Saturday, June 28, 2014

The Trustee's Artistic Metaphor

Recently I attended a CLE seminar in which the learned professor discoursed on the difference between a metaphor and a simile.   A metaphor is a statement which is not literally true (for example, you never see a wolf actually wearing sheep's clothing) but conveys a truth through comparison.     This discussion came in handy when I came across the following pleading filed by Western District of Texas Trustee John Patrick Lowe who used Whistler's first nocturne as an extended metaphor for the disclosure provided to him in the case.  I provide the pleading for you in its entirety.

Case Summary

It's Whistler's first "nocturne", created in 1871 when he was only 37 years old.  The viewer is on the Battersea bank of the river Thames in London at night looking across to Chelsea on the other bank. A stylized barge is on the river. Lights on the far side of the river reflect across the river surface. And a figure, also stylized, appears on the near bank. An example of what Whistler called "art for art's sake". No lesson of any sort, religious, moral, ethical or otherwise, nothing informative, nothing historical.

Only something created for the thrill of it. And for the thrill created in certain viewers. It's also an example of the manipulation of facts, the suppression of some facts and the enhancement of others. Suppressed were the range of a normal pallette, what with blue, blue, blue but with minor hints of black to distinguish outlines and yellow to depict the reflection of lights on the river Thames. A hundred years later and without the detail it could very well be a "Blue Rothko". Also suppressed were details, something which would enable the viewer to tell where we are, what time of day it is or what's we're looking at. None of the bustle or activity of the day. No buildings really. And one's sense of proportion is put off by the size of the figure in relation to the barge and to objects on the far bank. Enhanced were color, mood, atmosphere. The picture is nothing if not atmospheric.

Paragraph 10 of the Debtor's Statement of Financial Affairs discloses her transfer of interests in real property in Orange and Tyler Counties, Texas to her daughters in May and August of 2012, less than two years prior to the commencement of the case.  Those statements and her testimony at the meetings of creditors were also an example  in the enhancement and suppression of facts. Suppressed were evidence of the value of the interests, the presence in the chains of title of, not necessarily oil and gas leases, but instruments disclosing oil and gas companies' intent to engage in seismic activity with respect to some of the interests, the brutal and extremely material fact that her daughters had peddled on most of what they'd acquired from their mother, the Debtor, shortly after having acquired those interests. Enhanced were her medical condition and the medical conditions of several family members, financial hardship, divorce and the so-called lack of any value to the interests, their extreme "sentimental value" to the family. The interests had been in the family for years and should stay in the family for years, the Trustee was told.

The Trustee had to interpret these stylized facts; adjust his point of view; use his imagination. He discovered the facts which had been suppressed: oil and gas activity; real objective value attributable to the mineral estates; real objective value attributable to the surface estates; the lack of sentimental value as perceived by the Debtor's daughters; the recent resale of most of the interests for dramatically increased prices.  And ignored the facts which had been emphasized. And at the end of the day, the Trustee had settled the estate's claims to avoid the transfers and recover the transferred interests for an amount sufficient to pay all allowed creditors claims a 100% dividend plus post-petition interest.

The Trustee's final report before distribution also proposes a small surplus distribution to the Debtor, her fee, as it were, for having created this beguiling work. Art for art's sake.
 John Patrick Lowe, Case No. 13-11741, Dkt. #25 (Bankr. W.D. Tex. 6/5/14).

Saturday, June 21, 2014

Lessons on Fees from the Fifth Circuit's ASARCO Decision

While the Fifth Circuit has yet to definitively address the quirky Pro-Snax opinion, a new decision provides some helpful guidance on recovering attorneys' fees in bankruptcy.    ASARCO, LLC v. Jordan Hyden Womble Culbreth & Holzer, P.C. (Matter of ASARCO, LLC), No. 12-40997 (5th Cir. 4/30/14).    You can read the opinion here

What Happened

ASARCO was a copper mining, smelting and refining company.  It used to have a really big smokestack in my home town of El Paso, but that's another story. Two years before bankruptcy, ASARCO's parent, Americas Mining Corporation (AMC), directed ASARCO to transfer a controlling interest in Southern Copper Corporation to it.   After ASARCO filed chapter 11 in 2005, its attorneys, Baker Botts and Jordan Hyden Womble Culbreth & Holzer, filed a fraudulent transfer action against the parent company.    The attorneys did a really good job.   They recovered a judgment valued at between $7-$10 billion which, according to the Fifth Circuit "was the largest fraudulent transfer judgment in Chapter 11 history."    When ASARCO sought to monetize its judgment, AMC decided that it would be cheaper to fund the company's reorganization instead.   As a result, ASARCO emerged from bankruptcy after just  52 months with "little debt, $1.4 billion in cash, and the successful resolution of its environmental, asbestos and toxic tort claims."    

