A debtor was liberated from an objection to discharge where the deadline was extended to January 15, 2018, which was Martin Luther King, Jr. Day and the objection was not filed until the next day. Smart-Fill Management Group, Inc. v. Froiland (In re Froiland), 18-1006 (Bankr. W.D. Tex. 7/6/18). While most practitioners are familiar with the rule which extends deadlines that fall on a Saturday, Sunday or national holiday, there is an important caveat: the rule only applies to deadlines stated in days or a longer unit of time. Where a deadline is set for a date certain, there is no extension.
The Debtor filed bankruptcy on August 7, 2017. The deadline for objections to discharge was set based on sixty days after the first date set for the first meeting of creditors. The deadline was extended twice. The second extended date was set for January 15, 2018. January 15, 2018 was Martin Luther King, Jr. Day, a federal holiday. The creditor filed a complaint objecting to discharge on January 16, 2018 and the Debtor moved to dismiss the complaint as being untimely.
The Court's Ruling
Judge H. Christopher Mott noted that Rule 9006(a) once stated that "In computing any period of time prescribed by or allowed by these rules, by the local rules, by order of court, or by any applicable statute, . . . (t)he last day of the period so computed shall be include, unless it is a Saturday, Sunday, or a legal holiday . . . " In Chapman Investment Associates v. American Healthcare Management (Matter of American Healthcare Management), 900 F.2d 832 (5th Cir. 1990), the Fifth Circuit held that this rule extended a deadline set on a date specific which expired on a Saturday, Sunday or legal holiday. (Note: I worked on the brief for the losing side arguing that the specific date controlled).
In 2009, Rule 9006(a) was amended to provide:
When the period is stated in days or a longer unit of time . . . include the last day of the period, but if the last day is a Saturday, Sunday, or legal holiday, the period continues to run until the end of the next day that is not a Saturday, Sunday, or legal holiday.
To make it perfectly clear, the Advisory Committee stated that it was rejecting American Healthcare Management.
The time-computation provisions of subdivision (a) apply only when a time period must be computed. They do not apply when a fixed time to act is set. The amendments thus carry forward the approach taken in Violette v. P.A. Days, Inc., 427 F.3d 1015, 1016 (6th Cir. 2005) . . . and reject the contrary holding of In re American Healthcare Management, Inc., 900 F.2d 827, 832 (5th Cir. 1990) . . . . If, for example, the date for filing is “no later than November 1, 2007,” subdivision (a) does not govern. But if a filing is required to be made “within 10 days” or “within 72 hours,” subdivision (a) describes how that deadline is computed.
Judge Mott noted that "An Advisory Committee Note accompanying a federal rule is highly persuasive and afforded substantial weight in interpreting federal rules, even if it is not binding." Opinion, p. 7. As a result, Judge Mott found that the complaint was untimely and dismissed it.
As I mentioned above, I worked on American Healthcare Management and unsuccessfully argued that the date is the date. Until I read this opinion, I was not aware that the rule had been amended and had assumed that any deadline falling on a Saturday, Sunday or holiday was automatically extended. This opinion is a warning that the rules we grew up with do not remain static. In some cases they can change with serious consequences.
The new rule makes sense in the age of e-filing. In the old days, the courthouse had to be open to file a document. In some cases, courts had overnight dropboxes but there was always the risk that the pleading would be file-marked for the next day when the clerk actually received it. With e-filing, the clerk's office is open for business 24/7. There is nothing to prevent an enterprising lawyer from filing a document at 11:59 p.m. on Christmas Day.
There are two practice tips to be gleaned from this opinion. First, in setting specific dates in scheduling orders and the like, make sure not to set a deadline on a Saturday, Sunday or legal holiday. Second, if a deadline ends up falling on one of these dates and you don't want to work on a weekend or holiday, ask opposing counsel for an extension before the deadline expires.
President Donald Trump has selected D.C. Circuit Judge Brett Kavanaugh to be his second Supreme Court nominee. A post describing his bankruptcy opinions would be very short. I could find only one opinion authored by Judge Kavanaugh arising out of bankruptcy court and that case dealt with equitable subrogation under the laws of the District of Columbia. Smith v. First American Title Ins. Co. (In re Stevenson), 789 F.3d 197 (D.C. Cir. 2015). This is not surprising given the D.C. Circuit's footprint. The D.C. Circuit has one bankruptcy court with one bankruptcy judge. By contrast, the Fifth Circuit has nine districts staffed by 26 judges.
The Slim Experience of Judge Kavanaugh with Bankruptcy and the FDCPA
Judge Kavanaugh also was on the panel which decided several unremarkable decisions on cases originating in bankruptcy court. In Capitol Hill Group v. Pillsbury, Winthrop, Shaw, Pittman, LLC, 569 F.3d 485 (D.C. Cir. 2009), Judge Kavanaugh was on a panel that held that malpractice claims against a firm that represented a chapter 11 debtor were subject to "arising in" jurisdiction and that the bankruptcy court's order granting the firm's fee application was res judicata. He was also on panels that decided two cases against the Pension Benefit Guaranty Corporation which arose from bankruptcy filings. United Steel Workers v. Pension Benefit Guaranty Corp., 707 F.3d 319 (D.C. Cir. 2013); Davis v. Pension Guaranty Benefit Corp., 571 F.3d 1288 (D.C. Cir. 2009).
There is also another case where Judge Kavanaugh could have been exposed to some arguments about how bankruptcy courts are structured. Ali Hamza Ahmad Suliman Al Bahlul v. United States, 840 F.3d 757 (D.C. Cir. 2016)(en banc) was a case brought by a member of al Qaeda who sought to challenge his conviction for conspiracy by a military tribunal. One of Al Bahlul's arguments was that he was entitled to be tried by an Article III tribunal. Judge Kavanaugh's concurrence relied on the long history of using military commissions to try enemy war criminals. However, Judge Millett's concurrence concluded that structural Article III challenges could be forfeited by failure to raise them below. In making this argument, he discussed the Supreme Court's opinion in Wellness International Network, Ltd. v. Sharif, 135 S.Ct. 1932 (2015). You can see that I am reaching where the most exciting discussion of bankruptcy that I can find is a concurrence by another judge in a case that did not itself involve bankruptcy.
Judge Kavanaugh also appears to have very little experience with the Fair Debt Collection Practices Act. He was on the panel that decided Jones v. Dufek, 830 F.3d 523 (D.C. Cir. 2016). This case held that a collection letter sent by a law firm did not misrepresent that an attorney was meaningfully involved where it contained a prominent disclaimer stating that the attorney was acting as a debt collector and did not threaten legal action. (My partner Manny Newburger argued this case).
Judge Kavanaugh and the CFPB
One area where Judge Kavanaugh does have a lot of experience is the Consumer Financial Protection Bureau. He authored an opinion holding that the CFPB was unconstitutional because it was headed by a single director who could only be removed for cause. PHH Corp. v. Consumer Financial Protection Bureau, 839 F.3d 1 (D.C. Cir. 2016). However, that opinion was reversed by the en banc D.C. Circuit leaving Judge Kavanaugh in dissent. PHH Corp. v. Consumer Financial Protection Bureau, 881 F.3d 75 (D.C. Cir. 2018)(en banc). He also dissented from an opinion which held that a company could not obtain a preliminary injunction to block a civil investigative demand by the CFPB. Doe Co. v. Cordray, 849 F.3d 1129 (D.C. Cir. 2017). Judge Kavanaugh would have ruled that "the Company as a regulated entity has standing to raise its free-standing constitutional claim (that the structure of the CFPB is unconstitutional) and the claim is ripe."
He wrote two other opinions dealing with standing to challenge the CFPB, one for the majority and one in dissent. In State National Bank of Big Spring v. Lew, 795 F.3d 48 (D.C. Cir. 2015), he wrote that a Texas bank regulated by the CFPB had standing to challenge the constitutionality of the CFPB's structure as well as the recess appointment of its director. However, he found that a bank did not have standing to argue that a competitor's designation as "too big to fail" gave it a competitive advantage. In Morgan Drexen, Inc. v. Consumer Financial Protection Bureau, 785 F.3d 684 (D.C. Cir. 2015), he dissented from an opinion that found that an attorney who contracted with a debt settlement company did not have standing to challenge the bureau's structure. He wrote:
The Bureau is therefore regulating a business that Pisinksi engages in. That is enough for standing. We have a tendency to make standing law more complicated than it needs to be. When a regulated party such as Pisinksi challenges the legality of the regulating agency or of a regulation issued by that agency, "there is ordinarily little question that the party has standing" as the Supreme Court has indicated.
