Indiana Law Review


1998 Bankruptcy Law Update for
Seventh Circuit Practitioners

Timothy A. Ogden*

Introduction

The Seventh Circuit Court ofAppeals wrote a number of interesting, and in
some cases entertaining, decisions in the area of bankruptcy law. This Article
examines some of those decisions.

I. Equitable Subordination of Claims

In re Lifschultz Fast Freight^ involved a request by the bankruptcy trustee to

equitably subordinate a creditor's secured claim .^ The bankruptcy court denied
this request, but the district court reversed and remanded.^ The issue on appeal
was whether the bankruptcy court could exercise its power of equitable
subordination based on the debtor's purported undercapitalization."^ In this case,

Lifschultz Fast Freight Corporation (the "debtor"), developed from another

company, Lifschultz Fast Freight, Inc. ("LFFI"), which had operated in the

shipping industry since the beginning of the century.^ LFFI suffered tremendous

losses in the late 1980s (which approached $5.5 million in 1989). In an effort to

save the business, the owners established the company that would become the
debtor. Five individuals (the "insiders") held eighty percent of the debtor's

stock, and LFFI held the remaining twenty percent.^
From the outset, the debtor was cash poor. Thus, just weeks after its

inception, one of the insiders' affiliated companies, Salson Express, entered into

a secured loan agreement with the debtor. Essentially, three of the insiders

offered personal guarantees for money they borrowed from First Fidelity Bank.
They then lent that money to Salson Express, which in turn lent the money to the
debtor. Within one month, the debtor had borrowed more than $862,000 from
Salson Express.^ Significantly, the debtor also obtained another $1 million

* Partner, Ogden & Ogden, LLP, Warsaw. Associate Professor, Accounting and Business,
Manchester College. B.A., with distinction, 1987, Manchester College; M.B.A., 1989, Peter F.

Drucker Graduate Management Center, Claremont Graduate School; J.D., summa cum iaude, 1996,
Indiana University.

1. 132F.3d339(7thCir. 1997).

2. "Equitable subordination of a claim moves the creditor down in the order of payment

out of the assets in the bankruptcy estate, generally reducing (or eliminating) the amount the

creditor can recover." Id. at 34L After notice and a hearing, the court may "under principles of

equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to

all or part of another allowed claim . . . ." 11 U.S.C. § 510(c)(1) (1994).

3. In re Lifschultz, 132 F.3d at 341.

4. Seeid2XM2>.

5. See id at 342.

6. See id.

1. See id.



614 INDIANA LAW REVIEW [Vol. 32:613

through a factoring agreement with Ambassador Factors.^ This new money
permitted the debtor to pay off all but $300,000 of the insiders' secured loan.^
The insiders filed a claim in bankruptcy for the $300,000, and the trustee argued
that the secured interest should be equitably subordinated.^^

The bankruptcy court concluded that the debtor had not been
undercapitalized and that even if it had, equitable subordination required some
other inequitable conduct." The district court, however, decided that
undercapitalization alone was sufficient to justify invoking the doctrine of
equitable subordination and concluded that the debtor was "patently
undercapitalized."

'^

The court of appeals noted that one important theme of bankruptcy law is
maintaining claimants' state law rights and the order of their claims relative to
one another. ^^ The potential always exists for an equity holder, who comes last
on the priority list, to "dress[ ] up a claim she has on the firm as something else
ofhigher priority."^"* However, it may be even more likely in bankruptcy cases
involving closely held corporations because the players' roles may be less
distinct: "[T]he same person can be an owner of a company, its creditor and, as
in the instant case, its employee as well."^^ Nevertheless, insiders must remain

true to their fiduciary obligations to the company.^^ If they breach those duties
through a bad faith or unfair characterization of an equity infusion as debt, the

court may send the insiders to the end of the line.^^
The court in Lifschultz relied on the framework provided by the U.S. Court

ofAppeals for the Fifth Circuit in In re Mobile Steel Co. *^ The first step under
that framework is to search for inequitable conduct, and if there is none, the
bankruptcy court may not subordinate the claim .^^ The court proceeded through
a detailed discussion of undercapitalization and whether the fact of

undercapitalization alone would constitute such misconduct. While recognizing

that some courts have adopted this position,^° this court chose not to do so.

8. The agreement with Ambassador Factors required that its interest be superior to the

insiders' interest under the secured loan agreement, and Ambassador also received personal

guarantees from the insiders. See id.

