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.

Contumacious Case of Coercion or Merely Rude? Fifth Circuit Judges Debate the Meaning of Section 523(a)(6)

The case of a former corporate officer who demanded to be bought out for an alleged ownership interest and said some really nasty things resulted in a split decision with Fifth Circuit Judges Edith Jones and Catharina Haynes on opposite sides. Matter of Schcolnik, No. 10-20800 (5th Cir. 2/8/12), which can be found here.

What Happened

This statement of facts is synthesized from the two opinions in the case. Each judge referenced facts that the other did not. I am taking both opinions at face value.

Scott Schcolnik was Vice-President of Capstone Associated Services, Limited and President of Rapid Settlements, Ltd. Though the owners of the Companies occasionally referred to him as a partner, he allegedly rejected an offer to become an owner of Rapid. Nevertheless, he claimed to be a partial owner and was fired. At this point, things got colorful. Schcolnik allegedly absconded with corporate documents. He threatened to disclose alleged criminal and regulatory violations by the two Companies if they did not “buy out” his “ownership interests.” He threatened a “doomsday plan” if Stuart Feldman, the primary owner of the Companies did not “properly compensate” him for his ownership interests “which appear to be worth in excess of $1,000,000.” He threatened a “massive series of legal attacks . . . which will likely leave you disbarred, broke, professionally disgraced, and rotting in a prison cell.” He also expressed his hope that Feldman would be raped in prison.

The nasty grams* were sent on May 25 and 27, 2005. The Companies swiftly moved for a TRO, which they obtained on May 27, 2005. The TRO, which was later extended by agreement, prohibited Schcolnik from carrying out his campaign of mass destruction.

*--Nasty gram is a term of art in the Austin Division of the Western District of Texas referring to a particularly vituperative communication. While I am not completely certain, I believe I first heard the expression from Joe Martinec.

Six months later, the Companies instituted an arbitration proceeding against Schcolnik, seeking a declaration that he was not an owner. The Companies prevailed on the ownership issue, although the arbitrator noted that the Companies had held Schcolnik out as a partner, which was characterized as “excusable mistakes.”

The Companies requested attorney’s fees of $70,000 and received an award of $50,000. The fees were awarded as “equitable and just,” which is apparently a low standard.

Schcolnik filed for chapter 7 bankruptcy four days after the state court confirmed the arbitration award. The Companies filed a non-dischargeability complaint under 11 U.S.C. sections 523(a)(4)( and (a)(6). Both parties moved for summary judgment. Bankruptcy Judge Karen Brown granted summary judgment to Schcolnik on both claims. She conducted a trial on the creditors’ objection to discharge and ruled in favor of Schcolnik as well. The Companies appealed the dischargeability findings to the District Court which affirmed.

The Majority Opinion—Contumacious and Coercive

The majority opinion, written by Chief Judge Jones and joined in by District Judge Crone, affirmed the lower court holdings that the claim under section 523(a)(4) was properly denied. Although the Debtor was an officer of the Companies and owed them a fiduciary duty, the debt for attorney’s fees did not arise out of a fraud or defalcation in a fiduciary capacity. Judge Haynes concurred in this ruling.

However, the majority opinion found that summary judgment on the willful and malicious claim under section 523(a)(6) was premature. The District Court had found that the Debtor’s behavior was not “willful” as a matter of law because he did not intend to impose litigation expenses on the Companies, a contention they did not dispute.

However, Judge Jones pointed out that under Fifth Circuit precedent, an act can be considered “willful” if there was subjective bad intent or “an objective substantial certainty of harm.” The Court noted that “it would seem peculiar to deem an action causing injury not ‘willful’ when the tortfeasor’s action was in fact motivated by a desire to cause injury.” Judge Jones also noted In re Keaty, 397 F.3d 264 (5th Cir. 2005), where sanctions for baseless litigation were found to be a willful and malicious injury.

