Maine Bankruptcy Judge Rules That § 362(c)(3)(A) Automatically Terminates Automatic Stay

In the recent opinion of In re Smith, the Maine Bankruptcy Court (Fagone, J.) held that the termination of the automatic stay under 11 U.S.C. § 362(c)(3)(A) extends to the debtor, the debtor’s property, and property of the estate, disagreeing with the First Circuit Bankruptcy Appellate Panel.

The facts of the case are not complicated. In December 2014, Leland S. Smith, Jr., filed a voluntary petition under Chapter 13. In November 2016, Smith’s case was dismissed for failure to make plan payments. On December 28, 2016, Smith filed another voluntary petition under Chapter 13, putting Smith into the more restrictive gauntlet Congress crafted for repeat bankruptcy filers. Section 362(c)(3)(A) terminates the automatic stay after thirty days for debtors who file more than one case in a year unless a request is made to extend the stay.

Smith did not request an extension of the stay, perhaps relying on the First Circuit Bankruptcy Appellate Panel’s rulings, which agree with the majority rule that the § 362(c)(3)(A) stay termination relates only to the debtor and the debtor’s property, and not property of the estate. In other words, property that is owned by the debtor at the time of the bankruptcy filing was protected by the automatic stay and prevented creditors, even for repeat filers, from seeking to recover against a debtor’s prepetition assets.

Maine Revenue Services, apparently having some doubts as to the extent of the stay, sought an order from the bankruptcy court under § 362(j), confirming that the automatic stay had terminated so that it could pursue its collection efforts against the debtor for past due taxes. Smith opposed that relief, arguing that the court should follow the First Circuit BAP and majority rule.

However, after a survey of the case law on the issue, the bankruptcy court analyzed §362(c)(3)(A) in the context of the automatic stay provisions of the Bankruptcy Code, finding that the majority view focused on only a small part of the statute. The court also was persuaded by the reasoning of In re Daniel, 404 B.R. 318 (Bankr. N.D. Ill. 2009), because:

1. the subsection references subsection 362(a) in whole, not parts of it;
2.  the reference to “with respect to the debtor” in § 362(c)(3)(A) meshes with prior parts of § 362(c), which discuss the debtor in the context of single or joint cases; and
3.  the legislative history supports the minority view in that Congress was concerned about repeat filers interfering with creditors exercising their state court rights.

The court ultimately ruled that the automatic stay had terminated with respect to the debtor, the debtor’s property, and property of the estate.

Unless overturned on appeal, this ruling alters the landscape in Maine for creditors and debtors where the debtor is a repeat filer. Creditors now seem to have an advantage unless the debtor acts quickly to extend the automatic stay. Debtors and trustees will also have to be wary in such cases as a valuable protection of bankruptcy is eliminated for property of the estate, making the property vulnerable to attack by creditors.

Anthony Manhart is a Partner at Preti Flaherty and serves as Co-Chair of the Bankruptcy, Creditors' Rights and Restructuring Group. His practice focuses on bankruptcy and creditors' and debtors' rights, representation of Chapter 7 trustees and various parties in formal insolvency and collection proceedings and out-of-court workouts. He also serves on the Panel of Chapter 7 Trustees for the District of Maine.

Supreme Court Rules Creditors May Pursue Claims for Stale Debt in Bankruptcy

With its recent opinion in Midland Funding, LLC v. Johnson, the Supreme Court has put to rest the question of whether or not filing stale claims violates the Fair Debt Collection Practices Act (“FDCPA”), determining that proofs of claim filed for stale debt do not violate the FDCPA. This is the latest development in an issue the New England Bankruptcy Law Blog has followed as it has migrated its way through the courts since last June.

