Notable Reported Cases for the Week Ended 11/6/05

Here's our popular weekly roundup of significant recently decided cases involving complex bankruptcy disputes for the week ended 11/06/05. Guaranteed, you'll read here about decisions you won't ever find in West's Bankruptcy Reporter.

Reliance Ins. Co. v. Colonial Penn Franklin Ins. Co. (In re Montgomery Ward & Co., Inc.), 2005 WL 2877750 (3d Cir., 11/3/05)

In re Weber, 2005 WL 2862229 (BAP 10th Cir., 11/2/05)

Briarpatch Limited L.P. v. Geisler Roberdeau, Inc., 2005 WL 2861604 (S.D.N.Y., 11/1/05)

American Nat. Bank & Trust Co. v. Matrix IV, Inc. (In re S.M. Acquisitions Co.), 2005 WL 2857717 (Bankr. N.D. Ill., 10/31/05)

In re Toohey, 2005 WL 2850417 (Bankr. W.D. Ky., 10/27/05)

In re Ingrid Olsen, 2005 WL 2838986 (S.D.N.Y., 10/27/05)


Reliance Ins. Co. v. Colonial Penn Franklin Ins. Co. (In re Montgomery Ward & Co., Inc.), 2005 WL 2877750 (3d Cir., 11/3/05): This clash of insurance titans is over who's left holding the bag (a common bankruptcy ailment) for losses sustained on surety bonds that Reliance Insurance executed on behalf of Montgomery Ward. This case represents an appeal of a judgment of the district court holding that Forum Insurance Company was not obligatated to indemnify Reliance for losses sustained. Colonial Penn became the interested appellee as successor in interest by merger to Forum Insurance, which once had been a subsidiary of Montgomery Ward. The Third Circuit described the genesis of the dispute as follows:

In 1997, Montgomery Ward experienced financial difficulties and defaulted on the surety obligations Reliance had undertaken on its behalf. In light of the defaults, the obligees on these bonds made demands on Reliance for payment which Reliance satisfied. These payments directly led to this litigation as Reliance regarded the Forum Agreement as having created a cross-indemnification obligation requiring Forum to indemnify Reliance for those payments, and Reliance naturally requested Forum to honor that obligation. Forum refused payment as it denied that the Forum Agreement obligated it to indemnify Reliance for those payments. Consequently, Reliance filed a diversity of citizenship action in 1997 in the Eastern District of Pennsylvania against Forum to recover its losses on the Montgomery Ward bonds from Forum on the Forum Agreement.

Colonial Penn raised every affirmative defense imaginable, summarized as follows by the Third Circuit:

The affirmative defenses are that the Forum Agreement, if found to apply as Reliance contends, is unenforceable: due to vagueness and indefiniteness; due to the absence, inadequacy, or failure of consideration; because it is illegal under the Illinois Insurance Code; because it is void or voidable by the Illinois Director of Insurance; as it violates public policy as reflected in the provisions of the Illinois Insurance Code; because it was executed by a Forum officer acting beyond the scope of his authority; because the officer who signed it had neither actual nor apparent authority to do so; because it was a product of mutual mistake; because it was a product of Forum's unilateral mistake; as barred by the doctrine of equitable estoppel; and as barred by the doctrine of promissory estoppel. Forum also alleges that Reliance breached its duty of good faith and fair dealing.

The bankruptcy court conducted a bench trial to determine the scope of the agreement with Forum in the face of an alleged ambiguity in the agreement. The court inquired into whether the parties had reached a meeting of the minds on the question of whether the agreement required Forum to indemnify Reliance for losses sustained in issued the surety bonds in favor of Montgomery Ward. According to the Third Circuit:

On June 1, 2001, the bankruptcy court entered a judgment against Reliance, accompanied by a memorandum opinion, which the court stated constituted its findings of fact and conclusions of law. Ruling in favor of Forum, the bankruptcy court held that the extrinsic evidence surrounding the execution of the Forum agreement indicated that Forum never intended to indemnify Reliance for losses Reliance suffered by reason of being a surety on the Montgomery Ward bonds. Rather, Forum could be responsible only for losses Reliance suffered on account of the issuance of Forum's own bonds.

On appeal to the district court, the Third Circuit noted:

The district court, exercising de novo review, ruled on the matter on February 13, 2004, entering judgment in favor of Forum. It adopted all of the bankruptcy court's post-trial proposed findings of fact and conclusions of law and issued its own memorandum opinion. The district court agreed with the bankruptcy court's conclusion that the Forum Agreement was ambiguous, ... [and] that because it "reasonably interpreted" the Forum Agreement to be ambiguous, it was necessary and appropriate to consider extrinsic evidence related to the parties' intent. The district court noted that "the extrinsic evidence adduced at trial demonstrated that Forum was only willing to give an indemnity with respect to the two bonds for which it had applied and that Forum did not intend to indemnify Reliance for Montgomery Ward's bonds."

