“Public Rights” Doctrine for Bankruptcy Court Jurisdiction, While Always Tenuous, Is Now Dead and Buried

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RIP: “Public Rights” doctrine for bankruptcy court jurisdiction  (Photo by Marilyn Swanson)

By Donald L. Swanson

“Public rights” doctrine enters the bankruptcy scene thirty five years ago in the four-Justice plurality opinion of Northern Pipeline v. Marathon Pipe Line, 458 U.S. 50 (1982). Three Justices in that case write an vigorous dissent to such a use of public rights doctrine, while two other Justices concur with the plurality on only a narrow result.

Northern Pipeline Facts

Congress adopts a new Bankruptcy Code in 1978.

Northern Pipeline files Chapter 11 in January of 1980 under the new Bankruptcy Code and then sues Marathon Pipe Line in bankruptcy court for breaches of contract and warranty and for misrepresentation, coercion, and duress. Marathon has no other connection to the bankruptcy case.

Northern Pipeline Ruling

The U.S. Supreme Court, in its 1982 Northern Pipeline ruling, appears to adopt public rights doctrine as the basis for bankruptcy court jurisdiction, and a four-Justice plurality declares the new Bankruptcy Code unconstitutional in its entirety.  The combination of concurring and dissenting opinions, however, limits the extent of unconstitutionality to a narrow issue of jurisdiction.

A Dissenting View that Foreshadows Today’s Law

Chief Justice Burger foreshadows, in a separate dissenting opinion, what has become the actual state of today’s bankruptcy jurisdiction law. The Northern Pipeline plurality ruling is limited, says the Chief Justice back then, to these propositions:

–A “‘traditional’ state common law action” may be heard by a bankruptcy court upon “the consent of the litigants”;

–There is nothing “inherently unconstitutional about the new bankruptcy courts”;

–Bankruptcy courts may adjudicate all “claims ‘arising under’ or ‘arising in or related to cases under'” the Bankruptcy Code — with only limited exception; and

–The problems of the Northern Pipeline case can be resolved by “providing that ancillary common law actions . . . be routed to the United States district court of which the bankruptcy court is an adjunct.”

Basis for Public Rights Doctrine

The basis for the four-Justice plurality decision in Northern Pipeline, in its focus on “public rights,” is summarized by those Justices like this:

There are “three narrow situations” in which “the congressional assertion of a power to create legislative courts was consistent with” constitutional mandates of “separation of powers.” These three situations are, territorial courts, courts-martial, and cases involving “public rights.” And since bankruptcy courts are nothing like territorial courts or courts-martial, that leaves public rights as the only available basis for bankruptcy court jurisdiction.

Subsequent Developments

–Stern v. Marshall in 2011

In 2011, the Supreme Court, in Stern v. Marshall, issues a five-Justice majority opinion on bankruptcy court jurisdiction.  And the majority opinion is purportedly based on public rights doctrine.

Four Justices dissent in Stern v. Marshall, rejecting public rights doctrine and saying that the majority in Stern v. Marshall “overemphasizes the precedential effect of the plurality opinion in Northern Pipeline.”

Although Justice Scalia is part of the majority, he writes a concurring opinion expressing his belief that the majority opinion is not, truly, a public rights decision.  He stands alone in denouncing the majority opinion on these grounds:

“I count at least seven different reasons given in the Court’s opinion for concluding that an Article III judge was required to adjudicate this lawsuit,” all of which “have nothing to do with the text or tradition of Article III.”

–Wellness International v. Sharif in 2015

Fast-forward to the Supreme Court’s 2015 Wellness International v. Sharif opinion, in which three dissenting justices (including the now-deceased Justice Scalia) are holding on to the public rights doctrine.  They provide this public rights basis for their dissenting view:

–Congress may “confer power to decide federal cases and controversies” upon non-Article III judges in only “three narrow exceptions: territorial courts, courts martial, and disputes over ‘public rights'” (citing, “Northern Pipeline, 458 U. S., at 64–70 (plurality opinion)”).

