Yet Another Hanging Paragraph Creates a Taxing Situation

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A pair of new opinions suggests that dischargeability of taxes is even more complicated subsequent to BAPCPA. In Matter of McCoy, No. 11-60146 (5th Cir. 1/4/12), which can be found here, the Fifth Circuit found that, under Missisippi law, late filed returns did not constitute "returns" at all and thus were not subject to being discharged. In In re Hernandez, Adv. No. 11-5126 (Bankr. W.D. Tex. 1/11/12), which can be found here, Judge Leif Clark found that returns filed after the IRS made its own assessment on unfiled returns were not subject to discharge either. While these decisions may be consistent with the prevailing sentiment, they are not necessarily rooted on solid legal reasoning.

The Other Hanging Paragraph

One of BAPCPA's legacies will be the hanging paragraph, a piece of text hanging by itself which is not part of a specific subsection. We are reasonably familiar with the hanging paragraph of Section 1325(a)(*) which has to do with the valuation of vehicles in chapter 13 cases. Now, six years after BAPCPA took effect, a new hanging paragraph has been discovered, Section 523(a)(*), having to do with dischargeability of taxes. While dischargeability of taxes is dealt with in Section 523(a)(1), which would have been a logical place to put the additional language, Congress saw fit to add a codicil to Section 523(a)(1) at the end of Section 523(a). The new language states:

For purposes of this subsection the term "return" means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to ajudgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law.

Why do we care about the definition of return? Section 523(a)(1)(B) states that a debt is not dischargeable "with respect to which a return . . . was not filed or given; or" was filed "after two years before the date of the filing of the petition."

Prior to BAPCPA, a return could be filed late but at least two years before bankruptcy and still be dischargeable.

However, under the new jurisprudence, some late returns, even if filed more than two years before the date of the petition, are not returns at all.

Going to Mississippi

Linda McCoy, a resident of Mississippi, filed bankruptcy. Mississippi is one of those states that are not Texas which have a state income tax. (While most states have state income taxes, it is an unwritten law here in Texas that proposing a state income tax is a sacrilege on the same level as urinating on the Alamo). Linda McCoy did not file her state income tax returns for 1998 and 1999 when they were due. She did ultimately file her returns, but she filed them after the date they were due.

The Fifth Circuit held that under Mississippi law, a "return" meant a timely filed return. Therefore, a late return constituted an unfiled return and could not be discharged.

Turning to Texas

A few days later Judge Leif Clark interpreted the hanging paragraph of section 523(a)(*) in the context of federal taxes in Texas. (Have you ever noticed that "taxes" and "Texas" contain most of the same letters. It seems subversive since Texans hate taxes--just ask Rick Perry). The Hernandez decision involved a lot of years of taxes. The Debtor did not file timely returns for 1999 through 2006, although he eventually got them all filed. For the seven years in question, the IRS assessed liability for three years before the Debtor got around to filing returns. For the other four years, the IRS either did not get around to making assessments before the returns were filed or no taxes were due.

The IRS did not contest dischargeability for the years in which the Debtor filed his returns prior to taxes being assessed or where it acknowledged that no taxes were due. However, for the three years in which assessments preceded returns, it contended that the taxes could not be discharged--and the court agreed.

The Rationale

Prior to BAPCPA, the term "return" was not defined. Case law held that "a late filed return that required the government to assess the tax without the tax payer's assistance would not be treated as a return for section 523 purposes." McCoy, at 5. In order to constitute a "return" under prior law, it had to satisfy four requirements:

1. It had to purport to be a return;
2. It had to be executed under penalty of perjury;
3. It must contain sufficient information to allow calculation of the tax; and
4. It must represent an honest and reasonable attempt to satisfy the requirements of the tax law.

The new hanging paragraph replaced the old test with three guidelines:

1. The return must be a "return that satisfies the requirements of applicable nonbankruptcy law (including filing requirements);"
2. It would include a return "prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal; and
3. It would not include "a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law.

The Mississippi State Tax Commission argued that under the first factor an untimely return was not "a return that satisfies the requirements of applicable bankruptcy law (including filing requirements)." The Debtor argued that MSTC's construction would read the reference to section 6020(a) out of the statute. As acknowledged by the Fifth Circuit, returns under section 6020(a) involve cases in which the Debtor fails to file an actual return but nevertheless provides the IRS with all of the information necessary to calculate the liability.

The Fifth Circuit adopted MSTC's reasoning stating:

We find MSTC''s interpretation of section 523(a)(*) more convincing. We have previously explained that "the plain language of the [Bankruptcy] Code should rarely be trumped. Although the Code at times is 'awkward, and even ungrammatical . . . that does not make it ambiguous." (citation omitted). The plain language interpretation of section 523(a)(*) comports with this admonition.

McCoy at 8-9. The Court went on to find that returns prepared under section 6020(a) constituted a narrow exception to the rule that late filed returns were not returns. It also referred to other courts which have reached the same result.

The Hernandez Court did not significantly expand upon the Fifth Circuit opinion, stating:

Anticipating consistency on the part of the circuit court, this court concludes that late-filed returns cannot be treated as filed, for purposes of section 523(a)(1), save for returns that comport with the requirements of section 6020(b)(sic) of title 26. The exception is a narrow one, and does not apply on the facts of the case sub judice. [Ed. The correct statutory reference was section 6020(a). The court corrected the cite in an errata to the opinion].

Hernandez at 9.

If Every Other Court Jumped Off a Building Would You Join Them?

The Courts following the majority interpretation of section 523(a)(*) show a lemming-like ability to follow the crowd without careful thought. Section 523(a)(1)(B) provides that taxes are not dischargeable in two instances:

1. Where a return was not "filed or given;" or
2. Where the return "was filed or given after the date on which such return, report, or notice was last due, under applicable nonbankruptcy law or under any extension, and after two years before the date of the filing of the petition.

Thus, section 523(a)(1)(B) has two components to it: a substantive one and a temporal one. If no return was filed, then the tax cannot be discharged. However, if the return was filed at least two years before bankruptcy, even if it was not timely filed, it could be discharged (assuming that the other requirements for dischargeability are met).

The McCoy decision does not state when the returns were actually filed. However, In Hernandez, the Court's finding of fact explicitly recite that the returns for 1999, 2003 and 2004 were each filed more than two years before the petition date. Thus, Hernandez raises the Catch-22 situation in which a return filed at least two years before bankruptcy may be subject to discharge but a return filed one day late is not a return at all.

To be blunt, McCoy and Hernandez obliterate section 523(a)(1)(B)(ii) by stating that late-filed returns, much like disgraced party members in the former Soviet Union, are non-returns. (In the Soviet Union, party members who had fallen from favor would be erased from photographs and treated as though they had never existed). Why would the statute allow for returns filed more than two years prior to bankruptcy to be considered when all late filed returns would necessarily be considered non-returns? The obvious answer is that the hanging paragraph was meant to address the question of whether the document submitted was sufficient to constitute a return rather than whether it was a timely return. The reference to "filing requirements" in the hanging paragraph is best understood as a reference to whether the document was filed rather than when it was filed.

