Thursday, December 16, 2010

Supreme Court Grapples With the Meaning of the Means Test

The first case argued before the Supreme Court this term was No. 09-907, Ransom v. FIA Card Services, N.A. You can find the transcript of the oral argument here. This case raises the issue of whether Courts should give the means test a literal interpretation or follow a more functional approach.

In the case of In re Ransom, 577 F.3d 1026 (9th Cir. 2009), the Ninth Circuit (in contrast to the Fifth, Seventh and Eighth Circuits) held that a debtor could not claim an ownership expense for a vehicle unless there was an actual loan or lease payment. The problem is that the means test incorporated the Local Standards, which allowed an ownership deduction, while the Internal Revenue Manual clarified that an ownership deduction could only be claimed if there was an actual ownership expense. This raised the question of whether the Court should follow what Congress said (apply the Local Standard = ownership deduction) or what they meant (apply the Local Standards in the same manner as the IRS would have applied them). For more background, you can read my prior article about the subject here.

The oral argument shows the Justices getting deep into the weeds of how the Means Test works and how it should work. While Justice Scalia shows a clear preference for the plain meaning approach, the other justices appear to be struggling to make sense of the test. This gives rise to some very thoughtful exchanges. It also gives rise to the justices, in their enthusiasm to ask questions, interrupting and talking over themselves.

Why Is That the Crux Of It?

Almost immediately, Justice Alito presses debtor's counsel on why the Court shouldn't follow the IRS's interpretation of the standards.

MR. BURKE: Now, the crux of this is whether or not courts are allowed to dig in and cut out pieces of the standard aggregate amount.

JUSTICE ALITO: Why is that the crux of it? Congress made reference to the local standards, right?


JUSTICE ALITO: And were the -- was the commentary in the Collection Financial Standards in existence at the time when Congress enacted this provision?
MR. BURKE: There was a Collection Financial Analysis that was in place, and it was noted in 1998 as a prior version of the bill that ultimately wasn't passed.

JUSTICE ALITO: And that explains what the IRS understands the local standards to mean; isn't that right?

MR. BURKE: I would disagree with that. I would say -- well, it would -- it would explain what the IRS means, but that's where I would end it, because the IRS standards are used to collect taxes. They are discretionary. They -

JUSTICE ALITO: Well, I understand that, but Congress decided to make reference to the local standards in this bankruptcy provision, didn't it?
MR. BURKE: Standards.


MR. BURKE: It didn't go beyond that.

JUSTICE ALITO: And this -- and at the time when it did that, there was official IRS commentary regarding the meaning of those standards, correct?

MR. BURKE: For the IRS to use in collecting taxes.

JUSTICE ALITO: And your argument is that Congress intended to adopt the standards promulgated by the IRS, but not the IRS's interpretation of the standards.

MR. BURKE: Correct, not their methodology or interpretation.
Transcript, pp. 4-5.

First Reference to $1 And Absurd Results

In this exchange Justice Ginsberg attempts to argue that to have an ownership "cost," you must have a cost, while Justice Scalia points out the absurdity that even $1 of ownership cost would entitle the debtor to the full allowance.

JUSTICE GINSBURG: Doesn't the chart say "ownership costs"?

MR. BURKE (counsel for Debtor): Yes.

JUSTICE GINSBURG: And you would read that to mean non-costs as well? I mean, if the -- if the table is called ownership costs, then why not use the IRS's definition of what costs are, and that definition says, what, loan payments and lease payments?

MR. BURKE: Because you -- we have to look at it as a standard aggregate. And what I mean by that is -- okay, the Bankruptcy Code doesn't define ownership costs. And ownership costs could be the replacement value. It could be buying a new vehicle. It could be the costs associated with making payments on a vehicle.

What that -- that average number is, in this case, $471, is a nationwide figure that somebody would spend on average in a month. It doesn't mean that any one individual spends that amount.

JUSTICE SCALIA: Mr. Burke, isn't it -isn't it the case that, even on the other side's interpretation of it, it doesn't come down to actual costs anyway? Isn't it the case, or do I misunderstand it, that so long as there is one payment, you get the entire deduction?

MR. BURKE: That's their position, or even $1.

JUSTICE SCALIA: Even one payment of $1, you get the entire deduction. So to argue this case as though it's a question of whether you actually expend the money that you're getting the credit for is simply -- is simply false. You don't do that under either side's interpretation, right?

MR. BURKE: Again, I would perhaps -

JUSTICE SCALIA: I'm trying to help you, Mr. Burke.

Transcript, pp. 5-7.

When Justice Scalia says, "I'm trying to help you," it's time to pay attention.

Does Ownership Mean Loan or Lease Costs?

In the next exchange, Justice Breyer wants debtor's counsel to concede that ownership costs means lease or loan payments, but he won't go there.

JUSTICE BREYER: Of course you have all kinds of costs dealing with ownership, but what the IRS says, what it says in the statute, is you are supposed to take the applicable costs from IRS. And what it has on page 5a is it has something called "ownership costs."

MR. BURKE: Correct.

JUSTICE BREYER: And it defines those as $471.

MR. BURKE: Correct.

JUSTICE BREYER: And then on 3a, where it says what ownership costs are, it says the transportation standards consist of nationwide figures for monthly loan or lease payments, referred to as ownership costs. So when I read that, I said ownership costs means monthly loan or lease payments, nothing else.

Now, you have all kinds of other things. It's just these words "ownership costs" don't refer to those other things, because of that definition given right there. That's what I thought Justice Ginsburg was initially asking.


JUSTICE BREYER: And I -- and how -- how do you get out of that what I think of as very, very clear language which says what these standards refer to?

MR. BURKE: Because the standards refer to the numbers. It's a chart.

JUSTICE BREYER: Yes, but it doesn't -- for example, suppose you buy a dozen apples every month, and they cost you $48 extra. You're not going to say the ownership costs refer to the apples, even if you decorate the car with them.


MR. BURKE: What -- what -

JUSTICE BREYER: I mean, ownership costs refers to lease and loan payments. Nothing else.
Transcript, pp. 9-10.

What's the Language We're Dealing With?

At this point, Justice Scalia gets frustrated that everyone, including the debtor's lawyer, is talking about the statute in generalities without quoting the actual language.

JUSTICE SCALIA: What's the language we're dealing with, Mr. Burke? Do you want to quote the language to us?
Nobody's quoted the language. What does it say is applicable?
MR. BURKE: What the statute says is the applicable -- you shall get, mandatory, the applicable amounts specified based on where a debtor resides -

JUSTICE SCALIA: Wait. The -- the applicable amounts specified where?

MR. BURKE: In the national local standards.

JUSTICE SCALIA: Read the text of the statute, would you, please, for me? I couldn't even get it from your brief. You had to refer me back to the petition. Why isn't in an appendix to your brief or printed in the beginning of your brief, instead of kicking me back to dig out your petition?

MR. BURKE: "The debtor's monthly expenses shall be the debtor's applicable monthly expense amounts specified under the national local standards."

JUSTICE SCALIA: "Amount specified under" the standard.

MR. BURKE: Specific amount, "applicable" modifies "amounts specified."

JUSTICE SCALIA: "Applicable amounts specified," not the amounts specified if applicable.

MR. BURKE: Correct, based on where a debtor resides.
Transcript, pp. 10-12.

Deducting Nonexistent Costs

A little while later, Justices Breyer, Ginsberg and Kagan all join the conversation asking why a debtor could be allowed to deduct costs that are not incurred. This exchange marks the first time that Justice Kagan has spoken as an associate justice.

JUSTICE BREYER: Is there something wrong with the IRS saying what they mean? It says ownership costs means monthly loan or lease payments. Now, is there something

MR. BURKE: The problem

JUSTICE BREYER: That's what it says it means. Now, is there something illegal about it defining ownership costs in that way?

MR. BURKE: No, for the collection of taxes, there is not. But if you're going to use -- start digging into the manual, you might as well bring it all into 707(b), and, as we discussed earlier, there was language that said the collection financial analysis should be brought in, but that was deleted in the final version.

JUSTICE GINSBURG: Why not just -- it says you are supposed to look at the form; it says ownership costs. So the only thing you'd look at the IRS for is -- the manual -- is to define ownership costs. And they say ownership costs means those two things.

MR. BURKE: Well, I don't -- there's no reason to limit it. If you're going to -- the text doesn't say -- it says national local standards. It doesn't discriminate or give disparate treatment to that one item. If you're going to give it to one item, then it can be pulled in, and it should be -- the same treatment should be given to all items, and we should have to prove some type of a

JUSTICE GINSBURG: I don't follow that. If the simple thing is to just -- what does the word "costs" mean? And then you look to the IRS manual, and it tells you that "costs" means loan or lease payments.

