Venue Reform, Cristol Comments and More at NCBJ

I am at the National Conference of Bankruptcy Judges in Atlanta.    The conference includes some of the best bankruptcy continuing education in the country.    There is no way to report on it all, so I will be offering some random observations.   

Moonlight Run

The  healthiest event of NCBJ is Bernstein-Burkley’s Wake Up and Run.    This year’s event drew about 60 runners willing to meet up at 6am for a 5k run.    The race was done professionally with personalized race bibs, chip timing and souvenir tshirts.    It was still full on dark at the race’s start time of 7am, so it ended up being a moonlight run through the park.    Judge Elizabeth Stong of the Eastern District of New York finished second in the women’s division.    Judge Tony Davis was the fastest Texas runner I recognized with a blazing speed of 26:32.    I finished much further back in the pack behind such Texas luminaries as Hugh Ray and Allan Diamond.   I recognized the names of at least five judges who were brave enough to get up at the crack of dawn and go running in the dark. 

Venue

I attended a meeting of the Venue Working Group.   This is a group of about 100 attorneys from 35 states who are working to build support for venue reform in Congress.   The group is supported by the Commercial Law League of America and includes many members from the group.    Peter Califano made a presentation on the group’s work later in the day.   According to Peter, during 2003-2012, there were  559  chapter 11 cases filed in Delaware and 104 in the Southern District of New York which had their headquarters elsewhere.    Those cases involved $2 trillion in collective debt.   

The Working Group supports legislation similar to HR 2533, introduced by Reps. Smith and Conyers, which would have eliminated state of incorporation venue and restricted affiliate venue.

Douglas Rosner of the Working Group will be testifying before the ABI Chapter 11 Reform Commission in November.    The Group will also be participating in the CLLA’s legislative conference in February 2014.

363 Sales

The presentation on 363 sales raised more questions than it answered.    One rhetorical question asked is whether debtor’s management is a mere tool of the secured lenders and whether cases run for the benefit of the secured creditors are proper under the Code.   Another question was whether 363 sales can be structured to accomplish results that could not be obtained under a plan, such as paying some administrative claimants but not others and paying money to unsecured creditors when senior creditors are not being paid in full.    The question was posed of whether the judge could “throw out the Code to do the most good for the most people.”

Student Loans

Judges Anita Shodeen (Bankr. D. Ia) and Michael Williamson (Bankr. S.D. Fl.) had a “debate” on student loans.   I put debate in quotes because they agreed with each other far more than they disagreed.    However, the point-counterpoint format was lively.   

Judge Shodeen noted the difficulty of trying cases with pro se debtors who may suffer from mental illness.   She noted that North Carolina has a program for low cost mental health evaluations for student loan plaintiffs.   

Both judges suggested that practitioners push back on the Bruner test for undue hardship.    Judge Shodeen suggested that the legislative history indicated that section 523(a)(8) was originally intended as a guard against debtor abuse and that it should be brought back to that purpose.

Judge Williamson rejected the appeal to legislative history noting:

Looking to legislative history is like going to a cocktail party and looking for a friendly face.   You’ll probably find one.   

However, he emphasized that the Bruner test is a product of a bygone age when student loans could be discharged in as little as five to seven years and student loan defaults had not ballooned to over 17%.    He said that it is “time for trial courts to get a little aggressive” in pushing back against Bruner and urged attorneys to “push the envelope on these issues.”

Lawrence B. King Award

Judge Jay Cristol received the Lawrence B. King Award from the Commercial Law League.   While I was well acquainted with Judge Cristol’s poetic efforts, I was not aware of his service as a pilot.    During the Korean War, he flew submarine hunting missions off an aircraft carrier.   On a training run, he once shot a missile that ricocheted back and hit his own plane.    More recently, while flying patients for charitable medical treatments, he suffered engine failure and had to put his plane down on the highway.    He has also donated $1 million of his own funds to the University of Miami’s pro bono program.    Finally, he is the author of an acclaimed book on the Liberty Incident in which Israel fired on a U.S. ship during the Six Day War.  

