Court Opinion

ID: 9373919
Source: CourtListenerOpinion
Date Created: 2023-02-22 16:10:30.91852+00
Date Added: 2024-06-11T17:16:49.327584
License: Public Domain

FILED
                                                                                   NOV 3 2022
                          NOT FOR PUBLICATION
                                                                              SUSAN M. SPRAUL, CLERK
                                                                                U.S. BKCY. APP. PANEL
                                                                                OF THE NINTH CIRCUIT
           UNITED STATES BANKRUPTCY APPELLATE PANEL
                     OF THE NINTH CIRCUIT

 In re:                                              BAP No. CC-22-1122-GLS
 ROBERTO C. HERNANDEZ,
              Debtor.                                Bk. No.1:21-bk-11450-VK

 ROBERTO C. HERNANDEZ,
              Appellant,
 v.                                                  MEMORANDUM*
 RAFAEL HERNANDEZ,
              Appellee.

               Appeal from the United States Bankruptcy Court
                      for the Central District of California
               Victoria S. Kaufman, Bankruptcy Judge, Presiding

Before: GAN, LAFFERTY, and SPRAKER, Bankruptcy Judges.

                                  INTRODUCTION

       Chapter 111 debtor Roberto C. Hernandez (“Roberto”) appeals the

bankruptcy court’s order overruling his objection to the claim filed by his

brother and creditor Rafael Hernandez (“Rafael”).2 Roberto and Rafael

       *
         This disposition is not appropriate for publication. Although it may be cited for
whatever persuasive value it may have, see Fed. R. App. P. 32.1, it has no precedential
value, see 9th Cir. BAP Rule 8024-1.
       1 Unless specified otherwise, all chapter and section references are to the

Bankruptcy Code, 11 U.S.C. §§ 101-1532, and all “Rule” references are to the Federal
Rules of Bankruptcy Procedure.
       2 Because the parties share a last name, we refer to each by his first name to avoid

confusion. No disrespect is intended.
were equal partners in a mechanic and auto body shop and jointly

operated the business until 2015. They agreed to terminate the joint venture

and for Roberto to buy out Rafael’s interest. But after Roberto breached the

agreement, Rafael filed suit in state court and obtained a judgment.

      In the bankruptcy case, Roberto objected to Rafael’s proof of claim

and argued that he was entitled to a setoff against Rafael’s claim for one

half of his personal income tax liability incurred during the period the

brothers were partners in the business. The bankruptcy court overruled the

objection because Roberto did not establish a basis for joint liability of his

personal income taxes and, if the taxes were a joint liability, Roberto was

required by California Code of Civil Procedure (“CCP”) § 426.30 to file a

cross-complaint for relief in the state court action. Because Roberto did not

assert the claim in that action, he was barred from later asserting a setoff

right based on the tax liability.

      We find no error in the bankruptcy court’s ruling and AFFIRM.

                                    FACTS

A.    Prepetition Events

      In 2011, Roberto and Rafael formed a joint venture to purchase a

building and operate a mechanic and auto body service business there. The

brothers operated the joint venture as a 50/50 partnership, paying expenses

for the building and the business from earnings and sharing profits

equally.

                                       2
      Rafael became concerned that Roberto was not equally dividing net

proceeds from the business, and the brothers decided to cease working

together. They formally dissolved their joint venture by oral agreement in

November 2015 (the “Termination Agreement”). Under the Termination

Agreement, Roberto would take full ownership of the building and

business in exchange for paying Rafael $100,000 by February 2016 and an

additional $250,000 by January 1, 2017. Rafael fully performed under the

Termination Agreement by relinquishing his interest in the business and

property and starting his own business elsewhere. Roberto paid Rafael

$100,000 in February 2016, but he never paid the remaining $250,000.

      In 2018, Rafael filed suit in the Los Angeles County Superior Court

for breach of contract and other relief, alleging that Roberto failed to pay

the balance owed under the Termination Agreement. Roberto filed an

answer to the complaint, but he did not assert a defense of setoff or file a

cross-complaint for taxes or other amounts owed by Rafael. Instead,

Roberto contended that he was always the sole owner of the business, and

he testified that he paid expenses, including the taxes incurred on income

earned by the business, with his personal credit card. The state court

rejected Roberto’s argument because the purchase agreement for the

building and the equal monthly draws taken by the brothers corroborated

the existence of the partnership. And the state court noted that Roberto did

not present documentary evidence to support his claim that he paid the

taxes. The state court entered judgment in favor of Rafael for $250,000 plus

                                       3
prejudgment interest. Roberto appealed, and the California Court of

Appeal affirmed.

B.    The Bankruptcy and Claim Objection

      In August 2021, Roberto filed a chapter 11 petition, electing to

proceed under subchapter V. Rafael filed an unsecured proof of claim

based on the state court judgment.

