Tuesday, May 19, 2015

Supreme Court Rules Debtor Entitled to Funds Remaining Upon Conversion of Chapter 13 Case

Acknowledging that the statutory language "does not say expressly" what should happen, the Supreme Court nevertheless ruled that undistributed funds held by the Chapter 13 trustee should be returned to the debtor following a conversion.   The Court described its result as "the most sensible reading of what Congress did provide."   Justice Ginsberg wrote the opinion for an unanimous Court.   Harris v. Viegelahn, No. 14-400 (5/18/15).

What Happened

Charles Harris, III began his trip to the Supreme Court when he filed a chapter 13 petition in San Antonio, Texas in February 2010.   He was trying to save his home after defaulting upon his mortgage.    However, by November 2010, the Court had lifted the stay to allow the lender to foreclose.   A year later, he converted his case to chapter 7.   At that time, the Chapter 13 Trustee had over $5,500 on hand.  Rather than returning these funds to the debtor or paying them to the Chapter 7 trustee, she paid them to debtor's counsel and the unsecured creditors.   The Debtor filed a motion for return of the funds.   The Bankruptcy Court granted this motion and the trustee appealed.   The Fifth Circuit reversed, finding that the Bankruptcy Court's order would allow the Debtor to receive a "windfall."    In re Harris, 757 F.3d 468 (5th Cir. 2014).   The Supreme Court granted cert to reconcile a conflict with the Third Circuit.

The Ruling

The Court noted that prior to 1994, there was a split of authority over whether the debtor's post-petition earnings vested in the chapter 7 estate upon conversion.    This problem was solved when section 348(f) was added to the Code.   It provides that absent bad faith, property of the chapter 7 estate following conversion from chapter 13 consists of property which was originally part of the chapter 13 estate which remained "in the possession . . . or control" of the debtor on the date of conversion.  Thus, the funds held by the chapter 13 trustee would not become property of the chapter 7 estate.   

However, this did not answer the question of what the chapter 13 trustee could do with the funds upon conversion.   The court noted that under section 348(e), the chapter 13 trustee's "services" are terminated upon conversion.   The Court concluded that paying money to creditors was one of the "services" provided by the trustee and therefore something that could not be done after conversion.   The Court also concluded that paying money to creditors was not part of the trustee's duty to "wind up" the chapter 13 estate and that a chapter 13 plan did not vest funds in creditors until they were paid out.

The Court rejected the policy arguments that were relied upon by the Fifth Circuit.  It was not a "windfall" for the debtor to receive the undistributed funds for the reason that those funds would have belonged to the debtor if he had initially filed under chapter 7.    The Supreme Court agreed that it was a fortuity that some trustees had lots of money on hand when a case converted and others didn't.   However, the Court suggested that creditors "seek() to include in a Chapter 13 plan a schedule for regular disbursement of funds the trustee collects."   Opinion, p. 11.  The fact that creditors could protect themselves showed that the Court did not need to bend the statute to arrive at a reasonable result.

What Does It Mean?

In this case, the Supreme Court followed the text and structure of the statute rather than relying on easily manipulated policy arguments like the Fifth Circuit did.    The Supreme Court showed that it was willing to look at how the Bankruptcy Code functions to resolve a question that was not completely obvious.   While no statute expressly said that the debtor gets to keep funds in the hands of the chapter 13 trustee, the Court noted that other provisions, such as those revesting post-petition property in the debtor and terminating the services of the trustee, pointed to the correct answer.   This is a functional, pragmatic approach toward interpreting the law and will be useful to practicing lawyers.

The case will likely also encourage Chapter 13 trustees to seek authority to make interim distributions.   The ruling only applies to funds held by the Chapter 13 trustee on the date of conversion.   Had the Trustee received permission for interim distributions, there would have been a much smaller amount on hand and the Trustee would have received commissions on the funds which were distributed.   As the Court pointed out, there is nothing wrong with encouraging Trustees to make distributions early and often.    

Because Trustees will likely modify their procedures to address the ruling, the practical effect of the opinion will likely be minimal.   However, any time that the Supreme Court interprets the Bankruptcy Code, it provides valuable guidance as to how they might rule in other cases.    That will be the lasting impact of this case beyond the relatively small sum that Trustee Viegelahn will be required to pay.

Note:  The Bankruptcy Court order was entered by then-Bankruptcy Judge Leif M. Clark.   Over the years, Judge Clark has been a fertile source of material for this blog.   Congratulations to Judge Clark on being affirmed by the Supreme Court.    Congratulations also to local attorney Steven Cenammo who filed the motion which set this in motion.  

Thursday, May 07, 2015

Supreme Court Says Denial of Confirmation Not Automatically Appealable

In a surprisingly casual opinion, the Supreme Court, led by Chief Justice Roberts, has ruled that denial of confirmation of a chapter 13 plan does not give rise to a final order which can be appealed as a matter of right.    Bullard v. Blue Hills Bank, No. 14-116 (5/4/15).     The opinion can be found here.    The Chief's opinion compares the appellate process to the children's game of chutes and ladders, refers to insignificant matters as "small beer issues" and even includes a sentence fragment.   Notwithstanding the relaxed approach to writing, the Court offers clear guidance.   When the court denies a plan with leave to appeal, the debtor may refuse to amend and appeal the ultimate dismissal or may seek to follow the interlocutory appeal route, a process which must be renewed at each stage of the appeal.    However, the debtor may not appeal the denial as a matter of right.   

