Sunday, April 26, 2009

Pennsylvania Judge Writes Epic Opinion on Technology and Professional Responsibility

Technology has dramatically changed the practice of law. Thanks to Westlaw and Lexis, it is no longer necessary to keep large expensive libraries. PACER and ECF have made court filings and filing documents available 24/7. I recently observed a case where the parties used GoToMeeting to handle thousands of pages of exhibits electronically. All of these developments have made the practice of law more efficient. However, a recent opinion from Judge Diane Weiss Sigmund highlights that professionals must be masters of the technology rather than being mastered by it. In re Taylor, No. 07-15385 (Bankr. E.D. Pa. 4/15/09).

The Taylor case started with a simple question that comes up frequently in consumer bankruptcy cases: Why couldn’t the creditor’s lawyer get a payment history? The answer given to this question prompted Judge Sigmund to launch a one year investigation into the technology behind the case and how it was being used and to award some very creative sanctions. The Judge authored a 58 page opinion ”to share my education with participants in the bankruptcy system who may be similarly unfamiliar with the extent that a third party intermediary drives the Chapter 13 process.” Opinion, p. 30.

What Happened

Taylor involved a chapter 13 filing to try to keep a house. Two firms appeared on behalf of HSBC, the mortgage holder. A national firm filed a proof of claim, while a local firm filed a motion for relief from stay and responded to an objection to claim. All three documents were defective. The proof of claim attached the wrong mortgage and listed the wrong payment amount. The motion for relief from stay recited that the debtors had failed to make their post-petition payments for three months, when in fact they had been making the payments, but at a lower amount due to a dispute over flood insurance. According to the Court, “at the time the Stay Motion was filed, the Debtors were short $360 for payments more than 60-days overdue, a fact not clear from the canned pleading prepared by a paralegal from New Trak screens. The Debtors were charged $800 for the cost of the motion.” Opinion, p. 14. The motion also recited that the debtors had no equity in the property which the attorney later attributed to being part of a boilerplate form. The response to the objection to claim said that the claim was just fine when it was not.

The Debtor’s attorney did not do much better. She filed a late response, which incorrectly stated that the debtors had made all of their payments but they had been returned by HSBC. The Debtor’s attorney also failed to respond to requests for admission tendered with the motion, incorrectly believing that her response to the motion was sufficient.

Upon receiving the Debtor’s attorney’s response, HSBC’s local counsel continued the hearing for further investigation. The Debtor’s lawyer then filed an amended response, which included copies of the checks for the months of September through January with both front and back and the checks for February and March with just the front. The amended response alleged that the payments for September through March had all been made. As it turns out, the reason that there were only copies of the front side of the February and March payments was because the Debtor’s counsel was still in possession of these checks which had not yet been tendered. Debtor’s counsel erroneously mailed these checks to the person at HSBC’s attorney’s office who handled Sheriff’s Sales rather than to the Bankruptcy Department. The person in the Sheriff’s Sale department sat on the checks and did not inform the Bankruptcy Department that they had been received. The Debtor’s counsel also requested a payment history.

On May 1, a young associate appeared for HSBC and insisted on prosecuting the motion even though he had been provided with proof of payments. The young attorney sought to proceed based on the deemed admissions even though he knew they were not accurate. The court denied the motion and instructed the debtor to escrow the disputed flood insurance premiums while the parties worked through the issue.

One month later, the parties appeared on the claims objection and things rapidly escalated. The young associate (he had been licensed a few months at the time) stated that he could not get a payment history from his client. He explained that he had submitted a request for a payment history through an electronic system, but that he was forbidden to speak directly with the client. This statement caused the Court to issue a show cause order.

In response to the Court’s Show Cause Order, HSBC retained new counsel and the problem with the claim was quickly settled. As noted by the Court, “What could not be accomplished for six months through the use of electronic communication was finalized in an hour the old way, by people sitting down with all relevant information and talking to each other.” Opinion, p. 19.

While the contested matters were quickly settled, the Court was not satisfied. It launched an inquiry which brought the technology center stage.

The Technology and Professional Responsibility

The technology involved was the NewTrak system developed and operated by Lender Processing Services, Inc. f/k/a Fidelity Information Services, Inc. To its credit, LPS was “extremely cooperative” with the court’s inquiry and “provided a detailed demonstration of how NewTrak works in a hypothetical case.” Opinion, p. 9, n. 15. As a result, the Court had a substantial knowledge base to draw on when writing her opinion. NewTrak is an automation system which allows lenders and attorneys to communicate with each other. The lender uploads its information onto the system which then generates a referral to an attorney on the approved list. The attorney receives the information and generates the proof of claim, motion for relief from automatic stay or other pleading. The system also allows the attorney to request information from the client by opening an issue on the system. Another system called the mortgage servicing platform handles routine mortgage servicing. According to LPS, it was used by 39 of the 50 largest banks in 2007 and processed approximately 50% of the loans in the United States.

