The Honorable Brendan L. Shannon

In a decision signed October 25, 2017, Judge Shannon of the Delaware Bankruptcy Court issued an opinion requiring a professional to disgorge fees, pay a sanction of $25,000, and enjoined him from taking various actions in bankruptcy court. Judge Shannon’s opinion is available here (the “Opinion”).

The United States Trustee filed a Complaint for Injunctive relief, Fines and Civil Contempt against Robert F. Martin.  Mr. Martin has twice before been the subject of inquiry and action by the United States Trustee. First in 2011, the United States Trustee alleged that Mr. Martin was acting as a petition preparer in violation of 11 U.S.C. § 110. A Consent Order resolving that litigation was entered by the Court on March 28, 2012 (the “First Consent Order”) by which Mr. Martin agreed to disgorge fees and refrain from acting as a petition preparer in the future.

Two years later, the United States Trustee filed a new complaint against Mr. Martin, alleging that he had acted as a petition preparer in at least 19 cases in violation of the terms of the First Consent Order.  Mr. Martin again agreed to disgorge fees and to refrain from acting as a petition preparer in the future.

The United States Trustee alleged that Mr. Martin returned to his prior practice of encouraging homeowners to file for relief under Chapter 13, and assisting them in the process of filing bankruptcy in violation of § 110 of the Bankruptcy Code. Mr. Martin’s debtor clients were not adequately instructed  by Mr. Martin regarding the Chapter 13 filing and its potential consequences, and that his efforts constituted a violation of the provisions of Bankruptcy Code § 110 and the First and Second Consent Orders.

The Court held that “Mr. Martin’s business model is based upon practices that violate federal law and orders of this Court.”  Opinion at *14.  It then levied the above fines and directed that Mr. Martin was to refrain from taking any further actions in violation of Bankruptcy Code § 110.

While this is not the type of case normally discussed on this blog, it illustrates an important principle that I have seen play out several times in the Delaware Bankruptcy Court – each time you are penalized for the same bad act, the consequences get more severe.

On August 23, 2017, Judge Shannon of the Delaware Bankruptcy Court issued an order that is a reminder that this is a court of equity – and that at the end of the day, he will act equitably.  A copy of Judge Shannon’s opinion (the “Opinion”) is available here.  Mr. Welsh filed the complaint that led to this Opinion, seeking damages for emotional distress, and punitive damages, for alleged violations of the automatic stay.

Brian Welsh is a debtor in bankruptcy case no. 14-11503 in the Bankruptcy Court for the District of Delaware.  On April 13, 2012, despite his mortgage being in default, Bank of America (“BofA”) mistakenly recorded a satisfaction of mortgage.   On February 7, 2014, BofA
filed a complaint in the Superior Court in the State of Delaware to set aside the Satisfaction.  On June 18, 2014, prior to any disposition in the Superior Court litigation, Mr. Welsh filed his Chapter 13 petition. On November 3, 2014, in order to protect its interest, BofA filed a proof of claim on account of the mortgage.  In response to an adversary proceeding seeking to avoid BofA’s claim, the Court issued a decision on October 1, 2015, in which it held that a bona fide purchaser would not have been on notice of the Superior Court litigation as of the Petition Date, and the lien was therefore avoided pursuant to Section 544(a)(3).  At that time, Judge Shannon said that Mr. Welsh “will benefit mightily due to [Defendant’s] honest mistake”, in essence obtaining “a house for free”.

As the facts are provided by Judge Shannon in the Opinion, it appears that he would be inclined to rule that BofA did violate the automatic stay.  This is reinforced by his denial of the defendants’ motion to dismiss the complaint.  He does, however, issue a parting word of guidance to the parties that makes exceptionally clear that the Debtor should not expect to receive any amount of damages due to BofA’s violation of the automatic stay.  “Candor requires that the Court advise the parties that it is highly unlikely that, at trial, this Court would award damages to the Plaintiff beyond the free house he has already obtained.”

