Mortgage Wars Part 2--Attack of the Robo-Signers

The first post in this series discussed successful and (largely) unsuccessful claims brought against mortgage servicers.   In Ashley Martins v. BAC Home Loans Servicing, LP, No. 12-20559 (5th Cir. 6/26/13)(also discussed in part 1 of this series) and Reinagel v. Deutsche Bank National Trust Company, No. 12-50569 (5th Cir. 7/11/13), which can be found here and here, the Fifth Circuit has an extensive discussion of standing to commence a foreclosure.   In this era of mortgage securitization and MERS, there are legitimate issues being raised about whether the party claiming the right to foreclose actually has the right to do so.  In this post, I will discuss the Fifth Circuit's rulings with regard to "robo-signing" in Martins and Reingagel.  Part 3 will examine issues relating to ownership of the note and deed of trust and chain of title. 

Some Relevant Facts

In 2003, the Ashley Martins signed a note in favor of BSM Financial and executed a deed of trust naming  the Mortgage Electronic Registration System (MERS) as the beneficiary of the deed of trust and as nominee for BSM.  I have previously written about MERS here.   In November 2010, MERS assigned the deed of trust to BAC Home Loan Servicing (BAC) by way of an assignment recorded with the County Clerk.    The trustee under the deed of trust (or more likely the substitute trustee) gave notice of trustee's sale.    A foreclosure sale was conducted on April 5, 2011 and the Federal National Mortgage Association (Fannie Mae) purchased the property.   The Debtor alleged that the assignment of the mortgage from MERS to BAC had been "robo-signed."   

In May 2006, the Reinagels signed a home equity loan in favor of Argent Mortgage Company.   Argent allegedly transferred the note to Deutsche Bank National Trust Company which contended that it was pooled in a mortgage securitization trust of which Deutsche Bank was the trustee.    Although the loan was allegedly transferred to Deutsche Bank in 2006, documentation of the transfer was not executed until January 2008.   At that time, a person purporting to act as the "authorized agent" of "Citi Residential Lending, Inc. . . . Attorney in Fact for Argent" executed an assignment of the deed of trust to Deutsche Bank and this assignment was recorded with Bexar County.    A second assignment was executed in February 13, 2009 which purported to transfer both the note and deed of trust.   The second assignment was once again signed by a person acting on behalf of Citi Residential Lending.   When the Reinagels defaulted, Deutsche Bank commenced a judicial foreclosure proceeding.   The state court approved the sale.   However, the Reinagels brought suit to enjoin the foreclosure and obtained a temporary injunction.   The case was then removed to U.S. District Court where the Court dismissed the complaint.

 What is Robo-Signing?

In the Reinagel case, the Fifth Circuit described robo-signing as:

"Robo-signing"is the colloquial term the media, politicians, and consumer advocates have used to describe an array of questionable practices banks deployed to perfect their right to foreclose in the wake of the subprime mortgage crisis, practices that included  having bank employees or third-party contractors: (1) execute and acknowledge transfer documents in large quantities within a short period of time, often without the purported assignor's authorization and outside of the presence of the notary certifying the acknowledgment, and (2) swear out affidavits confirming the existence of missing pieces of loan documentation, without personal knowledge and often outside of the presence of the notary.

Reinagel, p. 5.  Robo-signing has a long history.   Thomas Jefferson complained that King Louis XIV "hunts one half the day . . . and signs whatever he is bid."    Letter from Thomas Jefferson to John Jay (Oct. 8, 1787), quoted in In re Obasi, 2011 Bankr. LEXIS 5011 (Bankr. S.D. N.Y. 2011).   While King Louis's blind signing was limited by his hunting schedule and the use of a quill pen, today's robo-signers, aided by technology, are able to execute hundreds of documents in a single day.

Robo-signing allegations have led to enforcement actions brought by State Attorneys General among others.   In one case, Bank of America, Wells Fargo, Citigroup, JP Morgan Chase Bank and Ally Financial agreed to a $25 billion settlement with forty state AGs.    Diana Olick, Forty States Sign on to Foreclosure "Robo" Settlement.   However, consumers have had a more difficult time advancing robo-signing claims as demonstrated by the Martins and Reinagel cases.

