z Bankruptcy Litigation Blog : Circuit Splits

7th Circuit Rejects Ex-CEO Hilbert's Claim that Certain of His Perks Were Executory When Conseco Filed Bankruptcy

Last year, in a post entitled "What Makes a CEO Perk Executory and the Circuits' Split Over the Definition of an Executory Contract," I reported on an interesting sideshow to the Conseco bankruptcy involving the rights of Conseco's ex-high flying ex-CEO Stephen Hilbert (and his enterprising wife, Tomisue Tomlinson) to four self-dealt "split-dollar" life insurance policies worth $87 million in the aggregate.  As noted in my prior post, Chicago's Judge Robert W. Gettleman ruled that Chicago's Bankruptcy Judge Carol W. Doyle was right in concluding that the policies were not "executory contracts" and were automatically terminated when Conseco filed for bankruptcy in December 2002.  He also agreed with Judge Doyle's conclusion that "because Conseco was not attempting to enforce a contract, its material breach of the Agreements in December 2001, when it stopped making premium payments, was of no consequence."

Last Friday, the 7th Circuit affirmed Judge Gettleman's decision, with Indiana's own Judge Michael S. Kanne authoring the opinion on behalf of a unanimous panel.  Dick ex rel. Amended Hilbert Residence Maintenance Trust v. Conseco, Inc. (In re Conseco, Inc.), 2006 WL 2328635 (7th Cir. 8/11/06) (pdf). 

In affirming the lower courts' rulings, the 7th Circuit made two important general statements regarding executory contracts in bankruptcy.  First, regarding when a contract is executory, the 7th Circuit stated:

Recognizing that the literal definition would render nearly all agreements executory, we determined that in order to effectuate Congress's intent, § 365 should be applied only 'to contracts where significant unperformed obligations remain on both sides.'  In other words, a contract is executory if each party is burdened with obligations which if not performed would amount to a material breach.  (Citation omitted.)

Second, as to what law applies in determining whether "the remaining obligations are significant," the 7th Circuit stated that the court should look to state law (and in this case, Indiana law) for answers.

Applying these general principles to the case, the 7th Circuit concluded on de novo review that the split-dollar policy agreements were not executory, reasoning as follows: 

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Proving an Intentional Fraudulent Transfer under the Bankruptcy Code and the UFTA: A Clear and Convincing Preponderance of Uncertainty

Univ. of Richmond Law School's Professor A. Benjamin Spencer, founder of the Split Circuits Blog (previously noted here), has posted today on a split recently discussed by Columbus Bankruptcy Judge John E. Hoffman, Jr. regarding the level of proof (whether "preponderance" vs. "clear and convincing") necessary to establish the existence of an intentional fraudulent transfer under Bankruptcy Code section 548(a)(1)(A) (which enables a trustee to avoid a transfer or obligation incurred "with actual intent to hinder, delay, or defraud" the debtor's creditors).  See In re Canyon Systems Corp., 343 B.R. 615 (Bankr. S.D. Ohio 2006) (pdf)

According to Chicago's Bankruptcy Judge Eugene R. Wedoff, the reason the preponderance standard must apply is because the US Supreme Court held in Grogan v. Garner, 498 U.S. 279, 286 (1991) (WL), that the "preponderance" standard of proof applies to all causes of action arising under the Bankruptcy Code “unless particularly important individual interests or rights are at stake.”  As Judge Wedoff explained in Baldi v. Lynch (In re McCook Metals, L.L.C), 319 B.R. 570 (Bankr. N.D. Ill. 2005) (pdf): 

There is a dispute over whether the higher, clear and convincing evidence standard applies to proof of actual fraud under 548(a)(1).  See Taylor v. Rupp (In re Taylor), 133 F.3d 1336, 1338 (10th Cir. 1998) [pdf].  The same dispute exists under the UFTA [i.e., the Uniform Fraudulent Transfer Act, adopted in most states (but not NY)].  See In re Solomon, 300 B.R. 57, 62-63 (Bankr. N.D. Okla. 2003) (holding that Oklahoma would apply the preponderance standard); Word Investments, Inc. v. Bruinsma (In re TML, Inc.), 291 B.R. 400, 436 [Bankr. W.D. Mich. 2003] (collecting authorities, and holding that Michigan would apply the clear and convincing standard under its version of the UFTA's predecessor, the Uniform Fraudulent Conveyance Act). The Illinois courts do not appear to have addressed the question.