MR. BURKE: To collect taxes, that's how they defined it. But in the statute it says you get "local standard amounts specified." It does not stretch it and say "under the IRS's interpretation." That language was taken out. And if we were to use the IRS's interpretation, here's the whole problem: It's discretionary. It goes up and down. It's based on an IRS revenue agent. It -- let me give you a separate example. Nobody

JUSTICE KAGAN: Mr. Burke, if we could stay with this. The $471 is derived by looking at the average loan or lease payments nationwide. Then, in addition to that, we know that the IRS has a separate category for operating costs that is meant to reflect costs of having a car that are not your loan and lease payments. So, between those two things, why wouldn't we say that ownership costs means your loan and lease payments, but operating costs means your other costs of having a car, and that you get the operating costs if you have a car but don't make loan and lease payments, and you get the ownership costs if you do make loan and lease payments?

MR. BURKE: Because to reach that, you have to go into the Internal Revenue Manual. It's not in the statute that says you have to owe on it to get it. And if you go into the Internal Revenue Manual -- let's look at operating expenses. What it says, in collecting taxes -- and it's in the Joint Appendix at pages 83 through 88. But what it says, when it comes to local national other expenses, an internal revenue agent has discretion. You only get these expenses -- this is the overall idea -- if they produce income or if it's for health and welfare.

And so, when we look at the Joint Appendix page 88, section B, under the local standard transportation expenses, when it talks about operating costs, which is something you just mentioned, it says you only get transportation expenses that are used to produce income or the health and welfare of an individual and their family. Plus, the fact that you own a car, the IRS under its discretion can take away the operating costs if it's on four cinder blocks in your backyard. You're not incurring fuel costs, mileage costs; you are not probably paying registration or any of those other operating costs. The IRS agent, under their manual, can take away that expense.

So, why stop and say, well, we're just going to look at the ownership costs? And all they're saying here is if you owe on it, you get it; if you don't owe, you don't get it. Let's not look at anything else in the Internal Revenue Manual, which is a 39-part, 500-page document that in some ways is almost incomprehensible, and direct the -

JUSTICE GINSBURG: Mr. Burke, the -- it's unusual to allow a deduction for the purpose of calculating disposable income although you don't have any expense. I understand how you get to that conclusion with respect to car ownership. Is there any other provision that in -- in calculating disposable income, you are allowed a deduction for an expense that you don't incur?

MR. BURKE: If the Court understands my view that Congress gave -

JUSTICE GINSBURG: No. The question -- is there anything else that works like this? You don't have the expense, nonetheless you have the deduction? Any -- I mean, there are a whole list of deductions, expenses. Is there any other one that works this way?

It doesn't matter whether you have the expense, in fact.

JUSTICE KAGAN: For example, Mr. Burke, what would happen if you didn't actually have any out-of-pocket medical costs? Could you still claim a deduction for out-of-pocket medical costs?

MR. BURKE: I'm saying you get all the deductions, whether you owe on it or not. Is there a specific one besides the car ownership that says you have to owe on it? No.

Transcript, pp. 13-18.

In this last exchange, Mr. Burke has grasped onto an important point. The Means Test was intended to take away discretion, while the IRS Collection Standards were intended to be used with discretion. Congress's choice of a standard invites ambiguity because it was not meant to be absolute. Justices Breyer, Ginsberg and Kagan all want the statute to make sense, while Justice Scalia and Debtor's counsel want it to mean what it says.

What Has to Be Actually Incurred?

From here, a number of the Justices get into a revealing discussion about whether other items in the Means Test must be actually incurred to be deducted.

JUSTICE SOTOMAYOR: Do they apply -- do the courts apply the housing and utilities listed amount whether or not you pay for a house or not, whether or not you rent?

MR. BURKE: There's two published cases I'm aware of, and both allowed it. One, somebody had military housing; one, the house was paid off. Both courts said you get it under the local standards. But the IRS manual would not give that to you, because under the local standards the IRS manual says you get the specific amount or your actual payment, whatever is less.

JUSTICE SCALIA: Of course, once again, Mr. Burke, this is -- I don't know why you don't point this out. This is not the difference between your position and the position of the other side. You get the deduction for the other side as well, whether or not you are making the payment. Now, maybe it can be adjusted by the trustee, but as far as the statute is concerned, so long as you make one payment of $1, under their theory you're entitled to claim the deduction; isn't that right?

MR. BURKE: That's correct.


JUSTICE KENNEDY: My question, incidentally, about courts was not with reference to the car expense. It was with reference to the hypothetical or to the issue proposed by one of my colleagues, that said, what if you don't -- Justice Kagan -- suppose you don't have the medical expense. And the answer -- and your -- and I wanted to know if your answer is supported uniformly by the courts that have looked at this, or if there is also a split on that point?

MR. BURKE: I apologize for not understanding it. No, every other expense deduction that I have seen besides the car ownership, somebody gets it.

CHIEF JUSTICE ROBERTS: And they get it whether or not they incur that expense or not?

MR. BURKE: Correct.

CHIEF JUSTICE ROBERTS: In other words, food -- you don't have to say, well, he did spend this much money on food, so he gets the standard deduction.

MR. BURKE: Correct.

CHIEF JUSTICE ROBERTS: If he doesn't eat as much as somebody else, he gets the same deduction, right?

MR. BURKE: Correct. Or if he lives at home and mom cooks for him.

JUSTICE KAGAN: But, Mr. Burke, even you would say -- is this correct -- that if you don't own a car at all, you can't claim the car costs?


JUSTICE SCALIA: Is that -- is that by reason of the Internal Revenue Service--


JUSTICE SCALIA: -- manual, or is it by reason of the Bankruptcy Code itself?

MR. BURKE: It's by reason of the Bankruptcy Code that refers to the standards, and the standards specifically say you have one car, no cars, and you get a public transportation, or two cars; pick the one.

JUSTICE SCALIA: So it's in the chart -

MR. BURKE: It's in the chart.

JUSTICE SCALIA: -- that you claim -- okay.

JUSTICE ALITO: What if you own a car, but it's completely inoperable and it has no value? You buy it for a dollar. It's a junk car, and you're planning possibly to restore it at some point. Do you get the deduction then?

MR. BURKE: Based on a strict reading of the code, you get it. Now, would the IRS allow it? Again, that's a discretionary standard, but any time you have an objective test, there's going to be line-drawing and perceived unfairness on the outskirts.

JUSTICE KENNEDY: And would your answer be the same if the allowance was set, the decree was made, and -- and the debtor then went out and bought the junker to put in his driveway just in order to get the 400-plus dollars a month, or would that be deemed an evasion of the law that could be addressed by the Bankruptcy Court?

MR. BURKE: It can addressed by the Bankruptcy Court, and that's the beauty of the statute. We don't need to go into the Internal Revenue Manual. We just need their tables, because there's a provision, 1325(a)(3), that deals with good faith. So if it appears somebody is not acting in good faith, then -

JUSTICE BREYER: What is -- we've got about half the courts in the country agreeing with you. And so you've read all those arguments, and what in your opinion is the best one on the point, again, where I am stuck, which is Justice Ginsburg's original point? I mean, I can think of millions of examples. You have a form that says -- the employer says entertainment expenses. Then it defines entertainment expenses as food and transport, and they leave out movies, you know. Or you could have vacation expenses, and vacation expenses are defined as transport and hotel, and they leave out meals. And here we have a definition of ownership expenses, and they say leasing and loaning, and they leave out other forms of ownership.

MR. BURKE: Because -

JUSTICE BREYER: Now, the argument is, well, that's what they mean by it, so that's what applicable. Now, what's the best argument against that in those 50 cases? Why is it trying -- why to try to get an expense which isn't loan or lease? Have you any more right to it than if you tried to get an expense to my totally irrelevant apples? I mean, it doesn't fit within the applicable definition. What's the answer?

MR. BURKE: The means test is a form, and if you look at the form -- the means test is a form.

JUSTICE BREYER: I've looked at the form.

MR. BURKE: If you look at the form -


MR. BURKE: It just says -


MR. BURKE: That's it. There's no definition in the form.

JUSTICE BREYER: But they -- two pages earlier they say what they mean by the word "ownership."

MR. BURKE: Not the -- the IRM does.


MR. BURKE: Not the statute and not the B22 form that's filled out by debtors.

JUSTICE BREYER: You say half the courts say, oh, you just sort of imagine what ownership expenses are, and anything that they can fall within that general English language word is what they can deduct; is that their approach? Because we -- you say cut off the definition, cut off the definition from the word "ownership"; don't use it. So what do we use to define what ownership is?

MR. BURKE: We don't have to. Congress gave standard amounts for -

JUSTICE BREYER: No, I know, but it's for ownership; it's not for, for example, whistling. It's for ownership. So -- so how do we define what that $471 attaches to? Do we use a State common law definition or something? How have they done it?

