Winter/Spring 2019 • Issue 65, page 1

Recent Developments in Business Bankruptcy 2018 (Part 1)

By Johnson, Honorable Stephen & Hayes, Jennifer & Katz, Ori*

The authors gratefully acknowledge the assistance of Stephen Finestone and Ryan Witthans of Finestone Hayes LLP, the summer associates, and clerks of Sheppard Mullin Richter & Hampton LLP, and Laurent Chen and Ken Conlan, Law Clerks to the Honorable Stephen Johnson.

This article is a reprint of a portion of the Recent Developments in Business Bankruptcy 2018 originally prepared for the Bay Area Bankruptcy Forum and the San Francisco Bar Association.


Because the Ninth Circuit’s mixed question of fact and law for the non-statutory insider test is more factual than legal, an appellate court should review this aspect of a non-statutory insider determination under a clear-error standard.

U.S. Bank Nat. Ass’n ex rel. CWCapital Asset Management LLC v. Village at Lakeridge, LLC, 138 S. Ct. 960 (2018).

The case arises out of a debtor’s efforts to cramdown its chapter 11 plan of reorganization. Debtor’s primary debts were $10 million on a bank loan and $2.76 million owed to its parent company, MBP. Debtor could separately classify the bank and MBP but, as an insider, MBP’s vote could not be the basis for a cramdown plan. A member of MBP’s board and one of debtor’s officers, Bartlett, approached a third party, Rabkin, and sold him MBP’s claim for $5,000. Rabkin voted in favor of Debtor’s plan. The bank argued that Rabkin was a non-statutory insider, based upon his romantic relationship with Barlett and the fact that the purchase of MBP’s claim was not an arm’s length transaction. The Bankruptcy Court rejected the bank’s argument, noting that the investment was a speculative one for which Rabkin conducted adequate due diligence and, even though there was a romantic relationship, Rabkin and Bartlett lived in separate homes and had independent finances. The Ninth Circuit affirmed, holding (in a split decision) that the determination of non-insider status was entitled to clear-error review.

The Supreme Court noted that analysis of the non-statutory insider issue involved three issues: one purely legal, the second purely factual, and the third a combination of the two. The legal issue was the appropriate test to decide if someone is a non-statutory insider. A court’s determination as to this issue is reviewed without deference. The second issue – the factual findings regarding Bartlett’s and Rabkin’s romantic relationship and Rabkin’s motivation for purchasing the claim, are reviewed for clear error. What remains is a mixed question of law and fact: “Given all the basic facts found, was Rabkin’s purchase of MBP’s claim conducted as if the two were strangers to each other?” The Court explained the considerations that go into different standards of review and concluded that the Ninth Circuit properly applied the clear-error standard to the lower court’s determination on the mixed question of law and fact.

Both concurring opinions note that the decision should not be interpreted as an approval of the Ninth Circuit’s non-statutory insider test. These opinions mention that, because the two prongs of the Ninth Circuit’s test are conjunctive, a finding that the transaction was arm’s length will inoculate a transaction regardless of the closeness of the relationship with debtor as long as the relationship is not specifically defined by the Code. This critique suggests the Supreme Court may consider the issue in a later case and might cause the Ninth Circuit to reconsider its conclusions in an appropriate case.

The 14-day appeal period in Bankruptcy Rule 8004 is jurisdictional so appeals that are filed late can be dismissed.

In re Wilkins, 587 B.R. 97 (B.A.P. 9th Cir. 2018).

By a single notice of appeal, Debtor appealed separate orders of the Bankruptcy Court converting her case to Chapter 7, granting the trustee’s motion to sell her real property, and granting a turnover order. The notice of appeal Debtor filed was not timely. The BAP issued a “notice of deficiency” requesting the parties “explain why these appeals should not be dismissed.” After reviewing the parties’ submission, the BAP in fact dismissed the appeal for lack of jurisdiction because it found the appeal untimely.

Soon after that, the Supreme Court issued a decision in Hamer v. Neighborhood Housing Servs. of Chicago, ___ U.S. ___, 138 S. Ct. 13 (2017), holding that Federal Rule of Appellate Procedure 4(a)(5)(C), limiting the length of extensions to file appeals, was not a jurisdictional rule but a “claims processing rule” that was subject to waiver or forfeiture. Thus, violation of the rule did not mandate dismissal of an appeal. The BAP issued an order for briefing on whether its dismissal of the appeal filed by Debtor was inappropriate.

The BAP held the 14-day deadline for filing a notice of appeal in Rule 8002(a) is jurisdictional and not a “claims processing rule”. First, the BAP determined there is a statutory basis for applying the 14-day time limit in that 28 U.S.C. § 158(c)(2) expressly refers to Rule 8002(a) as providing the time for appeal. Second, appeals to the BAP and District Court are to be taken, under § 158(c)(2), “in the same manner as appeals in civil proceedings are taken to the courts of appeal from the district courts.” The process of appealing in a civil case to the court of appeal has long been considered jurisdictional. Finally, it found public policy reasons to justify the decision, including the frequent time limits in bankruptcy cases which serve to expedite the administration of estates.

When a case is remanded to a trial court after appeal, the Rule of Mandate constrains the trial court from altering decisions that were appealed and decided. Matters not decided by the appellate court on appeal can be modified by the trial court on remand.

In re de Jong, 588 B.R. 879 (B.A.P. 9th Cir. 2018).

