Debtors Have to Show Up for 727 Trials: A Cautionary Tale

 A recent Fifth Circuit opinion brought back memories of a case I was involved with as a young lawyer. The lesson to be learned is that debtors are required to appear for a hearing on a complaint objecting to discharge regardless of whether they have been subpoenaed. Fed.R.Bankr.P. 4002(a)(2) requires a debtor to "attend the hearing on a complaint objecting to discharge and, if called, testify as a witness." In a recent Fifth Circuit opinion, Judge Edith Jones found that the debtor violated the rule but that it was harmless error. In a case I was involved with, the court was prepared to deny the discharge based on failure to appear.  The Fifth Circuit case is Black v. Triplett (In re Triplett), Case No. 25-40520 (5th Cir. 8/6/26), which can be found here. 

Fifth Circuit Opinion on Solvent Debtor Illustrates Tension Between Text and Tradition

Bankruptcy opinions tend to rely on two major tools for interpreting the Bankruptcy Code: the statutory text and pre-Bankruptcy Code practice. These two methods came into conflict in the Fifth Circuit's recent opinion in Ultra Petroleum Corp. v. Ad Hoc Committee (In re Ultra Petroleum), No. 21-20008 (5th Cir. 10/14/2022), which can be found here.   The majority relied on pre-Code practice to allow creditors of a solvent debtor to recover their full contractual interest. 

Nevertheless, FERC Persisted

When U.S. Sen Elizabeth Warren continued to speak at the confirmation hearing for AG Jeff Sessions after being cautioned by Majority Leader Mitch McConnell, it gave rise to the feminist slogan, "Nevertheless, she persisted." A new opinion from the Fifth Circuit adapts that slogan to the Federal Energy Regulatory Commission's attempts to prevent debtors from rejecting regulatory energy contracts. Judge Jerry Smith's opinion in Case No. 21-60017, Gulfport Energy Corporation v. Federal Energy Regulatory Commission (5th Cir. 7/19/22) points out that the Fifth Circuit and others have held that debtors "may 'reject' regulated energy contracts even if (FERC) would not like them to." Noting that FERC continued to press the issue, Judge Smith noted that "Nevertheless, FERC persisted." While many believe that Sen. Warren got the better of Majority Leader McConnell in their exchange, the Bankruptcy Code came out on top in the Fifth Circuit's new decision.

Fiffth Circuit Restricts Rooker-Feldman Doctrine Allowing Race to the Courthouse

The Fifth Circuit has issued a new decision restricting application of the Rooker-Feldman doctrine and repudiating a prior precedent.  Miller v. Dunn, Case No. 20-11054 (5th Cir. 6/2/22), which can be found here. Under the new rule, which brings the Fifth Circuit in line with other courts, Rooker-Feldman does not apply to a state court decision which is the subject of a pending appeal.

Rooker-Feldman is one of several doctrines which enforces comity between state and federal courts. The Rooker-Feldman doctrine, which is based on Rooker v. Fidelity Trust Co., 263 U.S. 413 (1923), and District of Columbia Court of Appeals v. Feldman, 460 U.S. 462 (1983) means that a federal court may not review and reverse a determination of a state court. Rooker-Feldman applies to "cases brought by state-court losers complaining of injuries caused by state-court judgments rendered before the district court proceedings commenced and inviting district court review and rejection of those judgments." Exxon Mobil Corp. v. Saudi Basic Indus. Corp., 544 U.S. 280, 284 (2005).

Fifth Circuit Opinion Illustrates Risks of Class Proofs of Claim

A new opinion from the Fifth Circuit highlights the perils of class proofs of claim, something I recently wrote about here. In West Wilmington Oilfield Claimants v. Nabors Corporate Services, Inc. (Matter of CJ Holding Company), Case No. 21-20394 (5th Cir. 3/10/22), the Fifth Circuit upheld a bankruptcy court decision which denied creditors covered by a putative class claim permission to file late claims. The opinion can be found here.

What Happened

In 2015, two former employees of an oilfield services company filed a class action in California state court. C & J Well Services, the defendant, removed the case to federal court. The defendant sought to enforce a company-wide arbitration agreement and class action waiver. The district court denied the motion. C & J appealed the case to the Ninth Circuit.

