UPDATE: At midnight on March 27, 2022, certain provisions of the CARES Act expired. Importantly for insolvency practitioners, the subchapter V debt limit of $7,500,000 reverted to the lower original amount of $2,725,625. It appears that Congress is working to reinstate the higher debt limit and at least one bill has been proposed (S. 3823) and passed by the Senate on April 8, 2022, reinstating the $7,500,000 debt limit and adding language to make it effective retroactively, but with a two year expiration date. However, the status of this bill or any other efforts by Congress to increase the subchapter V debt limit remains unclear.

 

 

April 20, 2022

Dear constituency list members of the Insolvency Law Committee:

The following is a case update written by Wendy W. Smith, a partner in Binder & Malter, LLP, analyzing a recent decision of interest:

SUMMARY
On December 16, 2021, Judge Colleen McMahon of the United States District Court, Southern District of New York, vacated the order confirming Purdue Pharma’s Chapter 11 plan of re-organization, holding that the bankruptcy court had no power to impose a non-consensual release by third parties of their direct claims against non-debtors. In re Purdue Pharma, L.P., 2021 WL 242236 (S.D.N.Y 2021). The non-debtors here included all of the Sackler family, owners of Purdue Pharma, who were to be released from virtually all non-criminal claims related to the companies and their primary product–OxyContin. In exchange for that release and the related injunctions (the “Shareholders Release”), the Sackers were to pay over $4.275 billion into the plan of reorganization.

To view the opinion, click here.

On first review, the opinion might appear as having limited impact outside the Second Circuit. But many of Judge McMahon’s arguments can apply to any situation where a bankruptcy court exercises authority that is not specifically described in the Bankruptcy Code, particularly to enjoin third parties from suing non-debtors.

FACTUAL BACKGROUND
The Sackler Family’s Role in Purdue Pharma and the OxyContin Litigation.

From the opening of her opinion, Judge McMahon reveals her sensitivity to the underlying issue driving the case—the catastrophic impact of the opioid crisis in America—and that her ruling will most likely result in undoing the Sackler’s funding of the proposed plan and its programs to address opioid addiction. (p. 137) Although the opinion rules only on matters of law, as no finding of fact was appealed, Judge McMahon repeatedly returns to the extreme circumstances of the case to color her legal analysis.

To provide that context, Judge McMahon devotes the first half of the opinion to the facts. She begins with the history of Purdue Pharma and its development and marketing of OxyContin, which has been blamed in large part for fueling the opioid crisis. Judge McMahon describes that before Purdue’s bankruptcy, OxyContin accounted for more than 90% of the company’s U.S. revenue. The Sackler family, which owns the companies, is described as being “long ranked on Forbes’ List of America’s Richest Families,” with a reported net worth in 2015 of $14 billion. (p.11) Judge McMahon states that the Sackler family controlled the operation of the Purdue companies until just before the bankruptcy filing.

The core of Judge McMahon’s factual description is Purdue’s aggressive, and allegedly deceptive, marketing of OxyContin for over 20 years and the resulting litigation with both governments and individuals. Most of the litigation claimed in part that Purdue’s actions caused the over-prescription of OxyContin, leading to addiction, which then resulted in addicted patients turning to street drugs when prescriptions were no longer available.

In 2007 Purdue settled litigation with 26 states, agreeing to pay $19 million and to implement an extensive program to limit OxyContin abuse. (p.21). Purdue was not required to stop the production or sale of OxyContin, however, which it continued. Litigation also continued. When the resulting discovery revealed that individual members of the Sackler family were involved with Purdue’s OxyContin marketing efforts, those individuals were added to the actions. [1]

After the 2007 settlement agreement, the Sacklers began taking substantially greater distributions of revenue from Purdue, which “substantively depleted Purdue’s treasury.” (p.37) Judge McMahon describes this as part of a greater plan by the Sacklers to first remove value from the companies and then use bankruptcy to obtain third-party releases in exchange for funding a bankruptcy settlement. The goal was “to secure for the Sacklers a release from any liability for past and even future opioid-related litigation, without having to pursue personal bankruptcy.” (p.43).

The Purdue companies filed their bankruptcy on September 15, 2019, and quickly obtained an injunction halting over 400 civil suits against the Sackler family.

The Plan and Shareholder Release

Judge McMahon acknowledges the extraordinary efforts of all of the parties to negotiate a plan, including mediators described by Judge McMahon as “the most experienced and respected mediators in the country.” (p. 47) .The opinion describes the plan in detail.

The Shareholders Release was a key element. In exchange for the Sackler’s $4.275 billion contribution, the plan released “third-party claims against over 1000 individuals and entities related to the Sackler family.” (p.55) The release included “claims that third parties have asserted or might assert in the future against the shareholder released parties,” and that were based on or related to the debtors or their bankruptcies. (p. 56) The release was further limited to claims where the “conduct, omission or liability of any Debtor or any Estate is the legal cause or is otherwise a legally relevant factor.” (p. 56) The Shareholders Release was non-consensual; all current and potential claims connected with OxyContin and other opioids would be covered.

Judge McMahon notes that the non-derivative claims against the released parties were “effectively being extinguished for nothing.” (p. 56) The plan prohibited “value being paid based on causes of action (whether pre-or post-petition) against the Sackler family or other non-debtor for opioid-related claims.” (p.56)

The critical element of these released claims is that they must be claims directly against the released parties arising from an independent duty to the claimant, and not derivative of any claim by or against the debtor.

Confirmation

Judge McMahon describes the bankruptcy judge’s opinion confirming the plan as a “judicial tour de force” delivered only days after a lengthy trial, and addressing “every conceivable legal argument in great detail.” (p.58)

The bankruptcy court’s opinion noted that the voting creditors overwhelmingly supported the plan. Of approximately 120,000 votes cast, “an amount far exceeding the voting in any other bankruptcy case” over 95% of those voting favored the plan. (p.62) It also observed that the failure to approve the settlement and confirmation would result in complex litigation and likely with the liquidation of the case and abandonment of the proposed $4.275 billion contribution by the Sacklers.

Judge McMahon briefly summarizes the various legal issues addressed by the bankruptcy court’s opinion, and then focuses on its justification for the third-party non-consensual releases. For its authority to grant the Shareholders Release, the bankruptcy court relied on the concept of its “necessary or appropriate” power to take actions under Section 105(a), combined with the authority in Section 1123(b)(6) to “include any other appropriate provision [in a plan] not inconsistent with the applicable provisions of this title.” (p. 68) The bankruptcy court also justified the grant of the Shareholders Release based on the “rare” and “unique” character of the case. (p.70)

As described below, Judge McMahon rejects these justifications.

[1] While mentioned only briefly in the opinion, it is important to note that the individual Sacklers have at all times denied any wrongdoing

REASONING
Bankruptcy court did not have jurisdiction to enter a final order on confirmation containing the Shareholders Release.

In the context of addressing the standard of review on appeal, Judge McMahon observes that the Shareholders Release would have permanently resolved certain independent claims against the Sackler family. Because the claims did not stem from the bankruptcy itself, and would not be resolved in the claims-allowance process, the only jurisdiction held by the bankruptcy court over them was “related to” the bankruptcy under 28 U.S.C. Section 157(a), as “non-core.”

Applying the Supreme Court ruling of Stern v. Marshall, 564 U.S. 462 (2011), Judge McMahon concludes that that a non-consensual release by a third party of a claim against a non-debtor that is part of a reorganization plan determines the claim with the same finality as it would if adjudicated at trial. Judge McMahon thus holds that the bankruptcy judge did not have jurisdiction to enter a final order confirming a plan which included such third-party release. Rather, the bankruptcy court should have tendered the proposed findings of fact and conclusions of law to the District Court for approval.

Bankruptcy court had subject matter jurisdiction under the Second Circuit case-law

The appellants challenged whether the bankruptcy court’s “related to” jurisdiction included the ability to grant the challenged Shareholders Release. Judge McMahon concludes that in the Second Circuit the only question a court need ask is whether the action’s outcome might have any conceivable effect on the bankruptcy estate. If the answer is yes, then “related to” jurisdiction exists, no matter how improbable it might be that the actions actually will have an effect on the estate. (p.85)

Judge McMahon held that the bankruptcy court had “related to” jurisdiction because claims against the Sackler family could have resulted in indemnification claims against Purdue and that such claims could have impacted the bankruptcy estate.

No bankruptcy statute either prohibits such releases or grants authority to issue them

Judge McMahon opens her discussion by expressing frustration with the Second Circuit for failing to provide guidance on this critical issue. She explains that, though the Bankruptcy Code has no prohibition against these releases, it also has no statute giving bankruptcy courts the authority to grant them. Judge McMahon analyzes each of the sections on which the bankruptcy court relied and finds they are insufficient to grant such authority. Finally, she explains that there is no “residual authority” or general equitable power of the bankruptcy court that can cure the lack of specific statutory authority in the Bankruptcy Code.

