Category Archives: bankruptcy

Bankruptcy, Filing Fees, and the Constitution

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The case of this week is In re Buffets LLC, No. 19-50765 (5th Cir. Nov. 3, 2020) (slip op.; Google Scholar).

When I was in college, doing moot court, I dreamed of one day doing “constitutional law.” In my head, constitutional law was this amazing and heady thing, dealing with rights to esoteric things like Life and Liberty and Property and Due Process. I imagined myself sitting in an appellate courtroom, with oak paneling , hardwood floors, and judges in wigs, waxing philosophical: “Mm, yes, your honor, but exactly how much ‘process’ is due?” When I got into the real world of practice, I learned that most of the practice of law is people on one side trying to find some excuse not to pay the people on the other side. Questions of how much process is due rarely come up. But they do, occasionally, and almost always because the side that doesn’t want to pay has a creative lawyer.

Buffets LLC operates a chain of buffet restaurants, including Ryan’s Family Steakhouse. It filed for bankruptcy under Chapter 11 in 2016, confirmed a plan in 2017, and was still making disbursements under that plan in 2018, when Congress amended 28 U.S.C. § 1930(a)(6).

Section 1930 governs the fees payable in bankruptcy cases, and paragraphs (a)(6) and (7) provide for quarterly fees payable in Chapter 11 cases. Subsection (a)(6) says that in most of the country (in “UST courts”) a “quarterly fee shall be paid to the United States trustee” based on the amount of disbursements by the debtor under the plan in that quarter. Subsection (a)(7) says that, in the rest of the country (in “BA courts”), the Judicial Conference “may require the debtor . . . to pay fees equal to those imposed by paragraph (6) of this subsection.” There  are two paragraphs because the country operates two systems for administering bankruptcy cases: the UST system and the BA system. U.S. trustees and bankruptcy administrators do essentially the same thing: they both monitor bankruptcy cases to make sure fees are paid, schedules and reports are filed, bank accounts are opened properly, etc. But U.S. trustees are funded by filing fees while bankruptcy administrators are funded out of the general budget of the judiciary. So: Congress controls quarterly fees in UST courts while the judiciary, through the Judicial Conference, controls quarterly fees in BA courts.

In 2018, to address budgetary problems in the UST system, Congress raised the cap on quarterly fees under section 1930(a)(6) from $30,000 to $250,000. The change was effective on a certain date and applied to all Chapter 11 cases pending on that date. In 2019, the Judicial Conference raised the quarterly fees under section 1930(a)(7) to match Congress’s raise, but limited the effect of the change to new cases filed on or after that date.

Now, like I said, Buffets LLC was still making disbursements under its Chapter 11 plan when the amendment came into effect in 2018. Because Buffets LLC had filed in the Western District of Texas (a UST court), its quarterly fee increased from $30,000 to $250,000. As you might expect, Buffets LLC resisted the fee hike. It raised number of factual and legal challenges—including that the fees were unconstitutional because they violate the Bankruptcy Clause of the Constitution.

Wait. What? Filing fees are unconstitutional? And there’s a bankruptcy clause in the Constitution? Yep:

The Congress shall have Power . . . To establish . . . uniform Laws on the subject of Bankruptcies throughout the United States[.]

U.S. Const. art. I, § 8, cl. 4. “The Bankruptcy Clause ‘might win’ a ‘contest for least-studied part’ of Article I’s congressional powers.” Slip Op. at 14. It “received ‘meager’ attention” at the Constitutional Convention after Charles Pinckney proposed it alongside the Full Faith and Credit Clause. “Roger Sherman raised the only doubt about the Bankruptcy Clause, expressing concern because ‘in England, some bankrupts were sentenced to death’.” Slip Op. at 14-15 n.8. The Bankruptcy Clause is mentioned only once in the Federalist Papers: “The power of establishing uniform laws of bankruptcy is so intimately connected with the regulation of commerce, and will prevent so many frauds where the parties or their property may lie or be removed into different States, that the expediency of it seems not likely to be drawn into question.” The Federalist No. 42. So if you’ve never heard of it before, you’re in good company.