In July 2016, while the appeal was pending, C & J and several of its affiliates filed bankruptcy in the Southern District of Texas. The Court entered an order setting a bar date and the deadline was advertised in national publications as well as by notice sent to creditors. The putative class representatives filed a proof of claim on behalf of the class for over $14 million. Twenty-seven individual claimants filed their own proofs of claim. A plan was confirmed which denied and expunged all claims filed after the bar date.

The Debtor also entered into a settlement agreement with Nabors Corporate Services to indemnify it for any allowed claims and authorized Nabors to object to any claims subject to the indemnity agreement. Nabors was an affiliate of a company which had merged into the Debtor which had employed the persons bringing the employment claims.

In February 2017, the bankruptcy court issued an order allowing the parties to the Ninth Circuit appeal to prosecute the appeal. In February 2018, the Ninth Circuit reversed the District Court and held that the arbitration and class waiver provisions were enforceable. Ninety-six claimants filed individual arbitration proceedings. However, only twenty-seven of these had filed individual proofs of claim.

In October 2018, Nabors filed an omnibus objection to the various employment proofs of claim. The Bankruptcy Court ruled that the two class representatives and the twenty-seven additional creditors who had filed individual proofs of claim could proceed with the arbitrations but that the remainder could not rely on the class proof of claim.

The Bankruptcy Court advised the claimants who had not filed claims that they could request leave to file late claims. The non-filing claimants did not file their motion for late-filed claims until August 2019, nearly two years after the bar date. After a hearing the Bankruptcy Court denied the motion. The claimants appealed to the District Court which reversed. Nabors then appealed to the Fifth Circuit. 

 

The Court's Ruling

The Fifth Circuit ruled that the Bankruptcy Court was correct in denying leave to file a late claim. How a tardily filed claim treated depends on the chapter. In Chapter 7, a late-filed claim is allowed but is subordinated to all timely-filed claims. 11 U.S.C. Sec. 726(a)(3). There is no provision for late-filed claims in Chapter 13, except that a debtor or trust may file a claim for a creditor within thirty days from the original bar date. In Chapter 11, a claim may be filed after the bar date if the late filing was the result of "excusable neglect." The Supreme Court has established a four-part test for excusable neglect: (1) “the danger of prejudice to the debtor,” (2) “the length of the delay and its potential impact on judicial proceedings,” (3) “the reason for the delay, including whether it was within the reasonable control of the movant,” and (4) “whether the movant acted in good faith.” Opinion, p. 8. 

The Fifth Circuit concluded that the risk of prejudice to the debtor weighed in favor of the claimants because the claims were known to the debtor and because Nabors had agreed to indemnify the debtor. 

 

However, the length of delay was another story. The creditors waited two years and nine months after the bar date had passed and one year and seven months after the Ninth Circuit held that the class action was not a viable remedy.  Adding 67 more arbitrations would add anywhere from two to three months to years to the process. 

 

Next the court found that the claimants had failed to reasonably explain the cause for the delay.  Excusable neglect "is the failure to timely perform a duty due to circumstances that were beyond the reasonable control of the person whose duty it was to perform." The Court found that most of the reasons proffered for the late filings were within the reasonable control of the creditors. 

 

Finally, the Court ruled against the claimants on the good faith prong. 

The Debtors argue that the Claimants’ and their counsel’s failure to act diligently throughout the bankruptcy proceeding was so severe that it undermines their argument that they acted in good faith. We agree. To be sure, we have not held authoritatively that lack of diligence constitutes bad faith per se. Nor do we do so now. But other courts have held, in persuasive fashion, that lack of diligence can at least cast doubt on a claim of good faith.

Opinion, p. 19. Thus, the Fifth Circuit agreed with the Bankruptcy Court with regard to three out of four factors. The Court noted that the standard of review was deferential to the Bankruptcy Court and thus reinstated its ruling denying leave to amend. 

Why It's Significant

This case illustrates the danger in filing a class proof of claim. In evaluating good faith, the Court stated:

Granted, the majority of circuits that have addressed the issue permit class proofs of claim. (citation omitted). However, this court has not spoken definitively on the issue. Yet, since 2016, the Claimants have ostensibly proceeded under the assumption that a class proof of claim would ultimately be available to them. Such is not settled law in this Circuit, and the Claimants’ reliance on unsettled law casts serious doubt on their claim of good faith.

