Welcome to Jim White

Does your employer (like mine) not give you MLK Day off?  Well, then Credit Slips has just the solution to your woes: reading the musings of our newest guest blogger, Prof. James J. White.  Good law nerds will be well acquainted with his celebrated co-authored treatise, but for those who need an introduction, Jim has been one of the nation's leading commercial law academics since, well,I don't know -- maybe the McKinley Administration?  In any event, how long he's been writing is not important.  What's important is that he's an insightful and provocative scholar.  I'm sure he'll provide a soothing tonic for those who fear the tone of this blog sometimes drifts toward the liberal end of the political spectrum...

Fargo (No, not North Dakota -- Argentina)

Just a heads up for another interesting international decision out of the Southern District of New York. Here, Chief Judge (Stuart, not Stan) Bernstein booted an involuntary petition opened against Fargo by some creditors who were unhappy with how things were unfolding in the Argentine "concurso" of Fargo, which is Argentina's largest commercial producer of bread and bread products. It's a fun story, involving an Argentine appellate court that may have been out in left field ("Indeed, Fargo has conceded certain procedural irregularities, and its own expert has acknowledged that the appellate ruling suffers from 'flaws.'") Basically, the aggrieved parties who want to move things Stateside are bondholders who were surprised to find that the Argentine appellate court, in ostensibly resolving the question whether the face value or market value of their notes should determine their claims and voting purposes, decided to value their claims based on neither and instead, adopting a position advocated by neither party, set their voting rights based on only the unpaid interest of the notes(!).

Anyway, there was a two-year back and forth with the Argentine Supreme Court and it appears that the noteholders basically got fed up and filed an involuntary 11 in SDNY. In exercising rights to dismiss the petition under § 305(a)(1), Chief Judge Bernstein  noted that other than the bondholders, all the players were in Argentina, that all the property save a trademark or two was held in Argentina, and that a hypothetically confirmed chapter 11 plan would have little effect, other than reddening the face of an Argentine judge when asked for recognition, and that the creditors were all participants (albeit unhappy ones) in the Argentine proceeding. As for the suggestions that the Argentine commercial judiciary is corrupt and that the peculiarities of Argentine insolvency law were public-policy-offensively different, he (rightly) brushed them aside. (I'm not even getting into the greenmailing sub-plot.)

Seeing the writing on the wall, the creditors asked that rather than dismiss the petition, the court should only suspend it, which would leave in place the U.S. stay and allow, in effect, Judge Bernstein to "take another look at the the progress in Argentina in the future. In other words, they want me to oversee the Argentine bankruptcy. []I decline the invitation. The automatic stay is not an end unto itself,  but a protection a debtor gets to allow it to reorganize." (He also noted the irony that the stay-favoring creditors had violated the Argentine stay by filing the involuntary 11!)

I see this as another good opinion taking a pragmatic and principled approach to cross-border insolvency. Perhaps a more technically literate reader will post a link to the opinion...

UPDATE (11/28): A copy of the opinion is now available here.

On Mortgage Brokering

I'm still trying to understand fully how this market works, and I've got some outstanding questions about which I'd be interested in getting some more information.

1) Many commentators contend banks charge more for their retail rates than mortgage brokers are able to procure for buyers (and still make a comfortable profit margin for the broker to boot).  This was certainly my experience when I tried using a broker and phoning some banks directly.  But I don't understand how that business model is economically tenable.  If this is pervasive, why wouldn't banks drop their rates and squeeze out the middleman?  Something doesn't add up here, but maybe it's just a market failure.

2) If part of the added value the broker brings to the table is fostering competition among originating banks, does the rise of the internet and the easier dissemination of information mean the days of brokers are numbered?  I am reminded of how the garden-variety travel agency business basically vanished when airlines started going online and price shopping became easy for consumers.

3) What is the profit incentive of the mortgage broker?  If she is an agent of the buyer (which the buyer would surely be reasonable in believing if the broker refers to the buyer as her "customer" or even her "client"), then I would expect, for an alignment of principal-agent interests, that the broker's profit would be incentivized to reduce the buyer's loan cost (i.e., interest rate).  That is, if the broker gets a 5% mortgage for the buyer, she gets paid X, but if she gets 4.9% mortgage, she gets paid something > X (which hopefully is less than 0.1%!).  Yet as I understand it, the broker gets more if she convinces the buyer to take a higher priced mortgage  (i.e., earns something > X if she gets buyer to take mortgage at 5.1%).  Have I got that right?  (Note that I am, for purposes of this question, agnostic as to the structuring of that compensation, be it a flat fee paid at closing or a deferred fee achieved through a YSP.)  Similarly, does the broker have an incentive to get the buyer to take out more debt rather than less debt (that is, does the greater face amount of the mortgage increase the broker's profit)?  If so, I again worry about a potential disalignment of incentives.

Now, a comment (or at least semi-rhetorical question):

I understand some defenders of the YSP pricing structure to be making the argument that if we assume the mortgage broker has to be paid (which seems a reasonable assumption), then compensating him through a YSP is just spreading out what would otherwise be a flat fee up front.  If so, it has the potential advantage of providing further financing for buyers who would otherwise be unable to afford mortgage brokers.  That seems to make sense.  My concern, however, is that if I make a further assumption -- that the mortgage broker's fee is a small outlay in relation to the overall mortgage debt -- then we are talking about putative buyers who are so close to the margin that they cannot afford to secure the financing if forced to pay a small portion of it (the brokerage cost) as an upfront fee.  Pursuing that assumption, I have misgivings whether it is socially beneficial to put these people into home mortgages.  Perhaps they'd be better off renting a bit longer until becoming more financially secure, as surely they are the marginal consumers who will take the first hits when the market sours.  I worry there's something regressive lurking here.

A High Grade for High-Grade

Apologies in advance for this post.  When my co-bloggers and I brainstormed this site, we talked about trying to merge scholarly issues with accessibility.  This post woefully shortchanges the latter.  But I can't help myself -- I'm just too excited about the recent High-Grade opinion out of Judge Lifland's chambers.

