R-E-S-P-E-C-T or Mr. Smith Goes to McDonald's

Last week, an incident was reported in Above the Law, that most entertaining blawg which calls itself “A Legal Tabloid.” William P. Smith, head of the bankruptcy department at the huge international firm of McDermott, Will & Emery, appeared before Bankruptcy Judge Laurel Isicoff of the Southern District of Florida. Judge Isicoff appears to be newly appointed, but a veteran of 20 years of sophisticated insolvency practice. In arguing whether a transaction in escrow would probably close, Smith told Judge Isicoff: “I suggest to you with respect, your honor, that you’re a few french fries short of a happy meal in terms of what’s likely to take place.”

With respect????

In my experience, United States Bankruptcy Judges seem to get less respect from the bar than a United States District Judge receives. If this is true, why should it be? Is it that their courtrooms are smaller and less impressive? Is the standard of practice at the bar lower in the Bankruptcy Court than in the District Court? Is it that bankruptcy lawyers are likely to have appeared before the same judge many times, and may even have known the judge before his or her appointment? In other words, might familiarity breed contempt? Is it because a Bankruptcy Judge may appear to the world not as an enforcer of promises and dispenser of justice but as the facilitator of broken promises? Is it that because so many decisions of the Bankruptcy Judges are discretionary, they are seen as making arbitrary rulings?

In any case, Smith will get a chance to explain himself on June 25, at the hearing on the Order to Show Cause why he shouldn’t be suspended from practice before the United States Bankruptcy Court, Southern District of Florida. I’m sure that he’ll say that he did not intend to disparage the judge. However, I suspect that if Smith had held in his heart true respect for the institution of the Court (or perhaps just an ounce of humility) he wouldn’t have said what he did.

Maybe Smith will be suspended down in Florida, or (more likely, I would guess) his apology will suffice. In any case, the blawgs have already held him and his firm up to worldwide ridicule. I would be lying if I said it didn’t brighten my day – in a sort of a dismayed “what is the world coming to” kind of way, of course.

Deepening Insolvency: Reports of Its Death Were Greatly Exaggerated

On May 18, the Delaware Supreme Court issued a major ruling on so-called “deepening insolvency” liability of corporate officers and directors. For those of you who haven’t heard of this by now, “deepening insolvency” is shorthand for a question that presents itself in many forms, both before and after bankruptcy. In an insolvent company, the shareholders have no equity and nothing to lose. In the past, the law has told us that the responsibility of corporate officers and directors was to the shareholders only. Do officers and directors face liability to creditors by running that company into deeper debt?

In North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 2007 WL 1453705 (Del. May 18, 2007), the Delaware Supreme Court ruled that no direct cause of action exists which would permit creditors of an insolvent company to sue directors. However, the Court held that creditors could sue derivatively for damages suffered by the insolvent corporation. The Court stated:

It is well settled that directors owe fiduciary duties to the corporation. When a corporation is solvent, those duties may be enforced by its shareholders, who have standing to bring derivative actions on behalf of the corporation because they are the ultimate beneficiaries of the corporation's growth and increased value. When a corporation is insolvent, however, its creditors take the place of the shareholders as the residual beneficiaries of any increase in value.

Consequently, the creditors of an insolvent corporation have standing to maintain derivative claims against directors on behalf of the corporation for breaches of fiduciary duties. The corporation's insolvency “makes the creditors the principal constituency injured by any fiduciary breaches that diminish the firm's value.” Therefore, equitable considerations give creditors standing to pursue derivative claims against the directors of an insolvent corporation. Individual creditors of an insolvent corporation have the same incentive to pursue valid derivative claims on its behalf that shareholders have when the corporation is solvent.

In the Ninth Circuit, bankruptcy trustees already had the green light to sue officers and directors who run a failing corporation into the ground for their own ends. See, Smith v. Arthur Andersen LLP, 421 F.3d 989 (9th Cir. 2005). The Gheewalla case now makes clear that “deepening insolvency” is a harm suffered by the corporation, not by shareholders or by any individual creditor. The trick in these cases will be to find the conflict of interest that takes the case outside the aegis of the business judgment rule.