This case addresses the standards that apply when Bankruptcy Court decisions are reversed and remanded on appeal, and then appealed again. The Debtors operated a dairy in Arizona on leased land. The lease was terminated and the land was sold at auction in 2013 but Debtors refused to leave, later filing their own bankruptcy case. They finally vacated the property in 2014. The new landowner filed a claim for pre- and post-petition damages associated with Debtors’ willful failure to vacate, e.g., trespass. The decision involved the calculation of damages associated with silage, or food, that the dairy cows ate during the holdover tenancy. The Bankruptcy Court held a trial and entered a decision awarding pre- and post-petition damages, which Debtors appealed. The decision was reversed and remanded for recalculation of damages associated post-petition silage. In its remand, the BAP made no mention of recalculating the silage charges for the pre-petition period even though those charges suffered the same flaw in calculation as the post-petition charges that were remanded. On remand, the Bankruptcy Court modified the damage award for the post-petition silage but it refused to change the (obviously wrong) award to correct the pre-petition silage damage claim. It held the BAP’s remand did not include the pre-petition silage charges. So Debtors appealed again. In this second appeal, the BAP stated that the Rule of Mandate means that a lower court commits jurisdictional error if it contradicts the mandate. However, the Rule of Mandate does not prohibit a trial court from reexamining issues that were not decided on appeal and made part of the mandate. Because the mandate was silent on the issue of pre-petition damages, the Bankruptcy Court had the power to change its mind on the question of the damage award related to those charges. This decision has been appealed to the Ninth Circuit.

Parties are not necessarily barred from appealing a decision just because they did not object to the relief at the Bankruptcy Court.

Matter of Point Center Financial, Inc., 890 F.3d 1188 (9th Cir. 2018)

Debtor filed a chapter 11 which later converted to chapter 7. In January 2014, the Bankruptcy Court imposed a deadline to assume all executory contracts by February 2014. Long after that deadline passed, the chapter 7 trustee moved to assume an operating agreement for an LLC. No one objected and the court granted the motion. Prior to entry of order, however, certain parties filed an emergency motion for reconsideration and sought an order vacating the prior order approving assumption. The Bankruptcy Court denied the motions, concluding, among other things, that the appellant was not likely to prevail on appeal. The District Court dismissed an appeal finding the appellant had no standing because it had not objected to the original motion despite having notice. The Ninth Circuit reversed. It held that standing is a prudential concern and is satisfied if appellant is a “person aggrieved.” A person is aggrieved if they are “directly and adversely affected pecuniarily” by a Bankruptcy Court order. An order that diminishes one’s property, increases one’s burdens, or detrimentally affects one’s rights affects a pecuniary interest. The appellants could make such claims and therefore had standing as persons aggrieved. A party can waive that right or forfeit it, however. The Ninth Circuit held there was no waiver here because the parties objected to the entry of the order and the Bankruptcy Court considered their arguments on reconsideration. It could not make a finding on whether he parties had forfeited their rights, however, and remanded on that basis solely.

Automatic Stay / Jurisdiction, Standing, or Process

Ship owner’s bankruptcy filing did not divest the District Court of in rem jurisdiction over ship. The automatic stay does not apply to maritime liens. The Bankruptcy Court had no authority to sell the ship free and clear of a maritime lien.

Barnes v. Sea Hawaii Rafting, LLC, 886 F.3d 758 (9th Cir. 2018).

Barnes, a seaman, was severely injured at the outset of a night snorkeling trip in Kona. The ship (the Tehani) exploded, and the hatch struck Barnes on his back and head, making him no longer able to work or drive a car. SHR, the company that owned the Tehani, lacked insurance to cover Barnes’ medical expenses. Barnes sued SHR and the Tehani in District Court seeking “maintenance and cure.” Shortly before trial, SHR filed a Chapter 7 petition. The Bankruptcy Court partially lifted the stay to permit the District Court to adjudicate Barnes’ maritime lien against the Tehani. The Bankruptcy Court then approved the Trustee’s sale of the Tehani free and clear of Barnes’ lien under 363(f)(4). Barnes appealed the District Court’s orders regarding in rem jurisdiction over the Tehani. The Trustee argued that, even if the District Court erred, Barnes’ claims were moot, because the Bankruptcy Court authorized the sale of the Tehani free and clear of liens. The Ninth Circuit rejected this argument, holding that the Bankruptcy Court lacked jurisdiction to dispose of Barnes’ maritime lien. First, the automatic stay did not apply to Barnes’ claims to enforce his maritime lien, because § 362(a)(4) is limited to land-based transactions where: (1) a recording of a lien interest is required; and (2) the creditor first-in-time is entitled to priority. Unlike these liens a maritime lien is a “sacred lien” entitled to protection “as long as a plank of the ship remains.” Second, the Bankruptcy Court lacked jurisdiction to adjudicate Barnes’ maritime lien because the admiralty court had already obtained jurisdiction over the Tehani. When there are two courts with jurisdiction over the subject matter, the court that first obtains jurisdiction retains it without interference from the second court. Third, even if the Bankruptcy Court had in rem jurisdiction over the Tehani, the Bankruptcy Court lacked the ability to sell the Tehani free and clear of Barnes’ maritime lien, which would have required application of maritime law (and not 363(f)) and Barnes’ voluntary submission to the Bankruptcy Court’s jurisdiction for this purpose.

When property has been pawned before a bankruptcy case is filed, the pawnbroker must obtain relief from stay to give the notice of redemption required by California law.

In re Sorensen, 586 B.R. 327 (B.A.P. 9th Cir. 2018).

In a case of first impression, the BAP determined that the right to redeem pawned property is part of the bankruptcy estate and that a pawnbroker must obtain relief from stay to give the statutory ten-day notice to the debtor of the termination of her loan and the right to redeem her property. Failure to obtain relief from stay renders the pawnbroker’s notice void. Debtor pawned five pieces of jewelry. Under California law, she had four months to pay back the loan. If the borrower does not pay back the loan within the four months, the pawnbroker issues a loan termination notice, which triggers a ten-day period to redeem the jewelry. If the jewelry is not redeemed within the ten days, it becomes the pawnbroker’s. Here, debtor filed a Chapter 13 prior to the four-month expiration date. The pawnbroker provided notice of the loan termination post-petition. Litigation ensued over the pawnbroker’s right to serve the notice without first obtaining relief from stay. The pawnbroker relied on Bankruptcy Code § 541(a)(8), which excludes certain property from the estate. The BAP ruled that the termination notice, triggering the ten-day redemption period, is an act to exercise control over property, or to enforce a lien, or to collect a debt. The termination was therefore void and Debtor could seek to redeem her property.

