October 25, 2010
9th Circuit Rules Alter Ego Cannot be Prosecuted by Trustee, at Least in California
AHCOM v. Smeding, --- F. 3d --- (9th Cir. October, 2010)
Issue: May a creditor bring an action to pierce the corporate veil without bankruptcy court approval?
appeal from District Court
Judge J. Clifford Wallace,
AHCOM was a creditor of Nuttery Farms, Inc. (“NFI”) NFI filed chapter 11. The creditor ignored the bankruptcy and sued NFI’s shareholders in district court under an alter ego theory. The district court dismissed the case saying that alter ego as alleged in the complaint was a “claim that harms not just Ahcom but all creditors and thus this claim is exclusively the property of the trustee.”
The 9th Circuit reversed. “The trustee may assert only claims belonging to the debtor corporation and ‘has no standing generally to sue third parties on behalf of the estate's creditors.’” “When the trustee does have standing to assert a debtor's claim, that standing is exclusive and divests all creditors of the power to bring the claim.” But under California law, “a trustee ‘cannot maintain an action against defendants on an alter ego theory absent some allegation of injury to the corporation giving rise to a right of action in it against defendants,’ without which ‘the asserted cause of action belongs to each creditor individually, and [the trustee] is not the real party in interest.’”
The opinion explained that the Davey Roofing and Folks rulings that a trustee can seek to pierce the corporate veil where “all creditors are affected” are wrong. “[We] conclude that California law does not recognize an alter ego claim or cause of action that will allow a corporation and its shareholders to be treated as alter egos for purposes of all the corporation's debts.”
October 13, 2010
Judge Markell Reduces Attorneys Fees from $800,000 to $38,000
brief by my law clerk Elizabeth Massaad:
In re Hotels Nevada, LLC, Inns Nevada, LLC, Case Nos. BK-S-09-31131-BAM & BK-S-09-31132-BAM
Issue: Are the fees billed by debtor’s counsel in this chapter 11 reasonable, necessary, or reasonably likely to benefit the debtor’s estate?
U.S. Bankruptcy Judge: Hon. Bruce A. Markell
The law firm of Quarles & Brady, LLP (“Quarles”) was retained by the debtors, Hotels Nevada, LLC and Inns Nevada, LLC, to represent them in their chapter 11 bankruptcy cases. The cases, filed on November, 5, 2009, were related to a disputed commercial transaction with L.A. Pacific, Inc. The cases were filed after the debtors and the former principal, Louis Habash, lost an arbitration in California. The California arbitrator assessed $141 million in damages against the debtors and Habash. Quarles was given approximately $800,000 as a retainer fee by another company that Habash controlled.
Quarles filed these chapter 11 cases because it wanted to “create a platform for the orderly administration of the [arbitration] Award.” Also to give the debtors time to evaluate affirmative claims of the estate against the professionals who allegedly caused the debtors’ damage. The debtors asserted that their former counsel committed professional malpractice in the arbitration proceeding causing the $141 million damage award. This claim against their former counsel was the only asset listed on both of the debtors’ schedules.
When the chapter 11 cases were filed, the court expressed that the cases were a chapter 7 just “waiting to happen.” Eventually, the court converted both cases to a Chapter 7. At the conversion hearing, the court found that Quarles had not acted in good faith in initiating the cases and that the filings were not made in good faith. Quarles then filed its fee application seeking $803,000 in fees and $77,000 in costs. The court ruled that most of the services Quarles performed in the debtor’s case were duplicative, unnecessary and not reasonably likely to benefit the debtors or their estates at the time rendered. The court allowed $39,875 in fees and $3,872 in costs.
The court, in determining if Quarles’ fees were reasonable, pointed out that Quarles was retained by the debtor pursuant to § 327 (a) and therefore, it was allowed to seek compensation for fees and expenses in accordance with § 330. Under section 330, a court may award to a professional person employed under section 327:
a) reasonable compensation for actual, necessary services rendered by a professional person or attorney, and
b) reimbursement for actual and necessary expenses.
When determining the amount of reasonable compensation to be given to the professional in question, Section 330 provides that the court shall consider the nature, extent, and the value of the services taking all relevant factors into account. Those relevant factors include: whether the services were necessary to the administration of the case, or beneficial at the time at which the service was rendered. The court is not allowed to award compensation for unnecessary duplication of services or services that were not reasonably likely to benefit the debtor’s estate or were not necessary to the administration of the case.
Pursuant to the Bankruptcy Appellate Panel for the Ninth Circuit, “the question governing attorney compensation should be whether services were necessary or beneficial at the time at which the service was rendered.” In re Roberts, Sheridan & Kotel, P.C. v. Bergen Brunswig Drug Co. (In re Mednet), 251 B.R. 103, 107 (B.A.P. 9th Cir. 2000). In practice, this means that “the statute does not require that the services result in a material benefit to the estate in order for the professional to be compensated; the applicant must demonstrate only that the services were reasonably likely to benefit the estate at the time the services were rendered.” Id.
After a review of the authorities, the court reasoned that the totality of circumstances demonstrates that Quarles’ actions were not necessary or beneficial and not reasonably likely to benefit the Debtors’ estate at the time rendered. Also Quarles’ actions benefitted non-debtors primarily, and the estate only incidentally. The debtors had no “operations to restructure, and their liabilities consisted of minor unpaid bills and the substantial arbitration award.” The court found that the Chapter 11 cases were not filed in good faith.
Additionally, the court found that most of the submitted timesheets detailed conferences with Mr. Habash and his other attorneys. Therefore, most of the actions that Quarles had taken were at the direction of Mr. Habash, and they were not beneficial to the estate. This failure to act in the best interests of the estate is further evidenced by Quarles’ failure to make any material progress toward turning these claims into tangible and beneficial assets of the estate.
The court also noted that Quarles spent a significant time reviewing the record of the prior proceedings. After that thorough review, Quarles should have realized that any further action aimed at overturning the arbitration award would have been “duplicative, unnecessary, and not reasonably likely at the time rendered to benefit the Debtors’ estates.” The court found that any amount of time that Quarles spent over 100 hours was useless and a waste of time. Since Quarles did not specify how much of the $77,448 in costs were due to unnecessary actions, the court reduced the costs by the same percentage reduction administered to Quarles’ fees.
The court also found that Quarles double billed for preparing statements and schedules, so that 38.1 hours of the double billing was disallowed. The court also did not allow the 133.7 hours that Quarles billed for preparing its employment and fee applications and responding to creditors’ objections to its employment. The court reasoned that the amount of time needed to prepare fee applications is approximately four hours considering the circumstances of these cases. Therefore, the court disallowed the remaining 129.7 hours for these categories.
The remaining 480.7 hours were reduced by the court by 95% or 456.7 hours. Quarles’ remaining costs were also reduced by 95%.
May 23, 2010
9th Circuit Rules that Damages Assessed Against Unlicensed Contractor under California Law Discharged Even Though Fraud is Found
Ghomeshi v. Sabban (In re Sabban), --- F. 3d --- (9th Cir. April, 2010)
Issue: Is a claim for disgorgement from an unlicensed contractor under Cal B&P 7031(b) dischargeable even when there is a specific finding of fraud on the basis that there were no actual damages?
appeal from the BAP
Judge William A. Fletcher,
The debtor operated an unlicensed home remodeling business. He falsely told Ghomeshi that he was licensed. “California law provides that a client who employs an unlicensed contractor may recover all compensation paid to that contractor, regardless of whether the contractor has committed fraud and regardless of whether the client has sustained actual harm. Cal. Bus. & Prof. Code § 7031(b).” After the work was done, Ghomeshi sued the debtor in state court under B&P 7031(b). The state court found that the debtor lied but found that Ghomeshi did not suffer any harm. Under California law, however, the state court awarded damages of $123,000, i.e., the full amount paid to the debtor. The debtor filed chapter 7 and Ghomeshi filed a non-dischargeability complaint. Ghomeshi argued that in Cohen v. Dela Cruz, the Supreme Court said that damages under state law are non-dischargeable once fraud is found. The bankruptcy court ruled that the debt was discharged and the BAP affirmed.
The 9th Circuit also affirmed distinguishing this case from Cohen.
