Friday, October 17, 2008

BAPCPA At Three Years Old: Measuring the Statistical Impact on Texas Filings

Today is the third anniversary of the effective date of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which seemed like a good time to look at the lasting impact of this legislation on bankruptcy filings. At this point, filings remain substantially down from the period prior to adoption of the statute. In fact, BAPCPA may have eliminated over 121,000 filings in Texas over a three year period. BAPCPA has also had a smaller impact in encouraging debtors to choose chapter 13 over chapter 7. However, the fact remains that cases under both chapter 7 and chapter 13 are way down.

How to Slice the Numbers

Most bankruptcy statistics are reported based on either a calendar year or a fiscal year which coincides with a calendar month. This is not very useful for evaluating the effect of BAPCPA because its effects took place within the middle of two months. Specifically, the legislation was adopted on April 20, 2005 and took effect on October 17, 2005. During the period between adoption and the effective date, there was an historic surge in filings followed by a substantial drop-off. Thus, to accurately measure the effect of BAPCPA, it is necessary to find a "normal" period of time to compare to each of the years which began on October 17 and ended on October 16 after the effective date. Additionally, in order to gauge the true impact of the legislation, it is necessary to factor out the huge increase in filings leading up to the effective date.

To accomplish this goal, I selected the period of October 17, 2003 to October 16, 2004 as my baseline or "normal" year. In a previous article, I used the period from April 20, 2004 to April 19, 2005 as my baseline period. However, there was already evidence of increased filings during the months when Congress was debating BAPCPA so that it was necessary to step back a little further. I used the period from October 17, 2004 to October 16, 2005 as my surge period. While there was not a surge going on for all of these months, the use of an annual period made it easier to calculate the full effects of the legislation. Then I used each of the years from October 17 to October 16 as my post-BAPCPA period.

Annual Filing Rates

The following table looks at the total filing rates for the state for each of the five years being compared.

The graphics are somewhat hard to read. However, the story that the numbers tell is that in 2003-2004, there were 92,872 chapter 7 and chapter 13 filings in Texas. This surged to 135,900 in 2004-2005. In the first year after BAPCA, filings dropped to just 29,163. In the two most recent years, they have grown to 41,095 and 43,631. This means that Texas chapter 7 and chapter 13 filings had dropped 53% from the last "normal" pre-BAPCPA year of 2003-2004. This indicates that BAPCPA is having a long-term effect on filings. The decline in filings is being felt across the board. While chapter 7 filings were down 60% from the pre-BAPCPA level, chapter 13 filings were down 44% as well.

Difference in Filings Because of BAPCPA

One way to look at the numbers is to project what filings would have been under the old law and compare them to filings under the new law. I started with the 2003-2004 filings of 92,872. Over three years, it could be predicted that there would have been 278,816 filings in Texas. There were actually 113,889 filings during the three years of 2005-06, 2006-07 and 2007-08. However, to get an accurate picture, it is necessary to subtract out the excess "surge" filings from 2004-05. Most likely, many of these debtors accelerated their decision to file bankruptcy. There were 43,028 filings in 2004-05 in excess of the baseline year. When these figures are added together, they indicate a net loss of almost 122,000 cases over three years.

Predicted Three Year Filings:
Less Actual Filings:
Less "Surge" Filings:
Net Loss:

While BAPCPA was intended to encourage debtors to file chapter 13, it has resulted in a dramatic decrease in the number of chapter 13 cases filed. Chapter 13 filings in Texas during 2007-08 were 44% below their level in 2003-04. Using the same calculation, the number of chapter 13 filings lost can be estimated as follows:

Predicted Three Year Filings:
Less Actual Filings:
Less "Surge" Filings:
Net Loss of Chapter 13 Cases:

Change in Chapters Filed

Although BAPCPA resulted in a net drop in the overall number of chapter 13 cases filed, it did result in a shift in the relative percentage of each chapter of cases filed.

