Wife's Homestead Claim Remains in Limbo With No Answer From Fifth Circuit

The plight of the non-filing spouse who stands to lose an interest in the homestead is a trap that is easy to overlook.   Under 11 U.S.C. Sec. 541(a)(2), when one spouse files bankruptcy, all joint management community property enters the bankruptcy estate.    This means that if the filing spouse elects not to claim the homestead as exempt in favor of selecting other property or is subject to a cap, the non-filing spouse may lose her interest in the property without having any say in the matter.     

I have previously written about the Odes Ho Kim case here.   In the Kim case, an involuntary petition was filed against Mr. Kim.    The creditors then sought to impose a cap upon his homestead exemption.  Mrs. Kim intervened asserting that she had an independent interest in the homestead.   The Bankruptcy Court and the District Court ruled that Mr. Kim was subject to a cap on the homestead exemption and that Mrs. Kim had no separate interest in the property.    If both spouses had filed, they would have been entitled to two times the amount of the cap.   However, with Mrs. Kim sitting outside of bankruptcy, her interest in the homestead was completely divested by the bankruptcy filing.

Up until this point, the result of the case illustrated an unfair result for the non-filing spouse, but one which was based on an arguable reading of the code.    However, things got interesting after the case was appealed to the Fifth Circuit.    On September 10, 2010, Pronske & Patel and Andrews & Kurth appealed the District Court ruling on behalf of the Kims.    The case was argued to Judges Higginbotham, Owens and Haynes on July 8, 2011.   Now, almost two years have passed since oral argument without a ruling.   According to the Bar Association for the Fifth Circuit, the case is the oldest bankruptcy case still under advisement and is the second oldest case of any kind under advisement.    

While speculation about the reason for the long gestation of the opinion is not worth much, I will engage in some anyway.   Both Judges Owens and Haynes sat on Texas state benches before being named to the Fifth Circuit.   (Indeed, Judge Owens was on the Texas Supreme Court).   Texas has a long tradition of protecting homestead rights.   Additionally, according to a recent book on the history of the Texas Supreme Court (Haley,The Texas Supreme Court: A Narrative History 1836-1986, University of Texas Press 2013),  Texas also was also the first state to recognize property rights for married women.    It may be that the judges are struggling with how to reconcile these strong Texas state law protections with the Bankruptcy law applicable here.   It will be interesting to see how the case is finally resolved.

Fifth Circuit Issues Two Decisions Easing Path for Chapter 11 Debtors

Within the span of a few days, Judge Patrick Higginbotham of the Fifth Circuit released two decisions which will ease the way for chapter 11 debtors to confirm their plans.   In the first decision, the Court definitively put a stake through the heart of the artificial impairment doctrine, while in the second, the Court held that the Till prime + formula, while not mandatory, was becoming the "default" rule for calculating interest in chapter 11 plans.    The cases are Matter of Village at Camp Bowie I, LP, No. 12-10271 (5th Cir. 2/26/13), which can be found here, and Matter of Texas Grand Prairie Hotel Realty, LLC, No. 11-11109 (5th Cir. 3/1/13), which can be found here.

Village at Camp Bowie and Artificial Impairment

Village at Camp Bowie involved an oversecured creditor whose claim overshadowed those of other creditors.    Western Real Estate Equities held a debt of $32.1 miliion secured by property valued by the court at $34 million.    The Debtor owed $59,398 to thirty-eight (38) trade creditors.    Under the plan, the Debtor's equity holders and related parties were to infuse $1.5 million in new equity.   As a result, the Debtor had sufficient funds to simply pay off the trade creditors and leave their claims unimpaired.   This would have allowed Western to veto the plan since there would not have been another class available to accept the plan.

Western objected that the Debtor's plan had not been proposed in good faith and that the plan hadn't really been accepted by an impaired class since the impairment was "artificial."     The Bankruptcy Court confirmed the Plan over Western's objections.

The Court noted that the Eighth Circuit requires that impairment be driven by economic need, while the Ninth Circuit did not distinguish between "discretionary and artificially driven impairment."    The Court also noted that it had previously rejected the concept of artificial impairment in Matter of Sun Country, Ltd., 764 F.2d 406 (5th Cir. 1986), but that because the court concluded that the impairment in that case was economically motivated "we deprived our analysis of precedential force."    On the other hand, the court had expressed concern over potential artificial impairment in Matter of Sandy Ridge Development Corp., 881 F.2d 1346 (5th Cir. 1989).  (Parenthetically, it is interesting to note that these cases involved two individuals who went on to achieve prominence on the Texas bench.   Leif Clark was the Debtor's lawyer in Sun Country, while Wesley Steen was the bankruptcy judge for Sandy Ridge during the period in which he was a judge in Louisiana).      

Judge Higginbotham found that artificial impairment was inconsistent with the statutory language of the Code, writing:

Today, we expressly reject Windsor [the Eighth Circuit decision] and join the Ninth Circuit in holding that § 1129(a)(10) does not distinguish between discretionary and economically driven impairment. As the Windsor court itself acknowledged, § 1124 provides that “any alteration of a creditor’s rights, no matter how minor, constitutes ‘impairment.’” By shoehorning a motive inquiry and materiality requirement into § 1129(a)(10), Windsor warps the text of the Code, requiring a court to “deem” a claim unimpaired for purposes of § 1129(a)(10) even though it plainly qualifies as impaired under § 1124.   Windsor’s motive inquiry is also inconsistent with § 1123(b)(1), which provides that a plan proponent “may impair or leave unimpaired any class of claims,” and does not contain any indication that impairment must be driven by economic motives.

