New York Law Review

Tag: bankruptcy law

  • In re Southeast Banking Corp., 93 N.Y.2d 178 (1999): The Rule of Explicitness in Subordination Agreements

    In re Southeast Banking Corp., 93 N.Y.2d 178 (1999)

    New York law requires specific language in a subordination agreement to alert a junior creditor to its assumption of the risk and burden of allowing the payment of a senior creditor’s post-petition interest demand, adhering to the Rule of Explicitness.

    Summary

    This case addresses whether New York law requires specific language in a subordination agreement to explicitly alert a junior creditor that they are assuming the risk of the senior creditor receiving post-petition interest. The New York Court of Appeals adopted the Rule of Explicitness, holding that subordination agreements must contain clear and specific language to subordinate a junior creditor’s interest to the senior creditor’s post-petition interest. The court emphasized the importance of reliance, definiteness, and predictability in commercial matters, noting that the Rule of Explicitness is a well-established principle that allows parties to intelligently negotiate their rights and duties.

    Facts

    Southeast Banking Corporation issued senior notes under a 1983 indenture with Chase Manhattan Bank (formerly Chemical Bank) as trustee, and Gabriel Capital, L.P. held a substantial portion. The indenture stipulated payment of principal and interest, including post-default interest. Southeast also issued subordinated notes under five indentures with First Trust of New York and Bank of New York as trustees. These subordinated indentures prioritized payment of senior notes in full before any payment to junior noteholders, particularly in bankruptcy scenarios. The subordinated indentures, however, were silent regarding post-petition interest.

    Procedural History

    Southeast filed for Chapter 7 bankruptcy in 1991. The Bankruptcy Court ordered distribution to the senior trustee for principal and pre-petition interest. The senior creditors sought post-petition interest from funds allocated to the junior noteholders, citing the subordination clauses. The Bankruptcy Court denied this claim, requiring explicit provisions for post-petition interest. The District Court affirmed, both relying on the Rule of Explicitness. The Eleventh Circuit reversed, questioning the Rule’s validity post-1978 Bankruptcy Code revisions and certified the question of New York law to the New York Court of Appeals.

    Issue(s)

    Whether New York law requires specific language in a subordination agreement to alert a junior creditor to its assumption of the risk and burden of allowing the payment of a senior creditor’s post-petition interest demand.

    Holding

    Yes, because New York law, in accordance with the Rule of Explicitness, requires specific language in a subordination agreement to alert a junior creditor to its assumption of the risk and burden of allowing the payment of a senior creditor’s post-petition interest demand.

    Court’s Reasoning

    The Court of Appeals adopted the Rule of Explicitness, emphasizing the importance of predictability and reliance in commercial law. The court noted the general bankruptcy rule disallowing post-petition interest, stemming from the principle that delays caused by law should not benefit or harm creditors disproportionately. The court reasoned that allowing senior creditors to recover post-petition interest from subordinated creditors could lead to inequitable outcomes, violating the general rule against such interest. Citing Matter of Pavone Textile Corp., the court analogized the situation to cases where express statutory language is required to supersede general rules regarding interest. The court observed that subordination agreements were often drafted with the Rule of Explicitness in mind and departing from it would disrupt established expectations in the financial markets. The court stated, “the general rule as to post-assignment interest prevails in the absence of any statute expressly providing for such interest.” They further noted, “Parties to subordination agreements undoubtedly relied on the Rule—their lawyers would have been quite remiss had they not—since recent case law, as well as a leading authority and many commentators have consistently recognized the continued vitality of the Rule”.

  • Marine Midland Bank v. Scallen, 73 N.Y.2d 1044 (1989): Effect of Bankruptcy Discharge on Judgment Liens

    Marine Midland Bank v. Scallen, 73 N.Y.2d 1044 (1989)

    A discharge in bankruptcy does not automatically invalidate a pre-existing judgment lien on real property; the debtor must take affirmative steps in the bankruptcy proceeding to avoid the lien.

    Summary

    This case addresses whether a discharge in bankruptcy automatically removes a judgment lien from real property. The plaintiff, discharged from personal liability for pre-existing debts in bankruptcy court, sought an unqualified discharge of a judgment against him held by the defendant bank. The bank cross-moved for a qualified discharge, arguing the judgment was a lien on the plaintiff’s real property. The New York Court of Appeals held that a discharge in bankruptcy only releases the debtor from personal liability; it does not automatically invalidate pre-existing liens. The debtor bears the burden of proving the lien was invalidated during bankruptcy proceedings. Because the debtor failed to demonstrate the lien was avoided, he was only entitled to a qualified discharge, which acknowledges the potential continued existence of the lien.

    Facts

    • Marine Midland Bank held a judgment against Scallen, which constituted a lien on Scallen’s real property.
    • Scallen obtained a discharge in bankruptcy, releasing him from personal liability for pre-existing debts.
    • Scallen then sought an unqualified discharge of the judgment held by Marine Midland Bank under New York Debtor and Creditor Law § 150.
    • Marine Midland Bank opposed the unqualified discharge, arguing that the judgment was a lien on Scallen’s real property and that the lien survived the bankruptcy discharge.

    Procedural History

    • Scallen commenced an action in Supreme Court for an order directing that a discharge be marked on the docket of the judgment.
    • Marine Midland Bank cross-moved to dismiss the cause of action or, alternatively, to grant Scallen only a qualified discharge.
    • The Supreme Court granted Scallen an unqualified discharge.
    • The Appellate Division affirmed the Supreme Court’s order.
    • The New York Court of Appeals modified the Appellate Division’s order, directing a qualified discharge instead of an unqualified discharge.

