Summer 2015 • Issue 55, page 1

Fending Off Bankruptcy Bullies: A New Strategy for Receivers

By Alsbrook, Blake*

About six months ago, I was sitting in the audience of a California Receivers Forum event regarding the crossover between bankruptcy and receiverships. United States Bankruptcy Judge Barry Russell was kindly providing insight about receivers' turnover duties to debtors in possession, among other things. As I listened to Judge Russell and the other panelists, however, I couldn't help but think that there had to be a better way. All too often, the former directors, officers, or partners of business entities inappropriately utilize bankruptcy petitions to wrest control of those entities away from state court receivers. And my experience has shown that it is often the same bad actors whose wrongdoing led to the receiver's appointment who become the debtors in possession. It is a hard pill to swallow when a receiver is forced to turn over company assets and control to a ne'er-do-well no one can trust. Sure, the receiver can wait for the party who sought his appointment to file an emergency motion for relief from turnover, but why is the receiver left to rely on other actors when he or she has clear duties outlined in the receivership order?

Fast forward to May of this year, and I was considering options under similar circumstances, where the general partner – the bad guy – of a limited partnership had filed a Chapter 11 petition, and it was plain to see (to me at least) that the petition was filed in bad faith for an attempted end-run around the California court's authority. Happily, I discovered an unpublished Central District case entitled In re Licores, 2013 WL 6834609 (C.D. Cal. Dec. 20, 2013). Interestingly, the majority of federal District Court decisions are likewise unpublished because publication of those cases only occurs when they are submitted to West, publisher of the Federal Supplement, by the deciding judge. Unlike unpublished California cases, however, unpublished federal District Court opinions are undoubtedly citable, and are considered persuasive authority at a minimum. See Sorrels v. McKee, 290 F.3d 965, 971 (9th Cir. 2002); Renick v. Dun & Bradstreet Receivable Mgmt. Servs., 290 F.3d 1055, 1058 (9th Cir. 2002); State Compensation Ins. Fund v. Zamora (In re Silverman), 616 F.3d 1001, 1005 (9th Cir. 2010) (question whether an Article III District Court opinion is binding on Bankruptcy Courts has not been addressed by the Ninth Circuit).

Licores concerned a partnership dispute between siblings that began in the Orange County Superior Court, where a receiver was appointed over the partnership in question. After the receiver's appointment, a number of the siblings attempted to improperly file a Chapter 11 bankruptcy petition to oust the receiver. The attempt by the siblings was fairly transparent. The receiver was excused from turnover and the petition eventually dismissed, after which the state receivership court issued an order barring the siblings from filing any petitions for bankruptcy relief on behalf of the partnership and placing sole authority to do so in the hands of the receiver. Licores, 2013 WL 6834609, at *1. Not surprisingly, the bad actor siblings simply ignored the Orange County Superior Court and filed for Chapter 11 relief on behalf of the partnership again. Thereafter, the receiver filed a motion to dismiss the case.

After hearing argument, United States Bankruptcy Judge Mark S. Wallace dismissed the case, finding, among other things, that “[i]f state law governs who may act on behalf of a corporate entity outside of bankruptcy, it follows that state law governs who may bring a corporate entity into bankruptcy.” Id. at *5. Because the state receivership court ordered that the receiver alone had the power to file for bankruptcy relief, Judge Wallace determined that the siblings' filing was improper.

The siblings appealed and, sitting in review, District Judge Virginia Phillips affirmed Judge Wallace's dismissal. First, the court engaged in a detailed standing analysis, which addressed the question whether the receiver had the right to bring a motion to dismiss before the Bankruptcy Court in the first place. Judge Phillips found that the state court receiver had statutory standing under 11 U.S.C.S. §1109(b), Article III standing, and prudential standing to bring her motion to dismiss. Id. at *2-4. Put simply, the District Court found that the state court had conferred a legally protected interest on the receiver vis-à-vis the order vesting sole authority to file a bankruptcy petition, and that the legal right had been damaged by the siblings' unilateral Chapter 11 filing in violation of that order. Id.; see also In re Ofty Corp., 44 B.R. 479 (Bankr. D. Del. 1984) (receiver has standing to bring motion to dismiss where petition filed to end-run liquidation order).

Reviewing the reasoning underlying Judge Wallace's dismissal, the District Court agreed, first noting that state law determines who may file a bankruptcy petition on behalf of a partnership and that, if "those who purport to act on behalf of the [entity] have not been granted authority by local law to institute the proceedings, [the Bankruptcy Court] has no alternative but to dismiss the petition." Id. at *5, quoting Price v. Gurney, 324 U.S. 100, 106–107 (1945) (citing In re Monterey Equities–Hillside, 73 B.R. 749, 752 (Bankr. N.D. Cal. 1987)). Judge Phillips then explained that "[s]tate law includes the decisions of state courts." 2013 WL 6834609 at p. 5, citing Tenneco West, Inc. v. Marathon Oil Co., 756 F.2d 769, 771 (9th Cir. 1985). Because the state receivership court had issued an order vesting the receiver with the sole authority to file a bankruptcy petition, the District Court found that the siblings' petition was improperly filed and that the Bankruptcy Court had correctly dismissed the case. Licores, 2013 WL 6834609, at *6.

Judge Phillips' decision is particularly important because she addressed and rejected the contrary reasoning set forth in In re Orchards Village Investments, LLC, 405 B.R. 341, 349 (Bankr. D. Or. 2009), where a Bankruptcy Court in Oregon stated that "a state court receivership proceeding cannot be used to preclude a debtor from seeking federal bankruptcy protection . . . ." Judge Phillips firmly rejected that argument, sagely noting that an order authorizing the receiver to file a bankruptcy petition on behalf of an entity "does not divest Debtor from the its power to seek bankruptcy protection; rather, the order identifies who has the power to file the bankruptcy petition on behalf of Debtor." Licores, 2013 WL 6834609, at *6.

So what does this mean on a practical level for receivers and their counsel? The Licores opinion instructs us that, if the circumstances are appropriate and a receiver is concerned about an inappropriate bankruptcy filing, it would be wise to have the appointment order include language such as "Defendants are divested of any and all authority to declare bankruptcy on behalf of [entity], and the Receiver shall hereafter be the only individual with the authority to file a bankruptcy petition on behalf of [entity]," or something similar. If, as they often do, the bankruptcy bullies ignore the appointment order and file a Chapter 11 petition, a receiver can now be confident filing an emergency motion for relief from turnover, accompanied by a motion to dismiss.

Finally, it is important to remember that Licores is likely only persuasive authority. With that said, Judges Wallace and Phillips are both well-respected jurists, and this decision should hold considerable weight in California, and particularly in the Southland. Hopefully, we will see a future opinion confirming the rationale set forth in Licores from the Bankruptcy Appellate Panel or, better yet, the Ninth Circuit Court of Appeal.

* Blake C. Alsbrook, Esq. is an associate at Pasternak & Pasternak, ALC, a Century City firm specializing in the practice of receivership law.