Court Opinion

ID: 2750491
Source: CourtListenerOpinion
Date Created: 2014-11-12 18:01:00.031303+00
Date Added: 2024-06-11T11:26:39.387411
License: Public Domain

FOR PUBLICATION

  UNITED STATES COURT OF APPEALS
       FOR THE NINTH CIRCUIT

IN THE MATTER OF: MORTGAGES            No. 12-15229
LTD.,
                      Debtor,             D.C. Nos.
                                     2:11-cv-00853-RCJ
                                     2:08-bk-07465-RJH
REV OP GROUP,
                        Appellant,

                v.

ML MANAGER LLC,
                         Appellee.

REV OP GROUP,                          No. 12-15438
                        Appellant,
                                          D.C. No.
                v.                   2:10-cv-01819-RCJ

ML MANAGER LLC, an Arizona
limited liability company,
                         Appellee,

MORTGAGES LTD.,
                     Debtor-In Re.
2        IN THE MATTER OF: MORTGAGES LTD.

IN THE MATTER OF: MORTGAGES            No. 12-16293
LTD.,
                      Debtor,             D.C. No.
                                     2:10-cv-01917-RCJ

BEAR TOOTH MOUNTAIN
HOLDINGS, L.L.P.; PUEBLO
SERENO MOBILE HOME PARK,
L.L.C.; QUEEN CREEK XVIII,
L.L.C.; MORLEY ROSENFELD,
M.D. P.C. RESTATED PROFIT
SHARING PLAN, and/or their
successsors and assigns
(collectively the Rev Op
Investors),
                       Appellants,

                v.

ML MANAGER LLC,
                        Appellee.

IN RE: MORTGAGES LTD.,                 No. 12-16725
                          Debtor,
                                          D.C. No.
                                     2:12-cv-00036-RCJ
QUEEN CREEK XVIII, L.L.C.,
                     Appellant,
                                         OPINION
                v.
            IN THE MATTER OF: MORTGAGES LTD.                       3

 ML MANAGER LLC,
                              Appellee.

        Appeal from the United States District Court
                 for the District of Arizona
        Robert Clive Jones, District Judge, Presiding

                   Argued and Submitted
        January 16, 2014—San Francisco, California

                   Filed November 12, 2014

   Before: J. Clifford Wallace and Jay S. Bybee, Circuit
 Judges, and Robert W. Gettleman, Senior District Judge.*

                   Opinion by Judge Wallace

  *
    The Honorable Robert W. Gettleman, Senior District Judge for the
U.S. District Court for the Northern District of Illinois, sitting by
designation.
4            IN THE MATTER OF: MORTGAGES LTD.

                           SUMMARY**

                            Bankruptcy

   The panel reversed the bankruptcy court’s declaratory
judgment that ML Manager LLC had agency authority to sell
property of the bankruptcy estate of Mortgages Ltd.

    Pursuant to the confirmed Chapter 11 plan of
reorganization of Mortgages Ltd., a private lender for certain
real estate investments in Arizona, ML Manager was the
manager of the loans left in Mortgages Ltd.’s portfolio.
Mortgages Ltd. raised money from investors to extend loans
to real estate purchasers, secured by the purchased real estate,
and acted as servicing agent for the loans and properties. The
investors received pass-through fractional interests in the real
estate that secured the loans and the resulting loan payments.
They acquired an actual interest in each underlying loan.

    Rev Op Group, a group of pass-through investors,
objected to ML Manager’s proposed sale of some of the
loans. The bankruptcy court held that these investors had
executed an agency agreement with ML Manager, which had
an agency coupled with an interest that was irrevocable under
Arizona law.

   The panel held that the appeal from the declaratory
judgment was not equitably moot because Rev Op Group
sought a stay and was diligent. In addition, even though
substantial consummation of the plan had occurred, the panel

  **
     This summary constitutes no part of the opinion of the court. It has
been prepared by court staff for the convenience of the reader.
           IN THE MATTER OF: MORTGAGES LTD.                  5

could fashion effective relief because modification of the
declaratory judgment would not inequitably affect innocent
third parties, and the bankruptcy court on remand would be
able to devise an equitable remedy.

