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.

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?

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.

Student Loan Crisis: High-Priced Colleges Support Beautiful Campuses (and Other Luxuries) on the Backs of their Students

IMG_0216By:  Donald L. Swanson

“Back when I was in school . . .”

This is a tired-old phrase, usually followed by tales of hardship.

The Olden Days

But here’s an opposite twist:  Back when I was in college (during the 1970s), you could actually pay your way through, with little-to-no debt, by working part-time jobs and summers and getting grants and scholarships; or by taking a semester (or two or three) off from school to make money for finishing.  “Cramming four years into six,” is the common (but not very funny) joke from back then about paying for school.

–For professional schools back then, add in (as in my case) a working spouse to make ends meet: we say that, while I earned my J.D. (“Juris Doctor” degree), she earned her P.H.T. (“Put Hubby Thru” degree).

Those days are gone!

The Student Loan Problem

Because I live in the professional world of bankruptcy, I see every now-and-then the fallout from student loans.  And the fallout is ugly.  It’s a picture of highly-educated people (mostly young) buried under a burden of student loans.  And in many cases it’s a debt they will never be able to repay — ever.  Heck . . . many can’t even keep pace with interest accruals, let alone make a dent in the principal balance!

And student loan debts can’t be discharged in bankruptcy, except for the most difficult of all hardship cases.

What is the culprit causing all this?  It’s the easy availability of student loans for the benefit of high-priced colleges.

Student loan programs developed over time with the best of intentions.  Who can argue with the benefits of making a college education at the best-of-all institutions available to everyone, regardless of financial means?  “No one!” is the unfortunate answer.

But the best of intentions can (and often do) go awry and produce unintended consequences.

A Diagnosis

Here’s what’s gone awry with student loan programs:  the true beneficiaries are high-priced colleges, not students.

The high-priced colleges, who revel in beautiful campuses and other luxuries, create a demand from tuition-paying students for luxuries.  And other colleges must-keep-pace or die.  Who wants to go to a college with low-quality facilities when luxuries can be enjoyed elsewhere?

And then there is the marketing-genius deception.  It seems, in many situations, that neither young college-bound students nor their parents can discern the difference between, (i) a college charging low-prices and offering limited scholarships, and (ii) a college charging outrageously-high prices but giving huge-percentage scholarships that result in a still-outrageously-high actual cost.  Student loans enable students to choose the still-outrageously-high-cost college.  Unfortunately, this marketing-genius deception merely feeds the beast and magnifies the problem.

An Ancient Proverb

Moreover, the following ancient proverb applies in full-force to the student loan crisis:  “The borrower is servant to the lender.”  Here are some real-life examples of how the proverb works for student loan debts:

–How about the young couple who met at a high-priced professional school and have been in the working world for several years.  Both are buried under a mountain of student loans.  One of them really, really wants to pursue a coaching career, instead of the schooled profession—but that’s not possible because student loans require continuation in the higher-paying career.

–How about the graduate from a high-priced school who works at a high-end salary in his/her schooled profession; but even with the high-end salary, the young professional is unable to pay accruing interest on student loans and can’t even begin to pay on principal.

–Or how about the older person who, feeling trapped in a dead-end job, is persuaded to spend large amounts on additional education at a high-priced college, only to learn the hard-way that this additional education provides little-or-no actual improvement in the student’s marketability.

–And what about the graduate who earns a sufficiently-high income to cover monthly student loan obligations but pines: “If I had known what my high-priced education would actually require in servicing student debt, I would never have taken that path!”

An Escalating Problem

But the high-priced schools from which these people graduated continue to charge their students outrageously-high amounts, continue to build gorgeous buildings and provide other luxuries, continue to invest huge sums into athletic teams, scholarships and facilities, and adamantly refuse to pursue an affordable-cost education model.

The upshot is that even traditionally-low-cost colleges (e.g., community colleges) are forced to compete in the luxury realm: are building fabulous campuses, are increasing their visibility, and are raising their tuition.  And the student loan crisis is hitting students even there.  This is a shame!

Dependency

Have you read the book, “The Millionaire Next Door”?  This book argues that adult children need to be economically self-sufficient, and it decries economic dependence of adult children on their parents.  In the student loan crisis, this argument is commonly applied to students and their parents.

I contend, however, that this argument is most-directly applicable to colleges and the providers of student loans.  Student loans have enabled a bent-toward-luxury among colleges—especially among high-priced colleges—and a related dependence of colleges on this economic support.  Most high-priced colleges (and now even low-cost colleges) are utterly dependent on the continued flow of easily-obtained student loans.  Such dependence always has prevented, and continues to impede, the development of affordability-based education models.

The Impact

Easy student loans have enabled and entrenched today’s unaffordable model of higher education.  And today’s higher education schools are dependent on such loans continuing.

Unfortunately, the ones who pay the ultimate price for such dependence are the loan-incurring students—not the dependent colleges.

