Month: June, 2018

Please Release Me? Colorado Bankruptcy Court Answers “Perhaps” in Midway Gold Case

by Nicole Leonard and Jeffrey Bernstein

This article is  reprinted with the permission of the American Bankruptcy Institute. It originally appeared in Volume 17, Number 1 of the ABI Business Reorganization Committee Newsletter, May 2018.

The permanent release of a nondebtor from a debt owed to a third party in a chapter 11 plan is barred per se in some courts and must meet a high standard to be allowed in others. The U.S. Bankruptcy Court for the District of Colorado in In re Midway Gold US Inc. addressed this issue in connection with confirmation of the joint chapter 11 plan of 14 debtor entities in the gold mining and exploration business.[1]

As a threshold issue, the Midway court looked to whether third-party releases are ever allowed in the Tenth Circuit or whether they are barred per se as had been argued and applied in other cases. The court analyzed the Western Real Estate case and concluded a chapter 11 plan could not “bar litigation against nondebtors for the remainder of the discharged debt” and that the court’s authority under § 105(a) could not be used in a manner inconsistent with § 524(e). However, such finding did not translate into an absolute bar of all nondebtor releases in all circumstances.[2]

In connection with its analysis of the nondebtor release, the Midway court reviewed the treatment of nondebtor releases in other circuits and found that while the “Fifth and Ninth Circuits have held a bankruptcy court does not have authority to issue and enforce third-party non-debtor releases in a Chapter 11 plan,” these circuits are in the minority.[3] Rather, the Midway court sided with the majority, represented by the First, Second, Third, Fourth, Sixth, Seventh, Eighth and Eleventh Circuits, permitting third-party releases under certain narrow circumstances.

Section 524(e) of the Bankruptcy Code provides in pertinent part that “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.” The majority of the circuits view this language as a “savings clause” that preserves post-confirmation rights (e.g., the right to pursue a nondebtor for a debt) rather than “an absolute bar to third-party releases.”[1]

Further, the court observed that, read together, §§ 105(a),[2] 1123(b)(3)(A)[3] and 1123(b)(6)[4] indicate that “enjoining a creditor’s claims against a nondebtor may be necessary, and within the bankruptcy court’s authority, to achieve a successful reorganization.”[5]

Before forging its own path, the court examined the standards used by the other circuits in determining whether nondebtor releases are acceptable, some of which overlap. The First and Eighth Circuits look generally to the following nonexclusive list of factors outlined in the case In re Master Mortg. Fund (the “Master Mortgage Factors”), including whether:

(1) there is an identity of interest between the debtor and the third party, usually an indemnity relationship, such that a suit against the nondebtor is, in essence, a suit against the debtor or will deplete assets of the estate;

(2) the nondebtor has contributed substantial assets to the reorganization;

(3) the injunction is essential to reorganization (i.e., without it, there is little likelihood of success);

(4) a substantial majority of the creditors agree to such injunction; specifically, the impacted class (or classes) has “overwhelmingly” voted to accept the proposed plan treatment; and

(5) the plan provides a mechanism for the payment of all, or substantially all, of the claims of the class or classes affected by the injunction.[6]

The Midway court found that courts in the Third Circuit do not have a specific test, although a Delaware bankruptcy court has looked to the Master Mortgage Factors as a foundation along with “other relevant factors.”[7] Third-party nondebtor releases are allowed in the Second and Seventh Circuit only “when truly ‘unusual circumstances’ exist.”[8] The Sixth Circuit also restricts allowing such releases to “unusual circumstances” and further looks to a set of seven factors, certain of which are identical or substantially similar to the Master Mortgage Factors referred to as the “Dow Corning Factors.” The Midway court found that the U.S. Courts of Appeals for the Fourth and Eleventh Circuits have also looked to the Dow Corning Factors.[1]

After analyzing Western Real Estate and the other circuits, the Midway court determined that “while § 524(e) does not expressly provide for the release of a third party’s claims against a nondebtor, § 524(e) does not expressly preclude such releases.” However, such releases are not given “carte blanche” and are acceptable only “in certain, and very limited, circumstances if the release is “appropriate” and not inconsistent with any other provision of the Bankruptcy Code, including § 524(e).”[2]

For its own approach, the Midway court found that “the Court must parse out exactly who is releasing whom from what.”[3] In other words, the court stressed the importance of distinguishing “between the Debtors’ release of nondebtors and third parties’ release of nondebtors” and to “find the release to be necessary for the reorganization and appropriately tailored to apply only to claims arising out of or in connection with the reorganization itself, and not to matters which would have no effect upon the estate.”[4] If not, there is potential for a jurisdictional issue that would preclude the authority of the bankruptcy court to enter a final order.