The Windsor court justified its strained reading of §§ 1129(a)(10) and 1124 on the ground that “Congress enacted section 1129(a)(10) . . . to provide some indicia of support [for a cramdown plan] by affected creditors,” reasoning that interpreting § 1124 literally would vitiate this congressional purpose.   But the Bankruptcy Code must be read literally, and congressional intent is relevant only when the statutory language is ambiguous.   Moreover, even if we were inclined to consider congressional intent in divining the meaning of §§ 1129(a)(10) and 1124, the scant legislative history on § 1129(a)(10) provides virtually no insight as to the provision’s intended role, and the Congress that passed § 1124 considered and rejected precisely the sort of materiality requirement that Windsor has imposed by judicial fiat.

The Windsor court also reasoned that condoning artificial impairment would “reduce [§ 1129](a)(10) to a nullity.”   But this logic sets the cart before the horse, resting on the unsupported assumption that Congress intended § 1129(a)(10) to implicitly mandate a materiality requirement and motive inquiry.   Moreover, it ignores the determinative role § 1129(a)(10) plays in the typical single-asset bankruptcy, in which the debtor has negative equity and the secured creditor receives a deficiency claim that allows it to control the vote of the unsecured class.   In such circumstances, secured creditors routinely invoke § 1129(a)(10) to block a cramdown, aided rather than impeded by the Code’s broad definition of impairment.

Opinion, pp. 8-10.

While the passage quoted above is rather long, I have quoted it in its entirety because I find its statutory analysis to be spot-on.  There is no need to make things more complicated by delving into the meaning of a provision when the words used are clear.   Congress set the bar for determining impairment quite low.  Thus, when Congress required acceptance by an impaired class, it similarly set an easily met standard.  (Note: when Judge Higginbotham speaks of judicial fiat, I can't help but think of a small Italian car filled with black-robed judges).

The Court also rejected the argument that Matter of Greystone III Joint Venture, 995 F.2d 1274 (5th Cir. 1991) embodied a "broad, extrastatutory policy against 'voting manipulation.'"   He stated:

Greystone does not stand for the proposition that a court can ride roughshod over affirmative language in the Bankruptcy Code to enforce some Platonic ideal of a fair voting process.    

Opinion, p. 11.    While it is comforting to see Greystone limited to its actual holding, you also have to admire a judge who can work "Platonic ideal" into a bankruptcy opinion.   (According to Wikipedia, Platonic idealism refers to universals or abstract objects.  Thus, a Platonic ideal of voting would mean voting according to abstract, universal principles.)

Nevertheless, the Court did point out that good faith was still a relevant inquiry.

We emphasize, however, that our decision today does not circumscribe the factors bankruptcy courts may consider in evaluating a plan proponent’s good faith. In particular, though we reject the concept of artificial impairment as developed in Windsor, we do not suggest that a debtor’s methods for achieving literal compliance with § 1129(a)(10) enjoy a free pass from scrutiny under § 1129(a)(3). It bears mentioning that Western here concedes that the trade creditors are independent third parties who extended pre-petition credit to the Village in the ordinary course of business. An inference of bad faith might be stronger where a debtor creates an impaired accepting class out of whole cloth by incurring a debt with a related party, particularly if there is evidence that the lending transaction is a sham.  Ultimately, the § 1129(a)(3) inquiry is factspecific, fully empowering the bankruptcy courts to deal with chicanery. We will continue to accord deference to their determinations.

Opinion, pp. 12-13.

Texas Grand Prairie and Cram-Down Interest Rates

In the second case, the Court affirmed a bankruptcy court ruling which confirmed a chapter 11 plan which using a 5% cram-down rate of interest under the Till decision.   In Grand Prairie, the parties agreed that the Till decision provided the appropriate method for calculating a chapter 11 cram-down interest rate.   The Debtor's expert, faithfully following the Till approach, concluded that prime + a risk factor of 1.75% was appropriate, so that the indicated interest rate was 5.0%.   Even though the lender stipulated that Till was the correct approach, its expert did not follow its methodology.  Instead, he opined that the proper rate was 8.8% by "taking the weighted average of the interest rates the market would charge for a multi-tiered exit financing package" and then adjusting for risk factors.  The Court adopted the 5.0% rate which had the effect of costing the lender $1,485,000 in interest per year based on the appraised value of $39,080,000.

On appeal, Wells Fargo sought to exclude the Debtor's expert testimony on the basis that his "purely subjective approach to interest-rate setting" violated the Supreme Court's call for an "objective inquiry" in Till.   The Court wisely observed that:

Here, Wells Fargo does not challenge Robichaux’s factual findings, calculations, or financial projections, but rather argues that Robichaux’s analysis as a whole rested on a flawed understanding of Till. As we read it, Wells Fargo’s Daubert motion is indistinguishable from its argument on the merits. It follows that the bankruptcy judge reasonably deferred Wells Fargo’s Daubert argument to the confirmation hearing instead of deciding it before the hearing.  We pursue the same path and proceed to the merits.

Opinion, p. 7. 

Next, the Court addressed the proper legal standard for calculating an interest rate under section 1129(b).   The court ultimately concluded that the Till decision was not binding on the court because:

•  Till was a plurality opinion; and

• Till expressly left open the issue of interest rates in chapter 11 in footnote 14.

As a result, the Court found that its prior decision in In re T-H New Orleans Partnership, 116 F.3d 790 (5th Cir. 1997) remained binding.   T-H New Orleans held that the Court would not "establish a particular formula for determining an appropriate cramdown interest rate," but would review the Bankruptcy Court's decision for "clear error."   Having concluded that the Till formula was not mandatory, the Court nevertheless found that it was becoming the majority approach.

