Decided: April 27, 2016

The Fourth Circuit affirmed in part, reversed in part, and remanded for review.

In 2011, plaintiffs, William Anderson, Jr. and Danni Jerrigan purchased a house from defendants, Wayne and Tina Hancock using a loan financed by the defendants. In exchange for the loan, the plaintiffs granted defendants a deed of trust on the property and executed a promissory note with monthly payments based on an interest rate of five percent over a term of thirty years. The note included a provision that stated if the plaintiffs default on the loan, the interest rate would increase to seven percent. Two years later, the plaintiffs defaulted on the loan, and the defendants imposed the seven percent interest rate. The defendants initiated foreclosure proceedings.

Shortly thereafter, plaintiffs filed for bankruptcy. The plaintiffs filed a proposed bankruptcy plan that proposed to pay off the loan using the five percent interest rate for each missed payment. The Defendants objected, stating that the payments should continue to reflect the seven percent interest rate. The bankruptcy court agreed with defendants, and found that the use of the five percent interest rate ran afoul of 11 U.S.C. § 1322(b)(2), which prevents plans from modifying the rights of creditors whose interests are secured by debtors’ principal residences.

The plaintiffs appealed to the district court, arguing their bankruptcy plan should be allowed to “cure” the increased default rate of interest. The district court rejected this argument, but held that acceleration and foreclosure were an alternative remedy to the default rate of interest, so that once the defendants accelerated the loan the interest rate reverted back to five percent. As such, the interest rate for a payment depended on whether the loan was in accelerated or decelerated status.

The plaintiffs again appealed, contending that a cure under the bankruptcy code could bring the loan back to its initial rate of interest. The Fourth Circuit disagreed, finding the deceleration of the loan and avoidance of the foreclosure to be the cure under the code. In reaching this conclusion, the court examined whether the proposed change of interest qualified as a “cure” under 11 U.S.C. § 1322(b)(3) or (5), or a prohibited “modification” under § 1322(b)(2). Relying on Nobelman v. Am. Sav. Bank, 508 U.S. 324, 329 (1993), the court determined that a change in the interest rate amounted to a fundamental alteration of the debtors’ obligations, thereby modifying the defendant’s rights. The court also examined the definition of the term “cure” within the context of the code, finding the term focuses on the ability of a debtor to decelerate and continue paying a loan. Understanding that the meaning of cure focuses on the maintenance of pre-existing payments, the court held that modification of the interest rate would amount to an improper modification.

The court further rejected plaintiffs’ argument that this interpretation would lead to an unfair result counter to the purpose of the bankruptcy code, providing two purposes of default interest rates. First, default interest rates represent the time value of money, and second, they serve as compensation for taking on risk. As such, the court argued that it did not intend to harm the plaintiff, but to enforce the statute and protect the mortgage market.

Finally, the Fourth Circuit disagreed with the district court’s finding that a five percent rate of interest should apply after acceleration of the loan because the court’s determination that accelerate was an alternative remedy was not a plausible construction of the promissory note.

Accordingly, the court affirmed the judgment of the district court insofar as it required that post-petition interest payments be calculated using the seven percent default rate of interest, but reversed the part of the judgment which applied only a five percent rate of interest to payments after acceleration, and remanded the case to the district court for further proceedings.

Full Opinion

Megan Clemency


Decided: March 11, 2016

The Fourth Circuit found that the elements of res judicata were satisfied and therefore the affirmed the lower court’s decision dismissing Plaintiff’s lawsuit against Defendant.

Plaintiff, Providence Hall Associates Limited Partnership (“PHA”), entered into three transactions with Wells Fargo’s predecessor-in-interest including; (1) a $2.5 million loan, (2) a $500,000 line of credit, and (3) an interest-rate-swap agreement, whereby PHA exchanged a fixed interest rate for a floating one based on the one-month U.S. Dollar London Interbank Offered Rate (“LIBOR”).  The loan and the line of credit contained a cross-default clause, which stipulated that a default on either loan would amount to a default on both.  Subsequently, PHA defaulted on the loans and filed a petition for Chapter 11 bankruptcy in March 2011. Shortly after the petition, Wells Fargo informed PHA that the default triggered over $3 million in termination damages and filed a proof of claim in the Chapter 11 case.  The bankruptcy court appointed a trustee who then took several steps to bring PHA out of bankruptcy, including obtaining the approval of the court to sell two of the bankruptcy estate’s property to satisfy the debts owed by PHA to Wells Fargo.  In the courts final sale order, the court explicitly stated that sale proceeds should be paid to Wells Fargo “up to the amount of the WFB Obligations,” where “WFB Obligations” was a defined term from Trustee Albert’s sale motion representing PHA’s debts arising out of the two loans and the swap agreement.  By November 2012, the proceeds of the sale had satisfied PHA’s debts to Wells Fargo and the principle of PHA filed a motion to dismiss the Chapter 11 proceedings, which the bankruptcy court granted.  More than a year later, PHA filed a suite alleging that the interest-rate-transaction was a “sham” because “the LIBOR rate was illegally rigged and manipulated.”  Wells Fargo filed a motion to dismiss, which the district court granted on res judicata grounds, giving preclusive effect to the bankruptcy’s sale order.  PHA appealed.

Under the doctrine of res judicata, or claim preclusion, a final judgment on the merits of an action precludes the parties or their privies from relitigating issues that were or could have been raised in that action. Pueschel v. United States, 369 F.3d 345, 354 (4th Cir. 2004). For res judicata to apply, three elements must be satisfied.  There must be: (1) a final judgment on the merits in a prior suit; (2) an identity of the cause of action in both the earlier and the later suit; and (3) an identity of parties or their privies in the two suits. Id. at 354–55.  In addition to the three elements, the court must consider whether the party or its privy knew or should have known of its claims at the time of the first action, and second, whether the court that ruled in the first suit was an effective forum to litigate the relevant claims. Grausz v. Englander, 321 F.3d 467, 473–74 (4th Cir. 2003).

Despite PHA’s argument that the sale orders were not “on the merits,” the Court did not find their argument convincing and found the cases from sister circuits that the lower court relied on persuasive.  The appointed trustee moved to sell property in satisfaction of specifically identified obligations arising out of PHA’s transactions with Wells Fargo, and the bankruptcy court approved those sales.  According to the Court, it would make little sense after the sales were made, the debt settled, and the bankruptcy proceeding closed, to then allow PHA to challenge in a new judicial proceeding the propriety of the transactions giving rise to its now-extinguished debt.  This would go against the purpose of res judicata—to promote finality.  Because the sale orders arose out of the same nucleus of facts as PHA’s claim in the case on appeal—the circumstances surrounding the three agreements between PHA and Wells Fargo—the Court determined the second prong had been met.  Regarding the third prong, the Court recognized that there was no dispute between the parties that the appointed trustee was in privity with the debtor as representative of the debtor’s bankruptcy estate.  Once the Court determined that the elements of res judicata had been met, they then determined that because PHA offered no argument that the trustee could not effectively litigate in bankruptcy court, therefore the Grausz, factors had also been satisfied.

Accordingly, the Court affirmed the judgement of the district court.

Full Opinion

Aleia M. Hornsby

IN RE: ANDERSON, NO. 15-1316

Decided: January 26, 2016

The Fourth Circuit affirmed the judgment of the district court.

On February 3, 2010, Henry L. Anderson, Jr. (the “Debtor”) filed a voluntary petition for relief under Chapter 11 of the Bankruptcy code. Thereafter, the bankruptcy court approved Stubbs & Perdue, P.A. (“Stubbs”) to serve as the Debtor’s counsel in the bankruptcy proceedings. Stubbs is owed approximately $200,000 in legal fees from its representation of the Debtor. The Debtor is also subject to around $1 million in secured tax claims, and his estate has insufficient funds to pay both the tax claim and Stubb’s fees. This case centered on whether Stubbs could “subordinate” the IRS’s claim in this manner was governed by 11 U.S.C. § 724(b)(2).

The Fourth Circuit first discussed general bankruptcy principles. In bankruptcy, secured claims are satisfied from the collateral securing those claims prior to any distributions to unsecured claims. However, in Chapter 7 liquidations, there is a limited exception to this general rule. Under Section 724(b)(2) of the Bankruptcy Code, “certain unsecured creditors may ‘step into the shoes’ of secured tax creditors in Chapter 7 liquidation proceedings, so that when the collateral securing the tax claims is sold, the unsecured creditors are paid first.” As a result, if Stubb’s claim for Chapter 11 administrative expenses was one of the unsecured claims covered by § 724(b)(2), then, but only then, could it recover from the estate. The Fourth Circuit, however, found that under the version of § 724(b)(2) in effect at the time the bankruptcy court rendered its decision, the secured tax claim takes priority over Stubb’s claim to fees. Stubb’s argued that the application of current law to its claim would have an “impermissible retroactive effect,” and that it should prevail under the prior version of §724(b)(2), which should govern this case. The Court disagreed and found that the bankruptcy court properly applied the version of §724(b)(2) in effect when it rendered its decision. Accordingly, under that provision, the Court held that Stubbs was not entitled to subordinate the IRS’s secured tax claim in favor of its unsecured claim to Chapter 11 administrative expenses.

For those reasons, the Court affirmed the judgment of the district court.

Full Opinion

Meredith Weisler


Decided: July 1, 2015

The Fourth Circuit vacated the judgment awarded by the district court, reversed its order dismissing the plaintiff’s claims against the Substitute Trustee, and remanded for further proceedings.

This appeal stemmed from the district court’s grant of defendant’s motion to dismiss concluding that Houck failed to allege facts that plausibly supported her claim that the violation of the automatic stay was willful, a required element of a 11 U.S.C. § 362(k) claim. Houck was deeded land in North Carolina, and Houck and her fiancé, Ricky Penley placed a mobile home on the property after receiving financing from a predecessor of LifeStore Bank. After refinancing in 2007, Houck lost her job and struggled making her loan payments. Later, Houck and Penley got married and asked LifeStore for a loan modification. LifeStore referred Houck to Grid Financial Services, who denied her request because she was unemployed. Soon, Houck defaulted on the loan.

In July of 2011, the Hutchens Law Firm served Penley with a notice of foreclosure. Houck, acting pro se, filed a Chapter 13 bankruptcy petition to stop the foreclosure proceedings. The bankruptcy court dismissed Houck’s petition because she failed to file certain required schedules and statements, and the Substitute Trustee, by its counsel, the Hutchens Law Firm, reactivated the foreclosure proceedings. Later, Houck filed a second Chapter 13 bankruptcy petition, and Penley called the Hutchens Law Firm to notify it of the filing. Also, Penley notified LifeStore who told Penley that it intended to wait for notice from the bankruptcy court before taking any action. A few days later, the Substitute Trustee, represented by Hutchens, sold Houck’s home at a foreclosure sale. The next day, the bankruptcy court dismissed Houck’s petition, and she did not object because her home had already been sold. Houck commenced this action against the Substitute Trustee, LifeStore, and Grid Financial asserting a claim under 11 U.S.C. § 362(k) for violation of the automatic stay.