There is no apparent reason for treating the interests of a defendant in an actual fraud proceeding under § 548(a)(1) as more important than the interests at stake in Garner-the dischargeability of a debt under § 523(a)(2). 

Conversely, while there are cases holding that the "preponderance" standard applies in state law-based intentional fraudulent transfer actions, a strong majority of UFTA cases appear to favor application of the "clear and convincing" standard to such cases.  See, e.g., Grochocinski v. Zeigler  (In re Zeigler), 320 B.R. 362 (Bankr. N.D. Ill. 2005), where Chicago's Bankruptcy Judge John Squires (author of these handy tips) wrote:

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5th Circuit Holds that Federal Anti-Assignment Act Doesn't Trigger "Ipso Facto" Termination of Mirant's Energy Contract

For a federal agency, the Bonneville Power Administration (BPA) is surely unique. Unlike most federal agencies, this one is self-funding. It boasts that it "recover[s] all of its costs through sales of electricity and transmission and repay[s] the U.S. Treasury in full with interest for any money it borrows." The story of the origins and growth of the BPA is one worth reading, as it holds many lessons regarding the social, political, and economic development in the Pacific Northwest and the US generally. To take one more extreme example, did you know that the BPA served as the inspiration for some of Woody Guthrie's most famous songs? According to one documentary, entitled Roll on Columbia: Woody Guthrie and the Bonneville Power Administration:

In spring 1941, the cusp of the Great Depression and Pearl Harbor, a 28 year old, unemployed Dust Bowl balladeer, Woodrow Wilson Guthrie took a one month, temporary job with the U.S. Department of the Interior's Bonneville Power Administration (BPA) on the Columbia River. The BPA needed a folksinger to promote the benefits of building dams to produce cheap electricity. Guthrie, and his wife and 3 kids needed the paycheck. He wrote 26 songs in 30 days - classics like Roll on Columbia and Pastures of Plenty. This ... is the ... most prolific moment in Guthrie's extraordinary career.

The BPA also is one of the lesser publicized casualties in the largest bankruptcies ever (Enron, Mirant, Calpine, Kaiser, PG&E, Longview Aluminum, to name a few), and its advocates both internally and at the Department of Justice have fought tooth and nail on behalf of the BPA against some of the best bankruptcy lawyers in the land.

Recently, the Fifth Circuit weighed in on a long-standing split among the circuits in the law regarding assumption and termination of non-assignable executory contracts. It held that the BPA could not unilaterally terminate its executory contract with Mirant for future electric power purchases under the contract's "ipso facto" clause (which excuses the solvent party from performance of the contract when the other party becomes insolvent or goes bankrupt) simply because the federal Anti-Assignment Act prohibited the assignment of the contract. In re Mirant Corp., 2006 WL 33012 (5th Cir., 2/13/06) (pdf).

In reaching this result, the Fifth Circuit stepped into the debate over whether to adopt the "actual" or "hypothetical" approach in determining whether, under Bankruptcy Code section 365(e)(2)(A), the contract can be terminated as a matter of law because --

applicable law [such as the federal Anti-Assignment Act - 41 USC § 15] excuses a party, other than the debtor, to such contract or lease from accepting performance from or rendering performance to the trustee or an assignee of such contract or lease, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties.

The Fifth Circuit framed the differing positions of the parties as follows:

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"Let Them Eat Cake!": Whither Fiduciary Duties to Creditors?

The British Independent recently announced here that Marie Antoinette may well be the "historical personality of the year" for 2006. According to the paper,

Marie-Antoinette lives again. The last great queen of France, guillotined in 1793, threatens to make us all lose our heads in 2006. She may rival, or even eclipse, her close contemporary and fellow Austrian, Mozart, as "historical personality" of the year. Mich�le Lorin, the president of the Marie-Antoinette Association in France, confidently predicts that we are about to plunge into a warm bath of "Marie-Antoinette mania".

Professor Larry Ribstein's reference on his Ideoblog to this working paper he co-authored with Gardner Carton's Kelli Alces entitled "Directors' Duties in Failing Firms" brought to mind a statement most commonly -- though wrongly -- ascribed to Marie Antoinette: "Let them eat cake!"

