit reversed on the contemporaneous exchange for new value question, finding that not only does the defense apply in the context of a credit relationship, but that it “covers little other than credit transactions” because if the defendant did not extend credit to the debtor, there would be no antecedent debt as required by 11 U.S.C. § 547(b). In that case, the plaintiff would have failed to make a prima facie case for a preference, and defenses would never have been implicated.

Instead, the court held that the relevant question was one of intent, i.e., whether the parties intended a contemporaneous exchange for new value even when the transaction is styled as a credit transaction. The Third Circuit noted that there can be such intent, even when there is delay between the incurrence of debt and payment, and discussed with approval cases so holding. Therefore, the Third Circuit reversed the Bankruptcy Court’s holding that the existence of a credit relationship per se excluded the possibility of contemporaneous exchange for new value, and remanded to the Bankruptcy Court to consider whether the parties intended a contemporaneous exchange for new value.

As to the ordinary course of business defense, the Third Circuit opened its analysis by stating that it would not presume the ordinariness of payments made within credit terms. Instead, the Third Circuit held that ordinariness is assessed “in the context of the relationship of the parties over time.” The court instead found that, because credit terms between the parties changed in a manner that was “so extreme, and so out of character with the long historical relationship between the parties,” that payments made within those new terms were appropriately found by the Bankruptcy Court to be outside the ordinary course of business between the parties. The Third Circuit also held that UFP vigorously enforced its credit limit during the preference period, resulting in marked acceleration of payments during that period. In sum, the Third Circuit found that the Bankruptcy Court correctly founded its ruling on accelerated credit terms, the imposition of a credit limit, UFP’s requirement that Hechinger make large, lump sum wire transfer payments and UFP’s requirement that Hechinger send remittance advices after making payment. These practices were not ordinary in the parties’ relationship.

The Third Circuit affirmed the Bankruptcy Court’s ruling on the spoliation motion, finding that when the debtor destroyed documents to save space following its bankruptcy petition, it did so without the requisite fault, and because there was no evidence that UFP was prejudiced by the destruction.

The Third Circuit also remanded to the Bankruptcy Court for an explanation of its decision not to award pre-judgment interest.

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In re Machne Menachem, Inc., 233 Fed. Appx. 119 (3d. Cir. Apr. 19, 2007) (Circuit Judge Julio M. Fuentes)

An insider of debtor Machne Menachem, Inc. purchased the claims of four unsecured creditors to alter the composition of the class of non-insider unsecured claimants. When the debtor’s plan or reorganization was then approved by voters and confirmed by the United States Bankruptcy Court for the Middle District of Pennsylvania, a former director of the debtor, who also was the proponent of a competing plan, appealed the confirmation order to the district court, arguing that the plan violated the good faith requirement of the plan confirmation provisions of the Bankruptcy Code. The district court reversed the bankruptcy court, and the Third Circuit affirmed the reversal, finding that the debtor impermissibly gerrymandered the classes to secure the necessary votes in favor of the plan.

The debtor, Machne Menachem, Inc., was a not-for-profit company that operated a summer camp for boys in Pennsylvania. During a battle for control of the debtor among its board of directors, the company filed a bankruptcy petition in the United States Bankruptcy Court for the Middle District of Pennsylvania. There were two competing plans of reorganization; one was filed by the debtor, and the second by a former director, Yaakov Spritzer. The court confirmed the debtor’s plan.

Spritzer argued that the plan could not be confirmed, contending that it was not a plan proposed in good faith. In support of this argument, Spritzer pointed to the purchase of the claims of four unsecured creditors by Levi Heber, the son of one of the debtor’s remaining directors. These claims were then reclassified from the Class 4 (non-insider unsecured claims) to Class 5 (insider unsecured claims). Because the plan required the consent of one impaired class, under 11 U.S.C. § 1129(a)(10), and Class 4 approved the plan by a three vote margin, Spritzer contended that the claims purchase by Heber was intended to rig the plan confirmation vote.

The district court vacated the confirmation order, ruling that the debtor gerrymandered Class 4 to secure confirmation. The debtor then appealed that ruling.

The Third Circuit Court of Appeals affirmed the district court decision, finding the purchase of claims by an insider of the debtor rendered the plan unconfirmable.  Such a course of action amounted to vote manipulation by gerrymandering, undermining the requirements of consent by unimpaired classes.

