Thursday, July 28, 2011

Fifth Circuit Trusts (Chapter 7) Trustee's Interpretation of Trust

In an interesting ruling that has more to do with trust law than bankruptcy, the Fifth Circuit has ruled that a bankruptcy court incorrectly held that a trust was not property of the estate. Roberts v. McConnell, No. 10-50462 (5th Cir. 6/15/11). You can find the opinion here.

Mary McConnell ("Mary") created a trust for her grandson Terry Hoff ("Terry"). The trust listed her as the Settlor. She contributed $100 to the trust. Terry's mom, Peggy McConnell ("Peggy"), on the other hand, contributed $70,000. The Trust provided that once the Settlor died, Terry would have the right to withdraw increasing amounts from the trust at age 30, age 35 and age 40.

Terry filed for chapter 7 bankruptcy when he was 37. Mary was deceased at this time, but Peggy was not. The critical question was whether Terry had the right to withdraw funds from the trust. If Mary was the sole settlor, then Terry would have the right to withdraw funds. On the other hand, if Peggy (who actually contributed 99% of the money to the trust) was a settlor, then Terry could not.

The Bankruptcy Court quite sensibly ruled that because Peggy had contributed funds to the trust and because she was not deceased that the trust funds were not property of the estate. I wrote about the Bankruptcy Court's opinion here.

The Fifth Circuit relied on both the language of the trust and the version of the Texas Trust Code then in effect to hold that Mary was the sole settlor of the trust. The Court shrugged off cases such as In re Bradley, 501 F.3d 421 (5th Cir. 2007) with the comment that they referred to self-settled trusts. Apparently persons other than the stated settlor can be settlors for a self-settled trust. The decision is of limited importance due to a change in the Texas Trust Code. Under the current version of the law, a settlor is "a person who creates a trust or contributes property to a trustee of a trust." Tex. Prop. Code Sec. 111.004(14). Unfortunately, this legislation was enacted after the debtor filed bankruptcy. As a result, it did not determine that Peggy was an additional settlor.

Because the trust designated Mary as the settlor and because she was deceased at the time that Terry filed bankruptcy, Terry's trustee was entitled to 50% of the trust. The only real take-away from this case is that prior to 2007 when the law was changed, the definition of a settlor under a Texas trust depended on whether the trust was self-settled or not. However, under current law, anyone who contributes property to a trust is a settlor.

Wednesday, July 27, 2011

Preserving Causes of Action In Plans

These days, defendants are getting more aggressive about repelling suits from bankruptcy estates. From jurisdictional squabbles based on Stern v. Marshall to judicial estoppel to failure to preserve a cause of action in a plan, the plaintiff’s road to judgment is just more difficult than it used to be. However, two recent decisions are examples of suits which avoided being detonated by clever challenges. In Matter of Texas Wyoming Drilling, Inc., No. 10-10717 (5th Cir. 7/21/11), a chapter 7 trustee prevailed against a claim that the former debtor in possession had failed to failed to make a “specific and unequivocal” reservation of claims and defeated a judicial estoppel claim. In Crescent Resources Litigation Trust v. Burr, No. 11-1013 (Bankr. W.D. Tex. 7/22/11), a litigation trust created by a plan defeated a defense that claims had not been adequately preserved. (There was another very interesting decision released in the Crescent case the same day about turnover of files from the debtors’ former attorneys. Because that case does not retention language under a plan, I will save that one for another day). You can find the opinions here and here.

The Disclosure Statement Wins Out

The Debtor in Texas Wyoming filed for chapter 11 relief and confirmed a plan. The plan provided for preservation of “Estate Claims.” The Disclosure Statement defined “Estate Claims” as claims arising under Chapter 5 of the Bankruptcy Code and included a chart listing potential claims, including “Various pre-petition shareholders of the Debtor” who might be sued for “fraudulent transfer and recovery of dividends paid to shareholders.”

The Debtor then sued its former shareholders to recover dividends paid under a fraudulent conveyance theory. The defendants sought to dismiss the action claiming that: (a) the Plan did not include a “specific and unequivocal” reservation of claims, (b) the disclosure statement did not name the parties who could be sued; and (c) the Debtor did not disclose the claims in its schedules.

Under Fifth Circuit precedent, a plan must “specifically and unequivocally” retain a cause of action. In re United Operating Company, 540 F.3d 352 (5th Cir. 2008). If the claim is not adequately reserved, then the post-confirmation debtor lacks standing to pursue it.

When the plan failed, the case was converted and the chapter 7 trustee pursued the claims. The Bankruptcy Court denied the defendants’ motion, but certified a direct appeal to the Fifth Circuit. The Fifth Circuit, in an opinion authored by Edith Brown Clement, made short work of the defendants’ claims.