One of the quiet successes of BAPCPA was finally getting Chapter 15 passed into law, which pertains to cross-border insolvency proceedings, an area that I write about a bit.  Yet there have been fits and starts in some early opinions by courts who, how shall I put this in a politic manner -- seem to be struggling.

One of the big deals from the theoretical side is Chapter 15's embrace of an idea that goes by the label "universalism," which basically means we would be better off with a coordinated system of choice of law in cross-border proceedings following some jurisdiction-selecting rule, as opposed to reverting to the choice of law "state of nature" of territorial sovereignty.  (Our European cousins are off and running with the centre of main interests test ("COMI") under their Regulation.)  One of the necessary foundations of a universalist approach to regulating transnational bankruptcies is what I dub "jurisdictional hierarchy," recognizing that some jurisdictions are going to have to bite the bullet and bow to the laws of other jurisdictions in any given case.

Chapter 15 imposes such a jurisdictional hierarchy by requiring U.S. courts to distinguish between a "main" and "non-main" foreign bankruptcy proceeding when a U.S. Chapter 15 proceeding is opened.  (A Chapter 15 is opened by a foreign representative, like a trustee, in a bankruptcy proceeding taking place abroad.)  And yes, the COMI test is used: if the foreign proceeding is being conducted in the country that houses the debtor's COMI, then it is a foreign "main" proceeding.  One reason it is important to get this distinction (i.e., is it a request from a main or a non-main (or possibly neither!) proceeding?) is because it signals the jurisdictional hierarchy.  If the proceeding is recognized as a foreign main proceeding, that means the U.S. court will be mindful of its necessarily inferior legitimacy to legislative (and maybe adjudicative) jurisdiction over the dispute.  If the proceeding is recognized as a non-main proceeding, the assistance offered to the foreign representative is curtailed, on the theory that he's not really the person who should be travelling abroad asking for help.

An ominous early case, SPhinX, tried to pooh-pooh the relevance of main vs. non-main, cavalierly implying it doesn't really matter because U.S. bankruptcy judges have such wide discretion they can shape and fashion almost any sort of remedy (and so get a non-main proceeding representative the sort of relief generally intended for a main proceeding representative).  In addition to stumbling a bit doctrinally, the SPhinX case was worrisome for trying to scuttle the very foundation of jurisdictional hierarchy so central to universalism -- and so importantly advanced, albeit gingerly, in Chapter 15.

Enter High-Grade.  In that case, the actual holding denied the (Cayman) foreign representative's request for assistance because it was found not only was the Cayman proceeding not a main proceeding (COMI of Bear Stearn's investment fund was, unsurprisingly, in New York), it wasn't even a non-main proceeding, because the connection to the Cayman Islands was purely a legal formalism devoid of economic substance (incorporating offshore for tax advantage).  Yet what is so important about the case is that (arguably in obiter dicta) it goes through a thoughtful and careful analysis of the centrality of the distinction between foreign main and non-main proceedings and hence of the importance of jurisdictional hierarchy in a Chapter 15 world.

SPhinX's retirement will be welcome; I predict it is High-Grade that will get the cites.  I just couldn't help but give it a "shout out" as it rolled hot off the presses.

Apologies again for readers who are now utterly bored.  You were warned.

Firm, Taut Prepack?

I've been following a little bit the Bally's Total Fitness chapter 11 in SDNY.  A couple things of note.  First, it sounded like it would be nice and smooth, with something like 99% of senior debt pledging support.  Then some unhappy creditors came in grumbling about the DIP proposal (which had priming provisions, so three guesses why they were irked).  Next thing I saw is an amended plan with some equity fund injecting cash, but a much different (and lower) level of support than the initial bold predictions of 99%.

So what's going on (I wonder semi-rhetorically to the Credit Slips audience)?  Is this case imploding, or is this par for the course?  Can a prepack "unwrap" itself and morph into a full-blown 11 (in which case, who tied the knots)?  Also, I'm wondering more generally why this business is bust.  Shouldn't be tied to mortgage market, and I'm not aware of corporate malfeasance.

Pottow & Zywicki: Together at Last!

Prof. Todd Zywicki, with whom some Credit Slips readers might be familiar, had an interesting editorial in last week’s Wall Street Journal called “The Two-Income Tax Trap.” I wanted to alert readers to it in part because it is intriguing and in part because it is something on which Todd and I find some agreement.

It’s not a complicated argument. Taking a page from Prof. Elizabeth Warren and Ms. Amelia Tyagi’s playbook, Todd takes stock of what expenses have gone up over the past few decades as a second spouse has entered the work force. Todd’s point is that one of the biggies is taxes, in part because of our progressive tax structure. Thus when gross income increased 75%, tax expense increased 140%. I will call this his “positive” point. He makes an important contribution by underscoring the effect of a second earner’s income being treated by a higher marginal rate. 

Before moving onto the normative point, a quick substantive comment: Todd uses the marginal tax rate as a shorthand – to maximize precision, one should probably use the effective tax rate, which will dampen the distinction somewhat. But I’m OK with shorthand.  I'm just flagging for number crunchers.

And also a quick stylistic point: Todd’s editorial could be read as implying Elizabeth/Amelia were derelict in not reporting these tax numbers. I don’t think so. I think they were just netting out taxes (as they say) to do apples-to-apples comparison of “disposable” income, so we could basically see whether consumers were getting greedier.  (I also think the numbers are there in an endnote, but it's been quite some time since I read the book.)  Thus I don’t think Todd’s commentary should be seen as a criticism of their book, but rather an extension of it.

Now, onto the normative. Todd concludes that this large increase in the tax burden engendered by a second earner should serve as a call for flatter taxes. Here, I’m more agnostic. I haven’t thought through the issue that much. I suppose if income redistribution (an end which I support) could be guaranteed through other means, then surely it’d save some costs to flatten out the income tax code. So I might be with Todd all the way. But I’d probably have to think more on this normative issue before I gave him my full support. But for now, I’ll settle for agreeing with him on raising an interesting positive point.

