Another chapter has unfolded in Austin’s development wars with the denial of the plan of reorganization proposed by the Save Our Springs Alliance. In re Save Our Springs (S.O.S.) Alliance, Inc., No. 07-10642 (Bankr. W.D. Tex. 4/11/08). While the case was a defeat for the debtor, it provides a wealth of useful case law for chapter 11 lawyers. It also provides a detailed examination of issues unique to a non-profit corporation attempting to reorganize. The issues discussed here could easily apply to a church or a cooperative as well.
Background
SOS is a “citizen action group whose primary purpose is to advance community awareness of water pollution and to protect water sources such as Barton Creek, the watershed in the surrounding community, and the Edwards Aquifer, which is the primary or only water supply in central and south Texas.” Memorandum Opinion, p. 4. One method that SOS used to advance its goals was to pursue litigation against developers.
Three of those lawsuits ended badly for SOS with the nonprofit being ordered to pay hundreds of thousands of dollars in attorney’s fees. This posed a quandary for the debtor. The corporation depended upon its contributions for its funding. However, environmentally minded donors were unlikely to make contributions for the purpose of paying attorney’s fees to developers. As a result, contributions either dried up or came with strings attached which prohibited their use to pay the judgments.
In addition to the judgment creditors, SOS owed $175,000 to Kirk Mitchell, one of its founders and largest donors. Mr. Mitchell had guaranteed a bank loan to SOS and was forced to pay off the debt when his guaranty was called. This left Mr. Mitchell holding a claim secured by all of the debtor’s assets.
SOS filed chapter 11 to try to work out of this dilemma. It proposed a plan which offered to raise $60,000 in contributions to pay its unsecured creditors. Those creditors were divided into three classes despite the fact that they would each receive a pro rata share of the same pot. Class 4 contained the claim of Sweetwater Austin Properties, LLC, the largest judgment creditor. Class 5 consisted of two other judgment creditors whose judgments were not yet final. Class 6 consisted of its other unsecured creditors, including the deficiency claim of Kirk Mitchell. Classes 4 and 5 voted to reject the plan, while Class 6 voted to accept. The debtor negotiated settlements with the two judgment creditors in class 5 which resulted in their votes changing to accept the plan.
This left the debtor in a confirmation battle with its largest creditor. The pleadings framed issues of which party was acting in good faith. The debtor accused Sweetwater of casting its ballot in bad faith for the ulterior motive of putting the environmental group out of business, while Sweetwater accused the debtor of gerrymandering its classes to engineer acceptance by a class and offering an infeasible yet inadequate payment to creditors.
The Court conducted the confirmation hearing over five days and then took the case under advisement. The Court’s 68-page ruling addressed the following issues (plus several others):
1. Whether SOS as a small business debtor had met its burden to extend the 45 day period to confirm a plan;
2. Whether the ballot of Sweetwater should designated as having been cast in bad faith;
3. Whether the debtor improperly gerrymandered its unsecured classes;
4. Whether the plan met the chapter 7 liquidation test;
5. Whether the plan was feasible;
6. Whether the plan satisfied the absolute priority rule; and
7. Whether the plan was proposed in good faith.
Timely Confirmation
Section 1121(e)(3) posed a difficult problem for the court. The Code requires a small business chapter 11 debtor to confirm its plan within 45 days after being filed. The confirmation hearing began on the last day of the period. The debtor filed a motion to extend the 45 day period which was heard on the first day of trial. Sweetwater argued that the debtor had failed to meet its burden to show that it was more likely than not that the debtor would confirm a plan within a reasonable time. With only one day of testimony received, it was objectively impossible to tell whether the plan was likely to be confirmed.
This raised a conundrum. If taken literally, a debtor could never obtain an extension to confirm a plan unless the confirmation hearing had already proceeded to the point where it was clear that the debtor was going to win. As a result, the more complex the case, the less likely it was that the debtor could meet its burden to gain an extension of time to complete the confirmation hearing. As the court pointed out:
“(U)nless a debtor is able to file and obtain a hearing on its motion to extend time well in advance of the end of the 45-day period, no purpose would be served by hearing the motion to extend time separately from the confirmation hearing. That is because the evidence that would allow the court to make the factual findings required by §1121(e)(3) is virtually the same as that which would be offered at the confirmation hearing. Thus, in most instances the debtor will have to act so that the confirmation hearing itself can be scheduled, conducted and concluded, and an order entered, within 45 days of the date the plan is filed. In many if not most cases this presents virtually insurmountable obstacles, particularly when the plan is amended after filing.”
Memorandum Opinion, at 30-31.
The Court found that the strict deadlines imposed by BAPCPA were unworkable. In their place, the court substituted a requirement that the debtor act promptly to bring its case and to trial and to request an extension of time.
“The Court finds BAPCPA’s small business confirmation deadlines provisions—the onerous showing required under §1121(e)(3) to get an extension, combined with the accelerated timeline for making that showing under §§1121(e)(3) and 1129(e)—are simply unworkable under the facts of this case. The Court is therefore reluctant to impose on the Debtor the full consequences of a failure to meet §1121(e)’s deadline, inasmuch as that failure was due to the impossibility of the Court’s receiving and considering the evidence in time to make the findings required to rule on the requested extension of that deadline.”
Memorandum Opinion at 34. As a result, the Court extended the deadline through the ruling on confirmation. However, because the Court denied confirmation of Debtor’s plan, it declined to grant the Debtor any further extension.
Motion to Designate Ballot
The opinion also considered whether the creditor’s ballot was cast in bad faith. Section 1126(e) allows the Court to disregard a ballot “whose acceptance or rejection . . . was not in good faith.” Although this provision is infrequently used, it will allow a ballot to be disregarded when the creditor acts with an unacceptable ulterior motive. The Debtor contended that Sweetwater opposed the plan for the ulterior purpose of putting SOS out of business and avoiding litigation over future developments. Sweetwater, on the other hand, contended that it merely sought to obtain the best recovery for its claim.
The Court found that it was not bad faith for a creditor to act according to its economic self-interest. Moreover, the creditor was entitled to be the sole judge of what was in its economic self-interest. As a result, the Debtor could not successfully argue that the creditor must be acting in bad faith because it would not receive a better bargain if the Debtor’s plan was denied.
The Court quoted from a leading opinion which stated:
“Too, what debtors think represents a ‘good deal’ may not look so rosy from a creditor’s point of view, and the voting process is expressly designed to give creditors the opportunity to express how the plan looks to them. The fact that a creditor may not know what is good for it, therefore, can again, of itself, not be grounds for disqualifying that creditor’s vote.”
Memorandum Opinion, page 39, quoting In re The Landing Associates, Ltd., 157 B.R. 791, 807 (Bankr. W.D. Tex. 1993).
Additionally, the Court found that the creditor was acting in its economic self-interest where it sought to prevent confirmation of the plan for the purpose of undercutting the Debtor’s ability to litigate the allowance of the creditor’s claim. This motivation also related to the creditor’s economic self-interest.
Ultimately, the Court found that it was just as likely that the creditor was acting in a defensive posture (that is, to prevent the debtor from imposing an unfavorable result on it) rather than offensively (that is, to take out a rival in the development wars).
Classification
The classification scheme in this case was reminiscent of the one from In re Greystone III Joint Venture, 995 F.2d 1274 (5th Cir. 1991). In Greystone, the Debtor proposed two classes of unsecured claims based on their separate legal status and motivation to vote on the plan. However, the plan provided the same treatment to both. The Fifth Circuit rejected this argument, finding that there was a presumption that all similar claims be classified together and that “thou shalt not classify similar claims differently in order to gerrymander an affirmative vote on a reorganization plan.” The Fifth Circuit found that separate classification could be warranted based on legitimate business reasons, but that legitimate business reasons were not present when the debtor proposed to give the two classes exactly the same treatment.
In this case, the Court found that the plan as originally proposed contained gerrymandering between classes 4, 5 and 6. However, once the Debtor settled with the creditors in Class 5, those claims were no longer similar in nature to the claims in classes 4 and 6. There were good business reasons for separately classifying the claims in class 5 because the treatment of those claims included additional provisions relating to the settlement. “A creditor’s ongoing involvement in litigation with the debtor has been held to be . . . a non-creditor interest, justifying separate classification of the claim.” Memorandum Opinion, at 47. Thus, although the plan as originally proposed involved unacceptable gerrymandering, and although the plan continued to gerrymander the separate classification of classes 4 (Sweetwater) and 6 (general unsecured creditors), separate classification of class 5 was not only permissible but required. This meant that the debtor succeeded in obtaining one accepting class of claims despite the gerrymandering finding.
Chapter 7 Liquidation Test
While Sweetwater argued that the debtor did not meet the best interests of creditors test, this was not a particularly difficult burden to meet. In this case, the Debtor was a non-profit corporation dependent on contributions for its operations. The Debtor convincingly testified that its meager assets, consisting of a conservation easement, some office furniture and computers, its name and its mailing list, were worth much less than the secured debt against them. As a result, any payment to unsecured creditors exceeded what they would receive in a chapter 7 liquidation. Like the union in In re General Teamsters, Warehousemen and Helpers Union Local 890 (9th Cir. 2001), the right to collect future contributions was not an asset which could be liquidated in a chapter 7 case.
Feasibilty
Feasibilty proved to be the Achilles Heel of this plan. The Debtor proposed to raise a fund of $60,000 to pay its unsecured creditors. The Court found that to satisfy the feasibility standard “a reasonable prospect of success must be shown” and that most courts require “specific, concrete evidence to support feasibility.” Memorandum Opinion, page 53.
The Plan allowed the Debtor 60 days to raise the $60,000 payment to be made to unsecured creditors. However, as of confirmation, the Debtor only had commitments for $12,500. The Court found that under this record, feasibility was lacking.
“The evidence was clear that the Debtor had not raised the $60,000 as of the confirmation hearing. The fact that SOS built into its Plan a delay in its obligation to obtain those funds does not relieve it of its burden to show that it will be able to perform under the Plan. True, under the terms of para. 7.3, it would not be in default the moment an order confirming the plan were entered but would have time to obtain more contributions to fund the Creditor Settlement Fund. However, it offered no evidence at the hearing to show that it could meet that obligation—no commitments, no evidence of relevant past performance, nothing. On the contrary, Kirk Mitchell testified that as of the date of the hearing he had expressly not agreed to contribute any amount to be used to fund the Creditor Settlement Fund.”
Memorandum Opinion at 53.
The Debtor argued that because the plan provided that failure to raise the necessary funds would be an event of default which would return the parties to the status quo that feasibility was a non issue. The Court found that, “Such a provision, rather than curing the Debtor’s failure to show the Plan is feasible, merely highlights that failure.” Memorandum Opinion at 57.
Thus, because the Debtor’s contributors would not commit to fund the Plan in advance, the Plan was defeated.
Absolute Priority Rule
While the absolute priority rule is a major focus of most chapter 11 cases involving cram-down, it was of little consequence to SOS. The absolute priority rule requires that junior classes not receive or retain any interest unless senior classes are paid in full. In the typical case, equity must be cancelled unless unsecured claims are paid in full. However, a non-profit corporation does not have equity holders. The members of a non-profit corporation may direct its affairs, but do not own an interest in the corporation. The laws of most states provide that upon dissolution, the assets of a non-profit corporation must be transferred to another non-profit entity.
In this case, Sweetwater made the novel argument that claims of insiders should be subordinated and not receive any distribution unless its claim was paid in full. Thus, the creditor argued that insider claims should be treated as de facto equity. The Court dismissed this argument, stating that “Several courts have expressed the opinion that the claim of an insider or equity holder may not be treated unequally unless the insider or equity holder used superior knowledge concerning the debtor’s affairs in an unfair manner or equitable subordination principles otherwise apply.” Memorandum Opinion at 61.
Good Faith
Good faith is shown where the plan is “proposed with the legitimate and honest purpose to reorganize and has a reasonable hope of success.” In re Sun Country Development, Inc., 764 F.2d 406, 408 (5th Cir. 1985). The Court found that, “”While the question is a close one precisely because of the Plan’s impermissible classification scheme and the small size of the payments proposed, the Court nevertheless finds that its provisions for Sweetewater’s claim . . . does not amount to bad faith.” Memorandum Opinion at 64.
One issue considered by the Court was whether the Debtor had played fast and loose with its donations for the purpose of evading creditors. Once the Debtor had judgments rendered against it, contributors began making “restricted” gifts which could not be used to pay the judgments. However, these restricted funds were commingled with the Debtor’s other assets. On the eve of bankruptcy, the Debtor transferred $31,156.21 into an Education & Outreach Fund. Based upon a tracing analysis, the Court found that at least half of these funds were unrestricted funds and that a portion of the restricted funds had been spent on other purposes. The Court found that the portion of these funds constituting “restricted” funds were not property of the estate despite the fact that they had been commingled. The Court also found that these facts did not establish bad faith.
“The Court finds, however, that the Debtor’s apparent unauthorized use of restricted funds should not override the express intent of the donors, and should therefore not destroy the overall character of the funds as restricted. The evidence on the issue was limited to the Debtor’s inability to explain the accounting that indicates its use of some of the funds was not authorized. The Court finds, however, that there was insufficient evidence to establish any sort of complicity between the Debtor and the donors, and or malfeasance or bad faith on the part of the Debtor. Confirmation of this Debtor’s Plan has presented a number of unusual and even unique issues, including what a Debtor in SOS’s position can and must offer creditors when its source of income is donors who have the right to choose whether or not to fund a plan. Based on all the evidence presented and the totality of the circumstances of this case, the Court finds and concludes that there was no credible evidence that the Plan was proposed with bad intent or malfeasance, or in contravention of any applicable law.”
Memorandum Opinion at 67-68.
Where Does This Leave the Parties?
At the end of the day, the Debtor’s Plan was not confirmed. The Debtor is past its 300 day window to propose a plan and past its 45-day window to confirm the previously filed plan. On the other hand, the Debtor’s assets remain encumbered by a lien held by a friendly party which greatly exceeds their value. Donors cannot be forced to contribute funds to pay the claim of Sweetwater. As a result, it appears that the decision leaves the parties in a stalemate.
Disclaimer: The law firm that I work for was a small unsecured creditor in this case. We voted to accept the plan.
Sunday, April 13, 2008
Tuesday, April 08, 2008
Fifth Circuit Clarifies Requirements of Rule 9011
The Fifth Circuit has written a new opinion requiring strict compliance with Rule 9011 prior to awarding sanctions. The Cadle Company v. Pratt, No. 07-10457 (4/8/08). Specifically, the Fifth Circuit held that prior to seeking sanctions under Rule 9011, the movant must serve a copy of the actual motion on the respondent 21 days prior to filing it and that a mere letter threatening sanctions was inadequate.
In Pratt, the Cadle Company objected to a debtor's discharge. The debtor failed to disclose his right to receive payments under his mother's will, but testified persuasively that he owed more in loans received from his mother than the distribution he would have received from her estate. Subsequently, the Cadle Company learned that the debtor had received loans from his mother's estate after her death. It is not clear from the opinion why this fact was significant. Perhaps Cadle viewed the estate loans as disguised distributions or perhaps they contradicted the testimony that loans were made during the mother's lifetime. At any rate, the Cadle Company blamed the debtor's lawyer for the non-disclosure of this fact.
Prior to filing a motion for sanctions, the Cadle Company sent not one but two letters to the debtor's lawyer alleging a Rule 9011 violation. However, when the motion came up for hearing, the Bankruptcy Court denied it because: (a) the Cadle Company had not served its proposed motion on the debtor's lawyer 21 days before filing it; and (b) the debtor's lawyer did not do anything sanctionable. The Bankruptcy Court then went on to award sanctions against the Cadle Company for bringing a frivolous motion for sanctions.
On appeal, the District Court affirmed the denial of the Cadle sanctions motion, but remanded the award of sanctions against Cadle for further consideration. Cadle appealed to the Fifth Circuit.
The Fifth Circuit affirmed the denial of the Cadle sanctions motion. It held that an informal notice did not meet the requirements of Rule 9011. In pertinent part Rule 9011 provides:
"The motion for sanctions may not be filed with or presented to the court unless, within 21 days after service of the motion (or such other period as the court may prescribe), the challenged paper, claim, defense, contention, allegation, or denial is not withdrawn or appropriately corrected, except that this limitation shall not apply if the conduct alleged is the filing of a petition in violation of subdivision (b)."
While the rule is not a model of drafting clarity, the Fifth Circuit sided with the Fourth, Eighth, Ninth and Tenth Circuits and rejected an opinion from the Seventh Circuit to hold that Rule 9011 requires that the party to be sanctioned be served with the actual motion 21 days before it is filed.
The practical difficulty lies in reconciling the language "may not be filed with or presented to the court" with "after service of the motion." On the one hand "service of the motion" is typically understood to refer to service of a motion which has been filed with the court. On the other hand, the preceeding language, says that the motion may not be filed until 21 days after it has been served. The Fifth Circuit reconciles this conflict (without expressly addressing it) by holding that the motion must be served before filing (and presumably then served again after filing).
The ruling of the Court of Appeals smooths over a difficultly worded rule. It adopts a policy position that sanctions should be an exceptional remedy and not just an added bonus for a victorious party. By requiring pre-filing "service" of the proposed motion, it requires the aggrieved party to stop and methodically lay out why the pleading is sanctionable rather than merely firing off a letter in anger or an excess of testosterone.
In addition to its main focus, the opinion contains an interesting discussion of finality for purposes of appeal. In this case, the District Court reversed and remanded. Only final orders may be appealed from the District Court to the Fifth Circuit. In this case, the Fifth Circuit held that the portion of the District Court opinion which affirmed the denial of sanctions to the Cadle Company was final and could be appealed, while the portion which remanded the sanctions against the Cadle Company was interlocutory and could not be appealed. The fact that a single order could be partially appealable and partially non-appealable provides a trap for the unwary. Here, appellate practice is like voting in Chicago or South Texas: appeal early and often.
In Pratt, the Cadle Company objected to a debtor's discharge. The debtor failed to disclose his right to receive payments under his mother's will, but testified persuasively that he owed more in loans received from his mother than the distribution he would have received from her estate. Subsequently, the Cadle Company learned that the debtor had received loans from his mother's estate after her death. It is not clear from the opinion why this fact was significant. Perhaps Cadle viewed the estate loans as disguised distributions or perhaps they contradicted the testimony that loans were made during the mother's lifetime. At any rate, the Cadle Company blamed the debtor's lawyer for the non-disclosure of this fact.
Prior to filing a motion for sanctions, the Cadle Company sent not one but two letters to the debtor's lawyer alleging a Rule 9011 violation. However, when the motion came up for hearing, the Bankruptcy Court denied it because: (a) the Cadle Company had not served its proposed motion on the debtor's lawyer 21 days before filing it; and (b) the debtor's lawyer did not do anything sanctionable. The Bankruptcy Court then went on to award sanctions against the Cadle Company for bringing a frivolous motion for sanctions.
On appeal, the District Court affirmed the denial of the Cadle sanctions motion, but remanded the award of sanctions against Cadle for further consideration. Cadle appealed to the Fifth Circuit.
The Fifth Circuit affirmed the denial of the Cadle sanctions motion. It held that an informal notice did not meet the requirements of Rule 9011. In pertinent part Rule 9011 provides:
"The motion for sanctions may not be filed with or presented to the court unless, within 21 days after service of the motion (or such other period as the court may prescribe), the challenged paper, claim, defense, contention, allegation, or denial is not withdrawn or appropriately corrected, except that this limitation shall not apply if the conduct alleged is the filing of a petition in violation of subdivision (b)."
