Daily Journal
July 15, 2020
By Zev Shechtman

With unemployment and economic distress reaching levels unseen since the Great Depression, businesses and their employees may be seriously considering all of their financial options — including filing for bankruptcy protection. A business considering bankruptcy may have questions relating to employment claims. For example, can employment claims be eliminated or otherwise adjusted in bankruptcy? Can employment lawsuits continue even after the bankruptcy case is filed? How are employment class actions resolved in bankruptcy? For employee plaintiffs who are creditors, how will the bankruptcy filing of the employer defendant impact the employees’ claim? Do employees get priority treatment above other types of creditors? Finally, what happens if an employee plaintiff files a personal bankruptcy case — can he or she still pursue the lawsuit while in bankruptcy?

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August 14 2020

Dear constituency list members of the Insolvency Law Committee, the following is a recent case update.

SUMMARY

On July 23, 2020, in Speier v. Brace, __ P.3d __, __, 2020 WL 4211750, 2020 Cal. LEXIS 4642 (July 23, 2020), the California Supreme Court issued an opinion answering questions posed by the Ninth Circuit Court of Appeals in Brace v. Speier (In re Brace), 908 F.3d 531 (9th Cir. 2018). In sum, the Court held that:

• The “form of title” presumption in California Evidence Code § 662 does not apply when it conflicts with the community property presumption in California Family Code § 760.
• Property acquired by spouses as joint tenants, with community funds, before January 1, 1975, is presumed to be separate property.
• Property acquired by spouses as joint tenants, with community funds, on or after January 1, 1975, is presumed to be community property.
• A grant deed from a third party, in itself, is not sufficient to overcome the community property presumption. What is required depends on whether the property was acquired before or after January 1, 1985.
• If the property was acquired before January 1, 1985, the community property presumption may be rebutted by substantial evidence of an oral or written agreement or a common understanding between the spouses. A court may consider the fact that title was taken as joint tenants as part of its determination as to whether such an agreement or understanding existed.
• If the property was acquired on or after January 1, 1985, there must be a written transmutation that satisfies the requirements of Family Code § 852. A grant deed, in itself, is not sufficient to transmute community property into separate property.

To read the California Supreme Court’s decision, click here.

BACKGROUND

Clifford and Ahn Brace were married in 1972. In the late 1970s, they purchased a home in Redlands. At some point, although it is not clear when, they also acquired a rental property in San Bernardino. They took title to each property as “husband and wife as joint tenants.”

In 2011, Mr. Brace filed a chapter 7 petition. After some preliminary legal issues were resolved, the bankruptcy court needed to decide whether the bankruptcy estate owned 100%, or just 50%, of each property.

In 2015, the bankruptcy court entered a judgment in favor of the chapter 7 trustee. The bankruptcy court determined that the properties were community property and, therefore, entirely property of the bankruptcy estate. See 11 U.S.C. § 541(a)(2).

In a published decision, the U.S. Bankruptcy Appellate Panel of the Ninth Circuit affirmed. Brace v. Speier (In re Brace), 566 B.R. 13 (9th Cir. BAP 2017). The BAP’s decision was the subject of an ILC e-Bulletin authored by Michael W. Davis and published on October 16, 2017. Mr. Davis’s e-Bulletin may be found here.

The Braces appealed to the Ninth Circuit. In a published order , the Ninth Circuit requested that the California Supreme Court decide the following certified question.

Does the form of title presumption set forth in section 662 of the California Evidence Code overcome the community property presumption set forth in section 760 of the California Family Code in Chapter 7 bankruptcy cases where: (1) the debtor husband and non-debtor wife acquire property from a third party as joint tenants; (2) the deed to that property conveys the property at issue to the debtor husband and non-debtor wife as joint tenants; and (3) the interests of the debtor and non-debtor spouse are aligned against the trustee of the bankruptcy estate?

Brace v. Speier (In re Brace), 908 F.3d 531 (9th Cir. 2018). The Ninth Circuit’s request was the subject of an ILC e-Bulletin authored by John N. Tedford, IV, and published on March 18, 2019. Mr. Tedford’s e-Bulletin may be found here.

The California Supreme Court reformulated the question as follows:

[W]hether the form of title presumption set forth in Evidence Code section 662 applies to the characterization of property in disputes between a married couple and a bankruptcy trustee when it conflicts with the community property presumption set forth in Family Code section 760.

The Court’s answer – a thorough 45-page majority opinion and a 12-page concurring and dissenting opinion by Justice Kruger – examines a “snarl of conflicting presumptions” going back to the 1800s. In the end, for property acquired after January 1, 1975, the Court adopted a bright-line rule that the California Legislature declined to expressly adopt in the 1980s.

