U.S. SUPREME COURT CASE NOTES
By Justice Brooks | Foster Garvey PC
County Cannot Overstep Authority in Foreclosure Related to Tax Debts
Tyler v. Hennepin Cnty., 598 U.S. 631 (2023)
In Tyler, the pivotal question before the U.S. Supreme Court was whether a Minnesota law that permits a county to retain more than the tax debt owed by a property owner constitutes a “taking” under the Takings Clause of the Fifth Amendment and if such excessive forfeiture also infringes upon the Excessive Fines Clause of the Eighth Amendment.
This legal battle originated when Geraldine Tyler, after relocating to a senior living facility, ceased paying property taxes, which accumulated to a debt of $15,000. Hennepin County subsequently foreclosed and sold her condominium for $40,000, retaining $25,000 over the debt amount.
The lower courts delivered conflicting decisions. The U.S. District Court for the District of Minnesota initially dismissed Tyler’s suit for failing to state a claim. However, upon appeal, the Supreme Court granted certiorari due to the broad implications of the case on public debt compensation practices, especially in the context of property forfeitures.
The Supreme Court unanimously ruled that the Minnesota statute indeed resulted in a “classic taking,” clearly violating the Fifth Amendment. The Court meticulously analyzed the statutory framework, highlighting that the plain language of the Takings Clause protects property owners from government overreach that extends beyond the debt owed. In its decision, the Court dismissed the county’s argument that Tyler had abandoned her property rights by failing to pay taxes, noting the absence of legal precedent supporting such a stance.
Furthermore, the Court chose not to fully address the Excessive Fines Clause issue since the resolution under the Takings Clause sufficiently remedied the harm to Tyler. Nonetheless, a concurrent opinion by Justice Gorsuch, joined by Justice Jackson, criticized the lower courts’ handling of the Excessive Fines analysis, indicating potential grounds for Tyler’s success on this issue as well.
This landmark decision not only clarified the scope of governmental authority in property foreclosures related to tax debts but also set a precedent emphasizing the constitutional protections against excessive governmental forfeiture.
NINTH CIRCUIT CASE NOTES
By Danny Newman and Eric Levine | Tonkon Torp LLP
Without a ‘Limited Fund’ Bankruptcy Plan, Creditors Lack Standing to Challenge Trustee Compensation
In re East Coast Foods, Inc., 80 F.4th 901 (9th Cir. 2023)
This case involved a challenge to the Chapter 11 trustee’s compensation by a general unsecured creditor where that creditor was eventually to be paid in full with interest. The 9th Circuit held that the general unsecured creditor lacked Article III standing to challenge fees under those circumstances.
In 2016, East Coast Foods filed for Chapter 11 bankruptcy, and an official committee of unsecured creditors was appointed to monitor East Coast Foods’ activities. After an examiner found that East Coast Foods could not meet its fiduciary obligations, Sharp was appointed as trustee.
By any measure, Sharp did a decent job. Over the course of two years, he worked with the committee and created a plan that guaranteed full payment—with interest—to all creditors. The guarantee was secured by a collateral package that included equity in assets with a value nearly doubling the outstanding debt. The plan is projected to pay off its final creditor in four to six years.
Sharp was so confident in his work that he sought the maximum fee for a trustee allowable under the Bankruptcy Code—then $1,155,844.71. That represented his loadstar figure ($758,955.50) plus an upward enhancement of 65% for exceptional services. An unsecured creditor, Clifton Capital Group, LLC (“Clifton”), objected to the enhancement. The bankruptcy court overruled the objection, and Clifton appealed to the district court.
There, Sharp argued Clifton lacked standing because it was not an aggrieved party. The district court disagreed, finding that Clifton was an “aggrieved party” because there was insufficient capital to pay it in full. It then held that Sharp’s increased compensation aggrieved Clifton by further subordinating its debt. It remanded for further factual finding on the reasonableness of Sharp’s enhancement. On remand, the bankruptcy court again found Sharp was entitled to an enhancement, and Clifton again appealed. This time, however, the district court affirmed Sharp’s fee award, and Clifton appealed to the 9th Circuit.
