Receivership News thanks the authors for the opportunity to publish this “highlights” version of their annual lengthy recent developments report.

The panelists gratefully acknowledge the assistance of Peggy Brister, Law Clerk to the Hon. Dennis Montali, Geoffrey A. Heaton, Duane Morris LLP, and Brian R. Hayag, Pillsbury Winthrop Shaw Pittman LLP, in the preparation of these materials.

JURISDICTION, STANDING, AND PROCESS

Parties Can (Implicitly) Consent to Final Adjudication of Stern Claims in Bankruptcy Court.

In what one hopes is the final chapter on Stern v. Marshall, the Supreme Court issued its decision in Wellness Int’l Network, Ltd. v. Sharif. A creditor held a district court judgment against a debtor. The creditor objected to the debtor’s discharge and sought declaratory relief that a trust the debtor administered was actually the debtor’s alter ego. Although debtor sought a judgment in his favor, he failed to comply with discovery orders. The bankruptcy court entered default judgment against him. Shortly after the debtor appealed to the district court, the Supreme Court issued its decision in Stern v. Marshall. The debtor sought leave to file supplemental briefing for a Stern objection on the alter ego claim. The district court denied his request as untimely, and affirmed the default judgment. On further appeal, the Seventh Circuit held that: (1) Stern objections cannot be waived because they implicate structural interests; and (2) the bankruptcy court lacked constitutional authority to enter a final judgment on the creditor’s alter ego claim.

The Supreme Court granted certiorari. It first described the history of adjudication by consent, and the ultimate lesson therein: that “entitlement to an Article III adjudicator is ‘a personal right’ and thus ordinarily ‘subject to waiver[.]’” It then examined whether bankruptcy court adjudication of Stern claims would impermissibly threaten the Judicial Branch’s institutional integrity. It compared bankruptcy judges to magistrate judges – they are both appointed and subject to removal by Article III judges; and they are both judicial officers of the district court and subject to its supervision.

The Supreme Court then addressed the debtor’s argument that consent to bankruptcy court adjudication must be express. It disagreed, again likening bankruptcy courts to magistrate courts. The Court had previously held that implied consent to magistrate court jurisdiction: (1) substantially honored Article III by permitting waiver based on actions rather than words; (2) increased judicial efficiency; and (3) checked gamesmanship. The Court emphasized that whether consent is express or implied, it “must still be knowing and voluntary.” “[T]he key inquiry is whether ‘the litigant or counsel was made aware of the need for consent and the right to refuse it, and still voluntarily appeared to try the case’ before the non-Article III adjudicator.”

Wellness Int’l Network, Ltd. v. Sharif, 135 S. Ct. 1932 (2015).

TRUSTEES AND PROFESSIONALS / FEES

No Fees for Defending Fee Applications.

A chapter 11 debtor in possession hired two law firms under § 327(a) to represent it as debtor’s counsel. On the debtor’s behalf, the firms brought fraudulent transfer claims against the debtor’s parent company and obtained a judgment worth $7 to $10 billion. The judgment contributed to a successful reorganization whereby the debtor paid all its creditors in full. When the law firms sought approval of their fees under § 330(a), the debtor – now controlled by its parent company – objected. Following extensive discovery and a six-day trial, the bankruptcy court overruled the debtor’s objection and awarded the firms $120 million for their work, as well as a $4.1 million enhancement for exceptional performance. The court also awarded the firms $5 million for fees incurred in defending against the fee objection.

The debtor appealed, and the Fifth Circuit reversed, holding that the American Rule (i.e., each side must pay its own attorneys’ fees) applies absent explicit statutory authority to the contrary. In this instance, the Fifth Circuit reasoned that there is no statutory authority for recovery of fees incurred defending a fee application. The Supreme Court affirmed, noting that § 330(a)(1) allows “reasonable compensation” for “actual, necessary services rendered.” The term “services,” the Court explained, ordinarily means “labor performed for another.” Thus, time spent litigating against a debtor in possession cannot be described as labor “performed for” that same entity. The Court also contrasted § 330(a) with other Code sections that explicitly contain fee-shifting provisions. Had Congress wished to shift the burdens of fee defense litigation under § 330(a), the Court concluded, it could have easily done so.

Baker Botts L.L.P. v. ASARCO LLC, 135 S. Ct. 2158 (2015).
California’s Reciprocal Fee-Shifting Statute Applies to Bankruptcy Disputes.

