Sunday, March 30, 2008

Fifth Circuit Releases Interest-ing Opinion on Chapter 13 Interest Rates

The Fifth Circuit has released a new opinion on interest rates in chapter 13 cases. Drive Financial Services, L.P. v. Jordan, 2008 U.S. App. LEXIS 5334 (5th Cir. 3/12/2008). While the opinion does not contain any earth-shattering conclusions, it provides an excellent starting point for a practitioner wanting to learn treatment of secured claims in chapter 13.

The Facts

Debtor financed a pickup truck with Drive Financial. The contract interest rate was 17.95%. When the Debtor filed chapter 13, he proposed to lower the rate to 6%. At the confirmation hearing, the parties stipulated that the rate would be 7.5% under the Supreme Court's Till v. SCS Credit Corp., 541 U.S. 465 (2004) decision or 17.95% under the Fifth Circuit's Green Tree Fin. Servicing Corp. v. Smithwick, 121 F.3d 211 (5th Cir. 1997). Under Till, the interest rate is to be determined based on the prime rate plus a risk premium, while Smithwick applied a rebuttable presumption that the contract rate should apply. The Bankruptcy Court applied Till and used the lower rate. The parties received permission to take a direct appeal to the Fifth Circuit.

The Hanging Paragraph Does Not Apply

The Fifth Circuit first dispelled the notion that the hanging paragraph of Sec. 1325(a)(*) applies to calculation of interest on a chapter 13 secured debt. Drive Financial argued that because Till dealt with the interest rate on a lienstripped claim, that it had no application to a post-BAPCPA claim on a vehicle claim protected from lienstripping under the hanging paragraph. The Fifth Circuit found that the fact that the claim had been subject to lienstripping did not play any part in the Supreme Court's decision to apply a prime + interest rate calculation and thus concluded that BAPCPA had not overruled the Till decision.

This raises an important point. Loans secured by a principal residence are protected from modification in both chapter 11 and chapter 13. On the other hand, loans incurred for purchase money on a vehicle within 910 days are protected from lienstripping (that is, having the secured claim reduced to the value of the collateral), but are still subject to having their interest rates modified. Thus, home mortgages receive greater protection than recent car loans.

The Till Plurality Is the Law; Smithwick Is Not

Next, the Fifth Circuit explored how to apply a plurality opinion from the Supreme Court. In Till, a plurality of four justices adopted a prime rate + approach, while Justice Thomas concurred in the judgment but found that a risk premium was not mandated. Where no single rationale is approved by a majority, the lower courts are required to follow the position of the justices who concurred in the judgment on the narrowest grounds. Drive Financial argued that because Justice Thomas did not concur in any part of the plurality opinion that Till was not binding. However, the Fifth Circuit noted that the fifth vote cast by Justice Thomas found that a prime + interest rate would always be sufficient to protect the secured creditor because the statute only required a risk free rate of return. Thus, there were five votes for the position that a prime + rate would adequately protect the interest of the secured creditor, and thus, that the lower courts must follow this result.

The Fifth Circuit also pointed out that, even if the reasons for adopting Till were murky, that the facts were the same as the present case. As a result, stare decisis required that the Fifth Circuit follow Till and not its own prior precedent.

As a result, the Fifth Circuit found that the prime rate + approach to calculating the interest rate in chapter 13 remains the law.

Friday, March 21, 2008

Sanctioned Lawyer Wins Reprieve From District Court; Court Clarifies Standards for Non-9011 Sanctions

This blog previously reported on In re Cochener, 360 B.R. 542 (Bankr. S.D. Tex. 2007), a case in which an attorney was sanctioned under 11 U.S.C. Sec. 105 and 28 U.S.C. Sec. 1927 based on events which had occurred years earlier. See "Brief Representation Comes Back to Haunt Attorney." (May 7, 2007). Now, a U.S. District Court has reversed most of the sanctions award and the case is on its way to the Fifth Circuit. Barry v. Sommers, No. H-07-0629 (S.D. Tex. 12/28/07).

What Happened in the Bankruptcy Court

The underlying case involved a debtor who had made questionable transfers prior to bankruptcy. When the trustee began asking difficult questions at the 341 meeting, the first attorney realized that he was in over his head and referred the case to a board certified attorney. The second attorney realized that the debtor was not helping herself by being in bankruptcy and tried to get the case dismissed. While the motion to dismiss was pending, the attorney advised the debtor not to attend a re-scheduled 341 meeting or to produce documents which the prior counsel had agreed to hand over. When the trustee sought to conduct a Rule 2004 examination, the second attorney argued against producing documents going back four years on the basis that 11 U.S.C. Sec. 548 only allowed the trustee to recover transfers made within one year prior to bankruptcy. The debtor failed to appear for the examination, after which the second attorney sought permission to withdraw. The second attorney was given permission to withdraw, but the court reserved the power to issue sanctions.