 

The Court's Rulings 

The two courts each addressed different aspects of the "robo-signing" issue.   The Martins Court concluded  simply that "BAC has offered sufficient evidence through its recorded assignment, that it was the rightful holder of the mortgage, and Martins failed to present evidence creating a genuine issue of fact."   Martins, p. 3.    It dismissed the allegation that the assignment was "robo-signed" as "hardly sufficient to maintain a claim for fraud, much less to avoid summary judgment."  

The Reinagel court offered a more thorough analysis.   The Debtors sought to challenge the two assignments that were filed.   They challenged the first assignment on the basis that it was executed on behalf of Argent by Dawn Reynolds, an authorized agent of Citi Residential Lending.   However, Citi's agent stated that she was attorney in fact for Argent.   Because the Debtors did not allege facts stating that the affiant lacked authority to act on behalf of either Citi or Argent, they did not state a claim that the assignment was unauthorized.   The Court rejected the notion that the Debtor raised a fact issue merely because a stranger to the transaction claimed to be the attorney-in-fact of the original creditor.    This presents a chicken and the egg problem.   To find out whether Citi Residential was in fact the power of attorney for Argent, it would be necessary to conduct discovery.   However, without specific facts establishing that Citi lacked authority, the complaint did not state a cause of action and it was impossible to conduct discovery. 

The Debtors did state specific facts with respect to the second assignment.    They alleged that Brian Bly, who signed the assignment on behalf of Citi Residential Lending, was actually an employee of a third-party contractor, Nationwide Title Clearing, and that his signature was scanned into documents and then notarized as an individual.   The court's opinion stated that even if Mr. Bly had fraudulently signed the assignment, this would make the assignment voidable at the election of the defrauded principal, but would not furnish a defense to the debtor.   "Bly's alleged lack of authority, even if accepted as true, does not furnish the Reinagels with a basis to challenge the second amendment."   Reinagel, at 14.

The court also dismissed the argument that scanning a signature onto a document that was later notarized as an original document did not render the document "void" as a forgery. 

This argument is a red herring. Texas recognizes typed or stamped signatures -- and presumably also scanned signatures -- so long as they are rendered by or at the direction of the signer, and the Reinagels do not allege that Bly's signature was scanned onto the document without his authorization. Moreover, acknowledgments are valid as long as they are made in the presence of the notary and meet certain other formalities the Reinagels do not challenge here; there is no requirement that the affiant affix his signature in wet ink. Finally, even if Bly's acknowledgment is defective counsel for the Reinagels conceded during oral argument "that there is no dispositive law that says [an assignment of a deed of trust] has to be a notarized document." While mortgage assignments must be acknowledged to be recorded, Texas's recording statute protects only subsequent purchasers for value and without notice. That is, while defects in the acknowledgment might prevent Deutsche Bank from foreclosing had a third party purchased the underlying real estate from the Reinagels without actual knowledge of the mortgage,they do not affect Deutsche Bank's rights against the Reinagels.

Reinagel, pp. 15-16.

In a concurrence, Judge James E. Graves, Jr. questioned this reasoning. 

I do not agree that the Reinagels' forgery argument is a red herring. Acknowledging a document at a different time or place than what was in fact the case is included in the Texas Penal Code's definition of "forge." (citation omitted). And forgery makes an assignment void, not voidable. (citation omitted).  I disagree with the majority that, even if the acknowledgment was improper, it did not invalidate the second assignment because assignments  are not required to be notarized in Texas. This is immaterial--regardless of whether Bryan Bly was required to sign the original assignment in wet ink or to have his signature notarized, the Reinagels claim that his signature was notarized at a time or place different than where Bly actually was. This satisfies the definition of "forge" under the Texas Penal Code. The Reinagels, however, did not sufficiently plead or brief this argument, having raised it for the first time in their reply brief.  (citation omitted). Because the Reinagels have waived the argument, I concur in the judgment.

 Reinagel, p. 24. 

 

 The majority opinion did wag a finger at potential robo-signers, letting them know that it was not giving carte blanche for bad behavior.

