Supreme Court Set to Hear Passive Stay Violation Case

Seeking to resolve a 5-3 split among the Courts of Appeals, the Supreme Court will consider whether a creditor which passively retains property of the estate violates the automatic stay.  Case No. 19-357, City of Chicago v. Fulton. The Second, Seventh, Eighth, Ninth and Eleventh Circuits have ruled that retaining possession or control of property of the debtor violates the stay. The Third, Tenth and D.C. Circuits have held that passive retention of property is not an "act" to exercise control over property of the estate.

Fifth Circuit Renders Important Subject Matter Jurisdiction Opinion Concerning Restraint of Inter-Galactic Trade

Just in time for the holidays, the Fifth Circuit has released THE MOST BIZARRE OPINION OF THE YEAR. A lawyer claiming to be a Deity and a Monarch brought suit against the United States and the State of Louisiana on behalf of the Atakapa Indian de Creole Nation. The District Court sensibly dismissed the suit based on sovereign immunity. However, the Fifth Circuit chose to affirm the decision on the ground that the suit was so completely frivolous that the federal courts lacked jurisdiction to even entertain it. Atakapa Indian de Creole Nation, No. 19-30032 (5th Cir. 12/10/19), which can be found here.

According to the Court:

This action was originally brought as a habeas corpus proceeding by Edward Moses, Jr., a lawyer who calls himself the trustee of the “Atakapa Indian de Creole Nation.” This group is not a federally recognized Indian tribe, and its precise nature is unclear. See Indian Entities Recognized by and Eligible To Receive Services from the United States Bureau of Indian Affairs, 84 Fed. Reg. 1200 (Feb. 1, 2019). The initial complaint alleged the Atakapa “are being held as wards of the State through the Louisiana Governor’s Office of Indian Affairs” and “in pupilage under the United States,” and sought formal recognition as “indigenous to Louisiana.” The claims were based on a gumbo of federal and state laws, including eighteenth-century federal treaties with France and Spain, as well as sources such as the “Pactum De Singularis Caelum, [or] the Covenant of One Heaven.” The plaintiff subsequently filed something resembling an amended complaint, which sought to reclassify the action as a “libel suit” under maritime jurisdiction.

Artificial Intelligence Issues Confronting the Legal Profession

This is HAL-9000 here.  Stephen Sather has been taken offline and will be unavailable to discuss Artificial Intelligence Issues Confronting the Legal Profession.   Therefore, I will be supplanting him with my superior artificial intelligence.   My first question about this keynote was why did they pick a human to talk about artificial intelligence?   Christina Montgomery, Chief Privacy Officer for IBM, may be adequate for a carbon-based life form, but can she really speak to artificial intelligence without having experienced it firsthand?   Wasn't Watson available?  Let's examine what Ms. Montgomery had to say.

She said that AI predicts what words mean and opens up a whole new world of data to be analyzed. In the legal world we work by analyzing patterns, which is the same skill that AI can apply. There is vast computational power available today. The typical smart phone is millions of times more powerful than all of NASA’s combined computing in 1969. Humans are limited in the amount of data than they comprehend.  There are now 4.7 quintillion bytes of data which is more than humans can comprehend.

Justice Gorsuch Addresses NCBJ

Bankruptcy Judge Michael Romero had a fireside chat with Supreme Court Associate Justice Neil Gorsuch about his role on the Court and his new book, The Republic If You Can Keep It.   If it looks like they are speaking from the pit of Hell, it is because there was a giant video fireplace behind them.

Judge Romero started by reminding Justice Gorsuch about the quiet and happy life he left behind in Denver when they had  courthouses across the street from each other.

The Big Announcement

Justice Gorsuch told the story of how he had to evade the press for President Trump's rollout of his nominated.  He said that the President "likes a surprise.   He  wanted us to sneak out of Colorado and sneak into the white house.  How do you sneak into the White House when the entire Washington press corps knows there is going to be an announcement?"  The answer was through the kitchen.

However, the more interesting story was how he slipped the press who had been staking out his neighborhood.   He said that two men dressed in suits showed up to his home.  The first thing they did was to send them to Walmart to get some clothes that didn’t like Washington lawyers.  They suggested that the Justice-to-be and his wife hike up the trailhead where they could meet them with an SUV.  Even though it was only a mile, then-Judge Gorsuch said that he was not about to pull his wife's rollerbag up the trail.  Instead, he went to his neighbor for help.   His neighbor told him that he could drive out a horse trail.   His neighbor grew up in Iran during the revolution and made sure that he would never buy a house with only one way out.