Public rights doctrine receives no support or reliance from any other justice in Wellness International. The majority opinion, in fact, doesn’t even mention “public rights.” Accordingly, such doctrine is held (in Wellness International) by only three Justices as a basis for bankruptcy court jurisdiction.

Problems with Public Rights Doctrine

Problems with public rights doctrine are that it, (i) has never been well defined, and (ii) leads to confusion. These problems existed in 1982 and still exist today. Here are illustrations:

–“The distinction between public rights and private rights has not been definitively explained in our precedents. Nor is it necessary to do so in the present cases.” [From the 1982 four-Justice plurality opinion in Northern Pipeline.]

–The “contours of the ‘public rights’ doctrine have been the source of much confusion and controversy.” [From the 2015 dissent in Wellness International.]

Public Rights Doctrine is Dead and Buried

Public rights doctrine, as a basis for bankruptcy court jurisdiction, is now dead and buried. Here’s why.

1. The Chief Justice’s description-in-dissent, back in 1982, of bankruptcy court jurisdiction foreshadows where today’s Supreme Court majority lands in Wellness International v. Sharif, including constitutional authority for bankruptcy court adjudication by consent of the parties.

2. The majority opinion in Wellness International does not discuss public rights doctrine — doesn’t even mention it.

3. The three dissenting Justices in Wellness International:

a. Were all part of the five-Justice majority in Stern v. Marshall, and
b. Include the now-deceased Justice Scalia, who previously championed public rights doctrine for bankruptcy court jurisdiction — so they are now down to two and without the former champion.

[Note:  For a review of Justice Scalia’s position, over the years, as champion of public rights doctrine for bankruptcy court jurisdiction, see this article.]

4.  I doubt that Justice Scalia’s replacement, Justice Gorsuch, will champion (or even support) public rights doctrine. Here are two reasons why.

i)  On the U.S. Circuit Court of Appeals, Judge Gorsuch wrote this about public rights doctrine as a basis for bankruptcy court jurisdiction (from In re Renewable Energy Development Corp.):

–Public rights doctrine “has something of ‘a potluck quality’ to it.”
–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.”
–The Supreme Court has acknowledged that its treatment of public rights 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.”

ii)  In his early career, Neil Gorsuch clerked for Justice Byron White who, as a Supreme Court Judge, wrote a dissenting opinion in Northern Pipeline v. Marathon and fought pitched battles against using public rights doctrine as a basis for deciding bankruptcy issues.

Conclusion

Public rights doctrine for bankruptcy court jurisdiction had a less-than-majority beginning.  And it is now surpassed by the dissenting opinion of the Chief Justice back then that foreshadows today’s post-Wellness reality.

And public rights doctrine has the support, today, of only two Justices.

In other words, public rights doctrine as a basis for bankruptcy court jurisdiction is dead and buried. RIP.

 

The Story of “The Last Bankrupt Hanged”

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London Tower and surrounding walls (Photo by Marilyn Swanson)

 

Hanging was a spectator sport in eighteenth-century England, and . . . the usual crowd turned out to watch [John Perrott] swing.  They came to see off not a murderer, rapist, or highwayman, but rather a bankrupt.”

E. Kadens, “The Last Bankrupt Hanged: Balancing Incentives in the Development of Bankruptcy Law,” 59 Duke L.J. 1229 (2010). All information and quotes herein are from this article.

–The Fateful Day

“Around eight o’clock in the morning on Wednesday, November 11, 1761, the condemned prisoner, John Perrott, was taken from his cell in London’s Newgate Prison. He spent some time praying with the prison chaplain and receiving the Sacrament; then his leg shackles were knocked off and his hands bound. At a quarter after ten, he appeared ‘pale and trembling’ in the prison yard.”

