Court Clears the Way for Simultantaneous Causes of Action Based on Discharge Violation

Nature abhors a vacuum. When Congress restricted access to bankruptcy in 2005, many debtor’s lawyers became plaintiff’s lawyers, filing suit over automatic stay and discharge violations which might have been allowed to pass in an earlier time. Not only are debtor’s lawyers suing more often, they are also asserting more causes of action as illustrated by a recent opinion from the Western District of Texas. Eastman v. Baker Recovery Services, Adv. No. 08-5055 (Bankr. W.D. Tex. 4/17/09).

Eastman shows a common fact pattern. A debtor filed a no asset case and failed to schedule a creditor. The unscheduled creditor later filed suit. The debtor did not answer the suit, but did inform the creditor of the discharge. The creditor took a default judgment. Several years later, after the debtor moved to reopen her bankruptcy case, the creditor finally had the judgment vacated. The debtor then filed an adversary proceeding for violation of the discharge after the judgment had been vacated. However, the debtor not only filed suit for violation of the discharge, but for violation of the Fair Debt Collection Practices Act, the Texas Debt Collection Practices Act, the Texas Deceptive Trade Practices Act and “tortiously engaged in practices that rise to the intentional infliction of emotional distress” (whatever that means).

This case shows a pattern of escalating failures which is not that unusual. The debtor blundered by not listing the creditor. However, because the case was a no-asset case, the debt was still subject to discharge. The creditor’s initial action to file suit in violation of the discharge was innocent because the creditor did not have notice of the bankruptcy case. The debtor blundered a second time when it did not answer the state court lawsuit. The creditor blundered when it took a judgment after being informed of the discharge. The debtor showed a curious indifference to her own rights when she waited for over a year to remedy the discharge violation. The creditor showed a cavalier disregard for its own liability when it waited until after the debtor had moved to reopen the bankruptcy case before it got around to vacating the judgment.

This case raises two issues 1) Can the same violation of the discharge give rise to multiple causes of action? and 2) Does the Bankruptcy Court have jurisdiction to hear all of them? Judge Clark answered yes to both questions.

There is currently a split between courts as to whether a discharge violation is also actionable under the FDCPA and other statutes. The Ninth Circuit holds that the bankruptcy discharge preempts other laws so that a plaintiff may not assert both causes of action. Walls v. Wells Fargo Bank, N.A., 276 F.3d 502 (9th Cir. 2002). On the other hand, the Seventh Circuit holds that one federal statute cannot preempt another and that implied repeal of another federal statute should not be done on less than imperative grounds. Randolph v. IMBS, Inc., 368. F.3d 726 (7th Cir. 2004). Judge Clark sided with the Seventh Circuit, finding that both federal causes of action could be asserted simultaneously. However, he went one step further and found that the state causes of action were not preempted either.

However, what is really interesting about this opinion is that Judge Clark also ruled that he had jurisdiction to consider all of the claims in one action. In doing so, he disagreed with Judge Clark. In Mahoney v. Washington Mutual , Judge Clark dismissed state law claims which arose from the same facts as an alleged discharge violation because they did not have any conceivable effect on the bankruptcy estate. In so ruling, Judge Clark followed the test for “related to” jurisdiction which has long been followed in the Fifth Circuit.

So, why did Judge Clark disagree with Judge Clark? The difference was an intervening Fifth Circuit decision. In Matter of Morrison, 555 F.3d 473 (5th Cir. 2009), the Fifth Circuit upheld a decision by a bankruptcy court which held a debt to be nondischargeable and entered a money judgment on the claim. The Fifth Circuit found that judicial efficiency should not require a creditor obtaining a finding of nondischargeability to file a separate action to obtain a judgment on the claim. Judge Clark found that the same logic applied in this situation as well. He said:

A similar rationale warrants a similar exercise of jurisdiction here. The action for violation of the discharge injunction is a core proceeding, one that arises under a provision of title 11. (citation omitted). The selfsame facts make out a case for violation of the FDCPA. There would be no judicial efficiency in requiring the beneficiary of a judgment finding the defendant liable for violating the discharge injunction to pursue a separate lawsuit in state or federal court in order to secure a money judgment against the defendant. (citation omitted). Thus, the court concludes, under the reasoning of Morrison, that it has the requisite subject matter jurisdiction to entertain the FDCPA cause of action.

Eastman, at 8.

If Judge Clark is correct, “related to” jurisdiction has substantially expanded in the Fifth Circuit. If a Bankruptcy Court has jurisdiction over a claim, then it also has jurisdiction over other claims arising from the same facts in the name of judicial efficiency. This conclusion is somewhat of a two-edged sword. On the one hand, it expands the Bankruptcy Court’s jurisdiction to include what would be known as supplemental jurisdiction for an Article III Court. However, it also undermines the ability of a plaintiff to pursue separate bankruptcy and state court claims arising from the same facts on the ground that the bankruptcy court lacked jurisdiction to hear the non-bankruptcy claims.

His English Teacher Would Be Proud

Many of us forgot the formal rules of grammatical construction as fast as we could, but not Justice Breyer. In an opinion today, he delivered a grammatical tour de force.

There are strong textual reasons for rejecting the Government’s position. As a matter of ordinary English grammar, it seems natural to read the statute’s word “knowingly” as applying to all the subsequently listed elements of the crime. The Government cannot easily claim that the word “knowingly” applies only to the statutes first four words, or even its first seven. It makes little sense to read the provision’s language as heavily penalizing a person who “transfers, possesses, or uses, without lawful authority” a something, but does not know, at the very least, that the “something” (perhaps inside a box) is a “means of identification.” Would we apply a statute that makes it unlawful “knowingly to possess drugs” to a person who steals a passenger’s bag without knowing that the bag has drugs inside?

The Government claims more forcefully that the word “knowingly” applies to all but the statute’s last three words, i.e., “of another person.” The statute, the Government says, does not require a prosecutor to show that the defendant knows that the means of identification the defendant has unlawfully used in fact belongs to another person. But how are we to square this reading with the statute’s language?

In ordinary English, where a transitive verb has an object, listeners in most contexts assume that an adverb (such as knowingly) that modifies the transitive verb tells the listener how the subject performed the entire action, including the object as set forth in the sentence. Thus, if a bank official says, “Smith knowingly transferred the funds to his brother’s account,” we would normally understand the bank official’s statement as telling us that Smith knew the account was his brother’s. Nor would it matter if the bank official said “Smith knowingly transferred the funds to the account of his brother.” In either instance, if the bank official later told us that Smith did not know the account belonged to Smith’s brother, we should besurprised.

Of course, a statement that does not use the word “knowingly” may be unclear about just what Smith knows. Suppose Smith mails his bank draft to Tegucigalpa, which (perhaps unbeknownst to Smith) is the capital of Honduras. If the bank official says, “Smith sent a bank draft to the capital of Honduras,” he has expressed next to nothing about Smith’s knowledge of that geographic identity. But if the official were to say, “Smith knowingly sent a bank draft to the capital of Honduras,” then the official has suggested that Smith knows his geography.

Flores-Figeroa v. United States, No. 08-108 (U.S. 5/4/09).

Justice Alito, who was also paying attention in English class, wrote separately to express his opinion on how the word knowingly should be used.

While I am in general agreement with the opinion of the Court, I write separately because I am concerned that the Court’s opinion may be read by some as adopting an overly rigid rule of statutory construction. The Court says that “[i]n ordinary English, where a transitive verb has an object, listeners in most contexts assume that an adverb (such as knowingly) that modifies the transitive verb tells the listener how the subject performed the entire action, including the object as set forth in the sentence.” Ante, at 4. The Court adds that counterexamples are “not easy to find,” ante,at 5, and I suspect that the Court’s opinion will be cited for the proposition that the mens rea of a federal criminal statute nearly always applies to every element of the offense.

I think that the Court’s point about ordinary English usage is overstated. Examples of sentences that do not conform to the Court’s rule are not hard to imagine. For example: “The mugger knowingly assaulted two people in the park—an employee of company X and a jogger from town Y.” A person hearing this sentence would not likely assume that the mugger knew about the first victim’s employer or the second victim’s home town. What matters in this example, and the Court’s, is context.

More to the point, ordinary writers do not often construct the particular kind of sentence at issue here, i.e., a complex sentence in which it is important to determine from the sentence itself whether the adverb denoting the actor’s intent applies to every characteristic of the sentence’s direct object. Such sentences are a staple of criminal codes, but in ordinary speech, a different formulation is almost always used when the speaker wants to be clear on the point. For example, a speaker might say: “Flores-Figueroa used a Social Security number that he knew belonged to someone else” or “Flores-Figueroa used a Social Security number that just happened to belong to a real person.” But it is difficult to say with the confidence the Court conveys that there is an “ordinary” understanding of the usage of the phrase at issue in this case.

While Flores-Figeroa is a criminal opinion, it pays to be in the know about how to construe knowingly in bankruptcy court as well. I hope that these excerpts make everything perfectly clear.

Chrysler Seeks the Ultimate 363 Sale as the Treasury Department Dictates the Pace

Chrysler, LLC filed for chapter 11 bankruptcy on April 30 with the United States Treasury firmly in the driver’s seat (pun intended). In its first day filings, Chrysler announced that it would be seeking $4.5 billion in DIP financing from the Treasury and that it intended to affect a sale of substantially all of its assets to a newly created entity within 60 days. The U.S. Treasury filed a statement concurring in the filing and noting that its commitment to provide DIP financing was conditioned on timely filing and approval of the motion for sale of assets free and clear of liens.

Chrysler’s Woes

According to Chrysler’s filings, it is “one of the most agile and innovative car manufacturers in the world” whose name is “synonymous with innovative engineering” and whose liquidation “would have significant adverse impacts on the nation’s economy.” However, the filings also show (or at least imply) that the company took on too much debt in a leveraged buyout, failed to keep up with technology and mortgaged its future to payment of employee benefits.

