Tag: debt

The Unredeemable Debtor

The law is the witness and external deposit of our moral life. Its history is the history of the moral development of the race.

– Oliver Wendell Holmes

Bankruptcy law decisions are replete with references to the “worthy debtor.”  In re Carp, 340 F.3d 15, 25 (1st Cir. 2003); In re BankVest Capital Corp., 360 F.3d 291 (1st Cir.2004); In re Institute of Business and Professional Educ., Inc., 79 B.R. 948 (Bankr. S.D. Fla. 1987); In re Nickerson, 40 B.R. 693 (Bankr. N.D. Tex. 1984); In re Marble, (Bankr. W.D. Tex. 1984); In re Doherty, 219 B.R. 665 (Bankr. W.D. N.Y. 1998).

These decisions typically employ the “worthy debtor” nomenclature in the context of the entitlements that are afforded by the provisions of the Bankruptcy Code.  It is always the “worthy debtor” that is entitled to a discharge of debts, a “fresh start”,  or to reject cumbersome contracts. This usage bespeaks a universe that also contains the “unworthy debtor,” a party whose behavior does not merit the statutory benedictions of the Bankruptcy Code. The identity of these parties is most often examined in the context of the discharge of debts and the behavior or actions that merit a denial of discharge or the finding that a particular debt is non-dischargeable.

There is a larger and more amorphous question though that also merits consideration, namely are their industries, companies, enterprises whose function and purpose is so odious and inconsistent with the precepts of good citizenship and the “moral development of the race”, to quote Justice Holmes, that they should be denied the benefits of reorganization afforded by the Bankruptcy Code.

If there is an argument to be made to prevent such enterprises from receiving the benefits of the Bankruptcy Code, to deny them the colloquial label of “worthy debtor”, that recourse likely lies within the provisions of the Bankruptcy Code that require that a plan of reorganization be “proposed in good faith and not by any means forbidden by law.”  11 U.S.C. § 1129(a)(3).  The “not forbidden by law” requirement is of limited utility in situations where the behavior is recognizable as immoral or intrinsically evil to most but has not yet been sanctioned by any legislative authority. Notably, and perhaps inversely, enterprises engaged in the sale and growing of cannabis are without access to the Bankruptcy Code because they act in contravention of the federal Controlled Substances Act, 21 U.S.C. §§ 801 et seq., which has been found to take precedence over state laws allowing the sale of cannabis. See, Gonzales v. Raich, 545 U.S. 1, 12 (2005).  As a result, bankruptcy being a creature of federal law, cannabis cases are generally being dismissed at the outset for cause in accordance with 11 U.S.C. § 1112(b) and not making it as far as the confirmation standard. See, In re Way To Grow, Inc., 597 B.R. 111 (Bankr. D. Colo. 2018).

If “forbidden by law” is unavailable as a source of relief, the last best hope to prevent the sanctioned reorganization of the unworthy debtor lies within the requirement that a plan be proposed in “good faith.”

“Good faith” is not defined by the Bankruptcy Code, a fact that makes it more likely that our  understanding of good faith may be transitory and that as the ‘moral development of the race’ proceeds, so might our understanding of ‘good faith.’  In other words, what was good faith yesterday might not, in light of our communal experience and growth as citizens, be good faith today.

In the first instance, we can understand from the ordering of the words within section 1129(a)(3) that the good faith standard exists independently of the ‘forbidden by law’ standard.  A plan of reorganization may describe a course of action not forbidden by law, but may still not meet the ‘good faith’ standard.

The good faith standard as used within section 1129(a)(3) is most commonly described as proposing a plan that fulfills the purposes and objectives of the Bankruptcy Code.  Those purposes and objectives within the context of Chapter 11 are most commonly understood as being “to prevent a debtor from going into liquidation, with an attendant loss of jobs and possible misuse of economic resources.”  NLRB v. Bildisco & Bildisco, 465 U.S. 513, 528 (1983);  see also, Bank of Am. Nat. Trust & Sav. Ass’n v. 203 N. LaSalle St. P’ship, 526 U.S. 434, 452 (1999) (“[T]he two recognized policies underlying Chapter 11 [are] preserving going concerns and maximizing property available to satisfy creditors”)

This case law, which is by far the most consistent usage of the term, emphasizes paying back creditors and preserving an ongoing enterprise. It does not suggest the existence of anything more amorphous beyond those standards and it supports the idea that the ‘good faith’ standard is not meant to be an existential inquiry into the moral worth of a particular industry.

Bankruptcy courts have, however, recognized that the absence of a definition of good faith leaves courts without “any precise formulae or measurements to be deployed in a mechanical good faith equation.”  Metro Emps. Credit Union v. Okoreeh–Baah (In re Okoreeh–Baah), 836 F.2d 1030, 1033–34 (6th Cir.1988) (interpreting good faith in context of Chapter 13).