Debtor whose real property was affected by in rem order for relief from stay under 11 U.S.C. § 362(d)(4) cannot maintain action alleging that order, entered in the bankruptcy case of a third party, was improper on due process grounds.

In re Greenstein, 576 B.R. 139 (Bankr. C.D. Cal. 2017).

When repeated bankruptcy cases are filed to stall foreclosure of real property, § 362(d)(4) authorizes the Bankruptcy Court to enter an “in rem” order that is effective to terminate the stay in a later filed case relating to the same real property. Those orders can be recorded. In a prior bankruptcy case not involving the debtor, the Bankruptcy Court entered an in rem order. Debtor in the new case was not party to that proceeding and received no notice of the in rem application or order. Debtor filed a bankruptcy case seeking to stop a foreclosure but the lender, relying on the in rem order, foreclosed on debtor’s property. Judge Barash of the Central District wrote a lengthy opinion holding that the in rem order was effective in the later filed case. Acknowledging that the Bankruptcy Code does not require notice be given to non-debtor parties, and disagreeing with the BAP, he held that a non-debtor whose property may be the subject of an in rem order should be given notice of that possibility. However, failing to give such notice does not mean there is a failure of due process: § 362(d)(4) permits a debtor in a later case to move to vacate such an order. So long as the debtor in the new case has notice of her right to vacate the order, there is no due process violation.

Chapter 11

A plan can eliminate a “due-on-sale” clause in its treatment without violating § 1111(b). The need for an impaired, assenting class in a cramdown plan applies on a per-plan basis (not a per-debtor basis).

In re Transwest Resort Properties, Inc., 881 F.3d 724 (9th Cir. 2018).

A group of related debtors holding real estate assets filed five Chapter 11 cases, which were jointly administered. The Debtors filed a joint plan of reorganization. The primary lender, whose claim was undersecured, made a § 1111(b) election. The plan provided for payment of the entire secured claim over twenty-one years, with a large balloon payment at the end. The plan included a due-on-sale clause, but provided that the clause did not apply if the property was sold between years five to fifteen. Lender rejected the plan, but several classes accepted it. Lender opposed confirmation on the basis that temporary elimination of the due-on-sale clause was not fair and equitable and violated its § 1111(b) election rights. Lender also opposed the plan because, as to one of the debtors, it was the only class voting on the plan. Thus, there was no class accepting the plan as to that debtor. The Bankruptcy Court approved the plan. Lender appealed, and the District Court affirmed. On appeal to the Ninth Circuit, the Circuit affirmed, holding that nothing in the code requires an inclusion of a due-on-sale clause (see, e.g., § 1129(b)(2)(A)(i)(I)). With respect to the “per plan” - “per debtor” dispute, the Court held that § 1129(a)(10) supported a “per plan” approach. (disagreeing with a Bankruptcy Court in Delaware – In re Tribune, 464 B.R. 126 (Bankr. D. Del. 2011)).

Plan votes could not be designated for bad faith based on partial purchase offer made to protect another, secured claim.

In re Fagerdala USA - Lompoc, Inc., 891 F.3d 848 (9th Cir. 2018).

To designate a creditor’s vote under 11 U.S.C. § 1126 rejecting a Chapter 11 plan for bad faith a court must consider the creditor’s motivation, and not the effect of the creditor’s actions. Offering to purchase only some of the unsecured claims, even if done solely to block the plan, is not enough by itself to establish bad faith.

Chapter 11 debtor moved to designate secured creditor’s vote against the plan, claiming secured creditor had attempted to block the plan in bad faith. Secured creditor had purchased a numerical majority of the unsecured claims in an explicit effort to block the plan. Secured creditor did not offer to purchase every unsecured claim, and the ones it did purchase did not equal a majority in terms of value. The Bankruptcy Court granted debtor’s motion, finding secured creditor’s move ensured an unfair advantage because of the value discrepancy and the fact that secured creditor did not offer to purchase all of the unsecured claims. The Ninth Circuit reversed.

To designate a vote for bad faith under § 1126, a court must find a creditor is seeking to secure an untoward advantage over other creditors for some ulterior motive. Creditors are not required to act in the best interest of other creditors or the debtor. A creditor is not acting in bad faith when it is simply looking out for its own best interests. Blocking a plan is not necessarily in bad faith. Likewise, a creditor who does not offer to buy every unsecured claim is not necessarily acting in bad faith (though proof of such an offer would be evidence of good faith). The lower court’s refusal to look at secured creditor’s motivation, and instead to look at the effect of secured creditor’s actions, was reversible error.

Appealing counsel were deemed to have waived opposition to the settlement by not filing an objection on their firms’ behalf and by limiting their appearance on behalf of their respective clients.

Reid and Hellyer v. Laski (In re Wrightwood Guest Ranch, LLC), 896 F.3d 1109 (9th Cir. 2018).

Laski was appointed as the Chapter 11 trustee in an involuntary case. Reid & Hellyer (“RH”) was appointed as counsel for the creditors’ committee. Walter Wilhelm Bauer (“WWB”) represented the debtor. GreenLake Real Estate Fund, LLC (“GreenLake”) was a secured creditor with a claim of $9.6 million secured against Debtor’s real property. GreenLake and the Trustee entered into an agreement providing: (i) GreenLake would be a stalking horse bidder at $8.5 million; (ii) it would limit its secured claim to that amount; (iii) it would carve out $150,000 to pay unsecured creditors and $350,000 to pay Laski and his counsel as a surcharge under § 506(c). The committee and two unsecured creditors filed objections to the settlement. Neither RH nor WWB filed an objection. RH and WWB appeared at the hearing on behalf of their clients, but did not appear on their own behalf. The Bankruptcy Court approved the settlement. RH and WWB appealed the order approving the settlement to the District Court. The District Court granted a motion to dismiss the appeals based upon lack of standing and equitable mootness. The law firms appealed to the Ninth Circuit, arguing that the Bankruptcy Court understood that they were objecting on their own behalf as well. The Ninth Circuit clarified that the parties had standing to appeal, as objection and appearance are not prudential standing requirements. It held, however, that the firms had both waived and forfeited their rights by not appearing at the hearing on the settlement in their capacities as administrative creditors, even though their arguments at the hearing were the type of arguments that an administrative creditor would make.

