KSB

08-13320 Ramsey and Stelter (Doc. # 90)

In Re Ramsey and Stelter, 08-13320 (Bankr. D. Kan. Mar. 26, 2014) Doc. # 90

PDFClick here for the pdf document.


SO ORDERED.
SIGNED this 26th day of March, 2014.

 

PUBLISHED

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS


IN RE:
TIMMY GENE RAMSEY,
RHONDA SUE STELTER,
Debtors.
)
)
)
)
)
Case No. 08-13320
Chapter 13

__________________________________________)

ORDER DENYING MOTION TO MODIFY CONFIRMED
PLAN AND DISMISSING CASE

When these debtors confirmed their chapter 13 plan in 2009, they were above-
median debtors whose applicable commitment period was five years. In calculating
their projected disposable income under §1325(b), they deducted from their current
monthly income over $900 a month for federal income tax withholding. On their
Schedules I and J, they explained that they were not withholding for taxes before

1


Case 08-13320 Doc# 90 Filed 03/26/14 Page 1 of 10


they filed. The IRS filed sizeable priority tax claims for several prepetition years.1
Under their confirmed plan, the debtors proposed to pay $10,000 in unpaid taxes to
the IRS. They also proposed to pay their ongoing home mortgage through the plan.
Then, in July of 2013, about six months before the five-year anniversary of their first
plan payment, and in response to the Trustee’s motion to dismiss for payment default,
they proposed a plan modification that would pay the IRS’s newly-filed post-petition
tax claims of more than $16,000 for the years 2011 and 2012.2 That claim would be
paid by effectively diverting those funds from the unsecured creditors, thereby
reducing the unsecured creditors’ take. The Trustee objected to debtors’ proposed
modification on several grounds.3 After reviewing the parties’ stipulations of fact and
their briefs, I deny the debtor’s motion to modify and, because the plan now exceeds
five years in duration, the case should either be converted or dismissed.4

Facts5

Timmy Ramsey and Rhonda Stelter filed their joint chapter 13 petition and
plan on December 23, 2008. They filed all of the necessary schedules with their
petition, including schedules I and J. On schedule I they stated that neither debtor
had withheld federal income tax from their pay after April of 2008, and that between

1 The IRS’s original proof of claim encompassed income tax liabilities from 2002-2007.
2 Dkt. 64.
3 Dkt. 66.
4 The debtors appeared by their attorney William Zimmerman. The chapter 13 trustee Laurie B.


Williams personally appeared.
5 The parties stipulated to the facts in this case. Those stipulations are found at Dkt. 76. The
controlling facts set forth are derived from the stipulations and pleadings in the case.


2

Case 08-13320 Doc# 90 Filed 03/26/14 Page 2 of 10


them, some $975 should have been withheld monthly. They incorporated these
figures into their Form B22C disposable income calculation as well as their Schedule
J expenses. Line 30 of Form B22C requests information about “the total average
monthly expenses that you actually incur” for taxes other than property or sales
taxes. The debtors inserted a figure of $1,943. According to the note added to Line 17
of Schedule I, the debtors anticipated the $975 in monthly withholding that they
reported as an expense on Schedule J and included that amount in reaching the
$1,943 allowed for the payment of taxes on Form B22C, Line 30. Their B22C reports
monthly disposable income of $500.27. Because the debtors’ income was “abovemedian,”
they were required to commit to a five-year repayment period under §
1325(b)(4) and § 1322(d)(1).

In their plan, the debtors proposed to pay their unsecured creditors not less
than $30,016.20 and to pay their ongoing mortgage payments through the trustee.6
This required them to commit to $2,000 monthly plan payments. On February 12,
2009, the Court confirmed their plan.7 In December of 2011, the Trustee moved to
dismiss the debtors’ case for payment default. On February 12, 2012, the court
entered an order overruling that motion, but increasing the monthly plan payment
to $2,029 until the debtors had paid in another $47,696 which would take, by my
calculation, another 24 months, or until February of 2014.8 In addition, the order

6 Dkt. 6, p. 2.
7 Dkt. 20.
8 Dkt. 53.

3

Case 08-13320 Doc# 90 Filed 03/26/14 Page 3 of 10


provided that as the IRS had filed an amended proof of claim to include post-petition
taxes due for 2010, that part of the Government’s claim would be paid through the
trustee with part of the newly-increased plan payments.9 Then, in June of 2013, the
Government again amended its claim to include unpaid taxes for 2011 and 2012 in
the amounts of $9,070 and $7,418.

After the debtors again defaulted on their plan payments, prompting the
trustee to file a second motion to dismiss in May of 2013, they filed the present motion
to modify.10 The debtors were behind on their plan payments, this time by $2,576,
and, as the Government’s amended proof of claim suggests, still not paying or
withholding for current income taxes. By November, the debtors were $5,460 behind
in plan payments. Under the debtors’ original plan, the first payment was due on
January 23, 2009.11 The sixtieth (60th) monthly plan payment of the applicable
commitment period was due January 23, 2014, now past.

In the July 2013 motion to modify their confirmed plan, the debtors ask that
their plan be extended beyond their “four payments remaining” and that the funds
originally to be paid to general unsecured creditors instead be paid to the IRS to cover
the 2011 and 2012 taxes to the extent the receipts permit.12 They request a “deviation
from their B22C results” to allow this to happen. The Trustee objects that (1) the

9 Id.
10 Dkt. 59 (Trustee’s Motion to Dismiss); Dkt. 64 (Debtors’ Motion to Modify).
11 See § 1326(a)(1). See also Baxter v. Evans (In re Evans), 183 B.R. 331, 332-34 (Bankr. S.D. Ga.


1995) (plan term begins when debtor is first obligated to make plan payment, not when plan is
confirmed).
12 Dkt. 64.


4

Case 08-13320 Doc# 90 Filed 03/26/14 Page 4 of 10


modification doesn’t address the current plan payment delinquency; (2) the
modification doesn’t address the debtors’ monthly mortgage payments; (3) the
modification would not commit all of the debtors’ disposable income; and (4) that the
motion to modify was not filed in good faith. In her brief, the Trustee adds that the
debtors have failed to demonstrate “changed circumstances” that would justify their
modification request.

Analysis

After a debtor’s chapter 13 plan is confirmed, the debtor or another party in
interest can propose modifications for certain purposes, including to increase or
decrease payments on particular classes of claims and to extend the time for paying
those claims.13 A proposed modification can only be approved if it comports with §
1322(a) and (b) which require, among other things, that the debtor’s plan provide for
the full payment of priority claims under § 507(a).14 As § 1329(b) only requires a
modified plan to comply with subsection (a) of § 1325, § 1325(b)’s means test need not
be considered. But § 1329(c) only allows the Court to extend the time for payment of
claims up to five years after the first payment was due under the debtor’s original
plan. In other words, a plan cannot be modified in a way that gets around the five
year limit found in § 1322(d).15

13 11 U.S.C. § 1329(a)(1) and (2).
14 § 1329(b)(1) and § 1322(a)(2).
15 See Profit v. Savage (In re Profit), 283 B.R. 567, 575-76 (9th Cir. BAP 2002) (plan could not be


modified after 60-month term had expired even though motion to modify was filed prior to expiration
of 60th month).

5


Case 08-13320 Doc# 90 Filed 03/26/14 Page 5 of 10


The Trustee is correct that the debtors’ proposed modification makes no
provision for curing the immediate $5,460 payment default. If they do not cure, the
debtors will have failed to honor their commitment to pay their projected disposable
income to their unsecured creditors. If the debtors do not cure the plan default by the
end of the five year applicable commitment period, they will not receive a discharge.16
And, as the Trustee points out, the debtors’ failure to make plan payments is grounds
for dismissal under § 1307(c)(6).

The fact that the other unsecured creditors will not receive what they expected
to get under the original confirmed plan is not necessarily a basis for rejecting this
modification if the debtors can show a reasonable basis for departing from that
original confirmation order. If, as the parties stipulate, the IRS has filed an amended
proof of claim for the post-petition taxes due for 2011 and 2012, those taxes constitute
allowed post-petition claims under § 1305. Because they are for income taxes, because
the IRS filed a proof of claim for them, and because the claim is to be allowed “the
same as if” the claims had arisen pre-petition, the claims constitute unsecured
priority claims under § 507(a)(8).17 Because § 1329(b)(1) reads § 1322(a)(2) and §
1325(a)(1) into the requirements for confirmation of a plan modification, the debtor
is required to provide for post-petition tax claims to be paid in full. This would operate
to reduce the payments to the general unsecured creditors while increasing payments
to a priority unsecured creditor as is permitted by § 1329(a)(1).

16 Section 1328(a)(1) only grants a discharge “after completion by the debtor of all payments under the plan.”
17 See In re Brensing, 337 B.R. 376, 381-82 (Bankr. D. Kan. 2006); 11 U.S.C. § 1305(a)(1) and (b).

6


Case 08-13320 Doc# 90 Filed 03/26/14 Page 6 of 10


The debtors have two other insurmountable problems. The first is that they
cannot pay the new priority tax claims in full over the life of the plan, rendering it
unfeasible. Even if they could pay, the debtors failed to demonstrate that their
circumstances have changed to a degree that would warrant modifying the present
plan.

The amended priority tax claims amount to $16,418. The debtors’ monthly
payments are $2,029 a month. The five year period within which their plan must be
completed, and which effectively brackets the time such a plan may be extended
under § 1329(c), ended on January 23, 2014. Thus, when the debtors sought this
modification on July 22, 2013, they had 6 months left in the life of their plan. Six
payments of $2,029 total $12,174, far short of what is needed to pay the government’s
§ 1305 claims.18 Even if the debtors had a means of curing the current $5,460 payment
delinquency, that would only yield a gross total amount paid under the modified plan
of $17,634 which, after deduction of the trustee’s fees, would not suffice to pay the tax
claims in full, contrary to §1322(a)(2). The modification is not feasible and does not
comply with §1325(a)(1) and (6), two other provisions that are read into the
modification confirmation requirements by § 1329(b)(1).19

Though the Code does not expressly require the debtors to show a change in
their circumstances sufficient to warrant confirmation of a modified plan, some courts

18 The debtors’ proposed modification does not change the amount of the monthly plan payment.
19 In re McClam, No. 08-11544PM, 2009 WL 2928240 (Bankr. D. Md. Aug. 13, 2009) (plan could not
be modified to extend duration to 76 months due to 5-year limitation in § 1329(c)).

7

Case 08-13320 Doc# 90 Filed 03/26/14 Page 7 of 10


hold as much.20 They reason that a confirmed plan is accorded a significant degree of
finality under § 1327(a) that should not be disturbed unless a debtor has experienced
a substantial or material unanticipated change in circumstances.21 Nothing in this
record suggests such a change. The debtors have failed to provide for the payment of
their post-petition taxes; they similarly failed to provide for those payments pre-
petition. Both debtors were employed at filing; they remain so today. Nor does
anything in their motion explain or justify their current plan default.

In short, the debtors’ failure to provide for a cure of their payment default,
their failure to provide for the full payment of the priority tax claims, the five-year
durational limit, and the lack of evidence of an unanticipated, material and
substantial change in the debtors’ circumstances all combine to defeat their motion
to modify.

I recognize that whether changed circumstances is a predicate for modifying a
confirmed chapter 13 plan remains uncertain in this Circuit as the Tenth Circuit
Court of Appeals has yet to decide that issue. Even so, the trustee has also raised the
debtors’ lack of good faith as an objection. The modification must be proposed in good

20 See Keith M. Lundin & William H. Brown, CHAPTER 13 BANKRUPTCY, 4TH EDITION, § 257.1, Sec.
Rev. June 9, 2004, www.Ch13online.com, for discussion of the changed-circumstances requirement
and the split of authority among the circuit and bankruptcy courts. The Tenth Circuit has not
decided this issue.
21 In re Grutsch, 453 B.R. 420, 427-29 (Bankr. D. Kan. 2011) (analyzing modification under the good
faith confirmation requirement of § 1325(a)(3) court held that debtor’s voluntary retirement was not
a sufficient change of circumstances justifying a reduction in the length of her plan from 60 months
to 36 months); In re Mellors, 372 B.R. 763, 769-71 (Bankr. W.D. Pa. 2007) (confirmation order is res
judicata on modifications that could have been litigated at the confirmation hearing; debtors post-
confirmation discovery of vehicle’s cracked frame was sufficient change of circumstances such that
debtors could modify creditor’s treatment by surrendering the vehicle).

8


Case 08-13320 Doc# 90 Filed 03/26/14 Page 8 of 10


faith under §§ 1325(a)(3) and 1329(b)(1). In this Circuit, the Flygare factors guide the
Court’s determination whether the modification is proposed in good faith.22 The
eleven factors are nonexclusive and the Court may consider other relevant
circumstances to determine good faith, including changed circumstances.23 Indeed,
the eighth Flygare factor itself is the existence of “special circumstances.”

I am troubled by the debtors’ apparent inability or unwillingness to withhold
or pay their post-petition income taxes for three years while under the court’s
protection and even after they chose to take those proposed withholdings as
deductions from income on schedule J in 2008 and on Form B22C to calculate
disposable income. The debtors’ good faith might not be questioned if their failure to
address their income tax responsibilities were an isolated circumstance. But it isn’t.
The debtors were not withholding in 2008 before they filed their petition – and they
recognized that fact when the filled out Schedule J and Form B22C. Indeed, the IRS’s
proofs of claim state that the debtors have not been paying their federal income taxes
since 2002.24 After confirmation, and in response to the trustee’s first motion to
dismiss, the debtors agreed to increase their plan payment, in part to pay their post-
petition 2010 tax liability of $10,000. This suggests that they never withheld taxes

22 Flygare v. Boulden, 709 F.2d 1344, 1347-48 (10th Cir. 1983).
23 See CHAPTER 13 BANKRUPTCY, 4TH EDITION, § 257.1 at ¶ 15, www.Ch13online.com, supra where the
treatise authors advocate that changed circumstances should be considered evidence bearing on

other statutory requirements for modification and might be probative of the proponent’s good faith
under § 1325(a)(3).
24 See Claim 9-4. Since 2009, the IRS’s claim has grown from $16,252 to $42,254. The Kansas Department of

Revenue’s claim seeks payment of unpaid taxes dating to 2005. Claim 12-1.
9

Case 08-13320 Doc# 90 Filed 03/26/14 Page 9 of 10


post-petition and simply applied those funds to other purposes. And debtors
thereafter failed to withhold or pay their taxes, prompting the current motion to
modify to address their 2011 tax liability of $9,000 and their 2012 tax liability of
$7,400. They weren’t paying their post-petition taxes, while simultaneously
defaulting on their plan payments. In short, the debtors’ refusal to pay their taxes
has been a problem for many years and, certainly, since day one of this case. This can
only be attributed to their own conduct and their unwillingness to withhold or pay
these tax obligations. The pattern of pre-petition nonpayment, combined with the
their repeated failure to pay their post-petition taxes as they came due and their
present desire to pay these non-dischargeable debts at the expense of the general
unsecured creditors suggests that they have learned little from their sojourn in
bankruptcy and strongly suggests their lack of good faith, supplying yet another
reason to deny the motion.25

The debtors’ motion to modify is DENIED. The Trustee’s motion to dismiss
under § 1307(c)(6) is GRANTED, but the order of dismissal shall be stayed for 14 days
to give the debtors an opportunity to convert their case to one under chapter 7.

# # #

25 See §§ 1325(a)(3) and 1329(b)(1).

10

Case 08-13320 Doc# 90 Filed 03/26/14 Page 10 of 10

11-12156 Hobson (Doc. # 77)

In Re Hobson, 11-12156 (Bankr. D. Kan. Feb. 14, 2014) Doc. # 77

PDFClick here for the pdf document.


