Romance and “Insider” Status, with Other Oddities, at U.S Supreme Court (U.S. Bank v. Village at Lakeridge)

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An Oddity

By Donald L. Swanson

On March 27, 2017, the U.S. Supreme Court grants certiorari in the case of U.S. Bank N.A. v. Village at Lakeridge, LLC, U.S. Supreme Court Case No. 15-1509.

The Facts

Kathie Bartlett is one of five owners of a company that owns the Debtor. So, both Kathie Bartlett and her company are “insiders” of the Debtor under § 101(31).

The bankruptcy Debtor proposes a plan of reorganization. The plan identifies only two impaired claims: (i) U.S. Bank’s $10 million, fully-secured claim, and (ii) a $2.76 million unsecured claim of the Debtor’s owner—i.e., Kathie Bartlett’s company. A problem for plan confirmation is the requirement that at least one impaired class of claims must vote to accept the plan – and insider claims aren’t counted in the vote (see § 1129(a)(10)). Since U.S. Bank opposes confirmation and the $2.76 million claim is held by an insider, the § 1129(a)(10) requirement for one-consenting-class is an impediment.

To get around this impediment, Kathie Bartlett’s company assigns its $2.76 million claim to Dr. Robert Rabkin for a payment of $5,000. This assignment gets dicey because Kathie Bartlett and Dr. Rabkin “share a close business and personal relationship.” Dr. Rabkin says he made this small, speculative investment for business reasons: for the chance to get a big payoff, since the plan provides a $30,000 dividend on this claim.  But U.S. Bank isn’t buying this reason: they think he’s conspiring with his girlfriend to evade a confirmation requirement.

From the Debtor’s perspective, the assignment to Kathie Bartlett’s close friend is a creative-but-legitimate way to satisfy a plan confirmation requirement. From the opposing creditor’s perspective, the assignment is the same as cheating—and the question is whether they’ll get away with it.

An Oddity

You’d think the primary issue discussed by the courts in this case would be:

Can an insider do that? Can an insider actually evade the non-insider acceptance requirement by assigning its claim to a friend who is not an insider?

As a bankruptcy practitioner, I want to know the answer to this question. I want to know how aggressive a debtor and its insiders might be in addressing plan confirmation requirements.

And you’d think we’d get a direct and clear explanation and answer for such a question in this case. But think again. Believe it or not, we probably won’t. Here’s why:

First, both the Ninth Circuit Court of Appeals and its Bankruptcy Appellate Panel focus on two questions in this case: (i) is Dr. Rabkin an insider, and (ii) did Dr. Rabkin act in good faith. They find in favor of Dr. Rabkin on both issues. And that, according to such courts, is the end of the inquiry and discussion.  But what about the good faith of the Debtor and the insider?

Second, in its Petition for a Writ of Certiorari to the U.S. Supreme Court, Appellant identifies three questions to be resolved. But the Supreme Court limits its grant of certiorari “to Question 2 Presented by the Petition.” And here is what Question 2 asks:

Whether the appropriate standard of review for determining non-statutory insider status is the de novo standard of review applied by the Third, Seventh and Tenth Circuit Courts of Appeal, or the clearly erroneous standard of review adopted for the first time by the Ninth Circuit Court of Appeal in this action?

Say what?! The Supreme Court is going to decide, in this case, only a “standard of review” question for determining who is/isn’t an insider?! Isn’t that question too narrow?  Now . . . I understand that standards for resolving insider/non-insider distinctions are important in a variety of contexts: as in the 90-days vs. one-year reach-back for preference liability. But still . . . I want a direct and clear explanation and answer on the how-aggressive-can-a-debtor-be question!!

The Ninth Circuit Court of Appeals had a clear opportunity to take on this how-aggressive question directly. In fact, the Ninth Circuit previously addressed this very question — and did so directly:

“[D]ebtors unable to obtain the acceptance of an impaired creditor simply could assign insider claims to third parties who in turn could vote to accept. This the court cannot permit.’”

Wake Forest Inc. v. Transamerica Title Ins. Co. (In re Greer West Inv. Ltd. P’ship), 81 F.3d 168, 1996 WL 134293, at *2 (9th Cir. Mar. 25, 1996) (unpublished) (emphasis added).

Instead of addressing the issue directly, however, the Ninth Circuit Court in the present case merely scolds the Appellant (in footnote 10) for citing an unpublished opinion.

Another Oddity

The courts in this case are struggling with how a romantic relationship fits into the insider v. non-insider analysis. The Ninth Circuit courts decide that Dr. Rabkin is NOT an insider, despite his romantic relationship with Kathie Bartlett. Here are details of their relationship, enumerated by the courts in this case and used to reach the non-insider decision:

–they see each other “regularly” but don’t “cohabitate”
–they pay their own bills and living expenses
–they’ve “never purchased expensive gifts” for each other
–she doesn’t “exercise control over” him
–he had “little knowledge of, and no relationship” with her business interests before the Debtor’s bankruptcy

Here’s hoping the courts can devise a better way to scrutinize romantic relationships for insider status, than trying to distinguish between “seeing regularly” vs. “cohabitating” or trying to decide if one party “exercises control” over the other. If they can’t, deposition and trial testimonies on the “insider” question could start resembling episodes of Seinfeld or Big Bang Theory.

A Third Oddity

One standard for evaluating an “insider” status is whether the transaction in question occurred at arms-length.

Dr. Rabkin testifies that his reasons for purchasing the $2.76 million claim are strictly business. However, the Bank believes his motives include helping his girlfriend. In an effort to prove as much, the Bank makes an offer—in its deposition of Dr. Rabkin—to purchase the same claim from him for a payment of $50,000. And then, in the same deposition, they increase the offer amount to $60,000. Dr. Rabkin doesn’t accept either offer or attempt any negotiations with the Bank—either during or after the deposition.

