Case Analysis: Ly v. Che (In re Ly), 2015 WL 1787575 (9th Cir. Apr. 21, 2015), Insolvency Law e-Bulletin, Insol. L. Comm., Bus. L. Sec., Cal. State Bar (July 30, 2015).

SUMMARY
In Ly v. Che (In re Ly), 2015 WL 1787575 (9th Cir. Apr. 21, 2015), the U.S. Court of Appeals for the Ninth Circuit affirmed the BAP’s issuance of sanctions against an appellant and its attorney for filing a frivolous appeal, but declined to issue further sanctions because (a) the BAP cases that foreclosed the appellant’s arguments were not binding on the Ninth Circuit, and (b) a non-frivolous argument could be made that the reasoning of those BAP cases should not be adopted by the Ninth Circuit.

To read the full, unpublished decision, click here:  1.usa.gov/1T7Xqn6.

FACTUAL BACKGROUND[1]
In 2006, a forged deed was recorded with the L.A. County’s recorder’s office, purporting to transfer title of certain residential real property from Michelle Che (“Che”) to occupant Alen Ly (“Ly”).  When Che found out about it, she sued Ly and obtained a default judgment declaring the deed void and enjoining Ly from coming within 100 yards of the property.  Ly apparently refused to move out.

Ly filed for bankruptcy in April 2012; in his schedules he claimed to own the property.  A few months later, Che filed a motion for relief from stay to commence eviction proceedings.  Ly opposed the motion on the grounds that Che was not a real party in interest, and lacked standing to seek relief, because Ly had allegedly purchased the property from Che in July 2006.  Ly claimed that he had retained counsel to handle the state court litigation, and was shocked when he later received a 5-day notice to quit.

The bankruptcy court granted Che’s motion for relief from stay, and Ly appealed to the BAP.  Che responded by, among other things, filing a motion asking the BAP to sanction Ly and his counsel for filing a frivolous appeal.  Ly did not file any response to the motion.

In an unpublished decision, the BAP affirmed.  In doing so, the BAP referred to two cases it published in 2011 holding that a party moving for stay relief has a colorable claim sufficient to establish standing to prosecute the motion if it has an ownership interest in the subject property.  See Veal v. Am. Home Mortg. Servicing, Inc. (In re Veal), 450 B.R. 897, 913 (9th Cir. BAP 2011); Edwards v. Wells Fargo Bank, N.A. (In re Edwards), 454 B.R. 100, 105 (9th Cir. BAP 2011).

The BAP also sanctioned Ly and his counsel pursuant to FRBP 8020.  The BAP identified two reasons for its issuance of sanctions.  First,

[Ly’s counsel] should have known from our published opinions in In re Veal and In re Edwards that Panel precedent quite clearly recognizes that a party moving for relief from stay who has a colorable claim to ownership of the subject property has prudential standing.  We assume that he read the Panel’s opinion in In re Veal because he cited it to us in [his] Opening Brief specifically for its “exhaustive” discussion of standing and real party in interest issues.

Second, the BAP found it “particularly troubling” that when Ly’s counsel filed Ly’s original excerpts of the record, he omitted exhibits to declarations filed in support of Che’s motion for relief from stay (including the certified copy of the judgment), though he did include exhibits to his own declaration.  Ly’s counsel “had to be aware that the Judgment was a critical part of the evidentiary record before the bankruptcy court supporting its finding that Che had standing to seek stay relief.”  Ly’s counsel only supplemented the excerpts of the record to include the judgment after the BAP’s motions panel ordered Ly “to supplement the record with a complete copy, ‘including exhibits,’ of the Stay Motion.”

Ly appealed the BAP’s affirmance of the bankruptcy court’s order, and the BAP’s issuance of sanctions, to the Ninth Circuit.  Che responded by filing a motion with the Ninth Circuit requesting additional sanctions against Ly and his counsel.

NINTH CIRCUIT’S RULING AND REASONING
First, the Ninth Circuit easily affirmed the BAP’s affirmance of the bankruptcy court’s order granting relief from stay.

Second, the Ninth Circuit ruled that the BAP did not abuse its discretion in sanctioning Ly and his attorney for filing a frivolous appeal. “Given the case law directly contradicting [Ly’s] position [i.e., Veal and Edwards], the result of Ly’s appeal was obvious and his arguments were ‘wholly without merit.’”

However, applying the exact same standard that the BAP applied when it issued its sanctions, the Ninth Circuit declined to issue further sanctions against Ly and his attorney because “the cases that foreclosed Ly’s arguments before the BAP, [Veal] and [Edwards], are not binding on this court.  Accordingly, because a non-frivolous argument could be made that the reasoning of those cases should not be adopted by this Court, although no such argument was made, we decline to impose sanctions for a frivolous appeal in the exercise of our discretion.”

AUTHOR’S COMMENTARY
Based on the facts described in the BAP’s decision, Che clearly had standing to move for relief from stay and Ly’s appeal was frivolous.  But mixed signals from the Ninth Circuit make this decision notable.  While a circuit court can certainly exercise its own discretion in deciding whether to issue sanctions, how can the further appeal to the circuit court be considered non-frivolous where the circuit court affirms a lower court’s issuance of sanctions for filing a frivolous appeal?

