How, Decades Ago, the U.S. Supreme Court Screwed-Up Our Bankruptcy World — Twice

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Screwed-Up

By: Donald L. Swanson

Here are two declarations of law, by the U.S. Supreme Court and from decades ago, that screwed-up our bankruptcy world — all the way to present:

“The bankruptcy power, like the other great substantive powers of Congress, is subject to the Fifth Amendment.”

Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555, 589 (1935); and

“where Art. III does apply, all of the legislative powers specified in Art. I and elsewhere [including the “Bankruptcies” power] are subject to it.”

Northern Pipeline v. Marathon Pipe Line, 458 U.S. 50, 73 (1982).

Here’s what’s common about these two declaration:

They make the U.S. Constitution’s “Bankruptcies” power “subject” and inferior to another power in the Constitution;

They move the analysis of bankruptcy issues away from the Constitution’s “Bankruptcies” power and into another part of the Constitution; and

They emasculate the Constitution’s “Bankruptcies” power.

Why, oh why, did the Court in these two cases fail to say something more like:

“In resolving bankruptcy issues under the ‘Bankruptcies’ clause, due process must be protected”; or

“In determining the scope of bankruptcy court jurisdiction and authority under the ‘Bankruptcies’ clause, Article III must be considered”?

Instead, their “subject to” declarations in both cases create simple (and simplistic) answers to complex questions—and create many more issues and problems than they solve.

Further, the “subject to” declarations distort the judicial focus: away from practicalities of what’s “best” for bankruptcy law (within the context of the entire Constitution) to doctrinaire positions on what’s “right.”

–In today’s world of business, credit and insolvency complexities, that’s bad for bankruptcy law!

Let’s look at the two cases.

Lousiville Joint Stock Land Bank v. Radford

The question in Radford is this: Whether subsection § 75(s) of the Bankruptcy Act “is consistent with the Federal Constitution”?

–The Case

Mr. and Mrs. Radford mortgaged their farm to a Bank. The farm had 170 acres valued at $18,000. The mortgage secured loans of $9,000 at 6% interest, payable in 34 annual installments.

Thereafter, the Bank declared a default and filed a foreclosure action.

The Radfords sought help under § 75(s) of the Bankruptcy Act, “praying” for an opportunity to reorganize their debts. Section 75(s) provides “alternative options” for dealing with mortgaged property, which include:

1. The bankrupt may, with mortgagee consent, purchase the property at its appraised price in deferred payments, with interest, as provided by § 75(s); or

2. If mortgagee won’t consent, the bankruptcy court will “stay all proceedings for a period of five years” while debtor retains possession and pays “a reasonable rental annually,” whereupon, the debtor may pay into court the appraised (or reappraised) price of the property to obtain full title—and also receive a discharge.

The Bank objected, claiming these bankruptcy alternatives to be unconstitutional. Such objections were overruled, and the § 75(s) bankruptcy process moved forward.

–Supreme Court’s Response

On appeal, the Supreme Court reached this conclusion:

–§ 75(s) is “void” because the Fifth Amendment commands that private property shall not be taken “without just compensation.”

And it added this odd-sounding statement:

–“If the public interest requires” the “taking of property of individual mortgagees” for the benefit of individual mortgagors, “resort must be had to proceedings by eminent domain” so that “the burden of the relief afforded in the public interest may be borne by the public.”

The Supreme Court identified the following “private property” that § 75(s) unconstitutionally “takes” from the Bank:

1. “The right to retain the lien until the indebtedness thereby secured is paid.”
2. “The right to realize upon the security by a judicial public sale.”
3. “The right to determine when such sale shall be held, subject only to the discretion of the court.”
4. “The right to protect its interest in the property by bidding at such sale.”
5. “The right to control” the property after default, “subject only to the discretion of the court,” and to collect the rents and profits toward satisfaction of the debt.

Walking-Back the Radford Result

After Radford, the Supreme Court began walking-back the details of its decision. Here are two examples:

1. Two years later, the Supreme Court unanimously declared § 75(s) (in substantially-the-same form) to be perfectly proper and constitutionally permissible:

–“we are of opinion that the provisions of subsection (s) [of § 75] make no unreasonable modification of the mortgagee’s rights, and hence are valid” (Wright v. Vinton Branch, 300 U.S. 440, 470 (1937)); and

2. Nearly five decades later (in 1983), Prof. James S. Rogers [Fn. 1] contends that the Radford ruling had evolved and that its “subject to” declaration had “crystallized” into this proposition:

–“any impairment of the liquidation value of a secured creditor’s collateral” by a bankruptcy law, “in the absence of just compensation,” violates “the takings clause of the fifth amendment.” [Fn. 2.]

