Monday, September 27, 2010

Best & Worst Posts of the Past Four Years: Looking for Reader Input

After four years of blogging, I am approaching my 200th post. I was planning to do a retrospective on my ten favorite posts. However, I think it would be even more interesting to hear what you, the readers, think. Please send me your nominations for best posts. Votes from current or former judges get double points. I will also take nominations for dishonorable mention. Since I am commenting on and critiquing other people's cases, I think that it is fair for you to let me know where I have been unfair, off the mark or just plain stupid.

If you would like to participate, please send an email to by October 15th. If you would like to include comments with your nominations, please feel free to do so. Any comments will be published anonymously unless you specifically request attribution.

Thanks in advance for your help.

Sunday, September 26, 2010

Escorts Read Bankruptcy Blogs

The latest trend which has turned up in the comments is thoughtful responses from women identifying themselves as escorts. Here is a sample:

It was extremely interesting for me to read that post. Thanx for it. I like such topics and everything that is connected to them. I definitely want to read more soon. H______ B_______ escorts kiev

It is extremely interesting for me to read this article. Thanks for it. I like such themes and anything connected to this matter. I would like to read a bit more soon. J______ H_____ adult escort
What to make of this? Do escorts take an interest in the intricacies of bankruptcy law or are they just hoping to meet some lonely bankruptcy lawyers? I would be more likely to publish the comments if they were not worded so similarly.

Monday, September 20, 2010

Pres. Obama Taps Liz Warren to Launch Consumer Financial Protection Bureau

Last Friday, President Obama tapped Harvard Prof. Elizabeth Warren to be a Special Assistant to the President to help launch the Consumer Financial Protection Bureau. If the only thing that I knew about her was that she was a Harvard professor, I might wonder if she was some ivory tower academic.

However, I do know better. She was my professor at the University of Texas Law School (granted it was Payment Systems and not Bankruptcy) where I got to observe her up close and personal three times a week.

Even after she left UT, she continued to be one half of the dynamic duo of Warren and Westbrook who would inaugurate each UT Bankruptcy Conference with their current case update, which was part serious academic discussion and part stand up.

Prof. Warren is that unique combination of academic law nerd and someone you might want to have a beer with (which says a lot because I am trying to cut down on carbs). Perhaps nothing says this better than her appearance on The Daily Show this year.

The Daily Show With Jon StewartMon - Thurs 11p / 10c
Elizabeth Warren
Daily Show Full EpisodesPolitical HumorTea Party

Congratulations Liz and good luck.

Sunday, September 19, 2010

Fifth Circuit Muddles Judicial Estoppel; En Banc Review Needed

In a new opinion, the Fifth Circuit has taken a big step backward in sorting out the doctrine of judicial estoppel. Reed v. City of Arlington, No. 08-11098 (5th Cir. 9/16/10). While adopting the principle that one panel of the Fifth Circuit cannot overrule another one, the opinion appears to be inconsistent with the Fifth Circuit's most recent prior ruling on judicial estoppel, thus indicating the need for en banc review. The opinion can be found here.

Two Wrongs and Two Rights Make a Mess

The first wrong in this case originated with the City of Arlington. It violated the Family Medical Leave Act with regard to Kim Lubke, a former firefighter. Lubke obtained a one million dollar judgment against the City.

A year later, while the judgment was on appeal, Lubke filed chapter 7. He forgot that he had a valuable judgment and apparently omitted a number of other assets as well. The Trustee closed the case as a no-asset filing.

The Fifth Circuit remanded the case for recalculation of damages. Subsequent to the remand, the City offered to enter into a Rule 68 judgment for $580,000. In discussing this offer with his client, the Debtor's non-bankruptcy attorney, Roger Hurlbut first learned about the bankruptcy. He promptly informed the Trustee's counsel. The Debtor and the Trustee successfully reopened the bankruptcy case and the Trustee sought to be substituted as plaintiff. The Debtor also agreed to have his discharge vacated.

Let's recap who behaved well and who behaved badly at this point:

The City of Arlington behaved badly when it violated the FMLA.