    The panel held that the bankruptcy court erred in
concluding that Rev Op Group was bound to the agency
agreements because the Group denied in its answer that its
investors had signed any documents that included the agency
provisions. The panel held that under the federal pleading
rules, a court cannot disregard statements in a pleading unless
the court specifically determines that the statement was made
in bad faith under Federal Rule of Civil Procedure 11, or
should be struck under Rule 12(f). Accordingly, the
bankruptcy court erred in rejecting Rev Op Group’s denials
as implausible. The panel reversed the bankruptcy court’s
declaratory judgment and remanded the case.

                         COUNSEL

Bryce A. Suzuki (argued), Robert J. Miller, Justin A. Sabin,
Bryan Cave LLP, Phoenix, Arizona, for Appellants.

Cathy L. Reece (argued), Fennemore Craig, P.C., Phoenix,
Arizona; Keith L. Hendricks and Joshua T. Greer, Moyes
Sellers & Hendricks, Phoenix, Arizona, for Appellee.
6          IN THE MATTER OF: MORTGAGES LTD.

                          OPINION

WALLACE, Senior Circuit Judge:

    Mortgages Ltd. was a private lender for certain real estate
investments in Arizona. Mortgages Ltd. raised money from
investors to extend loans to real estate purchasers, secured by
the purchased real estate, and acted as servicing agent for the
loans and properties. The investors received “pass-through”
fractional interests in the real estate that secured the loans and
the resulting loan payments. The pass-through investors
acquired an actual interest in each underlying loan.

    On June 24, 2008, Mortgages Ltd. filed for Chapter 11
bankruptcy. The company was restructured through a
confirmed bankruptcy plan. Pursuant to that plan, the entity
ML Manager LLC (ML Manager), the appellee here,
manages and operates the loans left in Mortgages Ltd.’s
portfolio. ML Manager took a $20 million loan in “exit
financing” to pay for expenses related to the completed
bankruptcy. The bankruptcy plan was confirmed by the
bankruptcy court in May 2009.

    After confirmation, ML Manager sought to sell some of
the loans in Mortgages Ltd.’s portfolio. In response, a group
of pass-through investors (Rev Op Group) objected to the
sales. Rev Op Group and ML Manager then moved,
essentially, for cross-declaratory judgments to resolve ML
Manager’s powers regarding Mortgages Ltd.’s portfolio.

    Rev Op Group moved for partial summary judgment on
the ground that because ML Manager acted as “agent” for
each investor, it could not sell the properties if any investor,
the “principal,” objected. According to Rev Op Group, if ML
           IN THE MATTER OF: MORTGAGES LTD.                 7

Manager sought to sell properties over its objection, the
investors in Rev Op Group could simply revoke the agency.
ML Manager responded that it did not have simple agency
authority, revocable at will by the principal. Instead, it
claimed that it held an interest in Mortgage Ltd.’s underlying
loan pool, which gave ML Manager an “agency coupled with
an interest,” which is not revocable under Arizona law. See
Phoenix Title & Trust Co. v. Grimes, 416 P.2d 979, 981
(Ariz. 1966) (in banc).

    Simultaneously, ML Manager moved for a declaratory
judgment that all investors had executed documents
designating ML Manager as agent and that those agency
documents had been properly transferred to ML Manager.
Rev Op Group denied that it had executed the agreements.
According to Rev Op Group, while its investors had signed
“Subscription” and “Revolving Opportunity” agreements, the
investors had not signed versions of those agreements that
included a provision binding all signers to an agency
relationship with ML Manager. Rev Op Group also argued
that even if its members had executed the agreements that
included the agency provision, the agreements were not
properly assigned to ML Manager.

