NCBJ 2014: Ethics and Supreme Debate

Saturday concluded NCBJ with ethics and the Supreme Court review.   (There was also a program on scientific studies of mindfulness which I missed).

Wait, Wait, Don’t Tell Me! An Ethics Game Show:  Retired Judge James H. Haines as Peter Segal, Christine Devine (DeMaillie & Lougee), Judge Benjamin Goldgar, Timothy Nixon (Godfrey & Kahn), Judge Neil Olack, Prof. Nancy Rapoport and Judge Erithe Smith.  

This was an entertaining quiz show style ethics panel.    For each ethical scenario, there were three answers only one of which was correct.   Here are the questions and correct answers.  

 

1.  Can law firm be sanctioned for failure to amend obvious errors in schedules?   Yes.    Section 707(b)(4)(C) and (D) and Rule 9011 require an attorney to certify that after making a reasonable inquiry, the petition, schedules and SOFA are correct and that he does not know of any information that would make them incorrect.   The specific hypothetical involved an international law firm which filed bankruptcy but failed to mention any of its international offices.

2.  Can an attorney ethically limit its representation of a chapter 7 debtor to exclude adversary proceedings when necessary to achieve the client’s goals?  No.   While unbundling can be done with full disclosure, an attorney cannot disclaim defending adversary proceedings if it is known in advance that this will be necessary to meet the client’s objectives.   In re Seare, 2014 Bankr.LEXIS 3584 (9^th Cir. BAP 2014).

3.  May CROs be employed under sections 105(a) and 363(b)(1)?  Yes.    Under what is known as the “Jay Alix Protocol,” a chief restructuring officer may be employed in the ordinary course subject to review of his fees for reasonableness.    Additionally, the CRO may only serve in one capacity.

4.  Can a Chinese Wall be used to prevent firm from being disqualified based on one attorney who is not disinterested?   The answer given was no, but that Texas follows minority rule.    An example of the majority rule is In re Essential Therapeutics, Inc., 295 B.R. 203, 211 (Bankr. D. Del. 2003), while the minority rule is illustrated by In re Cygnus Oil & Gas Corp., 2007 Bankr. LEXIS 1913 (Bankr. S.D. Tex. 2007).   I am not completely satisfied by the panel’s designation of these as majority and minority rules.  They might be worth more scrutiny.

5.  Can the same attorney be retained to represent multiple debtors with inter-company claims?    There is no per se disqualification rule.   Must decide on a case by case basis.

6.  What is appropriate sanction for undisclosed fee sharing?   Court may disqualify firm and order disgorgement of fees.   However, court should use least restrictive sanction to deter bad conduct.

7.  May an attorney withdraw when the client insists on taking a course of action that the attorney disagrees with?    Yes, but only with court permission.

8.  Can an attorney be sanctioned for “ghostwriting” a pleading for an acquaintance?  Maybe.   I think this one is too fact specific to give a definitive answer.   In the hypothetical, the attorney was asked to provide a law school acquaintance with a form claims objection which the debtor then used without modification.    In my mind, providing a form to another attorney is never “ghostwriting.”   There was some discussion that an attorney who prepares a pleading for a pro se party is required to sign it.  I am not convinced by this argument.

9.  Can a plan provide that Committee members will be able to recover their attorney’s fees?  No.  They have to justify that they made a substantial contribution.

10.  Can a firm get paid all of its fees when it obviously overstaffed the case?   No.

May You Live in Interesting Times:   The Supreme Court’s Year in Bankruptcy:   Eric Brunstad (Dechert, LLP) and Dean Erwin Chemerinsky

This panel took the form of a debate between Eric Brunstad and Erwin Chemerinsky on the subject of consent under Stern v. Marshall.   Brunstad took the position that Stern v. Marshall was correctly decided but that consent was permissible.    Chemerinsky took the position that Stern v. Marshall was wrongly decided and that if followed to its logical conclusion, consent would not be allowed.   In this section, I am referring to major Supreme Court cases by name rather than by citation.    However, they can be easily looked up on any number of free legal research sites.

Brunstad:

Brunstad argued that Article III originated from the experience in England where it was necessary to separate the judiciary from the crown.   On the other hand, the issue of who decides your case does not implicate the independence of the judiciary and can be waived.   According to Brunstad, Marathon stands for the proposition that you cannot assign a purely private dispute to an Article I tribunal.   However, in Schor, the Supreme Court indicated that the right to an Article III tribunal was a personal right which could be waived.   Granfinanciera equated the right to a jury trial and the right to an Article III tribunal.   Because a jury trial can be waived, an Article III tribunal could be as well.  

He then made the following points (which he numbered making it much easier for me to report):

1.  Schor designated the right to an Article III tribunal as a purely personal right.  Having a case decided by an Article I or an Article III judge does not implicate separate of powers concerns because separation of powers is concerned with conflicts between the judicial branch and the legislative or executive.

2.  By analogy, if you can waive your right to a jury trial, you can waive your right to an Article III judge.

3.  For hundreds of years, District Courts have relied on special masters.   With consent, a special master could make findings upon which the District Court would enter judgment.

4.  Arbitration allows decision by a non-Article III tribunal, although the arbitrator cannot enter a judgment.

5.  Bankruptcy judges are like magistrates who enjoy broad authority with consent.

6.  The consequences of not allowing consent would be detrimental to the modern administrative state.  

Chemerinsky:

According to Dean Chemerinsky, Stern v. Marshall was wrong because it misunderstood separation of powers.    He said that separation of powers is a means to an end rather than an end itself.   Separation of powers is invoked when one branch usurps or interferes in the operations of another branch.   Allowing bankruptcy courts to decide state law issues does not implicate either concern.   Therefore Stern was wrongly decided.

However, he said that once you accept that Stern adopted a formalistic approach to separation of powers rather than a functional one (which is what Dean Chemerinsky advocates), you must follow that logic to its end.   Mr. Brunstad’s arguments were functional rather than formalistic.   However, you cannot accept Stern and still take a functional approach.

Chemerinsky then argued that:

1.  Separation of powers violations cannot be overcome by consent.

2.  The authority of the federal courts cannot be changed by consent, a proposition which goes back to Marbury v. Madison.

Dean Chemerinsky went on to state that there is no good reason to distinguish between subject matter jurisdiction and authority to decide cases.    He said that under Mr. Brunstad’s logic, subject matter jurisdiction could be waived.  

While Mr. Brunstad relied on Schor, that case said that “essential attributes” are reserved to Article III courts.   

He also rejected the notion that there was a difference between personal and structural rights because all structural rights exist to protect personal liberties.   

The Dean also distinguished several of Mr. Brunstad’s analogies.   Neither a special master nor an arbitrator can issue a final judgment.   However, a bankruptcy judge can.   He said that federal magistrates are not a good comparison because their authority is still up in the air like that of bankruptcy courts.

Brunstad:

In rebuttal, Mr. Brunstad challenged Dean Chemerinsky’s contention that jurisdiction and authority to decide were similar.   He said that only Congress can create jurisdiction, but Article III does not specify the form that inferior courts must take.   Further, all Article III requires from a structural viewpoint is independence from the Executive and the Legislative branches.   By placing Bankruptcy Courts within the judicial branch, Congress insulated them from pressure by other branches.   

There are some rights which cannot be waived, such as the right against involuntary servitude.  There are other rights such as the right to a jury trial which may be waived.   The right to decision by an Article III tribunal is a right which can be waived.  

He said that Stern was decided correctly (a position he had to take since the argued for the winning side) but that it did not involve impermissible delegation of judicial powers.   He said that most things that bankruptcy courts do, such as adjudicating claims, are public rights.   Stern, on the other hand, involved a tort claim which was a purely private right.   In Stern, it was clear that Pierce Marshall did not consent to adjudication of the tort claim in bankruptcy.      

Chemerinsky:

Stern v. Marshall was decided wrongly because you should always take the functional approach to separation of powers.   Stern was wrong because there was no threat to separation of powers.  The central tension in Eric’s argument is that it takes a functional approach to a formalistic decision.   Separation of powers cannot be overcome by consent which resolves the consent issue.

Public rights are limited to suits by or against the government.   Because the government cannot be sued absent its consent due to sovereign immunity, it can allow actions to be resolved by or against it in a non-Article III tribunal.   However, most of the work of the Bankruptcy Court does not involve public rights.   Therefore, the public rights argument does not work.

Congress may create inferior courts, but it can’t give them authority beyond what Article III allows.    In Stern, Congress gave bankruptcy courts the power to decide counterclaims to proofs of claim and that authority was found to be unconstitutional.

The right to a jury trial was never structural.   Therefore it does not help on the separation of powers issue here.

Having listened to both arguments, I now have no idea how the consent issue in Wellness International will come out.  I thought that Dean Chemerinsky had the better argument in terms of consistency while Mr. Brunstad had the better argument in favor of making the system work.   Given that the Supreme Court vacillates between strict interpretation and practicalities, this one is very hard to handicap.   However, as a practitioner, the answer is easy:  bankruptcy courts need to be given as much authority as they need to do their jobs and the Constitution will still survive.

Post-script:

In the final minutes, they discussed the Court’s recent decisions.   They both observed that the court vacillates between strict statutory construction and policy concerns.   Law v. Siegel was an example of a strict statutory approach, while Clark v. Rameker (inherited IRAs are not exempt) was a practical approach.    This remains a constant tension with the court.