The Debtor behaved badly when he lied on his schedules.

The Debtor's nonbankruptcy lawyer performed blamelessly, representing the Debtor competently in the FMLA action and promptly notifying the Bankruptcy Trustee once he learned upon the bankruptcy.

The Bankruptcy Trustee did what she was supposed to do by moving promptly to reopen the bankruptcy case and pursue the litigation.

So at this point, we have two wrongs and two rights. For their part, the creditors did nothing wrong.

The District Court Tries to Follow the Fifth Circuit

The District Court considered the issue of judicial estoppel. After considering the Fifth Circuit's conflicting precedents on judicial estoppel, it found that the Debtor was subject to judicial estoppel. However, it found that the Trustee and the creditors should not be punished for the Debtor's wrongdoing. It allowed the Trustee to proceed with the case, but provided that once creditors were paid, any excess funds would go back to the City of Arlington rather than to the Debtor. Had the District Court been affirmed, the bad would have been punished and the blameless would not.

However, the Fifth Circuit chose not to affirm the District Court.

The Law of Judicial Estoppel

The Supreme Court has fashioned a three pronged test for whether judicial estoppel should apply:

(1) whether a party's later position is clearly inconsistent with its position in a prior case; (2) whether the party succeeded in persuading the first court to accept its position, creating “the perception that either the first or the second court was misled;”and (3) whether the party espousing the inconsistency has gained an unfair advantage or imposed an unfair detriment on an opposing party by that means.
City of Arlington v. Reed, slip op., p. 5, discussing New Hampshire v. Maine, 532 U.S. 742 (2001).

Prior to Reed, the Fifth Circuit had completed a trilogy of cases on judicial estoppel in bankruptcy.

The first of the recent Fifth Circuit cases was In re Coastal Plains, Inc., 179 F.3d 197 (5th Cir. 1999). In that case, the Debtor’s CEO formed a company which acquired the assets of the debtor corporation. The insider purchaser then filed suit on a claim which had not been disclosed in the schedules. The purchaser recovered $3.6 million on the undisclosed claim. The Fifth Circuit reversed on appeal, finding that accepting the argument that the claims were inadvertently left off the schedules “would encourage bankruptcy debtors to conceal claims, write off debts, and then sue on undisclosed claims and possibly recover windfalls.” In re Coastal Plains at 213.

Next came In re Superior Crewboats, 374 F. 330 (5th Cir. 2004). In that case, it was the debtor who was estopped. In that case, one of the debtors was injured prior to bankruptcy. During their chapter 13 case, they filed suit on a claim which was not listed in their schedules. After their case was converted to chapter 7, the debtors told the trustee about their claim, but represented that it was barred by limitations. As a result, the trustee abandoned the claim which the debtors continued to pursue. When the trustee learned about the case, he attempted to substitute in. However, the court granted summary judgment for the defendant.

The third component of the trilogy was Kane v. Nat’l Union Fire Ins. Co., 535 F.3d 380, 384 (5th Cir. 2008). That case looked a bit like Superior Crewboats, but with one major distinction. In Kane, the Debtor failed to disclose a claim. However, the Trustee did not abandon the claim. Instead, once the Trustee learned of the deception, the Trustee sought to pursue the claim on behalf of the creditors. The District Court granted summary judgment, relying on Superior Crewboats. However, the Fifth Circuit said not so fast. In its opinion, it stated:

There, because the trustee had abandoned the claim, he was not the real party in interest and was not entitled to be substituted as such. Rather, following the trustee’s abandonment, the interest in the claim had reverted to the debtors,who stood to collect a windfall from the asset at the expense of the creditors. In the case before us, the Kanes’ personal injury claim became an asset of their bankruptcy estate when they filed their Chapter 7 petition. The Trustee became the real party in interest in the Kanes’ lawsuit at that point and never abandoned his interest therein.