According to Midland, shortly after Aleida Johnson filed for Chapter 13 bankruptcy relief, Midland Funding filed a proof of claim for outstanding credit card debt of approximately $1,800. On its face, the proof of claim stated that the last charge on the debtor’s account was made more than ten years prior to the bankruptcy filing—clearly outside of the relevant statute of limitations for enforcement under state law. (Although the relevant state law nevertheless permitted a creditor to receive payment on account of its stale claim.) After the debtor objected, the bankruptcy court disallowed Midland’s claim. The debtor then filed a lawsuit in the district court, seeking damages for violations of the FDCPA. The district court found that the FDCPA did not apply to filing proofs of claim; however, the 11th Circuit Court of Appeals disagreed and reversed the decision. Midland appealed the 11th Circuit’s decision to the Supreme Court. At issue was whether filing a proof of claim on account of a stale debt was “false,” “deceptive,” “misleading,” “unconscionable,” or “unfair” as those terms are used in the FDCPA.

Siding with the majority of courts that have ruled on this issue, the Supreme Court determined that filing a proof of claim on account of stale debt is neither “false,” “deceptive,” “misleading,” “unconscionable,” nor “unfair.” The Court rejected the debtor’s contention that “claim” under the Bankruptcy Code means “enforceable claim.” The Court further found it was “more difficult to square [the debtor’s] interpretation with other provisions of the Bankruptcy Code.” For example, in the definitions section in the Bankruptcy Code, the term “claim” includes claims that are disputed (by such affirmative defenses as statutes of limitations). 

The majority was also not persuaded by the debtor’s arguments that finding in favor of Midland would encourage debt collectors to buy up stale debts at steep discounts and then file proofs of claim in bankruptcy proceedings, hoping to fool careless trustees. In particular, the Court pointed to the relative sophistication of parties in bankruptcy—particularly the trustees—who are well equipped to challenge creditor claims when necessary.

The Court determined that it should leave the current system intact, in which creditors’ proofs of claim are prima facie evidence of the creditors’ claim but subject to challenge on account of affirmative defenses and otherwise. This would allow the bankruptcy system to weed out defective claims. And to rule otherwise would require a far greater examination of the claims process than the Midland case contemplated. For example, would a creditor need to assess the merit of all affirmative defenses to its claim prior to filing a proof of claim? 

The debtor and the United States, which had filed an amicus brief, had more traction with the dissent. Justice Sotomayor, joined by Justices Ginsberg and Kagan, wrote with concern that the majority’s ruling does nothing to stem the practices of debt buyers who are now seeking to take advantage of bankruptcy courts to be paid on stale debts because they are not able to do so in state courts. Because creditors’ rights to collect on time-barred claims vary from state to state, creditors should consult with counsel when preparing proofs of claim.

The majority appears to come to the right answer; but this may not be the end of the story.  The Court leaves the door wide open for debtors and trustees to seek sanctions under Rule 9011 against creditors trying to game the system. And the dissent suggests, rather strongly, that Congress should amend the FDCPA to specifically address attempts by creditors to collect on time-barred debt in bankruptcy. 

There’s more to come on the intersection of the Bankruptcy Code and the FDCPA, we are sure.  

Anthony Manhart is a Partner at Preti Flaherty and serves as Co-Chair of the Bankruptcy, Creditors' Rights and Restructuring Group. His practice focuses on bankruptcy and creditors' and debtors' rights, representation of Chapter 7 trustees and various parties in formal insolvency and collection proceedings and out-of-court workouts. He also serves on the Panel of Chapter 7 Trustees for the District of Maine.

Third Circuit Widens the Circuit Split on Late-Filed Tax Returns

The Court of Appeals for the Third Circuit has joined the Fourth, Sixth, Seventh, Eighth, and Eleventh Circuits in employing a four-part test to determine whether debt associated with a late-filed tax return is dischargeable under section 523(a) of the Bankruptcy Code. This differs from the First, Fifth, and Tenth Circuits, which have held that a tax return that is filed late is not a “return” under section 523(a) of the Bankruptcy Code. As such, in those circuits, the debt associated with late-filed returns is not dischargeable in bankruptcy—even if they are only one day late.   