The Fourth Circuit determined that they had jurisdiction to hear Houck’s appeal under the doctrine of cumulative finality. Cumulative finality exists in circumstances where all claims are dismissed, albeit at different times, before the appeal taken from the first dismissal order is considered. See Equip. Fin. Grp., Inc. v. Traverse Computer Brokers, 973 F.2d 345, 347 (4th Cir. 1992). Because the district court’s February 20, 2014 order disposed the entire case, the order was a final judgment and the doctrine of cumulative finality must be considered. Here, Houck’s claims against the Substitute Trustee were dismissed in its October 1, 2013 order, leaving open the claims against LifeStore and Grid Financial. Because the district court could have certified such an order as a final judgment under Rule 54(b) and because the court later entered final judgment against the other defendants in its February 20, 2014 order before Houck’s interlocutory appeal was considered by the Fourth Circuit, the Fourth Circuit held that the doctrine of cumulative finality applied, and their jurisdiction is appropriate.

Additionally, the district court dismissed Houck’s federal claim on the ground that it lacked subject matter jurisdiction. The district court concluded that a claim under § 362(k) could only be brought in a bankruptcy court, not in a district court. However, the cases relied upon by the district court, analyzed the pre-1984 version of § 362, which lacked subsection (k)’s private cause of action. In 1984, with the enactment of the Bankruptcy Amendments and Federal Judgeship Act of 1984, Congress created a private cause of action for the willful violation of a stay. See 11 U.S.C. § 362(k). By creating this cause of action, Congress did not specify which courts possess jurisdiction over a § 362(k) claim. Therefore, the Fourth Circuit determined that in no circumstance did the Act, in conferring such adjudicatory authority give exclusive jurisdiction to a bankruptcy court, and subject matter jurisdiction was appropriate.   

Houck argues that the district court erred in dismissing her 362(k) claim against the Substitute Trustee, claiming that the court applied the incorrect legal standard and that her complaint was sufficient under the correct standard. The district court focused on the elements of a § 362(k) claim and noted that Houck failed to provide notice to the Substitute Trustee, precluding any allegation of willfulness. The Fourth Circuit determined that while the district court correctly accepted the complaint’s factual allegations as true, the district court incorrectly undertook to determine whether a lawful alternative explanation appeared more likely. In order to survive a motion to dismiss, a plaintiff need not demonstrate her right to relief is probable or that alternative explanations are less likely; rather, she must merely advance her claim “across the line from conceivable to plausible.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). The inquiry of the district court as to whether an alternative explanation was more probable violated the plausibility standard. Further, the Substitute Trustee argued that Houck failed to provide it with notice of her bankruptcy petition in writing and could not have willfully violated the automatic stay. However, the Fourth Circuit determined that the requirements of § 362(k) did not include any provision that a particular form of notice be given. Ultimately, the Fourth Circuit concluded that Houck stated a plausible claim under § 362(k).

Finally, the Substitute Trustee, as an alternative ground for dismissal of Houck’s claims, contended that Houck was not an eligible debtor when she filed her second bankruptcy petition within 180 days of her first petition and did not trigger the stay automatically under § 362(a). The Fourth Circuit determined that the issue of whether Houck was an eligible debtor when she filed her second petition is a question of fact that will require evidentiary support.

Full Opinion

Austin T. Reed   


JENKINS v. WARD, NO. 14-1385

Decided: April 27, 2015

The Fourth Circuit reversed and remanded the district court’s decision to deny dismissal of a trustee’s complaint because the trustee’s complaint was filed sixty-nine days after the creditors’ meeting, as opposed to the statutory limit of sixty days.

In 2012, Jenkins filed for Chapter 7 bankruptcy relief.  A creditors’ meeting was held on July 19 to discuss Jenkins’ financial affairs.  During a meeting, the trustee stated that she was “not going to conclude the meeting today.”  However, no notice of a continued meeting was ever filed and the meeting never reconvened.  The trustee filed a complaint objecting to Jenkins discharge due to Jenkins’ “general lack of cooperation” throughout the process.

As outlined in Bankruptcy Rule 4004(a), the trustee had to make the objection within sixty days after the meeting, but he didn’t object until sixty-nine days after.  Thus, the trustee’s objection to discharge was not timely.  Although trustee attempted to adjourn the creditors’ meeting on July 19, 2012, he failed to announce the date and time of the adjournment meeting or to file a statement thereafter containing that information.  Rule 2003(a) unequivocally requires these acts to effectuate an adjournment; therefore, the meeting was never adjourned and was actually concluded.  Accordingly, the Fourth Circuit dismissed trustee’s complaint because trustee didn’t properly adjourn the meeting, which means that the meeting ended on July 19, and therefore, trustee’s complaint was made sixty-nine days after the meeting.  Based on the foregoing, the Fourth Circuit reversed and remanded.

Full Opinion

Chris Toner


Decided: July 28, 2014

The Fourth Circuit held that Railworks could not recover a premium payment transfer under 11 U.S.C. § 550, nor avoid the transfer under 11 U.S.C. § 547, following a Chapter 11 bankruptcy filing.

Railworks, a national provider of railway services, filed for Chapter 11 bankruptcy. TIG provided insurance to Railworks, and CPG was TIG’s managing general underwriter. According to the agreement between CPG and TIG, CPG would hold all premiums collected in trust for TIG as the property of TIG. Guttman, the Chapter 11 Litigation Trustee for Railworks, filed to avoid and recover premium payments that had been paid to CPG within ninety days of Railworks bankruptcy filing.

Under the preference avoidance statute, § 547, a trustee may avoid transfers made out of the debtor’s estate before the bankruptcy petition is filed. These transfers are known as “preferences.” The trustee must show that the transfer was:

(1) of an interest of the debtor in property; (2) to or for the benefit of a creditor; (3) for or on account of an antecedent debt owed by the debtor before the transfer was made; (4) made while the debtor was insolvent; (5) made on or within ninety days of the filing of the bankruptcy petition; and (6) it must enable the creditor to receive a greater percentage of its claim than it would under the normal distributive provisions in a liquidation case under the Bankruptcy Code.

Morrison v. Champion Credit Corp., 952 F.2d 795, 798 (4th Cir. 1991). Under the recovery statute, § 550, a transfer may be recovered from “the initial transferee of such transfer or the entity for whose benefit such transfer was made.” § 550(a)(1). Because the Bankruptcy Code does not define “initial transferee,” the Fourth Circuit determined whether an entity is an “initial transferee” using the “dominion and control” test. The initial transferee must: “(1) have legal dominion and control over the property…and (2) exercise this legal dominion and control.” The initial transferee is not a “‘mere conduit’ for the party who had a direct business relationship with the debtor.” The Court further distinguished between avoidance of a transfer and recovery from the transferee. In order to recover from a transferee, a trustee must avoid a transfer; however, a trustee does not automatically recover under § 550 by avoiding the transfer. Thus in order for funds to be avoidable under § 547, the funds must first be recoverable under § 550.

The Fourth Circuit rejected CPG’s argument that Guttman failed to properly plead his claims under §§ 547 and 550 because a plaintiff is not limited by one specific legal theory in a complaint. The Court then proceeded to determine whether Guttman could recover the premium payment transfers under § 550. The Fourth Circuit reasoned that a party cannot be the entity for whose benefit the transfer was made if that entity is only a mere conduit for the party that had a direct business relationship with the debtor. The Court noted that according to the agreement between CPG and TIG, CPG, as a trustee for TIG, only had physical control of the transfers, but did not have the freedom to use the funds as CPG wished. If the extinguishment of contingent liability benefitted CPG, then there would be no conduit defense. The Court expressly noted that it was unwilling to eliminate the conduit defense. Because CPG was unquestionably a mere conduit, and a party cannot be both a conduit and a benefitting entity, the Fourth Circuit held that Guttman could not recover the premium payment under § 550.

Full Opinion

Verona Sheleena Rios


Decided: July 25, 2014

The Fourth Circuit affirmed the district court, and held that the National Heritage Foundation (“NHF”) failed to demonstrate exceptional circumstances to justify the enforcement of the Release Provision in its Chapter 11 reorganization plan.

Appellee, the NHF, is a non-profit public charity. In 2009, Appellee filed for Chapter 11 bankruptcy, and the bankruptcy court approved a plan containing a non-debtor release provision that claimed to release Appellee, and several appellee-related committees and directors, from liability in connection with the bankruptcy. The lower court ruled that the release provision was invalid, and NHF appealed.

In its reasoning, the Fourth Circuit addressed the six factors used to determine the validity of a release provision set forth in Class Five Nevada Claimants v. Dow Corning Corp. Those factors are the following:

(1) There is an identity of interests between the debtor and the third party . . . ; (2) The non-debtor has contributed substantial assets to the reorganization; (3) The injunction is essential to reorganization . . . ; (4) The impacted class, or classes, has overwhelmingly voted to accept the plan; (5) The plan provides a mechanism to pay for all, or substantially all, of the class or classes affected by the injunction; [and] (6) The plan provides an opportunity for those claimants who choose not to settle to recover in full.

The Court addressed each factor in turn. First, the Court determined that the presence of an indemnity obligation between the debtor and the released parties weighed in favor of the Appellee. However, the Court determined that all of the other factors weighed against the Appellee. NHF failed to satisfy the second factor because none of the released parties made any financial contribution to the reorganization. Appellee failed to satisfy the third factor largely because it provided little, or no, evidence that investor lawsuits would imperil the Appellee’s reorganization. On the fourth factor, Appellee failed to satisfy because the class most affected by the release provision was not given the opportunity to accept or reject the plan. Appellee failed to satisfy the fifth factor because of an absence of a mechanism for affected donors to pursue claims post-bankruptcy. Finally, Appellee failed to satisfy the sixth factor because, similar to the fifth factor analysis, NHF did not provide a mechanism to pay donor claims outside of the bankruptcy proceedings. Accordingly, the Fourth Circuit affirmed the lower court ruling because the totality of the Corning factors weighed against the Appellee.

Full Opinion

Chris Hampton


Decided: June 27, 2014

The Fourth Circuit held that the Non-Debtor Release Provision provided in the National Heritage Foundation’s (NHF) Chapter 11 reorganization plan was unenforceable, which affirmed the bankruptcy and district courts’ holding.

NHF, a non-profit public charity, filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code.  The bankruptcy court approved an amended plan which included a Non-Debtor Release Provision (the Release Provision).  The Release Provision essentially released NHF, its officers, directors, and employees from any liability arising out of NHF’s business, other than failure to follow the reorganization plan.  NHF donors appealed the bankruptcy court’s confirmation of the Release Provision; the donors averred that the provision was invalid.  On remand, the bankruptcy court concluded that the Release Provision was unenforceable and NHF appealed the decision.

Within the Fourth Circuit non-debtor releases are enforceable, but are to be approved “cautiously and infrequently.”  Behrman v. Nat’l Heritage Found., 663 F.3d 704, 712 (4th Cir. 2011).  The Court has instructed bankruptcy courts to consider the six factors provided in In re Dow Corning Corp., 280 F.3d 648 (6th Cir. 2002).  The six factors include whether (1) there is an identity of interests between the debtor and third party; (2) the non-debtor has contributed substantial assets to the reorganization; (3) the injunction is essential to reorganization; (4) the impacted class has overwhelmingly voted to accept the plan; (5) the plan provides a mechanism to pay for all, or most, of the class or classes affected by the injunction; and (6) the plan provides the opportunity for those claimants who choose not to settle to recover in full.  The Fourth Circuit concluded that only the first factor weighed in NHF’s favor.  Therefore, the Non-Debtor Release Provision was unenforceable.

Full Opinion

Amanda K. Reasoner


Decided: May 22, 2014

The Fourth Circuit, affirming the decisions of the bankruptcy and district courts, held that under North Carolina law, where a creditor subcontractor is entitled to a lien upon funds a third party owes a debtor construction company, the subcontractor’s property interest in the liens arises upon delivery of the materials to the building site.  Therefore, if the debtor construction company files a bankruptcy petition, a subcontractor entitled to a lien is exempt from the automatic stay on debt collections imposed during federal bankruptcy proceedings, notwithstanding its failure to perfect the lien pre-petition.