MR. BURKE: Because you can take it as a bunch of variables. It's not in the Bankruptcy Code. If -- so it could be replacement costs; it could be major repairs; it could be

JUSTICE SCALIA: Is this a problem distinctive to your case? Doesn't the other side have the same problem with ownership? Don't they acknowledge that even if you are leasing the car you get the deduction?


JUSTICE SCALIA: I don't see why this is distinctive to your case. It's a problem both sides face. And we don't avoid it by coming out against you, do we?

MR. BURKE: No, we don't.


JUSTICE ALITO: What if -- what if the definition of

JUSTICE BREYER: Why don't we?

JUSTICE ALITO: -- ownership costs was moved into the local standards themselves? Would the outcome be different then?

MR. BURKE: Are you saying in 707(b)?

JUSTICE ALITO: No. It's moved from the CFS to the local standards, which are referred to in the -in the code provision.

MR. BURKE: My answer would still be the same because that's not a congressional formula. That's a form that comes off the Department of Justice Website which administers the U.S. Trustee's program and that's their litigation position.

JUSTICE KAGAN: But, Mr. Burke, if the table said loan and lease costs, you wouldn't have a case? If it said -- instead of ownership costs, if it said loan and lease costs, then you would sit down and you would say I'm not entitled to that deduction?

MR. BURKE: No. I would say an individual who owns a car, whether they owe or not, gets the deduction because it's part of this aggregate standard.

JUSTICE KAGAN: Even if it's called loan and lease costs?

MR. BURKE: Correct. It's not a breakdown on what any one individual has. It's an aggregate.
The exchange is interesting because it shows that Supreme Court justices are not reluctant to talk over each other.

Grilling the Creditor's Lawyer

The attorney for FIA Card Services didn't get much past may it please the Court when she is pressed on whether costs must be actually incurred. Her position is that for a cost to be "applicable," it must be actually incurred. This would make the standards a ceiling rather than an entitlement. However, she then backed away and drew a distinction between the national and the local standards.

MS. MAYNARD: Mr. Chief Justice, and may it lease the Court: The Bankruptcy Code precludes an above median-income debtor like Petitioner from shielding from his creditors $471 a month for a car payment that he does not have. A debtor with -

JUSTICE SOTOMAYOR: -- food costs, housing costs, utility costs, by getting his parents to pay for those things and still take this deduction?

MS. MAYNARD: The statute allows a debtor to take an applicable monthly expense amount. So if the debtor truly has no food costs, then the food standard would be not applicable to the debtor, so

JUSTICE SOTOMAYOR: Your adversary said that only two courts have addressed this issue and have permitted those deductions. So under what reasoning would we apply a different standard to the car costs as opposed to those other costs?

MS. MAYNARD: Well, I think, with respect I think the cases he was talking about were housing.


MS. MAYNARD: Right. So housing and car costs are part of the local standards. Food, clothing, house cleaning supplies, those are part of the national standards. The -- in our view, the text that goes along with -- accompanies the tables, which is not the Internal Revenue Manual -- it's just the pages reprinted at 1a to 3a of our brief. The Collection Financial Standards, the prefatory explanation for what the tables mean. In our view, that is -- goes along with -incorporated into the national local standards.

The national standards, Justice Sotomayor, are allowed, as long as you have under the calculations -- as explained in the standards, under the national standards, a debtor would receive the allowance in the table as long as they have any such expense, so regardless of amount. However, if they have no such expense, then they are taken out by the statutory language in the means test, which says that the standard must be applicable to the debtor. And

Transcript, pp. 26-27.

Another $1 Hypothetical and Absurd Results

CHIEF JUSTICE ROBERTS: So if they have pre-purchased their food expenses, so long as they have $1 of food expense they get the entire expense even though they're not incurring it?

MS. MAYNARD: If they are -

CHIEF JUSTICE ROBERTS: And there are things like, you can pay up, you know, have the grocery deliver your food every month and you can pay in advance, and if you're paid up, you still get the full food expense that is allowed?

MS. MAYNARD: No, Your Honor. I think if, over the 60-month period looking forward, you know, that you're going to -- you've already paid up for your food for the next 60 months and you're not going to incur any additional food expenses, no, then in that situation the standard would be inapplicable to you. You would be having no -- in that hypothetical

CHIEF JUSTICE ROBERTS: But if you paid $1 for food, you'd get the full amount for 60 months?

MS. MAYNARD: Under the standard. That's the way the standards operate, Your Honor. I haven't seen any cases litigated over food expense

CHIEF JUSTICE ROBERTS: So your argument leads to a result that's just as absurd as your colleague's result on the other side.

MS. MAYNARD: I don't believe so, Your Honor

CHIEF JUSTICE ROBERTS: I mean, that was a big part of your argument. You said his position leads to an absurd result, and yours is just as absurd.

MS. MAYNARD: I don't think so, Your Honor, for this reason, which is that the national standards are food, clothing, house cleaning supplies, things that you expect every debtor to have. You don't see much litigation about those expenses. The local standards, however, operate differently. In our view -- and our view's different from the government's, Justice Scalia. In our view, under the local standards and the way that they apply as explained in the Collection Financial Standards, is that the debtor is allowed their actual expense for the local standard or the amount in the table, whichever is less. So in the hypothetical.
Transcript, pp. 27-29.

Here the creditor's lawyer appears to have stumbled. Besides having the Chief Justice point out an absurd result, she has undermined the concept of using a mechanical calculation to determine a debtor's ability to pay. If the Local Standards are based on the lesser of the standards or the debtor's actual expense, then it is necessary to do a detailed examination of the debtor's actual expenses.

Where Does It Say That?
JUSTICE SOTOMAYOR: Where does it say that?

MS. MAYNARD: In our -

JUSTICE SOTOMAYOR: The debtor's monthly expenses shall be the debtor's applicable monthly expense amounts specified under the national and local standards. So the national and local standards have amounts listed. Where does it say you take only the actual, not the national or local standard?

MS. MAYNARD: I read that text, Your Honor -- again, the Court doesn't need to decide this maximum cap issue to decide this case, because the Petitioner has no expense whatsoever, and so it's not applicable to him.

But in our view, Justice Sotomayor -- in our view, you get it from the language of the statute that says the debtor's applicable monthly expense amounts specified under the national standards and local standards. And the way that we understand the national and local standards to work is, if you look at page it's explained on page 1a of the petition to our brief, the red brief. Maximum allowance -- it's the third paragraph down: "Maximum allowances for housing and utilities and transportation, known as the Local Standards, vary by location. Unlike the National Standards, the taxpayer is allowed the amount actually spent or the standard, whichever is less."

JUSTICE SOTOMAYOR: But that's -- but that's not what the provision at issue here says. It says you use the amount specified under the national standards, and you use actual for everything else. That's what the statute said. So now you're trying to move the actual into the first half of the text?

MS. MAYNARD: No, Your Honor, that's not how I understand the text. The text provides

JUSTICE SOTOMAYOR: Why would you even bother? Why don't you -- if -- if what you're arguing is that only actual expenses are -- are what you can claim, you wouldn't need the first half.

MS. MAYNARD: Yes, you would, Your Honor, because what the -- what the statute's purpose here is -- I mean, I think it's helpful to step back. Chapter 13 sends one to chapter 7's means test for the purpose of calculating the amounts reasonably necessary for the maintenance and support of the debtor. And Congress chose to import the -- the methodology of the national standards and local standards as a way both to set the categories of expenses that debtors could receive payments for, and, with the case of the national and local standards, to set the amounts. They were worried about capping upper discretion because Congress -- it's quite clear from the text and the legislative history -- was concerned about above-median-income debtors taking luxurious expense amounts.

JUSTICE SOTOMAYOR: So what you would have the statute read is: The debtor's monthly expenses shall be the debtor's applicable monthly expense amounts specified, as a -- as a maximum. You would have to add "maximum" somewhere there.

MS. MAYNARD: No, Your Honor, because the amount under the national standards, as the national standards operate, is the -- is an allowance, not an actual, and the amount under the local standards, as they operate, is the amount actually spent or the amount in the table, whichever is less. And, again -
Transcript, pp. 29-32.

The Creditor Makes a Good Point

While Chief Justice Roberts wants to talk about debtors who prepay their food expenses, the credit card company's lawyer makes a valid point. If you pay your car off, it means you didn't use that money to pay your credit cards. If you then receive an ownership deduction, you are shielding the same money from creditors twice--once when you used it to pay off the car and twice when you deducted it under the means test.

