Hot Button Issues Before the U.S. Supreme Court: Bankruptcy Now Rules Docket

  Interesting statistic:  a litigant has a 1% or less chance of convincing the U.S. Supreme Court to review his, her or its burning legal issue that all other appellate courts have rejected, dismissed or pooh-poohed.  Don’t believe me? Look here:  http://dailywrit.com/2013/01/likelihood-of-a-petition-being-granted/

    As of today (December 15, 2014), the U.S. Supreme Court has accepted five—count ‘em, five—different bankruptcy issues to hear in its 2014-2015 term.  Depending upon your perspective, this is either like hitting a big-bucks lottery, or suffering the consequences of the old Chinese curse “May everything you wish for come true”.  In addition, the justices have decided, on January 9, 2015, to confer on whether to accept another bankruptcy issue on their docket of cases to hear and decide.

   Here are the five issues that the SCOTUS has agreed to decide, and the one it will consider in mid-January, in no particular order of importance:

1                 11 U.S.C. §506(d) Strip-Offs of Totally Unsecured Second Mortgages in Chapter 7:  At the circuit level, the 11^th Circuit stands alone in permitting Chapter 7 debtors to use §§506(a) and 506(d) to “strip-off” second mortgages when a first mortgage eats up all the value in a residence or other real property.  

    The SCOTUS has accepted certiorari on two 11^th Circuit decisions allowing second mortgage strip-offs: Bank of America, N.A. v. Caulkett, No. 13-1421 (lower court opinion here: https://cases.justia.com/federal/appellate-courts/ca11/14-10803/14-10803-2014-05-21.pdf); and Bank of America, N.A. v. Toledo-Cardona, No. 14-163 (lower court opinion here: http://sblog.s3.amazonaws.com/wp-content/uploads/2014/09/11thcir-toledo-cardona.pdf).

    For a more detailed examination of this issue, see my previous blog posts (on two other 11th Circuit cases denied certiorari) here:  http://impudentbankruptcylawyer.blogspot.com/2014/04/now-in-play-506d-strip-offs-in-chapter-7.html ;  and here: http://impudentbankruptcylawyer.blogspot.com/2014/06/11th-circuit-506d-strip-offs-part-deux.html.

2        Whether an Order Denying Confirmation of a Chapter 13 Plan is an Appealable “Final Order”:  This case originates from the First Circuit. This past spring, the First Circuit dodged the issue of whether a Chapter 13 debtor could propose and confirm a “hybrid” Chapter 13 plan (splitting a secured mortgage claim on underwater property into  “secured” and “unsecured” claims, and continuing paying the stripped-down secured claim after five years), and held instead that the debtor’s appeal  should be dismissed because the bankruptcy court’s order denying confirmation of the debtor’s Chapter 13 plan was not a “final” order for purposes of accepting appellate jurisdiction.

           The SCOTUS accepted certiorari on the First Circuit case, on December 12, 2014: Bullard v. Hyde Park Savings Bank, No. 14-116 (lower court opinion here: http://media.ca1.uscourts.gov/pdf.opinions/13-9009P-01A.pdf).  I examined the First Circuit opinion in my blog post here:  http://impudentbankruptcylawyer.blogspot.com/2014/05/sound-fury-no-hybrid-chapter-13-plan.html.

3        Bankruptcy Court Jurisdiction under Article III of the U. S. Constitution – Third Bite at the Apple:  First, we had Stern v. Marshall, in which the SCOTUS told us that bankruptcy jurisdiction—whether labeled ‘core” or “non-core”—did not extend to a bankruptcy court making final findings of fact or rulings of law on a state law issue that a debtor presents as a permissive (rather than mandatory) counterclaim to a creditor’s filed proof of claim.  The SCOTUS, in the majority opinion, assured us that its ruling was no sea-change to bankruptcy practice and limited in scope.  My previous blog post on Stern v. Marshall is here:  http://impudentbankruptcylawyer.blogspot.com/2012/12/stern-v-marshall-seminar-materials.html.