In discussing the history of bankruptcy, which once included debtor’s prisons, he said:

I once proposed lender’s prisons for bank officers who made loans that were not properly underwritten.  It was not well received.

Judge Cristol offered five suggestions for reforming bankruptcy and insolvency laws:

• Eliminate prebankruptcy credit counseling. 

Credit counseling is as valuable as telling a person with a heart attack to listen to a lecture on healthy eating habits before he can have open heart surgery.

•  While Judge Cristol did not oppose the personal financial management course, he said it came too late. He recommended that all high school students be required to complete a financial management course.

• He recommended bringing back “real” usury laws.

• He said that education should be free in the United States or that student loans should be dischargeable. He said that 

I see little difference between a person who borrows $100,000 to open a pizza business and the person who borrows $100,000 for an education. Why shouldn’t they both be dischargeable?

He also asked: 

“Why undue hardship? Why isn’t hardship enough?”

• He also said that chapter 13 would be more useful if courts could modify home mortgage loans. He said this “would be the law if the major banks were not so greedy and stupid.”

It is somewhat ironic that the person being honored by a creditors’ rights organization used his acceptance speech to criticize certain creditors. However, after 28 years on the bench and 38 years of service in the Naval Reserve, he has earned the right to speak his mind. His presentation was lively and drew a warm response from the crowd. 

Thursday’s Keynote Speech

Bloomberg News Editor Bill Rochelle gave the keynote address for the CLLA lunch.    Prior to joining Bloomberg in 2007, he was a bankruptcy lawyer for 35 years.

He thanked the CLLA for inviting him to an event where he wouldn’t have to pay for any of his food or drink for four days.

The more the bankruptcy business declines, the more the turnaround managers parties to hold onto market share

he remarked.

He predicted that Executive Benefits Insurance Agency v. Arkinson will not make much difference, but that “the next case will be a whopper.”   He said that when he attended oral arguments in Stern v. Marshall, he observed that all of the justices (even the ones who eventually dissented) were “very concerned about preserving the perogatives of Article III judges.”    He said that if the Supreme Court rules against the viability of waiver and consent, it will only affect cases currently pending.   However, the next case to reach the Supreme Court could hold that decisions in cases decided long ago are invalid.   He noted that Judge Jed Rakoff (S.D. N.Y.) has held that decisions by Bankruptcy Courts within the ambit of Stern v. Marshall are not entitled to res judicata or collateral estoppel effect and are only binding between the parties.   He said that the next case decided by the Supreme Court under Stern v.Marshall could spell the end of the U.S. Magistrate system.

However, he said that Law v. Siegel is likely to be the big case of the term.    Law v. Siegel is a Ninth Circuit case that I have previouslywritten about in which the Circuit affirmed the Bankruptcy Court’s decision to take away a debtor’s exempt property under section 105 based on misconduct.    He said that the case could be “a blockbuster case on whether federal courts can use their equity powers to override the plain meaning of statutes.”    He said that the case could be the turning point on equity.  

He proceeded to discuss numerous areas where there are splits between the circuits, including equitable mootness, artificial impairment, inherited IRAs, recharacterization of debt into equity, dismissal for bad faith based on pre-petition conduct, whether the Fair Debt Collection Practices Act is preempted by the Bankruptcy Code and whether wage garnishments within 90 days of bankruptcy are preferences.   

Rochelle proposed creating a Federal Circuit Court for Bankruptcy.    He noted that disagreements between the circuits are growing while the Supreme Court hears only a few bankruptcy cases.   Sending all bankruptcy cases to one federal circuit composed of judges from each of the other circuits would allow for uniformity in bankruptcy law that is not present today and reduce the opportunities for forum shopping.