In 2003-04, 57% of the cases were filed under chapter 7 and 43% were filed under chapter 13. Two years later in the first post-BAPCPA year of 2005-06, this had changed to 40% chapter 7 cases and 60% chapter 13s. In the most recent year of 2007-08, the breakdown was 49% for chapter 7 to 51% for chapter 13. Thus, one effect of BAPCPA has been to make chapter 13 the more commonly used chapter, although the gap has narrowed substantially.

Thursday, October 16, 2008

Bankruptcy Court Stakes Out Unique Position on Sec. 522(b)(3)(A) as Choice of Law Rule, Relies on Former State's Law Without Regard to Actual Residenc

A new decision from Bankruptcy Judge Craig Gargotta is likely to prompt discussion as the court held that a debtor could be prohibited from using federal exemptions based on the law of his prior residence even though that state's law only prohibited "residents" of the state from using the federal exemptions. In re Camp, No. 08-11056 (Bankr. W.D. Tex. 9/25/08). In so ruling, Judge Gargotta disagreed with the opinion in In re Battle, 366 B.R. 636 (Bankr. W.D. Tex. 2006) from his Western District colleague Leif Clark.

The Facts

Melvin Camp moved to Texas from Florida. Under 11 U.S.C. Sec. 522(b)(3)(A), his choice of exemptions was governed by the law of Florida because he had not resided in Texas for the requisite 730 days. Mr. Camp was a prime candidate to use the federal exemptions. His paltry possessions added up to only $24,205, but included cash of $3,100, a lot which was not his homestead valued at $4,500 and a pickup truck worth $13,750. Under the federal exemptions, he would be able to keep all of these assets.

The Debtor's lawyer had no doubt read In re Battle, which held that Sec. 522(b)(3)(A)'s mandate to apply Florida law meant to apply it exactly as written. Since Florida law prohibited residents of Florida from using the federal exemptions and Mr. Camp was NOT a resident of Florida, he should be able to claim federal exemptions and keep his property.

The Trustee objected to the Debtor's exemptions claiming that In re Battle was incorrectly decided. The Bankruptcy Court agreed with the Trustee and denied the exemption.

When Does A Statute Not Mean What It Says? When It is a Choice of Law Provision.

The Florida statute appears clear. It states that "residents of this state shall not be entitled to the federal exemptions provided in s. 522(d) of the Bankruptcy Code of 1978." Based on this language, Judge Clark's Battle opinion held that where Florida had adopted a limitation applicable to residents of Florida and Congress had deemed that the statute apply to persons who no longer resided in Florida, that the statute should be applied exactly as written--in other words, that Texans subject to Florida exemption law were not prohibited from using the federal exemptions.

Judge Gargotta acknowledged that, "At first blush, these courts' reasoning appears sound. It relies exclusively on the language of the applicable opt-out statute." Opinion, p. 4.

However, Judge Gargotta went on to consider Congress's intent in adopting these provisions and how they should be applied.

Florida has thus expressed its judgment that its residents who file bankruptcy should be restricted to claiming Florida exemptions. Congress decided when it enacted the 1978 Bankruptcy Code to honor such decisions by the states that have made them, by expressly incorporating such "opt-out" provisions by reference in Sec. 522(b)(2).

Residency restrictions in a state's exemption laws, including residency restrictions applicable to its opt-out statute, are equivalent to choice of law provisions--they address the question of what state's laws should determine the exemptions of a debtor who has moved from one state to another. (citation omitted). However, by adopting Sec. 522(b)(2) and (3)(A), congress expressed its own judgment that, in instances where a debtor moves from one state to another within 730 days before filing bankruptcy, his exemptions should be determined by the laws (including any opt-out law) of his former domiciliary state. Thus, the issue in this case (and in Battle and similar cases) arises because of the conflict between a state law choice of law provision and the federal choice of law provision contained in Sec. 522(b)(2) and (3)(A). Such conflicts are traditionally resolved by applying the doctrine of preemption. (citations omitted).