Here’s the oddity:

–The Bankruptcy Court apologizes to Rabkin “on behalf of the legal profession” for the “offensive conduct” of the Bank’s attorney in the deposition (see footnote 7 in BAP opinion).

–And the Bankruptcy Judge’s Order describes the conduct for which he apologized as an “offensive offer” to purchase Dr. Rabkin’s claim during his deposition “for twice as much as Dr. Rabkin could recover under the Debtor’s Plan.”

Seriously?! Offering twice-as-much is conduct worthy of an apology “on behalf of the legal profession”?! There must be something more about the manner-of-delivery – although none is identified. Otherwise, the twice-as-much offer seems like a clever attempt at exposing the existence of ulterior motives.

Conclusion

Here’s hoping that the U.S. Supreme Court will find a way to address the how-aggressive-can-a-debtor-be question in this case, despite its professed limitation to Question 2.

Mandating Mediation to Develop a Mediation Culture

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A glaring contradiction? (Photo by Marilyn Swanson)

By:  Donald L. Swanson

[T]he full benefits of mediation are not reaped when parties are left to participate in it voluntarily.

D. Quek, Mandatory Mediation: An Oxymoron? Examining the Feasibility of Implementing a Court-Mandated Mediation Program, Cardozo Journal of Conflict Resolution, Vol 11:479, at 483 (Spring 2010).

The article linked above is written by Dorcas Quek, whose resume includes this:

“L.L.B. (National University of Singapore); L.L.M. (Harvard Law School); Visiting Researcher at Harvard Law School (2008-2009); Assistant Registrar and Magistrate in the Singapore High Court (2005-2007) and District Judge in the Primary Dispute Resolution Centre in the Singapore Subordinate Courts (June 2009 onwards).”

Findings

Ms. Quek’s article examines “the current debate in the United States concerning court-mandated mediation.” Here are some of her findings:

Mediation “may well be under-utilized in certain jurisdictions” because parties and attorneys “are still accustomed to treating litigation as the default mode of dispute resolution” and because “initiating mediation” may be “perceived as a sign of weakness.”

“In many jurisdictions, the rates of voluntary usage of mediation have been low.”

Where the “reticence towards mediation is due to unfamiliarity with or ignorance of the process,” court-mandated mediation “may be instrumental” in overcoming “prejudices or lack of understanding.”

“Studies show that parties who have entered mediation reluctantly still benefited from the process even though their participation was not voluntary.”

Observation / Recommendation

Ms. Quek draws this interesting observation / recommendation:

The “most compelling reason” for a court to mandate mediation is “to increase awareness and the usage of mediation services.” So, court-mandated mediation:

–should be utilized “only” as “a short-term measure” in courts where mediation “is relatively less well developed”; and

–is an expediency that “should be lifted as soon as” the awareness and utilization of mediation “has reached a satisfactory level.”

Value Judgment

And she bases such conclusion, in part, on this value judgment:

The term “mandatory mediation” is “a glaring contradiction.” Mediation emphasizes “self-determination, collaboration and creative ways” of resolving disputes and concerns, and “attempts to impose” a mediation process may “undermine the raison d’ˆetre” of mediation. Accordingly, “there must be compelling reasons to introduce mandatory mediation.”

While we can quibble with the idea of limiting mandated mediation, her point on using it to jump-start mediation where it’s struggling to get traction is sound.

Quibbling

In most state and Federal trial courts these days, mediation is firmly entrenched. In such courts, mandatory mediation isn’t improper: it’s, simply, not needed. Here’s why:

If you listen to litigators (who practice in such courts) talking about their cases, about what they have coming-up-next, and about their successes and disappointments, mediation will be a focal point of those discussions. No one needs to suggest mediation to these litigators or to encourage its use: they’ve already factored mediation into their case strategies – and mediation will always play a role. So, discussions of “mandating” mediation, for these litigators, is more of a redundancy than anything else.

Changing the Culture

But for many bankruptcy courts, mediation is still an unfamiliar and little-used process. In these courts, efforts to mandate mediation would be helpful in changing the culture.

Studies show that practitioners with little-or-no experience in mediation are reluctant to use it—and are uncertain on how it can be used effectively. And it shouldn’t be a surprise that mediation is a seldom-used process among these practitioners.

And my experience is that, (i) the adoption of local mediation rules will not, in and of itself, create a demand for mediation: “build it and they will come” does not work for mediation rules; but (ii) a local judge can change things by ordering cases into mediation. Once the judge starts requiring mediation, either by direct order in specific disputes or by local rule, the culture starts to change: practitioners start to become comfortable with mediation and start using it.

Conclusion

So . . . a major initiative in courts where mediation is little-used would be to start ordering specific cases into mediation and to mandate mediation by local rule.

U.S. Supreme Court: Stale Claims, Attorneys and Trustees in Chapter 13 & Dissent’s Call for Congress to Overrule (Midland Funding v. Johnson)

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Chapter 13 of the Bankruptcy Code

By Donald L. Swanson

The case is Midland Funding, LLC v. Johnson, Supreme Court Case No. 16-348 (decided May 15, 2017).   It’s about creditors filing proofs of stale claims (i.e., claims barred by statute of limitations) in Chapter 13 cases.

The Facts

Aleida Johnson files Chapter 13 bankruptcy.  Then, Midland files a proof of claim for a credit-card debt of $1,879.71,  specifying that the debt is more than 10 years old and beyond the 6 year statute of limitations.  Johnson’s bankruptcy attorney objects to the claim, Midland does not respond, and the Bankruptcy Court disallows Midland’s claim.