Construing Illinois law, the Third Circuit held that the "venerable 'four corners' rule" should apply in this instance:

Illinois law makes clear that merely because the "parties to a contract disagree about its meaning does not [necessarily] show that it is ambiguous." FDIC v. W.R. Grace & Co., 877 F.2d 614, 621 (7th Cir. 1989). Rather, an agreement is ambiguous only if it is "reasonably or fairly susceptible to more than one construction." Omnitrus Merging Corp. v. Ill. Tool Works, Inc., 628 N.E. 2d 1165, 1168 (Ill. App. Ct. 1993)....


We hold that the bankruptcy and district courts' conclusions are erroneous because the Forum Agreement is not ambiguous as there is no competing valid interpretation of the Forum Agreement that differs from that which Reliance advances....

By this opinion we have established that the Forum Agreement as executed is applicable to the Montgomery Ward bonds and that Forum's cross-indemnification obligation applies to losses Reliance suffered on those bonds. Thus, the remaining issues relate to Forum's affirmative defenses and, if it is liable, damages. Forum's appeal will be dismissed.


In re Weber, 2005 WL 2862229 (BAP 10th Cir., 11/2/05): This case is interesting for its discussion of certain implications the Court it believed could be drawn from US Supreme Court's decision in Associates Commercial Corp v. Rash, 502 U.S. 953 (1997). Here, the debtors appealed the Bankruptcy Court's order granting a motion to redeem a 2003 Ford Taurus. The issue before the Bankruptcy Court was which valuation standard was to be used: the "trade-in" value or the "private party" value. The Bankruptcy Court granted the motion to redeem at a value of $10,940. Wells Fargo, the secured creditor, argued that Rash, applies to this case and mandates the application of "replacement value" in all redemption situations.

The Court, discussing the holding of Rash, stated:

In Rash, the Supreme Court initially observes the first sentence of § 506(a) sets no valuation standard. While that language instructs a court as to what it must evaluate, "it is not enlightening on how to value collateral." The Supreme Court then continues: "The second sentence of § 506(a) does speak to the how question. 'Such value,' that sentence provides, 'shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property." Of "paramount importance to the valuation question" is the proposed "disposition or use" of the subject collateral ... In a cram-down scenario, the debtor may keep the collateral over the creditor's objection so long as the creditor is provided with the equivalent of the present value of the collateral over the life of the plan. As a result, the creditor is exposed to "double risks" in that the debtor keeps the collateral under a court-imposed "crammed down" financing arrangement and, in the event of a subsequent debtor default, the "property may deteriorate from extended use." Use of the replacement standard in those instances is mandated by § 506 because it values " the creditor's interest in the collateral in light of the proposed [repayment plan] reality: no foreclosure sale and economic benefit for the debtor derived from the collateral equal to ... its [replacement] value." Because the secured creditor is receiving back neither the collateral nor its proceeds, liquidation value is not relevant to the debtor's intended use or disposition in the context of a Chapter 13 cram-down.


A § 722 redemption presents a totally different situation. "The true underpinning of Rash is its focus on the 'double risk' of a debtor's retention of property in a Chapter 13 case and payment of the value of the creditor's allowed secured claim over time." In a redemption situation, no such concerns exist...."

Rash, therefore, mandates that the creditor's interest in the collateral be valued in light of the proposed redemption reality: That is, the functional equivalent of a foreclosure sale will take place, and that is the "proper guide" under a prescription hinged to the property's "disposition or use" for purposes of valuation under section 722 redemption. Rash, 520 U.S. at 962-63. This interpretation of valuation in a § 722 redemption is consistent with the vast majority of courts that have dealt with this issue.

Further, when a statute is vague or ambiguous, other interpretive tools may be used, including an examination of the act's purpose and of its legislative history. A review of legislative history relating to § 722 which was added to the Bankruptcy Code in 1978 (no federal right of redemption existed under the Bankruptcy Act) adds further support to the use of a "trade-in" value herein. (Citations omitted throughout.)

Finally, the Court concluded:

Rash does not mandate application of replacement value in a § 722 redemption scenario. Indeed, to do so would ignore Rash's application of the plain language in § 506(a), which does not advocate blind adherence to replacement value in every case. The Court finds the "private party" valuation used by the Bankruptcy Court in this case was incorrect.
[Fn.33: the "private party" value, described as "as-is, carrying no warranty, and priced depending on the vehicle's actual condition and local market conditions," corresponds more closely to "replacement value" than to liquidation value. The "trade-in" value agreed upon by the parties reflects a value more in line with the reasoning set forth above.]