The Third Circuit also affirmed the district court’s finding that the plan violated the requirements that each claim or interest of a particular class receive equitable treatment under the plan. Although all Class 4 claimants were to be paid in full under the plan, two claims out of the four purchased outside the plan were not paid in full.

Thus, the Third Circuit found that the purchase of claims outside the plan violated the confirmation requirements of the Bankruptcy Code.

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Pickett v. Integrated Health Servs., Inc. (In re Integrated Health Servs., Inc.), 233 Fed. Appx. 115 (3d Cir. 2007) (Circuit Judge Maryanne Trump Barry)

Prior to the petition date of debtor Integrated Health Services, Inc., the debtor issued a memo assigning some interest in a corporate golf club membership to its Executive Vice President and Chief Financial Officer, C. Taylor Pickett. This membership was later scheduled by the debtor as an asset of the debtor on schedules signed by Pickett. After Pickett left employment of the debtor almost two years after the petition date, the debtor removed Pickett as the corporate designee on the membership. Pickett then sought a declaratory judgment from the bankruptcy court that the membership was assigned to him, and that the debtor had no interest in it. The bankruptcy court granted summary judgment in favor of the debtor, finding the assignment memo to be ambiguous, and that the parties’ behavior evidenced that they believed that the debtor retained ownership of the membership. The district court affirmed, and the Third Circuit affirmed the district court order.

In 1993, Integrated Health Services, Inc. purchased for $75,000 a corporate membership at Caves Valley Golf Club. The clubs by-laws provided that the membership and stock certificates were non-assignable

In 1998, the debtor issued a memo that purported to transfer to its Executive Vice President and Chief Financial Officer, C. Taylor Pickett, “all its rights, title and interests in and to the Membership,” but also provided that Pickett would “remain the [debtor’s] designated member” unless he resigned the membership or was terminated for cause. Two years later, in February 2000, when the debtor filed its petition in the United States Bankruptcy Court for the District of Delaware, it listed the golf club membership as a long term asset of the debtor.

Pickett left the employment of the debtor on December 31, 2001, and signed an agreement releasing all claims arising out of his agreements with the debtor through that date. However, he continued to use the golf club membership until, in August 2002, the debtor asked the golf club to remove Pickett as its corporate designee.

Pickett sought a declaratory judgment from the bankruptcy court that he was the owner of the membership, and that it was not part of the bankruptcy estate. The bankruptcy court granted summary judgment for the debtor, and the district court affirmed.

Analyzing the question under Maryland law, the Third Circuit rejected Pickett’s contention that the memo was unambiguous, and intended to be an unqualified assignment of the debtor’s golf club membership. The court noted that, although the memo purported to evidence an assignment of “all [the debtor’s] rights, title and interest related to the membership,” it also characterized Pickett as its “corporate designee” and provides for two conditions under which the debtor could have stripped Pickett of his membership rights. On this basis, the Third Circuit found that the assignment was ambiguous.

Also, the Third Circuit agreed with the bankruptcy court’s finding that extrinsic evidence showed the parties intended the memo to provide something other than a complete assignment of the debtor’s interests in the golf club membership. For instance, the membership was not assignable without the club’s consent, and such consent was not sought. Also, the debtor’s schedules filed with the bankruptcy court – which were signed by Pickett himself – listed the membership as an asset of the debtor. Pickett neither took possession of the stock certificate nor listed the assignment as income or executive compensation in public filings. These factors showed that the parties understood the debtor to retain ownership of the membership.

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In re Am. Pad & Paper Co., 478 F.3d 546 (3d Cir. 2007) (Circuit Judge Dolores Korman Sloviter)

Steven Singer, the Chapter 7 Trustee of American Pad & Paper Co. and its co-debtors, was elected under 11 U.S.C. § 702 more than two years after the entry of the order for relief in the debtors’ cases. Singer was elected subsequent to the appointment of an interim trustee under section 701, who was appointed eleven days before the two-year anniversary of the entry of the order for relief.

Singer thereafter commenced avoidance actions against approximately 150 defendants, many of whom moved to dismiss on the basis that such actions were time-barred by 11 U.S.C. § 546(a), which requires that such avoidance actions by filed by the later of two years after the entry of the order for relief, or one year after the appointment of a trustee under section 702, 1104, 1163, 1202 or 1302, if that appointment occurred before the two years after the entry of the order for relief. The Bankruptcy Court dismissed those actions, and the District Court affirmed. The Third Circuit affirmed, finding that under the plain language of the statute, the actions were time-barred.