While Chrysler bills itself as “the quintessential American automobile company,” its present difficulties as well as its plan for recovery arise from European alliances. In 1998, Chrysler merged with German automaker Daimler-Benz. At the time, the company was healthy and had cash reserves of $7.5 billion. The German alliance didn’t work out and Chrysler went private in a leveraged buyout in 2007. As part of this transaction, Chrysler incurred $10 billion in first lien debt (which has been paid down to $7 billion). According to Chrysler, this first lien debt is now trading at 15 cents on the dollar. It also incurred $2 billion in second lien debt from affiliates of its shareholders, including $1.5 billion from Daimler Financial. When Chrysler encountered financial difficulty last year, it received $4 billion in TARP funds from the U.S. Treasury, which are secured by a third lien. In addition to these secured debts, Chrysler owes $5.4 billion in trade debt, $1 million on its Amex cards and is required to spend $6.7 billion for settlement of claims relating to employee health care benefits. As will be discussed later, Chrysler's exit strategy in this case involves an alliance with Fiat.

Beginning in February 2007, the company began paring down its offerings to those which had the best sales and margins. Three of those identified in this class were the Jeep Grand Cherokee, the Dodge Ram truck and the Chrysler Town & Country minivan. All of these were large and not very fuel efficient. The implication is that Chrysler doesn't do so well in the market for fuel efficient cars, an impression reinforced by Chrysler's statements about the benefits of obtaining small car technology from Fiat.

According to Chrysler, it was hit hard by the financial crisis in the fall of 2008. When the market for securitizations imploded, there was no longer a means to sell auto loans to obtain new capital. Additionally, with the economy in free fall, people stopped buying vehicles. Chrysler points to sales in January to March of 2009, which were 35-37% below sales during the same months in 2008. In December 2008, Chrysler idled its plants for one month (with some staying closed longer).

One requirement of accepting the TARP money (which Chrysler notes that “many other large corporate pillars of the economy” requested), was that Chrysler had to submit a Viability Plan to the government and show its progress in meeting certain benchmarks. The government told Chrysler that it would support its working capital needs up through April 30 and required it to negotiate agreements with its creditors, the UAW and its proposed partner Fiat within this time. Chrysler reports that it reached the required agreements with almost all constituencies and filed bankruptcy on April 30 to implement the plan.

The Proposed Sale

While Chrysler paints a glowing picture of the progress it has made in negotiating with stakeholders, the U.S. Treasury has indicated that it is holding a gun to the company’s head and requires a sale to be approved and closed within 60 days. According to a statement released on behalf of Acting U.S. Attorney for the Southern District of New York Lev Dassin:

The President has made clear that the United States cannot commit to fund Chrysler if the company’s restructuring lacks a realistic probability of success. Treasury cannot and will not make an open-ended commitment to Chrysler for billions of dollars more, especially in light of the myriad other meritorious, competing demands for the public’s resources; its commitment to fund Chrysler’s bankruptcy must be contingent on Chrysler achieving the milestones necessary to close a sale in sixty days. Simply put, this time period for a sale is a necessary and critical condition to government funding.

Statement of the United States Department of the Treasury in Support of the Commencement of Chrysler, LLC’s Chapter 11 Case, p. 5.

As a condition of providing DIP financing, the government has required that Chrysler adhere to the following schedule in selling its assets:

May 4: File 363 motion
May 9: Hearing to approve sales procedures
May 10: Have final and non-appealable order entered
May 20: Receive bids
May 29: In court auction
June 1: Hearing to approve sale
June 15: Entry of final and non-appealable order approving sale
June 27: Close the 363 sale.

If Chrysler fails to meet this timeline, the Treasury reserves the right to cut off funding and drive the company into liquidation.

The United States Treasury, in addition to being a pre-petition lender and post-petition lender is also a proposed equity holder in the stalking horse bidder. Under the proposed 363 motion, Chrysler’s operating assets will be transferred to New Chrysler of which the United States will be an 8% interest holder.

The proposed transaction consists of the following elements:

1. Chrysler will transfer substantially all of its operating assets to New Chrysler.
2. New Chrysler will assume” certain liabilities” of Chrysler and pay $2 billion in cash to Chrysler.

3. Fiat will contribute “to New Chrysler access to competitive fuel-efficient vehicle platforms, certain technology, distribution capabilities in key growth markets and substantial cost saving opportunities” (whatever that means).

4. New Chrysler will be owned 55% by a Voluntary Employees Beneficiary Association, 8% by the United States, 2% by Canada and 20% by Fiat (with the right to increase its stake to 51%).

Although $2 billion is to be paid to Chrysler, it states that it anticipates that no cash will remain in the company. Instead, the company will be left with eight manufacturing plants which are not being transferred.

The documents filed so far are somewhat vague about which “certain liabilities” will be assumed. However, Chrysler’s declaration does state that the company’s largest first lien creditors, JP Morgan Chase, Goldman Sachs, Morgan Stanley and Citigroup, have agreed to write off 70% of their debt and that the $2 billion in second lien debt owed to Chrysler’s shareholders, Daimler Financial and Cerberus Capital, will be forgiven. The shareholders will also be required to fund hundreds of millions of dollars in pension liabilities. It does not expressly say what will happen to the U.S. government's third lien debt or the company's trade debt.

Implications

This is certainly an unprecedented case. However, the extent to which the United States is directing the outcome of the proceeding raises some major issues.

First, is this a sub rosa plan? The Second Circuit has held that sub rosa plans cannot be part of a Section 363 sale. In re Iridium Operating, LLC, 478 F.3d 452 (2nd Cir. 2007) (“The trustee is prohibited from such use, sale or lease if it would amount to a sub rosa plan of reorganization. The reason sub rosa plans are prohibited is based on a fear that a debtor-in-possession will enter into transactions that will, in effect, "short circuit the requirements of Chapter 11 for confirmation of a reorganization plan.").

The proposed sale transaction looks like it is rearranging the priorities of creditors, which would be a clear sign of a sub rosa plan. Based on what has been disclosed so far, first lien holders will receive only 28% of their claims and second lien holders will receive nothing. However, nothing is said about the third lien held by the United States or the trade creditor claims. Allowing junior claims to participate without payment in full of senior claims is a clear violation of the absolute priority rule unless the parties vote in favor of the plan. Since there is no voting on a sale, how can this consent take place?

Additionally, the sale motion essentially dictates the post-reorganization ownership of New Chrysler, allocating it between employee benefits, the United States and Canadian governments and Fiat. Dictating who will own the reorganized debtor is another sure sign of a sub rosa plan. Some clever lawyering was used to try to avoid this problem. The 363 motion will not dictate that the company is sold to New Chrysler, only that it will be the stalking horse bidder. However, given the extremely short time frame dictated by the U.S. Treasury, there is no meaningful opportunity for outsiders to bid.

There are also some very interesting separations of power issues. Typically, a bankruptcy judge would not allow a DIP lender to dictate that all of the company’s assets be sold within 60 days. However, in this case, the President of the United States, acting through the Treasury Department is the one dictating the result. Should the judicial branch defer to the executive branch in this instance or should the court be free to say no to the President. This one is easily answered. The Bankruptcy Judge can veto the Treasury Department’s terms for post-petition lending, but cannot force the Treasury Department to lend. Thus, the Judge must decide whether he is willing to take the responsibility for killing Chrysler. While this is an unfair burden to place on a judge, he is still free to act.

The other interesting question is how the U.S. Trustee can be an effective watchdog for the case when the President and the Treasury Department are potentially overstepping their bounds in directing how the case will proceed. Technically, there are separate lines of authority, since the Treasury Department is appearing through the U.S. Attorney and the U.S. Trustee is part of the Justice Department. However, they are both part of the United States executive branch with the President at the top. In a lower profile case, this might not be a problem. However, in a case of this magnitude, it seems like the U.S. Trustee is placed in a no win situation. However, I am not aware of any provision which allows someone outside of the executive branch to step in for the U.S. Trustee in the event of a conflict.

It will be interesting to see how Judge Gonzales and the U.S. Trustee navigate this minefield.

The Human Face of Bankruptcy

This week I received an unhappy call from the wife of a debtor whose case I had written about. Although the article was posted nearly two years ago, someone had recently told her that her husband's name was mentioned on the internet. She found this very distressing. I tried to explain to her that I was merely reporting on a published opinion by a United States Bankruptcy Judge. In the background, her husband was telling her that I could not use his name without permission and that I was just trying to make money from my blog (neither one of which was true). She insisted that her husband had done nothing wrong notwithstanding the judge's ruling to the contrary.

In the end, I decided to redact the article to remove the name of the debtor and replace it with "Name Withheld by Request." I was not under any obligation to do this, since the debtor's name was part of a published opinion. However, she seemed so clueless about what had happened. She sincerely believed that everything which had happened in the case was the fault of the lawyers and the judge. She was very embarrassed that people in their small town could know about their problems. Although I had very little sympathy for the husband (who was found to have committed bad acts by Judge Bohm and who was very threatening in the background of the conversation), I did feel sorry for this very confused and embarrassed woman.

I don't know that I would do it again, because it is difficult to talk about cases without mentioning their names. However, it does point out that behind every case is a human being. When we talk about Marrama, Geiger and Cohen, these are not just Supreme Court cases, but also the names of individuals who have been immortalized in the case reporters. At the same time, I don't think that a lot of debtors fully comprehend the seriousness of what they are undertaking. As former Bankruptcy Judge Larry Kelly was fond of saying, "When you filed bankruptcy, you made a federal case out of it." Bankruptcy is a matter of public record and the unfortunate few who get their names mentioned in unfavorable written opinions will find that the memory of their deeds lives on in written pages and the increasingly on the internet.

While the name of this particular debtor is no longer mentioned on my blog, anyone can go to 366 B.R. 677 to read all about his case. I wonder if Mr. Name Withheld By Request will try to sue West Publishing for using his name without permission?