In spite of Justice Scalia’s warning, the vast majority of bankruptcy courts have taken the Till plurality’s invitation to apply the prime-plus formula under Chapter 11. While courts often acknowledge that Till’s Footnote 14 appears to endorse a “market rate” approach under Chapter 11 if an “efficient market” for a loan substantially identical to the cramdown loan exists, courts almost invariably conclude that such markets are absent.   Among the courts that follow Till’s formula method in the Chapter 11 context, “risk adjustment” calculations have generally hewed to the plurality’s suggested range of 1% to 3%.   Within that range, courts typically select a rate on the basis of a holistic assessment of the risk of the debtor’s default on its restructured obligations, evaluating factors including the quality of the debtor’s management, the commitment of the debtor’s owners, the health and future prospects of the debtor’s business, the quality of the lender’s collateral, and the feasibility and duration of the plan.

 Opinion, pp. 14-15.

 
Under the Fifth Circuit's deferential clear error analysis, a bankruptcy court which followed the majority approach could not be faulted, even if the court could have found another approach more persuasive.   

The Court found that the Debtor's expert properly followed the Till approach.  

We agree with the bankruptcy court that Robichaux’s § 1129(b) cramdown rate determination rests on an uncontroversial application of the Till plurality’s formula method. As the plurality instructed, Robichaux engaged in a holistic evaluation of the Debtors, concluding that the quality of the bankruptcy estate was sterling, that the Debtors’ revenues were exceeding projections, that Wells Fargo’s collateral — primarily real estate — was liquid and stable or appreciating in value, and that the reorganization plan would be tight but feasible. On the basis of these findings — which were all independently verified by Ferrell — Robichaux assessed a risk adjustment of 1.75% over prime. This risk adjustment falls squarely within the range of adjustments other bankruptcy courts have assessed in similar circumstances.

Opinion, p. 18.

Finally, the Court rejected Wells Fargo's argument that the path taken by the Debtor's expert produces "absurd results."

Wells Fargo complains that Robichaux’s analysis produces “absurd results,” pointing to the undisputed fact that on the date of plan confirmation, the market was charging rates in excess of 5% on smaller, over-collateralized loans to comparable hotel owners. While Wells Fargo is undoubtedly correct that no willing lender would have extended credit on the terms it was forced to accept under the § 1129(b) cramdown plan, this “absurd result” is the natural consequence of the prime-plus method, which sacrifices market realities in favor of simple and feasible bankruptcy reorganizations.   Stated differently, while it may be “impossible to view” Robichaux’s 1.75% risk adjustment as “anything other than a smallish number picked out of a hat,” the Till plurality’s formula approach — not Justice Scalia’s dissent — has become the default rule in Chapter 11 bankruptcies.  (emphasis added).

Opinion, p. 19.    Thus, the Court is not required to apply Till, but if it does, it is not error to pick a "smallish number" out of a hat.

Final Thoughts

These two opinions, while both affirming confirmation of chapter 11 plans, take very different approaches to judging.    Village at Camp Bowie is very much a straightforward application of statutory analysis.    While I thought that Sun Country's statement that:

Congress made the cram down available to debtors; use of it to carry out a reorganization cannot be bad faith.

effectively killed the doctrine of artificial impairment, it is nonetheless heartening to see a judge put the final nail in the coffin.     Just as I noted in my prior post about Spillman Development Group, this is a case of a judge rejecting magical thinking.   In this case, the magical thinking was that Greystone III Joint Venture can be cited in talismanic fashion for the proposition that the secured creditor automatically gets a veto.

Texas Grand Prairie is a much more subversive opinion.   While ostensibly following T-H New Orleans' no formula approach, the court gave the green light to bankruptcy courts to follow the Till plurality's prime + approach, referring to it as the majority approach and the default rule.   On the other hand, the Court left bankruptcy courts free to reject Till as well.   If anything, this decision gives broad discretion to the factfinder, something that has been noticeably lacking since the adoption of BAPCPA. 

Finally, Texas Grand Prairie may spell the death of expert interest rate testimony in chapter 11 cases.   If the Debtor's expert can pull a "smallish number" out of a hat, why can't the Debtor's attorney do so without the intervention of an expert witness?   The irony of Wells Fargo's Daubert argument is that it probably was right, but not for the reason that Wells Fargo thought.   The logical extension of Till is that the fact-finder does not require "scientific, technical or other specialized knowledge . . . to understand the evidence or determine a fact in issue" as required by Fed.R.Evid. 702 so that neither side should have been allowed to tender an expert witness.   This case will probably not preclude courts from considering experts pontificating on interest rates, but it frees up the court to take it or trash it.


Post-script:   While Judge Higginbotham may not receive as much recognition as a scholar of bankruptcy law as some of his colleagues, it is worth noting that he has now authored about 50 bankruptcy opinions, which is more than some bankruptcy judges.   In addition to the opinions discussed in this post, some of his other influential opinions include Wells Fargo Bank, N.A. v. Stewart, 647 F.3d 553 (5th Cir. 2011); Milligan v. Trautman, 496 F.3d 366 (5th Cir. 2007); Supreme Beef Processors, Inc. v. USDA, 275 F.3d 432 (5th Cir. 2001); Krafsur v. Scurlock Petroleum Corp., 171 F.3d 249 (5th Cir. 1999); Miller v. J.D. Abrams, Inc., 156 F.3d 598 (5th Cir. 1998); In re Clay, 35 F.3d 190 (5th Cir. 1994); and In re Howard, 972 F.2d 639 (5th Cir. 1992).   In my view, this is sufficient to earn him a place among the leading bankruptcy lights on the court.

Fifth Circuit Affirms Ruling That "The Loan Has Been Paid!!!;" Rejects Stern and Jurisdictional Defenses

The case of a creditor who did not want to acknowledge that its debt had really and truly been paid received little sympathy from the Fifth Circuit which rejected a panoply of defenses and affirmed the Bankruptcy Court ruling that "The Senior Loan Has Been PAID!!!"   Fire Eagle, LLC v. Bischoff (Matter of Spillman Development Group, Ltd., Case No. 11-51057 (5th Cir. 2/28/13), which can be found here.   I previously wrote about the Bankruptcy Court decision from Judge Frank Monroe here.   The decision is significant because it shows that Stern v. Marshall is not a silver bullet for parties seeking to avoid bankruptcy court decisions.   As discussed below, it also rejects a magical approach to bankruptcy law.

