Friday, February 23, 2007

Lunchtime Conversation Prompts Judicial Inquiry, Pt. 2

An alert reader, Jim Hoeffner with Thompson Coe in Austin, pointed out that Sec. 525(b) has been interpreted to permit private employers to refuse to hire persons who have filed bankruptcy. Pastore v. Medford Savings Bank, 186 B.R. 553 (D. Mass. 1995); In re Hendrik, 2004 Bankr. LEXIS 1649 (Bankr. M.D. Fla. 2004)("It is well established now by several cases that Section 525(b) of the Code applies only to actions taken after an employment relationship has been established and does not cover a situation which might be a discriminatory hiring practice by private employers"); In re Stinson, 285 B.R. 239 (Bankr. W.D. Va. 2002).

As a result, my statement that "an entity which which functions as a gatekeeper for the bankruptcy process appeared to be violating the Bankruptcy Code" was more a statement of what the law should be than a statement of what the law currently is. A plain reading of the text "No private employer may ... discriminate with respect to employment against, an individual who is or has been a debtor under this title ...." would seem to prohibit refusal to employ as well as discrimination after an employment relationship has been established. However, that is not what the cases say.

Thus, in reading the tea leaves from Judge Isgur's brief opinion, we are left with the following possibilities:

1. Judge Isgur may be signaling a break with the existing case law on Sec. 525(b) and is willing to entertain a cause of action for failure to hire;

2. Judge Isgur may find that discrimination in employment by credit counseling agencies, while lawful, reflects negatively upon their fitness to provide services to potential debtors; or

3. Judge Isgur may find that cause has been shown and take no further action.

Obviously, the first two possibilities are more interesting. We will have to wait and see what happens.

Thursday, February 22, 2007

Lunchtime Conversation Prompts Judicial Inquiry

Over the past year, the Houston bankruptcy court judges have written quite a number of opinions calling attention to unprofessional practices. These opinions have reacted to proceedings coming before their courts, many of which have been quite disturbing. However, now Judge Marvin Isgur has gone one step further. He has initiated a proceeding to investigate a credit counseling agency based upon a lunchtime presentation he attended. In re Credit Counseling in the Southern District of Texas, No. MC-07-301 (Bankr. S.D. Tex. 2/15/07).

Judge Isgur Gets Indigestion and Issues An Order

According to Judge Isgur:

"On January 26, 2007, the undersigned judge attended the monthly meeting of the Houston Association of Debtors Attorneys. At that meeting, the speaker was the chief executive officer of Money Management International. In responding to a question from the audience, the speaker told the assembled group that Money Management International had an employment policy that barred the employment of any credit counselor who had previously been in bankruptcy."

This concerned Judge Isgur because 11 U.S.C. Sec. 525 provides that "no private employer may ... discriminate with respect to employment against an individual who is or has been a debtor under this title ... solely because such debtor or bankrupt" has been a debtor. Thus, an entity which functions as a gatekeeper for the bankruptcy process appeared to be violating the Bankruptcy Code.

Judge Isgur noted that the U.S. Trustee is given responsibility for regulating credit counseling agencies, but surmised that "the United States Trustee would not necessarily have inquired into Money Management International's employment practices as regulated by Sec. 525 of the Bankruptcy Code." In response to this concern, the court issued an order which "requires that the United States trustee determine whether Money Management International should remain on its approved list of counseling agencies." The court scheduled a hearing for March 1, 2007 for the U.S. Trustee to advise the court as to the current status of Money Management International.

By What Authority?

Judge Isgur's concern for the integrity of the bankruptcy system is commendable. It seems apparent that he wants to encourage Money Management International to amend its ways and comply with Title 11. However, the procedure followed is somewhat novel.

Congress gave the power to regulate credit counseling agencies to the United States Trustee, a division of the Department of Justice. Under 11 U.S.C. Sec. 111(b), the United States Trustee is given authority to approve a credit counseling agency for a probationary period of six months and then for successive one year periods. Any person who disagrees with a final decision to approve or deny a subsequent one year appointment may seek review from the appropriate district court of the United States within 30 days.

If this were the entirety of the statutory scheme, then Judge Isgur would appear to be on shaky ground. However, there is another curious provision. Sec. 111(e) states that:

"The district court may, at any time, investigate the qualifications of a nonprofit budget and credit counseling agency referred to in subsection (a) above, and request production of documents to ensure the integrity and effectiveness of such agency. The district court may, at any time, remove from the approved list under subsection (a) a nonprofit budget and credit counseling agency upon finding such agency does not meet the qualifications of subsection (b)."

