Winter/Spring 2015 • Issue 54, page 4
2014 Year End Review: Recent Developments in Business Bankruptcy
By Brister, Peggy, Clark, Robert, Dumas, Cecily, Heaton, Geoffrey, Montali, Honorable Dennis & Oliner, Ron*
Each year, Judge Dennis Montali, Cecily Dumas and Ron
Oliner present a two-hour program to the San Francisco Bar Association
and, separately, the Bay Area Bankruptcy Forum, covering developing case
law in the bankruptcy field. Together with authors Peggy Brister, Law
Clerk to the Hon. Dennis Montali; Clark LLP:“In determining the amount of reasonable compensation to be awarded to a trustee, the court shall treat such compensation as a commission, based on section 326.” In a long and detailed opinion, Judge Klein reviewed fee requests submitted by chapter 7 trustees in four different cases. The court had three primary concerns1 how to reconcile the “commission” with § 330’s other provisions, including that a trustee’s compensation must be “reasonable” and for “actual, necessary services rendered”§ 330(a1, and that a court is authorized to “award compensation that is less than the amount of compensation that is requested”§ 330(a2; and
Geoffrey A. Heaton, Duane Morris LLP, the group puts together very
comprehensive materials for attendees. These materials are reprinted in
complete form in the California Bankruptcy Journal. Here are excerpts from
the program materials, describing some of the most significant decisional
law rendered by courts in the Ninth Circuit, and the Supreme Court, in
2014.
PROPERTY OF THE ESTATE / EXEMPTIONS
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Inherited IRAs Are Not Exemptible “Retirement
Funds”
The Bankruptcy Code allows an exemption for retirement funds “to the
extent that those funds are in a fund or account that is exempt from
taxation” under specified sections of the Internal Revenue Code. One such
type of fund is the so-called “inherited IRA”–a retirement account held by
a parent or a spouse (for example) that passes to the holder’s heir upon
death. These accounts receive favorable tax treatment similar to regular
IRAs, but there are significant differences: the heir cannot contribute
new money to the funds, is allowed to withdraw money from the fund at any
time without penalty, and is required to either withdraw it all within
five years or a certain amount annually thereafter.
So are inherited IRAs exempted from the heir’s bankruptcy estate?
Affirming the Seventh Circuit, a unanimous Supreme Court held that they
aren’t. For the exemption to apply, it isn’t enough that the funds be
exempt from taxation under the IRC–they also need to be “retirement
funds”. And that determination can’t be made subjectively, based on the
debtor’s intended use of the money. It needs to be an objective test,
based on the funds’ legal characteristics. So evaluated, inherited IRAs
don’t qualify for the exemption: you can’t put more money into them, so
they don’t encourage saving for retirement; you have to withdraw the money
early and/or regularly, however far away from retirement you may be; and
pre-retirement withdrawals are entirely without penalty. These
characteristics aren’t consistent with the meaning of “retirement fund” or
the purpose of the retirement fund exemption: protecting debtors’ ability
to provide for themselves in old age. The money’s original status as
retirement funds for the deceased does not survive the inheritance.
Clark v. Rameker, 134 S. Ct. 2242 (2014).
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A Trustee Cannot “Equitably Surcharge” Exempt Property to Pay for
Debtor Malfeasance
With the appellate courts’ blessing (see, e.g., Latman v. Burdette, 366
F.3d 774 (9th Cir. 2004)), bankruptcy courts have made a practice of
equitably “surcharging” exempt property to remedy debtor misbehavior, such
as underreporting assets or misappropriating nonexempt property. In this
case, the debtor falsely claimed that his residence secured a loan to a
woman named “Lili Lin”, leaving no equity to satisfy his other creditors.
After a local acquaintance by that name denied any involvement, he
insisted that the lender was a different Lili Lin who lived in China–a
claim that took the chapter 7 trustee five years and more than half a
million dollars to fully litigate and disprove. The trustee then asked to
surcharge the debtor’s $75,000 homestead exemption to help defray those
costs, which the bankruptcy court, the district court, and the Ninth
Circuit all deemed appropriate.
A unanimous Supreme Court disagreed. Although bankruptcy courts have some
latitude in exercising their equitable powers, those powers are ultimately
circumscribed by the Bankruptcy Code. And the Code (at § 522(k)) says that
exempted property is (with limited exceptions) “not liable for the payment
of any administrative expenses”–including the trustee’s litigation
expenses. Nor could the surcharge have been replaced with an equitable
disallowance of the exemption, as such disallowances are themselves
limited to the “mind-numbingly detailed” range of circumstances provided
under the Code. There are other measures available to deal with a
dishonest debtor, from denial of discharge to sanctions under Rule 9011 to
outright criminal charges. But exempt property is not liable for
administrative expenses under the Code, and the bankruptcy court can’t
change that.
Law v. Siegel, 134 S. Ct. 1188 (2014).
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Just Because Property Has Been Abandoned Doesn’t Mean the Stay No
Longer Applies
The chapter 7 trustee of a corporate debtor abandoned a non-operational
gas station that was fully encumbered by secured creditor’s liens due to
lack of funds. After the abandonment order was entered, but before the
case was closed, the secured creditor foreclosed on the gas station. The
debtor moved to reopen the case so it could seek to set aside the
foreclosure and commence contempt proceedings for violation of the
automatic stay. The bankruptcy court reopened the case and sua sponte
annulled the stay retroactively.
On appeal, the BAP reversed, holding that the bankruptcy court erred
because even though the gas station was no longer property of the estate,
11 U.S.C. § 362(a)(5) protects property that remains property of the
debtor. The court held that the gas station was property of the debtor
until the case was closed, and therefore the foreclosure that occurred
weeks earlier was void. (The BAP disagreed with D’Annies Rest., Inc. v.
