A Unified Theory of Bankruptcy Court Jurisdiction: Wellness International v. Sharif

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A unified view

By Donald L. Swanson

Federal courts in the U.S. bankruptcy system have been struggling for decades with the extent and limits of bankruptcy court jurisdiction under the U.S. Constitution.

The difficulty begins with Articles I and III of the U.S. Constitution:

–Article I, Section 8, says:

“The Congress shall have power to . . . establish . . . uniform laws on the subject of bankruptcies throughout the United States.”

–Article III, Section 1, says:

“The judicial power of the United States, shall be vested in one Supreme Court, and in such inferior courts as the Congress may from time to time ordain and establish. The judges . . . shall hold their offices during good behaviour, and shall, at stated times, receive for their services, a compensation, which shall not be diminished during their continuance in office.”

The problem arises because bankruptcy courts are established under Article I (not under Article III), yet the end product of a bankruptcy court’s efforts is a judicial decision. So, we have an Article I judge serving an Article III – type role. This creates a separation-of-powers (between Congress and the judiciary) issue, and separation-of-powers is a crucial part of the constitutional system in these United States.

A Headache

This separation-of-powers issue has created, over many years, a headache for nearly everyone dealing with it. In the latest pronouncement on the issue by the U.S. Supreme Court (in Wellness International v. Sharif, decided May 26, 2015), we get a sense of that headache.

–The issue in Wellness is whether a bankruptcy court can hear and resolve the claim that a business entity is an alter ego of the bankruptcy debtor. The dissenting opinion authored by Chief Justice Roberts explains how the bankruptcy court, (i) has no constitutional authority to resolve a fraudulent transfer claim, but (ii) does have constitutional authority to resolve an alter ego claim.

[Editorial  Note: This minute distinction illustrates the technical difficulties involved.]

–The dissenting opinion authored by Justice Thomas emphasizes, (i) the difficulties and complexities of issues surrounding the constitutional authority of bankruptcy courts to issue judicial rulings, (ii) the need to grapple with and resolve these difficulties and complexities, and (ii) the failure of the majority opinion to do so in the Wellness case.

–The majority opinion rules that bankruptcy courts have authority to resolve all the types of disputes that Congress has assigned to it when the parties consent, either explicitly or by implication, to that authority.

–The majority opinion describes any constitutional concerns over its consent ruling as “de minimis”; while the dissenting opinion authored by Chief Justice Roberts sees great constitutional peril in the majority’s jurisdiction by consent ruling – it’s a slippery-slope type of concern he is expressing; and the dissenting opinion authored by Justice Thomas sees a middle ground in which the Supreme Court needs to grapple with and resolve the difficulties and complexities involved.

As a practical matter, the Wellness International ruling should resolve most constitutional issues on bankruptcy court authority. But it’s still troubling that there is no complete-consensus, on the U.S. Supreme Court, for a unified constitutional theory of bankruptcy court authority.

[Editorial Note:  It will be interesting to see how Justice Gorsuch fits into all of this.]

The Justice Thomas dissent describes the problem like this:

Modern bankruptcy courts “adjudicate a far broader array of disputes than their earliest historical counterparts. And this Court has remained carefully noncommittal about the source of their authority to do so.”

A Unified Theory

But it seems that the U.S. Supreme Court has, in fact, provided a unified theory of bankruptcy court jurisdiction in the Wellness International v. Sharif opinion. Here are the elements of that theory.

1. The source of authority is the specific “bankruptcies” reference in Article I of the Constitution;

2. Congress has properly expanded on the specific reference in Article I by making bankruptcy courts and bankruptcy judges a “unit” of the Article III district courts and subject to Article III control;

3. Congress has properly allocated the division of labor between Article III district courts and their bankruptcy court units, with the core/non-core and “related to” distinctions and the “proposed findings of fact and conclusions of law” mechanism; and

4. Stern v. Marshall issues are a limited exception to the proper allocation, but bankruptcy courts can still address these issues by consent of the parties or by “proposed findings and conclusions” to the district court.

Why wouldn’t these elements work as a unified theory? Answer: They should, according to the Supreme Court majority.

Why do we need to continue grappling with such history-based distinctions as public rights v. private rights that create confusion and difficulty? Answer: We don’t, according to the Supreme Court majority.

And how could this unified theory degenerate into the slippery-slope problem that Chief Justice Roberts envisions? Answer: It shouldn’t, according to the Supreme Court majority.

