A Guest Post by Yitzhak Greenberg: "Deeper into the Darkling Abyss: The 5th Circuit joins the 6th and 7th Circuits in Finding that Consent Cannot Cure A Bankruptcy Court's Stern Infirmity"

Blogging has enabled me to meet many people I otherwise likely would never have met.  On such person is Yitzhak Greenberg, a bankruptcy attorney in New York City who clerked for Judge Arthur Gonzalez and whose practice is focused on all aspects of bankruptcy (including the representation of both debtors and creditors).  Yitzhak is passionate about contributes to the advancement of our understanding of complex bankruptcy law issues.  Among other things, he has written for The Bankruptcy Strategist and the Norton Bankruptcy Advisor and has participated in panels sponsored by the PLI and Law Journal Newsletters.  He can be reached at YitzhakGreenberg@gmail.com or YGreenberg@bgandg.com.

Yitzhak has long taken an interest in the bankruptcy jurisprudence expounded by the US Supreme Court.  His discussion in the July 2011 issue of the Norton Bankruptcy Advisor, entitled Credit Bidding After Philadelphia Newspapers: The Fat Lady Has Not Sung, merited citation by the Radlax petitioner in its opening merits brief on the subject of credit bidding.

Yitzhak now graciously offers, through this guest post, an analysis of whether a bankruptcy court can enter a final order in a Stern proceeding with the parties' consent.  Yitzhak shows that the seemingly obvious answer is anything but.  His discussion is a good preview of the issues that the Supreme Court will address this coming term in Bellingham (see also Weil Bankruptcy Blog for further background into case).  

The famed Professor Karl Llewellyn equated the study and practice of law to the boy in the nursery rhyme who jumps into a bramble bush, thereby scratching out his eyes, and then summons "all his might and main" to jump into a second bush, thereby having them scratched back in.  Yitzhak in this guest post offers "a modest proposal" out of the bramble bush through amendments to the local district courts' standing orders of reference.  Still, even if Courts were to adopt Yitzhak's proposal, thereby avoiding further needless brain damage on the issue, the Supreme Court will rule on the issue, thus allowing us to both have the bramble bush and eat it (as suggested by John Heywood in his book of proverbs in 1546).

Special thanks to Yitzhak for offering to share his wisdom with readers of this blog.  My blogging has been a definite casualty of a busier work schedule and pretty mischievous twin boys (now five years older than in this post).  I hope Yitzhak's second guest post (first one on "Stub Rent") encourages other guest post submissions (and his return).  With total page views on the blog to date at over 750,000, it's a good way to hit one's target audience.

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US Supreme Court's Decision in Bullock: A Significant Development in Determining "Recklessness" Under Federal Law?

Last week I published a blog post on the US Supreme Court's unanimous decision in Bullock v. BankChampaign, N.A., No. 11-1518 (May 13, 2013) (pdf), that focused on the Court's application of the noscitur a sociis canon to the bankruptcy nondischargeability statute dealing with "defalcation in a fiduciary capacity."

I write this second blog post discussing Bullock because I think the case will prove especially noteworthy for those who deal with the concept of "recklessness" in their civil practice.  

Professor Ann Morales Olazábal authored an article entitled Defining Recklessness: Doctrinal Approach to Deterrence of Secondary Market Securities Fraud, 2010 Wis. L. Rev. 1415, in which she looked at attempts to define "recklessness" in tort, criminal, patent, securities, and employment law (among others) and concluded that "the single common thread among the recklessness standards employed in this mixed bag of legal inquiries may be their opacity and lack of susceptibility to any kind of uniform application."  Id. at 1422.  In the federal securities context, she writes, "[a]s in other legal arenas, recklessness in the 10(b) context has nowhere been defined serviceably or with any real consistency."  Id. at 1424.