A Chapter 11 petition lacking requisite authority by the board must be dismissed.

Sino Clean Energy, Inc. v. Seiden (In re Sino Clean Energy, Inc.), 901 F.3d 1139 (9th Cir. 2018).

A receiver was appointed over a Nevada corporation. The receiver replaced the corporation’s board of directors with a sole director. After the receiver replaced the board, the former chairman purported to reconstitute the former board and then file a Chapter 11 petition for the corporation. The Bankruptcy Court dismissed the petition as having been filed without corporate authority because the former board had been replaced by the receiver with a new, sole director. Under Nevada law, a majority of the board then in office is necessary for the transaction of business. Here, the individuals who filed the petition were not members of the board of directors at the time they filed the petition. The Ninth Circuit distinguished a 2006 Arizona Bankruptcy Court decision (Corporate & Leisure) heavily relied upon by the appellants holding that, no matter the equitable considerations, state law dictates who can file a bankruptcy petition on behalf of a corporation. The Ninth Circuit stated that it understood Corporate & Leisure as announcing a more limited holding that, when a state court purports to enjoin a corporation for filing bankruptcy altogether, federal law preempts that injunction.

Commencement of Case / Eligibility / Involuntary Cases

Even part of a debt being in dispute renders the entire debt in “bona fide dispute” for purposes of § 303.

Montana Dept. of Revenue v. Blixseth, 581 B.R. 882 (D. Nev. 2017).

Three taxing authorities filed an involuntary bankruptcy case against Timothy Blixseth. Blixseth reached settlements with two of the taxing authorities, who withdrew their support of the involuntary petitions nunc pro tunc to the petition date. The Bankruptcy Court then granted Blixseth’s motion to dismiss the petition, on the grounds that the petition lacked the support of three qualifying creditors, as is required when an alleged debtor has twelve or more qualifying creditors, which Blixseth had established. A qualifying creditor is one whose claim is not contingent as to liability or the subject of a bona fide dispute as to liability or amount. Qualifying creditors do not include employees, insiders, and any transferee of a voidable transfer. The taxing authority creditor (Montana) had failed to discharge its burden of establishing that some of Blixseth’s creditors should be excluded from the count (e.g. as having received a preferential, fraudulent, or postpetition transfer). 11 U.S.C. § 303(b)(1). On appeal, Montana argued that the Bankruptcy Court erred when it determined that 11 U.S.C. § 303(b), as amended in 2005, now provides that any bona fide dispute as to the amount of a petitioning creditor’s claim is sufficient to render that creditor unqualified under the statute (e.g. even if $99,900 of a $100,000 debt was undisputed but $100 was disputed). Examining § 303(b)’s history and the plain language of § 303(b), the District Court concluded that § 303(b) unambiguously disqualifies a creditor whose claim is the subject of any bona fide dispute as to amount. The court held that this interpretation did not lead to an absurd result given the Bankruptcy Code’s dual purposes of ensuring the orderly disposition of creditors’ claims and protecting debtors from coercive tactics.

Consumer, Exemption, and Discharge

A debt incurred to purchase a home in a distant location to accommodate an executive’s relocation does not qualify as “consumer debt” and cannot be the basis of a motion to dismiss under 11 U.S.C. § 707(b).

In re Cherrett, 873 F.3d 1060 (9th Cir. 2017).

Debtor worked in hotel administration in Wyoming and was offered an attractive executive job in Colorado. Due to family reasons and finances, he agree to relocate to Colorado only when his employer offered to lend him $500,000 to purchase a residence. His employment later ended. He then filed a bankruptcy case. His former employer (and the home lender) sought dismissal under 11 U.S.C. § 707(b)(1). That section permits a Bankruptcy Court to dismiss the case of a debtor with “primarily consumer debts if the granting of relief would be an abuse of the Bankruptcy Code.” The Bankruptcy Court denied the motion, concluding that debtor’s obligation on the $500,000 loan was not a “consumer debt.” The BAP and Ninth Circuit both affirmed. A debt is a “consumer debt” when it is “incurred by an individual primarily for a person, family, or household purpose.” 11 U.S.C. § 101(8). To make that determination, the court must evaluate whether Debtor had a business purpose in acquiring the property. Below market rate loans and employer-sponsored loans may not qualify as consumer debts when the employee is seeking to further a career rather than for a household or family purpose.

A lawsuit alleging that Debtor has come into title on property fraudulently can substitute for a formal objection to a claim of exemption.

In re Lee, 889 F.3d 639 (9th Cir. 2018).

Debtor had financial problems and consulted with bankruptcy counsel. Later, Debtor transferred two parcels of real property into a tenancy by the entireties. When he filed his chapter 7 bankruptcy petition, he claimed the real properties as exempt under Hawaii state law. The chapter 7 trustee filed an adversary proceeding alleging the transfer of title to be a fraudulent conveyance and, after trial, the Bankruptcy Court granted judgment in the trustee’s favor. Later, the trustee moved for turnover of the properties and debtor refused, contending the trustee failed to file a Rule 4003 objection to the exemptions within 30 days of the bankruptcy filing. The Ninth Circuit affirmed the Bankruptcy Court’s turnover order. It held Rule 4003 requires no particular form of objection. It found the adversary proceeding the trustee filed was an adequate substitute for the formal Rule 4003 objection because it was filed within 30 days of the § 341(a) meeting, was property served, and “its sole purpose was to prevent [Debtor] from retaining the exemptions.”

Creditors’ subjective good faith belief that the discharge did not apply to their claim is a defense to a motion for contempt for violation of the discharge.

