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Did the Bankruptcy Code Save Obamacare?

July 17, 2015

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Over the years, the United States Supreme Court has had to interpret ambiguous, imprecise, and otherwise puzzling language in the Bankruptcy Code, including the phrases “claim,” “interest in property,” “ordinary course of business,” “applicable nonbankruptcy law,” “allowed secured claim,” “willful and malicious injury,” “on account of,” “value, as of the effective date of the plan,” “projected disposable income,” “defalcation,” and “retirement funds.” The interpretive principles employed by the Court in interpreting the peculiarities of the Bankruptcy Code were in full view when the Court recently addressed another complex statute that affects millions of Americans each year—the Patient Protection and Affordable Care Act (“PPACA”). Both the majority opinion of Chief Justice Roberts and the dissent of Justice Scalia relied heavily on bankruptcy precedents in support of their interpretations of the PPACA.

In King v. Burwell, No. 14-114 (June 25, 2015), the Supreme Court had to decide whether tax credits critical to the operation of the PPACA are available nationwide or only in certain states. In particular, the parties advanced two possible interpretations of the statutory language “an Exchange established by the State” in 26 U.S.C. § 36B(b)(2)(A). The government argued that “Exchange established by the State” refers to an insurance exchange operating in a particular state, whether the exchange was set up by the state government or, alternatively, by the federal government after the state refused to establish one. The petitioners argued that “Exchange established by the State” refers only to a state-created exchange and excludes a federal exchange. (The petitioners did not want to purchase insurance, and they would not have been required to purchase it if their interpretation had prevailed, because, if they did not receive tax credits, the cost of the insurance would have exceeded 8% of their income.)

The Chief Justice’s first bankruptcy citation was to Lamie v. United States Trustee, 540 U.S. 526 (2004). Bankruptcy practitioners may recall Lamie as the case that established that a debtor’s attorney is not entitled to compensation from the bankruptcy estate in a Chapter 7 case. Id. at 538. The Bankruptcy Reform Act of 1994 amended Section 330(a)(1) of the Bankruptcy Code so that it read as follows:

After notice to the parties in interest and the United States Trustee and a hearing, and subject to sections 326, 328, and 329, the court may award to a trustee, an examiner, a professional person employed under section 327 or 1103—

(A)      reasonable compensation for actual, necessary services rendered by the trustee, examiner, professional person, or attorney and by any paraprofessional person employed by any such person; and

(B)       reimbursement for actual, necessary expenses.

Before the 1994 amendment, the introductory sentence above ended with “or to the debtor’s attorney—”. The parties’ arguments in Lamie turned on Congress’ failure to insert an “or” in the remaining list of eligible awardees after deleting the reference to the debtor’s attorney, as well as its inexplicable retention of the words “or attorney” in subsection (A).[1] The Court described Section 330(a) as “awkward, and even ungrammatical,” Lamie, 540 U.S. at 534, which is not so different from its description of the PPACA as containing “more than a few examples of inartful drafting.” King, slip op. at 14.

In Lamie, the Court had to address the fee applicant’s argument that the language “or attorney” in subsection (A) would be meaningless unless the statute permitted a debtor’s attorney to apply for compensation. The Court acknowledged that “or attorney” might be surplusage under the government’s interpretation, but it said that “[s]urplusage does not always produce ambiguity and our preference for avoiding surplusage constructions is not absolute.” Id. at 536. Chief Justice Roberts applied the same principle in rejecting the petitioners’ argument that the phrase “established by the State” would be unnecessary if the PPACA’s tax credits applied on both state and federal exchanges. King, slip op. at 14.