The court further warned against the releases providing “nondebtors with ‘blanket immunity’ for all times, transgressions and omissions and may not include immunity from gross negligence or willful misconduct.”[5] As the Midway court summarized it, “[i]t is not the intention of the Court to permit nondebtors to purchase immunity from unrelated torts, no matter how substantial their contribution to a debtor’s reorganization.”[6]

In summary, most jurisdictions will allow third party releases of nondebtors — but only in certain narrow circumstances. Courts will determine the issue based on the facts and dynamics of each case and will require that such releases be fully justified. Plan proponents must walk the tightrope of providing for the releases necessary to have a plan accepted while avoiding overbroad language and staying within the lines of bankruptcy jurisdiction.

 

CAN SPOUSES NOW SAVE MARITAL PROPERTY BY FILING SEPARATE BANKRUPTCIES?

by Virginia Shea

The New Jersey Appellate Division has crafted a potential new avenue for debtor spouses to protect marital property.  The Appellate Division recently clarified that a creditor of one spouse cannot execute on marital real or personal property held by the spouses as tenants by the entirety, absent consent of both spouses.  Bankruptcy law holds that property held as tenants by the entirety is exempt property, unless state law holds to the contrary, which New Jersey law, now, clearly does not.  Accordingly, spouses may be able to protect marital property by filing separate bankruptcies, whereby consent may be denied by the respective non-debtor spouse.

The New Jersey Appellate Division recently ruled that a New Jersey Statute enacted in 1988 supersedes prior case law, such that there is no question that an unsecured creditor of one spouse cannot seek partition of property held by spouses as tenants by the entirety.  In Jimenez v. Jimenez, __A.3d __, 2018 WL 2106639 (App. Div. 2018), Raul and his wife Gwyn[1] owned undeveloped land in Mansfield, NJ (the “Mansfield Property”), as tenants by the entirety.  Plaintiffs, relatives of Raul, sought to enforce a consent judgment entered against Raul only, which judgment had been recorded as a lien.  Plaintiffs tried to enforce the judgment by way of other collection efforts but were unsuccessful.  Plaintiffs then moved under R. 4:59-1(d) to compel the partition and sale of the Mansfield Property.  Raul opposed the motion arguing that a forced sale and partition is prohibited by N.J.S.A. 46:3-17.4.  The motion judge agreed with Raul and denied the partition application.  The Appellate Division affirmed stating that N.J.S.A. 46:3-17.4 precluded one spouse’s unsecured creditor from obtaining a forced partition of property owned by both spouses as tenants by the entirety.

In 1988, new statutes were enacted in New Jersey, N.J.S.A. 46:3-17.2 to -17.4, pertaining to tenancies created on or after the 1988 enactment date.  Section 17.2 provides that a tenancy by the entirety is created when a husband and wife take title to “real or personal property under a written instrument designating both of their names as husband and wife.”  A tenancy by the entirety is a form of joint ownership of property only available to spouses, whereby each co-tenant is the owner of the entire property and each co-tenant has the right of survivorship after the death of the other.  Jimenez, 2018 WL 2106639 at *2.  A spouse can alienate his or her right of survivorship,[2]  but a spouse cannot force the partition of the property during the marriage.  Id.

Section 17.4 of N.J.S.A. 4:3 statute states, “[n]either spouse may sever, alienate, or otherwise affect their interest in the tenancy by entirety during the marriage or upon separation without the written consent of both spouses.”  Prior to the adoption of the 1988 statute, case law authorized courts to compel the partition and sale of a spouse’s interest in property held in a tenancy by the entirety, in the court’s discretion, where it would be equitable to do so.  Id. at *3.  In Jimenez, equity otherwise would have warranted partition as the Mansfield Property, because it was not used as the marital residence, some of the funds loaned to Raul by the plaintiffs related to development of the Mansfield Property, and plaintiffs had expended significant effort trying to execute from other sources, to no avail.  Id.  Nevertheless, the Appellate Division was constrained by the language of the 1988 statute to preclude partition since Raul and Gwyn owned the Mansfield Property as tenants by the entirety.  “Otherwise, a free-wheeling spouse, by amassing such individual debt, could detrimentally ‘affect’ the other spouse’s interest in their co-owned property.” Id. Moreover, “[t]here would have been little point for the Legislature to have enacted Section 17.4 if it only intended to continue established principles of case law regarding tenancies by the entirety ….”  Id.  The Appellate Division reached this conclusion in part, after reviewing In re Wanish, 555 B.R. 596 (Bankr. E.D. Pa. 2016).

