Summer 2016 • Issue 58, page 1

The Honorable Steve Rhodes

By Phelps, Kathy Bazoian*

“A Tour de Force of Legal Acumen” was the headline of the Detroit Free Press article on the day that Bankruptcy Judge Steven Rhodes announced his opinion confirming the City of Detroit’s Chapter 9 Plan of Adjustment. The headline of that article stemmed from a quote from Detroit emergency manager Kevyn Orr, commenting on Judge Rhodes’ confirmation opinion. Receivership News had the privilege of interviewing Judge Rhodes for this issue’s Judges Profile.

Prior to his appointment as a bankruptcy judge in the Eastern District of Michigan in 1985, Judge Rhodes was first a prosecutor and then a magistrate judge. He served as a bankruptcy judge from 1985 to 2015, sitting also on the Bankruptcy Appellate Panel of the Sixth Circuit for two different terms totaling about 12 years. His list of accomplishments, writings, speeches, and community service would fill a few issues of Receivership News alone, so we thought we would focus on a just a few in this interview.

As the judge presiding over the City of Detroit Chapter 9 case, Judge Rhodes was “brilliant,” in the words of a lawyer representing the City in that case. The Detroit Free Press observed: “Throughout Detroit's 16-month bankruptcy, Judge Steven Rhodes never forgot the profound impact of the case on city residents, employees and retirees.”

“He was conscious of his own image and duty as a judge to stay out of the spotlight so the public's focus was on the case, not the judge.”

Judge Rhodes handled the Detroit case with the firmness that the disputing parties needed and a sensitivity that went above and beyond the call of duty. As if presiding over the largest municipal bankruptcy in U.S history wasn’t enough, Judge Rhodes just couldn’t sit still after his retirement party, and he accepted the position as Emergency Manager for the Detroit Public School System at the request of the Governor of Michigan.

This profile would also not be complete without a mention of Judge Rhodes’ contribution to the receivership community as well. He is the co-author of The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes (with me), and he is a friend of both the California Receivers Forum and the National Association of Federal Equity Receivers, speaking and writing for both organizations.

Below Judge Rhodes shares with us his views on his journey from the bench, to emergency management, to mediation, and the fun he has had along the way.

PHELPS: What did you find rewarding about your work as a bankruptcy judge?

RHODES: Only part of bankruptcy is about money and what to do when there isn’t enough to go around. It’s much more about the mistakes people make, the misfortunes they suffer, and their unsuccessful attempts to overcome. Occasionally, it is also about fraud, sometimes small, sometimes big. And these mistakes, misfortunes and frauds are not only on the debtors’ side; they are as much on the creditors’ side.

All of this makes every case interesting. Dealing with people and trying to help them make the decisions in their lives that will facilitate their true fresh start was the most emotionally rewarding part of the job. Intellectually most rewarding was the opportunity to work on interesting and consequential issues with really good lawyers.

PHELPS: Do you miss being a bankruptcy judge?

RHODES: I miss the people – my staff, my colleagues, the lawyers and the other professionals, but I do not miss the work. After almost 30 years of it and after the intensity of the Detroit case, I was done and ready to retire, although that didn’t last very long!

PHELPS: How did you become interested in Ponzi scheme cases?

RHODES: Over the years, I had
had a few small bankruptcy cases that appeared to be Ponzi schemes, but my involvement in them was largely superficial. My real entry into the world of Ponzi schemes occurred through speaking at conferences on fraudulent transfer law. I then began to see how fascinating and unduly complex the law of unravelling these schemes had become. It made me wonder whether that law needs its own “fresh start.” Equally intriguing is the psychology of both perpetrators and victims that allows such schemes to propagate. And then there are also the societal questions about how to prevent Ponzi schemes.

PHELPS: What motivated you to co-author The Ponzi Book, A Legal Resource for Unraveling Ponzi Schemes?

RHODES: There are so many Ponzi schemes, and so many judges, lawyers and other professionals working on unraveling them. As you and I investigated the resources available for these professionals, we found there was a need and a market for a logically organized resource that collected all of the law pertinent to unraveling Ponzi schemes – fraudulent transfer law, preference law, criminal law, securities law, property law, tort law, bankruptcy law, and even foreign law. Two years and 800+ pages later, we have a well-received book. It was a fascinating journey.

PHELPS: You have done some speaking and writing on federal equity receivership cases. What is it about the receivership process that has caught your attention?