“[I]n Cohen v. dela Cruz, the Supreme Court held that the reach of § 523(a)(2)(A) is not limited to the amount of benefit received by the debtor. Rather, §523(a)(2)(A) ‘prevents the discharge of all liability arising from fraud.’ Following Cohen, we have concluded that there is no requirement that the debtor ‘have received a direct or indirect benefit from his or her fraudulent activity in order to make out a violation of § 523(a)(2)(A).’”
“We note two ways in which the case before us is different from Cohen. First, unlike the tenants in Cohen, Ghomeshi suffered no actual harm as a result of [the debtor’s] misrepresentation that [he] held a contractor’s license. Actual damages are available under § 7160, but the state court specifically declined to award them, holding that Ghomeshi had suffered no harm. Second, unlike the New Jersey Consumer Fraud Act at issue in Cohen, § 7031(b) is not premised on the commission of fraud. In order to recover compensation paid to a contractor, a plaintiff in a §7031(b) suit need only show that the contractor was unlicensed.”
“We hold that because the award of $123,000 was made under a statute that is not premised on either fraud or actual harm, it is not a debt for money obtained by fraud within the meaning of 11 U.S.C. §523(a)(2)(A). We therefore affirm the bankruptcy court’s determination that the award of $123,000 under § 7031(b) is dischargeable.”
March 19, 2010
Local Judge Opines that an LLC is an Express Trust for Non-Dischargeability Purposes
This is a tentative ruling I copied off the calendar of one of our local judges. It's a pretty schocking ruling to my way of thinking but she really supports it with lots of 9th Circuit and California law. I'm going to have to update my Summary of Bankruptcy Law book. I was going to edit the tentative but it really all needs to be there to understand it.
The complaint filed by Nature's Wing Fin Design, LLC (NWFD) against debtor under 11 U.S.C. sections 523(a)(2) and (a)(4) alleges nondischargeability of a state court judgment entered on 8/19/05 in the amount of $849,754 (later reduced to $778,000) for breach of fiduciary duty in debtor's fulfillment of his role as a majority shareholder and manager of NWFD. The underlying complaint was filed derivatively by the minority shareholders and the judgment was entered after a three-week trial, and is now final as all avenues on appeal have been exhausted.
Specifically, the judgment was granted on the causes of action for breach of fiduciary duty, constructive trust, permanent injunction, and accounting. Detailed findings are contained in the statement of decision filed on 8/18/05 ("SOD") and include the following: debtor made improper distributions to himself before paying back investor funds, allowed an unauthorized investment in NWFD, commingled funds, interfered with a forensic audit, and improperly removed directors. In addition, the state court found that debtor "was not acting in good faith" (SOD, p.20-21). However, no punitive damages were awarded due to lack of proof of "sufficient reprehensibility or fraud" (SOD, p.22).
Collateral estoppel applies to findings made by the state court for purposes of section 523(a)(4) which show that debtor's acts constituted defalcation while serving in a fiduciary capacity and embezzlement, and the full faith and credit clause bars this court from reviewing the judgment. Debtor's opposition fails to include a statement of genuine issues of material fact.
For purposes of defalcation while acting in a fiduciary capacity, debtor was a fiduciary because in California LLC managers owe the same fiduciary duties as those owed by a partner to a partnership and its partners. In re Lewis, 97 F.3d 1182, 1185-86 (9th Cir. 1996). Defalcation occurs when, as here, debtor cannot account for the res, commingles funds and uses the company's money for personal benefit. Id. at 1186-87. Section 523(a)(4) requires that (1) the res was rightfully in the possession of the nonowner, (2) the nonowner appropriated the property for a use for which it was not entrusted and (3) circumstances indicate fraud. In re Littleton, 942 F.2d 551, 555 (9th Cir. 1991). These elements are met in this case and, although the findings do not include fraud, the state court found bad faith and fraudulent conduct which amounts to circumstances indicating fraud.
Summary judgment cannot be granted because there are genuine issues of material fact as to both elements of section 523(a)(4). First, whether an express preexisting trust was created as required by California law. Second, the three amounts at issue which constitute the judgment ($520,670.16 for a company loan for defense costs, $105,245 for mandatory distributions and $94,500 for a share transfer transaction) are dischargeable because they were proper, authorized and accounted for, and thus no defalcation occurred. Moreover, triable issues of material fact exist as to the Sommers transaction because the trial court did not consider all of the evidence.
In re Bigelow, 271 B.R. 178, 186-87 (9th Cir. BAP 2001), thoroughly discusses the elements that must be met to establish nondischargeability under section 523(a)(4). A debt is nondischargeable under § 523(a)(4) where “‘1) an express trust existed, 2) the debt was caused by fraud or defalcation, and 3) the debtor acted as a fiduciary to the creditor at the time the debt was created.’” In re Niles, 106 F.3d 1456, 1459 (9th Cir.1997) (citations omitted). “Defalcation is defined as the ‘misappropriation of trust funds or money held in any fiduciary capacity; [the] failure to properly account for such funds.’... Under section 523(a)(4), defalcation ‘includes the innocent default of a fiduciary who fails to account fully for money received.’ ” In re Lewis, 97 F.3d 1182, 1186 (9th Cir.1996) (citations omitted).
1. Existence of fiduciary relationship
State law is relevant to the inquiry whether a fiduciary relationship exists. In re Pedrazzini, 644 F.2d 756, 758 (9th Cir.1981). Cal. Code of Corp. section 17153 provides that "[t]he fiduciary duties a manager owes to the limited liability company and to its members are those of a partner to a partnership and to the partners of the partner." The word "manager" is defined in Cal. Code of Corp. 17001(w) as somebody identified as such in the articles of organization. Under California law, partners are trustees of the partnership's assets. Ragsdale v. Haller, 780 F.2d 794, 796-97 (9th Cir.1986).
Taking into consideration the California law background as stated above, federal law ultimately determines whether there is a fiduciary relationship within the meaning of § 523(a)(4). In re Hemmeter, 242 F.3d 1186, 1189 (9th Cir.2001). The parties have not presented and the court has been unable to locate a case directly on point. However, the Ninth Circuit has held that "California partners are fiduciaries within the meaning of [section] 523(a)(4)." Haller, 780 F.2d at 796-97. Thus, reading section 17153 in conjunction with Haller compels the conclusion that an LLC manager is a fiduciary for purposes of section 523(a)(4).
On the other hand, an officer of a corporation is not a fiduciary for purposes of section 523(a)(4) because s/he is more akin to an agent. In re Cantrell, 329 F.3d 1119, 1127-28 (9th Cir. 2003). In addition, at least one bankruptcy court has rejected the proposition that a controlling majority shareholder is automatically a fiduciary of the corporate res and subject to liability by the minority under section 524(a)(4). In re Bangerter, 106 B.R. 649, 654 (Bankr. C.D. Cal. 1989).
"Defalcation is defined as the 'misappropriation of trust funds or money held in any fiduciary capacity; [the] failure to property account for such funds.'" Lewis, 97 F.3d at 1186, quoting Black's Law Dictionary 417 (6th ed. 1990). This includes innocent, intentional or negligent defaults. Id. (omit cit.). "An individual may be liable for defalcation without having the intent to defraud." Id. at 1187. It is no longer the law that there must be some showing of bad faith or reprehensible conduct. Id. at 1186-87 (overruling In re Martin, 161 B.R. 672 (9th Cir. BAP 1993)). Lewis concerned a dispute between partners where one partner contributed funds, while two others contributed time and labor. The unrefuted evidence showed that the partners running the enterprise failed to provide a complete accounting and commingled funds, and this was enough to grant summary judgment against them. Although the question of defalcation in Lewis was decided under Arizona law, the court noted that Arizona and California law are identical on this point.
The complaint requests relief under sections 523(a)(2) and (a)(4); the motion is made pursuant to (a)(4) only. To the extent that Mr. McCarthy is trying to get this court to relitigate what has already been decided in state court, now that all avenues on appeal have been exhausted, this is impermissible under the Rooker-Feldman doctrine. Thus, this court will not examine evidence that has been or should have been presented in state court. Instead, this court will focus its inquiry on the issue of collateral estoppel and needs to decide the following:
(1) whether the issues are identical as those decided in the former proceeding; (2) whether the issues have been actually litigated; (3) whether the issues have been necessarily decided; (4) whether the decision is final and on the merits; and (5) whether the parties are the same or in privity. In re Harmon, 250 F.3d 1340, 1245 (9th Cir. 2001).
