The Investors’ Control of Their Investment Advisers. Who Has the Final Word?

TAMAR FRANKEL

BU Law emerita professor Tamar Frankel discusses an emerging issue affecting financial advisers—when a client may exercise control over the actions of the adviser. Frankel relates the story of an investment adviser that did not follow the client’s orders to cease certain investments, at a cost of almost $5 million to the client. As Frankel explains, the Securities and Exchange Commission (SEC) got involved, resulting in the investment adviser’s settlement for a significant payment to the client and other conditions.

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In re: Somerset Regional Water Resources, LLC

Court: US Court of Appeals for the Third Circuit

Docket: 19-1874

Opinion Date: February 11, 2020

Judge: Bibas

Areas of Law: Bankruptcy, Tax Law

Mostoller owned the Debtor, a business that serviced oil and gas wells. The Debtor owed the Trust $3 million, secured by a blanket lien on most of the Debtor’s assets and a personal guarantee by Mostoller. The Debtor petitioned for Chapter 11 reorganization. To entice the Trust to lend more money, Mostoller agreed to assign his anticipated federal tax refund. The taxable income and losses of the Debtor, an S Corporation, passed through to Mostoller, who had paid millions of dollars in federal taxes on that income. He could file amended 2013 and 2014 tax returns to carry back the Debtor’s 2015 losses, which would offset his taxable income for those two years and trigger a refund. 26 U.S.C. 172(a), (b)(1)(A)(i). Mostoller pledged “any rights or interest in the 2015 Federal tax refund due to him individually, but attributable to the operating losses of the Debtor. The bankruptcy court approved the agreement The Debtor defaulted on the emergency loan and converted to a Chapter 7 liquidation. Mostoller first refused to file the tax returns. When the tax refund came, Mostoller tried to keep it. The district court and Third Circuit affirmed in favor of the Trust, rejecting Mostoller’s argument that he pledged his refund on taxes that he paid for 2015 alone, excluding any refund on his 2013 and 2014 taxes. That reading would make the collateral worthless, so the Trust would never have made the loan.

Trendsetter HR LLC v. Zurich American Insurance Co.

Court: US Court of Appeals for the Fifth Circuit

Docket: 19-10056

Opinion Date: February 11, 2020

Judge: Don R. Willett

Areas of Law: Bankruptcy

Zurich filed suit against Trend after Trend purchased workers' compensation insurance from Zurich and then eventually went with a new insurance provider. Trend then filed for bankruptcy and the bankruptcy court allowed Zurich's claims for various unpaid invoices, estimated future losses, and unpaid fee schedule write-down fees. The Fifth Circuit affirmed the district court's decision upholding the bankruptcy court's allowance of Zurich's unpaid-invoices and future-losses claims. The court applied federal bankruptcy law and held that there was no legal error due to unintentionality; Zurich's unpaid-invoices claim was a cognizable bankruptcy claim because the underlying invoices were enforceable rights to payment under New York law; the bankruptcy court did not clearly err in its assessment of the evidence by concurrently allowing Zurich's claims such that the total allowance was $4,674,629 for "future losses." The court also held that there was no error in the bankruptcy court's allowance of Zurich's claim for unpaid fee schedule write-down fees. In this case, Zurich has a cognizable claim to the unpaid fee schedule write-down fees, and the bankruptcy court did not clearly err by concluding that the "25% of Total Savings" fee, as applied to fee schedule write-downs, was not unconscionable.

Whirlpool Corp. v. Wells Fargo Bank, N.A.

