Category Archives: Ninth Circuit Court of Appeals

August 30, 2016

Ninth Circuit Holds that the One-Year Period in Sec. 727(a)(2) is not Subject to Equitable Tolling

Ronald Neff was a dentist against whom his patient, Douglas DeNoce, obtained a judgment for malpractice. After he filed a chapter 13 petition, Neff recorded a quit-claim deed transferring a condominium from himself to a trust. This first chapter 13 case was dismissed, as was a second chapter 13 case filed by Neff. Neff then filed his third bankruptcy case, a chapter 7 proceeding, more than one year following the recording of the quit-claim deed. DeNoce filed an adversary proceeding, seeking the denial of Neff’s discharge under § 727(a)(2) of the Bankruptcy Code, asserting the transfer of the condominium was made with intent to hinder, delay or defraud creditors. Because § 727(a)(2) requires the transfer be made within one year before the bankruptcy filing, Neff contended the transfer of the condominium, which occurred more than a year before he filed his chapter 7 petition, did not bar his discharge.

The bankruptcy court granted Neff a summary judgment on the complaint, and DeNoce appealed, contending the one-year period in the statute is subject to equitable tolling based on Neff’s first two bankruptcy cases. The Ninth Circuit BAP affirmed, as did the Ninth Circuit. DeNoce v. Neff (In re Neff), 2016 WL 3201236 (9th Cir. 2016).

The sole question before the Ninth Circuit was whether the one-year time period contained in § 727(a)(2) can be subject to equitable tolling. The Ninth Circuit concluded it is not, in an straight-forward analysis. First, the court noted that equitable tolling “is fundamentally a equstion of statutory intent,” and that the Supreme Court presumes that Congress intended equitable tolling would be available “if the period in question is a statute of limitations.” Young v. United States, 535 U.S. 43 (2002). However, this presumption has only been applied to statutes of limitation and has not been applied to other statutes, such as statutes of repose. Lozano v. Montoya Alvarez, 134 S. Ct. 1224 (2014).

Consequently, the court determined the question before it was whether the time period in § 727(a)(2) is a statute of limitations. The court noted that a statute of limitations is generally “[a] law that bars claims after a specified period; specifically, a statute establishing a time limit for suing in a civil case, based on the date when the claim accrued.” CTS Corp. v. Waldburger, 134 S. Ct. 2175 (2014). The purpose of a statute of limitations is to encourage claimants to diligently pursue their claims. The court concluded that § 727(a)(2) was not a statute of limitations. Its purpose was not to encourage claimants to timely pursue claims against a debtor, but rather its purpose is to prevent dishonest debtors from abusing the bankruptcy process by evading the consequences of their misconduct. The court stated: “At the core of the Bankruptcy Code are the twin goals of ensuring an equitable distribution of the debtor’s assets to his creditors and giving the debtor a fresh start.” Sherman v. SEC (In re Sherman), 658 F.3d 1009 (9th Cir. 2011). The one-year is designed to set a date on transfers for which a debtor may be denied a discharge, and is not a statute of limitations by which a creditor must bring an action.

May 24, 2016

Default Interest Rates are Presumed Reasonable Under Sec. 506(b), and a Bankruptcy Court May Not Use the Fair and Equitable Language of Sec. 1129(b) to Conclude Otherwise

The Ninth Circuit BAP recently discussed on appeal the issue of whether a bankruptcy court may use the “fair and equitable” standard for confirmation in § 1129(b) to deny an oversecured creditor default interest on its claim to which it would otherwise be entitled under § 506(b). In Wells Fargo Bank, N.A. v. Beltway One Development Group, LLC (In re Beltway One Development Group, LLC), 547 B.R. 819 (9th Cir. BAP 2016), the Ninth Circuit BAP concluded that the fair and equitable standards for confirmation deal with treatment of an allowed claim post-confirmation, but that allowance of an oversecured claim is governed by § 506(b). The BAP held the bankruptcy court erred In using § 1129(b) to deny Wells Fargo default interest on its claim.

The facts in Beltway One were straightforward. The value of the bank’s collateral exceeded the amount the bank was owed. The debtor’s plan, however, provided that the bank would not be entitled to any default interest on its claim, and treated the claim by modifying its terms and providing for payment amortized over 30 years. The plan further provided that any pre-effective date defaults would be deemed to have been cured. The debtor’s argument was that the default was “cured” because it was paid with a new loan; therefore, under the Ninth Circuit’s decision in Great Western Bank & Trust v. Entz-White Lumber and Supply, Inc. (In re Entz-White Lumber and Supply, Inc.), 850 F.2d 1338 (9th Cir. 1988), the default had been cured and the bank was not entitled to default interest during the pendency of the case. Wells Fargo opposed confirmation, asserting the plan did not meet the “fair and equitable” test under § 1129(b)(1). The bankruptcy court agreed with the debtor, concluding the new loan under the plan “paid” the debt within the meaning of Entz-White, and confirmed the plan.

