by Herbert Wiggins | Mar 14, 2023 | bankruptcy, Crypto
Although it is not alone in its financial woes, the bankruptcy filing of cryptocurrency giant FTX Trading, Ltd., has probably gotten the most attention of the cryptocurrency firms that are in deep financial distress (“the Crypto Winter”).
This article discusses the basic structure of the Chapter 11 bankruptcy filing, as well as some interesting questions that will arise in the administration of this case. This article is not intended to be an exhaustive discussion of Chapter 11 bankruptcy, nor an exhaustive recitation of everything that is going to happen in this FTX proceeding. There are likely to be many twists and turns, in bankruptcy court as well as criminal court.
FTX was founded in 2019 by Sam Bankman-Fried, who earlier founded a firm called Alameda Research. FTX was described in its Forbes magazine profile as follows:
One of the largest crypto trading exchanges in the world, it handles some 11% of the $2.4 trillion in derivatives traded each month. (It) raised $1.5 billion in private funding last year (2022), jolting its valuation from $1.2 billion to $25 billion.
However, as its obligations grew, and the cryptocurrency market began to contract, contracted, Bankman-Fried continue to live a lavish lifestyle, and FTX continued to recruit celebrity evangelists. Unfortunately, it appeared to more and more observers that FTX was nothing more than a Ponzi scheme. Fortune, December 3, 2022; The Guardian, December 17, 2022.
On November 11, 2011, FTX filed for bankruptcy protection in Delaware. Meanwhile, Bahamian authorities sought to exercise jurisdiction on that island and in New York. The Bahamian and US authorities have now agreed to have the case heard in the Delaware District of the United States Bankruptcy Court. FTX Trading Ltd., Case No. 22-11068 (JTD)
Additionally, in December 2022, Mr. Bankman-Fried was arrested in Nassau by the Royal Bahamas Police Force, and charged with wire fraud, securities fraud, money laundering, and other crimes. He was released on a $250 MM bond, and extradited to the United States.
One commentator compared Bankman-Fried to Bernie Madoff. Financial Historian Diana Henriques, quoted in The Guardian, 12/17/2022.
In late February 2023, a superseding indictment in the US charged Bankman-Fried with bank fraud, operating an unlicensed money transmitter, modified campaign-finance law violations, and conspiracy to make unlawful political contributions. Coindesk, February 23, 2023.
FTX and its founder face significant legal jeopardy.
Now back to bankruptcy. A chapter 11 bankruptcy differs from a chapter 7 business liquidation, in the sense that the Chapter 11 debtor is not going out of business. It is reorganizing its debts. For example, the Los Angeles Dodgers General Motors, and Delta Airlines, all went through Chapter 11, to reorganize their debts.
The purpose of the chapter 11 bankruptcy is to allow the management of the debtor company to continue to manage and operate the company, pursuant to strict supervision by the United States Trustee. Quarterly reports are generated to show revenue and expenses. The goal is to maximize assets available for the plan of reorganization. The company, now known as a “debtor in possession,” is not allowed to waste, or misuse assets.
Eventually, the company will propose a plan of reorganization to its creditors, the largest of which organize themselves into a creditor’s committee. The creditors committee and the debtor in possession will haggle over the details of the plan, for example, to cut the debt by 20-, 30-, or 40%, or to stretch the debt out over an additional number of years, or some combination of both debt reduction and new repayment terms. Elizabeth Warren & Jay L. Westbrook, “The Success of Chapter 11: A Challenge to the Critics,” 107 Mich. Law Review 603 (2009).
If the parties cannot agree on a plan of reorganization, then the court has to decide whether it will force the debtor in possession and creditors to come up with another plan, or whether it will cram the debtor plan down the throat of the creditors (known as a “cram down hearing”).
Additionally, the Chapter 11 debtor-in-possession, with certain important exceptions, is entitled to the cancellation (“discharge”) of certain debts after the plan of reorganization is approved. 11 USC Sec. 1141(d)(1)
The Bankman-Fried criminal charges, however, throw in a different wrinkle: if for example FTX was operating as an alter ego of its founder, and not following all corporate formalities, some creditors may argue that FTX was a fraudulent enterprise, and is not entitled to bankruptcy relief. 11 USC Sec. 523(a)(2)(4) & (a)(4) [debts involving fraud not dischargeable]; 523(a)(6) [debts related to malicious conduct not dischargeable]; 11 USC Sec. 523 (c). Or, in the alternative, certain types of claims may be brought against the company, such as those dealing with fraud, which are not resolved as part of the plan of reorganization. The recent conviction of the Trump Organization on fraud charges in New York City provides an example of a prosecution that could result in a non-dischargeable debt, and could saddle FTX with significant fines and penalties.