   Next, we had Executive Benefits Agency  v. Arkinson, in which a unanimous SCOTUS assured us that if a bankruptcy court is confronted with a state law issue masquerading as a “core” issue—such as, in this case, a fraudulent transfer lawsuit—that invokes the specter of Stern v. Marshall,  the bankruptcy court and/or the U.S. District Court may treat the bankruptcy court’s findings and rulings as "proposed”, as they would in a true non-core matter, and no harm would be done. My previous blog post on Executive Benefits Agency  v. Arkinson is here: http://impudentbankruptcylawyer.blogspot.com/2014/06/executive-benefits-insurance-agency-v.html.

   In Executive Benefits Agency  v. Arkinson, Justice Thomas’s opinion conveniently ducked the issue of whether parties who had an Article III objection to bankruptcy court jurisdiction could expressly or impliedly “waive” that objection and allow a bankruptcy court to issue final findings and rulings on the matter.  That issue, like many buried issues, rears its ugly head again in Wellness International Network, Limited v. Sharif, No. 13-935, scheduled for argument in mid-January (lower court opinion here:  http://media.ca7.uscourts.gov/cgi-bin/rssExec.pl?Submit=Display&Path=Y2013/D08-21/C:12-1349:J:Tinder:aut:T:fnOp:N:1190505:S:0). In the Wellness International Network case, the SCOTUS has agreed to decide two issues: (a) whether  a subsidiary state property law issue that needs to be decided in order to determine whether property in the debtor’s possession is property of the bankruptcy estate stems from the bankruptcy itself or is an issue that a bankruptcy court lacks the constitutional authority to decide with a final order; and (b) whether litigant consent—express or implied—is enough  to permit a bankruptcy court’s exercise of the Article III judicial power, and if so, whether implied consent based on a litigant’s conduct is sufficient to satisfy Article III requirements for the exercise of that consent.

   The SCOTUS has scheduled January 14, 2015 for argument on this case; you can read all the briefs here:  http://www.scotusblog.com/case-files/cases/wellness-international-network-limited-v-sharif/.

4    Monies Paid into a Chapter 13 per a Confirmed Chapter 13 Plan: Who Gets the Funds if the Debtor’s Case is Converted to a Chapter 7 Case?:  There is a circuit conflict on this issue. 11 U.S.C. §348(f) says that, in a Chapter 13 case converted to Chapter 7 in good faith, the “property of the estate” is the property that the debtor came into bankruptcy with and “remains in the possession of or is under the control of the debtor on the date of conversion.” Such property apparently excludes undistributed monies—specifically, post-petition wages—that a debtor paid to the Chapter 13 trustee for distribution per a confirmed Chapter 13 plan.  The Third Circuit said that the statute (and 11 U.S.C. §1327(a)) required paid-in monies to be returned to the debtor and not distributed by creditors. In re Michael, 699 F.3d 305 (3rd Cir. 2012). The Fifth Circuit said that the statutes fail to adequately address the situation, the Chapter 13 plan needs to be respected, and the paid-in monies need to be distributed to creditors per the plan. Vieglelahn v. Harris, located here: http://www.jthomasblack.com/library/20140707-Vieglelahn-v.-Harris--13-50374--5th-Cir.-2014-.pdf. The SCOTUS accepted the debtor’s writ of certiorari regarding the Fifth Circuit decision; the case and docket number are Harris v. Viegelahn, No. 14-400.

5     The Extent of Bankruptcy Court Authority to Award Fees under 11 U.S.C. §330: Another Fifth Circuit decision is up for review.  Baker Botts, L.L.P. v. ASARCO, L.L.C., No. 14-103 (lower court opinion: http://sblog.s3.amazonaws.com/wp-content/uploads/2014/09/5ht-cir-12-40997-.pdf) involves a Chapter 11 case, but raises issues near and dear to all bankruptcy attorneys’ hearts:  (a) under 11 U.S.C. §330, can the bankruptcy court award “fee enhancements” (as opposed to fees based solely on hourly rates and time, i.e., the “lodestar” method) for exceptional results in a bankruptcy case; and (b) under the same statute, can the bankruptcy court approve fees for litigation associated with defending a fee application? The Fifth Circuit said “yes” to the fee enhancement, but “no” to the fee application litigation fees.  On the latter subject, the circuit court noted that §330(a)(6) allows for fees to be awarded only for preparation of a fee application.  I suspect, however, that the fee enhancement issue will draw much more attention in the briefs and argument of this case.