Then, Johnson sues Midland for violating the Fair Debt Collection Practices Act (the “Act”).  The District Court and the Court of Appeals disagree on whether the Act applies to Midland’s proof of claim, and the U.S. Supreme Court agrees to hear the case.

On May 15, 2017, the Supreme Court makes this ruling:

Since Midland’s proof of claim “on its face indicates that the limitations period has run,” the proof of claim is neither “false,” “deceptive,” “misleading,” “unconscionable” nor “unfair,” within the meaning of the Act.

The ruling is by a five-Justice majority (Breyer, Roberts, Kennedy, Thomas and Alito), with three Justices dissenting (Sotomayor, Ginsburg and Kagan) and one Justice (Gorsuch) not participating.

The Majority Opinion

The majority says a proof of claim disclosing facts that show the claim to be stale is not “false,” “deceptive” or “misleading” under the Act.  Here’s why:

A “claim” in bankruptcy is a “right to payment” and is to be given “the broadest available definition.”  For example, (i) § 502(b)(1) says an “unenforceable” claim will be disallowed: it does not say that an “unenforceable” claim is not a “claim,” and (ii) §101(5)(A) says a “claim” is a “right to payment,” even if that right proves to be unenforceable.

“The law has long treated” a statute of limitations argument “as an affirmative defense” that a debtor must raise.  The Bankruptcy Code adopts this same view (see §§502, 558).

In Chapter 13, the trustee is sophisticated and “likely to understand” these statute of limitations rules.

The majority also rejects “unconscionable” and “unfair” characterizations under the Act for several reasons.

First, several courts say the knowing assertion of a stale claim, in an ordinary collection lawsuit, is “unfair” because the debtor might pay the stale claim “unwittingly” or to avoid cost or embarrassment.  Such a concern is “significantly diminished” in Chapter 13 because, (i) the consumer initiates the bankruptcy, (ii) a knowledgeable trustee is involved, and (iii) claims review processes are “streamlined.”

One benefit to a Chapter 13 debtor from the filing of a stale claims is this: a debtor can discharge the stale claim and keep it off credit reports.

“More importantly,” an exception to “the simple affirmative defense approach” would require defining the boundaries of the exception.

The Act and the Bankruptcy Code have different purposes: (i) the Act seeks to help consumers “by preventing consumer bankruptcies in the first place,” while (ii) the Bankruptcy Code creates and maintains the “delicate balance of a debtor’s protections and obligations.”  To find the Act applicable here would upset that “delicate balance.”

The Dissenting Opinion

The dissenting Justices find Midland’s actions to be both “unfair” and “unconscionable.”  They decry the efforts of “debt buyers,” who purchase consumer debts from creditors and then attempt to collect what they can from the debtors and keep the profits:

–Such buyers “pay close to eight cents per dollar” for debts under three years old, pay “as little as two cents per dollar” for debts over six years old, and pay “effectively nothing” for debts over 15 years old;

–These buyers knowingly file suit on stale claims, hoping the debtor won’t raise the affirmative defense or won’t respond at all.  And such buyers have won “billions of dollars in default judgments” against consumer debtors on stale claims.

–“Every court to have considered the question,” has found such conduct “unfair” and “unconscionable” under the Act.

–“It does not take a sophisticated attorney to understand why” such practices are “unfair.”  It only takes “common sense” to conclude that “one should not be able to profit on the inadvertent inattention of other” or that “the law should not be a trap for the unwary.”

The dissent concludes with a call for Congress to overrule the majority decision:

“I take comfort only in the knowledge that the Court’s decision today need not be the last word on the matter. If Congress wants to amend the FDCPA to make explicit what in my view is already implicit in the law, it need only say so.  I respectfully dissent.”

How Chapter 13 Cases Actually Work

Once again, I’m struck by the failure of the U.S. Supreme Court to appreciate how bankruptcy cases actually work.  Here are two examples from the Midland Funding, LLC v. Johnson opinion.

  1.  Debtor Attorneys: Omitted from the discussion!

An important professional in a Chapter 13 case – perhaps, the most important professional – is debtor’s attorney.  Yet, there is nary a substantive reference to the role of a debtor’s attorney in the entire Midland v. Johnson case, other than in the recitation of facts (Debtor’s attorney is the one who objected to Midland’s stale claim).  There’s much talk in the opinion about the Chapter 13 trustee as a sophisticated player [rightly so], but there’s nothing about the debtor’s attorney.

This is a shame.  Why and how an important legal opinion like this can fail to even mention the debtor attorney role is puzzling.

For example, the Dissent seems exercised about the majority opinion and calls on Congress to change the majority ruling because, “most debtors who fail to object to a stale claim will end up worse off than had they never entered bankruptcy at all.” But Congressional involvement is not needed.  There is a simple and easily administered solution.

–Debtor attorneys will add the following item to their Chapter 13 case checklists–if it isn’t already there:

“Review filed claims, after claims deadline expires, and object to stale claims.”

–And, of course, their authorized fees (which are paid through the Chapter 13 plan) will need to increase accordingly.

Here’s why this checklist item is now an added service worthy of additional compensation.  A typical Chapter 13 bankruptcy happens like this:

The debtor files Chapter 13 because a bunch of unsecured debts cannot be paid.  The Chapter 13 plan proposes to pay all disposable earnings over several years to the Chapter 13 trustee, who will then distribute such funds under a confirmed plan.  The distributions go, as required by statute, (i) first, to administrative (e.g., attorney fees), priority (e.g., taxes) and secured (e.g., car loan) claims, and (ii) then, whatever is left over, to unsecured claims pro rata, who often receive only a few cents on each dollar.

