NGUYEN, Circuit Judge:
This case marks the third time we have been asked to intervene in the infamous feud over the estate of the late Texas oil magnate and billionaire J. Howard Marshall, II ("J. Howard"). J. Howard died in 1995, leaving nearly all his assets to his son, E. Pierce Marshall ("Pierce"), but excluding his young wife, Vickie Lynn Marshall, also known as Anna Nicole Smith ("Vickie"), and his other son, J. Howard Marshall, III ("Howard"), from receiving any part of his fortune. The ensuing controversy, pitting wife against son and brothers against each other, has defied resolution for nearly two decades, and has survived almost all of its original players.
After J. Howard died, Vickie and Howard each unsuccessfully challenged his will in Texas probate court. In addition to losing the will contest, Howard suffered a multimillion dollar judgment after Pierce successfully counterclaimed against him on the basis of fraud. Following this loss, Howard and his wife, Ilene, filed for Chapter 11 bankruptcy in the Central District of California. Their case was assigned to United States Bankruptcy Judge Samuel Bufford, who had previously presided over Vickie's Chapter 11 bankruptcy case.
Pierce moved for random reassignment or recusal of Judge Bufford, objected to Howard and Ilene's proposed Chapter 11 Plan, and moved to dismiss the bankruptcy action. Judge Bufford published three separate opinions: (1) denying Pierce's motion for reassignment or recusal; (2) confirming the Plan and denying Pierce's motion to dismiss with respect to his constitutional arguments; and (3) confirming the Plan and denying Pierce's motion to dismiss with respect to his statutory arguments. Pierce appealed to the district court, which affirmed the bankruptcy court's decisions in all respects on March 18, 2009.
Appellant Elaine T. Marshall ("Elaine"),
In the Texas probate court, Vickie claimed that she was entitled to a portion of J. Howard's estate, and that Pierce had tortiously interfered with her expectancy of a gift from her husband. While the probate case was pending, she filed for bankruptcy in California, and the matter was assigned to Judge Bufford. Pierce filed a proof of claim, arguing that he held a defamation claim against Vickie that was not subject to her bankruptcy discharge. Vickie counterclaimed, contending, as she had in probate court, that Pierce tortiously interfered with her expectancy of a gift from J. Howard. Judge Bufford dismissed Pierce's proof of claim against Vickie, and proceeded to consider Vickie's counterclaim against Pierce. Over the course of the bankruptcy proceedings, Judge Bufford determined that Pierce had engaged in various discovery abuses and issued both monetary and non-monetary sanctions against him.
In September 1998, Pierce moved to withdraw the case from bankruptcy court. District Judge William D. Keller withdrew the bankruptcy reference in part
Judge Bufford then held a five-day hearing on Vickie's counterclaim. On the first day, Judge Bufford conducted an unusual press conference of sorts on the record, where he responded to reporters' questions, noted that the case was related to the Texas probate litigation, and explained the procedures by which reporters could obtain public records or court filings. Approximately eleven months later, Judge Bufford entered judgment in Vickie's favor and against Pierce in the amount of $449,000,000, with an additional punitive
Several months later, the Texas probate court rendered judgment in favor of Pierce in the probate case, ordering Vickie to pay Pierce's attorneys' fees in the amount of $541,000. The Probate Court later modified its order to specify that the fee award arose solely out of conduct that occurred after Vickie's bankruptcy discharge. However, Judge Bufford overturned the probate court's fee award, finding that it violated Vickie's bankruptcy discharge and was barred by judicial estoppel. The district court affirmed Judge Bufford's decision, but we reversed and remanded, finding that the attorneys' fees award did not violate Vickie's bankruptcy discharge, as it was based solely on conduct that occurred after the discharge. Marshall v. Marshall (In re Marshall), 119 Fed.Appx. 136 (9th Cir.2004).
Howard also challenged J. Howard's estate plan, arguing that, inter alia, Pierce had exerted undue influence over their father for years, the estate plan had been formulated under duress, and the will was invalid and unenforceable. In his capacity as trustee of the Trusts, Pierce filed a fraud counterclaim against Howard.
Howard filed an appeal in the Texas courts, and on January 31, 2002, moved to stay execution of the Fraud Judgment, or in the alternative, to lower the amount of security for a supersedeas bond. As part of that motion, Howard submitted a sworn affidavit attesting to a total net worth of $22,413,220. Elaine contends that the parties engaged in numerous efforts to negotiate a potential settlement, which eventually resulted in an agreement to stay enforcement in return for a $10.4 million bond, but that Howard ultimately reneged on the agreement when he was unable to finance the bond. Pierce moved to enforce the Fraud Judgment, and at a July 18, 2002, hearing, the probate court suggested that Howard voluntarily move assets
On July 23, 2002, Howard and Ilene (collectively, "the Debtors") filed a Chapter 11 bankruptcy petition in the Central District of California. In connection with the petition, they filed a Statement of Related Cases and an addendum noting that Vickie's bankruptcy case involved a similar factual background and many of the same principal parties as their case. The Clerk assigned Howard and Ilene's case to Judge Bufford.
Several months later, Pierce moved for random reassignment of the case, or alternatively, recusal of Judge Bufford, pursuant to 28 U.S.C. § 455(a) and the Due Process Clause. Judge Bufford denied Pierce's motion at an October 29, 2002 hearing. He subsequently issued an Order to Show Cause ("OSC") why the motion should not be denied on the basis of standing because Pierce had not filed a proof of claim in Howard and Ilene's case. After a hearing on the OSC, Judge Bufford issued a March 27, 2003 amended written opinion in which he assumed that Pierce had standing (because the time for filing a proof of claim had not elapsed) and again denied the recusal motion. Pierce never filed a proof of claim in the Debtors' bankruptcy case.
The Debtors' initial plan of reorganization listed total assets of $8,391,904, personal property valued at $6,084,922, and identified the Texas Fraud Judgment as a disputed unsecured debt. Howard and Ilene filed an amended plan of reorganization on April 16, 2003 ("the Plan"). This time, the Plan provided for full payment of all debts except the Fraud Judgment, which the Plan proposed should nevertheless be discharged.
Pierce objected to the Debtors' proposed Plan on the grounds that it was unconstitutional and proposed in bad faith. Pierce argued that Howard and Ilene had initiated bankruptcy proceedings for the sole purpose of avoiding enforcement of the Fraud Judgment, that the Debtors misrepresented the value of assets and liabilities in their amended plan, and that Howard and Ilene were solvent and could easily satisfy their financial obligations without resort to bankruptcy. Citing similar concerns, Pierce also moved to dismiss the Debtors' Chapter 11 petition on the grounds of unconstitutionality and bad faith.
Howard and Ilene argued that they had filed their suit and proposed their Plan in good faith, based not only on their inability to pay the Fraud Judgment, but also on the threat of future litigation with Pierce and others which they claimed could cost them upwards of $100 million.
On August 26, 2003, Judge Bufford issued a written opinion confirming the Debtors' Plan and denying Pierce's motion to dismiss on bad faith grounds. Then, on October 9, 2003, he issued a second amended opinion rejecting Pierce's constitutional challenge. Pierce appealed all three of Judge Bufford's decisions to the district court, Judge David O. Carter, presiding, which affirmed on March 18, 2009.
We review de novo a district court's decision on appeal from a bankruptcy
We first address Elaine's contention that the district court erred in affirming the bankruptcy court's denial of her Motion for Reassignment or Recusal. We review the denial of a § 455(a) motion for recusal for abuse of discretion. United States v. Wilkerson, 208 F.3d 794, 797 (9th Cir.2000). "A bankruptcy court abuses its discretion if it applies the law incorrectly or if it rests its decision on a clearly erroneous finding of material fact." Computer Task Group, Inc. v. Brotby (In re Brotby), 303 B.R. 177, 184 (9th Cir. BAP 2003). "We examine the bankruptcy court's conclusions of law de novo and its factual findings for clear error." BCE W., L.P. v. Smith (In re BCE W., L.P.), 319 F.3d 1166, 1170 (9th Cir.2003).
"Clear error exists only when the reviewing court is left with a definite and firm conviction that a mistake has been committed." In re Brotby, 303 B.R. at 184. "If two views of the evidence are possible, the trial judge's choice between them cannot be clearly erroneous." Price v. Lehtinen (In re Lehtinen), 332 B.R. 404, 411 (9th Cir. BAP 2005). De novo review applies to Elaine's claim that Judge Bufford's partiality violated due process. See In re Victoria Station Inc., 875 F.2d 1380, 1382 (9th Cir.1989).
Pursuant to 28 U.S.C. § 137, cases are to be assigned among judges in the manner prescribed by local rules and general orders of the court. In the Central District of California, General Order 08-05 § 1.2 (2008), which applies equally to bankruptcy courts, directs the Clerk to assign cases to judges in the district randomly.
Elaine contends that assignment of the Debtors' bankruptcy case to Judge Bufford was improper because the two cases were not related, notwithstanding the Debtors' listing of the Vickie case in their 1015-2 Statement of Related Cases. The Debtors concede, and we agree, that the Debtors' bankruptcy case is not technically related to Vickie's case under Local Bankruptcy Rule 1015-2(a).
