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.

By Amanda Whorton

On March 11, 2016, the Fourth Circuit issued a published opinion in the civil case Providence Hall Associates v. Wells Fargo Bank. The court affirmed the district court’s dismissal of Providence Hall Associates’ (“PHA”) lawsuit against Wells Fargo Bank (“Wells Fargo”), holding that it was precluded by res judicata.

The Three Agreements and Bankruptcy Proceedings

PHA, a Virginia limited partnership, entered into three agreements with Wells Fargo. These transactions were a $2.5 million loan, a $500,000 line of credit, and an interest-rate-swap agreement. PHA defaulted on its loans and filed for Chapter 11 bankruptcy in March 2011. Wells Fargo filed a proof of claim in the bankruptcy proceeding for almost $3 million. PHA objected and filed an adversary complaint, alleging that Wells Fargo falsely represented that it would refrain from collecting the principal balance of the line of credit. PHA asserts that this caused it to default and enter bankruptcy.

The U.S. Trustee obtained court approval to sell two of PHA’s properties to satisfy its debts to Wells Fargo. In the Trustee’s sale motions, it requested that the proceeds be distributed to Wells Fargo. In November 2012, after PHA’s debts to Wells Fargo had been satisfied from the proceeds of the sales, the Chapter 11 bankruptcy proceeding was dismissed.

Over a year after the dismissal, PHA filed a suit in Virginia state court repeating the claims it made in the bankruptcy adversary complaint. Wells Fargo removed the suit to federal court and filed a motion to dismiss, which the district court granted on res judicata grounds, stating that the bankruptcy court’s sale orders precluded PHA from bringing this subsequent action.

Doctrine of Res Judicata

Res judicata, or claim preclusion, bars relitigation of issues that were or could have been raised in a previous action when the previous action constituted a final judgment on the merits and was between the same parties or their privies. Three elements of res judicata have to be met in order for it to bar a subsequent action: (1) final judgment on the merits, (2) identical causes of action between the prior and subsequent suits, and (3) identical parties or their privies in the two suits. The court also took into account two practical considerations, which include (1) whether a party or its privy knew or should have known of the claims during the first action, and (2) whether the court that ruled in the first action was an effective forum to litigate the claims.

The Sale Orders Meet the Three Elements of Res Judicata and the Two Practical Considerations

The Fourth Circuit found cases from its sister circuits persuasive in holding that the first prong of the res judicata analysis was met. Bankruptcy sale orders are considered final orders on the merits in the Fifth, Sixth, and Seventh Circuits. The Fourth Circuit further reasoned that the trustee, acting as PHA’s representative, would not have moved to sell the property to satisfy the debt if PHA did not in fact owe the amount that Wells Fargo claimed it was due. These motions to sell effectively conceded the validity of Wells Fargo’s claims and the proceeds of those sales satisfied PHA’s debts. The court reasoned that it would not serve judicial economy and promote finality if PHA was allowed to challenge in a new proceeding the transactions after the sales were made, the debt was satisfied, and the bankruptcy proceeding closed. Furthermore, the fundamental purpose of a Chapter 11 bankruptcy proceeding is the rehabilitation of the debtor. This is served by holding that PHA’s bankruptcy case ended in a final judgment on the merits.

The court held that the second prong of res judicata was also met. The Fourth Circuit uses the transactional approach with this prong: res judicata will bar a new claim if it is based on the same underlying transaction involved in the earlier suit. The court reasoned that the sale orders arose out of the same nucleus of operative facts as PHA’s claims in the current case, which are the three agreements between PHA and Wells Fargo.

The third prong was met, the Fourth Circuit reasoned, because the trustee was in privity with PHA as its representative in the bankruptcy proceeding. The trustee was able to therefore effectively litigate on PHA’s behalf.

The Fourth Circuit Affirmed the District Court

The Fourth Circuit held that PHA’s claims were barred by res judicata and affirmed the district court’s dismissal of PHA’s suit.

By Sarah Saint

In the March 11 civil case Providence Hall Associates Limited Partnership v. Wells Fargo Bank, the Fourth Circuit affirmed the district court’s decision to give res judicata effect to sale orders issued during Providence Hall Associates’ (“PHA”) Chapter 11 bankruptcy and thus dismiss PHA’s lawsuit against Wells Fargo Bank.

Procedural History of the Res Judicata Effect

PHA, a Virginia-based limited partnership, entered three transactions with Wells Fargo’s predecessor-in-interest prior to bankruptcy: (1) a $2.5 million loan, (2) a $500,000 line of credit, and (3) an interest-rate-swap agreement. The loan and line of credit had a cross-default clause–a default on one is a default on both–and were secured by deeds of trust, mortgages, and assignments of rent for PHA real estate holdings. When PHA defaulted on the loans, it filed a petition for Chapter 11 bankruptcy. Shortly after, PHA defaulted on the interest-rate-swap agreement.

Wells Fargo filed a proof of claim in the Chapter 11 case, to which PHA objected, alleging that Wells Fargo falsely represented that it would forbear the collection of the principal balance of the line of credit, which caused PHA to enter bankruptcy. The United States Trustee then moved to convert the Chapter 11 case to a Chapter 7 proceeding or, alternatively, dismiss it because PHA had failed to file monthly reports. Wells Fargo filed a memorandum in support of the motion, repeating that PHA’s principals used Wells Fargo’s cash collateral to pay distributions to themselves. The bankruptcy court decided to appoint a Chapter 11 trustee instead of converting or dismissing the case.

The trustee obtained court approval to sell two of the bankruptcy estate’s properties to satisfy the debts owed to Wells Fargo and bring PHA out of bankruptcy. The sale motions recognized PHA’s obligations to Wells Fargo, and the bankruptcy court noted that PHA was in debt to Wells Fargo in granting the motions. The proceeds of the sales satisfied PHA’s debts to Wells Fargo, and a principal of PHA filed a motion to dismiss the Chapter 11 proceeding, which was granted with the trustee’s consent.