Second, even if the Claimants had moved the bankruptcy court to apply Rule 23 to their purported class proof of claim, they had a second hurdle to overcome. Namely, the bankruptcy court would still have had to certify the class proof of claim. Only once the bankruptcy court determines, in its discretion, that Rule 23 applies does it then evaluate whether the proposed class meets Rule 23’s requirements.

Opinion, pp. 20-21. There are many things that can go wrong when individual creditors rely on a putative class rep to file a class claim. First, the jurisdiction might conclude that there is no authority for class claims. The class rep might fail to seek class certification in the bankruptcy court. If class certification is sought and denied, it would likely be after the bar date. 

One question that is left unanswered by the opinion is the specific notice that the individual claimants received. Notice is essential to due process. It is the debtor's burden to provide that notice. Given that twenty-nine claimants knew to file claims, there is an inference that notice was good. 

 

So what should the putative class reps have done? First, they should have moved for class certification immediately in the Bankruptcy Court. As I have discussed elsewhere, Fed.R.Bankr.P. 7023 allows class actions in bankruptcy. However, there is no specific rule authorizing class proofs of claim. Thus, a class claim must be treated as a class action within the bankruptcy. Second, the putative class reps should have moved to extend the bar date for claimants within the class prior to expiration of the bar date. It is much easier to extend the bar date before it has expired than it is to get permission for a late-filed claim. Finally, this case illustrates why creditors should engage knowledgeable bankruptcy counsel before dealing with these difficult issues. 

Fifth Circuit Upholds Injunctive Relief Against Single-Member Limited Liability Company

 One of the benefits of holding property or doing business through a limited liability company is that "entry of a charging order is the exclusive remedy by which a judgment creditor of a member or of any other owner of a membership interest may satisfy a judgment out of the judgment debtor's membership interest." Tex.Bus.Org. Code Sec. 101.112(d). But just how exclusive is that right? A recent Fifth Circuit opinion holds that a court may impose additional conditions on a judgment debtor's LLC in the name of carrying out the court's orders.  Thomas v. Hughes, Case No. 20-50827 (5th Cir. 3/3/22), a copy of which can be found here.

Fifth Circuit Opinion Upholds Limits on Actions Between Non-Debtors

 In a case involving multiple parties and proceedings, the Fifth Circuit has affirmed lower court rulings which prohibited one non-debtor from suing a second non-debtor and awarded sanctions against a party that told a state court to disregard the Bankruptcy Court's orders. In the Matter of PFO Global, Incorporated, Case No. 20-10885 (5th Cir. 2/9/22), which can be found here. While the result may sound extreme, it appears to be an unintended consequence of an agreed order entered years earlier.

Defaulting Auction Bidder Finds Evidentiary Mess

A new opinion from the Fifth Circuit shows multiple mishaps in connection with a bankruptcy-related auction. However, its most important holding has to do with authenticating evidence. The bottom line is that a trial court decision limiting a defaulting bidder's damages based on a webpage found on the Wayback Machine was reversed. Weinhoffer v. Davie Shoring, Inc., Case No. 20-30568 (5th Cir. 1/20/22).  You can find the opinion here. 

Fifth Circuit Binds Debtor to Plan Terms in Subsequent Case

 Recently I wrote about a Fifth Circuit case where a creditor tried to escape the terms of a confirmed plan in a subsequent case. Now the Court has written an opinion about a debtor that tried to do the same thing. Fortunately the result was the same in both cases: res judicata applied. BVS Construction, Inc. v. Prosperity Bank (Matter of BVS Construction, Inc.), Case No. 21-50274 (5th Cir. 11/15/21). You can find the decision here. 

Fifth Circuit Reminds Courts About Summary Judgment Standard

Summary judgment was intended to be a method of disposing of cases where there are not any disputed issues for the court to trial. Sometimes it seems that summary judgment is a way to get rid of cases that the court doesn't want to try. In a new opinion about insurance coverage, the Fifth Circuit has reminded lower courts that no genuine issue of material fact means exactly that. Guzman v. Allstate Assurance Company, Case No;. 20-11247 (5th Cir. 11/10/21).  While this is not a bankruptcy case, it has important lessons for attorneys practicing in the federal system.

