Supreme Court to Decide Whether Means Test Allows Ownership Expense Deduction for Vehicle Owned Free and Clear

This article appears in the June 2010 edition of the American Bankruptcy Institute Journal.

“(T)he code is more what you’d call ‘guidelines’ than actual rules.”(1)

The Supreme Court has agreed to hear a case which raises the issue of whether the collection standards contained within the IRS Financial Analysis Handbook (2), as incorporated into the Chapter 7 Means Test (3), are more of a code than a guideline(4). Three circuits and a Bankruptcy Appellate Panel have held that under a “plain meaning” reading of the Code, a debtor may claim an ownership expense deduction under the Means Test regardless of whether there is a debt or lease payment with regard to the vehicle (5), while the Ninth Circuit, adopting what is known as the IRM approach, has reached a contrary result (6). However, another way to describe the split is whether the IRS Collection Standards (hereafter IRS Standards)(7) as incorporated into the Means Test are more of a Code (the plain language approach) or a guideline (the IRM approach)(8). This article will examine how the search for an objective standard may lead to unintended consequences.

The Search for an Objective Standard

Prior to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), a debtor’s bankruptcy case could only be dismissed based on a finding of “substantial abuse,”(9) a standard which was not defined in the statute. BAPCPA changed this standard to one of “abuse” and provided for a presumption of abuse based on a formula that has become known as the Means Test (10). The purpose of the Means Test “is to determine if the debtors can repay a portion of their debt” (11). The Means Test applies to debtors with primarily consumer debts whose “current monthly income” exceeds the median income for a family of their size (12).

The Means Test is based on an elaborate formula found at 11 U.S.C. §707(b)(2). A bankruptcy filing is presumed to be abusive if the debtor can afford to pay the lesser of 25% of his nonpriority unsecured debts or $7,025, whichever is greater, or $11,725 (13). The Means Test determines this ability to pay by taking the debtor’s “current monthly income” and deducting categories of allowed expenses and multiplying by 60 (14). Like prior case law under the substantial abuse test, the Means Test looks at the debtor’s ability to pay his debts (15). However, the Means Test does not rely on the debtor’s current monthly income and expense. Instead, it uses an average of the debtor’s income for the preceding six months (16) and subtracts certain defined expenses.

Among other things, the Means Test allows deduction of

. . . the debtor's applicable monthly expense amounts specified under the National Standards and Local Standards, and the debtor's actual monthly expenses for the categories specified as Other Necessary Expenses issued by the Internal Revenue Service for the area in which the debtor resides. . . . Notwithstanding any other provision of this clause, the monthly expenses of the debtor shall not include any payments for debts.(17)

Separate provisions of the Means Test allows the debtor to deduct payments for secured debts scheduled to come due during the 60 months after the petition date as well as priority claims divided by 60(18).

The Means Test represents an attempt to replace the subjective “substantial abuse” test with a more objective standard. The IRS standards refer to such sources as Census Bureau and Bureau of Labor Statistics data (19). However, as used by the IRS, they are more of a guideline than a code (20). According to the Financial Analysis Handbook:

The standard amounts set forth in the national and local guidelines are designed to account for basic living expenses. In some cases, based on a taxpayer's individual facts and circumstances, it may be appropriate to deviate from the standard amount when failure to do so will cause the taxpayer economic hardship (see Note below bullet list). The taxpayer must provide reasonable substantiation of all expenses claimed that exceed the standard amount.(21)

The National and Local standards consist of tables of data. However, they are used in the context of the Financial Analysis Handbook which provides guidelines as to how they should be applied.

Furthermore, the standards consist of aggregate amounts for categories, including debt payments(22). However, the Means Test considers secured debts separately. This means that a debtor with a high mortgage payment or car payment could be allowed to deduct more than the amount allowed under the standards.

The Problem of Vehicle Ownership Expenses

Vehicle ownership expenses pose a potential conflict between the language of the Means Test and the IRM. Under the Means Test, the debtor may deduct

the debtor's applicable monthly expense amounts specified under the National Standards and Local Standards, and the debtor's actual monthly expenses for the categories specified as Other Necessary Expenses. . . . (23)

The Local Standards include both ownership and operating expenses (24). The IRM specifies that in determining a taxpayer’s ability to pay "[t]axpayers will be allowed the local standard or the amount actually paid, whichever is less."(25) In the specific case of vehicle payments, the IRM states "(i)f a taxpayer has a car, but no car payment [sic] only the operating cost portion of the transportation standard is used to figure the allowable transportation expense."(26)

The conflict arises because the statute refers to the Local Standards. The Local Standards consist of a table of expenses broken down by number of vehicles owned (27). Furthermore, under the Means Test, ownership costs and debt payments are separate allowances. Thus, since ownership costs and debt amounts are distinct allowances, it would be possible to have an ownership costs without a debt payment. However, the purpose of the Means Test is to "to ensure that debtors repay creditors the maximum they can afford."(28) The IRS standards have a similar purpose. Since the IRM would not allow an expense which was not an “actual” expense, neither should the Means Test.

What Expenses Are Applicable?

Both approaches seek to apply the plain meaning of the statute, particularly the word “applicable.”(29)

The Ninth Circuit quoted its Bankruptcy Appellate Panel as stating:

The ordinary, common meaning of "applicable" further impels us to this conclusion. "Applicable," in its ordinary sense, means "capable of or suitable for being applied."(Citation omitted). Given the ordinary sense of the term "applicable," how is the vehicle ownership expense allowance capable of being applied to the debtor if he does not make any lease or loan payments on the vehicle? In other words, how can the debtor assert a deduction for an expense he does not have? If we granted the debtor such an allowance, we would be reading "applicable" right out of the Bankruptcy Code (30).

In contrast, the Seventh Circuit applied “applicable” to mean:

707(b)(2)(A)(ii)(I) is more strongly supported by the language and logic of the statute. In order to give effect to all the words of the statute, the term "applicable monthly expense amounts" cannot mean the same thing as "actual monthly expenses." Under the statute, a debtor's "actual monthly expenses" are only relevant with regard to the IRS's "Other Necessary Expenses;" they are not relevant to deductions taken under the Local Standards, including the transportation ownership deduction. Since "applicable" cannot be synonymous with "actual," applicable cannot reference what the debtor's actual expense is for a category, as courts favoring the IRM approach would interpret the word. We conclude that the better interpretation of "applicable" is that it references the selection of the debtor's geographic region and number of cars.(31)

Thus, two circuits have reached diametrically opposed views of what the word “applicable” means in the applicable statute.

Going Beyond Applicable

If the plain meaning of the word “applicable” is not sufficient to resolve the debate, what other factors might illuminate the issue?

The courts taking the “plain meaning” approach add several other arguments in favor of their position. Among them, a prior version of the bankruptcy reform legislation included an express reference to the Internal Revenue Manual, a provision which was not included in the final bill (32); the Internal Revenue Manual itself includes a disclaimer that it is only to be used for tax collection purposes and not for purposes of bankruptcy (33); that it would be prudent to allow a debtor with no car payment to save for a new vehicle (34); that it would be absurd to allow a debtor with $1 in debt against the vehicle to take the ownership expense while denying it to a debtor without a car payment (35); and that the Bankruptcy Code provided for both an ownership expense and a secured debt deduction as separate items (36).

On the other hand, the Ninth Circuit looked to the purpose of the deduction. It quoted its Bankruptcy Appellate Panel as stating:

Congress has deemed the expense of owning a car to be a basic expense that debtors can deduct in calculating what they can afford to pay to their creditors. However, in making that calculation, what is important is the payments that debtors actually make, not how many cars they own, because the payments that debtors make are what actually affect their ability to make payments to their creditors.

The statute is only concerned about protecting the debtor's ability to continue owning a car, and if the debtor already owns the car, the debtor is adequately protected . . . . When the debtor has no monthly ownership expenses, it makes no sense to deduct an ownership expense to shield it from creditors. (37)

It also looked to the general purpose of BAPCPA.

This approach also is arguably supported by Congress's intent in implementing the means testing as part of BAPCPA--"to ensure that debtors repay creditors the maximum they can afford." (38)

Finally, it questioned the wisdom of allowing a debtor to subtract a “fictitious expense not incurred by the debtor” under the Means Test (39).

Finding an Answer

The ownership deduction cases illustrate the practical difficulties in using the IRS Standards as the basis for calculating an above median income debtor’s eligibility for chapter 7 or determining the amount that an above median debtor must pay under a chapter 13 plan. While the reference to tables of data based upon Census Bureau and Bureau of Labor Statistics figures appears objective and therefore practical to apply, the Internal Revenue Manual within which they appear is full of nuances. To further complicate the matter, Congress included numerous modifications to the IRS Standards within the text of Section 707(b). It is safe to say that Congress created ambiguity when it sought to graft a guideline into a Code.

In the conclusion to its opinion, the Ninth Circuit recognized the difficulty of the issue and suggested that Congress take action to clarify the legislation.

The "correct" answer to the question before us, which the courts have been struggling with for years--at the unnecessary cost of thousands of hours of valuable judicial time--depends ultimately not upon our interpretation of the statute, but upon what Congress wants the answer to be. We would hope, in this regard, that we the judiciary would be relieved of this Sisyphean adventure by legislation clearly answering a straightforward policy question: shall an above-median income debtor in chapter 13 be allowed to shelter from unsecured creditors a standardized vehicle ownership cost for a vehicle owned free and clear, or not? Because resolution of this issue rests with Congress, we have taken the unusual step of directing the Clerk of the Court to forward a copy of this opinion to the Senate and House Judiciary Committees.(40)

The Ninth Circuit makes a good point. While Congress may have intended the more parsimonious approach adopted in Ransom, numerous courts have concluded that the language they used does not accomplish that result. Thus, the unintended consequence of seeking an objective standard is that in this one case, debtors may receive a more generous allowance than they would have been granted under the Internal Revenue Manual or prior bankruptcy law.