The state court judgment is based on debtor's breaches of fiduciary duty, as is the complaint for nondischargeability; thus, the issues are identical. It is clear that the issues have been actually litigated since the state court conducted a three-week bench trial which resulted in extensive findings of fact and conclusions of law. The judgment is final and the parties are the same. Thus, the only question for this court to decide is whether the elements required under section 523(a)(4) have been necessarily decided, or whether this court must make additional findings for the debt to be deemed nondischargeable.
1. Fiduciary relationship
It is undisputed that the operating agreement discussed and quoted on pp.3-8 of the SOD is the document controlling the relationship between the parties. Under that agreement, debtor was in charge of "generally operating the business" and had "fairly broad managerial powers" (SOD p.3, para.9). The state court also found that at the time the improper acts took place, debtor was the sole manager and 59% owner of NWFD and that under Cal. Code of Corp. section 17153, "LLC managers owe the same fiduciary duties of care and loyalty as are owed by a partner to a partnership and its partners" (SOD p.2, para.2 & p.19, para.2), concluding that debtor was a fiduciary under California law (SOD p.20-21).
California law outlines the fiduciary duties of a partner which constitute an "express" or "technical" trust relationship, and this court is instructed to follow that determination. See Ragsdale, 780 F.2d at 797 ("[i]f state law makes clear that a partner necessarily is a trustee over partnership assets for all purposes, then that partner is a fiduciary within the narrow meaning of 523(a)(4)"). See also In re Stanifer, 236 B.R. 709, 715 (9th Cir. BAP 1999); Collier on Bankruptcy, para. 523.10[d], at 523-74 (16th ed. 2009). Trust relationships created by statute fall into this category. Pedrazzini, 644 F.2d at 758 n.2.
As outlined by the state court in its SOD, p.19-20, LLC managers have specific duties under Cal. Corp. Code section 16404 which clearly impose trust-like obligations on the debtor. The debtor was required to perform those obligations under the operating agreement (SOD, p.3-4; 20-21). In essence, the debtor was like the sole manager of a joint venture as described in In re Short, 818 F.2d 693 (9th Cir. 1987)(debtor in charge of joint venture affairs who had duty to act as trustee under agreement and statute held to be fiduciary for purposes of section 523(a)(4)). Therefore, this court finds that the required express trust relationship existed in this case and that debtor was a fiduciary for purposes of section 523(a)(4) at the time the improper acts took place.
The findings made by the state court show that debtor made improper distributions in violation of the operating agreement (SOD 20), improperly obligated the company (SOD 35), lied to the board about the cause for overpayments (SOD 37), used and lied about using company funds for personal expenses (SOD 37-38), commingled funds (SOD 39), interfered with an audit (SOD 41), and acted fraudulently and in bad faith to remove board members (SOD 58). Akin and beyond the facts of Lewis, the underlying judgment contains sufficient findings of improper activity to satisfy the element of defalcation under section 523(a)(4).
3. Debtor's case law:
Mr. McCarthy relies on the Ninth Circuit case of Cantrell. Although Cantrell contains applicable statements of law, its facts are inapposite in that it dealt with a default judgment against a corporate officer, not a judgment on the merits against a controlling shareholder and manager of an LLC. As such, Cantrell's holding is limited to its specific factual scenario and does not apply in this case. Further, Mr. McCarthy relies on the case of In re Niles, 106 F.3d 1456 (9th Cir. 1997). Niles is inapplicable because the holding in relevant part deals with who bears the burden of proof in a section 523(a)(4) proceeding; plaintiff was not asserting collateral estoppel based on findings already made in conjunction with a final state court judgment after trial, but instead was proceeding with trial in the bankruptcy court. Here, the state court has already conducted a trial and made detailed findings, and the bankruptcy court does not have to retry the case if it finds those findings sufficient for purposes of section 523(a)(4). However, the case is instructive to the extent that the relationship between the parties under state law (defendant was plaintiff's real estate broker and property manager) is expressly controlled by statute and thus was determined to be an express trust.
In addition, Mr. McCarthy relies on In re Abrams, 229 B.R. 784 (9th Cir. BAP 1999), aff'd, 242 F.3d 380 (9th Cir. 2000). Again, this case is distinguishable because it does not deal with the effect of a state court judgment, but instead focuses on the sufficiency of evidence presented during trial in the bankruptcy court in a nondischargeability proceeding under sections 523(a)(2) and whether the bankruptcy court properly decided that second-tier general partners are held to the same fiduciary obligations as first-tier general partners under California common law, and therefore are fiduciaries for purposes of section 523(a)(4). Mr. McCarthy points out that the court in Abrams examined the level of control exercised by the general partners to make its findings on the issue of whether they were fiduciaries; however, this court will not do so when sufficient findings have already been made by the state court judge who in this case relied on statute and not California common law (per Abrams, the court could have relied on either, depending on the existence of a statute on point).
Finally, the California Supreme Court case of Bainbridge v. Stoner, 16 Cal.2d 423 (Cal. 1940)(holding that a corporate director is an agent rather than a fiduciary) does not speak to the situation here which deals with Mr. McCarthy as manager of the LLC who not only had broad managerial powers but also used those powers to his personal benefit, as reflected in the state court's findings. Similarly, the California cases cited in Bainbridge refer to corporate shareholders and members of a limited liability company, but not a LLC manager empowered with broad managerial powers by an operating agreement. Bainbridge also discusses the two required elements for an express trust to exist under California law: (1) an explicit declaration of trust and (2) transfer of res to the trustee. Mr. McCarthy argues that no such transfer ever took place and therefore no express trust was created. Even if the court were to go this way and revisit these facts (which it is not), it must be noted that Bainbridge is a 1940 case which does not implicate a California statue clearly stating that a LLC manager owes the same fiduciary duties as a partner (Cal. Corp. Code section 17153) and another statute listing those duties (Cal. Corp. Code section 16404). The Ninth Circuit has since held that, in conjunction with these California statutes, partners are fiduciaries for purposes of section 523(a)(4). Ragsdale, 780 at 796-97.
Finally, Mr. McCarthy argues that certain admissions were made by NWFD in its third amended complaint which were not considered by the state court judge and which show that certain meetings and the votes taken during those meetings were invalid because Mr. McCarthy was not in attendance. Again, this is something that would have to be considered by the state court on a motion for a new trial or reconsideration. The whole section claiming that no defalcation or embezzlement occurred (p.37-59 of the opposition) discusses alleged error by the state court; again, this is not the proper forum to appeal these issues.
Since all of the elements of collateral estoppel have been met and it is fair to apply the doctrine in this case to prevent further unnecessary litigation that would not produce a different result in light of the fact that the state court's findings are sufficient to satisfy section 523(a)(4), summary judgment is proper and should be granted.
February 24, 2010
Great Comments from Alex Kozinski
I remember seeing a poster some time ago that said: "the only reason I hang around here is to see what happens next." I feel like the best part of continuing to practice law is to see what Judge Kozinski says next. Take a look at USA v. Lemus.
Kozinski writes in a dissent to an order denying a hearing in banc :
The panel goes to considerable lengths to approve a fishing expedition by four police officers inside Lemus’s home after he was arrested just outside it. The opinion misapplies Supreme Court precedent, conflicts with our own case law and is contrary to the great weight of authority in the other circuits. It is also the only case I know of, in any jurisdiction covered by the Fourth Amendment, where invasion of the home has been approved based on no showing whatsoever. Nada. Gar nichts. Rien du tout. Bupkes.
Did I mention that this was an entry into somebody’s home, the place where the protections of the Fourth Amendment are supposedly at their zenith?
Thanks to my friend Scott Clarkson for this.
January 09, 2010
9th Circuit Explains "Derived Quasi-Judicial Immunity" Protecting Trustees
Harris v. Wittman (In re Harris), ---- F. 3d ----, 2009 WL ------------- (9th Cir. Dec, 2009)
Issue: Can the debtor here sue the trustee for breach of contract, that being a settlement contract approved by the court?
Holding: No. The trustee has “derived quasi-judicial immunity.”