“A few minutes later the under sheriff came to transport Perrott to his execution. He was loaded onto a cart and carried the short distance to the scaffold erected at the ancient hanging place in West Smithfield. Once there, Perrott looked about anxiously, concerned to see his hearse. Reassured of its presence, he prayed fervently and at around eleven o’clock was ‘launched into eternity.’”

Professor Kadens

Professor Emily Kadens, in her article linked above, explores the historic role of punishment in compelling a bankrupt debtor’s cooperation and full disclosure of assets. In the article, Professor Kadens develops her original research into fascinating historical stories (like the one highlighted here) and creates a compelling argument about the role of punishment in bankruptcy.  Her article is a must-read!

John Perrott’s Story – As Told by Professor Kadens

John Perrott’s execution “captured the attention of the times” and became “so famous that a nineteenth-century editor of Blackstone’s Commentaries called Perrott the last bankrupt hanged.”  But he wasn’t.  “John Senior, a clothier from the village of Alverthope, outside Wakefield in Yorkshire,” in 1813 became the actual “last man hanged for fraudulent bankruptcy in England.”

Here are the facts of the John Perrot case – and how a bankrupt debtor goes about getting himself hanged for bankruptcy crimes in 1761.

–Background

John Perrott conducted business as a cloth merchant.

“Through 1758, Perrott had done business on a cash basis. In 1759, he suddenly began to buy on credit and in significantly larger quantities than before. But he had built a good reputation for honesty during the nearly thirteen years he had been trading for his own account, and his creditors let his debt mount.”

–Act of Bankruptcy

On January 17, 1760, John Perrott committed an act of bankruptcy: he “called his creditors together at the Half Moon Tavern in Cheapside, London to inform them that he could not pay his debts.”

Bankruptcy commissioners “found Perrott a bankrupt,” and he “surrendered himself as such.”  The commissioners “soon realized that a large sum of money was unaccounted for”: his books were in “total disorder,” his annual debt “suddenly and unaccountably increased from less than £300 in the years before 1758 to upwards of £27,000 in 1759,” and he had “begun to sell anonymously through a broker, Henry Thompson” — but neither Perrott nor Thompson “could produce records of these transactions.”

–Acts of Concealment

The commissioners also learned of “two potential acts of concealment”:

(i) “Perrott had his apprentice deliver a package to Thompson for safe keeping.” He told  Thompson “it contained personal papers unrelated to the bankruptcy,” but “two days before Thompson testified,” Perrott took the package back.  Perrott “later told the commissioners that the package contained ‘nothing but letters from the fair sex,’ which he had since destroyed.”

(ii) Patrick Donelly, a wigmaker, told the commission that “Perrott sent him two large boxes, claiming that the boxes contained his clothing and asking Donelly to hold onto them while he looked for lodging.”  Days later, “Perrott instructed Donelly to deliver the boxes” to “a house in the fashionable Queen Square” occupied by Mrs. Mary Anne Ferne, who acknowledged knowing Perrott “for about a year” but claimed she “had received no money, banknotes, or other effects from him.”

–Inadequate Explanation

Meanwhile, the commissioners could not account for “the whereabouts of £13,500,” which is “a very large sum” – “nearly twice the annual income of the highest paid barristers of the time.”  Here is Perrott’s explanation to the commissioners:

–he “lost about £2,000 on goods sold in the previous year”; and

–“for nine or ten years, I have, and am sorry to say it, been extremely extravagant, and spent large sums of money.”

The commissioners weren’t buying this explanation because, “Perrott had only been running up his credit for a year, and an amount like £13,500 was, they felt, too large to spend in so short a time, especially because Perrott claimed that he had never gambled and because his books showed him to be a man of frugal habits.”

–Commitment to Newgate Prison . . . and Back Again

“Exercising their statutory power, the commissioners had Perrott committed to Newgate Prison until he saw fit to provide a complete and reasonable account of the missing money.”

