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.