CLLA Afternoon Panels

The main thing that I took away from the discussion on complex litigation in Ponzi Scheme cases is that there is a presumption of fraud in Ponzi Scheme cases but no one agrees on its boundaries.   I also learned that Kathy Bazolan Phelps and Judge Steven Rhodes have written The Ponzi Book:   A Legal Resource for Unraveling Ponzi Schemes.  

The main take aways from the Current Developments program were that deepening insolvency is still viable in Europe where it is known as “wrongful trading” and can lead to jail time and that the cases over who owns the unfinished business of bankrupt law firms are still very much in play after being a major topic of discussion at last year’s NCBJ.

In the ethics panel, I learned that there is a new proposed Rule 2014 which will only require disclosure of material connections, but will require the firm to disclose how it defined materiality in doing the conflicts check.   It will also require firms to disclose what process they followed to score creditors’ committee gigs.

Another theme was that when caught in an ethical violation, remorse is good.   It is better for the firm and its partners to accept responsibility than to deny that anything happened or throw the young associate under the bus.    

Fifth Circuit Nixes Consent in Stern Cases

A failed bid to reap a Beanie Baby bonanza, which resulted in a fifteen year legal odyssey for a chapter 13 debtor and his attorneys, will live on a while longer as a result of the Fifth Circuit’s recent interpretation of Stern v. Marshall. Unlike the adorable plush toys giving rise to the dispute, the opinion here is neither cute nor soft.   Some sixteen months after oral argument, the Fifth Circuit concluded that consent cannot apply in Stern situations in a cryptic footnote.   The decision is likely to generate controversy until the Supreme Court clarifies the issue later this term.    Frazzin v. Haynes & Boone, LLP, et al (Matter of Frazin), No. 11-10403 (5^th Cir. 10/1/13).   The Fifth Circuit opinion can be found here and Bankruptcy Judge Barbara Houser’s opinion can be found here.   

Beanie Babies, Oral Agreements and Lawsuits 

The case began with an oral agreement between friends.   Michael Cohen and his company, Lamajak, Inc., had the right to purchase Beanie Babies and sell them in hospital gift shops.   Cohen believed that Beanie Babies were a passing fad, while his friend, Frazin, did not.   Cohen allegedly told Frazin that he could keep any Beanie Baby profits the company made in excess of $6 million.  Frazin did not ask his friend to put the promise in writing because he did not want to insult him.  When Beanie Babies turned out to be a big deal and made a lot of profits Cohen denied the agreement and litigation ensued.

Meanwhile, Frazin filed a chapter 13 petition.    He obtained court approval to employ Griffith & Nixon as special counsel.   After a two week jury trial in state court, Frazin was awarded a judgment for $6.3 million on several theories, including breach of contract, promissory estoppel and quantum meruit.   When Lamajak appealed, Frazin received court approval to engage Haynes & Boone as his appellate counsel.

On appeal, the state Court of Appeals found that there was not sufficient proof of an agreement and reversed the breach of contract damages.   The Court of Appeals also reversed the promissory estoppel claim on the basis that it belonged to Frazin’s company rather than to him individually.   The Court of Appeals ruling reduced Frazin’s recovery to $3.4 million.   While Lamajak was seeking review before the Texas Supreme Court, the parties agreed to settle the case for $3.2 million.  

While recovering $3.2 million would ordinarily seem like a good deal, Frazin did not think so.  When Griffith & Nixon and Haynes & Boone applied for their fees before the bankruptcy court, Frazin counterclaimed for malpractice, breach of fiduciary duty and claims under the Texas Deceptive Trade Practices Act.    The case was tried before Bankruptcy Judge Barbara Houser.   Judge Houser ruled against the Debtor on the malpractice and DTPA claims.   She found that there had been a breach of fiduciary duty, but that the breach was not sufficiently severe to warrant fee forfeiture.   She denied all of the Debtor’s claims and granted the fees requested.  

  

The Bankruptcy Court judgment was rendered on April 7, 2009, over a year prior to the Supreme Courts’s decision in Stern v. Marshall.  The District Court affirmed the Bankruptcy Court on January 14, 2011, which was subsequent to Stern v. Marshall.   The Fifth Circuit heard oral argument on June 6, 2012 and ruled some sixteen months later on October 1, 2013.

