Texas Supreme Court Uses "Common Sense" to Avoid Lender's Forfeiture on Home Equity Loan Violation

Texas has some of the strongest homestead protections in the country.   It was also one of the last states to allow home equity lending.   When it reluctantly amended its Constitution to allow home equity lending, it included some draconian provisions for lenders who didn't follow the rules, allowing forfeiture of principal and interest in some cases.   A lender's failure to provide a timely release after the borrower repaid the loan sparked a spirited disagreement among the Texas Justices as to whether to apply the Constitutional provision as written or to use common sense.   In a 7-2 decision, "common sense" and the lender prevailed. Garofolo v. Ocwen Loan Servicing, LLC., No. 15-0437 (Tex. 5/20/16).    You can read the opinion here and the dissent here.

What Happened

Teresa Garofolo took out a home equity loan for $159,700 in 2010.   She paid the loan off in April 2014.   While the lender recorded a release of lien, it did not provide her with a recordable release as required her loan documents.    She made demand upon Ocwen to provide her with the required paperwork.   When they failed to comply within sixty days, she filed suit in federal court seeking forfeiture of all principal and interest under the Texas Constitution.    The District Court dismissed the case.   When Ms. Garofolo appealed to the Fifth Circuit, the circuit certified two questions to the Texas Supreme Court:

 (1) Does a lender or holder violate Article XVI, Section 50(a)(6)(Q)(vii) of the Texas Constitution, becoming liable for forfeiture of principal and interest, when the loan agreement incorporates the protections of Section 50(a)(6)(Q)(vii), but the lender or holder fails to return the cancelled note and release of lien upon full payment of the note and within 60 days after the borrower informs the lender or holder of the failure to comply?

(2) If the answer to Question 1 is “no,” then, in the absence of actual damages, does a lender or holder become liable for forfeiture of principal and interest under a breach of contract theory when the loan agreement incorporates the protections of Section 50(a)(6)(Q)(vii), but the lender or holder, although filing a release of lien in the deed records, fails to return the cancelled note and release of lien upon full payment of the note and within 60 days after the borrower informs the lender or holder of the failure to comply? 

The Majority Opinion

The majority held that the Texas Constitutional provisions did not create substantive rights but merely set forth the conditions under which a creditor could have the right to foreclose a lien upon a homestead.   

Our initial inquiry is whether these terms and conditions amount to substantive constitutional rights and obligations. In concluding they do not, we first observe that section 50(a) does not directly create, allow, or regulate home-equity lending. Nowhere does it say all home-equity loans must include the constitutional terms and conditions, nor does it prohibit loans made on other terms. It simply describes what a home-equity loan must look like if a lender wants the option to foreclose on a homestead upon borrower default.

As to constitutional rights, section 50(a) creates but one: freedom from forced sale to satisfy debts other than those described in its exceptions. The delineation of home-equity lending terms and conditions serves only to set the boundaries of that constitutional right. The relevance of those terms and conditions is therefore contingent on the fundamental guarantee of section 50(a)—that the homestead is protected from forced sale “except for [a home-equity loan] that” includes the terms outlined in section 50(a)(6)(A)–(P) and “is made on the condition that” it also include the provisions set forth in section 50(a)(6)(Q)(i)–(xi). Those terms and conditions are not constitutional rights and obligations unto themselves. They only assume constitutional significance when their absence in a loan’s terms is used as a shield from foreclosure.

Majority Opinion, p. 6.   The majority went on to state that the constitutional protections did not apply because Ocwen did not seek to foreclose.

If Ocwen sought to foreclose on Garofolo’s homestead after she became delinquent in her payments, she could stand on the constitutional right to freedom from forced sale if her loan failed to include the release-of-lien requirement or forfeiture remedy. But that did not happen. Garofolo made timely payments and satisfied the balance in full. Ocwen never sought to foreclose, and there is no constitutional violation or remedy for failure to deliver a release of lien. Section 50(a) simply has no applicability outside foreclosure.

Majority Opinion, pp. 6-7.   Thus, the majority answered the first certified question "no."

It went on to answer the second question in the negative as well.   The majority said that while the loan documents contained the constitutionally required language about forfeiture of principal and interest, those provisions didn't apply to all violations of the loan documents.

