NCBJ 2012: Important Cases, Chapter 15, A Constitutional Tour De Force and the CFPB

I made it to three panels each on Friday and Saturday.   I will combine them here for ease of posting.  If you read nothing else, read the Supreme Court discussion, including late-breaking news on Stern v. Marshall.

The Most Significant Business Bankruptcy Decisions and Developments of 2011-2012

This panel discussed four recent cases.  I have discussed Highland Highgate and Gateway RadLAX elsewhere, so I will just focus on the two remaining decisions.

In Development  Specialists Inc. v. Akin Gump Strauss Hauer & Feld, 477 B.R. 318 (S.D.N.Y. 2012), the court considered the obligations of partners of a dissolved law firm to account for earnings from old firm business that they take to a new firm.   Under the Uniform Partnership Act, partners at the time of dissolution have a duty to each other to account for benefits they receive from “use” of partnership property.    The Court ruled that the departing partners owed the firm an accounting for profits earned measured by receipts less expenses.   The Court declined to rule on the following issues on summary judgment:

(1) The Partnership Law requires the departing partner to account for profits he realizes from the use of the dissolved firm's unfinished business. Is that measured by his share of the new firm's profit on the matter, or by the entire profit realized on the matter?

(2) What constitutes a deductible "expense" or "overhead" at the new firm? What portion of the new Firm's realized fee is profit and what is expense (which will entail dissection of billing rates to tease out the profit factor from the cost factor)?

(3) How does one value the Former Coudert Partner's contribution of "effort, skill and diligence" to the matter?

 

477 B.R. at 350.   The Court subsequently authorized an interlocutory appeal.    

The case raises serious questions about whether partners who remain with a firm at dissolution will constitute a burden on their new firms, since they may be forced to account for any profits on work brought from the old firm.   Since part of the attraction of a lateral hire partner is his book of business, this would severely diminish the attorney’s value in the marketplace.   Since the rule only applies to persons who are partners at dissolution, it also creates an incentive for lawyers to jump ship and thus hasten the decline of the firm.    

These are issues that law firms should address in their partnership agreements before they go bust.   Also, the rule might apply differently in jurisdictions which follow the Revised Uniform Partnership Act.

In In re TOUSA USA, Inc., 680 F.3d 1298 (11^th Cir. 2012), the parent company paid off existing debt by borrowing new funds secured by the assets of its subsidiaries.   The Bankruptcy Court avoided the transfer as to both the lenders who were paid off and the lenders who got new liens.  The District Court reversed as to the original lenders.   The 11^th Circuit affirmed the original bankruptcy court ruling.  Even though the original lenders did nothing more than receive payment on their debts, the fact that the funds came from encumbering the assets of the subsidiaries meant that they were transferees for whom the fraudulent transfer was made.   I will be writing more about this decision soon.

Round Two:   Scoring a Knockout on Appeal

This panel included Guy Cole, a former bankruptcy judge who now sits on the Sixth Circuit, Jim Haines of the First Circuit BAP, and Supreme Court advocates Eric Brunstad and Susan Freeman.

Judge Cole offered a bad joke based on an anecdote from Eric Brunstad at the prior day’s luncheon.  In a Supreme Court argument, Brunstad had tried to explain the need for prompt action by bankruptcy courts, giving the examples of rotting bananas and melting ice cream.  This prompted a straight-faced question from Chief Justice Rehnquist about “melting bananas,” demonstrating that even Supreme Court justices can mix a metaphor.  

Judge Cole asked:

Q:        What happens to a melting banana?

A:        It loses its appeal.

Sorry, I couldn’t resist repeating that.  (It might have actually been Judge Haines who told the joke, but I will give the credit to Judge Cole since he sits on a higher court).

I picked up a few practical points from this panel.

Focus on your audience.   While a bankruptcy judge or a BAP may be familiar with bankruptcy terms, an appellate judge will be unlikely to.   As noted by Judge Cole, about 70% of his docket consists of criminal appeals and pro se prisoner cases.    Someone pointed out that “indubitable equivalent” is half of a haiku.  I think the point was that our jargon may be confusing to higher courts.

Put it in context.   Since your case will be reviewed by judges unfamiliar with bankruptcy law and law clerks just out of law school, be sure to explain why it makes a difference.    If the difference between two different interest rates means that the debtor wins reorganization or faces liquidation, this would be a good thing to point out.

For oral argument, practice giving sound bite answers.  Susan Freeman pointed out that doing a moot court, especially for Supreme Court arguments, will work out weak areas in your argument.  Because oral argument is short, being able to give concise, responsive answers is a must.

Focus on the level of the court you are arguing to.   The Supreme Court does not care what a bankruptcy court somewhere has to say about an issue.   They care about what they have said before and what the circuits have to say.

Coming to America Broke:  Chapter 15 Plain and Fancy

In this discussion of chapter 15, Judge Alan Gropper had the best bankruptcy pun of the conference when he noted that, “We used to look for commies.   Now we look for COMIs.”    While both similarly sounding terms have international implications, COMIs or Centers of Main Interests, actually have a positive connotation under chapter 15.

While chapter 15 may sound exotic, it is simply the means by which an American court can provide assistance to a court conducting an insolvency proceeding in another country.   Chapter 15 is based on the UNCITRAL Model law adopted in 1997.  It is based on the concept that a foreign representative appointed in a foreign proceeding may request recognition and enforcement in the United States.

To begin with, there must be a “foreign proceeding” including the following elements:   

(i) a proceeding; (ii) that is either judicial or administrative; (iii) that is collective in nature; (iv) that is in a foreign country; (v) that is authorized or conducted under a law related to insolvency or the adjustment of debts; (vi) in which the debtor's assets and affairs are subject to the control or supervision of a foreign court; and (vii) which proceeding is for the purpose of reorganization or liquidation.      