The Dissents of Judge Kavanaugh
One important qualification for a Supreme Court justice is the ability to dissent. A dissent allows a losing justice to unleash his fire and fury on the majority while positioning himself to fight another day. I found 26 dissents by Judge Kavanaugh. Many of them were more interesting than his majority opinions.
His most consequential dissent was in Heller v. District of Columbia, 670 F.3d 1244 (D.C. Cir. 2011). In an opinion written by Judge Douglas Ginsberg*, the D.C. Circuit ruled that the Second Amendment did not establish an individual right to keep and bear arms. Judge Kavanaugh dissented and said that it did. The Supreme Court agreed with Judge Kavanaugh.
In United States Telecom Association v. FCC, 855 F.3d 381 (D.C. Cir. 2017), Judge Kavanaugh took on net neutrality. A panel of the D.C. Circuit found that the FCC had authority to craft the Open Internet Order known as net neutrality. Judge Kavanaugh dissented from the decision to deny en banc review. He argued that Congress had not granted the FCC the power to enact the rule and that it violated the First Amendment. He wrote:
The FCC's 2015 net neutrality rule is one of the most consequential regulations ever issued by any executive or independent agency in the history of the United States. the rule transforms the internet by imposing common-carrier obligations on internet service providers and there by prohibiting internet service providers from exercising control over the content they transmit to consumers. The rule will affect every internet service provider, and every internet consumer. The economic and political significance of the rule is vast.
The net neutrality rule is unlawful and must be vacated, however, for two alternative and independent reasons.
Of some interest to Austinites is his dissent in FTC v. Whole Foods Market, 548 F.3d 1028 (D.C. Cir. 2008).(Whole Foods is based in Austin). The FTC sought an injunction to block a merger between Whole Foods and Wild Oats. The District Court denied the injunction and the majority reversed. Judge Kavanaugh would have affirmed the denial of the injunction (meaning that the merger could go forward) because he felt that the relevant market was all supermarkets (of which Whole Foods had a small market share) as opposed to "organic supermarkets" (in which it was a behemoth). Whole Foods later agreed to divest some Wild Oats locations and then was itself acquired by Amazon.
Judge Kavanaugh also objected to OSHA's attempt to cite Sea World for having a dangerous workplace in connection with its killer whales. In pointing out that many occupations are full of danger, he wrote:
Many sports events and entertainment shows can be extremely dangerous for the participants. Football. Ice hockey. Downhill skiing. Air Shows. The circus. Horse racing. Tiger taming. Standing in the batter's box against a 95 mile per hour fastball. Bull riding at the rodeo. Skydiving into the stadium before a football game. Daredevil motorcycle jumps. Stock car racing. Cheerleading vaults. Boxing. The balance beam. The ironman triathalon. Animal trainer shows. Movie stunts. The list goes on.
But the participants in those activities want to take part, sometimes even to make a career of it, despite and occasionally because of the known risk of serious injury. . . .
The broad question implicated by this case is this: When should we as a society paternalistically decide that the participants in these sports and entertainment activities must be protected from themselves--that the risk of significant physical injury is simply too great even for eager and willing participants?
SeaWorld of Florida, LLC v. Perez, 748 F.3d 1202, 1216-17 (D.C. Cir. 2014)(Kavanaugh, Dissenting).
This is perhaps his most lyrical dissent and it is also the one where he breaks from a formal writing style and abandons complete sentences for emphasis.
In Fogo de Chao (Holdings), Inc. v. United States Department of Homeland Security, 769 F.3d 1127 (D.C. Cir. 2014), he dissented from a decision which found that Brazilian chefs had "specialized knowledge" which would entitle them to L1-B visas to work in a Brazilian steakhouse. He faulted the majority for refusing to accord deference to agency findings. He also agreed with the agency that "one's country of origin, or cultural background, does not constitute specialized knowledge under this immigration statute for purposes of being a chef or otherwise working in an ethnic bar or restaurant in the United States." Fortunately, the majority allowed the Brazilian chefs into the country and diners were able to eat expensive meals prepared by authentic culinary artists.
In Lorenzo v. SEC, 872 F.3d 578 (D.C. Cir. 2017), Judge Kavanaugh thought that the SEC had gone too far in punishing an employee of a registered broker-dealer for forwarding false statements prepared by his boss. The employee was the director of investment banking at the firm. However, Judge Kavanaugh's dissent made it sound as though he was a mere clerical employee:
Suppose you work for a securities firm. Your boss drafts an email message and tells you to send the email on his behalf to two clients. You promptly send the emails to the two clients without thinking too much about the contents of the emails. You note in the emails that you are sending the message "at the request" of your boss. It turns out, however, that the message from your boss to the clients is false and defrauds the clients out of a total of $15,000. Your boss is then sanctioned by the Securities and Exchange Commission (as is appropriate) for the improper conduct.
What about you? For sending along those emails at the direct behest of your boss, are you too on the hook for the securities law violation of willfully making a false statement or willfully engaging in a scheme to defraud?
Finally, Judge Kavanaugh dissented from an opinion allowing a former Congressional employee to sue her employer for racial discrimination and retaliation. Howard v. Office of the Chief Administrative Office of the United States House of Representatives, 720 F.3d 939 (D.C. Cir. 2013). LaTaunya Howard wanted to sue the Office of the Chief Administrative Officer of the United States House of Representatives for racial discrimination and retaliation under the Congressional Accountability Act. The District Court dismissed the suit for lack of jurisdiction based on the Speech and Debate Clause of the Constitution which provides that "for any Speech or Debate in any House, shall not be questioned in any other Place." The majority concluded that the Speech or Debate clause did not provide immunity to legislators if the case could proceed without inquiring into legislative acts or the motivation for legislative acts.
Judge Kavanaugh disagreed. He wrote:
Once we conclude (as we must here) that the employer's asserted reason for the decision involves legislative activity protected by the Speech or Debate Clause, I believe (unlike the majority opinion) that the case must come to an end. I do not see how a plaintiff employee such as Howard can attempt to prove either that she in fact adequately performed her legislative duties or that her performance of legislative activities was not the actual reason for the employment action without forcing the employer to produce evidence that she did not perform her legislative activities and that her poor performance of legislative activities was the actual reason for the employment action.
In the case, the stated reason for demoting and firing the employee had to do with her communications regarding the legislative branch's budget and her refusal to perform budget analysis for Congressional committees. To my unschooled eye, it seems to me that Judge Kavanaugh took a Constitutional protection of Speech or Debate and expanded it to any activity related to the legislature.
What Does This All Say About Judge Kavanaugh?
While I haven't done a deep dive into his jurisprudence it certainly seems to me that there are some patterns. When it comes to economic regulation or consumer protection, Judge Kavanaugh wants to keep federal agencies in their place. Whether it is questioning the structure of the CFPB or the authority of the FCC to promulgate net neutrality rules, Judge Kavanaugh insists on crystal clear constitutional and statutory authority. He also takes what he considers to be a commonsense approach in restricting the actions of the SEC, the FTC and OSHA. However, when a decision involves national security, such as the military commission case or the immigration case, he is much more deferential to the government. What does this mean for bankruptcy? Would he view bankruptcy courts as engaging in economic regulation and seek to strictly limit their powers? Would he be skeptical of rules promulgated by the United States Trustee? Based on the record presented, I can raise the questions but I don't have clear answers.
Note: Because my focus was on cases that could affect bankruptcy, I focused primarily on business and consumer cases. That is why I did not discuss Judge Kavanaugh's dissent in a case involving a pregnant teen who wanted an abortion.
*--An earlier version of this post incorrectly identified Judge Ginsberg as Ruth Bader Ginsberg. However, Justice Ginsberg was already on the Supreme Court at this time. Thank you to Lisa Fancher for pointing out the error.
During the first quarter of 2018, the Fifth Circuit’s bankruptcy opinions gave a break for Chapter 7 trustees on their fees, resolved important issues on exemptions and explored the interplay between valuation and the elusive Section 1111(b) election among others.
LeJeune v. JFK Capital Holdings, LLC (In re JFK Capital Holdings, LLC), 880 F.3d 747 (5th Cir. 1/26/18)
A trustee sought compensation under 11 U.S.C. §326. Although no objection was filed, the bankruptcy court substantially reduced the trustee’s commission. The district court reversed and remanded because the bankruptcy court had failed to give a reason for its action. The trustee argued that certain creditors in another bankruptcy estate lacked standing to participate in the appeal. The Fifth Circuit found that because those creditors had claimed an interest in the estate at issue, they had standing to participate in the appeal. The Court of Appeals then found that the statutory formula under11 U.S.C. §326 was not only the maximum for trustee compensation but was also “a baseline presumption for reasonableness in each case.”
