As noted in my brief post of last week, the US Supreme Court held in a 5-4 decision in Marrama v. Citizens Bank of Massachusetts, No. 05-996 (2/21/07) (pdf / WL) that chapter 7 debtors do not have an absolute right to convert their cases to chapter 13.  So much for the broad consensus for which Justice Roberts is striving.  Not surprisingly, it was Justice Kennedy who cast the deciding swing vote.

Don’t throw away the opinion as a useless bit of trivia rarely applicable in practice, though, for the opposing views of the majority and the dissent regarding the scope of the bankruptcy court’s general and equitable powers – a subject that has generated significant academic debate – provide significant food for thought.

By way of background, be sure to read the 2005 article at 79 Am. Bankr. L. J. 1 entitled, The Limited Scope of Implied Powers of a Bankruptcy Judge:  A Statutory Court of Bankruptcy, Not a Court of Equity, where Judge Alan M. Ahart of the Bankruptcy Court for the Central District of California (who was the bankruptcy judge in this messy affair before Judge Real took hold of the reins) argues that the repeal in 1984 of 28 U.S.C. § 1481 stemming from the Supreme Court’s Marathon decision divested the non-Article III bankruptcy courts of equitable powers not specifically granted by statute.  To Judge Ahart,

[t]he only situation in which a bankruptcy judge might be compelled to rely on inherent powers is in the functioning of the court itself.  She must have authority to uphold the dignity and integrity of the judicial process.

Would Judge Ahart agree with the majority’s extension of the bankruptcy court’s "inherent power" to sanction "abusive litigation practices" and thereby enable – in this case – "a prompt, rather than a delayed, ruling on an unmeritorious attempt to qualify as a debtor under Chapter 13"?  Op. at p. 10 (citing Roadway Express, Inc. v. Piper, 447 U.S. 752, 765, 100 S.Ct. 2455, 65 L.Ed.2d 488 (1980)).  Or would Judge Ahart adopt the narrower views of the dissent, which concluded that "a bankruptcy court’s inherent powers may have a role to play in a case such as this, … [b]ut whatever steps a bankruptcy court may take pursuant to … its general equitable powers, a bankruptcy court cannot contravene the provisions of the Code"?  Dissent at pp. 7-9 (citing Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 206 (1988)). 

Regardless, both the majority and dissent confirm Judge Ahart’s view that a bankruptcy court’s inherent powers remain extant at least where necessary to "uphold the dignity and integrity of the judicial process."  (Ahart at p. 6.)  It is the dissent’s unwillingness to use a bankruptcy court’s inherent equitable powers to override a debtor’s apparent absolute right to convert in § 706(a) that distinguishes its view from that of the majority.

Even more significant, however, is the Court’s discussion of the breadth and scope of § 105(a).  In summarizing § 105(a)’s function, Justice Stevens wrote on behalf of the majority:

[T]he broad authority granted to bankruptcy judges to take any action that is necessary or appropriate “to prevent an abuse of process” described in § 105(a) of the Code is surely adequate to authorize an immediate denial of a motion to convert filed under § 706 in lieu of a conversion order that merely postpones the allowance of equivalent relief and may provide a debtor with an opportunity to take action prejudicial to creditors.

Curiously, the second sentence of § 105(a) upon which the majority relies does not on its face provide the blanket affirmative grant of authority suggested by the majority.  Rather, this second sentence provides:

No provision of his title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.  (Emphasis added.)

A plain reading of the second sentence of § 105(a) suggests that the bankruptcy court’s power to fashion relief "necessary or appropriate … to prevent an abuse of process" is not unbounded, as suggested by the majority, but limited to instances where the Code or rules permit a particular issue to be raised by a party in interest.  In other words, to prevent an abuse of process, the court can sua sponte summarily take "necessary or appropriate" action to shut down a party in interest notwithstanding a provision in the Code that preserves within that party the right to be heard on the issue.  In effect, the majority read this qualification right out of the Code when it stated:

On the contrary, the broad authority granted to bankruptcy judges to take any action that is necessary or appropriate [**note the missing qualification here**] "to prevent an abuse of process" described in § 105(a) of the Code, is surely adequate to authorize an immediate denial of a motion to convert filed under § 706 in lieu of a conversion order that merely postpones the allowance of equivalent relief and may provide a debtor with an opportunity to take action prejudicial to creditors.  (Op. at pp. 9-10.)

As the following exchange indicates, Chief Justice Roberts seized upon this issue at oral argument, bringing it to a head before respondent’s counsel, Bingham McCutchen’s Eric Brunstad, had even finished just the third short sentence of his opening statement to the Court:

Continue Reading 5-4 US Supreme Court Majority Extends a Bankruptcy Court’s Power to Curtail a “Bad Faith” Debtor’s Seemingly Absolute Rights Under the Code

As discussed here, the US Supreme Court last term surprised many by deciding that the "plain meaning" of a bankruptcy statute must be filtered through a prism that, "in the main, secure[s] equal distribution among creditors [and] take[s] into account, as well, the complementary principle that preferential treatment of a class of creditors is in order only when clearly authorized by Congress."

Yesterday, as summarized in this post by Scott Riddle at the Georgia Bankruptcy Blog, the US Supreme Court ruled that provisions of the Bankruptcy Code that seemingly provide a debtor with an absolute right to do something (i.e., convert its case from chapter 7 to chapter 13) should be filtered through a lens that screens for the absence of "bad faith."  Marrama v. Citizens Bank of Massachusetts, No. 05-996 (2/21/07) (pdf/WL) (previewed here).

The decision isn’t surprising given bankruptcy’s equitable roots and the lack of sympathy one can muster for a "bad faith" debtor like Marrama.  More on the case later, as today I’m delivering the following two presentations for this scheduled event at the Licensing Executive Society Winter 2007 Meeting in San Francisco, and thus have neither the time nor the background briefs and transcripts at hand to provide much more insight into the case:

• IP Licensing & Bankruptcy:  An Issue Spotting Checklist for Analyzing Questions Regarding Assumption, Rejection, and/or Assignment of IP Licenses in Bankruptcy

                –   and  –

• From Bankruptcy to Success through Licensing:  The Cytomedix Story (with CRA International’s Jeff Snell)

Those wanting an insightful and controversial early look at the case, be sure to check out Professor Todd Zywicki’s lengthy post at the Volokh Conspiracy.

2/27/07 Update:  Here’s my follow up post on the Marrama decision, entitled 5-4 US Supreme Court Majority Extends a Bankruptcy Court’s Power to Curtail a "Bad Faith" Debtor’s Seemingly Absolute Rights Under the Code.

© Steve Jakubowski 2007