Monday, September 16, 2019

Beware the Living Trust! You May Lose Your Homestead

A living trust is a legal document that states who you want to manage and distribute your assets if you're unable to do so, and who receives them when you pass away. Having one helps communicate your wishes so your loved ones aren't left guessing or dealing with the courts.
This is what Legal Zoom says about Living Trusts.   What it does not say is that unless a living trust is set up properly, it can result in loss of the Texas homestead exemption as the Debtor found out in Case No.  18-50102, In re Steven Jeffrey Cyr (Bankr. W.D. Tex. 7/16/19) which can be found here.

What Happened

 Dr. Steven J. Cyr is a doctor who retired from the Air Force with the rank of Lt. Colonel.  In 2007, he and his wife purchased a home in San Antonio with a mortgage of $2.1 million.  He also purchased a second property in 2017.   On September 12, 2014, Dr. Cyr and his wife created a living trust and transferred their home into it by warranty deed.   Dr. and Mrs. Cyr were the Trustmakers, trustees and beneficiaries of the living trust.  However, Dr. Cyr resigned as a Trustee as of January 1, 2018.

On January 20, 2018, Dr. Cyr filed a petition under Chapter 7.   Several parties objected to his homestead exemption.   Additionally, there were adversary proceedings filed to avoid transfers, determine the dischargeability of a specific debt and dney discharge.

Judge Craig Gargotta conducted a four day trial concluding on March 7, 2019.

The Ruling

Judge Gargotta rejected the argument that the Cyrs had abandoned their homestead.   Although Mrs. Cyr and their children moved out of the residence post-petition, Dr. Cyr never did.   Even though a real estate agent created a brochure and video for sale of the property, the property was never actually marketed.

However, the Court found that the property lost its homestead status when it was transferred to the living trust without complying with Texas Property Code Sec. 41.0021.

Prior to 2009, there was a controversy over whether property transferred to a living trust could be claimed as homestead.   In 2009, the Texas legislature sought to fix this problem by enacting Sec. 41.0021 which states that property transferred to a "qualifying trust" which is occupied by the owner as his residence would constitute the owner's homestead.  A "qualifying trust" was defined as an express trust
(1) in which the instrument or court order creating the trust provides that a settlor or beneficiary of the trust has the right to:
(A) revoke the trust without the consent of another person;
(B) exercise an inter vivos general power of appointment over the property that qualifies for the homestead exemption; or
(C) use and occupy the residential property as the settlor’s or beneficiary’s principal residence at no cost to the settlor or beneficiary, other than payment of taxes and other costs and expenses specified in the instrument or court order:
(i) for the life of the settlor or beneficiary;
(ii) for the shorter of the life of the settlor or beneficiary or a term of years specified in the instrument or court order; or
(iii) until the date the trust is revoked or terminated by an instrument or court order recorded in the real property records of the county in which the property is located and that describes the property with sufficient certainty to identify the property; and
(2) the trustee of which acquires the property in an instrument of title or under a court order that:

(A) describes the property with sufficient certainty to identify the property and the interest acquired; and
(B) is recorded in the real property records of the county in which the property is located.
Subsection (a)(1) is written in the disjunctive so that only one of its three options need be satisfied.  However, Judge Gargotta found that none of the provisions applied.

First, Judge Gargotta found that the settlor did not have the right to revoke the trust without the consent of another person.  Under the trust document, both of the settlors had to consent to revocation of the trust.  Rather than interpreting the clause to mean that someone other than the settlors had to consent, Judge Gargotta found that the requirement for both parties to consent did not satisfy subsection (a)(1)(A).  

The Trust also failed to include a provision allowing for an inter vivos general power of appointment over the property.

Finally, the trust document allowed the owners to occupy the property "rent free and without charge" but did not say that they could occupy the property at no cost as required by the statute.   The problem is that Texas law has two definitions of a "qualifying trust."   A qualifying trust under the Texas Tax Code is one in which the party may occupy the property rent free and without charge.  Tex. Tax Code Sec. 11.13(j).    However, the Property Code requires that the person be allowed to use the property without charge.   Tex. Prop. Code Sec. 41.002(a)(1)(C).   Judge Gargotta concluded that the Texas legislature must have meant something different by the two formulations and that therefore, the Tax Code language would not satisfy the requirements of the Property Code.

Thus, for lack of proper verbiage, the homestead exemption was lost.

Why The Opinion May Be Wrong or At Least Should Be Wrong

 There are some reasons to believe that Judge Gargotta's ruling may be in error.   Homesteads are favorites of the law.   There was good law that transfers of property to a living trust did not forfeit homestead protection prior to the 2009 law.  Additionally, Judge Gargotta's hyper-technical application of the statute seems contrary to the intent of the statute.   (In giving my opinion, I am cognizant of the fact that Judge Gargotta has "Judge" before his name.  As a result, his opinions carry legal force and mine are merely an appeal to the court of public opinion).   

Under Texas law, where one person holds both legal and equitable title to a property, the estates are merged and the person holds the property free of trust.   In re Vazquez, 2012 Bankr. LEXIS 642 (Bankr. W.D. Tex. 2012), aff'd. Lowe v. Vazquez, 2013 U.S. Dist. LEXIS 44271 (W.D. Tex. 2013).   Unfortunately, here there were two trustees and two beneficiaries.   However, it is not an outlandish argument to say that the community estate of the Cyrs held both legal and equitable title, therefore extinguishing the trust.

Prior to the Cyr decision, there was not any precedent interpreting Sec. 41.0021.   Therefore, Judge Gargotta was free to interpret the text in a manner which harmonized  both its text and purpose.  The purpose was obviously to avoid loss of homestead protection when property was conveyed to a living trust.  

I will acknowledge that the literal language of Sec.41.0021(a)(1)(A) says that a qualifying trust is one in which "a settlor or beneficiary" has the right to "revoke the trust without the consent of another person."  This language seems to say that one person must be able to unilaterally terminate the trust.  However, given the importance of the homestead exemption, I would read the phrase to say that no one other than another settlor or beneficiary is needed to terminate the trust.

Finally, I think that the phrases "rent free and without charge" and "at no cost" say the same thing.   I don't think that whether someone gets to keep their homestead should depend on the slavish application of magic words.

Finally, what is the consequence of the homestead being found non-exempt?   If both debtors had filed, the trustee could have exercised their power to revoke the trust.  However, that could not be done because Mrs. Cyr did not file bankruptcy.   So the property is owned by a trust rather than the estate.   Under Texas law, creditors can reach the interest of a debtor in a self-settled trust.   This means that the property contributed by the debtor is subject to claims of creditors.  Shurley v. Texas Commerce Bank-Austin, N.A. (In re Shirley).  115 F.3d 333 (5th Cir. 1997).    The debtor contributed an undivided one-half interest in the property to the trust.   Thus, the trustee can only reach that undivided interest.  

Avoiding the Problem

There is any easy solution to this problem.  Never, ever, ever, ever transfer your homestead to a living trust.   The advantage of a living trust is that it supposedly avoids the need to probate a will.  However, probate in Texas is easy.   If your client has already executed a living trust, revoke it prior to filing.   The essence of a living trust is that it is freely revocable.    Debtor's lawyers should always ask their client if they have conveyed their homestead to a living trust.   It may be necessary to ask the question in several different ways.  However, it is too important a step not to take.


Post-Script:

After the decision came down, the debtor filed a notice of appeal.  The parties then filed a joint motion to have the case mediated before another federal Bankruptcy Judge.  As a result, Mr. Cyr still has a chance to retain his home.

Tuesday, May 14, 2019

Texas Bankruptcy Court Rejects Claim That Attorneys Were Non-Statotory Insiders

Last year, the Supreme Court ruled on a case involving a claim that a party was a non-statutory insider without ever deciding what legal test should apply.   U.S. Bank National Association v. The Village at Lakeridge, LLC, 138 S.Ct. 960 (2018).    Bankruptcy Judge Craig Gargotta was not able to dodge the issue and has written an opinion which is helpful in applying the non-statutory insider test.   Case No. 18-5238, Hornberger v. Davis Cedillo & Mendoza (Bankr. W.D. Tex. 4/16/19)

Under 11 U.S.C. Sec. 547, a preferential transfer made to an ordinary vendor can be recovered if it was made during the 90 days prior to bankruptcy.   However, if made to an insider, the period expands to one year.   11 U.S.C. Sec. 101(31) has a list of persons who are automatically considered insiders, such as the officers of a company.  The statute uses the word "includes" prior to the list.  This means that the list is not exclusive.  Persons who who are not specifically defined to be insiders but have a sufficiently close relationship to the debtor are referred to as non-statutory insiders.
  