In their paper, Professor Ribstein and Ms. Alces conclude that "corporate directors of failing firms do not have special duties to creditors" and that "creditors are not owed general fiduciary protection even if they are subject to a special risk of abuse in failing firms." In other words, "Let the[] [creditors] eat cake!" They write:

[W]hile the [Production Resources] court acknowledged the slight possibility that an individual creditor might have a fiduciary duty claim that was outside the bounds of specific creditor remedies, the scope of any such relief would be narrow. If the creditor of a corporation in or near insolvency can recover, it would most likely be under a traditional fraud or other theory whose application is shaped by the circumstances, including the corporation's insolvency.

These conclusions, however sound and noteworthy they may be, are not exactly the conclusions one would expect to obtain from a random sampling of bankruptcy professionals and judges being questioned about fiduciary duties owed to creditors upon the debtor's insolvency or entry into the "zone of insolvency." In Miller v. Dutil (In re Total Containment, Inc.), 335 B.R. 589, 603 (Bankr. E.D. Pa., 12/18/2005), for example, the bankruptcy court stated categorically, "Where a company becomes insolvent, the fiduciary duty owed by corporate officers and directors shifts to the company's creditors." Similarly, in FDIC v. Sea Pines Co., 692 F.2d 973, 976-77 (4th Cir. 1982), cert denied, 461 U.S. 928 (1983), the Fourth Circuit stated:

[W]hen the corporation becomes insolvent, the fiduciary duty of the directors shifts from the stockholders to the creditors. The law by the great weight of authority seems to be settled that when a corporation becomes insolvent, or in a failing condition, the officers and directors no longer represent the stockholders, but by the fact of insolvency, become trustees for the creditors, and that they cannot by transfer of its property or payment of cash, prefer themselves or other creditors.

Finally, in Rafool v. Goldfarb (In re Fleming Packaging Corp.), 2005 WL 2205703 (Bankr. C.D. Ill., 8/26/2005), the bankruptcy court concurred with the trustee that fiduciary duties to creditors arise upon the debtor's insolvency, stating:

Relying on the recent case of Production Resources Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772 (Del. Ch., Nov. 17, 2004), the Trustee asserts that upon insolvency, the existing duties owed by the directors to the corporation are not destroyed, but rather that additional duties, owed to the corporation's creditors, arise. The Trustee maintains that he may properly bring this action directly on behalf of the Debtor. In addition, because those duties which arise upon insolvency are owed to the creditors as a class and because any recovery for a breach of those duties would inure to the corporation, the Trustee contends that he has standing to bring those claims derivatively. This Court agrees.

The law may someday mirror the logically compelling conclusions reached by Professor Ribstein and Ms. Alces, but it doesn't appear that courts are there quite yet. Until then, expect that litigation by trustees and committees will continue to allege breaches of fiduciary duties by directors to creditors (and related claims of "deepening insolvency" -- whether arising as an injury from an independent wrong, as a measure of damages, or as an independent tort in its own right) in an attempt to pressure director defendants (and their D&O carriers) to pony up their allocable share of creditor losses (or at least a good chunk of the available D&O policy limits).

© Steve Jakubowski 2006

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The Fifth Circuit, Splitting 9-7, Holds that US Crop Relief Payment, Authorized by Legislation Enacted Postpetition, Is Not Property of the Debtor's Bankruptcy Estate

Last Friday, nine of 16 judges of the 5th Circuit Court of Appeals ruled, following an en banc rehearing, that crop disaster relief payments authorized by legislation enacted postpetition are not "property of the debtor's estate." Burgess v. Sykes (In re Burgess), 2006 WL 205043 (5th Cir. 1/27/06) (pdf).

This must-read decision rests on simple facts, but raises giant questions of law, as evidenced by the 31 page majority opinion authored by Judge Edward C. Prado and a 26 page dissent authored by the Circuit's recently named Chief Judge, the Honorable Edith Hollan Jones (who makes another compelling case in dissent).

In this case, a Louisiana farmer, Keith Burgess, filed for chapter 7 relief in August 2002 and received a discharge in December 2002. In 2001, Burgess sustained significant crop losses. In February 2003, Congress enacted the Agricultural Assistance Act of 2003, which authorized the issuance of "crop-disaster-relief" payments to qualifying farmers, like Burgess, who sustained crop losses in 2001 or 2002. In August 2003, the Farm Service Agency issued a $24,829 check to Burgess for losses sustained, but sent the check to the bankruptcy trustee, who moved to reopen the case for a ruling on what to do with the check.