A secured creditor held a claim against a chapter 13 debtor for a loan the debtor used to purchase a new car and pay off negative equity in her old car. The debtor proposed a plan that stripped down the creditor’s claim into secured and unsecured portions. The creditor objected under the “hanging paragraph” of Bankruptcy Code § 1325(a). And the bankruptcy court held that the creditor was not entitled to a secured claim for the portion of the loan used to pay off the negative equity. The district court and the Ninth Circuit affirmed that decision.

Later, the debtor moved to recover attorney fees for that dispute under: (1) the loan agreement’s unilateral fee-shifting provision covering disputes “on [the] contract;” and (2) Cal. Civ. Code § 1717, which can render such unilateral provisions reciprocal. The bankruptcy court denied the debtor’s motion, ruling that § 1717 did not apply to bankruptcy law disputes. The district court affirmed. The Ninth Circuit, however, reversed and remanded. It noted the Supreme Court’s decision in Travelers Casualty & Surety Co. v. Pacific Gas & Electric Co., 549 U.S. 443 (2007), which held that the Bankruptcy Code does not disallow attorney fee claims incurred in litigating bankruptcy law questions. It observed that California courts had applied § 1717 to bankruptcy law disputes. And it found that, as the “party prevailing on the contract,” the debtor was entitled to attorney fees under § 1717.

Penrod v. AmeriCredit Financial Services, Inc. (In re Penrod), 802 F.3d 1084 (9th Cir. 2015).
Credit Bid Doesn’t Factor into Cap on Trustee’s Compensation.

Under § 326(a), a bankruptcy court has discretion to award a trustee reasonable compensation up to a cap calculated as a percentage of “all moneys disbursed or turned over in the case by the trustee to parties in interest.” A chapter 7 trustee sold some condos at an auction. Secured creditors submitted the winning bid, credit bidding $1.5 million. In his fee application, the chapter 7 trustee factored the credit bid amount into his § 326 cap, which amounted to approximately $40,000 of his requested $109,000 in compensation. The bankruptcy court granted the full amount of the fees over the U.S. Trustee’s objection, and the BAP reversed. Affirming the BAP, the Ninth Circuit reasoned that under the “ordinary meanings,” i.e., dictionary definitions, of the terms “moneys,” “disbursed,” and “turn over,” the trustee may collect fees “only on those transactions for which he pays interested parties … in some form of generally accepted medium of exchange.” Legislative history supported this interpretation. The panel opined that Congress’ decision to exclude credit bids was rational, if not necessarily wise, noting that it may incentivize trustees to seek out third party buyers to obtain better results for the estate.

Tamm v. U.S. Trustee (In re Hokulani Square, Inc.), 776 F.3d 1083 (9th Cir. 2015).

TURNOVER AND AVOIDANCE ACTIONS

No Preference Liability for Insider Guarantor Who Waived Indemnification Rights.

A chapter 11 debtor’s president and CEO personally guaranteed a multi-million dollar loan to the debtor’s secured creditor, and unconditionally waived any right to indemnification from the debtor. Nine months before the petition date, the debtor paid down approximately $5 million of the loan. The president then paid off the loan balance – totaling over $3.5 million – from his personal funds, and never filed a claim in the bankruptcy case. The creditors’ committee sued the president to avoid and recover the $5 million loan pay-down as a preference, on the theory that the payment reduced the president’s exposure on the guaranty and was therefore to his benefit.

Affirming the bankruptcy and district courts, the Ninth Circuit held that the president had no preference liability due to his waiver of indemnity rights. Thus, he did not hold a claim against the debtor and was not a creditor. (Section 547(b)(1) requires that a preferential transfer be “to or for the benefit of a creditor”). The panel rejected a line of cases holding that an indemnity waiver is no defense to a guarantor’s preference liability because the guarantor can potentially buy the creditor’s note and thereby assert a claim against the debtor. Instead, a court should examine the totality of the facts to determine if there is actually evidence of a “sham” waiver (i.e., subsequent actions that negate the economic impact of the waiver). In this instance, based upon the evidence in the record, the president’s waiver was not a sham.

Stahl v. Simon (In re Adamson Apparel, Inc.), 785 F.3d 1285 (9th Cir. 2015).
Dominion Test Determines the “Initial Transferee.”

