NCBJ 2012: From Stern's Fallout to Arguing Before the Supreme Court

The National Conference of Bankruptcy Judges consistently delivers some of the best continuing legal education in the country for bankruptcy lawyers.   Here are some highlights from this year’s conference.

I started my day Thursday with the Bernstein-Burkley firm’s Wake Up and Run.   For the past three year’s the firm has sponsored a daybreak 5k run at the conference.   This year’s run drew about 80 participants who ran, jogged or meandered around the waterfront in San Diego.    At 33:58, I was near the back of the pack, so I can’t tell who the fastest judge was or how the Fifth Circuit fared against the Ninth Circuit.   The fact that so many people would get together at 6:30 a.m. to go for a communal run shows that you don’t have to be crazy to practice bankruptcy law, but it helps.

The Reaction to Stern v. Marshall

So much has been written about Stern v. Marshall that it is hard to say anything new.   The panel did a good job on focusing on the judicial reaction to the decision rather than rehashing the story of the former Playboy playmate who didn’t get her multi-million judgment because Congress created an unconstitutional allocation of work between the bankruptcy courts and the district courts.    The panel gamely tried to wade through the reams of decisions mentioning Stern v. Marshall.  As of October 25, there were 712 of them.    The trend appears to be that while there are still about 50 decisions a month mentioning the Supreme Court ruling, the sky is not falling.   Out of a sample of cases, the panel found that a majority of Stern-based motions to withdraw reference, motions to dismiss and motion to abstain had been denied.    Two early decisions which suggested that bankruptcy courts lacked the power to even consider matters which were core proceedings but could not be constitutionally decided by the bankruptcy court were walked back by subsequent decisions.   

The most important response to Stern v. Marshall is that a few courts have developed local rules to deal with the decision and the national rules committee has proposed a set of rules changes as well.   The Southern District of New York’s rules have provided the template for several other courts that have addressed the issue.  Their rules can be found here.   

The Southern District rules attempt to require parties to state whether they will consent to entry of a final judgment by the Bankruptcy Court or whether they object.   The new rules require a statement of consent in the first pleading filed in an adversary proceeding, in the first pleading filed by a defendant, and upon removal o f a case.    These rules reflect a belief, which is probably warranted, that the parties can consent to decision by a non-article III judge.   New Rule 9033-1 provide that if a matter is core but the court cannot constitutionally enter a final judgment, the Court shall enter proposed findings and conclusions “as if it is a non-core proceeding.”

The proposed national rules amendments can be found here.  The proposed rules eliminate the core/non-core terminology from rules 7008, 7012, 9027 and 9033.  Instead, parties will simply state whether they consent to entry of a final order by the bankruptcy court.   New Rule 7016(b) states that the court shall, either sua sponte or on timely motion of one of the parties decide  whether to enter a final judgment, enter proposed findings and conclusions or “take some other action.”   Parties may submit comments on the proposed rules amendments until February 15, 2013.

What the Puck:  Sports Teams in Bankruptcy

This presentation discussed the bankruptcies of the Phoenix Coyotes, the Texas Rangers and the Los Angeles Dodgers.   According to the panelists, a sports league is nothing more than a cooperative of the teams.    When an owner acquires a team, he agrees to give the league veto power over who will own the team and where it will be located.    This gives the league enormous power over the teams and theoretically gives it the power to veto most decisions that would be made in a bankruptcy proceeding.  In bankruptcy terms, the debtor is a party to an executory contract which either is not subject to being assumed or at or cannot be assumed in a manner compatible with the proposed reorganization.  Nevertheless, bankruptcy has been successful to varying degrees because of the incentive of the fellow owners to allow the bankrupt team to, in the words of Tom Salerno, “bend the league rules.”

The three cases each had their own unique stories.  The Phoenix Coyotes were losing money because Arizona was not a particularly good market for a hockey club.   Their owner wanted to sell out to a Canadian technology entrepreneur who would move the team.   However, the league had vetoed the proposed sale.   The Texas Rangers, on the other hand, were a profitable team, whose parent company was mired in debt.   The team owners and the league were both happy to allow the team to be sold to a group led by Nolan Ryan.   However, to get the benefit of bankruptcy, they had to allow a competitive sales process.   The Los Angeles Dodgers were losing money and had been drained of $240 million by owner Frank McCord.  McCord wanted to sell the media rights for a small fortune and hang onto the team.   The league did not want to allow this to happen.

All three cases resulted in auctions.   In the case of the Phoenix Coyotes, the league bought the team, even though it did not have the highest bid.  Three years later the team is still losing money and the league has not found a new owner.   In the case of the Texas Rangers, a sales process designed to favor the Nolan Ryan group was upset when Judge Michael Lynn convinced the parties to allow genuine competitive bidding.   Dallas Mavericks bad boy Mark Cuban almost got the team until he was outbid by the Ryan group.    In the Dodgers case, the team sold for $2 billion, which will likely allow Frank McCord to walk away with anywhere from hundreds of millions to a billion dollars.   In each case, the bankruptcy case transitioned the team to a new owner acceptable to the league (although in the Coyotes case, that owner was the league itself).

A Grimm Fairy Tale:   Perspectives in the Next Chapter of the U.S. Mortgage Market Story

My notes from this panel would fill a ten page article.   However, a few highlights will have to suffice.
  

New York Times journalist and author Gretchen Morgenson is the author of Reckless Endangerment:  How Outsized Ambition, Greed and Corruption Led to Economic Armageddon.   She argued that the government’s role in subsidizing home ownership through Fannie Mae and Freddie Mac corrupted the mortgage market.   When the executives, shareholders and lobbyists for Fannie and Freddie were able to get part of the subsidies for themselves, they promoted more demand for subsidized mortgages.  The private mortgage market which is based on securitization was rampant with conflicts of interest and lack of disclosure.    Due to the collapse of the private mortgage market, Fannie and Freddie now comprise 95% of the mortgage market.

She said that if the government is going to subsidize housing finance, it should do so directly on the government’s own balance sheet.   She also said that the private sector must be “deeply engaged in building a market that is trustworthy, clean and not corrupt.      

Another speaker pointed out the extent of the mortgage foreclosure crisis.   3.5 million foreclosures have been completed, 2 million more are in the pipeline and 7 million more are at risk.   Foreclosure has been shown to reduce the value of foreclosed homes by 27% and to reduce the value of homes in the neighborhood by 1%.   

Franklin Codel, head of Mortgage Production for Wells Fargo Home Mortgage stated that Wells Fargo works very hard with borrowers experiencing financial distress but servicers and investors were not ready for the elevated level of foreclosure activity.   Nevertheless, he said that Wells Fargo completes two mortgage modifications for every foreclosure.

Clifford White, Executive Director of the Executive Office for U.S. Trustees highlighted the role of the bankruptcy system in dealing with the mortgage crisis.   He said that “our experienced in the bankruptcy system has been that large banks were not performing well” and that the bankruptcy system has been at the forefront of identifying problems in the mortgage industry.   He added that 300,000 distressed homeowners go into chapter 13 each year.

Mr. White argued that the bankruptcy courts saw the mortgage crisis sooner than other segments of the economy, but that the U.S. Trustee’s program “faced an onslaught of resistance” to efforts to try to address the problem.   

