Special Feature: Venue Reform in the Spotlight

Contributors Rachel Albanese, Elliot Ganz & Clifford J. White III take on Venue Reform

Our Contributors tackle how Judge Jones’ sudden resignation and the shake-up in the Southern District of Texas’ bankruptcy panel will affect venue choices going forward. 

For several years now, the Southern District of Texas has been the venue of choice for large, complicated corporate bankruptcies.  Nearly 50% of all large commercial bankruptcy cases ended up in the Southern District of Texas in the first half of 2023.  Prior to the ascendancy of the Southern District of Texas, the Southern District of New York and the District of Delaware were the go-to destinations. New Jersey now seems to be on the rise.

Where do we go from here? Will opportunistic debtors continue to shop for forums perceived as “friendly”? Where will those be? and why? Will we finally see action to address venue shopping (or its pernicious cousin, judge shopping)?  Will the SDTX remain a preferred venue? 

Please read on.

Rachel Ehrlich Albanese
DLA Piper

One Code, One Court

Complaints about venue shopping are nothing new. While the court du jour has changed, and I’m grateful I spent that extra day in Camden years ago taking the NJ bar exam, we arguably jeopardize the credibility of the restructuring process when perceived outcome is prized over proximity or operational nexus. The Southern District of Texas created a complex case panel to provide predictability, but the benefits afforded by that designation have been overshadowed by claims of forum shopping and more.  But what if there were a national complex case panel?

Judges could apply or be nominated by their respective circuits to sit on the national panel. While the number would be determined by the US GAO, the judges who were selected for the panel could divide their duties between their home jurisdictions and their complex case assignments.

Employing the rational criteria adopted by the Southern District of Texas, a “complex case†could be a case or group of affiliated cases in which (i) the total liabilities of the debtors and their non-filing affiliates exceed $10 million; (ii) there are more than 50 parties-in-interest; or (iii) any claims against or interests in the debtors are publicly traded. If the debtors and their non-filing affiliates have less than $200 million in liabilities, the debtors could elect the complex case designation, but it would be mandatory in cases where the debtors and their non-filing affiliates have $200 million or more in liabilities.

Each such case would be randomly assigned to a judge from the national complex case panel. Geography is no longer a factor. Flying to Houston for an in-person hearing is no different than flying to St. Louis, for example, and zoom hearings remain popular.

In essence, one Bankruptcy Code governs all fifty states; one panel of experienced and sophisticated judges to apply that statute to complex cases across the country would work equally well.

Copyright © 2023 Creditor Rights Coalition. All rights reserved.

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Elliot Ganz
Loan Sales & Trading Association

Houston, We Have a (Bankruptcy Court) Problem

In a shocking turn of events, bankruptcy Judge David Jones of the Southern District of Texas (SDTX) abruptly announced his resignation in early October. The resignation came following revelations that Jones has since 2017 been living with a prominent Houston bankruptcy lawyer who represented debtors in many high-profile bankruptcy cases over which he presided.  Jones was the chief judge of the SDTX bankruptcy court and one of two judges on its complex-case division. Since January 2020 that court has presided over a third of all complex-bankruptcy cases with liabilities over $1 billion.  Jones himself handled 17% of all such cases during that time including some of the highest profile and contentious bankruptcies, such as Serta and Neiman Marcus. Jones’ resignation raises many important questions: What will happen to the cases he was running at the time of his resignation?  Did his relationship affect his rulings, and, if so, will those decisions be subject to reconsideration? Finally, will the SDTX bankruptcy court continue to be a sought-after venue? If not, where will all those cases migrate?

The answer to the first question is clear: The cases Jones was handling have been assigned to the two remaining judges in the complex-case division, Marvin Isgur and Christopher Lopez. Judge Isgur, previously one of the two members of that division, stepped away last year and has now returned. Judge Lopez joined the group when Isgur stepped away.

While vacating or reopening a court’s final decision is subject to a high bar, parties have started to test other paths to challenge some of Jones decisions. The U.S. Trustee has sought vacate compensation awarded to Jackson Walker in at least 26 cases. It seems that parties to some of the more contentious cases before Jones are likely to continue test his prior rulings.  Indeed, the “Excluded Lenders†in the Serta case recently submitted a reply brief case asking the Fifth Circuit to reverse Jones’ decision on “open market purchases†and remand to the Southern District of New York given Jones’ resignation. In Sorrento Therapeutics, the Equity Committee has objected to debtor’s counsel fees for failure to disclose the relationship between Liz Freeman and Judge Jones. The fall-out is likely to continue.