6     Whether a Bankruptcy Court can Limit or Eliminate “Plan Injunctions”  and Releases in Favor of Non-Creditors in a Chapter 11 Plan (Pending Petition for Certiorari): This writ of certiorari tests a bankruptcy court’s power to deny enforcement or approval of injunctions and releases in favor of non-creditors, which injunctions and releases are included in a proposed Chapter 11 plan. You can read the writ for certiorari here: http://sblog.s3.amazonaws.com/wp-content/uploads/2014/11/30262-pdf-Goroff.pdf;  and the lower case opinion (from the 4^th Circuit) here: http://www.ca4.uscourts.gov/Opinions/Published/131608.P.pdf.  The case and docket number are National Heritage Foundation v. The Highbourne Foundation, No. 14-481.

©Kevin C. McGee 2014

11th Circuit: §506(d) "Strip-Offs" Part Deux

What Has Gone Before

     Back in April, I posted about the U.S. Supreme Court's denial of certiorari on an unpublished order of the 11th Circuit Court of Appeals, in which the 11th Circuit followed a previous unpublished decision that allowed wholly unsecured liens to be "stripped off" in Chapter 7, using 11 U.S.C. §§506(a) & (e). As I discussed in that post, the 11th Circuit interpreted Dewsnup v. Timm, 502 U.S. 410 (1992) to be limited to partially secured first mortgages, and followed its own precedent  -- handed down before Dewsnup v. Timm --  in ruling that 11 U.S.C. §506 could be used to void wholly unsecured mortgages and liens in Chapter 7. See Folendore v. United States Small Bus. Admin., 862 F.2d 1537 (11th Cir. 1989).

     I also noted that the 11 Circuit stood as an outlier on this issue, and that the other circuits reaching the same issue had ruled that Dewsnup v. Timm controlled (and forbade)  the use of §506 against wholly unsecured liens in Chapter 7. My prior blog post is here:  http://impudentbankruptcylawyer.blogspot.com/2014/04/now-in-play-506d-strip-offs-in-chapter-7.html

  The 11th Circuit Speaks Again

 

     The 11th Circuit, on June 18, 2014, published a decision in which it adopted the majority view allowing debtors to use a "Chapter 20" to strip off liens. The decision is Wells Fargo Bank, N.A. v. Scantling (In re Scantling), ___ F.3d ____ (11th Cir. Docket No 13-10558, 6/18/14), and you can read it here: http://www.ca11.uscourts.gov/opinions/ops/201310558.pdf. 

     You won't find "Chapter 20" in the Bankruptcy Code; bankruptcy lawyers use it as a term of art to describe a two-step process used to strip off unsecured junior liens and mortgages. First, the debtor files a Chapter 7 bankruptcy and obtains a discharge of the underlying promissory note and other debt. Second, immediately after the Chapter 7 discharge, the debtor files a Chapter 13, in which the debtor files a plan (usually with token payments for lien creditors) and files a motion, under 11 U.S.C. §506, to determine that the liens remaining after the Chapter 7 are void because they are wholly unsecured.

     Here's the trick: the debtor in these circumstances does not care that he or she cannot get a "discharge" in Chapter 13; the debtor's sole purpose is to use his or her Chapter 13 case to void and "strip off" the unsecured mortgages. 11 U.S.C. §1328(f) mandates a four year waiting period (after the date the debtor filed the prior Chapter 7) for filing a Chapter 13 in which the debtor seeks a discharge. But -- nothing in the Bankruptcy Code prohibits the debtor from filing a Chapter 13 for another purpose in that four year waiting period, so long as the debtor can confirm a plan according to the dictates of Chapter 13.

     Wells Fargo argued that the Chapter 13 plan and discharge must go hand-in-hand. However, a Chapter 13 plan does more than secure a discharge after all its payments are completed: it allows the debtor to cure mortgage defaults; pay off income tax debt over five years, without further accrual of interest and penalties; and allows the avoidance of wholly unsecured mortgages, even on the debtor's primary residence. 11 U.S.C. §1322(b)(2) states that the plan may: "modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims." Although the SCOTUS has ruled that Chapter 13 debtors cannot use §506(a) to modify a partially secured mortgage on a residence,  Nobelman v. American Savings Bank, 508 U.S. 324 (1993), most circuits -- including the 11th Circuit -- have ruled that a §506(a) valuation can be combined with §1322(b)(2) provision in a plan to void a wholly unsecured mortgage. See Tanner v. Firstplus Financial, Inc. (In re Tanner), 217 F.3d 1357 (11th Cir. 2000). In other words, if there is no equity in the residence to secure any part of the mortgage, the mortgage becomes a wounded gazelle on the African savannah, and the Chapter 13 plan is the lion.

