Av104497 Bankruptcy Litigation

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BANKRUPTCY LITIGATION:

NEW DEVELOPMENTS AND STRATEGIES

WEST LEGAL ED CENTER WEBCAST

MARCH 30, 2010

Speakers:

The Honorable Sheri BluebondUnited States Bankruptcy Court - Central District of California

Howard J. Steinberg, Esq.Irell & Manella LLP

1800 Avenue of the StarsSuite 900

Los Angeles, California 90067

Program materials prepared by Howard J. Steinberg. The program materials are anadaptation of a small portion of materials included in the upcoming annual supplement to

the treatise, Steinberg, Bankruptcy Litigation (West).



TABLE OF CONTENTS

Page

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I. Pleading Requirements in Light of Twombly and Iqbal ............................................ 2

II. Pleading Requirements for Proof of Claims .............................................................. 7

III. Inadvertent Implied Consent to Bankruptcy Court Jurisdiction .............................. 10

IV. Loss of Jury Trial Rights through Assertion of Affirmative Defenses .................... 12

V. Developments in Venue Issues ................................................................................ 13

VI. Utilizing a Prepetition Injunction to Foreclose Bankruptcy Options ...................... 14

VII. Rule Change Affecting Expert Discovery ............................................................... 15

VIII. Backdoor Use of Plan Provisions and Court Orders to Circumvent AdversaryProceedings and Contested Matters ......................................................................... 16

IX. Recent Daubert Challenge ....................................................................................... 19

X. Recent Ponzi Rulings ............................................................................................... 22



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I. Pleading Requirements in Light of Twombly and Iqbal

FRCP 8(a)(2), made applicable to adversary proceeding by Bankruptcy Rule 7008,

requires “a short and plain statement of the claim showing that the pleader is entitled to

relief.” In Bell Atlantic Corp. v. Twombly,1 the Supreme Court overturned a prior pleading

standard stated in its 1957 decision in Conley v. Gibson,2

that “a complaint should not be

dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can

prove no set of facts in support of his claim which would entitle him to relief.” The Court in

Twombly noted that the problem was not that the pleadings were insufficiently specific.

Instead, the problem was that the pleadings did not allege sufficient facts to state a claim that

was plausible on its face. Twombly held that a complaint that merely states the legal theory

of the claim is not sufficient. 3 The Court stated that “[w]hile a complaint attacked by a Rule

12(b)(6) motion to dismiss does not need detailed factual allegations, a plaintiff’s obligation

to provide the ‘grounds’ of his ‘entitle[ment] to relief’ requires more than labels and

conclusions, and a formulaic recitation of the elements of a cause of action will not do.”

4

To survive a motion to dismiss, a complaint’s “[f]actual allegations must be enough to raise

a right to relief above the speculative level.” 5

In Ashcroft v. Iqbal6, the Court confirmed that the “plausibility standard”

expounded in its 2007 decision in Bell Atlantic Corp. v. Twombly, is not limited to pleadings

1 Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 577 (2007).2 Conley v. Gibson, 355 U.S. 41 (1957).

3 550 U.S. at 561.

4 Id. at 545 (quoting Conley v. Gibson, 355 U.S. 41, 47 (1957)).

5 Id. at 555.

6 Ashcroft v. Iqbal, 556 U.S. ___, 129 S.Ct. 1937 (2009).



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in an antitrust complaint and instead applies to “all civil actions.” The Court explained that

two principles should guide a district court when assessing a motion to dismiss:

1. Conclusions are not well-pleaded facts: Although a court must accept as true allallegations in the complaint, the court must not accept as true mere legal conclusionsor conclusory statements.

2. The plausibility standard: A complaint must state a plausible, not merely possible orconceivable, claim for relief. The allegations must create more than a sheerpossibility that a defendant has acted unlawfully. A complaint that alleges facts thatare merely consistent with liability is not sufficient.

7

In keeping with these principles, the Court suggested the following analyticalprocess:

a. Begin by identifying pleadings that are mere conclusions, which are notentitled to the assumption of truth.

b. Assume true any remaining well-pleaded factual allegations.

c. Determine whether the remaining well-pleaded factual allegations give rise toan entitlement to relief. 8

This is a context-specific task that requires the reviewing court to rely on its judicial

experience and common sense.9

These holdings have generated a number of decisions concerning the sufficiency of

pleadings in adversary proceedings. The holdings are at times inconsistent, and raise

questions as to what degree of facts provides sufficient specificity to support a claim for

relief. What is clear is that a common practice of merely parroting the legal elements of a

claim is not sufficient. A number of courts have granted motions to dismiss complaints

7 129 S.Ct. at 1949.8 129 S.Ct. at 1951-52.9 129 S.Ct. at 1950.