Before addressing whether Clifton was an “aggrieved person,” the 9th Circuit held that an “aggrieved person” standing in bankruptcy is prudential standing, and the court should first consider whether Clifton had Article III standing. Clifton argued that it suffered an injury in fact because it had not been paid in full on its claim. Sharp countered that injury was conjectural and hypothetical because the bankruptcy plan would pay all creditors in full, and Clifton would suffer no injury by a delay in receiving its payment because all creditors would be paid in full with interest.
The 9th Circuit agreed with Sharp. It held that the district court erred in applying “limited fund” jurisprudence to this case where “additional monies” were available if East Coast Foods deviated from the bankruptcy plan. Because the guarantee, if liquidated, was sufficient to pay all creditors in full with interest, there was no “limited fund,” and Clifton suffered no injury in fact. Nor did the 9th Circuit agree with Clifton that it was injured by a delay in payment. For one thing, Clifton would be paid interest on its debt, and for another, the bankruptcy plan did not guarantee a date by which all creditors would be paid. The 9th Circuit noted that the estimated time period when creditors would be paid had not elapsed by the time it decided this case, providing another example of why the case was not yet ripe.
This case is a good result for all of us who like to get our fees paid!
Increases in Home Equity Between Chapter 13 Reorganization Filing and Conversion to Chapter 7 Liquidation Belong to Estate and Not Bankruptcy Debtors
In re Castleman, 75 F.4th 1052 (9th Cir. 2023), cert. denied, 144 S. Ct. 813 (2024)
This case presented the question of whether post-petition, pre-conversion increases in the equity of an asset belong to the bankruptcy estate or to debtors who convert their Chapter 13 debt adjustment petition into a Chapter 7 liquidation. In a split decision, the 9th Circuit concluded that any appreciation in the property value and corresponding increase in equity belongs to the estate upon conversion.
Debtors John Felix Castleman, Sr., and Kimberly Kay Castleman (the “Castlemans”) filed Chapter 13 petitions. At the time, their house was valued at $500,000. About 20 months later, they had trouble making their payments and opted to convert to a Chapter 7 liquidation. In the interim, the value of the Castlemans’ home increased by about $200,000. The Chapter 7 trustee filed a motion to sell the house and recover its value for creditors; the Castlemans objected and argued the increased equity belonged to them.
On appeal, the 9th Circuit—as it has been doing more consistently for several years now—relied on the plain language of Section 348(f), which states, “property of the estate in the converted case shall consist of property of the estate, as of the date of filing of the petition, that remains in the possession of or is under the control of the debtor on the date of conversion.”
It held that this language was unambiguous when read in the context of the rest of the Bankruptcy Code. It looked to, most importantly, Section 541(a), which defines “property of the estate” as all legal or equitable interests of the debtor in property as of the commencement of the case. The court reasoned that post-petition appreciation in assets is not separate, after-acquired property. Rather, the equity is inseparable from the real estate, which was always property of the estate under Section 541(a).
In so holding, the 9th Circuit split with other courts. The court noted that many disagreeing courts rely on the legislative history for Section 348(f), which was enacted to clarify whether new property acquired during the course of Chapter 13 proceedings becomes property of the converted estate. However, the court held that the language of Section 348(f) was not ambiguous, so it would not consider the legislative history. It likewise disagreed with courts that rely on the implicit operation of Section 1327(b) because Congress could have expressly cross-referenced Section 1327(b) if that is what it intended.
The majority drew a spirited dissent from Judge Tallman, who argued the majority scarified the text of the bankruptcy statute on the altar of simplicity. He continued that reading the Bankruptcy Code as a whole, and not just Section 541(a), reveals that “property of the estate” is defined differently in the Chapter 7 and Chapter 13 contexts. To Judge Tallman, the majority’s reading contradicted the Code’s structure, object, policies, and legislative history. Judge Tallman concluded by stating that reasonable judicial minds could disagree on the issue and called on Congress to clarify the operation of Section 348.