    At a hearing on the cross-motions, the bankruptcy court
requested and received supplemental briefs on whether the
“plausibility” standard outlined in the then recent Supreme
Court decisions of Bell Atlantic Corp. v. Twombly, 550 U.S.
544 (2007), and Ashcroft v. Iqbal, 556 U.S. 662 (2009),
governed the denials made by Rev Op Group of the
allegations in ML Manager’s complaint.

   On July 27, 2010, the bankruptcy court ruled that Rev Op
Group’s denials would only be accepted as true if the denials
8          IN THE MATTER OF: MORTGAGES LTD.

were plausible. On the same day, the court resolved, on the
pleadings alone, both Rev Op Group’s motion for partial
summary judgment and ML Manager’s motion for a
declaratory judgment. The bankruptcy court held that Rev Op
Group’s denials were implausible, because Rev Op Group
admitted the investors had signed documents with the same
name as those that included agency agreements. Because the
denials were implausible, the bankruptcy court held that the
Rev Op Group investors had executed the agency agreement
with ML Manager. The bankruptcy court also denied Rev Op
Group’s motion for partial summary judgment, ruling that
ML Manager had an agency coupled with an interest and that
ML Manager was properly assigned the agency agreements.

    Thus, after this “Declaratory Judgment,” ML Manager
had irrevocable authority, subject to possible review by the
bankruptcy court under a “business judgment” standard, to
sell or liquidate the interests in property of any investors,
including objecting investors like the Rev Op Group,
foreclose on property of the estate, modify the terms of the
outstanding loan properties, and recover costs and expenses
from all investors.

    Armed with this order, ML Manager moved to sell two
properties in the portfolio. On August 30, 2010, Rev Op
Group moved to stay the Declaratory Judgment. The motion
to stay was denied by the bankruptcy court on September 10,
2010, because the bankruptcy court concluded that ML
Manager needed to liquidate the properties for the benefit of
all investors, who would suffer serious harm if the orders
were stayed unless Rev Op Group paid a large bond as
security. Rev Op Group stated that it could not afford such an
expensive bond. Rev Op Group appealed the denial of the
           IN THE MATTER OF: MORTGAGES LTD.                   9

motion to stay to the district court, which affirmed the
bankruptcy court on October 12, 2010.

    In March and November of 2011, ML Manager moved to
sell two other properties pursuant to the Declaratory
Judgment. The bankruptcy court overruled Rev Op Group’s
objections and approved the property sales.

    Rev Op Group appealed from all of these orders to the
district court. On January 10, 2012, the district court affirmed
the bankruptcy court’s order approving one of the property
sales, and held that ML Manager had an agency coupled with
an interest and had properly applied its business judgment.

    On February 15, 2012, having previously concluded that
ML Manager held an agency coupled with an interest, the
district court affirmed the rest of the bankruptcy court’s
Declaratory Judgment. The district court held that Rev Op
Group’s denials that investors had executed the agreements
attached to ML Manager’s declaratory judgment complaint
were a “sham” and thus should be disregarded. The district
court also affirmed that the agency agreements were properly
assigned to ML Manager.

    On May 2 and July 6, 2012, the district court affirmed the
other property sales based upon its prior rulings regarding
ML Manager’s irrevocable agency authority, proper
assignment, and Rev Op Group’s sham denials of executing
the agency agreements.
10          IN THE MATTER OF: MORTGAGES LTD.

    Rev Op Group filed timely notices of appeal from each
district court order.1 In this opinion, we address only its
appeal of the Declaratory Judgment. We have appellate
jurisdiction under 28 U.S.C. § 158(d)(1).

                                 I.

    ML Manager moves to dismiss this appeal as equitably
moot. Although we dismiss Rev Op Group’s appeals from the
sales orders as equitably moot in a concurrently filed
memorandum disposition, we must separately examine this
appeal to determine whether to dismiss it as equitably moot.
In re Filtercorp, Inc., 163 F.3d 570, 577–78 (9th Cir. 1998)
(holding that an appeal from a sale order was moot, but the
appeal from a related order was not moot); In re AOV Indus.,
Inc., 792 F.2d 1140, 1147–48 (D.C. Cir. 1986) (holding that
to determine equitable mootness, “a court cannot avoid its
obligation to scrutinize each individual claim, testing the
feasibility of granting the relief against its potential impact on
the reorganization scheme as a whole”). We analyze whether
each appeal is equitably moot separately because awarding
relief to the appellant in one appeal may threaten the
equitable disposition of the bankruptcy estate, but awarding
relief in another may pose no harm to the estate or third
parties.