Moreover, judges are vested with "inherent" authority to transfer cases among themselves "for the expeditious administration of justice." United States v. Stone, 411 F.2d 597, 598 (5th Cir.1969) (per curiam); see also Badea v. Cox, 931 F.2d 573, 575 (9th Cir.1991) ("District court judges have broad discretion regarding the assignment or reassignment of cases." (internal quotation marks omitted)). Had the Debtors' case been randomly assigned, it is likely that the assigned judge would have transferred the case to Judge Bufford, given his superior knowledge of the complex factual and procedural history of the parties' dispute in the Texas probate court.
Finally, a party has no due process right to random case assignment or to ensure the selection or avoidance of any particular judge absent a showing of bias or partiality in the proceedings. See Cruz v. Abbate, 812 F.2d 571, 574 (9th Cir.1987) (explaining that "a [party] has no right to any particular procedure for the selection of the judge[,]" so long as the decision is made "in a manner free from bias or the desire to influence the outcome of the proceedings"); Torbert, 496 F.2d at 157 (holding that non-random assignment of a case did not violate due process, particularly because there was no showing of actual prejudice resulting from the procedural irregularity). As discussed infra Section I.B., Elaine has not established actual or apparent bias on the part of Judge Bufford, and was therefore not prejudiced by the non-random assignment.
Elaine contends that Judge Bufford should have recused himself from the Debtors' bankruptcy case pursuant to 28 U.S.C. § 455. Section 455(a) requires recusal when "a reasonable person with knowledge of all the facts would conclude that the judge's impartiality might reasonably be questioned." F.J. Hanshaw Enters., Inc., v. Emerald River Dev., Inc., 244 F.3d 1128, 1144 (9th Cir.2001).
First, Elaine argues that Judge Bufford failed to apply the correct legal standard in denying recusal. During a hearing on the recusal motion, Judge Bufford stated that the "[a]ppearance of impropriety is not a basis for recusal." This was undeniably a misstatement of the law. See Liljeberg v. Health Servs. Acquisition Corp., 486 U.S. 847, 860, 108 S.Ct. 2194, 100 L.Ed.2d 855 (1988) ("The goal of section 455(a) is to avoid even the appearance of partiality." (quoting Health Servs. Acquisition Corp. v. Liljeberg, 796 F.2d 796, 802 (5th Cir.1986))). Proof of actual bias is not required under § 455(a). Instead, bias should "be evaluated on an objective basis, so that what matters is not the reality of bias or prejudice but its appearance." Liteky v. United States, 510 U.S. 540, 548, 114 S.Ct. 1147, 127 L.Ed.2d 474 (1994). "It is well established that the recusal inquiry must be made from the perspective of a reasonable observer who is informed of all surrounding facts and circumstances." Cheney v. U.S. Dist. Ct., 541 U.S. 913, 924, 124 S.Ct. 1391, 158 L.Ed.2d 225 (2004) (emphasis and internal quotation marks omitted).
Nevertheless, Judge Bufford articulated the correct standard in his subsequent written opinion and specified that his denial of recusal was based "on the grounds stated in the court's decision of this date." Thus, we find that Judge Bufford ultimately applied the correct legal standard. The salient inquiry, then, is whether Judge Bufford abused his discretion in concluding that his conduct in the Vickie case did not give rise to an appearance of bias against Pierce that warranted his recusal from the Debtors' proceedings.
Elaine contends that Judge Bufford's impartiality may be reasonably questioned in light of his handling of Vickie's case. Specifically, she claims that Judge Bufford's rulings demonstrated partiality towards Vickie, that his issuance of severe discovery sanctions and "critical" statements against Pierce and Pierce's attorney throughout the proceedings indicated prejudice against Pierce, and that his communications with the press and the district court evinced an uncommon interest in the case.
As a preliminary matter, we note that Elaine's examples of bias emanate exclusively from Judge Bufford's rulings and conduct during Vickie's case. Insofar as Elaine points to Judge Bufford's judicial rulings as evidence of bias, such "rulings alone almost never constitute a valid basis for a bias or partiality motion." Liteky, 510 U.S. at 555, 114 S.Ct. 1147. "Almost invariably, they are proper grounds for appeal, not for recusal." Id. Moreover, "the judge's conduct during the proceedings should not, except in the `rarest of circumstances' form the sole basis for recusal under § 455(a)." United States v. Holland, 519 F.3d 909, 913-14 (9th Cir. 2008) (quoting Liteky, 510 U.S. at 555, 114 S.Ct. 1147). "[O]pinions formed by the judge on the basis of facts introduced or events occurring in the course of the current proceedings, or of prior proceedings, do not constitute a basis for a bias or partiality motion unless they display a deep-seated favoritism or antagonism that would make fair judgment impossible." Liteky, 510 U.S. at 555, 114 S.Ct. 1147.
For example, Elaine contends that Judge Bufford advocated for Vickie by ruling in her favor on arguments neither raised nor briefed by the parties. While Judge Bufford may have erred in basing certain rulings on arguments not raised by the parties and without giving the parties an opportunity to respond, doing so several times in the course of lengthy and complicated litigation does not reasonably give rise to an inference that he is advocating for one side or another. Further, Elaine's argument suffers from the fact that neither Vickie nor Pierce were parties to Howard and Ilene's bankruptcy case.
Elaine also argues that, after initially denying Pierce's recusal motion, Judge Bufford instigated an improper sua sponte investigation to find additional grounds for denying the motion. Judge Bufford issued an OSC why the motion should not be denied for lack of standing, in light of Pierce's failure to file a proof of claim. We find nothing unusual or improper in the bankruptcy court's effort to determine whether a party has standing to litigate; in fact, such determination is required. See B.C. v. Plumas Unified Sch. Dist., 192 F.3d 1260, 1264 (9th Cir.1999) ("[F]ederal courts are required sua sponte to examine jurisdictional issues such as standing.").
As further evidence of bias, Elaine points to Judge Bufford's decisions declaring the district court's stay of his initial discovery sanctions ineffective and reimposing virtually the same sanctions in his Final Sanctions Order. Presumably, Elaine is insinuating that Judge Bufford openly defied the district court in order to ensure that Pierce would remain subject to his virtually insurmountable terminating sanctions. However, not only are judicial rulings rarely a basis for recusal, Liteky, 510 U.S. at 555, 114 S.Ct. 1147, these particular rulings cannot reasonably be seen as contravening the district court's direction. The district court subsequently adopted Judge Bufford's Final Sanctions Order, notwithstanding its similarity to the initial vacated order, and even increased the damages award against Pierce. In re Marshall, 275 B.R. 5, 58 (C.D.Cal.2002), rev'd on other grounds, 392 F.3d 1118 (9th Cir.2004), rev'd and remanded, sub nom., Marshall v. Marshall, 547 U.S. 293, 126 S.Ct. 1735, 164 L.Ed.2d 480 (2006), rev'd on remand, 600 F.3d 1037 (9th Cir.2010), aff'd, sub nom., Stern v. Marshall, ___ U.S. ___, 131 S.Ct. 2594, 180 L.Ed.2d 475 (2011).
With respect to the sanctions themselves, the district court's decision to increase Judge Bufford's sanctions significantly weakens Elaine's contention that the heavy sanctions create an appearance of bias on Judge Bufford's part. See Offutt v. United States, 348 U.S. 11, 15-16, 75 S.Ct. 11, 99 L.Ed. 11 (1954) (holding that heavy sanctions, which were later reduced by a higher court, constituted "compelling proof" of bias). Moreover, a reasonable person could find, as the district court did, that Judge Bufford's decision to sanction Pierce was based on his perception of Pierce's bad faith. See Matter of
Similarly, Judge Bufford's comments towards Pierce and his attorney during Vickie's case might also be reasonably seen as the product of Judge Bufford's frustration with Pierce's behavior throughout the litigation. See F.J. Hanshaw Enters., Inc., 244 F.3d at 1144-45 ("[P]redispositions developed during the course of a trial will [rarely] suffice." (citing Liteky, 510 U.S. at 544-45, 114 S.Ct. 1147)); United States v. Conforte, 624 F.2d 869, 881 (9th Cir.1980) (explaining that recusal under § 455(a) requires a finding of "an animus more active and deep-rooted than an attitude of disapproval toward certain persons because of their known conduct"). For example, Judge Bufford referred to Pierce as "a Defendant with extremely dirty hands," told Pierce's counsel to bring certain documents to court or "bring [his] toothbrush," to bring his "checkbook" to a hearing, and that he had "substantial experience with the way [Pierce's] side has handled cases." These statements, while potentially indicative of personal bias, are not serious enough to overcome the high standard set forth in Liteky:
510 U.S. at 555, 114 S.Ct. 1147 (emphasis added).
Elaine also contends that Judge Bufford's communications with the press gave rise to an appearance of partiality. Judge Bufford primarily took questions from reporters about the procedures for obtaining court documents and records. These procedural comments, themselves, do not indicate partiality and are not ethically proscribed. See Code of Judicial Conduct Canon 3(A)(6) ("This proscription [on judicial speech] does not extend to public statements made in the course of the judge's official duties, to the explanation of court procedures, or to a scholarly presentation made for purposes of legal education."); see also United States v. Microsoft Corp., 253 F.3d 34, 112 (D.C.Cir.2001) (distinguishing between "purely procedural matters," which the district judge may properly discuss in public, and the judge's "views on factual and legal matters at the
However, the fact that Judge Bufford initiated the "press conference" at all is highly unusual and of some concern. See In re Boston's Children First, 244 F.3d 164, 170 (1st Cir.2001) (noting that, in highly publicized cases, "even ambiguous comments may create the appearance of impropriety" and "[i]n fact, the very rarity of such public statements, and the ease with which they may be avoided, make it more likely that a reasonable person will interpret such statements as evidence of bias"); see also United States v. Cooley, 1 F.3d 985, 995 (10th Cir.1993) (holding that a judge's deliberate choice to express "strong views" on a pending case in a media forum "conveyed an uncommon interest... in the subject matter" and "created the appearance that the judge had become an active participant in [the litigation]").