The Fifth Circuit noted that the Kane case did not present any equitable concerns. Indeed, the creditors would be harmed if judicial estoppel was applied to preclude the trustee from pursuing the claims. The court quoted from a great Seventh Circuit opinion which made the obvious point:

[The debtor’s] nondisclosure in bankruptcy harmed his creditors by hiding assets from them. Using this same nondisclosure to wipe out [the debtor’s claim against the defendant] would complete the job by denying creditors even the right to seek some share of the recovery. Yet the creditors have not contradicted themselves in court. They were not aware of what [the debtor] was doing behind their backs. Creditors gypped by [the debtor’s] maneuver are hurt a second time by the district judge’s decision. Judicial estoppel is an equitable doctrine and using it to land another blow on the victims of bankruptcy fraud is not an equitable application.

Kane, quoting Biesek v. Soo Line R.R. Co., 440 F.3d 410, 413 (7th Cir. 2006).

The Fifth Circuit's Ruling in Reed

Given that Reed and Kane involved nearly identical circumstances, the Trustee could have reasonably expected a similar result. However, that was not to be.

The Court acknowledged that its precedents might be a bit hard to follow. However, it insisted that it was necessary to disregard Kane and follow Coastal Plains and Superior Crewboats. Writing for the panel, Chief Judge Edith Jones stated:

What are the bankruptcy courts, which confront these problems regularly in our circuit, to make of these decisions? The grounds on which Kane distinguished In re Coastal Plains are that, in In re Coastal Plains, a corporate officer's misdeeds detrimentally influenced the corporate reorganization process as well as depriving creditors of the concealed cause of action. Id. Kane purports to distinguish In re Superior Crewboats, moreover, based on the differing procedural consequences between a trustee's abandonment of a claim (to the debtor) and the non-disclosure of assets that are not administered although still within the debtor's estate. Id. at 386-87. Whether these distinctions are correct in principle or on the facts are matters for another debate. Absent en banc harmonization, we must endeavor to reconcile the authorities. We are also guided by the principle that one panel of this court cannot overrule another panel decision. (citation omitted). Thus, judicial estoppel remains applicable to litigation claims that are undisclosed in bankruptcy, and the doctrine's essential ingredients remain the same.

Reed at 7 (emphasis added). When one judge within the circuit contends that an opinion by another panel "purports" to distinguish a prior precedent, these are very strong words. Why does Judge Jones believe that the per curiam opinion from Judges King, Wiener and Elrod merely "purports" to distinguish the prior precedent?

Judge Jones makes it seem as though it were a mere procedural distinction, the difference between abandonment and non-abandonment. However, it rests on something much more substantive. In order for judicial estoppel to apply, the case must involve the same parties. The trustee is not the same party as the debtor. Therefore, judicial estoppel should NEVER apply to the trustee based on the Debtor's actions.

However, Judge Jones believes that the distinction between the trustee and the debtor is inconsequential. She writes:

(I)t is not sufficient to distinguish the debtor’s conduct from that of the trustee in applying judicial estoppel. Even though Reed herself takes no inconsistent legal positions, she succeeds to the debtor’s claim with all its attributes, including the potential for judicial estoppel.

Reed, at 7. Judge Jones does not provide any further analysis as to why the Trustee is bound by the Debtor's actions. Since this was the primary focus of the Kane opinion, a little more explanation would have been helpful.

While Judge Jones's statement is true in the abstract, it is disingenuous in the specific case. A trustee succeeds to the debtor's rights as of the petition date. Thus, a trustee would be bound by the fact that the debtor did not preserve his cause of action by filing suit within the period allowed by the statute of limitations. A trustee would also be bound if the debtor had settled the case on an arms length basis and squandered the proceeds before filing bankruptcy.

However, the facts constituting judicial estoppel do not exist on the petition date. Even if the debtor filed the false schedules with the bankruptcy petition, the element of receiving a benefit from the inconsistent position cannot occur until after the petition date.

