Reg A+ is Effective Today; Still Waiting for Crowdfunding Rules

The SEC's rules to facilitate Regulation A+ become effective today.  The rules implement Title IV of the Jumpstart Our Business Startups Act of 2012 (the JOBS Act).  Title IV Small Company Capital Formation  raised the cap on the amount of securities that can be sold in a 12 month period from $5 million (under Reg A) to $50 million (under new Reg A+), subject to disclosure requirements (e.g., a certified audit) not required for ordinary Reg A offerings.

Market watchers are not expecting that the newly effective Reg A+ rules will have much of an impact on start ups and small businesses that don't already have the cash necessary to comply with its  requirements.  The big development yet to occur is SEC adoption of final rules for Title III of the JOBS Act titled Crowdfunding.  In Title III, Congress directed the SEC to write rules implementing an exemption from securities laws for crowdfunding via the internet, and rules for a funding portal by which internet-based platforms could facilitate a market for securities without registering with the SEC as brokers.  The SEC published proposed rules for comment in October 2013 and the public comment period closed in February 2014.  The SEC announced that the final rules will be released in October 2015.

Crowdfunding sites are already operating to offer securities for accredited investors only under Regulation D.  Some commentators see a bleak future for crowdfunding for non-accredited investors under the rules the SEC has proposed.   The SEC estimates that to raise $100K via non-accredited investor crowdfunding, an issuer would have to incur around $39K in fees for accountants, lawyers and the funding portal.  To raise $1 million the estimated costs tops $150K.  An offering under Reg D, although restricted to accredited investors, is relatively light on required disclosure and much cheaper.  So, if/when the SEC promulgates the final crowdfunding rules, it may be that only the most desperate issuers will use it.

No Fees to Defend Fees

In Baker Botts LLP v. ASARCO LLC, the Supreme Court held that law firms that represented the debtor in possession (DIP) cannot recover from the estate for fees incurred defending their fee petition.  Two firms representing the DIP had successfully litigated a fraudulent transfer claim against ASARCO's parent corporation and obtained a judgment in favor of the estate worth around $7-10 billion.  The  parent objected to the fees and after a six day trial, the court awarded the firms about $120 million for legal services, a $4.1 million enhancement for exceptional performance, and over $5 million for time spent defending their fee petition.  The parent corporation appealed and the Fifth Circuit reversed on the award of fees for defending fees.  It held that absent express statutory authority, each party pays his own attorney's fees (the "American Rule"), and although the Bankruptcy Code provides for payment of fees for legal services rendered to the estate, it does not provide a statutory basis to shift to the estate the fees incurred defending a fee petition. 

Justice Thomas wrote the opinion for the majority (Thomas, Roberts, Scalia, Kennedy, Alito).  Justice Sotomayor concurred in part and concurred in the judgment.  Justices Breyer, joined by Ginsburg and Kagan, dissented.  Justice Thomas invoked the Court's general jurisprudence regarding attorneys' fee awards under the American Rule.  Under the Bankruptcy Code, the bankruptcy court may "award...reasonable compensation for actual, necessary services rendered by" such lawyers but only after "notice to the parties in interest and the United States Trustee, and a hearing....."  11 U.S.C. sec.330(a)(1).  The U.S. Trustee regulates and monitors the fee petition process and requires compliance with its guidelines for compensation which impose timekeeping and reporting standards for professionals who submit fee petitions.  The Court held that the phrase "reasonable compensation for actual, necessary services rendered" in section 330(a)(1) limits recovery of fees to those rendered for services to the DIP.  In contrast, the law firms' claim for attorneys' fees were incurred in representing themselves in the fee petition process. 

The law firms, of course, saw it differently.  They argued that the litigation over the propriety of their fees was part of "services rendered" to the estate.  The Court called that argument "untenable" and noted that the dissent rejected it too.  The balance of the opinion addressed the arguments made by the United States as amicus curiae.  The government conceded that defense of a fee application is not "service to the estate."  But, it argued that such fees should be borne by the estate because costs incurred in defending fees affect the net compensation an attorney receives.  This is the effect of the American Rule in every context in which it applies. 