“After six weeks in Newgate,” Perrott “sent notice to the commissioners that he would answer their question.”  He then “presented the commissioners with an account” in “round numbers, totaling £15,030” for “such items as rent, food, clothing, travel expenses, wages, commissions paid to his agent, and sales losses,” including £920 for “Tavern expenses, coffee-house expenses, and places of diversion” and £5,500 for “Expenses attending the connection I had with the fair sex.”

He “submitted no evidence to support this accounting,” so the commissioners “sent him back” to Newgate Prison.

–A Servant as Witness

The commissioners “concluded that Perrott was engaged in some sort of fraud, but they lacked hard evidence.”  One witness, “a former maidservant of Mary Ann Ferne,” came forward “seeking the advertised reward of 20 percent of the bankrupt’s estate to anyone uncovering the missing assets.”  The only meaningful information she could provide is that, “before meeting Perrott, Ferne had been poor” but that “now she was flush with money.”

The servant “mentioned that Ferne had hidden a paper package” containing banknotes and “claimed that Perrott had instructed her that if anyone came to search the house, she should show them his rooms and not Ferne’s.”  But such testimony was “considered insufficient” for legal action.  So, a dividend was then paid to creditors “of five shillings on the pound.”

–Writs of Habeas Corpus

Perrott then “brought writs of habeas corpus in King’s Bench” arguing that he “should be released” from Newgate Prison because “he had answered the commissioners’ questions.”  The petition resulted in “an important opinion that established the right of commissioners to keep bankrupts imprisoned even after they had answered the commission’s questions”:  “Rex v. Perrott, heard on February 10, 1761.”

Perrott lost this case because “Perrott’s answer to the commissioners was ‘very insufficient and unsatisfactory’” and because “bankruptcy statutes gave the commissioners the general power to examine and imprison the bankrupt . . . until he made a full answer.”

–Another Examination . . . and Back to Newgage

Perrott then submitted to “yet another examination by the commissioners.”  This time he explained about “a certain Sarah Powel, ” on whom he spent “for the first five years of their relationship £400 or £500.”  Then during 1759 “he had lavished money upon her to the amount of £5,000.”

“The commissioners were still not convinced” because, Perrott (i) couldn’t “provide any details” about expenditures on Powel or “remember where she had lived,” (ii) said none of  the money he sent to Powel came from “(traceable) bank notes,” and (iii) “could provide no proof” of sending large sums of money to Powel.  The commissioners found, instead, that “Powel had complained to others of Perrott’s parsimony” and that Powel “was a prostitute.”

Perrott went back to Newgate, and “once again he brought a habeas corpus petition before King’s Bench.”    Perrott lost, again, and the court “remanded Perrott to Newgate without opinion.”

–A Lodger / Maid as Witness

Next, Perrott “filed suit in Common Pleas for false imprisonment against the commissioners.”  But that proceeding “was halted when the commissioners made a ‘fatal discovery.’”  A creditor “was walking in the garden of Lincoln’s Inn when he saw a dejected-looking woman leaning against the wall.  He approached this stranger and asked her what was the matter (or at least so the ‘remarkably provindential’ [sic] story goes).   She told him that she had been fired by a certain Mrs. Ferne.”  The creditor recognized the name and directed her to his attorney.  Then, “she deposed as follows”:

She lodged with Ferne when “Ferne had very little money.”  Two years later, Ferne asked her to become Ferne’s maid.  She then lived with and worked for Ferne “from March 5 to June 4, 1761.”  During that time, “she saw banknotes worth £4,000 in Ferne’s possession.”  Ferne told Harris that “when she had met Perrott she had no money at all,” that “all her fortune was owing” to Perrott, and that “if she had known that . . . Perrott was going to fail, she would have got all she could from him . . . that his creditors should not have had any thing.”

–A Search Warrant

The commissioners “issued a warrant for Ferne’s house and Perrott’s rooms at Newgate.” At Ferne’s house they found “halves of five banknotes, dated February or March 1761, amounting to £185,” and they found the “other half of four of the notes turned up tied in a rag at the bottom of Perrott’s trunk in Newgate, along with half of a note for £1,000.”  These notes were traced to “Martin Mathias, a solicitor.”