While the rule is not a model of drafting clarity, the Fifth Circuit sided with the Fourth, Eighth, Ninth and Tenth Circuits and rejected an opinion from the Seventh Circuit to hold that Rule 9011 requires that the party to be sanctioned be served with the actual motion 21 days before it is filed.
The practical difficulty lies in reconciling the language "may not be filed with or presented to the court" with "after service of the motion." On the one hand "service of the motion" is typically understood to refer to service of a motion which has been filed with the court. On the other hand, the preceeding language, says that the motion may not be filed until 21 days after it has been served. The Fifth Circuit reconciles this conflict (without expressly addressing it) by holding that the motion must be served before filing (and presumably then served again after filing).
The ruling of the Court of Appeals smooths over a difficultly worded rule. It adopts a policy position that sanctions should be an exceptional remedy and not just an added bonus for a victorious party. By requiring pre-filing "service" of the proposed motion, it requires the aggrieved party to stop and methodically lay out why the pleading is sanctionable rather than merely firing off a letter in anger or an excess of testosterone.
In addition to its main focus, the opinion contains an interesting discussion of finality for purposes of appeal. In this case, the District Court reversed and remanded. Only final orders may be appealed from the District Court to the Fifth Circuit. In this case, the Fifth Circuit held that the portion of the District Court opinion which affirmed the denial of sanctions to the Cadle Company was final and could be appealed, while the portion which remanded the sanctions against the Cadle Company was interlocutory and could not be appealed. The fact that a single order could be partially appealable and partially non-appealable provides a trap for the unwary. Here, appellate practice is like voting in Chicago or South Texas: appeal early and often.
Wednesday, April 02, 2008
Minority Position on Surrendering Vehicles Subject to Hanging Paragraph Gains Support; Automobile Lenders Allowed Deficiency Claims
Some of the architects of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) have said that they would not change a word of this complex legislation. However, some of those words have left judges scratching their heads. One of the more troublesome provisions has been the so-called “hanging paragraph” of 11 U.S.C. Sec. 1325(a). Immediately following Sec. 1325(a)(9), it provides that the valuation provisions of Sec. 506(a) do not apply to a loan for purchase of a vehicle for personal use incurred within 910 days prior to bankruptcy.
In one context, the hanging paragraph is clear. If a debtor intends to retain a 910-day vehicle, he must pay the full amount owed regardless of its value. However, does the same logic apply in reverse? If the debtor elects to surrender the vehicle, must the lender give credit for the full amount of the debt regardless of the value?
The symmetry of an anti-valuation provision which applied in both directions (that is, retaining or surrendering) appealed to several courts. In fact, it became known as the majority position. Examples of this position include In re Payne, 347 B.R. 278 (Bankr. S.D. Ohio 2006); In re Turkowitch, 355 B.R. 120 (Bankr. E.D. Wis. 2006); In re Gentry, 2006 WL 3392947 (Bankr. E.D. Tenn. 11/22/06); In re Quick, 360 B.R. 722 (Bankr N.D. Okla. 2007).
However, several recent appellate decisions may have shifted the weight of authority. Four cases from the Sixth, Seventh and Eighth Circuits have all held that surrender of a 910-day vehicle does not prevent the creditor from filing an unsecured deficiency claim. In re Long, 2008 U.S. App. LEXIS 4549 (6th Cir. 3/4/08); AmeriCredit Financial Services, Inc. vs. Moore, 2008 U.S. App. LEXIS 2497 (8th Cir. 2/5/08); Capital One Auto Finance vs. Osborn, 515 F.3d 817 (8th Cir. 2008); Matter of Wright, 492 F.3d 829 (7th Cir. 2007). These cases take a broader look at the application of Sec. 502 and 506 to determine that a deficiency claim is not barred. Basically, they hold that Sec. 506(a) only applies to determination of a claim secured by property of the estate. Once the secured property is surrendered, the estate no longer has an interest in property to be valued. From that point, the issue shifts to Sec. 502, which determines allowance of claims. Because Sec. 502 does not contain any provision requiring disallowance of a 910-day deficiency claim, the claim should be allowed.
Within Texas, this shift in position should not affect a major change. Several Texas courts were already following the “minority” position adopted by the recent appellate opinions. In re Aguerro, No. 07-12195 (Bankr. W.D. Tex. 3/30/08)(Gargotta, B.J.); In re Newberry, 2007 Bankr. LEXIS 1589 (Bankr. W.D. Tex. 2007)(McGuire, B.J.); In re Gay, 375 B.R. 343 (Bankr. E.D. Tex. 2007)(Parker, B.J.).
In most cases, allowing or disallowing a deficiency claim will not have a major effect on the debtor, since the typical chapter 13 plan pays unsecured creditors mere pennies on the dollar. However, in some instances it could make a lot of difference. In re Esparza, No. 06-31040 (Bankr.W.D. Tex. 5/9/07) was just such a case. In Esparza, the debtors financed two vehicles with GECU. One vehicle was purchased within 910 days and the other was not. The debtors elected to surrender the 910 day vehicle, which resulted in a deficiency. Because the two loans were cross-collateralized, the deficiency from the surrendered vehicle attached to the retained vehicle. Because the balance owed on the retained vehicle was small enough, the value of this vehicle was sufficient to secured both the remaining value on the vehicle financed and the deficiency on the surrendered vehicle. If the one vehicle could have been surrendered in full satisfaction of the debt, the amount to be paid on the retained vehicle would have been much less. Thus, because the hanging paragraph did not mandate full satisfaction of the debt, the debtors had to pay an extra $11,809.84 as a secured claim. The only way to have avoided this result would have been to retain both vehicles (in which case the 910-day vehicle would have been required to be paid in full) or to surrender both vehicles in which case the deficiency, if any, would have been a mere unsecured claim).
Note: The original version of this article erroneously referred to In re Dominquez, No. 06-31167 (Bankr. W.D. Tex. 5/11/07) instead of In re Esparza, No. 06-31040 (Bankr. W.D. Tex. 5/9/07). The article has been corrected and now refers to the appropriate case.
In one context, the hanging paragraph is clear. If a debtor intends to retain a 910-day vehicle, he must pay the full amount owed regardless of its value. However, does the same logic apply in reverse? If the debtor elects to surrender the vehicle, must the lender give credit for the full amount of the debt regardless of the value?
The symmetry of an anti-valuation provision which applied in both directions (that is, retaining or surrendering) appealed to several courts. In fact, it became known as the majority position. Examples of this position include In re Payne, 347 B.R. 278 (Bankr. S.D. Ohio 2006); In re Turkowitch, 355 B.R. 120 (Bankr. E.D. Wis. 2006); In re Gentry, 2006 WL 3392947 (Bankr. E.D. Tenn. 11/22/06); In re Quick, 360 B.R. 722 (Bankr N.D. Okla. 2007).
However, several recent appellate decisions may have shifted the weight of authority. Four cases from the Sixth, Seventh and Eighth Circuits have all held that surrender of a 910-day vehicle does not prevent the creditor from filing an unsecured deficiency claim. In re Long, 2008 U.S. App. LEXIS 4549 (6th Cir. 3/4/08); AmeriCredit Financial Services, Inc. vs. Moore, 2008 U.S. App. LEXIS 2497 (8th Cir. 2/5/08); Capital One Auto Finance vs. Osborn, 515 F.3d 817 (8th Cir. 2008); Matter of Wright, 492 F.3d 829 (7th Cir. 2007). These cases take a broader look at the application of Sec. 502 and 506 to determine that a deficiency claim is not barred. Basically, they hold that Sec. 506(a) only applies to determination of a claim secured by property of the estate. Once the secured property is surrendered, the estate no longer has an interest in property to be valued. From that point, the issue shifts to Sec. 502, which determines allowance of claims. Because Sec. 502 does not contain any provision requiring disallowance of a 910-day deficiency claim, the claim should be allowed.
Within Texas, this shift in position should not affect a major change. Several Texas courts were already following the “minority” position adopted by the recent appellate opinions. In re Aguerro, No. 07-12195 (Bankr. W.D. Tex. 3/30/08)(Gargotta, B.J.); In re Newberry, 2007 Bankr. LEXIS 1589 (Bankr. W.D. Tex. 2007)(McGuire, B.J.); In re Gay, 375 B.R. 343 (Bankr. E.D. Tex. 2007)(Parker, B.J.).
In most cases, allowing or disallowing a deficiency claim will not have a major effect on the debtor, since the typical chapter 13 plan pays unsecured creditors mere pennies on the dollar. However, in some instances it could make a lot of difference. In re Esparza, No. 06-31040 (Bankr.W.D. Tex. 5/9/07) was just such a case. In Esparza, the debtors financed two vehicles with GECU. One vehicle was purchased within 910 days and the other was not. The debtors elected to surrender the 910 day vehicle, which resulted in a deficiency. Because the two loans were cross-collateralized, the deficiency from the surrendered vehicle attached to the retained vehicle. Because the balance owed on the retained vehicle was small enough, the value of this vehicle was sufficient to secured both the remaining value on the vehicle financed and the deficiency on the surrendered vehicle. If the one vehicle could have been surrendered in full satisfaction of the debt, the amount to be paid on the retained vehicle would have been much less. Thus, because the hanging paragraph did not mandate full satisfaction of the debt, the debtors had to pay an extra $11,809.84 as a secured claim. The only way to have avoided this result would have been to retain both vehicles (in which case the 910-day vehicle would have been required to be paid in full) or to surrender both vehicles in which case the deficiency, if any, would have been a mere unsecured claim).
Note: The original version of this article erroneously referred to In re Dominquez, No. 06-31167 (Bankr. W.D. Tex. 5/11/07) instead of In re Esparza, No. 06-31040 (Bankr. W.D. Tex. 5/9/07). The article has been corrected and now refers to the appropriate case.
Sunday, March 30, 2008
Fifth Circuit Releases Interest-ing Opinion on Chapter 13 Interest Rates
The Fifth Circuit has released a new opinion on interest rates in chapter 13 cases. Drive Financial Services, L.P. v. Jordan, 2008 U.S. App. LEXIS 5334 (5th Cir. 3/12/2008). While the opinion does not contain any earth-shattering conclusions, it provides an excellent starting point for a practitioner wanting to learn treatment of secured claims in chapter 13.
The Facts
Debtor financed a pickup truck with Drive Financial. The contract interest rate was 17.95%. When the Debtor filed chapter 13, he proposed to lower the rate to 6%. At the confirmation hearing, the parties stipulated that the rate would be 7.5% under the Supreme Court's Till v. SCS Credit Corp., 541 U.S. 465 (2004) decision or 17.95% under the Fifth Circuit's Green Tree Fin. Servicing Corp. v. Smithwick, 121 F.3d 211 (5th Cir. 1997). Under Till, the interest rate is to be determined based on the prime rate plus a risk premium, while Smithwick applied a rebuttable presumption that the contract rate should apply. The Bankruptcy Court applied Till and used the lower rate. The parties received permission to take a direct appeal to the Fifth Circuit.
The Hanging Paragraph Does Not Apply
The Fifth Circuit first dispelled the notion that the hanging paragraph of Sec. 1325(a)(*) applies to calculation of interest on a chapter 13 secured debt. Drive Financial argued that because Till dealt with the interest rate on a lienstripped claim, that it had no application to a post-BAPCPA claim on a vehicle claim protected from lienstripping under the hanging paragraph. The Fifth Circuit found that the fact that the claim had been subject to lienstripping did not play any part in the Supreme Court's decision to apply a prime + interest rate calculation and thus concluded that BAPCPA had not overruled the Till decision.
This raises an important point. Loans secured by a principal residence are protected from modification in both chapter 11 and chapter 13. On the other hand, loans incurred for purchase money on a vehicle within 910 days are protected from lienstripping (that is, having the secured claim reduced to the value of the collateral), but are still subject to having their interest rates modified. Thus, home mortgages receive greater protection than recent car loans.
The Till Plurality Is the Law; Smithwick Is Not
Next, the Fifth Circuit explored how to apply a plurality opinion from the Supreme Court. In Till, a plurality of four justices adopted a prime rate + approach, while Justice Thomas concurred in the judgment but found that a risk premium was not mandated. Where no single rationale is approved by a majority, the lower courts are required to follow the position of the justices who concurred in the judgment on the narrowest grounds. Drive Financial argued that because Justice Thomas did not concur in any part of the plurality opinion that Till was not binding. However, the Fifth Circuit noted that the fifth vote cast by Justice Thomas found that a prime + interest rate would always be sufficient to protect the secured creditor because the statute only required a risk free rate of return. Thus, there were five votes for the position that a prime + rate would adequately protect the interest of the secured creditor, and thus, that the lower courts must follow this result.
The Fifth Circuit also pointed out that, even if the reasons for adopting Till were murky, that the facts were the same as the present case. As a result, stare decisis required that the Fifth Circuit follow Till and not its own prior precedent.
As a result, the Fifth Circuit found that the prime rate + approach to calculating the interest rate in chapter 13 remains the law.
The Facts
Debtor financed a pickup truck with Drive Financial. The contract interest rate was 17.95%. When the Debtor filed chapter 13, he proposed to lower the rate to 6%. At the confirmation hearing, the parties stipulated that the rate would be 7.5% under the Supreme Court's Till v. SCS Credit Corp., 541 U.S. 465 (2004) decision or 17.95% under the Fifth Circuit's Green Tree Fin. Servicing Corp. v. Smithwick, 121 F.3d 211 (5th Cir. 1997). Under Till, the interest rate is to be determined based on the prime rate plus a risk premium, while Smithwick applied a rebuttable presumption that the contract rate should apply. The Bankruptcy Court applied Till and used the lower rate. The parties received permission to take a direct appeal to the Fifth Circuit.
The Hanging Paragraph Does Not Apply
The Fifth Circuit first dispelled the notion that the hanging paragraph of Sec. 1325(a)(*) applies to calculation of interest on a chapter 13 secured debt. Drive Financial argued that because Till dealt with the interest rate on a lienstripped claim, that it had no application to a post-BAPCPA claim on a vehicle claim protected from lienstripping under the hanging paragraph. The Fifth Circuit found that the fact that the claim had been subject to lienstripping did not play any part in the Supreme Court's decision to apply a prime + interest rate calculation and thus concluded that BAPCPA had not overruled the Till decision.
This raises an important point. Loans secured by a principal residence are protected from modification in both chapter 11 and chapter 13. On the other hand, loans incurred for purchase money on a vehicle within 910 days are protected from lienstripping (that is, having the secured claim reduced to the value of the collateral), but are still subject to having their interest rates modified. Thus, home mortgages receive greater protection than recent car loans.
The Till Plurality Is the Law; Smithwick Is Not
Next, the Fifth Circuit explored how to apply a plurality opinion from the Supreme Court. In Till, a plurality of four justices adopted a prime rate + approach, while Justice Thomas concurred in the judgment but found that a risk premium was not mandated. Where no single rationale is approved by a majority, the lower courts are required to follow the position of the justices who concurred in the judgment on the narrowest grounds. Drive Financial argued that because Justice Thomas did not concur in any part of the plurality opinion that Till was not binding. However, the Fifth Circuit noted that the fifth vote cast by Justice Thomas found that a prime + interest rate would always be sufficient to protect the secured creditor because the statute only required a risk free rate of return. Thus, there were five votes for the position that a prime + rate would adequately protect the interest of the secured creditor, and thus, that the lower courts must follow this result.
The Fifth Circuit also pointed out that, even if the reasons for adopting Till were murky, that the facts were the same as the present case. As a result, stare decisis required that the Fifth Circuit follow Till and not its own prior precedent.
As a result, the Fifth Circuit found that the prime rate + approach to calculating the interest rate in chapter 13 remains the law.
Friday, March 21, 2008
Sanctioned Lawyer Wins Reprieve From District Court; Court Clarifies Standards for Non-9011 Sanctions
This blog previously reported on In re Cochener, 360 B.R. 542 (Bankr. S.D. Tex. 2007), a case in which an attorney was sanctioned under 11 U.S.C. Sec. 105 and 28 U.S.C. Sec. 1927 based on events which had occurred years earlier. See "Brief Representation Comes Back to Haunt Attorney." (May 7, 2007). Now, a U.S. District Court has reversed most of the sanctions award and the case is on its way to the Fifth Circuit. Barry v. Sommers, No. H-07-0629 (S.D. Tex. 12/28/07).
What Happened in the Bankruptcy Court
The underlying case involved a debtor who had made questionable transfers prior to bankruptcy. When the trustee began asking difficult questions at the 341 meeting, the first attorney realized that he was in over his head and referred the case to a board certified attorney. The second attorney realized that the debtor was not helping herself by being in bankruptcy and tried to get the case dismissed. While the motion to dismiss was pending, the attorney advised the debtor not to attend a re-scheduled 341 meeting or to produce documents which the prior counsel had agreed to hand over. When the trustee sought to conduct a Rule 2004 examination, the second attorney argued against producing documents going back four years on the basis that 11 U.S.C. Sec. 548 only allowed the trustee to recover transfers made within one year prior to bankruptcy. The debtor failed to appear for the examination, after which the second attorney sought permission to withdraw. The second attorney was given permission to withdraw, but the court reserved the power to issue sanctions.
Over four years later, the trustee brought a motion for sanctions under Rule 9011 and 11 U.S.C. Sec. 105. Because the trustee had never given the safe harbor notice under Rule 9011, the court concluded that this relief was not viable. However, after hearing four days of testimony, the court granted relief under both Sec. 105 and 28 U.S.C. Sec. 1927 based upon the following actions:
(1) The attorney concocted a reason for the debtor not to attend the continued 341 meeting and then advised the debtor not to appear;
(2) The attorney did not attend the continued meeting of creditors;
(3) The attorney filed a motion to dismiss which included "blatantly false factual and legal allegations;"
(4) The attorney wrote a letter to the trustee which misstated the law regarding the appropriate lookback period for a fraudulent transfer case;
(5) The attorney instructed the debtor not to produce the documents requested at the initial meeting of creditors.
Based on these actions, the court awarded sanctions of $25,121.89 based upon disgorgement of the retainer paid to the attorney and payment of the trustee's attorney's fees incurred in resisting the motion to dismiss and prosecuting the motion for sanctions.
Reversal on Appeal
On appeal, the District Court reversed all of the sanctions, except for the disgorgement order. However, to get there, it had to work through several preliminary issues first.
The District Court refused to apply laches based on the delayed prosecution of the sanctions motion. While the four year delay in bringing the sanctions motion represented a long period of time, it was not prejudicial because the attorney had been placed on notice of the claim at the time of his withdrawal and because no evidence had become stale in the meantime.
The District Court also rejected the argument that the Bankruptcy Court lacked authority to issue sanctions under 11 U.S.C. Sec. 105. The Court noted the recent Supreme Court opinion in Marrama v. Citizens Bank of Massachusetts, 127 S.Ct. 1105 (2007)in which the court stated that section 105(a) provides Bankruptcy Courts broad authority to "take any action that is necessary or appropriate to prevent an abuse of process." The Court concluded that Sec. 105(a) gave bankruptcy courts the inherent power to sanction bad faith conduct that was applicable to Article III Courts under Chambers v. NASCO, Inc., 501 U.S. 32 (1991).
However, before sanctions could be awarded under the Court's inherent powers under Sec. 105(a), the court had to find bad-faith conduct. Bad faith conduct was equated with either an attempt to abuse the judicial process or an affirmative misrepresentation. After an exhaustive analysis, the District Court upheld the Bankruptcy Court's finding that the attorney had engaged in bad faith conduct when he told the debtor not to appear or produce documents at the continued 341 meeting. However, the District Court reversed the other findings as being clearly erroneous.
