On February 21, 2007, the US Supreme Court issued its decision in Marrama v. Citizens Bank of Massachusetts, et al., 549 US ___ (2007). The Court held that Chapter 7 debtors do not have the absolute right to convert their case to Chapter 13. Therefore, the involved Chapter 7 debtor who acted in bad faith by making a number of misleading or inaccurate statements in his bankruptcy schedules lost his right to proceed under Chapter 13. Section 706(a) provides that a Chapter 7 debtor “may convert a case under this chapter to a case under chapter 11, 12, or 13 of this title at any time, if the case has not been converted under section 1112, 1208, or 1307 of this title.” The debtor argued that this section provided him the one-time absolute right of conversion. The Court reviewed section 706(d) which provides a limitation on the right to convert. Section 706(d) provides that “a case may not be converted to a case under another chapter of this title unless the debtor may be a debtor under such chapter.” The Court concluded that a debtor who acted in bad faith does not qualify as a “debtor” under Chapter 13. Section 1307 (c) provides that a Chapter 13 case may be dismissed or converted to Chapter 7 “for cause” and that bad faith conduct is routinely treated as “for cause”. The Court held that the equitable power of the bankruptcy court to take any action necessary or appropriate to prevent an abuse of process as set forth in Section 105(a) as well as the Court’s inherent authority to sanction abusive litigation practices provided justification for denial of a motion to convert under section 706.
Archive for February, 2007
US Supreme Court Decision in Marrama v. Citizens Bank of Mass., et al.
February 21, 2007Federal Taxation of Individual Chapter 11 Debtor
February 17, 2007The IRS released Internal Revenue Bulletin 2006-40, Notice 2006-83 on October 2, 2006 to provide guidance to individuals filing bankruptcy under Chapter 11 on or after October 17, 2005. It further provides guidance for the employers of these individuals, persons filing Forms W-2, 1099 or other information returns that report payment to these individuals, and Chapter 11 trustees in cases filed by an individual.
The bankruptcy estate of an individual who files under Chapter 11 is a separate taxable entity under section 1398 of the Internal Revenue Code. In general, the estate, rather than the individual, must include in its gross income all of the debtor’s income to which the estate is entitled under the Bankruptcy Code. As a result of the enactment of section 1115 of the Bankruptcy Code by BAPCPA, the bankruptcy estate rather than the individual must include in its gross income both 1. the debtor’s gross earnings from post-petition services and 2. the gross income from post-petition acquired property. IRC Section 1398(e)(1).
Because the bankruptcy estate is a separate taxable entity, the trustee or debtor in possession must obtain an employer identification number for the estate and use it on any tax returns filed for the estate.
The individual must continue to file his own individual tax returns during the bankruptcy proceedings. IRC Section 6012(a)(1). The trustee or debtor in possession must prepare and file the income tax returns of the bankruptcy estate if required under IRC Section 6012(a)(9).
Although post-petition wages earned by a debtor are generally treated for income tax purposes as gross income of the estate rather than the individual, the reporting and withholding obligations of a debtor’s employer however have not changed as a result of the enactment of section 1115 of the Bankruptcy Code. Section 1115 has no effect on the determination of wages under FICA, FUTA, or for income tax withholding purposes. See IRC Section 3306(b) and 3401(a). An employer should continue to reflect such wages and accompanying tax withholding on a Form W-2 issued to the debtor under the debtor’s name and social security number.
The Single Satisfaction Rule
February 16, 2007The 11th Circuit Court of Appeals recently issued a decision in the case of In re Prudential of Florida Leasing, Inc., ___ F.3d ___, 2007 WL 445368 (11th Cir. (Fla.)) involving the “single satisfaction rule”. In general, the single satisfaction rule prevents one from recovering twice for the same damages. See, e.g. Fla. Stat. Section 46.015 (2).
The 11th Circuit held that federal rule of common law would be used in interpreting the “single satisfaction” rule of avoided transfers. It reversed the decisions of the bankruptcy court and the district court and held that the federal rule of common law, rather than state law, would be used in interpreting 11 USC 550(d) which bars a trustee from taking more than a “single satisfaction” on account of the same avoided transfer.
