Supreme Court to Decide Four Bankruptcy Cases This Term

The Supreme Court will decide four cases this term that are certain to have a significant impact on consumer bankruptcy cases. The Court will determine whether a debtor can obtain a student loan hardship discharge in bankruptcy court when the creditor is a state guaranty agency or state college; how much the debtor will need to make in present value interest payments in a chapter 13 cramdown; whether the deadline in the Bankruptcy Rules for creditor objections to discharge can be tolled on equitable grounds; and whether a debtor’s attorney can be paid out of estate property for services provided during the bankruptcy.

Sovereign Immunity - Tennessee Student Assistance Corp. v. Hood (Amicus Brief)

In Tennessee Student Assistance Corp. v. Hood, the Supreme Court will decide whether Congress has authority to abrogate state sovereign immunity under the Bankruptcy Clause of the Constitution (Article I, section 8, clause 4).1 The Sixth Circuit decided in Hood that § 106(a) of the Bankruptcy Code was a valid abrogation of a state’s immunity from suit since it was enacted pursuant to Congress’ powers under the Bankruptcy Clause.2 However, the majority of appellate courts have read the Supreme Court’s decision in Seminole Tribe of Florida v. Florida3 as severely limiting Congress’ authority in this area and have found that § 106 is not a valid abrogation.4

The student loan guaranty agency in Hood has argued that abrogation is unnecessary because a debtor can assert student loan bankruptcy dischargeability as a defense in some future state-initiated collection action. However, this argument is disingenuous since guaranty agencies almost never file court collection actions because they can use extra-judicial collection procedures. Unlike ordinary creditors, guaranty agencies can garnish wages, intercept tax refunds and seize retirement or other government benefits without bringing a court action, and can do so unhampered by state exemption laws, statutes of limitation, or other state and federal law collection restrictions. Importantly, a guaranty agency that is determined to avoid an undue hardship dischargeability determination after a debtor has filed bankruptcy can simply elect not to bring a state court action and instead rely exclusively on the non-judicial procedures. Thus, if guaranty agencies are immune from bankruptcy dischargeability proceedings, the right to a student loan hardship discharge will effectively exist without a remedy.5

Because a negative ruling on the abrogation issue will shield guaranty agencies from bankruptcy court determinations and leave debtors without a forum to get a hardship discharge ruling, hopefully the Supreme Court will either affirm in Hood or at a minimum provide some viable alternative for debtors. In its amicus brief, NACBA has suggested that the Court should reaffirm the vitality of the Ex Parte Young6 doctrine as one possible alternative. The Young doctrine permits suits for prospective declaratory and injunctive relief against state officers to prevent them from violating federal law. 7

A bankruptcy adversary proceeding filed against an officer of a student loan guaranty agency seeking a hardship discharge declaration is an appropriate use of the Young doctrine.8 A debtor whose student loan is dischargeable under § 523(a)(8) needs a dischargeability declaration only because the student loan authority has refused to recognize that the debt is dischargeable. In such cases where the debtor alleges that a state officer is acting unlawfully in refusing to implement the statute, the first prong of the Young doctrine is satisfied. 9 The final requirement for invoking the Young doctrine also applies because the debtor is typically requesting only prospective and injunctive relief, and not a request for retrospective damages.

Cramdown Interest Rate - Till v. SCS Credit Corp. (Amicus Brief)

One of the most controversial issues under the Code that has produced numerous conflicting opinions is the rate of interest required to be paid to a secured creditor to satisfy the chapter 13 cramdown provision in § 1325(a)(5)(B). The Second, Eighth and Ninth Circuits have adopted a “formula” method for computing the cramdown rate of interest, which generally involves some consideration of the rate of interest the creditor would have to pay to borrow an amount equal to the collateral’s value. Under the “formula” method, the court adopts a readily-available or national risk-free rate as a base and adds a premium based on the court’s determination of the risk anticipated under the plan.10

