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.