N.W. Nat. Bank of Mankato (In re D’Annies Rest., Inc.), 15 B.R. 828 (Bankr.
D. Minn. 1981), which held that when property of the estate is abandoned
and the debtor is a corporation–as opposed to an individual debtor the
stay no longer protects either the debtor or the subject property from
lien enforcement.)
Gasprom, Inc. v. Fateh (In re Gasprom, Inc.), 500 B.R. 598 (9th Cir. BAP
2013).
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Inheritance Acquired More than 180 Days After Petition Date Was
Property of Chapter 13 Estate
The chapter 13 debtors received a $30,000 inheritance more than 180 days
after the petition date, but prior to confirmation of their chapter 13
plan. On motion of the chapter 13 trustee, the bankruptcy court entered an
order determining that the inheritance was property of the estate, and
requiring the debtors either to (i) turn over the inheritance to the
trustee, or (ii) amend their plan to account for distribution of the
inheritance. The debtors appealed, and the BAP affirmed.
Section 541(a)(5)(A) provides that property of the estate includes a
“bequest, devise, or inheritance” that a debtor “acquires or becomes
entitled to acquire” within 180 days after the petition date. Section
1306(a)(1), in turn, provides that in a chapter 13 case, property of the
estate includes, “in addition to the property specified in section 541”,
all property specified in § 541 that a debtor acquires after the petition
date but before the case is closed, dismissed, or converted. Construing
the two statutes, the BAP adopted the position of the Fourth Circuit Court
of Appeals, holding that in a chapter 13 case § 1306(a)(1) extends §
541(a)(5)’s 180 day period until the case is closed, dismissed, or
converted.
Dale v. Maney (In re Dale), 505 B.R. 8 (9th Cir. BAP 2014).
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Jewel’s Death Knell? District Court Finds Firm Has No Property Interest
in Hourly Fee Matters
The bankrupt Heller firm’s dissolution plan
included a “Jewel waiver”: a waiver of any rights under the
doctrine of Jewel v. Boxer, 156 Cal. App. 3d 171 (1984), to collect
legal fees generated for hourly work performed by former Heller partners
following their departure. Heller partners landed at various law firms,
taking with them pending hourly matters formerly handled by Heller.
Heller’s trustee sued these firms, contending that the Jewel waiver was a
fraudulent transfer of Heller’s property. The district court granted the
defendant firms’ motion for summary judgment, finding that “neither law,
equity, nor policy recognizes a law firm’s property interest in hourly fee
matters.”
From a legal perspective, the court highlighted a number of critical
distinctions, including that Jewel was decided under the Uniform
Partnership Act, which had been superseded in 1999 by the Revised Uniform
Partnership Act (RUPA). Under RUPA, a dissolved firm does not have the
right to demand an accounting for profits earned by a former partner under
a new retainer agreement with a client. (The former Heller clients had
signed new retainer agreements with their new firms.) Looking to the
equities, the court reasoned that the new firms which performed legal work
on behalf of the clients should keep the fees earned for that work. Once
the clients retained new counsel, the client matters ceased to be Heller’s
partnership business and became partnership business of the new firms.
Finally, looking to policy, the court reasoned that the position advocated
by the trustee would incentivize partners to leave struggling but still
viable firms. New firms likewise would be discouraged from taking partners
or clients of a dissolved firm since the new firm would be unable to
profit from labor and capital invested in matters previously handled by
the dissolved firm.
Heller Ehrman LLP v. Davis, Wright, Tremaine, LLP, 2014 WL 2609743
(N.D. Cal. June 11, 2014).
JURISDICTION, STANDING, AND PROCESS
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Supreme Court Defers Deciding If Parties Can Consent (Explicitly or
Implicitly) to a Bankruptcy Court Adjudication of Stern-Type Matters
“Never put off till tomorrow what may be done day after tomorrow just as
well.”—Mark Twain.
In Stern v. Marshall, 131 S. Ct. 2595 (2011), the Supreme Court held that
a bankruptcy court could not enter a final order on a debtor’s state law
counterclaim that “in no way derived from or [was] dependent upon
bankruptcy law” and “existed without regard to any bankruptcy proceeding.”
That holding generated conflicting case law, and the Supreme Court granted
certiorari in Bellingham to address two issues: (1) whether the parties
could consent (explicitly or implicitly) to final adjudication by the
bankruptcy court; and (2) whether a bankruptcy court can enter proposed
conclusions of law and findings of fact in core matters purportedly
outside of its constitutional authority. Unfortunately, the bankruptcy
community still does not know the answer to the first, and most
significant, question regarding consent. The Supreme Court ducked that
issue and instead simply confirmed what many courts and practitioners
assumed: where a bankruptcy court lacks constitutional authority to enter
a judgment on a core matter, it may adjudicate the claim as non-core and
submit proposed findings of fact and conclusions of law to the district
court for de novo review.
The Supreme Court will perhaps resolve the lingering Stern issues next
term (including the consent issues), having granted certiorari to review
the Seventh Circuit’s decision in Wellness Int’l Network, Ltd. v. Sharif,
727 F.3d 751 (7th Cir. 2013) (discussed in last year’s materials). There,
the Seventh Circuit held that a litigant may not waive an Article III
objection to a bankruptcy court’s constitutional authority to enter final
judgment in a core proceeding. The Supreme Court certified the following
issues for review:
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Whether the presence of a subsidiary state property law issue in an 11 U.S.C. § 541 action brought against a debtor to determine whether property
in the debtor’s possession is property of the bankruptcy estate means that
such action does not “stem from the bankruptcy itself” and therefore, that
a bankruptcy court does not have the constitutional authority to enter a
final order deciding that action.
