Source: http://updates.mwbllp.com/2019_02_10_archive.html
Timestamp: 2019-04-25 22:20:32+00:00

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The U.S. Court of Appeals for the Eight Circuit recently affirmed a trial court judgment holding a bank and its principal in contempt and sanctioning them for violating a bankruptcy discharge injunction, based on the findings in a parallel state court proceeding.
In so ruling, the Eight Circuit held that the state court judgment did not preclude the bankruptcy court's ability to enforce its own orders.
A bank issued a loan to husband and wife borrowers for their business. After the business failed, a principal at the bank counseled them to obtain bankruptcy protection. The principal also recommended the borrowers retain a particular bankruptcy attorney to assist them.
The borrowers filed bankruptcy and eventually received a discharge. After the discharge, the bank still held security interests on the borrowers' property and on the property of the husband borrower's parents, but the bank would have realized a substantial loss if it foreclosed on its security. Therefore, instead of foreclosing, the bank sought and received commitments from the borrowers and the parents to pay new notes that were "substantially in excess of the security interests that had survived bankruptcy."
The borrowers and the parents defaulted on their post-bankruptcy obligation. Faced with collection efforts by the bank, the borrowers initiated a state court case in South Dakota to determine the amount they owed. They alleged their post-bankruptcy obligations were not enforceable because they were based on an improper attempt to reaffirm discharged debt. The bank and the principal asserted various counterclaims in response alleging that they could enforce the post-bankruptcy commitments.
The borrowers then filed an adversary action in bankruptcy court against the bank and the principal alleging a violation of the discharge injunction and seeking contempt sanctions. While the adversary action was pending, the state court initially entered summary judgment in favor of the bank and the principal on several counterclaims.
In turn, the bankruptcy court, found "that the state court possessed jurisdiction and authority to make discharge determinations." The bankruptcy court therefore declined to rule on a motion to dismiss and indicated that the borrowers could return to the bankruptcy court if the state court ultimately determined that the bank or the principal had wrongly "attempted to collect discharged debt." Although the bankruptcy court expressed doubt that it would ever re-open the adversary proceeding and in doing so seemed to grant the motion to dismiss, it expressly reserved its right to preside over proceedings in the future.
The state court later granted summary judgment in favor of the borrowers on the remaining counterclaims and reversed its prior summary judgment order on several counterclaims against the borrowers. After a bench trial the court determined that the bank and the principal coerced the borrowers into reaffirming their debt and wrongly attempted to collect on discharged debt. Separately, a jury found the bank and the principal obtained some of the post-discharge commitments through fraud. The South Dakota Supreme Court eventually affirmed the judgment.
Once the state court action concluded, the borrowers returned to bankruptcy court seeking attorneys' fees and a contempt sanction for violation of the discharge injunction. The bankruptcy court found that the bank and the principal violated the discharge injunction, held them in contempt, and found them liable for attorneys' fees.
The bank and the principal appealed to the Bankruptcy Appellate Panel and then to the trial court. Both affirmed and this appeal followed.
The bank and the principal argued that the bankruptcy court's initial abstention and the subsequent state court judgment precluded the bankruptcy court from later issuing its sanctions order. The Eight Circuit applied state law to examine the preclusive effect of the bankruptcy court's abstention ruling and the state court judgment. Like the Eight Circuit, South Dakota uses a practical analysis that examines "the parties' roles and actions in the underlying proceeding."
The Eight Circuit noted that the bankruptcy court did not permanently abstain from presiding over the adversary proceeding. Further, the Eighth Circuit also held that the bankruptcy court correctly determined that "the state court possessed the authority to make discharge determinations and to assess the true scope of what Appellants were actually seeking through their counterclaims."
Significantly, the borrowers always expressed their intention to return to the bankruptcy court when the state action concluded. The bank and the principal never objected to this plan. Faced with this silence in response to the borrowers' plan, the Eight Circuit declined to thwart the borrowers "clearly expressed intentions."
The Eight Circuit also rejected the argument that Apex Oil Company, Inc. v. Sparks, 406 F. 3d 538 (8th Cir. 2005) should have prevented the bankruptcy court from re-opening the adversary proceeding. Apex only held that "a bankruptcy court did not abuse its discretion in refusing to reopen a case." It did not strip a bankruptcy court's "jurisdiction to enforce its own orders."
Thus, because the bankruptcy court invited the borrowers to return if the state court ruled in their favor and later accepted the case again, the bankruptcy court did not abuse its discretion when it re-opened the adversary proceeding.
The Eight Circuit also rejected the argument that the law of the case prevented the bankruptcy court from later entering its sanction order. Because the bankruptcy court initially abstained from hearing the dispute, its comments on the merits at that time had no effect. Thus, the Eight Circuit held that the bankruptcy court's initial skepticism and election to allow the state court to examine the merits did not "establish the law of the case or preclude a later ruling on the merits."