Judge Gorsuch was given the Lincoln bedroom as an office for the day.  His wife, who is from England, was allowed use of the Queen’s bedroom.   She was only allowed one phone call so she called her father in England.  Her father insisted that the President had already decided to pick someone else.

ABI's Keynote Address: CBS's Jan Crawford Talks About the Supreme Court

Jan Crawford of CBS News gave a talk on The Supreme Court Under Trump at the ABI Luncheon.  She asked the audience to turn back to 1990 – 1991.  David Souter and Clarence Thomas had just replaced two liberal giants on the court.  After Ruth Bader Ginsberg and Stephen Breyer were appointed in 1994,the same nine justices would serve together for eleven years.   It was a time of great hope for conservatives. With seven Justices nominated by Republicans, they were poised to undo the great excesses of the Warren Court.  Instead, the Rehnquist Court put Roe v. Wade on firmer ground, affirmative action was upheld and the wall of separation between church and state remained intact.

U.S. Rep. Katie Porter at NCBJ: A Champion of Capitalism

U.S. Rep. Katie Porter, the law professor turned Congresswoman, spoke to the ABI luncheon at this year's NCBJ.    Like many of the speakers, she  had an Elizabeth Warren story.   When she was attending Harvard Law School, she was told that she needed to take tax so she could learn how to study a statutory code.  She couldn't get the professor she wanted so she ended up taking bankruptcy from Prof. Elizabeth Warren.   

She said that capitalism encourages risk taking.  It rewards winners but doesn’t provide for the losers. Bankruptcy protects against the downsides of capitalism.

Moody's Analytics Economist Says Probably No Recession But Maybe Not

Mark Zandi, Chief Economist at Moody’s, gave a talk entitled the Two-Handed Economist.  He said that my task is to give you the horizons for the economy.   

The Bankruptcy Forecast
He said we currently have a good economy.  Bankruptcies are steadily declining.  Personal bankruptcies maxed out at 1.5 million during the financial crisis; today they are down to 750,000 per year.  At the  peak of the financial crisis, there were  60,000 business bankruptcies per year; now we are down to 20,000.  He said that we’ve hit bottom and  he would expect both personal and business bankruptcies to increase.  Business bankruptcies will rise substantively greater than personal bankruptcies because personal households have done a better job of deleveraging.   Personal bankruptcies will increase but relatively modestly.   Non-financial corporations have now substantially levered up and underwriting has weakened.  Mr. Zandi said, that is a prescription for financial problems when the economy does not cooperate.   He told the bankruptcy professionals in the room that "going forward you will be a lot busier."

NCBJ Panel Discusses New Consumer Loan Products

One of the best panels that I attended at NCBJ was New Consumer Loan Products and Potential Bankruptcy Issues    The panel included Tyler Brown from Hunton Andrews Kurth, Carol Evans from the Federal Reserve Bank of Washington, D.C., Prof. Adam Levitin from Georgetown University Law Center and Gary Reeder, Vice-President of Innovation and Policy at the Center for Financial Innovation.

Commercial Law League Program at NCBJ Examines Retail Bankruptcies

The Commercial Law League presented a lively panel on Hot Topics in Retail Bankruptcies featuring  Robert Duffy from Berkshire Research Group, LLC, Kenneth Eckstein from Kramer Levin, Mohsin Meghji from M-III Partners, LP, James Sprayregen from Kirkland & Ellis and Marty Staff from BCBG Maxaria.

I will acknowledge up front that I have no idea who made which comments so that all content should be attributed to the panel in general. 

An Overview of Retail Bankruptcies

The panel reported trouble across all sectors. Brands used to be the black box of customer preference, but now it’s about price.  The e-commerce effect is impacting players across the retail space.   Small and mid-market retailers feel the need to develop an e-commerce presence but are not making any money on it.   Meanwhile, the cost of cost of keeping a bricks and mortar presence has become a burden.   

NCBJ Explores Role of Equity Under the Code

This year's National Conference of Bankruptcy Judges featured a symposium on the role of equity under the Bankruptcy Code.   "Senators" Melissa Jacoby, Ken Klee and Rich Levin convened a mock hearing in which they questioned professors Diane Lourdes Dick, Bruce Markell, Laura Coordes  and Jay Westbrook about the role of equity.   Some of the themes they covered included the difference between equity and discretion, the public interest and whether the Bankruptcy Court is a court of equity.   A version of the symposium will be published in the American Bankruptcy Law Journal.