In In re Wanish, a chapter 7 trustee in a Pennsylvania bankruptcy case, objected to a debtor’s claimed exemption in a mobile home owned with his non-debtor wife, which was located in New Jersey.  The Trustee conceded that New Jersey law applied in order to determine the exemption issue.  The bankruptcy court determined that based upon New Jersey’s 1988 statute, it was clear that creditors of one spouse could not levy or sell personal property held by a debtor as a tenant by the entirety, without the non-debtor spouse’s consent.  Id. 555 B.R. at 498.  Since it was clear under New Jersey law that creditors of the debtor were prohibited from levying on the mobile home without the consent of the non-debtor spouse, the debtor’s interest in the mobile home was exempt under 11 U.S.C. § 522(b)(3)(B).   Section 522(b)(3)(B) provides that a debtor may exempt as property “any interest in property in which the debtor had, immediately before the commencement of the case, an interest as a tenant by the entirety … to the extent that such interest as a tenant by the entirety … is exempt from process under applicable non-bankruptcy law.”  Here, New Jersey law no longer provides such “exempt[ion] from process,” such that property held as tenants by the entirety, is now clearly exempt under 11 U.S.C. § 522(b)(3)(B).

Along these lines, in 2012, the Bankruptcy Court for the Middle District of Florida, applied New Jersey law and determined that a trustee could not reach the sales proceeds generated by the sale of a debtor’s marital property.   In In re Montemoino, 491 B.R. 580 (2012), a married debtor, together with her non-debtor husband, sold real property held as tenants by the entirety, and deposited the net proceeds into a bank account titled solely in the non-debtor spouse’s name.   The trustee alleged that half the proceeds from the sale were property of the debtor and could be avoided as fraudulent, because the debtor transferred the proceeds to the non-debtor spouse for no consideration causing her to become insolvent as a result.  Id. at 583.  The debtor argued that the proceeds had originated from property held as tenants by the entirety,  and, as such, the proceeds maintained their tenant by entirety status, such that the proceeds were exempt.  The Florida bankruptcy agreed that New Jersey recognizes that personal property could be held as tenants by the entirety, and since the proceeds from the sale went to both spouses, the proceeds were presumed to be, under New Jersey law, held by the spouses as tenants by the entirety.  Id. at 586.  The bankruptcy court then held that although New Jersey common law prior to 1988 permitted creditors of a single spouse to execute on tenancy by the entireties property, “with the enactment of the tenancy by the entireties statutes, this Court concludes that creditors of just one spouse can no longer execute on entireties property.”  Id. at 588.  The court noted that the statute prevented a spouse from granting a mortgage on real property without the consent of the other spouse.  Id. at 589.  The court also pointed to a Third Circuit ruling that held “filing a bankruptcy petition does not sever a tenancy by the entirety and thus an individual spouse may be able to exempt the whole of entireties property from the bankruptcy estate in some circumstances.”  Id. (quoting In re O’Lexa, 476 F.3d 177 (3d Cir. 2007)).

Accordingly, Jimenez clarifies that with respect to creditors of a debtor who owns New Jersey property with a non-debtor spouse as tenants by the entirety, the entireties property is exempt under 11 U.S.C. § 522(b)(3)(B) because it is exempt from process under applicable non-bankruptcy law (absent a fraudulent conveyance).   A debtor may thus be able to protect marital property by filing for bankruptcy without his or her spouse, or by each spouse filing an indivi

[1] As plaintiffs and defendants surnames are “Jimenez,” all references will be to their first names.

[2] Presumably, by stepping into the debtor’s survivorship shoes, an unsecured creditor could acquire survivorship rights only such that the unsecured creditor could become owner of the entire property to the extent the debtor survives his or her non-debtor spouse after the marriage ends, whether by way of divorce or death.