Procrastinators’ Programs SM

Bankruptcy for Plaintiff’s Attorneys

Alicia M. Bendana Lowe Stein

Course Number: 0200131217 1 Hour of CLE

December 17, 2013 4:50 – 5:50 pm

Bankruptcy for Plaintiffs’ Attorneys

ALICIA M. BENDANAOf counsel, LOWE, STEIN, HOFFMAN,

ALLWEISS & HAUVER, L.L.P. One Shell Square, Suite 3600

701 Poydras StreetNew Orleans, Louisiana 70139

Telephone: (504) 581-2450

TABLE OF CONTENTS

I. WHEN YOUR CLIENT, THE PLAINTIFF, HAS FILED OR FILES FORBANKRUPTCY RELIEF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

A. Judicial Estoppel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

B. Standing: Is Your Client Still Your Client? .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

C. Retention and Compensation - The Basics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

D. Removal, Abstention and Remand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

1. Core v. Non-Core . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

2. Abstention and Remand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

E. Extension of Prescription . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

F. Derivative vs. Statutory Claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

G. In Pari Delicto Defense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

H. Adverse Domination as an Exception to the In Pari Delicto Defense and to Aid with Prescription Issues .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

I. Application of State Law Wage Exemption to Lost Wages Componentof Injury Claim . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

J. Settlements Require Court Approval . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

K. Arbitration .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

II. WHEN YOUR OPPONENT, THE DEFENDANT, FILES FOR BANKRUPTCY RELIEF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

A. The Automatic Stay . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

1. Purpose of Stay . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

2. Actions Stayed and Not Stayed .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

3. Consequences of Stay Violation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

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B. Discharge and Dischargeability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

1. Objecting to the Dischargeability of a Debt . . . . . . . . . . . . . . . . . . . . . . . 21

2. Objecting to Discharge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

C. Claims Estimation .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

D. Alter Ego and Single Business Enterprise Claims Belong to the Estate .. . . . . . . 25

E. Insurance Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

F. The Effect of Confirmed Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

1. Channeling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

2. Third Party Releases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

G. Extension of Prescription . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

H. Settlements Require Court Approval . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

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I. WHEN YOUR CLIENT, THE PLAINTIFF, HAS FILED OR FILES FORBANKRUPTCY RELIEF

A. Judicial Estoppel

If your client files a bankruptcy after the event giving rise to the cause of action and fails to

disclose the action as an asset, you have a problem.

- The Debtor has an affirmative duty to disclose all assets in her bankruptcy, including all

claims and causes of action, even potential, contingent or unliquidated claims. 11 U.S.C. 521(1),

11 U.S.C. § 541(a). The duty of disclosure is a continuing one.

- Federal law governs the application of judicial estoppel in federal courts.

- There are three components to judicial estoppel:

(1) the party against whom judicial estoppel is sought has asserted a legal position which

is plainly inconsistent with a prior position;

(2) a court accepted the prior position; and

(3) the party did not act inadvertently.

See, Jethroe v. Omnova Solutions, Inc., 412 F.3d 598, 600 (5 Cir. 2005); Superior Crewboats, Inc.th

v. Primary P & I Underwriters (In re Superior Crewboats), 374 F.3d 330, 335 (5 Cir. 2004). Theth

Fifth Circuit has held that “[j]udicial estoppel is particularly appropriate where . . . a party fails to

disclose an asset to a bankruptcy court, but then pursues a claim in a separate tribunal based on that

undisclosed asset.” Jethroe, 412 F.3d at 600.

In In re Superior Crewboats, Inc., Chapter 13 debtors failed to schedule a personal injury

case, filed a state court claim during the pendency of the Chapter 13, and then converted the Chapter

13 to a Chapter 7 case. Although the debtors disclosed the pending state court litigation in their

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converted case’s § 341 meeting, they told the trustee the claim was barred by a statute of limitations.

The bankruptcy was closed as a no asset case and the state court litigation was abandoned by the

trustee. The Fifth Circuit held that judicial estoppel barred the debtors’ pursuit of the claims.

In Kane v. National Union Fire Insurance Company, 535 F.3d 380 (5 Cir. 2008), the Fifthth

Circuit reached a different result under different circumstances. There, the debtors’ personal injury

action was pending in state court when they filed their Chapter 7 case. The debtors did not schedule

their claim or inform the trustee of their claim. The trustee declared the case a no asset case and the

debtors received a discharged. Subsequently, the state court defendant moved for summary

judgment on judicial estoppel grounds. The debtors then moved to reopen their bankruptcy case.

After the bankruptcy court reopened the case, the trustee moved to intervene in the state court

litigation as the real party in interest. The Fifth Circuit held:

- An unscheduled asset, such as the personal injury claim at issue, is not abandoned under §

554(c) & (d) and remains property of the estate even after the bankruptcy case closes. Id. at 385.

- The Chapter 7 trustee is the real party in interest, as she is the only party with standing to

prosecute the claim. Id.

- Equity under these circumstances weighs in favor of the bankruptcy estate and its creditors

over the state court defendant. (As opposed to Superior Crewboats where the debtor would have

been the beneficiary of the nondisclosure.) Id. at 387; but see In re Coastal Plains, Inc., 179 F.3d 197

(5 Cir. 1999) (where the court barred a Trustee from pursuing the debtor’s claims on the basis ofth

judicial estoppel).

In Reed v. City of Arlington, 650 F.3d 571 (5 Cir. 2011), the Fifth Circuit reinforced theth

distinction made in Kane between the debtor and a debtor’s estate and enforced judicial estoppel

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against the debtors, but not against the debtor’s estate/trustee/creditors. Id. at 574.

- The debtors’ nondisclosure (the first element, “inconsistent position”) and receipt of a no

asset dicharge (the second element, “court accpetance” of inconsistent position) occurred post

petition. Accordingly, the judicial estoppel defense was not applicable to the case trustee, who takes

pre-petition cause of action subject only to defenses that existed prepetition. Id. at 575-576.

- Additionally, given that judicial estoppel is an equitable defense, innocent creditors should

not bear the consequences of the debtors’ wrongful actions. Id. at 576. However, any surplus in the

bankruptcy case would be judicially estopped from going to the debtors. Id. at 577.

WARNING: Your client’s failure to disclose a cause of action may also (1) be used as

evidence of an “act of dishonesty” in the tort suit, (2) bar her discharge in bankruptcy (11 U.S.C. §

724(a)(4)(A)), (3) prevent her from obtaining the exemption for the lost wages component of her P.I.

claim, and (4) possibly result in criminal prosecution as a false oath under 18 U.S.C. §§ 152.

B. Standing: Is Your Client Still Your Client?

If your client files a Chapter 13 or 11 reorganizing bankruptcy, she will still be able to

pursue any causes of action she has post-filing. However, she will need to report regularly on the

status of the litigation to her Chapter 13 trustee, or in the case of a Chapter 11, to the bankruptcy

court.

If your client files a Chapter 7 liquidating bankruptcy, a trustee will be appointed to liquidate

her assets, including all pre-petition causes of action which qualify as “property of the estate”

pursuant to 11 U.S.C. § 541. Your client will lose standing to pursue the action.

