On January 12, 2018, the U.S. Supreme Court granted certiorari over the Eleventh Circuit’s decision in R. Scott Appling v. Lamar, Archer & Cofrin, LLP, which held that a fraudulent statement regarding a single asset may constitute a statement concerning the debtor’s financial condition, thereby allowing a debt incurred in reliance on the false statement to be discharged through a bankruptcy. The Eleventh Circuit’s decision focused on the dichotomy established in sections 523(a)(2)(A) and (B) of the Bankruptcy Code between fraudulent statements regarding the debtor’s “financial condition,” which only prevent the discharge of a debt if the false statement is made in writing, and other fraudulent statements giving rise to a debt, which can prevent a discharge even if the statement is only made orally. R. Scott Appling v. Lamar, Archer & Cofrin, LLP will allow the Supreme Court to address a split between the Circuits on this issue, as the Eleventh Circuit’s ruling is consistent with the approach adopted by the Fourth Circuit,[1] but contrary to the standard adopted by the Fifth, Eighth, and Tenth Circuit’s approach, which holds that a statement about a single asset does not “respect” a debtor’s financial condition as required by 523(a)(2)(A).[2]

The case arises out of an adversary proceeding initiated by Lamar, Archer & Cofrin, LLP (“Lamar”) against one of its clients, R. Scott Appling. Appling incurred certain legal fees when Lamar represented him in lawsuits against the former owners of his business; however, Appling was unable to pay his legal bills when they became due. During a meeting with attorneys from Lamar, Appling conveyed that he was expecting a substantial tax refund, which he represented would be sufficient to pay his outstanding legal bill as well, as to pay any future fees incurred during the ongoing litigation. In reliance of this statement, Lamar continued its representation of Appling and did not take any steps to immediately collect its overdue fees. However, Appling’s statement was false as he only received a modest refund, which he put into his business rather than to satisfy the outstanding legal fees owed to Lamar. Lamar eventually filed suit against Appling to collect the outstanding fees, and Appling subsequently filed for bankruptcy. The central issue is whether Appling’s oral statements regarding his tax refund, which pertained to a single asset, respected his financial condition and is therefore dischargeable.

The Supreme Court’s decision could have ramifications on the discharge of debts in bankruptcy. The narrower interpretation of the statute favored by the majority of circuits will limit the scope of the “financial condition” exception contained in section 523(a)(2)(B). This “gives effect to the fundamental bankruptcy policy that the bankruptcy courts will not provide safe haven for the perpetuators of fraud.”[3] Indeed, the exception was originally conceived by Congress to address certain consumer-finance companies that were deliberately encouraging customers to submit false statements for the purpose of insulating the creditor’s claim from discharge.[4] However, application of the majority view is difficult in practice because it creates “substantial line-drawing problems and may cause unjustified differential treatment of functionally equivalent scenarios.”[5]

On the other hand, applying the broader interpretation put forth by the Eleventh Circuit could promote predictability and accuracy while protecting debtors from abusive credit practices.[6] It encourages creditors to rely on written statements, which are more reliable as evidence, if they later seek an exemption.[7] The office of U.S. Solicitor General advanced this position and filed a brief as Amici Curiae agreeing with the Eleventh Circuit’s ruling. The Solicitor General argued that the broader interpretation best served Congress’s policy goals because it “gives creditors an incentive to create writings before the fact,” which may reduce fraud in the first instance.[8] By creating reliable evidence for future litigation, “such writing helps both the honest debtor prove his honesty and the innocent creditor prove a debtor’s dishonesty.”[9] Nevertheless, the Eleventh Circuit’s interpretation could expand the exception’s reach beyond its intended scope because “virtually every statement by a debtor that induces the delivery of goods or services on credit relates to his ability to pay.”[10] With the “financial condition” exception taking center stage, this Supreme Court decision will certainly be one to watch.

 

 

* This post was prepared with assistance from Jiun-Wen Bob Teoh.

[1] See Engler v. Van Steinburn, 744 F.2d 1060, 1061 (4th Cir. 1984) (holding that “a debtor’s assertion that he owns certain property fees and clear of other liens is a statement respecting his financial condition”).

