Ethics, Empiricists and International Insolvency at NCBJ

Saturday was the final day of the National Conference of Bankruptcy Judges.   The panels focused on ethics issues of the future, the role of empirical research and international insolvency.

Ethics

The first topic up on the ethics panel was reasonable investigation.    The hypothetical involved a lawyer who was unwittingly asked to facilitate money laundering and purchase of estate assets with hidden assets.   Recent cases to be aware of include In re Soare, 493 B.R. 158 (Bankr. D. Nev. 2013)(attorney who failed to investigate whether judgment was nondischargeable and then refused to represent debtor in nondischargeability action required to disgorge fees) and  In re Goodman, No. 12-1643 (9^th Cir. BAP 9/5/13)(sanctions against attorney for negligent representation affirmed)(unpublished opinion can be found here).   

We  learned that ABA opinion 465 says that there is not a per se prohibition on attorneys offering groupons.    (That doesn’t mean it’s a good idea, though).   

The Ethics 20/20 Commission is working on guidelines that would allow foreign lawyers to appear in U.S. proceedings on a pro hac vice basis.   However, a U.S. lawyer must reserve the absolute right to advice on American law.

Hunter v. Virginia State Bar, 744 S.E.2d 611 (Va. 2013) is an interesting case on the intersection between blogging and State Bar advertising requirements.   Hunter published a blog titled “This Week in Richmond Criminal Defense,” which was accessible from his firm’s website.    The overwhelming majority of posts were about cases in which he obtained favorable results for his clients.   The blog did not contain any disclaimers.   The Virginia Supreme Court found that Hunter’s blog constituted commercial speech subject to regulation by the Bar.    The Court found that the Bar could require Hunter to place disclaimers on his posts about his own cases to the effect that the results in the given case did not guarantee the same results for other people.    However, it found that the First Amendment allowed Hunter to discuss public details of his cases without the client’s permission.   A dissent would have found that the First Amendment prevented the Bar from regulating the blog.    

Muniz v. United Parcel Service, 2011 U.S. Dist. LEXIS 11219 (N.D. Cal. 2011) dealt with whether the defendant could subpoena the plaintiff’s lawyer’s postings to a listserv.    The Court quashed the subpoena.   The case illustrates the danger of revealing work product by posting on a listserv.

Empirical Research

The panel on empirical research features three academics:   Dean J. Richard Leonard of Campbell University School of Law, Prof. Theodore Eisenberg of Cornell Law School and Prof. Melissa Jacoby of UNC School of Law.   

Until recently, Dean Leonard was a bankruptcy judge.   He said that when he took the bench, he asked what he should read and was referred to Warren and Westbook’s empirical book, As We Forgive Our Debtors.   He pointed out that empirical studies published by just one law review, the American Bankruptcy Law Review, were cited in 32 opinions ranging from trial courts to the Supreme Court.   

Prof. Eisenberg said that empirical research can be used to disprove the conventional wisdom about bankruptcy.   He referred to the view that the American bankruptcy system is too pro-debtor and noted that the concept of a Debtor-in-Possession is shocking to other countries.   He pointed to empirical studies showing that U.S. reorganization cases paid 20% more to unsecured creditors than those in other countries.   Of twelve studies looking at payouts to unsecured creditors in different countries, the top five payouts were in American bankruptcies.   His conclusion was that the combination of the absolute priority and the Debtor-in-Possession led management to propose a higher dividend to unsecured creditors than plans in other countries.  

He also talked about the importance of studying fees.   He said, “From the day you graduate, (fees) will control your life.”    He said that big fees made news while small ones did not.   In this regard, he said that newspapers were just doing their jobs.   However, he said that the headlines did not reflect reality.  In smaller cases, the fees awarded average 17.6-21.6% of the assets of the debtor.  However, when the assets involved exceeded $100 million, the fees averaged 1-2% of assets.   He contended that fees charged by other professionals, such as investment bankers, charged more in fees.   

In an interesting study, courts denied requested fees at the following rates:

Delaware             0.74%

New York            4.50%

Everyone else      2.29%

While I did not catch his conclusion, mine would be that you can’t assume that judges in Delaware and New York always march in lockstep. 

Prof. Jacoby expressed the concern that empirical studies were too reactive.   She said that there were numerous studies framed in response to concerns that debtors were getting too much relief in bankruptcy.   She said that this approach was a limiting factor on the questions that academics ask and that academics should be more proactive in asking questions that others were not raising. 

Two random points that she made were that academics need more theory in empirical research and that empirical research meant observation and that academics should take the time to observe bankruptcy courts at work.

Prof. Eisenberg got on a soapbox about parties making unsubstantiated claims about the legal system.  He said:

You shouldn’t be able to stand in front of an audience and make nonsensical claims (with statistics).   The Chamber of Commerce does it every day.  

 He went on to say that we study areas that we care about, such as economic statistics.   He said:

You couldn’t say that the inflation rate is 20% (and get away with it).  However, you could say that plaintiffs are recovering multimillion dollar verdicts because of crazy juries. 

The learned professors also made two seemingly contradictory statements.   On the one hand, they stated that there is a lot of shoddy empirical research out there and that empirical studies should not be blindly accepted.   On the other hand, they said that the appeal of empirical research was the “ability of completely untrained people to get into it.”   I think that the point here was that anyone can pick a facet of the legal system to observe, but that it is helpful to partner with statistics geeks to help tell you the significance of what you observed.   (TBLB:  My words, not theirs).

International Insolvency:  The Good, the Bad and the Ugly

The international insolvency panel largely focused on three cases:  In re Lehman Brothers Holdings, Inc., No. 08-13555 (Bankr. S.D. N.Y.) (the good), In re Nortel Networks, Inc., No. 09-10138 (Bankr. D. Del.) (the bad) and Ad Hoc Group of Vitro Noteholders v. Vitro, SAB de CV (In re Vitro, SAB de CV), 701 F.3d 1031 (5^th Cir. 2012) (the ugly).   (The Clint Eastwood reference came from panelist Bruce Leonard).    The panelists were Judge James Peck from the Southern District of New York, Marc Adams of Wilkie Farr, Andrew Leblanc from Milbank Tweed and Bruce Leonard from the Ontario office of Cassels Brock.    In some cases, my notes do not indicate who said what so I will have to attribute comments generically to the panel. 