The lawyers for Buffets LLC, though, had heard of it. They argued that a scheme under which one set of fees was payable in one part of the country and a different set of fees was payable in a different part is unconstitutional because it is not “uniform . . . throughout the United States.” [n.1]

The Fifth Circuit was not persuaded. The Bankruptcy Clause “forbids only two things . . . arbitrary regional differences in the provisions of the bankruptcy code [and] private bankruptcy bills.” In re Reese, 91 F.3d 37, 39 (7th Cir. 1996). [n.2] The fee statute is clearly not a private bankruptcy bill, but is it an arbitrary regional difference? Not according to the majority: regional difference yes, but it is justified by the different funding mechanisms for UST courts and BA courts and so is not “arbitrary.” After all, Congress made two systems for a reason, so Congress can fund the two systems however best it makes sense to fund them. If you’re scratching your head, again, you’re not alone. Doesn’t that answer just beg the question about the uniformity—and therefore constitutionality—of the dual UST-BA system? Maybe, but Buffets LLC “do not ask us to ‘hold that the permanent division of the country into UST districts and BA districts violates the Bankruptcy Clause.” Slip Op. at 19. Constitutional question averted.

But maybe not forever. The dissent relied heavily on St. Angelo v. Victoria Farms, Inc., in which the Ninth Circuit held that the dual UST-BA system is dis-uniform and therefore unconstitutional. 38 F.3d 1525 (9th Cir. 1994), amended by 46 F.3d 969 (9th Cir. 1995). Now that we have sophisticated lawyers fighting over hundreds of thousands of dollars, the issue may come to a head sooner rather than later.

Notes:

  1. In fact, because of the geography of UST courts and BA courts, Buffets LLC could have argued that there is one part of the United States where the fees are not uniform even within city limits. The federal courthouse in Texarkana sits on the state line. The bankruptcy courts on one side, in the Eastern District of Texas, are UST courts. The bankruptcy courts on the other side, in the Western District of Arkansas, are BA courts.
  2. The Fifth Circuit had to cite the Seventh Circuit because Supreme Court case law is not particularly helpful—it only provides that the Bankruptcy Clause is “not an Equal Protection Clause for bankrupts.” Railway Labor Executives Ass’n v. Gibbons, 455 U.S. 457, 470 n.11 (1982). Whatever that means.

Clear and Unequivocal as Mud

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This week’s case is a funny little case from 2018: Wilmington Trust, N.A. v. Rob, 891 F.3d 174 (5th Cir. 2018). Kcevin and Angel Rob took out a home equity loan in July 2007. They stopped paying on the loan in March 2011. Over the next two years, Wilmington Trust [n.1] sent the Robs a series of notices of default, of intent to accelerate, and of acceleration. But, in November 2014, Wilmington Trust sent the Robs a notice of rescission of acceleration. The Robs continued not paying their mortgage, and Wilmington Trust sued for foreclosure in June 2015. The district court entered judgment in favor of Wilmington Trust, but the Fifth Circuit reversed.

Texas courts require clear and unequivocal notice of (1) intent to accelerate and (2) acceleration itself. “Unless a lender provides both forms of notice, it may not foreclose.”  Rob, 891 F.3d at 177. Here, Wilmington Trust may have provided clear and unequivocal notice at some point, but the notice of rescission in November 2014 made all of that very much less clear and unequivocal. Wilmington Trust, therefore, failed to prove that it had provided clear and unequivocal notice and was, accordingly, not entitled to a judgment of foreclosure. Trial court judgment reversed and rendered; game over.

BUT — this case should not be read as saying that Wilmington Trust can never foreclose. Rather, it should be read as saying that Wilmington Trust cannot foreclose yet. If the home equity loan has not yet matured, Wilmington Trust could probably just re-issue the notices of intent to accelerate and of acceleration, then sue for foreclosure. Sometimes you can stick it to the man a couple times, but you can’t stick it to him  forever.