Furthermore, in speaking with the press, Judge Bufford mentioned the interplay between the Texas probate case and Vickie's bankruptcy case, explaining that there were some overlapping issues that might be resolved in either venue. Given that the bankruptcy court's jurisdiction over Vickie's counterclaim was in dispute, such statements might be viewed as commentary on the merits of the case. See In re Boston's Children First, 244 F.3d at 170 (concluding that a judge's comment that one case was more "complex" than another could be seen as "a preview of a ruling on the merits of petitioner's motion for class certification" and called the judge's impartiality into question). While there is nothing wrong with a court providing procedural information to the press in a highly publicized case, an appearance of impropriety may be created where a judge voluntarily takes on that role, especially in open court during the course of the proceedings.
Still, notwithstanding our concerns, Judge Bufford's statements to the press are in and of themselves insufficient to warrant recusal. The lion's share of his comments dealt with courtroom procedures and policies, which is understandable given the strong media interest in Vickie's case. That several of his comments might be construed as a vague reflection on a disputed jurisdictional issue does not, alone, compel a finding of apparent bias.
In addition, Elaine makes much of a private communication Judge Bufford shared with Judge Keller regarding Pierce's motion to withdraw the bankruptcy reference. She argues that, by sending Judge Keller a "secret memorandum," Judge Bufford injected himself into the case under the guise of "assisting" Judge Keller's decision on whether to withdraw the reference, evincing an "uncommon interest and degree of personal involvement" in Vickie's case. Cooley, 1 F.3d at 995. However, context matters, and the record here does not support that conclusion.
In October 1998, Judge Keller issued a minute order withdrawing the bankruptcy reference in part. The minute order indicated that the bankruptcy judge would determine which discovery matters were necessary to "core" bankruptcy proceedings and should therefore remain before the bankruptcy court. At a January 1999 hearing, Howard and Ilene's counsel reminded Judge Bufford that the bankruptcy court "was going to be coming out with an order with respect to th[e] Court's belief as to the jurisdictional responsibilities ... which Judge Keller['s] ... minute order indicated he was awaiting." Judge Bufford clarified that his response to Judge Keller would "not take the form of an order[,]" but would be "a memorandum to Judge Keller to assist in his review of the matter." Judge Bufford then noted that
Although we are not privy to the contents of Judge Bufford's communication, this context strongly suggests that Judge Bufford's memo dealt with legitimate jurisdictional issues, and that Judge Bufford was merely responding to a request made by Judge Keller. At any rate, the record does not suggest that Judge Bufford was actively trying to retain jurisdiction over Vickie's case because of antagonism or favoritism towards the parties, as opposed to, for example, his understandable reticence to foist a complex case on the district court unless it was necessary to do so.
Elaine's examples of bias are almost exclusively based on Judge Bufford's conduct during Vickie's bankruptcy proceedings. Taken together, Judge Bufford's actions are not indicative of a "deep-seated favoritism or antagonism that would make fair judgment impossible." Liteky, 510 U.S. at 555, 114 S.Ct. 1147. As such, this case is not one of the "rarest of circumstances" where judicial conduct in prior proceedings should form the sole basis for recusal under § 455(a). Holland, 519 F.3d at 914. Judge Bufford's determination — that under all of the circumstances a reasonable person would not question his impartiality — does not reflect an incorrect application of the law and is not based on clearly erroneous factual findings. Therefore, we cannot say that Judge Bufford abused his discretion in denying Elaine's motion to recuse.
For the reasons outlined in the second amended opinion of the bankruptcy court filed on October 9, 2003, in the Central District of California, we conclude that the district court correctly affirmed the bankruptcy court's confirmation of Howard and Ilene's Chapter 11 plan and denial of Elaine's motion to dismiss with respect to the constitutional issues raised in the motion. See In re Marshall, 300 B.R. 507 (Bankr.C.D.Cal.2003). Therefore, we adopt the bankruptcy court's opinion on Elaine's constitutional claims, and affirm the district court's decision as to the issues addressed therein. See Appendix A.
Elaine contends that the bankruptcy court erred in confirming the Debtors' Chapter 11 Plan because the Plan does not satisfy the "Best Interests of Creditors" test and was proposed in bad faith. Elaine also argues that the bankruptcy case should have been dismissed because it was filed in bad faith.
We review the bankruptcy court's decision to confirm the Debtors' Chapter 11 Plan for abuse of discretion. In re Brotby, 303 B.R. at 184. The bankruptcy court's ruling on a motion to dismiss for bad faith is also subject to review for abuse of discretion. Stolrow's Inc. v. Stolrow's Inc. (In re Stolrow's, Inc.), 84 B.R. 167,
The so-called "Best Interest of Creditors" test requires that:
11 U.S.C. § 1129(a)(7)(A).
Because the Plan purported to discharge the Texas Fraud Judgment without any payment, Elaine contends that the Plan failed to ensure that Pierce would receive at least as much as he would have under Chapter 7 liquidation. However, Pierce never filed a proof of claim in the Debtors' Chapter 11 proceedings, and the deadline for doing so had passed by the time the bankruptcy court confirmed the Debtors' Chapter 11 Plan. Thus, § 1129(a)(7)(A) did not apply to Pierce or to the Fraud Judgment.
That Pierce would not have been foreclosed from filing a proof of claim under Chapter 7 is of no moment. See 11 U.S.C. § 726(a)(2) (permitting late-filed claims in Chapter 7 cases). We will not extend the "Best Interests of Creditors" test to individuals who are only hypothetically creditors, simply because the statute invokes a hypothetical Chapter 7 liquidation as a point of reference. Were we to go that far, a Chapter 11 Plan would not be confirmable unless it provided for all individuals who could potentially be entitled to distribution. Such a result would be untenable in practice and would eviscerate the proof of claim filing deadline in Chapter 11.
Under 11 U.S.C. § 1129(a)(3), a bankruptcy plan must be "proposed in good faith and not by any means forbidden by law." "A plan is proposed in good faith where it achieves a result consistent with the objectives and purposes of the Code." Platinum Capital, Inc. v. Sylmar Plaza L.P. (In re Sylmar Plaza, L.P.), 314 F.3d 1070, 1074 (9th Cir.2002).
Elaine argues that the Plan was not proposed in good faith because the Debtors (1) were actually solvent; (2) misrepresented the true value of their assets; and (3) filed the petition with the primary purpose of avoiding payment of the Texas Fraud Judgment.
We agree that the Debtors' claim of potentially costly future litigation — including a $5 million Louisiana lawsuit in which Howard was a named defendant and Pierce's separate threat of a $100 million lawsuit — was perhaps too speculative to support a finding that they were "insolvent." However, "insolvency is not a prerequisite to a finding of good faith under § 1129(a)." Id. at 1074-75. The bankruptcy court reasonably concluded that the Debtors' technical solvency did not bespeak bad faith given that they faced the threat of future litigation, not to mention their very concrete obligation to satisfy the Texas Fraud Judgment, amounting to nearly $12 million.
Finally, Elaine argues that the Plan was proposed in bad faith because the Debtors' primary purpose was to avoid paying the Texas Fraud Judgment. However, the only reason consummation of the Debtors' Plan would frustrate Elaine's attempt to collect on the Texas Fraud Judgment was because Pierce never filed a proof of claim. Significantly, the Debtors initially included the Fraud Judgment in their Plan, and amended to provide for discharge of the judgment only after Pierce failed to file a proof of claim. We find no reason to conclude that the Debtors knew Pierce would not file a proof of claim and we see nothing that prevented him from doing so.
In sum, the bankruptcy court's finding that the Debtors' Plan was proposed in good faith was not clearly erroneous under all the circumstances. Therefore, confirmation of the Debtors' Plan was not an abuse of discretion.
Under 11 U.S.C. § 1112(b), a Chapter 11 bankruptcy case may be dismissed "for cause." "Although section 1112(b) does not explicitly require that cases be filed in `good faith,' courts have overwhelmingly held that a lack of good faith in filing a Chapter 11 petition establishes cause for dismissal." In re Marsch, 36 F.3d at 828. The good faith requirement does not depend on a debtor's subjective intent, but rather "encompasses several, distinct equitable limitations that courts have placed on Chapter 11 filings." Id. Generally, a plan is not filed in good faith if it represents an attempt "to unreasonably deter and harass creditors" and to "achieve objectives outside the legitimate scope of the bankruptcy laws." Id.
Elaine argues that the petition was filed in bad faith and should have been dismissed. First, Elaine contends that the timing of the filing, within days of the Texas court's suggestion that Howard transfer assets to satisfy the Fraud Judgment, indicated bad faith. We agree that the timing of Howard and Ilene's filing may be an indication that the Debtors initiated bankruptcy proceedings for the purpose of avoiding or delaying payment of the judgment. See In re Leavitt, 171 F.3d 1219, 1225 (9th Cir.1999) (finding that the timing of debtor's bankruptcy petition, filed within two weeks of judgment, demonstrated that the debtor's primary motive was avoidance of the judgment). However, because the Debtors specifically included the Texas Fraud Judgment in their initial Plan, it appears just as likely that they filed their petition in order to "effect a speedy, efficient reorganization," and not "to unreasonably deter and harass creditors." In re Marsch, 36 F.3d at 828.
