Blog Posts
Bankruptcy
Splintering Door Frames (Almost) as U.S. Marshals Enforce Order of the Bankruptcy Court
Last month, Jim Hoffman of Offit Kurman, P.A., Counsel to Cheryl E. Rose, a Chapter 11 Bankruptcy Trustee, accompanied the U.S. Marshals and the Prince George’s County Police to the home of an uncooperative debtor to enforce a Bankruptcy Court order to seize his computers, computer equipment, books, records and other items that may assist Ms. Rose, as Trustee, to administer the Bankruptcy Estate (“Seizure Order”). Prior to that time, the Bankruptcy Court had the patience of Job – – month after month, the debtor broke promises to the Court and to the Trustee to cooperate when producing books and records for more than ten businesses that each own real estate. The debtor also liquidated and retained more than $150,000 of assets during the bankruptcy without Court approval. The Court issued orders to enforce contempt sanctions, but the debtor continued his obstructive behavior. Even a court-imposed detention with the Marshals for two days did not alter the debtor’s behavior. The Seizure Order drafted by Counsel was in the form of a Writ of Assistance. This relief is unusual and requires coordination among the Office of the U.S. Marshals, the Trustee, Counsel and others. The Marshals from the Greenbelt, MD, location were extraordinarily helpful. Ms. Rose coordinated the presence of a locksmith (to avoid splintering door frames), and the Marshals provided manpower and protection, although the debtor’s schedules stated that he had no firearms. The Marshals took no chances. Prior to the date of the seizure, the Marshals communicated with local police to determine whether outstanding warrants existed for the debtor. In fact, there was. So the Marshals, local police, a locksmith and Counsel appeared unannounced at the debtor’s residence worth more than $700,000. Counsel was told to stay far away as law enforcement approached the property. The Marshals called the debtor on two (2) different telephone lines and pounded on the door. No one answered. So the locksmith began drilling a lock behind a tactical shield, drilling – – later admitting it was not his best work under the eyes of so many spectators and the threat of gunfire. After the door was opened, law enforcement announced themselves. The debtor then appeared, claiming to be asleep (despite being fully dressed, television on). The local police arrested the debtor on a prior charge, and Counsel proceeded through the residence, gathering computers, thumb drives and 20 boxes of records. Counsel diligently searched looking for an external hard drive the debtor referenced at a hearing and for more thumb drives. Within the debtor’s nightstand, Mr. Hoffman found 20 rounds of ammunition – – right next to a thumb drive. After further searching, he located a handgun and two pellet guns. The Marshals called the local police again (they were processing the debtor on the prior charge). A policeman returned, took possession of the handgun and ammunition and then returned to the station to arrest, for a second time, the debtor on new charges. The debtor was a convicted felon and was not permitted to possess a weapon or ammunition. The Trustee and Counsel thank the Marshals, Prince George’s County police and others who bravely assisted in the enforcement of the Bankruptcy Court’s Seizure Order. Who said the practice of law was dull?
September 2, 2022
Bankruptcy
Chapter 7 Trustee's Perspective: Selling Litigation in Bankruptcy is Prohibited?
A Chapter 7 bankruptcy trustee may receive the opportunity to pursue a large claim for an avoidable transfer, such as a fraudulent conveyance, a preferential transfer or a pre-petition claim that the debtor holds. However, such litigation may be expensive to pursue and there may be a large risk of loss. Should the trustee engage in “Bet the Farm” litigation at the trustee’s personal financial risk when outside counsel will not accept the case on a contingency fee basis and there are no other assets in the Estate? Should the trustee abandon the claim to the detriment of the creditors? The best alternative may be to sell the litigation, but is the sale barred by old common law principles? This scenario involves the principles of maintenance, champerty and barratry (the “Principles”), which trace back supposedly to ancient Greece. The Supreme Court found that 1) maintenance is helping another prosecute a suit; 2) champerty is maintaining a suit in return for a financial interest in the outcome, and 3) barratry is a continuing practice of maintenance or champerty. In re Primus, 436 U.S. 412, 425 (1978). The Principles were intended to prevent the manufacturing of frivolous or vexatious litigation. The fifty states are not uniform in their treatment of the Principles, with some states upholding the common law doctrines of champerty and maintenance in some form[1] and others having abolished the doctrine altogether or not recognizing it.