      Roberto objected to the claim and argued that it should be reduced

by $102,634.49, which he asserted was one half of his tax liability incurred

during the period the brothers were partners. Roberto based his objection

on a theory of implied contractual indemnity under California law and

attached the proofs of claim filed by the IRS and the California Franchise

Tax Board (“FTB”) to substantiate his tax liability.

      In opposition, Rafael argued that Roberto’s “implied contractual

indemnity” claim was essentially a breach of contract claim against Rafael.

Because an action for implied contractual indemnity is predicated on the

indemnitor’s breach of contract, and it was Roberto, not Rafael, who

breached the contract, Rafael argued that Roberto had no basis for an

indemnity claim.

      Rafael also asserted that there was no evidence that he was

responsible for Roberto’s personal income taxes. And he argued that

Roberto’s claim for setoff was barred by CCP § 426.30 because the tax

liability existed at the time Roberto filed his answer, and it arose from the

“same transaction or occurrence” as the state court complaint.

                                       4
      In reply, Roberto maintained his claim against Rafael was unrelated

to the state court action because it was based on liabilities under the joint

venture agreement, not the Termination Agreement. He argued that

because Rafael was a 50% owner of the business which generated the

income, he was equally liable for the resulting taxes. Roberto attached his

personal tax returns for the relevant years and claimed that the tax liability

was based on the “total earnings of the auto body and repair business of

which Rafael Hernandez and I were determined to be 50/50 owners.”

      Roberto disputed that CCP § 426.30 barred his claim for setoff

because a claim for implied contractual indemnity would not accrue until

he paid the taxes. Since he had not yet paid the taxes at the time of the state

court action, Roberto argued that any claim against Rafael was permissive,

not compulsory.

C.    The Court’s Ruling

      After a hearing, the bankruptcy court issued a written ruling

overruling Roberto’s objection. It held that CCP § 426.30 barred Roberto’s

claim for setoff because his income tax liability was known at the time of

the state court action. The court reasoned that permitting Roberto an

extended period to assert a setoff would unnecessarily conflict with the

purposes of CCP § 426.30, and it would be inequitable to allow Roberto to

evade the statute merely by refusing to pay his taxes and allowing

subsequent interest and penalties to accrue.

                                       5
      Additionally, the bankruptcy court held that Roberto had not

demonstrated that his personal income taxes were an obligation of the joint

venture. If the taxes were assessed against only Roberto, and the taxing

authorities did not have a right to recover from Rafael, then Roberto had no

claim for implied contractual indemnity. The bankruptcy court entered its

order overruling Roberto’s objection, and Roberto timely appealed.

                               JURISDICTION

      The bankruptcy court had jurisdiction under 28 U.S.C. §§ 1334 and

157(b)(2)(B). We have jurisdiction under 28 U.S.C. § 158.

                                     ISSUE

      Did the bankruptcy court err by overruling Roberto’s objection to

Rafael’s claim?

                         STANDARDS OF REVIEW

      In the context of claim objections, we review the bankruptcy court’s

legal conclusions de novo and its findings of fact for clear error. Lundell v.

Anchor Constr. Specialists, Inc., 223 F.3d 1035, 1039 (9th Cir. 2000). The

bankruptcy court’s ruling that Roberto’s claim for setoff was barred under

state law is a legal conclusion which we review de novo. Under de novo

review, “we consider a matter anew, as if no decision had been made

previously.” Francis v. Wallace (In re Francis), 505 B.R. 914, 917 (9th Cir. BAP

2014).

      The bankruptcy court’s ruling that Roberto did not establish that his

taxes were a joint liability, and thus not subject to a claim for implied

                                        6
contractual indemnity, is a factual determination which we review for clear

error. Factual findings are clearly erroneous if they are illogical,

implausible, or without support in the record. Retz v. Samson (In re Retz),

606 F.3d 1189, 1196 (9th Cir. 2010).

                                DISCUSSION

A.    Legal Standards Governing the Claim Objection

      Pursuant to § 502(a), a proof of claim is deemed allowed unless a

party in interest objects, and pursuant to Rule 3001(f), the proof of claim

constitutes “prima facie evidence of the validity and amount of the claim.”

Upon objection, the bankruptcy court must disallow a claim to the extent it

is “unenforceable against the debtor and property of the debtor, under any

agreement or applicable law for a reason other than because such claim is

contingent or unmatured.” 11 U.S.C. § 502(b)(1).