In Giacchi, the debtor filed his tax returns (Form 1040) late for years 2000–2002. The Court of Appeals for the Third Circuit, rather than using the one-day rule, applied a four-part analysis called the “Beard Test” in order to determine whether the returns qualified as “returns” under section 523(a). In order to qualify as a return under the Beard Test: (1) it must purport to be a return, (2) it must be executed under penalty of perjury, (3) it must contain sufficient data to allow calculation of tax, and (4) it must represent an honest and reasonable attempt to satisfy the requirements of the tax law. Only the fourth factor was at issue: whether the filing represents an honest and reasonable attempt to satisfy the requirements of tax law. The Circuit Court found that the tax debts were not dischargeable as the debtor, by filing the returns late with no real justification, did not make an honest and reasonable effort to comply with the tax law. 

This circuit split will not be resolved in the near future. In February of this year, the U.S. Supreme Court denied certiorari in a case on appeal from the Ninth Circuit on the tax return issue.   

For a more detailed discussion on this issue, please see the article authored by Anthony J. Manhart and Bodie B. Colwell: The Bankruptcy Code’s Return Policy: Another Hanging Paragraph Hangs Consumers Out to Dry. The article discusses recent cases, including: In re Fahey, 779 F.3d 1 (1st Cir. 2015), In re Nilsen, 542 B.R. 640 (Bankr. D. Mass. 2015) and Berry v. Massachusetts Department of Revenue, Case No. 15-41218-CJP (Bankr. D. Mass. June 30, 2016).

Bodie B. Colwell practices as an associate with Preti Flaherty's Bankruptcy, Creditors’ Rights and Business Restructuring group from the Portland office. She focuses on supporting bankruptcy, insolvency, and creditors’ rights clients.

Anticipated Amendments to Bankruptcy Rules Require Changes to Claims Filing Procedures

The US Supreme Court recently authorized a number of significant changes to the procedural rules applicable to bankruptcy proceedings. Absent Congressional intervention, which appears unlikely, the new rules will take effect on December 1, 2017. The amendments will most impact creditors dealing with consumer debtors in Chapter 13 cases, creating new deadlines for filing proofs of claim and allowing debtors to prosecute challenges to secured creditor claims through the plan submission and confirmation process. Some of the more significant changes are:

• Adoption of an “official” Chapter 13 Plan. The new rules provide for an “official,” standardized Chapter 13 Plan. Under amended Rule 3015(c), debtors will need to use the “official” form unless their jurisdiction has adopted its own local form, which must itself include the information outlined in Rule 3015.1. Among other things, Rule 3015.1 will require local form Chapter 13 Plans to include a paragraph requiring the debtor to highlighting any nonstandard plan provisions, provisions that limit any secured creditor’s claim to the value of its collateral, or provisions that seek to avoid a lien on the debtor’s real or personal property.
• Required Notice for Chapter 13 Confirmation Hearings and Objections to Confirmation. Rule 2002 has been amended to establish definitive notice provisions in Chapter 13 cases. A new subsection (2002(a)(9)) will require the debtor to provide creditors with at least 21 days’ notice of the deadline for objecting to Chapter 13 Plans. Another new subsection (2002)(b))(3)) calls for 28 days’ notice of the confirmation hearing in Chapter 13 cases.
• Proofs of Claim. The amendments will also alter the procedures for filing proofs of claim. Specifically:

• Rule 3002 is amended to clarify that secured creditors must file proofs of claim to have their claims allowed. (However, the Rule makes clear that a secured creditor’s claim will not be rendered void if it chooses not to file a proof of claim.)
• Rule 3002(c) makes changes to the periods for calculating the claims bar deadline in Chapter 7 (liquidation), 12 (family farmer), and 13 (individual debt readjustment) cases. For those types of cases, the deadline for filing a proof of claim will be reduced. Whereas the current Rule requires proofs of claim to be filed within 90 days after the initial §341 meeting of creditors, the revised Rule will require creditors to file their proofs of claim within seventy (70) days after the bankruptcy petition filing date.
• When a case is converted to a case under Chapter 12 or 13, the new, 70-day period for filing proofs of claim will run from the date of the court’s order converting the case. If a case is converted to a case under Chapter 7, a new time period for filing claims will begin running.
• Amended Rule 3002(c)(6) will allow the Bankruptcy Court to extend any proof of claim deadline if the debtor has failed to file a complete list of his/her creditors.
• New Rule 3002(c))(7) establishes a 2-stage deadline for filing mortgage proofs of claim where the claim is secured by an interest in the debtor’s principal residence.