So, if an unsecured claim is unenforceable because of a statute of limitations issue but is allowed in the Chapter 13 case anyway:

–the ones injured by the allowance are the other unsecured creditors, whose pro rata shares are diminished by the allowance of a stale claim; and

–the debtor has little reason to care, because the amount debtor must pay under the plan will not be affected by the stale claim’s allowance.

Now, as explained in the Midland v. Johnson dissent, the Chapter 13 debtor must care.  And debtor attorneys need to act accordingly.

  2.  Chapter 13 Trustees: Duties regarding stale claims?

The majority opinion seems to misunderstand what Chapter 13 trustees actually do.  The majority seems to think there is a sophisticated bankruptcy administrator in every Chapter 13 case, called a trustee, [this much is true] who has unlimited capacity to examine every claim filed in every Chapter 13 case for staleness [this part is not true].

Chapter 13 of the Bankruptcy Code places explicit responsibility for examining and objecting to claims upon the trustee.  Here’s how:

–§ 1302(b) says:  “The trustee shall—(1) perform the duties specified in sections . . . 704(a)(5)”; and

–§704(a)(5) says: “The trustee shall— . . . (5) if a purpose would be served, examine proofs of claims and object to the allowance of any claim that is improper.”

However, the trustee’s obligation, under such statutes, to examine claims arises only when “a purpose would be served.”  Does the majority ruling now require Chapter 13 trustees to examine all claims for staleness?  Maybe so.  But such an examination would be redundant of the added checklist item for debtor’s attorney mentioned above: i.e., no purpose “would be served” by the trustee’s examination.

And the majority ruling will, undoubtedly, result in a much higher volume of stale claims filings: the dissent refers to a “deluge” of such filings.  Where is the compensation going to come from for any expanded efforts by the Chapter 13 trustee to examine claims?

Conclusion

It will be interesting to see what the fallout and effect will be from the Supreme Court’s majority decision in Midland v. Johnson and the dissent’s call for Congressional action.

How a Judge Makes Mediation Work: Minimizing Risks in Close-Call and Winner-Take-All Disputes

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Minimizing Risks (Photo by Marilyn Swanson)

By Donald L. Swanson

“The decision here is most likely all or nothing.  One side is going to win and the other side is going to lose—and that’s going to be very happy on one side and very tough on the other side.”

–Judge Steven Rhodes, encouraging parties to reach a settlement, as quoted in “Detroit Resurrected: To Bankruptcy and Back,” by Nathan Bomey.

This statement from Judge Rhodes is a powerful argument for insisting that parties mediate their disputes in close-call / winner-take-all circumstances.  Such circumstances create a moment, if ever one exists, for judicial activism in moving the parties into a mediation process.

Actions, like the quotation above from Judge Rhodes, meet an essential need:

–Imagine you are a party in a lawsuit.  Mediation has not occurred and is not being considered.  Trial day is approaching.  And imagine the judge believes this:

–the decision-after-trial is likely to be a close call; and

–the result is likely to be all-or-nothing for both sides.

–Wouldn’t you want to know this?  And, armed with such information, wouldn’t you appreciate one-last-chance to consider settlement possibilities?

A Duty

I suggest, in such circumstances, that the judge has a duty and obligation to communicate such beliefs to the parties and to direct them into mediation.

A Reason Why

Attorneys who’ve been working a case for an extended period of time often start to believe their arguments!

This is neither cynicism nor a joke.  Here’s how it works in the day-to-day grind of managing a case:

–Upon learning about a case from the client, the attorney’s first impression is of a weak case; but the client is in a difficult position and desperately needs to win.

–The attorney’s research identifies several legal theories, each of which, on its own, seems a bit of a stretch; but the attorney keeps developing the theories—which, collectively, begin after a while to seem plausible.

–After extensive work on the case, the attorney now has a carefully-crafted set of arguments that have an aura, in the attorney’s mind, of weightiness.

–The attorney and the party are beginning to believe they can actually win this case and need to forge ahead.

–They now believe their arguments.

This is one of the reasons why statements, like Judge Rhodes’s quotation above, need to be made to the parties in a close-call / winner-take-all situation.  And this is why the parties must, armed with such knowledge, have one last chance to mediate their case.

Conclusion

In such circumstances, every effort must be made by the judge to fully-inform the parties of the risks and to move the parties into mediation.  Then the parties can:

–take and receive a fresh-look at their arguments and assess anew the risks of their position; and

–take the resolution of their dispute into their own hands – rather than letting a stranger tell them what the resolution is going to be.

Because of Judge Rhodes’s efforts, like his quotation above, mediation worked well in the City of Detroit bankruptcy.

U.S. Supreme Court and Its Private Rights v. Public Rights Problem in Bankruptcy (Spokeo v. Robins)

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Protecting public rights or private rights?

By:  Donald L. Swanson

The opinion in the U.S. Supreme Court is Spokeo, Inc. v. Robins (issued on May 16, 2016, in Case No. 13-1339).

The Facts of the Case

Here are the facts:

Spokeo, Inc., operates a “people search engine”: you can search its website for a person’s name and get information about him/her.

Spokeo posts a picture of Mr. Robins and reports him to be in his 50s, married, employed in a professional or technical field, with children, a graduate degree, a “Very Strong” economic status, and a wealth level in the “Top 10%.”

The truth, back then, is that Mr. Robins is out-of-work, without a family, and actively seeking employment. And the picture Spokeo posts is of someone else.  [Note: It’s sort-of like the play, “I’m Not Rappaport.”]

Mr. Robins’s class action lawsuit alleges violations of the Fair Credit Reporting Act [the “Act”]. His expressed concern in the lawsuit is that Spokeo’s report creates “imminent and ongoing actual harm” to his employment prospects by making him “appear overqualified for jobs he might have gained, expectant of a higher salary than employers would be willing to pay, and less mobile because of family responsibilities.”

