Mediation in Consumer Bankruptcy Cases

TV lawyers are constantly heading into trial, sometimes after seeing the file for the first time that morning. On television, the clients never seem to worry about how they are going to pay their lawyers to go to trial. The reality is different in real life, especially when dealing with consumer bankruptcy cases. A consumer debtor seeks a fresh start because their finances are at their breaking point. When a litigation matter pops up, it stands in the way of the fresh start. 

     Consider the following scenarios:

•    Chapter 13 debtor files bankruptcy to save the family homestead. The loan has gone through five different servicers in the past three years. The current servicer claims arrears of $20,000.00 while the Debtor swears that she is only two payments behind.
•    A home remodeling contactor files bankruptcy. A customer files a non-dischargeability action claiming that hundreds of thousands of dollars were diverted to other projects. The contractor’s records are less than pristine but he claims all of the funds went project and that it was the change orders that caused the job to go over budget.
•    A debtor moves to Texas and invests $2.5 million in a lakefront home. 1,210 days later, his former attorney who he stiffed for hundreds of thousands of dollars in legal fees files an involuntary bankruptcy petition against him seeking to take advantage of the limitation on homesteads acquired within 1,215 days under 11 U.S.C. §522(p). The Debtor claims that he has more than twelve creditors so that a single creditor cannot put him into bankruptcy. However, a contractor who he stiffed on building his boat dock and the cable company join in the involuntary petition. The debtor disputes both of these debts.
•    A once successful businessman becomes enmired in litigation after he kills a child in an accident that occurred when he looked down to send a text on his phone. His insurance carrier provides a defense but under a reservation of rights. As the litigation drags on, he sells off his non-exempt assets to business associates and relatives on favorable terms. He then agrees to a divorce where his wife gets the remainder of his valuable assets, and he is left with only over encumbered assets. The U.S. Trustee objects to the discharge under 11 U.S.C. §727.

These scenarios illustrate some common circumstances which arise when consumer cases are a good fit for mediation:

•    One or both parties lack funds to litigate a case.
•    The facts or the law do not allow for an easy resolution, such as submitting the case to the court on stipulated facts.
•    The consequences of a loss may be devastating to one party or both.
•    Collection may be difficult without the other party’s cooperation.
•    There may be overlapping business and consumer issues, such as when a business owner files bankruptcy after a business failure.
•    There may be intense emotions involved such as when a consumer believes that they were swindled by a building contractor, or a loan servicer can’t or won’t account for payments made.

When is a consumer dispute appropriate for mediation?
 

    Mediation is a possible means to avoid a trial. If a dispute can be easily resolved, there is not a strong need for mediation. There also need to be parties willing to bargain in good faith. Usually this means that both parties understand that there is an element of risk to the case. Sometimes it may be too early to mediate a case if both parties are convinced, they have a 100% chance of winning. Good lawyers can help to counsel their clients to prepare them for mediation. There are some difficulties with mediating an objection to discharge under section 727. Those will be discussed in a separate topic.
 

The special problem of section 727.
 

    Mediating a complaint to deny or revoke a discharge requires special consideration. Some courts have held that an objection to discharge cannot be settled. As one early case stated:

Nothing in the Bankruptcy Code authorizes a trustee to seek funds from a debtor or to release a non-debtor entity as a price for giving up on a discharge complaint. Discharges are not property of the estate and are not for sale. It is against public policy to sell discharges.

In re Vickers, 176 B.R. 287, 290 (Bankr. N.D. Ga. 1994). It is a violation of criminal law if a person “knowingly and fraudulently gives, offers, receives, or attempts to obtain any money or property, remuneration, compensation, reward, advantage, or promise thereof for acting or forbearing to act in a case under title 11.” 18 U.S.C, §152(6). Thus, if a creditor brought a complaint to deny discharge and offered to dismiss the case if the debtor paid him $50,000, that would be a criminal act. The fact that the offer was made in the context of a mediation would not change that.

    However, there are circumstances where a case can be settled at mediation after a complaint to deny discharge has been brought. The most common is where a creditor brings both a complaint to determine non-dischargeability and a complaint to deny discharge. If the creditor settles the non-dischargeability case, it will have little motivation to continue to pursue an objection to discharge for the benefit of the other creditors. In this instance, it is permissible for the original creditor to dismiss the objection to discharge provided that other creditors are given a reasonable opportunity to step in and pursue the complaint. Hass v. Hass (In re Hass), 273 B.R. 45 (Bankr. S.D. N.Y. 2002). Another court found that a trustee could compromise a claim to deny discharge where the trustee would have difficulty proving the complaint and the settlement was in the public interest. In re Myers, 2015 Bankr. LEXIS 2935 (Bankr. N.D. Ohio 2015).   On the other hand, the court denied a proposed compromise where the allegations were serious and could be proven by the trustee. 