9. The court referred to Salson Express and the insiders interchangeably. See id. at 343.

10. See id.

11. Id

12. Id. The debtor was set up with $1000 in cash, and the insiders also transferred to the

debtor all of LFFI's operations outside New York, including its customer list, a valuable lease to
a California shipping terminal, and Los Angeles Dodgers season tickets. See id. at 342.

13. Mat 343.
14. Id.

15. /^. at 344.

1 6. See id.

17. See id.

18. 563 F.2d 692 (5th Cir. 1977).

19. See In re Lifschultz, 132 F.3d at 344.

20. Id at 345 (citing, e.g.. In re Fabricators, 926 F.2d 1458, 1470 (5th Cir. 1991)).



1 999] BANKRUPTCY 6 1

5

"Because mere undercapitalization does not, and should not, justify equitable
subordination, we think the better view is that, while undercapitalization may
indicate inequitable conduct, undercapitalization is not in itself inequitable

conduct."^'

This was not a case where the insiders attempted to convert already existing
equity into debt. They contributed fresh capital, and if no deception existed,
there was no reason to treat an insider's loan more harshly than a third party's
loan.^^ The court summarized its position as follows: "[U]ndercapitalization
alone, without evidence of deception about the debtor's financial condition or

other misconduct, cannot justify equitable subordination of an insider's debt

claim. Extraordinary circumstances might provide an exception . . . but we
believe that almost any such exception would arguably also involve other

misconduct of some sort."^^
The court also addressed the debtor's purported undercapitalization itself and

concluded that under Mobile Steel, undercapitalization would have existed at the

time the debtor received the loan from the insiders if an informed outside source

would not also have loaned the debtor a similar amount of money.^'^ "In this
case, we need not speculate about what might have happened. We know what
t//<i happen. The debtor not only could have gotten a third-party loan, it actually

did—from Ambassador Factors."^^ Furthermore, that Ambassador Factors
required personal guarantees from several insiders did not prove

undercapitalization.^^ Thus, the court found no clear error in the bankruptcy

court's factual conclusion.^^

Interestingly, however, the court still remanded the case.^^ The trustee had
also argued, among other things, that the insiders had inflated their salaries in the
spring and summer before the bankruptcy petition was filed. The court noted that
a "classic form of creditor misconduct is boosting the owner-employee's salary

as the firm is drifting into financial coUapse."^^ If an insider did commit such
misconduct, it could justify equitable subordination of the Salson Express

claim .^° The court remanded the case so that the bankruptcy court could
determine whether the insiders could meet their burden of showing that the
transactions were inherently fair and were undertaken in good faith.^'

21

.

Id. "Most often undercapitalization signifies nothing more than business failure, poor

access to capital, or both." Id.

22. Id. at 347.

23. Id. at 349 (citations omitted).

24. Id at 351 (citing In re Mobile Steel Co., 563 F.2d 692, 703 (5th Cir. 1997)).

25. /c^. at 353.

26. See id.

11. Id

28. Id at 355.

29. Id. at 354.

30. See id.

31. /^. at 354-55.



616 INDIANA LAW REVIEW [Vol. 32:613

II. Cases Involving THE Geraci Firm

A. Unjustified High Fees

Attorney Peter Francis Geraci and the associates in his firm (the "Geraci

firm") file thousands of bankruptcy cases each year in the Seventh Circuit,^^ and

the firm's practices provide the judges on the court of appeals with a number of
opportunities to earn their salaries. In re Gerac?^ dealt with twelve consumer
bankruptcy cases in which the Geraci firm had represented the debtors. The
cases were relatively straightforward and required little attorney time. In fact, the

attorneys spent an average of only thirty-six minutes preparing each petition,^"^

yet the Geraci firm charged a flat fee ranging from $1095 to $1900 in each.^^
"Believing that those fees were unreasonably high in light of the uncomplicated

nature of the cases at issue, the United States Trustee invoked Bankruptcy Rule

2017 to challenge the fees charged . . . ."^^

Bankruptcy Judge Fines analyzed the criteria listed in 11 U.S.C. § 330
regarding compensation ofprofessionals by considering the twelve factors set out
in Johnson v. Georgia Highway Express, Inc.^^ The bankruptcy court found that
the average fee charged in similar cases in that location was $550 and that neither
the Geraci firm's experience and ability nor the results obtained justified

significantly higher fees.^^ The bankruptcy court concluded that $800 was
presumptively reasonable and ordered Geraci to return to each of the twelve

debtors the portion of each fee that exceeded $800. The court also made the
order applicable to all future cases filed by that law firm in that court, which

meant that "Geraci either could accept a presumptively reasonable fee of $800
in no-asset consumer bankruptcy cases under Chapter 7, or file a detailed fee

itemization in support of a higher fee."^^

32. See In re Turner, 156 F.3d 713, 715 (7th Cir. 1998).

33. 138 F.3d 314 (7th Cir. 1998).