The Standing Doctrine Issue

The issue in the case is whether Mr. Robins has “standing” to bring this action against Spokeo under the Act. The majority of Supreme Court justices (Alito, Roberts, Kennedy, Thomas, Breyer and Kagan) answer this question in the negative: Mr. Robins does NOT have standing because the alleged damage is not sufficiently “concrete.” Two justices (Ginsburg and Sotomayor) dissent.

A History / Civics Lesson on Standing: Private Rights v. Public Rights

What’s interesting about this case is the history / civics lesson on “standing” provided by Justice Thomas in his concurring opinion.  Here is a sampling from the history / civics lesson he provides:

The “standing” doctrine preserves separation of powers by preventing the judiciary’s entanglement in disputes that are primarily political in nature. This entanglement concern is generally absent from a lawsuit by an individual seeking to enforce only his/her personal rights against another private party.

Such a distinction between “primarily political rights” (aka “public rights”) and “personal rights” (aka “private rights”) comes from the common-law courts, which “more readily entertained” suits by private plaintiffs alleging a violation of their own rights over suits by private plaintiffs asserting “claims vindicating public rights.”

Private rights traditionally include “rights of personal security (including security of reputation), property rights, and contract rights.” In suits to enforce such rights, courts historically presumed that a plaintiff’s right to sue arises “merely from having his personal, legal rights invaded.” Here’s an example:

“when one man placed his foot on another’s property, the property owner needed to show nothing more to establish” standing-to-sue.

In such a private rights suit, courts historically presumed a plaintiff has standing “merely from having his personal legal rights invaded.”

As to private parties asserting “claims vindicating public rights,” however, common-law courts required “a further showing of injury.” Public rights are duties owed “to the whole community . . . in its social aggregate capacity.” These include “free navigation of waterways, passage on public highways, and general compliance with regulatory law.” Generally, “only the government has the authority to vindicate a harm to the public at large”: criminal laws are a prime example.

To achieve standing for enforcing public rights, common-law courts required “a further showing of injury”: the plaintiff had to show “some extraordinary damage, beyond the rest of the community.”

This is a separation-of-powers issue under the U.S. Constitution. By limiting the ability of Congress to delegate law enforcement authority to private plaintiffs and the courts, the standing doctrine preserves executive discretion.

Overlap With Bankruptcy Law

What’s interesting about the foregoing is its overlap with bankruptcy law. Every bankruptcy attorney will recognize this public rights v. private rights distinction: it’s from struggles, in judicial opinions, over the extent of (and limits on) bankruptcy jurisdiction under Articles I (bankruptcy courts) and III (district courts) of the U.S. Constitution. The rule is that private rights require resolution by an Article III judge, while public rights may be resolved by an Article I judge.

A Bankruptcy Problem

The private rights / public rights distinction seems to make a lot of sense in the “standing” doctrine context.

But it creates huge difficulties and confusion in the bankruptcy context. Consider this:

–The enforcement of contract rights has always been viewed, unequivocally, as a private rights issue: contract disputes must be resolved by an Article III court.

–The filing, objection and resolution of proof of claim issues in bankruptcy has always been viewed, unequivocally, as a public rights issue: this process can generally be handled—from start-to-finish—by an Article I bankruptcy court.

–But the vast majority of all proofs of claim filed in bankruptcy cases assert contract claims.

So . . . how do we justify that?!! And the claims filing and resolution process is one of the most-basic of all bankruptcy functions.

The answer is that courts have experienced great difficulty in articulating the private rights v. public rights justification and applying that justification consistently across the broad spectrum of bankruptcy issues.

I suggest that we need a new-and-different way of looking at, and dealing with, bankruptcy court jurisdiction issues.

A Proactive Mediator Role: “Special Settlement Master”

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Antonio Stradivari of Cremona, Italy — A Special Master (Photo by Marilyn Swanson)

By Donald L. Swanson

Mediators are appointed as “special masters” in the U.S. District Courts.  Such appointments are authorized by Fed. R. Civ. P. 53.

Examples of Mediators as Special Settlement Masters

Mediators appointed as special settlement masters are often given a broad range of authority to act proactively on the court’s behalf.

One example is In re Syngenta case, a multi-district case pending in the U.S. District Court for the District of Kansas, where a mediator is appointed as special settlement master (aka mediator) under Fed.R.Civ.P. 53.  This settlement master (aka mediator) is given a broad grant of authority, under Rule 53, to:

–“Order the parties to meet face-to-face and engage in serious and meaningful negotiations”

–“Make recommendations to the court concerning any issues that may require resolution in order to facilitate settlement or to efficiently manage the litigation”

–“Communicate ex parte with the court at any time.”

Another example is the Argentina debt cases, in the Southern District of New York, in which the Court creates a mediator role, appoints a mediator, and dubs the mediator a “special master” under Rule 53.  This mediator/settlement master functions with a high level of autonomy and in a proactive manner.

“Judicial Adjuncts”

Special masters under Rule 53 are “judicial adjuncts,” which means they are appointed to assume some of the functions of a judge.

The special master’s “Handbook” (created by the Academy of Court Appointed Masters) explains the role of a “settlement master” (i.e., a mediator) as follows:

–Historical Development:  “The use of settlement masters to reach global settlements in large-scale tort litigation dates back at least to the Dalkon Shield litigation and Agent Orange litigation beginning in the late 1980s.”

–Authority:  “Courts have come to realize that the appointment of a neutral third-party who is granted quasi-judicial authority to act as a buffer between the court and the parties can provide a useful approach to reaching a settlement.”

–Complex and Multi-Party Cases:  “This [usefulness] is especially true in complex litigation involving numerous parties, or when the dispute has matured and individual settlements become repetitive and time-consuming.”

