A Texas Bankruptcy Lawyer's Blog

Nice Explanation of Excusable Neglect

2012-01-24T12:58:00.003-06:00

There is nothing quite like the horror of realizing that a deadline has been missed. As the heart pounds at the thought of notifying client and carrier, the mind should shift to damage control. Was this a deadline which could be extended after the fact based on excusable neglect? O'Brien v. Harnett, Adv. No. 11-5010 (Bankr. W.D. Tex. 1/19/12), which can be found here, is a nice addition to the jurisprudence of excusable neglect.

The point is that the notion of “excusable neglect” of necessity presumes that someone has made a mistake, someone has been careless, someone has been negligent. It is no answer, then, to a request for mercy that the party making the request should not have made the mistake. Hindsight always affords the clarity that confirms that, had the person simply been paying strict attention, no mistake would have been made. The reality is that human beings often are not paying strict attention all the time. Not even lawyers.

***

Of course it was a mistake for counsel not to then go back to the docket to confirm the entry of the order itself. Hindsight, as we have seen, makes us all perfect (or seem that we should have been). But his secretary was out of the office, it was the week between Christmas and New Years, and thus counsel, as most people in that time period tend to be, was more distracted than usual. (emphasis added).

Opinion, p. 4.

This opinion is not only a handy resource to use in making pleas for mercy in the case of inadvertently missed deadlines, but is also a good commentary on human nature. Anyone can be perfect in hindsight. However, the reality is that we don't always pay attention as well as we could and that condition is magnified during the holidays. Thank you, Judge Clark, for saying it.

Yet Another Hanging Paragraph Creates a Taxing Situation

2012-01-20T18:19:00.005-06:00

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A pair of new opinions suggests that dischargeability of taxes is even more complicated subsequent to BAPCPA. In Matter of McCoy, No. 11-60146 (5th Cir. 1/4/12), which can be found here, the Fifth Circuit found that, under Missisippi law, late filed returns did not constitute "returns" at all and thus were not subject to being discharged. In In re Hernandez, Adv. No. 11-5126 (Bankr. W.D. Tex. 1/11/12), which can be found here, Judge Leif Clark found that returns filed after the IRS made its own assessment on unfiled returns were not subject to discharge either. While these decisions may be consistent with the prevailing sentiment, they are not necessarily rooted on solid legal reasoning.

The Other Hanging Paragraph

One of BAPCPA's legacies will be the hanging paragraph, a piece of text hanging by itself which is not part of a specific subsection. We are reasonably familiar with the hanging paragraph of Section 1325(a)(*) which has to do with the valuation of vehicles in chapter 13 cases. Now, six years after BAPCPA took effect, a new hanging paragraph has been discovered, Section 523(a)(*), having to do with dischargeability of taxes. While dischargeability of taxes is dealt with in Section 523(a)(1), which would have been a logical place to put the additional language, Congress saw fit to add a codicil to Section 523(a)(1) at the end of Section 523(a). The new language states:

For purposes of this subsection the term "return" means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to ajudgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law.

Why do we care about the definition of return? Section 523(a)(1)(B) states that a debt is not dischargeable "with respect to which a return . . . was not filed or given; or" was filed "after two years before the date of the filing of the petition."

Prior to BAPCPA, a return could be filed late but at least two years before bankruptcy and still be dischargeable.

However, under the new jurisprudence, some late returns, even if filed more than two years before the date of the petition, are not returns at all.

Going to Mississippi

Linda McCoy, a resident of Mississippi, filed bankruptcy. Mississippi is one of those states that are not Texas which have a state income tax. (While most states have state income taxes, it is an unwritten law here in Texas that proposing a state income tax is a sacrilege on the same level as urinating on the Alamo). Linda McCoy did not file her state income tax returns for 1998 and 1999 when they were due. She did ultimately file her returns, but she filed them after the date they were due.

The Fifth Circuit held that under Mississippi law, a "return" meant a timely filed return. Therefore, a late return constituted an unfiled return and could not be discharged.

Turning to Texas

A few days later Judge Leif Clark interpreted the hanging paragraph of section 523(a)(*) in the context of federal taxes in Texas. (Have you ever noticed that "taxes" and "Texas" contain most of the same letters. It seems subversive since Texans hate taxes--just ask Rick Perry). The Hernandez decision involved a lot of years of taxes. The Debtor did not file timely returns for 1999 through 2006, although he eventually got them all filed. For the seven years in question, the IRS assessed liability for three years before the Debtor got around to filing returns. For the other four years, the IRS either did not get around to making assessments before the returns were filed or no taxes were due.

The IRS did not contest dischargeability for the years in which the Debtor filed his returns prior to taxes being assessed or where it acknowledged that no taxes were due. However, for the three years in which assessments preceded returns, it contended that the taxes could not be discharged--and the court agreed.

The Rationale

Prior to BAPCPA, the term "return" was not defined. Case law held that "a late filed return that required the government to assess the tax without the tax payer's assistance would not be treated as a return for section 523 purposes." McCoy, at 5. In order to constitute a "return" under prior law, it had to satisfy four requirements:

1. It had to purport to be a return;
2. It had to be executed under penalty of perjury;
3. It must contain sufficient information to allow calculation of the tax; and
4. It must represent an honest and reasonable attempt to satisfy the requirements of the tax law.

The new hanging paragraph replaced the old test with three guidelines:

1. The return must be a "return that satisfies the requirements of applicable nonbankruptcy law (including filing requirements);"
2. It would include a return "prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal; and
3. It would not include "a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law.

The Mississippi State Tax Commission argued that under the first factor an untimely return was not "a return that satisfies the requirements of applicable bankruptcy law (including filing requirements)." The Debtor argued that MSTC's construction would read the reference to section 6020(a) out of the statute. As acknowledged by the Fifth Circuit, returns under section 6020(a) involve cases in which the Debtor fails to file an actual return but nevertheless provides the IRS with all of the information necessary to calculate the liability.

The Fifth Circuit adopted MSTC's reasoning stating:

We find MSTC''s interpretation of section 523(a)(*) more convincing. We have previously explained that "the plain language of the [Bankruptcy] Code should rarely be trumped. Although the Code at times is 'awkward, and even ungrammatical . . . that does not make it ambiguous." (citation omitted). The plain language interpretation of section 523(a)(*) comports with this admonition.

McCoy at 8-9. The Court went on to find that returns prepared under section 6020(a) constituted a narrow exception to the rule that late filed returns were not returns. It also referred to other courts which have reached the same result.

The Hernandez Court did not significantly expand upon the Fifth Circuit opinion, stating:

Anticipating consistency on the part of the circuit court, this court concludes that late-filed returns cannot be treated as filed, for purposes of section 523(a)(1), save for returns that comport with the requirements of section 6020(b)(sic) of title 26. The exception is a narrow one, and does not apply on the facts of the case sub judice. [Ed. The correct statutory reference was section 6020(a). The court corrected the cite in an errata to the opinion].

Hernandez at 9.

If Every Other Court Jumped Off a Building Would You Join Them?

The Courts following the majority interpretation of section 523(a)(*) show a lemming-like ability to follow the crowd without careful thought. Section 523(a)(1)(B) provides that taxes are not dischargeable in two instances:

1. Where a return was not "filed or given;" or
2. Where the return "was filed or given after the date on which such return, report, or notice was last due, under applicable nonbankruptcy law or under any extension, and after two years before the date of the filing of the petition.

Thus, section 523(a)(1)(B) has two components to it: a substantive one and a temporal one. If no return was filed, then the tax cannot be discharged. However, if the return was filed at least two years before bankruptcy, even if it was not timely filed, it could be discharged (assuming that the other requirements for dischargeability are met).

The McCoy decision does not state when the returns were actually filed. However, In Hernandez, the Court's finding of fact explicitly recite that the returns for 1999, 2003 and 2004 were each filed more than two years before the petition date. Thus, Hernandez raises the Catch-22 situation in which a return filed at least two years before bankruptcy may be subject to discharge but a return filed one day late is not a return at all.

To be blunt, McCoy and Hernandez obliterate section 523(a)(1)(B)(ii) by stating that late-filed returns, much like disgraced party members in the former Soviet Union, are non-returns. (In the Soviet Union, party members who had fallen from favor would be erased from photographs and treated as though they had never existed). Why would the statute allow for returns filed more than two years prior to bankruptcy to be considered when all late filed returns would necessarily be considered non-returns? The obvious answer is that the hanging paragraph was meant to address the question of whether the document submitted was sufficient to constitute a return rather than whether it was a timely return. The reference to "filing requirements" in the hanging paragraph is best understood as a reference to whether the document was filed rather than when it was filed.

The language of the hanging paragraph reinforces the interpretation that it was meant to be a substantive rather than a temporal requirement. Under the hanging paragraph, "a written stipulation to a judgment or final order entered by a nonbankruptcy tribunal" would constitute a return. Thus, if a Debtor who filed nothing and waited for the taxing authority to initiate suit , but then agreed to the assessment would have been deemed to have filed a return. On the other hand, if the debtor filed his return one day late and the ever-vigilant taxing authority made its assessment in the intervening hours, the return would cease to exist. This makes no sense.

I may be missing something profound or obvious. However, these decisions appear to be just plain wrong.

Hat tip to Michael Baumer who got the word out on these decisions on the State Bar of Texas Bankruptcy Section listserve. Michael is a smart guy and caught the importance of these opinions before I did.

Best of the Rest

2012-01-01T10:21:00.008-06:00

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Every year, I read more cases than I have time to blog about. Here are some cases that I meant to write about but didn't have the time. My inability to get to these cases is demonstrated by the fact that I am concluding my year-end clean-up on January 2nd, two days into the new year.

Philadelphia Newspapers:

River Road Partners v. Amalgamated Bank, 651 F.3d 642 (7th Cir. 2011), cert granted, RadLAX Gateway Hotel, LLC v. Amalgamated Bank, No. 11-166 (2011). The Supreme Court has granted cert to resolve the Philadelphia Newspapers issue of whether a debtor can deny a creditor's right to credit bid in a plan by offering the creditor the "indubitable equivalent." The Third Circuit said yes. The Seventh Circuit said no. You can access all the relevant documents at SCOTUS Blog here.

Gifting and Bad Faith:

In re DBSD, North America, Inc., 634 F.3d 79 (2nd Cir. 2011). The Second Circuit held that "gifting" where a senior class of claims gives up property in favor of a junior class violates the absolute priority rule where an intervening class of claims is skipped. The Court also held that votes of a competitor could be designated as cast in bad faith.

Collateral Attacks on Plans:

Matter of Davis Offshore, LP, No. 09-41294 (5th Cir. 7/16/11), which can be found here.

Chapter 11 cases are frequently criticized for languishing in the courts. However, this prepackaged chapter 11 case proceeded to confirmation in less than a week, resulting in a sale to a group which included a member of the family which owned the companies. Unfortunately, that is when the bickering began. Although no party appealed the confirmation order, one of the former shareholders filed a motion to revoke confirmation under 11 U.S.C. §1144. The bankruptcy court determined that no fraud had taken place. The district court vacated the bankruptcy court’s order but dismissed the appeal due to equitable mootness. Rather than appealing this decision, the former shareholder then sued the purchasers for fraud. The bankruptcy court found that the fraud suit was an impermissible collateral attack on the confirmation order. A direct appeal to the Fifth Circuit was authorized.

The Fifth Circuit, in an opinion by Chief Judge Edith Jones affirmed the bankruptcy court. The following passage captures the essence of the opinion:

The principal question posed on appeal is whether the Plan and confirmation order bar the assertion of fraud claims against the defendants/appellees. This is an issue of perennial importance in bankruptcy procedure. Bankruptcy cases must be and often are resolved in haste to prevent the continuing depletion of a debtor’s value and assets. Haste, however, creates the danger that inadequate supervision of deals, valuations, and participants in the process may occur, leaving a fertile field for fraud. To this extent, the demands for finality and integrity in the process may be in tension. In some situations, fraud and related claims may outlive the bankruptcy process. (citation omitted).

We conclude that in this case, in the context of reorganizing a family owned company all of whose shareholders had access to sophisticated financial and legal assistance, and where the releases and exculpatory provisions in the Plan and confirmation order were essential to a reorganization that no party appealed, those provisions bar the (Appellant’s) current claims.

Opinion, pp. 3-4. This case goes to show that when you push to get a deal done quickly, you may be stuck with results that you don’t like.

Section 502(b)(6):

In re Dronebarger, No. 10-10889 (Bankr. W.D. Tex. 1/31/11), which can be found here. This case is significant as the maiden opinion from Judge H. Christopher Mott, who took the bench in October 2010. The issue was whether the guarantor of a lease could take advantage of the cap on damages resulting from lease termination under section 502(b)(6). In a forty page opinion, the Court said no. The Court's primary reasoning was that section 502(b)(6) was limited to damages arising from termination of a lease. Here, the damages arose from failure to repair the property during the pendency of the lease, not from termination of the lease. As a result, he distinguished the case from In re Mr. Gatti's, Inc., 162 B.R. 1004 (Bankr. W.D. Tex. 1994), where the damages resulted from rejection of the lease in bankruptcy. He also ruled that a guarantor could not take advantage of the cap because his liability arose under a guaranty rather than under the lease. The opinion has an excellent discussion of section 502(b)(6) and should be must reading for any party litigating under that section.

Disclosure: My firm became co-counsel to the Debtors subsequent to the court's opinion. We were not involved in the claims issue. Another interesting historical note is that Eric Taube represented the landlord in both Mr. Gatti's and Dronebarger. I represented the Debtor in Mr. Gatti's.

Fraudulent Transfers:

In re Wren Alexander Investments, LLC, No. 08-52914 (Bankr. W.D. Tex. 2/17/11). You can find the opinion here. This case goes to show that not all second acts are for the better. Charles Pircher is a former banker who went to prison during the bank scandal of the 1980s. After prison, he managed a series of professional employee organizations which minimized workers compensation costs by forming new entities to take advantage of lower rates given to new companies. The PEOs were supposed to pay wages and remit taxes to the government. They failed to accomplish the latter, resulting in a large IRS tax liability.

One of the PEOs acquired a ranch in Medina County, Texas. It proved to be a good investment because it was purchased for $630,000 in 1999 and was sold for $5,250,000 in 2009. Pircher used money from the PEOs to build a 10,000 square foot house, a 12,000 square foot horse stable and a 39,000 square foot quarter horse arena. While Pircher said that he had an informal agreement to pay the money back at some point, no documents were drafted and he paid no rent.

The first owner of the property, United Capital Investment Group, Inc., took out a hard money loan to pay off the original purchase price, to build improvements on the property and to pay Pircher's criminal restitution obligations. When the IRS started filing tax liens against the PEOs, Pircher transferred the property to Medina Heritage, Ltd., an entity he controlled. While the deed was dated prior to the filing of an IRS tax lien, it was not recorded until afterwards. The consideration for the transfer was assumption of the existing liabilities on the property.

The property was then transferred to Wren Alexander Investments, Ltd., the debtor in this case. Wren Alexander was controlled by a close business associate of Pircher's. The purchase price was the amount necessary to pay off the existing liens (although not the tax lien). Pircher's stated intent in selling the property was to get it out of his name while retaining control. The IRS filed a nominee lien against Wren Alexander Investments, Ltd.

Wren Alexander filed chapter 11 and the property was sold. The Debtor filed an objection to the claim of the IRS. The principal issue was whether the tax lien was valid against the transferee of the property. Judge Ronald King has an excellent discussion of Texas fraudulent transfer law. Judge King found that the transfer from United Capital to Medina Heritage was a fraudulent transfer because the property was sold for less than reasonably equivalent value while insolvent. The found that this provision could not be used to avoid the second transfer because the IRS was not an existing creditor of Wren Alexander. However, he did find that the transfer could be avoided as one made with actual intent to hinder, delay or defraud. The result was that the IRS received the remaining proceeds in the amount of approximately $1.2 million.

Avoiding a Foreclosure Sale:

Munoz v. James S. Nutter & Co., Adv. No. 10-3039 (Bankr. W.D. Tex. 2/22/11), found here.

The Munoz case involved the situation of a bankruptcy being filed after a foreclosure sale had been conducted but before the deed was recorded. The Court found that the debtors could not use the strong arm powers under section 522(h) because the recorded deed of trust would have placed a prospective purchaser on inquiry notice. The opinion is memorable for the following passage:

What a difference a day can make. This case presents a regrettable situation where Plaintiffs’ bankruptcy petition, for whatever reason, was filed one day late and Plaintiffs’ home was foreclosed upon before the bankruptcy. Thankfully these occurrences are infrequent, as the result can be disastrous to a debtor who can lose the opportunity to save their home. With the right set of facts and proof, the bankruptcy laws can provide relief to “undo” a pre-bankruptcy foreclosure, but the mountain that must be climbed is very technical and extremely steep. Few debtors have been successful in reaching the summit of this mountain and setting aside a foreclosure sale that occurred prior to the bankruptcy filing. Although this Court is extremely sympathetic to Plaintiffs’ plight, in this case it is unable to “reverse” the foreclosure and give Plaintiffs back their home.

Plaintiffs’ attempt to set aside the foreclosure sale under the “strong-arm power” of §544 must be denied as a hypothetical purchaser on the date of Plaintiffs’ bankruptcy filing would not have “bona fide purchaser” status under §544(a)(3) of the Bankruptcy Code and Texas state law. Plaintiffs also did not meet their burden of proof under §544, and for these reasons and those set forth in this Opinion, Plaintiffs may not avoid the foreclosure sale transfer of the Property to Navar under §544(a)(3).

Opinion, pp. 36-37.

Homestead Exemption on a Golf Course:

In re Schott, No. 10-54276 (Bankr. W.D. Tex. 3/15/11), found here.

Many golf widows may feel that their husbands live at the golf course. However, in this case involving a Texas homestead exemption, the debtor literally did live in the clubhouse (at least for a period of time.). When he filed bankruptcy, he claimed the golf course as his homestead and a creditor objected.

The court found that the property was rural and that the debtor had not abandoned the homestead. Therefore, the question was whether he could claim some of all of the property as homestead. The property consisted of two tracts separated by a county road.

Judge Leif Clark noted that under Texas law, where a rural homestead consists of two noncontiguous tracts, one tract must be used as a residence and the other tract must be used for the “comfort, convenience or support of the family.” The tract containing the clubhouse qualified as a residence. However, the tract containing the golf course did not fit within the definition of a homestead.

The court found that the debtor “does not play or even enjoy golf,” that he sometimes likes to take walks on the golf course and that he had intended to develop the property as a resort. While the term “comfort, convenience or support of the family” is a broad one, taking occasional walks on the property was not sufficient.

Non-Dischargeability Among Friends:

Turbo Aleae Investments, Inv. v. Borschow, Adv. No. 09-3005 (Bankr. W.D. Tex. 4/8/11), which can be found here. Judge Mott succinctly described the dispute in this case when he stated:

This case illustrates what can happen when a friend loans money to another friend, and then the relationship turns sour when the friend cannot repay the loan.

Opinion, p. 1.

The opinion contains a lengthy recitation of the conflicting narratives of the parties, highlighting that many of the critical terms were never reduced to writing.

The court distinguished between false pretenses and actual fraud, noting that earlier cases considered these two grounds for nondischargeabiilty under section 523(a)(2)(A) to have separate elements, while more recent Fifth Circuit cases pointed to a single test. The court rejected a claim of false pretenses on the basis that, if it still existed as a separate ground for nondischargeability, it required a false statement about current or past facts, not actions to be performed in the future.

The opinion is a good case study in how to prove or defend a non-dischargeability case. There were two main contentions made: 1. that the debtor lied about intending to use the loan proceeds to pay off a prior secured debt; and 2. that the debtor lied about intending to use the loan proceeds to pay off a debt owed to a related party to the lender.

In the case of the first representation, the court found insufficient evidence that the representation was made. The first time the representation was mentioned in writing was in an email after the fact. Although the stated reason for wanting the prior debt paid off was to obtain a security interest in the company's equipment, the loan documents did not provide for a security interest. Additionally, the lender did not inspect the equipment or attempt to determine its value. Finally, the lender acted inconsistently by referring the debtor to Chase Bank to get a loan to pay off the prior debt. As Judge Mott concluded:

While the Court is sympathetic to Turbo and believes that Omar and Ernest likely thought Allen should have used the money to pay off the SNB loan, after weighing the evidence and testimony, the Court concludes that Turbo has failed to show that Allen obtained the loan proceeds through actual fraud by falsely representing he would use the loan proceeds to pay off the SNB loan.

Opinion, p. 27.

On the other hand, the plaintiff's did show that the debtor committed fraud with regard to the second representation. The lender initially wanted to withhold the funds and pay them directly to the related party. The debtor said that he needed to receive the funds directly "for accounting purposes." However, when he received the funds, his business account was so far overdrawn that there were no funds left to repay the related party.

The differing outcomes between the two claims demonstrates that parties are rarely completely honest or completely devious, but that the truth is largely a combination of shades of gray.

In a very brief passage, the Court denied attorney's fees to the plaintiffs, noting that:

The Court also determines that each party shall bear their own attorneys fees and expenses. Specifically, the Court finds that the loan at issue is not primarily consumer debt, and that the positions of parties in this proceeding were substantially justified. Thus, awarding attorney fees is not appropriate in this case. See 11 U.S.C. §523(d).

Opinion, p. 37. Section 523(d) allows the court to award attorney's fees against a creditor who unsuccessfully seeks a determination of nondischargeability on a consumer debt and asserts a position that is not substantially justified. In this case, the debts involved were business debts so that the debtor could not have recovered attorney's fees. However, the court appears to be using the principles of section 523(d) by analogy to deny recovery of attorney's fees in a business dispute where each side offered positions that were substantially justified. I would have preferred to see the Court invoke the American Rule that each side pays its own fees in the absence of specific authority for fee-shifting. However, the court's ruling roughly adheres to this standard.

The take-away from this case is don't loan money to friends if you can't afford to lose the money or the friendship.

Remand:

Legal Xtranet, Inc. v. AT&T Management Services, LP, Adv. No. 11-5042 (Bankr. W.D. Tex. 5/24/11), which can be found here. This was a case involving a motion to remand. The Court found that state law contract disputes were non-core proceedings subject to mandatory abstention and that disputes over the tax liability of AT&T did not qualify for even "related to" jurisdiction. The most interesting part of the opinion is the Court's lament over AT&T's successful attempt at forum shopping. Judge Leif Clark wrote:

The court is reluctant to reward AT&T’s blatant forum shopping in this case. AT&T filed a jury demand and refused to consent to a jury trial in this court in an effort to bolster its argument that the parties’ dispute could be timely adjudicated in state court: AT&T’s refusal to consent to a jury trial here meant that even if the court retained jurisdiction over the parties’ dispute, the case would have to be tried in the federal district court, assuring AT&T that it would have a different judge to hear the case. That would also almost certainly mean that the case would not likely be heard for quite some time. Furthermore, it is not entirely clear that the parties’ dispute, as it currently stands, involves any factual issues for a jury to decide – the request of declaratory relief will not go beyond the terms of the contract itself unless there is ambiguity in the agreement (or unless the contract itself is found to point outside itself for the determination or application of its terms). Thus, AT&T’s jury demand machinations appear to be nothing more than an effort to forum shop. Nonetheless, as noted above, the question is not whether the case can be more timely adjudicated in state court than in the bankruptcy or district court; the question is simply whether it can be timely adjudicated in state court. AT&T established that it could be timely adjudicated in state court, and the court’s determination to that effect did not depend upon a finding that the case could not be timely adjudicated in the district court. And there is nothing in section 1334(c)(2) that permits a court to deny relief on grounds that the effort is motivated by a desire to forum shop. Indeed, the sad truth is that the structure of bankruptcy jurisdiction actually encourages and rewards forum shopping strategies. There is little this court can about that, other than to encourage Congress to consider the consequences that seem to flow from the current structure.