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suffering from this malady in a variety of contexts, including claims for relief asserting

preference, 10 fraudulent transfer, 11 and nondischargeability claims. 12 There are divergent

opinions as to what level of detail is required when identifying transfers that a trustee may

seek to avoid. Even before Twombly and Iqbal, some courts held that, among other things,

each alleged transfer must be alleged by (i) date; (ii) name of debtor; (iii) name of

transferee; and (iv) amount of transfer. 13 Some courts hold that in light of Twombly and

Iqbal, this is the proper pleading standard. 14 Others reject this reasoning and hold that this

level of specificity is not required to satisfy FRCP 8 pleading requirements.15

Thus, a court

concluded that the identity of each property transferred need not be identified.16 In the

preference context, a number of courts have held that the nature and amount of each

antecedent debt must be alleged. 17

Uncertainty with respect to pleading requirements is pervasive with respect to other

elements of avoiding action claims. Some recent cases have held that alleging that a transfer

was made while the debtor was insolvent is conclusory, and that information must be

10 In re Caremerica, Inc., 409 B.R. 737 (Bankr. E.D.N.C. 2009) (preference); In re

Hydrogen, LLC, 431 B.R. 337 (Bankr. S.D.N.Y. 2010) (preference and fraudulent transfer).11

In re Aphton Corp., 423 B.R. 76 (Bankr. D. Del. 2010).12 In re Vanarthos, 440 B.R. 67, 71 (Bankr. S.D.N.Y. 2010) (§523(a)(2)(A) claim);

In re Munson, __ B.R. __, 2011 WL 845846 (Bankr. C.D. Cal. 2011) (§523(a)(2)(A) claim); In re Fairgrieves, 426 B.R. 748, 758 (Bankr. N.D. Ill. 2010) (§523(a)(6) claim).

13 In re Valley Media, Inc., 288 B.R. 189 (Bankr. D. Del. 2003).14 In re Caremerica, 409 B.R. 737, 753 n. 2 (Bankr. E.D.N.C. 2009).15 In re NM Holdings Co., Inc., 407 B.R. 232, 256-57 (Bankr. E.D. Mich. 2009); In

re C.R. Stone Concrete Contractors, Inc., 434 B.R. 208, 221 (Bankr. D. Mass. 2010).16 In re Saba Enterprises, Inc., 421 B.R. 626, 646 (Bankr. S.D.N.Y. 2009).17 In re Caremerica, 409 B.R. 737, 751 (Bankr. E.D.N.C. 2009); In re McLaughlin,

415 B.R. 23, 27 (Bankr. D.N.H. 2009); In re Hydrogen, LLC, 431 B.R. 337, 353 (Bankr.S.D.N.Y. 2010).



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provided to demonstrate a negative net worth and inability to meet maturing obligations. 18

In contrast, a court has held that alleging that liabilities exceed assets is sufficient. 19 There

are also holdings prior to Twombly and Iqbal that take a contrary view.20

Whether they

remain good law remains to be seen.

A court has also held that to sufficiently plead that the recipient of an alleged

preference received more than what the creditor would have received in a Chapter 7 case if

the transfer had not been made, a mere recitation to that effect does not suffice. The

allegations were sufficient where there was a summary of the debtor’s schedules reflecting

that liabilities were far greater than assets. 21

Where constructive fraudulent transfer claims have been alleged, some courts have

held that the complaint must identify the consideration received by each transferor,

information why the value was less than the amount transferred, and facts supporting the

debtor’s insolvency at the time of the transfer.22

A number of courts have held post Twombly and Iqbal that, consistent with decisions

rendered prior to these holdings, a trustee can be held to a more relaxed standard of pleading

when pleading fraud under FRCP 9(b). 23 These decisions do not address the court’s

statement in Iqbal that:

18 In re Caremerica, 409 B.R. 737, 752 (Bankr. E.D.N.C. 2009); In re Aphton Corp.,

423 B.R. 76, 92 (Bankr. D. Del. 2010) (insolvency adequately pled where copy of 10-Kattached to complaint).

19 In re Saba Enterprises, Inc., 421 B.R. 626, 647 (Bankr. S.D.N.Y. 2009).20 Zahn v. Yucaipa Capital Fund, 218 B.R. 656, 674 n. 28 (D. R.I. 1998).21 In re Caremerica, 409 B.R. 737, 754 (Bankr. E.D.N.C. 2009).22 In re Caremerica, 409 B.R. 737, 755 (Bankr. E.D.N.C. 2009).23

In re Caremerica, 409 B.R. 737, 755 (Bankr. E.D.N.C. 2009); In re Saba

Enterprises, Inc., 421 B.R. 626, 640 (Bankr. S.D.N.Y. 2009).