Court: US Court of Appeals for the Seventh Circuit

Docket: 18-3363

Opinion Date: February 11, 2020

Judge: Diane S. Sykes

Areas of Law: Bankruptcy, Commercial Law

In 2011 Wells Fargo entered into a loan and security agreement with hhgregg to provide the retailer with operating credit. Wells Fargo had a perfected first-priority, floating lien on nearly all of hhgregg’s assets. In 2017, hhgregg petitioned for Chapter 11 bankruptcy, owing Wells Fargo $66 million. Wells Fargo agreed to provide debtor-in-possession (DIP) financing in return for a priming, first-priority security interest on substantially all of hhgregg’s assets, including existing and after-acquired inventory and its proceeds. The bankruptcy judge approved the DIP financing agreement and the super-priority security interest. Whirlpool had long delivered home appliances to hhgregg on credit for resale. Three days after the approval of the DIP financing, Whirlpool sent a reclamation demand seeking the return of $16.3 million of unpaid inventory delivered during 45 days before the petition date and filed an adversary complaint, seeking a declaration that its reclamation claim was first in priority as to the reclaimed goods. Reorganization proved unsuccessful. The bankruptcy judge authorized hhgregg to sell its inventory—including the Whirlpool goods—in going-out-of-business sales and entered summary judgment for Wells Fargo. The Seventh Circuit affirmed. Reclamation is a limited remedy that permits a seller to recover possession of goods delivered to an insolvent purchaser, subject to significant restrictions, 11 U.S.C. 546(c). A seller’s right to reclaim goods is “subject to the prior rights of a holder of a security interest in such goods or the proceeds thereof.” Whirlpool’s later-in-time reclamation demand is “subject to” Wells Fargo’s prior rights as a secured creditor; its reclamation claim is subordinate to the DIP financing lien.

Lerbakken v. Sieloff and Associates, P.A.

Court: US Court of Appeals for the Eighth Circuit

Docket: 18-3415

Opinion Date: February 7, 2020

Judge: William Duane Benton

Areas of Law: Bankruptcy

The Eighth Circuit affirmed the bankruptcy appellate panel's judgment upholding the bankruptcy court's determination that debtor's interest in his ex-wife's IRA and 401(k) retirement accounts that were awarded to him after the dissolution of marriage were not exempt as retirement funds. The court explained that debtor's interest in his ex-wife's IRA and 401(k) accounts lacked most of the legal characteristics of ordinary "retirement funds."

Paczkowski v. Garven

Court: US Court of Appeals for the Eighth Circuit

Docket: 19-6029

Opinion Date: February 13, 2020

Judge: Nail

Areas of Law: Bankruptcy

The Garvens contracted with Debtor and DRMP for home repairs and improvements. Unhappy with the results, the Garvens sued Debtor and DRMP in state court and obtained a default judgment against them. At the Garvens' request, the sheriff levied a writ of execution on Debtor's ownership interest in DRMP and scheduled an execution sale. At the execution sale, the Garvens purchased Debtor's ownership interest and became the sole owners of DRMP. Upon learning of the execution sale, Debtor allegedly began withdrawing assets from DRMP and transferring them to a different entity. Debtor then filed a chapter 7 bankruptcy petition. The bankruptcy court lifted the automatic stay to allow the Garvens and DRMP to commence a state court action against Debtor and related third parties to avoid the allegedly fraudulent transfers. The Eighth Circuit Bankruptcy Appellate Panel dismissed an appeal. The Garvens and DRMP filed their motion for relief from the automatic stay on June 5, 2019. The bankruptcy court rendered its final decision on September 19, 2019, more than 60 days after the motion was filed. The 60-day period was not extended, so the automatic stay was terminated by operation of law on August 5, 2019, rendering the order lifting the stay superfluous.

Ocwen Loan Servicing, LLC v. Marino

Court: US Court of Appeals for the Ninth Circuit

Dockets: 18-60005, 18-60006, 18-60040, 18-60041

Opinion Date: February 10, 2020

Judge: Lasnik

Areas of Law: Bankruptcy

The Ninth Circuit dismissed Ocwen's appeal of the Bankruptcy Appellate Panel's (BAP) decision affirming the bankruptcy court's contempt orders, holding that the panel lacked appellate jurisdiction. The panel held that the BAP's decision remanding the matter to the bankruptcy court was not final and appealable. The panel considered the need to avoid piecemeal litigation, judicial efficiency, the systemic interest in preserving the bankruptcy court's role as the finder of fact, and whether delaying review would cause any party irreparable harm, and ultimately concluded that all factors compelled dismissal of Ocwen's appeal. However, the panel held that it had jurisdiction over debtors' appeal and affirmed the BAP's conclusion that they were not entitled to attorney's fees for their appeal to the BAP. Therefore, the panel rejected debtors' claims that they were entitled to attorney's fees under Federal Rule of Appellate Procedure 38, the attorney's fee provision in the deed of trust with Ocwen, and section 105(a) of the Bankruptcy Code.