What Happened

The case involved a golf course that filed for chapter 11, which was a common occurrence in Austin.   After the debtor and a lienholder fought to a stalemate, the Bankruptcy Court ordered a section 363 sale.   The lienholder, Fire Eagle, LLC, held two liens, a first lien which was guaranteed, and a second lien which was not.    Fire Eagle was the high bidder at the sale, making a $9.3 million credit bid, which was approximately $200,000 more than the amount of its guaranteed first lien debt.  

Rejoicing at their good fortune, the guarantors requested a declaratory judgment that their obligation had been satisfied.   Fire Eagle objected to the Bankruptcy Court's jurisdiction as well as venue.  It also contended that its credit bid reduced its "claim" but not its "debt" and that it was therefore free to continue pursuing the guarantors.    The Bankruptcy Court ruled for the guarantors.   In addition to the quoted language above, the Court told Fire Eagle that "This is the Bankruptcy Court; not fantasy land" and "This is not rocket science."    The District Court affirmed.

The Fifth Circuit Explains Jurisdiction and Authority

In the post-Stern era, it is helpful to remember that there are three separate doctrines that govern a bankruptcy court's ability to render a  final decision:

a.  Jurisdiction under section 1334;

b.  Statutory authority under section 157; and

c.  Constitutional authority under Article III of the Constitution.

Under 28 U.S.C. Sec. 1334, there is jurisdiction for "civil proceedings arising under title 11, or arising in or related to cases under title 11."   "Related to" jurisdiction, which is the broadest category, applies if the case "could conceivably have any effect on the estate being administered in bankruptcy."    While Fire Eagle correctly stated that bankruptcy courts generally cannot "entertain collateral disputes between third parties that do not involve the bankruptcy or its property," the Fifth Circuit found that if Fire Eagle were to succeed in recovering from the guarantors, this would reduce its deficiency claim which would free up more money for the other creditors.     The Court noted that "We have previously held that similar attenuated, hypothetical effects of third-party litigation can give rise to related-to bankruptcy jurisdiction."    Opinion, p. 5.

Thus, jurisdiction turns on the broad "any conceivable effect" test.   However, this is not the end of the inquiry.    Once jurisdiction is present, the question is which court has the power to exercise that jurisdiction.

Statutory authority to render a final judgment is contained in 28 U.S.C. Sec. 157(b).   If a matter is statutorily defined as a "core" proceeding the Bankruptcy Court may enter a final judgment.   Otherwise, the Court must submit proposed findings of fact and conclusions of law to the U.S. District Court absent consent of the parties.

The Fifth Circuit found that the dispute between Fire Eagle and the guarantors qualified as a core proceeding because it was "dependent upon the rights created in bankruptcy."

Because the basis for this dispute is whether Fire Eagle’s credit bid had the effect of extinguishing the Senior Indebtedness, and because the right to credit bid is purely a creature of the Bankruptcy Code, see 11 U.S.C. § 363(k), we fail to see how this proceeding does not qualify as core under § 157(b)(1) and therefore hold that the bankruptcy court’s entering an order without reference to the district court was within its statutory authority.

Opinion, pp. 6-7.

Finally, there is the matter of constitutional authority to render a final judgment.   This is the legacy of Stern v. Marshall.    Because the Court of Appeal's discussion of Stern is succinct and clear, I quote it in its entirety below:

 In Stern v. Marshall, the Supreme Court held that it was unconstitutional for a bankruptcy court to issue a judgment on a state-law counterclaim for tortious interference with a gift expectancy, despite the fact that the claim itself was statutorily “core” pursuant to § 157(b)(2)(C) (defining as core proceedings “counterclaims by the estate against persons filing claims against the estate”). 131 S. Ct. 2594, 2600–01 (2011). It based this decision on the fact that the counterclaim was in no way reliant or dependent on proceedings in bankruptcy—it just happened to have been a counterclaim to a claim asserted in a bankruptcy proceeding. Id. at 2611. Fire Eagle contends that its claims in this matter are similarly beyond the constitutional authority of the bankruptcy courts to decide.

However, Stern itself stated that its holding was reliant on the fact that the counterclaim at issue was “a state law action independent of the federal bankruptcy law and not necessarily resolvable by a ruling on the creditor’s proof of claim in bankruptcy.” Id. Fire Eagle’s claim, on the other hand, is inextricably intertwined with the interpretation of a right created by federal bankruptcy law—the interpretation of the effect of Fire Eagle’s credit bid is in fact determinative of Fire Eagle’s claim. We therefore conclude that Stern is inapplicable and that there was no constitutional bar to the bankruptcy court’s exercise of its jurisdiction over this statutorily core matter.

 Opinion, p. 7.

The Fire Eagle opinion contains a formulation that I believe will be widely used in Stern analysis, namely, that if an issue relates in some substantive manner to a creditor's claim, then the Bankruptcy Court has authority to enter a final judgment.   While this is not the full extent of authority under Stern, it is a convenient way to handle many of the disputes likely to arise.