While NewTrak provides a flow of information between attorney and client, it is not meant to prohibit direct contact between the parties. The Default Services Agreement specifically provides that “The Firm will never be prohibited from directly contacting any client where, in the professional opinion of the Firm such contact is necessary.” Opinion, p. 34, n. 45. As a result, the agreement contemplates that the Firm will exercise professional judgment. However, the Court found that when an attorney mechanically uses the system “the attorney abandons any pretense of independent judgment to the greater goal of expeditious and economical client service.” Opinion, p. 31.

The Court contrasted the benefits of using the technology with its pitfalls when a matter is not routine.

It is a regrettable reality, especially in this economic climate, that many homeowners are defaulting on their mortgages. While bankruptcy affords an opportunity to save the family home through a Chapter 13 plan that stretches the payments of mortgage arrears, it also requires debtors to maintain current payment on their mortgages. (citation omitted). This obligation is beyond the capability of many debtors who use a bankruptcy to forestall the inevitable. It seems reasonable that a mortgage lender should be able to avail itself of economic and expeditious means of collecting defaulted loans through the use of technology and delegation of tasks to lower cost labor. In many cases, the motions are granted by default, the debtors, or often more accurately their attorneys, filing no answer or making no appearance, where there is simply no defense to the relief sought. However, where, as here, the debtor contests the relief sought, the flaws in the automated process become apparent. At this juncture, an attorney must cease processing files and act like a lawyer. That means she must become personally engaged, conferring with the client directly and abandoning her reliance on computer screens as an expression of her client’s will. This did not happen in this case until the Court became involved. It should not have taken judicial intervention to bring the Claim Objection to its conclusion.
Opinion, p. 32 (emphasis added).

In this case, the court found that professional judgment was not used.
The attorney for the national firm which filed the proof of claim testified that he reviewed only a representative sample of 10% of the claims which were electronically signed with his name. He did not review the specific claim in this case and as a result, did not find the mistakes in it.

The president of the local firm which utilized NewTrak testified that he delegated the administrative aspects of the firm’s practice and was unaware of how NewTrak worked.

The head of the bankruptcy section of the firm electronically signed all of the pleadings in the matter, but delegated all of the court appearances to an attorney who had been licensed for only one month when the initial pleading was filed. The court found that the head of the bankruptcy section failed to supervise the young attorney and asked the rhetorical question, “Could it be with ten lawyers and 130 paralegals and processors, a young attorney is expected to figure it out himself?” Opinion, p. 42.

The Court also found that the client had restricted the firm’s authority.

The Udren Firm’s authority from HSBC allowed them to take only three actions: (1) seek a continuance; (2) settle with Motion with an agreement for a six month maximum cure of the mortgage arrears with an agreement for stay relief upon certification of default of any future payment; and failing either of the foregoing; (3) press the motion. (citation omitted). No consultation with HSBC was expected nor occurred during the pendency of the contested matter.
Opinion, p. 37, n. 49.

Sanctions

The Court found that several parties to the case had violated their obligations under Rule 9011, including the obligation to make reasonable inquiry. However, the Court was also mindful that sanctions should be “limited to what is sufficient to deter a repetition of such conduct or comparable conduct by others similarly situated.” Rule 9011(c)(2). As a result, the Court granted some very creative relief.

As to the Udren Firm, which acted as local counsel, the Court found that the expense of having to hire counsel and defend itself and the productive time lost in attending to the matter was punishment enough. However, the Court devoted additional attention to the specific lawyers from the firm.

The Court found that the head of the Udren Firm’s bankruptcy section “may be so enmeshed in the assembly line of managing the bankruptcy department’s volume mortgage practice that she has lost sight of her duty to the court and has compromised her ethical obligations.” Opinion, p. 52. The Court ordered her to obtain 3 credits of CLE in professional responsibility/ethics in addition to her regular requirements.

The court declined to award sanctions against the young associate, finding that “I believe these proceedings have been very hard on this young lawyer and while lack of experience is not a defense to a Rule 9011 violation, I suspect that he has learned all that he needs to learn without protracting this unfortunate time in his nascent career.” Opinion, p. 52.

The Court found that the head of the firm “sets the tone and establishes its culture. He notes his firm’s reliance on NewTrak and other such aids as essential to the economic structure of the law practice. However, he had little familiarity with the actual operation of NewTrak and did not appear to get involved in the ‘weeds’ of the bankruptcy practice.” Opinion, pp. 52-53. The Court found this lack of involvement to be troubling and ordered relief accordingly.

Mr. Udren may not be aware of the questionable practices imposed by his firm’s acquiescence to NewTrak and how little legal judgment is employed as a result or he may be aware and find it acceptable. To examine these practices in light of extant ethical obligations, I will direct him to obtain training in NewTrak and spend a day observing his bankruptcy attorneys, paralegals, managers and processors as they handle referrals. Since policy emanates from the top, I will also order Udren and (the head of the bankruptcy section) to conduct a training session for all members of the bankruptcy department in the appropriate use of the escalation procedure and the requirements of Rule 9011 with respect to pre-filing due diligence.
Opinion, p. 53.