Our holding is a narrow one: we merely reaffirm that under Texas law, facially valid assignments cannot be challenged for want of authority except by the defrauded assignor. We do not condone "robo-signing" more broadly and remind that bank employees or contractors who commit forgery or prepare false affidavits subject themselves and their supervisors to civil and criminal liability.

 Reinagel, p. 21.

The Significance of Robo-Signing

 

As the Martins and Reinagel cases demonstrate, allegations of robo-signing are not likely to succeed when contesting a lender's chain of title.    As long as there is a chain of title (something that will be addressed in Part 3), the borrower cannot defeat that chain of title with allegations of robo-signing.   

 

While robo-signing is a trendy buzzword, it is important to remember why it matters.   Robo-signing refers to the rote, mechanical signing of large quantities of legal documents without personal knowledge.    For purposes of transferring title, this might be acceptable, assuming that the party had authority to act on behalf of someone who had title to transfer.    After all, if one lender is transferring a thousand loans to another lender, does the person doing the signing really need to review each assignment to make sure that it was supposed to be included in the package?   If the affiant errs, the consequence is that his principal may have given away more than he meant to.   

 

The more troubling circumstance appears where an apparent stranger to the transaction appears and inserts himself into the chain of title.   Would have the Fifth Circuit have been as sanguine if the assignment had been executed by Micky Mouse as attorney in fact for Argent?   What if a known fraudster, such as Bernie Madoff, signed an assignment to himself as power of attorney for the original creditor?   Would this overcome the presumption of facial validity?   Finally, what if Deutsche Bank, who was the assignee in this case, had signed an assignment to itself as power of attorney for the original creditor?   Under the Fifth Circuit's ruling, this would be facially valid in the absence of proof that Deutsche Bank did not actually hold a power of attorney.   Thus, if Deutsche Bank had acquired a portfolio of loans from Argent without obtaining proper assignments, there would be nothing to prevent Deutsche Bank from creating its own chain of title so long as it used the magic words "as attorney in fact for" and the original creditor did not object.  

The facially valid rule limits the debtor to raising a challenge where the chain of title is broken or there are two competing parties.   In the Reinagel case, if Citi Residential had signed the assignements on behalf of Argent without adding "as attorney in fact" the chain of title would be broken, or to put it in the Fifth Circuit's terms, the assignment would be facially defective.   Additionally, if both Argent and Deutsche Bank were demanding payment and threatening to foreclose, then the borrower could complain.   

 

It is important to remember that the robo-signing controversy arose from affidavits, not assignments.   When a robo-signer executes hundreds of affidavits without personal knowledge, he is committing a fraud upon the court.     As the Court in Midland Funding, LLC v. Brent, 644 F.Supp.2d 961 (N.D. Ohio 2009) stated:  

In finding assertions in the affidavit to be false and misleading, this Court is not concluding that all the information in the affidavit is incorrect. Brent has provided no evidence that the amount of the debt, the fact that it is unpaid, or other vital account information, is false. As discussed infra, the actual account information is probably either correct or likely thought correct in good faith by Midland and MCM (and likely a bona fide error if so).  

 

However, this Court finds that the affidavit as a whole is both false and misleading . . .  notwithstanding the fact that some of the data in it are correct. It is unclear to this Court why such a patently false affidavit would be the standard form used at a business that specialized in the legal ramifications of debt collection. 

 644 F.Supp.2d at 969.    The Court ultimately found that use of the affidavit was "false, deceptive and misleading" and a violation of the Fair Debt Collection Practices Act.    Id. at 970.

This is the real danger of robo-signing. When a creditor requests relief from a court based upon an affidavit signed by a person who, in the Midland Funding case, pulled a stack of affidavits off the printer and signed them without reading them, the creditor is lying to the court.    The difference is that an affidavit made without knowledge or investigation is no better than an unsworn pleading, but has dressed itself up as something authoritative.  Fortunately, the courts do not apply the "facially valid" rule to affidavits.  