Bankruptcy Landscape is Turning Grey

This will come as no surprise to practitioners in the trenches of consumer bankruptcy law, but . . . . the face of America’s debtor population is acquiring wrinkles. According to a study just released by the Administrative Office of the U.S. Courts, the average age of debtors in bankruptcy is increasing at a much faster rate than the age of the general population.

During the 8 year period from 1994 to 2002, the segment of our population aged 45 to 54 increased by 19.9%. The percentage of bankruptcy filers aged 45 to 54 increased by 43.9%.

Similarly, during the same 8 years the segment of our population aged 55 and over increased by 3.1%. The percentage of bankruptcy filers aged 55 and over increased by 45.8%.

We’ve all been anticipating the time when veterans of the credit economy who haven’t saved for retirement begin facing declining incomes in their declining years. The bankruptcy courts may be full of these folks for the next two decades. Will they organize? American Association of Retired Debtors (AARD)?

Some good news from the study: Bankruptcy filers aged under 25 declined by 60.4% during that same period, at a time when the spiraling cost of higher education has put huge economic pressure on kids. Credit education like the CARE program (Credit Abuse Resistance Education) may deserve part of the credit.

Its Not Final Until Its Over

A little understood aspect of the automatic stay is the effect of a bankruptcy filing on a judgment debtor’s appeal rights. Contrary to what you might think, when a judgment is entered in a pre-bankruptcy action against the debtor, prosecution of the debtor’s appeal of that judgment is subject to the automatic stay. This is on the rationale that the appeal is a “continuation of an action” against the debtor. See, Parker v. Bain, 63 F.3d 1131, 1135-36 (9th Cir. 1995).

I’ve used this a few times on behalf of judgment creditors, and its proved handy. If the debtor wants to continue a pending appeal, relief from stay is required. If the judgment creditor can make a deal with the trustee in the meantime, the expense of defending an appeal can possibly be avoided.

In re Ingeniero, 2007 WL 1453132 (Bankr. N.D. Cal. 2007) points out the flipside of this otherwise salutary rule, as far as judgment creditors are concerned. If a judgment debtor files a petition before the appeal period runs, the debtor is stayed from taking an appeal and the judgment can’t become final until the automatic stay is dissolved, for example by closing of the case. Bankruptcy Judge Jellen of the Northern District of California rejected the judgment creditor’s argument that the appeal period was merely extended under 11 U.S.C. §108(b).

A New Kind of Tax Shelter That Also Doesn’t Work, and Why Do Molehills Turn Into Mountains?

James and Beverly Nichols filed their 2001 federal income tax return on January 20, 2002. The return showed that they were entitled to a refund in the amount of $2,231.57. They checked the box on their return, making the irrevocable election to apply that amount to payment of future taxes, pursuant to 26 U.S.C. § 6513(d). Sixteen days later, the Nichols filed their chapter 7 petition.

More than five years after these events, the Ninth Circuit has ruled that “the pre-petition application of the right to the tax refund was an asset as of the petition date, and that the Debtors must therefore deliver to the trustee the value of the property under section 542(a).” In re Nichols, 2007 WL 1344219 (9th Cir. May 09, 2007). This is one of those results that seems obviously correct in effect, but a little difficult to lawyer your way into.

The Ninth Circuit’s opinion omits any mention of the amount in dispute. I had to mine the Bankruptcy Court docket for that. Over my years practicing bankruptcy law, I have seen many published decisions at the appellate level that do reveal that the underlying dispute is over a tiny amount of money. At least tiny in relation to the cost of filing a lawsuit in the bankruptcy court, prosecuting an appeal to the US District Court, and then briefing and arguing the case in San Francisco before the Ninth Circuit.