The Court did not award sanctions against the national firm which prepared the proof of claim, but not because she found their conduct appropriate. The Court found that the record had not been fully developed with regard to this party, that the practices were national in scope and that the U.S. Trustee was investigating the firm. As a result, the Court left it to another day and another court to address these issues.

The Court found that some of the problems in the case resulted from the Udren firm's reluctance to contact its client directly and found that other firms used by HSBC might be under the same impression. As a result, the Court ordered HSBC “to prepare and transmit by mail and e-mail a letter to all the Network Firms outlining the escalation policy and encourage its use consistent with the Rules of Professional Conduct. HSBC should also advise the Network Firms that use of direct contact will not reflect adversely on the firm.” Opinion, p. 55.

The Court did not sanction LPS.

Based on the record, I find that sactions against LPS are not warranted. While it does appear from the limited screens that have been introduced in this case, that LPS’ involvement goes beyond passing data through their automatic system, I cannot conclude that it imposed restrictions on the Udren Firm’s handling of this case. (citation omitted). The Udren Firm entered into a contract with Fidelity which it viewed as advantageous to the business relationships with its mortgage lender clients and presumably its bottom line. As attorneys, the Udren Firm understood an attorney’s obligations under Rule 9011 to investigate and took a lesser approach. While NewTrak prescribed that approach, LPS did not dictate how they would handle cases referred to them when problems with the procedure were apparent. By misusing the resources made available to them, the Udren Firm, not LPS, was responsible for the Rule 9011 deficiencies in this case.
Opinion, pp. 55-56.

Conclusion

Judge Sigmund’s remarkable opinion demonstrates that she is no Luddite. Her opinion focuses on the need to exercise professional judgment in conjunction with technology rather than mindlessly bashing the technology itself. In her conclusion, she stated:

My research has disclosed no other published opinion that explains the NewTrak process that is utilized by so many consumer mortgage lenders seeking relief in bankruptcy cases. I have attempted to share my education in this Opinion. Finally, it is my hope that by bringing the NewTrak process to the light of day in a published opinion, system changes will be made by the attorneys and lenders who employ the system or at least help courts formulate the right questions when they have not. While NewTrak has many features that make a volume business process more efficient, the users may not abandon their responsibility for fairness and accuracy to the seduction of electronic communication. The escalation procedures in place at HSBC and the Udren Firm existed on paper only. When an attorney appears in a matter, it is assumed he or she brings not only substantive knowledge of the law but judgment. The competition for business cannot be an impediment to the use of these capabilities. The attorney, as opposed to a processor, knows when a contest does not fit the cookie cutter forms employed by paralegals. At that juncture, the use of technology and automated queries must yield to hand-carried justice. The client must be advised, questioned and consulted. Young lawyers must be trained to make those judgments as opposed to merely following the form manual. Until they are capable of doing so they should be supported and not left to sink or swim alone in an effort for the firm to be more profitable by leveraging the cheapest labor.

At issue in these cases are the homes of poor and unfortunate debtors, more and more of whom are threatened with foreclosure due to the historic job loss and housing crisis in this country. Congress, in its wisdom, has fashioned a bankruptcy law which balances the rights and duties of debtors and creditors. Chapter 13 is a rehabilitative process with a goal of saving the family home. The thoughtless mechanical employment of computer-driven models and communications to inexpensively traverse the path to foreclosure offends the integrity of our American bankruptcy system. It is for those involved in the process to step back and assess how they can fulfill their professional obligations and responsibly reap the benefits of technology. Nothing less should be tolerated.
Opinion, pp. 57-58 (emphasis added).

Friday, April 24, 2009

On Gunslingers, Presumptions and Burdens of Proof

There have been an increasing number of cases dealing with objections to assigned credit card debt. These cases are a bit like a showdown between gunfighters with bad aim: there is a lot of shooting, but no one hits anything. While a gunfight where no one gets shot is a good thing, the court must still decide whether to allow or disallow the claim even when there is little or no evidence introduced. As a result, rules on presumptions and burden of proof often dictate the result.

Prima Facie Valid Or Not

The starting point is Fed.R.Bankr.P. 3001(f) states that “A proof of claim executed and filed in accordance with these rules shall constitute prima facie evidence of the validity and amount of the claim.” Thus, if the creditor files its claim in accordance with the rules, it starts out with a presumption of validity. However, before the claim receives prima facie validity, it must be filed in accordance with the rules, particularly Rule 3001. Among other things, Rule 3001(c) provides that if a claim is based upon a writing, that writing must be attached or a statement must be provided explaining why the writing cannot be attached. Several courts have held that merely attaching a summary which lists the name of the original creditor, the last four digits of the account number and the balance claimed to be owed does not meet the requirement that the writing be attached to the claim, thus depriving the claim of prima facie validity. In re Tran, 369 B.R. 312 (S.D. Tex. 2007); In re Cox, 2007 Bankr. LEXIS 4048 (Bankr. W.D. Tex. 2007).