The courts deciding Battle and similar cases, however, did not address this conflict between the applicable state opt-out statute and the federal statute, Sec. 522(b)(3)(A), or the question of preemption. Instead, those courts assumed, without discussion, that Sec. 522(b)'s incorporation of each state's substantive exemption laws also incorporated the state law choice of law provisions that each state applies to its exemption laws outside of bankruptcy (e.g., the residency restriction in its opt-out statute). In doing so, those courts have effectively written out of Sec. 522(b)(3)(A) Congress's own considered policy judgment on which state's law should apply when a debtor moves before filing bankruptcy.

Opinion, pp. 4-5.

The resourceful Judge Gargotta came up with an interesting example to make his point about how literally following a state's laws could frustrate the intent of Congress. Idaho law provides that residents of Idaho are entitled to use the Idaho exemptions and that nonresidents are entitled to use the law of the state of their residence. If this provision were applied literally, a debtor who moved from Idaho to another state would automatically be allowed to use the law of the new state despite Congress's mandate to apply Idaho law.

Judge Gargotta ultimately concluded that the proper approach was to apply the laws of the prior state "as if he had not moved for purposes of determining what property he may claim as exempt." Opinion, p. 8. Indeed, he adopted the position that in applying Sec. 522(b)(3)(A), the court must disregard the reality that the debtor actually resides in the state where he lives.

For example, if thirty days before filing bankruptcy a debtor moved from Texas to Louisiana and purchased a home, Sec. 522(b)(3)(A) requires the bankruptcy court to "disregard the element of reality" of the actual state of the debtor's residence (Louisiana), and instead engage in the fiction of considering the state of his or her former residence (Texas) to be the state where he or she currently resides. If the debtor chooses state exemptions, Texas exemption laws would apply to the debtor's home and other property located within the state--in this case, within "Louisiana qua Texas." This is not, however, the extraterritorial application of Texas's exemption laws. It is not under the authority of the State of Texas that its exemption laws are being applied to property outside Texas. Rather, it is a federal choice of law statute--Sec. 522(b)(3)(A)--that has expressly provided that the exemption laws of a particular state--Texas--are applicable to a debtor who, by definition, is no longer a domiciliary of that state and so whose property is almost certainly no longer located within that state.

Opinion, p. 11.

What Does It All Mean?
This is a difficult opinion to digest. It will likely result in the death of many trees (or perhaps the consumption of many electrons) as law professors try to sort this out. Judge Gargotta acknowledged that, "(N)o other court has yet expressly held that a state residency restriction in an opt-out statute is a choice of law provision that is preempted by Sec. 522(b)(3)(A)." Opinion, p. 7.

However, despite the density of the reasoning, there is a simple logic to the result--namely, that a debtor should neither be advantaged or disadvantaged by a move within 730 days before bankruptcy. While Sec. 522(b)(3)(A) has often been viewed as a measure designed to punish debtors who move to exemption friendly states, it can also have the reverse effect. If a debtor moves from Texas with its unlimited exemption to Maryland which has no homestead exemption, the Debtor could enjoy the benefits of the Texas exemption in Maryland.

Wednesday, October 08, 2008

First Circuit Reverses Massive Damage Award Based on Application of Chapter 13 Mortgage Payments

Application of mortgage payments in chapter 13 is a thorny problem. Although the Debtor may not modify the terms of a mortgage on a primary residence, she may cure the arrearages while remaining current on the post-bankruptcy mortgage payments. However, if the Debtor defaults on the post-petition payments, those may be rolled into the plan as well. Thus, the mortgage company may simultaneously be receiving payments on pre-petition arrearages, current post-petition payments and post-petition arrearages. If these various payments are not posted correctly, the Debtor may face late charges and default notices which are not warranted. In one recent case, the Bankruptcy Court awarded massive damages to a debtor who received a misleading payment history, but did not suffer any other adverse actions. That award has now been reversed by the First Circuit, which found that Section 1322(b) does not impose duties on lenders. However, the First Circuit offered some suggestions on how the legal issue could be addressed in the future. In re Nosek, No. 07-2173 (1st Cir. 10/3/08).