Finally, the Eight Circuit also rejected the argument that the bank and the principal acted in good faith because when they alleged their state court counterclaims "the law was unclear regarding the permissibility of obtaining a new commitment from a bankrupt debtor after discharge based upon a secured lender's forbearance in foreclosing on a security interest." The Eight Circuit found no authority allowing a lienholder to "leverage a security interest to obtain a larger repayment commitment" on a "discharged personal debt."
Although the bank and the principal argued that they only sought to collected non-discharged debt, the state court found that they "clearly knew no unsecured debt had survived bankruptcy." As such, given that the principal steered the borrowers into bankruptcy in the first place and then later sought to collect on the discharged debt, the bank and the principal "demonstrated a lack of good faith."
Thus, the Eight Circuit affirmed the judgment of the trial court affirming the judgment of the bankruptcy court.
The Court of Appeals for the Second District of California held that California's fee shifting statue in California Civil Code § 1717 permitted a former loan servicer and foreclosure trustee to recover their attorneys' fees authorized by the contract, even though the deed of trust was assigned to another financial institution.
However, the Court vacated the trial court's award of attorneys' fees against the borrower because the deed of trust only permitted attorneys' fees to be added to the loan balance.
The borrower defaulted on the mortgage and sued the loan servicer and foreclosure trustee (collectively, "defendants") to stop the foreclosure. Her complaint asserted four causes of action: (1) violation of California Civil Code § 2923.5, (2) quiet title, (3) unlawful debt collection practices in violation of the California Rosenthal Act, and (4) declaratory and injunctive relief.
The trial court sustained the defendants' demurrers without leave to amend. The appellate court affirmed the trial court's ruling on appeal. The defendants moved for attorneys' fees pursuant to the deed of trust and the Rosenthal Act.
In relevant part, section 9 of the deed of trust authorizes the lender pay "reasonable attorneys' fees to protect its interest in the Property and/or rights in the Security Instrument." Section 9 further states that "[a]ny amounts disbursed by Lender under this Section 9 shall become additional debt of Borrower secured by this Security Instrument."
Section 14 of the deed of trust states in pertinent part: "Lender may charge Borrower fees for services performed in connection with Borrower's default, for the purpose of protecting Lender's interest in the Property and rights under this Security Instrument, including, but not limited to, attorney fees."
The defendants argued that they were entitled to attorneys' fees pursuant to sections 9 and 14 -- even though the deed of trust had been assigned to another financial institution -- because California Civil Code § 1717 authorizes courts to enforce contractual attorney fee clauses.
The trial court granted the motion for attorneys' fees and ordered the borrower to pay the defendants $46,827.40. The trial court did not discuss the defendants' request for fees pursuant to the Rosenthal Act.
The first issue on appeal was whether the defendants were entitled to contractual attorneys' fees under the deed of trust even though they were neither the lender nor signatories to the promissory note or deed of trust.
As you may recall, California Civil Code § 1717(a) provides that "[i]n any action on a contract, where the contract specifically provides that attorney's fees and costs, which are incurred to enforce that contract, shall be awarded either to one of the parties or to the prevailing party, then the party who is determined to be the party prevailing on the contract, whether he or she is the party specified in the contract or not, shall be entitled to reasonable attorney's fees in addition to other costs."
Section 1717 has been "interpreted to further provide a reciprocal remedy for a nonsignatory defendant, sued on a contract as if he were a party to it, when a plaintiff would clearly be entitled to attorneys' fees should he prevail in enforcing the contractual obligation against the defendant." Reynolds Metals Co. v. Alperson (1979) 25 Cal.3d 124, 128.
Although the defendants were not the original lender identified in the note and deed of trust, the Court noted that the defendants were agents of the lender who had authority to enforce the lender's rights under the contracts. The borrower sued the defendants for taking actions authorized by the deed of trust during their tenure as loan servicer and trustee. Thus, in the Court's view the defendants stood in the shoes of a party to the contract and could recover attorney fees as provided by the contract pursuant to section 1717.
The second issue on appeal was whether the deed of trust authorized a separate award to pay attorneys' fees, as opposed to adding the fees to the loan balance.
The Court observed that section 9 of the deed of trust provides that any amounts disbursed by the lender "shall become additional debt of Borrower secured by this Security Instrument." The Court held that the text of section 9 did not authorize a separate award of attorneys' fees.
The Court also found that the word "charge" in section 14 of the deed of trust authorizes the lender to charge the borrowers attorneys' fees it may have incurred and add those fees to the outstanding balance due under the promissory note. In the Court's own words, "[t]here is no language in section 14 that indicates the trust deed permits a freestanding contractual attorney fees award."
The defendants argued that because they were no longer the active servicer or trustee of the deed of trust, their attorneys' fees were not amounts disbursed by the lender under section 9 and adding their attorneys' fees to the loan balance would be unjustified.
