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Media Alerts - In re Underhill - Bankruptcy Appellate Panel, Sixth Circuit
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October 24, 2013
  In re Underhill - Bankruptcy Appellate Panel, Sixth Circuit
Headline: A debtor's misleading LLC valuation prevents abandonment of debtors' bankruptcy-estate asset.

Area of Law: Bankruptcy.

Issues Presented: (1) Did the bankruptcy court abuse its discretion in granting the creditor bank's motion to reopen the debtors' bankruptcy estate? (2) Did the bankruptcy court err in ruling that all of the settlement proceeds received by the debtor in her capacity as the sole LLC member were property of the debtors' bankruptcy estate?

Brief Summary: When the debtors filed a Chapter 7 bankruptcy petition, they represented that an LLC had no value and that neither they nor the LLC owned any causes of action. After the debtors received a bankruptcy discharge, the LLC filed a claim for tortious interference against several defendants. The parties settled the lawsuit for $80,000, but the settlement proceeds were distributed directly to the attorney who represented the LLC and to one of the debtors, who was the sole member of the LLC.

After the creditor bank learned of the LLC's settlement, the bank moved to reopen the debtors' discharged bankruptcy case so that the settlement proceeds could be administered as a bankruptcy-estate asset. The bankruptcy court granted the creditor bank's motion, and the debtors appealed.

Significance: A creditor may reopen a debtor's discharged bankruptcy case to administer an LLC's settlement proceeds that were awarded after the debtors' case was closed if the proceeds resulted from an undisclosed, pre-petition cause of action. And state law must be used to determine the value of a debtor's LLC membership interest.

Extended Summary:

In January 2010, the debtors filed for Chapter 7 bankruptcy. Their bankruptcy schedule stated that the debtors had "a 100% ownership and membership interest in [the LLC]." The schedule also listed the creditor bank as holding a claim totaling $25,000, which was secured by a lien on all of the LLC's property and was personally guaranteed by one of the debtors. In addition, the creditor bank held a non-priority unsecured $105,000 loan, which was made to another debtor-owned company. The debtors also represented that neither they nor the LLC owned any causes of action.

In April 2010, the debtors' Chapter 7 trustee filed a report of no distribution, and several months after the debtors were discharged, the LLC filed a claim for tortious interference against several defendants. The case settled for $80,000, and the settlement proceeds were distributed as follows: the attorney who represented the LLC received $35,015, and the debtor who was the sole member of the LLC received $44,985.

After the creditor bank learned of the LLC's settlement, the creditor bank filed a motion to reopen the debtors' bankruptcy case to administer the settlement as an undisclosed asset. The debtors filed an objection to the creditor bank's motion, but the bankruptcy court granted the motion, holding that the tortious-interference claim "was sufficiently rooted in the debtors' pre-bankruptcy past so . . . the $80,000 settlement funds . . . constitute property of the estate." The debtors appealed, arguing that the bankruptcy court abused its discretion in granting the creditor bank's motion to reopen the case. They also argued that the bankruptcy court erred in holding that all of the settlement proceeds that were received by the debtor in her capacity as the sole member of the LLC were property of the debtors' estate.

In holding that the bankruptcy court did not abuse its discretion in reopening the debtors' bankruptcy estate, the Panel noted that the debtors didn't seriously challenge the bankruptcy court's authority to reopen the case. Instead, the debtors argued that the settlement proceeds were not property of their bankruptcy estate because (1) the settlement proceeds were paid to the debtor after the debtors received a discharge, and (2) the trustee abandoned the cause of action when the debtors' bankruptcy case was closed.

Section 541 of the Bankruptcy Code defines property of the estate as "all legal or equitable interests of the debtor in property as of the commencement of the case." And courts have held that interests of the debtor include causes of action. In determining whether a cause of action is property of the estate, courts apply the test from Segal v. Rochelle, 382 U.S. 375 (1966), which states that claims are property of the bankruptcy estate if they are "sufficiently rooted in the pre-bankruptcy past."

Applying the Segal test, the Panel affirmed the bankruptcy court's order, which held that the debtors' interest in the LLC included a contingent, unliquidated value for the LLC's claim for tortious interference. The Panel explained that because the LLC's claim began before the debtors filed their bankruptcy petition, the "claim had its roots in prebankruptcy and pre-abandonment conduct." Consequently, "the debtors' interest in the LLC included some or all of the settlement proceeds."

The Panel noted that state law must be used to determine the value of a debtor's LLC membership interest. And under Ohio law, if a company is dissolved, the LLC's assets "are retained for the benefit of creditors of the company, not for the benefit of its members." The Panel explained that if the debtor had listed the LLC's cause of action on her bankruptcy schedule, then when the case settled, the debtor's membership interest in the LLC would have been $80,000, less amounts owed to creditors of the LLC. After the LLC's creditors had been paid, then the balance of the settlement proceeds would have belonged to the debtors' bankruptcy estate for distribution to the debtors' creditors.

To determine if the trustee abandoned the cause of action, the Panel looked to section 554 of the Bankruptcy Code. According to section 554, if a debtor conceals or fails to schedule an asset, the asset "will not be deemed to be abandoned by the trustee and belongs to the bankruptcy estate." The Panel held that the LLC's claim for tortious interference was not abandoned because the debtors (1) knew about the tort claim before filing for bankruptcy, (2) failed to list the claim on the debtors' schedule, and (3) placed a value of zero on the LLC membership interest.

Therefore, the bankruptcy court correctly reopened the debtors' estate, and the Panel remanded the case to determine how the settlement proceeds should have been distributed under Ohio law.

Affirmed and remanded for further proceedings.

Link to Full Opinion: http://www.ca6.uscourts.gov/op...s.pdf/13b0004p-06.pdf

Panel: EMERSON, LLOYD, and McIVOR, Bankruptcy Appellate Panel Judges

Argument: August 20, 2013

Date of Issued Opinion: September 16, 2013

Docket Number: 12-8045

Decided: Affirmed and Remanded.

Case Alert Author: Sandra Reizen

Counsel: David S. Blessing, THE BLESSING LAW FIRM, Cincinnati, Ohio, for Appellants. Jody Michelle Oster, THE HUNTINGTON NATIONAL BANK, Columbus, Ohio, for Appellee.

Author of Opinion: MARCI B. McIVOR, Chief Bankruptcy Appellate Panel Judge

Case Alert Circuit Supervisor: Professor Tammy Asher

    Posted By: Mark Cooney @ 10/24/2013 12:31 PM     6th Circuit  

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