Sale Free and Clear of Interest of a Co-Owner; Claims (Sections 363(h) and 502)
UTSA Apartments, LLC v. UTSA Apartments 8, LLC (In re UTSA Apartments 8, LLC), 886 F.3d 473 (5th Cir. 3/27/18)
A student housing complex was owned by multiple tenants-in-common. The tenants-in-common had multiple disagreements with Woodlark, the management company for the complex. Some but not all of the tenants-in-common filed bankruptcy. While the bankruptcy was pending, several non-bankrupt co-tenants assigned their interests to UTSA, an affiliate of the management company. The property was sold free and clear of the interests of the co-owners pursuant to 11 U.S.C. Sec. 363(h).
The debtor co-tenants objected to paying the affiliate of the management company based on the interests that were assigned to it post-petition. Instead, they sought to limit the affiliate to the interest it owned on the petition date and to award the interests that were transferred to it to the co-tenants who had filed bankruptcy. The Bankruptcy Court agreed and reduced the interest of UTSA from 21.17% to 3.14%.
The Debtors also sued Woodlark for breach of fiduciary duty. The Court found breach of fiduciary duty but did not find any specific damages. Instead, it denied the portion of Woodlark’s claim for deferred management fees based on Texas law allowing for fee forfeiture in a case of insider dealings. However, it affirmed the portion of the claim relating to funds advanced to the project.
On appeal, the debtor co-tenants argued that the share attributable to UTSA, the affiliate of the management company, could be reduced as an “equitable remedy” for Woodlark’s breaches of fiduciary duty. However, UTSA was never sued. The Fifth Circuit found that the Bankruptcy Court could not reduce the share of proceeds payable to a non-debtor party who had not been sued.
The Fifth Circuit affirmed the reduction in the proof of claim based on breach of fiduciary duty.
Disclosure: I represented Woodlark and UTSA in the Bankruptcy Court and subsequent appeals. There is a motion for rehearing still pending.
Valuation/Section 1111(b) Election (Sections 506 and 1111)
The Houston Astros and the Houston Rockets formed a television network (the Network) to televise their games. The Network entered into an agreement with the Teams granting them the exclusive rights to broadcast their games. It also entered into an Affiliation Agreement with Comcast to carry the Network on its cable systems in return for a fee. An affiliate of Comcast loaned the Network $100 million secured by tangible and intangible assets.
After the Network defaulted on its payments to the Astros, the Astros threatened to terminate their agreement. This would have jeopardized Comcast which would not have been able to broadcast the games. Various Comcast entities filed an involuntary petition against the Network.
The Network reached an agreement with AT&T and DirecTV for those entities to acquire its equity and to enter into separate agreements to pay the Network to broadcast its content. In connection with this deal, the Teams agreed to waive $107 million in media-rights fees which had accrued during the bankruptcy.
Comcast made an 1111(b) election to have its claim treated as fully secured. The election did not apply to the Network’s tangible assets because those assets were to be sold and the 1111(b) election does not apply in the context of a sale. The Bankruptcy Court valued the Affiliation Agreement with Comcast as of the petition date. As of the petition date, the Court concluded that the value of the Affiliation Agreement was less than the amount of the media-rights fees to be paid by the Network. As a result, the Court valued the Affiliation Agreement at $0. Because an 1111(b) election cannot be made with regard to property which is of inconsequential value, the Court denied the election.
On appeal, the Fifth Circuit evaluated whether the collateral should have been valued as of the petition date or as of the effective date of the plan. It stated:
We conclude that a court is not required to use either the petition date or the effective date. Courts have the flexibility to select the valuation date so long as the bankruptcy court takes into account the purpose of the valuation and the proposed use or disposition of the collateral at issue.
Because the proposed use was under the plan, the Affiliation Agreement should have been valued based on that use. Because the Teams had agreed to waive the media rights fees, the Fifth Circuit found that it was error to deduct them from the value of the collateral. The Court stated:
Therefore, the value of the Agreement in the reorganized debtor’s hands is unaffected by these waived fees. Subtracting those costs from the value of Comcast’s collateral would value the Agreement in light of a hypothetical disposition of the property—i.e. liquidation—that will not occur.
As a result, the Court remanded for a new valuation.
It is important to note that this result is unique to a Chapter 9, 11 or 12 proceeding. In 2005, Congress amended Section 506 to state that valuation in Chapter 7 and 13 cases should be made as of the petition date based on replacement value.
Exemptions (Section 522)
Lowe v. DeBerry (In re DeBerry), 864 F.3d 526 (5th Cir. 3/7/18)
A debtor filed chapter 7 and claimed a Texas homestead as exempt. No party objected. While the case was still open, the debtor sold the homestead and used the proceeds to hire a criminal attorney among other items. The trustee then sued to recover the proceeds on the basis that failure to re-invest them in another Texas homestead within six months caused the exemption to lapse. The bankruptcy court denied the trustee’s motion but the district court reversed.
The Fifth Circuit ruled that property claimed as exempt in a chapter 7 case could not re-enter the estate based on subsequent events. The Court distinguished its prior precedent in Frost as being limited to the chapter 13 context.
Peake v. Ayobami (In re Ayobami), 879 F.3d 152 (5th Cir. 1/3/18)
A chapter 13 debtor sought to exempt 100% of the value of an asset up to the applicable limit under the federal exemptions. Following several rounds of objections to exemptions, the bankruptcy court certified a question to the Fifth Circuit as follows: “May a debtor claiming federal exemptions under §522 of the Bankruptcy Code ever exempt a 100% interest in an asset?” The Court’s answer was yes. Where the value of the asset, taken together with other exemptions in the same category, is below the statutory cap, the debtor may properly exempt 100% of the value of the asset. However, the Court declined to address whether exempting 100% of the value would be the same as exempting the asset itself.
Sanctions; Appellate Procedure
Kenneth Michael Wright, LLC v. Kite Bros., LLC (In re Kite), 710 Fed. Appx. 628 (5th Cir. 1/12/18)(unpublished)
A creditor filed an untimely appeal to the U.S. District Court. The District Court dismissed the appeal and awarded sanctions. The creditor appealed to the Fifth Circuit and the appellees again asked for sanctions.
On appeal, the appellant argued that the time limit of Rule 8002 to file a notice of appeal was not jurisdictional. The Fifth Circuit said that “an appeal is frivolous if the result is obvious or the arguments of error are wholly without merit and the appeal is taken 'in the face of clear, unambiguous, dispositive holdings of this and other appellate courts.” The Court noted that a deadline is jurisdictional if it is mandated by Congress. Because 28 U.S.C. §158(c)(2) specifically adopts the time limit set forth in Fed.R.Bankr.P. 8002, the deadline was jurisdictional and the argument that it was not was frivolous. The Court awarded nominal damages of $1 and double costs.
Mandel v. Thrasher (Matter of Mandel), 720 Fed.Appx. 186 (5thCir. 2/15/18) (unpublished)
A debtor misappropriated trade secrets. The bankruptcy court awarded $1 million to the inventor and $400,000 to the company’s chief creative officer. In the first appeal, the Fifth Circuit affirmed the liability finding but remanded for a new hearing on damages. On remand, the bankruptcy court awarded the same damages.
The Fifth Circuit quoted its prior opinion that damages for theft of trade secrets could be based on:
the value of plaintiff's lost profits; the defendant's actual profits from the use of the secret, the value that a reasonably prudent investor would have paid for the trade secret; the development costs the defendant avoided incurring through misappropriation; and a reasonable royalty.
The Fifth Circuit affirmed the damages awards from the lower courts.
Judge Jennifer Walker Elrod dissented. She said, “Our caselaw cannot be bent to support the award of unproven damages.” She explained that in the first instance, the bankruptcy judge had rejected all of the damage models offered and then awarded damages without stating what model it did use. On remand, the bankruptcy court awarded damages on a model it had previously rejected—the lost asset theory. She faulted the bankruptcy court for accepting a valuation based on a range of values of successful companies without considering the risk of failure. She concluded:
Valuing intellectual property is hard, and the misappropriation of that technology is potentially as easy as a download to a flashdrive. The difficulty of determining a correct valuation methodology, however, does not excuse the burden to show that the technology's value rises above mere speculation and is based on just and reasonable inferences from the credible evidence. Our flexible and creative standard is not a license for pie-in-the-sky damages; rather, damages must be grounded both in theory and fact.
The opinion is interesting not so much for the majority opinion but for the spirited dissent.
Here are a few non-bankruptcy decisions that I found interesting.