Thus, the "district court" is given almost blanket authority to review the status of credit counseling agencies "at any time." 28 U.S.C. Sec. 157(a)allows the District Court to refer proceedings arising under Title 11 to the Bankruptcy Court. Thus, unless the term "district court" is intended to refer to the actual U.S. District Court rather than the Bankruptcy Court acting under referral from the District Court, Judge Isgur acted exactly as Congress intended.

Who Is the District Court?

The choice of the words "district court" in Sec. 111 is unusual. In most instances, Title 11 refers to "the court" or "the bankruptcy court." The term "district court" is found in only a few sections. In a few cases, it is used to refer to the U.S. District Court appointed under Article III. For example, under the pre-BAPCPA version of 11 U.S.C. Sec. 110, the bankruptcy court was permitted to certify certain violations by bankruptcy petition preparers to the district court. (Under BAPCPA, this provision was changed to refer to "the court" and eliminate the need to certify the fact to a higher court). In Sec. 524(g)(3)(A), the issuance of certain channeling injunctions are valid if the confirmation order is issued or affirmed by the district court. Both of these sections clearly referred to the Article III court.

Two other provisions are more ambiguous. Sec. 526(c)(4) grants concurrent jurisdiction to the district courts of the state in situations where a state official could bring an action against a debt relief agency. However, other subsections within Sec. 526 refer to "the court" or "a Federal court" such that the context is not clear. In Sec. 1116(4), the debtor must file other documents required by a local rule of the district court. Bankruptcy court local rules are adopted under the authority of the district court. As a result, the reference to district court rules clearly refers to bankruptcy court rules.

While the use of the term "district court" in section 111(e) is ambiguous, it probably refers to the bankruptcy court acting under reference from the district court. The subsection contemplates the court initiating an investigation and making findings with regard to the suitability of a credit counseling agency. It is unlikely that a U.S. District Court, which has no direct dealings with credit counseling agencies, would have the time or inclination to launch such an investigation.


When I began this article, I expected to conclude that Judge Isgur had initiated a well-intentioned but unauthorized Star Chamber proceeding. I believed that the U.S. Trustee had the sole authority to regulate credit counseling agencies and that this case raised a separation of powers issue. Therefore, I was surprised to find that Congress had authorized this type of independent inquiry. This is a remarkable section of the Code and one which has received little attention.

Thus, what is really remarkable about Judge Isgur initating a Miscellaneous Case to investigate comments made at a bankruptcy luncheon is that it seems to be exactly what Congress intended. Sec. 111(e) appears to authorize the bankruptcy judge to launch independent investigations based on whatever facts come to his attention, whether in court, at a luncheon or in cocktail party chatter. This marks a dramatic shift in the role of the court. One of the hallmarks of the Bankruptcy Code of 1979 is that it removed the court from the role of administrator. Now, under BAPCPA, the same Congress which took away much of the Court's discretion with regard to means testing, has given the bankruptcy court an independent administrative role.

Wednesday, February 21, 2007

Supreme Court Limits "Absolute" Right to Convert to Chapter 13

In the first bankruptcy opinion of the term, the Supreme Court held in a 5-4 decision that a misbehaving Chapter 7 debtor does not have an absolute right to convert his case to Chapter 13. Marrama v. Citizens Bank of Massachusetts, No. 05-996, 549 U.S. ___ (2007). The Supreme Court stated that a debtor whose case could be converted or dismissed for cause under 11 U.S.C. Sec. 1307(c) had forfeited the right to proceed under Chapter 13 and thus was not a person eligible to convert to Chapter 13.

According to Justice Stevens writing for the majority:

"An issue that has arisen with disturbing frequency is whether a debtor who acts in bad faith prior to, or in the course of, filing a Chapter 13 petition by, for example, fraudulently concealing significant assets, thereby forfeits his right to obtain Chapter 13 relief. The issue may arise at the outset of a Chapter 13 case in response to a motion by creditors or by the United States trustee either to dismiss the case or to convert it to Chapter 7, see Sec. 1307(c). It also may arise in a Chapter 7 case when a debtor files a motion under Sec. 706(a) to convert to Chapter 13. In the former context, despite the absence of any statutory provision specifically addressing the issue, the federal courts are virtually unanimous that prepetition bad faith conduct may cause a forfeiture of any right to proceed with a Chapter 13 case. In the latter context, however, some courts have suggested that even a bad-faith debtor has an absolute right to convert at least one Chapter 7 proceeding into a Chapter 13 case even though the case will thereafter be dismissed or immediately returned to Chapter 7."

The Supreme Court took the course of pragmatism, finding that the bankruptcy court could skip to the ultimate result and deny the conversion where the Debtor would not be able to maintain the Chapter 13 case. However, to do this, they had to get around some apparently clear statutory language.

