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.