The Order of the Bankruptcy Court is hereby REVERSED, and the Bankruptcy Court is directed to enter judgment allowing redemption in favor of the Debtors and against Wells Fargo in the agreed-upon amount of $8,215.00.


Briarpatch Limited L.P. v. Geisler Roberdeau, Inc., 2005 WL 2861604 (S.D.N.Y., 11/1/05): This action was remanded by the Second Circuit Court of Appeals based on its decision in Briarpatch, Ltd. v. Phoenix Pictures, Inc., 373 F.3d 296 (2d Cir. 2004), in which it announced the "complete preemption doctrine," which it described as an "independent corollary" to the well-pleaded complaint rule that can "convert an ordinary state common law complaint into one stating a federal claim." According to the Second Circuit,

Complete preemption occurs when Congress so completely pre-empts a particular area that any civil complaint raising this select group of claims is necessarily federal in character. If a complaint asserts a state law claim pertaining to an area of law that has been completely preempted, any such suit must be regarded as purely a creature of federal law.

Following remand, the plaintiffs moved for leave to filed a first amended complaint. The district court held:

Given the difficulty of the jurisdictional issues presented by the change in the landscape of this action and the law of the case, it does seem prudent to start over with the hope that the submissions and decisions of the past will bring a final resolution in the near future.


American Nat. Bank & Trust Co. v. Matrix IV, Inc. (In re S.M. Acquisitions Co.), 2005 WL 2857717 (Bankr. N.D. Ill., 10/31/05): This case involves a lien priority dispute arising from credit that Matrix IV, Inc. ("Matrix") and American National Bank (the "Bank") extended to the debtor prior to its chapter 11 filing. The Bank had obtained its lien through a loan, and Matrix claimed that it obtained a lien through work done for the debtor. Since the Bank recorded its lien and Matrix didn't, it was determined that the Bank's lien primed Matrix's lien.

Matrix sought to subordinate the Bank's lien with an equitable subordination defense or, alternatively, by recharacterizing the claim as equity. The Bankruptcy Court, in an opinion chock full of citations to relevant authority, held that Matrix could not recharacterize the Bank's loan as equity. The Court further held that equitable subordination was not appropriate under Bankruptcy Code section 510(c). The Court stated:

Banks are not generally fiduciaries of their borrowers, but may be deemed a fiduciary where they "usurp" the borrower's ability to make business decisions. "In effect, the lending institution must become the alter ego of the customer before it can be held to a fiduciary standard." CSY Liquidation Corp. v. Harris Trust and Sav. Bank, 1998 WL 157065 (N.D. Ill. 1998)....


[T]he Bank's foregoing efforts to protect its collateral were not either such degree of control or any type of egregious conduct that might support subordination of its loan. The Bank simply did not "exercise sufficient authority over the corporate debtor so as to unqualifiedly dictate corporate policy and the disposition of corporate assets." In re Octagon Roofing, 124 B.R. 522, 530 (Bankr. N.D. Ill. 1991). Rather, taken as a whole, the Bank appears to have done nothing more than any prudent lender would have done under like circumstances as it watched its Debtor deteriorate economically....

Matrix failed to show, and following full discovery and several years of opportunity cannot show, that the loans to the Debtor were not ordinary commercial loans and arm's length transactions; hence the remedy of recharacterization is unavailable to it. Nor do the facts averred here rise to levels required to warrant the remedy of equitable subordination, and Matrix cannot prove either insider status or Bank impropriety.


In re Toohey, 2005 WL 2850417 (Bankr. W.D. Ky., 10/27/05): This case shows how an attorney can be hoisted by his own petard through inclusion of boilerplate language in a retention order that "compensation will be [insert approved terms], or as otherwise may be allowed by the Court upon proper application thereof." Here, the trustee's counsel filed an application for compensation seeking a fee of $1,478.34 for 3.30 hours of work performed in an action to avoid a preferential transfer. That fee represented a 1/3 contingency of amounts recovered in the preference action. Obviously uncomfortable allowing a $1,478 fee in a simple preference action based on 3.3 hours of work, the Court seized on the boilerplate language to limit the fees to a "reasonable amount" of $175 per hour. The Court stated:

In the recent Sixth Circuit Opinion, In re Airspect, Inc., 38 F.3d 915 (6th Cir. 2004), the court held that whether a court "pre-approves" a contingency fee arrangement under § 328 should be judged by the totality of the circumstances, with reference to both the application and the bankruptcy court's order. Id., 38 F.3d at 922. Other factors may include whether the motion specifically requested pre-approval, whether the order assessed the reasonableness of the fee and whether either the order or the motion expressly invoke § 328. Id.


In the case at bar, [counsel's] Application specifically referenced § 328, but the Order approving his Application specifically referenced a contingency fee arrangement "or as otherwise may be allowed by the Court upon proper application thereof." Under these circumstances, the Court finds that it did not "pre-approve" the contingency arrangement under § 328. Therefore, the Court will review the fee application pursuant to the factors of 11 U.S.C. § 330.