In re Taggart, 888 F.3d 438 (9th Cir. 2018), but see IRS v. Murphy, No. 17-1601 (1st Cir. June 7, 2018) (counter to Taggart) (retired Justice David Souter sitting by designation).

This is a factually complex case involving creditors’ return to state court to invalidate the debtor’s pre-petition transfer of his interest in a limited liability company and then to recover fees related to debtor’s post-discharge “return to the fray.” The Ninth Circuit affirmed the BAP’s ruling and reiterated the test for determining whether a creditor has run afoul of debtor’s discharge. By clear and convincing evidence, the debtor must establish that the creditor “(1) knew the discharge injunction was applicable and (2) intended the actions which violated the injunction.” Knowledge of the applicability of the discharge injunction to a creditor’s action must be proved as a fact and not inferred based on the creditor’s knowledge of the bankruptcy case. A good faith belief (even though ultimately wrong) is a defense even if the belief is unreasonable. In this case, the creditors’ reliance on a determination by the state court that debtor had “returned to the fray” was a good faith belief even though the state court ruling was later overturned on appeal.

A state court judgment that is deemed 
non-dischargeable runs interest at the state, not federal, rate.

In re Hamilton, 584 B.R. 310 (B.A.P. 9th Cir. 2018).

Debtors were executives in educational testing company, SDTS. They later took the know-how, materials, and customer lists from that company and started a new company. SDTS sued debtors in state court for breach of fiduciary duty, breach of duty of loyalty, intentional interference with prospective economic advantage and obtained a $2 million judgment. When debtors filed chapter 11 case, SDTS brought a 11 U.S.C. § 523(a)(6) nondischargeability complaint contending the judgment was not dischargeable. This case deals with two issues, the proper standard for a § 523(a)(6) determination and the calculation of interest on a state court judgment that is later found nondischargeable. As for the first, the BAP found that § 523(a)(6) requires a “willful” injury. This does not require proof of specific intent to cause harm but can be shown when the debtor either had a subjective motive to inflict injury or believed it was substantially certain to result as of his conduct. As to the second, a creditor is entitled to postjudgment interest at the state rate, not the much lower federal rate, when a judgment is determined to be nondischargeable. Generally speaking, that is because the Bankruptcy Court does not enter a new money judgment, it is simply determining, in the context of § 523(a), that a previously obtained money judgment is nondischargeable under federal law.

When a lease is assumed under Bankruptcy Code § 365(p), it does not also need to be reaffirmed to be enforceable as a post discharge liability.

Bobka v. Toyota Motor Credit Corporation, 586 B.R. 470 (S.D. Cal. 2018).

Section 365(p) provides a debtor a mechanism to assume a lease that is affirmatively rejected by a trustee or deemed rejected by operation of law. This section establishes a multi-step process for assumption, beginning with the debtor’s offer to assume the lease. The final step is a signed writing memorializing the terms of the assumption. In a related statute, § 524 establishes the steps required for the debtor to reaffirm a pre-petition obligation. The steps of § 524 are different than those of § 365(p) as, among other requirements, § 524 requires specified disclosures and the filing of a reaffirmation agreement. The question before the District Court was whether a lease assumed under § 365(p) had to be accompanied by a reaffirmation agreement under § 524 for the lessor to enforce the lease in the event the debtor committed a post-petition default. While noting that several courts nationwide require reaffirmation of an assumed lease, the District Court sided with other cases holding that such reaffirmation was unnecessary for the lease to be deemed assumed and enforceable. The decision includes a well-articulated effort at statutory construction and an analysis of the policies behind Sections 365(p) and 524.

Debtors cannot circumvent the provisions of a model chapter 13 plan by adding additional provisions modifying the plan period from a fixed term to one with an indefinite duration.

In re Escarcega, 573 B.R. 219 (B.A.P. 9th Cir. 2017).

Debtors’ counsel sought to modify the terms of the District’s new model plan to allow the plan to be for an indefinite period rather than a fixed term, and in so doing sought to create a situation in which a debtor could terminate a plan early and still receive a discharge. The Bankruptcy Court rejected this effort and the matters were appealed to the BAP. The BAP affirmed the “well-reasoned” rulings, finding that the modified provisions were inconsistent with Sections 1328 and 1329. These code sections, when considered together, require a fixed term to allow for the possibility that a debtor’s financial situation might change, and provide unsecured creditors a mechanism to seek modification of the plan in such circumstances. Of note, the plans provided that, once the allowed secured, priority, and administrative claims were paid, the plan would be deemed completed and no further payments would be required. The BAP determined that a plan with this provision violated Sections 1325(a) and (b). The BAP noted with disapproval the standing trustee’s failure to object to the plans, which objection would have triggered the application of § 1325(b), and her apparent acquiescence to the special provisions.

When a creditor has violated the discharge injunction the Bankruptcy Court has authority to award only “relatively mild” punitive damages.

In re Marino, 577 B.R. 772 (B.A.P. 9th Cir. 2017).

Debtors filed a motion for contempt against their mortgage lender (Ocwen) which, post-discharge, sent numerous letters and made many phone calls, even though Debtors had surrendered the property and Ocwen had obtained relief from stay and foreclosed. The Bankruptcy Court granted $119,000 in emotional distress damages ($1,000 for each improper contact). Debtors appealed the Bankruptcy Court’s failure to award punitive damages. Ocwen appealed the court’s denial of its motion for reconsideration. The BAP held that there is no meaningful difference between “punitive damages” and “noncompensatory fines” and noted that the Ninth Circuit permits a Bankruptcy Court to award “noncompensatory fines”; however any such award must be “relatively mild.” The BAP further noted that a District Court is not limited in granting punitive damages and punishing contempt and suggested that the Bankruptcy Court might choose to issue proposed findings and a recommended judgment on punitive damages to the District Court or refer the matter to the District Court for criminal contempt proceedings.

Under the Supremacy Clause, the Bankruptcy Code preempts Cal. Civ. Code § 2930 and a sold out junior lien cannot be enforced against real property subsequently acquired by a debtor who has obtained a discharge.