34. Seeid.dX'hX^.

35. See id. ziiZX^i.

36. /^. at 317.

37. 488 F.2d 714, 717-19 (5th Cir. 1974).

38. In re Geraci, 138 F.3d at 317. In fact, despite Geraci's description of himself as the

'"foremost consumer bankruptcy practitioner in the country,'" Judge Fines concluded that "[tjhe

work product of [the Geraci firm] is not extraordinary. It is not outstanding. It is not up to a level

that this [cjourt sees from the majority of practitioners who regularly appear before it." Id. at 3 17-

18.

39. Id. at 3 18. The trustee brought similar challenges in other bankruptcy courts throughout

Illinois, and those challenges resulted in orders similar to the one at issue here. Geraci informed

the court that "fee orders in 72 cases already have been appealed to this court and that

approximately 400 more appeals are on their way." /rf. at 3 18 n.3. Later, in the case In re Agnew,

144 F.3d 1013 (7th Cir. 1998), other bankruptcy judges in the same district determined that $575

and $600 were presumptively reasonable fees, and the Seventh Circuit affirmed. Id. at 1014. The

court stated that judges and trustees were pushed to take this approach to handling fees



1999] BANKRUPTCY 617

Geraci made a number of arguments on appeal, but to no avail. Geraci
argued that he was entitled to the market value ofhis services and that the market
value was whatever he was able to negotiate with his clients. The court
disagreed, stating that sections 329 and 330 of the Bankruptcy Code limit the
market's role in establishing professional fees in bankruptcy cases.'*^ There is no
requirement that there be overreaching by debtor's counsel or that there be no

arm's length transaction to check the reasonableness ofthe agreed-to fee in order

for the bankruptcy court to exercise its power of review, as Geraci contended.'*^
"Rather, the bankruptcy court is authorized to act whenever it determines that the

compensation the debtor has paid or agreed to pay his counsel exceeds the

reasonable value of the services provided.'"^^

The court also found that the bankruptcy court did not arbitrarily cap
Geraci 's fees because Geraci maintained the right to demonstrate that the

services provided justify a higher fee.'*^ Moreover, even if Geraci had not waived

his Equal Protection Clause argument by failing to raise it in the bankruptcy

court, he would not have prevailed.'*^ The record indicated that Judge Fines used

the same presumption of a reasonable fee in all similar cases before him."^^ The
Seventh Circuit therefore affirmed.'*^

B. Unilateral Reaffirmation ofPre-Petition Debts

Another case involving the Geraci firm. In re Turner^^ addressed the

situation where the debtor unilaterally reaffirmed a pre-petition debt. The court
of appeals agreed with the lower courts that such a reaffirmation did not

by a perception that Geraci conducts his practice in an abusive manner, taking advantage

of debtors who are unaware that his promises of superior services at a premium rate are

hot air (one bankruptcy judge found that ' Geraci 's work is not on a par with that of

other banlcruptcy practitioners, that his motions practice leaves much to be desired, and

that his abilities as a trial lawyer are substandard') ....

Id.

40. In re Geraci, 138 F.3d at 320 (referring to 1 1 U.S.C. §§ 229, 330 (1994)).

41. See id.

42. Id.

43. Id. a.i32\.

44. See id.

45. See id.

46. Id. Geraci was also involved in another appeal to the Seventh Circuit, In re Bryson, 1 3

1

F.3d 601 (7th Cir. 1997). There, Geraci 's client fired the Geraci firm and sought to have unearned

fees returned. The bankruptcy judge ordered Geraci to return to Bryson $182.50. Geraci, of course,

appealed. The district court found that Geraci filed a motion to reconsider in bad faith as a vehicle

for extending the time available for appeal, and it granted Bryson's motion to dismiss. Id. at 602-

03. The court of appeals reversed, opining that the court had more appropriate methods available

for dealing with a bad faith motion to reconsider. Id. at 603.

47. 156 F.3d 713 (7th Cir. 1998).