Trois v. Apple Tree Auction Center, Incorporated, 882 F.3d 485 (5th Cir. 2/5/18)
A Texas resident sued Ohio citizens in a Texas court based on breach of contract and fraudulent misrepresentation. The breach of contract claim was based on a contract executed and performed in Ohio. The fraudulent misrepresentation claim was based on a conference call from Ohio to Texas.
The Fifth Circuit found that there were not minimum contacts with regard to the breach of contract claim. The only Texas contacts were phone calls with regard to the contract. "[C]ommunications relating to the performance of a contract themselves are insufficient to establish minimum contacts.").
However, the Court found jurisdiction with regard to the fraud claim although narrowly so. The Court stated:
This case falls within the fuzzy boundaries of the middle of the spectrum. Although Schnaidt did not initiate the conference call to Trois in Texas, Schnaidt was not a passive participant on the call. Instead, he was the key negotiating party who made representations regarding his business in a call to Texas. It is that intentional conduct on the part of Schnaidt that led to this litigation. So Schnaidt is not being haled into Texas court "based on [his] 'random, fortuitous, or attenuated' contacts." To be sure, we are somewhat wary of drawing a bright line at who may push the buttons on the telephone.
Texas Debt Collection Act
Clark v. Deutsche Bank National Trust Company, 719 Fed. Appx. 341 (5thCir. 1/22/18)(unpublished)
Homeowner sued under Texas Debt Collection Act Sec. 392.304(a)(19) which prohibits debt collectors from using any other false representation or deceptive means to collect a debt. The Court found that communications with regard to renegotiation of a debt do not concern the collection of a debt. Therefore the District Court was correct to dismiss the action for failure to state a claim.
Williams v. Wells Fargo Bank, N.A., 884 F.3d 239 (5th Cir. 2/26/18)
Swis Community, Limited built a low-income housing project. The project was financed with debt which was assigned to Fannie Mae with Wells Fargo Bank as servicer. Swis Community defaulted on the debt. A Wells Fargo employee provided incorrect notice addresses to the substitute trustee. As a result, at least some obligors did not receive notice of acceleration or substitute trustee’s sale. Fannie Mae purchased the property at foreclosure.
Parties associated with the debtor brought suit against Fannie Mae, Wells Fargo and the substitute trustees. The District Court granted summary judgment in favor of the Defendants. The plaintiffs appealed the summary judgments in favor of Wells Fargo and Fannie Mae.
The Fifth Circuit affirmed the judgment as to Wells Fargo. Because Wells Fargo was merely the servicer of the debt, it was not a party to the deed of trust. Therefore, it could not have breached the deed of trust. However, the Fifth Circuit reversed the judgment in favor of Fannie Mae for breach of contract. Generally under Texas law, a party who has materially breached a contract cannot bring an action for breach of contract. However, the plaintiffs argued that the obligation to give proper notice under the deed of trust was an independent covenant which could still be enforced notwithstanding default under the note. The Fifth Circuit agreed. The notice provisions under the deed of trust could only come into play in the event of default. If they could not be enforced based on breach of the note, they would be of little benefit.
Smitherman v. Bayview Loan Servicing, LLC, 2018 U.S. App. LEXIS 5660 (5th Cir. 3/6/18)
Smitherman acquired property in 2005. He stopped making payments in 2011. When Bank of America sought to foreclose, he filed various suits to stop the foreclosure. In June 2016, he brought his fourth suit in which he alleged wrongful foreclosure and to quiet title. The District Court dismissed his claims and enjoined him from interfering with future foreclosure sales.
The Fifth Circuit found that the wrongful foreclosure claim was premature at the time the claim was dismissed since no foreclosure had occurred. The quiet title claim failed because the plaintiff made only conclusory claims that the assignment to the current lender was improper. As a result, it failed to state a cause of action.
Warren v. Bank of America, N.A., 717 Fed.Appx. 474 (5th Cir. 3/9/18)(unpublished)
A lender foreclosed upon a property and sent its contractor to change the locks. The lender did not allow the borrower to remove her property. The Court found that Warren was a tenant at sufferance following the foreclosure. As a result, the Court found that the District Court properly dismissed the borrower’s claims for wrongful foreclosure, unlawful lockout, trespass and invasion of privacy. The opinion raises the possibility that the borrower could have raised a claim for conversion. However, this point is not developed.
The Supreme Court resolves about eighty cases each year, ranging from major constitutional issues to smallish questions of statutory interpretation. The three bankruptcy cases decided this term fall into the latter category, answering narrow statutory questions.
Supreme Court Sinks Safe Harbor
The first case decided was Merit Management Group, LP v. FTI Consulting. Inc., Case No. 16-784 (2/27/18). This case asked whether a shareholder of a business could be protected from a fraudulent transfer action where the funds passed through a third-party escrow agent which happened to be a bank. Section 546(e) of the Bankruptcy Code exempts from recovery "a transfer made by or to (or for the benefit of) … a financial institution...in connection with a securities contract...." In this case, the funds to purchase the stock flowed from the purchaser through two financial institutions to the stock seller. The statutory issue was whether the payment was protected where it flowed through two financial institutions that were merely intermediaries and did not receive the funds for their own benefit.
Writing for a unanimous court, Justice Sotomayor held that the relevant transfer to consider was the one that the Trustee sought to avoid. Since neither the buyer nor the seller was a financial institution, the safe harbor did not apply. This decision prevents parties from insulating themselves from potential liability for a fraudulent transfer by routing the proceeds through a financial institution which does not have an interest in the transaction.
How Do You Review a Non-Statutory Insider?
Next, the Supreme Court weighed in on the narrow issue of the proper burden of proof when deciding whether a transferee was a non-statutory insider under 11 U.S.C. § 101(31). U.S. Bank, N.A. v. Village at Lakeridge, LLC, No. 15-1509 (3/5/18). In order to achieve a cram-down of a chapter 11 plan, a debtor must obtain the consent of a least one impaired class of creditors without counting votes of insiders. The class that accepted the plan consisted of a claim held by the debtor's sole owner, clearly an insider. One of the directors of the insider creditor (Bartlett) offered to sell the claim to a retired surgeon (Rabkin) with whom she had a romantic relationship (more on this later). Rabkin agreed to purchase the $2.76 million claim for $5,000.00 and agreed to accept the plan.
The list of defined insiders does not include a person in a romantic relationship with a director of an insider. However, the definition of "insider" states that the term "includes" the defined categories, meaning that the list is not exhaustive. U.S. Bank, which objected to the plan, argued that the romantic doctor was a non-statutory insider. The Bankruptcy Court found that the doctor was not an insider because he purchased the claim as a speculative investment after conducting due diligence. The Ninth Circuit affirmed applying a test that looked at (1) the closeness of the relationship and (2) whether the transaction was negotiated at less than arms-length. The Circuit found that the Bankruptcy Court's determination that the transaction was negotiated at arms-length was not clearly erroneous and affirmed.
The Supreme Court accepted the case, not on the question of the correct legal test to apply, but whether the Court of Appeals had applied the proper standard of review. Factual determinations must be upheld unless they are clearly erroneous while legal conclusions are reviewed on a de novo basis.
Justice Kagan, again writing for a unanimous court, found that it took a three step process to answer the question. The first step was purely legal, to determine the appropriate legal test to apply. The second step was purely factual, to determine the “basic” or “historical” facts relevant to the legal test. The final step was to apply the historical facts to the legal test. If factual issues predominated, the final step would be reviewed on the clear error standard, while de novo review would apply if legal issues dominated.
The Supreme Court denied cert on whether the Ninth Circuit applied the right legal test, which was the more interesting question. While applying the historic facts to the legal test is a mixed question of law and fact, it ultimately depends on its component parts—the legal test and the facts. Since the legal test was not at issue, what remained was the Bankruptcy Court’s fact-finding which is reviewed for clear error.
The Ninth Circuit’s clear error review may have been assisted by the following testimony from Bartlett, the party offering the claim for sale:
Q: Okay. I think the term has been a romantic relationship—you have a romantic relationship?
A: I guess.
Q. Why do you say I guess?
A. Well, no—yes.
Justice Kagan observed that “One hopes Rabkin was not listening.”
It is not clear why the Supreme Court accepted this case and this question since the answer was rather obvious. Justice Sotomayor, joined by Justices Kennedy, Thomas and Gorsuch, had the same concern. Justice Sotomayor said that “if that test is not the right one, our holding regarding the standard of review may be for naught.” Because the Court did not accept the legal standard question, Justice Sotomayor did not provide an answer either. However, she did suggest that the lower courts might want to spend some time thinking about what the legal test should be. Justice Kennedy, in his own concurrence, went further. He said, “The Court’s holding should not be read as indicating that the non-statutory insider test as formulated by the Court of Appeals is the proper or complete standard to use in determining insider status.” He also suggested that the Bankruptcy Judge may have erred in concluding that the transaction was made on an arms-length basis since the claim was not shopped to other parties.