NCBJ 2014: Thinking the Unthinkable: Bankruptcy for Large Financial Institutions

Jeffrey Lacker, President of the Richmond Federal Reserve Bank, made the case for why large financial institutions should subject to bankruptcy as the ABI Luncheon Keynote Speaker.  He started his address with the question "Why is a central banker interested in bankruptcy?"  His answer was that during the financial crisis of 2007-2008, the government played a role by distorting incentives of market players with multiple discretionary interventions which destabilized expectations.   He called on the government to realign incentives of major market participants by using bankruptcy instead of discretionary government interventions.   The full text of his speech is available here.

Mr. Lacker said that the advantages of the bankruptcy system are that it is a collective proceeding, it is subject to judicial supervision and is a predictable, rules-based system.    He described the bankruptcy process as "one of the best tools we have for reconciling the goals of creditors and debtors."   He said that the probability of bankruptcy versus the benefits of risk taking would change the incentives of large banks.

He gave some historical background for the problem.  When the Fed was founded 100 years ago, state law prevented branch banking.   As a result, there were 27,000 banks in the country.   This meant that banks could not pool capital between locations.  In 1933, the government adopted government funded deposit insurance primarily to protect small rural banks.   

Fast forward to the present era (my words, not his) and the government began intervening to protect the uninsured creditors of banks through assisted mergers (such as Bear Stearns) and lending on favorable terms.    These actions dampened incentives to tamp down risk.   As financial firms grew to greater size, there was a vicious circle as the government felt compelled to handle financial failure outside of bankruptcy which encouraged more risk taking.   In 1999, only 45% of the creditors of financial firms had explicit or implicit government guaranties.   By 2012, this had risen to 57%.

In 2007, there were two mutually reinforcing conditions present which led to problems.   Investors felt protected and the government felt compelled to confirm expectations.   They feared a domino effect where if they did not support firm A, investors would pull away from firm B.   

According to Mr. Lacker, the government's inconsistent actions exacerbated the problem.    The government arranged for the merger of Bear Stearns with JP Morgan, then it allowed Lehman Brothers to file bankruptcy, then it provided an emergency loan to rescue AIG.   As a result, he said that the expectations that created the problem remained alive and well.

Dodd-Frank was intended to remedy the problem.   He said that beefing up ex ante measures is good but it doesn't solve the problem once institutions are in trouble.   He said that it is asking too much for bank examiners to function as the frontline actors to prevent risky behavior.

Dodd-Frank also created the Orderly Liquidation Authority for large financial institutions.   Mr. Lacker said that while this borrows many features from bankruptcy, it retains many flaws.   The OLA allows some creditors to receive more than they would in bankruptcy.   The availability of funds injected from the treasury is like debtor-in-possession financing but without being tested by the market.    The OLA does not have the checks and balances of bankruptcy.   This system dampens creditors' incentives to monitor risk taking, he said.  If the FDIC is anticipated or assumed to provide assistance, it will likely provide it.

He also discussed the single point of entry feature of Dodd-Frank.   Under this provision, the government can take control of the top level holding company which the subsidiaries remain open.   The regulators create a bridge company to transfer the assets of the holding company to which will eventually be turned over to the private sector.   The expectation is that the shareholders of the holding company will be wiped out  while the creditors of the holding company receive the equity in the new entity.   He described this as a "bail-in" rather than a bail-out.     

Mr. Lacker said that the resolution plans required under section 165 of Dodd-Frank were a positive feature.   The goal is to have companies wound down under the Bankruptcy Code without government support.   This contrasts with past practice where there was little or no advance planning for insolvency of large financial institutions.    He stated that the recent dependence on short terms lending arose from regulators' aversion to bankruptcy, which this provision moves away from.   As a result of this planning or "living wills" for large financial institutions, they can be required to obtain more capital, restrict risk taking or divest assets.  

Lacker said that eleven banks have gone through this process but there is substantial work left to be done.   Other reforms to be addressed are requiring a "rational and less complicated legal structure," creating severability by making institutions self-contained in each country and keeping them from being dependent on inter-company lending.    However, he said that a continued problem is the excessive reliance on short term borrowing which would mandate substantial debtor-in-possession financing from the government in order to maintain operations.    

Mr. Lacker said that the Bankruptcy Code could be adapted to deal with large financial firms. He said that bankruptcy could be used to concentrate losses in the parent company.   A problem that he pointed out is that derivatives are excluded from the automatic stay and other bankruptcy provisions which encourages risk and a shadow banking system.    

Lacker stated that "if we do hard work" to make plans now, there will be a healthy realignment of expectations and incentives.   He said that this will not be complete until we allow a large financial entity to file for bankruptcy.    He said that the goal was that once we have robust provisions in place, we can eliminate the power to make ad hoc rescues.    He said that bankruptcy is advantageous for financial firms because it provides a common pool and consistent outcomes.

In closing, Mr. Lacker stated that expectations led to the financial crisis.  He said that the bailout friendly, too big to fail system is unstable and unfair.   

NCBJ 2014: Hedging Your Bets, Examining an Expert and Secured Creditors in Charge

I spent the morning listening to presentations on very disparate topics:  hedge funds, examining an expert witness and the balance between secured creditors and unsecured creditors.   I was not able to capture the full extent of the discussions and in some cases my descriptions below may be a bit cryptic.   My intent is not to provide a transcript, but rather to provide a flavoring of issues being discussed at NCBJ. 

However, the day began with the 5th annual Berkley-Bernstein 5k race.    As usual, I finished near the back of the back.   However, there is something perversely fun about seeing the sun come up over the water while gasping for breath with fellow bankruptcy practitioners and judges.   Kudos to Berkley-Bernstein for sponsoring this event.   

Watching the Hedges Grow: Inside the Mind of Distressed Investors:  Ret. Judge James Peck, William Derrough (Moelis & Co.), Bruce Bennett (Jones Day), Mark Brodsky (Aurelius Capital) and Ken Liang (Oak Hill Advisors)

This panel was billed as a chance to get inside the minds of hedge funds.   The panel explained that the difference between hedge funds and private equity funds is that hedge funds largely rely on publicly available information, while private equity funds rely on an intense review of internal documents.   There are about 350 hedge fund players and they get involved in cases as small as $50-$100 million.  

According to Ken Liang, hedge funds look for the fulcrum security.  His company believes that converting to equity produces the highest possible return, although they don't mind receiving payment either.

Mark Brodsky said that his firm may look for two or three places in the capital structure to invest and will focus on value created during the chapter 11 and then get out.

Ironically, the panelists said that hedging and short sales are only a small part of their strategy.

Hedge funds may form ad hoc committees when they feel that the agent or indenture trustee for the debt is not adequately representing the issue or when the Creditors' Committee either represents too many constituencies or is dominated by a group that excludes the hedge funds.   They added that unrepresented positions gets in trouble more often than not.   

William Derrough, who is a financial advisor to debtors, said that the challenge is to get a counter-party to talk to.   He said that there is a dance of dance of getting the fulcrum security to sit down and talk and to get them restricted from trading so that they can share nonpublic information.  This generally involves negotiation over what is confidential and how long the hedge fund should be restricted from trading.   The debtor will generally try to say that everything is confidential and secure a long restricted period, while the hedge fund will try for an extremely short period.   One of the hedge fund reps said that the case is about trying to reach a deal and that debtors are reluctant to provide information until their hand is forced.  
 
Mark Brodsky pointed out that the schedules and statement of financial affairs provide more information than is required by the SEC.    They want to get restricted early, get the information needed and be prepared to negotiate.   He also said that, "Because we are good investors, we believe that settlement is good."    He said that they frequently find themselves begging people to negotiate with them only to find that no one showed up.   He also urged courts to move cases along, stating, "The sooner you get to the courthouse steps, the sooner you settle."  

Judge Peck asked the parties whether, in light of the fact that litigation is so expensive, the threat to litigate is a tool.    Brodsky said that obtaining decisions costs money and that whether it gets that far is a function of how the case is managed.   Liang said that every dollar spent is a dollar taken away from value.   He expressed frustration with debtors who seek extensions of exclusivity.  He said that he wished they would just file a plan and tee up a value.

Judge Peck commented that the difference between hedge funds and other parties is that they have substantial resources and can pursue a credible fight, causing the other side to cave or engage in an arms race.  

Bruce Bennett said that it is important for judges to manage discovery.   He acknowledged that discovery disputes are boring, but said that not every dispute requires twenty depositions and that the court can manage disputes over documents so that the process is cheaper.  

When asked if hedge funds are good for the process, several panelists pointed to hedge funds as a source of new capital and de-leveraging the balance sheet and pointed out that they are better able to make decisions than banks and insurance companies which face regulatory pressures.    Liang said that because hedge funds buy in for less than par, they have more flexibility than banks.   Bennett said that they provide a market for distressed debt.  

Judge Peck concluded that the world of bankruptcy had changed during his time on the bench.   He said that there are now significant pools of capital available to take advantage of research and hard work to obtain solutions that would not have been possible.