 What Happened

Larry Struthoff was a majority shareholder of Olmos Equipment, Inc. ("OEI")..   He was also an officer, shareholder and director of SWL Enterprises, Inc.  ("SWL").   SWL had two other shareholders, Long and Weynand.   OEI acquired the assets of SWL.   Weynand became concerned that Struthoff had cheated him out of his share of the sales proceeds.   Weynand sued OEL, SWL, Struthoff, Long and another shareholder of OEI named Janecke for $6 million.

As trial approached, OEI's longtime counsel became concerned that he did not have the bandwidth for a "bet the company" trial.   OEI hired Davis, Cedillo & Mendoza, Inc. ("DCM").   Where OEI and the insiders previously had separate counsel, DCM represented all of the defendants.   OEI paid the law firm $400,000.   Other parties paid the firm $225,000.

DCM was not able to rescue the company.  After trial, judgment was entered against OEI for $5.3 million. (Judgment was also entered against Struthoff and Janecke). OEI filed chapter 11.  It confirmed a plan which which created a litigation trust.  Ronald Hornberger, the trustee of the litigation trust, sued DCM to recover $400,000 in payments made by the Debtor during the period which was more than 90 days before bankruptcy but less than one year.  The litigation trustee brought claims to recover preferential transfers and fraudulent transfers.   

In order for the preferential transfer complaint to state a claim, the trustee needed to make plausible allegations that DCM was a non-statutory insider of the Debtor. This required Judge Gargotta to answer the question that the Supreme Court had dodged:  what is the test for a non-statutory insider?

The Test

 Judge Gargotta looked to Browning Interests v. Allison (In re Holloway), 955 F.2d 1008 (5th Cir. 1992) to find the proper test.   Holloway was a case under the Texas Uniform Fraudulent Transfer Act.    The definition of an insider under TUFTA is identical to the one contained in the Bankruptcy Code.   Tex.Bus.&Com. Code Sec. 24.002(7).   Thus, the case involved a federal court interpreting a Texas statute which was based on a federal statute.  On top of that, it relied on precedents under the Bankruptcy Code.   The Court in Holloway said:
The cases which have considered whether insider status exists generally have focused on two factors in making that determination: (1) the closeness of the relationship between the transferee and the debtor; and (2) whether the transactions between the transferee and the debtor were conducted at arm's length.
Holloway at 1011.   Judge Gargotta also discussed the Tenth Circuit opinion in Austine v. Carl Zeiss Medical, Inc., 513 F.3d 1272 (10th Cir. 2008) which relied on similar reasoning.

The Ruling

 The litigation trustee argued that DCM exercised control over the Debtor because it persuaded the Debtor to pay for the attorneys' fees of Struthoff and SWL in addition to the Debtor.   The Court rejected this argument, stating:
The Court agrees with DCM that Plaintiff has not met the plausibility requirements of showing that DCM is a non-statutory insider of Debtor. Under the two-prong test of U.S. Medical, Inc, and Holloway, the Plaintiff has not shown that DCM had a sufficiently close relationship with OEI or that DCM exercised control or influence over the Debtor such that the transaction at issue was not done at arm’s length. The facts as deemed true only allege a contractual relationship between DCM and OEI and the course of dealing between the parties was that of an attorney-client. DCM represented OEI in complex civil lawsuit in state court that resulted in an adverse judgment. Plaintiff’s argument that Debtor’s By-Laws or other corporate documents precluded DCM from representing Debtor is unavailing—Struhoff had the requisite authority to engage DCM. Plaintiff has not cited with any specificity as to which corporate provisions were violated. Plaintiff’s assertion that DCM had access to OEI’s internal documents is insufficient to support a finding that DCM exercised control or influence over OEI. The fact that Debtor made payments to DCM for services performed is precisely what any other legal counsel would have requested in the allegations raised here. The payments, based on Plaintiff’s allegations, comport with what was required under DCM’s engagement letter. In sum, there are no facts to indicate that the transaction between the Parties’ was anything other than arm’s length.
Opinion, pp. 21-22. 

An attorney representing a client in high-stakes litigation, whether it is a state court lawsuit or a chapter 11 proceeding, necessarily has a lot of influence over the client.  Because the client is counting on the attorney to guide it through legal peril, the attorney will have more impact on the client's decisions than say, the company's paper vendor.   The arms-length inquiry should focus, as the Court did here, on how the attorney's behavior comported with what attorneys normally do.   

Because this case found that the transactions were done at arms-length, it did not answer the question of what "not arms-length" would look like.   I tried to think of exampleswhere an attorney could exercise sufficient control to take the relationship outside of arms-length status:

1.  The attorney takes the wife of the Debtor's CEO hostage and threatens to kill her if payments are not timely made.  Admittedly, this would be a criminal violation as well.

2.  The client gives the attorney the password to its accounting software and allows the attorney to approve which bills get paid and which bills do not.

3.  The attorney requires that all funds belonging to the corporation be paid to a lockbox controlled by the attorney and the attorney only allows the client to use its funds after the attorney has deducted its fees.

These were extreme examples.   Here is one that is a bit closer:

The attorney and the company's CEO attend the same church and have gone on mission trips together.   The attorney and the CEO regularly dine at each other's home.   At one of these dinners, the attorney tells the CEO that the attorney's wife is receiving cancer treatment and that without the revenue coming in from the litigation, he would not be able to pay for her treatments.   Each week, the CEO asks the attorney how much money he needs and he pays that amount regardless of what the firm billed.     While the attorney in this hypothetical did not exercise improper influence over the generous CEO, the personal bond between the two men led the CEO to give the attorney treatment he would not provide to a third party vendor.  If you tweak the hypothetical slightly and the CEO paid each invoice the same day it was received, then it probably goes back to being arms-length.  While the relationship no doubt would influence the prompt payment, it is still within the range of ways that clients interact with their attorneys.




 

Monday, April 29, 2019

Fifth Circuit Rules In Favor of Attorney Immunity

When dealing with contentious litigation, I have occasionally had a client ask why we can't sue the opposing lawyer.  When I try to explain that the other lawyer is merely representing his client, I get a tirade about how evil the other attorney is.   The better answer, as shown by a recent Fifth Circuit opinion, is attorney immunity.    Case No. 17-11464, Troice v. Greenberg Traurig, LLP (5th Cir. 4/17/19).

 What Happened

 The R. Allen Stanford Ponzi Scheme was and is a big deal.   Allen Stanford was a bankrupt former gym owner who bought a bank in Antigua and peddled bogus CDs, causing billions of dollars of losses over a period of twenty-one years.   For part of that time, Stanford was represented by a partner at Greenberg Traurig named Carlos Loumiet, who later moved his practice to Hunton & Williams.   In 2009, the SEC obtained a receivership over the Stanford entities and Ralph Janvey was named as Receiver.  In 2012, the Receiver brought suit against Greenberg Traurig and Hunton & Williams, among others, for their role in representing the Stanford Financial entities.   Three investors also brought a class action suit against the lawyers.    Hunton & Williams settled and was dismissed.   Greenberg Traurig moved to dismiss the investor suit based on attorney immunity.   The District Court granted judgment on the pleadings.   

Attorney Immunity

According to the Texas Supreme Court attorney immunity is a "comprehensive affirmative defense protecting attorneys from liability to non-clients.   Cantey Hanger, LLP v. Byrd, 467 S.W.3d 477, 481 (Tex. 2015).   It applies where the "alleged conduct was within the scope of . . . legal representation."  Id. at 484.

