Oversecured Creditor Entitled to Contractual Default Interest Rate: Ninth Circuit Narrows Its Prior Per Se Rule Against Default Rate

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


GECC v. Future Media Productions Inc.
9th Circuit Case # 07-55694

Second Amendment October 24, 2008; Amended August 7, 2008; originally filed July 3, 2008
(On direct appeal from the bankruptcy court under BAPCPA's new subsection 28 U.S.C. § 158(d)(2), providing for discretionary appellate jurisdiction over non-final orders of the bankruptcy court upon proper certification of that court or of all parties.)

The Ninth Circuit considered here whether an oversecured creditor, GECC, was entitled to its pre-default or rather its higher default rate of interest under § 506(b), which provides that such creditor “shall be allowed . . . interest . . . provided for under the agreement or State statute under which such claim arose.” The difference between the two rates of interest was only 2%, but since the debt at issue was nearly $6 million, about $165,000 of interest differential was at issue.

The Court's decision turned on whether or not this case was distinguishable from Ninth Circuit precedent as established in In re Entz-White Lumber and Supply, Inc., 850 F.2d 1338 (9th Cir. 1988), and whether that precedent and this case were affected by last year's U.S. Supreme Court opinion in Travelers Cas. & Sur. Co. of Am. v. Pac. Gas & Elec. Co., 127 S. Ct. 1199 (2007).

The Ninth Circuit distinguished this case from Entz-White, by restricting that precedent to "the rule that an oversecured creditor was not entitled to interest at the default rate when its claim was paid in full pursuant to the terms of a Chapter 11 plan." This is the so-called per se rule against using a default interest rate. Here to the contrary, GECC's claim was NOT paid off through the Chapter 11 plan but rather "as a result of a series of asset sales outside of a Chapter 11 plan." Therefore the Court held that the per se rule against use of the default interest rate was not applicable here, and remanded to the bankruptcy court "to decide whether the default rate should apply under the rule adopted by the majority of federal courts . . . : The bankruptcy court should apply a presumption of allowability for the contracted for default rate, 'provided that the rate is not unenforceable under applicable nonbankruptcy law'."

The Ninth Circuit also held that this "majority rule" is consistent with the Travelers Supreme Court opinion (which specifically addressed creditors' attorney fees), but Entz-White is not overturned by Travelers either. Let me explain.

The Essential Facts
Future Media owed a substantial commercial loan to GECC, secured by a first priority security interest on substantially all of Future Media's assets. The loan's terms included a default interest rate: a 2% increase in the rate if Future Media defaulted on loan payments. Future did default, which triggered the interest rate increase. Future Media then filed a liquidating Chapter 11 case, having "executed an agency agreement to sell its assets in an auction." It immediately arranged to enter into a "cash collateral" agreement with GECC--allowing it to use cash, which was collateral on the GECC debt, for winding down its business and preparing for the auction. The cash collateral agreement was delayed by objections from unsecured creditors, including an objection about GECC's right to impose the higher default interest rate (thereby reducing what was available to unsecured creditors from the liquidating auction). An amended cash collateral agreement was entered into allowing the default interest rate issue to be decided separately. On a subsequent motion raising that issue, the bankruptcy court decided that GECC was only entitled to the lower pre-default interest rate pursuant to the Entz-White opinion, and GECC appealed.

The Ninth Circuit's Rationale
In Travelers the Supreme Court said that “[c]reditors’ entitlements in bankruptcy arise in the first instance from the underlying substantive law creating the debtor’s obligation, subject to any qualifying or contrary provisions of the Bankruptcy Code.” The Ninth Circuit said that the facts in Entz-White fit within such a "qualifying or contrary provision" of the Code, but the present case did not. In Entz-White the specific issue was whether a creditor's claim was considered "impaired" for purposes of voting on a Chapter 11 plan, which it is not if the debtor "cures" any pre- or post-petition defaults. And since the Code permits "cures" under § 1124(2)(A) to negate all consequences of default including the imposition of a default interest rate, the debtor was permitted to avoid this higher rate "to cure a default to render it unimpaired for voting on a Chapter 11 plan." In the present case in contast, "GECC's oversecured claim was paid through a sale of assets governed by § 363, outside the context of a Chapter 11 plan" and so "the facts of Entz-White are distinguishable, and thus our per se rule from that case is inapplicable." "Because the Bankruptcy Code does not provide a 'qualifying or contrary provision' to the underlying substantive law here [as now required by Travelers], the bankruptcy court's extension of Entz-White to the loan agreement's default rate was error." Instead The Ninth Circuit remanded to the bankruptcy court to apply the federal majority rule as quoted above.