In either event (if your client wants you to continue on as plaintiff’s counsel; and/or the

trustee would like to hire you) your retention and compensation must be approved by the bankruptcy

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court after notice and hearing.

C. Retention and Compensation - The Basics

Bankruptcy trustees, Chapter 11 debtors in possession, and creditors committees are

permitted to retain a wide variety of professionals, including lawyers, to represent their interests

during the bankruptcy case. Any employment of professionals must be approved in advance by the

bankruptcy court.

In most cases, professionals hired to represent a trustee, debtor-in-possession or committee

are retained pursuant to §§ 327 and 1103 of the Bankruptcy Code, which authorize these entities,

subject to bankruptcy court approval, to employ “disinterested” professionals to represent them

during the course of the bankruptcy.

Under § 327(a), in order to be employed by the trustee or the debtor-in-possession, a

professional (1) may not hold interest adverse to the estate and (2) must be disinterested as that term

is defined in § 101 of the Bankruptcy Code.

An attorney who is to be employed “for a special purpose” (i.e., to represent the debtor or the

trustee in pending state court litigation), however, has a slightly relaxed standard for employment

pursuant to § 327(e). This section requires only that if the attorney previously represented the debtor,

the hiring must be in the best interest of the estate, and the professional not hold an interest adverse

to the debtor or estate with respect to the special matter.

Section 328 of the Bankruptcy Code authorizes the retention of professionals on any

reasonable terms and conditions of employment, including on an hourly basis or on a contingent fee

basis.

Specifically § 328(a) states:

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The trustee, or a committee appointed under section 1102 of this title, with thecourt’s approval, may employ or authorize the employment of a professional personunder section 327 or 1103 of this title, as the case may be, on any reasonable termsand conditions of employment, including on a retainer, on an hourly basis, on a fixedor percentage fee basis, or on a contingent fee basis. Notwithstanding such terms andconditions, the court may allow compensation different from the compensationprovided under such terms and conditions after the conclusion of such employment,if such terms and conditions prove to have been improvident in light of developments not capable of being anticipated at the time of the fixing of such terms andconditions.

11 U.S.C. § 328(a).

The Fifth Circuit has repeatedly interpreted § 328(a) as meaning: a professional may be

retained on any reasonable terms; but, once those terms have been approved pursuant to § 328(a),

the court may not stray from them at the end of the engagement unless developments subsequent to

the original approval, that were incapable of being anticipated, render the terms improvident. In re

Asarco, 701 F.3d 250, 251 (5 Cir. 2012), citing Coho Energy, Inc., 395 F.3d 198, 204-05 (5 Cir.th th

2004); In re Barron, 325 F.3d 690, 693 (5 Cir. 2003) (Barron II); In re Barron, 225 F.3d 583, 586th

(5 Cir. 2000) (Barron I) (admonishing the bankruptcy court for failing to rely “upon the plainth

language of” § 328(a)).

Section 328(a) therefore creates a “high hurdle” for a movant seeking to revise the terms

governing a professional’s compensation ex post facto. Id. at 258. Likewise, before a court may

revise a compensation agreement, it must explain with specificity why the subsequent developments

were “incapable” of being foreseen.” Id.

D. Removal, Abstention and Remand

The debtor, and anyone who is involved in litigation with the debtor, is permitted to remove,

or transfer litigation pending in state or other federal courts to the federal court that resides in the

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same judicial district as the bankruptcy court. Defendants looking for a way out of state court

frequently take advantage of bankruptcy removal statutes. To do so, the litigant must file a timely

notice of removal or transfer with the state or federal court in which an action involving the debtor

is pending. Removal of claims related to bankruptcy cases is governed generally by 28 U.S.C. §

1452 and Rule 9027 of the Federal Rules of Bankruptcy Procedure. These rules permit removal of

any claim or cause of action related to a bankruptcy case if the court otherwise has bankruptcy

jurisdiction pursuant to 28 U.S.C. § 1334 in accordance with the procedures set forth in Rule 9027.

1. Core v. Non-Core

Section 157 of Title 28 envisions three type of cases within bankruptcy jurisdiction: “Civil

proceedings” (1) “arising under Title 11,” (2) “or arising in [cases under Title 11]”, (3) “or related

to cases under Title 11.” 28 U.S.C. § 1334(b). While the federal district court has full jurisdiction

over all three types of cases, the bankruptcy court has full jurisdiction (i.e., the power to “hear and

determine”) only over “cases under Title 11 and all core proceedings arising under Title 11, or

arising in a case under Title 11. 28 U.S.C. § 157(b)(1). The first “arising under” category refers to

the bankruptcy case of a debtor: the process by which a debtor is either liquidated or reorganized.

The second and third categories refer to “core” and “non-core” proceedings.

Core proceedings are described in a non-exclusive list in 28 U.S.C. § 157(b)(2). Included

in that list of claims are “matters concerning the administration of the estate,” “motions to terminate,

annul, or modify the automatic stay,” and “other proceedings affecting the liquidation of assets of

the estate or the adjustment of the debtor-credit or the equity security holder relationship.” See 28

U.S.C. § 157(b)(2)(A), (G), (O).

Non-core matters are those that could exist outside of bankruptcy, but that nevertheless have

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some effect on the bankruptcy. Wood, 825 F.2d at 97. The debtor’s pre-petition tort claims against

third parties are usually non-core matters as they are products of state, not federal bankruptcy, law.

However, because such claims may augment a bankruptcy estate (and hence, creditors’ recoveries),

non-core matters are “related to” the bankruptcy and, therefore, are often referred to as “related to”

proceedings. FDIC v. Majestic Energy Corp. (In re Majestic Energy Corp.), 835 F.2d 87, 90 (5 Cir.th

1988) (A “related to” proceeding is one in which “the outcome could alter the debtor’s rights,

liabilities, options, or freedom of action (either positively or negatively) and which in any way

impacts upon the handling and administration of the bankrupt estate.”) Stern v. Marshall, 131 S.Ct.

2594, 2605 (2011) (“The terms ‘non-core’ and ‘related’ are synonymous”) (quoting Collier on

Bankruptcy, para. 3.02[2], p. 3-26, n. 5 (16 ed. 2010)).th

- The core versus non-core classification is important as it determines whether the bankruptcy

court has adjudicatory jurisdiction (in core proceedings), or has a restricted judicial role (in non-core

proceedings).” Mirant Corp. v. The Southern Co., 337 B.R. 107, 115-16 (N.D. Tex. 2006) (citations

omitted).

- Bankruptcy judges can hear and enter final orders in core matters. 28 U.S.C. § 157(b)(1).

However, with respect to non-core matters, a bankruptcy judge may only “submit proposed findings

of fact and conclusions of law to the district court,” which will then enter the final order of judgment

after de novo review. 28 U.S.C. § 157(c)(1). Notwithstanding this general rule, however, if all

parties to a proceeding consent, the bankruptcy judge may enter a final judgment in the non-core

proceeding. 28 U.S.C. § 157(c)(2).

- A person or entity who has not filed a proof of claim in the bankruptcy is entitled to a jury

trial if otherwise entitled under the Seventh Amendment. See Granfinanciera, S.A. v. Nordberg, 492

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U.S. 33 (1989).