    Issue(s)

    1. Whether a discharge in bankruptcy automatically invalidates a pre-existing judgment lien on real property.
    2. Whether the debtor bears the burden of proving that a pre-existing judgment lien was invalidated during the bankruptcy proceedings to obtain an unqualified discharge.

    Holding

    1. No, because liens and other similar secured interests ordinarily survive bankruptcy.
    2. Yes, because Debtor and Creditor Law § 150 (4)(h) requires the debtor to establish to the court’s satisfaction that the lien was invalidated or surrendered in the bankruptcy proceedings.

    Court’s Reasoning

    The Court of Appeals reasoned that a discharge in bankruptcy only releases the debtor from personal liability for debts; it does not automatically extinguish valid liens. The Court relied on established bankruptcy law principles, citing Farrey v. Sanderfoot and Long v. Bullard, which affirm the survival of liens through bankruptcy. The Court emphasized that under Debtor and Creditor Law § 150 (4) (h), the debtor seeking an unqualified discharge bears the burden of proving that the lien was invalidated or surrendered during the bankruptcy proceedings. The Court noted that the debtor’s reliance on the bankruptcy discharge itself and the homestead exemption was insufficient to meet this burden. The homestead exemption, while protecting a certain amount of equity, does not automatically extinguish liens. The court stated, “[I]n the absence of a timely objection from defendant or some other interested third party, plaintiff’s claim for an exemption would be deemed valid without more… However, plaintiff’s successful invocation of the homestead exemption did not automatically extinguish defendant’s lien against the property.” To avoid a lien on exempt property, the debtor must take affirmative steps under section 522(f)(1) of the Bankruptcy Code, which Scallen failed to do. Because Scallen did not demonstrate that the lien was invalidated during the bankruptcy proceedings, he was only entitled to a qualified discharge, serving as notice that the property might still be subject to the lien.

  • Dynamics Corp. of America v. Marine Midland Bank, 69 N.Y.2d 191 (1987): Debtor’s Duty to Disclose Claims in Bankruptcy

    69 N.Y.2d 191 (1987)

    A debtor-in-possession in a Chapter XI bankruptcy proceeding has a duty to disclose all known or knowable claims in its schedules of assets, and failure to do so precludes the debtor from pursuing those claims individually after the bankruptcy proceeding concludes, unless the claims were properly “dealt with” or abandoned during the bankruptcy.

    Summary

    Dynamics Corporation of America (DCA) sued Marine Midland Bank (Marine) for damages, alleging misconduct that led to DCA’s bankruptcy. DCA had previously undergone a Chapter XI bankruptcy proceeding where it didn’t disclose these claims against Marine. The court held that because DCA failed to list these claims as assets in its bankruptcy schedules, it could not pursue them individually after the bankruptcy concluded. The court reasoned that a debtor-in-possession has a duty to disclose all potential claims so they can be administered for the benefit of creditors.

    Facts

    DCA and Marine had a long-standing banking relationship. In August 1972, DCA initiated Chapter XI bankruptcy proceedings. Marine was a major creditor. In July 1975, DCA sued Marine for $70 million, alleging Marine conspired to destroy DCA’s business beginning in 1970. DCA claimed Marine made misrepresentations about loan renewals, leading DCA to forgo seeking other financing. DCA further alleged that Marine improperly offset DCA’s checking account and seized uncollected checks, forcing DCA into bankruptcy.

    Procedural History

    The Supreme Court, New York County, granted Marine’s motion for summary judgment, dismissing DCA’s complaint. The court relied on the principle that a discharged Chapter XI debtor cannot pursue claims it failed to include in its bankruptcy schedule. The Appellate Division affirmed. The New York Court of Appeals granted leave to appeal.

    Issue(s)

    Whether a debtor, after confirmation of a Chapter XI plan of arrangement, can pursue claims against a creditor that were not disclosed in the debtor’s schedules filed with the bankruptcy court.

    Holding

    No, because the debtor-in-possession has a duty to disclose all known or knowable claims in its schedules of assets, and failure to do so precludes the debtor from pursuing those claims individually after the bankruptcy proceeding concludes, unless the claims were properly “dealt with” or abandoned during the bankruptcy.

    Court’s Reasoning

    The Court emphasized the importance of disclosure in Chapter XI proceedings, where debtors-in-possession have a fiduciary duty to their creditors. The court stated that the requirement of disclosure includes “[u]nliquidated claims of every nature, with their estimated value.” The court reasoned that the only property that may revest in the debtor is property that was “dealt with” in the bankruptcy or abandoned. Property is “dealt with” when it has been listed in the debtor’s schedule of assets, administered by the bankruptcy court for the benefit of creditors, and not otherwise affected by the ultimate plan of arrangement involving the debtor’s other assets. Property can be considered abandoned only if the trustee or debtor-in-possession knows of it and manifests an intent to abandon it. Since DCA’s claims against Marine were not disclosed in its schedules, they were not “dealt with” in the bankruptcy and did not revest in DCA after the proceeding. The court found DCA’s argument that it didn’t learn of its fraud or improper offset causes of action until after the Chapter XI proceeding ended to be unpersuasive, holding that DCA presented no evidentiary material sufficient to raise a triable issue of fact. The court quoted Stein v United Artists Corp. in noting that without a rule precluding such a debtor from later pursuing claims about which it knew or should have known at the time of filing its petition, a debtor-in-possession might employ less than diligent efforts to ascertain and disclose all potential claims, thus undermining its obligation to the estate and prejudicing the interests of the unsecured creditors.