Before getting into the cases, Judge Peck provided an introduction to chapter 15.   Judge Peck noted that according to section 1501, the purpose of chapter 15 is to “incorporate the Model Law on Cross-Border Insolvency so as to provide effective mechanisms for dealing with cases of cross-border insolvency with the objectives of” increasing cooperation between courts of the United States and other countries.    However, as illustrated by the cases that followed, there are factors that get in the way of those purposes.

According to Mr. Abrams, chapter 15 is “the exclusive portal through which foreign representatives can seek assistance of the U.S. bankruptcy courts.”   Chapter 15 allows an American court to recognize and enforce orders and decrees from foreign courts.   It is not a reorganization chapter like chapter 11, but merely allows American courts to assist foreign courts with regard to assets of foreign entities in the United States.

Under Chapter 15, a foreign representative may seek recognition of a proceeding in another country as either a foreign main proceeding (Main Proceeding) or a foreign non-main proceeding (Non-Main Proceeding).    A Main Proceeding is one that is filed in the company’s center of main interest (COMI).    A Non-Main Proceeding is one filed anywhere else that the company has non-transitory economic activity.  A proceeding filed somewhere that is neither a COMI or has non-transitory economic activity is not entitled to recognition.    

Unlike the U.S. venue laws, the COMI determination pays little attention to the company’s domicile or state of incorporation.   Instead, it is more of a nerve center test.   While this may seem clear, Judge Peck commented that “what is written down is not necessarily clear until the circuit court tells you it is clear.”    In the recent case of Morning Mist Holdings Ltd. v. Krys (In re Fairfield Sentry Ltd.), 714 F.3d 127 (2d Cir. 2013), the Second Circuit held that COMI is determined as of the date of filing of the chapter 15 petition, so that activities of the foreign representative prior to the filing of the chapter 15 can change what would have otherwise been the COMI.  

   

The importance of being a Main Proceeding vs. a Non-Main Proceeding turns on sections 1520 and 1521.   Under section 1520, a Main Proceeding (which is a proceeding filed in the COMI) is entitled to automatic relief, including enforcement of the automatic stay and sales free and clear of liens for assets in the USA.    Under section 1521, there are various forms of discretionary relief that can be granted to either a Main Proceeding or a Non-Main Proceeding.

The panelists stated that Lehman Brothers and Nortel Networks shared many similarities.   Both were large entities with multi-national operations that took a major hit after the freeze of the credit markets in September 2008.   Nortel filed in September 2008, while Lehman Brothers held on until January 2009.   (TBLB:  The role of the U.S. government in orchestrating the filing of Lehman Brothers is well documented in the movie Too Big to Fail in which a committee of top economic advisors decides that Lehman Brothers should go ahead and file chapter 11 at which point someone asks whether the company should be informed).

In the Nortel case, the business operated in 140 countries through a series of five business lines as opposed to operating through subsidiaries.   It filed proceedings in the United States, Canada and the U.K.    The U.S. claimed priority based on the location of the assets, Canada claimed priority based on the company’s headquarters and the U.K. claimed dibs based on the location of the intellectual property.   The United States and Canadian proceedings recognized each other as contemplated by UNCITRAL.   The U.S. also recognized the U.K. proceeding as a Non-Main Proceeding.   However, the Canadian and U.K. administrators did not seek recognition of each other’s proceedings.  

Based on the view that the company’s assets were melting ice cubes, the three administrators quickly agreed upon a sale of the company’s assets for $7 billion.   However, four years later, the funds continue to sit in escrow because the parties could not agree upon a formula for allocating the sales proceeds.   After three failed mediations, a trial has been scheduled for 2014 with at least four competing formulas for distribution.   

Mr. Abrams commented that the Model Law was not well equipped to deal with the situation where there were three competing COMIs.

Judge Peck stated:

It is hard to design a law that gets to good results.   People have to get to good results.

The panel’s consensus was that because the Nortel assets were sold prior to obtaining an agreement for distribution of the proceeds that the parties lacked sufficient incentives to cooperate once the money was in the lockbox.   

According to Judge Peck, in Lehman Brothers, on the other hand, the assets were “not easily monetized” and “had to be cultivated.”   The only way to unlock the value was through a consensual plan, as opposed to Nortel where the creditors were in gridlock.    In Lehman Brothers, the parties negotiated a protocol for international cooperation and “based on the excuse given by the protocol, people talked to each other and developed a plan.” 

Vitro was a large Mexican glassmaker with U.S. debt.    It obtained approval of a concurso in Mexico and sought recognition in the United States.   In Mexico, all creditors vote together in a single class, including insiders and intercompany claims.   Furthermore, approval of a concurso constitutes a novation which releases all guarantors.   Finally, because a focus of the Mexican law is preserving jobs, a concurso must have the approval of equity.    

When Vitro sought recognition in the U.S., Judge Hale said no based primarily on section 1506, which states that relief need not be granted if it would be “manifestly contrary to the public policy of the United States.”     I have previously written about Judge Hale’s decision here.   The Fifth Circuit affirmed Judge Hale, but on different grounds.   You can find the Fifth Circuit opinion here.   The Fifth Circuit ruled that the granting of non-debtor releases is an issue that has divided the circuit courts.   Because federal courts do not agree upon this issue, allowing non-debtor releases could not be “manifestly contrary.”   Instead, the Fifth Circuit held that:

On the basis of the foregoing analysis, we hold that Vitro has not met its burden of showing that the relief requested under the Plan—a non-consensual discharge of non-debtor guarantors—is substantially in accordance with the circumstances that would warrant such relief in the United States. In so holding, we stress the deferential standard under which we review the bankruptcy court’s determination. It is not our role to determine whether the above-summarized evidence would lead us to the same conclusion. Our only task is to determine whether the bankruptcy court’s decision was reasonable.