Thus, what we have is a rather unnecessary explication of how to decide mixed questions of law and fact combined with a statement by four Justices encouraging the lower courts to look for a different standard than the one articulated by the Ninth Circuit. As a result, this opinion is more interesting for what it didn’t decide than for what it did.
Supreme Court Says Get It in Writing
Finally, in Lamar, Archer & Cofrin v. Appling, No. 16-1215 (6/4/18), the Court decided whether a false statement about a single asset constituted a statement of financial condition which must be in writing to form the basis for a non-dischargeable debt. 11 U.S.C. §523(a)(2)(B) carves out an exception from the general rule that debts arising from fraud are non-dischargeable. It provides that a statement “regarding the debtor’s or an insider’s financial condition” must be in writing in order to give rise to a non-dischargeable debt.
The case involved a client who got behind on paying his lawyers. When the lawyers threatened to withdraw, he told them that he was expecting to receive a tax refund of approximately $100,000 and would use those funds to bring the lawyers current and pay future fees. The trusting lawyers accepted his promise and soldiered on. However, it turned out that the tax refund was closer to $60,000 and the client spent the money on business expenses.
When the debtor filed bankruptcy, the unhappy law firm sued to prevent the debt from being discharged, claiming that the client made a false representation to gain their continued services. The Bankruptcy Court ruled that a statement regarding a single asset, in this case, the tax refund, was not a statement regarding financial condition, and found the debt to be non-dischargeable. The Eleventh Circuit disagreed.
Justice Sotomayor, writing once more for a unanimous court, found that a statement regarding a single asset qualified as regarding the debtor’s financial condition. Relying on grammar, she found that the term “regarding” in the statute broadened the clause such that it referred to both the object, statements of financial condition, and items related to the object. She also relied on the fact that cases interpreting similar language under the Bankruptcy Act had arrived at the same result. Since Congress did not change the verbiage, it must have intended to adopt the prior jurisprudence.
The lesson here is that a verbal statement about a debtor’s assets is not worth the paper it isn’t written on. If a creditor wants to rely on a statement about a debtor’s assets, it should get it in writing. In the case of the law firm, a simple email asking the debtor to confirm that he was expecting to receive a $100,000 tax refund (as opposed to the paltry $60,000 refund), if acknowledged by the client would have sufficed.
When a case is heard at the Supreme Court, the docket is filled with briefs of amicus curiae trying to say something that will catch the court's attention. With so many briefs filed, they sometimes cancel each other out in a flutter of pdf files sounding variations on the same themes. However, amicus briefs are much less common at the Court of Appeals level. Recently I was part of an effort where a panel of the Fifth Circuit reversed itself in one instance and reversed a district court in another. The cases are Hawk v. Engelhart (In re Hawk), 871 F.3d 287 (5th Cir. 2017) and Lowe v. DeBerry (In re DeBerry), 2018 U.S. Appl LEXIS 5772 (5th Cir. 3/7/18). In this post, I would like to share how our amicus briefs came together as well as some tips on amicus practice before the Fifth Circuit.
A Split Arises
The issue in Hawk and DeBerry was whether a chapter 7 debtor who disposed of exempt property post-petition could lose that exemption if the proceeds were not reinvested within the period allowed by state law. Outside of bankruptcy it is clear that proceeds that are not reinvested lose their exempt status and become subject to claims of creditors. However, under the Bankruptcy Code, if there is not a timely filed objection to exemption, the exemption is allowed, even if it was frivolous. Taylor v. Freeland & Kronz, 503 U.S. 638 (1992). This result was clouded by a Fifth Circuit decision which suggested that an "esssential element of the exemption must continue in effect even during the pendency of the bankruptcy case." Zibman v. Tow (Matter of Zibman), 268 F.3d 298, 301 (5th Cir. 2001). This led the Fifth Circuit to hold that if a Texas homestead was sold during a chapter 13 case and the proceeds were not exempted within six months as provided by Texas law, they would lose their exempt status. Viegelahn v. Frost (In re Frost), 744 F.3d 384 (5th Cir. 2014).
Following Frost, there was a split between Texas bankruptcy courts as to whether Frost's logic would apply in a chapter 7 case. Two cases made their way to the Fifth Circuit at about the same time. In Lowe v. DeBerry (In re DeBerry), 2017 U.S. Dist LEXIS 113203 (W.D. Tex. 2017), Bankruptcy Judge Craig Gargotta had ruled that proceeds from post-petition sale of a homestead could not be recaptured once the exemption became final. However, he was reversed by U.S. District Judge Royce C. Lamberth. In Hawk v. Engelhart (In re Hawk), 556 B.R. 788 (S. D. Tex. 2016), Bankruptcy Judge Jeff Bohm had ruled that proceeds from an IRA lost their exempt status if they were not reinvested within sixty days notwithstanding failure to object to the original exemption. He was affirmed by U.S. District Judge Melinda Harmon. Thus, there was two cases proceeding to the Fifth Circuit where the District Court had ruled that property could lose its exempt status in a chapter 7 case.
An Amicus Brief Takes Shape
I was approached by Professor Christopher Bradley to see if I would be interested in participating in an amicus brief in the DeBerry case. Chris had more than an academic interest in the issue (pun intended). He had clerked for Bankruptcy Judge Tony Davis. Judge Davis had written an opinion, In re D'Avila, 498 B.R. 150 (Bankr. W. D. Tex. 2013) holding that Frost did not apply in chapter 7. After finishing his clerkship and working in private practice, Chris had obtained an appointment at the University of Kentucky School of Law. I had written at least five blog articles on the disappearing exemption issue, including one which strongly criticized the Frost decision. Michael Baumer, who is a homestead expert within the consumer bar, agreed to join our group. We hastily filed our brief in the DeBerry case and waited.
A few days later, a different panel of the Fifth Circuit handed down an opinion in Hawk v. Engelhart (In re Hawk), 864 F.3d 364 (5th Cir. 2017) finding that un-reinvested proceeds lost their exemption and became property of the estate. This posed a huge problem for us because under the rule of orderliness, one panel of the Fifth Circuit could not overrule another. Thus, we fashioned a second amicus brief arguing that the en banc Fifth Circuit should reconsider the Frost decision, or, in the alternative, limit it to the chapter 13 context. Retired Bankruptcy Judge Leif Clark joined our group of collaborators for this second brief. Judge Clark had presciently written about the issue in In re Bading, 376 B.R. 143 (Bankr. W.D. Tex. 2007) in which he had tolled the period for the debtor to reinvest homestead proceeds out of a concern that Zibman could be applied even in the absence of a timely exemption. (In the interest of telling a compact story, I am not explaining all of the legal arguments in detail. However I did discuss these issues in more depth in my article for the ABI Journal, "Fifth Circuit Walks Back Disappearing Exemption Decision,"American Bankruptcy Institute Journal (Jan. 2018)).
The Hawk panel vacated its prior opinion and substituted an opinion limiting Frost to chapter 13 cases. One of the points that the panel relied upon was part of the ruling by Judge Ronald King in the Frost case that the case would have come out differently in a chapter 7 proceeding. Since we did not cite these comments in our brief, it is possible that our brief did not change the result. A few months later, the Fifth Circuit released its opinion in DeBerry in which it reversed the District Court and affirmed Judge Gargotta. The DeBerry opinion cited our brief which was gratifying.
A Few Notes on Amicus Practice in the Fifth Circuit
Amicus practice before the Fifth Circuit is a specialized area with strict time limits. An amicus brief must be filed within seven days after the brief of the party it supports. Fed.R.App. P. 29(a)(6). This means that the decision to file should be made well before the party being supported has filed its brief. Otherwise, there is not sufficient time to compose a credible brief.
Unless a brief is filed with the consent of both parties, it must be accompanied by a motion for leave to file the brief with a copy of the proposed brief. Fed.R.App. P. 29(a)(2). In my experience, parties rarely consent to filing an amicus brief in support of their opponent, so the proposed amicus should be prepared to file a motion for leave.
The proposed brief must state the interest of the amicus. Generally it is better to have an organization with an interest in the point of law sponsor an amicus brief. In our case, we were not able to find a sponsoring organization. However, having a professor and a retired judge among our collaborators certainly did not hurt.