Applicability to Chapter 13?
This Future Media case and Entz-White are both Chapter 11 cases, referring to sections of the Code which are unique to Chapter 11. But are their holdings also applicable to Chapter 13 cases? Are Chapter 13 oversecured creditors, whose claims are after all also covered by § 506(b), entitled to their default interest rate, and do the same rules specified above govern this question? To quote a controversial remark by a former Presidential candidate now President-elect, that question is "above my pay grade" at least for purposes of this Bulletin. My suspicion is that fully secured creditors paid through a Chapter 13 plan, such as a vehicle loan paid in full through the plan, are not entitled to a default interest rate but a creditor not being paid through the Plan, such as a current home mortgage, is entitled to default interest. But I could very well be wrong. I would appreciate comments from any readers who know.

Note that although Travelers was also a Chapter 11 case, the Supreme Court's overturning of the 9th Circuit's Fobian rule on creditor's attorney fees does apply to Chapter 13 since it involves interpretation of §502(b) of the Code, applicable to all Chapters. Please see my earlier Bulletin on Travelers entitled: Reminder about U.S. Supreme Ct's Reversal of 9th Circuit's Fobian Rule on Creditors' Atty Fees: Fees Recoverable Even on Issues Peculiar to B'cy Law

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

Retroactive Effect of U.S. Supreme Court Opinion Decided During Pendency of Unrelated Bankruptcy Case on Appeal

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

Ditto v. McCurdy (In re McCurdy)
Ninth Circuit Case No. 02-16252
December 14, 2007

This Ninth Circuit opinion addressed both substantive issues about nondischargeability "for willful and malicious injury by the debtor" under § 523(a)(6) of the Bankruptcy Code, and various procedural issues including 1) the retroactive effect of a Supreme Court opinion decided during the pendency of a case, and 2) amending a complaint to add a § 727 discharge objection to the § 523 dischargeabililty claim. The substantive nondischargeability matters are addressed in this website's Bulletin article of 11/13/08 entitled After 18 Years of Litigation Ninth Circuit Holds $2.8 Million Medical Malpractice Judgment "Not Non-Dischargeable" Under Section 523(a)(6). The two procedural issues are dealt with here in this Litigation Report.

1) Retroactive Effect of US Supreme Court Opinion on Pending Unrelated Cases
This case had a torturous procedural history spanning 18 years and including three different journeys up the chain of appellate courts, to the Hawaii Supreme Court once and to the Ninth Circuit twice. It is no wonder that the applicable case law changed in the interim.

Without detailing all the twists and turns of this history, here are the salient events for our purpose: a) After plaintiff won a large judgment in Hawaii state court against debtor in 1992, debtor both appealed that judgment and filed a Chapter 7 bankruptcy. b) In Plaintiff's adversary proceeding against the debtor for the nondischargeability of her claim based on her state court judgment, she won a summary judgment in her favor in 1996; she prevailed because of 9th Circuit case law of the time that "willful and malicious injury" under § 523(a)(6) meant that plaintiff did not have to show that "debtor acted with intent to injure" but only that he "committed a wrongful act . . . , done intentionally, necessarily produc[ing] harm and . . . without just cause or excuse, . . . even absent proof of a specific intent to injure." c) The following year the state trial court judgment found its way to the Hawaii Supreme Court, which affirmed the gross negligent portion of the judgment but reversed the fraud portion. d) Debtor filed a motion in bankruptcy court to set aside the nondischargeability summary judgment in light of this Hawaii Supreme Court decision. The bankruptcy court denied the motion, and debtor appealed to the U.S. District Court and then to the Ninth Circuit. e) But before this Court ruled on that motion, in 1998 the U.S. Supreme Court held in Kawaauhau v. Geiger, 523 U.S. 57 that “debts arising from recklessly or negligently inflicted injuries do not fall within the compass of § 523(a)(6).” f) As a consequence this Court overturned the bankruptcy court and U.S. District Court decisions, setting aside the summary judgment against debtor which had been based on pre-Geiger law. g) Debtor then prevailed in bankruptcy court in a summary judgment establishing the dischargeability of plaintiff's debt against him, the U.S. District Court affirmed, and plaintiff appealed to this Court, which is the matter now before it.

As to whether the Geiger decision should be applied to this case, generally speaking "a federal court must applly a new and supervening rule of federal law when applicable to the issues in the case." Accordingly the Ninth Circuit had applied Geiger retroactively in a number of cases. But this present case is distinguishable in that plaintiff "had already obtained a final judgment in 1996, which became non-appealable as of January 19, 1997—more than a year before Geiger was decided. [Plaintiff] maintains that the law as of that date ought to apply to this case, even after the former judgment was vacated following [debtor's] successful Rule 60(b) motion" to set it aside.

But instead the Ninth Circuit decided to the contrary, applying its own rationale that "[w]hen a judgment has been set aside pursuant to Rule 60(b), the case stands as if that judgment had never occurred in the first place. The case remains open on direct review, and the court must apply the law as it stands, including any intervening precedents," such as Geiger.

