5-4 US Supreme Court Majority Extends a Bankruptcy Court's Power to Curtail a "Bad Faith" Debtor's Seemingly Absolute Rights Under the Code

As noted in my brief post of last week, the US Supreme Court held in a 5-4 decision in Marrama v. Citizens Bank of Massachusetts, No. 05-996 (2/21/07) (pdf / WL) that chapter 7 debtors do not have an absolute right to convert their cases to chapter 13.  So much for the broad consensus for which Justice Roberts is striving.  Not surprisingly, it was Justice Kennedy who cast the deciding swing vote.

Don't throw away the opinion as a useless bit of trivia rarely applicable in practice, though, for the opposing views of the majority and the dissent regarding the scope of the bankruptcy court’s general and equitable powers – a subject that has generated significant academic debate – provide significant food for thought.

By way of background, be sure to read the 2005 article at 79 Am. Bankr. L. J. 1 entitled, The Limited Scope of Implied Powers of a Bankruptcy Judge:  A Statutory Court of Bankruptcy, Not a Court of Equity, where Judge Alan M. Ahart of the Bankruptcy Court for the Central District of California (who was the bankruptcy judge in this messy affair before Judge Real took hold of the reins) argues that the repeal in 1984 of 28 U.S.C. § 1481 stemming from the Supreme Court's Marathon decision divested the non-Article III bankruptcy courts of equitable powers not specifically granted by statute.  To Judge Ahart,

[t]he only situation in which a bankruptcy judge might be compelled to rely on inherent powers is in the functioning of the court itself.  She must have authority to uphold the dignity and integrity of the judicial process.

Would Judge Ahart agree with the majority's extension of the bankruptcy court's "inherent power" to sanction "abusive litigation practices" and thereby enable in this case "a prompt, rather than a delayed, ruling on an unmeritorious attempt to qualify as a debtor under Chapter 13"?  Op. at p. 10 (citing Roadway Express, Inc. v. Piper, 447 U.S. 752, 765, 100 S.Ct. 2455, 65 L.Ed.2d 488 (1980)).  Or would Judge Ahart adopt the narrower views of the dissent, which concluded that "a bankruptcy court's inherent powers may have a role to play in a case such as this, ... [b]ut whatever steps a bankruptcy court may take pursuant to ... its general equitable powers, a bankruptcy court cannot contravene the provisions of the Code"?  Dissent at pp. 7-9 (citing Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 206 (1988)). 

Regardless, both the majority and dissent confirm Judge Ahart's view that a bankruptcy court's inherent powers remain extant at least where necessary to "uphold the dignity and integrity of the judicial process."  (Ahart at p. 6.)  It is the dissent's unwillingness to use a bankruptcy court's inherent equitable powers to override a debtor's apparent absolute right to convert in § 706(a) that distinguishes its view from that of the majority.

Even more significant, however, is the Court's discussion of the breadth and scope of § 105(a).  In summarizing § 105(a)'s function, Justice Stevens wrote on behalf of the majority:

[T]he broad authority granted to bankruptcy judges to take any action that is necessary or appropriate “to prevent an abuse of process” described in § 105(a) of the Code is surely adequate to authorize an immediate denial of a motion to convert filed under § 706 in lieu of a conversion order that merely postpones the allowance of equivalent relief and may provide a debtor with an opportunity to take action prejudicial to creditors.

Curiously, the second sentence of § 105(a) upon which the majority relies does not on its face provide the blanket affirmative grant of authority suggested by the majority.  Rather, this second sentence provides:

No provision of his title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.  (Emphasis added.)

A plain reading of the second sentence of § 105(a) suggests that the bankruptcy court's power to fashion relief "necessary or appropriate ... to prevent an abuse of process" is not unbounded, as suggested by the majority, but limited to instances where the Code or rules permit a particular issue to be raised by a party in interest.  In other words, to prevent an abuse of process, the court can sua sponte summarily take "necessary or appropriate" action to shut down a party in interest notwithstanding a provision in the Code that preserves within that party the right to be heard on the issue.  In effect, the majority read this qualification right out of the Code when it stated:

On the contrary, the broad authority granted to bankruptcy judges to take any action that is necessary or appropriate [**note the missing qualification here**] "to prevent an abuse of process" described in § 105(a) of the Code, is surely adequate to authorize an immediate denial of a motion to convert filed under § 706 in lieu of a conversion order that merely postpones the allowance of equivalent relief and may provide a debtor with an opportunity to take action prejudicial to creditors.  (Op. at pp. 9-10.)