Other Circuits have applied variations of the “coerced loan” method,11 which was adopted by the Seventh Circuit in the Till case to be decided by the Supreme Court.12 The Till court described the coerced loan approach as follows: “Courts taking this view conceptualize the cramdown provision as forcing creditors to extend a new line of credit to the debtor. Consequently, ‘the creditor is entitled to the rate of interest it could have obtained had it foreclosed and reinvested the proceeds in loans of equivalent duration and risk.” 13 Applying this to the facts in Till, the Seventh Circuit concluded that the subprime creditor’s contract rate, which was 21%, should be used as the presumptive rate.

One problem (and there are many) with this approach is that it establishes a presumption in favor of the contract rate that is very difficult and costly for the debtor to rebut.14 The debtor needs to demonstrate that the creditor would charge an interest rate different than the contract rate when lending money to a similarly situated debtor. In the case of subprime and predatory lenders, the rate actually charged often reflects whatever the creditor is able to extract out of the consumer, and may be the product of deceptive or fraudulent practices. Moreover, debtors attempting to meet the evidentiary burden in rebutting the presumptive contract rate will be faced with expensive discovery battles as creditors will be unwilling to respond to discovery requests about their credit-granting standards.

In addition, the presumptive contract rate approach does not truly reflect the actual loan rate charged by creditors because in many situations the interest earned at the contract rate is reduced by a kick-back that a creditor gives to the original dealer or mortgage broker who initiated the loan (dealer mark-ups and yield spread premiums). And in the case of lenders that engage in predatory practices, the presumptive contract rate approach rewards the most exploitive and overreaching creditors, often at the expense of other creditors in the debtor’s bankruptcy.

Dischargeability Deadlines - Kontrick v. Ryan (Amicus Brief)

In Kontrick v. Ryan, the Supreme Court will decide whether the time deadlines established in Bankruptcy Rules 4004(a) and 4007(c) may be extended for reasons not expressly provided for in those rules, such as equitable considerations that might excuse an out-of-time objection based on waiver, fraudulent concealment, laches or excusable neglect.15 In the lower court, the Seventh Circuit held that the deadline could be extended under the facts of the case because the debtor had also been tardy in not promptly asserting as a defense to a nondischargeability action that an amended complaint raising a new dischargeability issue had not been brought within the 60-day filing deadline.16

In Taylor v. Freeland & Kronz,17 the Supreme Court refused to afford a permissive construction to a set of bankruptcy rules almost identical to those at issue in Kontrick v. Ryan. It did this by simply applying the plain language of the rules without attempting to determine whether the deadlines were “jurisdictional in nature.”18 If the Court follows Taylor, it should hold that the plain language controls, that a discharge objection action must be filed by the specified deadline, and that a bankruptcy court may not exercise discretion to extend the deadline based on equitable tolling doctrines.

If it affirms, hopefully the Court’s holding will be strictly limited to the situation in which a debtor commits laches by not asserting the timeliness defense before the dischargeability action has been litigated. Any other result that might permit a creditor to claim excusable neglect in bringing an untimely dischargeability action could seriously hurt debtors by encouraging the filing of frivolous non-dischargeability actions simply as a means to coerce settlements.19

Attorneys Fees - Lamie v. U. S. Trustee

Since enactment of the 1994 Code amendments, some debtors’ attorneys have had problems getting paid from the debtor’s bankruptcy estate. As part of the revisions to § 330, the reference to ‘‘the debtor’s attorney’’ as one of the persons who could be paid professional fees was omitted from the section. It is likely that this omission was a technical drafting error, as no legislative history indicates that a change was intended. However, it has created a split of authority on whether debtors’ attorneys can be paid. 20

To resolve the conflict in the Circuits, the Supreme Court granted certiorari in Lamie v. U. S. Trustee, a case in which the Fourth Circuit sided the Fifth and Eleventh Circuits in holding that the debtor’s attorney could not be paid.21 Regrettably, this problem with § 330(a) will likely require a legislative fix as the Court may not want to read words into the statute that do not exist.22

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1 The issue may more appropriately described as whether the states surrendered their sovereignty in bankruptcy matters through the ratification of Constitution.