 

 DESIGNATED FOR ONLINE PUBLICATION BUT NOT PRINT PUBLICATION

 

 

IN THE UNITED STATES BANKRUPTCY COURT

 FOR THE DISTRICT OF KANSAS

IN RE: )

 )

ANGELA KAY MYERS, ) Case No. 11-12155

 ) Chapter 7

 Debtor. )

__________________________________________)

 )

IN RE: )

 )

MARK ANDREW HOBSON, ) Case No. 11-12156

ELAINE MICHELLE HOBSON, ) Chapter 7

 )

 Debtors. )

__________________________________________)

 )

IN RE: )

 )

KYLE LYNN ROBERTS, ) Case No. 12-10752

HEATHER MARIE ROBERTS, ) Chapter 7

 )

 Debtors. )

__________________________________________)

 


REPORT AND RECOMMENDATION

ON CHAPTER 7 TRUSTEE’S MOTION TO WITHDRAW REFERENCE

 

 In these three cases, the debtors claimed a portion of their earned income tax
credit for the tax year 2011 exempt under KAN. STAT. ANN. § 60-2315 (2012 Supp.).
This much-litigated provision exempts a debtor’s right to receive an earned income
credit (EIC), but only if the debtor is a debtor in a bankruptcy case. The federal
constitutionality of this provision has been upheld by me, by Judge Karlin, by District
Judge Marten, and by the Bankruptcy Appellate Panel for the Tenth Circuit.1 Those
cases resolved trustees’ constitutional challenges to the state exemption on a number
of grounds, including whether it ran afoul of the Supremacy Clause, the Uniformity
Clause, and other provisions of the U.S. Constitution. No bankruptcy trustee has yet
asserted that the provision offends the Equal Protection Clause of the federal
Constitution.2 The bankruptcy trustee in the current cases instead alleges that this
statute violates the Uniformity Clause found in Article 2, Section 17 of the Kansas
Constitution which provides that “All laws of a general nature shall have a uniform
operation throughout the state ….”

1 In re Westby, 473 B.R. 392 (Bankr. D. Kan. Apr. 4, 2012) (Karlin, J.), aff’d 486 B.R. 509 (10th Cir.
B.A.P. Feb. 4, 2013) (Michael, J.), appeal dismissed No. 13-3044 (10th Cir. Mar. 29, 2013); In re Earned
Income Tax Credit Exemption Constitutional Challenge Cases, 477 B.R. 791 (Bankr. D. Kan. Aug. 2,
2012) (Nugent, J.), aff’d 2013 WL 4431267 (D. Kan. Aug. 16, 2013) (Marten, J.).

2 In the In re Earned Income Tax Credit Exemption Constitutional Challenge Cases litigation before
this Court, a different trustee initially raised an equal protection challenge in her objection to the
exemption, but the trustees in those proceedings abandoned this ground when they failed to brief the
argument. 477 B.R. at 806-07.

 The parties here join in asking that the reference of this matter be withdrawn
by the District Court so that it may certify the question of the exemption statute’s


validity to the Kansas Supreme Court.3 In defense of the bankruptcy-only exemption
statute, the intervener State of Kansas argues that the statute is in fact
constitutional and that only the Kansas Supreme Court may interpret the Kansas
Constitution. But questions of law should only be certified to the Kansas Supreme
Court where there is no controlling authority from that Court that bears on the issue.
That is not the case here. As such, withdrawal of the reference would serve no
purpose. Accordingly, I recommend that the District Court deny the request and
permit this Court to determine whether the exemption is valid and applicable in these
cases.4
Withdrawal of Reference
The Trustee’s motion is brought as one for permissive withdrawal for cause
under 28 U.S.C. § 157(d) and for discretionary abstention under 28 U.S.C. §
1334(c)(1).5 He contends that cause exists under D. Kan. Rule 83.8.6(a)(1) [interest of
comity with state courts or respect for state law to exercise discretionary abstention]
and (a)(6) [other specified cause].6 Note, though that this matter bears directly on
the degree and extent of the property of the estate and is fundamentally a core
3 These cases are submitted on stipulated facts and the Trustee’s motion to withdraw the reference for
cause to enable the District Court to certify the state constitutional question to the Kansas Supreme
Court. See In re Myers, Case No. 11-12155, Dkt. 60. Neither debtors nor the intervener State of Kansas
object to withdrawal of the reference for the purpose of certifying a state constitutional challenge, but
the State of Kansas defends the constitutionality of the state bankruptcy-only exemption.
4 D. Kan. 83.8.6(f) provides that the bankruptcy court submit a written recommendation on the motion
to the district court.
5 See also Fed. R. Bankr. P. 5011 and D. Kan. Rule 83.8.6(a).
6 The Trustee does not specify a “cause” under (a)(6) that differs much in substance from permissive
abstention incorporated in (a)(1), other than the alleged inability of the bankruptcy court to certify the
constitutional question. That “cause” for withdrawal of the reference is addressed in the next section.
3
Case 11-12156 Doc# 77 Filed 02/13/14 Page 3 of 11

proceeding, a fact which the Trustee concedes.7 Only in the most unusual event would
the District Court consider withdrawal of the reference to determine whether an
exemption applies in a particular case.8 The fact that the bankruptcy court is
determining application of a state law exemption statute is alone insufficient by itself
to warrant withdrawal of the reference, because allowing exemptions is intrinsically
connected to a debtor’s bankruptcy case.9 Indeed, KAN. STAT. ANN. § 60-2315, enacted
in 2011, has no application outside of a bankruptcy proceeding and would be unlikely
to ever arise in a state court proceeding.10 Judicial economy and uniform bankruptcy
administration is best served by having the bankruptcy court determine the validity
of the bankruptcy-only exemption at issue in this case. Numerous bankruptcy courts
have determined the constitutionality of state law bankruptcy specific exemptions
7 See Dkt. 60, p. 5, ¶ 15; 28 U.S.C. § 157(b)(2)(B). See also 11 U.S.C. § 522(l); Schwab v. Reilly, 560 U.S.
770, 130 S.Ct. 2652, 177 L.Ed. 2d 234 (2010) (All of a chapter 7 debtor’s assets become property of the
bankruptcy estate except that property which a debtor claims exempt).
8 Use of the “for cause shown” test in 28 U.S.C. § 157(d) indicates that Congress intended to have
bankruptcy proceedings adjudicated in the bankruptcy court unless a contravening interest requires
withdrawing the reference. See In re American Community Services, Inc., 86 B.R. 681, 686 (D. Utah
1988) citing In re DeLorean Motor Co., 49 B.R. 900, 912 (Bankr. E.D. Mich. 1985). See also Matter of
Edward Pirsig Farms, Inc., 47 B.R. 376 (D. Minn. 1984) (constitutional challenge to lien avoidance
statute § 544, did not require withdrawal of reference); In re Coe-Truman Technologies, Inc., 214 B.R.
183 (N.D. Ill. 1997) (Most important factor to consider is determining whether discretionary
withdrawal of the reference is appropriate is whether the proceeding sought to be withdrawn is core
or noncore).
9 Cf. Stern v. Marshall, 131 S. Ct. 2594, 2611-15 (2011) (state law tortious interference counterclaim
that existed independent of any bankruptcy proceeding required adjudication by an Article III court
that could enter a final judgment). See also In re Security Bank Corp., 2010 WL 2464966 (M.D. Ga.
2010) (refusing to withdraw the reference of a proceeding to determine whether a $17 million tax
refund was property of the estate; the proceeding was core and consideration of non-bankruptcy tax
law did not warrant withdrawal.).
10 See Container Recycling Alliance v. Lassman, 359 B.R. 358, 360 (D. Mass. 2007) (Withdrawal of
reference is an exception to the general rule that bankruptcy proceedings should be adjudicated in the
bankruptcy court and power to withdraw should be used only when it is essential to preserve a higher
interest.)
4
Case 11-12156 Doc# 77 Filed 02/13/14 Page 4 of 11

under their applicable state constitution.11 Given the discretionary nature of
withdrawal and abstention in these cases, I submit that the District Court should
allow this Court to retain and decide this matter, giving due respect for controlling
Kansas law regarding Art. 2, § 17 of the Kansas Constitution to guide its
determination.12
Certification of Questions of Law, KAN. STAT. ANN. § 60-3201, et seq.
Kansas has adopted that Uniform Certification of Questions of Law Act.13 The
statutes provide that the Kansas Supreme Court may answer legal questions certified
to it by the Supreme Court of the United States, a federal court of appeal, a United
States district court, or an appellate court from a sister state.14 It does not specifically
authorize bankruptcy courts to certify questions to the Kansas Supreme Court.
Indeed, one bankruptcy court concluded that without express authority to certify, it
11 See In re Joyner, 489 B.R. 292 (Bankr. S. D. Ga. 2012) (Georgia’s bankruptcy specific exemption in
the cash value of life insurance policies did not violate the equal protection clause of the Georgia
Constitution.); In re McFarland, 481 B.R. 242 (Bankr. S.D. Ga. 2012) (accord); In re Holt, 894 F.2d
1005 (8th Cir. 1990) (Arkansas exemption statute for proceeds of life, health, accident and disability
insurance was unconstitutional where it was in direct conflict with $500 limitation imposed by
Arkansas Constitution); In re Foster, 168 B.R. 183 (Bankr. S. D. Ind. 1994) (Indiana exemption statute
regarding IRAs, as amended, did not violate Indiana Constitution, Art. 1, § 22 regarding debtor’s right
to exempt a reasonable amount of property.); In re Butcher, 189 B.R. 357 (Bankr. D. Md. 1995)
(Maryland statute exempting monies payable to debtors due to personal injury claims did not violate
reasonableness requirement of Maryland Constitution protecting debtor’s property from execution).
12 The intervener cites Michigan v. Long, 463 U.S. 1032, 1041, 103 S. Ct. 3469, 77 L.Ed. 2d 1201 (1983)
for the proposition that only state courts may interpret their state constitutions. The facts of Michigan
v. Long, a criminal case, have no bearing on the issue before this Court and in any event, this Court
has available to it Kansas Supreme Court precedent as to the meaning and application of the
uniformity clause of the Kansas Constitution. The bankruptcy court is not seeking to interpret the
Kansas Constitution but instead, to apply the legal principles set forth in the Kansas uniformity cases
to the Kansas bankruptcy exemption statute.
13 KAN. STAT. ANN § 60-3201-3212 (2005).
14 § 60-3201.
5
Case 11-12156 Doc# 77 Filed 02/13/14 Page 5 of 11

would retain and decide the constitutionality of a state law exemption for itself.15 It
is not clear that if a legal question is to be certified, the reference must be withdrawn.
In 28 U.S.C. § 151 Congress declared that bankruptcy courts shall constitute
“a unit” of the district court and that bankruptcy judges are deemed to be a “judicial
officer of the district court.”16 Citing § 151, at least one bankruptcy court has
concluded that it has the power to certify a question of law to its state supreme
court.17 Thus, there is arguably authority for this Court to certify a question of law to
the Kansas Supreme Court, mooting the Trustee’s motion to withdraw the reference.
Even if the District Court withdraws the reference, it must conclude that
“there is no controlling precedent in the decisions of the supreme court and the court
of appeals of this state” to certify the question.18 Here, while there is no case that
specifically addresses the Kansas constitutionality of § 60-2315, there are many
Kansas cases that interpret and apply the Uniformity Clause of the Kansas
Constitution and state the controlling legal principles to which this Court is bound.
In addition, having heard and decided the federal constitutional challenges to the
Kansas earned income tax credit exemption, this Court is already intimately familiar
with both the exemption statute and the constitutional arguments, including the
15 In re Butcher, 189 B.R. 357, 364 (Bankr. D. Md. 1995).
16See Badami v. Sears (In re AFY, Inc.), 461 B.R. 541, 546-47 (8th Cir. BAP 2012) (“While the
bankruptcy court typically functions as a separate court, for jurisdictional purposes, it is not a court
apart from the district court. . . . whatever jurisdiction Congress vested in the district court, has now
been referred to the bankruptcy court.”)
17 See In re Sterling Mining Company, 415 B.R. 762, 768 (Bankr. D. Idaho 2009) citing JP Morgan
Chase Bank, N.A. v. Cougar Crest Lodge, LLC (In re Weddle), 2006 WL 3692425 at *2 and n. 8 (Bankr.
D. Idaho. Dec. 12, 2006).
18 § 60-3201.
6
Case 11-12156 Doc# 77 Filed 02/13/14 Page 6 of 11

Uniformity Clause of the U.S. Constitution and concepts such as geographic
uniformity.19 Those concepts are not unsettled under Kansas law nor novel to the
Kansas Constitution. As noted by the federal district court in Marzolf v. Gilgore:
“The decision to certify rests in the sound discretion of the federal
district court.” Allstate Ins. Co. v. Brown, 920 F.2d 664, 667 (10th Cir.
1990) (quoting Lehman Bros. v. Schein, 416 U.S. 386, 391, 94 S. Ct.
1741, 1744, 40 L.Ed. 2d 215 (1974)). Furthermore, “certification is
not to be routinely invoked whenever a federal court is presented with
an unsettled question of state law.” Armijo v. Ex. Cam., Inc., 843 F.2d
406 (10th Cir. 1998).
“If a district court or court of appeals believes that it can resolve
an issue of state law with available research materials already at
hand, and makes the effort to do so, its determination should not be
disturbed simply because the certification procedure existed but was
not used.” Lehman Bros. v. Schein, 416 U.S. 386, 395 . . .20
These certification principles were applied in In re Medill, a case where the chapter
7 trustee objected to debtors’ claim of exemption of a personal injury action and
asserted that the exemption violated the Minnesota Constitution.21 The debtors
19 The Supreme Court has spoken on geographic uniformity under the federal Constitution and the
Kansas Supreme Court has addressed it under the Kansas Constitution. See In re Agriprocessors, Inc.,
479 B.R. 835, 848 (Bankr. N.D. Iowa 2012) (No basis existed for bankruptcy court to order parties to
file request for withdrawal of reference of fraudulent and preferential transfer claims; bankruptcy
court’s familiarity with case, related adversary proceedings, and preference and fraudulent transfer
actions strongly weighed against any need for withdrawal of reference.).
20 924 F. Supp. 127, 129 (D. Kan. 1996). See also In re Sterling Min. Co., 415 B.R. 762, 767-68 (Even
where state law is unsettled or has not directly addressed an issue of law, certification is not
mandatory; bankruptcy court could apply the “holdings and principles articulated in the Idaho cases
and the state’s statutes and rules” to the facts); In re Touch America Holdings, Inc., 401 B.R. 107, 119-
20 (Bankr. D. Del. 2009) (federal court, in deciding whether to certify issues to state court, may
consider existence of sufficient sources of state law, such as statutes and judicial decisions to allow a
principled, rather than a conjectural, conclusion; declining to certify issues to Montana Supreme
Court).
21 119 B.R. 685 (Bankr. D. Minn. 1990).
7
Case 11-12156 Doc# 77 Filed 02/13/14 Page 7 of 11

sought to have the bankruptcy court certify the constitutional issue to the Minnesota
Supreme Court.22 In declining to certify, the bankruptcy court reasoned:
. . . its use should be confined largely to instances where the state
supreme court has never addressed the dispositive issue . . .
The constitutional issues at bar are certainly determinative of the
Trustee’s objection to Debtors’ claim of exemption. To be sure, the
Minnesota Supreme Court has never ruled on the constitutionality of
subd. 22. However, in a long line of cases applying art. 1, § 12 to
various exemption statutes enacted by the Minnesota state
legislature, that line commencing almost with the advent of statehood
and extending through . . . (1989), the Minnesota Supreme Court has
announced and refined an analysis which provides ample guidance to
this Court. The published history of the framing of the Minnesota
state constitution also sheds light on the questions posed. The lines
of authority for the present inquiry are settled, and certification is not
warranted.23
So too, here, there exists a body of Kansas Supreme Court case law interpreting
Art. 2, § 17 of the Kansas Constitution from which this Court may decide the validity
of the Kansas bankruptcy-only exemption. For all of these reasons, it is my
recommendation that the request for certification to the Kansas Supreme Court be
denied.
Uniformity under the Kansas Constitution, Art. 2, §17.
Article 2, section 17 of the Kansas Constitution provides—
All laws of a general nature shall have a uniform operation throughout
the state: Provided, The legislature may designate areas in counties that
have become urban in character as “urban areas” and enact special laws
giving to any one or more of such counties or urban areas such powers
22 The Minnesota version of the Uniform Certification of Questions of Law Act expressly authorized a
bankruptcy court to certify questions of law to the Minnesota Supreme Court. 119 B.R. at 688.
23 119 B.R. at 688.
8
Case 11-12156 Doc# 77 Filed 02/13/14 Page 8 of 11

of local government and consolidation of local government as the
legislature may deem proper.24
This provision has been amended several times since the Constitution was first
adopted in 1861. It initially contained two provisions, the first relating to “laws
of a general nature” and the second prohibiting the Legislature from enacting
a “special “law” where a general law can be made applicable. The Kansas
Supreme Court distinguished between laws of a general nature and general
laws defining the former as a law “whose subject is common to all of the people
of the state” and the latter as “which apply to and operate uniformly upon all
members of any class of persons, places, or things, by requiring legislation
peculiar to themselves in the matters covered by the laws.”25
The second clause was repealed, leaving only the “laws of a general
nature” reference. As the Kansas court has said in Stephens v. Snyder Clinic
Ass’n, “[t]he effect of this change is that the only prohibition contained in
Article 2, Section 17, relates to laws of a general nature which affect the people
of the state generally. Such laws must apply uniformly throughout the state
and thus be geographically uniform.”26 The court held in that case, and has
thereafter reaffirmed, that this provision of the Kansas constitution does not
24 KAN. CONST. Art. 2, § 17.
25 Stephens v. Snyder Clinic Ass'n, 230 Kan. 115, 124, 631 P.2d 222 (1981) (quoting from Richardson
v. Board of Education, 72 Kan. 629 (1906)).
26 Stephens, 230 Kan. 115, 127.
9
Case 11-12156 Doc# 77 Filed 02/13/14 Page 9 of 11