As the following exchange indicates, Chief Justice Roberts seized upon this issue at oral argument, bringing it to a head before respondent’s counsel, Bingham McCutchen's Eric Brunstad, had even finished just the third short sentence of his opening statement to the Court:

Mr. Brunstad:  Mr. Chief Justice, and may it please the Court.  The bankruptcy court need not sit idly by and grant a motion which is part of an abusive scheme.  The power of the court is there to deny such a motion.  It is there by statute under Section 105; it is there because the courts have always had power...

Chief Justice Roberts:  ... You think 105 is an affirmative grant of power?

Mr. Brunstad:  I think the second sentence of 105(a) supports the traditional powers that courts have had to grant relief, to prevent or to deny relief to prevent abuse or to remedy bad faith conduct.  The fact the debtor has the authorization under Section 706 to convert a case cannot be construed to prevent the court from sua sponte taking action to prevent abuse --

Chief Justice Roberts:  105(a) is much more limited than that.  It is only if you take the second clause of that out of context and quote it, as has been done, that it looks like an affirmative grant.  It says: "No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from taking sua sponte other action."  That's a much more limited, narrow provision telling you not to imply a negative predicate from a requirement that a particular party raise an issue [a]s a source of sweeping powers to [b]asically act as a roving commission in equity.  I think that's a mis-citation.

Tr. of Oral Argument at pp 27-28 (emphasis added).

In my view, the majority's willingness to read a 12 word qualifier out of § 105(a) is the hidden nugget of Marrama.  Following the majority's reasoning means that clear rights and directives contained in the Bankruptcy Code can be cast aside where "necessary or appropriate 'to prevent an abuse of process' described in § 105(a) of the Code" by a "bad faith" debtor.

How and when this expanded reading of § 105(a) will manifest itself is unclear, but it is a potent weapon indeed to use against the debtor (or possibly any party in interest) that engages in "atypical" and "extraordinary" "bad faith" behavior (even where the "bad faith" is not directly related to the specific "abuse of process" at issue).  (See Op. at 9 n.11 and Oral Argument Tr. at 44:19-23, where Chief Justice Roberts stated that Marrama is not about "a right to convert in bad faith."  "No one is arguing for that," he said.  Rather, he noted, Marrama is about the "right to convert despite the allegation of bad faith.").

In effect, Marrama may well stand for the proposition that any time a debtor engages in "atypical" and "extraordinary" "bad faith," then seemingly absolute rights granted it under the Code may be abridged should the court find that granting such right "merely postpones the allowance of equivalent relief and may provide a debtor with an opportunity to take action prejudicial to creditors."  Op. at 10.  In the chapter 11 context, one can envision challenges to the right of a "bad faith" debtor (who under § 1121(a) "may file a plan of reorganization ... at any time") to propose or file any plan of reorganization.  Other creative examples abound.

Happy hunting!

2/27/07 UpdateThanks to Todd Zywicki of The Volokh Conspiracy for linking to this post here, where the discussion about the case continues.

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The graphic is adapted from the cover of a 1992 book by Lee Epstein and Joseph F. Kobylka entitled, The Supreme Court & Legal Change: Abortion and the Death Penalty (publ. Thornton H. Brooks Series in American Law and Society) (available here).  According to the book's description at Amazon.com:

The authors analyze abortion and death penalty decisions by the Supreme Court and argue that they provide prime examples of abrupt legal change.  After proposing that the strength of legal arguments has at least as much impact on Court decisions as do public opinion and justices' political beliefs, they focus on the way litigators propel certain issues onto the Court's agenda and seek to persuade the justices to affect legal change.

© Steve Jakubowski 2007

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