Opinion, at p. 17. It seems unlikely that Congress will be moved to change section 1334(c)(2).

Till Interest Rate:

In re Village at Camp Bowie I, LP, No. 10-45097 (Bankr. N.D. Tex. 8/4/11), found here. In this single asset real estate case, the court considered, among other things, artificial impairment and
the proper interest rate for cramdown of a secured creditor.

The court found that artificial impairment standing alone was not enough to prevent a finding of good faith.

Indeed, at least one court has persuasively suggested that the drafters of the Code did not intend to create a system in which – even in a single asset real estate case – a lender could use its overwhelming share of the claims in a case to divest other creditors and equity owners of their economic interests. (citation omitted). Yet the only way around control of the reorganization by a debtor’s lender in a case like that at bar is through impairment and an affirmative vote of a class of unsecured creditors who will typically have small claims that could be readily satisfied through full payment with interest. For a debtor to have any leverage at all in such a case – e.g., in negotiations – it must be possible to look to those unsecured creditors to satisfy section 1129(a)(10).

Opinion, p. 10.

The Court also had an interest take on applying Till v. SCS Corporation, 541 U.S. 465 (2007). The court noted that under Till, the court left open the issue of whether a market rate could be set in the case where there was an efficient market for loans of the type proposed by the debtor in its plan. Because there was no such efficient market, the court determined to apply a formula approach. However, rather than using the Prime + 1-3% formula suggested by the Till Court, the Bankruptcy Court went through an elaborate approach of valuing different tranches of debt and adjusting for risk.

One of the experts (it is not clear whose) started with the five year treasury bill rate of 1.71% as a risk free rate. He then adjusted it for several factors and concluded that the rate for the first 65% of the collateral's value would be between 4.76%-5.01%. He concluded that the mezzanine rate for 65-85% of collateral value would be 13.02-14.88%. Finally, he concluded that the appropriate rate for amounts in excess of 85% of collateral value would be 18.63%. Taking all of these tranches into account and making other adjustments, he somehow came up with a blended rate of 6.25-7.75%.

The court adopted his methodology but tinkered with the assumptions to come up with a rate of 6.27-6.59%. Because the Debtor had proposed a rate of 5.83%, the Court denied confirmation with leave to file a plan providing for an interest rate of 6.4%.

Camp Bowie was a case involving a property valued at $34 million. Therefore, it might have been able to support the cost for the type of expert witness testimony used here. However, I have two concerns here. The first is that Till was supposed to provide an inexpensive and simple method for determining value. Most chapter 11 cases are small business cases which cannot afford the cost of an expert. Second, unless the Court has an advanced degree in finance (which several of the Texas bankruptcy judges do), it is likely that the competing experts will bamboozle the court which will be forced to split the difference.

In the Camp Bowie case, the Court could just as easily said prime + 3 and arrived at 6.25%, which is within .15% of the rate it reached through the elaborate calculations.

Recently, I was at a CLE seminar in New York sponsored by the Commercial Law League of America. Judge Robert Drain from the Southern District of Texas polled the room as to who represented debtors and who represented creditors. He then offered a hypothetical with choices between a prime rate + approach, a tranche approach and a there is no rate high enough approach. When only one hand went up for the prime + approach, he said, I see we've found the debtor's lawyer in the room (which was me). He then offered a very thoughtful analysis of why he thought the Supreme Court would adopt the prime + approach in a chapter 11 case.

This just goes to show that even after Till, there is still a lot of debate over how to select the cram-down interest rate.

Stern and Fraudulent Conveyances:

Kirschner v. Agoglia, Adv. No. 07-3060 (Bankr. S.D. N.Y. 11/30/11), found here. (Link will take you to the Southern District of New York Bankruptcy website. Go to opinions, then to Judge Drain to find the case).

During the past six months, practitioners have heard a lot of volume about Stern v. Marshall without getting a lot of clarity. (I plead guilty there since I have been on multiple panels and I am still trying to figure it out). Judge Robert Drain from the Southern District of New York has recently penned a very thoughtful opinion about the "firmly established historical practice" doctrine suggested by Justice Scalia in his concurrence. He noted that "the pursuit of avoidance claims has been 'a core aspect of the administration of bankruptcy estates since the 18th century.'" Opinion, at 9. He then offered a very thorough history of the ability of Article I judges to enter final judgments in fraudulent transfer cases. After all that, he found that the complaint did not state a cause of action and dismissed it as to one defendant.

The analysis that I would like to see (and would like to write some day if I had the time) would trace the origin of bankruptcy as a device to punish debtors who made fraudulent transfers. I suspect that it would show that bankruptcy law and fraudulent transfer law have been bound together since the very beginning.

Third Circuit Upholds Professional Responsibility in Age of Technology

2011-12-28T18:04:00.005-06:00

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A landmark case involving ethics and technology has reached its conclusion with an opinion from the Third Circuit Court of Appeals that an attorney cannot blindly rely on information provided by an automated system, especially when the accuracy of that information has been called into question. In re Taylor, 655 F.3d 274 (3^rd Cir. 2011). I have previously written about the bankruptcy court decision here and the district court opinion here. The Court of Appeals set the tone for the opinion with its opening statement:

This case is an unfortunate example of the ways in which overreliance on computerized processes in a high-volume practice, as well as a failure on the part of clients and lawyers alike to take responsibility for accurate knowledge of a case, can lead to attorney misconduct before a court.

In re Taylor, at 277.

What Happened

The Taylor case illustrates the problems that can arise when a consumer debtor finds himself in a battle with a faceless computer. The Taylors and HSBC had a dispute over whether flood insurance was required on the Taylors’ property. As a result, the Taylors sent in their payments minus the disputed amount. HSBC placed the partial payments into suspense until a full payment was received an imposed late fees on the payment.

When the Taylors filed for chapter 13 bankruptcy, HSBC sent a referral to the Udren Law Firm to file a motion for relief from automatic stay. The referral was processed through the NewTrak technology system. The Court of Appeals described the process as follows:

HSBC does not deign to communicate directly with the firms it employs in its high-volume foreclosure work; rather, it uses a computerized system called NewTrak (provided by a third party, LPS) to assign individual firms discrete assignments and provide the limited data the system deems relevant to each assignment. The firms are selected and the instructions generated without any direct human involvement. The firms so chosen generally do not have the capacity to check the data (such as the amount of mortgage payment or time in arrears) provided to them by NewTrak and are not expected to communicate with other firms that may have done related work on the matter. Although it is technically possible for a firm hired through NewTrak to contact HSBC to discuss the matter on which it has been retained, it is clear from the record that this was discouraged and that some attorneys, including at least one Udren Firm attorney, did not believe it to be permitted.

In re Taylor, at 278-79.

A non-lawyer employee with the Udren Firm used the information provided by NewTrak to prepare the motion for relief from automatic stay. A managing attorney at the Udren Firm reviewed the motion and authorized it to be filed under her electronic signature. The motion recited that the Debtors had not made payments for three post-petition months but added that there was a suspense balance of $1,040. The motion asserted that there was a total arrearage balance of $4,367. The motion listed a different payment amount than the amount listed in the proof of claim filed by a different firm on behalf of HSBC. Finally, the motion asserted that the Debtors had no equity in their property.

The Debtors responded to the motion and attached copies of canceled checks payable to HSBC. The Debtors also objected to the proof of claim filed by HSBC. HSBC’s counsel responded to the claims objection asserting that all amounts in the proof of claim were accurate, even though they conflicted with the numbers contained in the motion for relief from stay.

The Court had this to say about the firm’s due diligence in filing the motion:

Doyle did nothing to verify the information in the motion for relief from stay besides check it against "screen prints" of the NewTrak information. She did not even access NewTrak herself. In effect, she simply proofread the document. It does not appear that NewTrak provided the Udren Firm with any information concerning the Taylors' equity in their home, so Doyle could not have verified her statement in the motion concerning the lack of equity in any way, even against a "screen print."

In re Taylor, at 279.

At the hearing, a young attorney from the Udren Firm acknowledged that the Debtors had made post-petition payments, but sought to proceed with the motion anyway because the Debtors had failed to respond to requests for admission.

The bankruptcy court denied the request to enter the RFAs as evidence, noting that the firm "closed their eyes to the fact that there was evidence that . . . conflicted with the very admissions that they asked me [to deem admitted]. They . . . had that evidence [that the assertions in its motion were not accurate] in [their] possession and [they] went ahead like [they] never saw it." (App. 108-109.) The court noted:

Maybe they have somebody there churning out these motions that doesn't talk to the people that--you know, you never see the records, do you? Somebody sends it to you that sent it from somebody else.

In re Taylor, at 281.

The Court directed the Udren Firm to obtain a payment history from HSBC so that the amounts owed could be determined. However, at a subsequent hearing, the young attorney informed the Court that he had submitted the request through NewTrak but had not received a reply. He also informed the Court that he was not allowed to communicate directly with his client. The understandably perturbed Court issued an order for the firm and three of its attorneys to appear and respond to the Court’s concerns about how the case had been handled.

After four hearings, the Court concluded that the young associate, the managing attorney who signed the pleadings, the head of the firm, the firm itself and HSBC had all violated Rule 9011. The Court imposed creative, but largely symbolic sanctions. As explained by the Court of Appeals:

Because of his inexperience, the court did not sanction Fitzgibbon. However, it required Doyle to take 3 CLE credits in professional responsibility; Udren himself to be trained in the use of NewTrak and to spend a day observing his employees handling NewTrak; and both Doyle and Udren to conduct a training session for the firm's relevant lawyers in the requirements of Rule 9011 and procedures for escalating inquiries on NewTrak. The court also required HSBC to send a copy of its opinion to all the law firms it uses in bankruptcy proceedings, along with a letter explaining that direct contact with HSBC concerning matters relating to HSBC's case was permissible.

In re Taylor at 281-82.

The sanctions were aimed more at shaming the firm than financially penalizing it. Ordering the head of the firm to learn how NewTrak worked sent a symbolic message that he was out of touch with how his own law firm worked. Requiring Doyle, the bankruptcy managing attorney, the obtain three hours of CLE in professional responsibility sent the message that she needed this education. Requiring Udren and Doyle to conduct a training session on the requirements of Rule 9011 and how NewTrak worked was intended to correct their behavior. Finally, the requirement that HSBC send a copy of the opinion to all of its attorneys was meant to remedy the perceived view that such contact was forbidden.

The District Court reversed all of the sanctions, even those against HSBC, which had not appealed. The District Court found that Debtor’s counsel was equally at fault, that the Bankruptcy Court seemed more interested in sending a message to the bar in general than addressing the failings of counsel in the specific case and that Udren could not be sanctioned under Rule 9011 because he had not signed any pleadings.

The U.S. Trustee appealed to the Third Circuit.

The Third Circuit Opinion

The Third Circuit affirmed the District Court’s ruling that Udren, as shareholder of the firm, could not be sanctioned since he did not sign any pleadings. However, it reversed the remainder of the District Court ruling and reinstated the sanctions against Doyle, the Udren Firm and HSBC. In doing so, it provided a valuable guide to the requirements of Rule 9011 in the age of technology.

What’s a Reasonable Attorney to Do?

The Court of Appeals pointed out that merely making a false statement is not enough to invoke Rule 9011. The relevant inquiry is what the attorney could reasonably have believed.

The concern of Rule 9011 is not the truth or falsity of the representation in itself, but rather whether the party making the representation reasonably believed it at the time to have evidentiary support. In determining whether a party has violated Rule 9011, the court need not find that a party who makes a false representation to the court acted in bad faith. "The imposition of Rule 11 sanctions . . . requires only a showing of objectively unreasonable conduct."

In re Taylor, at 282.

The Court of Appeals identified four statements that were either false or misleading:

In this opinion, we focus on several statements by appellees: (1) in the motion for relief from stay, the statements suggesting that the Taylors had failed to make payments on their mortgage since the filing of their bankruptcy petition and the identification of the months in which and the amount by which they were supposedly delinquent; (2) in the motion for relief from stay, the statement that the Taylors had no or inconsequential equity in the property; (3) in the response to the claim objection, the statement that the figures in the proof of claim were accurate; and, (4) at the first hearing, the attempt to have the requests for admission concerning the lack of mortgage payments deemed admitted. As discussed above, all of these statements involved false or misleading representations to the court.

In re Taylor, at 283. It is not a good sign when an opinion identifies multiple cases of false or misleading statements to the court.

The Court of Appeals went on to find that the attorneys had not acted reasonably.

We must, therefore, determine the reasonableness of the appellees' inquiry before they made their false representations. Reasonableness has been defined as "an objective knowledge or belief at the time of the filing of a challenged paper that the claim was well-grounded in law and fact." (citation omitted). The requirement of reasonable inquiry protects not merely the court and adverse parties, but also the client. The client is not expected to know the technical details of the law and ought to be able to rely on his attorney to elicit from him the information necessary to handle his case in the most effective, yet legally appropriate, manner.

***

Central to this case, then, is the degree to which an attorney may reasonably rely on representations from her client. An attorney certainly "is not always foreclosed from relying on information from other persons." (citation omitted). . In making statements to the court, lawyers constantly and appropriately rely on information provided by their clients, especially when the facts are contained in a client's computerized records. It is difficult to imagine how attorneys might function were they required to conduct an independent investigation of every factual representation made by a client before it could be included in a court filing. While Rule 9011 "does not recognize a 'pure heart and empty head' defense," (citation omitted),, a lawyer need not routinely assume the duplicity or gross incompetence of her client in order to meet the requirements of Rule 9011. It is therefore usually reasonable for a lawyer to rely on information provided by a client, especially where that information is superficially plausible and the client provides its own records which appear to confirm the information.

That is, an attorney must, in her independent professional judgment, make a reasonable effort to determine what facts are likely to be relevant to a particular court filing and to seek those facts from the client. She cannot simply settle for the information her client determines in advance-- by means of an automated system, no less--that she should be provided with.

***

More generally, a reasonable attorney would not file a motion for relief from stay for cause without inquiring of the client whether it had any information relevant to the alleged cause, that is, the debtor's failure to make payments. Had Doyle made even that most minimal of inquiries, HSBC presumably would have provided her with the information in its files concerning the flood insurance dispute, and Doyle could have included that information in her motion for relief from stay--or, perhaps, advised the client that seeking such a motion would be inappropriate under the circumstances.

With respect to the Taylors' case in particular, Doyle ignored clear warning signs as to the accuracy of the data that she did receive. In responding to the motion for relief from stay, the Taylors submitted documentation indicating that they had already made at least partial payments for some of the months in question. In objecting to the proof of claim, the Taylors pointed out the inaccuracy of the mortgage payment listed and explained the circumstances surrounding the flood insurance dispute. Although Doyle certainly was not obliged to accept the Taylors' claims at face value, they indisputably put her on notice that the matter was not as simple as it might have appeared from the NewTrak file. At that point, any reasonable attorney would have sought clarification and further documentation from her client, in order to correct any prior inadvertent misstatements to the court and to avoid any further errors. Instead, Doyle mechanically affirmed facts (the monthly mortgage payment) that her own prior filing with the court had already contradicted.

Doyle's reliance on HSBC was particularly problematic because she was not, in fact, relying directly on HSBC. Instead, she relied on a computer system run by a third-party vendor. She did not know where the data provided by NewTrak came from. She had no capacity to check the data against the original documents if any of it seemed implausible. And she effectively could not question the data with HSBC. In her relationship with HSBC, Doyle essentially abdicated her professional judgment to a black box. (emphasis added).

In re Taylor, at 284-85.

Kudos to the U.S. Trustee

As a preliminary matter, it is important to recognize the role played by the U.S. Trustee. While the Debtor’s counsel at least raised the issues which allowed the Court to conduct its investigation, the Court of Appeals indicated that Debtor’s counsel was not much better than the Udren firm:

Taylor's counsel was also ultimately sanctioned and removed from the case. Counsel did not perform competently, as is evidenced by the Taylors' failure to contest HSBC's RFAs. She also made a number of inaccurate statements in her representations to the court. However, it is clear that her conduct did not induce the misrepresentations by HSBC or its attorneys. As the bankruptcy court correctly noted, "the process employed by a mortgagee and its counsel must be fair and transparent without regard to the quality of debtor's counsel since many debtors are unrepresented and cannot rely on counsel to protect them."

In re Taylor, at 282, fn. 10. As a result, it is important that the U.S. Trustee’s Office stepped in to protect the integrity of the system. This author has sometimes been critical of the U.S. Trustee’s Office. However, in this case, they did exactly what they should have done—to represent the broader interest of integrity in bankruptcy in a situation where debtor’s counsel was either unable to do so (in the case of Debtor’s initial counsel) or had no financial incentive to do so (presumably with respect to Debtor’s substitute counsel).

What It Means

The meaning of the opinion is that attorneys are professionals and cannot “abdicate (their) professional judgment to a black box.” In age of massive defaults, creditors cannot be faulted for wanting to minimize their costs. However, the attorney is more than an automaton communicating the demands of the client. If attorneys were mere mouthpieces for their clients, there would be no need for them. Instead, the client could simply generate form pleadings using an automated system. Attorneys exist to exercise professional judgment on behalf of their clients. While attorneys can and must be advocates for their clients, Rule 9011 imposes a duty to review the information provided by the client and determine whether it appears to be reasonable. More importantly, once information which once appeared reasonable is placed into doubt, the attorney has a duty to communicate with the client and determine which facts can reasonably be supported.

I believe that attorneys should be skilled craftsman rather than assembly line workers. In this case, a $540 dispute over flood insurance was magnified by a factor of nearly ten times. While it might have been reasonable to rely on the initial information provided by the client through NewTrak, this certainly became unreasonable when the Debtor provided canceled checks showing that payments which the computerized record said did not exist had been made. The significance of Taylor is that for lawyers to continue to have meaning, they must bring something to court above the mere repetition of what their client told them. The Taylor case represented an existential threat to the continuing relevance of attorneys. If the attorney does nothing more than repeat information provided by the client through an automated system, then there is no justification for requiring the additional cost represented by the participation of an attorney. Fortunately, the Third Circuit Court of Appeals provided a justification for the continued involvement of skilled counsel and gave support to the many creditors’ counsel who performs their duties with judgment and skill.

The Final Word

We appreciate that the use of technology can save both litigants and attorneys time and money, and we do not, of course, mean to suggest that the use of databases or even certain automated communications between counsel and client are presumptively unreasonable. However, Rule 11 requires more than a rubber-stamping of the results of an automated process by a person who happens to be a lawyer. Where a lawyer systematically fails to take any responsibility for seeking adequate information from her client, makes representations without any factual basis because they are included in a "form pleading" she has been trained to fill out, and ignores obvious indications that her information may be incorrect, she cannot be said to have made reasonable inquiry. Therefore, we find that the bankruptcy court did not abuse its discretion in imposing sanctions on Doyle or the Udren Firm itself. However, it did abuse its discretion in imposing sanctions on Udren individually.

In re Taylor, at 286.

Of Attorneys and Ostriches

2011-12-16T09:48:00.004-06:00

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Judge Richard Posner of the Seventh Circuit recently offered the following advice to appellate attorneys:

When there is apparently dispositive precedent, an appellant may urge its overruling or distinguishing or reserve a challenge to it for a petition for certiorari but may not simply ignore it. We don’t know the thinking that led the appellants’ counsel in these two cases to do that. But we do know that the two sets of cases out of which the appeals arise, involving the blood-products and Bridgestone/Firestone tire litigations, generated many transfers under the doctrine of forum non conveniens, three of which we affirmed in the two ignored precedents. There are likely to be additional such appeals; maybe appellants think that if they ignore our precedents their appeals will not be assigned to the same panel as decided the cases that established the precedents. Whatever the reason, such advocacy is unacceptable.

The ostrich is a noble animal, but not a proper model for an appellate advocate. (Not that ostriches really bury their heads in the sand when threatened; don’t be fooled by the picture below.) The “ostrich-like tactic of pretending that potentially dispositive authority against a litigant’s contention does not exist is as unprofessional as it is pointless.”

Gonzales-Servin v. Ford Motor Company, No. 11-1665 (7th Cir. 11/23/11), pp. 4-5. You can find the opinion here. To illustrate his point, he included the two photographs set forth below.

It is good to know that in these times of budget shortfalls that federal judges still have access to Photo Shop. This was indeed a case where two pictures were worth a thousand words.

Montana Blogger Tagged for Big Defamation Damages in Suit by Trustee

2011-12-10T15:30:00.003-06:00

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A Montana blogger has learned that First Amendment freedoms do not extend to saying that a bankruptcy trustee is “guilty of Fraud, Deceit on the Government, Illegal Activity, Money Laundering, Defamation, Harassment” among other things. In Obsidian Finance Group, LLC and Kevin D. Padrick v. Crystal Cox, 2011 U.S. Dist. LEXIS 137548 (D. Ore. 11/30/11), the Court ruled that the blogger was not entitled to protections accorded to traditional media and found that the trustee was not a public figure. You can read the opinion here. (PACER registration may be required). While the case is no doubt welcome news for trustees who can be exposed to some bizarre public criticism, it is troubling for its constricted definition of “media.”

What Happened

Summit Accomodators dba Summit 1031 Exchange was a company that was supposed to facilitate tax free 1031 exchanges. The company filed for chapter 11 relief on December 24, 2008 amid allegations that it had used customer’s money to fund insider ventures. At least four persons associated with the company have been indicted or convicted. The Debtor initially employed Terry Vance as Chief Restructuring Officer. It also employed Obsidian Finance Consultants, LLC as financial adviser and paid it a retainer of $100,000. Shortly after the case was filed, the Debtor sought to replace Mr. Vance as CRO with Obsidian Finance.

At the hearing to replace the CRO on February 11, 2009, the Court entertained an oral motion from the U.S. Trustee to appoint a Chapter 11 trustee. The Court granted the U.S. Trustee’s motion and suggested that perhaps Obsidian Finance or Kevin Padrick, who was one of its principals, could be appointed as Chapter 11 trustee. The U.S. Trustee did appoint Kevin Padrick as Chapter 11 trustee.

On May 12, 2009, the Court confirmed the First Amended Joint Plan of Reorganization filed by the Official Committee of Unsecured Creditors and the Chapter 11 trustee. The Plan provided for establishment of a Liquidating Trust with Kevin Padrick as Liquidating Trustee.

Crystal Cox is the daughter of one of the creditors of Summit Accomodators. She was present at the hearing on February 11, 2009 and subsequently met with Padrick on February 12, 2009. She became convinced that Mr. Padrick had used his position as financial adviser to undermine the CRO and get the job as Chapter 11 Trustee. She also was convinced that Mr. Padrick should not have been appointed Chapter 11 Trustee because his status as a principal of the Debtor’s financial adviser made him an insider and therefore ineligible for appointment.

On July 19, 2009, Crystal Cox started a blog with the URL www.obsidianfinancesucks.com. The headline of the blog reads “Kevin Padrick, Obsidian Finance Group, I Demand Transparency in the US Bankruptcy Courts.” In her blog, she described herself as follows:

I am the Self Appointed Real Estate Industry Whistleblower. I am a Self Appointed Real Estate Consumer Advocate. I want to be a voice for Real Estate Victims that are not being heard, that are Powerless, and that Have no voice.

