Supreme Court Decides One Case and Hints At Result in Another

While many continuing legal education conferences consist of regurgitations of things you already know, every once in a while, you gain an insight which makes it all worthwhile. Today at the State Bar of Texas Bankruptcy Section Bench-Bar Conference, I was fortunate enough to hear Nashville Bankruptcy Judge Keith Lundin tie together today's decision in Travelers Indemnity Co. v. Bailey, 557 U.S. ___ (6/18/09) with the decision to grant cert in Espinosa v. United Student Aid Funds,Inc., 545 F.3d 1113, as amended at 553 F.3d 1193 (9th Cir. 2008), cert granted, 2009 U.S. LEXIS 4361 (U.S. 6/15/09). The common link between the two cases is whether bankruptcy court orders which could have been objected to are subject to collateral attack when they are not. In Travelers, the Supreme Court held that a bankruptcy court injunction contained in a confirmation order was not subject to collateral attack. Judge Lundin suggested that the Supreme Court might be signalling a similar result in Espinosa, a case involving a chapter 13 confirmation order.

20 Year Old Order Trumps in Travelers

The Travelers case arose out of the Johns-Manville bankruptcy case. In return for contributing $770 million to a trust created by the plan of reorganization, Mansville's insurers received the benefit of an injunction preventing suits against them. Over a decade later, plaintiffs started suing Travelers for withholding information about the dangers of asbestos or conspiring with Manville to conceal the dangers of asbestos. Many of these suits accused Travelers of acting wrongfully in its own capacity rather than as Mansville's insurer.

Travelers agreed to settle with some of the plaintiffs in return for an order from the Bankruptcy Court clarifying that the suits were barred by the original 1986 order. The Bankruptcy Court granted the clarifying order, finding that the direct suits against Travelers were encompassed by its original order.

On appeal, the Second Circuit reversed. It held that it was not enough to look to the terms of the prior order. Instead, it was necessary to deteermine whether the order was within the subject matter jurisdiction of the Bankruptcy Court. Concluding that the Bankruptcy Court did not have subject matter jurisdiction to enjoin suits against a non-debtor insurance company based on the insuror's own misconduct, the Second Circuit reversed.

On writ of certiorari, the Supreme Court reversed the Second Circuit and reinstated the Bankruptcy Court's order. The Supreme Court stated:

If this were a direct review of the 1986 Orders, the Court of Appeals would indeed have been duty bound to consider whether the Bankruptcy Court had acted beyond its subject-matter jurisdiction. (citation omitted). But the 1986 Orders became final on direct review over two decades ago, and Travelers' response to the Circuit's jurisdictional ruling is correct: whether the Bankruptcy Court had jurisdiction and authority to enter the injunction in 1986 was not properly before the Court of Appeals in 2008 and is not properly before us.

Opinion of the Court, p. 10.

Travelers Ruling Hints At Espinosa Result

While this ruling is significant, it also suggests that direction that the Supreme Court might take in a case in which it granted certiorari earlier this week. In Espinosa v. United Student Aid Funds, Inc., a chapter 13 debtor included several provisions in its plan related to student loans:

1. It provided that the student loan claim would be paid in the amount of $13,250;

2. It provided that "The amounts claimed by the United Student Loan Aid Funds, Inc., et. al. for capitalized interest, penalties, and fees shall not be paid for the reasons that the same are penalties and not provided for in the loan agreement between the Debtor and the lender."

3. It provided that amounts not paid under the plan would be discharged.

The creditor also received a notice stating that if it did not agree with the treatment provided for its claim under the plan, that it was under an obligation to object.

United Student Aid Funds, Inc. filed a claim for a higher amount, but did not object to the plan. After the debtor completed its plan and received a discharge, United began intercepting the Debtor's tax refunds. Espinosa sought to hold United in contempt, while United sought a determination that the plan could not discharge its student loan debt. The Bankruptcy Court ruled that the plan controlled and that the student loan debt was discharged.

On appeal, United claimed that the plan could not discharge the debt because the Debtor did not file an adversary proceeding seeking a hardship discharge. The Ninth Circuit disagreed, stating:

(W)hen the creditor is served with notice of the proposed plan, it has a full and fair opportunity to insist on the special procedures available to student loan creditors by objecting to the plan on the ground that there has been no undue hardship finding. Rights may, of course, be waived or forfeited, if not raised in a timely fashion. This doesn't mean that these rights are ignored, or that a judgment that is entered after a party fails to assert them conflicts with the statutory scheme or is somehow invalid.

Espinosa, at 1118.

The Ninth Circuit rejected an argument that United did not receive due process.

It makes a mockery of the English language and common sense to say that Funds wasn't given notice, or was somehow ambushed or taken advantage of. The only thing the creditor was not told is that it could insist on an adversary proceeding and a judicial determination of undue hardship. But that's less a matter of notice and more of a tutorial as to what rights the creditor has under the Bankruptcy Code--a long-form Miranda warning for bankers. If that were the standard for adequate notice, every notification under the Bankruptcy Code would have to be accompanied by Collier's Treatise, lest the creditor overlook some rights it might have under the Code.

Esinosa, at 1121.

On motion for rehearing en banc, the Ninth Circuit found it necessary to add some additional authority to its opinion. One of its insertions referred to a treatise written by Judge Keith Lundin, stating:

Rather, we agree with Judge Lundin that "Pardee and Andersen stand soundly for the better-reasoned principle that notice of how the Chapter 13 plan affects creditors' rights is all that the Constitution, the Bankruptcy Code and the Bankruptcy Rules require to bind creditors to the provisions of a confirmed plan under § 1327(a)." Keith M. Lundin, Chapter 13 Bankruptcy § 229.1 (3d ed. 2000 & Supp. 2004)."

553 F.3d at 1196.

Judge Lundin makes an interesting point. If the confirmation injunction in Travelers was valid regardless of whether the Bankruptcy Court arguably exceeded its subject matter jurisidction, wouldn't it follow that an order confirming a chapter 13 plan would be entitled to similar respect even if the debtor failed to comply with the procedural niceties for commencing an adversary proceeding.

Will Espinosa Extend the Reach of Shoaf?

The outcome in Espinosa will have significant repercussions in the Fifth Circuit. The Fifth Circuit has three opinions holding that a provision in a plan cannot determine the allowance of a claim or the secured status of the claim. In re Taylor, 132 F.3d 256 (5th Cir. 1998)(chapter 11 plan could not establish amount of responsible person liability at $0); In re Howard, 972 F.2d 639 (5th Cir. 1992)(chapter 13 plan could not reduce amount of secured claim to $500); In re Simmons, 765 F.2d 547 (5th Cir. 1985)(no res judicata effect for chapter 13 plan which erroneously listed claim as unsecured). The Fifth Circuit has held that this trio of cases is an exception to the general rule contained in Republic Supply Co. v. Shoaf, 815 F.2d 1046 (5th Cir. 1987) that unobjected to provisions in a plan are enforceable based on res judicata. Since the rationale in the Simmons trio was that additional procedural requirements were required to affect a claim, an opinion upholding Espinosa could undermine these precedents.