 In re Betcorp, 400 B.R. 266 (Bankr. D. Nev. 2009).

If there is a foreign proceeding, a foreign representative may request recognition.   In order to receive recognition, a proceeding must be either a “foreign main proceeding” filed in the business’s Center of Main Interest (or COMI) or a “foreign nonmain proceeding” filed in a country in which the company has a business “establishment.”    In re Bear Stearns High-Grade Credit Strategies Master Fund, Ltd., 389 B.R. 325 (S.D. N.Y. 2008) established that a proceeding commenced in a so-called letterbox jurisdiction might be neither a main proceeding nor a nonmain proceeding.   In that case, a fund was established in the Cayman Islands, but all of its business activities were in the United States.   The Court refused to recognize the Cayman Islands proceeding.

Prof. Jay Westbrook said that international insolvency could be approached from a strictly territorial approach or a broad universal approach.   Because there is no international court system, chapter 15 acts on the basis of a modified universalist approach.   A court somewhere gets to be the lead court and other courts may assist.   

Recognition under chapter 15 is meant to be an easy process, and according to a study by Prof. Westbrook, is granted 95% of the time.   Once a proceeding has been “recognized,” a U.S. court may grant “additional relief” if parties are “sufficiently protected.”   The Vitro SAB case (which I wrote about here) is a case where the Court found that a Mexican proceeding did not sufficiently protect American creditors and denied additional relief.   The case is currently pending before the Fifth Circuit.  

According to Prof. Westbrook, there have been 585 chapter 15 cases commenced since 2005.   Initially these cases predominantly came from tax havens.  However, since the Bear Stearns case, some 65% come from Canada and the United Kingdom.   

The papers from this presentation are available to the public here.      

Bankruptcy Bingo:  The Battle for Bragging Rights

This panel discussed ten recent bankruptcy decisions of interest in a game show format.   Judge Sheri Bluebond, the game’s hostess, deserves high praise for taking a panel of ten judges and four contestants through ten cases in 60 minutes.    The cases discussed were:

In re Maharaj, 681 F.3d 558 (4^th Cir. 2012).   The absolute priority rule applies to property owned by the debtor pre-petition.   The exception to the absolute priority rule only applies to post-petition property.

Ackerman v. Eber, 687 F.3d 1123 (9^th Cir. 2012).   Court would not compel arbitration of dischargeability issues over debtor’s objection. 

In re Nortel Networks, Inc., 669 F.3d 669 F.3d 128 (3^rd Cir. 2011).   No police power exception to automatic stay where foreign government was seeking to protect its own interest in funding pensions.

Behrman v. National Heritage Foundation, Inc., 663 F.3d 704 (4^th Cir. 2011).   Court remanded case involving third party releases where bankruptcy court findings were couched in terms of generalities rather than specific findings.   

In re XMH Corp., 647 F.3d 690 (7^th Cir. 2011).   In an appeal involving assumption and assignment of a trademark license, the fact that the license had expired allowed the court to assign the non-executory portions of the contract.

In re TOUSA USA, Inc., 680 F.3d 1298 (11^th Cir. 2012).   Old lenders were entities for whose benefit avoidable transfers were made.

Peterson v. McGladrey & Pullen, 676 F.3d 594 (7^th Cir. 2012).   Suit brought against auditors of debtor who operated a ponzi scheme was barred by in pari delicto.   Because suit was brought under state law, state law defenses applied.

Perkins v. Haines, 661 F.3d 623 (11^th Cir. 2011).   Ponzi scheme investors established defense for return of principal.   They gave value and acted in good faith, thus entitling them to defense.

In re Friedman, 466 B.R. 471 (9^th Cir. BAP 2012).   Debtor may retain both Sec. 541 property and Sec. 1115 property without violating absolute priority rule.  This case conflicts with In re Maharaj above.

In re Mirant Corporation, 675 F.3d 530 (5^th Cir. 2012).   Although debtor was headquartered in Georgia, Georgia had no significant interest in enforcing repealed Georgia law in fraudulent transfer action.   Court applied New York law instead.   For reasons that are unclear to me without reading the opinion, the Fair Debt Collection Practices Act somehow affected a fraudulent conveyance case involving commercial transactions.

 The specific questions and answers can be found on the NCBJ website here.  

What 33 Years of Supreme Court Interpretations of the Bankruptcy Code CanTeach Us

Continuing the Supreme Court theme, Professors Erwin Chemerinsky and Ken Klee and Judge Judy Fitzgerald spoke about Supreme Court interpretations of the Bankruptcy Code.    These speakers deserve extra credit because they put their panel together on short notice after Justice John Paul Stevens was unable to make the conference.   They sounded several interesting themes, including the ongoing battle between textualists and purposefulists and how the circumstances of the court can affect major decisions.

The Supremes on Statutory Interpretation:

According to Prof. Klee, there are deep divides on the court as to how to interpret the Constitution and statutes.    The textualists, led by Justice Scalia, will follow the text even when their philosophical leanings would lead them elsewhere.    The purposefulists, led by Justice Breyer, will look more deeply into the purpose of the statue.     Nevertheless, the Supreme Court does not care deeply about bankruptcy.   According to Prof. Klee, they do the best that they can and leave it to Congress to fix it if they get it wrong.

Prof. Klee used three cases as illustrations.