The language of the hanging paragraph reinforces the interpretation that it was meant to be a substantive rather than a temporal requirement. Under the hanging paragraph, "a written stipulation to a judgment or final order entered by a nonbankruptcy tribunal" would constitute a return. Thus, if a Debtor who filed nothing and waited for the taxing authority to initiate suit , but then agreed to the assessment would have been deemed to have filed a return. On the other hand, if the debtor filed his return one day late and the ever-vigilant taxing authority made its assessment in the intervening hours, the return would cease to exist. This makes no sense.

I may be missing something profound or obvious. However, these decisions appear to be just plain wrong.

Hat tip to Michael Baumer who got the word out on these decisions on the State Bar of Texas Bankruptcy Section listserve. Michael is a smart guy and caught the importance of these opinions before I did.

Best of the Rest

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Every year, I read more cases than I have time to blog about. Here are some cases that I meant to write about but didn't have the time. My inability to get to these cases is demonstrated by the fact that I am concluding my year-end clean-up on January 2nd, two days into the new year.

Philadelphia Newspapers:

River Road Partners v. Amalgamated Bank, 651 F.3d 642 (7th Cir. 2011), cert granted, RadLAX Gateway Hotel, LLC v. Amalgamated Bank, No. 11-166 (2011). The Supreme Court has granted cert to resolve the Philadelphia Newspapers issue of whether a debtor can deny a creditor's right to credit bid in a plan by offering the creditor the "indubitable equivalent." The Third Circuit said yes. The Seventh Circuit said no. You can access all the relevant documents at SCOTUS Blog here.

Gifting and Bad Faith:

In re DBSD, North America, Inc., 634 F.3d 79 (2nd Cir. 2011). The Second Circuit held that "gifting" where a senior class of claims gives up property in favor of a junior class violates the absolute priority rule where an intervening class of claims is skipped. The Court also held that votes of a competitor could be designated as cast in bad faith.

Collateral Attacks on Plans:

Matter of Davis Offshore, LP, No. 09-41294 (5th Cir. 7/16/11), which can be found here.

Chapter 11 cases are frequently criticized for languishing in the courts. However, this prepackaged chapter 11 case proceeded to confirmation in less than a week, resulting in a sale to a group which included a member of the family which owned the companies. Unfortunately, that is when the bickering began. Although no party appealed the confirmation order, one of the former shareholders filed a motion to revoke confirmation under 11 U.S.C. §1144. The bankruptcy court determined that no fraud had taken place. The district court vacated the bankruptcy court’s order but dismissed the appeal due to equitable mootness. Rather than appealing this decision, the former shareholder then sued the purchasers for fraud. The bankruptcy court found that the fraud suit was an impermissible collateral attack on the confirmation order. A direct appeal to the Fifth Circuit was authorized.

The Fifth Circuit, in an opinion by Chief Judge Edith Jones affirmed the bankruptcy court. The following passage captures the essence of the opinion:

The principal question posed on appeal is whether the Plan and confirmation order bar the assertion of fraud claims against the defendants/appellees. This is an issue of perennial importance in bankruptcy procedure. Bankruptcy cases must be and often are resolved in haste to prevent the continuing depletion of a debtor’s value and assets. Haste, however, creates the danger that inadequate supervision of deals, valuations, and participants in the process may occur, leaving a fertile field for fraud. To this extent, the demands for finality and integrity in the process may be in tension. In some situations, fraud and related claims may outlive the bankruptcy process. (citation omitted).

We conclude that in this case, in the context of reorganizing a family owned company all of whose shareholders had access to sophisticated financial and legal assistance, and where the releases and exculpatory provisions in the Plan and confirmation order were essential to a reorganization that no party appealed, those provisions bar the (Appellant’s) current claims.

Opinion, pp. 3-4. This case goes to show that when you push to get a deal done quickly, you may be stuck with results that you don’t like.

Section 502(b)(6):

In re Dronebarger, No. 10-10889 (Bankr. W.D. Tex. 1/31/11), which can be found here. This case is significant as the maiden opinion from Judge H. Christopher Mott, who took the bench in October 2010. The issue was whether the guarantor of a lease could take advantage of the cap on damages resulting from lease termination under section 502(b)(6). In a forty page opinion, the Court said no. The Court's primary reasoning was that section 502(b)(6) was limited to damages arising from termination of a lease. Here, the damages arose from failure to repair the property during the pendency of the lease, not from termination of the lease. As a result, he distinguished the case from In re Mr. Gatti's, Inc., 162 B.R. 1004 (Bankr. W.D. Tex. 1994), where the damages resulted from rejection of the lease in bankruptcy. He also ruled that a guarantor could not take advantage of the cap because his liability arose under a guaranty rather than under the lease. The opinion has an excellent discussion of section 502(b)(6) and should be must reading for any party litigating under that section.

Disclosure: My firm became co-counsel to the Debtors subsequent to the court's opinion. We were not involved in the claims issue. Another interesting historical note is that Eric Taube represented the landlord in both Mr. Gatti's and Dronebarger. I represented the Debtor in Mr. Gatti's.

Fraudulent Transfers:

In re Wren Alexander Investments, LLC, No. 08-52914 (Bankr. W.D. Tex. 2/17/11). You can find the opinion here. This case goes to show that not all second acts are for the better. Charles Pircher is a former banker who went to prison during the bank scandal of the 1980s. After prison, he managed a series of professional employee organizations which minimized workers compensation costs by forming new entities to take advantage of lower rates given to new companies. The PEOs were supposed to pay wages and remit taxes to the government. They failed to accomplish the latter, resulting in a large IRS tax liability.

One of the PEOs acquired a ranch in Medina County, Texas. It proved to be a good investment because it was purchased for $630,000 in 1999 and was sold for $5,250,000 in 2009. Pircher used money from the PEOs to build a 10,000 square foot house, a 12,000 square foot horse stable and a 39,000 square foot quarter horse arena. While Pircher said that he had an informal agreement to pay the money back at some point, no documents were drafted and he paid no rent.

The first owner of the property, United Capital Investment Group, Inc., took out a hard money loan to pay off the original purchase price, to build improvements on the property and to pay Pircher's criminal restitution obligations. When the IRS started filing tax liens against the PEOs, Pircher transferred the property to Medina Heritage, Ltd., an entity he controlled. While the deed was dated prior to the filing of an IRS tax lien, it was not recorded until afterwards. The consideration for the transfer was assumption of the existing liabilities on the property.

The property was then transferred to Wren Alexander Investments, Ltd., the debtor in this case. Wren Alexander was controlled by a close business associate of Pircher's. The purchase price was the amount necessary to pay off the existing liens (although not the tax lien). Pircher's stated intent in selling the property was to get it out of his name while retaining control. The IRS filed a nominee lien against Wren Alexander Investments, Ltd.