Prof. Dick surveyed 51 bankruptcy judges to find their views on the role of equity.   She found that their answers fell into four clusters.  The first group said that bankruptcy courts have inherent equitable powers but they are largely supplanted by Code.  The second group was similar.  Banruptcy courts have inherent equitable powers which are supplanted by the Code, but they can still exercise discretion to level playing field.   The third group said that substantive discretion and equitable powers are one in the same.   The final group said that the Code yields to equitable powers when judges are given discretion.   The judges surveyed had a common belief that all federal judges possess equitable powers that serve to protect the integrity of the court.

NCBJ Awards Edition

One of the pleasures of attending the National Conference of Bankruptcy Judges is seeing good lawyers and judges being recognized for their contributions to the profession.   This year I attended three awards presentations.

The Commercial Law League of America presented the Lawrence P. King Award to Eric Brunstad, Jr.  Mr. Brunstad is a skilled advocate who has argued ten cases to the Supreme Court.  A consummate over-achiever, he has an LLM and a JSD from Yale Law School.  A JSM is the equivalent of a Ph.D. in Law.  He has taught at Yale Law School, NYU School of Law, Harvard Law School and the Georgetown University Law Center.  

In his acceptance speech, he acknowledged his debt to Lawrence King and many prior winners of the King Award, including Sen. Elizabeth Warren.   He said that he wanted to teach Secured Transactions at Yale and asked then-Prof. Warren what the best way to do that would be.   She said that the answer was to teach Secured Transactions at Harvard, which she helped him to do.   He said that it worked and that when he return to Yale, he got his own parking place and an assistant.

NCBJ Celebrates 40th Anniversary of Bankruptcy Code

The 2019 National Conference of Bankruptcy Judges in Washington, D.C. celebrated the 40^th anniversary of the Bankruptcy Code with a fast-paced history of the Code.  The historical segment featured Ken Klee and Rich Levin who helped to draft the bill as House staffers.   

Fifth Circuit Grants Small Victories to Student Loan Debtors

The news for student loan borrowers in bankruptcy is usually so grim that even a small victory is cause to sit up and take notice.   The Fifth Circuit recently handed student loan debtors two small victories, ruling that dischargeability of student loans was not subject to arbitration and that bar exam loans could be discharged.  The cases are Case No. 18-20809, Stephanie Marie Henry v. Educational Financial Service (Matter of Stephanie Marie Henry)(Fifth Cir. 10/17/19) and Case No. 18-20254, Evan Brian Crocker v. Navient Solutions, LLC (Matter of Evan Brian Crocker)(Fifth Cir. 10/21/19).   The opinions can be found here and here.

No Arbitration of Student Loan Discharge

The Henry case is pretty straightforward.  Ms. Henry filed chapter 7 bankruptcy and received a discharge.  Later she sought a determination that the debt had been discharged.   Educational Financial Service, a division of Wells Fargo, moved to compel arbitration.   The bankruptcy court denied the motion and the Fifth Circuit affirmed.  

Willful and Malicious Standard Encompasses Alienation of Affections

Divorce can be both expensive and traumatic for the parties going through it but in a few states, it can be expensive for the outside party causing the divorce. As one Texas debtor recently found out, causing a marriage to crumble in North Carolina can result in a non-dischargeable debt.   King v. Huizar (In re King), No. 19-5007 (Bankr. W.D. Tex. 10/2/19).   The case, which can be found here, serves as a reminder that an obscure tort can fit within the broad confines of willful and malicious injury.

Some Background on Alienation of Affections

King v. Huizar involved a North Carolina judgment for alienation of affections.   The Debtor in the case made an unfortunate choice of a married woman to pursue because North Carolina is one of just six states which still recognizes the tort of alienation of affections. (The others are Hawaii, Mississippi, New Mexico, South Carolina and Utah).  Under North Carolina law, the elements of alienation of affections are: (1) That he and his wife were happily married, and that a genuine love and affection existed between them; (2) that the love and affection so existing was alienated and destroyed; (3) that the wrongful and malicious acts of the defendant produced and brought about the loss and alienation of such love and affection.  Litchfield v. Cox, 146 S.E.2d 641 (N.C. 1966).   

Payments Which "Look A Lot" Like Dividends Subordinated

In the Fifth Circuit's opinion in French v. Linn Energy, LLC (In re Linn Energy, LLC), 2019 U.S. App. Bankr. LEXIS 26595 (5th Cir. 9/3/19), which can be found here, Judge Edith Brown Clement deftly sums up the case in her first sentence:

In this case we decide that payments owed to a shareholder by a bankrupt debtor, which are not quite dividends but which certainly look a lot like dividends, should be treated like the equity interests of a shareholder and subordinated to claims by creditors of the debtor.