After concluding that the phrase “established by the State” was ambiguous, the Chief Justice looked to the rest of the PPACA for clues to the meaning of Section 36B. In this portion of his opinion, he turned for support to United Savings Association of Texas v. Timbers of Inwood Forest Associates, Ltd., 484 U.S. 365 (1988). Timbers was a Chapter 11 case in which the parties disputed the meaning of the phrase “interest in property” in Section 362(d)(1) of the Bankruptcy Code, which requires the court to grant relief from the automatic stay if such an interest is not adequately protected. In particular, the secured lender sought compensation because the debtor’s bankruptcy filing prevented the lender from proceeding to foreclosure, while the debtor argued that the right to foreclose immediately was not a protected “interest in property.” The Court acknowledged that both interpretations were possible but recognized that “[a] provision that may seem ambiguous in isolation is often clarified by the remainder of the statutory scheme . . . because only one of the permissible meanings produces a substantive effect that is compatible with the rest of the law.” Id. at 371. A lengthy review of other provisions of the Bankruptcy Code convinced the Court that the right to immediate foreclosure was not one of the interests in property that must be adequately protected. See id. at 371–79.

The majority took a similar approach in King, recognizing that the elimination of tax credits under the petitioners’ interpretation “would destabilize the individual insurance market in any State with a Federal Exchange, and likely create the very ‘death spirals’ that Congress designed the Act to avoid.” King, slip op. at 15.

Justice Scalia’s dissent in King also relied on several bankruptcy cases, and it echoed another without directly citing it. After a lengthy discussion of the plain meaning of the PPACA—which, he contended, should preclude any recourse to the general purpose of the statute—Justice Scalia turned to the venerable precedent of Sturges v. Crowninshield, 17 U.S. (4 Wheat.) 122 (1819). Sturges preceded the modern Bankruptcy Code by more than 150 years, and in fact the case arose during a period in which Congress had not exercised its power to establish “uniform Laws on the subject of Bankruptcies throughout the United States.” U.S. Const. art. I, § 8. But New York had passed a law that “liberates the person of the debtor, and discharges him from all liability for any debt previously contracted, on his surrendering his property in the manner it prescribes.” Sturges, 17 U.S. at 197. The Court avoided the question whether this law was preempted by the Bankruptcy Clause and instead focused on whether it was a “Law impairing the Obligation of Contracts,” which also is prohibited by the Constitution. U.S. Const. art. I, § 10. The creditor argued that the New York discharge statute was not within the spirit of the constitutional prohibition because colonial and state legislatures had enacted similar legislation without controversy, and the framers of the Constitution intended to bar different types of laws. In response, Chief Justice Marshall wrote that “although the spirit of an instrument, especially of a constitution, is to be respected not less than its letter, yet the spirit is to be collected chiefly from its words” rather than from “extrinsic circumstances.” Sturges, 17 U.S. at 202. Justice Scalia argued for the application of this approach in King, arguing that “[o]nly by concentrating on the law’s terms can a judge hope to uncover the scheme of the statute, rather than some other scheme that the judge thinks desirable.” King, slip op. at 13 (Scalia, J., dissenting).

Justice Scalia returned to Sturges in his response to the majority’s argument that the phrase “established by the State” was inartfully drafted. Chief Justice Marshall had allowed that the plain meaning of a provision might be disregarded if “the absurdity and injustice of applying the provision to the case, would be so monstrous, that all mankind would, without hesitation, unite in rejecting the application.” Sturges, 17 U.S. at 203. He did not find the application of the Contracts Clause to the New York discharge statute to be quite that monstrous, and Justice Scalia argued that interpreting “established by the State” to exclude federal exchanges did not meet the monstrosity standard either. See King, slip op. at 17 (Scalia, J., dissenting).

Justice Scalia also relied on Lamie to support his argument. In the Sturges discussion mentioned just above, he argued that the Court did not have the power “‘to rescue Congress from its drafting errors.’” Id. (quoting Lamie, 540 U.S. at 542). And in the following section of the dissent, he sounded a similar note: “‘If Congress enacted into law something different from what it intended, then it should amend the statute to conform to its intent.’” Id. (quoting Lamie, 540 U.S. at 542).