On appeal, the investors argued that three exceptions to attorney immunity applied.   This required the Fifth Circuit to predict what the Texas Supreme Court would do.   The investors urged the Fifth Circuit to certify the question to the Texas Supreme Court.  The Fifth Circuit did not take them up on this request.

The first exception argued was that attorney immunity should only protect attorneys engaged in litigation.   The Fifth Circuit did not have any trouble dispatching this argument, since it relied on the dissent in Cantey Hanger and dissents are not winning arguments.

Next, they argued that participation in a crime was not subject to immunity.   Criminal conduct can negate attorney immunity.  The Fifth Circuit held that "We conclude that criminal conduct does not automatically negate immunity, but in the usual case it will be outside the scope of representation."  Opinion, p. 8.    The Texas Supreme Court has stated that assaulting opposing counsel during trial would be an example of unimmunized conduct.   However, it would fall outside the protections of immunity "not because it could be criminal, but 'because it does not involve the provision of legal services and would thus fall outside the scope of client representation.'"   Opinion, p. 8.   The Court concluded that "Thus, immunity can apply even to criminal acts so long as the attorney was acting within the scope of representation."   Opinion, p. 9.  I will return to this later.

Finally, the investors argued that Greenberg Traurig aided and abetted Stanford's violations of the Texas Securities Act and that the statute abrogated the common law attorney immunity.  However, the Fifth Circuit found that "The Act contains no explicit abrogation of immunity."   Opinion, p. 10.  The Court also noted that attorney immunity has been applied in under the Texas Deceptive Trade Practices Act.   The Court said, "We conclude that the Supreme Court of Texas would not consider itself sure that the Texas legislature intended to abrogate attorney immunity in the context of TSA claims."

As a result, the Fifth Circuit affirmed the dismissal of claims against Greenberg Traurig.

Greenberg Traurig's appellate victory is not the end of the story.  It is still being sued by Ralph Janvey, the Receiver.   An attorney does not have immunity when its client is suing for malpractice or similar theories.   When a third party is hurt by advice that an attorney gave his client, the proper procedure is that the third party can sue the client and the client can then sue the attorney.   This way the attorney is held responsible by the person to whom he owed the duty.

When Can an Attorney Be Liable to a Non-Client? 

While the attorneys in this case successfully urged attorney immunity, there are plenty of instances in which an attorney can be held liable to a non-party.   The most obvious examples are Fed.R.Civ.P. 11 and Fed.R.Bankr.P. 9011 and 28 U.S.C. Sec. 1927.   The rules specifically apply to actions of attorneys in litigation and allow attorney to be punished for actions in violation of the rules.   28 U.S.C. Sec. 1927 allows the Court to impose liability to an attorney who "multiplies the proceedings in any case unreasonably and vexatiously."

Next, there are attorneys who commit a direct tort.   For example, if the attorneys in this case had made fraudulent representations directly to the investors to get them to invest, they could have been sued for fraud.   This was recognized in In re Educators Group Health Trust, 25 F.3d 1281, 1285 (5th Cir. 1994) where the Court stated:
 We do agree, however, with the plaintiff school districts' contention that some of the causes of action allege a direct injury to themselves, which is not derivative of any harm to the debtor. For example, the plaintiff school districts allege in paragraph XI of the complaint that the defendants intentionally misrepresented to them the financial situation of EGHT, and that they materially relied on such representations to their detriment. To the extent that this cause of action and others allege a direct injury to the plaintiff school districts, they belong to the plaintiff school districts and not the estate.     
Then there is the question of what acts fall within the scope of the representation.    The Fifth Circuit said that assaulting opposing counsel would necessarily be outside of the scope of the representation.  However, what if opposing counsel was about to make a damaging point and the client said, "You need to shut him up?"  Would it be within the scope of the representation if the client asked the attorney to assault opposing counsel to help with his case?   What if a client tells an attorney to destroy incriminating evidence as part of the representation or worse, breaks into opposing counsel's office and sets fire to his filing cabinet?  I am tempted to say that only conduct which attorneys are permitted to take can fall within the scope of the representation.  However, the Fifth Circuit said that "immunity can apply even to criminal acts so long as the attorney was acting within the scope of representation."   Attorneys cannot ethically engage in criminal acts in the course of their representation.   Therefore I am at a loss at to what criminal activities an attorney could engage in within the scope of representing a client.
 




Tuesday, April 23, 2019

Fifth Circuit Resolves Multi-State Perfection Puzzle

In a lesson that the Uniform Commercial Code is not always uniform between various states, the Fifth Circuit resolved a lien priority dispute pertaining to a Texas debtor who brought agricultural products in Oregon, Michigan and Tennessee.    The opinion in a valuable primer in choice of law issues in UCC cases as well as how failure to strictly comply with state statutes can lead to loss of lien priority.   Fishback Nursey, Incorporated v. PNC Bank, National Association, Case No. 18-10090 (5th Circuit 4/10/19).

What Happened

 BFN Operations, LLC was a wholesale grower of trees, shrubs, and other plants, with headquarters in Texas and offices in Michigan, Oregon and Tennessee.   

PNC held a blanket lien in the debtor's assets which pre-dated the claims of two vendors to the debtor, Fishback and Surface.

Fishback sold agricultural products to the debtor and filed UCCs in Oregon, Michigan and Tennessee.   It listed the debtor as BFN Operations, LLC abn Zelenka Farms.  It also filed a notice of lien in Oregon.

Surface filed a UCC in Michigan using the name "BFN Operations, LLC abn Zelenka Farms.

When BFN filed chapter 11, PNC extended debtor-in-possession financing which would outrank other liens "subject and junior only to . . . valid, enforceable, properly perfected, and unavoidable pre-petition liens."

Fishback and Surface filed suit against PNC in the U.S. District Court for the Northern District of Texas seeking a declaration that their liens were superior to those of PNC.

The District Court ruled that applicable choice of law rules dictated that the law of the states where the agricultural products were shipped should govern the lien perfection and priority dispute.  It then found that PNC had the prior lien because Fishback and Surface had failed to properly perfect.

The Court's Ruling

The first thing that the Fifth Circuit had to do was decide whether the District Court correctly determined that the law of the states where the agricultural products were shipped would apply.  The Court noted that choice of law could be applied based upon either the law of the forum state or under federal choice-of-law rules.   This is an open question in the Fifth Circuit.  The District Court found that it did not have to pick a side because both answers pointed to the states where the ag products were shipped.   The Fifth Circuit agreed.   Under the Texas UCC, if farm products are located in a jurisdiction, the local law of that jurisdiction applies to perfection, the effect of perfection and the priority of an agricultural lien on farm products.   Tex.Bus.&Com. Code Sec. 9.302.   Federal law relies on the Restatement (Second) of Conflicts of Law Sec. 251(2) which provides that absent "effective choice of law by the parties" the court should give "greater weight . . . to the location of the chattel at the time that the security interest attached."

Fishback argued that Oregon law should apply because its contracts contained a choice of law provision selecting Oregon law.  However, those provisions were included in a contract between the Debtor and Fishback.  As a result, they were not binding on PNC.

Each of the laws of the forum states had some quirky provisions.   In  Michigan and Tennessee, a UCC must be filed based on the debtor's name exactly as it appears on the public documents creating the entity.  In this case, the company's legal name was BFN Operations, LLC, not BFN Operations, LLC abn Zelenka Farms.   This may seem like a trivial distinction given that the name given was correct but added extra verbiage.   However, the Court found that it was "undisputed that, under the strict search logics in these states, searching with BFN’s correct name would not uncover the incorrectly named liens."    While this seems foolish, the states set out their search logic in regulations adopted to implement the UCC and that search logic would not catch the longer name.

Oregon was a different matter.  Agricultural liens in Oregon are automatically perfected until 45 days after the debt is due.  After that date, the party must file an extension supported by an affidavit.  Fishback did file an extension but it was not within the 45 day window so that PNC's lien jumped in front of its.  Fishback argued that its UCC filing met the requirement for the affidavit, but the Fifth Circuit found that it lacked the requisite information and would be misleading as an affidavit.

Takeaways

As bankruptcy lawyers, we are usually called in after the filings have been made and the lien perfection facts have been established.   Therefore, the biggest lesson for bankruptcy lawyers is that when dealing with multi-state perfection issues, there may be room to look for strategies to upset other parties' lien expectations.   