The Fifth Circuit’s Ruling

The panel wrote three separate opinions:  a majority opinion by Judge Prado, in which Judge Owen joined and Judge Reavley joined in part; a concurring opinion by Judge Owen and an opinion concurring in part and dissenting in part by Judge Reavley.   Judge Prado’s majority opinion relied substantially on Stern v. Marshall.   In a footnote, the court rejected the notion that Frazin’s decision to sue his attorneys in Bankruptcy Court bound him to the results of that litigation.    The Court stated:

The Attorneys argue that Frazin consented to the jurisdiction of the bankruptcy court and waived any objection to the contrary by filing his claims there and failing to object. However, when “separation of powers] is implicated in a given case, the parties cannot by consent cure the constitutional difficulty . . . . When these Article III limitations are at issue, notions of consent and waiver cannot be dispositive because the limitations serve institutional interests that the parties cannot be expected to protect.” (citation omitted). As discussed above, Stern makes clear that the practice of bankruptcy courts entering final judgments in certain state-law counterclaims “compromise[s] the integrity of the system of separated powers and the role of the Judiciary in that system.” (citation omitted). Thus, structural concerns cannot be ameliorated by Frazin’s consent or waiver.

Opinion, p. 8, n. 3. 

 

Following Stern v. Marshall, the Court found that the Bankruptcy Court had authority only to decide so much as was necessary to determine the attorneys’ fee requests.   The Court found that the malpractice and breach of fiduciary duty claims were defenses to the fee request so that the Bankruptcy Court had the authority to enter a final judgment upon them.  The Court’s finding on fiduciary duty was grounded in the fact that the Debtor sought only the equitable remedy of fee forfeiture but did not seek affirmative damages.   However, the Court founds that the Bankruptcy Court could not decide the DTPA claims.

Because it was not necessary to decide the DTPA claim to rule on the Attorneys’ fee applications, we conclude that the bankruptcy court lacked the authority to enter a final judgment as to that claim.   Nevertheless, we hold that all factual determinations made in the course of analyzing Frazin’s DTPA claim were within the court’s constitutional authority because they were necessarily resolved in the process of adjudicating the fee applications.

Opinion, p. 15.

Finally, in remanding the case to the District Court for further proceedings, the Court added:

We note (though we do not express an opinion) that although the bankruptcy court did not have jurisdiction to make a final judgment on the DTPA claim, the district court may have that authority.

Opinion, p. 17.

The Clarifying Opinions

Judge Owen wrote separately to emphasize that the Bankruptcy Court retained the ability to “resolve discrete issues that a core bankruptcy proceeding and a state-law cause of action share in common.”   Owen, J., Concurring, p. 18.   

Though a bankruptcy court cannot issue a final judgment disposing of certain claims in cases like the present one, this does not mean that bankruptcy courts are neutered in adjudicating core proceedings under 11 U.S.C. § 157(b)(2). A bankruptcy court should examine and resolve all challenges to a fee application, even if the challenges could or do constitute one or more elements of state-law or other causes of action that must be finally resolved by an Article III or state court. A bankruptcy court has jurisdiction to resolve discrete factual issues that necessarily must be decided in adjudicating claims for professional fees under § 330. Bankruptcy courts should not shy away from the task of resolving all issues that pertain to a fee application, even if those issues also form the basis, in whole or in part, of a potential state-law cause of action.

Id.

Judge Reavley, on the other hand, would have affirmed the lower court judgments. 

We affirm the bankruptcy court’s distribution of estate funds, and that is all I see before us.

The two law firms had obtained a large recovery in the lawsuit against Lamajak, Inc., enough to satisfy all creditor claims, and then the court had only to distribute what was left. The firms filed fee applications, to which the debtor Frazin objected and then filed numerous claims against them, including negligence and malpractice and even deceptive trade practice, all directed at the conduct of the lawyers related to the lawsuit against Lamajak, Inc. There was no use of the word counterclaim and no pleading meeting Rule 8 requirements, as a counterclaim must do.