     1
     We resolve Rev Op Group’s appeals of the property sales in a
concurrently filed memorandum disposition. Rev Op Grp. v. ML Manager
LLC, Nos. 12-15229, 12-15438, 12-16293 & 12-16725. We also publish
with this Opinion an Opinion in other Rev Op Group appeals from the
“Clarification Order” and “Distribution Order.” Rev Op Grp. v. ML
Manager LLC, Nos. 12-15234 & 12-15459.
           IN THE MATTER OF: MORTGAGES LTD.                    11

   We examine four considerations to determine whether the
appeal from the Declaratory Judgment is equitably moot.

        We will look first at whether a stay was
        sought, for absent that a party has not fully
        pursued its rights. If a stay was sought and not
        gained, we then will look to whether
        substantial consummation of the plan has
        occurred. Next, we will look to the effect a
        remedy may have on third parties not before
        the court. Finally, we will look at whether the
        bankruptcy court can fashion effective and
        equitable relief without completely knocking
        the props out from under the plan and thereby
        creating an uncontrollable situation for the
        bankruptcy court.

In re Thorpe Insulation Co., 677 F.3d 869, 881 (9th Cir.
2012).

                               1.

    Unlike in Rev Op Group v. ML Manager LLC, Nos. 12-
15234 & 12-15459 and In re Roberts Farms, Inc., 652 F.2d
793, 798 (9th Cir. 1981), Rev Op Group sought a stay of the
Declaratory Judgment, but could not obtain it. Rev Op Group
thus did not sit on its rights. It diligently pursued this appeal.
Though Rev Op Group could not obtain a stay from the
bankruptcy or district court because of the high cost of the
bond necessary to secure the appeal, we are cautious about
not giving a party who is diligent – as Rev Op Group has
been in this case – an opportunity to present its appeal.
Thorpe, 677 F.3d at 881.
12         IN THE MATTER OF: MORTGAGES LTD.

                               2.

    We next turn to whether substantial consummation of the
plan has occurred. Id. at 882. We conclude that it has.
“Substantial consummation” as defined in the Bankruptcy
Code means:

        (A) transfer of all or substantially all of the
        property proposed by the plan to be
        transferred;

        (B) assumption by the debtor or by the
        successor to the debtor under the plan of the
        business or of the management of all or
        substantially all of the property dealt with by
        the plan; and

        (C) commencement of distribution under the
        plan.

11 U.S.C. § 1101(2). We clarify that the “transfers”
referenced in subsection (A) differ from the “distributions”
referenced in subsection (C). Subsection (A)’s “transfers of
property” are those that are necessary to accomplish
reorganization and to shape the new financial structure of the
debtor. Such transfers often take place on or shortly after the
effective date of a confirmed plan and may include the
transfer of a security interest to unsecured creditors, a transfer
of stock to creditors or third parties, a transfer of promissory
notes to creditors, transfers of property to secured creditors in
satisfaction of their claims, or transfers of property by third
parties to the debtor. See Antiques of Nev., Inc. v. Bala
Cynwyd Corp. (In re Antiques of Nev., Inc.), 173 B.R. 926,
929–30 (B.A.P. 9th Cir. 1994). Subsection (C)’s
           IN THE MATTER OF: MORTGAGES LTD.                    13

“distributions,” on the other hand, are payments to creditors
in satisfaction of the debtor’s debts. “Substantial
consummation” requires completion or near completion of
the former, but only commencement of the latter. Id.