My, Self appointed job or mission, have you is to get the TRUTH out so that real estate victims can get justice, get "made whole", get their MONEY and get on with their REAL LIFE...

Ms. Cox wrote hundreds of articles for her blog, many of which made accusations against Kevin Padrick and Obsidian Finance. In some cases, she would post ten or more articles in a day. She also wrote for:

www.BankruptcyCorruption.com
www.LiquidatingTrustee.com
www.BankruptcyTrusteeFraud.com
www.RealEstateIndustryWhistleblower.com

On January 14, 2011, the Trustee’s counsel filed a defamation action against Ms. Cox in the United States District Court of Oregon. The case went to trial on November 29, 2011. Ms. Cox represented herself. The jury found that Crystal Cox was liable for defamation to both Obsidian Finance Group, LLC and Kevin Padrick. It awarded damages of $1,000,000 to Obsidian and $1,500,000 to Mr. Padrick. The Court entered judgment against Ms. Cox on December 8, 2011.

Prior to trial, the Court made several rulings from the bench which were incorporated into a memorandum opinion on November 30, 2011.

The Trustee Was Not a Public Figure, Not Even a Limited One

The defendant argued that the trustee was a “public figure” so that proof of actual malice was required under New York Times Co. v. Sullivan, 376 U.S. 254 (1964). A person can be a public figure if they “occupy positions of such persuasive power and influence that they are deemed public figures for all purposes” or an individual may “voluntarily inject() himself or (be) drawn into a particular controversy and thereby become() a public figure for a limited range of issues.” Gertz v. Robert Welch, Inc., 418 U.S. 323, 351 (1974).

The Court found that the Trustee and his corporation were not “all purpose” public figures and that that they had not thrust themselves into a particular controversy so as to be limited purpose public figures. While the bankruptcy of Summit Accomodators itself received attention for its failure, agreeing to serve as trustee did not constitute “thrusting” oneself into a controversy. Moreover, a person must be a limited purpose public figure prior to the alleged defamatory statements rather than because of them. In this case, Ms. Cox could not create controversy over Padrick’s handling of the estate through her blog and then contend that this made him a public figure.

The case would have been a closer call if the Trustee had sought out publicity about the job he was doing. While many lawyers are publicity shy, some actively seek to keep their names in the news, issuing press releases and taking out ads trumpeting their successes. The lawyer who blows his own horn too much in a case of public interest may find himself to be a limited purpose public figure.

The Blogger Was Not Entitled to Protection As a Member of the “Media”

The Court noted that “plaintiffs cannot recover damages (against media defendants) without proof that (the) defendant was at least negligent and may not recover presumed damages absent proof of ‘actual malice.’” Opinion, p. 9. This would have made it more difficult for the plaintiffs to recover. However, the Court rejected the contention that the “investigative blogger” in this case qualified as media.

First, the Court noted that Defendant had not cited any cases giving media status to bloggers. “Without any controlling or persuasive authority on the issue, I decline to conclude that defendant in this case is ‘media,’ triggering the negligence standard.” Opinion, p. 9. This appears to be a bit of a cop out by the court, since blogging is a relatively new phenomenon. By holding that bloggers do not qualify as media because Courts have not previously granted them this status creates a self-fulfilling prophecy.

However, the Court did go one step further and lay out a test for what evidence would establish someone’s standing as a journalist.

Defendant fails to bring forth any evidence suggestive of her status as a journalist. For example, there is no evidence of (1) any education in journalism; (2) any credentials or proof of any affiliation with any recognized news entity; (3) proof of adherence to journalistic standards such as editing, fact-checking, or disclosures of conflicts of interest; (4) keeping notes of conversations and interviews conducted; (5) mutual understanding or agreement of confidentiality between the defendant and his/her sources; (6) creation of an independent product rather than assembling writings and postings of others; or (7) contacting "the other side" to get both sides of a story. Without evidence of this nature, defendant is not "media."

Opinion, p. 9. Unfortunately, the Court did not cite any precedent for this test. However, there is a growing body of case law which rejects this narrow definition.

Other Views on Bloggers and Journalists

Moreover, changes in technology and society have made the lines between private citizen and journalist exceedingly difficult to draw. The proliferation of electronic devices with video-recording capability means that many of our images of current events come from bystanders with a ready cell phone or digital camera rather than a traditional film crew, and news stories are now just as likely to be broken by a blogger at her computer as a reporter at a major newspaper. Such developments make clear why the news-gathering protections of the First Amendment cannot turn on professional credentials or status.

Glik v. Cunniffe, 655 F.3d 78, 84 (1st Cir. 2011)(rejecting qualified immunity for police officers who arrested citizen for filming them with a cell phone camera).

In another case, the Court refused to recognize a claim to a “reporter’s privilege” not to divulge sources on the grounds that it could lead to a slippery slope which would include bloggers.

The press in its historic connotation comprehends every sort of publication which affords a vehicle of information and opinion.'" (citation omitted). Are we then to create a privilege that protects only those reporters employed by Time Magazine, the New York Times, and other media giants, or do we extend that protection as well to the owner of a desktop printer producing a weekly newsletter to inform his neighbors, lodge brothers, co-religionists, or co-conspirators? Perhaps more to the point today, does the privilege also protect the proprietor of a web log: the stereotypical "blogger" sitting in his pajamas at his personal computer posting on the World Wide Web his best product to inform whoever happens to browse his way? If not, why not? How could one draw a distinction consistent with the court's vision of a broadly granted personal right? If so, then would it not be possible for a government official wishing to engage in the sort of unlawful leaking under investigation in the present controversy to call a trusted friend or a political ally, advise him to set up a web log (which I understand takes about three minutes) and then leak to him under a promise of confidentiality the information which the law forbids the official to disclose?

In re Grand Jury Subpoena (Miller), 397 F.3d 964, 979-80 (D.C. Cir. 2005)(Sentelle, Concurring).

Finally, one Court got it right when it held that “not all bloggers are journalists. However, some bloggers are without question journalists.”

Further, there is no published case deciding whether a blogger is a journalist.

However, in determining whether Smith was engaged in news reporting or news commentating, the court has applied the functional analysis suggested by commentators and the Plaintiffs in their memorandum in support of a preliminary injunction, which examines the content of the material, not the format, to determine whether it is journalism. (citation omitted). In addition, the court has considered the intent of Smith in writing the article. The court agrees that not all bloggers are journalists. However, some bloggers are without question journalists. (citation omitted).

Bidzerk, LLC v. Smith, 2007 U.S. Dist. LEXIS 78481 at *16-17, 35 Media L. Rep. 2478 (D. S.C. 2007).

Applying the Obsidian Test to A Texas Bankruptcy Lawyers Blog

It is a shame that the Judge in Obsidian v. Cox used an intellectually lazy definition of journalist when it probably did not influence the outcome of the case. The statements made by Ms. Cox in her blog were so outrageous that they likely would have failed a negligence or actual malice standard. I take personal offense because I like to think that the work that I do on this blog bears a passing resemblance to journalism. However, I doubt that I would qualify under Judge Hernandez’s test.

1. Any education in journalism. I took three years of journalism in high school and wrote for both my high school and college papers. Is that enough?

2. Any credentials or proof of any affiliation with any recognized news entity. My blog is distributed by the State Bar of Texas, the American Bankruptcy Institute and the LexisNexus Bankruptcy Community. However, these are all legal organizations rather than recognized news entities.

3. Proof of adherence to journalistic standards such as editing, fact-checking, or disclosures of conflicts of interest. I do edit my pieces, although my partner says that I should do more of it. I do fact check my posts, which are mostly based on court opinions and thus pretty easy to document. Finally, if I have involvement in a case I write about, I disclose that.

4. Keeping notes of conversations and interviews conducted. I rarely do interviews. However, when I do, I don’t necessarily keep my notes after the post is published unless it is because I have a messy desk and they get buried under something else.

5. Mutual understanding or agreement of confidentiality between the defendant and his/her sources. Sort of. If someone asks me not to use their name, I respect that. However, it just doesn’t come up that often.

6. Creation of an independent product rather than assembling writings and posts of others. Yes.

7. Contacting “the other side” to get both sides of a story. Generally, I write about judicial opinions. I do not contact the losing party to get their side of the story. If a party to a case contacts me and points out a factual error, I will correct it. Sometimes I will allow the other side to tell their side of the story in the comments. However, I did not contact Crystal Cox or Kevin Padrick about this post.

Out of seven criteria, I qualify completely under two, partially under four and not at all under one. However, if you compare my writing to that of Bill Rochelle, who writes for Bloomberg and is definitely a real journalist, you will see that we frequently write on the same topics and discuss the same issues. The difference is that he is better at it than I am and gets paid for it, while I still have my day job.

The Ironic Conclusion—It’s All in How You Say It

In reading through Crystal Cox’s rambling and often obsessive blog, there is occasionally some solid reporting and good questions raised. It certainly raised my eyebrows that the Court would appoint a trustee based on an oral motion without any prior notice to parties in interest. It also was unusual for the Court to suggest an individual to the United States Trustee. It was also a very close call as to whether the principal of the Debtor’s financial adviser qualified as a disinterested person eligible to be appointed as trustee. These were all good questions. However, from my personal review of the lawsuit and the blog, it appears that Ms. Cox took a wrong turn when she took the unusual circumstances of Mr. Padrick’s appointment and her personal dislike of him and constructed a narrative of wrongdoing and fraud. Blogs that traffic in rumor, innuendo and unsupported allegations make the rest of us look bad and bring disrepute to blogging in general. On top of that, rumor, innuendo and unsupported allegations belong on talk radio, where they can be advanced by serious journalists like Rush Limbaugh, Alex Jones and Glen Beck, not on blogs.

In Memoriam: John Worthy Alvis, 1945-2011

2011-11-25T17:45:00.005-06:00

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On Wednesday November 23, 2011, friends, colleagues and family members gathered at First Baptist Church in San Marcos, Texas to remember the life of John Worthy Alvis who passed away on November 19 after a brief battle with pancreatic cancer. John practiced bankruptcy law in Austin for thirty-six years and left behind a legacy of profound respect. This post, taken largely from the eulogies given by James Hoeffner, brothers James and Thomas Alvis, and son, John Reagan Alvis, will remember a few stories about John. Please feel free to add your own in the comments section.

Early Years

John was born on August 22, 1945 in Austin, Texas. His son read from an autobiography an autobiography that John wrote at age ten entitled “The Amazing Adventures of Atomic Age Alvis” in which he said that he didn’t know whether he or the atom bomb made the biggest bang, but that he had been “popping off ever since.” He also revealed that he always wanted to be a garbage man when he grew up.

John also had a bit of Tom Sawyer in him. Their family owned a lot which was covered in vegetation. His father offered his two older boys $11 to clear off the land. This should have required the use of a scythe and a lot of hard work and sweat. However, John found a farmer with a tractor mower who would do the job for $6 and he pocketed the difference without lifting a finger (until his father found out).

John once told younger brother Tom that he would buy him a Lionel Santa Fe Super Chief if he could run a mile. When Tom, who loved Lionel electric trains, easily completed the mile, John was faced with honoring the bet. Since he didn’t have the cash, he offered to go double or nothing if Tom could run a four minute mile. Since Tom didn’t know that no youth had ever run a four minute mile (that mark was broken by Jim Ryun shortly thereafter), he gamely tried his best. He didn’t run a four minute mile and John narrowly escaped having to pay off.

FBI Career

After completing law school at the University of Texas in 1970, John surprised his family by joining the FBI. His fellow agents nicknamed him Special Agent McGoo because of his glasses. He once shot out the tires of a hijacked 727 as he dodged gunfire coming from the cockpit. John received a commendation from the FBI for his heroics. However, much to the astonishment of his law partners, he never displayed it. In another case of bravery, John stood guard alone at a bank with his snub-nosed .357 after he was told that robbers were en route.

One of the less glamorous aspects of being a G man was picking up draft dodgers. One time John and a particularly obnoxious partner were dispatched to the poor side of town to look for a man at his parent’s house. When the boy’s mother answered the door, the aggressive agent went into his Barney Fife routine demanding to know where he was. Pointing to a closet beneath the stairs, he demanded to know what was in there. The following exchange took place:

“Oh sir, you don’t want to go in there.”

“Why, you hiding something?”

“You don’t want to go into that closet.”

The agent smugly replied, “Because your son is in there” and forced his way past. When he opened the door and pulled the light switch on, he found more cockroaches than in an Indiana Jones movie. As roaches began to cover the startled agent, the mother said, “I told you you didn’t want to go in there.” John said that it took all of his self-control not to burst out laughing.

According to Jim Hoeffner, “John was a lover of justice whether it was federal court justice or cockroach justice.”

Law Practice in Austin

In 1975, John’s father died. John took a sabbatical from the FBI to return to Austin to clean up his father’s files. John never returned to the FBI and instead took up his place in his father’s firm Alvis & Carssow (later Alvis, Carssow & von Kreisler and Alvis, Carssow & Ingalls). Jim Hoeffner remembered “We always had fun at Alvis, Carssow & von Kreisler practicing law and visiting in general. John was always the first to laugh and always had a pleasant disposition.” He also said, “Unlike Marcellus in Pulp Fiction, if you did something wrong to him, he did not go medieval on you.”

According to James Alvis, “The practice of law was his passion in life. . . . He genuinely liked to help people, to give the ordinary person an even break.”

However, John was not without his faults. His one shortcoming was sending out monthly bills and billing for what he did. When Jim Hoeffner joined the firm, he was told, “You get John to bill on a monthly basis and I will immediately make you an equity partner.”

On another occasion, when John was president of the Travis County Bankruptcy Bar and the names of the nominees for director positions were being read, a woman lawyer demanded to know “is there any reason why there are no females on the ballot.” Without batting an eye, John replied, “Because our bylaws prohibit that.” While this answer was not politically correct and also not true (our bar has had many female council members and several female presidents), it showed a mischievous side to his personality.

Final Days

John’s battle with pancreatic cancer was brief but intense. His brother James noted that John had a few minor stomach pains on Labor Day and was gone before Thanksgiving. He said that John’s passing was a “reminder of our own mortality” and that, “all we really have is the life we make today.”

However, in his illness, he continued his interests. John was a huge nature lover. When told that a fox had been seen in their yard, he wanted to know “red or gray?”

When his colleagues insisted that he sign a Durable Medical Power of Attorney, he was asked, “John, do you know what a Durable Medical Power of Attorney is?” In response, he started making choking motions around his throat, indicating the indignity of having to read another legal document. Nevertheless, through the fog of the pain medication, he read through line by line. He checked off the box for no heroic actions to sustain his life, but when it came to terminating food and water if he was in a coma, “being the independent, ever hopeful, did not approve of this provision.”

John passed away on November 19 at 10:45 a.m. in his own bed in the arms of his wife. His breath became more shallow until it was gone. According to Mr. Hoeffner, “He died in peace, the same way he lived.”

Comments from Colleagues

Since John’s untimely passing, many of his colleagues have remarked about his life. Here are some of their comments. Please feel free to share your own.

I very much remember John and consider him one of the very best. He had a great disposition, was always courteous and respectful to all participants and their legal counsel, was well informed on the facts and the law and I considered it a privilege to be able to work with lawyers when they were of that caliber.

I know he will be missed by all of his friends and family and I will miss him also.

--Former U.S. Bankruptcy Judge Larry Kelly

John was a superb attorney with a first-rate temperament. I remember dealing with him during my first week of practicing law, and my first impression was that John was one smart and stellar guy. Needless to say, my positive impression never changed; indeed, my respect and admiration for him grew each time I dealt with him (and he and I were almost always on adverse sides). To say that his passing is a loss is a woeful understatement; and it is no overstatement to say that his departure leaves a huge void in the Central Texas bankruptcy bar in particular and the Central Texas community in general.

--U.S. Bankruptcy Judge Jeff Bohm

As the many e-mails have indicated, the Austin Bankruptcy community has lost a true gentleman and friend. He will be sorely missed.

--Yvonne Knesek, President, Austin Bankruptcy Bar

I had the privilege of being a law clerk for John while still in law school and before passing the bar exam. He was one of the kindest and most honorable men I have ever met. I am glad to have known him and sad at his passing.

--Craig Smith

He was the most professional attorney I ever met. God love him.

--Steve Turner

I practiced law with John from 1986 to 1992. We ceased to be business partners at that time, but remained partners in spirit. And I am not the Lone Ranger in that regard.

--Jim Hoeffner

The Pro Se Problem

2011-11-05T12:42:00.003-05:00

A report from the Administrative Office of the U.S. Courts highlights a disturbing trend: since the adoption of the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005, pro se filings have grown dramatically. You can read the report here. In the past five years, filings by attorneys have increased by 98%, while pro se filings increased by 187% over the same period. During the twelve months ending June 30, 2011, there were 130,086 pro se cases filed accounting for 9% of the total filings in bankruptcy. During 2011, pro se filings accounted for 8% of chapter 7 cases and 10% of chapter 13 filings.

Pro se filings were most common in the Western United States, Florida and Georgia. In the Central District of California, pro se cases made up a staggering 27.1% of the total filings. Pro se filings were more modest in Texas. The Northern, Eastern and Western Districts of Texas had pro se filing levels in the range of 2.1% to 4.0% while the Southern District fell in the range of 4.1% to 8.0%.

The surge in pro se filings has two important consequences for the court system. One is that pro se filings are much less likely to succeed than filings by represented debtors. According to data presented by Professors Katie Porter and Jay Westbrook at the National Conference of Bankruptcy Judges, nearly 90% of pro se chapter 13 debtors had their cases dismissed prior to confirmation of a plan and only 4% still had a case pending after four years. Among pro se chapter 7 debtors, a 2001 sample showed that 100% received a discharge. A 2007 sample showed that 17.6% of pro se chapter 7 debtors had their cases dismissed for technical problems as compared to just 1.9% of represented debtors.

When people file for bankruptcy but are unable to obtain relief from the court system, they are likely to become angry, frustrated and cynical. It would not be surprising to see unhappy pro se debtors manning the barricades of the Occupy movement or acting out their frustrations in court.

Another problem identified by the Administrative Office is that pro se filings are frequently accompanied by filing fee waivers. According to the report:

Filing fees supply a significant amount of revenue to the courts, so a decline in bankruptcy fees collected will affect the resources available to the Judiciary at a time when they are needed to address an increase in workload.

While the Administrative Office report did not specifically identify the cause of the rise in pro se filings (other than noting a rise in districts where the foreclosure crisis is acute), one answer seems to be that BAPCPA has created a class of debtors who are too broke to file bankruptcy. By increasing the complexity of bankruptcy, Congress both increased the cost to file and made it more difficult to file pro se. This is a cause for concern.

National Conference of Bankruptcy Judges--10/15/11--A Conversation With Elena Kagan

2011-10-16T22:03:00.006-05:00

The National Conference of Bankruptcy Judges concluded with an interview of Supreme Court Justice Elena Kagan by Third Circuit Judge Marjorie Rendell and Bankruptcy Judge Randall Dunn. Justice Kagan was very humble and self-effacing, but was not overly forthcoming.

In an ironic twist, Justice Kagan took the Supreme Court bench with no expertise in bankruptcy, but her maiden opinion was in that area. She said she enjoyed her work on Ransom v. FIA Card Services. She said, “Everything is new. You learn a lot. I would be glad to do more (bankruptcy cases).”

She said that her service as Solicitor General was good preparation for the court because “the whole job is focused on the court.” However, she did admit that she felt funny being referred to as “General Kagan” during her prior job. She said, “It’s an embarrassing thing because you’re not a General.”

Justice Kagan acknowledged that despite having four law clerks and hearing only about 80 cases a year, the job was challenging. “All of the cases we get are hard. It’s such a different kind of judging.” She also said, “The whole thing’s difficult. It should be difficult. If you thought it was easy, you shouldn’t be doing it.”

She said that she had not yet developed a judicial philosophy. “I’m not a grand theoretical thinker, especially at this stage in my judicial career. I’m ready to take it a case at a time.”

Justice Kagan distinguished Constitutional interpretation from statutory interpretation. She said, “Statutory interpretation is frequently different from Constitutional interpretation because the Constitution is written so much more broadly and is so open-ended so it’s hard to approach it like you would the Bankruptcy Code.” In statutory interpretation, she said, “Start with the text, the particular provision in context, its purpose. Sometimes when the text is uncertain you move to more general purposive principles and legislative history. Congress wrote what it wrote and you have to follow that.”

When asked about the fact that there are three women on the court, she stated that “there are women’s faces and women’s voices coming from all over. We’re not shrinking violets.” However, she said that the female presence on the court “makes a world of difference in the perception of the court,” but “doesn’t make much difference in deliberations.”

She said that she was surprised that technology had passed the internal workings of the court by. She said that the justices do not email each other. She said that “coming back to the court after twenty-five years after being a clerk, they communicate in exactly the same way.” She spoke about memos written on heavy paper transmitted by messengers. However, she saw advantages in not using email. “How many times have you written an email, pressed send and then thought better of it. . . . The way we communicate, even though it’s less modern, there’s a certain deliberateness and thoughtfulness to it.”

Justice Kagan compared writing an opinion to teaching a class. She said, “”I’ve become aware that when I sit down to write an opinion it is the same as when I tried to prepare for a class. You explain something complicated to someone who doesn’t know much about it. You try to convey complex ideas so they understand it and it sticks with them.”

When it comes to questions in oral argument, she said, “We are an incredibly hot bench now. We have a lot to say. Odds that you will get no more than two or three sentences out are not great.” She said that she tries to “ask questions that they can actually answer.” She said that in asking questions, she looks at “what are the hang-ups in the person’s case for me. I want to give someone a chance to convince me.” Other times she asks questions to “convey views to the other people on the bench.”

Justice Kagan said that briefs are more important than oral argument, although oral argument “can crystallize things for you.”

Despite the ideological divide on the court, she said, “We all really like each other very much. We have lunch together every day we have argument or conference.” She pointed out that the closest friends on the court were Justices Ruth Bader Ginsburg and Antonin Scalia. She said, “Disagreements about how to do law shouldn’t carry over into the next case or into general relationships.” She said “I have eight great friends that I didn’t have before.”

On a completely random note, putting spellchecker in text messaging is not helpful. When my dad called me during this presentation, I texted him back to let him know that I couldn’t talk because I was listening to Supreme Court Justice Kagan. After I hit send, I realized to my horror that I had referred to Justice Pagan. I don’t think that Android has a right wing bias. I just think its artificial intelligence doesn’t know when to shut up

National Conference of Bankruptcy Judges--10/15/11--Mythbusters--Westbrook and Porter Share the Latest Empirical Research

2011-10-16T20:49:00.006-05:00

Prof. Jay Westbrook and Prof. Katie Porter presented a delightful tour de force of empirical research titled Mythbusters. They compared ten statements of conventional wisdom to the results of empirical research. As Jay said, “There are all kinds of things that everyone thinks are true but we don’t know whether they are really true.” (For this post, I will refer to the speakers as Jay and Katie since these two professors go out of their way to be accessible so that it just seems appropriate).

1. BAPCPA permanently crippled consumer bankruptcy.

The answer is not necessarily. Filings today are very similar to what was seen before BAPCPA. Today’s filing levels of 1.5 million cases per year are about equal to filings during 2001-2004. The income profiles today are similar with chapter 7 debtors averaging $24,000 per year and chapter 13 debtors averaging $34-35,000. The only thing that can’t be measured is what filings would have been like if BAPCPA had not been passed. Given the weak economy, filings might have been much higher without the legislation.