Wren Alexander filed chapter 11 and the property was sold. The Debtor filed an objection to the claim of the IRS. The principal issue was whether the tax lien was valid against the transferee of the property. Judge Ronald King has an excellent discussion of Texas fraudulent transfer law. Judge King found that the transfer from United Capital to Medina Heritage was a fraudulent transfer because the property was sold for less than reasonably equivalent value while insolvent. The found that this provision could not be used to avoid the second transfer because the IRS was not an existing creditor of Wren Alexander. However, he did find that the transfer could be avoided as one made with actual intent to hinder, delay or defraud. The result was that the IRS received the remaining proceeds in the amount of approximately $1.2 million.

Avoiding a Foreclosure Sale:

Munoz v. James S. Nutter & Co., Adv. No. 10-3039 (Bankr. W.D. Tex. 2/22/11), found here.

The Munoz case involved the situation of a bankruptcy being filed after a foreclosure sale had been conducted but before the deed was recorded. The Court found that the debtors could not use the strong arm powers under section 522(h) because the recorded deed of trust would have placed a prospective purchaser on inquiry notice. The opinion is memorable for the following passage:

What a difference a day can make. This case presents a regrettable situation where Plaintiffs’ bankruptcy petition, for whatever reason, was filed one day late and Plaintiffs’ home was foreclosed upon before the bankruptcy. Thankfully these occurrences are infrequent, as the result can be disastrous to a debtor who can lose the opportunity to save their home. With the right set of facts and proof, the bankruptcy laws can provide relief to “undo” a pre-bankruptcy foreclosure, but the mountain that must be climbed is very technical and extremely steep. Few debtors have been successful in reaching the summit of this mountain and setting aside a foreclosure sale that occurred prior to the bankruptcy filing. Although this Court is extremely sympathetic to Plaintiffs’ plight, in this case it is unable to “reverse” the foreclosure and give Plaintiffs back their home.

Plaintiffs’ attempt to set aside the foreclosure sale under the “strong-arm power” of §544 must be denied as a hypothetical purchaser on the date of Plaintiffs’ bankruptcy filing would not have “bona fide purchaser” status under §544(a)(3) of the Bankruptcy Code and Texas state law. Plaintiffs also did not meet their burden of proof under §544, and for these reasons and those set forth in this Opinion, Plaintiffs may not avoid the foreclosure sale transfer of the Property to Navar under §544(a)(3).

Opinion, pp. 36-37.

Homestead Exemption on a Golf Course:

In re Schott, No. 10-54276 (Bankr. W.D. Tex. 3/15/11), found here.

Many golf widows may feel that their husbands live at the golf course. However, in this case involving a Texas homestead exemption, the debtor literally did live in the clubhouse (at least for a period of time.). When he filed bankruptcy, he claimed the golf course as his homestead and a creditor objected.

The court found that the property was rural and that the debtor had not abandoned the homestead. Therefore, the question was whether he could claim some of all of the property as homestead. The property consisted of two tracts separated by a county road.

Judge Leif Clark noted that under Texas law, where a rural homestead consists of two noncontiguous tracts, one tract must be used as a residence and the other tract must be used for the “comfort, convenience or support of the family.” The tract containing the clubhouse qualified as a residence. However, the tract containing the golf course did not fit within the definition of a homestead.

The court found that the debtor “does not play or even enjoy golf,” that he sometimes likes to take walks on the golf course and that he had intended to develop the property as a resort. While the term “comfort, convenience or support of the family” is a broad one, taking occasional walks on the property was not sufficient.

Non-Dischargeability Among Friends:

Turbo Aleae Investments, Inv. v. Borschow, Adv. No. 09-3005 (Bankr. W.D. Tex. 4/8/11), which can be found here. Judge Mott succinctly described the dispute in this case when he stated:

This case illustrates what can happen when a friend loans money to another friend, and then the relationship turns sour when the friend cannot repay the loan.

Opinion, p. 1.

The opinion contains a lengthy recitation of the conflicting narratives of the parties, highlighting that many of the critical terms were never reduced to writing.

The court distinguished between false pretenses and actual fraud, noting that earlier cases considered these two grounds for nondischargeabiilty under section 523(a)(2)(A) to have separate elements, while more recent Fifth Circuit cases pointed to a single test. The court rejected a claim of false pretenses on the basis that, if it still existed as a separate ground for nondischargeability, it required a false statement about current or past facts, not actions to be performed in the future.

The opinion is a good case study in how to prove or defend a non-dischargeability case. There were two main contentions made: 1. that the debtor lied about intending to use the loan proceeds to pay off a prior secured debt; and 2. that the debtor lied about intending to use the loan proceeds to pay off a debt owed to a related party to the lender.

In the case of the first representation, the court found insufficient evidence that the representation was made. The first time the representation was mentioned in writing was in an email after the fact. Although the stated reason for wanting the prior debt paid off was to obtain a security interest in the company's equipment, the loan documents did not provide for a security interest. Additionally, the lender did not inspect the equipment or attempt to determine its value. Finally, the lender acted inconsistently by referring the debtor to Chase Bank to get a loan to pay off the prior debt. As Judge Mott concluded:

While the Court is sympathetic to Turbo and believes that Omar and Ernest likely thought Allen should have used the money to pay off the SNB loan, after weighing the evidence and testimony, the Court concludes that Turbo has failed to show that Allen obtained the loan proceeds through actual fraud by falsely representing he would use the loan proceeds to pay off the SNB loan.

Opinion, p. 27.

On the other hand, the plaintiff's did show that the debtor committed fraud with regard to the second representation. The lender initially wanted to withhold the funds and pay them directly to the related party. The debtor said that he needed to receive the funds directly "for accounting purposes." However, when he received the funds, his business account was so far overdrawn that there were no funds left to repay the related party.

The differing outcomes between the two claims demonstrates that parties are rarely completely honest or completely devious, but that the truth is largely a combination of shades of gray.

In a very brief passage, the Court denied attorney's fees to the plaintiffs, noting that:

The Court also determines that each party shall bear their own attorneys fees and expenses. Specifically, the Court finds that the loan at issue is not primarily consumer debt, and that the positions of parties in this proceeding were substantially justified. Thus, awarding attorney fees is not appropriate in this case. See 11 U.S.C. §523(d).

Opinion, p. 37. Section 523(d) allows the court to award attorney's fees against a creditor who unsuccessfully seeks a determination of nondischargeability on a consumer debt and asserts a position that is not substantially justified. In this case, the debts involved were business debts so that the debtor could not have recovered attorney's fees. However, the court appears to be using the principles of section 523(d) by analogy to deny recovery of attorney's fees in a business dispute where each side offered positions that were substantially justified. I would have preferred to see the Court invoke the American Rule that each side pays its own fees in the absence of specific authority for fee-shifting. However, the court's ruling roughly adheres to this standard.

The take-away from this case is don't loan money to friends if you can't afford to lose the money or the friendship.