• Claims Objections. Rule 3012, as amended, provides that any party-in-interest may seek a determination of the amount and priority of any claim. Moreover, in a departure from current practice, the amended Rule will permit plan proponents in Chapter 12 and Chapter 13 cases to include objections to the amount and/or priority of claims in the body of the Plan. Rule 3007, as amended, will require that a party objecting to a proof of claim must serve the affected creditor by first-class mail directed to the name and address indicated on the filed proof of claim form. Under amended Rule 3007, the Bankruptcy Court will no longer be required to schedule or hold a hearing on every claim objection.
• Objections to Liens or Transfers of Exempt Property.  Consistent with revised Rule 3012, amended Rule 4003(d) will allow a request to avoid a lien or other transfer of the debtor’s exempt property to be made either by motion or in the debtor’s Chapter 13 Plan.

Again, these changes to the Bankruptcy Rules are scheduled to take effect on December 1, 2017. Creditors should become familiar with the new requirements and begin developing internal procedures as necessary to ensure compliance. 

Landlords Who Violate Bankruptcy Stay May be Ordered to Pay Emotional Distress Damages and Punitive Damages

Landlords should use caution in attempts to take possession of leased space once a tenant files bankruptcy.  Recently, in Lansaw v. Zokaites, the Third Circuit Court of Appeals upheld an order of the Bankruptcy Court for the Western District of Pennsylvania awarding of emotional distress damages and punitive damages against a landlord who violated the automatic stay. 

Under section 362(a) of the Bankruptcy Code, the filing of a bankruptcy petition operates as a stay against debt collection activities by creditors.  For violations of the stay, individual debtors can recover actual damages, including costs and attorneys’ fees, and punitive damages.  

In Lansaw v. Zokaites, the debtors operated a daycare in leased space.  The court found that the landlord violated the automatic stay on three separate occasions.

The first violation consisted of the landlord and his attorney visiting the daycare during business hours to take photographs of the debtors’ personal property.  During that visit, the landlord intimidated one of the debtors and backed her against a wall.

For the second violation, the landlord visited the daycare after business hours using his own key to enter and padlocked and chained the doors.  The landlord left an “interim standstill agreement” on the door, which provided that the landlord would remove the chains if the debtors agreed to certain conditions, including reaffirming the lease with the landlord.

For the third violation, the debtors had found a new property to lease but still had property in the old leasehold.  The landlord directed his attorney to send a letter to the debtors’ new landlord, demanding that the new landlord terminate a lease with the debtors, and stated that, if the new lease was not terminated, the landlord would file a complaint against the new landlord.  The landlord’s attorney also called the new landlord multiple times in an attempt to have the new lease terminated. 

For these violations of the automatic stay, the debtors were awarded $7,500 for emotional distress, $2,600 in legal fees, and $40,000 in punitive damages from the landlord. 

In the opinion, the Third Circuit Court of Appeals found that the bankruptcy code authorizes the award of emotional distress damages as a form of “actual damages,” and that the debtors presented sufficient evidence to support such a claim.  Additionally, the Court found that the debtors were properly awarded punitive damages. 

When a tenant files bankruptcy, a landlord should be extremely cautious in attempts to collect back rent, take possession of the property, or evict a tenant.  Lansaw v. Zokaites was an extreme case; however, violations of the automatic stay may arise from typical landlord activities, such as sending certain notices and applying a setoff against a security deposit.