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Whether Article III permits the exercise of the judicial power of the
United States by the bankruptcy courts on the basis of litigant consent,
and if so, whether implied consent based on a litigant's conduct is
sufficient to satisfy Article III.
Exec. Benefits Ins. Agency v. Arkison, 134 S. Ct. 2165 (2014).
Wellness Intern. Network, Ltd. v. Sharif, 134 S. Ct. 2901 (2014) (Mem.)
(granting writ of certiorari).
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Think Twice Before You Agree to Prepare the Court’s Order
A debtor received funds from settlement of a personal injury action. A
creditor with a lien on the settlement funds filed an interpleader action
in state court against other creditors asserting liens on the funds. After
the debtor filed for bankruptcy, debtor’s counsel turned over the funds to
the bankruptcy trustee. The state court judge, aware of the bankruptcy and
informed that the funds had been turned over to the trustee, issued an
order to show cause why debtor’s counsel should not be held in contempt
for failing to deposit the funds with the state court. To that end, the
judge directed creditor’s counsel to prepare the OSC, which counsel
dutifully prepared. Debtor’s counsel, in turn, filed a complaint in
district court against the state court judge, creditor’s counsel, and
others for violation of the automatic stay. Although the district court
dismissed the judge from the suit based on the doctrine of absolute
judicial immunity, it found that creditor’s counsel was not protected by
absolute quasi-judicial immunity.
The Ninth Circuit affirmed, explaining that a non-judicial officer is only
entitled to absolute quasi-judicial immunity where the function performed
is a judicial act with “a sufficiently close nexus to the adjudicative
process,” and involves an exercise of “discretionary judgment.” Here, the
Court reasoned that although creditor’s counsel performed a function with
a close nexus to the judicial process (drafting a proposed order at the
direction of a judge), the act did not involve “discretionary judgment”
insofar as only the judge had the ultimate discretion to approve the order
and sign it. In a dissent, Judge Gilman pointed out that law clerks are
entitled to quasi-judicial immunity, and here creditor’s counsel was
essentially acting as the judge’s law clerk in preparing the order. The
dissent also noted the “fundamental unfairness of holding liable those who
carry out the orders of judges when the judges themselves are absolutely
immune”, and lamented that the Court’s decision “unfortunately puts at
risk the common practice of private attorneys drafting proposed orders on
behalf of a judge.”
Burton v. Infinity Capital Management, 2014 WL 2504728 (9th Cir. June 4,
2014).
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A Close Call for a Close Nexus
A bankruptcy court’s “related to” jurisdiction has a broad reach,
extending to any matter that could have a “conceivable effect” on the
estate. See Pacor, Inc. v. Higgins, 743 F.2d 984 (3d Cir. 1984). But that
reach is restricted after a plan is confirmed, covering only those matters
having a “close nexus” to the bankruptcy case. See In re Pegasus Gold
Corp., 394 F.3d 1189 (9th Cir. 2005). A close nexus typically means that
the matter will affect the interpretation, implementation, consummation,
execution, or administration of the confirmed plan. (The First Circuit has
held that the “close nexus” test only applies to reorganization plans, not
liquidation plans, see In re Boston Regional Med. Ctr., Inc., 410 F.3d 100
(1st Cir. 2005), but the Ninth Circuit hasn’t adopted that rule, and the
district court here rejected it.)
In this case, a liquidating trustee was trying to prosecute claims for
fraud and negligence against the principal and the auditor of a Ponzi-scheme
fund–claims that were assigned to the trustee by the fund’s creditors in
connection with the confirmed plan. The bankruptcy court didn’t think
there was a close enough nexus to support post-confirmation jurisdiction,
and so dismissed the action. The district court recognized that such a
determination needs to be made on a case-by-case basis, looking at the
“whole picture”, but was able to state generally that an explicit
reservation of jurisdiction by the plan would make no difference–a plan
proponent can’t write its own “jurisdictional ticket”. The court also
found it insufficient that the litigation could yield a potential benefit
to creditors, or that the state court might reach conclusions at odds with
those of the bankruptcy court–issues that arise in any estate litigation.
However, the claims in this case were specifically referenced in the plan,
and their anticipated pursuit was “part of the calculus” of the plan’s
negotiation. Under these conditions, litigating the claims qualified as
part of the plan’s execution and implementation. This relation to the plan
overrode the bankruptcy court’s concerns about the complaint’s timeliness,
the trustee’s apparent forum shopping, and the state court’s familiarity
with the issues, and sufficed to confer “related to” jurisdiction over the
matter.
Calvert v. Berg (In re Consolidated Meridian Funds), 511 B.R. 140 (W.D.
Wash. 2014).
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Notice Requirements: Bankruptcy Rules Trump Code of Civil Procedure
Debtors filed a motion to avoid a judicial lien of Wells Fargo Card
Services pursuant to § 522(f) and served it by mail addressed to the chief
executive officer of Wells Fargo at an address in Sioux Falls (as provided
on the FDIC’s website) and by mail addressed to the attorney for Wells
Fargo identified on the judgment lien. The bankruptcy court denied the
motion without prejudice on substantive grounds. Thereafter, the debtors
filed an amended motion and served it by certified mail to Wells Fargo’s
chief executive officer and by regular mail to the person and address
identified in Wells Fargo’s proof of claim. This time, however, they did
not serve the counsel identified on the judgment lien. The bankruptcy
court denied the motions because the notice did not identify the real
property which was the subject of the motion (although the accompanying
motion did identify the property) and the motion was not served on counsel
listed on the abstract of judgment as required under California Code of
Civil Procedure section 684.010.