THE COURT’S REASONING

1850–1930: The Community Property Presumption and the Married Woman’s Presumption

The California Legislature first enacted a general community property presumption in 1850. In 1872, it enacted former Civil Code § 164: “All other property acquired after marriage, by either husband or wife, or both, is community property.” However, the early community property system afforded a wife no management or control over community property.

In 1889, the Legislature enacted the so-called “married woman’s presumption.” First, if property was conveyed to a married woman by an instrument in writing, it was presumed to be her separate property. Second, if property was conveyed to a married woman and to her husband, the portion conveyed to her was presumed to be taken as a tenant in common unless a different intention was expressed in the instrument.

The fact that the phrase “unless a different intention is expressed in the instrument” appeared only as part of the married woman’s presumption is key. According to the majority, the married woman’s presumption is the only place in which the form of title, in itself, determined whether jointly titled property was characterized as community or separate property. As discussed below, the married woman’s presumption does not apply to property acquired on and after January 1, 1975. Therefore, according to the majority, neither does the rule that allowed the form of title to determine the character of the property.

1931–1932: The Siberell Rule

In some cases, former Civil Code § 164 led courts to determine that the wife owned 75% of property jointly deeded to a husband and wife. One such case was Dunn v. Mullan, 211 Cal. 583 (1931). After both spouses died, the Court determined that the wife had a separate interest in half of the property as a tenant in common, but that did not mean that the husband had a separate interest in the other half. Rather, under the general community property presumption, the other half of the property was community property. The wife’s 75% interest was probated to her heirs, and the husband’s 25% interest was probated to his.

The following year, the Court decided a key case called Siberell v. Siberell, 214 Cal. 767 (1932). Siberell was a dissolution action in which the wife argued that she had a 75% interest in a house titled in joint tenancy. In rather sweeping terms, for two reasons, the Siberell Court declined to extend Dunn’s rule to joint tenancy deeds in the context of divorce.

First, the Siberell Court stated that “from the very nature of the estate, as between husband and wife, a community estate and a joint tenancy cannot exist at the same time in the same property. The use of community funds to purchase the property and the taking of title thereto in the name of the spouses as joint tenants is tantamount to a binding agreement between them that the same shall not thereafter be held as community property but instead as a joint tenancy with all the characteristics of such an estate.”

Second, the Siberell Court said that, on its face, Civil Code § 164 had no application to a case where a different intention was expressed in the instrument. The Siberell Court concluded that the deed conveying title to the spouses as joint tenants was “an expression of the intention to hold the property otherwise than as community property and that the equal interest of the spouses must therefore be classed as their separate but joint estate in the property.”

As formulated by Justice Kruger in her concurring and dissenting opinion, the “Siberell rule” is as follows: “[S]pouses who take title to property as joint tenants are presumed to have intended to transmute their community property to separate property.”

In Brace, the majority interpreted Siberell narrowly. According to the majority, Siberell addressed a peculiar circumstance arising from the tension between the married woman’s presumption and fundamental concepts of joint tenancy. Also according to the majority, the decision in Siberell was limited to dissolution actions between spouses. The majority noted that less than one year earlier, in Hulse v. Lawson, 212 Cal. 614 (1931), the Court had held that one spouse’s creditor could reach the entirety of a couple’s property held in joint tenancy because it was community property. To the Brace majority, the fact that Siberell reached a different result in the dissolution context without disavowing Hulse indicates that the scope of Siberell’s holding is limited.

Justice Kruger, on the other hand, argued that Siberell’s holding was not limited to dissolution actions. She cited cases that applied the Siberell rule outside the dissolution context, including to claims made by third party creditors. She also noted that the Legislature understood Siberell to apply outside of the dissolution context in 1965 when it abrogated the Siberell rule for certain types of property held in joint tenancy, but solely for purposes of dissolution proceedings. According to Justice Kruger, there would not have been any need to limit the 1965 legislation (discussed below) to dissolution proceedings if the Siberell rule did not apply outside of the dissolution context.

1933–1974: Legislature’s Adoption of the Siberell Rule Where the Deed Identified the Spouses as Husband and Wife, and Extension of the Community Property Presumption to Certain Property Held As Joint Tenants (But Only When Dividing Property in a Dissolution Proceeding)

In 1935, the Legislature amended the married woman’s presumption in former Civil Code § 164 to add that a conveyance to spouses describing them as husband and wife created a presumption of community property “unless a different intention is expressed in the instrument.” According to the Brace majority, this phrase suggests that the Legislature approved of the Siberell view that an instrument that vests title as a joint tenancy expresses a “different intention” of the parties.