The United States argued that the unique nature of bankruptcy litigation justified a "judicial exception" to the American Rule.  Outside of bankruptcy, a dispute about attorneys' fees is a private matter between the lawyers and the client.  In a bankruptcy proceeding, the court supervises attorneys' fees (and other professional fees), with notice to and an opportunity to be heard from "parties in interest" who may raise their own objections to the fees on the merits or for strategic reasons.  Justice Thomas concluded that whether bankruptcy litigators are especially vulnerable to fee dilution due to abusive litigation over their fees, "Congress has not granted us 'roving authority... to allow counsel fees...whenever [we] might deem them warranted. (citation omitted).  Our job is to follow the text even if doing so will supposedly undercut a basic objective of the statute.'"

I Am Not Going to Tell You Again

The New York Court of Appeals decided that Warren County, NY did enough to notify  a delinquent taxpayer before foreclosing on his property.  In MacNaughton v. Warren County, the court considered the lament of the owner of a piece of undeveloped real property in Warren County who lost the property at a tax foreclosure sale.  The MacNaughtons lived in New Jersey.  They moved in 1993, their forwarding order at the post office expired in 1994, the last year they paid any property tax.  In 1998 the county sent a notice of foreclosure to the MacNaughton's last known address by mail which was returned as "undeliverable-- forwarding order expired."  The county began foreclosure procedings and sold the property at auction in 1999 for $3,700.  The MacNaughton's learned of the sale in 2003, and two years later sued the county claiming that the sale was void as a violation of their due process and equal protection rights.  They lost at trial and on appeal and  before New York's highest court.

In Jones v. Flowers (2006), the U.S. Supreme Court considered what process is due to a delinquent taxpayer before a foreclosure sale.  It held "that when mailed notice of a tax sale is returned unclaimed, the [taxing authority] must take additional reasonable steps to attempt to provide notice to the properyt owner before selling his property, if it is practicable to do so" but that the steps required "must be such as one desireous of actually informing the absentee might reasonably adopt to accomplish it."

The New York court distinguished Jones and held that the county did enough.  It would have been futile in this case to send notice of foreclosure to "occupant" at the MacNaughton's last known address.  Moreover, MacNaughtons did not show that had the county would have discovered their current address if it had consulted the post office.  (New York law tax foreclosure law changed to become more tax payer protective since the foreclosure sale, and under the new law, the county would have been required to check with the post office for the MacNaughton's current address.) 

The MacNaughton's were peeved that Warren County personally served notice of foreclosure sale on Warren County residents whose mailed notices were returned as undeliverable but for out of county taxpayers, did nothing to locate them.  The Court of Appeal's simply noted that MacNaughton's equal protection claim was without merit.

Didn't the MacNaughton's wonder about the taxes on their property in Warren County when they received no bill, and paid no tax year after year?  It's not relevant in the cosntitutional due process analysis (what process the county owes the taxpayer), but MacNaughton's clearly could have saved themselves a heap of aggravation by making sure the county had their current address.  

Global Growth is Good News for Lawyers

The U.S. Department of Commerce Bureau of Economic Analysis recently reported some interesting data on the operations of U.S. multinational companies at home and in foreign countries. Worldwide capital expenditures by US multinational corporations increased 3.9 % in 2012 to $621 billion. The rate of increase in capital expenditure abroad by majority-owned foreign affiliates outpaced spending by US parent companies in the US. (Capital expenditures in the US by US parent companies increased 3.3 % ($447 billion), whereas capital expenditures abroad by majority-owned foreign affiliates increased 5.5% ($173 billion)). Similarly, the rate of increase in sales by majority-owned affiliates (8.6%, $5,197 billion) outpaced the increase in sales by US parent companies in the US (6.8%, $9,843 billion).

An important motivation for capital expansion abroad used to be to access cheap labor. This new data shows that companies are investing abroad to access fast growing local markets, primarily India, China, Eastern Europe and Brazil. See generally: Kevin B. Barefoot and Raymond J. Mataloni Jr., Operations of US Multinational Companies in the United States and Abroad, Preliminary Results from the 2009 Benchmark Survey.