Over four years later, the trustee brought a motion for sanctions under Rule 9011 and 11 U.S.C. Sec. 105. Because the trustee had never given the safe harbor notice under Rule 9011, the court concluded that this relief was not viable. However, after hearing four days of testimony, the court granted relief under both Sec. 105 and 28 U.S.C. Sec. 1927 based upon the following actions:

(1) The attorney concocted a reason for the debtor not to attend the continued 341 meeting and then advised the debtor not to appear;
(2) The attorney did not attend the continued meeting of creditors;
(3) The attorney filed a motion to dismiss which included "blatantly false factual and legal allegations;"
(4) The attorney wrote a letter to the trustee which misstated the law regarding the appropriate lookback period for a fraudulent transfer case;
(5) The attorney instructed the debtor not to produce the documents requested at the initial meeting of creditors.

Based on these actions, the court awarded sanctions of $25,121.89 based upon disgorgement of the retainer paid to the attorney and payment of the trustee's attorney's fees incurred in resisting the motion to dismiss and prosecuting the motion for sanctions.

Reversal on Appeal

On appeal, the District Court reversed all of the sanctions, except for the disgorgement order. However, to get there, it had to work through several preliminary issues first.

The District Court refused to apply laches based on the delayed prosecution of the sanctions motion. While the four year delay in bringing the sanctions motion represented a long period of time, it was not prejudicial because the attorney had been placed on notice of the claim at the time of his withdrawal and because no evidence had become stale in the meantime.

The District Court also rejected the argument that the Bankruptcy Court lacked authority to issue sanctions under 11 U.S.C. Sec. 105. The Court noted the recent Supreme Court opinion in Marrama v. Citizens Bank of Massachusetts, 127 S.Ct. 1105 (2007)in which the court stated that section 105(a) provides Bankruptcy Courts broad authority to "take any action that is necessary or appropriate to prevent an abuse of process." The Court concluded that Sec. 105(a) gave bankruptcy courts the inherent power to sanction bad faith conduct that was applicable to Article III Courts under Chambers v. NASCO, Inc., 501 U.S. 32 (1991).

However, before sanctions could be awarded under the Court's inherent powers under Sec. 105(a), the court had to find bad-faith conduct. Bad faith conduct was equated with either an attempt to abuse the judicial process or an affirmative misrepresentation. After an exhaustive analysis, the District Court upheld the Bankruptcy Court's finding that the attorney had engaged in bad faith conduct when he told the debtor not to appear or produce documents at the continued 341 meeting. However, the District Court reversed the other findings as being clearly erroneous.

Having concluded that only one act was sanctionable, the District Court turned to the proper sanction to be applied. The Court noted that "Inherent powers may be exercised only if essential to preserve the authority of the court, and the sanction imposed must employ the least possible power adequate to the purpose to be achieved." Memorandum Opinion and Order, p. 81. The Court found that disgorgement of the retainer was appropriate under this standard. "Attorneys who instruct their clients to violate duties imposed by the Bankruptcy Code have not provided effective assistance of counsel and have not earned a fee." Memorandum, p. 83.

The District Court reversed the award of attorney's fees to the trustee. Because the Court found that filing the motion to dismiss was not sanctionable, it found that the Trustee could not recover his fees incurred in opposing the motion to dismiss. The District Court denied the attorney's fees incurred in prosecuting the motion for sanctions on the basis that the debtor's attorney (who had already withdrawn at this point) did not commit any sanctionable conduct during the time that the trustee was pursuing the motion for sanctions. As a result, an award of attorney's fees in connection with the motion for sanctions was not necessary to deter sanctionable conduct.

The District Court also found that the Bankruptcy Court abused its discretion in imposing sanctions under 28 U.S.C. Sec. 1927. The Court found that there were three elements to an award of sanctions of Sec. 1927: (1) the attorney must engaged in "unreasonable and vexatious" conduct; (2) the "unreasonable and vexatious" conduct must be conduct that "multiplies the proceedings;" and (3) the dollar amount of the sanction must bear a financial nexus to the excess proceedings, i.e., the sanction may not exceed the "costs, expenses and attorneys' fees reasonably incurred because of such conduct." The Court found that the motion to dismiss did not merit sanctions under Sec. 1927 because it could not be plausibly argued that it was filed in bad faith. Although the District Court found that the attorney could be sanctioned under Sec. 105 for advising the debtor not to attend the creditors' meeting, this conduct did not merit sanctions under Sec. 1927 for the reason that it did not multiply the proceedings.