When I was in law school, I heard numerous times that “pigs get fat and hogs get slaughtered”.  Mr. Welsh got a rich reward due to his handling of his bankruptcy petition – a free home.  Anything more than a free home, which had a mortgage of $205,000, may be more than a judge in a court of equity could in good conscience award.

On October 27, 2016, Chief Judge Brendan L. Shannon of the Delaware Bankruptcy Court issued an opinion overruling objections to the claims of Seegrid’s former CEO.  A copy of the Opinion is available here.

This is a relatively short Opinion considering the number of issues that it discusses.  The first issue was whether Mr. Horbal, the CEO at the relevant time had authority to use the Debtors; private jet.  The second issue was whether Mr. Horbal was under contract at the time of his termination, and whether such termination was for cause.

The first issue hinges upon what the applicable policies of the Debtor were at the time of Mr. Horbal’s use of the jet.  In this case, the applicable corporate policy required the approval of the CEO prior to using the corporate jet.  In this instance, the Court held that as the CEO, Mr. Horbal had the authority to approve of his use of the jet.

The second issue was the more interesting one.  The essential facts are as follows: Mr. Horbal was a President at the Debtor prior to becoming its CEO.  During his time as a President, he was employed under a contract that provided specific remuneration and benefits upon termination.  However, when he accepted the role of CEO, his contract was never revised.

While the Debtors argue that the change in position effected the termination of the agreement, Opinion at *14, Mr. Horbal argued that the parties continued to comply with the terms of the agreement, thereby ratifying it, despite the change in position, Id.  In this instance, Judge Shannon held that “Mr. Horbal has the better argument.”  Id.

My  $.02

This case provides a solid reminder of the importance of documentation.  In this case, the Debtors did not have documentation to support the allegations made in their claim objection.  The Debtors argued that the policy concerning the corporate jet was recently changed – but failed to produce any evidence to support the allegation.  The Debtors also argued that Mr. Horbal was fired for cause – but failed to produce any evidence to support the allegation.  As Judge Shannon noted, “when a company (and especially a company as actively represented by counsel as Seegrid) fires a senior executive for cause, somebody usually writes it down.”  Opinion at *17. 

On October 11, 2016, Chief Judge Brendan L. Shannon of the Delaware Bankruptcy Court issued a letter ruling in which he opined on the appropriate valuation of a first lien.  A copy of the Opinion is available here.

While the ruling is short, it is important that lenders are cognizant of it.  Judge Shannon cites to a prior opinion he issued in which he held that “the operative date for valuation of residential property under § 1322(b)” is the petition date.  In re DiMauro, 548 B.R. 685, 689 (Bankr. D. Del. 2016).

The result in this case is that the proof of claim filed by the first lien lender is operative in valuing the property, and the payoff amount sought by the first lien lender is not.  This is the value used to determine whether second (and possibly third) liens should be stripped off.

On February 19, 2016, Judge Brendan L. Shannon of the Delaware Bankruptcy Court granted in part the motion of K. Ivan F. Gothner (the “Defendant”) to dismiss a complaint filed by JLL Consultants, the Liquidating Trustee (the “Trustee”) in the AgFeed bankruptcy.  I summarized that opinion in a prior post: Opinion in AgFeed USA – Another (Mostly) Successful Motion to Dismiss

Since publishing that post, the Trustee filed his amended complaint, to which the Defendant filed another motion to dismiss (the “Motion”).  On September 13, 2016, Judge Shannon issued an opinion (the “Opinion”) deciding this Motion.  The “Opinion” is available here.

Because of the length of the complaint and the Motion, the Opinion weighs in at 32 pages.  The analysis in this Opinion is substantially similar to that of the prior opinion.  The Opinion indicates several times that no new information was provided in support of, or against, several of the claims of the complaint.  Thus, for purposes of this post I’ll focus on the single largest issue of new analysis provided by the Court – fraud.

The Third Circuit precedent that is followed in the Delaware Bankruptcy Court is provided in Seville Indus. Machinery Corp. v. Southmost Machinery Corp., 742 F.2d 786, 791 (3d Cir. 1984), cert. denied, 469 U.S. 1211, 105 S.Ct. 1179, 84 L.Ed.2d 327 (1985).  For those of you without ready access to Lexis or Westlaw, here is a link to the case in Google Scholar.

