Two Supreme Court Decisions Turn on Statutory Language

In two bankruptcy appeals decided this summer, the Supreme Court faithfully followed congressional intent in one case, while finding that the language used by Congress did not quite do the job in the other.    In RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S.Ct. 2065, 182 L.Ed.2d 967 (2012), the Court put In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3^rd Cir. 2010) to rest, holding that a chapter 11 plan which provided for sale of the debtors assets while denying lenders the right to credit bid could not be approved as providing the lender the “indubitable equivalent” of its collateral.     However, in Hall v. United States, 132 S.Ct. 1882, 182 L.Ed.2d 840 (2012), the Court held that a tax provision intended to benefit family farmers who sell their farm during a chapter 12 proceeding was ineffective in the particular case because chapter 12 cases do not create a separate taxable estate.    The two decisions point out the imprecision present in the English language.

Not So Rad for Debtors

In the RadLAX case, the Supreme Court had to consider whether one of three confirmation cram-down options could contradict another.   The debtor proposed to sell its property pursuant to a plan of reorganization, but did not want to allow the secured creditor to credit bid.    The bankruptcy court and the Seventh Circuit said no.   However, the Third Circuit had previously said yes.  The debtor and the Third Circuit said that it was possible to use the phrase “indubitable equivalent” to get in through the back door what would otherwise not be possible under the provision dealing with sales free and clear of liens.  Justice Scalia and seven of his brethren were not impressed.   (Justice Kennedy did not participate so the decision was a unanimous 8-0).

Under 11 U.S.C. Sec. 1129 (b)(1), a debtor seeking to overcome the dissenting class of claims must propose a plan that is “fair and equitable” and which does not discriminate “unfairly.”   The statute goes on to state that the requirement that a plan be “fair and equitable” “includes” certain requirements.   There may be more requirements to “fair and equitable” but Congress did not tell us what they are.    However, at a minimum, they include a checklist of items applicable to classes of secured claims, unsecured claims and interests.  

For secured claims, the checklist says that treatment must include one of the following options:

(       a. The creditor must retain its lien and receive payment of the present value of its secured claim;

(      b. The debtor may sell the property free and clear of liens subject to the creditor’s right to credit bid; or

(    c. The debtor must provide the creditor with the realization of the “indubitable equivalent” of its secured claim.

While the first two options are fairly specific, “indubitable equivalent” is neither a defined term nor one whose meaning is readily apparent with the use of a dictionary.   The term does have a very learned history, since it originated from Learned Hand’s opinion in In re Murel Holding Corp, 75 F.2d 941 (2^nd Cir. 1935). 

However, Justice Scalia did not find it necessary to wade into the thicket of what constituted the “indubitable equivalent” of a secured claim.    Instead, he invoked a canon of statutory interpretation.   

We find the debtor’s of §1129(b)(2)(A)—under which clause (iii) permits precisely what clause (ii) proscribes—to be hyperliteral and contrary to common sense.  A well established canon of statutory interpretation succinctly captures the problem:  “[I]t is a common place of statutory construction that the specific governs the general.”  (citation omitted).

132 S.Ct. at 2070-71.

Eric Brunstad, who successfully argued the case before the Supreme Court, described the case as “unsatisfying” in a keynote address to the National Conference of Bankruptcy Judges.  He compared canons of statutory interpretation to aphorisms, such as look before you leap and strike while the iron is hot—whoever chooses the canon to apply determines the outcome.

While the opinion goes on for some nineteen pages, these two sentences capture its essence.   cases, it simply was not necessary here.   Whatever else “indubitable equivalent” means, it does not mean that courts can make an end run around the more specific provisions of section 1129(b)(2)(A)(i) and (ii).

By the way, my preferred definition of “indubitable equivalent” is a treatment which causes the judge to don a monocle and remark “indubitably” in an upper-class British accent.

A Taxing Result

In Hall v. United States, the chapter 12 debtors were not able to save the farm or escape paying capital gains tax on its sale—despite Congressional efforts to the contrary.  The debtors filed chapter 12 and sold the family farm.   They sought to classify $29,000 in post-petition capital gains liability as a dischargeable pre-petition debt.   While this might seem audacious, the debtors were simply trying to take advantage of 2005 legislation meant to protect family farmers from crushing tax bills.   Under 11 U.S.C. Sec. 1222(a)(2)(A), a chapter 12 plan must pay priority claims under section 507 in full unless the claim:

arises as a result of a sale, transfer, exchange, or other disposition of any farm asset used in the debtor’s farming operation in which case the claim shall be treated as an unsecured claim that is not entitled to priority under section 507 . . . .

If Congress had simply stated that tax claims arising from sale of a farming asset shall be treated as unsecured claims, the Halls would have been protected.   However, because the exemption was included within a general section on priority claims, the provision interacted with other provisions to deny the debtors relief.    