  1. Technically, the notices were sent by one of Wilmington Trust’s predecessors in interest,  but that detail is not particularly important.

Pro Se at Your Own Risk

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The first rule of bankruptcy ought to be: Do not file for bankruptcy unless you have a clearly defined goal you are trying to accomplish. Maybe the bank is about to foreclose on your house or repossess your car. Bankruptcy may be able to stop (or at least delay) those things. Which leads me to the second rule: Do not file for bankruptcy unless you are confident that it will help you accomplish your goal.

Sarah Katherine Sussman lived on Clark Avenue in Tampa, Florida. She held title to the property as trustee for The Sussman Family Trust Living Trust. The Trust had obtained the property from Sarah’s mother, Teresa M. Gaffney, after her father, John J. Gaffney, died in December 2011. For whatever reason (the opinion does not say), the administrator of John’s estate wanted to undo that series of transfers. The administrator sued Sarah and Teresa in state court and obtained a final judgment on October 16, 2017, ordering that title be returned to John’s estate and that Sarah be evicted. Sarah appealed and moved to stay the judgment pending appeal, but that motion was denied. So, on October 24, she filed a pro se petition for bankruptcy, hoping “to obtain a stay of eviction from [the] property.”

It’s easy to see why she did that. Section 362 of the Bankruptcy Code says that the mere filing of a petition for bankruptcy automatically stays “the commencement or continuation” of any lawsuit against the debtor, the “enforcement, against the debtor or against property of the estate” of an existing judgment, and any act to obtain possession or control of property of the estate, among other things. 11 U.S.C. § 362(a)(1)-(3). It seems like an eviction would be the enforcement of a judgment against the debtor, so filing for bankruptcy should have kept her in the house. Right?

Not necessarily. The stay is broad and it is powerful, but it does not cover absolutely everything that might be related to the debtor or the bankruptcy. One major limitation is that it only applies to legal and equitable interests “of the debtor in property as of the commencement of the case.” 11 U.S.C. § 541(a)(1) (emphasis added). The automatic stay does not automatically undo things that happened before the petition was filed. There may be other procedures and remedies available to address those things, but the automatic stay does not automatically un-foreclose your house or un-repossess your car. You must file the petition before the foreclosure or repossession happens. Evictions are a little different. Unlike foreclosures and repossessions, evictions generally require a judicial determination of the right of possession before the eviction can occur. In this case, the state court determined that John’s Estate had the right of possession of the Clark Avenue house before Sarah filed for bankruptcy. Accordingly, the bankruptcy court, the district court, and the Eleventh Circuit all held that the bankruptcy petition would not undo that judgment or stop the eviction.

The Eleventh Circuit said that she filed for bankruptcy specifically to stop or delay the eviction. If so, that was a poor strategic choice, and not just because of the nuances of the distinctions between foreclosures and evictions. The first sentence of the Eleventh Circuit’s opinion tells us that Sarah is “a debtor proceeding pro se.” The “Disussion” section says they can only “discern from [Sarah’s] scattershot appeal, two issues sufficiently developed for appellate review.” The footnote to that sentence explains that several other issues were waived because they were either “not raised below or raised in a cursory fashion without citation to authority.” In other words, there may have been other arguments that would have worked but she didn’t raise them effectively. All of which is why you hire a lawyer: to help you know which arguments to make and how best to make them.

Gambling with your Credit

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When I was a kid, we would occasionally have disputes about how to spell things. Settling the matter took about four stages: first, we would both insist that we were right; second, we would escalate our insistence, through raised fists, threatening eyebrows, and oaths taken on our mothers’ lives; third, one of us would dare the other to check the dictionary; fourth, the loser would declare the winner a nerd.

The French, at the end of their kingdom and the beginning of their empire, had a similar idea, only it would spread to all disputes ever. They had this idea that The Law should be simple enough to fit into a single book that everybody could have on their bookshelf. The idea was that two Frenchmen could have any dispute at all and resolve it by going through the four phases I mentioned: (1) I’m right / no, I’m right; (2) I swear I’m right / yeah, well I would bet my last bottle of wine that I’m right; (3) oh yeah? Why don’t you check The Code?; (4) you’re such a nerd.