 

 

Mortgage Wars Part 1--Debtor Wins Rare (But Limited) Victory Under TDCA

The life of an appellate court judge is largely occupied by consideration of criminal appeals and prisoner petitions.    In FY2012, these cases made up 64% of the Fifth Circuit's docket.   (By contrast, bankruptcy appeals made up only 1.7% of cases docketed).    While they are statistically insignificant, the Fifth Circuit is having to devote an increasing amount of its time to cases involving persons unhappy about the foreclosure of their residence.   By my count, the Fifth Circuit has issued three published opinions and eighteen unpublished opinions so far during 2013.   These cases involve an increasing trend of litigants going to district court (usually a filing in state district court which is removed to U.S. District Court) to protest their foreclosures rather than going to bankruptcy court to prevent them.  

Many of these cases fall into one of two categories:   either the homeowner argues that the lender lied about the effect of a request for a HAMP modification or that the foreclosing party lacked authority.    This post will examine two published cases dealing with allegations of misbehaving HAMPsters, Part 2 will examine the robo-signing phenomenon and Part 3 will examine the technical requirements for a Texas foreclosure.   (A HAMPster is a cross between a hamster and a gangster.    While overworked, underpaid mortgage servicing employees often scurry about like hamsters trying to cope with overwhelming amounts of paperwork that they never manage to fully process, they often appear like gangsters to beleaguered  homeowners who are promised relief only to find that the HAMP process diverted their attention from the inevitably advancing foreclosure).    

James and Allene Miller and Ashley Martins were two sets of homeowners who found themselves dealing with BAC Home Loans Servicing, LP.    In an opinion authored by Chief Judge Carl Stewart, the Millers emerged with part of their lawsuit intact.   Miller v. BAC Home Loans Servicing, LP, No. 12-41273 (5th Cir. 8/13/13), which can be found here.   Mr. Martins was not so fortunate.   Martins v. BAC Home Loan Servicing, LP, No. 12-20559 (5th Cir. 6/26/13), which can be found here.   The Martins case will be discussed further in Parts 2 and 3.

What Happened

The Miller court succinctly summarized a story being heard often by attorneys:

The Millers allege that between March 10, 2010 and May 3, 2010, they called BAC at least three times, and that each call resulted in an unfulfilled promise from a BAC call center representative to send them a loan modification application. Further, the Millers allege that at least one of the call center representatives assured them that there would be no need to make a premodification payment to cure the default.

On May 3, 2010, the Millers received a letter from BAC’s foreclosure law firm stating that a foreclosure sale of the property would occur on June 1, 2010. The Millers allege that sometime between May 3, 2010, and May 18, 2010, a BAC foreclosure specialist named Victoria Masters informed them that she would make sure a loan modification application arrived, and that the foreclosure sale would be postponed while they attempted to modify their loan. The loan modification application arrived on May 18, 2010. The Millers returned their completed application by mail on May 28, 2010. 

That same day, they were contacted by an agent of BAC who informed them that the foreclosure auction would proceed on June 1, 2010. On May 31, 2010, the Millers again spoke with Ms. Masters, the BAC foreclosure specialist. She informed them that no postponement had yet been approved, but that she would attempt to obtain such approval from Fannie Mae. Later that day, the Millers allege Ms. Masters represented to them that she had obtained approval from Fannie Mae for foreclosure postponement pending disposition of their loan modification application.

Notwithstanding this alleged representation of postponement, the foreclosure sale proceeded as scheduled on June 1, 2010.

Miller, pp. 2-3.    The Martins case also involved an allegation that a representative of BAC "orally promised that his house would not be foreclosed if he submitted an application through the Home Affordable Modification Program (known as HAMP), which he did."    Martins, p. 9.

In both instances, the home was lost to foreclosure and the homeowner brought suit.   In both cases, the state court suit was removed to U.S. District Court which granted a motion to dismiss for failure to state a cause of action in the former case and a motion for summary judgment in the latter.

The Homeowners' Legal Theories

 The homeowners attacked the foreclosing parties under a number of state and federal theories, including the Fair Debt Collection Practices Act (FDCPA) , the Texas Debt Collection Act (TDCA), the Texas Deceptive Trade Practices Act (DTPA) and the Texas common law theories of promissory estoppel and wrongful foreclosure.    In these particular cases, the TDCA was the only theory to survive initial scrutiny.