Pending an answer from Congress, the Supreme Court will have to untangle the legislative knot. On April 19, 2010, the Supreme Court agreed to consider the following question:

Whether, in calculating the debtor's "projected disposable income" during the plan period, the bankruptcy court may allow an ownership cost deduction for vehicles only if the debtor is actually making payments on the vehicles.(41)

While this will be the third case that the Supreme Court has accepted with regard to BAPCPA, it will likely not be the last(42).
____________________________________________________

1. Pirates of the Caribbean: The Curse of the Black Pearl, quoted at http://www.imdb.com/title/tt0325980/quotes. The quote originally appears near the beginning of the movie when Elizabeth Swann invokes the Code of the Brethren to Captain Barbossa. Throughout the movie, characters use the guideline reference as a rationale to disregard the Code.
2. Internal Revenue Manual, §5.15.1, found at www.irs.gov/irm.
3. 11 U.S.C. §707(b).
4. In re Ransom, 577 F.3d 1026 (9th Cir. 2009), cert granted, 2010 U.S. LEXIS 3359 (2010).
5. In re Washburn, 579 F.3d 934 (8th Cir. 2009)(with dissenting opinion); Tate v. Bolen, 571 F.3d 423 (5th Cir. 2009); In re Ross-Tousey, 549 F.3d 1148 (7th Cir. 2008); In re Kimbro, 389 B.R. 518 (6th Cir. BAP 2008).
6. In re Ransom, supra.
7. The Collection Standards consist of the National Standards, Local Standards and Other Necessary Expenses.
8. The two approaches are described in more detail below.
9. In re Rudler, 576 F.3d 76 (1st Cir. 2009).
10. “The heart of the bill’s consumer bankruptcy reforms consists of the implementation of an income/expense screening mechanism (‘‘needs-based bankruptcy relief’’ or ‘‘means testing’’), which is intended to ensure that debtors repay creditors the maximum they can afford.” Report on the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, H.R. Rept. 109-31, 109th Cong., 1st Sess. (April 8, 2005).
11. Tate v. Bolen, at 425.
12. The requirement that debts be primarily consumer debts is found in 11 U.S.C. §707(b)(1), while exclusion for below median income debtors is contained in §707(b)(7).
13. 11 U.S.C. §707(b)(2)(A)(i). These amounts are adjusted for inflation and were most recently adjusted on April 1, 2010.
14. Id.
15. In re Goble, 401 B.R. 261 (Bankr. S.D. Ohio 2009).
16. 11 U.S.C. §101(10A) containing definition of “current monthly income.”
17. 11 U.S.C. §707(b)(2)(A)(i)(I).
18. 11 U.S.C. §707(b)(2)(A)(iii) and (iv).
19. IRM, §5.15.1.7.
20. http://www.irs.gov/individuals/article/0,,id=96543,00.html.
21. IRM, §5.15.1.7.6.
22. For example, the standards for housing state:

Housing and Utilities. Housing expenses include: mortgage (including interest) or rent, property taxes, necessary maintenance and repair, homeowner's or renter's insurance, homeowner dues and condominium fees. The utilities include gas, electricity, water, heating oil, bottled gas, trash and garbage collection, wood and other fuels, septic cleaning, telephone and cell phone.

IRM, §5.15.1.9.1.A
23. 11 U.S.C. §707(b)(2)(A)(i)
24. IRM §5.15.1.
25. IRM §5.15.1.7.
26. Id.
27. In re Kimbro, at 527.
28. H.R. Rep. 109-31(I), at 1.
29. In re Ransom, at 1030 ("As did our BAP, we decide this issue not on the IRS's manual, but instead on the "statutory language, plainly read."); In re Ross-Tousey, at 1158 ("To analyze this issue, we begin with the language of the statute. When the language is plain, the sole function of the courts is to enforce the statute according to its terms.”).
30. In re Ransom, at 1030-31.
31. In re Ross-Tousey, at 1158.
32. In re Ross-Tousey, at 1159; Tate v. Bolen, at 427.
33. In re Kimbro, at 527.
34. Tate v. Bolen, at 428; In re Ross-Tousey, at 1160.
35. In re Ross-Tousey, at 1161.
36. In re Kimbro, at 523.
37. In re Ransom, at 1030-31.
38. In re Ransom, at 1030.
39. In re Ransom, at 1030.
40. In re Ransom, at 1031-32.
41. http://www.supremecourt.gov/qp/09-00907qp.pdf.
42. The others are Milavetz, Gallop & Milavetz, P.A. v. United States, 559 U.S. __ (2010) and In re Lanning, 545 F.3d 1269 (10th Cir. 2009), cert. granted, 2009 U.S. LEXIS 7655 (2009).

A Judge Judging Himself: Another Opinion on Judicial Recusal

Last year I wrote about the unique challenge posed by a motion to recuse, in which the judge accused of being insufficiently impartial must rule on his own ability to hear the case. A judge judging himself: judicial recusal. I have come across yet another opinion from Texas on this sticky situation. Pease v. First National Bank of Giddings, Adv. No. 10-1011 (Bankr. W.D. Tex. 5/4/10).

What Happened

In the latest case, a pro se debtor thought he had scored a major coup. He sued a bank and recovered a default judgment for $8 million. However, the judgment had a few problems. First, the plaintiff did not serve the motion for default judgment on the defendants. Second, the motion sought unliquidated damages, which would have required a hearing. The bank was none too happy with the judgment, since it would have put it out of business. The bank moved promptly for reconsideration. This time the debtor did not appear. The court gamely recognized that it had made a mistake and vacated the judgment.

At this point, the case moved out of the procedural realm and into the pro se zone, a place where saying something makes it so. According to the court's opinion:

After the entry of the order setting aside the default judgment, a copy of the order was sent to the plaintiff. The plaintiff was evidently displeased with the ruling, as he filed a document entitled “Notice of Non Acceptance and Return of Order and Notice of Void Order” on May 3, 2010. The plaintiff attached a copy of the order, across the face of which the plaintiff had written “VOID” with the explanatory statement “Refusal for Cause, No Notice! No Security! Violation of Stay by Defendants!” He signed his name, under which he wrote “Surety in Fact” and dated it April 30, 2010. In the Notice, plaintiff states that the order must be void as a denial of his due process, and details his basis for that contention – that the expedited hearing was too expedited to be adequate notice under the Constitution. At the end of the pleading, the plaintiff states that the order of this court setting aside the default judgment “... is void and is hereby returned to the court.”

Opinion, p. 3.

While it is possible to understand the debtor's frustration at losing his victory over the bank, the specific language used suggests a magical view of the law where a judicial action may be invalidated merely by saying so. However, the debtor supplemented his response with one which was recognizable: a motion to recuse. This placed the court in the uncomfortable position of having to rule upon its own competency.

The court described the motion to recuse as follows:

On the same day, the plaintiff also filed this motion to recuse. In it, plaintiff recounts what he believes are multiple reasons why I should recuse myself. He recounts his version of the facts and the law in this case, and, in essence, asserts bias on my part because I do not agree with his version of the facts and the law. He also alleges bias based upon “extrajudicial sources and actions,” and for support, contends that “Judge Clark received and used false ex parte evidence, rumors and innuendo in the hearing to lift stay on February 1, 2010.” He then explains the basis for this contention, namely that the court heard evidence presented by the bank at that hearing “... although the Bank had never filed a claim against Plaintiff, nor submitted any nexus of debt between itself and the Plaintiff and sua sponte claimed that Plaintiff was responsible for his brother’s debt, even though the bank never sued his brother for the debt.” In other words, the plaintiff disagreed with this court’s ruling on the motion for relief from stay, and the basis of this court’s ruling. Plaintiff, in other words, finds bias from the fact that the court did not agree with the plaintiff’s version of the facts and the law.

For further support, the plaintiff claims bias from the fact that the court set aside the default judgment, and from what plaintiff describes as failing to “zealously guard the jurisdiction of the court.” He claims the court “knew from the filings that the Bank had trespassed on federal jurisdiction, and he made no move to hold the guilty parties in contempt, thereby ratifying the unlawful seizure and destruction of all of Plaintiff’s personal property.” This allegation is an evident reference to a pleading filed March 1, 2010, in which Plaintiff claimed “contempt of federal jurisdiction” in the main case. Plaintiff obviously finds prejudice from the fact that this court did not believe that any contempt had taken place. However, the pleading filed by plaintiff was entitled “Notice of Contempt of Federal jurisdiction.” On its face, the caption of the pleading was not a motion. No form of order was submitted with the pleading, meaning that, under the court’s electronic filing system, the motion would not have come to the court’s attention. The docket also reflects a “motion for expedited hearing” with regard to the notice of contempt, but the document actually filed on that date was a duplicate of the Notice. No order was uploaded with this document either. In the final paragraph of the Notice, plaintiff states “Petitioner prays for an expedited hearing on the matter of sanctions and requests that the trsutees of this court demand an accounting of the property held in trust and the taking, destruction, and devastation visited upon said property and that all actors be held responsible and accountable for their complete and total disregard and disdain for any authority other than that of their own making.”

Opinion, pp. 3-5.