What Happened

The Nosek case started with a $90,000 mortgage against a home in Massachusetts. After the Debtor defaulted, she filed several chapter 13 proceedings. The Debtor defaulted on her post-petition payments and entered into a stipulation with the lender to bring these amounts current. The Debtor confirmed a plan which provided for her to make her arrearage payments to the chapter 13 trustee and to make her regular payments directly to her mortgage company, Ameriquest.

The Plan did not specifically address how payments made under the plan should be credited. Apparently, Ameriquest used a dual system for recording bankruptcy payments. Under its regular accounting system, payments were applied to the oldest payment due first. If a payment was not sufficient to cover a full payment, it was held in a suspense account until it could be applied to a full payment. Ameriquest also kept a manual ledger where it tracked whether post-petition payments were being received on a timely basis.

Problems arose when Ms. Nosek sought to refinance her mortgage. In connection with her proposed refinancing, she requested a payment history. The history which she received was the general one which applied payments received to the oldest payment due. While it is not completely clear from the court's opinion, it appears that Ms. Nosek was not charged any extra fees or charges based upon the erroneous accounting. Indeed, the manual accounting (which the Debtor did not receive) showed her to be current on post-petition payments. Upon receiving the payment history, the Debtor became very distressed. This in turn distressed her attorney, who pragmatically filed a "Motion to Determine the Amount of Liens." The Bankruptcy Court ordered Ameriquest to provide the Debtor with an explantion of its accounting. When Ameriquest failed to do so, the Bankruptcy Court awarded sanctions of $500 and ordered the Debtor to file an adversary proceeding.

The Debtor filed an adversary proceeding containing multiple causes of action. At trial, the Debtor failed to prove that she had suffered any economic damages from the accounting she received. She did not show that she had been charged any unearned fees and failed to prove that she was denied her refinancing based upon the payment history. The Bankruptcy Court awarded nominal damages under RESPA and the Massachusetts Consumer Protection Act. The Bankruptcy Court also found that Ameriquest had violated the duty of good faith and fair dealing by failing to credit the payments properly. It awarded actual damages of $250,000 for emotional distress and punitive damages of $500,000. The duty of good faith and fair dealing ruling was based upon a violation of 11 U.S.C. Sec. 1322(b)(5), which allows a debtor to include provisions in a plan providing for the cure of a default.

On appeal, the District Court reversed the awards under RESPA and the duty of good faith and fair dealing, finding them to be pre-empted. It remanded for the Bankruptcy Court to consider damages under Sec. 105(a) and to reconsider its award under the Massachusetts Consumer Protection Act. On re-hearing, the Bankruptcy Court determined that the Consumer Protection Act claim was also pre-empted but awarded the same damages as before, but this time under Sec. 105(a). The District Court affirmed this judgment.

The Court of Appeals Ruling

The First Circuit reversed and directed that the judgment be vacated and the case dismissed. The main conclusion of the opinion was that Sec. 105(a) did not provide a basis for damages, since Sec. 1322(b) did not impose any duties upon the lender. The Court referred to Sec. 105(a) as a statutory contempt remedy, but pointed out that it must be used in the enforcement of another provision of the Bankruptcy Code. Since Sec. 1322(b) addresses provisions which a Debtor may include in a plan, it does not impose any duties upon creditors. The Court stated:

Ameriquest contests the bankruptcy court's conclusion that the company defied the text of Sec. 1322(b). It argues that the language of Sec. 1322(b) does not impose obligations on any party, let alone a lender. We agree. The plain language of Sec. 1322(b), relied upon by the bankruptcy court to find a violation of the code, does not impose any specific duties on a lender. It merely lists elements that a Chapter 13 debtor may include in her plan.

* * *

Because Sec. 1322(b) merely provides optional elements that a debtor may incorporate into her Chapter 13 Plan, the provision has no meaning separate and apart from the choices the Debtor makes and incorporates into her Chapter 13 Plan. In other words, to determine whether and how Nosek took advantage of the cure opportunity provided by Sec. 1322(b)(5), and whether her excercise of her cure rights was threatened by Ameriquest's accounting, we must look to the terms of Nosek's Plan itself.

