Restructuring

Contributed by Rich Mullen
We have all been there – you pull that delicious reheated chili from the microwave only to feel the radiated bowl burning through your fingers as you scamper to sit it on the counter.  Thankfully, because of the Bankruptcy Code and its interpretation by thoughtful judges, similarly frantic moments are often avoided during bankruptcy cases.  The United States Court of Appeals for the First Circuit recently reminded us, for example, that there are rules that can temper the turbulent moments that arise when a debtor seeks to abandon property of the estate.  In In re Furlong, the First Circuit held, among other things, that a corporate debtor’s asset – certain contract and tort claims against a former owner of the company – was sufficiently scheduled for abandonment by operation of law because the Bankruptcy Code does not require every component of a cause of action to be spelled out on a debtor’s schedule and the chapter 7 trustee had both inquiry notice and actual notice as to the extent of the asset.
Furlong involved three chapter 7 cases, one case for a corporate debtor, and two cases for the husband and wife owners of the corporate debtor.  The owners (the individual debtors) claimed that the corporate debtor failed because its former owner engaged in fraud with respect to the sale of the company to the individual debtors, and then competed with, and stole customers from, the company after the sale.  In their respective schedules of assets, both the corporate and individual debtors listed “Claims for Breach of Contract” against the former owner as an asset with “indeterminate” value.  The individual debtors also listed their ownership interest in the corporate debtor as an asset.
The breach of contract claim was discussed at a creditors’ meeting held pursuant to section 341 of the Bankruptcy Code, and it was disclosed and understood that there also were several related tort claims against the former owner that stemmed from his sale of the company.  Shortly after the creditors’ meeting, the individual debtors shared with the chapter 7 trustee a draft 16-count complaint against the former owner that set forth claims for breach of contract, misrepresentation, intentional interference with advantageous business or contractual relationships, and several other business tort claims.  The chapter 7 trustee, however, was never able to retain an attorney that would pursue the claims on behalf of the estates.
In the corporate case, the chapter 7 trustee filed a “No Asset and No Distribution Report,” and the corporate bankruptcy estate was subsequently closed.  In the individual cases, the chapter 7 trustee filed a “Notice of Intention to Abandon” that described the contractual and tort claims against the former owner, and sought to abandon the scheduled claims against the former owner.  No objections were filed, and the bankruptcy court approved abandonment of the claims.
After the chapter 7 trustee abandoned the claims against the former owner on behalf of the estates of the corporate and individual debtors, both the owners and the company (acting separately from their respective bankruptcy estates) initiated a suit against the former owner alleging claims similar to those raised in the 16-count draft complaint.  The former owner then sought to purchase the claims and the ownership interest in the company from the estates of the individual debtors, acting under the presumption that they were not abandoned by the personal bankruptcy estates.  The individual debtors responded to the offer by seeking to verify that the claims against the former owner and the ownership interest in the company were, in fact, abandoned by the personal bankruptcy estates.
The bankruptcy court ruled that the corporate debtor’s claims against the former owner were abandoned by operation of law pursuant to section 554(c) of the Bankruptcy Code, which  provides that all properly scheduled property that is not administered at the time of the closing of a case is abandoned to the debtor.  The bankruptcy court also ruled that the chapter 7 trustee abandoned the individual debtors’ claims against the former owner via notice pursuant to section 554(a) of the Bankruptcy Code, which provides that, after notice and a hearing, the trustee may abandon any property of the estate that is burdensome or of inconsequential value and benefit to the estate.  The bankruptcy court determined, however, that the individual debtors’ ownership interest in the corporate debtor was never abandoned by the chapter 7 trustee and remained property of the individual bankruptcy estates.  On appeal, the district court affirmed.
The First Circuit recognized that a debtor has a duty to carefully, completely, and accurately prepare schedules such that an asset is described with “reasonable particularization under the circumstances.”  The First Circuit rejected the former owner’s argument that the “breach of contract” claim was improperly scheduled, determining that the corporate debtor scheduled the claims against the former owner with “reasonable particularity” because it is common knowledge that, under Massachusetts law, business tort claims might arise out of the same underlying facts as a claim for breach of contract.  The First Circuit also stated that the chapter 7 trustee was given actual notice as to the extent of the corporate debtor’s claims against the former owner by way of the discussion at the creditors’ meeting and the 16-count complaint, and was, thus, given a full opportunity to complete his investigation before abandoning the asset.  Ultimately, the First Circuit held that the claims against the former owner claim were abandoned by operation of law upon the closing of the corporate bankruptcy case.
In the individual cases, the First Circuit determined that the individual debtors’ claims against the former owner were abandoned because the chapter 7 trustee clearly and unequivocally described the individual debtors’ claims against the former owner in the notice of abandonment (to which no objection was filed) as claims for misrepresentation and other business related torts.  The individual debtors’ ownership interest in the corporate debtor, however, was never described or listed in any notice of abandonment and the individual bankruptcy cases were still on-going.  The First Circuit, therefore, concluded that the ownership interest in the corporate debtor was never formally abandoned and continued to be property of the individual estates, the implication being that the former owner could purchase the ownership interest in the company from the personal bankruptcy estates.
The takeaway from Furlong?  To avoid unnecessary litigation, debtors should thoroughly schedule and describe assets on their bankruptcy schedules.  On the other hand, parties-in-interest should comb through those schedules because bankruptcy courts will not require every hot serving dish and utensil to be explicitly listed on a debtor’s schedule.