Court Opinion

ID: 9495053
Source: CourtListenerOpinion
Date Created: 2023-08-05 15:53:23.907122+00
Date Added: 2024-06-11T17:56:47.352552
License: Public Domain

ARMSTRONG, District Judge,
dissenting:
I do not concur with the majority’s analysis and conclusion with respect to Appel-lee Far East National Bank’s claim for equitable subrogation, and as such, I respectfully dissent from that portion of the majority’s opinion. To place my comments in their proper context, it is helpful to first briefly review the salient facts of this case.
I.
In or about 1985, James S. Hamada, M.D., (“Hamada”) was sued in Los Ange-les County Superior Court by his former medical partner G. Karlin Michelson, M.D., (“Michelson”) for fraud and breach of fiduciary duty. The matter was tried and a jury returned a verdict in favor of Michelson. The jury awarded Michelson compensatory damages in the amount of $500,000 and $1.25 million in punitive damages. On February 2, 1990, the trial court entered judgment in accordance with the jury’s verdict.
Hamada appealed and was required to post a supersedeas bond to stay enforcement of the judgment. He applied to Fidelity & Deposit Company of Maryland (“the Surety”) to post the requisite bond. As a condition of issuing the bond, the Surety required Hamada to sign an indemnification agreement secured by standby letters of credit. Hamada obtained letters of credit from Appellee Far East National Bank (“Far East”) and Imperial Bank (“Imperial”) which named the Surety as beneficiary. Hamada executed indemnity agreements in favor of each issuing bank which were secured by certain of his real and personal property.
In October 1995, Hamada filed for bankruptcy under Chapter 11 of the Bankruptcy Code. In January 1996, Michelson filed an adversary action in the bankruptcy court and obtained a determination that his judgment was not dischargeable under 11 U.S.C. §§ 523(a)(2)(A), 523(a)(4) and 523(a)(6).
Eventually, the California Court of Appeal affirmed the jury’s finding of liability but reduced the amount of the judgment.1 Michelson made a demand upon the Surety for satisfaction of the judgment. The Surety provided notice of the demand to Hamada who, in turn, directed the Surety to present a request to Far East and Imperial for payment pursuant to the standby letters of credit. Far East and Imperial honored their agreements and collectively tendered payment in excess of $2.5 million to the Surety, which it in turn paid to Michelson. The Surety then expressly assigned all of its rights against Hamada to Far East.
Far East and Imperial then filed an adversary action in bankruptcy court seeking a declaration that the debt owed by Hamada to them under the letters of credit was non-dischargeable. They based this petition on the theory that they were equitably subrogated to the rights of Michelson through the Surety, or alternatively, that such rights were assigned to them by the Surety. Upon considering the parties’ cross-motions for summary judgment, the *655bankruptcy court ruled in favor of Hama-da, finding that the debt was dischargea-ble.
Far East appealed to the district court which reversed the bankruptcy court’s decision. Hamada now appeals the district court’s ruling that the debt was not dis-chargeable. As noted, the majority believes that the district court erred in reversing the bankruptcy court’s ruling in favor of Hamada. I cannot agree with such a conclusion and would affirm the district court.
II.
A. Overview of Equitable Subrogation
“Equitable subrogation permits a party who has been required to satisfy a loss created by a third party’s wrongful act to ‘step into the shoes’ of the loser and pursue recovery from the responsible wrongdoer.” Fireman’s Fund Ins. Co. v. Maryland Casualty Co., 21 Cal.App.4th 1586, 1595-96, 26 Cal.Rptr.2d 762, 767 (1994). The purpose of this doctrine is “to place the burden for a loss on the party ultimately liable or responsible for it and by whom it should have been discharged, and to reheve entirely the insurer or surety who indemnified the loss and who in equity was not primarily hable therefor.” Fireman’s Fund Ins. Co. v. Maryland Cas. Co., 65 Cal.App.4th 1279, 1296, 77 Cal.Rptr.2d 296 (1998).
To invoke the remedy of equitable sub-rogation, five factors generally must be satisfied: (1) Payment was made by the subrogee to protect his own interest; (2) the subrogee has not acted as a volunteer; (3) the debt paid was one for which the subrogee was not primarily liable; (4) the entire debt has been paid; and (5) subro-gation would not work any injustice to the rights of others. Han v. United States, 944 F.2d 526, 529 (9th Cir.1991); Caito v. United Cal. Bank, 20 Cal.3d 694, 704, 576 P.2d 466, 144 Cal.Rptr. 751 (1978). “Equitable subrogation is a broad equitable remedy, not limited to circumstances where these five factors are met....” Caito, 20 Cal.3d at 704, 144 Cal.Rptr. 751, 576 P.2d 466 (emphasis added).
B. Primary Liability