Debtors filed a motion for reconsideration, asserting that the notice and
motion complied with the court’s local rules (B.L.R. 9013-1(b)(1) and
(2)); the national rules (Fed. R. Bankr. P. 9014 and 7004); and the
judge’s practices and procedures. Citing Beneficial Cal. Inc. v. Villar
(In re Villar), 317 B.R. 88 (9th Cir. BAP 2004), Debtors also contended
that service on the attorney that obtained the underlying judgment under
California Code of Civil Procedure 684.010 was not required.
The BAP reversed and remanded, observing that Rules 4003(d), 9014, and
7004 govern the notice and service requirements for lien avoidance motions
under § 522(f). Rule 4003(d) states that a proceeding to avoid a lien
shall be by motion in accordance with Rule 9014, which governs contested
matters. Rule 9014(b) states that service of the motion is required to be
in a manner provided in Rule 7004. Rule 7004(h), which governs service of
process on an insured depository institution such as Wells Fargo, states
that service shall be made by certified mail addressed to an officer of
the institution. Three exceptions to this rule exist, none of which
applied in this case. The BAP found that Rule 7004 did not require the
debtors to serve notice on the attorney named in the abstract of judgment,
and that service on him would not have satisfied Rule 7004 in the absence
of proper service on an officer of Wells Fargo. “Nowhere do the bankruptcy
rules require compliance with [Cal. Civ. Pro. § 684.010] nor do we
perceive any reason why compliance should be compelled in light of the
procedural due process safeguards provided by the rules themselves.”
Finally, the BAP held that while the notice of the motion did not specify
the liened property, the attached motion did so, and thus sufficiently
provided the creditor with an opportunity to present its objections.
Frates v. Wells Fargo Bank, N.A. (In re Frates), 507 B.R. 298 (9th Cir.
BAP 2014).
TRUSTEES AND COMMITTEES
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Chapter 11 Trustee Is Not a “Public Official” for Purposes of
Defamation Suit
A chapter 11 trustee filed a defamation suit against an individual who
published blog posts accusing the trustee of fraud, corruption,
money-laundering, and other illegal activities in connection with the
trustee’s administration of the debtor’s estate. At issue on appeal was
whether the trustee qualified as a “public official.” Under the U.S.
Supreme Court’s New York Times Co. v. Sullivan decision, a “public
official” who seeks damages for defamation is required to show “actual
malice,” i.e., that the defendant published the defamatory statement “with
knowledge that it was false or with reckless disregard of whether it was
false or not.” If, however, the plaintiff is not a public official, and
the statement involves a “matter of public concern,” then, under the
Supreme Court’s Gertz v. Robert Welch, Inc. decision, only a negligence
standard applies.
Following a thorough analysis of Supreme Court and other authorities, the
Ninth Circuit held that the trustee was not a public official, since he
was not elected or appointed to a government position, and did not
exercise “substantial … control over the conduct of governmental affairs.”
Rather, the trustee simply substitutes for a debtor in possession, and
receives compensation from the bankruptcy estate, not the government.
Accordingly, since public allegations that someone is involved in a crime
qualify as “matters of public concern,” the Gertz negligence standard
applied to the defendant.
Obsidian Fin. Group, LLC v. Cox, 740 F.3d 1284 (9th Cir. 2014).
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Further guidance on allowance of a chapter 7 trustee’s “commission”
under § 330(a)(7)
Section 330(a)(7) provides: “In determining the amount of reasonable
compensation to be awarded to a trustee, the court shall treat such
compensation as a commission, based on section 326.” In a long and
detailed opinion, Judge Klein reviewed fee requests submitted by chapter 7
trustees in four different cases. The court had three primary concerns:
(1) how to reconcile the “commission” with § 330’s other provisions,
including that a trustee’s compensation must be “reasonable” and for
“actual, necessary services rendered” (§ 330(a)(1)), and that a court is
authorized to “award compensation that is less than the amount of
compensation that is requested” (§ 330(a)(2)); (2) under what
circumstances should a court reduce fees below the commission; and (3) how
to screen trustee fee requests to identify fees that are subject to
reduction.
Ultimately, the court more or less adopted Judge Carlson’s analysis in In
re McKinney, 383 B.R. 490, concluding that § 330(a)(7) creates a
presumption that the commission calculated under § 326 is “reasonable,”
which may be rebutted if the fee is “unreasonably disproportionate.” The
value of a trustee’s services, moreover, while relevant, are not
necessarily dispositive of the unreasonable disproportion issue; other
circumstances can give rise to unreasonable disproportion as well.
The court also identified five circumstances where all trustees in the
district would be required to file formal fee applications supported by
time records and a written narrative of services performed, including
where the requested fees exceed $10,000 or exceed the amount remaining for
unsecured claims, and where there has been a carve-out or short sale. In a
concurring opinion, the other bankruptcy judges of the Eastern District
adopted these guidelines with the intention that they be incorporated into
the District’s local rules.
In re Scoggins, 2014 Bankr. LEXIS 3857 (Bankr. E.D. Cal. 2014).
ATTORNEYS AND OTHER PROFESSIONALS
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Malpractice Action Against Committee Counsel Is a Core Proceeding
A chapter 11 debtor sold its assets through a confirmed plan. The buyer
executed a promissory note for part of the sale price, to be secured by
liens on real and personal property. Debtor’s counsel failed to file the
financing statements necessary to perfect the personal property liens.