2 In re Hood, 319 F.3d 755 (6th Cir. 2003).

3 517 U.S. 44 (1996).

4 E.g., Nelson v. La Crosse County Dist. Atty., 301 F.3d 820 (7th Cir. 2002); In re Sacred Heart Hospital of Norristown, 133 F.3d 237 (3d Cir. 1997); Matter of Estate of Fernandez, 123 F.3d 241 (5th Cir. 1997); In re Creative Goldsmiths of Washington, 119 F.3d 1140 (4th Cir. 1997).

5 Advocates should not assume that all guaranty agencies are entitled to claim immunity, as they must prove that they are an “arm of the state.” See NCLC Reports, 19 Bankruptcy and Foreclosures Ed. (Nov/Dec. 2000).

6 209 U.S. 123 (1908). See also Alden v. Maine, 527 U.S. 706, 756-57 (1999); Idaho v. Coeur d’Alene Tribe of Idaho, 521 U.S. 261, 276-77 (1997); Seminole Tribe of Florida v. Florida, 517 U.S. 44, 48 (1996).

7 To invoke the Young doctrine, the party seeking enforcement of federal law must establish the following two elements. First, the party must allege that a state official is acting in violation of federal law. See Pennhurst State School & Hosp. v. Halderman, 465 U.S. 89, 106 (1984). Second, the relief sought must be prospective in that the party must seek to enjoin future violations of federal law rather than obtain monetary compensation or other retrospective relief for past violations. Green v. Mansour, 474 U.S. 64, 68, (1985); Quern v. Jordan, 440 U.S. 332, 346-49 (1979).

8 In re Schmitt, 220 B.R. 68 (Bankr. W.D. Mo. 1998)(student loan hardship dischargeability action may proceed against official of state college).

9 Some courts have wrongly held that the Young doctrine is not applicable in the student loan context by suggesting that the debtor cannot allege a continuing violation of federal law before a court has declared the debt to be dischargeable. See, e.g., In re Holland, 230 B.R. 387 (Bankr.W.D.Mo. 1999); In re Snyder, 228 B.R. 712 (Bankr.D.Neb. 1998). These cases are falsely premised on a reading of § 523(a)(8) to the effect that a student loan is not dischargeable unless a court has determined that it is dischargeable. See, e.g., In re Janc, 251 B.R. 525 (Bankr. W.D. Mo. 2000). While student loan creditors will, as a practical matter, continue collection efforts absent such a determination, the language of § 523(a)(8) clearly provides that a loan is dischargeable if it meets the undue hardship test; it does not provide that the loan is non-dischargeable until a court finds otherwise. There is no basis for distinguishing student loans from other types of debts which in certain circumstances can be non-dischargeable, such as tax debts. Student loans are either discharged or not discharged depending solely upon whether they fit the description in § 523(a). In contrast to the dischargeability provisions listed in § 523(c), which renders certain debts dischargeable unless the bankruptcy court specifically finds otherwise, a debt is not automatically discharged or not discharged under § 523(a)(8) or the other dischargeability provisions if the bankruptcy court does not make a determination of dischargeability. See Collier on Bankruptcy, ¶ 4007.03, n. 4a (15th ed. rev.).

10 E.g., In re Valenti, 105 F. 3d 55 (2d Cir. 1997)(treasury bond rate plus a 1-3% risk premium); In re Fowler, 903 F. 2d 694 (9th Cir. 1990), United States v. Doud, 869 F. 2d 1144 (8th Cir. 1989)(treasury bond plus 2% risk premium).