Musings on Sub-prime Meltdown

I have been wrestling with posting about the remarkable global economic occurrences triggered by the sub-prime mortgage meltdown in the United States, but I'm still not entirely sure I fully appreciate what is going on, let alone have anything helpful to share with Credit Slips readers.  I am astounded not just at the scope of the crunch (as in its penetration around the world) but also the depth of the turmoil (commercial paper is being hit because of sub-prime mortgage jitters?!).  As I struggle to comprehend just what is going on, I'm left with a couple thoughts/questions.

1) Is what we're seeing here like a macro-economic manifestation of the Two-Income Trap?  That is, we thought we were making families better off with the entry of the wife into the workforce.  It turns out, rather than diversifying risk we were inadvertently multiplying it.  Is this just what happened with bundling and packaging out sub-prime mortgages?  Instead of healthily diversifying risk, all we did was spread around the scope of possible entities (German banks!) to be hurt in the event of a collapse.

2) Can risk every be priced "accurately"?  It seems to me that as investment funds chased higher and higher returns (which we can blame on, pick your scapegoat -- how about cheap Chinese currency forcing a huge trade deficit and concomitant buy-up of U.S. debt?), that there was increasingly willful blindness regarding risk portfolios.  Was it really that hard to foresee CDOs eating up through the tranches to even the "safest" tier?  Even the quantiest of quants seemed to bet wrong, which strikes me as a sober reminder that humans, after all, oversee these programs and continue to suffer cognitive frailties.

3) Is it possible to isolate the effects of something like the mortgage market to mortgage investors?  Tough love regulators of course don't want to respond to "mere losses" in the investment markets by cutting interest rates, which should be the province of monetary policy, although that won't stop them from cheating (ie., achieving the same effect, admittedly with more control, by injecting the sorts of funds that the Fed and ECB have just done).  But as we're seeing, we can't just sit by and let a supposedly discrete group of investors take their lumps -- when credit gets squeezed in commercial paper, we realize it's just not that easy when credit gets crunched.  Call these what you want ("externalities" or whatever), but it strikes me that we're coming to the painful conclusion that the economic dislocation of Jack losing his sub-prime financed (declining valued) home involves a lot more pain than just that felt by Jack.  (And let's also not forget that Jack's hurting too).

I wish I had more learned or scholarly insight for readers, but I find myself intellectually overwhelmed....

The Unconstitutionality of 11 U.S.C. 522(p)

I’ve been mulling this provision of BACPA over for sometime now, including conferral with a colleague of mine on the faculty here who specializes in constitutional law, and I’m becoming increasingly convinced that s. 522(p) is unconstitutional.

For those who want to see the Code, I’ll copy it in at the bottom of this post.  For those who want a reminder, this is the “hard cap” of $125K homestead exemption that applies for debtors who have recently moved.

Why is it unconstitutional (in my view)?  It has nothing to do with the generic exemption challenges that have failed in the past (e.g., the dis-uniformity of different states having different exemptions, or the dis-uniformity of some states opting out of the federal exemptions).  No, this is a somewhat arcane matter of constitutional law that rarely gets litigated (just because it’s so unusual to be implicated).  The problem is that it inhibits the unenumerated but generally accepted right to interstate travel under the Fifth Amendment’s Due Process Clause.

Here’s the problem.  The Feds could exercise their Supremacy Clause power and pass hard caps in Bankruptcy for everyone.  (Cf. Recommendations of NBRC.)  But what they’ve done here, with 522(p)(2)(B), is made a cap but then made an exception to the cap for intra-state movers.  What this means, therefore, is that the cap only applies to inter-state moving debtors.  As such, it is a direct discrimination on those who move states.  Moreover, this is not like a “vesting requirement,” which has survived constitutional scrutiny in previous cases, because the rule is not that the debtor keeps his old exemptions until he vests into the new ones.  Rather, the rule is if he moves from Texas to Florida, he forfeits his unlimited exemption under each state’s laws just because he was an inter-state mover – a “penalty” visited by neither state’s laws!

If the level of scrutiny applied to this provision were strict, then I don’t see how it could possibly pass constitutional muster (I’m not even sure how it’d do on a lower standard).  I could be off-base, so I’m open to changing my mind.  Herewith the Code:

11 U.S.C. s. 522
….
(p)(1) Except as provided in paragraph (2) of this subsection and sections 544 and 548, as a result of electing under subsection (b)(3)(A) to exempt property under State or local law, a debtor may not exempt any amount of interest that was acquired by the debtor during the 1215-day period preceding the date of the filing of the petition that exceeds in the aggregate $125,000 [$125,000 (added by BAPCPA 10-17-05) effective 4-1-04. Adjusted every 3 years by section 104.] in value in--

            (A) real or personal property that the debtor or a dependent of the debtor uses as a residence;
            (B) a cooperative that owns property that the debtor or a dependent of the debtor uses as a residence;
            (C) a burial plot for the debtor or a dependent of the debtor; or
            (D) real or personal property that the debtor or dependent of the debtor claims as a homestead.

    (2)….
(B) For purposes of paragraph (1), any amount of such interest does not include any interest transferred from a debtor's previous principal residence (which was acquired prior to the beginning of such 1215-day period) into the debtor's current principal residence, if the debtor's previous and current residences are located in the same State.

BAPCPA's Success in Driving Lawyers from Bankruptcy Practice

Susan Thurston, Clerk of the Bankruptcy Court of the District of Rhode Island, had an insightful piece in last month's ABI Journal, "Behind the Numbers: The New Workload of the U.S. Bankruptcy Courts."  It is not a random national sample or anything so methodologically sophistated, but it is one clerk's reflections on the patterns in her courthouse.  She finds, which should surprise no-one, that while case numbers have gone down, the clerk's work per caseload (and, indeed, the number of motions per case) has gone up.  Here's what's even more interesting (and distressing): "So too, we have experienced an increase in the percentage of pro se filed cases from pre-BAPCPA days. . . .  [A] substantial time investment is required by clerk's office staff both at the intake counter as well as on the telephone to impart filing and procedural instructions to individuals who are overwhelmed by the complexity of the process . . . ."

