On Abstention, Multi-Prong Tests and Being Mistaken for David Bowie

Who would have thought that abstention could be so interesting? Judge Leif Clark has written a new opinion on abstention which jabs at some of the boilerplate language found in motions to abstain and contains a footnote destined to become a Clark-classic. The Official Committee of Unsecured Creditors of Schlotzsky's, Inc. v. Grant Thornton, LLP, Adv. No. 05-5109, 2006 Bankr. LEXIS 2435 (Bankr. W.D. Tex. 8/30/06).

In the Grant Thornton case, the creditors' committee received permission to sue the debtor's auditors. They brought seven causes of action, five of which arose under state law. Grant Thornton responded with a motion to abstain from hearing the state law claims and a motion to dismiss. In denying the motion to abstain, Judge Clark resisted the temptation to check off factors on a multi-prong test. In fact, he questioned the usefulness of such tests in general. He stated:

"Many courts, in an effort to give expression to the parameters of that (equitable) discretion, have developed multi-factor tests. While helpful, they are by their very nature, not dispositive. Mechanical applications of such tests to rule on equitable issues that are heavily fact-specific are often doomed to produce incorrect outcomes. The various tests offered by these opinions must be viewed in the larger context of the task presented--to arrive at the equitable application of the permissive abstention doctrine, as appropriately applied in the bankruptcy context. Or, more simply, we must avoid losing the forest for the trees."

Slip Op. at 5.

Judge Clark illustrated his point in a footnote which only he could have written.

"A person is sent into a crowded room with directions to find Judge Clark by applying the following multi-factor test: (1) tall, (2) blond hair, (3) angular features, (4) dressed stylishly and (5) having a resonant voice. The person returns with David Bowie in tow. If the person had simply been given a recent picture of Judge Clark (which would have been worth far more than all the factors one could write down on a piece of paper), chances are he would have quickly returned with the judge, not the singer."

Instead, Judge Clark tried to identify the larger policies served the abstention doctrine, stating:

"The larger context of permissive abstention is informed by the base principles that led to its inclusion in the bankruptcy jurisdiction statute in 1978. Those principles included the importance of centralized administration in one forum, the breadth of bankruptcy jurisdiction intended to have been conferred, the need to deal with unexpected exigencies or to step back when the matter to be litigated is especially important to be resolved in a state forum, and the need to do justice (as well as to avoid doing an injustice)."

Slip Op. at 5.

In the discussion which followed, Judge Clark addressed some of the boilerplate allegations which turn up in most motions to abstain:

* Forum Shopping
* State Law Issues
* Non-Core Status

With regard to forum shopping, Judge Clark pointed out that all parties with a choice of venue engage in forum shopping. The pertinent question is whether the particular exercize of forum shopping is abusive or consistent with the jurisdictional provisions of the Bankruptcy Code. In this case, the presumption in favor of centralizing proceedings related to the bankruptcy case in the Bankruptcy Court won out.

With regard to the prevalence of state law issues, Judge Clark pointed out many of the issues which the bankruptcy court deals with a daily basis, such as property of the estate, allowance of claims, determination of exemptions, validity and priority of liens, avoidance actions brought under section 544(b) and questions concerning the enforceability of executory contracts, all arise under state law. Judge Clark had previously ruled upon a case involving professional liability. Therefore, the mere presence of questions of state law was not dispositive.

With regard to non-core status, Judge Clark pointed out that this should really be a non-factor, since bankruptcy courts are expressly given the authority to hear non-core proceedings in the jurisdictional scheme of title 28. "Unless we are to read Congress' own enactment of section 157(c)(1) of title 28 as a perverse sort of statutory self-fulfilling prophesy, that section's operation should not factor into the abstention calculus." Slip Op. at 9. Properly understood, non-core status is a prerequisite to asking the abstention question. However, beyond that, it is not independently important.

At the end of the day, Judge Clark found that abstention was not appropriate.