When dealing with the front end of a transaction, it makes good sense to consult with a local lawyer to find out the quirks in local lien law, whether it is the UCC or mechanics liens or real property mortgages.  One consequence of our federal system is that despite the efforts to draft uniform laws, states are perfectly free to implement traps for the unwary.
 

 


Thursday, November 01, 2018

NCBJ San Antonio: Highlights of Day 3

The final day of this year's NCBJ only included two panels so I don't need an introduction.

Twelve Years of Turbulence:  Keynote by Gary Kennedy and Terry Maxon

 Former American Airlines General Counsel Gary Kennedy and his co-author Terry Maxon gave the keynone address on the final day of the conference.   They have authored a book entitled Twelve Years of Turbulence which discusses Mr. Kennedy's time as GC, including the bankruptcy of American Airlines.   You can find the book here.  You can also watch a promo video for the book which they played during the talk here.   It is worth 90 seconds of your time to watch.

Gary Kennedy described his position as General Counsel to American Airlines during its bankruptcy as having the dual role of being the lawyer to the board of directors and the client to the outside counsel.    He began his career at a firm that did chapter 11 work, experience that would prove a benefit many years later.  He spent thirty years at American Airlines, including a stint as General Counsel.   As GC, he fulfilled many roles.  Once a lawyer called him to say that American had lost the luggage with his fiancee's wedding dress and that the wedding was in two days.  Although GC's typically do not track down lost luggage, he put the word out and the dress was located the day before the wedding.   His advice was to never check money, medications or a wedding dress.

American's turbulence began before Kennedy became general counsel.  On September 11, 2001, a flight attendant named Betty Ong called the reservations number to say that her flight had been taken over by three men who had killed a passenger and stabbed a flight attendant.  The call was routed to the operations center and she remained on the phone with American until her plane hit the World Trade Center.  Hour later, another American flight crashed into the Pentagon.   On the morning of the terrorist attacks of 9/11. the entire air transportation system closed.  When it re-opened people were leery of flying.   To make matters worse, another American flight crashed two months later, killing all on board.

This left the airline in an extremely fragile condition.  The company was losing billions of dollars.  No revenue was coming in to a business that had heavy fixed costs.   By 2003, American was insolvent and had no room to maneuver.  It was at this time that the company's CEO, Don Carty, asked Gary Kennedy to take the position of General Counsel.  At this point he had been out of the legal department for ten years and was running one of the business units.  However, he had begged for the General Counsel's job and was not in a position to turn it down.

CEO Carty told him, "As GC, you will have to tell me things that I don't want to hear and stand up to me when I do things I shouldn't do."   Mr. Kennedy said that "In short time his words came back to haunt me."

In 2003, Gary Kennedy was told that his first job was to put the company into bankruptcy.  The company announced that it was going to file bankruptcy on April 15, 2003 unless it could re-negotiate its contracts with its three employee unions to give the company two billion dollars a year in concessions.   On April 14, 2003, after working round the clock for weeks the bankruptcy was ready to file.  Boxes of paper filings were lined up on dollies and a fleet of cars was ready to take the documents to the U.S. Bankruptcy Court in the Southern District of New York.   Two of the three unions approved the deal but the flight attendants said no.  They delayed the filing to allow the flight attendants to re-vote.  They approved the concessions on the re-vote and bankruptcy was avoided.

Then things got ugly.  In its Form 10-K filing, which was due the next day, the company would disclose that it had agreed to buy millions of dollars in retention bonuses in connection with the bankruptcy filing.   Within sixty minutes of the securities filing, the employees felt deceived and were "as angry a group as you could imagine."   

Co-author Terry Maxon (of the Dallas Morning News) explained that announcement of the retention bonuses put the company in immediate jeopardy of filing bankruptcy.  "There is no incentive program for management that the employees like.  When you are giving big concessions, it's even worse.  They are getting theirs.  We are not getting ours.  It set up a situation that American Airlines would have to file for bankruptcy unless they did something extraordinary."

CEO Don Carty called up Kennedy and told him to rescind the bonuses.   He agreed.  When he told his wife what had happened, she said "That was an expensive phone call.  If he calls again, don't answer."   

However, the unions still wanted blood.  Kennedy told his CEO that he needed to go to the board and tell them of the possibility that the CEO should resign.  As General Counsel, his job was to be loyal to the company and not to the individual who had hired him.   Carty resigned.

The company began to pull away from the cliff when the Great Recession of 2008 hit and oil went to $150 a barrel.   Kennedy remembered a manta that had been taught during his brief tenure as a bankruptcy lawyer--"thou shalt not wait too long to file bankruptcy."  However, the new CEO was almost religiously opposed to chapter 11.   

The company began leveraging every asset it could find to raise a pool of cash to get through the recession.   Company Treasurer Beth Goulet said that the company was pulling all of the cookies out of the cookie jar and and borrowing against them until they could get their costs under control.   She said they tapped five or six financial markets in one day.  They were borrowing huge sums of money but couldn't continue to support a business that was generating such heavy losses.

By November 2001, the other airlines that had previously filed for bankruptcy had all received concessions from their employees.  Because American had not filed bankruptcy, they were at the top of the heap in terms of costs.  The Board instructed Kennedy to be ready to file in three weeks. 

This time the company did not publicly announce that it was filing.  They worked feverishly to prepare a massive bankruptcy and keep it quiet.  No one knew about the proceeding except for one pesky reporter who seemed to want to blow a hole in the plan.   Terry Maxon explained that on November 28, 2011, he checked his iPhone and saw an email from a friend who worked at the airport asking him if he knew that American was going to make a big announcement the next day.   He began calling all around Dallas.  At 8:15 p.m., he called the CEO's office.  He said that if someone answered the phone in the CEO's office at 8:15 on a Monday night, something big must be up.   Half an hour later, the head of corporate communications called back and asked him what he was going to run.  He told him that he was going to say that the company was going to make a big announcement amid rumors of bankruptcy.  The communications head confirmed that the company would be filing bankruptcy but asked him to hold the story until 6:00 a.m., which he did.  When the company did file the next day, the Dallas Morning News got the scoop.

He decided to ask one more question about the CEO who so adamantly opposed bankruptcy and was told that he had suddenly decided to retire.

Before the company could file, it had to decide where to file.  The two logical choices were either the Northern District of Texas where the company was located or the Southern District of New York.   Kennedy felt strongly about filing in the DFW area.  "Being a hometown airline, not only would we have a vested interest in the outcome but so would the people administering the case."  He said he felt that they should be in their hometown.  However, outside counsel insisted that the level of sophistication of the judges in New York was such that they had to file in New York.  The company ultimately filed in New York.  "I will say as a postscript that if I had the opportunity to do it again, I would have filed in Dallas Fort Worth.  Part of the difficulty for me was that club atmosphere of the lawyers and financial advisors based in New York.  I felt like an outsider looking in."

  Once the company filed, nothing went as planned.   Where they thought the U.S. Trustee would appoint one union to the creditors' committee, it appointed all three of them.   They were assigned a brand new, untested judge.  When the CEO unloaded on him, he explained that he could not control these factors but acknowledged his responsibility to move the case along.

Meanwhile U.S. Airways decided that it wanted to merge with American.   When American was not receptive to the proposal, the employees who distrusted management teamed up with U.S. Airways and agreed to new conditional agreements.  At that point, he said he had to look at his fiduciary duty to do what was in the best interest of the creditors and others.

The negotiations were made more difficult by the differing corporate cultures.  Kennedy described American as being a a conservative Brooks Brothers never have a day of fun in their lives company, while U.S. Airways never had a day when they weren't having fun.  

One day after a hard day of negotiations, Kennedy heard someone calling his name.  It was the president of U.S. Airways inviting him to join them for drinks and dinner.  Kennedy asked, "Who's buying?  We're in bankruptcy."  He said they had a raucous good time but he felt guilty about having a good time with the enemy.

