Recent Developments Affecting Insolvency and Commercial and Consumer Finance in California and the Ninth Circuit
| Publication year | 2020 |
| Author | Judge Meredith Jury |
Judge Meredith Jury
Hon. Meredith Jury (Ret.) served as a Bankruptcy Judge for the Central District of California from 1997 to June 2018. She was simultaneously a member of the Bankruptcy Appellate Panel for the Ninth Circuit from 2007-2017, serving as chief from 2015-17. Prior to taking the bench her practice was primarily complex civil litigation, for her entire career at Best Best & Krieger in Riverside, Since retirement she does pro bono bankruptcy mediations and consumer appellate work, represents victims of elder abuse for Inland Counties Legal Services, and leads the ad hoc group of BLS authors who write the Westlaw Commercial Finance Newsletter.
This article briefly summarizes key features of decisions affecting insolvency and commercial and consumer finance rendered by state and federal courts primarily within the Ninth Circuit. It also includes a few decisions by other federal courts and state supreme courts when, in the author's opinion, these cases may have persuasive value in California or the Ninth Circuit. The article provides the author's editorial comments related to these decisions.1
A California appellate court has held that a fraudulent transfer claim attacking a collusive stipulated judgment between a judgment debtor and his brother is not subject to the litigation privilege. [Chen v. Berenjian, 33 Cal. App. 5th 811 (2019).]
Comment (DS): This result is exactly right. In this case the collusive judgment satisfies several of the "badges of fraud" articulated in California Civil Code section 3439.04(b). Among others:
(11) Whether the debtor transferred the essential assets of the business to a lienor that transferred the assets to an insider of the debtor.
This subsection is particularly pertinent. It refers to the familiar "friendly foreclosure" scenario, under which the debtor willingly defaults, a creditor forecloses, and then the assets are resold to an insider. Here, instead of creating a phony mortgage resulting in a phony foreclosure sale, two brothers created a phony judgment that would have resulted in a phony execution sale.
Relying on 11 U.S.C. § 544(b),2 a bankruptcy court in South Carolina has held that a trustee may invoke the power of the IRS to avoid the debtors' disclaimer of settlement proceeds, even though other unsecured creditors could not have done so under applicable state law. [In re Gaither, 595 B.R. 201 (Bankr. D.S.C. 2018).] Under federal tax law, the IRS is empowered to avoid the disclaimer of the proceeds. The court held that the IRS could serve as the triggering creditor for purposes of § 544(b), since the IRS was the holder of an actual unsecured claim.
Comment (DS and MJ): We include a South Carolina bankruptcy case because it is serves as an example of recent trustee action all over the country. It is a manifestation of the emerging "shoes of the taxman" theory. Here, the IRS had the power to override state law regarding disclaimers of settlement proceeds. The trustee's avoidance powers allowed him to enhance estate assets, even though none of the estate's other creditors could have done so. That sounds a little unfair, but that is the rule of Moore v. Bay, 284 U.S. 4 (1931): a transfer void as to one creditor is void as to all.
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The ability of bankruptcy trustees to use the IRS to leverage the estate's avoidance powers is very significant: since most bankrupt debtors have tax problems, many fraudulent transfer recipients will face an expanded risk of liability. Although we do not yet have much circuit-level guidance, we predict that this theory will be widely adopted and widely upheld.
A California appellate court has held that a judgment creditor was empowered to avoid a judgment debtor's premarital agreement opting out of the community property system, making earnings and assets acquired during marriage separate property, as an intentionally fraudulent transfer. [Sturm v. Moyer, 32 Cal. App. 5th 299 (2019).]
Comment (DS, MJ): Although the facts of this case were egregious, it would be a mistake to restrict this opinion to its facts. The premarital agreement in this case was written when the parties knew of a judgment creditor and was tailored to protect assets from the creditor. But there is no doubt this case puts the viability of such agreements, as asset protection vehicles, in question in California. The parties did not petition for hearing before the California Supreme Court, so for the time being this opinion is authority on this issue.
A bankruptcy court in northern California has held that the defense of in pari delicto barred a chapter 11 trustee's malpractice suit against the corporate debtor's former accountant. [In re Yellow Cab Cooperative, Inc., 602 B.R. 357 (Bankr. N.D. Cal. 2019).]