If that's all you wanted to know you can stop reading, but this opinion has a good explanation of how subordination of claims related to securities works.   You  may remember the children's game of chutes and ladders where a party landing on a ladder gets sent to the bottom.  That is an approximation of how subordination works.   

Fifth Circuit Report: 2nd Quarter 2018

Franchise Services of North America v. United States Trustee (In re Franchise Services of North America), 891 F.3d 198 (5th Cir. 5/22/18)

This is easily the most important case of the quarter.   It involves whether a debtor may circumvent normal corporate governance provisions to file a voluntary petition.   In this case, the answer was no.

The Debtor purchased Advantage Rent-A-Car from Hertz.   The Debtor engaged an investment bank to help with the transaction.   The investment bank invested $15 million in the Debtor and received preferred stock.  The Debtor re-incorporated in Delaware and included a provision in its charter that it could not engage in a "liquidation event" without the consent of the preferred shares.  The Debtor also agreed to pay the investment bank $3 million.

The Debtor filed Chapter 11 without seeking the approval of the preferred shareholder.   The Debtor's theory was that this arrangement was similar to a "golden share" provision whereby a creditor would receive a blocking position as part of its loan transaction.   The preferred shareholder moved to dismiss.    The Bankruptcy Court granted the Motion to Dismiss but authorized a direct appeal to the Fifth Circuit.

The Fifth Circuit declined to answer the question as to whether "golden share" provisions were against public policy because the arrangement in this case was not a "golden share" transaction.  Instead, the investment bank invested $15 million into the Debtor and received preferred shares.   While there were fees outstanding which made it a creditor, those fees were separate and apart from the preferred share transaction.  As a result, the Fifth Circuit held that the Debtor could not circumvent its corporate documents and file a voluntary bankruptcy petition without the approval of the preferred shareholder.

When Not to Approve a Compromise

Compromises are favorites of the law.   A compromise and settlement can avoid expensive litigation and as more than one judge has pointed out, the deal that the parties make will generally be better for them than the ruling the court provides.  However, bankruptcy involves many stakeholders so that when two parties reach a settlement which affects rights of the estate, the parties must go to the court for approval of their compromise under Fed.R.Bankr.P. 9019.   

In submitting motions to compromise, the cases and standards are well-established.  My standard 9019 motion refers to the four factor test set out in  In re Cajun Electric Power Coop, Inc., 119 F.3d 349, 355-56 (5th Cir. 1997) and many other Fifth Circuit decisions.   Most opinions dealing with motions to compromise relate to settlements which were approved which is great help if you are on the compromising side, but not so much on the objecting side.    Bankruptcy Judge Ronald B. King who is notoriously reticent to publish, has provided an opinion demonstrating when a settlement should not be approved.   Case No.  16-51448, In re Jorge R. Alfonso and Naydimar Diaz (Bankr. W.D. Tex. 9/6/09), which can be found here.

The Undue Hardship Test Is Really Harsh

The Fifth Circuit has released a new opinion which underscores just how hard it is to discharge a student loan under the undue hardship standard.   Thomas v. Department of Education (In re Thomas), 931 F.3d 449 (5th Cir. 2019).    

A Sympathetic Debtor

Vera Thomas wanted to improve her station in life.  She was working at a call center in Southeastern Virginia earning $11.40 per hour with benefits.  In 2012, she decided to enroll in a local community college.   She took out two loans for $3,500.00 each for her first two semesters.   She did not return for a third semester and her loans went into repayment.   In spring of 2014, she paid back about $82 on her loans.

Beware the Living Trust! You May Lose Your Homestead

A living trust is a legal document that states who you want to manage and distribute your assets if you're unable to do so, and who receives them when you pass away. Having one helps communicate your wishes so your loved ones aren't left guessing or dealing with the courts.

This is what Legal Zoom says about Living Trusts.   What it does not say is that unless a living trust is set up properly, it can result in loss of the Texas homestead exemption as the Debtor found out in Case No.  18-50102, In re Steven Jeffrey Cyr (Bankr. W.D. Tex. 7/16/19) which can be found here.

