After Woerner, Courts Look for "Good Gambles"

You've got to know when to hold 'em
Know when to fold 'em
Know when to walk away
And know when to run
--Kenny Rogers, The Gambler

After the Fifth Circuit’s opinion in Barron & Newburger, P.C. v. Texas Skyline Ltd. (Matter of Woerner), 783 F.3d 286 (5^th Cir. 2015), lawyers for bankruptcy estates breathed a sigh of relief, knowing that they could still be compensated for “good gambles” gone awry.   However, how would the courts measure a “good gamble” in the context of a case that didn’t quite work out?   Two decisions issued on the same day help answer that question.    In Case No. 13-33264, Digerati Technologies, Inc. (Bankr. S.D. Tex. 8/21/15), a highly contentious case resulted in a confirmed plan but only after an initial plan proposed by management was rejected.   In Case No. 10-11365, In re Woerner(Bankr. W.D. Tex. 8/21/15), the Bankruptcy Court that ruled in the case that was eventually reversed by the en banc Fifth Circuit reconsidered its ruling following remand.   In both cases, debtor’s counsel received some but not all of the fees requested.

Exemptions Continue to Feel Frost's Bite

The rift in the bankruptcy universe created by Viegelahn v. Frost (Matter of Frost), 744 F.3d 384 (5th Cir. 2014) continues to widen, drawing more exemptions into its vortex in seeming disregard of Supreme Court precedent.   The latest opinion to come down is  In re Hawk, 2015 Bankr. LEXIS 309 (Bankr. S.D. Tex. 1/30/15) which holds that the Debtor in a chapter 7 proceeding forfeited his IRA exemption when he liquidated the account after the deadline to object had expired.   

The Debtors filed their chapter 7 proceeding on December 15, 2013.   On this date, they held an IRA in the amount of $164,902.   Over the period from December 11, 2013 to July 14, 2014, the Debtors withdrew the funds from the IRA. The Trustee filed a no asset report on April 3, 2014.  The deadline to object to exemptions expired on April 28, 2014.  No party filed an objection.

A creditor objected to the Debtors' discharge.   At a deposition on November 18, 2014, the creditor learned of the liquidated IRA in a deposition.   The Trustee then made demand for the Debtors to turn over the IRA proceeds because they had not been reinvested within sixty days.   The Trustee then filed a motion for turnover of the funds.

The Bankruptcy Court granted the Trustee's motion for turnover, finding that the failure to file a timely objection was not material.   The Court stated:

(T)he Court finds that the pertinent threshold question is whether property deemed exempt under state law loses its statutory protection at any point during the pendency of a Chapter 7 case. Here, the Liquidated IRA Funds lost their exempt status under state law while the Debtors' bankruptcy case was open. Once the Liquidated IRA Funds became non-exempt, the Funds automatically became property of the estate and the Chapter 7 Trustee was immediately entitled to them.

Opinion, at *9.    The Court emphasized the Fifth Circuit's language in Frost that

a change in the character of the property that eliminates an element required for the exemption voids the exemption, even if the bankruptcy proceedings have already begun.

Frost at 388.   The Court found that it was significant that the IRA exemption under the Texas Property Code included a provision allowing proceeds to retain their exempt character if reinvested within sixty days.   As explained by the Court:

(A)pplication of the 60-day rule here is merely applying the entire IRA exemption statute and should not turn on whether a party in interest lodged an objection to the claimed IRA exemption In fact, the imposition of an objection condition when applying either the Texas homestead or IRA exemption statute would violate state law. There is no objection requirement in either sections 41.001 or 42.0021. Construing an extratextual objection requirement would preclude application of the reinvestment provisions--thereby contravening the intent of the Texas legislature.  (emphasis added).

Opinion, at *20-21.   Thus, according to the Court, in order to give effect to the intent of the Texas legislature, proceeds from an IRA must be timely reinvested to retain their exempt status.