618 INDIANA LAW REVIEW [Vol. 32:613

constitute an "agreement" for purposes of 1 1 U.S.C. § 524(0)."^^ In each of the

six bankruptcy cases underlying the appeal, the Geraci firm had filed a document
entitled "REAFFIRMATION AGREEMENT" or "AUTOMOBILE
REAFFIRMATION AGREEMENT" whereby the debtor purportedly agreed to
pay a pre-petition installment debt."^^ In each case, the debtor, but not the
creditor, signed the reaffirmation.^° The Geraci firm filed these "agreements"
without even notifying the creditors of their execution.^'

The bankruptcy court concluded that strict compliance with section 524 of
the Bankruptcy Code was mandatory and that the creditor's signature was
required in order to comply with that section.^^ Bankruptcy Judge Fines further
stated that "[rjeaffirmation agreements are unlike any other contractual

agreement under the law, . . . and nowhere else is the requirement that both
parties sign the agreement more critical."^^ The signature demonstrates not only
that the creditor is aware of the reaffirmation, but also that there is agreement

between the parties.^"^

The appeals court noted that in canvassing the U.S. Trustees and their field
offices, none saw these types of reaffirmation agreements outside this circuit's
judicial districts, and within this circuit, the only such reaffirmations the trustees

encountered were filed by the Geraci firm.^^ The court emphasized the statute's

repeated reference to an "agreemenf and noted that "[a]s unilateral statements
of reaffirmation, filed without notice to the creditors, let alone their consent, the

declarations at issue here cannot be understood as the mutual 'agreement' that

the statute requires."^^ The court also recognized that even though section 524(c)
does not expressly require the creditor's signature, the bankruptcy court's

reasoning in requiring such was not assailable.^^ That signature provides
concrete evidence of the creditor's awareness of and assent to the terms of the

reaffirmation.^^

III. Letters of Credit and Voidable Preferences

In re Bergner^^ was a relatively complicated case where Bergner made
payments (shortly before declaring bankruptcy) to Bank One in order to cover the

48. Mat 721.
49. Seeid.dXl\5. \

50. See id.

5 1

.

See id.

52. See id.

53. See id. (internal quotes omitted).

54. See id. at 720.

55. Id.2Xl\6.

56. Id.2Xl\9.

57. Id at 720.

58. See id.

59. 140 F.3d 1111 (7th Cir. 1998).



1999] BANKRUPTCY 619

bank's payments honoring certain letters of credit.^° Bergner later sought to

recover those payments as voidable preferences under 1 1 U.S.C. § 547(b). The
Seventh Circuit affirmed the district court's determination that the payments

were voidable preferences, but reversed on the issue of prejudgment interest.^*

The denial of such interest was an abuse of discretion, and the case was
remanded to determine the appropriate amount of interest due.^^

At Bergner' s request, Bank One issued standby letters of credit to AMC, one
of Bergner' s suppliers, and to Liberty Mutual Insurance, an insurance provider.^^

As long as Bergner paid these creditors, the letters of credit did not come into
play. However, the occurrence of certain events would entitle AMC and Liberty
Mutual (the beneficiaries) to go straight to Bank One for payments on Bergner'

s

promises without regard to Bergner' s financial health.^ One ofthose events was
a decision by Bank One not to renew the letters of credit upon their expiration.^^

By mid-summer 1991, Bank One had issued letters of credit exceeding $3 1 .2
million to AMC and exceeding $5.8 million to Liberty Mutual.^^ When Bank
One informed Bergner and these two beneficiaries that it would not renew the
letters of credit upon their expiration at the end of July, AMC notified Bergner
that it intended to exercise its rights under the agreement and draw down the full
amount of its credit. Bergner relied on a revolving line of credit (totaling
approximately $74 million) that it had with a Swiss bank group to fund AMC's
draw from Bank One.^^

Bergner' s financial position continued its downward spiral, however, and the
Swiss bank group eventually pulled the remaining $43 million line of credit.^^

Bank One exercised its rights under the Standby Letter of Credit Agreement and
took control of funds in Bergner' s account to satisfy future claims by Liberty

Mutual under its letter of credit. That same day, Bergner filed a Chapter 1

1

60. See id St W 14.
61. Mat 1123.
62. See id

63. SeeidatWU.
64. Bergner was paying Bank One approximately $300,000 per year for this service. See

id. at 1 1 15. In addition, the Standby Letter of Credit Agreement between Bergner and Barik One,

which established the terms of the agreement between these two parties, required Bergner to pay

Bank One the amount of any draft presented by a beneficiary either before or at the time of

presentation to Bank One for payment. See id.

65. It is important to note that the relationships in letter of credit arrangements are

independent of one another. For example, if an event occurred that permitted a beneficiary to draw

on the letter of credit, Bank One would be required to pay the beneficiary without regard to

Bergner' s obligations to Bank One. If Bergner breached his duty to pay Bank One under the

Standby Letter of Credit Agreement, Bank One would have a valid contract action against Bergner,

but it would be no less obligated to honor its contractual duty to the beneficiary. See id. at 1 1 19,

1114.