In What Is Securities Fraud?, 61 Duke L.J. 511, 534-36 (2011), Professor Sam Buell wrote that courts in the securities law context differ on whether recklessness should be defined by a "conscious disregard" or a "super-negligence" standard:

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US Supreme Court Deciphers "Defalcation" in Bullock: A Canonical Exercise in "Reading Law" (Scalia/Garner)

The US Supreme Court has long taught the importance of certain canons of interpretation unique to bankruptcy law, the more significant ones being:

  • The Fresh-Start Policy:  A primary purpose of bankruptcy is to relieve the debtor "from the weight of oppressive indebtedness and permit him to start afresh...." (Local Loan Co. v. Hunt, 292 U.S. 234, 244 (1934).
  • Equality of Distribution:  "[H]istorically one of the prime purposes of the bankruptcy law has been to bring about a ratable distribution among creditors of a bankrupt's assets...."  Young v. Higbee Co., 324 U.S. 204, 210 (1945); Union Bank v. Wolas, 502 U.S. 151, 161 (1991).  "Any doubt concerning the appropriate characterization [of a bankruptcy statutory provision] is best resolved in accord with the Bankruptcy Code's equal distribution aim."  Howard Delivery Serv., Inc. v. Zurich American Ins. Co., 547 U.S. 651, 667 (2006) (discussed at length in this blog post).
  • Narrow Construction of Priority Provisions:  Canon favoring equality of distribution gives rise to a "corollary principle that provisions allowing preferences must be tightly construed."  Howard Delivery Serv., Inc. v. Zurich American Ins. Co., 547 U.S. 651, 667 (2006).
  • Narrow Construction of Exceptions to Discharge:  "[E]xceptions to the operation of a discharge ... should be confined to those plainly expressed."  Gleason v. Thaw, 236 U.S. 558, 562 (1915).  This furthers bankruptcy's policy of achieving a "fresh start."  Kawaauhau v. Geiger, 523 U.S. 57, 62 (1998). 
  • Significance of Past Bankruptcy Practice:  "[Do] not read the Bankruptcy Code to erode past bankruptcy practice absent a clear indication that Congress intended such a departure."  Pennsylvania Dept. of Public Welfare v. Davenport, 495 U.S. 552, 563 (1990).

  • Property Rights in Estate Assets Dependent on State Law:  "Property interests are created and defined by state law.... Unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding."  Butner v. United States, 440 U.S. 48, 57 (1979).

  • Creditors' Rights Dependent on State Law:  "What claims of creditors are valid and subsisting obligations against the bankrupt at the time a petition in bankruptcy is filed is a question which, in the absence of overruling federal law, is to be determined by reference to state law."  Vanston Bondholders Protective Comm. v. Green, 329 U.S. 156, 161 (1946).

Last year, Justice Scalia and Professor Bryan Garner published a phenomenal book, Reading Law: The Interpretation of Legal Texts.  Many know of Justice Scalia, though he's probably at the low end of the already (unfairly) historically low favorability rating for the Supreme Court.  Many fewer know of Professor Garner, but if you're not his fan, you should be.  He's prolific beyond words, which are his specialty (and as to which he has no modern equivalent).  His writings include: Garner's Modern American Usage, Legal Writing in Plain English, Garner's Dictionary of Legal Usage, and The Winning Brief, each one of which should be on your bookshelf.  He also has been the Editor-in-Chief of Black's Law Dictionary since 1995.  Follow Professor Garner on Twitter and learn, among other things, of the latest smiling antiquarian bookseller whose shelves he recently raided.  Before Reading Law, Justice Scalia and Professor Garner published an invaluable guide to litigators entitled, Making Your Case: The Art of Persuading Judges (2008). 

In the book's introduction, Chief Judge Easterbrook called Reading Law "a great event in American legal culture."  Judge Posner, however, wasn't quite as enamored with it, which apparently got a bit under Justice Scalia's skin, prompting this retort from Judge Posner.  (All seems well now, however, as Judge Posner was placed at the same table as Justice Scalia at last month's Chicago Lawyers' Club luncheon event promoting the book, though as fate would have it Justice Scalia's plane was late, so we'll never know how that seating arrangement would have worked out.) 

The book cites to 57 interpretive canons (split among 5 "fundamental principles," 11 "semantic" canons, 7 "syntactic" canons, 14 "contextual" canons, 7 "expected-meaning" canons, 3 "government-structuring" canons, 4 "private right" canons, and 6 "stability" canons) and concludes by "exposing" 13 far more controversial "falsities" (such as "the false notion that committee reports and floor speeches are worthwhile aids in statutory construction").  It also contains the best bibliography imaginable of over 1,500 books and articles on legal interpretation dating back as early as 1621 (Coke's First Part of the Institutes of the Laws of England) and 1677 (Hatton's Treatise Concerning Statutes).