Opinion, at 22, 24

The Court of Appeals found that the Plan did not contain any provisions governing accounting for payments. It merely stated that the Debtor would continue to make her regular payments and would cure the arrearage by making 60 payments of $313.52 per month. The Court found that this language did not impose any duties on the creditor.

Like the text of Sec. 1322(b), this language does not place any specific obligations on Ameriquest, accounting or otherwise. Although we agree that the statement must be read in light of the purposes of Sec. 1322(b)(5) and Chapter 13 more generally--that a debtor can sure a default by paying off her pre-petition arrearages in a reasonable amount of time--this purpose along does not change the nature of appellant's obligations in this case. The Plan language says nothing about how Ameriquest must account for pre- and post-petition payments during the course of the repayment period if payments are short, late, or not made at all. Simply put, the terms of the Plan itself do not provide the specificity required to invoke the enforcement authority of Sec. 105(a).
Opinion, page 25.

The Court also faulted the Debtor for failing to prove injury.

Although a debtor need not show proof of economic damages to establish that her cure rights have been violated, she must at least establish that her right to cure the pre-petition default provided by the Chaper 13 Plan has been impaired or threatened by the creditor's actions. Nosek's subjective fear of such impairment, based on a document prepared by Ameriquest for internal purposes only, and in the absence of any evidence that the company regarded her as in default on the basis of its accounting practices, does not suffice. Indeed, Ameriquest stated that its internal records showed that Nosek was considered current in her payment history.

Opinion, page 27.

Finally, the Court of Appeals made clear that its ruling was not an endorsement of sloppy accounting practices.

Notwithstanding these legal conclusions, we are not unsympathetic* to Nosek's predicament as a debtor seeking to satisfy the terms of her Chapter 13 Plan and stave off foreclosure of her home. Her circumstances are all too common today. Given their prevalence, it is troubling that Ameriquest had not established a more efficient and accurate way of handling the accounting issues revealed by this case at the time of trial. We fully understand the bankruptcy court's concerns about the practices that it described.

Nevertheless, the bankruptcy court's legitimate concerns did not justify the remedy that it invoked. Nosek did not demonstrate here that Ameriquest's accounting practices caused her any economic harm or threatened her right to cure her pre-petition default. Moreover, even if such threat had been demonstrated by those practices, there was no language in Nosek's Plan, as it was confirmed, or in Sec. 1322(b), that addressed how Ameriquest was to apply the payments it received from Nosek or from the Trustee. Under such circumstances, the Plan would have to be amended to prescribe the accounting practices necessary to protect Nosek's right to cure before Ameriquest could be sanctioned for a violation of an order of the bankruptcy court.

Opinion, pages 29-30.

What to Make of This

There is a saying that pigs get fat and hogs get slaughtered. Certainly the fact that the Debtor almost recovered $750,000 for failure to correctly apply several thousand dollars worth of payments and did not suffer any economic damages suggests that the Debtor, with the aid of the Bankruptcy Court, had become a hog. As distressing as this must have been for the Debtor, this particular case did not present an abuse which would shock the conscience. Indeed, this fuss could easily have been cleared up once the Debtor got Ameriquest's attention (which appears to have been a little slow in coming).

Having said all that, the Court of Appeals did a good job of keeping its eye on the ball. It focused on the plain language of the statute and the plan and pointed out what could have been done differently. For Debtor's lawyers, the message is clear: draft your plans carefully. A plan which required that payments be applied separately to arrearages and regular payments and required notice of additional fees and charges being incurred would have put more teeth in the Debtor's plan. Since many districts use form plans, this is an excellent opportunity for the bankruptcy bar to cooperatively design plan language which addresses this issue.

In a footnote, the Court of Appeals also noted that BAPCPA added Sec. 524(i), which provides that a creditor violates the discharge injunction if it willfully fails to credit payments received under a plan in the manner specified by the plan if the failure to act causes material injury to the debtor. Under this subsection, Debtor's attorneys would be well advised to seek an accounting for payments made once the plan is completed. That way, if there is a problem, it can be addressed promptly with Sec. 524(i) as an attention getter.