Special Masters and Bankruptcy

It’s interesting to note that the Federal Bankruptcy Rules expressly reject the office of “special master.”   Fed. R. Bankr. P. 9031 is titled, “Masters Not Authorized,” and specifies: “Rule 53 F.R.Civ.P. does not apply in cases under the [Bankruptcy] Code.”

Nevertheless, at least 70% of all bankruptcy courts have local rules authorizing the appointment of mediators.  And bankruptcy courts have a recent history of investing mediators with a proactive role and function, similar to that of the settlement masters appointed in the In re Syngenta case and the Argentina debt cases.

–The prime example of such proactivity in bankruptcy is, of course, the City of Detroit case and the broad authority granted to and exercised by the mediators in that case.

The Future?

It will be interesting to watch, as time progresses, whether the proactive mediator authority granted and exercised in the In re Syngenta case, the Argentina debt cases and City of Detroit bankruptcy case, will become the norm in bankruptcy proceedings.

–My sense is that proactive mediation (like that of a settlement master under Fed.R.Civ.P. 53) is on-its-way to becoming standard practice for large bankruptcy cases — and for smaller cases as well.

 

 

 

 

U.S. Supreme Court: A Tale of Two Certioraris

IMG_0036By Donald L. Swanson

These are the best of times, these are the worst of times for 11 U.S.C. § 546(e).

§ 546(e) provides protection from fraudulent transfer liability in specialized circumstances: e.g., for sales of corporate stock through an intermediary.

The “best of times” are because five circuit courts of appeals construe § 546(e) broadly. The “worst of times” are because two circuit courts disagree and refuse to apply § 546(e) protections when the intermediary is a “mere conduit” and has no financial stake in the transaction.

Such a split of authority among circuit courts is one of the reasons for the U.S. Supreme Court to accept an appeal (i.e., to grant a petition for a writ of certiorari): so it can resolve the split.  And two appeals are currently before the Supreme Court on the same § 546(e) issue.

The First Certiorari

On May 1, 2017, the U.S. Supreme Court grants certiorari to hear an appeal from the Seventh Circuit in Merit Management Group, L.P. v. FTI Consulting, Inc., U.S. Supreme Court Case No. 16-784.

The facts of the case are these:

Valley View Downs and Bedford Downs are competing for a harness-racing license. Rather than fight over one license, Valley View and Bedford agree to combine. So, Valley View pays $55 million (using borrowed money) to purchase all the Bedford shares of stock. The parties use Citizens Bank, as escrow agent, to accomplish the deal.

Then, some bad luck ensues, and Valley View files Chapter 11 bankruptcy.

Thereafter, the bankruptcy estate files a fraudulent transfer suit against Merit Management Group (a 30% Bedford shareholder) to avoid the $16.5 million stock transfer payment (30% of the $55 million) to Merit.

The District Court below rules in favor of Merit under § 546(e). It finds that all elements for protection under § 546(e) exist, including the “made by or to (or for the benefit of) a . . . financial institution” element, because of the escrow agent’s involvement

The Seventh Circuit Court of Appeals then reverses, saying that the “made by or to (or for the benefit of)” element of § 546(e) is not satisfied, despite the escrow agent’s involvement. The Seventh Circuit rules that the escrow agent acted as a mere conduit: i.e., the exchange of payment and stock merely passed “through” the escrow agent – not “by or to (or for the benefit of)” the escrow agent.

The Second Certiorari

On May 1, 2017, the U.S. Supreme Court could also have granted certiorari to hear an appeal from the Second Circuit on the same issue, in Deutsche Bank Trust Company Americas v. Robert R. McCormick Foundation, US. Supreme Court Case No. 16-317. But it doesn’t grant certiorari. It still could – but it hasn’t yet.

The facts of the case are these:

A purchaser acquires all shares of stock in the Tribune Company for $8 billion. To fund the purchase and refinance some existing debt, (i) an investor puts in $315 million as equity, and (ii) Tribune borrows over $11 billion, pledging its assets as security. The parties use a securities clearing agency as intermediary for exchanging the purchase money for the stock shares.

A year later, Tribune files Chapter 11 bankruptcy, with debts exceeding asset values by more than $3 billion. So, unsecured creditors of the Tribune Company sue former stockholders to recover the $8 billion they received. The stockholders raise a § 546(e) defense.

The U.S. District Court dismisses the creditor lawsuits on “standing” grounds: because the bankruptcy estate is already pursuing similar fraudulent transfer claims.

The Second Circuit Court of Appeals disagrees on the “standing” argument but sustains the dismissal, anyway, because of § 546(e).

A Common Legal Question in Both Certiorari Petitions

Here is the question presented to the Supreme Court in the first certiorari petition:

Whether the safe harbor of 11 U.S.C. § 546(e) prohibits avoidance of a transfer made by or to a financial institution, without regard to whether the institution has a beneficial interest in the property transferred, consistent with decisions from the Second, Third, Sixth, Eighth, and Tenth Circuits, but contrary to decisions from the Eleventh Circuit and now the Seventh Circuit.

Here is the same question presented to the Supreme Court in the second certiorari petition:

Whether the 2nd Circuit correctly held – following the U.S. Courts of Appeals for the 3rd, 6th, and 8th Circuits, but contrary to the U.S. Courts of Appeals for the 7th and 11th Circuits – that a fraudulent transfer is exempt from avoidance under 11 U.S.C. § 546(e) when a financial institution acts as a mere conduit for fraudulently transferred property, or whether instead the safe harbor applies only when the financial institution has its own beneficial interest in the transferred property;

So . . . why did the Supreme Court grant certiorari in the first case above and not grant certiorari [or delay the grant] in the second case above? Only they know for sure.