Remand:

Legal Xtranet, Inc. v. AT&T Management Services, LP, Adv. No. 11-5042 (Bankr. W.D. Tex. 5/24/11), which can be found here. This was a case involving a motion to remand. The Court found that state law contract disputes were non-core proceedings subject to mandatory abstention and that disputes over the tax liability of AT&T did not qualify for even "related to" jurisdiction. The most interesting part of the opinion is the Court's lament over AT&T's successful attempt at forum shopping. Judge Leif Clark wrote:

The court is reluctant to reward AT&T’s blatant forum shopping in this case. AT&T filed a jury demand and refused to consent to a jury trial in this court in an effort to bolster its argument that the parties’ dispute could be timely adjudicated in state court: AT&T’s refusal to consent to a jury trial here meant that even if the court retained jurisdiction over the parties’ dispute, the case would have to be tried in the federal district court, assuring AT&T that it would have a different judge to hear the case. That would also almost certainly mean that the case would not likely be heard for quite some time. Furthermore, it is not entirely clear that the parties’ dispute, as it currently stands, involves any factual issues for a jury to decide – the request of declaratory relief will not go beyond the terms of the contract itself unless there is ambiguity in the agreement (or unless the contract itself is found to point outside itself for the determination or application of its terms). Thus, AT&T’s jury demand machinations appear to be nothing more than an effort to forum shop. Nonetheless, as noted above, the question is not whether the case can be more timely adjudicated in state court than in the bankruptcy or district court; the question is simply whether it can be timely adjudicated in state court. AT&T established that it could be timely adjudicated in state court, and the court’s determination to that effect did not depend upon a finding that the case could not be timely adjudicated in the district court. And there is nothing in section 1334(c)(2) that permits a court to deny relief on grounds that the effort is motivated by a desire to forum shop. Indeed, the sad truth is that the structure of bankruptcy jurisdiction actually encourages and rewards forum shopping strategies. There is little this court can about that, other than to encourage Congress to consider the consequences that seem to flow from the current structure.

Opinion, at p. 17. It seems unlikely that Congress will be moved to change section 1334(c)(2).

Till Interest Rate:

In re Village at Camp Bowie I, LP, No. 10-45097 (Bankr. N.D. Tex. 8/4/11), found here. In this single asset real estate case, the court considered, among other things, artificial impairment and
the proper interest rate for cramdown of a secured creditor.

The court found that artificial impairment standing alone was not enough to prevent a finding of good faith.

Indeed, at least one court has persuasively suggested that the drafters of the Code did not intend to create a system in which – even in a single asset real estate case – a lender could use its overwhelming share of the claims in a case to divest other creditors and equity owners of their economic interests. (citation omitted). Yet the only way around control of the reorganization by a debtor’s lender in a case like that at bar is through impairment and an affirmative vote of a class of unsecured creditors who will typically have small claims that could be readily satisfied through full payment with interest. For a debtor to have any leverage at all in such a case – e.g., in negotiations – it must be possible to look to those unsecured creditors to satisfy section 1129(a)(10).

Opinion, p. 10.

The Court also had an interest take on applying Till v. SCS Corporation, 541 U.S. 465 (2007). The court noted that under Till, the court left open the issue of whether a market rate could be set in the case where there was an efficient market for loans of the type proposed by the debtor in its plan. Because there was no such efficient market, the court determined to apply a formula approach. However, rather than using the Prime + 1-3% formula suggested by the Till Court, the Bankruptcy Court went through an elaborate approach of valuing different tranches of debt and adjusting for risk.

One of the experts (it is not clear whose) started with the five year treasury bill rate of 1.71% as a risk free rate. He then adjusted it for several factors and concluded that the rate for the first 65% of the collateral's value would be between 4.76%-5.01%. He concluded that the mezzanine rate for 65-85% of collateral value would be 13.02-14.88%. Finally, he concluded that the appropriate rate for amounts in excess of 85% of collateral value would be 18.63%. Taking all of these tranches into account and making other adjustments, he somehow came up with a blended rate of 6.25-7.75%.

The court adopted his methodology but tinkered with the assumptions to come up with a rate of 6.27-6.59%. Because the Debtor had proposed a rate of 5.83%, the Court denied confirmation with leave to file a plan providing for an interest rate of 6.4%.

Camp Bowie was a case involving a property valued at $34 million. Therefore, it might have been able to support the cost for the type of expert witness testimony used here. However, I have two concerns here. The first is that Till was supposed to provide an inexpensive and simple method for determining value. Most chapter 11 cases are small business cases which cannot afford the cost of an expert. Second, unless the Court has an advanced degree in finance (which several of the Texas bankruptcy judges do), it is likely that the competing experts will bamboozle the court which will be forced to split the difference.

In the Camp Bowie case, the Court could just as easily said prime + 3 and arrived at 6.25%, which is within .15% of the rate it reached through the elaborate calculations.

Recently, I was at a CLE seminar in New York sponsored by the Commercial Law League of America. Judge Robert Drain from the Southern District of Texas polled the room as to who represented debtors and who represented creditors. He then offered a hypothetical with choices between a prime rate + approach, a tranche approach and a there is no rate high enough approach. When only one hand went up for the prime + approach, he said, I see we've found the debtor's lawyer in the room (which was me). He then offered a very thoughtful analysis of why he thought the Supreme Court would adopt the prime + approach in a chapter 11 case.

This just goes to show that even after Till, there is still a lot of debate over how to select the cram-down interest rate.

Stern and Fraudulent Conveyances:

Kirschner v. Agoglia, Adv. No. 07-3060 (Bankr. S.D. N.Y. 11/30/11), found here. (Link will take you to the Southern District of New York Bankruptcy website. Go to opinions, then to Judge Drain to find the case).

During the past six months, practitioners have heard a lot of volume about Stern v. Marshall without getting a lot of clarity. (I plead guilty there since I have been on multiple panels and I am still trying to figure it out). Judge Robert Drain from the Southern District of New York has recently penned a very thoughtful opinion about the "firmly established historical practice" doctrine suggested by Justice Scalia in his concurrence. He noted that "the pursuit of avoidance claims has been 'a core aspect of the administration of bankruptcy estates since the 18th century.'" Opinion, at 9. He then offered a very thorough history of the ability of Article I judges to enter final judgments in fraudulent transfer cases. After all that, he found that the complaint did not state a cause of action and dismissed it as to one defendant.

The analysis that I would like to see (and would like to write some day if I had the time) would trace the origin of bankruptcy as a device to punish debtors who made fraudulent transfers. I suspect that it would show that bankruptcy law and fraudulent transfer law have been bound together since the very beginning.

Third Circuit Upholds Professional Responsibility in Age of Technology

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A landmark case involving ethics and technology has reached its conclusion with an opinion from the Third Circuit Court of Appeals that an attorney cannot blindly rely on information provided by an automated system, especially when the accuracy of that information has been called into question. In re Taylor, 655 F.3d 274 (3^rd Cir. 2011). I have previously written about the bankruptcy court decision here and the district court opinion here. The Court of Appeals set the tone for the opinion with its opening statement:

This case is an unfortunate example of the ways in which overreliance on computerized processes in a high-volume practice, as well as a failure on the part of clients and lawyers alike to take responsibility for accurate knowledge of a case, can lead to attorney misconduct before a court.