The big thing for business now is real global competition as multinational companies scramble to sell goods and services to customers in foreign markets. Actually doing business in foreign countries is considerably more complicated than simply manufacturing goods abroad for sale at home. Building market share in a foreign country requires understanding of all of the same factors that support profitable business at home—customers, supply chain, costs, labor, regulation, politics, and taxes, to name a few. Growth in foreign markets is low hanging fruit, but profitable growth is not any easier over there then it is over here.

And that is very good news for US lawyers who are ready for global business.

Red Lion Returns

It's not news by any standard, but this story stirred the Red Lion from slumber. For one moment, I am in solidarity with runway models who kicked off ridiculous shoes in exasperation over the absurdity of it all.

Fear of Foreclosure

The prominence of foreclosure in economic news and the skimpy coverage of the breakdown of foreclosure process in the popular press shows the literary force of the word: "foreclosure." It has the visceral impact of a word like "rape," connoting a violent, destructive, faceless goon that comes out of the darkness to destroy the weak and helpless. People are getting "foreclosed on," foreclosure is destroying neighborhoods and cities, and the nation is in a foreclosure crisis. Foreclosure is Voldemort.

Legally, foreclosure is tame and boring. It's a mopping-up operation that has for centuries been relegated to the losers bracket among lawyers, and the museum of antiquities in law. It's no wonder that the reporters don't explain the residential real property foreclosure process, or why law professors roll their eyes when I start to say that joblessness, default, unchecked speculation, arrogance and bad judgment are far scarier than foreclosure. Who wants to think about dirty socks and dust bunnies under the bed when the alternative is to imagine a scary monster?

What do you think? What explains the fear of foreclosure?

Ransom

Last Monday, the Supreme Court heard argument in In re Ransom. A colleague on the law faculty whose forte is not bankruptcy asked me about the case in advance. He was showing an Australian law professor the sights in D.C. on the First Monday in October and Ransom was on the docket. My colleague expressed disappointment that the First Monday docket was clogged with an unexciting bankruptcy case. I told him that Ransom is exciting to me.

The case is about the meaning of a hideously drawn provision that appeared in the Bankruptcy Code as part of the 2005 Reform Act-- the so-called "means test" that governs a debtor's eligibility for discharge of debt under chapter 7 and chapter 13. In simple terms, a consumer debtor is eligible for debt forgiveness if her income is less than the Census Bureau-reported median income for her state. If her income is greater than the median income, then she is eligible for relief in a chapter 7 liquidation case, only if she doesn't have the "means" to pay down her debts over time while paying her current living expenses. If she wants to keep her property and pay down her debts over time, she is eligible for debt forgiveness in a chapter 13 case only if she pays creditors from her income each month the amount she has the "means" to pay. In both settings, "means" means the difference between the debtor's "current monthly income" and her expenses.

The Code provides a staggeringly unreadable list of the expenses that are to be considered for purposes of this comparison. Rather than relegate to the bankruptcy judge the role of determining which expenses that the debtor actually incurs are "reasonable and necessary" as was the judge's role before the 2005 Reform Act, the Code now describes the expenses that the debtor may deduct by reference to IRS published guidelines for agents (the National and Local Standards) who are trying to settle tax delinquencies with taxpayers based on the amount the taxpayer can realistically pay each month and survive.

In Ransom, the dispute was over the amount the debtor could count as an expense of car ownership. Particularly, the question was whether the debtor should be able to count the amount referenced in the Local Standards for a loan or lease payment even if he owns his car free and clear and doesn't actually make any loan or lease payments. In short, does the Code mean that the debtor should be credited with expenses he doesn't actually have for the purpose of determining his "means?" The bankruptcy court held that a debtor has to have some actual car payment expenses before he can claim the IRS plug amount as an expense. The Ninth Circuit affirmed contributing to a split in the circuits on this issue.

I felt it was important to explain to my colleague why this case is so interesting. So I cut to the chase. The "plain meaning" reading in this case is not easy to see because the statute is so badly drawn. The debtor will benefit from a reading that gives her the largest expense total and the largest deduction from income in calculating her "means." The trustee for the benefit of unsecured creditors like MBNA, the unsecured creditor who paid lawyers to take this case all the way to the Supreme Court, will benefit from a reading that limits debtors to the smallest expense total.