Pennsylvania Judge Writes Epic Opinion on Technology and Professional Responsibility

Technology has dramatically changed the practice of law. Thanks to Westlaw and Lexis, it is no longer necessary to keep large expensive libraries. PACER and ECF have made court filings and filing documents available 24/7. I recently observed a case where the parties used GoToMeeting to handle thousands of pages of exhibits electronically. All of these developments have made the practice of law more efficient. However, a recent opinion from Judge Diane Weiss Sigmund highlights that professionals must be masters of the technology rather than being mastered by it. In re Taylor, No. 07-15385 (Bankr. E.D. Pa. 4/15/09).

The Taylor case started with a simple question that comes up frequently in consumer bankruptcy cases: Why couldn’t the creditor’s lawyer get a payment history? The answer given to this question prompted Judge Sigmund to launch a one year investigation into the technology behind the case and how it was being used and to award some very creative sanctions. The Judge authored a 58 page opinion ”to share my education with participants in the bankruptcy system who may be similarly unfamiliar with the extent that a third party intermediary drives the Chapter 13 process.” Opinion, p. 30.

What Happened

Taylor involved a chapter 13 filing to try to keep a house. Two firms appeared on behalf of HSBC, the mortgage holder. A national firm filed a proof of claim, while a local firm filed a motion for relief from stay and responded to an objection to claim. All three documents were defective. The proof of claim attached the wrong mortgage and listed the wrong payment amount. The motion for relief from stay recited that the debtors had failed to make their post-petition payments for three months, when in fact they had been making the payments, but at a lower amount due to a dispute over flood insurance. According to the Court, “at the time the Stay Motion was filed, the Debtors were short $360 for payments more than 60-days overdue, a fact not clear from the canned pleading prepared by a paralegal from New Trak screens. The Debtors were charged $800 for the cost of the motion.” Opinion, p. 14. The motion also recited that the debtors had no equity in the property which the attorney later attributed to being part of a boilerplate form. The response to the objection to claim said that the claim was just fine when it was not.

The Debtor’s attorney did not do much better. She filed a late response, which incorrectly stated that the debtors had made all of their payments but they had been returned by HSBC. The Debtor’s attorney also failed to respond to requests for admission tendered with the motion, incorrectly believing that her response to the motion was sufficient.

Upon receiving the Debtor’s attorney’s response, HSBC’s local counsel continued the hearing for further investigation. The Debtor’s lawyer then filed an amended response, which included copies of the checks for the months of September through January with both front and back and the checks for February and March with just the front. The amended response alleged that the payments for September through March had all been made. As it turns out, the reason that there were only copies of the front side of the February and March payments was because the Debtor’s counsel was still in possession of these checks which had not yet been tendered. Debtor’s counsel erroneously mailed these checks to the person at HSBC’s attorney’s office who handled Sheriff’s Sales rather than to the Bankruptcy Department. The person in the Sheriff’s Sale department sat on the checks and did not inform the Bankruptcy Department that they had been received. The Debtor’s counsel also requested a payment history.

On May 1, a young associate appeared for HSBC and insisted on prosecuting the motion even though he had been provided with proof of payments. The young attorney sought to proceed based on the deemed admissions even though he knew they were not accurate. The court denied the motion and instructed the debtor to escrow the disputed flood insurance premiums while the parties worked through the issue.

One month later, the parties appeared on the claims objection and things rapidly escalated. The young associate (he had been licensed a few months at the time) stated that he could not get a payment history from his client. He explained that he had submitted a request for a payment history through an electronic system, but that he was forbidden to speak directly with the client. This statement caused the Court to issue a show cause order.

In response to the Court’s Show Cause Order, HSBC retained new counsel and the problem with the claim was quickly settled. As noted by the Court, “What could not be accomplished for six months through the use of electronic communication was finalized in an hour the old way, by people sitting down with all relevant information and talking to each other.” Opinion, p. 19.

While the contested matters were quickly settled, the Court was not satisfied. It launched an inquiry which brought the technology center stage.

The Technology and Professional Responsibility

The technology involved was the NewTrak system developed and operated by Lender Processing Services, Inc. f/k/a Fidelity Information Services, Inc. To its credit, LPS was “extremely cooperative” with the court’s inquiry and “provided a detailed demonstration of how NewTrak works in a hypothetical case.” Opinion, p. 9, n. 15. As a result, the Court had a substantial knowledge base to draw on when writing her opinion. NewTrak is an automation system which allows lenders and attorneys to communicate with each other. The lender uploads its information onto the system which then generates a referral to an attorney on the approved list. The attorney receives the information and generates the proof of claim, motion for relief from automatic stay or other pleading. The system also allows the attorney to request information from the client by opening an issue on the system. Another system called the mortgage servicing platform handles routine mortgage servicing. According to LPS, it was used by 39 of the 50 largest banks in 2007 and processed approximately 50% of the loans in the United States.

While NewTrak provides a flow of information between attorney and client, it is not meant to prohibit direct contact between the parties. The Default Services Agreement specifically provides that “The Firm will never be prohibited from directly contacting any client where, in the professional opinion of the Firm such contact is necessary.” Opinion, p. 34, n. 45. As a result, the agreement contemplates that the Firm will exercise professional judgment. However, the Court found that when an attorney mechanically uses the system “the attorney abandons any pretense of independent judgment to the greater goal of expeditious and economical client service.” Opinion, p. 31.

The Court contrasted the benefits of using the technology with its pitfalls when a matter is not routine.

It is a regrettable reality, especially in this economic climate, that many homeowners are defaulting on their mortgages. While bankruptcy affords an opportunity to save the family home through a Chapter 13 plan that stretches the payments of mortgage arrears, it also requires debtors to maintain current payment on their mortgages. (citation omitted). This obligation is beyond the capability of many debtors who use a bankruptcy to forestall the inevitable. It seems reasonable that a mortgage lender should be able to avail itself of economic and expeditious means of collecting defaulted loans through the use of technology and delegation of tasks to lower cost labor. In many cases, the motions are granted by default, the debtors, or often more accurately their attorneys, filing no answer or making no appearance, where there is simply no defense to the relief sought. However, where, as here, the debtor contests the relief sought, the flaws in the automated process become apparent. At this juncture, an attorney must cease processing files and act like a lawyer. That means she must become personally engaged, conferring with the client directly and abandoning her reliance on computer screens as an expression of her client’s will. This did not happen in this case until the Court became involved. It should not have taken judicial intervention to bring the Claim Objection to its conclusion.

Opinion, p. 32 (emphasis added).

In this case, the court found that professional judgment was not used.
The attorney for the national firm which filed the proof of claim testified that he reviewed only a representative sample of 10% of the claims which were electronically signed with his name. He did not review the specific claim in this case and as a result, did not find the mistakes in it.

The president of the local firm which utilized NewTrak testified that he delegated the administrative aspects of the firm’s practice and was unaware of how NewTrak worked.

The head of the bankruptcy section of the firm electronically signed all of the pleadings in the matter, but delegated all of the court appearances to an attorney who had been licensed for only one month when the initial pleading was filed. The court found that the head of the bankruptcy section failed to supervise the young attorney and asked the rhetorical question, “Could it be with ten lawyers and 130 paralegals and processors, a young attorney is expected to figure it out himself?” Opinion, p. 42.

The Court also found that the client had restricted the firm’s authority.

The Udren Firm’s authority from HSBC allowed them to take only three actions: (1) seek a continuance; (2) settle with Motion with an agreement for a six month maximum cure of the mortgage arrears with an agreement for stay relief upon certification of default of any future payment; and failing either of the foregoing; (3) press the motion. (citation omitted). No consultation with HSBC was expected nor occurred during the pendency of the contested matter.

Opinion, p. 37, n. 49.

Sanctions

The Court found that several parties to the case had violated their obligations under Rule 9011, including the obligation to make reasonable inquiry. However, the Court was also mindful that sanctions should be “limited to what is sufficient to deter a repetition of such conduct or comparable conduct by others similarly situated.” Rule 9011(c)(2). As a result, the Court granted some very creative relief.

As to the Udren Firm, which acted as local counsel, the Court found that the expense of having to hire counsel and defend itself and the productive time lost in attending to the matter was punishment enough. However, the Court devoted additional attention to the specific lawyers from the firm.

The Court found that the head of the Udren Firm’s bankruptcy section “may be so enmeshed in the assembly line of managing the bankruptcy department’s volume mortgage practice that she has lost sight of her duty to the court and has compromised her ethical obligations.” Opinion, p. 52. The Court ordered her to obtain 3 credits of CLE in professional responsibility/ethics in addition to her regular requirements.

The court declined to award sanctions against the young associate, finding that “I believe these proceedings have been very hard on this young lawyer and while lack of experience is not a defense to a Rule 9011 violation, I suspect that he has learned all that he needs to learn without protracting this unfortunate time in his nascent career.” Opinion, p. 52.

The Court found that the head of the firm “sets the tone and establishes its culture. He notes his firm’s reliance on NewTrak and other such aids as essential to the economic structure of the law practice. However, he had little familiarity with the actual operation of NewTrak and did not appear to get involved in the ‘weeds’ of the bankruptcy practice.” Opinion, pp. 52-53. The Court found this lack of involvement to be troubling and ordered relief accordingly.

Mr. Udren may not be aware of the questionable practices imposed by his firm’s acquiescence to NewTrak and how little legal judgment is employed as a result or he may be aware and find it acceptable. To examine these practices in light of extant ethical obligations, I will direct him to obtain training in NewTrak and spend a day observing his bankruptcy attorneys, paralegals, managers and processors as they handle referrals. Since policy emanates from the top, I will also order Udren and (the head of the bankruptcy section) to conduct a training session for all members of the bankruptcy department in the appropriate use of the escalation procedure and the requirements of Rule 9011 with respect to pre-filing due diligence.

Opinion, p. 53.

The Court did not award sanctions against the national firm which prepared the proof of claim, but not because she found their conduct appropriate. The Court found that the record had not been fully developed with regard to this party, that the practices were national in scope and that the U.S. Trustee was investigating the firm. As a result, the Court left it to another day and another court to address these issues.