CHIEF JUSTICE ROBERTS: Your -- your position penalizes debtors who pay their expenses in advance, who don't incur additional debt to pay for things like their car. I would have thought the Bankruptcy Code would think that's a good thing, that they're not incurring debt that they can't afford to payoff, but instead, to the extent they can, they're paying expenses in advance. Why should somebody who does that be in a worse position than somebody -- than somebody who takes out a loan they can't afford to pay back?

MS. MAYNARD: Money is fungible, Your Honor, so to the extent the debtor has incurred expenses before going into bankruptcy instead of, as here, paying off this more than $85,000 in credit card debt, shouldn't be able to -

CHIEF JUSTICE ROBERTS: Well, he hasn't incurred -- he hasn't incurred expenses. It's the whole point, I guess, that he's paid for something.

MS. MAYNARD: He used his money, perhaps, to purchase his car outright, instead of to pay down his credit card debt, and so he has a salary of $50,000, and he has a credit card debt of $85,000, and he owns a 2-year car -- 2-year-old car outright. He should not be able to deduct, as a measure of his reasonably necessary expenses for his maintenance and support over the next 50 months, $28,000 that he doesn't need for a car payment that he doesn't make.
Transcript, pp. 32-33.

Local vs. National Standards and Actual vs. Standard Expenses

As the justices continue to press about whether expenses must be proven up, Ms. Maynard returns to her distinction between local and national standards.

JUSTICE SOTOMAYOR: So what you're proposing is that every debtor has to go to the Bankruptcy Court and show what their monthly food bills have been over what period of time, how much their personal supplies have been over what period of time? How can you calculate forward what they are going to spend on a monthly basis for each of those items? Isn't that the reason the tables are used, so that you don't have to do that?

MS. MAYNARD: Yes, Your Honor, and in the national standards, which all the items you just list are national standards, under the national standards you don't do the actuals. On page 1a, it explains: "Allowances for food, clothing and other items, known as the National Standards, apply nationwide except for Alaska and Hawaii.... Taxpayers are allowed the total National Standards amount for their family size and income level, without questioning amounts actually spent."

For -- yes, for those hard-to-calculate items, you do -- our position is you do get the amounts in the chart. For local standards -- the local standards, however, which include home, mortgage, lease expenses, utilities, and transportation, which include both ownership costs and operating costs, you get the actual or whichever is less.

JUSTICE SCALIA: I must say your position is more logical than the position that you read in some of the instructions applicable to the -- to the chart that's referred to in the Bankruptcy Code, but not others. I mean, it seems to me, if you're going to read in the requirement that have to have made a lease payment, you should also read in the requirement that you're referring to now, which would mean your deduction is limited by the -- by the amount of your lease payment.

I don't see why -- is there any reason why one would read in the other one and not read in yours?

MS. MAYNARD: Not in our view, Your Honor, because in our view the chart is -- is ambiguous about what the number stands for. And so in the national standards, the text, the prefatory text, explains that the amount is an allowance if you have the expense. In the local standards, the prefatory text explains that the amount operates as a cap.

But the important point for this case, Your Honor, is that you don't have to decide anything about the national standards because Petitioner is left at the statutory door. He has no applicable monthly expense amount for operating -
Transcript, pp. 33-35.

Having to resort to saying the chart is ambiguous when pressed does not help her case. She also has an unfortunate habit of telling the justices that they don't need their questions answered because they are irrelevant.

Replacing a Vehicle

Justice Kagan leads off an interesting discussion about whether the debtor should get the deduction if we know that there will be an ownership expense in the future. This is critical because one of the best arguments for allowing an ownership expense deduction when there is not a current loan or lease payment is that the debtor will likely need to replace the vehicle during a five year chapter 13 plan. The creditor responds that this is something which can be addressed by plan modification or even built into the plan.

JUSTICE KAGAN: Ms. Maynard, what would happen if the debtor had a car that was 200,000 miles old -- 200,000 miles, and it was going to break down, you know, within the next 5 years? Would the debtor then be able to take the deduction?

MS. MAYNARD: If the debtor owns the car outright at the time they file for bankruptcy, they would not get the deduction.

JUSTICE KAGAN: Even though if you look ahead, if you project forward, it's pretty clear that the debtor is going to have to incur those expenses?

MS. MAYNARD: They would not get the deduction under this calculation. However, under this Court's decision in Lanning, when one goes to project the disposable income, it's conceivable that the debtor could prove that it's known or virtually certain that they will need a new car and that that could be accounted for.

But -- but also the Bankruptcy Code in 1329 allows for modification of a plan, and so when the time arises that their car conks out and they need a new car, they can move to modify their plan. I think it's -

JUSTICE KAGAN: Well, the modification works for chapter 13, but it doesn't work for chapter 7; is that right?

MS. MAYNARD: Well, they make that statement in their reply brief, Your Honor, but I'm not sure exactly what they mean by that, because in chapter 7 this test is being used for a very different purpose.

It's the gateway; it's a presumptive test for abuse. And so, again, our reading makes perfect sense in that context because what you want to know is, does this debtor actually have moneys it can prepay its creditors, should it be -

* * *

MS. MAYNARD: So, in chapter 7, once you -if you decide it's presumptively --- not presumptively abusive, and you stay in chapter 7, then chapter 7 is a liquidation. There's no ongoing plan. So I -- all of your nonexempt assets are liquidated, your creditors are paid off, and then you are discharged. If 3 years from now your car conks out, you're just like you and me; you are not in bankruptcy, you just -- you try to make do.
Transcript, pp. 35-37.

We're Really Going to Get Into A Mess

JUSTICE BREYER: I think it is -- well, I'm trying to work out what was his point. And I don't blame him for this. But trying to figure it out, he says look: This whole thing was written for a different purpose than the IRS, and if we start reading all those things from the beginning into the tables, we're really going to get into a mess. For example, we are going to give people deductions when they have lease payments, even though they're not owners when they have lease payments. The company owns -- not even an ownership expense, but it does say use the lease payment. And then it has all these other things.

So forget it; do a simple thing. It says ownership expense. You go to the registry of motor vehicles and you say, is Smith the owner? And they'll tell you, yes or no. And if the answer is yes, he deducts $471. Sometimes that's too little; sometimes that's too much. But once we depart from that, we're really in a nightmare of trying to figure out what all these things mean that were written for other purposes.

So, what do you say to that?

MS. MAYNARD: I say, Justice Breyer, that there's nothing in the statute or the legislative history that suggests this was meant to be an overall budget for above-median-income debtors. This was about capping upper discretion and limiting the expenses available as reasonably necessary expenses for above-median-income debtors. And I think that point is made perfectly clear by the fact that if you can compare it to what happens now to a below-median-income debtor, a below-median-income debtor in the same situation as Petitioner, who owns his car outright, would be allowed no amount as an expense for his vehicle, because he doesn't have an actual expense that's reasonably necessary.

And I think that the 2005 Congress would think it was a senseless result, as they argue here, that Petitioner gets $471, above-median-income debtor, the very class of debtors with whom Congress was concerned in the 2005 amendments, to shield from his creditors over the life of the plan when he has no comparable expense.

Transcript, pp. 37-39.

Digging Into the Romanettes

In this final exchange, the Justices and Ms. Maynard get into an interesting discussion of the interaction between Romanette ii and Romanette iii of the Means Test. On the one hand, you do not count secured debt as an ownership expense under Romanette ii, while on the other hand, you do get the entire secured debt payment under Romanette iii. This points an interesting distinction between the IRS Collection Standards and the Means Test. By allowing unlimited deductions for secured debt under Romanette iii, the Ownership expense deduction under Romanette ii appears to be meaningless. Ms. Maynard makes an unconvincing argument that the Debtor gets the lesser of the debt payment or the Ownership Expense.

JUSTICE KENNEDY: What we are talking about is a paradigm of someone -- we're comparing someone who has a $470-a-month car payment and he gets -- and he gets the deduction. Why is that, in light of the second sentence -- let's see, the third sentence of the statute, which says, "Notwithstanding any other provision of this clause, the monthly expenses of the debtor shall not include any payments for debts." I mean, that would be the car company. And has -- has that point been litigated?

MS. MAYNARD: That -- that sentence is somewhat of a conundrum, Your Honor, and I think that the Court doesn't need to decide the meaning here, because whatever it does, it doesn't get Petitioner within the Romanette ii calculation -

JUSTICE KENNEDY: No -- no, but it would -

MS. MAYNARD: -- because he has no payment.

JUSTICE KENNEDY: It would eliminate the anomaly that -- one of the principal anomalies. There are many anomalies in each position. It would eliminate one of the principal asymmetries that seems to concern the counsel and the Court.

MS. MAYNARD: Well, my understanding of that provision is that it serves two purposes.


MS. MAYNARD: Serves two purposes. The first is that it makes clear -- in the back of our brief, we have the other necessary expenses from the IRM. And on -- near the back, page 25a, two of the categories of other necessary expenses are secured or legally perfected debts and unsecured debts.

