Case Notes/Summaries

Published on: October 28, 2014

Bankruptcy, Divorce and Marital Settlement Agreements (Mejia v. Reed)

By Binder Malter Harris & Rome-Banks LLP

In Mejia v. Reed, 31 Cal. 4th 657 (2003), the California Supreme Court held that: 1) transfers of real property under a Marital Settlement Agreement (“MSA”) may be fraudulent transfers under the Uniform Fraudulent Transfer Act (“UFTA”); 2) for purposes of determining insolvency, the value of future child support should not be considered; and 3) unearned income is not an asset for purposes of the UFTA unless it is subject to levy by a creditor.

Facts and Procedure:

Danilo Reed (Husband) had an extramarital relationship with Plaintiff Rhina Mejia that led to the birth of a child. In the subsequent divorce proceeding between Husband and Violeta Reed (Wife), a marital settlement agreement (“MSA”) was entered into, pursuant to which Husband transferred all his interests in jointly held real property to Wife and Wife conveyed all her interest in Husband’s medical practice to him. The MSA also provided that Husband would be solely responsible for his extramarital child support obligation. Within less than 2 years, Husband abandoned his medical practice, moved in with his mother and had no assets and little income.

Plaintiff Rhina Mejia then instituted this proceeding, asserting that the MSA was a fraudulent transfer under the UFTA. Plaintiff claimed that that the MSA was a fraudulent transfer by Husband to Wife with intent to hinder Plaintiff in her collection of future child support. Husband moved for summary judgment for failure by Plaintiff to provide evidence of intent to defraud on the part of Husband. Additionally, Husband claimed that the value of his medical practice at the date of separation was reasonably equivalent to the real property interests he conveyed to Wife. Plaintiff argued that the fair market value of the Husband’s medical practice was less than the present discounted value of Husband’s future child support, and thus Husband was insolvent at the time of the transfer rendering the MSA subject to the fraudulent transfer laws under the UFTA for making a transfer for less than reasonably equivalent value at a time when the debtor was insovent.

The trial court ruled that the UFTA applied to the MSA but granted Husband’s summary judgment motion on the grounds that no evidence was presented of actual intent to defraud and that the transfer did not render Husband insolvent. The Court of Appeal reversed, agreeing that the UFTA applied to MSAs and that the existence of triable issues of fact precluded summary judgment.
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Published on: October 7, 2014

Conversion from Chapter 11 to Chapter 7: What to do with Post-Petition Earnings?

By Binder Malter Harris & Rome-Banks LLP

In a case of first impression, in In re Markosian, 506 B.R. 273 (9th Cir.BAP Cal) 2014 WL 956475, the 9th Circuit Bankruptcy Appellate Panel (BAP) held that an individual debtor’s postpetition Chapter 11 earnings that are property of the debtor’s bankruptcy estate revert back to the debtor upon a subsequent conversion to Chapter 7. The court also notes in a footnote that there may be situations in which the court may have to separate earnings from personal services by an individual from the earnings of a business.

Facts and Procedural History
Mr. and Mrs. Markosian (Debtors) filed a chapter 7 petition. Debtors’ chapter 7 petition was subsequently converted to a chapter 11 bankruptcy and then re-converted to a chapter 7. When Debtors initially filed their chapter 7 petition, the U.S. Trustee moved to dismiss Debtors’ case based on the Debtors high income level and their ability to repay creditors. As a result, Debtors elected to convert their case to chapter 11. However, the Debtors were unable to confirm a chapter 11 plan because Mrs. Markosian lost her job. Thus, Debtors re-converted their case to a chapter 7.