After the buyer defaulted, the net recovery for creditors was
significantly less than it would have been with a perfected security
interest. Four creditors’ committee members sued committee counsel in
state court for malpractice, alleging that he had been negligent by
failing to ensure that debtor’s counsel had perfected the security
interest. Debtor’s counsel removed the action to the bankruptcy court, and
plaintiffs moved to remand.
The bankruptcy court denied the remand motion, determining that it had
federal jurisdiction over the malpractice action, and granted committee
counsel’s motion to dismiss. The district court affirmed, as did the Ninth
Circuit, citing to its prior decisions holding that a post-petition claim
against a court-appointed professional is a core proceeding. Here, the
malpractice claim was “inseparable” from the bankruptcy case. It was based
solely on acts that occurred within the administration of the estate, and
any alleged duties arose from obligations created under bankruptcy law.
Dismissal, moreover, was proper since committee counsel represented the
committee as a whole, not committee members individually, and had not been
involved in the sale or charged with recording the financing statements.
Schultze v. Chandler (In re Schultze), 2014 WL 3537030 (9th Cir. Aug. 1,
2013).
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Exercise Caution With an Unbundled Retainer Agreement
In connection with litigation against a former employer, Mr. Seare
admitted that he had “embellished” certain evidence, resulting in a
sanctions order, a $67,430 judgment for defendant’s attorneys’ fees, and a
finding that Mr. Seare had committed “fraud upon the court” by “knowingly
providing false information” and “instituting and conducting litigation in
bad faith.” The defendant obtained a writ of garnishment and garnished Mr.
Seare’s wages, prompting Mr. Seare and his wife to retain bankruptcy
attorney DeLuca.
The debtors executed a retainer agreement with DeLuca that “unbundled”
certain defined “basic services,” including the preparation and filing of
a petition and schedules, from services requiring “additional fees,”
including defending adversary proceedings. Although aware of the
garnishment order, DeLuca did not investigate into the underlying
judgment, or otherwise advise debtors of the likelihood of a
nondischargeability action. DeLuca also did not consult with the debtors
before rejecting a settlement proposal concerning the judgment’s
dischargeability, and then refused to represent the debtors when the
defendant later filed a nondischargeability action. The bankruptcy court
issued a published opinion sanctioning DeLuca for violating several
ethical rules and Code provisions, and the BAP affirmed.
While there were many missteps, the upshot, as summarized in a concurring
opinion by Judge Jury, is that DeLuca did not obtain his clients’ informed
consent. DeLuca’s failure to investigate into the judgment led to his
failure to advise of the likely nondischargeability action, and,
ultimately, to his failure to advise the debtors that the unbundled “basic
services” package was unlikely to provide the relief they sought.
De Luca v. Seare (In re Seare), 2014 WL 4186483 (9th Cir. BAP Aug. 25,
2014).
SALES AND COMPROMISES
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BAP Defines “Consummation” for Purposes of Exercising First Refusal
Rights Under
§ 363(i)
Section 363(i) provides that “[b]efore the consummation of a sale” of
estate property that was “community property of a debtor and the debtor’s
spouse immediately before commencement of the case,” the debtor’s spouse
may purchase the property “at the price at which such sale is to be
consummated.” Here, a chapter 7 trustee sold, with court approval, the
debtor’s interest in certain pending state court litigation for $40,000,
with payment due within 30 days of the sale order becoming final. A week
after the sale hearing, the debtor’s non-filing wife, who asserted a
community property interest in the claim, notified the trustee of her
intention to exercise first refusal rights under § 363(i). The bankruptcy
court approved the sale to the wife under § 363(i), and the original buyer
appealed, contending, among other things, that the sale had already been
consummated when the wife exercised her § 363(i) rights.
Affirming the bankruptcy court, the BAP held that the sale had not been
consummated for purposes of § 363(i) prior to the wife’s exercising first
refusal rights. Since “consummation” is not defined in the Code, the BAP
looked to dictionary definitions and, by analogy, to the definition of
“substantial consummation” in § 1101(2), concluding that the term
“involves more than mere approval of a sale and requires finalization of
the sale[,]” typically through payment. Here, payment was not due until
well after the point when the wife asserted her § 363(i) rights, and, in
fact, the original buyer had never tendered payment to the trustee.
Kallman & Co. LLP v. Gottlieb (In re Lewis), 2014 WL 4099248 (9th Cir. BAP
Aug. 20, 2014).
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There Is No Per Se Rule Banning Carve-out Agreements in Chapter 7
A chapter 7 trustee employed an auctioneer to conduct a public sale of the
debtor’s assets, consisting of inventory from its sporting goods business.
The trustee determined that the bank held a perfected security interest
encumbering all of the inventory. The bank and trustee entered into a
stipulation whereby the net proceeds of the inventory would be split
between the bank and the estate. The trustee believed that the transaction
would net approximately $4,400 for the estate. The bankruptcy court
declined to approve the stipulation, opining that arrangements between
chapter 7 trustees and secured lenders raise a presumption of impropriety,
and that the presumption had not been rebutted here.
On appeal, the BAP vacated the court’s ruling, explaining that there is no
per se rule banning carve-out agreements as proposed by the trustee. While
these types of transactions do raise a presumption of impropriety, the BAP
held that the presumption can be rebutted where (1) the trustee fulfills
his basic duties, (2) there is a benefit to the estate (i.e., prospects
for a meaningful distribution to unsecured creditors), and (3) the terms
of the carve-out have been fully disclosed to the court. In this instance,
the record confirmed that the trustee had fulfilled the first and third
requirements. The BAP remanded for the court to make findings as to
whether the estimated proceeds would result in a meaningful distribution
to unsecured creditors.