The Court stated:

Compromises of § 727 claims are viewed with heightened scrutiny. Section "727(a) is directed toward protecting the integrity of the bankruptcy system by denying discharge to debtors who engaged in objectionable conduct that is of a magnitude and effect broader and more pervasive than a fraud on . . . a single creditor." Accordingly, some courts have held that § 727 claims may never be compromised.  At the very least, courts view compromises of § 727 claims with heightened scrutiny.

In re Roquemore, 393 B.R. 474, 483-84 (Bankr. S.D. Tex. 2008).  

Another way to settle a complaint to deny discharge is to deny the discharge with the agreement that the trustee would not object to a subsequent attempt to discharge the debt in chapter 13 if a significant amount was to be paid to creditors. A person who has been denied a discharge in chapter 7 would not be prohibited from seeking a discharge in a subsequent chapter 13 case as shown by the fact that the chapter 13 discharge does not contain an exception for debts excluded from discharge in a prior chapter 7 case. Under 11 U.S.C. §523(a)(10), the discharge does not extend to a debt that was or could have been listed or scheduled by the debtor in a case in which the debtor waived or was denied a discharge. The chapter 13 discharge under 11 U.S.C. §1328(a) excludes various debts from its scope, including debts which are non-dischargeable under 11 U.S.C. §523(a)(1), (2), (3), (4), (5), (8) and (9) but does not cover section 523(a)(10). See In re Ault, 271 B.R. 617 (Bankr. E. D. Ark. 2002)(holding that prior denial of discharge in chapter 7 was not grounds for denying confirmation of chapter 13 plan based on lack of good faith).

 Is court approval necessary to conduct mediation?
 

    As a general rule, private parties do not need court permission to mediate. A requirement to mediate may also be part of a scheduling order so that no further approval would be necessary. However, there are other circumstances where court approval is required. If the parties intend to use a sitting judge as a mediator, it will be necessary to obtain an order appointing a judicial mediator. If the trustee is going to be a party to a mediation, it is good practice to seek permission, especially if the trustee will be paying a share of the mediator’s fee. The parties should also seek court permission to mediate if it requires changing an existing scheduling order. Finally, it is good practice to request permission to mediate if a particular judge is skeptical of mediation as occurred in the attached article “Over my dead body” bears out.

Selecting a mediator.
  

  If the parties cannot afford to litigate, they may not be able to afford an expensive mediator. Additionally, when mediating bankruptcy issues, a good general litigator may be out of his depth. In many districts, sitting bankruptcy judges will agree to mediate for their colleagues. This has the advantage of providing a mediator for no additional charge since the judge is already receiving a federal salary. A sitting judge brings gravitas to the mediation. Also, in many cases, there is a strong need for a client to tell their story. Being able to tell your story to a judicial mediator may provide catharsis to a party and make settlement possible. If a bankruptcy judge is not available, an experienced and respected consumer practitioner may be willing to act as mediator on a pro bono basis.

    There are some cases which may require a paid mediator. For example, in a national consumer class action against a sophisticated creditor, a highly skilled and well-paid mediator may be absolutely necessary. There are other circumstances where a client will take the mediation more seriously if they are paying something to mediate.
 

Preparing for the mediation.

   The pre-mediation conference between the mediator and the attorneys and the mediation statement can be very helpful in preparing for mediation. Difficult lawyers and difficult clients can make for a difficult mediation. The mediator can use the pre-mediation conference to gauge the ability of the attorneys to work together cooperatively. While many attorneys like to use their mediation statement to litigate their case, this is of limited benefit to the mediator (other than perhaps revealing where one side has unrealistic expectations). Instead, a mediation statement which explores the strengths and weaknesses of the case as well as the personal dynamics of the parties will be much more useful.
 

    The pre-mediation session is also useful in setting expectations for the mediation. If one party has childcare issues, it is better to have talked this through ahead of time rather than having one party leave midway through.

General Sessions.