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Rule 9 merely excuses a party from pleading discriminatory intentunder an elevated pleading standard. It does not give him license toevade the less-rigid though still operative-strictures of Rule 8. 24

Thus, in one decision where a court finds lack of specificity with respect to a preference

claim, it nonetheless held the complaint sufficient on an intentional fraudulent transfer claim

where the plaintiff merely alleged that the debtor transferred funds into the name of a non-

debtor entity for the purpose of hindering creditors from attaching the debtor’s bank

accounts.25

Bankruptcy Rule 7009 adopts FRCP 9, and there is no carve out for trustees

with respect to pleading requirements.

It is not uncommon for avoiding action and nondischargeability complaints to be

filed close to the date when a statute of limitations is looming. While a motion to dismiss

may be granted with leave to file an amended complaint, amendments are not allowed where

new factual allegations are needed to support the legal theories in the amended complaint

where the claims would otherwise be time barred. 26 Given the uncertainties with respect to

the degree of specificity required in pleading claims, a litigant, relying upon the Twombly

and Iqbal standards, should consider filing a motion to dismiss to take advantage of pleading

deficiencies to bar a trustee’s claims.

24 Ashcroft v. Iqbal, 556 U.S. ___, 129 S.Ct. 1937, 1954 (2009).25 In re Caremerica, Inc., 409 B.R. 737, 755 (Bankr. E.D.N.C. 2009).26 In re Bellanca Aircraft Corp., 850 F.2d 1275, 1283 (8th Cir. 1988); In re Damrill,

232 B.R. 767, 773 (Bankr. W.D. Mo. 1999).



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II. Pleading Requirements for Proof of Claims

The Bankruptcy Code is silent with respect to the degree of specificity that must be

contained within a proof of claim. There is limited guidance on this issue in the Bankruptcy

Rules. Bankruptcy Rules 3001(a) provides:

A proof of claim is a written statement setting forth a creditor’s claim.A proof of claim shall conform substantially to the appropriate OfficialForm.

Official Form 10 is perfunctory and has, among other things, spaces to be filled in

for the amount; basis of the claim; and a description of collateral if a secured claim is filed.

Bankruptcy Rule 3001(c) says that if a claim is based on a writing, an original or duplicate

of the writing should be filed with the claim unless the writing has been lost or destroyed;

when filing a secured claim, Bankruptcy Rule 3001(d) requires the filing of evidence of the

perfection of the security interest. Beyond this, no further guidance is provided in the

Bankruptcy Rules.

A number of courts have held that a proof of claim must satisfy FRCP Rule 8

pleading requirements.

1

One court has gone further and held that FRCP Rule 9(b) standards

must be satisfied when fraud is alleged. 2 Another court has differed, holding that FRCP

Rule 9(b) standards need not be satisfied for a proof of claim asserting fraud claims, but said

that such claims must satisfy FRCP Rule 8 standards. 3 In contrast to these decisions,

several courts have held that FRCP Rule 8 standards do not apply to proof of claims. 4

1 In re DJK Residential, LLC, 416 B.R. 100, 106-07 (Bankr. S.D.N.Y. 2009); In re

Rockefeller Center Properties, 272 B.R. 524, 542 (Bankr. S.D.N.Y. 2000) (analogizes Form10 to FRCP Rule 8(a)(2)).

2 In re DJK Residential, LLC, 416 B.R. 100, 106-07 (Bankr. S.D.N.Y. 2009). 3 In re O’Malley, 252 B.R. 451, 456 (Bankr. N.D. Ill. 1999).4 See, e.g., Matter of Rimsat, Ltd., 223 B.R. 345, 348 (Bankr. N.D. Ind. 1998).