In any event, litigants who intend to challenge a prior BAP ruling before the circuit court should elect to proceed before the district court or should be certain to make a non-frivolous argument that the prior BAP decision should be overruled.  Otherwise, even if a non-frivolous argument could be made that the BAP’s prior ruling should not be adopted by the circuit court, a party and counsel risk sanctions simply because the BAP considers its published rulings binding on subsequent panels.  See Ball v. Payco-Gen. Am. Credits, Inc. (In re Ball), 185 B.R. 595, 597 (9th Cir. BAP 1995) (“[w]e will not overrule our prior rulings unless a Ninth Circuit Court of Appeals decision, Supreme Court decision or subsequent legislation has undermined those rulings.”); Inst. of Imaginal Studies v. Christoff (In re Christoff), 527 B.R. 624, 634 (9th Cir. BAP 2015).

These materials were written by John N. Tedford, IV, of Danning, Gill, Diamond & Kollitz, LLP (jtedford@dgdk.com).  Editorial contributions were provided by Everett L. Green of the Insolvency Law Committee. 

Thank you for your continued support of the Committee.

Best regards,

Insolvency Law Committee

Understanding Credit Bidding in Bankruptcy Sales

INTRODUCTION
A creditor with a lien against property subject to a sale under the Bankruptcy Code generally is entitled to bid the value of its claim. This avenue for lenders to recover on their collateral may also be an opportunity for distressed asset investors. Looking for a market advantage, investors may seek to acquire loans and the associated liens with an eye toward foreclosure or the acquisition of the property outright through a section 363 sale. The credit bid is an attractive option to the purchaser who may have acquired the underlying loan rights at a steep discount. However, such a venture will not always be welcome by the trustee or debtor seeking to maximize the recovery from the sale of an estate asset.

THE STATUTE
11 U.S.C. § 363(k) provides as follows:

At a sale under subsection (b) of this section of property that is subject to a lien that secures an allowed claim, unless the court for cause orders otherwise the holder of such claim may bid at such sale, and, if the holder of such claim purchases such property, such holder may offset such claim against the purchase price of such property.

This provision warrants some unpacking. While the right to credit bid is an important right to creditors, this right is by no means absolute, as the bankruptcy court may “for cause” deny the right to credit bid.

THRESHOLD ISSUES
As a threshold matter, a party seeking to credit bid must have a valid secured claim. If the secured claim is subject to dispute at the time of the sale under section 363, the bankruptcy court may not allow the creditor to credit bid, or may allow the creditor to credit bid provisionally, requiring the creditor to pay in cash if the claim is reduced or the lien is invalidated.[1]

Another barrier to credit bidding is lien seniority. A junior lienholder may be barred from credit bidding where the collateral is so far underwater that the lien itself has no value.[2]

When such issues are overcome, there are yet other reasons, having more to do with the equities and the economics of the particular sale and case, that may constitute cause to deny the right to credit bid.

RadLAX
There is a line of cases in which the trustee or debtor-in-possession seeks to sell property without credit bidding. The most recent Supreme Court decision on the issue is RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065 (2012). The debtors in RadLAX purchased the Radisson Hotel at the Los Angeles International Airport in 2007. The debtors owed the bank $120 million when they filed for chapter 11 protection in 2009. The debtors proposed a chapter 11 plan which contemplated sale of the property, and which would require the bank to bid in cash. The bank objected. Turning to the “cramdown” provisions of section 1129(b), under which a debtor may confirm a plan over creditors’ objections, the Court determined that the denial of the right to credit bid was impermissible under the circumstances. Section 1129(b)(2)(A)(ii) provides:

For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements:

(A)With respect to a class of secured claims, the plan provides—…

(ii) for the sale, subject to section 363…(k) of this title, of any property that is subject to the liens securing such claims, free and clear of such liens, with such liens to attach to the proceeds of such sale, and the treatment of such liens on proceeds under clause (i) or (iii) of this subparagraph.

The debtors argued that they need not satisfy 1129(b)(2)(A)(ii) because they satisfied 1129(b)(2)(A)(iii), which provides:

    (A)With respect to a class of secured claims, the plan provides—…

(iii)for the realization by such holders of the indubitable equivalent of such claims.

The debtors reasoned that by paying the bank from sale proceeds, the debtors would be giving the bank the “indubitable equivalent” of its secured claim. The Court rejected this argument based on a basic canon of statutory interpretation—“that the specific governs the general.” Since (A)(ii) is specific to sales, it governs. In a footnote, the Court mentioned that that the bankruptcy court had found that there was no “cause” to deny credit bidding under section 363(k).[3]

“CAUSE” TO DENY THE RIGHT TO CREDIT BID
“Cause” to deny the right to credit bid is not defined in the Bankruptcy Code. Besides the circumstances concerning the validity or value of the lien addressed above, Courts have generally found “cause” to exist where denial is “in the interest of any policy advanced by the Code, such as to ensure the success of the reorganization or to foster a competitive bidding environment.”[4] A finding that a party has engaged in misconduct vis-à-vis the estate may be cause to deny the right to credit bid.[5] Beyond such examples, courts have found that the chilling of bidding can constitute cause.[6] The court in Fisker Automotive Holdings denied credit bidding because, under the circumstances, it determined that credit bidding would have made an auction essentially impossible.[7] These issues will be discussed at greater length in a future Inforuptcy blog post. It is sufficient for our purposes to conclude that, notwithstanding the generally accepted importance of the right to credit bid,[8] “cause” can be a fairly broad concept limiting, or eliminating, the right in many cases.