The Court went on to quote the conclusion of the motion at length:

Because Judge Clark’s fias or prejudice prevents Plaintiff from receiving a fair hearing before the court, the judge should recuse himself and his order of April 28, 2010, is void because the Defendants are in violation of the automatic stay as of February 27, 2010 and have never questioned the debt prior to this, although the proposal to contract was offered in 2007. At no time has the debt ever been questioned and it is apparent from the record that the debt was liquidated by the Court record. What is the new trial about? The debt is well plead and the Defendant bank is liable for numerous constitutional violations over a five year period against the Plaintiff. Judge Clark is not on the side of the Texas Legislature concerning the underlying possession issue and has clearly departed from his previous rulings in order to give the Defendants the right to violate the automatic stay, re-instate the stay in order to create the illusion of emergency and then set aside an eight million dollar judgment without any supporting affidavits or protection fro the Plaintiff in the form of a supersedeas bond is clearly non-governmental. Either tyhe Judge or Mr. Powell or both needs to post a ten million dollar bond and restore me to possession of the property.

Opinion, p. 6.

Considering the Motion to Recuse

On a motion for recusal, the judge is placed in the interesting position of evaluating his own ability to consider the case. Judge Clark noted that "A motion to recuse is entrusted to the sound discretion of the judge to whom the motion is submitted."

The standard for recusal is "whether a judge's impartiality might reasonably be questioned." A judge must recuse himself if he has a bias or prejudice against a party or has knowledge of disputed evidentiary facts. However, the judge is presumed to be impartial and bias arising from proceedings occurring in court is only grounds for recusal if the judge has "a disposition so extreme that as to display a clear inability to render a fair judgment."

Thus, if the judge determines that a party is a liar, the obligation to recuse would depend on the source of that belief. If the judge makes this determination based upon evidence submitted in court, he may remain on the case so long as he is capable of giving the witness the benefit of the doubt in future hearings. On the other hand, if he decides that the witness is a liar because someone from his church told him so, then the judge would need to recuse himself.

Turning to the allegations of the motion, the court found that "the plaintiff’s principal bases for claiming bias and prejudice is that this court has not agreed with his version of the facts, or his vision of how the law works. These are not valid bases for finding bias or prejudice." Opinion, p. 7.

This was not a difficult case. However, it illustrates the unique nature of motions to recuse. On a motion to recuse, the judge is both a fact witness and the trier of fact. This works as long as the judge has the integrity and the clear-sightedness to recognize even the appearance of impropriety.

However, there is potential for abuse, as shown by the case of U.S. District Judge Thomas Porteous, who is now facing impeachment, for among other things, refusing to recuse himself in a case where he had received gifts and things of value from one of the attorneys appearing before him.

The current system assumes that cases of outright dishonesty, such as the Porteous case, will be extremely rare. On the other hand, most requests for recusal, such as the one in this case, are likely to be based on sour grapes. The difficult case will be where the judge's bias clouds his own perception of whether he is biased. In those cases, appeal or mandamus will be available to correct the mistake. As long as the procedure gets the result right in the vast majority of cases, it is probably good enough despite its unusual aspects.

Interestingly, there is an alternate procedure for recusing a judge under 28 U.S.C. Sec. 144. Under Sec. 144, a judge must cease hearing a proceeding upon the timely filing of an affidavit by a party asserting bias and a certificate of counsel. However, this statute has been held to be inapplicable to bankruptcy judges. In re Johnson, 408 B.R. 123 (Bankr. S.D. Ohio 2009).

While it is not designed as a recusal mechanism, the procedure for withdrawing the reference to the district court is another way to achieve the same result.

The Pro Se Zone

On a final note, it would be a mistake not to comment on the eccentric pleadings filed by the debtor in this case. The terms that he used, such as "proposal to contract" and "notice of contempt of federal jurisdiction" are typical of the sovereign citizen movement. This is the same debtor who attempted to pay for the filing fee for his appeal with a self-created "Certified Money Order." They believe that the U.S. Government and its monetary system are illegal and that they can create their own alternate authority and money. However, when they get into trouble, sometimes they run to the federal bankruptcy court, whose jurisdiction they seek but ultimately reject.

Back in 2003, Manuel Newburger from my firm was quoted in an article in the ABA Journal about this phenomenon. I was not able to find the article online, but I did find a blog article which repeated some of its content, which I will link to here. It is certainly a strange world out there when people can copyright their names and pay their debts in self-created currency.

Dealing with these issues is just one of the challenges of being a federal judge.

What Does Kagan Nomination Mean for Bankruptcy Practitioners?

President Obama announced today that he would nominate Solitor General Elena Kagan to the United States Supreme Court. If confirmed, Ms. Kagan will be the first Supreme Court justice without prior judicial experience since the Nixon administration. While much of America will be focusing on hot button issues such as abortion and gun control, bankruptcy lawyers will be wondering what she thinks about the hanging paragraph. However, her history does not provide much illumination.

Since Ms. Kagan was not a judge, she does not have a body of written opinions to peruse. Her academic writings dealt primarily with constitutional law issues.

As Solicitor General, her department has appeared in three bankruptcy cases this term: Espinosa, Lanning and Milavetz. However, she did not personally argue any of these cases. In Espinosa, the Solicitor General's office argued that the student loans were not discharged, a position the Supreme Court rejected. In Milavetz, her office contended that the Debt Relief Agency provisions were constitutional, a position adopted by the Supreme Court. Finally, in Hamilton v. Lanning, the Solicitor General's office agreed with the debtor that projected disposable income must be forward-looking, that is, that adjustments may be made based on changes in circumstance likely to occur. Of these three cases, Lanning is the only one in which there was not a clear governmental interest.

However, her record is not totally devoid of bankruptcy connections. While at Harvard Law, she had Liz Warren as a colleague. Anything that she picked up from Liz would serve her well on the Supreme Court.

Supreme Court to Determine Whether Ninth Circuit Can Hold Ownership Expense Deduction for Ransom

On April 19, the Supreme Court granted cert in In re Ransom, 577 F.3d 1026 (9th Cir. 2009), cert granted, 2010 U.S. LEXIS 3359 (2010). The issue in the case is:

Whether, in calculating the debtor's "projected disposable income" during the plan period, the bankruptcy court may allow an ownership cost deduction for vehicles only if the debtor is actually making payments on the vehicles.

The Ninth Circuit held that a debtor could only claim a vehicle ownership expense on the means test if she had a debt or lease payment. The Fifth Seventh Circuit and Eighth Circuits and the Sixth Circuit BAP have all ruled that the ownership expense is available regardless of whether there is an actual payment. In re Washburn, 579 F.3d 934 (8th Cir. 2009)(with dissenting opinion); Tate v. Bolen, 571 F.3d 423 (5th Cir. 2009); In re Ross-Tousey, 549 F.3d 1148 (7th Cir. 2008); In re Kimbro, 389 B.R. 518 (6th Cir. BAP 2008).

The cases raise a fascinating issue under BAPCPA. The Means Test refers to the Local Standards, National Standards and Other Necessary Expenses referred to by the Financial Analysis Handbook within the Internal Revenue Manual. The standards themselves consist of tables of expenses. However, the manual itself provides guidelines for applying the standards and states that the deduction is only available if there is an actual payment. Thus, the issue is whether the availability of the deduction depends on how Congress wrote the statute (which references the standards) or the way the IRS would have applied the standards under the manual.

Since the stated goal of BAPCPA was "to ensure that debtors repay creditors the maximum they can afford," it would be ironic if the Supreme Court finds that the way the statute was actually drafted allows a more generous deduction than the IRS would have allowed.

I have an article discussing this issue in more detail coming out in the June ABI Journal.

Too Much CLE!

Last weekend had the convergence of three major CLE conferences in three different parts of the country. The American Bankruptcy Institute held its Annual Spring Meeting in Washington, D.C., the Commercial Law League held its Midwest Regional Meeting in Chicago and the National Association of Consumer Bankruptcy Attorneys held a confab on the West coast. I am a member of both CLLA and ABI and had the distinct pleasure of speaking at both conferences. In between my panels, I tried to absorb as much of the good CLE offerings as I could, but there was so much more I could have done.

I started my CLE marathon in Chicago on Thursday April 29. I heard excellent presentations on electronic evidence (scary stuff) and internet law sponsored by the Complex Litigation Committee. I also attended a judge’s panel on ethical issues in employment and retention, which was co-sponsored by the Chicago Bar Association featuring Bruce Black (Bankr. N.D.Ill), Carol Doyle (Bankr. N.D.Ill) and Jack Schmetterer (Bankr. N.D.Ill.). The panel featured some good information from the judges and offered 2.5 hour of ethics credit. However, I was left hungering for some more cutting edge issues.

I spent most of Friday preparing for my own panel. I was moderator of a panel featuring Judge Marvin Isgur (Bankr. S.D. Tex.), Judge Michael Lynn (Bankr. N.D. Tex.), Barbara Barron from my own firm and June Mann from Mann & Stevens. We had a two hour discussion on issues in discharge violations and home mortgage issues. The judges did most of the heavy lifting, making the moderator’s job extremely easy. The audience of creditors’ lawyers (with two trustees thrown in for good measure) asked a lot of good questions. The take away from this panel is that discharge violation cases are flying largely below the radar. While some plaintiffs’ lawyers are handling up to 400 new cases a month, the judges see about 1-2 cases per month, few of which are ultimately tried. On the other hand, problems with home mortgages in chapter 13, at least in the Southern District of Texas, are getting a lot of attention from the courts. Judge Isgur mentioned that he had multiple pending class actions before him. Although none of these classes have been certified yet, they have survived motions to dismiss.