[2] See, e.g., In re Bandi, 683 F.3d 671, 676 (5th Cir. 2012); In re Lauer, 371 F.3d 406, 413-14 (8th Cir. 2004); In re Joelson, 427 F.3d 700, 706 (10th Cir. 2005).

[3] Brief for Petitioner at 20, Lamar, Archer & Cofrin, LLP v. Appling, No. 16-1215 (Apr. 11, 2017).

[4] Brief for Petitioner at 22, Lamar, Archer & Cofrin, LLP v. Appling, No. 16-1215 (Apr. 11, 2017).

[5] Brief of United States as Amici Curiae at 18, Lamar, Archer & Cofrin, LLP v. Appling, No. 16-1215 (Nov. 9, 2017).

[6] Brief for Respondent at 20, Lamar, Archer & Cofrin, LLP v. Appling, No. 16-1215 (May 25, 2017).

[7] Brief for Respondent at 20, Lamar, Archer & Cofrin, LLP v. Appling, No. 16-1215 (May 25, 2017).

[8] Brief of United States as Amici Curiae at 8, Lamar, Archer & Cofrin, LLP v. Appling, No. 16-1215 (Nov. 9, 2017).

[9] Brief of United States as Amici Curiae at 17-18, Lamar, Archer & Cofrin, LLP v. Appling, No. 16-1215 (Nov. 9, 2017).

[10] Brief for Petitioner at 22, Lamar, Archer & Cofrin, LLP v. Appling, No. 16-1215 (Apr. 11, 2017).

On October 11, 2016, the United States Supreme Court granted certiorari to a debt collection agency in its appeal from the Eleventh Circuit case Johnson v. Midland Funding, LLC.[1] In Johnson, the Eleventh Circuit affirmed its decision in Crawford v. LVNV Funding, LLC,[2] which held that a debt collector violates the Fair Debt Collection Practices Act (the “FDCPA”) when it files a proof of claim in a bankruptcy case on a debt that it knows to be time-barred. In view of the emerging circuit split, the Supreme Court agreed to hear the case in order to resolve two issues: (1) whether the filing of a time-barred proof of claim in a bankruptcy proceeding exposes a debt-collection creditor to liability under the FDCPA and (2) whether the Bankruptcy Code, which governs and permits the filing of proofs of claim in bankruptcy, precludes a cause of action under the FDCPA for the filing of a time-barred proof of claim in a bankruptcy proceeding.

In Johnson, which originated in the District Court for the Southern District of Alabama, plaintiff Aleida Johnson (“Johnson”) filed a Chapter 13 bankruptcy petition in March 2014. In May 2014, a debt collection agency—Midland Funding, LLC (“Midland”)—filed a proof of claim in Johnson’s bankruptcy proceeding for an amount of $1,879.71.[3] This debt accrued over ten years before Johnson filed for bankruptcy and its collection was time-barred by Alabama’s statute of limitations, which permits a creditor only six years to collect an overdue debt.[4] Johnson brought suit against Midland’s filing of the proof of claim under the FDCPA, which provides that “[a] debt collector may not use any false, deceptive, or misleading representation or means in connection with the collection of any debt.”[5] This prohibition encompasses an attempt to collect a debt that is not permitted by law.[6] Johnson argued that pursuant to the language of the statute, Midland’s time-barred proof of claim was “unfair, unconscionable, deceptive, and misleading in violation of the FDCPA.”[7]

Midland promptly moved to dismiss Johnson’s FDCPA suit. The District Court granted the motion to dismiss, finding that the Bankruptcy Code’s affirmative authorization for creditors to file a proof of claim—regardless of whether it is time-barred—was in direct conflict with the FDCPA’s prohibition on debt collectors filing a time-barred claim. Under the doctrine of implied repeal, the District Court found that the later-enacted Bankruptcy Code effectively repealed the conflicting provision under the FDCPA and precluded debtors from challenging that practice as a violation of the FDCPA in a bankruptcy proceeding.[8]