Having laid out this background, Judge Jones reached the penultimate point of her opinion:

Shcolnik allegedly engaged in a course of contumacious conduct that required the Appellants to file meritorious litigation against him, resulting in the instant fee award; whereas in Keaty, the debtors pursued the burdensome suit that provoked a sanctions award against them. This is a distinction without a difference, however. It would make no sense for the infliction of expense in litigating a meritless legal claim to constitute willful and malicious injury to the creditor, as in Keaty, while denying the same treatment here to the infliction of expense by a debtor’s attempt to leverage an equally baseless claim through a campaign of coercion. That Texas law may allow the arbitrator to assess attorneys’ fees in favor of a party without specifically finding a willful and malicious injury is not conclusive. If the facts are as Appellants allege, Shcolnik either had the motive to inflict harm or acted so as to create “an objective substantial certainty of harm” to the Appellants. Id.

Viewed in light of our precedents, there is a genuine, material fact issue for trial. Shcolnik’s behavior resulted in willful and malicious injury if his claims of ownership were made in bad faith as a pretense to extract money from the Appellants. See Keaty, 397 F.3d at 273 (willful and malicious injury to intentionally “pursu[e] meritless litigation for the purpose of harassment[.]”). The litigation costs he forced upon them are different from the million dollar claim he made against them, but they were neither attenuated nor unforeseeable from his alleged intentionally injurious conduct. (emphasis added).

Opinion, pp. 6-7.

The Dissent—Insulting and Demeaning Is Not Enough

Judge Haynes concurred in the ruling on section 523(a)(4), but dissented with regard to willful and malicious injury. She cited three grounds for dissent:

The effect of the majority opinion is to transform all litigation precipitated by aggressive demand letters into potential “malicious” acts for purposes of nondischargeability. Additionally, the effect of the majority opinion is to allow an end-run around an arbitration proceeding in which both parties willingly participated. Finally, the majority opinion glosses over the lack of connection between the allegedly malicious acts and the arbitration award of attorneys’ fees now sought to be rendered non-dischargeable. Because the bankruptcy and district courts reached the correct result under our existing precedents, I would affirm.

Haynes Dissenting, p. 9.

Judge Haynes elaborated on her first point as follows:

Debtors often come to bankruptcy with judgments against them. It is certainly not an unusual occurrence for parties to make claims in litigation or arbitration that do not carry the day. Nonetheless, the majority opinion transforms the ordinary litigation loser into one who has caused “willful and malicious injury” to another. It does so, apparently, because of the colorful language used by Shcolnik, without the assistance of legal counsel, in his emailed demand letters that preceded litigation which in turn was followed by the arbitration proceeding in question. So, I start there.

No doubt the e-mail letters Shcolnik wrote are insulting and demeaning. I would not write such a document nor countenance another to do so. However, we are not here to teach a course in professionalism or civility. The majority opinion transforms incivility into “a campaign of coercion” or “contumacious conduct” by ipse dixit. The question arises – were these “nasty demand letters,” in fact, “coercive” or “contumacious?” We do not have a case setting out a test for where the quintessential demand letter ends and the parade of horrible suggested by the majority opinion begins. Wherever that line is, it is not crossed here, and I disagree with transforming the regrettable unpleasantness and aggressiveness that often attend the prelude to litigation into “coercive” or “contumacious” conduct so easily. Shcolnick’s e-mail letters, however reprehensible they undeniably are, do not. (emphasis added).

Haynes Dissenting, p. 10.

Between judges, “ipse dixit” is a strong term. Known as the “Bare Assertion Fallacy,” it literally translates as “he himself said it.” It is used to refer to an argument that is made without any support. The terms that were said to be ipse dixit were “coercive” and “contumacious.” “Contumacious” is defined as stubbornly defiant or rebellious, while “coercive” means serving or intending to coerce. While contumacious is closely associated with contempt of court, Shcolnik’s words were no doubt stubbornly defiant, but the question is “So what?” There does not seem to be a logical connection between stubbornly defiant and willful and malicious. Coercive is a more difficult question and I will return to that later.

Next, Judge Haynes turned to the results of the arbitration proceeding. Noting the strong federal policy of deferring to arbitration, she pointed out that the arbitrator had only awarded fees as “equitable and just” rather than for wrongdoing, malice or bad faith. She also noted that the arbitrator implicitly found that Shcolnik’s position had some merit when he found that the references to Shcolnik as a partner were “excusable mistakes.”