George Lindell controlled the finances of a company called The Mortgage Store (“TMS”). Lindell entered into a contract with Mano-Y&M, Ltd. (“Mano”) to purchase a shopping plaza. He caused TMS to wire the sale’s cash component to the closing attorney, who in turn disbursed most of the funds to Mano under the contract. TMS then filed chapter 7. The trustee discovered that TMS had operated a Ponzi scheme, and sued Mano to recover the funds as a fraudulent transfer. The bankruptcy court ruled for the trustee; it found that Mano was an initial transferee not entitled to § 550(a)’s subsequent transferee defenses. On appeal, the district court affirmed. On further appeal, the Ninth Circuit Court of Appeals likewise affirmed. Mano had argued that Lindell was the funds’ initial transferee. The Ninth Circuit reiterated its adoption of the “dominion test” which considers whether a recipient has title to the funds and can use them as he sees fit; the first person to establish “dominion” over funds after they leave the transferor is the initial transferee. Here, Lindell never had legal title to the funds, and had no ability to control the funds once TMS had transferred them to the closing attorney. Accordingly, he was not the funds’ initial transferee. The Ninth Circuit acknowledged the harsh result, but noted that it was Congress’s intent to place the “monitoring costs” of a transaction on initial transferees like Mano.

Mano-Y & M, Ltd. v. Field (In re The Mortgage Store, Inc.), 773 F.3d 990 (9th Cir. 2014).
County Tax Lien Subject to Avoidance Under § 545.

Los Angeles County recorded tax liens against a chapter 11 debtor based upon the debtor’s failure to pay property taxes. Under Cal. Rev. & T. Code § 2191.4, recordation created broad liens on the debtor’s personal property, but the liens are not valid against a good faith purchaser of the property for value. The debtor successfully avoided the liens under § 545(2), which allows a trustee to set aside a statutory lien that is not properly perfected against a bona fide purchaser. The County appealed, and the BAP affirmed. As the BAP noted, the Ninth Circuit previously held that liens created under Cal. Rev. & T. Code § 2191.4 are avoidable under § 545’s Bankruptcy Act predecessor, which contained substantially the same language as § 545.

Los Angeles County Treasurer and Tax Collector v. Mainline Equipment, Inc. (In re Mainline Equipment, Inc.), 539 B.R. 165 (9th Cir. BAP 2015).

CHAPTER 9

Bildisco Controls Rejection of Collective Bargaining Agreements in Chapter 9.

In this, the first of San Bernardino City Professional Firefighters Local 891’s (“Firefighters”) many appeals, the Firefighters appealed a bankruptcy court order rejecting their collective bargaining agreement. The firefighters’ primary argument was that the City of San Bernardino failed to meet its burden for rejecting such an agreement under the established precedent, NLRB v. Bildisco, 465 U.S. 513 (1984). In Bildisco, the Supreme Court held – in the chapter 11 context – that a collective bargaining agreement is a § 365 executory contract, and a debtor has the burden to show: (1) it made reasonable efforts to negotiate a voluntary modification, and such efforts are not likely to produce a prompt, satisfactory solution; (2) the agreement is a burden on the debtor; and (3) the balance of the equities weighs in favor of rejection. The district court affirmed, explaining that the inquiry into whether a municipality has made “reasonable efforts to negotiate a voluntary modification” involves the application of case specific facts. The district court also rejected the Firefighters’ claim that the city failed to prove that the collective bargaining agreement was a financial burden.

San Bernardino City Professional Firefighters Local 891 v. City of San Bernardino, California (In re City of San Bernardino, California), 530 B.R. 474 (C.D. Cal 2015).
California Can Try to Protect CalPERS from the Bankruptcy Code, But It Won’t Necessarily Stop Pension Modifications.

A creditor objected to confirmation of the City of Stockton’s plan, arguing that, because the plan did not modify the city’s pensions, the city had proposed the plan in bad faith. The pensions’ administrator – CalPERS – filed a response, arguing that California law prevented the city from modifying the pensions. The bankruptcy court disagreed, holding that the city could potentially modify CalPERS pensions. In examining the issue, the bankruptcy court described the rights that the California legislature had granted CalPERS under its Public Employees’ Retirement Law and questioned CalPERS standing to even make its arguments. Addressing a multitude of issues, the bankruptcy court observed that §§ 903 and 904 prohibit it from impairing the “political or governmental powers” of a municipality. To define “political or governmental powers,” the court searched for clues in the remainder of chapter 9. And it concluded that, “‘political or governmental’ powers relate to basic requirements of government and political polity and exclude financial and employment relations. To hold otherwise would read out of the Bankruptcy Code a number of provisions that plainly apply in [c]hapter 9.” It stated that there was nothing inherently governmental or political about CalPERS or its statutory protections and held that those protections did not fall within §§ 903 and 904’s ambit.

In re City of Stockton, California, 526 B.R. 35 (Bankr. E.D. Cal. 2015).