An amicus brief is limited to half the length of the brief it is supporting. Fed.R.App. P. 29(a)(5). This is particularly tricky on a petition for rehearing or rehearing en banc. Under Fed.R.App. P. 35(b)(2)(A), a petition for en banc hearing or rehearing is limited to 3,900 words. This means that the maximum length of an amicus in support of en banc hearing or rehearing is 1,950 words. This post is 1,401 words long which gives an idea of just how short 1,950 words is. A merits brief may run up to 13,000 words, Fed.R.App. P. 32(a)(7)(B), which allows for an amicus of up to 6,500 words. While the rule states that the length of an amicus brief is based on the maximum amount allowed for a principal brief, we had the clerk limit us to one-half of the actual brief filed which required some last minute cutting.
One final note is that the Fifth Circuit is a forum where strict compliance with format is enforced. I have had to resubmit briefs on multiple occasions to correct technical issues. There are two pieces of advice here. The first is to adhere strictly to the time limit for resubmitting a brief. The second is to be nice to the clerk's office. While it is frustrating to have to revise a brief for format issues, the clerk's office is uniformly willing to walk practitioners through how to make it right. Staying friendly with the clerk's office will avoid a world of unpleasantness.
The fourth quarter of 2017 was another slow period for Fifth Circuit opinions dealing with bankruptcy. There was only one published opinion and there were several opinions that I found on the Fifth Circuit's page but were not in LEXIS. Nevertheless, here they are for your consideration.The cases cover mootness, standing, and verbal statements about financial condition.
Dick v. Colo Hous. Enters., LLC, 872 F.3d 709 (5th Cir. 10/4/17)
Debtor sought to prevent a foreclosure sale including filing several bankruptcies. Two years after the last bankruptcy was dismissed, the substitute trustee posted the property for foreclosure. The Debtor obtained a TRO in state court. The Defendants removed the case to federal court. The U.S. District Judge denied the request for a preliminary injunction. The Debtor appealed and requested a stay pending appeal in the Fifth Circuit. The stay was requested the day before the foreclosure sale and was approved the next day. However, by this time, the substitute trustee had already conducted the foreclosure sale and sold the property to the lender.
The lender moved to the dismiss the appeal as moot. The Debtor argued that the Court could still grant relief since it could order the lender to rescind the foreclosure. The Debtor relied on an unpublished opinion. However, there was a published opinion stating that "[i]f the debtor fails to obtain a stay, and if the property is sold in the interim, the district court will ordinarily be unable to grant any relief." Matter of Sullivan Central Plaza I, Ltd., 914 F.2d 731, 732 (5th Cir. 1991). Based on the rule of orderliness, the Fifth Circuit declined to extend its prior unpublished opinion. The Court dismissed the appeal as moot, stating, "this court simply cannot enjoin that which has already taken place."
Khan v. Xenon Health, LLC (In re Xenon Anesthesia of Texas, PLLC), 698 Fed. Appx. 793 (5th Cir. 10/16/17)(unpublished)
Xenon Anesthesia of Texas, PLLC ("Xenon Texas") filed chapter 7 bankruptcy. Khan and Xenon Health, LLC ("Xenon Health") each filed claims. Khan objected to Xenon Health's proof of claim. Khan was previously a member of Xenon Texas. However, he was compelled to transfer his interest to another party in state court proceedings. After he was compelled to transfer his membership interest, he withdrew his proof of claim.
The Bankruptcy Court found that because Khan was not an owner of the Debtor and had withdrawn his proof of claim, he was not a party in interest who was entitled to object to a claim. The Fifth Circuit affirmed.
Tow v. Bulmahn (Matter of ATP Oil & Gas Corp.), Case No. 17-30077 (5th Cir. 10/27/17)(unpublished)
Trustee brought claims against Debtor's officers and directors for approving preferred stock dividends on the eve of bankruptcy and approving certain bonuses. The District Court dismissed. The Fifth Circuit affirmed. It was not enough to say that directors collectively approved dividends. It was necessary to show which ones voted in favor. Additionally, it was not sufficient to allege that dividends harmed the company's long term viability without additional explanation. Bonus claims were also dismissed due to failure to adequately allege why bonuses were excessive.
The Fifth Circuit also affirmed the ruling dismissing claims against the officers and directors who received the bonuses. It quoted a New Hampshire Bankruptcy Court decision which stated that "Bad business decisions without more cannot form the basis for a fraudulent conveyance action seeking recovery of compensation paid to an officer or a director."
The Fifth Circuit also affirmed the dismissal of related conspiracy claims and denial of leave to amend after the Second and Third Amended Complaints.
Garner v. Pillar Life Settlement Fund I, LP (Matter of Life Partners, Inc.), Case No. 16-11436 (5th Cir. 11/29/17)(unpublished)
Life Partners, Inc. sold undivided interests in life insurance policies that were found to be securities. The company filed chapter 11 and a trustee was appointed. Two different groups of investors filed adversary proceedings seeking class action status. The class actions were consolidated and the reference was withdrawn to the District Court. The Trustee and the named Plaintiffs sought to certify a class for settlement purposes. The District Court referred the matter to the Bankruptcy Court which conducted a hearing and recommended approval of the settlement. The District Court approved the settlement. A group of investors appealed approval of the class action settlement. Meanwhile, Life Partners confirmed a plan which incorporated the settlement. The objecting investors did not appeal plan confirmation and the plan was substantially consummated. The Fifth Circuit found that it could not grant any effectual relief based on appeal of only the Settlement Agreement. As a result, it dismissed the appeal as moot.
Haler v. Boyington Capital Group, LLC (In re Haler), 2017 U.S. App. LEXIS 27034 (5th Cir. 12/29/17)(unpublished)
The Debtor, Randall Lee Haler, was Executive Vice-President of McKinney Aerospace, L.P., a company that repaired and refurbished business jets. Haler told Boyington, a customer of McKinney Aerospace, that McKinney was in "very fine legally financial shape" and had plenty of cash. Apparently the company was not in very fine financial shape because when Boyington cancelled the contract, the company was unable to refund the unused portion of the funds obtained. Boyington sued in state court and obtained a fraud judgment against Haler for $258,000.
When Haler filed for chapter 7 bankruptcy, Boyington sued to obtain a non-dischargeable judgment under 11 U.S.C. Sec. 523(a)(2)(A). The Bankruptcy Court granted summary judgment based on the state court judgment and the District Court affirmed. The Fifth Circuit reversed. A non-dischargeable judgment under 11 U.S.C. Sec. 523(a)(2)(A) cannot be based on a statement respecting the debtor or an insider's "financial condition." Under 11 U.S.C. Sec. 523(a)(2)(B), a non-dischargeable debt can be based on a written statement of financial condition. The intersection of these two subsections means that oral statements of financial condition can never result in a non-dischargeable debt.
The Fifth Circuit found that Haler's statements were made concerning McKinney's financial condition and therefore could not result in a non-dischargeable judgment. The Fifth Circuit reversed the lower courts.
The third quarter of 2017 had one blockbuster opinion reaffirming the finality of exemptions in Chapter 7 and several less remarkable decisions. It was a slow quarter for bankruptcy.
Rosbottom v. Schiff (Matter of Rosbottom), 701 Fex. Appx. 330(5th Cir. 7/17/17)(unpublished)
The Debtor and his spouse conveyed their interests in a Louisiana residence to trusts. They then sold the residence for $1,850,000 and each deposited half the money in their own account. In 2005, Rosbottom divorced his spouse. He purchased a condominium in Dallas using his share of the proceeds from the Louisiana residence. He then conveyed the condo to his trust. Rosbottom filed for bankruptcy in 2009. He was convicted of bankruptcy fraud and a Chapter 11 trustee was appointed. After the Trustee confirmed a plan, the Trustee and the ex-spouse brought a declaratory judgment action seeking to determine that the Dallas condo was property of the estate.
The Bankruptcy Court found that the trust created by Rosbottom was invalid under Louisiana law because it violated Louisiana law prohibiting the conveyance of an undivided interest in community property. The Fifth Circuit affirmed. Because the creation of the trust was a nullity under Louisiana law, it never gained title to the Louisiana property. When that property was sold and a new residence was purchased, that property belonged to the Debtor and was property of the estate.
Cowin v. Countrywide Home Loans, Inc. (In re Cowin), 864 F.3d 344 (5th Cir. 7/18/17)
This was a dischargeability case under 11 U.S.C. Sec. 523(a)(4) and (a)(6). The Debtor entered into a scheme to purchase properties being foreclosed for unpaid condominium assessments. The properties were subject to mortgage liens which were not extinguished by the sales. The Debtor then arranged for a related party to purchase the ad valorem tax liens against the property and conduct a second sale. The tax lien sale extinguished the mortgage liens. However, the excess proceeds should have been paid to the mortgage lenders. Instead, they were diverted to a company controlled by the Debtor. This happened four separate times.