In addition, Elaine argues that the Debtors' sole purpose in filing the petition was to avoid filing a supersedeas bond pending appeal of the Texas Fraud Judgment. In Marsch, we held that a petition was correctly dismissed for bad faith where it "was filed solely to delay collection of the judgment and avoid posting an appeal bond, even though debtor had the ability to satisfy the judgment with nonbusiness assets." Id. at 831; see also In re Boynton, 184 B.R. 580, 581 (Bankr. S.D.Cal.1995) (finding bad faith where petition was filed in order to evade a tax judgment despite the fact that debtors had "significant assets" and "may have been able" to post a bond).
Here, unlike in Marsch and Boynton, the record suggests that Howard and Ilene's liquid assets were probably insufficient to satisfy the judgment or cover the cost of a supersedeas bond. The bankruptcy court found that the Fraud Judgment amounted to over $12 million plus interest, that the "custom" in Texas was to set appeal bonds at 150% of the judgment, and that Howard did not have sufficient liquid assets to post a bond of that size. Although the record does not invariably indicate that the Debtors could not finance a supersedeas bond, we cannot say that the bankruptcy court's determination was clearly erroneous. Moreover, notwithstanding their ability to finance a bond, Howard and Ilene's inclusion of the Fraud Judgment in their initial Plan suggests that they filed their bankruptcy petition for the proper purpose of reorganization, not as a mere ploy to avoid posting the bond.
Finally, Elaine contends that the absence of other unsecured creditors in the Plan shows that the Debtors filed their petition in order to avoid having to obtain a supersedeas bond or pay the Texas Fraud Judgment. See, e.g., Chinichian v. Campolongo (In re Chinichian), 784 F.2d 1440, 1445 (9th Cir.1986); Little Creek Dev. Co. v. Commonwealth Mortg. Corp.
However, notwithstanding their minimal unsecured debt, the Debtors' decision to file for bankruptcy does not indicate bad faith in light of the size of the Texas Fraud Judgment and the potential cost of obtaining a bond. As the bankruptcy court noted, all debtors file for bankruptcy in order to delay creditor action. Thus, although the Debtors' main motivation may have been to ameliorate the burden of the judgment, given that the Plan proposed payment of the judgment, we cannot say that they filed a Chapter 11 petition in order to avoid paying it altogether, or to unduly deter or harass creditors.
Moreover, we agree with the bankruptcy court that "[p]erhaps the most compelling grounds for denying a motion to dismiss grounded on bad faith is the determination that a reorganization plan qualifies for confirmation." This is because "[a] debtor's showing that a plan of reorganization is ready for confirmation essentially refutes a contention that the case is filed or prosecuted in bad faith." Id. The bankruptcy court properly considered the viability of the Debtors' proposed Plan as weighing heavily against dismissal.
Viewing the amalgam of factors together, it is not "obvious that [the Debtors are] attempting unreasonably to deter and harass creditors[.]" In re Thirtieth Place, Inc., 30 B.R. 503, 505 (9th Cir. BAP 1983) (quoting Matter of Levinsky, 23 B.R. 210, 218 (E.D.N.Y.Bankr.1982)). Accordingly, the bankruptcy court's finding of good faith was not clearly erroneous, and it did not abuse its discretion in denying the motion to dismiss.
For the foregoing reasons, the district court's decision is
Trustee of family trust filed his opposition to proposed Chapter 11 plan filed by his brother and his brother's wife and moved to dismiss their bankruptcy case on ground that they were not insolvent, and that Congress could not constitutionally provide for reorganization by solvent debtors. Amending and superceding prior opinion, the Bankruptcy Court, Samuel L. Bufford, J., held that: (1) bankruptcy law does not require that debtor be insolvent, either in "balance sheet" or in "liquidity" sense, in order to file Chapter 11 petition or to proceed to confirmation; (2) Congress has power under the Bankruptcy Clause to determine that debtor may invoke rights under the Bankruptcy Code to adjust his obligations before debtor becomes insolvent; and (3) allowing debtors who allegedly were not insolvent, in "balance sheet" sense, to file for Chapter 11 relief and to obtain confirmation of plan providing for discharge of their debts
Plan confirmed; dismissal motion denied.
Bankruptcy law does not require that debtor be insolvent, either in "balance sheet" sense of having liabilities that exceed his assets or in "liquidity" sense of being unable to pay his debts as they become due, in order to file a Chapter 11 petition or to proceed to confirmation of plan of reorganization.
While Congress is not free to define contours of bankruptcy without any limitation, insolvency, whether in "balance sheet" or in "liquidity" sense, is not prerequisite for the constitutional invocation of federal bankruptcy jurisdiction. U.S.C.A. Const. Art. 1, § 8, cl. 4.
United States bankruptcy law is designed to provide relief from creditor pressures for debtors with cash flow difficulties, even when they are clearly solvent under "balance sheet" test.
Congress has power under the Bankruptcy Clause to determine that debtor may invoke rights under the Bankruptcy Code to adjust his obligations with creditors before debtor becomes insolvent under "balance sheet" test. U.S.C.A. Const. Art. 1, § 8, cl. 4; Bankr.Code, 11 U.S.C.A. § 101 et seq.
Property rights enjoy at least a measure of protection in bankruptcy under the Due Process and Just Compensation Clauses of the Fifth Amendment. U.S.C.A. Const. Amend. 5.
While property rights enjoy at least a measure of protection in bankruptcy, Congress is not barred from passing laws that impair obligation of contracts.
Very essence of bankruptcy laws is modification or impairment of contractual obligations.
Protection of property rights in bankruptcy is measured, and Congress, acting in its bankruptcy power, may authorize bankruptcy courts to affect such property rights, as long as limitations of due process are observed. U.S.C.A. Const. Art. 1, § 8, cl. 4; U.S.C.A. Const.Amend. 5.
Allowing Chapter 11 debtors who allegedly were not insolvent, in sense that their liabilities did not exceed their assets, to file for Chapter 11 relief and to obtain confirmation of plan providing for discharge of their debts would not violate the Fifth Amendment economic substantive due process rights of judgment creditor who had neither property nor contract rights to assert against debtors, and who, as result of his refusal to file proof of claim, did not even have claim against estate, but only a Texas state court judgment which was on appeal. U.S.C.A. Const.Amend. 5.
Congress validly exercised its bankruptcy powers under the Constitution to authorize
Pub.L. No. 101-650, 101st Cong., 2d Sess. § 317(a) (1990).
Bankr.Code, 11 U.S.C.A. § 106(a).
Bankr.Code, 11 U.S.C.A. § 522(f).
J. Howard Marshall, III, Ilene Marshall, Pasadena.
Bingham McCutchen, LLP, Julia Frost-Davies, Rheba Rutkowski, Andrew J. Gallo, Boston, MA.
Bingham McCutchen, LLP, G. Eric Brunstad, Jr., Hartford, CT.
Bingham McCutchen, LLP, Matthew A. Lesnick, Los Angeles.
David L. Neale/Anne E. Wells, Levene Neale Bender Rankin et al., Los Angeles.
SAMUEL L. BUFFORD, Bankruptcy Judge.
In this case Pierce Marshall, as trustee for three family trusts (collectively referred to as "Pierce") opposes confirmation of the chapter 11
The court finds that the balance sheet test for insolvency was unknown in United States bankruptcy law until 1898, when balance sheet insolvency first entered United States bankruptcy law. Prior thereto, insolvency in the bankruptcy context always meant liquidity (or equity) insolvency.
The court further holds that the Bankruptcy Clause of the United States Constitution does not require that a debtor in bankruptcy be insolvent under any test, and that the debtors in this case may constitutionally invoke remedies provided under chapter 11.
The relevant facts in this case are set forth in the court's recently issued opinion on the non-constitutional issues involved in the pending plan confirmation and motion to dismiss. See In re Marshall, 298 B.R. 670 (Bankr.C.D.Cal.2003). The filing of this bankruptcy case was precipitated in part by a judgment in favor of Pierce and against Howard in the Texas probate case of their father J. Howard Marshall II ("J. Howard"). The judgment, which was then on appeal, was for $11 million plus costs
As amended, the debtors' schedules show assets worth $13,138,311.38 and liquidated debts of $13,914,112.39. In addition to the valued assets, the schedules disclose interests in a revocable family trust, claims made in the probate estate of Howard's father, J. Howard, and an interest in the Eleanor P. Stevens Irrevocable Gift Trust (which is described in detail in a full-page exhibit). In addition to the quantified debts, the schedules list nonpriority debts in unknown amounts owing to Wells Fargo Bank Texas, the City of Pasadena, a Dallas law firm and the Marshall Museum & Trust.
In addition to the $12 million judgment, Howard had been named as a defendant in a $5 million lawsuit in Louisiana. Furthermore, Pierce's lawyer also sent a letter to Howard's lawyer on May 20, 2002 providing substantial detail for another claim against Howard exceeding $100 million.
The court set a claims bar date of November 15, 2002. Pierce declined to file a proof of claim in this case. Pierce has moved to dismiss this case and has objected to the confirmation of the debtors' chapter 11 plan as amended.