Any successful collateral attack under section 1129(a)(3) on the ‘good faith’ of the immoral enterprise must likely follow the path of connecting the good faith standard to the “public good.”  Bankruptcy Courts have invoked the ‘public good’ in refusing to enforce certain contracts and have followed the dictates of some courts that “while violations of public policy must be determined through “definite indications in the law of the sovereignty,” courts must not be timid in voiding agreements which tend to injure the public good or contravene some established interest of society. Stamford Bd. of Educ. v. Stamford Educ. Ass’n., 697 F.2d 70, 73 (2d Cir.1982).

The concept of the ‘public good’ is not a foreign one in bankruptcy courts.  Seeking relief for debtors that are the only providers of a service within their geographic area is an immensely easier task, no court, and no bankruptcy judge, likes to see a business fail and when the business is important to the community, support for reorganization from the bench often works to make reorganization easier.  Bankruptcy courts, although restrained by a statutory scheme, are as a matter of practice courts of equity.  Employing those equitable arguments to support a reorganization is both achievable and a reality of present practice.

Whether equitable arguments can be inversely employed to graft a sense of the ‘public good’ onto the good faith requirement within section 1129(a)(3) is decidedly uncertain and is not directly supported by the case law as it exists.

Somewhere out there though in one of those small border towns between the places of unelected legislators and the judicious and novel application of historical precedent lies the “moral development of the race” and the bankruptcy court that finds that incumbent within the concept of good faith is fair consideration of the public good.

Article By Peter J. Haley of Nelson Mullins

For more bankruptcy and restructuring news, click here to visit the National Law Review.

Copyright ©2022 Nelson Mullins Riley & Scarborough LLP

Debt Ceiling Shrinks for Small Business Bankruptcies

Subchapter V of Chapter 11 of the Bankruptcy Code, which took effect in February 2020, creates a more streamlined and less expensive Chapter 11 reorganization path for small business debtors.  Under the law as originally passed, to be eligible for Subchapter V, a debtor (whether an entity or an individual) had to be engaged in commercial activity and its total debts — secured and unsecured – had to be less than $2,725,625.  At least half of those debts must have come from business activity.

In March 2020, in response to the COVID-19 pandemic, Congress passed the CARES Act, which raised the Subchapter V debt ceiling to $7.5 million for one year.  Congress extended it to March 27, 2022.  A bipartisan Senate bill would make the Subchapter V debt limit permanent at $7.5 million and index it to inflation.  But Congress has not yet passed the legislation or sent it to President Biden for signature.  So, for now, the debt ceiling has shrunk to the original $2,725,625.

Subchapter V has proven popular, with over 3,100 cases filed in the last two years (78 in North Carolina).  Many of those cases could not have proceeded under Subchapter V but for the higher debt limits.  The American Bankruptcy Institute has reported that Subchapter V cases are experiencing higher plan-confirmation rates, speedier plan confirmation, more consensual plans, and improved cost-effectiveness than if those cases had been filed as a traditional Chapter 11.  Anecdotally, most debtors in North Carolina are filing under Subchapter V if they are eligible.

We will continue to monitor legislative activity and report if Congress passes a law to reinstate the $7.5 million debt ceiling.

Article By Lance P. Martin of Ward and Smith, P.A.

For more financial and business legal news, click here to visit the National Law Review.

© 2022 Ward and Smith, P.A.. All Rights Reserved.

Trump Administration to Discharge the Federal Student Loan Debt of Totally and Permanently Disabled Veterans

On August 21, 2019, President Trump signed a Presidential Memorandum that streamlines the process by which totally and permanently disabled veterans can discharge their Federal student loans (Federal Family Education Loan Program loans, William D. Ford Federal Direct Loan Program loans, and Federal Perkins Loans).  Through the revamped process, veterans will be able to have their Federal student loan debt discharged more quickly and with less burden.

Under federal law, borrowers who have been determined by the Secretary of Veterans Affairs to be unemployable due to a service-connected condition and who provide documentation of that determination to the Secretary of Education are entitled to the discharge of such debt.  For the last decade, veterans seeking loan discharges have been required to submit an application to the Secretary of Education with proof of their disabilities obtained from the Department of Veterans Affairs.  Only half of the approximately 50,000 totally and permanently disabled veterans who qualify for the discharge of their Federal student loan debt have availed themselves of the benefits provided to them.