apply to challenges based on denial of equal protection that do not involve a
claim of geographical uniformity.27
The Trustee’s Uniformity Challenge is Not Based on Geography
The Trustee does not allege that Kan. Stat. Ann. § 60-2315 applies
differently in different parts of Kansas. Instead, he asserts that its operation
unfairly burdens the creditors of bankrupt debtors who avail themselves of this
exemption while allowing the creditors of non-bankrupt debtors access to those
debtors’ EIC. But, as the Stephens case shows, Art. 2, §17 doesn’t apply to this
alleged lack of uniformity.
There is already controlling Kansas Supreme Court case law on how to
apply Art. 2, §17 and that case law is easily applied to this situation. As the
“wrong” of which the Trustee complains is not “geographical,” this
constitutional provision does not apply. Accordingly, there is no basis for
certifying this already-answered question to the Kansas Supreme Court and,
therefore, no reason to withdraw the reference from this Court.
The Trustee cannot likely demonstrate that this “law of a general
nature” operates in a non-uniform fashion. As I stated in In re Lea, it is
anything but clear that a Kansas creditor of a non-bankrupt debtor would
receive any more of the EIC benefit than would a trustee constrained by this
statute.28 All that KAN. STAT. ANN. § 60-2315 exempts is the “right to receive
27 Id. See also Board of County Com’rs of Riley County v. City of Junction City, 233 Kan. 947, 958, 667
P.2d 868 (1983); State ex rel. Stephan v. Smith, 242 Kan. 336, 381-83, 747 P.2d 816 (1987).
28 In re Earned Income Tax Credit Exemption Constitutional Challenge Cases (In re Lea), 477 B.R.
791, 800 (Bankr. D. Kan. 2012), aff’d 2013 WL 4431267 (D. Kan. Aug. 16, 2013).
10
Case 11-12156 Doc# 77 Filed 02/13/14 Page 10 of 11

tax credits.” A creditor of a non-bankrupt Kansas debtor could only attach the
proceeds of the EIC in the hands of the debtor once she had received them.
That creditor could not, for instance, garnish the funds in the hands of the
Internal Revenue Service or the Kansas Department of Revenue because those
entities are authorized by statute to only pay refunds to the taxpayer, not to
creditors.29 The Trustee will receive exactly what a creditor outside bankruptcy
in Kansas would receive from the debtor’s “right to receive” the EIC: nothing.
I therefore recommend that the Trustee’s motions to withdraw the
reference in these three cases be denied and that the District Court order the
Bankruptcy Court to retain the reference of these matters for further decision.
For the District Court’s convenience, a copy of the Trustee’s Motion to
Withdraw the Reference, as well as his objection to debtors’ exemption, are
attached to this Report and Recommendation.30
# # #
29 See Brockelman v. Brockelman, 478 F. Supp. 141 (D. Kan. 1979) (creditor’s garnishment of tax refund
in hands of IRS was barred by sovereign immunity, citing Buchanan v. Alexander, 45 U.S. 20, 11 L.
Ed 857 (1846)); 26 U.S.C. § 6402; KAN. STAT. ANN. §§ 75-6204, -6203, -6216 and 79-3233j (2011 Supp.).
30 No. 11-12155, Dkt. 44, 60.
11
Case 11-12156 Doc# 77 Filed 02/13/14 Page 11 of 11

12-13337 Hildyard (Doc. # 172)

In Re Hildyard, 12-13337 (Bankr. D. Kan. Jan. 21, 2014) Doc. # 172

PDFClick here for the pdf document.


SO ORDERED.
SIGNED this 17th day of January, 2014.

 

OPINION DESIGNATED FOR ONLINE PUBLICATION
BUT NOT PRINT PUBLICATION


IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS


IN RE: )
)
BRENDA KAY HILDYARD, ) Case No. 12-13337
) Chapter 13
Debtor. )

__________________________________________)

ORDER (1) OVERRULING DEBTOR’S OBJECTION TO WESTERN
STATE BANK’S CLAIM; (2) DENYING WESTERN STATE BANK’S MOTION
FOR STAY RELIEF; AND (3) CONDITIONING THE CONTINUATION OF

THE AUTOMATIC STAY

Brenda Hildyard objects to the claim filed in this case by Western State Bank.1

She also objects to the Bank’s motion for stay relief.2 Her claim objection contains two

contentions: (1) that the Bank’s deed of trust on her home in Colorado only secures

1 Dkt. 74, 146.
2 Dkt. 56.

1

Case 12-13337 Doc# 172 Filed 01/17/14 Page 1 of 20


the repayment of one of two separate promissory notes; and (2) that she has an
equitable right to direct how the Bank should have applied the proceeds of a term life
insurance policy her late husband assigned as collateral on his debts to the Bank.

Whether the Bank’s deed of trust secures more than one note turns on whether
it contains a “future advance” clause and whether the notes it is supposed to secure
either (a) reference the mortgage as part of their collateral; or (b) are of a similar kind
or character as the note or notes to which the mortgage or deed of trust of trust
specifically refers. These principles are clearly established in Kansas by a
combination of case law and statutory references; they are similarly clear under
Colorado law. Here, Brenda Hildyard executed a deed of trust (DOT) covering a home
in Colorado.3 The DOT states that it was given to secure “a promissory note or notes”
dated July 16, 2009 in an amount in excess of $175,000 and an additionally typed-in
term provides that the DOT was given “to secure all present and future indebtedness
of the undersigned as set forth on separate page attached hereto as Exhibit B.” But
there was no Exhibit B, opening to question the extent to which the DOT secures
notes other than the one made on July 16. After careful consideration of the language
of the DOT as well as the loan agreements and notes that were executed
contemporaneously and afterwards, I conclude that the deed of trust on the Colorado
property adequately references future debt and therefore secures both promissory
notes.

3 Ex. 8.

2

Case 12-13337 Doc# 172 Filed 01/17/14 Page 2 of 20


As to her second contention, Brenda asserts that she should have been given
the opportunity to direct the manner in which her husband’s life insurance proceeds
were applied to the Bank’s claims. But, the terms of the collateral assignment
expressly grant the Bank the right to apply the proceeds as it deems fit.4 Moreover,
Brenda made no attempt to direct their application and, as a matter of common law,
when no directions are given, a creditor is free to apply payments to multiple debts
of the debtor in any order.

The final question here is how to resolve the Bank’s motion for stay relief. The
Bank only sought relief to enforce its liens on a condominium on Hill Street in Colby,
Kansas (the Hill Street Condo), and a home in Broomfield, Colorado (the Broomfield
Property).5 After the Bank filed its motion, Brenda sold the Hill Street Condo free
and clear of liens under 11 U.S.C. § 363(f).6 The stay may be lifted for lack of adequate
protection or if the debtor lacks equity in the property and it is unnecessary to an
effective reorganization. While the Bank showed that Brenda lacks equity in the
Broomfield Property, that property is necessary to an effective reorganization.
Brenda has made provisions to adequately protect the Bank’s interest in that
property. The continuation of the stay as to that property may be conditioned upon
the Bank being required to realize upon its other available security before foreclosing
upon and selling the Broomfield Property so long as Brenda adequately protects the

4 Ex. 11, ¶ I.
5 Dkt. 53.
6 See Dkt. 76 and 103. The Bank consented to the sale of the condo.


3

Case 12-13337 Doc# 172 Filed 01/17/14 Page 3 of 20


Bank’s interest by paying property taxes and debt service on the senior liens and
proposes a chapter 13 plan that contains a confirmable treatment of the Bank’s claim.

Jurisdiction

Motions for stay relief and objections to claims are core proceedings under 28

U.S.C. § 157(b)(2)(B) and (G), for which this Court may exercise subject matter
jurisdiction.7
Facts

Brenda Hildyard filed this chapter 13 case on December 12, 2012. According to
her petition and schedules, she resides at 1005 W. 7th Street in Colby, Kansas and
claims the 7th Street property exempt as her homestead.8 She was married for 32
years to Dr. Victor Hildyard, a physician in Colby. He died in July of 2012. Victor’s
practice was organized in partnership with Dr. Ladonna Regier as Colby Medical &
Surgery Center (CMS). He also operated Medical Arts, Inc., another health care
provider. The Bank had long been one of Dr. Hildyard’s lenders. By February of 2008,
the medical entities, Dr. Regier, and he personally owed the Bank over $1.476 million
secured by the entities’ and personal assets. When Victor, Regier, and the entities
defaulted on their debt, the Bank foreclosed.9 In an effort to resolve that case and to
preserve what they could of Victor’s practice, Victor, Brenda, and Dr. Regier entered
into workout agreements with the Bank, beginning in June of 2009. Regier left the

7 See 28 U.S.C. § 157(b)(1) and § 1334.

8 Dkt. 33. The Bank claims no interest in the 7th Street property. Under Brenda’s current
proposed plan, she proposes to sell her homestead, secured to Sunflower Bank, and reinvest the
equity in a future homestead – at trial identified as the Broomfield Property. Dkt. 35.

9 Ex. B, Foreclosure Petition filed April 16, 2009 in the District Court of Thomas County,
Kansas. Brenda was not a party to the foreclosure action.

4


Case 12-13337 Doc# 172 Filed 01/17/14 Page 4 of 20


partnership and made her separate peace with the Bank, agreeing on June 26, 2009
to pay it $140,000 cash in full satisfaction of its claims against her.10 Victor did not
consent to this agreement and, specifically, to the Bank releasing her. On July 16,
Medical Arts, CMS, Victor, and Brenda signed the first of two workout agreements
with the Bank.11 By this time, Regier had left the CMS partnership. Brenda was not
personally liable for any of Victor’s individual or business debts, though she was
personally liable on a $35,000 note that was secured to the Bank by a mortgage on
the couple’s Hill Street Condo. Nothing in the July 16 agreement referred to that
debt; nor was it included in the Bank’s foreclosure action.

The July 16 agreement provided for the entities and Hildyard to make two
notes to pay the remaining balance of the February 2008 obligation after Dr. Regier’s
$140,000 was applied and to provide additional collateral to secure the debt.12 Note 1
was to be for $960,000, bearing interest at 5.25% and payable in 60 monthly
instalments of $6,000 with a balloon payment for the remaining balance due thirty
days after the 60th monthly payment. Note 2 was in the amount of $498,174.17, due
on demand at any time after 60 months from its making or upon any default under
Note 1. As partial security for the repayment of these obligations, Victor agreed to
assign a $500,000 term life insurance policy owned by Medical Arts. Regier agreed to
assign a similar insurance policy, also owned by Medical Arts (though Regier did not

10 Ex. D. The Bank also retained a 2008 assignment of life insurance on the life of Dr.

Regier.
11 Ex. 1, Loan Agreement of July 16, 2009 and Ex. 3, Loan Agreement of September 1, 2009.
12 Ex. 1.

5


Case 12-13337 Doc# 172 Filed 01/17/14 Page 5 of 20


sign this workout agreement or a later one).13 The debtors all agreed that the Bank’s
liens under any pre-existing security agreements and mortgages would continue to
secure its claims.14 In addition, Victor and Brenda agreed “to execute a Deed of Trust
granting the Lender a third lien in the amount of $175,000 on their Colorado home .
. .” in Broomfield, Colorado.15 The Bank would accept these two notes as full payment
of the February, 2008 note and, if the monthly payments on Note 1 were timely paid,
Note 2 would be forgiven after 60 months.

The Hildyards signed the deed of trust on the Broomfield Property on July 16,
2009.16 Victor signed Note 2 on that date, both for himself and for his entities.17 For
reasons that are not clear in the record, Note 1 was not signed that day, inadvertently
creating an issue about the intent of the parties with respect to what the DOT was
intended to secure. On September 1, 2009, the same parties signed another loan
agreement that was substantially identical to the July loan agreement, except that
the amount of Note 1 had increased to $1.102 million and monthly payments
increased to $7,000.18 On the same date, Victor signed the revised Note 1 for himself

13 Id. at ¶ 2. See Ex. 10, Security Agreement dated July 16, 2009 executed by Victor for
Medical Arts, Inc. describing the insurance assignments as collateral. It appears that the life
insurance assignments had been previously given by Drs. Regier and Hildyard in October 2008. See

e.g. Ex. 11. The Court construes the workout agreements as acknowledging the assignments would
continue to secure Victor’s debt, Notes 1 and 2.

14 Ex. 1, ¶ 4.

15 Id. at ¶ 3. The DOT executed by the Hildyards is somewhat clumsily worded “for the
principal sum of in excess of One Hundred Seventy Five Thousand . . .” referring to the promissory
notes dated July 16, 2009. The Court acknowledges that Note 2 dated July 16, 2009 is in excess of
$175,000 and interprets the DOT to be limited to the amount of $175,000. See Ex. 8.

16 Ex. 8. It was recorded on August 10, 2009.

17 Ex. 2.

18 Ex. 3.

6

Case 12-13337 Doc# 172 Filed 01/17/14 Page 6 of 20


and his entities.19 Note 1 is identical in form to Note 2. Brenda did not sign either
note. The collateral description in both Note 1 and Note 2 specifically describes a “3rd
DOT dated 7-16-09.”

The parties agree that when Note 1 was finally signed in September, both it
and Note 2 were secured by the three commercial mortgages covering commercial
property in Colby, along with a security agreements dated February 27, 2002, another
dated July 16, 2009, and collateral assignments of the Hildyard and Regier insurance
policies. The parties also agree that Note 2, signed on July 16, 2009, was secured by
the DOT. Brenda Hildyard disputes that the DOT secures Note 1. That is the thrust
of her objection to the Bank’s claim.

Dr. Hildyard lost his admitting privileges at the Colby hospital, severely
curtailing his practice and income. In October of 2011, he and Brenda filed a chapter
11 case in Topeka after he failed to comply with the terms of the two workout
agreements.20 Then, Dr. Hildyard became gravely ill and was unable to complete the
chapter 11. That case was dismissed on May 25, 2012. In July of 2012, Dr. Hildyard
died intestate. Brenda is his only heir and is the administratrix of his probate estate.
The Bank realized on the life insurance policy on his life and applied the $500,000 it
received to Note 1. It continues to pay the premiums on the Regier policy. Victor’s
estate remains in probate in Thomas County District Court. After Brenda filed this
chapter 13 in December of 2012, she proposed a plan under which Victor’s property

19 Ex. 4.
20 Case No. 11-41646 (Bankr. D. Kan.).


7

Case 12-13337 Doc# 172 Filed 01/17/14 Page 7 of 20


would be sold in this case under §363 or in the probate proceedings. The Court has
approved her motion to sell the Hill Street Condo. She intends to move to Colorado
and live in the Broomfield Property at some point in the future after selling her
current homestead at 1005 West 7th Street in Colby. The Broomfield Property is
encumbered by three DOTs, the first and second in priority being in favor of Wells
Fargo. The Bank’s deed of trust is third. There are several Notices of Federal Tax
Lien of record against the Broomfield Property as well, but they are junior in priority
to the lenders’ deeds of trust.

Brenda objects to the Bank’s secured claim, specifically contending that the
DOT does not secure Note 1 and further arguing that she was entitled to direct the
Bank to apply the $500,000 life insurance benefit to pay off Note 2, which she believes
would render the Broomfield house free and clear of the Bank’s liens. Pursuant to an
adequate protection agreement that is outlined in an agreed Scheduling Order filed
in this case, Brenda has agreed to maintain current both the property taxes on the
Broomfield home as well as debt service on the two senior liens.21

Both Brenda’s objection to claim and the Bank’s motion for relief from the stay
were tried on October 22, 2013.22 Confirmation of her chapter 13 plan was deferred
until the claim objection could be determined.

Brenda’s Objections to the Bank’s Claim

21 Dkt. 106.

22 The debtor Brenda Hildyard appeared in person and by her attorney Elizabeth A. Carson.
Creditor Western State Bank appeared by its attorney Justin Whitney. The chapter 13 trustee
Laurie B. Williams appeared in person.