Having concluded that only one act was sanctionable, the District Court turned to the proper sanction to be applied. The Court noted that "Inherent powers may be exercised only if essential to preserve the authority of the court, and the sanction imposed must employ the least possible power adequate to the purpose to be achieved." Memorandum Opinion and Order, p. 81. The Court found that disgorgement of the retainer was appropriate under this standard. "Attorneys who instruct their clients to violate duties imposed by the Bankruptcy Code have not provided effective assistance of counsel and have not earned a fee." Memorandum, p. 83.
The District Court reversed the award of attorney's fees to the trustee. Because the Court found that filing the motion to dismiss was not sanctionable, it found that the Trustee could not recover his fees incurred in opposing the motion to dismiss. The District Court denied the attorney's fees incurred in prosecuting the motion for sanctions on the basis that the debtor's attorney (who had already withdrawn at this point) did not commit any sanctionable conduct during the time that the trustee was pursuing the motion for sanctions. As a result, an award of attorney's fees in connection with the motion for sanctions was not necessary to deter sanctionable conduct.
The District Court also found that the Bankruptcy Court abused its discretion in imposing sanctions under 28 U.S.C. Sec. 1927. The Court found that there were three elements to an award of sanctions of Sec. 1927: (1) the attorney must engaged in "unreasonable and vexatious" conduct; (2) the "unreasonable and vexatious" conduct must be conduct that "multiplies the proceedings;" and (3) the dollar amount of the sanction must bear a financial nexus to the excess proceedings, i.e., the sanction may not exceed the "costs, expenses and attorneys' fees reasonably incurred because of such conduct." The Court found that the motion to dismiss did not merit sanctions under Sec. 1927 because it could not be plausibly argued that it was filed in bad faith. Although the District Court found that the attorney could be sanctioned under Sec. 105 for advising the debtor not to attend the creditors' meeting, this conduct did not merit sanctions under Sec. 1927 for the reason that it did not multiply the proceedings.
The Final Analysis
In the final analysis, it appears that while Rule 9011, Sec. 105(a) and Sec. 1927 serve similar purposes, they each have slightly different focuses. Rule 9011 applies to pleadings and papers only. It applies where motions are filed for an improper purpose or are legally or factually frivolous. However, the mere filing of a frivolous or odorous pleading is not enough. It is the refusal to withdraw a sanctionable pleading after fair warning which triggers the penalty. This means that a victorious party cannot go back after the fact and decide that his opponent's position was friviolous. Sec. 105(a) and Sec. 1927, on the other hand, apply to any conduct and allow for an after the fact examination. As a result, these sections require a higher standard before sanctions can be awarded. In order to violate the Court inherent power under Sec. 105(a), counsel must make an affirmative misrepresentation or try to abuse the judicial process, either of which will add up to the requisite finding of bad faith. Sec. 1927 invokes the three-party test discussed above, which must include a finding that court proceedings were multiplied.
In this case, advising a client not to obey her duties under the Code was sanctionable, while filing a questionable motion to dismiss and taking a questionable position on a discovery matter (which was later abandoned) were not.
The Trustee has appealed this case to the Fifth Circuit, so that we may hear from this case again.
Kudos to the District Court
As a final note, U.S. District Judge Sim Lake deserves high praise for the diligence and speed with which he handled this bankruptcy appeal. He produced his thoughtful, 93-page opinion just ten months after the notice of appeal was filed and seven months after the last brief was filed. The Court did the parties and the bar a service with the prompt manner in which this case was handled.
Update:
On October 23, 2008, the Fifth Circuit reversed the opinion of the District Court and affirmed the opinion of the Bankruptcy Court. Matter of Cochener, No. 08-20048, 2008 WL 4681579 (5th Cir. 2008).
What Happened in the Bankruptcy Court
The underlying case involved a debtor who had made questionable transfers prior to bankruptcy. When the trustee began asking difficult questions at the 341 meeting, the first attorney realized that he was in over his head and referred the case to a board certified attorney. The second attorney realized that the debtor was not helping herself by being in bankruptcy and tried to get the case dismissed. While the motion to dismiss was pending, the attorney advised the debtor not to attend a re-scheduled 341 meeting or to produce documents which the prior counsel had agreed to hand over. When the trustee sought to conduct a Rule 2004 examination, the second attorney argued against producing documents going back four years on the basis that 11 U.S.C. Sec. 548 only allowed the trustee to recover transfers made within one year prior to bankruptcy. The debtor failed to appear for the examination, after which the second attorney sought permission to withdraw. The second attorney was given permission to withdraw, but the court reserved the power to issue sanctions.
Over four years later, the trustee brought a motion for sanctions under Rule 9011 and 11 U.S.C. Sec. 105. Because the trustee had never given the safe harbor notice under Rule 9011, the court concluded that this relief was not viable. However, after hearing four days of testimony, the court granted relief under both Sec. 105 and 28 U.S.C. Sec. 1927 based upon the following actions:
(1) The attorney concocted a reason for the debtor not to attend the continued 341 meeting and then advised the debtor not to appear;
(2) The attorney did not attend the continued meeting of creditors;
(3) The attorney filed a motion to dismiss which included "blatantly false factual and legal allegations;"
(4) The attorney wrote a letter to the trustee which misstated the law regarding the appropriate lookback period for a fraudulent transfer case;
(5) The attorney instructed the debtor not to produce the documents requested at the initial meeting of creditors.
Based on these actions, the court awarded sanctions of $25,121.89 based upon disgorgement of the retainer paid to the attorney and payment of the trustee's attorney's fees incurred in resisting the motion to dismiss and prosecuting the motion for sanctions.
Reversal on Appeal
On appeal, the District Court reversed all of the sanctions, except for the disgorgement order. However, to get there, it had to work through several preliminary issues first.
The District Court refused to apply laches based on the delayed prosecution of the sanctions motion. While the four year delay in bringing the sanctions motion represented a long period of time, it was not prejudicial because the attorney had been placed on notice of the claim at the time of his withdrawal and because no evidence had become stale in the meantime.
The District Court also rejected the argument that the Bankruptcy Court lacked authority to issue sanctions under 11 U.S.C. Sec. 105. The Court noted the recent Supreme Court opinion in Marrama v. Citizens Bank of Massachusetts, 127 S.Ct. 1105 (2007)in which the court stated that section 105(a) provides Bankruptcy Courts broad authority to "take any action that is necessary or appropriate to prevent an abuse of process." The Court concluded that Sec. 105(a) gave bankruptcy courts the inherent power to sanction bad faith conduct that was applicable to Article III Courts under Chambers v. NASCO, Inc., 501 U.S. 32 (1991).
However, before sanctions could be awarded under the Court's inherent powers under Sec. 105(a), the court had to find bad-faith conduct. Bad faith conduct was equated with either an attempt to abuse the judicial process or an affirmative misrepresentation. After an exhaustive analysis, the District Court upheld the Bankruptcy Court's finding that the attorney had engaged in bad faith conduct when he told the debtor not to appear or produce documents at the continued 341 meeting. However, the District Court reversed the other findings as being clearly erroneous.
Having concluded that only one act was sanctionable, the District Court turned to the proper sanction to be applied. The Court noted that "Inherent powers may be exercised only if essential to preserve the authority of the court, and the sanction imposed must employ the least possible power adequate to the purpose to be achieved." Memorandum Opinion and Order, p. 81. The Court found that disgorgement of the retainer was appropriate under this standard. "Attorneys who instruct their clients to violate duties imposed by the Bankruptcy Code have not provided effective assistance of counsel and have not earned a fee." Memorandum, p. 83.
The District Court reversed the award of attorney's fees to the trustee. Because the Court found that filing the motion to dismiss was not sanctionable, it found that the Trustee could not recover his fees incurred in opposing the motion to dismiss. The District Court denied the attorney's fees incurred in prosecuting the motion for sanctions on the basis that the debtor's attorney (who had already withdrawn at this point) did not commit any sanctionable conduct during the time that the trustee was pursuing the motion for sanctions. As a result, an award of attorney's fees in connection with the motion for sanctions was not necessary to deter sanctionable conduct.
The District Court also found that the Bankruptcy Court abused its discretion in imposing sanctions under 28 U.S.C. Sec. 1927. The Court found that there were three elements to an award of sanctions of Sec. 1927: (1) the attorney must engaged in "unreasonable and vexatious" conduct; (2) the "unreasonable and vexatious" conduct must be conduct that "multiplies the proceedings;" and (3) the dollar amount of the sanction must bear a financial nexus to the excess proceedings, i.e., the sanction may not exceed the "costs, expenses and attorneys' fees reasonably incurred because of such conduct." The Court found that the motion to dismiss did not merit sanctions under Sec. 1927 because it could not be plausibly argued that it was filed in bad faith. Although the District Court found that the attorney could be sanctioned under Sec. 105 for advising the debtor not to attend the creditors' meeting, this conduct did not merit sanctions under Sec. 1927 for the reason that it did not multiply the proceedings.
The Final Analysis
In the final analysis, it appears that while Rule 9011, Sec. 105(a) and Sec. 1927 serve similar purposes, they each have slightly different focuses. Rule 9011 applies to pleadings and papers only. It applies where motions are filed for an improper purpose or are legally or factually frivolous. However, the mere filing of a frivolous or odorous pleading is not enough. It is the refusal to withdraw a sanctionable pleading after fair warning which triggers the penalty. This means that a victorious party cannot go back after the fact and decide that his opponent's position was friviolous. Sec. 105(a) and Sec. 1927, on the other hand, apply to any conduct and allow for an after the fact examination. As a result, these sections require a higher standard before sanctions can be awarded. In order to violate the Court inherent power under Sec. 105(a), counsel must make an affirmative misrepresentation or try to abuse the judicial process, either of which will add up to the requisite finding of bad faith. Sec. 1927 invokes the three-party test discussed above, which must include a finding that court proceedings were multiplied.
In this case, advising a client not to obey her duties under the Code was sanctionable, while filing a questionable motion to dismiss and taking a questionable position on a discovery matter (which was later abandoned) were not.
The Trustee has appealed this case to the Fifth Circuit, so that we may hear from this case again.
Kudos to the District Court
As a final note, U.S. District Judge Sim Lake deserves high praise for the diligence and speed with which he handled this bankruptcy appeal. He produced his thoughtful, 93-page opinion just ten months after the notice of appeal was filed and seven months after the last brief was filed. The Court did the parties and the bar a service with the prompt manner in which this case was handled.
Update:
On October 23, 2008, the Fifth Circuit reversed the opinion of the District Court and affirmed the opinion of the Bankruptcy Court. Matter of Cochener, No. 08-20048, 2008 WL 4681579 (5th Cir. 2008).
Monday, March 03, 2008
A Modest Proposal
There has been a lot of talk about the sub-prime mortgage crisis lately. The presidential candidates are very concerned about it, but don't seem to be offering a lot of specifics. One of the candidates wants to impose a 90 day moratorium on foreclosures. This will help the problem--for about 90 days.
Perhaps we as bankruptcy lawyers can suggest a remedy from our area of the law: credit counseling. After all, when do you really need credit counseling? If it is good to use when deciding to file bankruptcy, wouldn't it be even better when deciding whether to incur the debt in the first place?
Here is what I would envision. Prior to taking out a mortgage loan, a prospective borrower would have to receive a credit counseling briefing from someone who had actually read their loan documents and looked at their financials. If the credit counselor recommends against the loan and the borrowers still want to do it, the borrowers would have to pass a test on the contents of their loan documents (a passing grade being 70, the same as it is in public school). If the prospective borrower receives a passing grade on the exam and still wants to take out the bad loan, the credit counselor would give them a stern talking to and would stamp "Don't Do It!!!" on the loan application. If at this point, the borrower insists, they would be allowed to do the loan. After all, this is a free country. However, if they choose to take out a bad loan after being told not to do it, reading the loan documents and being told not to do it a second time, they would forfeit all protections under federal law. If they default, they could be subjected to abusive debt collectors, barred from filing bankruptcy and be thrown in debtor's prison.
On the other hand, if the borrower passed credit counseling, they would be allowed to take out the loan and would also receive a golden ticket. If they ever got into financial difficulty and were posted for foreclosure, they could take their golden ticket to the bankruptcy court and exchange it for one that said "honest but unfortunate debtor". With the "honest but unfortunate debtor" ticket, they would be allowed to restructure their loan at whatever level they could afford to pay. Why would we do this? If they have the golden ticket, we know that they made a responsible decision to incur credit. Since they made a responsible decision to incur credit, any subsequent default would have to be the result of unforeseeable hardship or calamity. Thus, we would know that they were the very picture of the honest but unfortunate debtor that the bankruptcy laws are supposed to protect.
This would be a win-win solution for almost everyone. Once a few debtors were cast into outer darkness for taking out debts that they had no business incurring, other borrowers would learn to shy away from the "Don't Do It!!!!" stamp. On the other hand, if lenders knew that they would have to live with debtors holding the golden ticket, they might be more careful about who they lend to. Of course, the other possibility is that people won't learn and will keep making the same mistakes over and over again and that the only people who benefit will be the newly minted armies of credit counselors. However, at least we know that someone would benefit.
Disclaimer: No firm that I work for or any of their clients approves this proposal.
Perhaps we as bankruptcy lawyers can suggest a remedy from our area of the law: credit counseling. After all, when do you really need credit counseling? If it is good to use when deciding to file bankruptcy, wouldn't it be even better when deciding whether to incur the debt in the first place?
Here is what I would envision. Prior to taking out a mortgage loan, a prospective borrower would have to receive a credit counseling briefing from someone who had actually read their loan documents and looked at their financials. If the credit counselor recommends against the loan and the borrowers still want to do it, the borrowers would have to pass a test on the contents of their loan documents (a passing grade being 70, the same as it is in public school). If the prospective borrower receives a passing grade on the exam and still wants to take out the bad loan, the credit counselor would give them a stern talking to and would stamp "Don't Do It!!!" on the loan application. If at this point, the borrower insists, they would be allowed to do the loan. After all, this is a free country. However, if they choose to take out a bad loan after being told not to do it, reading the loan documents and being told not to do it a second time, they would forfeit all protections under federal law. If they default, they could be subjected to abusive debt collectors, barred from filing bankruptcy and be thrown in debtor's prison.
On the other hand, if the borrower passed credit counseling, they would be allowed to take out the loan and would also receive a golden ticket. If they ever got into financial difficulty and were posted for foreclosure, they could take their golden ticket to the bankruptcy court and exchange it for one that said "honest but unfortunate debtor". With the "honest but unfortunate debtor" ticket, they would be allowed to restructure their loan at whatever level they could afford to pay. Why would we do this? If they have the golden ticket, we know that they made a responsible decision to incur credit. Since they made a responsible decision to incur credit, any subsequent default would have to be the result of unforeseeable hardship or calamity. Thus, we would know that they were the very picture of the honest but unfortunate debtor that the bankruptcy laws are supposed to protect.
This would be a win-win solution for almost everyone. Once a few debtors were cast into outer darkness for taking out debts that they had no business incurring, other borrowers would learn to shy away from the "Don't Do It!!!!" stamp. On the other hand, if lenders knew that they would have to live with debtors holding the golden ticket, they might be more careful about who they lend to. Of course, the other possibility is that people won't learn and will keep making the same mistakes over and over again and that the only people who benefit will be the newly minted armies of credit counselors. However, at least we know that someone would benefit.
Disclaimer: No firm that I work for or any of their clients approves this proposal.
Thursday, February 21, 2008
How to Count Backwards
Deadlines are important. As a result, it is important to know when a deadline falls. Fed.R.Bankr.P. 9006(a) explains that the last day of a period is not counted if it falls on a Saturday, Sunday or legal holiday. In that instance, the time period “runs until the end of the next day which is not one of the aforementioned days.” This is straightforward when the period runs forward. Thus, if an action is required to be taken 25 days after a given date and the last day falls on Sunday, the deadline would expire at the end of Monday unless Monday was a legal holiday. In this case, the 25 day period becomes an 26 day period. However, what happens when time is counted backwards? Assume that an action must be taken 25 days before a set date and the last day falls on a Saturday. Does the deadline expire on Friday (in which case the deadline is expanded to 26 days) or on Monday (in which case the deadline is truncated to 23 days).
San Antonio Bankruptcy Judge Leif Clark recently ruled that “next day” means Monday, not Friday. While acknowledging that “both conclusions are reasonable under the circumstances” he noted that “alas, there can be only one deadline.” He stated that, “Because the calculation of this deadline requires counting backward, the court finds that the determination of this ‘next day’ should continue counting backward. Therefore, when, as was the case here, the 25th day falls on a Saturday, Sunday or holiday, the deadline must be the next countable day before the 25th day.” In re Russell Keith Dick, No. 05-56196 (Bankr. W.D. Tex. 1/11/08).
Counting backward is a trap for the unwary. When counting forward, the rule protects the person taking the action who gets another day. However, when counting backward, the rule protects the person who is waiting for the action to be taken. Thus, the next day is actually the prior day when viewed on the calendar.
San Antonio Bankruptcy Judge Leif Clark recently ruled that “next day” means Monday, not Friday. While acknowledging that “both conclusions are reasonable under the circumstances” he noted that “alas, there can be only one deadline.” He stated that, “Because the calculation of this deadline requires counting backward, the court finds that the determination of this ‘next day’ should continue counting backward. Therefore, when, as was the case here, the 25th day falls on a Saturday, Sunday or holiday, the deadline must be the next countable day before the 25th day.” In re Russell Keith Dick, No. 05-56196 (Bankr. W.D. Tex. 1/11/08).
Counting backward is a trap for the unwary. When counting forward, the rule protects the person taking the action who gets another day. However, when counting backward, the rule protects the person who is waiting for the action to be taken. Thus, the next day is actually the prior day when viewed on the calendar.
Ten Day Rule Protects Trustee
Most bankruptcy lawyers find the arcane details of the Federal Rules of Civil Procedure to be deadly dull. However, for Austin Bankruptcy Trustee Dan Roberts, the difference between Fed.R.Civ.P. 59 and 60 proved to be very important. In re Geneva Peterson Berg, No. 06-11933 (Bankr. W.D. Tex. 2/7/08)(Judge Frank R. Monroe).
In the Berg case, the estate included a mineral interest which appeared to have little value. The Debtor valued it as $6,987 in her schedules, but was only willing to offer $3,000 to purchase it. When the Trustee contacted the operator, he found out that there was a well upon the mineral interest and that it was expected to produce $5,260 per year. Based on this information, the Trustee negotiated a sale to the operator for $25,000. After the Debtor offered more and an auction ensued, the court approved a sale for $34,000 and the sale closed. At this point, the Trustee should have felt very good, having increased the original offer by ten-fold.
Three days after the sale closed, the Trustee received a check for $10,190.80 representing one month’s production. It turns out that the operator had failed to mention that two new wells had been drilled on the lease as a result of a farm-out the previous year. The operator apparently gave the trustee accurate information about the existing well, but apparently took an attitude of “don’t ask, don’t tell” about any other wells which might be drilled. Based upon the new production, the value of the mineral interest was estimated at $180,000 to $300,000.
The Trustee was not amused and filed a prompt motion to reconsider the order approving the sale. The motion was filed less than ten days after entry of the initial order, which proved to be important.