Judge McMahon initially dispenses with the appellants’ argument that Section 524(e) essentially prohibits the Shareholders Release. This section provides that the discharge of a debt in bankruptcy does not affect the liability of another for the same debt. Judge McMahon explains that this section does not prohibit a bankruptcy court from issuing an injunction, but addresses only the automatic effect of a discharge. Also, the section is limited to claims that are discharged in bankruptcy for which a third-party is also liable. It does not affect independent claims of third-parties against non-debtors–the type of claim included in the Shareholders Release.

The only sections in the Bankruptcy Code that specifically address third-party releases are Sections 524(g) and (h) regarding the release of third-party claims in asbestos cases. The sections were enacted after the first of several opinions in the case of Johns Manville, the nation’s leading asbestos manufacturers. MacArthur Co. V. Johns-Manville Corp. (In re Johns-Manville Corp.), 837 F.2d 89 (2nd Cir. 1988) (“Manville I”).

In Manville I, the Second Circuit affirmed the bankruptcy court’s entry of a permanent injunction against suing Manville’s insurance carriers, which had contributed the proceeds of their policies to the plan. Judge McMahon explains Sections 524(g) and (h) in detail, emphasizing that they applied to asbestos cases only. Judge McMahon argues that the limitation is evident both from the text of the statues as well as their legislative history, which expressly states that Congress was not acting regarding other industries (p. 100) Because of the limited scope of the asbestos statutes, Judge McMahon concludes that they cannot be read to imply authority to grant non-debtor releases in other types of cases.

The other Bankruptcy Code sections on which the bankruptcy court relied were Section 105(a), which provides general authority to make orders that are “necessary or appropriate to carry out the provisions of the code,” and three sections related to chapter 11 plans—Sections 1123(b)(5) and (b)(6), and 1129. The bankruptcy judge stated that the sections, along with his “residual authority,” gave him authority to approve the Shareholders Release. Judge McMahon rejects this position, holding that each of the sections “confers on the bankruptcy court only the power to enter orders that carry out other, substantive, provisions of the bankruptcy code.” (p.120)

Early in her opinion, Judge McMahon explains in detail that notwithstanding the general language of Section 105(a) it does not grant any general equitable authority. Relying on the Supreme Court opinions of Norwest Bank Worthington v. Ahlers, 485 U.S. 197 (1988) and Law v. Siegel, 571 U.S. 415 (2014), as well as several cases in the Second Circuit, Judge McMahon notes that a “bankruptcy court lacks the power to award relief that varies or exceeds the protections contained in the Bankruptcy Code — not even in rare cases, and not even when those orders would help facilitate a particular reorganization.” (p. 101)

The sections related to chapter 11 particularly do not expand that authority. Section 1123(b)(6) describes the possible contents of a plan of reorganization and provides that it may “include any other appropriate provision not inconsistent with the applicable provisions of this title.” Judge McMahon notes that the section is substantially similar to Section 105(a) and concludes that if general authority of Section 105(a) does not allow a bankruptcy court to grant relief beyond specific terms of the Bankruptcy Code, neither does Section 1123(b)(6).

An even more general section relied on by the bankruptcy court is Section 1129(a)(1), which provides that a bankruptcy court “shall confirm a plan only if… the plan complies with the applicable provisions of this title.” Judge McMahon holds that, like Section 1123(b)(6), the section does not grant any substantive authority that could support approving this type of third-party release.

Last, Section 1123(a)(5), also relied on by the bankruptcy court, gives no greater authority. This section provides that a plan must provide adequate means for its implementation. The plan proponents argued that the only way for the debtors to obtain the funds to implement the plan was to grant the Sacklers the Shareholders Release in exchange for the money that the Sacklers were to contribute. This requirement, they argued, meant that the releases were authorized by Section 1123(a)(5) as necessary for the plan’s implementation.

Judge McMahon rejects the argument for a range of reasons, including that Section 1123(a)(5) does not authorize a court to approve such releases “simply because doing so would ensure the funding of a plan.” (p.126) She states that “the fact that Purdue needs the Sacklers to give the money back does not mean that Section1123(a)(5) confers on the Debtors or the Sacklers any right to have the non-debtors receive a release” in exchange for the contribution. (p. 125)

Silence of the Bankruptcy Code does not grant the needed authority.

Judge McMahon rejects the argument that because this type of release is not prohibited it must be permitted. First, she notes that to assume authority from silence is inconsistent with the “comprehensive federal system … to govern the orderly conduct of debtors affairs and creditors rights.” (p. 127) Second, she notes that the type of release being requested includes relieving non-debtors of the types of claims –here for fraud and willful misconduct — that could not be discharged in their own bankruptcies and thus are entirely inconsistent with the Bankruptcy Code. Third, she refers again to Sections 524(g) and (h), which were enacted to allow third-party releases only in asbestos cases, even when there were other mass tort cases pending at the time. Judge McMahon notes that Congress made a conscious decision to exclude other industries, and that its “27 years of unbroken silence” since then “speaks volumes” to Congress’s disinclination to expand the statute.
(p. 129)

Judge McMahon’s review of case law and split in the circuits does not change her analysis.

Judge McMahon reviews the split in the Circuits regarding whether statutory authority exists to grant this type of release. She notes that the Fifth, Ninth and Tenth Circuits reject that bankruptcy court can authorize non-debtor releases outside of the asbestos context, based on Section 524(e). (As noted below, the Ninth Circuit has recently reopened this discussion in its opinion in in re Blixseth v. Credit Suisse, 961 F.3d 1074 (9th Cir. 2020).) She then comments that the remaining Circuits, including the Second, either have not identified any statute that grants such authority other than Sections 105(a) and 1123(b)(6) – which she rejects as inadequate—or have not opined on the issue.

Judge McMahon closes her discussion with an acknowledgment that the result of her invalidating the Shareholders Release will likely be the liquidation of the case and the loss of funding for “desperately need programs to counter opioid addiction.” She notes that, notwithstanding the bankruptcy court’s good intentions, its ability to grant relief to a non-debtor from non-derivative third-party claims could have only been exercised within the confines of the Bankruptcy Code. Because she finds that the Bankruptcy Code “confers no such authority” she holds she must vacate the order confirming the Purdue plan. (p. 137)

AUTHOR’S COMMENT
The primary takeaway from the opinion is that the mechanism of the Bankruptcy Code cannot accommodate every solution to the challenges facing a debtor and its creditors. Here, it is evident that the huge number of stakeholders in the process, and ultimately the bankruptcy court, became vested in trying to provide substantial relief–with the Sacklers’ payment–for the desperate circumstances caused by the opioid crisis. If anything, the Shareholders Release evidences the great forces driving the settlement and plan process. It released over 1,000 people and entities and included claims for fraud and willful misconduct, whether existing or brought in the future–terms that would have been rejected in any other context as overreaching.

Judge McMahon’s opinion provides powerful defenses against such excesses. First and foremost, she reaffirms that any authority of the bankruptcy court must be solidly bound to the Bankruptcy Code itself. While many cases recognize this limitation when applying Section 105(a), Judge McMahon applies it with equal force on all of the other general sections relied on by the bankruptcy court for its claim of “residual authority.”

Until recently, in the Ninth Circuit such third-party releases were not allowed at all on the basis that they were contrary to Section 524(e). In re Blixseth v. Credit Suisse 961 F.3d 1074 9th Cir. 2020) modified that rule and reopened the possibility of including such releases in a chapter 11 plan. In Blixseth, the court considered an exculpation clause in a Chapter 11 plan that released Credit Suisse, a creditor, for liability for post-petition actions “in connection with” among other things, negotiating the plan. The released claims did not include claims derived from the debtor. The court held that, contrary to prior understanding, Section 524(e) did not prohibit such third-party releases, for the same reasons described by Judge McMahon. While the releases in Bixseth included only negligence claims and were narrow in time and the number of parties, substantively, they covered the character of independent claims included in Purdue. The court in Blixseth allowed the releases. It found that both Section105(a) and Section 1123 provided the bankruptcy court with authority to impose such releases on a non-debtor, and that it was justified by the need to limit litigation and “so render the plan viable.” Supra, at p.1085. But, according to Judge McMahon, the referenced sections do not grant such authority, and “plan viability” does not justify granting a third-party release.

What is left open is whether any non-consensual third-party release of non-derivative claims against non-debtors can be approved even when it is limited to negligence claims against specific parties. Under this opinion, the answer is no, since there is no specific statute authorizing it, and neither “residual authority” nor “plan viability” will suffice.

Given the discussion and holdings in Purdue, and the recent 9th Circuit’s opinion in In re Blixseth v. Credit Suisse, the ruling on the likely Purdue appeal will be one to watch.

This review was written by Wendy W. Smith, a partner in Binder & Malter, LLP and a member of the ad hoc group. Editorial contributions were provided by Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., ret.), also a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.