Although the forfeiture remedy incorporated into Garofolo’s loan might be applicable to a lender’s failure to comply with some of her loan’s terms, it does not apply to a failure to deliver a release of lien. Accordingly, Garofolo must show actual damages to maintain her breach-of-contract claim or seek some other remedy, such as specific performance.

Majority Opinion, p. 8.  

So when would the forfeiture remedy apply?   Under the Texas Constitution, a lender must forfeit all principal and interest if it receives notice of a violation and fails to take one of the following actions within sixty (60) days:

(a) paying the owner an amount equal to any overcharge paid by the owner under or related to the extension of credit if the owner has paid an amount that exceeds an amount stated in the applicable Paragraph (E), (G), or (O) of this subdivision;

(b) sending the owner a written acknowledgment that the lien is valid only in the amount that the extension of credit does not exceed the percentage described by Paragraph (B) of this subdivision, if applicable, or is not secured by property described under Paragraph (H) or (I) of this subdivision, if applicable;

(c) sending the owner a written notice modifying any other amount, percentage, term, or other provision prohibited by this section to a permitted amount, percentage, term, or other provision and adjusting the account of the borrower to ensure that the borrower is not required to pay more than an amount permitted by this section and is not subject to any other term or provision prohibited by this section;

(d) delivering the required documents to the borrower if the lender fails to comply with Subparagraph (v) of this paragraph or obtaining the appropriate signatures if the lender fails to comply with Subparagraph (ix) of this paragraph;

(e) sending the owner a written acknowledgment, if the failure to comply is prohibited by Paragraph (K) of this subdivision, that the accrual of interest and all of the owner’s obligations under the extension of credit are abated while any prior lien prohibited under Paragraph (K) remains secured by the homestead; or

(f) if the failure to comply cannot be cured under Subparagraphs (x)(a)-(e) of this paragraph, curing the failure to comply by a refund or credit to the owner of $1,000 and offering the owner the right to refinance the extension of credit with the lender or holder for the remaining term of the loan at no cost to the owner on the same terms, including interest, as the original extension of credit with any modifications necessary to comply with this section or on terms on which the owner and the lender or holder otherwise agree that comply with this section . . . .

Texas Const. Art. XVI, Section 50(a)(6)(Q)(x).  

Garofolo argued that Ocwen could have cured the failure to provide the written lien release by paying her $1,000 under subparagraph (f).   The majority found that this would be a nonsensical cure since it would not address the actual violation.  

The unquestionably harsh forfeiture penalty is triggered when, following adequate notice, a lender fails to correct the complained-of deficiency by performing one of six available corrective measures. Ocwen argues forfeiture is simply inapplicable here because none of the six corrective measures addresses the failure to deliver a release of lien. Therefore, Ocwen could perform any or all of them yet still not correct the underlying deficiency. Garofolo argues, however, that performance of the catch-all remedy in subparagraph (f)—a $1,000 refund and an offer to refinance her loan—would have corrected the deficiency because Ocwen would have performed one of the measures required to avoid forfeiture. Of course, there was nothing to refinance—Garofolo had already paid off her loan—and a $1,000 payment would not buy her a document only Ocwen can provide. Nonetheless, Garofolo maintains that performance of subparagraph (f) was necessary to avoid forfeiture even if it completely fails to remedy or even address Garofolo’s actual complaint.

. . . Allowing lenders to avoid punishment by performing an irrelevant corrective measure at the expense of directly addressing the borrower’s complaint frustrates this intent. It follows that the six specific corrective measures exist to give lenders avenues to avoid forfeiture by fixing problems rather than furnishing technicalities that can be manipulated to avoid them.

Majority Opinion, pp. 10-11.  

In a somewhat tortured paragraph, the majority reasoned that forfeiture is triggered when a lender fails to correct the deficiency by performing one of the required acts.   If the deficiency cannot be cured by performing one of the required acts, then the forfeiture provision does not apply.