The Fifth Circuit found that it was permissible to consult the disclosure statement to see whether claims had been adequately disclosed. The Court stated:

We observe that the disclosure statement is the primary notice mechanism informing a creditor’s vote for or against a plan. See 11 U.S.C. § 1125. Considering the disclosure statement to determine whether a post-confirmation debtor has standing is consistent with the purpose of In re United Operating’s requirement: placing creditors on notice of the claims the post-confirmation debtor intends to pursue. (citation omitted). In light of the role served by the disclosure statement, the purpose behind the rule in In re United Operating, and the fact that, in similar contexts, courts routinely consider the disclosure statement to determine whether a claim is preserved, we hold that courts may consult the disclosure statement in addition to the plan to determine whether a post-confirmation debtor has standing.

Opinion, pp. 6-7.

While the language in the Plan was generic, the language in the Disclosure Statement identified claims arising under Chapter 5 and stated that pre-petition shareholders were at risk for being sued for recovery of dividends. That was enough to satisfy the “specific and unequivocal” requirement under prior Fifth Circuit precedent.

The Fifth Circuit also rejected the argument that failure to list the claims in the schedules would bar the claims under the doctrine of judicial estoppel. The Court noted that there was no inconsistent position taken since the Disclosure Statement specifically identified the claims.

The defendant’s argument founders on the first requirement because TWD did not take clearly inconsistent positions. As explained above, TWD’s plan and disclosure statement retained the right to pursue the Avoidance Actions. Because TWD explicitly retained the same claims against the defendants that the trustee is now pursuing, there is no inconsistency in its position.

Opinion, p. 9.

This holding is a victory for common sense interpretation versus the magical view that any failure to disclose evaporates the claim.

The take away from Texas Wyoming is that careful drafting at the disclosure statement stage may avoid creditor heartaches down the road.

Court Chooses the Categorical Approach

The Crescent Resources case involved 122 related debtors who filed a chapter 11 bankruptcy in Austin in 2009. On December 20, 2010, the Court confirmed the Debtors’ Revised Second Amended Plan of Reorganization. A major feature of the plan was creation of a Litigation Trust. One claim pursued by the Trust was against Edward Burr, a former insider of the Debtors. The claims involved two transactions:

1. Payment of $1.925 million to Burr in April 2007 to cover his personal tax liabilities; and

2. Payment of $4.5 million in cash plus forgiveness of $71 million in debt owed to Crescent in November 2007 in return for termination of his employment and conveyance of a 20% interest in one of the debtors.

The Trustee alleged that the transfers constituted fraudulent conveyances under state and bankruptcy law. The Defendant sought to dismiss the claims, asserting that the plan had not “specifically and unequivocally” reserved the claims and asserting failure to plead fraud with specificity.

The Defendant raised two arguments with regard to retention of claims: 1) that the plan failed to disclose that the Trust would pursue claims against him personally; and 2) that if the overall description was sufficient, that the plan failed to preserve claims for turnover pursuant to 11 U.S.C. §542.

The Plan provided that:

The Litigation Trust Assets shall include, but are not limited to, those Causes of Action arising under Chapter 5 of the Bankruptcy Code including those actions which could be brought by the Debtors under §§ 544, 547, 548, 549, 550, and 551 against any Person or Entity other than the Litigation Trust Excluded Parties.

Causes of Action was defined to mean “any and all Claims, Avoidance Actions, and rights of the Debtor, including claims of a Debtor against another Debtor or other affiliate.”

It is clear that neither the Plan, the Trust Agreement or the Disclosure Statement specifically referred to Mr. Burr or referred to claims for turnover under 11 U.S.C. §542.

The opinion contains an excellent discussion of the cases interpreting United Operating. At the conclusion of its discussion, the Court summarized as follows:

(W)hile the Fifth Circuit has not defined what “specific and unequivocal” means, cases have interpreted different plan language on case-by-case bases which this Court can use as guideposts with which to judge the plan language at issue here. Courts have held that listing causes of action by code section is sufficiently “specific and unequivocal.” (citations omitted). The courts have also held that a generic blanket reservation is insufficient. (citations omitted).

The cases in the Fifth Circuit all cited United Operating. United Operating, in making its holding, also discussed that one of the purposes of bankruptcy is to “secure prompt, effective administration and settlement of all debtor‟s assets and liabilities within a limited time.”(citation omitted). In order to facilitate this resolution of the estate, “a debtor must put its creditors on notice of any claim it wishes to pursue after confirmation.” (citation omitted). It is for this reason—notice to creditors—that the Fifth Circuit determined that the retention language needed to be “specific and unequivocal.” (citation omitted).