All the Courtroom's A Stage:  Honing Courtroom Presentation Skills: Circuit Judge Bernice Donald (6th Circuit), Richard Wynne (Jones Day), Timothy Draeglin (FTI Consulting), Shay Agsten (von Briesen & Roper), Stephen Hessler (Kirkland & Ellis), Ori Katz (Sheppard, Mullin, Richter & Hampton) and Demetra Liggins (Thompson & Knight)

This panel provided a demonstration of examining an expert witness.   Demetra Liggins "profferred" the testimony of the expert with a presentation that was as much legal argument as expert testimony. The judges (Judge Donald and Richard Wynne) commended her for using the proffer as argument and giving a delivery that was expressive and did not sound like mere reading.  

On cross-examination, Shay Agsten (who was making a practice point) made the mistakes of asking open-ended questions on cross, reinforcing the witness's testimony and allowing the witness to evade the questions.  

Stephen Ressler on re-direct exceeded the scope of cross without objection and also elicited legal conclusions from a non-lawyer.

On re-cross, Ori Katz did a much better job of pointing the witness to specific points in his report and trying to control the witness.   He was aggressive with the witness but made the mistake of giving a smart response to the court when admonished to avoid making a sidebar.   

The cross-examining lawyers were also advised that when the witness dodged a question to ask it a different way rather than simply repeating the question.  

Whose Case Is This Anyway:  Should A Chapter 11 Case Be Run Solely for the Benefit of Secured Creditors?   Judge Barbara Houser, Ross M. Kwasteniet (Kirkland & Ellis), Jeffrey Pomerantz (Pachulski, Stang, Ziehl & Jones), Damian Schaible (Davis, Polk & Wardlaw) and Jane Lee Vris (Millstein & Co.)

This panel examined the relationship between the secured creditor seeking to control the case, the debtor and the unsecured creditors trying to salvage some value.   Topics covered included plan support agreements, floating liens, credit bidding and 363 sales.

In theory, a plan support agreement is a positive thing.   Where the debtor and the secured creditor anticipate a filing well in advance, the debtor can look for holes in the creditor's collateral and negotiate a distribution for the unsecured creditors.   The process also needs to allow sufficient time for an unsecured creditors committee to be appointed and do due diligence.   On the other hand, where the unsecured creditors are cut out or are not given time to get up to speed, a plan support agreement will simply force the committee to fight.

Jane Vris pointed out the danger that a plan support agreement and DIP financing would be intertwined and therefore locked in at an early stage.

Jeffrey Pomerantz referred to plan support agreements that cut out the committee as a "pre-packaged cram-down."    

The parties spent considerable time discussing the implications of In re Residential Capital, LLC, 501 B.R. 479 (Bankr. S.D. N.Y. 2013) on floating liens.   In this case, the junior secured creditors had blanket liens on the debtor's assets and claimed that the equity in the debtor was subject to their security agreement.   Where value is created post-petition through the bankruptcy, this is not value which secures the creditors' pre-petition claims.    The panelists discussed whether it is even possible to have a lien upon the goodwill of a company and if so, how a creditor would foreclose this lien under the UCC.

Repeating a recurring theme, Pomerantz said, "If the secured creditor wants to participate in bankruptcy, they need to pay the freight."   His point was that if a secured creditor wants to use bankruptcy to realize upon its value, it probably means that the bankruptcy will generate more value than the creditor could have obtained out of court and that this value should be shared with the unsecured creditors.  

With regard to the melting ice cube problem, the parties discussed the problem that when an expedited sales process occurs, it may be impossible to fully determine the extent of the secured creditor's lien.   Where this occurs, they suggested a hold back to protect against the possibility that part of the secured creditor's claim might be disallowed.

The panelists discussed the problem of DIP orders that preserve the secured creditor's credit bidding rights and therefore prevent the court from modifying them later.   However, a creditor can't credit bid on an asset upon which it doesn't hold a lien.    Where the extent of the creditor's lien is in dispute, the creditor should be limited to credit bidding the undisputed portion of its lien or waiting until the lien issue has been thoroughly litigated.  

Judge Houser had the final word, stating that "for me as a judge, when I'm being told that we have 22 minutes to get this case done, I tend to think that's not true and there needs to be a modicum of due process."   She said that she may schedule a status conference to ask how the unsecured creditors will be protected in the process.   She said that she didn't want to have a district judge on appeal "thinking I'm a complete idiot."

NCBJ 2014: Fed Economist Says "I've Got to Admit It's Getting Better, A Little Better All the Time (It Can't Get Much Worse)"

William A. Strauss, an economist with the Chicago Fed, delivered the keynote address for the Commercial Law League of America's luncheon Thursday.   His overall forecast was for slow but steady growth, declining unemployment and low interest rates as the country digs its way out of the Great Recession.    In other words, he predicted a good climate for reorganizing debtors.

His only reference to bankruptcy was in his opening remarks when he stated:

Bankruptcy is good.  Unemployment is good.   They are necessary evils. . . . Unemployment makes workers available to industries that are rising.   Bankruptcy makes resources available to industries that are rising.

He described the economic picture as a good news, bad news story.   He said that the United States has the strongest economy in the world, although its growth is not impressive.   He said that we should see positive growth this year.   However, he tempered his remarks by pointing out that the relevant metric is not zero.   Each year the labor force grows by 1% while productivity can be expected to grow by 1.0-1.25%.   Thus, a growth in GDP of 2.0-2.25% is the expected trend line.

He said that the outlook for the next five years was growth at:

2014 +2.0%

2015 +2.9%

2016 +3.0%

2017 +2.0%

He said that the economy is recovering slowly from the Great Recession.   After the recessions in the 70s and the 80s, the economy improved by about 20% in the five years after the trough.   Here, the recovery is only expected to be about 11%.    During the Great Recession the economy declined 4% over an eighteen month period.  Subtracting the growth which should have occurred during this period, the economy was down 7%.    

However, the American economy looks positively rosy compared to the rest of the world.   Japan is expected to increase by 1.2-1.3%, Europe by 1.0-1.5% and Russia by 0-1%.    Strauss said that the U.S. needs for the rest of the world to do well in order for our economy to do well.

The housing market illustrates the double nature of the recovery.   On the one hand, housing starts are up 40% and prices are growing by double digits.   On the other hand, 15-20% of homes are still under water financially and prices are back to their levels of ten years ago in real terms.   

The stock market appears to be at record highs, but is not when adjusted for inflation.

Employment is another weak area.   8.7 million jobs were lost during the Great Recession.   We are currently adding about 1 million jobs per year which means that it will take 6 1/2 more years to recover.   He said that the natural unemployment rate is 5.25% and that we are about half a point above that level.   Labor force participation fell by 3% during the Great Recession and is back to 1978 levels.   1.5-2% of this is due to demographics, that is, older workers dropping out of the work force, while 1.0 - 1.5% is cyclical.    What is even more concerning is that participation levels for those aged 25-64 are constant, while the 16-19 and 20-24 year old demographics are down dramatically.   

3.5 million workers have given up looking for jobs and are not counted in the unemployment rate.   He said that the true level of unemployment beyond the natural level is about 4.5 million to which is added a percentage of those working part time who would prefer full time work.   (He gave the statistic.  I just didn't get it in my notes).   

He said that we are "far removed from a labor force that is in balance."

Mr. Strauss said that the demand side of the economy is growing but not by much.  He said that producing too much of anything results in reduced prices rather than inflation.  He predicted that inflation would only be 2.2% in 2014 and 2.1% in 2015.   The Fed's target inflation rate is 2%.   Strauss said that there is nothing wrong with going above the target rate if it will help the labor market. 

He described manufacturing as a stellar sector in the economy.  However, it has only brought back 31% of workers laid off.   The remaining gains have been due to productivity.   The companies that survived are more "lean and mean."  He also said that we have "world class manufacturing in the U.S."  We have 5% of the world's population and 24% of the output in the world.   One growth area is for vehicle manufacturing.   The average car on the road is eleven years old, something that would have been unthinkable a decade ago.  However, it also means that a lot of people will be replacing their vehicles.

Strauss spent a fair amount of time talking about monetary policy.   (He is from Chicago after all).   He said that in 2008, the Fed lowered the overnight lending rate to nearly zero.   He said that he wished they could have lowered it to -4% so that people would have been forced to take money out of the bank and spend it.   However, he said that would have been too disruptive.  Apparently Cyprus did just this by taxing bank deposits and the result was bad.   

He said that he expected the overnight rate to reach its natural rate of 3.0-3.25% by 2017.  He described this as a neutral rate, "not putting the foot on the brake, just taking the foot off the accelerator."

He quoted Milton Friedman as saying that inflation everywhere is a monetary phenomenon and that it results from monetary policy, not the monetary base.

Strauss said that he never had the occasion to study with Friedman.   However, he did have occasion to attend his 90th birthday party where a newly minted Fed Governor named Ben Bernanke was the keynote speaker.   Speaking of the Great Depression, he told Friedman, "We're sorry.   We're not going to let it happen again."   During the Great Depression, the Fed added to the monetary base but not as much as was being lost from bank failures.  As a result, the money supply declined which contributed to the depression.

During the Great Recession, the Bernanke Fed grew the monetary base by 20% but only grew the money supply by 6%.    However, he was true to his word and did not let the country slip into a full blown depression.