[2] According to the Fourth Circuit, most jurisdictions no longer recognize causes of action for damages based on champerty and maintenance and such actions arose only where the alleged wrongdoer had no interest in the litigation.American Hotel Management Associates, Inc. v. Jones, 768 F.2d 562, 570 (4th Cir.1985), but Maryland still does. See Rojas v. Huntington Neighborhood Ass'n, No. DLB-21-28, 2022 WL 616815, at *4 (D. Md. Mar. 1, 2022). Similarly, see In re DesignLine Corp., 565 B.R. 341 (Bankr. W.D.N.C. 2017) (holding that a proposed agreement between trustee and entity that had agreed to finance trustee's pursuit of litigation against debtor's insiders was prohibited by champerty under North Carolina law and could not be approved.) Of course, the bankruptcy court may need to address which state law to apply in any case. See Koro Co., Inc. v. Bristol-Myers Co., 568 F.Supp. 280 (D.D.C. 1983) (the court determined that New York law of champerty, rather than New Jersey law, applied to invalidate the assignment of claims.) Also, see Riffin v. Consol. Rail Corp., 363 F. Supp. 3d 569, 575 (E.D. Pa.), aff'd, 783 F. App'x 246 (3d Cir. 2019) Barratry and the other Principles may be defined by statute in some states and may cover a multitude of sins. See e.g. Md. Bus. Occ. & Prof. Code Ann. § 10-604(b).[3] As stated by the District Court of Maryland, the conduct proscribed by the current statute was first made a statutory offense in Maryland in 1908. “Before then, the officious stirring up of, maintaining, or meddling in litigation in which a person had no interest constituted the common law crime of barratry, maintenance, champerty, or embracery, depending on the particular nature of the conduct.” Abbott v. Gordon, No. CIV.A. DKC 09-0372, 2011 WL 828646, at *17 (D. Md. Mar. 7, 2011). Both champerty and barratry require proof that the intermeddler expected to personally gain from or share in the outcome of the litigation. Now let’s go back to our creative and diligent Chapter 7 trustee. In the case of In re Simply Essentials LLC, No. 20-305, 2022 WL 1026045 (Bankr. N.D. Iowa Apr. 5, 2022), the trustee proposed a sale of a potential worthwhile avoidance action against a creditor to another creditor that would litigate those suits in the best interest of the estate. The trustee sought authorization to sell the right to bring avoidance actions under Chapter 5 of the Bankruptcy Code regarding preferential and fraudulent transfers. The trustee believed the claims could provide the estate with a large recovery, but the Estate could not afford to pursue them. The bankruptcy court approved a settlement under which the trustee would sell the Estate’s right to bring avoidance claims to a creditor holding a $23.4 million claim over the potential defendant’s competing offer. The Court overruled an objection that these claims were not included in “property of the estate” and recognized the practicalities of the situation stating that: "To allow parties otherwise facing meritorious … avoidance claims to escape those claims because the trustee cannot afford to pursue them and they cannot be sold or transferred would be an absurd result.” The court reasoned that Section 541(a)(7) of the Bankruptcy Code recognizes these claims as assets of the Estate that can be sold under Section 363(f) of the Bankruptcy Code and B.R. 9019(b). Regardless of whether a debtor or creditor opposes or supports the sale of litigation in bankruptcy by a trustee, one should not forget to check the applicable statute or the common law Principles under governing law before making an argument to the court. [1] These states include, among others, the bankruptcy-friendly Delaware and New York as well as Alaska, D.C., Florida, Kentucky, Maine, Maryland, Mississippi, New York and Pennsylvania. [2]Arizona, California, Connecticut, New Jersey, New Hampshire, New Mexico, Oklahoma, Texas and recently Minnesota, among others, do not recognize the principles. [3] (b) Without an existing relationship or interest in an issue: (1) a person may not, for personal gain, solicit another person to sue or to retain a lawyer to represent the other person in a lawsuit; (2) a person who is not a lawyer may not, for personal gain, access a report for the purpose of soliciting another person to sue or to retain a lawyer to represent the other person; and (3) a lawyer, except as provided in the Rules of Professional Conduct, may not: (i) for personal gain, solicit another person to sue or to retain a lawyer to represent the person in a lawsuit; (ii) directly or indirectly employ or in any way compensate or agree to employ or compensate any person as an expert witness or otherwise for the purpose of having that person solicit or attempt to solicit clients for the lawyer; (iii) knowingly represent a person who retained the lawyer as a result of solicitation prohibited under this section; or (iv) cause a case to be instituted without the authority of a client.(c) Any solicitation involving acts described in this section is prima facie evidence that the person soliciting is acting for gain. (1) a person may not, for personal gain, solicit another person to sue or to retain a lawyer to represent the other person in a lawsuit; (2) a person who is not a lawyer may not, for personal gain, access a report for the purpose of soliciting another person to sue or to retain a lawyer to represent the other person; and (3) a lawyer, except as provided in the Rules of Professional Conduct, may not: (i) for personal gain, solicit another person to sue or to retain a lawyer to represent the person in a lawsuit; (ii) directly or indirectly employ or in any way compensate or agree to employ or compensate any person as an expert witness or otherwise for the purpose of having that person solicit or attempt to solicit clients for the lawyer; (iii) knowingly represent a person who retained the lawyer as a result of solicitation prohibited under this section; or (iv) cause a case to be instituted without the authority of a client.(c) Any solicitation involving acts described in this section is prima facie evidence that the person soliciting is acting for gain.