 Mediators differ on whether general sessions can be helpful. In a case where one attorney insists on posturing, a general session may cause the other side to become defensive and resistant to making a deal. One of the most difficult mediations I ever participated in involved a trustee’s attorney who gave a two-hour PowerPoint explaining how the debtor had already lost the case and should prepare to give up while my client and I glared at him. Where there is a high level of animosity between the parties (or even the attorneys) putting them together in the same room may cause conflict and set back the ability to bargain.
 

    There are some cases where a joint opening session may be useful. Where one party wishes to make a sincere apology and the other side is not likely to react with disgust or disbelief, a joint session may be helpful. The same may be true where the aggrieved party has a deep-seated need to tell the other party how they have been hurt and the harming party is willing to listen respectfully. Of course, this is fraught with peril and should require the consent of both lawyers. When in doubt it is better to skip the joint session. 

Conducting the mediation.

    In most respects consumer mediation is like any other mediation. A mediator will use the tools to their advantage to help the parties achieve a solution. Some of the skills a mediator may use include:

•    Finding out the true interests. While the parties may lay out their goals in the mediation statement, this may not be the same as their interests. In a dispute between family members, the aggrieved party’s interest might be in repairing feelings that mom liked the black sheep son better and that a piece of jewelry given to the daughter-in-law may be highly emotional. In a case where the husband’s liability is pretty certain, the husband’s interest may be in protecting his wife (or vice versa).
•    Setting expectations. If a creditor believes that a non-dischargeable judgment means that the judge will “make” the defendant pay, discussing what it means to have a judgment may be useful.
•    Exploring BATNA. In any mediation, there is a choice between making a deal or not making a deal. This involves looking at the Best Alternative to No Agreement. If the creditor’s best alternative to no agreement is foreclosing on a home with serious deferred maintenance in a bad neighborhood, it might be more inclined to make a deal where the debtor keeps the home. If a retiree’s best alternative to no agreement is that the creditor will take a judgment that will be uncollectible because all of the debtor’s assets are exempt and his income comes from social security, liquidating non-exempt property to avoid a judgment may not be a good bet.
•    Exploring options. Parties entering a mediation may be laser focused on how the dispute can be resolved. However, if they start to hit dead ends, encouraging the parties to think creatively about other options may be helpful. Sometimes the parties or the attorneys may think of an option that wasn’t apparent when the mediation started. Other times, the solution that one party thought was obvious might not interest their opponent and it may be necessary to consider other possibilities.
•    Getting the parties to bargain. Mediation where the parties spend the first eight hours fuming at the mediator may not be a case that is going to settle. The sooner the parties can begin exchanging offers, the sooner the mediator and the parties can tell how much ground they have to cover. There is a rhythm to mediation. When parties being exchanging offers, they may start to see the possibility of an agreement. A resolution that was unthinkable at 9:00 a.m. may be a possibility once the parties have covered some ground.

Writing up the agreement.
 

    Writing up the agreement is the most important part of the mediation. As one mediator put it, “an agreement that’s not in writing isn’t worth the paper it isn’t written on.” Letting the parties leave the mediation with an agreement in principle is an invitation for seller’s regret or bad faith attempts to retrade the deal.
 

Experienced mediators will often have a template for an agreement that can be filled in with the specific terms of the deal. There are some basics that will apply in all agreements, such as that the parties mediated, whether the agreement will be subject to court approval and what law will govern the agreement.
 

Once a draft agreement is prepared, all of the attorneys and parties need to take the time to review it and offer comments. Drafting the agreement will often bring to light details that the parties haven’t thought about and need to discuss further in order to get a binding agreement. The mediator needs to take the agreement through as many drafts as it takes to get approval in writing from all of the parties.
 

One issue to consider in drafting an agreement is whether it will require court approval. An agreement to settle a non-dischargeability complaint in a chapter 7 case should not require court approval since it only involves claims between private parties. The following disputes will require court approval at a minimum:
 

•    Any action to which the trustee is a party.
•    Any action which affects the creditors generally, such as whether to grant or deny a discharge or allowance of exemptions.
•    Any agreement which will be incorporated into a plan (although the plan approval process should be sufficient without a separate motion to compromise).

If an agreement requires court approval, the written settlement agreement should provide that the parties are bound to the agreement subject to court approval and that the parties are required to seek court approval. Otherwise, a bad faith actor could use the requirement of court approval to attempt to re-trade the deal. 

This paper was originally presented to the ABI Spring Meeting in April 2024.