The bankruptcy court held that the check was property of the estate that should be made available for creditors. The district court affirmed. A panel of the 5th Circuit reversed, Burgess v. Sykes (In re Burgess), 392 F.3d 782 (5th Cir. 2004), after which the matter was reheard en banc.

Judge Prado, writing for the nine judge majority, reasoned that the disaster relief payment was not "property of the estate" because the legislation was not enacted until after Burgess filed for bankruptcy, thus depriving Burgess's estate of any "legal or equitable right to payment" at the commencement of the case. The majority also ruled that the payment did not constitute, under Code section 541(a)(6), "proceeds" derived from "property of the estate." To the majority, "Section 541's temporal limitation is the key to deciding the case."

Chief Judge Jones, writing for six other judges in dissent, argued that the payments at issue were both "property of the estate" and "proceeds" derived from "property of the estate" because "these [Code] definitions, whether interpreted in light of venerable bankruptcy case law or state commercial law, are sufficiently broad to encompass the disaster payments made to Burgess." The dissent took issue with the "temporal limitation" adopted by the majority, stating:

The majority opinion focuses on the temporal limitation in § 541(a)(1), which it constructs as an iron curtain separating prebankruptcy property from whatever accrues to the debtor post-bankruptcy. The majority reads the cases to require that a prebankruptcy loss must have more than a mere hope or expectancy of recovery, and must in fact give rise to a prebankruptcy legal claim, in order for post-bankruptcy recovery for that loss to become part of the bankruptcy estate. This view has some force, but we respectfully reject its rigidity.

What turns this simple case into a 57 page combined opinion for the majority and dissent is the comprehensive discussion by both of relevant case law spanning over 150 years, including such venerable classics as Segal v. Rochelle, 382 U.S. 375 (1966), Butner v. United States, 440 U.S. 48 (1979), and United States v. Whiting Pools, 462 U.S. 198 (1983), as well as others requiring a good dusting off before reading (e.g., Williams v. Heard, 140 U.S. 529 (1891) (cited only six times since WWII), Milnor v. Metz, 41 U.S. 221 (1842) (cited only seven times in the preceding 100 years), and Emerson v. Hall, 38 U.S. 409 (1839) (cited only 11 times in the past 100 years)).

In the end, Judge Jones' dissent seems to offer a better resolution to some fundamental questions regarding "property of the estate" that divide not only the 5th Circuit, but -- as amply noted throughout both opinions -- the Circuits at large. We can only hope that the trustee, having taken the case this far, will file a petition for certiorari, and that the US Supreme Court will hear this important case that has been perfectly teed up for review.

© Steve Jakubowski 2006

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Third Circuit Rules that "Reverse Cramdown" Plan Proposed by Armstrong World Industries Violates the Bankruptcy Code's "Absolute Priority Rule"

One very important issue sharply dividing courts and commentators alike is that of "reverse cramdown," whereby an undersecured creditor with a lien on the debtor's assets will join with debtor's management and existing equity holders (often dominated by insiders) in a reorganization plan that offers existing equity holders a piece of the reorganized debtor despite the fact that a non-consenting intervening class of unsecured creditors receives little or nothing under the plan.

In an article distributed at the November 2005 National Conference of Bankruptcy Judges in San Antonio, Hugh Ray and Jon Daly, of Houston's Andrews Kurth LLP, strongly criticized this "tip" by undersecured creditors to junior equity classes, writing:

Underlying the practice of reverse cramdown is the rationale that since the secured lender has a lien on all the debtors' property and is undersecured, the secured lender can share or "give up" a portion of the enterprise value of the debtor to which it would otherwise be entitled to under the plan to whoever it want to, including the debtor's existing equity interest holders, who, absent the secured lender's generosity, would otherwise receive nothing under the plan. Courts have applied this rationale to circumvent not only the absolute priority rule but the prohibition against "unfair discrimination" contained in 11 U.S.C. § 1129(b)(1) as well.

[We] contend, however, that this rationale is flawed. Secured creditors should not be permitted to collatorate with junior creditors or equity owners to squeeze out intervening classes of creditors who are not provided for in full under a plan of reorganization. The legislative history to 11 U.S.C. § 1129(b)(2) expressly prohibits the practice of reverse cramdown. Moreover, it was inequitable practice similar to reverse cramdown that led to the creation of the absolute priority rule in the first place.