      To defeat a claim, the objecting party must present sufficient

evidence and show facts tending to defeat the claim by probative force

equal to the allegations in the proof of claim. Wright v. Holm (In re Holm),

931 F.2d 620, 623 (9th Cir. 1991). “If the objecting party fails to present

sufficient evidence to rebut the presumption of validity, ‘the claims

litigation ends there; the claim should be allowed without the claimant

bearing any further burden to demonstrate the validity of its claim.’”

Nations First Cap., LLC v. Decembre (In re Nations First Cap.), BAP No. EC-19-

1201-GLB, 2020 WL 3071983, at *7 (9th Cir. BAP June 5, 2020) (quoting

Bayview Loan Servicing, LLC v. Donnan (In re Donnan), BAP No. EC-18-1106-

                                        7
BSL, 2019 WL 1922843, at *3 (9th Cir. BAP Apr. 29, 2019)), aff’d, 851 F.

App’x 32 (9th Cir. 2021).

       Here, Roberto did not object to the validity of the state court

judgment; he asserted a right under state law to set off liability owed by

Rafael. 3 Consequently, we look to California law to determine whether

Roberto was entitled to a setoff for amounts owed by Rafael.

       “Under California law, the right of setoff is codified by [CCP]

§ 431.70.” Prior v. Tri Counties Bank (In re Prior), 521 B.R. 353, 362 (Bankr.

E.D. Cal. 2014). That statute generally preserves a party’s right to set off

liability, but it precludes setoff where a party was required by CCP § 426.30

to assert a cross-complaint. CCP § 431.70 provides in pertinent part:

       Where cross-demands for money have existed between
       persons at any point in time when neither demand was barred
       by the statute of limitations, and an action is thereafter
       commenced by one such person, the other person may assert in
       the answer the defense of payment in that the two demands are
       compensated so far as they equal each other . . . . The defense
       provided by this section is not available if the cross-demand is
       barred for failure to assert it in a prior action under Section
       426.30 . . . .

       3 “The Code preserves a debtor’s right to effectuate a setoff under § 558, as it
exists under state law.” A.B.C. Learning Ctrs. Ltd. v. RCS Cap. Dev., LLC (In re RCS Cap.
Dev., LLC), BAP No. AZ-12-1381-JuTaAh, 2013 WL 3618550, at *8 (9th Cir. BAP July 16,
2013) (citation omitted); see also Camelback Hosp. Inc. v. Buckenmaier (In re Buckenmaier),
127 B.R. 233, 237 (9th Cir. BAP 1991) (“The Code does not create or expand the setoff
right but instead merely preserves the common-law right under applicable non-
bankruptcy law.” (cleaned up)).
                                             8
CCP § 426.30(a) provides:

      Except as otherwise provided by statute, if a party against
      whom a complaint has been filed and served fails to allege in a
      cross-complaint any related cause of action which (at the time
      of serving his answer to the complaint) he has against the
      plaintiff, such party may not thereafter in any other action
      assert against the plaintiff the related cause of action not
      pleaded.

Thus, if a party fails to assert a cross-complaint for damages related to the

allegations in the complaint, that party is barred by CCP § 426.30(a) from

later asserting a right of setoff based on the alleged damages.

      The term “related cause of action” is defined as “a cause of action

which arises out of the same transaction, occurrence, or series of

transactions or occurrences as the cause of action which the plaintiff alleges

in his complaint.” Cal. Civ. Proc. Code § 426.10(c). The presence of a

common transaction renders the cross-complaint compulsory, and the

waiver provision of CCP § 426.30 is mandatory. Currie Med. Specialties, Inc.

v. Bowen, 136 Cal. App. 3d 774, 777 (1982).

      The purpose of CCP § 426.30 is “to require reciprocal rights flowing

from a common source to be determined in a single action, thus avoiding

not only unnecessary vexatious litigation, but also the contingency of

conflicting judgments.” Saunders v. New Cap. for Small Bus., Inc., 231 Cal.

App. 2d 324, 335 (1964) (emphasis omitted). To achieve this purpose, courts

liberally construe CCP § 426.30 and interpret the “relatedness” standard to

require “not an absolute identity of factual backgrounds for the two claims,
                                       9
but only a logical relationship between them.” Align Tech., Inc. v. Tran, 179

Cal. App. 4th 949, 960 (2009) (quoting Currie Med. Specialties, Inc., 136 Cal.

App. 3d at 777); see also ZF Micro Devices, Inc. v. TAT Cap. Partners, Ltd., 5

Cal. App. 5th 69, 84 (2016).

B.    The Bankruptcy Court Did Not Err by Overruling Roberto’s
      Claim Objection.

      Roberto argues that the bankruptcy court erred by holding that

his claim for setoff was barred by CCP § 426.30. He maintains that

because he and Rafael were equally responsible for partnership debts

under the joint venture agreement, Rafael is liable for half of the tax

liability incurred on income earned through the business. And

because he seeks a setoff under a theory of implied contractual

indemnity, which arises only after payment of a joint obligation, see

E.L. White, Inc. v. City of Huntington Beach, 21 Cal. 3d 497, 506 (1978),

Roberto argues that his claim did not exist at the time of the state

court action. He further contends that his indemnity claim was not

related to Rafael’s complaint for breach of the Termination

Agreement.