So I think the -- the otherwise -- the "notwithstanding" sentence makes clear that Romanette ii should not capture those other unsecured debts and secured debts, that it's the very purpose of this whole calculation to figure out how much money you have to pay those things.

The second purpose the sentence serves is to make sure that there is no double-counting, because Romanette iii, the very next provision in the means test, allows the debtor to claim monthly payments for secured debts. Now, many car loans are probably secured debts, and in our view if you actually have a car loan -- now, remember again, he neither has a car loan, nor a car lease payment, nor any kind of ownership payment.

But if -- if one actually did have a car loan that was secured by the car, which I think is the vast majority of car loans, in our view the debtor expenses nothing for that under Romanette ii, and only the actual amount of that debt under Romanette iii.

JUSTICE GINSBURG: I thought the -- the general position was you get either the actual payment or the 471, of whichever is higher.

MS. MAYNARD: Whichever is less. I think that -- that's my understanding of how the local standards work, Your Honor. I think, then, as a practical matter, that really will end up only applying to car leases with respect to transportation ownership costs, because I think that the "notwithstanding" sentence removes secured car loans from Romanette ii and has them calculated under Romanette iii, where there is no comparable cap.

And the -- but -- but the point at issue in this case doesn't involve the interaction between Romanette ii and Romanette iii, because no matter how those two things interact, when the debtor has no payment whatsoever, he ought not to be able to claim any car ownership costs, because what we're trying to figure out is what amounts does he reasonably need for his maintenance and support? And this question is a very important question. . . .
Transcript, pp. 39-43.

The Government Weighs In

The Asst. Solicitor General did a good job of getting to the point before she faced another $1 hypothetical.

MS. SAHARSKY: Mr. Chief Justice, and may it please the Court:

The only question this Court needs to resolve in this case is whether the vehicle ownership expense is applicable to Petitioner. The answer is no. The ownership cost is for loan and lease payments, the cost to acquiring the vehicle, and he just doesn't have any payments of that type. To allow him to pretend that he does would create absurd results. He'd be able to shield approximately $28,000 from his unsecured creditors, and he'd be better off than lower income chapter 13 debtors. And we just don't think that that's a result that Congress intended. We don't think it -

CHIEF JUSTICE ROBERTS: If he paid a dollar, he would be able to shield $27,999, and you're comfortable with that result?

MS. SAHARSKY: Well, that goes to the question of whether the amount in the table is the amount to be used or a cap on actual expenses. In our view, it is -

CHIEF JUSTICE ROBERTS: And I understood your brief to say it was the amount -- you get the whole amount, not simply as a cap.

MS. SAHARSKY: That's right. Now, of course, we haven't seen -- the executive office for U.S. Trustees has not seen any $1 payments. It doesn't know of any such commercially available payments. It suspects the payments would be -

CHIEF JUSTICE ROBERTS: If the point of the $1, counsel, is to lead to the extreme hypothetical that would flesh out your position, what if it were $10,000 and the amount would give him $30,000? The trustees have probably seen loans like that.

MS. SAHARSKY: What I'm saying, Your Honor, is that there are many circumstances in which an expense amount is a standard amount, but you still need to make a threshold showing that it's applicable to you. And if I could give the Court one example: When an individual does his Federal income tax forms, you can take a deduction for your dependents, but you can't just take a deduction for any child you have. You have to take a deduction -- you can take a deduction if the person lives at home with you for more than 1 year and have you a certain amount of expenses to support them, and that is a standard deduction that you get on your tax forms. The IRS doesn't ask everyone to figure out their actual costs.

It is the case in real life that there are allowance amounts that are average amounts that are given to people once they meet the criteria. And that's what we are saying happens here. Now, that is, again, only a disagreement as to what you do with people who actually have vehicle ownership expenses.

Transcript, pp. 43-45.

Can You Read the Commentary?

In an interesting exchange, the attorney for the United States agrees with the Debtor's lawyer that the statutory text refers only to the standards.
JUSTICE SCALIA: Why aren't -- why isn't one of the criteria the -- the provision that says maximum allowances for housing and utilities and transportation, known as the local standards, vary by location, and unlike the national standards, the taxpayer is allowed the amount actually spent or the standard, whichever is less? Why doesn't that apply?

MS. SAHARSKY: Well, because, Your Honor, in that case it's the IRS commentary we are referring to that's on page 1a of the red brief appendix.


MS. SAHARSKY: And that -- what that's referring to is -- it says the amount actually spent or the standard. And that's distinguishing between the amount that's actually spent or the standard, which is the standard -


MS. SAHARSKY: -- amount in the table. Right. And of course, we look to what -- the text that Congress enacted in the Bankruptcy Code, and that says that the debtor's monthly expenses shall be the debtor's applicable monthly expense amounts specified under the national standards and local standards.

JUSTICE SCALIA: It's not applicable. It's not applicable if, in fact, you haven't spent that much. Just as you claim it's not applicable if you have no payment at all.

MS. SAHARSKY: I think that it is -- it would further Congress's purposes to say that you have to -- that you look to the actual costs that the debtor has. But we just don't think the text goes that far, because it says that if the expense amounts -- the category is applicable to the debtor, that then you use the expense amounts specified under the table. But -

JUSTICE KENNEDY: No, but the -- but the gravamen of Justice Scalia's question is: Why are you running away from 1a, which is what Respondent's counsel relied on? And if that were clearly relevant to this statute, it would seem to me to answer the question.

Are you saying we -- we don't look at this because it's just simply an interpretation; it's not a regulation? What is -- what is -- in your view, what effect do we give to this language that Justice Scalia quoted? Nothing at all?

MS. SAHARSKY: It would not be relevant in the bankruptcy context, in our view, and the reason is because the -- the statutory text refers to the standards. And in our view, you can look to the IRS commentary to see what the standards mean, what their scope is, as Justice Breyer was discussing with his apples hypothetical.

But this additional language is guidance to IRS agents in tax delinquency cases about how to collect taxes. As Petitioners -

JUSTICE KENNEDY: Suppose we -- suppose we think the word "applicable" is ambiguous and difficult to construe. Do we then look at this language at 1a, or do you say it's irrelevant in all instance -- in all respects?

MS. SAHARSKY: You -- Your Honor, you could look at this language, but we think that it reflects not the standards, but what -- how the IRS uses the standards in individual cases of tax delinquency. To the extent that the IRS is defining what the standards are, what the scope of the standards are -- for example, that ownership costs are loan and lease payments -- of course, we would think that you would look to that, but this additional guidance to IRS agents we don't think is what Congress meant when it said "expense amounts specified under the standards." But we do think that the text could be read the way you suggest.

Transcript, pp. 45-48.

A Strange Question

CHIEF JUSTICE ROBERTS: Ms. Saharsky, I should -- I should probably know this, but if you do have amounts that are excluded from the disposable income because of car ownership, in other words, you actually have, from -- in your point of view, expenses, do they have to go to the -- pay off the car loan or are they available for everybody? All the creditors?

MS. SAHARSKY: They're not available for the creditors. The idea behind this calculation is that there, of course, are secured debts that have priority, and then this calculation is used to figure out how much money is left to pay unsecured creditors. And the idea is that the debtor has certain expenses, that he needs to keep money for himself so he can continue with the everyday business of life. For example, the car ownership payment is designed to ensure that a vehicle can still use and have access to a car, and if someone has a loan or lease payment, they need to be able to continue making that payment in bankruptcy, but if they don't have any such payment, then they don't have this need for this additional fund because -

CHIEF JUSTICE ROBERTS: But can he decide - let's say he has more food expense than is allowed. Can he decide of the amount that would otherwise go for the car payment that he's going to pay some of that for the food expenses?

MS. SAHARSKY: Well, certainly the Bankruptcy Court doesn't scrutinize, you know, what happens to that regard. What it's just trying to do is figure out the disposable income that is available to pay unsecured creditors, that the debtor doesn't need.

And I should just note with respect to this question of whether there is an overall budget that the debtor is allowed, you know, that's certainly not the case in any of the other provisions that follow this applicable monthly standards and local standards. You have the actual other necessary expenses, actual continuation of taking care of chronically ill family members. And Petitioner himself acknowledges that he has to show that he has a car. So it's not the case that every debtor is just getting some set amount of money to do what they will with. Congress has referenced the standards. The standards break this out into certain expenses. It says just take the applicable ones. And we just don't think it makes sense to interpret "applicable" in that circumstance to -
Transcript, pp. 49-51.

Back to the Romanettes
JUSTICE KAGAN: Ms. Saharsky, could you explain to me the government's position on when a debtor with loan and lease payments gets to deduct them under Romanette ii? In other words, this goes back to Justice Kennedy's question, the notwithstanding clause and whether the notwithstanding clause effectively excludes all loan and lease payments from Romanette ii?