What Happened

Bullard owned a multifamily property which was worth much less than was owed upon it.   Because the property was apparently not the debtor's residence (or perhaps only part of the property constituted the debtor's residence), the debtor was able to propose a plan which modified the debt.   Chapter 13 allows a debtor to cure and maintain payments on a long term debt or to pay a secured debt over the life of the plan.   Bullard creatively sought to continue making the regular monthly payments on the secured portion of the debt, while paying disposable income with regard to the unsecured portion.    This would give Bullard the ability to complete payments on the secured debt many years after the plan was completed while paying only 5% on unsecured claims.    According to the Chief Justice, it was "no surprise" that the bank objected.   The Bankruptcy Court sustained the objection even though there was contrary authority within the circuit.

 The debtor appealed to the Bankruptcy Appellate Panel which granted leave for an interlocutory appeal.    The BAP agreed with the Bankruptcy Court and affirmed denial of the plan.   The debtor then appealed to the First Circuit which did not permit an interlocutory appeal and dismissed the appeal.    Both the debtor and the bank agreed that the Supreme Court should grant cert to determine whether denial of a plan constituted a final order appealable as a matter of right.   The Solicitor General sided with the debtor and argued that denial of a plan should be appealable as a matter of right.   In an opinion both forceful and whimsical by turns, the Court rejected the arguments of the debtor and the Solicitor General.

The Court's Ruling

The Supreme Court ruled just thirty-three days after oral argument.    The Court noted that determining finality for purposes of appeal was "different in bankruptcy" than from a typical civil case.    
A bankruptcy case involves “an aggregation of individual controversies,” many of which would exist as stand-alone lawsuits but for the bankrupt status of the debtor. (citation omitted). Accordingly, “Congress has long provided that orders in bankruptcy cases may be immediately appealed if they finally dispose of discrete disputes within the larger case.”
 Slip Opinion, p. 4.   So when does a ruling finally dispose of a discrete dispute within the larger case?    The Court agreed with the Bank that confirming a plan would meet this standard but denying confirmation would not.
The relevant proceeding is the process of attempting to arrive at an approved plan that would allow the bankruptcy to move forward. This is so, first and foremost, because only plan confirmation—or case dismissal—alters the status quo and fixes the rights and obligations of the parties. When the bankruptcy court confirms a plan, its terms become binding on debtor and creditor alike. (citation omitted). Confirmation has preclusive effect, foreclosing relitigation of “any issue actually litigated by the parties and any issue necessarily determined by the confirmation order.” (citations omitted). . . .
When confirmation is denied and the case is dismissed as a result, the consequences are similarly significant.Dismissal of course dooms the possibility of a discharge and the other benefits available to a debtor under Chapter 13. Dismissal lifts the automatic stay entered at the start of bankruptcy, exposing the debtor to creditors’ legal actions and collection efforts. §362(c)(2). And it can limit the availability of an automatic stay in a subsequent bankruptcy case. §362(c)(3).

Denial of confirmation with leave to amend, by contrast,changes little. The automatic stay persists. The parties’ rights and obligations remain unsettled. The trustee continues to collect funds from the debtor in anticipation of a different plan’s eventual confirmation. The possibility of discharge lives on. “Final” does not describe this state of affairs. An order denying confirmation does rule out the specific arrangement of relief embodied in a particular plan. But that alone does not make the denial final any more than, say, a car buyer’s declining to pay the sticker price is viewed as a “final” purchasing decision by either the buyer or seller. “It ain’t over till it’s over.”
 Slip Op., pp. 5-6.  

 The language quoted above captures the essence of the opinion.   However, the Court went on to offer several practical reasons for its ruling.
  • Appeals take a long time.   "As Bullard's case shows, each climb up the appellate ladder and slide down the chute can take a year."    A more narrow construction on finality avoid delays and inefficiencies.
  • While debtors probably would not appeal over "small beer issues," the prospect of an appeal could be used for tactical reasons in negotiating with creditors.   Besides Chapter 11 lawyers might have the money to spend on appealing insignificant issues.
  • The Court also stated that lack of a guaranteed appeal would "encourage the debtor to work with creditors and the trustee to develop a confirmable plan as promptly as possible.
 The Court took the time to reject several arguments from the debtor and the Solicitor General.   The SG argued that any order which resolved a contested matter should be considered final for purposes of appeal.    In a firm putdown, the Court stated:
That version of the argument has the virtue of resting on a general principle—but the vice of being implausible. As a leading treatise notes, the list of contested matters is “endless” and covers all sorts of minor disagreements. (citation omitted). The concept of finality cannot stretch to cover, for example, an order resolving a disputed request for an extension of time.
 Slip Op., pp. 8-9.     The Court also suggested that arguing that all orders resolving contested matters should be appealable begged the question.
At other points, the Solicitor General appears to argue that because one possible resolution of this particular contested matter (confirmation) is final, the other (denial) must be as well. But this argument begs the question. It simply assumes that confirmation is appealable because it resolves a contested matter, and that therefore anything else that resolves the contested matter must also be appealable.  But one can just as easily contend that confirmation is appealable because it resolves the entire plan consideration process, and that therefore the entire process is the “proceeding.” A decision that does not resolve the entire plan consideration process—denial—is therefore not appealable.
Slip Op., p. 9.  

