Notable Reported Cases for the Week Ending 11/27/05

Below you'll find our weekly roundup for the week ending 11/27/05 of some recently decided bankruptcy cases. More to follow, so stay tuned!

Automatic Stay - Nondebtors: In re Gemini Equipment Business Trust, 2005 WL 3050174 (M.D. Pa., 11/14/05)

Claims Objections - Choice of Law - Circuits' Split: Global Indus. Techn., Inc. v. Ash Trucking Co., Inc. (In re Global Indus. Techn., Inc.), 2005 WL 3074184 (Bankr. W.D. Pa., 11/2/05)

Claims Objections - Evidentiary Issues // Derivative Suits - Standing: Carey v. Ernst, 2005 WL 3018334 (S.D.N.Y., 11/8/05)

Claims Objections - Preclusion: Kadish v. K-Mart Corp., 2005 WL 3077605 (N.D.Ill., 11/14/05)

Discharge - Willful and Malicious: Norm Gershman's Things to Wear, Inc., v. Peterson (In re Peterson), 2005 WL 3046491 (Bankr. D. Del., 11/15/05)

Fee Applications - Objections: Hennigan Bennett & Borman LLP v. Goldin Associates, LLC (In re Worldwide Direct Inc.), 2005 WL 3071275 (D. Del., 11/16/05)

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Automatic Stay - Nondebtors: In re Gemini Equipment Business Trust, 2005 WL 3050174 (M.D. Pa., 11/14/05). First Union Bank loaned Adams County Asphalt Company ("ACA") $100,000. First Union also increased ACA's line of credit to $3,000,000. ACA was a wholly owned subsidiary of Gemini Equipment Business Trust ("Gemini"), the appellant. When ACA defaulted, First Union initated a state court action against the guarantors of ACA's loans, Gemini and Robert Mumma (the principal shareholder).

In 2003, ACA filed for chapter 11 relief; two years later, Gemini did the same. First Union filed a motion in Gemini's case to lift the automatic stay in order to continue litigating against the guarantors in state court. The Bankruptcy Court entered an order granting First Union's motion, and further providing that First Union could proceed in state court "so that the claims of First Union could be liquidated; however, the bankruptcy court provided that First Union could only execute judgment against non-debtor third parties, specifically, Mr. Mumma." The Bankruptcy Court also prohibited First Union from executing any judgment against Gemini. The District Court affirmed on the basis that "neither the debtor nor the assets of the estate will be harmed" by granting the lift stay motion.


Claims Objections - Choice of Law - Circuits' Split: Global Indus. Techn., Inc. v. Ash Trucking Co., Inc. (In re Global Indus. Techn., Inc.), 2005 WL 3074184 (Bankr. W.D. Pa., 11/2/05). In this claim objection battle, the creditor alleged that the debtors sold it defective mining equipment and sought rescission of the contract. The creditor argued that the Court should apply the state's five year statute of limitation because the suit was originally filed there. The debtors disagreed, arguing that the claim was barred by the one year statute of limitations provision within the parties' contract.

Judge Judith K. Fitzgerald held that the contract's one-year limitations clause bars all of the creditor's claims except for the tort claim of fraud in the inducement. As to the limitations period applicable to that claim, the Court noted there is a split in the circuits on whether a bankruptcy court should apply the laws of the forum state or federal common law. The Court stated:

