Attorneys Danny Newman and Eric Levine wrote an in-depth article recapping recent Ninth Circuit case decisions for the Spring edition of the Oregon State Bar (OSB) Debtor-Creditor Section Newsletter. You can read their article in full below.
Danny Newman is a partner in Tonkon Torp’s Litigation Department, where he focuses his work in bankruptcy, reorganization, and insolvency and serves as Co-Chair of the Government Law & Disputes Practice Group.
Eric is an associate in Tonkon Torp’s Litigation Department. He has authored briefs filed in state and federal courts, including the U.S. Court of Appeals for the D.C. Circuit and the D.C. Court of Appeals; and he has contributed to amicus briefs filed with the Supreme Court of the United States.
NINTH CIRCUIT CASE NOTES
Without a ‘Limited Fund’ Bankruptcy Plan, Creditors Lack Standing to Challenge Trustee Compensation
In re East Coast Foods, Inc., 80 F.4th 901 (9th Cir. 2023)
This case involved a challenge to the Chapter 11 trustee’s compensation by a general unsecured creditor where that creditor was eventually to be paid in full with interest. The 9th Circuit held that the general unsecured creditor lacked Article III standing to challenge fees under those circumstances.
In 2016, East Coast Foods filed for Chapter 11 bankruptcy, and an official committee of unsecured creditors was appointed to monitor East Coast Foods’ activities. After an examiner found that East Coast Foods could not meet its fiduciary obligations, Sharp was appointed as trustee.
By any measure, Sharp did a decent job. Over the course of two years, he worked with the committee and created a plan that guaranteed full payment—with interest—to all creditors. The guarantee was secured by a collateral package that included equity in assets with a value nearly doubling the outstanding debt. The plan is projected to pay off its final creditor in four to six years.
Sharp was so confident in his work that he sought the maximum fee for a trustee allowable under the Bankruptcy Code—then $1,155,844.71. That represented his loadstar figure ($758,955.50) plus an upward enhancement of 65% for exceptional services. An unsecured creditor, Clifton Capital Group, LLC (“Clifton”), objected to the enhancement. The bankruptcy court overruled the objection, and Clifton appealed to the district court.
There, Sharp argued Clifton lacked standing because it was not an aggrieved party. The district court disagreed, finding that Clifton was an “aggrieved party” because there was insufficient capital to pay it in full. It then held that Sharp’s increased compensation aggrieved Clifton by further subordinating its debt. It remanded for further factual finding on the reasonableness of Sharp’s enhancement. On remand, the bankruptcy court again found Sharp was entitled to an enhancement, and Clifton again appealed. This time, however, the district court affirmed Sharp’s fee award, and Clifton appealed to the 9th Circuit.
Before addressing whether Clifton was an “aggrieved person,” the 9th Circuit held that an “aggrieved person” standing in bankruptcy is prudential standing, and the court should first consider whether Clifton had Article III standing. Clifton argued that it suffered an injury in fact because it had not been paid in full on its claim. Sharp countered that injury was conjectural and hypothetical because the bankruptcy plan would pay all creditors in full, and Clifton would suffer no injury by a delay in receiving its payment because all creditors would be paid in full with interest.
The 9th Circuit agreed with Sharp. It held that the district court erred in applying “limited fund” jurisprudence to this case where “additional monies” were available if East Coast Foods deviated from the bankruptcy plan. Because the guarantee, if liquidated, was sufficient to pay all creditors in full with interest, there was no “limited fund,” and Clifton suffered no injury in fact. Nor did the 9th Circuit agree with Clifton that it was injured by a delay in payment. For one thing, Clifton would be paid interest on its debt, and for another, the bankruptcy plan did not guarantee a date by which all creditors would be paid. The 9th Circuit noted that the estimated time period when creditors would be paid had not elapsed by the time it decided this case, providing another example of why the case was not yet ripe.
This case is a good result for all of us who like to get our fees paid!