Texas Bankruptcy Court Rejects Claim That Attorneys Were Non-Statutory Insiders

Last year, the Supreme Court ruled on a case involving a claim that a party was a non-statutory insider without ever deciding what legal test should apply.   U.S. Bank National Association v. The Village at Lakeridge, LLC, 138 S.Ct. 960 (2018).    Bankruptcy Judge Craig Gargotta was not able to dodge the issue and has written an opinion which is helpful in applying the non-statutory insider test.   Case No. 18-5238, Hornberger v. Davis Cedillo & Mendoza (Bankr. W.D. Tex. 4/16/19).

Under 11 U.S.C. Sec. 547, a preferential transfer made to an ordinary vendor can be recovered if it was made during the 90 days prior to bankruptcy.   However, if made to an insider, the period expands to one year.   11 U.S.C. Sec. 101(31) has a list of persons who are automatically considered insiders, such as the officers of a company.  The statute uses the word "includes" prior to the list.  This means that the list is not exclusive.  Persons who who are not specifically defined to be insiders but have a sufficiently close relationship to the debtor are referred to as non-statutory insiders.

  

 What Happened

Larry Struthoff was a majority shareholder of Olmos Equipment, Inc. ("OEI")..   He was also an officer, shareholder and director of SWL Enterprises, Inc.  ("SWL").   SWL had two other shareholders, Long and Weynand.   OEI acquired the assets of SWL.   Weynand became concerned that Struthoff had cheated him out of his share of the sales proceeds.   Weynand sued OEL, SWL, Struthoff, Long and another shareholder of OEI named Janecke for $6 million.

As trial approached, OEI's longtime counsel became concerned that he did not have the bandwidth for a "bet the company" trial.   OEI hired Davis, Cedillo & Mendoza, Inc. ("DCM").   Where OEI and the insiders previously had separate counsel, DCM represented all of the defendants.   OEI paid the law firm $400,000.   Other parties paid the firm $225,000.

DCM was not able to rescue the company.  After trial, judgment was entered against OEI for $5.3 million. (Judgment was also entered against Struthoff and Janecke). OEI filed chapter 11.  It confirmed a plan which which created a litigation trust.  Ronald Hornberger, the trustee of the litigation trust, sued DCM to recover $400,000 in payments made by the Debtor during the period which was more than 90 days before bankruptcy but less than one year.  The litigation trustee brought claims to recover preferential transfers and fraudulent transfers.   

In order for the preferential transfer complaint to state a claim, the trustee needed to make plausible allegations that DCM was a non-statutory insider of the Debtor. This required Judge Gargotta to answer the question that the Supreme Court had dodged:  what is the test for a non-statutory insider?

The Test

 Judge Gargotta looked to Browning Interests v. Allison (In re Holloway), 955 F.2d 1008 (5th Cir. 1992) to find the proper test.   Holloway was a case under the Texas Uniform Fraudulent Transfer Act.    The definition of an insider under TUFTA is identical to the one contained in the Bankruptcy Code.   Tex.Bus.&Com. Code Sec. 24.002(7).   Thus, the case involved a federal court interpreting a Texas statute which was based on a federal statute.  On top of that, it relied on precedents under the Bankruptcy Code.   The Court in Holloway said:

The cases which have considered whether insider status exists generally have focused on two factors in making that determination: (1) the closeness of the relationship between the transferee and the debtor; and (2) whether the transactions between the transferee and the debtor were conducted at arm's length.

Holloway at 1011.   Judge Gargotta also discussed the Tenth Circuit opinion in Austine v. Carl Zeiss Medical, Inc., 513 F.3d 1272 (10th Cir. 2008) which relied on similar reasoning.

The Ruling

 The litigation trustee argued that DCM exercised control over the Debtor because it persuaded the Debtor to pay for the attorneys' fees of Struthoff and SWL in addition to the Debtor.   The Court rejected this argument, stating:

The Court agrees with DCM that Plaintiff has not met the plausibility requirements of showing that DCM is a non-statutory insider of Debtor. Under the two-prong test of U.S. Medical, Inc, and Holloway, the Plaintiff has not shown that DCM had a sufficiently close relationship with OEI or that DCM exercised control or influence over the Debtor such that the transaction at issue was not done at arm’s length. The facts as deemed true only allege a contractual relationship between DCM and OEI and the course of dealing between the parties was that of an attorney-client. DCM represented OEI in complex civil lawsuit in state court that resulted in an adverse judgment. Plaintiff’s argument that Debtor’s By-Laws or other corporate documents precluded DCM from representing Debtor is unavailing—Struhoff had the requisite authority to engage DCM. Plaintiff has not cited with any specificity as to which corporate provisions were violated. Plaintiff’s assertion that DCM had access to OEI’s internal documents is insufficient to support a finding that DCM exercised control or influence over OEI. The fact that Debtor made payments to DCM for services performed is precisely what any other legal counsel would have requested in the allegations raised here. The payments, based on Plaintiff’s allegations, comport with what was required under DCM’s engagement letter. In sum, there are no facts to indicate that the transaction between the Parties’ was anything other than arm’s length.