Although a bankruptcy court's jurisdiction does not arise by way of diversity, one group of bankruptcy courts looks to federal diversity case law. When a federal court acquires jurisdiction via diversity, the federal court sitting in diversity must also follow and apply the conflict of laws principles of the forum state. This approach tends to favor the application of Klaxon, so as to apply the forum state's choice of law principles....Following the Klaxon approach in the current case, [the court] must look to the forum state of the bankruptcy court to determine appropriate conflict of laws principles.
The other approach relies on dicta in Vanston. Vanston involved a challenge to a creditor's claim to entitlement to be paid interest on interest under the Bankruptcy Act of 1898. The conflict was between New York (where the bonds had been written, signed, held and paid) and Kentucky (the principal place of business for the group which underwrote the bonds). The Bankruptcy Court for the Eastern District of Kentucky decided that New York law was to be applied. The Court of Appeals for the Sixth Circuit reversed and the U.S. Supreme Court affirmed the Court of Appeals. However the Supreme Court ruled that the bankruptcy court does not apply the law of the state where it sits to determine what claims are allowable and how assets will be distributed. "[B]ankruptcy courts must administer and enforce the Bankruptcy Act as interpreted by this Court in accordance with authority granted by Congress to determine how and what claims shall be allowed under equitable principles." [Vanston, 329 U.S.] at 163.
The Court, in resolving the issue under equitable principles, discussed the concept of conflict of laws. The Court stated that "[i]n determining which contact is the most significant in a particular transaction, courts can seldom find a complete solution in the mechanical formulae of the conflict of laws." [Vanston, 329 U.S.] at 161-62. The Court instead calls upon the "informed judgment" of the judges to balance the interests of all states involved. Id. at 162. The call for the use of informed judgment is part of the equitable nature of the bankruptcy court. The use of a strict formula removes equitable consideration and creates a result that may be in conflict with the goals of bankruptcy.
Vanston has been used by courts to reach the conclusion that federal common law conflict of laws principles should be applied by bankruptcy courts, rather than those of the forum state. (Citations omitted).

In the end, the Court found that the results would be the same under either approach, so that it didn't matter which approach was selected. Still, in ruling, the Court followed the Klaxon approach and applied the conflict of law principles of the forum state, not federal common law, stating:

[W]e apply conflict of laws principles of the forum state of the bankruptcy court to determine which state's statute of limitations will govern the dispute. These bankruptcies were filed in the Western District of Pennsylvania. Thus, we rely on Pennsylvania's borrowing statute to resolve any conflict with another state's limitations periods. Pennsylvania selects the shortest period of limitation between conflicting states' statutes of limitations. As a result, we must apply Pennsylvania's two year statute of limitations to the fraud in the inducement claim which is time barred by that statute. Therefore the Debtors' objection will be sustained.


Claims Objections - Evidentiary Issues // Derivative Suits - Standing: Carey v. Ernst, 2005 WL 3018334 (S.D.N.Y., 11/8/05). This case raises two discrete issues of interest: first, the right of a claimant to an evidentiary hearing to address objections to its proof of claim; second, the right of a claimant in a chapter 13 case to obtain standing to prosecute estate avoidance actions that the debtor refuses to bring. Here, a chapter 13 debtor objected to a proof of claim filed by its prepetition attorneys in the amount of $335,000 (represented primarily by a claim in the principal amount of $205,000, plus 12% interest). The bankruptcy court dispensed with an evidentiary hearing, despite having promised the claimant one. The district court reversed on this part of the appeal, holding that the judge should have given the firm an opportunity for a hearing when it had previously repeatedly said that an evidentiary hearing would be held on the claim objection. The district court concluded:

[B]ecause Judge Blackshear repeatedly stated that he parties would have an opportunity to address their dispute�the Court should have allowed [the law firm] an opportunity to present his evidence and to argue in support of his claim before the court reached a decision.

The law firm also appealed the bankruptcy court's order on a separate ground: the denial of the law firm's motion for leave to commence a couple of preference actions that it believed had merit. The firm argued that it was a creditor, that the firm had standing because the trustee expressly consented to the firm's bringing the suit, and that the suits were in the best interests of the estate. The debtors objected, noting that the firm's fee was nearly three times the aggregate value of the contemplated suits. Further, the debtors argued, "the legal expense of pursing such claims far outweighed any positive benefits and would only harass the Debtors and other parties, and delay confirmation in this case."

The debtors argued that the test in In re STN Enterprises, 779 F.2d 901 (2d Cir. 1985), should apply, and that the court should weigh the potential costs and benefits in determining whether pursuing purported benefits from the actions would justify the anticipated delay and expense in prosecuting them.

In conclusion, the district court agreed with the bankruptcy court that the law firm lacked standing under the standards of STN Enterprises because there were no "extraordinary circumstances" sufficient to merit giving the law firm standing (as required by STN Enterprises), and neither the law firm nor the trustee showed that the benefits of such an action would outweigh the costs. The district court, however, expressly noted that it agreed with Judge Blackshear's refusal to rule categorically that "a creditor could not have standing to bring an adversary action in a Chapter 13 proceeding."