Saturday morning I woke up early to fly to Washington. I arrived in time to hear a panel on the comparative benefits of chapter 11 and chapter 13 for insolvent professionals. The panel featured Judge Steven Rhoades of Detroit, Rebecca Connelly, standing chapter 13 trustee in Roanoke, Virginia, Peter Fessenden, standing chapter 13 trustee in Brunswick, Maine and Mark Williams with Norman, Wood, Kendrick & Turner. The presentation was thought-provoking and was benefitted by having Judge Eugene Wedoff and Prof. Nancy Rapoport in the audience.

I was on a panel on using social media to maintain a virtual presence, along with Prof. Nancy Rapoport as moderator, Andy Winchell, author of A Clean Slate and Karim Guirguis of ABI. Karim did a great job of pulling up relevant sites from the web in real time, including the ABI’s blog roll (which conveniently lists A Clean Slate and A Texas Bankruptcy Lawyer’s Blog near the top of its list), Nancy Rapoport’s Linked-In page and tweets about the Annual Spring Meeting. While I got to answer a few questions about blogging (including the ethics of writing about your own clients), I got several good ideas from the other speakers.

In particular, I want to increase my Linked-In presence. I had always thought of Linked-In as being a bit staid, a glorified on-line resume. However, either Andy or Karim made the point that in big firms the person with the biggest rolodex was the biggest rainmaker. Linked-In, with its interconnected networks, is like a giant on-line rolodex. I went back to my hotel room and accepted all of my pending invitations to join other people’s networks that I had been neglecting.

Andy also convinced me to try tweeting. I had never really seen the utility of sending random 140 character messages. However, Andy pointed it that Twitter’s real benefit is as a search engine and as a real-time source of breaking news. You can use Twitter to set up a feed on topics you are interested in or search Twitter for breaking news. When Michael Jackson died, it was all over Twitter hours before it was reported by the MSM.

My answer to the ethics question was that I limit what I write about cases or issues involving my clients. If I represent a client who is successful in a case involving an interesting issue, I may write about it (with an appropriate disclaimer about my interest). However, I try not to write about anything ongoing with my clients or anything that might focus unwanted attention on them. I have unwittingly broken this rule with regard to someone who I didn’t realize was a firm client, but it is something that I try to be sensitive to.

It was a rare delight to be able to participate in a panel where I was able to take away more than I contributed. We had a small audience, heavy on professors, but they were very active in the discussion and it was a lot of fun.

Sunday morning, I had a chance to listen to seven judges talk about effective advocacy points before I had to leave. They had several excellent points. One of the best was to tell a story. One of the judges (don’t remember which one), gave the example of a pleading which read like a trust indenture, setting out all the loan documents in great detail before ever telling what the pleading was about. They also made a great point about knowing your judge using a clip from one of the greatest lawyer movies ever, My Cousin Vinnie. Between the seven judges, some required hearings on all motions, while some allowed negative notice. Some of the judges allowed declarations to be used for direct testimony, but were unfamiliar with the concept of a proffer (the lawyer saying what the witness would testify to and the witness adopting that statement). The judges also appreciated any attempts to make their job easier, such as preparing a notebook with the two or three most important exhibits in a case with 24 binders of exhibits or using electronic presentation of evidence (something I have only recently attempted).

As I headed back to Austin, I returned with a wealth of materials but the feeling that I only sampled the offerings that were out there. It is a shame to have to choose between two good conferences or to mix and match like I did.

Supreme Court Affirms Espinosa on Procedural Grounds Without Endorsing Discharge by Declaration

Consistent with several prior rulings, a unanimous Supreme Court held that a creditor could not use a Motion under Rule 60(b)(4) to attempt to set aside a chapter 13 confirmation order which included a controversial "discharge by declaration" provision." United Student Aid Funds, Inc. vs. Espinosa, No. 08-1134 (U.S. 3/23/10).

Background

Espinosa involved a chapter 13 debtor who included a single student loan debt in his chapter 13 plan and provided that upon payment of the principal amount, the debt would be discharged. The plan violated 11 U.S.C. Sec. 523(a)(8) because it sought to discharge a student loan debt without a finding of undue hardship. However, the creditor did not object to the plan, the plan was confirmed and the debtor received a discharge after completing his payments. Several years after discharge, the student loan creditor began collection efforts. The debtor asked the bankruptcy court to enforce the discharge order, while the creditor asked the court to declare the order to be void under Rule 60(b)(4). The Bankruptcy Court and the Court of Appeals ruled that the orders were not void and could not be challenged at such a late date.

I have previously written about Espinosa here, here and here.

All About Voidness

Justice Thomas, writing for a unanimous Supreme Court, authored an opinion affirming the Ninth Circuit on finality grounds, while pointing out that inappropriate orders could be policed through other methods than declaring them void.

Justice Thomas explained that in order to set aside a judgment as void, there must be a jurisdictional defect or failure to afford due process.

“A judgment is not void,” for example, “simply because it is or may have been erroneous.” (citation omitted). Similarly, a motion under Rule 60(b)(4) is not a substitute for a timely appeal. (citation omitted). Instead, Rule 60(b)(4) applies only in the rare instance where a judgment is premised either on a certain type of jurisdictional error or on a violation of due process that deprives a party of notice or the opportunity to be heard. (citation omitted). The error United alleges falls in neither category.

Opinion, pp. 8-9.

Voiding a judgment for lack of jurisdiction is "reserved . . . only for the exceptional case in which the court that rendered judgment lacked even an 'arguable basis' for jurisdiction." Opinion, at 9. Section 523(a)(8)'s requirement that a court find undue hardship to discharge a student loan debt is a precondition for discharge, but is not a limitation on the court's jurisdiction. Similarly, the procedural requirement of an adversary proceeding and a summons is not jurisdictional.

Justice Thomas also found that failure to initiate an adversary proceeding did not deprive the student loan creditor of due process.

Espinosa’s failure to serve United with a summons and complaint deprived United of a right granted by a procedural rule. (citation omitted). United could have timely objected to this deprivation and appealed from an adverse ruling on its objection. But this deprivation did not amount to a violation of United’s constitutional right to due process. Due process requires notice “reasonably calculated, under all the circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections.” (citation omitted). (“[D]ue process does not require actual notice . . .”). Here, United received actual notice of the filing and contents of Espinosa’s plan. This more than satisfied United’s due process rights. Accordingly, on these facts, Espinosa’s failure to serve a summons and complaint does not entitle United to relief under Rule 60(b)(4).

Opinion, p. 10.

No Expansion of Voidness Concept

The Supreme Court also rejected an attempt to expand the concept of voidness to embrace statutory defects.

Unable to demonstrate a jurisdictional error or a due process violation, United and the Government, as amicus , urge us to expand the universe of judgment defects that support Rule 60(b)(4) relief. Specifically, they contend that the Bankruptcy Court’s confirmation order is void because the court lacked statutory authority to confirm Espinosa’s plan absent a finding of undue hardship. In support of this contention, they cite the text of §523(a)(8), which provides that student loan debts guaranteed by governmental units are not dischargeable “ unless ” a court finds undue hardship. 11 U. S. C. §523(a)(8) (emphasis added). They argue that this language imposes a “ ‘self-executing’ limitation on the effect of a discharge order” that renders the order legally unenforceable, and thus void, if it is not satisfied. (citation omitted). In addition, United cites §1325(a)(1), which instructs bankruptcy courts to confirm only those plans that comply with “the … applicable provisions” of the Code. Reading these provisions in tandem, United argues that an order confirming a plan that purports to discharge a student loan debt without an undue hardship finding is “doubly beyond the court’s authority and therefore void.” (citation omitted).

We are not persuaded that a failure to find undue hardship in accordance with §523(a)(8) is on par with the jurisdictional and notice failings that define void judgments that qualify for relief under Rule 60(b)(4). As noted, §523(a)(8) does not limit the bankruptcy court’s jurisdiction over student loan debts. (citation omitted). Nor does the provision impose requirements that, if violated, would result in a denial of due process. Instead, §523(a)(8) requires a court to make a certain finding before confirming the discharge of a student loan debt. It is true, as we explained in Hood , that this requirement is “ ‘self-executing.’ ” (citation omitted). But that means only that the bankruptcy court must make an undue hardship finding even if the creditor does not request one; it does not mean that a bankruptcy court’s failure to make the finding renders its subsequent confirmation order void for purposes of Rule 60(b)(4).

Given the Code’s clear and self-executing requirement for an undue hardship determination, the Bankruptcy Court’s failure to find undue hardship before confirming Espinosa’s plan was a legal error. . . . But the order remains enforceable and binding on United because United had notice of the error and failed to object or timely appeal.

United’s response—that it had no obligation to object to Espinosa’s plan until Espinosa served it with the summons and complaint the Bankruptcy Rules require, . . .is unavailing. Rule 60(b)(4) does not provide a license for litigants to sleep on their rights. United had actual notice of the filing of Espinosa’s plan, its contents, and the Bankruptcy Court’s subsequent confirmation of the plan. In addition, United filed a proof of claim regarding Espinosa’s student loan debt, thereby submitting itself to the Bankruptcy Court’s jurisdiction with respect to that claim. (citation omitted) . United therefore forfeited its arguments regarding the validity of service or the adequacy of the Bankruptcy Court’s procedures by failing to raise a timely objection in that court.

Rule 60(b)(4) strikes a balance between the need for finality of judgments and the importance of ensuring that litigants have a full and fair opportunity to litigate a dispute. Where, as here, a party is notified of a plan’s contents and fails to object to confirmation of the plan before the time for appeal expires, that party has been afforded a full and fair opportunity to litigate, and the party’s failure to avail itself of that opportunity will not justify Rule 60(b)(4) relief. We thus agree with the Court of Appeals that the Bankruptcy Court’s confirmation order is not void.