In issuing its final opinion in a civil case for 2005, the Third Circuit Court of Appeals rejected on de novo review a "reverse cramdown" proposed in a plan of reorganization by Armstrong World Industries (AWI), stating that such a plan violated the absolute priority rule incorporated into 11 U.S.C. § 1129(b)(2)(B)(ii). In re Armstrong World Indus., Inc., 2005 WL 3544810 (3d Cir. 12/29/05) (pdf here). To understand the Court's ruling, one must first understand what was proposed in AWI's reorganization plan. The Third Circuit summarized the relevant plan provisions as follows:

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Creditor Derivative Standing: Some Recent Cases Explore the Contours of the Doctrine and Split Among the Circuits

Rutgers Law School's Professor Keith Sharfman, an outspoken critic of "creditor derivative standing" in bankruptcy (see Sharfman, Derivative Suits in Bankruptcy, 10 Stan. J. L. Bus. & Fin. 1 (2004)), took note in a recent guest blog post on Ideoblog of a case from the Fourth Circuit, Scott v. National Century Financial Enterprises, Inc. (In re Baltimore Emergency Services II, Corp.), 2005 WL 3470039 (4th Cir., 12/20/05), which "denied creditors standing in the particular case and cast doubt on whether creditor standing could ever be available." Given the proliferation of litigation being commenced in bankruptcy courts "for the benefit of" and "on behalf of" aggrieved creditors left holding the bag, and the diverse decisions of courts across the land, the question of a plaintiff's standing to commence adversary litigation in the bankruptcy context has gained increased importance in the past several years.

The Baltimore Emergency Services II case is a worthwhile read. In it, the Fourth Circuit actually ruled very narrowly, holding that the plaintiffs lacked standing to seek a preliminary injunction against the chapter 11 debtor's former CEO who "oversaw the debtors' business operations, guided them into bankruptcy, and then abruptly jumped ship [by seeking] to undermine the debtors by securing for himself their workforce and their most valuable contracts." If any case cried out for a court's acceptance of creditor standing (with or without the debtor's consent), it is this one (which had the support of the lead secured creditor and the creditors' committee, whose aggregate claims against the debtor exceeded $430 million).

The opinion in Baltimore Emergency Services II begins by first examining the doctrine of "derivative standing," which itself -- according to the Court -- encompasses two situations: first, when the trustee or debtor-in-possession refuses to bring suit on its own; second, when the trustee or debtor-in-possession grants consent. The Court stated:

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Who Decides Disputes Over the Content of the Appellate Record? Ohio Bankruptcy Court Sides with Majority in Holding that Bankruptcy Court Decides Those Disputes

In Amedisys, Inc., v. JP Morgan Chase Manhattan Bank as Trustee, 2005 WL 3497805 (Bankr. S.D. Ohio, 12/22/05), the plaintiff appealed the bankruptcy court's order granting the defendants' partial summary judgment motion. The plaintiff designated items to be included in the record on appeal, and the defendants moved to strike some of these items.

The bankruptcy court looked at the split among the circuits on whether a bankruptcy court has the power to rule on disputes regarding the contents of the appellate record. In this well-researched opinion, the Court found that that a majority of courts hold that bankruptcy courts do have the power to rule on such disputes, stating:

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Delaware District Court Holds that Houlihan Lokey's Fixed Fee Retention Arrangement Is Governed by the "Improvident" Standard, Not the "Reasonableness" Standard

In a recent post, I noted the recent 10th Circuit case of In re Commercial Financial Services, Inc., 427 F.3d 804 (10th Cir., 10/25/05). In that case, the 10th Circuit cut a $1.9 million fee request by Houlihan, Lokey, Howard & Zukin Capital ("Houlihan") by over $1 million. The 10th Circuit focused, among other things, on boilerplate-type language in the retention application stating that Houlihan's fee request would be "[s]ubject to the approval of the court" as well as to "final review by the Bankruptcy court as to the relative fairness" of the proposed fee. In essence, the 10th Circuit adopted the "reasonable" standard of Bankruptcy Code section 330(a) in reviewing the appropriateness of Houlihan's monthly fixed fee request.

