Can't We All Just Even Give Up?

Bankruptcy Judge Wallace of the Central District of California (Riverside Division), recently entered a Memorandum Decision which declined to approve the settlement of a dischargeability action filed by a finance company against a pro se debtor.  The Memorandum Decision in First Mutual Sales Finance v. Cacciatori, 2012 WL 539783, (C.D. Cal. 2/15/2012) should give pause to creditors who bring flimsy dischargeability actions against penniless pro per debtors, counting on the fact that the cases "can always be settled for something."  The case should also be disconcerting to lawyers on both sides of the fence whose clients need to settle legitimate dischargeability disputes. 

First Mutual's dischargeability action was based on an allegedly false credit application which was filled out by a sales rep for a window company on a visit to the Debtor's home, then signed by the Debtor.  First Mutual alleged that the Debtor had intentionally overstated her income by signing the form. 

The Debtor, who had a lawyer in her no-asset chapter 7 bankruptcy, was not represented by counsel at any point in the adversary proceeding.  She filed an obviously homemade answer, and later signed a joint pretrial order which relieved First Mutual from the burden of proving much of its case.  Shortly after the trial commenced, counsel for First Mutual asked for a short recess to discuss settlement with the Debtor.  They returned to the courtroom and announced that a settlement had been reached.  The Debtor would stipulate to entry of a judgment for $32,853.87 [for windows?] with the proviso that the judgment would not be executed so long as Debtor paid First Mutual $100.00 per month until the full amount was paid (without postjudgment interest).  At that rate, the Debtor would have made $100.00 payments to the finance company for the next 27 years.  Counsel for First Mutual stated on the record that one of the reasons the Debtor was willing to settle the matter on these terms was that "she did not want a judgment of fraud entered against her." 

Judge Wallace refused to enter the requested stipulated judgment, and the trial proceeded.  First Mutual did not produce as a witness the sales rep who took the application, and the Debtor testified about everything the sales rep "explained" to her in taking the information to fill out the form.  The Court found that First Mutual did not sustain its burden of proof and entered judgment for the Debtor. 

The opinion states in part: 

The Court refused to accept such proposed settlement stipulation for two separate and independent reasons. First, there was no reasonable basis for such a settlement based upon a review of the pleadings and the Court's record. . . . A court is authorized to satisfy itself that there is a reasonable basis for the entry of a consent judgment. [citations]  Here, there was no reasonable basis for such entry. 

Second, the Court cannot and should not approve a settlement stipulation in a section 523(a)(2) matter that does not stipulate that fraud has been committed. [citations].  [The Debtor's] adamant (and, in the Court's view, totally justified) refusal to admit to fraud precluded the Court from accepting the proposed stipulated settlement.

As to the first "separate and independent" reason for refusing to implement the settlement:  This appeared to be by no means the weakest dischargeabilty case that ever crossed my path.  But it looks like once the trial started and Judge Wallace got a sniff of just how weak the case was, he simply wasn't going to let the pro per Debtor just give up and stipulate to judgment.  Certainly, the filing of dischargeability cases against debtors without the means to hire an attorney to defend themselves can be a strategy for oppression. 

It is the second reason which should give pause:  Should a debtor without the means to pay a cash settlement be required to admit to wrongdoing as a condition to being allowed to stipulate to payment of a compromise amount in installments?   Should a debtor's choice be to either admit in writing to having committed fraud or go to trial and incur both the attorney fees and the risk of an adverse result?  Such a rule penalizes a debtor for having the combination of prudence and integrity. 

The Salazar Saga Continues

 

Bankruptcy and foreclosure lawyers everywhere have been vitally interested in the fate of In re Salazar, 448 B.R. 814 (Bankr. S.D. Cal. 2011), which denied the lender's motion for relief from the automatic stay to complete an eviction after a pre-bankruptcy foreclosure sale.  The trust deed in Salazar named MERS as the beneficiary, but the foreclosure notices and trustee's deed referred instead to US Bank.  The opinion in Salazar concluded that California Civil Code section 2932.5, which states that the power of sale under a mortgage "may be exercised by the assignee if the assignment is duly acknowledged and recorded." was not satisfied by off-record assignments under the MERS system.  Since the assignment to US Bank was not recorded, the Court concluded that the Debtor had made a prima facie showing that the foreclosure was void, and declined to grant relief from the automatic stay for that reason.  The Court acknowledged, however, that the Salazars' title to their home "must finally be established in an adversary proceeding." 

The holding in Salazar denying relief from the automatic stay was a final order for purposes of appeal.  It was appealed to the District Court (Case No. 3:11-cv-00907).  That appeal has already been briefed and submitted without argument to Judge Lorenz.  Salazar has been several times distinguished and was also criticized in a couple of unpublished decisions:  See Kurek v. America's Wholesale Lender, 2011 WL 3240482 (N.D. Cal. Jul. 28, 2012) (Magistrate Judge Zimmerman); and Forbes v. Countrywide Home Loans, 2011 WL 4985965 (Cal. App. 4th Dist. Div. 2 Oct. 20, 2011). 