    Here, with respect to subsection (A), the plan proposed
various reorganizational transfers of property, including
transfer of non-loan assets and stock in the reorganized debtor
to the liquidating trust. All or substantially all of the property
proposed by the plan to be transferred was transferred shortly
after the plan was confirmed. Subsection (B) was satisfied
when ML Manager undisputedly assumed management of all
or substantially all of the property dealt with by the plan.
Subsection (C) was satisfied once ML Manager commenced
distribution of property to creditors, both from exit financing
funds and from liquidated property. We therefore conclude
that the plan was “substantially consummated” under
11 U.S.C. § 1101(2).

    Substantial consummation of a bankruptcy plan often
brings with it a comprehensive change in circumstances that
renders appellate review of the merits of the plan impractical.
First Fed. Bank of Cal. v. Weinstein (In re Weinstein),
227 B.R. 284, 289 (B.A.P. 9th Cir. 1998). But this is not
always the case. Thus, “the fact that a plan is substantially
consummated . . . does not, by itself, render an appeal moot.”
Id. We must still consider whether, despite substantial
consummation, we can fashion effective relief. Id. To do so,
we analyze the final two factors from Thorpe.

                               3.

    Therefore, we next consider “whether modification of the
plan of reorganization would bear unduly on the innocent.”
14         IN THE MATTER OF: MORTGAGES LTD.

Thorpe, 677 F.3d at 882 (internal quotation marks omitted).
Unlike in the companion case, modification of the
Declaratory Judgment would not “affect third party interests
to such an extent that the change is inequitable.” Id.
Regardless of whether we reverse the legal basis for the sales,
Rev Op Group could not disturb past sales because we have
dismissed the appeals of the sale orders. If we were now to
reverse the Declaratory Judgment, we would alter ML
Manager’s ability to act as agent for objecting investors like
Rev Op Group, but that would only affect prospective sales
of property to third parties, and perhaps prospective
distributions. That would not unduly bear on innocent third
parties.

                              4.

    Finally, “and most importantly,” we look to whether the
bankruptcy court on remand would be able to devise an
equitable remedy. Id. at 883. If we reversed the Declaratory
Judgment on any of the bases Rev Op Group argues were
erroneous, the bankruptcy court could proceed to discovery
on whether Rev Op Group’s denials were legally sufficient,
or require ML Manager to act with Rev Op Group’s consent,
or require that ML Manager properly transfer the agency
agreements. This would be equitable, if “incomplete,” relief
that would not “totally [] upset the [bankruptcy] plan.” Id.

    The appeal of the Declaratory Judgment is not equitably
moot. Unlike in the companion case, Rev Op Group
diligently pursued its rights by seeking a stay of the
Declaratory Judgment Order, even though it was unable to
obtain the stay. Although substantial consummation of the
bankruptcy plan has occurred, modification of the order
would not inequitably affect innocent third parties. Moreover,
           IN THE MATTER OF: MORTGAGES LTD.                15

“there are many options open to the bankruptcy court other
than complete plan reversal that can remedy some of [Rev Op
Group’s] claims if proved valid.” Id.

                             II.

    Rev Op Group challenges the Declaratory Judgment on
three grounds. First, Rev Op Group argues that the
bankruptcy court erred in subjecting its denials that its
investors had signed the agency agreements to a “plausibility
standard,” and then rejecting those denials as implausible.
Second, Rev Op Group argues that even if the denials were
implausible and the court properly determined that Rev Op
Group was subject to the agency agreements, ML Manager
does not hold an irrevocable agency power. Third, Rev Op
Group argues that the bankruptcy court erred in holding that
the agency agreements were properly transferred to ML
Manager.

    We review legal decisions of the bankruptcy court de
novo, and without deference to the district court’s decisions
during the initial appeal. In re Cossu, 410 F.3d 591, 595 (9th
Cir. 2005). We also review a judgment on the pleadings de
novo, and affirm if, taking all factual allegations in Rev Op
Group’s pleadings as true, ML Manager is entitled to
judgment as a matter of law. Marshall Naify Revocable Trust
v. United States, 672 F.3d 620, 623 (9th Cir. 2012).