The Eleventh Circuit reversed the District Court’s decision, holding that “[t]he Bankruptcy Code does not preclude an FDCPA claim in the context of a Chapter 13 Bankruptcy when a debt collector files a proof of claim it knows to be time-barred. . . . [W]hen a particular type of creditor—a designated ‘debt collector’ under the FDCPA—files a knowingly time-barred proof of claim in a debtor’s Chapter 13 bankruptcy, that debt collector will be vulnerable to a claim under the FDCPA.”[9] Under the Eleventh Circuit’s analysis, the allegedly conflicting provisions of the Bankruptcy Code and the FDCPA could co-exist harmoniously, and the presence of a “positive repugnancy” between the statutes necessitating application of the un-favored doctrine of implied repeal was lacking.[10] Thus, although the Bankruptcy Code guarantees a creditor’s right to file a proof of claim they know to be time-barred by the statute of limitations, those creditors do not thereby gain immunity from the consequences of filing those claims.[11] The Court rejected Midland’s assertion that such an interpretation would effectively force a debt collector to “surrender[] its right to file a proof of claim.”[12] The court likened this scenario to filing a frivolous lawsuit, stating that “[i]f a debt collector chooses to file a time-barred claim, he is simply opening himself up to a potential lawsuit for an FDCPA violation. This result is comparable to a party choosing to file a frivolous lawsuit. There is nothing to stop the filing, but afterwards the filer may face sanctions.”[13] Accordingly, the Eleventh Circuit found that the FDCPA lays over the top of the Bankruptcy Code’s regime, so as to provide an additional layer of protection to debtors against a particular kind of creditor—debt collectors.[14]

The Court in Johnson makes clear that its holding is limited in scope and should not have far-reaching consequences for most creditors. Most importantly, the Court acknowledges that the FDCPA’s prohibitions do not reach all creditors—the statute only applies to “debt collectors,” which are a narrow subset of the universe of creditors that might file proofs of claim in a bankruptcy proceeding.[15]  Furthermore, the FDCPA provides a safe harbor for debt collectors who unintentionally or in good-faith file a time-barred proof of claim.[16] Thus, a debt collector who files a time-barred proof of claim may escape liability by showing that the violation was not intentional and resulted from a bona-fide error.[17] These two limitations ensure that regardless of how the Supreme Court resolves this circuit split, there will not be a chilling effect on the submission of proofs of claims by the vast majority of creditors.

Although the direct impact of the Johnson ruling may be restricted to a limited creditor base, recent Supreme Court rulings involving bankruptcy cases have had broader knock-on effects on bankruptcy jurisprudence (and jurisdiction), and a decision on preemption as it relates to the Bankruptcy Code has the potential for a significant impact on various aspects of procedural and substantive bankruptcy law outside of the limited issue of the interplay of the FDCPA and the Bankruptcy Code. Accordingly, visit HHR’s Bankruptcy Report for future updates on this case and its potentially broader impact.

[1].      Johnson v. Midland Funding, LLC , 823 F.3d 1334 (11th Cir. 2016).

[2].      Crawford v. LVNV Funding, LLC, 757 F.3d 1254, 1261 (11th Cir. 2014).

[3].      Johnson, 823 F.3d  at 1336.

[4].      Id.

[5].      15 U.S.C. § 1692e (2012).

[6].      15 U.S.C. § 1692f(1) (2012).

[7].      Johnson, 823 F.3d at 1337 (internal quotation marks omitted).

[8].      Id.

[9].      Id. at 1338.

[10].    Id. at 1340.

[11].    Id. at 1338.

[12].    Id. at 1341 (alteration in original).

[13].    Id.

[14].    Id.

[15].    Id. at 1339.

[16].    Id.

[17].    Id.

On April 8, 2016, the Eleventh Circuit Court of Appeals held that a district court trying a bankruptcy case arising under title 11 of the United States Code is obliged to follow the Federal Rules of Bankruptcy Procedure, instead of the Federal Rules of Civil Procedure, in computing the deadline for filing post-trial motions.