Mr. White also stated that the bankruptcy system should think of itself as a regulatory mechanism. He highlighted the disclosures required by the amended bankruptcy rules.   He said that these rules “affect bank processors in a way that no other federal rules do.”

Both Mr.Codell and Steven Swartout, who is the Executive Vice-President for a community bank, stated that their institutions have a high level of modifying mortgages that they own but that they have difficulty getting responses from the investors on mortgages they service.  

Ms. Morgenson was critical of the HAMP program, describing it as “ill-conceived” and with very few sticks attached.   The program was voluntary and did not address second liens which were often retained by the originating bank.   She questioned whether the government was trying to strike a balance between protecting the financial sector and protecting bad actors.  

Mr. Swartout explained that there were different markets for long-term and short-term mortgages.  He said that there were only a limited number of entities that could take on the risk of a 30 year fixed rate mortgage.    As a community bank, their market is in making two, three or five year callable mortgages.   He said that the expectation is that these mortgages would be repriced at maturity.  However, he said that they would not meet the requirements of a “Qualified Mortgage” under proposed federal regulations.     

In closing Gretchen Morgenson complimented the work of the bankruptcy courts, stating, “without you questioning what came into your courtrooms we wouldn’t be even this close to a turnaround in the housing market.”

Justice Stevens and Advocacy Before the Supreme Court

The Commercial Law League luncheon featured the presentation of the Lawrence King Award to retired Supreme Court justice John Paul Stevens and a keynote address by Supreme Court advocate Eric Brunstad.    (Unfortunately, Justice Stevens was not able to accept the award in person).  The two blended nicely into a program on bankruptcy and the Supreme Court.  

A few stories about Justice Stevens:

Shortly after he was appointed to the Seventh Circuit, the court considered the case of protesters who had occupied the state capital grounds.   The legislature voted the protesters in contempt of the legislature and had them arrested.   This was during the height of the Nixon law and order days. While the other members of the panel had no problem with the arrest, it troubled Justice Stevens and he dissented.   He also assumed that he had lost his chance to be considered for the Supreme Court.  However, when President Nixon resigned and President Ford was looking for a nominee who was not closely tied to Nixon, Stevens got the nod.

Justice Stevens said that brilliance was not how much you knew but whether you used it in a wise and humane manner.

Justice Stevens, unlike many appellate judges, was most comfortable around practicing lawyers.

Bankruptcy Judge James Gregg accepted the award on behalf of Justice Stevens.    He described him as intelligent, inquisitive and cordial, the opposite of pompous and egotistical.    He said that Justice Stevens said that his most interesting bankruptcy case was Central Virginia Community College v. Katz, 126 S.Ct. 990 (2006) in which he found that sovereign immunity did not protect a state from recovery of a preference, a decision which dialed back the Supreme Court’s sovereign immunity jurisprudence which Justice Stevens felt had been exalted beyond anything the framers intended.

Eric Brunstad the keynote speaker, has argued ten cases before the Supreme Court including this year’s RadLAX decision.  He noted that Justice Stevens had authored three bankruptcy opinions:   Marrama, Katz and Till.    He praised Justice Stevens for being willing to consider cases on a case by case basis rather than being bound by a fixed judicial philosophy.   

He said that Justice Stevens’ approach to the law was exemplified by his decision in Marrama, which denied a debtor’s ability to convert from chapter 7 to chapter 13 despite statutory language referring to an absolute right.   He said that Justice Stevens viewed the inherent power of the court as an extension of its powers in equity to deny relief to a party with unclean hands.    He believed that even though you may not be able to waive a right, you could forfeit it.

Justice Stevens was also a big fan of liberty, viewing it as an interest which transcended the written words of the Constitution.  

Mr. Brunstad told several anecdotes about the Supreme Court.   On one day, it had snowed particularly hard.   A lawyer received a call from the court clerk asking if he needed a right to court.  Much to his surprise, an SUV showed up with Chief Justice Rehnquist and Justice Kennedy.   The Chief fretted that they would be late and told the driver, “I order you to drive through all red lights” to which Justice Kennedy replied, “do you have that power?”

On another occasion, Chief Justice Rehnquist was quizzing an attorney about how to limit the discretion of bankruptcy judges.   Before the advocate could get a word out, Justice Breyer quipped, “Isn’t that what they’re paid to do?”    

On another occasion, one of the Justices had asked about a long and involved hypothetical which left the lawyer puzzled.   Justice Scalia told him, “Just say yes,” which the lawyer did.   The follow up question was “Why?”  When the puzzled lawyer turned to Justice Scalia, he said, “You’re on your own.”

Brunstad said that he takes his approach for arguing cases from Aristotle, focusing on Logos—which refers to logic, Athos—which refers to credibility of the speaker and Pathos—which refers to an emotional connection with the audience.

Pre-Bankruptcy Ethics:  How to Avoid the Minefields Before Combat Begins

Prof. Nancy Rapoport had some good perspective on the role played by counsel for the Debtor-in-Possession.   She pointed out that, on the one hand, counsel represents the Debtor-in-Possession, which is a fiduciary to the creditors.   While counsel is not a fiduciary to the creditors, counsel is an officer of the court.    This may impose higher duties on counsel for the DIP than counsel for a private party.   She noted that counsel is generally protected when advising the DIP between several acceptable courses of action.  On the other hand, she said of possibility.”

Richard Carmody of Adams & Reese discussed the importance of representing the interests of the DIP and not its principals.  He pointed out that in the Diocese of Spokane case, the attorneys who represented the Diocese in its chapter 11 have now been sued alleging that they represented the interest of the former Bishop rather than the Diocese.  

Chapter 11 Update:  Hot and Emerging Issues

This presentation discussed several important new cases in the chapter 11 arena.   Here are a few cases to be aware of.

In Marathon Petroleum Co., LLC v. Cohen (In re Delco Oil Co.), 599 F.3d 1255 (11^th Cir. 2010), the debtor used cash collateral without permission.  A supplier who was paid for goods actually delivered was required to repay the funds as an unauthorized post-petition transfer.   On the other hand, in Abbot v. Arch Wood Protection, Inc. (In re Wood Treaters, LLC), 2012 WL 3059379 (Bankr. M.D. Fla. 2012), a vendor who received payment from a debtor who obtained permission to use cash collateral but was not in compliance with the order escaped liability.   The cases raise the issue of how much due diligence a party dealing with a DIP must perform in order to qualify for a good faith defense to an action under Sec. 549.

In re Heritage Highgate, 679 F.3d 132 (3^rd Cir. 2012) raised an interesting valuation question.  An appraisal at the beginning of the case showed that the debtor’s property exceeded the value of both the first and second liens.  By confirmation, the starting value of the property less lots sold during the bankruptcy was less than the amount of the first lien.    However, the debtor’s cash flows showed that future sales of lots would bring in enough money to pay both liens.   Critically, the second lienholder did not offer any independent appraisal testimony.   The court held that the debtor’s cash flows, which assumed future appreciation in the value of the debtor’s property, was not a valuation as of confirmation.   As a result, the second lien was completely underwater.