Why did the Trustee file the lawsuit? As far as I can tell, no other assets were administered in the Nichols’ case, so assuming that certiorari is denied (that was meant to be a joke but I wouldn’t be surprised . . . ) the Trustee will get to administer a $2,231.57 estate, plus some interest and costs. Does this come up all the time? Why did the Debtor mount two unsuccessful appeals? Was their lawyer trying to establish a legal principle for the benefit of his own practice and the debtors’ bar? Was it a grudge match? Or do they both just love it so?

I’m going to send a copy of this post to all of the combatants and invite them to comment. I will probably be ashamed in the presence of their diligence and public spirit. Check back to see what they have to say.

Chapter 11 Plan Feasibility and the Judgment on Appeal - Its Either the Long Wait Or the Educated Guess

Chapter 11 filings are often precipitated by the entry of a judgment against the debtor which is appealed. The parties must then argue about whether a chapter 11 plan is feasible and otherwise confirmable in the light of uncertainty over the amount of what might be the debtor's biggest liability.

Bankruptcy Code section 502(c) provides a solution to this dilemma by stating that the bankruptcy court "shall" estimate a contingent or unliquidated claim, "the fixing or liquidation of which, as the case may be, would unduly delay the administration of the case." This power was restricted early on by an amendment to 28 U.S.C. section 157, which expressly withholds jurisdiction to estimate an unliquidated personal injury claim. This jurisdictional limitation is a major factor which shapes mass tort chapter 11 cases, such as the Archdiocese case now pending in my hometown of San Diego.

Athough lawyers in a sense have a professional duty to estimate claims as they advise clients to litigate and settle them, bankruptcy judges seem reluctant to estimate claims, at least expressly under section 502(c). Its sort of like getting a doctor to guess out loud. In fact, up until very recently, the BAP's decision in In re Audre, Inc., 216 B.R. 19 (Bankr. App. 9th Cir.1997), barred bankruptcy judges from estimating claims represented by state court judgments that were on appeal. The rationale was that: (i) these claims really aren't contingent or unliquidated; and (ii) estimating them was to allow a collateral attack contrary to the Rooker-Feldman doctrine.

In an earlier post, I reported on In re Lopez, 2007 WL 1128811 (March 27, 2007), in which the 9th Circuit BAP abrogated Audre, on the basis of recent Supreme Court decisions which reminded us that Rooker - Feldman was a doctrine of narrow applicability.

The Ninth Circuit has taken another lick at the dead horse of Rooker-Feldman. In re Harbin, 2007 WL 1203545, (April 25, 2007) was a case in which a state court jury had entered a big verdict against the debtor, the trial judge had granted JNOV, and the defense judgment was on appeal. The Bankruptcy Court had confirmed a plan which provided for 100% payment to creditors except for the claim on appeal. The confirmation order apparently provided that if the appeal were successful the claim could be reopened as in In re Cobe, 229 B.R. 15, 18 (Bankr. App.9th Cir. 1998). A basis for this decision was the bankruptcy court's conclusion that Rooker-Feldman "precluded the court from taking into consideration the possibility" that the appeal would be successful.

In a split decision, the Ninth Circuit upheld a District Court judgment reversing the confirmation order, holding that a bankruptcy court "must evaluate the possible effect of a debtor's ongoing civil case with a potential creditor" in determining the feasibility of a chapter 11 plan.

Oh, incidentally, it looks like the JNOV was reinstated by the California Court of Appeal a long time ago in an unpublished decision, a fact not mentioned in the Ninth Circuit's opinion. See, Sherman v. Harbin, 2004 WL 1843288 (2004). Guess that's why the Ninth Circuit appeal wasn't moot.

The problem with Harbin, at least in cases not involving personal injury claims: Section 506(c) says that a claim shall be estimated. It doesn't authorize a bankruptcy court to decline to estimate a claim and then to consider the uncertain status of the claim in determining feasibility.

BAPCPA For Your Viewing Pleasure

On Tuesday the House Committee on the Judiciary held a day long hearing on the second anniversary of the enactment of BAPCPA. Before I assumed the responsibilities of a blogger, I didn't know that Congressional hearings were given snappy titles. The title of this hearing asked the question (no, I'm not making this up) "Are Consumers Really Being Protected Under the Act?"