When a debtor files bankruptcy, all of his legal rights become property of the estate under Section 541. The Trustee is the representative of the Estate. Therefore, if the claim had not been invalidated as of the petition date, the Trustee has the right to pursue it. When the Trustee closes a case, any properly scheduled assets which are not administered revert to the Debtor. However, undisclosed assets remain property of the estate subject to future administration by the Trustee. Since judicial estoppel cannot arise until after the bankruptcy filing and the Debtor is not the representative of the estate and the undisclosed asset never reverts to the Debtor, it should be clear that the Debtor cannot prejudice the rights of the Trustee subsequent to the petition.

This should be pretty obvious. However, the court dismissed it with one sentence and no further elucidation.

Judge Jones offers an alternate explanation of how judicial estoppel works. She writes:
The lowest common denominator appears to lie in a holistic, fact-specific consideration of each claim of judicial estoppel that arises from litigation claims undisclosed to a bankruptcy court.

Reed, at 6.

The Court then went on to find that the equities favored the City of Arlington.

The creditors are not materially advantaged if this case proceeds further. Only about one-sixth of the original creditors (reckoned in amount of claims) timely refiled when the case was re-opened a year after they were informed there were no non-exempt assets to distribute. See supra note 2. The untimely filers have little if any hope of recovery from the bankruptcy estate; the timely filers' recovery will be contingent on the payment of large priority administrative expenses caused by the ongoing litigation. True, Lubke agreed to revoke his discharge, but most creditors will have foregone alternative collection strategies at this point. The rincipal remaining bankruptcy “claimants” are Reed herself and Lubke's trial attorney Roger Hurlbut, who has already received from Lubke some payment for his services. Reed’s claim has been substantially increased because of this judicial estoppel litigation. Here, equity does not favor ignoring Lubke’s misuse of the court system for the primary benefit of attorneys.

Reed, at 8.

Equity is like pornography in that a person should be able to know it when they see it. Here, the court's view of equity is that the City of Arlington should be excused from liability for its wrongdoing because many of the creditors did not file timely claims and because the benefit of the case might go to attorneys.

Let's analyze the relative rights and wrongs here. The creditors who filed timely claims did not do anything wrong. However, under the Court's opinion, they will not stand any chance of recovery. The Debtor's nonbankruptcy attorney did everything right. However, he will lose out on the vast majority of his compensation. The Trustee did everything right. However, she will not receive any compensation. Indeed, the Debtor's nonbankruptcy attorney and the Trustee are placed in a suspect class because they are attorneys (just like the judge who wrote the opinion). The most charitable thing which can be said about the court's equitable analysis is that it is not obvious when you see it.

The Need for En Banc Review

The opinion in Reed was justified by the fact that one panel of the circuit cannot overrule another one absent en banc review. Judge Jones believes that the Kane court overruled Superior Crewboats and that its opinion should not be respected. An equally valid argument can be made that Reed overrules Kane. Of the four Fifth Circuit opinions dealing with judicial estoppel in the bankruptcy context, only two involved claims asserted by trustees. Those two opinions are diametrically opposed. This is a case where the en banc court needs to step in and resolve the inconsistency.

Integrity and Incentives

The en banc court should also consider whether this ruling promotes or hinders the integrity of the bankruptcy system and the larger federal court system. The integrity of the bankruptcy system is policed by multiple parties. At the outset, it depends upon the honesty of the debtor and the professionalism and ethics of the debtor's counsel. It also depends upon the trustee, creditors and the U.S. Trustee to ferret out wrongdoing.

Under Reed, the Debtor is given a perverse incentive to dishonesty. If the Debtor commits fraud and does not get caught, he keeps the benefits of his wrongdoing. If the Debtor commits fraud and does get caught, he has no opportunity to mitigate the damage. While there is no excuse for dishonesty, the Kane opinion gives the ethically wavering debtor the opportunity to make amends, while Reed does not.

The Reed opinion also removes the incentive for Debtor's counsel to bring fraud to light. The real hero in this case is Roger Hurlbut, the Debtor's nonbankruptcy counsel. When he learned about his client's omission, he immediately brought it to the Trustee's attention. His reward for displaying high ethics is that he loses the fee that he had earned. A less ethical lawyer knowing the penalty for disclosure might have been tempted to keep his mouth shut.