The LSTA has written extensively about the phenomenon of “bankruptcy judge shopping,†explaining how distressed borrowers are often able to strategically choose not just the venue in which to file (that used to be the goal), but actually the judge who will handle the case. Perhaps the most conspicuous examples of this trend were in Westchester, New York, where filing there assured that your case would be heard by Judge Robert Drain (who has since retired), and Houston, Texas, which got your case in front of either Jones or Isgur. While the LSTA has joined the Creditor Rights Coalition as well as many academics in arguing that this system corrupts the bankruptcy process, we have more to do to see this practice ended. In the meantime, the question becomes, where will the SDTX cases go? Likely candidates include Delaware and the Southern District of New York, whose robust bankruptcy courts have until recently presided over the bulk of large, complex cases, and “new kids on the block,†such as New Jersey, where Judge Michael Kaplan is presiding over several recent complex cases. With Jones’ resignation, the glory days of SDTX may be over.

Copyright © 2023 Creditor Rights Coalition. All rights reserved.

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Clifford J. White III*

Policy and Litigation Implications of the Scandal in the Bankruptcy Court in the Southern District of Texas

Whether or not the scandal unfolding in the Southern District of Texas bankruptcy court turns out to be a confined case of judicial hubris or a more far-reaching transgression, the entire bankruptcy system has suffered a body blow.[1]  It will not be quick or easy for the system to recover and regain public confidence.  But making long-debated reforms to chapter 11 bankruptcy practices is a necessary start.

Background

In some ways, recent revelations about conflicts of interest should remind us how we got the modern Bankruptcy Code in 1978.  As described in Congressional and other reports, there was a widespread perception that bankruptcy cases were controlled by a “closed ring†of professionals who operated in their own interest and not on behalf of stakeholders.  Among many other things, the new Code created a more transparent system that better defined the roles of the participants to ensure greater neutrality and professionalism in the administration of bankruptcy estates. 

The Houston scandal points out how the system of mega-chapter 11 case administration has moved backwards.  It is often free-wheeling and controlled by too few judges and practitioners.  As revealed by Professor Levitin, Judge David Jones in Houston controlled a grossly disproportionate share of the nation’s largest corporate cases.  It is no wonder that suspicions are raised (fairly or unfairly) that some districts campaign for big cases, while being cheered on by the local bar which shares in the financial prosperity. 

Although there are many bankruptcy reforms worthy of deliberation, the Judicial Conference and Congress should take steps now to stop judge-shopping and enact venue reform.  At the same time, the courts are sorting through scores of affected cases to ensure that any injustices are corrected.

Whither Big Case Bankruptcy Practice in the Southern District of Texas

Although the choice of forum remains in the discretion of a handful of law firms who are retained in the biggest cases, it would not be surprising if the number of new chapter 11 filings in Houston drops sharply.  Early indications show the biggest filings are migrating from Texas to New Jersey.  Law firms may feel they face reputational risk if they are closely associated with a tainted district.  Every court decision will be under the microscope.  Elevated public concern about procedural fairness might cause debtor’s counsel to go elsewhere unless Houston is truly the main hub of the corporate debtor.

None of this is to say that the bankruptcy court will readily accept a new status quo.  In the case of Barrett’s Minerals, Inc., case no. 23-90794 (Bankr. S.D. Tex.), the bankruptcy judge denied the official creditors’ committee motion for a transfer of venue to Montana where the debtor has its headquarters and mines its products.  One of the arguments made by opponents of venue change was convenience of the professionals.  Under that theory, I guess the bankruptcy case of a large company in Montana or other rural state should never be administered in the local jurisdiction.

Judge-Shopping

But voluntary restraint is not enough.  The judiciary should take immediate steps to stop judge-shopping nationwide.  The first step, of course, is for the Southern District of Texas to reform itself.  As laid out in a recent public letter signed by a still-growing number of bankruptcy scholars, practitioners, and organizations, the bankruptcy court in Texas should eliminate its current complex chapter 11 panel and adopt a random judicial assignment system. If the bankruptcy judges themselves do not do it, then the district court or Fifth Circuit should do it for them.

Beyond that, the Judicial Conference should better regulate local court case assignment practices.  While bankruptcy judges should retain some discretion, they should do so under strict guidelines that prevent the kind of “closed rings†that may develop where special panels replace random district-wide assignments.[2]
Judge-shopping favors the big players over the smaller stakeholders, resides too much case law-making in too few judges, and restricts the broader percolation of major issues.  The fast pace of bankruptcy cases makes this problem all the more acute.  Instead of issue development among a diversity of jurisdictions, a small number of judges can resolve a major legal issue as “one-and-done.â€Â  That may allow cases to move faster, but it is less fair and not the way our federal court system was designed to operate.

Impact on Venue Choices in Large Cases

Judge-shopping would be impossible without lax venue rules.  Under 28 U.S.C. 1408, large corporate debtors can file in almost any district in the country.  For example, debtors may file in their state of incorporation or where an affiliated entity files.  Manufacturing venue is as easy as incorporating a shell affiliate in a district with friendly case law.  That allows the troubled parent or related sister company to file soon afterwards in the same hospitable district. 