Many of the issues discussed in the case arose from the fact that Mr. Markosian received a large bonus from his employer for services that were rendered while the chapter 11 case was pending. The Debtors turned Mr. Markosian’s bonus over to the Trustee, but after re-converting their case to a chapter 7, filed a motion to compel the trustee to return the bonus to them arguing that the post-petition earnings were no longer the property of the estate upon conversion. The bankruptcy court found that the bonus constituted earnings from personal services within the meaning of §1115(a)(2), but concluded that it ceased to be property of the estate upon conversion to chapter 7.
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Published on: September 16, 2014

Chapter 13 Debtors Beware: Post Petition Inheritances in Chapter 13

By Binder Malter Harris & Rome-Banks LLP

In In re Dale, 505 B.R. 8 (B.A.P. 9th Cir. 2014), the BAP held that for purposes of determining what constitutes property of the bankruptcy estate in a Chapter 13 bankruptcy, §1306 of the Bankruptcy Code includes all property described in §541, but expands the 180 day post-filing timeframe of §541(a)(5) [for post-filing property that would have been property of the estate if it was acquired pre-filing] to include all property that the debtor acquires post-filing until the case is closed, dismissed or converted. In other words, §1306 includes property included in §541 but expands the time in which property acquired post petition is considered property of the estate from 180 days post-filing to until the case is closed, dismissed or converted.

Facts:
More than 180 days after Debtors (Robert and Kathy Dale) filed a chapter 13 bankruptcy petition, the mother of one of the two joint Debtors passed away, leaving Mr. Dale approximately $30,000. Nearly 2 months later, Debtors filed a declaration with the bankruptcy court disclosing Mr. Dale’s inheritance. The Chapter 13 trustee demanded that Mr. Dale turn over the inherited funds to the Trustee for distribution to Mr. Dale’s creditors. The Trustee subsequently filed a motion to dismiss Debtors’ bankruptcy for failing to make payments under their proposed plan. Later, the Trustee filed an amended motion to dismiss because: 1) the Debtors’ had failed to comply with the Trustee’s recommendations; 2) the Debtors had failed to disclose and turn over the nonexempt inheritance proceeds; and 3) the Debtors were still delinquent on plan payments. The Debtors argued that their case should not be dismissed because Mr. Dale’s post-petition inheritance was not property of the bankruptcy estate because he received the inheritance rights more than 180 days after filing bankruptcy.

The bankruptcy court held that inheritance received by a chapter 13 debtor before the case is closed, dismissed or converted is property of the bankruptcy estate under §1306. The Debtors timely appealed this holding to the 9th Circuit Bankruptcy Appellate Panel (BAP), which reviewed de novo.
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Published on: August 13, 2013

BAP Finding Affirms that a Spouse does Not need to be Directly Engaged in Fraud to have their Bankruptcy Discharge denied if the Fraudulent Conduct of the other Spouse can be Imputed to them

By Binder Malter Harris & Rome-Banks LLP

In In re: John Shart and Elke Gordon Shardt, an unpublished decision by the United States Bankruptcy Appellate Panel (BAP) for the Ninth Circuit, the BAP affirmed the bankruptcy court’s ruling that chapter 7 co-debtor’s spouse did not directly engage in fraudulent conduct, but remanded the action back to bankruptcy court for consideration and findings as to whether the co-debtor spouse had a partnership or agency relationship with her co-debtor husband such that his fraudulent behavior should be imputed to her for purposes of exception to discharge under §523(a)(2)(4).

Factual Background and Procedural History

Husband entered into various real and personal property transactions with creditors with whom the husband had a personal and business relationship. Creditors sued husband, his wife, and husband’s business in state court.

Husband and wife then filed a chapter 11 bankruptcy, which was converted to a chapter 7 bankruptcy. Creditors filed an adversary proceeding against the husband and wife debtors alleging the debtors: a) made misrepresentations to creditors with the intent to deceive them, b) had engaged in fraud or defalcations as fiduciaries, and c) willfully, maliciously and intentionally injured the creditors and converted their property. The creditors argued that the resulting debt should therefore be excepted from discharge under §523(a)(2)(A), §523(a)(4) and §523 (a)(6). Debtors filed an answer denying the allegations.

The bankruptcy court entered a judgment in favor of creditors against husband and declared that creditors’ claims against wife were discharged. A timely appeal was filed by creditors on September 27, 2012, challenging the part of the judgment holding that the claims against wife were not excepted from discharge.
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Published on: June 18, 2013

United States Supreme Court Protects Innocent Trustees by Holding that “Defalcation” under Bankruptcy Code § 523(a)(4) Requires a Culpable State of Mind

By Binder Malter Harris & Rome-Banks LLP

In Bullock v. Bankchampaign, N.A., 569 U.S. ___ (2013), the United State Supreme Court held that the term “defalcation” in the Bankruptcy Code includes a culpable state of mind requirement involving knowledge of, or gross recklessness in respect to, the improper nature of the fiduciary behavior giving rise to liability.

