Bankruptcy - Hon. James D. Walker, Jr. and Amber Nickell

• Publication year: 2008

Bankruptcyby Hon. James D. Walker, Jr.^* and Amber Nickell^**

I. Introduction

In 2007 the world of bankruptcy law lacked much of the excitement seen in 2005 and 2006. During the previous two years a variety of novel issues and intra-circuit conflicts arose as courts began interpreting the 2005 amendments to the Bankruptcy Code.¹ The pace settled down in 2007 as courts began work that consisted more of refinement than innovation. They tackled the scope of sovereign immunity, the automatic stay, undue hardship for student loan discharge, and the hanging paragraph in Sec. 1325(a).² These and other recent developments in Eleventh Circuit bankruptcy law are addressed in this Article.

II. Sovereign Immunity

In 2006 the united States Supreme Court held that when the states ratified the Constitution, they agreed to subject themselves to bankruptcy laws enacted by Congress.³ Consequently, the Supreme Court in Central Virginia Community College v. Katz⁴ held that states cannot raise sovereign immunity as a defense to preference suits, and bankrupt- cy judges may issue ancillary orders to enforce in rem jurisdiction.⁵ In Florida Department of Revenue v. Omine (In re Omine),⁶ the Eleventh Circuit Court of Appeals considered the scope of Katz.⁷

In In re Omine, the Florida Department of Revenue ("DOR") raised the questions of whether it could assert sovereign immunity when accused of an automatic stay violation and whether it is subject to damages as a result. After the debtors filed a Chapter 13 petition, the DOR filed a proof of claim. The DOR subsequently began garnishing the debtor-husband's wages and was found to have been in violation of the stay. The bankruptcy court awarded the debtors actual damages, attorney fees, and punitive damages, and the DOR appealed. The district court affirmed and remanded to the bankruptcy court with instructions. On remand, the bankruptcy court awarded the debtors actual damages, attorney fees, and sanctions (based on the debtors' new motions for sanctions), and the district court affirmed.⁸ The court of appeals affirmed in part and reversed in part.⁹

The Eleventh Circuit explained that Katz dealt with a preference action, which requires the defendant (in this case, the State) to return property belonging to the bankruptcy estate.¹⁰ However, when damages are awarded for an automatic stay violation, the state must turn over funds unconnected to the bankruptcy estate.¹¹ In other words, the DOR argued, it "allow[s] public funds held by a state treasury to be at risk to benefit an individual," which the DOR claimed is not authorized by Katz.¹²

The court of appeals disagreed, noting that the automatic stay is essential to the bankruptcy process, and the court's authority to enforce it flows from its in rem jurisdiction.¹³ "While motions for contempt and seeking sanctions that include attorney's fees and costs for violating the automatic stay may resemble money damage lawsuits in form, it is their function that is critical, and their function is to facilitate the [in rem] proceedings that form the foundation of bankruptcy."¹⁴ Consequently, orders enforcing the automatic stay are not subject to the defense of sovereign immunity.¹⁵

However, Congress's power to pass bankruptcy laws includes the power to limit the award of damages.¹⁶ The decision in Katz did not affect the applicability of 11 U.S.C. Sec. 106(a)(3),¹⁷ which prohibits the court from awarding punitive damages for a stay violation by a governmental unit.¹⁸ Therefore, the court vacated the award of sanctions and remanded the case for further proceedings.¹⁹

III. Professionals

An unsecured creditor's claim may include contractual attorney fees incurred for bankruptcy-specific post-petition services, according to the Supreme Court in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co.²⁰ Travelers Casualty & Surety Co. of America ("Travelers") had issued a bond to guarantee Pacific Gas & Electric Company's ("PG&E") workers' compensation benefits. When PG&E filed a Chapter 11 petition, Travelers filed a proof of claim. The parties engaged in litigation over certain language in PG&E's Chapter 11 plan. After the litigation was resolved, Travelers sought to recover attorney fees as provided for in its surety contract with PG&E. The bankruptcy court denied attorney fees, in accordance with the Ninth Circuit's Fobian rule, because the parties had been litigating a bankruptcy issue rather than an issue arising from their contract.²¹ The district court and the court of appeals affirmed.²²