Bodie B. Colwell practices as an associate with Preti Flaherty's Bankruptcy, Creditors’ Rights and Business Restructuring group from the Portland office. She focuses on supporting bankruptcy, insolvency, and creditors’ rights clients.

Massachusetts Bankruptcy Court Confirms that Chapter 13 Debtors May “Strip Off” Second Mortgages

Recently in In re Guerra, the Bankruptcy Court for the District of Massachusetts joined the majority of courts in finding that United States Supreme Court’s decision in Bankof Am. v. Caulkett does not affect a chapter 13 debtor’s ability to strip off a second mortgage.  In Caulkett, the Supreme Court held that a debtor in a chapter 7 bankruptcy may not void a junior mortgage lien under 11 U.S.C. § 506(d) when the debt owed on a senior mortgage lien exceeds the current value of the collateral. 

Prior to Caulkett, it was well established in the First Circuit that a chapter 13 debtor could “strip off” a wholly unsecured mortgage.  In the chapter 13 plan context, “strip off” means discharging a creditor’s junior mortgage on real property where the junior mortgage has no value because the amount of senior liens and encumbrances exceeds the value of the property. 

In Guerra, the debtors sought to strip off a second mortgage through their chapter 13 plan. Under the chapter 13 plan, the second mortgage was treated as a wholly unsecured claim subject to discharge under 11 U.S.C § 1328(a).  The second mortgage holder objected and argued that Caulkett prohibits the debtor from treating an “underwater” second mortgage as unsecured. 

The Bankruptcy Court disagreed with the junior mortgage holder and concluded that Caulkett had no effect on the interpretation of the interplay between §§ 506(a) and 1322(b)(2) of the Bankruptcy Code.  As such, the ability to strip off and discharge a wholly unsecured mortgage lien in a chapter 13 plan remains an option for debtors. 

The junior mortgage holder also argued that its lien couldn’t be stripped because (according to its appraisal) the value of the property had increased during the 15+ months since the filing of the bankruptcy case, to the point where there was now enough value to recoup at least some of the second mortgage debt.  In other words, the second mortgage claim wasn’t “wholly unsecured.”  That argument didn’t work either.  For a variety of reasons, the Bankruptcy Court ruled that for lien stripping purposes, a mortgaged property should be valued at the outset of the case.  Because there was apparently no dispute that the mortgaged property was worth less than the balance outstanding on the first mortgage when the case was filed, the Court concluded that the second mortgage claim was completely underwater as of the petition date, and that the debtors’ chapter 13 plan could therefore strip the second mortgage lien and treat that claim as unsecured.

As “strip off” is still an option for debtors, in order to protect their security interest, junior creditors should be mindful of debtor estimates of value in their petition and schedules, which could tee up a chapter 13 plan to strip junior liens.   

Bodie B. Colwell practices as an associate with Preti Flaherty's Bankruptcy, Creditors’ Rights and Business Restructuring group from the Portland office. She focuses on supporting bankruptcy, insolvency, and creditors’ rights clients.

Supreme Court Rules: Even Gifts Must Play by the (Absolute Priority) Rule

Last week, the Supreme Court handed down its opinion in Czyzewski v.Jevic Holding Corp., stating that non-consensual, priority violating, structured dismissals are not allowed under the Bankruptcy Code.  In a well-reasoned opinion, the Court gave a simple answer to what has become a complex issue, especially in large Chapter 11 cases where the path out of bankruptcy is not always clear: the absolute priority rule is absolute (unless the affected parties agree otherwise).

Czyzeweski v. Jevic Holding Corp. Case

The Jevic case involved the demise of a trucking company. As it closed down and just before seeking bankruptcy protection, the debtor fired most of its employees, including a group of truck drivers (the “Petitioners”). After company’s Chapter 11 filing, the Petitioners sued the debtor and Sun Capital Partners (who had acquired Jevic in a leveraged buyout) for violation of the Worker Adjustment and Retraining Notification Acts (“WARN”).  The Petitioners won a $12.4 million summary judgment award against the debtor on their WARN claims, entitling them to (among other things) an approximately $8.3 million priority wage claim against Jevic’s estate. The Petitioners also pursued similar WARN claims against Sun outside the bankruptcy proceeding.