Pierce makes both statutory and constitutional objections to the confirmation of the chapter 11 plan proposed by debtors Howard and Ilene Marshall. The court has previously found that the statutory requirements for confirmation are satisfied, and that the case should not be dismissed on good faith grounds. See Marshall, 298 B.R. at 675-684.
Pierce contends that the debtors' assets exceed their liabilities as of the date of filing, and that in consequence they were solvent under a balance sheet test. The court finds that determining the accuracy of this contention would be very difficult and very time consuming in this case. While for some purposes in bankruptcy it is necessary to make such a determination,
As a statutory matter, it is clear that the bankruptcy law does not require that a bankruptcy debtor be insolvent, either in the balance sheet sense (more liabilities than assets) or in the liquidity sense (unable to pay the debtor's debts as they come due), to file a chapter 11 case or proceed to the confirmation of a plan of reorganization. The Ninth Circuit firmly rejected such a view in Sylmar Plaza where it held, "insolvency is not a prerequisite to a finding of good faith under § 1129(a)." Platinum Capital, Inc. v. Sylmar Plaza, L.P. (In re Sylmar Plaza, L.P.), 314 F.3d 1070, 1074-75 (9th Cir. 2002); accord, In re James Wilson Associates, 965 F.2d 160, 170 (7th Cir.1992) (rejecting bad faith challenge to confirmation).
Pierce concedes that insolvency is not a statutory requirement for filing a voluntary bankruptcy case under chapter 11. Instead, he argues that the Bankruptcy Clause of the United States Constitution can only be invoked by a bankruptcy debtor who is insolvent under a balance sheet test. Pierce argues that the constitutional grant of authority to Congress to enact "uniform Laws on the subject of Bankruptcies throughout the United States"
Pierce argues that there must be some content to the Bankruptcy Clause in the
The test, according to Pierce, is that the Constitution must require that a debtor in a bankruptcy case be insolvent under a balance sheet test. Insofar as the Bankruptcy Code permits a bankruptcy filing by a debtor who is balance sheet solvent, according to Pierce, the law falls outside the powers granted by the Constitution to the federal government. In such a circumstance, the Constitution, and not the law, must govern the case. See Marbury v. Madison, 5 U.S. (1 Cranch) 137, 178, 2 L.Ed. 60 (1803) ("If then ... the constitution is superior to any ordinary act of the legislature; the constitution, and not such ordinary act, must govern the case to which they both apply.")
The court finds that neither balance sheet insolvency nor liquidity insolvency is required for the constitutional invocation of federal bankruptcy jurisdiction. The limits on the application of the Bankruptcy Clause lie elsewhere, not in balance sheet insolvency.
As a preliminary matter, it is necessary to distinguish the exercise of powers under the Bankruptcy Clause from the exercise of congressional powers under the Commerce Clause. These two powers are closely related. See Railway Labor Executives' Ass'n v. Gibbons, 455 U.S. 457, 465-66, 102 S.Ct. 1169, 71 L.Ed.2d 335 (1982). However, the conditions for invoking the Commerce Clause are different from those for invoking the Bankruptcy Clause, and each has its own limitations. As the Supreme Court has explained, "[u]nlike the Commerce Clause, the Bankruptcy Clause itself contains an affirmative limitation or restriction upon Congress' power," and "if we were to hold that Congress had the power to enact nonuniform bankruptcy laws pursuant to the Commerce Clause, we would eradicate from the Constitution a limitation on the power of Congress to enact bankruptcy laws." Id. at 468-69, 455 U.S. 457, 102 S.Ct. 1169.
Setting aside the Commerce Clause, the powers granted to Congress under the Bankruptcy Clause are expanded by art. 1, § 8, cl. 18, which grants Congress the power "To make all Laws which shall be necessary and proper for carrying into Execution the foregoing Powers...." See Wright v. Union Central Life Ins. Co., 304 U.S. 502, 513, 58 S.Ct. 1025, 82 L.Ed. 1490 (1938). Theoretically, this provision might be invoked to support the use of the Bankruptcy Clause in doubtful cases. However, the Supreme Court has never in fact utilized this approach to determine the constitutionality of bankruptcy provisions.
The court assumes without deciding that Congress was not exercising its Commerce Clause or its Necessary and Proper Clause powers in determining the qualifications for filing a bankruptcy case. Thus the court's constitutional analysis in this case is confined to the Bankruptcy Clause.
To analyze Pierce's argument, we examine the understanding of the framers of the Constitution at the time of its adoption, the history of bankruptcy law in the United States and its predecessor English statutes, and applicable Supreme Court case law. We also examine Pierce's argument that, insofar as the Bankruptcy Code permits a solvent chapter 11 debtor to file a case and proceed to plan confirmation, Congress has exceeded its Bankruptcy Powers and has deprived him of property without due process of law.
Before undertaking this analysis, we must first address what Pierce means by "insolvency," because this term has two commonly used definitions in the bankruptcy context.
For the purposes of this argument, Pierce urges the court to adopt the balance sheet definition of solvency in § 101(32)(A), which states in relevant part:
Section 101(32)(A) states the Bankruptcy Code version of the balance sheet test for Insolvency.
Section 101(32)(A) makes two modifications to the usual balance sheet insolvency test. First, the test requires the revision of balance sheet values to their "fair valuation." In contrast, a balance sheet prepared according to generally accepted accounting principles provides asset values at historical cost less any applicable depreciation or amortization. The "fair valuation" standard requires an adjustment in balance sheet values from historical cost to present market values. Second, the § 101(32)(A) definition excludes property that would otherwise appear on a balance sheet, but that is exempt under § 522 (providing exemptions for individual debtors).
The insolvency definition in § 101(32)(A) is designed to govern the handful of technical uses of this term in the Bankruptcy Code. In fact, "insolvent" is used only ten times in the entire statute, and in nine of those it is used to define narrowly drawn rights under particular statutory provisions. See § 365 (trustee may assume an executory contract notwithstanding a default relating to the debtor's insolvency); § 525 (protecting a debtor against discriminatory treatment during prepetition insolvency); § 541 (forfeiture based on insolvency does not prevent prepetition property from becoming property of the estate); § 543 (court may consider interests of equity holders of solvent debtor in determining whether to require a custodian to turn over property); § 545 (protecting a debtor from statutory liens predicated upon insolvency); § 546 (authorizing certain reclamation rights to creditors who have delivered certain goods to a debtor while insolvent before the bankruptcy petition was filed); § 547 (element of cause of action for preferential transfer); § 548 (element of certain causes of action for fraudulent transfers); § 553 (condition for prohibiting a creditor setoff). None of these uses sheds any light on the constitutional limits of the Bankruptcy Clause.
The final use of "insolvency" in the Bankruptcy Code occurs in § 109(c)(3), which requires a municipality to be insolvent as a condition of filing a bankruptcy case. The meaning of "insolvency" in this provision is entirely different from the balance sheet test,
This is known as the liquidity test for insolvency (also known as the "equity" or the "cash flow" test),
It is not uncommon for debtors to be solvent under the balance sheet test, and yet to have severe financial problems. This court frequently receives cases, filed under both chapter 7 and chapter 11 and especially under chapter 13 (a reorganization chapter for consumers), where the debtor is clearly solvent under a balance sheet test, but has substantial cash flow problems.
As to reorganizations under chapter 11, there is substantial reason for Congress to decide that a debtor should be eligible before the debtor becomes insolvent under a balance sheet test. The prospects for reorganizing a debtor in financial difficulty are much better when the debtor is still solvent than after it becomes insolvent. See generally 1 COLLIER ON BANKRUPTCY ¶ 1.19[1] (James William Moore ed., 14th ed.1988) [hereinafter COLLIER] (commenting on the reorganization provisions of the 1898 Act, as amended by the Chandler Act). If a debtor must wait until it becomes insolvent to invoke the reorganization provisions under the bankruptcy law, substantial economic values will often be irretrievably lost. Congress certainly could legitimately decide that it is best for the economy of the United States to permit solvent debtors to reorganize under the bankruptcy law to preserve economic values.
An additional vice of a balance sheet test as a criterion for admission to the bankruptcy system is that substantial time is consumed in determining whether a debtor is in fact insolvent. This case is illustrative — litigation over the debtors' solvency has consumed a large amount of time and effort, and a determination of the debtors'
If a reorganization is held up pending a determination of balance sheet insolvency, businesses will rarely be reorganized, and at least some of the reorganization value (the value of a business as reorganized as opposed to its liquidation value) will inevitably be lost. Indeed, this is the experience in countries that require insolvency, according to a balance sheet test, as a condition for admission to the bankruptcy system — businesses are generally not re-organizable, and substantial economic values are lost.
Accordingly, the court finds that the balance sheet test is not the appropriate test for insolvency in evaluating Pierce's constitutional challenge in this case. However, assuming that Pierce has implicitly claimed that the liquidity test should also be applied by the court, the court proceeds to consider Pierce's constitutional challenge.
The United States Congress has enacted five bankruptcy laws.
Congress enacted permanent federal bankruptcy legislation in 1898 ("the 1898 Act").
English law has included bankruptcy law continuously since 1542, when Parliament enacted the first bankruptcy law.
Before examining the English and United States statutes, we turn to the constitutional convention in 1789, to see whether there is anything in the records of the convention that might shed light on the role of insolvency in the meaning of "bankruptcies" in the Bankruptcy Clause.
