Recent Developments Affecting Insolvency and Commercial Finance in California and the Ninth Circuit
| Publication year | 2016 |
| Author | Dan Schechter |
Dan Schechter1
Dan Schechter has taught at Loyola Law School, Los Angeles, since 1980. He is a co-author of California Real Estate Finance (5th Ed.) and writes the weekly Westlaw Commercial Finance Newsletter. He also serves as a consultant and as an 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
• A guarantor's Deprizio waiver of his rights of subrogation and reimbursement from the debtor was valid, and he was therefore not a creditor of the debtor for purposes of liability under the preference statutes. [In re Adamson Apparel, Inc., 785 F.3d 1285 (9th Cir. 2015).]
Comment: If this issue ever makes it to the Supreme Court, the author predicts affirmance. The majority will reason that if Congress had wanted to ban Deprizio waivers, it would already have done so, since these waivers were in use long before the amendment to § 550(c). Note that if these waivers are enforceable, insulating the guarantor from preference liability paradoxically provides him with an even greater incentive to steer the company's assets preferentially to the lender and reduce his own exposure, while enjoying immunity from preference liability.
• The seven-year "statute of repose" contained in the Uniform Fraudulent Transfer Act is preempted by § 546(a) of the Bankruptcy Code. [In re EPD Inv. Co., LLC, 523 B.R. 680 (B.A.P. 9th Cir. 2015).]
Comment: Note that although § 546(a) does not distinguish between statutes of repose and statutes of limitations, it does not expressly say that it preempts both. This ruling places a huge evidentiary burden on defendants in fraudulent transfer cases. It means that records must be kept for nine years (the seven year state statute plus the two year federal statute).
• Under California law, a lender did not own a stream of rental income under a supposedly "absolute" assignment of rents, thus giving rise to potential fraudulent transfer liability. Further, the parent entity that transferred the money to the lender may not have received reasonably equivalent value, even though the payments were made on behalf of its own subsidiary. [In re Bay W. Kailua Bay, LLC, 2014 Westlaw 7272890 (Bankr. D. Haw. 2015).]
Comment: California Civil Code § 2938 means that even if the document says that the lender owns the rents, the lender doesn't own the rents. Therefore, the lender simply had a security interest in the rents, setting up a fraudulent transfer claim under the facts of the case.
With reference to the issue of "reasonably equivalent value," most circuits have held that "downstream" payments (i.e., payments made by parents on behalf of subsidiaries) are usually supported by "reasonably equivalent value," on the theory that the payments usually enhance the business prospects of the subsidiary (and hence the parent's equity interest).
• When a corporate insider established a separate secret account and used it to buy real estate for himself, the sellers were the "initial transferees" of the corporate funds and thus could not qualify for the good faith defense available to subsequent transferees. [In re Walldesign, Inc., 2015 Westlaw 4399843 (C.D. Cal. 2015).]
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Comment: This is a common problem: an innocent third party accepts a corporate check to pay an individual's debt and later has to give back the money. Here, the sellers presumably lost both the money and the property, a huge loss. There is no way that laypersons can avoid this trap, but attorneys consulted in such transactions should be on guard. In the context of real estate sales, perhaps escrow officers could be routinely instructed not to accept any checks drawn on accounts that are not in the buyer's name.
• A county tax lien encumbering a Chapter 11 debtor's personal property was avoidable by the estate under 11 U.S.C. § 545(2) because the lien was invalid under state law against a hypothetical subsequent bona fide purchaser of the debtor's assets. [In re Mainline Equipment, Inc., 539 B.R. 165 (B.A.P. 9th Cir. 2015).]
Comment: Assuming that this decision withstands appeal, it would not be surprising if the counties were to seek legislation to expand their rights vis-à-vis bona fide purchasers of defaulting taxpayers' personal property. The most parsimonious solution would be to permit counties to file with the Secretary of State's office, in order to provide the broadest possible notice to potential asset purchasers. From the standpoint of the commercial finance industry, it would make sense to continue to search for local tax lien filings prior to releasing any funds, unless and until the tax lien system is folded into the existing state-wide judgment lien filing regime.
B. Chapter 11.• A vendor holding nonrecourse purchase money paper could not assert a deficiency claim under § 1111(b) after the vendor's junior lien was extinguished by a senior creditor's post-petition nonjudicial foreclosure sale. [In re Salamon, 528 B.R. 171 (B.A.P. 9th Cir. 2015).]