Over the years, courts applied the Siberell rule and the statutory presumption in the context of both divorce proceedings and disputes involving third-party creditors. Doing so was particularly difficult in the divorce context, because courts were often unable to award the family home to one of the spouses.

The Legislature recognized that most spouses took title to their homes as joint tenants without really realizing what it meant to own property as joint tenants. Therefore, in 1965, the Legislature amended Civil Code § 164 to provide that when spouses acquired a single family residence as joint tenants, for purposes of division of the property upon divorce, the property was presumed to be community property.

1975–1984: Landmark Reforms Giving Spouses Equal Management over Community Property, and Prospective Abolition of the Married Woman’s Presumption

In 1973, the Legislature enacted landmark reforms to the community property system. Among other things, wives were allocated equal management rights over community property. The Brace majority observed that this “eroded the original impetus for” the married woman’s presumption, which was prospectively eliminated as of January 1, 1975. According to the majority, the Legislature also prospectively eliminated the 1935 language in former Civil Code § 164 (property jointly deeded to “husband and wife” is presumptively community property “unless a different intention is expressed in the instrument”).

According to the majority, the 1973 legislation eliminated (prospectively) the basis for the Siberell rule privileging the form of title. Thus, “as a result of the 1973 legislation, the form of title in property jointly held by a married couple can defeat the general community property presumption only for property acquired before 1975.” For property acquired on or after January 1, 1975, the general community property presumption applies.

Justice Kruger disagreed. She argued that Siberell remained good law after the 1973 amendments went into effect. She pointed out that, at the time, courts and the Legislature treated the Siberell form of title presumption as if it survived the 1973 amendments. According to Justice Kruger, it was the 1984 amendments (discussed below), not the 1973 amendments, that changed this aspect of the law.

During this time period, a transmutation could be shown by an oral or written agreement or a common understanding between the spouses.

1985-Present: Adoption of Strict Transmutation Requirements

In 1984, the Legislature enacted California’s present-day transmutation statutes. Under those statutes, for property acquired on or after January 1, 1985, a transmutation “is not valid unless made in writing by an express declaration that is made, joined in, consented to, or accepted by the spouse whose interest in the property is adversely affected.” This strict requirement was enacted to curb the risk of fraud, undue influence, and litigation arising from informal agreements between the spouses.

In 1992, the Legislature created the Family Code. Today:

• The general community property presumption is found in Family Code § 760. Unlike the former Civil Code provisions which also contained the married woman’s presumption, Family Code § 760 does not permit the community property presumption to be rebutted simply by the manner in which a married couple takes title.
• The married woman’s presumption and the post-Siberell rule allowing form of title to rebut the community property presumption are found in Family Code § 803 and apply only to property acquired before 1975.
• The transmutation requirements are found in Family Code §§ 850-853. Although a deed may expressly declare that title is vested as joint tenants, it does not contain language which expressly states that the characterization or ownership of the property is being changed between the spouses. Therefore, the form of the deed does not constitute an express declaration that transmutes community funds into separate property.
• The community property presumption applicable at divorce is found in Family Code § 2581 and extends to all property acquired by the parties during marriage in joint form, including joint tenancy. Section 2581 limits the type of evidence that may be used to rebut the presumption.

The Court rejected the notion that Evidence Code § 662 trumps Family Code § 760. The Court stated that ruling otherwise would carve a major hole in the community property system and would run counter to the intent of the 1973 legislation that prospectively eliminated separate property inferences from form of title.

The Court also rejected the Braces’ argument that because Family Code § 2581 establishes a community property presumption in the context of divorce, spouses hold property as joint tenants in their dealings with third parties. According to the Court, the general community property presumption may be rebutted by tracing. However, the community property presumption in Family Code § 2581 can only be rebutted by (1) a clear statement in the title document that the property is separate property and not community property, or (2) proof that the parties made a written agreement that the property is separate property. “Thus, the import of Family Code section 2581 is that it establishes a stronger presumption of community property at dissolution when title is held in joint form, while the general community property presumption, rebuttable by tracing, applies at dissolution to property not held in joint form.”

Finally, the Court said that its approach does not undermine the stability of title in the context of probate. The Court noted that courts have consistently held that, for property titled in joint tenancy, the form of title controls at death. The Court also found support for this proposition in Family Code § 2040 (requiring certain language in a divorce summons) and Civil Code § 682.1 (creating “community property with a right of survivorship” as a new form of title). The Court stated that its decision “does not alter the well-established default rule that form of title controls at death.”