The Court was more sympathetic to the debtor's argument that denying the right to appeal would leave the debtor with no effective means of obtaining appellate review. The debtor would be given the Hobson's Choice to either refuse to amend and appeal the dismissal order, which would result in loss of the automatic stay and probably the debtor's property, or to move forward with a plan the debtor did not want.    In a terse statement, the Chief commented "All good points" before noting that:
our litigation system has long accepted that certain burdensome rulings will be “only  imperfectly reparable” by the appellate process. (citation omitted). This prospect is made tolerable in part by our confidence that bankruptcy courts, like trial courts in ordinary litigation, rule correctly most of the time. And even when they slip, many of their errors—wrongly concluding, say, that a debtor should pay unsecured creditors $400 a month rather than $300—will not be of a sort that justifies the costs entailed by a system of universal immediate
 Slip Op., pp. 10-11.   Perhaps acknowledging that "life is unfair" was a less than satisfactory answer, the Court went on to note that important issues could be appealed through the interlocutory appeal process.   Indeed, in this case, the BAP allowed an interlocutory appeal although the Court of Appeals did not.  
While discretionary review mechanisms such as these “do not provide relief in every case, they serve as useful safety valves for promptly correcting serious errors” and addressing important legal questions.
 Slip Op., pp. 11-12.
What Does It Mean?

This short opinion contains several layers of meaning.    The most basic lesson is that orders denying relief which do not change the status quo cannot be appealed as a matter of right.   It does not matter whether it is an order denying confirmation of a plan, an order refusing to lift the automatic stay or an order declining to dismiss a case.    Any order which leaves the parties free to return to the field of battle another day is not subject to an automatic appeal.   In most cases, the only option will be to request an interlocutory appeal, a process which requires the aggrieved party to be persuasive on the front end of the appeal process.   The option of refusing to propose another plan and allowing the case to be dismissed probably will only apply in the plan confirmation process.   For example, if the court refuses to lift the automatic stay, the creditor cannot create a final order through inaction.  Instead, the debtor or trustee will be allowed to retain the property until some future action changes the status quo.

On a more philosophical note, the opinion shows that the Supreme Court trusts Bankruptcy Judges to make good decisions and does not want the higher courts to be troubled with appeals of many minor matters.    This vote of confidence could bode well for Bankruptcy Courts in the continuing tension between the boundaries of Article I and Article III authority.

There are also two points applicable to appellate argument to be noted here.   When in doubt, cite Collier on Bankruptcy.   This opinion relied on the Collier treatise three different times in a twelve page opinion.   This could lead to a surge in bankruptcy lawyers adding Collier's to their legal research plans.    Finally, just because the Chief Justice used a sentence fragment (which would have meant an automatic F in my high school English class) and used such mixed metaphors as chutes and ladders and small beer, does not mean that practitioners should.   While a well-chosen metaphor or an intentional grammatical error could add force to a brief, a poorly chosen one or too many discordant examples could prejudice the court.   The Chief Justice has life tenure and no one above him reviewing his decisions.   He can engage in written flights of fancy such as those observed here without any negative consequences.   Practitioners cannot.  

Tuesday, April 14, 2015

Fifth Circuit Report: March 2015

The big decision out of the Fifth Circuit this month was a Ponzi scheme case against The Golf Channel.    Honorable mentions included the follow up appeal in the Frazin case which first addressed consent in Stern cases and several cases involving mortgages.  Because there have been slim pickings among bankruptcy cases per se,  I have included several non-bankruptcy cases which generally involve debtor-creditor relations.
Torres v. Krueger, No. 13-11165 (5th Cir. 3/3/15)(unpublished)

This case involved a dispute between two parties with regard to Cru Energy, Inc., a renewable energy company, which they founded.     Krueger sued Torres for breach of fiduciary duty, fraud, conversion and the like.   Torres counterclaimed and obtained a temporary injunction against Krueger.   Krueger allegedly violated the injunction by transferring funds from Cru Energy.   Krueger filed chapter 7 bankruptcy prior to any contempt proceedings.   Cru obtained relief from the stay and Krueger was held in contempt.   The contempt order was reversed on application for habeas corpus because the injunction was not sufficiently specific.  

Cru also filed an objection to Krueger's discharge.   Krueger convened a shareholder meeting of Cru and voted to oust Torres and fire the attorneys who were pursuing the litigation against him.    The District Court gave notice that it intended to dismiss Cru's claims on the basis that it was a corporation that was not represented by counsel.   Torres sought to intervene in the 727 action and also sought authority to represent Cru on a derivative basis.     The District Court dismissed Cru's claims and denied Torres's motions.    Subsequently, the Trustee sold Krueger's shares in Cru and Krueger's bankruptcy case was dismissed.     