Over a year later, PHA filed suit in Virginia state court, which Wells Fargo removed to federal court, alleging the same claims in the bankruptcy adversary complaint and new theories of lender liability. PHA specifically claimed that the interest-rate-swap transaction was a sham because the rate was illegally manipulated. Wells Fargo then filed a motion to dismiss, which the district court granted on res judicata grounds. PHA subsequently appealed.

Standard of Review and Rules of Law

The Fourth Circuit reviewed de novo the district court’s dismissal based on res judicata. The doctrine of res judicata maintains that a final judgment on the merits precludes the parties from relitigating issues that were or could have been raised in that earlier action. Three elements must be satisfied for res judicata to apply: (1) a final judgment on the merits in a prior suit; (2) an identity of the claim in both the prior and present suit; and (3) an identity of parties or their privies in both the prior and present suit. Additionally, two practical considerations should be taken into account: whether the party knew or should have known of its claims at the time of the first action and whether the court that ruled in the first suit was an effective forum to litigate the other relevant claims.

Prong 1: A Final Judgment on the Merits

The district court used cases from the Fifth, Sixth, and Seventh Circuits to determine that the bankruptcy sale order was a final order on the merits. The Fourth Circuit found those circuit decisions persuasive and also concluded that the first prong of the res judicata test was satisfied. Despite PHA’s attempts to distinguish its suit from the Fifth, Sixth, and Seventh Circuit determinations, the Fourth Circuit found that the distinctions were misplaced, unhelpful, unmeaningful and unpersuasive.

The Court dedicated a large portion of its analysis to PHA’s attempted distinction from the Seventh Circuit decision, where the trustee alleged fraud surrounding the sale proceedings while PHA alleged fraud unrelated to the sale proceedings. The trustee in this case moved to sell PHA’s property to satisfy specific obligations arising out of PHA’s transactions with Wells Fargo, which the bankruptcy court approved. The Court reasoned that it would not make sense to allow PHA to challenge the transactions that gave rise to its now-extinguished debt. In fact, it would upend the purpose of res judicata, to promote finality and judicial economy.

Relying on the other Circuit’s decisions, as well as the purpose of Chapter 11 bankruptcy–to rehabilitate the debtor–the Court concluded that sale orders are final orders on the merit. The fact that a bankruptcy court sale order is an in rem proceeding does not remove in personam lender liability claims arising out of the same claims and involving the same parties from the reach of res judicata. PHA contended that a previous Fourth Circuit decision and a district court decision would decline to give preclusive effect to sale orders. The Fourth Circuit rejected the prior Fourth Circuit decision because the discussion about res judicata in that decision was merely dicta and because PHA’s fraud claims arose out of the same underlying transaction as the sale order. The Fourth Circuit also rejected the district court decision because it is not binding authority, because it involved a lift-stay order and not a sale order, and because it does not make sense to liquidate a bankruptcy estate and then allow claims to be brought against the creditor regarding the now-satisfied debts.

Prong 2: Identity of the Claims

Res judicata bars a second suit if it is based on the same underlying transaction that was involved in the first suit and if it could have been brought in the prior action. The Fourth Circuit concluded that the sale orders arose out of the same nucleus of facts as PHA’s prior claims: the circumstances surrounding the three agreements between PHA and Wells Fargo. Accordingly, the second prong of the res judicata test was met.

Prong 3: Identity of the Parties of their Privies

Even though PHA was not a party to the sale order–the trustee was–the trustee was in privity with PHA as a representative of the debtor’s bankruptcy case. Thus, the third prong of the res judicata test was met.

Practical Considerations

PHA argued that it, as a debtor who was no longer a debtor-in-possession, could not have effectively litigated its claims against Wells Fargo. However, in doing so, the Fourth Circuit reasoned that PHA was relying on a faulty premise because the trustee was the party to the sale order and not PHA. Thus, the question is whether the trustee could have effectively litigated in the bankruptcy court. Because PHA offered no argument that the trustee could not effectively litigate in the bankruptcy court, the Fourth Circuit concluded that the two practical considerations were met.

Conclusion

Because the Fourth Circuit found that the three elements of res judicata were met and the two practical considerations were also satisfied, the Fourth Circuit held that the district court properly dismissed PHA’s suit against Wells Fargo and affirmed the district court’s judgment.

By Taylor Ey

Chapter 11 Attorney vs. Bankruptcy Trustee

Today, the Fourth Circuit issued its published opinion in the civil case, In re Anderson.  In this case, the debtor, Mr. Henry L. Anderson, Jr., filed for Chapter 11 bankruptcy in February 2010 and was represented by Stubbs & Perdue, P.A.  Subsequently, Anderson’s Chapter 11 bankruptcy case converted to a Chapter 7 case.  James B. Angell was appointed as the Chapter 7 Trustee. Anderson had two outstanding debts: approximately $200,000 in legal fees related to the bankruptcy proceedings owed to Stubbs & Perdue, P.A., and nearly $1 million in secured tax claims owed to the IRS.  Anderson’s estate had insufficient funds to pay both of the outstanding debts.  Stubbs & Perdue sued the bankruptcy estate trustee, Angell, seeking the attorneys’ fees granted by order during the Chapter 11 proceedings.  Thus, the issue was whether the attorneys’ fees claim or the secured tax claims take priority in a Chapter 7 liquidation under the Bankruptcy Code.

Governing Law: Changes in the Bankruptcy Code Lead to Confusion as to Which Version Applies

Generally under the Bankruptcy Code (“the Code”), secured claims take priority over unsecured claims, such as the unsecured claim for attorneys’ fees from the bankruptcy proceedings.  There is a limited exception to this general rule under 11 U.S.C. § 724(b)(2) for “administrative expenses.”  Until 2005, the Code was relatively straightforward.  It provided that all holders of claims for administrative expenses had the right to subordinate secured tax creditors.  In 2005, Congress redrafted the language in the exception to narrow it, but this change created confusion.  Congress again amended the Code in 2010, clarifying that § 724(b)(2) did not subordinate Chapter 11 administrative expense claims to secured tax claims.