Comment: I have doubts about this decision. First, § 502(b), which is expressly incorporated into § 1111(b), states that in ruling on an objection to a claim, "the court, after notice and a hearing, shall determine the amount of such claim . . . as of the date of the filing of the petition . . . ." I know of no authority holding that a post-petition date controls the determination of the nature of the claim. When Congress wants to depart from the petition date in the evaluation of a secured claim, it does so explicitly, as it did in § 506(a)(1), which controls the treatment of oversecured creditors.
Second, under § 1111(b)(1)(A)(ii), Congress specifically carved out two types of post-petition sales for special treatment: either a sale under § 363, or a sale under the plan. When it drafted that provision, Congress was obviously aware of post-petition foreclosure sales, yet foreclosure sales were not included in that exception.
C. Other Bankruptcy Issues.• Bankruptcy courts have the power to adjudicate non-core disputes, if the parties have either expressly or impliedly consented to jurisdiction. [Wellness Int'l Network, Ltd., vs. Sharif, 135 S. Ct. 1932 (2015).]
Comment: The minority in this case formed the majority in Stern v. Marshall, 131 S. Ct. 2594, 180 L. Ed. 2d 475 (2011). Does that signal a possible retreat from the unreasonable strictures of Stern? Perhaps the swing voters (Justices Kennedy and Alito) belatedly realized that Stern had given rise to a huge increase in the paperwork associated with bankruptcy litigation, since the district courts have been forced to rubber-stamp the bankruptcy judges' "reports and recommendations."
Does this decision mean that the mere filing of a claim in a bankruptcy case constitutes implied consent to jurisdiction for all purposes? I don't think so: recall that in Stern, the non-bankrupt litigant had filed a claim, and yet the bankruptcy court was held to be without power to hear and determine a non-core counterclaim asserted against him.
• The unclean hands defense cannot be strictly enforced in a nondischargeability case, where the bankrupt's misconduct outweighed the victim's illegal behavior. [Northbay Wellness Grp., Inc., vs. Beyries, 789 F.3d 956 (9th Cir. 2015).]
Comment: The court cited Republic Molding Corp. v. B.W. Photo Utils., 319 F.2d 347, 350 (9th Cir. 1963), for the proposition that the unclean hands doctrine requires equitable balancing. The Northbay decision appears to revive that contextual approach, instead of applying the "unclean hands" rule as a strict per se defense involving no weighing and balancing. (Perhaps the name of the rule will have to be changed to the "uncleanest hands" defense.)
Unless Northbay is confined to the narrow context of attorney/client disputes, I predict (as I have before) that the Ninth Circuit (unlike other circuits) will soon hold that the unclean hands and "in pari delicto" defenses cannot be mechanically applied in suits by bankruptcy trustees against non-debtors but must instead yield to equitable balancing.
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• A liquidating trustee's claim against a bank that supposedly aided and abetted corporate wrongdoers was barred by the doctrine of in pari delicto ("equal fault"), despite earlier dicta in a Ninth Circuit opinion stating to the contrary. [In re Mortg. Fund '08 LLC, 527 B.R. 351 (N.D. Cal. 2015).]
Comment: Bankruptcy courts are courts of equity, and the Ninth Circuit's "dicta" in F.D.I.C. v. O'Melveny & Myers, 61 F.3d 17 (9th Cir. 1995), was based in equity, rather than on statutory grounds. Yet the district court in this case did not discuss whether the holding in O'Melveny (as distinguished from its dicta) was based on statutory or equitable grounds, since an equitable basis for the holding in O'Melveny would presumably apply in bankruptcy. Nor did the district court discuss why the rule in O'Melveny should apply to receivers but not to trustees; I do not know of a principled policy distinction between those two contexts.
• An ORAP lien is deemed to be a "commencement or continuation" of an action; thus, the lien's expiration is tolled by § 108(c) of the Bankruptcy Code. [In re Swintek, 2015 Westlaw 9285723 (B.A.P. 9th Cir. 2015).]
Comment: If this case goes up to the circuit level, I predict reversal. The problem is in the wording of§ 108(c). It applies solely to the "commencement or continuance" of an action. By contrast, see § 362(a), which expressly applies to "commencement or continuation" of an action in...
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