Appeal from the District Court
Judge Carlos T. Bea
The chapter 7 trustee in this case sued the debtor and his wife to avoid a fraudulent conveyance from the debtor to his wife. The trustee then “entered into an Agreement for Use and Assignment of Interests and Prosecution of Claims with appellee Jack Swain, an unsecured creditor of the estate, which assigned to Swain the right to prosecute the adversary proceeding to set aside the alleged fraudulent conveyance. In exchange, Swain was to be paid 68% of the net recovery he obtained, and to be reimbursed for any of his costs.” Swain’s attorney’s fees would also be paid by the estate. The agreement was approved by the bankruptcy court.
Two and a half years later, Swain, Harris, his wife and the trustee settled. The property was transferred to the estate. Mrs. Harris was to get a payment when the property was sold by the estate and everyone released everyone. Six months later, the trustee agreed to sell the same property to Swain for $125,000 plus Swain agreed to pay the costs and attorneys fees and waive his claim. Swain also agreed to pay Mrs. Harris when he sold the property. “Altogether, Swain’s waiver of claims and assumption of liability totaled around $900,000.” The bankruptcy court approved the “sale.”
Three years later, Harris sued the trustee and Swain in state court for breach of the settlement agreement, breach of fiduciary duties etc. Apparently he claimed that Swain’s waiver of claims etc was not worth $900,000. The trustee removed the case to bankruptcy court. The trustee and Swain filed a motion to dismiss. Harris then amended the complaint to allege state law breach of contract only apparently trying to take jurisdiction away from the bankruptcy court. The court dismissed the case saying “(1) the complaint was barred under the Barton doctrine due to Harris’s failure to obtain approval of the bankruptcy court prior to filing suit in state court, and (2) each defendant was entitled to derived quasi-judicial immunity as a result of the entry of the June 30, 2003 order, which approved the sale of the assets.” The district court affirmed.
The 9th Circuit also affirmed although it reversed as to the Barton doctrine. It agreed that the matter was a core proceeding and therefore the bankruptcy court had jurisdiction to dismiss the case. “Here, although this is a state law cause of action, Harris’s claim arose in his bankruptcy case because it could not exist independently of his bankruptcy case.” It said however that the case should not have been dismissed based on Harris failure to obtain permission to sue the trustee first. It said that only applies where the suit is brought in another court. “[T]he Barton doctrine is not a ground to dismiss a suit that is proceeding in the appointing bankruptcy court. As applied in the Ninth Circuit, the Barton doctrine requires ‘that a party must first obtain leave of the bankruptcy court before it initiates an action in another forum against a bankruptcy trustee or other officer appointed by the bankruptcy court for acts done in the officer’s official capacity.’” In re Crown Vantage, Inc., 421 F.3d 963, 970 (9th Cir. 2005). “When Harris’s case was removed to the appointing bankruptcy court, all problems under the Barton doctrine vanished.”
The 9th Circuit affirmed however on the basis of immunity. “’Bankruptcy trustees are entitled to broad immunity from suit when acting within the scope of their authority and pursuant to court order.’ Additionally, ‘court appointed officers who represent the estate are the functional equivalent of a trustee.’” “For derived quasi-judicial immunity to apply, the defendants must satisfy the following four elements: (1) their acts were within the scope of their authority; (2) the debtor had notice of their proposed acts; (3) they candidly disclosed their proposed acts to the bankruptcy court; and (4) the bankruptcy court approved their acts.” Those elements were all met and dismissal was therefore proper.
November 16, 2009
9th Circuit BAP Adds to Debate on Above-Median Chapter 13 Plans, How to Compute Projected Disposable Income
American Express Bank v. Smith (In re Smith), ---- B.R. ----, 2009 WL -------- (9th Cir. BAP Oct, 2009)
Issue: When computing the chapter 13 plan payment, can an above-median chapter 13 debtor deduct payments to secured creditors for property they intend to abandon?
Trial Judge: Paul Snyder, Washington
Montali, Jury, Hollowell
Opinion by Montali (Hollowell dissenting)
These are above-median chapter 13 debtors. Their means test net income was minus $1,789. That included deduction for payments to secured creditors for “two houses and a vehicle” which they were surrendering. The plan proposed to pay $889 for six months which would pay 4% to unsecured creditors. The debtors’ I and J net was apparently (as it is not clear) about $900 to the positive. The chapter 13 trustee and a creditor objected that the debtors were not paying their “projected disposable income” and the plan was not proposed in good faith. If the means test did not include the secured payments and did include the housing allowance, the debtors had a positive net of $4,191 per month and could pay unsecured creditors in full in 24 months. The bankruptcy court overruled the objections. “The bankruptcy court held that section 1325(b)(3) supersedes -- not supplements -- subsection (b)(2) when debtors have above-median incomes.”
The BAP reversed, 2-1. It first dealt with Kagenveama. “The issue before the Ninth Circuit in Kagenveama did not involve either the determination of what are proper expenses (under section 1325(b)(2)) or the measurement of them (under section (b)(3)).”
It then states:
“Subsections (b)(2) and (b)(3) of section 1325, read together, provide that if an expense is not reasonably necessary for a debtor’s and/or dependants’ maintenance and support, it is not included in the calculation of disposable income. If the expense is reasonably necessary, and the debtor is an above median income debtor, subsection (b)(3) requires the court to determine the amount in accordance with section 707(b)(2).”
“If the expense is reasonably necessary for the debtor’s and/or dependants’ maintenance and support, then section 1325(b)(3) requires the court to determine the amount in accordance with section 707(b)(2).” “Items that a debtor has surrendered or intends to surrender are not necessary for his or her support or maintenance. The concepts -- surrender and necessity – are mutually exclusive of one another. Phantom payments for the surrendered item are not reasonably necessary for a debtor’s support and maintenance.”
Dissent of Hollowell.
“Under the guise of a plain meaning statutory analysis, the majority holds that § 1325(b)(2) and (b)(3) must be read sequentially, thereby arriving at a ‘common sense’ result which only permits an above median-income debtor to use the means test to calculate expenses after the debtor demonstrates the expense is reasonably necessary. While I sympathize with the majority’s desire to achieve a common sense result, I cannot agree with its contorted statutory analysis.”
“I cannot join my colleagues in an interpretation that upends the statutory inclusion of the means test in chapter 13, reverting back to the pre-BAPCPA judicial discretion as to what expenses of a debtor are reasonably necessary.”
Yarnall v. Martinez (In re Martinez), ---- B.R. ----, 2009 WL -------- (9th Cir. BAP Oct, 2009)
Issue: When computing the chapter 13 plan payment, can an above-median chapter 13 debtor deduct payments to a secured creditor for a lien which has been “stripped off” pursuant to a Lam Motion?
Holding: No. Note: The opinion references and is essentially the same as In re Smith decided the same day by the same panel.
Trial Judges: Riegel, Markell, Nakagawa, Nevada
Montali, Jury, Hollowell
Opinion by Montali (Hollowell dissenting)
This is an appeal from three separate chapter 13 cases. The debtors are above-median chapter 13 debtors who filed successful Lam Motions yet still deducted the payment on the avoided second from the calculation of the plan payment. The bankruptcy judges in Nevada held a joint hearing and approved the plans holding that Kagenveama and Section 1325(b)(3) require a mechanical test and specifically permit deducting payments to secured creditors, even those they do not intend to make.
The BAP reversed. 2-1. It held that subsections (b)(2) and (b)(3) of section 1325 must be read together. The expense must first be “necessary” pursuant to (b)(2) and, if necessary, it must be computed pursuant to (b)(3). “[The debtors] made the decision to strip the liens, not the bankruptcy courts. Phantom payments cannot be necessary.” “[I]f an item is not necessary for a debtor’s support or maintenance, a debtor cannot engage in the fiction of pretending to pay for it.”
The dissent is virtually identical to Judge Hollowell’s dissent in Smith (see above).
August 23, 2009
9th Circuit Rules that Tax Assessed on a Post Chapter 13 Filed Tax Return for a Prepetition Year is a Prepetition Debt
Joye v. Franchise Tax Board (In re Joye), ---- F. 3d ----, 2009 WL 2568649 (9th Cir. Aug, 2009)
Issue: When a tax return for a prepetition year has not been filed prior to chapter 13 petition and plan, is the resulting tax a prepetition or a postpetition debt?