 

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Best regards,

Insolvency Law Committee

Co-Chair
Christopher D. Hughes
Nossaman LLP
chughes@nossaman.com

Co-Chair
Cathy Ta
Reorg Research, Inc.
cta@reorg.com

Co-Vice Chair
Kit J. Gardner
Law Offices of Kit J. Gardner
kgardner@gardnerlegal.com

Co-Vice Chair
Aaron E. de Leest
Danning, Gill, Israel & Krasnoff LLP
adeleest@danninggill.com

USA October 5 2021

Here we go again – proposed bankruptcy venue legislation is back after previous “reform” efforts came up empty. For those seeking legislative action, what are the chances for venue reform now?

Venue for bankruptcy cases is governed by 28 U.S.C § 1408, which provides that corporations may file in the district (a) in which their “domicile, residence, principal place of business in the United States, or principal assets in the United States” have been located during a majority of the prior 180 days, or (b) in any district where an affiliate, general partner or partnership has filed. Because of the different bases for venue, a company may have multiple choices where to file its chapter 11 case. For instance, if the company is incorporated in Delaware, like many companies are, venue in Delaware is permitted even if the company is headquartered in another state and otherwise has no connection to or assets located in Delaware. Alternatively, if the company has an affiliated debtor incorporated or located in a state, the company can file in its affiliate’s venue, even if the affiliate is insignificant in size or importance. All of this optionality may lead to “forum shopping,” meaning a company is strategically able to choose where to file its bankruptcy case, based on factors such as favorable case law in the district, the particular judges (and at times the fact that there is only one judge) in the district or the procedures employed in the district for complex cases. These choices can in many cases be dictated by lenders, who view the judges or jurisprudence in those districts as more favorable to their positions. Oftentimes, these choices lead to filings in Delaware, the Southern Districts of New York and Texas, as well as the Eastern District of Virginia—jurisdictions which are favored by debtors and lenders—which has resulted in a concentration of bankruptcy filings, especially by large public companies, in those jurisdictions.

The ramifications of this forum shopping are significant. For instance, many corporate chapter 11 cases are filed far away from the location of the company’s employees and creditors, in jurisdictions where the company only has tangential contact. This may limit the debtor’s employees and smaller creditors from having meaningful access to the proceedings. The concentration of large corporate cases in just a few select jurisdictions may limit diversity of judicial opinions by limiting the judges who are asked to decide complex and novel issues of law. Further, creditors who are sued by debtors—for instance, for recovery of preferential transfers—must defend themselves in jurisdictions with which they have little to no connection, forcing them to hire local counsel and significantly increasing the cost of defense.

These concerns, however, may be outweighed by other factors. For example, many bankruptcy cases use free, online case dockets, and particularly since the onset of COVID-19, increasingly hold hearings via telephone or Zoom. Local creditors are therefore able to stay actively engaged in a bankruptcy case regardless of where the case is filed. Furthermore, reform critics argue that concentration of large bankruptcy cases in select jurisdictions allows complex issues to be expeditiously decided, since the judges in those jurisdictions have substantial experience handling large complex cases. Lastly, it bears noting that although some believe that the integrity of the bankruptcy system is jeopardized with the current venue provisions, a party in interest may seek a change of venue in the interest of justice or for the convenience of the parties.

Previous efforts to reform bankruptcy venue have failed. Most recently, in 2018, Senators John Cornyn (R-Tex.) and Elizabeth Warren (D-MA) introduced the “Bankruptcy Venue Reform Act of 2018.” This bill would have required corporate debtors to file for bankruptcy protection in the district in which their principal assets or principal place of business was located. The bill did not receive a vote in either the House or Senate.

For those favoring venue reform, however, hope springs eternal. On June 28, 2021, Representatives Zoe Lofgren (D-Cal.) and Ken Buck (R-Tex.) introduced the “Bankruptcy Venue Reform Act of 2021” (H.R. 4193). Subsequently, on September 23, 2021, Senators Warren and Cornyn introduced the Senate’s substantively identical version of the “Bankruptcy Venue Reform Act of 2021.” The new bills would require a debtor to file where its headquarters or principal assets are located, severely limit the ability to use affiliates to establish venue and require a debtor to establish by “clear and convincing evidence” that venue in the selected jurisdiction is proper.

What are the chances for this latest bankruptcy venue reform? Unfortunately for reform advocates, the chances appear quite slim for any movement on the current bills and it is likely that the bills will run into strong resistance like prior reform efforts. For instance, right now it is unclear where House Judiciary Committee Chairman Jerrold Nadler (D-NY) stands on venue reform, although Chairman Nadler’s district includes the Southern District of New York, often a direct beneficiary of the current venue rules. Furthermore, even if the bill passed both the House and Senate, it is unclear whether President Biden would sign the bill into law. After all, President Biden is a former Senator from Delaware, a major beneficiary of the current venue rules, and was a strong proponent of the present venue statute.

USA September 24 2021

One valuable tool in formulating a successful exit from chapter 11 via a confirmed plan is the use of third-party releases. Such releases can take many forms, but the basic idea is that a non-debtor third party contributes property, usually cash, to the debtor or a trust created under the plan, with the cash to be distributed to unsecured claim holders, in exchange for a release of asserted or potential claims those claim holders may assert against the third party (often where there is co-liability with debtor). Generally, the third party wants a blanket release of all claims held by all creditors, especially where those creditors may have a direct cause of action they could assert, in exchange for the cash or other consideration given by the third party. The scope of who can be bound by such a release by the creditors varies by jurisdiction, with some courts permitting such releases in the plan only where each creditor has affirmatively consented to the release, with other courts approving or allowing confirmation of plans that bind all creditors to the release regardless of whether each creditor affirmatively consented or not.

The Bankruptcy Code is silent on whether such releases are permitted, and because they are not expressly prohibited, such provisions are permissible in a plan so long as the provision is consistent with the Bankruptcy Code. See 11 U.S.C. § 1123(b)(6). The only other provision addressing such releases in the current Code (actually, injunctions against pursuit of claims against third parties) is in section 524(g). However, that section is limited by its terms to an injunction against bringing claims for wrongful death, bodily injury or property damage for asbestos exposure.

These releases have become widely used in chapter 11 and are necessary to resolve mass tort cases, like the clergy abuse cases, USA Gymnastics, the Purdue Pharma bankruptcy involving the opioid crisis, and even the pending Boy Scouts of America case. These releases can be very useful in generating recoveries for unsecured creditors who may otherwise be out of the money in more run-of-the-mill cases, such as cases involving officer and director breach of duty claims.

Use of these releases has proved to be controversial, especially with respect to the Purdue Pharma case. In that case, there has been much criticism leveled against the deal struck by the Sackler family to provide cash to Purdue Pharma’s opioid abuse victims over a ten-year period in exchange for a release to be imposed on consenting and non-consenting claimants.. While Bankruptcy Judge Drain has confirmed the plan, thereby approving the releases, there are likely to be appeals from his ruling.

As a direct result of Purdue Pharma case, Democratic members of the US House and Senate have introduced legislation intending to curb such releases. If passed into law, the legislation will have significant ramifications in many bankruptcy cases going forward. The Senate bill, S. 2497, was introduced by Sens. Warren, Durbin and Blumenthal on July 28, 2021. The Senate bill proposes to add a new section 113 to the Bankruptcy Code. In sum, section 113 would prevent the bankruptcy court from approving any provision of a plan of reorganization or otherwise for discharge, release or modification of the liability of a non-debtor party or the bankruptcy estate, and the court may not enjoin the commencement or continuation of any other proceeding to enforce the claim or cause of action, save for a short-term stay. Section (b) of the bill does provide that notwithstanding the prohibition of section (a), the prohibition does not prevent the court from authorizing a sale, transfer or other disposition of property free and clear of claims or interests, the court may continue to prevent third parties from exercising control over a right or interest that is property of the estate, and the prohibition is not a bar against any claim for indemnity, reimbursement or contribution that a non-debtor entity has against a third party once it has been released by the debtor or the estate. Finally, the proposed prohibition does not apply to court approval of a plan providing for the release of a non-debtor in circumstances where clear and conspicuous consent to the release is given by each creditor. But that consent must be individually given and cannot be inferred to be given by acceptance or failing to accept or reject a proposed plan. Moreover, the treatment of similar creditors cannot be different by reason of such entity’s consent or failure to consent.

At first blush, the Senate bill appears to be narrowly targeted to prohibit use of releases in mass tort cases. Among other things it will be impossible or impractical to solicit a release from each claimant. But, if enacted, the legislation could also prevent use of such releases in ordinary commercial cases, except those with only a handful of unsecured creditors. As a result it will be difficult to generate some recovery to otherwise out of the money creditors. Without the ability to deliver creditor releases, non-debtor third parties and their insurers will have no incentive to contribute to the creditor recovery. Moreover, the legislation likely increases the chances of liquidation or sale of assets under section 363, rather than use of a chapter 11 plan to reorganize, because the reorganization process cannot be used to fully implement a collective solution. Hopefully these considerations will be taken into account and the legislation modified to accommodate these concerns.