Construction Supervision Services (CSS), a North Carolina construction company, placed orders with multiple subcontractors (the Subcontractors).  The Subcontractors in turn delivered the requested goods to the building site and invoiced CSS for the amount due.  CSS then failed to pay the creditor Subcontractors and filed for Chapter 11 bankruptcy.  While federal bankruptcy petitions trigger an automatic stay on creditor claims against the debtor, 11 U.S.C. § 362(b)(3) provides an exception for “any act to perfect . . . an interest in property to the extent that the trustee’s rights and powers are subject to perfection under section 546(b) . . . .”  Section 546(b) extends the exception to instances where state law creates a property interest before the date of perfection.  Under North Carolina law, the Subcontractors were entitled to a lien on funds owed to CSS and, with the belief that the exception to the stay applied, sought to serve notice to CSS’s debtors thereby perfecting the liens.  Branch Banking & Trust Company (BB&T), concerned with recovering funds in excess of one million dollars it lent to CSS, objected to the Subcontractors’ post-petition perfection.  BB&T averred that because the Subcontractors failed to notice and perfect their liens prior to CSS’s bankruptcy petition, they did not have a property interest in the liens; therefore, the exception did not apply and their claims were stayed by the federal bankruptcy court order.

Because the bankruptcy stay exception applies to any act to perfect a pre-petition property interest, the Court had to determine whether, under the relevant North Carolina statute, a subcontractor’s property interest begins when the subcontractor becomes entitled to a lien or instead only after the subcontractor perfects the lien.  After its analysis of the statute, the Court reasoned that the statute simply secures an already existing property interest.  Because entitlement to a lien arises at the time the creditor subcontractor delivers the materials, so does the subcontractor’s property interest.  Therefore, the Subcontractors had a property interest at the time that CSS filed its bankruptcy petition, and the bankruptcy stay did not preclude them from perfecting their interest post-petition.

Full Opinion

-Amanda K. Reasoner


Decided: April 28, 2014

The Fourth Circuit held that, absent extraordinary circumstances, Chapter 7 trustees must be paid on a commission basis, as required by 11 U.S.C. § 330(a)(7).  Thus, the Court reversed and remanded the district court’s decision, which affirmed the bankruptcy court’s non-commission-based fee award, with instructions to vacate the Trustee’s fee award, and remand the matter to the bankruptcy court to determine the proper commission-based fee to award to the Trustee.

The Trustee, Gold, in this Chapter 7 case, requested a trustee’s fee of $17,254.61.  Finding that Gold failed to properly or timely complete his duties, however, the bankruptcy court reduced his fee to $8,020.00.  In determining the Trustee’s fee, the bankruptcy court found that he did not properly discharge his duties.  Gold did not administer the estate expeditiously and in a manner compatible to the best interests of the parties in interest.  This court also found that he neglected to adequately supervise the case.  Consequently, the bankruptcy court based the Trustee’s compensation on an hourly rate, as opposed to a commission-based rate that § 330(a)(7) dictates.  The Trustee contends that the bankruptcy court violated his right to due process when it reduced his compensation (1) without advance notice that it thought his fee request to be extraordinary, or (2) a meaningful opportunity to put forth evidence to assuage the bankruptcy court’s misgivings.

The Court reviewed two questions in this appeal.  The first was one of first impression: whether, in light of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), a bankruptcy court is required, absent extraordinary circumstances, to compensate Chapter 7 trustees on a commission basis.  The second question was whether the case should be remanded to the bankruptcy court with instructions to apply the correct legal standard after an evidentiary hearing.

The Court followed the plain meaning rule, and determined that the definitions of the operative terms in the independent clause of § 330(a)(7) indicated that, absent extraordinary circumstances, a Chapter 7 trustee’s fee award must be calculated on a commission basis.  The Court held that the bankruptcy court should have determined what the maximum statutory commission rate for this case was pursuant to § 326(a).  Only after that determination should the bankruptcy court have decided whether any extraordinary circumstances existed such that the proper commission rate set out in § 326(a), which is presumptively reasonable, was unreasonable, and, thus, should have been reduced.  The Court did not decide the second question on appeal.  The Court reversed the district court’s decision affirming the bankruptcy court’s non-commission-based fee award, and remanded the case to the district court with instructions to vacate the Trustee’s fee, and remand the matter to the bankruptcy court to determine the proper commission-based fee to award to the Trustee.

Full Opinion

Grace Faulkenberry

IN RE PFISTER, No. 12-2465

Decided: April 17, 2014

The Fourth Circuit reversed the district court’s finding that a resulting trust severed the plaintiff’s legal and equitable interests in property.  Thus, the Fourth Circuit stated that the district court’s judgment was vacated and remanded the case back to district court.

On May 10, 2001, the plaintiff and her husband (the Pfisters) acquired property in Greer, South Carolina (SC), which they put in their names, and then leased to her husband’s wholly owned corporation, Architectural Glass Construction, Inc. (AGC).  AGC made its rental payments directly to the bank, and not the Pfisters.  The Pfisters subsequently refinanced the property’s mortgage several times, with the names of the borrowers differing on multiple occasions by listing the Pfisters, AGC, or both as the borrower.  On December 31, 2008, AGC received an $87,000 loan from Greer State Bank, and the Pfisters listed the property as collateral.  However, the attorney realized that AGC could not grant the mortgage because it was not listed on the property’s deed.  To fix this issue, the Pfisters deeded the property to AGC in exchange for ten dollars consideration. The plaintiff then declared bankruptcy seven months later, and the bankruptcy trustee moved to set aside the transfer as a constructively fraudulent conveyance because she disposed of the property for nominal consideration when her interest was worth $270,000.  The bankruptcy court agreed with the trustee and ordered AGC to reimburse the bankruptcy estate.  However, the district court found that AGC’s use of the property and payment of the mortgage warranted reversal, stating that the facts created a resulting trust under which AGC held equitable title to the property and the plaintiff held only bare legal title.  Thus, the district court found that the plaintiff’s interest lacked any value when she conveyed it such that she did not make a voidable, constructively fraudulent conveyance in 2008.  The trustee appealed.

On appeal, the Fourth Circuit stated that the Bankruptcy Code permits a bankruptcy trustee to recover property the debtor fraudulently conveyed before filing a petition for bankruptcy.  11 U.S.C. §§ 544 & 548.  The alleged constructive fraud occurs when an insolvent debtor, in the two years before filing for bankruptcy, transfers an asset for less than “reasonably equivalent value.”  Id. § 541(a)(1)(B).  If the debtor transfers an asset for less than “reasonably equivalent value,” the trustee may avoid the transaction, and the debtor must either surrender the property or provide the trustee with its cash equivalent.  Under SC law, the general rule is that when real estate is conveyed to a spouse, the presumption is that the property was supposed to be a gift or advancement.  Caulk v. Caulk, 43 S.E.2d 600, 603 (S.C. 1947).  Here, AGC paid for the property deeded to the Pfisters, and plaintiff’s husband is the sole owner of AGC.  Thus, SC law presumes that the property was intended as a gift to the plaintiff.  However, the gift presumption may be rebutted by clear evidence that a gift was not intended.  In order to overcome the gift presumption and establish a resulting trust, a party must prove by clear and convincing evidence that (1) it paid for the property, (2) with the intent to own it, and (3) on the date of purchase.  Although AGC committed to pay for the property under post 2001 mortgages, and intended to be the owner of the property after the 2008 transfer, the facts presented did not show that all of the requirements were met on the date the property was purchased in May 2001.  First, the property was entirely financed by BB&T on the date of purchase, and neither the Pfisters nor AGC paid for the property on the date it was purchased.  Second, at the time the property was purchased a rental agreement was propositioned indicating that AGC served as the property’s tenant, not the property’s owner, further proving that AGC did not intend to own the property on the date of its acquisition.  Thus, the Fourth Circuit concluded that the bankruptcy court did not clearly err when determining that there was no justification for a resulting trust.

Full Opinion

-Alysja S. Garansi


Decided: March 11, 2014

The Fourth Circuit held that the United States District Court for the Western District of Virginia properly concluded that the attorney’s fees expended by Jordan Oil in defense of its interests against fraud committed by Youssef Hafez Abdelbary (Abdelbary) in his bankruptcy proceedings were recoverable under the Mandatory Victim Restitution Act (MVRA), 18 U.S.C. § 3663A.  The Fourth Circuit therefore affirmed the judgment of the district court.

Abdelbary, the owner and operator of a gas station and convenience store, bought gas from Jordan Oil.  In February 2008, Jordan Oil stopped sending gas to Abdelbary after Abdelbary failed to pay for a gas delivery.  Jordan Oil then sued Abdelbary to recover the money owed.  In May 2008, Jordan Oil obtained a final judgment in its favor.  Abdelbary filed for bankruptcy after consulting with an attorney in July 2008.  On his bankruptcy filing, Abdelbary “denied having made any gifts within one year or having transferred any property within two years of the filing.”  Also, at the creditors’ meeting, Abdelbary said he had not transferred assets to a member of his family.  However, Abdelbary had in fact sent $76,000 to his brother during the two years prior to filing.

Abdelbary was eventually charged with, inter alia, bankruptcy fraud under 18 U.S.C. § 152(3).  Abdelbary was convicted on all counts.  At sentencing, the district court ordered Abdelbary to, inter alia, pay Jordan Oil restitution for the attorney’s fees it expended during Abdelbary’s bankruptcy proceeding.  While the district court cited both the MVRA and the Victim and Witness Protection Act (VWPA), 18 U.S.C. § 3663, it did not clarify which provision it was relying on.  On appeal, the Fourth Circuit vacated the award of restitution and remanded the case with regard to this award, as the district court did not clarify whether it relied on the MVRA or the VWPA and “had overlooked making the factual findings required by the appropriate act.”  On remand, Abdelbary and the government agreed that the MVRA governed the issue.  However, Abdelbary argued that, inter alia, the attorney’s fees expended by Jordan Oil constituted a consequential loss rather than a direct one—and therefore could not be compensable under the MVRA.  The district court rejected this position, ordering Abdelbary to pay restitution to Jordan Oil under the MVRA.  Abdelbary appealed, arguing that, inter alia, attorney’s fees are not compensable under the MVRA per the Fourth Circuit’s decision in United States v. Mullins, 971 F.2d 1138.  Abdelbary argued that Mullins—in which the Fourth Circuit held that VWPA restitution cannot include consequential damages such as attorney’s fees incurred to recover the property at issue—was consistent with the “American Rule” for attorney’s fees.

The Fourth Circuit found the American Rule inapplicable, as Abdelbary’s appeal involved the types of losses includable as criminal restitution rather than entitlement to fee shifting.  The Fourth Circuit then enumerated the rule applicable to the case at hand, quoting United States v. Elson, 577 F.3d 713: “[W]here a victim’s attorney fees are incurred in a civil suit, and the defendant’s overt acts forming the basis for the offense of conviction involved illegal acts during the civil trial . . . such fees are directly related to the offense of conviction” and can be recovered under the MVRA.  The Fourth Circuit then distinguished the instant case from Mullins, noting that Abdelbary’s bankruptcy fraud was the direct and proximate cause of Jordan Oil’s fee expenditures—and Abdelbary’s bankruptcy fraud therefore “result[ed] in damage to or loss or destruction of property of a victim of the offense,” 18 U.S.C. § 3663A(b)(1).