     The 11th Circuit recognized Chapter 13's versatility and thus followed the majority of bankruptcy courts, district courts and circuit courts in allowing Ms. Scantling's "Chapter 20" and her plan to void Well Fargo's second and third mortgages on her residence.

     Of particular interest is footnote 5 of the decision, in which the 11th Circuit stated:

      We are also mindful of the recent unpublished opinion in Wilmington Trust, National 5 Ass’n v. Malone (In re Malone), No. 13-13688, 2014 WL 1778982 (11th Cir. May 6, 2014), which was decided after oral argument in the instant case, in which a panel of this court recently found it was bound by prior published decisions and affirmed a decision by the bankruptcy court, in a Chapter 7 proceeding, that allowed a debtor to strip off a worthless second priority lien.

The Bottom Line

     Debtors in the 11th Circuit have the best of both worlds: if they are daring, they can try to strip off their wholly unsecured mortgages in their Chapter 7 case (and now, those debtors have a footnote in a published opinion to cite). If they are not daring (and have the funds for filing two bankruptcy cases), they can take the safer route of a "Chapter 20" to get rid of their second or third mortgage.

©Kevin C. McGee 2014

Now in Play: §506(d) "Strip-Offs" in Chapter 7

     On March 31, 2014, the Supreme Court of the United States denied certiorari in Bank of America, N.A. v. Sinkfield, Petition No. 13-700. To put it in terms appropriate to Major League Baseball’s opening day, this was the equivalent of Casey’s mighty whiff at strike three in the ninth inning, with the bases loaded, a full count, and the chance for a walk-off win.

     The elements were all in place; a “rogue” circuit makes a holding that three other circuits would not dare to make, on an issue that many debtor lawyers fantasize about revisiting and that many banks dread like a recurring nightmare. The 11^th Circuit (albeit summarily, in an order) held that a fully unsecured second mortgage lien could be “stripped off” a Chapter 7 debtor’s residence in Georgia, when the value of that residence is only enough to (partially) secure the first mortgage lien. The 11^th Circuit based the order on its previous (unpublished) decision in In re McNeal, No. 11-11352 (11th Cir. 5/11/12), in which the circuit limited the Supreme Court’s decision in Dewsnup v. Timm, 502 U.S. 410 (1992) to prohibiting the strip-down of partially secured first mortgages in Chapter 7.  The McNeal court held that fully unsecured second mortgages are fair game to be stripped off under 11 U.S.C. §506(d), and relied on its own, pre-Dewsnup 1989 decision, Folendore v. United States Small Bus. Admin., 862 F.2d 1537 (11th Cir. 1989), as precedent for doing so. The 4^th Circuit, 6^th Circuit, and 7^th Circuit (as well as many lower courts) all reached opposite results in holding that Dewsnup v. Timm did apply and prohibited any lien stripping in Chapter 7. Throughout most of the country, the old adage that liens float unaffected through a (Chapter 7) bankruptcy is alive and well.

Bankruptcy 101 on Lien-Stripping (in Chapter 7):

     11 U.S.C. §506(d) seems clear on its face. It states that:

  To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void, unless --  

(1)   such claim is disallowed only under section 502(b)(5)[as an unmatured debt for a domestic support obligation] or 502(e) [as a contingent claim for reimbursement or contribution] of this title; or

(2)  such claim is not an allowed secured claim due only to the failure of any entity to file a proof of claim under section 501 of this title.

      Add to this §506(a)(1), which states that “An allowed claim of a creditor secured by a lien on property in which the estate has an interest … is a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property … and is an unsecured claim to the extent that the value of such creditor’s interest … is less than the amount of such allowed claim.”  