The BAP reversed. The BAP noted a major factual difference between the Beltway One plan and the Entz-White plan in that the debtor in Entz-White­ actually cured the defaults on its secured creditor’s debt by paying the debt in full on the effective date of the plan, whereas Beltway One merely restructured the terms of its secured debt with Wells Fargo. Consequently, the BAP concluded Entz-White was not applicable to the present case. The BAP stated that determining post-petition interest on an oversecured claim under § 506(b) “is an issue separate and distinct from the fair and equitable test for plan confirmation under § 1129(b). The BAP held that determination of interest on an oversecured debt is a claim issue, not a confirmation issue.

This holding did not end the inquiry, however. The BAP also concluded that entitlement to default interest during the pendency of the case “is not automatic but may be allowed upon demonstrating that it meets certain requirements.” The BAP stated that the determination is accompanied with a presumption that the contract’s default interest rate is reasonable unless the debtor introduces evidence that it is not. The BAP based its conclusion on the Ninth Circuit’s decision in Gen. Elec. Capital Corp. v. Future Media Prods., Inc. (In re Future Media), 536 F. 3d 969 (9th Cir.), amended 547 F.3d 956 (9th Cir. 2008), which held that, if Entz-White does not apply, then the bankruptcy court must evaluate the viability of the contractual default interest rate by using applicable “substantive law creating the debtor’s obligation, subject to any qualifying or contrary provisions of the Bankruptcy Code.” In other words, the bankruptcy court should apply a presumption of allowability for the contract default interest rate, provided the rate is not unenforceable under applicable non-bankruptcy law. The creditor enjoys a presumption that the contracted for rate is reasonable, and the debtor bears the burden of demonstrating it is not, or that the rate is not enforceable under applicable non-bankruptcy law.

March 15, 2016

Secured Creditors Beware: Ninth Circuit Holds a Chapter 13 Debtor may Avoid Liens Even if not Entitled to a Discharge

Congress enacted § 1328(f) of the Bankruptcy Code when its passed BAPCPA. This section prohibits the granting of a chapter 13 discharge if the debtor received a chapter 7 discharge within four years prior to the commencement of his chapter 13 case. The Ninth Circuit in In the Matter of Blendheim, 803 F.3d 477 (9th Cir. 2015) held a chapter 20 debtor may in his chapter 13 case avoid a lien under § 506(d) even if § 1328(f) precludes him from receiving a discharge.

The creditor in Blendheim was HSBC Bank, which held a deed of trust lien on the debtors’ home. The debtors filed a chapter 7 case and received a discharge. Soon thereafter, they filed a chapter 13 case, mainly to restructure debts relating to their primary residence. HSBC timely filed a secured proof of claim based on its deed of trust against the debtors’ residence. The debtors objected to the claim, substantively objecting on the grounds that the note which formed the basis for the claim bore a forged signature. For some unknown reason, HSBC never responded to the debtors’ objection, and the bankruptcy court entered an order disallowing HSBC’s secured claim. In fact, after receiving notice that its secured claim had been disallowed, HSBC withdrew its proof of claim and requested the court to no longer send it electronic notifications in the case.

Thereafter, the debtors filed an adversary proceeding against HSBC seeking to void HSBC’s lien under § 506(d) which provides “to the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.” The debtors contended they were entitled to avoid the lien because the plain language of the statute says a lien securing a debt which is not an allowed secured claim is void. HSBC defended, asserting the debtors were not entitled to avoid the bank’s lien because the debtors were precluded from receiving a discharge by § 1328(f), which provides that a debtor may not receive chapter 13 discharge if he has received a chapter 7 discharge within four years prior to the commencement of his chapter 13 case.

The Ninth Circuit agreed the debtors could avoid HSBC’s liens even though they could not receive a chapter 13 discharge. First, the court concluded the plain language of § 506(d) entitled the debtors to avoid HSBC’s lien. Because this section provides that a lien is void if it secured a debt which is not an allowed secured claim, the court concluded that Congress’ intent was manifest, and held the purpose of § 506(d) was to nullify a creditor’s legal rights in a debtor’s property if the creditor’s claim is disallowed. The court stated its belief that the Supreme Court’s decision in Dewsnup v. Timm, 502 U.S. 410 (1992) confirmed its interpretation. In Dewsnup, the debtors argued that the creditor’s claim was not an allowed secured claim because it was undersecured, and therefore they could avoid it under § 506(d). The Supreme Court rejected this argument, holding “§ 506(d) did not void the lien on his property because the creditor’s claim has been fully ‘allowed.’”