- Although Louisiana district courts have standing orders referring bankruptcy related matters

to the bankruptcy courts, if the right to a jury trial exists and the parties do not consent to jury trial

before the bankruptcy judge, cause for withdrawal of the reference (back to district court) exists. In

re Orion Pictures Corp., 4 F.3d 1095 (2d Cir. 1993), cert. dismissed, 511 U.S. 1026 (1994); In re

Larry’s Apartment, L.L.C., 210 B.R. 469, 472 (D. Ariz. 1997). Once the district court withdraws

reference, the bankruptcy court loses jurisdiction over all matters withdrawn. Patterson v.

Williamson, 153 B.R. 32 (E.D. Va. 1993).

2. Abstention and Remand

Although a claim or lawsuit can be removed to federal court as being “related to” a

bankruptcy case under 28 U.S.C. § 1452(a), that doesn’t mean the case will stay there. Indeed, any

litigant to the proceeding may seek abstention or a remand of the action back to state court.

- Under § 1334(c)(2), in “non-core” proceedings federal courts must abstain from hearing a

state law claim for which there is no independent basis for federal jurisdiction other than § 1334(b)

“if an action is commenced, and can be timely adjudicated, in a state forum of appropriate

jurisdiction.” Edge Petroleum Operating Co. v. GPR Holdings, L.L.C., 483 F.3d 292 (5 Cir. 2007);th

In re Gober, 100 F.3d 1195, 1206 (5 Cir. 1996); see also Bankston v. Singleton, 2009 U.S. Dist.th

LEXUS 121805, at * 32 (W.D. La. 12/30/09) (The party moving for mandatory abstention does not

need to show that the action can be more timely adjudicated in state court, but only that the matter

can be timely adjudicated in state court.).

- A party is not entitled to mandatory abstention if it fails to prove any one of the statutory

requirements. In re WorldCom Secs. Litig., 293 B.R. 308, 331 (S.D. N.Y. 2003).

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If abstention is not mandatory, pursuant to § 1334(c)(2), a court may nevertheless exercise

its discretion to abstain. Factors for determining whether permissive abstention is appropriate

include: effect upon the administration of the estate; extent to which state law predominates;

difficulty of applicable state law; existence of a jurisdictional basis other than the court’s bankruptcy

jurisdiction; feasibility of permitting judgment to be entered in state court; burden on the bankruptcy

court’s docket; evidence of forum shopping; right to jury trial combined with refusal to consent to

jury trial before the bankruptcy judge; financial condition of the parties; and whether there are

nondebtor parties involved. See In re Chicago, Milwaukee, St. Paul & Pac. R.R., 6 F.3d 1184 (7th

Cir. 1993); In re Williams, 256 B.R. 885 (B.A.P. 8 Cir. 2001).th

- Discretionary abstention is appropriate when unique, unsettled, or difficult issues of state law

exist. In re Dow Corning Corp., 113 F.3d 565 (6 Cir.), cert. denied, 522 U.S. 977 (1997).th

- The federal district or bankruptcy court may abstain sua sponte under 28 U.S.C. § 1334(c)(1)

governing discretionary abstention. In re Gober, 100 F.3d 1195, 1207 n. 10 (5 Cir. 1996).th

Discretionary remand can be made “on any equitable ground.” 28 U.S.C. § 1452(b). The

following facts may be considered in deciding whether discretionary remand is appropriate:

(1) forum non conveniens;

(2) if the civil action has been bifurcated by removal, the entire action should be tried in

the same court;

(3) whether a state court is better able to respond to questions involving state law;

(4) the expertise of a particular court;

(5) duplicative and uneconomic effort of judicial resources in two forums;

(6) prejudice to the involuntarily removed parties;

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(7) comity considerations; and

(8) a lessened possibility of an inconsistent result.

KSJ Development Co. of Louisiana v. Lambert, 223 B.R. 677, 679 (E.D. La. 1998); O’Rourke v.

Cairns, 129 B.R. 87, 90 (E.D. La. 1991), citing Browning v. Navarro, 743 F.2d 1069, 1076 n. 21 (5th

Cir. 1984). The cited § 1452(b) factors are not the only factors which may be considered however.

As stated in 28 U.S.C. § 1452(b), “the presence of ‘any equitable ground’ is a sufficient basis for

remand . . .” Patterson v. Morris, 337 B.R. at 97.

- Additionally, the Court may evaluate the considerations applicable when addressing whether

to abstain under § 1334(c)(1). Terral v. SCH Management Solutions, Inc., 2004 WL 2115486 (E.D.

La. 9/21/04). Those factors include:

(1) the existence of two closely related proceedings based upon state law or a statelaw cause of action; (2) the absence of any basis for jurisdiction other than section1334; (3) the likelihood of timely adjudication in state court; (4) the predominanceof state law issues; and (5) the relatedness of the proceeding to the bankruptcy case.

Id. at * 3. O’Rourke v. Cairns, 129 B.R. 87,90 (E.D. La. 1991); In re Chiodo, 88 B.R. 780, 785

(W.D. Tex. 1988) (finding that “abstention and remand of bankruptcy related cases go hand-in-

hand”); J.T. Thorpe Co., 2004 WL 23323005, at * 6 (S.D. Tex. June 9, 2003) (Together, the

bankruptcy remand and abstention statutes “strongly evince a congressional policy that, absent

countervailing circumstance; the trial of state law created issues and rights should be allowed to

proceed in state court, at least where there is no basis for federal jurisdiction independent of § 1334

and the litigation can be timely completed in state court.”).

- Where the Bankruptcy Court dismisses the bankruptcy related claims as a result of settlement

or judgment, and the initial basis for federal jurisdiction no longer exists, the Bankruptcy Court has

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both the jurisdiction and the statutory authority to order a remand of the remaining non-bankruptcy

claims in the action. In re Telluride Income Growth LP, 364 B.R. 390, 398 (10 Cir. BAP 2007);th

see also In re Ciclon Negro, Inc., 260 B.R. 832, 834-835 (Bankr. S.D. Tex. 2001).

E. Extension of Prescription

Section 108 of the Bankruptcy Code addresses extensions of time. Specifically, § 108(a)

gives the trustee at least two years from the date of the order for relief (i.e., the filing of the

bankruptcy petition) to commence an action that the debtor could have brought on the petition date.

NOTE: If the action had already prescribed at the time of the bankruptcy petition filing, §

108 cannot be used to revive prescription. Thomas v. GMAC Resid. Funding Corp., 309 B.R. 453

(D. Md. 2004).

F. Derivative vs. Statutory Claims

Representatives of a bankruptcy estate, including Chapter 7 trustees, are empowered to bring

two different types of claims against third parties - derivative claims and statutory claims. Unlike

statutory claims which emanate from the Bankruptcy Code, derivative claims emanate from other

state or federal laws and could have been pursued by the debtor pre-petition. 264 B.R. 344, 363

(Bankr. D. Del. 2001), citing Hays & Co. v. Merrill, Lynch, Pierce, Senner & Smith, Inc., 885 F.2d

1149, 1154-55 (3d Cir. 1989); see also In re Gandy, 299 F.3d 489, 495-96 (5 Cir. 2002).th

- This distinction make a difference with respect to a defendant’s ability to enforce contractual

choice of law, arbitration, jurisdiction and/or venue provisions and to assert defenses against the

bankruptcy trustee.