So we find that as BAPCPA succeeds in driving lawyers out of practice, more people have to file pro se.  I'll leave aside the cynical suspicion that by driving debtors' lawyers out of practice, creditors were hoping to improve their distress negotations lot.  I'll also leave aside the serious issues of proceeding unrepresented in bankruptcy -- an already unenviable time.  What I want to underscore is that there's no such thing as a free lunch.  The BAPCPA proponents who celebrate scaring off part of the debtor's bar have just shifted costs onto overworked goverment clerks who continue to provide yeomen's service.  Yet another reason why my taxes are too high....

Welcome to Professor Lipson

Credit Slips readers are in for a treat this week.  Our guest blogger will be Prof. Jonathan C. Lipson, yet another bankruptcy law expert.  Unlike many academics who purport to have expertise in the field of bankruptcy, Prof. Lipson (on faculty at Temple but currently visiting at Penn) actually practiced law before he entered the academy.  It would be difficult to sum up his current research focus; he has such catholic interests as "constitutional exceptionalism" of bankruptcy law, ecclesiastical bankruptcies, executive compensation, and (one of my favorites) the role of the examiner in Chapter 11.  He also writes good stuff on Article 9 and other commercial law to boot.  Enjoy!

A Twist: Predatory Borrowing!

For reasons not entirely clear to me, I am receiving advertisements for seminars on debt collecting.  An example's here.   Leaving aside my need to "protect creditor assets" from the rapacious pitfalls of the FDCPA and other such scourges, I am particularly intrigued by the branding message to "steer clear of predatory debtors' attorneys".  This is surely a co-option of "predatory lending," which has (finally) worked its way into the policymaking lexicon.   Frank Luntz (sorry, Dr. Frank Luntz) would be so proud!

Debt Collector v. Widow

I wanted to draw Credit Slips readers' attention to a wonderful (front-page) feature a couple weekends ago (Sat. Apr. 28) by Ellen E. Schultz in the Wall Street Journal ($) regarding the above captioned. Yes, it's another depressing but highly humanized account of elderly debtors having their bank accounts drained by savvy creditors with garnishment writs. But there's an interesting twist regarding the garnishment of putatively exempt Social Security funds. The funds, while exempt of course, lose their exemption once deposited into a bank account, unless the account owner (here, the elderly debtor, presumably having independent knowledge of this arcane legal requirement) affirmatively files an exemption notice. Does the Social Security Administration help out by reminding of this legal hurdle, perhaps under its FAQ? Nope. How about the banks, out of a sense of customer service? In hand washing that would make even Pilate proud, most of them (with some commendable exceptions) say that's not their place to get involved in the private treatment of customers, etc., etc.  It's an eye-opening account about the chasm between legal formalism and statutory text ('exempt" social security in Congress' intent) and the less savory, and less inspiring, world on the ground....

Reckless Unreckless Lending

I was happily surprised to learn that Discover Card is offering a new product, the Motiva card, that actually rewards consumers for timely payment (offering an interest rebate after 6 months of timely bill payment).   Perhaps unreckless lending is making new headway?

Alas, no.  Sadly, one cannot qualify for the fiancial payment if one pays one's balance in full each month.  Only "loyal customers" who carry a balance get the reward.

Put another entry in the too-good-to-be-true column....

Merci, Danke, Thanks to Kilborn

While I don't generally think of Easter as a snowy holiday -- and I grew up in Canada -- I was brought some cheer from this cold snap by reading Jason Kilborn's wonderful Credit Slips posts this week.  He remains one of the most interesting and diligent U.S. scholars of comparative consumer insolvency; we were lucky to have him join us.

Pottow on "Lawless v. Tabb"

I was delighted to see a spirited debate on Credit Slips a month ago between Professors Lawless and Tabb on the latter's recent writings and the former's recent opinings on the means test, posted here.

Yet what even these two great legal minds neglected was that I have answered this question -- at least the one regarding new section 707(b)(3)(B) of the Code -- in "The Totality of the Circumstances of the Debtor's Financial Circumstances in a Post-Means Test World: Trying to Bridge the Wedoff/Culhane & White Divide, published at  71 Mo. L. Rev. 1053  (2006).   (And I will make the link to SSRN, just to see if I get any credit counselling services down my page's side too!)

I'll leave it to die-hards only to see on which side I came out....

Unreckless Lending

Credit Slips readers may recall my earlier academic article on reckless lending in the University of Illinois Law Review, which is now available on SSRN here.   So hopefully that will give me "street cred" as being no patsy of the consumer credit industry.  But I flatter myself as an academic to be even-handed.  And when I was visiting Florida recently (yes, my parents), I was happily surprised by an ad running on TV.  It was for, basically, a payday lending service, but the ad was full of disclosures and cautions.  It said that you shouldn't take out a loan if you won't be able to pay it back, or think you'll have to roll it over shortly, etc.  Sadly, I can't remember the name of the lender (a bad ad then?).  But the warnings were real, not a rushed filibuster of high-speed gibberish at the end.

I wonder whether this is good-spirited self-regulation, or whether Florida has a state law regulating payday lenders requiring these sorts of warnings (in which case, bravo Florida).  More cynically, it could be the former animated by fear of the latter.  But in any event, I thought this was good, responsible lending practice, at least based on my (literally) arm chair analysis.

So hurrah for (at least) one Florida payday lender!

Palindrome for a Silly Case? A Marrama

The Supreme Court handed down the Marrama opinion, resolving the burning question of bad-faith debtors' conversion rights under 706(a) of the Code:  Marrama v. Citizens Bank

Those namby-pamby softies on debtors?  The Chief Justice, and Justices Scalia, Thomas, and Alito (in dissent, per Justice Alito).  The hard-assed debtor-bashers?  Justices Stevens (writing), Kennedy, Souter, Ginsburg, and Breyer.