HSBC argued that such a conclusion would be inconsistent with decisions from the Eighth,[1] Fourth[2] and Seventh[3] Circuits, all of which held that avoiding liens for claims which were disallowed because they were untimely filed violated the long-standing principle that valid liens pass through bankruptcy unaffected. Viewing these decisions as holding that filing an untimely claim is akin to not filing a claim at all, the court determined the reasoning of these cases to be inapplicable since HSBC’s claim was disallowed on the merits. The court also noted that the Eleventh[4] and Fourth[5] Circuits have held that a chapter 13 debtor who cannot receive a discharge because of § 1328(f) may still void liens under § 506(d).

Finally, the court rejected HSBC’s argument that allowing avoidance of its lien in these circumstances would effectively grant the debtors on a de facto basis, the discharge to which they were not entitled. The court stated this argument ignored the difference between in personam and in rem liability. By enacting § 1328(f), Congress affected only the debtor’s in personam liability: “We take Congress at its word when it said in § 1328(f) that Chapter 20 debtors are ineligible for a discharge, and only a discharge.” The court further noted there is no language in the Bankruptcy Code which prevents Chapter 20 debtors from receiving the other benefits chapter 13 has to offer, and had Congress intended to prevent these debtors from avoiding liens, it would have included specific language when it enacted BAPCPA.

 

[1] In re Shelton, 735 F.3d 747 (8th Cir. 2013)

[2] In re Hamlett, 322 F.3d 342 (4th Cir. 2003)

[3] In re Tarnow, 749 F.2d 464 (7th Cir. 1984)

[4] In re Scantling, 754 F.3d 1323 (11th Cir. 2014)

[5] In re Davis, 716 F.3d 331 (4th Cir. 2013)

January 12, 2016

Ninth Circuit BAP Holds That a Wholly Unsecured Junior Lien, Discharged in Chapter 7, is not Included in Calculating Chapter 13 Eligibility Under Sec. 109(e)

Section 109(e) of the Bankruptcy Code limits eligibility for chapter 13 relief to those individual debtors whose noncontingent, liquidated unsecured debts do not exceed statutory limits. In calculating eligibility to file chapter 13, should a court consider debts which have been discharged in a prior chapter 7 case and which are “out of the money” because, while secured by a trust deed against the debtor’s residence, the value of the debtor’s residence is insufficient to cover the debt relating to the first trust deed? The Ninth Circuit Bankruptcy Appellate Panel answered this question in the negative, holding in Free v. Malaier (In re Free), 2015 WL 9252592 (9th Cir. BAP 2015) that such debts are not to be included in determining eligibility for chapter 13 relief.

In Free the debtors owned a home which they valued in their chapter 7 schedules at $425,000. The home secured three debts totaling over $900,000, with the first lien holder owed more than the value of the home. The debtors received a chapter 7 discharge and shortly thereafter commenced a chapter 13 case in which they sought to strip off the two subordinate liens. The chapter 13 trustee filed a motion to dismiss the case, arguing that these two wholly unsecured subordinate liens should be included in determining eligibility, and doing so rendered the debtors ineligible for chapter 13 relief. While noting that there was no Ninth Circuit controlling case directly on point, the bankruptcy court relied on several opinions in the Ninth Circuit in chapter 12 cases to conclude the subordinate liens should be included in the calculation and finding the debtors were not eligible for chapter 13 relief.

The BAP reversed, concluding that the discharged debts reflected by the wholly unsecured subordinate liens, should not be considered in determining chapter 13 eligibility. The court began its analysis with the definitions of “debt” and “claim” in section 101 of the Code. Because “claim” is defined as a right to payment and “debt” is defined as liability on a claim, the court held “there is no ‘unsecured debt’ unless the creditor has a ‘right to payment’ on an unsecured basis.” The court next concluded that the result of the debtors’ chapter 7 discharge resulted in their having no personal liability to pay the debts relating to the subordinate liens.