Full Opinion

– Stephen Sutherland

IN RE TANEJA, NO. 13-1058

Decided: February 21, 2014

The Fourth Circuit, finding that (1) the lower courts applied the correct legal principles relevant to evaluating defendant’s good-faith affirmative defense and (2) the lower courts did not clearly err in determining that defendant satisfied its burden of proving a good-faith defense under the Bankruptcy Code, affirmed the decision of the district court and the bankruptcy court dismissing the bankruptcy trustee’s adversary action.

Vijay Taneja (“Taneja”) operated Financial Mortgage, Inc. (“FMI”), a business engaged in originating home mortgages and selling those loans to secondary purchasers. In carrying out its business operations, FMI worked with numerous financial institutions known as “warehouse lenders.” The warehouse lenders would typically extend lines of credit and advance funds to FMI, thus, enabling it to extend mortgage loans to individual mortgagees. The warehouse lenders required FMI to sell the mortgage loans to secondary purchasers within a certain time period. After the sale, FMI would replenish the warehouse lenders’ lines of credit according to the terms of the particular agreement. At some point after 1999, Taneja and FMI began selling the same mortgage loans to several different secondary purchasers and conspiring with other business entities controlled by Taneja to conceal the fraud.

FMI began a business relationship with First Tennessee Bank, National Association (“First Tennessee”) in 2007. Before extending a line of credit to FMI, First Tennessee performed a standard investigation of FMI and Taneja. The investigation, however, did not reveal any negative business information involving FMI or Taneja, and the parties entered into an agreement in July 2007, under which First Tennessee agreed to extend to FMI a $15 million line of credit. The lending agreement obligated FMI to send certain documents to First Tennessee within two business days after each mortgage loan closed. Although FMI routinely did not meet this two-day timeline, it eventually provided First Tennessee with the most critical security document underlying each transaction, the original promissory note for each loan. By mid-October 2007, FMI owed nearly $12 million on its line of credit with First Tennessee. As a result, First Tennessee suspended payment of any additional advances to FMI. Thereafter, First Tennessee executives, Robert Garrett and Benjamin Daugherty, met with Taneja at FMI’s place of business in November 2007 to discuss strategies to clear the line of credit. In that meeting, Taneja informed Garrett and Daugherty that FMI’s failure to produce timely, adequate documentation to complete mortgage loan sales to secondary purchasers was caused by the unexpected departure of one of FMI’s loan processors.

Garrett and Daugherty again met with Taneja at FMI’s office in January of 2008 to address the outstanding balance of advanced funds. In that meeting, Taneja proposed a collateral swap, in which Taneja would sell other real estate to “pay the bank off.” Taneja represented that the mortgage loans had lost value, and that Tanenja did not want to sell them until their value increased. Also during that meeting, Garret asked Taneja’s attorney whether FMI’s loans were valid, and free from fraud. Taneja’s attorney assured Garret that there were no issues with the loans. After that meeting, Garrett and Daugherty performed additional research into the properties serving as security for FMI’s loans. Thereafter, the two met once again with Taneja and her attorney. At that meeting, Garret and Daugherty reiterated the importance of confirming that the mortgage loans were real. Again, they were assured that the loans were good, and First Tennessee ultimately approved a forbearance agreement with FMI, in which Taneja agreed to provide additional collateral to secure the bank’s interests. First Tennessee learned otherwise, however, in April 2008, when it discovered that the deeds of trust securing the mortgage notes held by it were fraudulent. Immediately thereafter, First Tennessee declared FMI in default under the lending agreement. As a result of First Tennessee’s relationship with FMI and Taneja, it lost more than $5.6 million.

Taneja and his corporate affiliates, including FMI, filed Chapter 11 bankruptcy in June 2008. The bankruptcy trustee filed an adversary pleading in the bankruptcy court against First Tennessee, seeking to avoid and recover the funds that FMI transmitted to the bank in the twelve payments made under the lending agreement on the grounds that the funds were conveyed fraudulently. In response, First Tennessee contended that it received the payments from FMI for value and in good faith. A three-day trial ensued. At trial, First Tennessee relied on the testimony of Garrett and Daugherty to establish its good faith defense. Ultimately, the bankruptcy court determined that First Tennessee reasonably thought that the lagging secondary mortgage market, rather than any inappropriate conduct by FMI and Taneja, was the cause of the delayed sales. The bankruptcy court further determined that First Tennessee did not have any information that would reasonably have led it to investigate matters further, and that its actions were in accordance with the industry’s usual practices. In making its determinations, the bankruptcy court acknowledged that Garrett and Daugherty were responsible for the bank’s warehouse lending and transactions with FMI, but stated that it considered these factors in assessing whether their employment and job conduct may have affected their credibility. Having concluded that First Tennessee established its good-faith defense, the bankruptcy court dismissed the trustee’s action. The district court affirmed that decision, and this appeal followed.

On appeal, the Fourth Circuit first addressed the bankruptcy trustee’s contention that both the bankruptcy court and the district court erred in applying the good-faith standard, as articulated in In re Nieves, in conducting their analyses. Addressing this contention, the Court declined to adopt a bright-line rule requiring that a party asserting a good-faith defense present evidence that his every action concerning the relevant transfers was objectively reasonable in light of industry standards. Instead, the Court noted its inquiry regarding industry standards serves only to establish the correct context in which to consider what the transferee knew or should have known. The Court, additionally, noted that a defendant asserting a good-faith defense is not compelled to present third-party expert testimony in order to establish prevailing industry standards. And, therefore, the Fourth Circuit held that the bankruptcy court and the district court applied the correct legal standard in evaluating whether First Tennessee proved its good-faith defense.

Next, the Fourth Circuit rejected the trustee’s argument that First Tennessee presented insufficient objective evidence to prove its good-faith defense. In so doing, the Court reasoned that, in light of Garrett and Daugherty’s extensive experience in warehouse lending, no third-party expert testimony was required on the objective component of the good-faith defense. The Court further observed that the bankruptcy court explicitly stated that it considered the fact that Garrett and Daugherty were employed by the bank in assessing the weight to be given their testimony. Thus, the Court found Garrett and Daugherty provided competent evidence regarding the objective component of the good-faith defense. The Court then addressed evidence cited by the trustee, which he alleged should have signaled to First Tennessee that Taneja and FMI were committing fraud. The Court, however, held that the bankruptcy court did not clearly err in concluding that First Tennessee accepted the relevant transfers from FMI in good faith and without knowledge of facts that should have alerted it that the transfers were part of a fraudulent scheme. Thus, the decisions of the bankruptcy court and district court were affirmed.

Full Opinion

– W. Ryan Nichols

United States of America v. Freeman, No. 12-4636

Decided: January 17, 2014

The Fourth Circuit reversed and remanded the district court’s order directing a defendant to pay restitution to victims that he defrauded because the crime for which the defendant was convicted did not cause the victims’ loss.

Defendant, Robert J. Freeman purported to be a minister and through fraudulent charities, caused several parishioners to take out substantial loans purportedly to help the church. In reality Freeman used the loan proceeds to accumulate substantial assets including: a $1.75 million house and more than $340,000 in luxury automobiles. Freeman convinced the parishioners that, although they took out the loan, he and the church would make payments. By October of 2005, Freeman and his wife owed debts in excess of $1.3 million and filed for bankruptcy. At his creditors meeting, Freeman falsely misrepresented his assets and presented fabricated earnings statements to a fictitious business.  The government charged Freeman with numerous crimes relating to his fraudulent activity; however, as a result of a plea agreement, he only pled guilty to one count of obstructing an official proceeding, relating to his misrepresentations at his bankruptcy hearing. Freeman was not convicted nor did he plead guilty to any crime relating to defrauding parishioners. The district court sentenced Freeman to 27 months in prison and ordered him to pay a total restitution of $631,050.52 to his victims. Freeman appealed to challenge the legality of the order of restitution.

On appeal, the Fourth Circuit first explained that a court may only order restitution based on statutory authority. In this case, the court determined that the district court ordered restitution as a condition of supervised release, pursuant to 18 U.S.C. § 3583(d). Under that section, a court may order restitution to repay victims “of the offense.” The Fourth Circuit held that, based on the plain language of the statute, “of the offense” meant that the court may order restitution “only for the loss caused by the specific conduct that is the basis of the offense of the conviction.”  In adopting this position, the Fourth Circuit sided with the overwhelming weight of authority from other circuits. In the present case, the Fourth Circuit held that the government failed to demonstrate the requisite causal connection between Freeman’s misrepresentations to bankruptcy officials and the victims’ significant financial loss. Even if Freeman had been entirely truthful at his bankruptcy proceeding, his victims would have suffered no less in unfortunate financial loss. Therefore, the Fourth Circuit reversed the district court order of restitution and remanded to the district court to determine whether or not to impose a fine.

Full Opinion

– Wesley B. Lambert

Jaffe v. Samsung Electronics Co., No. 12-1802

Decided: December 3, 2013

The Fourth Circuit held that the bankruptcy court reasonably exercised its discretion in balancing the interests of licensees with the interests of the debtor and found that application of Section 365(n) was necessary to sufficiently protect licensees. Therefore, the bankruptcy court’s ruling was affirmed.

In January 2009, Qimonda AG filed an insolvency proceeding in Germany. Dr. Michael Jaffé (“Jaffé “) was appointed to serve as insolvency administrator to liquidate the estate. The principal assets of the estate were approximately 10,000 patents, including 4,000 U.S. patents. The U.S. patents were subject to cross-license agreements with competitors.
Soon after the insolvency proceedings were commenced in Germany, Jaffé successfully commenced a Chapter 15 proceeding for recognition of the German proceeding as a “foreign main proceeding” under 11 U.S.C. § 1517. In addition, the bankruptcy court, pursuant to Section 1521(a)(5), entrusted him with all of Qimonda’s assets located within the United States, primarily the patents.

Contemporaneously with the Chapter 15 proceeding, Jaffé sent letters to Qimonda’s licensees under cross-license agreements declaring that the licenses were no longer enforceable under Section 103 of the German Insolvency Code.  The licensees, however, responded that they elected to retain their rights under the license pursuant to Section 365(n). In response, Jaffé sought a determination that Section 365(n) was not applicable. Initially, Jaffé prevailed in the bankruptcy court. However, on appeal, the district court reversed and remanded to the bankruptcy court for consideration of the Section 1522(a) balancing test and Section 1506 public policy considerations. After a four day evidentiary hearing on remand, the bankruptcy court issued an order holding that Section 365(n) applied with respect to the U.S. patents. The bankruptcy court found that the balancing of the debtor and creditor interests required by Section 1522 weighed in favor of application of Section 365(n). In addition, the bankruptcy court also concluded that deferring to German law under Section 1506, to the extent it allowed cancellation of U.S. patent licenses, would be contrary to public policy and therefore 365(n) should apply. This direct appeal to the Fourth Circuit followed.

On appeal, the Fourth Circuit addressed the significant question under Chapter 15 of the U.S. Bankruptcy Code of how to mediate between the United States’ interests in recognizing and cooperating with foreign insolvency proceeding and its interests in protecting creditors of the foreign debtor with respect to U.S. assets, as provided in Sections 1521 and 1522. Noting that the bankruptcy court properly recognized that in considering a request for discretionary relief under Section 1521(a), the court must also apply the balancing test set forth in Section 1522(a), the court held that the bankruptcy court reasonably exercised its discretion in (1) balancing the interests of licensees with the interests of the debtor and (2) finding that application of Section 365(n) was necessary to sufficiently protect licensees. Therefore, the bankruptcy court’s ruling was affirmed.