66. See id ai\\\5.

67. SeeidatWie.

68. See id.



620 INDIANA LAW JIEVIEW [Vol. 32:613

petition for bankruptcy.^^

The central issue in this case was whether the lower courts concluded
correctly that Bergner's payments to Bank One to cover the AMC and Liberty
Mutual obligations were voidable preferences under section 547(b) of the
Bankruptcy Code7° Bank One argued that it was only a collection agent for
Bergner, that the money simply flowed through the bank, and therefore if
Bergner were to recover these payments, it would receive a windfallJ^ The
problem was that "Bank One's position [did] not reflect the independent
obligations that ran from the bank to the beneficiaries."^^

Thus, when AMC presented its draft with conforming documents to
Bank One on July 19, 1991, Bank One was required to pay AMC the ftill
$31,207,000 that the letter of credit then provided, whether or not

Bergner gave it a red cent. If Bergner did not comply with its own
agreement with Bank One, under which it was required to give the bank
the amount ofthe draw either before or at the time of the payment to the
beneficiary, then Bank One would have had a perfectly good contract
action against Bergner, but it would have had no defense against
honoring the beneficiary's demand.

* * *

This means that at the moment AMC presented its draft, a debt arose
between Bergner (as debtor) and Bank One (as creditor), in the amount
ofthe requested draft.^^

The Seventh Circuit concluded that Bank One's arguments were simply
unpersuasive attempts to recharacterize the transaction and to attack the

independence principle.^"* The elements of section 547(b) were all present, and
the transfers were thus voidable preferences.^^

IV. State Claim for Support of Delinquent Minor

In re Platter^^ involved a debtor whose delinquent son was placed in a
residential treatment facility. Under Indiana Code section 31-6-4-18(b),^^ the

69. See id.

70. /^. at 1118.

71. 5eg /J. at 11 18-19.

72. /c?. at 1119.

73. Id. (citations omitted).

74. /^. at 1120.

75. 5ge/^. at 1119-20.

76. 140 F.3d 676 (7th Cir. 1998).

77. In 1997 Indiana lawmakers repealed this section and replaced it with Indiana Code

section 3 1-40-1-2, which provides: "The child's parent or the guardian ofthe estate of a child shall

reimburse the county for the costs paid under subsection (a) (or [Indiana Code section] 31-6-4-*



1999] BANKRUPTCY 621

mother was required to repay the $65,565 cost incurred by the DeKalb County
Division of Family and Children Services ("DFCS") in caring for her son7^
When Platter declared bankruptcy, DFCS argued that this obligation was not
dischargeable.^^ Despite the divided authority on this issue, the bankruptcy court

held Platter's debt dischargeable, and the District Court for the Northern District

of Indiana affirmed.^°

The first issue on appeal dealt with DFCS's purported immunity under the
Eleventh Amendment.^' DFCS argued that the bankruptcy court had no authority
to determine whether Platter's debt to the state agency was dischargeable.^^ "For

over a century, the Supreme Court has interpreted the Amendment to deny to the
federal courts authority to entertain a suit brought by a private party against a

state without its consent."^^ The court dealt with the issue summarily, however,

concluding that "[bjecause a state voluntarily chooses to enter a bankruptcy case

when it initiates an adversary proceeding, we hold that a state removes itself from
the Eleventh Amendment's protection by starting one.'*'* A state cannot enter a
federal forum voluntarily and then seek protection under the Eleventh

Amendment just because it does not like the result.^^
The second issue in the Platter case dealt with discharge of the debt. DFCS

relied upon section 523(a)(5) of the Bankruptcy Code.^^ This section provides

that a discharge does not discharge the debtor from a debt

to a spouse, former spouse, or child of the debtor, for alimony to,

maintenance for, or support of such spouse or child, . . . but not to the

extent that . . . such debt includes a liability designated as alimony,

maintenance, or support, unless such liability is actually in the nature of

alimony, maintenance, or support.^^

This debt was not owed to the spouse, former spouse or child. Therefore, the
Code section that DFCS relied on was inapplicable, and the debt could be
discharged.^^ Further, the court reviewed Congress' 1984 amendment to the

before its repeal) as provided under this article." IND. CODE § 3 1-40-1 -2(c) (1998).

78. In re Platter, 140 F.3d at 678.

79. See id.

80. Id.

8 1

.