Competing Arguments

Stubbs argued that the prior version of the § 724(b)(2) exception, before 2010, should apply and thus his claims for attorneys’ fees should subordinate the secured tax claims.  Angell argued that the law in effect at the time at the time of the decision should apply, that is the 2010 revision that clearly states that Chapter 11 administrative expense claims cannot subordinate secured tax claims.

Governing Principles: The Law in Effect at the Time of the Decision Governs and Retroactivity Is Disfavored

The Fourth Circuit stated that, unless the law in effect at the time of a decision would have retroactive effect, the law in effect will govern.  Therefore, in this case, because the 2010 version of the Code would not have retroactive effect, the Court applied the 2010 law.  The Court favored this outcome because it is clear and easy to administer.  This clarity is especially important in the bankruptcy context, said the Court, because the bankruptcy trustee has a fiduciary duty to repay the debtor’s creditors in an expeditious manner.

The Court Affirmed the District Court.

The district court applied the 2010 version of the Code, deciding that the secured tax claims had priority over the Chapter 11 administrative expenses.  The Fourth Circuit affirmed this decision.

 

By George Kennedy

On July 1, 2015, the Fourth Circuit issued a published opinion in the civil case of Houck v. Substitute Trustee Services, Inc. The Fourth Circuit held that the district court’s dismissal of Plaintiff’s claims brought under 11 U.S.C. § 362(k) was erroneous, and consequently vacated the district court’s judgment, reversed its order, and remanded the case for further proceedings.

Plaintiff’s Foreclosure Proceedings and Petition for Bankruptcy

In 2000, Plaintiff Diana Houck secured financing from Lifestore Bank, F.S.A. to purchase a mobile home for her property. In 2007, Houck refinanced the loan so that she could make renovations to her family farmhouse. Two years later, however, Houck lost her job and began to have difficulty making loan payments. Because of this, Houck asked Lifestore for a loan modification. In response, Lifestore referred Houck to a debt collection agency, Grid Financial Services, Inc., which denied Houck’s request.

In July 2011, the Hutchens Law Firm, representing both Lifestore and Grid Financial, served Houck with a notice of foreclosure. To stop the foreclosure proceedings, Houck filed for Chapter 13 bankruptcy protection because the filing of a bankruptcy petition triggers an automatic stay for certain debt collection actions under 11 U.S.C. § 362(a). While the bankruptcy court denied this first petition , Houck again filed for Chapter 13 bankruptcy protection. After filing the second petition, Houck called the Hutchens Law Firm to notify it of the bankruptcy filing. Notwithstanding Houck’s second bankruptcy petition, however, the Substitute Trustee, also represented by Hutchens, sold Houck’s property in a foreclosure sale.

Dismissal of Plaintiff’s Claims by the District Court

To undo the sale of her property, Houck commenced an action against Lifestore, Grid Financial, and the Substitute Trustee. Houck alleged a claim against the three Defendants under 11 U.S.C. § 362(k) for violation of the automatic stay triggered by the filing of a bankruptcy petition. Houck also alleged related state law claims.

In two separate orders, one in October 2013 and the other in February 2014, the district court dismissed all of Houck’s claims. In October 2013, the district court granted the Substitute Trustee’s motion to dismiss under Federal Rule of Civil Procedure 12(b)(6). The district court held that Houck failed to allege facts that showed that the Substitute Trustee’s violation of the automatic stay was willful. Since this is a necessary element for a claim under 11 U.S.C. § 362(k), the district court held that Houck failed to state a claim for relief and granted the Substitute Trustee’s motion. In February 2014, the district court dismissed the remaining claims against Lifestore and Grid Financial on the grounds that the court lacked subject matter jurisdiction to hear Houck’s claim under 11 U.S.C. § 362(k). The district court reasoned that such claims can only properly be heard in federal bankruptcy courts, and not district courts. The district court then dismissed Houck’s related state law claims.

The District Court Reversed

Ultimately, the Fourth Circuit held that the district court erred in dismissing Houck’s claims and rejected the reasoning underlying the district court’s holding. Yet before resolving Houck’s claims on the merits, the Fourth Circuit established that it had jurisdiction to hear Houck’s appeal. At issue in terms of appellate jurisdiction was whether Houck was appealing from a final judgment as required by 28 U.S.C. § 1291(a). The Fourth Circuit held that Houck was in fact appealing from a final judgment under the doctrine of cumulative finality. In so holding, the Fourth Circuit reasoned that the district court’s initial dismissal of Houck’s claims against the Substitute Trustee and subsequent dismissal of Houck’s claims against Lifestore and Grid Financial had the cumulative effect of rendering all Houck’s claims against these defendants as decided with finality.

Next, the Fourth Circuit addressed the district court’s holding that it did not have jurisdiction to hear claims brought under 11 U.S.C. § 362(k). The district court held that such claims can only be brought in the bankruptcy courts, and therefore, district courts do not have jurisdiction to resolve them. The Fourth Circuit disagreed, however, and held that the statute provides both district courts and bankruptcy courts with original jurisdiction over claims brought under 11 U.S.C. § 362(k). Therefore, the Fourth Circuit held the district court erred in dismissing Houck’s 11 U.S.C. § 362(k) claims against Lifestore and Grid Financial for lack of subject matter jurisdiction.