The FDCPA vs. the TDCA 

This case illustrates an important distinction between the state and federal debt collection statutes.   Both the FDCPA and the TDCA require that a person be a "debt collector" in order to be subject to its requirements.   A creditor is not a debt collector under FDCPA unless it acquired the debt after it was in default.   On the other hand, a creditor is a "debt collector" but is not a "third party debt collector" under the Texas statute.   The U.S. Magistrate recommended that both claims be dismissed on the basis that BAC did not fall within the definition of a debt collector.   While there was a question about whether the loan was in default when BAC took over the servicing, the debtor did not appeal the dismissal of its FDCPA claims.   On the other hand, the Fifth Circuit found that the TDCA did apply and that this claim was wrongly dismissed.   The Court stated:

We reject this conclusion, which erroneously affords the lone third-party debt collectors reference talismanic significance despite the fact that the FDCPA is a “distinguishable, federal statute.” (citation omitted). The TDCA’s definition of debt collector is broader than the FDCPA’s definition. (citation omitted). Unlike the TDCA, the FDCPA expressly excludes from its definition of debt collector: “any person collecting or attempting to collect any debt owed or due or asserted to be owed or due another to the extent such activity . . . concerns a debt which was not in default at the time it was obtained by such person.” 15 U.S.C. § 1692a(6)(F)(iii).

As noted above, we held in Perry that this FDCPA exclusion encompasses mortgage servicing companies and debt assignees “as long as the [mortgage] was not in default at the time it was assigned” by the originator. (citation omitted). However, we also held in Perry that servicers and assignees are debt collectors, and therefore are covered, under the TDCA. See id. (citation omitted). In light of Perry, we conclude that BAC qualifies as a debt collector under the broader TDCA, irrespective of whether the Millers’ mortgage was already in default at the time of its assignment.

 Miller, p. 7.

 The Miller sued under four provisions of the TDCA:   misrepresenting the character, extent or amount of a consumer debt or its status in a judicial or governmental proceeding; falsely representing the status or nature of the services provided by the debt collector; misrepresenting that the debt was being collected by an independent, bona fide third party; and "using any other false representation or deceptive means to collect a debt."    

The Court found that the debtors' allegation that the loan servicer promised to send the Millers a loan modification application and to delay foreclosure stated a cause of action under the TDCA provision relating to misrepresenting the services provided by a debt collector.    However, it found that the debtors' allegations did not state a claim under the other subsections.     

The Court found that BAC had not misrepresented the character, extent or amount of the debt because the Millers knew that they owed the debt, knew what they owed and knew that they had defaulted and that BAC said nothing to lead them to think differently.   The Court found that because the debtors had not "alleged any facts stating that BAC was a subterfuge organization for Bank of America" that they had not misrepresented that the debt was being collected by a bona fide third party.    Finally, the Court found that the debtors had not alleged any specific deceptive acts or practices.   From where I sit, BAC engaged in a false and deceptive practice when it told the borrowers that it would not foreclose while it was considering their HAMP application.    However, the Court did not see it this way.

DTPA

The Court affirmed dismissal of the Millers' DTPA cause of action on the basis that the DTPA applies to a consumer.   A consumer is a person who acquires or seeks to acquire goods or services.   A straight loan of money without more is neither a good nor a service.   A loan to acquire goods or services can make someone a consumer but only if the claim arises from the purchase of the goods or services.   Because the Millers' claim arose from the attempted modification of the loan rather than the purchase of the home, the court found that they did not meet the definition of a consumer and did not state a cause of action under the DTPA.

Promissory Estoppel

 Both sets of plaintiffs alleged that the doctrine of promissory estoppel precluded BAC from honoring its alleged promise not to foreclose while it was considering the HAMP modification.    However, the specifics of the Texas doctrine prevented them from gaining traction here.   In Moore Burger, Inc. v. Phillips Petroleum Co., 492 S.W.2d 934 (Tex. 1972), the Texas Supreme Court held that a promise to sign a document that would comply with the statute of frauds would preclude the promising party from raising the statute of frauds.    Under Texas law, an agreement to make a loan for more than $50,000 as well as an agreement relating to sale of real estate must be in writing to be enforceable. As a result, the Court found that BAC's promise not to foreclose was unenforceable unless it was contained in a signed writing.  The Plaintiffs alleged that BAC agreed not to foreclose while it was considering the HAMP modification request.   However, the Plaintiffs did not allege that BAC said that it would sign a document in writing confirming this.   As a result, the doctrine of promissory estoppel did not apply.