See id. "The Eleventh Amendment provides that the Judicial power of the United States

shall not be construed to extend to any suit in law or equity, commenced or prosecuted against one

of the United States by Citizens of another State, or by Citizens or Subjects of any Foreign State."

Id. (quoting U.S. CONST, amend. XI).

82. See id. at 679.

83. Id. at 678 (citing Hans v. Louisiana, 134 U.S. 1, 15 (1890)).

84. Id. at 679.

85. See id. at 680.

86. 5eezV/. at 680-81.

87. 1 1 U.S.C. § 523(a)(5) (1994 & Supp. Ill 1997).
88. See In re Platter. 1 40 F.3d at 68 1

.



622 INDIANA LAW REVIEW [Vol. 32:613

Code section at issue along with the relevant legislative history.^^ The court
concluded that DFCS's position was not supported.^^

V. Allocation of Taxes Between Landlord and Bankrupt Tenant

The Seventh Circuit decided an important issue last year that had been
addressed by numerous lower courts but not by a court of appeals. In re Handy
Andy Home Improvement Centers, Inc.^^ answered whether the bankrupt tenant's
debt to the landlord for taxes paid had to be prorated or whether it was entirely
a post-petition debt.^^ The Seventh Circuit affirmed the lower court decisions
that the debt had to be prorated, and it clarified that "the dividing line is . . . not

the date on which the petition is filed but the date on which the order for relief

is entered.
"^^

In Cook County, Illinois, taxpayers are billed after the period of assiessment,
and as elsewhere, landlords often pay the taxes as they come due and are later
reimbursed by their tenants.^"* The landlord in this case. National Terminals
Corporation ("National"), received the bill for the second installment of 1994

taxes in September 1995. In October 1995, tenant Handy Andy's creditors filed
an involuntary petition for bankruptcy. An order for relief, pursuant to 1 1 U.S.C.
§ 303(h), was entered on November 1, 1995.^^ Two weeks after the petition was
filed but before the order for relief was entered. National paid the tax bill and
invoiced Handy Andy. In February 1996 National received and paid the tax bill
for the first installment of 1995 taxes, and it invoiced Handy Andy again. Handy
Andy rejected the lease in April 1996.^^

Post-petition creditors receive high priority in the distribution of the debtor's

estate;^^ moreover, section 365(d)(3) of the Bankruptcy Code provides that the
trustee or the debtor in possession "shall timely perform all the obligations ofthe

debtor, . . . arising from and after the order for relief under any unexpired lease

of nonresidential real property, until such lease is assumed or rejected . . . ."^^

National argued that Handy Andy's obligation under the lease was a post-petition
debt—^that it could not have arisen until the billing date for tax reimbursement,
(i.e., the rental due date after National paid the county taxes).^^ The court
disagreed.

^°°

89. Mat 68 1-82.
90. Mat 683.
9L 144 F.3d 1125 (7th Cir. 1998).
92. Mat 1126.
93. Id.

94. See id.

95. See id.

96. See id.

97. See id. ail \21.

98. 11 U.S.C. § 365(d)(3) (1994).

99. See In re Andy, 144 F.3d at 1 126-27.

00. M



1999] BANKRUPTCY 623

Handy Andy's debt related entirely to an earlier period and was therefore no
different from debts to trade creditors incurred in 1994 but never paid.'^'

A trade creditor does not, by virtue of continuing to sell to the debtor
after the latter has gone into bankruptcy, obtain a priority for what the

debtor owes him for goods or services sold to the debtor before the
bankruptcy. National is in no different situation by virtue of section

365(d)(3).'''

The court opted for an interpretation of the statute that would not "make the
rights of creditors turn on the happenstance of the dating of tax bills and the

strategic moves of landlords and tenants."''^

VI. Discharge of Marital Obligations and the Burden of Proof

In the Seventh Circuit case In re Crosswhite,^^* the Crosswhites divorced,

and Mr. Crosswhite ("husband") agreed to assume and to hold Ms. Ginter

("wife") harmless on two joint debts. Husband did not pay the debts but instead

declared bankruptcy.''^ Wife paid one of the debts, and she restructured the

other and made payments on it. She then initiated an adversary proceeding in
husband's bankruptcy to determine whether husband's obligation under the

property settlement was dischargeable under 11 U.S.C. § 523(a)(15).''^ The
bankruptcy court held the obligations were dischargeable, and the district court

affirmed.^'' Wife appealed.^''

Section 523(a)(15) ofthe Bankruptcy Code provides that an individual is not
discharged from any debt "not of the kind described in paragraph (5) that is

incurred by the debtor in the course of a divorce or separation or in connection

with a separation agreement, divorce decree or other order of a court of record

. . . unless" one of two conditions exists. ^'^ The debt is dischargeable if "the
debtor does not have the ability to pay the debt from disposable income, or . . .

the benefit to the debtor in discharging the debt outweighs the detrimental

101. Seeidatmi'lS.

102. Id. at 1 128. The court also noted that section 365(cl)(3) establishes the date of the order

for relief as the cutoff. Id. at 1 127. Any obligation arising before that date would not fall within

this section. Here, that date was November 1, 1995. Id. at 1 126. National received a bill, paid it,

and invoiced Handy Andy for the second installment of the 1994 taxes before November 1, 1995.

