Ninth Circuit Reverses Both B'cy Court's & BAP's Summary Judgment on "Willful & Malicious Injury" Under § 523(a)(6)

Please note that this writer is not licensed to practice law in Oregon. This means that he is not legally permitted to give any legal advice or perform any legal services. This Bulletin and the entire contents of this website is written only for attorneys. and is not intended for the public. If any non-attorney is reading this, you must consult an attorney about ANYTHING you read here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Barboza v. New Form, Inc.

9th Circuit Case No. 06-56319

Sept. 23, 2008

Last week the 9th Circuit issued its second opinion in as many months interpreting the "willful and malicious injury" language in § 523(a)(6) of the Bankruptcy Code. The Litigation Report in this website for the week of September 21 - 28 highlighted the 1st of these two opinions, Lockerby.v. Sierra, on the necessary elements for an intentional breach of contract to be a nondischargeable "willful and malicious injury."

Now in Barboza, the 9th Circuit comes back to this same "willful and malicious injury" language, although not in the narrow breach of contract context. Here the Court reversed both the bankruptcy court and the BAP, primarily by finding that neither court applied the 9th Circuit's law on § 523(a)(6)'s "willful and malicious injury" language accurately. Procedurally, the bankruptcy court had granted the plaintiff creditor a motion for summary judgment, and the BAP agreed that summary judgment was appropriate. This Litigation Report summarizes the procedural aspects of this opinion; please see this website's Bulletin of 9/30/08 for a summary of the substantive law.

The issue was the appropriateness of granting a motion for summary judgment in favor of the creditor, that is , whether the pleadings and the evidence before the bankruptcy court "show that there is no genuine issue as to any material fact and that the movant is entitled to judgment as a matter of law.” Fed. R. Civ. P. 56(c). The complication here is that a judgment for willful copyright infringement had been entered against the debtors in federal District Court (for nearly $800,000) before they filed their bankruptcy case, and the bankruptcy judge decided that the trial court's findings would be binding in the adversary proceeding on nondischargeability. Those findings were sufficient to address some but not all of the elements of a § 523(a)(6) "willful and malicious injury." Each of the three courts--the bankruptcy court, BAP, and 9th Circuit--analyzed this interplay between the prior civil judgment against the debtors and the requirements under § 523(a)(6) differently.

The Bankruptcy Court

The pertinent jury instruction in the District Court trial was as follows:

To prove willful infringement, the Plaintiff must prove by a preponderance of the evidence that the Defendants knew that they were infringing the Plaintiff’s copyrights or that they acted with reckless disregard as to whether they were doing so. If you conclude that the Defendants reasonably and in good faith believed that they were not infringing the Plaintiff’s copyrights, then you may not find that they willfully infringed those copyrights.

The bankruptcy judge recognized that the "willful" in copyright infringement is broader than the "willful" in § 523(a)(6), that, as the above jury instruction shows, the former includes acting "with reckless disregard," not just acting deliberately and intentionally. So in response to the creditor's motion for summary judgment, the judge set the issue of subjective intent for trial. But the creditor persisted, filing a partial motion for summary judgment specifically on the issue of intent, although without any new evidence. In opposition the debtors filed affidavits stating that someone other than debtors had ordered the duplication of the copyrighted movies at issue, and had received and diverted the movies. But the court held that the evidence showing that debtors knew about the copyright, and that, together with the jury's finding of willful infringement, constituted a willful injury , and so it decided after all to grant summary judgment to creditor.

The BAP

The BAP affirmed as to the "willful" prong on the basis that the bankruptcy court appropriately determined that debtors "had the requisite subjective intent to injure another's property interest."

The BAP recognized that the bankruptcy court had failed to make a separate inquiry about the "malicious" prong of "willful and malicious." but its solution: the "BAP implied 'maliciousness' from the Bankruptcy Court’s finding of willfulness. The BAP reasoned that 'an award of statutory damages based on willful copyright infringement is a debt for an injury to the owner’s property interest.' Accordingly, the BAP reasoned that '[t]he only remaining proof required was that Debtors were aware of Appellee’s copyright at the time they infringed it.' ” So the BAP held that debtors' knowledge of the creditor's copyright interest at the time of infringement established the "substantial certainty" of the resulting injury.

The Ninth Circuit
Question of Material Fact about Willfulness

The Court held that the creditor did not meet its burden of showing the absence of a genuine issue of material fact about whether debtors' acted willfully. Based on the evidence before it on the two motions for summary judgment, the bankruptcy court " had no way to determine whether the jury found the willful infringement based on a reckless disregard or a knowing violation of [creditor's] copyright." Citing the U.S. Supreme Court opinion Kawaauhau v. Geiger, 523 U.S. 57 (1998), willful injuries under § 523(a)(6) are specifically limited to "deliberate or intentional" injuries.