It is refreshing to see Judge Clark take on some of the dogma surrounding abstention doctrine. So many of the opinions about abstention (and the briefs citing those same opinions) are long and self-important. However, abstention is really just about whether a particular choice of forum would be unfair. Although he did not use this specific formulation, his concept of not losing the forest amongst the trees could be summed up in two questions (which are arguably a multi-factor test themselves, but are certainly more direct and to the point):

(1) Is the Plaintiff trying to obtain an unfair advantage by its choice of forum?
(2) Is the Defendant being unfairly prejudiced by the choice of forum?

The answers to those questions should generally result in an answer as reliable as the multi-pronged tests.

(Note: In fairness to the promulgators of multi-factor tests, this approach is at least implied by the statute, which lists the interest of justice, comity with state courts and respect for state law as factors to be considered).

More Lawyer Problems in Houston

Judge Letitia Clark has added an entry to the growing list of opinions dealing with attorney problems in the Southern District of Texas. In In re John M. Diaz, No. 05-95123, 2006 Bankr. LEXIS 2008 (Bankr. S.D. Tex. 8/28/06), the Debtors' attorney in a chapter 13 case filed a fee application requesting $4,132.00 in fees and $301.50 in expenses. Apparently the Court had been tipped off as to problems with the case because both Debtors and several employees from the attorney's law firm testified at the fee application hearing. The picture painted by that testimony was not pretty.

According to the Debtors, they met with their attorney once for 30-40 minutes before filing the initial schedules and plan. They were not asked any questions about their budget. However, the documents filed under penalty of perjury included a detailed budget which contained just enough disposable income to pay secured claims and 7% to unsecured creditors. The Debtors then amended their plan and schedules five times with the result that under the final confirmed plan unsecured creditors were to receive a dividend of 100%. One of the amended schedules included an expense item of $800 per month despite the fact that the debtors had not made charitable contributions in several years. The Debtors testified that they did not understand the various changes to their schedules and plans and that all of their communications with the law firm were through secretaries and paralegals.

When Debtors' counsel realized that he was in trouble, he offered to reduce his fee to $500. However, the Court did not accept this offer. Instead, the court denied all fees. The court stated:

"In the instant case, (attorney) presented false schedules to the court, without adequately counseling his clients as to what the schedules represented, and without conducting any investigation into their veracity. It appears that the schedules contained figures invented by (attorney) or his subordinates, and filed for the improper purpose of evasion of Debtor's obligations to pay creditors. These services violated counsel's duty to instruct and supervise the Debtors, and violated (attorney's) ethical duty of candor to the tribunal. The services rendered by (attorney) and his subordinates were of zero value, no matter how much time was spent on such services, and irrespective of the ultimate confirmation of the plan in the instant case. In addition, (attorney) has imposed considerable burdens of time and detailed attention on his clients, the Trustee, and the court system, through his inadequate client counseling, filing of false documents, and lax supervision of staff."

Slip Op. at 13-14.

The facts of this case, if accurately found by the Court, are shocking. The Court found that the law firm made up numbers to minimize the Debtors' disposable income, did not bother to obtain actual expense figures and did not tell the Debtors what they were signing. It strains credibility a little bit to assume that Debtors making $11,000 a month were not sophisticated enough to know that something was not right with their filings, especially after the trustee requested amendments at the creditors meeting and filed several motions to dismiss based upon the inaccurate schedules. It also seems foolish at best that the attorney would risk being caught and exposed (as he ultimately was) just to earn a fee in a chapter 13 case.

On a certain level, this opinion is good because it points out that there are consequences for bad behavior. However, in a world of trial by anecdote, it gives fuel to the bankruptcy reformers who believe that all debtor's lawyers are unethical and out of control. This case is noteworthy precisely because it is an aberration. This was a case where the system worked. Therefore, it should not be viewed an an indictment of the system or the vast majority of the participants within that system.