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?

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.

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.

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.

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%

County	District	Rate
Shelby County	TN-W	14.60
Henry County	GA-N	13.88
Douglass County	GA-N	13.28
Newton County	GA-N	13.14
Walker County	GA-N	13.10
Clark County	NV	13.09
Gallatin County	KY-E	13.05
Rockdale County	GA-N	12.59
Grant County	KY-E	12.33
Clayton County	GA-N	12.23
Ware County	GA-S	11.72
Lauderdale County	TN-W	11.52
Glasscock County	GA-S	11.42
Paulding County	GA-N	11.33
Hopkins County	KY-W	11.26
Tuscaloosa County	AL-N	11.14
Barrow County	GA-N	11.09
Riverside County	CA-C	10.98
Dyer County	TN-W	10.92
Cook County	GA-M	10.84
McDuffie County	GA-S	10.75
Crook County	OR	10.59
Tipton County	TN-W	10.49
Lapeer County	MI-E	10.47
Pierce County	GA-S	10.44
Hardeman County	TN-W	10.39
Haywood County	TN-W	10.38
Crockett County	TN-W	10.35
Troup County	GA-N	10.33
Jennings County	IN-S	10.31
Madison County	TN-W	10.30
Deschutes County	OR	10.29
Gibson County	TN-W	10.11
Genesee County	MI-E	10.04
Whitley County	IN-N	10.01

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

County	District	Rate
New York County	NY-S	1.99
Los Angeles County	CA-C	7.11
Cook County (Chicago)	IL-N	7.23
Harris County (Houston)	TX-S	1.99
Maricopa County (Phoenix)	AZ	7.29
Delaware County(Philadelphia)	PA-E	2.45
Bexar County (San Antonio)	TX-W	2.45
San Diego County (San Diego)	CA-S	7.35
Dallas County (Dallas)	TX-N	2.76
Santa Clara County (San Jose)	CA-N	4.86

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.