In the meantime, the Salazars got around to filing their adversary proceeding to declare the foreclosure void and for damages on a variety of theories. (Case No. 11-90441)  On January 31, 2012, Judge Lorenz withdrew the reference in that adversary proceeding.  We can therefore ultimately expect to have an important ruling on the MERS issue, binding in our District until the Ninth Circuit speaks. 

Judge Lorenz's four page order explains that withdrawal of the reference was based on jurisdictional concerns raised by Stern v. Marshall, ––– U.S. ––––, 131 S.Ct. 2594, 2601–02 (2011).  Judge Lorenz reasoned that the complaint was a "wrongful foreclosure action which could have been filed in state court and would not be 'resolved in the process of ruling on a creditor's proof of claim.' [quoting Stern]."  This shows just how deep Stern v. Marshall may cut at the bankruptcy system.  Until a short time ago, no one would have thought that a bankruptcy court lacked jurisdiction to determine whether the debtors had title to property which they occupied as their home.  Will we have to wait for a decision on the appeal until the to-be-expected motion for summary judgment is briefed in the adversary proceeding? 

Would You Buy a Used Car From This Man?

A recent unpublished decision by Bankuptcy Judge Mann of the Southern District of California is a good quick resource for briefing dischargeability actions in her courtroom.  In Whited v. Galindo, 2012 WL 345942 (Feb. 1, 2012), S.D. Cal. Adv. No. 10-90473), the end result was a nondischargeable judgment for $1,648.29 in damages against the president of a used car dealer.  It is one of those cases that make you happy that a lawyer was found willing to handle the matter, and also proud of a judicial system that can devote this much time and care to a dispute like this one.

The plaintiff Jared Whited was a 20 year old sailor who purchased a Hyundai Sonata from Southbay Preowned, a car dealership which closed shortly thereafter.  Defendant Antonio Galindo was the owner and president of Southbay, who was a chapter 7 debtor as the result of having guaranteed financing arrangements for Southbay.  Whited contracted to purchase the 2006 Sonata for a total price of $13,600.  The Court found that Galindo made several affirmative misrepresentations in connection with the sale of the car, including that financing had been approved when it had not.  After the financing fell through and Southbay was obliged to keep the finance contract itself, Galindo caused the car to be repossessed and resold at a small profit.  The damages awarded consisted of that profit ($148.29) and Whited's down payment ($1,500.00). 

As it seems must be the case for most judicial acts by bankruptcy courts these days, the decision begins with a discussion of whether a bankruptcy court has jurisdiction to enter a money judgment in a dischargeability action in light of the Supreme Court's decision in Stern v. Marshall, ––– U.S. ––––, 131 S.Ct. 2594, 2601–02 (2011).  The Court raised the jurisdictional issue sua sponte, but noted that the parties had alleged and admitted jurisdiction in their pleadings.  The Court also cited pre-Stern authority to the effect that money judgments can be entered in dischargeability matters.  This issue is going to come up again in other cases and the ultimate answer is not clear to me.  In re Galindo had been long before closed as a no-asset case.  Does a bankruptcy court have jurisdiction, even exclusive jurisdiction, to enter a money judgment which will have no effect on a bankruptcy estate?  I believe so, because the judgment is a determination of the scope of the discharge, a matter historically within the province of the bankruptcy courts.  

The opinion contains a good discussion of the basic authority on the elements of section 523(a)(2) fraud nondischargeablity, including the sometimes unfortunately neglected doctrine of concealment as a species of "actual fraud" within the meaning of the statute.  In violation of regulations which apply to used car dealers, Galindo had not disclosed that the Sonata was formerly a rental vehicle.  The opinion states that "[n]ondisclosure of information that Galindo has a duty to disclose may also constitute a false representation under § 523(a)(2)(A)."  The Court also concluded that "justifiable reliance . . . need not be further proven when a party with a duty to disclose a material fact fails to do so." 

If you are dissatisfied with the $1,648.29 result, remember that attorney fees are yet to be awarded in the Whited case.  The opinion states that "an award of attorney's fees, even if larger than Whited's personal loss, furthers the public goal of deterring unfair or deceptive business practices. See Hayward v. Ventura Volvo, 108 Cal.App. 4th 509, 511–13 (Cal.App.2d Dist.2003) (affirming a $98,000 attorney's fee award in auto dealer CLRA violation case where compensatory damages were $14,812)."  I'll post a comment later to report on the anticipated attorney fee award. 

Concealed Assets and Exemptions

In a post last week, I reported on the 9th Circuit BAP’s recent decision, In re Onubah, 2007 WL 2701336 (Bankr. App. 9th Cir. August 31, 2007), which surcharged the Debtor’s allowed homestead and household goods exemptions in the amount of the attorney fees and other costs incurred by the trustee as a result of the Debtor’s legal and extra-legal obstruction of the sale of his home.

In the Onubah opinion, the Court tries to explain why the result, which amounts in part to an award of the Trustee’s attorney fees against the debtor, did not violate the “American Rule” that the parties to litigation bear their own fees:

[T]he American Rule has three exceptions: (1) when a litigant preserves or recovers a fund for the benefit of others; (2) when a losing party acts in bad faith; and (3) in a civil contempt action for disobedience of a court order. Perry v. O'Donnell, 759 F.2d 702, 704 (9th Cir.1985). . . . Even a charitable view of Onubah's conduct in this case would characterize it as being undertaken in “bad faith” and as an abuse of the bankruptcy process. This implicates the second exception to the American Rule.