Note that the Court did not cite any case law in support for this analysis, only a reference in a footnote to Am. Jur. 2nd Judgments about the setting aside of a judgment placing "the parties in the position they occupied before entry of the judgment," without any reference to the applicability of an intervening change in the case law.

2) Amending a Complaint to Add a § 727 Claim to a § 523 One
Referring (much more briefly!) to the procedural history above, plaintiff's original adversary proceeding complaint in 1992 contained not just a § 523(a)(6) nondischargeability claim but also § 727(a)(4) and (7) objections to discharge. After winning summary judgment in her favor on the § 523(a)(6) claim, she dismissed the § 727 claims. But then after that judgment was eventually set aside on remand from this Court in 2000, and the bankruptcy court granted debtor a discharge in February 2000, in May 2001 plaintiff moved to amend her complaint to add back her § 727 claim.

In determining whether to give plaintiff leave of court to amend the complaint, the Court referred to "[f]our factors . . commonly used to determine the propriety of a motion for leave to amend. These are: bad faith, undue delay, prejudice to the opposing party, and futility of amendment." But the appellate standard for reviewing how these rather vague factors were weighed by the bankruptcy court is whether the bankruptcy court abused its discretion, that is, whether the Ninth Circuit has "a definite and firm conviction that the district court committed a clear error of judgment in the conclusion it reached."

Noting that plaintiff had waited "more than fifteen months" between the discharge granted in 2000 and her motion to amend complaint, the Court held that the bankruptcy court had not abused its discretion in not permitting this amendment. It reasoned: "If the ordinary action of § 727(a) is extreme, it must surely be still more extreme to order, retroactively, a revocation of the discharge. Given the value of finality in bankruptcy, as well as the difficulty of unscrambling an egg by effectively revoking discharge . . . , we hold that the bankruptcy court did not err in denying [plaintiff] leave to amend her complaint."

Comment
Chapter 7 trustees commonly file motions to revoke the discharge when debtors fail to pay their oblgations to the estate, and no one complains then about "the difficulty of unscrambling an egg." And given that about eight years had passed between the filing of the Chapter 7 case in 1992 and the granting of the discharge in 2000, and given that the discharge of this debt continued to be under appeal for another seven years, the fifteen months that the Ninth Circuit considered to be excessive delay does not seem to be so in this context. At the very least, the Court does not explain its position well, although given the low "abuse of discretion" standard perhaps it does not need to beyond what it did.

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

What are the Standards for Motions for Reconsideration?: Judge Dunn's Suggestions in Schacher v. Dolph

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

Schacher v. Dolph (In re Dolph)
Oregon Bankruptcy Court Adversary Proceeding No. 07-3326-rld
June 11, 2008 opinion; July 24, 2008 reconsideration denied
Unpublished

The Oregon Bankruptcy Court's website entry under this adversary proceeding in fact contains two separate Memorandum Opinions by Judge Randall Dunn, the first consisting of his decisions resolving issues from the adversary proceeding trial, and the second his denial of plaintiff's motion for reconsideration of the first. Inexplicably, these two opinions were uploaded to the Court's website just last week although they were filed last June and July. This Litigation Report addresses the Memorandum Opinion on the motion for reconsideration.

(This website's Bankruptcy Bulletin dated November 4, 2008 will review the first Memorandum Opinion.)

Background
The litigation is part of a lengthy inheritance fight among stepbrothers and stepsisters: plaintiff Jim Schacher is a stepson of decedent Patricia Schacher, while defendant Donald Dolph, the Chapter 13 debtor, is a son. Plaintiff seeks to impose a constructive trust on assets of defendant, particularly his residence, because of transfers made by the decedent to defendant allegedly in violation of a 1988 Agreement to Execute Wills between the decedent and her husband, plaintiff's father. After trial in the adversary proceeding, Judge Dunn imposed a constructive trust on defendant's residence, but in the amount of only about $1,850 instead of the $90,000 amount plaintiff wanted. Before judgment was entered, plaintiff filed a motion for reconsideration on the amount of the constructive trust.

The Standard for Motions for Reconsideration
Federal Rule of Bankrutpcy Procedure 9023 incorporates Rule 59 F.R.Civ.P. into cases under the Bankruptcy Code, making motions for reconsideration "analogous to a motion for a new trial or to alter or amend the judgment pursuant to FRCP 59." Rule 59(a)(2) specifies the grounds for granting a new trial, where the trial was without a jury: "for any of the reasons for which rehearings have heretofore been granted in suits of equity in the courts of the United States . . . ." Judge Dunn referred to three reasons cited by the Ninth Circuit under Rule 59(a)(2): "(1) manifest error of law; (2) manifest error of fact; and (3) newly discovered evidence.”