Marrama was a badie in Chapter 7: among other transgressions, he tried to hide and fraudulently convey a house in Maine.  An angry trustee and creditor sought recovery, but Marrama schemed to divest the trustee of jurisdiction by converting, under section 706(a), to chapter 13 (which we all recall vests property of the estate under control of the debtor, not the trustee).

Trustee and Citizens cried foul and opposed the conversion.  All courts up the chain agreed, saying that Marrama's bad faith precluded him from converting to 13.  A recurring justification was that 706(d), which qualifies 707(a), says a debtor may not convert to a chapter if he's ineligible to be a debtor under that chapter.  Because Marrama's bad faith would preclude a confirmable plan under 1325(a)(3), he couldn't do anything in 13 (other than flail).  Accordingly, the courts held that because he couldn't be a "real" debtor in chapter 13, he was ineligible to convert thereto.  (I'm simplifying somewhat; also in there is the argument that if he did convert to 13, he could be quickly reconverted back to chapter 7 "for cause" due to his bad faith under section 1307(c).)

The dissenting Justices chafed at what they indirectly implied was yet another step of bankruptcy judge arrogation of power in the face of seemingly clear statutory text.  And they had a good point: if the limitation on who can be a debtor in 13 is supposed to be the true constraint on conversion power, per 706(d), then the proper place to look for those restrictions is 109(e), which defines the dollar amount, income regularity requirements, and other criteria for being a debtor under chapter 13.  So they were right that denying conversion because the debtor was ineligible for chapter 13 vis. section 1325(a)(3) was wrong (or hand-wavey).  Marrama COULD be a debtor under 13.  He wouldn't last long, but he could still be a debtor.  So the majority, at least in my view, bobbled this one.

The reason I think this case is so silly, however, is that this is really a case about section 105.  Everyone knows that bankruptcy judges have equitable powers to prevent an abuse of process.  Here, neither the majority nor dissent got the issue quite right.  It was not that the judge was using 105 to graft additional restrictions on conversion onto section 706 (as the dissent especially tries to suggest).  Rather, the judge was using 105 as an equitable vehicle of procedural economy.  If everyone agrees that a judge may dismiss a chapter 13 case "for cause" under 1307(c), and that "bad faith" may constitute cause, then what the bankruptcy judge decided was that rather than holding a conversion hearing under 706 and then the next day holding a dismissal (or conversion) hearing under 1307, he could collapse the two hearings into one for judicial economy, hearing and resolving the allegations of bad faith at one time.  Properly viewed, the judge was not expanding the scope of 706, he was entering a glorified scheduling order.  At such an omnibus hearing, there is nothing that would prevent (Justice Alito's confusion notwithstanding) a judge from entertaining evidence of what the debtor would propose to pay under a plan were he allowed into chapter 13.

Whatever one's belief on the proper scope of section 105, I find it difficult to begrudge a jurist the discretion to consolidate two redundant hearings for procedural efficiency into one session.  That is not aggrandizement; that is a common-sense lowering of my taxes.

Welcome to Professors Block-Lieb and Janger

Credit Slips is delighted to welcome the talented stylings of Block, Lieb & Janger (which is how I think their names should be if they formed a firm) for the upcoming week as our Guest Bloggers.  I am especially excited because I am a fan of both Professor Susan Block-Lieb of Fordham Law School and Professor Edward (Ted) Janger  of Brooklyn Law School.  Why?  Not just because I'm a bankruptcy geek -- as, proudly, are they, too -- but because I like their scholarship, both individually (where they have both written on a subject area close to my heart, cross-border insolvency) and jointly (where they have a nice piece in the Texas Law Review struggling to reconcile bankruptcy reform with insights from consumer behavioralism -- forthcoming, oxymoronically, in the May 2006 issue).  I last saw Susan and Ted in Brooklyn, where we all participated in Ted's excellent academic conference, which I called Bankruptcy in the Global Village, "The Revenge" -- because it was the decade-later gathering of the seminal conference, Bankruptcy in the Global Village.  They are two of the most interesting and independent scholarly voices in bankruptcy law today, in my opinion; I think we are most lucky to have them as visitors.  And with expectations thus set unachievably high, please enjoy their week...

PIRG to the People!

I thought Credit Slips readers might be interested to hear that PIRG has come up with a telephone script to help consumers negotiate rate adjustments (i.e., lowerings) on their personal credit cards.   Some lenders interviewed for a newspaper article said, sure they lower rates sometimes, but they were (understandably) coy about giving specifics on quantities.

Wall Street Journal Calls for Japanese Regulation!

Thanks to Bankruptcy Listserv reader David Yen for pointing out the Wall Street Journal's recent (December 15) editorial calling for more regulation of consumer lending in Japan.  Strictly speaking, the Journal's editors complain about the persistence of usury ceilings in Japan, but in so doing they  recognize the need for government regulation of a consumer lending market that is not functioning properly.  It looks like this is a policy area that will be heating up as the new Congress opens up its new session in 2007.

What the Market Needs: More Regulation!

The old saw goes that nothing burdens the market like the stifling oversight of government regulators.  But real life is much more complicated than sound bites.  Sometimes a market needs facilitating regulation to function.

An interesting derivation of this theme is the role of "creditor's rights" in comparative insolvency.  Some international comparative works have sought to support the intuition that if creditors have weak protection -- for example, the State can nationalize all property without compensation -- investors will exhibit expected skittishness.  If this intuition is correct, how sophisticated is it?  Sure, nationalization is scary.  But are investors really more scared off by, say, the American employee priority rule, with its higher wage level, than the Canadian one (currently under amendment) with its lower priority wage cut off?