Remaining Constitutional Authority Question

The only remaining constitutional authority question is this:

–Which issues still require “de novo” review (absent consent of the parties) under Stern v. Marshall, rather than a deferential review as a final judicial order?

Surely this narrow question can be resolved with dispatch and efficiency.

Conclusion

It looks like a unified theory of bankruptcy court jurisdiction is now provided by the U.S. Supreme Court!

Justice Neil Gorsuch Authors His First Opinion as Justice of the U.S. Supreme Court

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Supreme Court Justice Neil Gorsuch, with his wife Louise (photo from The Denver Post)

By Donald L. Swanson

The case is Henson v. Santander Consumer USA Inc., U.S. Supreme Court Case No. 16-349, decided June 12, 2017.  The case is on appeal from the Fourth Circuit Court of Appeals.  The question is whether the Fair Debt Collection Practices Act applies when you “purchase a debt and then try to collect it for yourself.”

The Fourth Circuit says the Act does not apply in such a circumstance.  And the unanimous opinion of the Supreme Court affirms the Fourth Circuit’s ruling.

The Henson v. Santander opinion is written by the newest member of the Supreme Court, Justice Neil Gorsuch.  And this is his first written opinion as a Supreme Court Justice.

Henson v. Santander is a companion case to the recently-decided Midland Funding v. Johnson opinion by the U.S. Supreme Court on a consumer bankruptcy issue under the Fair Debt Collection Practices Act (see this article on the Midland Funding decision).

The following are excerpts from the new Henson v. Santander opinion that provide a flavor of Justice Gorsuch’s writing style and analysis.

The Act

“Disruptive dinnertime calls, downright deceit, and more besides drew Congress’s eye to the debt collection industry” and resulted in “the Fair Debt Collection Practices Act, a statute that authorizes private lawsuits and weighty fines designed to deter wayward collection practices.”

The Issue

“So perhaps it comes as little surprise that we now face a question about who exactly qualifies as a ‘debt collector’ subject to the Act’s rigors. Everyone agrees that the term embraces the repo man—someone hired by a creditor to collect an outstanding debt. But what if you purchase a debt and then try to collect it for yourself—does that make you a ‘debt collector’ too? That’s the nub of the dispute now before us.”

Common Ground

Everyone agrees on the facts of the case and that Santander, as purchaser of CitiFinancial loans, “sought to collect in ways petitioners believe troublesome under the Act.”

Everyone also agrees that “third party debt collection agents generally qualify as ‘debt collectors’” under the Act, “while those who seek only to collect for themselves loans they originated generally do not.”  So, “[a]ll that remains in dispute is how to classify individuals and entities who regularly purchase debts originated by someone else and then seek to collect those debts for their own account.”

Textual Analysis

“[W]e begin, as we must, with a careful examination of the statutory text. . . . [T]he Act defines debt collectors to include those who regularly seek to collect debts ‘owed . . . another.’ And by its plain terms this language seems to focus our attention on third party collection agents working for a debt owner—not on a debt owner seeking to collect debts for itself.  . . . All that matters is whether the target of the lawsuit regularly seeks to collect debts for its own account or does so for ‘another.’”

Petitioners’ Arguments on Statutory Construction

“Petitioners reply that this seemingly straightforward reading overlooks an important question of tense. They observe that the word ‘owed’ is the past participle of the verb ‘to owe.’ And this, they suggest, means the statute’s definition of debt collector captures anyone who regularly seeks to collect debts previously ‘owed . . . another.’  . . . If Congress wanted to exempt all present debt owners from its debt collector definition, petitioners submit, it would have used the present participle ‘owing.’”

“But this much doesn’t follow even as a matter of good grammar, let alone ordinary meaning. Past participles like ‘owed’ are routinely used as adjectives to describe the present state of a thing—so, for example, burnt toast is inedible, a fallen branch blocks the path, and (equally) a debt owed to a current owner may be collected by him or her.  . . . Just imagine if you told a friend that you were seeking to ‘collect a debt owed to Steve.’ Doesn’t it seem likely your friend would understand you as speaking about a debt currently owed to Steve, not a debt Steve used to own and that’s now actually yours?”

“Looking to other neighboring provisions in the Act, it quickly comes clear that Congress routinely used the word ‘owed’ to refer to present (not past) debt relationships. For example, in one nearby subsection, Congress defined a creditor as someone ‘to whom a debt is owed.’  . . . In another subsection, too, Congress required a debt collector to identify ‘the creditor to whom the debt is owed.’ . . . Yet petitioners offer us no persuasive reason why the word ‘owed’ should bear a different meaning here.”