The majority opines that Far East may not equitably subrogate its claim against Hamada due to the absence of the third and fifth factors. With regard to the third factor concerning the issue of primary liability, the majority concludes that Far East was primarily liable for the debt which it paid; to wit, the letter of credit which it issued in favor of the Surety. The majority reasons that the letter of credit agreement between Far East and the Surety created a separate and independent obligation for which Far East bore primary responsibility to pay. As support for this proposition, the majority relies on San Diego Gas & Elec. Co. v. Bank Leumi, 42 Cal.App.4th 928, 933, 50 Cal. Rptr.2d 20 (1996), and Western Sec. Bank v.Super. Ct., 15 Cal.4th 232, 933 P.2d 507, 62 Cal.Rptr.2d 243 (1997), both of which confirm the “independent” nature of letters of credit. Western Sec. Bank, 15 Cal.4th at 248, 62 Cal.Rptr.2d 243, 933 P.2d 507 (recognizing that an issuer has the “primary obligation” to pay on letter of credit such that “literal compliance with the letter of credit’s terms for payment is all that is required.”); San Diego Gas & Elec. Co., 42 Cal.App.4th at 934, 50 Cal. Rptr.2d 20 (noting that the obligation to pay on a letter of credit is “independent” of any underlying agreement). However, for purposes of equitable subrogation, the question is not whether Far East was primarily liable under the letter of credit agreement. Rather, the relevant question *656is whether Far East was 'primarily liable for payment of the underlying judgment.
The approach advocated by Hamada, and followed by the majority, derives from authority which erroneously equates an issuer’s primary obligation to pay on a letter of credit with the “primarily liable” inquiry germane to equitable subrogation. Specifically, Hamada draws the Court’s attention to Kaiser Steel Corp. v. Bank of Am. National Trust and Savings Ass’n, 89 B.R. 150, 158 (Bankr.D.Colo.1988), which ruled that an issuer of a standby letter of credit could not pursue a claim for statutory sub-rogation under 11 U.S.C. § 509.2 The court reasoned that a letter of credit creates an independent obligation of the issuer to pay on demand, irrespective of any defenses arising from the underlying agreement. Id. at 152. In so doing, the court collapsed the “independent” liability of the issuer to pay upon demand with “primary” liability required under the doctrine of equitable subrogation. Based on such reasoning, the court concluded that “[w]hen the issuer pays its own debt it cannot step into the shoes of a creditor to seek subrogation ... from the debtor.” Id. at 153.
Unfortunately, the Kaiser court’s analysis is flawed. The mere fact that a letter of credit imposes upon the issuer an independent obligation to make payment once a demand is made does not convert the issuer to the “primary” obligor within the meaning of the equitable subrogation doctrine. This conclusion is supported by In re Valley Vue Joint Venture, 123 B.R. 199 (Bankr.E.D.Va.1991). In Valley Vue, the court criticized the Kaiser opinion for failing to recognize the critical distinction between the primary obligation to honor a letter of credit and the primary obligation to repay a debt or obligation:
The Kaiser court correctly observed that an issuer’s obligation to honor a standby letter of credit is considered a “primary” obligation.However, the Kaiser court failed to distinguish between the primary liability of a debtor to its creditor to repay a loan and the primary obligation of the issuer to its beneficiary to honor a letter of credit. When a standby credit supporting a loan is honored, the issuer [footnote] admittedly is satisfying its obligation as a primary obligor to honor the standby credit, but at the same time it is in fact satisfying a debt for which a person other than the issuer is primary liable. This distinction, although not recognized by the Debtor or the Kaiser court, is critical. [Footnote.] An issuer is not primarily liable on the debt supported by its standby credit.
Id. at 204 (emphasis added). The court explained that the “primary obligation” of an issuer to pay on a letter of credit simply “goes to the issue of whether the issuer can avoid its obligation by relying on the underlying transactional defenses,” and not to whether it is “primarily liable” for payment of the underlying debt. Id. at 206; see also San Diego Gas & Elec. Co., 42 Cal.App.4th at 933, 50 Cal.Rptr.2d 20 (noting that an issuer of a letter of credit is not considered the “primary obligor” with respect to the underlying debt or obligation).
The majority opinion also overlooks this distinction, and instead, assumes that Far East’s independent obligation under the letter of credit is dispositive. However, the majority does not explain how such independence necessarily compels the conclusion that the relevant obligation for which the issuer bears primary responsi*657bility is the obligation to honor payment of the letter of credit. Indeed, under this reasoning, an issuer of a letter of credit could never apply the doctrine of equitable subrogation because it will, by definition, always be primarily liable for that obligation. Such a rigid application of the doctrine cannot be reconciled with California’s decidedly flexible approach to equitable subrogation. See St. Paul Fire & Marine Ins. Co. v. Murray Plumbing & Heating Corp., 65 Cal.App.3d 66, 71, 135 Cal.Rptr. 120 (1976) (noting that equitable subrogation is “to be liberally applied to promote justice ....”) (emphasis added).