      The provision classifying taxes from sale of farm assets as unsecured claims is included in an exception to the rule that a chapter 12 plan must pay priority claims under section 507 in full.

.     

Section 507 has two tax provisions within it. Section 507(a)(8) grants priority status to prepetition tax claims.   Section 507(a)(2) incorporates section 503(b) which refers to “any tax . . . incurred by the estate.” 

 a. Under 26 U.S.C. Sec. 1398 and 1399, filing chapter 12 does not create a separate taxable estate. 

 b. As a result, post-petition taxes in a chapter 12 case are incurred by the debtor, not the bankruptcy estate.  

c. Because post-petition taxes in a chapter 12 case are incurred by the debtor and not the estate, they do not qualify as priority claims under section 507. 

 d. Because they do not qualify as priority claims under section 507, they do not get the benefit of the exception to treatment of priority claims in chapter 12. 

This is undoubtedly a result contrary to Congressional intent.   Sen. Charles Grassley, who authored the legislation, is known to be an ardent advocate for family farmers.   However, under the Supreme Court’s decision, capital gains arising from sale of a family farm prior to bankruptcy would be dischargeable as general, unsecured claims, while claims arising from a sale during the bankruptcy would be a non-dischargeable post-petition debt.    

Furthermore, the proceeds from sale of the farm would be property of the estate which would be required to be used to pay creditors, even though the debtor could not use that same estate property to pay the taxes.   Even if the IRS wanted to allow the taxes to be paid through the plan, there is not a statutory mechanism for doing so.   While section 1305(a), allows a post-petition creditor in a chapter 13 proceeding to file a claim, there is no similar provision in chapter 12.

This is unfortunately a case where the statutory language used was not robust enough to do the job.   If Congress wants to fix the problem, they could do so by replacing section 1222(a)(2)(A) with the following language:

A claim owing to a governmental unit arising from a sale, transfer, exchange, or other disposition of any farm asset used in the debtor’s farming operation, regardless of whether such sale, transfer, exchange or other disposition occurs prior to the petition date or during the pendency of the bankruptcy case, shall be includable in the plan and shall be treated as an unsecured claim that is not entitled to priority under section 507, but the debt shall be treated in such manner only if the debtor receives a discharge.

Preserving Causes of Action In Plans

These days, defendants are getting more aggressive about repelling suits from bankruptcy estates. From jurisdictional squabbles based on Stern v. Marshall to judicial estoppel to failure to preserve a cause of action in a plan, the plaintiff’s road to judgment is just more difficult than it used to be. However, two recent decisions are examples of suits which avoided being detonated by clever challenges. In Matter of Texas Wyoming Drilling, Inc., No. 10-10717 (5^th Cir. 7/21/11), a chapter 7 trustee prevailed against a claim that the former debtor in possession had failed to failed to make a “specific and unequivocal” reservation of claims and defeated a judicial estoppel claim. In Crescent Resources Litigation Trust v. Burr, No. 11-1013 (Bankr. W.D. Tex. 7/22/11), a litigation trust created by a plan defeated a defense that claims had not been adequately preserved. (There was another very interesting decision released in the Crescent case the same day about turnover of files from the debtors’ former attorneys. Because that case does not retention language under a plan, I will save that one for another day). You can find the opinions here and here.

The Disclosure Statement Wins Out

The Debtor in Texas Wyoming filed for chapter 11 relief and confirmed a plan. The plan provided for preservation of “Estate Claims.” The Disclosure Statement defined “Estate Claims” as claims arising under Chapter 5 of the Bankruptcy Code and included a chart listing potential claims, including “Various pre-petition shareholders of the Debtor” who might be sued for “fraudulent transfer and recovery of dividends paid to shareholders.”

The Debtor then sued its former shareholders to recover dividends paid under a fraudulent conveyance theory. The defendants sought to dismiss the action claiming that: (a) the Plan did not include a “specific and unequivocal” reservation of claims, (b) the disclosure statement did not name the parties who could be sued; and (c) the Debtor did not disclose the claims in its schedules.

Under Fifth Circuit precedent, a plan must “specifically and unequivocally” retain a cause of action. In re United Operating Company, 540 F.3d 352 (5^th Cir. 2008). If the claim is not adequately reserved, then the post-confirmation debtor lacks standing to pursue it.

When the plan failed, the case was converted and the chapter 7 trustee pursued the claims. The Bankruptcy Court denied the defendants’ motion, but certified a direct appeal to the Fifth Circuit. The Fifth Circuit, in an opinion authored by Edith Brown Clement, made short work of the defendants’ claims.