The Court found that some of the problems in the case resulted from the Udren firm's reluctance to contact its client directly and found that other firms used by HSBC might be under the same impression. As a result, the Court ordered HSBC “to prepare and transmit by mail and e-mail a letter to all the Network Firms outlining the escalation policy and encourage its use consistent with the Rules of Professional Conduct. HSBC should also advise the Network Firms that use of direct contact will not reflect adversely on the firm.” Opinion, p. 55.

The Court did not sanction LPS.

Based on the record, I find that sactions against LPS are not warranted. While it does appear from the limited screens that have been introduced in this case, that LPS’ involvement goes beyond passing data through their automatic system, I cannot conclude that it imposed restrictions on the Udren Firm’s handling of this case. (citation omitted). The Udren Firm entered into a contract with Fidelity which it viewed as advantageous to the business relationships with its mortgage lender clients and presumably its bottom line. As attorneys, the Udren Firm understood an attorney’s obligations under Rule 9011 to investigate and took a lesser approach. While NewTrak prescribed that approach, LPS did not dictate how they would handle cases referred to them when problems with the procedure were apparent. By misusing the resources made available to them, the Udren Firm, not LPS, was responsible for the Rule 9011 deficiencies in this case.

Opinion, pp. 55-56.

Conclusion

Judge Sigmund’s remarkable opinion demonstrates that she is no Luddite. Her opinion focuses on the need to exercise professional judgment in conjunction with technology rather than mindlessly bashing the technology itself. In her conclusion, she stated:

My research has disclosed no other published opinion that explains the NewTrak process that is utilized by so many consumer mortgage lenders seeking relief in bankruptcy cases. I have attempted to share my education in this Opinion. Finally, it is my hope that by bringing the NewTrak process to the light of day in a published opinion, system changes will be made by the attorneys and lenders who employ the system or at least help courts formulate the right questions when they have not. While NewTrak has many features that make a volume business process more efficient, the users may not abandon their responsibility for fairness and accuracy to the seduction of electronic communication. The escalation procedures in place at HSBC and the Udren Firm existed on paper only. When an attorney appears in a matter, it is assumed he or she brings not only substantive knowledge of the law but judgment. The competition for business cannot be an impediment to the use of these capabilities. The attorney, as opposed to a processor, knows when a contest does not fit the cookie cutter forms employed by paralegals. At that juncture, the use of technology and automated queries must yield to hand-carried justice. The client must be advised, questioned and consulted. Young lawyers must be trained to make those judgments as opposed to merely following the form manual. Until they are capable of doing so they should be supported and not left to sink or swim alone in an effort for the firm to be more profitable by leveraging the cheapest labor.

At issue in these cases are the homes of poor and unfortunate debtors, more and more of whom are threatened with foreclosure due to the historic job loss and housing crisis in this country. Congress, in its wisdom, has fashioned a bankruptcy law which balances the rights and duties of debtors and creditors. Chapter 13 is a rehabilitative process with a goal of saving the family home. The thoughtless mechanical employment of computer-driven models and communications to inexpensively traverse the path to foreclosure offends the integrity of our American bankruptcy system. It is for those involved in the process to step back and assess how they can fulfill their professional obligations and responsibly reap the benefits of technology. Nothing less should be tolerated.

Opinion, pp. 57-58 (emphasis added).

On Gunslingers, Presumptions and Burdens of Proof

There have been an increasing number of cases dealing with objections to assigned credit card debt. These cases are a bit like a showdown between gunfighters with bad aim: there is a lot of shooting, but no one hits anything. While a gunfight where no one gets shot is a good thing, the court must still decide whether to allow or disallow the claim even when there is little or no evidence introduced. As a result, rules on presumptions and burden of proof often dictate the result.

Prima Facie Valid Or Not

The starting point is Fed.R.Bankr.P. 3001(f) states that “A proof of claim executed and filed in accordance with these rules shall constitute prima facie evidence of the validity and amount of the claim.” Thus, if the creditor files its claim in accordance with the rules, it starts out with a presumption of validity. However, before the claim receives prima facie validity, it must be filed in accordance with the rules, particularly Rule 3001. Among other things, Rule 3001(c) provides that if a claim is based upon a writing, that writing must be attached or a statement must be provided explaining why the writing cannot be attached. Several courts have held that merely attaching a summary which lists the name of the original creditor, the last four digits of the account number and the balance claimed to be owed does not meet the requirement that the writing be attached to the claim, thus depriving the claim of prima facie validity. In re Tran, 369 B.R. 312 (S.D. Tex. 2007); In re Cox, 2007 Bankr. LEXIS 4048 (Bankr. W.D. Tex. 2007).

Courts have required different levels of documentation to satisfy the prima facie validity requirement. At the low end are courts requiring as little as a copy of an account statement from the original creditor, In re Griffin, 2007 Bankr. LEXIS 1749 (Bankr. W.D. Tex. 2007), while some courts require copies of the underlying contract, account statements and/or proof of assignment of the debt. In re Armstrong, 320 B.R. 97 (Bankr. N.D. Tex.2005)(account statement plus proof of assignment), In re Tran, 369 B.R. 312 (S.D. Tex. 2006)(requiring original contract), In re Leverett, 378 B.R. 793 (Bankr. E.D. Tex. 2007)(requiring documentary evidence of how claimant acquired the claim and proof that it is the holder of the claim); In re Plourde, 397 B.R. 207 (D.N.H. 2008)(requiring original contract plus statements plus proof of assignment); In re Kendall, 380 B.R. 37 (Bankr. N.D. Okla. 2007)(requiring contract plus itemization plus proof of assignment).

Effect of Prima Facie Validity

A recent opinion explained how failure to satisfy the requirements for prima facie validity affected the burden of proof on a claims objection.

Having little to none of the requirement information attached for a credit card debt, Roundup’s claim did not comply with Rule 3001(c). The Court, therefore, concludes that Roundup Funding’s claim is not entitled to prima facie validity under Bankruptcy Rule 3001(f). Without such validity, Debtors needed only to object to the claim pursuant to the applicable rules or statute, which they did. Debtors had listed this debt as ‘disputed’ so they did not judicially admit that they owe it. Although the Debtors did not attach any evidence to their objection to Claim Number 12, such as an affidavit, the objection was sufficient by being signed by their counsel under penalty of Rule 9011. (citation omitted).

After the Debtor’s valid objection, Roundup Funding had the burden of offering supporting documentation to carry its burden of proof in the face of an objection. It had to establish the claim by a preponderance of the evidence. (citation omitted). Roundup Funding presented no evidence to support its claim. Its information was submitted in the form of a response with attached exhibits, all in the nature of argument, and not by affidavit or by witness testimony. It provided no evidence to link the entity assigning the claim with an entity listed on the Debtor’s schedules. In any event, this attachment page to the claim is not a business record of the Debtor’s credit card account within the meaning of Federal Rule of Evidence 803(6).

In re Reyna, No. 08-10049 (Bankr. W.D. Tex. 7/28/08), Memorandum Opinion and Order, pp. 8-9; In re Plourde, 397 B.R. 207 (Bankr. D. N.H. 2008)(if claim is not prima facie valid, valid objection is all that is necessary to put creditor to its proof).

If the claim is entitled to prima facie validity, the Debtor must introduce sufficient evidence to rebut the prima facie case. In order to rebut the prima facie validity of a claim, the objecting party must produce “evidence tending to defeat the claim that is of a probative force equal to that of the creditor’s proof of claim.” In re Simmons, 765 F.2d 547, 552 (5th Cir. 1985). Sometimes the claim itself may be sufficient to rebut its own prima facie validity. In the case of In re Bootka, No. 08-11506 (Bankr. W.D. Tex. 2/23/09), the attachment to the proof of claim stated that the debt had been charged off more than four years before the petition date. As a result, the debt appeared to be barred by the four year statute of limitations applicable in Texas. The creditor filed an affidavit from the prior owner of the claim stating that a payment had posted to the account on January 18, 2008. This was significant because a payment could revive the statute of limitations under Texas law. However, the Court found that the creditor failed to meet its burden of proof because it did not state who made the payment or when it was actually made (as opposed to when it was posted). As a result, the prima facie case was rebutted and the creditor failed to prove its case by a preponderance of the evidence.

Judicial Estoppel/Party Admission

Sometimes, the creditor can prove its case simply because the debtor has already admitted the validity of the claim. If the debtor has scheduled a claim which can be identified to the proof of claim in approximately the same amount and has identified the claim as undisputed, then the debtor will be estopped to deny the validity of the claim or will be deemed to have made a party admission. Of course, if the debtor has scheduled the claim as disputed or if there is a significant variation between the claim and the schedules, then judicial estoppel will not apply. The case of In re Cox, 2007 Bankr. LEXIS 4048 (Bankr. W.D. Tex. 2007) illustrates how far the judicial admission doctrine may extend. In that case, the debtor scheduled three claims owing to Chase Bank. As an illustration, one claim was scheduled in the amount of $20,312.83 with the last four digits 0445. B-Real, LLC filed a claim in the amount of $21,534.50 in the name of B-Real, LLC/Chase Bank USA, N.A. on a claim with the last four digits 0445. The claim (as amended) was supported by account statements from Chase Bank showing the amount owed. Although the identity of the creditor was different, the court still found that the debtor had made a party-admission that the debt was owed. See also In re Kendall, 380 B.R. 37 (Bankr. N.D. Okla. 2007)(if debtor has listed claim as not disputed in its schedules, this is some evidence of validity). On the other hand, where the identity of the creditor was different, the schedules and the claim included different portions of the sixteen digit account number and the claim amounts were different, the court refused to apply judicial estoppel. In re Reyna, No. 08-10049 (Bankr. W.D. Tex. 7/28/08).