The Trustee also is deprived of any incentive to go after undisclosed assets. If the Trustee learns of an undisclosed asset which is being stealthily being pursued by the Debtor, the Trustee will have little motive to go after it. Trustees get paid on a commission. They succeed if the creditors succeed. However, under Reed, the diligent Trustee gets nothing for her effort. Indeed, the fact that she is a lawyer is cited as a reason why it would be inequitable to allow the case to proceed.

Finally, in the context of the larger federal court system, wrongdoers are given an opportunity to escape responsibility. Congress passed the FMLA because it beileved that its policies served an important goal in society. The City of Arlington apparently flouted those policies. The City was ready to settle until it learned that it had an out. What incentive does the City have to change its ways under this decision?

Here is what should happen in the case of an undisclosed asset. First, the parties to the case should have an incentive to discover the fraud and bring it to the trustee's attention. Second, the trustee should be given the first opportunity to pursue the claim. If the trustee does not elect to pursue the claim, then judicial estoppel should apply as to the debtor and the claim should be dismissed. However, if the trustee elects to pursue the claim, the alleged wrongdoer is in no worse position and may even be in a better position. As a fiduciary for the benefit of the creditors, the trustee may be willing to cut a better deal with the defendant so as to minimize the risk and delay to the creditors.

Hat Tip to Steve Roberts and St. Clair Newbern.

UPDATE: The Commercial Law League of America has submitted an amicus brief in support of the Trustee's motion for rehearing en banc. You can read it here.

Monday, September 13, 2010

Jernigan on Reaffirmations

I hate reaffirmation agreements. They are way too complicated under BAPCPA and consume way too much time. However, Judge Stacy Jernigan has written a 22 page opinion that explains everything you would ever want to know about reaffirmations. In re Grisham, No. 10-32524 (Bankr. N.D. Tex. 9/7/10). You can find it here. This opinion came to me with the recommendation, "this opinion is so excellent that I felt it would be a shame not to pass it along." I am doing my part by passing it along to this blog's readers.

The Facts

It starts with a debtor and a truck. The Debtor wanted to reaffirm a debt for $17,690.59 which was worth only $16,225 and contained an interest rate of 17.5%. The debtor had 71 months of payments left. His occupation was "retired/unemployed" and his income consisted of social security and unemployment benefits (which were about to expire). He also had about $200,000 in non-dischargeable debt consisting of taxes, alimony and student loans. His net income on Schedules I and J was -$1,091.

Initial Requirements

Judge Jernigan points out that reaffirmations are subject to mandatory requirements without which they are unenforceable.

The first requirement is that the reaffirmation be "made" prior to the granting of the discharge. That means that both parties must have signed it by this date. The reaffirmation met this test. However, if the parties needed more time, the court points out that they can file a motion to defer discharge under rule 4004(c)(2).

The second requirement is that the agreement be "filed" no later than 60 days after the first date set for the first meeting of creditors. Under Rule 4008, the Court has the power to enlarge the time for filing the reaffirmation agreement and may do so without a motion. In fact, the court can enlarge the time period simply by ignoring the fact that the agreement was not timely filed. The agreement in this case met the second test.

Whether to Require a Hearing

The next step in the process is to determine whether there must be a hearing. Judge Jernigan identifies the following cases where a hearing will be set:

1. If the debtor is not represented by counsel during the negotiation of the agreement, there must be a hearing. In order to be approved, the court must find that the agreement does not impose an "undue hardship" on the debtor and is in the debtor's "best interest."

The Court noted with dismay that some attorneys do not assist their clients with reaffirmation agreements.

It should be considered a basic part of chapter 7 debtor-representation that an attorney advise his client as to something as fundamental and significant as a reaffirmation agreement and assist him in negotiation of the same.
Opinion, p. 9 (emphasis in original).

