4th Circuit

In re Stanley; Case No. 10-50152; August 19th, 2010

Paying off non-filing spouse’s creditors in a Chapter 13 not good faith

Mr. Stanley, a below median debtor, filed a Chapter 13 bankruptcy by himself, although he was married.  He held a low paying job and his wife did not work, though she did receive unemployment compensation.  Most of her compensation went towards her own outstanding debt and Mr. Stanley’s income funded the Chapter 13 plan and paid their joint expenses.

The Trustee objected to confirmation of the plan on the basis that §1325(a)(3) of the bankruptcy code requires that a Chapter 13 plan be “proposed in good faith and not by any means forbidden by law.”  The Court noted that “good faith” is not defined and the Bankruptcy Code, but noted with approval Collier on Bankruptcy, which says “[w]hile no precise definition can be sculpted to fit the term ‘good faith’ for every Chapter 13 case . . ., ‘the basic inquiry should be whether or not under the circumstances of the case there has been an abuse of the provisions, purpose, or spirit of [the Chapter] in the proposal or plan.”  Collier on Bankruptcy, 9.20 at 319 (14th ed. 1978).   Good faith is determined on a case-by-case basis by examining the totality of the circumstances.

The court went on to cite  In re Solomon, 67 F.3d 1128, 1134 (4th Cir.1995), listed the factors of this totality of the circumstances inquiry:

1.  the percentage of proposed repayment to creditors,

2.  the debtor’s financial situation,

3.  the period of time over which creditors will be paid,

4.  the debtor’s employment history and prospects,

5.  the nature and amount of unsecured claims,

6.  the debtor’s past bankruptcy filings,

7.  the debtor’s honesty in representing the facts of the case,

8.  the nature of the debtor’s pre-petition conduct that gave rise to the debts,

9.  whether the debts would be dischargeable in a Chapter 7 proceeding, and

10. any other unusual or exceptional problems the debtor faces.

Solomon, 67 F.3d at 1134.

The court noted that the income and expenses of the non-filing spouse should be considered in determining whether a plan has been proposed in good faith under §1325(a)(3).  The income of a non-filing spouse is also regularly and properly considered in determining a debtor’s disposable income in a case under §707(b).

In this case, the court has a problem with the Debtor’s spouse paying her creditors in full while the debtor pays only 9% to his creditors, while coving all of their joint expenses.  With respect to the §1325(a)(3) objection, the court sustains the Trustees objection and denies confirmation.  “The proposed payment of a substantially higher dividend to the creditors of the non-filing spouse raises a serious question of good faith, which the court must view in the totality of the circumstances.

The court also, noting the non-filing spouse’s unemployment income was running out in two months and denied confirmation on feasibility grounds, §1325(a)(6), “a plan may be confirmed only if. .  .the debtor will be able to make all payments under the plan and to comply with the plan.”

United States v. Wolff; Case No. 09-1107; August 13th, 2010

Funds Held for Another in Bankruptcy and Amendment of Pleadings

The procedural history for this case is rather convoluted, but ultimately, this case involved the involuntary Chapter 7 bankruptcy of FirstPay, a company that provided payroll services to businesses.  FirstPay also made the proper withholding and then made the proper payments of the withholding to the IRS at the proper time.

The company began using money intended for the IRS for its own expenses.  The company then developed a sort of “ponzi scheme” using funds from some clients to pay the IRS obligations of other clients to make up for the funds that were taken.

The Trustee estimated that there were payments made to the IRS of about $300 million dollars within the three years preceding FirstPay’s bankruptcy, of which $28 million was transferred in the 90 days preceding the filing of the bankruptcy petition.

The Trustee sued the IRS on four separate grounds:

1.         for declaratory judgment that the US has no claim for taxes, interest or penalties against FirstPay clients whose payroll taxes were paid to FirstPay but not remitted to the United States’

2.         avoidance of preferences under 11 USC §547(b)(4)(A) and (B);

3.         avoidance as fraudulent conveyances under §548 and Maryland law; and

4.         turnover of preferences and/or avoided transfers under §550.