The Bankruptcy Court noted that a motion filed within ten days was governed by Fed.R.Civ.P. 59, as incorporated by Fed.R.Bankr.P. 9023. Rule 59 allows relief from a judgment “for any reason for which a new trial has heretofore been granted in a suit in equity.” On the other hand, Fed.R.Civ.P. 60(b) allows relief up to one year from entry of an order, but is limited to the specific grounds listed within the rule (such as mistake inadvertence, surprise, excusable neglect, fraud and newly discovered evidence). Judge Monroe pointed out that while a motion was Rule 59 was subject to “much more stringent time limitations than a comparable motion under Rule 60(b),” it was not subject to “the same exacting substantive requirements.”
In practice, the standards under Rules 59 and 60 may be very similar. In fact, in the Berg case, Judge Monroe analyzed the motion to reconsider based on newly discovered evidence, which is a specified ground under Rule 60(b)(2). However, in this case, the tipping point may have been the interest in protecting the finality of bankruptcy sales. Where the motion to reconsider was filed within ten days of entry of the order, it was unlikely that the purchaser would have significantly relied upon the order. On the other hand, had the motion been filed six months or a year later, the prejudice to the buyer could have been significant. Thus, while motions under Rules 59 and 60(b) may consider the same or similar grounds, the court is much more likely to grant an equitable do-over under Rule 59 than Rule 60.
In the Berg case, the estate included a mineral interest which appeared to have little value. The Debtor valued it as $6,987 in her schedules, but was only willing to offer $3,000 to purchase it. When the Trustee contacted the operator, he found out that there was a well upon the mineral interest and that it was expected to produce $5,260 per year. Based on this information, the Trustee negotiated a sale to the operator for $25,000. After the Debtor offered more and an auction ensued, the court approved a sale for $34,000 and the sale closed. At this point, the Trustee should have felt very good, having increased the original offer by ten-fold.
Three days after the sale closed, the Trustee received a check for $10,190.80 representing one month’s production. It turns out that the operator had failed to mention that two new wells had been drilled on the lease as a result of a farm-out the previous year. The operator apparently gave the trustee accurate information about the existing well, but apparently took an attitude of “don’t ask, don’t tell” about any other wells which might be drilled. Based upon the new production, the value of the mineral interest was estimated at $180,000 to $300,000.
The Trustee was not amused and filed a prompt motion to reconsider the order approving the sale. The motion was filed less than ten days after entry of the initial order, which proved to be important.
The Bankruptcy Court noted that a motion filed within ten days was governed by Fed.R.Civ.P. 59, as incorporated by Fed.R.Bankr.P. 9023. Rule 59 allows relief from a judgment “for any reason for which a new trial has heretofore been granted in a suit in equity.” On the other hand, Fed.R.Civ.P. 60(b) allows relief up to one year from entry of an order, but is limited to the specific grounds listed within the rule (such as mistake inadvertence, surprise, excusable neglect, fraud and newly discovered evidence). Judge Monroe pointed out that while a motion was Rule 59 was subject to “much more stringent time limitations than a comparable motion under Rule 60(b),” it was not subject to “the same exacting substantive requirements.”
In practice, the standards under Rules 59 and 60 may be very similar. In fact, in the Berg case, Judge Monroe analyzed the motion to reconsider based on newly discovered evidence, which is a specified ground under Rule 60(b)(2). However, in this case, the tipping point may have been the interest in protecting the finality of bankruptcy sales. Where the motion to reconsider was filed within ten days of entry of the order, it was unlikely that the purchaser would have significantly relied upon the order. On the other hand, had the motion been filed six months or a year later, the prejudice to the buyer could have been significant. Thus, while motions under Rules 59 and 60(b) may consider the same or similar grounds, the court is much more likely to grant an equitable do-over under Rule 59 than Rule 60.
Saturday, February 02, 2008
Impressions of Jury Duty
As a lawyer, I never expected to be selected for jury duty. Although I have gone through voir dire several times in the past, I had always been struck or not reached. As a result, when I was called for service in County Court at Law #7, I expected to be back in the office by the end of the afternoon.
When I was seated in the jury pool, the odds were still against being selected. I was seated in position #12. A misdemeanor jury consists of six jurors. That meant that in order to be picked, five people ahead of me would have to be struck and I would have to avoid being struck myself.
Voir dire was both a warm-up for the trial itself and an interesting examination of the human condition. This case involved a misdemeanor DWI charge. Out of the randomly selected jury panel, there were several people with DWI arrests and one person who had lost a family member to a drunk driver. There several panel members who expressed distrust of police in general. Balancing them out was a jury member who volunteered that he had not had a drink since the 1970s. There was also a medical doctor who was familiar with a specific test which would prove to be important later on.
There were several interesting moments during jury selection. The prosecutor asked the panel for a show of hands to see how many people had driven under the influence of alcohol. At least half the hands on the jury panel went up. At this particular moment, the defendant chose to stretch and thus raised his hand as well in subconscious answer to the prosecutor's question. When we were seated, there was a box of girl scout cookies poised on the edge of the railing between the jurors and the lawyers. Finally, when it was time for the defense lawyer to ask his questions, he picked up the box of cookies and used it to prop up one of his charts, prompting a collective "aha" moment from the jury panel. Those cookies had no doubt been on everyone's minds throughout the prosecutor's questions.
The lawyers did a good job of using voir dire to preview their case to the point where the opening statements the next day were almost superfluous. Based on the questions that were asked by both sides, it was possible to deduce that this was a case where the defendant was not falling down drunk, that his performance on a field sobriety test would be important to the case, that he had refused to take a blood alcohol test and that the burden of proof to show guilt beyond a reasonable doubt (as opposed to just being probably guilty) would be important.
I was questioned several times by both the prosecutor and the defense attorney. This made me feel like my time in sitting through jury selection was not being completely wasted, since at least my presence was being acknowledged. I managed to flub my answer to the question of what preponderance of the evidence meant, saying that it meant more reasonable than not, instead of more probable than not. I also got to be the defense lawyer's straight man when he asked what you call someone who doesn't speak up in jury selection. (The correct answer was "a juror.").
Although I was not trying to get selected (I had about a million other things to do), I was not completely disappointed when Judge Elisabeth Earle announced that I would be "one of the lucky six." After we were sworn in, the court reminded us that a lot of people had died for our right to be sitting in the jury box. While the civics lesson was a little trite, it helped reinforce that what we were doing was important business rather than just a personal inconvenience.
The trial itself last just one day and consisted of a single witness, a police officer from the DWI Enforcement Unit. It was clear that the police officer and the defense lawyer were well acquainted with each other. While a bankruptcy lawyer can build up experience appearing before a specific judge, it struck me that a criminal defense lawyer could build up experience sparring with a specific officer. In many respects, the case was a battle between the officer and the defense lawyer rather than between the two attorneys (which is not to minimize the prosecutor who put on a very professional and organized case).
This was a case where the visual evidence played an important role. The entire sequence from when the police officer decided to pull over the driver to the moment where he was walked up the ramp into the jail was recorded. As a result, the jury could see the exact tests which the officer conducted to determine intoxication. It was one thing to hear the officer testify that on a certain test that six out of eight clues for intoxication were present. It was far more powerful to see the actual test being performed. We watched the tape of the arrest backwards and forwards, at regular speed and at fast forward. One factor which became important in the trial was whether the defendant had swayed. When the tape was played at fast forward, the defendant could be seen standing straight as a ramrod while the officer swayed like a hula dancer. It may have been an unfair comparison, but it was effective.
This was also a case where common sense prevailed over expert testimony. Because the defendant had refused to take the breathalyzer test (thus subjecting himself to suspension of his driver's license), the legal standard (as given in the court's charge) was whether he had lost the "normal" use of his mental and physical faculties. Since "normal" is subjective (as opposed to .08 blood alcohol content, which is objective), the jury was given leeway to consider how normal the defendant appeared.
The evidence showed that the only things that the defendant did wrong prior to being pulled over was to drive 11 mph over the speed limit on a stretch of road where the limit was not posted (and where many people drive over the speed limit) and making a wide turn. When the officer lighted him up, the defendant made a safe and controlled turn into a nearby parking lot.
After the driver admitted that he had had "a couple of beers," the officer walked him through a field sobriety test. According to the officer, the defendant flunked each test that he was given. However, to the layman's eye, the defendant performed reasonably well on each part of the test. While the defendant stumbled a few times and could not walk heel to toe keeping his feet within half an inch of each other, the very nature of the tests being performed was abnormal. For example, there was one test where the defendant had to make a turn while keeping one foot planted on the ground. The defendant was not able to do this (which would be a very unusual way to turn), but made a smooth pivot at the other end of the test.
After the defendant was arrested, his main concerns were ensuring that his girlfriend got home safely and wondering when he could get bonded out (both showing the normal use of his mental faculties). At the very end of the tape, the defendant was able to walk smoothly up a ramp with his hands handcuffed behind his back (showing the normal use of his physcial faculties).
As a result, the expert testimony established that the defendant was clearly intoxicated, since he had failed every test that he was given. However, the layman's eye saw that the defendant was in possession of reasonably normal mental and physical faculties except when he was being asked to peform abnormal tests. The fact that some study somewhere established that this was a reliable method to establish intoxication was not sufficient to overcome the fact that the defendant did not look or act intoxicated (even when keeping in mind that intoxicated was a lesser standard than drunk).
Another factor which was important was the burden of proof. In voir dire and again in closing, the defense lawyer used a very effective graphic illustrating the various levels of proof from no evidence through probable cause, preponderance of the evidence, clear and convincing and beyond a reasonable doubt. Had our case involved a lesser standard of proof, it would have been much more difficult. However, the defendant's actions both before and after the field sobriety test were normal enough to raise a reasonable doubt. Had we been asked to decide more likely than not, we could easily have ruled for the prosecutor. However, the jury did not have a problem understanding and applying the higher standard of beyond a reasonable doubt.
When we retired to the jury room, there were initially four votes to acquit and two undecided votes. However, after an hour of deliberation we were able to bring back a verdict of not guilty. The defendant may well have been intoxicated that night. However, because the evidence was close, he was let off with a good scare and a hefty legal bill.
On a final note, both lawyers in the case gave a good impression. Both sides represented their clients zealously. However, they remained professional in that they avoided unnecessary sniping between themselves and didn't pull any stupid lawyer tricks (such as referring to things which not in evidence or trying to contradict the court's charge). They also tried their case efficiently and did not waste our time. While it is unlikely that I will be selected as a juror again, I would not hesitate to rule in favor of the earnest, young prosecutor in a case with stronger facts. I also would not hesitate to refer a client to the defense attorney (whose card I forgot to get).
When I was seated in the jury pool, the odds were still against being selected. I was seated in position #12. A misdemeanor jury consists of six jurors. That meant that in order to be picked, five people ahead of me would have to be struck and I would have to avoid being struck myself.
Voir dire was both a warm-up for the trial itself and an interesting examination of the human condition. This case involved a misdemeanor DWI charge. Out of the randomly selected jury panel, there were several people with DWI arrests and one person who had lost a family member to a drunk driver. There several panel members who expressed distrust of police in general. Balancing them out was a jury member who volunteered that he had not had a drink since the 1970s. There was also a medical doctor who was familiar with a specific test which would prove to be important later on.
There were several interesting moments during jury selection. The prosecutor asked the panel for a show of hands to see how many people had driven under the influence of alcohol. At least half the hands on the jury panel went up. At this particular moment, the defendant chose to stretch and thus raised his hand as well in subconscious answer to the prosecutor's question. When we were seated, there was a box of girl scout cookies poised on the edge of the railing between the jurors and the lawyers. Finally, when it was time for the defense lawyer to ask his questions, he picked up the box of cookies and used it to prop up one of his charts, prompting a collective "aha" moment from the jury panel. Those cookies had no doubt been on everyone's minds throughout the prosecutor's questions.
The lawyers did a good job of using voir dire to preview their case to the point where the opening statements the next day were almost superfluous. Based on the questions that were asked by both sides, it was possible to deduce that this was a case where the defendant was not falling down drunk, that his performance on a field sobriety test would be important to the case, that he had refused to take a blood alcohol test and that the burden of proof to show guilt beyond a reasonable doubt (as opposed to just being probably guilty) would be important.
I was questioned several times by both the prosecutor and the defense attorney. This made me feel like my time in sitting through jury selection was not being completely wasted, since at least my presence was being acknowledged. I managed to flub my answer to the question of what preponderance of the evidence meant, saying that it meant more reasonable than not, instead of more probable than not. I also got to be the defense lawyer's straight man when he asked what you call someone who doesn't speak up in jury selection. (The correct answer was "a juror.").
Although I was not trying to get selected (I had about a million other things to do), I was not completely disappointed when Judge Elisabeth Earle announced that I would be "one of the lucky six." After we were sworn in, the court reminded us that a lot of people had died for our right to be sitting in the jury box. While the civics lesson was a little trite, it helped reinforce that what we were doing was important business rather than just a personal inconvenience.
The trial itself last just one day and consisted of a single witness, a police officer from the DWI Enforcement Unit. It was clear that the police officer and the defense lawyer were well acquainted with each other. While a bankruptcy lawyer can build up experience appearing before a specific judge, it struck me that a criminal defense lawyer could build up experience sparring with a specific officer. In many respects, the case was a battle between the officer and the defense lawyer rather than between the two attorneys (which is not to minimize the prosecutor who put on a very professional and organized case).
This was a case where the visual evidence played an important role. The entire sequence from when the police officer decided to pull over the driver to the moment where he was walked up the ramp into the jail was recorded. As a result, the jury could see the exact tests which the officer conducted to determine intoxication. It was one thing to hear the officer testify that on a certain test that six out of eight clues for intoxication were present. It was far more powerful to see the actual test being performed. We watched the tape of the arrest backwards and forwards, at regular speed and at fast forward. One factor which became important in the trial was whether the defendant had swayed. When the tape was played at fast forward, the defendant could be seen standing straight as a ramrod while the officer swayed like a hula dancer. It may have been an unfair comparison, but it was effective.
This was also a case where common sense prevailed over expert testimony. Because the defendant had refused to take the breathalyzer test (thus subjecting himself to suspension of his driver's license), the legal standard (as given in the court's charge) was whether he had lost the "normal" use of his mental and physical faculties. Since "normal" is subjective (as opposed to .08 blood alcohol content, which is objective), the jury was given leeway to consider how normal the defendant appeared.
The evidence showed that the only things that the defendant did wrong prior to being pulled over was to drive 11 mph over the speed limit on a stretch of road where the limit was not posted (and where many people drive over the speed limit) and making a wide turn. When the officer lighted him up, the defendant made a safe and controlled turn into a nearby parking lot.
After the driver admitted that he had had "a couple of beers," the officer walked him through a field sobriety test. According to the officer, the defendant flunked each test that he was given. However, to the layman's eye, the defendant performed reasonably well on each part of the test. While the defendant stumbled a few times and could not walk heel to toe keeping his feet within half an inch of each other, the very nature of the tests being performed was abnormal. For example, there was one test where the defendant had to make a turn while keeping one foot planted on the ground. The defendant was not able to do this (which would be a very unusual way to turn), but made a smooth pivot at the other end of the test.
After the defendant was arrested, his main concerns were ensuring that his girlfriend got home safely and wondering when he could get bonded out (both showing the normal use of his mental faculties). At the very end of the tape, the defendant was able to walk smoothly up a ramp with his hands handcuffed behind his back (showing the normal use of his physcial faculties).
As a result, the expert testimony established that the defendant was clearly intoxicated, since he had failed every test that he was given. However, the layman's eye saw that the defendant was in possession of reasonably normal mental and physical faculties except when he was being asked to peform abnormal tests. The fact that some study somewhere established that this was a reliable method to establish intoxication was not sufficient to overcome the fact that the defendant did not look or act intoxicated (even when keeping in mind that intoxicated was a lesser standard than drunk).
Another factor which was important was the burden of proof. In voir dire and again in closing, the defense lawyer used a very effective graphic illustrating the various levels of proof from no evidence through probable cause, preponderance of the evidence, clear and convincing and beyond a reasonable doubt. Had our case involved a lesser standard of proof, it would have been much more difficult. However, the defendant's actions both before and after the field sobriety test were normal enough to raise a reasonable doubt. Had we been asked to decide more likely than not, we could easily have ruled for the prosecutor. However, the jury did not have a problem understanding and applying the higher standard of beyond a reasonable doubt.
When we retired to the jury room, there were initially four votes to acquit and two undecided votes. However, after an hour of deliberation we were able to bring back a verdict of not guilty. The defendant may well have been intoxicated that night. However, because the evidence was close, he was let off with a good scare and a hefty legal bill.
On a final note, both lawyers in the case gave a good impression. Both sides represented their clients zealously. However, they remained professional in that they avoided unnecessary sniping between themselves and didn't pull any stupid lawyer tricks (such as referring to things which not in evidence or trying to contradict the court's charge). They also tried their case efficiently and did not waste our time. While it is unlikely that I will be selected as a juror again, I would not hesitate to rule in favor of the earnest, young prosecutor in a case with stronger facts. I also would not hesitate to refer a client to the defense attorney (whose card I forgot to get).
Wednesday, January 30, 2008
Fifth Circuit Rules on Homestead Cap
The Fifth Circuit started off the new year with an opinion construing the homestead cap under 11 U.S.C. Sec. 522(p)(1). Matter of Rogers, 2008 U.S. App. LEXIS 129 (5th Cir. 1/4/08). While the case addresses a fairly narrow issue, it is significant because it appears to be the first appellate court opinion construing the new statute.
The issue in Rogers was whether a debtor triggered Sec. 522(p)(1)'s homestead cap when a property acquired more than 1,215 days prior to bankruptcy became the debtor's homestead within the statutory period. Sec. 522(p)(1) states that a debtor may not exempt "any amount of interest" in a homestead that was acquired by the debtor within 1,215 days before bankruptcy which exceeds $125,000 in value. The debtor inherited the property in 1994, but did not make it her homestead until January 2004 after she separated from her husband. The property was awarded to her in the parties' subsequent divorce in April 2004.
The debtor filed for bankruptcy in September 2005 and a creditor objected to the homestead exemption. The bankruptcy court denied the objection to exemption and the district court affirmed this ruling. However, the courts gave different reasons for their rulings. The bankruptcy court ruled that because the debtor obtained title to the property outside of the 1,215 day period that the cap did not apply. The district court ruled that it was impossible to have "a quantity of classification as homestead." As a result, it ruled that the word "interest" referred to the equity acquired by the debtor during the 1,215 day period. Because a homestead designation did not enhance the debtor's equity in the property, the district court held that the cap did not apply.
The split between the bankruptcy court and the district court mirrors a split within the cases nationally. In general, the proponents of the title and equity theories are each trying to avoid what they perceive to be a bad result. The cases which hold that the words "any amount of interest" refers to when the debtor acquired title were ruling on cases where the debtor acquired legal title more than 1,215 days prior to bankruptcy but enhanced their equity within the statutory period. The judges in these cases hold that where title is acquired outside of the statutory period that any enhancement of equity during the 1,215 days is not relevant because title is something which can be acquired, while equity is not. The equity cases generally deal with the situation where the debtor acquired a property whose equity was initially below the cap, but where passive appreciation increased the value beyond the amount of the cap. These cases reject the challenge to the homestead on the basis that the debtor did not acquire any more equity in the property during the statutory period but simply had the value increased by market forces.
The Fifth Circuit found it unnecessary to resolve the conflict. It found that at a minimum, the debtor must acquire "vested economic interests" within the 1,215 day period in order for the cap to apply. The court concluded that "A debtor acquires an interest in property, not in an exemption." As a result, it found that a property's change in status from non-homestead to homestead was not sufficient to trigger the limitation on what could be exempted.