Perhaps that crystallization is a good place to end, but:

Did it require an elevation of the Fifth Amendment over the “Bankruptcies” clause to get there? and

Couldn’t the same result have been achieved under the “Bankruptcies” clause alone?

Negative Fallout From Radford’s “subject to” Declaration

Here’s what Prof. James S. Rogers says about the impact of Radford’s “subject to” declaration:

“Perhaps more by dint of repetition than by analysis,” Radford’s “subject to the Fifth Amendment” statement has become “an accepted proposition of reorganization law”;

“Virtually every discussion of the problem includes a reference to” that declaration; and

Radford is “entirely unsound” because it creates a false assumption that “the proper treatment of secured creditors” in bankruptcy “is dictated by constitutional requirements rather than by policy considerations that are within the discretion of Congress.” [Fn. 4.]

–A Current Example

Here’s an example—from today—of the negative fallout from Radford’s “subject to” declaration:

–a creditor has a nearly-sacred right to bid the under-secured portion of its secured claim at a bankruptcy auction.

As a result of the “subject to” declaration in Radford, the Bankruptcy Code (§ 363(k)) and the courts still enforce the following proposition:

–An under-secured creditor must be allowed to bid the under-secured portion of its secured claim at a bankruptcy auction—as if it is bidding real and valuable dollars.

Yet the reality is this:

–Those under-secured dollars often have no real value, are commonly referred to as “funny money,” and can be akin to Monopoly money.

That’s bad bankruptcy policy. But it’s what we get when the Supreme Court supplants practicalities under the “Bankruptcies” clause with a doctrinaire requirement under another provision of the Constitution.

Northern Pipeline v. Marathon Pipe Line

Similarly, the Supreme Court in its 1982 decision in Northern Pipeline v. Marathon Pipe Line made a doctrinaire ruling in declaring the “Bankruptcies” power “subject to” Article III.

A dissenting opinion in Northern Pipeline explicitly emphasizes the narrow effect of the plurality and concurring opinions in that case. Yet, the “subject to” declaration stuck, creating confusion for decades — and to the present time.

In more recent times, the Supreme Court has been chipping away at Northern Pipeline’s “subject to” declaration (see, e.g., dissent in Stern v. Marshall and majority opinion in Wellness International).

Yet, Supreme Court opinions on bankruptcy law, involving Article III, still tend to be doctrinaire, rather than practical:

They fail to even mention the Constitution’s “Bankruptcies” clause, let alone analyze a relationship between that clause and Article III;

There is angst among some judges about a slippery slope eroding Article III with no place to stop [but what about the “Bankruptcies” clause itself—doesn’t that provide a limitation?]; and

There is a tendency [if not a tenet] that practicalities must be ignored, in favor of doctrinaire Article III positions:

–Supreme Court majorities, for example, have proclaimed a danger of bankruptcy judge subservience to the political branches — without even considering whether bankruptcy judges might, actually, be independent.

All of this is bad policy, and it screws up our bankruptcy world — unnecessarily.

Conclusion

The Supreme Court has prevented Congress from fully exercising its “Bankruptcies” power under the U.S. Constitution—by such opinions as Radford and Northern Pipeline.

It created, instead, doctrinaire limitations on Congress’s “Bankruptcies” power—by declaring such power to be “subject to” other provisions of the Constitution.

These doctrinaire limitations have screwed-up our bankruptcy world—for many decades.

Wouldn’t it be nice if the Supreme Court could extricate itself from doctrinaire positions and allow Congress to address the pressing needs of business, credit and bankruptcy realities—as the framers of the Constitution intended!

Footnote 1: The article is by Prof. James Steven Rogers, is titled “The Impairment of Secured Creditors’ Rights in Reorganization: A Study of the Relationship Between the Fifth Amendment and the Bankruptcy Clause,” and is published at 96 Harvard Law Review, 973-1031 (March 1983).
Footnote 2: Id., at 977.
Footnote 3: Id.
Footnote 4: Id., at 977, 78 & 79 (emphasis added).

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