The 9th Circuit instead found a genuine issue of material fact in evidence that someone else other than the debtors had ordered the pirated movies and therefore summary judgment on the willfulness element was in error.

Lack of Finding About Maliciousness

As to the bankruptcy court and its adoption of the trial court's findings, the 9th Circuit stated: "Because the District Court ... did not address the “malicious” prong of § 523(a)(6), and the jury made no findings in this regard, we cannot discover any separate findings of uncontroverted fact of maliciousness by the Bankruptcy Court." The 9th Circuit held that this lack of a separate finding on maliciousness was reversible error.

The BAP's reversible error was in implying maliciousness from willfulness. Although acknowledging
that

there may be some overlap between the test for “willfulness” and the test for “malice,” [citation omitted] the overlap does not mean that the Bankruptcy Court can ignore entirely the malice inquiry. We require a separate analysis for each of the “willful” and “malicious” prongs. [Citations omitted.] The BAP’s conclusion that the Appellants’ actions were malicious under § 523(a)(6) rested entirely on its conclusion that the Appellants’ actions were willful under § 523(a)(6).

The Bottom Line
1) If a bankruptcy court adopts the findings of a trial court in an adversary proceeding on nondischargeability of a "willful and malicious injury" claim under § 523(a)(6), the bankruptcy court must take care that the elements of the trial court's findings match the elements required for nondischargeability. Particularly, summary judgment for creditor is not appropriate if the definition of willfulness is broader in the trial court findings than under § 523(a)(6), such as when that definition included injuries from recklessness, leaving a genuine issue of material fact about whether the underlying judgment was based on conduct which is not adequate to determine nondischargeablity. Under that circumstance, the adversary proceeding must go to trial to establish if the conduct was intentional and deliberate, not just reckless.

2) A bankruptcy court must make separate findings as to the "willful" and "malicious" prongs under § 523(a)(6). One can not be inferred from the other.

by: Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

Please note that this writer is not licensed to practice law in Oregon. This means that he is not legally permitted to give any legal advice or provide and legal services. This Bulletin and the entire contents of this website is written only for attorneys. and is not intended for the public. If any non-attorney is reading this, you must consult an attorney about ANYTHING you read here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2008 Bankruptcy Litigation Support for Attorneys

When Is Intentional Breach of Contract Nondischargeable Under § 523(a)(6)?: 9th Circuit Proclaims Legal Standard for "Willful & Malicious Injury"

by Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com


Lockerby v. Sierra (In re Sierra)
9th Circuit Case No. 6-15928
August 7, 2008

This is a quick study in two published opinions about what it takes for a breach of contract claim to be nondischargeable under the "willful and malicious injury" provision of § 523(a)(6). One is the Lockerby opinion referenced above; the other is the January 2008 bankruptcy court opinion of Judge Perris' Home Instead Senior Care of Oregon v. Treon (In re Treon). Both of these rely heavily on a 2001 9th Circuit opinion, Petralia v. Jercich (In re Jercich), 238 F.3d 1202. The primary point of this quick study is to determine what if anything the recent Lockerby opinion added to the law on this issue in Oregon that wasn't already in Judge Perris' Home Instead opinion, other than the weight of greater authority. (Please see my earlier summary of this Home Instead opinion in the Oregon Bankruptcy Opinions section of my website.)
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These opinions are made a bit more personal in that Judge Perris was one of the three judges on the Bankruptcy Appellate Panel that had been overturned back in 2001 by the 9th Circuit in Jercich, which opinion she then used as her main precedent earlier this year in Home Instead.

9th Circuit in Lockerby

In the recent Lockerby opinion the 9th Circuit held that "an intentional breach of contract cannot give rise to nondischargeability under § 523(a)(6) unless it is accompanied by conduct that constitutes a tort under state law." It overruled both the underlying bankruptcy court and the district court in determining that the claim against debtor was dischargeable. The debtor was an attorney, the creditor a former client. The claim, a rather odd one, was based on a settlement agreement entered into to settle a malpractice claim by the client against the attorney, through which the client was to receive 50% of attorney's proceeds on four of his pending personal injury claims; the attorney breached that contract when he determined for himself that the client did not have a valid malpractice claim against him.

The Court relied heavily on the 2001 9th Circuit Jercich opinion referred to above, saying: "The Jercich court undertook a two-part inquiry to determine whether the breach of contract rendered the debt excepted from discharge, first examining whether the debtor’s conduct was 'tortious,' and then asking whether the debtor’s conduct was both 'willful' and 'malicious.' "

Interestingly, after referring to this "two-part inquiry," it's entire remaining analysis seemed to be on the first part. "Something more than a knowing breach of contract is required before conduct comes within the ambit of § 523(a)(6) and Jecich defined that 'something more' as tortious conduct."