Fifth Circuit Binds Creditor To Plan Terms in Subsequent Case

Third party releases are a controversial topic with Congress considering legislation to ban them. However, Judge Greg Costa, writing for the Fifth Circuit, has distinguished between an impermissible third-party release and a plan provision reducing a guarantor's liability in a new opinion.  New Falls Corporation v. LaHaye (Matter of LaHaye), No. 19-30795 (5th Cir. 11/12/21) which can be found here.

Change in Trial Location Renders Non-Party Deposition Admissible

Depositions serve two important functions in pre-trial procedure. First, they can be used to discover what a witness or party will say and tie down the witness’s story. Second, they can be used to create testimony which can be used at trial. However, the ability to use a non-party deposition at trial differs between Texas state and federal courts, a distinction which can be important into an attorney’s trial preparation. A recent decision from the Fifth Circuit highlights this distinction. Case No. 20-50604, Spectrum Association Management of Texas, LLC v. Lifetime HOA Management, LLC. (5^th Cir. 7/13/21). A copy of the decision can be found here. 

Maryland Bankruptcy Court Opinion Shows Difficulty of Applying Arbitration in Bankruptcy Setting

Bankruptcy and arbitration are both intended to provide a quick and relatively efficient resolution to disputes between a debtor and his creditors. Both allow adjudication without a jury. Both systems should be able to move more swiftly than a court of general jurisdiction because there are no competing priorities, such as in criminal cases subject to the requirement of a speedy trial. Both are recognized by federal law, specifically the Federal Arbitration Act and the Bankruptcy Code. So what happens when a party to a bankruptcy proceeding requests permission to proceed with arbitration? The Court in In re McPherson, 2021 Bankr. LEXIS 1487 (Bankr. D. Md. 6/2/21) grappled this issue with frustrating results.

What Happened

The Debtor and Camac Fund, L.P. ("Camac") entered into a Litigation Funding Agreement (the "Funding Agreement"). Under the Funding Agreement, Camac would advance money to the Debtor in return for a percentage the debtor’s interest in any recoveries from certain whistleblower lawsuits.

Under the Funding Agreement, Camac was to extend financing to the Debtor in exchange for a percentage of the Debtor's interest in certain whistleblower litigation cases. Disputes arose between the parties under the Funding Agreement, and Camac invoked its rights under the Funding Agreement's arbitration clause. The Debtor filed a response disputing, among other things, the validity of the arbitration and asserting counterclaims against Camac. A hearing was scheduled in the arbitration proceeding but was stayed by the filing of this Chapter 11 case.

Opinion, pp. 3-4.

After the bankruptcy was filed, the lawyers got busy. Camac filed a Motion for Relief from Automatic Stay seeking to proceed with the arbitration. The Debtor filed an adversary proceeding against Camac. Camac filed an adversary proceeding to determine dischargeability against the Debtor. Camac asked the Court to abstain from hearing the Debtor’s suit.

The Bankruptcy Court found that there were several types of claims involved: (i) claims concerning the parties' performance under, and alleged breaches of, the Funding Agreement (the "Contract Claims"); (ii) claims under the Fair Debt Collection Practices Act ("FDCPA") and state law allegedly governing the Funding Agreement (the "Non-Bankruptcy Claims"); and (iii) claims under sections 502, 510, 523, 543, 544, 547, and 553 of the Code (the "Bankruptcy Claims"

Who Gets to Decide?

The Bankruptcy Court is the gatekeeper which gets to decide where the ultimate issue will be decided. The automatic stay prevents actions in other forums absent bankruptcy court permission, while the broad grant of jurisdiction in 28 U.S.C. §1334 allows most disputes to be heard in the Bankruptcy Court. Thus, with limited exceptions, unless the Bankruptcy Court lifts the automatic stay and abstains from hearing the dispute itself, the matter will proceed in bankruptcy.