Judicial estoppel will only apply as to the debtor. Several courts have refused to apply judicial estoppel to the chapter 13 trustee. In re Plourde, 397 B.R. 207 (Bankr. D.N.H. 2008); In re Bootka, No. 08-11506 (Bankr.W.D. Tex. 2/23/09). The opinion from the Western District of Texas is based on Fifth Circuit precedent requiring that parties be identical for judicial estoppel to apply. Kane v. National Union Fire Insurance Co., 535 F.3d 380 (5th Cir. 2008). This result seems to follow the logic of judicial estoppel the closest, since only the party making the admission should be estopped. An opinion by the 10th Circuit BAP held that the trustee would not be bound by the debtor’s admission in the schedules, but that the schedules provided some evidence in favor of allowing the claim. In re Kirkland, 379 B.R. 341, 344, n. 12 (10th Cir. BAP 2007).

Proof of Assignment

Courts have disagreed on the extent to which proof of assignment must be established. The most creditor-friendly courts note that Rule 3001 only requires proof of assignment where the original creditor has previously filed a proof of claim. In re Gonzales, 356 B.R. 905 (Bankr. S.D. Fla. 2006); In re Griffin, 2007 Bankr. LEXIS 1748 (Bankr. W.D. Tex. 2007). Where only one creditor files a claim with respect to a debt scheduled by the debtor, the creditor will not be required to show how the debt was assigned to it. These cases take the position that if the debtor owes the debt and only one party is claiming to own it, that the debtor should not escape payment based on failure of the specific creditor to establish how it came to own the account. On the other hand, some courts have required proof of assignment and have gone further and required that the assignment reflect the specific debt rather than merely a blanket assignment. In re Armstrong, 320 B.R. 97 (Bankr. N.D. Tex.2005); In re Leverett, 378 B.R. 793 (Bankr. E.D. Tex. 2007); In re Kendall, 380 B.R. 37 (Bankr. N.D. Okla. 2007). Finally, some courts require proof of assignment, but will accept a blanket assignment. In re Samson, 392 B.R. 724 (Bankr. N.D. Ohio 2008).

Other Objections

Assuming that the claim is supported by prima facie evidence, the debtor’s objection to the claim must fall within one of the grounds identified by 11 U.S.C. §502(b), including that a claim is not enforceable under applicable law. In re Kirkland, 379 B.R. 341 (10th Cir. BAP 2007). Thus, a debtor could not object to a claim on the basis that the creditor had failed to redact the debtor’s social security number as required by Bankr. Rule 9037. Cordier vs. Plains Commerce Bank, No. 08-2037 (Bankr. D.Ct. 3/26/09). While the creditor violated a procedural rule, this was not a statutory ground for denying the claim.

Failure to file a timely claim is a stated ground for objection under 11 U.S.C. §502(b)(9). However, what happens if the claims bar date runs while the case has been dismissed, but is later reinstated? A thoughtful opinion holds that due process requires that the court be allowed to set a new bar date in this instance. In re Gulley, No. 07-33271 (Bankr. N.D. Tex. 3/3/2009).

Conclusion

Courts are struggling with objections to assigned credit card debt. Courts generally agree that a mere account summary prepared by the assignee will not satisfy the requirement to attach the documents on which the claim is based. However, courts differ as to whether the underlying contract or the account statement must be produced. A series of account statements will show that the debtor used the card and establish the pattern of dealings between the parties. This may be enough to prove the existence of a contract. Creditors should look to the proof required by a state court. If a sworn account or account statements would be adequate in state court, it should be sufficient in bankruptcy court. The underlying contract should not be necessary to satisfy the prima facie validity requirement (although many courts have required it). However, if the debtor objects to items such as calculation of interest or fees, the creditor may be required to provide the agreement in order to satisfy its ultimate burden of proof.

Courts also differ on whether proof of an assignment should be provided. On the one hand, proof of assignment is an element in establishing that the creditor is the holder of the claim. However, where the debtor has admitted owing the underlying account and no other party has filed a claim, it may be reasonable to conclude that a valid assignment occurred. Some courts have noted that Fed.R.Bankr.P. 3001(e) only requires proof of assignment of a claim if another creditor has already filed a claim. This may be misleading. Rule 3001(e) is designed to settle disputes between an original creditor and a party claiming to be an assignee. Where the claim is assigned prior to bankruptcy or prior to a claim being filed by the original creditor, there is no need to resolve this dispute. Instead, the issue concerns the more fundamental question of whether the creditor holds the claim.

The process for determining allowance of an assigned credit card debt can be summarized as a decision tree.

1. Does the claim include sufficient documentation to receive prima facie validity?
If yes, debtor must rebut prima facie case before creditor must put on case.
If no, debtor need only raise a valid objection to require creditor to carry burden of proof.

2. If claim is prima facie valid, has debtor rebutted the prima facie case?
If yes, creditor must prove claim by preponderance of the evidence.
If no, claim is allowed.

3. Has debtor judicially admitted validity of claim?
If yes, claim is allowed (unless a party other than the debtor is objecting).
If no, creditor must prove claim by preponderance of the evidence.

4. Has creditor established valid assignment of claim?
If yes, claim is allowed assuming creditor has met other requirements.
If no, claim is denied unless debtor is judicially estopped from denying claim or in jurisdictions which do not require proof of assignment.

5. If neither party has prevailed at this point, who produced more credible evidence?
If creditor, then claim is allowed.
If debtor, then claim is denied.

This article originally appeared in the ABI Consumer Bankruptcy Committee Newsletter, Vol. 7, No. 2 (April 2009).

Sign Costs Creditor $21,800

Chuck Newton's blog, stayviolation.com, has the details on a case he recently tried in which a creditor posted a sign in a small town stating: "BRAD COLLIER OWES ME $984.23 WILL YOU PLEASE COME AND PAY ME!" The Court awarded $21,820.00 in damages for violation of the automatic stay. No. 08-2004, James Bradley Collier v. Paul Hill (Bankr. E.D. Tex. 4/7/09). Go to Posting Signs About the Debtor Can Constitute A Stay Violation on Chuck's Blog for all the details.

10th Circuit Affirms Denial of Employment of Attorneys Who Were Too Expensive

In these days of exponentially increasing hourly rates, a bankruptcy court told a creditors' committee that its proposed counsel was too expensive when there were local firms competent to do the work for half the cost. That decision was recently affirmed by the 10th Circuit Court of Appeals. In re Southwest Food Distributors, No. 08-5160 (10th Cir. 3/31/09).

The Debtor filed a chapter 11 petition in Tulsa, Oklahoma. The Unsecured Creditors Committee sought to employ Bell, Boyd & Lloyd, a Chicago firm, and to also employ Gable & Gotwals of Tulsa as its local counsel. Bell Boyd sought to charge rates ranging from $250 to $505 per hour. A large unsecured creditor objected on the basis that there was no need to bring in a national firm when there were local firms available at half the cost. The Bankruptcy Court agreed and approved employment of the local counsel only.

On appeal to the 10th Circuit, the Court of Appeals ruled that the Bankruptcy Court is not required to rubberstamp a party's choice of counsel even when that counsel meets the requirements of 11 U.S.C. Sec. 1103 and Fed.R.Bankr.P. 2014. The court noted that close scrutiny is required when more than one attorney is sought to be employed.

Several thoughts come to mind after reading this opinion. Many, if not most, courts require that out of district firms retain local counsel. If retaining both primary counsel and local counsel is looked upon with disfavor, this is almost a de facto rule that outside attorneys need not apply. Was the bankruptcy court engaging in protectionism here or was this simply a case which could not afford the extra attorneys? The bankruptcy court's decision to promote the committee's local counsel to lead counsel raises an interesting issue. If local counsel was chosen purely to satisfy the requirement to have a local attorney and not because they had the expertise to represent the committee, should the committee be saddled with counsel who was not their first choice? Of course, in this case, the court found that local counsel was perfectly competent and that no one had objected to their qualifications. Perhaps the committee should have selected less qualified local counsel in order to obtain their choice of lead counsel. Finally, the objection stated that qualified local attorneys could be hired at half the cost of Bell Boyd's rates of $250-$505. Does this mean that the going rate for creditors' counsel in Tulsa is $125.00-$252.50 per hour? If that is the case, the Tulsa bankruptcy bar may find itself in demand elsewhere where the going rates are much higher.

Leif Clark on Reaffirmations: Six Short Clark Opinions on Reaffirmation and What They Mean

Leif Clark is one of the most prolific judges on the bankruptcy bench today. His opinions are generally both scholarly and entertaining to read. However, one adjective which is not usually applied to his opinions is short. Therefore, it is worthy of note that in the past year, Judge Clark his written no fewer than six opinions denying approval of reaffirmation agreements and giving guidance to the parties with regard to the unreaffirmed debt, none of which is longer than three pages.

One line of cases involves Texas home equity loans. In re Brown, No. 08-53373-C (Bankr. W.D. Tex. 4/3/09); In re Porras, No. 07-31488-C (Bankr. W.D. Tex. 3/27/08). As noted by Judge Clark, reaffirmation of a home equity loan is a contradiction in terms, since the Texas Constitution requires home equity loans to be made on a nonrecourse basis.

The subject of the agreement is a home equity loan. Such loans are non-recourse loans, as a matter of Texas law. There is thus no personal liability on the part of the debtor to USAA Federal Savings Bank. USAA's remedies prior to this bankruptcy being filed were limited to recourse to the property in the event of nonpayment and failure to cure. The bankruptcy changed nothing with regard to the nature of this liability. The debtor's discharge has no impact at all on USAA's claim because discharge only affects the debtor's personal liability on a debt, and the debtor never had any personal liability on this debt, even outside bankruptcy. With nothing to discharge, there should be nothing to reaffirm either.

Yet USAA now wants a reaffirmation agreement from the debtor anyway. Why? To what end? Surely not because USAA fears that without such an agreement, its efforts to enforce this debt might contravene the discharge injunction. That is a red herring, if ever there was one. Enforcement of a nonrecourse debt never violates the discharge, as a matter of law.

In re Brown.

