IN RE PALMDALE HILLS PROPERTY, LLCBAP Nos. CC-09-1100-HPaMk, CC-09-1101-HPaMk, CC-09-1102-HPaMk, CC-09-1103-HPaMk, CC-09-1104-HPaMk, CC-09-1105-HPaMk, CC-09-1106-HPaMk, CC-09-1107-HPaMk. Bankruptcy No. SA 08-17206-ES.
423 B.R. 655 (2009)
In re PALMDALE HILLS PROPERTY, LLC, Debtor.
Lehman Commercial Paper, Inc., Appellant,
Palmdale Hills Property, LLC, et al., Appellees.
Lehman Commercial Paper, Inc., Appellant,
Palmdale Hills Property, LLC, et al., Appellees.
United States Bankruptcy Appellate Panel of the Ninth Circuit.
Argued and Submitted on September 25, 2009.
Filed December 15, 2009.
Christopher Pace, Weil Gotshal & Manges, LLP, Miami, FL, Attorney for Lehman Commercial Paper, Inc. Paul John Couchet, Winthrop Couchet Professional Corp., Newport Beach, CA, Attorney for Palmdale Hills Property, LLC.
Before: HOLLOWELL, PAPPAS and MARKELL, Bankruptcy Judges.
HOLLOWELL, Bankruptcy Judge.
The issue presented in this appeal is whether a debtor violates the automatic stay of its creditor's bankruptcy case when it proposes to equitably subordinate the creditor's claim and transfer the lien securing the claim under § 510(c).
Lehman Commercial Paper Inc. ("Lehman Commercial") is a debtor in a chapter 11 bankruptcy case in the Southern District of New York. Palmdale Hills Property, LLC ("Palmdale") filed a chapter 11 bankruptcy petition on November 6, 2008, in the Central District of California. The case is being jointly administered with seventeen of Palmdale's related entities ("Debtors").
Lehman Brothers and its affiliates, including Lehman ALI, Inc. (ALI)
On November 10, 2008, soon after filing bankruptcy, Debtors sought blanket relief from the automatic stay in Lehman Commercial's bankruptcy case in the Southern District of New York "to allow the Debtors to generally administer their California Chapter 11 cases in order to avoid the need for having to file repeated relief from stay motions in New York." The bankruptcy court in New York denied the broad relief, but did so without prejudice so that Debtors could refile specific stay relief requests as needed.
Debtors' proposed joint chapter 11 plan of reorganization is based on their attempt to equitably subordinate the claims of ALI and Lehman Commercial ("Lehman Lenders"). On January 6, 2009, Debtors commenced an adversary proceeding against ALI to equitably subordinate its claim. Debtors amended the equitable subordination complaint to include Lehman Commercial as a defendant and proposed to file the amended complaint if the California bankruptcy court determined the complaint would not violate Lehman Commercial's automatic stay.
On January 29, 2009, the Lehman Lenders filed motions for relief from stay in Debtors' bankruptcy case asserting they were owed approximately $649 million in principal, plus interest, on various Lehman Lenders' loans.
The Lehman Lenders argued the properties securing the loans lacked equity and were declining in value ("Stay Relief Motion"). The Lehman Lenders also argued that Debtors' reorganization could not succeed since it was premised in part on subordinating Lehman Commercial's claim, which Lehman Commercial argued violated its stay.
On February 20, 2009, the bankruptcy court issued a tentative ruling on the Stay Relief Motion, finding that:
The parties addressed the tentative ruling during the hearing that same day. At the close of hearing, the bankruptcy court stated the tentative ruling would stand, finding there was not sufficient cause to grant stay relief and that Debtors could pursue equitable subordination, either through an adversary proceeding or through a plan or reorganization, as a defense to Lehman Commercial's Stay Relief Motion, which the court treated as an informal proof of claim. The final orders denying stay relief were entered March 10, 2009 ("Denial Orders"). The Denial Orders held that:
Lehman Commercial timely appealed the Denial Orders. Lehman Commercial does not contend the bankruptcy court abused its discretion in denying the Stay Relief Motion, but assigns error to the bankruptcy court's determination regarding the scope and application of Lehman Commercial's automatic stay.
The bankruptcy court had jurisdiction pursuant to 28 U.S.C. § 157(b)(1) and (2)(G) and (O). We have jurisdiction under 28 U.S.C. § 158.