–Tracing Bank Notes

Mathias testified that “Ferne had hired him . . . to work on Perrott’s case” and “brought him thirteen banknotes,” all of which “had been cut in half and glued back together with wax.”  Mathias said he believed the money “belonged to Ferne, whom he understood to be a lady of high birth and means.”

Ferne told the commissioners that she “acquired the money for granting favors” to two elderly gentlemen: “one who wore ‘a blue coat, and a star upon his breast, and a cockade in his hat’ and the other, a man of seventy, who wore ‘a white coat, with a star on it, and a light blue garter.’” She didn’t know their names but contacted them, when she needed money, at “coffee houses they frequented, and they would give her cash or notes.”  The half-notes “ended up in Perrott’s trunk for safe keeping because, ‘her Maid-servant being apt to drink, she, [Ferne], apprehended if she and her servant should both happen to be in liquor together, there would be some danger of setting the house on fire.’”

The commissioners traced back “most of the thirteen original banknotes to merchants who had paid Perrott’s agent for cloth.”

–“The Game Was Up”

In September 1761, creditors “preferred a bill of indictment against Perrot at the London criminal court, the Old Bailey, for concealing his effects,” and “Perrott was tried on October 21, 1761.”  Trial “lasted six hours as the prosecution painstakingly explored the money trail.”  Perrott in defense “could only say that he had sent all the money he received from Thompson to his mistress, Sarah Powel,” and that “the half banknotes in his trunk were Ferne’s.” She asked Perrott to keep them. ”He agreed to do so” because:

“I thought I should be very ungrateful, if I did not; and the reason she gave me was, her house had been attempted to have been broke open twice; and for the favours she was pleased to compliment me with, she said she thought she had some little right so to do.”

Perrott lost in court . . . again.  But this time the loss is fatal: the sentence is death!

–No Gallows Confession

“The day before his execution,” two creditors visited Perrott in prison. “They found him remorseful and willing to answer questions.”  Assuring him of their forgiveness, “they asked where the money was.”  Here’s the response:

“[A]fter a deep pause, Perrott said, I have this day received the Holy Sacrament, and will answer no more questions.”

The creditors “went away empty-handed.”

–Accomplice Prosecuted

Several days after Perrott’s execution, “Ferne was taken into custody.”  She then turned over “the half of two Bank notes; the other moiety of which were sometime since found in the possession of Perrott in Newgate.”  Certain other notes “were artfully concealed behind the backboard of Perrott’s picture, which was in this Lady’s apartment.”

In April 1762, Perrott’s creditors “unanimously agreed to prosecute the Celebrated Lady who was party in concealing the Bank-notes, with the utmost rigour.”

Conclusion

Bankruptcy laws, including bankruptcy crimes and punishments, have come a long way since the bankrupt-hanging days of two and three centuries ago.  But the underlying issues, and human nature, are still about the same.

Check out Professor Kadens’s article linked above for much more.

Why Bankruptcy Judges Have a 14-Year Term, Instead of Life Tenure (From Justice White in Northern Pipeline v. Marathon)

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Specialization

By Donald L. Swanson

Have you ever wondered why Congress, when it adopted the Bankruptcy Code in 1978, limited the term of service for bankruptcy judges to fourteen years?

–This term limitation, established in 28 U.S.C. Sec. 157(a)(1), assures that bankruptcy judges are serving as Article I judges under the U.S. Constitution. Life tenure would have given them the same protections as Article III judges.

–Lifetime tenure would also have eliminated, in all probability, the limited-jurisdiction struggles that have enveloped bankruptcy courts and their appellate overseers for the past thirty five years (beginning with the Supreme Court’s 1982 Northern Pipeline decision).

I’ve often wondered why Congress did this: and have never received a satisfactory answer — until recently.

