Recent Developments Affecting Insolvency and Commercial Finance in California and the Ninth Circuit
| Publication year | 2017 |
| 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 tax sale conducted in accordance with state law conclusively established that the sale was for a "reasonably equivalent value," thus precluding a fraudulent transfer attack against the purchasers.3
Comment: This result is not a surprise, and I would expect the other circuits to fall into line behind the Ninth, Fifth, and Tenth Circuits. Bottom line: don't buy a piece of property that has already been "tax defaulted" unless you are pretty sure that there is equity available and that you can raise the cash to pay off the tax liens. Otherwise, the property will be sold, and a fraudulent transfer attack on the sale will almost certainly fail.
• Payments between corporate affiliates were recoverable as fraudulent transfers because the parties failed to issue invoices for services rendered, thus negating the defense that the debtor received "reasonably equivalent value" for the payments.4
Comment: Many well-intentioned inter-corporate transactions are poorly documented, needlessly exposing the participants to fraudulent transfer liability. There is an unfortunate tendency on the part of smaller businesses (and their counsel) to treat parent/subsidiary or sibling deals as if they were purely intra-corporate events, and of course they are not.
• The Ninth Circuit has certified a question to the California Supreme Court, asking whether a dissolved law firm has a continuing property interest in post-dissolution hourly fees paid by its former clients to the firm's former attorneys.5
Comment: The technical differences between the former Uniform Partnership Act and the Revised Uniform Partnership Act are subtle. The result may ultimately depend on policy considerations, and I predict that the defendant law firms (challenging the interest of the dissolved firm) will prevail. If a waiver of Jewel v. Boxer6 is unenforceable, the departing attorneys cannot realistically perform hourly services for their former clients, and the clients would be forced to find new counsel. That hurts the clients, and that is not a trivial concern.
• A security interest in a vehicle was preferential because of the delay in filing a title application, which was caused by a bank's requirement that the loan documents be amended to correct technical problems with the signature block.7
Comment: This fact pattern presents a new twist on the "belated vehicle perfection" scenario. Usually, the delay in perfection is attributable to bureaucratic ineptitude on the part of the DMV. In this case, however, the fatal delay was the result of the bank's careful attention to detail: someone reviewing the file realized that there were inconsistencies between the recitals in the purchase agreement and the signature block and then insisted that the errors be corrected. No good deed goes unpunished.
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• Even though a quitclaim deed was nominally recorded, a trustee in bankruptcy had no constructive notice of it because the deed was "wild," and the trustee (as a hypothetical purchaser) was not required to search under the Assessor's Parcel Number.8
Comment: If the grantee had sought title insurance, the insurer would almost certainly have realized that the transaction was not properly recorded. In addition, the parties must verify that the document has been properly indexed. The grantee (or, preferably, the grantee's counsel) should calendar a post-closing check, after the dust settles.
B. Chapter 11.• When a plan of reorganization cures a Chapter 11 debtor's default on a secured debt, the creditor is entitled to collect interest at the default rate specified in the underlying promissory note, thus overruling In re Entz-White Lumber & Supply, Inc.9 10
Comment: If this decision stands, it will make it much harder for Chapter 11 debtors to cure existing defaults, since virtually all promissory notes contain default interest rates. Given the practical impact of this case, I think that it is a prime candidate for review en banc or by the Supreme Court.
• A third-party creditor holding a claim that was originally owned by the debtor's parent entity could vote for the debtor's cramdown plan, even though the claim had been purchased for far less than its full value and the creditor had a close personal relationship with a member of the parent's Board of Directors.11
Comment: This ruling violates the ancient principle of "nemo dat qui non habet," i.e., "no man gives that which he did not have." The parent could not have voted its claim for the cramdown plan; how can its assignee have acquired greater rights?
• The separate classification of a group of trade creditors in a Chapter 11 plan has to be based on a "legitimate business or economic justification," but the debtor does not have to show that the special treatment of that group is "critical, essential, or necessary" to the reorganization.12
Comment: The court took a realistic view of the objecting creditor's proposed (and stricter) rule. If the courts were to require a showing that the preferential treatment is really necessary, debtors would simply elicit that testimony from the favored class members: "Any vendor asked whether preferential treatment of its prepetition claim is a prerequisite to its future support of the debtor is likely to say 'yes.'"
C. Other Bankruptcy Issues.• Post-petition settlement funds stemming from construction defect litigation constitute "proceeds" of the lenders' collateral under 11 U.S.C.A. §552(b)(1), especially in light of the expansive definition of that term contained in the lenders' deeds of trust.13
Comment: This has to be the right result, but it is surprising that there is so little authority governing this issue. The problem is that § 552(b)(1) does not contain a definition of the word "proceeds," nor does § 101 of the Bankruptcy Code. Compare UCC § 9-102(64)(D), which defines proceeds to include "claims arising out of the loss, nonconformity, or interference with the use of, defect or infringement of rights in, or damage to, the collateral . . . ."
• A bankruptcy trustee could use a § 363 sale as a vehicle for settling claims between the estate and a secured lender; therefore, the objecting party's failure to seek a stay meant that the objections were moot.14
Comment: The lower courts have been reluctant to use § 363 sales as vehicles for the settlement of claims. When a court conducts a § 363 sale, as distinguished from a Rule 9019 settlement, the estate's causes of action are put up for sale to the highest bidder. This decision means that those claims could be purchased by third parties and then prosecuted on behalf of the estate. I would not be surprised if commercial claims purchasers were to organize investment groups to acquire those causes of action.
• Even though a bankrupt transferred her former home to her ex-husband after she had filed a bankruptcy petition, her ex-husband's automatic homestead exemption prohibited the ex-wife's trustee from selling her former home free and clear of the claimed exemption.15
Comment: It seems to me that this case provides a blueprint for fraud, or at least for "double dipping": the spouses buy two houses; they "separate"; one spouse files a bankruptcy petition; and both spouses claim homestead exemptions. The ex-wife in this case moved into her new home (in the court's words) "with no intention ever to return, hours before the joint petition was filed." Coincidence?
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• A foreclosure purchaser's eviction of a holdover homeowner did not violate the automatic stay in the homeowner's bankruptcy case, because the unlawful detainer judgment had terminated the former homeowner's possessory rights.16
Comment: This sounds like a big victory for foreclosure purchasers, but it is far from a panacea. Borrowers who default on home mortgages will simply file their bankruptcy petitions sooner, rather than later. Instead of waiting to file until after the unlawful detainer judgment has been entered (thus terminating all of their possessory rights), they will file bankruptcy as soon as they have been served with the unlawful detainer complaint, staying the state court proceedings and dragging the entire issue into bankruptcy court.
• When a vendor of real property pledges a note and trust deed encumbering that property as additional collateral for his own obligation to a bank, a remote third-party purchaser of the property could not pay off the vendor and thereby destroy the bank's interest in the deed of trust, especially where the purchaser had imputed notice of the bank's interest in the property.17
Comment: I think that this opinion is a case of "right result, wrong reason." The court failed to address the issue of the original vendor's lack of authority to accept payment on the note, after he had already pledged it as collateral to the bank. I know of no case holding that a borrower has actual authority to unilaterally accept payment on the note and extinguish the corresponding lien, without prior authorization from the secured party.
• A long-term installment land sale contract could be recharacterized as a disguised lease, thus permitting the vendor to use the remedy of unlawful detainer to evict the defaulting purchaser/tenant.18
Comment: Usually, the...
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