MS. SAHARSKY: It does not have that effect, Your Honor. What it does is to take out the actual debt payments that are part of the other necessary expenses -- these are on page 25a of the red brief - that counsel on our side mentioned. These are other necessary expenses that are actual debt payments, and the local and national standards are expense amounts. We don't think that Congress defined those to be debt payments. So the function of the payments for debts language, we agree with Respondent's counsel, would be twofold. First, it would excise the other necessary expenses that actually are debt payments, which makes complete sense. You know, one of them is an unsecured debt payment, and you wouldn't want to consider that one of your expenses because the whole point of the calculation is to figure out how much money you have left to pay unsecured debts. And then the other function that it serves is in Romanette iii because you were getting secured debt payments there to not double-count them in Romanette ii.

JUSTICE KAGAN: But, in other words, the loan and lease payments don't count as debt for purposes of the notwithstanding clause; they count as expense amounts?

MS. SAHARSKY: We say that those are expense amounts that are specified. They're not payments for debts. I should note, because Justice Kennedy asked this question, that this was not something that was relied upon by the courts below. I don't believe that there's any definitive court of appeals opinion that goes through in detail what that provision is designed to do. So I would urge this Court that it need not resolve it in this case and instead do what the court of appeals did, which is to say that, just looking at the plain text, the word "applicable" means not everybody can get these amounts in the national and local standards, and it needs to be someone who actually has those payment amounts. The whole point of this part of this statute is to figure out what money is available to pay unsecured creditors, and it's payments that need to be made for expenses that matter. It's not whether the individual debtor has a car.

I also note, just because it came up earlier and is a very important point, that to the extent that the Court only wants to look at the tables to figure out what are ownership costs, are they loan and lease payments, just looking at the title of the table, Ownership Costs, you need to have costs. Looking at the fact that there are two different ones -- there's ownership costs as opposed to operating costs -- makes clear that some of the things that Petitioner suggests might be ownership costs are, in fact, operating costs.

Transcript, pp. 51-53. The issue of the exclusion of debt payments from the allowable expenses under the local standards really seems to bother the justices. If ownership expense means loan and lease payments, but loan payments don't count, then the standard doesn't seem to cover much.

It Turns Out That They Are Really Only Arguing Over $100 Per Month

When it comes time for the Debtor's attorney to make his rebuttal, the Justices raise the most interesting question of the argument. Even though the means test said that the Debtor had disposable income of $210 per month, the Debtor's plan proposed to pay $500 per month. If the expense were not included in the means test, the Debtor would have to pay $600 per month. This means that a case went up to the Supreme Court over $100 per month. It also raises the question of why the Debtor would offer to pay more than he had to.

JUSTICE GINSBURG: Mr. Burke, would you explain one facet of this case to me? Given the deduction, the $471 deduction, disposable -- projected disposable income comes down to $210?

MR. BURKE: Correct.

JUSTICE GINSBURG: As opposed to -- it would be 600 some dollars if you didn't count the $471?

MR. BURKE: Correct.

JUSTICE GINSBURG: Even though the disposable income figure was $210, the debtor was willing -- the debtor proposed paying $500. Why did the debtor come up with a $500 figure when projected disposable income without the car ownership would be -if he gets the car ownership, would only be $210?

MR. BURKE: This is exactly why our view of the law works. The means test is a minimum amount. It's a bottom-line quick figure based on standard deductions. It was $200 based on our calculation if he's given his deductions based on age, location, et cetera.

We then go back to I and J, and J, which is on page 44 of the Joint Appendix, is his current expenses. And if we look at line 13A, there is no vehicle payment. He's not taking $471. He took his income and expense. The bottom line was 500. He knew he had to pay at least 200. He's willing to pay the 500. He's not getting a $471 deduction because there is no car payment on his Schedule J.

And if we look at the formula that way, the means test is a general form to give standard deductions, to give us a quick bottom line, and the debtor is either going to pay that amount or more based on his income and expense, and he would pay more if he really didn't have that expense. So if he didn't have a rent expense of $1,000 a month, it would show up on Schedule J that he didn't have 1,000, so his payment would go to $1,500 a month. That's the good faith that's involved in this case.

JUSTICE SCALIA: It would have to go to 1,500 a month, or he, out of the goodness of his heart, would decide to pay that amount?

MR. BURKE: He's going to have to pay an amount of at least $200.


MR. BURKE: It would be hard to confirm a case if he doesn't pay somewhere in that range.

JUSTICE SCALIA: Fine. So why -- why would we assume that he -- I don't know -- your client is an extraordinarily generous fellow. I don't think most people, when they go through bankruptcy, are going to cough up any more than they have to.

MR. BURKE: It's the only way for the form and the law to work. The means test is a bottom-line number. If you don't have one of those expenses, it shows up on Schedule J, and it gives you a number. If it's higher, we think you should probably pay it or in that range. If it's lower, Congress isn't saying you get away with it; it says you get out of chapter 13 if you're not going to pay this amount. So the formula is just to come up with a bottom line. Nobody is shielding anything. expenses. you - It's all black and white on his current If he doesn't have it -

JUSTICE ALITO: Do you think that the -- do

MR. BURKE: -- he's not getting it.
Transcript, pp. 54-56. Here, the Debtor's counsel has an interesting take. The Means Test provides the floor, but the Debtor must pay at least the amount of his actual disposable income as stated on Schedules I and J. Thus, the Debtor doesn't really get to deduct the non-existent car payment. By conceding that the Debtor must pay at least the Schedule I & J income, the practical effect of all the mental gymnastics that the justices and attorneys have been wrestling with is negligible.

Final Thoughts

The Justices seemed to grasp that Congress tried to pound a square peg into a round whole when it incorporated the IRS Collection Standards but also allowed actual deductions for secured debt. As the Chief Justice pointed out, you get absurd results under any interpretation. It's hard to read where the Court will come out on this issue. In the early stages of the argument, it looked like the liberal justices were lining up behind the creditor's position, while the conservative justices were taking the debtor's view. However, when it came time for the credit card company's lawyer to argue, the liberal justices seemed unconvinced of her arguments. I think it is a safe bet that Justice Scalia will side with the Debtor and vote to reverse the Ninth Circuit. However, it's anyone's guess where the other eight will come down.

Monday, November 29, 2010

What Do Circuit Judges Do? Not Much of it is Bankruptcy

A new report from the Fifth Circuit offers some interesting statistics on the work of the court of appeals. You can find the report here. During Fiscal Year 2010, the Court received 7,337 new appeals, just 1.1% of which were bankruptcy appeals. Nearly 64% of the appeals filed were either criminal or prisoner appeals. Bankruptcy was the second smallest category, beating out only mandamus cases at 0.3%. During Fiscal Year 2010, there were just 82 bankruptcy appeals, down from 130 in 2007. Only 12.5% of the appeals filed resulted in published opinions. I can't verify this, but in blogging about bankruptcy opinions, there seem to be a lot of published bankruptcy opinions. Does that mean that bankruptcy is a small but interesting part of the work of the court of appeals?

Saturday, November 27, 2010

Attorney Pays Steep Price for Unauthorized Filing

When dealing with the Soviet Union, Ronald Reagan famously quoted the Russian proverb "trust but verify." An experienced bankruptcy lawyer from Las Vegas would have avoided a lot of trouble if he had heeded this advice. In re Blue Pine Group, Inc., No. BK-S-09-13274-BAM (Bankr. D. Nev. 10/7/10. You can find the opinion here. (PACER registration required).

What Happened

Blue Pine Group, Inc. was a Nevada corporation with ownership split 50/50 between a California group and a Las Vegas group with a four person board of directors. The two shareholder groups didn't get along, resulting in a suit filed by the California group. The Las Vegas group "retaliated" (the Court's word) by hiring a bankruptcy lawyer to file chapter 7 for the company.

Under the Local Rules of the Bankruptcy Court for the District of Nevada, a bankruptcy petition for a corporation must be accompanied by a copy of a board resolution authorizing the filing. The attorney did not have one, but was assured by the attorney for the Las Vegas faction that the Board had in fact passed a resolution. This turned out not to be true.

Pressed by the Las Vegas faction to get the case on file in order to stop the Californians from looting the company, the Debtor's attorney filed a set of schedules and a statement of financial affairs. The Clerk assigned the filing a case number even though no petition had been filed. The Debtor's attorney also filed a "Declaration re: Electronic Filing of Petition" in which he swore under penalty of perjury that the filing was authorized.

Three days later, the attorney for the California faction wrote to the Debtor's attorney objecting to the filing. He included the corporation's articles of incorporation which showed the four initial directors. He also asserted that the California group owned 50% of the company.