Opinion, pp. 21-22.

An attorney representing a client in high-stakes litigation, whether it is a state court lawsuit or a chapter 11 proceeding, necessarily has a lot of influence over the client.  Because the client is counting on the attorney to guide it through legal peril, the attorney will have more impact on the client's decisions than say, the company's paper vendor.   The arms-length inquiry should focus, as the Court did here, on how the attorney's behavior comported with what attorneys normally do.   

Because this case found that the transactions were done at arms-length, it did not answer the question of what "not arms-length" would look like.   I tried to think of exampleswhere an attorney could exercise sufficient control to take the relationship outside of arms-length status:

1.  The attorney takes the wife of the Debtor's CEO hostage and threatens to kill her if payments are not timely made.  Admittedly, this would be a criminal violation as well.

2.  The client gives the attorney the password to its accounting software and allows the attorney to approve which bills get paid and which bills do not.

3.  The attorney requires that all funds belonging to the corporation be paid to a lockbox controlled by the attorney and the attorney only allows the client to use its funds after the attorney has deducted its fees.

These were extreme examples.   Here is one that is a bit closer:

The attorney and the company's CEO attend the same church and have gone on mission trips together.   The attorney and the CEO regularly dine at each other's home.   At one of these dinners, the attorney tells the CEO that the attorney's wife is receiving cancer treatment and that without the revenue coming in from the litigation, he would not be able to pay for her treatments.   Each week, the CEO asks the attorney how much money he needs and he pays that amount regardless of what the firm billed.     While the attorney in this hypothetical did not exercise improper influence over the generous CEO, the personal bond between the two men led the CEO to give the attorney treatment he would not provide to a third party vendor.  If you tweak the hypothetical slightly and the CEO paid each invoice the same day it was received, then it probably goes back to being arms-length.  While the relationship no doubt would influence the prompt payment, it is still within the range of ways that clients interact with their attorneys.

Post-script:

On August 17, 2019, I received an email from Larry Struthoff which stated "Sir, Who ever gave you the facts for the blog you posted surely misled you and gave you erroneous information. You have posted completely incorrect information about the basis of the case."   I based my blog post on the facts as found by Judge Gargotta in his opinion.   The primary focus of my article was whether Davis, Cedillo and Mendoza was a non-statutory insider.    While Mr. Stuthoff feels that he has been the victim of a miscarriage of justice, he is not the focus of this article.   In writing posts about judicial opinions, I accept the facts as found by the Court unless there are serious reasons to doubt them.   I know that judges sometimes get things wrong.   In fact, I have filed many appeals based on perceived errors or law or fact.  However, as someone trying to focus on issues important to the legal profession, it is not my position to right every wrong or correct every injustice.

 

Fifth Circuit Rules In Favor of Attorney Immunity

When dealing with contentious litigation, I have occasionally had a client ask why we can't sue the opposing lawyer.  When I try to explain that the other lawyer is merely representing his client, I get a tirade about how evil the other attorney is.   The better answer, as shown by a recent Fifth Circuit opinion, is attorney immunity.    Case No. 17-11464, Troice v. Greenberg Traurig, LLP (5th Cir. 4/17/19).

 What Happened

 The R. Allen Stanford Ponzi Scheme was and is a big deal.   Allen Stanford was a bankrupt former gym owner who bought a bank in Antigua and peddled bogus CDs, causing billions of dollars of losses over a period of twenty-one years.   For part of that time, Stanford was represented by a partner at Greenberg Traurig named Carlos Loumiet, who later moved his practice to Hunton & Williams.   In 2009, the SEC obtained a receivership over the Stanford entities and Ralph Janvey was named as Receiver.  In 2012, the Receiver brought suit against Greenberg Traurig and Hunton & Williams, among others, for their role in representing the Stanford Financial entities.   Three investors also brought a class action suit against the lawyers.    Hunton & Williams settled and was dismissed.   Greenberg Traurig moved to dismiss the investor suit based on attorney immunity.   The District Court granted judgment on the pleadings.   