Here's where readers may want to look at the new study by researchers from the United States and Finland (Timo Korkeamaki, Yrjo Koskinen, and Tuomas Takalo)  on what happened when Finland INCREASED regulatory oversight in insolvency proceedings and DECREASED creditor's entitements: investment returns seemed to increase. (!).  While I haven't had the chance to read the full article yet, this surely warrants exploration.  Article link: Phoenix Rising: Legal Reforms and Changes in Finland During the Economic Crisis

Congress Says Debtors' Thumbs May Be Amputated!

Strictly speaking, this may not be true.  (The reason this may be so is because the statement is a complete lie of my own fabrication.)

Yet as we visit my parents where many old Canadians flee for the winter (Florida), I was struck by a radio adverstisement.  My dad has something called XM radio in his car, which I think is satellite, so I don't know if the adverstisers are local or national.  The ad was one of those super-hyped, manicly-overlapping succession of rapid rhetorical questions: "Trouble with credit?  Did you know you can consolidate your loans at a lower rate?" Etc., etc.

Here's the question that stuck out to me: "Did you know what new laws require you to pay back twice as much debt?"  (Or it may have been "Did you know new laws require you to pay back half of your debt?")

I wonder to readers who may have heard this or similar ads: Is this how credit consolidators and others are framing BAPCPA?  (In fairness, maybe it was some quirky state-specific law in Florida, or maybe I misheard, distracted by the challenge of driving with octogenarians.)  If this really is BAPCPA-puffing, then I think it is a strong illustration that perception may be more important than reality for new bankruptcy laws.  (Indeed, could ads like these literally be scaring people away from filing for bankruptcy?)  Worrisome, at least to me.

Always a Silver Lining

Mark Whitehouse reports in this Monday's Wall Street Journal about the rising number of defaulting homeowners hitting the skids as those once-darling floating rate/interest-only loans start to rise (the current lull by the Fed notwithstanding).  What's the silver lining?  Why the propitious news for derivatives traders who have gobbled up new contracts that hedge against sub-prime mortgage defaults!  Yes, that's right, the good news is you can make a buck on the foreclose of that guy down the street.  I guess at least someone's figured out how to bet on the Don't Come Line in the crapshoot of life.

Can Generation Y Save?

Jennifer Levitz reports in the Wall Street Journal that Generation Y (defined as current 18-27 year-olds, which covers most of my students) do not seem to be taking well to retirement savings.  For example, only 1/3 have opened a 401(k) account.

Is the government stepping in to remedy this lackluster (slacker?) savings trend for an important demographic?  No, here it is the market that's actually coming to the rescue.  Which market?  401(k) management companies, who realize that as baby boomers start withdrawing funds -- as they have begun to do already -- assets under management, and hence fees, will diminish.

This is why we are starting to see things I never thought I'd write about: pizza parties and bungee runs -- to promote retirement savings (sponsored, of course, by Fidelity and their ilk)!

U.S. Trustee, Part II

Following up on Professor Porter's excellent observations on the U.S. Trustee program, while she is interested in the normative power wielded by the UST, I am taken by the more tawdry matter of the expansion of institutional bureaucracy.  BAPCPA has mandated a hugely invasive role for the UST office (certifying decisions not to bring means test challenges, etc.), which means that my taxpaying dollars are going to subsidize a government-run debt collection agency for the benefit of for-profit creditors.  Yes, fees have been raised, but I'm not so sure how much they'll cover.  BAPCPA's proponents must have been fans of an active, involved, and well-funded federal government!  (I wrote about this in a piece for a Spanish commercial law journal, but I don't have the link to the journal and, for that matter, only take it on good faith that they translated the piece instead of just inserting gibberish -- at least random gibberish as opposed to my structured gibberish.)

Mann's Calls Study

Professor Mann's proposed study is, as usual, interesting and thought-provoking.  (I confess to finding it somewhat exhibitionist to engage in a public dialogue with a colleague, awkwardly having to use the third person, but I guess that what a "blog" is all about.)  In any event, what I would counsel Professor Mann to consider as he pursues this project is the role of denial in the psychology of distressed debtors.  While his study is not designed to gather this sort of data specifically -- that is more the domain of co-blogger Professor Thorne -- it occurs that readers of this blog might have helpful anecdotal data to share with Professor Mann regarding his intuition that a bankruptcy filing comes in response to external legal prompting, and my related intuition that that passivity in turn stems from a denial of the seriousness of the debtor's affairs until objective forces conspire to make such denial no longer tenable.

Hold the CHAOS!

District Judge Marrero handed down his decision in the NWA appeal today.  He reversed the bankruptcy court and enjoined the union from implementing CHAOS (which, by the way, I was wrong to suggest would not involve mass walkouts).  "Court Tramples Right to Strike" is how the flight attendants cast it --see the flight attendants webpage.

Let me say this: at over 100 pages, it is an extremely thoughtful analysis that really tries hard to cut through the seemingly conflicting goals of federal labor and bankruptcy policy here.  In essence, the judge said that Congress really wanted national railway carriers (and their modern-day airline analogues) to negotiate and negotiate and negotiate under the cumbersome and intentionally drawn-out provisions of Section 6 the Railway Labor Act for as long as possible, before giving up.  Only at that "Despondence Day" [my term, not a legal one] -- when the Section 6 negotiating process has run its couse -- can the parties resort to self-help (i.e., labor can strike).

In bankruptcy, a debtor can change the rules somewhat: if it wins an 1113 motion, the debtor can change the terms of a labor CBA -- even if it never negotiated up to Despondence Day under Section 6 of the RLA.  So the question is: if Congress had ever thought about the issue directly -- which it never did, so a judge has to predict Congress's intent -- would it have analogized the granting of an 1113 motion as an "acceleration" to Despondence Day (in which case the labor State of Nature obtains and self-help is a go), or would it have seen an 1113 order as merely an "alteration" of the Section 6 negotiating environment: allowing the debtor to reject the CBA and alter some rules, but not excusing either party from finsishing the Section 6 dance before self-help?