Separately, the unsecured creditors’ committee pursued litigation against Sun and CIT Group, a secured creditor with which Sun had refinanced the debt incurred in Jevic’s LBO, for misdeeds in effectuating the leveraged buyout, fraudulent transfers, and preferential transfers. Eventually, Sun and CIT settled with the creditors’ committee. The deal provided that the estate would receive funds for administrative and some priority tax claims, with the remainder going to general unsecured creditors—skipping the priority wage claims of the Petitioners, and violating the priorities of the Bankruptcy Code (Sun admitted it did not want to fund the Petitioners’ WARN litigation against it).  The Bankruptcy Court approved the settlement and the District Court and Third Circuit Court of Appeals affirmed the decision.  The Supreme Court reversed and remanded, ruling that a bankruptcy court could not approve a structured dismissal that violated the priorities of the Bankruptcy Code.

Facing Bankruptcy

Jevic, like many Chapter 11 debtors, was faced with the difficult decision of how to get out of bankruptcy. The estate was administratively insolvent; it had $1.7 million in cash, which was not sufficient to pay administrative claimants in full, all subject to Sun’s lien. Unable to confirm a plan, Jevic was left with two options: conversion to a case under Chapter 7 or dismissal. Conversion would have resulted in the senior secured creditors receiving everything in the liquidation. If successful, a structured dismissal could provide some of the benefits of a plan—releases for the debtor’s management and professionals and, through a mechanism commonly described as “gifting” by a secured party of a portion of its collateral, payments to junior creditors who would otherwise receive nothing in a liquidation scenario.

At the tail end of a bankruptcy case, an administratively insolvent debtor such as Jevic is often at the mercy of its secured creditor, who holds a lien over all or substantially all of the debtor’s assets. Absent a “gift” from the secured creditor, the debtor often cannot offer any incentive to induce parties in interest to settle their disputes with the debtor (or pay its professionals). In Jevic, that gift came with strings attached: Sun would not permit payments to priority claimants who were also litigating against it. The Court cut one of those strings. Under Jevic, the party funding an end-of-case structured settlement cannot dictate terms that violate the absolute priority rule unless the adversely affected classes consent.

Consensual Dismissal

However, the Court left open the possibility for consensual dismissals that violate the priority scheme of the Bankruptcy Code. In addition, the Court specifically did not rule on the permissibility of other priority violating distributions, such as “first-day” pre-petition wage and critical vendor orders and “roll-ups” in debtor-in-possession financing, that allow certain prepetition creditors to be paid first on their prepetition claims in the early days of a bankruptcy case. Pointing to the policy rationale of preserving the debtor as a going concern and promoting the possibility of a confirmable plan, the Court did not address the viability of mid-case structured settlements that violate the Bankruptcy Code’s priority scheme but do not resolve the case. Neither of these rationales applies to an end-of-case settlement with an administratively insolvent debtor.

In addition, the Jevic case may provide additional leverage for taxing authorities and other priority claimholders in plan and/or dismissal negotiations, knowing that debtors (and their secured creditors) have one less arrow in their quiver.  And it remains to be seen whether secured parties will push for conversion to Chapter 7 of an administratively insolvent debtor when they can no longer dictate the terms of a structured dismissal to the detriment of priority claimants. Restructuring professionals should plan accordingly.

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For any assistance with bankruptcy and restructuring, contact Preti Flaherty’s Bankruptcy, Creditors’ Rights, and Restructuring Practice Group.

Rue Toland practices as an associate with Preti Flaherty's Business Law and Creditors' Rights Groups from the firm's Concord, NH office. Rue provides counsel on transactional and financing matters, secured and unsecured lending, out-of-court loan workouts, bankruptcy proceedings, and other distress situations.