Lastly, the Fourth Circuit reversed the district court’s dismissal of Houck’s claims against the Substitute Trustee under Rule 12(b)(6) of the Federal Rules of Civil Procedure. In dismissing Houck’s claim, the district court argued that Houck failed to allege facts that, if true, would have satisfied all the required elements under 11 U.S.C. § 362(k). In particular, the district court held that Houck failed to provide any facts showing that the Substitute Trustee’s violation of the automatic stay was willful. The Fourth Circuit disagreed, and argued that by notifying the Hutchens Law Firm of her bankruptcy petition, Houck provided the Substitute Trustee with notice since the Substitute Trustee was also represented by Hutchens. Therefore, the Fourth Circuit held that Houck did allege facts to show that the Substitute Trustee’s violation of the automatic stay was willful because Houck alleged that the Substitute Trustee had notice of Houck’s bankruptcy petition which triggers an automatic stay under 11 U.S.C. § 362(a).

Vacated, Reversed in Part, and Remanded

Because the district court erred in dismissing Houck’s claims against Lifestore, Grid Financial, and the Substitute Trustee, the Fourth Circuit vacated the district court’s judgment, reversed its order, and remanded the case for further proceedings.

 

piles-of-money

By Taylor Anderson

On April 27, 2015, the Fourth Circuit issued its published opinion regarding the civil case In re Jenkins. The appellant, Matthew Alan Jenkins (“Jenkins”), appealed the decision of the lower courts, arguing that the Bankruptcy Administrator and the Trustee’s (collectively, “the Trustee”) complaint should have been dismissed as untimely. The Fourth Circuit sided with the appellant and applied Rule 2003(e) of the Federal Rules of Bankruptcy Procedure in order to determine when a creditors’ meeting concludes. The Court held that the meeting of the creditors “concluded” on the date the rescheduled meeting ended when counsel for Trustee failed to adjourn the meeting in compliance with Rule 2003(e); however, the Fourth Circuit declined to adopt the bright-line rule that the per se conclusion of the creditors’ meeting is the date that the trustee fails to strictly comply with Rule 2003(e) in adjourning the creditors’ meeting.

Factual Background

On April 11, 2012, Jenkins filed a petition for Chapter 7 bankruptcy relief. The Trustee convened a creditors’ meeting at which Jenkins testified as to disputed proceeds he had received; however Jenkins did not provide all the necessary information that Trustee needed from this meeting. As a result, counsel for the Trustee requested an extension of the deadline to file a complaint objecting to Jenkins’s discharge because another creditors’ meeting was needed. Pursuant to Rule 4004(b) of the Federal Rules of Bankruptcy Procedure, the bankruptcy court granted the Trustee’s request and extended the deadline to “sixty days beyond . . . whenever the 341 [creditors’] meeting is concluded.”

The next creditors’ meeting was scheduled to reconvene on July 11, however Jenkins did not attend this meeting. At a rescheduled creditors’ meeting on July 19, Jenkins appeared by telephone, but he again failed to provide the Trustee with the necessary information on that date, and so, before ending the telephonic meeting, counsel for the Trustee announced that she was “not going to conclude the meeting today.” Counsel further explained, “I am going to talk with the trustee and, if he determines that we can adjourn the meeting, we will file a notice of that, but officially the meeting is continued.” No notice of a continued meeting was ever filed, nor did the meeting ever reconvene.

On September 26, 2012, sixty-nine days after the July 19 creditors’ meeting, the Trustee filed a complaint, objecting to Jenkins’s discharge in bankruptcy. Jenkins asserted that the Trustee’s complaint was “barred by the applicable statute of limitations.” The bankruptcy court found the Trustee’s complaint timely and denied Jenkins a bankruptcy discharge. The district court affirmed, and Jenkins appealed.

Rule 2003 Speaks in Terms That Are Plainly Mandatory

Rule 2003 of the Federal Rules of Bankruptcy Procedure supplies the procedures by which a creditors’ meeting must progress. Specifically, Rule 2003(e) explains how a trustee is to conclude a creditors’ meeting. It provides, in its entirety: “The meeting may be adjourned from time to time by announcement at the meeting of the adjourned date and time. The presiding official shall promptly file a statement specifying the date and time to which the meeting is adjourned.”

Date of Creditors’ Meeting Conclusion

Jenkins asserted that the creditors’ meeting concluded on July 19, 2012, when the Trustee failed to adjourn the meeting to a stated later date and time. The Fourth Circuit agreed, holding that Trustee failed to follow Rule 2003(e)’s clear procedures.

In discussing Rule 2003(e)’s legislative history, the Fourth Circuit mentioned that Rule 2003(e) was amended in 2011 to add the requirement that “[t]he presiding official shall promptly file a statement specifying the date and time to which the meeting is adjourned” in order to prevent indefinite adjournment. To allow Trustee to prevail in this situation would allow him to do precisely what Rule 2003(e) seeks to prevent.

The Fourth Circuit found that Trustee undeniably violated Rule 2003(e). Though Trustee attempted to adjourn the creditors’ meeting on July 19, 2012, he failed either to announce the date and time of the adjourned meeting or to file a statement thereafter containing that information. Because Rule 2003(e) unambiguously requires these actions to effectuate an adjournment, the meeting was never adjourned. The Fourth Circuit said “because the meeting was never adjourned, we hold it was concluded” on July 19, 2012. Because Trustee filed the complaint sixty-nine days after July 19, 2012, this was an untimely filing and thus Trustee’s complaint should not have been considered by the lower court.

Fourth Circuit Declines to Adopt Bright-Line Approach

The Fourth Circuit made clear that it was stopping short of adopting a Rule 2003(e) “bright-line approach.” This approach states that the per se conclusion of the creditors’ meeting is the date that the trustee fails to strictly comply with Rule 2003(e) in adjourning the creditors’ meeting.

The Court discussed an example where a trustee fails to announce at the initial meeting the adjourned date and time, but promptly thereafter files a written notice setting forth that information. The Fourth Circuit stated that although the trustee in that situation is not in strict compliance with Rule 2003(e)’s twin requirements, such an action may not warrant an automatic declaration of the meeting’s conclusion as the date of the improperly adjourned meeting.