“Congress expressly differentiated between a person ‘who offers’ credit (the originator) and a person ‘to whom a debt is owed’ (the present debt owner). . . . Elsewhere, Congress recognized the distinction between a debt ‘originated by’ the collector and a debt ‘owed or due’ another. . . . And elsewhere still, Congress drew a line between the ‘original’ and ‘current’ creditor. . . . Yet no similar distinction can be found in the language now before us.”

Petitioners argue that “debt purchasers surely qualify as collectors at least when they regularly purchase and seek to collect defaulted debts—just as Santander allegedly did here.”  They “point again to the fact that the statute excludes from the definition of ‘debt collector’ certain persons who obtain debts before default.”  This exclusion, they suggest, “implies that the term ‘debt collector’ must embrace those who regularly seek to collect debts obtained after default.”

The Court rejects this argument.  “For while the statute surely excludes from the debt collector definition certain persons who acquire a debt before default, it doesn’t necessarily follow that the definition must include anyone who regularly collects debts acquired after default. After all and again, under the definition at issue before us you have to attempt to collect debts owed another before you can ever qualify as a debt collector.”

Petitioners’ Arguments on Congressional Intent

“Faced with so many obstacles in the text and structure of the Act, petitioners ask us to move quickly on to policy. Indeed, from the beginning that is the field on which they seem most eager to pitch battle.”

“Petitioners assert that Congress passed the Act in large measure to add new incentives for independent debt collectors to treat consumers well. In their view, Congress excluded loan originators from the Act’s demands because it thought they already faced sufficient economic and legal incentives to good behavior. But, on petitioners’ account, Congress never had the chance to consider what should be done about those in the business of purchasing defaulted debt. That’s because, petitioners tell us, the ‘advent’ of the market for defaulted debt represents ‘one of the most significant changes’ to the debt market generally since the Act’s passage in 1977.”

“[W]e will not presume with petitioners that any result consistent with their account of the statute’s overarching goal must be the law but will presume more modestly instead ‘that [the] legislature says . . . what it means and means . . . what it says.’”

“In the end, reasonable people can disagree with how Congress balanced the various social costs and benefits in this area. . . . After all, it’s hardly unknown for new business models to emerge in response to regulation, and for regulation in turn to address new business models. Constant competition between constable and quarry, regulator and regulated, can come as no surprise in our changing world. But neither should the proper role of the judiciary in that process—to apply, not amend, the work of the People’s representatives.”

Conclusion

“The judgment of the Court of Appeals is Affirmed.”

U.S. Congress and Supreme Court Support ADR — But Some Bankruptcy Courts Remain Nonconformist on Mediation

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Nonconformity

By Donald L. Swanson

There is “a kind of ‘hostility to arbitration’ that led Congress to enact” the Federal Arbitration Act.

Kindred Nursing Centers v. Clark, U.S. Supreme Court Case No. 16-32 (decided May 15, 2017).

Alternative dispute resolution processes (“ADR”) include arbitration and mediation.

Arbitration

Congress passed the Federal Arbitration Act (“Arbitration Act”) to promote the use of arbitration for resolving disputes that would, ordinarily, be filed in state and Federal courts and to eliminate opposition to arbitration. And in the Kindred Nursing Centers v. Clark opinion, the U.S. Supreme Court upheld, last month, the broad reach and effectiveness of the Arbitration Act against challenges under Kentucky’s State Constitution.

Mediation

Similarly, Congress passed the Alternative Dispute Resolution Act of 1998 (“Mediation Act”) to promote the use of mediation in Federal courts and to eliminate opposition to mediation. The U.S Supreme Court has yet to rule upon the effectiveness of the Mediation Act, but the Supreme Court would, undoubtedly, support the Mediation Act’s statutory requirements for mediation in the same manner the Court is supporting statutory requirements for arbitration in Kindred Nursing Centers v. Clark.

The Mediation Act requires U.S. district courts, and their bankruptcy units, to establish local rules for, (i) promoting the use of mediation in their courts, and (ii) providing for mediation confidentiality.

Yet, some bankruptcy judges remain hostile to the use of mediation in their courts, or they are indifferent: seeing little value in mediation. Such hostility and indifference are reflected in the following three examples.