2. There must be a hearing if the presumption of undue hardship is triggered. If the debtor's post-bankruptcy income less other expenses is less than the amount of the debt being reaffirmed, then the presumption is triggered and there must be a hearing. The Court expressed dissatisfaction with attorneys who checked the no presumption box even though the debtor was "barely" negative or who failed to check either box. The Court also noted that if attorneys supplied more information as to how the debtor would be able to afford the payments, it might not be necessary to hold a hearing to determine that the presumption of undue hardship had been rebutted.

Special Cases

The rules are different for Credit Unions and Homesteads.

The presumption of undue hardship does not apply to credit unions. Thus, if the debtor is represented by the counsel, the court must approve the agreement. If the debtor is not represented by counsel, the court must still hold a hearing but need only consider whether the agreement is in the "best interest" of the debtor.

The best interest test does not apply to debts secured by homesteads. Thus, if the debtor is represented by counsel and the math is negative, the court must conduct a hearing limited to undue hardship. If the debtor is not represented by counsel and the math is positive, the court must hold a hearing to give the debtor the statutory warnings, but must approve the agreement.

When to Hold the Hearing

The hearing must be held before the discharge is entered. However, it is slightly more complicated than that. The presumption of undue hardship expires after 60 days. Therefore in a case where the math is negative, the court must conduct a hearing, if at all, within 60 days of when the agreement is filed.

Applying The Test to the Particular Case

In this case, the Debtor and the Creditor timely made the agreement and timely filed it. The Debtor's attorney checked the presumption of undue hardship box so that a hearing was required to be held. The Court held the hearing within 60 days and prior to entry of the discharge. Thus, the only question was whether the presumption of undue hardship was rebutted.

Going back to the original facts discussed above, the Court found that it was an undue hardship for a debtor with negative income which was only going to get worse to reaffirm a debt on a pickup truck with no equity and required 71 more payments at 17.5% interest, especially where the Debtor had large amounts of non-dischargeable debt.

The Conclusion

The Court's Conclusion is worth setting forth in its entirety:
It would be hard for anyone to deny that Section 524 of the Bankruptcy Code—the statute describing the process for reaffirmation of debt—is one of the most unwieldy and cumbersome provisions applicable to consumer bankruptcy cases. Section 524 makes for painful reading. In addition to the items discussed in this opinion, there are lengthy disclosures and other requirements in Section 524 that must be adhered to for a reaffirmation agreement to be enforceable. Moreover, the official form for a reaffirmation agreement has been modified numerous times over the years. Thus, on balance, it is not terribly surprising that compliance with this Code section (and the accompanying rules) is frequently woefully deficient. The court hopes that this Memorandum Opinion provides a resource in the future for those struggling with proper protocol in the area of reaffirmation agreements.

The court also hopes that the thought-process that this court shared, regarding the above-referenced Debtor (and, specifically, why the court would not approve his Reaffirmation Agreement), is useful. Bankruptcy is about “fresh starts” and new beginnings. It is about belt-tightening and shedding past bad habits. Too often, a reaffirmation agreement will reveal that someone just does not comprehend this, and wants to go forward in a manner that will impair his fresh start and perpetuate bad habits from the past.

The court realizes that this is sometimes complicated. In a context in which a debtor does not enter into a reaffirmation agreement during a chapter 7 case regarding a debt-encumbered vehicle, there are probably situations in which a vehicle-lender will repossess the debtor’s vehicle post-discharge, even when the debtor is making regular and timely contractual payments for the car post-discharge—for the simple reason that the debtor did not “reaffirm.” This court has heard intellectual pontificating regarding the legal propriety of such an action by a lender. It would appear that Sections 521(a)(6) and (d), combined with Section 362(h)(1)(A) and (j), may have ended the intellectual debate about this, and may allow such a course of action (at least from a Bankruptcy Code standpoint)—except for, perhaps, in a case in which the debtor entered into a reaffirmation agreement but such agreement was nevertheless not approved by the court. See 11 U.S.C. § 521(a)(6), (d) (2010).7 Thus, the court can understand why a debtor and his counsel might see the wisdom of entering into a reaffirmation agreement, even if they can envision the court may never approve it because of the negative math. Perhaps they imagine that this will help the debtor with the car lender post-discharge, if they at least tried to get the reaffirmation agreement approved with the court. Moreover, perhaps the debtor genuinely needs a car and worries that, absent an attempt at a reaffirmation agreement, he will surely lose the car post-discharge and may not be able to purchase (i.e., obtain financing) for another vehicle in the near future.