Appeal from the district court
Judge Wallace (Dissent by Judge Graber)
The debtors filed chapter 13 on Mar 7, 2001. They had not yet filed their 2000 tax return. They estimated their 2000 state income taxes at $10,000 and provided for that in their plan which was confirmed. The FTB did not object or file a proof of claim. The debtors filed their 2000 return on October 15, 2001 showing a tax owed of $28,000. The debtors later completed their plan and received a discharge. The FTB then began collection of the remaining 2000 tax. The debtors filed an adversary proceeding seeking to stop the FTB from trying to collect the tax. The FTB argued that it was a postpetition tax or that they did not receive adequate notice. The parties agreed that if it is a postpetition tax, it is not discharged. The bankruptcy court agreed with the debtors. The district court ruled that the tax was technically discharged but reversed holding that the FTB did not receive adequate notice.
The 9th Circuit reversed the district court agreeing that the tax was discharged. The chapter 13 discharge provides that debts "provided for under the plan" are discharged. Section 1305 provides that "[a] proof of claim may be filed by any entity that holds a claim against a debtor . . . (1) for taxes that become payable to a governmental unit while the case is pending." The issue then is whether the taxes "became payable" while the case was pending. The 9th Circuit went through a nice analysis of the meaning of payable. Generally in "'customary usage'" [it] means … `[c]apable of being paid' [and] `justly due' and `legally enforceable.' " But this is bankruptcy. We have to look to Section 502(i) which "addresses tax claims held by governmental entities. This section provides that `[a] claim [for certain tax liabilities owed to governmental units] that does not arise until after the commencement of the case . . . shall be determined, and shall be allowed . . . the same as if such claims had arisen before the date of the filing of the petition.'" Therefore the tax due for 2000 was a claim which "arose" before the filing and is "payable" before the filing, especially since is certainly could have been computed and paid before the filing. The opinion rejects the notion that "payable" means what the FTB rulings and manuals say (and even the IRS rulings and manuals) as this is bankruptcy law.
As to the notice issue, the opinion says "[w]hen the holder of a large, unsecured claim [in bankruptcy] . . . receives any notice from the bankruptcy court that its debtor has initiated bankruptcy proceedings, it is under constructive or inquiry notice that its claim may be affected, and it ignores the proceedings to which the notice refers at its peril." Citing Matter of Gregory, 705 F.2d 1118 (9th Cir. 1983). The FTB argued that it did not know how much was owed and could not file a proof of claim until the debtor filed the tax return. The 9th Circuit said that the FTB could have estimated the claim or asked for an extension of time to file the POC. "We acknowledge that the Board has the unenviable task of maintaining complete and accurate records for the millions of taxpayers in the State of California. But we are not at liberty to rework the Bankruptcy Code in order to lighten its burden."
The dissent argued that Section 502(i) is not relevant because it deals with claims "that arise" and 1305 deals with "taxes that become payable." She also says that the 9th Circuit should follow the 5th Circuit "because of the importance of national uniformity in administering the Bankruptcy Code." Now, she says, there is a split between the circuits.
August 19, 2009
California Bankruptcy Judge Rules that Completely Unsecured Secured Debt is Unsecured for Chapter 13 Eligibility Purposes
In re Smith, --- B.R. ---, 2009 WL ------------ (unpublished to date)(Bankr. C.D. Cal. Aug. 2009, Tighe. J.)
Issue: Is secured debt which is entirely unsecured because of the value of the collateral, treated as secured or unsecured for chapter 13 eligibility purposes?
Holding: Completely unsecured secured debt is unsecured for chapter 13 eligibility purposes.
This opinion rules on three similar cases. In each, the debtors filed Lam motions which were granted (one was by stipulation). If the debt covered by the Lam motion is added to the total unsecured debt, the debtors were well over the chapter 13 limits in Section 109(e). Lam motions apply usually to junior mortgages which are completed underwater. A Lam motion which is granted permits a chapter 13 plan to treat the debt as unsecured in the plan and extinguishes the lien at the end of the plan.
Judge Tighe first dealt with the issue of whether the “undersecured debt is ‘liquidated.’” The argument is that it is unknown on the filing date whether the Lam motion will be granted. Judge Tighe responded that usually the Lam motion requires only a simple hearing and that makes the debt liquidated.
Judge Tighe next dealt with Scovis, 249 F.3d 975, 981 (9th Cir. 2001) which required a judgment lien avoided under Section 522(f) to be treated as unsecured for eligibilty purposes. The debtors argued that Scovis does not apply because the undersecured lien there was a judgment lien, not a consensual lien. But Tighe said that if the chapter 13 is dismissed, the judgment lien comes back, same as Lam motions.
The debtors also argued that even after the Lam motion is granted, the debt is secured, at least until the discharge is entered. Tighe said that 506(a) says the debt is unsecured and 506(d) says that the lien is void “for bankruptcy purposes.”
Next Tighe dealt with the issue that 1322(b)(2) prevents the debtor from modifying loans when the collateral is the debtor’s residence. She writes, debtors “wish to extend the limitation placed on modifying a partially secured trust deed to wholly unsecured junior liens on the primary residence.” She acknowledges that there is a “problem with applying Scovis and Soderlund to debtor’s primary residence indebtedness.” She concludes, “In order to avoid treating a lien one way for confirmation and another for eligibility, and to treat the partially secured senior trust deeds consistent with Nobleman and Zimmer, any lien which is partially secured on debtor’s primary residence will be treated as a secured debt for §109(e) purposes as well.”
Judge Tighe invited appeals at the end of the ruling and said she would consider stays pending appeal. She also said she would consider certifying the matter for direct appeal.
June 27, 2009
9th Circuit Rules that Assets in "Single Owner" Corporate Pension Not Exempt under California Law
Cunning v. Rucker (In re Rucker), ---- F. 3d ----, 2009 WL ---------(9th Cir. June, 2009)
Issue: Did the bankruptcy court err when it found that the debtor’s contributions to a corporate pension plan were primarily made to shelter assets and avoid paying debts and therefore not exempt?
Holding: No. The test is one of clear error and the bankruptcy court did not commit clear error. The court should look to the totality of the circumstances when determining the debtor’s intent in making transfers to a corporate pension plan at least when seeking to exempt the assets under California.
Appeal from the district court
The debtor transferred assets of about $1 million to a corporate pension plan over a period of a few years. At the time of the transfers, he had a judgment against him for about $6 million. The corporations were “wholly owned” by the debtor and he was the only employee of each. He did not make any withdrawals from the plans during these years however he “overfunded” the plans to about 20% of the total assets per IRS regs. The contributions equaled or exceeded his compensation by the entities for those years. Rucker filed chapter 7 and claimed the assets exempt under CCP 704.115(b), “which exempts ‘all amounts held, controlled, or in process of distribution by a private retirement plan.’ [The judgment creditor] objected to the exemption, claiming that the Plans were not exempt because they were not designed or used primarily for retirement purposes.” The bankruptcy court conducted a trial and “determined that the Plans were not exempt because Rucker designed and used the Plans primarily to shield his assets from Cunning. Instrumental in the bankruptcy court’s reasoning were the facts that Rucker overfunded the Plans, that Rucker took at least one constructive rent payment, and that Rucker did not accurately disclose his contributions as required by IRS regulations.” The district court reversed.
The 9th Circuit reversed the district court and reinstated the ruling of the bankruptcy court that the funds were not exempt. It said that 9th Circuit “precedent establishes that ‘whether a plan is designed and used for retirement purposes is a question of fact that we review for clear error.’” “In deciding whether a plan is designed and used primarily for retirement purposes, ‘[a]ll factors are relevant; but no one is dispositive.’ Many factors previously considered by us and by California courts concern the extent of a debtor’s withdrawals or loans from the plan. Courts have also considered a debtor’s subjective intent in deciding whether the plans have a retirement purpose.”
“We conclude that the bankruptcy court did not commit clear error in determining that Rucker used his Plans primarily to hide assets from Cunning, and not primarily for retirement. Once we articulate the totality of circumstances standard, and recognize that a bankruptcy court decision on the fact-intensive issue of a retirement plan’s primary purpose is reviewed only for clear error, we conclude that the bankruptcy court’s initial decision on that issue must be here reaffirmed and the district court’s contrary conclusion reversed.”
