Wake Forest Law Review

By Mickey Herman

On Thursday, March 30, 2017, the Fourth Circuit issued a published opinion in LVNV Funding, LLC v. Harling, a bankruptcy case. Creditor-appellant, LVNV Funding, LLC (“LVNV”) appealed the bankruptcy court’s decision to sustain Rhodes’ and the Harling’s (collectively “Debtors”) objections to LVNV’s unsecured claims, which were raised after the confirmation date. After rejecting LVNV’s argument that such objections were precluded by the doctrine of res judicata, the Fourth Circuit affirmed the bankruptcy’s judgments.

Facts & Procedural History

In July 2014, Jeffrey Rhodes filed for bankruptcy relief under Chapter 13. Rhodes’ Chapter 13 plan was confirmed in October 2014. In June 2015, Derek and Teresa Harling similarly filed for relief under Chapter 13. Their plan was confirmed in August 2015. The Debtors’ Chapter 13 plans both “provided for treatment of unsecured creditors as a single class,” the members of which would be paid pro rata to the extent that funds remained after payment of all other claims. They also reserved to the Debtors the right to object to claims after plan confirmation.

LVNV filed proofs of claim in each case before the plans were confirmed, and neither the Debtors, nor their trustees, acted on the claims before their plans’ respective confirmations. Following their plans’ confirmations, the Debtors—relying on the reservation of rights clauses—objected to LVNV’s proof of claims, arguing that they were barred by the statute of limitations. Although LVNV conceded that its claims would ordinarily be so barred, it characterized the confirmation orders as final judgments and argued that the Debtors’ objections were precluded under the doctrine of res judicata. The bankruptcy courts disagreed with LVNV and sustained the Debtors’ objections. LVNV appealed, and the Fourth Circuit consolidated the Debtors’ cases.

Analysis

The court began by summarizing the role of res judicata in bankruptcy cases. Because “[a] debtor’s bankruptcy case ‘involves an aggregation of individual controversies,’” the court emphasized that it “may contain many ‘final decisions’ that do not necessarily fit squarely into the conventional formulation of res judicata.” Still, the court emphasized, confirmation orders “have a preclusive effect on those issues litigated at confirmation.” Resolution of the issue, therefore, required the court to consider what issues were determined by the confirmation orders and whether the courts “adjudicate[d] the merits of any individual unsecured creditor’s claim.”

The court first addressed the statutory structure of the Bankruptcy Code. After summarizing the distinctions between treatment of unsecured and secured claims, it emphasized that “[n]o provision of the . . . Code provides for the determination of the merits of an individual unsecured claim within the class of unsecured claims as part of plan confirmation.”

It turned next to the question of whether the elements of res judicata were met in the instant case. “Res judicata applies where three conditions are met: (1) there is a prior judgment, which was final, on the merits, ‘and rendered by a court of competent jurisdiction in accordance with the requirements of due process’; (2) the parties to the second matter are identical to, or in privity with, the parties in the first action; and (3) ‘the claims in the second matter are based upon the same cause of action involved in the earlier proceeding.’” Noting that both parties agree that the confirmation orders constitute final judgments “as to their subject matter” and that the parties were before the court when such confirmations were ordered, the court concluded that the first two elements of the doctrine were met.

The court concluded its analysis by considering “whether the ‘cause of action’ in the later proceeding—the validity of the Debtors’ objections to LVNV’s claims—was any part of the cause of action in the first proceeding, plan confirmation.” Ultimately, the court determined that the causes of action differed in that while the Debtors’ objections focused on LVNV’s claims, the plan confirmations only considered unsecured creditors as a class. This result is necessitated by the structure of the Bankruptcy Code, in which “Congress had made Chapter 13 plan confirmation and claim-allowance on contested unsecured claims to be separate and distinct actions within a . . .  proceeding.”

Conclusion

Rejecting the contention that plan confirmation constitutes a final judgment as to an individual unsecured creditors claim, the Fourth Circuit affirmed, holding that the Debtors’ objections to LVNV’s claims were not barred by the doctrine of res judicata.