The six corrective measures each present an avenue through which a lender might actually correct a deficiency. But as this case demonstrates, these corrective measures do not speak to every manifestation of a lender’s failure to comply with its obligations. Accordingly, a lender might actually correct a deficiency but fail to do so through performance of a corrective measure. For example, if Ocwen delivered Garofolo’s release of lien within 60 days following notice, it would have actually corrected its failure to comply but would not have done so “by” performance of a constitutionally specified corrective measure. See id. Should it suffer forfeiture? Garofolo argues it should, but this view ignores that forfeiture is available only when a lender fails to correct its “failure to comply by” performance of a specific corrective measure. See id. (emphasis added). If none of those measures actually correct the lender’s failure to meet its obligations, the lender cannot correct its failure to comply “by” performing one of them, and therefore forfeiture is simply unavailable. See id. (a lender “shall forfeit all principal and interest . . . if the lender or holder fails to comply with the lender’s or holder’s obligations . . . and fails to correct the failure to comply . . . by” performing a corrective measure (emphasis added)). Accordingly, if a lender fails to meet its obligations under the loan, forfeiture is an available remedy only if one of the six corrective measures can actually correct the underlying problem and the lender nonetheless fails to timely perform the relevant corrective measure.

Majority Opinion, pp. 13-14.   Thus, the majority concluded that the forfeiture provision didn't really apply because it didn't make sense in the context of the specific default.   Instead, the majority said that Garofolo's remedy was to seek traditional breach of contract remedies or specific performance.

The Dissent

The dissenting opinion accused the majority of re-writing the law to achieve what it considered to be "common sense."

I do not agree with the Court’s answer to the Fifth Circuit’s second question, and instead conclude that the parties’ agreement expressly gives the borrower a contractual right to forfeiture of all principal and interest paid upon the lender’s “failure to correct [a] failure to comply” with its obligations under the loan. Though the Court is concerned about such a “harsh forfeiture remedy,” it is the remedy the text requires and to which both parties agreed. To reach the opposite conclusion, the Court adds words to the parties’ contract and to the Constitution’s language, and rewrites both to achieve the result it believes “common sense suggests.” Although the Court’s result may comport with “common sense,” or at least with the Court’s view of “common sense,” it is not what the parties agreed to or what the Constitution requires.

Dissent, p. 1.   The dissent found that the Constitutional language was straightforward and required forfeiture.

Consistent with the first required condition, the lender and borrower in this case agreed to a security instrument that requires the lender to give the borrower a recordable release of lien within a reasonable time after termination and full payment of the loan.  And consistent with the second condition, the agreement requires the borrower to give the lender notice of the lender’s failure to comply with an obligation, allows the lender “60 days after receipt of notice to comply with the provisions of Section 50(a)(6),” and provides that “only after lender has failed to comply, shall all principal and interest be forfeited by Lender, as required by Section 50(a)(6)(Q)(x), Article XVI of the Texas Constitution in connection with failure by Lender to comply with its obligations.”

Dissent, p. 3.   The dissent went on to say that if the default couldn't be cured by performing one of the six required cures that forfeiture was mandated rather than excused.

The Court concludes that the security instrument does not require the holder to forfeit all principal and interest unless one or more of the six corrective measures listed in subsections (a)–(f) of section 50(a)(6)(Q)(x) would “actually correct the lender’s failure to meet its obligations.” The Court then concludes that the corrective measure in subsection (f), on which the borrower relies, would not have “actually corrected” the holder’s failure to deliver the release of lien, and it would therefore be “ridiculously futile” and “irrelevant” for the holder to perform subsection (f)’s requirements.  Because the security agreement only permits forfeiture “as required by Section 50(a)(6)(Q)(x),” the Court concludes that forfeiture is not available here.  I disagree for four separate reasons: (1) subsection (f) expressly provides that it applies if the corrective measures in subsections (a)–(e) will not cure the holder’s breach, so it must apply here; (2) subsection (f) “corrects” the underlying deficiency for purposes of avoiding forfeiture and motivates the holder to timely deliver the release of lien; (3) it is not “ridiculously futile” or “irrelevant” for the holder to perform the actions subsection (f) requires; and (4) even if the holder could not “correct” its breach by performing subsection (f)’s requirements, the agreement would expressly require forfeiture, not excuse it.

Dissent, p. 4.    The dissent also appealed to Supreme Court Justice Antonin Scalia for the importance of reading the law as written as opposed to how the Court would prefer to read it.