Opinion, p. 58.  

The panel was critical of this opinion, asking whether it meant that the United States would be exporting its laws to other countries.    Judge Peck stated:

Recognition was intended to be a presumption to facilitate the reorganization goals of other jurisdictions.   Vitro seems to have changed that model.  

Mr. Abrams argued that:

The panel put blinders on when applying a plain meaning approach.

Abrams also said that he thought Judge Hale had the right approach in examining whether the result was manifestly contrary to the public policy of the United States, even though he did not agree with the Judge’s conclusion.  

 

The panel noted that the Fourth Circuit has opined that Courts should avoid reaching the section 1506 issue to avoid retaliation.   Judge Peck stated that:

I defer to a court that is at least civilized.

He gave the example of a case decided by a local court in India that he had deferred to.   

In the Fairfield Sentry case, the Second Circuit was asked to address the “manifestly contrary” issue in the context of a foreign proceeding in which the records had been sealed.   It held that open records were not a matter of such importance to US policy as to negate recognition.

Mr. Abrams concluded with the remark that

It is not time to trigger an Amber Alert for Chapter 15 and international cooperation yet.

Parting Thoughts:

This is a very good conference.   However, when I attend, I am usually pulling down long days and am mainlining coffee to stay awake.   I can’t help but notice that some very smart people are not very dynamic speakers.    If you are speaking at a conference as prestigious as the National Conference of Bankruptcy Judges, is it not too much to ask that you look up from your notes and speak loudly enough to be heard.    If you sound bored with your own presentation, you are probably putting your audience to sleep.   I would also like to put in a word for more diversity in program formats.     Four people on a one hour panel who don’t interact with each other is nothing more than a series of short monologues.   While brevity is much to be desired, fifteen minutes or less is not enough time to tell me something I don’t already know.   When it comes to putting together a panel, quality of content is to be desired over quantity of talking heads.    If you are going to put multiple people up there, make them interact with each other and preferably disagree on some things.   In the words of Robin Williams, “If you are going to go into the jungle, clash.”  The student loan debate was a good example of how to keep things lively.

Blogging, Economics and Bankruptcy Reform Commission at NCBJ

This is continuing coverage of the 2013 National Conference of Bankruptcy Judges.   Today I was able to attend a program on blogging, listen to an economist prognosticating and observe a hearing of the ABI Commission to Study the Reform of Chapter 11.

Blogging

Judge Robert Kessel (Bankr. D. Minn.), Judge Bruce Harwood (Bankr. D. N.H.), Bob Lawless (of Credit Slips) and Debra Dandenau (of Weil Bankruptcy Blog) presented an informative panel on blogging.   Including this panel at NCBJ (with two judges participating) is evidence that blogs have come a long way in terms of respectability.     It also underscores the point that judges read bankruptcy blogs.

Blogs are part of the larger group of content classified as “electronic social media,” which puts them in the same category as Facebook and Twitter.    The term blog is a contraction of web log and refers to the origin of blogs as personal journals published on the internet.    The blogs on the internet are distinguished from the same term used to describe a strong drink of indiscriminate content used by science fiction writers.   (I would not have known this if it wasn’t for Judge Harwood).

Debra Dandenau is an editor of the Weil Bankruptcy Blog (WBB), which can be found here.    In order to distinguish themselves from other blogs, they made the decision to publish daily.   This is possible when you have an army of minions (associates) jumping at the chance to be published.   The Weil authors publish an average of once a month which must mean that they have at least twenty authors contributing.    The firm uses the blog as a marketing tool which means that the Weil name is on every page.   

Prof. Bob Lawless is a contributor to Credit Slips, which can be found here.   Credit Slips is also a group effort.   It began as a way for a diverse group of academics working on a major research project to maintain contact with each other.  

The two blogs have contrasting approaches to their corporate identity.   At WBB, editors who are partners review the content to ensure quality and make sure that the blog represents the firm.    Associates are required to send an email around to all of the partners in the department to make sure that the blog does not take a position contrary to client interests.   In contrast, each of the Credit Slips bloggers are solely responsible for their own content and they do not attempt to do message control.   This blog, on the other hand, is purely a solo effort.   While I have been approached by strangers offering to do guest posts, I would not be comfortable accepting content from someone I did not know well.  

WBB tries to engage its readers through devices such as surveys and humor.   Their October 31 posting was on the Ghost of Anna Nicole.   

Writing a blog raises legal and practical issues.   As explained by Dandenau, authors strive to provide more insight than can be gained from simply reading the cases, but are careful not to betray client confidences or work product.   As a result, the firm rarely writes about ongoing cases in which it is involved.   (A practice that I follow as well).   Prof. Lawless noted that it was important to make disclosure when writing about a case that the author has an interest in.  

Another important decision to make is how much of an editorial voice to use.   Ms. Dandenau stated that they never criticize bankruptcy judges, although they may occasionally point out an issue that presumably was not brought up by the parties.    The blog is somewhat more willing to take a position on appellate decisions.  

There are also judicial bloggers, including Hercules and the Umpire (found here) and the Becker Posner blog (found here).   According to ABA FormalOpinion 462, judges can participate in electronic social media, but must “avoid any conduct that would undermine the judge’s independence, integrity, or impartiality, or create an appearance of impropriety.”    Thus, a judge could get in trouble for making comments on a blog or other social media that reflected favorably or poorly on an attorney appearing before her.  

According to Prof. Lawless, the benefits of writing a blog include:

• Getting your name out
• Showcasing your expertise
• Networking with the media
• Staying current on the issues
• Engaging with the community that reads your blog
• One way to engage with the community is through the comments section of the blog.   

WBB make a conscious decision not to allow comments, while Credit Slips allows unmoderated comments (although they have software to screen out spam).   Prof. Lawless said that one recent commenter who took him to task succeeded in changing his mind.   On the other hand, nasty comments may come back to bite the commenter.   Recently, an irate reader of Scotusblog posted a comment that read  “go f***yourself and die.”   Scotusblog tracked down the anonymous commenter though his IP address and outed him to their list of 174,000 twitter followers.    I moderate comments because I haven’t figured out a better way to block spam, but also because I get the occasional hateful comment about a judge, lawyer or party.