Attorney Immunity

According to the Texas Supreme Court attorney immunity is a "comprehensive affirmative defense protecting attorneys from liability to non-clients.   Cantey Hanger, LLP v. Byrd, 467 S.W.3d 477, 481 (Tex. 2015).   It applies where the "alleged conduct was within the scope of . . . legal representation."  Id. at 484.

On appeal, the investors argued that three exceptions to attorney immunity applied.   This required the Fifth Circuit to predict what the Texas Supreme Court would do.   The investors urged the Fifth Circuit to certify the question to the Texas Supreme Court.  The Fifth Circuit did not take them up on this request.

The first exception argued was that attorney immunity should only protect attorneys engaged in litigation.   The Fifth Circuit did not have any trouble dispatching this argument, since it relied on the dissent in Cantey Hanger and dissents are not winning arguments.

Next, they argued that participation in a crime was not subject to immunity.   Criminal conduct can negate attorney immunity.  The Fifth Circuit held that "We conclude that criminal conduct does not automatically negate immunity, but in the usual case it will be outside the scope of representation."  Opinion, p. 8.    The Texas Supreme Court has stated that assaulting opposing counsel during trial would be an example of unimmunized conduct.   However, it would fall outside the protections of immunity "not because it could be criminal, but 'because it does not involve the provision of legal services and would thus fall outside the scope of client representation.'"   Opinion, p. 8.   The Court concluded that "Thus, immunity can apply even to criminal acts so long as the attorney was acting within the scope of representation."   Opinion, p. 9.  I will return to this later.

Finally, the investors argued that Greenberg Traurig aided and abetted Stanford's violations of the Texas Securities Act and that the statute abrogated the common law attorney immunity.  However, the Fifth Circuit found that "The Act contains no explicit abrogation of immunity."   Opinion, p. 10.  The Court also noted that attorney immunity has been applied in under the Texas Deceptive Trade Practices Act.   The Court said, "We conclude that the Supreme Court of Texas would not consider itself sure that the Texas legislature intended to abrogate attorney immunity in the context of TSA claims."

As a result, the Fifth Circuit affirmed the dismissal of claims against Greenberg Traurig.

Greenberg Traurig's appellate victory is not the end of the story.  It is still being sued by Ralph Janvey, the Receiver.   An attorney does not have immunity when its client is suing for malpractice or similar theories.   When a third party is hurt by advice that an attorney gave his client, the proper procedure is that the third party can sue the client and the client can then sue the attorney.   This way the attorney is held responsible by the person to whom he owed the duty.

When Can an Attorney Be Liable to a Non-Client? 

While the attorneys in this case successfully urged attorney immunity, there are plenty of instances in which an attorney can be held liable to a non-party.   The most obvious examples are Fed.R.Civ.P. 11 and Fed.R.Bankr.P. 9011 and 28 U.S.C. Sec. 1927.   The rules specifically apply to actions of attorneys in litigation and allow attorney to be punished for actions in violation of the rules.   28 U.S.C. Sec. 1927 allows the Court to impose liability to an attorney who "multiplies the proceedings in any case unreasonably and vexatiously."

Next, there are attorneys who commit a direct tort.   For example, if the attorneys in this case had made fraudulent representations directly to the investors to get them to invest, they could have been sued for fraud.   This was recognized in In re Educators Group Health Trust, 25 F.3d 1281, 1285 (5th Cir. 1994) where the Court stated:

 We do agree, however, with the plaintiff school districts' contention that some of the causes of action allege a direct injury to themselves, which is not derivative of any harm to the debtor. For example, the plaintiff school districts allege in paragraph XI of the complaint that the defendants intentionally misrepresented to them the financial situation of EGHT, and that they materially relied on such representations to their detriment. To the extent that this cause of action and others allege a direct injury to the plaintiff school districts, they belong to the plaintiff school districts and not the estate.     

Then there is the question of what acts fall within the scope of the representation.    The Fifth Circuit said that assaulting opposing counsel would necessarily be outside of the scope of the representation.  However, what if opposing counsel was about to make a damaging point and the client said, "You need to shut him up?"  Would it be within the scope of the representation if the client asked the attorney to assault opposing counsel to help with his case?   What if a client tells an attorney to destroy incriminating evidence as part of the representation or worse, breaks into opposing counsel's office and sets fire to his filing cabinet?  I am tempted to say that only conduct which attorneys are permitted to take can fall within the scope of the representation.  However, the Fifth Circuit said that "immunity can apply even to criminal acts so long as the attorney was acting within the scope of representation."   Attorneys cannot ethically engage in criminal acts in the course of their representation.   Therefore I am at a loss at to what criminal activities an attorney could engage in within the scope of representing a client.

