Enough with the Ovoid Metaphors: Equitable Mootness and a Split about Unscrambling Eggs

Equitable mootness prevents an appellate court from reaching the merits of an appeal. Duff v. Cent. Sleep Diagnostics, LLC (7th Cir. 2015). It is a judicially created, prudential doctrine unique to bankruptcy appeals. Specifically, the doctrine applies to appeals from orders confirming chapter 11 reorganization plans (but the circuits are even split on that point). In re Cont’l Airlines (3d Cir. 1996).

Equitable mootness is not Constitutional (Article-III) or statutory mootness. In re UNR Indus., Inc. (7th Cir. 1994). Rather, as Judge Easterbrook recognized in In re UNR Indus., Inc., equitable mootness is an “unwillingness [to] alter the outcome.” (1994). In certain circumstances, the driving force is simply pragmatism. For example, the debtor’s reorganization plan may be near the end, and was so complex that to reverse the plan at such a late date would be impractical and inequitable. In re Manges (5th Cir. 1994). Doing so would cause harm to innocent third parties that relied on the finality of a chapter 11 confirmation order. In re Club Assocs. (11th Cir. 1992). To use the ovoid metaphors of which appellate courts are fond, appellate courts are not Humpty Dumpty repairmen and they cannot unscramble the egg. In re Tribune Media Co. (3d Cir. 2015); In re Cont’l Airlines (3d Cir. 1996).

Equitable Mootness in the Circuits

This doctrine has created controversy for four main reasons. First, the circuits do not apply a uniform test when determining whether an appeal is equitably moot. The Fourth, Fifth, and Sixth Circuits apply a four factor test; the Third and Tenth apply a five factor test; and the Second, Seventh, and Eleventh each have their own specific analyses. Second, the circuits cannot agree on a name for the doctrine, leading Judge Easterbrook to banish the term in the Seventh Circuit:

[T]he doctrine goes under the banner “equitable mootness,” but the name is misleading. There is a big difference between inability to alter the outcome (real mootness) and unwillingness to alter the outcome (“equitable mootness”). Using one word for two different concepts breeds confusion. Accordingly, we banish “equitable mootness” from the (local) lexicon. We ask not whether this case is moot, “equitably” or otherwise, but whether it is prudent to upset the plan of reorganization at this late date.

In re UNR Indus., Inc. (1994).

Third, despite the doctrine’s express limitation to complex reorganizations with intricate transactions, litigants have pressed, and appellate courts have applied, equitable mootness in appeals from relatively simple reorganizations, In re One2One Commc’ns, LLC (3d Cir. 2015) (Krause, J., concurring); liquidation plans, In re BGI, Inc. (2d Cir. 2014); and, as recently as October 3, chapter 9. In re City of Detroit, (6th Cir. 2016).

Fourth, and most importantly, equitable mootness is essentially a “super-finality” rule that binds an appellate court from exercising its jurisdiction—“[A] self-imposed straight jacket [that] contradicts [Article III courts’] virtually unflagging obligation to exercise the jurisdiction we have been given.” In re City of Detroit, (6th Cir. 2016) (Moore, J., dissenting).

This controversy came to a head in the later summer of 2015 when the Third Circuit’s Judge Cheryl Krause issued a call to arms against the doctrine. In re One2One Commc’ns, LLC (3d Cir. 2015) (Krause, J., concurring). In a separate concurrence that was double the length of the actual opinion she pronounced:

We must consider whether to end or endure the mischief of equitable mootness . . . [T]he doctrine has gone virtually unchallenged. This may be because litigants—and bankruptcy attorneys—wield the weapon of equitable mootness just as often as they suffer its blows. But it is time for the challenge, and I am not alone in urging it.

(3d Cir. 2015). Less than a month later, Judge Thomas Ambro wrote a concurrence in In re Tribune Media Co., that was essentially a reply brief to Judge Krause. (3d Cir. 2015) (Ambro, J., concurring). Judge Ambro, relying on the principle that bankruptcy courts are courts of equity, recognized that the equities of a situation sometimes take precedence over a meritous, even legally justifiable, appeal:

The doctrine of equitable mootness recognizes those few situations where the practical harm caused by granting relief would greatly outweigh the benefit. Discretion is no less appropriate in the plan confirmation context than in ordering other equitable remedies; hence we believe that the One2One concurrence’s formal challenge that equitable mootness lacks a basis in law misses the point that it is in the equitable toolbox of judges for that scarce case where the relief sought on appeal from an implemented plan, if granted, would leave the plan in tatters and/or bankruptcy battlefield strewn with too many injured bodies . . .  In a very few cases, shutting an appellant out of the courthouse does substantially less harm than locking a debtor inside.

Looking Forward

To date, the Supreme Court has declined to address equitable mootness three times. See Tribune (2016); BGI (2015); GWI, (2001). Yet given the implications the doctrine has and the lack of uniformity across the circuits, the Court must address this doctrine and provide guidance.