The Court found the argument unpersuasive because the defendants' right to seek attorneys' fees in the first place, despite being non-parties to the contracts, depended on their assertion that they acted as the lender's agents and stood in the lender's shoes. As the Court explained, the defendants "must take the bitter with the sweet."
Thus, the Court concluded that the deed of trust permitted the defendants to recover their attorneys' fees but did not authorize a separate fee award against the borrower.
The loan servicer also argued that it was entitled to attorneys' fees under the Rosenthal Act, as an independent basis for a fee award against the borrower.
As you may recall, the Rosenthal Act includes a provision authorizing a court to award reasonable attorneys§ fees to a "prevailing creditor upon a finding by the court that the debtor's prosecution or defense of the action was not in good faith." Civil Code § 1788.30(c).
The Court determined that the borrower advanced a colorable argument in her complaint, and therefore the Rosenthal Act did not authorize an award of attorneys' fees to the loan servicer under these circumstances.
Accordingly, the Court reversed the order compelling the borrower to pay $46,827.40 in attorneys' fees and remanded for further proceedings consistent with its opinion.
The Circuit Court of the First Judicial Circuit in and for Santa Rosa County, Florida recently rejected a borrower's argument that a purchase and sale agreement for future receivables constituted a "loan" that was unenforceable under New York usury law, because payment to the creditor was not absolutely guaranteed, but instead contingent, and thus, not a loan subject to the law of usury.
A business funding entity ("Creditor") entered into a Purchase and Sale Agreement ("Agreement") with a pharmaceutical clinic ("Borrower"), which agreed to sell its future receivables with a face value of $586,500.00 to Lender for an upfront discounted price of $425,000.00.
The Agreement was backed by a security agreement and guaranty executed by the Borrower's principals.
The Agreement was for an indefinite term, contained a Reconciliation Clause (permitting the Pharmacy to request that Creditor reconcile its payments with actual receipts), but did not guarantee absolute repayment under all circumstances, providing that bankruptcy or otherwise ceasing operations would not constitute a breach or default under the Agreement.
However, the parties agreed that a transfer or sale of all or substantially all of the Borrower's assets would constitute a default, and entitle the Creditor to enforcement the personal guaranty and security agreements for the full purchase amount of $568,500.
The Borrower defaulted by transferring its assets in violation of the Agreement. Accordingly, the Creditor filed suit to collect amounts recoverable under the Agreement. The Creditor moved for summary judgment, arguing that no genuine issues of material fact existed, as the Borrower had defaulted under the Agreement by improperly transferring its assets.
Although the Borrower did not dispute that it defaulted under the Agreement, it argued that the Agreement was unenforceable under New York law, because if the agreement were deemed a loan, the repayment schedule amounted to a as usurious interest rate of approximately 65%.
Under New York law, it is presumed that a transaction is not usurious. The defense only applies if the agreement in question is a loan or forbearance of money. NY Capital Asset Corp. v. F & B Fuel Oil Co., Inc., 55 Mis. 3d 1229(A) at *5 (N.Y. Sup. Ct. Mar. 8, 2018).
The Court noted that, in determining whether a transaction is a loan, New York courts focus upon whether the plaintiff is entitled to absolute repayment under all circumstances or whether payment rests upon a contingency. Id. If repayment is absolute, the agreement is a loan, and the defense of usury may be applicable; however, if payment rests upon a contingency, the agreement is not considered a loan and is otherwise enforceable despite providing a return above the legal rate of interest. Id.; Colonial Funding Network, Inc. v. Epazz, Inc., 252 F. Supp. 3d 274, 281 (S.D.N.Y. 2017)(internal citations omitted).
Here, the Court noted that the Creditor was not absolutely entitled to repayment under the Agreement, due to the aforementioned terms that: (i) the Borrower would not owe anything to Creditor and would not be in breach or default under this Agreement if it filed bankruptcy or otherwise ceased operations in the ordinary course of business; (ii) the Borrower agreed to sell future receipts "without recourse [except] upon an Event of Default," and; (iii) the Agreement contains a Reconciliation Clause, is for an indefinite term, and does not consider bankruptcy a default.
Accordingly, the Court held, the Agreement was not a loan under New York law and, as such, was not subject to the law of usury.
The Court further rejected the Borrower's argument that the Agreement was a loan subject to the defense of usury due to the security and guaranty agreements ensured Creditor's entitlement to because the Creditor's right to absolute repayment was still contingent upon an Event of Default as defined in Section 3.1 of the Agreement such as the transfer of all or substantially all of the assets of the business, as took place here.
Significantly, a default under the Agreement did not include the Borrower 's failure to remit payments because it "ceases operations in the ordinary course of business" under which Creditor would be entitled to nothing. Thus, the security and guaranty agreements did not guarantee the Creditor absolute repayment and do not convert the Agreement into a loan.
Accordingly, summary judgment was granted in favor of the Creditor, and against the Borrower, and the Court also held that Creditor was entitled to a sum of $122,423.00 plus fees and costs due under the Agreement.

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