Consumer Protection and the Code Pre-emption and Enforcement

Journal Issue

Jun 1999

Column Name

Affairs of State

Journal HTML Content

Little did I know when I volunteered to write for this column that my first submission would be due

just as the bankruptcy bills were coming to the floor in Congress. There are a hundred topics with

respect to those bills, but I have been thinking about one hot debate, namely reconciling the various

cases that have issued since the famous—or infamous—Sears reaffirmation cases with current

proposals that would make state attorneys general part of the enforcement mechanism against

creditor abuses. And frankly, I'm confused.

As we all recall, in November 1996, Francis Latanowich stirred up a hornet's nest

when he asked the bankruptcy court in Massachusetts to reopen his case because

his reaffirmation payments were "keeping food off the table for my kids." The

problem was, of course, that there was no evidence in his file that he had agreed

to reaffirm any of his debts, including the $1,300 he owed to Sears.<a href="#2">2</a> As Judge

Kenner made further inquiries, she learned that Sears had obtained a signed

reaffirmation from Mr. Latanowich but had not filed it with the court and that this was standard operating procedure, not a

mere aberration. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Latanowich, 207 B.R. 326 (Bankr. D. Mass. 1997)</a>.

At that point, Sears' senior management, knowing of the "smoking cannons" that were in its files, threw in the towel and

entered into intensive negotiations with a variety of interested parties, including the U.S. Trustee's office, the Federal Trade

Commission, the collective state attorneys general and representatives of several class actions.<a href="#3">3</a> The final results included

class action and other settlements that resulted in the payment by Sears of hundreds of millions of dollars to consumers in

refunds and cancellation of debt, tens of millions of dollars in attorneys' fees to class counsel and penalties to the attorneys

general, and a $60 million criminal fine to the United States. Similar suits have subsequently been brought by parties,

including the attorneys general, against a number of other creditors, such as May's, Federated and GECC, resulting in

similar settlements.

Why am I confused? Well, since the initial flurry of actions, there have been attempts to bring similar cases with respect to

other alleged violations of the Code. In these cases, though, the defendants have begun contesting the courts' jurisdiction to

resolve class actions in the context of a single debtor's case, and the results have been widely varying. Some of the

difference can be explained by different facts, but some are simply contradictory. Nor are all of the difficult issues

addressed in the cases and, most importantly, they don't answer what should be the law in this area. For instance, should

there be different standards for pre-empting consumer protection law than for other kinds of state law claims (and, if so,

does it matter who brings such a suit)? Issues like these are policy issues and, by coincidence, we have bankruptcy bills

going through now that address some of these precise issues. So, am I happy with their treatment of the issue? Well, no, but

maybe if they changed the bills just a little bit?

So, what's the problem? Well, let's look at the law in the Northern District of Illinois that has become the focal point of

these cases. In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Zale Delaware Inc., 1998 WL 397841 (N.D. Ill. 1998)</a>, the debtor sought to file a class action with

respect to an allegedly unlawful reaffirmation. The district court held that §524, unlike §362(h), did not provide a private

right of action, that the only remedy was to seek contempt in bankruptcy court, and that the state law claims were

pre-empted by the Code, since the "expansive reach of the Code pre-empts virtually all claims relating to alleged

misconduct in the bankruptcy courts."

The next case, <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Wiley, 224 B.R. 58 (Bankr. N.D. Ill. 1998)</a>, was therefore filed in bankruptcy court, again seeking class

action status and again asserting violations of §524 and state law. Judge Schmetterer held that the issues were "core" with

respect to the debtor's own claims as to injunctive and compensatory relief, but that there was not even "related to"

jurisdiction with respect to the putative class damage claims because such amounts could not affect the size of the

plaintiff's estate. And in any event, there was no commonality of issues on damages, such that a class action could be

certified,<a href="#4">4</a> but he could certify a class with respect to injunctive relief regarding the form agreement that was used by the

creditor.

Several other cases then took up a new issue—is there a viable claim against a creditor that fails to bifurcate an

undersecured claim and, if so, may such an action be brought as a class action? In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Simmons, 224 B.R. 879 (Bankr.