Because the bankruptcy court based its ruling in part on the U.S. Supreme Court’s decision in Johnson v. Home State Bank, 501 U.S. 78 (1991), the BAP addressed its perceived distinctions between the facts in Johnson and the facts in the present case.   In Johnson, the debtor obtained a chapter 7 discharge of a judgment in a foreclosure action and then filed a chapter 13 case with the intent to pay the in rem judgment through his chapter 13 plan. In addressing the question of whether an in rem claim for which personal liability has been discharged can properly be included in a chapter 13 plan, the Supreme Court held that such a claim can be treated in a chapter 13 plan because the claim was enforceable against the debtor’s property even though it was not enforceable against the debtor himself.

The BAP also distinguished the decision of the Ninth Circuit in Quintana v. Commissioner, 915 F.2d 513 (9th Cir. 1990) and the Ninth Circuit BAP in Davis v. Bank of America (In re Davis), 2012 WL 3205431 (9th Cir. BAP 2012), both of which involved chapter 12 proceedings. In Quintana, a judgment creditor agreed to waive any deficiency judgment following the sale of the debtor’s real property securing the judgment. Because the real property had not yet been sold, making a determination of the relative amounts of the secured and unsecured debts uncertain, the Ninth Circuit held it appropriate to include the full amount of the judgment debt in determining the debtor’s eligibility for chapter 12 relief. The BAP also noted the differences between § 109(e), which segregates secured and unsecured debts in determining eligibility, and § 101(18), which determines who is a family farmer by looking to the individual’s aggregate debts. The BAP distinguished its prior decision in Davis on similar grounds.

The BAP then distinguished the Ninth Circuit’s decision in Scovis v. Henrichsen (In re Scovis), 249 F.3d 975 (9th Cir. 2001) and the Ninth Circuit BAP’s decision in Smith v. Rojas (In re Smith), 435 B.R. 637 (9th Cir. BAP 2010) both of which held that the unsecured portion of partially secured debts are to be included in determining chapter 13 eligibility on the grounds that both Scovis and Smith dealt with cases where the chapter 13 proceeding was not preceded by a chapter 7 discharge of the debtor’s personal liability on the debt in question.

Finally, the BAP addressed the U.S. Supreme Courts’ decisions in Dewsnup v. Timm, 502 U.S. 410 (1992) and Bank of America v. Caulkett, 135 S. Ct. 1995 (2015) in connection with lien stripping efforts by chapter 13 debtors. The Court in Dewsnup held that a chapter 7 debtor cannot strip down a partially unsecured lien under § 506(d) to the value of the collateral. Subsequently in Caulkett the Court extended its holding in Dewsnup to situations involving wholly unsecured junior liens. The BAP noted that, following Dewsnup and Caulkett, litigants have argued that debtors who first file a chapter 7 case and obtain a personal discharge and then file a chapter 13 case seeking to strip the remaining in rem claim are acting in bad faith. The BAP refused to reach this issue as it had not been brought forward in the appeal but did state that this argument must be raised by filing a motion to dismiss the chapter 13 case as a bad faith filing and not in the context of whether the debtor is eligible under § 109(e) to file a chapter 13 case.

October 20, 2015

Ninth Circuit Holds That Debtor May Recover Attorneys’ Fees Incurred Prosecuting Action for Damages Relating to Violation of Automatic Stay

    The Ninth Circuit has overruled its own relatively recent decision and has held that a debtor who sues for damages to redress a violation of the automatic stay may recover the reasonable fees it incurs prosecuting the action, even after the stay violation is cured.

    The Bankruptcy Code’s automatic stay provision, section 362, includes this fee recovery clause: “[A]n individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys’ fees . . . .”  11 U.S.C. § 362(k).  The Ninth Circuit, in contrast to every other court to consider the issue, held in 2010 that section 362(k) allows a debtor to recover only those fees incurred to end the stay violation itself, not the fees incurred to prosecute an action for damages.  See Sternberg v. Johnston, 595 F.3d 937 (9th Cir. 2010).  In a decision issued last week, the Ninth Circuit overruled its own Sternberg decision and held that a debtor may recover the reasonable fees it incurs prosecuting a damages action relating to a stay violation.  See In re Schwartz-Tallard, Case No. 12-60052 (9th Cir. Oct. 14, 2015).  (See opinion here.)

    In Schwartz-Tallard, a loan servicer foreclosed on the home of a chapter 13 debtor during the debtor’s bankruptcy, while the debtor was making its monthly payments.  The bankruptcy court found that the creditor had violated the automatic stay and ordered the creditor to reconvey the home to the debtor.  The creditor promptly complied.  The debtor also sought a damages award, and prevailed.  The creditor appealed the damages award, and the debtor prevailed on appeal.  The debtor then sought to require creditor to reimburse the attorney fees the debtor incurred defending its damages award on appeal.  The bankruptcy court denied the motion because under Sternberg, debtors could be reimbursed only for the fees they incurred to end the stay violation.  Here, the creditor had remedied the stay violation before the successful appeal, and thus no fees could be awarded in connection with the appeal. 