The Court found that it was not an abuse of discretion to deny intervention or leave to pursue claims derivatively.   Also, the Court found that when Krueger's bankruptcy was dismissed, it had the practical effect of keeping him from receiving a discharge.   It shows that a party should realize when to declare victory and not keep appealing.

Wheeler v. Collier (In re Wheeler), No. 14-30961 (5th Cir. 3/4/15)(unpublished).  

This case stands for the proposition that a court cannot sua sponte impose relief against a party without prior notice.  It also shows how difficult life can be when you get on the wrong side of a federal judge.   Collier was a Louisiana bankruptcy lawyer who advertised "No money down" chapter 7 bankruptcies. Wheeler, one of his clients, sued him for violation of the automatic stay after he debited her account post-petition.    The case proceeded in U.S. District Court after Collier requested a jury trial.   Following a status conference, the Court set a hearing to determine whether the defendants had violation 11 U.S.C. Sec. 528 (one of the Debt Relief Agency provisions) and whether they should be held in contempt for violating the discharge injunction.    The Court found that the defendants had violated both sections 526 and 528 and that they had violated the discharge injunction.   The Court awarded disgorgement of $1,300, $10,000 in actual damages, $30,000 in punitive damages and attorneys' fees.   It also assessed contempt sanctions of $10,000 payable to the Clerk of the Court and ordered the lawyers to cease and desist from "all Chapter 7 consumer 'No Money Down' bankruptcies" and to cancel all "No Money Down" advertisements.    

The attorneys appealed the $10,000 sanction and the injunction.    The Fifth Circuit reversed.   The docket notation with regard to contempt under section 105 for violation of the discharge injunction did not provide notice that the court would consider criminal contempt sanctions.   Civil contempt under section 105 is intended to compensate, while criminal contempt is intended to punish.   Ordering the attorneys to pay sanctions to the Clerk of the Court constituted criminal contempt.   Because the Court did not provide advance notice that it intended to consider this sanction, it lacked authority.   The same result applied to the injunctive relief.      

This is the second time that a proceeding related to this matter has reached the Fifth Circuit.   Previously, the Fifth Circuit had granted a writ of mandamus when the District Court ordered Mr. Collier imprisoned for 48 hours for criminal contempt.    You can read about the prior opinion here.

While the lawyer succeeded in reversing both sanctions, he can hardly be said to have gotten off scot-free.    It is both difficult and expensive to take a case up to the Fifth Circuit.

Janvey v. The Golf Channel, Incorporated, No. 13-11305 (5th Cir. 3/11/15)

This was the big case out of the Fifth Circuit this month.   In order to generate awareness for its brand (which consisted of running a Ponzi scheme), Stanford International Bank advertised on the Golf Channel.   It paid at least $5.9 million for this advertising.   Ralph Janvey, the receiver for Stanford, sued to recover the funds as a fraudulent transfer.   The District Court found that the Golf Channel had a complete defense because it had received the funds in good faith and had provided reasonably equivalent value.    

The Fifth Circuit reversed.   It looked at whether the property or service exchanged had any value as a matter of law and then at whether that value was reasonably equivalent.    The Fifth Circuit noted that Texas courts had not ruled on whether payments made in furtherance of a Ponzi scheme constituted value.     The Court held that the relevant question was not whether the payments would provide value to an ordinary business but rather, whether they provided value to the creditors in the actual case.   The Court wrote:
Golf Channel’s services did not, as a matter of law, provide any value to Stanford’s creditors. Just like the broker’s (unknowing) efforts to extend the Ponzi scheme in Warfield, Golf Channel’s (unknowing) efforts to extend Stanford’s scheme had no value to the creditors. While Golf Channel’s services may have been quite valuable to the creditors of a legitimate business, they have no value to the creditors of a Ponzi scheme.  Ponzi schemes by definition create greater liabilities than assets with each subsequent transaction. Each new investment in the Stanford Ponzi scheme decreased the value of the estate by creating a new liability that the insolvent business could never legitimately repay.  (citation omitted). Services rendered to encourage investment in such a scheme do not provide value to the creditors.
Opinion, pp. 8-9.    The Court concluded that the relevant test was whether the creditor provided a benefit to the creditors of the Ponzi scheme, not whether the services themselves were valuable.   Thus, an insurance premium paid to insure the fine art bought with the proceeds of the Ponzi scheme would conceivably provide value to creditors, while the wages paid to the receptionist who answered the phone might not.    This is a harsh result for the creditor who unknowingly propped up an illegitimate scheme.    While the creditor could sue the promoter of the Ponzi scheme for fraud in not disclosing the scheme's existence, the promoter is likely to be sent to jail and have his assets seized.   

This is a problem which deserves a legislative solution.   

Dawson v. Bank of America, No. 14-20560 (5th Cir. 3/13/15)(unpublished). 