In re KVN Corp., Inc., 514 B.R. 1 (9th Cir. BAP 2014).
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A Covenant May Be Wiped Out by Foreclosure, But That Doesn’t Mean a
Trustee Can Get Rid of It
In the 1980s and 1990s, the Redevelopment Agency of the City of West
Covina conveyed several properties to the debtor for the operation of auto
dealerships. The debtor agreed to certain covenants governing the use of
the properties, including one that granted the agency the right to approve
or disapprove any future owner of the properties, as well as any future
operator of auto dealerships on the property. Following conversion of the
case from chapter 11 to chapter 7, the trustee moved for approval of a
sale of the properties free and clear of the covenants and contractual
interests of the agency. The agency, in turn, filed a motion for
enforcement of those covenants and contractual interests.
The bankruptcy court denied the agency’s motion and granted the trustee’s
motion, holding that the ownership restriction was not enforceable as a
contractual interest, a real property covenant, or an equitable servitude.
The bankruptcy court held, however, that the operations restriction was
enforceable as an equitable servitude. Notwithstanding this finding, the
court concluded that the trustee could sell the properties free and clear
of this equitable servitude under § 363(f)(5) as the agency and its
successors “could be compelled, in a legal or equitable proceeding, to
accept a money satisfaction of such interest.” In approving the sale, the
bankruptcy court agreed with the trustee that if the senior lienholder
foreclosed, the junior covenants and equitable servitudes would be
extinguished. Consequently, the agency or its successors would be
“compelled, in a legal or equitable proceeding, to accept a money
satisfaction of such interest.”
The agency appealed and obtained an order staying the sale pending appeal.
The district court thereafter reversed on the merits. It first agreed with
the bankruptcy court’s conclusion that under California law, the parties’
operating covenant was enforceable as an equitable servitude. However, it
concluded that foreclosure of a senior lien held by a third party did not
constitute a “legal or equitable proceeding” in which city could be
compelled to accept a money satisfaction of its interest. In particular,
the term “ ‘satisfaction’–at least in the context of ‘satisfaction of [an]
interest’–connotes giving something of value in exchange for terminating
an outstanding obligation.” A foreclosure sale could simply wipe out a
junior lien or interest without giving anything of value to the junior
interest holder. Consequently, the bankruptcy court erred by construing
the Bankruptcy Code to authorize a sale free and clear of the equitable
servitude.
In re Hassen Imports P’ship, 502 B.R. 851 (C.D. Cal. 2013).
AVOIDING POWERS
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Bankruptcy Court Has Authority to Avoid Transfers of Interests In
Foreign Property
Prior to their bankruptcy, the debtors purchased an interest in property
in Mexico. Under Mexican law, they could not hold fee simple title in the
property, and thus a Mexican bank held the title and the debtors held a
right to use the property. The vendor of the property thereafter obtained
a judgment in district court (S.D. Cal.) requiring them to return their
interest in the property or pay damages. During that litigation, the
debtors transferred their interests in the Mexican property to an alter
ego shell company and subsequently filed their chapter 7 case. While the
chapter 7 case was pending, the shell company then sold the property
interest to two individuals at a price adjusted to account for obligations
owed by the debtors to the purchasers. The purchasers, who knew about the
bankruptcy and the possibility that a trustee could seek to avoid the
initial transfer of the property interest to the alter ego company, paid
most of the consideration to entities other than the shell company but
still associated with the debtors.
The trustee filed an action to avoid the transfer of the property interest
from the debtors to their alter ego company. The trustee also sought to
avoid the transfer from the alter ego to the purchasers as an unauthorized
postpetition transfer. The bankruptcy court affirmed, and the district
court affirmed. On appeal, the purchasers contended that the bankruptcy
court inappropriately exercised jurisdiction over Mexican land and
improperly applied U.S. bankruptcy law extraterritorially. The Ninth
Circuit affirmed, holding that the bankruptcy court, by virtue of its
exclusive jurisdiction over property of the estate wherever located, could
adjudicate unauthorized postpetition transfer proceeding affecting Mexican
realty. It also held that the bankruptcy court did not abuse its
discretion in declining to enforce a forum selection clause contained in
the relevant documents. The panel concluded that the bankruptcy court’s
order did not implicate principles of international comity and Mexico was
not a necessary party in adversary proceeding to unwind transfer. Finally,
the Ninth Circuit held that the bankruptcy court could apply United States
bankruptcy law in deciding whether downstream purchasers of a beneficial
interest in Mexican realty completed the purchase in good faith.
In a related appeal involving the same parties and property, the Ninth
Circuit affirmed the award of contempt of court sanctions against the
purchasers and held that it had jurisdiction over the appeal even though
the district court had partially remanded the matter to the bankruptcy
court for recalculation of the amount of sanctions. The Ninth Circuit also
held that the bankruptcy court had the power to facilitate transfer of the
property (i.e., by compelling execution of certain documents) even though
the fraudulent transfer judgment was on appeal. “After an appeal is filed,
a court generally may not ‘alter or expand upon the judgment,’ [although]
it retains jurisdiction to supervise a required course of conduct.”
Kismet Acquisition, LLC v. Icenhower (In re Icenhower), 757 F.3d 1044 (9th
Cir. 2014) (affirming fraudulent transfer judgment).
Kismet Acquisition, LLC v. Diaz-Barba (In re Icenhower), 755 F.3d 1130
(9th Cir. 2014) (affirming the award of contempt of court sanctions
against the purchasers).
