Planning ahead with the Eastern District Bankruptcy Court

Katherine Gullo, the clerk of the Bankruptcy Court for the Eastern District of Michigan wants you to know that the court’s Electronic Case Files (ECF) system will be out of commission on Thursday, Sept. 20 from 5:30 p.m. to 7:30 p.m.

Update: ECF system will be unavailable on Saturday, Sept. 29, 2012 from 1 p.m. to 8 p.m..

The Administrative Office of the U.S. Courts will be making changes to PACER-net at that time.

Huntington Bank must pay $81M for 2002-04 fraud scheme

Last year, we reported about a bankruptcy court’s ruling that Huntington National Bank failed to act in good faith when it allowed a company’s money to continue funneling through Huntington accounts months after fraud was suspected.

The March 2011, ruling, authored by Hon. Jeffrey Hughes of U.S. Bankruptcy Court for the Western District of Michigan, said the bank could be required to pay up to $73 million in recoverable transfers to a trustee representing lenders defrauded by the now-defunct CyberNET Engineering (d/b/a Cyberco).

On Aug. 1, 2012, Hughes’ final report to U.S. District Court for the Western District of Michigan — based on his July 23, 2012, opinion — was issued, and it awarded the trustee approximately $81 million. The total includes approximately $9 million interest from the date that each fraudulent transfer was received by Huntington from September 2002 through October 2004.

The fraudulent deals started out small — less than $1 million — but by 2004, they rapidly got larger. In all, up to 40 finance companies and banks were bilked out of up to $90 million.

Douglas Donnell of Mika Meyers Beckett & Jones PLC in Grand Rapids, who represented the trustee, told Michigan Lawyers Weekly last year that enough red flags had sprouted up along the way to give Huntington cause to drop Cyberco’s credit line.

One of them was highlighted in Hughes’ March 2011 opinion, where the bank’s then-regional security officer discovered in April 2004 that Cyberco head Barton Watson had served three years in prison for securities fraud, but didn’t tell his superiors or others investigating Cyberco until four months later.

“That’s almost a textbook definition of willful blindness,” Donnell told Lawyers Weekly at the time. “You can’t stick your head in the sand and pretend like you don’t know anything when, in fact, in this case, you did know it.”

Eyes on Detroit

As Michigan news junkies closely follow the news surrounding Detroit, and whether or not the city will enter into a consent agreement with the state [Update: it did], or whether Gov. Rick Snyder will appoint an emergency financial manager (EFM), one word that has come up from time to time is: bankruptcy.

That’s a big can of worms. What would happen if the city went into Chapter 9 bankruptcy?

Well, the thing is, it can’t, said Butzel Long attorney Max Newman.

“In order to file Chapter 9 the city would need permission from the state. And there’s no basis in law for the state to give that permission,” Newman said. “The state would have to pass legislation to allow it.”

But that doesn’t mean that he would rule it out. That’s because, he said, if the Michigan Supreme Court finds the state’s EFM law to be unconstitutional, one way or the other, legislators are going to have to drop everything (probably interrupting their summer break) and quickly rework the EFM law, or draft legislation to allow the state to authorize the city’s bankruptcy.

There wouldn’t be much difference between the two, Newman said. Neither option brings in any money to the financially troubled city.

“The biggest difference would be that the emergency financial manager statute gives the manager the power to open collective bargaining agreements without court supervision. In a Chapter 9, court supervision would be required,” he said. “As long as the city has a revenue stream, either one could be useful.”

That’s one of the reasons Detroit can’t do what other communities have done when they’ve entered Chapter 9 — cut deeply into even essential services, namely the police department. One example is the city of Vallejo, Calif., which laid off nearly half its police department while it worked through a bankruptcy. But if Detroit does that, Newman noted that it would be mighty difficult, if not impossible, to attract businesses and residents that are sorely needed to build up the city’s tax base.

Whether by emergency manager, consent agreement or bankruptcy, the city is going to have to get its biggest creditors — the unions and bond holders — to the table.

“They’re going to have to restructure their bond debts and union contracts no matter what,” Newman said. “If they can’t do that, the problem is way beyond any emergency financial manager or Chapter 9 issues.”

In any event, eyes are on the city of Detroit because there has been nothing like it before. The wealthy county of Orange County, Calif., went bankrupt, but that was different, Newman said, because it was the result of malfeasance on the part of the treasurer. The revenue stream necessary for working through the bankruptcy was solid. And the bankruptcy in Harrisburg, Pa., is different because, although the city is much like Detroit in that its troubles stemmed from a decline in manufacturing, its nowhere near the size of Michigan’s largest city.

“There has never been anything exactly like this. In the history of Chapter 9, there hasn’t been anything like Detroit,” Newman said.