Debtor defaulted on debt but negotiated a modification agreement.   Debtor then sued bank for failure to record the modification agreement and report her payment history to the credit bureaus.   The Fifth Circuit affirmed dismissal for failure to state a claim.   There is no cause of action against a credit provider for failure to report positive information under FCRA.

Hawkins v. JP Morgan  Chase Bank, No. 13-50086 (5th Cir. 3/16/15)(unpublished)

Debtor sought to bring a class action alleging that Texas home equity loan restructurings which capitalized past-due interest, fees, taxes and escrow into the principal constituted extensions of credit which would need to follow the requirements for an original home equity loan.    Relying on a recent Texas Supreme Court case, Sims v. Carrington Mortg. Servs., L.L.C., 440 S.W.3d 10, 17 (Tex. 2014), the Court affirmed dismissal of the claims.    This is a good result for borrowers because it removes an impediment to loan restructurings which could allow the borrower to keep the property.

Frazin v. Haynes & Boone, LLP (In re Frazin), No. 14-10547 (5th Cir. 3/30/15)(unpublished)

Frazin hired two law firms to bring claims on his behalf in his chapter 13 bankruptcy.   After they only recovered $3.2 million, he brought claims for malpractice, breach of fiduciary duty and DTPA as counterclaims to their fee applications.    The Bankruptcy Court denied all relief.    In the first appeal,  the Fifth Circuit found that the malpractice and breach of fiduciary duty claims could be decided by the Bankruptcy Court because they were necessarily decided in ruling upon the fee application.    The Fifth Circuit remanded for reconsideration of the DTPA claims by the District Court.    I previously wrote about the case here.

On remand, the District Court dismissed the DTPA claims.    The Court found that the DTPA claim "is merely a restated negligence claim."    It additionally found that claims for rendering professional services are exempt under the DTPA.    The District Court's order can be found here.   The Fifth Circuit affirmed for the reasons stated by the District Court.

Thus, the odyssey of Mr. Frazin and his attempt to sue his lawyers has come to an end.

Monday, April 13, 2015


By Guest Blogger Michael V. Baumer

On June 12, 2014, the U.S Supreme Court issued an opinion in Clark v. Rameker, 134 S.Ct. 2242 (2014) in which the court, in a 9-0 decision, affirmed a decision by the 7th Circuit holding that an IRA inherited by a daughter from her mother is not exempt under 522(b)(3)(C).

It is important to note that although Clark determined whether inherited IRAs are exempt under 522(b)(3), the decision should also apply to whether inherited IRAs are exempt under 522(b)(2) and (d)(12). Both statutes exempt “Retirement funds to the extent that those funds are in a fund or account that is  exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986.” The Clark court concluded that funds in an inherited IRA are not “retirement funds,” although “retirement funds” is not defined in either the Bankruptcy Code or the Internal Revenue Code.

522(b)(1) says that a debtor can claim exemptions under 522(b)(2) which we commonly refer to as “federal exemptions,” or 522(b)(3)  which we commonly refer to as “state exemptions.” [522(b)(2) includes the “opt out” provision which allows the individual states to deny the federal exemptions to their residents.] It is not really that simple. The federal exemptions under 522(b)(2) are limited to the exemptions listed in 522(d). There is abundant case law that says that other federal exemptions not contained in 522(d) are not allowed in a bankruptcy case. And 522(b)(3) is not limited to exemptions allowable under state law. 522(b)(3)(A) specifically allows a debtor to exempt “any property that is exempt under federal law” [except 522(d)] as well as “State or local law.” 

In the first paragraph of its opinion, the Clark court stated “The question presented is whether funds contained in an inherited individual retirement account (IRA) qualify as ‘retirement funds’ within the meaning of this [522(b)(3)(C)] bankruptcy exemption. We hold that they do not.” Clark, at 2244.

The court almost casually notes “If the heir is the owner’s spouse, as is often the case, the spouse has a choice: He or she may ‘roll over’ the IRA funds into his or her own IRA, or he or she may keep the IRA as an inherited IRA (subject to the rules discussed below).” Clark, at 2245, (citing IRC Publication 590).

I think that this seemingly innocuous statement may actually give significant guidance to what the court might do in the case of an IRA inherited by a spouse. The court does acknowledge that a spouse may roll over the inherited IRA into his/her own IRA [in which case, it would qualify as a rollover IRA under 522(b)(4)(C)] or treat it as an inherited IRA. If the spouse elects to treat the IRA as an inherited IRA under the Internal Revenue Code, it seems only reasonable that it would/should also be treated as an inherited IRA under the Bankruptcy Code and would be subject to the court’s interpretation that funds in an inherited IRA are not retirement funds. If the spouse elects to roll over the IRA, it would no longer be an “inherited” IRA, but the spouse’s “own” IRA.

In Clark, the IRA was inherited by a daughter from her mother. This is very significant because the IRC provides substantially different treatment for inherited IRAs if the beneficiary is the spouse of the decedent or if the beneficiary is someone other than a spouse. The actual holding in Clark is that funds inherited by a child (someone other than a spouse) are not retirement funds and are not exempt under 522 (b)(3)(C).