1.  A Bankruptcy Judge in Texas declares in open court that he does not like mediation, believes mediation is a waste of time and money, and is unlikely to approve mediation under any circumstances.

2.  The bankruptcy district in Northern Illinois (Chicago) recently revokes its existing local rules on mediation (including confidentiality provisions) as “unnecessary.”

3.  Approximately 70% of all bankruptcy districts have adopted some type of local rule on mediation. The rest, however, haven’t. And judges in the don’t-have districts often earn a reputation for being indifferent, or even hostile, to mediation.

In light of the requirements of the Mediation Act, each of these three examples seems out-of-place, at a minimum, and in violation of Federal law, when viewed in a less-generous light.

Moreover, the absence of local mediation rules in approximately 30% of all bankruptcy districts is particularly troubling because of the existence of such resources as the Model Local Rules on Mediation and the accompanying Commentary offered by the American Bankruptcy Institute.

How can this be!!

What Happens to Fraudulent Transfer Claims When Barred by Bankruptcy’s Two-Year Statute of Limitations?

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Are the claims dead and buried?

By Donald L. Swanson

Two Hypotheticals and a Question:

First Hypothetical: Debtor makes a fraudulent transfer shortly before filing Chapter 7 bankruptcy. The Chapter 7 Trustee refuses to pursue the fraudulent transfer claim, and the Bankruptcy Code’s two-year statute of limitations expires.

Second Hypothetical: Debtor makes a fraudulent transfer shortly before filing Chapter 11 bankruptcy. The Chapter 11 debtor continues in possession, without appointment of an official committee. The Bankruptcy Code’s two-year statute of limitations expires, without any effort to pursue the fraudulent transfer claim.

A Question: What happens to the fraudulent transfer claims in these hypotheticals after expiration of the two-year statute of limitations?

U.S. District Court’s Answer

The answer from one U.S. District Court is this: the fraudulent transfer claims “automatically revert” to creditors, who may then pursue those claims in state court. Here’s the District Court’s analysis:

“Because creditors’ avoidance claims are not property of the estate, the trustee has a limited time in which to bring them,” and “when the two-year limitation on trustee avoidance claims expires, the claims automatically revert” to creditors.

In re Tribune Company Fraudulent Conveyance Litigation, Multidistrict Litigation No. 11 MD 2296, 499 B.R. 310  (S.D.N.Y. 2013).

The District Court cites three cases to support its answer.

First case – A farm equipment dealership:

In re Integrated Agri, Inc., 313 B.R. 419, 427-28 (Bankr. C.D.Ill. 2004).  In this Chapter 7 case the trustee files a fraudulent transfer action after expiration of the Bankruptcy Code’s two-year statute of limitations. The court rules that, once the trustee’s claim is prohibited by expiration of the statute of limitations, a creditor “regains standing to pursue a state law fraudulent conveyance action, in its own name and for its own benefits.”

Second case – An embezzler:

Klingman v. Levinson, 158 B.R. 109, 113 (N.D. Ill. 1993). The Defendant embezzeles money, and Plaintiff sues. Levinson files bankruptcy but does not receive a discharge of Plaintiff’s claim. Levinson’s bankruptcy trustee does not pursue any fraudulent conveyance claim. Accordingly, the court rules: “The trustee’s exclusive right to maintain a fraudulent conveyance action expires and creditors may step in (or resume actions) when the trustee no longer has a viable cause of action.”

Third case – A murderer:

In re Tessmer, 329 B.R. 776, 779 (Bankr. M.D. Ga. 2005). Ethel Tessmer kills her husband. After her conviction for felony murder, she transfers her interest in real estate to her parents. Then the former mother-in-law sues her for wrongful death, and the murderer files Chapter 7 bankruptcy. The bankruptcy case then follows “a somewhat tortured path,” involving a court-approved settlement of the fraudulent transfer claim, the grant of a discharge to debtor, and considerable litigation over the legal effects of such events, which result “in a great deal of confusion.” However, the Court determines that the trustee’s settlement prevents further action by the mother-in-law: “[C]reditors do not regain the right to sue unless the trustee abandons the claim or he no longer has a viable cause of action because, for example, the statute of limitations has run.”

Appeal to Second Circuit

On appeal, the Second Circuit Court of Appeals rejects the District Court’s answer above in a § 546(e) defense context. Here is what the Second Circuit says:

–The inference is that, if the two-year statute of limitations is not met by the bankruptcy estate, the fraudulent transfer claims “revert” to creditors “in full flower,” who may then pursue their own state law fraudulent transfer actions.