Judgment Reversed and Remanded

Because the Trustee did not comply with any part of Rule 2003(e), the judgment of the district court was reversed and the case was remanded for further proceedings.

By Chad M. Zimlich

On Monday, March 16, 2015, the Fourth Circuit in Moses v. CashCall, Inc., a published civil opinion, considered an appeal from a district court affirmation of a bankruptcy court decision from the Eastern District of North Carolina.

The appeal centered around whether claims for declaratory relief and for monetary damages asserted by Oteria Moses, a resident of Goldsboro, North Carolina, against CashCall, Inc. were subject to arbitration. The bankruptcy court retained jurisdiction over both claims, denying CashCall’s motions to compel arbitration. With respect to the claim of monetary damages, the bankruptcy court also made recommended findings of fact and conclusions of law. The district court affirmed the bankruptcy court’s decision.

On appeal, the Fourth Circuit held that that the district court did not err in affirming the bankruptcy court’s exercise of discretion to retain in bankruptcy Moses’ first claim for declaratory relief. However, the majority of the Court found that the district court erred in retaining in bankruptcy Moses’ claim for damages under the North Carolina Debt Collection Act and denying CashCall’s motion to compel arbitration of that claim. As to this part of the holding, the judges were split three ways, Judges Gregory and Davis for concurring in a judgment reversing the issue of arbitration for the money damages, and Judge Niemeyer dissenting.

A Question of Where the Case Belongs: Bankruptcy or Arbitration

The issue that the Fourth Circuit was confronted with was whether it was appropriate for either of Moses’ claims to be submitted to arbitration, or if one or both claims required the use of the bankruptcy court system. The question may seem simple, however, there were two distinct inquiries regarding each claim centered on the jurisdiction that the bankruptcy court had.

Loan Sharking By Western Sky

Facing financial difficulties, Moses signed a Western Sky Consumer Loan Agreement (“Loan Agreement”) on May 10, 2012, and agreeing to pay Western Sky, or any subsequent holder of the debt, $1,500 plus 149% interest. Pursuant to the agreement, Western Sky gave Moses $1,000, and retained $500 as a “prepaid finance charge/origination fee.” The Loan Agreement stated that the annual percentage rate for the loan was 233.10%, with the amount of all scheduled totaling $4,893.14. North Carolina law limits interest rates to a maximum of 16%. The Loan Agreement also gave Western Sky’s address as being in South Dakota and stated that the agreement was subject to the Indian Commerce Clause of the Constitution. Additionally, Western Sky was not licensed to make loans in North Carolina.

The Loan Agreement provided that any disputes relating to it were to be resolved by arbitration “conducted by the Cheyenne River Sioux Tribal Nation.” Lastly, the Loan Agreement stated that the arbitration could take place either on tribal land or within 30 miles of Moses’ residence, but in either case the Cheyenne River Sioux Tribe would retain sovereign status or immunity.

Three days after signing the Loan Agreement, Moses received a notice from Western Sky that the Agreement had been sold to WS Funding, LLC, a subsidiary of CashCall, Inc., and would be serviced by CashCall. Three months later Moses filed a Chapter 13 bankruptcy petition in the Eastern District of North Carolina. One week later, CashCall filed a proof of claim in the bankruptcy proceeding, asserting that Moses owed it $1,929.02. Moses objected on the basis the loan was not enforceable in North Carolina, both because of the unlicensed lending and the 16% limit. Moses also filed an adversary proceeding against CashCall seeking a declaratory judgment that the loan was void under North Carolina law, as well as damages against CashCall for its illegal debt collection.

After the bankruptcy court approved Moses’ bankruptcy plan, CashCall filed simultaneous motions to withdraw it’s claims, or, in the alternative, to compel Moses to arbitrate pursuant to the Loan Agreement. Because Moses had already filed an adversary proceeding against CashCall, CashCall could not withdraw its proof of claim without court approval. Moses objected to CashCall’s motion to withdraw its proof of claim. She contended that CashCall, which had 118 similar claims in the Eastern District of North Carolina, sought to withdraw its proof of claim in her case only after she had challenged its practices. The purpose of the withdrawal, Moses argued, was simply an attempt by CashCall to divest the bankruptcy court of jurisdiction.

The bankruptcy court denied CashCall’s motion to dismiss the complaint or to stay and compel arbitration, concluding that Moses’ claim for a declaratory judgment that CashCall’s loan was void was a “core” bankruptcy claim. As to Moses’ second claim, which sought damages, the court concluded that the claim was non-core, over which it could only recommend findings of fact and conclusions of law for a decision by the district court. The bankruptcy court also denied CashCall’s motion to withdraw its proof of claim, finding that the withdrawal would prejudice Moses by removing the court’s jurisdiction over the other causes of action. CashCall filed interlocutory appeals on both counts to the district court. The district court affirmed the bankruptcy court’s orders.

Whether a Claim is Statutorily or Constitutionally Core, and Tensions Between the FAA and Bankruptcy Code

The rule iterated by the Fourth Circuit was the basis of this decision hinges on whether or not the claim in question was constitutionally core according to the Supreme Court’s decision in Stern v. Marshall. The Court there held that “Article III of the Constitution prohibits bankruptcy courts from issuing final orders regarding statutorily core claims unless they ‘stem[] from the bankruptcy itself or would necessarily be resolved in the claims allowance process.’” That means that, should the claim be based in a statute but raise no constitutional questions, it should be treated as statutorily non-core and the district court is given de novo review, making it the court of first impression.

However, a further issue was the tension between the Federal Arbitration Act (“FAA”), which favors the use of arbitration and grants the decision to arbitrate to the court of first impression, and the Bankruptcy Code, which gives the bankruptcy courts their jurisdiction and lays out a completely separate purpose intended by Congress.