Several days later, the Debtor's attorney received a corporate resolution signed by the Las Vegas directors only. He was told that these were the only signatures required since the California directors had been removed. He did not request evidence of these assertions. It turned out that the California directors were removed at a meeting that they were not given notice of, so that the action was invalid.

Finally, seven days after the initial filing, the Debtor's attorney filed a bankruptcy petition signed by one of the Las Vegas parties. The Debtor's attorney also filed an adversary proceeding against the California parties without consulting the Chapter 7 trustee.

The California group filed a Motion to Dismiss the case, which the Court granted. The Californians then filed a Motion for Sanctions against the Debtor's lawyer. They did not file against the Las Vegas group because they had previously settled with them. The Court granted the Motion for Sanctions and awarded $109,528 to the California group.

Authority for Sanctions

Under Rule 9011, an attorney who signs a bankruptcy petition certifies that it is not being presented for any improper purpose and that the allegations contained therein have evidentiary support or, if expressly stated, are likely to have evidentiary support after opportunity for further investigation and discovery. This was a problem for the Debtor's attorney because the petition was filed for an improper purpose (retaliating against the California group) and he failed to adequately investigate his client's claim that it was authorized. He also continued to defend the filing after it should have been clear that it was problematic.

The Debtor's attorney defended by asserting that he was simply following his client's instructions. The court rejected this defense.

Mr. (Debtor's Attorney) defended in part on the assertion that the need for relief, as stated to him by the client, justified his continuing efforts to defend the initial petition. This justification may seem to be absolute, but the rules of professional responsibility, applicable to all lawyers, underscore that it is not: a client’s demands cannot alone support taking unjustified and unjustifiable positions. Rule 3.1 of Nevada’s Rules of Professional Conduct states:

"A lawyer shall not bring or defend a proceeding, or assert or controvert an issue therein, unless there is a basis in law and fact for doing so that is not frivolous, which includes a good faith argument for an extension, modification or reversal of existing law. . . ."

This rule requires a lawyer to exercise independent judgment with respect to claims a client wishes to bring and to decline to pursue claims that are frivolous. As indicated in a leading treatise:

"[A] lawyer’s duty to refrain from making frivolous contentions will result in conflict with the client if the client insists that the contentions nevertheless be made. When such conflicts arise, Model Rule 3.1 and practice rules such as Rule 11 of the Federal Rules of Civil Procedure dictate that the interests of the fair administration of justice must be given priority over the client’s desires."

(citation omitted).
Memorandum, p. 7.

The Court also faulted the attorney for continuing to follow his client's instructions after the position had become untenable.

This “later advocating” of an untenable position (and the corresponding failure to take corrective action, such as removing his inaccurate filings from the docket) was (Debtor's Lawyer's) primary failing in this matter and forms the basis for the restitutionary award to Humitech. To quote Hazard, Hodes & Jarvis:

"If the lawyer carries out the client’s instruction after becoming aware of the frivolous nature of the contentions, both the lawyer and the client can be civilly liable for sanctions under FRCP Rule 11, as well as subject to the exercise of the court’s inherent supervisory powers."

(citation omitted). As this court has previously stated:

"To act on such frivolous claims, then, without independent investigation, was to succumb to the so-called “butler-style” of representation, under which the sequaciously servile lawyer does whatever the client wants and then cites that client’s command as a shield to the improper actions. This style of lawyering, however, has no place in bankruptcy court or, for that matter, in any court. (citation omitted)."
Memorandum, p. 10.

I had to look up "sequaciously servile" to fully comprehend the passage. The Random House College Dictionary defines "sequacious" as "following, imitating, or serving another person, esp. unreasonably." It defines "servile" as "slavishly submissive or obsequious; fawning." Thus, it means a slavishly submissive following of another person. Since attorneys are supposed to be strong-willed, it is a strong insult to be labeled as submissive.

What It Means

This was a case where an attorney was hung out to dry for blindly listening to his client. The client meanwhile settled with the other side and escaped liability. This shows the delicate tightrope that attorneys must walk between representing their clients zealously and protecting themselves from their clients. If the attorney's testimony is to be given credence, he was lied to by both his client and his client's other attorney. However, under Judge Markell's opinion, being lied to is not a defense to a sanctions motion if the attorney should have investigated his client's statements more carefully.

The Debtor's attorney could have protected himself better at several points:

1. He could have refused to file the case until he had the corporate resolution.
2. Once a question was raised about the validity of the corporate resolution, he could have asked to see the corporate documents removing the other two directors.
3. When his client could not back up his statements, he could have withdrawn and refused to defend against the Motion to Dismiss.

The attorney's fees incurred of $109,528 seem excessive for a case which was dismissed within 90 days of filing. However, the tone of the opinion suggests that the case was vigorously fought. The Court refers to "needless discovery disputes." Thus, the Court's ire may have been raised by the fact that the attorney not only asserted frivolous positions, but did so aggressively. That is one explanation for the high level of the fees. Another possibility is that the California group knew they were likely to win and engaged in a bit of piling on. However, it is impossible to tell from the opinion.

The case has been appealed to the Ninth Circuit Bankruptcy Appellate Panel.

Wednesday, November 17, 2010

Debtor Wins Big Damages in Fraudulent Conveyance Case

When fraudulent transfer claims arise in bankruptcy, the debtor is usually accused of being the dishonest transferor. However, in a recent case from Chief U.S. Bankruptcy Judge Ronald King, the Debtor successfully pursued a claim against her disbarred ex-husband. Galaz v. Galaz, Adv. No. 08-5043 (Bankr. W.D. Tex. 11/12/10). The opinion can be found here.

A Tangled Procedural Web

The procedural context of the case is incredibly complex (but fortunately is not necessary to understand the 14 page opinion). Denise Vernon sued Lisa Galaz in a dispute over a company called Worldwide Subsidy Group, LLC. Lisa then filed chapter 13. Both Denise and Lisa's ex-husband Raul filed non-dischargeability complaints against Lisa. Lisa removed Denise's action to bankruptcy court. Lisa then sued Raul as a third party defendant relating to the WSG transactions. While this action was pending, Lisa also sued Raul, his father Alfredo and their company Segundo Suenos, LLC for transactions arising out of another company called Artists Rights Foundation, LLC ("ARF"). After mediation, Denise and Lisa settled their claims and those disputes were dismissed. Raul then tried to force Lisa to join Julian James, the other member of ARF. Instead, the Court allowed Raul to file a third party claim against Julian. Julian filed a claim against Raul. Thus, by the time the case went to trial, Lisa and Julian were asserting claims against Raul, Alfredo and Segundo Suenos, who asserted claims back against them.

The Underlying Facts

So what gave rise to all these dead trees? It all had to do with the right to collect royalties from the popular funk and soul group The Ohio Players. Raul and Julian formed ARF to collect royalties relating to The Ohio Players. When Raul and Lisa were divorced, Lisa was awarded 1/2 of Raul's interest in ARF. Raul then sent a notice to Julian seeking to remove him as a member due to failure to pay expenses related to ARF (including legal fees charged by Raul after he was disbarred as a California attorney). Raul sent this notice to the address designated in the LLC agreement even though he knew that Julian would not receive this notice. Raul then unilaterally conveyed the assets of ARF to Segundo Suenos, LLC and dissolved ARF.

The Issues

The issues at trial were:

1. Was the transfer from ARF to Segundo Suenos, LLC void for failure to be authorized by the company?
2. Was Raul collaterally estopped to deny the invalidity of the transaction?
3. Was the transfer a fraudulent conveyance?
4. Did Raul breach his fiduciary duty to Lisa and Julian?

A Short Course in LLC Law

The Court's ruling highlights the intricacies of limited liability company law. Under the LLC agreement, Raul and Julian were the members of the company. The divorce decree awarded Lisa 1/2 of Raul's interest. Under the LLC agreement, assignees were deemed to hold an "economic interest" in the LLC but would not be members unless agreed to by all of the members. By signing off on the Divorce Decree, Raul agreed to allow Lisa to be a member. However, Julian did not. As a result, Lisa held an "economic interest" but was not entitled to vote. Under the LLC agreement, if a member failed to respond to a written request for capital contributions within 10 days, his interest could be converted into an "economic interest." Raul sent a notice to Julian at the address specified in the LLC agreement and Julian did not respond. However, this was not surprising, since Raul knew that Julian would not receive a notice sent to this address.

Raul contended that he had carte blanche to convey the ARF assets because he was the only voting member. He contended that Lisa was never a member and that Julian ceased being a member by virtue of the notice. The Court held that he was half right. As an assignee, Lisa did not have the right to participate in management due to Julian's failure to approve her as a member. However, the notice sent to Julian was not sufficient to take away his vote because it did not identify any specific expenses to pay and was not received by him to boot. Thus, the transfer was not authorized.