The issue then becomes what is tortious conduct for this purpose? Conduct is not tortious, according to Lockerby, again using Jercich as precedent, "simply because injury is is intended or 'substantially likely to occur,' but rather is only tortious if it constitutes a tort under state law." Otherwise, reasoned the Court, the core principle of debtors' "fresh start" would be seriously challenged, because a large portion of debts arise from debtors' intentional breaches that are substantially likely to harm the creditor. Since the debtor's breach of the settlement agreement was not tortious according to Arizona law, the creditor's claim arising from it was dischargeable under § 523(a)(6).

Judge Perris in Home Instead

Judge Perris' bankruptcy court opinion issued in January 2008, Home Instead Senior Care of Oregon v. Treon, involved a debtor's breach of a Non-Compete Agreement with her former employer.


The judge based her entire analysis of the facts under the Jercich standard:

Under Jercich, the first question in determining whether a breach of contract is excepted from discharge under § 523(a)(6) is whether debtor’s conduct was tortious. [Citation deleted.] The second question is whether the debtor’s conduct resulted in willful and malicious injury to the Home Instead. Both requirements must be met before a debt arising from conduct that also constitutes breach of a contract will be nondischargeable under § 523(a)(6).

On the first question, the judge held that debtor’s breach of this Agreement was not tortious because the evidence did not establish 3 of the 6 necessary elements under Oregon law for the tort of intentional interference with an economic relationship: 1) a valid business relationship for debtor to interfere with, 2) her intentional interference with that relationship, and 3) a causal effect between this interference and the damage to the economic relationship.

Judge Perris also analyzed the second question of willful and malicious injury even though her "findings [on the tortious conduct question] are sufficient to support a decision in favor of debtor" "because [her] conclusions provide an alternative basis for [her] determination that debtor should prevail." She found that debtor's conduct was neither willful nor malicious, and so the creditor's claim was dischargeable for not meeting those criteria as well.

She went through this second question presumably because as the trial judge, she wanted to make a full record not just for the benefit of the parties, but also in case there was an appeal there would be an alternate basis to find in favor of debtor.

In contrast, at first glance it is not clear why the 9th Circuit in Lockerby presented Jercich's two-part inquiry but then did not apply the second part. Was it trying to change Jercich's holding without expressly saying so or did it not have to get into the second part because as the appellate court the first was sufficient. The Court answers this question itself: "Having determined that state specific tortious conduct is required under § 523(a)(6), we can only affirm the district court if [debtor] engaged in conduct that would constitute a tort under Arizona law." The Court found that the conduct did not, and so it could hold that a "breach of contract is not 'willful and malicious' under § 523(a)(6), allowing it to overrule the lower courts without needing to get to the second part.

Thus beyond clarifying Jercich and indirectly affirming Judge Perris' analysis in Home Instead, and of course adding the substantial weight of the 9th Circuit to this area of nondischargeability, Lockerby did not add substantially to what was already Oregon law through Home Instead.

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

© 2008 Bankruptcy Litigation Support for Attorneys

The Rights of a Bona Fide Purchaser Buying Estate Assets Without Knowledge of Debtor's B'cy: Are State BFP Statutes Preempted by the Bankruptcy Code?

by Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com


Burkart v. Coleman (In re Tippett)
9th Circuit Case No. 6-15411
Sept. 4, 2008

A recent Bankruptcy Bulletin on this website (entitled "New 9th Circuit Opinion Adjusts the Line Between Void & Voidable Transfers in Violation of the Automatic Stay: Bona Fide Purchaser Defeats Trustee," dated 9/8/08) summarized this Burkart opinion and but reserved discussion about the federal preemption argument there for this Litigation Report.

The key rationale of the 9th Circuit panel was that the automatic stay of § 362 which generally makes post-petition transfers "void, not voidable" does not apply to transfers BY DEBTORS. Those transfers are instead addressed by § 549(a), which gives the trustee power to "avoid a transfer of property of the estate . . . that occurs after commencement of the case, and . . . that is not authorized under [the Code] or by the court." § 549(c) exempts bona fide purchasers (BFP's) from this trustee avoidance power. Because the postpetition sale by debtors of their residence without trustee or court approval, and without the buyer's knowledge of the bankruptcy, was not covered by the automatic stay, the sale was valid and so the BFP prevailed over the trustee.

In the midst of this analysis the Court also had to ask whether the state BFP statute was preempted by federal bankruptcy law to the extent that this statute conflicted with the bankruptcy court's authority over bankruptcy estate assets. Since the relevance of this opinion to Oregon is affected by the similarity of the Oregon BFP statute to the California BFP statute at issue in the opinion, let's compare them:

* Cal. Civ. Code § 1214: "Every conveyance of real property . . . is void as against any subsequent purchaser or mortgagee of the same property, or any part thereof, in good faith and for a valuable consideration, whose conveyance is first duly recorded . . . ."