Only: the law deals with life, and life is more complicated than spelling. In the first place, Napoleon’s “book” has spread to over 3,000 pages. In the second place, the hardest part of practicing law is almost never finding a piece of law to support your position. Rather, it’s deciding which arguments of several would be best and most likely to help you win.

Take this week’s case, In re Nicolaus, out of the 8th Circuit. Anthony Nicolaus ran a business with his brother. They ran into trouble with the IRS, apparently failing to pay withholding taxes. The IRS began collection efforts, so Nicolaus filed bankruptcy under Chapter 7.

Let’s pause for just a second. Chapter 7 is frequently touted as an “easy” way to get rid of debt without paying it. But there are some debts that don’t get discharged in Chapter 7. For example, child support is never discharged, nor is any debt for death or personal injury resulting from a D.W.I. 11 U.S.C. § 523(a)(5), (9). Student loans are almost never discharged. 11 U.S.C. § 523(a)(8). And debts for taxes are very difficult to discharge. 11 U.S.C. § 523(a)(1)(A) (referring to 11 U.S.C. § 507(a)(8) (referring to any tax “to be collected or withheld and for which the debtor is liable in whatever capacity,” including withholding taxes)). So if Mr. Nicolaus wanted to get out of his debt for not paying withholding taxes, Chapter 7 may not have been the way to go.

Back to the case. He files for bankruptcy. The IRS files a proof of claim. He files an objection. The IRS never responds. The bankruptcy court sustains the objection and disallows the claim. He does not have to pay the IRS.

A year later, the IRS files a motion to vacate the order disallowing the claim. According to the IRS, Mr. Nicolaus had to serve the objection not just on the IRS, but also on the attorney general and the local U.S. attorney. Since he had only served the IRS, the order disallowing the claim was invalid for lack of personal jurisdiction. The bankruptcy court agreed, as did the district court on appeal. The Eighth Circuit, however, disagreed. At the time Mr. Nicolaus filed his objection, the rules only required service on the IRS. The requirement of service on the attorney general and the local U.S. attorney were added later. Therefore, the IRS was properly served, and the bankruptcy court had jurisdiction to sustain the objection and disallow the claim. Mr. Nicolaus does not have to pay the IRS.

But that’s largely because the IRS wasn’t paying attention. If Mr. Nicolaus filed for bankruptcy in order to get out of his debt to the IRS, he was taking a major gamble. If the IRS had been paying attention, he could have ruined his credit for nothing.

Avoiding Professional Discipline through Bankruptcy

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Most debts are discharged in bankruptcy—but not all. In In re Albert-Sheridan, the Ninth Circuit addressed the issue of whether a cost assessment in disciplinary proceedings against a lawyer can be discharged.

The Ninth Circuit says “no.”

Lenore L. Albert-Sheridan was a lawyer in California specializing in consumer advocacy. She got into trouble with the California bar in 2015, and the state bar ordered her license suspended for 30 days in 2016. The suspension order conditioned her reinstatement on the payment of $18,714 to the state bar in ” ‘reasonable costs’ for the disciplinary proceedings under California Business and Professions Code § 6086.10(b)(3).” (Slip Op. at 6.) The order was affirmed on appeal and the suspension went into effect in December 2017.

Ms. Albert filed for bankruptcy in February 2018. Two months into it, she filed an adversary complaint against the state bar to determine whether the cost award in the suspension order would be discharged in her bankruptcy. The bankruptcy court found in favor of the state bar and held the cost award to be non-dischargeable. The bankruptcy appellate panel and the Ninth Circuit both affirmed.

In a chapter 7 bankruptcy, the basic rule of dischargeability is that all of a debtor’s prepetition debts will be discharged in bankruptcy, unless they fit into one of the exceptions in section 523. 11 U.S.C. § 727(b). Among other things, section 523 provides:

A discharge under section 727 . . . of this title does not discharge an individual debtor from any debt . . . to the extent such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss, other than a tax penalty . . . .