Opinion, pp. 11-14.

The Court's Independent Duty

However, the Supreme Court did chastise the Ninth Circuit for finding that Bankruptcy Courts were under an obligation to confirm plans containing improper "discharge by declaration" language absent objection.

As Espinosa concedes. . . a Chapter 13 plan that proposes to discharge a student loan debt without a determination of undue hardship violates §§1328(a)(2) and 523(a)(8). Failure to comply with this self-executing requirement should prevent confirmation of the plan even if the creditor fails to object, or to appear in the proceeding at all. (citation omitted). That is because §1325(a) instructs a bankruptcy court to confirm a plan only if the court finds, inter alia , that the plan complies with the “applicable provisions” of the Code. (citation omitted). Thus, contrary to the Court of Appeals’ assertion, the Code makes plain that bankruptcy courts have the authority—indeed, the obligation—to direct a debtor to conform his plan to the requirements of §§1328(a)(2) and 523(a)(8).

Opinion, pp. 14-15.

Deterring Bad Behavior

Finally, the Supreme Court reinforced its holding in Taylor v. Freeland & Kronz that deterring bad behavior is not a sufficient reason to allow untimely objections.

United argues that our failure to declare the Bankruptcy Court’s order void will encourage unscrupulous debtors to abuse the Chapter 13 process by filing plans proposing to dispense with the undue hardship requirement in the hopes the bankruptcy court will overlook the proposal and the creditor will not object. In the event the objectionable provision is discovered, United claims, the debtor can withdraw the plan and file another without penalty.

We acknowledge the potential for bad-faith litigation tactics. But expanding the availability of relief under Rule 60(b)(4) is not an appropriate prophylaxis. As we stated in Taylor v. Freeland & Kronz , 503 U. S. 638 (1992) , “[d]ebtors and their attorneys face penalties under various provisions for engaging in improper conduct in bankruptcy proceedings,” (citation omitted). The specter of such penalties should deter bad-faith attempts to discharge student loan debt without the undue hardship finding Congress required. And to the extent existing sanctions prove inadequate to this task, Congress may enact additional provisions to address the difficulties United predicts will follow our decision.

Opinion, pp. 16-17.

Summing It Up

This opinion is consistent with both Taylor v. Freeland & Kronz and last summer's opinion in Travelers Indemnity Co. v. Bailey, 557 U.S. ____ (2009) that deadlines have meaning and that untimely attacks on orders will not be allowed merely because the orders were unwise or unwarranted. At the same time, the Supreme Court stressed the obligation of the Bankruptcy Court to perform its own independent review to determine that only proper orders are entered and to use Rule 9011 to police parties who openly flaunt the rules in the hopes that they won't get caught. The Supreme Court's approach emphasizes the necessity for all parties to follow the rules but to do so in a timely fashion. The debtor's attorney has an obligation to include only arguable plan provisions; the court has an obligation to independently review the plan before approving it; and the creditor has an obligation to make a timely objection or else lose its complaint.

Kudos to Bankruptcy Judge Keith Lundin who correctly predicted this result at the State Bar of Texas Bankruptcy Bench-Bar Conference in June 2009.

Creative Debtor Not Allowed to Finance His Appeal From U.S. Treasury

Judge Leif Clark has authored a new opinion which belongs in a Payment Systems textbook. In re Rhett Webster Pease , No. 09-54754 (Bankr. W.D. Tex. 3/12/10) involved a debtor who filed a Notice of Appeal but neglected to include the filing fee. When informed that his appeal would be dismissed, he submitted a "Certified Money Order."

Judge Clark described the instrument submitted for payment as follows:

The document purports to be a form of money order, and states at the bottom that “This negotiable instrument is authorized and backed by the full faith and credit of the United States Govern-ment.” The body of the document does contain negotiable instrument language -- it says “Pay to the Order of:” However, from there on, the document is an entire work of fiction.

First, the purported negotiable instrument purports to be “drawn on” the United States Treasury Account, “Prepaid Account” followed by what appears to be the debtorʼs social security number (not reproduced here, of course). An address follows -- 1500 Pennsylvania Avenue, NW, Washington, D.C. (that is the physical address of the Department of the Treasury).

Next, the purported negotiable instrument directs the drawee to pay to the order of “U S Treasury.” This is similar to writing a check drawn on a bank, directing that the bank pay itself out of an account maintained by the drawer at that bank. The amount shown to be paid is, of course, $255.00.

Next, the document is signed by Rhett Webster Pease (the court recognizes his signature) beneath the legend “Drawer as Agent for the Secretary.” It is not clear exactly what Secretary the debtor means, though one could infer that this is intended to refer to the Secretary of the Treasury. Beneath the signature line is the identifier “Authorized Signature of Agent.”

Finally, there is a “Certification of Signatory” executed by a notary (one Paula M. Boyd), to the effect that Mr. Webster “acknowledged to me that he was the authorized signatory for the above mentioned account and that he executed this instrument as an agent for the Secretary under this account.”

The net effect of all of this verbiage is that Mr. Pease evidently believes that (a) he can write checks on what he claims to be his social security account, as though it were a checking account, (b) that he can issue a check right back to the treasury, since the filing fee is payable ultimately to the US government anyway, and (c) that he can act as the self-appointed agent for the Secretary of the Treasury. In this way, he claims to have satisfied his obligation to the clerk of court to pay the filing fee.

Order Dismissing Notice of Appeal, pp. 1-2.

Judge Clark patiently explained why Mr. Pease could not simply write a check upon his social security account, concluding:

Mr. Pease clearly has some strongly held beliefs about the role of government,the legitimacy of the monetary system in the United States, and perhaps even the legitimacy of government itself. The court will not waste its time attempting to dissuade Mr. Pease of his strongly held beliefs. Suffice it to say that this court does not subscribe to those beliefs.

A filing fee must be paid using the recognized currency of the United States. The “Certified Money Order” submitted by Mr. Pease does not qualify either as recognized currency or a legal document that would result in the payment in the recognized currency of the United States. The document submitted is a complete work of fiction or fantasy at best, and a fabrication and a fraud at worst. In all events, it is ineffective as a means of payment.

Order, p. 3.

You really have to marvel at the audacity of some people. Judge Clark showed remarkable patience in dealing with this debtor.

(Note: The original post had a comment wondering whether Judge Clark had too much time on his hands. While meant to be a backhanded compliment referencing Judge Clark's tremendous capacity for writing opinions, it came off a little snarky, so I re-wrote the final paragraph.).

Supreme Court Upholds Constitutionality of Debt Relief Agency Provisions

A unanimous Supreme Court has ruled that attorneys are "debt relief agencies" and that the provisions prohibiting debt relief agencies to advise debtors to incur debt in contemplation of bankruptcy and the mandatory disclosures required are constitutional. United States v. Milavetz, Gallop & Milavetz, P.A., No. 08-1119 (3/8/10). However, in doing so, the Court adopted a narrow reading of the speech restriction, finding that it did not apply to advice to incur debt for a permissible purpose.

Justice Sotomayor delivered the opinion for the Court. Justices Scalia and Thomas filed opinions concurring in part and concurring in the judgment.

Lawyers As Debt Relief Agencies

The Court had no trouble finding that attorneys were debt relief agencies. Justice Sotomayor wrote:

In advocating a narrower understanding of that term, Milavetz relies heavily on the fact that Sec. 101(12A) does not expressly include attorneys. That omission stands in contrast, it argues, to the provision's explicit inclusion of "bankruptcy petition preparer[s]"--a category of professionals that excludes attorneys and their staff, see Sec. 110(a)(1). But Milavetz does not contend, nor could it credibly, that only professionals expressly included in the definition are debt relief agencies. On that reading, no professional other than a bankruptcy petition preparer would qualify--an implausible reading given that the statute defines "debt relief agency" as "any person who provides any bankruptcy assistance to an assisted person . . . or who is a bankruptcy petition preparer."

Opinion of the Court, pp. 6-7.

This is no great surprise.

Advising Assisted Persons to Incur Debt In Contemplation of Bankruptcy

Having concluded that attorneys were debt relief agencies, the court turned its attention to whether the restrictions on debt relief agencies were constitutional. The first provision considered was Sec. 526(a)(4), which prohibits a debt relief agency from advising an assisted person to "incur more debt in contemplation of such person filing a case under this title."

The Supreme Court rejected the Eighth Circuit's conclusion that this was a broad restriction which precluded an attorney from advising a prospective debtor to incur any debt while contemplating bankruptcy regardless of whether it was in the debtor's best interest. Thus, the issue was whether the phrase "in contemplation of" meant "while considering whether to file bankruptcy" or something more narrow. The Court stated:

After reviewing these competing claims, we are persuaded that a narrower reading of Sec. 526(a)(4) is sounder, although we do not adopt precisely the view the Government advocates. The Government's sources show that the phrase "in contemplation of" bankruptcy has so commonly been associated with abusive conduct that it may readily be understood to prefigure abuse. As used in Sec. 526(a)(4), however, we think the phrase refers to a specific type of misconduct designed to manipulate the protections of the bankruptcy system. In light of our decision in Pender and in context of other sections of the Code, we conclude that Sec. 526(a)(4) prohibits a debt relief agency from advising a debtor to incur more debt because the debtor is filing for bankruptcy, rather than for a valid purpose.

Opinion of the Court, pp. 12-13.