To the extent that the court’s holding extends to spouses, it is dicta, not holding. In interpreting the phrase “retirement funds,” the court concluded that “retirement funds” are only retirement funds for the person who sets them aside for their own retirement. It would seem that this is typically not the case with married couples - they are saving for their joint retirement (singular), not their individual retirements (plural).

I would also note that the court engages in at least a little bit of public policy argument, in addition to judicial interpretation The court states that the purposes of bankruptcy exemptions are to “protect the debtor’s essential needs,” “to provide a debtor with the basic necessities of life so that she will not be left destitute and a public charge,” and “to ensure that debtors will be able to meet their basic needs.” Clark, at 2247. The court might want to consider 522(n) which allows a debtor to exempt an IRA with a value up to $1,245,475. In a joint case, that amount is doubled for a total of $2,490,950. And that does not include amounts in any other retirement plans. (Apparently, my notion of what is “basics” and “necessities” could be more expansive.)

Texas Property Code Sec. 42.0021(a) specifically provides that inherited IRAs are exempt to the same extent as they would be in the hands of the original owner of the IRA. Several commentators have expressed the opinion that inherited IRAs are exempt in a bankruptcy case using Texas exemptions, notwithstanding Clark. Many of those commentators note that the bankruptcy court opinion in Clark held that inherited IRAs are not exempt under the Wisconsin exemption statute. They distinguish this from the Texas exemptions which specifically provide that inherited IRAs are exempt. I think this interpretation is erroneous. The Supreme Court opinion in Clark never mentions whether inherited IRAs are exempt under Wisconsin law. The court held that inherited IRAs are not “retirement funds” as a matter of federal law under 522(b)(3)(C), so it never reached the issue of whether they can be exempt under applicable state law.

I am not sure how to reconcile this with 522(b)(3)(A) which permits a debtor to exempt “any property that is exempt under … State or local law.” The subsections of 522(b)(3) are stated in the conjunctive, not the disjunctive – debtors get to claim the exemptions in subsections (A), (B), and (C), so it would seem that even if a debtor is not entitled to exempt retirement accounts under 522(b)(3)(C), they should still be able to exempt them under 522(b)(3)(A) to the extent it is applicable. If Congress had intended that 522(b)(3)(C) would preempt 522(b)(3)(A), they coulda/shoulda/woulda done so explicitly. [They did, in fact, do this with the homestead caps under 522(o) and (p), which are expressly referenced in 522(b)(3)(A).]

My interpretation of the current status of the law based on what I understand Clark’s actually holding to be:

1.                  IRAs inherited from anyone other than a spouse are not exempt under 522(b)(3)(C). [Or 522(d)(12) – this is not part of the actual holding, but the statutory language is identical.]

2.                  IRAs inherited from a spouse which are not rolled over into the debtor’s own IRA should not be exempt under 522(b)(3)(C) or 522(d)(12), but should be treated as inherited IRAs.

3.                  IRAs inherited from a spouse which are rolled over into the debtor’s own IRA should be exempt under 522(b)(3)(C) or 522(d)(12).  Clark does not say that, but to the extent the statement in the opinion that inherited IRAs are not exempt is applied to a spouse is dicta, and the factual and legal basis for the opinion does not apply to spouses who elect to rollover an IRA inherited from a spouse. (Because they are treated differently under the IRC, they should also be treated differently under the Bankruptcy Code.)

4.                  Claiming an inherited IRA as exempt under Texas law is more problematic, at least as far as trying to read the judicial tea leaves.

a.                   Texas Property Code §42.0021(a) provides, in part:

"For purposes of this subsection, the interest of a person in a plan, annuity, account or contract acquired by reason of the death of another person, whether as an owner, participant, beneficiary, survivor, coannuitant, heir or legatee, is exempt to the same extent that the interest of the person from whom the plan, annuity, account or contract was exempt on the date of the person’s death."

It seems clear from the breadth of the language that the intent of the Texas legislature was to protect inherited retirement interests to the greatest extent possible. But how does Texas Property Code interact with the Bankruptcy Code in this context?

b.            In Clark the Bankruptcy Court held, in part, that the inherited IRA was not exempt because the Wisconsin exemption statute did not provide an exemption for inherited IRAs. The Supreme Court, however, never mentions whether the account was exempt under state law, but held that funds in an inherited IRA are not “retirement funds” under 522(b)(3)(C).

c.                Clark, however, never mentions 522(b)(3)(A) which allows a debtor to exempt “any property that is exempt under Federal Law, other than subsection (d) of this section or State or local law that is applicable on the date of filing of the petition.…” 522(b)(3)(A) does not contain the “retirement funds” language found in 522(b)(3)(C) or 522(d)(12).

d.             522(b)(3)(A), (B) and (C) are stated in the conjunctive – the debtor gets to claim (A), (B), and (C), so even if an inherited IRA is not exempt under 522(b)(3)(C), the debtor should still be able to exempt it under 522(b)(3)(A). Assuming that the state exemption statute allows a debtor to exempt an inherited IRA (as does the Texas Property Code), it should be allowed under this subsection.