The Fifth Circuit found that it was permissible to consult the disclosure statement to see whether claims had been adequately disclosed. The Court stated:

We observe that the disclosure statement is the primary notice mechanism informing a creditor’s vote for or against a plan. See 11 U.S.C. § 1125. Considering the disclosure statement to determine whether a post-confirmation debtor has standing is consistent with the purpose of In re United Operating’s requirement: placing creditors on notice of the claims the post-confirmation debtor intends to pursue. (citation omitted). In light of the role served by the disclosure statement, the purpose behind the rule in In re United Operating, and the fact that, in similar contexts, courts routinely consider the disclosure statement to determine whether a claim is preserved, we hold that courts may consult the disclosure statement in addition to the plan to determine whether a post-confirmation debtor has standing.

Opinion, pp. 6-7.

While the language in the Plan was generic, the language in the Disclosure Statement identified claims arising under Chapter 5 and stated that pre-petition shareholders were at risk for being sued for recovery of dividends. That was enough to satisfy the “specific and unequivocal” requirement under prior Fifth Circuit precedent.

The Fifth Circuit also rejected the argument that failure to list the claims in the schedules would bar the claims under the doctrine of judicial estoppel. The Court noted that there was no inconsistent position taken since the Disclosure Statement specifically identified the claims.

The defendant’s argument founders on the first requirement because TWD did not take clearly inconsistent positions. As explained above, TWD’s plan and disclosure statement retained the right to pursue the Avoidance Actions. Because TWD explicitly retained the same claims against the defendants that the trustee is now pursuing, there is no inconsistency in its position.

Opinion, p. 9.

This holding is a victory for common sense interpretation versus the magical view that any failure to disclose evaporates the claim.

The take away from Texas Wyoming is that careful drafting at the disclosure statement stage may avoid creditor heartaches down the road.

Court Chooses the Categorical Approach

The Crescent Resources case involved 122 related debtors who filed a chapter 11 bankruptcy in Austin in 2009. On December 20, 2010, the Court confirmed the Debtors’ Revised Second Amended Plan of Reorganization. A major feature of the plan was creation of a Litigation Trust. One claim pursued by the Trust was against Edward Burr, a former insider of the Debtors. The claims involved two transactions:

1. Payment of $1.925 million to Burr in April 2007 to cover his personal tax liabilities; and

2. Payment of $4.5 million in cash plus forgiveness of $71 million in debt owed to Crescent in November 2007 in return for termination of his employment and conveyance of a 20% interest in one of the debtors.

The Trustee alleged that the transfers constituted fraudulent conveyances under state and bankruptcy law. The Defendant sought to dismiss the claims, asserting that the plan had not “specifically and unequivocally” reserved the claims and asserting failure to plead fraud with specificity.

The Defendant raised two arguments with regard to retention of claims: 1) that the plan failed to disclose that the Trust would pursue claims against him personally; and 2) that if the overall description was sufficient, that the plan failed to preserve claims for turnover pursuant to 11 U.S.C. §542.

The Plan provided that:

The Litigation Trust Assets shall include, but are not limited to, those Causes of Action arising under Chapter 5 of the Bankruptcy Code including those actions which could be brought by the Debtors under §§ 544, 547, 548, 549, 550, and 551 against any Person or Entity other than the Litigation Trust Excluded Parties.

Causes of Action was defined to mean “any and all Claims, Avoidance Actions, and rights of the Debtor, including claims of a Debtor against another Debtor or other affiliate.”

It is clear that neither the Plan, the Trust Agreement or the Disclosure Statement specifically referred to Mr. Burr or referred to claims for turnover under 11 U.S.C. §542.

The opinion contains an excellent discussion of the cases interpreting United Operating. At the conclusion of its discussion, the Court summarized as follows:

(W)hile the Fifth Circuit has not defined what “specific and unequivocal” means, cases have interpreted different plan language on case-by-case bases which this Court can use as guideposts with which to judge the plan language at issue here. Courts have held that listing causes of action by code section is sufficiently “specific and unequivocal.” (citations omitted). The courts have also held that a generic blanket reservation is insufficient. (citations omitted).

The cases in the Fifth Circuit all cited United Operating. United Operating, in making its holding, also discussed that one of the purposes of bankruptcy is to “secure prompt, effective administration and settlement of all debtor‟s assets and liabilities within a limited time.”(citation omitted). In order to facilitate this resolution of the estate, “a debtor must put its creditors on notice of any claim it wishes to pursue after confirmation.” (citation omitted). It is for this reason—notice to creditors—that the Fifth Circuit determined that the retention language needed to be “specific and unequivocal.” (citation omitted).

This Court agrees with the reasoning behind those cases applying what has been referred to as the “Categorical Approach,” and adopts the test established in Texas Wyoming Drilling to determine if the plan language meets the “specific and unequivocal” requirement. (citation omitted). That test, again, was to make a determination “whether the language in the [p]lan was sufficient to put creditors on notice that [the debtor] anticipated pursuing the [c]laims after confirmation.” (citation omitted). If so, the language meets the “specific and unequivocal” requirement.