The real bankruptcy lawyers were separated from the poseurs when they stayed home to watch this event on CSPAN. Coming in a distant second were those who Tivo'ed the action. If you weren't even in this group, why would you be reading my blog? Anyway, you still have a chance to watch the hearings video online at the Committee website.

Not surprisingly, the witnesses gave differing explanations of the indisputable fact that consumer bankruptcy filings are down drastically so far in 2007, over a year removed from the effective date of BAPCPA. Steve Bartlett, President of the Financial Services Roundtable, testified that eligibility restrictions and credit counseling have resulted in lower filings. Yes, he really was serious about the credit counseling. Henry Sommer, President of the National Association of Consumer Bankruptcy Attorneys, testified that increased costs "and the widespread misperception that bankruptcy is no longer available (aggravated by collection agent misrepresentations to consumers) are the primary reasons that bankruptcy case filings have declined so precipitously. "

Well, we're going to see. If the decline in bankruptcy filings proves permanent over the next couple of years, during a period when the housing bust should be causing more filings, its going to be hard to maintain the NACBA position.

The real question that few seem interested in answering is "are less bankruptcy filings good for the economy?" I assume that "good for the economy" means the same as "good for the consumer." Is there an economist out there who has figured this out?

Doesn't matter, really. There is no politically potent pro-bankruptcy consitutency. Envision a Congress full of Democrats and its still hard to imagine most of BAPCPA being rolled back. The future of bankruptcy reform for the forseeable future is nibbling around the edges. And sorry, NACBA, that may mean plugging loopholes as much as relaxing BAPCPA's more silly provisions.

The only thing that we can all agree on was neglected at the hearings: When are the front line troops (the chapter 7 trustees) going to be taken care of? BAPCPA drastically increased their responsibilities and has cut their income. The compensation for no asset chapter 7 cases needs to go to $100 now. Could that bill possibly pass without becoming hostage to the political football of bankruptcy reform?

Security Is More Than A Feeling

Section 101(37) of the Bankruptcy Code defines “lien” as a “charge against or interest in property to secure payment of a debt . . . .” and section 101(51) defines “security interest” as a “lien created by an agreement.” Most of us who get hired to enforce homemade loan documents have encountered a promissory note or other contract that clearly contemplates the application of specific property to pay the debt in the event of a default, but which doesn’t exactly say “Joe grants a security interest to Bob.”

A source of confusion for the non-lawyer is that “security” also has a common meaning – according to Merriam Webster: “Freedom from fear or anxiety” Real commercial lawyers hate it when someone says that a loan is “secured by a personal guaranty.” The guaranty may make the lender feel more “secure” but it doesn’t give the lender a security interest as either the UCC or the Bankruptcy Code defines it. It is sometimes hard to make an unsophisticated client understand that having lots of promises from a borrower doesn’t help much once the major promise – the promise to repay the debt – has been broken.

In re Ryalls, 2007 WL 1228789 (Bankr. N.D. Cal. April 23, 2007) interpreted the following language in a homemade loan agreement:

Borrowers agree to repay Lender the entire principal of $18,000 on or before April 1st, 2005. If Borrower cannot refinance their current mortgage to cover this amount, or, if another source of funds is unavailable, Borrowers agree to sell their mobile home in order to repay Lender.

After the debtor received a chapter 7 discharge the secured creditor sent a “Notice of Default” and then filed a lawsuit in the Superior Court to foreclose on the mobile home. Bankruptcy Judge Jaroslovsky, without wasting time citing a lot of readily available authority, held that “the Loan Agreement does not objectively indicate the intent to create a security interest. Specifying when a loan is to be repaid and promising to sell an asset if necessary is not the same thing as granting a security interest in the asset.”

On behalf of all lawyers everywhere: God bless all do it yourselfers. What makes them secure may help to make us secure.