June 22, 2009
9th Circuit Rules that Ch 7 Case Automatically Dismissed under Section 521(i)(a) is not Automatically Dismissed if the Bankruptcy Court Waives the Duty to File Schedules Even After the Automatic Dismissal
Wirum v. Warren (In re Warren), ---- F. 3d ----, 2009 WL 1694188 (9th Cir. June, 2009)
Issue: May the bankruptcy court waive the duty of the debtor to file schedules thus preventing the chapter 7 case from being automatically dismissed under 521(i)(1) even though the 45 days set forth in 521(i)(1) has elapsed and the case presumably therefore has been “automatically dismissed”?
Appeal from the district court.
Judge T.G. Nelson
The debtor filed chapter 7 as a response to the state of California attempting to collect past due child support. The debtor apparently filed only the emergency forms and not the remainder. The court warned the debtor and set a hearing to consider dismissal and sanctions. Immediately before the hearing, the chapter 7 trustee advised the court there may be assets to administer and asked the court not to dismiss the case and the court agreed. Later, the debtor filed a motion to dismiss arguing that the 45 days to file the remainder of the schedules under Section 521(i)(1) had run and therefore the court was required to dismiss. Section 521(i)(1) says that if the debtor does not file the required schedules within 45 days, the case “’shall be automatically dismissed effective on the’ forty-sixth day.” The trustee argued that the schedules required to be filed under 521(a)(1) were subject to the proviso “unless otherwise ordered by the court.” The bankruptcy court denied the motion to dismiss, ordered that the remainder of the schedules need not be filed, and the debtor appealed. The district court reversed saying that the dismissal was mandatory.
The 9th Circuit Court of Appeals reversed the district court and upheld the refusal to dismiss the case. The Court noted that there is no deadline in 521(a)(1) to “order otherwise.” It said that the language of 521(i)(1) is ambiguous with respect to whether, under 521(a)(1), the court may “order otherwise” after the 45 days has elapsed. “Given the ambiguity in the statutory language, we must ‘evaluate the alternative readings in light of the purpose of the statute.’” The Court pointed out that the “order otherwise” language predated BAPCPA. Congress did not limit the power of the court to “order otherwise” when it provided in BAPCPA that the case would be automatically dismissed. Plus “Congress’s core purpose in enacting BAPCPA was to prevent abusive bankruptcy filings.” The court acknowledged that its ruling was in the minority but said that its reading of the code was necessary to prevent debtors from “manipulating the system.”
June 01, 2009
9th Circuit Rules that Repyament of 401(k) Loans not Deductible on the Means Test Because the Loan is not a Debt
Egebjerg v. Peter Anderson (In re Egebjerg), ---- F. 3d ----, 2009 WL 1492138 (9th Cir. May, 2009)
Issue: Is the repayment of a secured loan against the debtor’s 401(k) deductible on the means test?
Direct appeal from the bankruptcy court
The debtor is single making $6,100 per month. His unsecured debt was $31,000. Two years before filing he took a loan from his 401(k) which he was repaying at $733 per month. On the means test, he deducted this payment as a payment on a secured debt leaving him with net disposable income of $15 per month. The UST moved to dismiss under both 707(b)(2) and (b)(3). The bankruptcy court agreed that the deduction was proper under (b)(2) but dismissed under (b)(3) on the totality of the circumstances since the loan would be repaid in full in just over one year. The court ruled that even if the deduction was not proper under (b)(2), it would qualify as “special circumstance” which could rebut the presumption of abuse under (b)(2).
The 9th Circuit affirmed but ruled that the bankruptcy court should have dismissed under (b)(2). “We join the vast majority of courts in holding that the debtor’s obligation to repay a loan from his or her retirement account is not a ‘debt’ under the Bankruptcy Code.” One reason is that the plan will never sue the member; it is simply an offset against future benefits. “Congress expressly gave Chapter 13 debtors the ability to deduct 401(k) payments from their disposable income calculation, § 1322(f), but did not include any similar exemption for Chapter 7 debtors. Congress also added a section which provides that the automatic stay does not apply to automatic deductions to repay a retirement plan loan, but expressly stated that the provision shall not be construed to provide that such a loan constitutes a ‘claim’ or ‘debt.’ § 362(b)(19). ‘In light of the amendments sprinkled throughout the Code [addressing 401(k) loans] — especially section 1322(f) — the lack of a 401(k) provision in section 707 is a glaring indication that Congress did not intend 401(k) loan repayments to be deducted in Chapter 7.’”
The debtor argued that the deduction was an “other necessary expense.” The court rejected that argument, saying “The IRS’s guidelines foreclose Egebjerg’s contention. The guidelines, which Congress expressly incorporated into § 707(b)(2)(A)(ii), state specifically that ‘[c]ontributions to voluntary retirement plans are not a necessary expense.’” “[I]t is hard to argue that the replenishment of past voluntary contributions to the 401k account by repaying loans is a necessary expense.”
As to the “special circumstance,” the 9th circuit said that it was possible that it could be a special circumstance but not here. The debtor’s “only” reason for borrowing the money in the first place was to pay debts to avoid bankruptcy. This is “commendable” but insufficient. “Indeed, if the original unsecured consumer obligation could not be considered a special circumstance, it would seem problematic to find ‘special circumstances’ for the 401(k) loan that merely replaced those debts.”
February 24, 2009
Two New 9th Circuit Cases
In re Simpson, --- F.3d ----, 2009 WL ------ (9th Cir. Feb 2009)(single-premium annuity here does not qualify as exempt property under California Code of Civil Procedure Sec. 704.100 where debtor purchased it as an individual and annuity was not established for debtor by employer)
Full text http://www.metnews.com/sos.cgi?0209%2F0715626
McKay v. Ingleson, --- F.3d ---, 2009 WL ------ (9th Cir. Feb, 2009)(Student's financial arrangement with university allowing her to defer tuition payments until end of each semester constituted a nondischargeable educational loan under 11 U.S.C. Sec. 523(a)(8))
Full text http://www.metnews.com/sos.cgi?0209%2F0735362
February 08, 2009
More on 707(b)(3) - Totality of the Circumstances
In re Baeza, ---- B.R. ---, 2008 WL 5411118 (Bkrcy, E.D. Cal. Dec. 2008, Lee. J.)
Issue: Where the debtor intends to surrender collateral which will result in substantial “net disposable income,” can that be the basis for dismissal of the case under 707(b)(3)?
These chapter 7 debtors have $436,000 of secured debt and about $54,000 of unsecured. Based on their Statement of Intentions, they intend “to surrender the collateral for almost all of their secured debt, approximately $433,876, including their home, one vehicle, an ATV, and a travel trailer.” Their CMI is $10,348. The means test net is minus $1110. The UST moved to dismiss the case as an abuse both under 707(b)(2) and (3). As to (b)(2), the argument was that payments for secured debt for property which is going to be surrendered should not be included. As to (b)(3), the court should look to the totality of the circumstances and once the collateral is surrendered, the debtors will have significant net disposable income to pay to creditors as part of a plan.
Judge Richard Lee in Fresno granted the motion and dismissed the case. He said first that he did not need to consider the (b)(2) arguments if (b)(3) applies. He said next that ability to pay is part of the totality of the circumstances. “It would be counterintuitive to construe this same phrase [totality of the circumstances], as used in BAPCPA, to exclude a consideration of the debtor's ability to pay.”
“Turning now to the facts of this case, it appears that at least two of the Price factors, the first and second, are relevant. The Debtors have enjoyed an annual income that is substantially more than the applicable median family income in California. While their income may have recently decreased, they also are no longer burdened with oppressive payments to secured creditors which consumed a large percentage of their income. There is no showing that the Debtors filed this joint petition as a result of illness, disability, unemployment, or calamity. The Debtors' own schedules show that the Debtors have the ability to repay a substantial portion of their unsecured debts based on their current financial situation.”