Judge Harwood said that he reads bankruptcy blogs because they are updated frequently, have focused content and have hyperlinks to useful material.   He compared blogs to law reviews with the analogy that blogs are business casual while law review articles are black tie.   Law reviews get dressed up but don’t go out very often.  

Judge Hannah Blumenstiel (Bankr. N.D. Cal.) stated that she uses blogs as a shortcut to do legal research.   She said that they did not violate the prohibition against a judge consulting outside sources because they were used to find the law rather than the facts.

The most popular blogs read by panelists were:

• Credit Slips
• Hercules and the Umpire
• Weil Bankruptcy Blog
• The Ponzi Blog
• Wall Street Journal Bankruptcy Beat

Even though they did not mention this blog, I am glad to give a hat tip to these well-written selections.   (Their written materials did refer to both A Texas Bankruptcy Lawyer’s Blog and Spiritually Bankrupt by Ron Satija).

Judge William L. Norton, Jr. Award

Judge Barry Russell (Bankr. C.D. Cal.) was honored by the American Bankruptcy Institute with the William L. Norton, Jr. Award.   Judge Russell was appointed as a Bankruptcy Referee in 1974 and became a Bankruptcy Judge in 1979.   He is currently the longest serving Bankruptcy Judge in the United States.  He is the author of West’s Bankruptcy Evidence Manual and established a mediation program in his district.   In his acceptance speech, he called his long friendship with Judge Norton and noted that Judge Norton encouraged him to write his first evidence book.

The Economist’s Viewpoint

Prof. Jeffrey Rosensweig of Emory University, who was formerly a senior economist for the Atlanta Fed, gave the luncheon address for the ABI.    His presentation was full of slides packed full of charts and economic data, some of which I could read.    Any errors are due to my poor eyesight.

Prof. Rosensweig presented a lot of data pointing to different trends.   One recurring theme was that the incoming Fed Chairman Janet Yellen will keep interest rates low for the foreseeable future but that they will go up.     He said that Yellen would continue the quantitative easing program of the Fed where it buys U.S. government debt from banks in order to put more money back into the economy.    He pointed out that treasury debt held by the Federal Reserve System had increased from $1.5 trillion to $2.0 trillion in the last three years.  

So long as the Fed keeps pumping money into the economy interest rates will remain low.   Recently the expectation that the Fed would begin tapering its purchases caused interest rates to go up by a point.   However, when the Fed did not taper, they resumed their downward path.   The 10 year U.S. Treasury interest rates upon which most mortgages are priced has declined from 7% to less than 2%, went up to 3% but is expected to drop to 2.5%.  

Beyond the interest rate news, he was fairly gloomy.   He noted that the developing countries were showing tremendous growth while Europe was stagnant or declining.   The U.S. economy will grow at a rate of 1.5% this year and is expected to grow by 2.5% next year.    This will not be sufficient to put a dent in unemployment.  

One reason for poor growth is that housing is no longer the locomotive driving growth.   During the housing bubble, home starts were up at two million, which exceeded the long term average of 1.5 million per year.   After the crash, they dropped as low as half a million before rebounding to one million.  Thus, even though housing starts are up from the bottom, they are not back to historic levels.

Among other industries, health care employment is up by 35% over ten years, while manufacturing employment is down 30%.   Construction had crashed but is coming back.   Government employment has been steadily declining for years.

He said that the unemployment rates published gave a misleading impression of the labor market.   While unemployment is down, labor force participation is at its lowest point since women entered the workforce in the 60s and 70s.   (He was quick to point out that women had always been working but were not counted as being in the workforce until they began working outside the home).    He described labor force participation and unemployment as the donut and the hole.   Participation is the donut, while unemployment is the hole in the donut.   He said that when you buy a donut, you care about how big the donut is, not the size of the hole.   The donut is shrinking.

Prof. Rosensweig noted that inflation has been running below target.   To keep the economy humming, an inflation rate of 2% is healthy.   We have been running below 2% and declining.

However, he was not overly pessimistic about the national debt and entitlement spending.   The national debt has grown from $1 trillion in 1981 to a projected $18 trillion next year   Meanwhile the ratio of debt to GDP grew from 30% of GDP in 1981 to over 100% in 2011.   Now the percentage has dropped below 100% which means that the economy will not implode (my words not his).   On an annual level, the deficit has dropped from $1.4 trillion in in 2009 to $680 billion in 2013.   As a percentage of GDP, this is a drop from 10% to 3%.    He said that as long as the economy grows faster than the new debt being accumulated, we will be able to stay ahead of the deficit.   He likened it to a family that is going deeper in debt, but whose income is rising faster than their debt payments.

Finally, he said that we will be able to maintain entitlement spending but that it will be necessary to raise the retirement age.   He said that in order to have the same number of workers paying into social security and medicare in 2030 as in 2010, it will be necessary to raise the retirement age to 70, although we may be able to get away from 68 or 69.   On the other hand, if the retirement age remains at 65, there will be a serious imbalance between working and retired people.  

ABI Commission to Reform the Bankruptcy Laws

The ABI is conducting a series of hearings on reforming chapter 11.   Today’s hearing was on corporate governance.   The six witnesses combined a chorus of pleas for the status quo with a few startling proposals for change.

Dennis Dunne of Milbank Tweed testified that the current system of official committees worked just fine and should be kept.   He argued that ad hoc committees were a poor substitute because they did not owe fiduciary duties and tended to come and go.   However, he did note a potential problem where a committee represented unsecured creditors who were out of the money.   In that situation, the committee would have an incentive to pursue chancy litigation and prolong the case in order to fulfill its fiduciary duty to get something for the unsecureds.   However, he did feel that the committee still had a role in order to investigate the secured creditor’s liens and make sure there were not any unencumbered assets.

