The Eastern District of Pennsylvania Bankruptcy Conference (EDPABC) is a non-profit organization that was formed in 1988 to promote the education and interests of its members and the citizens of the Commonwealth of Pennsylvania residing in the ten counties within the United States District Court for the Eastern District of Pennsylvania. Members include lawyers, other professionals, and paraprofessionals who specialize in the practice of Bankruptcy and Creditors’ Rights law in the Eastern District of Pennsylvania. Please visit EDPABC’s website, www.pabankruptcy.org, for more information or to join the organization.
Each year, the EDPABC’s Education Committee formulates challenging hypotheticals based on recent case law. At the EDPABC’s Annual Forum, professors from local law schools facilitate lively discussions among EDPABC members about the hypotheticals in small-group breakout sessions. The hypotheticals are always engaging—and sometimes deliberately ambiguous—to mirror the complexity of everyday practice and foster debate among even the most seasoned bankruptcy professionals.
The hypotheticals are accompanied by summaries of the underlying case law and other relevant authorities inspiring the fact patterns. The summaries are intended to give readers insights into how similar issues have been argued before and decided by the courts and to inform their answers to the questions presented in the hypotheticals.
This hypothetical from a previous forum, titled “Dr. Hibbert and Dr. Nick,” describes the highly contentious chapter 11 case of a joint venture formed by the two doctors. Dr. Hibbert filed for the joint venture after escalating disagreements resulted in Dr. Nick (through a family trust) seizing its medical equipment to open a competing practice next door. The hypothetical poses questions relating to the automatic stay, extensions of time under section 108 of the Bankruptcy Code and redemption rights, cause to appoint a chapter 11 trustee, and competing chapter 11 plans.
Dr. Hibbert and Dr. Nick
After completing their respective radiology residency programs, Dr. Hibbert and Dr. Nick open an outpatient imaging center together. The joint business venture is funded by a revolving loan from a traditional bank (the Bank) secured against medical receivables and a purchase money loan from Dr. Nick’s family trust (the Nick Trust) secured by the imaging equipment. The two doctors obtain a single National Provider Identifier (NPI) from the Centers for Medicare and Medicaid Services (CMS).
Several years later, the two doctors have a falling out. Dr. Hibbert accuses Dr. Nick of being a quack physician engaged in dubious patient acquisition and billing practices. Dr. Nick accuses Dr. Hibbert of stealing money from the company, defaming him in front of patients, and sleeping with his spouse.
Dr. Hibbert, who has sole check writing authority over the business’ deposit accounts, opts to fail to make the next payment due to the Nick Trust on the equipment loan. The Nick Trust opts to notice the default, accelerate the loan, and demand payment in full. Dr. Hibbert opts not to fund Dr. Nick’s next payroll check.
The Nick Trust then opts to utilize some self-help of its own. In full compliance with applicable law, the Nick Trust repossesses the imaging equipment and moves it into adjoining medical office space—newly leased by the Nick Trust. Without the imaging equipment, Dr. Hibbert is unable to provide patient services.
Four days later, Dr. Nick announces the grand opening of “Dr. Nick’s Medical Imaging Center.” Dr. Nick begins providing services to patients utilizing the imaging equipment. Dr. Nick also issues reimbursement requests for such services to CMS using the NPI.
Unable to continue to operate, Dr. Hibbert files a voluntary petition for chapter 11 bankruptcy protection on behalf of the joint business venture. Four days later, Debtor’s counsel sends a letter to the Nick Trust demanding the return of the imaging equipment and threatening sanctions for its willful violation of the automatic stay. The Nick family accountant, who solely controls the Nick Trust, ignores the letter.
Debtor’s counsel ultimately files a motion, pursuant to 11 U.S.C. § 542 and 11 U.S.C. § 362(k), seeking turnover of the medical equipment as estate property and sanctions against the Nick Trust. The Nick Trust responds that it lawfully repossessed the imaging equipment prepetition and has only passively retained it since its repossession.
Discovery confirms that the Nick family accountant, (a) repossessed the imaging equipment at the request of Dr. Nick with actual knowledge of Dr. Nick’s retaliatory goal vis-à-vis Dr. Hibbert, but (b) was unaware that Dr. Nick had been using the imaging equipment because Dr. Nick effectively concealed the same from the Nick family accountant.
- Has the Nick Trust willfully violated the automatic stay?