After oral argument, on October 20, 2009, Debtors filed a motion to dismiss the appeal for lack of jurisdiction as a result of decisions made in the bankruptcy court regarding the ownership of Lehman Commercial's loans ("October Order"). Specifically, the bankruptcy court determined that certain Lehman Commercial loans were sold, not simply transferred to a third party, Fenway Capital ("Fenway Capital Loans"), for security. Thus, in the October Order, the bankruptcy court ruled that Lehman Commercial was not the creditor with respect to the Fenway Capital Loans. The bankruptcy court reserved ruling on whether Lehman Commercial could file proofs of claim as an agent for Fenway Capital.
Debtors argue that Lehman Commercial does not own any interest in the Fenway Capital Loans, and therefore, the automatic stay could not bar subordination of such loans. As a result, Debtors argue the appeals are moot and that Lehman Commercial lacks standing. Lehman Commercial contends that a portion of at least one of the loans was not part of any sale or transfer to Fenway Capital.
An appeal is moot if events have occurred that "prevent an appellate court from granting effective relief." Varela v. Dynamic Brokers, Inc. (In re Dynamic Brokers, Inc.),
However, we find that effective relief could be granted to Lehman Commercial, since it is not clear that all the loans Lehman Commercial made to the Debtors were the subject of the October Order. Moreover, Lehman Commercial has filed a motion for clarification of the October Order and the bankruptcy court's findings. Thus, no final order regarding the ownership of the loans has yet been entered (and Lehman Commercial has stated that it will appeal the final order after it is entered).
For similar reasons, we find that Lehman Commercial has standing to appeal the Denial Orders. The Ninth Circuit has adopted the "person aggrieved" test as the standard for determining whether a party possesses standing in a bankruptcy appeal. See, e.g., Fondiller v. Robertson (In re Fondiller),
Accordingly, we conclude we have jurisdiction over these appeals and address the merits.
Do Debtors violate Lehman Commercial's automatic stay when they attempt to equitably subordinate Lehman Commercial's claims and transfer its liens to the estate?
IV. STANDARDS OF REVIEW
The scope or applicability of the automatic stay under § 362 is a question of law, which is reviewed de novo. Salazar v. McDonald (In re Salazar),
A. The Automatic Stay Protects a Debtor's Estate
The filing of a bankruptcy petition creates a bankruptcy estate, which is protected by an automatic stay of actions by all entities to collect or recover on claims. 11 U.S.C §§ 541(a) and 362(a). The automatic stay arising in the bankruptcy court where a debtor files a petition for relief (the home bankruptcy court) applies to all other bankruptcy courts. Snavely v. Miller (In re Miller),
The policy behind § 362 is to protect the estate from being depleted by creditors' lawsuits and seizures of property in order to provide the debtor breathing room to reorganize. White v. City of Santee (In re White),
Although the scope of the automatic stay is broad, it does not stay all proceedings. Courts have recognized the automatic stay does not apply to actions against the debtor in the debtor's home bankruptcy court. In re Miller, 397 F.3d at 730; In re N. Coast Vill., Ltd., 135 B.R. at 643. Additionally, the automatic stay has been found inapplicable to lawsuits initiated by the debtor. Eisinger v. Way (In re Way),
Debtors contend Lehman Commercial initiated the action against Debtors by filing its Stay Relief Motion, which was treated by the bankruptcy court as a proof of claim.
The bankruptcy court agreed that Debtors' equitable subordination claims against Lehman Commercial did not violate Lehman Commercial's automatic stay because they were raised as a defense to the Stay Relief Motion. Because equitable subordination would alter the lien rights of the creditor, we agree that equitable subordination involves the question of a debtor's equity and may be properly asserted as a defense to a motion seeking relief from the automatic stay. See In re Poughkeepsie Hotel Assocs. Joint Venture,
At the hearing on the Stay Relief Motion, the bankruptcy court stated:
Hr'g Tr. at 63:8-20 (February 20, 2009).
The bankruptcy court correctly recognized that a separate procedure was required to litigate the merits of Debtors' equitable subordination claim. See Rule 7001(8) (a request to subordinate an allowed claim or interest requires an adversary proceeding except when a debtor's plan provides for the relief). As one court explained:
In re Poughkeepsie Hotel Assocs. Joint Venture, 132 B.R. at 290.
However, the bankruptcy court conflated the defense of equitable subordination to a motion for relief from stay with equitable subordination as a defensive action against (or objection to) a claim. There is a "'tremendous difference between adjudication of the merits and mere consideration of counterclaims and defenses' raised in a motion for stay relief." Id. at 293 (quoting In re Tally Well Serv., Inc.,
B. Under These Facts, Equitable Subordination is Not a Defensive Action
Debtors contend they are "entitled to take any action necessary to defeat" a claim asserted in their bankruptcy case. Thus, Debtors frame their equitable subordination action as a defensive action against Lehman Commercial's claim.