The Statement of Services filed with the Application shows a total of 3.30 hours of work consisting primarily of the drafting and filing of a routine complaint to avoid a preferential transfer and a motion and affidavit in support of a default judgment. This resulted in payment of the amount requested by the Trustee. Considering the amount of work performed in light of the factors set forth in 11 U.S.C. § 330, the Court finds a reasonable fee to be $175.00 per hour for 3.30 hours of work for a total compensation award of $577.50.


In re Ingrid Olsen, 2005 WL 2838986 (S.D.N.Y., 10/27/05): The Debtor appealed from the bankruptcy court's order granting an application for attorneys' fees. The issue presented was whether the firm, Robinson Brog, was authorized to file an application for attorney's fees under Section 503 of the Bankruptcy Code. Here, the debtor and her husband, Reynold, owned a co-operative apartment that was sold at an auction pursuant to the bankruptcy court's order. Proceeds from this sale were held in escrow by Robinson Brog, counsel for Reynold. Robinson Brog then submitted its application under Section 503 for services rendered to Reynold in connection with the sale. The Bankruptcy Court granted Robinson Brog's application, and ordered that it be paid $75,000 out of Ingrid and Reynold's portion of the sale proceeds. The district court recounted the facts as follows:

Specifically, the [bankruptcy] court ordered that based upon the surplus funds available for distribution in the Debtor's Estate and to Reynold on account of his interest as a tenant by the entirety in the co-operative apartment previously owned by Reynold and the Debtor and sold at auction in the Bankruptcy Court, Robinson Brog shall be entitled to immediate payment of $75,000, allocated seventy-five (75%) to Reynold's portion of the surplus sale proceeds and twenty-five (25%) allocated to the Debtor's portion of the surplus sales proceeds.

The Court then discussed the appropriate interpretation to be applied to section 503, stating:

A broader interpretation of section 503 is possible. As Robinson Brog suggests, the "entity" referred to in subsection [503](a) could be read as separate and distinct from the "entity" referred to in subsection [503](b)(4). If so, a creditor's attorney, acting on his own behalf, would qualify as an "entity" under subsection (a) and could seek payment from the estate. This reading, however, conflicts with the conventional view that "[c]osts like attorneys' fees are awarded not to the lawyer but to the client." Shula v. Lawent, 359 F.3d 489, 492 (7th Cir.2004) (Posner, J.).

In vacating the Bankruptcy Court's order and remanding the case for further proceedings, the District Court stated:

As pointed out by a leading treatise in discussing section 503(b)(4): [I]t should be kept in mind that the professional has been retained by the entity rather than by the estate. The professional does not need to seek, nor is the professional able to seek, authorization of the professional's employment under [11 U.S.C. § 327]. The terms of the professional's retention are a matter between the professional and its client. The professional is entitled to look only to its client for payment and not to the estate, and it is the responsibility of the client to pay its professionals. While an entity is able to seek reimbursement of its payment obligation from the estate, the granting or denial of an award does not affect the payment relationship between the professional and its client, absent an agreement between them to that effect. The right to request compensation, therefore, belongs to the client and not to the professional.

The Court recognized the unusual facts presented in this case, and stated:

In most cases, the interests of lawyer and creditor client are aligned and both will actively seek the payment of the attorney's fees from the estate. Here, the debtor (Ingrid) and creditor (Reynold) are married, and in granting Robinson Brog's application, the Bankruptcy Court may (understandably) have been responding to the concern that Reynold was attempting to avoid paying his lawyers for their work, or reducing the assets available for his other creditors, by sheltering assets in his wife's bankruptcy estate. Indeed, at the same time Reynold objected to Robinson Brog's request for fees from Ingrid, he also sought to authorize Ingrid to retain the full proceeds of the apartment sale, a proposal that the Bankruptcy Court rejected in the interest of Reynold's creditors. Such concerns, however, do not authorize a Bankruptcy Court "to create substantive rights that are otherwise unavailable under applicable law." Deutsche Bank AG, London Branch v. Metromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F.3d 136, 142 (2d Cir. 2005), quoting New England Dairies, Inc. v. Dairy Mart Convenience Stores, Inc. (In re Dairy Mart Convenience Stores, Inc.), 351 F.3d 86, 92 (2d Cir. 2003) (internal quotation marks omitted). This does not mean that Robinson Brog is without recourse to secure its fees and expenses; like any other creditor, if it cannot obtain payment of its fees from Reynold, it may seek relief against him in an appropriate court.


Steve Jakubowski

Hat tips to Ryan Zeller and Kelly Frame.

© Steve Jakubowski 2005

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