In a recent unpublished bankruptcy appellate panel
decision (In Re Domum Locis, LLC, 2015 WL 4697747 (9th Cir. BAP
2015)), the BAP reversed the bankruptcy court’s published decision in
which the bankruptcy court held that a transfer of property in
receivership by the defendant without permission of the receivership
court, was void. In Re Domum Locis, LLC, 521 B.R. 661 (Bankr. C.D.
Cal. 2014). The bankruptcy court’s decision was discussed in the
Winter/Spring 2015 issue of Receivership News. To refresh the
reader’s recollection, an individual had borrowed $9,000,000 and secured
the loan with a deeds of trust on three income producing properties. The
borrower defaulted and the bank had a receiver appointed over the
properties. The individual then formed an LLC (in which he was the 100%
owner), conveyed the properties to the LLC, and then filed a chapter 11
bankruptcy. The debtor LLC then filed a motion to use “cash collateral”
(the rents). The bank opposed the motion and filed a motion for relief
from the automatic stay and to excuse the receiver from having to turn
over the properties to the new debtor. 11 U.S.C. §543(b). The case turned
on the legal issue of whether the transfer of the properties to the LLC
was void or voidable. If void, the new debtor had no assets because the
properties remained in the individual’s name and in the receivership. If
voidable, the properties would be property of the LLC’s bankruptcy estate,
subject to the bank or receiver suing to set aside the transfers, if
possible, or bringing a contempt motion against the individual, in state
court, for violating the receivership court’s order.
The bankruptcy court pointed out that, although the
question of whether property claimed by the debtor is “property of the
estate” is a federal question to be decided under federal law, bankruptcy
courts must look to state law to determine whether and to what extent the
debtor has any legal or equitable interest in the property as of the
commencement of the case. The court, therefore, was required to look to
California law to see whether the debtor had any interest in the
properties when the case commenced. The bankruptcy court cited a number of
California cases, including two California Supreme Court cases, that state
property subject to a receivership is held in custodia legis (in the
custody of the court). Based on this concept, the bankruptcy court held
only the receivership court could authorize a transfer or encumbrance of
such property, and any attempt to transfer an interest in property that is
held in custodia legis is void. As a result, the bankruptcy court held
that the properties were not assets of the LLC’s bankruptcy estate, that
they remained in the receivership estate subject to the receiver’s
control, and, therefore, that the debtor had no assets.
The BAP reversed for a number of reasons. First,
citing the California Supreme Court in North v. Cecil B. DeMille
Prods., Inc., 2 Cal 2d 55, 57-58 (1934), the BAP pointed out that a
receiver pendente lite is appointed to take possession of property pending
final judgment in a case and only obtains possession of
the property by order of the court. “The title to the property is not
changed by the receiver’s appointment. The receiver acquires no title, but
only the right of possession as an officer of the court. The title remains
in those in whom it was vested when the appointment was made.” The
receiver and the receivership court obtain equitable title to the
property, because the property is held in equitable trust for those whom
the court ultimately decides are entitled. The BAP held that the fact that
the property is in custodia legis does not change this analysis,
and it specifically found that the bankruptcy court’s interpretation of
application of the in custodia legis doctrine was “overly broad in
the context of the receivership proceedings over the properties.”
The BAP also pointed out that the bankruptcy court’s
decision that the transfer was void is inconsistent with California law as
explained in Mercantile Trust Code of San Francisco v. Sunset Road Oil
Co., 50 Cal. App. 45, 498-499 (1920) . In that case, the court
distinguished between receiverships that were for the benefit of one
creditor (such as a foreclosing bank) and receiverships that were for the
benefit of all creditors. It held that transfers without leave of court
would only be void if the receivership was for the benefit of all
creditors. The bankruptcy court had characterized the reasoning in
Mercantile Trust as “unsound” and rejected it, in part, because the case
had not been cited by any other California court and because the court did
not believe the reasoning was persuasive in drawing a distinction between
receiverships for the benefit of one creditor and all creditors. The BAP
disagreed.
The BAP stated, citing Cal. Probate Code §10260, that
California had enacted certain legislation that provides that a sale is
not sufficient to transfer title, in certain situations, without a court
order confirming the sale and that there are no such statutory
restrictions on property in receivership. But this analogy is flawed. Cal.
Code of Civ. Proc. §568.5 provides: “A receiver may, pursuant to an order
of the court, sell real or personal property in the receiver’s
possession…[but that] The sale is not final until confirmed by the court.”
That is really no different from the Probate Code section the BAP cites.
Further, both Civ. Proc. §568.5 and Probate Code §10260 are really
irrelevant to the analysis because one deals with sales by a receiver, the
other by an executor or personal representative, not transfers by another
person having an interest in the property.