You would think that everyone would be very happy with the work done by the attorneys.    The two firms applied for their lodestar fees plus a 20% enhancement as well as their expenses for preparing and litigating their fee applications.    ASARCO, which was now under the control of its parent, challenged the fees.   One discovery request sent to Baker Botts requested every document that the firm had produced during the bankruptcy case.   This resulted in production of 2,350 boxes of documents plus 189 GB of electronic data.   

After a six day trial, the Bankruptcy Court awarded Baker Botts $113 million in fees plus an enhancement of $4.1 million for the work performed on the fraudulent conveyance case.   Jordan Hyden recovered $7 million in fees as well as an enhancement of $125,000.   The Court also awarded fees for defending the fee applications, which amounted to $5 million for Baker Botts and $15,000 for Jordan Hyden.  

The District Court affirmed.

The Fifth Circuit's Ruling

The Fifth Circuit affirmed the enhancements but denied the fees for defending the fee applications.   Its analysis recapped the three-pronged approach adopted by the Court in In re Pilgrim's Pride Corp., 690 F.3d 650 (5th Cir. 2012) in which the Court held that fees should be determined under a combination of the lodestar approach, the factors specified in 11 U.S.C. Sec. 330(a) and the twelve factors from Johnson v. Georgia Highway Express, Inc., 488 F.2d 714 (5th Cir. 1974).    The Court explained that
Section 330(a), the lodestar method, and the Johnson factors work in conjunction with each other to guide the court's discretion.
Opinion. p. 6.   The Court further explained that the lodestar calculation (reasonable rates multiplied by a reasonable number of hours) provides the starting point for the analysis and that the lodestar amount can be adjusted up or down based upon the other factors.    The fact that the lodestar can be adjusted up provides the analytical basis for fee enhancements in "rare and extraordinary cases."   

The Court rejected challenges from ASARCO that fee enhancements could never be allowed, that enhancements had to be approved by the client and that enhancements could only be allowed where there was a "plus factor" in addition to extraordinary results.  

The Court also considered whether Baker Botts's fees were "below market" as found by the Bankruptcy Court.   The firm's blended rate was $353.98 per hour with partners charging $365-$800 per hour and associates billing $$195-$525 per hour.   The Court ruled that because "reasonable attorneys' fees in federal court have (not) been 'nationalized,'" it was improper to look at fees charged in other circuits.   Opinion, p. 10.   Nevertheless, the Court found that the Bankruptcy Court's finding was supported by enough evidence to survive clear error review.   Indeed, the rates charged by Baker Botts were less on a blended rate basis than any of the other firms in the case.   See In re ASARCO, LLC, 2011 Bankr. LEXIS 5487 (Bankr. S.D. Tex. 2011).

However, the Court was not persuaded by the award of fees for defending the fee application.   The Court stated:
We conclude that, correctly read, Section 330(a) does not authorize compensation for the costs counsel or professionals bear to defend their fee applications.
Opinion, p. 13.   The Court based this ruling on the language of section 330(a), which expressly allows fees for preparing a fee application but not for defending one.  
Parties in interest as well as the United States Trustee are entitled to receive notice and the opportunity for a hearing to question bankruptcy professional fees. Section 330(a)(1). Implicit in this procedure is the possibility of fee litigation. Nevertheless, Section 330 states twice, in both positive and negative terms paraphrased above, that professional services are compensable only if they are likely to benefit a debtor’s estate or are necessary to case administration. Matter of Pro-Snax Distributors, Inc., 157 F.3d 414, 418 n.7 (5th Cir. 1998). The primary beneficiary of a professional fee application, of course, is the professional. While the debtor’s estate or its administration must have benefitted from the services rendered, the debtor’s estate, and therefore normally the creditors, bear the cost. This straightforward reading strongly suggests that fees for defense of a fee application are not compensable from the debtor’s estate. The Eleventh Circuit adopted this interpretation in a factually similar case, holding that “. . . the issue is whether the services rendered were reasonable and necessary to the administration of the estate. [internal citation omitted] The answer to this question is no. The subject of the [appeal and cross-appeal] was the fee to be paid to [the professional] for his services rendered in the administration of the estate. The appeals brought absolutely no benefit to the estate, the creditors, or the debtor.”(citation omitted).  