Courts have required different levels of documentation to satisfy the prima facie validity requirement. At the low end are courts requiring as little as a copy of an account statement from the original creditor, In re Griffin, 2007 Bankr. LEXIS 1749 (Bankr. W.D. Tex. 2007), while some courts require copies of the underlying contract, account statements and/or proof of assignment of the debt. In re Armstrong, 320 B.R. 97 (Bankr. N.D. Tex.2005)(account statement plus proof of assignment), In re Tran, 369 B.R. 312 (S.D. Tex. 2006)(requiring original contract), In re Leverett, 378 B.R. 793 (Bankr. E.D. Tex. 2007)(requiring documentary evidence of how claimant acquired the claim and proof that it is the holder of the claim); In re Plourde, 397 B.R. 207 (D.N.H. 2008)(requiring original contract plus statements plus proof of assignment); In re Kendall, 380 B.R. 37 (Bankr. N.D. Okla. 2007)(requiring contract plus itemization plus proof of assignment).

Effect of Prima Facie Validity

A recent opinion explained how failure to satisfy the requirements for prima facie validity affected the burden of proof on a claims objection.

Having little to none of the requirement information attached for a credit card debt, Roundup’s claim did not comply with Rule 3001(c). The Court, therefore, concludes that Roundup Funding’s claim is not entitled to prima facie validity under Bankruptcy Rule 3001(f). Without such validity, Debtors needed only to object to the claim pursuant to the applicable rules or statute, which they did. Debtors had listed this debt as ‘disputed’ so they did not judicially admit that they owe it. Although the Debtors did not attach any evidence to their objection to Claim Number 12, such as an affidavit, the objection was sufficient by being signed by their counsel under penalty of Rule 9011. (citation omitted).

After the Debtor’s valid objection, Roundup Funding had the burden of offering supporting documentation to carry its burden of proof in the face of an objection. It had to establish the claim by a preponderance of the evidence. (citation omitted). Roundup Funding presented no evidence to support its claim. Its information was submitted in the form of a response with attached exhibits, all in the nature of argument, and not by affidavit or by witness testimony. It provided no evidence to link the entity assigning the claim with an entity listed on the Debtor’s schedules. In any event, this attachment page to the claim is not a business record of the Debtor’s credit card account within the meaning of Federal Rule of Evidence 803(6).

In re Reyna, No. 08-10049 (Bankr. W.D. Tex. 7/28/08), Memorandum Opinion and Order, pp. 8-9; In re Plourde, 397 B.R. 207 (Bankr. D. N.H. 2008)(if claim is not prima facie valid, valid objection is all that is necessary to put creditor to its proof).

If the claim is entitled to prima facie validity, the Debtor must introduce sufficient evidence to rebut the prima facie case. In order to rebut the prima facie validity of a claim, the objecting party must produce “evidence tending to defeat the claim that is of a probative force equal to that of the creditor’s proof of claim.” In re Simmons, 765 F.2d 547, 552 (5th Cir. 1985). Sometimes the claim itself may be sufficient to rebut its own prima facie validity. In the case of In re Bootka, No. 08-11506 (Bankr. W.D. Tex. 2/23/09), the attachment to the proof of claim stated that the debt had been charged off more than four years before the petition date. As a result, the debt appeared to be barred by the four year statute of limitations applicable in Texas. The creditor filed an affidavit from the prior owner of the claim stating that a payment had posted to the account on January 18, 2008. This was significant because a payment could revive the statute of limitations under Texas law. However, the Court found that the creditor failed to meet its burden of proof because it did not state who made the payment or when it was actually made (as opposed to when it was posted). As a result, the prima facie case was rebutted and the creditor failed to prove its case by a preponderance of the evidence.

Judicial Estoppel/Party Admission

Sometimes, the creditor can prove its case simply because the debtor has already admitted the validity of the claim. If the debtor has scheduled a claim which can be identified to the proof of claim in approximately the same amount and has identified the claim as undisputed, then the debtor will be estopped to deny the validity of the claim or will be deemed to have made a party admission. Of course, if the debtor has scheduled the claim as disputed or if there is a significant variation between the claim and the schedules, then judicial estoppel will not apply. The case of In re Cox, 2007 Bankr. LEXIS 4048 (Bankr. W.D. Tex. 2007) illustrates how far the judicial admission doctrine may extend. In that case, the debtor scheduled three claims owing to Chase Bank. As an illustration, one claim was scheduled in the amount of $20,312.83 with the last four digits 0445. B-Real, LLC filed a claim in the amount of $21,534.50 in the name of B-Real, LLC/Chase Bank USA, N.A. on a claim with the last four digits 0445. The claim (as amended) was supported by account statements from Chase Bank showing the amount owed. Although the identity of the creditor was different, the court still found that the debtor had made a party-admission that the debt was owed. See also In re Kendall, 380 B.R. 37 (Bankr. N.D. Okla. 2007)(if debtor has listed claim as not disputed in its schedules, this is some evidence of validity). On the other hand, where the identity of the creditor was different, the schedules and the claim included different portions of the sixteen digit account number and the claim amounts were different, the court refused to apply judicial estoppel. In re Reyna, No. 08-10049 (Bankr. W.D. Tex. 7/28/08).