While the Court may be correct as to the intent of the Texas legislature, why is this relevant?   Exemptions in bankruptcy are a matter of federal law.  When a Debtor claims exemptions under Texas law, he does so as a matter of federal law.    In re Dyke, 943 F.2d 1435 (5th Cir. 1991).  Federal bankruptcy law very definitely does contain an objection requirement.  Under bankruptcy law, any property claimed by the Debtor as exempt leaves the estate absent a timely objection.   According to this term's opinion in Law v. Siegel, 134 S.Ct. 1188 (2014), "a trustee's failure to make a timely objection prevents him from challenging an exemption."   Under the previous Supreme Court opinion in Taylor v. Freeland & Kronz, 503 U.S. 638 (1992), a clearly invalid claim of exemption could not be challenged once the objection period had passed.    According to the Court:

We reject Taylor's argument. Davis claimed the lawsuit proceeds as exempt on a list filed with the Bankruptcy Court. Section 522(l), to repeat, says that "unless a party in interest objects, the property claimed as exempt on such list is exempt." Rule 4003(b) gives the trustee and creditors 30 days from the initial creditors' meeting to object. By negative implication, the Rule indicates that creditors may not object after 30 days "unless, within such period, further time is granted by the court." The Bankruptcy Court did not extend the 30-day period. Section 522(l) therefore has made the property exempt. Taylor cannot contest the exemption at this time whether or not Davis had a colorable statutory basis for claiming it.

 Taylor, at 643-44. 

There seems to be a clear conflict here.   The Supreme Court has stated that once property becomes exempt, it remains exempt.   It has now said this for over twenty years.   However, under Frost, as interpreted by Judge Bohm, property must retain its exempt character at all times during the pendency of the case or be subject to turnover.    It does not seem possible to reconcile the Supreme Court opinions in Taylor and Law with Frost and Hawk.  If property could be claimed by the trustee at any time that it lost its exempt character, then property which was never exempt could be challenged at any time.    However, the Supreme Court expressly rejected that proposition.   To reiterate, if we protect property claimed as exempt with no colorable basis, as the Supreme Court did in Taylor, how can we fail to protect property which was legitimately exempt on the date of filing?

With any luck, this issue will eventually make its way back to the Fifth Circuit, or if necessary, the Supreme Court.   Until then, the watchword is debtors beware:  your exemptions are less secure than you might think.

Hat tip to Steve Roberts.

Judge Says "Over My Dead Body" to Trustee's Mediation Plans

The importance of alternate dispute resolution to resolve cases is enshrined in federal law, 28 U.S.C. §651(a), and is encouraged by most judges.   However, one bankruptcy judge recently told lawyers in a case that they would mediate “over my dead body.”    While the court’s ruling was triggered by the parties’ failure to request permission to expend estate funds, his comments expressed a high level of skepticism toward mediation in general.  The case is In re Cody Smith, No. 12-32096 (Bankr. S.D. Tex. 9/3/14).

What Happened

The Cody Smith case involves several different adversary proceedings.   When the parties asked to abate various deadlines so that they could mediate, the following discussion took place.   This is my attempt at transcription from the electronic recording of the proceeding.   Any errors are unintentional.

The Court:               As I understand it, the Second Joint Emergency Motion is being filed because you’re going to mediate.

Mr. Wentworth (Trustee’s attorney):    That’s correct, your Honor.

The Court:                  Did I give you permission to go to mediation?

Mr. Wentworth:          Your Honor, maybe I’ll defer to Mr. Lemmon on that.  I didn’t file any motion.

The Court:                   Mr. Lemmon, did I give the Trustee permission to mediate?

Mr. Lemmon (Trustee’s Special Counsel):      No, your Honor.

The Court:                  Does the Trustee have any intention of paying the mediator out of estate funds?

Mr. Lemmon:             My firm is advancing . . . .

The Court:                 That’s not my question, not who’s advancing.    Is the Trustee eventually going to be using estate funds to pay the mediator?

Male Speaker:             I think that’s what we had envisioned.

The Court:                  Over my dead body.  I do not like mediation.    I think it is wasteful for the most part and you all needed to get my permission.  I assume counsel for the Trustee is going to the mediation and I assume counsel for the Trustee’s going to ask me to approve those fees.

Mr.  Lemmon:             Yes, your  Honor.

Male Speaker:            For the mediatior . . .

The Court:                  Aint gonna happen.   Don’t you ever do that again, Mr. Cage.

Mr. Cage (the Trustee):           Yes, your Honor.