USA June 25 2021

The Vault

Or to put it in legalese—“no concrete harm, no standing.” It does not get more simple than that. On June 25, 2021, the U.S. Supreme Court decided Trans Union v. Ramirez (“Ramirez”), a case involving whether class members who suffer no actual injury can be included in a damages class under Federal Rule of Civil Procedure 23. In a 5-4 decision written by Justice Kavanaugh, the Supreme Court held that they cannot because they do not have standing under Article III of the Constitution. The holding is important because it places limits on Congress’s ability to create statutory schemes that provide for damages in the absence of a concrete injury to potential class members.

In Ramirez, the lower court certified a class encompassing 8,124 absent class members who were allegedly subjected to inaccurate credit reporting by TransUnion, but the vast majority of whom had not actually suffered any injury because their credit reports were never disseminated to any third party. Specifically, the case involved the inaccurate reporting of consumers’ placement on a list of “specially designated nationals” by the Office of Foreign Assets Control (“OFAC”) indicating they were subject to sanctions and with whom business entities were forbidden to transact business. The lead plaintiff Ramirez had attempted to purchase a car from a dealership but was denied the opportunity when a credit report from TransUnion indicated he was on the OFAC list. Ramirez sued and sought to represent a class of 8,124 absent class members, 75% of whom Ramirez conceded suffered no actual concrete injury remotely similar to that sustained by him, when he was denied the opportunity to purchase a vehicle. Indeed, the credit reports of these absent class members had never been distributed to any third party. At most, the vast majority of absent class members were simply informed by TransUnion that their names had been reported on the OFAC list and had been subjected to potentially confusing mailings about the reports and how could they address them.

The lower courts found that the proposed class by Ramirez was certifiable under Rule 23. Specifically, the Ninth Circuit Court of Appeals, over a dissent, ruled that the claims of the lead plaintiff were sufficiently “typical” and that absent class members suffered an “injury” because they had been erroneously notified by mail that they were on OFAC’s sanctions list. Further, the mere possibility that the erroneous reports could have been distributed to third parties “suffic[ed] to show a material risk of harm to the concrete interests of all class members.” Accordingly, the Ninth Circuit Court of Appeals affirmed an adverse trial verdict against TransUnion though it lowered a class-wide punitive damages award.

The Supreme Court reversed. It held that in assessing whether a class member has suffered a “concrete harm” under Article III, as required by its earlier decision in Spokeo v. Robins, courts must “[a]ssess . . . whether the asserted harm has a “close relationship” to a harm traditionally recognized as providing a basis for a lawsuit in American courts – such as physical harm, monetary harm, or various intangible harms including (as relevant here) reputational harm.” In so ruling, the Court placed important restrictions on Congress’s authority to create statutory schemes involving damages where no “concrete harm” has been sustained. Such power would not only violate Article III requirements for bringing suit, but would also infringe upon Executive Branch prerogatives concerning law enforcement and thereby violate the separation of powers. As Justice Kavanaugh wrote, under Article III an injury in law is not an injury in fact. In the instant case, the Court ruled that those class members whose credit reports with the allegedly offending information were never disseminated to third parties suffered no cognizable concrete harm. In addition, the Court ruled that the receipt of potentially confusing mailings from Trans Union likewise did not cause concrete injury. For those class members whose credit reports were disseminated to third parties, the Court recognized that being labeled a “potential terrorist” was analogous to a false and defamatory statement and, therefore, satisfied Article III. The decision is important in that plaintiffs seeking to bring actions in federal courts predicated on statutory damages schemes will also need to demonstrate they sustained a “concrete harm” which, in many cases, they will be unable to do so.

 

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May 26, 2021

The following is a case update written by Leonard Gumport analyzing a recent case of interest.

SUMMARY

In Graylee v. Castro, 52 Cal. App. 5th 1107 (2020) (“Graylee”), the California Court of Appeal ruled that California Code of Civil Procedure section 664.6, which allows a court to enter a judgment under the terms of a settlement of pending litigation, does not authorize a court to enter or enforce a judgment that contains an invalid liquidated damages clause. A copy of the Graylee decision is here.

FACTUAL BACKGROUND

In May 2015, John and Rosa Castro (the “Castros”) leased a residential property in Anaheim, California from Fred Graylee (“Graylee”). The monthly rent was $3,195. In June 2018, Graylee served the Castros with a three-day notice to pay rent or quit. In the notice, Graylee alleged that the Castros owed $27,170 in unpaid rent. On July 3, 2018, Graylee filed an unlawful detainer action against the Castros. On August 2018, Graylee filed a first amended complaint, which sought $27,170 in past-due rent, reasonable attorney’s fees, and forfeiture of the lease agreement. In an answer, the Castros disputed Graylee’s complaint and asserted affirmative defenses, including that Graylee had accepted rent from the Castros. Trial was scheduled for October 2, 2018.

On the trial date, Graylee and Castros filed a handwritten stipulation (the “Stipulation”) on a preprinted form for entry of judgment. The trial court approved the Stipulation on the same day. The Stipulation required the Castros to vacate the property by 3:00 p.m. on October 31, 2018, and to leave the property in broom-swept condition. The Stipulation provided that a $28,970 judgment for unpaid rent, damages, and attorney’s fees and costs would be granted against the Castros “only if” they failed to comply with the Stipulation. The Stipulation provided that, if the Castros timely vacated the property, then Graylee would waive the $28,970 money judgment; if the Castros failed to comply, then the full judgment amount of $28,970 would be due. In the Stipulation, the Castros waived all claims against Graylee through the date of the Stipulation.

In January 2019, Graylee filed a motion for entry of a stipulated judgment for $28,970 against the Castros. The motion was supported by a declaration from Graylee’s property manager, who stated that the Castros vacated the property one day after the October 31, 2018 deadline and did not leave the property in broom-swept condition. The declaration did not provide details about how the property fell short of the broom-swept condition requirement. The Castros opposed Graylee’s motion and alleged that they had timely vacated.

On June 10, 2019, after an evidentiary hearing, the trial court found that the Castros did not vacate the property by the October 31, 2018 deadline. Pursuant to the Stipulation, the trial court entered a judgment for $28,970 against the Castros. On September 26, 2019, the trial court vacated that judgment and entered an amended judgment (“Stipulated Judgment”) for $28,970 against the Castros pursuant to the Stipulation. They appealed. On July 13, 2020, the Court of Appeal reversed the Stipulated Judgment.

REASONING

In Graylee, the Court of Appeal began its analysis by deciding whether Code of Civil Procedure section 664.6, which authorizes stipulated judgments to settle pending litigation, is an exception to Civil Code section 1671, which prohibits enforcement of unreasonable liquidated damages clauses. Section 664.6 allows a court to enter a judgment under the terms of a settlement agreement, and, if requested, to retain jurisdiction to enforce the settlement.

Graylee rejected the landlord’s contention that section 664.6 is an exception to the prohibition in Civil Code section 1671(b) on unreasonable liquidated damages clauses. Section 1671(a) states that it “does not apply in any case where another statute expressly applicable to the contract prescribes the rules for determining the validity” of the liquidated damages provision. The terms of section 664.6 do not allow a court to endorse or enforce a provision of a settlement agreement or stipulation that is illegal, contrary to public policy, or unjust. Unenforceable liquidated damages provisions are void as against public policy. A stipulated judgment that includes an unlawful liquidated damages provision is void and may be vacated. Graylee, 52 Cal. App. 5th at 1114.

The Stipulation contained a liquidated damages provision, even though the Stipulation did not use the words “liquidated damages.” Liquidated damages are the compensation to be paid in the event of a breach of contract, the amount of which is fixed by agreement and may not ordinarily be altered when the damages actually resulting from the breach are different from the agreed upon amount. Courts look beyond the language of a contract to determine the actual circumstances of a liquidated damages clause. The $28,970 monetary provision of the Stipulation was a liquidated damages clause because the Stipulation “predetermined the amount of damages the landlord would be entitled to receive if the tenants breached their settlement obligations.” Id. at 1114. It was irrelevant that the Stipulation did not use the phrase “liquidated damages.” Id.

Under Civil Code section 1671(b), a liquidated damages provision “is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.” The liquidated damages provision must represent a reasonable endeavor by the parties to estimate a fair average compensation for any loss that may be sustained. Otherwise, the clause will be construed as an unenforceable penalty. Id. at 1115.

The Stipulated Judgment was unenforceable because it constituted an unenforceable penalty, not valid liquidated damages. “[A] court cannot enter a judgment that contains an unenforceable liquidated damages clause.” Id. at 1113. There was no meaningful relationship between the $28,970 amount of the Stipulated Judgment and the Castros’ failure to vacate by October 31, 2018 or to leave the vacated premises in broom-swept condition. In addition, the record did not show any effort by the parties to reasonably anticipate the amount of damages that might flow from a breach of the Stipulation. Similarly, nothing in the record showed the “the landlord’s chances to completely succeed at trial and recover all the unpaid rent allegedly owed.” Id. at 1118.