Exploring the Zen of a Credit Bid

 There is a theory making the rounds of the creditor's bar that there is a critical distinction between a "debt" and a "claim" and that if a dispute can be phrased in terms of the "debt," that the Bankruptcy Court lacks the ability to act upon the "debt."   This theory finds its support in cases such as In re Five Boroughs Mortg. Co., Inc., 176 B.R. 708, 712 (Bankr. E.D. N.Y. 1995).  Fire Eagle made a variant of this argument, contending that the credit bid affected only the the claim in bankruptcy and not the underlying debt.   This required the Court to consider the meaning of a credit bid.   Not surprisingly, the Court of Appeals concluded that there is no functional difference between a credit bid and cash.   The Court wrote:

Fire Eagle’s first argument is logically unsound. If Fire Eagle had been outbid at the § 363(b) auction, as it nearly was, or if it had simply declined to credit bid its claims, then the cash proceeds from that auction would have been applied against the Senior Indebtedness as the most senior debt in the bankruptcy estate. If the Senior Indebtedness was paid in full with these cash proceeds, then it would be absurd to suggest that Fire Eagle could separately proceed against the guarantors. Under such a theory, Fire Eagle would be undeniably receiving recovery in excess of the face value of the Senior Indebtedness by virtue of guarantees that explicitly provide for their own termination on the payment in full of the Senior Indebtedness.

Consequently, for Fire Eagle’s argument to be correct, its credit bid must not have been equivalent to a cash payment for the assets purchased. Title 11U.S.C. § 363(k), though, provides that credit bidders “may offset [their] claim against the purchase price” of the property that is the subject of the § 363(b) bankruptcy sale. This provision explicitly contemplates mixed bids of cash and claims, implicitly presupposing an equivalence with cash of the value of the credit bid. We agree with the bankruptcy court and district court that Fire Eagle’s credit bid constituted a payment-in-full of the Senior Indebtedness, just as if SDG’s assets had been sold for cash.

Opinion, p. 10.    The Court of Appeals also rejected several other insubstantial arguments.

Conclusion

The Fifth Circuit should be commended for providing a clear road map on some difficult issues of bankruptcy law.   The Court also deserves kudos for rejecting the magical view of bankruptcy law.  I have heard apocryphal stories that when the Bankruptcy Code was in its infancy, creditors would make arguments that the automatic stay did not control over a creditor's contract rights or that the discharge was not effective without the creditor's consent.   These particular instances of wishful thinking are now in the distant past.    However, in recent years there have been a rash of cases in which unhappy parties asserted that the Bankruptcy Court simply did not have the power to do whatever it did.   The Supreme Court rejected these challenges in United Student Aid Funds, Inc. v. Espinosa, 130 S.Ct. 1367 (2010) and Travelers Indemn. co. v. Bailey, 129 S.Ct. 2195 (2009), each of which involved collateral attacks on bankruptcy court orders, but limited the Bankruptcy Court's power in Stern v. Marshall, 131 S.Ct. 2594 (2011).    The resurgence of these types of challenges requires practitioners to remain sharp in their basic bankruptcy concepts and requires courts to distinguish between serious arguments and those which are seductive but ultimately insubstantial.   In the present case, the Fifth Circuit succeeded in making this distinction.   

Fifth Circuit Affirms Stanford Receiver's Fraudulent Transfer Judgment Against Democratic and Republican Committees

In a display of pre-election bipartisanship, the Fifth Circuit affirmed a fraudulent transfer judgment in favor of Stanford International Bank Receiver Ralph Janvey against five Democratic and Republican campaign committees totaling approximately $1.6 million.    Janvey v. Democratic Senatorial Campaign Committee, Inc., No. 11-10704 (5th Cir. 10/23/12), which can be found here. While the opinion involved a receivership rather than a bankruptcy proceeding, the issues under the Texas Uniform Fraudulent Transfer Act have bankruptcy implications as well.

The District Court granted summary judgment to the Receiver on claims that the contributions were made with actual intent to hinder, delay or defraud creditors.    The Receiver alleged, and the District Court agreed, that payments made as part of a Ponzi scheme are presumptively made with intent to hinder, delay or defraud.   According to the Receiver, this shifted the burden to the committees to show a defense such as good faith or reasonably equivalent value.   The Committees did not argue on appeal that the Stanford entities received reasonably equivalent value for their political contributions.   Unfortunately this meant that the opinion did not contain what would have been an interesting discussion of what contributors receive for their donations.   The Committees no doubt concluded that the political risks of arguing that fraudsters receive a reasonably equivalent benefit for their contributions was too dangerous to advance (even if it could have been factually supported).

Instead, the Fifth Circuit addressed three issues.   First, the Court ruled that a Receiver, like a bankruptcy trustee, may pursue claims under the Texas Uniform Fraudulent Transfer Act on behalf of creditors.   The Committee had argued that the Receiver was not himself a creditor and therefore lacked standing to pursue the claims.

Next, the Court concluded that the transfers were made within the applicable limitations period.    Under Tex. Bus. & Com. Code Section 24.010(a)(1), a plaintiff must institute an action to recover transfers under the intent to defraud provision within one year after the later of when the transfers were made or when they "reasonably could have been discovered by the claimant."    In this case, the Receiver was appointed on February 16, 2009 and filed suit on February 20, 2010.    The Committees argued that because records of  the contributions were available online and had been discussed in the media, that the Receiver should have known about them not later than February 18, 2009, which would have made the suit untimely.   Because February 16 was President's Day, the Receiver was not able to gain access to the Stanford offices until February 17.    While this would have given the Receiver two days to discover the fraud, the Fifth Circuit applied a more sympathetic standard.   It stated:

 

Given the extent of the Stanford enterprises, the Receiver’s duties with regard to them, and the extent of the fraudulent transfers, it would not have been reasonable to expect him to immediately discover the fraud.

Opinion, p. 7.   Furthermore, the Court noted that it was the Defendants' burden to prove the limitations defense which meant that they were required to prove when the Receiver should have discovered the fraud.   Apparently, three days to discover a fraud, even one based on publicly available records, was reasonable.  