The Eighth Circuit Court of Appeals recently aligned itself with the Castleman panel majority. See Goetz v. Weber (In re Goetz), 95 F.4th 584 (8th Cir. 2024) (holding that “a post-petition, pre-conversion increase in equity in the debtor’s residence became property of her converted bankruptcy estate”).
Debtor with Assets Who Fails to Properly Serve Creditor Will Not Discharge Any Debt to Them
Licup v. Jefferson Ave. Temecula LLC, __ F.4d __, 2024 WL 1151662 (9th Cir. 2024)
This case presented the question of whether any portion of an unscheduled debt is dischargeable in a Chapter 7 bankruptcy proceeding. The 9th Circuit concluded the answer is no.
Christina Castro and her spouse, Edwin C. Licup, filed for Chapter 7 bankruptcy but did not give notice to one creditor. For that creditor, Jefferson Avenue Temecula LLC (“Jefferson”), Castro and Licup incorrectly listed the mailing address for Jefferson’s attorney on their schedule. Jefferson did not file a claim in the bankruptcy action, which closed in 2016.
In 2021, Jefferson sued to collect its debt. Castro and Licup filed a motion for summary judgment arguing that the only nondischarged debt was the limited amount that Jefferson would have recovered had it filed its claim in the original bankruptcy and been treated the same as other unsecured creditors ($1,614.74 out of $31.780.29). The bankruptcy court rejected this argument and sua sponte granted summary judgment for Jefferson. It concluded that no portion of Jefferson’s debt was dischargeable because it was undisputed that Jefferson had no notice of the bankruptcy case, and holding otherwise would violate its due process rights. The bankruptcy appellate panel affirmed.
The 9th Circuit also affirmed. As an initial matter, the court concluded that Jefferson had standing. Castro and Licup argued Jefferson lacked standing because its debt—an unlawful detainer judgment against Christina Castro, LLC, and not Christina Castro, D.D.S.—was unenforceable. The court did not decide on that question. For standing purposes, it concluded that Jefferson suffered an injury in fact when its debt remained unpaid. Whether it could enforce its judgment was a matter of state law, and a separate question from the one presented by the appeal: whether a debt could be discharged without providing notice.
On the merits, Castro and Licup argued that the court should apply its “non-asset” bankruptcy jurisprudence to cases where there are assets to limit the nondischargeable amount to the amount the creditor would have received if it filed a claim. Non-asset cases, such as In re Beezley, 994
F.2d 1433 (9th Cir. 1993) (per curiam), found no problem with discharging all debts despite the debtor not notifying creditors of the bankruptcy.
The 9th Circuit rejected the Debtors’ argument because in no-asset, no-bar-date Chapter 7 bankruptcy cases, there are no assets to distribute, so it would be “meaningless and worthless” for creditors to file claims. Because the court refused to create a carve-out to reduce the nondischargeable amount in any way, 11 U.S.C. § 521(a)(1) applied in full. Castro and Licup failed to comply with the requirements to have a debt discharged, so their debt to Jefferson rode through unimpacted and stood as if the bankruptcy had never occurred.
Factoring Company Holding Itself Out as Secured Creditor Is Treated as Creditor against Bankruptcy Estate and Not Purchaser of Future Asset
In re Medley, 2024 WL 49806 (9th Cir. Jan. 4, 2024)
Factorers often make creative arguments about their idiosyncratic arrangements with debtors. The 9th Circuit has rejected several of them in a potential blow to the industry.
Jill Suzann Medley was a real estate broker who received an advance on her commission for the sale of a property from Precision Business Consulting, LLC (“Precision”). Before the property was sold, Medley filed for Chapter 13 bankruptcy. Later, when the property was under contract, and several months after receiving notice of the bankruptcy petition, Precision contacted both Medley and her client to collect its assigned portion of the commission. Subsequently, Medley’s petition was dismissed, and she filed a motion for sanctions against Precision for violating the automatic stay under 11 U.S.C. § 362(k). After an evidentiary hearing, the bankruptcy court granted the motion. The BAP affirmed.