Wrongful Foreclosure

Both sets of plaintiffs also unsuccessfully alleged wrongful foreclosure.   Under Texas law, there are three requirements for wrongful foreclosure:   (1) a defect in the foreclosure sale proceedings; (2) a grossly inadequate sales price; and (3) a causal connection between the two.   Mr. Martins alleged that failure to receive notice of the sale was a defect in the sales process.   However, the Court found that the notice need merely be sent, not received.   Additionally, it found that foreclosure for 92% of appraised value was not "grossly inadequate."   While the lower court accepted that the Millers' HAMP misrepresentation claims constituted a defect in the foreclosure sale process, it found that they had not attempted to satisfy the second and third elements of the test.   Instead, the Millers argued that they did not have to meet the second and third requirements where they sought damages but did not seek to set the foreclosure aside.   The Court disagreed.  

 What Does This Mean For Homeowners Chewed Up by HAMPsters?

In a perfect world (or even a pretty good one), lenders would realize that these cases are not an aberration and take steps to make the program work better.   After all, people who default upon their mortgages are not mere deadbeats disconnected from the rest of society.   They have friends and relatives who might be future customers and might be turned off by stories of homes lost due to duplicity concerning the benefits of the HAMP program.   These same people might also have long memories the next time that Wall Street turns to Washington for a bailout.  

Nevertheless, until the home mortgage crisis resolves itself, the Miller and Martins cases (and the eighteen unreported cases that I did not discuss) demonstrate that suing a mortgagor/servicer, even one that makes misrepresentations, is a daunting task.    If a loan servicer promises to forebear on a pending foreclosure based on a HAMP request, it is a good idea to have a bankruptcy lawyer waiting in the wings.  However, if that strategy doesn't work or isn't available, the cases discussed here provide a few litigation ideas.   First, if you have the luxury of talking to your client at the time that the loan servicer is promising that HAMP will make everything better, tell your client to ask for the agreement in writing.   They won't put it in writing, but they might say they would.   Offering to put the agreement not to foreclose in a signed letter would be enough to bring the case within promissory estoppel.  Second, be sure to remember the TDCA when pleading causes of action.   While it is not as sexy as the FDCPA, it was the only theory that worked in these cases.   Third, remember that there are three elements to wrongful foreclosure and make sure that you allege each of them (or perhaps omit the claim in favor of a stronger one).   Finally, call your Congressman and tell him that HAMP doesn't work and is being abused.     

Secured Claims and the Non-Participating Creditor

It is a much misunderstood truism that  a "secured creditor ‘with a loan secured by a lien on the assets of a debtor who becomes bankrupt before the loan is repaid may ignore the bankruptcy proceeding and look to the lien for satisfaction of the debt.'"     In re Howard, 972 F.2d 639, 641 (5th Cir. 1992).   Of course, the Bankruptcy Code does not say this.    In the case of a chapter 11 proceeding, what the Code does say is that 

except as otherwise provided in the plan or in the order confirming the plan, after confirmation of the plan, the property dealt with by the plan is free and clear of all claims and interests of creditors, equity security holders and of general partners of the debtor.

11 U.S.C. Sec. 1141(c).    Unfortunately, the courts in several circuits, including the Fifth Circuit, have added a judicial gloss to this clear statutory language and have held that in order for the provision to apply, that the creditor "must participate in the reorganization."    Elixir Industries v. City Bank & Trust Co. (In re Ahern Enterprises), 507 F.3d 817, 822 (5th Cir. 2007).     A new decision from the Fifth Circuit illustrates the perils of this rule.   Acceptance Loan Company, Incorporated v. S. White Transportation, Incorporated (Matter of S. White Transportation, Incorporated), No. 12-60648 (5th Cir. 8/5/13), which can be found here.