2. For big business, reorganization in Chapter 11 really just means a 363 sale.

While 363 sales are more common in large cases, they are not the norm. Cases with above $50 million in assets resulted in 363 sales in less than 33% of the cases while in chapter 11 cases of all sizes only 10-15% resulted in 363 sales.

3.Young people are more likely to file bankruptcy because of a decline in stigma.

Research shows two things: survey respondents report mortifyingly high rates of stigma and bankruptcy is increasing among the elderly and declining among the young. A study in 2001 showed that 84.3% of persons filing bankruptcy said they would be embarrassed or very embarrassed if their families or friends found out. Another survey showed that bankruptcy was more traumatic than the death of a friend or separation from a spouse.

Another study showed that people are waiting longer before they file bankruptcy. In 1981, people filed bankruptcy when their debt to income ratio was 1.41 while in 2001 that number had more than doubled to 3,04. Of persons surveyed, most had been struggling with debt for more than two years before filing.

Bankruptcy filings for those aged 75-84 increased by 433.3% from 1999-2007 and rates for those aged 65-74 increased 125%. Meanwhile the overall rate of filing decreased 29.2% and the filing rate for those aged 18-24 fell by 64.1%. The unfortunate fact is that bankruptcy is becoming a reality for the Greatest Generation.

4. There is nothing important in business bankruptcy between Mom & Pop and WorldCom.

Among some academics, there are two categories of chapter 11 cases, important (more than $100mm) and not important (everyone else). In the real world, 60% of chapter 11 cases fall into the range of $100,000 - $5 million in assets, while only 6% had $100 million in assets or more. Additionally, 20% of all chapter 11 cases were filed by individuals. The professors opined that this shows the difficulty of trying to construct a one size fits all chapter 11 model.

5. Small businesses linger endlessly in chapter 11.

A study done prior to BAPCPA showed that 50% of small business cases that ultimately failed were dismissed or converted within six months while 50% of successful cases took 15 months to confirm. The professors noted that small business cases take just as long to confirm as big business cases, although small business cases were dismissed or converted much faster than their larger counterparts (107 days faster in 2002).

According to Jay, if the 2005 time limits had been in effect in 2002, 80% of the successful small business cases might have failed. He added that the effect of the 2005 small business amendments may have been to “maim cases that could have succeeded.”

6. The bankruptcy experience is race neutral.

While the Bankruptcy Code is race neutral on its face, the “Ideal Debtor” for chapter 7 is one who holds retirement accounts, has high but reasonable expenses, financially supports only legal dependents and has little or no child support of student loan obligations. This is more likely to describe a white debtor than a minority debtor.

The most accurate predictor of whether someone will file chapter 13 is whether they are African American. African Americans file for chapter 13 at twice the rate of other debtors.

In 2007, Hispanics were likely to pay 25% more in attorney’s fees than white or African American debtors.

The professors were quick to say that they can’t say why this is happening, only that this is what the numbers show.

7. Forum shopping is all about getting to Delaware or New York.

It turns out that forum shopping happens in other parts of the country as well. Of 409 large cases filed outside of Delaware and New York since 1980, 27% were forum shopped

According to Katie, large cases should file in Jay and Kate’s districts because they would have easy access to academics and cheap beer. Jay noted that Austin had live music as well.

8. Bankruptcy works for pro se filers.

Chapter 7 works reasonably well for pro se filers, while chapter 13 is a complete disaster. Among pro se chapter 7 debtors, 17.6% of debtors had their cases dismissed for technical reasons compared to 1.9% of those with counsel.

Among pro se chapter 13 debtors filing since 2006, only 4% had their cases pending or discharged at the four year mark compared to 45% of those represented by counsel. 90% of pro se chapter 13 cases are dismissed prior to confirmation compared to just 15% of those represented by counsel.

According to Katie, pro se debtors are playing Las Vegas odds in chapter 13 and might do better taking their filing fee to Las Vegas. She said we have “constructed a complex machine that most of the time may require a lawyer.”

9. Many of the chapter 13 cases that do not complete plans are actually successes.

When Warren, Westbrook and Sullivan released their study that only 33% of chapter 13 cases result in discharge, they were treated as heretics. Now this success rate is conventional wisdom, but a new narrative has arisen that failed chapter 13 cases may actually be successes. The data says no.

While the debtor remained in bankruptcy, chapter 13 avoided foreclosure for 81% of debtors while 70% faced loss of their home within 2-3 months after dismissal.

Once their cases were dismissed, 57.5% of debtors reported that their situation was the same or worse than when they filed. 60% of debtors very much disagreed with the statement that they exited bankruptcy because they had accomplished their goals or found another solution compared to 20% who agreed or agreed very much with the statement.

In a chilling statistic, 33% of debtors whose chapter 13 cases were dismissed reported that they struggle to pay for food.

10. Lenders maximize recoveries in each case.

Sarah Pei Woo conducted a study of chapter 11 bankruptcies of residential real estate developers during the recession. Tragically, she passed away after a brief illness after her study was completed.

She found that banks acted not to maximize recovery but to increase short-term liquidity and accede to regulatory pressure. The question was not how much they would recover but when.

Among residential real estate developers, 81.7% were liquidated, 11.1% were sold in 363 sales and just 4.6% reorganized. Secured lenders filed a motion for relief from stay in 72.5% of the cases. Banks who were in financial distress were 24.9% to 28.6% more likely to seek relief from the automatic stay.

National Conference of Bankruptcy Judges--10/14/11--Too Big to Fail

2011-10-16T20:43:00.000-05:00

Dr. Thomas Hoenig was the Friday luncheon speaker. He served for twenty-five years as President and CEO of the Federal Reserve Bank of Kansas City. He said that he “wanted to get you on board that Too Big to Fail is bad policy.” He warned that the crisis brought about by Too Big to Fail in 2008 was likely to recur. He said that “unless you acknowledge the problems that brought about the crisis, it would happen again. He identified some of the factors as distorted incentives, not allowing the market to function and subsidizing favored groups.

Dr. Hoenig identified three pieces of legislation as creating the climate for Too Big to Fail. The Glass-Steagall Act extended protections to commercial banks in the form of deposit insurance in return for separating out their risk-based activities. He described Glass-Steagall as “a covenant between government and the private sector” to “extend protection around you because of your role in society.” He said that “in return for special protection, we will limit (the activities of commercial banks) to payment systems and financial intermediation systems because these are the purposes we want to protect.” He said that if commercial banks wanted to engage in risk-based activities, they would have to do so with their own capital in a separately chartered entity. He said that Glass-Steagall was the system in place until the 1980s and “worked reasonably well.”

According to Hoenig, “with stability comes its own sources of weaknesses.” The demand to take down the wall between commercial banking and other activities led to the Gramm-Leach-Bliley Act of 1979. The effect of GLB was to allow banks to invest in risk with a federal backstop. The risk of this was predicted by Adam Smith who noted that merchants would seek to widen the market and narrow their competition. While widening the market is desirable, narrowing competition is not. GLB narrowed competition by allowing some players an artificial subsidy. By eliminating Glass-Steagall, the market share of the largest banks was increased from 14% in 1979 to 60% in 2007. “Thus was born too big to fail.”

The Dodd-Frank legislation was supposed to fix Too Big to Fail. He said, “I am concerned that it won’t” because “the incentives haven’t changed.” The largest institutions are now 20-30% bigger and the cost of capital is being kept artificially low. Under Dodd-Frank, if a TBTF institution finds itself on the ropes, the regulators must make a decision about whether the institution is solvent but illiquid or insolvent. This decision must be made on a Friday afternoon and must be approved by the Secretary of the Treasury and the Chairman of the Federal Reserve with possible involvement by the courts. He asked, “Who can take an institution of $2.2 trillion into receivership over the weekend?” As a result, he predicted that regulators would be inclined to find that the entity was solvent but illiquid and inject federal dollars to keep it afloat. As a result, he said, “the market doesn’t function” and “there is no cleansing of the market.”

Dr. Hoenig said that anything this large cannot be allowed to fail. As a result, the incentives must be changed. He noted that in the current system, profits are privatized and losses are socialized. He recommended that investment banking, trading and other risk-based activities be moved into separate entities with private capital. He also called for making the competitive market more fair. He said that regional banks cannot compete with the twenty largest entities because they are not subsidized.

Dr. Hoenig said that he disagreed with those who said that current capital requirements for commercial banks are too stiff. He disagreed, noting that before there was a federal safety net, financial institutions maintained capital of 15-20% compared to the current 7%. He said that (15-20% capital) is “what the market called for.”

He also disagreed with those who said that such measures would place U.S. financial institutions at a competitive disadvantage compared to institutions in other parts of the world. Dr. Hoenig said that foreign banks were not a good model to follow. He said “look at their banks.” He said, we are “not in a competitive process to excellence, but a competitive process to the bottom.”

He also warned that the country was too leveraged. He said that consumer debt as a percentage of GDP had grown from 80-90% to a high of 125% before dropping to the current level of 114%. At the same time the savings rate fell from 8% to 0% although it has risen back to 5%.

Dr. Hoenig described the federal government as being in crisis. He said that government debt had increased from 40% of GDP in 1990 to 100%. Currently interest rates average 2.5%. He asked what if market interest rates began to apply? He said that monetary policy has been captured by Too Big to Fail.

(I apologize in advance if I incorrectly transcribed any of Dr. Hoenig’s statistics or their units of measurement. I was taking notes as quickly as I could but possibly not quickly enough. Any statements that do not make sense are the result of my reporting rather than the content of the speaker).

National Conference of Bankruptcy Judges--10/14/11--The Consumer Financial Protection Bureau

2011-10-16T20:34:00.001-05:00

Rajeev Date had the unenviable job of filling a speaking slot originally assigned to Elizabeth Warren to discuss the creation of the Consumer Financial Protection Bureau. He is currently the Special Advisor to the Secretary of the Treasury on the Consumer Protection Bureau. Prior to that, he worked for over a decade in the financial services industry, including stints at Capital One Financial and Deutsche Bank.

Mr. Date described the similarities between his job and that of bankruptcy lawyers pointing out that both deal with people getting wiped out because of something financial and both seek to help consumers.

The Consumer Financial Protection Bureau was a signature part of the Dodd-Frank legislation. He stated that its goal was making consumer financial markets work. Before Dodd-Frank, consumer protection functions were assigned to seven agencies which had other responsibilities as well.

He sketched out some recent history to show the need for the Bureau. He said that consumer debt exploded during the years before the financial crisis. He said that it “covered everything, big ticket, small ticket, secured unsecured. Everything grew and everything grew fast.” From 1999-2007, household debt nearly tripled. He cited college kids with credit cards, home mortgages with teaser rates and people exhausting their savings on high cost debt as emblematic of the period. Mr. Date said that consumers were signing up for “things they didn’t understand.”

Mr. Date noted that the mortgage industry was at the epicenter of the financial crisis. While lenders usually have incentives to ensure borrowers can pay them back, the mortgage industry was different. Because the brokers and banks that originated loans were compensated up front, risk and reward were delinked.

He also said that there was a breakdown in the market. Because originators could shop for the most favorable legal regime, they did so.

Additionally, there were problems with transparency. He defined transparency as both parties understanding the terms of the deal and talking about the same deal. Mr. Date said that transparency was absent during the years leading up to the financial crisis. The fastest growing products were things that were hard to understand. In order to gauge the risk involved in some financial products, it was necessary to have extensive knowledge of how the rate caps worked and interest rate history. He said that “problems of transparency continue today. Borrowers deserve to know what they are signing up for.”

Mr. Date was enthusiastic about the prospect of starting a new agency from the ground up. He quoted Steve Jobs for the proposition that “the only way to great work is to love what you do.” He described his challenge as creating new perspectives, creating a new structure and recruiting new talent.

Although the CFPB is only a few months old and lacks an Executive Director, it has grown to 690 employees, has begun taking consumer complaints, started education programs and has released examination guidelines. Notwithstanding the lack of an Executive Director, the authority to carry out the Bureau’s powers has transferred to the Secretary of the Treasury.

He pointed out that from 2001-2007, the volume of unusual mortgages exploded dramatically. He described one of the worst products offered as a mortgage with a one month teaser rate. He said that while the Bureau is working to clean up new originations, there are already $10 trillion in mortgages out there.

Mr. Date answered several questions related to mortgage servicing. He said that when he was in the financial services business, he would walk the floors of collection operations for automobile lenders and credit card lenders to evaluate whether to purchase the business. He said that they understood that there were some people who wouldn’t pay and planned for it.

On the other hand, income in the mortgage servicing industry is largely fixed regardless of whether the loan performs or does not. When a loan is performing, the cost to service the loan is less than the fees paid. However, when a loan is not performing, the servicer’s costs exceed their revenue. As a result, “the incentives don’t line up” for mortgage servicers to work with borrowers in default.

He also pointed out a disparity in that mortgage servicers can “fire” their borrowers by selling the portfolio to a new servicer, while borrower cannot fire their servicer.

The CFPB has released its manual for mortgage servicer examinations. Mr. Date said that in the past, examinations of mortgage servicers were neglected because these operations did not affect the “safety and soundness” of the financial institution. He said that the servicing manual does two things: it sets standards for consistency and lets servicers know what to expect.

Three different judges asked questions relating to home mortgage modifications. One judge spoke about debtors who submitted everything they were asked to and didn’t hear back for months only to be told their information had been lost. Another judge asked, “What do I do? What do I tell them?”

Mr. Date pointed out that mortgage brokers were good at holding consumers’ hands during the application process. However, no one is holding their hand in the modification process. He pointed out that the CFPB will put consumers in touch with HUD-approved housing counselors. This information is available at consumerfinance.gov.

He also said that enforcement was a tool available to the Bureau. He said that the Bureau would choose the right areas for investigation and bring cases when we need to. He said, “There are bad guys. If you don’t know who they are, you may be one yourself.”

National Conference of Bankruptcy Judges--10/14/11--Does the Bankruptcy World Need Another Talk on Stern v. Marshall?

2011-10-16T19:35:00.000-05:00

Prof. Ralph Brubaker and Prof. Ken Klee spoke on “Not Again! Will Bankruptcy Courts Survive the Supreme Court’s Second Look At Stern v. Marshall?” However, their panel could have been titled, “Does the Bankruptcy World Need Yet Another Talk on Stern v. Marshall?” Fortunately the answer was yes.

The History of Summary/Plenary

Prof. Brubaker discussed the history of bankruptcy adjudication going back “before the beginning” to English bankruptcy practice. He said that the summary/plenary distinction began with English bankruptcy commissioners. Commissioners operating under the supervision of the Lord Chancellor could administer bankruptcy estates and make certain determinations of law and fact, such as adjudicating claims. Their power was by the concept of in rem so that they could decide any question regarding property in the possession of the assignee, who was the equivalent of a trustee. If the assignee had to sue someone to recover property, that proceeding had to be brought in the appropriate superior court.

In the Bankruptcy Act of 1800, Congress expressly allowed non-Article III bankruptcy commissioners to adjudicate all summary proceedings in a manner similar to English practice. This principle became even more firmly in place in the Bankruptcy Act of 1898. The jurisdictional statute expressly stated that there was no plenary jurisdiction except for some matters such as preferences and fraudulent conveyances. The 1898 Act introduced non-Article III officers similar to commissioners designated as Bankruptcy Referees. The full extent of the referee’s authority was not defined with perfect clarity resulting in multiple Supreme Court decisions. The Supreme Court invoked the summary/plenary distinction finding that plenary matters had to be brought before an Article III judge, while bankruptcy referees could determine summary matters and their decisions would be given the same effect as one from an Article III judge.

When Congress reformed the bankruptcy laws in 1978, it expanded the scope of bankruptcy jurisdiction. Jurisdiction was now extended to any proceeding related to the Bankruptcy case. All of that very broad jurisdiction was to be exercised by non-Article III bankruptcy judges subject to appellate review. The Marathon decision struck down the 1978 jurisdictional scheme as unconstitutional. However, the Court in Marathon never said where the constitutional line was. Indeed, there was not even a majority opinion in the case. Nevertheless, he said that “the most obvious explanation for why the court found the Code unconstitutional was that the Marathon case would have been a plenary suit which should have been tried in an Article III court.

Congress reacted to Marathon by enacting the core/non-core distinction which Prof. Brubaker equated to a codification of the summary/plenary distinction. He noted that in Granfinanciera, Justice Brennan, who authored the Marathon plurality, equated the Seventh Amendment right to trial by jury with plenary suits under the Bankruptcy Act of 1898 that could only be tried in an Article III court. He said that Congress could not take away the right to jury trial by classifying a matter as a core proceeding. Prof. Brubaker described this as constitutionalizing the summary/plenary distinction. He noted that in Stern v. Marshall, Chief Justice Roberts relied heavily on Seventh Amendment decisions to establish the right to decision by an Article III judge.

Prof. Klee said that Stern v. Marshall was not a politically decided case. Rather, it was about fundamental power, whether non-Article III courts should be limited or whether their authority should be based on pragmatism.

Prof. Klee had two good lines that don’t otherwise fit with this post. He said “Vicki was well endowed in her own right but not financially.” He also said that as a result of Pierce Marshall’s attorneys decision to file a proof of claim “history was made.”

Power vs. Jurisdiction

Prof. Klee was quick to point out that Stern v. Marshall was not about jurisdiction. Jurisdiction was vested in the district court. The Bankruptcy Judge can decide matters if they are delegated by the District Court and that delegation is constitutional. As a result, the case was not about jurisdiction, but who could exercise that jurisdiction. He said this distinction was important to the question of whether parties could consent to decision by a Bankruptcy Judge. “If it’s just lack of power, you can consent. If it is lack of subject matter jurisdiction, you can’t consent.”

Public Rights

Chief Justice Roberts placed a lot of emphasis on the early case of Murray’s Lessee which held that if an action could have been decided by the English courts of law, equity or admiralty, they could not be assigned to non-Article III tribunals in the absence of a public rights exception.

According to Prof. Klee, the public rights exception in bankruptcy is probably limited to cases in which the United States is a party. (Although not pointed out by the speakers, the Chrysler and GM cases would be good examples of the public rights exception). However, he made the interesting comment that Justice Scalia’s concurrence showed that in his heart, he does not want to overturn the bankruptcy system because it is a long-established system. This was similar to his ruling in the BFP case in which he relied on the long-established practice of state foreclosure laws. Thus, for Justice Scalia, historical practice is a way to get to authority. Prof. Klee recommended perusing Blackstone’s Commentaries to look for historical practice.

Claims and Consent

Under Stern, Bankruptcy Courts can still decide proofs of claim. Filing a claim establishes a claim to the bankruptcy res and constitutes consent to adjudication of the claim itself. However, filing of a proof of claim does not constitute consent to anything beyond that. In Stern, Pierce Marshall’s filing of a proof of claim was not consent to determination of Vicki’s counterclaim. As the Supreme Court pointed out, Pierce really had no choice about filing a proof of claim, so he did not consent to anything beyond determination of the claim.

Prof. Brubaker said that filing a claim is only consent to determining the claim because that is a natural consequence of filing a claim.

Prof. Klee argued that “The current court is re-writing history. Under the Act, we had jurisdiction by ambush.” In Gardener v. New Jersey, the court held that the state’s filing of a proof of claim waived sovereign immunity. The Court also held that filing a proof of claim waived the Seventh Amendment right to jury trial. Prof Brubaker rejected the notion of jurisdiction by ambush as consent. “Jurisdiction by ambush means they are not consenting to anything.”

Supplemental Jurisdiction

Prof. Brubaker would analyze Stern v. Marshall as a case on supplemental jurisdiction. “The Stern majority never acknowledged supplemental jurisdiction, but signed on to it.” However, he said that the nexus for supplemental jurisdiction is “tightly circumscribed.” He said it is only available to the extent necessary to dispose of independent matters already before the court.

Things That Can Be Done or Not

Prof. Klee said that there are still many things Bankruptcy Judges can do. They can employ counsel, approve compensation (which drew applause from the audience) and administer the estate. However, he noted that according to Blackstone, English commissioners could not enter the discharge. They could certify the discharge to the Chancellor but could not enter it. He added, “If bankruptcy judges cannot enter discharges, we are in a new world.”

The professors had a vigorous discussion on whether bankruptcy judges could enter money judgments in nondischargeability cases. Prof. Klee thought it was permissible so long as the debtor was the defendant. On the other hand, Prof. Brubaker said that “historically courts have considered nondischargeability as a separate claim.” Prof. Klee responded that the debtor was res to which Prof. Bubaker said “nah.”

They also discussed whether Bankruptcy Courts could follow the report and recommendation procedure in core proceedings where the Bankruptcy Court lacked constitutional power to enter a final judgment. Prof. Klee pointed out that there were now three categories of cases: core proceedings where the Bankruptcy Court can constitutionally enter a final judgment, noncore proceedings in which the Bankruptcy Court may submit proposed findings of fact and conclusions of law and core proceedings in which the Bankruptcy Court lacks power to enter a final judgment. Prof. Brubaker said that if Congress had authorized courts to enter a final judgment, it implicitly had authorized them to take the lesser action of submitting proposed findings and conclusions. Prof. Klee, while initially taking the position that submitting proposed findings and conclusions was not authorized noted that the best retort to his own position was Stern v. Marshall in which the Supreme Court “didn’t bat an eye” when the District Court treated the Bankruptcy Court’s ruling as proposed findings and conclusions.

So What Are We Left With?

My question after listening to this discussion is whether the Bankruptcy Court has any broader power now than it did under the Bankruptcy Act of 1898 or than was possessed by English bankruptcy commissioners. I am more sanguine than the professors. I think that will be too difficult to turn back the clock on thirty years of expansive power exercised by Bankruptcy Judges. To the extent that historical practice or specialized expertise are grounds for vesting power in a non-Article III tribunal, there is a case for vesting more power in the Bankruptcy Courts than they enjoyed prior to 1979. Bankruptcy Courts have developed specialized expertise in dealing with the consequences of financial failure. They have developed into our national courts of commerce. While most historians would scoff at thirty years as a mere blip in time, it is significant enough that it will be difficult to roll back the clock.

National Conference of Bankruptcy Judges--10/14/11--The Long and the Short of It

2011-10-16T16:36:00.002-05:00

The Long and Short of It: Financial Engineering Meets Chapter 11 was one of the more esoteric presentations at the conference with an unusual lineup of panelists. The group included New York Bankruptcy Judge James Peck, investment banker David Barse, Professor Edward Janger, Dr. Riz Mokal from the World Bank and Edward Murray, an English solicitor. They discussed the effect of safe harbors granted to certain financial contracts under sections to 555 to 562 of the Code. These sections were extensively re-written by BAPCPA.

Certain financial contracts, such as swaps and repos are granted safe harbors under the Bankruptcy Code. These contracts can be liquidated, terminated or accelerated notwithstanding the Bankruptcy Code. They are also exempt from recovery under preference and fraudulent transfer theories. According to the panelists, this was done to protect the interest of sophisticated parties and avoid the risk of financial contagion. The rationale was that if one party went down, that the transaction could not be unwound and pull down the counter-party. Additionally, the ability to do close-out netting under a contract allows parties to reduce their risk.

One problem with these provisions is that, even with the extensive re-writing of definitions in 2005, the definitions are still imperfectly drawn. Section 555 applies to securities contracts and was intended to protected intermediaries. However, as written, it could apply to a transaction with Bernie Madoff’s Ponzi scheme.

Prof. Janger suggested that these provisions may have “done exactly the opposite of what they were supposed to do” in the 2008 financial crisis. He said that when a Bear Stearns or a Lehmann Brothers files bankruptcy, their hands are tied and they can’t reorganize. The drafters did not anticipate that large entities would be filing bankruptcy.