The Bankruptcy Court has a second gatekeeper function, which is to determine “arbitrability.” As the Bankruptcy Court explained:

[F]irst, it must determine whether the parties agree to arbitrate; second, it must determine the scope of that agreement; third, if federal statutory claims are asserted, it must consider whether Congress intended those claims to be nonarbitrable; and fourth, if the court concludes that some, but not all, of the claims in the case are arbitrable, it must then decide whether to stay the balance of the proceedings pending arbitration.

Opinion, pp. 15-16. Although the Bankruptcy Court didn’t get there until page 15 of its opinion, the decision whether to allow arbitration is really a two-step process. First, the Court decides whether the parties intended this particular dispute to be subject to arbitration. Then it decides how to exercise its discretion as to whether to allow arbitration.

The Bankruptcy Court’s position as gatekeeper should provide the debtor with an important home field advantage in keeping the dispute in the debtor’s chosen forum. However, in Shearson/American Exp., Inc. v. McMahon, 482 U.S. 220, 226 (1987), the Supreme Court found that "the party seeking to prevent enforcement of an arbitration agreement [must] show that 'Congress has evinced an intention to preclude waiver of judicial remedies for the statutory rights at issue.'” Opinion. p. 9. Therefore, the rule is that the Court should allow arbitration unless there are important bankruptcy reasons not to.

Fortunately, Congress has provided guidance on what disputes are most important to the bankruptcy process. In 28 U.S.C. §157(b)(2)(B), Congress has defined certain bankruptcy disputes as “core” proceedings. These include such matters as allowing proofs of claim, selling property and deciding whether the stay should apply. The Supreme Court has further provided that some, but not all, core proceedings are “constitutional core” proceedings meaning that the Bankruptcy Court has authority to enter a final judgment without the consent of the parties. See Stern v. Marshall, 564 U.S. 462 (2011) and the Supreme Court’s subsequent decisions. Thus, if a decision is a “constitutional core” proceeding, there are good grounds for retaining the suit.

So, is there a hard and fast rule? No. As explained by the Bankruptcy Court:

If a claim is a constitutionally core proceeding, the bankruptcy court has the discretion to retain the proceeding and not enforce the terms of the parties' arbitration agreement. See, e.g.,Taylor, 420 F. Supp. 3d at 448 ("Arbitration of constitutionally core claims 'inherently conflict[s] with the purposes of the Bankruptcy Code,' and therefore a bankruptcy court is generally well within its discretion to refuse arbitration of constitutionally core claims.") (citation omitted). Again, this discretion arises from the inherent conflict in allowing an arbitrator to resolve proceedings that are grounded in the Code itself or that are integral to the debtor's reorganization efforts. A bankruptcy court's discretion is far more limited with respect to non-constitutionally core or non-core proceedings.

Opinion, p. 12. Essentially, the Bankruptcy Court has a lot of discretion to retain a constitutionally core matter and a little bit of discretion to retain anything else. While the “constitutional core” distinction is helpful, the decision still comes down to the Bankruptcy Court’s discretion.

The Bankruptcy Court was following Fourth Circuit precedent in Moses v. CashCall, Inc., 781 F.3d 63 (4^th Cir. 2015), where the Court held that sending a constitutionally core proceeding to arbitration “would pose an inherent conflict with the Bankruptcy Code” while requiring arbitration of a claim which was not a constitutional core proceeding would not. Interestingly, the judge who wrote the opinion dissented from the court’s opinion as to the claims which were not constitutionally core. The judge found that the non-core claim was directly tied to the core claim and that it would be inefficient to have two tribunals adjudicate the identical issue. The Fifth Circuit, while relying on a similar standard, has concluded that dividing a case and sending some claims to arbitration “would be of disservice to the parties and defeat the purposes of the Bankruptcy Code.” Gandy v. Gandy (In re Gandy), 299 F.3d 489, 499 (5^th Cir. 2002).  

The Court’s Ruling

The Court found that the parties agreed to arbitrate disputes arising under the Funding Agreement. For reasons that are unclear to me, the Court found it unnecessary to resolve whether the parties had agreed to arbitrate the specific disputes at issue. After an extensive discussion, the Court decided to bifurcate the claims. The claims arising under the Bankruptcy Code would not be subject to arbitration while the contract and non-bankruptcy claims would go to arbitration. This is a very unsatisfactory answer although it mirrors the result in CashCall. How could the Bankruptcy Court determine allowance of Camac’s claim (a bankruptcy claim not subject to arbitration) without determining the parties’ performance under the Funding Agreement (a non-bankruptcy claim subject to arbitration)? The only thing that makes sense is sending the FDCPA claim to arbitration since this is an independent claim between the two parties. However, was that even covered by the arbitration clause? As I mentioned above, I don’t think that the FDCPA claim arose under the Funding Agreement and therefore should not have been subject to arbitration at all.

