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Legal Views on Bankruptcy, Insolvency & Creditors’ Rights

New York and Florida Courts Enforce E-Notes

Posted in CFPB, Foreclosure, Kentucky Law, Note Sales

Appellate courts in New York and Florida recently ruled that mortgage lenders “holding” electronic notes had standing to foreclose on the real property securing the E-Notes. Although Congress passed the Electronic Signatures in Global and National Commerce Act (ESIGN) in 2000, and nearly all states have passed the Uniform Electronic Transactions Act (UETA) in the last decade, there have been very few cases addressing and confirming the enforceability of E-Notes.  Last year, the Consumer Financial Protection Bureau opined that e-mortgage lending can benefit consumers.  These cases may reduce lenders’ perceived risks and provide greater certainty enforcing electronic documents.

In Rivera v. Wells Fargo Bank, the borrower argued that the Bank could not prove that it had possession of the E-Note. The Florida court analyzed the UETA requirements, and determined that the E-Note would be a note if it were in writing, and that the bank had control of it because there was a single authoritative copy identifying the person asserting control as the person to whom it was issued, or to the transferee of such person.  The court found substantial evidence that these requirements were met.

In New York Community Bank v. McClendon, the trial court dismissed the foreclosure complaint, apparently concluding that the bank had failed to establish that it was entitled to enforce the E-Note.  The appellate court reversed, and after analyzing the requirements of the ESIGN Act, concluded that the E-Note was a transferrable record and that the bank had established control of it.

Although Kentucky also adopted the UETA in 2000 (KRS 369.101 to 369.120), it still needs to pass additional legislation to fully implement E-Mortgage lending. It should consider the Uniform Real Property Electronic Recording Act, which would facilitate recording in the county clerks offices by electronic means.  It should expand its non-uniform version of UETA to include real estate transactions.  Finally, it should consider adopting the National E-Notarization Standards proposed by the National Association of Secretaries of State and the Revised Uniform Law on Notarial Acts.

We Said It Once and We’ll Say It Again – Debt Collectors Face FDCPA Liability for Filing Time-Barred Proofs of Claim

Posted in Circuit Split, FDCPA, Proof of Claim

In 2014, the Eleventh Circuit Court of Appeals released its highly-controversial opinion in Crawford v. LVNV Funding, LLC, 758 F.3d 1254 (11th Cir. 2014), becoming the first circuit to rule that a debt collector violates the FDCPA when it files a proof of claim in a bankruptcy case on a time-barred debt. The collection industry sought to have Crawford reversed by the Supreme Court, but the petition for a writ of certiorari was denied last April. Last week, the Eleventh Circuit doubled down on Crawford in Johnson v. Midland Funding, 2016 U.S. App. LEXIS 9478 (11th Cir. May 24, 2016).

The Johnson plaintiffs both claimed that the debt-collector defendants violated the FDCPA by filing proofs of claim on time-barred debt which, under Crawford, would have been unlawful. However, the district court refused to follow Crawford and dismissed the lawsuits, reasoning that Crawford created an irreconcilable conflict between the FDCPA and the Bankruptcy Code (which permits time-barred proofs of claim). The district court applied the doctrine of implied repeal to hold that a creditor’s right to file a time-barred claim under the Code precluded debtors from challenging that practice as a violation of the FDCPA in the Chapter 13 context.

The Eleventh Circuit reversed, concluding that “[a]lthough the Code certainly allows all creditors to file proofs of claim in bankruptcy cases, the Code does not at the same time protect those creditors from all liability. A particular subset of creditors – debt collectors – may be liable under the FDCPA for bankruptcy filings they know to be time-barred.”

The Eleventh Circuit has given debtors the opportunity to trick creditors.  The debtor, Judy Brock, scheduled the alleged time-barred obligation to the creditor.  See In re Brock, Case No. 14-01200 (Bankr. S.D. Ala. 2014), Schedule D.  The debt had been sold to the debt collector who responded by filing a proof of claim (Claim 7-1).  The claim listed the last transaction date as January 16, 2008.  Brock objected to the claim based on lack of supporting documentation but made no mention of the claim being time-barred [Dkt. No. 36].  The bankruptcy court sustained the objection on negative notice.  By scheduling the debt, the debtor asked how much she owed.  The claimant filed its ministerial proof of claim which was disallowed.  And then the debtor sued for an alleged FDCPA violation.