In re Loop 76, LLC, 465 B.R. 541 (9^th Cir. BAP 2012) went against the majority of cases in allowing separate classification of a deficiency claim.   The court allowed separate classification because the deficiency claim had the benefit of personal guaranties.  

Several recent cases have applied the Till decision to chapter 11 cases.   In In re Cottonwood Corners Phase V, LLC, 2012 WL 566426 (Bankr. D. N.M. 2012), the debtor sought to reinstate the debt at the contract rate of 5.8%   Using a formula approach based on the 10 year treasury bill rate plus risk factor points, the court found that 7.0% was appropriate.   In In re North Valley Mall, LLC, 2012 WL  1071646 (Bankr. C.D. Cal. 2012), the Court used a blended “tranche” approach to come up with an interest rate of 8.5%.   Finally, in In re Walkabout Creek Limited Dividend Housing Association, LP, 460 B.R. 567 (Bankr. D. D.C. 2012), the court said that the interest rate should be at least 1% above the equivalent treasury bill rate.   Because this exceeded the rate proposed by the debtor, the court denied confirmation.    The court said that the prime + 1-3% formula in Till did not even rise to the level of dicta.   These cases strike me as wrongly decided.    The chapter 13 statuory language interpreted in Till is identical to the language in chapter 11.   Most chapter 11 cases are too small to support dueling experts.   As a result, the Till formula presents an appropriate starting point for most cases.

Two recent cases have rejected use of the “indubitable equivalent” prong of section 1129(b)(2)(A).   In In re River East Plaza, LLC, 669 F.3d 826 (7^th Cir. 2012), the court rejected replacing the debtor’s real property collateral with treasury bills.    If this is not the indubitable equivalent, I don’t know what would be.   In Cottonwood Corners Phase V, the debtor proposed to repay arrearages on the debt over time without interest on the basis that the arrearages already included default interest.   This did not work.

Gentry v. Siegel, 668 F.3d 83 (4^th Cir. 2012) is an interesting case on class proofs of claims.   If a party files a class proof of claim and the class is certified, the class is approved retroactively.   If the class is not certified, the court must allow class members additional time to file a claim.   Procedurally, a class claim is deemed allowed in the absence of an objection.   If there is an objection, the class rep must seek to invoke the adversary rules to obtain class certification.    In the specific case, the court did not certify the class because a class of several hundred employees was not necessary in a case with thousands of creditors.  

National Conference of Bankruptcy Judges--10/15/11--Mythbusters--Westbrook and Porter Share the Latest Empirical Research

Prof. Jay Westbrook and Prof. Katie Porter presented a delightful tour de force of empirical research titled Mythbusters. They compared ten statements of conventional wisdom to the results of empirical research. As Jay said, “There are all kinds of things that everyone thinks are true but we don’t know whether they are really true.” (For this post, I will refer to the speakers as Jay and Katie since these two professors go out of their way to be accessible so that it just seems appropriate).

1. BAPCPA permanently crippled consumer bankruptcy.

The answer is not necessarily. Filings today are very similar to what was seen before BAPCPA. Today’s filing levels of 1.5 million cases per year are about equal to filings during 2001-2004. The income profiles today are similar with chapter 7 debtors averaging $24,000 per year and chapter 13 debtors averaging $34-35,000. The only thing that can’t be measured is what filings would have been like if BAPCPA had not been passed. Given the weak economy, filings might have been much higher without the legislation.

2. For big business, reorganization in Chapter 11 really just means a 363 sale.

While 363 sales are more common in large cases, they are not the norm. Cases with above $50 million in assets resulted in 363 sales in less than 33% of the cases while in chapter 11 cases of all sizes only 10-15% resulted in 363 sales.

3.Young people are more likely to file bankruptcy because of a decline in stigma.

Research shows two things: survey respondents report mortifyingly high rates of stigma and bankruptcy is increasing among the elderly and declining among the young. A study in 2001 showed that 84.3% of persons filing bankruptcy said they would be embarrassed or very embarrassed if their families or friends found out. Another survey showed that bankruptcy was more traumatic than the death of a friend or separation from a spouse.

Another study showed that people are waiting longer before they file bankruptcy. In 1981, people filed bankruptcy when their debt to income ratio was 1.41 while in 2001 that number had more than doubled to 3,04. Of persons surveyed, most had been struggling with debt for more than two years before filing.

Bankruptcy filings for those aged 75-84 increased by 433.3% from 1999-2007 and rates for those aged 65-74 increased 125%. Meanwhile the overall rate of filing decreased 29.2% and the filing rate for those aged 18-24 fell by 64.1%. The unfortunate fact is that bankruptcy is becoming a reality for the Greatest Generation.

4. There is nothing important in business bankruptcy between Mom & Pop and WorldCom.

Among some academics, there are two categories of chapter 11 cases, important (more than $100mm) and not important (everyone else). In the real world, 60% of chapter 11 cases fall into the range of $100,000 - $5 million in assets, while only 6% had $100 million in assets or more. Additionally, 20% of all chapter 11 cases were filed by individuals. The professors opined that this shows the difficulty of trying to construct a one size fits all chapter 11 model.

5. Small businesses linger endlessly in chapter 11.

A study done prior to BAPCPA showed that 50% of small business cases that ultimately failed were dismissed or converted within six months while 50% of successful cases took 15 months to confirm. The professors noted that small business cases take just as long to confirm as big business cases, although small business cases were dismissed or converted much faster than their larger counterparts (107 days faster in 2002).

According to Jay, if the 2005 time limits had been in effect in 2002, 80% of the successful small business cases might have failed. He added that the effect of the 2005 small business amendments may have been to “maim cases that could have succeeded.”

6. The bankruptcy experience is race neutral.

While the Bankruptcy Code is race neutral on its face, the “Ideal Debtor” for chapter 7 is one who holds retirement accounts, has high but reasonable expenses, financially supports only legal dependents and has little or no child support of student loan obligations. This is more likely to describe a white debtor than a minority debtor.

The most accurate predictor of whether someone will file chapter 13 is whether they are African American. African Americans file for chapter 13 at twice the rate of other debtors.

In 2007, Hispanics were likely to pay 25% more in attorney’s fees than white or African American debtors.

The professors were quick to say that they can’t say why this is happening, only that this is what the numbers show.

7. Forum shopping is all about getting to Delaware or New York.

It turns out that forum shopping happens in other parts of the country as well. Of 409 large cases filed outside of Delaware and New York since 1980, 27% were forum shopped

According to Katie, large cases should file in Jay and Kate’s districts because they would have easy access to academics and cheap beer. Jay noted that Austin had live music as well.

8. Bankruptcy works for pro se filers.

Chapter 7 works reasonably well for pro se filers, while chapter 13 is a complete disaster. Among pro se chapter 7 debtors, 17.6% of debtors had their cases dismissed for technical reasons compared to 1.9% of those with counsel.

Among pro se chapter 13 debtors filing since 2006, only 4% had their cases pending or discharged at the four year mark compared to 45% of those represented by counsel. 90% of pro se chapter 13 cases are dismissed prior to confirmation compared to just 15% of those represented by counsel.