By Sophia Blair

On January 5, 2017, the Fourth Circuit published an amended opinion for the civil case, Lynch v. Jackson, originally decided on January 4, 2017.

Bankruptcy Court Decision and Appeal to the Fourth Circuit

Gabriel and Monte Jackson (“Jackson”) filed a petition for Chapter 7 bankruptcy relief. Marjorie Lynch (“Lynch”), a Bankruptcy Administrator, moved to dismiss their case as an abuse. Lynch alleged that the Jacksons over reported their expenses when filing for relief because they used the National and Local Standard amounts in their application form instead of their actual expenses, which were lower.

In filing for Chapter 7 bankruptcy, the Jacksons had to fill out a means test because they earned over the median income for a family of their size. The test is used to determine the amount of a debtor’s disposable income, which may reveal abuse if that income is above a certain level and prevent them from proceeding under Chapter 7. The Jacksons followed the instructions of form 22A-2, which says, “Deduct the expense amounts set out in lines 6-15 regardless of your actual expense. In later parts of the form, you will use some of you actual expenses if they are higher than the standards.” The Jacksons used the standard mortgage and car payment expenses, even though both were higher than their actual expenses.

Lynch argued that the official forms were incorrect and that a Chapter 7 debtor was “Limited to deducting their actual expenses or the applicable National or Local Standard, whichever [was] less.” The Jacksons countered, stating the statute was unambiguous. The Bankruptcy Court denied Lynch’s motion to dismiss on the basis that the Jackson’s interpretation comported with the plain meaning of the statute, and both parties filed a request for permission to directly appeal to the Fourth Circuit.

The Fourth Circuit held that they had jurisdiction over the appeal, and granted the appeal with respect to the question: does 11 U.S.C. § 707(b)(2) permit a debtor to take the full National and Local Standard amounts for expenses even though the debtor incurs actual expenses that are less than the standard amounts?

Was there an abuse of Bankruptcy Relief?

The Fourth Circuit held that under the plain meaning of the statute, a debtor is entitled to deduct the full National and Local Standard amounts even though their actual expenses are below the standard amounts.

In order to determine whether the Jacksons abused bankruptcy relief, the Fourth Circuit looked to the plain meaning of § 707(b)(2)(A)(ii)(I) of the statute. This section states: “the debtor’s monthly expenses shall be the debtor’s applicable monthly expense amounts specified under the National Standards and Local Standards, and the debtor’s actual monthly expenses for the categories specified as Other Necessary Expenses issued by the Internal Revenue Service for the area in which the debtor resides . . . .”

Where the statute’s language is plain, the Fourth Circuit ends its inquiry after enforcing the statute according to its terms in the context of the overall statutory scheme. See Hartford Underwriters Ins. Co. v. Union Planters Bank, N.A., 530 U.S. 1, 6 (2000); Davis v. Mich. Dep’t of Treasury, 489 U.S. 803, 809 (1989). The court found that the language of  § 707(b)(2)(A)(ii)(I) was clear on its face because it specified that “[t]he debtor’s monthly expenses shall be the debtor’s applicable monthly expense amounts specified under the National Standards and Local Standards.” The court relied on the theory of statutory construction that where Congress uses different words in the same statute, they should have different meanings. Here the court distinguished between “applicable monthly expenses” in the first clause of the statute, and “actual monthly expenses” in the second clause. Therefore, the court understood that the”applicable monthly expenses” were the full National and Local Standard amounts.

Additionally, the Fourth Circuit opined that to construe “applicable” and “actual” to have the same meaning would have the absurd result of punishing frugal debtors. A frugal debtor would be punished to for spending less. Relying on Griffin v. Oceanic Contractors, Inc., 458 U.S. 564, 575 (1982), the court sought to read the statute in such a way as to avoid absurd results.

Disposition

The Fourth Circuit affirmed the bankruptcy court’s judgment to deny Lynch’s motion to dismiss, because the Jacksons had not abused bankruptcy relief by providing the National and Local Standard amounts, instead of their actual expenses in form 22A-2.