Application of the Standard for Motion for Reconsideration

1) "Newly discovered evidence": The judge dispensed with this potential reason for reconsideration by stating that he had "closed the evidentiary record" immediately after the trial, had reminded plaintiff's counsel of this at the scheduling hearing on this motion, but plaintiff made no request under FRCP 59 to reopen the evidentiary record. So there is no "newly discovered evidence" here. (Had additional evidence been offered, the judge would have "need[ed] to evaluate whether any additional evidence offered is 'new' evidence that was not available at the time of Trial.")

2) "Manifest error of law," "manifest error of fact":
First, plaintiff contends that the calculations for determining the constructive trust amount should take into account "the cost to the Probate Estate inherent in the delay in recovering the funds wrongfully received by Mr. Dolph."
To the contrary, Judge Dunn held that a constructive trust does not "affect rights in the res until it is imposed," and therefore property appreciation or other impacts on the property prior to a court imposition of the constructive trust on the property do not benefit the plaintiff.

Second, plaintiff argues that the calculation should not include a credit for defendant's "legitimate share of the Probate Estate, either because that share cannot be determined at this time or, alternatively, because Mr. Dolph has waived that share through his confirmed chapter 13 plan."

As to the defendant's plan's purported waiver of his claim against plaintiff, the judge ruled that this was specifically a waiver "by Mr. Dolph of the right to receive any additional distribution he otherwise might be entitled to receive from the Probate Estate," and the plan provision did NOT "preclude Mr. Dolph from asserting, as an offset for purposes of calculating the amount by which he was unjustly enriched."

As to plaintiff's objection to crediting defendant's legitimate share of the estate, "[i]n order to calculate the amount Mr. Dolph was unjustly enriched, I am required to subtract the amount Mr. Dolph was entitled to receive from the Probate Estate from the amount he actually received."

Since the only evidence presented at trial of Mr. Dolph's legitimate share was plaintiff's proof of claim, the judge used this for his calculations over plaintiff's objections. Plaintiff argued that the appropriate offset amount would not be known until the other potential wrongdoers--Mr. Dolph's two sisters--had paid their obligations back to the estate. Judge Dunn rejected this, saying that if he accepted that argument, the various siblings would be dead before the matter was resolved! Since the plaintiff failed to provide evidence of the diminished value of the probate estate, he cannot now argue that as a consequence the constructive trust was larger than the evidence indicated.

With a lack of "newly discovered evidence" or of any "manifest error of law or fact," the judge denied plaintiff's motion for reconsideration.

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

The Last Ten Litigation Reports On Bankruptcy Litigation and Procedure from Recent Ninth Circuit and BAP Opinions

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



This website has published ten weekly Litigation Reports. They are all summaries of recent 9th Circuit and Bankruptcy Appellate Panel (BAP) opinions on important issues about bankruptcy litigation and procedure. Together they comprise an essential recent package of law that every bankruptcy attorney practicing in Oregon or anywhere in the Ninth Circuit should know. To help get to that knowledge quickly and easily, here is a list of these ten Litigation Reports with a short descriptive excerpt from each, with convenient links BOTH to the Reports (click on the Report title) as well as directly to the full opinions themselves (click on the case name). The opinions are in reverse chronological order of court publication, with the most recent one on top, the 9th Circuit ones separate from the BAP ones.


Ninth Circuit Opinions

October 10, 2008
American Sports Radio Network v. Krause (In re Krause)
Litigation Report Title: 9th Circuit Certifies Question of Law to State Supreme Court on Capacity of Administratively Dissolved Corporation to Prosecute Adversary Proceeding Excerpt: "This is not an opinion, merely a lengthy order certifying a question to the Nevada Supreme Court. And yet the 9th Circuit takes 13 pages to do this. The Court's discussion is valuable from a bankruptcy litigation perspective both for its substantive issue--the capacity of an administratively dissolved corporation to file an adversary proceeding against a debtor, and the appellate procedural one--when is it appropriate for a bankruptcy appellate court to seek formal assistance from a state supreme court in interpreting that state's laws. Oh, and by the way: 'several million dollars' are at stake in this Chapter 7 nondischargeability adversary proceeding."

September 23, 2008
Barboza v. New Form, Inc.
Litigation Report Title: Ninth Circuit Reverses Both B'cy Court's & BAP's Summary Judgment on "Willful & Malicious Injury" Under § 523(a)(6) Excerpt: "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."

September 4, 2008
Burkart v. Coleman (In re Tippett)
Litigation Report Title: 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?
Excerpt: "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."

August 22, 2008
McDonald v. Checks-N-Advance, Inc. (In re Ferrell)
Litigation Report Title:
Excerpt:"In this per curiam decision . . . , 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."

August 7, 2008
Lockerby v. Sierra (In re Sierra)
Litigation Report Title: When Is Intentional Breach of Contract Nondischargeable Under § 523(a)(6)?: 9th Circuit Proclaims Legal Standard for "Willful & Malicious Injury"
Excerpt: "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."