Given the desire to avoid strikes that was a "primary objective" of the RLA, Judge Marrero held that Congress would have probably wanted the latter: the parties have to keep slogging through Section 6 before self-help, even though the CBA has been rejected under section 1113 of the Bankruptcy Code.

But wait a minute!, cried the flight attendants, Northwest gets the best of both worlds: It gets self-help right away (after all, self-help for management *is* the unilateral imposition of labor terms), but the union's hands are tied (no strike) until the end of Section 6.  How is that fair?

It is fair, answered the judge.  Yes, management can impose unilateral terms, but not *any* unilateral terms; they are bound only to implement the terms of their last proposal in the 1113 process.  And by the way, recall that the only reason NWA won the 1113 motion is because the bankruptcy judge had to find that the union rejected that proposal without good cause.  So what at first blush may appear like unfairness is not nearly so one-sided as the flight attendants tried to paint.  That's what I think Judge Marrero is trying to say in his book-length opinion and why the bankruptcy judge was reversed.

This isn't over yet: (1) on the litigation front, the union may appeal to the Second Circuit; and (2) on the negotiating front, they've got to continue with the Section 6 process with NWA.  Who knows, that still may end up going all the way to Despondence Day without an agreement.  And then, let slip the dogs of war!  But it may not.  Just maybe, if the Congress that designed the RLA correctly predicted that as tempers subside over time, voluntary agreements can work out, then NWA and the flight attendants will hunker down, hash something out, and put all this customer-irritating unrest behind them.  That's what I'm hoping for.

CHAOS Anyone?

As resident blogger from Michigan, I feel compelled to alert readers to the interesting labor developments at Northwest Airlines.  (Northwest "hubs" in Detroit and employs a good swath of people in this area.)

A very complex issue of federal jurisdiction is unfolding regarding the intersection of federal bankruptcy law, federal labor law, federal court injunctive jurisdiction (the Norris-LaGuardia Act), and the specific provisions of the Railway Labor Act.  As the various airlines have gone through this round of bankruptcies, they have avoided this issue by settling with their respective unions by extracting voluntary concessions -- so it has never been litigated.  Not so with the flight attendants at Northwest.  They are pushing this issue to an explosive head (unperturbed by Northwest's effective ignoring of the earlier mechanics' strike).

The legal issue at dispute pertains to the ability of the attendants to strike.  As bankruptcy types know, federal bankruptcy law allows the judge to order the "rejection" of a collective bargaining agreement with a labor union upon request by the debtor, provided the debtor clears a hurdle showing need (a hurdle that is much more onerous than the general one required to reject a regular business contract).  NWA did indeed request to reject the flight attendant contract, made its showing, and was thus recently granted permission by the court.  With no CBA in place, NWA was unfettered by contract and could implement its own labor rules.  And it did.

The thorny battle arises over what happens next: the union takes the position it can now initiate a strike, making the fairness argument that if management can impose unilateral work rules, workers should be able to respond with the "ultimate sanction" in labor disputes.  Management contends that this is not so, for reasons that are difficult to get down in bloggable format.  (If you really want to know, the argument depends in part upon the fact that to order rejection of a CBA, the bankruptcy judge must find that the union did not have good cause to reject the last offer in negotiations -- which he necessarily did because he granted the motion -- as well as the general duty to bargain in good faith in negotiating an initial CBA.)

Management and the union went to court to thrash it out.  They argued passionately.  And a decision came down.  The Bankruptcy Court judge said the union could strike (more precisely, there was no jurisdiction to enjoin the flight attendants from striking).

Victory for those who control the means of production?  Not quite -- the ruling was immediately appealed.  In bankruptcy, an appeal goes to the federal district court in the relevant district (here, the Southern District of New York, i.e., Manhattan).  The District Court judge responded to the appeal by entering a temporary, limited injunction blocking the union from striking for the time being -- until he has a chance to rule on the merits of the appeal.  Clinging desperately to the hope of a consensual resolution [that is my read], he asked the parties to tell him what the prospects for future discussions looked like.  NWA said they were still willing to talk; the flight attendants said they couldn't see the point in more discussion.

The District Court judge's ruling in the appeal is expected shortly -- although my prediction is the loser will probably turn around and appeal up the legal ladder to the presiding appellate court: the U.S. Court of Appeals for the Second Circuit (which sits in Manhattan and hears appeals from trial courts in New York, Vermont, and Connecticut).

In the meantime, the flight attendants talk about a semi-strike, "CHAOS," which will entail random sickouts and slowdowns, but not an outright walkout.  For its part, NWA has recalled all furloughed flight attendants, which in better labor-relations times might have been good news; here it may be nothing more than a preemptive strategy to fend off possible strike-induced shortages.  I am waiting to see what happens, especially since it is not beyond comprehension that one of the bankrupt airlines will not survive chatper 11.  Will NWA's labor dysfunction, I wonder, prove the key to its undoing?  We will see.

Links: Flight Attendants Webpage.
          NWA Chapter 11 Webpage.
          Detroit Free Press.    (Journalist Jewel Gopwani has excellent, unbiased coverage.)

Dana Redux: Bank Power!

When Sen. Edward Kennedy (D-MA) got 503(c) into the new bankruptcy bill, I am sure he thought he was protecting rank-and-file employees from the perceived ravages of excessive corporate executive compensation.  And maybe he was.  But as someone who doesn't think KERPs are inherently evil, I was struck by Floyd Norris' insightful reporting in today's New York Times -- which I just saw Co-Blogger Lawless has posted a link to -- regarding the denial of the Dana executive compensation package under 503(c).  I will not repeat Professor Lawless's thoughtful comments, but I will add another, which may buttress his, that troubled me with the ruling.  I don't mind purposive statutory interpretation, but one must acknowledge that it can sometimes open a can of worms.  And one of the worms that has crawled out in this case is the well placed criticism that Dana's exec comp package doesn't look all that different from Calpine's, which recently got the judicial OK.  At pains to distinguish Calpine, Judge Lifland noted that the creditors there logrolled with the plan, whereas with Dana, they did not.  (For that matter, neither did Dana's shareholders, employees, nor even the US Trustee.)  But was that the basis of distinction that Congress truly wanted, if we are searching for legislative purpose -- whether the creditors said it quacked too much like a KERP?  Was according creditors another veto right in the debtor's magement affairs what Sen. Kennedy had in mind when pushing 503(c)?  I am doubtful.