Opinion, pp. 21-22.

The Court found that the reference to “state fraudulent transfer law claims” was not specific and unequivocal because it did not refer to a specific code cite. The Court went on to find that a reference to “Causes of Action arising under chapter 5 of the Bankruptcy Code, including those actions which could be brought by the Debtor under §§544, 547, 548, 549, 550, and 551” was sufficiently detailed so that “a creditor could not feign surprise that the Trust would pursue a claim under Section 542.”

Conclusion

Taken together, Texas Wyoming and Crescent Resources set a fairly low bar for preserving claims and causes of action under a plan. Both cases take a pragmatic attitude, essentially relying on a surprise standard. From a policy standpoint, it is about fairness. If a creditor is being asked to vote on a plan, it should be clear whether that person runs the risk of being sued. In Texas Wyoming, the Disclosure Statement clearly signaled that the Debtor intended to sue former shareholders who had received dividends. In Crescent Resources, the language could have been stronger, but it wasn’t really surprising that an insider who had received large transfers prior to bankruptcy would be sued.

While the Court found that the Crescent language was sufficient, it would have been stronger if it had referred to “Causes of Action arising under chapter 5 of the Bankruptcy Code, including those actions which could be brought by the Debtor under §§542, 543, 544, 545, 547, 548, 549, 550, 551, 552 and 553 which may be brought against any entity receiving a transfer from any of the Debtors during the four years prior to bankruptcy, including but not limited to insiders, employees, officers, and equity holders of the Debtors.”

Diocese of Milwaukee Seeks Chapter 11 Protection From Sexual Abuse Claims

The Diocese of Milwaukee filed a petition for chapter 11 relief on January 4, 2011 after twenty years of dealing with sexual abuse claims and an unfavorable ruling on its insurance coverage. In re Diocese of Milwaukee, Case No. 11-20059 (Bankr. E.D. Wisc. 1/4/11). Milwaukee is the eighth U.S. Catholic Diocese out of 194 to seek bankruptcy protection as the result of sex abuse claims. The Catholic Diocese bankruptcies illustrate how bankruptcy can help to resolve complex social problems as well as mere contractual disputes.

The Diocese bankruptcies share several common factors.

1. They are precipitated by overwhelming tort claims involving horrific crimes perpetrated by persons in positions of authority. According to the Diocese of Milwaukee, "A tragedy that runs contrary to every teaching and tradition of the Church has unfolded in the Church as a whole and in the Archdiocese in particular: a small number of clergy and others took advantage of their positions of trust and respect in the community to sexually abuse children. ("The Abuse")." The website of the Archdiocese lists 44 priests who have "substantiated reports of abuse of a minor." Whether this is a "small number" can be debated.

2. Many of these incidents happened a long time ago. Of the 44 priests listed on the website, 17 are deceased. According to the Archdiocese, it took formal steps to address the abuse problem in 1989. According to published reports in other cases, much of the abuse dates back to the 1950s and very little has occurred since the 1980s.

3. The financial cost of the tort claims is substantial. According to the Archdiocese, it had incurred costs of $29,564,678 based upon claims resulting from abuse of a minor as of June 30, 2010. There are currently claims from 17 plaintiffs pending with another seven who have given notice.

4. The Catholic Diocese bankruptcies pose a perplexing social problem. Who should pay for the abuse? Almost half of the priests who committed the abuse are deceased. The Diocese itself is an artificial entity. It is dependent upon the 657,519 registered Catholics for its income. It employs 177 persons, many of whom are engaged in good works. How do you apportion the blame for at least 24 persons who may have been wronged among 657,519 registered Catholics and 177 employees, many of whom were not even born when the abuse took place?

5. Chapter 11 provides a structure for resolving the claims. Claimants must come forward within a reasonable period of time so that claims do not continue to show up decades later. Assets can be mobilized to pay claims. In the case of the Archdiocese of Milwaukee, the courts have absolved their insurance carriers and the Archdiocese claims that the assets of individual parishes are held in separate corporations. As a result, donations from the faithful are the most likely source of compensation to the victims. On the one hand, it is horribly unfair. Parishioners who had no complicity in the abuse must voluntarily pay for its consequences. On the other hand, it is at least somewhat fair. The faithful take responsibility for their shepherds. If the clergy betray the faithful, the faithful have an obligation to make it right. Therein lies the dilemma. The faithful didn't cause the problem. The faithful don't have unlimited resources. How do you strike a balance between the interest of those who have faced horrific wrongdoing and those have committed no wrong? Chapter 11 provides a framework for answering these questions.