Questions directed to Mr. Dunne concerned whether there should be multiple committees for jointly administered debtors or one committee for all creditors, secured and unsecured creditors alike.   Mr. Dunne testified that too many committees could prevent reorganization while a single committee, including secured creditors, would have impossible and conflicting duties.    He was also asked about the problem of ad hoc committees holding out for substantial contribution claims.   He acknowledged that having to pay two sets of committees was a problem, but said there was not a statutory fix.            

William Snyder of Deloitte Financial Advisory Services, LLP testified about the virtues of Chief Restructuring Officers.    In his view, a Chief Restructuring Officer allows a business to address is problems while retaining the institutional knowledge of the board of directors.   He said that anyone who thinks they can step into a business and know everything within 2-4 weeks is delusional.  

He gave the analogy of a plane in trouble.   In that case, there is one pilot to fly the plane and one pilot to fix the problem.   Presumably, the CRO would be the pilot fixing the plane.  

He said that to work, a CRO must have the power to hire, fire, sign checks and refuse to sign checks.  

He recommended that section 101(14) be amended to allow a pre-petition CRO to be employed as a professional.   Currently, “officers” are defined as not disinterested.   Since the O in CRO stands for officer, this is a problem.

One of the commissioners questioned whether the CRO was a threat to the traditional DIP model.   He described the CRO as “just a trustee picked by the secured creditor before the case is filed.”   Mr. Snyder pushed back against this notion, asserting that while someone in the capital structure usually forces the issue but the debtor selects the CRO.    He said that if the creditor requesting the CRO provides a list of acceptable candidates, those parties are usually blacklisted.  

One of the commissioners suggested that the debtor’s lawyer usually has the most control over selection of the CRO.

Brady Williamson, who chaired the National Bankruptcy Review Commission, advised the Committee to forget about persuading Congress with their recommendations and instead focus on educating the courts, US Trustees and public of the need for change.   He pointed out that BAPCPA was vetoed by the President and blocked by one house of Congress or the other on at least four occasions before it eventually passed.   He said that today’s Congress is much more divided.    He said that the Commission could improve the public perception of the bankruptcy system by showing that it is fundamentally sound.

Clarkson McDow is the former U.S. Trustee for Region Four.   His message was that the U.S. Trustee system is a valuable part of the system.   In particular, he was emphatic that the U.S. Trustee continue to appoint trustees and examiners so that judges can avoid fulfilling an administrative role.    He insisted that appointing a chapter 11 trustee was not an extreme remedy and encourage more use of chapter 11 trustees in liquidating chapter 11 cases.   He said it was important to get a trustee in place before the most valuable assets were gone.    Mr. McDow encouraged the panel to resist appointing persons with trustee-like powers in favor of appointing actual trustees.

Prof. Anne Lawton of Michigan State University College of Law reported on her empirical research.   She said that the 300 day deadline for a small business debtor to file a plan and the45 day deadline to confirm a plan were solutions in search of a problem.   She said cases were being disposed of quickly prior to BAPCPA.    Of small business cases, only 47% were still pending at 345 days into the case.   However, she said that of cases still pending at the 345 day mark, 71% proposed a plan and 46% confirmed a plan.   This compares to a confirmation rate of 26% overall.   She said that it just takes longer to get to confirmation.   

She also testified that cases more likely to succeed typically had committees appointed.   However, she did not advocate for more committee appointments.   Instead, she said that appointment of a committee was a signal that the creditors believe that the case is one worth paying attention to.  

Prof. Lawton said that there were adequate means for quickly getting rid of cases with low prospects for success.    On the other hand, she said that there were too many levers to pull to dispose of a case that might succeed.   She said that we need a more efficient system for determining keepers.  

 

Mark Gittelman, Chief Practice Counsel-Asset Recovery for PNC Bank, had the most provocative recommendations.    Unlike the other witnesses, who proposed no changes or at most one tweak, he had a six point plan:

• He recommended bifurcating bankruptcy courts into commercial courts and consumer courts.
• He also recommended creating mega courts for large and complex cases.   He said that the system could start with the courts in Delaware and New York and add a few others elsewhere in the country.   In return for creating the mega court, mid-market cases would be filed in their local venues.
• Mr. Gittelman also recommended that bankruptcy judges be rotated among different courts to encourage uniform practices between locales.
• He recommended that the selection process for professionals be more transparent and that courts be open to billing arrangements other than on an hourly basis.
• He favored enforcing the rules on timely filing of schedules and monthly operating reports so that creditors can receive needed information early in the process.   (Apparently he was referring to the practice of routinely granting schedule extensions in large cases).
• Finally, he recommended uniformity in first day motion practices.   He said that many cases were needlessly delayed because lawyers failed to file all of the first day motions they should.   He recommended developing a series of uniform first day motions to be filed in every case.

Venue Reform, Cristol Comments and More at NCBJ

I am at the National Conference of Bankruptcy Judges in Atlanta.    The conference includes some of the best bankruptcy continuing education in the country.    There is no way to report on it all, so I will be offering some random observations.   

Moonlight Run

The  healthiest event of NCBJ is Bernstein-Burkley’s Wake Up and Run.    This year’s event drew about 60 runners willing to meet up at 6am for a 5k run.    The race was done professionally with personalized race bibs, chip timing and souvenir tshirts.    It was still full on dark at the race’s start time of 7am, so it ended up being a moonlight run through the park.    Judge Elizabeth Stong of the Eastern District of New York finished second in the women’s division.    Judge Tony Davis was the fastest Texas runner I recognized with a blazing speed of 26:32.    I finished much further back in the pack behind such Texas luminaries as Hugh Ray and Allan Diamond.   I recognized the names of at least five judges who were brave enough to get up at the crack of dawn and go running in the dark. 

Venue

I attended a meeting of the Venue Working Group.   This is a group of about 100 attorneys from 35 states who are working to build support for venue reform in Congress.   The group is supported by the Commercial Law League of America and includes many members from the group.    Peter Califano made a presentation on the group’s work later in the day.   According to Peter, during 2003-2012, there were  559  chapter 11 cases filed in Delaware and 104 in the Southern District of New York which had their headquarters elsewhere.    Those cases involved $2 trillion in collective debt.   

