Posts Tagged ‘Bankruptcy’

9th Circuit partially rejects attorney fee award in automatic stay claim

Thursday, November 19th, 2009

An October 22, 2009 by the 9th Circuit Court of Appeals upsets the understanding that a debtor in bankruptcy who pursues an adverary proceedings claim against a creditor who violated the automatic stay may be awarded costs and attorneys’ fees. The case is
Sternberg v. Johnston

In 1997, the Bankruptcy Appellate Panel of the 9th Circuit had approved a claim for attorneys’ fees asserted by a successful debtor in the prosecution of an appeal of a stay violation. In re Walsh, 208 B.R. 949, affirmed 219 B.R. 873 (Bkrtcy.N.D. Cal.1997). This led most bankruptcy practitioners to conclude that attorney fees for prosecution of a violation of the stay were allowed under 11 USC section362(k)(1) which states in part:

an individual injured by any willful violation of a stay . . . shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.

In Sternberg, the 9th Circuit interpreted this language as meaning that the debtor could only recover attorneys’ fees incurred in defending against an act resulting from a violation of the automatic stay, not in prosecuting a claim against the violating creditor. The 9th Circuit acknowledged that its interpretation was at odds with the 5th Circuit, but decided that if Congress intended to abrogate the “American Rule” (the common law rule that each party bears its own costs and attorneys’ fees absent agreement or statute), it would have done so more explicitly. It seemed to reason that the phrase “actual damages and attorneys’ fees” means only “actual damages, including attorneys’ fees spent defending a wrongful action.”

This is an odd interpretation of what one would expect from plain statutory language. But the 9th Circuit invoked the US Supreme Court case Fogerrty v. Fantaxy, Inc., 510 US 517 (1994) in support. (As an aside, this was John Fogerty of Creedance Clearwater fame.) Fogerty involved a defendant’s claim for attorneys’ fees against a plaintiff after he successfully defended against a copyright lawsuit. The statute in question gave the District Court discretion to award attorneys’ fees, but did not require it. The Supreme Court held that, because the copyright statute stated that the court “may” award attorneys’ fees, it was not required to.

The obvious problem jumps out. Section362(k)(1) states that attorneys’ fees “shall” be awarded. The 9th Circuit did not discuss this distinction.

Nevertheless, right now in the 9th Circuit it looks like there is no authority for asking for attorneys’ fees in a prosecution for violation of relief from stay.

The other issue in Sternberg was whether a lawyer representing a divorced wife pursuing delinquent support willfully violated the automatic stay by defending her claim in state court proceedings after the bankruptcy petition had been filed. The 9th Circuit said yes, restating the affirmative duty of creditors to essentially undo state proceedings to the extent that such proceedings impair a bankrupt debtor’s estate.

Contractor’s liens on projects that go bankrupt in Washington

Wednesday, November 11th, 2009

Contractors, engineers, architects, suppliers and other construction businesses face a potentially bad situation when the owners of a project they were working for go bankrupt. In the State of Washington, these people generally have a right to file a lien upon the property to secure payment for the services or materials they provided to improve the property.

But what to do if the owner goes bankrupt before the construction provider was able to establish a lien?

In bankruptcy, the general rule is that a creditor cannot do anything to further a claim against the entity going bankrupt during the period of the “automatic stay.” Section 362 of the bankruptcy code imposes this automatic stay, “applicable to all entities,” upon filing of a bankruptcy petition. In most cases, a creditor must file a motion with the bankruptcy court requesting “relief from stay,” and the request must be supported by facts showing specific reasons why the creditor should be able to get such relief ahead of other creditors.

But section 362 provides exceptions. 362(b) allows an exception for:

any act to perfect, or to maintain or continue the perfection of, an interest in property to the extent that the trustee’s rights and powers are subject to such perfection under section 546(b) of this title or to the extent that such act is accomplished within the period provided under section 547(e)(2)(A) of this title.

OK, maybe that is not helpful yet. Looking at section 546(b) we see that the powers of a trustee

are subject to any generally applicable law that—(A) permits perfection of an interest in property to be effective against an entity that acquires rights in such property before the date of perfection. . . . such interest in such property shall be perfected, or perfection of such interest shall be maintained or continued, by giving notice with the time fixed by such law for such seizure or such commencement.

Putting 362(b) and 546(b) together, we see that the automatic stay does not apply to perfecting an interest against property if there is a general law allowing it.

Washington has such a law, RCW 60.04, which allows contractors and suppliers to place a lien upon property that they have worked on or provided supplies to. The statute has specific requirements that I won’t go into here, but generally, you must record your lien (called generally a “mechanic’s lien”) in the county of the property within 90 days of completion of services. (Note, there are other wrinkles for property owned by someone for whom you did not contract with—I am simplifying things).

After recording, in order to maintain your claim, you generally must file a lawsuit on the claim within 8 months of recording. In Washington, this period is tolled during a bankruptcy.

Keep in mind that the automatic stay prohibits you from filing a lawsuit to enforce your lien rights. But the bankruptcy code allows you to record your claim of lien in the 90 day period. And section 546(b) requires that you give notice in the bankruptcy court during the 8 month period after recording.

Summary: If you are a contractor who has not been paid for work on a project that has gone bankrupt, consider whether you have time to record a lien for your work or supplies. Once you have done that, be sure to file with the bankruptcy court a notice that you intend to pursue your claim. It also is a good idea to request the court to provide you special notice of all proceedings so that you can determine when the case is finished. It would be a shame for you to go to this trouble and find that the case was dismissed without you knowing, and the 8 month period for enforcement has lapsed.


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Cancellation of debt income.

Wednesday, October 28th, 2009

 Many people do not realize that if they negotiate with a creditor to reduce the debt they owe, they might be imputed income for the amount of the reduction.

In other words, if you have a debt you cannot pay, and the creditor writes it off, you might receive a 1099 stating that you have income in the amount of the forgiven debt.

This gets reported to the IRS, and, if an exception does not apply, it will expect you to pay taxes on it. 

There are exceptions, though, and in many cases these exceptions are helpful.  For instance, discharge in bankruptcy is not taxable. 

In addition, forgiven debts on principal residence are, in many cases, not taxable.  The Mortgage Debt Relief Act of 2007 allows $2 million of forgiven debt on a qualified principal residence ($1 million if married filing separately). 

Also, if you were insolvent at the time of debt forgiveness, the amount is not taxable.  Being insolvent means that your total debts exceed your total assets.  This calculation can become complicated by the fact that you may recognize a reportable capital gain even if you are insolvent.  The IRS provides worksheets to calculate insolvency.

When attempting to work out debt reduction, if the amounts are substantial, it is a good idea to have a tax professional review the proposed plan prior to making it final.  Strategic planning can often minimize the tax bite.

Some additional information from the IRS:,,id=179414,00.html