Judicial estoppel will only apply as to the debtor. Several courts have refused to apply judicial estoppel to the chapter 13 trustee. In re Plourde, 397 B.R. 207 (Bankr. D.N.H. 2008); In re Bootka, No. 08-11506 (Bankr.W.D. Tex. 2/23/09). The opinion from the Western District of Texas is based on Fifth Circuit precedent requiring that parties be identical for judicial estoppel to apply. Kane v. National Union Fire Insurance Co., 535 F.3d 380 (5th Cir. 2008). This result seems to follow the logic of judicial estoppel the closest, since only the party making the admission should be estopped. An opinion by the 10th Circuit BAP held that the trustee would not be bound by the debtor’s admission in the schedules, but that the schedules provided some evidence in favor of allowing the claim. In re Kirkland, 379 B.R. 341, 344, n. 12 (10th Cir. BAP 2007).

Proof of Assignment

Courts have disagreed on the extent to which proof of assignment must be established. The most creditor-friendly courts note that Rule 3001 only requires proof of assignment where the original creditor has previously filed a proof of claim. In re Gonzales, 356 B.R. 905 (Bankr. S.D. Fla. 2006); In re Griffin, 2007 Bankr. LEXIS 1748 (Bankr. W.D. Tex. 2007). Where only one creditor files a claim with respect to a debt scheduled by the debtor, the creditor will not be required to show how the debt was assigned to it. These cases take the position that if the debtor owes the debt and only one party is claiming to own it, that the debtor should not escape payment based on failure of the specific creditor to establish how it came to own the account. On the other hand, some courts have required proof of assignment and have gone further and required that the assignment reflect the specific debt rather than merely a blanket assignment. In re Armstrong, 320 B.R. 97 (Bankr. N.D. Tex.2005); In re Leverett, 378 B.R. 793 (Bankr. E.D. Tex. 2007); In re Kendall, 380 B.R. 37 (Bankr. N.D. Okla. 2007). Finally, some courts require proof of assignment, but will accept a blanket assignment. In re Samson, 392 B.R. 724 (Bankr. N.D. Ohio 2008).

Other Objections

Assuming that the claim is supported by prima facie evidence, the debtor’s objection to the claim must fall within one of the grounds identified by 11 U.S.C. §502(b), including that a claim is not enforceable under applicable law. In re Kirkland, 379 B.R. 341 (10th Cir. BAP 2007). Thus, a debtor could not object to a claim on the basis that the creditor had failed to redact the debtor’s social security number as required by Bankr. Rule 9037. Cordier vs. Plains Commerce Bank, No. 08-2037 (Bankr. D.Ct. 3/26/09). While the creditor violated a procedural rule, this was not a statutory ground for denying the claim.

Failure to file a timely claim is a stated ground for objection under 11 U.S.C. §502(b)(9). However, what happens if the claims bar date runs while the case has been dismissed, but is later reinstated? A thoughtful opinion holds that due process requires that the court be allowed to set a new bar date in this instance. In re Gulley, No. 07-33271 (Bankr. N.D. Tex. 3/3/2009).

Conclusion

Courts are struggling with objections to assigned credit card debt. Courts generally agree that a mere account summary prepared by the assignee will not satisfy the requirement to attach the documents on which the claim is based. However, courts differ as to whether the underlying contract or the account statement must be produced. A series of account statements will show that the debtor used the card and establish the pattern of dealings between the parties. This may be enough to prove the existence of a contract. Creditors should look to the proof required by a state court. If a sworn account or account statements would be adequate in state court, it should be sufficient in bankruptcy court. The underlying contract should not be necessary to satisfy the prima facie validity requirement (although many courts have required it). However, if the debtor objects to items such as calculation of interest or fees, the creditor may be required to provide the agreement in order to satisfy its ultimate burden of proof.

Courts also differ on whether proof of an assignment should be provided. On the one hand, proof of assignment is an element in establishing that the creditor is the holder of the claim. However, where the debtor has admitted owing the underlying account and no other party has filed a claim, it may be reasonable to conclude that a valid assignment occurred. Some courts have noted that Fed.R.Bankr.P. 3001(e) only requires proof of assignment of a claim if another creditor has already filed a claim. This may be misleading. Rule 3001(e) is designed to settle disputes between an original creditor and a party claiming to be an assignee. Where the claim is assigned prior to bankruptcy or prior to a claim being filed by the original creditor, there is no need to resolve this dispute. Instead, the issue concerns the more fundamental question of whether the creditor holds the claim.