I need not spell out my objections to this court’s judgment because no harm is done, at least in this case, and the district court will no doubt simply dismiss whatever has been remanded. However, if it were necessary, I would hold that a bankruptcy court does not lose jurisdiction in deciding the administration of the estate when that has some collateral effect not easily avoided.

Reavley, J., Concurring in part and dissenting in part, p. 20.

A Curious Collection of Opinions

The Frazin opinions are curious for the reason that they seem to have arisen in a vacuum.  Although Stern v. Marshall has been a hot topic nationally, there were no amicus briefs submitted in this case.    After holding the case under advisement for sixteen months (which is a really long time), the Court disposed of the most critical issue in a footnote.   The footnote basically said that the answer was obvious. It was as if the Court had said, “Well, duh!”  In doing so, the Court avoided discussing the Fifth Circuit’s own opinion about the validity of consent to trial before a magistrate, Automation Servs. Corp. v. Liberty Surplus Ins. Corp., 673 F.3d 399, 405 (5^th Cir. 2012) or the plethora of cases dealing with arbitration.   If the very integrity of the Constitution was at stake, it would have been nice to explain why consent was a non-starter here but works in the other contexts.  

    

In ruling on the issue of consent, the Court did not acknowledge the conflicting opinions from the Sixth and Ninth Circuits or note that the Supreme Court has granted cert on this issue.  Exec. Benefits Ins. Agency v. Arkinson (In re Bellingham Ins. Agency, Inc.), 702 F.3d 553, 565–66 (9th Cir. 2012), cert. granted 133 S. Ct. 2880 (2013); Waldman v. Stone, 698 F.3d 910, 921–22 (6th Cir. 2012), cert. denied 133 S. Ct. 1604 (2013).   However, the Court did mention these decisions in passing in connection with the authority of the District Court.   Thus, the Court was aware of the opinions but chose not to discuss them.

While the judges went to great lengths to point out that their opinion had little practical impact in the present case, they did not acknowledge the significant problems this could cause in a host of other contexts.    

Given the lengthy amount of time that the case was under submission, the three opinions and the cursory attention given to the most significant issue, it looks suspiciously as though the Court was having great difficulty with the issue and decided to issue an opinion that would resolve the specific case without addressing the herd of elephants in the room.   Of course, this is just speculation.

What Does It Mean?

This may mean very little once the Supreme Court rules on the issues of consent and waiver in the Bellingham Insurance Agency case.    However, in the meantime, Fifth Circuit bankruptcy courts will have to examine Stern v. Marshall without having consent as a fallback.   Frazin makes clear that bankruptcy courts may determine claims against estates and any state law issues absolutely necessary to make that determination.   Bankruptcy courts can also determine facts related to those issues and have those facts be determinative of other issues that the bankruptcy court itself could not itself issue a final decision on.   The Fifth Circuit seems to have inadvertently created a situation in which the bankruptcy court is a super-magistrate able to determine claims against the estate and claims relating to property of the estate and to make factual determinations relating to those claims.    Any legal conclusions or facts within these categories would be subject to normal appellate review.   While the opinion did not go this far, it seems to be saying that the District Court may enter judgment on state law counterclaims in which the Bankruptcy Court was allowed to find the operative facts.   Furthermore, if the operative facts were not necessary to a claims or property issue, then the District Court would be permitted to conduct de novo review of the factual findings and make legal conclusions. 

  

On a final note, the opinion means that the appellate courts are having trouble with the Stern lingo.   The panel opinion referred to Stern as having to do with jurisdiction to enter a judgment, while the issue is properly one of authority.    Judge Owen’s concurrence referred to core proceedings.   However, because Stern’s effect was to remove authority for bankruptcy courts to decide one type of core proceeding, the core/non-core distinction has lost much of its significance.