THE “FULL CREDIT BID”
As a final consideration in this overview, it must be noted that the concept of credit bidding is enshrined under nonbankruptcy law.[9] Under nonbankruptcy law, the “full credit bid” (that is an amount equal to the unpaid principal, interest and foreclosure expense) has the effect of extinguishing the creditor’s rights and remedies, including against guarantors and insurers. Thus, it should be exercised with caution.[10]

CONCLUSION
The credit bid in bankruptcy is a potentially powerful tool and valuable asset to creditors and distressed property investors. It must however be approached and exercised with knowledge of the potential pitfalls.

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[1] See, e.g., In re St. Croix Hotel Corp., 44 B.R. 277, 279 (Bankr. D.V.I. 1984).
[2] In re Valley Bldg. Supply, Inc., 39 B.R. 131, 133 (Bankr. D. Vt. 1984).
[3] RadLAX, 132 S. Ct. 2070 n. 3.
[4] In re Philadelphia Newspapers, LLC, 599 F.3d 298, 316 n. 14 (3d Cir. 2010), as amended (May 7, 2010).
[5] See e.g., In re Aloha Airlines, Inc., No. 08-00337, 2009 WL 1371950, at *8 (Bankr. D. Haw. May 14, 2009).
[6] See e.g., In re Antaeus Technical Servs., Inc., 345 B.R. 556, 564 (Bankr. W.D. Va. 2005).
[7] In re Fisker Auto. Holdings, Inc., 510 B.R. 55, 60 (Bankr. D. Del. 2014) leave to appeal denied, No. 14-CV-99, 2014 WL 546036 (D. Del. Feb. 7, 2014) and leave to appeal denied, No. 14-CV-99 (GMS), 2014 WL 576370 (D. Del. Feb. 12, 2014).
[8] In re The Free Lance-Star Publ’g Co. of Fredericksburg, VA, 512 B.R. 798, 804 (Bankr. E.D. Va.) appeal denied sub nom. DSP Acquisition, LLC v. Free Lance-Star Pub. Co. of Fredericksburg, VA, 512 B.R. 808 (E.D. Va. 2014).
[9] Cal. Civ. Code § 2924h(b) (“The present beneficiary of the deed of trust under foreclosure shall have the right to offset his or her bid or bids only to the extent of the total amount due the beneficiary including the trustee’s fees and expenses.”).
[10] See In re Miller, 442 B.R. 621, 628 (Bankr. W.D. Mich.) aff’d, 459 B.R. 657 (B.A.P. 6th Cir. 2011) aff’d, 513 F. App’x 566 (6th Cir. 2013); In re Spillman Dev. Grp., Ltd., 401 B.R. 240, 253-54 (Bankr. W.D. Tex. 2009) subsequently aff’d, 710 F.3d 299 (5th Cir. 2013).

Bankruptcy Decision Addressing State Sovereignty in the Context of Actions to Avoid Fraudulent Transfers Under 11 U.S.C. § 544(b)(1), Bankruptcy E-Bulletin, Insol. L. Comm., Bus. L. Sec., Cal. State Bar (July 7, 2015).

SUMMARY:

A Michigan bankruptcy court recently held that the doctrine of sovereign immunity is abrogated by 11 U.S.C. § 106(a)(1) with respect to a bankruptcy trustee’s action to avoid fraudulent transfers against a branch of the state under 11 U.S.C. § 544(b)(1). The court found that the requirement that an “actual creditor” be able to assert a fraudulent transfer action under applicable bankruptcy law did not make the doctrine of sovereign immunity applicable notwithstanding the express language of section 106(a)(1). Kohut v. Wayne Cnty. Treasurer (In re Lewiston), 528 B.R. 387 (Bankr. E.D. Mich. 2015).

FACTS:

The chapter 7 trustee filed a complaint against the county to avoid and recover $307,602.83 in fraudulent transfers pursuant to 11 U.S.C. §§ 544(b)(1) and 550. The individual debtor was a real estate developer. During the six years prior to his bankruptcy filing, the debtor personally made transfers to the county to pay taxes and fees owed by his real estate projects. The debtor had no legal obligation to personally pay the taxes; the debtor’s projects were insolvent when he made the transfers to the county; and the debtor received no benefit in exchange for his payments to the county. The county moved to dismiss the complaint based primarily on the doctrine of sovereign immunity.