* ORS 93.640: "Every conveyance . . . affecting the title of real property within this state which is not recorded as provided by law is void as against any subsequent purchaser in good faith and for a valuable consideration of the same real property, or any portion thereof, whose conveyance . . . thereof is first filed for record . . . ."

They appear to be substantially the same, each with virtually the same elements. So it seems that the 9th Circuit's federal preemption holding as to California's statute would apply equally to Oregon's.

The Court did not cite any other opinions that addressed preemption of state BFP statutes. It referred to two kinds of preemption: "field" and "direct-conflict". The direct-conflict type "arises, if at all, from the operation of the automatic stay. Accordingly, the direct-conflict inquiry collapses into the statutory analysis of the automatic stay provision" which I addressed in my 9/08/08 Bulletin and briefly summarized above. The Court's preemption discussion focused on the "field" type.

The "field" occupied by the Bankruptcy Code at issue here is "the field of title transfers initiated by Chapter 7 debtors." The issue was whether "the scheme of federal regulation is so pervasive as to make reasonable the inference that Congress left no room for the States to supplement it."

In its analysis the Court looked at the purpose of bankruptcy law and whether the BFP statue is consistent with that purpose. Beyond the general purposes of Chapter 7 in giving debtors a fresh start and fairly dividing debtors' assets, the more focused purposes of the automatic stay: "it provides debtors with protection from hungry creditors" and "assures creditors that the debtor's other creditors are not racing to various courthouses to pursue independent remedies to drain the debtor's assets." The Court discussed only the last of these purposes as the only one applicable to the situation, and decided that the BFP "statute is wholly consistent with this congressional goal."

First, because the proceeds of sale become property of the estate and valid prepetition liens on the property get paid as appropriate, "neither the total value of the assets available to the creditors through the estate nor the equity of the distribution among creditors is markedly affected." (Not that this neglects the reality that the debtors here pocketed the sale proceeds of $76,583, well beyond their homestead exemption, and depending on the extent to which those funds have been dissipated, practically speaking the assets readily available to the creditors may well have been "markedly affected.")

Second, with § 549(a) providing trustees power to avoid unauthorized transfers, but not as to BFP's, this "suggests that Congress is sufficiently comfortable with the protection of bona fide purchasers within the bankruptcy scheme that an implied preemption is not in order."

And last, a trustee who was concerned about a potential transfer by a debtor or simply whenever she wished to protect potential equity for creditors, "can simply protect the estate and its creditors" by recording the bankruptcy or a notice of it at the recorder's office.

Since the BFP statute was not meaningfully inconsistent with the federal purposes of the automatic stay, the 9th Circuit held that the California BFP statute is not federally preempted, and thus the Oregon BFP statute is not either.

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

© 2008 Bankruptcy Litigation Support for Attorneys

The "Law of the Case" Doctrine Applied in the Most Recent 9th Circuit BAP Opinion, Written by Judge Dunn

by Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com



FDIC v. Kipperman (In re Commercial Money Center, Inc)'
BAP Case No. SC-07-1298-DCMo
August 4. 2008

This most recent of the 9th Circuit BAP opinions was written by Judge Randall Dunn in his capacity as a BAP judge. The facts and procedural background are so involved that they take the first nearly 18 pages of his opinion, in part because this is the second appeal in the adversary proceeding. But the focus of this Litigation Report is on just one particular aspect: the doctrine of "the law of the case."

As stated in this opinion, "[u]nder the law of the case doctrine, a court is barred from reconsidering an issue that already has been decided in the same court or in a higher court on the same case. [Citation omitted.] For the law of case doctrine to apply, the issue must have been decided, either expressly or by necessary implication."

The overall legal issue to be decided on appeal involved the perfection of security interests: did a creditor, NetBank, perfect its security interest in equipment lease payments owed to debtor, Commercial Money Center, and its security interest in surety bonds procured by debtor to guarantee these lease payments, so as to withstand trustee's avoidance powers under §§ 544 and 547(b)? These secured assets were worth about $47 million. The bankruptcy court had ruled that NetBank had failed to perfect its security interest in these two sets of assets, thus allowing the trustee to avoid these security interests.

Just one of the sub-issues was whether the "law of the case" doctrine barred NetBank from arguing that some of the surety bonds were "instruments" rather than "supporting documents" under Nevada's Article 9 of the UCC. If they were instruments then this creditor could argue that it had perfected its security interest by possession before the 90-day preference period, and so the trustee could not avoid that security interest .