In re Taylor, at 277.

What Happened

The Taylor case illustrates the problems that can arise when a consumer debtor finds himself in a battle with a faceless computer. The Taylors and HSBC had a dispute over whether flood insurance was required on the Taylors’ property. As a result, the Taylors sent in their payments minus the disputed amount. HSBC placed the partial payments into suspense until a full payment was received an imposed late fees on the payment.

When the Taylors filed for chapter 13 bankruptcy, HSBC sent a referral to the Udren Law Firm to file a motion for relief from automatic stay. The referral was processed through the NewTrak technology system. The Court of Appeals described the process as follows:

HSBC does not deign to communicate directly with the firms it employs in its high-volume foreclosure work; rather, it uses a computerized system called NewTrak (provided by a third party, LPS) to assign individual firms discrete assignments and provide the limited data the system deems relevant to each assignment. The firms are selected and the instructions generated without any direct human involvement. The firms so chosen generally do not have the capacity to check the data (such as the amount of mortgage payment or time in arrears) provided to them by NewTrak and are not expected to communicate with other firms that may have done related work on the matter. Although it is technically possible for a firm hired through NewTrak to contact HSBC to discuss the matter on which it has been retained, it is clear from the record that this was discouraged and that some attorneys, including at least one Udren Firm attorney, did not believe it to be permitted.

In re Taylor, at 278-79.

A non-lawyer employee with the Udren Firm used the information provided by NewTrak to prepare the motion for relief from automatic stay. A managing attorney at the Udren Firm reviewed the motion and authorized it to be filed under her electronic signature. The motion recited that the Debtors had not made payments for three post-petition months but added that there was a suspense balance of $1,040. The motion asserted that there was a total arrearage balance of $4,367. The motion listed a different payment amount than the amount listed in the proof of claim filed by a different firm on behalf of HSBC. Finally, the motion asserted that the Debtors had no equity in their property.

The Debtors responded to the motion and attached copies of canceled checks payable to HSBC. The Debtors also objected to the proof of claim filed by HSBC. HSBC’s counsel responded to the claims objection asserting that all amounts in the proof of claim were accurate, even though they conflicted with the numbers contained in the motion for relief from stay.

The Court had this to say about the firm’s due diligence in filing the motion:

Doyle did nothing to verify the information in the motion for relief from stay besides check it against "screen prints" of the NewTrak information. She did not even access NewTrak herself. In effect, she simply proofread the document. It does not appear that NewTrak provided the Udren Firm with any information concerning the Taylors' equity in their home, so Doyle could not have verified her statement in the motion concerning the lack of equity in any way, even against a "screen print."

In re Taylor, at 279.

At the hearing, a young attorney from the Udren Firm acknowledged that the Debtors had made post-petition payments, but sought to proceed with the motion anyway because the Debtors had failed to respond to requests for admission.

The bankruptcy court denied the request to enter the RFAs as evidence, noting that the firm "closed their eyes to the fact that there was evidence that . . . conflicted with the very admissions that they asked me [to deem admitted]. They . . . had that evidence [that the assertions in its motion were not accurate] in [their] possession and [they] went ahead like [they] never saw it." (App. 108-109.) The court noted:

Maybe they have somebody there churning out these motions that doesn't talk to the people that--you know, you never see the records, do you? Somebody sends it to you that sent it from somebody else.

In re Taylor, at 281.

The Court directed the Udren Firm to obtain a payment history from HSBC so that the amounts owed could be determined. However, at a subsequent hearing, the young attorney informed the Court that he had submitted the request through NewTrak but had not received a reply. He also informed the Court that he was not allowed to communicate directly with his client. The understandably perturbed Court issued an order for the firm and three of its attorneys to appear and respond to the Court’s concerns about how the case had been handled.

After four hearings, the Court concluded that the young associate, the managing attorney who signed the pleadings, the head of the firm, the firm itself and HSBC had all violated Rule 9011. The Court imposed creative, but largely symbolic sanctions. As explained by the Court of Appeals:

Because of his inexperience, the court did not sanction Fitzgibbon. However, it required Doyle to take 3 CLE credits in professional responsibility; Udren himself to be trained in the use of NewTrak and to spend a day observing his employees handling NewTrak; and both Doyle and Udren to conduct a training session for the firm's relevant lawyers in the requirements of Rule 9011 and procedures for escalating inquiries on NewTrak. The court also required HSBC to send a copy of its opinion to all the law firms it uses in bankruptcy proceedings, along with a letter explaining that direct contact with HSBC concerning matters relating to HSBC's case was permissible.

In re Taylor at 281-82.

The sanctions were aimed more at shaming the firm than financially penalizing it. Ordering the head of the firm to learn how NewTrak worked sent a symbolic message that he was out of touch with how his own law firm worked. Requiring Doyle, the bankruptcy managing attorney, the obtain three hours of CLE in professional responsibility sent the message that she needed this education. Requiring Udren and Doyle to conduct a training session on the requirements of Rule 9011 and how NewTrak worked was intended to correct their behavior. Finally, the requirement that HSBC send a copy of the opinion to all of its attorneys was meant to remedy the perceived view that such contact was forbidden.

The District Court reversed all of the sanctions, even those against HSBC, which had not appealed. The District Court found that Debtor’s counsel was equally at fault, that the Bankruptcy Court seemed more interested in sending a message to the bar in general than addressing the failings of counsel in the specific case and that Udren could not be sanctioned under Rule 9011 because he had not signed any pleadings.

The U.S. Trustee appealed to the Third Circuit.

The Third Circuit Opinion

The Third Circuit affirmed the District Court’s ruling that Udren, as shareholder of the firm, could not be sanctioned since he did not sign any pleadings. However, it reversed the remainder of the District Court ruling and reinstated the sanctions against Doyle, the Udren Firm and HSBC. In doing so, it provided a valuable guide to the requirements of Rule 9011 in the age of technology.

What’s a Reasonable Attorney to Do?

The Court of Appeals pointed out that merely making a false statement is not enough to invoke Rule 9011. The relevant inquiry is what the attorney could reasonably have believed.

The concern of Rule 9011 is not the truth or falsity of the representation in itself, but rather whether the party making the representation reasonably believed it at the time to have evidentiary support. In determining whether a party has violated Rule 9011, the court need not find that a party who makes a false representation to the court acted in bad faith. "The imposition of Rule 11 sanctions . . . requires only a showing of objectively unreasonable conduct."

In re Taylor, at 282.

The Court of Appeals identified four statements that were either false or misleading:

In this opinion, we focus on several statements by appellees: (1) in the motion for relief from stay, the statements suggesting that the Taylors had failed to make payments on their mortgage since the filing of their bankruptcy petition and the identification of the months in which and the amount by which they were supposedly delinquent; (2) in the motion for relief from stay, the statement that the Taylors had no or inconsequential equity in the property; (3) in the response to the claim objection, the statement that the figures in the proof of claim were accurate; and, (4) at the first hearing, the attempt to have the requests for admission concerning the lack of mortgage payments deemed admitted. As discussed above, all of these statements involved false or misleading representations to the court.