Several lenders, including Bank of America and Countrywide, filed suit. The Debtor filed two chapter 11 proceedings which were dismissed. After the second bankruptcy was dismissed, the bankruptcy court retained jurisdiction over the adversary proceedings. The Debtor entered into an agreed judgment with Bank of America. After the Countrywide case was tried but before the Bankruptcy Court entered findings and conclusions, the Debtor filed a chapter 7 proceeding. However, the Debtor did not file a suggestion of bankruptcy until after the Bankruptcy Court ruled that the debt was nondischargeable. The Bankruptcy Court entered judgment in favor of Countrywide after it learned of the second bankruptcy filing. Bank of America sued for a nondischargeable judgment in the second case.
On appeal, the Debtor argued that the agreed judgment with Bank of America was a new debt which could be discharged and that the Bankruptcy Court violated the automatic stay by entering judgment in the Countrywide adversary.
The Debtor argued that the Bankruptcy Court erred in imputing his co-conspirator's actions to him. The Fifth Circuit found that he participated sufficiently in the conspiracy to have personal liability and that actions of a co-conspirator could be imputed to him. Thus, the Court found that Cowin's actions constituted larceny and were nondischargeable under 11 U.S.C. Sec. 523(a)(4).
The Fifth Circuit found that it did have a clear precedent on whether the automatic stay prevented the Bankruptcy Court in one case from entering a judgment after a second case was filed. The closest precedent the court had was that filing a proof of claim in a bankruptcy case did not violate the stay. However, the Court found that any error was harmless because the Bankruptcy Court could have simply lifted the automatic stay to enter the judgment.
The Court did not directly address the claim that the Bank of America judgment extinguished any possible claim for nondischargeability. However, the Supreme Court decision in Archer v. Warner, 123 S.Ct. 1462 (2003) seems to foreclose this argument.
Hawk v. Engelhart (In re Hawk), 864 F.3d 364 (5th Cir. 7/19/17), vacated, 871 F.3d 287 (5th Cir. 9/5/17)
A debtor filed a petition under chapter 7 and claimed an IRA account as exempt. No party objected to the exemption. Later it turned out that the Debtor had withdrawn the IRA funds and had not re-invested them within 60 days as required by the exemption statute. The Trustee sued for turnover and prevailed in the Bankruptcy Court. Initially, the Fifth Circuit ruled in the Trustee's favor, finding that exempt property must retain its exempt status throughout the case. On petition for rehearing, the Fifth Circuit withdrew its opinion and distinguished its prior Frost opinion. It held that in a Chapter 13 proceeding, property that was exempt could come into the estate once it lost its exempt status because of 11 U.S.C. Sec. 1306(a)(1). I was one of the amici who sought to overturn the original decision.
Bynane v. The Bank of New York Mellon. 866 F.3d 351 (5th Cir. 8/3/17)
Plaintiff bought a home. Mortgage was assigned to a securitization trust. Bank of New York Mellon was the trustee for the trust. Property was sold at foreclosure to Guzman. Plaintiff filed suit in state court which was removed to federal court. Plaintiff sought to remand based on incomplete diversity. District Court denied the motion and dismissed plaintiff's claims.
Court found that citizenship of trust was based on citizenship of trustee. Because Bank of New York was domiciled in New York it did not defeat diversity. Court declined to hold that trust was a citizen of each of the domiciles of its shareholders. Plaintiff also sought to establish that Guzman transferred property to a Texas resident who should be considered the real party in interest. Court said that it would determine diversity based on the actual parties not a non-party with a potential interest in the case.
Court also rejected argument that Bank of New York did not hold good title because assignment to it was forged or was not authorized. Court ruled that obligor could not defend itself on a ground that rendered the assignment voidable but not void. The without authority ground would only make the assignment voidable. While a forged assignment would be void, the Plaintiff did not meet the pleading requirements of Fed.R.Civ.P. 9 to establish fraud.
Court also rejected promissory estoppel claim based on alleged promise from Bank of America to sign a modification agreement. However, Plaintiff did not plead what the terms of the alleged modification were so that claim failed.
Dorsey v. U.S. Department of Education (Matter of Dorsey), 870 F.3d 359 (5th Cir. 9/1/17)
Debtor sought a hardship discharge under 11 U.S.C. Sec. 523(a)(8). After his creditors successfully moved to re-open the bankruptcy case to file proofs of claim, the Debtor filed a notice of appeal in the main case. Thereafter, the Court conducted a trial on the adversary proceeding at which the Debtor failed to appear. The Debtor then sought to amend his statement of issues and record in the District Court to include matters relating to the adversary proceeding. The District Court found that because there was not a notice of appeal in the adversary proceeding, it lacked jurisdiction over the attempt to appeal from the adversary proceeding. The Fifth Circuit affirmed.
In 2005, Congress amended 11 U.S.C. Sec. 507(8) to add the following category of non-dischargeable debts:
any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual
A "qualified education loan" is one where the interest is tax deductible. The amendment had the effect of making private student loans non-dischargeable if the interest could be deductible.
If Congress repeals the definition of "qualified education loan" as part of the process of eliminating the deduction for student loan interest, there would be no corresponding provision in the tax code for Sec. 507(a)(8)(B) to refer to. In that case, Courts could find that the language added in 2005 does not refer to anything and is a null set. Of course, Court could try to apply Congressional intent and apply the non-existent provision of the tax code as though it were still there. If this passes, it will raise some interesting issues.
Jevic--The Inside Story and the Impact on Future Chapter 11s featured participants from the case offering their perspective on the case and what it meant. Dan Dooley of MorrisAnderson was the Chief Restructuring Officer for Jevic. Domenic Pacitti of Klehr Harrison was Debtor's counsel. Rene Roupinan of Outten & Golden represented the WARN Act claimants. The panel was moderated by Judge Gregg W. Zive (Bankr. D. Nev.).
Jevic Holding Company was a trucking company based in New Jersey. It had been acquired by Sun Capital and was financed by CIT Group. CIT requested that the debtor liquidate itself in Chapter 11. The Debtor apparently gave WARN Act notices. However, New Jersey had its own state statute which was stricter than the national statute.
When the case was filed, the CRO Dan Dooley, negotiated a wind-down budget which included $3.0 million for paying accrued wages and related payroll obligations. After the company was liquidated, the Debtor was holding $1.7 million which was subject to Sun's lien (it was also a secured creditor). There were two other important pieces of litigation. The WARN Act claimants sued the Debtor and Sun Capital. They alleged that the Debtor and Sun were a unitary employer. The Official Committee of Unsecured Creditors sued Sun and CIT to unwind the leveraged buyout as a fraudulent transfer.
Eventually a settlement was reached where Sun allowed the $1.7 million to be used to pay creditors and CIT paid another $2.0 million to cover priority and administrative claims. However, in the settlement Sun did not want any money to go to the WARN Act claimants because they were also suing Sun. As a result, a structured dismissal was set up which provided that the settlement funds would be paid to creditors but not to the WARN Act claimants. This involved skipping over the WARN Act claimants' priority claims.
The Bankruptcy Court approved the structured dismissal and the Third Circuit affirmed under the "rare circumstances" doctrine. The Supreme Court reversed finding that a debtor could not violate the priority scheme under the Bankruptcy Code in a non-consensual an end of case distribution. The Court left open the possibility that paying creditors out of sequence would be allowed in cases such as paying employee wage claims and critical vendor claims where doing so would advance Code-related goals.
Mr. Pacetti (the Debtor's lawyer) explained that they used a structured dismissal because there are only three ways to end a chapter 11 case--a plan, conversion or dismissal. 11 U.S.C. Sec. 349(b) says that the parties shall revert to the status quo ante unless the court "orders otherwise." The structured dismissal was an attempt to have the court "order otherwise."
Judge Zive focused on the Court's reference to allowing priorities to be skipped based on a Code-related objective. He raised the case of Motorola, Inc. v. Official Committee of Unsecured Creditors (In re Iridium Operating, LLC), 478 F.3d 452 (2nd Cir. 2007). In Iridium, the debtor had claims against its parent, Motorola, and Motorola had administrative claims against the estate. In settlement of other litigation, a fund of money was created to fund a litigation trust to sue Motorola. Any money remaining in the litigation trust would go to the unsecured creditors. Motorola objected to diverting funds which could have paid its administrative claim to the trust. The Second Circuit generally found that the settlement was permissible because having a well-funded creditors' trust would increase the value of the claims against Motorola. However, it remanded for an explanation of why the residual funds in the trust would go to the unsecured creditors instead of being distributed in priority order.
Mr. Dooley stated that the Code-related objective here was maximizing the pie.
Judge Zive said that other areas where priority-skipping would be allowed would be wage orders, critical vendor motions and roll-ups as part of DIP financing. He said these are all orders that allow the case to proceed.
