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Tuesday, December 31, 2013

Happy New Year!

Happy New Year from Macdonald Fernandez LLP.

Monday, December 30, 2013

Quick Note on Judgment Liens in California

In California, a judgment lien against real property generally remains in effect until 10 years from the date of entry of the judgment, unless the judgment is earlier satisfied or the lien is released. Cal. Civ. Code § 697.310(b); FDIC v. Charlton, 17 Cal. App. 4th 1066, 1069 (1993).  The lien may be extended for an additional 10 years upon renewal of the judgment and the filing of a certified copy of the renewal application before expiration of the judgment lien. Cal. Civ. Code § 683.180; Beneficial Fin. Inc. v. Durkee, 206 Cal. App. 3d 912, 916–917 (1988).  The 10-year period for the extension runs from the date of filing of the application for renewal with the court clerk. Cal. Civ. Code § 683.180.

By Matthew J. Olson

Friday, December 27, 2013

Happy Holidays!

Merry Christmas from Macdonald Fernandez LLP, and have a Happy New Year!

Wednesday, December 18, 2013

Partnership That Never Existed Cannot Create Nondischargeable Debt

In Utnehmer v. Cruel (In re Utnehmer), 2013 Bankr. LEXIS 4482, NC-12-1362-PaDJu (9th Cir. BAP Oct. 10, 2013), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit ("BAP") ruled that Bankrupcty Code Section 523(a)(4) did not apply to render a debt nondischargeable in relation to a partnership that was never formed.  Specifically, an agreement to re characterize debt as profit-sharing equity was conditional upon events that did not occur.

William Utnehmer participated in a general partnership for real estate development.  In connection with the development of a luxury residence, Utnehmer provided the plaintiffs with a loan agreement, a promissory note and a private offering memorandum.  To summarize, the documents provided that the plaintiff would make a loan of $100,000 at 12% interest secured by a lien against the property.  Conditional upon the drafting and execution of a formal operating agreement, $50,000 of the loan would be re characterized as an equity contribution with a 10% annual preferred return and a 35% share of the profits, prorated based on the equity contribution.  The agreements were executed, and the loan was funded, but the operating agreement was never prepared.  The plaintiffs received interest payment in the three years that followed, but no principal.

After the plaintiffs retained counsel to enforce the obligation, Utnehmer and his spouse agreed to pay $50,000 in installments of $2,000 per month and that the remaining $50,000 would be recharacterized as equity upon the sale of the property and paid along with a 10% preferred return and their prorated share of 35% of the net proceeds.  Only $4,000 was paid, and when the property was sold for $3,725,000, Utnehmer apparently told the plaintiffs he could not pay them from the proceeds.  The plaintiffs brought and action, which resulted in a default judgment for $213,645.17.

Thereafter, Utnehmer and his spouse filed a chapter 7 bankruptcy case, and the plaintiffs brought an action to render the debt nondischargeable.  The complaint plead causes of action under Bankruptcy Code Sections 523(a)(2) (fraud) and 523(a)(6) (willful and malicious injury), which were unavailing, but prevailed under Section 523(a)(4), which was raised at trial and not challenged as untimely.

Bankruptcy Code Section 523(a)(4) provides that a debt "for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny" is nondischargeable.  The phrase "while acting in a fiduciary capacity" has long been interpreted to require the existence of an express trust (arising by agreement) or technical trust (arising by statute or by law).  The Ninth Circuit previously applied a very low standard to "defalcation," holding that it includes any failure to account sufficiently, regardless of benign intent.  In re Lewis, 97 F.3d 1182, 1186-1187 (9th Cir. 1996).  To summarize, the claim that arises when a trustee takes property out of trust is not dischargeable in bankruptcy.

The bankruptcy court applied In re Lewis in finding that there was a defalcation.  However, there was a subsequent change in the law when the Supreme Court of the United States decided Bullock v. BankChampaign, N.A., 133 S.Ct. 1754 (2013), in which the Court rule that "defalcation" includes "a culpable state of mind requirement akin to that which accompanies application of the other terms in the same statutory phrase.  We describe that state of mind as one involving knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior."