The Court went on to on its narrow construction, stating, "In context, Sec. 526(a)(4) is best understood to provide an additional safeguard against the practice of loading up on debt prior to filing." The Court further explained:

Covered professionals remain free to tal[k] fully and candidly about the incurrence of debt in contemplation of filing a bankruptcy case. (citation omitted). Section 526(a)(4) requires professionals only to avoid instructing or encouraging assisted persons to take on more debt in that circumstance. . . . Even if the statute were not clear in this regard, we would reach the same conclusion about its scope because the inhibition of frank discussion serves no conceivable purpose within the statutory scheme.

Opinion of the Court, p. 16.

Having concluded that the statute had a narrow focus, the Court found that it was constitutional.

Mandatory Disclosures

Section 528 requires debt relief agencies to make certain statements, such as:

"We are a debt relief agency. We help people file for bankruptcy relief under the Bankruptcy Code."

The Court found that this provision was aimed at preventing misleading commercial speech and thus was permissible so long as it was reasonably related to the government's interest in preventing deception of consumers. The Court addressed one of the most annoying aspects of the statute, the fact that attorneys must use the newly coined term "debt relief agencies."

Because Sec. 528 by its terms applies only to debt relief agencies, the disclosure are necessarily accurate to that extent: Only debt relief agencies must identify themselves as such in their advertisements. This statement provides interested observers with pertinent information about the adviser's services and client obligations.

Opinion of the Court, pp. 21-22.

In other words, because Congress defines consumer bankruptcy attorneys as "debt relief agencies," it is not misleading to make them state this fact. This analysis does not really address whether the term is demeaning or whether the reference to "agencies" is misleading. Perhaps the result would have been different if Congress had chosen a term which more obviously intended to insult. For example, if Congress had required consumer bankruptcy attorneys to state, "We are unethical, thieving sleazebags who you should be embarrassed to associate with," the result might be different. By choosing a relatively innocuous term, Congress was able to meet the low bar for being rationally related.

The Court also dismissed the argument that the statute could be construed to apply to firms which only represented creditors and thus would be misleading. The Court noted that it was in a section of the Code labeled "Debtor's Duties and Benefits."

In context, reading Sec. 528 to govern advertisements aimed at creditors would be as anomalous as the result of which Milavetz complains. Once again, we decline Milavez's invitation to adopt a view of the statute that is contrary to its plain meaning and would produce an absurd result.

Opinion of the Court, pp. 22-23.

The Concurrences

Justice Scalia wrote a three page concurring opinion expressing his disagreement with a footnote which relied upon the legislative history to BAPCPA. He stated:

Such statements tell us nothing about what the statute means, since (1) we do not know that the members of the Committee read the Report, (2) it is almost certain that they did not vote on the Report (that is not the practice), and (3) even if they did read and vote on it, they were not, after all, those who made this law. the statute before us is a la because its text was approved by a majority vote of the House and the Senate, and was signed by the President. Even indulging the extravagant assumption that Members of the House other than members of its Committee on the Judiciary read the report (and the further extravagant assumption that they agreed with it), the Members of the Senate could not possibly have read it, since it did not exist when the Senate passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. And the President surely had more important things to do.

The footnote's other source of legislative history is truly mystifying. For the proposed that "the legislative record elsewhere documents misconduct by attorneys" which was presumably the concern of Congress, the court cites a reproduction of a tasteless advertisement that was (1) an attachment to the written statement of a witness, (2) in a hearing held seven years prior to this statute's passage, (3) before a subcommittee of the House considering a different consumer bankruptcy reform bill that never passed. "Elsewhere" indeed.

Concurring Opinion of Justice Scalia, p. 2.

Justice Thomas wrote separately to disagree with the Court's analysis of the Sec. 528 advertising requirements, but not to disagree with the result. He stated, "I have never been persuaded that there is any basis in the First Amendment for the relaxed scrutiny this Court applies to laws that suppress nonmisleading commercial speech." He found that in order to regulate speech, there must be a showing that "the particular advertising is inherently likely to deceive or where the record indicates that a particular form of advertising has in fact been deceptive."

However, in this particular case, the specific advertisements used by the Milavetz firm were not in the record. Because there was at least one set of facts (ad promising to wipe away debts without mentioning bankruptcy) in which the law could be constitutionally applied, he refused to strike it down on its face.

Conclusion

BAPCPA has survived its first constitutional challenge. However, the Court's ruling emphasizes a narrow, reasonable construction, one which would avoid the theoretical parade of horribles which the statute could have unleashed. In the heady days of 2005 when this legislation was first passed, there was concern that it signaled open season on consumer bankruptcy and consumer bankruptcy lawyers. For a period of time, filings dropped to a record low. However, as time has passed, filings are on their way back up and lawyers have learned to live with the new law. As a result, the Supreme Court's upholding of the debt relief agency provisions reflects the fact that the statute has grown up to be more of a house cat than a devouring lion.

The other take away from this case is NEVER, EVER cite legislative history to Justice Scalia.

District Court Reverses Sanctions Ruling in Legal Technology Case

A U.S. District Judge found that it was an abuse of discretion for a bankruptcy court to award sanctions against two attorneys and a law firm in a case involving the NewTrak legal technology system. In re Taylor, No. 09-cv-2479-JF (E.D. Pa. 2/18/10). The opinion can be found here. Last year, I wrote a posting about a lengthy opinion by Judge Diane Weiss Sigmund who sought to "”to share my education with participants in the bankruptcy system who may be similarly unfamiliar with the extent that a third party intermediary drives the Chapter 13 process.” While the District Court noted that "the frustrations of the Bankruptcy Court are understandable," it found that the rather creative sanctions imposed by the Bankruptcy Court were not appropriate.

What Happened

The Taylor case involved debtors in a chapter 13 case who got behind on their mortgage payments because of a disputed charge for flood insurance. The creditor firm filed an inaccurate motion which alleged that the debtors had not been making their post-petition payments. The debtor's attorney filed an untimely and inaccurate response indicating that the debtors were making the payments but that they had been refused by the creditor. Upon being presented with proof of payments, the young associate representing the mortgage company insisted on going forward with the motion based upon deemed admissions.

The Bankruptcy Court denied the motion for relief from stay, while noting its displeasure. The following exchange took place.

The Court: I understand the position of local counsel to, you know--I understand. But you can pass it up the line that I was not pleased with this motion for relief.

Mr. Fitzgibbon: Thank you, your Honor.

The Court: And--and--and so that they'd better act in good faith because I'm cutting them a break this time. Because I really find this motion to be in questionable good faith.

District Court Opinion, p. 3, n. 1.

However, at the next hearing, which was on the Debtor's Objection to Claim, the young associate told the court that he had requested a payment history by opening an inquiry with the NewTrak system, but that he had not received a response from his client. He also indicated that he was not permitted to contact the client directly.

As a result of this hearing, the Bankruptcy Court issued an order for the creditor and its attorneys to appear for a hearing the purpose of which is "twofold: (1) to address the Objection to HSBC's claim and (2) to investigate the practices employed in this case by HSBC and its attorneys and agents and consider whether sanctions should issue against HSBC, its attorneys and agents."

After conducting several days of hearings, the Bankruptcy Court made the following rulings:

1. The young associate was not sanctioned despite pressing a motion based on deemed admissions which he knew were incorrect because "I suspect that he has learned all that he needs to learn without protracting this unfortunate time in his nascent career."

2. The head of the bankruptcy section of the firm was sanctioned because "she failed to observe her duty to make reasonable inquiry of the two documents she signed." She was ordered to take additional continuing legal education courses in ethics.

3. The head of the firm (who had not signed any pleadings or appeared at any of the hearings in question) was sanctioned because he "sets the tone and establishes [the firm's] culture." He was ordered to obtain training in how the NewTrak system worked and conduct a training session for all firm members.

4. HSBC, the creditor, was ordered to send a copy of the Bankruptcy Court's opinion to all of its attorneys.

While the actual sanctions assessed were mild, the rebuke from the Bankruptcy Court carried quite a sting. The Udren firm and its two sanctioned attorneys brought an appeal to the U.S. District Court. The U.S. Trustee's Office defended the appeal.

The District Court's Ruling

The District Court reversed the sanctions award.

The Bankruptcy Court imposed sanctions pursuant to Federal Rule of Bankruptcy Procedure 9011, the counterpart of Federal Rule of Civil Procedure 11. The decision is reviewed under the abuse of discretion standard. (citation omitted). After a careful review of the record, I am constrained to hold that it was an abuse of discretion for the Bankruptcy Court to impose sanctions on the appellants here.

The frustrations of the Bankruptcy Court are understandable; delays caused by a lack of accurate information are unfair to debtors, to creditors, and to the courts. However,I am persuaded that the sanctions were inappropriate in this case, for two reasons: First, because the conduct of the debtors’ counsel was at least equally responsible for the difficulties in resolving the status of the mortgage payments, and second, because the record leaves the indelible impression that the appellants were sanctioned less for their specific failings than for the Bankruptcy Court’s desire to “send a message” regarding systemic problems in the litigation of bankruptcy cases and the reliance on computer databases in mortgage disputes.

The actions of the debtors’ counsel materially contributed to the difficulties in resolving the status of the Taylors’ mortgage. In an order relating to counsel fees, the Bankruptcy Court held that the debtors’ counsel provided legal services that “were below the level of competency required to handle this Chapter 13 case effectively.” Order of April 15, 2009 (Document No. 195). Although the errors of the debtors’ counsel do not relieve the appellants of their duty to comply with Rule 9011, they are relevant to a finding of sanctionable conduct. Had the debtors’ counsel responded to the requests for admissions, or submitted a timely request for a complete accounting, the appellants would have been on notice of the payment disputes and the delays may have been minimized or avoided.