In other words, the criminal charges against Bankman-Fried, and the eventual evidence showing the relationship between him and the company, may have a lot to do with what type of relief FTX eventually receives from the bankruptcy court, even assuming a very business friendly Delaware bankruptcy judge.
WARNING: THIS POST DOES NOT CONSTITUTE LEGAL ADVICE!! PLEASE CONSULT AN ATTORNEY!!
by Herbert Wiggins | Nov 17, 2022 | Fair Lending, Red Lining
During the years of the Financial Crash (2007-2012), one could read in the press about something called “predatory lending,” or “lending discrimination,” or “disparate treatment,” or “disparate impact.” These concepts and legal doctrines were important because they spoke to the fact that persons of color were treated deceptively or unfairly, or tended to receive subprime loans, or loans that they could not repay, or were preyed upon by certain lenders. The end result was that minority borrowers were much more likely to have their homes foreclosed upon than were Caucasian borrowers.
Central to the effects of the Financial Crash upon minority borrowers, in particular, was the belief among certain lenders that they could do whatever they wanted with regard to minority borrowers.
A recent ruling from Pennsylvania points to the continued need for vigilance with regard to lending discrimination. The US Department of Justice and the Consumer Financial Protection Bureau sued Trident Mortgage for redlining practices against borrowers of color in the Philadelphia area. Consumer Financial Protection Bureau v. Trident Mortgage Company LP, Case No. 2:22-cv-02936, U.S. District Court for the Eastern District of Pennsylvania.
In its press release of July 27, 2022, announcing the settlement with Trident Mortgage, the Department of Justice stated that:
“Redlining is an illegal practice in which lenders avoid providing credit services to individuals living in communities of color because of the race, color, or national origin of residents of those communities. The complaint in federal court today alleges that from at least 2015 to 2019, Trident failed to provide mortgage lending services to neighborhoods of color in the Philadelphia Metropolitan area, that its offices were concentrated in majority-white neighborhoods, and that its loan officers did not serve the credit needs of neighborhoods of color. The complaint also alleges that loan officers and other employees sent and received work e-mails containing racial slurs and referring to communities of color as ‘ghetto.’ ”
The director of the Consumer Financial Protection Bureau, Rohit Chopra, stated the importance of fighting discrimination, when he said, in connection with the Trident settlement, “With housing costs so high, it is critical that illegal discrimination does not put homeownership even further out of reach.”
The Department of Justice, in commenting on the consent order, stated that the Truth in Lending Laws and other anti-discrimination laws must continue to be enforced. 15 USC §§1601, et seq (Truth in Lending Act); 15 USC §1691 (Equal Credit Opportunity Act); 15 USC §1681 et seq. (Fair Credit Reporting Act). Courts will have an important role, looking to the letter of the anti-discrimination laws, their intent, and to the reality on the ground, rather than finding excuses to look the other way, and blame the victim, simply because confronting reality may be uncomfortable or inconvenient.
Warning: These Posts Does Not Constitute Legal Advice; Please Consult An Attorney
by Herbert Wiggins | Oct 20, 2022 | bankruptcy, student loans
The conventional wisdom is that “student loans cannot be discharged in bankruptcy.”
But the “conventional wisdom” is WRONG.
There is a high evidentiary bar for a debtor to discharge (cancel) her or his student loans, but discharge is possible.
In a recent case, the bankruptcy court discharged the loan of a Cambodian immigrant who, as a medical student, had amassed $440,000 in loans for his medical education. In re Koeut, 622 B.R. 72 (2020) [unpublished].
The test for relieving student debt is laid out in Brunner v. New York State Higher Education Servs. Corp., 831 F.2d 395 (2d Cir.1987) The Koeut court applied the 3-part Bruner test to relieve the medical student from the debt:
(1) The debtor cannot maintain, based on current income and expenses, a minimal standard of living for herself and her dependents if forced to repay the loans;
(2) Additional circumstances exist indicating that this extreme situation is likely to persist for a significant portion of the repayment period of the student loan; and
(3) The debtor has made good faith efforts to repay the loans.