Several additional cases concern the situation where the debtors request approval of a reaffirmation but the court denies it for reasons including undue hardship, reconsideration by the debtors and untimeliness. In re Gamboa, No. 08-52028-C (Bankr. W.D. Tex. 1/7/09); In re Davidson, No. 08-51818-C (Bankr. W.D. Tex. 11/21/08); In re Self, No. 08-52687-C (Bankr. W.D. Tex. 11/21/08); In re Morales, No. 07-31453-C (Bankr. W.D. Tex. 3/27/08). In these cases, the Court denied the reaffirmation, but explained where this decision left the parties.

Notwithstanding such denial, the court finds and concludes that the creditor holds a valid and enforceable in rem claim. The creditor is accordingly expressly authorized and permitted to enforce the obligation of the debtors to the creditor as an in rem obligation, such enforcement to include the right to notify the debtor of payments that are or are to become due, the right to demand payment when such payments are not made (either in full or in part), the right to threaten resort to in rem remedies in the event of non-payment, the right to accelerate the indebtedness, the right to give notice of foreclosure sale, and the right to conduct and complete such foreclosure sale, so long as all of the foregoing are conducted in accordance with applicable non-bankruptcy law. None of the foregoing shall ever constitute a violation of the discharge injunction entered in this case pursuant to section 524(a) of title 11.

Further the creditor is authorized and permitted to communicate with the debtor regarding the status of the account, either orally or in writing, and the debtors are authorized and permitted to obtain information from the creditor, either orally or in writing, regarding the status of the account. The creditor is authorized and permitted to afford the debtors the same services with respect to this account as they would enjoy had there been no bankruptcy, including as applicable internet access to the account, the use of electronic funds transfers as a means of payment, the right to receive regular billing statements, and regular escrow updates. The provision of all such services shall never constitute a violation of the discharge injunction entered in this case pursuant to section 524(a) of title 11.

Further, the creditor is authorized and permitted to renegotiate the terms of the indebtedness with the debtors (provided that such renegotiated indebtedness shall remain as an in rem liability of the debtors), to provide payoff amounts for the purposes of any refinancing with a third party, or for purposes of a sale of the underlying property. The provision of any of the foregoing shall never constitute a violation of the discharge injunction entered in this case pursuant to section 524(a) of title 11.

In re Gamboa.

What is happening here? While these brief opinions may never find their way into the published case reports, they show the court taking an active interest in the welfare of the debtors appearing before it. Not all reaffirmation agreements should be approved. The Code prohibits the Bankruptcy Court from approving an agreement where it would constitute an undue hardship or it is not timely submitted. However, rather than simply denying the agreements and leaving the parties to figure out the consequences, Judge Clark has spelled out what it means to have an ongoing in rem obligation. While his missives may constitute advisory opinions, they are useful in that they may reassure lenders that it is okay to continue to communicate with their borrowers. More importantly, they undermine a lender's ability to retaliate against a debtor who has not reaffirmed a debt by freezing them out post-discharge.

This issue recently came up in one of my cases. A debtor had received his discharge some five years earlier. The lender changed servicers around the time of the discharge and no reaffirmation agreement was ever tendered to the debtors. The debtors continued to make their payments and ultimately refinanced the debt. When they sought to purchase a new property, the underwriters for the prospective lender could not understand how a debtor had continued to make payments on a discharged debt. As a result, they did not want to credit that payment history. I was able to provide an explanation of how bankruptcy works with a copy of the Gamboa opinion to show that I was not just making it up. Hopefully, the underwriters will read and comprehend the opinion.

When Is a Small Business Debtor Not a Small Business Debtor?

One of the changes that the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made to small business bankruptcy cases was to eliminate the ability to opt in to treatment as a small business debtor. However, it appears that the Bankruptcy Rules may have given back the option which Congress intended to take away.

Under the 1994 bankruptcy reform legislation, special provisions for small business debtors were created. However, debtors were given the option to elect whether to be considered as a small business debtor and few did. The National Bankruptcy Review Commission recommended that this option be removed, stating:

The Commission recommends that choice of treatment as a "small business" debtor under the Bankruptcy Code should not be optional. If as a policy matter, Congress decides that small business debtors merit special treatment under the Bankruptcy Code, all debtors who meet the definition of "small business" should be subject to the same special track. Otherwise, the separate track will not likely be used.

Report of the National Bankruptcy Review Commission, Sec. 2.5.1.

BAPCPA added a new definition of "small business debtor" to the Bankruptcy Code. Under Sec. 101(51D), a debtor was a small business debtor if: (i) it was a person engaged in commercial or business activities (ii) but not a person whose primary activity was the business of owning or operating real property (iii) that has aggregate noncontingent liquidated secured and unsecured debts as of the date of the petition or the date of the order for relief in an amount not more than $2,000,000 (which has been adjusted for inflation to $2,190,000) and (iv) for which a creditor's committee has not been appointed or is not sufficiently active and representative to provide effective oversight of the debtor. Under this definition a debtor either is or is not a small business debtor. There is no choice in the matter.

If a person is a small business debtor, it is subject to added scrutiny designed to weed out nonviable cases. 11 U.S.C. Sec. 1116. It is also subject to more flexible provisions for proposing and confirming a plan. A small business debtor has an exclusivity period of 180 days (as compared to just 100 days for a small business debtor under the prior law). 11 U.S.C. Sec. 1121(e)(1). However, the outside date for any party to file a plan is 300 days. 11 U.S.C. Sec. 1121(e)(2). The debtor is allowed to file a combined plan and disclosure statement and receive conditional approval of its disclosures, thus eliminating the need for a separate disclosure statement hearing. 11 U.S.C. Sec. 1125(f). However, the plan proponent must obtain confirmation of a plan within 45 days after filing. 11 U.S.C. Sec. 1129(e).

Thus, the small business debtor provisions offer a series of carrots and sticks which are intended to be mandatory. However, Fed.R.Bankr.P. 1020(a) brings the right to elect in through the back door. Under this Rule, "the debtor shall state in the petition whether the debtor is a small business debtor." The U.S. Trustee and creditors may object to this statement within 30 days after the conclusion of the creditors' meeting. However, "the status of the case with respect to whether it is a small business case shall be in accordance with the debtor's statement . . . unless and until the court enters an order finding that the debtor's statement is incorrect."

Thus, a debtor can make an election not to be treated as a small business debtor by checking the wrong box and hoping that no one objects. One of the reasons that Congress eliminated the small business election was the perceived apathy of creditors in these cases. However, the provision in the rules allows debtors to make an incorrect designation and count on creditor apathy to allow it to pass unnoticed.

However, the fact that the debtor has a de facto election does not mean that the debtor can change status at will. In the case of In re Save Our Springs (SOS) Alliance, Inc., 393 B.R. 452 (Bankr. W.D. Tex. 2008), a debtor designated itself as a small business debtor. The debtor was arguably not eligible to be a small business debtor because it was an environmental advocacy group, which likely would not fall within the definition of a person engaged in commercial or business activities. The debtor proposed a plan which was hotly contested. By the time that the court denied confirmation, the debtor was beyond its 300 day window for proposing a plan. The debtor then amended its petition to revoke its designation as a small business debtor. The court found that having received expedited treatment based on its designation as a small business debtor, the debtor was judicially estopped to say that it wasn't. As a result, the court dismissed the case.

However, an incorrect designation may be corrected. In a case where I am involved, the debtor's previous counsel failed to check the box to indicate small business status. The debtor then proposed a combined plan and disclosure statement within the 300 day window given to a small business debtor. When the court noted that the debtor had not designated itself as a small business debtor, I filed a motion to designate the debtor as a small business debtor which the court granted. The difference in my case was that the debtor had never tried to obtain a benefit from not being a small business debtor and indeed had acted as if it were one from the beginning of the case. (Of course, it probably also helped that the designation in my case really was incorrect).

Thus, the small business election lives on in a practical sense, but is subject to challenge.

Texas Chapter 11 Filings Double

Chapter 11 filings are a good indicator of how the economy is doing as well as the market for bankruptcy lawyers. If the latest filings are any indication, Texas bankruptcy lawyers are going to be very busy. In the first quarter of 2009, chapter 11 filings doubled over their level from the same time during 2008. During the first quarter of 2009, 259 cases were filed statewide compared to 129 the previous year. Over the first three quarters of 2008, filings fell within a lackluster range of 128 to 152 per quarter or about 50 cases per month. In the fourth quarter of 2008, filings jumped to 213 and then increased again in the first quarter of 2009.

When I have more time, I will look at the types of entities filing (i.e., real estate, health care, etc.) and the size of the filings (small business debtors to mega-cases).

Remembering Our Colleagues

Yesterday I heard that a bankruptcy lawyer I know had passed away. It turned out to be a case of mistaken identity, much to my relief. However, it got me thinking that we have lost several members of our bar in the past months and I wanted to take a moment to remember them. Please feel free to share your memories in the comments section as well as letting me know if I missed anyone.

Gray Byron Jolink: June 23, 2008

Gray was a dear friend and a colleague. For a complete article about Gray, go to In Memory of Gray Byron Jolink.

Garry Offerman: August 2, 2008

Garry Offerman was a witty, urbane bank lawyer from Beaumont. He was unfailingly gracious and offered us the use of his office when we were in Beaumont. He passed away in a motorcycle accident at the age of 52.

David Young: October 5, 2008

The intellectual light of the bankruptcy bar dimmed when David Young passed away on October 5, 2008. David was the ultimate law nerd, a former history professor who became an in-house academic for Austin's McGinnis, Lochridge & Kilgore. David had a graceful manner and a far-reaching intellect which made him the epitomy of a scholar and a gentleman.

Two anecdotes from his memorial service bear repeating.

One of David's law school professors told of how David completed a curve-busting exam which found and correctly addressed every issue the professor had thought of, as well as a few that he hadn't thought of. Later, David sheepishly admitted that he was unsure about the course, so that he had taken it pass-fail.