With all that said, until we get further clarification, I would suggest that it is very risky to claim an IRA inherited from a spouse as exempt under federal exemptions, or to claim an IRA inherited from anyone under the Texas Property Code.

Any volunteers?

Friday, April 10, 2015

Fifth Circuit Reverses Pro-Snax

In a unanimous decision, the en banc Fifth Circuit Court of Appeals walked back a prior precedent which mandated an identifiable, tangible and material benefit before professionals employed in bankruptcy cases could be compensated.   No. 13-50075, Barron & Newburger, P.C. v. Texas Skyline, et al (5th Cir. 4/9/15).    You can read the opinion here.

What Happened

The case stemmed from the chapter 11 bankruptcy of a businessman whose case was ultimately converted to chapter 7.   When the Debtor's counsel filed its fee application, both a creditor and the U.S. Trustee objected.   Relying upon In re Pro-Snax Distributors, Inc.,  157 F.3d 414 (5th Cir. 1998), the Bankruptcy Court denied 85% of the requested fees on the basis that they did not produce tangible results (although a portion of the fees was denied for other reasons).    The District Court affirmed.  2013 U.S. Dist. LEXIS 188262 (W.D. Tex. 2013).  A panel of the Fifth Circuit affirmed the case based on the prior precedent but recommended that Pro-Snax be reconsidered by the en banc court.  758 F.3d 693 (5th Cir. 2014).   The Court agreed to grant en banc review.   771 F.3d 820 (5th Cir. 2014).   In the en banc briefing, the U.S. Trustee changed its position and agreed with the Debtor that Pro-Snax applied an improper standard.   However, it still contended that the fees should be denied under any standard.

The En Banc Ruling

The Fifth Circuit unanimously voted to abrogate the Pro-Snax decision. (See explanatory note below).   In summarizing the Court's ruling, Judge Prado stated:
We now recognize that the retrospective, “material benefit” standard enunciated in Pro–Snax conflicts with the language and legislative history of § 330, diverges from the decisions of other circuits, and has sown confusion in our circuit. Correspondingly, we overturn Pro–Snax’s attorney’s-fee rule and adopt the prospective, “reasonably likely to benefit the estate” standard endorsed by our sister circuits.
Opinion, p. 2.     The Court also stated:
B & N and the U.S. Trustee contend that the “hindsight” or “material benefit” standard we enunciated in Pro–Snax conflicts with the text and legislative history of § 330 and unnecessarily places us at odds with our sister circuits. We agree.
 Opinion, p. 8.   

The Court found that section 330 adopts a standard which includes allowing fees for services which were necessary "at the time at which the service was rendered" and denying them if the services "were not reasonably likely to benefit the debtor's estate or necessary to the administration of the estate."    The Court found that this language precluded a results-only approach.
Section 330, then, explicitly contemplates compensation for attorneys whose services were reasonable when rendered but which ultimately may fail to produce an actual, material benefit. “Litigation is a gamble, and a failed gamble can often produce a large net loss even if it was a good gamble when it was made.” (citation omitted).    The statute permits a court to compensate an attorney not only for activities that were “necessary,” but also for good gambles—that is, services that were objectively reasonable at the time they were made—even when those gambles do not produce an “identifiable, tangible, and material benefit.” What matters is that, prospectively, the choice to pursue a course of action was reasonable.
 Opinion, pp. 12-13.

The statutory language relied upon by the Court was added to section 330 in 1994.   However, the only case relied upon by the Pro-Snax court to support the material benefit standard was based on the language of the statute prior to 1994.   

In conclusion, Judge Prado stated:
We conclude that § 330 embraces the “reasonable at the time” standard for attorney compensation endorsed by our colleagues in the Second, Third,and Ninth Circuits. As explained above, the text and legislative history of § 330 contemplate a prospective standard for the award of attorney’s fees relating to bankruptcy proceedings—one that looks to the necessity or reasonableness of legal services at the time they were rendered. Under this framework, if a fee applicant establishes that its services were “necessary to the administration” of a bankruptcy case or “reasonably likely to benefit” the bankruptcy estate “at the time at which [they were] rendered,” see 11 U.S.C. § 330(a)(3)(C), (4)(A), then the services are compensable.

In assessing the likelihood that legal services would benefit the estate, courts adhering to a prospective standard ordinarily consider, among other factors, the probability of success at the time the services were rendered, the reasonable costs of pursuing the action, what services a reasonable lawyer or legal firm would have performed in the same circumstances, whether the attorney’s services could have been rendered by the Trustee and his or her staff, and any potential benefits to the estate (rather than to the individual debtor). (citations omitted). Whether the services were ultimately successful is relevant to, but not dispositive of, attorney compensation. See 11 U.S.C. § 330(a)(3) (“[T]he court shall consider the nature, the extent and the value of such services, taking into account all relevant factors . . . .”  (citations omitted).

Insofar as Pro–Snax precludes resort to this prospective analysis, we overrule those portions of the opinion. . . .  (W)e observe that our ruling today is not intended to limit courts’ broad discretion to award or curtail attorney’s fees under § 330, “taking into account all relevant factors,” 11 U.S.C. § 330(a)(3).
Opinion, pp. 15-17.