Another Way to Look at This Case

I found this opinion to be very confusing and the outcome to be arbitrary. I would like to suggest a simplified approach. First, decide if the contract requires arbitration. If the contract does not require arbitration, that is the end of the inquiry. If the contract does require arbitration, then consider the impact on the bankruptcy process and other parties. For example:

• If a contract requires arbitration of any attempt to restructure a debt, that interferes with the Court’s ability to confirm a plan and arbitration should not be allowed.

• If a contract requires arbitration of disputes as to lien priority and validity and there are three parties asserting a lien, two of whom do not have arbitration clauses, arbitration should not take place.

• If the bankruptcy case cannot proceed without resolution of the dispute and the arbitration clause refers disputes to the Mongolian Arbitration Forum which requires a minimum of three years and two gallons of yak milk to decide, arbitration should not be granted.

I offer impact on the bankruptcy process and other parties as an alternate test because the whole constitutional core test doesn’t really work. Most arbitration clauses are going to decide claims between the parties. The Supreme Court has said that the authority of bankruptcy courts is greatest when “the action at issue stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process.” Stern v. Marshall, 564 U.S. at 499. Since most arbitration clauses apply to deciding who owes what to whom, they are always likely to involve constitutionally core claims (unless it is purely a matter of a claim by the debtor against the contract counter-party). If constitutionally core claims are the norm, it doesn’t make much sense to use this as the basis for a decision. Additionally, as shown by this case and CashCall, bifurcating claims between those that are subject to arbitration and those which are not can lead to twin forums deciding the same issues which should be a real problem. Thus, impact on the process and other parties is a much more workable test.

If I were to apply my test to the case, I would probably have denied arbitration in its entirety. The parties agreed to arbitrate claims “arising under” the Funding Agreement. The FDCPA claims do not appear to arise under the Funding Agreement since the FDCPA will only apply when a debt collector is attempting to collect a debt. In Bankruptcy Court, we know the difference between “arising under” and “relating to” and these claims do not appear to “arise under” the Funding Agreement. I would also have found that the preference and fraudulent transfer claims did not arise under the Funding Agreement, since they arise under the Bankruptcy Code.  If the parties had agreed to arbitrate disputes “related to” the Funding Agreement, the result might have been different.

The disputes concerning performance under the Funding Agreement certainly arise under the Funding Agreement. However, they are part and parcel of claims allowance process which arises under the Bankruptcy Code. That would take us to the second level of my analysis: what is the impact on the bankruptcy process and other parties? The opinion doesn’t really answer these questions, and in fairness, the parties may not have raised them.

What I would like to have learned is how long the arbitration process would last and how would the allowance or denial of claims have affected other creditors and parties in interest. This was a Chapter 11 case. The Debtor has an exclusive period to propose a plan (or if it was a SubChapter V case, an absolute deadline to propose a plan). Would arbitration interfere with that process? How would determination of who did what to whom affect other creditors? If the only issue was how much Camac would owe the Debtor, then there probably would not have been much of an impact on other creditors. Similarly, if all the other creditors were secured creditors and Camac was the only unsecured creditor, then maybe allowance of Camac’s claim would not have affected other creditors. However, if Camac was one of several unsecured creditors and the amount payable to each unsecured creditor would depend on whether Camac had a big claim or a small claim, it might have had a lot of impact on other creditors.

If there is a law professor looking for his next article, I suggest this would make a great subject.

The Consent Trap

A new decision from the Fifth Circuit holds that implied consent cannot overcome a formal denial of consent to entry of a final judgment by a magistrate judge, even when the objecting party expressly consented.  PNC Bank v. Ruiz, Case No. 20-50255 (5th Cir. 3/3/2021), which can be accessed here.  The decision is of interest to bankruptcy lawyers because the issue of consent is common to the actions of both bankruptcy judges and magistrate judges.