Further supporting this interpretation is Section 330(a)(6), which limits potential professional fees in two ways. First, the specification of an award for “preparation of a fee application” is clearly different from authorizing fees for the defense of the application in a court hearing. Second, tailoring the award to the “level and skill reasonably required to prepare the application” emphasizes scrivener’s skills over other professional work. It is untenable to construe this language alone to encompass satellite litigation over a fee application. Had Congress intended compensation for professional fee applications to be allowable as “reasonable and necessary” under Section 330(a)(3)(C), there would have been no need to create the limits specified in subdivision (4). The broad reading of Section 330(a)(3)(C) urged by Baker Botts would render Section 330(a)(4) superfluous.
Opinion, pp. 13-14.   The Court then explained how the American rule weighed against fees for defense.
Because Congress designed fee shifting provisions in express derogation of the American Rule that each party to litigation bears its own costs, the losing party should bear the full costs of counsel for the winner. In bankruptcy, the equities are quite different. Both the debtor and creditors have enforceable rights, and there is a limited pool of assets to satisfy those rights and compensate court-approved professionals; in certain cases, moreover, professionals paid from the debtor’s estate represent competing interests. No side wears the black hat for administrative fee purposes. In the absence of explicit statutory guidance, requiring professionals to defend their fee applications as a cost of doing business is consistent with the reality of the bankruptcy process. The perverse incentives that could arise from paying the bankruptcy professionals to engage in satellite fee litigation are easy to conceive.  (emphasis added).
Opinion, p. 16.

The Court dismissed the argument that denying fees for defense of a fee application would encourage excessive fee litigation with the comment that
Too frequently, court-appointed counsel for debtor[’s] and the official creditor committees’ interests in a case, sharing the mutual goal of securing approval for their fees, enter into a conspiracy of silence with regard to contesting each other’s fee applications. (citation omitted).
Opinion, p. 18.  Nevertheless, the Court allowed that fees for defense could be allowed where "an adverse party has acted in bad faith, vexatiously, wantonly, or for oppressive reasons."   Opinion, p. 19.

Thus, the final result was that Baker Botts was able to retain its enhancement of $4.1 million but lost its fees for defense of $5 million.   Jordan Hyden fared slightly better, retaining its enhancement of $125,000 while having $15,000 in cost of defense fees cut.   The Court tried to place this loss in context, stating:
In this case, the huge cost of defending Baker Botts's core fees seems a drastic reduction in absolute terms, but it amounts to only about 4.4% of the core fee.
Opinion, p. 17.   Thus, the message to Baker Botts from the appellate court was you did an amazing job, but you still have to pay the cost of proving that you did an amazing job.

Take-Aways from the Opinion

While this opinion addresses two very discrete issues, the extensive discussion contains some important lessons about attorneys' fees in bankruptcy.