The panel debated whether the immunities granted to financial contracts increase the risk of transactions. Dr. Mokal noted that the provisions were put in the Code in 2005 and the financial crisis followed three years later.

Ed Murray described the immunities as a “safety net” and said that they did not eliminate incentives to monitor credit risk. He said that parties want to make good transactions and noted that “credit officers are a pain” regardless of the immunities.

David Barse was much more direct. He said, “If we don’t get comfort, we don’t participate. If secondary parties don’t participate, then primary can’t participate.” He described the protections as providing a “comfort zone” and said that “providing great clarity is very important.” He added that “the practical answer is that two parties to a contract should be allowed to play it out and shouldn’t be regulated.”

Dr. Mokal stated that the safe harbors are an important part of a sophisticated insolvency system. He said that in other countries, there are not sophisticated bankruptcy regimes and that there is “no certainty about the court’s ability to understand or apply sophisticated rules or statutes.” He said that this was “unlike in this country where courts understand exactly what Congress intended,” a comment which drew chuckles from the audience.

The panel also discussed how financial contracts could be used to commit mischief in the bankruptcy system. Prof. Janger discussed the problems of empty voting and the empty creditor where there is a separation of the economic interest from the ownership interest and separation of the economic interest from governance rightst in bankruptcy and workout situations. He said that creditors can go short and bet against a company’s reorganization and then cause trouble. He analogized the problem to a secured creditor voting its deficiency claim to sink the reorganization and acquire the asset. He said that the tools available to bankruptcy judges to combat this problem included disclosure under Rule 2019, designating ballots and subordination.

Mr. Barse said that this was a big problem. He said that creditors using ever more sophisticated tools can drive decisions on corporate governance. He said that while his firm doesn’t use these tools to drive corporate governance that they could be used by corporate raiders. He also added that “Derivatives are tools of destruction. We don’t really know what they do.”

National Conference of Bankruptcy Judges--10/13/11--The Not So Gloomy Economist

2011-10-15T06:35:00.003-05:00

Thursday’s lunchtime speaker was Gregory L. Miller, Chief Economist for SunTrust Banks, Inc. His presentation was not too gloomy but a bit disturbing. He began Saturday Night Live style saying, “I’m the economist and you’re not.”

Miller predicted that “there is not going to be a double dip recession.” He said that his “subjective prospect that the economy will fall into recession is not significant.” He estimated the prospect of recession at 25% which he said was not great because at any given time, there is a 15% prospect of recession.

On the other hand, Mr. Miller said that the rest of the world has a 60% chance of recession, noting that at least three countries in the Euro Zone were already in recession and that others were at risk.” Nevertheless, he said that, “whether or not the rest of the world goes into recession, we will not.” Mr. Miller suggested that a global recession could even help the United States, since it would make foreign goods less expensive. He said this would be good for lovers of French wine. He noted that despite the weak economy elsewhere in the world U.S. exports were still increasing.

Miller noted that the private sector in the United States was “fine under the circumstances” but that the “public sector is not pulling its weight at a time when it should be doing it.” He added that “Pulling the economy deeper when it’s already in the soup is not a government function but that’s what it’s doing.” Miller said that the private sector was growing at a rate of 3.6% while the overall economy was growing at a rate of 2.8% indicating that the public sector was a net drain of 0.8% on the economy.

Mr. Miller said that in the U.S. economy, the housing, government and credit sectors were weak. He said that the housing sector was at the bottom but that condos were “a virtual black hole.” He said that housing and credit are usually leading sectors, but that the rules are different now and the standards are higher. He said that two trillion dollars has been dumped into bank balance sheets where it is stuck in capital accounts of regulated banks who aren’t sure what their capital requirements are. He said that banks were reluctant to put loans on the books when they don’t know whether they will pass audit.

With regard to the labor market, he pointed out that the Obama administration’s current jobs bill consists largely of former Republican proposals. However, “the opposition is obliged to hate the dominant party’s policy even if it is the right thing.”

Mr. Miller noted that the current $450 billion proposal would have more effect than the previous $800 billion stimulus bill because it funneled money to the private sector where the multiplier is higher rather than the prior stimulus which went through state and local governments.

However, he said, “It’s not the jobs. Nine percent unemployment is not what’s wrong with the economy.” He said that the natural unemployment rate is 6% and that when we had 4% unemployment, there was too much employment in the economy. He said that 30% of the newly unemployed came from the construction and mortgage finance sectors. He said there is a mismatch between those who want jobs and those who are looking to employ. He said that two-thirds of the unemployed would likely remain unemployed and “we don’t want them employed.”

Miller said that interest rates will remain painfully low until at least the middle of 2012. Nevertheless, banks are finding it more profitable to park their cash at the Fed where they can earn 0.25% interest. He pointed out that reserves have increased from $500 billion to $3 trillion. He said that to get banks lending, the Fed would need to lower the rate it pays to zero or even charge banks to keep their cash parked at the Fed.

He said that the Euro sovereign debt crisis was a crisis of banking and culture, not an economic crisis. He said that U.S. banks held only 0.10% of their assets in European sovereign debt and that this was concentrated in banks that could afford to absorb the loss.

In summary, the U.S. economy is not going into recession, the prospect for the rest of the world looks bleak, unemployment is not going back to where it once was, banks are not lending and the U.S. government is dysfunctional. That’s about as rosy of a view as you can get from an economist.

National Conference of Bankruptcy Judges--10/13/11--Roundup of Business and Consumer Programs

2011-10-14T17:27:00.005-05:00

I am at the 2011 National Conference of Bankruptcy Judges in Tampa, Florida. For this first day, I heard a good mix of consumer and chapter 11 programs along with a provocative economist. Here are a few highlights.

Chapter 11 Issues

On the chapter 11 side, the topic du jour was In re DBSD North America, Inc., 634 F.3d 79 (2nd Cir. 2011) which was discussed by no less than three speakers. Prof. Troy McKenzie and Judge Mary Diehl each discussed the gifting aspects of the case, while Ronald Peterson talked about designation of votes in chapter 11.

Gifting

The latest word on “gifting” (that is, a senior creditor ceding value to a junior class of creditors over the objection of an intervening class) is that is violates the absolute priority rule. DBSD North America presented an extreme version in that secured creditors gave up value to equity who would receive value on account of, among other things, their equity interest. The Second Circuit held that this was a clear violation of the absolute priority rule. However, other scenarios were not as clear. For example, in In re SPM Manufacturing Corp., 984 F.2d 1305 (1st Cir. 1993), a secured creditor and a junior class reached a gifting agreement. However, no plan was confirmed and the case was converted to chapter 7. After the secured creditor obtained relief from the stay, it announced that it would honor its prior agreement. The court of appeals held that the secured creditor could do whatever it wanted with its money.

It seems that “gifting” only raises an absolute priority rule problem when it occurs under a plan and is “on account of” an equity interest. If it is done in the context of a 9019 compromise and settlement or a 363 sale, it is more likely to work. It was also suggested that because the absolute priority rule was enacted with equity interests in mind, a gifting arrangement between two classes of creditors might pass muster.

Designation of Ballots

Ron Peterson discussed the history of designation of ballots. Prior to the Chandler Act in 1937, the Bankruptcy Act did not contain a provision for disallowing a ballot. However, a case involving a hotel in Waco, Texas prompted William O. Douglass to press for a disallowance of ballot provision. In that case, Hilton Hotels invested substantial monies in a hotel in Waco, Texas under a lease. The debtor cancelled the lease and filed for reorganization. Hilton Hotels bought up a blocking position in the debtor’s unsecured debt and insisted that the lease be reinstated. In that case, there was no provision to prevent the attempt to hijack the reorganization.

Since that time, designation of ballots has been allowed where a creditor votes to put a competitor out of business, acts based on sheer malice, acts on inside information or seeks to gain an unfair advantage over other similar creditors. In DBSD North America, the court of appeals affirmed a decision to designate ballots of a competitor who purchased a blocking position with the intent to gain control of the debtor’s telecommunications spectrum rights. On the other hand, where a creditor strikes a hard bargaining position but acts out of economic self-interest, its vote will be allowed. In the words of Gordon Gecko, “greed is good.”

I was disappointed that Ron did not discuss my case on designating ballots, In re The Landing Associates, Ltd., 157 B.R. 791 (Bankr. W.D.Tex. 1993). However, since he mostly stuck to circuit cases, this was not surprising.

Rights Offerings

Clifton Jessup gave an interesting talk on rights offerings. Fortunately, Judge Diehl made him explain what a rights offering was. A rights offering is an offer by the debtor to sell securities (usually equity securities) to its existing creditors at a discount in order to obtain financing to emerge from bankruptcy. Rights offerings also involve a backstop party who agrees to purchase any securities not purchased by others in return for a fee.

Structured Dismissals

Nan Coleman from the Executive Office of the U.S. Trustee and Prof. Troy McKenzie discussed structured dismissals. A structured dismissal is a procedure where the debtor’s assets are sold and then a case is dismissed with conditions. Those conditions may include affirming protections to the purchaser in the 363 sale, releases to parties and a modified claims procedure. Ms. Coleman advocated that U.S. Trustee position that structured dismissals are contrary to the Bankruptcy Code and should not be allowed. She said, “Let’s be clear. It’s not a gift. It’s a quid pro quo. Someone is getting something and someone is giving up something. Prof. McKenzie offered a tepid defense stating that some features in structured dismissals raise eyebrows but that “perhaps they should be given a little room to develop before they are squelched.”

Employment of Counsel/Committee Solicitation

Employment of counsel and committee solicitation were both discussed in the ethics portion of the program. In an unusual opinion, Judge Michael Lynn has ruled that debtor’s counsel need not be disinterested. In re Talsma, 436 B.R. 908 (Bankr. N.D. Tex. 2010). If debtor’s counsel is owed fees, it may sell its claim prior to bankruptcy to avoid being disqualified for being a creditor. In re 7677 E. Berry Ave. Assoc., LP, 419 B.R. 833 (Bankr. D. Col. 2009). However, this did not work when payment for the claim was contingent on what the purchasing creditor received in the bankruptcy. In re Fish & Fischer, Inc., 2010 WL 5256992 (Bankr. S.D.Miss. 2010).

In re Universal Building Products, 2010 WL 4642046 (Bankr. D. Del. 2010) illustrates that state disciplinary rules apply when soliciting a committee. In that case, prospective committee counsel asked a Chinese speaking party they had a prior relationship with if he would contact Chinese speaking creditors. He was offered the position of translator for the committee. Model Rule 7.3 restricts direct solicitation of prospective clients and Delaware had adopted a version of this rule. Based on the violation of Rule 7.3, counsel was disqualified from representing the committee.

Consumer Issues

Untangling the Mortgage Morass: Rules, Rogues and Repairs

This panel handled the sexy topic of the new Bankruptcy Rules applicable to mortgage claims which takes effect in December 2011. The panel did a good job of laying out the history of the rules and issues likely to arise.

The rules had their genesis with Jones v. Wells Fargo Bank, 366 B.R. 584 (Bankr. E.D. La. 2007) and Padilla v. GMAC Mortgage, 389 B.R. 409 (Bankr. E.D. Pa. 2007). These cases raised the specter of a debtor successfully completing a chapter 13 plan and then immediately being posted for foreclosure based on undisclosed charges that accrued during the bankruptcy proceeding.

Under the new rules, there are three changes which will take effect in December. First, mortgage claims must include an attachment listing delinquent amounts as of the petition date, including any charges and the date they were incurred. Among other things, this will require disclosure of the amount of escrow shortage as of the petition date. Fed.R.Bankr .P. 3001(c)(2), Official Form 10, Attachment A. Next, mortgage creditors must give notice of a change in payment amount 21 days before it takes effect. Fed.R.Bankr. 3002.1(b), Official Form 10, Supplement 1. Additionally, mortgage creditors must give notice of post-petition fees and costs incurred every 180 days. Fed.R.Bankr.P. 3002.1(c),(d). Finally, at the conclusion of a chapter 13 case, the trustee or debtor must give a Notice of Final Cure Payment. Fed.R.Bankr.P. 3002.1(f).

The panel identified several interesting issues under these rules. One issue is that the form does not take a position on how to calculate the escrow shortage. The Third and Fifth Circuits have taken the position that any amount charged to the debtor for escrow pre-petition is escrow shortage, In re Rodriguez, 629 F.3d 136 (3rd Cir. 2010) and In re Campbell, 545 F.3d 348 (5th Cir. 2008), while one major mortgage servicer has taken the position that only amounts advanced out of pocket prior to the petition date constitute escrow shortage. As pointed out by Judge Eugene Wedoff (Bankr. N.D. Ill.), this makes a big difference. Because the escrow shortage is part of the pre-petition claim, it can be paid out over the life of the plan. However, if amounts accrued but unpaid are not considered pre-petition claims, then they are included in the post-petition escrow amount and must be paid within one year. John Rao stressed that it was important to avoid doublecounting by including the escrow shortage in the proof of claim and then seeking to recoup it post-petition as part of the ongoing mortgage payment. A petition for cert has been filed in the Rodriguez case and the Supreme Court has requested that the Solicitor General comment, which is a sign that the court may be considering granting the petition.

The new attachment to proof of claim must be signed. Faiq Mihlar suggested that before attorneys sign the attachment that they read the Third Circuit’s opinion in In re Taylor, 2011 U.S. App. LEXIS 17651 (3rd Cir. 2011) in which an attorney was sanctioned for signing claims without reading them or knowing whether they were accurate. He said that the best practice was to have the attorney prepare the attachment and have the client review and sign it. He said that while he enjoyed appearing in court, he preferred not to do so as a witness.

John Rao pointed out that the 21 day period for providing the notice of change in payment is the same period provided under RESPA. He said that the new form is merely a cover sheet and that the mortgage servicer may simply attach its regular notice of payment terms.

When giving notice of charges incurred during the case, it is only necessary to give notice of charges that will be sought to be charged to the borrower. It is important that charges only be listed once. For example, if a lender incurs attorney’s fees in one six month period and they are not paid, it should only report new attorney’s fees incurred subsequently and should not report the prior fees again.

If the creditor does not give timely notice of the fees incurred, it is barred from collecting them later. The failure to request fees could be the basis for judicial estoppel in a subsequent state court proceeding.

Mark Redmiles from the U.S. Trustee’s office explained the procedure for giving notice of completed cure payment. Within 30 days after completion of payments, the trustee or debtor must give notice that payments have been completed. The mortgage creditor has 21 days to respond. If the creditor does not respond, then the loan is deemed to be current.

Faiq Mihlar argued that the 21 day period was too short and that lenders would not have time to receive the document and act on it. This raised the possibility that conniving debtors could simply fail to make their last several payments before completion of the plan knowing that the lender would probably fail to respond to the Notice of Final Cure Payment. Judge Wedoff suggested that the creditor could request an extension of time under Rule 9006 if it could not respond within the deadline. He also suggested raising the time limit with the rules committee.

So You Think Consumer Bankruptcy Is Easy? Challenges of a Complex Code

This panel discussed several difficult consumer issues. However, the best comment did not relate to the specific topics. Judge Shelley Chapman (Bankr. S.D. N.Y.) acknowledged that prior to taking the bench eighteen months ago, she had only practiced chapter 11 law. She described the chapter 13 docket as “the hardest thing I have done so far.” She said that it was “a daunting task” facing a room full of consumer bankruptcy lawyers. Judge Chapman’s humility and candor were refreshing.

This illustrates how the selection of bankruptcy judges has changed. In the 1980s, the circuits often appointed judges with no prior bankruptcy experience. Today, the circuits tend to favor chapter 11 practitioners. While this is a marked improvement, it still leaves a gap in the judge’s experience.

The panel had a lively discussion on whether a wholly unsecured junior lien could be stripped in a chapter 20 case (a chapter 7 followed by a chapter 13). In a chapter 20 case, the debtor is not entitled to a discharge in the chapter 13 case. Can he strip off the junior lien based on its lack of security?

Judge Chapman opined that, perhaps it was her chapter 11 bias, but that “allowed secured claim” meant that a claim was secured within the meaning of Section 506(a),that secured claim equates to economic interest. She stated that she requires the second lienholder to grant a release and give it to the chapter 13 trustee to hold in escrow until completion of payments.

John Clement, the debtor’s lawyer on the panel, argued against lienstripping. He argued that secured claim referred to the state law security interest. He cited the Supreme Court decisions in Dewsnup v. Timm, 112 S.Ct. 773 (1992) and Nobelman v. American Savings Bank, 113 S.Ct. 2106 (1993) as evidence that the Supreme Court does not look favorably upon the economic definition of secured claim.

John Gustafson, a chapter 13 trustee, warned that practitioners should be careful how far they push the issue. While most circuits currently allow lienstripping in chapter 20 cases, the Supreme Court might not be so favorable.

John Gustafson discussed the problem of social security income in chapter 13 cases. Under the means test, social security income is not counted. However, what about the debtor who has a high income and is also receiving social security? Should this debtor be allowed to pay less? In chapter 7, the problem is addressed by the distinction between Section 707(b)(2) and 707(b)(3). While Section 707(b)(2) applies the means test, Section 707(b)(3) examines the totality of the circumstances in cases in which the means test is satisfied. Perhaps the good faith requirement of Section 1325(a)(4) should fulfill a similar purpose.

Frederick Clement noted that BAPCPA was intended to take discretion away from bankruptcy judges while the totality of the circumstances approach to good faith would grant discretion. Mr. Gustafson countered that “sure it’s subjective but so is Section 707(b)(3).” He likened it to putting a bandaid over our glasses and not looking at the social security income. He also suggested that if judges couldn’t consider extra social security income alone, perhaps they could consider it along with other factors, such as the debtor wanting to keep a Harley (apparently that’s a bad thing).

Frederick Clement talked about the tension between the binding nature of a plan under Section 1327(a) and the ability to modify a plan under Section 1329(a). If the debtor confirms a plan and later decides that he doesn’t want to pay as much, “is there some threshold other than I want to” when proposing a modification? If not, how is the plan binding? He gave the example of In re Noble, in which the debtor proposed to retain a vehicle and later sought to surrender it. The Court held that the Debtor was bound.

John Gustafson asked whether creative lawyers could draft around such future contingencies. He suggested that a debtor could offer to make extra payments up front in return for the option to surrender the vehicle later in the plan.

Frederick Clement pointed out that in Ransom v. FIA Card Services, 131 S.Ct. 716 (2011)and Hamilton v. Lanning, 130 S.Ct. 2464 (2010), the Supreme Court appeared to assume that debtors could modify their plans at will. He said “If that is the case, how are you bound at all?” He suggested that a plan could only be modified for substantial and unanticipated circumstances and only to address the specific changes authorized in Section 1329, such changing the payment amount or length of the plan. He noted that while you could change the term of the plan, you could not change the “applicable commitment period” so that an above median debtor could not shorten a plan to less than 60 months.

Sanctions for Attempting to File a Piece of Paper?

2011-10-11T11:46:00.004-05:00

The PACER and CM/ECF programs have revolutionized the practice of bankruptcy law. Thanks to PACER, I can download a document filed in almost any district in the country for the low price of $.08 per page (soon to go up to $.10 but still cheap). Thanks to CM/ECF, I can meet a deadline to file a pleading from home at 11:59 p.m.

The purpose of PACER and CM/ECF is to offer greater public access to government records. According to the Administrative Office of the U.S. Courts:

The Case Management/Electronic Case Filing (CM/ECF) system is the Federal Judiciary's comprehensive case management system for all bankruptcy, district and appellate courts. CM/ECF allows courts to accept filings and provide access to filed documents over the Internet.

CM/ECF keeps out-of-pocket expenses low, gives concurrent access to case files by multiple parties, and offers expanded search and reporting capabilities. The system also offers the ability to: immediately update dockets and make them available to users, file pleadings electronically with the court, and download documents and print them directly from the court system.

The Dark Side

While these electronic access programs make the system more transparent, democratic and user-friendly there is also a dark side. Mandatory e-filing can be burdensome on the casual filer, such as a state court practitioner who rarely ventures into bankruptcy court. Many courts have adopted procedures to assist pro se parties and occasional filers. Some examples include allowing paper filing with court permission, allowing documents to be submitted on disk or be scanned at the clerk's office and allowing proofs of claim to be filed without a CM/ECF password and login.

A Scary Order

However, in an extreme case, a court in Pennsylvania has charged an attorney a $150 "processing fee and sanction" for filing a paper document. You can see an image of the order below (I apologize for the poor copy).

In pertinent part, the order states:

(T)he Court has determined that a processing fee and sanction of $150.00 shall be assessed in the event of any failure to comply with the rules concerning electronic filing. The processing fee and sanction shall be paid each time an attorney files a document by means other than the Court's CM/ECF system.

The attorney named below has filed a document on paper, disk or via scanning at the Clerk's office in violation of the Court's long standing procedures in this regard, therefore,

It is hereby ORDERED, ADJUDGED and DECREED that on or before October 7, 2011, Attorney (name redacted) shall pay a $150 processing fee and sanction for failure to electronically file a document with this Court by use of its CM/ECF system. This fee must be paid from the funds of the attorney or his law firm. counsel shall not charge to or collect the $150.00 from the client as a fee, cost, expense. or other charge in this case.

Why It's Bad

This order concerns me for (at least) three reasons. The first is a matter of due process. I have read the local rules of the Bankruptcy Court for the Western District of Pennsylvania. There is no provision for a processing fee or sanction for attempting to file a document other than electronically. Indeed, the Court's procedure manual explicitly states that submitting a document on disk or scanning it at the clerk's office is allowed. Because the order does not distinguish between filing on paper, disk or by scanning at the clerk's office, the order punishes behavior that is expressly allowed by the court's procedures.

Second, I have trouble finding a justification for the order. It is my understanding that individual judges do not have the authority to set fees. While the judicial conference of a circuit may authorize certain miscellaneous fees, I don't think individual judges have this power. I also don't believe that this qualifies as sanctionable conduct. It doesn't fall within Rule 9011 and it is my understanding that the court's inherent authority to sanction is limited to cases of bad faith.

Finally, I have a philosophical objection to the order. One of the stated purposes for the Bankruptcy Code was to break up the incestuous "bankruptcy rings" where local attorneys, trustees and judges had an overly cozy relationship to the exclusion of outsiders. The E-Government Act of 2002 was intended to make government records more accessible. This order violates both of these purposes. It brings the judicial power of the United States down on an attorney who made a procedural mistake. While the amount of the sanction is minimal, it is still a court-imposed sanction which must be reported in some cases. A careful review of the Court's rules and procedures would not have disclosed the peril (although the attorney would have seen that something called e-filing was mandatory). Besides the shock of receiving a judicial reprimand by return mail, the order also sends the message that outsiders practice here at their peril.

Admittedly, bankruptcy is a technical and difficult area of the law. Through the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Congress made it much more challenging for the average practitioner to wander into bankruptcy court representing a consumer debtor. Nonetheless, the courts, as public servants, should use their power to make the courts more accessible rather than less. This order is offensive.

Steve Jobs and Bankruptcy

2011-10-06T11:28:00.003-05:00

Tech visionary Steve Jobs died yesterday. One of many items being circulated about him is a commencement address he gave at Stanford in 2005. I have copied it in its entirety below. However, I wanted to focus on one passage which speaks to what we do as bankruptcy lawyers. Here, Jobs talks about being fired from Apple, the company he had founded, at age 30:

I didn't see it then, but it turned out that getting fired from Apple was the best thing that could have ever happened to me. The heaviness of being successful was replaced by the lightness of being a beginner again, less sure about everything. It freed me to enter one of the most creative periods of my life.