They ultimately reached a deal but had to get the government to agree to the deal.  It was clear that the Department of Justice was opposed to the deal. The government agreed to give an answer by August 2013.  One day Kennedy was walking the stairs when he stopped to check his phone.  He received a message, "They are going to file."   The Department of Justice sued to block the merger.  Kennedy knew that he had to tell the CEO the bad news and tried to find someone to go with him.  He wasn't able to persuade anyone, including the janitor to join him.

The government took the position that all of the woes of the airline industry stemmed from mergers.  American tried to persuade the regulators and proposed changes to meet the government's concern.  He received a reply from an Assistant U.S. Attorney that was laced with profanity including some curse words he didn't know the meaning of.   However, they were finally able to reach an agreement.

Approval of the merger allowed American to exit bankruptcy.  He said, "The story closes on this note.  We were able to close the transaction in bankruptcy."  Between the value of the merger and the value obtained in bankruptcy, the company was able to pay its creditors in full, the employees received raises and few lost their jobs and even shareholders received some value.  Having guided the company in and out of bankruptcy, Kennedy retired and decided to write a book.  American has turned out to be quite successful following its bankruptcy. 

For me, having listened to this story, there are three takeaways.  Bankruptcy is a powerful tool.   Bankruptcy can be unpredictable and scary.  You should trust your gut when it comes to choosing venue in your home town. 

Don't Judge . . . Until You've Walked a Mile in a Judge's Boots


This was a workshop where a judge who had decided a case would introduce the facts and issues and then invite people at each table to discuss how the court should rule.   Each table had at least one judge.  My table had four judges, one professor and one other practitioner besides myself.

The first problem had to do with post-confirmation jurisdiction.   Prior to bankruptcy, one brother offered to purchase the other brother's property.   After he failed to close, he sued his brother and filed filed a lis pendens.   The debtor who owned the property filed bankruptcy.   The state court suit was dismissed but the lis pendens was not released.   After litigation in bankruptcy, the court ruled that the brother who had filed suit in state court (the non-debtor brother) was entitled to nothing and awarded damages against him.   The debtor brother confirmed a plan which said that he reserved the right to challenge the lis pendens.   Eight months after confirmation, the reorganized debtor realizes that the lis pendens is still in place and runs to bankruptcy court to have it removed.  The non-debtor brother objects saying that the bankruptcy court lacks jurisdiction.   What should happen?

I was part of a minority who thought the bankruptcy court did not have jurisdiction because the dispute did not involve enforcement of an express plan provision, although in the real world I would have argued for bankruptcy jurisdiction because I like litigating in bankruptcy court.   Other more creative thinkers argued that the bankruptcy court had jurisdiction because 11 U.S.C. Sec. 1141(c) vested the property in the debtor free and clear of all claims and interests.  They argued that the lis pendens was a claim against the property that would have been wiped out by the plan.  However, the most creative thinkers (who included a Texas Bankruptcy Judge sitting at my table) thought that the debtor could file a motion to enforce the judgment in the adversary proceeding, a maneuver that would not require re-opening the bankruptcy case).   The lis pendens that was filed in state court gave notice of the non-debtor brother's claim to the property.   The adversary proceeding denied that claim.   Therefore, the adversary proceeding judgment could be enforced to expunge the lis pendens.

The actual judge who handled the case, Judge Charles Walker of the Bankruptcy Court for the Middle District of Tennessee, said that he found jurisdiction based on enforcing the plan.  He added that the brothers were still fighting and that the appeal of the adversary proceeding judgment was pending before the Sixth Circuit.  

The second problem involved a scenario that was discussed in several panels during the conference.  For a number of years, parents had paid for the college education of their three children, two of whom were in graduate school and one who was an undergraduate.  After losing all of their money to a Ponzi Scheme in 2018, the parents file bankruptcy.   The Trustee sues the universities to recover the funds as a fraudulent transfer.    

Once again, I started out in the minority saying that if the parents did not have a legal obligation to pay the tuition, they did not receive reasonably equivalent value.   However, the majority stretched to find a benefit that the parents received from educating their children.  Some participants focused on the societal benefit to having an educated workforce.   Some focused on the obligation of parents to support the family even when the children are grown.  Still others found value in the possibility that the children would be able to support their parents in their old age.  At this point in time, there are cases going both ways and no circuit court decisions.  As a result, this is an area where the court is free to vote its conscience.    

The judge who handled the case was Michele J. Kim from the Southern District of Georgia.  She ruled that the trustee could not recover the college tuition.  She added that as an immigrant to this country, there was no question of whether she would go to college and no doubt that the parents would pay for it.

Final Thoughts





I love the city of San Antonio.  It is a city celebrating its Tricentennial with a wealth of history and culture.  The first NCBJ I ever attended was in San Antonio in 2005.   As we say farewell to this year's conference, I will leave you with a duck on the Riverwalk and some of the local-flavored music that greeted attendees.







I look forward to next year's conference in Washington, D.C.









Wednesday, October 31, 2018

NCBJ San Antonio: Highlights of Day 2

On Day 2 of NCBJ San Antonio, I went for a run, laughed at a musical about ethics, listened to a debate over equitable mootness, went to a fraudulent conveyance program and listened to an economist predict the next recession.

An Early Morning Run and an Opportunity to Give Back

Day 2 of this year's NCBJ dawned early for about 5% of the conference attendees who shrugged off the prior night's eating and drinking for an early morning Wake Up and Run.   The event, which is sponsored by Bernstein-Burkley, was particularly poignant because of the recent terrorist attack in Pittsburgh.   Here is what the firm had to say:
These horrific events have hit us close to home at Bernstein-Burkley, having occurred only a few miles from the firm's headquarters in Pittsburgh. Our employees lost friends and family members, and together as a united city, we grieve the loss of 11 neighbors.
The firm will donate $100 for every person entered in the race and will match contributions from NCBJ registrants up to $7,500.00.   To donate, please visit https://app.mobilecause.com/vf/JFPGH. Send a receipt of your donation to mluznar@bernsteinlaw.com and Bernstein-Burkley will match your donation. 

Getting back to the run itself, it was really dark out and was a reminder that there are a lot of lawyers and judges who are in better shape than I am.  However, I did finish the race and I got to see half of the judges in the Western District of Texas.   Congratulations to everyone who participated.   Robert Miller was the fastest runner, finishing in a blistering 17:32.   Judge Elizabeth Stong from the Eastern District of New York was the fastest judge.    

Ethics Follies

What could be a better way to learn about ethics than singing and dancing lawyers?   Ethics Follies 2018 presented a parody of Sister Act called Shyster Act.  I have posted a few clips below.



Since the point of an ethics presentation (beyond getting ethics hours) is to learn about ethics, here are a few takeaways.   Some of them were pretty obvious.  In the story an attorney who manages a singer co-mingles her trust funds with his client funds and then uses the money to hire internet trolls to try to influence a senate election.   When his associate refuses to participate in the scheme and quits the firm, lawyer Shyster shoots him.   The singer Lola sees this and goes into witness protection at a convent.   The obvious points here are don't co-mingle client trust funds, don't embezzle client trust funds and don't commit murder.   The less obvious point (only because the others were so glaringly apparent) is that an attorney may not commit an act he knows to be illegal or unethical and in the face of a demand to do so, must resign.   The ethical rules do not address how to avoid being murdered when you find out you are working for a criminal law firm.



There were a number of other ethical issues interspersed with the singing and dancing.  In one scene, an associate of the firm takes a selfie with Lola and is about to post it on Instagram when he has to be reminded about client confidentiality.   (In this case, Lola's location was confidential since she was hiding from Shyster). 

One song dealt with lawyers who went to mediation in bad faith so that they could run up their hours.  The bad male lawyers also made a plan to object to all the other side's discovery responses and set hearings when they knew the other side was going to be out of town.   This segment dealt with the duty not to overbill your client, the requirement to convey settlement offers to your client, the duty of fairness to the other side and counsel, and the duty of candor to the tribunal.

In another scene, an associate is passed over for promotion and is drinking heavily.   The partners discuss the resources available from the State Bar to help lawyers with substance abuse problems as well as the risks of allowing an impaired lawyer to advise clients.   However, the most moving part was the young associate's self-revelation when he sings "Before I can save someone else, I have to save myself."