In re Wagabaza, 582 B.R. 486 (Bankr. C.D. Cal. 2018).

Chapter 7 debtor’s real property had two liens attached to it prior to debtor’s discharge. The senior lienholder foreclosed, which extinguished the junior lien. Debtor’s sister bought the property from the foreclosing lender and allowed debtor to live in the property. Seven years after discharge, debtor was able to qualify for her own mortgage and reacquired the property from her sister. When debtor went back on title, the junior lienholder tried to reimpose its lien arising out of its trust deed on the property under California Civil Code § 2930.

The court held that debtor’s discharge extinguished her personal liability on the junior lien, so at the time she reacquired the property, she owed no money to the junior lienholder and there is no consideration for the lien. Moreover, the junior lienholder had no lien when debtor received her discharge because the senior lienholder had foreclosed. Furthermore, under § 552(a), property acquired by a debtor postpetition is not subject to any lien resulting from any security agreement entered into by the debtor before the commencement of the case. To the extent § 2930 of the Cal. Civil Code compels a different result, it is preempted by the Bankruptcy Code under the Supremacy Clause.

A truck lender’s purchase money security interest did not secure the portion of the claim attributable to optional contracts financed by the Debtor in connection with the purchase.

In re Jones, 583 B.R. 749 (Bankr. W.D. Wash. 2018).

On an issue of first impression, the court held that optional contracts for gap insurance and vehicle maintenance should not be treated as secured under the “hanging paragraph” of § 1325(a). The collateral (a truck) did not secure the amounts financed to pay for the optional contracts, which were not part of the “price” for purposes of the lender’s PMSI. Similar to negative equity (In re Penrod), the optional contracts were not sufficiently related to the purchase of the truck to fall within the definition of “price” under (Washington’s version of) § 9-103 of the UCC. The contracts were optional, and not akin to sales tax and license fees, which are required payments in order to obtain a vehicle. The court then determined the amount of the bifurcated claim under § 506(c) by calculating how to allocate the prepetition payments made on the loan. The court held that, under the “dual status rule”, which allows part of a loan to have purchase money status and the remainder to be secured by a regular security interest, the prepetition payments should be allocated as follows: by subtracting the amount found to be unsecured from the total amount financed ($61,062 (total price) -$3,946 (price of the optional contracts)) and using that percentage to allocate prepetition payments between secured and unsecured portions.

A state-court judgment arising out of debtor’s harassing, disparaging text messages satisfied the requirements of non-dischargeability under § 1328(a)(4).

Plys v. Ang (In re Ang and Komori), 589 B.R. 165 (Bankr. S.D. Cal. Aug. 16, 2018).

Plaintiff and his friends received over twenty disparaging text messages concerning the paternity of his infant child. Through investigation and police involvement, plaintiff tracked defendant down as the sender. Plaintiff sued in small claims court and obtained a judgment for $10,150, plus costs and attorney’s fees. Defendant then filed Chapter 13. Plaintiff filed an untimely complaint under Bankruptcy Code Sections 523(a)(2), (a)(4) and (a)(6), which were dismissed. Plaintiff then brought a complaint under § 1328(a)(4), which provides, inter alia, that civil awards based on willful or malicious personal injury or wrongful death are nondischargeable. There is no deadline for bringing a claim under this subsection. The court noted that there are few cases interpreting § 1328(a)(4). It noted that, unlike § 523(a)(6), a court need only find the defendant’s conduct is willful or malicious. The court also wrestled with the issue of whether the “personal injury” referenced in § 1328(a)(4) related only to physical injury or included non-physical injury as well. The court concluded that § 1328(a)(4) is intended to include non-physical injury. The court then concluded that defendant’s conduct was willful and malicious, as he intended to harass and cause plaintiff emotional distress, likening the state court claim to private nuisance, which the court deemed a personal injury. The claim was therefore excepted from discharge under § 1328(a)(4).

Executory Contracts

Small company buy-sell stockholder agreement is not an executory contract and cannot be assumed.

In re Eutsler, 585 B.R. 231 (B.A.P. 9th Cir. 2017).

Debtor Eutsler and business partner Dorr incorporated Softbase Development, Inc., splitting the stock. Later, they sold 49% of the stock to minority shareholders. They also entered into a Buy-Sell Agreement which provided that the company, or another shareholder, could purchase the stock of any shareholder who suffered a “terminating event” such as a bankruptcy filing. The agreement required the parties to give notice to the other contracting parties of such events. Later, Eutsler filed a chapter 13 case. He gave notice to Dorr but not the minority shareholders. His confirmed chapter 13 plan ignored the existence of the Buy-Sell Agreement (e.g., it was not assumed or rejected). When they learned of the bankruptcy filing, the minority shareholders moved for relief from stay so they could purchase debtor Eutsler shares. The Bankruptcy Court denied the motion, holding that that the Buy-Sell Agreement was not an executory contract. The BAP affirmed, concluding that the Bankruptcy Court did not clearly err on this question of fact.

A contract is executory if the obligation of both the debtor and the other party are so far unperformed that the failure of either to complete performance would constitute a material breach. The Bankruptcy Court must determine whether, under state law, a party’s remaining unperformed obligations would excuse the other party from performing. In the option context, the Ninth Circuit has held that a “paid-for but not exercised option” is not an executory contract. The minority shareholders had not exercised their right to purchase. Consequently, Debtor’s failure to notify them of the bankruptcy and his remaining obligations was only a basis for an award of damages. This obligation did not render the Buy-Sell Agreement executory.

Issue and Claim Preclusion (and other estoppel theories)

Section 502(b)(4) can limit the reasonableness of an attorneys’ fees claim, even if a prepetition state court judgment determines the amount of the claim.

In re CWS Enterprises, Inc., 870 F.3d 1106 (9th Cir. 2017).