The process for determining allowance of an assigned credit card debt can be summarized as a decision tree.

1. Does the claim include sufficient documentation to receive prima facie validity?
If yes, debtor must rebut prima facie case before creditor must put on case.
If no, debtor need only raise a valid objection to require creditor to carry burden of proof.

2. If claim is prima facie valid, has debtor rebutted the prima facie case?
If yes, creditor must prove claim by preponderance of the evidence.
If no, claim is allowed.

3. Has debtor judicially admitted validity of claim?
If yes, claim is allowed (unless a party other than the debtor is objecting).
If no, creditor must prove claim by preponderance of the evidence.

4. Has creditor established valid assignment of claim?
If yes, claim is allowed assuming creditor has met other requirements.
If no, claim is denied unless debtor is judicially estopped from denying claim or in jurisdictions which do not require proof of assignment.

5. If neither party has prevailed at this point, who produced more credible evidence?
If creditor, then claim is allowed.
If debtor, then claim is denied.

This article originally appeared in the ABI Consumer Bankruptcy Committee Newsletter, Vol. 7, No. 2 (April 2009).

Thursday, April 16, 2009

Sign Costs Creditor $21,800

Chuck Newton's blog, stayviolation.com, has the details on a case he recently tried in which a creditor posted a sign in a small town stating: "BRAD COLLIER OWES ME $984.23 WILL YOU PLEASE COME AND PAY ME!" The Court awarded $21,820.00 in damages for violation of the automatic stay. No. 08-2004, James Bradley Collier v. Paul Hill (Bankr. E.D. Tex. 4/7/09). Go to Posting Signs About the Debtor Can Constitute A Stay Violation on Chuck's Blog for all the details.

Wednesday, April 08, 2009

10th Circuit Affirms Denial of Employment of Attorneys Who Were Too Expensive

In these days of exponentially increasing hourly rates, a bankruptcy court told a creditors' committee that its proposed counsel was too expensive when there were local firms competent to do the work for half the cost. That decision was recently affirmed by the 10th Circuit Court of Appeals. In re Southwest Food Distributors, No. 08-5160 (10th Cir. 3/31/09).

The Debtor filed a chapter 11 petition in Tulsa, Oklahoma. The Unsecured Creditors Committee sought to employ Bell, Boyd & Lloyd, a Chicago firm, and to also employ Gable & Gotwals of Tulsa as its local counsel. Bell Boyd sought to charge rates ranging from $250 to $505 per hour. A large unsecured creditor objected on the basis that there was no need to bring in a national firm when there were local firms available at half the cost. The Bankruptcy Court agreed and approved employment of the local counsel only.

On appeal to the 10th Circuit, the Court of Appeals ruled that the Bankruptcy Court is not required to rubberstamp a party's choice of counsel even when that counsel meets the requirements of 11 U.S.C. Sec. 1103 and Fed.R.Bankr.P. 2014. The court noted that close scrutiny is required when more than one attorney is sought to be employed.

Several thoughts come to mind after reading this opinion. Many, if not most, courts require that out of district firms retain local counsel. If retaining both primary counsel and local counsel is looked upon with disfavor, this is almost a de facto rule that outside attorneys need not apply. Was the bankruptcy court engaging in protectionism here or was this simply a case which could not afford the extra attorneys? The bankruptcy court's decision to promote the committee's local counsel to lead counsel raises an interesting issue. If local counsel was chosen purely to satisfy the requirement to have a local attorney and not because they had the expertise to represent the committee, should the committee be saddled with counsel who was not their first choice? Of course, in this case, the court found that local counsel was perfectly competent and that no one had objected to their qualifications. Perhaps the committee should have selected less qualified local counsel in order to obtain their choice of lead counsel. Finally, the objection stated that qualified local attorneys could be hired at half the cost of Bell Boyd's rates of $250-$505. Does this mean that the going rate for creditors' counsel in Tulsa is $125.00-$252.50 per hour? If that is the case, the Tulsa bankruptcy bar may find itself in demand elsewhere where the going rates are much higher.

Tuesday, April 07, 2009

Leif Clark on Reaffirmations: Six Short Clark Opinions on Reaffirmation and What They Mean

Leif Clark is one of the most prolific judges on the bankruptcy bench today. His opinions are generally both scholarly and entertaining to read. However, one adjective which is not usually applied to his opinions is short. Therefore, it is worthy of note that in the past year, Judge Clark his written no fewer than six opinions denying approval of reaffirmation agreements and giving guidance to the parties with regard to the unreaffirmed debt, none of which is longer than three pages.

One line of cases involves Texas home equity loans. In re Brown, No. 08-53373-C (Bankr. W.D. Tex. 4/3/09); In re Porras, No. 07-31488-C (Bankr. W.D. Tex. 3/27/08). As noted by Judge Clark, reaffirmation of a home equity loan is a contradiction in terms, since the Texas Constitution requires home equity loans to be made on a nonrecourse basis.

