December 6, 2011

Charlene Hicks, Senior Attorney, National Legal Research Group

In a civil lawsuit against a close corporation, it is relatively common for the plaintiff to allege that the corporate veil should be pierced and the corporate officers or shareholders be held personally liable for the corporation's wrongful actions.  If the corporation files a bankruptcy petition in the midst of the proceedings, the civil action against it is automatically stayed pursuant to 11 U.S.C. § 362(a).  The question then arises as to whether the automatic stay in bankruptcy extends to the alter ego claims against the corporate officers or shareholders.

Generally speaking, the automatic stay provided by § 362(a) does not extend to third parties such as officers of the debtor corporation.  However, courts have carved out certain important exceptions to this general rule.  Because state law determines whether a specific claim belongs to the bankruptcy estate or to an individual creditor, these exceptions are not uniformly recognized but, rather, vary from state to state.

In a recent illustrative case, Shaoxing County Huayue Import & Export v. Bhaumik, 120 Cal. Rptr. 3d 303 (Ct. App. 2011), the California Court of Appeal addressed the effect of a corporation's bankruptcy filing upon a creditor's alter ego claims against an individual who controlled the corporation's business operations.  In that case, a corporate creditor filed a state court complaint for breach of contract against both the corporation and the company's general manager.  In regard to the manager, the creditor alleged that the corporate veil should be pierced because the manager was responsible for the corporation's actions and he used the company as a device to "avoid individual liability and for purposes of substituting a financially insolvent entity in place of himself."  Id. at 306.  After suit had been commenced, the corporation filed a Chapter 7 bankruptcy petition, and the creditor voluntarily dismissed the corporation from the action.  The manager then moved for a stay, arguing that the creditor's alter ego claims belonged to the bankruptcy estate and that the bankruptcy trustee had exclusive standing to pursue the action against him.

In addressing this issue, the court acknowledged that the line separating claims of the debtor, which the bankruptcy trustee has exclusive standing to assert, and claims of an individual creditor against a third party is not always clear.  To determine the nature of the claim, the focus of the inquiry must be on whether the injury to be redressed is one that was suffered by the debtor corporation.  Id. at 309.  If the corporation has not sustained an injury but, rather, the creditor alone has been injured by the alleged conduct, then the claim does not belong to the bankruptcy estate and, by extension, the bankruptcy trustee.  Id.

The Lawletter Vol 36 No 4

Jim Witt, Senior Attorney, National Legal Research Group

In McPherson v. McPherson, 705 S.E.2d 314 (Ga. Ct. App. 2011), the Court of Appeals of Georgia reviewed the law governing the extent of a trustee's discretion that has been bestowed upon him or her by the trust instrument as to making distributions from the trust.  The case shows that even where a trustee is given broad discretion, complications can arise in the analysis of whether the trustee has abused that discretion.

The settlor, Howard E. McPherson, had four adult children from his first marriage at the time he established the trust:  Scott, Lisa, Robin, and Eric.  Howard later remarried and had an additional child, also named Howard.  The trust provided that during Howard senior's lifetime,

[t]he Trustee shall . . . have the discretion to pay out of income, if any, or principal or both of this trust such amount or amounts, whether equal or unequal and whether the whole or a lesser amount,  to  the  Trustor's  children . . . as may be needed for their support, maintenance, education and medical needs in reasonable comfort, taking into consideration any other means of support they or any of them may have to the knowledge of the Trustee.

Id. at 316 (court's emphasis).

Scott was named as trustee.  In 1992, Scott consented to the addition of his three adult siblings as cotrustees.  From 1992 until his removal as a cotrustee, Eric received his equal share of distributions from the trust in accordance with the settlor's direction that the children be treated equally.

In June 2004, Howard warned Eric that he was considering removing Eric as a cotrustee because of his difficult behavior, including refusing to sign legal documents after having verbally promised to do so, placing his girlfriend on the company payroll, and threatening to sue his siblings.  Soon thereafter, Eric sued his siblings for the first time.  In March 2005, Howard removed Eric as cotrustee and replaced him with Howard's lawyer.