The bankruptcy court had held (after the BAP had remanded back to it after the first appeal) that the law of the case doctrine barred this argument because 1) NetBank had argued earlier, before the first appeal, that the surety bonds were supporting obligations, 2) the trustee also asserted the same, and 3) therefore "the bankruptcy court believed it implicitly determined that the surety bonds were supporting obligations by finding that NetBank did not perfect its security interest in the lease payments and that the trustee was entitled to summary judgment avoiding NetBank's security interest in all of the transferred assets, including the surety bonds."

But the BAP held to the contrary, that the law of the case doctrine did not apply here. The bankruptcy court "neither expressly nor implicitly decided whether the surety bonds were instruments or supporting obligations . . . [; it] simply assumed that the surety bonds were supporting obligations because both NetBank and the trustee argued that the surety bonds were supporting obligations and determined that NetBank did not have a perfected security interest in the lease payments." Therefore, the BAP concluded that NetBank could raise the issue that the security interests in some of the surety bonds were instruments and not supporting documents, and therefore were perfected.

However, after all that, the BAP analyzed the convoluted facts of the case, applied the UCC's definitions to these two types of assets, and held that as a matter of law the surety bonds were indeed supporting documents and not instruments, therefore NetBank's security interests in them were not perfected, and thus were avoidable by the trustee. Earlier in the opinion the BAP had also held that NetBank had not perfected its security interest in the lease payments either, and so those security interests were avoidable by the trustee as well. Since the bankruptcy court on remand had come to the same conclusions, the BAP affirmed its summary judgment in favor of the trustee.

BOTTOM LINE: For the law of the case doctrine to bar a court from considering an issue, that issue must have already been decided, either expressly or by necessary implication, in the same court or in a higher court on the same case. It is not enough, as here, for both adversaries and the court to have earlier ASSUMED that a particular issue was resolved a particular way without such a decision having been either expressly made necessarily made by implication. The challenge of logic is distinguishing between an issue having been merely assumed instead of having been "decided by necessary implication."

by Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

© 2008 Bankruptcy Litigation Support for Attorneys

Transferees Must Pay Chapter 7 Trustee "Millions of Dollars" under § 548(a) with Debtor's Plea Agreement As Sole Evidence of His Fraudulent Intent

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com



Johnson v. Nielson (In re Slatkin)
Ninth Circuit Case No. 06-56334
May 6, 2008
Affirmed District Court's affirmation of the Bankruptcy Court's granting of summary judgment to Chapter 7 trustee.

In this opinion the Ninth Circuit Court of Appeals ruled that the appellants must pay back to the trustee "millions of dollars" they had received from debtor as "profits" from their investments in debtor's Ponzi scheme, even though appellants had no knowledge of debtor's fraudulent intent and even though some of these funds may have been based on legitimate investments.

The Circuit Court addressed three issues of interest in this Litigation Report: A) can a debtor's fraudulent intent be based on the sole evidence of his guilty plea and plea agreement in a criminal case, authorizing the trustee's avoidance of transfers arising from such intent; B) can a bankruptcy court deny a transferee's motion for a continuance to conduct further discovery before having the opportunity to depose the debtor-transferor, or to review a transcript of the debtor-transferor's prior testimony; and C) does the bankruptcy court have the authority to grant an award of prejudgment interest if the transferee-defendants have demanded a jury trial?

A) The primary issue was this evidentiary one: could the bankruptcy court grant summary judgment on the issue of debtor's actual intent to "hinder, delay, or defraud" his creditors with the sole evidence consisting of debtor's guilty plea and the plea agreement, thus enabling the trustee to avoid and recover transfers from debtor to transferees under § 548(a) of the Bankruptcy Code and a similar California state statute?

The Circuit Court held:

1) The plea agreement was hearsay, but admissible under the exception in Federal Rule of Evidence 807 because:

• The plea agreement was offered as evidence of the material fact of debtor's operation of a Ponzi scheme and his actual fraudulent in doing so;
• The plea agreement and its admissions were not only more probative than any other evidence that could be procured through reasonable efforts, they were unusual direct proof of fraudulent intent, where usually circumstantial evidence must suffice;
• Admission of the plea agreement into evidence to establish fraudulent intent furthered the purposes of the evidentiary rules and served the interests of justice;
• The plea agreement had "equivalent circumstantial guarantees of trustworthiness" in that it was made under oath, with the advice of counsel and after debtor was advised of his constitutional rights, it subjected debtor to severe criminal penalties (a 14-year prison sentence), and was accepted by the criminal court only after the court determined that the plea was voluntary.