The Working Group supports legislation similar to HR 2533, introduced by Reps. Smith and Conyers, which would have eliminated state of incorporation venue and restricted affiliate venue.

Douglas Rosner of the Working Group will be testifying before the ABI Chapter 11 Reform Commission in November.    The Group will also be participating in the CLLA’s legislative conference in February 2014.

363 Sales

The presentation on 363 sales raised more questions than it answered.    One rhetorical question asked is whether debtor’s management is a mere tool of the secured lenders and whether cases run for the benefit of the secured creditors are proper under the Code.   Another question was whether 363 sales can be structured to accomplish results that could not be obtained under a plan, such as paying some administrative claimants but not others and paying money to unsecured creditors when senior creditors are not being paid in full.    The question was posed of whether the judge could “throw out the Code to do the most good for the most people.”

Student Loans

Judges Anita Shodeen (Bankr. D. Ia) and Michael Williamson (Bankr. S.D. Fl.) had a “debate” on student loans.   I put debate in quotes because they agreed with each other far more than they disagreed.    However, the point-counterpoint format was lively.   

Judge Shodeen noted the difficulty of trying cases with pro se debtors who may suffer from mental illness.   She noted that North Carolina has a program for low cost mental health evaluations for student loan plaintiffs.   

Both judges suggested that practitioners push back on the Bruner test for undue hardship.    Judge Shodeen suggested that the legislative history indicated that section 523(a)(8) was originally intended as a guard against debtor abuse and that it should be brought back to that purpose.

Judge Williamson rejected the appeal to legislative history noting:

Looking to legislative history is like going to a cocktail party and looking for a friendly face.   You’ll probably find one.   

However, he emphasized that the Bruner test is a product of a bygone age when student loans could be discharged in as little as five to seven years and student loan defaults had not ballooned to over 17%.    He said that it is “time for trial courts to get a little aggressive” in pushing back against Bruner and urged attorneys to “push the envelope on these issues.”

Lawrence B. King Award

Judge Jay Cristol received the Lawrence B. King Award from the Commercial Law League.   While I was well acquainted with Judge Cristol’s poetic efforts, I was not aware of his service as a pilot.    During the Korean War, he flew submarine hunting missions off an aircraft carrier.   On a training run, he once shot a missile that ricocheted back and hit his own plane.    More recently, while flying patients for charitable medical treatments, he suffered engine failure and had to put his plane down on the highway.    He has also donated $1 million of his own funds to the University of Miami’s pro bono program.    Finally, he is the author of an acclaimed book on the Liberty Incident in which Israel fired on a U.S. ship during the Six Day War.  

In discussing the history of bankruptcy, which once included debtor’s prisons, he said:

I once proposed lender’s prisons for bank officers who made loans that were not properly underwritten.  It was not well received.

Judge Cristol offered five suggestions for reforming bankruptcy and insolvency laws:

• Eliminate prebankruptcy credit counseling. 

Credit counseling is as valuable as telling a person with a heart attack to listen to a lecture on healthy eating habits before he can have open heart surgery.

•  While Judge Cristol did not oppose the personal financial management course, he said it came too late. He recommended that all high school students be required to complete a financial management course.

• He recommended bringing back “real” usury laws.

• He said that education should be free in the United States or that student loans should be dischargeable. He said that 

I see little difference between a person who borrows $100,000 to open a pizza business and the person who borrows $100,000 for an education. Why shouldn’t they both be dischargeable?

He also asked: 

“Why undue hardship? Why isn’t hardship enough?”

• He also said that chapter 13 would be more useful if courts could modify home mortgage loans. He said this “would be the law if the major banks were not so greedy and stupid.”

It is somewhat ironic that the person being honored by a creditors’ rights organization used his acceptance speech to criticize certain creditors. However, after 28 years on the bench and 38 years of service in the Naval Reserve, he has earned the right to speak his mind. His presentation was lively and drew a warm response from the crowd. 

Thursday’s Keynote Speech

Bloomberg News Editor Bill Rochelle gave the keynote address for the CLLA lunch.    Prior to joining Bloomberg in 2007, he was a bankruptcy lawyer for 35 years.

He thanked the CLLA for inviting him to an event where he wouldn’t have to pay for any of his food or drink for four days.

The more the bankruptcy business declines, the more the turnaround managers parties to hold onto market share

he remarked.

He predicted that Executive Benefits Insurance Agency v. Arkinson will not make much difference, but that “the next case will be a whopper.”   He said that when he attended oral arguments in Stern v. Marshall, he observed that all of the justices (even the ones who eventually dissented) were “very concerned about preserving the perogatives of Article III judges.”    He said that if the Supreme Court rules against the viability of waiver and consent, it will only affect cases currently pending.   However, the next case to reach the Supreme Court could hold that decisions in cases decided long ago are invalid.   He noted that Judge Jed Rakoff (S.D. N.Y.) has held that decisions by Bankruptcy Courts within the ambit of Stern v. Marshall are not entitled to res judicata or collateral estoppel effect and are only binding between the parties.   He said that the next case decided by the Supreme Court under Stern v.Marshall could spell the end of the U.S. Magistrate system.

However, he said that Law v. Siegel is likely to be the big case of the term.    Law v. Siegel is a Ninth Circuit case that I have previouslywritten about in which the Circuit affirmed the Bankruptcy Court’s decision to take away a debtor’s exempt property under section 105 based on misconduct.    He said that the case could be “a blockbuster case on whether federal courts can use their equity powers to override the plain meaning of statutes.”    He said that the case could be the turning point on equity.  

He proceeded to discuss numerous areas where there are splits between the circuits, including equitable mootness, artificial impairment, inherited IRAs, recharacterization of debt into equity, dismissal for bad faith based on pre-petition conduct, whether the Fair Debt Collection Practices Act is preempted by the Bankruptcy Code and whether wage garnishments within 90 days of bankruptcy are preferences.   

Rochelle proposed creating a Federal Circuit Court for Bankruptcy.    He noted that disagreements between the circuits are growing while the Supreme Court hears only a few bankruptcy cases.   Sending all bankruptcy cases to one federal circuit composed of judges from each of the other circuits would allow for uniformity in bankruptcy law that is not present today and reduce the opportunities for forum shopping.