In conclusion, he said that we will continue to grow the economy at a decent rate for the next several years and that employment will continue to rise at a moderate level.

In response to a question that I don't remember, he quoted Warren Buffett as saying "You don't know who's swimming naked until the tide goes out."   I don't remember the context, but I like the quote.
  

NCBJ 2014: Chapter 9, Closely Held Businesses, e-Discovery, Claims Buying and Sale Free and Clear of Interests

NCBJ is in Chicago this year.   The weather is pleasantly cool compared to the continuing Austin heat and the first day of CLE had some interesting programs.   Here is a wrap of Day 1, which included Chapter 9, reorganization for closely held companies, e-discovery, an economist from the Chicago Fed, claims trading and treatment of "interests" in section 363 sales.     I will divide the day between separate posts on the educational seminars and the economist's prognostications.  There will be another Fed economist speaking tomorrow.

Chapter 9:  Judge Steven Rhodes, Daniel Heimowitz (RBC Capital Markets), Marc Levinson  (Orrick, Herrington & Sutcliffe, LLP), Ron Oliner (Duane Morris) and Judge Elizabeth Perris

While Chapter 9 may seem exotic and unusual, three California Cities, as well as Detroit and Jefferson County, Alabama have all used this mechanism.   In Texas, it has been used on a smaller scale for many road and water districts.    

Municipal finance is big business.   There is about $3.7 trillion of municipal bonds outstanding with 11,464 issued during 2013.  Nevertheless, only about 4-5 default in any given year.   However, when they do, it creates a big stir.

The  most unique aspect of chapter 9 is its public nature.   Ron Oliner referred to the process as trying both "a political and a legal case" which is challenging for lawyers not used to dealing with the political process.   One of the speakers described dealing with the "crazy" ever present media and politicians and having clients constantly talking to the media to try to influence public opinion.   In the City of San Bernadino case, the City Attorney was recalled shortly after the case was filed, prompting the Mayor to state that the City Attorney's "26 year reign of terror" had ended.   Marc Levinson described the circus nature of city council meetings where decisions must be made in public.   Judge Perris, who has been the judicial mediator for several of the California cases, explained the difficulty of mediating cases where the principals could not be in the room due to open meetings law.  She also described having the media stake out mediations and reporting on the comings and goings of the various participants.   

One important issue discussed was eligibility.   There are several hoops that a municipality must jump through in order to qualify for relief, including being authorized to file by state law and having negotiated in good faith.   Conversely, if an entity is a municipality, it is not eligible to file for chapter 11.   The New York Off-Track Betting Corporation was found to be a municipality, while the Las Vegas Mono-Rail and the Orange County investment pool were not.   In re: New York Off-Track Betting Corporation, 427 B.R. 256 (Bankr. S.D. N.Y. 2010); In re Las Vegas Monorail Co., 429 B.R. 770 (Bankr. D. Nev. 2010); In re County of Orange, California, 183 B.R. 594 (Bankr. C.D. Cal. 1995).

Frequently, labor union difficulties are a factor in Chapter 9 cases.   Because section 1113 does not apply in Chapter 9, the more lenient standard of NLRB v. Bildisco & Bildisco, 465 U.S. 513 (1984) applies to rejection of collective bargaining agreements.   Nevertheless, the politics of public unions encourages negotiated solutions.  

The requirements to confirm a plan appear similar but are tricky.   When dealing with a secured creditor, it is often necessary to engage a municipal finance expert to determine whether the bond instrument has created a pledge of funds or merely provided for funds to be paid from a particular source.   The absolute priority rule has little application since municipalities do not have equity holders.   However, the necessity of obtaining bond financing in the future deters parties from burning bridges.    Feasibility is a challenge where projections must go out forty years.   

Judge Perris pointed out the importance of mediation in Chapter 9 cases, stating that the parties need to make deals and need to make peace.    She said that many of the players in Chapter 9 cases are repeat players and are constantly worrying about what will happen in the next case down the road.

All in the Family:  Advising the Closely Held Company: Whitman Holt (Klee, Tuchin, Bogdanoff & Stern, LLP), Mindy Mora (Bilzin, Sumberg, Baena, Price & Axelrod), Douglas Rosner (Goulston & Storrs) and Michael St. Patrick Baxter (Covington & Burling)

The panel discussed the importance of spelling out the nature of the representation.   Doug Rosner said that at the beginning of the representation when the interests of the company and the shareholder are blurred that "the conversation is equally blurred."   Mindy Mora suggested obtaining an initial engagement letter specifying that the firm represented both the individual and the company prior to bankruptcy but would be representing the company only once bankruptcy was filed.   Rosner said that when talking to the individual, "my job is to tell you when you need to talk to your own counsel."

They also discussed the plight of the independent director.   While an independent director is under no obligation to stay ("it's not maritime law, you don't have to go down with the ship"), the director may benefit from staying on because decisions made on advice of counsel will likely be protected and directors can obtain releases under a plan.

There was a lot of discussion about so-called "bad boy" guarantees, where the principal's liability is triggered by a bankruptcy filing.   This creates a conflict of interest between the individual's personal interest in not having the guaranty take effect and the fiduciary duty to the company and creditor's.  Interestingly enough, in one case, the springing guaranty took effect upon an involuntary bankruptcy filed by the lender who was the beneficiary of the provision.    The panel discussed the situation in the Extend-A-Stay case where the debtor's principal sued his personal counsel after they advised him that his exposure on a breach of fiduciary duty claim was greater than his springing guaranty.   However, the case was dismissed, which was affirmed on appeal.

Another conflict of interest arises from the attorney's retainer.    Without a retainer, the company cannot obtain competent counsel.    However, the company's funds are often subject to a creditor's liens.   If the company pays counsel with encumbered funds, counsel may be forced to disgorge and be disqualified.   Trying to launder the funds through a related entity is even worse.    

Pre-bankruptcy forebearance agreements are a trap for the unwary.   Lenders may insist upon waiver of the automatic stay, disgorgement of counsel's retainer and an unlimited guaranty from the principal while providing only limited forebearance.   (The correct answer here is not to agree to these provisions).

If the company does not file, it probably will not be able to protect the principal from suits while a plan is being negotiated.    Judge Allen Gropper has two recent decisions where he refused to grant a section 105 injunction to a restaurant owner being sued for wage violations.   In re SDNY 19 Mad Park, LLC, 2014 Bankr. LEXIS 3877 (Bankr. S.D.N.Y. 2014); In re Capitale I Ventures, LLC, 2014 Bankr LEXIS 3099 (Bankr. S.D. N.Y. 2014).    (Practice point:   don't stiff your employees if you plan to file chapter 11).     

Assuring eDiscovery Does Not Become eDisaster, District Judge James F. Holderman, Jason Lichter (Pepper Hamilton), Stephen Lerner (Squire Sanders), Camisha Simmons (Rose Norton Fulbright)

While I took a lot of notes from this panel, there were several top take-aways:

• If you have an eDiscovery issue, tell your judge to call Judge Holderman.   Even though he was considerably older than his fellow panelists, he has worked through these issues extensively and is happy to discuss them with other judges.   His phone number is 312-435-5632.
• The Seventh Circuit Electronic Discovery Pilot Program, www.discoverypilot.com, has lots of useful information, including forms and free webinars.    The Seventh Circuit is very proud of this site and it is the current judicial state of the art.
• If the case is going to involve eDiscovery, have your client designate an eDiscovery Liason  and have her work with an eDiscovery Liason from your firm.   Make sure that your firm understands all there is to know about how your client collects, maintains and preserves electronically stored information (ESI).
• The ABA has a Best Practices Report on Electronic Discovery (ESI) Issues in Bankruptcy Cases. http://apps.americanbar.org/buslaw/committees/CL160000pub/newsletter/201307/esi_best_practices.pdf.
• Before ESI issues arise in the case, develop an ESI Protocol with opposing counsel.   If opposing counsel won't agree, file a motion to establish one.   However, don't make it a first day motion.   An ESI Protocol can deal with issues such as clawback of privileged documents and parameters for searching documents.   For example, the parties could agree to a protocol that accepts that 80% accuracy in searching is acceptable.

The requirement to preserve ESI arises when an attorney "reasonably anticipates litigation."   The attorney should put in place a litigation hold consisting of written instructions to the client's custodians of ESI.

There are proposed amendments to the Federal Rules of Civil Procedure which will take effect on December 1, 2015 if approved by the Supreme Court.   Among them, Rule 37(e) will be amended to provide that a spoilation instruction can only be given where the court finds there was an "intent to deprive" the opposing party of ESI.   This would replace the current negligence standard applicable in some circuits (and no, I don't know which ones).    There is also a proposed amendment to Rule 26(b)(1) which will replace the reasonably calculated to lead to the discovery of admissible evidence standard with one which refers to information which is relevant and proportional to the needs of the case.   Proportionality looks to what is reasonable under the circumstances of the case given the resources of the parties.    

An interesting concept to discuss with your transactional lawyers is the litigation pre-nup.   It defines what ESI protocols the parties will use if there is ever litigation over the deal.   This may be the wave of the future.

The only bad thing about attending this program is that now I can't claim to be ignorant of these issues.