On January 10, 2000 a number of creditors filed involuntary Chapter 11 petitions against American Pad & Paper Co. and six related companies. On January 14, 2000, each of those debtors filed a voluntary Chapter 11 petition. On that same day, the United States Bankruptcy Court for the District of Delaware entered an order for relief as to each of those debtors. On December 21, 2001, the Court granted a motion by the creditors committee to convert the cases to cases under Chapter 7, with the conversion to be effective on January 3, 2002. On January 3, 2002, Jeoffrey L. Burtch was appointed interim Chapter 7 trustee under 11 U.S.C. § 701. The date of the trustee’s appointment was significant because it was eleven days prior to the two-year anniversary of the entry of the order for relief. On February 13, 2002, a new trustee, Steven Singer, was elected under 11 U.S.C. § 702.

Thereafter, between August and December 2002, Singer filed approximately 150 avoidance actions. A number of defendants in those actions moved to dismiss on the basis that these avoidance actions were time-barred under 11 U.S.C. § 546(a), contending that, under that section of the Bankruptcy Code, the deadline to file the avoidance actions was January 14, 2002.

Singer argued, however, that because Burtch was appointed as interim trustee under section 701 prior to January 14, 2002, Singer should have had an additional year to commence the avoidance actions. As the Bankruptcy Court and the District Court had already decided, the Third Circuit pointed out the absence of any textual support for Singer’s position. The appointment of a trustee under section 701 was not included in the statute as an event that extends the statute of limitations by an additional year. To hold otherwise would require the court to ignore the plain meaning of section 546(a). The Court also discussed the statutory history of section 546(a), and noted that Congress, when revising the statutes of limitations for such actions in 1994, omitted section 701 trustees from the tolling statute. Also, in other sections of the Bankruptcy Code, Congress included section 701 trustees, so Congress apparently included section 701 trustees where it intended to do so.

Finally, the Court rejected Singer’s argument that the statute, as written, produced absurd results, and provided no notice of when avoidance actions must be commenced, nor a reasonable period of time within which to bring such actions. The Court pointed out that the plain language of section 546(a) made the statutes of limitations for avoidance actions clear, and put all parties on notice. While the court did not dispute that Singer had no time to bring the avoidance actions, the court noted that other parties in interest could have done so prior to the expiration of the two-year statute of limitations. The mere fact that the actions were time-barred by the time Singer was appointed did not make the application of the statute absurd as written. The statute was clear on its face, and there was no basis to read the section 701 trustee into other sections of the Bankruptcy Code where such a trustee was excluded.

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In re Valley Media, Inc., 226 Fed. Appx. 120 (3d Cir. 2007) (Circuit Judge Maryanne Trump Barry)

The Massachusetts Department of Revenue filed a proof of claim in the bankruptcy case of Valley Media, Inc., asserting that Valley owed the commonwealth for uncollected sales tax for goods drop-shipped on behalf of retailers by Valley to customers in Massachusetts. The United States Bankruptcy Court for the District of Delaware sustained the debtor’s objection to the claim, finding that the term “delivery” is defined in accordance with the Uniform Commercial Code, and further finding that such shipments were not a “delivery in the commonwealth” subject to sales tax under Massachusetts law. The United States District Court for the District of Delaware sustained the objection, and the Third Circuit affirmed.

Debtor Valley Media was a wholesale music and video distributor based in California. Pursuant to various vendor contracts with internet retailers, Valley Media drop shipped sales of Valley products to customers of those internet vendors in Massachusetts. Under those transactions, a retail customer would order from internet vendors who were not subject to taxation in Massachusetts. The internet vendor would then order the product from Valley, who would ship the product directly to the customer in Massachusetts, F.O.B. Valley’s California warehouse.

Massachusetts asserted that Valley was obligated to collect sales tax on these transactions because the commonwealth’s tax code defined a retail sale, subject to sales tax, as follows:

The delivery in the commonwealth of tangible personal property by an owner or former owner thereof, or by a factor, or agent or such owner, former owner or factor, if the delivery is to a consumer or to a person for redelivery to a customer, pursuant to a retail sale made by a retailer not engaged in business in the commonwealth, is a retail sale in the commonwealth by the person making the delivery.

Massachusetts filed a proof of claim, asserting that Valley owed the commonwealth for uncollected sales tax during the period from 1997 through 2000. The amount in question (exclusive of interest and penalties) was $1,462,703.
On appeal to the Third Circuit, Massachusetts presented the question of whether the District Court erred in using the UCC and the agreements between the parties to determine that the drop shipments at issue were not subject to sales tax.