The story behind this procedural ruling began eight years earlier, when several companies filed an involuntary chapter 7 bankruptcy petition against Maury Rosenberg.  The bankruptcy court granted Rosenberg’s motion to dismiss the petition with prejudice because the companies were not eligible creditors.  The bankruptcy court retained jurisdiction to award Rosenberg his costs, reasonable attorney’s fees, and damages under section 303(i) of the Bankruptcy Code.  Rosenberg then filed an adversary complaint against the defendants seeking: (1) attorney’s fees and costs for defending the involuntary petition, (2) compensatory and punitive damages for filing the petition in bad faith, and (3) attorney’s fees incurred in the prosecution of the adversary proceeding.  The district court granted the defendants’ motion to withdraw the reference because the claims for damages under section 303(i)(2) of the Bankruptcy Code were analogous to common-law claims for malicious prosecution.  The damages claims were tried before a jury in district court; Rosenberg’s claims for attorney’s fees and costs remained in bankruptcy court.

The jury found that the defendants acted in bad faith and awarded Rosenberg compensatory and punitive damages, and on March 14, 2013, the district court entered final judgment.  Twenty-eight days later, defendants moved for judgment as a matter of law under Fed. R. Civ. P. 50(b).  Rosenberg moved to strike the motion as untimely, arguing that the deadline for filing a Rule 50(b) motion under Fed. R. Bankr. P. 9015(c) was fourteen days after entry of the judgment.

The Eleventh Circuit addressed whether the Federal Rules of Civil Procedure or the Federal Rules of Bankruptcy Procedure supplied the deadline for filing a Rule 50(b) motion for a district court trying a bankruptcy case arising under title 11.  First, the court noted that a “plain reading” of the Federal Rules of Bankruptcy Procedure make clear that the Federal Bankruptcy Rules have primacy in cases arising from title 11, and that the Federal Rules of Civil Procedure only apply to the extent that they have been explicitly incorporated by the Bankruptcy Rules.  Therefore, F.R.C.P. 50(b) must be read “through the lens” of the Bankruptcy Rules, which incorporates F.R.C.P. 50(b), with the “explicit limitation that renewed motions for judgment must be filed within 14 days of the entry of the judgment.”  See Fed. R. Bankr. P. 9015(c).

Next, although the precise question had not been decided by other district or circuit courts, the Eleventh Circuit found guidance in decisions of other courts for holding that the Federal Rules of Bankruptcy Procedure apply.  For example, both the Fourth and Seventh Circuits have applied the Bankruptcy Rules in determining whether service of process was sufficient.  See In re Celotex Corp., 124 F.3d 619, 630 (4th Cir. 1997); Diamond Mortg. Corp. v. Sugar, 913 F.2d 1233, 1243-44 (7th Cir. 1990).  In addition, the Third Circuit ruled in Phar-Mor, Inc. v. Coopers & Lybrand, 22 F.3d 1128, 1238 (3d Cir. 1994) that “Bankruptcy Rules govern non-core, ‘related to’ proceedings before a district court.”  Also relevant was a decision by the District of Delaware in which the district court concluded that the Federal Rules of Bankruptcy Procedure apply in counting the days to determine the timeliness for filing a motion for a new trial, rather than the Federal Rules of Civil Procedure, which do not count weekends and holidays.  VFB LLC v. Campbell Soup Co., 336 B.R. 81 (D. Del. 2005).

The Eleventh Circuit rejected the cases cited by defendants.  Although the Sixth Circuit has applied a 28-day filing deadline from the Federal Rules of Civil Procedure instead of the 14-day deadline in the Bankruptcy Rules with regard to a motion to alter or amend a judgment under Fed. R. Civ. P. 59, the Eleventh Circuit explained that in that case, the court provided “no analysis of the issue” and explained that there was “no indication that the parties urged or that the court even considered applying the deadline found in the Bankruptcy Rules.”  Therefore, that case did not support applying the Federal Rules of Civil Procedure to a case arising under title 11.  The Eleventh Circuit also noted that applying the 14-day deadline “does not create an overly onerous obligation on parties proceeding in district court any more than it does in bankruptcy court.”