The trustee brought the complaint under 11 U.S.C. § 544(b)(1) which allows a trustee to avoid transfers that an unsecured creditor of the debtor could avoid pursuant to applicable nonbankruptcy law. Pursuant to section 544(b)(1), the trustee brought the complaint under the Michigan Uniform Fraudulent Transfer Act (“MUFTA”). The court noted two significant differences between a cause of action brought under 11 U.S.C. § 548 (the Bankruptcy Code’s fraudulent transfer statute) and one brought under MUFTA pursuant to section 544(b)(1): (1) MUFTA allows the avoidance of fraudulent transfers made within six years before the filing of the complaint while section 548 has a shorter two year reach back period; and (2) section 544(b)(1) requires that an actual unsecured creditor could have brought the fraudulent transfer claim under applicable nonbankruptcy law.

In its motion to dismiss, the county contended that an actual unsecured creditor could not bring the MUFTA cause of action under applicable nonbankruptcy law because the doctrine of sovereign immunity bars causes of action against the county. The county argued that it is a political subdivision of the state and thus is immune from suit unless it consents under the 11th Amendment of the United States Constitution and Michigan state law. See Pohutski v. City of Allen Park, 641 N.W.2d 219 (Mich. 2002). The trustee generally did not dispute these claims, but argued that the county’s sovereign immunity was expressly waived under 11 U.S.C. § 106(a)(1), which provides that “[n]otwithstanding an assertion of sovereign immunity, sovereign immunity is abrogated as to a governmental unit to the extent set forth in this section with respect to” section 544, among various other specifically enumerated Bankruptcy Code sections.

The county conceded that section 106(a)(1) abrogates sovereign immunity with respect to section 544 and did not attempt to challenge the holding of the United States Supreme Court in Central Virginia Community College v. Katz, 546 U.S. 356 (2006), which upholds the power of Congress to abrogate states’ sovereign immunity in enacting bankruptcy laws pursuant to the Bankruptcy Clause (Art. I, § 8, cl. 4). Rather, the county’s argument was that since an “actual” creditor under nonbankruptcy law could not bring the cause of action because of sovereign immunity, neither could the trustee by virtue of section 544(b)(1).

REASONING:

The case law on this issue is split. The Seventh Circuit, the only circuit court to address the issue, found in In re Equipment Acquisition Resources, Inc. 742 F.3d 743 (7th Cir. 2014) that an action could not be brought against the I.R.S. under section 544(b)(1) because an actual creditor could not sue the Internal Revenue Service (“I.R.S.”) under the Illinois Uniform Fraudulent Transfer Act under the doctrine of sovereign immunity. Accord Dillworth v. Ginn (In re Ginn-La St. Lucie Ltd.), No. 10-2976-PGH, 2010 WL 8756757 (Bankr. S.D. Fla. Dec. 10, 2010); Pyfer v. Katzman (In re National Pool Construction, Inc.), no. 09-34394, 2015 WL 394507 (Bankr. D.N.J. Jan. 29, 2015).

On the other side, there are cases such as Zazzali v. Swenson (In re DBSI, Inc.), 463 B.R. 709 (Bankr. D. Del. 2012) which concluded, based on a textual analysis of section 106(a)(1), that the express abrogation of sovereign immunity with respect to section 544 was not consistent with the application of sovereign immunity under certain circumstances. Quoting another case, the court rhetorically inquired:

Why would Congress explicitly waive sovereign immunity for all other avoidance actions under the Bankruptcy Code, and include a waiver of sovereign immunity for actions under section 544 knowing that section 544 encompasses state law theories, but then require a separate waiver of sovereign immunity for the necessary state law component in actions under section 544? The argument offered by the United States defies logic.

In re DBSI, 463 B.R. at 717 (quoting Furr v. I.R.S. (In re Pharmacy Distributor Services, Inc., 455 B.R. 817, 821 (Bankr. S.D. Fla. 2011)). Accord VMI Liquidating Trust v. United States (In re Valley Mortgage Inc.), no. 12-01277-SBB, 2013 WL 5314369 (Bankr. D. Colo. Sept. 18, 2013).

Recognizing the split in the statutory interpretation, the Michigan bankruptcy court here concluded in favor of abrogation of sovereign immunity. The court reasoned:

The statute is susceptible to only one interpretation: it simply eliminates sovereign immunity however and whenever it applies “with respect to” the 59 sections of the Bankruptcy Code listed in § 106(a)(1). Section 544 is one of those sections. In this case, the Complaint is brought under § 544. That ends the inquiry. Wayne County cannot raise sovereign immunity as a defense to the Complaint under § 544 because sovereign immunity with respect to § 544 is unequivocally and unambiguously abrogated by § 106(a)(1).

The argument that the “actual creditor” requirement of section 544 cannot be met outside of bankruptcy because of sovereign immunity, the court concluded, did not pass logical muster. Indeed, an actual creditor could prevail, notwithstanding sovereign immunity, because section 106(a)(1) expressly abrogates sovereign immunity with respect to an action brought under section 544. Accordingly, the court denied the county’s motion to dismiss.