- When a trustee is pursuing a debtor’s state law “derivative” claim, she is subject to the same

contractual and equitable defenses that the Debtor herself would have been subject to. This is not

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the case where the Trustee is pursuing federal bankruptcy causes of action such as claims that seek

to avoid or unwind fraudulent transfers.

- Things get tricky when a bankruptcy trustee possesses both “core” bankruptcy claims

stemming from the Bankruptcy Code and state law claims against the same defendant, and such

claims are inextricably intertwined. Obviously, certain equitable defenses can be applied on a claim

by claim basis, but the enforcement of jurisdiction, venue, and arbitration provisions will, if the

issues cannot reasonably be severed, have to be decided as to the whole action.

- In cases where trustees bring state law claims that are “inextricably intertwined” with “core”

federal bankruptcy claims, courts will look to the claims that predominate in order to determine

applicability of various forum clauses.

- In In re Manchester, Inc., the court enforced a venue selection clause against a “litigation

trustee” who was designated by the Debtor to represent a “litigation trust” created by the debtor in

its plan of reorganization. This litigation trustee pursued claims belonging to the debtor pursuant

to the latter’s confirmed plan of reorganization. 417 B.R. 377 (N.D. Tex. 2009). Although, the

litigation trustee did bring some core claims in the subject proceeding, such claims were

“inextricably entwined” with the non-core claims which governed and formed “the heart” of the

adversary proceeding. To that end, the Court found:

Accordingly, and in the words of the Fifth Circuit, the “underlying nature” of theAdversary Proceeding, does not “derive exclusively from the provisions of theBankruptcy Code” and is in fact “derivative of the pre-petition legal . . . rightspossessed by [the] debtor,” In re Gandy, 299 F.3d at 495; In re Nat’l Gypsum, 118F.3d at 1067, as evidenced by the fact that these breach of contract claims werepending prepetition in the New York Action.

Id. at 386-87.

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G. The In Pari Delicto Defense

“The equitable defense of in pari delicto, which means ‘in equal fault,’ is based on the

common law notion that a plaintiff’s recovery may be barred by his own wrongful conduct.” In re

Tocfhbi, Inc., 413 B.R. 523, 536-37 (Bankr. S.D. Tex. 2009) citing Howard v. Fidelity and Deposit

Co. Of Maryland, (In re Royale Airlines, Inc.), 98 F.3d 852, 855 5 Cir. 1996). th

- “Two fundamental premises underlie this defense: (1) that courts should not lend their good

offices to mediating disputes among wrongdoers; and (2) that denying judicial relief to an admitted

wrongdoer is an effective means of deterring illegality.” Id.; citing Murray v. Royal Alliance Assoc.,

375 B.R. 208, 213 (M.D. La. 2007).

- Unlike other common defenses, the doctrine of in pari delicto has been analyzed by some

courts as a matter of standing. See Baena v. KPMG LLP, 389 F.Supp.2d 112, 117 - 118 (D. Mass.

2005), aff’d, 453 F.3d 1 (1 Cir. 2006) (“[T]he Second Circuit and courts in the First Circuit havest

viewed [in pari delicto] as a standing issue.”). Others, like the Fifth Circuit, recognize it as simply

an affirmative defense. Schertz-Cibolo-Universal City Indep. Sch. Dist. v. Wright (In re Educators

Group Health Trust), 25 F.3d 1281, 1286 (5 Cir. 1994). th

- Under 11 U.S.C. § 541, causes of action enter the estate subject to affirmative defenses that

would exist outside of bankruptcy.

- In pari delicto applies as an affirmative defense even if the estate is asserting the cause of

action to benefit innocent creditors and the wrongdoers will not benefit from any recovery.

Claybrook v. Broad and Cassell, P.A., et al (In re Scott Acquisition Corp.), 47 B.C.D. 280 (Bankr.

Del. 2007).

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H. Adverse Domination as an Exception to the In Pari Delicto Defense and to Aidwith Prescription Issues

Note that even if the in pari delicto defense could otherwise be asserted against a trustee

relative to a debtor’s pre-petition state law claim, the trustee may be able to employ the adverse

domination exception to the in pari delicto defense when the debtor is a business entity.

Under the “adverse domination” exception to the in pari delicto defense, the malfeasance of

corporate actors will not be imputed to the corporation when they act adversely to the corporation

and in their own interests. If the misconduct did not benefit the debtor, but rather only benefited the

debtor’s principals, the in pari delicto defense can be overcome. The test is whether the corporate

agent acted adversely to the interest of the corporation, and if so, the knowledge and conduct of the

agent will not be imputed to the corporation. The Fifth Circuit has acknowledged that:

a well established rule of imputed knowledge holds that

where an officer is dealing with the corporation in his own behalf, or is, for any otherreason, interested in a transaction adversely to the corporation, knowledge possessedby him in the transaction is not imputable to the corporation, even though the officerobtaining the knowledge was, at the time, the managing agent of the corporation, oreven though the officer processing the knowledge or having the notice attended themeeting at which the matter in question was considered . . .

Id., citing 3 W. Fletcher, § 819 at 90 (footnotes omitted); see also FDIC v. Aetna Cas. & Surety Co.,

426 F.2d 729, 744 (5 Cir. 1970) (holding that, under Texas law, the knowledge of defendantth

directors could not be imputed to the wronged corporation as such directors were acting adversely

to its interest).

Prescription

In the case of In re Magnesium Corp. of America, the defendants moved to dismiss the

trustee’s derivative D & O claim, inter alia, on the basis that the applicable statute of limitations had

14

run prior to the trustee filing suit. 399 B.R. 722 (Bankr. S.D.N.Y. 2009). The trustee, however,

alleged that all of the debtor’s officers and directors were culpable with respect to the causes of

action set forth in his complaint and remained in corporate control until the limitations period

expired. Therefore, the trustee argued, absent an innocent member of management, the debtor

company could not have “known” of the existence of its causes of action until an empowered

outsider was brought in. Addressing this issue, the Bankruptcy Court opined:

In considering the application of the statutory discovery rule in § 78-12-27, the UtahSupreme Court has explained how a corporation “discovers” wrongdoing by its owninsiders for the purposes of tolling the statute of limitations:

A corporation discovers wrongdoing by its officers, directors orcontrolling shareholders through outside shareholders or independentdirectors. “Discovery” of breach of fiduciary duty thus has twocomponents: The shareholders or directors must have knowledge ofthe wrongdoing or facts that put them on inquiry and must besufficiently independent to be able to assert a claim on behalf of thecorporation.

Id. at 746; see also AIG, Inc. v. Greenburg, 965 A.2d 763, 806 - 807 (2009) (holding that where

“officers and directors have disabling conflicts that give them an interest in hiding information from

a corporation’s independent directors and stockholders, the conflicted fiduciary’s knowledge is not

imputed to the corporation for purposes of holding those fiduciaries liable for the harm they caused

to the corporation.”)