N.D. Ill. 1998)</a>, Judge Lefkow held that there was no violation of the Code and that the state law claims were not property

of the estate and, as such, were not within the court's "related to" jurisdiction. In the next case, <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Sherman, 1999 WL

117754 (N.D. Ill. 1999)</a>, the court, while ignoring the class claims, held that there was no violation in the individual case

because the issue was or could have been resolved in the plan; hence, the valuation was res judicata. In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Lenior, 1999

WL 135067 (Bankr. N.D. Ill. 1999)</a>, Judge Schmetterer considered a proposed class action that raised state law claims and

asked that the court use §105 to bar the practice. The judge again concluded that he had no jurisdiction over a class claim

for damages and held that the action was substantively barred because §105 does not provide a cause of action. In addition,

he noted injunctive relief is not warranted where an adequate damages remedy exists, and the plaintiff had no standing to

seek an injunctive order since she had not alleged that she would be subject to the practice again in the future.<a href="#5">5</a> And finally,

he held, the Code pre-empted state remedies for alleged Code violations. Two weeks later, though, Judge Katz in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re

Aiello, 1998 WL 1025914 (Bankr. N.D. Ill. 1999)</a>, disagreed and held that he did have jurisdiction over a national class

action for damages in a case alleging that a creditor deliberately filed dischargeability complaints without adequate

investigation, concluding that the case "arose under" the Code regardless of whether the damages related to a particular

debtor's case. Nor, he concluded, would the need to determine individual damages necessarily bar the use of a class action.

So, do the normal rules of injunctions and standing and res judicata apply to these kinds of claims? Presumably yes, and

since the Supreme Court's decision in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Products Inc. v. Windsor, 117 U.S. 2231 (1997)</a>, it has not been as easy to

simply certify a class for "settlement purposes" and thereafter ignore the normal requirements for bringing a class action.

But does it make sense to require these kinds of actions to be brought one case at a time? With literally tens and hundreds

of thousands of debtors affected, the courts would be overwhelmed with that approach. And what of the role of state law?

In Sears, the states approached the case in the context of traditional consumer protection law under which, for instance, it is

generally illegal to threaten to do something—such as repossessing collateral—that one does not actually intend to carry

out. Such issues were at the core of the states' suits because, at bottom, they were why the creditors' pressure worked.

Accordingly, the state settlements included injunctive relief directed at those issues.

It is not clear that the Code alone can remedy such issues or that state law does not have a role to play. In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Trust

Co. v. Smith, 212 B.R. 599 (8th Cir. BAP 1997)</a>, for instance, the debtors complained when the creditor communicated

directly with them instead of their counsel. The creditor filed an adversary action for a declaratory judgment that its actions

were legal, but the bankruptcy court and the Bankruptcy Appellate Panel (BAP) disagreed, holding that it had violated state

law, which barred such contacts with represented persons. The BAP held that there was no inherent conflict between the

state law and the Code and that the provision could therefore be enforced. That holding seems obvious, but it is not at all

clear what the appropriate standard to be applied to pre-emption issues is. Plainly, Congress does not intend for the Code to

pre-empt all state laws.<a href="#5">6</a> Indeed, the Code is replete with places where state law controls the outcome. However, if we limit

the issue to the question of state law remedies for alleged Code violations, the issue of pre-emption becomes more relevant.

In general, when one is considering whether a federal law pre-empts an area that states have traditionally regulated, such as

consumer protection, the initial presumption is that Congress does not intend to displace state law.<a href="#7">7</a> That presumption is the

basis for what is known as "conflict" pre-emption— i.e., that the federal law bars the use of state law only to the extent that

there is an actual conflict such that it is impossible to comply with both laws.<a href="#8">8</a>

On the other hand, Congress may either expressly or implicitly "occupy the field" such that all other forms of regulation in

the area are barred. This form of pre-emption will be found where the "scheme of federal regulation is so pervasive as to

make reasonable the inference that Congress left no room for the states to supplement it."<a href="#9">9</a> Field pre-emption may be

accompanied by its corollary, "negative pre-emption," which holds that regulation may be so pervasive that it controls not

only with respect to what has been enacted, but also with respect to the decision not to enact other provisions. For example,

the court has found that Congress intended that the National Labor Relations Act (NLRA), as interpreted by the National