Massachusetts argued that delivery occurred in Massachusetts, while Valley argued that delivery occurred in California, when the goods left the debtor’s warehouse, and that, as a result, the sales tax statute was inapplicable.

Under the UCC definition of delivery, the Valley goods would have been delivered in California, when titled passed. Massachusetts argued that it was error to apply the UCC definition of the term. The Court noted, however, that the Supreme Judicial Court of Massachusetts has looked to the UCC definition in interpreting the word “title,” as used in the tax code. Accordingly, the Court held that delivery was not made in Massachusetts, and affirmed the order of the District Court.

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Mfrs. and Traders Trust v. Wyo. Sand and Stone, 223 Fed. Appx. 146 (3d Cir. 2007) (Circuit Judge Anthony J. Scirica)

A lender holding a security interest in vehicles of the debtor executed releases of those liens, and delivered those releases to an auctioneer selling the debtor’s vehicles. Execution of the releases prior to auction was purportedly going to assist in obtaining a higher price for the vehicles. An unsecured creditor of the debtor asserted that the proceeds of the sale did not belong to the lender because the liens were released prior to the sale. The Third Circuit Court of Appeals affirmed the bankruptcy court’s holding that by executing the releases, the lender released its liens.

Manufacturers and Traders Trust held liens on vehicles of the debtor, Wyoming Sand and Stone. Travelers Casualty and Surety Company was an unsecured creditor of the debtor. Prior to the commencement of the debtor’s bankruptcy case, the debtor requested that M&T execute releases of the liens on certain vehicles that were to be auctioned, and promised that the funds realized from these auctions would be used to reduce the debtor’s indebtedness to M&T. The debtor requested the releases based on the reasoning that the vehicles might sell for a higher price without the liens. Some of those vehicles were sold at auction, while others did not sell.

M&T then requested new titles from the Pennsylvania Department of Motor Vehicles indicating its lien on the vehicles that were not sold at auction. The DMV issued the new title documents. Post-petition, M&T hired an auctioneer to sell the remaining vehicles. M&T’s auctioneer asked M&T to release the liens. M&T agreed, and delivered the executed releases of the title liens to the auctioneer. The proceeds from the auction were held in escrow under a stipulation between M&T and Travelers.

M&T thereafter filed a complaint against the debtors and Travelers to obtain the auction proceeds. Travelers filed a motion for summary judgment on the basis that the liens were released and therefore the auction proceeds were to be shared by unsecured creditors of the debtor’s estate. The United States Bankruptcy Court for the Middle District of Pennsylvania granted Traveler’s Motion for Summary Judgment, holding that M&T had released its security interests in the vehicles. The district court affirmed.

The Third Circuit also affirmed, finding that the absence of any notation of a lien on the certificate of title indicated that no lien existed. M&T argued that because the loan agreement between M&T and the debtor was not marked “paid,” and because the agreement and title certificates were not delivered to the debtors, the liens remained intact. The court disagreed, holding that the crucial factor was whether the liens were noted on the certificates, which they were not.

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In re Genesis Health Ventures, Inc., 204 Fed. Appx. 144 (3d Cir. Oct. 4, 2006) (per curiam)

This decision from the Third Circuit, which was entered per curium and marked “non-precedential,” involved an appeal from a former shareholder of the debtor, Genesis Health Ventures, Inc., who was proceeding pro se. Shortly after the bankruptcy court confirmed the debtors’ plan of reorganization in 2001, the former shareholder, James Hayes, filed a motion for formation of an equity committee post-confirmation. Because of the other appeals he was pursuing in the bankruptcy case, his motion was left pending for over three years, at which point he returned to the bankruptcy court, where the court then denied the motion as untimely and subject to the doctrine of “equitable mootness.” The district court agreed, and so did the court of appeals. Underlying the discussion of that doctrine lay the implicit proposition that the motion was really a challenge to the terms of the plan, though presented procedurally in a manner distinct from plan objections.

Former shareholder Hayes, in 2001, filed objections to the debtor’s plan of reorganization and requested that an equity committee be appointed. The bankruptcy court, in September 2001, rejected his objections to the plan, denied his request for an equity committee and entered judgment confirming the plan. Hayes filed notices of appeal from the denial of his objections to the plan and his equity committee request. He also filed a motion in the bankruptcy court for an appointment of a post-confirmation equity committee. The course of his appeals from the first two orders took nearly three years before they were exhausted. Hayes then went back to the bankruptcy court to seek a hearing on the motion for a post-confirmation equity committee that he filed in 2001. The court denied that motion in 2004, holding that it was grossly untimely, and applied the doctrine of equitable mootness. The district court affirmed on the grounds of equitable mootness and also because the debtor was insolvent.