The Eleventh Circuit also rejected defendants’ argument that even if the 14-day deadline was applied, the time did not begin to run until the bankruptcy court entered the final judgment on Rosenberg’s claims for attorney’s fees.  The court was “unpersuaded” and explained that because the matters were tried by different judges, on different courts, operating under different timetables set by their respective dockets, deeming the two cases as one for purposes of when an appeal may be taken “makes little sense.”

The decision provides clear guidance for practitioners litigating bankruptcy claims in district court.  Finding that “both the plan language of the rules and the weight of authority counsel for the application of the Bankruptcy Rules to bankruptcy proceedings tried in district court,” the Eleventh Circuit’s decision has potentially broader applicability to other procedural deadlines as well.

In a follow-up to our post on the treatment of tax-sharing arrangements in bankruptcy, the Ninth Circuit held last month in an unpublished decision that a rebate that a holding company received pursuant to an ambiguous tax-sharing agreement (“TSA”) created a debtor-creditor relationship between the holding company and its banking subsidiary.  In the Matter of: Indymac Bancorp, Inc., (12-56218) (9th Cir., April 21, 2014).  As a result, the refund was property of the bankruptcy estate of the holding company, a significant windfall for the holding company and a significant loss to its subsidiary’s estate.  The Ninth Circuit’s decision is in contrast to the twin decisions of the Eleventh Circuit in the fall of 2013,[1] finding that two separate TSAs in unrelated cases created an agency relationship between a holding company and its subsidiary, thereby excluding the refund from the estate. See In Re Bamkunited Financial Corp., 12-11392 (11th Cir. Aug. 15, 2013); In Re Netbank, Inc., 12-13965 (11th Cir. Sept. 10, 2013)

As explained in our prior post, when a bankruptcy occurs, one affiliate may be holding the rebate for the entire conglomerate and the distinction between the relationships between the affiliated entities affects how that refund will be treated in bankruptcy.  If the TSA created an agency relationship, the refund will be excluded from the estate and the refund will be split as it would in the ordinary course of business.  If, however, the TSA create a debtor-creditor relationship, the entire refund becomes property of the estate holding the rebate and the other entities receive only an unsecured creditor claim for that refund – a potentially significant windfall for creditors of the rebate-holding entity and a significant loss of funds for creditors of the other entities of the conglomerate.

The Ninth Circuit distinguished Indymac from the Eleventh Circuit’s Netbank decision based on two factors: (i) that the Netbank case involved a TSA with an explicit incorporation of the Interagency Statement on Income Tax Allocation in Holding Company Structure (which the Indymac TSA did not), and (ii) that California law applied in Indymac rather than the Georgia law that governed Netbank.  The Ninth Circuit held that under California law, the TSA did not create a principal-agent relationship – despite specific language that appointed the holding company the subsidiary bank’s “agent and attorney-in-fact” because the subsidiary bank did not exercise control over its holding company’s activities with respect to any aspect of the tax filing.  Separately, the Ninth Circuit held that the TSA’s lack of language establishing a trust relationship was explicitly an indication of a debtor-creditor relationship under California law.

This case reinforces the need for a company considering the creation of a TSA to address explicitly how any tax refund will be treated in the event of a bankruptcy.  Given the varying decisions from courts on ambiguous TSAs and the potential effects of different state laws, a TSA that does not address how it should be interpreted in bankruptcy creates uncertainty as to where any tax refund may wind up in a bankruptcy, and creates the risk that in a bankruptcy resources of the estate will be wasted on litigation over the interpretation of an ambiguous TSA.


[1]               In re Bankunited Financial Corp., 12-11392 (11th Cir. Aug. 15, 2013); In Re Netbank, Inc., 12-13965 (11th Cir. Sept. 10, 2013)

When a multi-national conglomerate corporation fails, how the corporation’s tax-sharing arrangements (“TSAs”) will be interpreted in bankruptcy can be a multi-million dollar question, especially where a holding company is being reorganized separately from a subsidiary.  If the TSA is deemed to create debtor-creditor relationships between the affiliates, the affiliate holding the rebate on the date of bankruptcy need only distribute any refund owed to other affiliates at an unsecured creditor rate – resulting in a significant loss to the other companies and a windfall to the affiliate holding the rebate when the music stopped.  If, however, the TSA is deemed to create an agency relationship between the affiliates, the rebate should be distributed between them in parity notwithstanding the bankruptcy.  For a subsidiary – such as a bank owned by a holding company – the difference can be a matter of millions of dollars and have a substantial impact on its creditors’ recovery rates.