This is a Good Thing

In light of the grant of certiorari in the first case, I hope they don’t grant it in the second case. This would be a good thing.  Here’s why.

The fact context and legal question in the first case are clear, precise and narrow. There is only one question presented: Do § 546(e) protections apply to a mere conduit? And there is no better example of a mere conduit than an escrow agent. So, if the Supreme Court answers, “Yes,” the mere conduit issue will be resolved. And if the Supreme Court answers, “No,” the only questions remaining will be on how to distinguish between a mere conduit and an intermediary with a beneficial interest. There is little danger of the Supreme Court providing an analysis that has unexpected and unintended consequences in other contexts.

The fact context and legal questions in the second case are, on the other hand, more complex and broad. For example:

–There are two additional questions presented. One deals with whether “the presumption against federal pre-emption of state law” applies “in the bankruptcy context.” The other is whether “it is for Congress, and not the courts, to balance the multiple purposes of the Bankruptcy Code, and that courts must therefore rely first and foremost on the text of the code.” These are broad and far-ranging questions that, if answered directly, could have unexpected and unintended consequences in many other contexts.

–Whether the Supreme Court answers, “Yes” or “No,” on either of the two additional questions, we will all be left wondering what the extent and limits and exceptions to that answer might be. It will be like the Supreme Court’s simple “No” answer to a complex question in the recent In re Jevic case, which raises other questions that appear to be unexpected and unintended.

Some have suggested that the new Supreme Court Justice, Neil Gorsuch, is the deciding vote on whether certiorari is granted in the second case above. Hopefully, we are seeing evidence that his vote is, “No.”

“The Walls of the Mediation Room are Remarkably Transparent”: From a Study on Mediation Confidentiality

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Remarkably Transparent Walls

By Donald L. Swanson

“In sum, the walls of the mediation room are remarkably transparent.”

— James Coben & Peter Thompson

The State of California is studying mediation confidentiality in the context of legal malpractice disputes.

Suprise # 1

A surprise of the study is from a 2006 law review article by Coben and Thompson titled,  Disputing Irony: A Systematic Look at Litigation About Mediation.  The surprise is this:

In actual practice, mediation confidentiality is often ignored.

Coben and Thompson reach the following conclusions in their article:

–there is a “large volume” of reported court opinions in which “courts considered detailed evidence of what transpired in mediations without a confidentiality issue being raised—either by the parties or sua sponte by the court.”

–“uncontested mediation disclosures occurred in thirty percent of all decisions in the database, cutting across jurisdiction, level of court, underlying subject matter and litigated mediation issues.”

–Disclosures of mediation information in court include:

forty-five opinions in which mediators offer testimony,

sixty-five opinions where others offer evidence about mediators’ statements or actions, and

266 opinions where parties or lawyers offer evidence of their own mediation communications and conduct

And all of these disclosures are “without objection or comment.”

So much for confidentiality as a highest-priority in mediation cases.

Surprise # 2

Here is another surprising set of findings by Coben and Thompson:

“Courts expressly refused to protect mediation confidentiality in sixty opinions.”

Of those sixty, “few” involve “a reasoned weighing of the pros and cons of compromising the mediation process.”

Instead, the “admissibility or discovery of mediation information” is “routinely justified” on such grounds as:

–waiver and consent

–the information is not “confidential”

–the process is “not mediation”

–the provider of the evidence is “not a mediator”

–the evidence is offered “for a permissible purpose”

–the evidence is “not material” or its introduction “constituted harmless error.”

Conclusion

Total or nearly-complete confidentiality in mediation is far from reality.  Should something be done about this?

 

The U.S. Supreme Court and Funny-Money in Credit Bidding Auctions

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Footnote No. 2 in Supreme Court’s RadLAX Opinion

By: Donald L. Swanson

The U.S. Supreme Court has a penchant for rulings that, as a practical matter, screw up our bankruptcy world. The most recent example is the Supreme Court’s March 22, 2017, ruling in the In re Jevic case [see this article].

Another case, where the U.S. Supreme Court did us no favors in the practical world of bankruptcy, is In re RadLAX Gateway Hotel, LLC,, 132 S.Ct. 2065 (2012).  This RadLAX case deals with credit bidding by a secured creditor at a bankruptcy auction.

Credit bidding is defined as a secured creditor bidding its existing debt, instead of new cash, at an auction of its collateral.

RadLAX involves a bankruptcy auction of all debtor’s assets, consisting of a hotel and parking garage with related furnishings and equipment. The debtor’s primary lender holds a $142 million secured claim against all asset. The RadLAX debtor asks that credit bidding rights of the secured creditor be limited. The bankruptcy court rejects this request, as does the Court of Appeals. And the U.S. Supreme Court affirms.

Such a result is neither surprising nor unexpected. But the Supreme Court’s analysis in a near-unanimous opinion is disappointing in this respect: it provides a one-sided explanation of credit bidding.

The Court describes (in footnote no. 2–see photo above) how credit bidding protects a creditor “against the risk that its collateral will be sold at a depressed price.” While this description is certainly true, it’s not the whole story.

What the Court fails to mention is that credit bidding can have a funny-money component, in which an under-secured creditor bids far beyond the market value of its collateral—to the disadvantage and damage of everyone else. This is a pathology: it’s a defect in our bankruptcy system.

Credit Bidding and Funny-Money

Bankruptcy is very good at a few things. One of those things is selling a debtor’s assets.

Bankruptcy sales work well because buyers know the sale will actually happen and will be, (i) free and clear of liens and encumbrances, and (ii) governed by the market value of assets. This knowledge gives buyers confidence to spend time, effort, and money on preparations for bidding and to show up at the auction ready to bid.