AUTHOR’S COMMENT:

The Insolvency Law Committee recently published an e-Bulletin regarding the above cited case of Pyfer v. Katzman (In re National Pool Construction, Inc.), no. 09-34394, 2015 WL 394507 (Bankr. D.N.J. Jan. 29, 2015), which came to the opposite result. As noted in the earlier e-Bulletin, the court in National Pool Construction did not provide a full discussion of case law coming out on the side of abrogation of sovereign immunity. Here, however, the court considered both sides of the argument and came out in favor of abrogation. What we are left with is a significant divide in the statutory interpretation, with one faction interpreting the “actual creditor” requirement in section 544 to come ahead of section 106(a)(1), and the other finding that the abrogation of sovereign immunity set forth in section 106(a)(1) as it applies to section 544 must be understood to apply to the underlying state law.

These materials were prepared by Zev Shechtman (zshechtman@dgdk.com) of Danning Gill Diamond & Kollitz LLP, Los Angeles, California. Editorial contributions were provided by ILC member Doris A. Kaelin, of Gordon & Rees LLP and Peter J. Gurfein (pgurfein@lgbfirm.com) ILC e-Bulletin co-editor-in-chief.

Case Analysis: Todd v. Rothschild (In re Todd), 2015 WL 1544585 (9th Cir. BAP 2015), Insolvency Law e-Bulletin, Insol. L. Comm., Bus. L. Sec., Cal. State Bar (June 8, 2015).

SUMMARY

In Todd v. Rothschild (In re Todd), 2015 WL 1544585 (9th Cir. BAP 2015), the U.S. Bankruptcy Appellate Panel of the Ninth Circuit held that a bankruptcy court lacked jurisdiction to determine the debtor’s claim of exemption in property, where the bankruptcy court had previously approved a settlement between the trustee and a creditor in which the trustee acknowledged and agreed that the property belonged to the creditor.

To read the full unpublished decision, click here: http://1.usa.gov/1Gdz8E7.

FACTS

Brenda Todd suffered serious injuries in a car accident, and ultimately received a settlement of $2.5 million; she deposited $1.5 million of the proceeds into a pre-existing Solomon Smith Barney account which at the time had a balance of about $535,000 (the “Account”). Subsequently, a judgment was entered against Todd for $18.5 million due to Todd having improperly transferred the plaintiff’s property into Todd’s personal accounts. The judgment enjoined the transfer of assets that were traceable proceeds of the judgment creditor’s assets and which were in the name of the debtor and others, including funds in the Account.

Todd filed for bankruptcy, and her case was converted to chapter 7. The debtor purported to claim an exemption in the settlement proceeds under a Nevada statute permitting her to exempt compensation for loss of future earnings.

Over a year later, the chapter 7 trustee and the judgment creditor entered into a settlement to avoid litigation over ownership of the debtor’s assets. The terms of the settlement included the following:

[The trustee] acknowledges and agrees that all funds held in the [Account and certain other accounts], all in the name of Todd . . . are properly owned by, and the assets of, [the judgment creditor] . . .. [The trustee] agrees that such funds will be turned over to [the judgment creditor] on the Effective Date . . ..

The debtor objected, arguing that the settlement ignored her exemption rights. On the record at the hearing on the trustee’s motion for approval of the settlement, the bankruptcy court confirmed its understanding that the settlement did not resolve any issues as to what exemptions the debtor might have had, and that the estate wouldn’t get the asset if the debtor was entitled to the exemptions to begin with. The trustee’s and judgment creditor’s attorneys both confirmed that the bankruptcy court’s understanding was correct. The bankruptcy court then approved the settlement, saying:

Everybody agrees. All right. So to the extent there are exemptions, those exemption issues are preserved. If you have outstanding objections to exemptions, you better bring them back on calendar. Otherwise, the exemptions stand.

Technically, however, neither the settlement agreement nor the bankruptcy court’s order expressly preserved the debtor’s alleged exemption rights. Nor did they expressly provide for the carve-out of any funds in the Account pending the determination of those rights. The bankruptcy court approved the proposed settlement in August 2011. In its order, the bankruptcy court instructed Solomon Smith Barney and others to “accept any and all instructions for account transactions from [the judgment creditor], who is the owner of the accounts as of the date of this Order.”

Thereafter, the judgment creditor filed an objection to the debtor’s claimed exemptions. The bankruptcy court initially issued summary judgment in favor of the judgment creditor, but that judgment was reversed by the district court because there were genuine issues of material fact to be tried. Then, after a trial, the bankruptcy court found that (a) $986,769 of the $1.34 million in the Account on the petition date was attributable to the settlement proceeds, and (b) the debtor was entitled to exempt about $462,000 of those funds for loss of future earnings. The debtor appealed, and the judgment creditor cross-appealed.

REASONING

Exercising its obligation to consider the presence or absence of subject matter jurisdiction, the BAP vacated the bankruptcy court’s order and dismissed the appeal because the bankruptcy court lacked jurisdiction to determine the debtor’s claimed exemption.

The BAP made this determination based on the settlement, which “placed ownership of the [Account] in [the judgment creditor]. When property is no longer property of the estate the court’s jurisdiction ends.” Once the bankruptcy court entered its order approving the settlement, the bankruptcy court’s jurisdiction over the Account lapsed “since it was no longer property of the estate nor was it property of the Debtor.” Parties cannot create subject matter jurisdiction by consent, so it was irrelevant that the bankruptcy court and the parties all understood that the debtor’s exemption rights were preserved.