Friday, October 03, 2008

Vice-Presidential Candidates Debate Bankruptcy Reform

Bankruptcy reform received attention at the Vice-Presidential debate last night as viewers witnessed a gaffe from the moderator and Sen. Biden staked out a bold position on modifying home mortgages.

Moderator Gwen Ifill asked Gov. Palin about bankruptcy reform, but managed to muddle her question:

IFILL: Next question, Governor Palin, still on the economy. Last year, Congress passed a bill that would make it more difficult for debt-strapped mortgage-holders to declare bankruptcy, to get out from under that debt. This is something that John McCain supported. Would you have?

Of course, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was not passed "last year." Also, while the legislation made it more difficult to file bankruptcy in general, it did not make any substantive changes to home mortgages. It just goes to show that even smart people from PBS can get their facts wrong.

Initially both candidates dodged the question. Gov. Palin said that she would have supported the legislation at the time, but intimated that she would not support it today--and then changed the subject.

PALIN: Yes, I would have. But here, again, there have -- there have been so many changes in the conditions of our economy in just even these past weeks that there has been more and more revelation made aware now to Americans about the corruption and the greed on Wall Street.

We need to look back, even two years ago, and we need to be appreciative of John McCain's call for reform with Fannie Mae, with Freddie Mac, with the mortgage-lenders, too, who were starting to really kind of rear that head of abuse.

And the colleagues in the Senate weren't going to go there with him. So we have John McCain to thank for at least warning people. And we also have John McCain to thank for bringing in a bipartisan effort people to the table so that we can start putting politics aside, even putting a campaign aside, and just do what's right to fix this economic problem that we are in.

It is a crisis. It's a toxic mess, really, on Main Street that's affecting Wall Street. And now we have to be ever vigilant and also making sure that credit markets don't seize up. That's where the Main Streeters like me, that's where we would really feel the effects.
When Sen. Biden was asked about his support for BAPCPA, he initially gave a disjointed answer, but then dropped a bombshell.

IFILL: Senator Biden, you voted for this bankruptcy bill. Senator Obama voted against it. Some people have said that mortgage- holders really paid the price.

BIDEN: Well, mortgage-holders didn't pay the price. Only 10 percent of the people who are -- have been affected by this whole switch from Chapter 7 to Chapter 13 -- it gets complicated.

But the point of this -- Barack Obama saw the glass as half- empty. I saw it as half-full. We disagreed on that, and 85 senators voted one way, and 15 voted the other way.

But here's the deal. Barack Obama pointed out two years ago that there was a subprime mortgage crisis and wrote to the secretary of Treasury. And he said, "You'd better get on the stick here. You'd better look at it."

John McCain said as early as last December, quote -- I'm paraphrasing -- "I'm surprised about this subprime mortgage crisis," number one.

Number two, with regard to bankruptcy now, Gwen, what we should be doing now -- and Barack Obama and I support it -- we should be allowing bankruptcy courts to be able to re-adjust not just the interest rate you're paying on your mortgage to be able to stay in your home, but be able to adjust the principal that you owe, the principal that you owe. (emphasis added). That would keep people in their homes, actually help banks by keeping it from going under. But John McCain, as I understand it -- I'm not sure of this, but I believe John McCain and the governor don't support that. There are ways to help people now. And there -- ways that we're offering are not being supported by -- by the Bush administration nor do I believe by John McCain and Governor Palin.
Until recently, the Obama-Biden ticket's support for bankruptcy reform has been somewhat tepid. Earlier this year, both Sens. Obama and Biden voted for a proposal to allow bankruptcy judges to modify home mortgages, although that proposal was defeated. The Obama-Biden campaign's website, which is laden in detailed proposals does not mention modifying home mortgages in its section on Bankruptcy Reform. However, it does contain this proposal within its section titled Protect Home Ownership and Crack Down on Mortgage Fraud. No doubt this is a case of poor editing and not an attempt to confuse bankruptcy junkies.