CLLA Afternoon Panels

The main thing that I took away from the discussion on complex litigation in Ponzi Scheme cases is that there is a presumption of fraud in Ponzi Scheme cases but no one agrees on its boundaries.   I also learned that Kathy Bazolan Phelps and Judge Steven Rhodes have written The Ponzi Book:   A Legal Resource for Unraveling Ponzi Schemes.  

The main take aways from the Current Developments program were that deepening insolvency is still viable in Europe where it is known as “wrongful trading” and can lead to jail time and that the cases over who owns the unfinished business of bankrupt law firms are still very much in play after being a major topic of discussion at last year’s NCBJ.

In the ethics panel, I learned that there is a new proposed Rule 2014 which will only require disclosure of material connections, but will require the firm to disclose how it defined materiality in doing the conflicts check.   It will also require firms to disclose what process they followed to score creditors’ committee gigs.

Another theme was that when caught in an ethical violation, remorse is good.   It is better for the firm and its partners to accept responsibility than to deny that anything happened or throw the young associate under the bus.    

Fifth Circuit Nixes Consent in Stern Cases

A failed bid to reap a Beanie Baby bonanza, which resulted in a fifteen year legal odyssey for a chapter 13 debtor and his attorneys, will live on a while longer as a result of the Fifth Circuit’s recent interpretation of Stern v. Marshall. Unlike the adorable plush toys giving rise to the dispute, the opinion here is neither cute nor soft.   Some sixteen months after oral argument, the Fifth Circuit concluded that consent cannot apply in Stern situations in a cryptic footnote.   The decision is likely to generate controversy until the Supreme Court clarifies the issue later this term.    Frazzin v. Haynes & Boone, LLP, et al (Matter of Frazin), No. 11-10403 (5^th Cir. 10/1/13).   The Fifth Circuit opinion can be found here and Bankruptcy Judge Barbara Houser’s opinion can be found here.   

Beanie Babies, Oral Agreements and Lawsuits 

The case began with an oral agreement between friends.   Michael Cohen and his company, Lamajak, Inc., had the right to purchase Beanie Babies and sell them in hospital gift shops.   Cohen believed that Beanie Babies were a passing fad, while his friend, Frazin, did not.   Cohen allegedly told Frazin that he could keep any Beanie Baby profits the company made in excess of $6 million.  Frazin did not ask his friend to put the promise in writing because he did not want to insult him.  When Beanie Babies turned out to be a big deal and made a lot of profits Cohen denied the agreement and litigation ensued.

Meanwhile, Frazin filed a chapter 13 petition.    He obtained court approval to employ Griffith & Nixon as special counsel.   After a two week jury trial in state court, Frazin was awarded a judgment for $6.3 million on several theories, including breach of contract, promissory estoppel and quantum meruit.   When Lamajak appealed, Frazin received court approval to engage Haynes & Boone as his appellate counsel.

On appeal, the state Court of Appeals found that there was not sufficient proof of an agreement and reversed the breach of contract damages.   The Court of Appeals also reversed the promissory estoppel claim on the basis that it belonged to Frazin’s company rather than to him individually.   The Court of Appeals ruling reduced Frazin’s recovery to $3.4 million.   While Lamajak was seeking review before the Texas Supreme Court, the parties agreed to settle the case for $3.2 million.  

While recovering $3.2 million would ordinarily seem like a good deal, Frazin did not think so.  When Griffith & Nixon and Haynes & Boone applied for their fees before the bankruptcy court, Frazin counterclaimed for malpractice, breach of fiduciary duty and claims under the Texas Deceptive Trade Practices Act.    The case was tried before Bankruptcy Judge Barbara Houser.   Judge Houser ruled against the Debtor on the malpractice and DTPA claims.   She found that there had been a breach of fiduciary duty, but that the breach was not sufficiently severe to warrant fee forfeiture.   She denied all of the Debtor’s claims and granted the fees requested.  

  

The Bankruptcy Court judgment was rendered on April 7, 2009, over a year prior to the Supreme Courts’s decision in Stern v. Marshall.  The District Court affirmed the Bankruptcy Court on January 14, 2011, which was subsequent to Stern v. Marshall.   The Fifth Circuit heard oral argument on June 6, 2012 and ruled some sixteen months later on October 1, 2013.

The Fifth Circuit’s Ruling

The panel wrote three separate opinions:  a majority opinion by Judge Prado, in which Judge Owen joined and Judge Reavley joined in part; a concurring opinion by Judge Owen and an opinion concurring in part and dissenting in part by Judge Reavley.   Judge Prado’s majority opinion relied substantially on Stern v. Marshall.   In a footnote, the court rejected the notion that Frazin’s decision to sue his attorneys in Bankruptcy Court bound him to the results of that litigation.    The Court stated:

The Attorneys argue that Frazin consented to the jurisdiction of the bankruptcy court and waived any objection to the contrary by filing his claims there and failing to object. However, when “separation of powers] is implicated in a given case, the parties cannot by consent cure the constitutional difficulty . . . . When these Article III limitations are at issue, notions of consent and waiver cannot be dispositive because the limitations serve institutional interests that the parties cannot be expected to protect.” (citation omitted). As discussed above, Stern makes clear that the practice of bankruptcy courts entering final judgments in certain state-law counterclaims “compromise[s] the integrity of the system of separated powers and the role of the Judiciary in that system.” (citation omitted). Thus, structural concerns cannot be ameliorated by Frazin’s consent or waiver.

Opinion, p. 8, n. 3. 

 

Following Stern v. Marshall, the Court found that the Bankruptcy Court had authority only to decide so much as was necessary to determine the attorneys’ fee requests.   The Court found that the malpractice and breach of fiduciary duty claims were defenses to the fee request so that the Bankruptcy Court had the authority to enter a final judgment upon them.  The Court’s finding on fiduciary duty was grounded in the fact that the Debtor sought only the equitable remedy of fee forfeiture but did not seek affirmative damages.   However, the Court founds that the Bankruptcy Court could not decide the DTPA claims.