A plain reading of the adopted language reveals the framers’ intent, but the Court rewrites this language to effectuate its own intent. The Court confuses the term “correct” with “cure,” adds the word “actually,” and renders inoperative the language that says subsection (f) applies if subsections (a)–(e) do not. The Court says “common sense suggests” its interpretation, but our assessment of “common sense” does not permit us to ignore the adopted language. ANTONIN SCALIA & BRYAN A. GARNER, READING LAW: THE INTERPRETATION OF LEGAL TEXTS 237 (2012) (noting that “judicial revision of . . . texts to make them (in the judges’ view) more reasonable” presents “a slippery slope”).

Dissent, p. 7.   The dissent also ridiculed the Court's futility analysis.

Applying its common sense, the Court concludes that lenders and holders who fail to deliver a release of lien as promised should not have to comply with subsection (f) to avoid forfeiture because paying the borrower $1,000 and offering to refinance the note would be “ridiculously futile” and “irrelevant.” Instead, the Court believes the language should permit the holder to avoid forfeiture simply by delivering the release of lien. In fact, under the Court’s construction, the lender can always avoid forfeiture when it fails to deliver a lien release, even by doing nothing at all, because the forfeiture remedy simply does not apply to a failure to deliver a release. But this is not what the text says.

In any event, the holder’s compliance with subsection (f) is not as futile or irrelevant as the Court suggests. While subsection (f) does not expressly or directly require the holder to “correct” or “cure” its failure to deliver the release of lien by actually delivering the release of lien, it serves to motivate the holder to avoid the failure in the first place, thus preventing the obligation to pay the borrower $1,000 and offer to refinance. Within sixty days of receiving notice that it has failed to deliver a release of lien, the holder must pay the borrower $1,000 and offer to refinance, or the holder is subject to forfeiture. If the holder pays the $1,000 and offers to refinance, but does not deliver the release of lien, it will avoid forfeiture but remain in breach of its obligation to deliver the release of lien.   Certainly, at that point, the borrower can sue for specific performance to obtain the release. Regardless, at a minimum, subsection (f) provides the holder a catch-all method to “correct” a failure to comply when the five other methods will not “cure” it, and by doing so motivates the holder to avoid the deficiency all together.

Dissent, pp. 8-9.   Thus, the two justices in dissent would have applied the forfeiture remedy against Ocwen.

What It Means

It makes for good theater to watch the Texas justices sparring over whether to apply plain meaning or common sense when the result would be to penalize a business interest and offer a windfall to a consumer.    It is remarkable that two justices on the all Republican court would stand for principle against a traditional Republican constituency.  

The dueling opinions also illustrate how difficult it is to apply plain meaning analysis.    Both sides made plausible arguments from the constitutional text.    However, the majority's resort to "common sense" suggests that they knew were drawing a fine distinction.

Notwithstanding the majority's tortured analysis, the opinion makes practical sense.   Failure to timely deliver a release is a minor inconvenience compared to the remedy of forfeiture of all principal and interest.    Prior to a loan being satisfied, the prospect of taking away a person's home provides a strong policy basis for imposing strict liability upon lenders who do not follow the law.   After the loan is paid, the lender no longer holds any significant power to harm the borrower.   Allowing forfeiture in this case could have chilled the market for home equity lending in Texas (although other cases allowing forfeiture have not).   As a matter of public policy, the decision was probably correct.   The big question is whether the majority had to butcher the text to get to "common sense."

Southern District of Texas Takes Itself to Task for Failure to Follow Chapter 13 Rules

In an unusual collaborative proceeding initiated by two judges from the Southern District of Texas and concluded by a third, the Court has taken the Standing Chapter 13 Trustee to task for following the guidance of the former judge and has effectively judged the system guilty.   The opinion exposes an apparent rift between the current and former judges of the district and demonstrates an activist approach to problem solving by the judiciary.     Misc. Case No. 15-701, In re:  Chapter 13 Plan Administration in the Brownsville, Corpus Christi and McAllen Divisions.    The Court's Amended Order can be found here.  

What Happened

The Southern District of Texas adopted a standard plan in 2008 which provided that when a mortgage payment was increased or decreased, the debtor's plan payment would be increased or decreased by the same amount.     This was to be done automatically without the necessity for a plan modification.  