Labor Relations Board, would determine which economic weapons were barred to labor and management. Thus, a state law

that imposed additional limits on one side, even if it did not conflict with the NLRA, was barred because it conflicted with

the rights of the other side to exercise all of its remaining options.<a href="#10">10</a>

So, should these cases be analyzed under field pre-emption or conflict preemption? In Greenwood, the creditor asserted

conflict pre-emption and under that standard the court found no problem with the state statute. But would the answer be the

same under field pre-emption? In other areas, such as filing a malpractice claim against a case professional or malicious

prosecution with respect to a failed action in bankruptcy court, the courts have generally taken a broad view of the Code's

pre-emptive effect. See, e.g., In the <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… of Southmark Corp., 1999 WL 303 (5th Cir. 1999)</a> and Cox and Lenior, supra

and cases cited therein. Are those holdings easily reconciled with the use of state law in Sears and related cases? Not for

me, in any event.

What is the answer? Is the Code broad enough to deal with quintessential consumer protection claims? Do bankruptcy

judges have the background and the expertise to appreciate the variety of such claims that might arise? Some judges have

plainly been brushing up on the Truth in Lending Act,<a href="#11">11</a> but do we really expect that they should all become consumer

protection lawyers? Should such claims be allowed if they are pendant or supplemental to traditional bankruptcy law

claims? Is there jurisdiction to hear such claims as class actions,<a href="#12">12</a> and if there is, do we want them handled in that way? Or

if we are leery of class actions, can we just leave it to the governmental agencies, including the U.S. Trustees' offices and

the state attorneys general, to take action to resolve these issues on a collective basis?

<h3>Pending Legislation</h3>

The current bills do deal with the issue in certain respects. Both H.R. 833 (§106) and S. 625 (§224) provide that with

respect to debt relief agencies the state may seek injunctive relief and damages "on behalf of its residents." The U.S. district

courts are given "concurrent jurisdiction," presumably with the state courts, although this is not clear. In addition, if the

bankruptcy court, on its own motion or on the motion of the U.S. Trustee, finds that there is an "intentional" violation or a

"clear and consistent pattern or practice" of violations, it may enjoin them or impose a civil penalty. Finally, they also

provide that the new Code provisions do not exempt compliance with state law "except to the extent that such law is

inconsistent with those sections, and then only to the extent of the inconsistency." In addition, the Senate bill (§204) also

provides for the states to deal with abusive reaffirmations, noting that nothing in Title 11 "pre-empt[s] any state law

relating to unfair trade practices that imposes restrictions on creditor conduct that would give rise to liability (1) under this

section or (2) under §524, for failure to comply with applicable requirements for seeking a reaffirmation of debt," and

allows states to bring actions for their residents for damages and enforce a state criminal law that is similar to §152 or 157

of Title 18.

There are several concerns with this language. For instance, it suggests that states should be the primary enforcers of these

provisions—a flattering assignment, but one that they are not necessarily able to carry out. And, while they want to be able

to proceed when they choose, it's not clear why bankruptcy courts and the U.S. Trustees—the traditional parties who deal

with such violations—are barred from acting except under a relatively rigid standard and with relatively limited remedies,

thus further throwing the burden on the state. In addition, limiting attorneys general to seeking damages only for their own

residents is a wasteful use of resources in cases where a state has that authority to seek damages for all victims. There are

other ambiguities,<a href="#13">13</a> but the largest concern is the possibility of negative inferences. To the extent that these sections

explicitly exempt certain state laws and certain violations, do they reinforce the view that other laws are pre-empted? Those

other issues may be in dispute now, but the limits might be more easily found if these sections are passed.<a href="#14">14</a>

Given a choice, the states would prefer a simpler, broader statement that would establish the principle of conflict

pre-emption, at least with respect to actions by the state itself to enforce police and regulatory statutes in a

nondiscriminatory fashion. Language that might accomplish this goal could be included as an amendment to <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. 959</a>

or could be placed in the Code itself. In short, without being ungrateful, the states would like to make a "Yes, but" response

to the current legislative proposals. Hopefully, there is still time before the final result is reached.<hr>