While Johnson characterizes itself as resolving the last open issue for stale proofs of claim in bankruptcy, there remain many more questions.  By scheduling the debt, does a debtor consent to the creditor/debt collector filing a proof of claim?  The debtor invited the claimant to the party only to pull the chair out from underneath it.  Further, does the scheduling the debt revitalize the claim even if the statute of limitations has passed?  And who owns the alleged FDCPA violation?  In a Chapter 13 case, would this post-petition asset inure to the benefit of the other creditors?  If the debtor amends its schedules to include the FDCPA claim and values that claim, is that valuation binding?  Brock amended her Schedules B & C with a valuation of the potential lawsuit of $1.00.  If this was an FDCPA violation, it comes with a statutory penalty of $1,000.00.  Has the debtor perjured herself with this false valuation?  When the debtor objects to the claim based on lack of supporting documentation, is the statute of limitations issue waived?

The underlying bankruptcy case shows how the system is designed to work.  Debtors schedule all assets and claims to put the world on notice.  Parties who may have a claim—a very broad definition under the Bankruptcy Code—file it with the court.  The debtor raises objections to any claims which are disputed.  And the court makes a determination as to the validity of the claim.  Claim administration is one area of the bankruptcy court’s power which is not subject to a Stern challenge.  And the claim administration process worked for Brock.  But the Eleventh Circuit has created this unnecessary wrinkle in smooth case administration by permitting a cause of action for filing a purported stale claim.

Unfortunately for debt collectors doing business in the Eleventh Circuit (Alabama, Florida and Georgia)—and maybe the Northern District of Indiana, it appears Crawford and Johnson are here to stay. Luckily for those elsewhere, some lower courts have refused to adopt Crawford, leading to Johnson-like challenges in other federal appellate courts. The result could be a circuit split that ultimately winds up before the Supreme Court.

Debt Collectors: Remember Opposing Counsel is Not Competent

Posted in Circuit Split, FDCPA, Shameless Promotion, Stites & Harbison PLLC

Well, at least that is the case as the Eleventh Circuit rules on communications between attorneys.  Recently, I read a warning from a colleague about the expansion of liability for creditor’s lawyers under the FDCPA.  In Bishop v. Ross, Early & Bonan, P.A., the Eleventh Circuit reversed the dismissal of an FDCPA complaint brought by a homeowner whose attorney received a letter from the HOA’s counsel regarding unpaid assessments.  At issue was a purported violation based on a faulty disclosure under 15 U.S.C. § 1692g(a)(4).  The homeowner’s counsel received this purported defective notice and within two months filed an FDCPA complaint on behalf of the homeowner for the indirect communication.  But if her counsel had sufficient competency to know that the notice failed to state the law correctly so that he could meet his Rule 11 obligations before filing the FDCPA claim,  how could the purported misstatement of the law be “false, deceptive, or misleading” within the meaning of the FDCPA?  Within a month to the day, the Eleventh Circuit has issued two opinions (Bishop and Diaz v. First Marblehead Corp.) with significant ramifications for the collegiality of the debtor/creditor bar.

Another issue that Bishop raises, but does not address, is the varying writing requirements of § 1692g. Section 1692g(a)(3) requires a statement that unless the debtor disputes the validity of the debt within thirty days, the debt will be assumed to be valid by the debt collector.  Section 1692g(a)(4), however, requires a statement that if the consumer notifies the debt collector in writing during the thirty-day period that the debt—or any portion thereof—is disputed, the debt collector will obtain verification of the debt.  So the consumer has the right to dispute a debt in any manner—verbally or in writing—but to obtain verification, the dispute must be in writing.  If you state the dispute must be in writing, you could violate the FDCPA.  If you fail to state the request for verification must be in writing, you could violate the FDCPA.  It is a statute fraught with perils for the unwary attorney.  And, unfortunately, the Eleventh Circuit does not want lawyers to communicate informally to work through these issues.