Given the overall posture of this case, I cannot agree that the conduct of the appellants was sanctionable in its own right. As noted above, the Bankruptcy Court had determined at the May 1, 2008 hearing that sanctions would not be imposed based
on the Stay Motion. Only Mr. Fitzgibbon (who was not sanctioned)appeared in court for the later hearing. After a close reading of the transcript of the hearings, I am persuaded that the Bankruptcy Court objected to general practices in bankruptcy
mortgage disputes, rather than the specific conduct of the appellants. By way of example, the Bankruptcy Court stated in the hearings that:

"I do not have any adverse views about Mr. Fitzgibbon. You know, this is not about Mr. Fitzgibbon. This is about when attorneys stand up in this Court and they’ve been asked to provide loan histories and they can’t get it. And it’s not just – if it was one young attorney who was having a problem that would be one thing. We wouldn’t have done all this if it was one young attorney who didn’t know that he could do this. But I have attorneys that stand here week after week and can’t get loan histories. I’ve just sat through an hour and a half of this system which is telling me that they should be able to get it not in thirty days, which is the time your attorneys always ask for, but they should be able to get it the next day."

N.T. Oct. 23, 2008 at 107-08 (emphasis added). There is nothing in the record to support a finding that any of the other attorneys referenced are from the Udren firm; to the contrary, the system used by many law firms representing many mortgage holders in bankruptcy cases appears to be at fault. As the Bankruptcy Court stated, “[t]he bottom line from my perspective is that I just want to know when a lawyer stands up in court and says, I want to continue this, I can’t get a document. I want to know why. I want to be able to move these cases.” N.T. Oct. 23, 2008 at 148.

Understandably, something needs to be done when the bankruptcy courts cannot obtain timely and accurate information. According to the Bankruptcy Court’s opinion, the problem of inaccurate mortgage payment information is less likely to arise in the United States Bankruptcy Court for the District of New Jersey because the local rules of that court require that the client certify the truth and accuracy of the averments. Opinion at n.21. Clarity in the rules would benefit all counsel and litigants.

The sanctions imposed in this case were an abuse of discretion, as the Bankruptcy Court already had determined that the Stay Motion did not merit sanctions, and Mr. Fitzgibbon’s failure to obtain the accounting (the only event after the denial of the Stay Motion) was an insufficient basis for the imposition of sanctions against the appellants.

District Court Opinion, pp. 5-9.

What It Means

The Bankruptcy Court's opinion was an example of what could be called inquisitorial justice. The Bankruptcy Court observed what it perceived to be an abuse and conducted an investigation under the guise of awarding sanctions under Rule 9011. However, as the District Court opinion points out, Rule 9011 does not provide a good vehicle for addressing systemic problems.

The Bankruptcy Court's opinion was blogworthy because it was a searching inquiry into the relationship between professionalism and technology. However, the District Court opinion points out that there are technical elements which must be met in order to proceed under Rule 9011. Rule 9011(b) requires that there be a paper which is presented to the court "whether by signing, filing, submitting or later advocating." Thus, it would never have been possible to sanction the head of the firm for setting the tone and establishing the firm culture. Rule 9011 just doesn't get there.

The reversal of the sanction against the head of the bankruptcy section is more problematic. In that case, the Bankruptcy Court granted sanctions for failure to perform an adequate pre-filing investigation. The District Court's ruling is largely non-responsive to this issue. For example, the argument that Debtor's counsel contributed to the problem, while accurate, does not address the review which took place prior to filing the pleadings. However, the District Court may have concluded that when the bankruptcy court initially announced that it was "cutting them a break" on the motion for relief from stay, that it could not go back later and award sanctions.

The important point to take away from the District Court opinion is that sanctions awards under Rule 9011 must flow from the specific conduct identified in the rule. While the Court may also award sanctions under Sec. 105 or its inherent powers, these remedies have their own requirements which must be observed.

Hat tip to Jonathan Bart who sent me the opinion.

Sixth Circuit Releases Remarkable Opinion on Debt Buyers, Mootness and Sanctions

Unsecured claims held by credit card companies, and in particular by debt buyers, have kept bankruptcy judges and appellate courts busy recently. In the typical case, a credit card company or debt buyer files a claim which contains a summary listing the original creditor, the last four digits of the account number and the amount of the claim. The debtor objects on the basis that the claim is not supported by the documents establishing the claims and/or that the debtor does not know who the debt buyer is. The creditor will offer varying amounts of proof ranging from none to the debtor's schedules and a business records affidavit with respect to the claim.

Some of the recent decisions include: In re Kirkland, 572 F.3d 838 (10th Cir. 2009), holding that an unsubstantiated claim may not be allowed upon objection by the trustee; In re Plourde, 418 B.R. 495 (1st Cir. BAP 2009), holding that failure of creditor to provide proof of nature of claim relegated claim to subordinated status for penalties; and In re DePugh, 409 B.R. 84 (Bank. S.D. Tex. 2009), holding that creditor who failed to include supporting documentation could not amend claim after objection was filed without leave of court.

U.S. Bankruptcy Judge Jeff Bohm (author of the DePugh decision) has adopted a Notice and Order That Federal Rule 15, As Made Applicable Bankruptcy Rule 7015, Shall Apply Whenever an Objection to a Proof of Claim is Filed," which provides that creditors who amend their claims without leave of court after an objection has been filed shall be subject to sanctions.

Suffice it to say that credit card creditors have not been feeling the love lately. However, a new decision out of the Sixth Circuit gives debt buyers a modicum of respect. In In re Wingerter, No. 08-4455 (6th Cir. 1/25/10), the Sixth Circuit reversed a bankruptcy court's sanctions order which struck at the heart of a debt buyer's business model.

The case began with a claim for $431.57 filed by B-Line, LLC, a debt buying firm. B-Line had bought the claim from Covenant Management, LLC, who in turn had purchased it from the original creditor, GTE. Unlike many of these cases, the Debtor insisted that he had never owed a debt to GTE. When B-Line could not obtain proof that the debt existed, it withdrew the claim.

However, that was not the end of the story. The Bankruptcy Court issued a series of show cause orders to B-Line to explain its business practices in general and its handling of the specific claim as well. The Court found that B-Line had violated Rule 9011(b) by failing to make a "reasonable pre-filing inquiry" that the claim was valid and supported by evidence.

The Bankruptcy Court stated:

This Court finds that B-Line did not fulfill its Rule 9011 obligations in filing the B-Line POC without having possession of the underlying transactional documents or any reliable proxy for such documents. As a prospective matter, B-Line and other purchasers in the claims trading industry should understand that this Court views the filing, without review of originating documents, of a proof of claim by an assignee/purchaser to fall short of reasonable inquiry under Rule 9011 when the obligation has not been scheduled by the debtors and the purchase of the claim was not accompanied by reliable representations of claim validity. Because of the time and energy that B-Line's senior management devoted in response to this Court's show cause order, however, the Court does not view any further sanctions to be necessary in this case.

In re Wingerter, 376 B.R. 221, 238 (Bankr. N.D. Ohio 2007).

This left B-Line in the awkward position that it had dodged the bullet on sanctions in the particular case, but would be subject to sanctions in the future if it continued to file claims based on electronic records without viewing the originating documents. B-Line appealed to the Bankruptcy Appellate Panel which dismissed the appeal as moot. With one judge dissenting, the Sixth Circuit reversed both the Bankruptcy Appellate Panel and the Bankruptcy Court.

B-Line's Business Model

One thing which is interesting about this opinion is that the court of appeals went to great lengths to explain how a debt buyer, such as B-Line, does business. This business model forms the backdrop for the opinion.

B-Line is a business entity that specializes in purchasing "consumer bankruptcy debt." It purchases such debt from both original creditors and intermediaries. B-Line then files proofs of claim in the respective debtors' bankruptcy cases, or has existing proofs of claim transferred to it.

When B-Line purchases a claim, it does not acquire the supporting documentation. Instead, it requests several pieces of information from the claim's seller that B-Line stores in an electronic database. This information typically includes the debtor's name, address, contact information, and Social Security number, as well as the original account number, the original creditor's name, the original amount owed, the date the original account was opened, and the bankruptcy case information.

B-Line relies on the sellers from whom it purchases the claims to provide accurate, truthful information, and it negotiates a purchase agreement with these sellers to protect itself in case a seller misrepresents the validity of a claim. The purchase agreement requires, in particular, a warranty that each claim sold to B-Line "represents a legal, valid and binding obligation of the related Debtor." To keep down its costs, B-Line does not request copies of a claim's originating documents unless a debtor challenges the claim.

Opinion, p. 2.

Appeal Not Moot

The Bankruptcy Appellate Panel ruled that because no monetary sanctions were assessed that there was no live controversy to appeal. However, the Bankruptcy Court's order found that B-Line had violated Rule 9011 but that it did not view "any further sanctions to be necessary in this case." The Court of Appeals found that this was a non-monetary sanction which could be appealed just as an attorney could appeal a non-monetary sanction which affected his reputation. The majority concluded:

Compared to the somewhat vague injury to "reputation" suffered by sanctioned attorneys, which has the potential to harm their economic interests, B-Line's injury is more direct and certain because part of the company's core business practices has been declared sanctionable. B-Line's business is thus thrown into uncertainty, either forcing the company to comply with the bankruptcy courts more stringent (and more expensive) filing requirements or placing it at risk of being sanctioned in bankruptcy courts throughout the country. The court's sanctions order, therefore, has caused direct, financial injury to B-Line. Under these particular circumstances, B-Line's appeal of the court's sanctions order is not moot.