Damned If You Do, Damned If You Don’t: The FDCPA, the Bankruptcy Code, and a Split on Time-Barred Claims

Filing a claim is one of the most basic components of bankruptcy law.  In fact, it’s the only way a creditor can hope to get their investment back in a bankruptcy proceeding.  But what if pursuing your legal remedy opened you up to liability?  Sounds like a catch-22 doesn’t it?  That’s the exact situation that the Supreme Court is about to decide.

What’s Going On

As we all know, bankruptcy is federal law.  However, the contract claims which fall under federal bankruptcy provisions are governed by state law.  These state law provisions provide for such things as enforceability, including when a debt is considered “stale” or the statute of limitations on its enforceability has run.

In addition to these state imposed limitations on debt collection, the federal government has a separate set of rules whose purpose is to protect debtors from unscrupulous debt collectors known as the Fair Debt Collection Practices Act (FDCPA).  One portion of this act bans the collection of stale consumer debts.

So What’s the Problem?

Even though stale debts are technically unenforceable, there is still a market for them.  Purchasers of stale debts hope for one of two outcomes.  That the debtor somehow see’s the light and voluntarily repays their remaining obligations or, the more likely outcome, the debtor files bankruptcy and the holder of the debt files a claim as a creditor in bankruptcy court.  Option two, however, comes with a bit of a problem: a stale claim is still a claim under the bankruptcy code, putting the bankruptcy code in direct conflict with the FDCPA by potentially allowing a creditor to collect on a stale debt.

The Split

Currently, the courts are split over how to resolve this clash between the bankruptcy code and the FDCPA.  The split revolves around whether the bankruptcy code preempts the FDCPA or whether both can apply to a creditor at the same time.  In essence, bringing around the hypothetical posed at the beginning of this article.

(Some history before we dive in. The Eleventh Circuit, in the opinion described below, was responding to some confusion sowed after a prior ruling in Crawford v. LVNV Funding, LLC. In Crawford, the Eleventh Circuit held that the FDCPA applied to a Chapter 13 claim filed for a time-barred debt. The Supreme Court denied cert. District courts, in the wake of Crawford, stated the FDCPA and the bankruptcy code were in irreconcilable conflict and, under a doctrine termed implied repeal, held that the bankruptcy code preempted FDCPA claims. Johnson reversed that holding, reinstating the Crawford regime that held the FDCPA applied to claims for stale debts.)

In Johnson v. Midland Funding, the Eleventh Circuit found that the two statutes were not irreconcilably different, and that the FDCPA is violated when a creditor files a claim on a time-barred debt. The Eleventh Circuit reasoned that:

The Code establishes the ability to file a proof of claim, see11 U.S.C. § 105(a), while the FDCPA addresses the later ramifications of filing a claim, see Crawford, 758 F.3d at 1257.

The Eighth Circuit on the other hand came to the opposite conclusion, finding that the bankruptcy code and FDCPA are in direct conflict, and that the filing on a time-barred debt is not barred by the FDCPA.  In making its decision, the Eighth Circuit noted that due to the special protections afforded to debtors in bankruptcy, the concerns for which the FDCPA was originally enacted are not present.  Stating:

These protections against harassment and deception satisfy the relevant concerns of the FDCPA. “There is no need to protect debtors who are already under the protection of the bankruptcy court, and there is no need to supplement the remedies afforded by bankruptcy itself.” Simmons v. Roundup Funding, LLC, 622 F.3d 93, 96 (2d Cir. 2010) (so stating while rejecting an FDCPA suit even where the proof of claim was inaccurate and inflated).

The ultimate decision reached by the Eighth Circuit was also reached by the Fourth and Seventh Circuits, albeit for slightly different reasons.  But the underlying thread between the decision was the extra layer of protections afforded do debtors in bankruptcy.

I’m Not Broke (Yet), Why Should I Care?

The outcome of this circuit split will have large implications not only for the creditors filing these stale claims but also for the debtors.

If the Eleventh Circuit’s reasoning is followed, then not only will creditors miss out on an opportunity to be repaid, but the debtor will now have a civil cause of action against the holder the debt.

On the other hand, if the Fourth, Seventh, and Eighth Circuits are followed, holders of time barred debt will be able to continue to assert claims and hope to receive payment.  And if this riveting split wasn’t reason enough to follow this case, the Supreme Court just granted cert to Johnson v. Midland.

Just One-Day-Late: A Split On Filing Deadlines

It’s always a terrible feeling to be late. It can incite panic as you rush to finish a task. Being late by just one day has disqualified mayoral and Presidential candidates from making it onto the ballot. In the bankruptcy context, being a day late can prevent you from escaping from sizable debts. If only you had one day more!

The “One-Day-Late” Rule

The First, Fifth, and Tenth Circuits have developed the so-called “one-day-late rule,” prohibiting the discharge of a tax debt with respect to which a tax return was filed merely one day late.