Again, the court is not unsympathetic and realizes this can all be very complicated. The court realizes that we are in a world where car lenders may not always act like economically rational animals. And, the court appreciates that car lenders may sometimes have their own economic pressures with which to contend. But, again, the fresh start is the overriding purpose of a chapter 7 bankruptcy case. Many reaffirmation agreements presented to the court are the farthest thing from a “fresh
start” that one could ever imagine. Many times it is time to say “good riddance” to the car. And many times—maybe, just maybe—a car lender will see the wisdom of renegotiating a car loan if reaffirmation is denied.


IT IS ORDERED that the Reaffirmation Agreement between the Debtor and Capital is disapproved.
Opinion, pp. 19-22 (emphasis added).

This opinion doesn't make me like reaffirmations any more, but it does make the process a bit more clear. I plan to use the language about making a fresh start and ditching bad habits with my clients.

Hat Tip to David DeSoto.

Monday, September 06, 2010

Bankruptcy Court Predicts Fifth Circuit Will Adopt Broad View of Statement of Financial Condition

Section 523(a)(2) is a Code section which is very familiar to most experienced practitioners, but still can be tricky. In particular, the distinction between statements regarding financial condition and all other fraudulent statements has prompted disagreement among the courts. A new opinion from Judge Craig Gargotta predicts that the Fifth Circuit would join the minority position on this issue. Material Products International, Ltd. v. Ortiz, No. 09-1062 (Bankr. W.D. Tex. 8/27/10). You can find the opinion here.

There are three types of fraudulent statements under 11 U.S.C. Sec. 523(a)(2):

1. Statements which are not made "respecting the debtor's or an insider's financial condition" which are actionable under Sec. 523(a)(2)(A);

2. Written statements "respecting the debtor's or an insider's financial condition" which are actionable under Sec. 523(a)(2)(B) and have a higher reliance standard; and

3. Verbal statements "respecting the debtor's or an insider's financial condition" which cannot form the basis for a non-dischargeability complaint based on fraud.

Because the distinction between statements about the debtor or an insider's financial condition and all other statements is significant, it is important to know what a "statement respecting the debtor's or an insider's financial condition" means.

The majority opinion, as represented by the Tenth Circuit's opinion in In re Joelson, 427 F.3d 700 (10th Cir. 2005), holds that only statements which concern a debtor's overall financial condition, that is, are the equivalent of a financial statement, will be subject to the restriction. The minority position holds that "financial condition" is broader than simply a financial statement and that statements regarding an individual asset may qualify.

In the Ortiz case, the creditor alleged that the Debtor had lied about whether equipment at a restaurant was free of liens. (The restaurant was located in my neighborhood and I ate there once. There was nothing about the food which indicated that it was or was not subject to prior liens). The creditor's complaint alleged the elements of Section 523(a)(2)(A) and quoted the statute. The complaint did not reference Section 523(a)(2)(B). The debtor filed a motion for judgment on the pleadings under Rule 12(c).

The court ruled that whether the equipment was subject to prior liens was a statement regarding financial condition. Thus, it could not be brought under Sec. 523(a)(2)(A). Although the Fifth Circuit has not ruled on this issue, the Court found the Fifth Circuit's opinion in In re Mercer, 246 F.3d 391 (5th Cir. 2001) to be instructive. Judge Gargotta wrote:

The parties readily agree that the Fifth Circuit has not addressed this issue. That said, the Court agrees with the Defendants that the Fifth Circuit’s opinion in AT&T Universal Card Svcs. v. Mercer (In re Mercer), 246 F.3d 391, 405 (5th Cir. 2001) is suggestive of how the Fifth Circuit might rule.