In re Taylor, at 283. It is not a good sign when an opinion identifies multiple cases of false or misleading statements to the court.

The Court of Appeals went on to find that the attorneys had not acted reasonably.

We must, therefore, determine the reasonableness of the appellees' inquiry before they made their false representations. Reasonableness has been defined as "an objective knowledge or belief at the time of the filing of a challenged paper that the claim was well-grounded in law and fact." (citation omitted). The requirement of reasonable inquiry protects not merely the court and adverse parties, but also the client. The client is not expected to know the technical details of the law and ought to be able to rely on his attorney to elicit from him the information necessary to handle his case in the most effective, yet legally appropriate, manner.

***

Central to this case, then, is the degree to which an attorney may reasonably rely on representations from her client. An attorney certainly "is not always foreclosed from relying on information from other persons." (citation omitted). . In making statements to the court, lawyers constantly and appropriately rely on information provided by their clients, especially when the facts are contained in a client's computerized records. It is difficult to imagine how attorneys might function were they required to conduct an independent investigation of every factual representation made by a client before it could be included in a court filing. While Rule 9011 "does not recognize a 'pure heart and empty head' defense," (citation omitted),, a lawyer need not routinely assume the duplicity or gross incompetence of her client in order to meet the requirements of Rule 9011. It is therefore usually reasonable for a lawyer to rely on information provided by a client, especially where that information is superficially plausible and the client provides its own records which appear to confirm the information.

That is, an attorney must, in her independent professional judgment, make a reasonable effort to determine what facts are likely to be relevant to a particular court filing and to seek those facts from the client. She cannot simply settle for the information her client determines in advance-- by means of an automated system, no less--that she should be provided with.

***

More generally, a reasonable attorney would not file a motion for relief from stay for cause without inquiring of the client whether it had any information relevant to the alleged cause, that is, the debtor's failure to make payments. Had Doyle made even that most minimal of inquiries, HSBC presumably would have provided her with the information in its files concerning the flood insurance dispute, and Doyle could have included that information in her motion for relief from stay--or, perhaps, advised the client that seeking such a motion would be inappropriate under the circumstances.

With respect to the Taylors' case in particular, Doyle ignored clear warning signs as to the accuracy of the data that she did receive. In responding to the motion for relief from stay, the Taylors submitted documentation indicating that they had already made at least partial payments for some of the months in question. In objecting to the proof of claim, the Taylors pointed out the inaccuracy of the mortgage payment listed and explained the circumstances surrounding the flood insurance dispute. Although Doyle certainly was not obliged to accept the Taylors' claims at face value, they indisputably put her on notice that the matter was not as simple as it might have appeared from the NewTrak file. At that point, any reasonable attorney would have sought clarification and further documentation from her client, in order to correct any prior inadvertent misstatements to the court and to avoid any further errors. Instead, Doyle mechanically affirmed facts (the monthly mortgage payment) that her own prior filing with the court had already contradicted.

Doyle's reliance on HSBC was particularly problematic because she was not, in fact, relying directly on HSBC. Instead, she relied on a computer system run by a third-party vendor. She did not know where the data provided by NewTrak came from. She had no capacity to check the data against the original documents if any of it seemed implausible. And she effectively could not question the data with HSBC. In her relationship with HSBC, Doyle essentially abdicated her professional judgment to a black box. (emphasis added).

In re Taylor, at 284-85.

Kudos to the U.S. Trustee

As a preliminary matter, it is important to recognize the role played by the U.S. Trustee. While the Debtor’s counsel at least raised the issues which allowed the Court to conduct its investigation, the Court of Appeals indicated that Debtor’s counsel was not much better than the Udren firm:

Taylor's counsel was also ultimately sanctioned and removed from the case. Counsel did not perform competently, as is evidenced by the Taylors' failure to contest HSBC's RFAs. She also made a number of inaccurate statements in her representations to the court. However, it is clear that her conduct did not induce the misrepresentations by HSBC or its attorneys. As the bankruptcy court correctly noted, "the process employed by a mortgagee and its counsel must be fair and transparent without regard to the quality of debtor's counsel since many debtors are unrepresented and cannot rely on counsel to protect them."

In re Taylor, at 282, fn. 10. As a result, it is important that the U.S. Trustee’s Office stepped in to protect the integrity of the system. This author has sometimes been critical of the U.S. Trustee’s Office. However, in this case, they did exactly what they should have done—to represent the broader interest of integrity in bankruptcy in a situation where debtor’s counsel was either unable to do so (in the case of Debtor’s initial counsel) or had no financial incentive to do so (presumably with respect to Debtor’s substitute counsel).

What It Means

The meaning of the opinion is that attorneys are professionals and cannot “abdicate (their) professional judgment to a black box.” In age of massive defaults, creditors cannot be faulted for wanting to minimize their costs. However, the attorney is more than an automaton communicating the demands of the client. If attorneys were mere mouthpieces for their clients, there would be no need for them. Instead, the client could simply generate form pleadings using an automated system. Attorneys exist to exercise professional judgment on behalf of their clients. While attorneys can and must be advocates for their clients, Rule 9011 imposes a duty to review the information provided by the client and determine whether it appears to be reasonable. More importantly, once information which once appeared reasonable is placed into doubt, the attorney has a duty to communicate with the client and determine which facts can reasonably be supported.

I believe that attorneys should be skilled craftsman rather than assembly line workers. In this case, a $540 dispute over flood insurance was magnified by a factor of nearly ten times. While it might have been reasonable to rely on the initial information provided by the client through NewTrak, this certainly became unreasonable when the Debtor provided canceled checks showing that payments which the computerized record said did not exist had been made. The significance of Taylor is that for lawyers to continue to have meaning, they must bring something to court above the mere repetition of what their client told them. The Taylor case represented an existential threat to the continuing relevance of attorneys. If the attorney does nothing more than repeat information provided by the client through an automated system, then there is no justification for requiring the additional cost represented by the participation of an attorney. Fortunately, the Third Circuit Court of Appeals provided a justification for the continued involvement of skilled counsel and gave support to the many creditors’ counsel who performs their duties with judgment and skill.

The Final Word

We appreciate that the use of technology can save both litigants and attorneys time and money, and we do not, of course, mean to suggest that the use of databases or even certain automated communications between counsel and client are presumptively unreasonable. However, Rule 11 requires more than a rubber-stamping of the results of an automated process by a person who happens to be a lawyer. Where a lawyer systematically fails to take any responsibility for seeking adequate information from her client, makes representations without any factual basis because they are included in a "form pleading" she has been trained to fill out, and ignores obvious indications that her information may be incorrect, she cannot be said to have made reasonable inquiry. Therefore, we find that the bankruptcy court did not abuse its discretion in imposing sanctions on Doyle or the Udren Firm itself. However, it did abuse its discretion in imposing sanctions on Udren individually.

In re Taylor, at 286.