The Court reasoned that a uniform rule of federal law was preferable because the rule of single satisfaction concerned the judicial process as opposed to a substantive matter and that state law ordinarily does not govern the procedures of federal courts. Furthermore, applying state law -here Florida which erred on the side of preventing a single satisfaction – had the potential to frustrate the purposes of the Bankruptcy Code. The Court also reasoned that applying a uniform rule of federal law would not disturb any pre-existing commercial expectations predicated on state law, and was supported by a textual analysis of the Code
The Two Schools of Thought Construe BAPCPA
February 14, 2007The Court in In re Grydzuk, 353 B.R. 564 (Bankr.N.D.Ind. 2006) submitted that there are two major schools of thought now prominent among bankruptcy scholars and bankruptcy judges as to the manner in which the BAPCPA is to be construed.
The first school of thought is the “literalist” movement which holds that “it says what is says it says” even though if it does not make any sense. Under the literalist movement, the law must be construed in strict accordance with the statutory language.
The other school of thought is the “common sense” approach which accepts the fact that the BAPCPA in many instances makes no sense whatsoever and that it must be construed against the background of what it is presumed the drafters intended to change from the prior law.
Passive Homestead Appreciation Not Subject to $125,000.00 Cap
February 14, 2007Bankruptcy Judge K. Rodney May from the Middle District of Florida recently held that the equity passively resulting from market appreciation is not to be counted towards the $125,000.00 cap placed by 11 USC 522 (p) on a homestead exemption for property “acquired” during the 1,215 prepetition period. In re Chouinard, 2006 WL 3873437 (Bankr. M.D. Fla.). The Court followed the holding of In re Rasmussen, 349 B.R. 747 (Bankr. M.D. Fla. 2006) that passive market appreciation is not an interest that a debtor “acquired” during the 1,215 period. See also In re Sainlar, 344 B.R. 669 (Bankr. M.D. Fla. 2006).
The Court further pointed out that there was nothing in the record that indicated that the debtors actively increased their equity by anything other than scheduled mortgage amortization payments. The regularly scheduled mortgage payments increased the debtors’ equity only nominally. The rest of the increased equity was from market appreciation.
The Court was not required to reach the debtors’ argument that they were entitled to each to a $125,000.00 cap for a total cap of $250,000.00, ie. similar to “exemption stacking”, but noted that it found persuasive the holding in Rasmussen that each joint debtor is eligible to take the $125,000.00 amount for a total of $250,000.00 pursuant to 11 USC 522 (m) which provides that section 522 shall apply separately with respect to each debtor in a joint case.
Florida Bankruptcy Filing, Maryland Exemptions, Real Property Exempt under Florida Tenants by Entireties Law
February 13, 2007The January 30, 2007 case of In re Schwarz, __ B.R. ___, 2007 WL 247649 (Bankr. SD Fla. Olson) held certain real property as exempt from administration in the estate under 11 USC 522 (b)(3)(B) which allows for the exemption of any interest in property which the debtor held as tenants by the entireties to the extent that it is exempt from process under applicable nonbankruptcy law.
In this case, the debtor was unable to exempt his real property under the Florida homestead provision of Art. X Section 4 (a)(1) of the Florida Constitution as the new provisions of BAPCPA of 11 USC 522 (b)(3) required the debtor to use the Maryland exemptions as the debtor had not been a domiciliary of Florida for the entire 730 day period prior to filing of the bankruptcy case. The parties agreed that Maryland does not provide for a specific homestead exemption. Nonetheless, the debtor was able to exempt his entire interest in the real property in Florida as he held it as tenants by the entireties on the date of filing pursuant to section 522 (b)(3)(B).
It is significant that the Court looked to Florida tenants by the entireties law as the “applicable nonbankruptcy law” for such determination and not Maryland law.
Property held by a debtor in a tenancy by the entireties is exempt from the claims of individual creditors in bankruptcy under Florida common law with certain exceptions for joint creditors or fraudulent conveyances. In this case, there were no joint creditors nor any indication of a fraudulent conveyance.
Interestingly enough, section 522 (b)(3)(B) does not require the debtor to be residing in the property on the date of filing, but only requires that the debtor hold an interest in the property as a tenant by the entireties immediately before the commencement of the case. In this case, the debtor did not move into the property until after the filing of the case but held an interest in the property as a tenant by the entireties before the commencement of the case.