In published accounts, Sen. Obama has championed incremental change, such as exempting military families, senior citizens, victims of national disasters and persons filing due to medical bills from credit counseling and means testing, supporting a minimum national homestead exemption for senior citizens and proposing a 120 day moratorium on foreclosures and credit reporting (although some reports have also mentioned modifying home mortgages in passing). In his acceptance speech in August, Sen. Obama mentioned reforming bankruptcy laws to protect people's pensions. Finally, just last week, Sen. Obama opposed adding bankruptcy reform to the Wall Street rescue plan.

Now that Sen. Biden stressed modifying home in the debate, the issue is likely to take on a higher profile. Thus far, the McCain-Palin ticket has railed against Wall Street greed, but has not taken a stand on bankruptcy reform (at least not that I have been able to find). It will be interesting to see whether this issue is addressed further in the upcoming debates between the presidential candidates.

Thursday, October 02, 2008

Equitable Mootness Fails to Prevent Disgorgement

The Schlotzsky's case got a little woolier as the Fifth Circuit ordered that an appeal over funds disbursed from a reserve account could not be dismissed based upon equitable mootness. Wooley v. Faulkner, No. 07-50912 (5th Cir. 8/28/08).

The Schlotzsky's case involved disputes between John and Jeffrey Wooley and the Debtor. Prior to a change in management, the Wooleys (who had been officers and directors) had made secured loans to the company with the approval of the then Board of Directors. After bankruptcy, the Unsecured Creditors' Committee brought suit for equitable subordination. In an elaborate mechanism, the Wooleys received a distribution of $2,867,600 on their secured claim, but had to post a letter of credit for $2,939,200 in case the equitable subordination case went against them. Additionally, the plan created a $500,000 reserve to pay any additional secured claims allowed. After the Bankruptcy Court rendered judgment subordinating the secured claims, the Plan Administrator moved to disburse the funds in the reserve account, which the Bankruptcy Court approved. Some of the funds were used to pay the Plan Administrator's attorneys. The Wooleys appealed the adverse orders on equitable subordination and disbursement of the reserve fund.

The Fifth Circuit reversed the judgment granting equitable subordination. Wooley v. Faulker, 532 F.3d 355 (5th Cir. 2008); see "5th Circuit Rejects Equitable Subordination Claim with Deepending Insolvency Aspect," A Texas Bankruptcy Lawyer's Blog (7/1/08).

Having disposed of the first appeal, the Fifth Circuit then turned its attention to the reserve fund account. The Plan Administrator raised several arguments, but the most interesting one was equitable mootness. There are numerous instances in which equitable mootness will prevent an appeal from proceeding where a stay pending appeal is not obtained and the parties have acted in reliance on the order. In those cases, the appeal may be dismissed for equitable mootness. Plan confirmations are the type of order to which equitable mootness may apply.

The Fifth Circuit described the doctrine as follows:

'The concept of [equitable] 'mootness' from a prudential standpoint protects the interest of non-adverse third parties who are not before the reviewing court but who have acted in reliance on the plan as implemented.' The ultimate question to be decided is whether the Court can grant relief without undermining the plan and thereby, affecting third parties. For the doctrine of equitable mootness to apply, the Court must determine: "...(i) whether a stay has been obtained, (ii) whether the plan has been 'substantially consummated,' and (iii) whether the relief requested would affect either the rights of parties not before the court or the success of the plan.'
Opinion, p. 6.

At first blush, the requirements seemed to be satisfiable. The Wooleys had asked for a stay pending appeal, which was denied and the plan had been substantially consummated. The difficult question was whether the appeal would affect the rights of parties not before the court or the success of the plan. The Wooleys made a wise tactical decision to limit their appeal to seeking disgorgement only of the fees paid to the Plan Administrator's counsel. The Fifth Circuit was quick to point out that they were not seeking the return of money paid to third party creditors.