August 1, 2008
Educational Credit Management Corp. v. Coleman
Litigation Report Title: NOTE: THIS OPINION WAS VACATED: 9th Circuit Holds that Ch. 13 "Undue Hardship" Student Loan Determinations Need NOT Wait Until End-of-Case Discharge
Excerpt: "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."

May 6, 2008
Johnson v. Nielson (In re Slatkin)
Litigation Report Title: Transferees Must Pay Chapter 7 Trustee "Millions of Dollars" under § 548(a) with Debtor's Plea Agreement As Sole Evidence of His Fraudulent Intent
Excerpt: "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?"

April 16, 2008
Barclay v. Mackenzie (In re AFI Holding, Inc.) Litigation Report Title: 9th Circuit on Fraudulent Transfers: "Actual Intent to Hinder, Delay, or Defraud," "Reasonably Equivalent Value," & the "Good Faith Exception"
Excerpt: "In this opinion the 9th Circuit analyzed fraudulent transfers under § 548 of the Code (and its analogous provision in state law) in the form of payments paid out to "investors" in a Ponzi scheme. (A Ponzi scheme involves "paying investors purported interest payments with funds
raised from other investors, rather than from the profits of the . . . business".) The Court focused on the § 548(c) exception to fraudulent transfers for transferees who take "for value and in good faith," and particularly on the "reasonably equivalent value" that transferee received in his role as a limited partner of the debtor."


BAP Opinions (of the 9th Circuit)

August 4. 2008
FDIC v. Kipperman (In re Commercial Money Center, Inc)
Litigation Report Title: The "Law of the Case" Doctrine Applied in the Most Recent 9th Circuit BAP Opinion, Written by Judge Dunn
Excerpt: "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.' "

April 22, 2008
White v. Brown
Litigation Report Title: Chapter 13 Debtor Must Account for $145,000 in Unreinvested Homestead Proceeds After Converting from Chapter 7 Case Excerpt: "This 9th Circuit BAP opinion addresses this question: what is the effect of an asset turnover order against a Chapter 7 debtor when he responds by converting his case into a Chapter 13? The BAP's discussion of this leads to a better understanding of two concepts that can get tricky especially when combined: asset turnover orders and conversions from Chapter 7 to 13."


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

9th Circuit on Fraudulent Transfers: "Actual Intent to Hinder, Delay, or Defraud," "Reasonably Equivalent Value," & the "Good Faith Exception"

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


Barclay v. Mackenzie (In re AFI Holding, Inc.)
9th Circuit Case No. 06-55033
April 16, 2008

In this opinion the 9th Circuit analyzed fraudulent transfers under § 548 of the Code (and its analogous provision in state law) in the form of payments paid out to "investors" in a Ponzi scheme. (A Ponzi scheme involves "paying investors purported interest payments with funds
raised from other investors, rather than from the profits of the . . . business".) The Court focused on the § 548(c) exception to fraudulent transfers for transferees who take "for value and in good faith," and particularly on the "reasonably equivalent value" that transferee received in his role as a limited partner of the debtor.

The Court's Holdings
1) On the transferee's argument that he was entitled to the "profits" not just the funds "invested", the Court held that no genuine issues of material fact existed as to whether the debtor, a corporation that had been operated by a person who was convicted of federal securities fraud for operating a Ponzi scheme, made the transfers at issue with the "actual intent to hinder, delay, or defraud" a creditor, because: a) " 'the mere existence of a Ponzi scheme' is sufficient to establish actual intent under § 548(a)(1) or a state’s equivalent to that section"; and b) debtor's principal's criminal plea agreement showed his fraudulent intent existed before defendant transferee "invested" in the debtor and before the transfers at issue, when debtor paid him back his "investment" along with the "profits."

2) On trustee's argument that the good faith exception to a fraudulent transfer claim under § 548(c) and its state law equivalent is barred as a matter of law, the Court held that the good faith exception is NOT barred because the transferee received in exchange for the transfers "reasonably equivalent value" in the form of "a proportionately reduced restitution claim" against the debtor. related to his role as a purported limited partner to the debtor.

Statutory Language
The Court pointed out that on one hand § 548 of the Code did not apply because the transfers at issue occurred well beyond its 1-year statute of limitations (extended to 2 years under BAPCPA), but "[w]here state statutes are similar to the Bankruptcy Code, cases analyzing the Bankruptcy Code provisions are persuasive. It then based virtually its entire analysis on 9th Circuit case law primarily interpreting § 548 of the Code.

§ 548(a)(1) and (c) state, as pertinent here:

The trustee may avoid any transfer . . . of an interest of the debtor in property . . . that was made . . within one year before the date of the filing of the petition, if the debtor voluntarily or involuntarily-- (A) made such transfer . . . with actual intent to hinder, delay, or defraud any entity to which the debtor was . . . indebted; or (B) received less than a reasonably equivalent value in exchange for such transfer ... .

c) . . . a transferee . . . of such a transfer . . . that takes for value and in good faith . . . may retain any interest transferred . . . to the extent that such transferee . . . gave value to the debtor in exchange for such transfer ... .