The debtors argued that in a chapter 13 there would be no payments to unsecured creditors under the facts here. “The Debtors' argument mischaracterizes the issue and misstates the law. The question before the court is not whether the Debtors would be required to pay anything to their unsecured creditors in a chapter 13, but rather, whether they have the ability to pay something substantial to their unsecured creditors. The answer to that question is unequivocally yes.” He said that this is not a chapter 13 case and therefore that is not an issue. He concluded, “Based on the foregoing, the court finds and concludes, based on the totality of the circumstances, that the Debtors have the ability to pay a substantial portion of the debts for which they seek a discharge and that the granting of a discharge in this case would be an abuse of chapter 7.”
January 28, 2009
Judge Peter Bowie in San Diego Opines re Whether a Significant Mortgage Which Allows the Debtor to Pass the Means Test can be the Basis for a Finding of Abuse and Dismissal
In re Johnson, ---- B.R. ---, 2008 WL 5265740 (Bkrcy, S.D. Cal. Dec. 2008, Bowie. J.)
Issue: Can the debtor’s large mortgage payment be the basis for a finding of abuse even though the debtor has passed the means test?
Holding: Not here on these facts.
The debtors own an “approximately 4,000 square foot Residence [they built] in May of 2003. Unfortunately for Debtors, shortly after the Residence was completed, Mr. Johnson, an airline pilot, had to accept a $60,000 cut in pay. The Debtors list the value of the Residence at $900,000, and the debt secured by it at nearly $1,100,000. The monthly mortgage expense for the Residence is $6,060, and total expenses associated with the property are scheduled at $8,286.” The debtors passed the means test. The UST moved to dismiss under 707(b)(3) arguing that “Debtors' expenses to pay their mortgage and to maintain their Residence are unreasonably high. If they would give up the property they could purchase or rent at substantially lower expense, and in so doing they would free up income for the benefit of unsecured creditors.” Judge Bowie ruled in favor of the debtors.
“[T]he presumption of § 707(b)(2) does not arise in this case. When the presumption does not arise (or is rebutted), § 707(b)(3) sets forth two alternate considerations for assessing abuse. Under § 707(b)(3) the Court is to consider whether the petition was filed in bad faith (§ 707(b)(3)(A)), or whether an abuse exists based on the ‘totality of the circumstances ... of the debtor's financial situation.’ No allegations of bad faith have been presented. Accordingly, the Court must evaluate the Trustee's motion to dismiss based solely on the ‘totality of the circumstances ... of the debtor's financial situation.’ This brings us to the issue at hand.”
“In a nutshell, the issue is whether Congress, by allowing secured claims to be included without limitation in the Means Test of (b)(2), has limited the courts' discretion to consider them under the totality of circumstances test of (b)(3).” “[T]his Court is persuaded there are circumstances that warrant dismissal under § 707(b)(3) although a debtor may have ‘passed’ the Means Test.” “In the minds of many, including this Court, there is a point at which allowing an individual debtor relief from unsecured debt while sinking most income into maintaining the debt service on such a property seems egregious.”
[But] “If Congress determines that there should be no cap on secured debt obligations on a debtor's primary residence for purposes of the Means Test, and therefore no presumption of abuse arises under § 707(b)(2), can Congress properly be understood to intend that that same primary residence secured obligation can, by itself, be the basis for a finding of abuse under § 707(b)(3)?” “[I]t would seem quite ironic if Congress went through all it did to establish the assertedly more objective Means Test in place of individual discretion, only to turn around in § 707(b)(3) and hand the same discretion right back.”
Judge Bowie looked at the Price factors. Two Price factors appear to be relevant; “whether the debtor has a likelihood of sufficient future income to fund a Chapter 11, 12, or 13 plan which would pay a substantial portion of the unsecured claims....” and “whether the “proposed family budget is excessive or extravagant.” But the determination of future income in chapter 13 and 11 for an individual comes from 707(b)(2) which permits unlimited mortgages to be deducted. As to the extravagance, “we are back to the core issue of whether that can be considered under the new § 707(b)(3) given the policy decisions Congress made in § 707(b)(2).”
Bowie concluded, “Assuming that the size of the mortgage payment can be considered notwithstanding § 707(b)(2), the Court is comfortable in concluding that the mortgage payment in this case is neither sufficiently excessive nor extravagant as to warrant dismissal on a totality of the circumstances basis under § 707(b)(3).”
January 25, 2009
9th Circuit Rules on CMI - Income Which is Not Income is Included in CMI
Blausey v. U.S. Trustee (In re Blausey), ---- F. 3d ----, 2008 WL -------- (9th Cir. January 2009)
Issue: Are receipts from a private disability insurance policy “income” for CMI purposes?
Holding: Yes, even though the receipts are not income under the IRC.
Direct appeal from bankruptcy court, Alan Jaroslovsky
Per curiam, dissent from Judge Gorsuch
The debtor was receiving $4,000 per month from a private disability policy she had previously purchased. “[T]hey did not include these benefits in their calculation of CMI.” The UST moved to dismiss under 707(b)(1) or (b)(2). Including the income caused the debtors to fail means test. The bankruptcy judge granted the UST motion and the case was dismissed. The court then certified the matter for direct appeal to the court of appeals.
The court of appeals affirmed. “The Blauseys’ chief argument is that ‘income’ in the definition of CMI should be interpreted as consistent with ‘gross income’ as defined in the Internal Revenue Code.” “The plain language of the Bankruptcy Code, however, does not support this interpretation.” “The phrase ‘without regard to whether such income is taxable income’ in 11 U.S.C. § 101(10A)(A) reflects Congress’ judgment that the Internal Revenue Code’s method of determining taxable income does not apply to the Bankruptcy Code’s calculation of CMI.” “In addition, the statute specifically excludes certain payments, such as Social Security payments and payments to victims of war crimes and terrorism, from CMI. 11 U.S.C. § 101(10A)(B). The general rule of statutory construction is that the enumeration of specific exclusions from the operation of a statute is an indication that the statute should apply to all cases not specifically excluded.” The debtors also argued that various dictionaries established that income does not include these benefits. The court rejected those arguments. “The purpose of the means test is to ‘help the courts determine who can and who cannot repay their debts and, perhaps most importantly, how much they can afford to pay.”
The dissent dealt with whether the debtors had properly perfected their direct appeal to the court of appeals. When the bankruptcy judge certified the direct appeal, the debtors were required to file “a petition requesting permission to appeal” within 10 days which they did not do. The majority was prepared to ignore that shortcoming.
January 08, 2009
Schizophrenic 9th Circuit Punts on In re Beverly
I can't post a brief on the new 9th Circuit published case of In re Beverly because the opinion says "see the BAP opinion - it's so good we didn't bother." The same 9th Circuit that ruled in Kagenveama that if the BAPCPA amendments, read literally (who are we anyway? - just the judge), lead to a ridiculous result, well who are we anyway? "Congress - you wrote it buddy!" But in Beverly where the BAP reversed the trial court after a lengthy trial and put doubt into many divorce settlements and other prepetition planning, the 9th couldn't be bothered.
In In re Beverly, the debtor and wife were in a nasty divorce. The debtor transferred his interest in a big house to his wife in exchange for her interest in his pension. Those were really their only two assets. As was made clear during the divorce, the two hated each other. The deal was made as part of a mediation, approved by the family court, and no one in the bankruptcy arena even suggested that the deal was not a fundamentally equal exchange or a fair result. The problem you say? Hubby, an attorney with a former client suing him for malpractice, had made several (written) comments to his wife's attorney that we need to get this deal done because I need to file bankruptcy and my creditors will get nothing because the pension will not be property of the estate, see Shumate v. Paterson. The trustee said this shows "actual intent" on his part to hinder creditors and that makes the transfer avoidable and is grounds for denial of the discharge.
So I repeat, "actual intent." Judge Donovan listened to everyone at trial at great length and made factual findings that there was no actual intent. The BAP reversed, see Wolkowitz v. Beverly (In re Beverly), 374 B.R. 221 (9th Cir. BAP July, 2007). On December 24, 2008, the 9th Circuit said, "1. Good job BAP" on the 548 fraudulent transfer issue," and "2. the 727 issue is not ripe so we won't decide that." I can't blame them on the 727 issue. If it's not final its not, but it's a shame that they could not have made that determination a year ago. But the conveyance issue is on the basis of actual intent which seems to me to lead to denial of the discharge (some day) and certainly another round of appeals and certainly more litigation in family court since wife will have to give her half of the house to the trustee.