2) The plea agreement "preclusively establishe[d debtor's] intent to defraud in relation to transfers to [the defendants]," as follows:

• Debtor's actual intent to defraud was established by his admissions in the plea agreement, in which he admitted operating a massive Ponzi scheme used to defraud 800 investors of over $593 million, since prior 9th Circuit opinions had established that the mere existence of a Ponzi scheme was sufficient to establish actual intent under § 548(a);
• Debtor's plea agreement provided a sufficient factual basis to support the bankruptcy court's finding that the transfers to the defendants were fraudulent, because once the existence of a Ponzi scheme is established payments received as "profits" by investors (amounts beyond the initial "investment") are deemed fraudulent transfers as a matter of law;
• Debtor's tax return did not raise a genuine issue of material fact in that his reporting of income to the IRS and delineating of capital gains attributable to various investors including the defendants because the tax return was not inconsistent with his operation of the Ponzi scheme.

B) On the matter of the bankruptcy court's denial of a motion for a continuance to conduct further discovery, given the incredible amount of money at stake it is certainly understandable that, before the court's granting of summary judgment on the issue of debtor's intent, defendants wanted to depose the debtor as to his intent regarding the specific transfers at issue. Defendants also wanted to review a transcript of debtor's testimony in a prior proceeding with the trustee (not involving defendants). The Circuit Court followed an earlier 9th Circuit opinion, Bank of America v. PENGWIN, 175 F.3d 1109 (9th Cir.1999), in stating that the defendants had to show that allowing additional discovery would have precluded summary judgment on the issue of debtor's fraudulent intent. Apparently at some point after the summary judgment ruling, defendants did have the opportunity to depose the debtor and to review the transcript of the prior proceeding, but according to the Circuit Court did not identify anything from that deposition or that transcript that contradicted the bankruptcy court's finding of fraudulent intent. So the Court determined that the bankruptcy court did not abuse its discretion in denying time for further discovery before granting summary judgment on the issue of intent.

C) Given the huge amount of the judgment awarded to the trustee, the bankruptcy court's granting of prejudgment interest on this judgment involved much more money than usual. (The Circuit Court's opinion did not provide any specific amounts as to either the transfers or the prejudgment interest, perhaps as a subtle way of indicating that the dollar amounts do not change the legal principles?) The Court looked at the appropriateness of prejudgment interest under California and federal law.

A California statute provided for interest to be awarded in fraud cases "in the discretion of the jury," so defendants argued that only a jury and not the bankruptcy court had the authority to award prejudgment interest. The Court reviewed the state case law and instead held that "when a court has granted judgment as a matter of law on all substantive issues, the court has authority to award prejudgment interest under [that statute]."

As to federal law on prejudgment interest, the Court rejected the defendant's argument that under federal law if they demanded a jury trial they were entitled to have a jury decide this interest issue, and the Court instead held that a bankruptcy court has the authority to award prejudgment, with no discussion other than to briefly distinguish a US Supreme Court case, Osterneck v. Ernst & Whinney, 489 U.S. 169 (1989)

(Note that the Court also determined through a detailed analysis (taking nearly 8 pages of the 24-page opinion on this issue) that the debtor was not a "stockbroker" under the Bankruptcy Code, critical here because under § 546(e) settlement or margin payments by a stockbroker are not avoidable. That analysis is beyond the scope of this Report so please see the opinion itself for that.)

BOTTOM LINE:

1) A debtor's criminal plea agreement can be admitted as evidence under an exception to hearsay if it meets certain conditions, especially if it has "equivalent circumstantial guarantees of trustworthiness."

2) A plea agreement can establish a debtor's intent to defraud for purposes of § 548(a) as to transfers by debtor of "profits" to "investors" if the plea agreement contains admissions of a Ponzi scheme, since as a matter of law the mere admitted existence of such a scheme establishes actual intent.

3) Payments made in a Ponzi scheme to "investors" of any sums beyond the amounts invested are deemed fraudulent transfers as a matter of law.

4) A bankruptcy court does not abuse its discretion if the party, who was, prior to the court's decision on a motion for summary judgment on a person's intent, denied a motion for continuance to conduct further discovery about that intent, cannot subsequently show that the requested additional discovery would have contradicted the court's finding of intent.

5) Bankruptcy courts have authority to award prejudgment interest in a fraudulent transfer case, in spite of transferees' demand for and lack of a jury trial, under both California statute and federal law.

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorney.com

© 2008 Bankruptcy Litigation Support for Attorneys

9th Circuit 8/22/08 Opinion: Ch. 13 Trustee NOT Entitled to Actual or Statutory Damages, Atty. Fees or Costs Under Portions of Truth in Lending Act

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

McDonald v. Checks-N-Advance, Inc. (In re Ferrell)

Ninth Circuit Case No. 06-17243

In this per curiam decision published on August 22, 2008, the Ninth Circuit Court of Appeals held that certain specific violations of the federal Truth in Lending Act (TILA) do not result in the award of actual damages, statutory damages, or attorney fees and costs for the consumer, or specifically in this case for the Chapter 13 trustee acting on behalf of the consumer. The court affirmed the ruling of the Bankruptcy Appellate Panel, which had affirmed the judgment of the bankruptcy court. This was a case of first impression for the Ninth Circuit as to the issue of statutory damages, and precisely as to whether the specific TILA violations.here fell within any of TILA's exceptions to statutory damages.