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There are certainly grounds to argue that FRCP Rule 8 pleading requirements are not

applicable. Unless a proof of claim is coupled with a demand for relief under Bankruptcy

Rule 7001, an objection to claim gives rise to a contested matter.5

Contested matters are

governed by Bankruptcy Rule 9014. Under Bankruptcy Rule 9014(c), a number of the rules

in Part VII are made applicable and Bankruptcy Rule 7008 is not among them; however,

Bankruptcy Rule 7009 is made applicable. Thus, there are grounds to argue that FRCP Rule

9(b) standards must be satisfied if a proof of claim is based upon fraud.

The difficulties regarding pleading standards can raise serious problems for a

creditor’s counsel. Objections to claims are typically not filed until after the claims bar date.

If there is an inadequate factual description of the claim, the creditor may be foreclosed from

amending the claim. The Bankruptcy Code and Bankruptcy Rules do not address the

circumstances under which a proof of claim can be amended. 6 While FRCP Rule 15

addresses amendments to pleadings, it is not applicable to contested matters unless the court

directs that it be made applicable. 7 Nonetheless, many courts have either applied FRCP

Rule 15 by analogy or explicitly when addressing the propriety of a proposed amended

claim. 8 In the adversary proceeding context, proposed amendments after the statute of

limitations have expired have not been allowed where new factual allegations are needed to

support the legal theories advanced in the amended complaint. 9 Thus, a failure to

adequately set forth facts upon which a proof of claim is based may subject the claim to

5 In re Fairchild, 969 F.2d 866, 868 (10th Cir. 1992); Advisory Committee Note toBankruptcy Rule 3007.

6 In re Enron Corp., 328 B.R. 75, 87 (Bankr. S.D.N.Y. 2005).

7 Bankruptcy Rule 9014(c).8 In re Enron Corp., 419 F.3d 115, 133 (2d Cir. 2005); Matter of Stavriotis, 977 F.2d

1202, 1204 (7th Cir. 1992).9 In re Bellanca Aircraft Corp., 850 F.2d 1275, 1283 (8th Cir. 1988); In re Damrill,

232 B.R. 767, 773 (Bankr. W.D. Mo. 1999).



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disallowance without leave to amend. When faced with such a dilemma, a court may

provide relief under 11 U.S.C. § 502(j). 10

10 In re Cyberco Holdings, Inc., 431 B.R. 404, 424 (Bankr. W.D. Mich. 2010).



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III. Inadvertent Implied Consent to Bankruptcy Court Jurisdiction

Bankruptcy Rule 7008(a) requires as a general rule of pleading that in an adversary

proceeding before a bankruptcy judge, the complaint, counterclaim, cross-claim, or third

party complaint contain a statement that the proceeding is core or non-core and, if non-core,

that the pleader does or does not consent to entry of final orders or judgments by the

bankruptcy court. When answering the complaint, the defendant should likewise set forth its

position with respect to these issues.

The purpose of this rule is to address the problem of “jurisdiction by ambush”, where

a party inadvertently consents to authorizing the bankruptcy judge to enter a final judgment.

The Advisory Committee Notes to Bankruptcy Rule 7008 provide in part:

Failure to include the statement of consent does not constituteconsent. Only express consent in the pleadings or otherwise iseffective to authorize entry of a final order or judgment by thebankruptcy judge in a non-core proceeding.

Notwithstanding the Advisory Committee Note, where a plaintiff alleged a

proceeding was core and the defendant did not respond to the allegation in its

answer, a court held the defendant consented to the bankruptcy court’s entering a

final order. 1 This ruling can be supported by FRCP Rule 8(b)(6), made applicable to

adversary proceedings by Bankruptcy Rule 7008, which provides that an allegation

is admitted if it is not denied. However, a court has recently taken this a step further

and found implied consent by the defendant who failed to raise it in his answer

notwithstanding the fact that the plaintiff failed to plead in his complaint whether the

proceeding was core or non-core. 2 This said, the notion that written consent must

be in writing may be subject to challenge in light of the Supreme Court’s decision in

1 In re Aero-Fastener, Inc., 177 B.R. 120, 132 (Bankr. D. Mass. 1994).

2 In re Tyson, 433 B.R. 68, 77 (S.D.N.Y. 2010).



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Roell v. Withrow, 3 where the Court held that consent to have a magistrate could be

implied by conduct notwithstanding a requirement in the rules for written consent. 4

Thus, the concept of jurisdiction by ambush may be alive and well.