Western District suspends bankruptcy lawyer

Southfield bankruptcy attorney Jeffrey David Thav has been suspended from practice for one year in the U.S. District Court for the Western District of Michigan.

A three-judge panel issued the suspension after concluding that Thav

failed to meet the basic practice standards of this District in failing to show up for hearings on repeated occasions and despite multiple warnings from more than one Bankruptcy Judge in this District.

Thav had been on an informal probation, designed by Bankruptcy Judge Scott Dales to address Thav’s failure to appear for scheduled hearings. The informal probation was lifted, after which Thav missed more scheduled hearings, prompting disciplinary proceedings under the Western District’s Local Rule 83.1(k).

Other matters involving Thav “illustrates an underlying practice management problem that is at the root of why the panel believes a one-year suspension is necessary.”

The panel noted Thav’s late payment of court fees.

On no less that forty-two occasions over less than ten months[,] payments from Attorney Thav’s office were significantly late, even when the fees at issue had been collected in advance from the client

Thav’s required fee disclosures “in several matters appeared inaccurate, or at least incomplete, in some material aspects,” according to the panel’s order.

The panel also noted that Thav

who lives and works outside the [Western] District[,] [had] some kind of arrangement with an attorney who lived and worked in the Western District to cover [Thav’s] hearings in the [Western] District.

It did not appear, however, that the arrangement was disclosed to or approved by the affected clients.

Thav was engaged in a multi-district bankruptcy practice but was unable to meet the Western District’s “basic practice standards,” said the panel.

A one-year suspension will give Attorney Thav an opportunity to consolidate his practice, concentrate his resources and build his legal and management skills to the point where he may well be able to handle a multi-district practice that includes … [the Western] District … .

The case is In the Matter of Attorney Jeffrey David Thav. Administrative Order 12-019.

Sixth Circuit nixes suit against bankruptcy trustees

It’s not often that the United States government, as a plaintiff, uses its sovereign immunity as a sword against lawsuit defendants, in this case the bankruptcy trustees of the Eastern District of Michigan.

More typically, the government raises sovereign immunity as a shield after being sued for transgressions, real and imagined.

And, if the government wields sovereign immunity as a sword, the thrust, as the 6th U.S. Circuit Court of Appeals explains in United States v. Carroll, et al., must be against the correct parties.

Our story: In 2008, the clearance rate for Eastern District Chapter 13 bankruptcy cases was among the lowest in the country — 79th out of 90 judicial districts.

Some of the Eastern District bankruptcy judges devised a plan to improve the situation. When a debtor was due a tax refund, the bankruptcy court would order the IRS to send the refund directly to the trustee overseeing the debtor’s case. That way, the trustees could directly disburse funds to Chapter 13 creditors while eliminating the debtor, who might find other uses for the money, as a middleman.

At first, the IRS went along with this, even though redirecting the refunds to the trustees required the IRS to hand-process the affected tax returns. But the number of affected returns grew from an initial 400 to almost 5,000. And, because Chapter 13 reorganizations typically last three to five years, the refund-redirect orders were creating a significant headache for the IRS.

So, the IRS asked the United States to sue the trustees, claiming that the redirect orders violated the government’s sovereign immunity.

The government’s argument was that the bankruptcy code abrogates sovereign immunity “to the extent set forth” in 11 U.S.C. § 106. Section 106 requires that debts owed to the bankruptcy estate must be paid to the trustee. But, according to the government, this language does not clearly waive sovereign immunity with respect to the refund-redirect orders.

The federal district court thought this was a pretty good argument. The court enjoined the trustees from enforcing existing redirect orders and issued a writ of mandamus to prohibit the bankruptcy court from issuing redirect orders in future Chapter 13 cases.

The trustees appealed to the Sixth Circuit. Judge Jeffrey S. Sutton set the stage:

Even though both sets of parties would prefer that we resolve this lawsuit on the merits, we lack the jurisdiction to do so. The government sued the wrong parties, depriving it of standing to bring this lawsuit.

Of the three “irreducible constitutional minimum[s]” of standing — injury in fact, causation and redressability, Lujan v. Defenders of Wildlife, 504 U.S. 555, 560 (1992) — the government satisfies just one of them. Given the administrative burden to the United States of complying with the bankruptcy court’s orders, to say nothing of the alleged violation of sovereign immunity underlying them, the government has suffered the requisite injury.

But, Sutton said, causation and “redressability” are much more problematic.

The government sued a group of bankruptcy trustees, but the harm it suffered — administrative costs associated with processing tax refunds — flows not from the trustees’ actions but from the bankruptcy court’s orders.

When an entity does not like a court order, the answer is not to sue the lawyer or party who recommended the order; it is to appeal the order or, if utterly necessary, to sue the court. Bankruptcy trustees do not control bankruptcy courts.