The Bankruptcy Clause received little discussion in the constitutional convention. The bankruptcy issue arose in a discussion of the Full Faith and Credit clause, and drove the constitutional extension of the Full Faith and Credit clause to acts of the legislature as well as judicial decisions. See MANN, at 183; see generally id. at 182-87. Because credit, like commerce, was not limited by state boundaries, the delegates recognized that a national system of bankruptcy law was needed to support a national credit system upon which commerce depended. See id. at 185-87.
The only vote against the Bankruptcy Clause was cast by Roger Sherman of Connecticut. He opposed this provision on the grounds that bankruptcies were punishable by death in some cases in England, and he opposed granting Congress this power in the United States. See Railway Labor Executives' Ass'n v. Gibbons, 455 U.S. 457, 472 n. 13, 102 S.Ct. 1169, 71 L.Ed.2d 335 (1982) (citing 2 M. FARRAND, RECORDS OF THE CONVENTION OF 1787, at 489 (1911)).
The Federalist Papers, which discuss in detail virtually every aspect of the Constitution, make only a single reference to the Bankruptcy Clause. In Federalist No. 42, James Madison wrote:
THE FEDERALIST No. 42, at 239 (James Madison) (Clinton Rossiter ed., 1961).
A few decades later Justice Story (then a professor at Harvard Law School), in his famous Commentaries, stated:
3 JOSEPH STORY, COMMENTARIES ON THE CONSTITUTION OF THE UNITED STATES § 1108 n.25. (1833) [hereinafter STORY]. In Justice Story's view, it is the failure to pay debts, not insolvency, that distinguishes a debtor who is an eligible subject for bankruptcy relief.
Having found the evidence from the constitutional convention unhelpful, we now take a broader look to see what meaning "bankruptcy" was given in relevant legislation on the subject, both before and after the writing of the Constitution. As the Supreme Court has told us, "Probably the most satisfactory approach to the problem of interpretation here involved [the power of Congress under the Bankruptcy Clause] is to examine it in the light of the acts, and the history of the acts, of Congress which have from time to time been passed on the subject...." Continental Illinois Nat'l Bank & Trust. v. Chicago, Rock Island & Pac. Ry. Co., 294 U.S. 648, 670, 55 S.Ct. 595, 79 L.Ed. 1110 (1935).
Historically, bankruptcy laws have not been conceived in the United States or England for the protection of debtors, whether honest or dishonest. Bankruptcy laws were enacted principally for the benefit of trade and for the protection of creditors, to give them more powers acting in concert to collect debts than they possessed individually. See, e.g., 2 WILLIAM BLACKSTONE, COMMENTARIES *472 [hereinafter BLACKSTONE]. Indeed, some of the worst abuses were committed by debtors who refused to pay their debts even though they were solvent and eminently capable of paying. The principal benefit to debtors was the avoidance of debtors' prison or the discharge therefrom. See id.
An analysis of the history of bankruptcy laws in the United States, and of their predecessors in England, shows that the Bankruptcy Clause has never been tied to balance sheet insolvency, or insolvency of any other type. No United States bankruptcy act, and none of its English predecessors, has ever required balance sheet insolvency as a condition of either voluntary or involuntary bankruptcy. Of the five United States bankruptcy laws and its three principal English predecessors, only the 1841 and the 1867 Acts required a voluntary debtor to plead that the debtor was insolvent in a liquidity sense, i.e. that the debtor was unable to pay his or her debts as they became due, and such a pleading was unchallengeable.
For involuntary bankruptcy cases, insolvency began to creep into United States bankruptcy law in the 1867 Act as an element in one or more "acts of bankruptcy," any one of which would support an involuntary bankruptcy petition. However, insolvency did not become the chief basis for an involuntary petition until the adoption of the Bankruptcy Code in 1978. Even now, under the Bankruptcy Code, the insolvency test for an involuntary petition is the liquidity test, and not the balance sheet test for insolvency.
The 1841 Act was the first United States law to authorize a debtor to file a voluntary bankruptcy petition.
This was only a pleading requirement. Neither the parties nor the court had the authority to inquire into whether a debtor was in fact insolvent. See, e.g., Ex parte Hull, 12 F.Cas. 853, 856 (S.D.N.Y.1842). Indeed, the court was required to declare a voluntary petitioner bankrupt on the debtor's sworn representation of inability to pay his or her debts, irrespective of the debtor's actual wealth and financial condition. See id.
A debtor filing a voluntary bankruptcy petition under the 1867 Act was similarly required to "set forth ... his inability to pay all his debts in full...." See id. § 11. Immediately upon filing a petition stating the debtor's inability to pay his or her debts in full and the debtor's willingness to surrender his or her estate and effects for the benefit of creditors and a desire to obtain the benefits of the bankruptcy law, the debtor was entitled to be adjudicated a bankrupt. See, e.g., In re Patterson, 18 F.Cas. 1315, 1317 (S.D.N.Y.1867). No further inquiry as to the debtor's ability to pay was permitted. See id. at 1318.
The 1898 Act provided that a voluntary debtor could file a bankruptcy case with no requirement of insolvency. See id. § 4(a). Unlike the 1841 and 1867 Acts, the 1898 Act did not require a debtor to plead inability to pay his or her debts as they came due. Collier explains § 4(a) as follows:
1 COLLIER ¶ 4.03 (interpreting bankruptcy law as it existed before the Bankruptcy Code took effect in 1979); see Caplin v. Marine Midland Grace Trust Co., 406 U.S. 416, 423, 92 S.Ct. 1678, 32 L.Ed.2d 195 (1972) ("Chapter X proceedings [under the 1898 Act as amended in 1938] are not limited to insolvent corporations but are open to those corporations that are solvent in the bankruptcy (asset-liability) sense but are unable to meet their obligations as they mature") (citing United States v. Key, 397 U.S. 322, 329, 90 S.Ct. 1049, 25 L.Ed.2d 340 (1970)).
After arising in the 1841 Act as a pleading requirement, insolvency of any kind disappeared entirely in 1878 (the date of repeal of the 1867 Act) as a condition of filing a voluntary bankruptcy petition in the United States.
Thus the statutory history shows that no United States bankruptcy law has ever required a voluntary debtor to show that he or she was in fact insolvent, under a balance sheet test or otherwise, as a pre-requisite of taking advantage of bankruptcy.
Similarly, insolvency has never been required for a debtor to become an involuntary bankrupt, either under United States bankruptcy law or under its English predecessors.
The English bankruptcy laws prior to the United States revolution uniformly provided only for involuntary bankruptcy. Uniformly, also, these laws made no provision for insolvency as a condition of the filing of a petition in bankruptcy against a debtor. Instead, these statutes based the right to file an involuntary bankruptcy petition on what became known as a debtor's "acts of bankruptcy." Any single act of bankruptcy, under each of these laws, was sufficient to support an involuntary bankruptcy petition. The qualifying acts included such conduct as refusing to pay creditors, departing the country, staying in one's house (to avoid service of process), taking sanctuary, and permitting himself or herself to be arrested (presumably for not paying debts). In addition, the creditor was required to show that the debtor took such an action with the intent to hinder or delay his or her creditors.
BLACKSTONE'S COMMENTARIES ON THE LAWS OF ENGLAND, published in 1765 to 1769, are in accord with the English laws. Blackstone wrote extensively in his COMMENTARIES about bankruptcy law. However, like the English bankruptcy law of his time, Blackstone makes no reference to insolvency as a qualification for bankruptcy. See 2 BLACKSTONE, supra, at *471-88.
Blackstone's COMMENTARIES were well known to the writers of the Constitution and to early United States judges and lawyers. See Hanover Nat. Bank v. Moyses, 186 U.S. 181, 187, 22 S.Ct. 857, 46 L.Ed. 1113 (1902); Nelson v. Carland, 42 U.S. (1 How.) 265, 270-73, 11 L.Ed. 126 (1843) (dissenting opinion of Justice Catron).
In the United States, the first two bankruptcy acts, the 1800 Act and 1841 Act permitted a creditor to file an involuntary bankruptcy petition against a debtor only if the debtor had committed an act of bankruptcy. The 1800 Act specified ten qualifying acts of bankruptcy, which largely mirrored those in the English statutes. See 1800 Act, § 1. The 1841 Act reduced to five the qualifying acts of bankruptcy. See 1841 Act, § 1. Like their predecessor English laws, none of the qualifying acts of bankruptcy in either the 1800 or the 1841 Acts included insolvency as an element or factor to be considered in making an adjudication of bankruptcy.
The 1867 Act was the first to introduce insolvency as an element in any of the acts of bankruptcy. Of the nine statutory acts of bankruptcy
In the 1898 Act insolvency began to take a prominent role in the acts of bankruptcy that could support an involuntary petition. The original version of the 1898 Act decreased
Congress amended the fourth act of bankruptcy (making an assignment for the benefit of creditors) in 1903 to include having a receiver or trustee take charge of the debtor's property while the debtor was insolvent. See Act of February 5, 1903, 32 Stat. 797; see also In re Valentine Bohl Co., 224 F. 685 (2d Cir.1915) (dismissing involuntary petition on three grounds: the debtor was balance sheet solvent when the state court receiver was appointed, it was impossible to determine whether the district court receivership was ordered "because of [balance sheet] insolvency" (as the clause required for an involuntary receivership), and there was no evidence of a fraudulent transfer). In 1926, Congress added yet a fifth act of bankruptcy involving the debtor's insolvency to the 1898 Act: suffering, while insolvent, a lien that was not vacated or discharged within thirty days thereafter. See Act of May 27, 1926, 44 Stat. 662.