The BAP opined that the inability of the bankruptcy court to preserve the debtor’s exemption rights also flowed from the plain language of § 522, which provides that a debtor may exempt property “from property of the estate.” “Once the [Account] was transferred out of [the] estate, there was nothing to exempt per the plain language of § 522(b).”

The BAP also concluded that the bankruptcy court lacked “related to” jurisdiction because the outcome of the proceeding would have no effect on the debtor’s estate. Because the settlement “transferred 100% ownership of the [Account] to [the judgment creditor], the chapter 7 trustee gave up any rights to the funds.”

AUTHOR’S COMMENTARY

Approval of a settlement under FRBP 9019 only requires that a court find that the settlement is minimally fair, reasonable, and adequate. But unless the court makes specific findings, approval of a settlement does not constitute a judicial determination as to the accuracy of all stipulations set forth therein. Nevertheless, parties situated similarly to the debtor in this case perhaps should insist that the court’s order (or better yet the settlement agreement itself) reflect that the settlement is not intended to and shall not be construed so as to strip the objecting party of his or her rights and interests.

The trustee validly exercised his business judgment to agree in the settlement to an objectively inaccurate fact, simply to avoid litigation. The bankruptcy court and all parties seem to have understood that the trustee’s “acknowledgment” and “agreement” that the Account belonged to the judgment creditor only applied to non-exempt funds in which the estate might have otherwise claimed an interest. The debtor’s exemption rights (and implicitly the debtor’s right to show that funds in the Account constituted property of the debtor on the petition date) were understood to be preserved. Indeed, after trial, the bankruptcy court found that $986,769 in the Account on the petition date was attributable to the settlement proceeds (and, at least implicitly, was property of the debtor – not the judgment creditor – as of that date). The fact that a trustee agrees in a settlement to transfer (or disclaim) the estate’s ownership (or claim of ownership) in an allegedly exempt asset should not divest the bankruptcy court of jurisdiction to determine (a) whether the asset was property of the debtor on the petition date, and (b) whether the debtor is entitled under the Bankruptcy Code to claim an exemption in that asset.

These materials were written by ILC member John N. Tedford, IV (jtedford@dgdk.com), of Danning, Gill, Diamond & Kollitz, LLP in Los Angeles, California. Editorial contributions were provided by ILC member Peter Jazayeri (peter@jaz-law.com), of Jaz, A Professional Legal Corporation in Los Angeles, California.

Thank you for your continued support of the Committee.

Best regards,

Insolvency Law Committee

Sale of a Claim or Compromise of an Asset?

Bankruptcy trustees are authorized to use, sell or lease estate property.[1] Trustees are also authorized to enter into compromises or settlements on behalf of the estate.[2] Both sales outside of the ordinary course of business under section 363 of the Bankruptcy Code and compromises of disputes under rule 9019 of the Federal Rules of Bankruptcy Procedure require bankruptcy court approval after notice and a hearing. In general, sales, on one hand, and compromises, on the other, each require the satisfaction of different legal standards. When considering a sale under section 363, the court’s obligation is “to assure that optimal value is realized by the estate under the circumstances.”[3] When considering the approval of a compromise, the court must determine whether the proposed compromise is “fair and equitable,” which requires the consideration of four factors: (1) probability of success in litigation, (2) collectability; (3) complexity, expense, inconvenience and delay attendant to continued litigation; and (4) the “paramount” interest of the creditors.[4]

While settlements of disputes and sales of assets might generally seem like two clearly distinct and distinguishable events, there are circumstances, blurring the line between the two. For example, what happens if the trustee settles claims against a defendant for cash, but a creditor contends that the claims are worth more than what the trustee is getting for them? On the other hand, what if a trustee seeks to sell a property interest in the estate’s claims to a third party or even one of the litigants? What standard applies?

In the case of In re Mickey Thompson Enter. Grp., the trustee originally sought to compromise a dispute of potential fraudulent transfer claims. A creditor objected because a third party was willing to pay more than the settlement amount for the settled claims. Although the trustee first replied that he would set overbidding procedures in order to obtain the best sale price for the claims, at the hearing the trustee reversed course asserting that the original settlement was in the best interest of the estate “when he entered it” and that he was contractually bound by the agreement. Although the bankruptcy court decided that it could not substitute its judgment for the trustee’s, the Bankruptcy Appellate Panel for the Ninth Circuit Court of Appeals (“BAP”) reversed. The BAP found that both the standards for compromises and sales were implicated by the transaction. The BAP opined that any purported contractual obligation of the trustee was trumped by the duty to maximize estate assets.[5]

The case of In re Lahijani involved a trustee’s efforts to sell claims against the debtor and others to the highest bidder. The trustee sought from the sale an all-cash offer as opposed to a combination of cash and a percentage of the recovery from the lawsuit. The successful bidder was a company set up by the debtor’s co-defendant, who had no intention of actually prosecuting the claims. The unsuccessful bidder appealed. The BAP reversed because the bankruptcy court wrongly ruled solely based on the sale price, when it should have examined each factor of the fair and equitable test in order to approve what fundamentally was also a compromise.[6]