On appeal to the court of appeals, the Third Circuit found the doctrine of equitable mootness applied. The court emphasized the public policy favoring the finality of bankruptcy judgments. The court did not comment on the district court’s alternative ruling that the debtor was insolvent.

In applying the doctrine of equitable mootness, the court focused on the judgment of the bankruptcy court confirming the plan, and held that the plan could not be equitably unscrambled, years after it was confirmed. Implied though unstated was the principle that the appointment of a post-confirmation equity committee had to have been a part of the plan. The actual denial of the motion for appointment of the post-confirmation equity committee by the bankruptcy court did not occur until three years after the plan was confirmed, but a stay of the plan’s implementation would have been needed to keep Hayes’ motion from becoming moot.

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Banks v. Moore (In re Banks), No. 06-1828, 204 Fed. Appx. 141, 2006 WL 2818950 (3d Cir. Oct. 3, 2006) (per curiam)

This court of appeals ruling affirming a default judgment in favor of a creditor in an adversary action on non-dischargability turned on the principle that “the debtor who failed to keep the court apprised of his proper mailing address has only himself to blame.” In this case, the debtor’s new address was the county jail. This decision was entered per curiam and is marked as “not precedential.”

A creditor of Frederick Banks (the debtor) filed an adversary action in the Bankruptcy Court to determine the non-dischargability of a debt owed by the debtor to him for reasons of alleged defalcation and embezzlement. When the action was filed, the debtor was represented by counsel. However, three weeks before trial, the debtor’s counsel filed motions to withdraw and for continuance of trial. Those motions were granted and the trial was scheduled for two months later. The bankruptcy court sent notice of the trial to the address the debtor had submitted in his bankruptcy petition papers. The debtor did not appear at trial and a judgment was entered in favor of the creditor.

Less than a week after entry of the judgment, the bankruptcy court received papers from the debtor which were docketed as a “motion for pro se appearance.” (There was no indication of an awareness that permission to appear pro se was not required.) Two days later, the bankruptcy court received from the debtor a notice of appeal from the judgment. On both documents, the debtor listed his updated address as the Allegheny County jail.

In his appeal in district court, the debtor claimed he was not served with his former counsel’s motions, and did not know of the trial date. The district court denied his appeal. The Third Circuit affirmed.

The court of appeals dismissed the appeal because it “had no arguable basis in fact or law.” The court did not use the word “credibility,” but found that the debtor’s unawareness of the former counsel’s motion was unsupported by the record. The record was replete with examples of how his former counsel had tried to communicate with him by letters, phone calls and emails, while there were no examples of the debtor seeking to contact his attorneys, and as such, there was no evidence to support the debtor’s assertion that his former attorneys knew he had been incarcerated. Similarly, there was no evidence that the debtor had apprised the bankruptcy court of his new jail address until after entry of the judgment in favor of the creditor.

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In re Kaiser Aluminum Corp., 456 F.3d 328 (3d Cir. 2006) (Circuit Judge Marjorie O. Rendell)

In this issue of first impression in the circuit courts, the Third Circuit Court of Appeals held that when an employer in Chapter 11 seeks voluntarily to terminate multiple pension plans under ERISA’s “reorganization test,” a court must consider termination of the plans in the aggregate, rather than on a plan-by-plan basis.

          During the reorganization, the Debtor originally sought to replace 7 pension plans that had been established in connection with collective bargaining agreements, but thereafter determined to voluntarily terminate 6 of the plans pursuant to ERISA. ERISA § 4041(c) permits termination of a pension plan if an employer in Chapter 11 satisfies certain notice requirements and demonstrates that it will be unable to pay its debts and continue in business outside Chapter 11 unless the pension plan is terminated. This inquiry is called the Reorganization Test.

            The Delaware Bankruptcy Court applied the Reorganization Test in the aggregate, rather than reviewing the request to terminate on a plan-by-plan basis. The Pension Benefit Guaranty Corporation appealed to the District Court, which affirmed. The PBGC then took a timely appeal to the Third Circuit.