In no case, then, could that obligation have arisen after the order for relief However, the court did

not rely on this line of reasoning because Handy Andy did not. Id. at 1 127.

103. /^. at 1128.

104. 148 F.3d 879 (7th Cir. 1998).

105. See id at SSI.

106. See id.

107. See id.

108. See id

109. 11 U.S.C. § 523(a)(15) (1994).



624 INDIANA LAW REVIEW [Vol. 32:613

consequences to the debtor's former spouse or child."^^^ The bankruptcy court
held that, despite husband's '"somewhat parasitic existence,'" it was appropriate
to discharge the debt because the benefit to husband outweighed the detriment

to wife.^^^

Wife did not object to carrying the initial burden of showing the existence
of a nondischargeable debt—one that was incurred by the debtor pursuant to a
divorce but did not fall under section 523(a)(5). Instead, she contended that the

court incorrectly failed to place on husband, the debtor, the burden of
establishing an affirmative defense—either that he could not pay the debt or that
the benefit to him of discharge outweighed the detriment to wife of no
discharge.

^^^

The Seventh Circuit concluded that "there is a clear shift in the burden of
proofunder [section] 523 (a)(15). The burden of proving initially that she holds

a subsection (15) claim against the debtor should be borne by the creditor
(nondebtor/former spouse)."* ^^ Once the creditor has overcome this hurdle, "the
burden of proving that he falls within either of the two exceptions to
nondischargeability rests with the debtor."*'"*

The court stated that both the bankruptcy court and the district court
"appeared to acknowledge, at one point, that the burden of establishing the

exception is on the debtor."**^ Nonetheless, the court vacated the decision and

remanded it,**^ because "a reading of both opinions in their entirety leaves us
with grave doubt as to whether abstract verbalization of the correct standard

actually was applied in the courts' analyses .... Rather, it appears to us that
these courts may well have placed improperly the burden of satisfying the test
under [section] 523(a)(15)(B) on the creditor, [wife], rather than on the debtor,

[husband]."**^ The dissent disagreed.**^

1 10. In re Crosswhite, 148 F.3d at 883 (citing 1 1 U.S.C. § 523(a)(15)(A)-(B)).

111. /^. at 883-84.

112. See id. at SS4.

113. Id.

114. /c/. at 884-85.

115. /^. at 886.

116. Mat 889.
117. /^. at 886.

118.

Both of the lower courts stated the appropriate burden of proof, but this court remands

because it questions whether they actually applied that burden. I conclude that they did

apply the burden they recited, leaving the key question of whether the bankruptcy court

abused its discretion in balancing the harms under (a)(15)(B) in favor of [husband]. In

my view it did not, and therefore, I would affirm.

Id. at 890 (Manion, J., dissenting).



1999] BANKRUPTCY 625

VII. Discretion to Deny Fees

In re Crivello^^^ addressed the issue ofcompensating professionals employed

in the bankruptcy who, as discovered later, were not disinterested. Crivello, the

debtor in possession, sought to retain Kravit, Gass & Weber, S.C. ("KGW") as
his bankruptcy counsel.^^° KGW failed to disclose earlier dealings it had with the
debtor, and it failed to disclose pre-petition claims it held against him.'^^

When KGW later applied to the bankruptcy court for final compensation of
more than $334,000, the U.S. Trustee objected, arguing that "KGW was not
disinterested, that KGW failed to disclose its connections to insiders adequately,
and that the amount of the request was unreasonable."*^^ After KGW filed an
amended affidavit of disinterestedness explaining why certain facts had not been
included in the original affidavit, the bankruptcy court revoked the firm's order

ofemployment and denied its request for compensation entirely.*^^ The district
court affirmed.*^"*

The court of appeals discussed the issue of professional compensation as a
backdrop to its determination of the question "whether a bankruptcy court must

deny fees when it subsequently learns that a professional never should have been
employed under [section] 327(a) in the first place or whether it has discretion to

deny fees."'"'