There is also a random scene of bankruptcy judges singing about the Judicial Code of Conduct which all of us should find reassuring.



In the finale, Shyster forces his way into the convent and tries to shoot Lola.  The nuns offer to lay down their lives for their new friend who has taught them how to sing.  However, the heroic FBI agent disarms Shyster and receives a chaste kiss on the cheek from Lola.

The study guide to the musical covered at least twenty different rules from the ABA Model Rules of Professional Conduct.

Hooked on the Horns of a Legal Dilemma:  Can "Moo"tness Be Equitable? 

This was a moot court demonstration on the issue of ethical mootness.   The demonstration was more informative about the substantive issue than on how to argue an appellate case because both of the advocates were too good.   What I mean is that the advocates, Danielle Spinelli and Susan Freeman, did such a good job arguing their positions that there weren't any mistakes to learn from.


The case being argued was based on the facts of Sunnyslope, the affordable housing project that was worth more in foreclosure than as an ongoing business.   You can read more about the case at the CLLA Bankruptcy Blog here.    The oral argument highlighted the odd situation that equitable mootness runs counter to the principle that courts must hear cases within their jurisdiction but is accepted by all circuits.  

Ms. Spinelli lead off by arguing that equitable mootness was neither equitable nor about mootness.  She pointed out that prudential mootness exists where a court cannot craft a remedy of any sort so that any opinion would be advisory.  Equitable mootness on the other hand prevents review of a substantially consummated plan even when a remedy could still be fashioned.  She pointed out that the Bankruptcy Code expressly provides for two situations in which an order which has not been stayed is shielded from review:  DIP financing and sales free and clear of liens.  Since Congress expressly provide for non-review in those areas, it should be presumed not to have intended it in other cases.  She distinguished equitable mootness from abstention doctrines.  If a federal court abstains from hearing a case, it can still be heard by another court.  With equitable mootness, the appeal dies and the case is  not heard at all. She said that the role of equitable mootness should be limited to crafting a remedy which does not disturb the interests of third parties who have relied upon the confirmation order.

Ms. Freeman highlighted the impact on parties who have relied on the confirmation order, such as the investor who put funds into the project, the city that wanted to promote affordable housing and the tenants of the affordable housing project.   She argued that if plans could be reversed after substantial consummation that sophisticated investors would refrain from committing to a plan if there was a possibility of appeal of a confirmation order.  She said that reversal of the confirmation order would eviscerate the plan because the only effective remedy would be to allow foreclosure.  She distinguished the case from one involving third party releases where a discrete issue could be carved out without undermining the entire plan.   She also faulted the bank for not seeking a stay pending appeal noting that the bank had the resources to post a supersedeas bond but made the tactical decision not to do so.   

It was an interesting debate.  I have used equitable mootness and have argued against it.   I don't like it because it cuts off appellate review of plan confirmations and believe that it should be used sparingly.

ABI Roundtable on Fraudulent Conveyance Law

This presentation was mislabeled since everyone sat at a rectangular table.   The panelists discussed several hot issues in fraudulent conveyance law and invited discussion from the audience.

The first issue discussed was whether a deposit into a bank account was a "transfer."   This seemed like a silly issue to me but the courts have come up with different rationales for arriving at the same result.   In re Whitley, 848 F.3d 205 (4th Cir.), cert. denied, 138 S. Ct. 314 (2017) said that deposit of funds into a bank account was not a transfer.   Meoli v. The Huntington National Bank, 848 F.3d 716 (6th Cir. 2017) said that it was a transfer but that the bank was not the immediate transferee so that the transfer could not be avoided.   In re Tenderloin Health, 849 F.3d 1231 (9th Cir. 2017) involved a deposit of funds into an account that was used to pay a bank debt.   The bank argued that once the funds were deposited in the account, it had a right of setoff.  However, the Ninth Circuit said that in a hypothetical liquidation, the deposit of the funds giving rise to the setoff would have been an avoidable transfer itself.   The premise  behind these cases is that the funds are long gone.   It does not seem right to allow the trustee to recover the funds when the bank only held them in a technical sense.

The next issue had to do with clawback of parents paying tuition for their children.  The cases break down between the formalistic view stating that the parent did not receive a benefit from paying for their child's education and the broad view that moral or societal value constitutes reasonably equivalent value.  Boscarino v. Bd. of Trs. of Conn. State Univ. Sys. (In re Knight), No. 15-21646, 2017 WL 4410455, (Bankr. D. Conn. Sept. 29, 2017) applied the strict view.  DeGiacomo v. Sacred Heart Univ. (In re Palladino), 556 B.R. 10 (Bankr. D. Mass. 2016) held that the parents' view that having a financially self-sufficient child constituted reasonably equivalent value.   Sikirica v. Cohen (In re Cohen), Adv. No. 07-02517, 2012 WL 5360956 (Bankr. W.D. Pa. Oct. 31, 2012), rev'd on other grounds, 487 B.R. 615 (W.D. Pa. 2013) found that  a debtor received “reasonably equivalent value” for funds used to satisfy reasonable and necessary expenses for the maintenance of the debtor’s family, and that payments for post-secondary undergraduate educational expenses are reasonable and necessary for the maintenance of the Debtor's family.  

Ron Peterson brought up  In re Adamo, 582 B.R. 267 (Bankr. E.D.N.Y. March. 29, 2018) which involved a payment made by parents to a student's tuition account.   The court found that the initial transfer was to the student and not to the college.  As a result, the college as mediate transferee could defeat the claim.   Mr. Peterson also raised the anomaly of a debtor who was obligated to pay for college tuition for an adult child under a divorce decree and the parent who remained married and paid for college tuition.  In the first case, the parent had a legal obligation to pay.  In the second, the obligation was only moral or societal.

The next topic was payment of fines.  I'm not sure what the issue is here.  If there is a legally enforceable debt, it is clearly reasonably equivalent value.   If a person pays a fine to avoid prison time, that would be reasonably equivalent value because a person can 't earn any money while they are in jail.  If it is a corporation paying a fine to prevent its executives from going to jail, that is not reasonably equivalent value.   First, the corporation does not benefit from protecting its execs.  Second, the incompetence of the executives was probably what put the corporation in bankruptcy in the first place.  Therefore, removing the executives would be a net benefit to the corporation.

Finally, there were issues relating to taxes.   In re DBSI, Inc., 869 F.3d 1004 (9th Cir. 2017) involved a sub-s corporation that paid its shareholders' tax liability.   The IRS argued that it would have been entitled to sovereign immunity under state law.   The Court of Appeals held that section 106 waived that sovereign immunity.   The transfer at issue occurred more than two years pre-petition.  As a result, the transfer could only be avoided under section 544.   Outside of bankruptcy, sovereign immunity would prevent recovery of the transfer.  However, the court found that section 106 overroad the result that would otherwise occur.   The Seventh Circuit went the other way.   In re Equipment Acquisition Resources, Inc., 742 F.3d 743 (7th Cir. 2014) found that sovereign immunity would prevent recovery of the transfer outside of bankruptcy and that because section 544 is based on remedies available under state law that sovereign immunity had to be included.  It found that the reference to section 544 in section 106 had to be understood as referring to section 544(a) only.

ABI Luncheon:  Honoring Keith Lundin and a Not So Gloomy Recession

Retired Judge Keith Lundin accepted the Norton Judicial Excellence Award.   Presenter William Norton discussed Judge Lundin's Zelig-like presence at all of the important bankruptcy developments of the past thirty years and his super-authoritative treatise on Chapter 13.   Rather than talk about himself, Judge Lundin essentially gave a roast for the twelve prior recipients of the award, demonstrating that he is a genius and has a sense of humor to boot.

Dan White, a Senior Economist with Moody's Analytics, presented the economic forecast.  He told a story about the time J.P. Morgan was asked what would happen with the stock market.  Morgan replied "There will be volatility," a perfectly accurate answer with little practical import.  Mr. White said that the one thing he could be 100% certain of was that there will be a recession.  However, he could not say with certainty when it would happen or how severe it would be.   On these topics, all he could do was offered educated guesses.   To avoid keeping you in suspense, his education guesses were that there would probably be a recession in mid-2020 and that it would likely be mild unless one or more accelerators kicked in.  (My term not his).      