    The Bankruptcy Appellate Panel reversed on grounds not relevant here and held that the debtor could recover her fees relating to the appeal.  The Ninth Circuit, first as a three-judge panel and then sitting en banc, affirmed the BAP’s decision, but not on the same grounds.  The Ninth Circuit held that Stenberg was decided incorrectly and that the plain text of section 362(k) allows a debtor to collect attorney fees regardless of whether the fees were incurred to remedy the stay violation or to seek damages resulting from a stay violation.  Though it found the text of section 362(k) unambiguous, the Ninth Circuit went on to state that the policies presumably underlying section 362(k) would be advanced only if debtors had adequate “means or financial incentive (or both)” to “vindicate their statutory right to the automatic stay’s protection.”

    The most obvious practical impact of Schwartz-Tallard is identified in the decision itself: debtors who previously lacked the financial incentive to pursue damages for stay violations may now be more willing to bring those actions.  For creditors and their attorneys, Schwartz-Tallard is simply another reminder to scrupulously respect the automatic stay.

October 6, 2015

File a Proof of Claim, Lose Your Lien? Ninth Circuit Holds That Lien Associated With Disallowed Claim is Void

A recent decision by the Ninth Circuit Court of Appeals (found here) changes the strategic calculus for a secured creditor deciding whether to file a proof of claim in a bankruptcy case in the Ninth Circuit.  It has long been true that a secured creditor does not necessarily imperil his lien if he ignores a bankruptcy proceeding and declines to file a claim in connection with his lien.  See U.S. Nat’l Bank in Johnstown v. Chase Nat’l Bank of N.Y.C., 331 U.S. 28, 33 (1947).  But the Ninth Circuit’s decision in In re Blendheim, 2015 WL 5730015 (Oct. 1, 2015) holds that a creditor who actually files a claim, and has that claim disallowed, may have its lien voided under Bankruptcy Code § 506(d).  Thus, filing a proof of claim, at least in a chapter 13 case, may expose a secured creditor to greater risk than simply observing the case from the sidelines.  This contradicts the conventional wisdom that (issues of jurisdiction aside) it is often advisable to file a “protective” proof of claim to preserve your rights.

In re Blendheim was a “chapter 20” case—a chapter 13 case that followed a chapter 7 case by the same debtors.  HSBC Bank (“HSBC”) filed a proof of claim reflecting its first position lien on the Blendheims’ home.  The Blendheims objected to the claim on the basis that HSBC had not produced a copy of the promissory note upon which the claim was based, and that a previously provided promissory note appeared to bear a forged signature.  HSBC never responded to the claim objection and HSBC's claim was disallowed.  In the words of the bankruptcy court, HSBC “slept on its rights.”  Id. at *3.  In a subsequent adversary proceeding, the bankruptcy court held that HSBC’s lien would be void and cancelled “upon Debtors’ completion of a Bankruptcy.”  Id.

The Ninth Circuit, on appeal, was asked to consider whether the bankruptcy court properly voided HSBC’s lien.  The Blendheims argued that, because HSBC’s claim had been disallowed, the lien associated with that claim was void under the plain language of Bankruptcy Code § 506(d).  That section provides:

To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void, unless—

(1) such claim was disallowed only under section 502(b)(5) or 502(e) of this title; or

(2) such claim is not an allowed secured claim due only to the failure of any entity to file a proof of such claim under section 501 of this title.

The Ninth Circuit held that the bankruptcy court properly voided the lien.  Under the plain language of the introductory clause of § 506(d), HSBC’s lien was void because it secured a claim that was disallowed.  Although a creditor may decline to participate in a bankruptcy case, and its lien may ride through the bankruptcy unaffected, “where a claim is timely filed and objected to,” and ultimately disallowed, the lien becomes void.  The Ninth Circuit recognized an exception, reflected in the decisions of other circuits, where a claim is disallowed solely because it was not timely filed.  In that situation, the lien is not void.  But, under the Ninth Circuit’s Blendheim decision, if a secured creditor’s claim is disallowed for any reason other than (1) untimeliness, or (2) the exceptions listed in section 502(d), the lien associated with the disallowed claim is void. 