According to Katie, pro se debtors are playing Las Vegas odds in chapter 13 and might do better taking their filing fee to Las Vegas. She said we have “constructed a complex machine that most of the time may require a lawyer.”

9. Many of the chapter 13 cases that do not complete plans are actually successes.

When Warren, Westbrook and Sullivan released their study that only 33% of chapter 13 cases result in discharge, they were treated as heretics. Now this success rate is conventional wisdom, but a new narrative has arisen that failed chapter 13 cases may actually be successes. The data says no.

While the debtor remained in bankruptcy, chapter 13 avoided foreclosure for 81% of debtors while 70% faced loss of their home within 2-3 months after dismissal.

Once their cases were dismissed, 57.5% of debtors reported that their situation was the same or worse than when they filed. 60% of debtors very much disagreed with the statement that they exited bankruptcy because they had accomplished their goals or found another solution compared to 20% who agreed or agreed very much with the statement.

In a chilling statistic, 33% of debtors whose chapter 13 cases were dismissed reported that they struggle to pay for food.

10. Lenders maximize recoveries in each case.

Sarah Pei Woo conducted a study of chapter 11 bankruptcies of residential real estate developers during the recession. Tragically, she passed away after a brief illness after her study was completed.

She found that banks acted not to maximize recovery but to increase short-term liquidity and accede to regulatory pressure. The question was not how much they would recover but when.

Among residential real estate developers, 81.7% were liquidated, 11.1% were sold in 363 sales and just 4.6% reorganized. Secured lenders filed a motion for relief from stay in 72.5% of the cases. Banks who were in financial distress were 24.9% to 28.6% more likely to seek relief from the automatic stay.

National Conference of Bankruptcy Judges--10/14/11--Too Big to Fail

Dr. Thomas Hoenig was the Friday luncheon speaker. He served for twenty-five years as President and CEO of the Federal Reserve Bank of Kansas City. He said that he “wanted to get you on board that Too Big to Fail is bad policy.” He warned that the crisis brought about by Too Big to Fail in 2008 was likely to recur. He said that “unless you acknowledge the problems that brought about the crisis, it would happen again. He identified some of the factors as distorted incentives, not allowing the market to function and subsidizing favored groups.

Dr. Hoenig identified three pieces of legislation as creating the climate for Too Big to Fail. The Glass-Steagall Act extended protections to commercial banks in the form of deposit insurance in return for separating out their risk-based activities. He described Glass-Steagall as “a covenant between government and the private sector” to “extend protection around you because of your role in society.” He said that “in return for special protection, we will limit (the activities of commercial banks) to payment systems and financial intermediation systems because these are the purposes we want to protect.” He said that if commercial banks wanted to engage in risk-based activities, they would have to do so with their own capital in a separately chartered entity. He said that Glass-Steagall was the system in place until the 1980s and “worked reasonably well.”

According to Hoenig, “with stability comes its own sources of weaknesses.” The demand to take down the wall between commercial banking and other activities led to the Gramm-Leach-Bliley Act of 1979. The effect of GLB was to allow banks to invest in risk with a federal backstop. The risk of this was predicted by Adam Smith who noted that merchants would seek to widen the market and narrow their competition. While widening the market is desirable, narrowing competition is not. GLB narrowed competition by allowing some players an artificial subsidy. By eliminating Glass-Steagall, the market share of the largest banks was increased from 14% in 1979 to 60% in 2007. “Thus was born too big to fail.”

The Dodd-Frank legislation was supposed to fix Too Big to Fail. He said, “I am concerned that it won’t” because “the incentives haven’t changed.” The largest institutions are now 20-30% bigger and the cost of capital is being kept artificially low. Under Dodd-Frank, if a TBTF institution finds itself on the ropes, the regulators must make a decision about whether the institution is solvent but illiquid or insolvent. This decision must be made on a Friday afternoon and must be approved by the Secretary of the Treasury and the Chairman of the Federal Reserve with possible involvement by the courts. He asked, “Who can take an institution of $2.2 trillion into receivership over the weekend?” As a result, he predicted that regulators would be inclined to find that the entity was solvent but illiquid and inject federal dollars to keep it afloat. As a result, he said, “the market doesn’t function” and “there is no cleansing of the market.”

Dr. Hoenig said that anything this large cannot be allowed to fail. As a result, the incentives must be changed. He noted that in the current system, profits are privatized and losses are socialized. He recommended that investment banking, trading and other risk-based activities be moved into separate entities with private capital. He also called for making the competitive market more fair. He said that regional banks cannot compete with the twenty largest entities because they are not subsidized.

Dr. Hoenig said that he disagreed with those who said that current capital requirements for commercial banks are too stiff. He disagreed, noting that before there was a federal safety net, financial institutions maintained capital of 15-20% compared to the current 7%. He said that (15-20% capital) is “what the market called for.”

He also disagreed with those who said that such measures would place U.S. financial institutions at a competitive disadvantage compared to institutions in other parts of the world. Dr. Hoenig said that foreign banks were not a good model to follow. He said “look at their banks.” He said, we are “not in a competitive process to excellence, but a competitive process to the bottom.”

He also warned that the country was too leveraged. He said that consumer debt as a percentage of GDP had grown from 80-90% to a high of 125% before dropping to the current level of 114%. At the same time the savings rate fell from 8% to 0% although it has risen back to 5%.

Dr. Hoenig described the federal government as being in crisis. He said that government debt had increased from 40% of GDP in 1990 to 100%. Currently interest rates average 2.5%. He asked what if market interest rates began to apply? He said that monetary policy has been captured by Too Big to Fail.

(I apologize in advance if I incorrectly transcribed any of Dr. Hoenig’s statistics or their units of measurement. I was taking notes as quickly as I could but possibly not quickly enough. Any statements that do not make sense are the result of my reporting rather than the content of the speaker).

National Conference of Bankruptcy Judges--10/14/11--The Consumer Financial Protection Bureau

Rajeev Date had the unenviable job of filling a speaking slot originally assigned to Elizabeth Warren to discuss the creation of the Consumer Financial Protection Bureau. He is currently the Special Advisor to the Secretary of the Treasury on the Consumer Protection Bureau. Prior to that, he worked for over a decade in the financial services industry, including stints at Capital One Financial and Deutsche Bank.

Mr. Date described the similarities between his job and that of bankruptcy lawyers pointing out that both deal with people getting wiped out because of something financial and both seek to help consumers.

The Consumer Financial Protection Bureau was a signature part of the Dodd-Frank legislation. He stated that its goal was making consumer financial markets work. Before Dodd-Frank, consumer protection functions were assigned to seven agencies which had other responsibilities as well.

He sketched out some recent history to show the need for the Bureau. He said that consumer debt exploded during the years before the financial crisis. He said that it “covered everything, big ticket, small ticket, secured unsecured. Everything grew and everything grew fast.” From 1999-2007, household debt nearly tripled. He cited college kids with credit cards, home mortgages with teaser rates and people exhausting their savings on high cost debt as emblematic of the period. Mr. Date said that consumers were signing up for “things they didn’t understand.”

Mr. Date noted that the mortgage industry was at the epicenter of the financial crisis. While lenders usually have incentives to ensure borrowers can pay them back, the mortgage industry was different. Because the brokers and banks that originated loans were compensated up front, risk and reward were delinked.