The Fifth Circuit also dismissed as a red herring the argument that the debtor acquired her interest in the property through the divorce decree. Because the property had been inherited, it was the debtor's separate property. The divorce decree merely confirmed the property's status as her separate property rather than conveying any new interest.
Disclaimer: I have a case pending which may turn on the title vs. equity distinction. While I have tried to accurately summarize the distinctions between the two lines of cases, anyone interested in these issues should read the cases for themselves.
The issue in Rogers was whether a debtor triggered Sec. 522(p)(1)'s homestead cap when a property acquired more than 1,215 days prior to bankruptcy became the debtor's homestead within the statutory period. Sec. 522(p)(1) states that a debtor may not exempt "any amount of interest" in a homestead that was acquired by the debtor within 1,215 days before bankruptcy which exceeds $125,000 in value. The debtor inherited the property in 1994, but did not make it her homestead until January 2004 after she separated from her husband. The property was awarded to her in the parties' subsequent divorce in April 2004.
The debtor filed for bankruptcy in September 2005 and a creditor objected to the homestead exemption. The bankruptcy court denied the objection to exemption and the district court affirmed this ruling. However, the courts gave different reasons for their rulings. The bankruptcy court ruled that because the debtor obtained title to the property outside of the 1,215 day period that the cap did not apply. The district court ruled that it was impossible to have "a quantity of classification as homestead." As a result, it ruled that the word "interest" referred to the equity acquired by the debtor during the 1,215 day period. Because a homestead designation did not enhance the debtor's equity in the property, the district court held that the cap did not apply.
The split between the bankruptcy court and the district court mirrors a split within the cases nationally. In general, the proponents of the title and equity theories are each trying to avoid what they perceive to be a bad result. The cases which hold that the words "any amount of interest" refers to when the debtor acquired title were ruling on cases where the debtor acquired legal title more than 1,215 days prior to bankruptcy but enhanced their equity within the statutory period. The judges in these cases hold that where title is acquired outside of the statutory period that any enhancement of equity during the 1,215 days is not relevant because title is something which can be acquired, while equity is not. The equity cases generally deal with the situation where the debtor acquired a property whose equity was initially below the cap, but where passive appreciation increased the value beyond the amount of the cap. These cases reject the challenge to the homestead on the basis that the debtor did not acquire any more equity in the property during the statutory period but simply had the value increased by market forces.
The Fifth Circuit found it unnecessary to resolve the conflict. It found that at a minimum, the debtor must acquire "vested economic interests" within the 1,215 day period in order for the cap to apply. The court concluded that "A debtor acquires an interest in property, not in an exemption." As a result, it found that a property's change in status from non-homestead to homestead was not sufficient to trigger the limitation on what could be exempted.
The Fifth Circuit also dismissed as a red herring the argument that the debtor acquired her interest in the property through the divorce decree. Because the property had been inherited, it was the debtor's separate property. The divorce decree merely confirmed the property's status as her separate property rather than conveying any new interest.
Disclaimer: I have a case pending which may turn on the title vs. equity distinction. While I have tried to accurately summarize the distinctions between the two lines of cases, anyone interested in these issues should read the cases for themselves.
Wednesday, January 16, 2008
Judge Follows Legal Priority While Acknowledging "Moral Priority" Of Losing Parties
San Antonio Bankruptcy Judge Leif Clark is known as the master of the footnote. Thus, when faced with a relatively straightforward case requiring him to construe a confirmed chapter 11 plan, he held his nose and applied the law. In re Texas Pig Stands, Inc., No. 05-52336 (Bankr. W.D. Texas 1/10/08). However, he used his written opinion to let the disappointed parties know that they had "moral priority" and told them where to complain.
Texas Pig Stands is a case, like many, that didn't work out quite as well as it should have. The Debtor confirmed a liquidating plan. The Liquidation Trustee sold the Debtor's property. After the first lienholder and the property taxes were paid at closing, there was a balance of $62,655.35 left over. The parties acknowledged that some of these funds would have to go to pay the lienholder's attorney and a mechanic's lien creditor. The question was what to do with the remaining balance.
The Liquidation Trustee requested permission to pay the employees and vendors who had incurred post-confirmation claims. The State of Texas asserted that the balance should go to pay its tax claim, which had accrued pre-petition, pre-confirmation and post-confirmation. Interestingly enough, the State's claim had not been a secured claim prior to bankruptcy. However, the default language in the plan allowed the State to exercise "all right and remedies under applicable non-bankruptcy law." Of course, one of these remedies is to file a tax lien. When the Liquidation Trustee failed to pay the State under the terms of the confirmed plan, the State gave notice of default and then filed a post-confirmation tax lien. When it came time to distribute the sales proceeds, the State contended that its lien covered all taxes, whether incurred pre-petition, pre-confirmation or post-confirmation.
Judge Clark methodically worked through the issues, concluding that he had post-confirmation jurisdiction to hear the dispute, that the default language of the plan allowed the filing of the tax lien and that the tax lien secured all of the taxes. As a result, the Judge concluded that:
"(T)he Comptroller is entitled to distribution from the sales proceeds to the extent that the proceeds are available to satisfy the Comptroller's tax lien, subject to the payment of prior liens and claims. Unfortunately, the sale proceeds will not satisfy the Comptroller's tax lien in full. The employees, trade vendors aand all other general unsecured creditors therefore will remain unpaid."
Order Granting Authority for Liquidation Trustee to Distribute Sales Proceeds, p. 7.
However, the Court did not stop there. In a footnote, the Judge told the parties where to complain.
"This is, no doubt, an unfortunate result, but one which is mandated by the Texas Tax Code itself. The court can only refer these unpaid employees and trade vendors to Governor Rick Perry's office and to the office of the Texas Comptroller for a fuller explanation for why the state elected to deprive them of their honest, hard-earned compensation. The unpaid employees have a clear moral priority over the claims of the Comptroller for unpaid sales taxes. But for the employees' willingness to work at the restaurant and the trade vendor's willingness to extend credit to the Liquidation Trustee, there would not have been any money to pay the Comptroller. The state clearly is receiving an economic windfall, and further expects these employees to work for free to confer that windfall. Despite the employees' and vendors' moral priority, the Comptroller nonetheless holds legal priority under the Texas Tax Code and the confirmed plan. This court is bound by the latter."
Order, n. 5 (emphasis added).
With all respect to His Honor's good intentions, what else could the State have done? Under Texas law, monies collected for sales taxes are trust funds required to be held for the benefit of the State. The State apparently acquiesced in allowing the Debtor and later the Liquidation Trustee to continue to operate the business despite the fact that tax monies were being collected and not remitted to the State. When the Liquidation Trustee defaulted under the plan, over a year before the sale took place, the State could have closed the restaurant down, in which case the employees would have been unemployed and uncompensated much sooner. Instead, the State, like all the other parties in the case, waited to see whether a brighter future lay ahead. When that prospect did not fully materialize, the State insisted on its legal rights. Had the State passed on its right to get paid ahead of those with lower priorities, the elected officials who are the public face of the State would have opened themselves up to a firestorm of criticism from the public for giving away the State's money.
The Liquidation Trustee was faced with a terrible choice here. He was tasked with paying creditors under a plan and maximizing the value of the Debtor's assets. When the Debtor's business could not pay for current operations, the Trustee had a choice. He could either close the business and likely lose it to foreclosure, or he keep cross his fingers and hope that things got better. While closing the business and not incurring further post-confirmation debt was the correct legal answer (first, do no harm), all of the parties--the Liquidation Trustee, the employees, the vendors, the first lienholder, the State--apparently thought it was better to keep going. In a perfect world, the parties drafting the plan could have created a carve-out for payment of post-confirmation expenses. However, who goes into a plan anticipating that the Debtor won't be able to pay operating expenses? Also, who anticipates that the boilerplate default language contained within a plan will allow a seventh priority unsecured creditor to become a secured creditor?
While the result in this case is unfortunate for the employees who did not get paid, it is not all that unusual. To draw an analogy from George Orwell's Animal Farm, some creditors are more equal than others. Employees, vendors and customers will always rank below lienholders. When businesses fail, there are always winners and losers and those without liens are always the losers. If the Judge wanted to drop a bomb onto someone's lap, he could have directed the unpaid employees to contact their state legislators and demand to know why there is not a floating lien for unpaid wages, much like the floating lien for perishable agricultural commodities. While such a proposal would be politically infeasible, it would at least raise the issue of whether legal priorities should be more closely aligned with moral priorities.
Texas Pig Stands is a case, like many, that didn't work out quite as well as it should have. The Debtor confirmed a liquidating plan. The Liquidation Trustee sold the Debtor's property. After the first lienholder and the property taxes were paid at closing, there was a balance of $62,655.35 left over. The parties acknowledged that some of these funds would have to go to pay the lienholder's attorney and a mechanic's lien creditor. The question was what to do with the remaining balance.
The Liquidation Trustee requested permission to pay the employees and vendors who had incurred post-confirmation claims. The State of Texas asserted that the balance should go to pay its tax claim, which had accrued pre-petition, pre-confirmation and post-confirmation. Interestingly enough, the State's claim had not been a secured claim prior to bankruptcy. However, the default language in the plan allowed the State to exercise "all right and remedies under applicable non-bankruptcy law." Of course, one of these remedies is to file a tax lien. When the Liquidation Trustee failed to pay the State under the terms of the confirmed plan, the State gave notice of default and then filed a post-confirmation tax lien. When it came time to distribute the sales proceeds, the State contended that its lien covered all taxes, whether incurred pre-petition, pre-confirmation or post-confirmation.
Judge Clark methodically worked through the issues, concluding that he had post-confirmation jurisdiction to hear the dispute, that the default language of the plan allowed the filing of the tax lien and that the tax lien secured all of the taxes. As a result, the Judge concluded that:
"(T)he Comptroller is entitled to distribution from the sales proceeds to the extent that the proceeds are available to satisfy the Comptroller's tax lien, subject to the payment of prior liens and claims. Unfortunately, the sale proceeds will not satisfy the Comptroller's tax lien in full. The employees, trade vendors aand all other general unsecured creditors therefore will remain unpaid."
Order Granting Authority for Liquidation Trustee to Distribute Sales Proceeds, p. 7.
However, the Court did not stop there. In a footnote, the Judge told the parties where to complain.
"This is, no doubt, an unfortunate result, but one which is mandated by the Texas Tax Code itself. The court can only refer these unpaid employees and trade vendors to Governor Rick Perry's office and to the office of the Texas Comptroller for a fuller explanation for why the state elected to deprive them of their honest, hard-earned compensation. The unpaid employees have a clear moral priority over the claims of the Comptroller for unpaid sales taxes. But for the employees' willingness to work at the restaurant and the trade vendor's willingness to extend credit to the Liquidation Trustee, there would not have been any money to pay the Comptroller. The state clearly is receiving an economic windfall, and further expects these employees to work for free to confer that windfall. Despite the employees' and vendors' moral priority, the Comptroller nonetheless holds legal priority under the Texas Tax Code and the confirmed plan. This court is bound by the latter."
Order, n. 5 (emphasis added).
With all respect to His Honor's good intentions, what else could the State have done? Under Texas law, monies collected for sales taxes are trust funds required to be held for the benefit of the State. The State apparently acquiesced in allowing the Debtor and later the Liquidation Trustee to continue to operate the business despite the fact that tax monies were being collected and not remitted to the State. When the Liquidation Trustee defaulted under the plan, over a year before the sale took place, the State could have closed the restaurant down, in which case the employees would have been unemployed and uncompensated much sooner. Instead, the State, like all the other parties in the case, waited to see whether a brighter future lay ahead. When that prospect did not fully materialize, the State insisted on its legal rights. Had the State passed on its right to get paid ahead of those with lower priorities, the elected officials who are the public face of the State would have opened themselves up to a firestorm of criticism from the public for giving away the State's money.
The Liquidation Trustee was faced with a terrible choice here. He was tasked with paying creditors under a plan and maximizing the value of the Debtor's assets. When the Debtor's business could not pay for current operations, the Trustee had a choice. He could either close the business and likely lose it to foreclosure, or he keep cross his fingers and hope that things got better. While closing the business and not incurring further post-confirmation debt was the correct legal answer (first, do no harm), all of the parties--the Liquidation Trustee, the employees, the vendors, the first lienholder, the State--apparently thought it was better to keep going. In a perfect world, the parties drafting the plan could have created a carve-out for payment of post-confirmation expenses. However, who goes into a plan anticipating that the Debtor won't be able to pay operating expenses? Also, who anticipates that the boilerplate default language contained within a plan will allow a seventh priority unsecured creditor to become a secured creditor?
While the result in this case is unfortunate for the employees who did not get paid, it is not all that unusual. To draw an analogy from George Orwell's Animal Farm, some creditors are more equal than others. Employees, vendors and customers will always rank below lienholders. When businesses fail, there are always winners and losers and those without liens are always the losers. If the Judge wanted to drop a bomb onto someone's lap, he could have directed the unpaid employees to contact their state legislators and demand to know why there is not a floating lien for unpaid wages, much like the floating lien for perishable agricultural commodities. While such a proposal would be politically infeasible, it would at least raise the issue of whether legal priorities should be more closely aligned with moral priorities.
Friday, January 11, 2008
Fifth Circuit Recommends Impeachment of Federal Judge Based on Bankruptcy Misconduct
On December 20, 2007, the Judicial Council of the Fifth Circuit entered a Memorandum Order and Certification in which it certified to the Judicial Conference of the United States its determination that U.S. District Judge G. Thomas Porteous had engaged in conduct which might constitute grounds for impeachment. In re: Complaint of Judicial Misconduct against United States District Judge G. Thomas Porteous, Jr., under the Judicial Conduct and Disability Act of 1980, Docket No. 07-05-351-0085. One of the grounds stated for possible impeachment was the Judge's misconduct while he was a Chapter 13 debtor.
Judge Porteous was appointed to the U.S. District Court bench in New Orleans in 1994. On March 28, 2001, he filed a chapter 13 bankruptcy petition in the Bankruptcy Court for the Eastern District of Louisiana. The Bankruptcy Judges for the Eastern District recused themselves on the basis that they were a unit of the District Court of which Judge Porteous was a judge. The Judicial Council of the Fifth Circuit appointed Bankruptcy Judge William Greendyke to hear the case. Judge Porteous confirmed a plan and ultimately received a discharge on July 22, 2004.
The Judicial Council made the following findings about the Judge's bankruptcy case:
"Judge Porteous filed numerous false statements under oath during his and his wife's Chapter 13 bankruptcy, including filing the petiiton under a false name; concealing assets of the bankruptcy estate; failing to identify gambling losses; and failing to list all creditors. Judge Porteous additionally violated bankruptcy court orders forbidding him from incurring debt during the course of the Chapter 13 cse without approval of the trustee or bankruptcy judge, in that he continued regularly to incur short-term extensions of credit from various casinos. Judge Porteous additionally made unauthorized and undisclosed payments to preferred creditors after the commencement of the bankruptcy case."
Memorandum Order, p. 3.
In addition to the bankruptcy grounds stated, the Judicial Council found that the Judge had engaged in deceptive conduct concerning a debt he owed to Regions Bank prior to bankruptcy, that he received gifts and things of value from attorneys who had cases pending before him and that he failed to report the gifts on his financial disclosures.
According to an article in The New Orleans Times-Picayune, there were 7,462 complaints filed against federal judges in the decade ending September 30, 2006. Out of those complaints, eight required action by a judicial council and none was referred to the Judicial Conference for possible impeachment. Meghan Gordon, "Move to impeach federal judge a rarity," The Times-Picayune, December 23, 2007. Since the current law was passed in 1981, three federal judges have been removed from office through impeachment, all of them during the 1980s.
From this point, the Judicial Conference of the United States will review the case and will make a recommendation to the House of Representatives. If the House of Representatives votes for impeachment, there will be a trial before the Senate.
Judge Porteous was appointed to the U.S. District Court bench in New Orleans in 1994. On March 28, 2001, he filed a chapter 13 bankruptcy petition in the Bankruptcy Court for the Eastern District of Louisiana. The Bankruptcy Judges for the Eastern District recused themselves on the basis that they were a unit of the District Court of which Judge Porteous was a judge. The Judicial Council of the Fifth Circuit appointed Bankruptcy Judge William Greendyke to hear the case. Judge Porteous confirmed a plan and ultimately received a discharge on July 22, 2004.
The Judicial Council made the following findings about the Judge's bankruptcy case:
"Judge Porteous filed numerous false statements under oath during his and his wife's Chapter 13 bankruptcy, including filing the petiiton under a false name; concealing assets of the bankruptcy estate; failing to identify gambling losses; and failing to list all creditors. Judge Porteous additionally violated bankruptcy court orders forbidding him from incurring debt during the course of the Chapter 13 cse without approval of the trustee or bankruptcy judge, in that he continued regularly to incur short-term extensions of credit from various casinos. Judge Porteous additionally made unauthorized and undisclosed payments to preferred creditors after the commencement of the bankruptcy case."
Memorandum Order, p. 3.
In addition to the bankruptcy grounds stated, the Judicial Council found that the Judge had engaged in deceptive conduct concerning a debt he owed to Regions Bank prior to bankruptcy, that he received gifts and things of value from attorneys who had cases pending before him and that he failed to report the gifts on his financial disclosures.
According to an article in The New Orleans Times-Picayune, there were 7,462 complaints filed against federal judges in the decade ending September 30, 2006. Out of those complaints, eight required action by a judicial council and none was referred to the Judicial Conference for possible impeachment. Meghan Gordon, "Move to impeach federal judge a rarity," The Times-Picayune, December 23, 2007. Since the current law was passed in 1981, three federal judges have been removed from office through impeachment, all of them during the 1980s.
From this point, the Judicial Conference of the United States will review the case and will make a recommendation to the House of Representatives. If the House of Representatives votes for impeachment, there will be a trial before the Senate.
Thursday, January 10, 2008
Texas Supreme Court Limits Penalties for Invalid Home Equity Loan
Texas has a long tradition of protecting its homesteads. Texas was the last state in the nation to allow home equity lending. When it did, the loans came with a host of technical requirements and draconian penalties for failing to meet those requirements. In certain circumstances, failure to comply with the home equity laws results in forfeiture of principal and interest. However, under a new opinion from the Texas Supreme Court, the forfeiture to be suffered does not extend to any constitutionally valid liens which were refinanced with the invalid home equity loan.
In LaSalle Bank National Association vs. Geistweidt, No. 06-1016 (Tex. 12/21/07), the borrowers owned a 53.722 acre homestead property which had a prior purchase money lien for $185,010.51 and also a valid lien for ad valorem taxes in the amount of $9,410.96. The lender advanced $260,000.00 to the borrowers which paid off the prior liens and paid the borrowers $57,518.50 in additional money. The borrowers defaulted after making only five payments on the loan. When the lender tried to foreclose, the borrowers claimed that the lien was secured by property designated for agricultural use and thus invalid. The trial court and the court of appeals both agreed and ruled that the lender had to forfeit all principal and interest with the result that the borrowers would get to keep their homestead free and clear. This would be a substantial benefit for the borrowers, since it would mean that they could keep the $57,000 in new money which they had received and would be excused from paying nearly $200,000 in liens which had been validly established against the homestead prior to the refinance.
On petition for review to the Texas Supreme Court, LaSalle Bank did not dispute that they had made an invalid home equity loan. Instead, they took the more modest position that the constitutional provisions relating to home equity loans did not displace the prior case law allowing for equitable subrogation. It has long been the law in Texas that a party that pays off a valid lien against a homestead is subrogated to the position of the prior lender.