In the 1898 Act (but not previously), "insolvency" was defined. This definition adopted the modified balance sheet test that now appears in § 101(32)(A). See 1898 Act § 1(19); see also American Nat'l Bank & Trust Co. v. Bone, 333 F.2d 984, 986-87 (8th Cir.1964) (utilizing a balance sheet to show insolvency); Syracuse Engineering Co. v. Haight, 110 F.2d 468, 471 (2d Cir.1940). This definition was a change from the previous understanding of solvency for the purposes of bankruptcy law. While the previous statutes contained no definition of solvency, it was generally understood that the liquidity test applied in the bankruptcy context. See generally 1 COLLIER ¶ 1.19[1].
The Chandler Act in 1938, which substantially amended the 1898 Act, expanded the scope of the 1903 addition by applying it both when the debtor was insolvent (on a modified balance sheet basis) and when the debtor was unable to pay his or her debts as they matured (the liquidity definition). The Chandler Act also revised the various reorganization provisions added to the 1898 Act beginning in 1933. For these provisions (the predecessors of chapter 11), the liquidity definition of insolvency was ordinarily invoked.
Throughout the career of the 1898 Act (which was repealed effective September 30, 1979), making a general assignment for the benefit of creditors was an act of bankruptcy that did not require the insolvency of the debtor. See id. § 3(a)(4).
The Bankruptcy Code, while reducing to two the acts of bankruptcy that can support an involuntary petition, continues to permit an involuntary bankruptcy notwithstanding a debtor's solvency. The Code permits a court to order relief against the debtor if, within 120 days of the filing of the petition, a custodian, receiver or agent is appointed or takes possession of less
However, virtually every involuntary petition filed under the Bankruptcy Code relies on § 303(h)(1),
The court concludes from the foregoing history that, at the time that the Constitution was written, insolvency of any kind was utterly unknown as a requirement for filing a bankruptcy case. Thus it is not credible that the framers of the Constitution thought that a requirement of insolvency was included in the concept of bankruptcy that found its way into the Bankruptcy Clause. Furthermore, insolvency has never been a statutory requirement for either voluntary or involuntary bankruptcy under United States bankruptcy law. Finally, balance sheet insolvency was altogether unknown for bankruptcy purposes in the United States until 1898.
The development of bankruptcy law did not end with the writing of the Bankruptcy Clause in the United States Constitution in 1787. There are three watershed developments in United States bankruptcy law since that date.
The first major development, which was introduced in the 1841 Act, was the authorization for a debtor to file a voluntary bankruptcy case without waiting for a creditor to file an involuntary petition against the debtor. Justice Catron, sitting on circuit in the district of Missouri, found this provision constitutional in In re Klein, 42 U.S. 277, 1 How. 277, 11 L.Ed. 275, 14 F.Cas. 716, 718 (1843), reported in a note to Nelson v. Carland, 42 U.S. (1 How.) 265, 277, 11 L.Ed. 126 (1843). The Supreme Court cited Klein with approval on this issue in Hanover Nat'l Bank v. Moyses, 186 U.S. 181, 186, 22 S.Ct. 857, 46 L.Ed. 1113 (1902).
The second landmark major development, also adopted in the 1841 Act, was the extension of the bankruptcy law to individuals who are not traders. The Supreme Court approved this development also in Moyses, 186 U.S. at 186, 22 S.Ct. 857, again relying on Klein.
The third major landmark development was the addition of reorganization as a mode of bankruptcy authorized under the Bankruptcy Clause. This first reorganization provision appeared in United States law in the Act of March 3, 1933, which was signed by President Hoover on his last day in office.
Each of these provisions constituted a landmark change in bankruptcy law from that known in 1787 when the Bankruptcy Clause was written into the Constitution. In the words of the Supreme Court itself, these extensions of bankruptcy law were of a "fundamental and radically progressive nature." Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555, 588, 55 S.Ct. 854, 79 L.Ed. 1593 (1935) (quoting Continental Illinois, 294 U.S. at 671, 55 S.Ct. 595, 79 L.Ed. 1110). Nonetheless, the Supreme Court found that each of these developments comes within the ambit of the Bankruptcy Power, and thus is constitutional. Radford, 295 U.S. at 587-88, 55 S.Ct. 854; Continental Illinois, 294 U.S. at 671, 55 S.Ct. 595, 79 L.Ed. 1110.
More generally, the Supreme Court has very recently stated that the Constitution should not be restricted to a particular generation's interpretation of the Constitution: "As the Constitution endures, persons in every generation can invoke its principles in their own search for greater freedom." Lawrence v. Texas, 539 U.S. 558, 123 S.Ct. 2472, 2484, 156 L.Ed.2d 508 (2003) (finding due process violation in Texas statute prohibiting same-sex sodomy).
In contrast to these landmark bankruptcy law changes, the filing of a bankruptcy case by or with respect to a solvent debtor has always been permitted under bankruptcy law, both under every bankruptcy law enacted in the United States and under every prior law enacted in England.
Supreme Court case law likewise gives no support to the thesis that, as a constitutional matter, congressional power to provide bankruptcy protection must be limited to those who are insolvent, whether under a balance sheet test or otherwise.
The United States Supreme Court has consistently taken an expansive view of the Bankruptcy Powers, to permit their application in the context of the enormous expansion of the economy since 1787 and the correspondingly great elaboration of the legal structures supporting it:
Continental Illinois, at 668, 294 U.S. 648, 55 S.Ct. 595. The Supreme Court has repeatedly and consistently held that the Bankruptcy Powers are not limited to the meaning of the term "bankruptcy" at the time of the formulation of the Constitution. See, e.g., Wright v. Union Central Life Ins. Co., 304 U.S. 502, 58 S.Ct. 1025, 82 L.Ed.
The core of the federal bankruptcy power, according to the Supreme Court, is "the restructuring of debtor-creditor relations...." Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50, 71, 102 S.Ct. 2858, 73 L.Ed.2d 598 (1982) (plurality opinion). Beyond this core, as a general rule, the Supreme Court has said, "the subject of bankruptcies is incapable of final definition." Gibbons, 455 U.S. at 466, 102 S.Ct. 1169; accord Wright v. Union Central, 304 U.S. at 513, 58 S.Ct. 1025; Continental Illinois, 294 U.S. at 669-70, 55 S.Ct. 595 ("[t]hose limitations have never been explicitly defined, and any attempt to do so now would result in little more than a paraphrase of the language of the Constitution without advancing far toward its full meaning."). In Gibbons the Supreme Court stated:
Gibbons, 455 U.S. at 466, 102 S.Ct. 1169 (emphasis added, quotations and citations omitted).
In Moyses, the Court added that the debtor "may be, in fact, fraudulent, and able and unwilling to pay his debts; but the law takes him at his word, and makes effectual provision, not only by civil, but even by criminal, process, to effectuate his alleged intent of giving up all his property." Id. at 861. Thus the "subject of bankruptcies" includes the power to discharge a debtor from contracts and legal liabilities, and to distribute the debtor's property to creditors. Id. at 188, 22 S.Ct. 857 (upholding the constitutionality of the Bankruptcy Act of 1898 insofar as it authorized the discharge of a judgment on a promissory note). The Court in Moyses also stated: "all intermediate legislation, affecting substance and form, but tending to further the great end of the subject, — distribution and discharge, — are in the competency and discretion of Congress." Id. at 186, 186 U.S. 181, 22 S.Ct. 857 (quoting In re Klein, 42 U.S. 277, 1 How. 277, 11 L.Ed. 275, 14 F.Cas. No. 716 (C.C.D.Mo.1843), reprinted in a note to Nelson v. Garland, 42 U.S. (1 How.) 265, 277, 11 L.Ed. 126, 130 (1843)).
The Court further stated in Continental Illinois that bankruptcy "may be construed to include a debtor who, although unable to pay promptly, may be able to pay if time to do so be sufficiently extended," i.e., a solvent debtor. Id. at 668, 55 S.Ct. 595. There is no reason to believe that the bankruptcy laws of the nineteenth century exhausted congressional power under the Bankruptcy Clause. See id.
The Supreme Court has also spoken on the essential purposes of chapter 11, under which the debtors filed this case. In NLRB v. Bildisco & Bildisco, 465 U.S. 513, 527, 104 S.Ct. 1188, 79 L.Ed.2d 482 (1984), the Court stated that the policy of
Id. The Court used this rationale in Toibb to hold that individual consumers, like the debtors in this case, are entitled to take advantage of chapter 11 to reorganize their financial affairs, even though they may have no business to reorganize. See id. at 160-66, 111 S.Ct. 2197.
Similarly, in Bank of America NTSA v. 203 N. LaSalle St. P'ship, 526 U.S. 434, 119 S.Ct. 1411, 143 L.Ed.2d 607 (1999), the Court stated that, "the two recognized policies underlying Chapter 11[are] preserving going concerns and maximizing property available to satisfy creditors...." Id. at 453, 119 S.Ct. 1411.
The debtors in this case at least qualify as "nonpaying" debtors, in the terminology of Gibbons, and they certainly appeared to be failing when they filed their case. If they enjoy a bonanza from their chapter 11 plan, it will result from Pierce's refusal to file a claim on his $12 million Texas judgment.