The impact is significant. Imagine: you declare bankruptcy, hoping to have a fresh start, only to discover that twenty-four hours and a few clicks, (maybe some licks of an envelope), is all that prohibits you from financial relief. (Read this link for a more practical explanation of how the one-day-rule impacts financial relief. Beware: there are, like, numbers and stuff.)

The courts behind the “one-day-late rule” developed it from case law, statutes, and two particular provisions of the U.S. Bankruptcy code, §§ 523(a)(1)(B)(i) and 523(a)(1)(B)(ii).

Combining the relevant sub-levels of § 523 produces a relatively succinct summary of the background law:

A discharge under . . . this title does not discharge an individual debtor from any debt for a tax or a customs duty with respect to which a return, or equivalent report or notice, if required, was not filed or given or was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition.

Thus, a tax-debt is nondischargeable if it is both filed late and filed within two years of the petition. A lot of the action revolves around whether the late filing is a return. If so, and if filed two years before the filing, then the debt is dischargeable. If, however, the tax filing is construed not to be a return, the debt is non-dischargeable.

What’s In A Name?

Complicating matters is the “hanging paragraph” 523(a)(*). The hanging paragraph defines “return” as a return that satisfies the requirements of “applicable nonbankruptcy law.” Accordingly, courts refer to applicable nonbankruptcy law in order to determine whether a debtor’s debt is to be barred or discharged.

The leading test defining what is or is not a return is termed the “Beard test. The test, which arose in the tax context, has four elements, with much of the action revolving around the third element: “[T]here must be an honest and reasonable attempt to satisfy the requirement of tax law.” (This was the only element at dispute in the Tenth Circuit case linked above. Also, a brief note on ordering. The original articulation of the Beard test siloed “honest and reasonable” as the third prong of a four-part test. Some courts, notably the Eleventh and Seventh, state the above element is the “fourth” element in the Beard test. Some still cite it as the third. There is no actual difference. Kooky courts! They look so alike, but they’re so different!)

With respect to the one-day-rule, the courts hold that tax forms filed after the IRS assesses liability do not have a valid purpose, and therefore do not satisfy the Beard test. Because the post assessment filings are per se not “honest and reasonable” attempts to satisfy the requirements of tax law—which requires that returns shall be filed on a certain date—the filing is not a return for purposes of dischargeability.

Although the Tenth Circuit in In Re Mallo quibbled with the use of the Beard test, it functionally reached the same result by construing the phrase “applicable filing requirements” in the hanging paragraph to include filing deadlines (thereby obviating the need to even use the Beard test in the first instance).

The result—either via the Tenth Circuit’s reasoning or a straightforward application of the Beard test—is often the same:

We agree with these decisions and hold that, because the applicable filing requirements include filing deadlines, § 523(a)(*) plainly excludes late-filed Form 1040s from the definition of a return.

The Fifth Circuit held the same in a prior case, reasoning not under Beard, but under the applicable filing requirements strain of logic.

The IRS has rejected this approach, and the Eleventh Circuit and the Ninth Circuit Bankruptcy Appellate Panel have refused to adopt it and suggested that it is incorrect. (I should note that, while the IRS has rejected the approach, it has not rejected the result. As the Tenth Circuit said in Mallo: “Even though the IRS interpretation results in the same outcome as our reading of Section 523(a) under the present facts, it is analytically incompatible with and would render our analysis of the hanging paragraph irrelevant . . . .”)

Justice Approach

The Eleventh Circuit’s decision in Justice v. US typifies the opposite side of the split.

Here, the Plaintiff-Appellant declared Chapter 7 bankruptcy in 2011 and sought to discharge his federal income tax liability for 2000-2003, despite having filed taxes for that time period many years late.

The Eleventh Circuit assumed arguendo that the one-day-late rule was incorrect and applied four factors from Beard v. Comm’r of Internal Revenue  to determine if the Plaintiff-Appellant’s tax returns from 2000-2003 satisfy “the requirements of applicable nonbankruptcy law.”

The Eleventh Circuit joined the IRS and the Fourth, Sixth, Seventh, and Ninth Circuits to hold that determining “an honest and reasonable attempt” requires analysis of the entire time frame relevant to the taxpayer’s actions. The Eighth Circuit, as well as a dissent in the Seventh Circuit by Judge Easterbrook, argue that only the time frame in which the belated return itself is filed should be examined.

Looking Forward

These split(s) are difficult. Does a late filing render a debt non-dischargeable? Courts seem to say yes, but why? Is it because the filing no longer qualifies as a return? That’s what Beard and its progeny suggest. Is it because the one-day-late rule bars a filing from qualifying as a return? That’s what the First, Fifth, and Tenth circuits suggest (see Mallo). And what to make of the fourth (third?) Beard prong? Do we examine whether a taxpayer was honest and reasonable with respect to whether they filed on time? Or does the Eighth Circuit (and Easterbrook) have a better take on the issue?

In 2015, the Supreme Court had the opportunity to resolve the split, but denied certiorari to the 10th Circuit’s decision in Mallo v. IRS.

Someday, we’ll get the right answer—let’s just hope it’s not a day too late.