The U.S. trustee relied on the holding in the case Michel v. Federated
Department Stores, Inc.^^^ in support ofa mandatory denial of fees. The Seventh

Circuit rejected the trustee's argument based on the plain language of the

statute. *^^ Section 328(c) states that the court "may deny allowance of
compensation ... if, at any time during such professional person's employment
. . . such professional person is not a disinterested person, or represents or holds

an interest adverse to the interest ofthe estate with respect to the matter on which

such professional person is employed."'^^

The court stated that in order to reach the trustee's conclusion, it would have
to interpret the word "is" in section 328(c) to mean "becomes," and it would have
to insert the word "valid" before the word "employment."*^^ This the court
refused to do.*^^ "Under the plain language of the provision, [section] 328(c)
covers questions about whether this erroneously employed professional merits

119. 134F.3d831(7thCir. 1998).

120. See id. at 833.

121. See id. at 834.

122. Id.

123. See id. at 834-35.

124. Seeid.-aHZZ'b.

125. Id. at 836 (emphasis in original)

126. 44F.3dl310(6thCir. 1995).

127. In re Crivello, 134 F.3d at 837.

128. 11U.S.C.§ 328(c) (1994).

129. In re Crivello, 134 F.3d at 837.

130. Id.



626 INDIANA LAW REVIEW [Vol. 32:613

compensation. Thus a bankruptcy court has discretion in denying that
professional's fees."*^'

VIII. Two Other Decisions Worth Mentioning

In re Linton^^^ involved a situation where a party wanted to sue a bankruptcy

trustee in state court after the bankruptcy proceeding had been closed. Betty
Lasiter and Richard Scharpf sought leave from the bankruptcy court to sue the

trustee Paul Gresk for malicious prosecution of an adversary action he filed
against them while the bankruptcy proceeding was pending.^^^ The bankruptcy
court denied the motion, and both the district court and the court of appeals
affirmed.'^'

Although the court did not find any federal appellate court cases addressing

the requirement for leave after the bankruptcy is closed, it concluded such leave

to sue the trustee is required. ^^^ The rationale for the requirement during
bankruptcy also applies after the bankruptcy has been wound up (e.g., if the
trustee "is burdened with having to defend against suits by litigants disappointed

by his actions on the court's behalf, his work for the court will be impeded"; and
"it will be harder for courts to find competent people to appoint as trustees").

^^^

In In re Greenig^^^ the Greenigs submitted and the bankruptcy court

confirmed their Chapter 12 reorganization plans. The plans listed United Feeds
as a creditor holding an allowed claim, but United Feeds failed to file the

required proof of claim before the deadline passed. '^^ When United Feeds did
not receive its first payment from the Greenigs under the reorganization, it filed
a motion for leave to file a late proof of claim. The bankruptcy court granted the
motion, but the district court reversed.'^'

The Seventh Circuit affirmed the district court's decision. ^"^^ A bankruptcy
court does not possess the equitable power to permit a new claim that is filed

131. Id. Nevertheless, the court of appeals reversed the district court and remanded the case

to the bankruptcy court because the "bankruptcy court's erroneous findings of fact may have tainted

its discretion." Id. at 839. The district court found no support in the record for the bankruptcy

court's determination "that KGW attempted to thwart the Code's disclosure requirements and that
KGW willfully failed to disclose its prior representation." Id. at 840. Because the district court did
not consider whether these erroneous findings may have tainted the lower court's exercise of

discretion, the court of appeals was obligated to reverse. Id.

132. 136 F.3d 544 (7th Cir. 1998).

133. See id at 544-45.

134. M at 544, 547.
135. Mat 545.
136. Id.

137. 152 F.3d 631 (7th Cir. 1998).

138. See id at 632.

139. See id at 633.

140. Mat 636.



1999] BANKRUPTCY 627

late.''*' This is different from a Chapter 1 1 case where a proof of claim may be
deemed filed if the debt is scheduled.'"*^ "In a Chapter 12 bankruptcy case, the
creditor has [ninety] days to file a proof of claim, unless an exception of [Federal

Rule of Bankruptcy Procedure] 3002(c) applies. This requirement may not be
circumvented, either by the existence of a confirmed plan, or by the presence of

equitable considerations.'"'*^

Conclusion

These decisions address important questions for Indiana practitioners. Next
year at this time, attorneys will likely be reading not only about important

developments in the case law, but also significant changes in the Bankruptcy

Code itself.

141. See id. at 635.

142. See id. sA 633.

143. Id. at 636.