Redressability, too, is a problem. The question is whether the requested relief would fix the problem at hand … . Even if the trustees have a role in enforcing these orders, that does not mean a judgment against the trustees will eliminate the problem. Trustees are not the only parties to Chapter 13 bankruptcies. Other parties, including the debtor and creditors, have an interest in ensuring that tax refunds make their way to the trustees.

Nothing prevents these entities from asking the bankruptcy court to issue the same order. …

This lawsuit was apparently born of three good intentions: (1) a need to resolve the government’s sovereign-immunity defense to the redirection orders; (2) a timing exigency in view of the growing administrative burden of the orders; and (3) a desire not to sue federal judges — thank you — unless absolutely necessary.

Yet the government’s unusual vehicle for handling these concerns was not the only one available. The government could have filed a direct appeal from the entry of a redirection order in one (or more) of the cases in which the IRS is a party.

Good intentions, yes; good trial strategy, no

Bankruptcy and prepetition credit counseling: flexible requirement

Before an individual can seek bankruptcy relief, 11 U.S.C. § 109(h) requires the would-be debtor to participate in credit counseling:

[A]n individual may not be a debtor under this title unless such individual has, during the 180-day period preceding the date of filing of the petition by such individual, received from an approved nonprofit budget and credit counseling agency described in section 111(a) an individual or group briefing (including a briefing conducted by telephone or on the Internet) that outlined the opportunities for available credit counseling and assisted such individual in performing a related budget analysis.

So, what happens if you don’t and file the petition anyway?

The Bankruptcy Code doesn’t expressly state what you’d think would be the obvious answer: the case should be dismissed.

Federal courts addressing the issue have broken into two camps. Some view the requirement as jurisdictional, so non-compliance requires dismissal. Others view the requirement as one of eligibility, which vests a bankruptcy court with discretion to waive the requirement under the proper circumstances.

Most courts faced with debtors who use their noncompliance strategically — for example, not moving for dismissal until after the trustee has uncovered assets that can be sold for the estate’s benefit — don’t hesitate to waive the debtor’s compliance. Gaming the system is frowned upon. The Bankruptcy Appellate Panel for the Sixth Circuit, in In re Amir, illustrates this point nicely.

But what about debtors who simply, and without any ulterior motive, don’t finish up the required counseling until after the petition is filed. What should become of their bankruptcy cases?

Up until late last week, the Sixth Circuit BAP had not addressed the issue. Now, under In re Ingram, the prepetition credit counseling requirement is a matter of eligibility, not jurisdiction, and decisions to enforce the requirement are reviewed for an abuse of discretion.

In William Ingram’s case, his prepetition counseling had two components: an online portion which he completed the day he filed his petition, and a telephone component, which he completed a day later. The bankruptcy court dismissed the petition without prejudice because both components hadn’t been completed prepetition.

The court turned aside Ingram’s argument that the counseling provider led him to believe that the Internet component was sufficient. The court ruled that if that was the case, Ingram could ask the counseling provider for his money back, but it didn’t provide a reason to excuse compliance with the counseling requirement.

The BAP affirmed:

The requirements of § 109(h) are clear and unambiguous. As such, the bankruptcy court, except in the limited circumstances set forth in § 109(h)(2), (3), and (4) which were not present here, did not have discretion to ignore, modify, or defer the requirements of § 109(h)(1).

Compliance with § 109(h) is a prerequisite to obtaining relief under the Bankruptcy Code. By definition, an individual may not be a debtor who is eligible for bankruptcy relief unless he has complied with § 109(h). …

Because the Debtor did not comply with the requirements of § 109(h), or qualify for a deferral of the credit counseling requirement, he is not eligible to be a debtor. Therefore, the bankruptcy court properly dismissed the Debtor’s case.

Former Borders workers get $797 for their hard work

Nearly 200 ex-Borders employees will be getting severance pay of sorts, thanks to a settlement with the now-defunct bookseller. reported that Borders Group Inc., which is in the final stages of liquidating its estate, will pay $240,000 to those who filed a class-action lawsuit. The suit accused the bookstore chain of violating federal regulations regarding large-scale layoffs.

The agreement amounts to $797 per person after legal fees are paid, according to a document describing details of the settlement that was filed with the U.S. Bankruptcy Court for the Southern District of New York.

The plaintiffs accused the company of failing to give corporate employees proper notice of their layoffs under the federal Worker Adjustment and Retraining Notification (WARN) Act.

The report added that Borders claimed it did provide proper notice — and even if it did not, attorneys said Borders was exempted from the WARN Act under a stipulation that allows fast layoffs in the event of “unforeseeable business circumstances.”

Then again, there’s always the argument that the book-/coffee-/DVD-/CD-/general trinket-seller could have seen such circumstances a long time ago.