What happened recently is that I finally read (from beginning to end) all the plurality, concurring and dissenting opinions in the U.S. Supreme Court’s 1982 bankruptcy case of Northern Pipeline v. Marathon Pipe Line, 458 U.S. 50 (1982).

The four-Justice plurality opinion in Northern Pipeline declares the entire Bankruptcy Code unconstitutional. Fortunately, however, the combined effect of the five other Justices, who write concurring and dissenting opinions, limits the ultimate reach of Northern Pipeline to a narrow jurisdiction issue.

The dissenting opinion in Northern Pipeline, authored by Justice White (joined by Chief Justice Burger and Justice Powell), answers the why-no-lifetime-tenure question. Justice White’s answer escapes notice because it appears in the very-last paragraph of his dissenting opinion, which is the last of four lengthy opinions printed in the case.

Justice White puts the 14-year term limitation question this way:

–“The real question is not whether Congress was justified in establishing a specialized bankruptcy court.” Rather, the question is whether Congress “was justified in failing to create a specialized, Art. III bankruptcy court.”

He then expresses his own view of what Congress had in mind. His view focuses on the specialized nature of bankruptcy courts and the fluctuating nature of their workload, along with an evolution-not-revolution approach. Here’s what he writes.

Specialization

–The “very fact of extreme specialization may be enough, and certainly has been enough in the past, to justify the creation of a legislative court.”

–“Congress may legitimately consider the effect on the federal judiciary of the addition of several hundred specialized judges”:

(i) “We are, on the whole, a body of generalists”; and
(ii) “The addition of several hundred specialists may substantially change, whether for good or bad, the character of the federal bench.”

Fluctuating Workload

–Congress wanted to “maintain some flexibility” in “future responses to the general problem of bankruptcy.”

–“There is no question that the existence of several hundred bankruptcy judges with life tenure” would have “severely limited Congress’ future options” because:

(i) the “number of bankruptcies may fluctuate, producing a substantially reduced need for bankruptcy judges”; and
(ii) if specialized bankruptcy judges don’t serve in the “countless nonspecialized cases that come before” the district courts, Congress “would then face the prospect of large numbers of idle federal judges.”

[Editorial note: The reduced caseloads, reduced budgets and reduced staff that characterize today’s bankruptcy courts are “Exhibit A” for this “Congress’ future options” point.]

Evolution-Not-Revolution

–Congress “believed that the change [in 1978] from bankruptcy referees to Art. I judges was far less dramatic, and so less disruptive of the existing bankruptcy and constitutional court systems, than would be a change to Art. III judges.”

Conclusion

Justice White’s view on this point is very interesting, indeed!

Justice Gorsuch’s First Supreme Court Dissent is Scaliaesque on Statute Construction but Non-Scalia on Public Rights Doctrine (Perry v. Merit Systems)

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Illumination

By Donald L. Swanson

On June 23, 2017, Neil Gorsuch issues his first dissenting opinion as a Supreme Court Justice. The case is Perry v. Merit Systems Protection Board (Supreme Court Case No. 16-399). It’s about statutory procedures for litigating Federal employee claims.  The dissent by Justice Gorsuch illuminates a comparison of ideas with those of his predecessor, the now-deceased Justice Antonin Scalia.

Scaliaesque Moments – Statute Construction

There are certainly some Scaliaesque moments illuminated in Justice Gorsuch’s dissent. These are when Justice Gorsuch writes about applying statutes as written. Here are two examples from the Gorsuch dissent.

–“If a statute needs repair, there’s a constitutionally prescribed way to do it. It’s called legislation. To be sure, the demands of bicameralism and presentment are real and the process can be protracted. But the difficulty of making new laws isn’t some bug in the constitutional design: it’s the point of the design, the better to preserve liberty”; and

–“At the end of a long day, I just cannot find anything preventing us from applying the statute as written—or heard any good reason for deviating from its terms. Respectfully, Congress already wrote a perfectly good law. I would follow it.”