This Court agrees with the reasoning behind those cases applying what has been referred to as the “Categorical Approach,” and adopts the test established in Texas Wyoming Drilling to determine if the plan language meets the “specific and unequivocal” requirement. (citation omitted). That test, again, was to make a determination “whether the language in the [p]lan was sufficient to put creditors on notice that [the debtor] anticipated pursuing the [c]laims after confirmation.” (citation omitted). If so, the language meets the “specific and unequivocal” requirement.

Opinion, pp. 21-22.

The Court found that the reference to “state fraudulent transfer law claims” was not specific and unequivocal because it did not refer to a specific code cite. The Court went on to find that a reference to “Causes of Action arising under chapter 5 of the Bankruptcy Code, including those actions which could be brought by the Debtor under §§544, 547, 548, 549, 550, and 551” was sufficiently detailed so that “a creditor could not feign surprise that the Trust would pursue a claim under Section 542.”


Taken together, Texas Wyoming and Crescent Resources set a fairly low bar for preserving claims and causes of action under a plan. Both cases take a pragmatic attitude, essentially relying on a surprise standard. From a policy standpoint, it is about fairness. If a creditor is being asked to vote on a plan, it should be clear whether that person runs the risk of being sued. In Texas Wyoming, the Disclosure Statement clearly signaled that the Debtor intended to sue former shareholders who had received dividends. In Crescent Resources, the language could have been stronger, but it wasn’t really surprising that an insider who had received large transfers prior to bankruptcy would be sued.

While the Court found that the Crescent language was sufficient, it would have been stronger if it had referred to “Causes of Action arising under chapter 5 of the Bankruptcy Code, including those actions which could be brought by the Debtor under §§542, 543, 544, 545, 547, 548, 549, 550, 551, 552 and 553 which may be brought against any entity receiving a transfer from any of the Debtors during the four years prior to bankruptcy, including but not limited to insiders, employees, officers, and equity holders of the Debtors.”

Sunday, July 24, 2011

Congressman Hinojosa's Bankruptcy Plan Appears to Violate Bankruptcy Code, Including BACPA Provisions He Voted For

Congressman Ruben Hinojosa was one of many representatives who voted for the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. As a chapter 11 debtor, he will now be tested to see whether must follow the same rules he voted for, as well as those previously in place. In re Ruben Hinojosa, Case No. 10-70900, pending in the United States Bankruptcy Court for the Southern District of Texas.

Special Treatment?

Congressman Hinojosa has represented Texas's 15th Congressional District since 1996. On December 18, 2010, he filed a petition for chapter 11 relief after receiving an unfavorable arbitration award in a proceeding brought by Wells Fargo Bank. His bankruptcy case initially raised concerns about preferential treatment when the United States Trustee signed an agreed order exempting the Congressman from closing his pre-petition bank accounts and providing that he did not need to include the notation "Debtor-in-Possession" on his checks. When he inadvertently included copies of his 2009 federal tax return and his financial disclosure statement on his petition and amended petition, he filed a motion to seal those documents. Bankruptcy lawyer and blogger Alexander Wathen unsuccessfully opposed this motion and has filed an appeal. Wathen v. Hinojosa, No. 7:11cv141, pending in the United States District Court for the Southern District of Texas. You can read about it on Alex's blog here, here and here.

The Plan and Disclosure Statement Make for Interesting Reading

On July 15, 2011, debtor-in-possession Hinojosa filed his plan and disclosure statement which appear to contain flagrant violations of the Bankruptcy Code and at least one violation of BAPCPA.

The Congressman's Disclosure Statement is largely a puff piece for his service in Congress. Most of the 67 pages discuss his Congressional career, while nearly all of the substantive material that would normally be contained in a disclosure statement is buried in exhibits. To put it charitably, the information contained in the disclosure statement is confusing and contradictory.

According to the liquidation analysis, creditors in a chapter 7 liquidation would receive $560,613.56, which would yield a distribution of 20%. The liquidation analysis represents that creditors would receive at least 20% on their claims under the Plan. However, this is NOT what the Plan provides. The Plan states that unsecured creditors will receive sixty payments totaling 0.00009% of their claims. The Congressman's projections indicate that he intends to pay his unsecured creditors (who total nearly $3 million) $250.00 per month. Meanwhile, the Congressman will be spending $3,000.00 a month on rent, $2,244.75 on insurance, $1,154.58 on "college fund and school expenses" and $500.00 per month for "vehicle replacement expense." As a chapter 11 debtor owing primarily business debts, the Congressman is not subject to the means test applicable to consumer debtors in chapters 7 and 13. However, if he were, he clearly would not be allowed to save for his children's college education and for a new vehicle at the expense of his creditors.