Into The Void: Kentucky Adopts Uniform Fraudulent … er, I Mean … Voidable Transactions Act

Posted in Fraudulent Transfer, Kentucky Law

voidUntil 2016, Kentucky was one of just a few states that had not adopted a model statute relating to fraudulent transfers.  As mentioned in a prior post on Kentucky’s statutory quirkiness, its statute descended neither from the Uniform Fraudulent Transfer Act (“UFTA”) nor the Uniform Fraudulent Conveyance Act (“UFCA”).  Effective this year, however, Kentucky is at the leading edge of uniform creditor avoidance statutes (KRS 378A), having become among the first 9 states (as of this writing) to adopt the new Uniform Voidable Transactions Act (“UVTA”).  I have written on UVTA generally, and will try to stay focused on how UVTA will likely change avoidance action practice for Kentucky practitioners.  Here are some highlights:

  • The Commissioners Really Want Everyone To Stop Using The Phrase “Fraudulent Transfer.”  According to the commentary, “the word ‘fraudulent’ in the original title, though sanctioned by historical usage, was a misleading description of the Act as it was originally written.”  This is a good point, because constructively fraudulent transfers never required fraudulent intent on the part of either the transferor or transferee.  Moreover, even intentionally fraudulent transfers did not require transferee intent, and transferor intent was typically proven circumstantially via “badges of fraud.”  The Commissioners further note that the use of the old phrase bred bad habits, including uses of “oxymoronic and confusing shorthand tags” like “constructive fraud.”  The change is not designed to be substantive, and the UVTA amendments are not a “comprehensive revision” of the predecessor UFTA.  In Kentucky, of course, where we had no UFTA, UVTA is a comprehensive revision to our old statute.  Either way, its easy to see how a simple phrase change may have unintended substantive effect.  If we’re supposed to take the fraud out of fraudulent transfers, must a plaintiff plead with Rule 9(b) particularity when asserting a Section 4(1)(a) claim (which we all used to call an “intentionally fraudulent transfer”)?  That’s currently the rule in many courts, especially when interpreting Section 548 of the Bankruptcy Code, which admittedly uses the phrase “fraudulent transfers” in the title.  See this Skadden piece on the recent Lyondell II decision from the Southern District of New York.
  • What’s Voidable In Kentucky Now:
    • 4(1)(a) Claims:  Transfers made with actual intent to delay, hinder or defraud creditors are avoidable by existing and future creditors, and UVTA has saved us all a bunch of research time by specifically delineating the “badges of fraud” we all know and love.
    • 4(1)(b) Claims:  This appears to be a super-duper constructively fraudulent transfer action that, unlike garden-variety constructively fraudulent transfers, may be asserted by creditors whose claims arise after the transfer in question.  To prevail, plaintiffs must show a lack of reasonably equivalent value, and either (1) transferor undercapitalization or (2) that the transferor should have known that it was incurring debts beyond its ability to repay.
    • 5(1) Claims:  This is the old-school constructively fraudulent transfer action, available only to existing creditors, who must prove a lack of reasonably equivalent value and insolvency.
    • 5(2) Claims:  This is a new insider preference statute, available to existing creditors if “the transfer was made to an insider for an antecedent debt, the debtor was insolvent at that time, and the insider had reasonable cause to believe that the debtor was insolvent.”  The prior state law preference statute has been repealed.  The lookback on insider preferences under this section is 1 year.
  • The Lookback Period For Voidable Transfers In Kentucky Is Now 4-years.  Kentucky previously operated on a 5-year lookback for fraudulent transfers, but KRS 378A.090 “extinguishes” a creditor’s claim if not asserted by the fourth year after the subject transfer (but 1 year for the insider preference, as noted above).
  • A New Basis In Kentucky to Request a Receiver!  Section 7 of UVTA is a remedy toolkit available to a creditor plaintiff, and it includes the ability to obtain:  (i) attachment and/or other provisional remedies (query how nicely this will play with our still-existing prejudgment attachment statute, which has some tricky technical requirements discussed here); (ii) an injunction against further property disposition by a debtor or transferee; and (iii) the “appointment of a receiver to take charge of the asset transferred or of the other property of the transferee.”  Historically, state law receiverships in Kentucky most often arise as a supplemental remedy to judicial foreclosure, and we have heretofore lacked anything akin to federal equity receivership.  This new language could be very powerful.  Expect judges to look to the federal receivership jurisprudence before applying this.  If not approached carefully, plaintiffs may demand the appointment of a receiver over all of the property owned by an unlucky, unknowing garden-variety, constructively-fraudulent (er… I mean voidable) transfer defendant.