In a pre-petition arbitration between a client and his attorneys, the arbitrator determined that the contingency fee contract was not unconscionable and held that the terms of the fee contract were reasonable. The arbitrator’s award was confirmed as a judgment by the Superior Court. The client filed bankruptcy prior to enforcement of the judgment and challenged the amount of the claim as unreasonable under Bankruptcy Code § 502(b)(4). The Bankruptcy Court applied a lodestar to counsel’s hours and reduced the award from $2.5 million to $440,250, finding that “reasonableness” under state law was different than that required by the bankruptcy code. The District Court reversed, and debtor appealed. The Ninth Circuit held: The bankruptcy code’s reasonableness cap limits a pre-petition attorney fee claim even if the fees were allowed under state law and have been reduced to a judgment. The Court adopted the following approach used by the 10th Circuit: an acknowledgement or determination that the fee contract was breached; an assessment of the damages under state law; a determination under § 502(b)(4) of the reasonableness of the damages provided by application of state law; and a reduction of the claim to the extent it is excessive. Having adopted the approach, however, the Ninth Circuit held that the arbitrator’s award had determined that the contingency contract was not unconscionable and determined that the fee was reasonable given the amount of work put into the case and the risk of non-payment. Having so held, the arbitrator’s decision was entitled to issue preclusive effect.

Court refused to grant motion to vacate large sanctions award, but agreed to vacate the damages portion, noting that the sanctions decision is not to be given preclusive effect.

In re Sundquist, 580 B.R. 536 (Bankr. E.D. Cal. 2018).

After the Court awarded the debtors approximately $6 million and required Bank of America to pay public interest entities $40 million for the Bank’s gross misconduct in violating the automatic stay, debtors and the bank reached a settlement. The settlement provided for payment to the debtors of approximately $9 million. As required by the settlement, the bank and debtors moved to vacate the judgment and dismiss the adversary proceeding. Likening the bank’s requirement that the debtors cooperate in this effort to a “hostage standoff”, the court denied the request. The court adopted a cautious approach to the effort to “buy and bury” the negative judgment. It noted that the portion of its previous decision cancelling the fee contract of debtors’ prior counsel and awarding $70,000 was on appeal. It determined that the bank’s concern over claim preclusion was resolved by the comprehensive release provided by the debtors. The bank’s concern that the decision might be used by third parties for preclusive effect, which the court deemed remote, was resolved by the court vacating the damages award and ruling that the findings were not “sufficiently firm” to receive preclusive effect within the meaning of the Restatement (Second) of Judgments in any subsequent litigation with third parties. The Court’s large punitive damage award to public interest entities was resolved by two factors: (i) the entities, which were previously allowed to intervene, appeared and advised the court that they did not wish to stand in the way of debtors’ settlement; and (ii) debtors agreed to contribute $300,000 to the public interest entities, thereby recognizing the public interest component of the court’s ruling. The court noted, however, that its previous opinion would remain on the public record.

State court judgment against debtor for abuse of process did not establish a claim under § 523(a)(6).

Herrera v. Scott (In re Scott), 588 B.R. 122 (Bankr. D. Idaho 2018).

Debtor sued his neighbors in Idaho state court for injunctive relief and defamation. The neighbors counterclaimed for breach of quiet enjoyment and abuse of process. A jury found against debtor on the abuse-of-process claim and awarded damages totaling $150,000. After debtor filed bankruptcy, the judgment creditor filed an action under § 523(a)(6) and moved for summary judgment based upon the jury’s finding. As to the “willful” requirement of § 523(a)(6), the jury’s finding that debtor’s abuse of process was “willful” and that he intended to use the process as a “threat or club” was sufficient. Turning to the “maliciousness” prong, a plaintiff must prove that an act is: (1) wrongful, (2) done intentionally, (3) necessarily causing injury, and (4) without just cause or excuse. The court found that the state court judgment satisfied elements 1, 2 and 4, but did not satisfy the third element related to damages. The jury presumably awarded damages to cover the cost of renovations to plaintiffs’ property, but there was no evidence of what the damages would have been if they had not renovated their house. Therefore, the record did not establish that plaintiffs were “necessarily” injured by the abuse of process.

Jurisdiction, Standing, and Process

Post-discovery delay in filing a fraudulent transfer action does not preclude equitable tolling.

In re Milby, 875 F.3d 1229 (9th Cir. 2017).

The estate of debtor discovered debtor’s allegedly fraudulent transfers days before the statute of limitations on avoidance claims was set to expire. The complaint was not filed until almost a year after the discovery. The Bankruptcy Court dismissed the action as time-barred and held that the delay in filing after the discovery of the transfers precluded equitable tolling. The BAP reversed, holding that post-discovery delay is irrelevant to whether equitable tolling applies.

The Ninth Circuit held that both the Bankruptcy Court and the BAP got it wrong. A litigant seeking equitable tolling bears the burden of establishing two elements: (1) that he has been pursuing his rights diligently, and (2) that some extraordinary circumstance stood in his way and prevented timely filing. The second element was not in dispute, as all the courts agreed that extraordinary circumstances existed. The Bankruptcy Court held that the failure to file a complaint after the extraordinary circumstances had ceased but before the limitations period would normally expire erred in being too restrictive. The BAP, by holding that post-discovery diligence is never relevant to whether equitable tolling applies, erred by being too permissive. Instead, the Ninth Circuit held that courts may consider a plaintiff’s diligence, after extraordinary circumstances have passed, as one factor in determining diligence. In this case, the court held that it would be unreasonable to expect the estate to file a complaint less than one week after discovery and before the statute of limitations expired. The complaint here was filed nearly a year after discovery which the Ninth Circuit concluded satisfied the diligence element in view of all the circumstances.

Discussing the sort of evidence that can be considered by a trial court on a motion to dismiss.

Khoja v. Orexigen Therapeutics, Inc., 899 F.3d 988 (9th Cir. 2018).