The subject of the agreement is a home equity loan. Such loans are non-recourse loans, as a matter of Texas law. There is thus no personal liability on the part of the debtor to USAA Federal Savings Bank. USAA's remedies prior to this bankruptcy being filed were limited to recourse to the property in the event of nonpayment and failure to cure. The bankruptcy changed nothing with regard to the nature of this liability. The debtor's discharge has no impact at all on USAA's claim because discharge only affects the debtor's personal liability on a debt, and the debtor never had any personal liability on this debt, even outside bankruptcy. With nothing to discharge, there should be nothing to reaffirm either.

Yet USAA now wants a reaffirmation agreement from the debtor anyway. Why? To what end? Surely not because USAA fears that without such an agreement, its efforts to enforce this debt might contravene the discharge injunction. That is a red herring, if ever there was one. Enforcement of a nonrecourse debt never violates the discharge, as a matter of law.

In re Brown.

Several additional cases concern the situation where the debtors request approval of a reaffirmation but the court denies it for reasons including undue hardship, reconsideration by the debtors and untimeliness. In re Gamboa, No. 08-52028-C (Bankr. W.D. Tex. 1/7/09); In re Davidson, No. 08-51818-C (Bankr. W.D. Tex. 11/21/08); In re Self, No. 08-52687-C (Bankr. W.D. Tex. 11/21/08); In re Morales, No. 07-31453-C (Bankr. W.D. Tex. 3/27/08). In these cases, the Court denied the reaffirmation, but explained where this decision left the parties.

Notwithstanding such denial, the court finds and concludes that the creditor holds a valid and enforceable in rem claim. The creditor is accordingly expressly authorized and permitted to enforce the obligation of the debtors to the creditor as an in rem obligation, such enforcement to include the right to notify the debtor of payments that are or are to become due, the right to demand payment when such payments are not made (either in full or in part), the right to threaten resort to in rem remedies in the event of non-payment, the right to accelerate the indebtedness, the right to give notice of foreclosure sale, and the right to conduct and complete such foreclosure sale, so long as all of the foregoing are conducted in accordance with applicable non-bankruptcy law. None of the foregoing shall ever constitute a violation of the discharge injunction entered in this case pursuant to section 524(a) of title 11.

Further the creditor is authorized and permitted to communicate with the debtor regarding the status of the account, either orally or in writing, and the debtors are authorized and permitted to obtain information from the creditor, either orally or in writing, regarding the status of the account. The creditor is authorized and permitted to afford the debtors the same services with respect to this account as they would enjoy had there been no bankruptcy, including as applicable internet access to the account, the use of electronic funds transfers as a means of payment, the right to receive regular billing statements, and regular escrow updates. The provision of all such services shall never constitute a violation of the discharge injunction entered in this case pursuant to section 524(a) of title 11.

Further, the creditor is authorized and permitted to renegotiate the terms of the indebtedness with the debtors (provided that such renegotiated indebtedness shall remain as an in rem liability of the debtors), to provide payoff amounts for the purposes of any refinancing with a third party, or for purposes of a sale of the underlying property. The provision of any of the foregoing shall never constitute a violation of the discharge injunction entered in this case pursuant to section 524(a) of title 11.

In re Gamboa.

What is happening here? While these brief opinions may never find their way into the published case reports, they show the court taking an active interest in the welfare of the debtors appearing before it. Not all reaffirmation agreements should be approved. The Code prohibits the Bankruptcy Court from approving an agreement where it would constitute an undue hardship or it is not timely submitted. However, rather than simply denying the agreements and leaving the parties to figure out the consequences, Judge Clark has spelled out what it means to have an ongoing in rem obligation. While his missives may constitute advisory opinions, they are useful in that they may reassure lenders that it is okay to continue to communicate with their borrowers. More importantly, they undermine a lender's ability to retaliate against a debtor who has not reaffirmed a debt by freezing them out post-discharge.

This issue recently came up in one of my cases. A debtor had received his discharge some five years earlier. The lender changed servicers around the time of the discharge and no reaffirmation agreement was ever tendered to the debtors. The debtors continued to make their payments and ultimately refinanced the debt. When they sought to purchase a new property, the underwriters for the prospective lender could not understand how a debtor had continued to make payments on a discharged debt. As a result, they did not want to credit that payment history. I was able to provide an explanation of how bankruptcy works with a copy of the Gamboa opinion to show that I was not just making it up. Hopefully, the underwriters will read and comprehend the opinion.

Monday, April 06, 2009

When Is a Small Business Debtor Not a Small Business Debtor?

One of the changes that the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made to small business bankruptcy cases was to eliminate the ability to opt in to treatment as a small business debtor. However, it appears that the Bankruptcy Rules may have given back the option which Congress intended to take away.