Fifth Circuit Resurrects Fraud Suit Based on Removal to Bankruptcy Court

 In a very convoluted case, a plaintiff learned that removal to Bankruptcy Court can result in a do-over of adverse state court rulings.  Cohen v. Gilmore (Matter of Alabama & Dunlavy), Case No. 19-20152 (5th Cir. 12/15/20).  While the Rooker-Feldman doctrine prohibits a federal court from re-examining findings in an unrelated state court case, it does not grant similar protections in a removed action for the reason that the removed action is a continuation of the original case, just with a different presiding court.

What Happened (In Brief)

The facts of the case are very complicated. Here is an overly simplified summary. Alabama & Dunlavy owned some real property in Houston.  A trust controlled by Cohen was the 80% limited partner of Alabama & Dunlavy (A & D). In 2008, the Great Recession hit and the debt matured. Dilick controlled the general partner of A & D and also controlled the remaining limited partnership interest. Abercrombie was a developer. Abercrombie and Dilick approached the trustee of Cohen's trust about selling the property for $16.7 million. The trustee said yes because the partnership would make a profit. However, Abercrombie and Dilick failed to disclose that HEB was interested in signing a ground lease which would greatly increase the value of the property.

Abercrombie signed the ground lease with HEB under an entity named TAFI that had yet to be formed. Dilick then caused A & D to sell the property to TAFI for $13.5 million.  Shortly after acquiring the property     TAFI took out a loan for $19.9 million against the property. Various people got money, including  HEB's director of real estate. 

Cohen sued Abercrombie and TAFI among others. The state court granted Abercrombie and TAFI's motion for summary judgment after it excluded most of Cohen's summary judgment evidence.  The summary judgment apparently was never severed out of the case and remained interlocutory.   Several years later in 2015, A & D filed Chapter 7 bankruptcy and Regions Bank, which was another defendant, removed the case to Bankruptcy Court. The case was referred to the U.S. District Court. The District Court entered an agreed final judgment on February 7, 2019 among the remaining parties.  Abercrombie and TAFI never participated in the District Court litigation. Abercrombie and his lawyer both died. The property was sold to a third party. 

The Issue Arrives at the Fifth Circuit

Cohen then appealed to the Fifth Circuit. So, what was the Fifth Circuit doing reviewing a summary judgment granted by a state court? Although the District Court never addressed the Abercrombie and TAFI claims, they were still part of the case.

 In this circuit, when a case is removed from state court to federal court, the federal court takes the case as it finds it and treats the state court rulings as its own. . . . Since the Fifth Circuit has eschewed legal formalities and treated cases like this one as reviewable even if the district court provided little discussion of the state court decision, this case is ready for appellate review.

Opinion, p. 7. 

What A Difference A Court Makes

Where the change in forum really made a difference was in the Fifth Circuit's review of the State District Court's ruling on the motion for summary judgment. In Texas State Court, rulings on summary judgment evidence can be very informal. In this case, the State Court signed an order which granted or denied various evidentiary objections without explanation. This is not adequate in federal court. 

Cohen contends that the state trial court abused its discretion in granting several evidentiary objections in TAFI’s and Abercrombie’s favor. We agree. The grant of these objections improperly excluded important evidence from consideration. To start, the state trial court offered no explanation as to why it granted the objections. It simply checked boxes on a form saying that the objections were sustained. Since a trial court can abuse its discretion by failing to explain the reasons for excluding evidence, the lack of a reasoned explanation weighs in favor of overturning the objections.  Courts also typically consider evidence unless the objecting party can show that it could not be reduced to an admissible form at trial.

Opinion, pp. 8-9.  

This passage illustrates a remarkable difference between the state and federal courts. In my experience, state courts rarely explain their rulings. In the unusual cases where a motion for summary judgment is taken under advisement, the typical ruling from the court is a one sentence letter stating that the motion is granted or denied. Evidentiary objections are disposed of with a simple granted or denied.

Because the Court considered it an abuse of discretion to exclude evidence without stating a reason, it considered the summary judgment evidence. Because the Court examined the summary judgment evidence, it found that there were fact issues. Because the Court found that there were fact issues, it reversed the summary judgment.  As a result, seven years and one month after the summary judgment was granted, and after both the defendant and his lawyer had passed away, the summary judgment was reversed.