IRS Loses Out on Inheritance Bait and Switch

While the government has many powers, the Fifth Circuit recently decided that the IRS had no remedy when proceedings in a Louisiana state court deprived it of the benefits it was supposed to receive under a confirmed chapter 11 plan. The opinion can be found here. United States v. Lewis, No. 08-30964 (5th Cir. 10/1/09).

When Caroline and Nelson Hunt filed chapter 11 in the 1980s, they owed over $100 million in non-dischargeable taxes. As part of their plan, they agreed that any inheritance received by Caroline would go to the IRS. Caroline was the niece of Turner Hunt Lewis, who was in his 70s, childless and intestate at the time. This meant that if he died, his estate would be divided between his three nieces and nephews. His estate was ultimately worth $16.5 million.

However, when Mr. Lewis was on his deathbed some 13 years later in 2002, his nephews petitioned the state court in Louisiana for an inderdictment, which is like a guardianship. With the approval of the Louisiana court, they created a trust in which the share of the estate which would have gone to Caroline went to her children. The nephews acknowledged that they did this with Caroline's blessing for the purpose of keeping her share out of the hands of the IRS. The IRS was not given any notice of the proceedings.

Some years later, the IRS sued in federal court to set aside the trust. The District Court granted summary judgment against the IRS. In an unusually brief and blunt published opinion, the Fifth Circuit dispensed with the government's contentions.

The effect, and presumably the intent, of this course of action was to pass the estate to family who had no such tax obligation. Its legality is challenged here. The government has filed this federal suit claiming that the curators’ course of action was in fact contrary to Louisiana state law and that we should protect its rights by striking down the trust provision in favor of Caroline’s descendants and awarding Caroline the money she should have inherited, to be remitted to the I.R.S. according to the 1989 agreement.

We confess the considerable difficulty of understanding the basis under which this claim proceeds. In answering this question, we note what the United States has not alleged. The United States has not argued that any party committed tax fraud or violated any other specific internal revenue law with relation to the Turner Hunt Lewis Trust. The United States does not argue that Caroline or Nelson Hunt violated their agreement with the I.R.S. In essence, the government asks that we sit as a general court of review for a seven year old Louisiana district court trust law decision because it has the ultimate effect of redirecting the path of funds to a path beyond the reach of the federal government.

But the government has no claim to money that Caroline Hunt did not inherit, and the state court judgment decided no right of the government. Rather, it decided the authority of Lewis’s representatives to dispose of his property. Had Turner Hunt Lewis omitted Caroline Hunt from his will, the government would have had no recourse. His representatives did omit her. If their decision was effective, the matter ends. And a solemn judgment of a Louisiana state court with jurisdiction over the interdiction approved the omission of Caroline Hunt and is unchallenged. We see no reasoned basis for our authority to review that judgment and the I.R.S. offers none.

The government’s creditor relationship with the interdiction and state court judgment raises questions of standing and failure to state a claim. These issues are here not easily disentangled. Congress has given the I.R.S. access to federal courts to collect taxes, and – while this case pushes the outer limits of that license – we will reach the merits and affirm the district court’s rejection of the government’s claim. Ultimately, the government is unable to demonstrate any entitlement to the disputed moneys by virtue of its contract with Caroline Hunt.

Memorandum Opinion, pp. 3-4.

A concurring opinion noted that under Louisiana law, an affected party could have sought annulment of the judgment within one year of discovery if it was obtained through "ill practices." Having failed to utilize the remedy created by state law, the government was without a remedy in federal court.

The opinion is remarkable in that the Fifth Circuit panel chose to publish an opinion whose discussion did not cite any cases, statutes or rules (although the concurrence did reference the Louisiana annulment procedure). This could be seen as a public rebuke to the government both for pursuing a meritless claim and for failing to protect its interest.

While the precedential value of this opinion is minimal, it offers several practical lessons. The first is that state court judgments matter. Far too many debtors wait until after an adverse judgment has been rendered to seek bankruptcy relief. By that time, it may be too late. Once a judgment has been rendered in state court, it can only be challenged in state court no matter how badly it smells. The second lesson is to be careful in drafting plans and agreements. In this case, the expectation was that Caroline would receive an inheritance which would go to the government. However, there were many ways that expectation could have been thwarted. Caroline could have predeceased her rich uncle, he could have prepared a will excluding her or he could have lost the money in a casino. The fact that the nephews used a suspect, last minute move to divert the inheritance did not change the fact that the original promise was rather illusory to begin with.

Texas Chapter 11 Filings Continue to Soar

Texas chapter 11 filings continue to soar, with second quarter 2009 filings nearly triple the level from the same quarter in 2008. Filings in each of Texas's four districts were greater than in any of the previous five quarters.

Statewide, there were 430 new chapter 11 cases filed from April 1, 2009 to June 30, 2009. During the same period in 2008, there were only 152 cases filed.