Furthermore, the court finds that the chapter 11 plan in this case maximizes the property available to satisfy creditors. At the time of filing, it was not at all clear that the debtors could pay their creditors in full. The plan settles this issue.
There are very few Supreme Court cases holding that Congress has exceeded its constitutional powers in legislating on the subject of bankruptcy. In light of the foregoing expansive descriptions of Congress' powers under the Bankruptcy Clause, these cases shed little light on any relevant limitations on Congress' Bankruptcy Powers.
Perhaps the best known case holding unconstitutional a provision of bankruptcy law is Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555, 55 S.Ct. 854, 79 L.Ed. 1593 (1935), which invalidated the Frazier-Lemke addition to the 1898 Act that permitted a farmer to pay rent instead of mortgage payments for five years and then retire the mortgage by paying only the (likely reduced) fair market value of the property. The principal vice of this provision, the Supreme Court found, was that Congress applied it only to mortgages existing on the date of enactment, and thus it constituted a taking of existing property rights of mortgage holders in violation of the Just Compensation clause of the Fifth Amendment.
In Railway Labor Executives' Ass'n v. Gibbons, 455 U.S. 457, 469-73, 102 S.Ct. 1169,
In Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 109 S.Ct. 2782, 106 L.Ed.2d 26 (1989), the Supreme Court held that the bankruptcy power did not permit Congress to eliminate a party's Seventh Amendment jury trial right by relabeling the cause of action and assigning it to a specialized court in equity. Id. at 61, 109 S.Ct. 2782. Also well known is Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50, 102 S.Ct. 2858, 73 L.Ed.2d 598 (1982), where the Supreme Court found in 1982 that the Bankruptcy Clause did not authorize Congress to grant bankruptcy jurisdiction to judges lacking Article III tenure.
There are also very few lower court decisions finding a bankruptcy law provision unconstitutional. There is one contemporary example. A battle rages among lower courts today on whether rights clearly legislated under the Bankruptcy Clause can be enforced under § 106(a) in federal court against state governments in light of the Eleventh Amendment (constitutionalizing state sovereign immunity) and case law thereunder. In Hood v. Tennessee Student Assistance Corp. (In re Hood), 319 F.3d 755, 761-68 (6th Cir.), cert. granted, 539 U.S. 986, 124 S.Ct. 45, 156 L.Ed.2d 703 (2003), the Sixth Circuit held that the Bankruptcy Clause authorized Congress, notwithstanding the Eleventh Amendment, to abrogate state sovereign immunity in bankruptcy matters. In contrast, the following circuit court decisions have held that the Eleventh Amendment prevents Congress from abrogating state sovereign immunity in bankruptcy matters: Nelson v. La Crosse County Dist. Attorney (In re Nelson), 301 F.3d 820, 832 (7th Cir.2002); Mitchell v. Franchise Tax Bd. (In re Mitchell), 209 F.3d 1111, 1121 (9th Cir.2000); Sacred Heart Hosp. v. Pennsylvania (In re Sacred Heart Hosp.), 133 F.3d 237, 243 (3d Cir.1998); Department of Transportation and Development v. PNL Asset Mgmt. Co. LLC (In re Fernandez), 123 F.3d 241, 243 (5th Cir.), amended by 130 F.3d 1138, 1139 (5th Cir.1997); Schlossberg v. Maryland (In re Creative Goldsmiths), 119 F.3d 1140, 1145-46 (4th Cir.1997).
This case today does not require the court to determine the limits of the Bankruptcy Powers granted to the federal government
Pierce contends that Howard's bankruptcy case deprives him of his substantive due process rights, thereby invoking "dormant" substantive economic due process rights that have disappeared from Supreme Court jurisprudence since the 1930's. The Fifth Amendment provides, in relevant part, "nor shall any person ... be deprived of life, liberty or property, without due process of law...." Under this theory, the Fifth Amendment is a limitation on the scope of "the subject of bankruptcies."
Recent Supreme Court decisions make it clear that substantive due process is alive and well in its jurisprudence, insofar as it concerns individual rights and liberties. See, e.g., Lawrence v. Texas, 539 U.S. 558, 123 S.Ct. 2472, 2484, 156 L.Ed.2d 508 (2003) (finding due process violation in Texas statute prohibiting same-sex sodomy). In contrast, substantive economic due process remains sound asleep in Supreme Court jurisprudence. Thus, entirely apart from the particular controversy before this court, Pierce faces a steep uphill climb to invoke substantive economic due process.
Apparently the only Supreme Court case addressing substantive due process rights in the bankruptcy context is Canada Southern Ry. v. Gebhard, 109 U.S. 527, 3 S.Ct. 363, 27 L.Ed. 1020 (1883), where New York bondholders challenged a Canadian railroad "scheme of arrangement" specially authorized by Canadian statute. The bondholders had not participated in the Canadian proceeding. The Court found that the scheme was "no more than is done in bankruptcy" in the United States, and thus that the scheme should be enforced in a United States court against all creditors. See id. at 537-40, 3 S.Ct. 363. The Supreme Court rejected the substantive due process challenge to the arrangement. See id. at 537, 3 S.Ct. 363.
Procedural due process rights under the Fifth Amendment clearly apply in the bankruptcy context. In Hanover Nat. Bank v. Moyses, 186 U.S. 181, 187, 22 S.Ct. 857, 46 L.Ed. 1113 (1902), for example, the Supreme Court found that the notice requirements of the Fifth Amendment Due Process Clause applied and were satisfied. The Court rejected the contention that personal notice of the filing was required. The Court found that bankruptcy proceedings are, generally speaking, in the nature of proceedings In rem, for which notice by publication and mail satisfy due process requirements. Pierce does not complain of procedural due process violations in this case.
The court finds it unnecessary to explore in detail the constitutional consequences of bankruptcy legislation that falls outside the Bankruptcy Powers of the Constitution. If this case were to fall outside the scope of the Bankruptcy Clause, the court assumes without deciding that the law would violate some constitutional provision. However, the court does not reach this issue because the court finds that Congress has the power under the Bankruptcy Clause to determine that a debtor may invoke rights under the Bankruptcy Code to adjust obligations with creditors before the debtor becomes insolvent under a balance sheet test.
The larger constitutional issue concerns the power to extinguish debts and cancel contractual obligations. Under the Articles of Confederation, the states possessed and used this power, to the consternation of many. See Alexander Hamilton, THE FEDERALIST NO. 85, praising the new constitution's "precautions against the repetition of those practices on the part of the
What has happened to this power? The grand bargain of 1787 was that states surrendered it to the new federal government in exchange for the checks and balances of a federal system that would restrain the new national legislature from unwise debt forgiveness. Moyses, 186 U.S. at 187, 22 S.Ct. 857. Thus, the grant of power to Congress over the "subject of bankruptcies" in Article I, Section 8 is balanced with the prohibition in Article I, Section 10, forbidding states from impairing the obligation of contracts. The power to discharge debts and contractual obligations was not extinguished: it was surrendered to the federal government. See id.
There is a significant difference, with respect to the Bankruptcy Power, between property interests and contract rights. See Webber v. Credithrift (In re Webber), 674 F.2d 796, 802 (9th Cir.1982). In the bankruptcy context, property rights enjoy at least a measure of protection under the Due Process and Just Compensation Clauses of the Fifth Amendment. See, e.g., Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555, 55 S.Ct. 854, 79 L.Ed. 1593 (1935) (just compensation); United States v. Security Industrial Bank, 459 U.S. 70, 103 S.Ct. 407, 74 L.Ed.2d 235 (1982) (same). On the other hand, Congress is not prohibited from passing laws that impair the obligation of contracts. See, e.g., Continental Bank v. Rock Island Ry., 294 U.S. 648, 680, 55 S.Ct. 595, 79 L.Ed. 1110 (1935); Webber, 674 F.2d at 802. "In fact, the very essence of bankruptcy laws is the modification or impairment of contractual obligations." Webber, 674 F.2d at 802.
The protection of property rights in the bankruptcy context, however, is measured. The Supreme Court made this clear in Wright v. Union Central Life Ins. Co., 304 U.S. 502, 58 S.Ct. 1025, 82 L.Ed. 1490 (1938):
Id. at 518, 58 S.Ct. 1025.
In this case, Pierce has neither property rights nor contract rights to assert against the debtors. He does not even have a claim against the debtors in this case, because he refused to file his claim. He has only a Texas state court judgment that is on appeal. This claim is in danger of discharge if the debtors' chapter 11 plan is confirmed. The court finds that this is an insufficient basis to find a violation of Pierce's Fifth Amendment economic substantive due process rights in this case.
The court concludes that Pierce's constitutional challenge to the debtors' bankruptcy case and their plan of reorganization under chapter 11 cannot be sustained. The court finds that the balance sheet test for insolvency was unknown in United States bankruptcy law until 1898, when balance sheet insolvency first entered United States bankruptcy law. Prior thereto, insolvency in the bankruptcy context always meant liquidity (or equity) insolvency.
The court has previously found against Pierce on his statutory objections to the chapter 11 plan and on his motion to dismiss based on bad faith. Accordingly, the court finds that the chapter 11 plan should be confirmed and the motion to dismiss should be denied.
Pursuant to Dressler v. Seeley Co. (In re Silberkraus), 336 F.3d 864, 869 (9th Cir. 2003), the court HEREBY GIVES NTICE of the filing of its Second Amended Opinion on Plan Confirmation And Motion To Dismiss (Constitutional Issues) in the above case, a copy of which is attached.