In July 2005, the trustees elected to distribute $300,000 of trust income per stirpes to each McPherson child.  However, $50,000 of Eric's share was given to subtrusts created for the benefit of his children; the trustees' motive for this was to create additional resources for Eric's children, given his attempt, by means of a false affidavit, to reduce his child support payments.  As to the remaining $250,000 due Eric, the trustees directed that $157,000 be deducted to account for the expense incurred by the trust in defending against Eric's first suit.  Eric therefore received a check for $93,000, which he negotiated without objection.

Eric brought an amended version of his subsequent action, started in July 2006, in July 2009, alleging that the trustees' distributions from 2005 through 2008, and in particular their 2005 withholding of the $157,000 spent on the defense against his suit, had violated their fiduciary duties under the trust. Both sides moved for summary judgment.  The trial court granted the trustees' motion and denied Eric's.  On the appeal, Eric argued that the trustees had abused their discretion in failing to consider the needs of each of Howard's children, including the minor Howard, who was still living at home with his father.

The Lawletter Vol 36 No 4

Tim Snider, Senior Attorney, National Legal Research Group

The Supreme Court recently rendered a decision that may rival the impact of Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982), which had declared aspects of the then newly enacted Bankruptcy Code unconstitutional.  In Stern v. Marshall, 131 S. Ct. 2594 (2011), the notorious Anna Nicole Smith ("Vickie") had married tycoon J. Howard Marshall II, Pierce Marshall's father, approximately one year before the former's death.  Shortly before J. Howard died, Vickie had filed a suit against Pierce in Texas state court, asserting that J. Howard had meant to provide for Vickie through a trust and that Pierce had tortiously interfered with that gift.  After J. Howard died, Vickie filed for bankruptcy in federal court.  Pierce filed a proof of claim in that proceeding, asserting that he should be able to recover damages from Vickie's bankruptcy estate because Vickie had defamed him by inducing her lawyers to tell the press that he had engaged in fraud in controlling his father's assets.  Vickie responded by filing a counterclaim for tortious interference with the gift she had expected from J. Howard.

The bankruptcy court granted Vickie's motion for summary judgment on the defamation claim and eventually awarded her hundreds of millions of dollars in damages on her counterclaim.  Pierce objected that the bankruptcy court lacked jurisdiction to enter a final judgment on that counterclaim because it was not a "core proceeding" as defined by 28 U.S.C. § 157(b)(2)(C).  As set forth in § 157(a), Congress has divided bankruptcy proceedings into three categories:  those that "aris[e] under title 11"; those that "aris[e] in" a Title 11 case; and those that are "related to a case under title 11."  District courts may refer all such proceedings to the bankruptcy judges of their district, 28 U.S.C. § 157(a), and bankruptcy courts may enter final judgments in "all core proceedings arising under title 11, or arising in a case under title 11," id. § 157(b)(1).  In noncore proceedings, by contrast, a bankruptcy judge may only "submit proposed findings of fact and conclusions of law to the district court."  Id. § 157(c)(1).  Section 157(b)(2) lists 16 categories of core proceedings, including "counterclaims by the estate against persons filing claims against the estate."  Id. § 157(b)(2)(C).

The bankruptcy court held that the counterclaim was a core proceeding, but the district court reversed, concluding that to hold all counterclaims to be core proceedings would be unconstitutional under Northern Pipeline.  The court of appeals vacated the district court's judgment, concluding that because the subject matter of the counterclaim was not so closely related to the underlying core proceeding, the bankruptcy court should not have entertained it but instead should have given the Texas state court judgment preclusive effect.  The Supreme Court affirmed, but on different grounds.  The Chief Justice, writing for a 5-4 majority, concluded that while § 157(b)(2)(C) permitted the bankruptcy court to entertain the counterclaim, Article III of the Constitution does not.