RHODES: I have spoken at conferences put on by both the California Receivers Forum and the National Association of Federal Equity Receivers. The educational content I have seen at these receiver organizations is extremely valuable, and I’ve certainly learned more than a few things along the way.
What is so interesting about these cases is that in providing relief to victims of a fraud in these types of cases, the federal district judge is exercising full equity jurisdiction. The judge is therefore not bound by statutory rules of decision. In creating solutions, the judge is guided solely by conscience, good judgment and, of course, any precedential authority. The receiver that the judge appoints is the means by which the judge implements those solutions. This is unique in the law. In fact, it is so unique and so contrary to what judges normally do that it is not well-understood or effectuated. And that is unfortunate because when judges do try to apply legal doctrine to cases in equity, the result is sometimes unduly complex and even unfair.

PHELPS: How would you compare the bankruptcy process and the receivership process for addressing fraud schemes?

RHODES: They are as different as they can be. Although bankruptcy courts are said to be “courts of equity,” legal doctrine is applied to all phases of the process, from the marshalling and sale of assets to the ultimate distribution under the priorities established in law. The receivership process is, as noted, an equitable process. The judge’s discretion determines how to achieve a fair resolution, although that basic principle of equity seems to have been lost.

PHELPS: Which is the better process in Ponzi scheme cases?

RHODES: Actually, I don’t like either one. On the bankruptcy side, trustees sometimes use fraudulent transfer claims to coerce settlements from investors who have already lost all or almost all of their assets in the fraud. The “good faith” defense that these defendants offer is confusing, complex and expensive to administer. And bankruptcy’s strict distribution scheme is not an equitable scheme that accounts for prepetition distributions from the perpetrator.

On the receivership side, the potential to create, on a case by case basis, a fair, expeditious and efficient result is there, but that potential is not always realized because, unfortunately, judges often prefer to apply legal rules of decision rather than the discretion that equity allows.

Beyond that, both bankruptcy and receiverships suffer from the silly rule that puts the trustee and the receiver “in the shoes” of the perpetrator. The resulting issues of standing and in pari delicto are complex and unjustified. They also create unfairness and increase delay and expense.

Now add to all of that a parallel criminal forfeiture proceeding and the remedial process becomes a nightmare!

If I have to choose, I would give the nod to the receivership process, but with two conditions. First, the receivership judge must be willing to exercise the equitable jurisdiction that Congress clearly granted in these cases. Second, all forfeited property should go into the receivership estate to be distributed with the receivership assets as the judge determines.

PHELPS: What lessons should people around the country take from the Detroit bankruptcy case?

RHODES: 1. If a municipality is insolvent and has no realistic plan to dig out, it should not wait eight years to file bankruptcy like Detroit did. 2. An emergency manager that makes decisions for the municipality during the case makes the process much more efficient. 3. Strong mediation is a key to an efficient result. 4. Municipal bond creditors and pension creditors are all unsecured creditors unless their claims are secured in a way that bankruptcy law accepts. 5. Municipal bankruptcy has no impact on municipal bond interest rates. 6. Creditors should support, not oppose, municipal bankruptcy; municipalities cannot print money and the alternative is chaos. 7. For every dollar that a debtor borrows knowing it shouldn’t, there is a creditor lending that dollar knowing it shouldn’t.

PHELPS: How did you deal with the pressure of the Detroit case?

RHODES: One day at a time. I insisted on resolving every contested matter as promptly as possible with the minimum due process that the constitution and law required. I had a great staff. And the lawyers also made the job more bearable by narrowing the issues as much as they could and by their great arguments on the remaining ones.

PHELPS: You have had personal experience with emergency management in the Detroit case and now with the Detroit school system. Are there any similarities in the work of an emergency manager and the work of a receiver?

RHODES: Both obviously involve displacing management for the purpose of addressing the consequences of an insolvency. Both a receiver and an emergency manager begin their work with only the vaguest idea of what to expect and how their work will proceed. Both work under the supervision of the appointing authority. Both need substantial legal and accounting support and expertise. Both are accountable to perhaps large numbers of people who are deeply concerned about their futures and are vocal about those concerns.

The obvious difference is that more often than not, a receiver’s goal is liquidation but an emergency manager’s goal is always reorganization and revitalization.

PHELPS: What’s going on with the ABI band, the Indubitable Equivalents, that you play in?

RHODES: I love playing in the band. It’s a great group of guys and we are good! We recently had a blast playing at the California Bankruptcy Forum May 2016 Annual Conference at the Indian Wells Music Fest. We are about to reinvent and revitalize our set list with many new tunes, so that we can continue to entertain our adoring fans.

PHELPS: What are your plans following your work with the Detroit schools?

RHODES: I plan to retire. Again. And then next spring, I plan to do some mediation and arbitration work through JAMS, which is opening a new office in Detroit.

*Kathy Bazoian Phelps is a partner at Diamond McCarthy, LLP, Los Angeles, and the co-author of The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes. She frequently represents receivers and trustees.