Fall 2014 • Issue 53, page 8

The Institutionalization of a Rumor: The Ten Day Safety Rule v. Bankruptcy Code Section 543(a)

By Bronston, Edythe*

This is a case study of how a California state commission institutionalized a rumor and ostensibly proceeded to assert jurisdiction over a federal court. If only we could figure out how it happened.

The federal Bankruptcy Code requires a receiver to turnover assets to the bankruptcy trustee on the date the receiver learns of the bankruptcy.1 An optional form order for receivers in the Los Angeles Superior Court contains language that appears to give receivers a 10 day grace period.2 Does a state form order trump the Bankruptcy Code?

A recent discussion with the Honorable Barry Russell, United States Bankruptcy Judge, made clear that the United States Bankruptcy Court for the Central District of California has no idea that this rule exists as part of a California form order. Nor does that court believe that such a form order is necessarily solid guidance for receivers or binding on the Bankruptcy Court.

So one must question how this state ten day safety rule landed in a form order that state courts approve and upon which receivers rely. In the late 1990’s, Rule 981.1 of the California Rules of Court initially went into effect, preempting all local rules and forms. At the request of the Los Angeles Superior Court, the Judicial Council authorized a partial, temporary exception to preemption in the receivership area until January 1, 2002, to allow for the development of statewide rules and form orders. In October 2001, the Civil and Small Claims Advisory Committee of the Judicial Council of California issued a Report proposing new rules and optional form orders for rents, issues and profits receiverships. Several lawyer members of the California Receivers Forum had been contacted by the Advisory Committee, which was seeking our input as they had no experience in this area of the law. This group of seasoned receivership lawyers, all of whom had bankruptcy experience (David Ray, David Pasternak, Peter Davidson, Michael Wachtell, Michael Abney, Richard Weissman, Steven Linkon and myself), was requested to work with the Council because of our earlier extensive work in assisting the Los Angeles Superior Court, under the leadership of the Honorable Robert H. O’Brien, in developing a series of local rules. Those local rules, for the first time, spelled out the duties and responsibilities of a court-appointed receiver.3 To my knowledge, the earliest official reference to the ten day safety rule was set forth in an order either developed or approved by the Honorable Bruce Mitchell in Department 59 of the Los Angeles Superior Court in the late 1990’s. This was probably the impetus for the ten day provisions in the form orders, as the language is almost identical.

Our committee, joined by the judicial officers who handled receivership matters in the Los Angeles Superior Court, worked with the Judicial Council for over a year. In 2002, proposed rules were circulated for comment and ultimately became effective on January 1, 2004. Although the optional form orders apply only to rents, issues and profits receiverships, many California judges have required equity receivers to incorporate the provisions into their orders. The practice appears to have been accepted and institutionalized.

The committee discussed extensively the impact of bankruptcy on a receivership estate, and those discussions centered on protection of the receiver who is required by 11 U.S.C. § 543(b)(1) to turn over assets to the bankruptcy trustee or the debtor in possession upon receipt of a notice of bankruptcy. It is well established that a receiver who remains in custody and control of assets after receiving notice of a bankruptcy filing may be courting disaster or, at the least, non-payment of his/her fees and expenses. Since many rents, issues and profits receivers are not lawyers, and even those who are lawyers often lack bankruptcy experience, it was felt that the form order should spell out the receiver’s immediate duties and very limited authority when notified of a bankruptcy filing. At no time, however, did any of the experienced bankruptcy/receivership lawyers serving on the committee put forth the proposition that a ten day holding period was safe. In fact, the only time ten days was ever mentioned in this context was during the development of the local rules.....long before the statewide Judicial Council was involved. At that time, an informal meeting had been held with the Honorable Lisa Hill Fenning who agreed that we should address the ambiguity of the timing of the turnover by a custodian pending a party’s motion for an excuse from turnover under section 543. It may have been the case that a ten day period was mentioned as “reasonable,” but at no time was it ever suggested that a state court (or council) could preempt a federal statute and unilaterally decree that there was a “ten day rule.” In fact, the 21 federal judges who then sat on the bankruptcy bench each had their own local rules, known by practitioners as the “local, local rules,” and woe to the unsuspecting lawyer who failed to follow them.

This case study is a cautionary tale for receivers. A bankruptcy court will likely have no problem totally ignoring the ten day safety rule if it determines to enforce the more immediate language contained in section 543 of the Bankruptcy Code. It behooves a receiver when faced with these circumstances to immediately make a report to the federal court following a party’s advice that a § 543(d) motion is forthcoming.....and to hope for the best. The issue of who authorizes payment and who pays the receiver’s bills for reporting to both courts and for the receiver’s interim acts is an entirely separate topic.

1. 11 U.S.C. § 543(b)(1) states: (b) A custodian shall— (1) deliver to the trustee any property of the debtor held by or transferred to such custodian, or proceeds, product, offspring, rents, or profits of such property, that is in such custodian’s possession, custody, or control on the date that such custodian acquires knowledge of the commencement of the case.

2. Form Order RC-200, para. 27 and Form Order RC-310, para. 25 (c) each state: “Turn over property if no motion for relief is filed within 10 days after notice of the bankruptcy. If the party who obtained the receivership fails to file a motion within 10 court days after his or her receipt of notice of the bankruptcy filing, the receiver shall immediately turn over the property to the appropriate entity- either to the trustee in bankruptcy if one has been appointed or, if not, to the debtor in possession – and otherwise comply with 11 United States Code section 543.”

3. I am pleased to note that many if not most of the Los Angeles Superior Court’s Local Rules were ultimately adopted into the California Rules of Court in 2002.

*Edythe L. Bronston is a Principal with the Law Offices of Edythe L. Bronston in Sherman Oaks, California. Ms. Bronston is a court-appointed fiduciary, acting as a Receiver, Provisional Director, Partition Referee and Grantor Trustee.