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Bankruptcy Rules Rule the Day in the Eleventh Circuit

Posted in Bankruptcy Trends, Circuit Split

Sometimes we forget that the Federal Rules of Bankruptcy Procedure differ from the Federal Rules of Civil Procedure by more than just the numbering scheme that adds two digits to the front of the bankruptcy rules.  The defendants in Rosenberg v. DVI Receivables XIV, LLC, et al., failed to appreciate that there are also different filing deadlines.  The Eleventh Circuit held that in a case tried in the district court arising under the Bankruptcy Code, the Bankruptcy Rules apply.  Thus, the 14-day deadline of FRBP 9015(c) applied to the defendants’ filing of a renewed motion for judgment as a matter of law under FRCP 50(b), and not the 28-day deadline under FRCP 50(b).  As a result, the court held that the defendants untimely filed their motion on the 28th day after judgment, and reinstated the $6.1MM adverse jury verdict.

The creditors had filed an involuntary petition in 2008 in Pennsylvania which was transferred to Florida and dismissed.  The Florida bankruptcy court retained jurisdiction to award costs to the putative debtor under § 303(i).  Rosenberg filed an adversary proceeding asserting bad faith on the part of the creditors.  In addition to seeking his attorney fees and costs for defeating the involuntary petition, he sought compensatory and punitive damages—and fees for pursuing the damages.  Rosenberg demand a jury trial and the creditors asked the district court to withdraw the reference.  Likening the § 303(i)(2) claims to malicious prosecution, the district court withdrew the reference.  The issue of attorney fees and costs remained with the bankruptcy court.  The jury found bad faith and awarded $1.12MM in compensatory damages and $5MM in punitive damages.  28 days later, the defendant creditors filed a Rule 50(b) motion.  Rosenberg moved to strike the motion as untimely.  The district court granted the motion, vacated the punitive damages award, and upheld only $360K in compensatory damages.

The Eleventh Circuit started with FRBP 1001 which states that the Bankruptcy Rules govern procedure in every case under the Bankruptcy Code to secure the just, speedy, and inexpensive determination of every issue.  The 1987 advisory committee notes indicate that amended FRBP 1001 makes the Bankruptcy Rules applicable to cases and proceedings under Title 11, whether before the district judges or the bankruptcy judges of the district.  FRCP 81(a)(2) provides for the primacy of the Bankruptcy Rules.  The Fourth and Seventh Circuits have held that nationwide service of process under FRBP 7004 applies in cases arising under the Bankruptcy Code but tried in district court.  The Eleventh Circuit viewed these opinions dealing with service of process—a fundamental aspect of the courts’ authority—as counseling applying the Bankruptcy Rules since personal jurisdiction is more significant than the deadline for renewing post-trial motions.  The Third Circuit has even applied the Bankruptcy Rules in non-core, ‘related to’ proceedings before a district court.  The Sixth Circuit, however, has applied the 28-day filing deadline for a motion under FRCP 59, not the 14-day deadline of FRBP 9023.  The Eleventh Circuit dismissed this ruling because it focused on a judicial estoppel issue, not which rules to apply.  The Court dismissed the defendants remaining arguments on conflicts with the Federal Rules of Appellate Procedure and the finality of the opinion with the bifurcated fee issue remaining in bankruptcy court.  The plain language of the rules and the weight of authority counseled for applying the 14-day deadline.  Even though the Court did not need to address the merits of the cross-appeal, it held that the defendants had waived the issue of the availability of emotional distress damages by not properly preserving.

On my first read of this case, I was thinking of some interesting questions: Is an involuntary petition a viable creditor strategy?  What are the limits of damages if the involuntary petition fails?  Should defendants seek to have the reference withdrawn?  Is there an ASARCO issue with seeking fees for chasing fees? (The Eleventh Circuit held in the separate appeal of this case that a putative debtor could recover its fees for pursuing its damages under § 303(I)—recognizing the split with the Ninth Circuit.)  But ultimately, the only question that I need to answer is: Can my calendaring system handle the rule of this case?