The bankruptcy court also concluded that the debtor and the plaintiff were partners based upon the loan agreement's terms providing for a re characterization if debt as equity.  California law provides that that all partners hold partnership assets in trust.  Ragsdale v. Haller, 780 F.2d 794 (9th Cir. 1986).  

The BAP reviewed this determination de novo and found that the loan agreement was insufficient to establish a partnership as a matter of law.  Specifically, the text of the agreement plainly stated that the loan would be partially re characterized as equity only upon the execution it an operating agreement for a limited liability company to be formed in the future.  An agreement to be partners in the future or upon the fulfillment of a contingency does not establish a partnership until that time arrives.  Solomont v. Polk Dev. Co., 245 Cal.App.2d 488, 496 (1966).  The parties may have become partners of they actually shared profits or management, but they never did.  

Moreover, the court notes that there is no case applying the rule in Ragsdale to a limited liability company.  Likewise, California law provides that officers and directors of a corporation do not hold company assets in trust within the meaning if Bankruptcy Code Section 523(a)(4).  Cal-Micro, Inc. v. Cantrell, 329 F.3d 1119 (9th Cir. 2003).

Also seen on Legal By the Bay, the Bar Association of San Francisco's blog.

Friday, December 13, 2013

Order for Relief From the Automatic Stay in Husband's Bankruptcy Case Enforced in Wife's Subsequent Case

In Alakozai v. Citizens Equity First Credit Union (In re Alakozai), 2013 Bankr. LEXIS 4380, NC-12-1470-PaDJu (9th Cir. BAP Oct. 2, 2013), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit ("BAP") affirmed a bankruptcy court order granting relief from the automatic stay to proceed with an unlawful detainer action against the debtor notwithstanding the filing of the sixth bankruptcy case involving her residence.  The BAP also ruled that the lender’s prior foreclosure on the debtor’s real property during the fifth case did not violate the automatic stay because the lender’s order granting relief from the automatic stay in the fourth case (filed by her husband only) was effective in rem under Bankruptcy Code Sections 362(d)(4) and (20).
Debra Alakozai held a community property interest in certain real property encumbered by a promissory note in her husband's name secured by a deed of trust.  Her husband defaulted on the note and a trustee’s sale was scheduled. Thereafter, Alakozai and/or her husband variously filed a total of six bankruptcy cases.  The lender obtained relief from the automatic stay in the fourth case under Bankruptcy Code Section 362(d)(4) pursuant to an order providing that it was effective as to the property for 180 days.  The lender recorder the order after the case was dismissed.
Alakozai filed her fifth case within the 180-day period, and later that day the lender obtained title to the property at trustee’s sale.  The case was dismissed a month later, but Alakozai and her husband refused to vacate.  The lender commenced an unlawful detainer action.  Several months later, Alakozai and her husband filed the sixth case.  The lender obtained relief from the automatic stay to prosecute its unlawful detainer action, and Alakozai appealed.
Alakozai argued that the bankruptcy court in the fourth case, which was filed by her husband, did not make the necessary findings of fact to support in rem relief.  Therefore, she argued, the bankruptcy court's subsequent order in the sixth case was void.  On the contrary, the BAP found that the prior order was effective when the fifth case was filed and  Alakozai could not challenge the factual findings by collaterally attacking the unappealable and final order. 
Bankruptcy Code Section 362(d)(4) provides that “if the court finds that the filing of the petition was part of a scheme to delay, hinder, or defraud creditors that involved . . . multiple bankruptcy filings affecting such real property” and the creditor records the order, it “shall be binding in any other case under this title purporting to affect such real property filed not later than 2 years after the date of the entry of such order."  Bankruptcy Code Section 362(b)(20) provides that the automatic stay does not bar a lienholder from enforcing its lien if Section 362(d)(4) applies.
Alakozai argued that she was not a debtor in her husband’s bankruptcy case, in which the prior order was entered.  However, the court ruled that an order under Section 362(d)(4) binds any party asserting an interest in the affected property, including "every non-debtor, co-owner, and subsequent owner of the property.”  

Section 362(d)(4) was added to the Bankruptcy Code as part of the Bankruptcy Abuse Prevention and Consume Protection Act of 2005 ("BAPCPA") for the apparent purpose of curbing serial filings.  It will be interesting to see whether the BAP's broad language aids that goal or gives rise to unintended consequences, such as frustrating the reorganization efforts of an arms-length buyer.