As to the first ground, Judge Haynes is probably wrong. Where a court makes a finding on a lesser standard but does not expressly negate the higher standard, the parties are free to establish whether the higher standard could have been met. Archer v. Warner, 538 U.S. 314 (2003) is not completely on point, but it allowed a plaintiff who had received a promissory note in settlement of a fraud claim to go behind the note and prove fraud in the original transaction. However, Judge Haynes is closer on the second point. If the arbitrator found that the Debtor did not assert a baseless claim, then the Companies would be precluded from relitigating that point in bankruptcy court. Here, the finding is implicit so that it is a close call.

Finally, Judge Haynes found that the connection between the nasty emails and the arbitration proceeding was to remote to connect them. She wrote:

Indeed, even if the e-mail letters were “coercive” or “contumacious” and even if we ignore the lack of arbitration findings to support the majority opinion, the undisputed facts show that any burden imposed on Appellants by the e-mail letters was quickly removed – the purportedly wrongful documents were sent on May 25 and 27, 2005. On May 27, 2005, the state district court granted a temporary restraining order that was later extended and continued by agreement throughout the litigation and arbitration, barring Shcolnik from taking the actions Appellants claimed put them in immediate fear. It was not until six months later that the matter was referred to the arbitration at issue here, breaking any purported causal connection between the claimed wrongful behavior and the fee award here at issue.

Moreover, the lack of causal connection is precisely why the arbitrator made no specific finding of wrongfulness. Indeed, the allegedly wrongful acts caused the arbitration of the ownership/partnership dispute, in which case, the arbitrator’s lack of a specific finding to that effect (and findings inconsistent with that) is meaningful, or they did not, in which case, the alleged “campaign of coercion” or “contumacious conduct” did not cause the attorneys’ fees award.

The majority opinion concludes that “Shcolnik’s behavior resulted in willful and malicious injury if his claims of ownership were made in bad faith as a pretense to extract money from the Appellants.” Maj. Op. at 7. The opinion rests on a misconstruction of Keaty. Moreover, it is undeniable that the majority opinion’s conclusion is not supported by the record, the arbitrator’s decision, or, indeed, the events that actually transpired below. As we gave effect to the sanctions in Keaty, we should give effect to the arbitrator’s ruling here. The attorneys’ fees awarded as equitable and just in the arbitration were for resolution of the ownership/partnership dispute, not for anything else.

Haynes Dissenting, pp. 13-14.

What It Means

This case is significant for several reasons. The fact that two bright, articulate and conservative judges reached diametrically opposite results shows both the independence of the judges involved and the difficulty of the question.

The opinions by Judge Jones and Judge Haynes recall the story of the blind men and the elephant. They are both describing the same thing, but they are describing different parts of it. Judge Jones focused on the apparent intent of the original emails. It is not unreasonable to construe the emails as a blatant attempt at extortion. It would be illegal to demand money in exchange for not releasing damaging information, so the debtor demanded a buyout instead. However, the fact that he demanded a buyout under the threat of destroying his former employer says volumes about his intent.

On the other hand, Judge Haynes focused more on the disconnect between the “nasty” emails and the arbitration proceeding. Yes, the emails were reprehensible. However, the campaign was brought to a half within two days and the arbitration was not even commenced for another six months. The Companies would have had a good claim for a willful and malicious injury if the Debtor had actually used the purloined documents to wreak havoc. The Companies probably would have had a good claim for their costs in obtaining the TRO. However, the Companies sought to recover their attorney’s fees for what Judge Haynes characterized as “resolution of the ownership/partnership dispute, not for anything else.” While the ownership dispute may have been commenced for sinister reasons, unlike the sanctionable conduct in Keaty, it was not baseless.

I think Judge Haynes has the better argument. While the opening salvos of the campaign clearly could have resulted in willful and malicious injury, they did not. It is like someone who threatens to shoot but after considering the consequences puts the gun down. The conduct could be characterized as a terroristic threat, but it is not murder. Both judges are right to focus on Keaty. However, the important question is whether the legal position taken was baseless. If the position taken, although asserted for ulterior motives, was not baseless, then it should not give rise to a nondischargeable debt.

It will be interesting to see whether the en banc court steps in to resolve the dispute.