The final paragraph of Justice Scalia’s dissent echoed a theme he developed decades earlier. In King, he wrote this:

Perhaps the Patient Protection and Affordable Care Act will attain the enduring status of the Social Security Act or the Taft-Hartley Act; perhaps not. But this Court’s two decisions on the Act will surely be remembered through the years. The somersaults of statutory interpretation they have performed (“penalty” means tax, “further [Medicaid] payments to the State” means only incremental Medicaid payments to the State, “established by the State” means not established by the State) will be cited by litigants endlessly, to the confusion of honest jurisprudence. And the cases will publish forever the discouraging truth that the Supreme Court of the United States favors some laws over others, and is prepared to do whatever it takes to uphold and assist its favorites.

King, slip op. at 21 (Scalia, J., dissenting). His discouragement at the result and the potential consequences for future litigation are consistent with those he expressed in Dewsnup v. Timm, 502 U.S. 410, 435-36 (1992) (Scalia, J., dissenting):

The principal harm caused by today’s decision is not the misinterpretation of § 506(d) of the Bankruptcy Code…. The greater and more enduring damage of today’s opinion consists in its destruction of predictability, in the Bankruptcy Code and elsewhere. By disregarding well-established and oft-repeated principles of statutory construction, it renders those principles less secure and the certainty the are designed to achieve less attainable. When a seemingly clear provision can be pronounced “ambiguous” sans textual and structural analysis, and when the assumption of uniform meaning is replaced by “one-subsection-at-a-time” interpretation, innumerable statutory texts become worth litigating…. Having taken this case to resolve uncertainty regarding one provision, we end by spawning confusion regarding scores of others.

So, did the Bankruptcy Code save Obamacare? No, not really. The multiple citations to bankruptcy cases in King are interesting, but both sides employed them effectively in support of their positions. The interpretative principles that emerge from the Supreme Court’s bankruptcy cases are important, but they are hardly unique. For example, Chief Justice Roberts may have relied on Timbers because it contained just the sort of phrasing he was looking for, and no case involving RICO or the Carmack Amendment would have served his purpose quite as well. But it’s also possible that he used Timbers because it was authored by Justice Scalia.

[1] Congress cleaned up these problems in 2005, so the direct impact of Lamie was short-lived.

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Debtors Cannot Void Junior Liens on Underwater Property in Chapter 7

June 23, 2015

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On June 1, 2015, the Supreme Court released its opinion in Bank of America, N.A. v. Caulkett, No. 13-1421, 575 U.S. ____ (2015), in which it held that a Chapter 7 debtor may not void a junior mortgage under Section 506(d) of the Bankruptcy Code merely because the debt owed on a senior mortgage exceeds the present value of the property and the creditor’s claim is secured by a lien and allowed under Section 502. For now, this opinion cuts off a Chapter 7 debtor’s ability to “strip off” an underwater junior lien.

In Caulkett, the debtor had two mortgage liens on his home; Bank of America held the junior lien. The amount owed on the senior mortgage exceeded the value of the home, rendering Bank of America’s junior mortgage fully “underwater,” or with no current economic value. Generally, where the value of a creditor’s interest in its collateral is zero, a creditor’s claim cannot be a “secured claim,” and the lien securing the junior mortgage can be voided in a Chapter 7 case.

The authority for this voiding procedure lies in Section 506 of the Bankruptcy Code. Under Section 506(a), “[a]n allowed claim of a creditor secured by a lien on property . . . is a secured claim to the extent of the value of such creditor’s interest in . . . such property,” and “an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim.” 11 U.S.C. § 506(a)(1). Under Section 506(d), “[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.” 11 U.S.C. § 506(d). Based on this understanding of Section 506, the Caulkett debtor argued that Bank of America’s junior lien should be void.