The Claim of a Declaratory Judgment Belonged to the Bankruptcy Court

The Court first noted that previous courts that have considered agreements similar to the Loan Agreement, specifically the Eleventh and Seventh Circuits and the District of South Dakota, have “found that the Cheyenne River Sioux Tribe has no laws or facilities for arbitration and that the arbitration procedure specified is a ‘sham from stem to stern.’” The Fourth Circuit agreed and found that the Loan Agreement was clearly illegal under North Carolina law due to the extreme interest rate, however that did not negate the fact that the agreement specified that Indian tribal law would apply and that any dispute under the agreement would be resolved by the Sioux Tribe’s arbitration.

However, while arbitration agreements should normally be enforced, in this case the Court found that the fundamental public policy present in the Bankruptcy Code was in direct conflict with a decision to arbitrate. Meaning that, should it be declared that the Loan Agreement was illegal this would have a direct and substantial impact on Moses’ Chapter 13 bankruptcy proceedings. Therefore, as the bankruptcy court had first impression for this claim, its denial of arbitration was not a violation of its discretion.

The Problem of the Claim of Damages and a Flurry of Opinions

Moses’ claim for damages was based on the North Carolina Debt Collection Act, and the majority’s opinion found no inherent conflict between the Bankruptcy Code and the effect that arbitration would have on Moses’ bankruptcy proceeding. However, even the two-judge majority split in their reasoning for this conclusion.

Judge Gregory relied on the Ninth Circuit’s opinion in Ackerman v. Eber in stating that bankruptcy courts generally have no discretion in refusing to arbitrate a claim that is found to not be constitutionally core. His concurrence went on to state that, while the claims shared a common question, the claim of damages did not pose an inherent conflict with the reorganization of Moses’ estate under the Chapter 13 bankruptcy proceeding. Additionally, Judge Gregory saw no issue with conflicting results, as the arbitrator’s order would be subject to enforcement by the district court. In this case, any conflicts that may arise would not be “inherent” and “sufficient” to the point that they overrode the presumption in favor of arbitration.

Judge Davis relied on a previous Fourth Circuit decision from 2005, In re White Mountain Mining Co., L.L.C., which spoke indirectly on the subject. Judge Davis’ opinion, while reflecting on the “odiousness” of CashCall’s practices and perhaps faulty arbitration procedures, emphasized the fact that the non-core claim of damages that Moses had in this case would in no way be frustrated by arbitration itself, and therefore the lack of direct conflict required deference to the FAA.

Judge Niemeyer’s dissent argued that the district court’s exercise of discretion to retain the damages claim presented the same question as the declaratory judgment. So in this view, if the loan agreement were invalid, separating the two claims would be inefficient and create issues of collateral estoppel. Therefore, the district court had not abused its discretion.

Bankruptcy Court May Keep Declaratory Judgment But Must Lose Damages Claim

The Fourth Circuit concluded that resolution of Moses’ claim for a declaratory judgment could directly impact the claims against her estate, and arbitration with the Cheyenne River Sioux Tribe would “significantly interfere” with the bankruptcy reorganization. Therefore, the district court was not in error in upholding the bankruptcy court’s decision. However, the money damages sought were not in direct conflict with the Bankruptcy Code and its procedures for Moses under Chapter 13, and the question of damages was one for an arbitrator and not the bankruptcy court.

By Taylor Ey

Today, the Fourth Circuit issued its public opinion in Covert v. LVNV Funding, LLC, affirming the decision of the District Court of Maryland, Greenbelt.

Procedural History

In 2008, Plaintiffs Covert, Haworth, Haworth, Ayele, and Brown separately filed petitions for Chapter 13 bankruptcy in Bankruptcy Court for the District of Maryland.  Defendants, LVNV Funding, LLC (“LVNC”) had acquired defaulted debt against each plaintiff.  LVLN filed proofs of claim against each plaintiff.  “A proof of claim is a form filed by a creditor in a bankruptcy proceeding that states the amount the debtor owes to the creditor and the reason for the debt.”  The bankruptcy court confirmed a plan that these claims were to be paid in pro rata amounts.

In March 2013, plaintiffs filed a class-action lawsuit, alleging that defendants had violated the federal Fair Debt Collection Practices Act (“FDCPA”) and Maryland law by filing proofs of claim without a Maryland debt collection license.  The district court granted defendants’ motion to dismiss for failure to state a claim under Fed. R. Civ. Pro. 12(b)(6).

The District Court Properly Dismissed Plaintiffs’ Complaint for Failure to State a Claim

Plaintiffs alleged that the defendants were not legally entitled to collect the debt because they did not have a license at the time they filed in bankruptcy court.  Plaintiffs requested injunctive relief and an instruction requiring defendants to return to the plaintiffs all the money paid pursuant to the proofs of claim.  Defendants asserted that plaintiffs failed to state a claim for which relief could be granted, and thus the claims should be dismissed.  The Fourth Circuit held that the district court properly dismissed the claims, but should have done so on res judicata grounds.

The Doctrine of Res Judicata in the Bankruptcy Context

In bankruptcy cases, prior bankruptcy judgment has res judicata effect when three conditions are met: “(1) the prior judgment was final and on the merits, and rendered by a court of competent jurisdiction in accordance with the requirements of due process; (2) the parties are identical, or in privity, in the two actions; and, (3) the claims in the second matter are based upon the same cause of action involved in the earlier proceeding.”  In re Varat Enters., Inc., 81 F.3d 1310, 1315 (4th Cir. 1996).

The Bankruptcy Court Decision Had Res Judicata Effect

The confirmation of a bankruptcy plan was a final judgment on the merits, and thus the bankruptcy judgment met the first element of the test.

Because both plaintiffs and defendants were parties to the proceedings in the bankruptcy court, the second element was met.