8

Case 12-13337 Doc# 172 Filed 01/17/14 Page 8 of 20


The Deed of Trust on the Broomfield Property Secures Both Notes.

Both Notes 1 and 2 are on an identical printed form that reference the July 16,
2009 DOT under the section titled “Collateral Description.” Both Notes also contain
a printed clause that reads:

Collateral. This Note is secured by real property and the debt evidence by
this Note and all other obligations of Debtor to Lender . . . are secured by all
collateral securing this Note and by all other security interests and mortgages
previously or later granted to Lender as more specifically described [in those
documents] . . . .23

The Deed of Trust is not so straightforward. It provides that Victor and Brenda
“executed a promissory note or notes hereinafter referred to in the singular, dated
July 16, 2009, for the principal sum of in excess of One Hundred Seventy Five
thousand and no/100- Dollars . . . .”24 Victor signed the notes for himself and his
entities. He executed Note 2 and the DOT on July 16, 2009, but did not sign Note 1
until September. Nowhere in the printed language of the DOT is there a future
advance provision. But someone typed verbiage into a blank area on page 2 that
reads—

This mortgage is made to secure all present and future indebtedness of theundersigned as set forth on separate page attached hereto as Exhibit B and
made a part hereof by reference.”25

This language was inserted in a space left for the notation of any exceptions to
the grantors’ covenant of title. The Bank concedes that there is no Exhibit B. This
document’s absence further fuels Brenda’s objection to the reach of the DOT lien.

23 Ex. 2 and 4.
24 Ex. 8.
25 Id.


9

Case 12-13337 Doc# 172 Filed 01/17/14 Page 9 of 20


Brenda testified that she did not intend to be personally liable for any of
Victor’s debts, including those incurred or restated under the Loan Agreements. But
she admits signing the agreements, both of which clearly contemplate that all of the
collateral described in them would secure both Notes. The Loan Agreements express
the purpose of renegotiation of the 2008 loan so that “the Lender can receive
additional collateral to secure the debt.”26 The July 16, 2009 DOT is the additional
collateral and is expressly agreed to by Victor and Brenda in the Loan Agreements.27

The Bank’s DOT secures the repayment of Note 1 if the DOT, by its terms,
secures future advances and Note 1 references it, or if Note 1 evidences an obligation
of similar character to Note 2. The parties assume that Kansas law governs here. The
Loan Agreements, Notes and the DOT were all executed in Kansas, but because title
to Colorado property is affected, we should consider which state’s law applies in
interpreting the DOT. As explained below, I reach the same conclusion whether
Kansas or Colorado law is applied.

Federal courts apply the choice of law principles employed by the courts of the
state in which they sit when adjudicating state law issues.28 The meaning of the Loan
Agreements, Notes, and DOT implicate state law issues; they are contracts between
the parties and the rules of construction applicable to contracts apply.29 Kansas state

26 Ex. 1 and 3.

27 Id. at ¶ 3.

28 Dang v. UNUM Life Ins. Co. of America, 175 F.3d 1186, 1190 (10th Cir. 1999); In re
Patterson, 375 B.R. 652, (Bankr. D. Kan. 2007) (While dischargeability of debt is a bankruptcy issue,
whether debt was owed was a state law issue requiring Kansas bankruptcy court to apply Kansas
choice of law principles.).

29 Mark Twain Kansas City Bank v. Cates, 248 Kan. 700, 709-10, 810 P.2d 1154 (1991).

10


Case 12-13337 Doc# 172 Filed 01/17/14 Page 10 of 20


courts traditionally apply choice of law principles as reflected in the original

Restatement of Conflict of Laws.30 Section 8(1) of the original Restatement provides

that “all questions of title to land are decided in accordance with the law of the state

where the land is, including the Conflict of Laws rules of that state.”31 Consistent

with § 8(1) and specific to mortgages, the Restatement (Second) of Conflict of Laws, §

228(1) provides that “whether a mortgage creates an interest in land and the nature

of the interest created are determined by the law that would be applied by the courts

of the situs.” But Kansas also recognizes in the Restatement (Second) an exception to

this choice of law rule if there is an enforceable choice of law provision in the

documents.32 In Mark Twain Kansas City Bank v. Cates, the Kansas Supreme Court

applied Missouri law to determine whether a future advance clause in a mortgage on

Kansas property secured the lender’s loan, citing § 187 of the Restatement (Second)

and reasoning:

It is not unusual for commercial transactions to traverse state
lines. Although the Uniform Commercial Code . . . does not apply to
mortgages, it does state our legislature’s intent that territorialrestrictions should not hinder commerce. . . . when a transaction
bears a reasonable relation to Kansas and also to another state, the
parties are allowed to contract that the laws of Kansas or the other
state will govern the rights and the duties of the parties. K.S.A. 84-1


30 See Raskin v. Allison, 30 Kan. App. 2d 1240, 1242, 57 P.3d 30 (2002).
31 Restatement (First) of Conflict of Laws § 8 (1934); see also, Restatement (Second) of
Conflict of Laws §§ 223 and 228 (1969).

32 See Restatement (Second) of Conflict of Laws, § 187 (1969) (law of the state chosen by the
parties to govern their contractual rights and duties); Mark Twain Kansas City Bank v. Cates, 248
Kan. 700, 705-07, 810 P.2d 1154 (1991) (applying Missouri law to a mortgage executed in Missouri
on Kansas property where the mortgage contained a Missouri choice of law provision to determine
whether the bank’s loan was secured by the future advance clause of the mortgage).

11


Case 12-13337 Doc# 172 Filed 01/17/14 Page 11 of 20


105. The same public policy applies to a loan and mortgage executed
in Missouri on land located in Kansas.33
In our case, the Loan Agreements contain a Kansas choice of law provision and
are governed by Kansas law, even if one of the parties may in the future become a
resident of another state.34 The Notes also provide for application of Kansas law:
“ADDITIONAL PROVISIONS. . . . (3) This Note and the obligations evidenced by
it are to be construed and governed by the laws of the state indicated in Lender’s
address [Kansas] shown in this Note.”35 The DOT does not contain its own choice of
law provision, but arguably, Kansas law governs it as well where the Note references
the DOT, if it is considered an “obligation[ ] evidenced by” the Note. All of these
documents [Loan Agreements, Notes, and DOT] were part of the same basic loan
workout transaction in 2009 and must be considered together.36 All of the documents
were executed in Kansas. All the parties to the transaction were Kansas parties.
Except for the Broomfield Property, all of the other property securing the loans is
located in Kansas. Thus, the transaction bears a reasonable relation to Kansas and
the parties’ choice of Kansas law may apply.

Under Kansas law, future advance clauses or dragnet clauses in a real estate
mortgage are permitted and enforceable.37 In First Nat’l Bank & Trust Co. v. Lygrisse
the Kansas Supreme Court stated that subsequent debts may be secured under the

33 248 Kan. 700, 706-07.

34 Ex. 1 and 3, ¶ 10.

35 Ex. 2 and 4 (Emphasis added).

36 Carpenter v. Riley, 234 Kan. 758, 763, 675 P.2d 900 (1984).

37 See KAN. STAT. ANN. § 58-2336 (2005); Potwin State Bank v. Ward, 183 Kan. 475, 491, 327
P.2d 1091 (1958).

12


Case 12-13337 Doc# 172 Filed 01/17/14 Page 12 of 20


dragnet clause of a real estate mortgage in one of two ways: (1) by specifically
referencing the mortgage on the face of the new note that it is secured by the prior
mortgage; or (2) by showing that the subsequent debt is of the same kind or character
as, or part of the same transaction or series of transactions with, that originally
secured by the mortgage.38 Both of these methods for securing Note 1 are satisfied
here. On the face of Note 1 dated September 1, 2009 the DOT is referenced in the
collateral description as “3rd DOT DATED 7-16-09.” There was no evidence presented
at trial that more than one deed of trust on the Broomfield Property was executed on
July 16, 2009 and it was undisputed that the Bank’s DOT dated July 16, 2009 was in
a third position behind Wells Fargo. Both Notes referenced the Bank’s 3rd DOT of
July 16, 2009 as securing the indebtedness.

Reading the “all present and future indebtedness” language in the context of
the July and September Loan Agreements makes clear that both Notes were intended
to be signed simultaneously and be secured by the DOT. Even though they weren’t,
it is also clear from the identical language of the Loan Agreements that the parties
intended that all of the security granted or retained pursuant to those agreements,
including the Broomfield Property DOT, would secure both Notes. If I consider all of
the documents pertaining to the workout agreement together, as I must, I can readily
conclude that the July and September 2009 Loan Agreements, Notes, and the DOT
are all related and part of a series of transactions to effectuate the terms of the loan

38 First Nat’l Bank & Trust Co. v. Lygrisse, 231 Kan. 595, Syl. ¶ 1, 647 P.2d 1268 (1982). See
also, Mark Twain Kansas City Bank v. Cates, 248 Kan. at 712.

13


Case 12-13337 Doc# 172 Filed 01/17/14 Page 13 of 20


workout of Victor’s defaulted 2008 loan. The Loan Agreements clearly contemplated
renewal of the 2008 loan balance by dividing the principal balance between Notes 1
and 2. The principal amounts of those Notes correspond with the two Loan
Agreements. The date of Note 2 corresponds with the July 16, 2009 Loan Agreement.
The date of Note 1 corresponds to the September 1, 2009 revised Loan Agreement.
Both Loan Agreements expressly recite Brenda’s agreement to grant the Bank a third
lien on the Broomfield Property in the amount of $175,000 by executing a DOT –
additional collateral to secure the debt. The Loan Agreements did not limit the DOT
to securing only Note 2. And while the typed-in clause in the DOT was somewhat
incomplete by the omission of Exhibit B describing the “present and future
indebtedness of the undersigned,” there is little doubt from the Loan Agreements and
the Notes that the parties intended the DOT to secure Victor’s, Medical Arts, and
CMS’s present and future indebtedness, including the outstanding balance of Victor’s
2008 defaulted note – to be allocated between Note 1 and Note 2. Reading these
contracts together, Note 1 was part of the 2008 loan workout transaction and was
secured by the DOT on the Broomfield Property.

Even if the choice of Kansas law designation is inapplicable or unenforceable
and we default to Colorado law as the situs of the Broomfield Property subject to the
DOT by applying Restatement (Second) of Conflict of Laws, § 228, the same result
obtains. Colorado case law on future advance clauses is similar to Kansas law. “[A]
trust deed or a mortgage given to secure payment of an indebtedness may include

14


Case 12-13337 Doc# 172 Filed 01/17/14 Page 14 of 20


advances to be made in the future.”39 In order for a debt to be secured by a deed of
trust containing a dragnet clause, the parties must have intended the deed of trust
to secure the debt at the time the deed of trust was executed.40 The court should
examine whether the parties reasonably contemplated the obligation at the time of
the agreement.41 As discussed and applied above, the facts and documents here
readily demonstrate that the DOT was intended to secure both Note 1 and Note 2,
that both Notes were contemplated by the workout agreement, and that Note 1,
executed less than two months after Note 2, was related to Note 2 and was of the
same nature. Accordingly, under Colorado law, Note 1 was secured by the DOT
granted by Brenda.

Brenda had the burden to meet the presumed validity of the Bank’s claim on
this point and, had she succeeded in doing that, the burden of proof would have
shifted to the Bank to demonstrate its claim’s validity on the merits. She failed to
present sufficient evidence to meet the presumption that the Bank’s claim on this
point is valid. This portion of her objection must be overruled.42

The Bank Could Apply Victor’s Life Insurance Proceeds to Any of His
Debts.

39 Kimmel v. Ratty, 168 Colo. 431, 435, 451 P.2d 751, 753 (1969). See also COLO. REV. STAT. §
4-9-204(c) (2001) (Colorado version of UCC recognizing and allowing future advance and dragnet
clauses).

40 Mohler v. Buena Vista Bank and Trust Co., 42 Colo. App. 4, 7, 588 P.2d 894 (1978) (deed of
trust dragnet clause unenforceable where there was no evidence of intent to secure the collateralindebtedness).

41 In re Grizaffi, 23 B.R. 137, 139 (Bankr. D. Colo. 1982) (construing dragnet clause in context
of loans secured by personal property; intent cannot be inferred where the debt transaction is
unrelated to the original financing or is not of the same nature).

42 Fed. R. Bankr. P. 3007.

15


Case 12-13337 Doc# 172 Filed 01/17/14 Page 15 of 20


Brenda also claims that the Bank should have applied Victor’s $500,000 death
benefit to Note 2, instead of Note 1. If only Note 2 was secured by the deed of trust,
and if the death benefit were first applied to that note, it would be paid in full and
the Bank would be required to release the deed of trust.43 Her second contention fails
because Brenda offered no evidence that she attempted to direct the payment of the
proceeds to one note or the other. Even if she had, the express terms of the insurance
assignment allow the Bank to apply the benefit as it sees fit.

Longtime Kansas precedent holds that if a debtor owes a creditor more than
one debt, in the absence of the debtor’s directing the creditor to apply a payment to a
particular debt, the creditor may apply the debt as it sees fit.44 In addition, the
insurance assignment expressly authorized the Bank to apply the proceeds of the
policy to any of the liabilities it secured. 45 The Bank had a contractual right to apply
the death benefit to Note 1, first to accrued interest, and then to reduce principal.
Brenda again failed to meet the presumption of validity of this aspect of the Bank’s
claim and her second objection must be overruled.46

43 The assignment of the insurance policy on Victor’s life expressly provides that it is security
“for any and all liabilities of the undersigned, or any of them, to [Western State Bank], either now
existing or that may hereafter arise between [them] with respect to the above policy . . .”. See Ex. 11,
¶ D. At the time of the assignment dated October 27, 2008, CMS, Medical Arts, and Victor wereindebted to the Bank under the February 2008 Note.

44 Aetna Cas. and Surety Co. v. Hepler State Bank, 6 Kan. App. 2d 543, 554-55, 630 P.2d 721
(1981).

45 Ex. 11, ¶ I.

46 Brenda raised a third contention at trial, that when the Bank entered into a separate
agreement with Regier, that agreement released Victor. But Regier’s release came prior to the Loan
Agreements with Victor and Brenda and, in any event, both Notes contain clauses that provide for
each maker to waive various suretyship defenses including the release of any other debtor. Victor
therefore waived that defense.

16


Case 12-13337 Doc# 172 Filed 01/17/14 Page 16 of 20


The Bank’s Stay Relief Motion is Denied, but Continuation of the

Stay is Conditioned.

Western State Bank sought relief from the automatic stay to foreclose its
interests in the Broomfield Property and the Hill Street Condo in Colby. Brenda has
obtained an order approving the sale of the Hill Street Condo, with the Bank’s
consent.47 This leaves the Broomfield Property. The Bank proceeds on both grounds
under § 362(d), that it lacks adequate protection of its interests under (d)(1) and that
Brenda lacks equity in the property and that it is not necessary to her effective
reorganization under (d)(2). Brenda has agreed to pay the real estate taxes and the
debt service on the senior liens on the Broomfield Property. The Bank has agreed to
accept assurances of payment as adequate protection of its interests.

Concerning the Bank’s claim that Brenda lacks equity in the property, the
Bank’s deed of trust is a third priority lien that is junior to first and second deeds of
trust securing, respectively, debts of $296,334 and $37,000 payable to Wells Fargo.
The Bank’s total claim, after application of the life insurance proceeds, is
approximately $1.1 million. That claim is secured by, among other things, the
Broomfield third deed of trust that, per its terms, secures up to $175,000 in debt.
Brenda values the Broomfield Property at $365,000. The Bank has demonstrated
that Brenda lacks equity in the Broomfield Property. The first two liens encumber
$333,334 of its value and the Bank’s $175,000 lien more than consumes the rest of it.

47 Dkt. 103.

17

Case 12-13337 Doc# 172 Filed 01/17/14 Page 17 of 20


The Bank also has mortgages in the Hildyard entities’ real estate and security
interests in their personal property. The medical buildings have values that range
between their scheduled value of $500,000 and the $585,000 to which the debtor
testified at trial. In addition, the Bank has an assignment of Dr. Regier’s $500,000
life insurance policy. The Bank is paying the premiums on that policy. But, no one
can predict when that policy might pay out and there is no actuarial evidence in the
record to support such a prediction. Plus, the policy is for term insurance and only
remains in force as long as the Bank pays the premiums. It has no cash surrender
value. For the purpose of this Order, I conclude that its value is zero.

Summarizing, the Bank’s collateral consists of its small equity position in the
Broomfield Property by virtue of its third lien, its mortgages on the commercial
properties valued at between $500,000 and $585,000, and Victor Hildyard’s furniture,
fixtures, and equipment of undetermined value, and the Regier insurance policy that
has no present value.