Precision made three arguments, and the 9th Circuit rejected them all. First, it argued that as a factoring company, it had purchased Medley’s commission, so the commission was not part of the bankruptcy estate. The court applied the test for recharacterization from Boucher v. Shaw, 572 F.3d 1087 (9th Cir. 2009) (en banc), to determine that the transaction was a loan, not a sale. That was so because Medley would have full liability if settlement failed to occur—i.e., she bore the full transaction risk. See Shaw, 572 F.3d at 802 (holding that the primary factor for recharacterizing a sale as a loan is who bears the risk). Moreover, Precision held itself out as a secured creditor by filing a proof of claim, commenting that it had perfected a security interest in the property. That was sufficient to determine Precision made a loan, not a purchase, and the commission was part of the bankruptcy estate.
Next, Precision argued it did not intentionally violate the stay because it had a good faith belief that it had purchased the commission. The court again rejected that position because intentional volition of the stay provision requires only knowledge of the stay and that the creditor’s actions that violated the stay were intentional.
Finally, Precision argued that it owned the money it gave Medley before she filed for bankruptcy, and Medley simply possessed it. Therefore, its collection effort was simply an attempt to retain its own property. However, the court concluded that an automatic stay is intended to preserve the status quo. And because Medley held the money at the time of filing for bankruptcy, the stay operated to allow her to continue holding it. As the court rejected all three of Precision’s arguments, it affirmed the sanctions imposed against Precision.
NINTH CIRCUIT BAP CASE NOTES
By Reece Petrik | Law Clerk to Judge Teresa H. Pearson
Deferred Settlement Agreements Cannot Be Assumed as Executory Contracts
In re Svenhard’s Swedish Bakery, 653 B.R. 471 (B.A.P. 9th Cir. 2023)
The Ninth Circuit BAP recently explored the issue of whether deferred settlement agreements can be assumed as executory contracts pursuant to 11 U.S.C. § 365. The BAP affirmed the lower bankruptcy court and held that the settlement agreement at issue could not be assumed. A closer look at the facts and reasoning follows.
Prior to bankruptcy, the Debtor operated a bakery business. The Debtor executed a sale of the business to a third party in 2014 with a five-year lease-back of its operations. In 2015, the Debtor closed its Oakland, Calif., bakery and relocated to Exeter, Calif., terminating its union workforce in the process, effectively withdrawing from the Confectionery Union and Industrial Pension Fund. The Pension Fund notified the Debtor it had incurred liabilities totaling approximately $50.6 million due to its withdrawal from the Pension Fund and its failure to make contributions to the fund related to severance pay and accrued vacation.
The Debtor was unable to pay and instead negotiated a settlement agreement with the Pension Fund, wherein the Debtor would make monthly payments on a reduced liability in exchange for a release of the Pension Fund’s claims against the Debtor. The Debtor later defaulted on its payment due for December 2019 and shortly thereafter filed for bankruptcy. In the bankruptcy case, the Debtor sought to assume and assign the settlement agreement to the third party to which it had sold its business. The Pension Fund objected, arguing that it was not an executory contract under Ninth Circuit law. The bankruptcy court agreed with the Pension Fund, and the Debtor appealed.
On appeal, the BAP agreed with the bankruptcy court’s denial of the motion to assume and assign the settlement. In doing so, the BAP explained that the Ninth Circuit uses the “Countryman test” definition for executory contracts. See In re Robert L. Helms Constr. & Dev. Co., 139 F.3d 702, 705 (9th Cir. 1998). Coined by Professor Countryman, that test states “[A] contract is executory if ‘the obligations of both parties are so unperformed that the failure of either party to complete performance would constitute a material breach and thus excuse the performance of the other.’” Id. (quoting Griffel v. Murphy (In re Wegner), 839 F.2d 533, 536 (9th Cir. 1988). Maryland law governed the settlement agreement. The BAP applied Maryland’s law on contracts and found that the Pension Fund’s obligation to release its claims against debtor only arose when the condition precedent—debtor’s full payment under the agreement—was met.