Because it was not necessary to decide the DTPA claim to rule on the Attorneys’ fee applications, we conclude that the bankruptcy court lacked the authority to enter a final judgment as to that claim.   Nevertheless, we hold that all factual determinations made in the course of analyzing Frazin’s DTPA claim were within the court’s constitutional authority because they were necessarily resolved in the process of adjudicating the fee applications.

Opinion, p. 15.

Finally, in remanding the case to the District Court for further proceedings, the Court added:

We note (though we do not express an opinion) that although the bankruptcy court did not have jurisdiction to make a final judgment on the DTPA claim, the district court may have that authority.

Opinion, p. 17.

The Clarifying Opinions

Judge Owen wrote separately to emphasize that the Bankruptcy Court retained the ability to “resolve discrete issues that a core bankruptcy proceeding and a state-law cause of action share in common.”   Owen, J., Concurring, p. 18.   

Though a bankruptcy court cannot issue a final judgment disposing of certain claims in cases like the present one, this does not mean that bankruptcy courts are neutered in adjudicating core proceedings under 11 U.S.C. § 157(b)(2). A bankruptcy court should examine and resolve all challenges to a fee application, even if the challenges could or do constitute one or more elements of state-law or other causes of action that must be finally resolved by an Article III or state court. A bankruptcy court has jurisdiction to resolve discrete factual issues that necessarily must be decided in adjudicating claims for professional fees under § 330. Bankruptcy courts should not shy away from the task of resolving all issues that pertain to a fee application, even if those issues also form the basis, in whole or in part, of a potential state-law cause of action.

Id.

Judge Reavley, on the other hand, would have affirmed the lower court judgments. 

We affirm the bankruptcy court’s distribution of estate funds, and that is all I see before us.

The two law firms had obtained a large recovery in the lawsuit against Lamajak, Inc., enough to satisfy all creditor claims, and then the court had only to distribute what was left. The firms filed fee applications, to which the debtor Frazin objected and then filed numerous claims against them, including negligence and malpractice and even deceptive trade practice, all directed at the conduct of the lawyers related to the lawsuit against Lamajak, Inc. There was no use of the word counterclaim and no pleading meeting Rule 8 requirements, as a counterclaim must do.

I need not spell out my objections to this court’s judgment because no harm is done, at least in this case, and the district court will no doubt simply dismiss whatever has been remanded. However, if it were necessary, I would hold that a bankruptcy court does not lose jurisdiction in deciding the administration of the estate when that has some collateral effect not easily avoided.

Reavley, J., Concurring in part and dissenting in part, p. 20.

A Curious Collection of Opinions

The Frazin opinions are curious for the reason that they seem to have arisen in a vacuum.  Although Stern v. Marshall has been a hot topic nationally, there were no amicus briefs submitted in this case.    After holding the case under advisement for sixteen months (which is a really long time), the Court disposed of the most critical issue in a footnote.   The footnote basically said that the answer was obvious. It was as if the Court had said, “Well, duh!”  In doing so, the Court avoided discussing the Fifth Circuit’s own opinion about the validity of consent to trial before a magistrate, Automation Servs. Corp. v. Liberty Surplus Ins. Corp., 673 F.3d 399, 405 (5^th Cir. 2012) or the plethora of cases dealing with arbitration.   If the very integrity of the Constitution was at stake, it would have been nice to explain why consent was a non-starter here but works in the other contexts.  

    

In ruling on the issue of consent, the Court did not acknowledge the conflicting opinions from the Sixth and Ninth Circuits or note that the Supreme Court has granted cert on this issue.  Exec. Benefits Ins. Agency v. Arkinson (In re Bellingham Ins. Agency, Inc.), 702 F.3d 553, 565–66 (9th Cir. 2012), cert. granted 133 S. Ct. 2880 (2013); Waldman v. Stone, 698 F.3d 910, 921–22 (6th Cir. 2012), cert. denied 133 S. Ct. 1604 (2013).   However, the Court did mention these decisions in passing in connection with the authority of the District Court.   Thus, the Court was aware of the opinions but chose not to discuss them.

While the judges went to great lengths to point out that their opinion had little practical impact in the present case, they did not acknowledge the significant problems this could cause in a host of other contexts.    

Given the lengthy amount of time that the case was under submission, the three opinions and the cursory attention given to the most significant issue, it looks suspiciously as though the Court was having great difficulty with the issue and decided to issue an opinion that would resolve the specific case without addressing the herd of elephants in the room.   Of course, this is just speculation.

What Does It Mean?

This may mean very little once the Supreme Court rules on the issues of consent and waiver in the Bellingham Insurance Agency case.    However, in the meantime, Fifth Circuit bankruptcy courts will have to examine Stern v. Marshall without having consent as a fallback.   Frazin makes clear that bankruptcy courts may determine claims against estates and any state law issues absolutely necessary to make that determination.   Bankruptcy courts can also determine facts related to those issues and have those facts be determinative of other issues that the bankruptcy court itself could not itself issue a final decision on.   The Fifth Circuit seems to have inadvertently created a situation in which the bankruptcy court is a super-magistrate able to determine claims against the estate and claims relating to property of the estate and to make factual determinations relating to those claims.    Any legal conclusions or facts within these categories would be subject to normal appellate review.   While the opinion did not go this far, it seems to be saying that the District Court may enter judgment on state law counterclaims in which the Bankruptcy Court was allowed to find the operative facts.   Furthermore, if the operative facts were not necessary to a claims or property issue, then the District Court would be permitted to conduct de novo review of the factual findings and make legal conclusions. 

  

On a final note, the opinion means that the appellate courts are having trouble with the Stern lingo.   The panel opinion referred to Stern as having to do with jurisdiction to enter a judgment, while the issue is properly one of authority.    Judge Owen’s concurrence referred to core proceedings.   However, because Stern’s effect was to remove authority for bankruptcy courts to decide one type of core proceeding, the core/non-core distinction has lost much of its significance.