Graylee distinguished Jade Fashion & Co., Inc. v. Harkham Industries, Inc., 229 Cal.App.4th 635 (2014). In that case, the amount owed was undisputed, and the settlement was not an agreement to settle a disputed claim. Instead, the settlement was an agreement to forbear on the collection of a debt that was admittedly owed. Graylee, 52 Cal. App. 5th at 1117. In contrast, the Stipulation was a compromise of disputed claims, and the Castros never admitted that they owed $27,100 in unpaid rent. Id. at 1118.

In reversing and remanding, Graylee directed the trial court, among other things, to determine “whether the landlord suffered any actual damages as a result of the tenants’ breach of the stipulation.” Id. at 1119.

AUTHOR’S COMMENTS

Three takeaways from Graylee are: (1) a stipulated judgment that contains an invalid liquidated damages provision (or that results from an invalid liquidated damages provision in an underlying settlement) is not enforceable; (2) stipulated judgments and other settlements that provide for contingent reductions or increases in settlement payments must withstand a liquidated damages analysis, which should be made by the parties at the time of negotiating those payment contingencies, in the course of drafting the liquidated damages provision in the settlement; and (3) in determining whether a stipulated judgment or other settlement contains an unenforceable penalty, the court will be entitled to examine the underlying circumstances.

EDITOR’S COMMENTS

As a retired judge who has mediated many bankruptcy cases, both while active and in retirement, I find this holding by the California Court of Appeal troubling. A common way to settle pending litigation is an agreement for the defendant to pay a sum certain in installments. As an incentive for the defendant to perform, the agreement often has a provision that if the defendant defaults, after appropriate notice and opportunity to cure, a stipulated judgement for a sum greater than the installment sum will be entered, giving credit for any payments made. Under the reasoning ofGraylee, without more, such stipulated judgment would be found unenforceable as based on liquidated damages. One practice tip to avoid that consequence might be to structure the agreement to pay as a forbearance on collection of the greater amount (to be included in the Stipulated Judgment upon default). The Graylee court indirectly suggests this alternative by distinguishing the holding of Jade Fashion & Co v. Harkham Industries, Inc. by saying in that case the amount owed was undisputed and the agreement was a forbearance agreement. Perhaps my alternative will not work, however, where the amount owed is disputed, which is usually the case. The Court of Appeal implies that a party settling litigation with installment payments and forbearance must admit to the amount of damages before a stipulated judgment for a greater sum entered after default will be enforceable. Since almost all mediated settlements are premised on no admission of liability by the settling parties, if that admission is mandatory, this tool for settling cases may be disappearing.

These materials were written by Leonard L. Gumport of Gumport Law Firm, PC in Pasadena (lgumport@gumportlaw.com). Editorial contributions were provided by Meredith King of Higgs|Fletcher|Mack in San Diego (kingm@higgslaw.com) and the second edit and Editor’s Comment were provided by the Hon. Meredith Jury, retired Bankruptcy Judge and member of the ILC (majury470@gmail.com).

Best regards,

Insolvency Law Committee

Co-Chair
Michael W. Davis
DTO Law
mdavis@dtolaw.com

Co-Chair
Michael J. Gomez
Frandzel Robins Bloom & Csato, L.C.
mgomez@frandzel.com

Co-Vice Chair
Cathy Ta
Reorg Research, Inc.
cta@reorg.com

Co-Vice Chair
Christopher D. Hughes
Nossaman LLP
chughes@nossaman.com

Source: https://calawyers.org/section/business-law/

DLA Piper

USA May 24 2021

The COVID-19 pandemic created unprecedented disruptions across the global economy, perhaps most severely in the retail sector. Shelter-in-place orders, government-mandated closures and other restrictions drastically reduced or entirely wiped out revenue streams, resulting in an increased number of bankruptcy filings by retail debtors.

While bankruptcy generally provides a breathing spell from creditors, debtors usually must continue paying rent to landlords. To help address cash flow and liquidity issues caused by the pandemic, some debtors have sought to defer their commercial lease obligations, including rent, in addition to attempting to invoke force majeure clauses and/or the “frustration of purpose” doctrine. These efforts have achieved mixed success.

A. Section 365(d)(3) of the Bankruptcy Code1

Section 365(d)(3) of the Bankruptcy Code generally requires that debtors remain current on lease obligations during bankruptcy, subject to a limited exception that allows the court to defer obligations for 60 days after the petition date upon a showing of cause.2,3

Prior to the COVID-19 pandemic, section 365(d)(3) had been most thoroughly discussed in the context of stub rent, including whether a debtor could defer paying stub rent until confirmation of a plan.4 In a leading case, the Circuit City5 court ruled that stub rent is a post-petition obligation entitled to treatment as an administrative expense of the bankruptcy estate, but that it did not have to be paid at the beginning of the case under section 365(d)(3). Instead, debtors could pay stub rent upon plan confirmation, with other administrative expenses.

The court noted that while section 365(d)(3) requires a debtor to timely perform post-petition lease obligations, the obligation to pay stub rent arose before the bankruptcy filing, when the monthly rent came due. The court noted that the Bankruptcy Code provides no express remedy for failing to comply with section 365(d)(3), including nothing that would elevate a landlord’s claim to “super-priority” status requiring immediate payment before other administrative expenses.

B. Pier 1 Imports

One of the first cases to address lease obligations during the pandemic was In re Pier 1 Imports.6 Pier 1 Imports filed for Chapter 11 bankruptcy on February 17, 2020. The debtors initially anticipated only minor disruptions due to the virus’s impact on Chinese suppliers. The court wrote, “No constituency in these cases predicted that the world would effectively grind to a halt.”7 By the end of March, however, the company was forced to close nearly all its retail outlets due to stay-at-home orders and mandated closures of non-essential businesses.

Pier 1 filed a motion asking to pay only “critical expenses,” such as insurance, utilities, and security, for a “Limited Operations Period.” During that period, certain landlords would not receive rent, notwithstanding the terms of the leases or section 365(d)(3). Not surprisingly, numerous landlords objected.

The court granted Pier 1’s motion and allowed the debtors to defer paying rent. The court extensively discussed the unprecedented nature of the pandemic, described as “a temporary, unforeseen, and unforeseeable glitch in the administration of the Debtors’ Bankruptcy Cases.”8 Recognising the “extraordinary nature of the relief” it was granting, the court relied on the broad equitable powers granted by section 105(a) of the Bankruptcy Code.9 The court acknowledged the apparent inconsistency with section 365(d)(3), but found, in reliance on the former Circuit City decision, that section 365(d)(3) does not provide a separate remedy if a debtor cannot comply with its rent obligations. The court concluded that failing to pay rent does not result in a super-priority claim that must be paid immediately, but only an administrative expense.

Critically, the court noted the lack of a realistic alternative – Pier 1 could not generate sufficient revenue to pay rent because it was prohibited from opening its stores, and it could not liquidate inventory while the stores were closed. The court noted that landlords were the only objectors, though lenders, thousands of furloughed employees, and suppliers were also negatively affected.

At least one other court, in Bread & Butter Concepts, fully adopted the reasoning from Pier 1 and granted similar relief.10 In that case, the court similarly noted that only landlords had objected, and found that the “unprecedented circumstances require temporary relief to preserve the Debtors’ opportunity to benefit from the reorganisation afforded by Chapter 11.”11

C. CEC Entertainment

On the other end of the spectrum, in December 2020, the court in In re CEC Entertainment Inc. ruled that section 365(d)(3) prohibits rent deferrals.12 The debtors operated a nationwide chain of Chuck E. Cheese venues, and had filed for bankruptcy on June 24, 2020. In early August, the debtors filed a motion to abate rent payment for 141 locations that continued to be impacted by governmental orders or regulations.

The CEC debtors presented three arguments: (1) sections 365(d)(3) and 105(a) give the court equitable power to alter post-petition rent obligations (i.e. the Pier 1 argument); (2) government orders eliminating or reducing operations triggered force majeure clauses in the leases; and (3) debtors should be relieved from paying rent by the “frustration of purpose” doctrine. By the time of the court’s ruling, the debtors had reached agreement with all but 6 landlords.

The court denied the motion, holding that section 365(d)(3) unambiguously requires timely performance of all lease obligations during bankruptcy. The court found that it could not grant relief that directly violated a provision of the Bankruptcy Code. In rejecting the “broad equitable powers” arising under section 105(a) argument, the court noted that such powers are not unlimited. Rather, section 105(a) only authorizes “bankruptcy courts to fashion such orders as are necessary to further the substantive provisions of the Code.” Because the motion directly contradicted section 365(d)(3), the court could not approve lease deferrals. The court expressly disagreed with the holding in Pier 1, though noted that such disagreement was perhaps only “on the margins.” The court also rejected the debtors’ force majeure and frustration of purpose arguments under applicable state law and the terms of the relevant leases.