The distinction between defensive and offensive actions affecting a debtor's estate is appropriate in determining the applicability of the automatic stay because courts have held that a debtor may defend against suits brought against it without violating a bankruptcy stay. Justus v. Fin. News Network, Inc., (In re Fin. News Network, Inc.),
Accordingly, Debtors argue that if the complete elimination of a claim or lien can be achieved through a claim objection without a stay violation, then the "lesser defensive remedy of subordination" cannot be considered an offensive action that violates the automatic stay. We disagree with Debtors' characterization of subordination as a mere defense to a claim or a "lesser remedy" than claim disallowance.
A claim is a right to payment. 11 U.S.C. § 101(5)(A). A proof of claim is prima facie evidence of the validity and amount of a claim. Rule 3001(f). A party objecting to a claim has the burden of overcoming the prima facie case by challenging the validity of the claim. In a claim objection, the court investigates the existence, validity, and enforceability of claims and determines whether the claim is allowed by applicable law. Murgillo v. Cal. State Bd. of Equalization (In re Murgillo),
Even though equitable subordination, "if established, may be functionally equivalent to disallowance (i.e., no distribution on the claims)," it is a legally distinct proceeding which seeks to reprioritize the order of allowed claims based on the equities of the case, rather than to disallow the claim in the first instance. In re USA Commercial Mortgage Co., 377 B.R. at 617; see also In re Enron Corp., 2003 WL 23965467, 2003 Bankr.LEXIS 2261 at *26; In re County of Orange,
Equitable subordination is sought when a creditor has engaged in some type of inequitable conduct that resulted in injury to the debtor's other creditors or conferred an unfair advantage on the claimant. United States v. Noland,
Section 510(c)(1) allows for subordination of otherwise allowed claims "when the principles of equity would be so offended by the allowance of such claims on a parity with those of other creditors." 4 COLLIER ON BANKRUPTCY ¶ 510.01 (Alan N. Resnick & Henry J. Sommer, eds. 15th ed. rev.2009). If the subordinated claim is secured by a lien, under § 502(c)(2), the lien is transferred to the debtor's estate. The subordinated lien claim becomes unsecured and the property securing such claim becomes part of the debtor's estate.
Thus, unlike in claim disallowance, in the situation of equitable subordination, a creditor has the right to payment on its claim, but that property right may be modified by the bankruptcy court based upon equitable principles.
As the Panel has previously noted:
In re Murgillo, 176 B.R. at 533; Benjamin v. Diamond (Matter of Mobile Steel Co.),
This scenario differs markedly from a case cited by Debtors, In re Metiom,
Simply because Lehman Commercial filed a proof of claim (whether formally or informally) does not mean that Debtors may take any action against Lehman Commercial without violating Lehman Commercial's automatic stay. Debtors may not initiate an action or proceeding against Lehman Commercial that seeks affirmative relief, such as a counterclaim without violating the automatic stay.
One of the purposes of the automatic stay is to protect the bankruptcy court's jurisdiction over the debtor and the property of the estate. The protection of Lehman Commercial's automatic stay did not evaporate when it filed a proof of claim in Debtors' bankruptcy case. See In re Miller, 397 F.3d at 732. If Debtors were allowed to subordinate Lehman Commercial's claim in the California bankruptcy
Therefore, while the California bankruptcy court may have concurrent jurisdiction to determine the scope or applicability of the automatic stay, the New York bankruptcy court must have the final say as to whether the automatic stay applies to the bankruptcy case before it. See Erti v. Paine Webber Jackson & Curtis, Inc. (In re Baldwin-United Corp. Litig.),
For the forgoing reasons, we REVERSE and void those provisions of the Denial Orders that find Debtors may prosecute an adversary proceeding, or propose a reorganization plan, seeking to equitably subordinate Lehman Commercial's claim and transfer its liens to the estate in the California bankruptcy case without first obtaining relief from the automatic stay in the New York bankruptcy case.
MARKELL, Bankruptcy Judge, dissenting:
I respectfully dissent. The majority essentially holds that a debtor may not, in its own bankruptcy, unilaterally defend against a lender's inequitable claim if that lender is also a bankruptcy debtor. I disagree.
The central inquiry here is what a debtor may do in response to a creditor's filing a proof of claim.
Here, however, the creditor is also a debtor in bankruptcy. As such, the creditor is entitled to the benefits of the automatic stay with respect to actions against it and its estate. That much is undisputed.
Existing law does not mandate this result. The Code and our precedents recognize implicit equitable exceptions to the automatic stay that permit a debtor to defend against a filed proof of claim in any manner permitted by applicable nonbankruptcy law. All the bankruptcy court did here was to protect that right. Even if I am wrong, however, I believe Lehman Commercial waived its right to raise automatic stay issues when it filed its proof of claim. I would therefore affirm the bankruptcy court's ruling.