Leading the state was the Western District of Texas with 176 new chapter 11 cases. This contrasts with less than 20 filings per quarter in each of the first three quarters of 2008. The Western District numbers were boosted by the filing of 121 cases related to Crescent Real Estate. However, when these cases are backed out, the Western District still had 55 additional cases, which would be a recent high for the district.

To place the Western District of Texas numbers in perspective, the Clerk's office has a summary of annual filings since 1993. See here. During the period from 1993 to 2008, the Western District had a low of 79 chapter 11 cases in 2006 and a high of 246 in 1993. In one day, the Western District had more chapter 11 filings than for the entire years of 1999, 2000, 2005, 2006, 2007 and 2008. The 228 cases filed during the first half of 2009 are greater than any year's annual totals except for 1993 when there were 246 filings. However, this record will likely be eclipsed by the end of the year.

The Northern District of Texas followed with 134 cases compared to just 57 during the same quarter of 2008. The Southern District of Texas reported 93 new chapter 11s, while the Eastern District of Texas had 27 new cases.

Chapter 11 in Texas: Introduction to the 2008 Cases

Enron filed in the Southern District of New York. However, there are still chapter 11 cases being filed in Texas. During 2008, there were a total of 701 chapter 11 cases filed in Texas. This will be the first of a series of posts examining the Class of 2008. In future posts, I hope to look at who filed, who represented them and how many were successful.

Where Do Texas Chapter 11s File?

In this post, I will look at something more basic: where did the cases file. The answer is that more chapter 11 cases are filed in big cities than in small towns. While there is nothing surprising about the fact that more chapter 11s were filed in Dallas or Houston than in Lubbock, it is interesting that some large metropolitan areas attract a disproportionate number of cases.

The cases were distributed among the four districts of Texas as follows:

Southern District of Texas--271
Northern District of Texas--249
Western District of Texas---102
Eastern District of Texas----79

Of the cases filed in Texas, 663 originated within Texas and 38 were filed by out of state debtors. During 2007 (which is the most recent year available), the population of Texas was 23,904,380. That means that on average, there was one chapter 11 filed for every 36,055 residents. However, that does not mean that every county with at least 36,055 residents could claim a chapter 11 of their very own. Indeed, some 29 counties with at least this much population, including Midland and Taylor did not have any cases. Instead, the cases were skewed toward the larger counties.

The 20 largest counties gave rise to 589 filings for an 89.7% share of the total cases originating from Texas. These counties only contain 71% of the state's population. Thus, it appears that the large counties get a disproportionately large share of the filings compared to the state at large. This is not true across the board. The county with the lowest ratio of residents to filings was humble Camp county. This county had seven filings (all related to Pilgrim's Pride) and a population of 12,557 for a rate of one chapter 11 case for every 1,794 residents.

When the filings per population are compared between the 20 largest counties, there is a definite bias in favor of the Dallas/Fort Worth and Houston megaplexes.

The term Ch.11PP refers to Chapter 11 cases filed per population. A low number means that more cases were filed than would be predicted by the population, while a high number indicates the reverse.

While there is not a complete correlation, counties in the D/FW and Houston area, including Collin, Dallas, Denton, Harris and Tarrant, a a lower Ch.11PP rate (meaning had more cases than would be predicted strictly by population) than the rest of the state. However, some of the outlying counties in the Houston megaplex, including Fort Bend, Montgomery, Brazoria and Galveston counties, had fewer cases than would be expected. The border counties did not show a clear trend. Webb and Cameron counties had higher filing rates, while El Paso, Bexar and Hidalgo counties were in the bottom group. Rounding out the less than expected group were Travis, Nueces, Jefferson and Bell Counties (although Travis was just about average, one of the rare occasions that designation will be applied to the capital of Keeping It Weird).

Why?

Why do cases flock toward some localities and avoid others? Access to judges may be part of the answer. Harris County has four resident judges, while Dallas county has three. On the other hand, Lubbock County, Jefferson County and El Paso County all share judges with other divisions. However, this does not explain Bexar County, which has two resident judges but a low filing rate. Access to the chapter 11 bar may be a factor. Many of the counties which had lower rates of filings were outliers from major metropolitan areas. Montgomery, Fort Bend, Brazoria and Galveston Counties are all part of the Houston megaplex with lower than expected filing rates. If most of the chapter 11 lawyers are located in Houston, individuals and small businesses in outlying areas might be deterred from hiring a lawyer in the big city. Another possibility may be that the types of business prevalent in an area might influence the filing rate. For example, areas with high amounts of agriculture (Lubbock, Nueces) seem to be lower in filings. Suburban areas have very inconsistent results, with Denton, Collin and Williamson Counties ranking high and Ft. Bend, Montgomery and Brazoria counties ranking low.