Having concluded that the Pro-Snax standard should be abrogated, the Court turned to the issue of whether the case should be remanded for a new hearing on fees.   The Court found that a remand was necessary in order to allow the bankruptcy court to make findings under the revised standard.  
Because our opinion today announces a new legal rule, and out of an abundance of caution given the complex facts of the case before us, we remand this matter for the bankruptcy court to evaluate whether B & N is entitled to fees under the prospective, “reasonable at the time” standard.
Opinion, p. 19.   Thus, the bottom line is that Barron & Newburger will receive the opportunity to have its fees considered under the reasonable at the time standard.   This may result in more fees being awarded or perhaps it won't.    That remains to be seen.

Placing the Opinion in Context

This opinion restores the discretion given to the Bankruptcy Court in awarding compensation.   For many years, In re First Colonial Corp. of America, 544 F.2d 1291 (5th Cir. 1977), a decision under the Bankruptcy Act, was the leading decision on attorney compensation.   It adopted the 12 factor Johnson test for compensation which had been used in fee-shifting cases.   While the result was one factor under the test, it was not the overriding factor.    Some thirty-five years later, the Court stated that the statutory text together with the lodestar approach and the Johnson factors “coalesce . . . to form the framework that regulates the compensation of professionals employed by the bankruptcy estate.” In re Pilgrim’s Pride Corp., 690 F.3d 650, 656 (5th Cir. 2012).    These formulas, which contain multiple factors, gave the Bankruptcy Court considerable latitude in deciding how much weight to give to specific factors.   Pro-Snax was an outlier because it severely limited what could be considered.   Now that Pro-Snax has been repudiated, courts can consider and weight as many factors as they deem appropriate.    While this may result in less predictable outcomes, it treats judges as professionals capable of exercising discretion rather than mechanical calculators.

The opinion also gives greater recognition to the professional judgment of attorneys.   Under Pro-Snax a losing gamble could equal uncompensated work depending upon whether any party objected to the fee application.  Because fee applications in unsuccessful cases often passed through without objection, the rule was often more honored in the breach.   When it was invoked, its application was often inconsistent, a fact noted by the Fifth Circuit. However, for the attorney unlucky enough to draw the black bead and face a strict application of the test, the results were harsh.   Under the new standard (which is actually a return to the old standard), the Court is permitted to examine the attorney's exercise of judgment in pursuing an action.  Courts often comment that the decision in a case was a close one or that both sides presented solid evidence and arguments.   In these circumstances, the Court is freed to look at the totality of the circumstances rather than simply looking at whether the applicant prevailed.   By rewarding even failed efforts, the Court both encourages and rewards professionalism. 


Pro-Snax had two holdings.   Its primary holding was that Debtor's counsel could not receive compensation from the estate after appointment of a Chapter 11 Trustee.   That holding was affirmed by the Supreme Court in another case.   The secondary holding of Pro-Snax, which was more in the nature of dicta, concerned the material benefit standard.   It is only the material benefit standard that was modified.    


My firm was the Appellant in this case and I personally worked upon it.   While I hope that I have been fully accurate in describing the case, I make no claim of impartiality.



Wednesday, March 11, 2015

As Oil Prices Fall, Oil & Gas Bankruptcies Rise

While a new report from the Administrative Office of the U.S. Courts shows a 46% decline in chapter 11 filings from 2010 to 2014, there appears to be an uptick in energy related filings, especially by Texas-based companies.

The report from the Administrative Office shows that chapter 11 filings decreased from 14,191 in fiscal year 2010 to 7,658 in fiscal year 2014, a decline of 46% in just four years.    A separate report from the U.S. Energy Information Administration shows the price of West Texas Intermediate Crude dropping from over $100 per barrel in July 2014 to just over $50 per barrel in January 2015.  While bankruptcy is typically a lagging indicator in the economy, oil and gas related bankruptcy filings appear to be on the rise with at least three publicly traded companies filing this month.   

I was able to locate eleven energy-related filings with aggregate debt of $4.9 billion in the past few months.   While all of the American debtors were Texas-based, they included filings in Delaware, Utah and the Southern and Western Districts of Texas.   Calgary, Canada has also received two filings, including one which resulted in a Chapter 15 in the Western District of Texas.

Case #
Case Name
Endeavour Operating Corporation (Houston, TX)
Marion Energy, Inc. (McKinney, TX)
KiOR, Inc. (Pasadena, TX)
Alberta, Canada
Gasfrac Energy Services, Inc. (Calgary)
$88.7M CDN + $10M USD
WBH Energy, LP (Austin, TX)
Ch. 15
Gasfrac Energy Services, Inc.(Calgary)
$88.7M CDN + $10M USD
Royalty Partners, LLC  (Houston, TX)
Alberta, Canada
Ivanhoe Energy Inc. (Calgary)
$103M CDN
Cal Dive International, Inc. (Houston, TX)
Dune Energy, Inc. (Houston, TX)
BPZ Resources, Inc. (Houston, TX)
Quicksilver Resources, Inc. (Fort Worth, TX)