With respect to the turnover preferences, the court looked at the principles of bankruptcy law, ie “that creditors of equal priority should receive pro rata shares of the debtor’s property.”  Begier v. IRS, 496 U.S. 53, 58 (1990).  The question becomes, what is property of the estate?  Under §541(a)(1), the commencement of a bankruptcy action creates an estate, “comprised of all legal or equitable interests of the debtor in property as of the commencement of the case.”  However, “property in which the debtor holds. . . only legal title and not an equitable interest. . . becomes property of the estate only to the extent of the debtor’s legal title to the property, but not to the extent of any equitable interest in such property that the debtor does not hold.”  11 USC § 541(d).

The Court cited a similar case out of the First Circuit that found that “the plain text of §541(d) excludes property from the estate where the bankrupt entity is only a delivery vehicle and lacks any equitable interest in the property it delivers.”  City of Springfield v. Ostrander, 329 F.3d 204, 210 (1st Cir. 2003).

The Court ultimately held that the Bankruptcy Court needed to take a closer look at the status of the payments held for the government; specifically, whether that property was held in trust for the government, or became the property of the debtor that was then transferred to the government.

With respect to the claims dealing with the tax obligation of third party, the court declined to change the ruling of the lower courts and affirmed “substantially for the reasons stated,” that the Trustee lacked standing to assert a claim against the government on behalf of the Debtor’s clients and that section 505(a) does not extend the bankruptcy court’s jurisdiction to parties other than the debtor.

Finally, the court addressed the District court’s ruling preventing the government from amending its answer to the Complaint to allow the entry of an affirmative defense.  The Court noted that “[w]hen a party fails to assert an affirmative defense in the appropriate pleading, such a failure will sometimes result in a binding waiver.”  Emergency One, Inc. v. American Fire Eagle Engine Co., Inc., 332 F.3d 264, 271 (4th Cir. 2003).  The court went on to point out that it had, “nevertheless,. . . observed that where there is a waiver, it ‘should not be effective unless the failure to plead resulted in unfair surprise or prejudice.”  S. Wallace Edwards & Sons, Inc. v. Cincinnati Ins. Co., 353 F. 3d 367, 373 (4th Cir. 2003).  The court then cited a “longstanding approach to the liberal amendment of pleadings in the absence of undue prejudice” which “applies equally to amendments to assert affirmative defenses.”

The Court then remanded the case for further proceedings.

Anderson v. Suntrust; Case No. 09-02540; August 5th, 2010

Trustee avoiding liens as a bona fide purchaser


This case was before the court on the Trustee’s appeal of the Bankruptcy Courts order and judgment in favor of Suntrust in which the court determined that under Florida law, constructive notice prevents the Trustee from using his strong-arm powers to avoid the Lender’s mortgages.

This bankruptcy case was filed on May 4th, 2006.  Prior to that date, the debtor had a piece of property with 4 mortgages on it and a judgment.  The debtor had sold the property to his father.  Neither the transfer to the father, nor the mortgages the father took were recorded at the time the debtor filed.  Subsequently, the debtors four mortgages and the judgment lien were released with the funds from the mortgages taken by the fathers mortage.

The Trustee argues that the mortgage lien from Suntrust is subordinate to his interest pursuant to the Bankruptcy Code §544(a)(3).  Suntrust argues that the Trustee’s status as a hypothetical bona fide purchaser is defeated by the Trustee’s constructive notice of the Suntrust mortgages derived through the unsatisfied liens of record.


As the facts were stipulated to, the Court reviews a bankruptcy court’s findings of law de novo.

Pursuant to §544(a), a trustee occupies the status of an ideal judicial lien creditor or a bona fide purchaser without actual knowledge of any outstanding claim, lien, or equity, without regard to the actual knowledge or notice of any actual creditor, the debtor, or the trustee.  Crestar Bank v. Neal (In re Kitchin Equip. Co. of Virginia Inc.), 960 F. 2d 1242, 1245 (4th Cir. 1992).  Although a bankruptcy trustee is innocent of knowledge as a matter of law, the definition of a trustee’s rights as a bona fide purchaser is a matter of state property law.  The court then turns to Florida law to answer the question of whether a perfected mortgage of record puts a purchaser on inquiry notice with regard to any information that would be discovered if the purchaser were to contact the mortgagee to determine the status of the mortgage.

The court, after reviewing Florida law, decides that the prior unreleased mortgages does not defeat the hypothetical bona fide purchaser status of the Trustee.