As Judge Shannon provided in the course of dismissing the Trustee’s allegation of Intentional Misrepresentation by Nondisclosure (which is a common law fraud claim), “Fraud requires: (1) a false representation of material fact; (2) the knowledge or belief that the representation was false, or made with reckless indifference for the truth; (3) the intent to induce another party to act or refrain from acting; (4) the action or inaction taken was in justifiable reliance on the representation; and (5) damage to the other part as a result of the representation.”  Opinion at *28.

In this claim, the Trustee failed to allege with particularity that any action was taken in reliance of the Defendant’s representations.  Judge Shannon includes a quote from the Delaware Chancery Court that the “conclusory statement [that plaintiff ‘relied upon’ a statement] is insufficient; to plead reliance with particularity, plaintiff must explain what he did or refrained from doing, in justifiable reliance upon the statement.”  Opinion at *29 (quoting Smith v. Smitty McGee’s, Inc., 2998 WL 246681, 15 *5 (Del. Ch. May 8, 1998)).  In this case, the Trustee includes only the conclusory statement that shareholders relied upon the Defendant’s representations without providing any specific instance in which this occurred.

In the end, the result of the amended complaint was essentially identical to the original complaint.  The same causes of action survived the Motion and no new actions survived the Motion.  Judge Shannon closed the Opinion with what should be considered a firm warning to the Trustee – “the Court has previously expressed and now reiterates its profound concerns with respect to the dissipation of monies otherwise available for distribution to stakeholders being burned up in litigation of dubious merit and questionable collectability.”  Opinion at *32.

My $.02

Having already provided the Trustee a second bite at the apple, Judge Shannon declined to allow them another opportunity to amend the complaint.  The Delaware Bankruptcy Court, like other courts across the U.S., takes a hard look at allegations of fraud, and requires them to comply with the elevated pleading standard of Fed. R. Civ. P. 9(b).  Counsel looking to defeat a motion to dismiss may want to consider having a fresh set of eyes review complaints containing fraud allegations.  Ideally, this ‘fresh set of eyes’ will handle the review with no more background than the Judge would have, and with either no bias or with a bias towards dismissal.  This will help ensure that the complaint complies with the enhanced requirements of Fed. R. Civ. P. 9(b).  It is said that you can’t make any shot you don’t take — but you also can’t make any shot you take with 1/2 the force needed to reach the goal.

On August 2, 2016, Judge Brendan L. Shannon of the Delaware Bankruptcy Court issued an opinion (the “Opinion”) in the Refco Public Commodity Pool, L.P. bankruptcy, Case No. 14-11216.  A copy of the Opinion is available here.  The Opinion holds that this Debtor’s failure to file its taxes was due to reasonable cause, and the associated tax penalties are, therefor, claims that can be excused and disallowed.

Judge Shannon provides extensive background in this case, as the legal issues are highly fact specific and require him to adjudicate the debtor’s tax liability.  Opinion at *6.  The history of the debtor reads like a painful drama.  The partnership invested nearly everything into a managed futures fund (“SMFF”).  Then, SMFF failed, filing for bankruptcy in 2005.  At that point, SMFF’s financial reports and accounting system fell into disarray.  The debtor, claiming that they could not rely upon the financial reports of SMFF, failed to file tax returns for 2006-2008.  Opinion at *16.

The IRS filed a claim asserting a general unsecured claim of $4,112,000 for the fines incurred for failing to file tax returns.  Opinion at *5.  As provided by the Bankruptcy Code, the Court “may determine the amount or legality of any tax, any fine, or penalty relating to a tax…”  Opinion at *6.  According to the Internal Revenue Code, a taxpayer can obtain a waiver of penalties for failing to file a partnership return if the failure was “due to reasonable cause and not due to willful neglect.”  Opinion at *8.