Such confidence evaporates, however, when credit bidding by an under-secured creditor is involved: when the value of  the creditor’s collateral is less than the creditor’s remaining loan balance.

Credit bidding gets out-of-whack when an under-secured creditor has an incentive to credit bid more than the market value of its collateral. This is “bidding funny-money.”

–If, for example, a creditor has a $100,000 loan balance, but its collateral has a market value of only $50,000, this creditor might have an incentive to bid more than $50,000—that’s the funny-money. The creditor knows it has a bidding advantage, because the creditor is bidding dollars it will never recover (i.e., the funny-money) against real-dollar bids from others.

–Reasons for a secured creditor’s funny-money bid might include, (i) testing how high other bidders will actually go, (ii) wanting to re-market the collateral later, or (iii) preventing someone else from getting the collateral.

Competing bidders understand this funny-money problem. So, they tend to back-away from sales where credit bidding can occur. This is a huge problem. It chills competitive bidding and accounts for many failed bankruptcy auctions.

A Funny-Money Example

Here’s an example of a funny-money credit bid that actually happened:

There is a bankruptcy auction of a closed-down processing facility in the upper Midwest. Extensive advertising efforts result in a $13 million opening cash bid from a highly qualified buyer, who intends to reopen the facility immediately and start employing many people, purchasing huge quantities of goods and services, paying large amounts of Federal, state, and local taxes, etc. Whereupon, the under-secured creditor counters with a $32 million credit bid . . . and that’s the end of the auction. Thereafter, the facility remains closed for a long time.

There is no way this facility had a fair market value, in that auction, anywhere near the $32 million credit bid. Why did the secured creditor make such a high bid? Only they know. But the immediate effect of their bid is to bury any possibility of an ongoing business that would maximize value for many, many people.

This lender presents a funny-money credit bid. And everyone else pays a heavy price in lost opportunities!

The RadLAX Analysis

The Supreme Court’s analysis in its RadLAX opinion is, almost entirely, a grammatical parsing of Bankruptcy Code language. For example, the Court writes:

“The general/specific canon [of statutory interpretation] is perhaps most frequently applied to statutes in which a general permission or prohibition is contradicted by a specific prohibition or permission. To eliminate the contradiction, the specific provision is construed as an exception to the general one. . . . But the canon has full application as well to statutes such as the one here, in which a general authorization and a more limited, specific authorization exist side-by-side. There the canon avoids not contradiction but the superfluity of a specific provision that is swallowed by the general one, “violat[ing] the cardinal rule that, if possible, effect shall be given to every clause and part of a statute.”

I’m fine with this kind of analysis, of course. Heck, they know vastly more than I about such things.

A Disappointment

But what’s disappointing is this:

Not once does the Supreme Court opinion, in RadLAX, even mention the need for market-driven bidding in bankruptcy auctions to maximize value for everyone.  And not once does the Supreme Court give even a nod-of-the-head or of-the-keyboard to the funny-money problem.

–And that’s despite references in the opinion to such statutory criteria as, (i) “common sense” in interpreting §1129(b)(2)(A), (ii) a “fair and equitable” standard for plan confirmation, and (iii) limiting credit bidding rights “for cause” under § 363(k).

In a ruling like RadLAX, it would be helpful to know that the Justices, (i) acknowledge the existence of the funny-money component of credit bidding, and (ii) are making a conscious choice in favor of continuing the funny-money pathology over a more market-driven approach.  Otherwise, it looks like they don’t understand what happens out here in the real world of day-to-day bankruptcy cases—or don’t care.

Surely there is a better way?

In re SunEdison: Mandatory Mediation to the Rescue?

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A Rescue

By:  Donald L. Swanson

Whereas, mediation may provide an opportunity to consensually resolve the Mediation Issues . . . It Is Therefore, Ordered” that “Representatives of the following parties and their counsel are directed to attend the Mediation in person: (i) the Debtors, (ii) the Committee, . . . [etc.] . . .

Stuart M. Bernstein, U.S. Bankruptcy Judge (In re SunEdison, Doc. 2795, Case No. 16-10992, S.D.N.Y., 04/18/17).

SunEdison has been in Chapter 11 bankruptcy for a year (since April 21, 2016). One of the major issues in the case involves preference, fraudulent transfer and related avoidance claims against a group of businesses with insider-type connections to SunEdison.

The Official Committee of Unsecured Creditors in the SunEdison case explains the avoidance claims and issues like this (in Doc. 2666):

“It is undisputed that recoveries on account of the Avoidance Actions inure to the benefit of – and may be one of only a very few sources of recovery for – unsecured creditors.”

The avoidance claims are based on this information: “while Debtors were insolvent,” the insider-type entities received valuable assets from SunEdison, consisting of “completed energy projects, services and payments worth hundreds of millions, if not billions, of dollars, for which the Debtors did not receive reasonably equivalent value in exchange.” [Emphasis added.]

SunEdison proposes to resolve the avoidance claims by a settlement with its insider-type businesses and allocating $16.1 million from the settlement funds to unsecured creditors. The Committee objects to this “mere $16.1 million” amount, contending that, (i) additional discovery is needed to fully evaluate the settlement, and (ii) the Committee should be allowed to pursue such claims, rather than allowing SunEdison to dictate the terms of a settlement with its insiders.

Last week, Judge Bernstein orders this set of disputes into mediation.

–Time will tell how this mandated mediation plays out: can it provide a rescue?

–The stakes are high: back on March 7, 2017, during a hearing in open Court, the Judge says, “if there isn’t some resolution of the allocation issue by whatever the deadline is, it may be that’s the end of the case.”

It will be interesting to see whether the mediator, the parties and their counsel are up to the rescue challenge.