Any ideas on what can be done about this problem?

Next Steps for a Court with Basic Mediation Rules: Mandated and Early Mediation

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The next steps

By: Donald L. Swanson

Here is a common experience in the bankruptcy courts (and other courts) where mediation is a new or little-used tool:

Attorneys have been practicing for years in this court without using mediation.  And mediation is slow to catch on.  Here’s why:

–Attorneys who practice in this court aren’t accustomed to using mediation, aren’t comfortable with inserting mediation into their case planning habits, and rarely even think of mediation as a possibility; and

–Judges in this court aren’t comfortable with the idea of mandating mediation by local rule or by order in a particular case.

            MANDATORY MEDIATION

The Voluntary Mediation Problem

The problem with voluntary mediation, in a new or little-used mediation program, is explained by these two conclusions from a study of empirical data:

–When the goal is to achieve a “regular and significant use” of mediation to resolve court cases, “[v]oluntary mediation programs rarely meet this goal because they suffer from consistently small caseloads.”

–By contrast, “judicial activism in ordering parties into mediation triggers increased voluntary use of the process.”

Moreover, according to the study,  “settlement rates” and a litigant’s perceptions of “procedural justice” are about the same in mandatory mediation as in voluntary mediation.

Three Examples of Mandatory Mediation Rules

Example No. 1.  Circuit Courts of Appeals.  All but one of the U.S. Circuit Courts of Appeals have a mandatory mediation program.  Data from these mandatory programs show them to be highly successful in achieving mediated settlements across all types of cases and regardless of levels of animosity or distrust between the parties.

Example No. 2.  Delaware Bankruptcy Court.  The Delaware Bankruptcy Court, and attorneys who practice there, have extensive experience over many years with using mediation to resolve bankruptcy disputes.  In 2013, the Delaware Bankruptcy Court intensifies its mediation program by adding this mandatory provision to its Local Rule 9019-5(a):

“all adversary proceedings filed in a chapter 11 case . . . shall be referred to mandatory mediation.”

It must be noted that the trajectory of changes to local mediation rules in the Delaware Bankruptcy Court is toward mandated mediation – and away from a voluntary system.

Example No. 3.  New Jersey Bankruptcy Court.  The New Jersey Bankruptcy Court, and attorneys who practice there, also have extensive experience over many years with mediation.  In 2014, the New Jersey Bankruptcy Court expands its mediation program by adding a “presumptive mediation” local rule.  This new rule 9019-2(a) provides:

“Every adversary proceeding will be referred to mediation after the filing of the initial answer to the adversary complaint, except [when a specified exception applies]”; and

“A contested matter . . . may also be referred to mediation . . . by the court at a status conference or hearing.”

In New Jersey, like Delaware, the trajectory of changes to local mediation rules is toward mandated mediation and away from a voluntary system.

EARLY MEDIATION

The Early Mediation Need – Generally

The study of empirical data referenced and linked above observes that mediation “tends to occur late in the life of a case.”  And it issues these findings about mediation timing:

“Holding mediation sessions sooner after cases are filed, however, yields several benefits,” including:

–“Cases are more likely to settle”;

–“Fewer motions are filed and decided”; and

–“Case disposition time is shorter, even for cases that do not settle.”

An Intensified Need for Early Mediation – In Business Bankruptcy

Superimposed over many disputes in a business bankruptcy is an urgent need to maximize value from a debtor’s operations or liquidation.  And this urgency often takes precedence over standard litigation processes like formal discovery and pretrial wrangling.  Accordingly, the need in a business bankruptcy for early and extensive mediation efforts can be particularly intense.

The role of mediation in the early stages of a business bankruptcy case needs to be different from the typical role of mediation that occurs at the end of a lawsuit:

–The role and goal of an early-mediation in a business bankruptcy is to set-the-stage and narrow-the-issues and create-a-direction and a focus for further progression of the case.

–That’s a much different role than a shortly-before-trial mediation in a one-and-done session at the end of a lawsuit, where the goal is to resolve all remaining disputes.

Here’s a link to an example of how mediation can be effectively utilized at the beginning of a Chapter 11 case.

An Example of an Early Mediation Rule

The Delaware Bankruptcy Court recently adopted a provision in its Local Rule 9019-5(j) that allows a defendant to opt for an early mediation of a preference case with less than $75,000 at stake.

Within 30 days after a response to the preference Complaint is due, the defendant in such cases may elect an early mediation of all claims raised in the lawsuit.  In cases where more than $75,000 is at stake, the parties may agree to participate in the early mediation process.

Action Item:

I am passionate about encouraging:

–Bankruptcy courts to adopt local rules on mediation and to expand the role and reach of mediation through mandatory and early mediation requirements; and

–Attorneys who practice is such courts to utilize mediation for resolving their disputes.

And I’d be delighted to discuss such matters with anyone interested in expanding the role and reach of mediation in a local court.

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

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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!!