<h3>Footnotes</h3>

<a name="1">1</a> The views expressed herein are solely those of the author who, while she is the bankruptcy counsel for the National

Association of Attorneys General, has not discussed this topic with any of the Attorneys General. Accordingly, neither they

nor their staffs should be held responsible for this discussion or the conclusions, if any, reached by the author. <a href="#1a">Return to

article</a>

<a name="2">2</a> For purposes of this article, "Sears" is used as a generic term for Sears, Roebuck & Co. and its subsidiaries and affiliates.

It is not meant to assign responsibility to any particular entity on whom it does not properly fall. <a href="#2a">Return to article</a>

<a name="3">3</a> Initially, a proposed national class action was filed in the bankruptcy court asserting both violations of the Code and

Massachusetts state law. A second class action was later filed in the district court when class counsel became "concerned

about the jurisdiction of a bankruptcy court over a nationwide class action." <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Sears, Roebuck and Co., 222 B.R.

181 (D. Mass. 1998)</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> Although such considerations were not thought to preclude class certification in Sears and the later cases, where such

matters were simply dealt with in the damages award process. <a href="#4a">Return to article</a>

<a name="5">5</a> Part of my confusion is why those issues were not also relevant to the decisions in the Sears case and similar actions—but

perhaps it is simply that no one thought to ask them. <a href="#5a">Return to article</a>

<a name="6">6</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… National Bank v. New Jersey Dept. of Environmental Protection, 474 U.S. 494 (1986)</a>. <a href="#6a">Return to article</a>

<a name="7">7</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… & Trades Council v. Associated Builders, 113 S.Ct. 1190 (1993)</a>. <a href="#7a">Return to article</a>

<a name="8">8</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Lime & Avocado Growers Inc. v. Paul, 373 U.S. 132 (1963)</a>. <a href="#8a">Return to article</a>

<a name="9">9</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Santa Fe Elevator Corp., 331 U.S. 218, 230 (1947)</a>. <a href="#9a">Return to article</a>

<a name="10">10</a> See <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… State Transit Corp. v. Los Angeles, 475 U.S. 608 (1986)</a>. <a href="#10a">Return to article</a>

<a name="11">11</a> See, i.e., <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Bruzzese, 213 B.R. 444 (Bankr. E.D.N.Y. 1997)</a>. <a href="#11a">Return to article</a>

<a name="12">12</a> Congress is clearly ambivalent on the issue. H.R. 833, for instance, in §114, contains language that allows a debtor to

collect the greater of actual damages or $1,000, along with costs and attorneys fees, for willful violations of the

reaffirmation provisions—but prohibits an action to recover those damages from being brought as a class action. Thus, the

exact kind of suit that was brought as a class action in Latanowich would be barred under the House language—apparently

even if it only sought to collect actual damages, and not the $1,000 minimum damages. Section 202 of the Senate bill, on

the other hand, contains neither the mandatory minimum damages or the class action bar. From these contrary indications,

it is difficult to predict where Congress will end up, other than to say that it is obviously leery of providing incentives for

the filing of more class actions. <a href="#12a">Return to article</a>

<a name="13">13</a> For instance, what is a state law "similar to §152 or 157 of Title 18?" Since those sections deal exclusively with Title 11

violations, and it is unlikely that state laws are directed at bankruptcy violations, what degree of similarity is needed? Is it

enough that the law deals with fraudulent concealment of assets? <a href="#13a">Return to article</a>

<a name="14">14</a> In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Solutions Inc. v. Service Support Specialties Inc., 124 F.3d 487 (3rd Cir. 1997)</a>, the court held that a state

law restriction barring the sale of tort claims was a limit on §363, which authorizes a sale but does not exempt the trustee or

debtor from state law or give them property interests that they do not otherwise possess. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. 959</a> states that principle,

but applies only to the debtor and trustee and does not deal with applying state law to creditors in the case. <a href="#14a">Return to article</a>

Journal Authors

Karen Cordry

Journal Date

Tuesday, June 1, 1999 - 12:00