The Court:                  I’m going to do a general order to put all my chapter 7 cases (on notice).  You are not to mediate without my approval.   Or if you’re gonna do it, you’re going to get my approval or if you’re going to do it (without my approval), I’m not going to allow attorneys to be paid.   I think for the most part mediation is a waste of time and money.  You all are grown up big boy attorneys.   You can talk settlement.   You’ve been talking settlement.    And I’m not going to allow more money to go to a mediator.   Either you settle it or you don’t.   But don’t ever do that again.

Mr. Cage:                    Understood, your Honor.

Mr. Lemmon:             This is Steve Lemmon.   I am sorry your Honor.   The idea of doing a mediation was my idea, so I apologize.

The Court:                  Mr. Lemmon, I’ll grant you a lot of judges love mediation, but I don’t.   I think mediation is undercutting the jury trial system in this country and I think it is making lawyers lazy and judges lazy and I also think it’s excess costs to pay for a mediator.   Lawyers are supposed to do two things.    They are supposed to get ready for trial and they are supposed to talk settlement professionally.    And I think it is rare that I allow people to go to mediate so don’t do it ever again.   If you want to mediate, then file a motion and come in here and explain to me why, but I’m not going to allow a mediation, not in this case certainly, so I’m going to deny the Second Joint Emergency Motion and with that you all are free to go.

Recording, 9/3/14, 3:04:01-3:07:22 (emphasis added).

My Perspective

I have not been involved in the Cody Smith case although I know most of the lawyers involved.   None of them asked me to write this article.    I heard about from an observer who happened to be in the courtroom that day.   However, I have heard Judge Bohm express similar comments informally.  The fact that the judge made the comments on the record and expressed an intent to issue a general order on the subject made it an appropriate subject for a blog article in my mind.

I am a trained mediator, although I use that experience as a participant in mediations much more than as a mediator.    More importantly, I practice with an attorney who is an artist when it comes to mediation and has successfully settled many difficult cases.   All of this gives me a bias in favor of mediation.

On the other hand, I have no problem with trying cases.   I enjoy trying cases although my work is in bankruptcy court where juries are forbidden absent consent.  In nearly twenty-eight years of practice, I have been second chair on two jury trials and I served on a jury once.   As a result, the jury system is something I have heard about more than I have experienced.

Why the Hostility to Mediation?

Judge Bohm has a legitimate point that parties wishing to use estate funds to mediate should request court permission.  However, in most courts, that request would be met with enthusiasm.    Indeed, federal policy encourages mediation.    28 U.S.C. §651(b) provides that:

Each United States District Court shall authorize by local rule adopted under section 2071(a), the use of alternate dispute resolution processes in all civil actions, including adversary proceedings in bankruptcy in accordance with this chapter  . .  . .

Southern District of Texas Local Rule 16.4 states that mediation is approved for use in bankruptcy proceedings and goes on to state that:

If the parties agree upon an ADR method or provider, the judge will respect the parties’ agreement unless the judge believes another ADR method or provider is better suited to the case and parties.

Local Rule 16.4C.

Let’s look at the reasons given by Judge Bohm for his distaste for mediation.

1.                  Mediation is a waste of time and money.    Judge Bohm expressed his opinion that “grown up big boy attorneys” should be able to “talk settlement professionally.”    If you follow Judge Bohm’s logic, either the case should be able to settle, in which case the lawyers should be able to get there on their own, or it needs to go to trial, in which case mediation would be a waste of time.    I think this logic is oversimplified.   In my experience, there are plenty of cases where qualified, professional attorneys will be unable to settle a case without assistance from a third party.   However, I do agree with Judge Bohm in part.   Attempting to mediate with the wrong mediator at the wrong time can be a waste of time.   As a result, it is important to carefully select a case for mediation and to pick the right mediator.   I will give my opinions about which cases are good for mediation below.

2.                  Mediation undermines the jury system.   This one baffles me.  Judge Bohm is a bankruptcy judge.   Juries are not allowed in bankruptcy without consent of both parties and are an extreme rarity.  As a result, allowing mediation in bankruptcy cases could never have an effect on the jury system.  However, beyond that, I wonder, what is so great about the jury system?   I have to admit a bias here.      No one ever comes to a Debtor’s lawyer and says I need to file bankruptcy because the jury got it right.    It is my personal opinion that the jury system today is often used for tactical reasons, such as to delay trial or increase costs, or in cases where emotion can be counted on to overwhelm the facts.   While juries are intended as a protection for the accused, they convict innocent people often enough to cause concern.   Having said that, the only jury that I served on voted to acquit.     Even if you acknowledge that juries serve a valuable function, they are expensive and not every case needs one.   If every civil and criminal case resulted in a jury trial, the system would quickly collapse.