 

Because 11 U.S.C. Sec. 546 gives a bankruptcy trustee two years to commence an avoidance action, the benefit of the one year discovery rule is not readily apparent.    However, if a transfer took place more than one year prior to bankruptcy but was not readily discoverable during that time, a trustee could still file suit within two years after the order for relief.   Assume that a transfer was made on January 1, 2010 and the Debtor filed bankruptcy on January 1, 2012.    If creditors of the Debtor could not have discovered the transfer during the one year period prior to bankruptcy, then the trustee would have until January 1, 2014 to file suit.   While the discovery rule does not extend the trustee's period of time to file suit after bankruptcy is filed, it would extend the reach-back period for avoiding a transfer made prior to bankruptcy.   

 

Finally, the Fifth Circuit held that federal election law did not preempt TUFTA.    The Federal Campaign Act of 1971 preempts "any provision of State law with respect to election to federal office."    Unfortunately for the Committees, the Court held that generally applicable fraudulent transfer laws are not state laws "with respect to election to federal office."   The Court also held that the federal election laws do not occupy the field of election law so thoroughly as to preempt the suit.   The Court wrote that the federal election law did not apply to a contributor using an impermissible source of funds as opposed to the committee making an improper use of those funds.   Further, the Court noted that the committees' argument would lead to the absurd result that funds "stolen by force or fraud" would be protected so long as the committees otherwise complied with election law.

Because firms likely to fail have been known to curry favor by making political contributions, this opinion may help trustees avoid preemption arguments in the future.  

Fifth Circuit Declines to Apply Judicial Estoppel to Inconsistent Creditor Claims in Subsequent Case

The Fifth Circuit has added a new decision to its judicial estoppel jurisprudence, holding that a creditor that submitted claims in different amounts in successive cases was not estopped.   While it may seem that the court is applying the estoppel doctrine in an uneven manner, penalizing debtors but not creditors, the decision faithfully follows the elements laid out by the court.    Wells Fargo Bank, N.A. v. Oparaji (Matter of Oparaji), No. 11-20871 (5^th Cir. 10/5/12), which can be found here.   

What Happened

The Debtor Titus Chinedu Oparaji filed a chapter 13 proceeding on September 2, 2004 (“First Case”).   During the First Case, he fell behind on his mortgage payments to Wells Fargo.   Over time, Wells Fargo filed several amended claims and the Debtor filed several modified plans.   The amended claims filed by Wells Fargo understated the amount of the post-petition arrearages.  When the Debtor failed to complete his plan payments within five years, the First Case was dismissed.

After the First Case was dismissed, the Debtor continued to miss payments to Wells Fargo.  On February 1, 2010, the Debtor filed his second chapter 13 case (“Second Case”).   By this time, the arrearage owed to Wells Fargo had grown to $86,003.25.   The Debtor argued that based on the claims filed in the First Case that the arrearage could not possibly be that high.   The Bankruptcy Court found that Wells Fargo was bound by the claims filed in the First Case under the doctrine of judicial estoppel and the District Court affirmed.

The Ruling

The Fifth Circuit reversed, finding that Wells Fargo had not “asserted a legally inconsistent position that was accepted by the Bankruptcy Court.”   Opinion, p. 6.   

The elements of judicial estoppel are: (1)  a party asserts a legal position that is “plainly inconsistent” with the position taken in another case; (2) the court in the other case accepted the party’s original position; and (3) the inconsistent positions were not taken inadvertently.

The Court found that a creditor who files a post-petition claim in one case is not estopped from asserting a higher claim in a subsequent case.   Under section 1305(a), a creditor may file a post-petition claim but is not required to.   This contrasts with the common scenario where a debtor omits an asset.   While a debtor must list all assets in its schedules, the creditor is not under a duty to amend its proof of claim to include post-petition arrearages.   

The Debtor argued that while Wells Fargo was not required to file a post-petition claim, that once it did so, it was required to include all post-petition amounts.   The Fifth Circuit distinguished the Oparaji case from In re Burford, 231 B.R. 913 (N.D. Tex. 1999).  In Burford, the confirmation order required the creditor to create a payment schedule that would “fully retire the debt.”   However, in this case, the creditor submitted a claim without expressly representing that there were no additional amounts owing.

Because Wells Fargo never asserted that the amount contained in its post-petition claim constituted all the amounts owed, the Fifth Circuit found that it had not asserted inconsistent positions.   As a result, judicial estoppel did not apply.    The Court went further and found that even if Wells Fargo had asserted inconsistent positions, the dismissal of the First Case meant that the parties were returned to their position status quo ante.  

What It Means

Judicial estoppel is meant to prevent parties from gaming the system. While, on the surface, it might appear that Wells Fargo took inconsistent positions, its inconsistency was not legally significant.  Wells Fargo’s only fault was that they did not assert their rights in the First Case as aggressively as they could have.   Had the Debtor completed its plan in the First Case, the parties and the Court would have had a difficult time sorting out which post-petition defaults were included in the plan and which ones were not.   Had the Debtor filed an “all current” motion at the conclusion of its plan and obtained an order, it could have bound Wells Fargo.  However, neither one of these occurred.   The Debtor did not complete its plan and it did not obtain a determination that it was current on its mortgage.   

As a general rule, a dismissed case should rarely, if ever, give rise to judicial estoppel.   By definition, a dismissed case is one in which no party obtains relief (although the debtor enjoyed the benefits of the automatic stay for a period of time).    If a party does not obtain relief, then it is hard to say that the court accepted the party’s position in any meaningful respect.   The real benefit of this case may be for debtors who omit a creditor or an asset in an initial case and then accurately disclose it in a subsequent case.   In that instance, Oparaji should be good precedent that judicial estoppel will not apply.