If you would like a copy of the chart which is easier to read, please send an email to ssather@bnpclaw.com.

Coming Attraction

The next installment of the Class of 2008 will look at the flameouts, the cases that were dismissed or converted in the first 90 days. Although I have not done the research yet, I suspect that paying the filing fee in installments may be an indicator that a case is on rocky ground. I am amazed at just how many cases there are in this category.

When Is a Small Business Debtor Not a Small Business Debtor?

One of the changes that the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made to small business bankruptcy cases was to eliminate the ability to opt in to treatment as a small business debtor. However, it appears that the Bankruptcy Rules may have given back the option which Congress intended to take away.

Under the 1994 bankruptcy reform legislation, special provisions for small business debtors were created. However, debtors were given the option to elect whether to be considered as a small business debtor and few did. The National Bankruptcy Review Commission recommended that this option be removed, stating:

The Commission recommends that choice of treatment as a "small business" debtor under the Bankruptcy Code should not be optional. If as a policy matter, Congress decides that small business debtors merit special treatment under the Bankruptcy Code, all debtors who meet the definition of "small business" should be subject to the same special track. Otherwise, the separate track will not likely be used.

Report of the National Bankruptcy Review Commission, Sec. 2.5.1.

BAPCPA added a new definition of "small business debtor" to the Bankruptcy Code. Under Sec. 101(51D), a debtor was a small business debtor if: (i) it was a person engaged in commercial or business activities (ii) but not a person whose primary activity was the business of owning or operating real property (iii) that has aggregate noncontingent liquidated secured and unsecured debts as of the date of the petition or the date of the order for relief in an amount not more than $2,000,000 (which has been adjusted for inflation to $2,190,000) and (iv) for which a creditor's committee has not been appointed or is not sufficiently active and representative to provide effective oversight of the debtor. Under this definition a debtor either is or is not a small business debtor. There is no choice in the matter.

If a person is a small business debtor, it is subject to added scrutiny designed to weed out nonviable cases. 11 U.S.C. Sec. 1116. It is also subject to more flexible provisions for proposing and confirming a plan. A small business debtor has an exclusivity period of 180 days (as compared to just 100 days for a small business debtor under the prior law). 11 U.S.C. Sec. 1121(e)(1). However, the outside date for any party to file a plan is 300 days. 11 U.S.C. Sec. 1121(e)(2). The debtor is allowed to file a combined plan and disclosure statement and receive conditional approval of its disclosures, thus eliminating the need for a separate disclosure statement hearing. 11 U.S.C. Sec. 1125(f). However, the plan proponent must obtain confirmation of a plan within 45 days after filing. 11 U.S.C. Sec. 1129(e).

Thus, the small business debtor provisions offer a series of carrots and sticks which are intended to be mandatory. However, Fed.R.Bankr.P. 1020(a) brings the right to elect in through the back door. Under this Rule, "the debtor shall state in the petition whether the debtor is a small business debtor." The U.S. Trustee and creditors may object to this statement within 30 days after the conclusion of the creditors' meeting. However, "the status of the case with respect to whether it is a small business case shall be in accordance with the debtor's statement . . . unless and until the court enters an order finding that the debtor's statement is incorrect."

Thus, a debtor can make an election not to be treated as a small business debtor by checking the wrong box and hoping that no one objects. One of the reasons that Congress eliminated the small business election was the perceived apathy of creditors in these cases. However, the provision in the rules allows debtors to make an incorrect designation and count on creditor apathy to allow it to pass unnoticed.

However, the fact that the debtor has a de facto election does not mean that the debtor can change status at will. In the case of In re Save Our Springs (SOS) Alliance, Inc., 393 B.R. 452 (Bankr. W.D. Tex. 2008), a debtor designated itself as a small business debtor. The debtor was arguably not eligible to be a small business debtor because it was an environmental advocacy group, which likely would not fall within the definition of a person engaged in commercial or business activities. The debtor proposed a plan which was hotly contested. By the time that the court denied confirmation, the debtor was beyond its 300 day window for proposing a plan. The debtor then amended its petition to revoke its designation as a small business debtor. The court found that having received expedited treatment based on its designation as a small business debtor, the debtor was judicially estopped to say that it wasn't. As a result, the court dismissed the case.

However, an incorrect designation may be corrected. In a case where I am involved, the debtor's previous counsel failed to check the box to indicate small business status. The debtor then proposed a combined plan and disclosure statement within the 300 day window given to a small business debtor. When the court noted that the debtor had not designated itself as a small business debtor, I filed a motion to designate the debtor as a small business debtor which the court granted. The difference in my case was that the debtor had never tried to obtain a benefit from not being a small business debtor and indeed had acted as if it were one from the beginning of the case. (Of course, it probably also helped that the designation in my case really was incorrect).