He also said that there was a breakdown in the market. Because originators could shop for the most favorable legal regime, they did so.

Additionally, there were problems with transparency. He defined transparency as both parties understanding the terms of the deal and talking about the same deal. Mr. Date said that transparency was absent during the years leading up to the financial crisis. The fastest growing products were things that were hard to understand. In order to gauge the risk involved in some financial products, it was necessary to have extensive knowledge of how the rate caps worked and interest rate history. He said that “problems of transparency continue today. Borrowers deserve to know what they are signing up for.”

Mr. Date was enthusiastic about the prospect of starting a new agency from the ground up. He quoted Steve Jobs for the proposition that “the only way to great work is to love what you do.” He described his challenge as creating new perspectives, creating a new structure and recruiting new talent.

Although the CFPB is only a few months old and lacks an Executive Director, it has grown to 690 employees, has begun taking consumer complaints, started education programs and has released examination guidelines. Notwithstanding the lack of an Executive Director, the authority to carry out the Bureau’s powers has transferred to the Secretary of the Treasury.

He pointed out that from 2001-2007, the volume of unusual mortgages exploded dramatically. He described one of the worst products offered as a mortgage with a one month teaser rate. He said that while the Bureau is working to clean up new originations, there are already $10 trillion in mortgages out there.

Mr. Date answered several questions related to mortgage servicing. He said that when he was in the financial services business, he would walk the floors of collection operations for automobile lenders and credit card lenders to evaluate whether to purchase the business. He said that they understood that there were some people who wouldn’t pay and planned for it.

On the other hand, income in the mortgage servicing industry is largely fixed regardless of whether the loan performs or does not. When a loan is performing, the cost to service the loan is less than the fees paid. However, when a loan is not performing, the servicer’s costs exceed their revenue. As a result, “the incentives don’t line up” for mortgage servicers to work with borrowers in default.

He also pointed out a disparity in that mortgage servicers can “fire” their borrowers by selling the portfolio to a new servicer, while borrower cannot fire their servicer.

The CFPB has released its manual for mortgage servicer examinations. Mr. Date said that in the past, examinations of mortgage servicers were neglected because these operations did not affect the “safety and soundness” of the financial institution. He said that the servicing manual does two things: it sets standards for consistency and lets servicers know what to expect.

Three different judges asked questions relating to home mortgage modifications. One judge spoke about debtors who submitted everything they were asked to and didn’t hear back for months only to be told their information had been lost. Another judge asked, “What do I do? What do I tell them?”

Mr. Date pointed out that mortgage brokers were good at holding consumers’ hands during the application process. However, no one is holding their hand in the modification process. He pointed out that the CFPB will put consumers in touch with HUD-approved housing counselors. This information is available at consumerfinance.gov.

He also said that enforcement was a tool available to the Bureau. He said that the Bureau would choose the right areas for investigation and bring cases when we need to. He said, “There are bad guys. If you don’t know who they are, you may be one yourself.”

National Conference of Bankruptcy Judges--10/14/11--Does the Bankruptcy World Need Another Talk on Stern v. Marshall?

Prof. Ralph Brubaker and Prof. Ken Klee spoke on “Not Again! Will Bankruptcy Courts Survive the Supreme Court’s Second Look At Stern v. Marshall?” However, their panel could have been titled, “Does the Bankruptcy World Need Yet Another Talk on Stern v. Marshall?” Fortunately the answer was yes.

The History of Summary/Plenary

Prof. Brubaker discussed the history of bankruptcy adjudication going back “before the beginning” to English bankruptcy practice. He said that the summary/plenary distinction began with English bankruptcy commissioners. Commissioners operating under the supervision of the Lord Chancellor could administer bankruptcy estates and make certain determinations of law and fact, such as adjudicating claims. Their power was by the concept of in rem so that they could decide any question regarding property in the possession of the assignee, who was the equivalent of a trustee. If the assignee had to sue someone to recover property, that proceeding had to be brought in the appropriate superior court.

In the Bankruptcy Act of 1800, Congress expressly allowed non-Article III bankruptcy commissioners to adjudicate all summary proceedings in a manner similar to English practice. This principle became even more firmly in place in the Bankruptcy Act of 1898. The jurisdictional statute expressly stated that there was no plenary jurisdiction except for some matters such as preferences and fraudulent conveyances. The 1898 Act introduced non-Article III officers similar to commissioners designated as Bankruptcy Referees. The full extent of the referee’s authority was not defined with perfect clarity resulting in multiple Supreme Court decisions. The Supreme Court invoked the summary/plenary distinction finding that plenary matters had to be brought before an Article III judge, while bankruptcy referees could determine summary matters and their decisions would be given the same effect as one from an Article III judge.

When Congress reformed the bankruptcy laws in 1978, it expanded the scope of bankruptcy jurisdiction. Jurisdiction was now extended to any proceeding related to the Bankruptcy case. All of that very broad jurisdiction was to be exercised by non-Article III bankruptcy judges subject to appellate review. The Marathon decision struck down the 1978 jurisdictional scheme as unconstitutional. However, the Court in Marathon never said where the constitutional line was. Indeed, there was not even a majority opinion in the case. Nevertheless, he said that “the most obvious explanation for why the court found the Code unconstitutional was that the Marathon case would have been a plenary suit which should have been tried in an Article III court.

Congress reacted to Marathon by enacting the core/non-core distinction which Prof. Brubaker equated to a codification of the summary/plenary distinction. He noted that in Granfinanciera, Justice Brennan, who authored the Marathon plurality, equated the Seventh Amendment right to trial by jury with plenary suits under the Bankruptcy Act of 1898 that could only be tried in an Article III court. He said that Congress could not take away the right to jury trial by classifying a matter as a core proceeding. Prof. Brubaker described this as constitutionalizing the summary/plenary distinction. He noted that in Stern v. Marshall, Chief Justice Roberts relied heavily on Seventh Amendment decisions to establish the right to decision by an Article III judge.

Prof. Klee said that Stern v. Marshall was not a politically decided case. Rather, it was about fundamental power, whether non-Article III courts should be limited or whether their authority should be based on pragmatism.

Prof. Klee had two good lines that don’t otherwise fit with this post. He said “Vicki was well endowed in her own right but not financially.” He also said that as a result of Pierce Marshall’s attorneys decision to file a proof of claim “history was made.”

Power vs. Jurisdiction

Prof. Klee was quick to point out that Stern v. Marshall was not about jurisdiction. Jurisdiction was vested in the district court. The Bankruptcy Judge can decide matters if they are delegated by the District Court and that delegation is constitutional. As a result, the case was not about jurisdiction, but who could exercise that jurisdiction. He said this distinction was important to the question of whether parties could consent to decision by a Bankruptcy Judge. “If it’s just lack of power, you can consent. If it is lack of subject matter jurisdiction, you can’t consent.”

Public Rights

Chief Justice Roberts placed a lot of emphasis on the early case of Murray’s Lessee which held that if an action could have been decided by the English courts of law, equity or admiralty, they could not be assigned to non-Article III tribunals in the absence of a public rights exception.