3538 U.S. 580, 123 S.Ct. 1696 (2003).

4 538 U.S. 580, 123 S.Ct. 1696, 1703 (2003).



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IV. Loss of Jury Trial Rights through Assertion of Affirmative Defenses

Absent consent of the parties, a bankruptcy judge cannot preside over a jury trial. 1

However, filings in the bankruptcy case may nonetheless result in a loss of a party’s right to

a jury trial. The Supreme Court has held that filing a proof of claim results in a loss of a

right to a jury trial on both the claims set forth in the proof of claim and with respect to

claims asserted against the creditor to the extent they affect the allowance or priority of the

claim. 2

The assertion of certain affirmative defenses in an answer can likewise result in a

loss of a right to a jury trial, although there are conflicting decisions on this issue. The

assertion of setoff or recoupment claims as affirmative defenses which seek an affirmative

recovery has been said to result in a loss of a right to a jury trial. 3 However, there is a split

of authority as to whether there is a waiver if setoff and recoupment defenses are asserted

solely defensively. 4 In a further broadening of the waiver decisions, a court has recently

held that the assertion of indemnity and setoff defenses, even where no affirmative recovery

is sought, resulted in a loss of a jury trial right, noting that the effect of these defenses would

diminish the estate. 5

1 28 U.S.C. § 157(e).2 Langenkamp v. Culp, 498 U.S. 42, 44-45, 111 S.Ct. 330, 331 (1990).3 In re Concept Clubs, Inc., 154 B.R. 581, 589 (D. Utah 1993).4 Compare In re Commercial Financial Services, Inc., 251 B.R. 397, 406-08 (Bankr.

N.D. Okla. 2000) (loss of right) with In re M & L Business Machine Co. Inc., 178 B.R. 270,272 (Bankr. D. Colo. 1995).

5 In re Big Springs Realty LLC , 430 B.R. 629, 633-35 (Bankr. D. Mont. 2010).



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V. Developments in Venue Issues

When filing a petition for purposes of initiating a bankruptcy case, venue

considerations are controlled by 28 U.S.C. § 1408. This statute provides six alternative

grounds upon which to choose the venue for filing. One of these alternatives provides that a

case may be commenced in the district which is the debtor’s “principal place of business in

the United States.”

Bankruptcy courts have applied a variety of standards to determine what constitutes

the debtor’s principal place of business. Some courts have held it is where general

supervision is given;1

some have applied the nerve center test;2

and other courts have

rejected the nerve center test. 3

In Hertz Corp. v. Friend , 4 the Supreme Court, in interpreting the phrase “principal

place of business” in 28 U.S.C., § 1332(c)(1), held that for a corporation, it refers to “where

a corporation’s officers, direct, control, and coordinate the corporation’s activities. 5 The

Court noted that this has been referred to by other courts as the corporation’s nerve center,

and is normally the place where the corporation maintains its headquarters. 6

This decision will undoubtedly influence bankruptcy courts when interpreting this

ground of the venue requirements in § 1408.

1 In re Newport Creamery, Inc., 265 B.R. 614 (Bankr. M.D. Fla. 2001).2 In re Peachtree Lane Associates, Ltd., 188 B.R. 815, 830 (N.D. Ill. 1995); In re

Dock of the Bay, Inc., 24 B.R. 811, 814 (Bankr. E.D.N.Y. 1982).3 In re EDP Medical Computer Systems, Inc., 178 B.R. 57, 62 (M.D. Pa. 1995).4 130 S.Ct. 1181 (2010).5 130 S.Ct. at 1192.6 130 S.Ct. at 1192.



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VI. Utilizing a Prepetition Injunction to Foreclose Bankruptcy Options

In an effort to avoid entanglements in bankruptcy, creditors may seek prepetition

court rulings or enter into agreements with the debtor that restrain a debtor’s rights in a

bankruptcy case. This said, agreements to waive the benefits conferred by bankruptcy law

have been held to be void as contrary to public policy. 1 The Second Circuit recognized an

exception to this policy where a federal receivership is pending, enforcing a stipulation and

order which precluded the debtor from filing bankruptcy. 2

In S.E.C. v. Byers, 3 the Second Circuit has upheld the authority of a district court to

issue an injunction in the context of an SEC receivership barring persons from filing actions,

including bankruptcy cases. The court concluded that creditors, even those who were not

parties to the proceeding before the court, do not have an absolute right to file an involuntary

bankruptcy petition. 4 The court further noted that the district court can provide that in the

event of a bankruptcy filing, the receiver would automatically become the debtor in

possession, subject to later challenge by parties in interest. 5

Courts have also enforced prepetition injunctions which dictate the venue in which a

debtor can file a bankruptcy case. 6 Depending upon the issues in controversy, given splits

in circuit court decisions, such a ruling may be very advantageous for creditors.