Full Opinion

-W. Ryan Nichols

Carroll v. Logan, No. 13-1024

Decided: October 28, 2013

The Fourth Circuit held that a Chapter 13 bankruptcy debtor’s estate includes the debtor’s inheritance of property beyond the 180-day time limit under Bankruptcy Code § 541 but before the close, modification, or dismissal of the bankruptcy estate.

Bankruptcy debtors, Ricky and Cheri Carroll (“Carrolls”) filed for Chapter 13 bankruptcy in February of 2009. The reorganization plan approved by the bankruptcy court in August 2009 required the Carrolls to pay $2,416 for 6 months followed by $2,480 for 54 months. In August 2012, the Carrolls notified the bankruptcy court that Mr. Carroll anticipated a $100,000 inheritance after the death of his mother. The Chapter 13 trustee therefore moved to modify the Carrolls’ bankruptcy estate to include the $100,000 inheritance. Over the Carrolls’ objection, the bankruptcy court ordered the inheritance be included in the debtors’ plan to pay unsecured creditors. The Carrolls appealed the bankruptcy court’s decision to the Fourth Circuit.

On appeal, the Carrolls argued that the bankruptcy court erred in modifying the Carrolls’ bankruptcy estate to include Mr. Carroll’s inheritance because it occurred more than 180 days after the Carrolls’ bankruptcy petition. The Fourth Circuit disagreed based on its interpretation of Bankruptcy Code Sections 541 and 1306(a). The Court found that Bankruptcy Code Section 541 generally identifies the property in the bankruptcy estate to include, “any interest in property…that the debtor acquires or becomes entitled to acquire within 180 days [of filing the petition]…[including] by bequest, devise, or inheritance.” Then, the Court then explained that Bankruptcy Code Section 1306(a) expands the scope of the bankruptcy estate under Section 541 to also include, “all property of the kind specified in [Section 541] that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted…whichever occurs first.” The Court determined that Sections 541 and 1306(a) together provided a formula for the bankruptcy estate that included the combination of: (1) property described in Section 541 subject to the 180 day time limit, and (2) property described in Section 541 (including inheritances) acquired before the Chapter 13 case is closed, dismissed or converted.  Beyond the plain language of the Bankruptcy Code, the court also noted that the majority of courts addressing the issue have also concluded that Section 1306 modifies the Section 541 time period in Chapter 13 bankruptcies. Therefore, the court held that the bankruptcy court properly included Mr. Carroll’s inheritance in the Chapter 13 bankruptcy estate.

Full Opinion

– Wesley B. Lambert

In Re Alvarez, No. 12-1156

Decided:  October 23, 2013

The Fourth Circuit held that the bankruptcy court correctly determined that it lacked the authority to “strip off” the debtor’s valueless lien because only the debtor’s interest in the estate was before the bankruptcy court.  The Fourth Circuit rejected the debtor’s argument that the bankruptcy court should have stripped off the lien on the ground that his spouse’s property interest was not part of the bankruptcy estate.

Jose Alvarez filed a Chapter 13 petition in the U.S. Bankruptcy Court for the District of Maryland.  In that petition, Mr. Alvarez identified his property, which was owned by Mr. Alvarez and his wife as tenants by the entireties.  Importantly, Mrs. Alvarez was not a party to the bankruptcy petition, nor did she file a separate petition of her own.  At the time the petition was filed, the property was encumbered by two mortgage liens.  Chase Home Finance held the first-priority mortgage lien and HSBC Mortgage Service (HSBC) held the second-priority mortgage lien.  At the time of the petition, the value of Mr. Alvarez’s property was less than the full amount owned on the first-priority lien, thus rendering HSBC’s second-priority lien valueless.  As required by the Federal Rules of Bankruptcy Procedure, Mr. and Mrs. Alvarez jointly filed a complaint in the bankruptcy court against HSBC.  In the complaint, they maintained that because the HSBC lien was valueless and, thus, was unsecured under 11 U.S.C. § 506(a), they were entitled to strip off the lien from the property.  The bankruptcy judge held that the lien could not be stripped off because both “tenants by the entireties” had not filed a petition for bankruptcy.  The district court affirmed the decision and Mr. and Mrs. Alvarez filed this appeal.

The Court began its opinion by explaining the statutory framework for stripping off a valueless lien in a bankruptcy proceeding.  The Court provided that the main issue in the case was “whether a bankruptcy court, in a Chapter 13 case filed by only one spouse, can strip off a valueless lien on property that the debtor and his non-debtor spouse own as tenants by the entireties.”  The Fourth Circuit noted that this was an issue of first impression among the federal appellate courts and the bankruptcy courts had reached different conclusions on the issue.  The Court then discussed Maryland property law as it related to tenancy by the entirety.  According to the Court, a property held in a tenancy by the entirety, under Maryland law, is property not owned by either spouse individually, but rather by the marital unit where each spouse has an undivided interest in the whole property.  The Court provided that a tenancy by the entirety could only be severed, when both spouses are alive, by divorce or by the joint action of both spouses.  The Court then explained that when an individual files a bankruptcy petition, 11 U.S.C. § 541 mandates that a debtor’s bankruptcy estate contain “all legal or equitable interest of the debtor in property as of the commencement of the case.”  The Court agreed with the bankruptcy court that it lacked the authority to strip off the valueless lien on the property because where one spouse has filed for bankruptcy, then only that spouse’s interest in the entireties property, rather than the whole of the property, was before the bankruptcy court.  Therefore, the Court held that the bankruptcy court was without authority to modify a lienholder’s rights with respect to a non-debtor’s interest in property held in a tenancy by the entirety.

Full Opinion

– John G. Tamasitis

Ranta v. Gorman, No. 12-2017

Decided:  July 1, 2013

The Fourth Circuit held that a bankruptcy court’s denial of confirmation of a debtor’s debt adjustment plan under Chapter 13 of the Bankruptcy Code (“Chapter 13”), 11 U.S.C. §§ 1301–30, and a district court’s affirmance of that denial, can constitute final orders for purposes of appeal; that Social Security income is excluded from the calculation of “projected disposable income” under 11 U.S.C. § 1325(b)(1)(B); and that, when a debtor intends to use Social Security income to fund a debt adjustment plan, the bankruptcy court must include this income in its feasibility analysis under 11 U.S.C. § 1325(a)(6).  The Fourth Circuit therefore vacated the order of the United States District Court for the Eastern District of Virginia and remanded the case with instructions to remand to the bankruptcy court.

Robert D. Mort Ranta (“Mort Ranta”) voluntarily petitioned for bankruptcy under Chapter 13, seeking the adjustment of certain debts.  When Mort Ranta proposed a debt adjustment plan (“plan”), the Trustee objected to it.  The Trustee asserted that Mort Ranta’s recorded expenses were overstated, and that Mort Ranta therefore had not dedicated all of his “projected disposable income” to unsecured creditors as mandated by 11 U.S.C. § 1325(b)(1)(B)—which applies when, inter alia, a Trustee objects to a debt adjustment plan.  In a bankruptcy court hearing, Mort Ranta conceded some overstatement of expenses.  However, Mort Ranta asserted that that Social Security income is excluded from “disposable income” calculations, and that his disposable income would therefore still be negative after downward adjustment of his expenses; thus, Mort Ranta contended that he should not have to make payments to unsecured creditors.  Despite Mort Ranta’s arguments, the bankruptcy court took the Social Security income into account and found that Mort Ranta could make larger payments.  However, because Mort Ranta did not include his Social Security benefits as income, the bankruptcy court did not take the Social Security benefits into account when evaluating the feasibility of his plan.  The court therefore concluded that his plan was not feasible.  The bankruptcy court then issued an order denying confirmation of Mort Ranta’s plan, ordering dismissal of the case in 21 days unless Mort Ranta took an enumerated action under the court’s local bankruptcy rules.  The district court affirmed the denial of confirmation.  Mort Ranta appealed, arguing that the Bankruptcy Code excludes Social Security income from projected disposable income calculations, and that—taking his Social Security income into account—his plan was a feasible one.

The Fourth Circuit first determined that bankruptcy proceedings entail a “relaxed rule of appealability,” in which the concept of finality is applied in a more pragmatic way.  Thus, for purposes of appeal, the Fourth Circuit concluded that a denial of confirmation can constitute a final order even though the case has not been dismissed.  Second, the Fourth Circuit noted that, under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), Pub. L. No. 109–8, 119 Stat. 23 (2005), the definition of “current monthly income” used to calculate disposable income explicitly excludes Social Security benefits.  Furthermore, per the United States Supreme Court’s decision in Hamilton v. Lanning, 130 S. Ct. 2464, “projected disposable income” is based on “disposable income,” plus any alterations necessary to account for foreseeable income changes.  Thus, because Social Security income is excluded from calculations of disposable income, it must also be excluded from calculations of projected disposable income. Lastly, the Fourth Circuit found that income not counted under the definition of “disposable income” can still be considered as income for purposes of a Chapter 13 debt adjustment plan.  Thus, when it is included in a debtor’s debt adjustment plan, Social Security income must be considered by bankruptcy courts for purposes of analyzing feasibility.

Full Opinion

– Stephen Sutherland

SG Homes Associates, LP v. Marinucci, No. 12-1621

Decided: June 4, 2013

The Fourth Circuit affirmed the District Court for the District of Maryland, which affirmed the bankruptcy court’s finding of fraud and entry of a non-dischargeable judgment in favor of the Appellee, SG Homes Associates, LP (“SG Homes”).

Marinucci was the president and, along with Munnikhuysen, a fifty percent shareholder of Chesapeake Site Contracting, Inc. (“Chesapeake”). On January 28, 2008, SG Homes accepted Chesapeake’s bid for site work on a building project at Crabbs Branch Way in Montgomery County Maryland (“The Project”) and requested, among other things, a performance and payment bond (the “P&P Bond”). Almost immediately after SG Homes accepted the bid, before any formal written contract was signed, Chesapeake hired subcontractors and suppliers and began work on The Project.  Soon thereafter Marinucci completed a bond request form and informed Randall, SG Homes’ procurement vice president, that Chesapeake was pursing the P&P Bond. However, by mid-March, Marinucci had decided not to obtain the P&B Bond because his wife refused to sign a personal guaranty as required by the bonding company. Nonetheless, on March 26, 2008, Munnikhuysen copied Marinucci on an email sent to SG Homes’ procurement manager, DeVerger, indicating that his office had advised him that SG Homes should see the P&P Bond by the end of the next week. Meanwhile, work continued on The Project and Chesapeake submitted monthly payment application to SG Homes containing a certification that the work covered by the application had been completed in accordance with the contract documents and all amounts previously paid to Chesapeake under the contract had been used to pay Chesapeake’s costs for labor, materials, and other obligations. Marinucci reviewed each application and directed an employee to sign each certification. Chesapeake deposited each payment into a common fund from which it paid some of its subcontractors and suppliers on The Project as well as other creditors who did not provide services or supplies for The Project. A written contract (“the Contract”) governing The Project was executed on May 12, 2008. The Contract was ambiguous as to whether SG Homes required the P&B Bond. Consequently, Munnikhuysen sent an email on May 14, 2008 informing DeVerger that the P&B Bond had been canceled because Chesapeake assumed SG Homes no longer wanted it. However, DeVerger insisted that there must have been a communication breakdown because SG Homes still wanted the P&B Bond. Subsequently, Marinucci was copied on several email exchanges between Munnikhuysen and DeVerger regarding the status of the P&B Bond, including one that indicated Marinucci was handling the issue. Thereafter, beginning in September 2008, multiple subcontractors and suppliers informed SG Homes that they were not receiving payment from Chesapeake. On October 29, 2008 Randall informed Marinucci that other subcontractors and suppliers had reported nonpayment and indicated that SG Homes would pay them directly with funds due to Chesapeake. After the subcontractors and suppliers were paid, SG Homes’ calculations indicated that no money was due to Chesapeake. The Contract was subsequently terminated. Thereafter, in February of 2009, SG Homes sued Chesapeake and Marinucci. While the case was pending, Marinucci filed chapter 7 bankruptcy and the suit was stayed against Marinucci, but preceded against Chesapeake. A default judgment was entered against Chesapeake and a final judgment was entered in favor of SG Homes in the amount of $208,806.89. Four days later, SG Homes filed an adversary proceeding against Marinucci in bankruptcy court, seeking a declaration that Marinucci’s debt was non-dischargeable under 11 U.S.C. §523(a)(2)(A). SG Homes asserted that the debt was non-dischargeable because Marinucci committed fraud when he falsely represented that Chesapeake would obtain a payment bond and when he falsely certified that Chesapeake was paying its subcontractors and suppliers in the monthly payment applications. The case went to trial in the bankruptcy court, and the court found that SG Homes had proven fraud by Marinucci on both theories, finding each ground as an independent basis for judgment against Marinucci for fraud, the amount of damages, and the non-dischargeability of the debt. On appeal, the district court affirmed that bankruptcy court’s findings and subsequently Marinucci appealed to the Fourth Circuit.