During the next five years, I started a company named NeXT, another company named Pixar, and fell in love with an amazing woman who would become my wife. Pixar went on to create the worlds first computer animated feature film, Toy Story, and is now the most successful animation studio in the world. In a remarkable turn of events, Apple bought NeXT, I returned to Apple, and the technology we developed at NeXT is at the heart of Apple's current renaissance. And Laurene and I have a wonderful family together.

I'm pretty sure none of this would have happened if I hadn't been fired from Apple. It was awful tasting medicine, but I guess the patient needed it. Sometimes life hits you in the head with a brick. Don't lose faith. I'm convinced that the only thing that kept me going was that I loved what I did. You've got to find what you love. And that is as true for your work as it is for your lovers. Your work is going to fill a large part of your life, and the only way to be truly satisfied is to do what you believe is great work. And the only way to do great work is to love what you do. If you haven't found it yet, keep looking. Don't settle. As with all matters of the heart, you'll know when you find it. And, like any great relationship, it just gets better and better as the years roll on. So keep looking until you find it. Don't settle.

Steve Jobs was able to take a monumental setback and come back brilliantly. As bankruptcy lawyers, we give both individuals and companies the opportunity to recover from devastating financial losses. Who knows--the next individual debtor who you help to get a fresh start or the next company you reorganize may use that opportunity to develop something revolutionary just as Steve Jobs did.

Steve Jobs: "Find What You Love"

I am honored to be with you today at your commencement from one of the finest universities in the world. I never graduated from college. Truth be told, this is the closest I've ever gotten to a college graduation. Today I want to tell you three stories from my life. That's it. No big deal. Just three stories.

The first story is about connecting the dots.

I dropped out of Reed College after the first 6 months, but then stayed around as a drop-in for another 18 months or so before I really quit. So why did I drop out?

It started before I was born. My biological mother was a young, unwed college graduate student, and she decided to put me up for adoption. She felt very strongly that I should be adopted by college graduates, so everything was all set for me to be adopted at birth by a lawyer and his wife. Except that when I popped out they decided at the last minute that they really wanted a girl. So my parents, who were on a waiting list, got a call in the middle of the night asking: "We have an unexpected baby boy; do you want him?" They said: "Of course." My biological mother later found out that my mother had never graduated from college and that my father had never graduated from high school. She refused to sign the final adoption papers. She only relented a few months later when my parents promised that I would someday go to college.

And 17 years later I did go to college. But I naively chose a college that was almost as expensive as Stanford, and all of my working-class parents' savings were being spent on my college tuition. After six months, I couldn't see the value in it. I had no idea what I wanted to do with my life and no idea how college was going to help me figure it out. And here I was spending all of the money my parents had saved their entire life. So I decided to drop out and trust that it would all work out OK. It was pretty scary at the time, but looking back it was one of the best decisions I ever made. The minute I dropped out I could stop taking the required classes that didn't interest me, and begin dropping in on the ones that looked interesting.

It wasn't all romantic. I didn't have a dorm room, so I slept on the floor in friends' rooms, I returned coke bottles for the 5¢ deposits to buy food with, and I would walk the 7 miles across town every Sunday night to get one good meal a week at the Hare Krishna temple. I loved it. And much of what I stumbled into by following my curiosity and intuition turned out to be priceless later on. Let me give you one example:

Reed College at that time offered perhaps the best calligraphy instruction in the country. Throughout the campus every poster, every label on every drawer, was beautifully hand calligraphed. Because I had dropped out and didn't have to take the normal classes, I decided to take a calligraphy class to learn how to do this. I learned about serif and san serif typefaces, about varying the amount of space between different letter combinations, about what makes great typography great. It was beautiful, historical, artistically subtle in a way that science can't capture, and I found it fascinating.

None of this had even a hope of any practical application in my life. But ten years later, when we were designing the first Macintosh computer, it all came back to me. And we designed it all into the Mac. It was the first computer with beautiful typography. If I had never dropped in on that single course in college, the Mac would have never had multiple typefaces or proportionally spaced fonts. And since Windows just copied the Mac, it's likely that no personal computer would have them. If I had never dropped out, I would have never dropped in on this calligraphy class, and personal computers might not have the wonderful typography that they do. Of course it was impossible to connect the dots looking forward when I was in college. But it was very, very clear looking backwards ten years later.

Again, you can't connect the dots looking forward; you can only connect them looking backwards. So you have to trust that the dots will somehow connect in your future. You have to trust in something — your gut, destiny, life, karma, whatever. This approach has never let me down, and it has made all the difference in my life.

My second story is about love and loss.

I was lucky — I found what I loved to do early in life. Woz and I started Apple in my parents garage when I was 20. We worked hard, and in 10 years Apple had grown from just the two of us in a garage into a $2 billion company with over 4000 employees. We had just released our finest creation — the Macintosh — a year earlier, and I had just turned 30. And then I got fired. How can you get fired from a company you started? Well, as Apple grew we hired someone who I thought was very talented to run the company with me, and for the first year or so things went well. But then our visions of the future began to diverge and eventually we had a falling out. When we did, our Board of Directors sided with him. So at 30 I was out. And very publicly out. What had been the focus of my entire adult life was gone, and it was devastating.

I really didn't know what to do for a few months. I felt that I had let the previous generation of entrepreneurs down - that I had dropped the baton as it was being passed to me. I met with David Packard and Bob Noyce and tried to apologize for screwing up so badly. I was a very public failure, and I even thought about running away from the valley. But something slowly began to dawn on me — I still loved what I did. The turn of events at Apple had not changed that one bit. I had been rejected, but I was still in love. And so I decided to start over.

I didn't see it then, but it turned out that getting fired from Apple was the best thing that could have ever happened to me. The heaviness of being successful was replaced by the lightness of being a beginner again, less sure about everything. It freed me to enter one of the most creative periods of my life.

During the next five years, I started a company named NeXT, another company named Pixar, and fell in love with an amazing woman who would become my wife. Pixar went on to create the worlds first computer animated feature film, Toy Story, and is now the most successful animation studio in the world. In a remarkable turn of events, Apple bought NeXT, I returned to Apple, and the technology we developed at NeXT is at the heart of Apple's current renaissance. And Laurene and I have a wonderful family together.

I'm pretty sure none of this would have happened if I hadn't been fired from Apple. It was awful tasting medicine, but I guess the patient needed it. Sometimes life hits you in the head with a brick. Don't lose faith. I'm convinced that the only thing that kept me going was that I loved what I did. You've got to find what you love. And that is as true for your work as it is for your lovers. Your work is going to fill a large part of your life, and the only way to be truly satisfied is to do what you believe is great work. And the only way to do great work is to love what you do. If you haven't found it yet, keep looking. Don't settle. As with all matters of the heart, you'll know when you find it. And, like any great relationship, it just gets better and better as the years roll on. So keep looking until you find it. Don't settle.

My third story is about death.

When I was 17, I read a quote that went something like: "If you live each day as if it was your last, someday you'll most certainly be right." It made an impression on me, and since then, for the past 33 years, I have looked in the mirror every morning and asked myself: "If today were the last day of my life, would I want to do what I am about to do today?" And whenever the answer has been "No" for too many days in a row, I know I need to change something.

Remembering that I'll be dead soon is the most important tool I've ever encountered to help me make the big choices in life. Because almost everything — all external expectations, all pride, all fear of embarrassment or failure - these things just fall away in the face of death, leaving only what is truly important. Remembering that you are going to die is the best way I know to avoid the trap of thinking you have something to lose. You are already naked. There is no reason not to follow your heart.

About a year ago I was diagnosed with cancer. I had a scan at 7:30 in the morning, and it clearly showed a tumor on my pancreas. I didn't even know what a pancreas was. The doctors told me this was almost certainly a type of cancer that is incurable, and that I should expect to live no longer than three to six months. My doctor advised me to go home and get my affairs in order, which is doctor's code for prepare to die. It means to try to tell your kids everything you thought you'd have the next 10 years to tell them in just a few months. It means to make sure everything is buttoned up so that it will be as easy as possible for your family. It means to say your goodbyes.

I lived with that diagnosis all day. Later that evening I had a biopsy, where they stuck an endoscope down my throat, through my stomach and into my intestines, put a needle into my pancreas and got a few cells from the tumor. I was sedated, but my wife, who was there, told me that when they viewed the cells under a microscope the doctors started crying because it turned out to be a very rare form of pancreatic cancer that is curable with surgery. I had the surgery and I'm fine now.

This was the closest I've been to facing death, and I hope it's the closest I get for a few more decades. Having lived through it, I can now say this to you with a bit more certainty than when death was a useful but purely intellectual concept:

No one wants to die. Even people who want to go to heaven don't want to die to get there. And yet death is the destination we all share. No one has ever escaped it. And that is as it should be, because Death is very likely the single best invention of Life. It is Life's change agent. It clears out the old to make way for the new. Right now the new is you, but someday not too long from now, you will gradually become the old and be cleared away. Sorry to be so dramatic, but it is quite true.

Your time is limited, so don't waste it living someone else's life. Don't be trapped by dogma — which is living with the results of other people's thinking. Don't let the noise of others' opinions drown out your own inner voice. And most important, have the courage to follow your heart and intuition. They somehow already know what you truly want to become. Everything else is secondary.

When I was young, there was an amazing publication called The Whole Earth Catalog, which was one of the bibles of my generation. It was created by a fellow named Stewart Brand not far from here in Menlo Park, and he brought it to life with his poetic touch. This was in the late 1960's, before personal computers and desktop publishing, so it was all made with typewriters, scissors, and polaroid cameras. It was sort of like Google in paperback form, 35 years before Google came along: it was idealistic, and overflowing with neat tools and great notions.

Stewart and his team put out several issues of The Whole Earth Catalog, and then when it had run its course, they put out a final issue. It was the mid-1970s, and I was your age. On the back cover of their final issue was a photograph of an early morning country road, the kind you might find yourself hitchhiking on if you were so adventurous. Beneath it were the words: "Stay Hungry. Stay Foolish." It was their farewell message as they signed off. Stay Hungry. Stay Foolish. And I have always wished that for myself. And now, as you graduate to begin anew, I wish that for you.

Stay Hungry. Stay Foolish.

Thank you all very much.

Supreme Court Preview: No Blockbusters Scheduled Yet

2011-10-03T13:54:00.004-05:00

Today is the first Tuesday in October which marks the start of the Supreme Court's October Term 2011. So far the Court has granted cert in forty-eight cases, only one of which involves bankruptcy. There are a few interesting petitions pending but no bombshells like last term's Stern v. Marshall.

Cert Granted:

No. 10-875, Hall v. United States. This case concerns whether post-petition capital gains in a chapter 12 case constitute a claim against the estate. The case arises because chapter 7 and chapter 11 cases give rise to a separate taxable estate while chapter 12 and chapter 13 cases do not. The Ninth Circuit found that because a chapter 12 estate is not a taxable entity, it could not "incur" a tax. Because the estate did not incur the tax, the tax could not be treated under the debtor's plan. The Ninth Circuit position conflicts with opinions from the Eighth Circuit and the Tenth Circuit Bankruptcy Appellate Panel.

You can read the docket here.

Petitions Pending:

No. 11-166, RadLAX Gateway Hotel, LLC v. Amalgamated Bank. This case raises the Philadelphia Newspapers issue of whether a plan can propose a sale of property without allowing the lender to credit bid. The Seventh Circuit ruled that it could not. The Third Circuit has allowed a sale without credit bidding as the "indubitable equivalent" of the creditor's claim.

You can read the docket here.

No. 10-1285, Countrywide Mortgages v. Rodriquez. This case has to do with the troublesome issue of how to calculate escrow payments on a mortgage claim in chapter 13. The Third Circuit held that, notwithstanding RESPA, the lender could not factor pre-petition escrow shortgages into the debtor's post-petition payment. The Fifth Circuit has ruled consistently with the Third Circuit.

You can read the docket here.

Cert Denied:

No. 10-1443, AmeriCredit Financial Services v. Penrod. This case involved whether a creditor who financed negative equity still had a purchase money security interest under the hanging paragraph of Section 1325(a). The Ninth Circuit said that it did not, while the other eight circuits to consider the issue ruled in favor of the purchase money status. The Supreme Court denied cert today. This means that the circuit split is not resolved.

Security is the Enemy of Achitecture

2011-09-26T11:25:00.005-05:00

The Austin Bankruptcy Court is housed in the Homer Thornberry Judicial Building. When the building was converted from a post office to a courthouse, the designers included an elegant entryway. Alas, this was before Oklahoma City and 9/11. Now the entryway is covered by a gate and a sign directing those with business in the building to the functional entrance, the one with the metal detector. While it is sad that the vision of the architect has been overshadowed, at least we are secure.

Southern District Submits Model Plan for Individual Chapter 11 Cases for Comment

2011-09-25T15:14:00.002-05:00

The Southern District of Texas has proposed several local rules for public comment. One of the interesting proposals is a model plan to be used by individual chapter 11 debtors.

You can find the announcement with links to related documents here.

You can find the link to the proposed model plan here.

Civility Begins On the Bench

2011-09-25T11:57:00.004-05:00

One of the legacies of the Works Progress Administration was the construction of majestic federal courthouses and courtrooms. When you walk into the en banc courtroom of the Fifth Circuit Court of Appeals in New Orleans or Judge Leif Clark's courtroom in San Antonio or any one of dozens of other courtrooms, it is hard not to be filled with reverence for the important work which goes on there. However, several recent incidents of judicial incivility prompted the Above the Law blog to ask the question:

Can you enforce civility by being… uncivil? That’s the question being raised, over and over again, by federal judges from Texas these days.

Above the Law's query was prompted by three incidents: an order dated August 26, 2011 from U.S. District Judge Sam Sparks inviting lawyers to a "kindergarten party," an email reprimand from Chief Judge Edith Jones dated August 30, 2011 and Chief Judge Jones's own comments telling fellow Circuit Judge Dennis to "shut up" in oral argument on September 20, 2011.

Act I: An Invitation to a Kindergarten Party

The series of highly unfortunate events began when non-parties to a civil action sought to quash deposition notices addressed to them. This prompted an order from Judge Sparks which included the following language:

Greetings and Salutations!

You are invited to a kindergarten party on THURSDAY, SEPTEMBER 1,2011, at 10:00 a.m. in Courtroom 2 of the United States Courthouse, 200 W. Eighth Street, Austin, Texas.

The party will feature many exciting and informative lessons, including:

• How to telephone and communicate with a lawyer
• How to enter into reasonable agreements about deposition dates
• How to limit depositions to reasonable subject matter
• Why it is neither cute nor clever to attempt to quash a subpoena for technical failures of service when notice is reasonably given; and
• An advanced seminar on not wasting the time of a busy federal judge and his staff because you are unable to practice law at the level of a first year law student.

Invitation to this exclusive event is not RSVP. Please remember to bring a sack lunch! The United States Marshals have beds available if necessary, so you may wish to bring a toothbrush in case the party runs late.

Morris v. Coker, et al, No. A-11-MC-712-SS (W.D. Tex.). The order was disturbing on several levels. First, it pre-judged the dispute as frivolous and implicitly threatened imprisonment without having heard the merits. Second, the order castigated the objecting parties for wasting the court's time when Fed.R.Civ.P. 45 dictates that failure to comply with a subpoena is punishable by contempt, thus requiring a party to act promptly to avoid waiving an objection, even a technical objection. Finally, the order gave little concern to the fact that the subpoenas were addressed to non-parties who were involuntarily drawn into the dispute.

Act II: The Email Heard Round the District

Chief Judge Edith Jones of the Fifth Circuit Court of Appeals responded promptly, critiquing Judge Sparks for his "cute" orders.

Dear Sam,

It has not escaped my attention, or that of my colleagues or, I am told, nationally known blog sites that you have issued several ‘cute’ orders in the past few weeks. The order attached below is the most recent.

Frankly, this kind of rhetoric is not funny. In fact, it is so caustic, demeaning, and gratuitous that it casts more disrespect on the judiciary than on the now-besmirched reputation of the counsel. It suggests either that the judge is simply indulging himself at the expense of counsel or that he is fighting with counsel in what, as Judge Gee used to say, is surely not a fair contest. It suggests bias against counsel.

No doubt, none of us has been consistently above reproach in our professional communications with counsel. We are all prone to human error. But no judge who writes an order should allow such rhetoric to overcome common sense.

Ultimately, this kind of excess, as I noted, reflects badly on all of us. I urge you to think before you write.

Sincerely,
Edith Jones.

When contacted by the Texas Lawyer, Judge Jones stated that she was "saddened that somebody breached the intended limited scope of the intended distribution." However, the fact that she copied all of the District Judges of the Western District of Texas on the email virtually guaranteed that it would be leaked.

Act III: Judge Dennis Gets a Talking To for Talking Too Much

In United States v. Delgado, No. 07-11401 (5th Cir. 1/19/11), a panel of the Fifth Circuit reversed a criminal conviction. Judge James L. Dennis, joined by Judge Wiener, wrote the opinion, while Judge Clement dissented. On September 20, 2011, the en banc court heard oral arguments. At 47:40 in the argument, which you can listen to here, the following exchange took place:

MR. TURNER: I think the amount of drugs in that truck supports the intent to distribute. And the jury….

JUDGE DENNIS: Well, we’ve said over and over that the amount…. this court, no court has said that you can infer….
CHIEF JUDGE JONES: Judge Dennis….
JUDGE DENNIS: … just on the basis of the amount of drugs …
CHIEF JUDGE JONES: Judge Dennis!
JUDGE DENNIS: Can I, can I, can I ask a question?
CHIEF JUDGE JONES: You have monopolized, uh, uh, seven minutes….
JUDGE DENNIS: Well, I’m way behind on asking questions in this court. I have been quiet a lot of times, and I am involved in this case….
CHIEF JUDGE JONES slams her hand down on the table (loudly), stands halfway up out of her chair, and points toward the door.
CHIEF JUDGE JONES: Would you like to leave?
JUDGE DENNIS: Pardon? What did you say?
CHIEF JUDGE JONES: I want you to shut up long enough for me to suggest that perhaps….
JUDGE DENNIS: Don’t tell me to shut up….
CHIEF JUDGE JONES: … you should give some other judge a chance to ask a question …
JUDGE DENNIS: Listen, I have been in this courtroom many times and gotten closed out and not able to ask a question. I don’t think I’m being overbearing….
CHIEF JUDGE JONES: You’ve been asking questions for the entire seven minutes….
JUDGE DENNIS: Well, I happen to be through. I have no more questions.
CHIEF JUDGE JONES: I just want to offer any other judge an opportunity to ask a question. Some may support your position. If nobody else chooses to ask a question, then please go forward.

(I am relying on Above the Law's transcription. Please listen to the argument yourself to ensure the accuracy of the statements quoted).

It is not surprising that the author of the panel opinion would take an active role in the en banc argument. Indeed, when I appeared before the en banc court earlier this year, Judge Jones engaged me in spirited questioning throughout most of my allotted time. I found that the opportunity to engage the strongest opponent of my position to be quite rewarding.

Civility Begins at the Top

The media is full of images of lawyers behaving badly in court, whether it is Arthur Kirkland screaming "You're out of order, this whole trial is out of order" in "And Justice for All," Captain Harmon Rabb discharging an automatic weapon in the courtroom in the TV series JAG and Louis Litt (in my favorite new lawyer show Suits) berating a deponent who later suffers a heart attack. That is how the world of entertainment portrays us.

In the real world, judges have a right to expect a high standard of conduct from the lawyers appearing in front of them. In Matter of First City Bancorporation, 282 F.3d 864 (5th Cir. 2002), the Fifth Circuit not only upheld but increased an award of sanctions against a lawyer who repeatedly abused opposing counsel and parties. The court rejected the defense that his hyper-obnoxious approach brought results.

However, civility begins at the top. Serving as a federal judge (whether under Article I or Article III) is one of the highest honors an attorney can receive. Federal judges should treat the high office they hold with respect, even when attorneys engage in unnecessary discovery disputes or a colleague monopolizes oral argument. To her credit, Chief Judge Jones did apologize at the conclusion of the session's arguments. However, it would have been better if she had held her tongue in the first instance.

Post-Script

I have made intemperate remarks in the past and will, no doubt, do so again. I live in a glass house and sometimes I throw stones when I shouldn't. When that happens, please feel free to throw my own words back at me.

Good Opinion on Requests for Admissions

2011-09-22T14:04:00.004-05:00

Call me crazy, but I believe that trial should be about each side presenting their case within the limits of the Rules of Evidence. I tend to be very skeptical about what I call trial by exclusion, the use of procedural rules to prevent the other guy from putting on his evidence. It does not take much legal skill to win a case when the other guy has to stand there gagged and silent. That is why I was heartened to see a recent opinion out of the Texas Third Court of Appeals which struck down an improper request for admission. Lucas v. Clark, No. 03-10-00474-CV (Tex. App.--Austin, 6/15/11). You can find the opinion here.

Under the Texas Rules of Civil Procedure, a party may serve discovery requests together with the petition. In this case, the Plaintiff included a request for admission which stated:

Request for Admission 2: As a proximate result of your breaching the contract made the basis of this suit, the Plaintiffs have suffered consequential damages in an amount not less than ten million dollars.

The defendant did not answer the lawsuit or the requests for admissions. As a result, the Plaintiff requested a default judgment. The only evidence of damages offered was the deemed admission. The Court awarded damages of $10 million.

On appeal, the Court of Appeals (in an opinion written by Justice Henson and joined by Chief Justice Jones and Justice Goodwin) said not so fast.

The primary purpose of requests for admissions is to “simplify trials by eliminating matters about which there is no real controversy.” (citation omitted). They were never intended to be used as a demand upon a plaintiff or defendant to admit that he had no cause of action or ground of defense. Id. Courts have cautioned that litigants should not be allowed to use requests for admissions as a tool to trap their opposition. (citation omitted). The rule regarding requests for admissions “was designed, not as a trap to prevent the presentation of the truth in a full hearing but as a tool for the fair disposition of litigation with a minimum of delay.” (citation omitted). When a party uses deemed admissions to try to preclude presentation of the merits of a case, however, due process concerns may arise. Therefore, overly broad, merits-preclusive requests for admissions are improper and may not result in deemed admissions. (citations omitted).

Opinion, pp. 6-7.

As a result, the Court of Appeals found that the request for admission should not be given evidentiary effect and found that there was no evidence as to damages. The Court of Appeals reversed and remanded for a new hearing on damages.

This is a good opinion, indeed a courageous opinion. I applaud the Austin Court of Appeals for their ruling.

Here is a rebuttal to this post from James Jolly Clark, the plaintiff in the case. He sent this to me with the title "Sather's crap." These are Mr. Clark's words with no editing by me.