      Thus, under recent Supreme Court precedent, it seems like a “no-brainer” to hold that the statutes say what they say:  you determine secured claims according the value of the debtor’s property (and we can fight about what that “value” is); there is no secured claim or lien beyond the value of the property;  the only exceptions to the lien-voiding rule in §506(d) are certain unmatured  and contingent secured claims; and a creditor does not have to file a proof of claim to have its lien determined as an “allowed secured claim”.  After all, look at the unanimous decision last month in Law v. Seigel, in which the justices solemnly proclaimed that “’whatever equitable powers remain in the bankruptcy courts must and can only be exercised within the confines of ‘the Bankruptcy Code” and “We have recognized  … that in crafting the provisions of§522, ‘Congress balanced the difficult choices that exemption limits impose on debtors with the economic harm that exemptions visit on creditors.’  … The same can be said of the limits imposed on recovery of administrative expenses by trustees. For the reasons we have explained, it is not for courts to alter the balance struck by the statute.” [1]

But - Dewsnup v. Timm

      As many law school professors will gleefully tell you after you cite this straight-forward analysis – we have the 1992 precedent of Dewsnup v. Timm, in which the Supreme Court held that a partially unsecured first mortgage could not be “stripped down” in Chapter 7 using these two statutes. The pillars of that decision are as follows:

 (a)  Congress could not have meant to change long-standing bankruptcy law that “that liens pass through bankruptcy unaffected”, and courts do not look at a clean slate (with no history) when interpreting Bankruptcy Code provisions;

(b)  even though §506(a) and §506(d) both use the term “allowed secured claim”, it is an ambiguous, undefined term, and does not necessarily mean the same thing in each statute or elsewhere in the Bankruptcy Code;

(c)  the function of §506(a) is to determine the relative interests of secured creditors and debtors in property that is part of the debtor’s estate, while the function of §506(d) is to void “only liens corresponding to claims that have not been allowed and secured”; and

(d)  if the Court were to hold otherwise, it would ignore pre-Code bankruptcy practice and “freeze the creditor's secured interest at the judicially determined valuation.  By this approach, the creditor would lose the benefit of any increase in the value of the property by the time of the foreclosure sale. The increase would accrue to the benefit of the debtor, a result some of the parties describe as a ‘windfall.’”

      Dewsnup contains a dissent authored by Judge Scalia, who – unsurprisingly – disagrees with the majority’s decision because the plain language of both §506(a) and §506(d) compels the voiding of the unsecured portion of the lien, notwithstanding pre-Bankruptcy Code practice. Judge Scalia is still on the Supreme Court;  one of the justices joining the majority, Judge Kennedy, is also still on the Supreme Court. The rest of the participants in the majority opinion – Judge Blackmun (the author of the majority opinion), Judge O’Connor, Judge White, and Judge Stevens – have been replaced. So has Judge Souter, who joined in Judge Scalia’s dissent. But Judge Thomas, who did not participate in the decision and often joins with Judge Scalia, is still on the court.

     So, all the conditions seemed right for a revisiting of §§506(a) & 506(d): a split in the circuits; a (mostly) new cast of characters on the Supreme Court; and a different perspective in recent decisions of the Supreme Court on whether the plain language of the Bankruptcy Code or the historical precedent of bankruptcy practice is more important.  Yet, the petition for certiorari is denied, and mortgagees across the country breathe a sigh of relief -- except, of course, in Georgia, Alabama, and Florida, where motions and adversary proceedings for lien-strip offs in Chapter 7 continue unabated[2].  Casey was expecting a fast ball on a 3 and 2 count, and got a curve ball instead, leaving the home crowd unsatisfied.

     The practical effect is that a debtor’s attorney in the First, Second, Fifth, Eighth, Ninth, or Tenth Circuit will have to take the right case up for an appeal, and obtain a reasoned circuit decision on this issue. The 11^th Circuit has the outlier opinion already in In re McNeal – it’s just a matter of finding an appeal with the right ingredients.

---

[1]  Note also that the justices threw an earlier Supreme Court case, Marrama v. Citizens Bank of Mass., 549 U. S. 365 (2007) under the bus, ignoring that the Marrama court had blessed an equitable exception to express statutory language, and then finessing the issue by saying that another statute disqualified the debtor from converting his case to Chapter 13.

[2]  The NACBA’s amicus brief opposing the certiorari petition likely gives the real reason for the order denying certiorari: Bank of America “fast-tracked” the petition by agreeing that the 11 Circuit’s order was final, and deprived the Supreme Court of a “deliberative” decision by a circuit court setting up a true conflict in the circuits on the issue.

©Kevin C. McGee