Recent Developments Affecting Insolvency and Commercial Finance in California and the Ninth Circuit

• Jurisdiction: California,United States,Federal
• Author: Dan Schechter
• Publication year: 2019
• Citation: Vol. 2019

Recent Developments Affecting Insolvency and Commercial Finance in California and the Ninth Circuit

Dan Schechter¹

Dan Schechter taught at Loyola Law School, Los Angeles, from 1980 to 2018. He is the author of "Mapping the Deal: A Visual Method for Understanding Secured Transactions in California Real Property" and writes the weekly Westlaw Commercial Finance Newsletter. He serves as a consultant and expert witness in cases involving finance, insolvency, and real property.

This article briefly summarizes key features of decisions affecting insolvency and commercial finance rendered by state and federal courts within the Ninth Circuit. It also provides the author's editorial comments related to these decisions.²

I. Bankruptcy.

A. The Trustee's Avoidance Powers and Related Claims.

• Even though cash stemming from a leveraged acquisition had been routed through two entities covered by the § 546(e) "settlement payment" safe harbor, the ultimate recipients of that cash were not protected from fraudulent transfer liability. [Merit Management Group, LP v. FTI Consulting, Inc., -- U.S. -- , 138 S. Ct. 883, 200 L. Ed. 2d 183 (2018).]

Comment: Many observers (including myself) have long decried the abuse of the § 546(e) "safe harbor" defense, which became a "get out of jail free" card for corporate looters. Amazingly, the Supreme Court has put an end to the charade, unanimously holding that the intermediate conduits of the money are to be disregarded: the trustee (or the debtor) can target the ultimate recipients of the funds, without having to deal with the intermediary entities. One quibble, though: when is an intermediary more than just a conduit? The courts will now have to articulate the shrunken boundaries of the "safe harbor."

• A group of selling shareholders were liable to the IRS as fraudulent transferees following the leveraged acquisition of their stock as part of a tax avoidance scheme. [Slone v. Commissioner of Internal Revenue, 896 F.3d 1083 (9th Cir. 2018).]

Comment: In retrospect, is there anything the selling shareholders could have done to protect themselves from this foreseeable risk? Yes: a portion of the cash sufficient to satisfy the IRS could have been placed in an escrow, to be released to the parties if and when the IRS obligation had been magically obliterated, as the stock purchaser falsely promised it would be.

• A dissolved law firm had no property interest in the profits generated by its former partners' post-dissolution work on hourly fee matters. [Heller Ehrman v. Davis Wright Tremaine LLP, 4 Cal. 5th 467, 411 P.3d 548, 229 Cal. Rptr. 3d 371 (2018).]

Comment: The court's opinion was largely policy-based, centered on protecting the rights of clients to follow the attorneys to their post-dissolution firms. Although there is still a split of authority on this issue throughout the nation, I think that this decision is consistent with the overall trend in the recent case law.

• After a judgment debtor transferred funds to pay his son's university tuition, the father's judgment creditors could not recover from the son under the Uniform Voidable Transfer Act on the theory that the son was the "person for whose benefit the transfer was made." [Lo v. Lee, 24 Cal. App. 5th 1065, 234 Cal. Rptr. 3d 824 (Cal. Ct. App. 2018).]

[Page 20]

Comment: The court did not address the father's potential liability for having made the fraudulent transfer. Note that most (but not all) of the cases in this area have held that the payment of tuition by a parent confers "reasonably equivalent value" on the parent. The court also wondered, in a footnote, why the university had not been joined as a defendant. Again, although the decisions in this area are mixed, the trend is in favor of the universities.

• The payment of a judgment in favor of an unsecured creditor was preferential because neither the filing of a lis pendens nor the creation of a consensual escrow had created a perfected lien in favor of the creditor. [In re Price, -- B.R. --, 2018 Westlaw 3213603 (D. Haw.).]

Comment: I have doubts. This case involved two separate but related disputes, one over the real property and one over the cash proceeds, which are personal property. And the issue of perfection as to personal property under § 547 is governed not by the "hypothetical bona fide purchaser" rule of § 547(e)(1) (A) but rather by the "hypothetical judicial lien creditor" rule of § 547(e)(1)(B). Could a judicial lienor really have reached those proceeds?