In an interesting footnote, the court noted that because the Trustee’s bona fide purchaser status was not defeated by notice, the Court specifically did not reach the question of whether a broad inquiry notice rule conflicts with the language of §544, which accords bona fide purchaser status to the trustee “without regard to any knowledge of . . .any creditor.”  Thus, suggesting that such a broad inquiry notice rule, if it does exist, may be trumped by the language in §544, which specifically holds the trustee innocent of any knowledge.

It is the humble author’s opinion that reliance on §544(a)(1) might be required instead of §544(a)(3) which uses the state law defined “bona fide purchaser” language.  In most states, to be a “bona fide purchaser,” the knowledge of the party is essential to the definition of such purchaser.  Relieving the trustee of any inquiry notice would gut the meaning of “bona fide purchaser” and turn that phrase, essentially, “any purchaser.”

Avoiding Security Interests Without an Adversary Proceeding. .  .What is an Attorney for Anyway?

In 1995, the Fourth Circuit decided Cen-Pen Corp. v. Hansen, 58 F.3d 89 (4th Cir. 1995) which determined what was necessary, within a Chapter 13 case, to alter the security interests of a secured creditor.  The facts around how the security interest arose were a little convoluted, but suffice it to say, the pre-bankruptcy security status of the lien was not at issue.

However, the Hanson’s filed a Chapter 13 plan that treated Cen-Pen as an unsecured creditor.  The plan further required creditors to submit proofs of claim and objections within a specified time period and provided that the plan would be automatically confirmed if no objections were received.  A few years after the Hansen’s received their discharge, Cen-Pen filed a Complaint in bankruptcy court to determine the validity of its liens on the Hanson residence

The Hanson’s argument rested on 11 USC § 1327(c) which reads that, “[e]xcept as otherwise provided in the plan or in the order confirming the plan, the property vesting in the debtor under subsection (b) of this section is clear of any claim or interest of any creditor provided for by the plan.”  Id. The Hanson’s argued that because Cen-Pen received a copy of the plan in which they were treated as an unsecured creditor and failed to object prior to confirmation, the confirmation of the plan acted as res judicata due to § 1327 as to Cen-Pen’s current claim of having a valid lien against the Hanson’s property.

The Court began by noting the general rule that liens pass through bankruptcies unaffected, see Dewsnup v. Timm, 502 U.S. 210 (1992), and that “for a debtor to extinguish or modify a lien during the bankruptcy process, some affirmative step must be taken toward that end.”  Cen-Pen Corp., 58 F.3d at 92.  The court looked to Bankruptcy Rule 7001(2) for that affirmative step.  That rule requires the initiation of an adversary proceeding “to determine the validity, priority, or extent of a lien or other interest in property.” Id.

Noting with favor the holding of the Northern District of Indiana, the Court repeated that the “confirmation generally cannot have preclusive effect as to the validity of a lien, which must be resolved in an adversary proceeding.”  Cen-Pen Corp, 58 F.3d at 93 (citing In re Beard, 112 B.R. 951 (Bankr.N.D.Ind. 1990)).  Continuing, “if an issue must be raised through an adversary proceeding it is not part of the confirmation process and, unless it is actually litigated, confirmation will not have a preclusive effect. . . [and a] secured creditor is not bound by the terms of the confirmed plan with respect to limitations upon the scope or validity of the lien securing its claim.” Id.

The Hanson’s maintained that the plan “provided for” Cen-Pen’s claim sufficiently to satisfy the requirements of § 1327(c).  The Fourth Circuit refuted this by citing several district courts that held that a plan “provides for” the lien held by a secured creditor only when it provides for payment to the creditor in an amount equal to its security.  Based on this, the court did not believe that treatment in the plan was not enough to alter the security interest, absent payment in full or the initiation of an adversary proceeding.

Modified security interests, how much notice required?

In 1993, the Fourth Circuit decided Piedmont Trust Bank v. Linkous, 990 F.2d 160 (4th Cir. 1993), which addressed the notice required to a secured creditor when confirmation of a bankruptcy plan requires a valuation under 11 USC 506(a) of the bankruptcy code.  In this case, Piedmont owned a security interest in a mobile home and a vehicle and was due balances of roughly $18,000.00 on the mobile home and $4,000.00 on the vehicle.  The Chapter 13 plan proposed by Linkous treated only $6,000 of the mobile home loan as secured and $1,000.00 of the car loan as secured.  The Plan treated the remaining balances as unsecured.  Piedmont was given a summary of the Chapter 13 plan but was not otherwise notified of the ‘506(a) valuation.