   The bankruptcy court erred in concluding that Rev Op
Group is bound to the agency agreements, because Rev Op
Group had denied in its answer that its investors had signed
any documents that included the agency provisions. Under
the federal pleading rules, which apply to adversary
proceedings in bankruptcy court, see FED. R. BANKR. P.
16         IN THE MATTER OF: MORTGAGES LTD.

7008(a), a court cannot disregard statements in a pleading
unless the court specifically determines that the statement
was made in bad faith under Federal Rule of Civil Procedure
11, or should be struck under Rule 12(f). PAE Gov’t Servs.,
Inc. v. MPRI, Inc., 514 F.3d 856, 859–60 (9th Cir. 2007). A
court can only disregard statements in a pleading under Rule
11 if the court “invoke[s] the rule’s procedural safeguards”
and “employ[s] the rule’s substantive standard . . . that [the
party or its counsel] acted in bad faith.” Id. at 859. A court
can only strike a statement in a pleading under Rule 12(f) if
the statement is “(1) an insufficient defense; (2) redundant;
(3) immaterial; (4) impertinent; or (5) scandalous.”
Whittlestone, Inc. v. Handi-Craft Co., 618 F.3d 970, 973–74
(9th Cir. 2010), citing FED. R. CIV. P. 12(f).

    The bankruptcy court here followed neither Rule 11 nor
Rule 12(f). In its Declaratory Judgment, the court did not
invoke the procedural safeguards of Rule 11, or determine
that the denials were made in bad faith. Nor can Rev Op
Group’s denials be properly struck under Rule 12(f). The
bankruptcy court never cited Rule 12(f) or its bankruptcy rule
equivalent. Additionally, Rev Op Group’s denials were a
sufficient defense to ML Manager’s complaint, because if the
denials are true, Rev Op Group would not be bound to the
agency agreement pleaded by ML Manager. Rev Op Group’s
denials were not redundant, immaterial, impertinent or
scandalous.

    Though we review only the bankruptcy court’s order, not
the district court’s affirmance, Cossu, 410 F.3d at 595, we
point out that the district court’s similar disregard for the
denials was also erroneous. The district court held that Rev
Op Group’s denials were “simply untenable” and “obviously”
           IN THE MATTER OF: MORTGAGES LTD.                   17

“frivolous and a sham,” citing our decision in Harvey
Aluminum (Inc.) v. NLRB, 335 F.2d 749, 758 (9th Cir. 1964).

    In Harvey Aluminum, the National Labor Relations Board
(NLRB) brought an administrative action against a company,
Harvey Aluminum, for a violation of the National Labor
Relations Act. Id. at 751. The NLRB also sued General
Engineering, a company the NLRB alleged was “affiliated”
with Harvey Aluminum, and thus could be treated as a
“single employer” with Harvey Aluminum, both subject to
the NLRB’s jurisdiction. Id. at 757. In its answer to the
complaint, General Engineering denied the information in the
complaint, but offered no factual allegations to challenge the
NLRB’s pleading. Id. The NLRB trial examiner ruled that the
failure to respond “would be taken as a concession that the
relationship between Harvey [Aluminum] and General
[Engineering] during the relevant period was such that they
might properly be treated as a single employer.” Id. General
Engineering appealed this ruling, and we affirmed.

     Under the federal regulations governing NLRB
administrative actions, an answer to a complaint had to be
signed by the respondent’s attorney, and if it is not signed or
“is signed with intent to defeat the purpose of this rule, it may
be stricken as sham and false and the action may proceed as
though the answer had not been served.” Id. at 757 n.31,
quoting 29 C.F.R. § 102.21. We compared the federal
regulation to “comparable provisions of the Federal Rules of
Civil Procedure,” including what was then the “essentially
identical” Rule 11. Id. at 758 & n.32. We stated that under the
comparable Federal Rules, “an answer asserting want of
knowledge sufficient to form a belief as to the truth of facts
alleged in a complaint does not serve as a denial if the
assertion of ignorance is obviously sham,” and that “[i]n such
18         IN THE MATTER OF: MORTGAGES LTD.

circumstances the facts alleged in the complaint stand
admitted.” Id. at 758. Thus, we held that the trial examiner
was justified under the federal regulation in refusing to accept
“clearly frivolous” statements in an answer. Id.

