Recent Decisions from the First Circuit regarding Bankruptcy

Preference payments recovered where corporate funds used to pay personal creditor cards “mere conduit” and “earmarking” defenses fails:

WISCOVITCH-RENTAS v. SANTA (IN RE: LASER REALTY, INC.), 2011 Bankr. LEXIS 2281 (Bankr. D.P.R. 6/7/11).

JUDGE:   Enrique S. Lamoutte, Bankruptcy Judge.

PRIOR HISTORY: Wiscovitch Rentas v. Marti Santa (In re Laser Realty, Inc.), 2009 Bankr. LEXIS 3939 (Bankr. D.P.R., Nov. 18, 2009)

PROCEDURAL POSTURE: Plaintiff, the chapter 7 trustee, brought an adversary action to avoid and recover alleged fraudulent transfers made by the principal of debtor corporation to defendant transferees, pursuant to 11 U.S.C.S. §§ 548(a) and 550.
OVERVIEW: The trustee sought to recover 22 transfers in the total amount of $128,947.28 that were made within a year preceding the filing of the bankruptcy petition, while the debtor was insolvent, and for which the debtor did not receive anything of value. The payments were made to the transferees' credit card accounts. The transferees claimed the payments were not made from property of the estate and that debtor was a mere conduit for the payments, or that the payments were earmarked funds. The court rejected both of those defenses. The principal had used corporate funds, received from a lessee, to pay his own personal liability to the transferees for the purchase of stock in a related corporation. Although the principal had represented that the funds were his, the checks were written out of the debtor's checking account. The debtor had been vested with the dominion and control of the funds pursuant to law. P.R. Laws Ann. tit. 31, § 1111 and 1114.  The funds against which Laser made the checks or transfers to Mr. Venancio Marti Santa were in a checking account under the dominion and control of Laser. The fact that Laser's principal, Mr. Antonio Fernandez, used these funds for his personal benefit does not divest Laser of the legal right to the same. In re Anton Noll, Inc., 277 B.R. 878-881. Therefore, Laser was not a mere conduit of the funds deposited in its checking account. It had dominion and control of the funds, even when its principal determined how they would be used, including paying his personal debts, as the one incurred with Mr. Marti Santa.

The debtor (Laser) exercised control over the funds disposition, and was not a mere conduit. In re Reale, 393 B.R. 827.  The  facts of this case are in sharp contrast with the facts before this court in In re Net Velazquez, 397 B.R. 231 (Bankr. D. P.R. 2008). In In re Net the debtor never transferred or negotiated a check in favor of a corporation he owned. The check was drawn in debtor's name and was never indorsed in favor of the corporation. "The debtor merely cashed the check by simultaneously depositing it in the company's account." In re Net Velazquez, 397 B.R. 239. The debtor in In re Net was a conduit because it " did not have any rights in, or control and dominion of the check or the funds." The conduit was a dormant paper corporation. In this case the debtor as lessee received payments from related corporations and deposited them in a checking account over which it had legal dominion and control. Once the lease payments were deposited in Laser's checking account, Laser was vested with the dominion and control necessary to claim ownership under Puerto Rico law. 31 L.P.R.A. §§ 1111 and 1114.

Earmarking Doctrine:  Closely related to the conduit defense is the earmarking doctrine. Earmarked funds pass through a conduit for payment to a creditor. If the debtor exercises no control over the disposition of the earmarked funds, the funds do not become property of the estate, and there is no transfer of an interest in property of the debtor as required by section 548. As this court held in In re Net Velazquez:   In a classic "earmarking" situation, an old creditor is substituted for a new creditor that lends or advances funds to the debtor on the specific condition that said funds shall be used to pay off the old creditor. " In such circumstances, the debtor functions as a 'mere conduit' and exercises no control over the funds' disposition." Such a transaction merely replaces one creditor for another without any effect on distributions to other creditors. The debtor never becomes the owner of the funds which are momentarily placed in its hands (the debtor acts as a kind of bailee). . . . This approach "leaves the estate no worse off than it would have been if the [new creditor] had advanced nothing to the debtor but paid off the debt directly.
OUTCOME: The trustee recovered the amount of $128,947.28 from the transferees.
 

Debtors’ failure to respond to admissions was excused, and such failure will not then support the adversary’s summary judgment motion:

SCOTIABANK DE PUERTO RICO V. PR ACQUISITONS, LLC (IN RE DIAZ), 2011 Bankr. LEXIS 2367 (D.P.R. 6/13/11).

JUDGE:  Brian K. Tester, Bankruptcy Judge.