But in a 1992 opinion, Dewsnup v. Timm, 502 U.S. 410 (1992), the Supreme Court adopted a different construction of the term “secured claim” that focused on two things: (1) the validity of the creditor’s perfected security interest in its collateral; i.e., Does the lender have a valid lien? and (2) whether the creditor’s claim was “allowed” under Section 502, which governs the allowance of claims in bankruptcy cases; i.e., did the lender file a proper claim in the bankruptcy case, and did anyone object? Notably, the Dewsnup construction of “secured claim” did not take into consideration the collateral’s value.

The Supreme Court in Caulkett explained that it was bound by the Dewsnup construction. Accordingly, the debtor could not void Bank of America’s junior mortgage because the mortgage was (1) secured by valid a lien and (2) supported by an allowed claim to which no party had objected.

In a footnote, which Justices Kennedy, Breyer, and Sotomayor declined to join, the Court acknowledged that “[f]rom its inception, Dewsnup . . . has been the target of criticism.” This is because it appears to be at odds with the plain language of Section 506. In addition, Dewsnup has generally not been applied to Chapter 13 cases, where the stripping off of underwater liens is common, and debtors can rely on other similar sections of the Bankruptcy Code.

On the other hand, preserving a junior lien is especially important during times of depressed real estate prices. Once a creditor’s lien has been stripped, upon the sale of the property—even where the value of the property has later appreciated—the junior mortgage creditor gets nothing, and the benefit goes to the debtor. Under Caulkett, the lender is not harmed by a temporary drop in real estate prices, as it may retain its lien even if the property appears to be completely underwater. Chapter 7 debtors like the one in Caulkett may argue that, under Dewsnup and now Caulkett, they are unduly burdened by a lender’s lien, and that the “fresh start” they hoped a bankruptcy case would afford them is diminished.

But the Court emphasized that it wasn’t asked to overrule Dewsnup, and the Court concluded that, under Dewsnup, a Chapter 7 debtor may not void a junior mortgage lien under Section 506(d) merely because the debt owed on a senior mortgage lien exceeds the value of the collateral. With the Court appearing to have left open the possibility of revisiting its Dewsnup decision, it is likely that this contentious issue will remain in play.

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Good News for Rent-Stabilized Debtors in New York

February 25, 2015

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Late last year, the New York Court of Appeals issued an interesting opinion: In Mary Veronica Santiago-Monteverde v. John. S. Pereira, 24 N.Y.3d 283 (2014), the Court held that a bankruptcy debtor’s interest in her rent-stabilized apartment is exempted from her bankruptcy estate as a “local public assistance benefit.”

The debtor lived in Manhattan for 40 years in a rent-stabilized apartment. In 2011, after her husband passed away, she became unable to pay her credit-card debts, which totaled about $23,000, and she subsequently filed for Chapter 7 bankruptcy. In her initial filing, the debtor listed her apartment lease as an ordinary unexpired lease.

The debtor’s landlord offered the trustee a deal: The landlord would pay the $23,000 credit-card debt in exchange for the debtor’s interest in the lease and would continue to let the debtor live in the apartment at the rent-controlled rate of $703 a month for the rest of her life. The “catch,” so to speak, is one that anyone living in any of New York’s approximately one million rent-controlled apartments would quickly recognize: If the debtor’s interest in the lease were regained by the landlord, then the debtor’s son, who shares her apartment, would not be able to inherit the lease and keep paying the rent-controlled rental rate. Consequently, when the trustee advised the debtor that her interest in the lease was to be sold, the debtor amended her bankruptcy schedules to list the value of her lease as personal property exempt from the bankruptcy estate under New York Debtor and Creditor Law § 282(2) as a “local public assistance benefit.”

The Bankruptcy Court, granting a motion by the trustee, struck the claimed exemption and said that “the benefit of paying below market rent is not a ‘public assistance benefit’ that is entitled to any exemption in bankruptcy” and that the benefit “is a quirk of the regulatory scheme in the New York housing market, not an individual entitlement.” In re Santiago-Monteverde, 466 B.R. 621 (Bankr. S.D.N.Y. 2012).