Factual Background and Procedural History

In 1978, Petitioner’s father established a trust for the benefit of his five children. He made Petitioner the trustee and transferred to the trust a single asset, a life insurance policy. The trust instrument permitted Petitioner, as trustee, to borrow funds from the insurer that issued the life insurance policy against the policy’s value. Initially at his father’s request, and later on his own, Petitioner borrowed money from the trust. All of the money borrowed by Petitioner was repaid with interest.

In 1999, Petitioner’s brothers sued Petitioner in Illinois state court. The state court held that Petitioner had committed a breach of fiduciary duty, stating that Petitioner “does not appear to have had a malicious motive in borrowing the funds from the trust” but was nonetheless “clearly involved in self-dealing.” After Petitioner tried unsuccessfully to liquidate certain assets to make court-ordered payments, Petitioner filed for bankruptcy. BankChampaign, as trustee for the constructive trust imposed by the state court on Petitioner’s assets in order to secure Petitioner’s payment of the judgment against him, opposed Petitioner’s effort to obtain a bankruptcy discharge of his debts to the trust. The bankruptcy court granted summary judgment in BankChampaign’s favor, holding that Petitioner’s debts were non-dischargeable under Bankruptcy Code § 523(a)(4) “as a debt for defalcation while acting in a fiduciary capacity.” The Federal District Court and the Court of Appeals both affirmed, with the Court of Appeals finding that “defalcation requires a known breach of fiduciary duty, such that the conduct can be characterized as objectively reckless.”

Petitioner sought certiorari, asking the Supreme Court to decide whether the bankruptcy term “defalcation” applies “in the absence of any specific finding of ill intent or evidence of an ultimate loss of trust principal.” Noting lower courts’ disagreement over whether “defalcation” includes a scienter (intent) requirement and, if so, what kind of scienter it requires, the Supreme Court granted certiorari.
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Published on: June 4, 2013

Bankruptcy Appellate Panel Affirms Bankruptcy Court’s Finding that ‘Cause’ Existed under Bankruptcy Code Section 707(a) to Dismiss Corporate Contractor’s Chapter 7 Case

By Binder Malter Harris & Rome-Banks LLP

In re: M.P. Construction Company, Inc., an unpublished decision by the United States Bankruptcy Appellate Panel (BAP) for the Ninth Circuit, the BAP affirmed the bankruptcy court’s ruling that ’cause’ existed to dismiss a corporate debtor’s chapter 7 bankruptcy under Bankruptcy Code Section 707(a) and to impose sanctions on debtor and its counsel under Bankruptcy Rule 9011 when the debtor contractor filed a chapter 7 bankruptcy petition to try to enable it to transfer its suspended contractor’s license to a new entity formed and owned by the adult children of debtor’s principals and the debtor was not eligible for a discharge and had no assets to distribute to creditors.

Factual Background and Procedural History

In 2005, the Wongs contracted with debtor contractor, M.P. Construction Company, Inc., to remodel their home. After being paid over $1.6 million for services originally estimated to cost $995,000, debtor sued to collect approximately $75,000 in unpaid invoices. The Wongs countersued. Following a week-long arbitration, a $601,322 judgment was entered in the Superior Court in favor of the Wongs in January 2010. The unsatisfied judgment resulted in debtor’s contractor’s license being suspended by operation of law.

In July 2009, prior to the judgment being entered, a new entity named Avenue 35 Construction Co., Inc. (“Avenue 35”) was incorporated by the three adult children of debtor’s owners, Mario and Ana Piumetti. In August 2009, Avenue 35 acquired debtor’s assets for $120,000. To facilitate this transaction, Mr. Piumetti loaned each child $40,000. The $120,000 paid to debtor was then used to repay undocumented loans that Mr. Piumetti asserted he made to debtor. Mr. Piumetti then attempted to transfer debtor’s contractor’s license to Avenue 35.
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