- Citing the Third Circuit’s decision in In re: Denby-Peterson, the bankruptcy court holds that the Nick Trust did not violate the automatic stay willfully because the Nick Trust’s possession of the imaging equipment post petition had been passive. The issue is appealed to the Supreme Court, which grants the writ of certiorari to resolve the circuit split among the Second Circuit, the Third Circuit, and the Tenth Circuit. If you were a Supreme Court Justice, how would you decide the issue?
Assume that the bankruptcy court’s order is not appealed. Instead, new evidence comes to light that the Nick family accountant was aware that Dr. Nick had been using the imaging equipment and, in fact, had worked with Dr. Nick to accomplish his scheme of opening “Dr. Nick’s Medical Imaging Center.” With this new evidence in hand, Dr. Hibbert seeks reconsideration of the bankruptcy court’s order.
In response, the Nick Trust presents a written agreement among Dr. Hibbert, Dr. Nick, and the Nick Trust entitled the “Discounted Repayment Option Contract” (the Agreement). The Agreement provides that Dr. Hibbert will deliver the imaging equipment to the Nick Trust at the adjoining medical office space leased by the Nick Trust.
It further provides Dr. Hibbert and Dr. Nick with the option, but not the obligation, to make a discounted repayment of the equipment loan owed to the Nick Trust in exchange for a return of the imaging equipment. Under the terms of the Agreement, such discounted repayment must occur within seven days of the date of the Agreement.
If such discounted repayment is not timely made, the Agreement provides the Nick Trust with the option, but not the obligation, to retain the imaging equipment in full satisfaction of the equipment loan.
If neither option is exercised, the Nick Trust may pursue its common law rights and remedies. The Agreement is silent as to what the Nick Trust may do with the equipment while in possession of it.
The Nick Trust argues that it did not violate the automatic stay willfully because the debtor did not make the discounted repayment within the seven-day time period. Further, the debtor’s counsel’s demand letter was not sent until after the seven-day time period had expired.
The debtor’s counsel replies that the Agreement provides for a cure period with respect to the payment default under the equipment loan. The debtor’s counsel further argues that the Agreement is analogous to a common law equitable right of redemption. Therefore, 11 U.S.C. § 108(b) extends the time period under which the debtor may make the discounted repayment to the sixtieth day following the petition date. The argument being that the Agreement “fixes a period within which the debtor … may … cure a default, or perform any similar act.”
The Nick Trust sur-replies with the following arguments. Any and all cure rights under the agreement documenting the equipment loan have indisputably expired. Further, a discounted repayment is not a cure, or similar to a right of redemption, because payment in full is not being made.
Moreover, the Agreement is a standalone option contract. Because the Agreement creates options, and not obligations, the debtor is not in default of the Agreement. Because the debtor is not in default of the Agreement, 11 U.S.C. § 108(b) does not apply because there is no default to be cured. Further, the exercise of an option under an option contract is not similar to curing a default under the contract.
- Does 11 U.S.C. § 108(b) extend the deadline under the Agreement by which the debtor must exercise the option to make the discounted repayment?
- Assume that the Agreement did not contain mutual options between the debtor and the Nick Trust. Instead, assume that the Agreement provided the debtor with the unilateral option to make the discounted repayment within the seven-day time period and that, if such discounted repayment was not timely made, the Agreement automatically and immediately terminated. Under these facts, the Nick Trust argues that 11 U.S.C. § 108(b) does not apply because the prerequisite of the existence of “an agreement” is no longer satisfied, i.e., 11 U.S.C. § 108(b) can only be used to extend cure or similar rights under non-terminated agreements. Can 11 U.S.C. § 108(b) be used to extend the post-petition termination of the Agreement?
- Do any of these new facts impact your view as to whether the Nick Trust willfully violated the automatic stay?
The bankruptcy court ultimately orders the Nick Trust to return the imaging equipment to the debtor. With the equipment returned, Dr. Hibbert recommences the debtor’s operations.
Unhappy with the result, Dr. Nick and the Nick Trust pursue a scorched-earth litigation strategy in the bankruptcy case, using their combined equity and secured creditor rights to oppose every motion filed by the debtor, to bring their own motions, and to commence adversary proceedings against the debtor and Dr. Hibbert. Dr. Nick and the Nick Trust make it a point to ensure that every hearing in the case becomes a multiple-day affair. They instruct their counsel to summarily reject any requests made by the debtor, when legally permitted to do so, to be completely unhelpful to the debtor’s counsel, and to approach every issue with a tone of righteous indignation and rancor.