Although almost the entire opinion was devoted to the Truth in Lending issues, the Court also ruled against awarding attorney fees and costs to plaintiff under Nevada's consumer fraud act apparently because of a pleading error by the plaintiff. More about this shortly.

The plaintiff (again, the Chapter 13 trustee acting on behalf of the debtor) claimed that the defendant, a payday loan creditor, failed to provide TILA-required disclosures before the transaction (15 U.S.C Section 1638(b)(1)) , and failed to conspicuously disclose the finance charge and annual percentage rate (15 U.S.C. Section 1632(a)). (All statutory references hereafter are to Title 15.) Defendant did not timely respond to the complaint, and the bankruptcy court entered a default judgment against defendant and granted plaintiff-trustee's objection to this creditor's proof of claim. The primary issue on appeal was whether the particular TILA violations pled by trustee are of the type entitling it to statutory damages.

(Note: although at least in Oregon payday lenders have greatly restricted their business activity since new state laws went into effect a couple years ago, these TILA issues remain pertinent to any closed-end consumer loans.)

The court held that that these two violations were not of the type resulting in statutory damages because they fit within the scope of the exceptions to such damages in Section 1640(a). The detailed statutory construction the court used to arrive at this conclusion is beyond the scope of this summary, other than to note that in doing so it rejected the contrary analysis of a Michigan U.S. District Court and followed the 6th and 7th Circuit opinions upon which the Bankruptcy Appellate Panel decision on appeal had also relied.

Based on TILA's statutory scheme, once the trustee could not show any liability entitling her to statutory damages under Section 1640(a)(2), she was also not entitled to attorney fees and costs under Section 1640(a)(3).

As for actual damages, the court followed its own holding in Smith v. Gold Country Lenders (In re Smith), 289 F.3d 1155 (9th Cir. 2000) that to be awarded actual damages under TILA, a borrower has to show "detrimental reliance," that he could have gotten a better interest rate elsewhere or would have not gotten the loan at all. The trustee could not establish these facts as to the debtor, so she was not entitled to any actual damages.

The trustee's pleading error I referred to above resulted in her being unable to separately recover attorney fees and costs under a Nevada consumer fraud statute. Had she not made this error, it appears she would have been so entitled. In her adversary proceeding complaint the trustee asked for attorney fees and costs under a particular Nevada statute. After defendant did not appear to defend the complaint and the bankruptcy court found that defendant had violated the Truth in Lending Act, the trustee asserted the right to attorney fees and costs under a different Nevada statute, one that made violations of the Truth in Lending Act a "deceptive trade practice" under Nevada law . Because the judgment ended up being entered by default against defendant, under Fed. R. Bankr.P 7054(a), following Fed. R. Civ. P. 54, the trustee had "to plead with specificity the statute under which she now claims to be entitled to costs and fees." The standard "for such other relief as the court deems appropriate" prayer was too general to help here. Failure to plead with specificity meant that defendant was not put on notice as to the basis for an award of attorney fees and costs, and so the trustee was not entitled to attorney fees and costs under the Nevada statute.

BOTTOM LINE: 1) The specific TILA violations referred to here will not result in awards for statutory damages, or attorney fees and costs. 2) To be awarded actual damages the consumer must meet the "detrimental reliance" standard. 3) Consumer must plead the accurate statutory basis for the requested damages or else better not plan on being awarded those damages, especially if the lender does not answer and a default judgment is entered.

by Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

© 2008 Bankruptcy Litigation Support for Attorneys

9th Circuit Holds that Ch. 13 "Undue Hardship" Student Loan Determinations Need NOT Wait Until End-of-Case Discharge

by Andrew Toth-Fejel, Bankruptcy Litigation Services for Attorneys, Andy@BLSforAttorneys.com

Educational Credit Management Corp. v. Coleman, (9th Cir 2008)
Case # 06-16477
Published 8/1/08

***ON AUGUST 22, 2008 THE 9TH CIRCUIT COURT OF APPEALS VACATED THIS AUGUST 1, 2008 OPINION BECAUSE IT APPARENTLY DETERMINED IN THE INTERIM THAT IT DID NOT HAVE JURISDICTION TO CONSIDER THE APPEAL FROM THE DISTRICT COURT, SINCE THE BANKRUPTCTY COURT'S ORDER BEING APPEALED FROM WAS AN INTERLOCUTORY ORDER. LINK HERE TO SEE THE CIRCUIT COURT'S VACATING ORDER. THE CASE WAS REMANDED TO THE DISTRICT COURT TO DETERMINE WHETHER IT WOULD CERTIFY THE CASE FOR APPEAL. IF THAT COURT DOES SO, AND THE 9TH CIRCUIT THEN DETERMINES IT DOES INDEED HAVE JURISDICTION, THIS NOW-VACATED OPINION MAY BE RE-PUBLISHED. IN THE MEANTIME IT IS NOT GOOD LAW. AT BEST IT IS SOME INDICATION OF HOW THE 9TH CIRCUIT MAY RULE ON THIS ISSUE IN THE FUTURE, IN THIS CASE OR OTHERWISE.***