Bankruptcy and the Markets:  The Uneasy Relations Between Debtors, Traders and Judges: Judge Jeffrey Deller, David Eaton (Kirkland & Ellis),   Debra Grassgreen (Pachulski Stang, Ziehl & Jones), Thomas Moes Mayer (Kramer, Levin, Naftalis & Frankel, LLP), Jeffrey Rich (Rich Michaelson Magaliff Moser) 

The panel distinguished between strategic and non-strategic purchases of claims.   Non-strategic purchasing of claims is buying a claim in the hopes of recovering more than was paid.   Strategic claims purchasing, on the other hand, is purchase of claims with the intention of influencing the case.   This could mean attempting to obtain equity or control in the reorganized debtor or to block a plan and force a sale of the debtor's assets.   

Strategic claims purchases can be either good or bad depending on the motivation of the purchaser.   Good motivations are those which advance the purchaser's economic interest as a creditor.  Negative motivations can include driving a competitor out of business or extorting a disproportionate payment to stop interfering with the reorganization.   

Tools for dealing with improper use of purchased claims include designating the creditor's ballot under section 1126(e), equitable subordination and denying credit bidding.   Major cases include In re DBSD North America, Inc., 634 F.3d 79 (2nd Cir. 2011), where the court affirmed designation of the vote of a competitor who purchased claims for above par late in the case to block confirmation, In re Lightsquared, Inc., 513 B.R. 56 (Bankr. S.D. N.Y. 2014), where a creditor was allowed to vote despite an improper motive where plan was "abysmal" and any creditor would have opposed and, In re Fisker Auto Holdings, 510 B.R. 55 (Bankr. D. Del. 2014), where a creditor who purchased a claim was limited to credit bidding the amount it paid for the claim.

Section 363 Sales:  What You Get and What You are Stuck With:   Hon. David Coar (ret.), Barry Bressler (Schnader Harrison Segal & Lewis, LLP), Lisa Hill Fenning (Arnold & Porter), George W. Schuster (Wilmer Cutler Pickering Hale & Dorr), Richard W. Young (Quarles & Brady)

This panel examined what it means to sell property free and clear of "interests."   The first scenario it examined was successor liability.    In the case of  In re Trans World Airlines, Inc., 322 F.3d 283 (3rd Cir. 2003), the term "interests was defined broadly enough to extend to vouchers given to flight attendants in compromise of labor claims.    In Chrysler, the debtor proposed to sell the assets of the company and assume warranty claims for post-closing sales of vehicles but not pre-sale tort claims.   The Ad Hoc Committee of Consumer Claims appealed and the Second Circuit affirmed.  In re Chrysler, LLC, 576 F.3d 108 (2nd Cir. 2009).    The Supreme Court vacated the Second Circuit decision based on mootness.   Nevertheless, the Debtor later agreed to assume some claims for the purpose of preserving the value of unsold vehicles.    In General Motors, there was not a third party buyer.   The "sale" allocated 10% of the value in Newco for tort claimants and assumed liability for future tort claims.   However, the company did not disclose certain known claims based on cars switching off.

Intellectual property is another example of an interest possible "interest."    Intellectual property consists of patents and copyrights, which exist under federal law, trademarks, which exist under federal law, state law and common law, and trade secrets, which are created by common law.   

Liens on intellectual property can be perfected by filing under the UCC.  The Patent and Trademark Office can record an assignment of patents or copyrights but not a mortgage.   

Intellectual property can be transferred pursuant to exclusive license, non-exclusive license or sale.  An exclusive license allows the licensee to use the IP to the exclusion of other parties but may include a reversion to the licensor.  A non-exclusive licensee may use the IP but the licensor is free to grant licenses to multiple parties.   Finally, a complete transfer vests ownership in the IP to the purchaser.

A non-exclusive license may not be assigned without the consent of the licensor.   A true exclusive license may be assigned.   Originally, trademarks could not be licensed because they were identified with the owner.   However, the law subsequently allow trademarks to be licensed so long as the licensor controlled the quality.   

A debtor who is a licensee may not assign its license without consent of the licensor.   On the other hand, if the debtor is the licensor, it can assign its right to receive royalties.   However, a debtor may not sell its IP free and clear of existing licenses.   This is provided by section 365(n).        

Precision Indus., Inc. v. Qualitech Steel SBQ, LLC, 327 F.3d 537, 545 (7th Cir. 2003), Dishi & Sons v Bay Condos, LLC, 510 B.R. 696 (S.D.N.Y. 20140 and In re Spanish Peaks Holdings II, LLC, 2014 Bankr. LEXIS 913 (Bankr. D. Mt. 2014) are three cases dealing with whether property could be sold free and clear of the rights of others to use the property.   

Qualitech held that a debtor could sell property free and clear of the lessee's right to possession so long as the lessee was provided adequate protection.   The court reasoned that although the debtor could not dispossess the tenant by rejecting under section 365, section 363 allowed the sale free and clear of liens.

In Bay Condos, the Court also held that section 363(f) and 365(h) were not in conflict.  However, in order to sell under section 363(f), the debtor must meet one of five conditions stated.   While the tenants interests could have been extinguished under section 363(f), The Court found that section 363(f) would rarely ever allow a sale free and clear of the tenant's right to possession.  

Finally, in Spanish Peaks, the court found that the two sections were in conflict.   The Court allowed sale of the property free and clear of the interests of leases granted to insider affiliates of the debtor.

The Short Case for Venue Reform

Today I had the opportunity to debate venue reform at the National Conference of Bankruptcy Judges in Chicago.   We had two excellent teams of debaters.   Arguing for the pro-reform position were Prof. Samir Parikh, retired Bankruptcy Judge Leif Clark and myself.   The pro-status quo team consisted of Prof. Douglas Baird, retired Bankruptcy Judge Arthur Gonzalez and Dan DeFranceschi of Richards, Layton & Finger, P.A.   Jamie Sprayregen of Kirkland & Ellis moderated the debate.  We had a good, vigorous debate.     There was at least some agreement that venue for preference actions should be reformed.    The debate was sponsored by the Commercial Law League of America.

Here is the opening statement that I gave for the pro-reform side:

Good afternoon, my name is Steve Sather. My colleagues, retired Bankruptcy Judge Leif Clark and Prof. Samir Parikh and I will be arguing that the current bankruptcy venue law, 28 U.S.C. § 1408, should be reformed to prevent forum shopping in Chapter 11 cases.

By forum shopping we mean filing in a venue where the company has little or no physical presence.   Examples would include the Los Angeles Dodgers and the Chicago Tribune filing bankruptcy in Delaware.

Forum shopping is allowed by the current law for two main reasons.  First, by equating domicile with state of incorporation, the courts have allowed companies to file in jurisdictions that have little to do with their actual business operations.   Second, by allowing venue where there is a case concerning an affiliate, venue for an entire corporate group can be based on the locale of a minor subsidiary or even one created for the purpose of obtaining venue.

   Judge Leif Clark, Prof. Samir Parikh and Steve Sather debate at NCBJ
 
Forum shopping occurs with great regularity.   Prof. Parikh’s study found that 69% of large companies that filed chapter 11 during the Great Recession forum shopped.   This is not just happening in Delaware and New York.   Pilgrim’s Pride, ASARCO and Crescent Resources are all examples of cases that were forum shopped to my home state of Texas.   It is not just happening in large cases either.  In a study by the Venue Reform Group, of which I am a member, half of the 559 out of state cases filed in Delaware since 2003 had less than $15 million in assets.   The current venue law is so open-ended that it has been referred to as a non-law.

Forum shopping is a problem because it confounds creditor expectations and deters participation by local parties.    Think of the City of Detroit case where Judge Steven Rhodes viewed the local community and allotted a full day for local residents to address the court.   That could not have happened if the case had been filed in Delaware.   When a bank or a trade creditor deals with American Airlines in Fort Worth, they know that they may have to go to Ft. Worth to enforce their debt.   However, they do not expect to have to hire local counsel in Delaware to defend a preference action. 

Forum shopping also creates the perception that the process is manipulated by insiders and major players to the detriment of small creditors.  When Enron filed in New York, it looked like the company was fleeing from its very public problems in Houston.   While Houston was good enough for the criminal trials of the Enron executives, the reorganization was held elsewhere.  Bankruptcy is big business and when it takes place far away from the home forum, we can expect the public to be skeptical of the process and the results.   I don’t blame the lawyers because they are simply taking advantage of the choices given to them under existing law, but the current process feeds the Wall Street vs. Main Street narrative that is dividing our country.

While we acknowledge that there are skilled and hard working judges in New York and Delaware, there are excellent judges all over the country and we see that in cases where forum shopping is not an option such as municipal bankruptcies and the Catholic Diocese cases.    Think Steven Rhodes with the City of Detroit or Susan Kelly with the Diocese of Milwaukee.   

In our discussion today, we will offer several solutions, including separate venue provisions for individuals and artificial entities, which was the rule immediately prior to enactment of the Code, reforming the affiliate venue rules, creating a national bankruptcy court of appeals and procedural reforms to ensure that venue issues are resolved promptly and efficiently and that forum shopping is deterred.

Note:  My original post referred to Dennis DeFranceschi.   His name is actually Dan, which I knew.  I apologize to both Dan and his parents for trying to rename him.