The claims before the district court arose “out of the same transaction or series of transactions, or the same core of operative facts” as those in the bankruptcy court action.  Varat, 81 F.3d at 1316. The plaintiffs would need to rely on the same facts as in the bankruptcy case to succeed in the present action.  Therefore, the bankruptcy judgment met the third element of the test.  Because all three elements are met, the plaintiffs’ claims were barred by res judicata.

The District Court’s Reading of the Cen-Pen Exception Was Too Broad

The district court held that plaintiffs’ claims were not barred by res judicata because it applied the Cen-Pen exception.  In Cen-Pen, the Fourth Circuit held that “[i]f an issue must be raised through an adversary proceeding it is not part of the confirmation process and, unless it is actually litigated, confirmation will not have a preclusive effect.”  Cen-Pen Corp. v. Hanson, 58 F.3d 89, 93 (4th Cir. 1995).

According to the Fourth Circuit, the district court misread Cen-Pen as creating a rule that “plan confirmation does not have preclusive effect to any issue that must have been decided through an adversary process.”

In this case, the Fourth Circuit clarified the rule.  First, the exception is limited to the facts; it applies to cases of secured claims after a bankruptcy proceeding.  In contrast, the present case involved a process used to collect an unsecured claim.  Moreover, because the parties in Cen-Pen were not directly involved in the bankruptcy proceeding that court sought to protect those parties’ rights in the subsequent proceeding.  Instead, the parties in this case were on notice as parties to the previous bankruptcy proceeding and did not need protection.

The District Court’s Decision Is Affirmed

Because plaintiffs did not assert any evidence suggesting that they could not have raised their present claims in the previous action, plaintiffs’ claims were barred.  The Fourth Circuit warned that holding otherwise would run counter to bankruptcy law policy.

by David Darr

Today, in Kingston at Wakefield Homeowners Association, Inc. v. Castell, an unpublished per curium opinion, the Fourth Circuit affirmed the decisions of the Eastern District of North Carolina and a North Carolina bankruptcy court finding Kim Castell, the debtor, did not have to pay $678.75 to Kingston at Wakefield Homeowners Association (HOA).

Was There a Lien on the Debtor’s House?

The only issue on appeal was whether the bankruptcy court erred in deciding that there was no lien on Castell’s real property making it unsecured debt because the HOA did not follow proper lien procedures.

Filing for Bankruptcy

On June 20, 2012, Castell filed for Chapter 13 bankruptcy. At that time, she owned the HOA $678.75 in dues associated with her ownership of real property in Kingston at Wakefield Plantation. This property was subject to the Declaration of Covenants, Conditions, and Restriction for Kingston at Wakefield Plantation (Declaration). The HOA claimed that the $678.75 was secured debt by a lien on Castell’s real property, thus not dischargeable in the bankruptcy proceeding. However, the HOA did not follow the statutory procedure of filing this lien with the county. The HOA’s claim was that the Declaration provided that the lien did not have to be filed to be effective, thus forming a valid lien without following the statutory provisions. The bankruptcy court found that there was no lien on Castell’s property. The HOA appealed and the Eastern District of North Carolina affirmed from which the HOA again appealed.

The Statutory Procedure vs. Declaration’s Procedure for Filing a Lien

North Carolina General Statute § 47F-3-116(a) states that a claim of lien must be “filed of record in the office of the clerk of superior court of the county in which the lot is located” and when filed “a claim of lien secures all sums due to the association.” However, it “does not prohibit other actions to recover sums.” In contrast the Declaration, states that unpaid dues shall become a lien on the real property, but also says that notice shall be given and recorded with the county.

No Common Law Procedure for Liens

The HOA argued on appeal that the language in the statute that allows “other actions to recover sums” points to a common law ability of a HOA to place liens on its real property and that the Declaration does not require the HOA to file a lien with the county. The Fourth Circuit disagreed with the HOA on both points. There is no common procedure way to file a lien because the statutory procedure is very specific and extensive and would preempt any common law rights. Secondly, the Fourth Circuit decided that even if there was a common law procedure for liens, the Declaration says to do the exact same thing as the statute. Both the statute and Declaration required filing with the county by their plain language. The HOA did not file with the county so no lien existed.

The Fourth Circuit Affirms

For the reasons stated above, the Fourth Circuit affirmed the decisions of the Eastern District of North Carolina and the bankruptcy court.

By: Lauren Durr Emery

In Susquehanna Bank v. United States of America/ Internal Revenue Service, the Fourth Circuit examined competing claims from Susquehanna Bank  and the Internal Revenue Service (IRS) to a company’s assets following its filing of Chapter 11 bankruptcy.

On September 20, 2004, the IRS assessed tax deficiencies in excess of $60,000 from Restivo Auto Body, Inc. (Restivo) for unpaid employment taxes.  However, the IRS did not file a lien until January 10, 2005.  On January 4, 2005, Restivo borrowed $1 million from Susquehanna Bank secured by a deed of trust for two parcels of property.  Susquehanna Bank did not record the deed until February 11, 2005.    In April of 2011, Restivo filed for Chapter 11 bankruptcy and Susquehanna sought a declaratory judgment from the court that its security interest had priority over the tax lien filed by the IRS.

Though federal law governs federal tax liens, 26 U.S.C. §6323(h)(1)(A) gives an IRS tax lien only those protections that local law would afford  to “a subsequent judgment lien arising out of an unsecured obligation.”  Thus, the court had to examine Maryland law to see if any of its provisions gave the bank priority in those circumstances.

Does a bank’s security interest in a parcel of land have priority over a federal tax lien if it was secured by a deed of trust executed before the lien, but not recorded until after?

The district court found that the security interest held by the bank had priority over the federal tax lien for two reasons.  First, the district court found that Md. Code Ann., Real Prop. § 3-201 allows a deed of trust’s effective date, upon recordation, to be the date when the deed of trust was executed.  In this way, it concluded, that though the deed of trust was recorded on February 11, 2005, the relation-back provision meant it was effective as of January 4, 2005 when the deed was executed.  In this way, Susquehanna’s interest had priority.  Second, the district court found that the bank’s security interest would have taken priority even if the deed had never been recorded based on Maryland’s doctrine of equitable conversion.  This doctrine entitles the holder of a deed of trust to the same protections as a bona fide purchaser, who takes title free and clear of all subsequent liens regardless of recordation.”