- Louisiana law also recognizes this exception to the “imputation rule.” In Leurey v. Bank of

Baton Rouge, the Louisiana Supreme Court held that the knowledge of an officer of a corporation

will not be imputed to the corporation, if he could not reasonably be expected to act on the

knowledge or communicate it to the corporation such as when he is acting adversely to the

corporation’s best interest. 58 So. 1022, 1025-26 (La. 1912); see also 1 La. Prac. Corp. § 7:155

15

(2008 - 2009 ed.) (same).

- Although Louisiana law is not well developed, nearby Texas follows the “majority” version

of the adverse domination doctrine which requires that, in order for a limitations period to run

against a corporation’s right of action against one of its own directors, two things must occur: (1)

notice (2) to a disinterested majority of its board members. See FDIC v. Dawson, 4 F.3d 1303, 1310

(5 Cir. 1993). Also, courts have generally held that a corporation “likewise cannot reasonably beth

expected to pursue a claim against those who aided and abetted the controlling wrongdoers or acted

in concert with them, until the controlling wrongdoers are no longer in control.” In re Adelphia

Communications Corp., 365 B.R. 24, 58-59 (Bankr. S.D. N.Y. 2007).

- NOTE: In some jursidictions there is an exception to the “adverse domination” exception:

namely the “sole actor” exception, which holds that if the wrongdoer principals are the sole

representatives or “alter ego” of the corporation, their wrongdoing will be imputed to the corporation

even when they act adversely to it. Similarly, the “Wagoner Rule,” a creature of New York state

law, provides that, under certain circumstances, if there is no damage to the corporation, or

alternatively, if the corporation is run by one person who is the “sole shareholder and decision

maker,” a trustee has no standing to sue third parties. See In re Magnesium Corp. Of Amer., 399

B.R. 722, 756-766 (Bankr. S.D.N.Y. 2009).

I. Application of State Law Wage Exemption to Lost Wages Component of InjuryClaim

Judge Magner, Bankruptcy Judge for the Eastern District of Louisiana, has in In re Burns,

482 B.R. 164, 167 (Bankr. E.D. La. October 5, 2012) determined that, under Louisiana law, the

portion of settlement proceeds representing reimbursement for prepetition wages lost as a result of

16

debtor’s medical condition constitute exempt “disposable earnings.” Even though the debtor no

longer worked, the court found the proceeds in question were a substitute for lost exempt property.

NOTE: In Burns, Judge Magner provides an intelligent review and criticism of another case

out of the Middle District of Louisiana, In re Ballard, 238 B.R. 610 (Bankr. M.D. La. 1999) which

reached a different result. In Ballard, the court held that the proceeds of a personal injury suit are

merely revenues or products of a non-exempt asset (i.e. a personal injury cause of action), thus the

proceeds should also be non-exempt. In re Burns found, however, that disallowing the LA wage

exemption on an award for loss of earnings is contrary to the purpose of the exemption.

J. Settlements Require Court Approval

Rule 9019 of the Federal Rules of Bankruptcy Procedure provides that, on motion by the

trustee [or debtor in possession] and after a hearing on not less than twenty-one days’ notice by mail

to creditors, the U.S. Trustee, the debtor, and to such other entities as the Court may designate, the

Court may approve a compromise or settlement.

- In deciding whether to approve a proposed settlement, the bankruptcy court considers the

following five factors:

(1) The probability of success in the litigation;

(2) The likely difficulties in collection;

(3) The complexity of the litigation;

(4) The expense, inconvenience, and delay necessarily attending it; and

(5) The paramount interest of the creditors.

In re Jackson Brewing Co., 624 F.2d 605, 607 (5 Cir. 1980). th

- Courts are split as to whether bankruptcy court approval is discretionary or mandatory.

17

Although the statute itself states that the court “may” approve a compromise, the following decisions

hold that a settlement or compromise is not binding, enforceable, or effective unless approved by the

bankruptcy court. In re Rothwell, 159 B.R. 374 (Bankr. D. Mass. 1993); In re Handy & Harman

Refining Group, Inc., 304 B.R. 49, 146 (Bankr. D. Conn. 2004); In re Cincinnati Microwave, Inc.,

210 B.R. 130 (Bankr. S.D. Ohio 1997); In re Bramham, 38 B.R. 459 (Bankr. D. Nev. 1984); In re

Degenaars, 261 B.R. 316 (Bankr. M.D. Fla. 2001).

- Other courts hold that court approval of a settlement or compromise is discretionary and not

mandatory. In re Novak, 383 B.R. 660 (Bankr. W.D. Mich. 2008).

Although the Fifth Circuit has not directly addressed this issue, the prudent course is always

to obtain bankruptcy court approval of settlements. If nothing else, it is a safe harbor for your client.

- The court may approve a settlement regarding a debtor’s claim against one defendant and

enjoin non-settling defendants from asserting contribution and indemnification claims against the

settling defendant. See In re Munford, Inc., 93 F.3d 449 (11 Cir. 1996). th

K. Arbitration

Bankruptcy Rule 9019 also provides that “[o]n stipulation of the parties to any controversy

affecting the estate, the Court may authorize the matter to be submitted to a final and binding

arbitration period.”

II. WHEN YOUR OPPONENT, THE DEFENDANT, FILES FOR BANKRUPTCYRELIEF

A. The Automatic Stay

11 U.S.C. § 362(a) creates a stay of -

- The commencement of continuation (including the issuance or employmentof process)

18

- of a judicial, administrative, or other action or proceeding

- against the debtor that was or could have been commenced before thecommencement of the case under this title,

- or to recover a claim against the debtor that arose before the commencement of thecase under this title.

This stay applies to actions (1) against the debtor, (2) against the debtor’s property, and (3) against

estate property.

1. Purpose of Stay

The automatic stay has two primary purposes: To give the debtor a “breathing spell” from

creditors and to protect creditors by avoiding a “race to the courthouse” to foreclose on the debtor’s

assets and instead, providing for an orderly liquidation or other distribution procedure.

2. Actions Stayed and Not Stayed

Stayed

- The commencement or continuation (including appeals!) of any judicial or

administrative action or other proceeding (i.e. physician or accountant panel

proceeding) against the debtor that could have been commenced before the

case.

- Civil contempt actions. In re Atkins, 176 B.R. 998, 1006 (Bankr. D. Minn.

1994).

Not Stayed

- § 362 is not applicable to pursuit of the debtor’s claims. See In re U.S.

Abatement Corp., 157 B.R. 278 (E.D. La. 1993), judgment aff’d, 39 F.3d 563

(5 Cir. 1994). (Although standing may be an issue!)th

19

- Debtor’s cross-claim against co-defendant for contribution is not stayed.

Boone v. Beacon Bldg. Corp., 613 F.Supp. 1151, 1155 (D.N.J. 1985).

- There is no stay of action against non-debtor parties to litigation. Matter of

S.I. Acquisition, Inc., 817 F.2d 1142 (5 Cir. 1987). This is true even if thoseth

other parties are in a similar legal or factual nexus with the debtor. Seiko

Epson Corp. v. Nu-Kote International, Inc., 190 F.3d 1360, 1364 (Fed. Cir.