Tort Liability in Consumer Credit Article

Those in attendance at Charles Tabb's excellent symposium on BAPCPA this past spring in Chicago will recall a discussion we had on this topic prompted by my article, which is also being published in the Illinois Law Review, on this very theme --  "Reckless Lending: Time for a New Lender Liability?"

Here is a link to the symposium web page, although I do not know whether they have the articles available for downloading yet:  Illinois Law Review.  My article explores the various policy arugments in favor of -- and some non-trivial ones against -- creditor liability in this area.  It's an idea which traces a pedigree back to the inimitable Vern Countryman.  Those who can't wait to read the article may be interested to know at the outset that because the idea has so many complicated ramifications, I also propose a "gentler" version than outright tort liability.  That is of an affirmative defense to a collection proceeding, but no independent cause of action for consequential damages.

The Debt Collection Market

The Boston Globe's excellent analysis into the actual workings of the debt collection world brings up at least two points worth policy reflection.

First, it should not be surprising that as consumer debt explodes, so too does consumer debt default.  That means ancillary markets, such as those for debt collection services, will also explode.  (If people start driving more cars, then there will be more mechanics, not to mention more lawyers bringing tort lawsuits.)  The question, therefore, is do we want to regulate this emerging market?  After reading the Globe's series, how can anyone seriously interested in civil society not answer yes?  Indeed, we do have federal regulation on debt collection, such as the fair debt collection practices act, so the real question is do we want to make enforcement meaningful and back it up with necessary funding?  The Massachusetts experiences shows what happens when, in the necessary and commendable effort to balance deficits, states cut back on court services and the Attorney General's oversight capacity.  (One almost pities the assistant-magistrates' crushing debtload and perhaps sees some explanation to their routinized treatment of grinding debtors through a legal mill.)  So the first call to order is to meaningfully police this debt collection market.  We need to revisit the constable oversight system, just as we need to enforce legal requirements on creditors using the courts to help collect their debts (such as seriously sanctioning those who ignore bankruptcy laws and holding plaintiffs to their required standards of proof in court).

The second point is even more troubling.  This is not just about the need to regulate a market as prospectively sound policy, but about the development of a market that is fundamentally dysfunctional.  The problem is that what should be, ideally, a way to deliver state services (the public execution of debt) competitively (by farming out to delegated constables) has turned into a profitable business for collectors that is utterly divorced from the amount of the underlying debts.  Making $600 on hooking a car (not the tow company, this is the constable, for his official oversight "time") is a quick way to make a buck by feeding off a legal system.  And, moreover, it is one that creates the sorts of incentives that result in the story of the lady whose car was re-hooked three times, or the constable who doublecharged for one tow on the theory that he was "entitled" to a separate fee for each creditor's judgment he was enforcing (2 creditors warranted 2 oversight fees in his mind for the 1 tow).  This should give us broad, worrisome pause about what happens when well meaning local politicans see a quick fix to budget shortfalls by outsourcing public work to private entities (which is what the constables essentially are, their glorified appointment by public officials notwithstanding).  The Globe's pieces serve as a sobering lesson of how privatizing sheriff's levies has worked out so far in the Bay State: great for the private constables, not so great for the debtors in the system, and ambiguous for the initial creditors.

Pension Legislation

Congress is putting the final touches on a pension reform bill as the House-Senate Conference is ironing its final differences.  This bill deals with some relatively arcane but nontheless vital issues,
especially for workers with traditional defined-benefit pension plans.

When companies make pension promises to workers, they are in effect binding themeselves to pay future debts.  How do we know these promises aren't pie in the sky that the companies will never be able to pay?  Because the government requires companies to "fund" these future pension obligations.  It does so by making a bunch of actuarial calculations on what these future promises will cost, and how many assets the companies will need to cover them.  When companies don't have enough assets to cover these liabilities, as set forth in the pension regulators' formula, their pension plans are deemed "underfunded."

In the big pension reform of the 1980s, Congress gave companies with underfunded pension plans 30 years to make catch-up payments, and even then they only had to reach a target of assets sufficient to cover 90% of pension liabilities.

The new bill clamps down (at least somewhat).  For example, it would require fully funding underfunded pensions within 7 years (the airlines have squalked they'll fold with that requirement, so will probably get a carve-out exception).  And by "fully funded," they mean it this time: 100% coverage, not just 90%.

Good news for future pensioners (i.e., current workers, i.e., most of us), right?  Not necessarily.  One of the clear results of Congress's sensible clamp down on underfunded pensions is that other companies will do just what the airlines are doing in bankruptcy: discontinue defined-benefit pension plans for their workers.  When we account honestly for how expensive these plans really are to American businesses, the unfortunate price for our commendable transparency is the unhappy realization that many companies simply can't afford the promises they're making (or, more precisely, the promises that were made some time ago).  Whether they were dishonest in making those promises back then, grossly optimistic, or just incompetent is, sadly, now water under the bridge.  Whatever the reason, as the true costs of defined-benfit pension plans set in -- and are drawn into the light by the new pension bill which makes them harder to hide -- companies will simply get out of defined-benefit plans altogether and move to defined-contribution plans (the fancy name for 401(k)s).  We've seen this happening already with historical data gathered by the Survey of Consumer Finance.  So instead of shouldering the huge risk of uncertain future health care costs and longevity increases of a baby-boom population, businesses will pass that risk along to their workers.  If the workers make poor investment decisions and lose all their future pension money, they'll always have the final, ultimate defined-benefit plan of all: social security.  At least for now.  (That's an underfunded pension plan that Congress has so far avoided.)