Fifth Circuit Affirms Ruling That "The Loan Has Been Paid!!!;" Rejects Stern and Jurisdictional Defenses

The case of a creditor who did not want to acknowledge that its debt had really and truly been paid received little sympathy from the Fifth Circuit which rejected a panoply of defenses and affirmed the Bankruptcy Court ruling that "The Senior Loan Has Been PAID!!!"   Fire Eagle, LLC v. Bischoff (Matter of Spillman Development Group, Ltd., Case No. 11-51057 (5th Cir. 2/28/13), which can be found here.   I previously wrote about the Bankruptcy Court decision from Judge Frank Monroe here.   The decision is significant because it shows that Stern v. Marshall is not a silver bullet for parties seeking to avoid bankruptcy court decisions.   As discussed below, it also rejects a magical approach to bankruptcy law.

What Happened

The case involved a golf course that filed for chapter 11, which was a common occurrence in Austin.   After the debtor and a lienholder fought to a stalemate, the Bankruptcy Court ordered a section 363 sale.   The lienholder, Fire Eagle, LLC, held two liens, a first lien which was guaranteed, and a second lien which was not.    Fire Eagle was the high bidder at the sale, making a $9.3 million credit bid, which was approximately $200,000 more than the amount of its guaranteed first lien debt.  

Rejoicing at their good fortune, the guarantors requested a declaratory judgment that their obligation had been satisfied.   Fire Eagle objected to the Bankruptcy Court's jurisdiction as well as venue.  It also contended that its credit bid reduced its "claim" but not its "debt" and that it was therefore free to continue pursuing the guarantors.    The Bankruptcy Court ruled for the guarantors.   In addition to the quoted language above, the Court told Fire Eagle that "This is the Bankruptcy Court; not fantasy land" and "This is not rocket science."    The District Court affirmed.

The Fifth Circuit Explains Jurisdiction and Authority

In the post-Stern era, it is helpful to remember that there are three separate doctrines that govern a bankruptcy court's ability to render a  final decision:

a.  Jurisdiction under section 1334;

b.  Statutory authority under section 157; and

c.  Constitutional authority under Article III of the Constitution.

Under 28 U.S.C. Sec. 1334, there is jurisdiction for "civil proceedings arising under title 11, or arising in or related to cases under title 11."   "Related to" jurisdiction, which is the broadest category, applies if the case "could conceivably have any effect on the estate being administered in bankruptcy."    While Fire Eagle correctly stated that bankruptcy courts generally cannot "entertain collateral disputes between third parties that do not involve the bankruptcy or its property," the Fifth Circuit found that if Fire Eagle were to succeed in recovering from the guarantors, this would reduce its deficiency claim which would free up more money for the other creditors.     The Court noted that "We have previously held that similar attenuated, hypothetical effects of third-party litigation can give rise to related-to bankruptcy jurisdiction."    Opinion, p. 5.

Thus, jurisdiction turns on the broad "any conceivable effect" test.   However, this is not the end of the inquiry.    Once jurisdiction is present, the question is which court has the power to exercise that jurisdiction.

Statutory authority to render a final judgment is contained in 28 U.S.C. Sec. 157(b).   If a matter is statutorily defined as a "core" proceeding the Bankruptcy Court may enter a final judgment.   Otherwise, the Court must submit proposed findings of fact and conclusions of law to the U.S. District Court absent consent of the parties.

The Fifth Circuit found that the dispute between Fire Eagle and the guarantors qualified as a core proceeding because it was "dependent upon the rights created in bankruptcy."

Because the basis for this dispute is whether Fire Eagle’s credit bid had the effect of extinguishing the Senior Indebtedness, and because the right to credit bid is purely a creature of the Bankruptcy Code, see 11 U.S.C. § 363(k), we fail to see how this proceeding does not qualify as core under § 157(b)(1) and therefore hold that the bankruptcy court’s entering an order without reference to the district court was within its statutory authority.

Opinion, pp. 6-7.

Finally, there is the matter of constitutional authority to render a final judgment.   This is the legacy of Stern v. Marshall.    Because the Court of Appeal's discussion of Stern is succinct and clear, I quote it in its entirety below:

 In Stern v. Marshall, the Supreme Court held that it was unconstitutional for a bankruptcy court to issue a judgment on a state-law counterclaim for tortious interference with a gift expectancy, despite the fact that the claim itself was statutorily “core” pursuant to § 157(b)(2)(C) (defining as core proceedings “counterclaims by the estate against persons filing claims against the estate”). 131 S. Ct. 2594, 2600–01 (2011). It based this decision on the fact that the counterclaim was in no way reliant or dependent on proceedings in bankruptcy—it just happened to have been a counterclaim to a claim asserted in a bankruptcy proceeding. Id. at 2611. Fire Eagle contends that its claims in this matter are similarly beyond the constitutional authority of the bankruptcy courts to decide.