Legislative reform should ensure that filings are made where there are substantial connections between the debtor and the district.  Eve of bankruptcy corporate machinations give a bad look to the whole bankruptcy system and should be proscribed.

The Commercial Law League of America (CLLA) has long been advocating for venue reform.  The CLLA is particularly persuasive in making points about the inconvenience and unfairness to smaller creditors who cannot afford to participate in cases far from their home base.  The CLLA recently issued a letter in support of the anti-judge-shopping letter mentioned above.  It merits careful study. 

Impact on Cases Decided by Judge Jones

As of this writing, well over 20 cases have been filed in connection with  Judge Jones or cases he decided.  More can be expected.  All of the cases involve the law firm of Jackson Walker where Judge Jones’s romantic partner was a lawyer.  Direct actions against Judge Jones were filed in the district court and transferred to the Western District of Texas.  The rest were filed by the United States Trustee (UST).   In one case, the UST challenged a pending disclosure statement because Judge Jones mediated a pivotal settlement.  In others, the UST is seeking to revisit fee awards Jackson Walker.   The UST also asks that the district court “withdraw the reference†from the bankruptcy court and transfer the matters to a judge from the Western District of Texas who will hear the direct causes of action.

Even though the UST has already filed many challenges, its approach remains surgical.  By addressing the award of about $18 million in professional fees awarded to Jackson Walker, the UST is acting squarely within its bailiwick.  The questions to be resolved pertain to disclosure (e.g., the adequacy of the affidavit filed in the case) and other ethical obligations in cases in which Judge Jones was the presiding judge or acted as a mediator.  Jackson Walker has filed a strong defense, but these cases may present an eschatological challenge for the firm.

Beyond the threat to one law firm, the fees of any professionals who participated in the cases also may be at risk if they breached fiduciary duties, failed to follow applicable ethics rules, or filed incomplete statements of connections as required by bankruptcy law. 

In an earlier action seeking Judge Jones’s recusal two years ago, the Houston bankruptcy court denied the movant’s right to obtain discovery on the very issue that is now at the core of the scandal – whether Judge Jones lived with his romantic partner and presided over cases involving her or her law firm.

The UST now gets to ask the “Howard Baker Question†from Watergate: what did the lawyers know and when did they know it? 

By seeking a review of fees, the UST is potentially opening up a broader investigation that some say the Circuit stopped pursuing when Judge Jones abruptly resigned from the bench last month. 

Can Equitable Mootness Be Used to Prevent Redress?

The UST also has statutory authority to challenge the merits of non-fee decisions.  It may be more likely, however, that aggrieved private parties will seek to undo substantive legal decisions.  It is not unusual for other courts, including through appellate review, to reconsider decisions made by a judge who failed to recuse herself from a case.  For cases in which reorganization plans were already confirmed, the process of unravelling becomes difficult.  In the fee cases, it should be fairly simple because disgorgement of fees will simply pay more money to more parties in accordance with the plan.  In fact, the UST’s settlement with McKinsey & Company in Westmoreland Coal (case no. 18-35672) involved precisely that scenario.

It can be expected that some parties will assert equitable mootness as a reason to obstruct court review of previous decisions.  The Fifth Circuit has suggested that the doctrine of equitable mootness is not jurisdictional or mandatory.  See In re Texxon Petrochemicals, LLC, 67 F.4th 259 (5th Cir. 2023).  Under the circumstances of the Jones cases, it seems unlikely that a court will preclude review based upon a dubious and hotly debated theory of law.  It could make a determination on the merits and then decide on the practicality of a remedy.  (The Supreme Court declined to hear a challenge to equitable mootness a few months ago.)

Conclusion

The saga of the clearly conflicted bankruptcy judge in Houston is sad for the administration of justice and a black eye for the bankruptcy system.  Sometimes an egregious situation focuses attention on the need for broader policy reform.  Or, to borrow the Mel Brooks paraphrase of Nietzsche, sometimes “out of chaos comes order.â€

Copyright 2023 Creditor Rights Coalition

*Cliff White served as head of the Justice Department’s “bankruptcy watchdog,†the United States Trustee Program, for seventeen years before retiring last year. He is currently an executive with a financial technology company. The views expressed are those of the author only.

^ 1 Without recounting the details, the essential facts of the scandal are set forth in a complaint filed by the Chief Judge of the United States Court of Appeals for the Fifth Circuit in which she found â€probable cause†that Judge David Jones committed judicial misconduct by presiding over, or mediating, cases involving a former law clerk with whom he shared a household or her law firm.

^ 2 There may statutory limitations on direct action over internal procedures adopted by district and bankruptcy courts.  See 28 U.S.C.331 and 333.  To the extent the Judicial Conference and Circuit Courts need additional authority, then Congress should act.