But Who Cares If You Were Actually Confused? No Proof of Confusion Required for Claims Under Section 1692g of the FDCPA

Posted in FDCPA

This week the Seventh Circuit Court of Appeals ruled that claims under Section 1692g of the FDCPA can survive summary judgment, even without extrinsic proof the plaintiffs were confused by a creditor’s correspondence.  In Janetos v. Fulton Friedman & Gullace, Case No. 15-1859, 2016 U.S. App. LEXIS 6361 (7th Cir. Apr. 7, 2016), the Plaintiffs brought suit alleging a law firm/debt collector had violated the FDCPA by failing to disclose the identity of the current creditor and by failing to disclose that the current creditor could be vicariously liable for the law firm’s actions. The district court granted the law firm’s motion for summary judgment, recognizing the letters at issue were ambiguous as to the identity of the current creditor but ruling that the Plaintiffs needed to present extrinsic evidence of confusion to survive summary judgment. The district court also concluded that, even if the Plaintiffs had presented evidence they were confused by the law firm’s correspondence, their claims would still fail because the ambiguity about the current creditor’s identification was immaterial and “would neither contribute to nor undermine the [FDCPA’s] objective of providing ‘information that helps consumers to choose intelligently.’”

The Seventh Circuit reversed. Although it agreed with the district court that the law firm’s correspondence failed to clearly identify the name of the current creditor, the Seventh Circuit disagreed that additional evidence of confusion was necessary to establish a violation of Section 1692g. The Court pointed out that Section 1692g requires debt collectors to disclose the name of the creditor, and failure to do so constitutes a violation of the Act regardless of whether the consumer was actually confused. The Court also rejected the district court’s application of a materiality requirement to claims under Section 1692g: “[F]or good reason, we have not extended the materiality requirement of Section 1692e to reach claims under Section 1692g(a)…Since Section 1692g(a)(2) clearly requires the disclosure, we decline to offer debt collectors a free pass to violate that provision on the theory that the disclosure Congress required is not important enough.”

The Court also addressed whether the owner of the debt, also a debt collector itself under the FDCPA’s definition, could be vicariously liable for the law firm’s violations. Following the Third Circuit and the Ninth Circuit, the Seventh Circuit decided that vicarious liability could exist.  This reiterates the importance of determining if you are a “debt collector.”  If the owner of the debt is not a “debt collector,” the Sixth Circuit has held that it is not vicariously liable for its debt collector’s actions.

Opinions like this should give “debt collectors” a reason to pause and reevaluate the letters they are sending and those that are being sent on their behalves. In addition to putting letters through a thorough in-house evaluation before they are sent, test the letters on friends and relatives from various backgrounds. If any confusion arises, no matter how slight, revisions should be considered.  And don’t forget the mandated disclosures under Section 1692g(a)(2) where actual confusion apparently does not matter.

Kentucky Legislative Tweaks

Posted in Kentucky Law

With only one day left in the 2016 legislative session—the legislature is scheduled to adjourn sine die on April 12—the General Assembly has passed, and the Governor signed, less than 30 of the 941 bills introduced—a success rate of only 3%.  Most of the remaining time will be spent in budget negotiations, and the Governor will be considering whether to sign or veto some additional bills.

For creditors, the Governor has signed some technical amendments of note:

  1. A termination statement of a lien noted on a motor vehicle (or other) certificate of title may be faxed from any county clerk to the county clerk of the county where originally filed. SB 74, amending KRS 186.045.
  2. The effectiveness of a lien noted on a motor vehicle (or other) certificate of title is extended from 7 years to 10 years. Continuation statements must be filed within 6 months of expiration, and will last 5 years (down from 7) counting from the date the existing lien would have expired. SB 122, amending KRS 186A.190.
  3. The provisions requiring deeds and mortgages to refer to the source of title of grantor or mortgagor are clarified – some were concerned that the language “next immediate source” meant a second step back in title. The amendment drops the word “next, ” and leaves it “immediate source.” SB 122, amending KRS 382.110 and 382.290.
  4. In foreclosures, the grantee by commissioner’s deed must be recorded within five days of receipt from the commissioner. SB 122, amending KRS 382.110.  This is a change supported by consumer advocates, thought it is not clear that there was a problem that needed fixing.
  5. The provisions allowing correction of mortgages by attorney’s affidavit were clarified to confirm that limitations prohibiting changes to terms, dollar amounts and interest rates apply only to affidavits of amendments, and not to amendments signed by both mortgagor and mortgagee. Also, the provision clarifies that such affidavits may be used to correct manifest clerical or typographical errors, such as spelling, punctuation or numbering mistakes in typing or printing. SB 122, amending KRS 382.297.