Section § 362(d) provides that the stay may be modified or conditioned upon a
finding that the Bank lacks adequate protection of its collateral, or that the debtor
lacks equity in the property in question and that the property is unnecessary to an
effective reorganization.48 The creditor has the burden of proof on the question of
lack of equity; the debtor has the burden on all other issues.49 As noted above, Brenda
has no equity in the Broomfield Property. But, she is planning to sell her 7th Street

48 11 U.S.C. § 362(d)(2).
49 § 362(g).

18

Case 12-13337 Doc# 172 Filed 01/17/14 Page 18 of 20


home in Colby and intends to live in the home in Broomfield. It is necessary to her
effectively reorganizing. Because she is adequately protecting the Bank’s interest in
the Broomfield Property as required by §362(d)(1) by maintaining debt service on the
senior liens and keeping her property taxes current, there is no cause for relief from
the stay under that subsection. Because she requires the home to effectively
reorganize in chapter 13, the stay should not be lifted under § 362(d)(2).

Continuation of the stay in this case shall be conditioned upon Brenda
maintaining current the ad valorem taxes and debt service on the senior liens owed
to Wells Fargo on the Broomfield Property. The Bank shall realize upon all of its other
collateral. If Brenda continues to adequately protect the Bank’s interest in the
Broomfield Property, the stay will remain in effect as to that property. If the Bank’s
claim is not satisfied in full by the liquidation of other property, the Bank may renew
this motion for leave to foreclose the deed of trust on the Broomfield Property, but it
shall not proceed against that property before obtaining the further order of this
Court.

Conclusion

Brenda’s objections to Western State Bank’s claim are OVERRULED and the
Bank’s claim is allowed. Western State Bank’s motion for relief from the automatic
stay is DENIED, but the continuation of the stay as to the Broomfield Property is
CONDITIONED as set forth above.

19


Case 12-13337 Doc# 172 Filed 01/17/14 Page 19 of 20


The confirmation hearing on debtor’s chapter 13 plan (dkt. 35) scheduled for
February 12, 2014 at 1:30 is passed to February 20, 2014 at 11:00 a.m. for a final
pretrial conference on confirmation.

# # #

20


Case 12-13337 Doc# 172 Filed 01/17/14 Page 20 of 20

12-10393 Garcia (Doc. # 204)

In Re Garcia, 12-10393 (Bankr. D. Kan. Jan. 24, 2014) Doc. # 204

PDFClick here for the pdf document.


SO ORDERED.
SIGNED this 24th day of January, 2014.

 

DESIGNATED FOR ONLINE PUBLICATION BUT NOT PRINT PUBLICATION

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS


IN RE:
PAUL A. GARCIA,
Debtor.
____________________________________
)
)
)
)
)
)
Case No. 12-10393
Chapter 13

ORDER ON FIRST MOTION FOR ADMINISTRATIVE EXPENSES OF
MARK J. LAZZO

Mark J. Lazzo, counsel to debtor Paul Garcia, filed his First Motion for
Administrative Expenses on December 6, 2013.1 Both creditor Lenore Garcia Trust
and the chapter 13 Trustee objected. The Trust’s objections center on whether Mr.
Lazzo’s work was in furtherance of the debtor Garcia’s allegedly improper efforts to
misappropriate the Lenore’s La Casita restaurant from the Trust. The Trust also says

1 Dkt. 155.
1

Case 12-10393 Doc# 204 Filed 01/24/14 Page 1 of 19


that Mr. Lazzo should be denied compensation in its entirety because he failed to
timely file a Fed. R. Bank. P. 2016(b) disclosure of the funds he received from Paul
Garcia as payments toward his fees. The Trustee complains about the reasonableness
and necessity of several time entries. After hearing evidence in this matter on
January 15, 2014, reviewing the memoranda filed in the matter, and independently
reviewing Lazzo’s attorneys fee statements, I conclude that the Trustee’s and Trust’s
objections to the allowance of the requested fees under §330(a) should be
OVERRULED, but that the fees must be reduced as a sanction for counsel’s failure
to timely file his Rule 2016(b) disclosure.

Facts Concerning Retainer and Underlying Controversy

a. Background
Paul Garcia and his brother Alex each filed chapter 13 cases in late February
2012.2 Attorney Sarah Newell filed both cases. Paul and Alex operated Lenore’s La
Casita, a restaurant in Salina, having acquired the restaurant from their mother’s
Trust after her death. This had been their mother’s restaurant and it was the source
of family discord even before these cases were filed. Paul and Alex were each members
of Lenore’s La Casita LLC, each claiming a one-half equity interest in the venture.
The LLC was in good standing, but no one offered in evidence its operating
agreement. Nor is there any evidence that the members ever appointed a manager.
Both Alex and Paul testified that they each received bi-weekly draws of about $1,000.
They would share any remaining profits from the restaurant from time to time. The

2 In re Alex Garcia, Case No. 12-10394 (Bankr. D. Kan.)
2

Case 12-10393 Doc# 204 Filed 01/24/14 Page 2 of 19


LLC paid the legal fees they incurred in defending against prepetition state court
litigation relating to their administration of Lenore’s Trust that was brought against
them by their brothers. Alex maintained the LLC checkbook and was responsible for
paying the operating expenses of the company, at least until Paul allegedly excluded
him from the premises and took over operating the restaurant at some point during
2013.

b. Lazzo’s Entry of Appearance and Fee Agreement
Sometime after these cases were filed, the brothers fell out. Each asserts that
the other disrupted the business. Each filed a protection from stalking case against
the other in Saline County District Court. With this conflict between the brothers
came a conflict for Ms. Newell, too. She could no longer represent either of them. In
January of 2013, she approached Mark Lazzo to represent Paul. After telephone and
office conferences with Paul, on January 24, 2013, Lazzo executed a fee agreement
with him that provided for Garcia to pay a $2,000 retainer against Lazzo’s attorney
fees which would be billed at $200 per hour.3 No one has objected to the
reasonableness of this hourly rate. Lazzo entered his appearance and Newell her
notice of withdrawal on February 18, 2013.4 Garcia paid Lazzo the $2,000 retainer
by a check dated January 23 and drawn on his personal account as the fee agreement
provides.5 Though that agreement only called for a $2,000 retainer, Paul Garcia paid
much more, sending Lazzo another $2,000 on February 15, 2013 for “lawyers fee.”6

3 Trustee Ex. S.
4 Dkt. 82.
5 Trustee Ex. A. The memo line of the check notes that it is a retainer.
6 Trustee Ex. B.


3

Case 12-10393 Doc# 204 Filed 01/24/14 Page 3 of 19


Then, in late March, Garcia sent Lazzo a check drawn on the Lenore’s La Casita
account for another $2,000, but that check was returned purportedly after Alex
stopped payment on it.7 On April 7 and 22, Paul paid Lazzo another $2,500 and $500
by checks drawn on his personal account.8 On May 4, Paul paid $500 to Lazzo for
attorneys fees from the Lenore’s La Casita account; that check cleared.9 Paul made
two additional $500 payments to Lazzo from his personal account on May 12 and 22.10
Finally, he paid Lazzo two checks in October and November for $1,000 each written
on La Casita Salina which is the trade name of Paul Garcia, L.L.C., the company that
houses Paul’s restaurant.11 In all, Lazzo collected $10,500, all of which he deposited
in his law practice trust account, but did not file his Rule 2016(b) disclosure until the
Trustee moved to dismiss this case in November of 2013.12 He has not applied any of
this money to his fee.

c. Services Rendered and Disputed Entries
By the time Lazzo entered the case, the trustees of the Trust had filed an
adversary proceeding to except a variety of debts from both Alex and Paul Garcias’

7 Trustee Ex. C. The record of the check indicates it was returned for insufficient funds.
8 Trustee Ex. D and E.
9 Trustee’s Ex. C. Both of the Lenore’s La Casita checks were signed by Paul Garcia; he was an
authorized signatory on the account. According to Paul, the $500 Lenore’s check represented his
share of the profits from the restaurant.
10 Trustee Ex. F.
11 Trustee Ex. G and H.
12 By the Court’s calculation, these checks total $10,500, not $11,000. But the parties have
proceeded on the premise that the amount received by Lazzo is $11,000 – apparently due to Lazzo’s
Rule 2016(b) disclosure indicating that he has received payments totaling $11,000. Lazzo’s Trust
Account deposit summary also totals $11,000. See Trustee’s Ex. V. This discrepancy in the amount
of fees paid by Garcia has not been explained.


4


Case 12-10393 Doc# 204 Filed 01/24/14 Page 4 of 19


discharge.13 The trust generally alleged that Alex and Paul Garcia breached their
fiduciary duties as trustees of their mother Lenore Garcia’s living trust by failing to
honor its testamentary provisions and by failing to account for its income and assets
to the other Garcia heirs. In addition to this problem, Lazzo also discovered that some
of the Trustee’s requests for information about the La Casita restaurant had not been
answered. Knowingly or not, Lazzo had stepped into a maelstrom of internecine
family disputes that involved not only state and bankruptcy court litigation, but also
bad blood among the Garcia brothers over the alleged dissipation of their mother’s
estate. Any lawyer entering this case at this stage could anticipate that getting up to
speed would be time-consuming and expensive.

The Trustee questions five (5) of Lazzo’s time entries: March 28, April 2 and
3, and July 17 and 18, as to their reasonableness and necessity.14 No claim is made
that the hourly rate proposed by Lazzo is unreasonable. Lazzo’s time entries were
made contemporaneous with his performance of the work.

On March 28, he charged 1.1 hours to confer with Paul Garcia regarding the
Trustee’s subpoena of information from La Casita and for time spent e-mailing with
accountant Jessica Loveland regarding responding to same. On April 2, he billed 1
hour for a conference with his client concerning the Trustee’s motion to compel a
response to her request for financial information and taking a call from Alex Garcia.

13 Adv. Proc. No. 12-5126 filed August 2, 2012. This proceeding is set for trial on January 28, 2014.
It is being pursued by Paul’s brothers, William Garcia and Victor Garcia, the successor trustees to
the Lenore Garcia Revocable Inter Vivos Trust.
14 See Dkt. 155-1 (Debtor Ex. 1) for Lazzo’s billing statement.


5

Case 12-10393 Doc# 204 Filed 01/24/14 Page 5 of 19


On April 3, he billed .2 hours for a conversation with the Trustee regarding her
inquiries.

Lazzo says he did this work in response to the Trustee’s subpoena and written
request for information about the restaurant. On December 21, 2012, the Trustee
served a subpoena on the LLC by sending it to Sarah Newell, then Alex and Paul’s
lawyer. On January 14, 2013, the Trustee filed a motion to compel compliance with
the subpoena and I entered an order granting that motion on February 7. Then, on
February 18, Newell withdrew as counsel and Lazzo entered his appearance for Paul.
On March 19, the Trustee filed a motion to dismiss, based in part on Paul’s failure to
respond to requests for information. Lazzo’s work on March 28 and April 1, 2, and 3
appears to have been prompted by this motion. It is clear that the subpoena had not
been adequately answered by the time he entered the case. In fact, the Trustee’s letter
of May 23, 2013 acknowledges receipt of what Lazzo sent her on March 30 and poses
follow up questions.15

The Trustee also questions whether Lazzo should be paid for work done on July
17 and 18 that related to preparation of a motion to allow Garcia to lease the Lenore’s
location and to purchase the Lenore’s restaurant equipment from its secured creditor,
the Bank of Tescott, after negotiations with these third parties. Lenore’s had
defaulted on the rent and was facing eviction. It had also defaulted on its bank debt
and the Bank of Tescott was preparing to foreclose. This work amounts to 2.8 hours
of time. The motion was never filed because, according to Lazzo, the landlord backed

15 Trustee Ex. DD.

6

Case 12-10393 Doc# 204 Filed 01/24/14 Page 6 of 19


out of the arrangement and made additional demands for curing Lenore’s back rent.
The Trustee questions the necessity and reasonableness of the time spent and
whether Lazzo should be paid for work on pleadings that weren’t ultimately filed and
deals that were not consummated.

The Trust claims that Lazzo should receive no compensation because he failed
to file a timely Fed. R. Bankr. P. 2016(b) disclosure and because his work contributed
to what it claims is Paul Garcia’s misappropriation of the Lenore’s business. Lazzo
testified that when he entered the case, he concluded that the restaurant was Paul
Garcia’s only means of funding his chapter 13 plan and that, after the disputes with
the landlord and the lender cropped up, preservation of the restaurant operation by
securing a new lease and acquiring the equipment was Paul’s most viable means of
servicing his debt. The Trust also asserts in its brief that Lazzo actively concealed his
receipt of these funds when he responded to the Trustee’s May 23 query about unpaid
rents by stating that Alex had not paid the rent.

d. The Disclosure Issue
The Trustee did not raise Lazzo’s failure to file a timely Rule 2016(b) disclosure
as a basis for objecting to his fees. Instead, she filed a separate motion to disgorge the
retainer pending this Court’s further allowance of Lazzo’s applications.16 Lazzo
acquiesced in that motion and has agreed to turn over the retainer to the Trustee
pending this Court’s further order.

16 See Dkt. 146.

7

Case 12-10393 Doc# 204 Filed 01/24/14 Page 7 of 19


Lazzo admits that he should have filed a formal disclosure of his retainer and
fees received from Garcia before November 21, 2013.17 He did not provide a cogent
reason why he failed to do so, other than his testimony that he verbally disclosed his
receipt of payments to the Trustee. He testified that he told Karin Amyx (formerly
Tollefson), the Trustee’s attorney, about having received the retainers in a telephone
conversation sometime in June or July of 2013 in response to her conversational
question about how he would be getting paid for his work in a messy case. Amyx
testified that Lazzo didn’t tell her he’d received a retainer; instead she said that when
she asked him how he expected to be paid, he replied that he’d file a fee application.
Ms. Amyx had no written record of this conversation and Lazzo’s time records contain
no specific reference to these discussions, although they do refer to a number of
conversations between him and the Trustee or her counsel, including one with Amyx
on June 20 “regarding cure of payment default under plan.”18 As this conversation
only took 12 minutes (.2 hours), it is possible that Lazzo didn’t mention the retainer
or that he did and Amyx forgot about it. On this record, I cannot conclude that it is
more likely than not that Lazzo specifically told Amyx about the retainer payments.
Other references in Lazzo’s billings identify contact or communication with the
Trustee early on, but none is specific to the matter of his attorney fees or payment
thereof.

The Rule 2016 disclosure, like the fee agreement, discloses that Lazzo will be
paid an hourly rate of $200. Unlike the fee agreement, the disclosure, reveals that

17 Dkt. 145; Trustee Ex. U.
18 Dkt. 155-1, p. 7.

8

Case 12-10393 Doc# 204 Filed 01/24/14 Page 8 of 19


the debtor or La Casita Salina, Paul Garcia’s LLC, had paid a total of $11,000
between January-November 2013 toward prospective fees as approved by the court
after application and order.19 The disclosure makes no reference to Lenore’s La
Casita LLC being the source of at least one fee payment.20

On September 1, 2013 Lazzo generated an invoice to Garcia, itemizing his time
and services for attorney fees for the period January 17, 2013 to August 14, 2013 in
the amount of $10,260.21 He attached the invoice to his First Application for Fees and
Expenses filed December 6, 2013.22

Analysis

1. Lazzo’s Fees Are Allowable Under §§330(a) and 503(b).
Chapter 13 debtors’ attorneys may receive reasonable compensation for
services they perform—

. . . for representing the interests of the debtor in connection with the
bankruptcy case based on a consideration of the benefit and necessity
of such services to the debtor and the other factors set forth in this
section.23

Attorneys for debtors in the other remedial chapters cannot recover
compensation for services that are not reasonably likely to benefit the estate or are
necessary to its administration.24 Chapter 12 and 13 debtors’ lawyers are not

19 Trustee Ex. U (Dkt. 145).
20 Trustee Ex. C (May 4, 2013 check in amount of $500).
21 There was no testimony that Lazzo sent the invoice to Garcia or that Garcia received the invoice in
the September time frame.
22 Dkt. 155 and 155-1 (Debtor’s Ex. 1).
23 11 U.S.C. § 330(a)(4)(B) (2005).
24 §330(a)(4)(A)(ii).


9


Case 12-10393 Doc# 204 Filed 01/24/14 Page 9 of 19


similarly constrained. As long as the time they charge is reasonable, taking into
account the six factors that §330(a)(3) requires courts to consider, they may be paid
for “representing the interests of the debtor” as opposed to the estate. The fees they
are granted under this provision are administrative expenses under §506(b) that are
payable under the plan as §1326(b)(1) provides.

