Creditors’ Rights and Bankruptcy Section Newsletter
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| Greetings:
Summer has begun. The floods Texas has recently seen are starting to subside. It is heating up outside. It is also the time the SCOTUS hands down decisions before its summer recess. Once such decision involving secondary lien markets and stripping down of liens is discussed in this issue. Also in this issue is an article involving garnishment of wages and the impact of bankruptcy on estate planning.
As always, should you have any questions, please feel free to contact me at any time.
Bruce W. Akerly
Chair, Creditors’ Rights & Bankruptcy Practice Group
Cantey Hanger LLC, Dallas |
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Common Sense to the Rescue of Junior Lenders
Authored by Christopher A. Klement, Associate
In two cases of importance to the second lien market, common sense has won the day as the Supreme Court of the United States (SCOTUS) rejected a pair of debtors’ attempts to strip down underwater junior liens in a chapter 7 bankruptcy. In Bank of America v. Caulkett and Bank of America v. Toledo-Cardona, SCOTUS ruled that a chapter 7 debtor “may not void a junior mortgage under [U.S.C.] §506(d) when the senior mortgage lien exceeds the current value of the collateral.” The ruling centered on the disputed meaning of “secured claim” and SCOTUS recognized the term as defined under section 506(d) of the Bankruptcy Code as “a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim.”
In reaching its decision, SCOTUS relied on its ruling in Dewsnup v. Timm—which had previously defined “secured claim.” Justice Clarence Thomas, the decision’s author, offered an opinion intended to avoid “an odd statutory framework” that “could lead to arbitrary results” by creating too fine a distinction between this case and Dewsnup. Instead of attempting to overrule Dewsnup, the debtors asked the Court to limit that decision’s construction of “secured claim” to partially underwater liens—as opposed to wholly underwater liens. Justice Thomas worried this proposed interpretation of the Bankruptcy code would create circumstances where a single dollar would determine a debtor’s ability to “strip off the entire junior lien.” SCOTUS refused to engage in such line-drawing. Significantly, Justice Thomas recognizes the appropriate use of line-drawing in bankruptcy proceeding but only where Congress sets the lines—not the Court.
The ruling reverses the decisions of the Eleventh Circuit Court of Appeals, District Court, and Bankruptcy Court. In the lower courts, debtors had successfully advocated for an interpretation of “secured claim” that borrowed meaning from the term’s use in another subsection of the Bankruptcy code. Under section 506(a)(1), a creditor’s allowed claim to a lien on property “is a secured claim to the extent of the value of such creditor’s interest in…such property.” In contrast, the same section refers to allowed claims with a value greater than the creditor’s interest in the property as “unsecured claims.” Using this construction—ultimately too limited even for Justice Antonin Scalia—the lower courts considered Bank of America’s claims void because they were “unsecured claims,” rather than “allowed secured claims.”
While the decision does much to protect commercial lenders’ interests in junior liens, it reinforces the strain between first- and second-mortgage lenders during bankruptcy proceedings. First-mortgage lenders would have benefited from the ability to strip underwater junior liens. Without these junior liens to contend with, first-mortgage lenders would have had an easier time selling the property to recover a greater amount of their claim. Instead, second-lien lenders will retain their place at the negotiating table.
Ultimately, this ruling protects the growing home-equity market and preserves the ability of consumers to access the equity in their homes. A contrary ruling might have slowed the market, restricted the access to credit, and driven up the price of credit. The Court gave lenders consistent protection for junior liens and a reason to have confidence in these products.
Unfortunately, the risk to junior liens might not be completely over. While the Court refused to draw a fine-line distinction to Dewsnup, the opinion repeatedly points out that the debtors did not ask the Court to overrule the prior case. This raises the potential of a future decision that redefines section 506(d) by overruling Dewsnup. For now, that risk remains dicta, and a common sense interpretation of section 506(d) carries the day.
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Judgment Debtors: Don’t Pack Your Bags For Texas Just Yet
Authored by Lee Kirner, Partner
The Texas Constitution prohibits the garnishment of wages except for court-ordered child support payments and spousal maintenance. Debtor’s often move to Texas to gain advantage of is generous exceptions to garnishment and attachment. In Daus v. Daus, the Dallas Court of Appeals upheld the trial court’s ruling that the judgment creditor could garnish the wages of the defendant, a Texas resident for something other than child support or spousal maintenance. A chink in the debtor’s armor?
No, the decision is not a judicial attempt to circumvent the separation of powers doctrine and amend or repeal the State Constitution. At first glance it might appear so. Before discussing Daus, however, for those of you who pay debts, you may not know what garnishment means. Garnishment is a term used to describe a court order directing that money or property of a third party (usually wages paid by an employer) be seized to satisfy a debt owed by a debtor to a plaintiff creditor.