OUTCOME:  Summary Judgment denied. 
Because permitting the withdrawal of the admission will facilitate resolution of the dispute on the merits, and because the Movant has not alleged any substantial difficulty in obtaining evidence necessary to prove the veracity of the admission, the Movant's Motion for Summary Judgment [Dkt. No. 34] is hereby DENIED.

OVERVIEW:  On August 22, 2009, Edil Quinonez Vélez and Ernestina González Díaz ("Debtors") filed a voluntary Chapter 13 petition. They allegedly received a letter seeking to collect a pre-petition debt owed to the Movant and Co-Movant. On September 17, 2010, Debtors filed an adversary complaint alleging that the collection letter violated the automatic stay provision under 11 U.S.C. § 362.

On January 13, 2011, the Movant filed a Motion for Summary Judgment (amended the same day), and on January 24, 2011, Co-Movant motioned to join in that motion. Movant alleges that the request for Debtors' admission that no damages were suffered as a result of the violation is now deemed admitted, since Debtors failed to respond to the Movant's Request for Admissions within the requisite thirty days. Debtors respond that the Court should permit withdrawal or amendment of the alleged admission because (1) Debtors have engaged in settlement discussions with the Movant during the relevant time period; (2) they have health issues which have been exacerbated by the stress of the violation; and (3) allowing amendment or withdrawal would promote presentation of the merits of the action pursuant to Fed. R. Civ. P. 36(b).  The Court has the discretion to permit amendment or withdrawal of an admission. A matter admitted under this rule is conclusively established unless the court, on motion, permits the admission to be withdrawn or amended. Fed. R. Civ. P. 36(b). In determining whether or not to permit withdrawal or amendment of a statement admitted by failure to respond to a request for admissions, the court considers: (1) whether the presentation of the merits of the action will be subserved thereby and (2) whether the party who obtained the admission will be prejudiced in maintaining the action or defense on the merits if the admission is withdrawn. As to the first factor, the Debtors in this action did not voluntarily admit that there were no damages suffered as a result of the collection letter; in fact, their position is just the opposite. They assert that this violation exacerbated their existing health problems. Therefore, the Court finds that permitting withdrawal of the admission would facilitate resolution of the dispute on its merits, i.e., whether or not the Debtors suffered damages due to the alleged § 362 violation. The second factor looks to "the difficulty a party may face in proving its case . . . because of the sudden need to obtain evidence with respect to the questions previously answered by the admissions." The Movant has not alleged any such difficulty in obtaining evidence necessary to establish the veracity of the alleged admission. Thus, this Court finds that they would not be prejudiced by a withdrawal or amendment of the alleged admission.

Dismissal denied as factual allegation sufficient to support a claim; impleader proper where same set of core facts and it promotes judicial economy:

MEDICAL EDUCATIONAL AND HEALTH SERVICES, INC. V. INDEPENDENT MUNICIPALITY OF MAYAGUEZ, ET ALS., (IN RE: MEDICAL EDUCATIONAL AND HEALTH SERVICES, INC.),

2011 Bankr. LEXIS 2280 (D.P.R. 6/7/11).

JUDGE:  Brian K. Tester, Bankruptcy Judge.

OVERVIEW: In ad adversary proceeding for breach of contract brought by the debtor, the third-party plaintiff filed a third-party complaint against a defendant corporate officer for breach of fiduciary duty, for which he moved to dismiss for failure to state claim.

OUTCOME:  Motion to dismiss denied. It was plausible from the factual allegations that he breached a fiduciary duty.  The secondary issue, regarding impleader was that it was proper since the parties shared core facts from the plaintiff’s claim and it served judicial economy to do so.

Recoupment cannot be used to obtain affirmative relief, thus a time barred rescission claim will not succeed:

JOHN A. KELLY v. DEUTSCHE BANK NATIONAL TRUST COMPANY, 2011 U.S. Dist. LEXIS 61983 (D. Mass. 6/9/11).

OVERVIEW: Plaintiff borrower sought to prevent the foreclosure of his home by rescinding the underlying mortgage. The court held that plaintiff's claim for rescission by way of recoupment was time-barred under Mass. Gen. Laws ch. 140D, § 10(f) because plaintiff did not attempt to invoke the right to rescind until more than four years after the loan transaction was consummated and plaintiff could not use recoupment to obtain affirmative relief. Under Mass. Gen. Laws ch. 244, § 14, even if defendant bank did not hold the underlying note, defendant could initiate a foreclosure because it held the mortgage.
OUTCOME: The court allowed defendant's motion to dismiss.

JUDGE:  Richard G. Stearns, District Judge.