Last week, in Houlihan, Lokey v. NorthWestern Corp. (In re NorthWestern Corp.), 2005 WL 3018590 (D. Del., 11/8/05), Judge Farnan for the District Court for the District of Delaware affirmed in part and reversed in part a fee order of the bankruptcy court, holding that since the Bankruptcy Court had already approved Houlihan's $175,000 monthly fee as "reasonable" in Houlihan's retention order, the Bankruptcy Court erred by applying the "reasonable" standard of Bankruptcy Code section 330(a) instead of the "improvident" standard of Bankruptcy Code section 328(a). Under this standard, the Court noted, "only 'developments not capable of being anticipated at the time of the fixing of [the] terms and conditions' of engagement may render a previously approved term improvident."

Additionally, in allowing the fixed monthly fees, the District Court found that the potential for duplication of services by Houlihan and Lazard Freres (the Debtor's financial advisor), which the Bankruptcy Court had found "could not have been foreseen ... at the time it approved the Committee's application," was a "clearly erroneous" finding of fact because "whether or not those services were inappropriately duplicative, the potential for duplication was certainly not unforeseeable."

The crux of the District Court's analysis in reversing the Bankruptcy Court's decision regarding the standard of review applicable to a monthly fixed fee retention agreement is provided below:

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Sixth Circuit Notes Circuits' Split in Holding a Debtor Has No Absolute Right to Convert a Case from Chapter 7 to Chapter 13 under Bankruptcy Code Section 706

Cracking the Code, the blog of the American Bankruptcy Institute, reports on In re Marrama, 2005 WL 2840634 (1st Cir., 10/31/05), and In re Copper, 2005 WL 2648960 (6th Cir., 10/18/05), in which the 1st and 6th Circuits held that where the case had not been previously converted, a debtor's right to convert a case from chapter 7 to chapter 13 under Bankruptcy Code section 706 "is not absolute but is subject to an exception for motions filed in bad faith."

According to the post's author, Mark P. Williams, of Norman, Wood, Kendrick & Turner; Birmingham, Alabama:

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Illinois Bankruptcy Court Addresses Circuits' Split Regarding a State Court's Jurisdiction Over the Automatic Stay's Applicability and a Debtor's Right to Unilaterally Waive the Automatic Stay's Protections

Another solid opinion from the Bankruptcy Court for the Northern District of Illinois, this time in In re Mid-City Parking, Inc., 2005 WL 2857728 (Bankr.N.D.Ill, 10/31/05). In this case, Mid-City (the debtor in possession or "DIP") filed a petition for relief under chapter 11. Subsequent to the filing, the DIP appealed a judgment that had been entered against it prepetition in favor of Clark Polk Land, LLC ("Clark Polk"). Notably, the DIP did not seek to modify the stay under section 362(d) in advance. Clark Polk shrewdly filed a motion in the state court to dismiss debtor's appeal, arguing that the appeal violated the automatic stay. The Illinois Appellate Court granted Clark Polk's motion. Not satisfied leaving well enough alone, Clark Polk then filed a motion in the DIP's bankruptcy case seeking costs and attorneys' fees related to the effort to seek dismissal of the appeal. The Bankruptcy Court undertook an extensive analysis of two central unsettled questions which have generated significant splits among the circuits:

1. Does a bankruptcy court have exclusive jurisdiction over whether a state court proceeding is subject to the automatic stay?

2. Can the trustee or debtor in possession unilaterally waive the protections of the automatic stay "with acts of estate administration that would otherwise violate 11 U.S.C. § 362(a) if performed by anyone else"?

After an extensive review of applicable law, Judge Jacqueline Cox answers the first question by choosing the first of three distinct approaches taken by various courts (including an earlier case from the same district that had selected the second of the three alternative approaches):

(A) the bankruptcy and state courts have concurrent jurisdiction to determine jurisdiction, with the bankruptcy court having the final say;

(B) the bankruptcy court has exclusive jurisdiction (and thus the state court ruling has no legal effect);

(C) the bankruptcy and state courts have concurrent jurisdiction to determine jurisdiction, but a prior state court ruling strips the bankruptcy courts of jurisdiction under the Rooker-Feldman doctrine. [Ed. Note: Though the Bankruptcy Court did not raise this, consider whether another ground for rejecting this third approach is the US Supreme Court's unanimous ruling last term in Exxon Mobil Corp. v. Saudi Basic Indus. Corp., 125 S.Ct. 1517 (2005), which held that the Rooker-Feldman doctrine could not be invoked in cases involving concurrent or parallel state and federal court proceedings.]