Of Attorneys and Ostriches

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Judge Richard Posner of the Seventh Circuit recently offered the following advice to appellate attorneys:

When there is apparently dispositive precedent, an appellant may urge its overruling or distinguishing or reserve a challenge to it for a petition for certiorari but may not simply ignore it. We don’t know the thinking that led the appellants’ counsel in these two cases to do that. But we do know that the two sets of cases out of which the appeals arise, involving the blood-products and Bridgestone/Firestone tire litigations, generated many transfers under the doctrine of forum non conveniens, three of which we affirmed in the two ignored precedents. There are likely to be additional such appeals; maybe appellants think that if they ignore our precedents their appeals will not be assigned to the same panel as decided the cases that established the precedents. Whatever the reason, such advocacy is unacceptable.

The ostrich is a noble animal, but not a proper model for an appellate advocate. (Not that ostriches really bury their heads in the sand when threatened; don’t be fooled by the picture below.) The “ostrich-like tactic of pretending that potentially dispositive authority against a litigant’s contention does not exist is as unprofessional as it is pointless.”

Gonzales-Servin v. Ford Motor Company, No. 11-1665 (7th Cir. 11/23/11), pp. 4-5. You can find the opinion here. To illustrate his point, he included the two photographs set forth below.




It is good to know that in these times of budget shortfalls that federal judges still have access to Photo Shop. This was indeed a case where two pictures were worth a thousand words.

Montana Blogger Tagged for Big Defamation Damages in Suit by Trustee

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A Montana blogger has learned that First Amendment freedoms do not extend to saying that a bankruptcy trustee is “guilty of Fraud, Deceit on the Government, Illegal Activity, Money Laundering, Defamation, Harassment” among other things. In Obsidian Finance Group, LLC and Kevin D. Padrick v. Crystal Cox, 2011 U.S. Dist. LEXIS 137548 (D. Ore. 11/30/11), the Court ruled that the blogger was not entitled to protections accorded to traditional media and found that the trustee was not a public figure. You can read the opinion here. (PACER registration may be required). While the case is no doubt welcome news for trustees who can be exposed to some bizarre public criticism, it is troubling for its constricted definition of “media.”

What Happened

Summit Accomodators dba Summit 1031 Exchange was a company that was supposed to facilitate tax free 1031 exchanges. The company filed for chapter 11 relief on December 24, 2008 amid allegations that it had used customer’s money to fund insider ventures. At least four persons associated with the company have been indicted or convicted. The Debtor initially employed Terry Vance as Chief Restructuring Officer. It also employed Obsidian Finance Consultants, LLC as financial adviser and paid it a retainer of $100,000. Shortly after the case was filed, the Debtor sought to replace Mr. Vance as CRO with Obsidian Finance.

At the hearing to replace the CRO on February 11, 2009, the Court entertained an oral motion from the U.S. Trustee to appoint a Chapter 11 trustee. The Court granted the U.S. Trustee’s motion and suggested that perhaps Obsidian Finance or Kevin Padrick, who was one of its principals, could be appointed as Chapter 11 trustee. The U.S. Trustee did appoint Kevin Padrick as Chapter 11 trustee.

On May 12, 2009, the Court confirmed the First Amended Joint Plan of Reorganization filed by the Official Committee of Unsecured Creditors and the Chapter 11 trustee. The Plan provided for establishment of a Liquidating Trust with Kevin Padrick as Liquidating Trustee.

Crystal Cox is the daughter of one of the creditors of Summit Accomodators. She was present at the hearing on February 11, 2009 and subsequently met with Padrick on February 12, 2009. She became convinced that Mr. Padrick had used his position as financial adviser to undermine the CRO and get the job as Chapter 11 Trustee. She also was convinced that Mr. Padrick should not have been appointed Chapter 11 Trustee because his status as a principal of the Debtor’s financial adviser made him an insider and therefore ineligible for appointment.

On July 19, 2009, Crystal Cox started a blog with the URL www.obsidianfinancesucks.com. The headline of the blog reads “Kevin Padrick, Obsidian Finance Group, I Demand Transparency in the US Bankruptcy Courts.” In her blog, she described herself as follows:

I am the Self Appointed Real Estate Industry Whistleblower. I am a Self Appointed Real Estate Consumer Advocate. I want to be a voice for Real Estate Victims that are not being heard, that are Powerless, and that Have no voice.

My, Self appointed job or mission, have you is to get the TRUTH out so that real estate victims can get justice, get "made whole", get their MONEY and get on with their REAL LIFE...

Ms. Cox wrote hundreds of articles for her blog, many of which made accusations against Kevin Padrick and Obsidian Finance. In some cases, she would post ten or more articles in a day. She also wrote for:

www.BankruptcyCorruption.com
www.LiquidatingTrustee.com
www.BankruptcyTrusteeFraud.com
www.RealEstateIndustryWhistleblower.com

On January 14, 2011, the Trustee’s counsel filed a defamation action against Ms. Cox in the United States District Court of Oregon. The case went to trial on November 29, 2011. Ms. Cox represented herself. The jury found that Crystal Cox was liable for defamation to both Obsidian Finance Group, LLC and Kevin Padrick. It awarded damages of $1,000,000 to Obsidian and $1,500,000 to Mr. Padrick. The Court entered judgment against Ms. Cox on December 8, 2011.

Prior to trial, the Court made several rulings from the bench which were incorporated into a memorandum opinion on November 30, 2011.

The Trustee Was Not a Public Figure, Not Even a Limited One

The defendant argued that the trustee was a “public figure” so that proof of actual malice was required under New York Times Co. v. Sullivan, 376 U.S. 254 (1964). A person can be a public figure if they “occupy positions of such persuasive power and influence that they are deemed public figures for all purposes” or an individual may “voluntarily inject() himself or (be) drawn into a particular controversy and thereby become() a public figure for a limited range of issues.” Gertz v. Robert Welch, Inc., 418 U.S. 323, 351 (1974).

The Court found that the Trustee and his corporation were not “all purpose” public figures and that that they had not thrust themselves into a particular controversy so as to be limited purpose public figures. While the bankruptcy of Summit Accomodators itself received attention for its failure, agreeing to serve as trustee did not constitute “thrusting” oneself into a controversy. Moreover, a person must be a limited purpose public figure prior to the alleged defamatory statements rather than because of them. In this case, Ms. Cox could not create controversy over Padrick’s handling of the estate through her blog and then contend that this made him a public figure.

The case would have been a closer call if the Trustee had sought out publicity about the job he was doing. While many lawyers are publicity shy, some actively seek to keep their names in the news, issuing press releases and taking out ads trumpeting their successes. The lawyer who blows his own horn too much in a case of public interest may find himself to be a limited purpose public figure.

The Blogger Was Not Entitled to Protection As a Member of the “Media”

The Court noted that “plaintiffs cannot recover damages (against media defendants) without proof that (the) defendant was at least negligent and may not recover presumed damages absent proof of ‘actual malice.’” Opinion, p. 9. This would have made it more difficult for the plaintiffs to recover. However, the Court rejected the contention that the “investigative blogger” in this case qualified as media.