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You Can Be the Target of a Turnover Motion Even If You No Longer Have
the Property
A chapter 7 trustee filed a motion against a debtor for turnover of funds
that were in the debtor’s bank account on the petition date. However, at
the time the trustee filed the turn-over motion the funds were no longer
in the debtor’s account due to certain payments and transfers made
post-petition. The bankruptcy court denied the turnover motion because the
debtor did not have possession or control of the funds at the time the
trustee filed the motion. The trustee appealed, and the district court
affirmed.
Reversing the district court, the Ninth Circuit held that a trustee may
seek turnover from an entity that had “possession, custody, or control” of
the subject property during the bankruptcy case, regardless of whether the
entity had possession, custody, or control at the time the turnover motion
was filed. In arriving at its holding, the Court looked to the plain
language of § 542(a), which only requires possession, custody, or control
“during” the case, and allows a trustee to recover the value of the
subject property if the entity is no longer in possession when the motion
is filed. The Court’s ruling was also supported by pre-Code turnover
practice.
Shapiro v. Henson, 739 F.3d 1198 (9th Cir. 2014).
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Just Like Foreclosure Sales, Regularly Conducted Tax-Default Sales Are
Not Fraudulent Transfers
About a month before the chapter 11 debtor’s petition date, the Los
Angeles County Treasurer and Tax Collector duly conducted tax sales of two
of the debtor’s real properties at public auction. The debtor filed an
adversary proceeding against the county to avoid the tax sales as
fraudulent transfers under § 548(a), among other relief. The bankruptcy
court granted the county’s Rule 12(b)(6) motion and dismissed the
complaint with prejudice, finding that the debtor could not amend the
complaint to state a viable cause of action. The debtor appealed.
Affirming the bankruptcy court, the BAP looked to the U.S. Supreme Court’s
decision in BFP v. Resolution Trust Corp., 511 U.S. 531 (1994), which held
that a “fair and proper price, or ‘reasonably equivalent value,’ for a
foreclosed property, is the price in fact received at the foreclosure
sale, so long as all the requirements of the State’s foreclosure law have
been complied with.” The BAP, agreeing with courts across the country,
held that BFP’s holding should be applied to regularly conducted sales of
tax-defaulted real property in California. In this instance, there was no
evidence that the tax sales did not comply with all applicable notice and
other statutory requirements. Accordingly, there was a conclusive
presumption that the sales were for reasonably equivalent value. The tax
sales therefore were not subject to avoidance under § 548(a). On a
separate note, the BAP also held that the county’s post-petition
recordation of the tax deeds was a ministerial act, and therefore did not
violate the automatic stay.
Tracht Gut, LLC v. County of Los Angeles, Treasurer and Tax Collector (In
re Tracht Gut, LLC), 503 B.R. 804 (9th Cir. BAP 2014).
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District Court Finds That Section 544(b) Does Not Apply to
Post-petition Transfers
A chapter 11 debtor scheduled certain real property located in
Hillsborough, California as having a value of $1.2 million. The debtor’s
chapter 11 plan provided that upon confirmation all property of the estate
would vest in the debtor. Two months after the plan was confirmed (and the
property had vested in the debtor), the debtor sold the property for over
$3.1 million. The debtor received $1.9 million out of escrow, nearly all
of which it wired to a corporation created by the debtor’s insider 21 days
earlier. After the case converted to chapter 7, the trustee filed an
adversary proceeding to set aside the sale as a fraudulent transfer under
§ 544(b) and Cal. Civ. Code § 3439.04. Section 549 was not available to
the trustee, as it applies by its terms only to unauthorized post-petition
transfers of estate property.
Reversing the bankruptcy court, the district court ruled that § 544(b)
does not apply to post-petition transfers. Based upon an analysis of case
law, statutory language, and legislative history, the court reasoned that
Congress intended § 549 to be the sole section addressing post-petition
transfers, as evidenced by, among other things, the fact that § 549
contains its own statute of limitations keyed to the date of the transfer
(“two years after the [post-petition] transfer sought to be avoided”).
Section 544(b)’s statute of limitations, in contrast, set out in § 546(a),
expires after the later of two years after entry of the order for relief
or one year after appointment of a trustee. If § 544(b) were intended to
apply to post-petition transfers, it would make little sense to cut off
the limitations period so early. The court acknowledged that a window had
been “left open” for debtors to engage in mischief, but concluded that it
was Congress’s responsibility to close it.
Casey v. Rotenberg (In re Kenny G. Enterprises, LLC), 2014 WL 2889650
(C.D. Cal. June 24, 2014).
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Paying Off Credit Card Bill Every Month Qualifies for Ordinary Course
Defense
During the 90 days preceding their petition date, the chapter 7 debtors
made four payments totaling $10,868.58 on their credit card account with
Barclays Bank. The chapter 7 trustee sued Barclays to avoid the payments
as preferences. After evaluating the litigants’ cross-motions for summary
judgment, the bankruptcy court found that Barclays had a complete defense
under either prong of the ordinary course of business defense. In
particular, under § 547(c)(2)(A), all payments were for the full amount
due, or close to it, which was consistent with the debtors’ pre-preference
period payment history. The payments also satisfied the “ordinary business
terms” standard of sub-section (c)(2)(B), after taking into account
studies showing that approximately half of credit card users pay the full
balance each month. In addition, Barclays established a new value defense
as to all but about $3,000 of the transfers.
Notably, the court was critical of Barclays for stating in its
cross-motion that it objected to the court’s constitutional authority to
enter final judgment per Stern, but then concluding with a request that
the court enter final judgment in favor of Barclays and dismiss the action
with prejudice. As the court put it, “Barclays cannot have it both ways,”
and wait to see how the court rules before deciding whether to consent to
entry of final judgment. Ultimately, the court concluded that Barclays had
waived or forfeited its Stern objection by affirmatively asking for entry
of final judgment by the bankruptcy court.