The court applied these factors to the $440,000 that Mr. Koeut declared in the Bankruptcy Court. The Bankruptcy Court eventually discharged about $432,000.
The Koeut court reasoned:
“[Mr.] Koeut has satisfied the tripartite analysis of the Brunner test sufficiently to support a partial discharge of his student loans. Koeut’s current income and expenses do not support a minimal standard of living, even without making loan payments. Koeut’s inability to repay his full loan balance will persist over his remaining expected working life to an extent that he can only make partial payments without [622 B.R. 85] enduring undue hardship. As the DOE admits, Koeut deserves a break. A partial discharge of $432,173.99 of Koeut’s student loans will be ordered, leaving a balance of $8,291.67 with interest to accrue at .11%. Koeut will be required to make payments of $41.87 per month to the DOE from December 2031 to December 2048.” [emphasis added]
Therefore, a debtor who seeks discharge of a student loan in bankruptcy must make a very thorough, detailed showing. And the debtor (and the lender) have the right of appeal, no matter how the Bankruptcy Court decides.
A difficult road, yes; but not an impossible one.
WARNING: THIS POST DOES NOT CONSTITUTE LEGAL ADVICE, AND READING IT DOES NOT CREATE AN ATTORNEY-CLIENT RELATIONSHIP. PLEASE CONSULT WITH AN ATTORNEY!!
#bankruptcy #studentloans #education #finances #lending #banking #fairlending
by Herbert Wiggins | Oct 21, 2021 | bankruptcy, creditors, Lien Stripping, mortage, Real Estate
One of the axioms of bankruptcy is that a bankruptcy will discharge unsecured debt. Unsecured debt is that which is not backed up with some type of collateral.
Typical unsecured debt consists of credit cards, medical bills, promises to pay bills without a promissory note secured by a deed of trust, etc.
A controversial question arose 30 years ago, which became more acute during the Great Recession (aka, the Financial Crash or the Housing Crash). That question has been, with regard to residential real estate, where the mortgage debt exceeds the fair market value of the property, may those mortgages be reduced to correspond to that fair market value? This proposition, of reducing or eliminating such debt in Chapter 7 bankruptcy, is referred to as “lien stripping.”
For example, if a home is worth $600,000, and the senior (first) mortgage is $400,000, and the junior (second) mortgage is also $400,000, then the first is fully secured. That is to say, if the house were sold, the property has enough value to fully pay off the first mortgage. However, with regard to the junior mortgage, the house is undersecured, because if the house were sold, it would yield only $600,000, meaning that $200,000 of the junior mortgage would go unpaid.
As another example, if the fair market value of the same home is $600,000, and the first mortgage is $800,000, then the first is undersecured by $200,000, but the second is unsecured, because a foreclosure sale of the home would yield nothing to the lender of that second mortgage.
So, the owner of such a home, should he or she file for Chapter 7 bankruptcy, might argue that the debt, for purposes of the proceedings, should be reduced (stripped) down to the fair market value of the home. Otherwise, the homeowner would argue, he or she is being penalized with a hopelessly “underwater” property.
Unfortunately, despite the logical appeal of this argument, the US Supreme Court rejected this approach, affirming decisions of the bankruptcy court and the US Court of Appeals. The reasoning appears to be, as long as the homeowner retains title, at least in Chapter 7 cases, the homeowner owes the full amount of all mortgage debts, regardless of property value.
Although this situation became acute in the Great Recession, the SCOTUS laid down the marker for its approach to these cases in the late 1980’s, long before the 2008 Financial Crash. The Dewsnups, a bankrupt debtor couple, sought to have the bankruptcy court reduce (“strip down”) the mortgage debt from the original loan value of $120,000, to their property’s fair market value of $39,000.
The US Supreme Court rejected this argument, based on Sec. 506 of the Bankruptcy Code:
“The practical effect of [the debtor’s] argument is to freeze the creditor’s secured interest at the judicially determined valuation. By this approach, the creditor would lose the benefit of any increase in the value of the property by the time of the foreclosure sale. The increase would accrue to the benefit of the debtor, a result some of the parties describe as a “windfall.”
“We think, however, that the creditor’s lien stays with the real property until the foreclosure. That is what was bargained for by the mortgagor and the mortgagee. The voidness language sensibly applies only to the security aspect of the lien and then only to the real deficiency in the security. Any increase over the judicially determined valuation during bankruptcy rightly accrues to the benefit of the creditor, not to the benefit of the debtor and not to the benefit of other unsecured creditors whose claims have been allowed and who had nothing to do with the mortgagor-mortgagee bargain.”