Hall v. United States, 132 S.Ct. 1882  (2012).   This chapter 12 case dealt with the question of what happens to taxable gain when farmer has low basis and the farm is foreclosed upon during the bankruptcy.   The farmer can be left with a terrible problem because the tax is not part of estate and not subject to discharge.  Sen. Grassley authored legislation to avoid this problem.  Unfortunately, the intent not reflected in language of statute.   Justice Sotomayor wrote majority opinion for a 5-4 court.  The Court applied a strict textualist approach to find that the language should be interpreted as written, rather than as intended.   Prof. Klee speculated that this opinion might mean that Justice Sotomayor might actually have some textualist leanings.  This problem  would not occur in an individual  chapter 11 case because there is a separate taxable estate in a chapter 11 case.

Marrama v. Citizens Bank, 127 S.Ct. 1105 (2006).  In this 5-4 statutory interpretation case, a debtor who filed chapter 7 and was caught in wrongdoing sought to convert to chapter 13.  Although the statute said there was an absolute right to convert, Justice Stevens, applying a purposefulist approach, upheld the bankruptcy court decision denying conversion.   Justice Stevens said that it was nonsensical to allow conversion if the debtor could not stay in chapter 13 absent good faith.   The textualist minority said there because there was an absolute right to convert, the only proper approach was to allow conversion and then re-convert the case.   The majority said that bankruptcy was for the benefit of the honest but unfortunate debtor and that scoundrels should not have the right to convert (whether the Code says so or not).

RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S.Ct. 2065 (2012).   In this 8-0 decision, the court, rather than examining the extensive history of the term “indubitable equivalent” relied on a statutory canon to determine that the specific provision of Sec. 1129(b)(2)(A)(ii) controlled over the more general Sec. 1129(b)(2)(A)(iii).   

Prof. Erwin Chemerinsky noted that the fact that there have only been three statutory interpretation cases relating to the Bankruptcy Code in recent years reflects the reduced number of cases being heard by the Supreme Court.   Throughout much of the 20^th Century, the Court heard over 200 cases per year.  In 1978, the Court decided 162 cases.   While Chief Justice Roberts lamented the Court’s declining docket in his confirmation hearing, the court decided just 65 cases in the last term.   As a result, many important legal issues will go for longer periods of time without decisions.

Prof. Chemerinsky said that the court has a deeply divided bench with regard to both statutory and constitutional interpretation.  Justice  Scalia’s largest impact on the court has been changing how judges approach  legislative history.   He was the first justice to suggest that legislative history is irrelevant and he often gets a majority to join him. While Justice Breyer advocates looking at the underlying purpose of the statute and is willing to look at legislative history, he considers history to be just an indication of the purpose of the statute.   

Prof. Chemerinsky decried an over reliance on the plain meaning approach, noting that rarely will cases come to the Supreme Court with texts that have plain a meaning.   Where there are two plausible interpretations, either one can be supported under the plain meaning approach.    In that instance, the words of the statute don’t answer the question.   

Stern v. Marshall Dissected and Placed in Historical Context:

Prof. Chemerinsky argued that the two most important constitutional decisions relating to bankruptcy were driven by very different concerns.   In Northern Pipeline Construction Co. v. Marathon Pipeline Co., 458 U.S. 50 (1982), a plurality led by Justice Brennan held that the jurisdictional scheme of the Bankruptcy Reform Act of 1979 was unconstitutional because it allowed non Article III bankruptcy courts to determine state law issues between non-debtor parties.   Prof. Chemerinsky asked, why did the liberal wing of the court care about giving too much power to non-Article III judges?   His answer is that they didn’t.   At the time, Congress was threatening to remove the power of  the federal courts to hear controversial issues such as abortion and affirmative action.   According to Prof. Chemerinsky, “I think that what the Supreme Court did in Marathon was to send a message to Congress about the ability of Congress to limit the power of the (Article III) courts.”   He noted that the only possible constitutional fix to this problem was to make bankruptcy judges Article III judges.   However, Chief Justice Burger and the Article III judiciary opposed this move.    Congress created the core/non-core distinction which did not really solve the problem.     

    

Over time, the Supreme Court changed its approach toward non-Article III Courts.   In Thomas v. Union Carbide Agricultural Products Co., 473 U.S. 568 (1985) and Commodity Futures Trading Commission v. Schor (1986),  the court adopted a functional approach.   The core/non-core distinction made sense from a functional point of view.

All of this changed  with Stern v. Marshall, 131 S.Ct. 2594 (2011), which Chemerinsky described as the second most important case with  regard to the Bankruptcy Reform Act of 1978.  In this case, it was the conservative wing of the court that sought to limit the power of the bankruptcy court.    Chief Justice Roberts and the conservative wing of the court took a formalistic approach which looked to what the term judicial power of the United States meant when the Constitution was adopted.   The liberals, led by Justice Breyer, took a functional approach, noting that the core/non-core distinction worked as a practical matter.   Prof. Chemerinsky said that one of the puzzles of the two cases is why the Supreme Court found it important to require Article III courts to determine matters of state law.   After all, most state law issues are decided by state courts which do not have the protections guaranteed by Article III.  The answer, which I think was left unstated, is that the bankruptcy courts are a football being kicked back and forth between the liberal and conservative wings of the court to advance other agendas.

Prof. Chemerinsky said that a big question is whether consent will solve the problem.  He said that if consent works, there will not be much practical impact from Stern.    He then dramatically added that “Until yesterday, consent was enough to solve the problem.”   On October 26, 2012, while the NCBJ was proceeding, the Sixth Circuit decided Stone v. Waldman,  No. 10-6497 (6^th Cir. 2012), which can be found here.     