The Court answered the second question in the affirmative, stating:

A Chapter 11 debtor-in-possession or case trustee may waive the protections afforded by § 362(a) when the actions that would otherwise violate the stay are in furtherance of his statutory duties of administering the bankruptcy estate, including appealing judgments against the debtor's estate in nonbankruptcy forums. In so holding, this Court approves the result reached by the U.S. Court of Appeals for the Tenth Circuit and the Indiana Supreme Court rather than that reached by the First Circuit and the Ninth Circuit. Until a debtor-in-possession or trustee takes affirmative action showing an intent to prosecute the appeal of a judgment claim, however, an appeal from a judgment against the debtor's estate is stayed pursuant to § 362(a)(1).

In support of this conclusion, the Court provides a thoroughly researched analysis, much of which follows:

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Mandatory Absention of a Removed State Court Action: A New Case Reviews the Split Among the Circuits

In Allen v. J.K. Harris & Co, LLC, 2005 WL 2600205 (E.D. Pa., 10/12/05), a state court consumer class action seeking damages based on unfair trade practices was removed by the defendants to federal district court following the plaintiff/debtor's filing of a chapter 13 petition for relief. The plaintiff/debtor then moved to remand the case back to state court.

The district court considered whether abstention is mandatory under 28 U.S.C. § 1334(c)(2), which says that courts "shall abstain" from exercising jurisdiction over an adversary proceeding where a party timely moves for abstention based on a state law claim that does not arise in the bankruptcy case and could be "timely adjudicated" in the state forum.

In noting the split among the circuits as to whether the doctrine of mandatory abstention can be applied to an already removed case, the Court (indicating that the Third Circuit has not decided the matter) sided with the majority view that the doctrine of mandatory abstention may be applied to a removed proceeding. The Court stated:

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What Makes a CEO Perk Executory and the Circuits' Split Over the Definition of an Executory Contract

Back in the early to mid-1990's, while Conseco's profligate CEO, Steve Hilbert, was on his way to becoming America's highest paid CEO (with a whopping $277 million between 1991 and 1996), Hilbert was (forever?) smitten with the lovely 25 year old Indy stripper Tomisue Tomlinson as she jumped out of a cake at his stepson's bachelor party.

Unlike Hilbert's five previous marriages, this one has survived the test of time (and loss of money). Conseco's bankruptcy appears to have joined them at the hip (or maybe the prepetition asset transfer to Tomisue did), as evidenced by a recently decided case in Conseco's post-confirmation bankruptcy saga, here involving the rights of the Hilberts' "irrevocable trusts" to four "split-dollar" life insurance agreements established in 1998. In re Conseco, 2005 WL 2737507 (N.D. Ill., 10/18/05).

Under these self-dealt policies, Conseco agreed to pay annual premiums owing under the policies (worth between $12.5 million and $25 million each). The Hilberts were also required to pay a portion of the policy premiums (presumably the minimum required to maximize tax benefits). If the Hilberts failed to pay their portion, the trusts could pay on their behalf. The Court noted that the Agreements had early termination provisions if Conseco went bankrupt, or if the Hilberts or their trusts failed to pay Conseco a share of the premiums. Upon termination, the trusts could repurchase the policy from Conseco by reimbursing Conseco for premium payments made. If, within 60 days, the trusts did not exercise this repurchase option, Conseco could either become the owner of the policy or surrender the policies and get its premium payments back.

In December 2001, Conseco stopped making payments on the insurance policies, believing the Hilberts owed Conseco millions of dollars in defaulted D&O loans. Apparently, after Conseco stopped making payments, the trusts responded by converting the policies into paid-up policies with lower death benefits so that no further payments were due under the insurance policies.

One year later, Conseco filed for bankruptcy, and on September 10, 2003, it's reorganization plan went effective. Notably, neither the Hilberts nor their trusts exercised their option to purchase the policies from Conseco within 60 days of the bankruptcy filing, but rather filed claims against Conseco in the bankruptcy case seeking damages for alleged breach of the Agreements. (Perhaps they were thrown off by the ipso facto clauses in the Agreements that provided for termination in the event of bankruptcy, which every bankruptcy lawyer knows will not alone terminate an executory contract.)