NCBJ 2012: Important Cases, Chapter 15, A Constitutional Tour De Force and the CFPB

I made it to three panels each on Friday and Saturday.   I will combine them here for ease of posting.  If you read nothing else, read the Supreme Court discussion, including late-breaking news on Stern v. Marshall.

The Most Significant Business Bankruptcy Decisions and Developments of 2011-2012

This panel discussed four recent cases.  I have discussed Highland Highgate and Gateway RadLAX elsewhere, so I will just focus on the two remaining decisions.

In Development  Specialists Inc. v. Akin Gump Strauss Hauer & Feld, 477 B.R. 318 (S.D.N.Y. 2012), the court considered the obligations of partners of a dissolved law firm to account for earnings from old firm business that they take to a new firm.   Under the Uniform Partnership Act, partners at the time of dissolution have a duty to each other to account for benefits they receive from “use” of partnership property.    The Court ruled that the departing partners owed the firm an accounting for profits earned measured by receipts less expenses.   The Court declined to rule on the following issues on summary judgment:

(1) The Partnership Law requires the departing partner to account for profits he realizes from the use of the dissolved firm's unfinished business. Is that measured by his share of the new firm's profit on the matter, or by the entire profit realized on the matter?

(2) What constitutes a deductible "expense" or "overhead" at the new firm? What portion of the new Firm's realized fee is profit and what is expense (which will entail dissection of billing rates to tease out the profit factor from the cost factor)?

(3) How does one value the Former Coudert Partner's contribution of "effort, skill and diligence" to the matter?

 

477 B.R. at 350.   The Court subsequently authorized an interlocutory appeal.    

The case raises serious questions about whether partners who remain with a firm at dissolution will constitute a burden on their new firms, since they may be forced to account for any profits on work brought from the old firm.   Since part of the attraction of a lateral hire partner is his book of business, this would severely diminish the attorney’s value in the marketplace.   Since the rule only applies to persons who are partners at dissolution, it also creates an incentive for lawyers to jump ship and thus hasten the decline of the firm.    

These are issues that law firms should address in their partnership agreements before they go bust.   Also, the rule might apply differently in jurisdictions which follow the Revised Uniform Partnership Act.

In In re TOUSA USA, Inc., 680 F.3d 1298 (11^th Cir. 2012), the parent company paid off existing debt by borrowing new funds secured by the assets of its subsidiaries.   The Bankruptcy Court avoided the transfer as to both the lenders who were paid off and the lenders who got new liens.  The District Court reversed as to the original lenders.   The 11^th Circuit affirmed the original bankruptcy court ruling.  Even though the original lenders did nothing more than receive payment on their debts, the fact that the funds came from encumbering the assets of the subsidiaries meant that they were transferees for whom the fraudulent transfer was made.   I will be writing more about this decision soon.

Round Two:   Scoring a Knockout on Appeal

This panel included Guy Cole, a former bankruptcy judge who now sits on the Sixth Circuit, Jim Haines of the First Circuit BAP, and Supreme Court advocates Eric Brunstad and Susan Freeman.

Judge Cole offered a bad joke based on an anecdote from Eric Brunstad at the prior day’s luncheon.  In a Supreme Court argument, Brunstad had tried to explain the need for prompt action by bankruptcy courts, giving the examples of rotting bananas and melting ice cream.  This prompted a straight-faced question from Chief Justice Rehnquist about “melting bananas,” demonstrating that even Supreme Court justices can mix a metaphor.  

Judge Cole asked:

Q:        What happens to a melting banana?

A:        It loses its appeal.

Sorry, I couldn’t resist repeating that.  (It might have actually been Judge Haines who told the joke, but I will give the credit to Judge Cole since he sits on a higher court).

I picked up a few practical points from this panel.

Focus on your audience.   While a bankruptcy judge or a BAP may be familiar with bankruptcy terms, an appellate judge will be unlikely to.   As noted by Judge Cole, about 70% of his docket consists of criminal appeals and pro se prisoner cases.    Someone pointed out that “indubitable equivalent” is half of a haiku.  I think the point was that our jargon may be confusing to higher courts.

Put it in context.   Since your case will be reviewed by judges unfamiliar with bankruptcy law and law clerks just out of law school, be sure to explain why it makes a difference.    If the difference between two different interest rates means that the debtor wins reorganization or faces liquidation, this would be a good thing to point out.

For oral argument, practice giving sound bite answers.  Susan Freeman pointed out that doing a moot court, especially for Supreme Court arguments, will work out weak areas in your argument.  Because oral argument is short, being able to give concise, responsive answers is a must.

Focus on the level of the court you are arguing to.   The Supreme Court does not care what a bankruptcy court somewhere has to say about an issue.   They care about what they have said before and what the circuits have to say.

Coming to America Broke:  Chapter 15 Plain and Fancy

In this discussion of chapter 15, Judge Alan Gropper had the best bankruptcy pun of the conference when he noted that, “We used to look for commies.   Now we look for COMIs.”    While both similarly sounding terms have international implications, COMIs or Centers of Main Interests, actually have a positive connotation under chapter 15.

While chapter 15 may sound exotic, it is simply the means by which an American court can provide assistance to a court conducting an insolvency proceeding in another country.   Chapter 15 is based on the UNCITRAL Model law adopted in 1997.  It is based on the concept that a foreign representative appointed in a foreign proceeding may request recognition and enforcement in the United States.

To begin with, there must be a “foreign proceeding” including the following elements:   

(i) a proceeding; (ii) that is either judicial or administrative; (iii) that is collective in nature; (iv) that is in a foreign country; (v) that is authorized or conducted under a law related to insolvency or the adjustment of debts; (vi) in which the debtor's assets and affairs are subject to the control or supervision of a foreign court; and (vii) which proceeding is for the purpose of reorganization or liquidation.      

 In re Betcorp, 400 B.R. 266 (Bankr. D. Nev. 2009).

If there is a foreign proceeding, a foreign representative may request recognition.   In order to receive recognition, a proceeding must be either a “foreign main proceeding” filed in the business’s Center of Main Interest (or COMI) or a “foreign nonmain proceeding” filed in a country in which the company has a business “establishment.”    In re Bear Stearns High-Grade Credit Strategies Master Fund, Ltd., 389 B.R. 325 (S.D. N.Y. 2008) established that a proceeding commenced in a so-called letterbox jurisdiction might be neither a main proceeding nor a nonmain proceeding.   In that case, a fund was established in the Cayman Islands, but all of its business activities were in the United States.   The Court refused to recognize the Cayman Islands proceeding.

Prof. Jay Westbrook said that international insolvency could be approached from a strictly territorial approach or a broad universal approach.   Because there is no international court system, chapter 15 acts on the basis of a modified universalist approach.   A court somewhere gets to be the lead court and other courts may assist.   

Recognition under chapter 15 is meant to be an easy process, and according to a study by Prof. Westbrook, is granted 95% of the time.   Once a proceeding has been “recognized,” a U.S. court may grant “additional relief” if parties are “sufficiently protected.”   The Vitro SAB case (which I wrote about here) is a case where the Court found that a Mexican proceeding did not sufficiently protect American creditors and denied additional relief.   The case is currently pending before the Fifth Circuit.  

According to Prof. Westbrook, there have been 585 chapter 15 cases commenced since 2005.   Initially these cases predominantly came from tax havens.  However, since the Bear Stearns case, some 65% come from Canada and the United Kingdom.   

The papers from this presentation are available to the public here.      

Bankruptcy Bingo:  The Battle for Bragging Rights

This panel discussed ten recent bankruptcy decisions of interest in a game show format.   Judge Sheri Bluebond, the game’s hostess, deserves high praise for taking a panel of ten judges and four contestants through ten cases in 60 minutes.    The cases discussed were:

In re Maharaj, 681 F.3d 558 (4^th Cir. 2012).   The absolute priority rule applies to property owned by the debtor pre-petition.   The exception to the absolute priority rule only applies to post-petition property.

Ackerman v. Eber, 687 F.3d 1123 (9^th Cir. 2012).   Court would not compel arbitration of dischargeability issues over debtor’s objection. 

In re Nortel Networks, Inc., 669 F.3d 669 F.3d 128 (3^rd Cir. 2011).   No police power exception to automatic stay where foreign government was seeking to protect its own interest in funding pensions.

Behrman v. National Heritage Foundation, Inc., 663 F.3d 704 (4^th Cir. 2011).   Court remanded case involving third party releases where bankruptcy court findings were couched in terms of generalities rather than specific findings.   

In re XMH Corp., 647 F.3d 690 (7^th Cir. 2011).   In an appeal involving assumption and assignment of a trademark license, the fact that the license had expired allowed the court to assign the non-executory portions of the contract.

In re TOUSA USA, Inc., 680 F.3d 1298 (11^th Cir. 2012).   Old lenders were entities for whose benefit avoidable transfers were made.

Peterson v. McGladrey & Pullen, 676 F.3d 594 (7^th Cir. 2012).   Suit brought against auditors of debtor who operated a ponzi scheme was barred by in pari delicto.   Because suit was brought under state law, state law defenses applied.

Perkins v. Haines, 661 F.3d 623 (11^th Cir. 2011).   Ponzi scheme investors established defense for return of principal.   They gave value and acted in good faith, thus entitling them to defense.