D. Conclusion

These cases are just two examples of how courts and restructuring professionals have sought to address the continuing impact of the pandemic on retail operations for companies in bankruptcy. Many cases involve consensual agreements between the affected parties that did not require the court to make a substantive decision. These issues will continue to develop as the long-term impact of the pandemic continues to be addressed through ongoing bankruptcy cases.

DLA Piper – Aaron Applebaum

 

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USA May 7 2021

We knew this day would come, since email is now the primary means of written communication. A material supplier made a payment bond claim solely via email. No letter was sent by mail, much less sent by certified mail as required under the Maryland Little Miller Act for payment bond claims. And yet, a federal District Court judge has held that notice by email was sufficient, and denied the surety’s motion for summary judgment.

The plaintiff was a material supplier to a first-tier sub, providing materials from January to May 2019. On October 30, 2019, the plaintiff sent an email to the GC concerning the unpaid amounts, and attached documents to back up its claim. The email identified the project, the first-tier sub and the amount due. The supplier also asked for a copy of the payment bond, which the GC eventually provided.

The surety provided the supplier with a proof of claim form, which the supplier submitted back to the surety. There was no dispute that the supplier never sent any notice by certified mail. (Although not clear from the decision, it may be that all communications were via email.)

The Maryland payment bond statute states that notice “shall be sent by certified mail to the contractor.” This was admittedly not done. But the judge noted:

this Court must still look to the purpose of the statute to determine whether email is a sufficient means of delivery. In this case, a liberal construction of the means of delivery does not contravene the remedial purpose of the statute. The purpose of certified mail is to ensure receipt of the claim. In this case, receipt of the claim was ensured by email which provided a digital history of delivery.

Further, there was no argument about the timing, content or even receipt of the email notice. The only argument was to the form of delivery of the notice. Since the GC and surety had received timely notice from the supplier with the pertinent information provided, the delivery of that notice by email was found to satisfy the purpose of the payment bond law.

The case is Johnson-Lancaster & Assocs. v. H.M.C., Inc., 2021 U.S. Dist. LEXIS 83566 (D. Md., April 29, 2021) (paywall).

 

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USA April 29 202 

On April 22, 2021, the Supreme Court limited the Federal Trade Commission’s ability to seek restitution or disgorgement under Section 13(b) of the FTC Act. Justice Stephen G. Breyer, author of the unanimous 90 decision, interpreted the language and history of the statute to find that the FTC’s ability to obtain equitable monetary remedies under the statute would allow “a small statutory tail to wag a very large dog.l Background and Procedural History 

Section 13(b) of the Federal Trade Commission Act (the Act) authorizes the FTC to seek “a permanent injunction” in federal court against any person, partnership, or corporationbelieved to be “violating, or [which] is about to violate, any provision of law” that the FTC enforces “in proper cases.2 The FTC has interpreted this provision expansively over the last few decades to authorize it to seek equitable monetary damages in federal court. Federal courts and the majority of courts of appeal have agreed with the FTCs position that Section 13(b) allows the agency to seek restitution and disgorgement as well.Section 13(b) differs from Sections 5 and 19 of the Act, which expressly allows the FTC to seek monetary relief on behalf of consumers when the FTC engages in administrative proceedings to seek penalties for violations of a cease and desist order. 

In AMG Capital, the FTC filed a lawsuit in federal district court against Scott Tucker, an owner of several payday lending companies, alleging unfair and deceptive acts in violation of Section 5 of the Act. Tucker

ough several companies, provided borrowers with shortterm payday loans amounting to more than $1.3 billion under allegedly misleading terms.” The FTC relied on Section 13(b) to seek and obtain not only a permanent injunction, but also $1.27 billion in restitution and disgorgement. A skeptical Ninth Circuit upheld the district courts monetary damages order, noting that “Tucker’s argument has some force, but it is foreclosed by our [30 years of] precedent.” The Ninth Circuit’s decision aligned with decisions of other circuit courts except for a recent Seventh Circuit decision that rejected the argument that Section 13(b) permitted the FTC to seek restitution and other monetary relief (V&E previously discussed this case here). The Court’s Reasoning 

The Supreme Court granted certiorari to resolve the circuit court split and revised the Ninth Circuit. The Supreme Court found that the plain text of 13(b) does not permit the FTC to seek, or a court to award, equitable monetary relief such as restitution or disgorgement.In holding that the FTC does not have such power, the Court found that

  • A statutory grant of an injunction” does not automatically authorize a court to provide monetary relief. 8 

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5/3/2021 

Unanimous Supreme Court Limits FTCs Ability to Seek Monetary Remedies CLA Business Law Section Newsstand Powered by Lexol… 

  • The provision uses language such as is violatingor is about to violate,suggesting that the law is 

focused on relief that is prospective (such as an injunction), not retrospective (such as monetary awards).

  • The Court highlighted instances in the Act, under Section 5 and 19, where the FTC is explicitly 

authorized to impose limited monetary penalties and to award monetary relief, 10 and reasoned that Congress would have done the same in 13(b) had that been its intent.To find otherwise, according to the Court, would effectively allow the FTC to bypass Section 19 of the FTC Act, which allows the FTC to seek redress, including equitable monetary relief, after following certain requirements, including issuing a cease and desist order and filing suit in federal court, and other limitations

The Court seemed to recognize that its decision may not be the most desirable outcome, but left to Congress the decision of whether to grant the FTC power to obtain retrospective monetary relief. Justice Breyer explained that the FTC is free to ask Congress to grant it further remedial authority.12 

Takeaways 

The Courts decision will require the FTC to rethink its enforcement strategy. The FTC has relied heavily on Section 13(b) to collect billions in monetary penalties in recent years. In 2016 alone, the FTC utilized its Section 13(b) authority to receive $12 billion due to restitution and disgorgement, with about $10 billion coming from its settlement with Volkswagen AG due to the dieselemissions scandal.13 In fiscal year 2019, the FTC obtained 81 permanent injunctions and orders, resulting in $723.2 million in consumer redress or disgorgement. 14 

Without its ability to use Section 13(b) to seek monetary relief, the FTC will need to shift reliance to its administrative capabilities, which it has historically used far more sparingly than its Section 13(b) powers. In 2019, the FTC only issued 21 new administrative complaints and 21 final administrative orders, less than half of the 49 complaints filed in federal court. 15 The FTC utilizes its administrative powers less frequently because it can only seek equitable monetary remedies for those who engage[d] in any unfair or deceptive act or practice

o which the Commission has issued a final cease and desist order which is applicable to such person.“16 Therefore, the FTC is much more limited in its ability to seek monetary remedies through its Sections 5 and 19 powers

The decision is also likely to provoke a Congressional response. Rebecca Kelly Slaughter, Acting Chairwoman of the FTC, found that the Courts decision “deprived the FTC of the strongest tool we had to help consumers when they need it most.The Chairwoman “urge[d] Congress to act swiftly to restore and strengthen the powers of the agency so we can make wronged consumers whole.l/ The FTC also asked Congress for that authority in a recent Congressional hearing. For its part, Congress is considering at least one bill, with potentially more in the pipeline. Such action by Congress in response to judicial restrictions on agency authority has recent precedent. In 2020, Congress utilized the annual National Defense Authorization Act to expand the Securities and Exchange Commission’s ability to obtain disgorgement and other equitable remedies after the Supreme Court limited the agency’s ability to obtain disgorgement.19 

Until Congress acts, the FTC will not be able to pursue monetary relief in the same manner it has for the last few decades. The FTC has preferred 13(b) actions over administrative actions because it affords the FTC a wider range of equitable remedies. The ruling will cut off a key facet of the FTC’s enforcement in the consumer protection space as it often used 13(b) to seek restitution against companies in cases of fraud or misrepresentation. The ruling will also impact the FTCs toolkit in combating alleged anticompetitive practices 

Source: https://www.jdsupra.com/legalnews/unanimous-supreme-court-limits-ftc-s-7687888/#:~:text=Unanimous%20Supreme%20Court%20Limits%20FTC’s%20Ability%20To%20Seek%20Monetary%20Remedies,-Michael%20Mathews%2C%20Darren&text=On%20April%2022%2C%202021%2C%20the,b)%20of%20the%20FTC%20Act.