Reviewing the bankruptcy court’s decision independently, the Fourth Circuit first addressed Marinucci’s contention that the bankruptcy court erred in entering a non-dischargeable judgment against him because SG Homes failed to prove two of the elements of fraud: reliance and damages. Rejecting this argument, the Fourth Circuit found that the bankruptcy court relied on solid evidence, which indicated that SG Homes justifiably relied on Marinucci’s false certifications in the monthly payment applications and was therefore damaged because SG Homes would not have otherwise continued to pay Chesapeake had it known Chesapeake was making false certifications. Next, the court addressed the bankruptcy court’s finding that SG Homes incurred $208,806.89 in damages—the amount SG Homes double paid for work completed and material furnished by Chesapeake’s subcontractors and suppliers—as a result of Marinucci’s fraud. Rejecting this argument, the court found that Marinucci’s unsupported testimony was not sufficient to rebut SG Homes’ prima facie case of damages. Lastly, because SG Homes obtained a judgment based on the fraud after having shown (1) fraud; (2) reliance on the fraud; and (3) damages attributable to the fraud, the court concluded that the bankruptcy court did not err in determining that the judgment debt was non-dischargeable pursuant to 11 U.S.C. § 523(a)(2)(A).

Full Opinion

-W. Ryan Nichols

Wilson v. Dollar General Corp., No. 12-1573

Decided: May 17, 2013

The Fourth Circuit affirmed the United States District Court for the Western District of Virginia.

In his youth, Wilson suffered a detached retina in his right eye causing permanent blindness in that eye. Years later, in September 2009, he began working night shift at one of Dollar General’s distribution centers, processing inventory and loading merchandize for transportation. Unfortunately, in February of 2010, Wilson developed a serious inflammatory condition in his left eye and was diagnosed with Iritis—a medical condition characterized by inflammation of the iris. Initially he was prescribed eye drops, which as a side effect limited his abilities to perform his job by blurring his vision. Following the onset of this medical condition, Wilson took leave from work and underwent treatment. He was granted a total of eight weeks of leave, six weeks pursuant to Dollar General’s medical leave policy plus an additional two weeks. At the conclusion of his treatment, on April 6, 2010, Wilson was again prescribed eye drops and cleared to return to work that night though his vision did not fully return before he was supposed to report to work. As a result, Dollar General granted him an additional day of leave and permitted him to return to work on April 7 however his condition worsened and he was forced to seek additional treatment. After receiving treatment on April 7, Wilson informed his manager that he would be unable to return to work that evening as he had previously indicated. He further indicated that he had additional upcoming medical appointments at Duke Medical Center. At that point, according to Wilson, he was then offered an ultimatum, return to work that evening; or be terminated and reapply after his condition improved. Following his termination, Wilson contacted the Equal Employment Opportunities Commission (“EEOC”) and inquired about his option for legal recourse and filed a charge of discrimination. Soon thereafter, he filed for Chapter 13 bankruptcy. In March of 2011, the EEOC issued Wilson a notice of his right to sue Dollar General and on June 15, 2011, this suit was filed. Wilson alleged Dollar General had unlawfully discriminated against him by failing to provide a reasonable accommodation for his disability, resulting in his discharge, in violation of the American’s with Disabilities Act (“ADA”). In the district court, Dollar General moved for summary judgment, asserting that (1) Wilson lacked standing as a result of his status as a Chapter 13 debtor; and (2) Wilson failed to establish genuine issues of material fact as to his underlying claim. With respect to standing, Dollar General’s motion was denied; however, with respect to the underlying ADA claim, the motion was granted. This appeal followed.

On appeal, the Fourth Circuit first addressed the standing issue and, in conformance with all of other circuit courts that had considered the issue, affirmed the district court, finding that Chapter 13 debtors, unlike Chapter 7 debtors, have standing to bring causes of action in their own name on behalf of the estate. Next, the court addressed the merits of Wilson’s ADA claim that Dollar General discriminated against him by failing to make “reasonable accommodations” for him as required under the ADA. Affirming the district court, the Fourth Circuit found that Wilson was not a “qualified individual” as he was not able to show that “with reasonable accommodation he could perform the essential functions of the position.” In so holding, the court noted that Wilson was not able to identify a possible reasonable accommodation, other than leave, that would have enabled him to perform the essential functions of his position; nor was he able to produce evidence that had he been granted such leave, he could have performed the essential functions of his position on his requested return date.

Full Opinion

– W. Ryan Nichols

In Re: Derivium Capital, LLC, No. 12-1518

Decided: May 24, 2013

The Fourth Circuit affirmed the district court’s grant of summary judgment in favor of the defendants following the bankruptcy and collapse of an alleged Ponzi scheme. The court held that the bankruptcy trustee was not entitled to recover securities transfers, cash transfers, nor commissions, fees, and margin interest payments paid to the defendants as fraudulent conveyances under the Bankruptcy code, 11 U.S.C. §§ 544 and 548. The court also dismissed the debtor’s tort claims under the doctrine of in pari delicto.

The trustee’s claims stem from a “stock-loan program” whereby customers transferred stock to the debtor in exchange for three-year non-recourse loans worth ninety percent of the stocks’ market value. The customers of the “stock-loan program” transferred their stocks into the defendants’ brokerage accounts (“Customer Transfers”). The debtor, instead of managing the stocks, directed the defendants to liquidate the stock and used the proceeds to fund its own ventures (“Cash Transfers”).  When the loans matured, customers could either repay the principal loan amount with interest or refinance the loan for an additional term. As a result, the debtor could not meet the obligation to return their customers’ stock when the loans matured, forcing the debtor to file for Bankruptcy. The bankruptcy trustee sought to recover three categories of transactions with the defendant: (1) the Customer Transfers, (2) the Cash Transfers, and (3) certain commissions, fees, and margin interest paid to the defendants. Defendants moved for summary judgment. The bankruptcy court granted summary judgment and the district court affirmed.

On appeal, the trustee first argued that the district court erred in affirming the bankruptcy court’s determination that the Customer Transfers were not “transfers of debtor property” that the trustee could recover under the Bankruptcy code. The Fourth Circuit disagreed. The court found that the debtor’s customers transferred stock directly from their personal accounts into the brokerage accounts of the defendants to be managed by the debtor. Although the debtor directed the customers to make the transfer, the debtor acquired no property right to the customers’ stock when transferred to the defendants. Therefore, the trustee could not recover the customer transfers.

Second, the trustee contended that the district court erred in affirming the bankruptcy court’s grant of summary judgment for defendants on the Cash Transfers claim.  The Fourth Circuit affirmed the lower court’s decision because the defendants were not the “initial transferee” as required by the Bankruptcy Code. The Fourth Circuit applied the “dominion and control” test to determine whether the defendants were an initial transferee.” Under that test, an initial transferee must have legal dominion and control over the property and exercise this legal dominion and control. The court held that, regardless of whether the defendants had the requisite dominion and control over the property, the defendants could not be initial transferees because they exercised no control over the property. Each time the defendant made a Cash Transfer, it acted at the direction and with the consent of the account holder.

Third, the trustee argued that the district court erred in affirming the bankruptcy court’s determination that the defendants’ commissions and fees were protected as “settlement payments” under 11 U.S.C. § 546(e). The trustee submitted that § 546(e) did not protect commissions and, even if it did, the defendants’ commissions were too uncommonly low to be protected. The court disagreed. Congress’ amendments to the Bankruptcy Code in 2006 explicitly cover settlement payments “made to or for the benefit of stockbrokers.” While the court acknowledged that § 546(e) might not protect all commissions, the court found that the commissions in this case qualified as “settlement payments” made to brokers as part of a regular securities transaction. Furthermore, the court found that it was not unusual for defendants to offer steep discounts to customers, such as the debtor, that provided a great deal of business. Therefore, the commissions and fees paid in this case were protected by § 546(e). Additionally, the court held that the margin interest payments to the defendants were protected “margin payments.” The court also rejected the trustee’s argument that the court should adopt an exception under § 546(e) for fraudulent transfers.

Finally, the trustee contended that the district court and the bankruptcy court erred in dismissing its tort claims under the doctrine of in pari delicto.  The Fourth Circuit disagreed. The court defined in pari delicto as “an affirmative defense that precludes a plaintiff who participated in the same wrongdoing as the defendant from recovering damages from that wrongdoing.” As the bankruptcy trustee, the trustee could only assert tort claims that the debtor could bring. Thus, standing in the shoes of the debtor, the trustees claimed were barred by their wrongdoing under the doctrine of in pari delicto. Furthermore, the trustee could not claim the “adverse interest exception” to in pari delicto because the trustee was the debtor’s “sole actor.”

Full Opinion

– Wesley B. Lambert

In re: Davis No. 12-1184

Decided: May 10, 2013

The Fourth Circuit Court of Appeals affirmed the bankruptcy court’s confirmation orders stripping off junior liens against debtors’ residences. The Chapter 13 bankruptcy trustee (the “Trustee”) challenged the confirmation orders. However, the court rejected the Trustee’s argument that the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) creates a per se rule barring lien-stripping in so-called “Chapter 20” cases. The court agreed with the debtors that because BAPCPA left intact the operative lien-stripping provisions of the Code, Congress did not intend to alter the ability of bankruptcy courts to enter lien-stripping orders in Chapter 13 cases.

On June 7, 2008, Bryan Davis and Carla Bracey-Davis filed a Chapter 7 bankruptcy petition with the United States Bankruptcy Court for the District of Maryland. At the time they ran a large monthly deficit and Mrs. Davis was unemployed. Although Chapter 7 prohibits lien-stripping, the Davises nevertheless proceeded under Chapter 7 because they were ineligible to convert to a Chapter 13 case. On September 17, 2008, they received a Chapter 7 discharge. Later the Davises obtained gainful employment but still had no savings and a large mortgage in arrears. On September 4, 2009, they filed a Chapter 13 petition and on March 30, 2011, the bankruptcy judge stripped off all three liens on their property. Both the Trustee and the holder of the third-priority lien against the Davises’ home, TD Bank, N.A., appealed to the district court, which affirmed.