In sum: “The particular manner in which property is acquired, titled, or held by a married couple is conceptually and legally distinct from the underlying character of the spouses’ ownership of the property as separate or community.”

AUTHOR’S COMMENTARY

First, when spouses purchase a home in California, they usually don’t give much thought as to how title should be held. Historically, spouses have taken title as joint tenants so that, when one spouse dies, the ownership interest of the deceased spouse automatically transfers to the surviving spouse. This “right of survivorship” is convenient because it avoids the need for a probate. But most people don’t realize that if the joint tenancy is given full effect each spouse separately owns a one-half interest in the property and has the power to transfer his or her one-half interest without the other spouse’s consent. Obviously, this is not what most spouses intend when they buy a family home. Brace brings things back in line with spouses’ expectations.

Second, for both of the properties at issue in Brace, the Court’s answers to the seemingly academic questions of what presumption applies for property acquired before 1975, and what rules apply to property acquired from 1975 through 1984, will make a difference.  For example, the Braces purchased their Redlands residence in the late 1970s.  Under the majority rule, because the residence was acquired after January 1, 1975, it is presumed to be community property.  But because it was acquired before 1985, the Braces can theoretically rebut the presumption by providing substantial evidence of an oral or written agreement or a common understanding between the spouses.  (I say “theoretically” because it appears that the bankruptcy court may have already found that no such agreement or understanding existed.)  In contrast, if Justice Kruger’s minority view had prevailed, each of the Braces would be presumed to have a separate property joint tenancy interest in the residence; it would then be the Trustee’s burden to rebut that presumption.

Third, in 2003, the Ninth Circuit held that the community property presumption is rebutted when spouses acquire real property from a third party as joint tenants, and that there is a rebuttable presumption that “‘where the deed names the spouses as joint tenants . . . the property [is] in fact held in joint tenancy.’” Hanf v. Summers (In re Summers), 332 F.3d 1240, 1243-44 (9th Cir. 2003) (quoting Hansen v. Hansen, 233 Cal.App.2d 575, 594 (1965)). Brace effectively overrules Summers. So under Brace’s ruling, money that used to go to non-debtor spouses will go to pay costs of administration and creditors.

Fourth, when the California Law Revision Commission recommended in 1983 that the Legislature enact transmutation requirements now found in Family Code §§ 850-853, it also recommended the following new statute:

Except as otherwise provided by statute, the form of title to property acquired by a married person during marriage does not create a presumption or inference as to the character of the property, and is not in itself evidence sufficient to rebut the presumptions established by this article.

The perceived need for such a provision bolsters Justice Kruger’s conclusion that the Siberell rule survived the 1973 amendments. Notably, the Estate Planning, Trust and Probate Law Section of the California State Bar opposed it on the grounds that “the form of title should create a presumption as to the character of the property.” See In re Marriage of Brooks, 169 Cal.App.4th 176, 189 (2008). To allow for additional time to consider the proposed presumptions and their effect, this provision was deleted from a then-pending bill. Id. The Court arguably has now adopted a rule that the Legislature declined to enact.

Fifth, while in my view the Court reached the right conclusion, I struggle to reconcile it with Family Code § 2581. Brace effectively holds that property acquired by spouses in joint form is presumed to be community property. If that has been the law all along since 1975 or 1985, there seems to be no reason for § 2581 to establish that rule specifically for the purpose of division of property in divorce proceedings.

Finally, the case will now return to the Ninth Circuit for further proceedings.  As to the residence in Redlands, I predict that the Ninth Circuit will affirm because (a) the parties stipulated below that the property was acquired in 1977 or 1978, and (b) the bankruptcy court applied the correct legal standard by presuming that the property was community property.  Unless the Ninth Circuit concludes that the bankruptcy court erroneously determined that the Braces failed to rebut the presumption, the judgment should stand.

On the other hand, as to the rental property in San Bernardino, the Ninth Circuit may remand for one of two reasons.  First, evidence in the record does not appear to conclusively establish the date on which the property was acquired; if that is the case, the Ninth Circuit cannot determine from the record whether the bankruptcy court correctly presumed that the property was community property.  Second, based on public records, it appears that the Braces acquired the property in 1973; if that is the case, and if the parties stipulate to (or the Ninth Circuit takes judicial notice of) that fact, the Ninth Circuit may rule that the bankruptcy court applied the wrong legal standard and must determine in the first instance whether the evidence at trial rebutted the separate property presumption.  Either way, remand seems appropriate.