Dewsnup v. Timm, 502 U.S. 410, 112 S.Ct. 773. Argued Oct. 15, 1991; Decided Jan. 15, 1992 [emphasis added]
Some District Courts and Courts of Appeal were not satisfied with this analysis. Particularly in light of the drop in home values during the Financial Crash, there were many properties whose value was far less than the outstanding mortgages. In fact thousands of people simply walked away from their properties, rather than pay mortgages that were far above the value of the homes they owned.
Naturally, the lending industry was keen to maintain the viability of Dewsnup. But in the Southeast, the US Circuit Court of Appeals for the 11th Circuit (Alabama, Georgia & Florida), pushed back on this disallowance of lien stripping in 2012, in a case in which the bankrupt debtor sought to fully strip an unsecured junior mortgage:
“That GMAC’s junior lien is both “allowed” under 11 U.S.C. § 502 and wholly unsecured pursuant to section 506(a) is undisputed.
“To determine whether such an allowed — but wholly unsecured — claim is voidable, we must then look to section 506(d), which provides that “[t]o the extent that a lien secures a claim against a debtor that is not an allowed secured claim, such lien is void.” See 11 U.S.C. § 506(d).
“Several courts have determined that the United States Supreme Court’s decision in Dewsnup v. Timm, 502 U.S. 410, 112 S.Ct. 773, 116 L.Ed.2d 903 (1992) — which concluded that a Chapter 7 debtor could not “strip down” a partially secured lien under section 506(d) — also precludes a Chapter 7 debtor from “stripping off” a wholly unsecured junior lien such as the lien at issue in this appeal. See, e.g., Ryan v. Homecomings Fin. Network, 253 F.3d 778 (4th Cir.2001); Talbert v. City Mortg. Serv., 344 F.3d 555 (6th Cir.2003); Laskin v. First Nat’l Bank of Keystone, 222 B.R. 872 (9th Cir. BAP 1998). But the present controlling precedent in the Eleventh Circuit remains our decision in Folendore v. United States Small Bus. Admin., 862 F.2d 1537 (11th Cir.1989). In Folendore, we concluded that an allowed claim that was wholly unsecured — just as GMAC’s claim is here — was voidable under the plain language of section 506(d).
“A few bankruptcy court decisions within our circuit — including the decision underlying this appeal — have treated Folendore as abrogated by Dewsnup. See, e.g., In re McNeal, No. A09-78173, 2010 Bankr.LEXIS 1350, at *9-12 (Bankr.N.D.Ga. Apr. 9, 2010); In re Swafford, 160 B.R. 246, 249 (Bankr.N.D.Ga.1993); In re Windham, 136 B.R. 878, 882 n. 6 (Bankr.M.D.Fla.1992). But Folendore — not Dewsnup — controls in this case.
“Under our prior panel precedent rule, a later panel may depart from an earlier panel’s decision only when the intervening Supreme Court decision is `clearly on point.’” Atl. Sounding Co., Inc. v. Townsend, 496 F.3d 1282, 1284 (11th Cir.2007). Because Dewsnup disallowed only a “strip down” of a partially secured mortgage lien and did not address a “strip off” of a wholly unsecured lien, it is not “clearly on point” with the facts in Folendore or with the facts at issue in this appeal.
“Although the Supreme Court’s reasoning in Dewsnup seems to reject the plain language analysis that we used in Folendore, “`[t]here is, of course, an important difference between the holding in a case and the reasoning that supports that holding.’” Atl. Sounding Co., Inc., 496 F.3d at 1284 (citing Crawford-El v. Britton, 523 U.S. 574, 118 S.Ct. 1584, 1590, 140 L.Ed.2d 759 (1998)). “[T]hat the reasoning of an intervening high court decision is at odds with that of our prior decision is no basis for a panel to depart from our prior decision.” Id. “As we have stated, `[o]bedience to a Supreme Court decision is one thing, extrapolating from its implications a holding on an issue that was not before that Court in order to upend settled circuit law is another thing.” Id. In fact, the Supreme Court — noting the ambiguities in the bankruptcy code and the “the difficulty of interpreting the statute in a single opinion that would apply to all possible fact situations” — limited its Dewsnup decision expressly to the precise issue raised by the facts of the case. 112 S.Ct. at 778.”