However, Stern itself stated that its holding was reliant on the fact that the counterclaim at issue was “a state law action independent of the federal bankruptcy law and not necessarily resolvable by a ruling on the creditor’s proof of claim in bankruptcy.” Id. Fire Eagle’s claim, on the other hand, is inextricably intertwined with the interpretation of a right created by federal bankruptcy law—the interpretation of the effect of Fire Eagle’s credit bid is in fact determinative of Fire Eagle’s claim. We therefore conclude that Stern is inapplicable and that there was no constitutional bar to the bankruptcy court’s exercise of its jurisdiction over this statutorily core matter.

 Opinion, p. 7.

The Fire Eagle opinion contains a formulation that I believe will be widely used in Stern analysis, namely, that if an issue relates in some substantive manner to a creditor's claim, then the Bankruptcy Court has authority to enter a final judgment.   While this is not the full extent of authority under Stern, it is a convenient way to handle many of the disputes likely to arise.

Exploring the Zen of a Credit Bid

 There is a theory making the rounds of the creditor's bar that there is a critical distinction between a "debt" and a "claim" and that if a dispute can be phrased in terms of the "debt," that the Bankruptcy Court lacks the ability to act upon the "debt."   This theory finds its support in cases such as In re Five Boroughs Mortg. Co., Inc., 176 B.R. 708, 712 (Bankr. E.D. N.Y. 1995).  Fire Eagle made a variant of this argument, contending that the credit bid affected only the the claim in bankruptcy and not the underlying debt.   This required the Court to consider the meaning of a credit bid.   Not surprisingly, the Court of Appeals concluded that there is no functional difference between a credit bid and cash.   The Court wrote:

Fire Eagle’s first argument is logically unsound. If Fire Eagle had been outbid at the § 363(b) auction, as it nearly was, or if it had simply declined to credit bid its claims, then the cash proceeds from that auction would have been applied against the Senior Indebtedness as the most senior debt in the bankruptcy estate. If the Senior Indebtedness was paid in full with these cash proceeds, then it would be absurd to suggest that Fire Eagle could separately proceed against the guarantors. Under such a theory, Fire Eagle would be undeniably receiving recovery in excess of the face value of the Senior Indebtedness by virtue of guarantees that explicitly provide for their own termination on the payment in full of the Senior Indebtedness.

Consequently, for Fire Eagle’s argument to be correct, its credit bid must not have been equivalent to a cash payment for the assets purchased. Title 11U.S.C. § 363(k), though, provides that credit bidders “may offset [their] claim against the purchase price” of the property that is the subject of the § 363(b) bankruptcy sale. This provision explicitly contemplates mixed bids of cash and claims, implicitly presupposing an equivalence with cash of the value of the credit bid. We agree with the bankruptcy court and district court that Fire Eagle’s credit bid constituted a payment-in-full of the Senior Indebtedness, just as if SDG’s assets had been sold for cash.

Opinion, p. 10.    The Court of Appeals also rejected several other insubstantial arguments.

Conclusion

The Fifth Circuit should be commended for providing a clear road map on some difficult issues of bankruptcy law.   The Court also deserves kudos for rejecting the magical view of bankruptcy law.  I have heard apocryphal stories that when the Bankruptcy Code was in its infancy, creditors would make arguments that the automatic stay did not control over a creditor's contract rights or that the discharge was not effective without the creditor's consent.   These particular instances of wishful thinking are now in the distant past.    However, in recent years there have been a rash of cases in which unhappy parties asserted that the Bankruptcy Court simply did not have the power to do whatever it did.   The Supreme Court rejected these challenges in United Student Aid Funds, Inc. v. Espinosa, 130 S.Ct. 1367 (2010) and Travelers Indemn. co. v. Bailey, 129 S.Ct. 2195 (2009), each of which involved collateral attacks on bankruptcy court orders, but limited the Bankruptcy Court's power in Stern v. Marshall, 131 S.Ct. 2594 (2011).    The resurgence of these types of challenges requires practitioners to remain sharp in their basic bankruptcy concepts and requires courts to distinguish between serious arguments and those which are seductive but ultimately insubstantial.   In the present case, the Fifth Circuit succeeded in making this distinction.