The Onubah decision is tantalizingly close to Ninth Circuit authority for the proposition that an exemption can be denied in its entirety for bad faith conduct in relation to the exempt asset. The paradigm case is one in which the debtor, intending to conceal an asset from the trustee, fails to list it on the schedules. After the trustee discovers the asset and spends time and money preparing to liquidate it, the Debtor seeks to amend Schedule C to claim the asset exempt. The Tenth Circuit has recently ruled that such an amendment will not be allowed. See, In re Ford, 492 F.3d 1148 (10th Cir. 2007), following In re Grogan, 300 B.R. 804 (Bankr. D. Utah 2003).

A debtor’s attorney could argue that denial of an exemption for bad faith conduct is already addressed by Bankruptcy Code section 522(g), which forbids the taking of an exemption in property recovered by the trustee using the avoiding powers, if the avoided transfer was voluntary. The argument would be that if Congress had wanted to deny exemptions as punishment for unsuccessfully attempting to conceal an asset from the trustee, it could have said so expressly in section 522. A debtor’s attorney in the 9th Circuit might also argue that denying an exemption for bad faith conduct, as opposed to carefully surcharging the exemption by the amount of the fees and costs occasioned by the debtor’s bad faith conduct, amounts to withholding an exemption to punish the debtor, which is forbidden by Latman v. Burdette, 366 F.3d 774 (9th Cir. 2004)

The key distinction supporting the result in Ford may be that in the concealed asset cases the debtor must seek to amend Schedule C, and that the allowance of an amendment is within the discretion of the Court.

The Tenth Circuit’s ruling in Ford is welcome. It imposes serious additional, real consequences on the debtor for concealing an asset. The loss of an exempt asset by an otherwise “judgment proof” debtor has more real-life impact than even a denial of the bankruptcy discharge. The loss of an exemption also may benefit creditors in dollars and cents, immediately.

Debtors: On Vacating the Premises, Take Your Goo With You!

A landlord has successfully circumvented the “cap” on lease rejection damages imposed under Bankruptcy Code section 502(b)(6). In deciding a case with highly unusual (and sympathetic) facts, Ninth Circuit Judge Alex Kozinski has made some broad statements that will henceforth encourage landlords to structure their claims, and their leases, to try to “beat the cap.” The case is In re El Toro Materials Company, 2007 WL 2822019 (9th Cir., October 1, 2007).

You’ve got to love these facts: The debtor was a mining company which had leased land from the Saddleback Valley Community Church. The rent was $28,000 per month. The debtor rejected the lease and vacated the property, leaving (in Judge Kozinski’s words) “one million tons of its wet clay “goo,” mining equipment and other materials.” Saddleback claimed “$23 million in damages for the alleged cost of removing the mess, under theories of waste, nuisance, trespass and breach of contract.” The bankruptcy court held that this claim was not subject to section 502(b)(6), which limits in amount “the claim of a lessor for damages resulting from the termination of a lease of real property.” The BAP reversed, reluctantly concluding that it was bound by its own precedent in In re McSheridan, 184 B.R. 91 (Bankr. App. 9th Cir.1995). McSheridan contains a broad holding to the effect that any damages arising from breach of any lease covenant is subject to the cap.

Here’s how the Ninth Circuit opinion distinguishes the damages for the abandoned “goo” (which certainly was a breach of a lease covenant) from other damages which would be subject to the cap:

The cap applies to damages “resulting from” the rejection of the lease. 11 U.S.C. § 502(b)(6). Saddleback's claims for waste, nuisance and trespass do not result from the rejection of the lease-they result from the pile of dirt allegedly left on the property. Rejection of the lease may or may not have triggered Saddleback's ability to sue for the alleged damages. But the harm to Saddleback's property existed whether or not the lease was rejected. A simple test reveals whether the damages result from the rejection of the lease: Assuming all other conditions remain constant, would the landlord have the same claim against the tenant if the tenant were to assume the lease rather than rejecting it? . . . The million-ton heap of dirt was not put there by the rejection of the lease-it was put there by the actions and inactions of El Toro in preparing to turn over the site.

Are you persuaded? Well, as a landlord’s attorney I sure am! The opinion expressly overrules McSheridan to the extent that it holds that the cap is (to quote the El Toro opinion) “a limit on tort claims other than those based on lost rent, rent-like payments or other damages directly arising from a tenant's failure to complete a lease term.” Incidentally, in a footnote Judge Kozinski suggests that the BAP might amend its rules to allow for en banc hearings in order to address questionable precedent like McSheridan.

El Toro obviously will prompt landlords to express their claims not in terms of breach of contract but rather in terms of torts such as conversion, trespass and fraud. Drafters of leases may change language that used to characterize “restore to shell” and similar obligations on termination as rent. Instead, new lease forms may expressly reserve tort claims for these sorts of tenant obligations.