  1. The accolades heaped upon Baker Botts are a measure of respect for the bankruptcy profession.   Even though Baker Botts plays in a more rarified world than the average bankruptcy practitioner, recognition for one bankruptcy professional is approval for the profession as a whole, just as incompetent, dishonest or mercenary behavior by bankruptcy lawyers tends to diminish it.    
  2. The Fifth Circuit has re-affirmed the unique amalgamation of three tests first announced in Pilgrim's Pride.   Professionals litigating attorneys' fees in the Fifth Circuit cannot simply rely on the language of the statute, but should consider whether the other two tests enhance or detract from their position.
  3. The Court's comments about national vs. regional fees reflect a compromise position between the efficiency of administration standard under the Bankruptcy Act and the "greed is good" mantra of Gordon Gecko.    While bankruptcy is no longer the poor stepsister of the legal practice, professionals cannot charge amounts exceeding the local prevailing rate simply because that is what they charge in some other, more expensive jurisdiction.
  4. The Fifth Circuit mentioned Pro-Snax, but not for its most infamous holding.   While the lower courts have struggled to implement the "tangible, identifiable and material benefit" standard, the Fifth Circuit has not revisited this language since its 1998 debut.   In this opinion, the Court mentioned one of Pro-Snax's less controversial statements that fees must be likely to benefit the estate or necessary to administration in order to be compensable.  This may be a signal from the Circuit that it will focus on the parts of the opinion that are uncontroversial while de-emphasizing the questionable language.     
  5. The Court recognized that challenging another professional's fees, while distasteful, is an important part of the process.   The Court's warning against the "conspiracy of silence" as well as its no black hats in fee litigation suggest that professional fees should be exposed to the same adversary process as other facts required to be determined by the courts.   While it may be easier to let the U.S. Trustee or the bankruptcy court do the heavy lifting, the parties will often have the most knowledge and incentive to develop the record.

Saturday, June 14, 2014

Supreme Court Denies Exemption for Inherited IRAs But Texas Debtors May Still Be Able to Keep Them

Most Americans don’t save enough money for retirement.   However, the Supreme Court recently dealt with the opposite situation—what happens when someone saves more than they need and their heirs receive the money (and then file bankruptcy).   

This is the third time that the high court has considered what happens to retirement funds in bankruptcy.  In Patterson v. Shumate, 504 U.S. 753 (1992), the Court held that funds in an employer's pension plan were not property of the estate. In Rousey v. Jacobsen, 544 U.S. 320 (2005), the Court ruled that non-inherited IRAs were included under the exemption for “a stock bonus, pension, profitsharing, annuity, or similar plan or contract” under 11 U.S.C. §522(d)(10)(E).  This time, the Court held that an inherited IRA does not constitute “retirement funds” under 11 U.S.C. §522(b)(3)(C) and 522(d)(12).    Clark v. Rameker, Trustee, No. 13-299 (6/12/14).    The opinion can be found here.   

While the opinion denies the exemption under two subsections of the Bankruptcy Code, it does not address exemptions under state law.   As will be discussed below, this makes a big difference for Texas debtors.   

What Happened

The facts are pretty straightforward.   Ruth Heffron established a traditional IRA in 2000 and passed away the next year.   Her daughter and beneficiary, Heidi Heffron-Clark, received the IRA and elected to take monthly distributions from it.    In October 2010, she and her husband filed bankruptcy.    She claimed the $300,000 in the inherited IRA under both Wisconsin law and 11 U.S.C. §522(b)(3)(C).    The Bankruptcy Court ruled against her on both grounds.   In re Clark, 450 B.R. 858 (Bankr. W. D. Wisc. 2011).   The District Court reversed, but the Seventh Circuit reinstated the Bankruptcy Court’s ruling.  In re Clark, 714 F.3d 559 (7th Cir. 2013).    The Supreme Court granted cert to resolve the conflict between the Seventh Circuit and the Fifth Circuit’s decision in In re Chilton, 674 F.3d 486 (5th Cir. 2012). 
Exemption Statutes and Types of IRAs

Retirement accounts can be broken into two main categories:   employer plans and individual retirement accounts (IRAs).   Employer plans are required to contain anti-alienation language which the Supreme Court previously held was sufficient to keep them from ever becoming property of the estate.

IRAs do not have the same anti-alienation protection.  As a result, they come into the bankruptcy estate and only come out if there is an applicable exemption statute.    Prior to 2005, IRAs could be exempted under state law under 11 U.S.C. §522(b)(3)(A) or under 11 U.S.C. §522(d)(10) in the handful of states that permitted use of the federal exemptions.   Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Congress allowed Debtors electing state or federal exemptions to claim:
retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986.
11 U.S.C. §522(b)(3)(C) and (d)(12).   The effect of this amendment was that all debtors could keep those funds so long as they were “retirement funds” and were in a fund or account exempt from taxation under the listed sections of the Internal Revenue Code. 
IRAs are governed by 26 U.S.C. §§408 and 408A.   As a result, they fall within the enumerated sections.    According to the Supreme Court, there are three types of IRAs.   Under a conventional IRA, contributions are tax deductible, while under a Roth IRA, qualified distributions are tax free.    Both types of accounts are subject to a 10% penalty if funds are withdrawn prior to age 59 ½.     (Remember when you were a kid and you were quick to point out that you were 7 ½ as opposed to just 7?   With IRAs, your half-birthday becomes important once again).   