Thus, the Trust’s claim that Lazzo’s work did not “benefit the estate” is beside
the point. Lazzo does not represent the estate—he represents the debtor. In chapter
13, the Trustee represents the estate. The Trust generally objects that Lazzo’s actions
assisted Paul Garcia’s allegedly improper post-petition conduct in attempting to
secure the restaurant’s operation for himself. The Trust did not call out specific time
entries to which it took exception.

The Court has an independent duty to scrutinize these entries and determine
if they meet the standards of §330(c)(3) and (4)(A).25 In performing that duty, I
observe that only some of Lazzo’s time was spent in activities aimed at securing the
restaurant’s operations. There are entries in May and June that describe dealings
with Alex and his chapter 7 trustee to resolve Alex’s alleged efforts to undermine the
restaurant.26 Lazzo also worked in May and June to resolve issues with the landlord
of La Casita and the Bank of Tescott. Most of the time charged in May, June and July
is devoted to this effort. There are 5.6 hours’ worth of entries in July that relate to
negotiations for the lease of the La Casita location, the purchase of its equipment

25 In re Cascade Oil Co., Inc., 126 B.R. 99, 106 (D. Kan. 1991) (Even in absence of objection to fee
application, the bankruptcy court has independent judicial duty to determine whether compensation
is reasonable and service necessary); In re Albrecht, 245 B.R. 666, 672 (10th Cir. BAP 2000).
26 Alex’s case was converted to chapter 7 on May 29, 2013. See, Case No. 12-10394, Dkt. 100.

10


Case 12-10393 Doc# 204 Filed 01/24/14 Page 10 of 19


from the secured creditor, and the preparation of pleadings that were never filed. The
balance of Lazzo’s time appears to have been spent dealing with Trustee requests for
information, responding to motions to convert or dismiss, and defending the
adversary proceeding.

After carefully reviewing the time records set out on Lazzo’s invoice, I conclude
that the time spent on the services he describes was reasonable. His requested rate
of $200 per hour is, based on my experience reviewing employment and fee
applications in this District, quite reasonable given Mr. Lazzo’s more than 25 years
of experience as a debtor’s lawyer and his often-demonstrated skill and experience
practicing in this Court. The services appear to have been performed on a timely
basis. While there is no evidence in the record either way concerning the “customary
compensation of comparably skilled practitioners in cases other than cases under this
title,” it would be difficult for me to conclude that a comparably skilled attorney with
over 25 years of experience practicing civil law in the U.S. District Court for this
District, or in the Sedgwick County District Court, would bill less than $200 per hour,
particularly in a case that revolves around a messy intra-family dispute.

Turning to the Trustee’s specific complaints, the work performed on March 28
and April 1-3 in connection with the Trustee’s record subpoenas and motion to compel
was necessary. The court record shows that the Trustee issued a subpoena to Paul as
resident agent of Lenore’s La Casita LLC in Alex’s case on December 21, 2012 and
moved to compel compliance with that subpoena in January of 2013.27 Paul was

27 See Case No. 12-10394, dkt. 70, 71, and 74.

11

Case 12-10393 Doc# 204 Filed 01/24/14 Page 11 of 19


ordered to comply in response to the Trustee’s motion to compel. When he failed to do
so, the Trustee moved to dismiss Paul’s case on March 19.28 At the hearing, the
Trustee’s attorney complained about Lazzo “taking it upon himself” to resolve the
issues surrounding the failed response. In fact, his efforts appear to have been in
direct response to the Trustee’s March 19 motion and were entirely consistent with
Lazzo’s duty to his client (and to the Court) in this case. His efforts to deal with the
motion to dismiss and the issues that prompted it were reasonable and are
compensable. That portion of the Trustee’s objection to his application must be
overruled.

As for the Trustee’s complaint that Lazzo should not be compensated for some
of his work in connection with the new lease and the equipment purchase, the time
expended on these matters appears to be appropriate. The fact the pleadings were
not filed after the deal fell through should not prevent Lazzo’s being compensated for
preparing them. If lawyers only got paid for their successful efforts in this Court,
more than a few lawyers would never be paid at all. Success on the merits is only a
part of the §330(a)(3) equation. What matters is whether the time spent here was
necessary or beneficial at the time the work was done, not in retrospect.29 This part
of the Trustee’s objection must also be overruled.

The Trust’s objection that Lazzo should be denied compensation because he
assisted in the misappropriation of the restaurant should likewise be overruled.
Based on the record in this hearing and on my review of the Pretrial Order entered

28 Dkt. 86.
29 See §330(a)(3)(C).

12

Case 12-10393 Doc# 204 Filed 01/24/14 Page 12 of 19


in the adversary proceeding, Paul and Alex formed an LLC of which they were equal
members to acquire and operate Lenore’s La Casita. Among the Trust’s claims in the
adversary proceeding is an assertion that the brothers had a duty to pay for this
acquisition shortly after their mother’s death and that they defaulted on that duty,
among others. Alex and Paul were operating the restaurant while they were in
chapter 13 cases. It was their sole means of support and, not coincidentally, of
servicing their chapter 13 plans. No LLC operating agreement was placed in
evidence, nor was there any evidence that either Paul or Alex was the manager,
leaving me to conclude that this entity was “member-managed,” meaning each
member had the authority to run it and to act as the LLC’s agent.30

In light of that, Paul’s effort to resolve the LLC’s eviction and bank loan default
by seeking to enter into a new lease and acquire the Bank’s collateral via a
bankruptcy sale appears, at least based on this sparse record, to have been consistent
with his rights and duties as a member. As both he and Alex derived their livelihoods
from this operation, preserving it was certainly in their interests. Lazzo represented
Paul in this effort and that work appears to have been beneficial and necessary to his
client’s case. There is simply no showing on this record that Mark Lazzo’s actions
were improper or inappropriate and he should not be denied compensation on that
basis. Under §330(a), his fee application is allowable (but not allowed) in the amount
of $10,260.

30 KAN. STAT. ANN. § 17-7693(a) (Absent other provision in operating agreement, management of
LLC vested in members in proportion to their percentages of interest; unless otherwise provided in
said agreement, each member has authority to bind the company.).

13


Case 12-10393 Doc# 204 Filed 01/24/14 Page 13 of 19


2. Lazzo Failed to Comply with Rule 2016(b).
Compliance with Bankruptcy Rule 2016(b) is more than a pesky technicality:
as this case shows, failure to comply goes to the heart of the Court’s supervision of
the payment of debtors’ attorneys that §329 contemplates. Rule 2016(b) requires that
within 14 days of receipt of any compensation, the attorney “shall” file a supplemental
statement that discloses it and transmit the statement to the United States Trustee.31
Rule 2016(b) implements §329(a) which requires that a debtor’s attorney must file
with the court a statement of the compensation the debtor has paid or is to pay, and
its source. If an attorney fails to comply with §329(a) and Rule 2016(b), the Court, the
creditors, and the U.S. Trustee have no way to know what funds have been paid or
where they came from. That effectively strips all three of the ability to evaluate the
reasonableness of the attorney’s compensation and to demand an accounting for or
disgorgement of the unreasonable portions, if any.

Here, Lazzo did not disclose his receipt of any of the $11,000 he received from
Paul Garcia or his company until the Trustee filed her motion to dismiss the case on
November 18, 2013.32 Only then did Lazzo file his disclosure which, in turn, prompted
the Trustee to file her motion for disgorgement the next day.33 This motion demanded
that he turn over the retainer payments to her pending the Court’s determining
whether his fee application is reasonable. Lazzo acquiesced to the turnover on the
record. As noted above, he defends his failure to disclose stating that he orally

31 Fed. R. Bankr. P. 2016(b).
32 Dkt. 145.
33 Dkt. 146.


14

Case 12-10393 Doc# 204 Filed 01/24/14 Page 14 of 19


informed Ms. Amyx of his receipt of the payments in the summer of 2013, a statement
she controverted in her testimony. Whether he did or didn’t tell her about the retainer
payments matters only to a small degree—oral statements are not a Rule 2016(b)
disclosure.

As Judges Lundin and Brown have stated in their treatise, “The 2016(b)
disclosure is not an especially onerous duty in Chapter 13 cases, but it is required of
every debtor’s attorney.”34 Many courts have denied debtors’ attorneys all of their
compensation as a sanction for failing to disclose. The Trustee doesn’t seek that
remedy here, but the Trust does.

The Tenth Circuit Bankruptcy Appellate Panel has held that the bankruptcy
court has the discretion to deny all compensation for failure to disclose. In In re
Smitty’s Truck Stop, Inc., a chapter 11 case, the BAP found that debtor’s counsel
failed to disclose the receipt of his retainer in a Rule 2016(b) statement he filed with
the petition.35 In that case, counsel filed a 2016(b) that stated he had received no
funds as compensation other than the filing fee. Eleven days later, he filed a
statement of affairs that listed the $5,000 retainer, but never amended his disclosure.
When, three years after the case had been converted to chapter 7, the attorney filed
an application for compensation, he stated for the first time that he had in fact
received the $5,000 and, later, in his amended application, he disclosed the source of
the funds. It turned out that the funds were cash collateral, causing the court to

34 Keith M. Lundin & William H. Brown, CHAPTER 13 BANKRUPTCY, 4TH EDITION, §36.3, at ¶ 5, Sec.
Rev. Aug. 12, 2009, www.Ch13online.com.
35 Jensen v. U.S. Trustee (In re Smitty’s Truck Stop, Inc.), 210 B.R. 844, 846 (10th Cir. B.A.P. 1997).


15


Case 12-10393 Doc# 204 Filed 01/24/14 Page 15 of 19


conclude that the lawyer had a conflict of interest with the creditor claiming a lien in
the funds. The BAP noted that the requirements of §329 and Rule 2016 are
mandatory, not permissive, and that an attorney who “fails to comply with the
disclosure requirements of § 329 and Rule 2016(b) forfeits any right to receive
compensation for services rendered on behalf of the debtor and may be ordered to
return fees already received.”36 The attorney’s application was denied.

Other courts in the Tenth Circuit have followed suit. In In re South Station,
LLC, the debtor’s attorney filed a Rule 2016(b) statement erroneously representing
that no retainer had been paid.37 In fact, the debtor had paid $20,000 and that
prepetition payment was reported on the statement of financial affairs. The attorney
explained the error as the result of a “computer glitch,” but that error, in concert with
other inconsistencies concerning amounts retained in the lawyer’s trust account led
the court to conclude that the disclosure was incomplete and inadequate. Following
Smitty’s Truck Stop and extensive case law authority from other jurisdictions, it
denied the fee application in its entirety.38

Both those cases hold that the Court has the discretion to deny all fees as a
sanction for failing to comply with Rule 2016(b). In the chapter 13 setting, other
courts have exercised their discretion only to partially deny fees. In re Argento39 and
In re Chapman40 are two such cases. In Argento, the debtor’s attorney filed a timely

36 Id. at 848, citing In re Investment Bankers, Inc., 4 F.3d 1556, 1565 (10th Cir. 1993).
37 464 B.R. 46 (Bankr. D. Utah 2011).
38 Id. at 58-9, citing Neben & Starrett, Inc. v. Chartwell Financial Corporation (In re Park-Helena
Corp.), 63 F.3d 877 (9th Cir. 1995).
39 282 B.R. 108 (Bankr. D. Mass. 2002).
40 323 B.R. 470 (Bankr. W.D. Wis. 2005).


16


Case 12-10393 Doc# 204 Filed 01/24/14 Page 16 of 19


2016(b) that disclosed receipt of a $1,500 flat fee for present and future services in
the case, but the statement was inconsistent, suggesting that some or all of the money
had been paid post-petition. In addition, the debtor’s lawyer failed to supplement it
as he received more money. Noting that other courts have barred all fees for
disclosure errors, that court reduced the attorneys fee by about one-third and warned
that strict compliance would be expected in the future.41 In Chapman, the attorney
made a disclosure that the court found was intentionally misleading because the
attorney had not retained the fees in her trust account as she represented in her
statements to the court. As a result, the court admonished her, published its opinion,
referred her to the state’s disciplinary authorities, and cut the fee by one-half.42

There are problems in this case that stem directly from Mr. Lazzo’s failure to
timely disclose. Garcia has paid him far more in retainer than the fee agreement
provides for. The undisclosed additional $9,000 flowed in freely during times when
Garcia was in default on his plan payments and his business was failing. Lazzo only
disclosed the payments when prompted to do so by the Trustee’s motion to dismiss.
He offered neither an explanation nor an excuse for his delay other than the alleged
telephone conversation with the Trustee’s attorney. That, of course, is not a sufficient
“disclosure.” To Lazzo’s credit, he held the funds in his trust account, but did not take
them as a fee, pending the approval of this application. He entered the case in the
middle and has worked diligently going forward to represent the debtor’s interests.
And his receipt of the additional funds was not entirely a secret. Alex Garcia knew

41 Argento, 282 B.R. 108, 115.
42 Chapman, 323 B.R. 470, 479.

17

Case 12-10393 Doc# 204 Filed 01/24/14 Page 17 of 19


Paul attempted to pay at least $2,000 in March of 2013; Alex stopped payment on
that check drawn on the Lenore’s La Casita account, some eight months before the
Trustee filed her motion to disgorge. At least one member of the Garcia family knew
Paul was paying attorney fees to Lazzo at that time.43

It goes against my grain to cut a lawyer’s fees, but in this case, I cannot let a
failed fee disclosure go unremarked. As noted above, courts have exercised their
discretion to remedy a Rule 2016(b) violation by reducing or withholding an attorney’s
otherwise allowable fees. Considering that Mr. Lazzo has worked effectively in a
difficult matter and that he remains on the hook to defend Paul Garcia’s discharge at
the trial on the pending adversary proceeding that is set for January 28, 2014, I
decline to deny his compensation in its entirety. But he along with the other lawyers
who practice in this Court need to be reminded that compliance with the rules that
govern attorneys’ compensation in bankruptcy is not optional. Here, the failure to
disclose led to the trustee’s disgorgement motion, a contested fee application,
discovery, and a half-day trial—a considerable amount of effort that could have been
avoided by the timely filing of a very simple pleading.

Lazzo’s fees, otherwise allowable in the amount of $10,260, shall therefore be
reduced by one-third, or $3,420, to $6,840. He and any other readers of this Order go
warned that future failures to disclose, particularly by lawyers of his experience and
ability, will not be treated so lightly.

43 Alex was called by the Trust’s lawyer at this hearing as a witness against Lazzo.
18

Case 12-10393 Doc# 204 Filed 01/24/14 Page 18 of 19


The Trustee shall distribute $6,840 to Mr. Lazzo as full payment of the fees
he requested in the First Motion for Administrative Expenses, and shall hold the
balance of the disgorged funds pending the further order of the Court.

# # #

19


Case 12-10393 Doc# 204 Filed 01/24/14 Page 19 of 19

13-11934 WK Lang Holdings LLC (Doc. # 115)

In Re WK Lang Holdings LLC, 13-11934 (Bankr. D. Kan. Dec. 13, 2013) Doc. # 115

PDFClick here for the pdf document.


SO ORDERED.
SIGNED this 11th day of December, 2013.

 

OPINION DESIGNATED FOR ONLINE PUBLICATION
BUT NOT PRINT PUBLICATION


IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS


IN RE: ) Jointly Administered
)
WK LANG HOLDINGS, LLC, ) Case No. 13-11934
) Chapter 11
Debtor. )

________________________________________________)

ORDER ON DEBTORS’ AMENDED MOTION FOR SALE NO. 1

Chapter 11 debtors in possession may exercise a trustee’s power to sell assets
free and clear of liens under § 363(b) and (f). Even when a sale is proposed outside the
plan process and includes all or a substantially portion of the debtor’s assets, the
bankruptcy court may approve it under subsection (b) as long as it meets certain
benchmarks. The sale must (1) be based on sound business reasons; (2) be adequately
noticed to interested parties with full disclosure both of the sale terms and the debtor’s

-1


Case 13-11934 Doc# 115 Filed 12/11/13 Page 1 of 23


relationship with the buyer; (3) be for a fair and reasonable price; and (4) be in good
faith. In the Tenth Circuit, the price is reasonable if the sale will yield 75% of the fair
market value of the assets sold. Case law in many circuits also suggests that a sale by
the debtor to an insider of the debtor is not in bad faith, per se, so long as there is no
fraud, collusion or unfair advantage.1 To sell the assets free and clear of interests in
the property, the court must find that the sale satisfies one of the five conditions
enumerated in § 363(f). Here, the debtors submit that (f)(3) and (f)(5) are satisfied.