The Texas Supreme Court agreed with the lender. They looked at Tex. Const. Art. XVI, sectin 50(e), which states that a refinance that includes the advance of additional funds "may not be secured by a valid lien against the homestead" unless the refinance was an advance of credit authorized by the home equity provisions or was to pay reasonable costs necessary to the refinance.
One way to read the statute is to look at the words "a refinance of debt secured by a homestead ... may not be secured by a valid lien" unless the conditions are met. Reading this language literally, it would appear that the refinanced debt could not be secured by a valid lien in any event. However, the state Supreme Court found that the statute "contains no language that would indicate displacement of common law remedies was intended, and we decline to engraft such a prohibition onto the constitutional language." Slip Op. at 4. Thus "not be secured by a valid lien" was read as "not be secured by a valid lien except under equitable principles."
While this reading may appear to strain the text, another way to look at the constitional language is to say that the home equity loan itself would not be secured by a valid lien, but that the lender would still have the rights that any other person paying off a valid lien against a homestead would have. This seems to be the direction that the court was going.
From an equitable point of view, this result makes sense. The homestead is not burdened by any more debt than it had before the invalid home equity loan was placed upon it and the lender's penalty for not following the law is the loss of over $57,000.
In LaSalle Bank National Association vs. Geistweidt, No. 06-1016 (Tex. 12/21/07), the borrowers owned a 53.722 acre homestead property which had a prior purchase money lien for $185,010.51 and also a valid lien for ad valorem taxes in the amount of $9,410.96. The lender advanced $260,000.00 to the borrowers which paid off the prior liens and paid the borrowers $57,518.50 in additional money. The borrowers defaulted after making only five payments on the loan. When the lender tried to foreclose, the borrowers claimed that the lien was secured by property designated for agricultural use and thus invalid. The trial court and the court of appeals both agreed and ruled that the lender had to forfeit all principal and interest with the result that the borrowers would get to keep their homestead free and clear. This would be a substantial benefit for the borrowers, since it would mean that they could keep the $57,000 in new money which they had received and would be excused from paying nearly $200,000 in liens which had been validly established against the homestead prior to the refinance.
On petition for review to the Texas Supreme Court, LaSalle Bank did not dispute that they had made an invalid home equity loan. Instead, they took the more modest position that the constitutional provisions relating to home equity loans did not displace the prior case law allowing for equitable subrogation. It has long been the law in Texas that a party that pays off a valid lien against a homestead is subrogated to the position of the prior lender.
The Texas Supreme Court agreed with the lender. They looked at Tex. Const. Art. XVI, sectin 50(e), which states that a refinance that includes the advance of additional funds "may not be secured by a valid lien against the homestead" unless the refinance was an advance of credit authorized by the home equity provisions or was to pay reasonable costs necessary to the refinance.
One way to read the statute is to look at the words "a refinance of debt secured by a homestead ... may not be secured by a valid lien" unless the conditions are met. Reading this language literally, it would appear that the refinanced debt could not be secured by a valid lien in any event. However, the state Supreme Court found that the statute "contains no language that would indicate displacement of common law remedies was intended, and we decline to engraft such a prohibition onto the constitutional language." Slip Op. at 4. Thus "not be secured by a valid lien" was read as "not be secured by a valid lien except under equitable principles."
While this reading may appear to strain the text, another way to look at the constitional language is to say that the home equity loan itself would not be secured by a valid lien, but that the lender would still have the rights that any other person paying off a valid lien against a homestead would have. This seems to be the direction that the court was going.
From an equitable point of view, this result makes sense. The homestead is not burdened by any more debt than it had before the invalid home equity loan was placed upon it and the lender's penalty for not following the law is the loss of over $57,000.
Friday, December 21, 2007
Interesting Cases That I Didn't Get Around To This Year
As we reach the end of another year, I have a few cases that I meant to blog about, but never quite found the time. Many of these cases are every bit as important as the ones that I did write about. Here are the best of the rest in capsule form. Maybe I will find time to write some more about them next year.
The National Benevolent Association of the Christian Church vs. Weil, Gotshal & Manges, LLP, No. 05-5134 (Bankr. W.D. Tex. 2/6/07). Debtor sued its former attorneys for actions taken during the bankruptcy case. Judge King ruled that where the Court approved the Debtors' motion to sell property free and clear of liens and approved the Debtors' plan of reorganization, res judicata prevented the Debtors from suing their lawyers based on their successful representation of the Debtors. Additionally, failure to disclose the claims in the disclosure statement barred the claims under the doctrine of judicial estoppel. (Note: Although Weil, Gotshal prepared the disclosure statement which did not disclose the claims against it, the Debtors did have a second law firm which could have insisted that the claims be included).
Mahoney v. Washington Mutual, Inc., No. 06-5187 (Bankr. W.D. Tex. 4/23/07). Judge Clark ruled that reporting debt to credit bureau standing alone did not violate the debtor's discharge. Discharge did not make debt go away. Therefore, creditor could continue to report debt as delinquent despite discharge so long as creditor did not steps to try to collect. Excellent discussion on the relationship between sacrificing goats to Mercury and the discharge.
In re Spillman Development Group, Ltd., No. 05-14415 (Bankr. W.D. Tex. 9/20/07). Two determined parties battle intensely. "The parties were in full combat mode sparing no expense." The secured creditor ultimately purchased the property by exercising a credit bid. Did Debtor's counsel achieve a tangible, identifiable benefit which would allow it to be compensated under Pro-Snax? Judge Monroe said yes, although he reduced the fees in some respects. This opinion has an interesting discussion of how the debtor can achieve a positive benefit while acting in opposition to the wishes of the major creditor. The opinion is also full of Judge Monroe's no-holds barred commentary on the no-holds barred tactics of the litigants.
In re Sanders, No. 07-50783 (Bankr. W.D. Tex. 10/18/07). Debtors purchased a new vehicle but could not afford to pay off the old one. Depending on how you analyze the transaction, the negative equity was either financed as part of the new purchase or paid off with a rebate on the new vehicle. Debtor proposed to cram-down the vehicle even though it was purchased 846 days before bankruptcy (which was less than 910 days) and creditor objected. Judge Clark ruled that where the deficiency from the prior vehicle was included in the amount financed, that the loan did not qualify as a PMSI loan which was protected from cram-down under Sec. 1325(a)(*). Judge Clark ruled that PMSI status was an all or nothing proposition so that the entire debt was subject to cram-down even though the majority of the debt was purchase money in character.
The National Benevolent Association of the Christian Church vs. Weil, Gotshal & Manges, LLP, No. 05-5134 (Bankr. W.D. Tex. 2/6/07). Debtor sued its former attorneys for actions taken during the bankruptcy case. Judge King ruled that where the Court approved the Debtors' motion to sell property free and clear of liens and approved the Debtors' plan of reorganization, res judicata prevented the Debtors from suing their lawyers based on their successful representation of the Debtors. Additionally, failure to disclose the claims in the disclosure statement barred the claims under the doctrine of judicial estoppel. (Note: Although Weil, Gotshal prepared the disclosure statement which did not disclose the claims against it, the Debtors did have a second law firm which could have insisted that the claims be included).
Mahoney v. Washington Mutual, Inc., No. 06-5187 (Bankr. W.D. Tex. 4/23/07). Judge Clark ruled that reporting debt to credit bureau standing alone did not violate the debtor's discharge. Discharge did not make debt go away. Therefore, creditor could continue to report debt as delinquent despite discharge so long as creditor did not steps to try to collect. Excellent discussion on the relationship between sacrificing goats to Mercury and the discharge.
In re Spillman Development Group, Ltd., No. 05-14415 (Bankr. W.D. Tex. 9/20/07). Two determined parties battle intensely. "The parties were in full combat mode sparing no expense." The secured creditor ultimately purchased the property by exercising a credit bid. Did Debtor's counsel achieve a tangible, identifiable benefit which would allow it to be compensated under Pro-Snax? Judge Monroe said yes, although he reduced the fees in some respects. This opinion has an interesting discussion of how the debtor can achieve a positive benefit while acting in opposition to the wishes of the major creditor. The opinion is also full of Judge Monroe's no-holds barred commentary on the no-holds barred tactics of the litigants.
In re Sanders, No. 07-50783 (Bankr. W.D. Tex. 10/18/07). Debtors purchased a new vehicle but could not afford to pay off the old one. Depending on how you analyze the transaction, the negative equity was either financed as part of the new purchase or paid off with a rebate on the new vehicle. Debtor proposed to cram-down the vehicle even though it was purchased 846 days before bankruptcy (which was less than 910 days) and creditor objected. Judge Clark ruled that where the deficiency from the prior vehicle was included in the amount financed, that the loan did not qualify as a PMSI loan which was protected from cram-down under Sec. 1325(a)(*). Judge Clark ruled that PMSI status was an all or nothing proposition so that the entire debt was subject to cram-down even though the majority of the debt was purchase money in character.
Update on Deductibility of 401k Loan Payments Under Means Test
This blog previously reported on Judge Larry Kelly's decision in In re Otero which allowed payments on 401k loans to be deducted under the chapter 7 means test. http://stevesathersbankruptcynews.blogspot.com/2006_11_01_archive.html. That decision was subsequently reversed on appeal by the U.S. District Court. McVay vs. Otero, 371 B.R. 190 (W.D. Tex. 4/26/07). The District Court looked at the same language as Judge Kelly and concluded that a loan against a 401k plan was NOT a debt, so that it could not be a secured debt deductible under the means test. In making this ruling,the District Court followed the majority position.
The Debtors did not further appeal the District Court ruling. Instead,they converted to Chapter 13 and proposed a plan which allowed them to deduct the 401k payments from disposable income. The Debtor's plan was confirmed on November 19, 2007. Under the confirmed plan, the Debtors will pay $99 a month for 36 months and unsecured creditors will receive approximately 3% on their claims. Thus, while the U.S. Trustee was successful in its legal argument, the practical effect to creditors in the specific case appears to be negligible.
This is a subject which merits further discussion. The majority position followed by the District Court seems to be inconsistent with the treatment of 401k loans elsewhere under BAPCPA. Under Sec. 523(a)(18), a debt owed to a 401k plan is not dischargeable. Similarly, Sec. 362(b)(19) has an exception to the automatic stay relating to a "loan" from a tax qualified retirement plan. If Congress considered a loan owed to a 401k plan to be a "debt" for purposes of Sec. 523(a)(18) and created an exception for payments on a "loan" under Sec. 362(b)(19), why would payments owed to a tax qualified retirement plan not be considered to be debts under the means test? This seems to be a case where the majority has the weaker side of the argument.
The Debtors did not further appeal the District Court ruling. Instead,they converted to Chapter 13 and proposed a plan which allowed them to deduct the 401k payments from disposable income. The Debtor's plan was confirmed on November 19, 2007. Under the confirmed plan, the Debtors will pay $99 a month for 36 months and unsecured creditors will receive approximately 3% on their claims. Thus, while the U.S. Trustee was successful in its legal argument, the practical effect to creditors in the specific case appears to be negligible.
This is a subject which merits further discussion. The majority position followed by the District Court seems to be inconsistent with the treatment of 401k loans elsewhere under BAPCPA. Under Sec. 523(a)(18), a debt owed to a 401k plan is not dischargeable. Similarly, Sec. 362(b)(19) has an exception to the automatic stay relating to a "loan" from a tax qualified retirement plan. If Congress considered a loan owed to a 401k plan to be a "debt" for purposes of Sec. 523(a)(18) and created an exception for payments on a "loan" under Sec. 362(b)(19), why would payments owed to a tax qualified retirement plan not be considered to be debts under the means test? This seems to be a case where the majority has the weaker side of the argument.
Gadzooks Update
This blog previously reported on an opinion by Judge Harlin Hale of the Northern District of Texas which limited the effect of the Fifth Circuit's opinion in Matter of Pro-Snax Distributors, Inc., 157 F.3d 414 (5th Cir. 1998). http://stevesathersbankruptcynews.blogspot.com/2006_10_01_archive.html. U.S. District Judge Jane Boyle has now reversed the Bankruptcy Court opinion. William Kaye vs. Hughes & Luce, LLP, No. 3:06-CV-01863-B (N.D. Tex. 7/13/07).
Judge Boyle found that although the Fifth Circuit's Pro-Snax discussion of the correct standard to apply in awarding attorney's fees under Sec. 330 was dicta, that it was judicial dicta rather than obiter dicta. Judical dicta is defined as an opinion on an issue which was directly briefed and argued by the parties, but which was not essential to the decision. Judge Boyle found that judicial dicta should not be lightly disregarded. The Court also questioned whether the Circuit's instructions on the test to be applied on remand was really dicta at all.
The District Court engaged in a curious discussion of whether Pro-Snax was inconsistent with the language of Sec. 330. On the one hand, the District Court noted that it was bound to apply Pro-Snax regardless of whether it was correct. It also noted that many courts had disagreed with its logic. It then engaged in a rather tortured analysis of how Pro-Snax could be reconciled with the language of Sec. 330. Thus, the District Court fulfilled its obligation to follow binding precedent and did so with a straight face.
Finally, the District Court rejected the Bankruptcy Court's attempt to limit Pro-Snax to its original context of awarding fees to debtor's counsel. The District Court found that the language of Sec. 330 did not distinguish between different types of professionals.
The District Court ruling has been appealed to the Fifth Circuit. This may set the stage for the en banc Fifth Circuit to reconsider Pro-Snax.
Judge Boyle found that although the Fifth Circuit's Pro-Snax discussion of the correct standard to apply in awarding attorney's fees under Sec. 330 was dicta, that it was judicial dicta rather than obiter dicta. Judical dicta is defined as an opinion on an issue which was directly briefed and argued by the parties, but which was not essential to the decision. Judge Boyle found that judicial dicta should not be lightly disregarded. The Court also questioned whether the Circuit's instructions on the test to be applied on remand was really dicta at all.
The District Court engaged in a curious discussion of whether Pro-Snax was inconsistent with the language of Sec. 330. On the one hand, the District Court noted that it was bound to apply Pro-Snax regardless of whether it was correct. It also noted that many courts had disagreed with its logic. It then engaged in a rather tortured analysis of how Pro-Snax could be reconciled with the language of Sec. 330. Thus, the District Court fulfilled its obligation to follow binding precedent and did so with a straight face.
Finally, the District Court rejected the Bankruptcy Court's attempt to limit Pro-Snax to its original context of awarding fees to debtor's counsel. The District Court found that the language of Sec. 330 did not distinguish between different types of professionals.
The District Court ruling has been appealed to the Fifth Circuit. This may set the stage for the en banc Fifth Circuit to reconsider Pro-Snax.
Thursday, December 20, 2007
Dallas Judge Investigates Mortgage Rescue Scam; Urges Debtor's Bar to Warn Clients
Dallas Judge Stacey Jernigan recently issued an opinion concerning a mortgage protection scheme which the court found to prey upon both desperate debtors and mortgage lenders seeking to protect their legal rights. In re Michael White, No. 06-32324 (Bankr. N.D. Tex. 12/7/07). The Court ultimately concluded that the debtors were naive victims of a shady operation designed to fraudulently delay enforcement of mortgage liens. In addition to ordering the perpetrators to appear and show cause, the Court made a referral for a possible bankruptcy crime violation and urged the consumer debtor's bar to warn their clients about similar schemes.
Desperate Debtors
The debtors in this case filed chapter 13 to save their homestead. Unfortunately, they were not able to make the post-petition payments required. This led to an order conditioning the stay, which the debtors defaulted upon as well. With the stay lifted, the stage was set for the debtors to receive a barrage of solicitations (eight to twelve per day) from "foreclosure specialists" offering to legally save the house. The debtors responded to one of these offers from an operation calling itself "North American Foreclosure." According to North American Foreclosure, the debtors could delay foreclosure for years if they were to deed a 1% interest in their home to a company which would file bankruptcy and invoke a new automatic stay. In return for this service, the debtors would pay $650 per month to buy back the interest they had deeded over for as long as they needed the service. North American Foreclosure assured the debtors that everything was legitimate because: (a) the document transferring the 1% interest would be notarized; and (b) the transaction would be disclosed to the new bankruptcy court.
Although North American Foreclosure was apparently located in California, they arranged for a local agent named David Curtis, whose business card identified him as working for Jireh Capital Services, LLC to visit the debtor's home. This local agent had the debtors sign several contracts which required that payment be made in cash only. The Debtors were then given a backdated deed to sign. The deed was executed in the name of "C**** C****" who the debtors were assured was an agent of the company. On the eve of foreclosure, the mortage company's servicer received an anonymous fax containing a copy of the deed to C**** C**** and a copy of C**** C****'s bankruptcy petition which had been filed in the Central District of California the previous month.
The Lender Shows Good Sense
The mortgage servicer acted with remarkable restraint. As noted by the Court: "In any event, despite the questionable validity and effect of the Warranty Deed document, and despite the mysterious manner of its delivery (from anonymous senders), HomEq did what one might hope any prudent creditor would do: it took no further action with regard to its collection efforts as to the Homestead (i.e., it did not record the substitute trustee's deed reflecting the foreclosure sale that had already occurred earlier in the day) out of concern over the implications of the C**** C**** bankruptcy case and the automatic stay as to her alleged 1% interest." Memorandum Opinion and Order, p. 5.
HomEq's restraint was commendable in that this was not the first time they had received a notice involving conveyance of a fractional interest to a bankruptcy filer. According to HomEq, this was something which happened several times a month. As a result, they filed a Motion Requesting Show Cause Order. The Court ordered that both sets of debtors appear and show cause. The debtors in both the Northern District of Texas and the Central District of California showed remarkably good judgment by cooperating with Judge Jernigan's Show Cause Order. The Texas debtors testified and produced copies of their documents with North American Foreclosure. It turned out that the California debtor had filed a pro se petition and had nothing to do with the scheme. Instead, North American Foreclosure obtained the name of a random pro se debtor who had recently filed bankruptcy in the Central District of California and arranged for the deed to be executed in the name of an innocent third party.
Judge Jernigan accepted the Debtors' testimony. She concluded that, "This court is satisfied that the Whites have been naively duped in this matter and have not themselves knowingly or fraudulently participated in acts that might be described as a bankruptcy crime. (citation omitted). At worst, they appear to be 'bit characters' in a scheme to defraud borrowers and lenders alike who are in the midst of foreclosure proceedings." Memorandum Opinion and Order, p. 13.
A Cottage Industry of Bottom Feeders
Judge Jernigan had much greater concern for the perpetrators of the scheme. In a section of her opinion entitled "A New Cottage Industry of Bottom Feeders: For Every Action (i.e., Foreclosure Crisis) there is an Opposite Reaction (i.e., Folks Trying to Make a Buck)," she detailed other instances in which similar shenanigans had surfaced.
Judge Jernigan ordered North American Foreclosure, LLP (the instigator of the scheme), David Curtis (the local agent who signed the debtors up and took their money) and Jireh Capital Services, LLC (Curtis's company) to appear and show cause why they should not be found to have violated the automatic stay and be held liable for damages. The Court ominously noted that David Curtis might come to regret the fact that he had accepted a check from the debtors (despite the contract's cash only requirement), which created a paper trail.
The Court annulled the automatic stay to allow HomEq to record its substitute trustee's deed. This was more in the nature of a comfort order, since it appears unlikely that there was ever a new automatic stay arising from the C**** C**** bankruptcy.
The Court gave notice to the U.S. Attorney that a possible bankruptcy crime had taken place.