 This is the first circuit court decision to hold that the Stern problem cannot be solved through consent.    He said that if this decision is followed, the impact will be enormous.   If the Supreme Court takes up Stone v. Waldman and rules that consent is not adequate, then bankruptcy courts will be required to do reports and recommendations in all matters in which they cannot issue a final order.    This would lead to ping-ponging back and forth between bankruptcy and district courts, delay, additional expense and the elevation of form over substance as overworked district courts rubberstamp bankruptcy court rulings.   He added, “In the end, I am of the conclusion that the only solution is to make Bankruptcy Judges Article III judges, but question whether there is the political will to do this.”   

Prof. Klee noted that in Stern v. Marshall, the plaintiff was found to have consented to determination of his state law defamation claims in the dischargeability context.   He said, “If the bankruptcy courts can’t decide claims,  we should close up shop and go home.”

Bankruptcy Judge Judy Fitzgerald asked, how far can I go in determining a claim?

In Stone v. Waldman, a chapter 11 debtor-in-possession argued that he had been defrauded by a creditor.    The bankruptcy court denied the creditor’s claim and also awarded $3 million in damages to the DIP.    On appeal, the defendant argued that the Bankruptcy Court lacked authority to enter judgment against him under Stern v. Marshall.   The Sixth Circuit found that the federal courts had jurisdiction over the debtor’s affirmative fraud claim but that the bankruptcy court lacked authority to enter a final judgment.  

As I read the decision, the Sixth Circuit ruled on waiver rather than consent.   The defendant did not object to the Bankruptcy Court’s ability to enter a final judgment against him.   The Sixth Circuit found that a party could not waive the right to have a claim determined by a constitutionally valid court.  It stated:

Waldman’s objection thus implicates not only his personal rights, but also the structural principle advanced by Article III. And that principle is not Waldman’s to waive.

Opinion, p. 8.  

Prof. Chemerinsky argued that this was a consent case because Waldman affirmatively pled that the claims against him were core proceedings.   I do not read the case that expansively.   While Waldman agreed that the claim was core, that does not end the issue, since Stern v. Marshall created the new category of core but unconstitutional.   Additionally, the Court used the term waiver in its analysis.  Is there a difference between waiver and consent?   I think so.    Time will tell.

Prof. Klee suggested that perhaps the solution was to have the U.S. Trustee designated as the representative of the estate so that all matters brought on behalf of the estate would implicate rights of the federal government and thus be public matters.

Prof. Chemerinsky described that as “an incredibly clever approach” but questioned whether the United States would be a real party in interest notwithstanding the designation.    In Qui Tam cases, a private party may sue in the name of the United States, but that is a situation where the U.S. is the party that has suffered the loss.   

Judge Fitzgerald then asked if changing case captions from “In re” to “Ex rel” would solve the problem.

 Prof. Chemerinsky predicted that there will be a split among the circuits. At this year’s Seventh Circuit Judicial Conference, Judge Easterbrook was dismissive of the notion that consent would not work.

One of the professors (sorry my notes are unclear) stated that if the court is going to take Stern seriously, what does that mean for magistrate judges and arbitrators?   While magistrate judges function more like true adjuncts to the district courts, they have the ability to conduct jury trials with consent.   The question was asked how that could survive if Waldman is the law.

 Prof. Chemerinsky said that it was difficult to try to predict what will happen in the future.  If the court takes a functional approach, it will “back away and take consent as solution.”  However, he said that he was skeptical that Supreme Court judges have any concept of what bankruptcy judges do and may decide the issue without thinking about what it means for the bankruptcy courts.

A Little Speech:

From there, the professors pivoted to discuss Milavetz, Gallop & Milavetz v. United States, 130 S.Ct. 1324 (2010).    Prof. Chemerinsky noted that BAPCPA regulates speech in many ways.   One area where he believed Congress had acted unconstitutionally was the provision prohibiting a Debt Relief Agency from advising an assisted person to incur debt in contemplation of bankruptcy.   Nevertheless, a unanimous Court, in an opinion by Justice Sotomayor, found the provision constitutional.   Justice Sotomayor read the provision as prohibiting an attorney from advising a debtor to take out debt for an improper purpose.   The professor opined that “just because the Supreme Court says something doesn’t make it right” and that it was a “nice way of writing the statute, but it’s not how Conress wrote it.”   He noted that even the textualist judges signed on the opinion, illustrating that consistency only goes so far (the last clause was mine, not Prof. Chemerinsky’s).

Prof. Klee argued that the court read a good faith requirement into statute.   “Here they took a statute about incurring more debt in contemplation of filing a case and limited it to incurring debt that is not good debt.”  He added that reading something into a statue that is not there to avoid a constitutional problem is not the same as the doctrine of constitutional avoidance.  He concurred that it was a “fascinating statutory interpretation case because the court rewrote the statute and the textualists went along with it.”  

Prof. Klee noted that statutory interpretation had changed since the Code was drafted in 1978.   At that time, the Supreme Court was clear that legislative history matter and the Code was drafted with that in mind. 

Immunity for the Sovereign (Don't Tell the Tea Party):  

Finally, the professors turned to sovereign immunity.   

Prof. Klee described 106(a) which waives sovereign immunity as an abomination.  He said that when the Court rejected a general waiver of sovereign immunity, a deal was cut in 1994, the parties sat in a room and went through every provision and negotiated whether immunity would be waived or not.  He said that this micro approach increased the probability that something would be missed.

Prof. Chemerinsky discussed the conflict in the Supreme Court’s sovereign immunity decisions.  In Pennsylvania v. Union Gas Co., 491 U.S. 1 (1989), the Court said that states could be sued if Congress said so. In Seminole Tribe of Florida v. Florida, 517 U.S. 44 (1996), the Court said no. As a result, the carefully drafted language of section 106(a) became irrelevant after Seminole. 

