March 2017

Chapter 7 Policy Maker: How Creditors Can Benefit from Chapter 7 Proceedings

Creditors often refrain from actively participating in Chapter 7 bankruptcy proceedings. Jack O’Connor interviews his colleague, Michael Traison, who represented the creditors in a Chapter 7 case and was able to recoup a significant amount for the estate in a precedent-setting decision.



Attorneys can help their clients be lawmakers. It’s a lesson law students are taught in classrooms across the country, but in practice, it is often lost. In the case of In re Connolly North America, LLC,1 however, Michael Traison of Sugar Felsenthal Grais & Hammer paved new ground on behalf of not just his client, but creditors in general, in the context of realizing value from Chapter 7 bankruptcy proceedings and ensuring that proactive creditors are compensated for their efforts.

The Connolly Case

The case background in Connolly is filled with twists and turns. The debtor, Connolly North America, was a producer of leather goods. The company filed for Chapter 11 bankruptcy in the U.S. Bankruptcy Court for the Eastern District of Michigan. During the course of the proceedings, the case converted to a Chapter 7 liquidation.

During the Chapter 7 proceedings, a key source of recoveries for the creditors arose from litigation claims against Connolly’s former accounting firm. The originally-appointed Chapter 7 trustee (predecessor trustee) pursued these claims, but the bankruptcy court declared a mistrial due to the trustee and its counsel’s violations of discovery rules.

Following the mistrial, the litigation against the accounting firm was dismissed. Instead of pursuing these claims further on behalf of the creditors (which were likely to yield value to the debtor’s bankruptcy estate if properly pursued), the predecessor trustee sought to close the bankruptcy case.

Instead of sitting idly by and allowing the predecessor trustee to close the bankruptcy case, creditor Coface Argentina and Mediofactoring, represented by Traison, took on a proactive role.

Trustee Accused of Negligence

On July 17, 2009, Coface filed a motion (through Traison’s former firm, alongside special counsel) to remove the predecessor trustee. Coface asserted to the bankruptcy court that the debtor’s estate should not be closed and the Chapter 7 case should continue, because the estate held a number of valuable claims against the predecessor trustee and his law firm for gross negligence and mishandling of the litigation claims against the accounting firm.

The bankruptcy court granted Coface’s motion to remove the predecessor trustee, over the objection of the U.S. Trustee’s office, and a new trustee (the successor trustee) was appointed to replace him. The bankruptcy court further directed that a disinterested Chapter 7 panel trustee be appointed from another jurisdiction, the Northern District of Ohio, to ensure objectivity.

Immediately upon his appointment, the successor trustee employed special counsel to pursue the litigation claims against the predecessor trustee for gross negligence in handling the accounting firm litigation. All the while, Coface, through Traison and his firm, provided informal assistance to the successor trustee’s special counsel in an effort to ensure the litigation yielded funding for creditor recoveries. The litigation ultimately resulted in a significant settlement for the debtor’s estate.

Creditors Recover Expenses

Following the settlement, Coface filed a motion to allow, as an administrative expense in the Chapter 7 case, $164,336 in costs and fees associated with removing the predecessor trustee, and for its role in prosecuting and resolving the estate’s claims against the predecessor trustee. Coface argued that a creditor’s application for administrative expense status in a Chapter 7 case should be granted, under the bankruptcy court’s § 105(a), when the services performed have substantially benefited the estate, and assisted the successor trustee in the recovery of assets, even if the application does not fall within one of the enumerated categories set forth in § 503(b).

Although there were no objections by any creditor or other party, and although the successor trustee supported the request, the U.S. Trustee’s office opposed the motion, on the basis that § 503(b) of the Bankruptcy Code provided no specifically-enumerated basis to allow administrative expense claims in Chapter 7 proceedings. The bankruptcy court agreed and denied the motion. Coface appealed to the district court, which affirmed the bankruptcy court’s decision. Coface then appealed to the Sixth Circuit.

In an opinion filed on September 21, 2015, the Sixth Circuit reversed and remanded the district court’s decision, adopting an expansive reading of § 503(b)’s inclusive language, that allows for “bankruptcy courts to reimburse expenses not specifically mentioned in § 503(b)’s subsections.”2 The court ultimately struck down the U.S. Trustee’s and lower courts’ strict reading of the Bankruptcy Code, leaving the motion unopposed on remand to the bankruptcy court. And finally, in early 2016, the bankruptcy court entered an order granting the motion and allowing Coface its requested fees and expenses in the case as administrative expenses under § 503(b) by application of its equitable authority under § 105(a).

Traison Explains the Significance

So what are the ramifications of the Connolly decision? Should creditors view their role in Chapter 7 cases differently? After succeeding in his litigation, Traison shared a number of insights regarding the Connolly decision’s implications for the future.

“At the end of the day, the client was happy, and we managed to provide significant benefits to the stakeholders in the case. It’s particularly nice to be able to deliver a win for a client, while simultaneously building precedent,” he says.

But more than that, he views the decision as a signal to creditors that their participation in Chapter 7 liquidations should be encouraged and that attorneys representing creditors should view their role (as long as the client is willing to make the effort with them) as policymakers.
“As members of a profession that can directly influence how the courts make law, we have the opportunity and privilege of advocating for change to benefit individuals beyond just our individual clients,” Traison says.

Creditors Should Engage in Chapter 7

Traison expanded on the idea that decisions like this ought to fuel engagement by creditors in Chapter 7 liquidations across the board. “If [creditors] know that they may be able to recoup the cost of pursuing claims that can augment the value for all creditors, they are incentivized to participate more actively in the bankruptcy process. Creating an upside for creditors ought to enhance the bankruptcy process overall,” he says.
Traison’s victory before the Sixth Circuit Court of Appeals in the Connolly case also serves as a useful reminder to creditors’ rights attorneys that, when you put forth an effort on your client’s behalves, attorneys have the unique ability to help clients shape policy, build precedent and be agents of change on an individual and much broader basis.

Footnotes

  1. 802 F.3d 810 (6th Cir. 2015).
  2. In re Connolly North America, LLC, 802 F.3d 810, 817 (6th Cir. 2015).