–This inference “finds no support in the language of the [Bankruptcy] Code” or its “purposes” and is a ”glaring anomaly.”

However, the Second Circuit limits its ruling on this “revert to creditors” issue to the § 546(e) context before it:

–“We resolve no issues regarding the rights of creditors to bring state law, fraudulent conveyance claims” outside the § 546(e) context.

Appeal to U.S. Supreme Court

The Second Circuit’s ruling in this case is, currently, the subject of a Petition for a Writ of Certiorari to the U.S. Supreme Court in the case of Deutsche Bank Trust Company America v. Robert R. McCormick Foundation, Supreme Court Case No. 16-317. The Supreme Court has yet to rule on this Petition.

It will be interesting to see if, and how, the U.S. Supreme Court addresses this fraudulent transfer issue.

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.

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.

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 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?

New Supreme Court Justice Neil Gorsuch Will be Good for Bankruptcy Law

Trump Supreme Court
New Supreme Court Justice Neil Gorsuch, with wife Louise (photo from The Denver Post)

By: Donald L. Swanson

The only things I know about Judge (now Justice) Neil Gorsuch are from what I’ve read in two contexts:

  1. His rating by the American Bar Association’s Standing Committee on the Federal Judiciary, which voted unanimously to give its best possible rating to Judge Gorsuch as a Supreme Court nominee; and
  2. Five bankruptcy opinions he authored as a Tenth Circuit Judge.

Based on these five opinions, I can appreciate why the American Bar Association gave him their best possible rating.

By the way, I try to ignore national politics as much as possible because it seems, many days, that national politics is a vicious business, worthy of contempt on all sides of the partisan divides.

Fortunately, bankruptcy issues rarely provide fodder for partisan disputes.  It’s difficult, for example, to get conservatives, moderates or liberals rallying ‘round issues like cash collateral, credit bidding and structured dismissals.

Based on the five Gorsuch bankruptcy opinions I’ve read, here is my first reaction:

Supreme Court Justice Neil Gorsuch will be good for bankruptcy law.

Here’s why.

Six Examples from Five Opinions

First of all, Judge Gorsuch is an engaging writer—and for those of us required by profession to read lots of cases, this is a bonus!  Here’s an example — it’s a summary of an issue on whether the bankruptcy court can decide a particular dispute (from In re Renewable Energy Development Corp.):

“This case has but little to do with bankruptcy. Neither the debtor nor the creditors, not even the bankruptcy trustee, are parties to it. True, the plaintiffs claim they once enjoyed an attorney-client relationship with a former bankruptcy trustee. True, they now allege the former trustee breached professional duties due them because of conflicting obligations he owed the bankruptcy estate. But the plaintiffs seek recovery only under state law and none of their claims will be necessarily resolved in the bankruptcy claims allowance process. And to know that much is to know this case cannot be resolved in bankruptcy court.”

Second, Judge Gorsuch respects and honors the limitations on his authority.  As a Circuit Judge he is subservient to higher authority — to decisions of the U.S. Supreme Court and to enactments of Congress — despite flaws he may see in those decisions and enactments.  In the In re Woolsey case, for example, he writes:

“We do not doubt a strong argument can be made that the language and logic of § 506 permit the Woolseys to void not only Citibank’s lien but any lien to the extent it is unsupported by value in the collateral. But we fail to see any principled way we might, as lower court judges, get there from here. [The Supreme Court’s Dewsnup opinion] may be a gnarled bramble blocking what should be an open path. But it is one only the Supreme Court and Congress have the power to clear away.”

Third, Judge Gorsuch will bring clarity to jurisdiction issues that have been hounding bankruptcy courts.  The following lengthy analysis shows that he understands (and can explain with clarity) this difficult legal problem and its over-arching civic context (from In re Renewable Energy Development Corp.):

The Constitution assigns “[t]he judicial Power” to decide cases and controversies to an independent branch of government populated by judges who serve without fixed terms and whose salaries may not be diminished. U.S. Const. art. III, § 1. This constitutional design is all about ensuring “clear heads … and honest hearts,” the essential ingredients of “good judges.” . . . After all, the framers lived in an age when judges had to curry favor with the crown in order to secure their tenure and salary and their decisions not infrequently followed their interests. Indeed, the framers cited this problem as among the leading reasons for their declaration of independence. . . . And later they crafted Article III as the cure for their complaint, promising there that the federal government will never be allowed to take the people’s lives, liberties, or property without a decision maker insulated from the pressures other branches may try to bring to bear. . . . To this day, one of the surest proofs any nation enjoys an independent judiciary must be that the government can and does lose in litigation before its “own” courts like anyone else.