May 27, 2022
Bankruptcy
Lenders Beware
WHEN IS A LENDER CROSSING THE LINE AND ENTERING LENDER LIABILITY WONDERLAND? A 2022 decision out of a bankruptcy court in Texas reminded lenders that an overly aggressive approach to a borrower can result in lender liability[1] and substantial damages. In this case, brought by a Chapter 7 trustee, the bankruptcy court concluded that the lender destroyed the debtor’s enterprise value and future as a going concern and ultimately drove the debtor out of business. The Court found that for the lender’s actions, the debtor would not have failed as a going concern and would not have had to file bankruptcy. As a result, the Court awarded $16,966,928 in damages for breach of contract and breach of the duty of good faith and fair dealing, fraudulent misrepresentation, contractual and business interference, and willful violation of the automatic stay. The lender unsuccessfully tried to argue that the debtor was dead on arrival. [1] As the bankruptcy court put it, “[l]ender liability” is a broad umbrella term often used to describe various theories through which a borrower (or its trustee in bankruptcy) seeks to impose liability (or a remedy of some sort) against a former lender in a lending relationship that has soured.” THE STORY BEHIND THE AWARD Bailey Tool & Manufacturing Company and its subsidiaries and affiliates (“Bailey”) was the debtor/borrower in this tragic story. Republic Business Credit, LLC (“Republic”) was the lender. Before filing bankruptcy, Bailey and Republic entered into a factoring arrangement and an asset-based loan facility in February 2015. Republic performed substantial diligence in late 2014 and early 2015 before entering into the agreements. During the due diligence process, Republic had identified several issues, including unpaid ad valorem taxes, stretched accounts payable, and a major customer (the Department of Defense) that paid on a milestone rather than progressive billing basis. Despite these issues, the underwriter viewed the proposed transaction as a “strong deal” and approved it. Four months after entering into the agreements, Republic refused to advance funds as expected, declared default and made payments to itself from Bailey’s lockbox under the factoring agreement to pay down the ABL (Asset Based Lending) facility. The Court found that Republic took complete and total control of Bailey’s cash. It controlled not only the collections through the lockbox and all disbursements too. All funds advanced from July 2015 forward were sent directly to vendors selected by Republic vendors and a payroll company for the payroll of employees selected by Republic. The Court held that the lender’s handling of disbursement was inconsistent with the parties’ agreements—specifically, the Factoring Agreements contemplated that Republic would “pay to Seller [Bailey] an Advance.” In September 2015, Republic stopped funding altogether. Republic also became involved in replacing management and otherwise micromanaging the Debtor. It forced the Debtor’s Chief Executive Officer to give the Republic a lien on his exempt homestead. THE DECISION In a meticulous 145-page decision, the Court analyzed the Republic’s conduct, including and highlighting numerous internal lender email communications produced in discovery and presented during the trial. The Court adopted the bankruptcy trustee’s theory of the case, i.e. that the lender: (i) refused to advance funds in good faith and in the manner promised almost immediately after the agreements were signed taking a stance that the businesses were in an “over-advanced” position, which was not a defined concept in the agreements and was problematic in light of several weeks of due diligence and awareness regarding certain slow-paying accounts and inventory status; (ii) charged fees, expenses, penalties and other items against “reserves” (contributing to the alleged “over-advanced” position), without any transparency; (iii) exercised excessive control over the businesses by controlling what vendors, employees, and expenses got paid and insisting on direct payments to them by the factoring company rather than funding to the businesses as contemplated by the underlying agreements (i.e., the argument being that this was an improper exertion of control; there were no amendments of documents or forbearance agreements to justify deviating from the underlying agreements). WHAT ACTION TO AVOID AS A LENDER This decision can now serve as a roadmap for borrowers to establish lender liability. In summary, the factors considered by the Court include: Taking over the business function and exercising business judgment – Without the requisite knowledge and experience, Republic approved payments to certain vendors and materials suppliers, reordered the sequence in which different products at Bailey were manufactured, and changed the manufacturing priorities from keeping long-term customers, to doing “quick-turn” projects; Controlling the workforce at Bailey through controlling the payroll and ordering who got paid and who did not and what types or classifications of employees could get paid; Directing vendors of Bailey to pay Republic instead of Bailey under the threat of litigation, destroying the goodwill that Bailey had built up with these vendors; Lack of transparency and misrepresentations as to why: (i) why it considered Bailey to be in default, (ii) the status of funds availability or lack thereof, (iii) application of funds collected and charging numerous fees and expenses. The conduct of the lender, in this case, appears egregious. Still, it is a reminder for lenders to closely review with counsel contractual remedies and exercise caution in implementing these remedies.
March 31, 2022