In In re Fitzgerald, the trustee sought to sell the estate’s interest in a certain company and litigation claims consisting of a pending cross-complaint in a pending action. The only bidders were the plaintiff/cross-defendant and the life partner of the debtor/defendant/cross-complainant. The bankruptcy court approved the sale based on a dollar-to-dollar comparison of the bids. However, in light of the relationships between the parties and the constrained competition due to the nature of the asset, the BAP found that the transaction required stricter scrutiny. Indeed, the BAP again found that the bankruptcy court should have applied the fair and equitable standard applicable to compromises.[7]

The lesson from this line of cases is that, when in doubt as to which standard applies in a contested transaction, a trustee or purchaser should ensure that both the “optimal value” standard for sales and the “fair and equitable” standard for compromises are fully satisfied.

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[1] 11 U.S.C § 363. With certain exceptions, chapter 11 debtors in possession are generally vested with the same rights and duties as trustees. See 11 U.S.C. § 1107.
[2] Fed. R. Bankr. P. 9019.
[3] In re Lahijani, 325 B.R. 282, 288 (B.A.P. 9th Cir. 2005).
[4] Id. at 290.
[5] In re Mickey Thompson Enter. Grp., 292 B.R. 415 (B.A.P. 9th Cir. 2003). The BAP suggested that the concern about a potential breach of contract by the trustee was misplaced since the agreement would only be enforceable after approval by the court. Id. at 421.
[6] Lahijani, 325 B.R. 282.
[7] In re Fitzgerald, 428 B.R. 872 (B.A.P. 9th Cir. 2010).

Case Analysis: Elliott v. Weil (In re Elliott), ___ B.R. ___, 2014 WL 6972472 (9th Cir. BAP 2014), Insolvency Law e-Bulletin, Insol. L. Comm., Bus. L. Sec., Cal. State Bar (February 20, 2015).

SUMMARY

In Elliott v. Weil (In re Elliott), ___ B.R. ___, 2014 WL 6972472 (9th Cir. BAP 2014), the U.S. Bankruptcy Appellate Panel of the Ninth Circuit held that Law v. Siegel, ___ U.S. ___, 134 S.Ct. 1188 (2014), abrogated Ninth Circuit authority under which a debtor’s exemption could be denied, or under which a debtor could be denied the right to amend his or her exemptions, on the basis of bad faith or prejudice to creditors.

FACTUAL BACKGROUND

In an effort to conceal his Los Angeles home from judgment lien creditors, Edward Elliott (“Elliott”) transferred his residential real property to a business entity formed by the son of a former associate. The property was later transferred to another corporation formed and controlled by Elliott. Then, in December 2011, Elliott filed a chapter 7 petition. He failed to schedule any interest in the property or the corporation and he omitted certain judgment lien creditors. According to his schedules and testimony at his 341(a) meeting of creditors, he lived in Granada Hills and owned no real property. Relying on the schedules and Elliott’s testimony, the trustee filed a “no asset” report, Elliott was granted a discharge, and the case was closed.

A few weeks later, Elliott’s corporation quitclaimed the residence back to Elliott for no consideration. Elliott advised his judgment lien creditors that he acquired the property postpetition, and demanded that their judicial liens be removed. After an investigation, the judgment lien creditors successfully moved to reopen Elliott’s bankruptcy case.

In June 2013, the trustee filed a complaint for turnover of the property and revocation of Elliott’s discharge. In April 2014, the bankruptcy court granted summary judgment, revoked the discharge, vested title to the property in the trustee, and ordered that the property be turned over to the trustee. Elliott did not appeal the judgment.

While the adversary was pending, and almost one year after the case was reopened, Elliott amended his schedules to disclose an interest in the property and claim a $175,000 homestead exemption therein. The trustee objected to the claimed exemption due to Elliott’s bad faith concealment of the asset. The trustee also argued that Elliott could not claim a homestead exemption because he did not hold title to the property on the petition date. The bankruptcy court sustained the trustee’s objection on the basis that the debtor belatedly claimed the exemption in bad faith, but did not address the trustee’s alternative argument. Elliott appealed. Less than one month after the appeal was filed, the U.S. Supreme Court issued its decision in Law v. Siegel.

REASONING

The BAP first concluded that Law v. Siegel abrogated Ninth Circuit authority under which exemptions could be denied if a debtor acted in bad faith or creditors had been prejudiced. See Martinson v. Michael (In re Michael), 163 F.3d 526 (9th Cir. 1998); Arnold v. Gill (In re Arnold), 252 B.R. 778 (9th Cir. BAP 2000). Although the bankruptcy court’s ruling was supported by then-existing Ninth Circuit law, under Law v. Siegel, unless statutory power exists to do so, a bankruptcy court may not deny a debtor’s exemption claim – or bar a debtor from amending his or her exemptions – on the basis of bad faith or prejudice to creditors.