     In 1964, Rule 11 was “essentially identical” to 29 C.F.R.
§ 102.21, stating that if a pleading “is not signed or is signed
with intent to defeat the purpose of this rule, it may be
stricken as sham and false and the action may proceed as
though the pleading had not been served.” See Ely Valley
Mines, Inc. v. Lee, 385 F.2d 188, 191 n.1 (9th Cir. 1967),
quoting FED. R. CIV. P. 11. Our sister circuits and treatises
thus correctly understood our holding in Harvey Aluminum as
authorizing both NLRB trial examiners and federal courts
applying the federal rules to disregard statements in answers
when the statements were “obviously sham.” See Am.
Photocopy Equip. Co. v. Rovico, Inc., 359 F.2d 745, 747 (7th
Cir. 1966); 5 Charles Alan Wright & Arthur R. Miller, et al.,
Fed. Prac. & Proc. Civ. § 1262 n.13 (3d ed.).

    But Rule 11 is no longer “essentially identical” to
29 C.F.R. § 102.21. In 1983, the Rule 11 provision that
authorized district courts to “strike pleadings . . . as sham and
false . . . was eliminated.” PAE Gov’t, 514 F.3d at 859 n.3.
One of the purposes of eliminating that provision was to stop
decisions that “‘tended to confuse the issue of attorney
honesty with the merits of the action.’” 5A Charles Alan
Wright & Arthur R. Miller, Fed. Prac. & Proc. Civ. § 1336.3
(3d ed.), citing Advisory Committee Note to the 1983
amendments, reprinted at 97 F.R.D. 165, 199. After the 1983
amendments to Rule 11, “absent a finding of bad faith, factual
allegations in the complaint (or answer) must be tested
through the normal mechanisms for adjudicating the merits.”
PAE Gov’t, 514 F.3d at 859 n.3 (emphasis added). Thus, our
            IN THE MATTER OF: MORTGAGES LTD.                      19

suggestion in Harvey Aluminum that a district court has “free-
standing authority to strike pleadings simply because” it
believes them to be a sham is no longer valid. See PAE Gov’t,
514 F.3d at 859.2 Instead, the “district court’s powers are
generally limited to those provided by the Federal Rules of
Civil Procedure.” Id. The district court erred in holding that
Rev Op Group’s denials of the allegations in ML Manager’s
complaint were a sham without using “the mechanism for
doing so,” which is Rule 11. Id.

    In sum, courts cannot examine statements in an answer or
other pleading and decide, on the basis of their own intuition
that the statements are implausible or a sham and thus can be
disregarded. Factual allegations in a pleading, as opposed to
legal conclusions, must be presumed to be true. Twombly,
550 U.S. at 555. Both the bankruptcy and district court erred
here by “effectively resolv[ing] those allegations” in Rev Op
Group’s denials “on the merits,” instead of reviewing them
for legal sufficiency. PAE Gov’t, 514 F.3d at 858.

    Perhaps Rev Op Group’s denials are implausible. Perhaps
the denials should be deemed a sham under Rule 11. But the
bankruptcy court did not find that the denials were made in
bad faith, nor were the denials liable to be stricken under Rule
12(f). We reiterate that in the absence of any such findings,
“factual allegations in the complaint (or answer) must be
tested through normal mechanisms for adjudicating the
merits.” Id. at 859 n.3. We reverse the bankruptcy court’s
determination in its Declaratory Judgment that each member

  2
    The text of 29 C.F.R. § 102.21 has not changed since 1964, so our
holding in Harvey Aluminum is still authoritative in the context of
administrative actions brought by the NLRB.
20       IN THE MATTER OF: MORTGAGES LTD.

of the Rev Op Group had executed the agency agreements,
and was “to be bound to” those agreements.

     REVERSED AND REMANDED.