The Supreme Court reversed, determining there is no basis for the Fobian rule in the Bankruptcy Code.²³ First, the Court noted that "an otherwise enforceable contract allocating attorney's fees (i.e., one that is enforceable under substantive, nonbankruptcy law) is allowable in bankruptcy except where the Bankruptcy Code provides otherwise."²⁴ Second, the Court reviewed the circumstances under which a court can disallow a claim and determined that a court can disallow a claim if one of nine exceptions applies.²⁵ In this case, only one exception was relevant—whether or not the claim for attorney fees was enforceable "'under any agreement or applicable law.'"²⁶ Because the bankruptcy court did not determine whether the fees were enforceable under state law, the Court reversed and remanded for additional proceedings.²⁷

Attorney fees were targeted from a different angle in Quarles & Brady LLP v. Maxfield (In re Jennings),²⁸ in which the Eleventh Circuit emphasized the importance of transparency in Rule 2014 disclosures.²⁹ A law firm representing eleven debtors in a consolidated bankruptcy proceeding failed to disclose certain potential or actual conflicts among the debtors on its Rule 2014 disclosure form. The conflicts related to claims certain debtors had against other debtors. The attorneys argued the conflicts were fully disclosed in various pleadings unrelated to the Rule 2014 disclosure statement. The bankruptcy court found the law firm's disclosure to be insufficient and held that all disclosures must be listed in the 2014 form.³⁰ "Bankruptcy courts are not obliged to hunt around and ferret through thousands of pages in search of the basic disclosures required by Rule 2014."³¹ Consequently, the court of appeals affirmed the bankruptcy court's ruling that the attorneys (1) violated the disclosure rules, (2) should be disqualified, (3) should receive no compensation, and (4) should disgorge any retainer they had already received.³²

IV. ADMINISTRATION

In Martin v. Pahiakos (In re Martin),³³ the Eleventh Circuit held that a trustee can bind a debtor with a settlement agreement.³⁴ In In re Martin, a creditor sued a debtor in state court and obtained a default judgment. The debtor alleged deficiency of service of process and filed a motion to set aside the default judgment. Thereafter, the debtor filed a Chapter 11 petition. When the case was later converted to Chapter 7, the trustee replaced the debtor as the real party in interest in the state court action. As part of a settlement of that action, the trustee agreed to waive defenses with regard to service of process defects and to withdraw the debtor's motion to set aside default judgment. The bankruptcy court approved the settlement agreement without objection from the debtor. The trustee later abandoned any remaining interest in the state court proceedings, and the debtor again asserted his improper service defense.³⁵ His efforts were rebuffed by the bankruptcy and district courts, which both found that he was bound by the settlement agreement and ordered compliance.³⁶

The court of appeals affirmed, noting that the debtor never objected to the settlement agreement despite notice and opportunity to do so.³⁷ The court also held that the settlement met all the criteria for preclusive effect.³⁸ First, it was entered by a court of competent jurisdiction—the bankruptcy court—in accordance with due process.³⁹ The trustee's subsequent abandonment of any remaining interest in the state court case did not give the debtor a right to relitigate it, nor did it affect the bankruptcy court's order approving the settlement.⁴⁰ Second, the settlement order was final, such that it was entitled to preclusive effect because in a Chapter 7 case, no further orders (such as confirmation) are necessary to determine the rights of all parties.⁴¹ Third, the parties to the settlement agreement were the same parties to the state court litigation, with the trustee standing in the debtor's shoes.⁴² Fourth, the causes of action were identical.⁴³

V. AUTOMATIC STAY

Two cases considered slightly different aspects of the limited automatic stay as applied to a debtor who has had one case pending and dismissed during the year prior to his or her current filing.⁴⁴ In such circumstances, the stay expires after thirty days if not extended by the court.⁴⁵

In In re Ajaka,⁴⁶ the debtor's case was subject to a limited stay. The debtor sought an extension, which was denied because the extension hearing was not held within thirty days of her bankruptcy filing.⁴⁷ The bankruptcy court also refused to impose a stay pursuant to 11 U.S.C.A. Sec. 362(c)(4)⁴⁸ because the plain language of the statute provides that it applies only when the debtor had "'2 or more single or joint cases'" pending and dismissed in the year prior to the current filing.⁴⁹ Nevertheless, the court determined that an extension was unnecessary because, in accordance with the majority view, the limited stay only terminates with regard to the debtor, not the property of the estate.⁵⁰

The issue in In re James⁵¹ was slightly different. The debtor in that case was also subject to the limited stay, which the court refused to extend.⁵² The debtor then argued that the need for an extension was moot because the stay only expires with regard to creditors who initiated action against the debtor prior to the current bankruptcy filing.⁵³ The court disagreed based on the...