According to Prof. Klee, the public rights exception in bankruptcy is probably limited to cases in which the United States is a party. (Although not pointed out by the speakers, the Chrysler and GM cases would be good examples of the public rights exception). However, he made the interesting comment that Justice Scalia’s concurrence showed that in his heart, he does not want to overturn the bankruptcy system because it is a long-established system. This was similar to his ruling in the BFP case in which he relied on the long-established practice of state foreclosure laws. Thus, for Justice Scalia, historical practice is a way to get to authority. Prof. Klee recommended perusing Blackstone’s Commentaries to look for historical practice.

Claims and Consent

Under Stern, Bankruptcy Courts can still decide proofs of claim. Filing a claim establishes a claim to the bankruptcy res and constitutes consent to adjudication of the claim itself. However, filing of a proof of claim does not constitute consent to anything beyond that. In Stern, Pierce Marshall’s filing of a proof of claim was not consent to determination of Vicki’s counterclaim. As the Supreme Court pointed out, Pierce really had no choice about filing a proof of claim, so he did not consent to anything beyond determination of the claim.

Prof. Brubaker said that filing a claim is only consent to determining the claim because that is a natural consequence of filing a claim.

Prof. Klee argued that “The current court is re-writing history. Under the Act, we had jurisdiction by ambush.” In Gardener v. New Jersey, the court held that the state’s filing of a proof of claim waived sovereign immunity. The Court also held that filing a proof of claim waived the Seventh Amendment right to jury trial. Prof Brubaker rejected the notion of jurisdiction by ambush as consent. “Jurisdiction by ambush means they are not consenting to anything.”

Supplemental Jurisdiction

Prof. Brubaker would analyze Stern v. Marshall as a case on supplemental jurisdiction. “The Stern majority never acknowledged supplemental jurisdiction, but signed on to it.” However, he said that the nexus for supplemental jurisdiction is “tightly circumscribed.” He said it is only available to the extent necessary to dispose of independent matters already before the court.

Things That Can Be Done or Not

Prof. Klee said that there are still many things Bankruptcy Judges can do. They can employ counsel, approve compensation (which drew applause from the audience) and administer the estate. However, he noted that according to Blackstone, English commissioners could not enter the discharge. They could certify the discharge to the Chancellor but could not enter it. He added, “If bankruptcy judges cannot enter discharges, we are in a new world.”

The professors had a vigorous discussion on whether bankruptcy judges could enter money judgments in nondischargeability cases. Prof. Klee thought it was permissible so long as the debtor was the defendant. On the other hand, Prof. Brubaker said that “historically courts have considered nondischargeability as a separate claim.” Prof. Klee responded that the debtor was res to which Prof. Bubaker said “nah.”

They also discussed whether Bankruptcy Courts could follow the report and recommendation procedure in core proceedings where the Bankruptcy Court lacked constitutional power to enter a final judgment. Prof. Klee pointed out that there were now three categories of cases: core proceedings where the Bankruptcy Court can constitutionally enter a final judgment, noncore proceedings in which the Bankruptcy Court may submit proposed findings of fact and conclusions of law and core proceedings in which the Bankruptcy Court lacks power to enter a final judgment. Prof. Brubaker said that if Congress had authorized courts to enter a final judgment, it implicitly had authorized them to take the lesser action of submitting proposed findings and conclusions. Prof. Klee, while initially taking the position that submitting proposed findings and conclusions was not authorized noted that the best retort to his own position was Stern v. Marshall in which the Supreme Court “didn’t bat an eye” when the District Court treated the Bankruptcy Court’s ruling as proposed findings and conclusions.

So What Are We Left With?

My question after listening to this discussion is whether the Bankruptcy Court has any broader power now than it did under the Bankruptcy Act of 1898 or than was possessed by English bankruptcy commissioners. I am more sanguine than the professors. I think that will be too difficult to turn back the clock on thirty years of expansive power exercised by Bankruptcy Judges. To the extent that historical practice or specialized expertise are grounds for vesting power in a non-Article III tribunal, there is a case for vesting more power in the Bankruptcy Courts than they enjoyed prior to 1979. Bankruptcy Courts have developed specialized expertise in dealing with the consequences of financial failure. They have developed into our national courts of commerce. While most historians would scoff at thirty years as a mere blip in time, it is significant enough that it will be difficult to roll back the clock.

National Conference of Bankruptcy Judges--10/13/11--The Not So Gloomy Economist

Thursday’s lunchtime speaker was Gregory L. Miller, Chief Economist for SunTrust Banks, Inc. His presentation was not too gloomy but a bit disturbing. He began Saturday Night Live style saying, “I’m the economist and you’re not.”

Miller predicted that “there is not going to be a double dip recession.” He said that his “subjective prospect that the economy will fall into recession is not significant.” He estimated the prospect of recession at 25% which he said was not great because at any given time, there is a 15% prospect of recession.

On the other hand, Mr. Miller said that the rest of the world has a 60% chance of recession, noting that at least three countries in the Euro Zone were already in recession and that others were at risk.” Nevertheless, he said that, “whether or not the rest of the world goes into recession, we will not.” Mr. Miller suggested that a global recession could even help the United States, since it would make foreign goods less expensive. He said this would be good for lovers of French wine. He noted that despite the weak economy elsewhere in the world U.S. exports were still increasing.

Miller noted that the private sector in the United States was “fine under the circumstances” but that the “public sector is not pulling its weight at a time when it should be doing it.” He added that “Pulling the economy deeper when it’s already in the soup is not a government function but that’s what it’s doing.” Miller said that the private sector was growing at a rate of 3.6% while the overall economy was growing at a rate of 2.8% indicating that the public sector was a net drain of 0.8% on the economy.

Mr. Miller said that in the U.S. economy, the housing, government and credit sectors were weak. He said that the housing sector was at the bottom but that condos were “a virtual black hole.” He said that housing and credit are usually leading sectors, but that the rules are different now and the standards are higher. He said that two trillion dollars has been dumped into bank balance sheets where it is stuck in capital accounts of regulated banks who aren’t sure what their capital requirements are. He said that banks were reluctant to put loans on the books when they don’t know whether they will pass audit.

With regard to the labor market, he pointed out that the Obama administration’s current jobs bill consists largely of former Republican proposals. However, “the opposition is obliged to hate the dominant party’s policy even if it is the right thing.”

Mr. Miller noted that the current $450 billion proposal would have more effect than the previous $800 billion stimulus bill because it funneled money to the private sector where the multiplier is higher rather than the prior stimulus which went through state and local governments.

However, he said, “It’s not the jobs. Nine percent unemployment is not what’s wrong with the economy.” He said that the natural unemployment rate is 6% and that when we had 4% unemployment, there was too much employment in the economy. He said that 30% of the newly unemployed came from the construction and mortgage finance sectors. He said there is a mismatch between those who want jobs and those who are looking to employ. He said that two-thirds of the unemployed would likely remain unemployed and “we don’t want them employed.”

Miller said that interest rates will remain painfully low until at least the middle of 2012. Nevertheless, banks are finding it more profitable to park their cash at the Fed where they can earn 0.25% interest. He pointed out that reserves have increased from $500 billion to $3 trillion. He said that to get banks lending, the Fed would need to lower the rate it pays to zero or even charge banks to keep their cash parked at the Fed.