November 22, 2011

Brett Turner, Senior Attorney, National Legal Research Group

A recent Virginia Supreme Court decision clarifies the law on classification of stock options.  In Schuman v. Schuman, Record No. 100967, 2011 WL 5325292 (Va. Nov. 4, 2011), the wife received stock options during the marriage.  The options did not vest until after the marriage was over.  The trial court held that the stock options were entirely the wife's separate property.  The court of appeals affirmed, holding that the options had not been acquired during the marriage, because they did not vest until after the marriage was over.  Schuman v. Schuman, Nos. 0631‑09‑4, 1259‑09‑4, and 1260‑09‑4, 2010 WL 1539955 (Va. Ct. App. Apr. 20, 2010) (unpublished).  The court's holding was consistent with prior authority, holding that stock options are acquired on the date of vesting.  Shiembob v. Shiembob, 55 Va. App. 234, 685 S.E.2d 192 (2009); Ranney v. Ranney, 45 Va. App. 17, 608 S.E.2d 485 (2005).

On further appeal, the Virginia Supreme Court reversed.  Virginia's equitable distribution statute provides that deferred compensation benefits, "whether vested or nonvested," can constitute marital property.  Va. Code Ann. § 20-107.3(G)(1).  If the court of appeals' position were correct, unvested options could never be marital property, because they would never vest until after the divorce.  "The inclusion of the phrase 'whether vested or nonvested' clearly indicates that the date of vesting is not, by itself, dispositive of whether the deferred compensation is marital or separate property."  Schuman, 2011 WL 5325292, at *2.

What, then, is the correct way to determine when stock options are acquired?  Section 20-107.3(G)(1) applies the same rules to both retirement benefits and deferred compensation benefits, such as stock options.  "[T]he legislature clearly intended for the delineated plans of compensation to be treated uniformly. Therefore, it is axiomatic that the marital share of deferred compensation should be calculated in the same manner as the marital share of pensions or other retirement benefits."  Id. at *3.

Virginia law is clear that retirement benefits are acquired when they are earned, not when they vest.  E.g., Dietz v. Dietz, 17 Va. App. 203, 436 S.E.2d 463 (1993).  Schuman applied the same rule to stock options.   "'[S]tock options, like retirement benefits, are acquired when they are earned, and not at the time of receipt, vesting or exercise.'"  Schuman, 2011 WL 5325292, at *2 (quoting 2 Brett R. Turner, Equitable Distribution of Property § 6:49, at 292 (3d ed. 2005)).  The marital interest is therefore a fraction, equal to the total time married during the earning period, divided by the total earning period.^[1]

The court did not determine the date of earning on the facts of Schuman, instead leaving that issue for the trial court on remand.  But Schuman adopted the general majority rule, so there is ample relevant authority from other states.

November 8, 2011

Jeremy Taylor, Senior Attorney, National Legal Research Group

The U.S. Supreme Court recently decided a case involving the issue of federal preemption of state law warning claims against manufacturers of the generic drug metoclopramide.  See Pliva, Inc. v. Mensing, 131 S. Ct. 2567 (2011).  The plaintiffs were users of the drug who filed state court actions alleging that their long-term use of metoclopramide had caused them to suffer tardive dyskinesia.  In the first case, the U.S. District Court for the Eastern District of Louisiana granted in part and denied in part the manufacturer's motion to dismiss, and the manufacturer appealed.  The U.S. Court of Appeals for the Fifth Circuit affirmed.  In the second case, the U.S. District Court for the District of Minnesota granted the manufacturers' motions for summary judgment, and the consumer appealed.  The U.S. Court of Appeals for the Eighth Circuit reversed in part.  The Supreme Court granted certiorari, and the cases were consolidated.  The Court ruled that federal law preempts state laws imposing a duty on generic drug manufacturers to change a drug's label.