The Final Analysis

In the final analysis, it appears that while Rule 9011, Sec. 105(a) and Sec. 1927 serve similar purposes, they each have slightly different focuses. Rule 9011 applies to pleadings and papers only. It applies where motions are filed for an improper purpose or are legally or factually frivolous. However, the mere filing of a frivolous or odorous pleading is not enough. It is the refusal to withdraw a sanctionable pleading after fair warning which triggers the penalty. This means that a victorious party cannot go back after the fact and decide that his opponent's position was friviolous. Sec. 105(a) and Sec. 1927, on the other hand, apply to any conduct and allow for an after the fact examination. As a result, these sections require a higher standard before sanctions can be awarded. In order to violate the Court inherent power under Sec. 105(a), counsel must make an affirmative misrepresentation or try to abuse the judicial process, either of which will add up to the requisite finding of bad faith. Sec. 1927 invokes the three-party test discussed above, which must include a finding that court proceedings were multiplied.

In this case, advising a client not to obey her duties under the Code was sanctionable, while filing a questionable motion to dismiss and taking a questionable position on a discovery matter (which was later abandoned) were not.

The Trustee has appealed this case to the Fifth Circuit, so that we may hear from this case again.

Kudos to the District Court

As a final note, U.S. District Judge Sim Lake deserves high praise for the diligence and speed with which he handled this bankruptcy appeal. He produced his thoughtful, 93-page opinion just ten months after the notice of appeal was filed and seven months after the last brief was filed. The Court did the parties and the bar a service with the prompt manner in which this case was handled.


On October 23, 2008, the Fifth Circuit reversed the opinion of the District Court and affirmed the opinion of the Bankruptcy Court. Matter of Cochener, No. 08-20048, 2008 WL 4681579 (5th Cir. 2008).

Monday, March 03, 2008

A Modest Proposal

There has been a lot of talk about the sub-prime mortgage crisis lately. The presidential candidates are very concerned about it, but don't seem to be offering a lot of specifics. One of the candidates wants to impose a 90 day moratorium on foreclosures. This will help the problem--for about 90 days.

Perhaps we as bankruptcy lawyers can suggest a remedy from our area of the law: credit counseling. After all, when do you really need credit counseling? If it is good to use when deciding to file bankruptcy, wouldn't it be even better when deciding whether to incur the debt in the first place?

Here is what I would envision. Prior to taking out a mortgage loan, a prospective borrower would have to receive a credit counseling briefing from someone who had actually read their loan documents and looked at their financials. If the credit counselor recommends against the loan and the borrowers still want to do it, the borrowers would have to pass a test on the contents of their loan documents (a passing grade being 70, the same as it is in public school). If the prospective borrower receives a passing grade on the exam and still wants to take out the bad loan, the credit counselor would give them a stern talking to and would stamp "Don't Do It!!!" on the loan application. If at this point, the borrower insists, they would be allowed to do the loan. After all, this is a free country. However, if they choose to take out a bad loan after being told not to do it, reading the loan documents and being told not to do it a second time, they would forfeit all protections under federal law. If they default, they could be subjected to abusive debt collectors, barred from filing bankruptcy and be thrown in debtor's prison.

On the other hand, if the borrower passed credit counseling, they would be allowed to take out the loan and would also receive a golden ticket. If they ever got into financial difficulty and were posted for foreclosure, they could take their golden ticket to the bankruptcy court and exchange it for one that said "honest but unfortunate debtor". With the "honest but unfortunate debtor" ticket, they would be allowed to restructure their loan at whatever level they could afford to pay. Why would we do this? If they have the golden ticket, we know that they made a responsible decision to incur credit. Since they made a responsible decision to incur credit, any subsequent default would have to be the result of unforeseeable hardship or calamity. Thus, we would know that they were the very picture of the honest but unfortunate debtor that the bankruptcy laws are supposed to protect.

This would be a win-win solution for almost everyone. Once a few debtors were cast into outer darkness for taking out debts that they had no business incurring, other borrowers would learn to shy away from the "Don't Do It!!!!" stamp. On the other hand, if lenders knew that they would have to live with debtors holding the golden ticket, they might be more careful about who they lend to. Of course, the other possibility is that people won't learn and will keep making the same mistakes over and over again and that the only people who benefit will be the newly minted armies of credit counselors. However, at least we know that someone would benefit.

Disclaimer: No firm that I work for or any of their clients approves this proposal.