      Roberto focuses solely on the bankruptcy court’s application of CCP

§ 426.30 and whether his claim for implied contractual indemnity was

compulsory at the time of the state court action. He makes no argument

relevant to the bankruptcy court’s finding that he failed to establish joint

liability of the taxes and, consequently, had no basis for a setoff claim.

                                       10
Thus, Roberto has waived the issue. See Smith v. Marsh, 194 F.3d 1045, 1052

(9th Cir. 1999).

      Moreover, we agree with the bankruptcy court that Roberto did not

establish any basis for Rafael’s joint liability. Although Roberto contends

the taxes were incurred for income earned through the business during the

period that the brothers were partners, the tax returns he provided are his

personal income tax returns. He presented no evidence to support a claim

that the partnership was a separate taxable entity or that Rafael shares

responsibility for the taxes.

      For purposes of federal income tax, “partnerships are not taxable

entities; they pay no federal income taxes and file only informational

returns.” Cent. Valley AG Enters. v. United States, 531 F.3d 750, 755 (9th Cir.

2008) (citing I.R.C. §§ 701, 6031). The same is true under California law. See

Cal. Rev. & Tax. Code § 17851 (applying I.R.C. §§ 701-776 to California

partnerships). Individual partners are “separately or individually liable for

income taxes on their distributive share of partnership items.” Cent. Valley

AG Enters., 531 F.3d at 755.

      Without evidence that Rafael is jointly liable for Roberto’s personal

income taxes, Roberto cannot maintain a viable claim for indemnity or

setoff. See Prince v. Pac. Gas & Elec. Co., 45 Cal. 4th 1151, 1166 (2009) (“[O]ur

recognition that a claim for implied contractual indemnity is a form of

equitable indemnity . . . corrects any misimpression that joint liability is not

a component of such claims.” (cleaned up)). The bankruptcy court did not

                                       11
clearly err by determining that Roberto failed to present a basis to set off

his personal income taxes, and we would affirm on this basis alone.

        But we also find no error in the court’s application of CCP § 426.30. If

Roberto could demonstrate that Rafael was jointly liable for his income

taxes—which is essential to the claim for setoff—he was required by CCP

§ 426.30 to file a cross-complaint to assert that liability. Roberto incurred

the tax between 2012 and 2015, well before his answer to the state court

complaint was due in 2018, and his knowledge of the liability is shown by

his testimony in state court that he paid the taxes with his personal credit

card.

        Whether denominated as a breach of contract claim, a claim for

partnership accounting, or a claim for implied contractual indemnity, any

claim that Rafael was jointly responsible for Roberto’s tax liability was at

least “logically related” to the state court action. See, e.g., Align Tech., 179

Cal. App. 4th at 960 (“Because of the liberal construction given to [CCP

§ 426.30] . . . , ‘transaction’ is construed broadly; it is ‘not confined to a

single, isolated act or occurrence . . . but may embrace a series of acts or

occurrences logically interrelated.’” (quoting Saunders, 231 Cal. App. 2d at

336)); Frog Creek Partners, LLC v. Vance Brown, Inc., 206 Cal. App. 4th 515,

538 (2012) (“In the breach of contract context, [CCP § 426.30] means any

claims the defendant has against the plaintiff based on the same contract

generally must be asserted in a cross-complaint, even if the claims are

                                         12
unrelated to the specific breach or breaches that underlie the plaintiff’s

complaint.”).

      The state court complaint involved whether Roberto breached the

Termination Agreement, but it necessarily involved the scope and

existence of the partnership, which Roberto disavowed. The question of

Rafael’s liability for the taxes was dependent on the existence of the

partnership, which was essential to Rafael’s claim that Roberto breached

the Termination Agreement. Consequently, if the brothers had joint

liability for the taxes, that liability existed at the time of the state court

action and arose from the same transaction or occurrence at issue in that

action.

      The bankruptcy court properly overruled Roberto’s objection to

Rafael’s proof of claim because Roberto failed to establish joint liability for

the taxes. And if he could establish joint liability, his claim for setoff would

be barred by CCP § 426.30 because he did not file a cross-complaint in the

state court action. Roberto has not demonstrated any error by the

bankruptcy court.

                                 CONCLUSION

      Based on the foregoing, we AFFIRM the bankruptcy court’s order

overruling Roberto’s objection to Rafael’s claim.

                                         13