The Court agrees with the Defendants’ assertion that while it has not expressly addressed the scope of a “statement respecting a debtor’s or insider’s financial condition,” the Fifth Circuit Court of Appeals’s decision regarding the applicability of § 523(a)(2) to credit card use is consistent with the broad interpretation of that phrase. Under that approach, courts have included statements that reflect on the debtor’s ability to pay as statements respecting a debtor’s financial condition. See Mercer, 246 F.3d at 405 (5th Cir. 2001) (noting that “if [credit] card-use could be understood as a representation not only of intent, but also ability, to pay, the latter is not actionable under § 523(a)(2)(A); as noted, it excludes from its scope ‘a statement respecting the debtor’s . . . financial condition.’”) (emphasis and footnote omitted); (additional citations omitted).

Therefore, as a matter of law, taking all Plaintiff’s allegations in the Complaint as true, Plaintiff cannot show that the claim is non-dischargeable under § 523(a)(2)(A) as it alleges, and the Defendants are entitled to judgment on the pleadings denying the Plaintiff’s cause of action requesting that the claim be declared non-dischargeable.
Ortiz, slip op. at 15-16.

This opinion is significant because Judge Gargotta adopted the minority position. By taking a broad view of what constitutes a statement of financial condition, the Court has given creditors a higher burden of both pleading and proof. When in doubt about whether a representation is a statement of financial condition, it is better to plead both subsections (A) and (B) in the alternative.

Thursday, September 02, 2010

Jurisdiction to Enforce a Settlement

When parties settle a case, there are good feelings all around and relief that the dispute is over. However, parties who have been disagreeable prior to settlement often remain that way after they have compromised their dispute. A recent Fifth Circuit case makes the point that it is important to think about how the settlement will be enforced should the parties go back to feuding. SmallBiz Pros, Inc. v. MacDonald, No. 09-50879 (5th Cir. 9/1/10). The opinion can be found here.

In SmallBiz Pros, the parties settled a dispute which required turnover of documents among other things. They entered a Stipulation of Dismissal pursuant to Rule 41(a)(1)(A)(ii). This was a non-bankruptcy case. However, the same provision would apply under Bankruptcy Rule 7041. The Stipulation referenced a "Stipulated Settlement Order." The Court signed the Stipulated Settlement Order. However, the order did not contain "so ordered" language and did not provide for the Court to retain jurisdiction to enforce the order.

Disagreements arose and SmallBiz Pros returned to court to have MacDonald held in contempt. The District Court obliged and MacDonald appealed. The Fifth Circuit reversed, finding that the District Court lacked jurisdiction to enforce the settlement.

In its conclusion, the Court stated:

Each of the parties and the district court likely intended for the district court to retain ancillary jurisdiction to enforce the terms of the settlement agreement, but jurisdiction is a strict master and inexact compliance is no compliance. The Stipulation effectively dismissed the case when it was filed on August 7, 2009 pursuant to Rule 41(a)(1)(A)(ii). It did not expressly provide for ancillary jurisdiction. It referenced and attached the terms of the settlement in a document styled an “Order,” but did not make the dismissal expressly contingent upon the district court’s signing the Order or upon any other act. Moreover, the “Order” was not a proper dismissal order. The parties could have filed a joint “stipulation and order of dismissal,” expressly provided for ancillary jurisdiction or embodied the terms of the settlement in the order, and made the filing contingent upon the district court’s entry of the order, but they chose not to do so. Because the district court lacked jurisdiction to enforce the terms of the settlement agreement, we hereby VACATE the contempt order and REMAND to the district court with instructions to dismiss for lack of jurisdiction.
Slip Op. at 8-9.

I like the language that "jurisdiction is a strict master and inexact compliance is no compliance." As a matter of practice, I don't like using a Stipulation of Dismissal under Rule 41(a)(1)(A)(ii) because it does not result in a court order. However, I had not thought about including language in the order that the court retains jurisdiction to enforce it. I think I will now.