Under the 1994 bankruptcy reform legislation, special provisions for small business debtors were created. However, debtors were given the option to elect whether to be considered as a small business debtor and few did. The National Bankruptcy Review Commission recommended that this option be removed, stating:

The Commission recommends that choice of treatment as a "small business" debtor under the Bankruptcy Code should not be optional. If as a policy matter, Congress decides that small business debtors merit special treatment under the Bankruptcy Code, all debtors who meet the definition of "small business" should be subject to the same special track. Otherwise, the separate track will not likely be used.

Report of the National Bankruptcy Review Commission, Sec. 2.5.1.

BAPCPA added a new definition of "small business debtor" to the Bankruptcy Code. Under Sec. 101(51D), a debtor was a small business debtor if: (i) it was a person engaged in commercial or business activities (ii) but not a person whose primary activity was the business of owning or operating real property (iii) that has aggregate noncontingent liquidated secured and unsecured debts as of the date of the petition or the date of the order for relief in an amount not more than $2,000,000 (which has been adjusted for inflation to $2,190,000) and (iv) for which a creditor's committee has not been appointed or is not sufficiently active and representative to provide effective oversight of the debtor. Under this definition a debtor either is or is not a small business debtor. There is no choice in the matter.

If a person is a small business debtor, it is subject to added scrutiny designed to weed out nonviable cases. 11 U.S.C. Sec. 1116. It is also subject to more flexible provisions for proposing and confirming a plan. A small business debtor has an exclusivity period of 180 days (as compared to just 100 days for a small business debtor under the prior law). 11 U.S.C. Sec. 1121(e)(1). However, the outside date for any party to file a plan is 300 days. 11 U.S.C. Sec. 1121(e)(2). The debtor is allowed to file a combined plan and disclosure statement and receive conditional approval of its disclosures, thus eliminating the need for a separate disclosure statement hearing. 11 U.S.C. Sec. 1125(f). However, the plan proponent must obtain confirmation of a plan within 45 days after filing. 11 U.S.C. Sec. 1129(e).

Thus, the small business debtor provisions offer a series of carrots and sticks which are intended to be mandatory. However, Fed.R.Bankr.P. 1020(a) brings the right to elect in through the back door. Under this Rule, "the debtor shall state in the petition whether the debtor is a small business debtor." The U.S. Trustee and creditors may object to this statement within 30 days after the conclusion of the creditors' meeting. However, "the status of the case with respect to whether it is a small business case shall be in accordance with the debtor's statement . . . unless and until the court enters an order finding that the debtor's statement is incorrect."

Thus, a debtor can make an election not to be treated as a small business debtor by checking the wrong box and hoping that no one objects. One of the reasons that Congress eliminated the small business election was the perceived apathy of creditors in these cases. However, the provision in the rules allows debtors to make an incorrect designation and count on creditor apathy to allow it to pass unnoticed.

However, the fact that the debtor has a de facto election does not mean that the debtor can change status at will. In the case of In re Save Our Springs (SOS) Alliance, Inc., 393 B.R. 452 (Bankr. W.D. Tex. 2008), a debtor designated itself as a small business debtor. The debtor was arguably not eligible to be a small business debtor because it was an environmental advocacy group, which likely would not fall within the definition of a person engaged in commercial or business activities. The debtor proposed a plan which was hotly contested. By the time that the court denied confirmation, the debtor was beyond its 300 day window for proposing a plan. The debtor then amended its petition to revoke its designation as a small business debtor. The court found that having received expedited treatment based on its designation as a small business debtor, the debtor was judicially estopped to say that it wasn't. As a result, the court dismissed the case.

However, an incorrect designation may be corrected. In a case where I am involved, the debtor's previous counsel failed to check the box to indicate small business status. The debtor then proposed a combined plan and disclosure statement within the 300 day window given to a small business debtor. When the court noted that the debtor had not designated itself as a small business debtor, I filed a motion to designate the debtor as a small business debtor which the court granted. The difference in my case was that the debtor had never tried to obtain a benefit from not being a small business debtor and indeed had acted as if it were one from the beginning of the case. (Of course, it probably also helped that the designation in my case really was incorrect).

Thus, the small business election lives on in a practical sense, but is subject to challenge.

Sunday, April 05, 2009

Texas Chapter 11 Filings Double



Chapter 11 filings are a good indicator of how the economy is doing as well as the market for bankruptcy lawyers. If the latest filings are any indication, Texas bankruptcy lawyers are going to be very busy. In the first quarter of 2009, chapter 11 filings doubled over their level from the same time during 2008. During the first quarter of 2009, 259 cases were filed statewide compared to 129 the previous year. Over the first three quarters of 2008, filings fell within a lackluster range of 128 to 152 per quarter or about 50 cases per month. In the fourth quarter of 2008, filings jumped to 213 and then increased again in the first quarter of 2009.

When I have more time, I will look at the types of entities filing (i.e., real estate, health care, etc.) and the size of the filings (small business debtors to mega-cases).