In furtherance of their North Carolina divorce, Mr. and Mrs. Daus executed an agreement wherein Mr. Daus agreed to pay child support for their three children and “support, maintenance and alimony” to Mrs. Daus. Mrs. Daus and the children later moved to Nevada. Mr. Daus did not pay the required amounts. Mrs. Daus sued in Nevada, received a judgment against Mr. Daus and the Nevada Court issued an “Order For Assignment of Wages” (i.e. a garnishment order) ordering the employer of Mr. Daus to direct $6,938.00 of Mr. Daus’s monthly wages to Mrs. Daus at her Nevada address. Of this amount, $1,938.00 was for child support and $5,000 for alimony. Mr. Daus filed a petition in Dallas County, Texas, to contest the Nevada wage assignment order as it applied to alimony since that is not child support or spousal maintenance as described in the Texas Constitution. Mr. Daus lost at the trial court level and filed an appeal. Mr. Daus lost again. Why?
The Full Faith and Credit Clause of Article IV, section 1 of the United States Constitution requires that each state give full faith and credit to the public acts, records and judicial proceedings of every other state regardless of the laws or public policy of the other states. Thus, the confirmation of an order from Nevada may result in the garnishment of a Texas resident’s wages even though a Texas court would be limited or precluded from issuing the same order against a Texas resident. For instance, it is clearly the law of Texas that if Mrs. Daus had attempted to register her Nevada judgment in Texas and then asked a Texas court to issue the garnishment order, such order would violate the Texas Constitution to the extent it sought to withhold wages for alimony or anything other than child support or spousal maintenance.
Mr. Daus has petitioned the Texas Supreme Court to look at the issue, but the Texas Supreme Court is under no obligation to consider the matter. Mr. Daus may be more than a simple sore loser. The court of appeals relied upon Knighton v. Int’l Bus. Mach. Corp., a 1998 Texas court of appeals decision with essentially the same holding, however the 2 to 1 decision came with a vigorous dissent. The dissenting judge did not see this as a constitutional issue and articulated his belief that that the full faith and credit clause would only apply in a situation where Texas does not recognize the underlying cause of action giving rise to the sister state’s garnishment order, but is required to honor the law of the sister state (i.e. a Texas court honoring a Nevada judgment for unpaid gambling debts even though Texas does not permit gambling). Under this line of reasoning the holdings in the Knighton and Daus cases use a faulty constitutional analysis to authorize the use of a collection procedure that is available in a sister state but is unconstitutional in Texas. Taking this one step further, the dissenting judge asks if this means a person’s constitutional right in Texas to be free from garnishment of wages (other than child support or spousal maintenance) is dependent upon whether the person’s Texas employer is subject to the jurisdiction of the state issuing the garnishment order?
It’s an interesting question and we will see if the State Supreme Court takes the bait and considers the issue. |
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What is the Impact of Bankruptcy on Estate Planning?
Authored by Bruce W. Akerly, Partner
Bankruptcy impacts almost every substantive practice area. One area not traditionally considered as being impacted by a bankruptcy filing is estate planning. Depending on where you are in the process and what is involved, consultation with an experienced bankruptcy practitioner is important to be sure you are proceeding with maximum efficiency and safety in the bankruptcy arena. Here are a few ways bankruptcy can impact estate planning.
#1 – The Automatic Stay. The commencement of a bankruptcy case prohibit actions against the debtor(s). If the debtor is someone involved in the estate planning you should carefully consider how continuation of estate planning might be impacted by the automatic stay. For example, if property of a debtor was contemplated to be placed into a trust, continuation of that process will be stayed pending relief from the automatic stay or other relief because the assets involved may be considered property of the debtor’s bankruptcy estate.
#2 – Funds/Property Held in Trust. Trusts are considered a valuable tool for estate planning. Trusts can, and often do, survive a bankruptcy filing by a settlor, trustee or beneficiary of the trust. Trusts and interests in trusts must be disclosed in bankruptcy. A bankruptcy court has jurisdiction over property of the bankruptcy estate. The definition of property of the estate is broad and includes interests in certain trusts. Whether or not property constitutes property of the bankruptcy estate is a question of law for the bankruptcy court to determine. When and how a trust was established, as well as it how it is funded, may be scrutinized by a bankruptcy trustee and creditors to determine the debtor’s relationship to the trust, role, and whether or to what extent transfers to the trust and/or trust assets are property of the bankruptcy estate.
#3 – Exemptions. While the definition of property of the bankruptcy court is quite broad this does not mean that all property is subject to the claims of creditors. Some property is exempt. Whether property is exempt may be determined by reference to state or federal law. Claims of exemptions must be asserted in a debtor’s Schedule C or waived. Objections must be asserted within a specific time or waived.
#4 – Probate. Bankruptcy courts are specialized courts that were created by Congress that fall under the umbrella of the United States District Courts which are Constitutional courts. One reason for establishing bankruptcy court was the necessity of a specialized forum and the practical matter that the District Court could not handle the volume. As a general proposition, bankruptcy courts are specialized courts. There are many specialized state courts, as well. This includes probate courts. In most instances, if a debtor has matters pending in probate court at the time the case is filed they must be disclosed, they matters may be stayed if they are against the debtor, but the bankruptcy court will abstain from hearing such matters.
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Bruce W. Akerly leads the firm’s Creditors’ Rights & Bankruptcy Practice Group. He has extensive experience in commercial litigation, bankruptcy, financial restructuring, and creditors’ rights.
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“If you are tied to a rope called Yesterday you can only go so far.”
Pastor Tony Evans, Dallas, Texas
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