The Supreme Court's recent unanimous decision in Bullock v. BankChampaign, N.A., No. 11-1518 (May 13, 2013) (pdf), which was decided primarily based on the book's Canon No. 31, the "Associated-Words Canon" (better known as noscitur a sociis--"it is known by its associates"), highlights the importance of keeping Justice Scalia's and Professor Garner's book close at hand.  In describing how this canon works, Justice Scalia and Professor Garner call it "a classical version, applied to textual explanation, of the observed phenomenon that birds of a feather flock together."  They further explain:

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The Mass of Contradictions that Define "Bad Boys" in Sports, Art, Life, and the Law

The phrase “bad boys” is one that conjures up a multitude of contradictory connotations. In sports, the Detroit Pistons wore the moniker proudly as they pummeled their way to consecutive NBA championships. Those bad boys, however, are long gone and now the same team is just plain bad

In art, Jerry Bruckheimer produced “Bad Boys” in 1995 and “Bad Boys II” in 2003, starring Will Smith and Martin Lawrence as bad boy Miami detectives. These likeable actors, however, failed to convey much of a bad boy image and critics panned the movies. Not deterred, a third installment, “Bad Boys III,” is scheduled for 2015, but it too (like "Die Hard 5") is likely to disappoint.

In life, John Alleman had become a Las Vegas sensation. Starting in about June 2011, he stood outside the Heart Attack Grill for nothing more than the love of the place (and some occasional free food) and colorfully pitched and cajoled people to sample such delicacies as Flatliner Fries, Butterfat Shakes, and the king-of-them-all, the Quadruple Bypass Burger (which holds the Guinness World Record for the “most calorific burger”). Late last year, this bad boy suffered a massive heart attack at a bus stop and died, thus ending his short—but glorious—reign as Sin City’s leading tempter of fate.

In the law, bad boys often find they pay a hefty and quite disproportionate price for their bad acts. Consider, for example, the case of Michael Turner. This bad boy received a $40,000 insurance settlement check three days before he filed bankruptcy and then cashed the check three days after he filed bankruptcy, using about one-quarter of the proceeds to pay down a mortgage while pocketing the rest.  His failure to disclose this asset in his bankruptcy schedules, as mandated by the Code, led a grand jury three years later to return a six-count indictment against him that eventually resulted in a bankruptcy fraud conviction and a 27 month jail sentence.  The 11th Circuit recently upheld his sentence as appropriate under today’s harsh federal sentencing guidelines. United States v. Turner, 2013 WL 510092 (11th Cir., Feb. 12, 2013) (PDF).

Some bad boys, however, manage to avoid the cudgel of the law by seizing onto a loophole that averts near certain doom. Consider, for example, bad boy Bernie Kurlemann, whose bank fraud conviction was reversed because the statute only criminalizes “false statements.”  Since he kept his mouth shut and told only half the truth, the court ruled, he couldn’t be convicted under a statute that does not criminalize “half-truths,” “material omissions,” or “concealments.”   United States v. Kurlemann, 2013 WL 513976 (6th Cir., Feb. 13, 2013) (PDF). True, Kurleman was still convicted on bankruptcy fraud charges, but that paled in comparison to the time he would have served had the bank fraud conviction been upheld.

Finally, consider so-called "bad boy" bank guaranties, where one’s personal liability to a lender is instantly multiplied from a fraction of the loan amount to the full indebtedness simply because one engaged in any one of various enumerated “bad acts” (such as waste, fraud, misappropriation, bankruptcy, receivership, violation of special purpose entity covenants, or incurrence of subordinate debt without the lender's consent). Here in Illinois, bad boy Laurance Freed, developer of the long-vacant “Block 37” on North State Street in Chicago, committed such a bad boy act when he had the temerity to contest the bank’s appointment of a receiver and file defenses to the bank’s foreclosure action. Though the ensuing delays were but a mere nuisance for the bank, that didn’t stop the Illinois Appellate Court from affirming that (i) Freed’s nominal challenges to the bank’s actions triggered the full $206 million recourse liability (up from $50 million) and (ii) the increase was not wholly disproportionate to the damages suffered by the bank from having to deal with the nuisance litigation and so was not an unenforceable penalty. In sum, the Court held, if you’re a “bad boy” under your own contractual definition of one, don’t expect a Court to bail you out of your own mess. Bank of America v. Freed, 2012 WL 6725894 (Ill. App. Ct., December 28, 2012) (PDF).

In conclusion, there’s a clear moral to this story:

Except perhaps in sports and art, being a bad boy can be hazardous to life (RIP Mr. Alleman), liberty (Turner / Kurlemann), and the pursuit of happiness (Freed)!

Thanks for reading!