Conclusion

Secured creditors should consider carefully the advantages and disadvantages of filing a proof of claim in a chapter 13 case.  Depending on the facts of the case, a better strategy may be to play a passive monitoring role and allow liens to ride through the bankruptcy.  If the decision is made to file a claim, secured creditors should be vigilant in defense of their claims.  If the creditor’s claim is disallowed, the creditor will lose its lien, and with it the right to seek foreclosure in the future.

September 29, 2015

Another Marijuana Bankruptcy Case Bites the Dust as the Arizona Bankruptcy Court Dismisses an Involuntary Case Filed Against a Medical Marijuana Dispensary

Following its sister court in Colorado[1] the United States Bankruptcy Court for the District of Arizona recently held that the debtor’s operation of a business that it illegal under federal law mandates dismissal of an involuntary bankruptcy petition filed against the debtor.  In re Medpoint Management, LLC, 528 B.R. 178 (Bankr. D. Az. 2015).  Medpoint Management managed the operations of Arizona Nature’s Wellness (“ANW”), which held an Arizona Department of Health Services-issued Dispensary Certificate allowing it to operate a branded medical marijuana dispensary under the Arizona Medical Marijuana Act.  In its capacity as manager, Medpoint owned ANW’s name and trademark under which ANW sold its marijuana products.  When several of its creditors filed an involuntary bankruptcy petition against it Medpoint filed a motion to dismiss the petition.  In the context of the motion to dismiss, the court analyzed the issue as “whether [the court] can or should enter an involuntary order for relief against Medpoint despite the fact that Medpoint’s current and former business affairs are illegal under applicable federal criminal statutes.”

Medpoint argued that the case should be dismissed because the trustee could not lawfully administer the bankruptcy estate’s marijuana-related assets without violating the Controlled Substance Act, 21 U.S.C. § 801 et seq.  The petitioning creditors argued that an order for relief was not precluded under federal law because their claims against Medpoint were not related to it’s the actual proceeds of its marijuana sales, that Medpoint had received a federal tax identification number and maintained a bank account at an FDIC-insured bank, and that Consolidated and Further Continuing Appropriations Act (“Cromnibus Act”) prohibited the use of appropriated funds to “prevent Arizona from implementing its own law that authorizes the use, distribution, possession or cultivation of medical marijuana.”

The court decided to dismiss the case for cause.  It was persuaded by the opinions from the Colorado bankruptcy court dismisses two marijuana related cases.  The first, In re Arenas, held dismissal proper because the chapter 7 trustee could not take control of or administer the debtor’s assets without violating the Controlled Substance Act.  The court in In re Rent-Rite Super Kegs held that dismissal was proper in a case where the debtor owned real property that was rented to a marijuana entity and that the debtor’s continuing lease with that entity constituted gross mismanagement of the estate.  The Arizona court was persuaded by these decisions.  The court determined that the bankruptcy trustee would be placed in an untenable position, with the debtor’s assets subject to the prospect of possible forfeiture or seizure by the federal government under the Controlled Substance Act.  The fact that the Cromnibus Act prohibited the use of appropriations by the government under it to enforce the Controlled Substance Act did not persuade the court, as it noted the Department of Justice had other sources of funds from which it could prosecute violations of the Controlled Substance Act.  In short, the court held that entering an order for relief would result in the trustee necessarily violating federal law in carrying out his or her duties under the Code.  As a result, the court found cause existed to dismiss the involuntary petition.



[1] In re Arenas, 514 B.R. 887 (Bankr. D. Colo. 2014); In re Rent-Rite Super Kegs W. Ltd., 484 B.R. 799 (Bankr. D. Colo. 2012)

August 4, 2015

In a Case of First Impression at the Circuit Level, Ninth Circuit Holds an Insider Who Waives his Right to Indemnification from the Debtor is not a “Creditor” for Purposes of Preferential Transfers Under Sec. 547 of the Bankruptcy Code

In a case of first impression at the Circuit Level, the Ninth Circuit has held that an insider who waives his right to indemnification from a debtor is not a “creditor” for purposes of preferential transfers under § 547(b)(4). The facts before the court in Alberta Stahl, Chapter 7 Trustee v. Simon (In re Adamson Apparel), 2015 WL 2081575 (9th Cir. 2015) were straightforward.  Arnold Simon was an insider of Adamson Apparel and personally guaranteed its debt to CIT Group.  The guaranty provided that Simon to irrevocably waived his right of indemnification by Adamson Apparel in connection with the loan.  There was no indication that the waiver was a sham.  More than 90 days before Adamson Apparel filed bankruptcy, it paid almost $5,000,000 to CIT in partial satisfaction of its debt.  Following Adamson Apparel’s bankruptcy filing, Simon paid with his personal funds the remaining $3,500,000 owed to CIT by the debtor.  Simon did not file a proof of claim against the bankruptcy estate for the funds he personally paid to CIT on account of his guaranty.  The Trustee filed an adversary proceeding against Simon seeking recovery from him of the $5,000,000 paid by the debtor to CIT as a preference. 