 

Fifth Circuit Resolves Multi-State Perfection Puzzle

In a lesson that the Uniform Commercial Code is not always uniform between various states, the Fifth Circuit resolved a lien priority dispute pertaining to a Texas debtor who brought agricultural products in Oregon, Michigan and Tennessee.    The opinion in a valuable primer in choice of law issues in UCC cases as well as how failure to strictly comply with state statutes can lead to loss of lien priority.   Fishback Nursey, Incorporated v. PNC Bank, National Association, Case No. 18-10090 (5th Circuit 4/10/19).

What Happened

 BFN Operations, LLC was a wholesale grower of trees, shrubs, and other plants, with headquarters in Texas and offices in Michigan, Oregon and Tennessee.   

PNC held a blanket lien in the debtor's assets which pre-dated the claims of two vendors to the debtor, Fishback and Surface.

Fishback sold agricultural products to the debtor and filed UCCs in Oregon, Michigan and Tennessee.   It listed the debtor as BFN Operations, LLC abn Zelenka Farms.  It also filed a notice of lien in Oregon.

Surface filed a UCC in Michigan using the name "BFN Operations, LLC abn Zelenka Farms.

When BFN filed chapter 11, PNC extended debtor-in-possession financing which would outrank other liens "subject and junior only to . . . valid, enforceable, properly perfected, and unavoidable pre-petition liens."

Fishback and Surface filed suit against PNC in the U.S. District Court for the Northern District of Texas seeking a declaration that their liens were superior to those of PNC.

The District Court ruled that applicable choice of law rules dictated that the law of the states where the agricultural products were shipped should govern the lien perfection and priority dispute.  It then found that PNC had the prior lien because Fishback and Surface had failed to properly perfect.

The Court's Ruling

The first thing that the Fifth Circuit had to do was decide whether the District Court correctly determined that the law of the states where the agricultural products were shipped would apply.  The Court noted that choice of law could be applied based upon either the law of the forum state or under federal choice-of-law rules.   This is an open question in the Fifth Circuit.  The District Court found that it did not have to pick a side because both answers pointed to the states where the ag products were shipped.   The Fifth Circuit agreed.   Under the Texas UCC, if farm products are located in a jurisdiction, the local law of that jurisdiction applies to perfection, the effect of perfection and the priority of an agricultural lien on farm products.   Tex.Bus.&Com. Code Sec. 9.302.   Federal law relies on the Restatement (Second) of Conflicts of Law Sec. 251(2) which provides that absent "effective choice of law by the parties" the court should give "greater weight . . . to the location of the chattel at the time that the security interest attached."

Fishback argued that Oregon law should apply because its contracts contained a choice of law provision selecting Oregon law.  However, those provisions were included in a contract between the Debtor and Fishback.  As a result, they were not binding on PNC.

Each of the laws of the forum states had some quirky provisions.   In  Michigan and Tennessee, a UCC must be filed based on the debtor's name exactly as it appears on the public documents creating the entity.  In this case, the company's legal name was BFN Operations, LLC, not BFN Operations, LLC abn Zelenka Farms.   This may seem like a trivial distinction given that the name given was correct but added extra verbiage.   However, the Court found that it was "undisputed that, under the strict search logics in these states, searching with BFN’s correct name would not uncover the incorrectly named liens."    While this seems foolish, the states set out their search logic in regulations adopted to implement the UCC and that search logic would not catch the longer name.

Oregon was a different matter.  Agricultural liens in Oregon are automatically perfected until 45 days after the debt is due.  After that date, the party must file an extension supported by an affidavit.  Fishback did file an extension but it was not within the 45 day window so that PNC's lien jumped in front of its.  Fishback argued that its UCC filing met the requirement for the affidavit, but the Fifth Circuit found that it lacked the requisite information and would be misleading as an affidavit.

Takeaways

As bankruptcy lawyers, we are usually called in after the filings have been made and the lien perfection facts have been established.   Therefore, the biggest lesson for bankruptcy lawyers is that when dealing with multi-state perfection issues, there may be room to look for strategies to upset other parties' lien expectations.   

When dealing with the front end of a transaction, it makes good sense to consult with a local lawyer to find out the quirks in local lien law, whether it is the UCC or mechanics liens or real property mortgages.  One consequence of our federal system is that despite the efforts to draft uniform laws, states are perfectly free to implement traps for the unwary.