The Plan also provides for "sale of all or a portion of the non-exempt assets of the Estate which sums amount to an unknown percentage of the Allowed Unsecured Claims." Under the Means for Implementation section of the Plan, it states that the Congressman will liquidate his real estate holdings. However, going back to the liquidation analysis, the Congressman has only one real estate holding--a property valued at approximately $72,000. Neither the Plan nor the Disclosure Statement say when or how the Congressman will liquidate "some or all" of his non-exempt assets so that the promise of liquidation is so vague as to be unenforceable.

Another outrageous feature of the Plan concerns the discharge. Under BAPCPA, which Rep. Hinojosa voted for, individual chapter 11 debtors do not receive a discharge until they complete their plan payments. 11 U.S.C. Sec. 1141(d)(5). However, Congressman Hinojosa's Plan states:


It seems like the Congressman was not paying attention the day he voted on BAPCPA. Otherwise, he never would have allowed his lawyers to insert this provision into the Plan.

A Final Question

At a minimum, it appears that this Plan violates the chapter 7 liquidation test and the absolute priority rule and probably is not proposed in good faith. Creditors will probably not find much to like about this Plan. However, the big question is what will the U.S. Trustee do? In the Western District of Texas, which has the same U.S. Trustee as the Southern District of Texas, the U.S. Trustee nitpicks thoroughly reviews every minor detail of a plan. Will the same standard apply to Rep. Hinojosa? I hope that the U.S. Trustee will fulfill its role as a watchdog. rather than being a lapdog. (Ed.: Poor choice of words in original posting).

Saturday, July 23, 2011

Despite Bad Behavior By Wells Fargo, Court Finds That Broad Remedial Injunction Was Unwarranted

Despite clear cut abuse by a mortgage lender, the Fifth Circuit has found that a bankruptcy court lacked authority to enter a broad remedial injunction requiring Wells Fargo to conduct an extensive audit of claims filed in the Eastern District of Louisiana. Matter of Stewart, No. 09-30832 (5th Cir. 7/22/11). You can find the opinion here.

Lack of Cooperation, Evasion and Inflated Claims

The Fifth Circuit succinctly stated the facts of the case as follows:

When elderly widow Dorothy Chase Stewart filed for bankruptcy in 2007, Wells Fargo Bank filed a proof of claim with the bankruptcy court reciting debts owed from an outstanding mortgage on Ms. Stewart’s house. From her limited funds, Ms. Stewart hired a lawyer to request a full accounting of Wells Fargo’s charges.

Wells Fargo did not cooperate. It provided a list of charges by type, but without the amount, date, or payee for each charge, and without invoices or proofs of payment for the third-party fees it charged to Ms. Stewart. At a hearing convened by the bankruptcy court, Wells Fargo sent lawyers unfamiliar with her case and unable to provide further information or documentation. As the hearing went on, “errors in billing became evident.”

Two further hearings and four months of research passed before the bankruptcy court was able to unravel Wells Fargo’s accounting. After Ms. Stewart’s attorney “painstakingly identified the additional information needed, or explanations required” to review the claim, Wells Fargo finally produced a full reconciliation of Ms. Stewart’s mortgage account. Inspecting those records, the bankruptcy court concluded Wells Fargo’s proof of claim was rife with errors, including:

* Calculations that were “wholly incorrect” under the terms of the mortgage contract;

* Late fees generated through questionable accounting and imposed without notice to the debtor;

* Charges for drive-by inspection reports that were plainly erroneous, with some reports describing a wood-frame house and others describing a house with a brick exterior;

* Charges for broker price opinions (BPOs) that Wells Fargo was unable to document, several with duplicative charges, and charges for a BPO that could not have been generated on its stated date because Ms. Stewart’s parish was then under a mandatory evacuation order for Hurricane Katrina;

* Attorneys’ fees and cost invoices that were invalid or inadequately documented.

The bankruptcy court found that these errors caused Wells Fargo to overstate its claim by more than $10,000.

Opinion, pp. 2-3.

The Court also referred to another case involving Wells Fargo in which the Court described a proof of claim as:
such a tangled mess that neither Debtor, who is a certified public accountant, nor Wells Fargo's own representative could fully understand or explain the accounting offered.
Opinion, p. 2, n. 2.

Of these violations, my personal favorite is charging for a Broker's Price Opinion at a time when the Parish was under a mandatory evacuation order. Those brokers must have been awfully brave.