Here, Judge Shannon held that the debtor’s failure to file its tax returns was reasonable and “arose from events beyond its control.”  Opinion at *12.  The debtor had two options in this instance, file tax returns it believed to be extremely inaccurate, or file no returns.  Because a filer must declare that its tax return is “true, correct, and complete” under penalty of perjury, the debtor was reasonable in not filing its return.  Opinion at *15-16.  Not only was it reasonable before failing to file, it was reasonable after failing.  Opinion at *17.  Both the IRS and the debtor agreed that this was not a case of willful neglect and Judge Shannon agreed.  Opinion at *17.

This is one of a few rare cases in which tax penalties were denied by the Bankruptcy Court.  And as a review of the Opinion shows, it is a highly fact specific inquiry and, if this case is any indicator, requires debtors to meet a high evidentiary burden.  I would recommend that anyone considering filing bankruptcy in an effort to avoid penalties for failing to file their taxes have a thorough discussion with a legal professional as this is a very risky proposition.

While many people only see the glamorous, large Chapter 11 cases filed in the Delaware Bankruptcy Court, the Court still handles individual bankruptcies – treating them with just as much respect as any other case.  On July 8, 2016, the chief bankruptcy judge, Brendan L. Shannon, issued an opinion valuing the mobile home of Ms. Anita Barnard.  A copy of the Opinion is available here.  This was a situation when the valuation methodology was agreed upon – yet there are still some judgment calls.

Case law in this jurisdiction teaches, that the NADA Retail Value Guidebook for Manufactured and Mobile Homes (“NADA”) method is the proper resource for mobile home valuations.  Opinion at *1.  The case law then requires that, for cram-down purposes, a formula is applied to determine the appropriate interest rate – Prime plus 1-3 percent.  While lenders will always aim for the top, the borrower will, naturally, aim for the lowest possible rate.  This is exactly what happened here.

While Judge Shannon does not provide extensive analysis of why he selected the rate he did, he ultimately held that “based on the record” the lower of the proposed rates was appropriate.  Opinion at *3.  I can’t help but wonder – if the lender had sought a more moderate rate, rather than going for the max, would they have received it?  This is likely a question that will never be answered, as what lender would voluntarily reduce their demand – and thus the perceived strength of their position.

In a 9-page opinion issued in the Syntax-Brillian case on May 11, 2016, Chief Judge Brendan L. Shannon lays out three principles of law that all litigants should know (if they don’t already).  A copy of the Opinion is available on the Court’s website: Here.  The Opinion was issued as a ruling on the motion of Alan Levine for relief from the order accepting the first-day-declaration of Gregory F. Rayburn.

As Judge Shannon provides in the Opinion, it appears that Mr. Levine filed his motion under the belief that if the first day declaration was found to be fraudulent, that all the relief provided in the bankruptcy case would be undone.  Opinion at *6.  This leads to lesson #1.  Judge Shannon quickly puts this misbelief to rest, stating “Striking or vacating the First Day Affidavit, even if ordered by this Court, will not affect or unwind these steps and transactions.”  Id.

Mr. Levine supports his motion by arguing that new evidence has come to light.  Judge Shannon recently denied a motion to dismiss an adversary complaint filed by the Liquidating Trustee, holding that he was required to treat all pleadings as true for the purpose of ruling on a motion to dismiss, including allegations of fraud.  Mr. Levine argued that this ruling was tantamount to the Court finding that there was fraud, which should result in the reversal of all orders which were entered in reliance on that fraud.  This leads to lesson #2.  Judge Shannon made clear the difference between a ruling on a motion to dismiss and one made after a full trial.  Opinion at *8.  “When the Court stated in the Rule 12(b) Decision that “it accepts as true” the allegations made in the Trustee’s complaint, it does not mean that the Trustee has conclusively proven such allegations.”  Id.

Mr. Levine also requested to be able to seek discovery.  The Liquidating Trustee argued vigorously against such relief, claiming that opening this door would create excessive costs for the Trust.  This brings us to our final lesson.  Judge Shannon held that because “there is no pending proceeding before this Court to which the Movant’s document request would relate” he would deny the request.  Opinion at *9

We can learn this lessons from others or experience them ourselves.  The former is far less costly.