The Court also found that Raul was bound by a California Court of Appeals opinion finding that Segundos Sueno had not established its entitlement to the Ohio Players royalties and found that the case contained sufficient badges of fraud to constitute a fraudulent transfer.

Relying on California law, the Court found that members of an LLC owed a fiduciary duty to each other, but not to persons holding an "economic interest" in the company. The California LLC statute expressly adopted the fiduciary standard applicable between general partners which did not reach assignees. As a result, Julian could recover for breach of fiduciary duty but Lisa could not. However, the Court ruled that Lisa and Julian could recover from Raul for fraud.

The Damages

Lisa was awarded actual damages of $250,000 and punitive damages of $250,000, while Julian recovered actual damages of $500,000 and punitive damages of $500,000. The Court ruled that the royalties would vest 50% in Julian, 25% in Raul and 25% in Lisa. It also ruled that Lisa and Julian could collect their damages out of Raul's share.

What Does This Mean for the Chapter 13?

One goal of BAPCPA was to expedite confirmation of chapter 13 plans. This case illustrates that there are some cases that just don't fit that mold. When the case was filed the Debtor scheduled her interest in WSG at $0 and did not list her interest in ARF. If the case had been confirmed at that time based on the facts known at that time, the Debtor would have been required to make a very low distribution to creditors.

However, apparently as the result of the extensive amounts recovered from litigation in the case, the Court ordered the Debtor to pay $200,000 to unsecured creditors plus amounts paid to secured creditors and attorneys. Since the Debtor is already required to effectively pay 100% to unsecured creditors, the recovery from Raul would not appear to increase her obligation to creditors except for one important point. The Debtor was required to make her payment to unsecured creditors in addition to her payments to attorneys. Since the attorney's fees required to litigate the matter were substantial (the court has already approved over $75,000 in fees), the cost to recover the asset is borne directly by the Debtor. It seems a cruel twist of fate that the harder the Debtor and her attorneys had to work to recover funds for the creditors, the more the Debtor is required to pay.

What Does It All Mean?

On one level, this is a case about California LLC law and the difference between a member and the holder of an economic interest. However, on a big picture basis, it is a testament to the perils of dealing with a case involving an ex-spouse and assets that could only be recovered through litigation. When the Debtor's counsel took this case, he most likely did not contemplate that a chapter 13 bankruptcy in San Antonio would generate 418 docket entries in the main case alone. The result of the hard work by Debtor's counsel and Special Counsel is that unsecured creditors will get paid in full.

Saturday, November 13, 2010

Fifth Circuit Protects Texas Tax Lien Purchasers

In a case where private enterprise meets governmental finance, the Fifth Circuit has ruled that purchasers of Texas tax liens are protected from having their contractual interest rates modified in a plan. Tax Ease Funding, LP v. Thompson, et al, No. 09-20777 (5th Cir. 11/11/10). The opinion can be found here.

The case involved consolidated appeals regarding private parties who had purchased Texas property tax liens. In order to boost property tax collections, the State of Texas passed a law allowing property owners to enter into a transaction with a private lender to pay the taxes on their property. In return, the tax lien funder is subrogated to the lien of the taxing authority and takes an assignment of the tax lien. Under the law, the private party can charge any negotiated interest rate up to the usury limit of 18% as compared to the statutory rate of 12%. TEX. TAX CODE § 32.06(a-1).

One of the new sections created by BAPCPA was 11 U.S.C. Sec. 511, which provides that a "tax claim or on an administrative expense tax" shall be entitled to "the rate of interest shall be the rate determined under applicable nonbankruptcy law."

The cases before the court involved debtors who had financed their tax liens at high interest rates and then sought to reduce the rates under a plan. If the debtors had not engaged in the private party finance transactions, it appears clear that they would have been required to pay 12% interest to the original governmental creditor. However, by virtue of the private party transaction,the contract obligated the debtor to pay 14.8%.

The questions for the Fifth Circuit were whether the creditor held a "tax claim" and whether the creditor was entitled to the rate the original tax creditor would have received or the higher negotiated rate.

The court noted that the term "tax claim" is not defined under BAPCPA. The court began with the expansive definition of claim as right to payment. The court stated, "(i)n the simplest terms, a tax claim is a broad right to payment of taxes." The court found that private parties were entitled to "tax creditor" status because the court used the broader term of "tax creditor" as opposed to the more limited term "governmental unit."

The debtors argued that because the private party received only an assignment of the tax lien and not the taxes themselves that they were not entitled to protection of their negotiated interest rate. The court relied upon Johnson v. Home State Bank, 501 U.S. 78, 83, 111 S. Ct. 2150, 2154 (1991)to hold that a party with a lien held a "claim" against the debtor. Therefore, a tax lien equated to a tax claim.

The Fifth Circuit rejected the Bankruptcy Court's conclusion that the "tax claim" was extinguished when the private party paid the taxes. Under state law, the purchaser was subrogated to all the rights and remedies of the taxing authorities. The court found that contractual subrogation did not limit the subrogee to the exact same rights as the original creditor held.

Thus, a private party was entitled to non-modification of its higher contractual rate of interest.

Because the Fifth Circuit confined its analysis to a code to code connect the statutes approach, it did not look at the policies behind the statutes. However, there is an arguable case that local taxing authorities benefit from having their taxes paid from private parties now rather than having to pursue their own collection efforts. If the private party receives a greater reward for paying the taxes, that is simply the premium which must be paid to entice a private party into the market. Because the debtor's decision to refinance the tax lien is purely voluntary, the debtor has difficulty claiming that it was prejudiced.

There are two take aways here. The first is that Congress intended to protect local taxing authorities when it adopted Sec. 511. The second is that a party owing ad valorem taxes in Texas should seriously examine the wisdom of refinancing the tax lien. While it may provide short-term relief from the tax man, the debtor will be stuck with the burden of the bargain.

Monday, November 08, 2010

Bankruptcy Map Gives New Meaning to "Red" States

A map showing Bankruptcy Filings Per Capita gives new meaning to the term "Red State." The map prepared by the Administrative Office of the United States Courts analyzes bankruptcy filings per capita for each of the nation's counties for the year ending September 30, 2010. The higher the per capita filing rate, the redder the map. (You can access the map via the link in the first sentence, but be sure to click on the 2010 tab to get the right map).

The map shows the highest per capita filings in Southern California/Nevada, the Midwest and the Southeast. Texas had light filings compared to the rest of the nation. In Travis County, where I live, the rate was 1.9 filings per thousand residents or about 1 bankruptcy for every 500 people. In contrast, Shelby County, TN had a rate of 14.6 filings per thousand or about 1 filing for every 68 residents. When you think about it, 1 in 68 is a lot of bankruptcies.

The following is a list of those counties experiencing per capita filing rates above 10 per thousand, which works out to 1% (The list may not be exact because it is necessary to mouse over a county to get its specific rate. It is entirely possible that my mousing skills may have left some counties unnoticed).

Counties With Per Capita Filing Rates Above 1%




Shelby County



Henry County



Douglass County



Newton County



Walker County



Clark County



Gallatin County



Rockdale County



Grant County



Clayton County



Ware County



Lauderdale County



Glasscock County



Paulding County



Hopkins County



Tuscaloosa County



Barrow County



Riverside County



Dyer County



Cook County



McDuffie County



Crook County



Tipton County



Lapeer County



Pierce County



Hardeman County



Haywood County



Crockett County



Troup County



Jennings County



Madison County



Deschutes County



Gibson County



Genesee County



Whitley County



The Districts with the most high per capita filings were the Northern District of Georgia (nine counties) and the Western District of Tennessee (eight counties). What does this tell us? A lot of people are filing for bankruptcy in the rural Southeast.

None of the highest per capita filing counties were in major metropolitan areas. However, the general pattern held for the ten largest cities in the United States. There were lower per capita filings in the Northeast (New York and Philadelphia) and Texas (Houston, San Antonio and Dallas) and higher filing rates in the Midwest (Chicago), Arizona (Phoenix) and California (Los Angeles, San Diego and San Jose).

Per Capita Filing Rates of Counties With Ten Largest Cities




New York County



Los Angeles County



Cook County (Chicago)



Harris County (Houston)



Maricopa County (Phoenix)



Delaware County(Philadelphia)



Bexar County (San Antonio)



San Diego County (San Diego)



Dallas County (Dallas)



Santa Clara County (San Jose)



Note: I could not find a correlation between "red" counties in the per capita filing rates and "red" Congressional districts in the 2010 elections. Of the counties with the ten highest filing rates, 5 1/6 elected Republican representatives and 4 5/6 elected Democratic representatives. The fractions result from the fact that some counties are included in more than one Congressional district.