What Happened

In S. White Transportation, the creditor claimed a lien on the debtor's property and the debtor disputed the validity of the lien.   They had fought over the lien in state court without resolution.    When the debtor filed chapter 11, it scheduled the creditor as secured, but listed its claim as disputed.   The creditor did not file a proof of claim.   The confirmed plan acknowledged the lien dispute and provided for no distribution to the creditor.    The creditor did not object or vote upon the plan and it was confirmed.    After confirmation, the creditor requested a declaratory judgment that its lien had survived confirmation.   The Bankruptcy Court said no based on the rationale that notice and opportunity to participate was sufficient.   The District Court required actual participation and reversed.    

The Fifth Circuit, relying on Black's Law Dictionary on rulings from other circuits, said that participation must be active to be effective.    The Court held:

In light of our interpretation of the definition of the word “participate” and in accordance with the above-cited persuasive authority from our sister circuits, we hold that meeting the participation requirement in In re Ahern Enterprises requires more than mere passive receipt of effective notice.

Opinion at p. 5.

Judicial Gloss

The difficulty with this decision is that the judicial gloss overshadows the statutory language.    The Code says that "property dealt with by the plan is free and clear of all claims and interests."    The Code does not that "property dealt with by a plan is free and clear of all liens and interests of parties who actively participated in the bankruptcy case."    

Espinosa and Due Process

Due process requires that a party receive notice 

reasonably calculated, under all the circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections.

United Student Aid Funds, Inc. v. Espinosa, 559 U.S. 260, 272 (2010), quoting Mullane v. Central Hanover Bank & Trust Co., 339 U.S. 306, 314 (1950).  Clearly the creditor here received notice which satisfied the requirements of due process.

The Fifth Circuit brushed Espinosa in a footnote, stating that it was a case about a motion for relief from judgment under Rule 60(b).    However, Espinosa was about more than simply Rule 60(b)--it was about the binding effect of a plan.    In Espinosa the creditor argued that the Court lacked the power to discharge its otherwise nondischargeable claim in a plan and was rebuffed.   In this case, the creditor argued that the Court lacked the power to avoid its lien and was validated.   Something is clearly amiss here.

Practical Problems and Reductio Ad Absurdum

The S. White decision also presents practical difficulties.   If a creditor alleges a lien, no matter how spurious, and does not file a claim, does this exempt the creditor from the bankruptcy process?     The Bankruptcy Rules allow the debtor to file a claim on a creditor's behalf which the debtor could object to.   However, if the creditor remains silent in response to the claims objection, then it still has not actively participated in the case.    The debtor could file an adversary proceeding to determine the lien's validity.   This would delay the bankruptcy and no doubt lead to criticism from the U.S. Trustee.   On the other hand, if the debtor files an adversary proceeding and obtains a default judgment, then the creditor still has not actively participated.   While it is true that an adversary proceeding provides the creditor with more more due process, the requirements of due process had already been met.   The problem with judicial creations such as this one is that they have the prospect of taking on a life of their own.   The reductio ab absurdum here is that if the active participation principle is taken to its extreme then every creditor could opt out of the chapter 11 process by not participating and a chapter 11 plan would be a worthless scrap of paper.   

 The Need for Rehearing En Banc

It is time for the Fifth Circuit to reconsider the active participation rule.    This judicial gloss is inconsistent wit the language of the Code and is contrary to Supreme Court precedent.   It encourages a creditor who knows that its lien is being challenged to remain silent and hide behind the log to the detriment of the debtor and its other creditors.   In S. White, there were three other creditors who held undisputed liens upon the same property.    These creditors had the right to rely upon the terms of the plan and should not be subordinated to the claim of a creditor who sought to subvert the process through its silence.    

On Abstention, Multi-Part Tests and Being Mistaken for David Bowie (Updated)

Who would have thought that abstention could be so interesting? Judge Leif Clark has written an opinion on abstention which jabs at some of the boilerplate language found in motions to abstain and contains a footnote destined to become a Clark-classic. The Official Committee of Unsecured Creditors of Schlotzsky's, Inc. v. Grant Thornton, LLP, Adv. No. 05-5109, 2006 Bankr. LEXIS 2435 (Bankr. W.D. Tex. 8/30/06), which can be found here.