The BAP opinion discusses California FTA law at length and how there is no "one free fraudulent conveyance" because it's a divorce. This was a great chance for the 9th Circuit to straighten that out but it just punted.
November 28, 2008
9th Circuit Rules on Requirement that a Debtor Keep Records
Sun Communities v. Caneva (In re Caneva), ---- F. 3d ----, 2008 WL -------- (9th Cir. November 2008)
Issue: Does the debtor’s admission that he did not keep business records establish a prima facie case that his discharge should be denied such that summary judgment is appropriate?
appeal from District Court Arizona
This chapter 7 debtor owned and operated “numerous business entities, recreational vehicle and mobile home parks in Florida, and an airplane.” Sun Communities filed an adversary proceeding asserting that the debtor should be denied a discharge for failure to keep sufficient books and records. Section 727(a)(3). During a 2004 exam, the debtor “admitted that he kept no records for the entities, despite the fact that some of them had business operations and others existed as holding companies for active businesses. [He] also admitted during the Rule 2004 Examination that he had no documentation regarding the payment of $500,000 to Bowden as a brokerage fee for a $20 million loan that [the debtor] stated he did not receive.” Sun filed a Motion for Summary Judgment which was granted. The district court affirmed.
The 9th Circuit affirmed also. “The statute does not require absolute completeness in making or keeping records. Rather, the debtor must ‘present sufficient written evidence which will enable his creditors reasonably to ascertain his present financial condition and to follow his business transactions for a reasonable period in the past.’ This exception to dischargeability, however, ‘should be strictly construed in order to serve the Bankruptcy Act’s purpose of giving debtors a fresh start.’ A creditor states a prima facie case under § 727(a)(3) by showing ‘(1) that the debtor failed to maintain and preserve adequate records, and (2) that such failure makes it impossible to ascertain the debtor’s financial condition and material business transactions.’ After showing inadequate or nonexistent records, ‘the burden of proof then shifts to the debtor to justify the inadequacy or nonexistence of the records.’”
The debtor argued that there was a triable issue of fact as to whether the significant records that were turned over were sufficient to meet the test. He also argued that additional records were available to Sun through at least one criminal action that had taken place prepetition. “We disagree. The Seventh Circuit has held that § 727(a)(3) ‘places an affirmative duty on the debtor to create books and records accurately documenting his business affairs.” Peterson v. Scott (In re Scott), 172 F.3d 959, 969 (7th Cir. 1999) The court also noted that when a debtor is sophisticated and carries on a business involving substantial assets, ‘creditors have an expectation of greater and better record keeping.’” “Without the records that [the debtor] admitted he did not keep, Sun cannot determine what assets his business entities held or may still hold, what assets passed through them and where they might have gone, and what their present value is, if anything. Without any documentation related to the payment to Bowden, Sun cannot determine the details of that transaction or verify that it actually took place.” Further the debtor did not provide any justification for the failure to keep records in his opposition to the MSJ.
November 25, 2008
9th Circuit Rules that Payment to Trustee of a Preference Resurrects the Debt for Non-Dischargeability Purposes
Busseto Foods v. Laizure (In re Laizure), ---- F. 3d ----, 2008 WL ------ (9th Cir. November 2008)
Issue: When the debtor pays an otherwise non-dischargeable debt to the creditor during the prepetition preference period and the creditor is forced to return the payment later to the trustee, is the debt resurrected to the extent that the creditor can obtain a non-dischargeability judgment?
appeal from BAP
The debtor admitted prepetition to embezzling from his employer, the plaintiff here. The debtor settled with the employer and made 3 payments based on the settlement. When the debtor filed chapter 7, the trustee sued the employer to return the last the payments, $38,000, as a preference. The employer paid the trustee and then filed a non-dischargeability action against the debtor. The debtor defended saying that there was no debt when the chapter 7 was filed and repaying the payment to the trustee did not resurrect the debt so it could not be non-dischargeable. The bankruptcy court ruled for the debtor and the BAP affirmed.
The 9th Circuit reversed. “According to the language of § 502(h), the trustee, through using this § 550 recovery ability, revived Busseto’s claim to prepetition status. Consequently, Busseto has a claim against Laizure ‘the same as if . . . [it] had arisen before the date of the filing of the petition.’ 11 U.S.C. § 502(h).” Section 502(h) states that a “claim arising from the recovery of property
under section . . . 550 . . . of this title shall be determined, and shall be allowed . . . or disallowed . . ., the same as if such claim had arisen before the date of the filing of the petition.” “The BAP’s conclusion . . . conflicts with our precedent as well as the relevant statutory language. In In re Verco we stated: [T]he import of Section 502(h) is that where a claim is allowable as provided in that section, its status is as a claim in existence on the date of the filing of the petition regardless of when, after the petition, the trustee has taken the necessary action and recovered.”
October 04, 2008
9th Circuit Rules on Effect of Completion of Chapter 13 Plan on Unpaid Student Loans
Espinosa v. United Student Aid Funds (In re Espinosa), ---- F. 3d ----, 2008 WL 4426634 (9th Cir. October 2008)
Issue: When a confirmed chapter 13 plan is completed and the discharge injunction is entered, is the unpaid portion of the student loan discharged when the lender received actual notice of its treatment in the plan and did not object?
Holding: Yes, the discharge injunction may be set aside only pursuant to FRCP60(b) and then based on a lack of sufficient notice.
Judge Alex Kozinski
The debtor’s chapter 13 plan
“provided for repayment of $13,250 in student loans to United Student Aid Funds, Inc. (Funds). Funds was notified and filed a proof of claim in the amount of $17,832.15. The bankruptcy court eventually confirmed the plan, and the Chapter 13 Trustee mailed Funds a notice advising it that ‘[t]he amount of the claim filed differs from the amount listed for payment in the plan. Your claim will be paid as listed in the plan.’ The notice also contained the following warning: If an interested party wishes to dispute the above stated treatment of the claim, it is the responsibility of the party to address the dispute. The claim will be treated as indicated above unless the Trustee receives within 30 days from this mailing, a written request for different treatment. The request should set forth the specific grounds for alternative treatment and should be filed with the Clerk of the Court, with a copy mailed to the Trustee. Funds did not object and Espinosa successfully completed the plan.”
The discharge was then entered. Three years later Funds began collection efforts. The bankruptcy court ruled for the debtor and ordered Funds to cease collection efforts. The District Court reversed. Funds defended arguing that an adversary proceeding was required with a finding that there was a hardship. Kozinski writes, “Great Lakes Higher Educ. Corp. v. Pardee (In re Pardee), 193 F.3d 1083, 1086 (9th Cir. 1999), which is on all fours with our case, forecloses this argument.” “In essence, Pardee held that a discharge is a final judgment and cannot be set aside or ignored because a party suddenly claims, years later, that the trial court committed an error.” “Regardless, when the creditor is served with notice of the proposed plan, it has a full and fair opportunity to insist on the special procedures available to student loan creditors by objecting to the plan on the ground that there has been no undue hardship finding.” “A discharge injunction does not operate by way of res judicata; it is, rather, an equitable remedy precluding the creditor, on pain of contempt, from taking any actions to enforce the discharged debt.” “Had the creditor wanted to insist on an adversary, it could have objected to the Chapter 13 plan on the ground that there was no judicial finding of undue hardship. Had Funds so objected, the bankruptcy court would have been required to disapprove the plan and Espinosa would have been put to the hard choice of commencing an adversary or abandoning Chapter 13. But Funds didn’t object to the plan and didn’t appeal the order confirming the plan, as it well could have. See Lawrence Tractor Co. v. Gregory (In re Gregory), 705 F.2d 1118 (9th Cir. 1983). Instead, it accepted the payments made by the debtor during the plan’s life and then acted as if the whole thing never happened.”
“It makes a mockery of the English language and common sense to say that Funds wasn’t given notice, or was somehow ambushed or taken advantage of.”
The lender must go through FRCP 60(b)(4) or (6) to vacate the judgment. That comes down to whether or not it received sufficient notice. “We reject the idea that a creditor who is in the business of administering student loans has a constitutional right to ignore a properly served notice that clearly specifies that its debt will be discharged on successful completion of the plan.”