On February 2, 2016, Hancock Fabrics, Inc. and 6 affiliates filed for relief under chapter 11 of the Bankruptcy Code.  The cases are jointly administered under Case Number 16-10296 and presided over by Judge Shannon.  The first day hearing was held on February 3, 2016.  The second day hearing is scheduled for February 22, 2016 at 1:00 p.m.

The majority of the information available about the Debtors comes from the Declaration of Dennis Lyons in Support of Chapter 11 Petitions and Request for First Day Relief (D.I. 4) (the “Declaration”).  On March 21, 2007, Hancock and its affiliates filed for bankruptcy for the first time.  Since that time, the Debtors have experienced a challenging business environment and have been burdened by significant legacy debt.  Declaration at *5.  The Debtors state that their intent in filing for bankruptcy is to “(i) gain access to liquidity, (ii) reduce pension and operational costs, (iii) realign its store locations and format and (iv) execute on one or more options to create value for stakeholders.”  Declaration at *6.  Pursuant with these goals, the Debtors have planned to undergo a very accelerated sales process, with a goal of having a final sale hearing on March 14, 2016.  Declaration at *7.

If you want to stay up-to-date on the filings in this case, I’d recommend you keep an eye on the website created by the claims and noticing agent, Kurtzman Carson Consultants LLC.  The website contains a copy of the bankruptcy docket, free to download and view.  The website is located at http://www.kccllc.net/hancockfabrics.  If you are a creditor of the Debtors, you may want to consider participating in the formation meeting, which has not yet been scheduled.  The formation meeting is the meeting at which the United States Trustee appoints a committee of unsecured creditors.  Being on the creditors’ committee is the best way for an unsecured creditor to stay involved in, and an active participant in, the bankruptcy proceedings.

On December 15, 2015, Judge Brendan L. Shannon of the Delaware Bankruptcy Court granted the motion of Hormel Foods (the “Defendant”) to dismiss a complaint filed by JLL Consultants, the Liquidating Trustee (the “Trustee”) in the AgFeed bankruptcy.  The “Opinion” is available here.

Judge Shannon’s opinion, and the dismissal of the complaint, arises entirely because of a previous settlement reached between Hormel and AgFeed.  Because the Trustee was the successor to AgFeed’s litigation rights vis-à-vis Hormel, any releases granted by AgFeed are considered to have been granted by the successor.  In this instance, AgFeed and Hormel had reached a settlement as a result of prior litigation that provided “for a complete and final settlement of all matters including all disputes between the parties accruing prior to the Effective Time of the settlement agreement.  Opinion at *8.  The settlement agreement also included a “Mutual Covenant Not to Sue”, wherein the parties “promised never to file a lawsuit asserting any claims that were released in Section 1 of the Settlement Agreement.”  Id.

Notably, the causes of action alleged in the complaint dismissed here arose prior to the settlement, as is apparent by the Trustee’s reliance upon a letter created by Hormel in 2010, almost three years prior to the execution of the settlement agreement.  As Judge Shannon noted, the Settlement Agreement “contains intentionally broad and extensive language” and was “negotiated by sophisticated and experienced parties who were represented by counsel.”  Opinion at *13-14.  Both of these facts led the Court to determine that litigation based on prior acts of the parties was broadly released, and all of the causes of action alleged were contemplated by the Settlement Agreement.  Opinion at *15-16.  He then ruled that the Settlement Agreement barred the causes of action alleged in the complaint, and granted the motion for dismissal.

My $.02

A broad release of “all known and unknown” causes of action may seem like a good idea, but parties should keep in mind that it really will be upheld by a court.  This creates a situation akin to insider trading – a party will know what it is being protected from, but it can’t ever be certain what causes of action it may be giving up.  So if you are considering entering a contract with this broad a release, make sure you have done your due diligence – not just of the company, but of its principals.  At the end of the day, it is their integrity that will determine the true cost of this type of release.