11 E.g., In re Smithwick, 121 F. 3d 211 (5th Cir. 1997); United Carolina Bank v. Hall, 993 F. 2d 1126 (4th Cir. 1993); GMAC v. Jones, 999 F. 2d 63 (3d Cir. 1993); In re Hardzog, 901 F. 2d 858 (10th Cir. 1990); United States v. Arnold, 878 F. 2d 925 (6th Cir. 1989).

12 In re Till, 301 F.3d 583 (7th Cir. 2002).

13 Till, 301 F.3d at 591, citing Koopmans v. Farm Credit Servs. of Mid-America, ACA, 102 F.3d 874, 875 (7th Cir. 1996).

14 Additional arguments against adoption of a coerced loan approach are contained in the amicus curiae brief filed in Till by NCLC, NACBA and the Consumer Federation of America.

15 Both Rules 4004(a) and 4007(c) state that a complaint objecting to a debtor’s discharge or the discharge of a particular debt under § 523(c) of the Code must be filed within 60 days of the date first set for the meeting of creditors. Both Rules also provide that the court may for cause extend the deadline, but only if the party seeking the extension files a motion before the time deadline expires. No other exceptions are provided for in the Rules. In addition, Rule 9006(b)(3) states that the strict time deadline in Rules 4004(a) and 4007(c) may be enlarged “only to the extent and under the conditions stated in those rules.”

16 Ryan v. Kontrick, 295 F.3d 724, 730 (7th Cir. 2002).

17 503 U.S. 638 (1992)(time deadline established for the filing of objections to exemptions under Rule 4003(b) is absolute and may not be extended).

18 The Seventh Circuit concluded that the time deadlines in Rules 4004(a) and 4007(c) are not jurisdictional. Kontrick, 295 F.3d at 733. Compare In re Benedict, 90 F.3d 50 (2d Cir. 1996); Farouki v. Emirates Bank Int’l, Ltd., 14 F.3d 244 (4th Cir. 1994); with In re Leet, 274 B.R. 695 (B.A.P. 6th Cir. 2002).

19 Low and moderate-income debtors have reason to be apprehensive of a rule construction that would encourage the filing of untimely dischargeability actions. These debtors do not have the financial means to engage in protracted litigation over dischargeability claims. As such, they are particularly vulnerable to creditor attempts to settle threatened or filed dischargeablity actions so as to avoid litigation costs, even when the actions are groundless either in terms of the merits of the equitable tolling argument or the underlying claim. See, e.g., In re Grayson, 199 B.R. 397 (Bankr.W.D.Mo. 1996). A creditor who has not been diligent in meeting the 60-day filing deadline, but who appreciates the economics of the situation, will not be deterred from threatening suit, knowing that the debtor will likely pay $500 as a nuisance settlement rather than face $3,000 in litigation costs to defend the claim on the merits.

20 The Third and Ninth Circuits have held that a bankruptcy court may award compensation to debtors’ attorneys, notwithstanding the fact that the words “the debtor’s attorney” appear to have been inadvertently omitted. In re Top Grade Sausage, Inc., 227 F.2d 123 (3d Cir. 2000); In re Smith, 305 F.3d 1078 (9th Cir. 2002); and In re Century Cleaning Servs., Inc., 195 F.3d 1053 (9th Cir. 1999). See also, In re Ames Dep’t Stores, 76 F.3d 66, 71-72 (2d Cir. 1996)(dicta). In contrast, the Fifth and Eleventh Circuits have held that counsel for the debtor may not be compensated. In re American Steel Prod., Inc., 197 F.3d 1354 (11th Cir. 1999); and In re Pro-Snax Distrib., Inc., 157 F.3d 414 (5th Cir. 1998).

21 In re Equipment Services, Inc., 290 F.3d 739 (4th Cir. 2002).

22 Fortunately, section 330(a)(4)(B) makes clear that the court can award fees to debtors’ attorneys in chapters 12 and 13.