Judicial Estoppel Not a Slam Dunk

Posted in Bankruptcy Trends, Circuit Split

Seeing my Virginia Cavaliers lose to the Syracuse Orange and reading Mefford v. Norton Hospitals, reminds me that any discussion of judicial estoppel needs to be tempered by the doctrine’s exceptions and that the game is not over after the first half.  In Mefford, the Kentucky Court of Appeals reversed the trial court’s summary judgment based on judicial estoppel.  The debtor initially filed for Chapter 13 relief.  Post-confirmation, Norton treated the debtor in its emergency room.  The debtor moved to suspend her plan payments due to having “suffered several strokes and being unable to work.”  Shortly after suspending her plan payments, the debtor’s malpractice counsel put Norton on notice of the potential claim and filed suit.  The debtor continued to have difficulty making plan payments and the bankruptcy court ordered the dismissal of the case if the debtor failed to turnover her 2012 tax refund.  Facing dismissal, the debtor moved to convert the case to one under Chapter 7.  In her amended schedules and at the meeting of creditors, the debtor did not disclose the pending malpractice litigation.  The debtor answered in the negative to a direct question regarding current lawsuits.  After the bankruptcy court granted a discharge, Norton moved for summary judgment on the malpractice claim based on the debtor’s failure to disclose the litigation in her bankruptcy schedules.  The trial court granted the motion.  The appellate court reversed and remanded.

The appellate court began with the proposition that judicial estoppel is a harsh remedy which “may bind a party to a position without regard to the ‘truth-seeking function of the court.'”  The equitable doctrine is not absolute with courts recognizing that it is not appropriate in cases amounting to nothing more than mistake or inadvertence.  This inadvertence can be shown if the debtor lacks knowledge of the factual basis of the undisclosed claims or lacks a motive for concealment.  Since the debtor had been deposed in the malpractice litigation and knew the factual basis, she instead relied on advice of counsel to show that she had no motive.  At this point, the procedural history of her bankruptcy case became important.  In a Chapter 13 bankruptcy, the bankruptcy estate includes all property—including tort claims— that is acquired during the pendency of the case.  In a Chapter 7 bankruptcy, however, only claims which exist “as of the commencement of the case” become property of the estate.  Prior to 1994, courts had split on the result in a converted Chapter 7 case.  Congress amended § 348 to establish that, in the absence of bad faith, the estate property in a converted Chapter 7 only includes that which existed “as of the date of filing of the petition, that remains in the possession of or is under the control of the debtor on the date of conversion.”  Even with this amendment, post-conversion issues remain.  Most recently, the U.S. Supreme Court has held that the Chapter 13 Trustee must return all undistributed payments upon conversion (Harris v. Viegelahn).  But tort claims that arose post-petition have consistently been held not to be property of the converted estate.  Courts have also pointed out that a Chapter 13 debtor does not have an obligation to disclose post-petition tort claims because they are not included in § 541(a)(5).  Another issue pointed out in Mefford is that if the claim is completely exempt, there is no motive for concealment.

While Mefford came to the correct conclusion based on the procedural history of the bankruptcy case, it does raise a concern with the potential validity of an advice of counsel defense.  After the debtor disclosed the pending litigation, her counsel made the professional decision not to list the litigation on the post-conversion amended schedules.  While her counsel’s assessment that the claim was not property of the estate was correct, Mefford should not stand for the proposition that, as long as it is the attorney that encourages the cynical gamesmanship upon which judicial estoppel is based, the debtor cannot be held responsible.  In Mefford, this resulted in the debtor falsely answering a question of the Chapter 7 Trustee.  He may have had no claim to the current malpractice litigation, but the debtor did have a current lawsuit.  When the debtor testified falsely at the meeting of creditors, her counsel had some obligation to correct the testimony.  Bankruptcy is a remedy for the “honest but unfortunate debtor” and the rule of disclosure by the debtor should remain one of full disclosure.  Judicial estoppel—while a harsh remedy—protects the integrity of the bankruptcy process by preventing the gamesmanship which was present in Mefford.