APPEALS

No Appeals for Orders Denying Plan Confirmation with Leave to Amend.

A chapter 13 debtor proposed a plan that stripped down a mortgagee’s claim and paid the secured portion beyond 5 years. The mortgagee objected, and the bankruptcy court denied confirmation as the plan did not provide full payment of the secured portion during the plan’s term. The court thus ordered the debtor to amend his plan within 30 days. Instead, the debtor appealed the decision to the First Circuit BAP. The BAP found the appeal interlocutory, but nonetheless exercised its 28 U.S.C. § 158(a)(1) discretion to address the merits and affirmed. On further appeal, the First Circuit noted that § 158(d)(1) permits appeals only of final orders; it explained that “an order of the BAP cannot be final unless the underlying bankruptcy court order is final.” It dismissed the appeal for lack of jurisdiction, adopting the majority view holding that an order denying plan confirmation is not final so long as the debtor remains free to propose another plan. The debtor (whom the U.S. Solicitor General supported with an amicus brief) appealed to the Supreme Court, which affirmed and held that an order denying plan confirmation with leave to amend is not a final order that the debtor can immediately appeal as of right.

Bullard v. Blue Hills Bank, 135 S. Ct. 1686 (2015).
A Ninth Circuit Trilogy: When Is An Appeal of a Confirmation Order Equitably Moot?

Equitable mootness is a prudential doctrine by which a court elects not to reach the merits of a bankruptcy appeal; an appeal is equitably moot if the case presents transactions so difficult to unwind that parties are entitled to rely on the final bankruptcy court order. In the last year, the Ninth Circuit panel issued three decisions addressing the equitable mootness of chapter 11 plan confirmation appeals, raising concerns that confirmation and other plan effectuating orders are appealable notwithstanding substantial consummation. In all three cases, the Ninth Circuit identified the following equitable mootness considerations: (1) whether the appellant fully pursued its rights by seeking a stay; (2) whether there is substantial plan consummation; (3) what effect a remedy may have on third parties not before the court; and (4) whether the bankruptcy court can fashion effective and equitable relief without knocking the plan’s props out and creating an uncontrollable situation. In Mortgages I and Mortgages II, different entities filed separate appeals of orders related to plan confirmation. The appellees requested dismissal for equitable mootness based on substantial plan consummation. Because the Mortgages II appellants had diligently (though unsuccessfully) sought a stay pending appeal, and the Mortgages I appellants had not, the Ninth Circuit panel dismissed only the Mortgages I appeal for equitable mootness.

In comparison, the Ninth Circuit Transwest panel focused on the last “and most important” consideration of “whether the bankruptcy court could fashion equitable relief without completely undoing the plan.” The majority held that even where such relief would be partial, the appeal is not moot. In a strongly-worded dissent, Judge Milan Smith noted the panel members’ agreement that the plan had been substantially consummated, and that this factor weighed in favor of equitable mootness. But, unlike the other panel members, Judge Smith considered substantial consummation to be the “foremost consideration” in assessing equitable mootness, observing that other circuits hold that substantial consummation creates a presumption of equitable mootness, and substantial consummation should at least have significant weight in determining whether an equitable and effective remedy is available. Further, the Transwest majority had concluded that equitable mootness is not meant to protect a third-party investor’s interests merely because that investor participated in the confirmation proceedings. But Judge Smith strongly disagreed: once that investor agreed to fund the plan, it was “only natural” that it would be involved in the bankruptcy proceedings as its investment made the proposed reorganization feasible.

JPMCC 2007–C1 Grasslawn Lodging, LLC v. Transwest Resort Properties Inc. (In re Transwest Resort Properties Inc.), 801 F.3d 1161, 2015 WL 5332447 (9th Cir. 2015) (withdrawing and replacing prior opinion at 791 F.3d 1140).

Rev Op Group v. ML Manager LLC (In re Mortgages Ltd.) (“Mortgages I”), 771 F.3d 1211 (9th Cir. 2014) (appeal of bankruptcy court order was equitably moot, given investors’ failure to seek stay).

Rev Op Group v. ML Manager LLC (In re Mortgages Ltd.) (“Mortgages II”), 771 F.3d 623 (9th Cir. 2014) (appeal of a bankruptcy court’s order was not equitably moot, notwithstanding inability to obtain stay pending appeal).
Just How Flexible is the Ninth Circuit in Determining the Finality of Bankruptcy Appeals?