Debtors Charged Unconstitutional UST Fees Are Entitled to Refunds
USA Sales, Inc. v. Office of United States Tr., 76 F.4th 1248 (9th Cir. 2023)
This case answers a question left open by the Supreme Court in the October 2021 term: are bankruptcy debtors who paid unconstitutional fees to the Office of United States Trustee (“UST”) entitled to a refund? Or, as the 9th Circuit framed the question, “Can the government take the money and run?”
As a refresher, the UST administratively manages bankruptcy proceedings for all but six districts in the United States. Those six, located in North Carolina and Alabama, are administered by Bankruptcy Administrators (“BA”). Fees are uniform between the two systems so that they do not violate the bankruptcy uniformity clause of the Constitution. The Bankruptcy Judgment Act of 2017 (the “Act”) took effect on January 1, 2018, and increased fees in UST jurisdictions but did not simultaneously raise fees in BA jurisdictions. Fee increases were to come later in BA jurisdictions.
USA Sales, Inc., filed for Chapter 11 bankruptcy in 2016, and by 2021 had this appeal pending. The UST managed the bankruptcy case and initially charged USA Sales, Inc., about $13,000 per quarter in fees. On January 1, 2018, that jumped to $87,000 per quarter. From then until November 2019, when the court approved a structured dismissal of the case, UST charged USA Sales, Inc., $595,849 in fees more than USA Sales, Inc., would have been charged in a BA jurisdiction.
USA Sales, Inc., sued for a refund of all excess fees charged, arguing that the fee increase violated the Bankruptcy Clause of the Constitution and that the fee increase did not apply to it because USA Sales, Inc., had filed for bankruptcy before Congress passed the Act authorizing the increases. The district court agreed with USA Sales, Inc., and UST appealed to the 9th Circuit. While the appeal was pending, the Supreme Court held that fee increases pursuant to the Act were unconstitutional, but it reserved the remedy question.
UST urged that prospective relief was a sufficient remedy, or failing that, retroactively increasing fees on BA jurisdictions was more appropriate than refunding fees in UST jurisdictions.
Unsurprisingly, given how the 9th Circuit framed the issue, it rejected UST’s arguments. It relied on case law regarding unconstitutionally discriminatory taxes to guide its analysis for prospective relief. And, in that context, taxpayers are entitled to retrospective relief even if a taxing authority fixed its constitutional issue. As the 9th Circuit put it, “prospective relief alone provides no relief and instead serves to cement the unconstitutional treatment” because “promising not to take the money again is not the same as giving the money back.”
Once USA Sales, Inc., was entitled to retroactive relief, the court had to determine what form that relief should take. The 9th Circuit was unpersuaded by UST’s argument that it should retroactively raise fees on cases administered in BA jurisdictions. As an initial matter, the court lacked authority to do that because the BA jurisdictions were in North Carolina and Alabama—neither of which is in the 9th Circuit.
Moreover, the court was unpersuaded on the merits as well. UST’s plan to reopen bankruptcies after more than half a decade and impose significant fees violated the heightened need for finality in bankruptcy.
Finally, to the extent Congressional intent favored clawing back BA fees, that statutory construction would violate the due process rights of UST jurisdiction bankruptcy debtors. As the court rejected all of UST’s arguments on appeal, it affirmed USA Sales, Inc.’s refund.
This same issue is pending before the Supreme Court in Office of the U.S. Tr. v. John Q. Hammons Fall 2006, LLC, No. 22-1238, which was argued on January 9, 2024. There is a pending cert petition in the USA Sales matter (No. 23-489), which will likely be held until the Supreme Court resolves the John Q. Hammons case.
Increases in Home Equity Between Chapter 13 Reorganization Filing and Conversion to Chapter 7 Liquidation Belong to Estate and Not Bankruptcy Debtors
In re Castleman, 75 F.4th 1052 (9th Cir. 2023), cert. denied, 144 S. Ct. 813 (2024)
This case presented the question of whether post-petition, pre-conversion increases in the equity of an asset belong to the bankruptcy estate or to debtors who convert their Chapter 13 debt adjustment petition into a Chapter 7 liquidation. In a split decision, the 9th Circuit concluded that any appreciation in the property value and corresponding increase in equity belongs to the estate upon conversion.