1999). However, see limited co-debtor stay provisions applicable to

collection of certain consumer debts, found at 11 U.S.C. § 1301.

EXCEPTION: While ordinarily, the automatic stay under § 362 does not apply to actions

against a nondebtor, In re TXNB Internal Case, 483 F.3d 292, 301 (5 Cir. 2007), courts recognizeth

that it may, in very limited situations, apply to an action against nondebtor defendants depending on

their relationship to the debtor. See Reliant Energy Servs., Inc. v. Enron Can. Corp., 349 F.3d 816,

825 (5 Cir. 2003) (“[A] bankruptcy court may invoke § 362 to stay proceedings againstth

nonbankrupt codefendants where ‘there is such an identity between the debtor and the third-party

defendant that the debtor may be said to be the real party defendant and that a judgment against the

third-party defendant will in effect be a judgment or finding against the debtor.” (quoting A.H.

Robins Co. v. Piccinin, 788 F.2d 994, 999 (4 Cir. 1986))). th

- It has also been held that bankruptcy courts, in the exercise of their authority to enter

necessary or appropriate orders, may extend the automatic stay to enjoin suits against third parties,

if the suits threaten to thwart or frustrate the debtor’s reorganization efforts.

- The party invoking the stay has the burden to show it is applicable. See 2 William L. Norton,

Jr., Norton Bankruptcy Law and Practice § 43:4 (3d ed. Supp.2010); see also Arnold v. Garlock, Inc.,

20

278 F.3d 426, 436 (5 Cir. 2001).th

3. Consequences of Stay Violation

Generally, actions taken in violation of the automatic stay are void. Moreover, a party may

be liable for sanctions for violating the automatic stay, even if the violation was inadvertent. A

willful violation of a stay entitles the debtor to recover actual damages, including costs and

attorney’s fees and, in appropriate circumstances, punitive damages. 11 U.S.C. § 362(k).

B. Discharge and Dischargeability

“Discharge” in bankruptcy usually occurs within 3 - 6 months after the bankruptcy is filed

in chapter 7. In individual chapter 11 and 13 cases, the discharge does not occur until the debtor

completes all payments under the court-approved repayment plan.

Because the discharge releases the debtor of personal liability for certain types of debt, your

client may be forever barred from bringing claims or recovering damages from the debtor. 11 U.S.C.

§ 524.

The Bankruptcy Code does provide exceptions to the debtor’s discharge, however, including

claims for false representations and fraud (11 U.S.C. § 523(a)(2) and (4)); for willful and malicious

injury by the debtor to another (§§ 523(a)(6)); for injuries caused by the debtor driving under the

influence of alcohol or drugs (523(a)(9)); and for liabilities to a pension, or certain other plan in

certain instances resulting from federal securities law violations or fraud. (§ 523(a)(18)).

1. Objecting to the Dischargeability of a Debt

Bring a Law Suit

- Under Section 523(a), a creditor must object to the discharge of a particular debt through an

adversary proceeding. Fed. R. Bankr. Pro. 7001; see also In re Kennerley, 995 F.2d 145, 146-47 (9th

21

Cir. Cal. 1993) (A motion to lift the automatic stay is not either a valid complaint to determine

dischargeability or a motion to extend the deadline under Bankr. R. 4007(c)).

Bring the Suit Timely

- For causes of action within the exclusive jurisdiction of the bankruptcy court, the complaint

objecting to the dischargeability of a debt must be filed “not later than 60 days following the first

date set for the meeting of creditors held pursuant to § 341(a).” Fed. R. Bankr. P. 4007(c).

- A motion to extend the 60-day period must be made prior to the end of the period and must

be made by the creditor. Fed. R. Bankr. P. 9006(b)(3).

NOTE: Unless the creditor relies upon an incorrect bar date being provided by the court, the

bankruptcy court will not allow the late filing of a claim objecting to discharge. Neeley v.

Murchison, 815 F.2d 345 (5 Cir. 1987) (i.e., no excusable neglect).th

- Under Bankruptcy Rule 1019(2), if a Chapter 11 case is converted to Chapter 7, a new filing

period commences. If the Chapter 11 case partially concluded by way of a confirmed plan that

discharged the debt, the new time period can be used only for post confirmation issues of discharge.

In re Pavlovich, 952 F.2d 114 (5 Cir. La. 1992) (conversion to Chapter 7 after confirmation ofth

individual debtor’s Chapter 11 plan precludes creditors whose claims were dealt with under the plan

from challenging discharge or disability). Although, if a case started as a Chapter 7, converts to a

Chapter 11 and then is coverted back to a Chapter 7, the reconversion will not start a new period.

See In re Jones, 966 F.2d 169 (5 Cir. Tex. 1992) (reconversion did start a new period for filingth

objections to discharge pursuant to Fed. R. Bankr. P. 1019(2) and 4004).

If You Don’t Know the Bar Date, Find it out

A creditor with actual notice of the bankruptcy but not the bar date must take reasonable steps

22

to ascertain the bar date or lose the right to object. In re Sam, 894 F.2d 778 (5 Cir. 1990).th

2. Objecting to Discharge

Section 727 of the Bankruptcy Code provides for the denial of the debtor’s discharge in

Chapter 7 cases. This denial of discharge relates to all of the debtor’s debts, not just the debt owed

to your client. Section 1328 provides for the denial of the debtor’s discharge in Chapter 13 cases.

Section 727 requires the court to grant the debtor a discharge unless one of eight conditions is met.

- The first condition is that the debtor is not an individual. This means that corporations,

limited liability companies, and partnerships cannot be discharged in liquidation cases. However,

to the extent that the company’s assets are being distributed in the bankruptcy, this should have no

effect on your client’s recovery, unless the entity resumes business after the bankruptcy case is

closed.

- The next three grounds for denial of discharge center on the debtor’s wrongdoing in, or in

connection with, the bankruptcy case.

- The fifth ground for denial of discharge is a failure of the debtor to explain satisfactorily any

loss of assets or deficiency of assets.

- The sixth ground concerns refusal to testify.

- The seventh ground for denial of discharge is the commission of an act specified in grounds

two through six during the period before the debtor’s case in connection with another bankruptcy

case concerning an insider.

- Finally, if the debtor has been granted a discharge in another case within six years preceding

the present bankruptcy case, discharge will be denied.

- As is the case with § 523 complaints, the time for filing a complaint objecting to discharge

23

relating to prior bankruptcy filings is 60 days after the first date set for the meeting of creditors,

regardless of when the meeting is actually held. See Federal Rule of Bankruptcy Procedure 4004(a);

see also Advisory Committee Note - 1999 Amendment. Parties in interest have the right to file a

motion for an extension of time to file a complaint objecting to discharge in accordance with Rule

4004(b).

- In a Chapter 11 case, the complaint objecting to discharge shall be filed no later than the first

date set for the hearing on confirmation. See Bankruptcy Rule 4004(a).