Sec. 706(a) states that "The debtor may convert a case under this chapter to a case under chapter 11, 12 or 13 of this title at any time, if the case has not been converted under section 1112, 1208, or 1307 of this title. Any waiver of the right to convert a case under this subsection is unenforceable." This language seems pretty straightforward. The debtor may convert "at any time." The right to convert cannot be waived. Not so fast said the nimble Justice Stevens. Section 706(d) states that "a case may not be converted to a case under another chapter of this title unless the debtor may be a debtor under such chapter." According to Justice Stevens, a person might not be eligible for Chapter 13 relief on one of two grounds. First, Sec. 109(e) might provide that the person was not eligible. Second, Sec. 1307(c) might allow the case to be dismissed for "cause." Since a case could possibly be dismissed for cause, a person committing an act constituting cause was never eligible to be a debtor under Chapter 13 and his request for conversion could be denied.

In a display of consistent dedication to text, Justice Alito, joined by Chief Justice Roberts and Justices Scalia and Thomas, dissented. They pointed out that the statutory language is "clear" and "unambiguously provides that a debtor who has filed a bankruptcy petition under Chapter 7 has a broad right to convert the case to another chapter." He also pointed out that the word "eligible" under Sec. 706(d) refers to eligibility under Sec. 109(e), which is appropriately titled "Who may be a debtor." Sec. 1307(c) is not an eligibility provision, but rather a device for weeding out eligible but deficient cases. "...Sec. 1307(c) plainly does not set out requirements that an individual must meet in order to 'be a debtor' under Chapter 13. Instead, Sec. 1307(c) sets out the standard ('cause') that a bankruptcy court must apply in deciding whether, in its discretion, an already filed Chapter 13 case should be dismissed or converted to Chapter 7."

The dissent also points out that the majority mistakenly decided that "following the literal terms of the Code would be pointless." Justice Alito pointed out that by denying the right to convert, the majority would deprive a debtor of the ability to propose a plan and convince the court that the plan was filed in good faith. He concluded that, "Today's opinion renders these questions academic, and little is left to guide what a bankruptcy court must consider, or may disregard in blocking a Sec. 706(a) conversion."

This is a case where the conservative justices, with their emphasis on following the text, have the better argument. In trying to simplify procedure in the specific circumstance before them, the majority has muddied the law in several important respects:

1. The court has confused eligibility to file a case with the ability to remain in that case once filed. An ineligible debtor has no right to file. However, a debtor who has committed acts which could rise to the level of cause is at least entitled to file his case and try to convince creditors and the court that he can do better for them in the current chapter. Whether "cause" exists will not be readily apparent until after the court examines the debtor's conduct in the current chapter, i.e., whether he is using chapter 13 for the good faith purpose of paying his creditors or as a continuation of his efforts to evade creditors. Because "cause" often cannot be determined at the outset of a case, it should not form the basis for eligibility to file or convert.

2. From a procedural point of view, the Supreme Court has required the "cause" determination to be made too early. If the court must determine whether "cause" to reconvert the case exists at the time of the original request for conversion, the court is making its decision based on a hypothetical set of facts. While the debtor may be able to talk about what he would do in a potential Chapter 13 case, the court would not have the benefit of seeing the actual plan proposed by the debtor or gaining the input of the Chapter 13 Trustee on that plan.

3. Finally, the Supreme Court blithely stated that federal courts are "virtually unanimous" that pre-petition bad faith conduct may forfeit the right to proceed in Chapter 13. This is not really very accurate. Indeed, some of the "virtually unanimous" cases cited by the Supreme Court dealing with pre-petition bad faith conduct do not actually support the proposition. For example, In re Alt, 305 F.3d 413 (6th Cir. 2002) relied upon a totality of the circumstances test and focused primarily upon the debtor's failure to schedule a known claim. Similarly In re Leavitt, 171 F.3d 1219 (9th Cir. 1999) relied upon a totality of the circumstances test and gave the most emphasis to the debtor's failure to schedule assets, overstated expenses and refusal to amend his plan. Most bad-faith cases rely on a combination of both pre-petition and post-petition conduct. It seems that the Supreme Court has confused general bad faith with pre-petition bad faith. This would be a huge mistake. While bankruptcy is generally designed to benefit the "honest but unfortunate" debtor, Chapter 13 has traditionally been a forum where the previously dishonest debtor may repent and amend his ways to the benefit of both himself and his creditors. Allowing Chapter 13 cases to be dismissed solely based upon pre-petition conduct would be a significant shift in bankruptcy policy.