Note that the Oregon and California's fraudulent transfer statutes pertinent to this decision are substantively identical, both based on the Uniform Fraudulent Transfer Act. So this opinion applies to Oregon no less than it does to California. Compare 11 U.S.C. § 548(a)(1) with Cal. Civ. Code § 3439.04(a) and ORS 95.230 (allowing a transfer to be avoided when the debtor acted with “actual intent to hinder, delay, or defraud” an entity or creditor, or where indicia of constructive fraud are present); and compare 11 U.S.C. § 548(c) with Cal. Civ. Code §3439.08(a) and ORS §95.270 (the safe harbor good faith exception to transferees who took in good faith and for value).

Actual Intent to Defraud
The transferee argued that there remained a genuine issue of fact on the debtor's actual intent to defraud any entity or creditors, and that therefore he should be entitled to go to trial on the transfer to him of "profits" not just the original "investment." The 9th Circuit disagreed, citing its own case law that fraudulent intent can be found from circumstantial evidence and that " 'the mere existence of a Ponzi scheme' is sufficient to establish actual intent under § 548(a)(1) or a state's equivalent to that section." The opinion pointed out that from the debtor's principal's admissions in his plea agreement, the Ponzi scheme was in effect at the time the transferee "invested" and continued to be throughout the time he received the payment, and that was sufficient to find actual fraudulent intent. So there was no genuine issue of material fact on this and so trustee prevailed as to the "profits," since the "reasonably equivalent value" exception about to be discussed only applied to the "investment" portion.

Existence of Reasonably Equivalent Value
The Court spent most of its analysis on this issue, primarily explaining two of its own precedents interpreting "reasonably equivalent value" in the Ponzi context and their application to the present case. In its own words:

in Agretech [Hayes v. Palm Seedlings Partners-A (In re Agric. Research and Tech. Group, Inc.), 916 F.2d 528 (9th Cir. 1990)], . . . we held that a distribution on account of a partnership interest relative to an investor’s capital contribution was not “reasonably equivalent value” as defined by the Bankruptcy Code and Hawaii’s analog. . . . [I]n United Energy [Wyle v. C.H. Rider & Family (In re United Energy Corp.), 944 F.2d 589 (9th Cir. 1991)], . . . we held that a transfer in exchange for a proportionally reduced restitution claim was “reasonably equivalent value” as defined by the Bankruptcy Code and California’s analog. . . . . The question before us today is whether the transfer from [the debtor to the transferee] was a distribution under Agretech, or a transfer in exchange for a proportionally reduced restitution claim under United Energy.

The Court rejected the trustee's arguments that Agretech should control. 1) The fact "that Agretech dealt with affirmative defenses to actually fraudulent transfers [under § 548(a)(1)(A), as in the case here], whereas United Energy dealt with the prima facie case for constructively fraudulent transfers [§ 548(a)(1)(B)], was "a distinction without a difference." 2) "Although limited partnership interests are present in Agretech and in this case, [the transferee] was defrauded by [debtor's principal], creating rights different that the rights held by the limited partners in Agretech."

Instead the Court held that United Energy controls. Quoting the District Court opinion which it affirmed on this issue, the tranferee "exchanged his partnership interest for a proportionately reduced restitution claim." The 9th Circuit acknowledged that this exchange of payments for restitution claim did not occur expressly, but that, as in United Energy "we delve beyond the 'form' to the 'substance' of the transaction." Because debtor's business was a Ponzi scheme by the time transferee invested in it, the transferee"acquired a restitution claim at the time he bought into [the] ... Ponzi scheme, just as the investors in United Energy acquired a restitution claim at the time they bought [the debtor's fraudulently produced equipment]. It is this restitution claim, in toto, that [the transferee] exchanged when [debtor] returned [transferee's] principal 'investment' amount."

Ninth Circuit's Bottom Line
So the Court remanded to the bankruptcy court to determine if transferee took the transfers in good faith. If so, he will be entitled to retain the amount he initially "invested" in with debtor, because that would be covered by his restitution claim, now fully paid off with the debtor's transfers. But the "profits" would be beyond any restitution claim and so must be paid to the trustee.

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

9th Circuit Certifies Question of Law to State Supreme Court on Capacity of Administratively Dissolved Corporation to Prosecute Adversary Proceeding

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



American Sports Radio Network v. Krause (In re Krause)
9th Circuit Case No. 07-55131
October 10, 2008

This opinion has no holding, indeed it is merely a lengthy order certifying a question to the Nevada Supreme Court. And yet the 9th Circuit takes 13 pages to do this. Indeed the Court's discussion IS valuable from a bankruptcy litigation perspective both for its substantive issue--the capacity of an administratively dissolved corporation to file an adversary proceeding against a debtor, and the appellate procedural one--when is it appropriate for a bankruptcy appellate court to seek formal assistance from a state supreme court in interpreting that state's laws.