On February 1, 2010, Marquita Moore filed a Chapter 7 petition and received discharge on October 20, 2010. One week later she filed a Chapter 13 petition. On January 5, 2011 the bankruptcy court granted Moore’s motion to strip off the second lien on her home and the Trustee appealed the lien-stripping component of the confirmation order.

The issue in this case was whether the BAPCPA precludes the stripping off of valueless liens by Chapter 20 debtors ineligible for a discharge.  Before reaching the main issue, the court addressed the question of whether a bankruptcy court may strip off a valueless lien in a typical Chapter 13 proceeding. Citing sections 506 and 1322(b) of the Bankruptcy Code, the court found that a bankruptcy court may provide such relief. Under 506, the status of a creditor’s claim as secured or unsecured by a lien depends on the value of the collateral. Section 506(a) classifies valueless liens as unsecured claims. Under section 1322(b)(2), a Chapter 13 bankruptcy plan may modify the rights of secured claim holders other than principle residences, as well as the rights of unsecured claim holder. The court found that these two sections together permit a bankruptcy court, in a Chapter 13 case, to strip off a lien against a primary residence with no value. However, the court recognized this applies only to completely valueless liens and not partially secured liens.

The court then addressed the main issue of whether a debtor may strip off liens in a Chapter 20 case. The court cited to its holding in Bateman that a Chapter 13 debtor need not be eligible for a discharge in order to take advantage of the protections afforded by Chapter 13. According to that holding, the court concluded that if the Bankruptcy Code provides a mechanism for stripping off worthless liens absent a discharge, a debtor may avail himself of that relief. As previously discussed, the court found that sections 506(a) and 1322(b) provide such a mechanism.  However, because the sections work in tandem, the court must evaluate the claim under both sections and not under either section alone. The court noted that this mechanism permitting lien-stripping in Chapter 20 cases does not create an end-run around Dewsup’s bar to such relief in Chapter 7 cases. It also noted that the unavailability of a discharge in the Chapter 20 context is not determinative. While bankruptcy discharge alters in personam rights, lien-stripping orders at issue here alter in rem liability where the creditor’s lien has no value. Therefore, lien-stripping orders become permanent, even in the absence of a discharge.

The court concluded that although BAPCPA clearly tipped the bankruptcy scales back in the direction of creditors, it found nothing in the Act to suggest that Congress intended to bar lien-stripping of worthless liens in Chapter 20 proceedings. The judgment of the district court was affirmed.

Full Opinion

– Sarah Bishop

In Re: ESA Environmental Specialists

Decided: March 1, 2013

The Fourth Circuit Court of Appeals affirmed the district court’s award of summary judgment by the bankruptcy court to The Hanover Insurance Co. (“Hanover”).  The court found that ESA’s transfer of money to Hanover within 90 days of ESA’s filing for bankruptcy did not constitute an avoidable preference under the bankruptcy code.

ESA performed construction projects for the federal government and was required to obtain surety bonds before contracts were awarded. In 2006, Hanover issued bonds on behalf of ESA prior to the government awarding eight contracts. Additionally ESA took out a $12.2 million loan from Prospect Capital Corp. (“Prospect”).  ESA also received money from Prospect to put into a CD. In 2007 ESA was awarded additional contracts, however filed for bankruptcy on August 1, 2007. The bankruptcy court sold all of ESA’s assets to Prospect. The bankruptcy trustee filed an adversarial proceeding against Hanover, because it claimed that Hanover was an indirect beneficiary of ESA’s transfer of its loan proceeds into a CD. The bankruptcy court ultimately granted Hanover’s motion for summary judgment.

The court of appeals held that the bankruptcy court erred in holding that the earmarking defense applied to Hanover. The court noted that the funds in this case were not used to pay an antecedent debt which is a crucial element of the defense.  The court of appeals held, however, that the bankruptcy court correctly held that Hanover proved all of the necessary elements to establish the new-value defense under § 547(c)(1) of the bankruptcy code. The court determined that there was no error by the bankruptcy court in concluding that the earmarking defense applied because the new-value defense did apply.

Judge Traxler dissented stating that Hanover was not entitled to summary judgment because it did not have a valid new-value defense. He argued that a receipt of a conditional promise for payment in the future does not constitute “new value.”

Full Opinion

-Samantha James

In re Beach First National Bancshares, No. 11-2019

Decided: December 28, 2012

This matter arose out of an action brought by the trustee in bankruptcy of Beach First National Bancshares, Inc. (the “Trustee” and “Bancshares,” respectively) against the former directors and officers of Bancshares (the “Directors”), who also all formerly served as the officers and directors of Bancshares’ wholly owned subsidiary, First National Bank of Myrtle Beach, SC (the “Bank”).  After the U.S. Office of the Comptroller of Currency (the “OCC”) closed the Bank in 2010 and named the Federal Deposit Insurance Corporation (the “FDIC”) as the Bank’s receiver and liquidated all of the Bank’s assets, Bancshares filed for bankruptcy under Chapter 7.  The Trustee subsequently filed claims against the Directors for breach of fiduciary duty and negligence in their capacity as the officers and directors of Bancshares.  The District Court for the District of South Carolina determined that the Trustee lacked standing to bring this action and granted the Directors’ motion to dismiss.  The Trustee then appealed to the Fourth Circuit.

On appeal, the Fourth Circuit applied South Carolina law to address the Trustee’s claims supporting her argument that the district court erred in granting the Directors’ motion to dismiss.  The Trustee first argued “that she did not plead derivative claims against the Directors, but instead asserted direct claims that do not fall within the purview of the FDIC.”  After initially recognizing that “[a] trustee in bankruptcy succeeds to all rights of the debtor, including the right to assert any causes of action belonging to the debtor,” the court determined that the “Trustee has the authority to assert any cause of action that Bancshares could have brought in its own right,” including “the right to assert derivatives claims of Bancshares (as the Bank’s sole shareholder) against the Directors in their capacity as officers and directors of the Bank.”  However, because the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) provides that “the FDIC, when appointed receiver of a bank, succeeds to ‘all rights, titles, powers, and privileges of the insured depository institution, and of any stockholder … of such institution …,” and because the court determined that “[t]he actual basis of liability the Trustee pled against the Directors … flows only from the duties the Directors may have violated in their operation and management of the Bank,” it found that “the Trustee has not pled a harm or an act that occurred at the Bancshares (parent) level that did not simultaneously and primarily occur at the Bank (subsidiary) level.”  Therefore, the court determined that “the Trustee has pled mainly claims deriving from defalcations at the Bank level, not a distinct and separate harm specific to Bancshares at the holding company level,” and as such “the Trustee lacked standing to pursue the derivative claims under FIRREA as the right to pursue such claims belongs to the FDIC.”

After rejecting the Trustee’s first argument on appeal, the court turned to the Trustee’s contention that “she ha[d] pled three particular acts by the Directors that caused distinct harm to Bancshares and that are sufficiently distinct from acts at the Bank level to be direct claims not within the ambit of the FDIC through FIRREA.”  The court rejected the Trustee’s first two claims that the “Directors breached a duty owed to Bancshares by appointing unqualified directors to the Bank’s board” and that “the Directors caused Bancshares to guarantee the Bank’s restoration plan while simultaneously failing to ensure that the Bank complied with OCC requirements” based on its determination that the Trustee lacked standing to bring these two claims.  With respect to the first claim, the court determined that any injury resulting from “the appointment of unqualified directors to the Bank’s board … primarily occurred to the Bank,” and as such the Trustee’s claim “[was] essentially a derivative claim that the Trustee lack[ed] standing to raise.”  As to the Trustee’s second claim, the court conceded that it could “envision circumstances where directors or officers could be liable in a direct claim for inappropriately causing the parent holding company to guarantee the debt of a subsidiary (like the Bank),” but it concluded that the Trustee “fail[ed] to plead the causal connection between the act of making the gauranty to ‘damages unique to’ Bancshares.”  Therefore, the court determined that the Trustee’s second claim was a “derivative claim of harm at the Bank level that the Trustee lack[ed] standing to bring.”

As to the Trustee’s third claim “that the Directors caused Bancshares to improperly subordinate its equity interest in the LLC that owned real property,” the court found that “[t]his particular act does indeed support a direct claim against the Directors, and the district court erred in granting the motion to dismiss as to that claim.”  The court determined that the Trustee “adequately [pled] direct harm to Bancshares unrelated to any defalcation at the Bank level,” and therefore, unlike the first two claims, this claim was not a derivative action and the Trustee could proceed with the claim in the district court.

Finally, the court considered the Trustee’s argument that “even if any or all of her claims are derivative, the statutory rights of the FDIC under FIRREA do not deprive her of standing against the Directors under the facts of this case.”  The Trustee argued that because the FDIC declined to take any civil action against the Directors, she “ha[d] full authority to proceed against the Directors on all derivative claims.”  The court rejected this argument, finding “no direct statutory authority [under FIRREA] by which the FDIC may transfer to another party its exclusive statutory rights.”  Additionally, the court noted that the Trustee presented no cases supporting her purported authority.  Finally, the court rejected the Trustee’s argument that a FDIC letter, which stated that the FDIC would not recommend that any claim be pursued against the directors or officers of Bancshares, served as proof that the FDIC had “defer[red] to her pursuit of the claims against the directors.”  The court found that “even if the FDIC had the authority to transfer its statutory rights to another party, the FDIC letter at issue [could not] properly be read to do any such thing.”

Based on the above, the court held “that the Trustee may pursue her claims only as to the Directors’ alleged improper subordination of Bancshares’ LLC interest,” and reversed and remanded the district court’s judgment as to that particular claim but affirmed its judgment in all other respects.

Full Opinion

– Allison Hite

Johnson v. Zimmer, No. 11-2034

Decided on: July 11, 2012

Johnson (“the Debtor”) filed a voluntary petition for Chapter 13 bankruptcy in September 2010.  The Debtor and her ex-husband (“the Creditor”) share joint custody of two minor sons.  The sons reside with the Debtor for 204 days each year, and her current husband has joint custody of three children from his previous marriage.  The Debtor’s proposed Chapter 13 plan claimed a household of seven members.  Upon receiving notice of the Debtor’s motion for confirmation of a plan, the Creditor objected that the proposed plan overstated the Debtor’s household size because the five children did not reside with her full-time, resulting in an inaccurate calculation of her monthly expenses.  The Creditor maintained that the Debtor’s proposed Chapter 13 plan improperly showed a “disposable monthly income” insufficient to make payments on two unsecured loans for which the Creditor was jointly liable.

The bankruptcy court observed that neither the Bankruptcy Code (“the Code”) nor case law define household.  Other bankruptcy courts have followed three different approaches to define household: the “heads-on-beds” approach, the “income tax dependent” method, and the “economic unit” approach.  In re Johnson, No. 10-0724408-JRL, 2011 WL 5902883, at *1–2 (Bankr. E.D.N.C. July 21, 2011).  The bankruptcy court adopted a variation of the “economic unit” approach, assessing the number of individuals whose income and expenses are intermingled with the Debtor’s, and calculating how much time any part-time residents were members of the Debtor’s household.  Part-time residents counted as part-time members of the Debtor’s household, thus each of the Debtor’s sons constituted .56 members of her household and each step-child constituted .49 members of her household.  This yields a total of 2.59 children in the Debtor’s household full-time, rounded up to three, plus the Debtor and her husband for a total of five persons in the household.  The issue of household size was certified for interlocutory appeal.