 

In Tennessee Student Assistance Corp. v. Hood, 124 S.Ct. 1905 (2004), the pendulum swung back the other way.   The Supreme Court essentially ducked the constitutional issue and held that it did not apply because the discharge operated “in rem.”  Justices Scalia and Thomas dissented, arguing that whether jurisdiction is in rem or in personam, there is still an effect on an unwilling state.   Finally, in Central Virginia Community College v. Katz, 126 S.Ct. 990 (2006), the court held in a 5-4 decision that sovereign immunity did not apply to recovery of a preference in bankruptcy.  The decision came down in  Jan. 2006, just days before Sandra Day O’Connor left the court.  Prof. Chemerinsky stated that he always believed that the result would have been different if the opinion had come down two weeks later.    He believes that there are now five justices willing to overrule Katz who don’t accept that sovereign immunity doesn’t apply in bankruptcy.   

My heard hurt after this panel—not because it was bad, but because I think I got an entire Constitutional law course in one hour.   For my money, this fill-in panel was the highlight of the conference. 

Consumer Financial Protection Bureau’s Big Assignment

The final panel of the conference examined the Consumer Financial Protection Bureau.   Last year’s conference also included a CFPB presentation, but the bureau had been functioning for less than 90 days at that time.   The panelists included Prof. Pat McCoy, who had been with the bureau at its founding, Holly Petraus, Assistant Director for the Office of Servicemember Affairs and Gretchen Morgenson of the New York Times.

Prof. McCoy explained the new for the bureau pointing out that during the home mortgage boom, federal regulators did “precious little to deter reckless mortgage lending.”   Although the Federal Reserve was the one federal regulator that could have issued a regulation requiring that loans only be made to borrowers who could pay, Alan Greenspan had a philosophical opposition to banking regulation and said no.   The CFPB will be promulgating such a regulation by January 21, 2013.   The fragmented set of federal regulators prompted a “race to the bottom” to see which regulatory agency could get the most charters by offering the least regulation.    Additionally, banks faced competition from unregulated non-bank lenders.   This put pressure on banks to compete.   Finally, consumer protection was divided among four federal regulators whose core missions were bank safety and monetary policy rather than consumer protection.   Prof. McCoy stated that in the mortgage area, lack of controls over “nearly brought down the financial system.”    She added that ignoring consumer financial protection can lead to system-wide financial problems of “catastrophic proportions.”   

The Dodd-Frank legislation created the CFPB as the one federal regulator whose sole mission was consumer financial protection.    The Bureau opened its doors on July 31, 2011.   The Bureau reduced fragmentation by providing one agency responsible for consumer protection.   It took measures to avoid the regulatory race to the bottom by ensuring that lenders could not avoid regulations by switching to a new regulator.   It also subjected non-bank lenders to CFPB examination.   The bureau was also designed to avoid regulatory inaction on philosophical grounds because it was affirmatively required to enact rules.

Ms. Petraeus said that her goal was to “ensure that no one can build a financial model around deceptive business practices.”  She stressed the importance of requiring disclosure so that people can see the costs. 

She said that her job involved ensuring that servicemen received financial education, to monitor complaints and to protect military families.  She said that she has been to 40 military bases in connection with her job and that pay day lenders and scams were a major emphasis.

Ms. Petraeus also pointed out the difficulties involved for service members and home mortgages.   She said that she had moved 24 times during her husband’s 37 years of military service.   When a service member receives PCS orders, they may not be able to sell their property or rent it for enough to pay the mortgage.  

However, many service members do not qualify for mortgage modification programs because they are either are not in default at the time they receive orders or are no longer occupying their property.    While some lenders allowed mortgage modifications for service members transferred into a combat zone, they did not address the much more common scenario of regular transfers.    She said that the recent Attorney Generals’ settlement provided more options for service members and that they were working to ensure that a home would be deemed to be owner occupied if the service member planned to return to it.   

She said that defaulting on a mortgage in order to qualify for a modification program posed special problems for service members.   She said that financial problems constituted the number one cause of losing a security clearance in the military.   When this happens, the service member cannot work in his trained field and the military must find someone else to fill the vacancy.  

 

Ms. Petraeus spoke about the importance of financial education for service members.  She said that currently it is offered as part of basic training.   She said that when you take a new recruit and push him to his physical limits and then place him in a dark room where someone is giving a powerpoint talk, the natural result is nap time.    She spoke about how the military is now sending financial education packages to recruits during the period between enlistment and when they arrive to begin their service.  This deferred entry period can sometimes be substantial and allows an opportunity for education. 

Parting Thoughts

This makes the Fifth NCBJ I have attended.   This year’s conference attracted about 1,900 registrants and over 150 bankruptcy judges.    I made it to twelve panels in two and a half days, which is a lot of information to take in.   In between blogging, I had the opportunity to meet some new people, catch up with previous acquaintances, eat some convention lunches and drink a lot of coffee.   However, the most illuminating moment came during the closing night dinner on Friday when the dance floor was swarmed by judges, quite a few of whom displayed silver hair, dancing to the beat of Creedence Clearwater Revisited (composed of the band’s original rhythm section).  While there may have been a few practitioners up there, I saw a lot of blue badges (indicating judges) moving in that direction.  It was a good metaphor for the fact that we may be getting older and we have to overcome challenges such as the awkwardly drafted language of BAPCPA, but the bankruptcy community still has a lot of vigor and a bit of fun left in it.  However, I really wish I had taken some pictures.  See you next year in Atlanta.