This is not a bankruptcy case but it applies to federal litigation. The defendant, a pharmaceutical development company, was attempting to bring to market a drug for obese persons. Plaintiff was an investor in defendant’s stock. When the company’s stock value dropped plaintiff brought a lawsuit alleging the company violated the securities laws by misrepresenting facts and concealing adverse information. Defendant brought a motion to dismiss the lawsuit under Rule 12(b)(6) (failure to state a claim). Defendant requested the court take ‘judicial notice’ of market analyses, blog posts, Forbes magazine internet articles, SEC filings, USPTO files, among other things, in support of its motion to dismiss. Alternatively, it argued the court could find those documents were ‘incorporated by reference’ in the complaint. The District Court granted the motion to dismiss and the Ninth Circuit reversed. The District Court committed error in its analysis of both issues. In the context of a motion to dismiss, the court can take judicial notice under Evidence Rule 201, but should only do so if the facts are not subject to reasonable dispute. The Ninth Circuit held that the events taking place on an investor conference call, and the reports of a European regulator, among other things, could not be judicially noticed because the underlying facts were subject to dispute. Further, documents are ‘incorporated by reference’ only if the “plaintiff refers extensively to the document or the document forms the basis for the plaintiff’s claim.” Some of the documents the District Court considered were not “extensively” referred to in the complaint. Others were referred to but did not obviously form the basis of Plaintiff’s complaint. Finally, some introduced factual questions. The Ninth Circuit set out a categorical rule that, “[I]t is improper to assume the truth of an incorporated document if such assumptions only serve to dispute facts stated in the well-pleaded complaint. This admonition is, of course, consistent with the prohibition against resolving factual disputes at the pleading stage.”

The parties to a contract may delegate the question of arbitrability (or, whether a dispute qualifies for arbitration) to the arbitrator. Arbitration clauses are not terminated by a discharge in bankruptcy.

Crooks v. Wells Fargo Bank, N.A., 312 F.Supp. 3d 932 (S.D. Cal. 2018).

Debtor purchased a car financed by Wells Fargo Bank. Debtor later filed a chapter 7 case and obtained a discharge of her personal liability on the loan. After she obtained a discharge, Wells Fargo Bank “pulled a credit report” on Debtor. She sued in District Court alleging violations of the Federal Fair Credit Reporting Act. Because the financing agreement included an arbitration provision, Wells Fargo Bank moved to compel arbitration under the Federal Arbitration Act. The court held the standard for determining if the FAA applies has two “gateway issues”: (1) whether a valid agreement to arbitrate exists and, if it does, (2) whether the agreement encompasses the dispute at issue. The burden of proof lies with the party resisting arbitration.

The primary issue in the case considered whether the parties can delegate to the arbitrator the gateway issue of arbitrability, that is, whether the arbitration agreement covers the dispute that the parties agreed to arbitrate. Case law has held that it is permissible to do so if the agreement so provides. Here, it did. The secondary issue concerned Debtor’s contention that the arbitration provision was void due to her chapter 7 discharge. The District Court held that such provisions were not terminated by the discharge. Further, the District Court declined to exercise its discretion to except the case from arbitration, finding the purpose of the provision did not conflict with the Bankruptcy Code.

When faced with concurrent motions to remand and to transfer, the court should consider the remand motion first except under rare circumstances

In re Caesars Entertainment Operating Company, Inc., 588 B.R. 233 (B.A.P. 9th Cir. 2018).

In state court action removed to federal court based on debtors’ Chapter 11 filing, concurrent motions were filed for remand and for transfer of venue. The Bankruptcy Court decided the remand motion first, which the court granted, and then denied the motion to transfer as moot. The BAP held that the Bankruptcy Court did not abuse its discretion in deciding the remand motion first. When faced with concurrent motions to remand and to transfer, courts should resolve the motion to remand first, and only in “rare circumstances” should transfer motions be considered before remand motions. The BAP dismissed the appeal of the remand order because it is not reviewable on appeal pursuant to 28 U.S.C. § 1447(d).

Bankruptcy Court does not have “related to” post-confirmation jurisdiction over a proceeding removed from state court between non-debtors, even if the outcome of the action may affect claims against the estate.

In re International Manufacturing Group, Inc., 574 B.R. 717 (Bankr. E.D. Cal 2017).

Plaintiffs and defendants in a state court action were both defendants in separate adversary proceedings maintained by the chapter 11 trustee. Because of this connection, the defendants removed the state court action, which did not pertain to the trustee’s actions and did not involve the trustee, to the Bankruptcy Court. The state court action did not involve bankruptcy law. The Bankruptcy Court held that it did not have “related to” postconfirmation jurisdiction over the removed action because it was essentially a dispute between non-debtor parties. The fact that a judgment in the state court action might reduce the prevailing party’s claims against the estate did not confer “related to” postconfirmation jurisdiction.

A party’s failure to comply with specific requirements of a local rule regarding a jury demand does not result in a waiver of a party’s jury trial right when its demand was timely and otherwise proper under FRCP 38(b).

In re Daley, 584 B.R. 911 (Bankr. C.D. Cal. 2018).

Defendant in an adversary proceeding answered the complaint and included a demand for jury trial. It failed to state whether it consented to jury trial in the Bankruptcy Court. The local rules permit the Bankruptcy Court to conduct trials with the consent of the parties. Plaintiff argued the failure to include a statement regarding consent, which was expressly required by the Bankruptcy Local Rules, constituted a waiver of the right to jury in an Article III court. The Bankruptcy Court disagreed, finding the local rule could not work as a waiver in view of Federal Rule of Civil Procedure 38, which does not expressly require such a statement.

Part 2 of Recent Developments continued in RN#66.

*Judge Stephen L. Johnson was appointed to the bench in the Northern District of California by the Ninth Circuit Court of Appeals in 2010.

*Jennifer C. Hayes
is a partner of Finestone Hayes LLP, a San Francisco law firm specializing in insolvency law, bankruptcy law, and business disputes. Prior to her current firm, Ms. Hayes was a partner at the international law firm, Dentons.

*Ori Katz
is a partner in the Finance and Bankruptcy practice group in the San Francisco office of Sheppard, Mullin, Richter & Hampton LLP, where he is also the Co-Office Managing Partner. He specializes in business bankruptcies and other aspects of insolvency law.