Conglomerate corporations use TSAs principally because they offer a mechanism for simplifying and organizing the tax filings of companies in a consolidated group.  Under certain conditions, federal law permits a parent company to file a consolidated tax return on behalf of itself and its subsidiaries.  Since federal law does not specify how the tax liabilities or refunds should be allocated between the companies, TSAs exist to allocate the liabilities and refunds between the companies in the group.

When a bankruptcy occurs, one affiliate may be holding the rebate for the entire conglomerate.  In these cases, the TSA must be interpreted to determine whether the estate of the affiliate holding the rebate effectively gets a windfall, such that a significant portion of the refund will go to that affiliate’s creditors, or whether the rebate will be split between the entities in the conglomerate as it would have been outside of the bankruptcy context.  Many TSAs are silent on how a refund should be handled in a bankruptcy and so bankruptcy courts must determine, according to the governing state’s contract law, how the refund will be treated.

In a pair of recent cases, the Eleventh Circuit interpreted two tax-sharing agreements to create an agency relationship between the parent company and its subsidiary.  In both cases, a dispute arose between the holding company in Chapter 11 and the FDIC as receiver for a subsidiary bank over the proper treatment of the tax refund.

In In Re Bamkunited Financial Corp., 12-11392 (11th Cir. Aug. 15, 2013), U.S. Bankruptcy Judge Laurel Isicoff held that the rebates became the property of the holding company estate on receipt, and that the obligation to transfer the refunds to the FDIC (as receiver for the bank) became a debt of the holding company estate.  On appeal, after finding that the contract was silent on the issue of the holding company’s “ownership” of the refunds before they were forwarded to the bank under the TSA, the Eleventh Circuit applied Delaware law in determining that the contract should be interpreted to create an agency relationship.  The court relied on two key aspects of the contract: first, the absence of any collateral or any other contractual protection for the subsidiary for the obligation owed by the parent company;  and second, the absence of any language from which a debtor-creditor relationship was created or implied, and the absence of any method to determine the terms of the indebtedness.

About three weeks later, the Eleventh Circuit decided In Re Netbank, Inc., 12-13965 (11th Cir. Sept. 10, 2013), again holding in similar circumstances that, under Georgia law, a TSA should be interpreted to create an agency relationship.  The court based its decision on two specific clauses in the TSA; first, a provision that incorporated the language of the FDIC’s Policy Statement on TSAs that notes that the parent receives refunds as an “agent” on behalf of group members; and second, a provision that stated that the TSA should result in “no less favorable” treatment for the subsidiary than if it had filed on its own.  The Eleventh Circuit held that reducing the subsidiary’s claim to the refund to that of an unsecured creditor would result in giving the subsidiary less favorable treatment than if it had filed alone.

While a going concern is free to write its TSA to specify whether the relationship between the entities should be considered a debtor-creditor relationship or an agency relationship, in most cases the situation will never be considered until the conglomerate is in bankruptcy.  Prudence counsels that any corporation considering a new TSA should consider the issue of how the refund should be treated in bankruptcy and explicitly state that the TSA creates an agency relationship (if the corporation desires that the refund distribution not be affected by a bankruptcy), or a debtor-creditor relationship (if the conglomerate seeks to advantage the estate of the company holding the refund in the event of a bankruptcy).

These two Eleventh Circuit decisions provide a blueprint for arguing that existing TSAs that are silent on the status of the refunds should be interpreted to create an agency relationship and remove refunds owed to other companies from the bankruptcy estate.  They strongly support the position that the default interpretation of an ambiguous TSA should be an agency relationship, resulting in complete distribution of the refund in the event of bankruptcy.  This gives the trustee or receiver of a subsidiary company owed a tax refund a significant advantage in obtaining the refund in full from the parent company’s estate, either through a negotiated settlement or litigation.