The Court's Response

Cheating widows is not looked upon favorably in most quarters. The Bible says:
Cursed be anyone who perverts the justice due to the sojourner, the fatherless, and the widow.
Deut. 27:19.

Judge Elizabeth Magner was not very happy either. She found Wells Fargo to have been "duplicitous and misleading." In re Stewart, 391 B.R. 327 (Bankr. E.D. La. 2008). Judge Magner awarded damages in the amount of $10,000.00 and attorney's fees in the amount of $12,350.00. She further sanctioned Wells Fargo $2,500.00 for presenting a consent order which did not reflect the agreement of the parties and an additional $2,500.00 for filing "significantly erroneous proofs of claim."

She also granted broad injunctive relief.

In order to rectify this problem in the future, the Court orders Wells Fargo to audit every proof of claim it has filed in this District in any case pending on or filed after April 13, 2007, and to provide a complete loan history on every account. For every debtor with a case still pending in the District, the loan histories shall be filed into the claims register and Wells Fargo is ordered to amend, where necessary, the proofs of claim already on file to comply with the principles established in this case and Jones. For closed cases, Wells Fargo is ordered to deliver to Debtor, Debtor’s counsel and Trustee a copy of the accounting. The Court will enter an administrative order for the review of these accountings and proofs of claim. The Court reserves the right, if warranted after an initial review of the accountings, proofs of claim and any amended claims filed of record, to appoint experts, at Wells Fargo’s expense, to review each accounting and submit recommendations to the Court for further adjustments based on the principles set forth in this Memorandum Opinion and Jones.
In re Stewart, supra.

The Fifth Circuit Ruling

The Fifth Circuit found that the Court lacked jurisdiction to grant the injunction. Relying on Supreme Court precedent, the Fifth Circuit found that past injury is not sufficient to grant an injunction unless there is a "real and immediate threat" that the person will suffer injury in the future. Because there was "no demonstrated likelihood that Ms. Stewart will ever again be subject to an incorrect proof of claim filed by Wells Fargo," she lacked standing to pursue an injunction (and indeed, she had not requested one).

The Court also found that the injunction could not be justified based on "the inherent power of the court to protect its jurisdiction and judgments and to control its docket."
While the deficiencies found in Wells Fargo's claim here do cast a shadow on its other claims, misdeeds in other cases can be addressed by the judges in those cases. If the case-by-case process, with the discipline of developed jurisprudence, is thought to be inadequate, there remains the rulemaking authority
Opinion, p. 7.

In conclusion, the Court stated:
We need not here undertake to draw bright boundaries to the well established power of a court to correct abuses of its process. We say only this: the injunction here was outside that boundary. The issued injunction ranges far beyond the dimensions of this case to police a range of cases untested here by the adversary process. Its specific commands are not for the benefit of Ms. Stewart, whose injuries are fully remedied without the injunction. Rather, the injunction is aimed at other cases in which Wells Fargo has appeared or might appear before the bankruptcy courts. While justification for the bankruptcy court’s frustration is plentiful, its injunction lacks jurisdictional legs. We must therefore vacate the injunction as exceeding the reach of the bankruptcy court in this case. (emphasis added).
Opinion, p. 7.

What It Means

The problem of mortgage accounting in bankruptcy is a national scandal. Judge Magner recognized the seriousness of the issue and tried to do something about it. Unfortunately, her creative remedy "lack(ed) jurisdictional legs." This does not mean that there are not any remedies. The Debtor in this case got her mortgage cleaned up. The Fifth Circuit tacitly encouraged other debtors to challenge their mortgage accountings. The Court's reference to "the discipline of developed jurisprudence" appears to this author to be a warning to Wells Fargo that it has developed a record of negligence and will be subject to further scrutiny. However, that scrutiny will need to come in individual cases, class actions or the rule making process.

While Judge Magner's order was reversed, thanks to Harrington & Myers, who represented the Debtor, Wells Fargo has received a polite but public scolding from the Fifth Circuit. That should count for something.

This case also illustrates the need for the Consumer Financial Protection Bureau. Most debtor's attorneys will not have the tenacity of Harrington & Myers. Similarly, the U.S. Trustee's office does not have the resources to handle systemic problems such as this one. While I am generally not a fan of government regulation, this may a case where it is firmly warranted.

Coming Attractions:

Judge Magner will be speaking on the topic of Mortgage Accounting at the State Bar of Texas Advanced Consumer Bankruptcy Course in Houston, Texas on September 8-9, 2011. She is just one of the many excellent speakers we have lined up.