The issue before the court was whether the trustee could recover the debtor’s payment to CIT from Simon as a preference because the payment benefitted him, or whether the trustee’s recovery was precluded by the fact that Simon was not a creditor of the debtor as a result of his waiver of his right of indemnification by the debtor.  In addressing this issue, the Ninth Circuit noted that there was a split among the bankruptcy courts on this issue but no opinions at the district or circuit level answering the question.

The court noted first the plain language of § 547(b)(4), which provides that a preference includes a transfer made between 90 days and one year before the bankruptcy filing if the creditor involved is an insider of the debtor.  There was no dispute that Simon was an insider, and the focus of the court’s analysis was whether he should be considered a creditor despite his waiver of indemnification.  The trustee relied on numerous bankruptcy court decisions which hold that insider waivers of indemnification are invalid because the insider could conceivably purchase the debt rather than just paying under the guaranty.  Bankruptcy courts adopting this line of reasoning do so on the opinion that such waivers are sham provisions unenforceable as a matter of public policy.  Other bankruptcy courts have concluded that such waivers are not ipso facto against public policy and have held that an insider who waives his indemnification right in good faith is not a creditor and, therefore, not subject to preference liability under the plain language of the statute.

The Ninth Circuit agreed with those courts who hold that a good faith waiver of indemnification insulates an insider from preference liability.  The court stated that the potential that a waiver may be a sham does not mean it actually is, rejecting an analysis based on what could happen and holding a court instead should focus on what has happened in the case before it.  In the present case, Simon irrevocably waived his right of indemnification in the guaranty, and nothing in the guaranty or other loan documents gave him a contractual right to purchase the debt from CIT.  As a result, the court concluded that, had Simon approached CIT with a proposal to purchase the debt, there was no certainty that CIT would have agreed to sell it to Simon.  The court considered the absence of this contractual right a key factor, stating that had Simon had a contractual right to purchase the debt but did not do so, the court would be more concerned with the waiver being a sham.  With these facts before it, and the plain language of § 547 requiring the insider to be a creditor, the court concluded that the trustee could not recover the debtor’s payment to CIT from Simon.

July 21, 2015

Ninth Circuit Holds Public Policy Prevents Attorney from Defending Client’s Fraud Claim Under the Unclean Hands Doctrine

Client, with the assistance of its attorney, engages in illegal conduct.  Client places money received from its illegal conduct in the attorney’s trust account.  Attorney absconds with these illegal funds.  When the client brings a non-dischargeability action in the attorney’s bankruptcy case, may the attorney defend the action under the unclean hands doctrine because the funds he stole were gained by the client through its own illegal conduct?  As a matter of public policy, the Ninth Circuit has answered this question in the negative.  In Northbay Wellness Group, Inc. v. Beyries (In re Beyries), 2015 WL 3529634 (9th Cir. 2015), the attorney, Michael Beyries, served on Northbay Welness’ board of directors and acted as its counsel.  Northbay engaged in business in California as a medical marijuana dispensary, a business illegal under federal law.  Northbay deposited $25,000 into Beyries’ trust account to hold for use as a legal defense fund for Northbay and its employees.  Beyries stole the money, resigned from Northbay’s board, and absconded. 

Eventually Beyries filed bankruptcy, and Northbay filed a non-dischargeability action for the theft of its trust funds.  Although it found that such conduct would result in a judgment of non-dischargeability, the bankruptcy court dismissed the adversary proceeding because the funds held by Beyries in trust were the proceeds of Northbay’s own illegal conduct.  The U.S. District Court affirmed the dismissal, but the Ninth Circuit reverse. 

The Ninth Circuit’s opinion was based on public policy grounds.  The court noted that a plaintiff seeking a denial of the discharge of his debt must come to the court “with clean hands,”  and a plaintiff who does not cannot obtain a judgment of non-dischargeability.  However, the court noted that a defendant wrongdoer cannot always “retain the profits of his wrongdoing merely because the plaintiff himself is possibly guilty of transgressing the law.”  In addition, the court held that the unclean hands doctrine should not be strictly enforced when doing so would frustrate an important public policy.  Consequently, courts are required to balance the plaintiff’s wrongdoing against that of the defendant.  In the present case, Beyries was on Northbay’s board of directors and, in the court’s opinion, therefore as guilty of the illegal conduct as was Northbay.  Significantly, Beyries was Northbay’s attorney, owing it a fiduciary duty to maintain the funds placed with him in trust by his client:  “A lawyer’s ‘[m]isappropriation of a client’s prop is a gross violation of general morality likely to undermine public confidence in the legal profession and therefore merits severe punishment.’”  (citing Greenbaum v. State Bar, 544 P.2d 921, 928 (Cal. 1976). 