The trusts asserted in their proofs of claims that Conseco's bankruptcy filing did not terminate the Agreements. Conseco objected to the claims, smartly asserting that the Agreements were not executory, and thus were terminated because neither the Hilberts nor the trusts exercised their option to purchase the policies from Conseco within 60 days of the bankruptcy filing (the ipso facto clause notwithstanding). In September 2004, Conseco's attorneys advised the trusts that the Agreements were terminated and that Conseco intended to enforce its rights to recoup the premium payments made. Counsel for the trusts responded that the trust "would consider your taking of the cash value of the policies not only to be an additional breach of the [Agreements], but also to be conversion as well."

The Bankruptcy Court, however, disagreed with the trust counsel's assessment, holding that the Agreements were not "executory contracts" under Bankruptcy Code section 365, and thus were automatically terminated when Conseco filed for bankruptcy in December 2002. The Bankruptcy Court also found that "because Conseco was not attempting to enforce a contract, its material breach of the Agreements in December 2001, when it stopped making premium payments, was of no consequence."

The District Court, reviewing the bankruptcy court's rulings and conclusions of law de novo, ruled that the bankruptcy court correctly adopted the "Countryman definition" of an exectuory contract as one in which "the obligation of both the bankruptcy and the other party are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance by the other." (Citing Vern Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn L. Rev. 439, 460 (1973)). The District Court also concurred with the Bankruptcy Court's logical extension of the Countryman definition in concluding that "if any of the parties' duties is deemed immaterial, then the contract is deemed not executory."

As regards whether a contract is "executory," the District Court noted the split in the circuits between the majority Countryman "material breach" test and the minority "functional test" (with the Seventh Circuit following the Countryman definition), stating as follows:

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Hell Hath No Fury Like a Lover Scorned: Stan, Joelene, and the Circuits' Split Over the Section 523(a)(2) Discharge

[This is the first of many posts highlighting cases that touch on the splits among the federal circuit courts on various topical bankruptcy issues.]

"Hell hath no fury like a lover scorned" is a well-known epithet that comes to mind when reading the Tenth Circuit's recent opinion in Cadwell v. Joelson (In re Joelson), (2005 WL 2722891) (10th Cir., 10/24/05). The case recounts how Stan Cadwell (a retired single man from Casper, Wyoming) met Joelene Joelson (a waitress) in a Casper "cafe" where Joelene worked. Stan took out a mortgage on his house for $50,000 for the benefit of his erstwhile lover, but not until after he had performed some due diligence of his own into Joelene's claims to ownership of a sizable, though illiquid, estate. When the affair ended, and Joelene didn't repay her debt, Stan sued Joelene in Wyoming state court on the $50,000 he had given her. Joelene demurred, saying it was but a gift from her former lover, but the state court disagreed, and entered judgment against Joelene. She later filed a petition for chapter 7 relief.

Stan proved that "hell hath no fury like a [Cadwell] scorned" and filed an adversary proceeding in the bankruptcy court seeking to bar the discharge of all of Joelene's debts (or, at a minimum, his state court judgment). The bankruptcy court would not deny the discharge of all of her debts, but did agree that Stan's claim was non-dischargeable under Bankruptcy Code section 523(a)(2)(A). This section states that a debt obtained by "false pretenses, a false representation, or actual fraud" is nondischargeable, subject to this important exception: if a debt is obtained by a false oral "statement respecting the debtor's ... financial condition," the debt is dischargeable. Conversely, under Bankruptcy Code section 523(a)(2)(B), a debt obtained by a false written statement "respecting the debtor's ... financial condition" is nondischargeable, provided certain conditions are met.

In finding the debt to Stan nondischargable, the bankruptcy court found actionable Joelene's misrepresentations to Stan that she owned "residences in both Casper and Glendo, a motel in Glendo, and a number of antique vehicles stored in Glendo." On appeal, the BAP affirmed the ruling of the bankruptcy court, holding that some of Joelene's misrepresentations to Stan were not statements "respecting [her] financial condition," thus rendering her debt to Stan nondischargable.

The case is notable for its exceptional analysis of the roots of § 523(a)(2) (whose origins are found in the Bankruptcy Act of 1898) and the prevailing split in the circuits on the meaning of the phrase "respecting the debtor's ... financial condition." In affirming the ruling of the lower courts, the Tenth Circuit outlined the respective legal positions of Stan and Joelene, and concluded that Stan's "strict interpretation" of the phrase was "most consistent with the text and structure of the Bankruptcy Code, Congress's intent as expressed in the legislative history of 11 U.S.C. § 523(a)(2)(A) and (B), and case law," stating:

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