NCBJ 2012: From Stern's Fallout to Arguing Before the Supreme Court

The National Conference of Bankruptcy Judges consistently delivers some of the best continuing legal education in the country for bankruptcy lawyers.   Here are some highlights from this year’s conference.

I started my day Thursday with the Bernstein-Burkley firm’s Wake Up and Run.   For the past three year’s the firm has sponsored a daybreak 5k run at the conference.   This year’s run drew about 80 participants who ran, jogged or meandered around the waterfront in San Diego.    At 33:58, I was near the back of the pack, so I can’t tell who the fastest judge was or how the Fifth Circuit fared against the Ninth Circuit.   The fact that so many people would get together at 6:30 a.m. to go for a communal run shows that you don’t have to be crazy to practice bankruptcy law, but it helps.

The Reaction to Stern v. Marshall

So much has been written about Stern v. Marshall that it is hard to say anything new.   The panel did a good job on focusing on the judicial reaction to the decision rather than rehashing the story of the former Playboy playmate who didn’t get her multi-million judgment because Congress created an unconstitutional allocation of work between the bankruptcy courts and the district courts.    The panel gamely tried to wade through the reams of decisions mentioning Stern v. Marshall.  As of October 25, there were 712 of them.    The trend appears to be that while there are still about 50 decisions a month mentioning the Supreme Court ruling, the sky is not falling.   Out of a sample of cases, the panel found that a majority of Stern-based motions to withdraw reference, motions to dismiss and motion to abstain had been denied.    Two early decisions which suggested that bankruptcy courts lacked the power to even consider matters which were core proceedings but could not be constitutionally decided by the bankruptcy court were walked back by subsequent decisions.   

The most important response to Stern v. Marshall is that a few courts have developed local rules to deal with the decision and the national rules committee has proposed a set of rules changes as well.   The Southern District of New York’s rules have provided the template for several other courts that have addressed the issue.  Their rules can be found here.   

The Southern District rules attempt to require parties to state whether they will consent to entry of a final judgment by the Bankruptcy Court or whether they object.   The new rules require a statement of consent in the first pleading filed in an adversary proceeding, in the first pleading filed by a defendant, and upon removal o f a case.    These rules reflect a belief, which is probably warranted, that the parties can consent to decision by a non-article III judge.   New Rule 9033-1 provide that if a matter is core but the court cannot constitutionally enter a final judgment, the Court shall enter proposed findings and conclusions “as if it is a non-core proceeding.”

The proposed national rules amendments can be found here.  The proposed rules eliminate the core/non-core terminology from rules 7008, 7012, 9027 and 9033.  Instead, parties will simply state whether they consent to entry of a final order by the bankruptcy court.   New Rule 7016(b) states that the court shall, either sua sponte or on timely motion of one of the parties decide  whether to enter a final judgment, enter proposed findings and conclusions or “take some other action.”   Parties may submit comments on the proposed rules amendments until February 15, 2013.

What the Puck:  Sports Teams in Bankruptcy

This presentation discussed the bankruptcies of the Phoenix Coyotes, the Texas Rangers and the Los Angeles Dodgers.   According to the panelists, a sports league is nothing more than a cooperative of the teams.    When an owner acquires a team, he agrees to give the league veto power over who will own the team and where it will be located.    This gives the league enormous power over the teams and theoretically gives it the power to veto most decisions that would be made in a bankruptcy proceeding.  In bankruptcy terms, the debtor is a party to an executory contract which either is not subject to being assumed or at or cannot be assumed in a manner compatible with the proposed reorganization.  Nevertheless, bankruptcy has been successful to varying degrees because of the incentive of the fellow owners to allow the bankrupt team to, in the words of Tom Salerno, “bend the league rules.”

The three cases each had their own unique stories.  The Phoenix Coyotes were losing money because Arizona was not a particularly good market for a hockey club.   Their owner wanted to sell out to a Canadian technology entrepreneur who would move the team.   However, the league had vetoed the proposed sale.   The Texas Rangers, on the other hand, were a profitable team, whose parent company was mired in debt.   The team owners and the league were both happy to allow the team to be sold to a group led by Nolan Ryan.   However, to get the benefit of bankruptcy, they had to allow a competitive sales process.   The Los Angeles Dodgers were losing money and had been drained of $240 million by owner Frank McCord.  McCord wanted to sell the media rights for a small fortune and hang onto the team.   The league did not want to allow this to happen.

All three cases resulted in auctions.   In the case of the Phoenix Coyotes, the league bought the team, even though it did not have the highest bid.  Three years later the team is still losing money and the league has not found a new owner.   In the case of the Texas Rangers, a sales process designed to favor the Nolan Ryan group was upset when Judge Michael Lynn convinced the parties to allow genuine competitive bidding.   Dallas Mavericks bad boy Mark Cuban almost got the team until he was outbid by the Ryan group.    In the Dodgers case, the team sold for $2 billion, which will likely allow Frank McCord to walk away with anywhere from hundreds of millions to a billion dollars.   In each case, the bankruptcy case transitioned the team to a new owner acceptable to the league (although in the Coyotes case, that owner was the league itself).

A Grimm Fairy Tale:   Perspectives in the Next Chapter of the U.S. Mortgage Market Story

My notes from this panel would fill a ten page article.   However, a few highlights will have to suffice.
  