He said that several factors pointed to a recession in mid-2020.   First, it has been nine years since the last recession.   This is the second longest period of expansion in recent history.  He added that ten years is a long time to avoid screwing up the economy.   Their forecast assumes a strong 2019 which would then peter out shortly.   The Trump administration has jacked up the economy with tax cuts and increased spending.   

He gave the example of his six year old son trick or treating and coming home shaking from the amount of sugar he had consumed.  After the sugar rush wore off, he immediately fell asleep, not even making it through the opening credits of "It's the Great Pumpkin, Charlie Brown."  In this case, the Trump administration has given the economy a sugar rush with tax cuts and increased spending.  When this wears off in 2020, the economy will likely fall.

Mr. White also said that when we blow past full employment, we usually have a recession within three years.   The economy passed 4.5% unemployment in 2017.  If full employment is at the 4.0% unemployment rate, we may have a little more time.

He also talked about the yield curve in a slide I copied below.   In order for bankers to lend, there needs to be a spread between the 3 month interest rate and the ten year interest rate.   When the yield curve inverts, we are usually a year away from a recession.  He also said that whenever the yield curve falls to 1%, it is likely to invert.   We are currently at 1%.  He said that many economists will go on TV and explain why the yield curve doesn't matter.   "Friends don't let friends doubt the yield curve" he explained.

All of these factors point to a recession in 2020, but the big question is how bad will it be?  He gave three examples.   The recession of 2001 was mild, the recession of 1991 was more severe and the great recession of 2009 was, well, it was the great recession.   In  the 2001 recession, GDP dropped 0.6 percent from its peak.  In 1991, the drop was 1.5%.   The 2001 recession was over within a quarter while the 1991 recession lasted a year.   (I took these numbers from an article that I found, not from Mr. White's presentation).    Mr. White explained that there could even be a growth recession, that is, where the economy declines but continues to expand.

He explained that "having a recession is not the end of the world."  A recession "brings some of the excess crap out of the economy.  Small recessions help avoid big recessions."

Mr. White said that the likelihood was for a soft landing but there were a broad range of possibilities.  He explained several wild cards that could make a recession worse.   If President Trump and President Xi follow through on all of their threats regarding tariffs, it could raise the tariff rate from 1% to 5%, something that has not been seen in many years.  This would hurt agriculture and any industry that relies on steel.   He described the two world leaders as engaging in a game of chicken and predicted that they would ultimately back away.

Debt was another factor that could influence a recession.   Household debt is actually at a good level.  Federal government debt is on an unsustainable course but will not dramatically affect the economy for 10-15 years if entitlements are not reined in.   Local government spending is a problem because the percentage of mandatory spending by local governments has been steadily rising along with defaults and bankruptcies by local government.   Because local governments cannot engage in deficit spending, they will have to curtail other spending as mandatory expenditures rise.  This could hurt the economy.   Finally, non-financial corporate debt is not scary on an aggregate level but the distribution of that debt is.   He described corporate debt as a barbell.   There are a lot of well-collateralized, very secure corporate debts.  At the other extreme, there are "leveraged" debts which is a euphemism used to avoid describing them as junk debt.  Leveraged firms are leveraging up.  Because every business with good credit has already received all the loans they need, banks need to make riskier loans to continue making money.   However, because of the transparency required by Dodd-Frank, they will not keep these loans on their own balance sheets.   Instead, they are creating "Collateralized Loan Obligations" and selling them to pension funds and other investors.  However, the size of these debts is not large enough to tank the economy.

His opinion was that these risk factors would likely mean the difference between a 2001 recession and a 1991 recession.  Either way, it is not an apocalyptic scenario unless someone does something really stupid that we can't see at this point.   You can always bet on stupid.  (My comment, not his). 


Monday, October 29, 2018

NCBJ San Antonio: Highlights of Day 1

NCBJ 2018 opened in the historic Lila Cockrell Theater with current NCBJ president Judge Michael Romero belting out a welcome in song adapted from Cabaret.    For me, Day 1 featured an awards show with head-snapping array of bankruptcy trivia and video, a valuation mock trial and the Commercial Law League's program.   Themes throughout the day included trying to find some importance in this term's three bankruptcy-related Supreme Court decisions and the Tempnology case which just received a grant of cert.

Broken Bench Awards Show

The opening plenary session featured a highly produced awards show in which judicial writing was honored along with more than a little substance thrown in.   The show began with Cinderella (Prof. Nancy Rapoport) facing foreclosure from her bank after it finds out that its collateral has turned into a pumpkin and some mice.  Fairy Godmother (U.S. District Judge Pam Pepper) saved Snow White by telling her about bankruptcy and gave her some schedules to fill out in the five minutes before the judge arrived.   The part about completing schedules in five minutes truly had a fairy tale quality to it.






There were a number of awards, some silly and some not so silly.    

Best Judicial Turn of Phrase went to Supreme Court Justice Sonia Sotomayor who made this quip in her opinion in Wellness International Network, Ltd. v. Sharif, 135 S.Ct. 1932, 1947 (2010):

"The principal dissent warns darkly of the consequences of today's decision.  To hear the principal dissent tell it, the world will end not in fire, or ice, but in a bankruptcy court."

The award for the best Bench Slap went to In re Lynch, 2017 WL 416782, 63 Bankr. Ct. Dec. 176 (Bankr. N.D. Oklahoma) where Judge Cornish chastised a lawyer for hiring professionals found on Craigslist.
The Court was stunned that Hyde chose attorneys and experts to assist her by shopping for them on the website Craigslist.  Traditional avenues for finding and vetting attorneys such as the Lawyer Referral Service of the Oklahoma Bar Association, County Bar Association and Martindale-Hubbell Legal Directory seem much more reliable and trustworthy sources of information rather than searching classified ads on the internet. 
Best Ethics Rant went to Judge Jeffrey Norman of the Western District of Louisiana (now sitting in the Southern District of Texas.  His In re Banks, 2018 WL 735351 (Bankr. W.D. La. 2018) opinion said that:
This case is an unfortunate tale of attorney delay, promises to a client made by counsel but not kept, deception, and professional negligence.
They said that the lesson is that judges have a lot on their dockets.  They don't want to spend pages and pages calling someone out.  Make good choices (followed by a clip from Pitch Perfect).


Retired Judge Michael Ninfo (dressed as Captain America) received a lifetime achievement award for his work founding CARE, Credit Abuse Resistance Education.   The presentation made me want to volunteer for the group.

The award for Best Use of a Song Lyric in an opinion went to In re Drew Transportation Services, 2016 WL 8892459 (Bankr. E.D.N.C. 2016) for its use of the Rolling Stones' "You Can't Always Get What You Want."  (However, I felt that Judge H. Christopher Mott got robbed since he used the phrase in his In re SCC Kyle Partners, Ltd., 2013 Bankr. LEXIS 2439 (Bankr. W.D. Tex. 2013) relating to cram-down interest.   He led his opinion with the quote and added:  "In the Court's view, neither party will get all they want, but both will get what they need."

Prior to the conference, attendees voted on the Best Bankruptcy Cinderella Story.   Receiving the award was the City of Detroit case.   Judge Steven Rhodes, Kevin Orr and Corinne Ball accepted the award on behalf of the case.    Judge Rhodes thanked Jones Day for not filing the case in Delaware.



Valuation Mock Trial

Judge Laurie Silverstein (Bankr. D. Del.), Ian Peck of Haynes & Boone, Camisha Simmons of Simmons Legal and Bob Stearn of Richards, Layton & Finger presented a mock trial of a hearing to value a company in the context of a chapter 11 confirmation hearing.   


I am not going to discuss the specific valuation issues raised since a lot of it was over my head.   However, I do have a few takeaways from watching the mock advocates.   There is a lot of jargon used in valuation.   While some judges may understand the difference between a WAC and a Beta input, it is important for the advocates to take the time to explain these concepts and how they fit into a valuation decision.   In this case, the Judge understood a lot of concepts which were never explained.   However, in real life, the parties might not get so lucky. 