1 In re Tru Block Concrete Products, Inc., 27 B.R. 486, 492 (Bankr. S.D. Cal. 1983); In re Madison, 184 B.R. 686, 690 (Bankr. E.D. Pa. 1995).

2 U.S. v. Royal Business Funds Corp., 724 F.2d 12, 15-16 (2d Cir. 1983).

3 609 F.3d 87 (2d Cir. 2010).

4 609 F.3d 87, 91 (2d Cir. 2010).

5 609 F.3d 87, 93 (2d Cir. 2010).

6 Hunt v. Bankers Trust Co., 799 F.2d 1060 (5th Cir. 1986).



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VII. Rule Change Affecting Expert Discovery

Discovery of expert witnesses is governed by F.R.C.P. Rule 26, which is made

applicable to adversary proceedings by Bankruptcy Rule 7026 and to contested matters by

Bankruptcy Rule 9014(c). F.R.C.P. Rule 26 was amended effective December 1, 2010, to

“provide work-product protection against discovery regarding draft expert disclosures or

reports and – with three specific exceptions – communications between expert witnesses and

counsel.” 1 F.R.C.P. Rule 26(a)(2)(B)(ii) was amended to provide disclosure of “facts or

data considered by the witness in forming” an opinion, and replaced language which

required disclosure of “data or other information.” The purpose of this change was “to limit

disclosure to material of a factual nature by excluding theories or mental impressions of

counsel.” 2 The three exceptions to disclosure are contained in F.R.C.P. Rule 26(b)(4)(C),

and are communications that:

(i) relate to compensation for the expert’s study or testimony;(ii) identify facts or data that the party’s attorney provided and that the expert

considered in forming the opinions to be expressed; or(iii) assumptions that the party’s attorney provided and that the expert relied on in

forming the opinions to be expressed.

Notwithstanding the changes to the rule, it is not entirely clear that draft reports will

be sacrosanct. For instance, a draft report may be discoverable if it forms a basis of the

expert’s opinion.

While the revised rule limits disclosure of communications between attorney and

expert with respect to counsel’s mental impressions or litigation theories, it does not shield

discussions of a factual nature, nor does it limit counsel’s discussions concerning

assumptions that counsel asked the expert to make. The dividing line between these areas

are not always clear.

1Advisory Committee Notes to 2010 Amendment to F.R.C.P. Rule 26.

2 Advisory Committee Notes to 2010 Amendment to F.R.C.P. Rule 26.



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VIII. Backdoor Use of Plan Provisions and Court Orders to Circumvent Adversary

Proceedings and Contested Matters

Bankruptcy Rule 7001 sets forth the types of proceedings that must be resolved by

an adversary proceeding. The adversary proceeding process requires the filing of a

complaint and the litigation procedures largely mirror those contained in the Federal Rules

of Civil Procedure.

Notwithstanding these procedural safeguards, the Supreme Court in United Student

Aid Funds, Inc. v. Espinosa,1 approved the right of a debtor to utilize a plan to grant the

debtor a right to a discharge of a student loan, even though discharge proceedings must be

resolved by an adversary proceeding and the relief obtained in the plan was improper

because there had been no hardship determination by the bankruptcy court. 2

The Court focused on the fact that there was a final order confirming the plan, which

order was enforceable even if it was erroneous.3

The Court also rejected a due process

argument which contended that the order was not valid because the creditor had not been

served with a summons and complaint. 4

The Court acknowledged that its decision could foster bad-faith litigation tactics,

with parties seeking to slip in remedies to which they would not otherwise be entitled, but

concluded that under such circumstances relief should be sought under Bankruptcy Rule

9011, not FRCP Rule 60(b)(4). 5

1 130 S.Ct. 1367 (2010).

2 130 S.Ct. at 1380.

3 130 S.Ct. at 1377.

4 130 S.Ct. at 1378.

5 130 S.Ct. at 1382.