In the Grant Thornton case, the creditors' committee received permission to sue the debtor's auditors. They brought seven causes of action, five of which arose under state law. Grant Thornton responded with a motion to abstain from hearing the state law claims and a motion to dismiss. In denying the motion to abstain, Judge Clark resisted the temptation to check off factors on a multi-prong test. In fact, he questioned the usefulness of such tests in general. He stated:

 Many courts, in an effort to give expression to the parameters of that (equitable) discretion, have developed multi-factor tests. While helpful, they are by their very nature, not dispositive. Mechanical applications of such tests to rule on equitable issues that are heavily fact-specific are often doomed to produce incorrect outcomes. The various tests offered by these opinions must be viewed in the larger context of the task presented--to arrive at the equitable application of the permissive abstention doctrine, as appropriately applied in the bankruptcy context. Or, more simply, we must avoid losing the forest for the trees.

Slip Op. at 5.

Judge Clark illustrated his point in a footnote which only he could have written.

A person is sent into a crowded room with directions to find Judge Clark by applying the following multi-factor test: (1) tall, (2) blond hair, (3) angular features, (4) dressed stylishly and (5) having a resonant voice. The person returns with David Bowie in tow. If the person had simply been given a recent picture of Judge Clark (which would have been worth far more than
all the factors one could write down on a piece of paper), chances are he would have quickly returned with the judge, not the singer.

Leif M. Clark

Not Leif Clark

Not Leif Clark

 Unless, of course, Judge Tony Davis was in the room, in which case the searcher might come back with two jurists.

Instead, Judge Clark tried to identify the larger policies served the abstention doctrine, stating:

The larger context of permissive abstention is informed by the base principles that led to its inclusion in the bankruptcy jurisdiction statute in 1978. Those principles included the importance of centralized administration in one forum, the breadth of bankruptcy jurisdiction intended to have been conferred, the need to deal with unexpected exigencies or to step back when the matter to be litigated is especially important to be resolved in a state forum, and the need to do justice (as well as to avoid doing an injustice).

Slip Op. at 5.

In the discussion which followed, Judge Clark addressed some of the boilerplate allegations which turn up in most motions to abstain:

* Forum Shopping

* State Law Issues

* Non-Core Status

With regard to forum shopping, Judge Clark pointed out that all parties with a choice of venue engage in forum shopping. The pertinent question is whether the particular exercize of forum shopping is abusive or consistent with the jurisdictional provisions of the Bankruptcy Code. In this case, the presumption in favor of centralizing proceedings related to the bankruptcy case in the Bankruptcy Court won out.

With regard to the prevalence of state law issues, Judge Clark pointed out many of the issues which the bankruptcy court deals with a daily basis, such as property of the estate, allowance of claims, determination of exemptions, validity and priority of liens, avoidance actions brought under section 544(b) and questions concerning the enforceability of executory contracts, all arise under state law. Judge Clark had previously ruled upon a case involving professional liability. Therefore, the mere presence of questions of state law was not dispositive.

With regard to non-core status, Judge Clark pointed out that this should really be a non-factor, since bankruptcy courts are expressly given the authority to hear non-core proceedings in the jurisdictional scheme of title 28. "Unless we are to read Congress' own enactment of section 157(c)(1) of title 28 as a perverse sort of statutory self-fulfilling prophesy, that section's operation should not factor into the abstention calculus." Slip Op. at 9. Properly understood, non-core status is a prerequisite to asking the abstention question. However, beyond that, it is not independently important.

At the end of the day, Judge Clark found that abstention was not appropriate.

It is refreshing to see Judge Clark take on some of the dogma surrounding abstention doctrine. So many of the opinions about abstention (and the briefs citing those same opinions) are long and self-important. However, abstention is really just about whether a particular choice of forum would be unfair. Although he did not use this specific formulation, his concept of not losing the forest amongst the trees could be summed up in two questions (which are arguably a multi-factor test themselves, but are certainly more direct and to the point):

(1) Is the Plaintiff trying to obtain an unfair advantage by its choice of forum?

(2) Is the Defendant being unfairly prejudiced by the choice of forum?

The answers to those questions should generally result in an answer as reliable as the multi-pronged tests.

(Note: In fairness to the promulgators of multi-factor tests, this approach is at least implied by the statute, which lists the interest of justice, comity with state courts and respect for state law as factors to be considered).