Plea to the Debtor's Bar
Finally, the Court issued a "Plea to the Consumer Debtor Bankruptcy Bar," stating:
"The court urges attorneys representing consumer debtors to warn their clients of the apparent schemes being solicited to debtors such as the Whites. while this court is of teh view in this matter that the Whites were naive 'bit characters' who did not fully understand the consequences of their actions and did not set out to defraud HomEq, this may not always be the case. The Whites have lost $1,300 and have not saved their home. This court suspects other debtors have lost even more. The court hopes that it will become a standard part of consumer debtor representation in this district to warn debtors of the hazards of dealing with some of the non-attorney Bankruptcy Services that are offering the illusion of relief from foreclosure for a steep fee."
Memorandum Opinion and Order, pp. 21-22. So, there you have it. Warn your clients. If something seems to be too easy, it is probably a scam. Also, please tell your clients that if you, as a trained bankruptcy professional cannot help them, that they should not expect that a non-lawyer who sends them a slick brochure and expects to be paid in cash can do any better.
Desperate Debtors
The debtors in this case filed chapter 13 to save their homestead. Unfortunately, they were not able to make the post-petition payments required. This led to an order conditioning the stay, which the debtors defaulted upon as well. With the stay lifted, the stage was set for the debtors to receive a barrage of solicitations (eight to twelve per day) from "foreclosure specialists" offering to legally save the house. The debtors responded to one of these offers from an operation calling itself "North American Foreclosure." According to North American Foreclosure, the debtors could delay foreclosure for years if they were to deed a 1% interest in their home to a company which would file bankruptcy and invoke a new automatic stay. In return for this service, the debtors would pay $650 per month to buy back the interest they had deeded over for as long as they needed the service. North American Foreclosure assured the debtors that everything was legitimate because: (a) the document transferring the 1% interest would be notarized; and (b) the transaction would be disclosed to the new bankruptcy court.
Although North American Foreclosure was apparently located in California, they arranged for a local agent named David Curtis, whose business card identified him as working for Jireh Capital Services, LLC to visit the debtor's home. This local agent had the debtors sign several contracts which required that payment be made in cash only. The Debtors were then given a backdated deed to sign. The deed was executed in the name of "C**** C****" who the debtors were assured was an agent of the company. On the eve of foreclosure, the mortage company's servicer received an anonymous fax containing a copy of the deed to C**** C**** and a copy of C**** C****'s bankruptcy petition which had been filed in the Central District of California the previous month.
The Lender Shows Good Sense
The mortgage servicer acted with remarkable restraint. As noted by the Court: "In any event, despite the questionable validity and effect of the Warranty Deed document, and despite the mysterious manner of its delivery (from anonymous senders), HomEq did what one might hope any prudent creditor would do: it took no further action with regard to its collection efforts as to the Homestead (i.e., it did not record the substitute trustee's deed reflecting the foreclosure sale that had already occurred earlier in the day) out of concern over the implications of the C**** C**** bankruptcy case and the automatic stay as to her alleged 1% interest." Memorandum Opinion and Order, p. 5.
HomEq's restraint was commendable in that this was not the first time they had received a notice involving conveyance of a fractional interest to a bankruptcy filer. According to HomEq, this was something which happened several times a month. As a result, they filed a Motion Requesting Show Cause Order. The Court ordered that both sets of debtors appear and show cause. The debtors in both the Northern District of Texas and the Central District of California showed remarkably good judgment by cooperating with Judge Jernigan's Show Cause Order. The Texas debtors testified and produced copies of their documents with North American Foreclosure. It turned out that the California debtor had filed a pro se petition and had nothing to do with the scheme. Instead, North American Foreclosure obtained the name of a random pro se debtor who had recently filed bankruptcy in the Central District of California and arranged for the deed to be executed in the name of an innocent third party.
Judge Jernigan accepted the Debtors' testimony. She concluded that, "This court is satisfied that the Whites have been naively duped in this matter and have not themselves knowingly or fraudulently participated in acts that might be described as a bankruptcy crime. (citation omitted). At worst, they appear to be 'bit characters' in a scheme to defraud borrowers and lenders alike who are in the midst of foreclosure proceedings." Memorandum Opinion and Order, p. 13.
A Cottage Industry of Bottom Feeders
Judge Jernigan had much greater concern for the perpetrators of the scheme. In a section of her opinion entitled "A New Cottage Industry of Bottom Feeders: For Every Action (i.e., Foreclosure Crisis) there is an Opposite Reaction (i.e., Folks Trying to Make a Buck)," she detailed other instances in which similar shenanigans had surfaced.
Judge Jernigan ordered North American Foreclosure, LLP (the instigator of the scheme), David Curtis (the local agent who signed the debtors up and took their money) and Jireh Capital Services, LLC (Curtis's company) to appear and show cause why they should not be found to have violated the automatic stay and be held liable for damages. The Court ominously noted that David Curtis might come to regret the fact that he had accepted a check from the debtors (despite the contract's cash only requirement), which created a paper trail.
The Court annulled the automatic stay to allow HomEq to record its substitute trustee's deed. This was more in the nature of a comfort order, since it appears unlikely that there was ever a new automatic stay arising from the C**** C**** bankruptcy.
The Court gave notice to the U.S. Attorney that a possible bankruptcy crime had taken place.
Plea to the Debtor's Bar
Finally, the Court issued a "Plea to the Consumer Debtor Bankruptcy Bar," stating:
"The court urges attorneys representing consumer debtors to warn their clients of the apparent schemes being solicited to debtors such as the Whites. while this court is of teh view in this matter that the Whites were naive 'bit characters' who did not fully understand the consequences of their actions and did not set out to defraud HomEq, this may not always be the case. The Whites have lost $1,300 and have not saved their home. This court suspects other debtors have lost even more. The court hopes that it will become a standard part of consumer debtor representation in this district to warn debtors of the hazards of dealing with some of the non-attorney Bankruptcy Services that are offering the illusion of relief from foreclosure for a steep fee."
Memorandum Opinion and Order, pp. 21-22. So, there you have it. Warn your clients. If something seems to be too easy, it is probably a scam. Also, please tell your clients that if you, as a trained bankruptcy professional cannot help them, that they should not expect that a non-lawyer who sends them a slick brochure and expects to be paid in cash can do any better.
Tuesday, November 06, 2007
Pakistani Lawyers Risk Lives for Rule of Law
In Pakistan, thousands of lawyers dressed in black suits and ties took to the street to protest the dissolution of the supreme court and the suspension of the constitution. It is estimated that 500-700 were arrested. "Bush criticizes Musharraf," Austin American Statesman, November 6, 2007, p. A1. Meanwhile, in the United States, 37,000 dissidents gathered (in cyberspace) around a slogan implicitly advocating overthrow of the government ... and set a one-day fundraising record for Republicans. "YouTube video, Guy Fawkes motto help Paul collect $4.2 million in 1 day," Austin American Statesman, November 6, 2007, p. A6.
What do these two stories have in common? The connection is arguably tenuous, but the common link seems to be fear or the lack thereof.
In Pakistan, the president feared the power of an independent judicial branch and the rule of law which it represented. When the Supreme Court questioned his right to seek another term, Gen. Musharraf chose to impose emergency rule. Curiously, the General dissolved the supreme court but left parliament in place. This seems to suggest that a cowed legislative branch is less of a threat to absolute power than an independent judiciary. In a system where the rule of law is subordinate to the rule of power, lawyers are reduced from independent actors to government functionaries. Thus, the lawyers correctly perceived that they were under attack and took to the streets.
The story about Ron Paul's fundraising is not grim. Indeed, it is humorous in its cheekiness. Ron Paul is the Texas Congressman running a longshot campaign for the Republican nomination for president. The Paul campaign organized a one-day internet fundraiser around the slogan "Remember, remember the 5th of November." This is the first line from a poem recalling the attempt by Guy Fawkes to blow up parliament and assasinate King James I. It also featured prominently in the recent movie "V for Vendetta" in which a masked vigilante leads a mob of citizens to overthrow an oppressive British government. Ron Paul and his band of followers fancy themselves as modern day revolutionaries. They oppose most everything government does from social security to the war in Iraq. However, when they openly use the language of revolution to advance their cause, it evokes at best a chuckle or a yawn, but not fear.
While the story about Ron Paul is somewhat silly (and in no way compares to the bravery of the Pakistani lawyers), perhaps it makes a point about what we take for granted. Here, we can talk about overthrowing the government because we allow for the potential of overthrowing the government every four years. We know that on January 20, 2009, President Bush will voluntarily leave the White House. There is a good possibility that he will hand over power to the opposing party. On the other hand, the Pakistani lawyers and judges have no assurance that their constitution will prevail and that Gen. Musharraf will cede power to anyone other than a hand-picked successor.
What do these two stories have in common? The connection is arguably tenuous, but the common link seems to be fear or the lack thereof.
In Pakistan, the president feared the power of an independent judicial branch and the rule of law which it represented. When the Supreme Court questioned his right to seek another term, Gen. Musharraf chose to impose emergency rule. Curiously, the General dissolved the supreme court but left parliament in place. This seems to suggest that a cowed legislative branch is less of a threat to absolute power than an independent judiciary. In a system where the rule of law is subordinate to the rule of power, lawyers are reduced from independent actors to government functionaries. Thus, the lawyers correctly perceived that they were under attack and took to the streets.
The story about Ron Paul's fundraising is not grim. Indeed, it is humorous in its cheekiness. Ron Paul is the Texas Congressman running a longshot campaign for the Republican nomination for president. The Paul campaign organized a one-day internet fundraiser around the slogan "Remember, remember the 5th of November." This is the first line from a poem recalling the attempt by Guy Fawkes to blow up parliament and assasinate King James I. It also featured prominently in the recent movie "V for Vendetta" in which a masked vigilante leads a mob of citizens to overthrow an oppressive British government. Ron Paul and his band of followers fancy themselves as modern day revolutionaries. They oppose most everything government does from social security to the war in Iraq. However, when they openly use the language of revolution to advance their cause, it evokes at best a chuckle or a yawn, but not fear.
While the story about Ron Paul is somewhat silly (and in no way compares to the bravery of the Pakistani lawyers), perhaps it makes a point about what we take for granted. Here, we can talk about overthrowing the government because we allow for the potential of overthrowing the government every four years. We know that on January 20, 2009, President Bush will voluntarily leave the White House. There is a good possibility that he will hand over power to the opposing party. On the other hand, the Pakistani lawyers and judges have no assurance that their constitution will prevail and that Gen. Musharraf will cede power to anyone other than a hand-picked successor.
Wednesday, October 24, 2007
Timely Amended Claim Avoids Usury Penalty
After just sixteen days on the bench, Austin Bankruptcy Judge Craig Gargotta has penned his first opinion. In Ingalls vs. Cunningham, Adv. No. 06-1236 (Bankr. W.D. Tex. 10/16/07), Judge Gargotta considered whether a creditor which filed an arguably usurious claim could take advantage of Texas's usury cure provision when it amended the claim to delete the offending charges. Judge Gargotta concluded that it could.
In this case, the creditor filed an initial claim for $89,280 on November 19, 2005. On April 24, 2007, the Trustee sought to amend an existing adversary proceeding to include a claim for usury. Ten days later, the creditor objected to the motion and filed an amended claim for $32,041.66 which eliminated the offending charges. The parties entered an agreed order which allowed the amendment but preserved the defendant's right to challenge the usury claim.
On defendant's motion to dismiss, the court considered whether the creditor's amended claim was sufficiently timely to constitute an allowable cure under the Texas Finance Code. Texas has two separate usury cure provisions. If the creditor discovers the usury violation, Texas Finance Code Sec. 305.103 allows the creditor to correct the violation within 60 days from "the date the creditor actually discovered the violation" by giving notice to the obligor. A second section, Texas Finance Code Sec. 305.006, applies when the obligor discovers the violation. It requires the obligor to give the creditor 60 days notice prior to filing suit or filing a counterclaim. During the 60 day period, the creditor may correct the violation in the same manner as under Sec. 305.103 (that is, by giving notice to the debtor).
In this case, the court found that Sec. 305.006 applied because this case involved a suit by the debtor's chapter 7 trustee. The court found that the trustee's motion for leave to amend constituted notice to the obligor of the usury violation triggering the 60 day period to cure. The court found that amending the proof of claim to exclude the allegedly usurious charges consituted an adequate cure. Because the creditor filed its amended claim well within the 60 day cure period, it was not subject to being sued for usury. As a result, the court granted the motion to dismiss.
This case raises several practice points. The first is that a proof of claim in a bankruptcy case can constitute a demand for usurious interest. As a result, alert debtors and trustees should scrutinize the claims filed to see if there are claims which could be asserted. Second, the two usury cure provisions appear to work independently. If a creditor discovers the usury, it has 60 days to cure the violation. However, if the creditor fails to do so, it has a second 60 day period once it receives notice from the obligor. Thus, although Texas has "draconian" usury penalties, a prudent creditor has an easy means to avoid liability if it acts promptly.
In this case, the creditor filed an initial claim for $89,280 on November 19, 2005. On April 24, 2007, the Trustee sought to amend an existing adversary proceeding to include a claim for usury. Ten days later, the creditor objected to the motion and filed an amended claim for $32,041.66 which eliminated the offending charges. The parties entered an agreed order which allowed the amendment but preserved the defendant's right to challenge the usury claim.
On defendant's motion to dismiss, the court considered whether the creditor's amended claim was sufficiently timely to constitute an allowable cure under the Texas Finance Code. Texas has two separate usury cure provisions. If the creditor discovers the usury violation, Texas Finance Code Sec. 305.103 allows the creditor to correct the violation within 60 days from "the date the creditor actually discovered the violation" by giving notice to the obligor. A second section, Texas Finance Code Sec. 305.006, applies when the obligor discovers the violation. It requires the obligor to give the creditor 60 days notice prior to filing suit or filing a counterclaim. During the 60 day period, the creditor may correct the violation in the same manner as under Sec. 305.103 (that is, by giving notice to the debtor).
In this case, the court found that Sec. 305.006 applied because this case involved a suit by the debtor's chapter 7 trustee. The court found that the trustee's motion for leave to amend constituted notice to the obligor of the usury violation triggering the 60 day period to cure. The court found that amending the proof of claim to exclude the allegedly usurious charges consituted an adequate cure. Because the creditor filed its amended claim well within the 60 day cure period, it was not subject to being sued for usury. As a result, the court granted the motion to dismiss.
This case raises several practice points. The first is that a proof of claim in a bankruptcy case can constitute a demand for usurious interest. As a result, alert debtors and trustees should scrutinize the claims filed to see if there are claims which could be asserted. Second, the two usury cure provisions appear to work independently. If a creditor discovers the usury, it has 60 days to cure the violation. However, if the creditor fails to do so, it has a second 60 day period once it receives notice from the obligor. Thus, although Texas has "draconian" usury penalties, a prudent creditor has an easy means to avoid liability if it acts promptly.
Monday, October 22, 2007
Court Protects Homestead Proceeds But Leaves Open Question on Tardy Objections
Texas has one of the most generous homestead exemptions in the country. However, a quirk in the law allows an exemption in homestead proceeds to be lost due to the passage of time. San Antonio Bankruptcy Judge Leif Clark recently found a creative solution to the problem created by an obstreperous creditor seeking to outlast the debtor and preclude reinvestment of the proceeds from sale of a homestead. In re Bading, No. 06-52750 (Bankr. W.D. Tex. 9/22/07). However, the opinion raises the question of why Judge Clark had to work so hard when Supreme Court precedent provided a simpler alternative.
The Vanishing Exemption and Absolute Protection of Exempted Property
Most exemption statutes are limited by the type and value of the property to be claimed as exempt, but are not limited as to time. Thus, exempt property will keep its status so long as it retains its exempt character. However, a sale or other transformation of the exempt property will usually cause it to lose its exempt character. The Texas homestead exemption extends not only to a homestead owned and occupied by the debtor, but to the proceeds from sale of a homestead as well. Tex. Prop. Code §41.001(c). The proceeds exemption is one which is limited by time. It lasts for the lesser of six months or until the debtor acquires another homestead. The purpose of the proceeds exemption is to give the debtor a limited period of time in which to acquire a new homestead. As a result, the statute creates a vanishing exemption. Homestead proceeds which were fully protected five months and 29 days after sale of the home become cash subject to claims of creditors after six months and one day.
This vanishing exemption creates a potential conflict between state and federal law in the bankruptcy context. According to 11 U.S.C. §522(c), “property exempted under this section is not liable during or after the case for any debt of the debtor that arose, or that is determined under section 502 of this title as if such debt had arisen, before the commencement of the case” (with certain exceptions). Thus, the Bankruptcy Code gives exempted property absolute protection from pre-petition claims.
This absolute protection is implemented in two ways. First, the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure provide a limited time in which to object to exempt property. 11 U.S.C. §522(l); Fed.R.Bankr.P. 4003(b). If the property is claimed as exempt and the exemption is not timely challenged, the property remains exempt regardless of whether it would have been subject to a valid objection. Taylor v. Freeland & Kronz, 503 U.S. 638 (1992). Second, the property’s exempt status is determined as of the petition date using the “snapshot” approach. Matter of Zibman, 268 F.3d 298 (5th Cir. 2001).
A Fading Snapshot
While the Zibman decision recognized the “snapshot” approach, it also noted that like a bad Polaroid, the picture could fade. According to the Fifth Circuit:
“(T)he law and facts existing on the date of filing the bankruptcy petition determine the existence of available exemptions but . . . it is the entire state law applicable on the filing date that is determinative. Courts cannot apply a juridical airbrush to excise offending images necessarily picture in the petition-date snapshot.”
Zibman at 304.
Thus, Zibman teaches that where conditions exist on the petition date which would limit the exemption, the snapshot approach does not eliminate those limitations. However, it seems important to the Fifth Circuit’s analysis that the condition must exist as of the petition date. In the Zibman case, the debtors had sold their homestead approximately two months prior to bankruptcy. Thus, the snapshot on the petition date revealed an exemption which had just four months remaining in the absence of reinvestment. Since the debtors had moved to another state, reinvestment was not a possibility.
In the Zibman case, the Trustee obtained an order extending the time to object to exemptions until after the six month reinvestment period expired. When the debtor failed to purchase a new homestead, the trustee objected and was sustained by the Fifth Circuit. Thus, although the exemption was still valid on the petition date, it was a limited exemption and was defeated by the timely filed objection.
Although the Trustee benefitted from an extension of time in Zibman, the court noted that the debtor could benefit from one as well. In a footnote, the Court noted that although the debtors could have requested tolling of the six month period, they failed to do so.
Bading Determines Calculation of Six Month Period
In Judge Clark’s Bading decision, the court examined how to calculate the six month period in the face of creditor obstruction. The debtor owned two contiguous lots which made up her homestead. Prior to bankruptcy, Gulfside Supply, Inc. recorded an abstract of judgment against the debtor. Under Texas law, an abstract of judgment creates a lien against all real estate owned by the debtor in the county, but does not attach to a homestead. Since the debtor only owned a homestead, the abstract of judgment should have been a nullity. However, as noted by the Bankruptcy Court, “title companies are notorious cowards.” When the creditor refused to release the lien, the debtor was put to a Hobson’s choice to either pay off the invalid lien or risk losing the ability to sell the property.
In this case, the debtor found a middle ground. It reached an agreement with the creditor to release its lien from one of the two tracts. The sale of the first lot closed on December 4, 2006 and the debtor received proceeds of approximately $142,000. The debtor did not reinvest these proceeds out of fear that acquiring a new homestead would void the exemption on the second tract.