Non-Scalia Moments – Public Rights Doctrine

But we are beginning to see a gulf separating former-Justice Scalia and now-Justice Gorsuch on public rights doctrine.

Perry v. Merit Systems is a classic example of a public rights doctrine case: a suit against the Federal government based on rights created by Congress and decided by a non-Article III body with a deferential appellate review.  There is nothing controversial here.

Public rights doctrine, however, has a long history of hot-disputes in the bankruptcy context.

–A Scalia / Gorsuch Contrast

It’s difficult to imagine Justice Scalia allowing the Perry v. Merit Systems occasion to pass without at least mentioning public rights doctrine.  We’d expect Justice Scalia to write in such a case about public rights doctrine and explain how Perry’s claims fit nicely within its purview.

There is no such public rights reference from Justice Gorsuch in his Perry v. Merit Systems dissent.

–Scalia History on Public Rights Doctrine

Antonin Scalia became a Supreme Court Justice in 1986. So he missed the Supreme Court’s ruling in Northern Pipeline v. Marathon, 458 U.S. 50 (1982), where a four-Justice plurality nearly (but not quite) succeeded in declaring the entire Bankruptcy Code unconstitutional, based on distinctions between public rights and private rights (aka “public rights doctrine”).

After his appointment to the Supreme Court, Justice Scalia becomes the undisputed champion of public rights doctrine for bankruptcy issues.  Here are three examples of his position — and of its progressively-lesser levels of support as time goes along.

   1. In Granfinanciera v. Nordberg, 492 U.S. 33 (1989), Justice Scalia joins five other Justices in requiring jury trials for certain suits in bankruptcy, based on public rights doctrine.  Those five other Justices aren’t fond of the Bankruptcy Code: in footnote 16, for example, they (i) describe the Bankruptcy Code, enacted in 1978, as accomplishing “sweeping changes” and “radical reforms,” and (ii) accuse Congress of failing, in 1984 amendments, to consider constitutional implications of denying “the right to a jury trial in preference and fraudulent conveyance actions.”

Justice Scalia, in Granfinanciera, emphasizes a public rights doctrine element:

–“In my view a matter of ‘public rights,’ whose adjudication Congress may assign to tribunals lacking the essential characteristics of Article III courts, must at a minimum arise ‘between the government and others.'”

   2. In Stern v. Marshall, 564 U.S. 462 (2011), Justice Scalia joins the majority in limiting the authority of bankruptcy courts, based on public rights doctrine. Yet he chides them for a lack of purity on public rights:

“I adhere to my view . . . that—our contrary precedents notwithstanding—‘a matter of public rights . . . must at a minimum arise between the government and others.’”

“The sheer surfeit [i.e., excessive amount] of factors that the Court was required to consider in this case should arouse the suspicion that something is seriously amiss with our jurisprudence in this area.”

   3. In Wellness International v. Sharif (decided May 26, 2015), Justice Scalia is in the minority.  He joins a three-Justice dissent in declaring that an alter ego claim can be resolved by a bankruptcy court under the public rights doctrine.  In joining this dissent, Justice Scalia apparently abandons his former insistence that government-as-a-party is a “minimum” requirement of public rights doctrine.

–Gorsuch History on Public Rights Doctrine

Justice Gorsuch, on the other hand, is critical of public rights doctrine in bankruptcy contexts.

–Tenth Circuit Opinion

Here’s what Neil Gorsuch writes about public rights doctrine while serving as a Judge on the Tenth Circuit Court of Appeals (from In re Renewable Energy Development Corp., 792 F.3d 1274 (10th Cir. 2015)):

–Public rights doctrine “has something of ‘a potluck quality’ to it.”

–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.”

–The Supreme Court has acknowledged that its treatment of public rights 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.”