New York Times journalist and author Gretchen Morgenson is the author of Reckless Endangerment:  How Outsized Ambition, Greed and Corruption Led to Economic Armageddon.   She argued that the government’s role in subsidizing home ownership through Fannie Mae and Freddie Mac corrupted the mortgage market.   When the executives, shareholders and lobbyists for Fannie and Freddie were able to get part of the subsidies for themselves, they promoted more demand for subsidized mortgages.  The private mortgage market which is based on securitization was rampant with conflicts of interest and lack of disclosure.    Due to the collapse of the private mortgage market, Fannie and Freddie now comprise 95% of the mortgage market.

She said that if the government is going to subsidize housing finance, it should do so directly on the government’s own balance sheet.   She also said that the private sector must be “deeply engaged in building a market that is trustworthy, clean and not corrupt.      

Another speaker pointed out the extent of the mortgage foreclosure crisis.   3.5 million foreclosures have been completed, 2 million more are in the pipeline and 7 million more are at risk.   Foreclosure has been shown to reduce the value of foreclosed homes by 27% and to reduce the value of homes in the neighborhood by 1%.   

Franklin Codel, head of Mortgage Production for Wells Fargo Home Mortgage stated that Wells Fargo works very hard with borrowers experiencing financial distress but servicers and investors were not ready for the elevated level of foreclosure activity.   Nevertheless, he said that Wells Fargo completes two mortgage modifications for every foreclosure.

Clifford White, Executive Director of the Executive Office for U.S. Trustees highlighted the role of the bankruptcy system in dealing with the mortgage crisis.   He said that “our experienced in the bankruptcy system has been that large banks were not performing well” and that the bankruptcy system has been at the forefront of identifying problems in the mortgage industry.   He added that 300,000 distressed homeowners go into chapter 13 each year.

Mr. White argued that the bankruptcy courts saw the mortgage crisis sooner than other segments of the economy, but that the U.S. Trustee’s program “faced an onslaught of resistance” to efforts to try to address the problem.   

Mr. White also stated that the bankruptcy system should think of itself as a regulatory mechanism. He highlighted the disclosures required by the amended bankruptcy rules.   He said that these rules “affect bank processors in a way that no other federal rules do.”

Both Mr.Codell and Steven Swartout, who is the Executive Vice-President for a community bank, stated that their institutions have a high level of modifying mortgages that they own but that they have difficulty getting responses from the investors on mortgages they service.  

Ms. Morgenson was critical of the HAMP program, describing it as “ill-conceived” and with very few sticks attached.   The program was voluntary and did not address second liens which were often retained by the originating bank.   She questioned whether the government was trying to strike a balance between protecting the financial sector and protecting bad actors.  

Mr. Swartout explained that there were different markets for long-term and short-term mortgages.  He said that there were only a limited number of entities that could take on the risk of a 30 year fixed rate mortgage.    As a community bank, their market is in making two, three or five year callable mortgages.   He said that the expectation is that these mortgages would be repriced at maturity.  However, he said that they would not meet the requirements of a “Qualified Mortgage” under proposed federal regulations.     

In closing Gretchen Morgenson complimented the work of the bankruptcy courts, stating, “without you questioning what came into your courtrooms we wouldn’t be even this close to a turnaround in the housing market.”

Justice Stevens and Advocacy Before the Supreme Court

The Commercial Law League luncheon featured the presentation of the Lawrence King Award to retired Supreme Court justice John Paul Stevens and a keynote address by Supreme Court advocate Eric Brunstad.    (Unfortunately, Justice Stevens was not able to accept the award in person).  The two blended nicely into a program on bankruptcy and the Supreme Court.  

A few stories about Justice Stevens:

Shortly after he was appointed to the Seventh Circuit, the court considered the case of protesters who had occupied the state capital grounds.   The legislature voted the protesters in contempt of the legislature and had them arrested.   This was during the height of the Nixon law and order days. While the other members of the panel had no problem with the arrest, it troubled Justice Stevens and he dissented.   He also assumed that he had lost his chance to be considered for the Supreme Court.  However, when President Nixon resigned and President Ford was looking for a nominee who was not closely tied to Nixon, Stevens got the nod.

Justice Stevens said that brilliance was not how much you knew but whether you used it in a wise and humane manner.

Justice Stevens, unlike many appellate judges, was most comfortable around practicing lawyers.

Bankruptcy Judge James Gregg accepted the award on behalf of Justice Stevens.    He described him as intelligent, inquisitive and cordial, the opposite of pompous and egotistical.    He said that Justice Stevens said that his most interesting bankruptcy case was Central Virginia Community College v. Katz, 126 S.Ct. 990 (2006) in which he found that sovereign immunity did not protect a state from recovery of a preference, a decision which dialed back the Supreme Court’s sovereign immunity jurisprudence which Justice Stevens felt had been exalted beyond anything the framers intended.

Eric Brunstad the keynote speaker, has argued ten cases before the Supreme Court including this year’s RadLAX decision.  He noted that Justice Stevens had authored three bankruptcy opinions:   Marrama, Katz and Till.    He praised Justice Stevens for being willing to consider cases on a case by case basis rather than being bound by a fixed judicial philosophy.   

He said that Justice Stevens’ approach to the law was exemplified by his decision in Marrama, which denied a debtor’s ability to convert from chapter 7 to chapter 13 despite statutory language referring to an absolute right.   He said that Justice Stevens viewed the inherent power of the court as an extension of its powers in equity to deny relief to a party with unclean hands.    He believed that even though you may not be able to waive a right, you could forfeit it.

Justice Stevens was also a big fan of liberty, viewing it as an interest which transcended the written words of the Constitution.  

Mr. Brunstad told several anecdotes about the Supreme Court.   On one day, it had snowed particularly hard.   A lawyer received a call from the court clerk asking if he needed a right to court.  Much to his surprise, an SUV showed up with Chief Justice Rehnquist and Justice Kennedy.   The Chief fretted that they would be late and told the driver, “I order you to drive through all red lights” to which Justice Kennedy replied, “do you have that power?”