USA April 27 2021 

Highlights 

  • The U.S. Court of Appeals for the Eleventh Circuit’s recent ruling in Hunstein v. Preferred Collection and 

Management Services, Inc. may upend the longstanding and rather routine business practice of financial services companies using thirdparty vendors to manage, service and collect on outstanding debt

  • Citing ostensibly to general privacy concerns and applying a textual analysis of the Fair Debt Collection 

Practices Act (FDCPA), the Eleventh Circuit reversed the lower court, holding that when a debt collector provides an outside letter vendor with personal account information relating to the collection of a debt, it rises to the level of an impermissible communication with a third party to which there is no exception if there is no consumer consent

. Although the “offending” vendor in Hunstein is a letter vendor, the case could potentially be used by the 

plaintiff’s bar to implicate a variety of other vendors, including target loan servicers, subservicers and others in both single action and class action litigation across a wide range of financial products, as opposed to just “pure” debt collectors

  • If left unchecked, the opinion will significantly broaden the scope of the FDCPA. In addition, expect consumer advocates and courts to continue finding privacy rights imbedded in other consumer protection laws

In a first-of-its-kind ruling, the U.S. Court of Appeals for the Eleventh Circuit may have upended the long standing and rather routine business practice of financial services companies using thirdparty vendors to manage, service and collect on outstanding debt. If left unchecked, the opinion will significantly broaden the scope of the Fair Debt Collection Practices Act (FDCPA)

In Hunstein v. Preferred Collection and Management Services, Inc., No. 8:19-cv00983TPBTGW (11th Cir. April 21, 2021), the appellate court reversed the lower court and held that when a debt collector provides an outside letter vendor with personal account information relating to the collection of a debt, it rises to the level of an impermissible communication with a third party to which there is no exception if there is no consumer consent

This case does not expand who is a debt collector under federal law. The impact, however, is concerning for financial services companies. One example of the potential unintended consequences and expanding net of this decision is in cases where a lender uses a vendor to service mortgage loans that have gone delinquent. When 

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1/4 

4/29/2021 

Financial Services Industry Braces for Impact of Eleventh Circuits Kunstein Decision CLA Business Law Section Newsstand Powered..

that loan is transferred, the servicer becomes a debt collector, If that servicer then hires a vendor to assist with documenting loan modification agreements as consumers come off of COVID19 forbearances, courts may now see this as a FDCPA violation

Although the “offendingvendor in Hunstein is a letter vendor, the case can and many expect it will be used by the plaintiffs bar to implicate a variety of other vendors. It will likely be used to target loan servicers, subservicers and others in both single action and class action litigation across a wide range of financial products, i.e., auto loans, credit cards, mortgages, etc., as opposed to just “puredebt collectors. The court’s holding may very well be weaponized and serve as a new wellspring of litigation, especially in the wake of the U.S. Supreme Courts recent Telephone Consumer Protection Act (TCPA) decision in Facebook, Inc. v. Duguid et al., which was seen as a financial industry win. (See Holland & Knight’s previous alert, “Supreme Court’s Facebook Decision Impacts TCPA Litigation,April 1, 2021.) 

At first blush, the Eleventh Circuit’s ruling can be viewed as an additional limitation on how the debt collection industry does business rather than advancing consumer protection. The court itself hints that this may be the case. Hunstein, No. 8:19-cv-00983TPBTGW at 22. In potentially dismantling how financial services companies have done business for the past few decades, the court focused its attentions on a strict textual reading of the FDCPA and to a theme that is rooted in all consumer protection laws: privacy

Over the past decade, privacy has become a powerful tool used by litigants to generate class claims from seemingly innocuous and widespread activities such as call recording and website activity. In this case, the Eleventh Circuit used what it determined is the plain language of the FDCPA to once again place a spotlight on privacy. Expect this to be a continuing theme as courts are asked to find privacy rights imbedded in other consumer protection laws

The Statute 

The specific section of the FDCPA at issue is 15 U.S.C. $ 1692c(b). In this section, the FDCPA sets forth who a debt collector can communicate with in connection with the collection of a debt without the consumers consent. In relevant part, this section states that: Except as provided in section 1692b of this title, without the prior consent of the consumer given directly to the debt collector, or the express permission of a court of competent jurisdiction, or as reasonably necessary to effectuate a postjudgment judicial remedy, a debt collector may not communicate, in connection with the collection of any debt, with any person other than the consumer, his attorney, a consumer reporting agency if otherwise permitted by law, the creditor, the attorney of the creditor, or the attorney of the debt collector. 

15 U.S.C. § 1692c(b) (emphasis added) 

The case ultimately turned on two things. First, what the court understood the following eight words to mean in $ 1692c(b) “in connection with the collection of any debt” when a debt collector communicates with a third party without consent. Second, the interplay between the statute and ostensible privacy concerns. 

The Case 

The unanimous decision was issued by a mixed panel of judges appointed by Presidents Ford, Clinton, Obama and Trump, and written by Judge Kevin Newsom, who was appointed to the bench in 2017. In some ways, the opinion creates a judicial alliance of strange bedfellows to tackle what the judges perceive to be privacy violations, rather than more traditional abuses in debt collection practices. The invasion of privacy concept is a 

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theme that runs throughout the opinion, and the court cites to congressional findings that the FDCPA, at least in part, was drafted to address privacy concerns. Sharing information, however, with a third-party letter vendor, is far different than disclosing debts a consumer may owe with their employer. Yet the court did not appear overly concerned with this distinction or attempt to reconcile these differences. Given the court‘s later musings that its holding may not provide consumers with any further privacy protections, it seems possible that the specter of privacy found its way into the opinion in a bid to make the cases holding somewhat more palatable

The lawsuit itself stems from a collection or “dunning” letter sent to the plaintiff. Richard Hunstein, relating to a debt incurred from medical treatment his son received. To send the letter, the defendant, Preferred Collection and Management Services Inc. (Preferred Collection), took steps that are not uncommon in the financial services industry, employing the assistance of a thirdparty letter vendor. So that the vendor, Compumail Inc., had the necessary information to “create, print and mailthe letter, Preferred Collection shared data showing that Hunstein was a debtor, the amount he owed, the entity to which the monies were owed and the name of his son. Hunstein, No. 8:19cv00983TPBTGW at 2. Hunstein asserted that in doing so, the defendant violated the FDCPA when sharing that data with an unauthorized third party. 

The Ruling and Arguments 

In making its ruling, the Eleventh Circuit first addressed whether there was a true case or controversy giving Hunstein standing to file suit. In resolving this issue in favor of the plaintiff, and citing to Spokeo, Inc. v. Robins, 136 S. Ct. 1540, 1547 (2016), the court noted that standing requires there to be an injury in fact

sability. The court took great pains in analyzing whether there was an injury in fact, and ultimately found that because it deemed the communication of data to a third party to be a violation of Section 1692c(b), that this statutory violation was enough. The court also exam a century involving invasion of privacy cases and noted that the FDCPA shares a common structure with other laws that say “A may not share information about B with C.” Hunstein, No. 8:19cv-00983TPBTGW at 11. In addition, the court noted that Congress “identified the ‘invasion[] of individual privacy’ as one of the harms against which the statute is directed.Id. at 12 (internal citations omitted). 

With standing established, the court looked at three key arguments that Preferred Collection made in asserting that its actions did not constitute violations of the FDCPA. First, the defendant asserted that for a communication to be made “in connection with the collection of any debt,” there must be a corresponding demand for payment. Next, it asked the court to adopt a multifactor balancing test used in the Sixth Circuit, in which district courts there classify a communication as being made “in connection with the collection of any debt.” And lastly, Preferred Collection asked the court to consider the impact to the industry if its actions were found to constitute a violation of the FDCPA, given widespread reliance on thirdparty vendors for a variety of services such as mailing. 

The court found each of Preferred Collection’s arguments unpersuasive. In reviewing the text of the statute, the court said it was obligated to find meaning to every word and provision, and rejected Preferred Collections argument that Congress intended to limit the scope of § 1692c(b) to include only demands for payment. In so ruling, the court sidestepped other courts that interpreted similar language in other sections of the FDCPA to require a demand for payment before a communication could be classified as being “in connection with the collection of any debt.” After dispatching this argument, the court next refused to adopt the multifactor test used in the Sixth Circuit

Finally, the court held that it could not take into account the potential impact of its decision across the financial services industry. 

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We presume that, in the ordinary course of business, debt collectors share information about consumers not only with dunning vendors like Compumail, but also with other thirdparty entities. Our reading of Ş 1692c(b) may well require debt collectors (at least in the short term) to insource many of the services that they had previously outsourced, potentially at great cost. Id. at 22 (emphasis added) 

The court instead held that it was bound by the confines of the statute, which Congress could change if it so desired

Impact and Takeaways 

While the court acknowledged that a consequence of its decision is the likely substantial costs associated with rolling back the financial industry’s decades-long reliance on vendors, it was not sympathetic to the enormous challenge of inhousing all currently outsourced processes. There is no switch to flip. People need to be hired and trained amid a global pandemic. Software, printers and other letter-writing tools need to be purchased and then tested. Meanwhile, in the interim, lenders, servicers and other parties in the financial industry must weigh the Hobbesian choice of not communicating with their customers, which is not always an option given competing regulatory requirements at the federal and state level, or facing litigation when they do. 