In an interesting use of a double negative, the Fifth Circuit stated that the Plan Administrator's counsel "is not a party who is not before the court." (italics in original). In other words, even though the Plan Administrator's counsel was not a formal party to the appeal, they were before the court in a very practical sense of the term. The Fifth Circuit also noted that equitable mootness should not be used to prevent the disgorgement and return to the estate of attorney's fees.

In the final analysis, the Fifth Circuit remanded the case for a determination of the additional secured claim held by the Wooleys and ordered that the Plan Administrator's attorneys disgorge their attorney's fees paid out of the reserve to the extent necessary to satisfy whatever secured claim was allowed.

Fifth Circuit Dismisses Gadzooks Appeal

Practitioners waiting for further illumination of the Fifth Circuit's Pro-Snax decision will have to continue waiting. The Gadzooks case involves whether Hughes & Luce will be compensated for nearly a million dollars worth of legal work done for an equity security holders' committee in a case where subsequent, unforeseen events negated the value of the committee's work.

The Bankruptcy Court found an exception to the requirement in Matter of Pro-Snax Distributors, Inc., 157 F.3d 422, 426 (5th Cir. 1998) that services yield “an identifiable, tangible and material benefit to the bankruptcy estate.” The District Court reversed and an appeal was taken to the Fifth Circuit.

The Fifth Circuit has now dismissed the appeal for lack of jurisdiction. Kaye v. Hughes & Luce, LLP, No. 07-10813 (5th Cir. 9/9/08). When the District Court ruled, it reversed and remanded the case to the Bankruptcy Court for further proceedings. Under 28 U.S.C. Sec. 158(d), the Fifth Circuit has jurisdiction over "final decisions, judgments, order and decrees." When a case is remanded for "significant further proceedings," the order is not final. Instead, the parties must obtain leave for an interlocutory appeal under 28 U.S.C. Sec. 1292.

Now that the appeal has been dismissed, the parties must proceed with the remand and then take the case back up the appellate chain. As a result, it is not likely that the Fifth Circuit will resolve the apparent conflict between Pro-Snax and 11 U.S.C. Sec. 330(a)(3)(C) for some time.

Update on Possible Impeachment of U.S. District Judge for Bankruptcy Fraud

There has been a new development in the case of a U.S. District Judge facing possible impeachment based in part upon his conduct as a Chapter 13 debtor. On September 10, 2008, The Judicial Council of the Fifth Circuit issued an Order and Public Reprimand in Docket No. 07-05-351-0085, In re Complaint of Judicial Misconduct Against Judge G. Thomas Porteous, Jr. under the Judicial Conduct and Disability Act of 1980. The Order publicly reprimands the Judge for conduct including perjury and violation of ethical canons, orders that no new cases be assigned to him for two years or until Congress completes impeachment proceedings and suspends his authorization to employ staff.

I previously wrote about this case last January after the Fifth Circuit recommended that Judge Porteous be referred for possible impeachment proceedings. Now the Judicial Conference of the United States has accepted the Report and Recommendation from the Judicial Conference fo the Fifth Circuit.

While the Order details substantial misconduct, the following item pertains to his personal bankruptcy case.

Judge Porteous repeatedly committed perjury by signing false statements under oath in a personal bankruptcy proceeding in violation of 18 U.S.C. Sec. 152(1)-(3), 1621 as well as Canons 1 and 2A of the Code of Conduct for United States Judges. This perjury allowed him to obtain a discharge of his debts while continuing his lifestyle at the expense of his creditors. His systematic disregard of the Bankruptcy Court's orders also implicates 11 U.S.C. Sec. 521(a)(3) and 18 U.S.C. Sec. 401(1).

Order and Public Reprimand, pp. 2-3.

While a public reprimand and suspension from receiving new cases may sound mild, the Circuit stressed that it was taking the maximum action available to it.

In issuing this Order and Public Reprimand and executing the actions contained herein, the Council is taking the maximum disciplinary steps allowed by law against Judge Porteous. Any further action to remove Judge Porteous from office and the emoluments thereof is the responsibility of Congress.

Order and Public Reprimand, p. 5.

The House Judiciary Committee has formed a task force to investigate the possible impeachment of Judge Porteous.