In re Friedman, 466 B.R. 471 (9^th Cir. BAP 2012).   Debtor may retain both Sec. 541 property and Sec. 1115 property without violating absolute priority rule.  This case conflicts with In re Maharaj above.

In re Mirant Corporation, 675 F.3d 530 (5^th Cir. 2012).   Although debtor was headquartered in Georgia, Georgia had no significant interest in enforcing repealed Georgia law in fraudulent transfer action.   Court applied New York law instead.   For reasons that are unclear to me without reading the opinion, the Fair Debt Collection Practices Act somehow affected a fraudulent conveyance case involving commercial transactions.

 The specific questions and answers can be found on the NCBJ website here.  

What 33 Years of Supreme Court Interpretations of the Bankruptcy Code CanTeach Us

Continuing the Supreme Court theme, Professors Erwin Chemerinsky and Ken Klee and Judge Judy Fitzgerald spoke about Supreme Court interpretations of the Bankruptcy Code.    These speakers deserve extra credit because they put their panel together on short notice after Justice John Paul Stevens was unable to make the conference.   They sounded several interesting themes, including the ongoing battle between textualists and purposefulists and how the circumstances of the court can affect major decisions.

The Supremes on Statutory Interpretation:

According to Prof. Klee, there are deep divides on the court as to how to interpret the Constitution and statutes.    The textualists, led by Justice Scalia, will follow the text even when their philosophical leanings would lead them elsewhere.    The purposefulists, led by Justice Breyer, will look more deeply into the purpose of the statue.     Nevertheless, the Supreme Court does not care deeply about bankruptcy.   According to Prof. Klee, they do the best that they can and leave it to Congress to fix it if they get it wrong.

Prof. Klee used three cases as illustrations.

Hall v. United States, 132 S.Ct. 1882  (2012).   This chapter 12 case dealt with the question of what happens to taxable gain when farmer has low basis and the farm is foreclosed upon during the bankruptcy.   The farmer can be left with a terrible problem because the tax is not part of estate and not subject to discharge.  Sen. Grassley authored legislation to avoid this problem.  Unfortunately, the intent not reflected in language of statute.   Justice Sotomayor wrote majority opinion for a 5-4 court.  The Court applied a strict textualist approach to find that the language should be interpreted as written, rather than as intended.   Prof. Klee speculated that this opinion might mean that Justice Sotomayor might actually have some textualist leanings.  This problem  would not occur in an individual  chapter 11 case because there is a separate taxable estate in a chapter 11 case.

Marrama v. Citizens Bank, 127 S.Ct. 1105 (2006).  In this 5-4 statutory interpretation case, a debtor who filed chapter 7 and was caught in wrongdoing sought to convert to chapter 13.  Although the statute said there was an absolute right to convert, Justice Stevens, applying a purposefulist approach, upheld the bankruptcy court decision denying conversion.   Justice Stevens said that it was nonsensical to allow conversion if the debtor could not stay in chapter 13 absent good faith.   The textualist minority said there because there was an absolute right to convert, the only proper approach was to allow conversion and then re-convert the case.   The majority said that bankruptcy was for the benefit of the honest but unfortunate debtor and that scoundrels should not have the right to convert (whether the Code says so or not).

RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S.Ct. 2065 (2012).   In this 8-0 decision, the court, rather than examining the extensive history of the term “indubitable equivalent” relied on a statutory canon to determine that the specific provision of Sec. 1129(b)(2)(A)(ii) controlled over the more general Sec. 1129(b)(2)(A)(iii).   

Prof. Erwin Chemerinsky noted that the fact that there have only been three statutory interpretation cases relating to the Bankruptcy Code in recent years reflects the reduced number of cases being heard by the Supreme Court.   Throughout much of the 20^th Century, the Court heard over 200 cases per year.  In 1978, the Court decided 162 cases.   While Chief Justice Roberts lamented the Court’s declining docket in his confirmation hearing, the court decided just 65 cases in the last term.   As a result, many important legal issues will go for longer periods of time without decisions.

Prof. Chemerinsky said that the court has a deeply divided bench with regard to both statutory and constitutional interpretation.  Justice  Scalia’s largest impact on the court has been changing how judges approach  legislative history.   He was the first justice to suggest that legislative history is irrelevant and he often gets a majority to join him. While Justice Breyer advocates looking at the underlying purpose of the statute and is willing to look at legislative history, he considers history to be just an indication of the purpose of the statute.   

Prof. Chemerinsky decried an over reliance on the plain meaning approach, noting that rarely will cases come to the Supreme Court with texts that have plain a meaning.   Where there are two plausible interpretations, either one can be supported under the plain meaning approach.    In that instance, the words of the statute don’t answer the question.   

Stern v. Marshall Dissected and Placed in Historical Context:

Prof. Chemerinsky argued that the two most important constitutional decisions relating to bankruptcy were driven by very different concerns.   In Northern Pipeline Construction Co. v. Marathon Pipeline Co., 458 U.S. 50 (1982), a plurality led by Justice Brennan held that the jurisdictional scheme of the Bankruptcy Reform Act of 1979 was unconstitutional because it allowed non Article III bankruptcy courts to determine state law issues between non-debtor parties.   Prof. Chemerinsky asked, why did the liberal wing of the court care about giving too much power to non-Article III judges?   His answer is that they didn’t.   At the time, Congress was threatening to remove the power of  the federal courts to hear controversial issues such as abortion and affirmative action.   According to Prof. Chemerinsky, “I think that what the Supreme Court did in Marathon was to send a message to Congress about the ability of Congress to limit the power of the (Article III) courts.”   He noted that the only possible constitutional fix to this problem was to make bankruptcy judges Article III judges.   However, Chief Justice Burger and the Article III judiciary opposed this move.    Congress created the core/non-core distinction which did not really solve the problem.     

    

Over time, the Supreme Court changed its approach toward non-Article III Courts.   In Thomas v. Union Carbide Agricultural Products Co., 473 U.S. 568 (1985) and Commodity Futures Trading Commission v. Schor (1986),  the court adopted a functional approach.   The core/non-core distinction made sense from a functional point of view.

All of this changed  with Stern v. Marshall, 131 S.Ct. 2594 (2011), which Chemerinsky described as the second most important case with  regard to the Bankruptcy Reform Act of 1978.  In this case, it was the conservative wing of the court that sought to limit the power of the bankruptcy court.    Chief Justice Roberts and the conservative wing of the court took a formalistic approach which looked to what the term judicial power of the United States meant when the Constitution was adopted.   The liberals, led by Justice Breyer, took a functional approach, noting that the core/non-core distinction worked as a practical matter.   Prof. Chemerinsky said that one of the puzzles of the two cases is why the Supreme Court found it important to require Article III courts to determine matters of state law.   After all, most state law issues are decided by state courts which do not have the protections guaranteed by Article III.  The answer, which I think was left unstated, is that the bankruptcy courts are a football being kicked back and forth between the liberal and conservative wings of the court to advance other agendas.

Prof. Chemerinsky said that a big question is whether consent will solve the problem.  He said that if consent works, there will not be much practical impact from Stern.    He then dramatically added that “Until yesterday, consent was enough to solve the problem.”   On October 26, 2012, while the NCBJ was proceeding, the Sixth Circuit decided Stone v. Waldman,  No. 10-6497 (6^th Cir. 2012), which can be found here.     

 This is the first circuit court decision to hold that the Stern problem cannot be solved through consent.    He said that if this decision is followed, the impact will be enormous.   If the Supreme Court takes up Stone v. Waldman and rules that consent is not adequate, then bankruptcy courts will be required to do reports and recommendations in all matters in which they cannot issue a final order.    This would lead to ping-ponging back and forth between bankruptcy and district courts, delay, additional expense and the elevation of form over substance as overworked district courts rubberstamp bankruptcy court rulings.   He added, “In the end, I am of the conclusion that the only solution is to make Bankruptcy Judges Article III judges, but question whether there is the political will to do this.”   

Prof. Klee noted that in Stern v. Marshall, the plaintiff was found to have consented to determination of his state law defamation claims in the dischargeability context.   He said, “If the bankruptcy courts can’t decide claims,  we should close up shop and go home.”

Bankruptcy Judge Judy Fitzgerald asked, how far can I go in determining a claim?

In Stone v. Waldman, a chapter 11 debtor-in-possession argued that he had been defrauded by a creditor.    The bankruptcy court denied the creditor’s claim and also awarded $3 million in damages to the DIP.    On appeal, the defendant argued that the Bankruptcy Court lacked authority to enter judgment against him under Stern v. Marshall.   The Sixth Circuit found that the federal courts had jurisdiction over the debtor’s affirmative fraud claim but that the bankruptcy court lacked authority to enter a final judgment.  

As I read the decision, the Sixth Circuit ruled on waiver rather than consent.   The defendant did not object to the Bankruptcy Court’s ability to enter a final judgment against him.   The Sixth Circuit found that a party could not waive the right to have a claim determined by a constitutionally valid court.  It stated:

Waldman’s objection thus implicates not only his personal rights, but also the structural principle advanced by Article III. And that principle is not Waldman’s to waive.

Opinion, p. 8.  