Debtors WK Lang Holdings, L.L.C., Hardwood Millwork and Supply, L.L.C.,
Hardwood Manufacturing, L.L.C., and Hardwood Cabinets, L.L.C. filed their amended
motion to sell assets free and clear of liens to HWM, Inc. on November 15, 2013.2 Under
the proposed agreement, HWM will acquire certain real estate, some vehicles,
accounts, inventory, general intangibles, and a line of woodworking equipment. HWM
is a new entity owned and organized by one of the current owners of the debtors, the
Lang living trust. Current creditor First Bank of Newton proposes to finance this
purchase. Midland Bank, the secured creditor that holds a lien on the equipment,
objects that the sale price is not fair and reasonable and that the sale is not in good
faith. After hearing evidence concerning the structure of the debtors, the proposed

1 See In re Medical Software Solutions, 286 B.R. 431, 445 (Bankr. D. Utah2002) (citing In re Wilde Horse Enterprises, Inc., 136 B.R. 830, 842 (Bankr. C.D. Cal.
1991)); see also In re Condere Corp., 228 B.R. 615, 632 (Bankr. S.D. Miss. 1998)
(Where debtor and purchaser share the same management the proposed sale wouldbe subjected to heightened scrutiny.).

2 Dkt. 96, amending dkt. 75.

-2


Case 13-11934 Doc# 115 Filed 12/11/13 Page 2 of 23


transaction, and the value of the property to be sold, I conclude that the sale complies
with § 363 and, as orally modified at the hearing, may be approved.

Facts

The debtors in these jointly-administered cases have interlocking ownership and
management. WK Lang Holdings, LLC (WKL) owns Hardwood Manufacturing
(Manufacturing) and Hardwood Cabinets (Cabinets).3 Manufacturing owns Hardwood
Millwork and Supply (Millwork), the operating entity. The Steve C. Lang Revocable
Trust, Melinda Lang Revocable Trust, and Steven C. Lang Irrevocable Trust No. 2 each
own a third of the interest in WKL. The Lang family has been in the custom hardwood
millwork and cabinet business in Burrton, Kansas since 1988, specializing in millwork
and cabinetry for homes selling for not less than $300,000. Ninety percent of their
business is in new home construction. At one time, the business had as many as 135
workers, but now employs 25. Manufacturing holds all the assets, pays overhead, and
manages payroll for the various other debtors. Cabinets is a regional maker and seller
of custom cabinetry. Manufacturing, through its operating subsidiary Millwork, makes
hardwood trim and moldings and engages in other millwork that is sold locally and
regionally. When the economy faltered in 2008 and 2009, Cabinet lost over 75% of its
sales in a 45-day period.4 Steve Lang is the managing member and chief executive

3 WKL formerly owned an interest in a third affiliated entity McKinleyHardwoods, LLC located in Oklahoma City but McKinley was sold to the minorityinterest holder Mike McKinley in 2010.

4 Cabinets was a stand alone manufacturer of cabinets but ceased business
operations in 2011 and only minor amounts of equipment and inventory remain

-3


Case 13-11934 Doc# 115 Filed 12/11/13 Page 3 of 23


officer who makes the debtors’ business decisions. The business is currently operated
at 202 East Dean in Burrton.

Midland National Bank holds a variety of claims against the debtors. Other
banks, including Kanza Bank, signed participation agreements with Midland and
under those agreements, one lender, Kanza Bank, could assert control of the credits
and act as lead lender if it became dissatisfied with Midland’s servicing efforts.
Midland’s claims filed in this case that are affected by the proposed sale are:

Note ***89 dated November 1, 2007 with a remaining balance of $830,300.89.

Note ***73 dated November 1, 2007, with a remaining balance of $761,262.38,

All four Lang companies co-made notes 73 and 89 and cross guaranteed them.
Those two notes are secured by real estate mortgages covering land commonly
described as 302 E. Dean (the former Cabinet location that was sold in 2011), 110 N.
Reno, and 115 N. Reno, all in Burrton. Those two notes are also secured by a security
interest in all of the debtors’ machinery and equipment. The mortgages and liens are
perfected. In addition to the security held by Midland, the United States Department
of Agriculture Rural Development Service has guaranteed repayment of up to 75% of
the unsecured portion of these two notes.5 Midland’s president indicated that these
USDA guaranties are provided through the Business and Industry Loan Program.
They are similar to SBA (Small Business Administration) guaranties. The USDA

after an online auction of assets was held.
5 Ex. S and T.

-4


Case 13-11934 Doc# 115 Filed 12/11/13 Page 4 of 23


guaranty comes with a variety of conditions, three of which are that the full amount
of debt must be obtained before it will consent to the release of collateral, USDA must
approve all modifications to guarantied loans, and any sales of collateral must be for
a proper business purpose.6

Midland also holds other notes of the various debtors as follows:

WKL Note ***78 dated January 18, 2011, with a remaining balance of $153,034.

WKL Note ***86, dated January 18, 2011, with a remaining balance of

$711,583.

Millwork Note ***70 dated January 18, 2011, with a remaining balance of

$148,246.

Millwork Note ***74 dated January 15, 2012, with a remaining balance of

$621,749.

Millwork and Cabinet have guaranteed repayment of Notes 78 and 86. Millwork
and WKL have guarantied Notes 70 and 74. Each of these notes is also secured by the
above-referenced security interests in the companies’ machinery and equipment as well
as mortgages on the real property, cross-guaranties among the companies, and
personal guaranties of Mr. and Mrs. Lang. These notes are not, however, backed by the
USDA guaranties.

In addition to these debts and claims, several of the debtors owe the First Bank
of Newton on the following obligations:

6 See also Ex. U, providing that USDA’s policy is to “not allow debt writedown/
adjustments and leave the same principals in charge of the business.”

-5


Case 13-11934 Doc# 115 Filed 12/11/13 Page 5 of 23


Cabinet Note *4299, dated January 12, 2011 with a remaining balance of

$187,837.33.

Note *2423, dated April 7, 2011 with a remaining balance of $1,150,890.79.

Mr. and Mrs. Lang co-signed the Cabinet note and are the makers of Note *2423.
These notes are secured by Cabinet’s inventory, accounts, and general intangibles,
along with a series of real estate mortgages that encumber farm ground owned by the
Langs as well as the company’s current manufacturing facility located at 202 East
Dean in Burrton, whose construction First Bank originally financed in 2004.

As part of the proposed Sale No. 1,7 debtors offer to sell 202 East Dean and the
personal property collateral to the new Lang entity HWM in exchange for HWM
assuming the First Bank real estate mortgages of $1.15 million on East Dean and
payment of $725,000 cash for accounts receivable and inventory. The Steve C. Lang
Revocable Trust owns the equity in HWM; he is the president and sole director of
HWM. Charity Bowman, the debtors’ chief financial officer, is the secretary/treasurer
of HWM.8 The original Notice of Sale provided for the debtors to also sell Millwork’s
machinery and equipment to the new entity for $350,000 cash. As orally amended at
trial, that offer has increased to $410,000 cash. The vehicles will be sold for $50,000
cash. Midland has a security interest in the vehicles and machinery and equipment
that secures its guarantied debt. First Bank will extend the necessary credit to fund

7 See Dkt. 96.
8 Ex. 9


-6


Case 13-11934 Doc# 115 Filed 12/11/13 Page 6 of 23


the cash purchases.9 Midland specifically objects to the sale of the machinery,
equipment, and vehicles on a number of grounds.

We now turn to the circumstances leading up to proposed Sale No. 1. In 2010,
Kanza asserted its right to act as lead lender under the Midland participation and
foreclosed. To resolve the foreclosure, the Lang entities sold an affiliated entity,
McKinley Hardwood, at a substantial loss, leaving Midland with a substantial
deficiency, but also temporarily resolving the foreclosure which Kanza dismissed. In
2011, Cabinet sold most of its assets. The building at 302 E. Dean in Burrton brought
$1.0 million. The machinery and equipment was sold via online auction, the results of
which were disappointing, again leaving Midland short. Cabinet, which had operated
at a loss since its inception in 2006, closed its doors.

In 2012, the debtors entered into a workout agreement with Midland and First
Bank that allowed them to pay interest-only on their debts for a brief time. But in
2013, the debtors were again unable to service their principal debt and requested
further forbearance. Kanza refused, causing Midland, as lead lender to encourage the
Lang entities to seek other lenders. The debtors sought financing from several area
lenders and considered selling the companies. They also sought outside investment.
They received offers of financing from two banks in Wichita and Newton as well as a

9 The original motion to sell included the real estate at 115 E. Reno. Dkt. 75.
After Midland objected to the sale, the debtors amended their notice of sale andremoved that tract. Dkt. 96.

-7


Case 13-11934 Doc# 115 Filed 12/11/13 Page 7 of 23


new proposal from First Bank.10 They held an informal creditors’ meeting in May of
2013 that included Midland, First Bank, the Kansas Department of Commerce, and the
USDA. Kanza opted not to participate and again foreclosed. The debtors responded by
filing these chapter 11 cases on July 26, 2013.11 Shortly after the filings, Steve Lang
formed HWM, Inc. to acquire the assets subject to this sale with the intention of
seeking another lender to finance the acquisition and satisfy the Midland loan.12

Less than two months later, on September 16, 2013, the debtors filed their
initial sale motion, drawing an immediate objection from Midland who says that the
contemplated sale by these debtors to a new entity formed and owned by the debtors’
ownership was not negotiated at arm’s length, is not in good faith, and is for
insufficient consideration.13 Under Midland’s and USDA’s guaranty agreement,
Midland has a variety of servicing duties to the Government and cannot unilaterally
agree to the sale because it is to Steve Lang’s newly formed company. As a matter of
policy, the USDA does not fund insiders’ acquiring assets from affiliates. Exceptions
to this policy must be obtained from the Administrator of the Rural Business-
Cooperative Service, a division of that agency.14 In response to this objection, the

10 Ex. 3, 4, and 5.

11 Ex. 18, Foreclosure petition filed June 7, 2013.

12 See Ex. V, Articles of Incorporation of HWM, Inc., dated August 20, 2013.

13 Dkt. 74 (Amended Asset Purchase Agreement), 75 (sale motion), 86 (sale

motion addendum), and 83 (Midland objection).
14 Ex. U.

-8


Case 13-11934 Doc# 115 Filed 12/11/13 Page 8 of 23


debtors filed a motion asking the court to “denominate the U.S. Department of
Agriculture as a Party in Interest” to which the government has objected.15 That
motion has been deferred pending the outcome of this sale motion.

An evidentiary hearing was held on November 20, 2013 and the parties offered
closing arguments on November 25, 2013.16 Shortly before the hearing, debtors and
HWM filed their Amended Motion for Sale No. 1 and submitted a Second Amended
Asset Purchase Agreement entered into on November 18, 2013.17 This amendment
deleted from proposed Sale No. 1, the 115 North Reno property mortgaged to Midland.

Good Faith and Sound Business Reasons

The debtors pursued a number of avenues in their attempt to preserve the core
business and its highly-skilled employees. These included obtaining several loan
proposals, including First Bank’s commitment to lend and attempts to secure outside
investment. Lang and Bowman dealt openly with all of the creditors concerned, even
convening a creditors meeting with them and including them in the negotiation process
and terms of the proposed sale. Both Midland’s and First Bank’s presidents stated that
the lending relationship with the companies had been cordial and cooperative.

Steve Lang stated that he hadn’t considered selling what remained of the

15 Dkt. 46, 63.

16 The debtor Lang entities appeared by their counsel Edward J. Nazar.
Midland Bank appeared by its attorney David Burns. First Bank of Newton
appeared by its attorney Timothy Hodge.

17 Dkt. 96, 103.

-9


Case 13-11934 Doc# 115 Filed 12/11/13 Page 9 of 23


business because he was concerned about a possible poor return. When he sold the 302
East Dean property as part of the 2011 workout after the first Kanza foreclosure, it
was the first such building to sell in Burrton in 10 years. The results of the online
equipment auction the debtors conducted as part of that workout were acutely
disappointing. The debtors received roughly ten cents on the dollar.18 Lang believes
that selling the business would not serve the lenders well and would be harmful to the
business, the community, and, of course, his experienced and loyal employees. He
considers that the likely prospective purchasers in such a sale would be his competitors
who survived the 2009 collapse.19 He points out that those competitors don’t need the
equipment or real estate, rather they seek debtors’ customers. Such a sale is likely to
result in Burrton losing an employer and 25 skilled employees losing their jobs. Lang
believes that his 12-year borrowing relationship with First Bank makes the HWM sale
the best option for all concerned. While the operating margin is thin, HWM is capable
of cash-flowing.20

Ms. Bowman, who is a certified public accountant, agreed that what First Bank
is prepared to lend and Steve Lang is prepared to pay exceeds what any outsider might
pay for the equipment and land. She and First Bank’s president stressed that the

18 For that auction, Midland and the USDA approved minimum bids.

19 Midland’s equipment valuation expert Dan Bashaw estimated that 80% ofthe woodworking industry market “went under.”

20 Ex. 19. Under Bowman’s cash-flow analysis, the business would generate amonthly margin of approximately $1,900, but would be able to make the principaland interest loan payments for the first time in several years.

-10


Case 13-11934 Doc# 115 Filed 12/11/13 Page 10 of 23


Bank’s offer to finance had a short deadline, creating time pressure in completing this
transaction. Adding to that pressure is the ongoing push-back the company receives
from its customers and the competitive disadvantage that being in bankruptcy
presents. A further source of concern is the looming expiration of a state tax exemption
in January of 2014. All of these factors militate against the debtor taking the time that
filing and confirming a plan and disclosure statement might take.

Value of machinery, equipment and vehicles

Midland’s principal factual dispute centers on the value of the line of machinery
and equipment to be acquired by HWM. Both WKL and Midland presented value
testimony at the hearing on this motion. The debtors relied on the appraisal report of
Duckwall & Company, Inc. Daniel Duckwall inspected some, but not all, of the
equipment at Burrton shortly before the hearing. He is certified as compliant with
USPAP21 and works as an auctioneer and appraiser of industrial equipment and
machinery. He presented a written report that included photographs of some of the
larger items.22

Duckwall testified that the fair market value of the equipment to be sold to
HWM is $474,610. In that report, he defines “fair market value” as what a willing
buyer would pay a willing seller, not under compulsion, and with full knowledge of

21 The Uniform Standards of Professional Appraisal Practice are thegenerally accepted standards for professional appraisal practice in North America,
as developed by the Appraisal Standards Board of the Appraisal Foundation. See
www.appraisalinstitute.org/ppc/ethics_standards.aspx on December 5, 2013.

22 Ex. 7.

-11


Case 13-11934 Doc# 115 Filed 12/11/13 Page 11 of 23


what is being sold. Duckwall also testified that, at liquidation, this equipment would
be worth not more than $278,325.23 Duckwall’s fair market valuation assumed that the
goods would be exposed to the market in place at Burrton for as long as six months. His
liquidation value opinion assumed that the equipment would be sold over a period not
to exceed 90 days. He suggested that the equipment being in Burrton, Kansas might
depress its value, but that the greatest single factor depressing its value is the
significant increase in competition in the domestic and international cabinet business.
He also noted that woodworking equipment auctions that he has recently observed
have not been well attended.

On cross examination, Midland established that Duckwall’s appraisal did not
include a few items of property, most notably several forklifts and a table saw. These
items, taken together at Bashaw’s values, amount to $28,810.24 But, as noted below,
these are retail, not fair market, values. The other discrepancies are explained by
Duckwall’s grouping various related component items together, rather than listing
them by line item. Adding the missing components at Bashaw’s values increases the
total fair market value of the equipment to $493,420.