The third type of IRA is an inherited IRA.    If the beneficiary is the deceased’s spouse, they can roll the funds over into their own IRA account in which case, they become part of the conventional or Roth IRA.   However, if the beneficiary is not a spouse or if the spouse elects not to take the roll over, they can be treated as an inherited IRA.    Funds can be withdrawn from an inherited IRA at any time without penalty.   The beneficiary must either withdraw all of the funds within five years or elect to take minimum distributions on an annual basis.   The beneficiary cannot make additional contributions into the account.   

The Supreme Court’s Ruling

Engaging in its role as dictionary of last resort, Justice Sonia Sotomayor’s opinion explored what it meant for funds to be “retirement funds.”   Because the relevant statutes do not define “retirement funds,” the court attempted to divine the term’s “ordinary meaning.”  Opinion, p. 4.

Justice Sotomayor found three reasons why inherited IRAs were not “retirement funds”:
Three legal characteristics of inherited IRAs lead us to conclude that funds held in such accounts are not objectively Three legal characteristics of inherited IRAs lead us to conclude that funds held in such accounts are not objectively set aside for the purpose of retirement. First, the holder of an inherited IRA may never invest additional money in the account. 26 U. S. C. §219(d)(4). Inherited IRAs are thus unlike traditional and Roth IRAs, both of which are quintessential “retirement funds.” For where inherited IRAs categorically prohibit contributions, the entire purpose of traditional and Roth IRAs is to provide tax incentives for accountholders to contribute regularly and over time to their retirement savings.

Second, holders of inherited IRAs are required to withdraw money from such accounts, no matter how many years they may be from retirement. Under the Tax Code, the beneficiary of an inherited IRA must either withdraw all of the funds in the IRA within five years after the year of the owner’s death or take minimum annual distributions every year. See §408(a)(6); §401(a)(9)(B); 26 CFR§1.408–8 (Q–1 and A–1(a) incorporating §1.401(a)(9)–3 (Q–1 and A–1(a))). Here, for example, petitioners elected to take yearly distributions from the inherited IRA; as a result, the account decreased in value from roughly$450,000 to less than $300,000 within 10 years. That the tax rules governing inherited IRAs routinely lead to their diminution over time, regardless of their holders’ proximity to retirement, is hardly a feature one would expect of an account set aside for retirement.

Finally, the holder of an inherited IRA may with draw the entire balance of the account at any time—and for any purpose—without penalty. Whereas a withdrawal from a traditional or Roth IRA prior to the age of 59½ triggers a 10 percent tax penalty subject to narrow exceptions, see n. 4, infra—a rule that encourages individuals to leave such funds untouched until retirement age—there is no similar limit on the holder of an inherited IRA. Funds held in inherited IRAs accordingly constitute “a pot of money that can be freely used for current consumption,” 714 F. 3d., at 561, not funds objectively set aside for one’s retirement.
Opinion, pp. 5-6.

Because “plain meaning” analysis is never quite so plain as its proponents contend (especially if the case has made its way to the Supreme Court), the Court buttressed its ruling with policy considerations.    Among them, the purpose of an exemption is to allow the debtor to meet “essential needs.”   Encouraging (although not requiring) debtors to keep their funds in an IRA until after age 59 ½ sort of aligns with the goal of ensuring that debtors have sufficient funds to support themselves in their golden years and do not become a burden on society.   On the other hand, inherited IRAs can be freely withdrawn and could be used on “a vacation home or sports car immediately after her bankruptcy proceedings are complete.”   Opinion, p. 7.   This conclusion seems a bit strained.   Funds in a conventional or Roth IRA could also be used for wild living once the bankruptcy was over; it’s just that there would be tax consequences if the person was under age 59 ½.   Further, in an age when the full retirement age is 67 and rising, being allowed to utilize fund at age 59 ½ means that they will likely be used as a stopgap to carry the person to retirement rather than funding actual retirement costs.