David's son recalled his dad laughing hysterically at a scene from the raunchy cartoon South Park. It seems that David had noticed an inscription in Latin over the doorway to the planetarium, which translated to "Beam Me Up Scotty." David was one of the few people who would have caught an inside joke in a dead language in an off-color cartoon.

John Ventura: October 28, 2008

John Ventura was a consumer bankruptcy attorney who practiced in Austin and in the Valley. However, he was best-known for his writing. John was the author of many how-to books on legal topics, including Good Advice for a Bad Economy (2002), Divorce for Dummies (2009) and The Credit Repair Handbook: Everything You Need to Know to Maintain, Rebuild and Protect Your Credit (2007). He was also the 2nd place winner in the 2008 Texas Bar Journal Short Story Fiction Contest. He was the executive director of the Texas Consumer Complaint Center at the University of Houston Law Center and was an associate professor at the school.

Michael C. Barrett: January 11, 2009

Michael Barrett founded and served as chairman of the powerhouse Barrett Burke law firm. He served on the Executive Advisory Board of Frost Bank Group and on the Executive Board of the Dedman School of Law at Southern Methodist University. He received Safari Club International records, including No. 2 elk in the world in January 2009. He was a philanthropist and supporter of veteran's causes.

Paul N. Buchanan: January 23, 2009

Paul Buchanan was a consumer bankruptcy attorney from Round Rock. He lost a painful battle with cancer this year.

Weldon Grisham: January 24, 2009

Weldon Grisham was a consumer bankruptcy attorney from Fort Worth. He passed away at the age of 62 after practicing bankruptcy law for over 20 years.

Bill Turman: March 6, 2009

Bill Turman was an attorney in Austin for over 40 years. He practiced with McGinnis, Lochridge & Kilgore and for many years with his own firm. He appeared in over 1,000 cases on behalf of individuals, financial institutions and taxing authorities.

They will be missed.

The Bankruptcy Reform Rube Goldberg Device

The Bankruptcy Code of 1978 was intended to simplify the law and make it more functional. In most respects, it worked beautifully. The same cannot be said for the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Badly drafted is one of the kinder adjectives applied to it. Now history seems poised to repeat itself. On March 5, 2009, the House passed H.R. 1106, the Helping Families Save Their Homes Act. While the bill’s purposes are laudatory, its drafting is tortured. This article will walk you through the bankruptcy-related provisions of the bill section by section. If you want to skip ahead to the good stuff, start with Section 103.

Section 100 Definition

The first thing that the bill does is introduce a definition of “qualified loan modification.” We later learn that this definition has almost nothing to do with modifying mortgages in bankruptcy and amounts to little more than legislative clutter. To further complicate things, the definition of a “qualified loan modification” is tied to “the guidelines of the Obama Administration’s Homeowner Affordability and Stability Plan as implemented March 4, 2009.” Thus, a definition in the Bankruptcy Code is tied to a non-legislative document. However, it does get President Obama’s name permanently added to the Bankruptcy Code.

Section 101 Eligibility for Relief

The next thing that the bill does is eliminate certain home mortgage debts from the chapter 13 debt limits. The bill eliminates any home mortgage or debt that was previously secured by a home which was foreclosed upon if the value of the home was less than the applicable debt limits. While this provision isn’t entirely clear, I think that it means that if a home mortgage is less than $1,010,650, that debt is not included in calculating eligibility for chapter 13, so that a debtor can have an additional $1,010,650 in secured debts and still file for chapter 13. This is an interesting idea, but what problem is it solving? If the problem is that some homeowners don’t qualify for chapter 13 because their home mortgages exceed $1,010,650, wouldn’t it be easier just to raise the debt limits?

Section 102 Prohibiting Claims Arising from Violations of the Truth in Lending Act

The third substantive bankruptcy provision of the bill allows a claim to be denied if the debtor could have rescinded the loan based upon a truth in lending violation. While this is certainly a good result, how does this add anything to Sec. 502(b)(1) which allows a claim to be denied because it is unenforceable against the debtor?

Sections 103 and 105 Authority to Modify Certain Mortgages

Finally, six pages into the bill, we get to the heart of the matter. Section 103 contains the major terms allowing modification of home mortgages in chapter 13. The section modifies Sec. 1322, which is the permissive list of provisions which may be included in a chapter 13 plan by adding four new subsections. The new subsections go on for nearly seven pages and contain a lot of material to digest. Additionally, Section 105 modifies section 1325, which contains the requirements for confirmation of a plan.

Eligibility

In order to be eligible for modification, proposed Sec. 1322(b)(11) states that a loan must be “originated before the effective date of this paragraph and secured by a security interest in the debtor’s principal residence that is the subject of a notice that a foreclosure may be commenced with respect to such loan.” This provision reflects two interesting policy choices. First, it only applies to loan originated before the effective date of the bill. Thus, no future mortgages will be subject to modification. If mortgage modification is a good idea, why limit it to only pre-existing mortgages? One possible answer is that the bill is intended to encourage lenders to make new loans, secure in the knowledge that they will not be subject to modification. However, since Congress can always modify the provision, it seems like this is a bit illusory. The other curious choice about eligibility is that a mortgage must be the subject of a foreclosure notice before it can be modified in a bankruptcy. Thus, if a debtor has been keeping his mortgage current by borrowing against credit cards or from relatives and reaches the point where he can’t go on, he would not immediately be able to file chapter 13 and restructure the mortgage. On the other hand, a debtor who stopped paying his mortgage to finance a trip to Las Vegas would be able to secure a modification. It seems like a questionable decision to deny relief to someone who has made an honest effort to pay his debts, while granting it to his more profligate neighbor.

To make things more complicated, there is a second eligibility provision a few pages later in proposed Sec. 1322(h). For a case commenced more than 30 days after the effective date of the bill, the debtor must certify that that he contacted his lender and provided it with documentation equivalent to Schedules I and J and then “considered any qualified loan modification offered to the debtor by the holder of the claim.” Of course, all the debtor has to do is “consider” the offer so it doesn’t offer much protection to the lender. In the alternative, the debtor may certify that the property was subject to a foreclosure sale scheduled to be held within 30 days. Since the property already has to be subject to a foreclosure notice (as contrasted with a scheduled foreclosure sale) in order to be eligible under the first eligibility section, it is unlikely that the requirement to ask the lender for a pre-foreclosure modification contains any teeth. However, with regard to a case already pending, before the debtor may submit a plan proposing to modify a loan or propose to modify an existing plan to modify a loan, the debtor must certify that he “attempted to contact the holder of such claim (or the entity collecting payments on behalf of such holder) regarding modification of the loan that is the subject of such claim.” This requirement is pretty toothless as well, since all the debtor need do is certify that he attempted to contact the lender regarding modification. Thus, a debtor could certify that one hour prior to filing his motion to modify, he sent the lender an email requesting that the loan be modified to eliminate the requirement to make payments. That would comply with the technical language of the statute.

Why place the eligibility provisions in two different places? Cue up Avril Lavigne singing “Why do you have to make things so complicated?”

If a debtor is eligible, he can choose from the following menu of modifications:

Valuation

First, she can provide for payment of the secured claim as provided by Sec. 506(a)(1), that is, write the mortgage down to the value of the property. However, we learn in subsequent section 1322(i) that valuation under Sec. 506(a)(1) “shall be the fair market value of such residence on the date such value is determined and, if the issue of value is contested, the court shall determine such value in accordance with the appraisal rules used by the Federal Housing Administration.” Thus, we are using Sec. 506(a)(1) for valuation, but this section shall have a special meaning applicable only to valuing home mortgages.

If the property is sold during the life of the plan, the debtor must share any gain with the lender based upon a sliding scale. If the property is sold in the first year of the plan, then the lender receives 90% of the difference between the sales price (after subtracting cost of sale and the value of improvements made) and the amount of the secured claim as determined under Sec. 506(a)(1). By year 5, the lender’s share of the gain is limited to 10% of the excess.

Interest Rates

Second, a debtor may convert an adjustable rate loan into a fixed rate loan or make adjustments to the manner in which the adjustable rate is calculated. Additionally, another provision allows the debtor to adjust the interest rate to a fixed rate based on the “currently applicable average prime rate offer as of the date of the order for relief under this chapter corresponding to the repayment term determined under the preceding paragraph as published by the Federal Financial Institutions Examination Council in its table entitled ‘Average Prime Offer Rates—Fixed’ plus a reasonable premium for risk.” Why have two different sub-parts dealing with setting the interest rate, especially when the provision allowing tinkering with adjustable rates is completely unnecessary in light of the later provision allowing a fixed rate. By tying the interest rate to a rate announced in a specific table of a specific publication, Congress runs the risk that it will have to amend the bill if the publication ever goes away or is changed. For example, what happens if the Federal Financial Examination Council changes its name to the Federal Lending Institution Council? Is there still an applicable rate? Further, the use of a specified rate is undercut somewhat by allowing the addition of a “reasonable” risk premium. Wouldn’t it just be easier to use the Till standard for interest rates?

There is also a provision stating that on request of the debtor or a senior secured creditor, the court can confirm a plan which reduces the interest rate but does not reduce the principal amount of the debt “provided the total monthly mortgage payment is reduced to a percentage of the debtor’s income in accordance with the guidelines of the Obama Administration’s Homeowner Affordability and Stability Plan as implemented March 4, 2009 if, taking into account the debtor’s financial situation, after allowance of expenses that would be permitted for a debtor under this chapter subject to paragraph (3) of subsection 9b), regardless of whether the debtor is otherwise subject to such paragraph, and taking into account additional debts and fees that are to be paid in this chapter and thereafter, the debtor would be able to prevent foreclosure and pay a fully amortizing 3-year loan at such reduced interest rate without such reduction in principal.” Wouldn’t it just have been easier to say that a debtor cannot reduce principal if a reduction in the interest rate would be enough to grant relief to the debtor?

Reamortization

Third, the debtor may reamortize the loan to provide for a term not to exceed 40 years from its origination.