            PBGC argued that if the Debtors’ various pension plans were considered individually and without regard to the Debtors’ obligations under the other plans, 4 of the 6 plans could continue to be funded in a reorganization, while two might have to be terminated. Because these plans were created in connection with collective bargaining agreements, however, the Bankruptcy Court found, and the Third Circuit agreed, that an individualized approach would violate the Bankruptcy Code’s requirement in section 1113(b) that debtors bargain freely and equitably with unions.

            The Circuit Court looked particularly to the language of ERISA for guidance as to whether to evaluate plans individually or in the aggregate and found none. Likewise, while the Court found cases where multiple plans had been terminated (apparently without contest from the PBGC), little guidance was provided by those decisions as to why those courts examined the plans on an aggregate basis.

The PBGC argued that ERISA’s use of the singular terms “single-employer plan” and “plan” evidenced Congress’ intent that the plan-by-plan approach to terminations be used. The Circuit Court disagreed, noting that, in construing statutory provisions, 1 U.S.C. § 1 provides that use of the singular includes the plural unless context indicates otherwise.

The Court held that context did not indicate that ERISA’s use of “plan” required a plan-by-plan analysis. Instead, the Court held that such an interpretation would make the statute “unworkable.” “[T]he reorganization test cannot be rationally applied on a plan-by-plan basis unless a court makes basic assumptions about the order in which the plans should be considered and the status of the other plans that the employer is seeking to terminate.” The Circuit court was unwilling to engage in such speculation, noting, through the use of a few hypotheticals, that the outcome of a plan-by-plan analysis could change dramatically based upon the ground rules that a court might employ. Considering that bankruptcy courts are fundamentally courts of equity, the Circuit Court found such inequitable results untenable, and affirmed the practice of applying the reorganization test in the aggregate to all plans to be terminated.

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Pension Transfer Corp. v. Beneficiaries Under the Third Amendment to Fruehauf Trailer Corp. Retirement Plan No. 003 (In re Fruehauf Trailer Corp.), 444 F.3d 203 (3d Cir. 2006) (Circuit Judge Thomas L. Ambro)

The Delaware District Court approved the avoidance of an alleged fraudulent transfer under §548(a)(1) of the Bankruptcy Code of a surplus from a union pension plan that was used to provide benefits to management through a pre-petition amendment to the debtor’s pension plan.

The pension plan had been amended on September 19, 1996 and the Debtor filed its bankruptcy petition approximately two weeks later.

The District Court found that there was not reasonably equivalent value provided to the Debtor for the loss of the surplus used to provide benefits to management. The Defendants had failed to prove that the plan amendment helped to retain key personnel so that the debtor could sell its assets as a going concern.

On appeal, the Third Circuit concluded that the amendment to the pension plan was fraudulent despite the lack of a precise calculation of the benefits conferred and received by the plaintiff.

In the midst of financial turmoil, the result of an aggressive over expansion that left the company with a negative net-worth, Fruehauf’s board held an emergency meeting on September 19, 1996. During that meeting, the board approved an amendment to the pension plans of approximately 400 employees, primarily executives or managers, which provided immediate benefits and future benefits to those employees who remained with the company through March 31, 1997. The benefits were paid out of a surplus of funds Fruehauf had earmarked for the union members’ pension plan. Under the amendment, unused funds would revert back to the company.

The company filed for protection under Chapter 11 on October 7, 1996. After a sale of substantially all of its assets to Wabash National L.P., Fruehauf’s remaining assets were placed in a liquidation trust and the pension plan was taken over by the Pension Transfer Corporation, a subsidiary of the liquidation trust.

The Debtor filed an adversary proceeding in the Bankruptcy Court against the pension plan alleging that the payments under the amendment to the plan would result in a fraudulent transfer under §548 of the Bankruptcy Code. The Court approved a preliminary injunction that prohibited the plan from making distributions under the amendment. After Fruehauf’s plan of reorganization was approved, PTC was made the administrator of the pension plan and was substituted as the plaintiff in the adversary proceeding, which was then transferred to the District Court.

The District Court ruled that the pension amendment was a fraudulent transfer under §548 of the Bankruptcy Code, finding that the amendment was never properly presented to Fruehauf’s board and payments contemplated under the amended pension plan exceeded the amount normally paid to retain key employees. There was no evidence that Wabash paid more money for Fruehauf because it was an “ongoing operation.” The District Court held that the PTC had a property interest in any surplus in the union members’ pension plan and the amended plan irrevocably transferred this property interest to the defendants. Any value the Debtor may have received was not “reasonably equivalent” to the cost of the transfer. The District Court concluded that payments under the amended pension plan would be an avoidable fraudulent transfer of property of the debtor’s estate.