Instead, the debtor then filed bankruptcy on December 29, 2006 and filed a motion to avoid lien on the second tract. The motion to avoid lien was granted. However, at this point, the debtor was faced with a timing dilemma. The creditor, which had not objected to the debtor’s exemptions, contended that it was not required to file an objection until after the property lost its exempt character and that the six month clock had begun to run on the sale of the first tract. Under the creditor’s position, there was only one month in which to complete the sale of the second tract and invest the proceeds from both tracts in a new homestead. To avoid this problem, the debtor, relying on the Zibman dicta, filed a motion to toll the reinvestment period.
After a hearing, the Bankruptcy Court came to three important conclusions:
1) The fact that Gulfside failed to file a timely objection to exemption was irrelevant. The court stated:
“Gulfside responds that a creditor should not be required to file a ‘conditional objection’ based on what might happen after the close of the time allowed for objection to exemptions, on pain of those exemptions being allowed as a matter of law under section 522(l). The court agrees with Gulfside on this issue. Were the rule otherwise, then trustees and creditors alike would have a duty to object in every proceeds case, just to make sure they preserved their rights. That strikes the court as an unnecessary formality, and one that is difficult to square with the rationale employed by the Fifth Circuit in Zibman to reach its result.”
Bading, slip op., p. 6, n. 5.
2) The six month clock did not begin to run until the second tract was sold.
The six month clock is triggered by sale of “a” homestead, not part of the homestead. Here, the debtor had a single purchaser for both parts of the homestead. The closing of the sale of the complete homestead was delayed by the creditor’s unjustified refusal to release its lien. As a result, there was not a sale of “a” homestead until the second closing, so that the six month clock did not begin to run until that date.
3) If the single sale theory did not work, the court found that equitable tolling would apply.
The court noted that both Texas law and the Zibman opinion held open the possibility that the six month period to reinvest could be tolled. Tolling is an equitable principle. Where, as here, the creditor delayed the debtor’s ability to sell through its refusal to release an invalid lien, there were sufficient grounds to toll the six month reinvestment period.
Thus, the net result was that the debtor was able to sell her homestead free of the offending judgment lien and the creditor’s stall tactics failed to achieve their desired result.
Invoking Avril Lavigne
Judge Clark’s reasoning is elegant and avoided an obvious injustice. However, it raises an obvious question: “Why do you have to make things so complicated?”* Judge Clark would never have had to reach the issues of unitary homestead sales or equitable tolling if he had simply followed Taylor v. Freeland & Kronz and ruled that failure to timely object to the claimed exemption ended the inquiry.
Judge Clark justified his failure to deem the objection waived on two grounds:
1) Practicality; and
2) Fealty to the Fifth Circuit’s reasoning in Zibman.
The practical argument questions the reasonableness of requiring conditional objections in cases involving homestead proceeds. The most reasonable response to this argument is: So what? Cases involving exemptions of homestead proceeds are relatively rare. In order to have a case involving proceeds, the sale must have taken place pre-petition. The deadline to object to exemptions occurs 30 days after the conclusion of the first meeting of creditors. Fed.R.Bankr.P. 4003(b). While the creditors’ meeting must be commenced 20-40 days after the filing of the petition, Fed.R.Bankr.P. 2003(a), there is no rule as to when the meeting must be concluded. As a result, the trustee may simply continue the meeting to a date after the conclusion of the six month reinvestment period. If that isn’t satisfactory, a creditor could move to extend the time to object or could file a conditional objection. All of these solutions are easy to accomplish. Since proceeds cases are unusual, it is reasonable to require trustees and creditors to take these nominal steps to preserve their rights rather than to argue that Supreme Court precedent should be disregarded.
The rationale of the Zibman opinion offers offers little support to the tardy creditor. In that case, the trustee obtained an order extending the time to object to exemptions. The trustee filed his objection within that time period. As a result, Zibman should not be construed as authorizing out of time objections. Indeed, the Zibman rationale simply recognizes that the debtor’s right to exempt proceeds may depend on events happening after the petition date. This is not an invitation to ignore the rules requiring timely objections to exemptions.
Finally, allowing untimely objections to exemptions based on events occurring after the petition date would lead to absurd results. Under Taylor v. Freeland & Kronz, which is an intellectual cousin to Republic Supply Co. v. Shoaf, 815 F.2d 1046 (5th Cir. 1987), failure to file a timely objection to exemption allows the debtor to retain the claimed property regardless of whether the debtor had a colorable claim of exemptions in the first place. If Zibman is read as allowing untimely objections, it means that a conditional claim to exemption of homestead proceeds would receive less protection than a debtor’s attempt to exempt a stack of gold bullion or a herd of Ethiopian hog-nosed goats** as his homestead. The legal system would be seriously out of joint if it accorded greater rights to the frivolous than the conditionally correct. The entire concept of statutes of limitation assumes that creditors must be diligent to protect their rights. If a creditor is unable to focus its attention on a claim which will be resolved in less than six months, the court should not create a judicial do-over for it.
*--This is the refrain from a recent song by semi-punk songstress Avril Lavigne.
**--A rare form of livestock found only in Bastrop County. Apologies to Joe Martinec and Eric Borsheim. For the full story of the Ethiopian hog-nosed goats, write to me at ssather@bnpclaw.com.
The Vanishing Exemption and Absolute Protection of Exempted Property
Most exemption statutes are limited by the type and value of the property to be claimed as exempt, but are not limited as to time. Thus, exempt property will keep its status so long as it retains its exempt character. However, a sale or other transformation of the exempt property will usually cause it to lose its exempt character. The Texas homestead exemption extends not only to a homestead owned and occupied by the debtor, but to the proceeds from sale of a homestead as well. Tex. Prop. Code §41.001(c). The proceeds exemption is one which is limited by time. It lasts for the lesser of six months or until the debtor acquires another homestead. The purpose of the proceeds exemption is to give the debtor a limited period of time in which to acquire a new homestead. As a result, the statute creates a vanishing exemption. Homestead proceeds which were fully protected five months and 29 days after sale of the home become cash subject to claims of creditors after six months and one day.
This vanishing exemption creates a potential conflict between state and federal law in the bankruptcy context. According to 11 U.S.C. §522(c), “property exempted under this section is not liable during or after the case for any debt of the debtor that arose, or that is determined under section 502 of this title as if such debt had arisen, before the commencement of the case” (with certain exceptions). Thus, the Bankruptcy Code gives exempted property absolute protection from pre-petition claims.
This absolute protection is implemented in two ways. First, the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure provide a limited time in which to object to exempt property. 11 U.S.C. §522(l); Fed.R.Bankr.P. 4003(b). If the property is claimed as exempt and the exemption is not timely challenged, the property remains exempt regardless of whether it would have been subject to a valid objection. Taylor v. Freeland & Kronz, 503 U.S. 638 (1992). Second, the property’s exempt status is determined as of the petition date using the “snapshot” approach. Matter of Zibman, 268 F.3d 298 (5th Cir. 2001).
A Fading Snapshot
While the Zibman decision recognized the “snapshot” approach, it also noted that like a bad Polaroid, the picture could fade. According to the Fifth Circuit:
“(T)he law and facts existing on the date of filing the bankruptcy petition determine the existence of available exemptions but . . . it is the entire state law applicable on the filing date that is determinative. Courts cannot apply a juridical airbrush to excise offending images necessarily picture in the petition-date snapshot.”
Zibman at 304.
Thus, Zibman teaches that where conditions exist on the petition date which would limit the exemption, the snapshot approach does not eliminate those limitations. However, it seems important to the Fifth Circuit’s analysis that the condition must exist as of the petition date. In the Zibman case, the debtors had sold their homestead approximately two months prior to bankruptcy. Thus, the snapshot on the petition date revealed an exemption which had just four months remaining in the absence of reinvestment. Since the debtors had moved to another state, reinvestment was not a possibility.
In the Zibman case, the Trustee obtained an order extending the time to object to exemptions until after the six month reinvestment period expired. When the debtor failed to purchase a new homestead, the trustee objected and was sustained by the Fifth Circuit. Thus, although the exemption was still valid on the petition date, it was a limited exemption and was defeated by the timely filed objection.
Although the Trustee benefitted from an extension of time in Zibman, the court noted that the debtor could benefit from one as well. In a footnote, the Court noted that although the debtors could have requested tolling of the six month period, they failed to do so.
Bading Determines Calculation of Six Month Period
In Judge Clark’s Bading decision, the court examined how to calculate the six month period in the face of creditor obstruction. The debtor owned two contiguous lots which made up her homestead. Prior to bankruptcy, Gulfside Supply, Inc. recorded an abstract of judgment against the debtor. Under Texas law, an abstract of judgment creates a lien against all real estate owned by the debtor in the county, but does not attach to a homestead. Since the debtor only owned a homestead, the abstract of judgment should have been a nullity. However, as noted by the Bankruptcy Court, “title companies are notorious cowards.” When the creditor refused to release the lien, the debtor was put to a Hobson’s choice to either pay off the invalid lien or risk losing the ability to sell the property.
In this case, the debtor found a middle ground. It reached an agreement with the creditor to release its lien from one of the two tracts. The sale of the first lot closed on December 4, 2006 and the debtor received proceeds of approximately $142,000. The debtor did not reinvest these proceeds out of fear that acquiring a new homestead would void the exemption on the second tract.
Instead, the debtor then filed bankruptcy on December 29, 2006 and filed a motion to avoid lien on the second tract. The motion to avoid lien was granted. However, at this point, the debtor was faced with a timing dilemma. The creditor, which had not objected to the debtor’s exemptions, contended that it was not required to file an objection until after the property lost its exempt character and that the six month clock had begun to run on the sale of the first tract. Under the creditor’s position, there was only one month in which to complete the sale of the second tract and invest the proceeds from both tracts in a new homestead. To avoid this problem, the debtor, relying on the Zibman dicta, filed a motion to toll the reinvestment period.
After a hearing, the Bankruptcy Court came to three important conclusions:
1) The fact that Gulfside failed to file a timely objection to exemption was irrelevant. The court stated:
“Gulfside responds that a creditor should not be required to file a ‘conditional objection’ based on what might happen after the close of the time allowed for objection to exemptions, on pain of those exemptions being allowed as a matter of law under section 522(l). The court agrees with Gulfside on this issue. Were the rule otherwise, then trustees and creditors alike would have a duty to object in every proceeds case, just to make sure they preserved their rights. That strikes the court as an unnecessary formality, and one that is difficult to square with the rationale employed by the Fifth Circuit in Zibman to reach its result.”
Bading, slip op., p. 6, n. 5.
2) The six month clock did not begin to run until the second tract was sold.
The six month clock is triggered by sale of “a” homestead, not part of the homestead. Here, the debtor had a single purchaser for both parts of the homestead. The closing of the sale of the complete homestead was delayed by the creditor’s unjustified refusal to release its lien. As a result, there was not a sale of “a” homestead until the second closing, so that the six month clock did not begin to run until that date.
3) If the single sale theory did not work, the court found that equitable tolling would apply.
The court noted that both Texas law and the Zibman opinion held open the possibility that the six month period to reinvest could be tolled. Tolling is an equitable principle. Where, as here, the creditor delayed the debtor’s ability to sell through its refusal to release an invalid lien, there were sufficient grounds to toll the six month reinvestment period.
Thus, the net result was that the debtor was able to sell her homestead free of the offending judgment lien and the creditor’s stall tactics failed to achieve their desired result.
Invoking Avril Lavigne
Judge Clark’s reasoning is elegant and avoided an obvious injustice. However, it raises an obvious question: “Why do you have to make things so complicated?”* Judge Clark would never have had to reach the issues of unitary homestead sales or equitable tolling if he had simply followed Taylor v. Freeland & Kronz and ruled that failure to timely object to the claimed exemption ended the inquiry.
Judge Clark justified his failure to deem the objection waived on two grounds:
1) Practicality; and
2) Fealty to the Fifth Circuit’s reasoning in Zibman.
The practical argument questions the reasonableness of requiring conditional objections in cases involving homestead proceeds. The most reasonable response to this argument is: So what? Cases involving exemptions of homestead proceeds are relatively rare. In order to have a case involving proceeds, the sale must have taken place pre-petition. The deadline to object to exemptions occurs 30 days after the conclusion of the first meeting of creditors. Fed.R.Bankr.P. 4003(b). While the creditors’ meeting must be commenced 20-40 days after the filing of the petition, Fed.R.Bankr.P. 2003(a), there is no rule as to when the meeting must be concluded. As a result, the trustee may simply continue the meeting to a date after the conclusion of the six month reinvestment period. If that isn’t satisfactory, a creditor could move to extend the time to object or could file a conditional objection. All of these solutions are easy to accomplish. Since proceeds cases are unusual, it is reasonable to require trustees and creditors to take these nominal steps to preserve their rights rather than to argue that Supreme Court precedent should be disregarded.
The rationale of the Zibman opinion offers offers little support to the tardy creditor. In that case, the trustee obtained an order extending the time to object to exemptions. The trustee filed his objection within that time period. As a result, Zibman should not be construed as authorizing out of time objections. Indeed, the Zibman rationale simply recognizes that the debtor’s right to exempt proceeds may depend on events happening after the petition date. This is not an invitation to ignore the rules requiring timely objections to exemptions.
Finally, allowing untimely objections to exemptions based on events occurring after the petition date would lead to absurd results. Under Taylor v. Freeland & Kronz, which is an intellectual cousin to Republic Supply Co. v. Shoaf, 815 F.2d 1046 (5th Cir. 1987), failure to file a timely objection to exemption allows the debtor to retain the claimed property regardless of whether the debtor had a colorable claim of exemptions in the first place. If Zibman is read as allowing untimely objections, it means that a conditional claim to exemption of homestead proceeds would receive less protection than a debtor’s attempt to exempt a stack of gold bullion or a herd of Ethiopian hog-nosed goats** as his homestead. The legal system would be seriously out of joint if it accorded greater rights to the frivolous than the conditionally correct. The entire concept of statutes of limitation assumes that creditors must be diligent to protect their rights. If a creditor is unable to focus its attention on a claim which will be resolved in less than six months, the court should not create a judicial do-over for it.
*--This is the refrain from a recent song by semi-punk songstress Avril Lavigne.
**--A rare form of livestock found only in Bastrop County. Apologies to Joe Martinec and Eric Borsheim. For the full story of the Ethiopian hog-nosed goats, write to me at ssather@bnpclaw.com.
Wednesday, October 17, 2007
Creditor Trust Fails to Revive Claims Brought by Debtor; Creditors Found to Have Derivative Standing Only
While plan trusts have many uses, overcoming res judicata is not one of them. In Medlin, Trustee v. Wells Fargo Bank, N.A., Adv. No. 04-5041 (Bankr. W.D. Tex. 7/31/07), the Bankruptcy Court considered whether claims contributed to a plan trust by investors could overcome a prior take nothing judgment entered in a suit by the debtor’s trustee. In this case, the motto try, try again proved unavailing.
In the initial action, Len Blackwell, Chapter 11 trustee for the Inverworld debtors brought claims against Wells Fargo Bank, N.A. and Wells Fargo Bank of Texas, N.A. Pursuant to a Cash Management Services Agreement, the claims were referred to arbitration. The arbitration resulted in a take nothing judgment.
Subsequently, the cases proceeded to confirmation. The plan allowed for creditors to contribute their claims to an investor claim trust. The investor claim trust then brought its own claims. Although the reference was withdrawn, the Bankruptcy Court retained preliminary matters. The Bankruptcy Court was asked to consider whether the creditor claims were barred by res judicata.
Drawing an analogy to Orson Welles who proclaimed that Gallo Wineries would sell no wine before its time, the Bankruptcy Court noted that this issue was now ripe for decision since a new opinion by the Delaware Supreme Court resolved the issue. In North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, __ A.2d __, 2007 WL 1453705 (Del. Sup. 5/18/07), the Delaware Supreme Court held that creditors of an insolvent firm could assert breach of fiduciary claims; however, such claims were derivative claims just like those which could be asserted by shareholders. Because the creditor claims were derivative of the company’s claims, they were barred by res judicata based on the prior adverse ruling against the company. Thus, even though both the company and the creditors were allowed to assert clams, they were not considered to be separate parties for purposes of res judicata.
The derivative nature of these breach of fiduciary duty claims raises an interesting race to the courthouse problem. Because multiple parties have standing to pursue the same claim, it is possible that the first party to file might be the least qualified to pursue the claim or might have an actual incentive to sandbag the claims. For example, if debtor's management chooses to pursue claims against other members of management, it is possible that they might pursue the claims for the purpose of eliminating them. Thus, if management puts on a weak case and loses, the creditors would be barred. The same logic would seem to apply if management pursued the claims and then settled them on behalf of the company. There is some protection where the party sabotaging the claims is part of the debtor's management. In that case, the disingenuous pursuit of breach of fiduciary claims could give rise to new breach of fiduciary claims against the parties who caused the prior claims to be lost. However, if the claims are pursued by a small third party creditor who simply lacks the resources to put on a good case, there is no similar protection. Indeed, it is possible that a friendly creditor could bring claims for the express purpose of allowing them to go down to defeat. In that case, the creditor would not have a pre-existing fiduciary duty to the company (although it might acquire one by virtue of pursuing the claims)and its failure would bind both the debtor and its creditors.
In the initial action, Len Blackwell, Chapter 11 trustee for the Inverworld debtors brought claims against Wells Fargo Bank, N.A. and Wells Fargo Bank of Texas, N.A. Pursuant to a Cash Management Services Agreement, the claims were referred to arbitration. The arbitration resulted in a take nothing judgment.
Subsequently, the cases proceeded to confirmation. The plan allowed for creditors to contribute their claims to an investor claim trust. The investor claim trust then brought its own claims. Although the reference was withdrawn, the Bankruptcy Court retained preliminary matters. The Bankruptcy Court was asked to consider whether the creditor claims were barred by res judicata.
Drawing an analogy to Orson Welles who proclaimed that Gallo Wineries would sell no wine before its time, the Bankruptcy Court noted that this issue was now ripe for decision since a new opinion by the Delaware Supreme Court resolved the issue. In North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, __ A.2d __, 2007 WL 1453705 (Del. Sup. 5/18/07), the Delaware Supreme Court held that creditors of an insolvent firm could assert breach of fiduciary claims; however, such claims were derivative claims just like those which could be asserted by shareholders. Because the creditor claims were derivative of the company’s claims, they were barred by res judicata based on the prior adverse ruling against the company. Thus, even though both the company and the creditors were allowed to assert clams, they were not considered to be separate parties for purposes of res judicata.
The derivative nature of these breach of fiduciary duty claims raises an interesting race to the courthouse problem. Because multiple parties have standing to pursue the same claim, it is possible that the first party to file might be the least qualified to pursue the claim or might have an actual incentive to sandbag the claims. For example, if debtor's management chooses to pursue claims against other members of management, it is possible that they might pursue the claims for the purpose of eliminating them. Thus, if management puts on a weak case and loses, the creditors would be barred. The same logic would seem to apply if management pursued the claims and then settled them on behalf of the company. There is some protection where the party sabotaging the claims is part of the debtor's management. In that case, the disingenuous pursuit of breach of fiduciary claims could give rise to new breach of fiduciary claims against the parties who caused the prior claims to be lost. However, if the claims are pursued by a small third party creditor who simply lacks the resources to put on a good case, there is no similar protection. Indeed, it is possible that a friendly creditor could bring claims for the express purpose of allowing them to go down to defeat. In that case, the creditor would not have a pre-existing fiduciary duty to the company (although it might acquire one by virtue of pursuing the claims)and its failure would bind both the debtor and its creditors.
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