Debtors John Felix Castleman, Sr., and Kimberly Kay Castleman (the “Castlemans”) filed Chapter 13 petitions. At the time, their house was valued at $500,000. About 20 months later, they had trouble making their payments and opted to convert to a Chapter 7 liquidation. In the interim, the value of the Castlemans’ home increased by about $200,000. The Chapter 7 trustee filed a motion to sell the house and recover its value for creditors; the Castlemans objected and argued the increased equity belonged to them.
On appeal, the 9th Circuit—as it has been doing more consistently for several years now—relied on the plain language of Section 348(f), which states, “property of the estate in the converted case shall consist of property of the estate, as of the date of filing of the petition, that remains in the possession of or is under the control of the debtor on the date of conversion.”
It held that this language was unambiguous when read in the context of the rest of the Bankruptcy Code. It looked to, most importantly, Section 541(a), which defines “property of the estate” as all legal or equitable interests of the debtor in property as of the commencement of the case. The court reasoned that post-petition appreciation in assets is not separate, after-acquired property. Rather, the equity is inseparable from the real estate, which was always property of the estate under Section 541(a).
In so holding, the 9th Circuit split with other courts. The court noted that many disagreeing courts rely on the legislative history for Section 348(f), which was enacted to clarify whether new property acquired during the course of Chapter 13 proceedings becomes property of the converted estate. However, the court held that the language of Section 348(f) was not ambiguous, so it would not consider the legislative history. It likewise disagreed with courts that rely on the implicit operation of Section 1327(b) because Congress could have expressly cross-referenced Section 1327(b) if that is what it intended.
The majority drew a spirited dissent from Judge Tallman, who argued the majority scarified the text of the bankruptcy statute on the altar of simplicity. He continued that reading the Bankruptcy Code as a whole, and not just Section 541(a), reveals that “property of the estate” is defined differently in the Chapter 7 and Chapter 13 contexts. To Judge Tallman, the majority’s reading contradicted the Code’s structure, object, policies, and legislative history. Judge Tallman concluded by stating that reasonable judicial minds could disagree on the issue and called on Congress to clarify the operation of Section 348.
The Eighth Circuit Court of Appeals recently aligned itself with the Castleman panel majority. See Goetz v. Weber (In re Goetz), 95 F.4th 584 (8th Cir. 2024) (holding that “a post-petition, pre-conversion increase in equity in the debtor’s residence became property of her converted bankruptcy estate”).
Debtor with Assets Who Fails to Properly Serve Creditor Will Not Discharge Any Debt to Them
Licup v. Jefferson Ave. Temecula LLC, __ F.4d __, 2024 WL 1151662 (9th Cir. 2024)
This case presented the question of whether any portion of an unscheduled debt is dischargeable in a Chapter 7 bankruptcy proceeding. The 9th Circuit concluded the answer is no.
Christina Castro and her spouse, Edwin C. Licup, filed for Chapter 7 bankruptcy but did not give notice to one creditor. For that creditor, Jefferson Avenue Temecula LLC (“Jefferson”), Castro and Licup incorrectly listed the mailing address for Jefferson’s attorney on their schedule. Jefferson did not file a claim in the bankruptcy action, which closed in 2016.
In 2021, Jefferson sued to collect its debt. Castro and Licup filed a motion for summary judgment arguing that the only nondischarged debt was the limited amount that Jefferson would have recovered had it filed its claim in the original bankruptcy and been treated the same as other unsecured creditors ($1,614.74 out of $31.780.29). The bankruptcy court rejected this argument and sua sponte granted summary judgment for Jefferson. It concluded that no portion of Jefferson’s debt was dischargeable because it was undisputed that Jefferson had no notice of the bankruptcy case, and holding otherwise would violate its due process rights. The bankruptcy appellate panel affirmed.