Comment (DS, MJ): The bankruptcy court noted that there was no definitive Ninth Circuit authority on this issue. It distinguished Federal Deposit Insurance Corp. v. O'Melveny & Myers, 61 F. 3d 17 (9th Cir. 1995), which precluded the application of in pari delicto against an FDIC receiver. Eventually, the Ninth Circuit is going to have to tackle this issue head-on. When it does, we predict that it will apply O'Melveny to bankruptcy trustees. The Ninth Circuit's ruling in O'Melveny was based in equity, rather than on statutory grounds. The defense of in pari delicto is equitable, and bankruptcy courts are courts of equity. There is nothing equitable about shielding wrongdoers from their own misconduct by invoking an equitable defense against a receiver or a trustee.
In contrast to Yellow Cab, a district court in New York has held that a liquidation trustee was not precluded by the doctrine of in pari delicto from asserting a breach of fiduciary duty claim against a group of corporate looters. [In re FKF3, LLC, 2018 WL 5292131 (S.D.N.Y. 2018).]
Comment (DS, MJ): We think that the federal courts have become disgusted by New York's extreme tolerance for corporate misconduct and will find a way around New York's aggressive interpretation of the doctrine of in pari delicto. There is no reason to spare insiders who loot corporate assets, and there is no reason to allow their third-party co-conspirators to shelter under that rule. This case kept in mind that the doctrine of in pari delicto is equitable in nature.
B. Other Bankruptcy IssuesThe sale or assignment of an interest in consumer credit transactions, if achieved pursuant to a chapter 11 plan of reorganization, is not subject to the limitations imposed by 11 U.S.C. § 363(o) on the free and clear transfers of consumer credit transactions. However, §§ 363(f) and (o) must be considered in determining whether plan proponents have met their burden under the best interests test mandated by § 1129(a)(7). [In re Ditech Holdings, Corp., 606 B.R. 544 (Bankr. S.D.N.Y. 2019).]
Comment (Uzzi Raanan): The court's ruling that § 363(o)'s limitation on free and clear sales applies only to sales under § 363, but not those conducted pursuant to a plan, is buttressed by the plain language in § 363(o) (e.g., "if such interest is purchased through a sale under this section") as well as relevant legislative history. However, its finding that debtors failed to satisfy the best interests of creditors' test under § 1129(a)(7) raises questions. The Debtors had not assigned any value to the consumer creditors' claims and defenses in their chapter 7 liquidation analysis, which doomed the plan.
A true valuation of the consumer creditors' claims would have been unworkable. In practice, a case-by-case evaluation of the claims, many of which are factually and legally undeveloped, would be prohibitively expensive, time-consuming, and fraught with other logistical obstacles. It is apparent from the court's well-documented factual account that Debtors had a hard time locating the two buyers, and that a sale of the assets would be negatively impacted were it not achieved free and clear of consumer creditors' claims and defenses. It is also clear that Debtors worked hard to try to resolve all creditor objections but failed to do so regarding the consumer creditors. The court's ruling appears to leave the Debtors, and the case, in a precarious position.
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The Ninth Circuit has held that a trial court correctly ordered equitable restitution of $1.27 billion due to a payday lender's deceptive practices. [Fed. Trade Comm'n v. AMG Capital Mgmt., LLC, 910 F. 3d 417 (9th Cir. 2018).] A concurring opinion urged en banc review. The concurrence cast doubt on the continuing vitality of FTC v. Commerce Planet, 815 F. 3d 593 (9th Cir. 2016), relied on by the majority, in light of Kokesh v. SEC, ___ U.S. ___, 137 S. Ct. 1635 (2017), which can be construed to hold that restitution is not a permissible equitable remedy. The concurrence argued that the award of more than $1 billion constituted a damage award and could not be characterized as merely injunctive relief.
Comment (DS): Given the amount of money involved, it is not surprising that a petition for certiorari was docketed on October 21, 2019.
Going out on my authorial limb, I predict that the Supreme Court will grant certiorari and that it will reverse, holding that if Congress had wanted to grant the FTC the power to obtain an award of damages as part of injunctive proceedings, the statute would have said so much more clearly than it does. I am not sure that the Supreme Court will even need to reach the issue of whether Kokesh, an SEC case, applies in the context of an FTC case.
A California appellate court has held that a post-judgment examination of a non-debtor third party is restricted to matters involving the judgment debtor's property held by that third party or money owed by that third party to the judgment debtor. [Fin. Holding Co., LLC v. American...
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