The beneficiaries of the amended plan appealed to the Third Circuit raising three issues: 1) the PTC did not have a property interest in the union members’ pension surplus; 2) the District Court erred in not applying the correct test for determining whether a transfer is fraudulent because PTC did not satisfy its burden of proving the value surrendered and received by the Debtor; and 3) the District Court erred in assigning the burden of proof to the Defendants.

The Third Circuit stated that the party bringing the fraudulent conveyance action had the burden of proving that: (i) the Debtor had a property interest in the pension surplus; (ii) the interest was transferred within one year of the filing of the Debtor’s bankruptcy case; (iii) insolvency of the Debtor at the time of the transfer or that the Debtor became insolvent as a result of the transfer; and (iv) that the Debtor did not receive reasonably equivalent value for the transferred property interest. There was no dispute between the parties as to either insolvency of the Debtor or whether the alleged fraudulent conveyance was within the prescribed statutory time limit.

The Third Circuit noted that the broad definition of “property” in the Code included “all legal or equitable interests of the debtor in property,” including “future interests” and the “opportunity to receive an economic benefit.” Under ERISA, an employer who sponsors a qualifying retirement plan is entitled to recapture any surplus when the plan terminates and “the recoupment right is a transferable property interest.” The Debtor’s potential recoupment of the pension surplus was, thus, a transferable property interest under §548.

Similarly, the Code also defines “transfer” broadly. Benefits accruing under a qualified pension plan are irrevocable, so the pension surplus which was awarded to the defendants under the amended pension plan was fully transferred to them. Under this reasoning, the Third Circuit held that the irrevocable allocation of the pension surplus was a transfer as defined in §548.

Finally, the Third Circuit considered whether Fruehauf received reasonably equivalent value for the transfer. The opportunity to receive an economic benefit is defined as value under the Bankruptcy Code. Fruehauf forfeited value when it amended the pension plan. Reasonably equivalent value is determined by examining the totality of the circumstances including (1) the fair market value of the benefit received as a result of the transfer, (2) the existence of an arm’s-length relationship between the debtor and the transferee, and (3) the transferee’s good faith.

The Third Circuit, citing Mellon Bank, N.A. v. Metro Communications, Inc., 945 F.2d 635 (3d Cir.1991), stated that “the value of consideration received must be compared to the value given by the debtor.” The Court rejected a rigid application of this test, stating that the rule must bow “to common sense,” and that if the “totality of the circumstances” demonstrates that the debtor received only minimal value for the benefit it conferred, an exact calculation is not necessary.

The Court concluded that the District Court did not commit error. First, the Third Circuit found no error in the District Court’s conclusion that the pension plan amendment conferred some benefit to Fruehauf. Second, the District Court had sufficient evidence to conclude that the cost of funding the amended pension plan was at least $2.4 million. The Debtor’s own calculation of the cost of the amended pension plan was $2.4 million. The PTC had offered evidence of a $4.4 million calculation. The defendants provided no evidence of a calculation. Finally, the District Court properly relied on testimony that the amendment was not properly presented to the board and that the cost of the amended pension plan was double normal costs expended to retain key employees. The Third Circuit therefore concluded that under the totality of the circumstances, the pension amendment did not confer reasonably equivalent value upon the debtor. The Third Circuit Court also noted that several factors demonstrate the plan amendment lacked good faith: (1) the unions were never apprised of the use of the surplus, (2) the amendment was presented to the board for approval as an administrative formality that did not require discussion and (3) the plan amendment proponents told the board the amendment did not involve a cash expenditure from Fruehauf. The Court also held that PTC’s failure to provide evidence that no benefit to Fruehauf accrued was not error in light of the other circumstances surrounding the plan amendment.

Finally, the Court addressed the beneficiaries’ contention that the District Court wrongly assigned the burden of proof to them on the issue of reasonably equivalent value. The Third Circuit did not find this argument convincing and noted that the District Court stated several times that PTC had the initial burden of establishing the elements of a prima facie case of a fraudulent transfer and that the beneficiaries had no burden. The court concluded, however, that when PTC satisfied its burdens the burden then shifted to the beneficiaries to rebut the PTC’s proof.