Moreover, to focus solely on Far East’s obligations attendant to the letter of credit is inconsistent with the purpose of equitable subrogation, which is to place the burden for a loss on the party ultimately responsible for the loss. Caito, 20 Cal.3d at 704, 144 Cal.Rptr. 751, 576 P.2d 466. As such, in the context of equitable subro-gation, the proper focus should be on which party is primarily liable for payment of the underlying obligation. In this case, the underlying obligation is the Michelson judgment — an obligation for which Hama-da should bear primary responsibility. Therefore, it is Hamada — not Far East— who should be deemed “primarily liable” for satisfaction of the Michelson judgment.3
C. Injustice to the Rights of Others
Next, the majority concurs with the bankruptcy court’s conclusion that the equities do not favor Far East. The majority reasons that dischargeability was “eminently fair” with respect to Michelson, since the latter was a direct victim of Hamada’s fraud. In contrast, the majority notes that Hamada “committed no fraud on Far East” and dismisses Far East’s loss as the result of a conscious business decision. In other words, since Far East knowingly accepted certain of Hamada’s real estate holdings as collateral, it automatically assumed the risks attendant to such an arrangement. The majority notes that it was only after the value of these assets declined that Far East was left holding the proverbial bag. As a result, the majority reasons that declaring Hama-da’s debt to Far East non-dischargeable is inappropriate because it would unfairly place Far East “in a much better position relative to the other creditors.”
The majority’s supposition that dis-chargeability is reasonable with respect to Michelson-but not as to Far East — is ostensibly at odds with the fundamental purpose of the dischargeability under the Bankruptcy Code. Indeed, the same policy considerations underlying the bankruptcy court’s finding that the judgment against Hamada was non-dischargeable as to Michelson should apply with equal force to Far East. The bankruptcy court found the Michelson judgment non-dischargeable under various subsections of 11 U.S.C. § 523(a). The purpose of these exceptions to discharge is to “ ‘prevent a debtor from retaining the benefits of property obtained by fraudulent means and to ensure that the relief intended for honest debtors does not go to dishonest debtors.’” In re Slyman, 234 F.3d 1081, 1085 (9th Cir.2000) (quoting 4 Collier on Bankruptcy ¶ 523.08[l][a] (15th ed. rev.2000)) (emphasis added). Yet, that is precisely what the majority’s decision does — it allows Hamada to escape any liability for payment of the Michelson judgment.
It is also difficult to harmonize the majority’s analysis with the fundamental purpose of equitable subrogation, which is to *658place “the burden for a loss on the party ultimately liable or responsible for it... Fireman’s Fund Ins. Co., 65 Cal.App.4th at 1296, 77 Cal.Rptr.2d 296. That burden should be borne by Hamada, and Hamada alone. In this respect, it is important to note that a jury found that Hamada had defrauded and breached his fiduciary duty to his business partner. The fact that the jury imposed a significant punitive damage award underscores the particularly egregious nature of Hamada’s misconduct. See Flyer’s Body Shop Profit Sharing Plan v. Ticor Title Ins. Co., 185 Cal.App.3d 1149, 1154, 230 Cal.Rptr. 276, 278 (1986) (“Punitive damages are appropriate ... only when the tortious conduct rises to levels of extreme indifference to the plaintiffs rights, a level which decent citizens should not have to tolerate.”).
And yet, despite the jury’s verdict and despite having lost on his state court appeal, the majority proposes to wipe the slate clean and absolve Hamada of any responsibility for the judgment rendered against him based on the “equities” of this case. With this I cannot agree. Hamada should not be placed in a better position simply by virtue of the fact that he chose to appeal and sought to stay payment of the judgment by obtaining a supersedeas bond. I am also concerned that the majority’s ruling could have the potential of chilling access to the courts. Under today’s decision, banks must now assume greater risk in issuing standby letters of credit. This could, in turn, make it more difficult for litigants to secure the requisite bond to pursue appeal. At bottom, a decision in favor of Hamada is hardly equitable. Therefore, contrary to the majority, I would find that Far East has met all of the requisite elements necessary for equitable subrogation.
Ill
For the reasons stated above, I do not concur with the majority that Far East should bear responsibility for payment of the Michelson judgment. That responsibility lies with Hamada — and Hamada alone. Accordingly, I would affirm the district court and respectfully dissent from the Court’s opinion.

. On November 7, 1997, the California Court of Appeal issued its decision in which it gave Michelson the option of accepting a reduced punitive damage award of $500,000 or to proceed with a new trial on the issue of punitive damages. Michelson opted to accept a remittitur of $500,000 for the punitive damage award.

. Although the court was addressing the matter of statutory subrogation, it applied the five-part test applicable to equitable subrogation. Kaiser, 89 B.R. at 153.

. Notably, the bankruptcy court agreed that Hamada should bear such responsibility as evidenced by its determination that the Michelson judgment was not dischargeable.