–Clerkship with Justice White

An interesting twist in the development of Neil Gorsuch’s view on public rights doctrine is this:

–At the beginning of his legal career, Neil Gorsuch served as judicial clerk for Byron White, right after White retired from the U.S. Supreme Court and sat by designation on the Tenth Circuit Court of Appeals.

–Notably, Justice White wrote the dissenting opinions in both Northern Pipeline v. Marathon and Granfinanciara v. Nordberg, where he fought pitched battles against “public rights” arguments made by plurality and majority opinions in those cases.

Conclusion

It seems clearly illuminated, at this early stage of Justice Gorsuch’s Supreme Court experience, that he will bear a close-resemblance to former Justice Scalia on statute construction issues but will break from Scalia on using public rights doctrine to resolve bankruptcy issues.

 

 

 

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!!

A History of Ancient Bankruptcy Laws

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Ancient History   (photo by Marilyn Swanson)

By: Donald L. Swanson

Etymology of the word “Bankrupt”

According to the 1899 treatise linked below, the word “bankrupt” comes from the ancient days of Florence, Italy, when that city “occupied a prominent place among the commercial cities of the world.”

The word “bankrupt” arises from the Latin words, “banca rotta,” which mean “broken bench” or “broken counter.”  A creditor’s custom, for a debt-delinquent merchant in ancient Florence, is to break the merchant’s bench or counter.

The British later adopt this phrase in its own debtor/creditor laws but anglicized it like this:

–insert “bank” for “banca”; and

–replac “rotta” with “rupt,” which means “broken” (“rupture” is a derivative).

Hence, the word, “bankrupt.”

Ancient Bankruptcy History

Centuries before the rise of Rome, creditor/debtor remedies are harsh.  The Draconian code, for example, “permitted creditors to dismember the body of their debtor.”

Ouch!!

As Rome rises to predominance, however, creditor/debtor laws improve.

–In Caesar’s time, the “distinguishing feature of modern bankruptcy” begins:

“the debtor who surrendered all of his goods to his creditors was relieved of the harsh penalties of the older systems.”

–And, over subsequent time, such penalties “were further mitigated by discharging him of his obligations.”

England Bankruptcy History

The first English law on debtor/creditor issues (enacted in 1542) is, essentially, a penal statute:

–“Debtors who fled the kingdom or concealed themselves were made criminals, and their effects were seized and distributed among their creditors without extinguishing their obligations.”

–These provisions applied “to all who ‘craftily obtaining into their hands great substance of other men’s goods, do suddenly flee to parts unknown, or keep their houses, not minding to pay, or return to pay, but at their own wills and pleasures consume the substance obtained by credit from other men for their own pleasure and delicate living, against all reason, equity and good conscience.’”

The term “acts of bankruptcy” is first found in The Charitable Uses Act of 1601 (a/k/a the Statute of Elizabeth).  Such “acts” allow a commission to seize and distribute a bankrupt’s property.

Upon enactment of the Statute of Anne in 1706, bankruptcy becomes a civil matter, instead of a statutory crime.

–A debtor can now surrender all his property to a commission and receive a “discharge” of “his person” and of “any property that he might subsequently acquire” from all existing debts.

The treatise linked below explains that this “humane enactment” of 1706, which is “followed in all subsequent legislation on the subject,” has a two-fold object:

“(1) To dedicate the property of an insolvent debtor to the ratable payment of his debts”; and

“(2) to grant him a discharge from his existing obligations, to the end that he may be restored to the activities of life, freed from the burdens visited upon him by previous misfortunes in business.”

The 1899 treatise adds this opinion on such two-fold object of the 1706 law:

“It may be justly remarked that there is nothing more to be accomplished by any law on the [bankruptcy] subject; all other provisions are matters of detail more or less effectively designed to accomplish these ends.”

 

TREATISE:

Bush,   “The National Bankruptcy Act of 1898, with Notes, Procedure and Forms“, (1st Edition, 1899), The Banks Law Publishing Co.

 

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.

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.