- In a Chapter 13 case, a motion objecting to the debtor’s discharge shall be filed no later than

60 days after the first date set for the meeting of creditors. It is 60 days for filing a motion under §

727(a)(8) or (a)(9) (i.e. that the debtor has already been granted a discharge).

Parties in interest may request revocation of a debtor’s discharge for other fraud and bad acts

within one year after the discharge is granted or under circumstances before the later of

- one year after the granting of the debtor’s discharge; and

- the date the case is closed.

C. Claims Estimation

Section 502 of the Bankruptcy Code, along with Rules 3001 et seq. of the Federal Rules of

Bankruptcy Procedure, address the allowance and disallowance of claims. Under § 502(a), a claim

is “deemed allowed” if no one objects to it, as the proof of claim is prima facie evidence of the

claim. If a party in interest does object, the court generally determines the validity and the amount

of the claim. The amount of the claim is determined as of the date of the filing of the bankruptcy

petition.

Section 502(c) authorizes courts to estimate “any contingent or unliquidated claim, the fixing

24

or liquidation of which, as the case may be, would unduly delay the administration of the case.”

D. Alter Ego and Single Business Enterprise Claims Belong to the Estate

Any alter ego or single business enterprises claims that can be asserted by any of the debtor’s

creditors are property of the debtor’s bankruptcy estate and thus may only be pursued by the debtor’s

Trustee on behalf of all creditors. See In re Schimmelpennick, 183 F.3d 347, 359 (5 Cir. 1999);th

see also, In re Bell & Beckwith, 64 B.R. 144, 147 (Bankr. N.D. Ohio 1986) (“any cause of action

which has accrued to the Debtor as of the filing of the petition is property of the estate and may only

be prosecuted on behalf of the estate”); In re S.I. Acquisition, Inc., 817 F.2d 1142 (5 Cir. 1987)th

(Creditors cannot (i) bring causes of action that belong to a corporate debtor, or (ii) recover or

control of property of the corporate debtor.); In re Seven Seas Petroleum, Inc., 522 F.3d 575, 584 (5th

Cir. 1994) (If a cause of action alleges only indirect harm to a creditor, and the debtor could have

raised a claims for its direct injury under applicable law, then the cause of action belongs to the

estate.).

E. Insurance Coverage

Upon the filing of a bankruptcy petition, the debtor’s insurance policies automatically

become property of the estate. 11 U.S. C. § 541(a). If an insurance contract contains a provision that

attempts to terminate the policy if the insured files bankruptcy, that provision is void under the

Bankruptcy Code. See 11 U.S.C. § 541(c)(1)(B).

Are the proceeds of insurance policies property of the estate? That depends on whether the

debtor, or someone else, is entitled to those proceeds.

- When a state court plaintiff is asserting a liability claim against a debtor, courts will usually

permit the plaintiff to proceed against the debtor’s liability insurer in a direct action. Although in

25

this situation, the insurance proceeds would not be considered property of the estate, it is still

advisable to obtain a bankruptcy court order acknowledging that § 362 does not operate as a stay of

the action against the insurer. Frequently, debtor’s counsel will consent to such an order, especially

if the plaintiff agrees not to pursue the debtor’s estate.

- Indemnity insurance is different from general liability insurance because indemnity insurance

is paid directly to the debtor. In the D&O insurance context, courts are divided as to whether

indemnification proceeds should be considered property of the estate. Some courts have found that

when coverage limits are depleted by requested indemnification, which could render the policyholder

without coverage for future indemnification demands, the indemnification proceeds should be

considered estate property.

Some courts have held that if there is a risk that policy limits will not be sufficient to fund

payment to claimants, the policy proceeds should be considered property of the estate to ensure an

equitable distribution to all parties with covered claims. Id. at 55. In addition:

In the mass tort context, the decisions by several courts to include the proceeds asproperty of the estate appear to be motivated by a concern that the court would not otherwise be able to prevent a free-for-all against the insurer outside the bankruptcyproceeding . . .. There was also a threat that unless the policy proceeds, weremarshalled in the bankruptcy proceeding, they would not cover plaintiffs’ claims andwould expose the debtor’s estate. These concerns are answered once the court findsthat the policy itself is property of the estate. . . .

Id. at 56 n. 21 (citing First Fidelity Bank v. MaAteer, 985 F.2d 114 (3d Cir. 1993); McArthur Co.

v. Johns-Manville Corp., 837 F.2d 89 (2d Cir.), cert. denied, 488 U.S. 868 (1988); In re Louisiana

World Exposition, Inc., 832 F.2d 1391 (5 Cir. 1987); Tringali v. Hathaway Mach. Co., 796 F.2dth

553 (1 Cir. 1986); A.H. Robins Co. v. Piccinin, 788 F.2d 994 (4 Cir. 1985), cert. denied, 479 U.S.st th

876 (1986); In re Davis, 730 F.2d 176 (5 Cir. 1984); Wedgeworth v. Fibreboard Corp., 706 F.2dth

26

541 (5 Cir. 1983)).th

- Even if insurance proceeds are considered property of the estate, such proceeds will not be

distributed to all unsecured creditors on a pro-rata basis. Because property of the estate comes into

the estate subject to any and all restrictions applicable under state law (unless in direct conflict with

the Bankruptcy Code) insurance proceeds only get distributed to those whom the state insurance law

or the policies themselves, recognize have a right to receive such proceeds. See Landry v. Exxon

Pipeline Co., 260 B.R. 769, 787 n. 62 (Bankr. M.D. La. 2001).

- The overriding question when determining whether insurance proceeds are propertyof the estate is whether the debtor would have a right to receive and keep thoseproceeds when the insurer paid on a claim. . . . In other words, when the debtor hasno legally cognizable claim to the insurance proceeds, those proceeds are notproperty of the estate.

In re Edgeworth, 993 F.2d 51, 55 (5 Cir. 1993). As a general rule:th

- Examples of insurance policies whose proceeds are property of the estate includecasualty, collision, life, and fire insurance policies in which the debtor is abeneficiary. Proceeds of such insurance policies, if made payable to the debtor ratherthan a third party such as a creditor, are property of the estate and may inure to allbankruptcy creditors. But under the typical liability policy, the debtor will not havea cognizable interest in the proceeds of the policy. Those proceeds will normally bepayable only for the benefit of those harmed by the debtor under the terms of theinsurance contract.

Id. at 56.

F. The Effect of Confirmed Plans

Chapter 11 relieves the debtor from its liabilities in exchange for its promise to pay (money

or stock) to the creditors included in the confirmed plan. 11 U.S.C. § 1129(a)(7)(a)(ii). This

obligation to pay is a secured by the plan which has the force and effect of a federal district court

judgment. 11 U.S.C. § 1141(a); 28 U.S.C. § 151; In re National Gypsum, 257 B.R. 184, 203 (Bankr.

27

N.D. Tex. 2000). The plan binds everyone subject to it, including the creditors and other parties

subject to the court’s jurisdiction. Unless otherwise stated, the plan terminates the interest of the pre-

petition equity holders. Section 1141(d)(1)(B). The debtor emerges revested with its assets. Section

1141(b). The debts are discharged. Section 1141(d)(1)(A). The amount which creditors can expect

should equal or exceed what creditors would get in a Chapter 7.