Despite the Constitution’s general rule, over time the Supreme Court has recognized three “narrow” situations in which persons otherwise entitled to a federal forum may wind up having their dispute resolved by someone other than an Article III judge.  . . . [One of these three situations is] public rights doctrine.

As developed to date, public rights doctrine has something of “a potluck quality” to it. . . . The original idea appears to have been that certain rights belong to individuals inalienably — things like the rights to life, liberty, and property — and they may not be deprived except by an Article III judge. Meanwhile, additional legal interests may be generated by positive law and belong to the people as a civic community and disputes about their scope and application may be resolved through other means, including legislation or executive decision. . . . But the boundary between private and public rights has proven anything but easy to draw and some say it’s become only more misshapen in recent years thanks to seesawing battles between competing structuralist and functionalist schools of thought. . . . Indeed, the Court itself has acknowledged, its treatment of the doctrine “has not been entirely consistent.” . . .

Bankruptcy courts bear the misfortune of possessing ideal terrain for testing the limits of public rights doctrine and they have provided the site for many such battles. . . . Even today, it’s pretty hard to say what the upshot is. Through it all, the Supreme Court has suggested that certain aspects of the bankruptcy process may implicate public rights and thus lawfully find resolution in Article I courts. . . . But the Court has also emphasized time and again that not every “proceeding [that] may have some bearing on a bankruptcy case” implicates a public right amenable to resolution in an Article I tribunal. . . .

That much, of course, hardly decides cases. What most everyone wants to know is which aspects of typical bankruptcy proceedings do and don’t implicate public rights. Yet even Stern, perhaps the Court’s most comprehensive tangle with the question, offered no comprehensive rule for application across all cases. Instead, it invoked a number of different factors to support the result it reached in the particular and rather unusual case at hand.

Fourth, Judge Gorsuch does much more than a grammatical parsing of statutory language.  In the In re Dawes case, Judge Gorsuch deals with farmer-tax issues under Chapter 12, on which the Eighth and Ninth Circuit Courts of Appeals had split. Judge Gorsuch sides with the Ninth Circuit, based on three separate considerations: (i) “the plain language of the statute before us,” (ii) “the larger statutory structure,” and (iii) “Congress’s expressed purposes.”  As to Congressional purposes, Judge Gorsuch says:

Our interpretation as well gives effect and respect to the congressional purpose they identify. Ordinarily, of course, taxes are not dischargeable in bankruptcy; the tax man is rarely avoidable. Yet under our interpretation of § 503(b), income taxes incurred as a result of the pre-petition disposition of certain farm assets are eligible for § 1222(a)(2)(A)’s generous rule allowing them to be treated as unsecured claims, compromised, and discharged. . . . Clearly, then, our reading gives respect to Congress’s wish to provide a substantial form of special assistance targeted to farmers. We only stop short of extending § 1222(a)(2)(A)’s treatment to income taxes incurred post-petition by the debtor rather than the estate.

The U.S. Supreme Court ended up siding with Judge Gorsuch and the Ninth Circuit on this farmer-tax issues.

Fifth, Judge Gorsuch respects and applies non-binding precedent.  In the Ardese v. DCT, Inc. case, Judge Gorsuch applies the law and rationale developed in a prior Tenth Circuit case, indicating that “there is little obvious daylight between [the prior case] and Ms. Ardese’s case.”

Finally, Judge Gorsuch shows professional humility in the TW Telecom Holdings, Inc. v Carolina Internet Ltd. case.  The Tenth Circuit had been applying a specific rule of law involving the automatic bankruptcy stay.  Judge Gorsuch notes that at least “nine other circuit courts of appeals disagree” and that the Tenth Circuit rule is based on faulty reasoning.  So, his opinion overrules the Tenth Circuit rule and declares that the Tenth Circuit will thereafter follow the same rule applied in other circuits.

Conclusion

Based upon these five opinion, I like Judge Gorsuch and believe he will be good for bankruptcy law as a Supreme Court Justice.