Midland relied on the valuation testimony of Dan Bashaw of Overland Tool and
Machinery. While Bashaw did not state that he was a certified appraiser, his business
is the onsite sale and brokerage of equipment. Indeed, some of the debtors’ equipment

23 Ex. 8.
24 See Ex. W, lines 103, 104, 118 and at top of page 4.


-12


Case 13-11934 Doc# 115 Filed 12/11/13 Page 12 of 23


was purchased from Overland. He has performed valuation services from time to time
and bases his opinions upon information he accumulates in his business and on his 36
years in the equipment sales business. Bashaw did not supply a typical expert report.
Instead, he testified from a spreadsheet inventory of equipment based on lists he
received from Lang and Bowman with values attributed to each line item.25 Bashaw
opined that the value of the equipment where it is located and if well-maintained in a
safe environment is $777,811. He based that opinion on his experience as a dealer and
broker. His pricing is based on information available to Overland through trade group
member databases. His value opinion assumes a transaction between an unrelated
buyer and seller after exposing to the market for between a few weeks and a number
of months. If Bashaw were to buy all of this equipment in a lot, he would expect to
receive a 10% discount. He admitted that it would be difficult to obtain fair market
value for this equipment if it were sold piecemeal. Bashaw considers himself a retail
dealer. He admitted that his approach to valuing the equipment was affected by that

perspective.26

Bashaw also testified that the liquidation value of the equipment is $466,000,
though, on cross examination, he stated that he would only pay $350,000 for all of it
if he were buying it for resale. He also noted that he would liquidate the equipment by

25 Ex. W.

26 Bashaw estimated that 95% of Overland’s business is retail and a verysmall percentage (less than 8%) of Overland’s inventory is comprised of usedequipment.

-13


Case 13-11934 Doc# 115 Filed 12/11/13 Page 13 of 23


selling it at a dispersal auction as opposed to selling it as a package. He conceded that
he typically sells new equipment and that what he sells used he acquires via trading
or purchases for resale. He noted, too, that there are valuation resources for
equipment, but he did not cite to any in his testimony.

I credit Mr. Bashaw’s experience in the field, but note that he is, in fact, a
retailer whose opinion was not based on auction or liquidation experience. Nor was it
based on any comparative sales information. By contrast, Mr. Duckwall’s testimony
was based on his experiences as an auctioneer and appraiser of industrial equipment
with significant experience in appraising and selling woodworking tools. Given the
wide range in values testified to at trial, from Duckwall’s liquidation value of $278,000
to Bashaw’s fair market value of $778,000, and given the two witnesses’ agreement
that the market for this equipment is challenged at best, I conclude that Mr.
Duckwall’s report, as modified by the few pieces of equipment he appears to have
missed, better reflects the fair market value of this equipment where it is situated
today. I accordingly find that the fair market value of the equipment offered for sale
in the motion is not less than $474,610 and not more than $493,420 if full credit at
Bashaw’s values of the omitted pieces is added to Duckwall’s value. I also find that its
liquidation value does not exceed $350,000, the amount that Bashaw said he would pay
if he were to purchase all of it for resale.

Analysis

Section 363(b) Sales in General

As debtors in possession, the debtors in this case may sell estate assets outside

-14


Case 13-11934 Doc# 115 Filed 12/11/13 Page 14 of 23


the ordinary course of business under § 363(b) after notice and a hearing. Case law and
practice have developed a set of standards for determining whether a proposed sale
may be approved under subsection (b).

The Debtor must show (1) that a sound business reason exists for thesale; (2) there has been adequate and reasonable notice to interestedparties, including full disclosure of the sale terms and the Debtor'srelationship with the buyer; (3) that the sale price is fair and reasonable;
and (4) that the proposed buyer is proceeding in good faith.27

Turning first to the basic sale approval factors, there are sound business reasons
to proceed as the debtors have requested.28 This business cannot long languish in
chapter 11 and remain viable. If, however, the principals are permitted to convey its
assets to a new entity that is financed by a willing lender on reasonable terms, and if
all parties will receive something akin to what they would get in a conventional
chapter 11 plan, there is no reason not to permit a sale, assuming the proposal meets
the other terms and provisions of § 363. The risks of waiting for a plan to be confirmed
include (1) that the debtors’ tax exemptions and deferral of principal payments will
soon expire; (2) that 25 highly skilled people will lose their jobs; (3) that uncertainty
about the enterprise’s future has become a tool for its competitors to use against it in
the marketplace; and (4) that an ongoing business in a very small town will collapse.
Considering the efforts the debtors’ management has made to resolve the debts outside

27 In re Medical Software Solutions, 286 B.R. 431, 439-40 (Bankr. D. Utah2002).

28 There were no objections to the sufficiency of notice here, nor does anyoneallege that the sale terms and the debtors’ relationship with the buyer were notfully disclosed.

-15


Case 13-11934 Doc# 115 Filed 12/11/13 Page 15 of 23


of bankruptcy and to secure replacement financing, the debtors have exercised sound
management practices in trying to move the business to safe ground in the most
expeditious way.

The third and fourth general sale factors are whether the price is fair and
reasonable and whether the buyer has acted in good faith. These factors overlap.
Again, case law provides the controlling standard. In the Tenth Circuit, courts have
long held that a sale is in good faith if the price received is 75% of the appraised value
of the assets.29 Following the Tenth Circuit’s Bel Air decision, the Bankruptcy
Appellate Panel has recently reaffirmed that “[i]n order to obtain good faith status
under § 363(m), a purchaser must (i) buy the property without “fraud, collusion
between the purchaser and other bidders or the trustee, or an attempt to take grossly
unfair advantage of other bidders” and (ii) pay “at least 75% of the appraised value of
the assets.”30

I have concluded that the fair market value of the machinery and equipment to
be sold under this agreement is not more than $493,420. Seventy-five percent of that
amount is $370,065. Lang testified that the Bank was prepared to lend up to $410,000
to consummate the sale of the equipment line. The debtors orally amended their
motion to sell to reflect an increased offer by HWM in that amount. Under Tenth

29 Tompkins v. Frey (In re Bel Air Assocs., Ltd.), 706 F. 2d 301, 305 n. 12 (10thCir. 1983), citing Greylock Glen Corp. v. Community Sav. Bank, 656 F. 2d 1, 4 (1stCir. 1981) and In re Rock Indus. Machinery Corp., 572 F. 2d 1195, 1197 n.1 (7th Cir1978).

30 In re Crowder, 314 B.R. 445, 450 (10th Cir. B.A.P. 2004).

-16


Case 13-11934 Doc# 115 Filed 12/11/13 Page 16 of 23


Circuit authority, that amount is more than sufficient to support a finding that the sale
is for a fair and reasonable price and in good faith.

Good faith in this context is based not only on the adequacy of proposed sale
price, but also on whether the purchaser bought “without fraud, collusion between the
purchaser and other bidders or the trustee, or an attempt to take grossly unfair
advantage of other bidders.”31 When the purchaser at the proposed sale is an insider
of the debtor, heightened scrutiny of the circumstances is required.32 While sales to
fiduciaries are not per se prohibited, they should be carefully examined for fraud or
collusion. After hearing the testimony of the debtors’ principal owner, the debtors’ chief
financial officer, and Ray Penner, president of First Bank, I am comfortable that no
fraud or collusion informs this transaction. Lang has openly interacted with his lenders
and other creditors throughout the case. The terms and provisions of the sale as well
as his involvement in it have been fully disclosed. While he may benefit from its
approval, his intentions to continue to operate the business and employ residents of a
small country town belie any assertion of misconduct on his part. The sale was legally
and appropriately noticed and no other bidders have cropped up. I cannot conclude that
Lang or the trusts are taking unfair advantage of other participants in the
marketplace.33 Moreover, preserving established businesses in small agrarian

31 Id. See also In re Bel Air Assocs., Ltd., 706 F.2d at 305 nn. 11–12.

32 In re Medical Software Solutions, 286 B.R. at 445; In re Bidermann Inds.,
Inc., 203 B.R. 547, 553 (Bankr. S.D.N.Y. 1997);

33 See In re Condere Corp., 228 B.R. 615, 631-32 (Bankr. S.D. Miss. 1998).

-17


Case 13-11934 Doc# 115 Filed 12/11/13 Page 17 of 23


communities is entirely consistent with the overarching goals and policies of the USDA

Rural Development programs.34

When a pre-plan sale is proposed in a chapter 11, courts often refer to the

“Lionel Factors” to determine whether such a sale comports with sound business

judgment and is appropriate. Those factors include:

(1) the proportionate value of the asset to the estate as a whole; (2) theamount of elapsed time since the filing; (3) the likelihood that a plan ofreorganization will be proposed and confirmed in the near future; (4) theeffect of the proposed disposition on the future plans of reorganization; (5)
the proceeds to be obtained from the disposition vis-a-vis any appraisalsof the property; (6) which of the alternatives of use, sale or lease theproposal envisions; and (7) most importantly perhaps, whether the asset
is increasing or decreasing in value. 35
Applying the Lionel factors here, those that weigh against permitting the sale

to go forward are outweighed by those that condone it. The short time between filing

and the sale and the fact that this machinery and equipment are among the last

saleable assets from which Midland can expect to realize on its security interest weigh

against approval of the proposed sale. And, as Midland points out, a future

reorganization of the remaining debtor assets seems unlikely once this sale is

34 See www.rurdev.usda.gov/BCP_gar.html on December 6, 2013, describingthe purpose of the Business and Industry Guaranteed Loan Program “to improve,
develop, or finance business, industry and employment and improve the economicand environmental climate in rural communities.” See also
www.rurdev.usda.gov/Business.html on December 6, 2013, for the articulated
mission of the USDA Rural Development.

35 Comm. of Equity Security Holders v. Lionel Corp. (In re Lionel Corp.), 722
F.2d 1063, 1071 (2nd Cir. 1983) (enumeration and emphasis added).

-18


Case 13-11934 Doc# 115 Filed 12/11/13 Page 18 of 23


complete.36 But the likelihood that this business will survive long enough to make it
through the confirmation process is low. The property will be sold for a large proportion
of its value compared to appraisals. The business is deteriorating and the current
proposed lender may well back out if forced await the outcome of confirmation hearing.
The most important Lionel factor, whether the assets are increasing or decreasing in
value, weighs in favor of the proposed sale. Both valuation witnesses noted the lack
of a favorable market to sell the equipment as a lot and agreed that a piecemeal sale
would lower its value.37 On balance, the Lionel factors weigh in favor of permitting the
proposed pre-plan sale.

Section 363(f): Sales Free and Clear of Interests in Property.

Section 363(f) of the Code permits § 363(b) sales of property to be free and clear
of liens and interests in the property. Subsection (f)(1)-(5) sets out five conditions for
sales free and clear. Because those conditions are listed in the disjunctive, satisfying
any one of them is all that is necessary for the trustee or a debtor in possession to sell
free and clear, so long as the other elements of § 363 are met. Midland argues that the
debtors’ proposed sale does not meet any of the subsection (f) criteria and relies
primarily on subsections (f)(2) and (f)(3). Subsection 363(f)(2) requires that the secured

36 The 115 N. Reno property that was removed from proposed Sale No. 1 bythe amended sale motion will be the debtors only remaining asset. Its futureseparate sale is contemplated and Lang has offered to assist Midland to sell theReno property.

37 The debtors’ experience when they sold the Cabinet equipment in Octoberof 2011 undoubtedly lends credence to debtors’ view that the equipment in Sale No.
1 is more likely decreasing in value.

-19


Case 13-11934 Doc# 115 Filed 12/11/13 Page 19 of 23


creditor consent to the sale and Midland refuses to do that. Subsection 363(f)(3),
requires that the sale be for not less than an amount greater than the “aggregate value
of all liens.”

The courts are somewhat divided on the meaning of § 363(f)(3). Most courts have
concluded that the “aggregate value” of the liens is equal to or not greater than the
value of the collateral being sold. But one court disagrees. In Clear Channel Outdoor,
Inc., the Ninth Circuit Bankruptcy Appellate Panel held that the price of the property
sold must be greater than the aggregate amount of all claims held by the lienholders
and rejected the view that the statutory language refers to the economic value of the
liens, i.e., the value of the collateral.38 No court of appeal has adopted this view and the
great weight of lower court authority is to the contrary. Most courts reason that if § 363
sales had to generate proceeds in excess of all of the claims that attached to the assets
sold, few, if any of them would ever be approved.39 This is the better view.
Nevertheless, this sale does not meet (f)(3) under either view, because the fair market
value of the property to be sold exceeds the actual sales price. While meeting the 75%
good faith threshold may suffice to gain a sale’s approval under § 363(b), it does not
stretch to § (f)(3).

The proposed sale meets the requirement of subsection (f)(5). This subsection
allows the property to be sold free and clear of an entity’s lien if “such entity could be

38 Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25, 41
(9th Cir. B.A.P. 2008).

39 In re Boston Generating, LLC, 440 B.R. 302, 323 (Bankr. S.D.N.Y. 2010).

-20


Case 13-11934 Doc# 115 Filed 12/11/13 Page 20 of 23


compelled, in a legal or equitable proceeding, to accept a money satisfaction of such
interest.”40 Midland’s “interest” is an Article Nine security interest in personal property
that, outside of bankruptcy, could be enforced by self-help or foreclosed in a court of
appropriate jurisdiction.41 Midland could be compelled to accept less than payment in
full of the debt in a state law foreclosure and, to the extent the proceeds of the
foreclosure sale were insufficient to pay the claims in full, Midland would receive an
unsecured deficiency or, if it wished, Midland could credit-bid up to the amount of its
claim under at the foreclosure sale. Here, Midland had the right to credit-bid up to the
amount of its claim under § 363(k).42 Midland chose not to do that.

Were these debtors to attempt to cram Midland down in a chapter 11 plan, §
1129(b)(2)(B) would permit them to pay Midland a stream of payments with a present
value equal to the value of Midland’s collateral and the balance of Midland’s claim, at
least as to the machinery, would be unsecured.43 Several courts have held that “[b]y its
express terms, Section 363(f)(5) permits lien extinguishment if the trustee can
demonstrate the existence of another legal mechanism by which a lien could be

40 11 U.S.C.A. § 363(f)(5). See In re Gulf States Steel, Inc. of Alabama, 285

B.R. 497, 508 (Bankr. N.D. Ala. 2002) (Section 363(f)(5) refers to a legal or equitableproceeding “in which the nondebtor could be compelled to take less than the value ofthe claim secured by the interest;” it requires a showing that some mechanismexists to address extinguishing the lien without paying in full).
41 See Clear Channel Outdoor, Inc., 391 B.R. at 42 (The term “interest” insubsection (f)(5) includes a lien.)

42 Boston Generating, LLC, 440 B.R. at 323.

43 Scherer v. Fed. Nat’l Mortgage Assoc. (In re Terrace Chalet Apartments,
Ltd.), 159 B.R. 821, 829-30 (N.D.Ill.1993).

-21


Case 13-11934 Doc# 115 Filed 12/11/13 Page 21 of 23


extinguished without full satisfaction of the secured debt. Section 1129(b)(2) cram

down is such a provision.”44 Midland could be crammed down and, therefore, compelled

to accept a money satisfaction of its lien.45 Therefore, the proposed Sale No. 1 satisfies

§ 363(f)(5) and may be approved as a sale free and clear of liens.

Conclusion

The proposed sale free and clear of liens noticed by the debtors in their Amended

Notice for Sale No. 1 (dkt. 96) and as orally amended at the hearing to increase the

price offered for the equipment to $410,000 meets the requirements of § 363(b) and

(f)(5) and is approved. Midland did not exercise its right to credit bid. Its objections are

OVERRULED and the debtors’ Motion for Sale No. 1, as amended and modified herein,

is GRANTED. The debtors may sell the property that secures Midland’s claim to HWM

44 Id. at 829. See also Compass Bank v. Investment Co. of the Southwest, Inc.
(In re Investment Co. of the Southwest, Inc.), 302 B.R. 112 (unpublished table
decision) (10th Cir. B.A.P. Dec. 8, 2003) (recognizing chapter 11 cram down as a legalor equitable proceeding under § 363(f)(5), citing Collier’s bankruptcy treatise); In re
Healthco Intern., Inc., 174 B.R. 174 (Bankr. D. Mass. 1994) (hypothetical chapter 11plan cramdown qualified as money satisfaction of taxing authority’s interest withinmeaning of § 363(f)(5)). But see Clear Channel Outdoor, Inc., 391 B.R. at 45-6
(Holding that § 1129(b)(2) cramdown is not a legal or equitable proceeding underthis section; if Code provided elsewhere for money satisfaction, there would be noneed for § 363(f)(5)).

45 See also, In re Jolan, Inc., 403 B.R. 866, 869-70 (Bankr. W.D. Wash. 2009)
where the bankruptcy court identified a number of legal or equitable proceedings inthe State of Washington where a lienholder’s interest could be cleared: its UniformCommercial Code Article 9 default remedies permitting a senior secured party todispose of collateral, a receiver’s authority to sell free and clear, a personal propertytax sale, a federal tax lien sale, and judicial and nonjudicial foreclosure sales.

-22


Case 13-11934 Doc# 115 Filed 12/11/13 Page 22 of 23


and the lien of Midland will attach to the proceeds of that sale in the hands of the
debtors.

# # #

-23


Case 13-11934 Doc# 115 Filed 12/11/13 Page 23 of 23

You are here: Home