Oh, and by the way: "several million dollars" are at stake in this Chapter 7 nondischargeability adversary proceeding.

Dissolved Corporation's Capacity to Sue

The Court's discussion about the corporate capacity to sue is worthwhile not for the answers it provides--because it provides none, but rather for how it formulates the question. This ends up being more interesting and challenging than would first appear.

The threshold consideration is that corporate capacity to sue is determined "by the law under which it was organized," FRCP 17(b), FRBP 7017, so we look to the law of the state where the corporation is incorporated.

Then stating the question is simple: does a corporation, which was administratively dissolved by the state for failing to pay its annual fees and in that status files a timely adversary proceeding in bankruptcy court, and then has its corporate charter reinstated by the state within weeks after filing the adversary proceeding, have capacity to continue that adversary proceeding?

This question gets more interesting. If the administrative dissolution of a corporation results in a forfeiture of its "right to transact business," does this necessarily include the right to sue when transacting business is not defined in the state statute nor interpreted in its case law? The bankruptcy court and district court on appeal had determined that by a plain reading of the statute the right to sue is included in the right to transact business, but to the contrary the 9th Circuit decided that transacting business did not NECESSARILY include the right to sue.

What if the corporation did not have capacity to sue at the time it filed the adversary proceeding, which was just a day before the bar date, but the state statute provides that reinstating the corporate charter after dissolution "reinstates the corporation's right to transact business as if such right had at all times remained in full force and effect?" In contrast the bankruptcy court had dismissed the adversary proceeding WITH PREJUDICE, and the district court affirmed. The 9th Circuit held that the statute was ambiguous, had no state court precedent, and so determined that it needed to certify the question to the state supreme court.

And if the corporation did not have capacity to sue at the time it filed the adversary proceeding, did its directors have that capacity, since by state law they have some right to hold the dissolved corporation's assets in trust, including such assets as the claim against the debtor? And if so, should the bankruptcy court give the directors the opportunity to be substituted for the corporation as the plaintiff? The 9th Circuit did not address whether the bankruptcy court or district court looked at this question, but the Court decided that with no statute or case law directly on point, it again needed to certify the question to the state supreme court, as follows:

Under Nevada law, may a domestic corporation whose charter has been revoked under Nevada Revised Statutes section 78.175(2) prosecute a lawsuit either (a) in its own corporate name or (b) through its directors? If not, is the defendant entitled to have such a lawsuit dismissed with prejudice, or must the plaintiff corporation first be given a reasonable opportunity to reinstate its charter? Cf. Executive Mgmt. Ltd. v. Ticor Title Ins. Co., 38 P.3d 872 (Nev. 2002).

The Appellate Procedure of Certifying Questions to a State Supreme Court

Without asserting that this is the procedure in all states, the 9th Circuit stated in the Order the two elements required under Nevada's Rules of Appellate Procedure for a federal or other state's highest court to certify a question to the Nevada Supreme Court: 1) that "the answer to this question will be determinative of the matter pending before this court, and [2) that] there is no clearly controlling precedent in the decisions of the Nevada Supreme
Court."

Compare this to the pertinent Oregon statute, ORS 28.200, which contains the same two elements:

Supreme Court authorized to answer questions of law certified by other courts. The Supreme Court may answer questions of law certified to it by the Supreme Court of the United States, a Court of Appeals of the United States, a United States District Court, a panel of the Bankruptcy Appellate Panel Service or the highest appellate court or the intermediate appellate court of any other state, when requested by the certifying court if there are involved in any proceedings before it questions of law of this state which may be determinative of the cause then pending in the certifying court and as to which it appears to the certifying court there is no controlling precedent in the decisions of the Supreme Court and the intermediate appellate courts of this state.

The short title of the act containing this ORS section is the Uniform Certification of Questions of Law Act.

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

Chapter 13 Debtor Must Account for $145,000 in Unreinvested Homestead Proceeds After Converting from Chapter 7 Case

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


White v. Brown
9th Circuit BAP
Published opinion No. AZ-07-1385-KPaJu
April 22, 2008

This 9th Circuit BAP opinion addresses this question: what is the effect of an asset turnover order against a Chapter 7 debtor when he responds by converting his case into a Chapter 13? The BAP's discussion of this leads to a better understanding of two concepts that can get tricky especially when combined: asset turnover orders and conversions from Chapter 7 to 13.