Thus, the small business election lives on in a practical sense, but is subject to challenge.

Texas Chapter 11 Filings Double

Chapter 11 filings are a good indicator of how the economy is doing as well as the market for bankruptcy lawyers. If the latest filings are any indication, Texas bankruptcy lawyers are going to be very busy. In the first quarter of 2009, chapter 11 filings doubled over their level from the same time during 2008. During the first quarter of 2009, 259 cases were filed statewide compared to 129 the previous year. Over the first three quarters of 2008, filings fell within a lackluster range of 128 to 152 per quarter or about 50 cases per month. In the fourth quarter of 2008, filings jumped to 213 and then increased again in the first quarter of 2009.

When I have more time, I will look at the types of entities filing (i.e., real estate, health care, etc.) and the size of the filings (small business debtors to mega-cases).

Fourth Catholic Diocese Files Chapter 11

This week the Diocese of Davenport filed for chapter 11 protection in the Southern District of Iowa (Case No. 06-02229). At least three other Catholic Dioceses have filed for chapter 11 protection in response to sexual abuse lawsuits. Each of the three other cases was filed during 2004. Of the prior cases, the Roman Catholic Church of the Diocese of Tucson has successfully confirmed a plan (although that order is under appeal), while the cases for the Roman Catholic Archbishop of Portland and the Catholic Bishop of Spokane are pending with competing plans. Together, the four dioceses serve nearly 900,000 parishioners.

The Difficult Dynamic

The Catholic Diocese cases present an unusual dynamic for a chapter 11 case.

(1) The cases were prompted by waves of sexual abuse tort claims dating back decades. In each instance, the case was precipitated by sexual abuse tort claims. The underlying acts of abuse occurred anywhere from the 1930s to the 1980s. However, the lawsuit claims did not emerge until the late 1990s and early 2000s. Although several of the dioceses were able to settle an initial wave of cases, they found more cases coming out of the woodwork as publicity spread and claims averaged in the millions. As a result, the dioceses could not determine how many claims would ultimately be filed and could not rely upon insurance and current assets to resolve claims as they came in.

(2) The cases created a conflict between the betrayed and the faithful. The bad acts were performed by a limited number of bad actors (approximately 15 in the Spokane case) and were allegedly covered up by a finite number of persons in positions of authority. However, it was not possible to get justice from the bad actors and their facilitators, some of whom were already dead themselves. Instead, the major liability would be borne by the dioceses and their insurance companies. The insurance companies, many of whom were defending under a reservation of rights, were able to limit their exposure through their contracts. That left the dioceses themselves holding the final liability. However, a diocese is nothing more than the current and accumulated contributions of the faithful. As a result, the current faithful were in a position of having to pay for the sins of their church. This conflict between the faithful and the betrayed was especially apparent in Spokane and Portland where the courts ruled that property used by the parishes was owned by the dioceses rather than the individual congregations.

The challenge for the Catholic Dioceses and the lawyers for the tort claimants was to find a solution which would provide compensation and vindication to those who had been sexually abused without so alienating the parishioners that they lost faith and allowed the diocese to collapse.

A Learning Process

The Catholic Dioceses appear to be learning from experience. The Portland case, which was the first filed, was marked by acrimony from day one. While first day motions are normally routine, one pro se creditor objected to a motion to maintain cash management systems on the ground that the church should not be allowed to use a bank with Catholic officers due to the potential for conflict of interest. In the subsequent cases, the first day motions were used as a vehicle to tell the Diocese's story with descriptions of the historic background of the diocese, the ministries provided, the persons served and the church's response to the sexual abuse crisis. The first day motions in the recent Davenport case show a remarkable similarity to those in the Tucson and Spokane cases.

In the Portland case, the Debtor did not file a plan for sixteen months (by which time it was docket entry #2389) and drew a competing plan shortly thereafter. However, in the Tucson case, the Debtor filed a plan on the first day of the case, which was ultimately confirmed.


In the Portland and Spokane cases, the Debtor was faced with adversary proceedings determining that parish properties were property of the estate. In the Tucson and Davenport cases, the Debtor entered the case with a position as to why the parish properties were not included in the estate.

Based on a review of the lengthy docket in the Portland case, it appears that every issue that could be committed to paper and litigated was. In at least the Tucson case, the process appeared to be more focused and battles were chosen more selectively.

A Note About Fees

One feature common to all of the Catholic Diocese cases has been the relatively low billing rates charged by Debtor's counsel. The rates charged by principal counsel include $200 per hour in Spokane, $230 per hour in Davenport, $300 per hour in Tucson and $325 per hour in Portland. This contrasts with the eye-popping rates of $500-$600 per hour starting to appear in some large cases. Perhaps the church lawyers realized that there was already plenty that would appear obscene in their cases without obscene billings.