Opinion, p. 9.

Debt Buyer's Conduct Not Sanctionable

The Court of Appeals disagreed with the Bankruptcy Court's conclusion that B-Line did not conduct an adequate pre-filing inquiry. The Bankruptcy Court found that B-Line's inquiry was insufficient because it did not review original documents and because it did not obtain representations and warranties from the seller.

The Court of Appeals found the factual conclusion that B-Line did not obtain representations and warranties as to the validity of the claim to be clearly erroneous. It pointed to specific language in the transfer documents in which Covenant warranted that the accounts were eligible for purchase.

The Court ruled that reliance on Covenant's representations and warranties, along with the due diligence of both debt buyers was sufficient to constitute reasonable pre-filing inquiry. The Court of Appeals credited testimony that B-Line had purchased over 1,000 accounts from Covenant and that only two had been found to be invalid. It also discussed the due diligence which B-Line and Covenant conducted, which included review of electronic databases and the fact that the debtor had received several validation notices from debt collectors but had never disputed the debt.

Finally, the Court of Appeals found that failure to attach documentation to the proof of claim was not sanctionable in and of itself. The Court stated:

Admittedly, as the bankruptcy court stressed, B-Line's proof of claim was submitted on an incomplete Form 10. This deficiency violated Rule 3001(c) of the Federal Rules of Bankruptcy Procedure, which requires that a proof of claim based on writing include a copy of that writing. The ramifications for this type of violation are well-established, however, and do not result in sanctions. See Heath v. Am. Express Travel Related Servs. Co., Inc. (In re Heath), 331 B.R. 424, 433 (B.A.P. 9th Cir. 2005) (explaining that a failure to comply with Rule 3001 results in the creditor's proof of claim not being prima facie evidence of the claim's validity and amount). Not complying with Rule 3001 might be a factor in determining whether a Rule 9011(b) violation has occurred under different circumstances, but it is not a relevant factor in this case given the track record and warranties between Covenant and B-Line and the efforts that both businesses undertook to validate the Wingerter claim.

Opinion, p. 13.

What It Means

Wingerter is significant because it is an appellate level decision which examined the practices of a debt buyer and did not find them wanting. B-Line did a good job of explaining how its business model worked and how it provided adequate protections. While many credit card cases are decided based upon an insufficient record, B-Line provided an extensive record. This case is also very important because the Court of Appeals considered disruption of a creditor's business model to be a relevant factor. Rather than dictating that the creditor change its business practices, the Court looked at whether the creditor's existing practices could be reconciled with the obligations under Rule 9011. Finally, the court of appeals refused to get on the lack of documentation bandwagon, finding that failure to attach supporting documents deprives a claim of prima facie validity, but does not indicate bad conduct by the creditor.

This is a case where the system worked. A creditor filed a claim which probably was not valid. The debtor challenged it. When the creditor could not obtain verification, it withdrew the claim. However, you can't help but notice that an awful lot of ink was devoted to one claim for $431.57.

Court of Appeals Wades Through Mootness Maze

You know that an opinion is going to be challenging when the first sentence reads:

The procedural background is a bit of a maze, but it is a facet of the appeal that we need to keep straight in our minds.

Opinion, p. 1. Thus begins the Fifth Circuit's recent opinion on equitable mootness and section 1127(b). In re Blast Energy Services, Inc., No. 08-20702 (5th Cir. 1/7/10).

The Procedural Maze

While the issue decided by the Fifth Circuit was equitable mootness, the underlying dispute concerned an executory contract. In 2006, the Debtor and Alberta Energy Partners entered into a contract where Alberta transferred a 50% interest in its technology to the Debtor and the parties agreed to "work together to develop and manage the technology."

In January 2007, the Debtor filed for chapter 11 reorganization. Alberta filed several motions seeking to compel the Debtor to reject the executory contract on the basis that it could not be assumed over Alberta's objection. Those motions were denied and an appeal ensued. Meanwhile, on February 26, 2008, the Bankruptcy Court confirmed the Debtor's plan which provided for assumption of the contract.

Alberta appealed that order as well. However, the Debtor substantially consummated its plan and the District Court dismissed the appeal of the Confirmation Order based on equitable mootness. Alberta moved for rehearing, which was denied. The parties stipulated that dismissal of the confirmation appeal would not affect the appeal of the executory contract orders. The District Court rejected the parties' stipulation and dismissed the earlier appeal as well. Alberta appealed both the denial of the motion to reconsider the order dismissing the confirmation appeal and the order dismissing the executory contract appeal.

So, does Alberta get to appeal or not? The Fifth Circuit said yes.

Which Order Should Have Been Appealed?

At first, the Debtor argued that the appeal was moot because Alberta had appealed the order denying the motion for rehearing, rather than the order dismissing the confirmation appeal. The mootness argument was that reversing the rehearing order would not have affected the dismissal order so that no relief could be granted. The Fifth Circuit rejected this argument, finding that if the rehearing order was reversed, the District Court could be ordered to grant rehearing and vacate dismissal of the appeal. The circuit also found that despite the fact that the notice of appeal only pertained to the rehearing order, it was clear that Alberta was appealing both rulings.

Equitable Mootness

The Fifth Circuit opinion has a good explanation of equitable mootness. The opinion stated:

Equitable mootness authorizes an appellate court to decline review of an otherwise viable appeal of a Chapter 11 reorganization plan, but only when the re-organization has progressed too far for the requested relief practicably to be granted. (citation omitted). Unlike Article III mootness, equitable mootness is pru-dential, not jurisdictional. (citation omitted). In addressing whether an appeal of a confirmation plan is equitably moot, the Fifth Circuit considers a three-pronged analysis: “(i) whether a stay has been obtained, (ii) whether the plan has been ‘substantially consummated,’ and (iii) whether the relief requested would affect either the rights of parties not before the court or the success of the plan.”

There is no set weight given to the respective prongs. In some cases, a single prong may be determinative, but more often the first two are relevant only insofar as they affect the answer to the third question; if no stay has been obtained and the plan has been substantially consummated, the more likely the third prong indicates equitable mootness. Nevertheless, although substantial consummation is a “momentous event,” it is not necessarily fatal to the appeal of a confirmed reorganization plan. (citation omitted).

Only when the relief that a party requests will likely unravel the plan does it become impracticable and inappropriate for a court to grant such relief; in such a case, the court abstains from reviewing the appeal. (citation omitted). However, when a court applies the doctrine of equitable mootness, it does so “with a scalpel rather than an axe.” (citation omitted). To that end, a court may “fashion whatever relief is practicable” instead of declining review simply because full relief is not available. (citation omitted). Similarly, a court considering whether an appeal is equitably moot should “scrutinize each individual claim, testing the feasibility of granting the relief against its impact on the reorganization scheme as a whole.”

Opinion, at 7-8 (paragraph breaks added).

Reduced to its essence, equitable mootness asks whether it is possible to grant relief without affecting the rights of third parties. This was also the prong that the District Court relied upon in dismissing the appeal. While the District Court concluded generally that assumption or rejection of executory contracts was central to the plan and would affect third parties, it did not make specific findings. The Fifth Circuit noted that the Debtor was not using the technology, had no plans to do so and that the Debtor had stipulated that the executory contract issue would not affect the plan. As a result, the Fifth Circuit reversed and remanded the order for reconsideration by the District Court. The Court of Appeals suggested that the District Court "should articulate in detail the reasons for its conclusion, with references to the record."

Modification Under Section 1127(b)

Finally, the Fifth Circuit rejected the District Court's alternate conclusion that 11 U.S.C. Sec. 1127(b) barred the appeal. Section 1127(b) bars modification of a plan which has been substantially consummated. The Circuit made clear that appealing a confirmation order is not the same as attempting to modify a confirmed plan.

Just How Far Does "Related-To" Jurisdiction Go?

The Fifth Circuit has a new opinion in which it finds that a dispute between two non-bankrupt parties fell within "related-to" jurisdiction based upon a contractual indemnification clause. Lone Star Fund V (US), LP v. Barclays Bank, PLC, No. 08-11038 (5th Cir. 1/11/10).

The Lone Star Fund V case involved a suit over alleged fraud in the sale of mortgage-backed securities. New Century sold mortgages to Barclays, which packaged them into mortgage-backed securities. Barclays sold some of them to Lone Star Fund. Lone Star claimed that the mortgages were bad and sued Barclays. Meanwhile, New Century was in bankruptcy in Delaware. Barclays removed the action to federal court asserting "related to" jurisdiction. The District Court found that it had jurisdiction and dismissed the action for failure to state a claim. Lone Star appealed to the Fifth Circuit.

The Fifth Circuit affirmed on all grounds, including jurisdiction. It noted that related to jurisdiction exists where the "outcome could alter, positively or negatively, the debtor's rights, liabilities, options, or freedom of action or could influence the administration of the bankruptcy estate." In this case, New Century had agreed to indemnify Barclays for claims arising from the sale of the mortgages. Thus, a judgment against Barclays would give rise to liability of New Century under the indemnification clause.

The court distinguished In re Federal-Mogul Global, Inc., 300 F.3d 368 (3rd Cir. 2002), in which the court found that a tort suit in which further litigation would be required to establish a right of contribution against the debtor did not confer related-to jurisdiction. The difference is when a right of contribution "accrues." With a contractual indemnification, the right of indemnification was already accrued because it was provided for in a contract. Thus, a judgment against Barclays would be a judgment against the debtor. However, in the tort context, a judgment against the non-debtor party would not automatically translate to a claim against the Debtor absent further litigation. As a result, the underlying suit was not "related to" the bankruptcy case.