Pilgrim's Pride Opinion Allows Enhancements in Bankruptcy, Offers Comprehensive Overview of Bankruptcy Fees

The Fifth Circuit has affirmed a $1 million fee enhancement to a chief restructuring officer who achieved results described as “rare and exceptional.”  Matter of Pilgrim’s Pride Corp., No. 11-10774 (5^th Cir. 8/10/12).   The opinion can be found here.   The Court rejected the argument that a recent Supreme Court opinion on fee shifting precluded enhancements and, in the process, set forth a comprehensive framework for allowance of professional fees in bankruptcy.   Curiously, the opinion did not mention the Court’s opinion in Matter of Pro-Snax Distributors, Inc., 157 F.3d 414 (5^th Cir. 1998).

What Happened

When Pilgrim’s Pride Company filed for chapter 11 relief in December 2008, its prospects did not look good.   It had lost about $1 billion the previous fiscal year and was incurring negative cash flow of $300 million a year.   The Debtors anticipated that unsecured creditors would receive, at best, a debt for equity swap, and that equity would be cancelled. 

  

CRG Partners, LLC was engaged as chief restructuring officer.    Just over a year later, the company confirmed a plan which paid all secured and unsecured creditors in full and distributed equity interests valued at $450 million to the pre-petition shareholders.   

After the plan was confirmed, CRG requested that it be allowed compensation of $5.98 million plus an enhancement of $1 million.    The Debtor’s Board of Directors supported the enhancement.   The U.S. Trustee objected to the enhancement on the basis that CRG had already been adequately compensated through its lodestar-calculated fee.   The Bankruptcy Court denied the request for enhancement based on Perdue v. Kenny A. ex rel. Winn, 130 S.Ct. 1662 (2010).   The District Court reversed, finding that Perdue was not binding in the bankruptcy context.

On remand, the Bankruptcy Court approved the enhancement and the U.S. Trustee appealed.    The UST argued that Perdue precluded the enhancement.   The Fifth Circuit rejected the Trustee’s position and affirmed the Bankruptcy Court order approving the additional award.

An Overview of Professional Fees

In reaching its conclusion that enhancements remained viable, the Court of Appeals provided an extensive discussion of the history of awards of professional fees in the Fifth Circuit.   Under the Bankruptcy Act, courts in the Fifth Circuit applied the twelve Johnson factors, which included such requirements as the time and labor required, the novelty and difficulty of the questions, skill required, undesirability of the case and reputation of the attorneys.    In re First Colonial Corp. of America, 544 F.2d 1291, 1298-99 (5^th Cir. 1977), quoting Johnson v. Georgia Highway Express, Inc., 488 F.2d 714 (5^th Cir. 1974).   (Attorneys of a certain level of experience will remember preparing fee applications reciting the twelve Johnson/First Colonial factors even though many of them were usually irrelevant to the specific case).   While Johnson was a civil rights case, the First Colonial court found the factors to be “equally useful whenever the award of reasonable attorneys’ fees is authorized by statute.”     Id. at 1299.   While the same factors might be applicable, bankruptcy courts were advised to make awards at the lower end of the spectrum in light of the “strong policy of the Bankruptcy Act that estates be administered as efficiently as possible.”    Id.

The lodestar method was recommended by another Act case, In re Lawler, 807 F.2d 1207 (5^th Cir. 1987).    Under the lodestar method, the Court determines a reasonable number of hours multiplied by a reasonable rate and then adjusts the resulting fee up or down based upon the other Johnsonfactors.

When section 330(a) was adopted as part of the Bankruptcy Code, it retained the overall framework of compensation under the Act, but rejected the “economy of the estate” limitation.   This meant that bankruptcy lawyers could be compensated at the same rate as other skilled professionals.   

Section 330(a) was amended in 1994 to include a list of six non-exclusive factors to be considered in awarding compensation and two instances in which the court should deny compensation.    Notwithstanding the statutory definition, the Fifth Circuit found that the prior case law and the statutory provisions provided a complimentary framework.

Following the Bankruptcy Code’s enactment, we made clear that the lodestar, Johnson factors, and §330 coalesced to form the framework that regulates the compensation of professionals employed by the bankruptcy estate.   (citation omitted).   Under this framework, bankruptcy courts must first calculate the amount of the lodestar.   (citation omitted).    After doing so, the courts “then may adjust the lodestar up or down based on the factors contained in §330 and [their] consideration of the factors listed in Johnson.”   (citation omitted).    We have also emphasized that bankruptcy courts have “considerable discretion” when determining whether an upward or downward adjustment of the lodestar is warranted.

Opinion, at p. 8.   

The Court also conducted an historical analysis of fee enhancements in bankruptcy, finding that, although they were extraordinary, they had been allowed under both the Bankruptcy Act and the Code.    The Court noted that 

(I)f enhancements were possible when fees were awarded “at the lower end of the spectrum of reasonableness,” then they surely remained possible after that ceiling was removed and the statutory text was otherwise unchanged.

Opinion, at p. 13.    The Court’s point is that because the Bankruptcy Act allowed enhancements despite the focus on economy of administration that it would be reasonable for enhancements to be allowed under the more liberal provisions of the Bankruptcy Code.

In conclusion, the Court ruled that enhancements were a part of the process of upward or downward adjustment of the lodestar and remained available in extraordinary situations.

In sum, we have consistently held that bankruptcy courts have broad discretion to adjust the lodestar upwards or downwards when awarding reasonable compensation to professionals employed by the estate pursuant to § 330(a). However, this discretion is far from limitless. Upward adjustments, for instance, are still only permissible in rare and exceptional circumstances--such as in Rose Pass Mines and Lawler, where the applicants had provided superior services that produced outstanding results--that are supported by detailed findings from the bankruptcy court and specific evidence in the record.

Opinion, at 15.