Ms. Roupinan was asked how Jevic would change WARN Act litigation. She said that requiring parties to follow the absolute priority rule would provide clarity and predictability and improved ability to negotiate.
Mr. Pacetti said that in skipping priorities, it was important to consider what the stage of the case is. First day motions will get greater latitude than end of case distributions. He also stressed the importance of making an evidentiary record.
Judge Zive seconded this notion stating that any time you want the court to do something you should provide sufficient facts. He gave the example of routine motions for cash management and continuing bank accounts which could result in de facto sustantive consolidation.
Ms. Roupinian asked whether priority-skipping would be ok if all parties consented. She asked what would happen if the U.S. Trustee was the only party objecting.
Judge Zive replied that the policy of the U.S. Trustee is not the Bankruptcy Code. He said that "if everyone is consenting, I don't have a problem with that." However, he focused on what constituted consent? He said that if a party is given notice and fails to object, they have waived their objection.
Mr. Dooley said that the take-away from the case was that it was really about the absolute priority rule, not structured dismissals.
Judge Zive said that one of the problems with Jevic was that there was no going concern value to protect and no jobs. As a result, the Code-related objective was much weaker. A few moments later, he emphasized that priority skipping can be allowed to protect going concern value, jobs, etc. but that "there has to be a significant reason."
The panel also discussed gifting, that is, where one creditor gives up value so that it can go to a creditor with lesser priority. Judge Zive pointed out In re LCI Holding Co., 802 F.3d 547 (3rd Cir. 2015) where lenders acquired the debtor's asset via a credit bid but deposited funds in escrow for professional fees and paid some funds directly to unsecured creditors. Where the funds were paid directly by the secured lender, they were never property of the estate and thus the court had no jurisdiction over them.
Mr. Pacetti that lawyers should cut deals earlier in the case and read Jevic for what it says. However, Ms. Roupinian said that parties should either follow the absolute priority rule or get consent.
Judge Zive said that courts would be skeptical about non-consensual priority-skipping and that lawyers should get the evidence that shows why the settlement is proper.
Mr. Dooley said that doing priority skipping "requires real proof." He also said that structured dismissals must be squeaky clean and that first day orders may be more carefully examined. He said that the ruling will embolden the U.S. Trustee.
The take-aways from the panel were build your evidentiary record, identify a Code-related objective and do your deal at a time when it will still advance the reorganization.
Asset Protection Trusts--How to Make Them and How to Break Them examined a phenomenon emerging in the laws of several states, including Nevada. This panel was moderated by Ron Peterson of Jenner & Block with Neal Levin of Freeborn & Peters, Judith Greenstone Miller of Jaffe Raitt Heuer Heuer & Weiss, P.C., Rebecca Hume of Kobre & Kim, and Judge Brian F. Kenney of the U.S. Bankruptcy Court for the Eastern District of Virginia.
According to Judith Greenstone Miller, there are now seventeen states that allow Debtor Asset Protection trusts ("DAPs"). Some states have a statute of limitations as short as eighteen months to challenge a DAP while others may allow up to four years or more for an existing creditor that did not have knowledge of the transfer. Some states require an affidavit of solvency.
Michigan was the seventeenth state to allow DAPs in March 2017 and amended the Uniform Fraudulent Transfer Act (UFTA) to exempt a "qualified disposition." There are also variations in state law between those following the Uniform Fraudulent Transactions Act (UVTA) and the Uniform Voidable Transfers Act. While UFTA does not have a specific choice of law provision, UVTA does.
Ms. Miller explained that DAPs require giving up control and that high net worth indiiduals don't like to give up control. DAPs are attractive to individuals with plenty of assets now who fear future liabilities such as doctors.
In Michigan, DAPs must be irrevocable. The Trustee must reside in Michigan. The settlor must execute an affidavit that the transfer of assets into the trust will not render them insolvent and that they are not subject to pending litigation other than as described. They may retain the power to direct investments and request distributions of income and principal although they cannot demand a distribution. The sole means to challenge a DAP is to bring an action under the UVTA by clear and convincing evidence. The statute of limitations in Michigan is shortened from six years to two years, although it starts at the time of the qualified disposition. If a claim arises after the disposition, the statute of limitations is two years from when the claim arises. Beyond the state statute of limitations, the only resort is to Sec. 548 of the Bankruptcy Code for actual intent to hinder, delay or defraud. If a transfer is set aside, the property reverts to the settlor and only to the extent necessary to satisfy the claim.
Neal Levin described Nevada's DAP law, which he described as an "absolute shield" for assets. It has been around since 1999 and has a two year statute of limitations with a six month discovery rule. There is no requirement for an affidvait of solvency. The burden of proof is clear and convincing evidence. Additionally, the settlor retains incredible control over the trust assets. He said that the only exception to the Act's protections is an action under the UVTA.
Judge Brian F. Kenney described the Virginia law as being one of the least protective. He said that his state statute says that a transfer is not voidable solely because is was made to a self-settled trust without consideration. As with the law of several other states, Virginia's statute contains a provision shielding professionals who structure a transfer from liability. However, at the same time, Virginia adopted a statute providing for sanctions against any party within its jurisdiction who transfers assets with knowledge of a judgment. Thus, there is some conflict in the law.
Rebecca Hume came all the way from the Cayman Islands to discuss foreign asset protection trusts which she described as a war between the world and the debtor's assets with a gate that only the debtor has a key to. She described the Cook Islands as the worst jurisdiction for creditors with the Island of Nevis close behind. The law of the Cayman Islands provides that issues relating to Cayman Islands trusts must be governed by the law of the Cayman Islands and that any order of a foreign court attempting to assert control over a Cayman Islands trust would be unenforceable. In the Cook Islands, a claim must be brought within two years of when the transfer was made. The creditor must prove a fraud beyond a reasonable doubt. Further, the creditor must hire a lawyer in the Cook Islands and may not enter into a contingent fee arrangements. She said she knew of only one case where a Cook Islands Trust was set aside.
Judge Kenney said that Sec. 548(e) was added to the Code to address the problem of DAPs. He said that it allows a ten year lookback for a self settled trust and requires an intent to hinder, delay or defraud. This standard relies on the traditional badges of fraud analysis. The Trustee has two years to commence an action but that the statute could be equitably tolled.
Ron Peterson asked Judge Kenney what he could do to a debtor who was ordered to repatriate assets from a Cook Islands Trust but refused to do so. He said that under Sec. 105(a), he has the power to enforce his orders. He said that as a practical matter, incarceration for civil contempt will often be referred to the U.S. District Court because the District Court has more tools available to deal with incarceration. In one case, a debtor named Sala raised the defense of impossibility but the Court ruled that where is the impossibility is self-created, the defense would be rejected. He described it as a game of chicken between the debtor who is willing to sit in jail without giving up his funds and the Court that keeps him there.
In U.S. v. Grant, Neal Levin said that the settlor's widow raised the impossibility defense saying "I asked for the money back but they said no." The Court found that this was not sufficient to purge the contempt.
Mr. Levin pointed out that one-third of the world's wealth is kept in off-shore jurisdictions. He said that it was important to work with professionals in the affected jurisdiction.
Ms. Hume said that many offshore jurisdictions allow the settlor to retain great control over the trust and would only impose an independent trustee when "things get dicey." She said that settlors frequently retain the policy to change the trustee. She pointed to a court of appeals decision which required a settlor to disclose where trusts were located and what was within them. She described a Privy Council decision where a settlor had a power to revoke the trust but refused to exercise that power. The Council held that it could appoint a receiver over the power of revocation which allowed the trust to be revoked and the money collected.
Mr. Levin talked about how most wire transfers pass through New York banks. Because these banks are in the United States, the U.S. Courts have jurisdiction over them and they can be brought into the case.
Ron Peterson pointed out that the U.S. has treaties with countries such as Switzerland and that the U.S. Attorney can be brought to enforce the treaty in limited instances.
Mr. Levin pointed out that on the other side are "the forces of evil" such as foreign judges who view their responsibility as limited solely to enforce their laws and foreign professionals who want to protect their fees. He also said that the United States is now considered to be the largest recipient of offshore funds as foreign citizens are transferring funds to DAPs in the United States. He described the problem of professionals helping people conceal their assets as a "pervasive problem."
Ms. Hume pointed out that the Cayman Islands are now parties to various statutes requiring disclosures of cash transfers so that there is greater transparency and less advantage to hiding assets in the Cayman Islands.
The main take-away from the panel was that when dealing with DAPs or offshore trusts, the key is to engage qualified professionals who understand the local law in order to avoid committing malpractice whether trying to set up one of these vehicles or challenging one.