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Given that Bankruptcy Rule 9011 has a “safe harbor” provision that allows an

offending party not less than 21 days to withdraw an offending filing, this is a less than

satisfying means of addressing the problem.6

The effect of this ruling is not limited to plans of reorganization. As long as there is

proper service and notice, a party may seek relief via motion to which it is otherwise not

entitled and if a final order is entered, an opposing parties’ rights can be severely prejudiced.

Such rulings could conceivably cover a wide array of matters, including claims allowance,

perfection of a security interest, and assumption or rejection of executory contracts.

Separate and apart from the use of orders to intentionally eviscerate a party’s

procedural rights, entry of an order may also have unintended consequences and serve as a

basis to bar claims. This was recently evidenced in the context of a retention order for a

professional. In In re All American Semiconductor, Inc.,7 the debtor’s financial advisor

disclosed in its retention application that it had received $330,000 in payments prepetition.

Final orders were entered approving the advisor’s employment and fees. An adversary

proceeding was subsequently commenced seeking to recover the prepetition payments under

preference and fraudulent transfer theories, and asserting, among other things, claims of

professional malpractice. The court held that all of the claims were barred by res judicata

and collateral estoppel as a consequence of its prior orders. 8

While these types of orders have been utilized to bar malpractice claims, 9 extending

them to avoiding action claims may be problematic. Prepetition payments are commonly

made to estate professionals, and an examination as to whether they are avoidable is

6 Bankruptcy Rule 9011(c)(1)(A).

7 427 B.R. 559 (Bankr. S.D. Fla. 2010).

8 427 B.R. 566-70.

9 See, e.g., In re Intelogic Trace, Inc., 200 F.3d 382, 388 (5th Cir. 2000).



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generally not undertaken at the time a retention order is entered. To avoid a release, the

retention and fee orders should contain a carve out of such claims.



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IX. Recent Daubert Challenge

The admissibility of all expert testimony is governed by the principles of Federal

Rule of Evidence (“F.R.E.”) 104(a).1

Under F.R.E. 104(a), the proponent of the evidence

has the burden of establishing by a preponderance of the evidence that the testimony is

admissible. 2

The standards for the admissibility of expert opinion evidence are set forth in F.R.E.

702, which provides:

If scientific, technical, or other specialized knowledge will assistthe trier of fact to understand the evidence or to determine a fact inissue, a witness qualified as an expert by knowledge, skill,

experience, training, or education, may testify thereto in the formof an opinion or otherwise, if (1) the testimony is based uponsufficient facts or data, (2) the testimony is the product of reliableprinciples and methods, and (3) the witness has applied theprinciples and methods reliably to the facts of the case.

F.R.E. 702 reflects the decisions by the United States Supreme Court in

Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993), and Kumho

Tire Co. v. Carmichael, 526 U.S. 137 (1999), which mandate that trial judges act

as gatekeepers to exclude unreliable expert testimony. Under Kumho, this

gatekeeper function applies to all expert testimony, not just scientific testimony. 3

An opinion from an expert who is not a scientist should receive the same degree

of scrutiny for reliability as an opinion from an expert who purports to be a

scientist. 4

1 See F.R.E. 702 cmt (West Supp. 2005).2 See Bourjaily v. United States, 483 U.S. 171, 175 (1987).3 See Kumho, 526 U.S. at 148.4 See Watkins v. Telsmith, Inc., 121 F.3d 984, 991 (5th Cir. 1997) (“[I]t seems

exactly backwards that experts who purport to rely on general engineering principles andpractical experience might escape screening by the district court simply by stating that theirconclusions were not reached by any particular method or technique.”).



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F.R.E. 702 measures the reliability of an expert’s testimony by considering:

(1) the facts underlying the opinion, (2) the principles and methods applied, and (3) the

application of the methods to the facts. A court must make three determinations:

1. whether a witness is qualified to testify as an expert in the matter;2. whether the witness’ testimony is based upon reliable data and methodology;

and3. whether the expert’s testimony is relevant. 5

Qualification is liberally construed and there is no requirement that the expert have

practical experience or academic training. 6

In In re Young Broadcasting, Inc.,7 a creditors’ committee and debtor submitted

competing plans. The committee designated an expert, an investment banker, who was

prepared to testify about the debtor’s ability to sell or refinance the company several years

down the road; about valuation; and feasibility of the plan. A motion in limine to exclude

the expert’s testimony was filed several weeks before the confirmation hearing, and heard at

the time of the confirmation hearing.