Haley v. Barclay’s Bank Delaware (In re Carter), 506 B.R. 83 (Bankr. D.
Ariz. 2014).
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Subcontractor’s Release of Stop Notices Provided Contemporaneous
Exchange Defense
The chapter 7 debtor was a contractor for various school districts. During
the 90 days preceding its petition date, the debtor made a $75,000 payment
to a subcontractor, who in turn released several statutory stop notices.
The subcontractor served several stop notices within the 90 days as well.
The chapter 7 trustee sued the subcontractor to avoid the payment and the
stop notices as preferences. Following a trial, the bankruptcy court ruled
that the subcontractor established complete (or nearly complete) ordinary
course, new value, and contemporaneous exchange defenses with respect to
the payment.
Of particular note, the court found that the stop notice releases provided
in return for the payment constituted a contemporaneous exchange for new
value. The releases constituted new value because they obviated the
equitable lien the debtor’s surety otherwise would have had against the
construction fund if the surety had made the payment instead of the
debtor. Significantly, in making this determination, the court found that
the surety would have been fully secured at the time of the transfer,
since the amount in the construction fund exceeded the amount of matured
claims against the bond. In addition, the court found that the stop
notices were statutory liens that could not be avoided by operation of §
547(c)(6) (providing that a trustee may not avoid a transfer “that is the
fixing of a statutory lien that is not avoidable under section 545”).
Stahl v. Whelan Electric, Inc. (In re Modtech Holdings, Inc.), 503 B.R.
737 (Bankr. C.D. Cal. 2013).
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Trustee Successfully Invokes “Sham Affidavit Rule” in Avoiding
Transfers of Trademarks
Within two years before their bankruptcy filings, chapter 11 debtors
transferred for no consideration their most valuable assets–trademarks to
their “Girls Gone Wild” adult entertainment business–to an entity managed
and controlled by the debtors’ insider. Following the assignment, the
debtors continued to use the trademarks, but paid no licensing fees or
royalties to the transferee. Shortly before the petition date, the
transferee terminated the debtors’ rights to use the trademarks and then
relicensed the trademarks to the debtors in return for a fee of
$274,250.52. The fee, paid just before the petition date, effectively
cleaned out the debtors’ bank accounts.
The chapter 11 trustee sought to avoid the foregoing transfers as
fraudulent transfers under § 548(a). In his motion for summary judgment,
the trustee presented overwhelming evidence that the debtors made the
transfers with actual intent to hinder, delay, or defraud their creditors
(including testimony by the insider’s lawyer that the trademarks were
transferred so that creditors could not seize them). The trustee
established multiple “badges of fraud” as well. In opposition, the insider
submitted a declaration which was “glaringly discordant” and otherwise
implausible given his prior deposition testimony. The court essentially
threw out the declaration based on the “sham affidavit rule,” which
prevents a party from simply raising an issue of material fact by
submitting a declaration that contradicts the party’s prior deposition
testimony. The court granted the trustee’s motion under the actual fraud
standard of § 548(a)(1)(A).
Argyle Online, LLC v. Nielson (In re GCW Brands LLC), 504 B.R. 577 (Bankr.
C.D. Cal. 2013).
CHAPTER 11
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Substantive Consolidation of Chapter 11 Debtors and Non-Debtor Entities
Justified under Bonham Standard
A chapter 11 trustee filed an adversary proceeding against a host of
entities related to the debtors (all of which were controlled by the
debtors’ insider), seeking substantive consolidation of the debtors’
estates with the defendant entities (i.e., the defendants’ assets and
liabilities would be pooled together with those of the estates, as if all
were a single entity). Following a very lengthy and detailed set of
factual findings, the bankruptcy court determined that substantive
consolidation nunc pro tunc to the petition date was warranted, and
granted the trustee’s motion for summary judgment.
In a thorough discussion of the legal standards and rationales for
substantive consolidation, the court looked to the Ninth Circuit’s Bonham
decision and its adoption of the so-called “Augie/Restivo” factors,
distilled as follows: whether creditors dealt with entities as a single
economic unit, and whether the affairs of the debtor are so entangled that
consolidation will benefit all creditors. Here, the undisputed facts
established, among other things, that (1) it was impossible to identify
and segregate the assets of the debtors and defendants given the thousands
of inter-company transactions over a nine-year period and the lack of
adequate records establishing the purposes of the transfers; (2) debtors
and defendants were not treated as separate entities but rather as alter
egos of one another; (3) substantive consolidation would promote fairness
to all creditors by ensuring ratable distribution of defendants’ assets
while avoiding the cost of trying to determine who owes what to whom; and
(4) defendants’ creditors dealt with defendants and debtors as if they
were all the same entity.
Sharp v. Salyer (In re SK Foods, LP), 499 B.R. 809 (Bankr. E.D. Cal.
2013).
*Robert E. Clark is a partner in the firm of Dumas & Clark LLP.
*Peggy Brister is the law clerk to the Hon. Dennis Montali.
*Geoffrey A. Heaton is Special Counsel at the San Francisco office of
Duane Morris LLP.
*Cecily Dumas is a partner in the San Francisco firm of Dumas & Clark LLP.
*Ron Mark Oliner is a partner at the San Francisco office of Duane Morris
LLP.
*Hon. Dennis Montali is a United States Bankruptcy Judge sitting in the
San Francisco Division of the Northern District of California.
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