The 9th Circuit also affirmed. As an initial matter, the court concluded that Jefferson had standing. Castro and Licup argued Jefferson lacked standing because its debt—an unlawful detainer judgment against Christina Castro, LLC, and not Christina Castro, D.D.S.—was unenforceable. The court did not decide on that question. For standing purposes, it concluded that Jefferson suffered an injury in fact when its debt remained unpaid. Whether it could enforce its judgment was a matter of state law, and a separate question from the one presented by the appeal: whether a debt could be discharged without providing notice.
On the merits, Castro and Licup argued that the court should apply its “non-asset” bankruptcy jurisprudence to cases where there are assets to limit the nondischargeable amount to the amount the creditor would have received if it filed a claim. Non-asset cases, such as In re Beezley, 994 F.2d 1433 (9th Cir. 1993) (per curiam), found no problem with discharging all debts despite the debtor not notifying creditors of the bankruptcy.
The 9th Circuit rejected the Debtors’ argument because in no-asset, no-bar-date Chapter 7 bankruptcy cases, there are no assets to distribute, so it would be “meaningless and worthless” for creditors to file claims. Because the court refused to create a carve-out to reduce the nondischargeable amount in any way, 11 U.S.C. § 521(a)(1) applied in full. Castro and Licup failed to comply with the requirements to have a debt discharged, so their debt to Jefferson rode through unimpacted and stood as if the bankruptcy had never occurred.
Factoring Company Holding Itself Out as Secured Creditor Is Treated as Creditor against Bankruptcy Estate and Not Purchaser of Future Asset
In re Medley, 2024 WL 49806 (9th Cir. Jan. 4, 2024)
Factorers often make creative arguments about their idiosyncratic arrangements with debtors. The 9th Circuit has rejected several of them in a potential blow to the industry.
Jill Suzann Medley was a real estate broker who received an advance on her commission for the sale of a property from Precision Business Consulting, LLC (“Precision”). Before the property was sold, Medley filed for Chapter 13 bankruptcy. Later, when the property was under contract, and several months after receiving notice of the bankruptcy petition, Precision contacted both Medley and her client to collect its assigned portion of the commission. Subsequently, Medley’s petition was dismissed, and she filed a motion for sanctions against Precision for violating the automatic stay under 11 U.S.C. § 362(k). After an evidentiary hearing, the bankruptcy court granted the motion. The BAP affirmed.
Precision made three arguments, and the 9th Circuit rejected them all. First, it argued that as a factoring company, it had purchased Medley’s commission, so the commission was not part of the bankruptcy estate. The court applied the test for recharacterization from Boucher v. Shaw, 572 F.3d 1087 (9th Cir. 2009) (en banc), to determine that the transaction was a loan, not a sale. That was so because Medley would have full liability if settlement failed to occur— i.e., she bore the full transaction risk. See Shaw, 572 F.3d at 802 (holding that the primary factor for recharacterizing a sale as a loan is who bears the risk). Moreover, Precision held itself out as a secured creditor by filing a proof of claim, commenting that it had perfected a security interest in the property. That was sufficient to determine Precision made a loan, not a purchase, and the commission was part of the bankruptcy estate.
Next, Precision argued it did not intentionally violate the stay because it had a good faith belief that it had purchased the commission. The court again rejected that position because intentional volition of the stay provision requires only knowledge of the stay and that the creditor’s actions that violated the stay were intentional.
Finally, Precision argued that it owned the money it gave Medley before she filed for bankruptcy, and Medley simply possessed it. Therefore, its collection effort was simply an attempt to retain its own property. However, the court concluded that an automatic stay is intended to preserve the status quo. And because Medley held the money at the time of filing for bankruptcy, the stay operated to allow her to continue holding it. As the court rejected all three of Precision’s arguments, it affirmed the sanctions imposed against Precision.
This article was originally published in the Spring 2024 issue of the Oregon State Bar Debtor-Creditor Newsletter.