In a statement that appears to rub salt in the wound, the court recognizes that the sweeping changes that its decision will necessitate are unlikely to usher in much in the way of ‘real’ consumer privacy, as we doubt that the Compumails of the world routinely read, care about, or abuse the information that debt collectors transmit to 

heless, the court concluded that its “obligation is to interpret the law as written, whether or not we think the resulting consequences are particularly sensible or desirable.Id. 

An en banc appeal to the full Eleventh Circuit is underway, but even if the case is accepted and the panel is reversed, that new decision will not likely arrive before millions of communications with consumers will need to be made. As industry members consult with counsel on potential litigation, regulatory and statutory fixes, those in the financial industry must come to grips with how it will handle the fallout from this case. Now is the time to take stock of not only how you communicate with your customers, but also what vendors you use more broadly and for what functions, and what third parties your vendors use as well. 

Holland & Knight LLP Joshua C. Prever, Eugene Chikowski and Courtney Oakes 

Source: LEXOLOGY

Authors: Peter A. Stokes, Andy Guo, Saul Howard Perlofti United States Publication | April 5, 2021 

A recent U.S. Supreme Court decision should bring needed clarity and relief for businesses following a torrent of class action litigation under the Telephone Consumer Protection Act (“TCPA”). In Facebook, Inc. v. Duguid, the Supreme Court ruled that the TCPA’s prohibition against sending unsolicited telephone and text messages from automatic dialing systems only applies to those systems with the capacity to use a “random or sequential number generatorto store or produce telephone numbers to be dialed.2 The decision overrules prior Ninth Circuit authority allowing TCPA claims over dialing systems that merely have the capacity to “store” numbers and dial them automatically, without the capacity to generate numbers sequentially or randomly. Because many modern dialing systems (particularly in the context of text message advertising campaigns) lack the capacity to use a random or sequential generator, this decision should significantly restrict the ability of plaintiffs to bring TCPA claims over automated text and dialing campaigns, although the TCPA’s separate prohibitions against telephone calls using “an artificial or pre-recorded voice” remain in place. 

Background The TCPA, which became law in 1991, restricts the use of an automatic telephone dialing system (ATDS) to transmit calls or texts to mobile numbers without the recipient’s prior express consent. Companies face a minimum statutory civil penalty of $500 for each call or text made in violation of the statute. This penalty has led to hundreds of TCPA class actions, putting companies at risk of severe liability when damages are calculated on a classwide basis. In some of these cases, companies were sued under an agency theory for promotional campaigns run by outside marketing firms. Other cases involved automated messages sent by businesses with existing customer relationships, but which were received by persons who allegedly did not consent to receiving them or did not actually have a prior business relationship. 

The Duguid case involved this second category of TCPA litigation. Plaintiff Noah Duguid, who did not have a Facebook account, allegedly received a text message from Facebook advising him that someone had attempted to access the Facebook account associated with his telephone number. He filed suit, alleging that Facebook violated 47 U.S.C. 227(b)(1)(A) by purportedly using an ATDS to send text messages to his mobile number without his “prior express consent,” Facebook moved to dismiss, arguing that there was no allegation in Duguid’s complaint that its system sent text messages to numbers that were randomly or sequentially generated.? The district court agreed with Facebook that the allegations failed to support an inference that Facebook’s dialing system had the capacity to store or dial numbers using a random or sequential number generator.8 

After the district court dismissed Duguid’s complaint, the Ninth Circuit held in Marks v. Crunch San Diego, LLC that a dialing system need not be able to use a random or sequential generator to store numbers, but instead could qualify as an ATDS if it merely had the capacity to “store numbers to be called’ and ‘to dial such numbers automatically.”9. The Ninth Circuit reached this outcome by holding that the phrase “using a random or sequential number generator” in the TCPA’s definition of an ATDS modifies the word “produce” but not the word “store” in the “store or produceclause that precedes it, which would mean that a system could qualify as an ATDS even if it did not have the capacity to generate numbers using a random or sequential number generator 10 Relving on this intervening decision, the Ninth Circuit reversed the dismissal of Duguid’s complaint.”. Other circuits, however, have held that the “random or sequential number generator” clause modifies both “store” and “produce,and that a system would not be an ATDS if it did not have the capacity to generate numbers randomly or sequentially.12 The Supreme Court granted certiorari to resolve this circuit split.13 

The Supreme Court’s decision 

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In a unanimous decision authored by Justice Sonia Sotomayor, the Supreme Court reversed the Ninth Circuit’s decision and held that a dialing system must have “the capacity to use a random or sequential number generator to either store or produce phone numbers to be called” to qualify as an ATDS.14. Relying on the “seriesqualifier” interpretive canon, which provides that a modifier at the end of a series of verbs will usually apply to all verbs in the series, the court concluded that the most natural reading of the ADTS definition was to apply the “random or sequential” generation requirement to both “store” and “produce, “15 The use of a comma immediately before the “random or sequentialphrase further supported reading that phrase as applying to both verbs that preceded it, 16 The opinion also noted that applying the Ninth Circuits construction would effectively make all modern cellphones fall within the definition of ATDS, as virtually all smartphones have the capacity to store and dial sets of numbers,17 

Justice Sotomayor further observed that applying the “random or sequentialgeneration requirement to both verbs was consistent with the TCPA’s statutory purpose, noting that “Congress expressly found that the use of random or sequential number generator technology caused unique problems for business, emergency, and cellular lines” through the risk of such a system “dialing emergency lines randomly or tying up all the sequentially numbered lines at a single entity.”18. It was therefore consistent with Congressional intent to construe the ATDS definition as applying only to devices with this capacity:19. In rejecting Duguid’s contention that such an interpretation would “unleash” a “torrent of robocalls,” the Supreme Court also noted that the TCPA’s separate prohibition against the use of “an artificial or prerecorded voice” in other types of phone calls would continue to apply,20 Justice Samuel Alito wrote a separate concurrence fully supporting the court’s conclusion that “using a random or sequential number generator” applied to the word “store,” but emphasizing that the use of the “series-qualifiercanon is context-specific and should not be applied “mechanically.”21 

Takeaways The Facebook decision should make it significantly more difficult for TCPA plaintiffs to allege and prove that a dialing system is an ATDS. Many modern dialing systems, including those used to send automated text messages, do not use random or sequential number generation technology. Companies should nonetheless remain vigilant in securing express consent from recipients before sending text messages automatically. Companies should also exercise caution in ensuring that outside marketing firms conducting text or telephone advertising campaigns on their behalf are procuring express consent from recipients and are not using a system with the capacity to generate numbers randomly or sequentially. While district courts should grant dismissal more readily following the Supreme Court’s decision, plaintiffs may continue to bring TCPA claims with the hope of getting access to discovery. Companies should also keep in mind that the TCPA’s separate prohibitions against telephone messages using “an artificial or prerecorded voice” still apply, as do the TCPA’s prohibitions against sending unsolicited advertisements by fax and the TCPA’s protections for numbers listed on an applicable “Do-Not-Calllist 22 While the Facebook decision should hopefully reduce the number of TCPA class actions that are filed, companies should remain vigilant given the draconian class-wide damages awards possible in such matters

Footnotes 1 S.Ct. -, 2021 WL 1215717 (Apr. 1, 2021). 

2 See id. at 2, 7

3 See id. at 3. 

4 See 47 U.S.C. 5 227(b)(1)(A). 

5 See 2021 WL 1215717, at *3

6 See id. (quoting 47 U.S.C. & 227(b)(1)(A)). 

7 See id. 

8 See id. (citing Duguid v. Facebook, Inc., No. 15-CV-00985JST, 2017 WL 635117, at *35 (N.D.Cal. Feb. 16, 2017)). 

9 904 F.3d 1041, 1053 (9th Cir. 2018). 

10 See id. (analyzing requirement in 47 U.S.C. $ 227(a)(1)(A) that an ATD$ have the capacity to “store or produce numbers to be called, using a random or sequential number generator”). 

11 See Duguid v. Facebook, Inc., 926 F.3d 1146, 1151 (9th Cir. 2019)

12 See, e.g., Gadelhak v. AT&T Servs, Inc., 950 F.3d 458, 463-68 (7th Cir. 2020); Glasser v. Hilton Grand Vacations Co., 948 F.3d 1301, 1306-12 (11th Cir. 2020)

13 See Facebook, Inc. v. Duguid, 141 S. Ct. 193 (2020)

14 See Facebook, 2021 WL 1215717, at *7

15 See id, at *4 (citing A. Scalia & B. Garner, Reading Law: The Interpretation of Legal Texts 147 (2012)). 

18 See id. at *5. 

17 See id, at *6

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18 See id, at 6, 7

19 See id, at *7

20 See id

21 See id, at *9 (Alito, do, concurring). 

22 See 47 U.S.C. & 227(b)(1): 47 C.F.R. 99 641200(b)(d)

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