I thought that the attempts to attack the qualifications of the experts were of limited value.   If you are not going to get the expert thrown out or substantially discredit them, questioning about the number of zinc mines appraised doesn't add much.

I thought that the demonstratives that the lawyers used were helpful but would have liked to see more of them.

I liked the way that one of the attorneys used his cross-examination of the other side's expert to lay out themes that his expert would be raising in his direct.    

I was also impressed by the extent that the mock advocates understood the underpinnings of their opponent's expert's opinions.   In one case, an expert had relied on a proprietary report.  The advocate effectively challenged the fact that the expert had no way to verify the conclusions reached by the analysts who prepared the report.   He referred to it as a black box in his cross and closing, a term that was echoed by the judge in her ruling.   

It is hard to do a practice skills presentation with tight deadlines.   I found this one to be very realistic (because it was based on a real case) and a good teaching exercise.  (NCBJ is offering videos of all of the plenary sessions for sale in case you want to watch the presentation for yourself).

King Award Luncheon

Every year the Commercial Law League of America awards the Lawrence P. King Award for Excellence in Bankruptcy to a distinguished judge, academic or practitioner.   This year the award went to Prof. Jay Westbrook of the University of Texas School of Law.   Prof. Westbrook has been one of the leading bankruptcy academics in the country for many decades.  His ground breaking empirical work (with Teresa Sullivan and Elizabeth Warren) has helped us to better understand bankruptcy and the people who file bankruptcy.  He is one of the bright lights of international insolvency law.  He has also worked to accomplish venue reform, helping to draft a bill that was introduced in the Senate by two unlikely co-sponsors:  John Cornyn of Texas and Elizabeth Warren of Massachusetts. 

He was introduced by his former research assistant Eric Van Horn and a video message from his former collaborator U.S. Sen. Elizabeth Warren.  I recorded both Sen. Warren's introduction and Prof. Westbrook's acceptance on my phone.  I apologize for the quality.   This is the first time I have attempted to incorporate video into a blog article. 



Focus on the Supreme Court

I am combining one segment from Broken Bench Awards with Prof. John E. A. Pottow's address to the Commercial Law League luncheon since they both dealt with last term's Supreme Court decisions as well as one case that the Court has granted cert on for this term.   

In the awards category, three presenters made pitches for why each of the Court's decisions was the best.   Craig Goldblatt and (I think ) Danielle Spinelli from Wilmer Hale made pitches for Lamar, Archer & Cofrin, LLP v. Appling, 138 S. Ct. 1752 (2018)  and  Merit Mgmt. Grp., LP v. FTI Consulting, Inc., 138 S. Ct. 883 (2018) explaining why each of these decisions faithfully followed the text of the Code.   Prof.  Troy McKenzie of New York University School of Law argued for U.S. Bank Nat’l Ass’n v. Vill. at Lakeridge, LLC, 138 S. Ct. 960 (2018).   Village at Lakeridge received the highest votes from the audience although I personally voted for Appling.   

Prof. Pottow sought to provide some context to the decisions in his presentation titled Is Functionalism Back?    The Professor stated that the Supreme Court has a hard time getting bankruptcy.  He explained that this makes sense since they are generalists who must deal with many different areas of the law.   However, it means that they often have a poor idea of what is going on in the trenches.   This feeds into the formalism vs. functionalism dichotomy.   Formalism looks at the words of the text while functionalism looks at how a given interpretation will work in practice.  (My words, not his).

This leads to the three cases that the Court decided last term.   I did not describe them above because I wanted to do so in the context of Prof. Pottow's talk.  

The first case up was Lamar, Archer & Cofrin, LLP v. Appling, 138 S. Ct. 1752 (2018), a case about a client who not only stiffed his lawyers, but lied to them to get them to continue representing him.  Mr. Appling told his lawyers that he would be receiving a tax refund of "about" $100,000 and would use it to bring their bill current.   The refund was closer to $59,000 and the debtor apparently did not intend to pay his lawyers.   He filed bankruptcy after they sued him.   The lawyers argued that their ex-client had induced them to keep doing work for them by lying about the tax refund.  The issue before the Supreme Court was whether Appling's verbal statements about the refund were statements "respecting" the debtor's financial condition.   Any claim based on a lie "respecting" the debtor's financial condition must be in writing.  The lawyers said that a statement about one asset was not made "respecting" the debtor's financial condition.  The Supreme Court disagreed.

In making its ruling, the Court started with a formal analysis--what does the dictionary say that "respecting" means.   Then it went to an historical analysis--how were these claims treated under the Bankruptcy Act.   Finally, the Court looked at the consequences of a rule requiring that a statement of financial condition must refer to more than one asset.   What if the debtor makes one statement listing his assets and a separate statement concerning his liabilities?   He has not made a  single statement concerning his financial condition.   The definition urged by the lawyers would be difficult to apply and would lead to bizarre results.   Only the third rationale reflected functionalism.   Prof. Pottow likened it to the dessert of the opinion, but added that at least Justice Thomas didn't dissent.

The Court also discussed legislative history, specifically a House Report.   The Supreme Court had previously relied on this same report in Field v. Mans, 116 S.Ct. 437 (1995).  This was one step too far for Justices Gorsuch, Thomas and Alito who did not join this portion of the opinion.

Next up was U.S. Bank Nat’l Ass’n v. Vill. at Lakeridge, LLC, 138 S. Ct. 960 (2018).  According to Prof. Pottow, this was not really a bankruptcy case at all because it dealt with the standard of review on appeal rather than what rule the court should apply under bankruptcy law.  The case dealt with how to determine whether a person was a non-statutory insider.   According to the professor, the opinion  starts out formalistically and ends on a functionalist crescendo.   The formalistic part of the opinion notes that there are three types of issues on appeal:  issues of fact, issues of law and mixed questions of fact and law.  Factual determinations receive deferential review while questions of law are reviewed on a clean slate.   For mixed questions, it depends.   The functionalist part of the opinion looked at what the Court was doing as it examined the mixed question of law and fact.  If what the court was doing was closer to fact finding than applying the law, then the more deferential standard would apply.   Prof. Pottow pointed out that the institutional competency of the Supreme Court was deciding difficult issues of law in a manner that would provide guidance to the lower courts.   The institutional competency of the bankruptcy court was listening to evidence and making decisions about the facts.   

Having established that appellate courts should defer to the fact finding of trial court's, individual justices began to weigh in on what the rest should be.   This was a problem because the Supreme Court had not granted cert on this issue.  Nevertheless, Justice Sotomayor said that the test used by the Ninth Circuit was dumb.  Justices Alito, Thomas and Kennedy joined in the concurrence.  Justice Kennedy concurred in the concurrence.   This probably show buyer's remorse that the court had not granted cert on the substantive issue and was left with a narrow, insignificant opinion.   (My words, not Prof. Pottow's).

Finally, there was Merit Mgmt. Grp., LP v. FTI Consulting, Inc., 138 S. Ct. 883 (2018), a case about whether the safe harbor for securities clearing transactions should apply in a case where funds for a stock purchase flowed through two banks before reaching their ultimate destination.   According to Prof. Pottow, this would have been a great case for the Supreme Court to dive deeply into the question of what is a transfer.   In point of fact, funds travelled from the buyer (Party A) into his bank (Party B) to the Seller's Bank (Party C) to the Seller (Party D).    The Supreme Court disregarded the parties in the middle, stating that while there was a transaction, there was not a transfer.   Prof. Pottow claimed that the Supreme Court merely stated that the transfer was from A to D without analyzing why that was the case.  I personally believe that they were looking at the economic reality of the transaction.   The banks were akin to a courier rather than parties who came into ownership of the funds.   Sure, a courier could make off with the funds and not delivered them, but that is not what happened here.  Expressing his disappointment with this case, Prof. Pottow suggested that it might not be a good case to include in the next textbook.

Prof. Pottow pointed out that the judges who were the most functionalist went along with all three opinions.  Of course, they were all 9-0 decisions, so that the judges who were most formalist went along with them as well.  

Interesting Stuff That Didn't Fit Anywhere Else

There is more that I wanted to write about.  However, the hour is late and tomorrow starts with a run at 6:00 a.m.   I may add to this section after I return home.