Second, the BAP addressed the trustee’s argument that Elliott could not claim a homestead exemption because he did not own the property on the petition date. The BAP held that for purposes of CCP § 704.730, continuous residency, not continuous ownership, controls the analysis. That exemption applies to any interest in the property so long as the debtor satisfies the continuous residency requirement set forth in CCP § 704.710(c). Because the bankruptcy court’s inquiry was confined to Elliott’s bad faith, the BAP remanded for the bankruptcy court to determine whether Elliott was, in fact, entitled to a homestead exemption under CCP § 704.730. Third, the BAP identified an alternative statutory basis for denying Elliott’s homestead exemption on remand. Section 522(g) provides that a debtor may claim an exemption in previously-transferred property that a trustee recovers under sections 510(c)(2), 542, 543, 550, 551 or 553 if “such transfer was not a voluntary transfer of such property by the debtor” and “the debtor did not conceal such property.” Since the trustee prevailed in her turnover action under section 542, Elliott’s right to claim an exemption is limited by section 522(g), and the BAP suggested that the limitation be considered on remand.

AUTHOR’S COMMENTARY

Some bankruptcy courts interpret Law v. Siegel narrowly, limiting its holding to cases in which trustees seek to surcharge exemptions after the objection period has expired. These courts continue to follow Michael and Arnold, sustaining timely filed objections when debtors conceal assets and then amend their schedules to claim exemptions after trustees discover and incur expenses administering those assets. The trustee in Elliott conceded the point in her brief, so the BAP’s decision was rendered without the benefit of a party advocating a contrary position. Before bankruptcy courts, this likely remains an open issue.

These materials were written by John N. Tedford, IV, of Danning, Gill, Diamond & Kollitz, LLP. Editorial contributions were provided by ILC member Doris A. Kaelin, of Gordon & Rees LLP.

Thank you for your continued support of the Committee.

Best regards,

Insolvency Law Committee

Bankruptcy Decision Addressing Effective Service, Bankruptcy E-Bulletin, Insol. L. Comm., Bus. L. Sec., Cal. State Bar (Aug. 26, 2013).

Summary:

The U.S. Bankruptcy Appellate Panel of the Ninth Circuit (“BAP”) affirmed the Central District of California bankruptcy court’s denial of a bank’s motion for relief from stay in a single asset real estate chapter 11 case because the bank failed to serve parties on the list of 20 largest unsecured creditors to the attention of an “officer, a managing or general agent,” or other authorized agent, as required under the applicable rules. Bank of America, N.A. v. LSSR, LLC (In re LSSR, LLC), BAP No. CC-12-1636 (9th Cir. BAP May 29, 2013). To read the full decision, click http://cdn.ca9.uscourts.gov/datastore/bap/2013/05/29/LSSR,%20LLC%20Memo%2012-1636.pdf

Facts:

The chapter 11 debtor owned real property encumbered by a bank’s trust deed. The bank’s trust deed also encumbered real properties owned by affiliates of the debtor. The bank commenced a state court action against the debtor, its affiliates and other related entities (“Defendants”) for defaulting on their obligations under the trust deed. A resolution of that litigation required those Defendants to enter into a “Confession of Judgment” accepting joint and several liability to the bank for over $5,000,000, which the bank would file if the Defendants defaulted further.

The debtor filed a chapter 11 petition and the bankruptcy court determined it to be a single asset real estate debtor. Thereafter, the debtor’s manager paid the bank the monthly interest on the loan. The bank filed a motion for relief from stay claiming that the payment was both not enough and made by the debtor’s manager (rather than the debtor).

There were two unsecured creditors listed on the debtors’ schedules. The bank’s proof of service indicated service on the two unsecured creditors at their addresses but not to the attention of any officer or registered agent. The bankruptcy court denied the motion because: (1) the bank did not properly serve the 20 largest unsecured creditors; and (2) the debtor made the payment required in a single asset real estate case. See 11 U.S.C. § 362(d)(3). The bank appealed.

Reasoning:

The BAP affirmed the bankruptcy court’s decision. The BAP found that the bank did not serve the motion in compliance with the Federal Rules of Bankruptcy Procedure (“FRBP”) and the Local Bankruptcy Rules of the United States Bankruptcy Court for the Central District of California (“LBR”). In a chapter 11 case, the FRBP and LBR require a motion for relief from stay to be served on the unsecured creditors committee or, if none is appointed, on the 20 largest creditors. Further, in a contested matter, such as a motion for relief from stay, service on a corporation or partnership must be “to the attention of an officer, a managing or general agent” or to an authorized agent for service of process. FRBP 4001(a)(1), 7004(b), 9014(b). The proof of service must also “explicitly indicate how each person who is listed on the proof of service is related to the case.” LBR 9013-3(c).

The BAP determined that service of the motion was defective because the bank did not indicate on the proof of service that the motion was mailed to “an officer, a managing or general agent or any other authorized agent” of the two unsecured creditors.

Author’s Comment:

Although personal service is often not necessary in bankruptcy cases, this case is a reminder of the need to pay attention to detail, particularly the applicable federal and local rules, when executing service by United States mail.

These materials were prepared by Zev Shechtman (zshechtman@dgdk.com) of Danning, Gill, Diamond & Kollitz, LLP, in Los Angeles, California. Editorial contributions were provided by ILC member Asa S. Hami of SulmeyerKupetz, PC, in Los Angeles, California.