Call me crazy & you are wrong - Lucas was served as it was proven by the process server in testimonial deposition, under oath and the opportunity to file for a trial after Travis County sent him a letter telling him he had a judgment against him. He fully acknowledged he received that notification. In addition, he had the opportunity to file for a Bill Of Review. The deemed admissions outlined some of the losses. They were actually over $50 million, with a personal invested cash loss of over $1,000,000 and another $1,300,000 loss in assets. Was the Plaintiff supposed to go to Lucas's home and beg him to accept service? As a former banker, Lucas knew very well he was served and what he had to do to avoid a judgment. The law suit came about by his purposely, with greedy malice afore thought, reneging on a contact, trying to run Clark into bankruptcy, so he could steal Clark's company for 10¢ on the dollar from a trustee. We found that long before the suit was filed, he set up a corporation to take over the company. I called 4 attorneys looking for one to assist me in filing garnishments - 3 of the 4 had sued Lucas. (If that tells you anything.) Not only did Judge Diane Henson not speak to the 3 issues raised by Lucas in his appeal, she had to go way, way out in left field to manufacturer a fuzzy reason to negate settled law on deemed admissions in order to overturn this judgment. No where in the judgment did it mention lost profits which she said was the reason for her decision. It appears she personally decided a person should not get $10 million on a default judgment and didn't give a damn about the law. If it had been $1,000,000 I 'm sure the outcome would have been different. She was way off base, dead wrong and has added insult to my grievous financial injury, caused by Lucas. My only hope now is if the good Republican Supreme Court does not listen to this liberal Democrat and her manufactured musings, overturns her and affirms "Deemed Admissions" as settled law.

Fifth Circuit to Consider Impact of Stern v. Marshall on U.S. Magistrates

2011-09-21T16:53:00.006-05:00

While the paparazzi followed every move of Anna Nicole Smith during her tragically shortened life, those of us of the legal paparazzi now stalk every new development in the case which bears her legal name, Stern v. Marshall. Some commentators have asked whether the newly emphasized limitations on the jurisdiction of U.S. Bankruptcy Judges to enter final judgments will apply to U.S. Magistrates as well. The Fifth Circuit has indicated that it will soon be considering this issue.

On September 9, 2011, the Fifth Circuit directed the parties to submit

letter briefs of not more than six pages addressing whether the reasoning of Stern applies to magistrate judges, which, like bankruptcy judges, are not Article III judges, and whether, under Stern, a magistrate judge can enter final judgment in a case tried to a magistrate judge by consent under 28 U.S.C. § 636(c) where jurisdiction is based on diversity of citizenship and state law provides the rule of decision.

Technical Automation Services Corp. v. Liberty Surplus Insurance Corporation, No. 10-20640 (5th Cir. 9/9/11), Order, p. 2.

Thus, it looks like there may be a circuit-level opinion on Stern v. Marshall sooner rather than later.

Hat Tip to Prof. Ken Klee.

You can read the order in full below.

Sloppiness Does Not Equal Vexatiousness or Bad Faith

2011-09-21T10:10:00.003-05:00

Dealing with mortgage servicers can be frustrating. Sometimes it is difficult or impossible to get a clean chain of title or a good accounting. In a new opinion by Judge Stacey Jernigan, the Court was faced with a request for fees incurred by a chapter 13 debtor's counsel in dealing with two motions for relief from stay over a three year period, one of which was withdrawn and the other one of which was denied for failure to prove standing. Counsel sought to recover fees based on 28 U.S.C. Sec. 1927 and the court's inherent authority. In a well-reasoned opinion, Judge Jernigan concluded that Rule 9011 was the proper vehicle for seeking fees based on deficient pleadings and that the present case did not rise to the high standard necessary to award fees under Sec. 1927 or the Court's inherent authority. In re Pastran, No. 06-34728 (Bankr. N.D. Tex. 9/20/11). You can find the opinion here.

While the twenty-two page opinion is worth reading in its entirety, I will leave you with the conclusion:

The court is certainly cognizant of the fact that the mortgage servicing industry does not always show itself to be the perfect, well-oiled machine that one would hope it to be. As more and more individuals have gone into default on their home mortgages and resorted to seeking bankruptcy protection, bankruptcy courts have seen certain problems that exist in the home mortgage servicing industry, particularly issues when it comes to chain of title and other documentation. Some of these cases may require bankruptcy courts to take action and issue appropriate orders to ensure that such practices do not continue; however, in this case, the court does not believe it to be a good exercise of discretion to do so.

The court would conclude by stating that Rule 11 seems to be the more appropriate tool to use when requesting sanctions or fee shifting, not only because it allows a party an opportunity to remedy any mistakes it may have made, but also because it seems to make parties engage in a dialogue which could ultimately facilitate settlement. The court found it very enlightening to read Debtor’s Exhibit G, which was a myriad of emails that were exchanged between Debtor’s Counsel and HWALLP over the approximately 3-year period that this matter was pending. From the court’s review of these emails, there was certainly no evidence of inappropriate behavior by HWALLP, AHMSI, or Citi. In fact, the overall tone of the emails was quite professional and courteous. If anything, this case appeared to be one primed for settlement, as there were significant discussions about a possible loan modification. However, settlement and/or a loan modification never happened. Instead, HWALLP filed the Citi Stay Lift Motion and the AHMSI Stay Lift Motions with certain chain of-custody gaps and documentation errors (first no indorsement; then ultimately an indorsement-in-blank supplied but not offered into evidence). While this was sloppy and bad form (which justified denying stay relief), this, in and of itself, did not rise to the level of bad faith or vexatious litigation that would legitimize fee shifting. (emphasis added).

Opinion, pp. 20-22.

Court Finds Recharacterization of "Loans" Depends on State Law

2011-08-20T16:47:00.004-05:00

The Fifth Circuit has upheld a Texas bankruptcy court's order recharacterizing the ostensible debt of a non-insider as equity. Matter of Lothian Oil Incorporated, No. 10-50683 (5th Cir. 8/9/11). Unlike other circuits to consider the issue, the Fifth Circuit relied on Sec. 502(b) and Texas state law rather than the Court's equitable powers under Sec. 105. You can find the opinion here.

What Happened

Israel Grossman advanced $350,000.00 to Lothian Oil pursuant to two ambiguous documents. The documents stated that Grossman "loans" or "shall loan" a sum of money to the company. In return for the "loans," he would receive a royalty from certain oil wells "without further investment" and would receive repayment of the funds advanced from certain equity placements.

When Lothian filed for Chapter 11, Grossman filed numerous proofs of claim. Some were allowed. However, the Bankruptcy Court denied the two claims making up the $350,000 on the basis that they were equity rather than debt. The District Court reversed, holding that recharacterization could only be applied to insiders.

The Fifth Circuit's Approach to Recharacterization

The Fifth Circuit upheld the Bankruptcy Court's recharacterization order, but did not rely on the Court's equitable powers under Sec. 105(a). In doing so, the Court broke with the Third, Fourth and Sixth Circuits.

The opinion, authored by Chief Judge Edith Jones, relied on a seductively simple logic. Under Sec. 502(b)(1), a claim shall be allowed unless it is "unenforceable against the debtor . . . under any agreement or applicable law." The term "applicable law" refers to State law. Thus, if state law would classify an instrument as equity rather than debt, the Court should disallow the claim and recognize the interest as equity.

Taken together, Butner and § 502(b) support the bankruptcy courts’ authority to recharacterize claims. If a claim asserts a debt that is contrary to state law, the bankruptcy court may not allow the claim. Moreover, where the reason for such disallowance is that state law classifies the interest as equity rather than debt, then implementing state law as envisioned in Butner requires different treatment than simply disallowing the claim. The Fourth Circuit identified the inadequacy of traditional disallowance in noting that “[w]hen a bankruptcy court disallows a claim, the claim is completely discharged. By contrast, recharacterization is appropriate when the claimant has some rights via-a-vis the bankrupt.” In re Dornier Aviation, Inc., 453 F.3d 225, 232 (4th Cir. 2006) (internal citation omitted; emphasis in original). These rights, fixed by state law, are not irrelevant to the court’s decision to disallow a claim. To the contrary, recharacterizing the claim as an equity interest is the logical outcome of the reason for disallowing it as debt.

Opinion, p. 6.

Because Sec. 502(b) and state law provided a direct route to determining the issue, it simply was "unnecessary" to resort to Sec. 105. Similarly, equitable subordination under Sec. 510(c) was not implicated.

Equitable subordination and recharacterization, although sometimes based on the same facts, are directed at different conduct and have different remedies.

Id.

Applying the Test

Turning to Texas state law, the Court found that Texas uses a sixteen factor test imported from federal tax law. Thus, it was a case of a federal court turning to state law which redirected the Court back to federal law. The Court also noted that the Fifth Circuit has also applied a thirteen-factor test and an eleven-factor test. Fortunately, the confluence of these tests does not require the Court to weigh the sixteen, thirteen and eleven factors together in a forty-point balancing test. Instead, it is a more organic exercise of asking: Does this look more like debt or equity? (Ed.--my characterization, not the Court's).

In the specific case, although the documents used the word "loan" in them, they did not provide for an interest rate, terms of repayment or a maturity date. Instead, they would be paid from royalties and "equity placements." Critical to the Court's ruling "was the inclusion of a royalty payment, which depended on the success of Lothian's business, instead of a prescribed interest rate." Opinion, p. 8.

An Objective Test

This brief opinion is a welcome addition to bankruptcy jurisprudence. In my practice, I have often seen equitable subordination and recharacterization applied interchangably as a rule against recognizing insider debt. The Lothian opinion helpfully distinguishes between the two doctrines and applies an objective test for determining recharacterization. The opinion also diminishes the relevance of insider status. While insiders may face greater scrutiny, they do not face automatic recharacterization.

Bidders Reimbursed For Auction Which Never Occurred: The Fifth Circuit's ASARCO Opinion

2011-08-20T15:25:00.006-05:00

The Fifth Circuit has ruled that, under the facts of the specific case, that bidders could recover their costs without a showing of direct benefit to the estate. Matter of ASARCO LLC, No. 10-40930 (5th Cir. 8/16/11). The specific holding was that reimbursement of costs incurred in submitting a bid were governed by the business judgment standard under 11 U.S.C. Sec. 363(b) rather than the benefit to the estate standard under 11 U.S.C. Sec. 503(b). You can find the opinion here.

A Billion Dollar Judgment And An Auction That Wasn't

This was a case about a big judgment and a unique procedure to auction off that judgment. In 1999, Grupo Mexico S.A.B. de C.V. (Grupo Mexico) purchased ASARCO. ASARCO owned 260 million shares of Southern Peru Copper Company (SCC). Through a series of transfers, the SCC shares were transferred from ASARCO to a subsidiary of Grupo Mexico. After ASARCO filed for chapter 11 relief in 2005, it sued the transferee, which was a subsidiary of Grupo Mexico. ASARCO won big. It obtained a judgment for actual fraudulent transfer, aiding and abetting a breach of fiduciary duty and conspiracy. ASARCO LLC v. Americas Mining Corp., 396 B.R. 278 (S.D. Tex. 2008). Not only did it get the shares back, but it also recovered a judgment for $1.4 billion. ASARCO LLC v. Americas Mining Corp., 404 B.R. 150 (S.D. Tex. 2009). (I have included the citations here because they are informative opinions for fraudulent transfer litigation).

Having a valuable asset in hand, ASARCO proposed a plan of reorganization. Its plan was to be funded in part by selling the SCC Judgment. It proposed a two-stage bid solicitation process. In the first stage, its financial adviser identified potential bidders for the judgment. In a variant on the typical auction process, ASARCO invited a select group of bidders to proceed to the second phase of the process. In order to entice the bidders to perform the expensive legal due diligence necessary to evaluate the asset, ASARCO sought and obtained an order from the Bankruptcy Court authorizing it to reimburse qualified bidders for their due diligence expenses. The Bankruptcy Court granted the motion finding that ASARCO had demonstrated a "compelling and sound business justification" for the order.

Grupo Mexico appealed the reimbursement order which was stayed. Meanwhile Grupo Mexico confirmed a plan of reorganization which paid all creditors in full, released the judgment and gave it control of ASARCO. Since Grupo Mexico now controlled ASARCO, ASARCO was not interested in defending the appeal. However, two of the bidders were granted leave to intervene and defend the order.

The Appeal

On appeal, the Appellants argued that because the sale was never concluded, there was not a benefit to the estate and the bidders expenses could not be reimbursed under Sec. 503(b). The bidders argued that the Bankruptcy Court could authorize the payment under the business judgment standard of Sec. 363(b). The business judgment test was a lower bar since it looked at whether the order was reasonable at the time it was sought; on the other hand, the benefit to the estate standard would have analyzed the benefit in hindsight.

The Fifth Circuit distinguished two Third Circuit cases which had disallowed break-up fees. While the Third Circuit had rejected break-up fees on the ground that they chilled the bidding, here the Fifth Circuit found that the reimbursement order sought to increase competition and was offered to all bidders invited to the second round. The Fifth Circuit also distinguished the break-up fee cases on the basis that the auction involved a "very unique and very valuable but possibly worthless asset."

The Ruling

In upholding the order, the Fifth Circuit wrote:

On this record, we conclude that the business judgment standard is the better fit for assessing ASARCO’s reimbursement motion. Section 363 addresses the debtor’s use of the estate property, and in its motion ASARCO sought authorization to make discretionary use of the estate’s funds. Section 503, in contrast, generally applies to third parties that have already incurred expenses in connection to the debtor’s estate. The unsuccessful bidders in O’Brien and Reliant Energy sought payment for expenses incurred without the court’s preapproval for reimbursement, and thus section 503 was the proper channel for requesting payment. In ASARCO’s case, however, the bankruptcy court issued the Reimbursement Order before any potential qualified bidders, including the Intervenors, had incurred due diligence and work fees. In this context, application of the business judgment standard is appropriate.

Opinion, pp. 11-12. Having concluded that the business judgment standard applied, the court had no difficulty finding that the standard had been satisfied.

In a final footnote, the Court hinted that it would have upheld the award under the benefit to the estate standard as well, noting that the District Court had found that the auction process "was perhaps the final impetus needed to encourage the Parent to file its plan which pays creditors in full."

Why It Matters

This case is important for two reasons. One is that large bankruptcy cases are increasingly being resolved by Sec. 363 sales. There are not many circuit level opinions on 363 sales, since most appeals are rendered moot by the sale closing. As a result, any opinion which explains the Sec. 363 process is useful.

Second, this particular opinion, while very fact specific, provides some useful pointers. First, reimbursement orders should be obtained before any due diligence expenses are incurred. Second, the complexity of the asset will influence the advisability of reimbursing due diligence costs. There is a big difference between a tract of raw land and a billion dollar judgment. Finally, and perhaps most importantly, reimbursement orders are justifiable when they will increase competition. In the typical case, a stalking horse bidder is granted reimbursement if it is outbid. This encourages the stalking horse to invest in the due diligence necessary to submit a bid. Conversely, it can be used to tilt the auction procedures in favor of the stalking horse. Here, the unique aspect of the process was that all bidders invited to the second round were granted a right of reimbursement. Thus, the process was even-handed and fostered competition rather than inhibiting it.

Court Orders Turnover of Attorney Files in Billion Dollar Case

2011-08-13T16:50:00.004-05:00

Attorneys are entrusted with a lot of sensitive information. The attorney-client privilege exists to allow clients to speak candidly with their attorneys. However, when the same attorney represents multiple parties, the privilege may not be so absolute. In the case of In re Crescent Resources, LLC, No. 09-11507 (Bankr. W.D. Tex. 7/22/11), Bankruptcy Judge Craig Gargotta was asked to decide who could access the attorney files in a billion dollar dispute. You can find the opinion here.

What Happened

Crescent Resources was a real estate development and management organization. It was formed by Duke Energy Corporation to manage and develop approximately 300,000 acres of real estate owned by Duke. Crescent grew over the years, eventually operating about 100 projects through over 120 entities. In 2006, Duke, Crescent and several real estate investment entities entered into a series of transactions where the Crescent entities pledged their assets to secure a loan from Bank of America in the amount of $1.225 billion, much of which was upstreamed to Duke.

By June 2009, the Crescent entities had filed for chapter 11 in Austin, Texas. The Court confirmed a plan which created a litigation trust. The litigation trust sued Duke Energy Corporation, et al alleging that the 2006 transaction rendered the debtors insolvent. Shortly after filing suit, Dan Bensimon, the litigation trustee, filed a motion to compel a firm named Robinson, Bradshaw & Hinton, P.A. (RBH) to turn over its files with regard to work done for the debtors. RBH responded that it had concerns about Duke's rights to keep the files confidential. After five months of procedural wrangling, the Court conducted a hearing and took the matter under advisement.

The files at issue fell into three categories: 1) pre-2006 files from the period when Crescent was a subsidiary of Duke; 2) files related to the 2006 transaction (known as Project Galaxy); and 3) files subsequent to 2006 when Crescent was no longer a Duke subsidiary.

On July 22, 2011, the Court delivered its decision. Based on stipulations, it was largely clear that Crescent was a joint client with Duke for the pre-2006 files and was the sole client for the post 2006 files. That left the Project Galaxy files. The Court ruled that the Trust was a joint client and thus entitled to use the files in its litigation with Duke.

Turnover/Burden of Proof

Section 542 has two relevant subsections relating to turnover. Sec. 542(a) provides that a person in possession of property which the trustee may use, sell or lease shall turn over such property to the trustee. On the other hand, Sec. 542(e) provides that "(s)ubject to any applicable privilege . . . an attorney, accountant, or other person that holds recorded information . . . related to the debtor's property or financial affairs" can be ordered to "turn over or disclose such recorded information to the trustee."

The Court found that the Trust had the initial burden to establish that the files "related to the debtor's property or financial affairs." At that point, the burden would shift to Duke to show that there was an attorney-client privilege between Duke and the law firm. The Court also rejected arguments from Duke that the Trust's burden had to be met by clear and convincing evidence. Instead, it found that the preponderance standard applied.

Project Galaxy

Having established this framework, the Court, following the lead of the parties, apparently assumed that the Trust had met its burden to show that the files related to the debtor's property or financial affairs. As a result, the Court spent the rest of its opinion discussing whether the Trust was "a joint or sole client, or no client at all, of RBH with respect to the Project Galaxy files." Opinion, p. 13.

Duke made an interesting argument. It suggested that RBH represented Crescent prior to Project Galaxy and after Project Galaxy, but that Crescent was not represented at all during Project Galaxy.

The Trust argues that RBH represented Crescent Resources, while Duke would have the Court believe that RBH jointly represented Crescent Resources before the 2006 Duke Transaction and after the 2006 Duke Transaction, but not during the 2006 Duke Transaction. Duke further alleges that Crescent Resources was not represented by counsel at all during the 2006 Duke Transaction.

Opinion, p. 14.

The Court had to analyze North Carolina law to determine whether Crescent had an attorney client relationship with RBH. North Carolina considers the question to be primarily one of fact and does not rely on formalities.

The Trust was able to bring forward some pretty good evidence. In its application to be employed in the Crescent bankruptcy case, RBH stated that it had represented Crescent since 1986. It also presented an Opinion letter in which RBH stated that it had represented Crescent and certain of its subsidiaries in connection with the execution and delivery of a credit agreement. Finally, several of the RBH lawyers stated that they had represented Crescent in $1.5 billion credit transaction.

Duke argued that it retained RBH to represent it in the transaction and that everyone but Crescent was represented by counsel. Duke presented evidence such as the engagement letter and declarations from RBH lawyers. However, the Engagement Letter stated that the firm was engaged to represent Duke Energy (or any of its subsidiaries or affiliates)." All invoices were submitted to and paid by Duke. Furthermore, RBH said that it took its direction from Duke and not Crescent and that no one at Crescent ever said that they thought they were represented by RBH.

The Court weighed several factors under North Carolina law, finding that:

1. Crescent was not represented by other counsel;
2. Crescent had been represented by RBH in the past;
3. RBH had access to Crescent's confidential information;
4. The services were billed to Duke, not Crescent;
5. RBH represented Crescent after the transaction;
6. There was no withdrawal of representation.

Weighing these factors, the Court found that RBH did, in fact, represent Crescent during the Galaxy Project transaction.

The Court relied on North Carolina law to find that "where two or more persons employ the same attorney to act for them in some business transaction, their communications to him are not ordinarily privileged inter sese." The Court also relied upon its own decision in In re Bounds, 443 B.R. 729 (Bankr. W.D. Tex. 2010), a case in which I represented the debtor subsequent to the events in the opinion.

In the end, the Court found that Crescent was a joint client and could use the files in its litigation with Duke but not otherwise.

The Court's order has been appealed and is subject to a stay pending appeal. As a result, it may be a while before the Trustee finds out what, if anything, is contained in the law firm's files. However, given the effort that Duke is taking to keep the files confidential, it may well be interesting.

I think the take away from this case is that if you are doing a billion dollar deal, make sure that everyone has their own counsel. It will be more expensive and may be more difficult, but at least your privileged will be protected.

Disclosure: My firm has engaged Dan Bensimon as a consultant and expert in several cases. Indeed, I would go so far as to say that he is a friend of the firm and an all around good guy. However, we do not represent him in the Crescent case and this post is based solely on my reading of Judge Gargotta's 39-page opinion. If you want to know as much as I do, read the opinion for yourself.

En Banc Fifth Circuit Changes Course on Judicial Estoppel

2011-08-12T17:44:00.003-05:00

In an important ruling, the Fifth Circuit Court of Appeals sitting en banc ruled that a debtor's nondisclosure would not bar a trustee from pursuing a large judgment for the benefit of creditors. Reed v. City of Arlington, No. 08-11098 (5th Cir. 8/11/11). The opinion overruled an earlier panel decision. You can read the new opinion here.

A Quick Trip Through the Facts

Diane G. Reed was appointed chapter 7 trustee for debtor Kim Lubke. When Lubke filed his schedules, he neglected to mention that he had recovered a one million dollar judgment against the City of Arlington. He omitted several other assets as well. While the bankruptcy was proceeding, Lubke's case went up to the Fifth Circuit, which remanded for a new calculation of damages. At this point, the Debtor mentioned his bankruptcy to his trial lawyer, Roger Hurlbut. Hurlbut promptly informed the trustee about the undisclosed claim. However, when the trustee sought to intervene as real party in interest, the City of Arlington withdrew an offer of judgment and sought summary judgment based on judicial estoppel. U.S. District Judge Terry Means rendered a mixed decision. He ruled that the trustee was not barred by judicial estoppel, but that the debtor would be barred from any recovery.

On appeal to the Fifth Circuit, Chief Judge Edith Jones authored an opinion finding that both the debtor and the trustee were estopped from pursuing the claim. I wrote about the panel opinion in Fifth Circuit Muddles Judicial Estoppel; En Banc Review Needed. The decision set up a conflict between the circuit's two most prominent bankruptcy experts. Chief Judge Jones dismissed a prior opinion by Judge Carolyn King, In re Kane, 535 F.3d 380 (5th Cir. 2008), on the basis that it "purported" to distinguish prior precedents.

The Trustee, supported by the Commercial Law League of America as amicus curiae, sought en banc review.

On August 11, 2011, the full court released its opinion. Judge Carolyn King, joined by eleven other judges wrote the majority opinion, while Chief Judge Edith Jones, joined by two other judges penned the dissent.

The Majority Opinion

The majority set the tone for its opinion with a statement of purpose.

Here, we apply judicial estoppel “against the backdrop of the bankruptcy system and the ends it seeks to achieve.” (citation omitted). These ends are to “bring about an equitable distribution of the bankrupt’s estate among creditors holding just demands,” (citation omitted), and to “grant a fresh start to the honest but unfortunate debtor,” citation . Therefore, judicial estoppel must be applied in such a way as to deter dishonest debtors, whose failure to fully and honestly disclose all their assets undermines the integrity of the bankruptcy system, while protecting the rights of creditors to an equitable distribution of the assets of the debtor’s estate.

Opinion, p. 4.

The Court cited the three-part test which has been a consistent factor in its decisions:

(1) the party against whom judicial estoppel is sought has asserted a legal position which is plainly inconsistent with a prior position;

(2) a court accepted the prior position; and

(3) the party did not act inadvertently.