Practice Tips

The obvious practice tip for a party receiving an unexplained and possibly unconsidered ruling from a state court is to get the case to federal court before the judgment is final. This won't always be possible. If the claims on which summary judgment were granted were the only claims in the case, the judgment would have been final prior to bankruptcy. Similarly, filing bankruptcy after a state court has ruled but before it has entered its order is unlikely to provide any relief. However, in a complicated suit with lots of parties and claims, a terrible, horrible ruling might face a stricter review in federal court as opposed to being rubber stamped in state court.

The practice point for the party better the terrible, horrible ruling (or the wonderful, well-thought out decision depending on where you sit) is to get the ruling severed into its own case so it can become final. While I don't know what happened (any counsel is no longer around to explain), what probably occurred was that the defendants got their take-nothing ruling and assumed the case was over. Unfortunately, it was not.   

On a final note, this case just smelled bad and that may have affected the ruling.

 

 

 

Fifth Circuit Renders Important Subject Matter Jurisdiction Opinion Concerning Restraint of Inter-Galactic Trade

Just in time for the holidays, the Fifth Circuit has released THE MOST BIZARRE OPINION OF THE YEAR. A lawyer claiming to be a Deity and a Monarch brought suit against the United States and the State of Louisiana on behalf of the Atakapa Indian de Creole Nation. The District Court sensibly dismissed the suit based on sovereign immunity. However, the Fifth Circuit chose to affirm the decision on the ground that the suit was so completely frivolous that the federal courts lacked jurisdiction to even entertain it. Atakapa Indian de Creole Nation, No. 19-30032 (5th Cir. 12/10/19), which can be found here.

According to the Court:

This action was originally brought as a habeas corpus proceeding by Edward Moses, Jr., a lawyer who calls himself the trustee of the “Atakapa Indian de Creole Nation.” This group is not a federally recognized Indian tribe, and its precise nature is unclear. See Indian Entities Recognized by and Eligible To Receive Services from the United States Bureau of Indian Affairs, 84 Fed. Reg. 1200 (Feb. 1, 2019). The initial complaint alleged the Atakapa “are being held as wards of the State through the Louisiana Governor’s Office of Indian Affairs” and “in pupilage under the United States,” and sought formal recognition as “indigenous to Louisiana.” The claims were based on a gumbo of federal and state laws, including eighteenth-century federal treaties with France and Spain, as well as sources such as the “Pactum De Singularis Caelum, [or] the Covenant of One Heaven.” The plaintiff subsequently filed something resembling an amended complaint, which sought to reclassify the action as a “libel suit” under maritime jurisdiction.

Payments Which "Look A Lot" Like Dividends Subordinated

In the Fifth Circuit's opinion in French v. Linn Energy, LLC (In re Linn Energy, LLC), 2019 U.S. App. Bankr. LEXIS 26595 (5th Cir. 9/3/19), which can be found here, Judge Edith Brown Clement deftly sums up the case in her first sentence:

In this case we decide that payments owed to a shareholder by a bankrupt debtor, which are not quite dividends but which certainly look a lot like dividends, should be treated like the equity interests of a shareholder and subordinated to claims by creditors of the debtor.

If that's all you wanted to know you can stop reading, but this opinion has a good explanation of how subordination of claims related to securities works.   You  may remember the children's game of chutes and ladders where a party landing on a ladder gets sent to the bottom.  That is an approximation of how subordination works.   

The Undue Hardship Test Is Really Harsh

The Fifth Circuit has released a new opinion which underscores just how hard it is to discharge a student loan under the undue hardship standard.   Thomas v. Department of Education (In re Thomas), 931 F.3d 449 (5th Cir. 2019).    

A Sympathetic Debtor

Vera Thomas wanted to improve her station in life.  She was working at a call center in Southeastern Virginia earning $11.40 per hour with benefits.  In 2012, she decided to enroll in a local community college.   She took out two loans for $3,500.00 each for her first two semesters.   She did not return for a third semester and her loans went into repayment.   In spring of 2014, she paid back about $82 on her loans.

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.

 

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.