Weighing the relative wrongdoing, the court determined that the doctrine of unclean hands cannot prevent recovery of funds stolen from a client.  As a result, the Ninth Circuit held the bankruptcy court abused its discretion in dismissing Northbay’s complaint for non-dischargeability.

July 7, 2015

Ninth Circuit BAP Holds that Denial of a Student Loan Debt under Sec. 523(a)(8)(A)(ii) Requires Actual Receipt of Funds by the Debtor

In a case of first impression for the Ninth Circuit BAP, the court held that student loan debts can be denied a discharge under § 523(a)(8)(A)(ii) only if the debtor actually received funds from the plaintiff.  Institute of Imaginal Studies dba Meridian University v. Tarra Nichole Christoff (In re Christoff), 2015 WL 1396630.  The court reached its conclusion based on the plain language of the statute.

In Christoff, the debtor enrolled in Meridian University and received in her first year a financial aid package which provided her with a tuition credit but under which she did not receive any actual funds.  The debtor signed a promissory note to repay the tuition credit in monthly installments after she completed her coursework or withdrew from the institution.  She received a similar financial aid package for her second of study.  The debtor failed to make all payments required under her promissory notes and eventually filed a chapter 7 bankruptcy petition.  Meridian filed an adversary proceeding seeking denial of the discharge of its debt under 11 U.S.C. § 523(a)(8)(A)(ii). 

Sec. 523(a)(8)(A)(ii) provides that, unless for hardship, a debt is not dischargeable if it constitutes “an obligation to repay funds received as an educational benefit, scholarship, or stipend.”  The dispute in Christoff centered on the “funds received” language of the statute.  Without question, the debtor received no funds from Meridian.  The transaction involved the granting of a tuition credit in the debtor’s two years of study with the debtor signing promissory notes to repay the amount of those credits after she completed her coursework or withdrew from the university. The bankruptcy court held the debt was dischargeable because the plain language of the statute required the debtor to receive funds, and the debtor had not received any funds from Meridian.  The BAP affirmed.

Meridian argued that the phrase “funds received” should be construed as the equivalent of the word “loan” as described in the other two subsections of 523(a)(8).  The debtor argued that, by using the phrase “funds received” in § 523(a)(8)(A)(ii), Congress intended to restrict the denial of a discharge for student debts to for-profit universities to those instances where the debtor receives actual funds.  The BAP agreed.  The court began its analysis by noting that any construction begins with the language of the statute, stating that the words of the Bankruptcy Code “must be read in their context and with a view to their place in the overall statutory scheme.”   Further, the provisions of § 523 are to be strictly construed in favor of debtors.  The BAP relied heavily on the Ninth Circuit’s decision in Hawkins v. Franchise Tax Bd. Of Cal., 769 F.3d 622 (9th Cir. 2014) and its interpretation of the pre-BAPCPA provisions on student loan debt.  In Hawkins, the debtor entered into an agreement with Ohio University agreeing to practice medicine for five years after licensure in exchange for admittance to the university’s medical school.  The agreement contained a liquidated damages provision in the event she breached the requirement that she practice medicine in Ohio for five years.  The debtor promptly moved to California following her graduation. After the university sued her to obtain a judgment on the liquidated damages provision, the debtor filed a chapter 7 petition.  The Ninth Circuit concluded the liquidated damages was not an educational loan stating “while an educational loan need not include an actual transfer of money . . . to [the] debtor, in order for it to fall within the definition of . . . § 523(a)(8), the loan instrument must sufficiently articulate definite repayment terms and the repayment obligation must reflect the value of the benefit actually received [by the debtor] rather than some other ill-defined measure of damages or penalty.”  More importantly, the BAP relied on the Ninth Circuit’s language in Hawkins that the liquidated damages were dischargeable “because the plain language of this prong of the statute requires that a debtor receive actual funds in order to obtain a nondischargeable educational benefit.” 

As a result, since the provisions of the statute are to be construed narrowly, and because the plain language of the statute refers to “funds received” by the debtor, the BAP affirmed the ruling of the lower court that the debtor was dischargeable because the tuition credits were not “funds received” by the debtor.