On August 1, 2008 the 9th Circuit Court of Appeals ruled that a Chapter 13 debtor could get a judicial determination whether her student loans constituted an “undue hardship” and were thus dischargeable without waiting until close to or after the discharge at the end of the case. Going against two other Circuits, the Fifth and the Eighth, and joining one other Circuit, the Fourth, the 9th Circuit held that the matter was ripe for adjudication, although the debtor’s Chapter 13 case was less than a year past confirmation of debtor’s five-year plan. Interestingly, it buttressed its position by citing an earlier 9th Circuit Bankruptcy Appellate Panel opinion, In re Taylor, 334 B.R. 747, 751-52 (1998), which had been overturned on other grounds.

The panel applied U.S. Supreme Court standards for “constitutional ripeness” and “prudential ripeness”.

Constitutional ripeness existed here because 1) a “substantial controversy” arose from debtor’s attempt to discharge the debt and the student loan creditor’s objection to the discharge, 2) this controversy was “definite and concrete, not hypothetical or abstract” because it was about a specific debt, and 3) was “of sufficient immediacy and reality” and not “impermissibly speculative” since it relied on only “ a single factual contingency,” her completion of plan payments, instead of a “series of contingencies.”

Prudential ripeness turns on “the fitness of the issues for judicial decision” and “the hardship of the parties of withholding judicial consideration.”

On the “fitness” issue the Court of Appeals determined that the undue hardship issue requires a bankruptcy court to look usually far into the future to weigh the debtor’s ability to repay the debt during the lengthy term of the loan, and that delaying a relatively short time “is unlikely to provide much, if any, additional benefit to the bankruptcy court’s resolution of the issue.” And as for whether there has been enough time to determine whether the debtor has made a sufficient good faith efforts to repay the debt, that depends on the timing of each case—here the Court determined that debtor’s attempts to repay from 1999 until her Chapter 13 filing in 2004 was a sufficient time for the bankruptcy court to make this evaluation. (The Court strongly implied that a debtor who files her Chapter 13 case soon after becoming liable on her student loans would not have a ripe controversy.) Importantly, the Court disagreed with the Eighth Circuit in holding that the “hardship” determination does NOT need to be made IN REFERENCE TO THE TIME OF DISCHARGE; there is no such timing requirement in § 523(a)(8).

On the “hardship of the parties” prong of the prudential ripeness test, the Court became very pragmatic and frank, at least as to the hardship to the debtor. It stated that subjecting a debtor to committing all her disposable income for five years is “a considerable burden to bear without any guarantee that the debt will be ultimately discharged.” Fascinatingly, the Court acknowledged that the primary reason the debtor was still in her Chapter 13 case, instead of converting to Chapter 7 when her income was reduced, was because she could not pay the up-front attorney fees in a Chapter 7 case to fight the “undue hardship” battle whereas in a Chapter 13 case these fees could be spread out over time. The Court concluded by relying on the “fresh start” purpose of bankruptcy in candidly stating: “In a case where a debtor faces genuine undue hardship from student loan debt, the debtor’s best shot at a fresh start may be to litigate the matter in a Chapter 13 case.”

BOTTOM LINE: To the extent that the 1998 In re Taylor BAP opinion has been uncertain authority, having been overturned albeit on other grounds, and given that there has been apparently NO OTHER Circuit ruling on this, this brand new 9th Circuit opinion gives Chapter 13 debtors’ attorneys, in the appropriate circumstances, strong ammunition to file “undue hardship” adversary proceedings earlier rather than later. And this case also provides some guidance for student loan creditors to argue lack of ripeness in the appropriate cases. Finally, this opinion virtually invites debtors’ attorneys confronted with a new client who had a good “undue hardship” case but no way to pay up-front attorney fees to litigate it, to think seriously about filing a Chapter 13 case instead of Chapter 7, when it is legally and ethically fitting to do so.

THIS OPINION WAS VACATED BY THE 9TH CIRCUIT ON 8/22/08--SEE NOTE AT THE TOP OF THIS REPORT

by Andrew Toth-Fejel, Bankruptcy Litigation Services for Attorneys, Andy@BLSforAttorneys.com

© 2008 Bankruptcy Litigation Support for Attorneys