In applying the test, the Court found that four factors supported a decision that the trustee was not bound by the debtor's omission:

1. The result followed from bankruptcy law;
2. The result followed from equity;
3. The result was consistent with the Court's prior precedents; and
4. The result was consistent with other circuits.

A. Judicial Estoppel and Bankruptcy Law

The Court wrote:

Judicial estoppel, as an equitable remedy, must be consistent with the law. (citations omitted). In this case, the relevant law is the Bankruptcy Code, which distinguishes between the debtor and the debtor’s estate immediately upon the filing of a Chapter 7 bankruptcy. Therefore, while Lubke himself was properly estopped for his dishonesty, his post-petition misconduct does not adhere to the Trustee, who received the judgment asset free and clear of a defense that arose exclusively from Lubke’s post-petition actions.

Opinion, p. 5. The Court walked through a series of Code sections with regard to property of the estate, the role of the trustee and preservation of undisclosed causes of action. The Court noted that the trustee inherits causes of action subject only to defenses existing on the petition date. As a result, the debtor's post-petition misconduct in concealing a cause of action could not bind the trustee.

B. Equity

Judge King found that equity favored the trustee as well. She wrote:

Because judicial estoppel is an equitable doctrine, courts may apply it flexibly to achieve substantial justice. (citation omitted). “The challenge is to fashion a remedy that does not do inequity by punishing the innocent.” (citation omitted). Estopping the Trustee from pursuing the judgment against the City would thwart one of the core goals of the bankruptcy system—obtaining a maximum and equitable distribution for creditors—by unnecessarily “vaporizing” the assets effectively belonging to innocent creditors.

Lubke’s unsecured creditors, including his FMLA attorney Roger Hurlbut, filed timely proofs of claim in the reopened bankruptcy case in the sum of $504,951.87. Other creditors filed late claims in the sum of $84,846.61. Those creditors having meritorious claims are entitled to an equitable distribution of the estate’s assets, which include the judgment against the City.

Opinion, pp. 8-9.

In its equitable analysis, the Court rejected an argument that it was inequitable to allow a claim to be pursued where an attorney would be the primary benefactor:

The City argues that equity does not favor the Trustee. Chief among its complaints is the fact that Roger Hurlbut, whose claim for legal fees stemming from the FMLA action makes him the primary creditor of Lubke’s estate, is an attorney. Section 726 of the Bankruptcy Code requires the property of the estate to be distributed without considering whether the debt is owed to an attorney, a credit card company, or any other type of creditor. (citation omitted). Unable to articulate why Hurlbut’s occupation is relevant here, the City suggests that Hurlbut is somehow associated with Lubke’s deception and is therefore not an innocent creditor. The district court explicitly found otherwise, (citation omitted), and we find no reason to doubt its conclusion.

Opinion, p. 9. As an attorney, I am encouraged that the court rejected the appeal to attorney bashing.

C. Prior Precedents

Between 1999 and 2010, the Fifth Circuit decided four cases involving judicial estoppel in bankruptcy. Those cases can be summarized as follows:

In re Coastal Plains, Inc., 179 F.3d 197 (5th Cir. 1999). Debtor's insider failed to disclose claim and then bought assets of the debtor. Purchasing company entered into a sharing agreement with the trustee where the trustee would receive only 15% of the proceeds. Judicial estoppel applied because the "recovery would benefit the individual who actually perpetrated the bankruptcy fraud in great disproportion to the bankruptcy estate."

In re Superior Crewboats, Inc., 374 F.3d 330 (5th Cir. 2004). Debtors did not schedule the claim and incorrectly told the trustee that the claim was proscribed by the statute of limitations. As a result, the trustee abandoned the claim. The Court held that the debtors were estopped to pursue the undisclosed/mis-disclosed claims.

Kane v. National Union Fire Insurance Co., 535 F.3d 380 (5th Cir. 2008). Debtor failed to disclose claim. Trustee sought to pursue claim. Judicial estoppel was not applied.

Reed v. City of Arlington, 620 F.3d 477 (5th Cir. 2010). Debtor failed to disclose claim. Trustee sought to pursue claim. Judicial estoppel applied to trustee.

In analyzing the precedents, the Court concluded that the common factor was that the cases turned on whether an innocent trustee sought to pursue claims for the benefit of innocent creditors. Under this test, the panel opinion in Reed v. City of Arlington was the odd case out.

D. Other Circuits

The Court noted that its ruling was consistent with rulings in the Seventh, Tenth and Eleventh Circuits. Biesek v. Soo Line Railroad Co., 440 F.3d 410 (7th Cir. 2006); Eastman v. Union Pacific Railroad Co., 493 F.3d 1151 (10th Cir. 2007); Parker v. Wendy's International, Inc., 365 F.3d 1268 (11th Cir. 2004).

By harmonizing its result with sister circuits, the Fifth Circuit avoided a circuit split and reduced the likelihood of a trip to the Supreme Court.

The Bottom Line

Absent unusual circumstances, an innocent bankruptcy trustee may pursue for the benefit of creditors a judgment or cause of action that the debtor—having concealed that asset during bankruptcy—is himself estopped from pursuing.

Opinion, p. 13.

The Dissent

In dissent, Chief Judge Jones argued that the majority's bankruptcy centered inquiry was too narrow. She wrote:

With due respect to my brethren, I respectfully dissent from their balancing of the equities in this case and from one significant legal point. We do not disagree on the general principles governing judicial estoppel except for one thing. The majority posits that only the interests of the bankruptcy process are involved here. I would contend that the federal district and circuit courts are part of the relevant judicial process, and that a broader view should have been taken of the impact of satellite litigation generated by Lubke’s deception. First, our court had to expend significant resources concluding an opinion in the original appeal of this case, only to find that the plaintiff was no longer the proper party. Accordingly, we were required to remand for reconsideration by the district court a plethora of procedural issues made necessary only by Lubke’s deception. These events necessitated a special oral argument hearing, another appellate opinion, and eventually, an en banc decision attempting to resolve our conflicting precedents. Second, because this two-party dispute evolved into a protracted three-party dispute with the trustee and her counsel, the fairness of the fee award exacted against the taxpayers of the City of Arlington has been seriously compromised, contrary to the courts’ duty to impose reasonable fees on a defendant. This may be brushed off as simply the logical consequence of the convoluted legal proceedings, but it is Lubke’s deception that set them in motion,not the City’s violation of his FMLA rights. Thus, the majority’s reasoning purports to protect the interests of creditors in general, while overlooking that the goal of judicial estoppel is to protect the integrity of the entire judicial process.

* * *

One may extol the virtues of “innocent” trustees, and I do not question the integrity of this trustee at all, but let us not romanticize what’s going on here. Lubke is going on with his life, effectively freed by the passage of time from the claims of unsecured creditors. It is pure speculation to say, as does the majority, that he has “no assets.” He was not honest about this litigation, why not about other assets? The expressed concern for “the creditors” lacks a certain depth of feeling. Those creditors were, and remain, almost exclusively credit card companies. Two-thirds of their claims will never be repaid because they were not renewed when the case was re-opened long after it had been declared a no asset filing. The record suggests that others cut their losses by bundling and selling their unpaid claims to third parties.

As for the lawyers, Hurlbut received over $100,000 from Lubke even before the bankruptcy was filed, yet claims from the estate nearly $450,000 in additional fees. The trustee and her attorney will be reimbursed well into six figures as administrative priority claimants who will be paid ahead of the unsecured creditors. All this is legal, but in the commercial world, the transactional costs of such creditor recovery are wildly disproportionate. Surely courts need not cover our eyes against the real dollar impact of our balancing of “equities.”

The majority notes that in “unusual circumstances,” the doctrine of judicial estoppel may occasionally prevent a trustee from recovering on a claim that the debtor concealed from the courts upon filing for bankruptcy relief. Unfortunately, the majority did not balance the factual equities here as I think was obviously appropriate.

Opinion, pp. 14-15, 16.

The dissent is curious. Its balancing test grants priority to the courts, who were required to spend undue time dealing with the debtor's dishonesty, and the City of Arlington, whose taxpayers will shoulder a greater obligation because its judicial estoppel argument failed. On the other hand, the interest of creditors was minimized because their claims were held by debt buyers and attorneys.

It is indisputable that the courts were required to exercise substantial resources to deal with the case. However, the courts were not a party to the dispute; rather, the courts exist for the purpose of resolving disputes. The City expended substantial resources. However, this was a direct result of the unsuccessful legal positions taken by the City. If the City had not withdrawn its Offer of Judgment, its taxpayers would have been better served.

Finally, the dissent's argument that the identity of the unsecured creditors is relevant is disturbing. Equal treatment of similar claims is a core principal of bankruptcy. Once we start down the road of dividing creditors between the worthy and the less worthy, we start down a slippery slope. Should we find that it is more equitable to favor trade vendors than banks? Should we look with greater favor on community banks than national banks? Should we look down on the tort victim who hit a home run in the litigation lottery? The majority's emphasis on the equality of creditors is both statutorily correct and practically sound. Congress established priorities among different classes of creditors. It is not for the courts to rewrite those priorities.

While I may be biased (see Personal Note and Disclosure below), the dissent seems rather subjective. Equity should be about more than picking winners and losers based on our personal predilections. Indeed, the entire concept of the rule of law over the rule of man seems to be that we make decisions without regard to whether we like the persons who benefit, or perhaps that we make decisions based on fixed rules despite our personal preferences. The dissent seems to be based on the lowest common denominator of deciding who we like and ruling in their favor.

We are all subject to subjectivity. If I were a taxpayer in the City of Arlington, I would not like the result in this case. However, the focus of that anger should be at the public officials who caused the liability, not the courts or the trustee or the debtor's creditors.

Personal Note and Disclosure:

In this blog, I have written favorably about Kane and have critiqued the panel opinion in Reed. I was the principal author of the amicus brief filed by the Commercial Law League of America and participated in oral argument on behalf of the League. I consider the opportunity to argue before the full Court of Appeals, if only for ten minutes, to be one of the most exciting moments of my career.

While I am a partisan, my views are my own. No client paid me to blog on this issue and the Commercial Law League did not pay me to write their brief (although they did reimburse my expenses to travel to New Orleans to argue on their behalf--thanks CLLA!).

As a lawyer, I am pleased that the majority resisted the urge to find that lawyers are less equal than other creditors. As a bankruptcy lawyer, I am gratified that the majority found that the statutory structure and goals of the bankruptcy system formed an appropriate frame of reference.

Civil Rights Opinion May Affect Attorney's Fees in Bankruptcy

2011-08-09T18:40:00.004-05:00

A decision reviewing attorney's fees in a complex Title VII class action may have repercussions for attorney's fees in bankruptcy cases as well. McClain v. Lufkin Industries, Inc., No. 10-40036 (5th Cir. 8/8/11). You can find the opinion here.

What Happened

The Lufkin Industries case appears to be a David v. Goliath case where David decided he needed reinforcements. Timothy Garrigan, an attorney with a three attorney firm in Nacogdoches, Texas filed a class action suit against Lufkin Industries, Inc. under Title VII, alleging disparate treatment and disparate impact theories. While Mr. Garrigan was found to be well-qualified to handle the class-action, he determined that "it was imperative to associate with co-counsel in order to successfully try this case." The Court wryly noted that, "The case's ultimate trajectory, which spanned a decade and involved thousands of attorney hours, confirmed his initial impression."

When Mr. Garrigan went searching for co-counsel, he had to cast a wide net. After being turned down by multiple Texas firms, he ultimately associated Goldstein, Demchak, a firm from Oakland, California. The plaintiffs' team was successful. Although their initial judgment was reversed and paired down, the plaintiff class still recovered $3.3 million in back pay for discriminatorily lost promotions dating back to 1994.

The plaintiff's attorneys sought $7.7 million in fees. The Court allowed $4.7 million in fees. In doing so, they calculated the lodestar for both the Texas and the California lawyers at $400.00 per hour. This displeased the California lawyers who had sought an award based on $650.00 per hour. Specifically, the District Court ruled that fees should be awarded based on the prevailing market rate in the relevant legal market.

The Ruling

On appeal, the Fifth Circuit considered how to calculate the lodestar, that is, the proper hourly rate to be multiplied by the proper number of hours. The Court stated:

The precedents and purposes governing fee-shifting awards in civil rights cases are well established. The awards facilitate plaintiffs’ access to the courts to vindicate their rights by providing compensation sufficient to attract competent counsel. Fee awards must, however, be reasonable. (citation omitted). The linchpin of the reasonable fee is the lodestar calculation, a product of the hours reasonably expended by the law firms and the reasonable hourly rate for their services. (citation omitted). Charges for excessive, duplicative, or inadequately documented work must be excluded. (citation omitted).

Seminal to this case is the principle that “reasonable” hourly rates “are to be calculated according to the prevailing market rates in the relevant community.” (citation omitted). Further, Blum noted, “the burden is on the applicant to produce satisfactory evidence . . . that the requested rates are in line with those prevailing in the community for similar services by lawyers of reasonably comparable skill, experience and reputation.” (citation omitted). In an unbroken and consistent line of precedent, this court has interpreted rates “prevailing in the community” to mean what it says. Thus, as early as 1974, this court required district courts to consider the customary fee for similar work “in the community.” (citations omitted). Most telling, perhaps, is this court’s decision in a landmark affirmative action case reducing the fee of plaintiffs’ counsel, a former U.S. Assistant Attorney General and subsequent U.S. Solicitor General, from the rates he charged in Washington, D.C., to the prevailing rate in the forum, Austin, Texas. (citation omitted).

Opinion, pp. 8-9.

In the particular case, the Court found that

(W)here, as here, abundant and uncontradicted evidence proved the necessity of Garrigan's turning to out-of-district counsel, the co-counsel's '"home'' rates should be considered as a starting point for calculating the lodestar amount.

Opinion, p. 11.

What It Means

This conclusion is significant for the opposite of what it says. Out of district rates were allowed as the starting point for the lodestar because there was extensive evidence that no Texas lawyer was willing to touch the case. The converse is that an out-of-district lawyer cannot charge out-of-district rates if there was a qualified, local lawyer who could have taken the case.

The application to bankruptcy cases (which follow the same lodestar approach) is that a New York lawyer cannot charge New York rates in Houston without showing that a similarly qualified Houston lawyer was not available, or that a Houston lawyer could not charge Houston rates in Austin without showing that a similarly qualified Austin lawyer was not available, or that an Austin lawyer could not charge Austin rates in Waco without showing that a similarly qualified Waco lawyer was not available.

If this decision is applied to bankruptcy cases, it could prove to be a boon to local lawyers who are perfectly qualified to handle difficult cases but are willing to charge local rates. After all, if Ted Olson was limited to Austin rates in Hopwood v. State of Texas, why would a bankruptcy court in Austin allow a Washington, D.C. firm to charge D.C. rates in a bankruptcy case in Austin, Texas?

The Concurrences

Almost as interesting as the majority opinion are the concurrences. Chief Judge Jones and Circuit Judge Dennis each wrote separately to discuss aspects of the case. Since Chief Judge Jones authored the majority opinion, her concurrence to her own opinion is interesting to say the least.

Chief Judge Jones wrote to express her concern that the California lawyers were, let's be frank here, being greedy. She stated:

It cannot escape the reader’s attention that the Goldstein Demchak firm has been authorized to receive several million dollars in fees, and a million dollars in expenses, for prevailing in this protracted case. But to them, that’s not enough, and they seek an hourly increase that will add $3 million more to their award. If that happens, the attorneys will have received nearly double the dollar award of the plaintiffs. What has fee shifting come to? This is not an appeal about incentivizing modestly compensated attorneys for pursuing noble goals: the $400 hourly rate awarded to Mr. Garrigan is hardly a day laborer’s fee. This appeal is designed simply to enrich, not to enhance or encourage. The Supreme Court holds that fee-shifting cannot bring a windfall to attorneys. (citation omitted). On remand, the district court should exercise its discretion within the parameters we have set out to prevent a windfall recovery.

Opinion, at pp. 20-21. Do you think that Judge Jones made her feelings about the fees in this case clear enough? While Chief Judge Jones' majority opinion allowed the possibility of higher rates for out of district counsel, her concurrence suggests that she strongly objects to allowing that possibility in practice. Query whether she would show the same scorn for a bank's lawyers who sought to obtain a "windfall recovery"?

Judge Dennis wrote separately to suggest that the "hourly rates charged by the defendant's attorney's provide a helpful guide in determining whether similarly high rates and hours requested by the plaintiffs were reasonable." In the bankruptcy context, if the creditor's lawyers are charging obscene fees, then the debtor's lawyers may charge merely scandalous fees.

I think that this opinion, while affirming national rates in the specific case, is a victory for local rates in general. Of course, it bears mentioning that determining the appropriate market rates to use in the lodestar is only the starting point. Courts are still free to adjust upward or downward based upon the facts of the specific case.

Meet Judge Mott

2011-08-08T10:17:00.004-05:00

Welcome to a new feature of A Texas Bankruptcy Lawyer’s Blog. This will be the first in a series of profiles on the bankruptcy judges in Texas, beginning with H. Christopher Mott.

On September 20, 2010, H. Christopher Mott became Texas’s newest bankruptcy judge, holding court in the Austin and El Paso divisions of the Western District of Texas. He grew up in El Paso, graduating from Eastwood High School (a distinction he shares with Jim Wilkins and myself). He earned a B.B.A with Highest Honors from Texas Tech University in 1980 and graduated with High Honors from Texas Tech School of Law in 1983.

Private Practice

Judge Mott had a twenty-seven year career in private practice in El Paso. He was a founding partner of the firm now known as Gordon, Davis, Johnson and Shane.

At the time he graduated, Texas was in the midst of an oil and gas bust. He said

I got my start in the bankruptcy arena right out of law school in 1983 with the oil industry bust in Midland/Odessa. Bettina Whyte was a chapter 11 trustee, examiner or Plan Agent in several cases where I was her counsel. Many debtors there were high-flying oilmen and the FDIC had closed the largest banks in the area, forcing debtors (individuals and companies) into bankruptcy. The result was many adventurous cases and quick experience for a young lawyer.

His most significant case in private practice was neither a bankruptcy case nor one in Texas. On April 14, 2000, the State Banking Commissioner of Illinois placed Independent Trust Company (known as Intrust) into receivership in Cook County State Court. PriceWaterhouseCoopers was appointed as Receiver and the Receiver hired Judge Mott as its counsel. According to Judge Mott:

Intrust was the largest trust company failure in Illinois history and the largest trust company nationally to fail since the Great Depression. Intrust administered approximately $2 billion in assets for over 17,000 account holders. Approximately $70 million in trust assets were missing, haven been stolen over the previous ten years. The case was significant as it involved issues of first impression under Illinois insolvency law, extremely complicated facts, eight months of litigation at the trial court level, expedited appeals and a high profile. The time pressures in the case were tremendous, as trust accounts were frozen due to lack of liquidity and solvency and over 17,000 account holders were impacted. In the end, the Receiver was successful in allocating the loss and selling the trust business and accounts to another trust company.

Another significant case that he handled was In re Clay, 35 F.3d 190 (5^th Cir. 1994), in which the Fifth Circuit held that Bankruptcy Courts did not have the statutory or constitutional authority to conduct a jury trial absent consent of the parties.

Bon Mots from Judge Mott

Judge Mott has been a prolific writer and speaker on bankruptcy topics. Here are a few bon mots* from his writings:

In some respects, working in a law firm should be like playing a secret agent in a James Bond movie. Secret agents learn confidential information that must be treated as “top secret” and cannot be disclosed. In the course of your law firm job, you become privy to sensitive and confidential information about clients of the law firm. This client information must be treated as “top secret” by law firm employees. Legal secretaries, paralegals, and other employees of the firm must be very careful not to disclose—whether inadvertently or intentionally—confidential client information to anyone outside the firm, including family and friends.

“Secret Agents: Your Responsibility to Protect Confidential Client Information,” http://www.texasals.org/Confidential.html.

Navigating the troubled seas of bankruptcy court jurisdiction makes many lawyers feel like Coleridge’s Ancient Mariner, or in more modern times, Russell Crowe as Captain Jack Aubrey in Master and Commander: The Far Side of the World. These seas are awash with technical phrases (such as core, related to, abstention, remand and removal), interlocking and sometimes conflicting statutes and rule, and multiple judicial interpretations of how to properly navigate the waters.

“Bankruptcy Jurisdiction—The Far Side of the World,” Bankruptcy Litigation: Pre-Trial Practice & Procedural Workshop (January 20-21, 2005).

Summary judgment practice is a rifle shot, not a shotgun approach to disposing of issues. The KISS rule (keep it simple stupid) applies to summary judgment motions. The chances of success on a summary judgment motion raise as you make the case appear simple, they fall if you make it look more complex.

“Drafting a Motion for Summary Judgment *Tips for Success*”, Bankruptcy Litigation: Advanced Pre-Trial Practice & Procedure Workshop (January 29-30, 2004).

From these brief quotes, we can learn that Judge Mott is a fan of a well-turned analogy, that he likes movies and that he takes a practical approach to law.

Honors

Judge Mott served a term as Chair of the State Bar of Texas Bankruptcy Section. He said:

My personal favorite has always been the Elliott Cup Bankruptcy Moot Court competition sponsored by the Section. It has expanded to include all law schools in the Fifth Circuit (including Texas). The talent level of the law students and their knowledge of bankruptcy law is astounding.

Other honors and credentials he has earned include being a Fellow of the American College of Bankruptcy, Board Certified in Business Bankruptcy Law by the Texas Board of Legal Specialization, a former Commissioner of the Texas Bankruptcy Certification Exam Commission, and being included as a Texas Super Lawyer as well as being named to Best Lawyers in America and Corporate Counsel—Top Lawyer.

He is no relation to Christopher Mott, the actor who played Howard K. Stern in an episode of The Final 24 devoted to Anna Nicole Smith.

Judge Mott in the Courtroom

His courtroom demeanor is very calm. In an interview with the ABA Section of Litigation, he said:

I just try to be myself, a plain, straight-speaking person. I do try to exercise more patience and display more even-handedness than I might in a private setting, such as with friends.

In the same interview, he said that he wears a shirt and tie under his robe, but not a jacket. He said, “For some reason wearing a tie helps me to focus better.”

He expressed admiration for his fellow judges, stating:

There is great camaraderie among bankruptcy judges. It is like a 300-person fraternity. Bankruptcy judges seem to be cut from a different cloth; they take their jobs seriously, but not themselves.

When asked about his biggest challenge on the bench, he said:

One of the biggest challenges is to figure out what hearings /trials are actually going to go forward and be contested; and what will be settled or continued (often at the last minute). I try to prepare for hearings so I can rule from the bench when possible. There is not enough time in the day for me (and my law clerks) to prepare for every hearing that gets set so the educated guess on what matters are actually going to be contested and go forward is a challenge.

Off the Bench

Judge Mott keeps busy off the bench.

I am kind of a workout nut, because my job is sedentary and exercise reduces stress. At this point, I mix it up a lot—run, mountain bike, swim (Barton Springs pool is awesome), rowing on Town Lake (new and fun for me), gym work. I have many hobbies that I enjoy, but am not particularly good at, such as golf, scuba diving, fly fishing, and mountain climbing. I also love watching football and reading, and most importantly, spending time with my wonderful wife of 30 years and my 20-year-old daughter and 23-year-old son.

The final word from Judge Mott:

"I may be stupid but I am not dumb."

*--A bon mot is defined as a clever saying, phrase or witticism.

Acknowledgement: Portions of this article were taken from “Interview with the Honorable H. Christopher Mott,” ABA Section of Litigation (July 14, 2011).