Statutory interpretation of the Code is reviewed de novo.  Botkin v. DuPont Cmty. Credit Union, 650 F.3d 396, 398 (4th Cir. 2011).  The Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”) changed how a Chapter 13 debtor’s projected disposable income is calculated.  Disposable income is current monthly income received less amounts reasonably necessary to be expended for maintenance and support, for qualifying charitable contributions, and for business expenditures.   In part, this determination turns on the size of the Debtor’s household.  An above-median-income debtor can only include certain specified expenses, calculated using the “means test” set forth in § 707(b)(2).  The means test is designed to ensure that debtors who can pay creditors do pay them.

Whether the household is calculated at five or seven, the Debtor remains an above-median-income debtor under § 1325, therefore she must use the means test set forth in § 707(b)(2).  The Debtor contends that the dispositive issue will be the application of the means test, which requires determining who her dependents are.  She argues that the court should adopt an ordinary meaning of “dependent.”  The Creditor agrees that the court should recognize that the definition of dependent is the issue, but focuses on why § 707(b)(2)’s use of “dependent” should not be used as a basis for defining “household.”  Because § 1325(b)(3) directs debtors to calculate the relevant median family income for his or her area based on “household” size, the Fourth Circuit will not ignore how the bankruptcy court calculated household size.  The bankruptcy court’s order did not specifically address how the § 707(b) means test should be performed.  The language in § 707(b)(2)(A)(ii)(I) permits a debtor to claim deductions based on actual expenses for reasonable and necessary items, including those for their “dependents,” “dependent children,” and “households.”  The Fourth Circuit’s interpretation of “household” will impact the entire § 707(b) means test.

The Debtor argues that “household” should be interpreted using the ordinary and common meaning of the word, which would make the “heads-on-beds” approach, counting all people who occupy a housing unit as part of the household, proper.  If Congress intended to require familial or economic ties to limit the definition of “household,” it could have expressed such limitations in the Code.  The Creditor argues that the bankruptcy court correctly adopted the economic unit approach and the Code’s purposes are best served by using a definition of “household” based on financial interdependence.  The economic unit approach provides an accurate picture of the Debtor’s household when considered over a period of time.

Where statutory language is facially clear and within Congress’ constitutional authority, courts must enforce it according to its terms.  In assessing whether the language is plain, a court should consider the language itself, the context in which the language is used, and the broader context of the statute as a whole.  Words that are not defined are generally given their ordinary meaning, as provided by a dictionary.  The dictionary definition of “household,” however, does not resolve the issue because the term has multiple definitions.  The Debtor relies on a broad definition of “household” and ignores the narrower definitions.  A household may consist of the heads-on-beds approach, but other definitions suggest a household consists of something beyond co-residency. Accordingly, it is not evident which ordinary definition of “household” Congress intended.  Context provides some additional guidance, but does not resolve the fundamental uncertainty of what Congress intended.  Since Congress used “household” instead of “family” or “dependent,” Congress intended the term to mean something other than what those terms mean, despite the fact that the definitions of those words often overlap.

Bankruptcy courts have offered reasoned explanations for why one method of defining “household” is more or less appropriate based on the context within § 1325(b), the BAPCPA amendments, and the Code as a whole, but no approach is directly required by the statute.  The court has a responsibility to determine which approach best corresponds to Congress’ intent despite the ambiguous meaning of the text used.  Some bankruptcy courts adopted the heads-on-beds approach, using the Census Bureau definition of “household,” thought their rationales for doing so varied.  Some bankruptcy courts have reasoned that this definition of “household” is simply its plain meaning, while other bankruptcy courts based their use of the heads-on-beds approach upon § 1325(b)’s reference to Census Bureau statistical data.  However, the Fourth Circuit was not persuaded that Congress intended such a broad definition, particularly as nothing in § 1325(b) supports the conclusion that bankruptcy courts are required to use such a broad definition.

In the absence of clear direction in the Code to use the heads-on-beds approach, the question becomes whether the bankruptcy court erred in failing to choose that method over other approaches.  The Fourth Circuit agreed with a majority of bankruptcy courts in concluding that the heads-on-beds approach using the Census Bureau’s expansive definition of “household” is inconsistent with the purpose of the Code.  The Census Bureau’s definition is wholly unrelated to any bankruptcy purpose and does not serve the Code’s objective of identifying a debtor’s disposable income.  Furthermore, the Census Bureau definition is at odds with § 1325(b)’s purpose, as the calculation of a debtor’s monthly income and expenses is aimed at ensuring that debtors pay the amount they can reasonably afford to pay. It does not make sense to allow debtors to broadly define their “households” so as to include individuals who have no financial impact on expenses because it would lead to an incorrect determination of the debtor’s disposable income.   Accordingly, the bankruptcy court did not err in rejecting the heads-on-beds approach.

Because the text does not define “household” and leaves room for different connotations, the economic unit approach does not inherently contradict the language of § 1325(b) and is in fact consistent with § 1325(b), the BAPCPA, and the Code.  Examining the financial interdependence of individuals allows bankruptcy courts to avoid over- and under-inclusive results that would result by artificially defining “household.”  The approach is flexible because it recognizes that a debtor’s “household” may include individuals who may not be claimed on a tax return, but nevertheless impact the debtor’s financial situation.  The economic unit approach is appropriate because the debtor’s finances are the focal point of the Code.  Furthermore, it is consistent with other components of the § 1325(b)(2) analysis, particularly in addressing whether the debtor’s income or expenses are interdependent with another individual’s.  For the aforementioned reasons, the bankruptcy court did not err in adopting the economic unit approach.

Neither party advocated the income tax dependent model as the best method of defining “household.”  This approach puts limitations on the bankruptcy court’s ability to accurately determine household size and fails to match the goals of the BAPCPA and the Code.  A “household” includes the individuals allowed as dependents on the taxpayer’s tax returns or those who could be included.  The § 707(b) means test mentions dependents and refers debtors to use certain IRS tables as part of their calculations in determining deductible monthly expenses.  However, several factors negate the appropriateness of using “dependents” as the definition for “household.”  First, neither § 707(b) nor § 1325(b) expressly incorporates the IRS definitions.  Second, the IRS definition of “dependent” was created with a markedly different purpose from the Code’s definition of “household.”  Finally, § 1325(b)(2) refers to “dependents” at one point and “household” at another.  If Congress intended for “household” to refer to the debtor and his or her dependents, it could have done so.  The income tax dependent approach tends to be under-inclusive.  Accordingly, the district court did not err in rejecting the income tax dependent approach.

The bankruptcy court opted to further refine the economic unit approach to account for part-time members of the Debtor’s “household.”  The Debtor argues that even if the bankruptcy court did not err in using an economic unit analysis, it erroneously relied  on the outlier case of In re Robinson, 449 B.R. 473, 478–82 (Bankr. E.D. Va. 2011), to divide the children into fractions.  The bankruptcy court did not err in applying the economic unit approach in a manner that accounted for part-time members of the household.  The cases upon which the Debtor relies differ from the facts of the instant case because the children do not live with the Debtor on a full-time basis.  The bankruptcy court had to consider that the Debtor’s “household” fluctuated from two to seven individuals depending on the day; allowing the use of fractions is more accurate than choosing between two extremes, which would be either under- or over-inclusive.  The bankruptcy court did not err in applying the economic unit method and using fractions to determine the Debtor’s “household” size.  Accordingly, the Fourth Circuit affirmed the bankruptcy court’s decision.

Circuit Judge Wilkinson dissented due to an inability to approve the bankruptcy court’s decision to break the Debtor’s children into fractions, as it contravenes statutory text, allows judges to unilaterally update the Code, and subjects debtors to needlessly intrusive and litigious proceedings.  If the means test applies, as the parties agree it did in the instant case, the amount of the deduction is based in part on the number of “dependents” the Debtor has, pursuant to § 707(b)(2)(A)(ii)(I).  The bankruptcy court’s fractional view is not how courts ordinarily interpret statutes.  Just because Congress does not define “household” or “dependents” does not mean bankruptcy courts can take liberties with the terms.  Instead, when statutory terms are undefined, they are given their ordinary meaning, which does not include “partial people.”  Wilkinson also objected to the bankruptcy court’s decision to update the Code to address the increase in split custody arrangement, as this matter should be left to Congress.  Finally, by allowing judges to treat dependents as fractions, the majority’s decision will require courts to conduct more intrusive and litigious proceedings in order to apply the Chapter 13 means test.  While bankruptcy courts have some discretion in applying the Code, they lack the authority to depart from the rules in the Code and implement their own policy views.  Accordingly, the bankruptcy court erred in dividing the Debtor’s children and stepchildren into fractions for purposes of the means test.

Full Opinion

-Michelle Theret

In re Maharaj, No. 11-1747

Decided: June 14, 2012

In this case, the Fourth Circuit resolved a longstanding division among bankruptcy and district courts, holding that the “absolute priority” rule remains applicable to individual debtors who file a Chapter 11 bankruptcy despite the 2005 enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”).

The court began its opinion by providing a history of the absolute priority rule.  In essence, the rule states that in a Chapter 11 business reorganization, the “stockholders are not entitled to any share of the capital stock nor to any dividend of the profits until all the debts of the corporation are paid.”  The court next described how the “cram down” procedure can be utilized by a debtor intending to retain property to achieve confirmation of a reorganization plan, but only if the absolute rule is complied with in regards to any dissenting creditors.  After Congress passed BAPCPA, however, there was disagreement over the application of the absolute priority rule “when the Chapter 11 debtor is an individual.”  While some courts read the amendments to BAPCPA as abrogating the absolute priority rule in individual debtor cases, other courts interpreted the statute narrowly to “merely have the effect of allowing individual Chapter 11 debtors to retain property and earnings acquired after the commencement of the case.”

In the dispute before the court, Ganess and Vena Maharaj (“Debtors”) filed a petition for bankruptcy under Chapter 11 after their auto body repair shop became burdened by significant debt.  The debtors submitted a Plan of Reorganization with the bankruptcy court that proposed dividing the creditors into four separate classes.  Class III was composed of general unsecured creditors whose claims would be impaired under the Debtors’ plan, and one of its members, Discover Bank, voted to reject the plan.  Due to Discover Bank’s opposition, the Debtors sought a cram down to confirm the plan, a move which would still allow the Debtors to retain and operate their business if, as the Debtors requested, the bankruptcy court ruled that the BAPCPA amendments abrogated the absolute priority rule.  If the court found that the absolute priority rule remained in effect, the Debtors “would have to liquidate their business to effectuate [the] cram down.”

The Fourth Circuit held that the plain language of the BAPCPA amendments was ambiguous and could be interpreted in multiple ways.  Despite the ambiguity of the statutory text, however, the court affirmed the bankruptcy court’s ruling that the absolute priority rule had not been abrogated by the BAPCPA provisions.   According to the court, viewing the specific circumstances surrounding the statute’s enactment along with the broader context of modern bankruptcy law, demonstrated Congress’ intent to preserve “the absolute priority rule as it operated prior to the passage of BAPCPA.”  As it related to a Chapter 11 proceeding, the BAPCPA provisions simply allowed an individual debtor requesting a cram down to “retain post-petition acquired property and earnings.”  The court relied on the Supreme Court’s view that the implied repeal of a longstanding bankruptcy doctrine, such as the absolute priority rule, “is strongly disfavored.”  The court stated that if Congress intended such a major change to the reorganization process, it would have been more clearly expressed in the statute.

Full Opinion

-John C. Bruton, III