The Memorandum directs the Secretary of Education to develop as soon as practicable a process, consistent with applicable law, to facilitate the swift and effective discharge of applicable debt.  In response, the Department of Education has said that it will be reaching out to more than 25,000 eligible veterans.  Veterans will still have the right to weigh their options and to decline Federal student loan discharge within 60 days of notification of their eligibility.  Veterans may elect to decline loan relief either because of potential tax liability in some states, or because receiving loan relief could make it more difficult to take future student loans.  Eligible veterans who do not opt out will have their remaining Federal student loan debt discharged.

Copyright © by Ballard Spahr LLP
Article by Stacy H. Rubin of Ballard Spahr LLP.
For more veteran’s affairs, see the National Law Review Government Contracts, Maritime & Military Law page.

When Your Customer is In Bankruptcy, There Are Two Major No-Nos That You Must Remember.

First, don’t violate the automatic stay, which prevents a creditor from attempting to collect a debt while the debtor is in bankruptcy unless the creditor gets prior court approval.  Second, don’t violate the discharge injunction, which absolves a debtor of liability for those debts covered by the bankruptcy court’s discharge order.  The automatic stay takes effect when the debtor files bankruptcy, while the discharge injunction typically comes at the end of the case.

The United States Supreme Court recently decided a case involving the discharge injunction.  In Taggart v. Lorenzen, the issue was the legal standard for holding a creditor in civil contempt when the creditor violates the bankruptcy discharge order.  In a unanimous decision, the Supreme Court held that a court may hold a creditor in civil contempt for violating a discharge order if there is no fair ground of doubt as to whether the order barred the creditor’s conduct. In other words, civil contempt may be appropriate if there is no objectively reasonable basis for concluding that the creditor’s conduct might be lawful.

Bradley Taggart was a part owner of an Oregon company called Sherwood Park Business Center.  He got into a dispute with some of the other owners, and they sued him in state court for breach of Sherwood’s operating agreement.  During the lawsuit, Taggart filed a Chapter 7 bankruptcy. In Chapter 7, a debtor discharges his debts by liquidating assets to pay creditors.   Taggart ultimately obtained a discharge.  After the bankruptcy court entered the discharge order, the parties returned to the state court lawsuit.  The parties who had sued Taggart before he filed bankruptcy obtained an order from the state court requiring him to pay post-bankruptcy attorneys’ fees of $45,000.00.  Taggart contended this debt had been discharged and the parties’ actions violated his bankruptcy discharge.

Multiple appellate courts reached different conclusions as to whether – and why or why not – the parties had violated the discharge order.  One issue the courts struggled with was the standard to apply to the parties’ conduct.  Should the courts apply an objective test based solely on their conduct or should they consider their subjective beliefs and motivations?  Should the courts impose strict liability for discharge violations or should they let creditors off the hook if they didn’t realize their conduct was improper?  The Supreme Court agreed to resolve these questions.

In adopting the “no fair ground of doubt” standard, the Supreme Court noted that civil contempt is a severe remedy and basic fairness requires those enjoined know what conduct is outlawed before being held in contempt.  The standard is generally an objective one.  A party’s subjective belief he was complying with an order ordinarily will not insulate him from civil contempt if that belief was objectively unreasonable.  Bad faith conduct, and repeated or persistent violations can warrant civil contempt.  Good faith can mitigate against contempt and factor into the appropriate remedy.

Although a discharge order often has little detail, the Supreme Court pointed out that, under the Bankruptcy Code, all debts are discharged unless they are a debt listed as exempt from discharge under Section 523.  A domestic support obligation, for instance, is exempt from discharge.  (This recent article discusses how debts involving intentional, fraud-like conduct may be exempted from discharge.)  In other words, ignorance of the bankruptcy law is no excuse.

In adopting the “no fair ground of doubt standard,” the Supreme Court rejected two other standards, one more lenient and one more harsh.  First, the Supreme Court rejected a pure “good faith” test – a creditor’s good faith belief that its actions did not violate the discharge would absolve it of contempt. Second, the Supreme Court rejected a strict liability test – if a creditor violated the discharge, he would be in contempt regardless of his subjective beliefs about the scope of the discharge order or whether there was a reasonable basis for concluding that his conduct did not violate the discharge order.

The discharge injunction is no joke, and creditors violate it at their peril.  A debtor can be compensated for damages resulting from a discharge violation.  In this case, the bankruptcy court initially awarded Taggart over $100,000 for attorneys’ fees, emotional distress, and punitive damages.  Creditors with customers in bankruptcy, or who have filed bankruptcy in the past, should consult counsel who can advise them on what debts they can pursue.  And if a creditor finds itself accused of violating the discharge injunction, it should contact counsel to assess its chances of passing or failing the “no fair ground of doubt” test.

© 2019 Ward and Smith, P.A.. All Rights Reserved.