Wednesday, December 11, 2013

In re Gasprom: Foreclosure After Abandonment, Before Closure of Chapter7 Case, Violated Automatic Stay

In In re Gasprom, 500 B.R. 598 (9thCir. BAP 2013), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit ("BAP") held that a lienholder violated the automatic stay in bankruptcy by foreclosing on assets abandoned by the trustee before the corporate debtor's chapter 7 case was closed.

Following conversion of the case from chapter 11, the trustee moved to abandon the estate's chief asset, which was a defunct gas station with permitting and hazardous waste issues.  The asset was fully encumbered by a lien.  The bankruptcy court granted the motion over the debtor's objection (citing In re D’Annies Restaurant, 15 B.R. 828 (Bankr. D.M.N. 1981)) and noted that the effect of the abandonment would be to terminate the automatic stay.  The lienholder foreclosed later that day, and the case was closed shortly thereafter.

The debtor filed a motion to reopen the case so that it could set aside the foreclosure and recover for the alleged violation of the automatic stay.  The court reopened the case but denied the motions in advance, ruling that upon entry of the abandonment order, the automatic stay no longer enjoined the sale, and that the court would annul the automatic stay sua sponte to the extent necessary.

The BAP reversed, holding that although the collateral left the estate upon abandonment, the automatic stay remained in effect with respect to property of the debtor under Bankruptcy Code Section 362(a)(5).  The BAP declined to follow authorities holding that the automatic stay only protects the property of an individual debtor (and not a corporate debtor) following abandonment.  Instead, the court followed authorities holding that abandonment returns property to the debtor nunc pro tunc as if no bankruptcy petition had been filed.

Tuesday, December 10, 2013

Update: Disposition of Nortel Cash to be Determined in Joint US-CanadianCourt Hearings, Not Arbitration

Following up on our post on November 4, 2013, the United States Court of Appeals for the Third Circuit ruled on Friday that the diaposition of Nortel Networks' $7.5 billion in cash will be decided in joint US-Canadian court hearings.  The court disagreed with an argument by Nortel's European estates that an agreement referring to undefined "dispute resolvers" compelled arbitration.

Thursday, December 5, 2013

Ninth Circuit BAP Rules California Law Bars Nondischargeability Action by Sold Out Junior on Purchase Money Residential Loan Under $150,000 Notwithstanding Fraud

In Heritage Pacific Financial, LLC v. Montano (In re Montano), 13 C.D.O.S. 12820, NC-12-1579-PaDJu (9th Cir. BAP November 27, 2013), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit ruled that California's statutory one-action rule and anti-deficiency judgment scheme barred an action under Bankruptcy Code Section 523(a)(2)(B) brought by the purchaser of a sold-out junior purchase money mortgage formerly secured by a residence for less than $150,000 regardless of any fraudulent conduct.  

While California Civil Code Section 580b generally prohibits the recovery of a deficiency judgment after foreclosure, Section 726(f) provides an exception such that certain lenders may bring an action "based on fraud" where the borrower's fraudulent conduct induced the original lender to make the loan.  However, Section 726(g) provides an exception to the exception, barring such an action if the loan is secured by a single-family, owner-occupied residence, actually occupied as represented to the lender in obtaining the loan, and the loan is for $150,000 or less (adjusted annually with the Consumer Price Index as published by the United States Department of Labor).

Although certain facts were disputed, the court found that the original lender made both the senior and junior loan to the borrower in connection with his purchase of the home, and the junior loan was for less than $150,000 (the amount demanded was $89,990).  The court dismissed arguments that the $150,000 limit should apply to the aggregate of all purchase money loans, holding that the statute is plain on its face.  

The court also analyzed and affirmed the bankruptcy court's award of attorney's fees and costs to the borrower under Bankruptcy Code Section 523(d), which generally provides for such an award where a creditor brings a nondischargeability action on a consumer debt without substantial justification.  Specifically, the claim buyer could not submit competent evidence that the original lender actually relied on the alleged misrepresentations as to income in the borrower's loan application as the original lender was defunct.

Also seen on Legal By the Bay, the Bar Association of San Francisco's new blog.