1. Channeling

Mass tort defendants, asbestos producers and manufacturers, and or other uninsured or

underinsured defendants routinely file large scale Chapter 11's that culminate in a complex plan of

reorganization which typically provide for payments due mass tort victims from a trust fund which

is financed by newly issued common stock of the revested debtor.

Most mass tort plans “channel” the damage claims to a trust fund away from the debtor who

emerges from the plan as the revested debtor and ready to re-enter the commercial world,

unburdened by the billions of dollars in litigation liabilities. These multi-million or billion dollar

trust funds provide for compensation due hundreds of thousands or millions of claimants over a

period of many years.

The Bankruptcy Code was amended in 1994 to provide a procedure for the treatment of

present and future asbestos claims and to authorize “channeling injunctions” permitting claimants

to be directed toward trust funds created pursuant to plans of reorganization. See 11 U.S.C. §

524(g). While this provision is designed to permit the funding of a trust to deal with mass future

claimants, nothing in the Code requires that trusts are to be the sole method of compensating mass

future claimants.

28

2. Third Party Releases

Can the bankruptcy court grant a third-party release to nondebtor parties who make major

contributions to chapter 11 plans of reorganization where creditors and other parties in interest do

not consent?

The majority of circuit courts, which have ruled definitively, allow nonconsensual third-party

releases in chapter 11 plans under appropriate circumstances. These are the Seventh, Second, Sixth,

D.C., and Fourth Circuits. See e.g., Menard-Sanford v. Mabey (In Re A.H. Robbins Co., Inc.), 880

F.2d 694 (4 Circuit, 1989) (A Chapter 11 plan will extinguish by release, discharge, or injunctionth

the creditor’s claims against non debtors, such as the guarantors.), In re Dow Corning Corp., 280

F.3d 648, 658 (6 Circuit, 2001), and Airadigm Communications, Inc. v. Federal Communicationsth

Commission (In re Airadigm Communications, Inc.), 519 F.3d 640, 657 (7 Cir. 2008). th

The issue remains open in the Third and Second Circuits although those courts may allow

such releases. See Gillman v. Continental Airlines (In re Continental Airlines), 203 F.3d 203, 213-

14 (3d Cir. 2000) (noting that the hallmarks of permissible non-consensual third-parties releases are

fairness, necessity to the reorganization, and specific findings to support these conclusions).

The Ninth and the Tenth Circuits, however, never permit such releases. See e.g. Deutsche

Bank AG v. Mertromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F.3d 136,

142-43 (2d Cir. 2005) (noting that third-party releases may be allowed in unique circumstances, but

noting that such unique circumstances may exist where, for example, the estate receives substantial

consideration for the release, or where the plan provides for payment in full of the enjoined claims).

The Fifth Circuit probably would not permit third party releases. Although that court has not

directly addressed the issue, in In re Pacific Lumber Co., it addressed the issue of exculpation of non-

29

debtor third parties for actions taken after, and in connection with, the filing of the bankruptcy. Bank

of N.Y. Trust v. Office Unsecured Creditors’ Comm. (In re Pacific Lumber Co.), 584 F.3d 229, 252-

53 (5 Cir. 2009). The court determined that exculpation was inappropriate as to anyone other thanth

the unsecured creditors’ committee relying exclusively on § 524(e) of the Bankruptcy Code for the

proposition that non-consensual releases of non-debtors are not allowed. Section 524(e) of the

Bankruptcy Code provides a “discharge of a debtor does not affect the liability of any other entity

on . . . such debt.”

When asked to consider the more lenient approaches of other circuits to releases and

exculpations, particularly those that relate to the chapter 11 case and the plan, the Court incorrectly

concluded that other circuits only allow third-party releases and exculpations in cases involving

global settlements of mass claims against the debtor and co-liable parties.

In Pilgrim’s Pride Corporation, et al, 2010 Bankr. LEXIS 72 (Bankr. N.D. Tex., Jan. 14,

2010), the United States Bankruptcy Court for the Northern District of Texas relying on Pacific

Lumber, declined to approve releases and exculpations of debtors’ employees, officers, directors and

professionals, as well as other third parties (other than the creditors’ committee and its members and

professionals), even though Pilgrim’s Pride’s chapter 11 plan paid creditors in full in cash, and there

was no indication of bad conduct by any of the third parties or professionals. The Pilgrim’s Pride

court acknowledged that “a third-party exculpation provision arguably might be defended as justified

by the bankruptcy court’s equitable powers given by [section 105 of the Bankruptcy Code],” but it

felt constrained by Pacific Lumber to follow the Fifth Circuit precedent. Id. at 9.

G. Extension of Prescription

If a potential defendant to a civil action files for bankruptcy, thus staying the plaintiff’s filing

30

of a lawsuit, and the defendant’s bankruptcy is later dismissed without a discharge of the action, the

plaintiff has at least thirty days after notice that the automatic stay has ended (whether that be, i.e.,

through dismissal of the bankruptcy case, or an order denying discharge or dischargeability of

client’s debt) to file suit, irrespective of the fact that the prescriptive period may have run during the

pendency of the bankruptcy proceeding. 11 U.S.C. § 108(c).

NOTE: This Bankruptcy Code section provides for an “extension” on prescription. The Fifth Circuit

has held that it “does not create a separate tolling provision.” Rogers v. Corrosion Prod., Inc., 42

F.3d 292, 297 (5 Cir. 1995). Thus, 108(c) does not provide an interruption of prescription and allth

of the attendant consequences thereof.

H. Getting Court Approval for Settlements

If your client’s opponent is a debtor in bankruptcy, any settlement requires bankruptcy court

approval after notice and hearing pursuant to Bankruptcy Rule 9019. See discussion at Section I,

I, supra.

Class action settlements, however, must also satisfy Fed. Rule Civ. Pro. 23(e) which is made

applicable in adversary proceedings by Bankruptcy Rule 7023.

The Court has Different Perspectives in Reviewing Settlements Under Fed. R. Civ. P. 23(e) andBankruptcy Rule 9019.

1. Under Rule 23(e), the court’s focus is on fairness of the settlement from the standpoint of the

members of the class. Amchem Products, Inc. v. Windsor, 117 S.Ct. 2231, 2249 (1997);

Piambino v. Bailey, 610 F.2d 1306, 1327 (5 Cir.), cert denied, 101 S.Ct. 568 (1980).th

2. Under the Bankruptcy Rule 9019, the bankruptcy court must focus on fairness of the

settlement from the standpoint of the debtor’s estate. In re Refco, Inc., 505 F.3d 109, 119

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(2d Cir. 2007); CFB-5, Inc. v. Cunningham, 371 B.R. 175, 181 (N.D. Tex. 2007).

3. At least one court has held that bankruptcy courts can balance Rule 23(e) and Bankruptcy

Rule 9019 considerations. See In re World.com, Inc., 347 B.R. 123, 139-40 (Bankr.

S.D.N.Y. 2006) (concluding that “it is possible that the Settlement will fall within the

appropriate range of reasonableness or fairness as is required for each party and therefore

warrant approval under both Rule 23 and Rule 9109”).

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