So, my colleague, an afficionado of legislative process and statutory interpretation, watched the argument and concluded that the Justices seemed stumped. The interpretation of the statute offered by both sides led to at least two completely absurd scenarios each. The one indisputable fact is that the statute let everyone down and the Court got the dirty job of cleaning up the mess.

My colleague offered the idea of a post legislative, pre-judicial clean up team -- a panel of "special masters" with bankruptcy expertise who would take the legislation that extrudes out of the Congressional sausage maker, consult with the ALI, lenders, borrowers, practitioners and academics, and draft a recommendation for courts who are put to the task of interpreting and applying the legislation.

My reaction to this idea was not good. I am already footing the bill for Congress and I do not want to pay for another layer of government workers who would be subject to the same political pressures that render the officials we elect to make law obviously and completely incapable of doing it. I think that the time for consultation with interest groups, academics, etc. is before the statute is enacted by Congress.

The problem I see is that legislators are hopelessly unmotivated and unable to understand the legislation they enact. The Supreme Court is now the cleanup operation of last resort for all sorts of badly drawn, ill conceived, utterly impractical and inscrutable legislation.

By way of history, as part of the 1994 amendments to the Bankruptcy Code, Congress ordered the creation of the National Bankruptcy Review Commission. This Commission undertook a complete review of the Code and held hearings at which bankruptcy scholars, practitioners and related industry experts had an opportunity to comment. It issued a comprehensive report and reform proposal with a vigorous dissent. Congress entirely ignored all of it. The bankruptcy bar picked to bits the consumer provisions in the legislation that ultimately became the 2005 Reform Act during the years it floated around Congress before it was enacted. Congress ignored it all. And it was easy, because congressmen and senators do not understand anything about the laws they enact. The voices of those who were advocating for technical amendments or otherwise pointing out absurdity in the proposed revisions to the Bankruptcy Code were no more than refrigerator hum. Bankruptcy, tax, administrative law, market regulation, environmental law, you name it -- it's all refrigerator hum.

The problem is easy to see but hard to fix. Bankruptcy policy is fundamental and richly complex. In a simple and broad sense, bankruptcy law describes whose debts may be forgiven. If you stop there, the politics are already hopeless. In debt as in life, sometimes you are the windshield and sometimes you are the bug. Nobody is always for more forgiveness or always for less. So the politics is really in the details. The problem is that as soon as you move past the core function of bankruptcy law into the practical and administrative issues,the core function becomes quickly lost and inaccessible to non-specialists. Instead of considering the basic contours of debt forgiveness directly, the Code provides for exemptions, avoidance powers, claims processes and, as in Ransom, eligibility for relief stated in nearly incomprehensible and arguably absurd terms. Legislators probably don't even think for a second about the macro implications of the law they are enacting: How does this law affect the question of who is forgiven? Rather, legislators tinker around the edges in response to special interest groups whose requests affect the measure of forgiveness in ways that would take at least a 14 week law school course to explain. In short, there are plenty of experts willing to teach members of Congress how changes in the law will or may affect the measure of forgiveness. The problem is the shortage of members of Congress who really want to make the investment necessary to acquire that information.

The second problem is related to the first. Negotiating legislation, like negotiating anything else is expensive. To reduce transaction costs, legislators translate complicated provisions into broad terms. For example, Republicans can sell to their base the idea that the cost of debt forgiveness is borne by people who find a way to live within their means, and thus, it should be harder to discharge debts in bankruptcy. Democrats can sell to their base (what Elizabeth Warren is selling) that the credit card companies are making oodles on consumer debt and they should bear a little pain to make life worth living for working people who hit hard times. The broad principles on which political bargaining occur are so broad that the actual legislation is left to non-legislator staffers and lobbyists who are primarily interested in getting the deal done rather than getting it done in a way that will not appear absurd to a court. The means test language before the Court in Ransom is a small part of a drafting exercise left to drafters who have no stake in the legislation post-enactment.

After the oral argument before the Court in Ransom, who on the Hill is red-faced about the unmissable disrespect for their work? That's right. Nobody. It's a sad indictment of democracy when citizens accept that legislators of all political persuasions are not personally or politically embarrassed by the shoddy quality legislation they impose on the citizens who elect them.