Judicial Estoppel Better than Not Being a Debt Collector

Posted in Bankruptcy Trends, FDCPA

When handling an FDCPA claim, there are many initial questions to ask.  Besides the definitional issue, it is valuable to look for prior bankruptcies.  When a debtor fails to disclose the claim on the bankruptcy schedules, judicial estoppel prevents the debtor from later asserting it.  In Jarrett v. LVNV Funding, the Western District of Kentucky Court made quick work dismissing the debtors’ claim.  The debtors had listed the debt on Schedule F but had not indicated a dispute.  The bankruptcy court granted a discharge and two months later the debtors filed an FDCPA action in state court.  The creditor properly—and wisely—removed the action.

Judicial estoppel prevents a debtor from abusing the process through gamesmanship.  Not listing the potential claim on Schedule B renders any assertion post-discharge contrary to that initial position relied upon by the bankruptcy court.  To avoid the application of judicial estoppel, the debtor must show mistake or inadvertence in omitting the claim.  In Jarrett, the debtor’s assertion of mistake failed because the same attorney represented the debtor in the bankruptcy and the FDCPA action.  While the opinion discusses that the debtor failed to schedule the debt as disputed on Schedule F, this should not create a new escape for debtors.  The Sixth Circuit has held that it is important that the disclosure be made on Schedule B—not on the SOFA—so that the trustee can know the value of the claim.  Listing a debt as disputed on Schedule F provides no valuation or even an indication that there is an affirmative claim.

Judicial estoppel should be an arrow in every defense litigator’s quiver, not just creditor attorneys.  It can be difficult to have a state court enforce the doctrine and requires explaining bankruptcy schedules and the bankruptcy process (which may need the help of a bankruptcy attorney).  Often the debtor will attempt to correct the non-disclosure by reopening the bankruptcy case, but allowing the disclosure of a claim after being caught to cure the non-disclosure only encourages gamesmanship.  Also, there remains the possibility that the bankruptcy trustee will pick up the ball when it is returned to his court.  But at that point you will be dealing with a detached plaintiff who will only look at the economics of the claim.

Artificial Impairment, Artificial Confirmation

Posted in Bankruptcy Trends, Chapter 11, Circuit Split

Similar to pizza ingredients, artificial impairment of creditors results in artificial confirmation of the Chapter 11 plan.  In Village Green I, GP v. Fannie Mae (In re Village Green I, GP), the Sixth Circuit affirmed the decision to vacate the confirmation order a second time.  The debtor had three creditors: its lender, its former lawyer, and its former accountant.  The debtor’s only collateral, an apartment building, partially secured the lender’s claim ($3.2MM unsecured).  The debtor proposed paying the two minor claims in full over 60 days while cramming down the lender.  The plan provided for $2 million in principal payments over ten years while releasing the debtor from its obligation to maintain and insure the collateral adequately.  In the first appeal, the district court remanded for a determination as to whether the debtor had proposed the plan in good faith.  On remand, the bankruptcy court found good faith but the district court again vacated and remanded the case.  The bankruptcy court dismissed the case and the debtor appealed.

The Sixth Circuit addressed two issues with the confirmation of the plan.  In order to impair any class of creditors, under § 1129(a)(10), at least one class must accept its proposed impairment.  Section 1124 defines impairment but only asks if the creditor’s rights have been altered, not if the alteration appears contrived.  The Sixth joins the Fifth and Ninth Circuit in requiring the artificial nature of the impairment to be tested under § 1129(a)(3).  Only the Eighth Circuit makes a distinction on whether the impairment is economically driven or an exercise of discretion.  But when the Sixth tested whether “the plan has been proposed in good faith,” it noted that the debtor had ample cash flow to satisfy the minor claims.  Further, the closely allied “impaired” creditors compounded the appearance of circumvention.  Finally, the lender had offered to pay the minor claims in full.  The artifice employed by the debtor to “impair” a class showed the lack of good faith.

Artificial impairment occurs most often in single asset real estate (SARE) cases because the debtor must deal with the controlling lender.  SARE cases also provide opportunity for the lender to control the class of other creditors through claim buying.  But after Village Green, maybe debtors will attempt to disguise the artificial impairment better or make the cramdown a little more palatable.