• When a corporation's check, delivered to a creditor prior to bankruptcy, was then honored after the petition had been filed, the trustee's recovery of those funds is pursuant to § 549, rather than § 547. [In re Cresta Technology Corp., 583 B.R. 224 (9th Cir. BAP 2018).]

Comment: This is not a particularly surprising result, but it clears up an unresolved issue. (Note, however, that there are some seemingly-inconsistent decisions rendered by bankruptcy courts in other circuits.) It makes sense to apply Barnhill v. Johnson, 503 U.S. 393, 112 S. Ct. 1386, 118 L. Ed. 2d 39 (1992), equally to all of the trustee's avoidance powers. The policy behind Barnhill is that the date of physical delivery of a check may depend on extrinsic evidence, while the date of honor is objectively verifiable.

• A refinancing lender was unable to invoke the "substantially contemporaneous" defense to preference liability when the delay in the protection of its lien was attributable to the lender's own sloppy business practices, especially where the lender and the borrowers were located in different states. [In re Power, 2018 Westlaw 1887318 (Bankr. D. Idaho).]

Comment: This entire fiasco was attributable to the fact that the borrower and the lender never actually met face-to-face to go over the documents, an increasingly common scenario in today's lending market. So how can web-based lenders prevent the problems presented by this fact pattern? Employee training is hit-or-miss. The fallback solution is an automated checklist, to make sure that all of the paperwork is completed correctly and on time.

B. Chapter 11.

• A senior lender that purchased some (but less than all) of the claims outstanding in a Chapter 11 case was not necessarily acting in bad faith, thus enabling the lender to block the debtor's reorganization plan. [In re Fagerdala USA - Lompoc, Inc., 891 F.3d 848 (9th Cir. 2018).]

Comment: This is a very significant decision: it will make it much easier (and cheaper) for lenders to kill cramdown plans by making strategic claims purchases. Here, the secured creditor purchased more than half in number of the outstanding unsecured claims, but it acquired only 10% of the claims by value. The total cost of this blocking position was approximately $13,000. That is a clever and cost-effective strategy!

I am reminded of the time that John F. Kennedy was accused of using his family's wealth to buy votes during his 1958 Senate campaign. During a speaking engagement, he did not deny that accusation. Instead, he pulled a small piece of paper from his pocket: "I just received the following wire from my generous Daddy: Dear Jack, don't buy a single vote more than is necessary. I'll be damned if I'm going to pay for a landslide."

C. Other Bankruptcy Issues.

• A bankruptcy court's ruling that a creditor was not a "non-statutory insider" is to be reviewed under a "clear error" standard, rather than on a "de novo" basis. [U.S. Bank Nat. Ass'n. v. Village at Lakeridge, -- U.S. --, 138 S. Ct. 960, 200 L. Ed. 2d 218 (U.S. 2018).]

Comment: The egregious facts of this case (which involved insider "claim laundering") illustrate why this ruling is so subtly pernicious. It tilts the field in favor of the launderers by finding, as a factual (and not legal) matter, that the transfer was conducted at arm's length, insulating that finding from meaningful appellate review. In turn, this means that the proponents of a collusive cramdown plan can much more easily create the necessary artificially impaired consenting class, thus making it possible to prolong an otherwise-doomed reorganization.

[Page 21]

• The expiration of a secret "ORAP" lien,³ created by a state statute, was tolled by 11 U.S.C.A. § 108(c), even though that section does not apply to the enforcement of judgments. [In re Swintek, 2018 Westlaw 5117193 (9th Cir.).]

Comment: I think the dissent was right, but I also think that this decision settles the issue. However, given the "stealth survival" of ORAP liens under this decision, wouldn't it make sense for the California Legislature to provide for the recording of these liens? To put it another way, the unfairness of Swintek could be mitigated somewhat if other creditors had the ability to find ORAP liens quickly and easily.

• A judgment creditor was precluded by the automatic stay from recording abstracts of judgment against a non-bankrupt's interest in real property as a tenant in common because a bankrupt tenant in common held contingent interests in the affected parcels of real property pursuant to a pending settlement agreement. [In re Levine, 583 B.R. 231 (Bankr. C.D. Cal. 2018).]

Comment: I have doubts. If the bank had been allowed to record its abstracts, the resulting judgment liens would have encumbered the non-debtor's interest in the property as a tenant in common but would have had no effect on the debtor's interest in those properties as a tenant in common. See, e.g.,...