He said that the Euro sovereign debt crisis was a crisis of banking and culture, not an economic crisis. He said that U.S. banks held only 0.10% of their assets in European sovereign debt and that this was concentrated in banks that could afford to absorb the loss.

In summary, the U.S. economy is not going into recession, the prospect for the rest of the world looks bleak, unemployment is not going back to where it once was, banks are not lending and the U.S. government is dysfunctional. That’s about as rosy of a view as you can get from an economist.

National Conference of Bankruptcy Judges--10/13/11--Roundup of Business and Consumer Programs

I am at the 2011 National Conference of Bankruptcy Judges in Tampa, Florida. For this first day, I heard a good mix of consumer and chapter 11 programs along with a provocative economist. Here are a few highlights.

Chapter 11 Issues

On the chapter 11 side, the topic du jour was In re DBSD North America, Inc., 634 F.3d 79 (2nd Cir. 2011) which was discussed by no less than three speakers. Prof. Troy McKenzie and Judge Mary Diehl each discussed the gifting aspects of the case, while Ronald Peterson talked about designation of votes in chapter 11.

Gifting

The latest word on “gifting” (that is, a senior creditor ceding value to a junior class of creditors over the objection of an intervening class) is that is violates the absolute priority rule. DBSD North America presented an extreme version in that secured creditors gave up value to equity who would receive value on account of, among other things, their equity interest. The Second Circuit held that this was a clear violation of the absolute priority rule. However, other scenarios were not as clear. For example, in In re SPM Manufacturing Corp., 984 F.2d 1305 (1st Cir. 1993), a secured creditor and a junior class reached a gifting agreement. However, no plan was confirmed and the case was converted to chapter 7. After the secured creditor obtained relief from the stay, it announced that it would honor its prior agreement. The court of appeals held that the secured creditor could do whatever it wanted with its money.

It seems that “gifting” only raises an absolute priority rule problem when it occurs under a plan and is “on account of” an equity interest. If it is done in the context of a 9019 compromise and settlement or a 363 sale, it is more likely to work. It was also suggested that because the absolute priority rule was enacted with equity interests in mind, a gifting arrangement between two classes of creditors might pass muster.

Designation of Ballots

Ron Peterson discussed the history of designation of ballots. Prior to the Chandler Act in 1937, the Bankruptcy Act did not contain a provision for disallowing a ballot. However, a case involving a hotel in Waco, Texas prompted William O. Douglass to press for a disallowance of ballot provision. In that case, Hilton Hotels invested substantial monies in a hotel in Waco, Texas under a lease. The debtor cancelled the lease and filed for reorganization. Hilton Hotels bought up a blocking position in the debtor’s unsecured debt and insisted that the lease be reinstated. In that case, there was no provision to prevent the attempt to hijack the reorganization.

Since that time, designation of ballots has been allowed where a creditor votes to put a competitor out of business, acts based on sheer malice, acts on inside information or seeks to gain an unfair advantage over other similar creditors. In DBSD North America, the court of appeals affirmed a decision to designate ballots of a competitor who purchased a blocking position with the intent to gain control of the debtor’s telecommunications spectrum rights. On the other hand, where a creditor strikes a hard bargaining position but acts out of economic self-interest, its vote will be allowed. In the words of Gordon Gecko, “greed is good.”

I was disappointed that Ron did not discuss my case on designating ballots, In re The Landing Associates, Ltd., 157 B.R. 791 (Bankr. W.D.Tex. 1993). However, since he mostly stuck to circuit cases, this was not surprising.

Rights Offerings

Clifton Jessup gave an interesting talk on rights offerings. Fortunately, Judge Diehl made him explain what a rights offering was. A rights offering is an offer by the debtor to sell securities (usually equity securities) to its existing creditors at a discount in order to obtain financing to emerge from bankruptcy. Rights offerings also involve a backstop party who agrees to purchase any securities not purchased by others in return for a fee.

Structured Dismissals

Nan Coleman from the Executive Office of the U.S. Trustee and Prof. Troy McKenzie discussed structured dismissals. A structured dismissal is a procedure where the debtor’s assets are sold and then a case is dismissed with conditions. Those conditions may include affirming protections to the purchaser in the 363 sale, releases to parties and a modified claims procedure. Ms. Coleman advocated that U.S. Trustee position that structured dismissals are contrary to the Bankruptcy Code and should not be allowed. She said, “Let’s be clear. It’s not a gift. It’s a quid pro quo. Someone is getting something and someone is giving up something. Prof. McKenzie offered a tepid defense stating that some features in structured dismissals raise eyebrows but that “perhaps they should be given a little room to develop before they are squelched.”

Employment of Counsel/Committee Solicitation

Employment of counsel and committee solicitation were both discussed in the ethics portion of the program. In an unusual opinion, Judge Michael Lynn has ruled that debtor’s counsel need not be disinterested. In re Talsma, 436 B.R. 908 (Bankr. N.D. Tex. 2010). If debtor’s counsel is owed fees, it may sell its claim prior to bankruptcy to avoid being disqualified for being a creditor. In re 7677 E. Berry Ave. Assoc., LP, 419 B.R. 833 (Bankr. D. Col. 2009). However, this did not work when payment for the claim was contingent on what the purchasing creditor received in the bankruptcy. In re Fish & Fischer, Inc., 2010 WL 5256992 (Bankr. S.D.Miss. 2010).

In re Universal Building Products, 2010 WL 4642046 (Bankr. D. Del. 2010) illustrates that state disciplinary rules apply when soliciting a committee. In that case, prospective committee counsel asked a Chinese speaking party they had a prior relationship with if he would contact Chinese speaking creditors. He was offered the position of translator for the committee. Model Rule 7.3 restricts direct solicitation of prospective clients and Delaware had adopted a version of this rule. Based on the violation of Rule 7.3, counsel was disqualified from representing the committee.

Consumer Issues

Untangling the Mortgage Morass: Rules, Rogues and Repairs

This panel handled the sexy topic of the new Bankruptcy Rules applicable to mortgage claims which takes effect in December 2011. The panel did a good job of laying out the history of the rules and issues likely to arise.

The rules had their genesis with Jones v. Wells Fargo Bank, 366 B.R. 584 (Bankr. E.D. La. 2007) and Padilla v. GMAC Mortgage, 389 B.R. 409 (Bankr. E.D. Pa. 2007). These cases raised the specter of a debtor successfully completing a chapter 13 plan and then immediately being posted for foreclosure based on undisclosed charges that accrued during the bankruptcy proceeding.

Under the new rules, there are three changes which will take effect in December. First, mortgage claims must include an attachment listing delinquent amounts as of the petition date, including any charges and the date they were incurred. Among other things, this will require disclosure of the amount of escrow shortage as of the petition date. Fed.R.Bankr .P. 3001(c)(2), Official Form 10, Attachment A. Next, mortgage creditors must give notice of a change in payment amount 21 days before it takes effect. Fed.R.Bankr. 3002.1(b), Official Form 10, Supplement 1. Additionally, mortgage creditors must give notice of post-petition fees and costs incurred every 180 days. Fed.R.Bankr.P. 3002.1(c),(d). Finally, at the conclusion of a chapter 13 case, the trustee or debtor must give a Notice of Final Cure Payment. Fed.R.Bankr.P. 3002.1(f).