3.                  Mediation makes lawyers and judges lazy.   I can’t speak for judges since I have never been one.  However, in my experience, mediation does not make good lawyers lazy.   Mediation forces a lawyer to prepare his case in order to persuade the other side that going to trial is a real option.  It also forces lawyers to examine the weaknesses in their case and to find ways around them.    Mediation also allows lawyers to spend focused time with their client talking about the case.    Mediation is about finding a better alternative than trial, not for the unprepared lawyer to avoid trial  Some cases are really difficult and will inevitably lead to a bad outcome for both sides if they go to court.  I have witnessed mediation resolve disputes that had festered for a decade or more.  As a result, I believe that dedicated, hard-working attorneys can use mediation as a tool.   Obviously, mediation can be used as a crutch by the unprepared or unwilling, but that is the fault of the lawyer rather than the procedure.

What Makes for a Good Mediation?

Economics teaches that an efficient market depends upon a willing buyer and a willing seller with access to complete information.   Lawsuits are similar.   In order to settle, there have to be parties who are willing to negotiate in good faith and have good information.   Mediation can change a party’s willingness to settle if the unwillingness was based on an unreasonable attorney or where the mediation process allows the party to save face.  This is especially true where emotional considerations rather than money are driving the case. Otherwise, having an unwilling party probably means an unsuccessful mediation.   

Mediation can be very successful when parties have been acting on incomplete information.    Attorneys are supposed to be both counselors and advocates.   However, the process of obtaining clients often depends on projecting strength and confidence rather than giving good counsel about the weaknesses of a case.   Other times, a client will filter out information he doesn’t want to hear.    A combination of a good lawyer and a good mediator can help a difficult client evaluate his case more accurately and reach an agreement.  

There are also cases involving difficult situations which require a lot of creativity to solve.   While the parties could theoretically resolve these cases on their own, the presence of a neutral third party can help the attorneys and the parties consider solutions they would not have thought of otherwise in a format allowing vigorous give and take.   This is especially true of multi-party cases.   

Finally, there are a few cases where both sides show up ready to make a deal and arrive at a sensible result within a short period of time.   There is no reason that these cases should not have settled without mediation.  However, sometimes the mediation process itself serves to focus a party’s attention on settling better than a series of calls with counsel.   

Final Thoughts

I can agree with Judge Bohm to a very limited extent.    Mediation can be a waste of time and money if the parties are doing it for the wrong reasons or are not prepared.    I can also agree with Judge Bohm that a lazy attorney may seek out mediation if he is not ready for trial and is trying to stall.     However, when good attorneys tell the court that they favor mediation, the Court should defer to their judgment, as I believe is required by Local Rule 16.4C.  

I agree that it is a good practice to seek court approval for mediation on any number of grounds.   First, it helps to keep the Court informed and allow the Court to ask questions as to the reasons for the mediation.    Good lawyers should be prepared to give good answers to those questions.    Second, I agree with Judge Bohm that paying a mediator is an expense not in the ordinary course of business which should be approved in advance.  I don’t think it is necessary for attorneys who represent estates to get special permission to participate in a mediation.  When an attorney is appointed in a case where litigation is involved, mediation is inherently part of that appointment.   Finally, I think that mediation pursuant to court order is useful because it binds the parties to mediate in good faith.   While the parties will ordinarily agree to mediation in advance, a court order makes it harder for parties to back out at the last minute to try to secure a tactical advantage.     A court order also helps to impress the parties with the seriousness of the process.

Federal Rule of Civil Procedure 1 states that the rules "should be construed and administered to secure the just, speedy, and inexpensive determination of every action and proceeding."    I believe that mediation is a valuable tool to achieve these goals in appropriate cases.   I would encourage Judge Bohm to reconsider his hostility toward mediation, or at the very least, to discuss the issue in a public forum where a back and forth dialog can take place..