Another factor which was not mentioned in the opinion was that the Debtors had $300,000 in the inherited IRA and had unsecured debts scheduled of $311,000.    As a result, the Debtors could have used the funds to settle with their creditors and likely had money left over.   Instead, they tried to file bankruptcy and keep it all.  While there is nothing wrong with using the tools made available by the law, avoiding a windfall to the Debtors at the expense of the creditors could have been rolling around in the back of the justices’ minds.

Thus, inherited IRAs cannot be retained in a bankruptcy proceeding—except for the cases in which they can.

What It Means

The Court’s opinion only addressed 11 U.S.C. §522(b)(3)(C) and (d)(12).    It did not address either exemptions under applicable state law.    In the Clark case, the Bankruptcy Court had ruled that Wisconsin law did not include an exemption for inherited IRAs.   However, the relevant Texas statute provides:
(a) In addition to the exemption prescribed by Section 42.001, a person's right to the assets held in or to receive payments, whether vested or not, under any stock bonus, pension, annuity, deferred compensation, profit-sharing, or similar plan, including a retirement plan for self-employed individuals, or a simplified employee pension plan, an individual retirement account or individual retirement annuity, including an inherited individual retirement account, individual retirement annuity, Roth IRA, or inherited Roth IRA, or a health savings account, and under any annuity or similar contract purchased with assets distributed from that type of plan or account, is exempt from attachment, execution, and seizure for the satisfaction of debts to the extent the plan, contract, annuity, or account is exempt from federal income tax, or to the extent federal income tax on the person's interest is deferred until actual payment of benefits to the person under Section 223, 401(a), 403(a), 403(b), 408(a), 408A, 457(b), or 501(a), Internal Revenue Code of 1986, including a government plan or church plan described by Section 414(d) or (e), Internal Revenue Code of 1986. For purposes of this subsection, the interest of a person in a plan, annuity, account, or contract acquired by reason of the death of another person, whether as an owner, participant, beneficiary, survivor, coannuitant, heir, or legatee, is exempt to the same extent that the interest of the person from whom the plan, annuity, account, or contract was acquired was exempt on the date of the person's death. If this subsection is held invalid or preempted by federal law in whole or in part or in certain circumstances, the subsection remains in effect in all other respects to the maximum extent permitted by law. (emphasis added).
Tex.Prop.Code §42.0021(a).    The language specifically including inherited IRAs was added to the statute in 2013 after a Texas Bankruptcy Court concluded that inherited IRAs were not exempt under state law.   In re Jarboe, 365 B.R. 717 (Bankr. S. D. Tex. 2007).  (Given the dysfunctional nature of the Texas legislature, Judge Bohm should be proud of the fact that his opinion prompted them to do something, even if it was to legislatively overrule his decision).  The fact that the Texas legislature amended the statute to add specific language about inherited IRAs is pretty good evidence that they really intended these accounts to be exempt.    

 The practice tips for Texas debtors are:
  1. If you are in financial difficulty, leave the money in the inherited IRA.   If you pull it out, it may lose its protection.
  2. If you have an inherited IRA, always choose Texas state exemptions.
  3. If you don’t live in Texas, move here and wait two years (but please don't move to Austin as there are too many people here already).
  4. If you can settle with your creditors and then withdraw the funds, you might want to do so.   The best bankruptcy you can ever have is sometimes the one you don’t file.
Hat-tip to Quincy Long with Quest IRA, Inc. who pointed out the new language in the Texas Property Code to me.

Tuesday, June 10, 2014

Supreme Court Dodges Consent Issue in Bellingham But Signals No New Challenges to Bankruptcy Court Authority

In the follow-up to Stern v. Marshall, the Supreme Court concluded that it didn’t need to answer the primary questions addressed to it, leaving open (on the surface at least) the issue of whether parties can consent to final adjudication by a bankruptcy court in situations where the court could not otherwise issue a final decision.   The Court also assumed but did not decide the question of whether a fraudulent conveyance action would violate Stern.   In fact, the only issue the Court did decide was that bankruptcy courts may issue reports and recommendations in core proceedings where they lack authority to make a final ruling.   While the decision is not as expansive as many practitioners would have liked, it doesn’t do any violence to the bankruptcy system and has some helpful subtext.  The case is Executive Benefits Insurance Agency v. Arkison (In re Bellingham Insurance Agency, Inc.), No. 12-1200 (June 9, 2014).   You can find the opinion here.