Based on these distinctions, the BAP held that the
mere existence of the receivership did not make the transfer void as a
matter of law. The BAP acknowledged that the receivership court could
vacate the sale because the sale was made in violation of the receivership
court’s order but, because the
debtor held a legal title to the property, the property constituted
property of the bankruptcy estate irrespective of the property being in
receivership. Property of the estate is defined very broadly under the
Bankruptcy Code and includes “all legal or equitable interests of the
debtor in property as of the
commencement of the case.” 11 U.S.C. §541(a)(1). The BAP did, however,
affirm the bankrupt court’s granting of relief from the automatic stay to
allow the bank’s return to the receivership court to have the receivership
court determine whether the transfer of the properties should be voided;
which the BAP felt would give the state court the opportunity “to resolve
completely difficult and unsettled issues of California state law.”
In its decision, the BAP downplays the bankruptcy
court’s citation to a number of California authorities, and federal
authorities, which the bankruptcy court asserted hold that attempts to
sell or transfer property held in custodial legis are ineffective,
including Pacific Railway Co. v. Wade, 91 Cal. 449 (1891);
Tapscott v. Lyon, 103 Cal. 297 (1894); Withington v. Shay, 47
Cal. App. 2d 69 (1941) and North v. Evans, 1 Cal. App. 2d 64
(1934). The BAP only addressed the language in Pacific Railway Co. v. Wade
which states: “No sale can take place, no debt can be paid, no contract
can be made, which does not receive the sanction of the court,” stating
that language only means the receiver cannot take such action without
court approval.
So, should the superior court find the transfer of
the properties void, voidable, or ok? The BAP is correct in stating that
the appointment of a receiver does not change legal title to property
placed in receivership and that all the receiver gets is equitable title.
That does not mean, however, that a defendant in a receivership case can
transfer property in the court’s custody. By having possession and
equitable title to the property, the court can, for example, sell the
property, through its receiver, to a third party even though the court
does not have a legal title. It can authorize the transfer of the property
by transferring equitable title and by issuing, in effect, an injunction
preventing interference with the new buyer’s ownership.1
This happens all the time. Whether the defendant retains legal title,
therefore, does not answer the question of whether the transfer of
property in custodia legis is void or voidable.
Two analogous situations highlight the problem with
California law in this area. For example, if the bank asserted that the
transfer of the property to the LLC was a violation of an injunction
issued by the receivership court (because the appointing order also
enjoins interference with the receiver’s injunction be void or voidable? A
long line of California cases hold that a sale of real property in
violation of an injunction is voidable, but not void. Bagley v. Ward,
37 Cal. 121 (1869); American Trust Co. v. de Albergaria, 123 Cal.
App. 76 (1932); Warburton v. Kieferle, 135 Cal. App. 2d 278 (1955).
Whereas, on the other hand, if the bank asserted that the defendant
transferred title to the property with the “actual intent to hinder delay
or defraud” the bank and hence, the transfer was a voidable transfer under
California law,2 California law is
clear that the transfer would be void, not merely voidable. In Re Cass,
476 B.R. 602, 614 (Bankr. S.D. Cal. 2012), aff’d 606 Fed. Appx. 318
(9th Cir. 2015), citing Swinford v. Rodgers, 23 Cal. 233, 235-236
(1893) (“[T]he law is well settled, that a conveyance made with intent to
defraud creditors is void…”). As can be seen, therefore, whether the
transfer is void or merely voidable appears to depend on legal theory
advanced to deal with the unauthorized transfer. Not a satisfying
situation.
The bankruptcy court's decision that any transfer of
receivership property without permission of the receivership court is void
is much cleaner and, of course, much preferred by receivers. However, the
BAP’s opinion that the transfer is only voidable makes sense, given that
the receiver and the receivership court do not obtain legal title simply
by placing the property in receivership and the law that transfers in
violation of injunctions also are only voidable, not void. Whether this
ultimately turns out to be the law in California will depend on what
happens in the superior court and any appellate decision or in the 9th
Circuit where the appeal of the BAP decision is currently pending.
1 SEC v. American
Capital Investments, Inc., 98 F. 3d 1133, 1144 (9th Cir. 1996),
abrogated on other grounds, 523 U.S. 83, 93-94 (1998) (“Clark also teaches
that a receiver’s sales do not even purport to convey ‘legal’ title, but
rather ‘good,’ equitable title enforced by an injunction against suit. See
2 Clark on Receivers §§ 342, 344, 482(a), 487, 489, 491.
When a court of equity orders property in its
custody to be sold, the court itself as vendor confirms the title in the
purchaser. Neither the court nor [the receiver] gives a legal title to the
purchaser because neither the court nor its officer has legal title to
give.... A court of equity acts by a process of injunction against the
owner and against the parties to the suit and protects the purchaser
against interference and assures him a quiet title and quiet enjoyment.”).
2 Effective January 1, 2016
California’s Uniform Fraudulent Transfer Act was amended and became the
Uniform Voidable Transactions Act. Among other things, the word
“fraudulent” was excised from the statute and replaced with the word “voidable”.
*Peter A. Davidson is a Partner of Ervin
Cohen & Jessup LLP a Beverly Hills Law Firm. His practice includes
representing Receivers and acting as a Receiver in State and Federal
Court.
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