Trustee Payments

Proposed Sec. 1322(b)(11)(D) allows for a modified mortgage to be paid either directly to the lender or through the Chapter 13 trustee. If payments are made directly through the standing trustee, the trustee’s commission on the mortgage payments will be reduced to 4% or may be waived altogether if the debtor’s income is less than 150% of the poverty threshold.

Good Faith

Proposed Sec. 1325(a)(11) imposes a special good faith requirement applicable only to mortgage modifications in chapter 13. In order to confirm a plan providing for modification of a mortgage, the court must find that “such modification is in good faith.” Of course, Sec. 1325(a)(3) already requires that the entire plan be proposed in good faith, so that this requirement must require really good faith. The statute proceeds to tell us what really good faith is and is not. It is not good faith if the debtor proposes to modify a mortgage which he could afford to pay without modification. Additionally, in deciding whether the debtor acted in good faith “the court shall consider whether the holder of such claim (or the entity collecting payments on behalf of such holder) has offered to the debtor a qualified loan modification that would enable the debtor to pay such debts and such loan without reducing such principal amount.” Also, the court must find that “the debtor has not been convicted of obtaining by actual fraud the extension, renewal or refinancing of credit that gives rise to a modified claim.”

The new requirements for good faith modifications raise several issues. Good faith is a term which is not defined anywhere in the Code, but has an established meaning. By adding a definition here, is Congress intending to define good faith elsewhere in the Code or is this a special subset of good faith applicable only to this subsection? Considering whether the debtor rejected a reasonable proposal from the lender and whether the debtor needs to modify the loan in order to be able to pay his debts both make good sense. However, what to make of the provision that the debtor is not acting in good faith if he has been convicted of fraud with respect to the loan? Do we really need to put this in a statute or isn’t it obvious? Further, by providing that the debtor acted in bad faith if he was convicted of fraud, it suggests that it would not be bad faith if the debtor acted fraudulently but was never prosecuted or even was indicted but hadn’t been convicted yet.

Section 104 Combating Excessive Fees

Wedged inbetween sections 103 and 105, which contain the mortgage modification provisions, is section 104 which establishes a new procedure for establishing the reasonableness of post-petition fees and charges assessed to a debtor. Under this section, the debtor, the debtor’s property and the property of the estate are not liable for a fee, cost or charge incurred while the case is pending unless (i) the creditor serves a notice of the charges on the debtor, debtor’s attorney and chapter 13 trustee not later than one year after the charges are incurred or less than 60 days before the case is closed, (ii) the charges are law, reasonable and authorized by the applicable security agreement; and (iii) secured by property worth more than the amount of the claim. Failure to follow the procedure would result in waiver of the charge and any attempt to collect the charge would subject to the lender to liability for violation of the automatic stay or discharge. The section also provides for waiver of prepayment penalties on claims secured by the debtor’s principal residence.

Section 108 Effective Date

The statute would take effect upon enactment and would apply to cases filed before, on or after that date. As a result, debtors with pending cases could go back and modify their plans under this legislation.

What Are The Lessons Here?

What can we learn from this confusing bill? A few lessons for drafting emerge.

1. Don’t add unnecessary definitions to Sec. 101of the Bankruptcy Code. It is too long and confusing as it is.

2. Don’t tie definitions in Title 11 to executive branch documents. While H.R. 1106 does this with the Obama Administration’s Homeowner Affordability and Stability Plan and the Federal Financial Institutions Examination Council’s table entitled “Average Primate Offer Rates—Fixed,” BAPCPA made the same mistake when it incorporated the IRS collection standards. There are two problems here, one practical and one substantive. The practical problem is that tying legislation to outside sources requires the reader to consult another document in order to understand the legislation. The substantive problem is that the legislative branch is effectively allowing the executive branch to define the content of a statute. This raises important separation of powers issues.

3. Don’t rely on a complicated solution when a simple one will do because there may be unintended consequences. In Sec. 101, the bill excludes home mortgages from the chapter 13 eligibility limits. This means that a debtor could file chapter 13 even though he had a million dollar home and a million dollar vacation home. While that may benefit AIG executives who may face financial hardship from not receiving large bonuses anymore, it doesn’t really help the average homeowner.

4. Don’t add feel-good grounds for objecting to claims in Sec. 502(b) if they aren’t necessary. One of the reasons that the Bankruptcy Code is beginning to resemble the Internal Revenue Code (or the Los Angeles phone book) is that Congress keeps adding minutiae to existing statutes. BAPCPA did this to Sec. 362 and 523. Adding a definition of good faith applicable only to home mortgage modifications is confusing and could change the meaning of the term in other situations as well. Stating that value will be determined according to Sec. 506(a)(1) and then setting specific rules for determining value under that section is confusing and contradictory.

5. Keep similar provisions together. HR 1106 tosses rules for eligibility for mortgage modification and determining interest rates around randomly, requiring the reader to go to multiple locations to figure out how the statute works.

6. Don’t come up with a complicated solution when a simple one is available. The Supreme Court provided a standard for calculating interest rates in bankruptcy which was elegant in its simplicity. Rather than using the existing concept, HR 1106 requires the reader to look up a table published somewhere else and then requires the court to apply a “reasonable” risk premium. Why not just use the prime rate plus an appropriate risk premium. The effort to incorporate the Obama Administration’s Homeowner Affordability and Stability Plan is confusing at best. This Plan factors into the legislation in at least three places. First, it applies in determining eligibility for mortgage modification depending upon whether the lender made a proposal in compliance with the Obama Administration’s Plan and whether the debtor “considered” it. If all the debtor has to do is “consider” a proposal from the lender, wouldn’t it be easier to just say that the debtor has to consider any proposal offered by the lender in good faith? Second, the Obama Plan comes into play in determining whether the debtor’s proposal is made in good faith. Wouldn’t it be easier to just say that the debtor can’t modify the mortgage if the debtor rejected a plan which was at least as generous as the debtor could have obtained in bankruptcy? Finally, the Obama Plan is used in deciding whether the debtor should be allowed to propose a plan which reduces the interest rate but doesn’t reduce principal. Wouldn’t it be easier just to say that the debtor cannot reduce principal if an interest rate reduction would be enough to make the plan work?

7. Don’t include meaningless requirements. Requiring the debtor to “consider” an offer from the lender doesn’t impose a meaningful restriction, since the debtor is free to consider the proposal and then reject it. Similarly, does it really help to say that a debtor who has been convicted of fraud in connection with a loan is not acting in good faith? This will exclude very few debtors while potentially protecting fraudulent actors who managed to avoid a criminal conviction. Thus, the “restriction” lets in more people than it keeps out.

I haven’t had a chance to review the Senate Bill yet. However, if it is as quirky and complex as the House bill, the likelihood that a conference committee could sort out the difficulties or that the resulting product would make any sense are not cause for optimism.

Exemption Cases Take a Campy Turn

When Bankruptcy Judge Craig Gargotta decided In re Camp, 396 B.R. 194 (Bankr. W.D. Tex. 2008), he staked out a unique position on how exemption laws should be applied when Sec. 522(b)(3)(A) requires application of the law of another state. Judge Gargotta concluded that Sec. 522(b)(3)(A) was a choice of law provision so that the law chosen should be applied to the debtor as though the state where he currently resided was the state whose law was being applied. As a result, Judge Gargotta concluded that where a Florida resident living in Florida would be prevented from using the federal exemption scheme that a Texas resident subject to Florida law could not claim federal exemptions either. In reaching this decision, Judge Gargotta disagreed with In re Battle, 366 B.R. 635 (Bankr. W.D. Tex. 2006), a decision by his Western District colleague Judge Leif Clark. Indeed, Judge Gargotta's analysis appeared to be unique to him. Now two additional courts have considered the Camp analysis, reaching differing results.

Camp Followed

The Camp choice of law approach has now been applied by a second judge. In re Morgan C. Smith, No. 07-20614 (Bankr. S.D. Tex. 3/12/09) is a decision by Judge Richard Schmidt which applies Louisiana law to a Texas resident. The Debtors lived in Louisiana from 1991 to 2007. During that time, his parents conveyed 245 acres in San Patricio County to the debtor and his siblings. After the property was partitioned, the Debtor received 81.79 acres solely in his name. Later in 2007, the Debtors filed under Chapter 12 and claimed Texas exemptions. Under these facts, the exemption allowed to the Debtor would be:

Unlimited as to 81.79 acres if Texas law applied;
Limited to $40,400 if federal exemptions could be claimed; or
Limited to $25,000 if Louisiana law applied.

The Court concluded that because the Debtors had only been domiciled in Texas for 230 days prior to filing that Texas law did not apply.

The Court then concluded that under the Camp decision, because Louisiana law did not allow debtors to choose federal exemptions, that this choice was not available either.

As a result, the Court found that Louisiana law was the only choice available for the Debtors and limited the exemption to $25,000. The Louisiana statute did not specify that only land in Louisiana could be claimed as homestead. However, if the Court followed the Camp opinion to its logical conclusion, the Debtor would be able to claim the full Louisiana exemption on a Texas property for the reason that the Court would be required to apply the law as if the Texas property were really in Louisiana.

Camp Rejected

While Smith followed Camp to allow extra-terratorial application of the Louisiana law, the 10th Circuit BAP rejected Camp but still allowed extra-terratorial application of the Iowas homestead law. In In re Stephens, 2009 Bankr. LEXIS 305 (10th Cir. BAP 3/9/09), a debtor sold his Iowa homestead and moved to Oklahoma. Iowa law allowed an exemption in proceeds of a homestead sale for a "reasonable" time. The Court rejected the Camp choice of law analysis, which would have held that restrictions on applying Iowa law to property outside of Iowa were preempted. However, the court reached the same result by concluding that nothing in the Iowa law prevented it from being applied to homestead proceeds taken to another state. As a result, the Court concluded that Iowa could have chosen to prevent its homestead exemption from being applied to property located in another state, but had not done so.

I have one final comment after reading these cases: Does your head hurt yet? Mine does.