What Happened

Nicholas Palaveda and his wife owned Bellingham Insurance Agency, Inc. (BIA).   Palaveda used Bellingham’s assets to set up a new business, Executive Benefits Insurance Agency, Inc.  (EBIA).   When BIA filed bankruptcy, its trustee, Arkison, sued EBIA to recover the assets as a fraudulent transfer.   EBIA did not assert its right to a hearing before an Article III judge and either consented to adjudication by the Bankruptcy Court or waived its right to district court review.   Arkison filed a motion for summary judgment which was granted.   The District Court affirmed the Bankruptcy Court.   Because this was a review of a summary judgment, the District Court’s review was necessarily on a de novo basis.  

 The Ninth Circuit, after inviting amicus briefs, affirmed.   It found that while a fraudulent conveyance action was not within the Bankruptcy Court’s authority to enter a final decision, that EBIA had consented to the Bankruptcy Court’s authority and could not question it on appeal.   Thus, the Ninth Circuit answered two important questions:  1) did the Bankruptcy Court have final authority to rule on a fraudulent conveyance (no); and 2) could the parties consent to the Bankruptcy Court’s ability to enter a final ruling (yes).

The Supreme Court’s Ruling

Unless the contentious ruling in Stern, Bellingham was a 9-0 decision comprising a scant 13 pages of text.    The Court avoided ruling on either of the main conclusions of the Ninth Circuit, assuming without deciding that fraudulent conveyance claims violated Stern and finding that it need not reach the consent issue.   As will be discussed below, the opinion is more significant for what it implies than what it decided.

The court began with a history of bankruptcy jurisdiction, taking practitioners through the familiar history of summary vs. plenary jurisdiction under the Bankruptcy Act, the expansive but unconstitutional jurisdiction granted under the Bankruptcy Reform Act of 1979 and the core vs. non-core dichotomy enacted by the Bankruptcy Amendments and Federal Judgeship Act of 1984.  

The core vs. non-core distinction attempted to remedy the finding of unconstitutionality contained in Northern Pipeline Construction Co. v. Marathon Pipeline Co., 458 U.S. 50 (1982).    According to Justice Thomas,
The 1984 Act largely restored the bifurcated jurisdictional scheme that existed prior to the 1978 Act.   The 1984 Act implements that bifurcated scheme by dividing all matters that may be referred to the bankruptcy court into two categories: “core” and “non-core” proceedings.
Opinion, p. 6.  In a footnote, Justice Thomas noted that the “core” designation tracked language used by the plurality opinion in Northern Pipeline.

Justice Thomas summarized the current working of the bankruptcy system as follows:
Put simply:  If a matter is core, the statute empowers the bankruptcy judge to enter final judgment on the claim, subject to appellate review by the district court.   If a matter is non-core, and the parties have not consented to final adjudication by the bankruptcy court, the bankruptcy judge must propose findings of fact and conclusions of law.   Then the district court must review the proceeding de novo and enter final judgment. (emphasis added).
Opinion, p. 7.

In several brief passages, the Court addressed what the Stern decision did and did not address.  According to Justice Thomas, Stern “considered a constitutional challenge to the statutory designation of a particular claim as ‘core.’”  The answer was that “some claims labeled by Congress as ‘core’ may not be adjudicated by a bankruptcy court in the manner designated by §157(b).”    Left unanswered in Stern was “how the bankruptcy court should proceed in those circumstances.”   Id.  