At a hearing on December 16, 2015, Judge Marvin Isgur learned that the Standing Chapter 13 Trustee was not automatically adjusting the plan amounts, but was instead waiting for debtors to file a motion to modify.   As a result, Judge Isgur and Judge Eduardo Rodriguez issued an Order to Show Cause in  Miscellaneous Case No 15-701 on December 22, 2015.    Among other things, the Order to Show Cause stated that:

• It appears that the Chapter 13 Trustee may have made distributions to creditors and debtors with an incorrect application of the Plan.
• If the issue were only an historic issue, the Court would not issue the emergency relief contained in this Order.
• The magnitude of the errors, and the appropriate remedy (if any) for the errors is unclear.
• The Court recognizes the difficult position that this Order imposes on the Chapter 13 Trustee.  Accordingly, the Chapter 13 Trustee should not hesitate to retain counsel, directly or through her errors and omissions carrier.

The judges then issued an order which provided for an Initial Status Conference to take place approximately two weeks later.   They requested that David Jones, the Chief Judge for the District, preside over the hearing.    The judges also required that the Standing Chapter 13 Trustee and the U.S. Trustee appear.   Judge Jones handled all subsequent proceedings.

The Chapter 13  Trustee filed a response in which she stated that she had followed the direction of the former Judge who interpreted the standard plan to require that the Debtor file a motion to modify the plan if the mortgage amount changed. 

For years, at least as early as 2004, I have administered Chapter 13 Plans in accordance with Judge Richard Schmidt’s interpretation of the Plan and his direction and approval. Until his retirement on July 30, 2015, Judge Schmidt required debtors file a motion to modify in the event an increase in mortgage payment caused the plan to not timely pay out. If the debtor failed to file a motion to modify, the Trustee would file a motion to dismiss. If there was no objection filed by the debtor, the Trustee would increase the amount of the mortgage payment to reflect the new increased mortgage payment; however, the debtor’s overall payment to the Plan did not increase unless the court signed an order modifying the plan. This was the standard practice for many courts, including Judge Schmidt’s Court until his retirement.

She also submitted an affidavit from the now retired judge stating that he had in fact provided this direction.  

While the Court and the Trustee had adopted a practice "as early as 2004," the judges of the Southern District adopted a standard plan in May 2006 which took a different approach.  Under the standard plan, upon filing of a Mortgage Payment Change Notification, the Trustee was supposed to automatically increase or decrease the amount of the Debtor's payments so that the distribution to unsecured creditors remained constant.    According to Judge Jones, "(t)he effect of this change was to shift responsibility for any change in the debtor's ongoing mortgage payment from the unsecured creditors to the debtor."    However, the practice apparently followed was to put the burden on the debtor to request a modification or for the unsecured creditors to object.       

Following an initial status conference on January 11, 2016, the Court required the Standing Trustee to provide a report identifying all affected cases.     According to the Trustee's report, there were 367 open cases where Debtors had made aggregate underpayments totaling $820,843.47 and 173 open cases where Debtors had made overpayments totaling $412,881.32.   

The Trustee proposed to remedy the situation by refunding overpayments to the extent of available funds and, if this proved insufficient, to seek to recover the overpayments from creditors.   Where debtors had underpaid, the Trustee proposed (i) changing plan payments to the extent feasible, (ii) extending plans beyond sixty months; and (iii) granting hardship discharges where payments could not be made up.    According to the Court, the Trustee resisted the idea that she give notice to all affected parties and inform them that they might have claims against her.  

The Court's Order

On May 5. 2016, the Court issued its Order (which was modified slightly by an amended order the next day).    The Court began with a quote from Abraham Lincoln:

It is as much the duty of government to render prompt justice against itself, in favor of citizens, as it is to administer the same between private individuals. ABRAHAM LINCOLN, Message to Congress in special session, July 4, 1861.

What followed was a sharp critique of the administration of chapter 13 cases in the Brownsville, Corpus Christi and McAllen divisions of the Southern District of Texas, in effect, the Southern part of the Southern District.     The Court stated that "(r)esponsibility for the administration of the chapter 13 process is vested primarily in three independent parties:  the Court, the United States Trustee and the chapter 13 standing trustee."   Amended Order, page 5.   The Court did not mention the role of the debtors, creditors and their attorneys in administering the system.  However, the Court may have implicitly acknowledged the practical difficulty for someone who makes a living within the system to stand up to those tasked with its implementation.  