Claims Objections - Preclusion: Kadish v. K-Mart Corp., 2005 WL 3077605 (N.D. Ill., 11/14/05). Here, the district court affirmed the order of Illinois Bankruptcy Judge Susan Sonderby, in which she approved a settlement of a nearly $17 million lease rejection claim. Notably, that settlement was reached not in the Illinois case, but in a separate New York bankruptcy case involving K-Mart, the landlord, and the landlord's secured lender. Two other parties objected in the NY bankruptcy case to the contemplated settlement, but the NY court found not only that the settlement was fair and reasonable, but that it would be unreasonable for one of the objecting parties (whose consent could not be unreasonably withheld to the settlement) to so withhold its consent.

The objecting party in the NY bankruptcy case objected to the proposed allowance of the lease rejection claim in the K-Mart case pending in the Illinois Bankruptcy Court, arguing that the Illinois court should disregard the decision of the NY bankruptcy court because the NY court made the wrong call on the merits. The District Court disagreed, stating that it would have been inappropriate for the Illinois court to review the propriety of the NY court's ruling because "[a]ll of the requirements of issue preclusion appear to be satisfied, [and thus] appellants are precluded from relitigating the issue of their consent to the settlement."

In a procedural sidenote, the winning appellees argued that the appeal should be dismissed on issue preclusion grounds, but the District Court disagreed, stating that "issue preclusion is an affirmative defense, and thus a ground for affirming Judge Sonderby's order rather than dismissing the appeal." As such, the District Court denied the appellees' motion to dismiss and affirmed the bankruptcy court's order.


Discharge - Willful and Malicious: Norm Gershman's Things to Wear, Inc., v. Peterson (In re Peterson), 2005 WL 3046491 (Bankr. D. Del., 11/15/05). This case involves a "dirty debtor," literally. Here, the debtor filed a voluntary chapter 7 petition, listing a judgment debt owed of $10,845.51 resulting from the damages attributable to the mess the debtor's dogs had caused in the judgment creditor's home. The judgment creditor tried to have the bankruptcy court declare the debt nondischargeable under Bankruptcy Code section 523 for the debtor's "willful and malicious" actions in allowing her dogs to damage the creditor's property. The case is interesting primarily because of the Court's refusal to find, under the doctrine of claim preclusion, that the state court's failure to award punitive damages would -- as a matter of law -- bar the bankruptcy court from making a finding that the was nondischargeable under Bankruptcy Code section 523(a)(6). In the end, the court applied both the "subjective" and "objective" approach, and concluded that the debtor's conduct was not "willful and malicious" under either approach. It's nice to see Delaware's bankruptcy court giving due time to matters not only great, but small too.


Fee Applications - Objections: Hennigan Bennett & Borman LLP v. Goldin Associates, LLC (In re Worldwide Direct Inc.), 2005 WL 3071275 (D. Del., 11/16/05). This case involves an appeal filed by Hennigan Bennett & Dorman, LLP ("HBD") from a bankruptcy court order paring back its requested fees. HBD initially sought $5,872,609.90 in fees, and $1,042,422.46 in expenses. The Trustee demanded a 7% reduction for the fees and expenses, but HBD rejected the Trustee's demand. The Trustee followed by filing an objection to HBD's fee application, which was granted in part. HBD then filed a supplemental application for fees associated with defending against the Trustee's objections, which the bankruptcy court rejected, stating:

Although the Trustee's objection did not have a sound basis in fact, the fees sought in the supplemental application would nevertheless not be awarded because the benefit by responding to [fee] objections is for the benefit of the professional, not the estate.

HBD challenged the Bankruptcy Court's ruling on appeal, and won. In overruling and remanding the Bankruptcy Court's ruling, the District Court stated:

To uphold the Bankruptcy Court's approach would be to provide an unhealthy incentive for persons opposed to professional fees to mount spurious objections as a means of extracting fee reductions, rather than because the work done for the estate was genuinely not for the benefit of the estate. In other words, requiring counsel who has successfully defended a fee claim to bear the costs of that defense is no different than cutting counsel's rate or denying compensability on an earlier fee application. The economic effect is precisely contrary to the Third Circuit's instruction that bankruptcy professionals are to stand on an equal footing with their non-bankruptcy counterparts.

Thanks to Ryan Zeller and Kelly Frame for their help in compiling this post.

© Steve Jakubowski 2005