Preliminarily, the court struck a portion of the expert’s testimony that was based

upon the expertise of others in his office, reasoning that there was a denial of an opportunity

to cross examine witnesses who were not testifying. The court also excluded a portion of

the expert’s affidavit that contained new opinion and information that was not contained in

the expert’s report. 8

In addressing qualification issues, the court found the witness qualified even though

he had no M.B.A., business education credentials, commercial banking experience, or

5 In re Young Broadcasting, Inc., 430 B.R. 99, 121 (Bankr. S.D.N.Y. 2010).

6 Young, 430 B.R. at 122.

7 430 B.R. 99 (Bankr. S.D.N.Y. 2010).

8 Young, 430 B.R. at 111 n. 15.



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publications. The witness was said to be qualified based upon his years of background and

experience in transactions in the industry in which the debtor engaged, and his prior work in

the industry where he worked on financing and mergers and acquisitions for his employer.9

The witness’ testimony was found to be reliable with respect to the debtor’s ability to

consummate a sale or refinance in the future where the expert relied on industry data,

applied it to the debtor’s circumstances, and based his conclusion on his experience, even

though he made some assumptions about the economy in general in reaching his

conclusion.10

The witness’ testimony was found to be unreliable with respect to valuation and

feasibility where he employed what he characterized as a leveraged discounted cash flow

method. While the court recognized that a discounted cash flow method was commonly

used, the expert used a method that differed from the generally accepted method, made

“novel” assumptions in his analysis, and presented no evidence that his methodology was

relied upon by other experts, discussed in publications, or accepted in the community. 11

9 Young, 430 B.R. at 122-23.

10 Young, 430 B.R. at 125.

11 Young, 430 B.R. at 126-28.



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X. Recent Ponzi Rulings

The fallout from the Bernard Madoff Ponzi scheme has generated a number of

opinions on the topic, none of them very favorable for defendants.

In In re Bernard L. Madoff, Inv. Securities LLC, 1 the court addressed the sufficiency

of claims set forth in the trustee’s complaint. Among other things, the court noted:

• the existence of a Ponzi scheme establishes that transfers were made withintent to hinder, delay, and defraud creditors;

• a debtor’s guilty plea that he operated a Ponzi scheme establishes fraudulentintent under § 548(a)(1)(A);

• restitution claims are limited to up to the amount that innocent investorsinvested;

• an investor is not innocent and has no right to restitution if he had knowledge

of and played a part in the fraud;• there is no reasonably equivalent value with respect to payments received by

investors in excess of the amount of their principal;

• a defendant’s expectation damages for his lost investment is not appropriatein a Ponzi scheme case where the debtor is insolvent and being liquidated.

The court also addressed statute of limitations issues. The court held that as long as

the statute of limitations had not expired as of the petition date, the trustee could reach back

for transfers under a § 544 claim for the full time period under state law, in this case, six

years, as long as the complaint was filed within 2 years of the petition date. Thus, the

trustee could reach back to December 11, 2002 in a case filed December 11, 2008, where the

complaint was filed on May 1, 2009.

1 ____B.R. ____, 2010 WL 5841402 (Bankr. S.D.N.Y. 2011).



A court also recently shot down the defendant’s attempts to assert counterclaims

against the Madoff trustee. In In re Bernard L. Madoff Inv. Securities LLC,2 the trustee sent

a letter to Goldman Sachs (“GS”), where a defendant had an account, and advised GS that

the monies in the customer’s account was property of the estate and that GS would be held

liable if it distributed the money. In response, GS froze the account. The trustee was sued

for tortious interference with contract; tortious interference with business relationship;

conversion; and violation of the 5th Amendment. The counterclaims were said not to be

plausible and were dismissed. Among other things, the court held that the trustee had

innunity, 3 that the elements of the interference claims could not be satisfied, 4 and that there

was no proof of conversion. 5

In the category of more bad news for Ponzi defendants, a court held that a state court

judgment for unjust enrichment brought under state securities laws against an investor for

disgorgement of profits made as an investor in a Ponzi scheme was nondischargeable under

11 U.S.C. § 523(a)(19) even though the investor-debtor played no role in carrying out the

Ponzi scheme.6

2 440 B.R. 282 (Bankr. S.D.N.Y. 2010).3 440 B.R. at 290-92.4

440 B.R. at 294-95.5 440 B.R. at 297.6 Oklahoma Dept. of Securities ex rel. Faught v. Mathews, 423 B.R. 684, 688-89

(W.D. Okla. 2010).

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Av104497 Bankruptcy Litigation

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