This led up to the main question actually addressed by Bellingham (as opposed to the ones it granted cert on):  whether there is a gap in the statutory scheme of core vs. non-core.   BAFJA allowed entry of final orders on core matters and proposed findings in non-core.   What to do with core proceedings in which bankruptcy courts cannot constitutionally enter a final judgment?   Are these matters left in limbo, incapable of being resolved?   The sensible answer from the Supremes is no.    BAFJA, like most statutes, contains a severability clause.   The Court concluded that any matter upon which the bankruptcy courts cannot properly enter a final judgment should simply be treated as non-core.   
The plain text of this severability provision closes the so-called “gap” created by Stern claims.   When a court identifies a claim as a Stern claim, it has necessarily held “invalid” the application of §157(b)—i.e., the “core” label and its attendant procedures—to the litigant’s claim.   (citation omitted).    In that circumstance, the statute instructs that “th[e] remainder of the Act . . . is not affected thereby.  (citation omitted).   That remainder includes §157(c), which governs non-core proceedings.   With the “core” category no longer available for the Stern claim at issue, we look to §157(c)(1) to determine whether the claim may be adjudicated as a non-core claim—specifically, whether it is “not a core proceeding” but is “otherwise related to a case under Title 11.”    If the claim satisfies the criteria of §157(c)(1), the bankruptcy court simply treats the claims as non-core:  the bankruptcy court should hear the proceeding and submit proposed findings of fact and conclusions of law to the district court for de novo review and entry of judgment.
Opinion, pp. 9-10.

In the particular case, the bankruptcy court should have submitted proposed findings and conclusions to the district court which would then conduct a de novo review and enter judgment.  As Justice Thomas noted, “(a)lthough this case did not proceed in precisely that fashion, we affirm nevertheless.”    Opinion, p. 12.    When a court grants summary judgment, its order is reviewed as a matter of law, which is de novo review.   Thus, the district court did conduct a de novo review and did enter a judgment affirming the bankruptcy court.   As a result, the substance of the law was satisfied.
In light of the procedural posture of this case, however, we need not decide whether EBIA’s contentions are correct on either score.   At bottom, EBIA argues that it was entitled to have an Article III court review de novo and enter final judgment on the fraudulent conveyance claims asserted by the trustee.   In effect, EBIA received exactly that.
Opinion, p. 12.   Thus, the opinions of the lower courts were affirmed and Mr. Palaveda’s scheme remained unraveled notwithstanding the detour to the Supreme Court.

So What Did the Court Decide?

Prudentialism is the school of supreme court jurisprudence that says that the court should decide as little as possible to conserve the court’s power and prestige.  It can also be described as passive-aggressive judging. This was certainly an example of prudential review.    No doubt it is frustrating to the litigants to go all the way to the Supreme Court without receiving answers on the main questions that they briefed.   However, the Court’s non-answers to the larger questions may speak volumes.

First, the court preserved the core vs. non-core system that we have been operating under since 1984.   In the wake of Stern v. Marshall, many commentators had declared this structure to be a dead letter, since it was unconstitutionally overbroad.   Not so, says the high court.  It simply needs to be fine-tuned by our friend severability.   This should properly be viewed as a signal, although oblique, that the Supreme Court does not wish to throw out the bankruptcy system as some had feared.

Second, while the court did not expressly decide the consent issue, it did so indirectly.   By saying that core but unconstitutional matters should be treated as non-core under the statutory procedures of 28 U.S.C. §157(c), the court referred to a statutory provision which included consent.   Indeed, Justice Thomas’s discussion of the statutory scheme expressly stated that proposed findings and conclusions are only necessary where the parties have not consented.   If consent was not constitutionally viable, the Court would have been expected to at least drop a footnote stating that they were not opining on that portion of the law.    When Justice Thomas said that courts should follow §157(c), which includes consent, he was implicitly upholding consent.

Finally, while the Court did not rule on whether fraudulent conveyance claims failed the Stern test, it noted that no party had disputed this conclusion.   Thus, while it is not a direct holding, it is a clear signal.   

In my opinion, Bellingham is a signal from a unanimous Court that the BAFJA core vs. non-core system still works, although it needed to be tweaked.   The new “core” proceedings will look somewhat like the old summary jurisdiction under the Bankruptcy Act.   Proceedings intended to augment the estate which are not necessary to determination of a claim, will now be considered non-core matters regardless of how Congress classified them in 1984.

However, I do see one big issue that remains to be decided.   What happens if a Bankruptcy Court enters a final judgment on a matter that is constitutionally non-core and no party seeks de novo review from the District Court?   Is that an invalid judgment that can be collaterally attacked or does the failure to seek de novo review constitute consent?    Must there be actual de novo review or merely the opportunity for de novo review?  There are certainly other questions lingering out there as well.   This means that while the boat has not been capsized (at least for today), we have not felt the last ripples from Stern v. Marshall.