First, the Court noted that Defendant had not cited any cases giving media status to bloggers. “Without any controlling or persuasive authority on the issue, I decline to conclude that defendant in this case is ‘media,’ triggering the negligence standard.” Opinion, p. 9. This appears to be a bit of a cop out by the court, since blogging is a relatively new phenomenon. By holding that bloggers do not qualify as media because Courts have not previously granted them this status creates a self-fulfilling prophecy.

However, the Court did go one step further and lay out a test for what evidence would establish someone’s standing as a journalist.

Defendant fails to bring forth any evidence suggestive of her status as a journalist. For example, there is no evidence of (1) any education in journalism; (2) any credentials or proof of any affiliation with any recognized news entity; (3) proof of adherence to journalistic standards such as editing, fact-checking, or disclosures of conflicts of interest; (4) keeping notes of conversations and interviews conducted; (5) mutual understanding or agreement of confidentiality between the defendant and his/her sources; (6) creation of an independent product rather than assembling writings and postings of others; or (7) contacting "the other side" to get both sides of a story. Without evidence of this nature, defendant is not "media."

Opinion, p. 9. Unfortunately, the Court did not cite any precedent for this test. However, there is a growing body of case law which rejects this narrow definition.

Other Views on Bloggers and Journalists

Moreover, changes in technology and society have made the lines between private citizen and journalist exceedingly difficult to draw. The proliferation of electronic devices with video-recording capability means that many of our images of current events come from bystanders with a ready cell phone or digital camera rather than a traditional film crew, and news stories are now just as likely to be broken by a blogger at her computer as a reporter at a major newspaper. Such developments make clear why the news-gathering protections of the First Amendment cannot turn on professional credentials or status.

Glik v. Cunniffe, 655 F.3d 78, 84 (1st Cir. 2011)(rejecting qualified immunity for police officers who arrested citizen for filming them with a cell phone camera).

In another case, the Court refused to recognize a claim to a “reporter’s privilege” not to divulge sources on the grounds that it could lead to a slippery slope which would include bloggers.

The press in its historic connotation comprehends every sort of publication which affords a vehicle of information and opinion.'" (citation omitted). Are we then to create a privilege that protects only those reporters employed by Time Magazine, the New York Times, and other media giants, or do we extend that protection as well to the owner of a desktop printer producing a weekly newsletter to inform his neighbors, lodge brothers, co-religionists, or co-conspirators? Perhaps more to the point today, does the privilege also protect the proprietor of a web log: the stereotypical "blogger" sitting in his pajamas at his personal computer posting on the World Wide Web his best product to inform whoever happens to browse his way? If not, why not? How could one draw a distinction consistent with the court's vision of a broadly granted personal right? If so, then would it not be possible for a government official wishing to engage in the sort of unlawful leaking under investigation in the present controversy to call a trusted friend or a political ally, advise him to set up a web log (which I understand takes about three minutes) and then leak to him under a promise of confidentiality the information which the law forbids the official to disclose?

In re Grand Jury Subpoena (Miller), 397 F.3d 964, 979-80 (D.C. Cir. 2005)(Sentelle, Concurring).

Finally, one Court got it right when it held that “not all bloggers are journalists. However, some bloggers are without question journalists.”

Further, there is no published case deciding whether a blogger is a journalist.

However, in determining whether Smith was engaged in news reporting or news commentating, the court has applied the functional analysis suggested by commentators and the Plaintiffs in their memorandum in support of a preliminary injunction, which examines the content of the material, not the format, to determine whether it is journalism. (citation omitted). In addition, the court has considered the intent of Smith in writing the article. The court agrees that not all bloggers are journalists. However, some bloggers are without question journalists. (citation omitted).

Bidzerk, LLC v. Smith, 2007 U.S. Dist. LEXIS 78481 at *16-17, 35 Media L. Rep. 2478 (D. S.C. 2007).

Applying the Obsidian Test to A Texas Bankruptcy Lawyers Blog


It is a shame that the Judge in Obsidian v. Cox used an intellectually lazy definition of journalist when it probably did not influence the outcome of the case. The statements made by Ms. Cox in her blog were so outrageous that they likely would have failed a negligence or actual malice standard. I take personal offense because I like to think that the work that I do on this blog bears a passing resemblance to journalism. However, I doubt that I would qualify under Judge Hernandez’s test.

1. Any education in journalism. I took three years of journalism in high school and wrote for both my high school and college papers. Is that enough?

2. Any credentials or proof of any affiliation with any recognized news entity. My blog is distributed by the State Bar of Texas, the American Bankruptcy Institute and the LexisNexus Bankruptcy Community. However, these are all legal organizations rather than recognized news entities.

3. Proof of adherence to journalistic standards such as editing, fact-checking, or disclosures of conflicts of interest. I do edit my pieces, although my partner says that I should do more of it. I do fact check my posts, which are mostly based on court opinions and thus pretty easy to document. Finally, if I have involvement in a case I write about, I disclose that.

4. Keeping notes of conversations and interviews conducted. I rarely do interviews. However, when I do, I don’t necessarily keep my notes after the post is published unless it is because I have a messy desk and they get buried under something else.

5. Mutual understanding or agreement of confidentiality between the defendant and his/her sources. Sort of. If someone asks me not to use their name, I respect that. However, it just doesn’t come up that often.

6. Creation of an independent product rather than assembling writings and posts of others. Yes.

7. Contacting “the other side” to get both sides of a story. Generally, I write about judicial opinions. I do not contact the losing party to get their side of the story. If a party to a case contacts me and points out a factual error, I will correct it. Sometimes I will allow the other side to tell their side of the story in the comments. However, I did not contact Crystal Cox or Kevin Padrick about this post.

Out of seven criteria, I qualify completely under two, partially under four and not at all under one. However, if you compare my writing to that of Bill Rochelle, who writes for Bloomberg and is definitely a real journalist, you will see that we frequently write on the same topics and discuss the same issues. The difference is that he is better at it than I am and gets paid for it, while I still have my day job.

The Ironic Conclusion—It’s All in How You Say It

In reading through Crystal Cox’s rambling and often obsessive blog, there is occasionally some solid reporting and good questions raised. It certainly raised my eyebrows that the Court would appoint a trustee based on an oral motion without any prior notice to parties in interest. It also was unusual for the Court to suggest an individual to the United States Trustee. It was also a very close call as to whether the principal of the Debtor’s financial adviser qualified as a disinterested person eligible to be appointed as trustee. These were all good questions. However, from my personal review of the lawsuit and the blog, it appears that Ms. Cox took a wrong turn when she took the unusual circumstances of Mr. Padrick’s appointment and her personal dislike of him and constructed a narrative of wrongdoing and fraud. Blogs that traffic in rumor, innuendo and unsupported allegations make the rest of us look bad and bring disrepute to blogging in general. On top of that, rumor, innuendo and unsupported allegations belong on talk radio, where they can be advanced by serious journalists like Rush Limbaugh, Alex Jones and Glen Beck, not on blogs.