Their strategy results in a few initial victories in the bankruptcy court. As a result, Dr. Hibbert and the debtor’s counsel feel compelled to no longer take the high road and instead fight fire with fire. Thus, Dr. Hibbert and the debtor return the favor by pursuing their own scorched-earth litigation strategy.
Exclusivity under 11 U.S.C. § 1121 expires without the debtor filing a plan. At the first opportunity, the Bank files a proposed plan of liquidation. Dr. Hibbert responds with a competing plan of reorganization. Dr. Nick and the Nick Trust respond with their own competing plan of reorganization.
During the second day of oral argument on the parties’ respective first amended disclosure statements, the bankruptcy court makes the off-hand, somewhat joking comment, “There is so much acrimony among Dr. Hibbert, Dr. Nick, and the Nick Trust that I’m considering the sua sponte appointment of a chapter 11 trustee pursuant to the Third Circuit’s decision in In re Marvel Entertainment Group.”
Dr. Nick and the Nick Trust seize on the comment and the next day file a motion for the appointment of a chapter 11 trustee for “cause” pursuant to 11 U.S.C. § 1104. The sole basis for the motion is the alleged clear and convincing evidence of the “acrimony” among Dr. Hibbert, Dr. Nick, and the Nick Trust, which has risen to a level beyond the healthy conflicts that always inherently exist in bankruptcy cases.
Dr. Hibbert and the debtor oppose the motion, arguing that the level of acrimony in the case is legally insufficient and, in any event, Dr. Nick and the Nick Trust created the acrimony and, therefore, should not obtain relief based on it.
Because the Bank may or may not have properly perfected its security interest in the medical receivables—which issue has so far gone unnoticed because of the focus on the issues among Dr. Hibbert, Dr. Nick, and the Nick Trust—the Bank also summarily opposes the motion.
- If you are representing Dr. Nick and the Nick Trust, how would you present clear and convincing evidence of legally sufficient acrimony to carry your motion?
- If you are representing Dr. Hibbert or the debtor, how do you present evidence of a lack of legally sufficient acrimony to carry your objection to the motion?
- What facts are required to be proven by clear and convincing evidence to establish that the acrimony has risen to a level beyond the healthy conflicts that always inherently exist in bankruptcy cases?
- At the hearing, the Bank concedes that the acrimony among Dr. Hibbert, Dr. Nick, and the Nick Trust has risen to a level beyond the healthy conflicts that always inherently exist in bankruptcy cases. Nevertheless, the Bank argues that the acrimony in the case is legally insufficient for the appointment of a trustee because the appointment of a trustee is not the only effective way to move the case forward. Instead, the Bank argues that because competing plans have been filed, all that is left to do in the case is hold a vote on the plans. Is the Bank’s argument persuasive?
- The bankruptcy court agrees with the Bank and does not appoint a chapter 11 trustee. As a result, the Bank’s proposed plan of liquidation is confirmed. Given that an independent, undistracted fiduciary may have uncovered the potential issues with the Bank’s security interest, has the case nevertheless reached an acceptable result?
List of Authorities for Question #1
11 U.S.C. § 542
(a) Except as provided in subsection (c) or (d) of this section, an entity, other than a custodian, in possession, custody, or control, during the case, of property that the trustee may use, sell, or lease under section 363 of this title, or that the debtor may exempt under section 522 of this title, shall deliver to the trustee, and account for, such property or the value of such property, unless such property is of inconsequential value or benefit to the estate.
(b) Except as provided in section 362(a)(7) of this title, an entity that has neither actual notice nor actual knowledge of the commencement of the case concerning the debtor may transfer property of the estate, or pay a debt owing to the debtor, in good faith and other than in the manner specified in subsection (d) of this section, to an entity other than the trustee, with the same effect as to the entity making such transfer or payment as if the case under this title concerning the debtor had not been commenced.
(e) Subject to any applicable privilege, after notice and a hearing, the court may order an attorney, accountant, or other person that holds recorded information, including books, documents, records, and papers, relating to the debtor’s property or financial affairs, to turn over or disclose such recorded information to the trustee
11 U.S.C. § 362
(a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities, of—
(2) the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the case under this title;
(3) any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate;
(4) any act to create, perfect, or enforce any lien against property of the estate;
(1) Except as provided in paragraph (2), an individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.
(2) If such violation is based on an action taken by an entity in the good faith belief that subsection (h) applies to the debtor, the recovery under paragraph (1) of this subsection against such entity shall be limited to actual damages.