11 U.S.C. § 523(a)(7).

There are three elements to non-dischargeability under section 523(a)(7):

  1. the debt is a fine, penalty, or forfeiture,
  2. that is payable to and for the benefit of a governmental unit, and
  3. that does not constitute compensation for actual pecuniary costs.

(Slip Op. at 10.)

Section 6086.10(a) of the California Business and Professions Code requires that “Any order . . . imposing discipline . . . shall include a direction that the licensee shall pay costs.” Subsection (b) provides how to calcalute the costs:

(b) The costs required to be imposed pursuant to this section include all of the following:
(1) The actual expense incurred by the State Bar for the original and copies of any reporter’s transcript of the State Bar proceedings, and any fee paid for the services of the reporter.
(2) All expenses paid by the State Bar which would qualify as taxable costs recoverable in civil proceedings.
(3) The charges determined by the State Bar to be “reasonable costs” of investigation, hearing, and review. These amounts shall serve to defray the costs, other than fees for the services of attorneys or experts, of the State Bar in the preparation or hearing of disciplinary proceedings, and costs incurred in the administrative processing of the disciplinary proceeding and in the administration of the Client Security Fund.

Cal. Bus. & Prof. Code § 6086.10(b) (boldface added).

Your humble writer suggests that the cost award under section 6086.10(b) is tied to costs and expenses actually incurred by the state bar, and therefore should “constitute compensation for actual pecuniary loss.” That would seem to pull the cost award outside the scope of section 523(a)(7), rendering the cost award dischargeable in bankruptcy.

But case law said otherwise. The Ninth Circuit addressed this question head-on in 2010 in In re Findley, 593 F.3d 1048 (9th Cir. 2010). There, the court looked at the cost award in light of section 6086.10(e), which explains that “costs imposed pursuant to this section are penalties . . . to promote rehabilitation and to protect the public.” Cal. Bus. & Prof. Code § 6086.10(e). Apparently, calling a cost award a penalty does the trick: “we conclude that [subsection (e) is] sufficient to render attorney discipline costs imposed by the California State Bar Court non-dischargeable in bankruptcy pursuant to 11 U.S.C. § 523(a)(7).” Findley, 593 F.3d at 1054.

According to Judge Bumatay, “Findley stands on all fours with this case.” (Slip Op. at 9.) The cost award was non-dischargeable in Findley, so it is non-dischargeable in the case at bar.

The Fifth Circuit says “maybe.”

Things are not so simple in the Fifth Circuit: “Even where a debt bears a label that fits within § 523(a)(7)’s definition of dischargeable debts, we have looked to the nature and purpose of the debt and declined to declare it nondischargeable.” In re Schaffer, 515 F.3d 424, 428 (5th Cir. 2008).

In Schaffer, the Louisiana State Board of Dentistry disciplined a practicing dentist by revoking his license and ordering him to pay “all costs of the Committee Proceedings including, but not limited to, stenographer fees, attorneys’ fees, investigative fees and expenses, and witness fees and expenses and the per diem and expenses of the Committee members.” Schaffer, 515 F.3d at 426. The order also provided that the Board would not consider any re-applications by him untli he had paid the costs, with interest. Five years later, he filed for bankruptcy, and the board brought an adversary proceeding to have the cost award declared non-dischargeable.

The bankruptcy court and the district court held in favor of the Board, but the Fifth Circuit reversed. First, the cost award was not a “fine, penalty, or forfeiture.” The statute authorizing the cost award had authorized both fines and cost awards. It stands to reason, then, that a cost award is not a fine. Second, the language of the statute and the order made clear that the cost award “assessed costs to repay some of the Board’s expenses incurred in the proceeding.” Schaffer, 515 F.3d at 433–34. Therefore, the cost award constituted compensation for actual pecuniary losses.

In the Fifth Circuit, at least, a cost award assessed as part of professional disciplinary proceedings may be discharged in the right circumstances.