Judge Jones went on to state:

Based on the affidavits submitted by Ms. Boudloche and her statements to the Court during this proceeding, the Court finds that chapter 13 debtors in the Brownsville, Corpus Christi and McAllen divisions of the Southern District of Texas were intentionally treated in a manner contrary to the Uniform Plan and to other debtors in the Houston, Galveston, Victoria and Laredo divisions of the Southern District of Texas. This disparate treatment was apparently the result of communications between the Court and Ms. Boudloche and the implementation of an unwritten rule or agreement to disregard the Uniform Plan. The Court finds that Ms. Boudloche violated her duties as a chapter 13 trustee. The Court further finds that the United States Trustee violated its duties of oversight and supervision of Ms. Boudloche. Most embarrassing, the Court violated its duty to uphold the integrity and independence of the judiciary.

Amended Order, pp. 7-8.   

The Court adopted the following remedial measures in open cases with a mortgage change notice:

1.   Where the debtor had overpaid, the Court required that the trustee: (i) immediately adjust the plan; (ii) issue a refund to the debtor to the extent of available funds within fourteen days; (iii) recover any overpayments from creditors within sixty days; and (iv) failing that, the Trustee would be required to "satisfy the unpaid deficiency."

2.  Where the debtor had underpaid, the Court required the trustee to immediately file a "mortgage payment change notice" for cases with more than three months remaining.   The debtor would then be required to object within twenty-one days or be bound by the increase.    The Court also required any debtor wishing to assert affirmative relief against the Chapter 13 Trustee to file a pleading within the Miscellaneous Case within 45 days or the claim would be waived.    Once the debtor completed payments under the plan, the trustee would be required to file a Notice of Plan Completion including language stating:

In this case, the chapter 13 trustee failed to administer the debtor(s)’ plan in accordance with its terms. This failure may have resulted in a distribution to unsecured creditors that is less than what would have been received had the chapter 13 trustee properly administered the plan in accordance with its terms. If you object to the granting of a discharge or wish to assert a claim against the chapter 13 trustee, you must file a written pleading in this bankruptcy case specifically setting forth your objection or claim within 21 days of the date of this notice or any such objection or claim is forever waived.

Thus, the Court gave creditors an opportunity to object to the debtor's discharge or assert a claim against the trustee if they were shortchanged.    If creditors remained silent, the debtor's discharge would go through.

Thus, the Court's remedial procedure consisted of moving to compliance on a prospective basis while allowing parties to object or assert claims within a limited window.   If the parties chose not to upset the status quo (as they had done during the previous ten years when the plan was being ignored), the sins of the past would be laid to rest.

However, the Court did not stop there.    The Court ordered the U.S. Trustee to conduct a review of the standing trustee.   The Court stated:

The Court notes that it has listened to over 20 hours of proceedings involving Ms. Boudloche in her capacity as chapter 13 trustee. The Court encourages the United States Trustee to do the same. The Court will reserve further action pending receipt and review of the United States Trustee’s report.

Amended Order, page 10.

The Court concluded its order with an apology.

On behalf of the Bankruptcy Court, the undersigned offers its sincere apology to those debtors and their families that did not receive the justice they deserve. The Court hopes that practitioners in these divisions will share this Order with their clients and convey just how hard it is for the undersigned to publicly recognize the failure of a system that he took an oath to protect. There will be no more secret rules, unspoken practices or disparate treatment of citizens in different divisions. We are one Bankruptcy Court with a single set of written rules. All citizens within the Southern District of Texas will be treated equally and with respect.

Amended Order, page 10.

The Inquisitorial System of Justice

This case involved a judge-driven investigation.    This is a sharp contrast to the adversary system which is the norm in America.    A few words about the distinction between the adversary system and the inquisitorial system are in order.

The American system of justice is characterized by the adversary system in which the litigation is primarily driven by the parties and their advocates.   The adversary system is followed by most of the countries which inherited their legal system from England.   In contrast, most of the rest of the world follows the inquisitorial system of justice in which the Court takes the lead.    I found a good discussion of this topic in an online legal dictionary.

The inquisitorial system can be defined by comparison with the adversarial, or accusatorial, system used in the United States and Great Britain. In the Adversary System, two or more opposing parties gather evidence and present the evidence, and their arguments, to a judge or jury. The judge or jury knows nothing of the litigation until the parties present their cases to the decision maker. The defendant in a criminal trial is not required to testify.