In re Denby-Peterson, 941 F.3d 115 (3d Cir. 2019)
Ms. Denby-Peterson purchased a Chevrolet Corvette, which was repossessed pre-petition by secured creditors following a payment default. Ms. Denby-Peterson subsequently filed for chapter 13 bankruptcy in the Bankruptcy Court for the District of New Jersey (the Bankruptcy Court). Denby-Peterson notified the secured creditors of her bankruptcy filing and demanded they return the Corvette. The creditors refused, prompting Denby-Peterson to file motions for turnover of estate property pursuant to 11 U.S.C. § 542 and for sanctions for willful violation of the automatic stay under 11 U.S.C. § 362(k).
The Bankruptcy Court held a hearing on these matters, granting the motion for turnover but denying the motion for sanctions. The sanctions motion was denied on the basis that there could be no willful violation of the stay absent violation of the turnover order, which obviously had yet to occur. Denby-Peterson appealed the denial of the sanctions motion, but the U.S. District Court for the District of New Jersey (the District Court) upheld the Bankruptcy Court’s rulings. Denby-Peterson then appealed once again, this time to the U.S. Court of Appeals for the Third Circuit (the Court).
The Court was confronted with the question of whether passive retention of collateral seized pre-petition constituted a “willful violation” of the automatic stay. The Court answered this question in the negative and therefore upheld the District Court’s ruling affirming the Bankruptcy Court. The Court looked to the obligations governing turnover of collateral in 11 U.S.C. §§ 362 and 542 and found that these obligations were not “self effectuating.” While the turnover provision of § 542 is mandatory, the Court noted that it is not automatic—certain statutory conditions must be met to trigger the turnover obligations, e.g. 11 U.S.C. § 542(a). To allow a debtor to demand turnover absent fulfillment of these statutory conditions would be to allow the stripping of a creditor’s property without due process. Rather than approve Denby-Peterson’s self-effectuating interpretation of § 542 turnover, the Court instead held that the turnover provisions do not take effect until they are empowered by judicial order.
Turning to 11 U.S.C. § 362(k), the Court found that retention of property seized pre-petition did not constitute the necessary “exercise of control” to give rise to sanctions. Looking to the statutory language, the Court concluded that “exercise of control” requires an affirmative act on the part of the party accused of violating the stay. The Court held that mere passive retention of property already in a party’s possession did not rise to the level of an affirmative act. Without such an affirmative act, there was no “exercise of control,” and without that, there could be liability under § 362(k). To button the issue up, the Court referenced the Supreme Court’s decision in Maryland v. Strumpf, 516 U.S. 16 (1995), which allowed a bank to freeze and retain a debtor’s assets without violating the stay. The Court found that this ruling would not be reconcilable with a requirement that turnover of assets be automatic and self-effectuating.
Weber v. SEFCU (In re Weber), 719 F.3d 72 (2d Cir. 2013)
This case concerned a secured creditor (Creditor) seizing a debtor’s vehicle pre-petition owing to payment default. Debtor subsequently filed for chapter 13 bankruptcy in the Bankruptcy Court for the Northern District of New York (the Bankruptcy Court), of which Creditor was aware. Creditor nonetheless failed to return possession of Debtor’s vehicle after becoming aware of its bankruptcy petition. Debtor subsequently filed an adversary proceeding requesting turnover of the vehicle under 11 U.S.C. § 542 and sanctions pursuant to 11 U.S.C. § 362(k). Creditor returned the vehicle following the adversary action, but maintained that it could not be liable for sanctions under § 362(k) as it had not been holding the vehicle in violation of any turnover order. This understanding had previously been articulated by the U.S. District Court for the Northern District of New York (the District Court) in the case of Manufacturers & Traders Trust Co. v. Alberto (In re Alberto), 271 B.R. 223 (N.D.N.Y. 2001). The Bankruptcy Court determined that Creditor was in compliance with Alberto, and therefore could not be subject to sanctions under § 362(k).
Debtor appealed that decision to the District Court, which overturned its earlier Alberto decision. Relying primarily on the Supreme Court case of United States v. Whiting Pools, Inc., 462 U.S. 198 (1983), the District Court found that Creditor had been required to return the vehicle as soon as it was aware of the bankruptcy filing. To retain control over the vehicle was “exercising control” over it in violation of § 362, meaning that Creditor was liable for sanctions under § 362(k). Creditor subsequently appealed the District Court’s decision to the U.S. Court of Appeals for the Second Circuit (the Court).