Although I believe this case is controlled by recognized exceptions to the automatic stay, those exceptions are not found in § 362(b). While § 362(b) lists explicit exceptions to the automatic stay, there are additional, implicit, equitable exceptions necessary for a practical and functioning bankruptcy system. One is that a creditor does not need relief from stay to seek relief from stay. Another is that a creditor does not need relief from stay to file and prosecute a proof of claim. Common sense dictates both these exceptions, even if § 362(b) does not mention them.
Our precedents identify a third equitable exception: a debtor need not seek relief from stay to object to a proof of claim filed by a creditor who coincidentally happens to be a debtor in bankruptcy. As we stated in Hi-Tech Commc'n. Corp. v. Poughkeepsie Bus. Park, LLC (In re Wheatfield Business Park, LLC),
Merrick provides the analytical underpinning for this equitable exception. In Merrick, we noted that:
Merrick, 175 B.R. at 338.
The majority rejects Merrick and our other precedents as inapplicable on two grounds. Initially, they contend that we permitted these equitable exceptions only in the context of disallowance of a claim under § 502 but not subordination under § 510, and therefore any attempt to subordinate Lehman Commercial's claim under § 510 would be "offensive."
Neither of these arguments is convincing. The majority initially distinguishes between claim allowance and claim subordination. Under these facts, this is a distinction without a difference. A bankruptcy court has core jurisdiction over "proceedings affecting the . . . adjustment of the debtor-creditor . . . relationship." 28 U.S.C. § 157(b)(2)(O). Along with claim disallowance, equitable subordination has historically been one such proceeding within that broad grant of jurisdiction. Long before the enactment of the 1978 Bankruptcy Code, the Supreme Court had recognized that "[i]n appropriate cases, acting upon equitable principles, [the bankruptcy court] may also subordinate the claim of one creditor to those of others in order to prevent the consummation of a course of conduct by the claimant which, as to them, would be fraudulent or otherwise inequitable." Heiser v. Woodruff,
Heiser and § 510(c) confirm that equitable subordination has a venerable history as a doctrine available to avoid inequitable distributions. With this heritage, equitable subordination is surely as much a part of the adjustment of debtor-creditor rights as is claim disallowance. I thus fail to see any link between § 510's language regarding application to "allowed claims" and the nonapplicability of Merrick equitable principles. Put another way, there is no good reason to require a bankruptcy estate to seek permission from another court to avoid inequitable results in its own case, so long as what is sought is confined to the defense of the claim asserted. Any other result unnecessarily hobbles estates in their attempt to maximize fair returns to their creditors.
The unfairness of the majority's position can be seen under the facts present here. When Lehman Commercial sought to establish its claim, the Debtors had a duty on behalf of the estate to respond by raising all appropriate responses. The Debtors believed this response included a challenge to the equity of Lehman Commercial's claimed priority. But the majority's position would have required the Debtors to obtain permission from Lehman Commercial's home bankruptcy court before responding on this ground. This extra step is just the type of "gratuitous impediment in dealing with an adversary who suffers no correlative constraint" that Merrick condemned. See also In re Metiom,
The majority's reliance on § 362(a)(3) also does not survive scrutiny. In this context, adjustment of lien priorities is no different from an adjustment of claim priorities. A lien is nothing but an incident of the debt it secures; there can be no lien without a debt to support it. See, e.g., Satsky v. United States,
Finally, the majority's fears that the bankruptcy court's ruling could somehow usurp the alleged right of Lehman Commercial's home court to determine whether subordination would violate § 362(a)(3) are easily allayed. By filing the proof of claim, Lehman Commercial clearly put its entire claim at risk. At a minimum, Lehman Commercial impliedly consented to have all its claims against the Debtors adjudicated in the Debtors' bankruptcy case. Metiom, a decision from Lehman Commercial's home court, holds as much. Moreover, as the Ninth Circuit has made explicit, "[w]hen a creditor submits to bankruptcy court jurisdiction by filing a proof of claim in order to collect all or a portion of a debt, it assumes certain risks. . . bankruptcy converts the creditor's legal claim into an equitable claim to a pro rata share of the res." Hong Kong & Shanghai Banking Corp. Ltd. v. Simon (In re Simon),
It is the height of formalism — and the nadir of equity — to allow Lehman Commercial to file its proof of claim under an implied waiver from the Debtors' stay, only to deny the Debtors a correlative and reciprocal waiver with respect to any accepted challenge to that proof of claim.
For these reasons, I would affirm.
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