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

  1. 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).

  2. 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).

  3. 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).

  4. 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).

  5. 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

  1. 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:

    1. 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.

    2. 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).

  2. 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).

  3. 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).

  4. 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

  1. 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).

  2. 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

  1. 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).

  2. 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

  1. 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).

  2. 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).

  3. 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

  1. 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).

  2. 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).

  3. 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).

  4. 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).

  5. 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).

  6. 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).

  7. 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

  1. 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.