On another occasion, Chief Justice Rehnquist was quizzing an attorney about how to limit the discretion of bankruptcy judges.   Before the advocate could get a word out, Justice Breyer quipped, “Isn’t that what they’re paid to do?”    

On another occasion, one of the Justices had asked about a long and involved hypothetical which left the lawyer puzzled.   Justice Scalia told him, “Just say yes,” which the lawyer did.   The follow up question was “Why?”  When the puzzled lawyer turned to Justice Scalia, he said, “You’re on your own.”

Brunstad said that he takes his approach for arguing cases from Aristotle, focusing on Logos—which refers to logic, Athos—which refers to credibility of the speaker and Pathos—which refers to an emotional connection with the audience.

Pre-Bankruptcy Ethics:  How to Avoid the Minefields Before Combat Begins

Prof. Nancy Rapoport had some good perspective on the role played by counsel for the Debtor-in-Possession.   She pointed out that, on the one hand, counsel represents the Debtor-in-Possession, which is a fiduciary to the creditors.   While counsel is not a fiduciary to the creditors, counsel is an officer of the court.    This may impose higher duties on counsel for the DIP than counsel for a private party.   She noted that counsel is generally protected when advising the DIP between several acceptable courses of action.  On the other hand, she said of possibility.”

Richard Carmody of Adams & Reese discussed the importance of representing the interests of the DIP and not its principals.  He pointed out that in the Diocese of Spokane case, the attorneys who represented the Diocese in its chapter 11 have now been sued alleging that they represented the interest of the former Bishop rather than the Diocese.  

Chapter 11 Update:  Hot and Emerging Issues

This presentation discussed several important new cases in the chapter 11 arena.   Here are a few cases to be aware of.

In Marathon Petroleum Co., LLC v. Cohen (In re Delco Oil Co.), 599 F.3d 1255 (11^th Cir. 2010), the debtor used cash collateral without permission.  A supplier who was paid for goods actually delivered was required to repay the funds as an unauthorized post-petition transfer.   On the other hand, in Abbot v. Arch Wood Protection, Inc. (In re Wood Treaters, LLC), 2012 WL 3059379 (Bankr. M.D. Fla. 2012), a vendor who received payment from a debtor who obtained permission to use cash collateral but was not in compliance with the order escaped liability.   The cases raise the issue of how much due diligence a party dealing with a DIP must perform in order to qualify for a good faith defense to an action under Sec. 549.

In re Heritage Highgate, 679 F.3d 132 (3^rd Cir. 2012) raised an interesting valuation question.  An appraisal at the beginning of the case showed that the debtor’s property exceeded the value of both the first and second liens.  By confirmation, the starting value of the property less lots sold during the bankruptcy was less than the amount of the first lien.    However, the debtor’s cash flows showed that future sales of lots would bring in enough money to pay both liens.   Critically, the second lienholder did not offer any independent appraisal testimony.   The court held that the debtor’s cash flows, which assumed future appreciation in the value of the debtor’s property, was not a valuation as of confirmation.   As a result, the second lien was completely underwater.

In re Loop 76, LLC, 465 B.R. 541 (9^th Cir. BAP 2012) went against the majority of cases in allowing separate classification of a deficiency claim.   The court allowed separate classification because the deficiency claim had the benefit of personal guaranties.  

Several recent cases have applied the Till decision to chapter 11 cases.   In In re Cottonwood Corners Phase V, LLC, 2012 WL 566426 (Bankr. D. N.M. 2012), the debtor sought to reinstate the debt at the contract rate of 5.8%   Using a formula approach based on the 10 year treasury bill rate plus risk factor points, the court found that 7.0% was appropriate.   In In re North Valley Mall, LLC, 2012 WL  1071646 (Bankr. C.D. Cal. 2012), the Court used a blended “tranche” approach to come up with an interest rate of 8.5%.   Finally, in In re Walkabout Creek Limited Dividend Housing Association, LP, 460 B.R. 567 (Bankr. D. D.C. 2012), the court said that the interest rate should be at least 1% above the equivalent treasury bill rate.   Because this exceeded the rate proposed by the debtor, the court denied confirmation.    The court said that the prime + 1-3% formula in Till did not even rise to the level of dicta.   These cases strike me as wrongly decided.    The chapter 13 statuory language interpreted in Till is identical to the language in chapter 11.   Most chapter 11 cases are too small to support dueling experts.   As a result, the Till formula presents an appropriate starting point for most cases.

Two recent cases have rejected use of the “indubitable equivalent” prong of section 1129(b)(2)(A).   In In re River East Plaza, LLC, 669 F.3d 826 (7^th Cir. 2012), the court rejected replacing the debtor’s real property collateral with treasury bills.    If this is not the indubitable equivalent, I don’t know what would be.   In Cottonwood Corners Phase V, the debtor proposed to repay arrearages on the debt over time without interest on the basis that the arrearages already included default interest.   This did not work.

Gentry v. Siegel, 668 F.3d 83 (4^th Cir. 2012) is an interesting case on class proofs of claims.   If a party files a class proof of claim and the class is certified, the class is approved retroactively.   If the class is not certified, the court must allow class members additional time to file a claim.   Procedurally, a class claim is deemed allowed in the absence of an objection.   If there is an objection, the class rep must seek to invoke the adversary rules to obtain class certification.    In the specific case, the court did not certify the class because a class of several hundred employees was not necessary in a case with thousands of creditors.