In re: Lorraine McNEAL, Debtor. Lorraine McNeal, Plaintiff-Appellant v. GMAC Mortgage, LLC, 735 F.3d 1263 (11th Circuit, issued May 11, 2012)
Although the 11th Circuit had valid reasons for its decision, the SCOTUS was not friendly to this trend of pushing back on Dewsnup. Eventually the issue came back before The Supreme Court. In 2015, the Supreme Court restated its Dewsnup ruling, in the context of property value severely affected by the Housing Crash. The Court would overrule the reasoning of the 11th Circuit:
“The Code suggests that [Bank of America’s] claims are not secured. Section 506(a)(1) provides that “[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.” (Emphasis added.) In other words, if the value of a creditor’s interest in the property is zero—as is the case here—his claim cannot be a “secured claim” within the meaning of §506(a). And given that these identical words are later used in the same section of the same Act—§506(d)—one would think this “presents a classic case for application of the normal rule of statutory construction that identical words used in different parts of the same act are intended to have the same meaning.” Desert Palace, Inc. v. Costa, 539 U. S. 90, 101 (2003) (internal quotation marks omitted). Under that straightforward reading of the statute, the debtors would be able to void the Bank’s claims.
“Unfortunately for the debtors, this Court has already adopted a construction of the term “secured claim” in §506(d) that forecloses this textual analysis. See Dewsnup v. Timm, 502 U. S. 410 (1992). In Dewsnup, the Court confronted a situation in which a Chapter 7 debtor wanted to “ ‘strip down’ ”—or reduce—a partially underwater lien under §506(d) to the value of the collateral. Id., at 412–413. Specifically, she sought, under §506(d), to reduce her debt of approximately $120,000 to the value of the collateral securing her debt at that time ($39,000). Id., at 413. Relying on the statutory definition of “ ‘allowed secured claim’ ” in §506(a), she contended that her creditors’ claim was “secured only to the extent of the judicially determined value of the real property on which the lien [wa]s fixed.” Id., at 414.
“The Court rejected her argument. Rather than apply the statutory definition of “secured claim” in §506(a), the Court reasoned that the term “secured” in §506(d) contained an ambiguity because the self-interested parties before it disagreed over the term’s meaning. Id., at 416, 420. Relying on policy considerations and its understanding of pre-Code practice, the Court concluded that if a claim “has been ‘allowed’ pursuant to §502 of the Code and is secured by a lien with recourse to the underlying collateral, it does not come within the scope of §506(d).” Id., at 415; see id., at 417–420. It therefore held that the debtor could not strip down the creditors’ lien to the value of the property under §506(d) “because [the creditors’] claim [wa]s secured by a lien and ha[d] been fully allowed pursuant to §502.” Id., at 417. In other words, Dewsnup defined the term “secured claim” in §506(d) to mean a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim. Under this definition, §506(d)’s function is reduced to “voiding a lien whenever a claim secured by the lien itself has not been allowed.” Id., at 416.
“Dewsnup’s construction of “secured claim” resolves the question presented here. Dewsnup construed the term “secured claim” in §506(d) to include any claim “secured by a lien and . . . fully allowed pursuant to §502.” Id., at 417. Because the Bank’s claims here are both secured by liens and allowed under §502, they cannot be voided under the definition given to the term “allowed secured claim” by Dewsnup.”
BANK OF AMERICA, N. A. v. CAULKETT & BANK OF AMERICA, N. A. v. TOLEDO-CARDONA, No. 13–1421 (2015)
There are signs that there is continued discontent with the Dewsnup construction. But for the moment, it remains the law. At this time, as housing values have continued to climb in the pandemic, those who own homes are apparently not in danger of losing the full value and being underwater, the way home owners were between 2008 and 2012.
However, we know that markets are volatile, and that business cycles are just that, and eventually, the Supreme Court will have to look again at whether consumers should be forced to pay back loans far in excess of their property’s value, when their disposable income has drastically decreased.
QUOTATIONS FROM COURT OPINIONS ARE PRESENTED AS PART OF COMMENTARY BY THE AUTHOR, AND THUS CONSTITUTE “FAIR USE” UNDER FEDERAL LAW.
THIS POST DOES NOT CONSTITUTE LEGAL ADVICE, AND READING IT DOES NOT CREATE AN ATTORNEY-CLIENT RELATIONSHIP. PLEASE CONSULT YOUR ATTORNEY IF ANY QUESTIONS!!
#bankruptcy #mortgages #lienstripping #dewsnup