Under these facts, the Pension Fund was incapable of materially breaching the contract in such a way that would excuse the Debtor’s obligation to perform. Rather, the Debtor’s performance was required first under the contract, and only then did the Pension Fund have an obligation to perform by executing releases. The BAP also cast doubt on whether a failure to execute releases would be a “material” breach, noting that the releases would be merely ministerial when the Debtor’s proof of payment could otherwise serve as a complete defense to any collection action. In reaching this conclusion, the BAP deftly noted that “an executory contract is one where both parties have something at risk,” and here, the Debtor bore no risk if the Pension Fund materially breached its end of the deal. Thus, the contract could not be assumed and assigned pursuant to 11 U.S.C. § 365.
Section 1322(c)(2) Permits Bifurcation of Mortgages Maturing Before Final Plan Payment
In re Lee, 655 B.R. 340 (B.A.P. 9th Cir. 2023)
The BAP recently decided an issue of first impression in the Ninth Circuit: whether a mortgage maturing before a final plan payment may be bifurcated and crammed down. The BAP affirmed the lower bankruptcy court, which held that pursuant to 11 U.S.C. § 1322(c)(2), chapter 13 debtors may bifurcate and cram down such claims. In doing so, the BAP joined the Fourth Circuit, Eleventh Circuit, and other courts that have previously addressed the issue. The decision has since been appealed to the Ninth Circuit, which has yet to issue a ruling.
The opinion itself covers numerous facts, arguments, and issues. But the central facts and issues can be summarized relatively easily. The Debtors were a husband and wife whose primary asset was their home. The home had a first mortgage against it followed by a junior lien arising from a HELOC. The Debtors’ first plan proposed bifurcating the HELOC claim pursuant to 11 U.S.C. § 1322(c)(2). The HELOC creditor disputed the home’s value, amongst numerous other objections, and the court eventually fixed the value at an amount that still left the HELOC claim undersecured.
The HELOC creditor raised objections to the Debtors’ first, second, third, and fourth proposed plans. In their objection to the third plan, the HELOC creditor argued for the first time that the Debtors’ proposed treatment was impermissible under 11 U.S.C. § 1322(b)(2), which prohibits
modification of a claim secured by the Debtor’s primary residence. The HELOC creditor raised the argument again in their objection to the fourth plan. When confirming the fourth plan, the bankruptcy court held that 11 U.S.C. § 1322(c)(2), while not very clearly written, permitted the Debtors’ proposed bifurcation of the claim. The HELOC creditor appealed.
On appeal, the BAP looked at 11 U.S.C. §§ 1322(b)(2), (c)(2), and 1325(a)(5), as well as relevant case law. The HELOC creditor argued that the Supreme Court’s decision in Nobelman v. Am. Sav. Bank, 508 U.S. 324 (1993) prohibited the bankruptcy court from modifying anything other than the repayment terms of its claim. Meanwhile, the Debtors argued that 11 U.S.C. § 1322(c)(2) allows modification of the claim itself. The BAP noted that the Nobelman decision predated Congress’s amendment of 11 U.S.C. § 1322(c)(2), and this amendment overrode the Court’s interpretation in Nobelman. Turning to how other courts had addressed the issue, the BAP noted the Fourth Circuit had initially agreed with the HELOC creditor in its Witt v. United Co. Lending Corp. (In re Witt), 113 F.3d 508 (4th Cir. 1997) decision, only to reverse 22 years later in its Hurlburt v. Black, 925 F.3d 154 (4th Cir. 2019) decision. In addition, numerous other jurisdictions had reached the same result as Hurlburt.
In all these decisions, the courts agreed that 11 U.S.C. § 1322(c)(2) was an exception to the general prohibition outlined in 11 U.S.C. § 1322(b)(2), while 11 U.S.C. § 1322(c)(2)’s plain language permitted modification not just of payment terms, but also of the claim itself, by its reference to 11 U.S.C. § 1325(a)(5). The BAP agreed, noting that 11 U.S.C. § 1322(c)(2)’s language is not ambiguous, though perhaps not ideal or perfect either. Thus, for the time being, chapter 13 debtors may now bifurcate undersecured claims against their primary residence in the Ninth Circuit.