The panel identified several interesting issues under these rules. One issue is that the form does not take a position on how to calculate the escrow shortage. The Third and Fifth Circuits have taken the position that any amount charged to the debtor for escrow pre-petition is escrow shortage, In re Rodriguez, 629 F.3d 136 (3rd Cir. 2010) and In re Campbell, 545 F.3d 348 (5th Cir. 2008), while one major mortgage servicer has taken the position that only amounts advanced out of pocket prior to the petition date constitute escrow shortage. As pointed out by Judge Eugene Wedoff (Bankr. N.D. Ill.), this makes a big difference. Because the escrow shortage is part of the pre-petition claim, it can be paid out over the life of the plan. However, if amounts accrued but unpaid are not considered pre-petition claims, then they are included in the post-petition escrow amount and must be paid within one year. John Rao stressed that it was important to avoid doublecounting by including the escrow shortage in the proof of claim and then seeking to recoup it post-petition as part of the ongoing mortgage payment. A petition for cert has been filed in the Rodriguez case and the Supreme Court has requested that the Solicitor General comment, which is a sign that the court may be considering granting the petition.

The new attachment to proof of claim must be signed. Faiq Mihlar suggested that before attorneys sign the attachment that they read the Third Circuit’s opinion in In re Taylor, 2011 U.S. App. LEXIS 17651 (3rd Cir. 2011) in which an attorney was sanctioned for signing claims without reading them or knowing whether they were accurate. He said that the best practice was to have the attorney prepare the attachment and have the client review and sign it. He said that while he enjoyed appearing in court, he preferred not to do so as a witness.

John Rao pointed out that the 21 day period for providing the notice of change in payment is the same period provided under RESPA. He said that the new form is merely a cover sheet and that the mortgage servicer may simply attach its regular notice of payment terms.

When giving notice of charges incurred during the case, it is only necessary to give notice of charges that will be sought to be charged to the borrower. It is important that charges only be listed once. For example, if a lender incurs attorney’s fees in one six month period and they are not paid, it should only report new attorney’s fees incurred subsequently and should not report the prior fees again.

If the creditor does not give timely notice of the fees incurred, it is barred from collecting them later. The failure to request fees could be the basis for judicial estoppel in a subsequent state court proceeding.

Mark Redmiles from the U.S. Trustee’s office explained the procedure for giving notice of completed cure payment. Within 30 days after completion of payments, the trustee or debtor must give notice that payments have been completed. The mortgage creditor has 21 days to respond. If the creditor does not respond, then the loan is deemed to be current.

Faiq Mihlar argued that the 21 day period was too short and that lenders would not have time to receive the document and act on it. This raised the possibility that conniving debtors could simply fail to make their last several payments before completion of the plan knowing that the lender would probably fail to respond to the Notice of Final Cure Payment. Judge Wedoff suggested that the creditor could request an extension of time under Rule 9006 if it could not respond within the deadline. He also suggested raising the time limit with the rules committee.

So You Think Consumer Bankruptcy Is Easy? Challenges of a Complex Code

This panel discussed several difficult consumer issues. However, the best comment did not relate to the specific topics. Judge Shelley Chapman (Bankr. S.D. N.Y.) acknowledged that prior to taking the bench eighteen months ago, she had only practiced chapter 11 law. She described the chapter 13 docket as “the hardest thing I have done so far.” She said that it was “a daunting task” facing a room full of consumer bankruptcy lawyers. Judge Chapman’s humility and candor were refreshing.

This illustrates how the selection of bankruptcy judges has changed. In the 1980s, the circuits often appointed judges with no prior bankruptcy experience. Today, the circuits tend to favor chapter 11 practitioners. While this is a marked improvement, it still leaves a gap in the judge’s experience.

The panel had a lively discussion on whether a wholly unsecured junior lien could be stripped in a chapter 20 case (a chapter 7 followed by a chapter 13). In a chapter 20 case, the debtor is not entitled to a discharge in the chapter 13 case. Can he strip off the junior lien based on its lack of security?

Judge Chapman opined that, perhaps it was her chapter 11 bias, but that “allowed secured claim” meant that a claim was secured within the meaning of Section 506(a),that secured claim equates to economic interest. She stated that she requires the second lienholder to grant a release and give it to the chapter 13 trustee to hold in escrow until completion of payments.

John Clement, the debtor’s lawyer on the panel, argued against lienstripping. He argued that secured claim referred to the state law security interest. He cited the Supreme Court decisions in Dewsnup v. Timm, 112 S.Ct. 773 (1992) and Nobelman v. American Savings Bank, 113 S.Ct. 2106 (1993) as evidence that the Supreme Court does not look favorably upon the economic definition of secured claim.

John Gustafson, a chapter 13 trustee, warned that practitioners should be careful how far they push the issue. While most circuits currently allow lienstripping in chapter 20 cases, the Supreme Court might not be so favorable.

John Gustafson discussed the problem of social security income in chapter 13 cases. Under the means test, social security income is not counted. However, what about the debtor who has a high income and is also receiving social security? Should this debtor be allowed to pay less? In chapter 7, the problem is addressed by the distinction between Section 707(b)(2) and 707(b)(3). While Section 707(b)(2) applies the means test, Section 707(b)(3) examines the totality of the circumstances in cases in which the means test is satisfied. Perhaps the good faith requirement of Section 1325(a)(4) should fulfill a similar purpose.

Frederick Clement noted that BAPCPA was intended to take discretion away from bankruptcy judges while the totality of the circumstances approach to good faith would grant discretion. Mr. Gustafson countered that “sure it’s subjective but so is Section 707(b)(3).” He likened it to putting a bandaid over our glasses and not looking at the social security income. He also suggested that if judges couldn’t consider extra social security income alone, perhaps they could consider it along with other factors, such as the debtor wanting to keep a Harley (apparently that’s a bad thing).

Frederick Clement talked about the tension between the binding nature of a plan under Section 1327(a) and the ability to modify a plan under Section 1329(a). If the debtor confirms a plan and later decides that he doesn’t want to pay as much, “is there some threshold other than I want to” when proposing a modification? If not, how is the plan binding? He gave the example of In re Noble, in which the debtor proposed to retain a vehicle and later sought to surrender it. The Court held that the Debtor was bound.

John Gustafson asked whether creative lawyers could draft around such future contingencies. He suggested that a debtor could offer to make extra payments up front in return for the option to surrender the vehicle later in the plan.

Frederick Clement pointed out that in Ransom v. FIA Card Services, 131 S.Ct. 716 (2011)and Hamilton v. Lanning, 130 S.Ct. 2464 (2010), the Supreme Court appeared to assume that debtors could modify their plans at will. He said “If that is the case, how are you bound at all?” He suggested that a plan could only be modified for substantial and unanticipated circumstances and only to address the specific changes authorized in Section 1329, such changing the payment amount or length of the plan. He noted that while you could change the term of the plan, you could not change the “applicable commitment period” so that an above median debtor could not shorten a plan to less than 60 months.