Adding the necessary details to the initial question: if a Chapter 7 debtor exempts from the estate the proceeds of the pre-petition sale of his homestead--about $145,000, then fails to reinvest these proceeds in another homestead within the time permitted by state law for preserving the exemption (18 months here), but instead debtor spends these funds on bad investments and living expenses, and then, after the Chapter 7 trustee reopens his case and gets a turnover order as to those homestead sale proceeds, debtor converts that case to a Chapter 13 case, will that $145,000 be considered a non-exempt asset for purposes of the best-interests test? I propose that the intuitive answer is, "No." The rationale: if debtor innocently albeit foolishly invested and lost most of the homestead sale proceeds and lived off the rest of it, then converted his case to Chapter 13, the debtor should no longer have to account for the now nonexistent assets.

According to this 9th Circuit BAP opinion, my intuitive sense would be wrong but I would not be alone--this conclusion was shared by the very strong dissenting opinion. But here's how the majority opinion analyzed this.

It started by admitting that the "bankruptcy status of the Arizona 18-month temporary homestead sale proceed exemption is a festering sore." (Note that Oregon, California and numerous other states, have such "temporary sale proceed" exemptions.)

The BAP then dealt with a necessary and contentious threshold issue: is this appeal made moot by the conversion to Chapter 13? The argument for mootness is that upon conversion to Chapter 13, the Chapter 7 trustee who got the conversion order no longer exists in the case, and indeed through § 1306(b) the debtor takes possession of all assets of the estate. An order for the debtor to turn over to himself the no-longer-existent sale proceeds, or in affect to collect on a judgment against himself in that amount, seems to make no sense.

But the BAP analyzed the turnover order as a determination, effectively a judgment, that the Chapter 7 trustee has a right to the $145,000 in non-exempt assets, one which did not come into effect and so could not be pursued until the 18-month reinvestment period had passed. So at the time of the conversion, the property of the estate included a right to recover $145,000 from the debtor. But the Chapter 13 trustee, as a successor to the original trustee, is not able to enforce the turnover "judgment" against debtor because this trustee does not have the right to possession of estate assets, debtor does. However, the Chapter 13 trustee DOES have the right to object to confirmation of a plan that does not require payments enough to cover the value of nonexempt assets. This gives the trustee standing in this dispute, and "enables de facto enforcement of the . . . turnover order by opposing confirmation of any plan that does not distribute property of the estate to creditors in the manner and sums . . . required by the Bankruptcy Code."

But once the Chapter 13 Trustee has standing, the debtor can still argue that 1) there is no legal restriction on his "use of homestead sale proceeds during the period of temporary exemption," and 2) so "he is not required to account for the postpetition loss of net homestead sale proceeds." And finally, that 3) the trustee failed to timely object to his claim of objection so is now unable to request turnover of the proceeds.

The BAP began its response to these arguments with bankruptcy law, basing it largely around a 9th Circuit opinion England v. Golden (In re Golden), 789 F.2d 698, 700 (9th Cir. 1986) applying the analogous California 6-month homestead sale proceeds exemption. Golden held that

upon the expiration of [that] sale proceeds exemption, proceeds that have not been reinvested in a new homestead "revert to the trustee." Rejecting argument that there should be credit for expenditures, the Ninth Circuit also held that the amount that reverts is the sum claimed as exempt at the time of filing.

But Golden, and its BAP progeny, did not address the permissible uses of sale proceeds during the exemption period, which is largely an issue of state law: state law creates the property exemption and so in this opinion the BAP looked to state law to determine the nature of that exemption.

Without here getting into the intricacies of Arizona's proceeds-of-homestead exemption law (which again may or may not be sufficiently analogous to Oregon statute and case law), the Court then tried to figure out how the Arizona Supreme Court would respond to debtor's three arguments listed above.

First, the BAP held that use of the sale proceeds is restricted during the period of temporary exemption because a "contingent, reversionary interest" attached to the homestead proceeds upon the filing of the Chapter 7 case, and remains for the full duration of the estate.

Second, the debtor must account for the post-petition loss of the homestead proceeds because of his lack of intent to reinvest the proceeds for an exempt purpose, "as evidenced, inter alia, by trading activities in risky investments 'so contrary to' the claim of exemption as to constitute abandonment of the exemption."

And third, the Chapter 7 trustee's lack of objection to the debtor's exemption did not effect the trustee's right to request turnover. Until the temporary exemption period expired, the trustee had nothing to which to object. So trustee did not lose the right to turnover for objecting to the exemption only after learning about the spending of the proceeds.

BOTTOM LINE: This is a contentious issue, or really a set of them. Not only is there a vigorous dissent in this BAP opinion (for which I do not have space here to give due credit), prior BAP cases interpreting Golden have had dicta and concurring opinions raising concerns. The holding here, that a Chapter 7 debtor must account in his converted Chapter 13 case for temporarily exempt homestead proceeds spent contrary to the exemption's purpose, may well apply in Oregon, but requires a careful comparison of the Arizona and Oregon statutes, and of the states' case law.



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

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