In the inquisitorial system, the presiding judge is not a passive recipient of information. Rather, the presiding judge is primarily responsible for supervising the gathering of the evidence necessary to resolve the case. He or she actively steers the search for evidence and questions the witnesses, including the respondent or defendant. Attorneys play a more passive role, suggesting routes of inquiry for the presiding judge and following the judge's questioning with questioning of their own. Attorney questioning is often brief because the judge tries to ask all relevant questions.

The goal of both the adversarial system and the inquisitorial system is to find the truth. But the adversarial system seeks the truth by pitting the parties against each other in the hope that competition will reveal it, whereas the inquisitorial system seeks the truth by questioning those most familiar with the events in dispute. The adversarial system places a premium on the individual rights of the accused, whereas the inquisitorial system places the rights of the accused secondary to the search for truth.

The inquisitorial system was first developed by the Catholic Church during the medieval period. The ecclesiastical courts in thirteenth-century England adopted the method of adjudication by requiring witnesses and defendants to take an inquisitorial oath administered by the judge, who then questioned the witnesses. In an inquisitorial oath, the witness swore to truthfully answer all questions asked of him or her. The system flourished in England into the sixteenth century, when it became infamous for its use in the Court of the Star Chamber, a court reserved for complex, contested cases. Under the reign of King Henry VIII, the power of the Star Chamber was expanded, and the court used torture to compel the taking of the inquisitorial oath. The Star Chamber was eventually eliminated as repugnant to basic liberty, and England gradually moved toward an adversarial system.

After the French Revolution, a more refined version of the inquisitorial system developed in France and Germany. From there it spread to the rest of continental Europe and to many African, South American, and Asian countries. The inquisitorial system is now more widely used than the adversarial system. Some countries, such as Italy, use a blend of adversarial and inquisitorial elements in their court system.

http://legal-dictionary.thefreedictionary.com/Inquisitorial+System

While Bankruptcy Courts primarily function under the adversary system, section 105(a) authorizes court-led investigations such as the one in this case.    Specifically, section 105(a) provides:

No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.

In order to satisfy due process requirements, these proceedings often begin with an order to show cause which informs the responding party of the actions being questioned and allows a response.   In re Gleason, 492 Fed. Appx. 86 (11th Cir. 2012)(unreported).    There is also an inherent tension with the Court's ability to initiate and prosecute a proceeding and remain impartial.   In the case of In re Johnson, 921 F.2d 585 (5th Cir. 1991), the Fifth Circuit reversed an order suspending a trustee where the Circuit Court found that the Bankruptcy Court should have recused itself.   This may explain why, in this particular case, Judges Isgur and Rodriguez initiated the proceeding but then referred it to Chief Judge Jones.    This was all the more important for Judge Rodriguez who had been a volume practitioner in this same court until he was appointed to replace Judge Schmidt.

The inquisitorial proceeding in bankruptcy court is a unique creature.  The ability of the Court to compel a party to appear and show cause in a proceeding where the Court initiates the action, defines its boundaries and renders a judgment is a powerful one.   There are many words that could be written about whether this type of proceeding can comply with due process or whether there are separation of powers problems when the judicial branch compels the executive branch to act.  I will leave those for another author.

Disclaimers:

I am presently representing a client in another Miscellaneous Case in the Southern District of Texas.   Nothing written here is intended to be a comment on that proceeding which involves substantially different facts and legal issues.  

In reporting on this opinion, I have relied on the publicly available record and the descriptions of the proceedings contained within the court orders.    I did not participate in these proceedings and have no personal knowledge other than what I read.  

The period for appealing the Court's order has not yet expired.   As a result, the Order is still subject to modification or reversal on appeal.

Fifth Circuit Report: First Quarter 2016

During the first quarter of 2016, the Fifth Circuit handed down some important decisions relating to bankruptcy and debt.     These include cases about how attorneys get paid from PACA proceeds, standing to object, denial of discharge, dismissal for cause, enforcing a chapter 11 plan, preferences, more fallout from the Stanford Ponzi scheme and some cases of general interest.

Click on the style of the case to go to the opinion.