Fourth Circuit says Maryland’s relation-back provision does not give Susquehanna Bank priority over IRS

The Fourth Circuit held that the district court erred in its application of the relation-back provision in Md. Code Ann., Real Prop. § 3-201.  It reasoned that the deed was only subject to the relation-back protections after it had been recorded.  Thus, since the deed was not recorded until February 11, 2005, it did not yet relate back by when the IRS had filed its tax lien on January 10, 2005.

Fourth Circuit finds Susquehanna Bank does have priority over the IRS tax lien as a result of equitable conversion

Under Maryland’s doctrine of equitable conversion, when lenders, like Susquehanna Bank, receive a conditional deed to secure repayment of its loan, it receives the same protections as a bona fide purchaser for value.  In contrast, the IRS is treated as a judgment creditor and its claim is “subject to prior, undisclosed equities” and “must stand or fall by the real and not apparent rights of the defendant in the judgment.”  Thus, upon the execution of the deed of trust on January 4, 2005, Susquehanna Bank secured an interest in the property which precedes the IRS tax lien of January 10, 2005.

Dissent: Susquehanna Bank’s interest is not protected by equitable conversion

In Judge Wynn’s dissent, he argues that Restivo never had an unencumbered title which it could convey to Susquehanna Bank.  Instead, he states that the federal tax lien arose at the time of the original assessment on September 20, 2004.  Judge Wynn explains that this is a tax lien, rather than a judgment lien as the majority argues, and thus is governed solely by federal law.  Thus, this lien did not need to be filed or recorded in order to have priority.  Instead, he argues that the case should be governed by the principle “first in time is first in right.”

By Karon Fowler

Yesterday, in Pliler v. Stearns, the Fourth Circuit affirmed and remanded an appeal from the United States Bankruptcy Court for the Eastern District of North Carolina. The court held that above-median income debtors with negative disposal income are obligated to maintain Chapter 13 bankruptcy plans that last for five years when their unsecured creditors have not been paid in full.

Joe and Katherine Pliler filed a voluntary petition for Chapter 13 relief along with a proposed Chapter 13 plan.  The plan contained an early termination provision that would have allowed them to complete the plan within fifty-five months. The Trustee filed an objection to confirmation of the plan and a motion to dismiss for failure to file a plan in good faith and failure to pay an amount necessary during the applicable commitment period to comply with the statutory requirements. The Chief Bankruptcy Judge entered an order denying the objection and motion to dismiss. He directed the Trustee to file a motion for confirmation of a plan requiring the Plilers to pay a certain amount for sixty months with no early termination language. The Judge held that the statute’s “applicable time period” mandates that an above-median-income debtor commit to a sixty-month plan period irrespective of projected disposable income.

If the trustee or an unsecured creditor objects to the confirmation of a proposed Chapter 13 plan, the court may not confirm the plan unless “the plan provides that all of the debtor’s projected disposable income to be received in the applicable commitment period beginning on the date that the first payment is due under the plan will be applied to make payments to unsecured creditors under the plan.” (emphasis added).

The court reviewed the definition of applicable commitment period in 11 U.S.C. § 1325(b)(4) and held that an “applicable commitment period” is a temporal requirement. This is in step with all other circuits to have addressed the issue. The court’s plain language interpretation of the statute, in turn, effectuates the core purpose of the 2005 bankruptcy code revisions as “ensuring that debtors devote their full disposable income to repaying creditors.” This purpose is best achieved when Chapter 13 plans are required to last for three or five years, depending on the debtors’ income, unless all unsecured claims are fully repaid sooner.

The Plilers nevertheless argued that because their monthly disposable income as calculated on their initial bankruptcy form showed negative $291.20, no “projected disposable income” will be received “in the applicable commitment period,” rendering the plain length requirement senseless. However, the court explained the lack of projected disposable income at the time a plan is confirmed does not necessarily preclude additional funds from appearing later. It is not absurd for debtors to expectantly receive income (e.g., inheritances).

The court also rejected the Pliliers’ argument that the “applicable commitment period” only functions in relation to the provision requiring that all of the debtor’s projected disposable income to be received in the applicable commitment period be applied to make payments to unsecured creditors. However, the court points out that § 1329 expressly allows for post-confirmation plan modification. For purposes of plan modification, the court interprets the applicable commitment period as serving to measure plan duration in a manner wholly unrelated to debtors’ disposable income. Therefore, because the Plilers are above-median-income debtors, they are obligated to maintain a five year plan.

The Plilers’ other argument on appeal was that the bankruptcy court erred in looking beyond the negative disposable income calculation on their initial form to evaluate their projected disposable income. On this point, the Fourth Circuit expressed dissatisfaction with the bankruptcy court’s statement that it has the liberty to abandon the Code’s disposable income formula in favor of Schedules I and J completely, at least where debtors have not disposable income. Yet, the court recognized that a bankruptcy court undoubtedly has the ability to consider Schedule I, Schedule J, or other such evidence to ascertain “known or virtually certain” changes to disposable income. The court explained that the bankruptcy court did not err in relying on the Plan payment figure the Plilers themselves had proposed by stretching that figure over the full five-year period.

The order below was rendered at a joint session dealing with other cases. The Plilers did not receive an individualized hearing with an opportunity to present evidence regarding the feasibility of a five-year plan and any other pertinent points. Therefore, the Fourth Circuit ordered the opportunity be made available on remand.

Amicus briefs were filed by the National Association of Consumer Bankruptcy Attorneys, as well as the Ecast Settlement Corporation.