Debtor filed for bankruptcy after a state court certified a class of its current and former employees in a wage-and-hour class action. The employees filed a class claim and the bankruptcy court allowed a claim of approximately $15 million, concluding that that California law required the debtor to pay class members a prevailing wage for the time they spent: (1) traveling to and from public worksites; and (2) fabricating parts for use on public worksites. The district court affirmed the parts fabrication finding, but it reversed and remanded the travel time finding. Moreover, it remanded for “additional fact finding” on “[t]he terms of [the debtor’s] public works contracts and the practical conditions of the jobsite” to determine liability. Both parties appealed.

Observing that a district court order is typically considered final when it “ends the litigation on the merits and leaves nothing for the court to do but execute the judgment[,]” the Ninth Circuit has “taken a more nuanced and ‘flexible’ approach to assessing the finality of appeals in bankruptcy cases” because “the fluid and sometimes chaotic nature of bankruptcy proceedings necessitates a degree of jurisdictional flexibility.” In this case, though, “even this flexible approach [was] stretched beyond its breaking point by this appeal from a district court order that include[d] a remand to the bankruptcy court with explicit instructions to engage in ‘further fact-finding.’”

Most significantly, in a footnote, the Ninth Circuit indicated a willingness to reexamine its “flexible finality” standard, noting (but not deciding) that it may conflict with Supreme Court authority:
Sahagun v. Landmark Fence Co., Inc. (In re Landmark Fence Co., Inc.), --- F.3d ----, 2015 WL 5295114 (9th Cir. Sept. 11, 2015).

MISCELLANEOUS

Trustee Can Pay Estate’s Taxes Only After “Notice and a Hearing.”

A chapter 7 trustee paid $340,895 in estate funds to the IRS to satisfy the bankruptcy estate’s federal income tax liability for 2005. The tax liability qualified as an administrative expense under § 503(b). But the trustee did not provide notice and a hearing before making the payment, and the bankruptcy court did not authorize the payment. When the trustee sought approval of his final report, a creditor objected, demanding a hearing to determine the amount of the 2005 taxes. The bankruptcy court overruled the objection, and the district court affirmed.

The Ninth Circuit reversed, holding that under § 503(b)’s plain language, a “notice and hearing” were required before the trustee could pay the taxes. The Ninth Circuit rejected the trustee’s argument that the notice and hearing requirement conflicted with his duty to pay all federal taxes on or before the date they come due, even if the government does not file a request for payment of administrative expenses (per § 503(b) and 28 U.S.C. § 960). The Ninth Circuit found that these duties were “easily reconcilable” with the notice and hearing requirement, which provides creditors with an opportunity to contest a proposed tax payment before the estate’s funds are diminished.

Dreyfuss v. Cory (In re Cloobeck), 788 F.3d 1243 (9th Cir. 2015).
Just Like § 510(b) Says: It’s Not What the Claim “Is” on the Petition Date; It’s What the Claim “Arises From” that Counts.

Before filing its bankruptcy petition, a debtor agreed to purchase an individual’s membership interests in it, but the parties were unable to agree on the interest’s value. An arbitrator awarded the member some $400,000. When the debtor failed to pay, the member obtained a state court judgment for that amount. At that point, the debtor filed for bankruptcy relief and the member filed a proof of claim. The debtor sued to subordinate that claim under § 510(b), and the bankruptcy court granted summary judgment in its favor. Both the BAP and the Ninth Circuit affirmed, quoting § 510(b): “damages arising from the purchase or sale of [] a security . . . shall be subordinated[.]” The member argued that her claim did not arise from the purchase or sale of a security because her judgment converted her equity to debt. The Ninth Circuit noted that, in other courts, § 510(b) subordination requires an equity interest as of the petition date. But it explained that in the Ninth Circuit – based on § 510(b)’s plain language – the question is not what the claim is on the petition date, but rather what the claim arises from. It then found that member’s claim arose from the debtor’s repurchase of her membership interest, and that it was subject to § 510(b) subordination.

Pensco Trust Company, et al. v. Tristar Esperanza Properties, LLC (In re Tristar Esperanza Properties, LLC), 782 F.3d 492 (9th Cir. 2015).

The complete Recent Developments in Business Bankruptcy report will be published in the May 2016 California Bankruptcy Journal, Vol. 33, Issue 4 Cal. Bankr. J. on Westlaw.

*Hon. Dennis Montali is a United States Bankruptcy Judge sitting in the San Francisco Division of the Northern District of California.

*Cecily Dumas is a partner in the San Francisco office of Pillsbury Winthrop Shaw Pittman LLP.

*Ron Mark Oliner is a partner at the San Francisco office of Duane Morris LLP.