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Cohen v. KB Mezzanine Fund II (In re Submicron Sys. Corp.), 432 F.3d 448 (3d Cir. 2006) (Circuit Judge Thomas L. Ambro)

The Plan Administrator for the Debtor’s estate commenced an adversary proceeding seeking to recharacterize the secured claims of insiders of the debtor from debt to equity, or in the alternative, to equitably subordinate the claims and impose a constructive trust. The District Court entered judgment in favor of the defendants, and the Third Circuit affirmed. The Third Circuit held that the creditors’ security interests were properly perfected, and that their credit bids to purchase assets of the debtor were not capped by the economic value of the collateral securing their claims. Instead, they could credit bid up to the full face value of their secured claims.

Appellant Howard S. Cohen, Plan Administrator for the SubMicron debtors, challenged the sale of SubMicron’s assets under 11 U.S.C. § 363(b) to an entity created by Sunrise Capital Partners, LP. Sunrise negotiated directly with several of SubMicron’s creditors before presenting its bid to the District Court. These creditors — The KB Mezzanine Fund II, LP, Equinox Investment Partners, LLC, and Celerity Silicon, LLC, who had, pre-petition, advanced the debtors approximately $11 million on Tranche One and Tranche Two Notes (the “1999 Fundings”) — agreed to contribute toward the purchase of SubMicron’s assets new capital along with all of their claims against SubMicron in exchange for equity in Akrion LLC, the entity formed by Sunrise to acquire the assets. Akrion in turn credit bid the full value of the Lenders’ secured claims, pursuant to 11 U.S.C.§ 363(k). The District Court (Robinson, J.) approved the sale, and Cohen appealed.

Cohen first argued that the 1999 Fundings should have been recharacterized as equity. The Third Circuit noted that although there are different tests among the circuits for whether recharacterization is appropriate, the overarching test is ultimately whether the party doing the funding intended to act as a banker, being repaid with interest, no matter the debtor’s fortunes, or as an investor, with repayment tied to the fortunes of the debtor. Having decided that this is a question of fact, the Court held that appellate review is under the clearly erroneous standard.

The 1999 Notes were called “debt” on their face, and were reported by the debtors in their SEC and UCC filings as secured debt. The District Court had also considered the testimony of witnesses, and found that, even though the debtor was undercapitalized when the Lenders advanced the funds, that did not support an equity characterization.

Cohen also argued that if the 1999 Fundings were debt, then they were not secured debt. This is a state law issue, but the results would have been the same under any of the possible choices of law. Each state’s codification of U.C.C. §§ 9-203 and 9-302 in 1999 required a written security agreement in favor of the lender describing the collateral and, for the collateral in question, the filing of a properly executed financing statement. Cohen contended that the financing statements filed by the Lenders were ineffective because they listed only “Equinox Investment Partners, LLC, as Collateral Agent” as the secured party. The Court held that because the financing statements named both SubMicron as debtor and Equinox as secured party, provided mailing addresses for both entities, and described the collateral that is subject to the security agreement, any interested party would be on notice to communicate with Equinox regarding the status of its interest in SubMicron’s assets, which is sufficient for Article 9 perfection purposes. The Court also concluded that, on the record before them, there was no doubt that KB and Celerity were intended secured parties served by their agent, Equinox. In the schedule of liabilities filed with the District Court, SubMicron listed KB and Celerity as secured noteholders. Therefore, they concluded that the Lenders presented valid secured claims for the 1999 Fundings.

Cohen also argued that that the § 363(k) credit bid was improper because the Lenders did not demonstrate that some portion of their claims remained secured by collateral, as defined in § 506(a). Thus, Cohen argued that, because the secured debt had no economic value, it could not be credit bid under § 363(k). The Court, however, held that because that section empowers creditors to bid the total face value of their claims, the District Court did not err in allowing the Lenders to credit bid their claims.

Cohen also argued that because the Lenders were not partially undersecured,
but completely undersecured, this case is different. The Court, however, stated that because the Lenders have a valid security interest in all the assets sold, by definition they were entitled to the satisfaction of their claims from available proceeds of any sale of those underlying assets. Their credit bid did nothing more than preserve their right to the proceeds.

Lastly, Cohen contended that the Lenders’ claims in relation to the 1999 Fundings should be equitably subordinated. The Court held that, because the District Court found no injury resulted to SubMicron’s unsecured creditors as a result of the Lenders’ dealings with Akrion, they did not need to reach the issue of inequitable conduct in order to affirm the District Court’s equitable subordination holding.

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