The Chapter 13 Plan was confirmed and two weeks later Piedmont filed its claims which treated the full balance of the claims as secured.  Piedmont then filed a Motion to Revoke the Order Confirming the Plan and Dismiss or Convert the Case.  The bankruptcy court determined that it did not have grounds to revoke the confirmation noting that Piedmont had been given notice and failed to use procedures available to it to protect its interest.

The Fourth Circuit determined that the statute required notice that the debtor planned to hold a section 506 valuation hearing and that in order to reasonably convey the required information, Linkous’ notice must state that such hearing will be held.  In this case, the notice Linkous gave did not make reference to any intent to reevaluate the secured claims pursuant to ‘506(a).

The Court commented that though a sophisticated lender should have known its interests where in jeopardy but nonetheless held that the failure to inform the secured creditor of an intent to reclassify its claim into partially secured and partially unsecured status was a violation of Piedmont’s due process right, and that vacating the final order of the bankruptcy court, with respect to Piedmont’s rights, was appropriate and that a ‘506 valuation hearing should be held to determine what portions of Piedmont’s loans should be considered secured and what portions unsecured.

Locally, the Eastern District of Virginia has promulgated Special Notice requirements for secured creditors whose security interests are proposed to be altered by the Chapter 13 plan. See Local Rule 3015-2.  This Special Notice must be served by the debtor or debtor’s bankruptcy attorney on the creditor within 15 days after filing the plan to inform.  This form was generated in response to the aforementioned Piedmont Trust Bank decision.  However, the current Chapter 13 plan utilized by the Eastern District does notify the secured creditor of the intent to reclassify its claim into partially secured and partially unsecured status in at least 3 separate locations.  Unlike the Chapter 13 plan before the court in Piedmont, a little over a full page of the six page plan is devoted to informing secured creditors of the intent to value collateral at its replacement cost and treat the remaining portion of the debt as unsecured.  Further, the Plan specifically says, in bold, underlined text on the first page that the motions in paragraphs 3, 6 & & to value collateral. . . may be granted without further notice or hearing unless a written objection is filed not later that seven (7) days prior to the date set for the confirmation hearing and the objecting party appears at the confirmation hearing.

In light of this Plan language, is an extra Special Notice required, in addition to the ominous language in the Plan regarding the valuation of security interests, to comply with the standard set forth in the Fourth Circuit’s Piedmont decision?   I’m not so sure.

Modifying a Chapter 13 Plan

In Murphy, Jr. v. O’Donnell v. Goalski, 474 F.3d 143 (4th Cir. 2007), the Fourth Circuit determined when and how a confirmed Chapter 13 plan may be modified.  There were two fact patterns at issue in this matter and the Court started out by setting forth the principal that a confirmed Chapter 13 plan is “a new and binding contract, sanctioned by the court, between the debtors and their pre-confirmation creditors,” id., citing Matter of Penrod, 169 B.R. 910, 916 (Bankr.N.D.Ind. 1994).

The Court continued that, “like other contracts, a confirmed Chapter 13 plan is subject to modification.” Murphy, 474 F.3d at 148 (citing In re Arnold, 869 F.2d 240, 241 (4th Cir. 1989); but see snarky comment (unlike other contracts, both parties do not need to consent to the modification).  Section 1329 of the Bankruptcy Code provides that a confirmed plan may be modified at any time after confirmation of the plan but before the completion of payments at the request of the debtor, the Chapter 13 trustee, or an allowed unsecured creditor in order to, among other things, increase or reduce the amount of payments on claims of a particular class provided for by the plan, [or to} extend or reduce the time for such payments. See 11 U.S.C. 1329.

The Court directed that a three part inquiry is required to determine if it will allow a modification of the plan.  For the first part of that inquiry, the bankruptcy court must first determine if the debtor experienced a substantial and unanticipated change in his post-confirmation financial condition.  This inquiry will inform the bankruptcy court of the question of whether the doctrine of res judicata prevents modification of the confirmed plan.  Next, the court must decide whether the proposed modification meets one of the circumstances listed in §1329(a).  If so, the court must then consider whether the proposed modification complies with §1329(b)(1).