Copyright Steve Jakubowski 2013

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Chief Judge Easterbrook Writes That Free Market Competition Trumps Equity's Attempted Free Lunch Under the New Value Exception to the Absolute Priority Rule

A 7th Circuit opinion authored by Chief Judge Easterbrook last week had me again looking across the street at 203 North LaSalle and wondering whether the US Supreme Court will ever finally decide whether there is a “new value” exception to the absolute priority rule (which requires that when an unsecured creditor class objects to a plan of reorganization, it must be paid in full before junior claims or interests get anything). 

The question of whether there’s a “new value” exception to the absolute priority rule (i.e., whether old equity can contribute new capital and receive new equity interests in the reorganized entity) was expressly left open by the US Supreme Court in Bank of America National Trust & Savings Ass'n v. 203 North LaSalle Street Partnership526 U.S. 434 (1999).  Before the case went to the Supreme Court, the 7th Circuit ruled in 203 N. LaSalle  that the oft-ignored decision in Case v. Los Angeles Lumber Products Co.308 U.S. 106 (1938), provided the basis for the new value exception in cases where the equity interest holder contributes new value that is both reasonably equivalent to the value of the equity interest and necessary for the debtor’s successful reorganization.  In re 203 N. LaSalle St. P’ship, 126 F.3d 955 (7th Cir. 1997).  While refusing to specifically endorse a new value exception or “corollary” to the absolute priority rule, the Supreme Court in 203 N. LaSalle held: “[A]ssuming a new value corollary [exists], [then] plans providing junior interest holders with exclusive opportunities free from competition and without benefit of market valuation” violate the absolute priority rule.”  203 N. LaSalle, 526 U.S. at 458.

In In re Castleton PlazaNo. 12–26392013 WL 537269 (7th Cir. Feb. 14, 2013), the 7th Circuit Court of Appeals faced an issue never before addressed by a Court of Appeals, that being whether “an equity investor can evade the competitive process by arranging for the new value to be contributed by (and the new equity to go to) an ‘insider’ [as defined in the Bankruptcy Code]”?  The 7th Circuit found no difficulty in answering this question with a resounding “NO”!  Notably, instead of chopping through the bramble bush of nuanced statutory interpretation, the Court's opinion relied principally on broad bankruptcy policy objectives.  The Court stated:

In 203 North LaSalle the Court remarked on the danger that diverting assets to insiders can pose to the absolute-priority rule.  526 U.S. at 444.   It follows that plans giving insiders preferential access to investment opportunities in the reorganized debtor should be subject to the same opportunity for competition as plans in which existing claim-holders put up the new money….

Nor does the rationale of 203 North LaSalle depend on who proposes the plan. Competition helps prevent the funneling of value from lenders to insiders, no matter who proposes the plan or when.  An impaired lender who objects to any plan that leaves insiders holding equity is entitled to the benefit of competition.  If, as [the debtor and insiders] insist, their plan offers creditors the best deal, then they will prevail in the auction.  But if, as [the objecting secured lender] believes, the bankruptcy judge has underestimated the value of [the debtor’s] real estate, wiped out too much of the secured claim, and set the remaining loan's terms at below-market rates [via cramdown], then someone will pay more than $375,000 (perhaps a lot more) for the equity in the reorganized firm.

The judgment of the bankruptcy court is reversed and the case is remanded with directions to open the proposed plan of reorganization to competitive bidding.

But if the plan was confirmed, how is it that the direct appeal of the plan confirmation order to the 7th Circuit did not get mooted out through substantial consummation of the plan?  Simple.  The parties in this motion stipulated to entry of this order by the Bankruptcy Court, thereby staying the effectiveness of the confirmation order pending resolution of the issue on appeal.  Of course, since the only major creditor in the case was the senior secured lender (with a large unsecured deficiency claim) who was objecting to the plan, it had a lot more flexibility in respect of the bonding requirement necessary to stay the effectiveness of the confirmation order pending appeal.  Indeed, as the Court-approved disclosure statement demonstrates, the secured lender appealing the decision was virtually the only creditor of significance in this single asset real estate case.  As such the lender here really didn’t have much to lose by appealing the order since obtaining a stay of the confirmation order pending appeal likely would not have required it to dig very deep to come up with the funds necessary to post a bond and obtain a stay pending appeal.