Prof. Chemerinsky argued that this was a consent case because Waldman affirmatively pled that the claims against him were core proceedings.   I do not read the case that expansively.   While Waldman agreed that the claim was core, that does not end the issue, since Stern v. Marshall created the new category of core but unconstitutional.   Additionally, the Court used the term waiver in its analysis.  Is there a difference between waiver and consent?   I think so.    Time will tell.

Prof. Klee suggested that perhaps the solution was to have the U.S. Trustee designated as the representative of the estate so that all matters brought on behalf of the estate would implicate rights of the federal government and thus be public matters.

Prof. Chemerinsky described that as “an incredibly clever approach” but questioned whether the United States would be a real party in interest notwithstanding the designation.    In Qui Tam cases, a private party may sue in the name of the United States, but that is a situation where the U.S. is the party that has suffered the loss.   

Judge Fitzgerald then asked if changing case captions from “In re” to “Ex rel” would solve the problem.

 Prof. Chemerinsky predicted that there will be a split among the circuits. At this year’s Seventh Circuit Judicial Conference, Judge Easterbrook was dismissive of the notion that consent would not work.

One of the professors (sorry my notes are unclear) stated that if the court is going to take Stern seriously, what does that mean for magistrate judges and arbitrators?   While magistrate judges function more like true adjuncts to the district courts, they have the ability to conduct jury trials with consent.   The question was asked how that could survive if Waldman is the law.

 Prof. Chemerinsky said that it was difficult to try to predict what will happen in the future.  If the court takes a functional approach, it will “back away and take consent as solution.”  However, he said that he was skeptical that Supreme Court judges have any concept of what bankruptcy judges do and may decide the issue without thinking about what it means for the bankruptcy courts.

A Little Speech:

From there, the professors pivoted to discuss Milavetz, Gallop & Milavetz v. United States, 130 S.Ct. 1324 (2010).    Prof. Chemerinsky noted that BAPCPA regulates speech in many ways.   One area where he believed Congress had acted unconstitutionally was the provision prohibiting a Debt Relief Agency from advising an assisted person to incur debt in contemplation of bankruptcy.   Nevertheless, a unanimous Court, in an opinion by Justice Sotomayor, found the provision constitutional.   Justice Sotomayor read the provision as prohibiting an attorney from advising a debtor to take out debt for an improper purpose.   The professor opined that “just because the Supreme Court says something doesn’t make it right” and that it was a “nice way of writing the statute, but it’s not how Conress wrote it.”   He noted that even the textualist judges signed on the opinion, illustrating that consistency only goes so far (the last clause was mine, not Prof. Chemerinsky’s).

Prof. Klee argued that the court read a good faith requirement into statute.   “Here they took a statute about incurring more debt in contemplation of filing a case and limited it to incurring debt that is not good debt.”  He added that reading something into a statue that is not there to avoid a constitutional problem is not the same as the doctrine of constitutional avoidance.  He concurred that it was a “fascinating statutory interpretation case because the court rewrote the statute and the textualists went along with it.”  

Prof. Klee noted that statutory interpretation had changed since the Code was drafted in 1978.   At that time, the Supreme Court was clear that legislative history matter and the Code was drafted with that in mind. 

Immunity for the Sovereign (Don't Tell the Tea Party):  

Finally, the professors turned to sovereign immunity.   

Prof. Klee described 106(a) which waives sovereign immunity as an abomination.  He said that when the Court rejected a general waiver of sovereign immunity, a deal was cut in 1994, the parties sat in a room and went through every provision and negotiated whether immunity would be waived or not.  He said that this micro approach increased the probability that something would be missed.

Prof. Chemerinsky discussed the conflict in the Supreme Court’s sovereign immunity decisions.  In Pennsylvania v. Union Gas Co., 491 U.S. 1 (1989), the Court said that states could be sued if Congress said so. In Seminole Tribe of Florida v. Florida, 517 U.S. 44 (1996), the Court said no. As a result, the carefully drafted language of section 106(a) became irrelevant after Seminole. 

 

In Tennessee Student Assistance Corp. v. Hood, 124 S.Ct. 1905 (2004), the pendulum swung back the other way.   The Supreme Court essentially ducked the constitutional issue and held that it did not apply because the discharge operated “in rem.”  Justices Scalia and Thomas dissented, arguing that whether jurisdiction is in rem or in personam, there is still an effect on an unwilling state.   Finally, in Central Virginia Community College v. Katz, 126 S.Ct. 990 (2006), the court held in a 5-4 decision that sovereign immunity did not apply to recovery of a preference in bankruptcy.  The decision came down in  Jan. 2006, just days before Sandra Day O’Connor left the court.  Prof. Chemerinsky stated that he always believed that the result would have been different if the opinion had come down two weeks later.    He believes that there are now five justices willing to overrule Katz who don’t accept that sovereign immunity doesn’t apply in bankruptcy.   

My heard hurt after this panel—not because it was bad, but because I think I got an entire Constitutional law course in one hour.   For my money, this fill-in panel was the highlight of the conference. 

Consumer Financial Protection Bureau’s Big Assignment

The final panel of the conference examined the Consumer Financial Protection Bureau.   Last year’s conference also included a CFPB presentation, but the bureau had been functioning for less than 90 days at that time.   The panelists included Prof. Pat McCoy, who had been with the bureau at its founding, Holly Petraus, Assistant Director for the Office of Servicemember Affairs and Gretchen Morgenson of the New York Times.

Prof. McCoy explained the new for the bureau pointing out that during the home mortgage boom, federal regulators did “precious little to deter reckless mortgage lending.”   Although the Federal Reserve was the one federal regulator that could have issued a regulation requiring that loans only be made to borrowers who could pay, Alan Greenspan had a philosophical opposition to banking regulation and said no.   The CFPB will be promulgating such a regulation by January 21, 2013.   The fragmented set of federal regulators prompted a “race to the bottom” to see which regulatory agency could get the most charters by offering the least regulation.    Additionally, banks faced competition from unregulated non-bank lenders.   This put pressure on banks to compete.   Finally, consumer protection was divided among four federal regulators whose core missions were bank safety and monetary policy rather than consumer protection.   Prof. McCoy stated that in the mortgage area, lack of controls over “nearly brought down the financial system.”    She added that ignoring consumer financial protection can lead to system-wide financial problems of “catastrophic proportions.”   

The Dodd-Frank legislation created the CFPB as the one federal regulator whose sole mission was consumer financial protection.    The Bureau opened its doors on July 31, 2011.   The Bureau reduced fragmentation by providing one agency responsible for consumer protection.   It took measures to avoid the regulatory race to the bottom by ensuring that lenders could not avoid regulations by switching to a new regulator.   It also subjected non-bank lenders to CFPB examination.   The bureau was also designed to avoid regulatory inaction on philosophical grounds because it was affirmatively required to enact rules.

Ms. Petraeus said that her goal was to “ensure that no one can build a financial model around deceptive business practices.”  She stressed the importance of requiring disclosure so that people can see the costs. 

She said that her job involved ensuring that servicemen received financial education, to monitor complaints and to protect military families.  She said that she has been to 40 military bases in connection with her job and that pay day lenders and scams were a major emphasis.

Ms. Petraeus also pointed out the difficulties involved for service members and home mortgages.   She said that she had moved 24 times during her husband’s 37 years of military service.   When a service member receives PCS orders, they may not be able to sell their property or rent it for enough to pay the mortgage.  

However, many service members do not qualify for mortgage modification programs because they are either are not in default at the time they receive orders or are no longer occupying their property.    While some lenders allowed mortgage modifications for service members transferred into a combat zone, they did not address the much more common scenario of regular transfers.    She said that the recent Attorney Generals’ settlement provided more options for service members and that they were working to ensure that a home would be deemed to be owner occupied if the service member planned to return to it.   

She said that defaulting on a mortgage in order to qualify for a modification program posed special problems for service members.   She said that financial problems constituted the number one cause of losing a security clearance in the military.   When this happens, the service member cannot work in his trained field and the military must find someone else to fill the vacancy.  

 

Ms. Petraeus spoke about the importance of financial education for service members.  She said that currently it is offered as part of basic training.   She said that when you take a new recruit and push him to his physical limits and then place him in a dark room where someone is giving a powerpoint talk, the natural result is nap time.    She spoke about how the military is now sending financial education packages to recruits during the period between enlistment and when they arrive to begin their service.  This deferred entry period can sometimes be substantial and allows an opportunity for education. 

Parting Thoughts

This makes the Fifth NCBJ I have attended.   This year’s conference attracted about 1,900 registrants and over 150 bankruptcy judges.    I made it to twelve panels in two and a half days, which is a lot of information to take in.   In between blogging, I had the opportunity to meet some new people, catch up with previous acquaintances, eat some convention lunches and drink a lot of coffee.   However, the most illuminating moment came during the closing night dinner on Friday when the dance floor was swarmed by judges, quite a few of whom displayed silver hair, dancing to the beat of Creedence Clearwater Revisited (composed of the band’s original rhythm section).  While there may have been a few practitioners up there, I saw a lot of blue badges (indicating judges) moving in that direction.  It was a good metaphor for the fact that we may be getting older and we have to overcome challenges such as the awkwardly drafted language of BAPCPA, but the bankruptcy community still has a lot of vigor and a bit of fun left in it.  However, I really wish I had taken some pictures.  See you next year in Atlanta.