Structured Dismissal Negotiations are Ripe for Mediation: Until the Supreme Court Upends Precedent (In re Jevic)

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Ripe for eating

By: Donald L. Swanson

We are not final because we are infallible, but we are infallible only because we are final.”

–From concurring opinion of U.S. Supreme Court Justice Robert H. Jackson, in Brown v. Allen, 344 U.S. 443 (1953), on role and function of the U.S. Supreme Court.

Structured dismissals are [correction: were] a rapidly developing field in today’s bankruptcy world.  That all changed on March 22, 2017, when the U.S. Supreme Court puts the kibosh on structured dismissals in its In re Jevic ruling.

Negotiations in this rapidly developing field would be ripe for mediation.  But, alas, that will not happen, because of the In re Jevic ruling.  Now, the rule is simple:  distribute sale proceeds through the Bankruptcy Code’s priority scheme.

Necessity Produces Creativity

Creative processes, like structured dismissals, arise out of a need in bankruptcy to maximize value and distribute proceeds in an efficient and prompt manner.  Plan confirmation processes are, often, inefficient and expensive in the extreme.  So, when an opportunity arises to maximize value and distribute proceeds in a way that is quick, efficient and effective, practitioners gravitate to that opportunity.  Structured dismissals provide one of those opportunities.

Some History

Bankruptcy courts have been struggling for as long as I can remember with how to handle asset sales and the distribution of sale proceeds.  My first recollection of a bankruptcy sale issue relating to today’s structured dismissals is from 1982:

–a bankruptcy judge rules in 1982 that a bankruptcy trustee may not “serve as the handmaiden” of secured creditors in liquidating collateral.  Accordingly, a sale of assets should not occur in a Chapter 7 case, the judge says, when the only persons to benefit are secured creditors.

–The judge in 1982 explains: “Secured creditors by consent and the trustee by acquiescence cannot impose upon the [Bankruptcy] Court the duty to serve as a foreclosure or collection forum.”

The “handmaiden” phrase from 1982 stands the test of time.  It’s still good law today, especially in Chapter 7 liquidation cases: if all debtor’s nonexempt assets are fully encumbered, the Chapter 7 trustee must issue a “no asset” report.

But a bankruptcy sale of fully-encumbered property can still provide benefits to the bankruptcy estate in a business reorganization.  Such benefits might include keeping a business alive under new ownership, which will continue providing jobs and business activity and tax payments in the local community.

Additionally, parties in a bankruptcy often negotiate for ways to create benefits to the bankruptcy estate from a sale of fully-encumbered property.  One way is to carve-out a portion of the funds the secured creditor would receive from a sale and then gift that portion to priority wage claims or to unsecured creditors.

A Long-Standing Precedent

That’s what happened, for example, in the case of  In re SPM Manufacturing Corp., 984 F.2d 1305 (1st Cir. 1993).

–In the In re SPM case, a secured creditor would get all proceeds from the sale of debtor’s assets.  So, the secured creditors enters into a pre-plan settlement agreement for distributing proceeds from a bankruptcy sale.  The agreement would gift to unsecured creditors a portion of sale proceeds the secured creditor would otherwise receive.

–The bankruptcy court rejects this agreement because tax claims have a higher priority, aren’t receiving any of the gift, and remain unpaid.  The District Court affirms, and the case is appealed to the First Circuit Court of Appeals.

–The First Circuit reverses and approves the agreement.  Here is part of the First Circuit’s rationale:

The Bankruptcy Code’s distribution scheme “does not come into play until all valid liens on the property are satisfied.  . . .  Because [the secured creditor’s] claim absorbed all of SPM’s assets, there was nothing left for any other creditor in this case.  . . . creditors are generally free to do whatever they wish with the bankruptcy dividends they receive, including to share them with other creditors.”  [984 F.2d at 1312-13.]

This In re SPM ruling has been the law-of-the-land in the First Circuit for fourteen years.  And the ruling makes sense, as reflected by this fact: an online research tool [Casemaker] says this In re SPM decision, (i) has been cited 183 times, and (ii) has been “criticized” only once on unrelated grounds.

Overruled?

So . . . did the U.S. Supreme Court decide to overrule this long-standing In re SPM rule in its In re Jevic decision . . . without even mentioning it?!  Perhaps not: the In re SPM decision might be distinguishable (arguably, at least).  But In re Jevic’s “simple answer” of “no” suggests otherwise.

This result is unfortunate in the extreme for bankruptcy practitioners and judges striving to maximize and distribute value in an efficient and effective manner!!