The Court first determined that the text of 11 U.S.C. §§ 541 and 542 required that all of the assets of a debtor’s estate be returned to the debtor at the filing of a bankruptcy case; doing so was necessary to build and administer the estate. Citing heavily to Whiting Pools, the Court found that retaining property of the estate that was repossessed pre-petition effectively deprives the estate of that property. To avoid this, a creditor must return any estate property to the debtor at the filing of the estate. Doing so does not surrender the creditor’s interest in the property; it is merely a surrender of physical possession.
The Court next turned to the question of whether the turnover provision was “self-effectuating,” or, as the Alberto court had held, was only implicated upon entry of an order for turnover. The Court found that, by the language of § 541 detailing what constituted “property of the estate,” any property in which the debtor had an interest held by anyone anywhere at the time of the filing becomes property of the estate. The Court reasoned that this would be incompatible with the Alberto court’s ruling that turnover is not self-effectuating. By retaining control of the vehicle, Creditor had been “exercising control” over it; no affirmative act was necessary, as the property was unquestionably estate property which was in Creditor’s control. To retain control of estate property after the filing of the petition was a violation of the automatic stay.
The Court last addressed whether Creditor could still be liable for sanctions under 11 U.S.C. § 362(k) despite its reliance on the precedent of Alberto. Considering the question of whether the stay violation was “willful,” the Court determined that nothing prevented Creditor from surrendering Debtor’s vehicle at the time Debtor requested. Creditor simply chose to retain possession of the vehicle because it felt case law entitled it to do so. The “willful” in 11 U.S.C. § 362(k), according to the Court, meant only that the stay violation was a voluntary act. The Court did not read any specific intent requirement into § 362(k). Given that Creditor chose to retain the vehicle—and unwittingly violate the stay—of its own free will, the violation was “willful” under § 362(k) and the Creditor was liable for damages.
WD Equip., LLC v. Cowen (In re Cowen), 849 F.3d 943 (10th Cir. 2017)
Jared Cowen (Debtor) owned two commercial trucks, both of which were repossessed under questionable and possibly fraudulent circumstances. Debtor filed a chapter 13 petition in the Bankruptcy Court for the District of Colorado (the Bankruptcy Court) and demanded the creditors return his two trucks. Both creditors refused; one claimed that he had transferred legal title of the truck over to his own name pre-petition, and the other claimed that the truck had been sold to an unknown Mexican national for cash in an undocumented sale, though a bill of sale was later produced. Debtor filed a motion for sanctions for willful violation of the automatic stay owing to both creditors’ failure to turn over the trucks, which he alleged were property of his bankruptcy estate. The Bankruptcy Court agreed with Debtor, finding that the documentation showing that his legal interest in both trucks had been forged, the failure to return the trucks violated 11 U.S.C. § 362(a)(3), and awarding damages pursuant to 11 U.S.C. § 362(k). That order was substantively affirmed on appeal to the U.S. District Court for the District of Colorado (the District Court). The creditors thereafter appealed to the U.S. Court of Appeals for the Tenth Circuit (the Court), arguing that their retention of the trucks, or proceeds of the trucks, did not constitute an “act” to “exercise control of” estate property, as the trucks were seized pre-petition.
The question before the Court was whether the passive retention of estate property seized pre-petition constitutes a violation of the automatic stay after notice of a bankruptcy filing. The Court noted that the Bankruptcy Court and the District Court seemingly subscribed to the “majority view” of this question, which holds that such activity is a violation of the automatic stay. In reversing the District Court, the Court held that the majority view took a policy-driven approach not supported by the text of the Bankruptcy Code. The Court put particular emphasis on the word “act” in 11 U.S.C. 362(a)(3): “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” The Court reasoned that the requirement that there be an “act” meant that an affirmative post-petition action on the part of the creditor was necessary to incur liability for a stay violation. Mere passive retention of property seized pre-petition did not rise to that level. The Court further elaborated that the majority view’s reliance on reading § 362(a)(3) in conjunction with 11 U.S.C. § 542 also was unsupported by the text, as the two provisions had no intertextual connection. The Court expressed its belief that if Congress had intended to add an affirmative obligation of turnover to the automatic stay provisions of 11 U.S.C. § 362(a)(3), it would have done so explicitly; Congress does not “hide elephants in mouseholes.” The Court finished by noting that its holding did not absolve the creditors of liability under § 362(k), as their fraudulent acts taken to effect and conceal their repossession of the estate property constituted “acts” within the scope of 11 U.S.C. § 362(a)(3).