Is this decision significant?  You bet, and I expect it to reverberate loudly as time progresses.  Before this decision, creative lawyers could reach into their trick bag and try to evade 203 N. LaSalle’s competitive bidding requirements by arguing that the statute doesn’t apply to “new value” contributors who held no equity interests prepetition.  They then could solicit the support of senior secured creditors and propose a “new value” plan acceptable to the secured lender that would call for “new value” contributions from friendly sources and thereby squeeze value to which the intervening unsecured class would be entitled under the absolute priority rule.  And since unsecured creditors in more complex business reorganizations—unlike secured lenders in single asset real estate cases—generally lack the financial incentive or wherewithal to obtain a stay of a plan confirmation order pending appeal, they are swiftly mooted out in the process, leaving equity to walk away with the value while unsecureds are left “holding the bag” (as our founding fathers were wont to say).

Now, however, with the 7th Circuit’s decision in the books, there’s no authority for filing such plans in the first place (at least in the 7th Circuit, though I expect other Courts and Circuits will follow its lead).  Of course, there’s always the hope that the Supreme Court will take this case up on appeal given how rarely such issues wind their way through the appeals process without getting mooted out along the way.  That was a good reason for the Court to take upRadLAX and is an equally good reason to take up this decision too (particularly since, as the 7th Circuit noted, “[b]ankruptcy judges have disagreed on the answer” to the question posed by the case).

Finally, it’s worth noting how a rather simple and seemingly straightforward Supreme Court decision like the one inRadLAX can never be underestimated.  To the 7th Circuit, RadLAX established a policy directive of “protect[ing] creditors against plans that would give competing claimants too much for their new investments and thus dilute the creditors' interests.”  That’s the first time I’ve seen RadLAX being cited for such a broad policy objective.  It is a principle worth remembering, however, especially when responding to legal gimmickry that attempts to grind Bankruptcy Code provisions like trees in a wood chipper.  Such gimmicks simply won’t carry the day, regardless of their artfulness and basis in principles of statutory construction, where they undermine important policy objectives established in Supreme Court precedent.

Thanks for reading!

©  Steve Jakubowski  2013

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Bankruptcy Tweets of 2011-2012 Cases - A Year in Review - V.9

Here's more in the continuing "Year in Review" series.  The inset photo is of the Senator Thad Cochran United States Bankruptcy Court in Aberdeen, Mississippi (pictures and story here), a 47,000 square foot complex that is home to the Bankruptcy Court for the Northern District of Mississippi, where Bankruptcy Judges Houston and Olack sit.  Last year there were 6,101 total bankruptcy filings in the Northern District of Mississippi.  By way of comparison, the Bankruptcy Court for the Northern District of Illinois--which could probably fit in the lobby of this mammoth structure--had the most filings at 59,093.  Talk about influence! 

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Bankruptcy Tweets of 2011-2012 Cases - A Year in Review - V.8

Here's more in the continuing "Year in Review" series.  Catching up after the long Jewish holiday season.  The inset photo is of the Garmatz Federal Courthouse (story here), home to the Bankruptcy Court for the District of Maryland in Baltimore, where Bankruptcy Judges Alquist, Derby, Gordon, Rice, and Schneider sit.

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Bankruptcy Tweets of 2011-2012 Cases - A Year in Review - V.7

Here's more in the continuing "Year in Review" series.  The inset photo is of the Jacob Weinberger US Courthouse (story here), home to the Bankruptcy Court for the Southern District of California in San Diego, where Bankruptcy Judges Adler, Bowie, Mann, Meyers, and Taylor sit.

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Bankruptcy Tweets of 2011-2012 Cases - A Year in Review - V.6

Here's more in the continuing "Year in Review" series, catching up on more of my backlog of twitter posts of case developments in the past 12 months.

Each post in this Year in Review series features a different federal courthouse in each state of the Union. The inset photo is of the US Courthouse for the Bankruptcy Court for the Northern District of California in Oakland, California, which is home to Bankruptcy JudgesEfremskyHammond, and Lafferty.

 

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Bankruptcy Tweets of 2011-2012 Cases - A Year in Review - V.5

Here's more in the continuing "Year in Review" series, catching up on more of my backlog of twitter posts of case developments in the past 12 months.

Each post in this Year in Review series features a different federal courthouse in each state of the Union. The inset photo is of the US Courthouse for the Bankruptcy Court for the Eastern District of California in Fresno, California, where 28 dairies have filed chapter 11 in 2012, and which is home to Bankruptcy Judges Clement, Ford, Lee, and Rimel.

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