Sub Silentio and the Rule of Orderliness 

Having concluded that enhancements remained viable, the Court turned its attention to whether the Supreme Court had “unequivocally, sub silentio overruled our circuit’s bankruptcy precedent.”   Opinion, p. 15.  

 

In Perdue, the Supreme Court rejected a request for an enhancement in a civil rights case.   In interpreting the term “reasonable fees” under 42 U.S.C. §1988, the Supreme Court noted that the courts had initially applied the twelve Johnsonfactors, but had transitioned to a lodestar approach in order to “cabin() the discretion of trial judges.”    The Supreme Court concluded that enhancements could be allowed under section 1988, but only where the hourly rate used in the lodestar calculation did not adequately measure the attorney’s true market value, where the litigation involved an “extraordinary” outlay of expenses and where there was an “exceptional delay” in payment, especially where that delay was due to the defense.    The Court also noted that in civil rights cases, the presumption should be against an enhancement because defendants would be less likely to settle if faced with an open-ended fee request and because civil rights judgments were often paid by the public rather than the defendant. 

  

The Fifth Circuit found that Perdue did not apply in the bankruptcy context.   Relying on the rule of orderliness, as recently articulated in Technical Automation Services Corp. v. Liberty Surplus Insurance Corp., 673 F.3d 399 (5^th Cir. 2012)(which held that Stern v. Marshall did not implicate the authority of Magistrate Judges), the Fifth Circuit found that Perdue was not directly on point and therefore did not compel the Court to abandon its prior precedent.   Among other things, the Court found that bankruptcy fee requests did not entail the same settlement considerations as civil rights cases and that the bankruptcy estate rather than the taxpayer would be paying the fees. 

 

The Court also noted that while the term “reasonable fees” in section 1988 offered little guidance to courts, that section 330(a) of the Bankruptcy Code contained detailed criteria for awarding fees.   

As a result, the Court concluded that until rescinded by a higher authority, fee enhancements were still possible in bankruptcy.   As a result, the Court affirmed the bankruptcy court’s enhanced fee award to CRG Partners.

What It Means

In the particular case, Pilgrim’s Pride means that a particular professional was recognized for doing an extraordinary job.    In the larger context, Pilgrim’s Pride is significant for what its historical analysis said for what it left unsaid.    

From an historical perspective, Pilgrim’s Prideevidences the development of bankruptcy law as its own discipline.    As of 1977, both bankruptcy law and civil rights law followed the twelve Johnsonfactors.   In the intervening 35 years, bankruptcy has developed its own body of fee jurisprudence.    While both bankruptcy law and civil rights law moved from the Johnson factors to a primarily lodestar based approach, Congress saw fit to define bankruptcy standards in more detail.     The Pilgrim’s Pride decision recognizes that bankruptcy fees fulfill a different role than fees in civil rights cases.    While the Court did not fully articulate it, I believe the difference is this.   Bankruptcy is inherently a collective process in which scarce resources are marshaled for the benefit of the creditor body and (in some cases) equity.    Allowing enhanced fees in rare cases provides incentives for professionals to take on difficult cases and be recognized when they deliver superior results.   Civil rights cases, on the other hand, are focused on compensating a harm and are a zero sum proposition.   Every dollar paid to the plaintiffs and their attorneys is a dollar taken away from the defendants and, by extension, the taxpayers.    While civil rights actions should incentivize government actors to obey the law in future cases, this function is secondary to compensating the wronged individual.    In a bankruptcy case, the professional may not only allocate scarce resources according to an ordered scheme of priorities, but may actually increase the pool of resources.   In a civil rights case, it seems that counsel is focused on obtaining an equitable transfer of resources from one party to another.    

Pilgrim’s Pride also curious because it does not mention the requirement that a professional demonstrate an “identifiable, tangible and material benefit to the bankruptcy estate” as required by In re Pro-Snax Distributors, Inc. in order to be compensated.   There is a tension between Pro-Snax and section 330(a)(4)(A)(i)(I) which mandates denial of fees for services not “reasonably likely to benefit the debtor’s estate.”   There is a significant difference in requiring that services be “reasonably likely” to benefit the estate as opposed to actually yielding an “identifiable, tangible and material benefit.”    In the one instance, compensation is based on whether the services appeared to be reasonable at the time, while the other makes compensation contingent on results.    Pilgrim’s Pride discusses the Johnson factors, the lodestar test and the statutory provisions of section 330(a), but does not discuss Pro-Snax.  Judge Carl Stewart, who authored Pro-Snax, was on the panel that decided Pilgrim’s Pride.

It is certainly possible that the panel did not see the need to discuss Pro-Snax for the reason that Pilgrim’s Pride was a case involving not just an “identifiable, tangible and material benefit,” but an extraordinary one at that.    However, given the Court’s comprehensive discussion of the framework for fees in bankruptcy and its contrast with fees in civil rights cases, the actual results requirement would seem to be a reasonable thing to mention.   

My personal opinion (which is partially motivated by self-interest) is that the Pro-Snax panel never intended to impose an actual results requirement.    The Pilgrim’s Pride opinion discusses how “the lodestar, Johnson factors, and §330 coalesced to form the framework that regulates the compensation of professionals employed by the bankruptcy estate.”    Under Johnson, results were one of twelve factors to be considered.   Under section 330(a), the court is instructed to examine whether the services were “beneficial at the time” and whether they were “reasonably likely to benefit the debtor’s estate.”   The lodestar may be adjusted upwards or downwards based upon the results.    Given that results are a factor to be considered under each of these approaches, it is much more reasonable to conclude that the Pro-Snax panel meant to emphasize the importance of results but not to make them an absolute requirement.   At the very least, it will make for an interesting argument when the Court is asked directly to reconcile Pilgrim’s Pride, Pro-Snax and the language of section 330(a).

Disclosure:   I have a case pending on appeal that raises the application of Pro-Snax.