The District Court affirmed, and the United States Court of Appeals for the Second Circuit certified the “local public assistance benefit” question to the New York Court of Appeals. In disagreeing with the decision of the Bankruptcy Court, the New York Court of Appeals noted that “When the rent-stabilization regulatory scheme is considered against the backdrop of the crucial role that it plays in the lives of New York residents, and the purpose and effect of the program, it is evident that a tenant’s rights under a rent-stabilized lease are a local public assistance benefit.” 24 N.Y.3d at 289. The Court also indicated that the Bankruptcy Court’s description of the rent stabilization program as “quirk of the regulatory scheme in New York…” may be true, but the fact that it is a local quirk lends credence to the debtor’s claim that it is in fact a local public assistance benefit.

While the rent-stabilization program does not provide payments directly to participants in the way that many traditional public assistance programs do, the Court held that the program conferred a clear benefit on the debtor that was intended by the legislature that created the program. The Office of the New York Attorney General and the city’s Law Department agreed and filed a joint brief in the case arguing that the sale of the lease would undermine the benefits intended to be provided by rent stabilization. Indeed, had the Court held the opposite, it would have become easier for landlords to evict rent-stabilized tenants who filed for bankruptcy by purchasing their leases from the trustee, charging market rent (rather than offering to allow the debtor to remain at a stabilized rate, as the landlord in this case did), and then evicting the tenants who could no longer afford the rates.

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U.S. Supreme Court: Inherited IRA Funds not “Retirement Funds”

September 29, 2014

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On June 12, 2014, the Supreme Court issued a unanimous opinion in Clark v. Rameker, Dkt. No. 13-299, 573 U.S. ___ (2014), holding that funds held in inherited Individual Retirement Accounts are not “retirement funds” within the meaning of 11 U.S.C. § 522(b)(3)(c) and therefore not exempt from the bankruptcy estate. This opinion limits retirement funds that remain out of creditors’ reach when an individual files a bankruptcy case.

In Clark, Heidi Clark inherited a traditional IRA account established by her mother. Clark then filed a Chapter 7 bankruptcy case and claimed the inherited IRA account as exempt from the bankruptcy estate under Section 522(b)(3)(C). The trustee and unsecured creditors objected, arguing that the inherited IRA funds were not “retirement funds” within the meaning of the statute.

The Court distinguished between inherited IRAs and traditional IRAs, noting that holders of inherited IRAs are prohibited from making contributions to those accounts, setting them apart from traditional retirement accounts; that holders of inherited IRAs are required to withdraw money from such accounts, regardless of how many years they may be from retirement; and that holders of inherited IRAs may withdraw the entire balance of the account at any time and for any purpose, without penalty. Observing that the funds in an inherited IRA could be spent on even a “vacation home or a sports car,” the Court expressed concern that allowing an inherited IRA to be exempt from the bankruptcy estate would convert the Bankruptcy Code’s purposes of providing a “fresh start” into a “free pass.”

The Clark opinion resolves a split among Circuits. The Fifth Circuit ruled in In re Chilton, 674 F. 3d 486 (5th Cir. 2012) that inherited IRAs constituted retirement funds within the “plain meaning” of § 522 of the Bankruptcy Code and were thus exempt from the bankruptcy estate, under § 522(d)(12) (the federal exemptions). The Seventh Circuit, in Clark, disagreed, emphasizing that the Bankruptcy Code should not be used to exempt from creditors’ reach funds that were freely accessible for current use by the debtor, without penalty.

Although Clark excludes inherited IRAs from exemption under Section 522(b)(3)(c), some states, including Missouri, provide a separate exemption for inherited IRAs under state law. The Clark decision is not likely to affect bankruptcy cases and practices in these states.

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