Following approval by the Food and Drug Administration ("FDA") of the sale of metoclopramide under a brand name, generic manufacturers began producing the drug, which is used to treat digestive disorders.  The plaintiffs had been prescribed the brand-name drug but had received generic metoclopramide from their pharmacists.  After having used the drug for several years, both plaintiffs developed tardive dyskinesia, a severe neurological disorder.  They sued the manufacturers in state court for failing to provide adequate warnings of the dangers of the drug.  The manufacturers argued that federal statutes and the FDA regulations preempted the state products liability causes of action, and they asserted that because federal law required them to use the same safety and efficacy labeling as was used in their brand-name equivalents while state law required the use of a different label, it was therefore impossible for them simultaneously to comply with both federal law and state law.  The Court noted that evidence has mounted that metoclopramide can cause tardive dyskinesia.  As a result, warning labels for the drug have been strengthened and amended several times.  In 2004, the brand-name manufacturer requested, and the FDA approved, a label change to provide that therapy with the drug should not exceed 12 weeks.  In 2009, the warning was intensified to caution that treatment with the drug can cause tardive dyskinesia, an often irreversible movement disorder.

October 25, 2011

Steve Friedman, Senior Attorney, National Legal Research Group

Congress enacted the Real Estate Settlement Procedures Act ("RESPA") of 1974, 12 U.S.C. §§ 2601-2617, in response to the need for significant reforms in the residential real estate settlement process.  See RESPACReal Estate Settlement Procedures Act Home Page (last visited Oct. 12, 2011) ("[RESPA] insures that consumers throughout the nation are provided with more helpful information about the cost of the mortgage settlement and protected from unnecessarily high settlement charges caused by certain abusive practices.").

Indeed, the legislation expressly states that it is intended to, among other things, eliminate "kickbacks or referral fees that tend to increase unnecessarily the costs of certain settlement services."  12 U.S.C. § 2601(b)(2).  To that end, § 8(b) of RESPA provides as follows:  "No person shall give and no person shall accept any portion, split, or percentage of any charge made or received for the rendering of a real estate settlement service in connection with a transaction involving a federally related mortgage loan other than for services actually performed."  Id. § 2607(b).

The U.S. Department of Housing and Urban Development, the federal agency responsible for enforcing RESPA, has asserted that four types of overcharging schemes are prohibited by § 8(b):

1.         Fee splitting, where two or more persons split a fee, any portion of which is unearned;

2.         Mark-ups, where a service provider charges the borrower for services performed by a third party in excess of the cost of the services to the service provider but keeps the excess itself [without providing any additional goods or services];

3.         Undivided unearned fees, where a service provider charges the borrower a fee for which no correlative service is performed; and

4.         Overcharges, where a service provider charges the borrower for services actually performed but in excess of the service's reasonable value.

Freeman v. Quicken Loans, 626 F.3d 799, 802 (5th Cir. 2010) (citing RESPA Statement of Policy 2001-1, 66 Fed. Reg. 53,052 (Oct. 18, 2001)).

All U.S. Courts of Appeals that have addressed the issue agree that § 8(b) plainly prohibits the first and fourth types of schemes, fee splitting and overcharges.  See id. (citing cases).  However:

The circuits disagree on the remaining two types of fees: mark‑ups and undivided unearned fees.  The Fourth, Seventh, and Eighth Circuits have each held that RESPA § 8 is exclusively an anti‑kickback provision.  [See Boulware v. Crossland Mortg., 291 F.3d 261 (4th Cir. 2002); Krzalic v. Republic Title, 314 F.3d 875 (7th Cir. 2002); Haug v. Bank of Am., 317 F.3d 832 (8th Cir. 2003).]  Accordingly, RESPA ' 8(b) requires two culpable parties, a giver and a receiver of the unlawful fee, rendering mark‑ups by a sole services provider not actionable.  The Second, Third, and Eleventh Circuits have rejected the two‑party requirement and held that RESPA § 8(b) prohibits mark‑ups.  [See Kruse v. Wells Fargo Home Mortg., 383 F.3d 49 (2d Cir. 204); Santiago v. GMAC Mortg. Group, 417 F.3d 384 (3d Cir. 2005); Sosa v. Chase Manhattan Mortgage Corp., 348 F.3d 979 (11th Cir. 2003).]  Only the Second Circuit has explicitly addressed whether RESPA § 8(b) prohibits a sole provider's undivided unearned charges and found that it did.  Cohen v. JP Morgan Chase & Co., 498 F.3d 111 (2d Cir. 2007).  Presumably, the three circuits that require two culpable actors would not find undivided unearned charges actionable.