11th Circuit Court of Appeals Throws in its Fifty Cents in Case Involving Rejection of Rap Singer’s Executory Contract
February 8, 2007The 11th Circuit Court of Appeal recently issued its decision in the case of Thompkins v. Lil’ Joe Records, Inc. et al., ___ F.3d ___, 2007 WL 316302 (11th Cir. 2007). The resolution of the case hinged on the effect of the previous rejection of certain executory contracts.
In this case, a recording company previously rejected its contract with a rap star to purchase certain copyrights from him while it was in chapter 11. The confirmed chapter 11 plan ordered that all contracts between the parties be rejected and that the copyrights be sold to a rival recording company. Years later, the rapper brought suit claiming inter alia that he was still the owner of the copyrights due to the previous rejection of the executory contract.
The 11th Circuit affirmed the District Court’s decision in the recording studio and its assignees favor. It held that the rejection of the transfer agreement of the copyright as an executory contract to the debtor in possession did not cause the ownership of the copyrights to revert to the rap artist. Therefore, the copyrights properly passed into the recording company’s bankruptcy estate and from there were legally sold and assigned to a rival recording company.
The 11th Circuit rejected the argument that the rejection of an executory contract is the functional equivalent of a contract rescission which would render the contract void and put the parties back into the positions they occupied before the contract was formed. The Court explained that section 365 of the bankruptcy code ordinarily deems the rejection of an executory contract to be “a breach of such contract…immediately before the date of the filing of the [bankruptcy] case” and that while it is true that a debtor must either assume or reject an executory contract in its entirety, that rejection of a contract does make the contract disappear–it merely frees the estate from the obligation to perform. The rejection of a contract has absolutely no effect upon a contract’s continued existence–the contract is not cancelled, repudiated, rescinded, or in any other fashion terminated.
The Court further observed that that the rejection of an executory contract affects the unperformed portion of an executory agreement differently from those provisions of the agreement that by their nature are fully executed. Section 365 addresses only future performance obligations of the parties and does not have any impact upon the executed portions of a contract.
In the case herein, the transfer of the copyrights to the debtor in possession was fully executed and they did not revert to the transferor as a result of the rejection of the executory contract. The rejection only freed the debtor in possession from its future obligations and allowed the other party a pre-petition claim for damages resulting from the breach. In short, the rejection had no effect on the now former debtor in possession ’s ownership of the copyrights.
Fifth Amendment Privilege During a Deposition in Aid of Execution
February 4, 2007The Florida 2nd District Court of Appeals recently reviewed the nature of the 5th Amendment’s privilege against self-incrimination in the context of a deposition in aid of execution in the case of De Leo v. Wachovia Bank, NA, 32 Fla. L. Weekly D 226 (2nd DCA 2007). The Court held that the debtor was entitled to invoke the Fifth Amendment privilege if he has reasonable grounds to believe that his answers would provide a link in the chain of evidence needed to prove a crime against him.
L’audace, l’audace, toujours l’audace
February 2, 2007One can brush up on their French by reading the recent decision of the Florida 3rd District Court of Appeals in the case of Klein vs. Joel Robbins, 32 FLW 237 (3rd DCA 2007). At issue was whether the home involved was “substantially completed” on the January 1st of the year and thereby taxable per Fla. Stat. 192.042 (1). The Trial Court entered a summary judgment in favor of the Property Appraiser. The 3rd DCA reversed on the Mc Queen case’s standard for denial of a summary judgment which denies a summary judgment were “even the slightest doubt exists regarding the existence of material issues.”
In arguing for the upholding its victory by summary judgment at the Trial Court level, the Property Appraiser’s Counsel suggested that a more “modern” standard for summary judgment should be adopted and cited his own Florida Bar Journal article for the proposition!
For this faux pas, the Court stated it was “a bit audacious to cite oneself” but mused that Frederick the Great* recommended “L’audace, l’audace, toujours l’audace” (Audacity, audacity, always audacity.)
*Frederick the Great (1712-1786) a/k/a Frederick II of Prussian a/k/a Freidrich der Grosse