These materials were written by John N. Tedford, IV, of Danning, Gill, Israel & Krasnoff, LLP, in Los Angeles (jtedford@DanningGill.com). Editorial contributions were provided by the Hon. Meredith A. Jury (United States Bankruptcy Judge, C.D. Cal., Ret.).

Best regards,
Insolvency Law Committee

Co-Chair
Kyra E. Andrassy
Smiley Wang-Ekvall, LLP
kandrassy@swelawfirm.com

Co-Chair
Gary B. Rudolph
Sullivan Hill Rez & Engel, APLC
rudolph@sullivanhill.com

Co-Vice Chair
Michael W. Davis
DTO Law
mdavis@dtolaw.com

Co-Vice Chair
Michael J. Gomez
Frandzel Robins Bloom & Csato, L.C.
mgomez@frandzel.com

 

March 26, 2020

Dear constituency list members of the Insolvency Law Committee:

The following is a case update written by Uzzi O. Raanan, a partner at Danning, Gill, Israel & Krasnoff, LLP, analyzing a recent decision of interest:

The Fifth Circuit Court of Appeals rejects lower court ruling that a bankruptcy trustee could avoid prepetition transfers and recover their values under 11 U.S.C. section 550(a), when the immediate transferee had returned the funds in question to the debtor prepetition, as such recovery would violate the prohibition against double recovery in Section 550(d). Matter of DeBerry, ___ F.3d ___, 2019 WL 7046904 (5th Cir. 2019).

To view the full opinion, click here.

Facts:

A few months before debtor Curtis DeBerry filed for bankruptcy under chapter 7, his wife Kathy DeBerry (maiden name Whitlock) opened a joint Wells Fargo bank account with her sister-in-law Cheri Whitlock. Mrs. DeBerry allegedly wanted to use the account to transfer funds to her adult children who were away at school. As the appellate court noted, it is not clear why the joint account was needed to accomplish this goal.

Mrs. DeBerry was briefly on the joint account with Ms. Whitlock but removed herself after about three days. However, she instructed Ms. Whitlock about how the money in the account, which was funded with a $275,000 check written on a DeBerry joint account, should be disbursed. At Mrs. DeBerry’s request, Ms. Whitlock authorized transfers of $33,500 to a culinary school attended by the DeBerry’ daughter, $9,200 to Marla Bainbridge, whom Ms. Whitlock did not know, $32,000 to Mrs. DeBerry’s personal bank account, which was held in her name alone, and $200,000 to an account owned by the debtor’s LLC, “MBC”. All transfers were made within two months of when the account was opened.

Ms. Whitlock testified that she never questioned requests that she make the above transfers, as the funds belonged to Mrs. DeBerry. She was merely helping her sister-in-law.

About four months after the last two transfers, Mr. DeBerry filed his chapter 7 case. His trustee sued Ms. Whitlock for fraudulent transfer and sought to recover from her $241,500 under Section 550(a). The trustee settled with the DeBerry daughter regarding the $33,500 transfer.

Ms. Whitlock raised two defenses: (1) she was never a “transferee” of the funds in question, as she was merely a “conduit” for the DeBerrys, and (2) the funds she transferred to her sister-in-law and to MBC represented a return of funds to the debtor, so the trustee could not recover the funds from her a second time.

The bankruptcy court held that Ms. Whitlock was the “initial transferee” of the funds under Section 550(a)(1), as they became her sole property and she had dominion and control over the money. The more difficult question was whether allowing the trustee to recover from Ms. Whitlock would result in an impermissible double recovery to the debtor’s estate. Section 550(d) states, “The trustee is entitled to only a single satisfaction under subsection (a) of this section.”

The bankruptcy court ruled that the single satisfaction rule does not apply when the funds in question were returned prior to the petition date. It therefore entered a judgment for the trustee, holding Ms. Whitlock liable for the entire $241,500.

The district court affirmed the trial court’s ruling and Ms. Whitlock appealed to the Fifth Circuit Court of Appeals.

Reasoning:

The court of appeals reversed the trial court’s ruling, holding that a transferee who received but returned a fraudulent transfer prepetition cannot be required to return the assets a second time when the transferor subsequently files for bankruptcy.

The court rejected the Trustee’s argument that a plain reading of Section 550(d) establishes that the single-satisfaction rule does not apply when funds are returned to the debtor prepetition, rather than post-petition. The Trustee had asserted that if funds were returned to the debtor without a need to sue under Section 550(a), it could not be argued later that the trustee had utilized his rights under that section and thus there was no double-recovery under Section 550(d). The Trustee had relied on the language in Section 550(d), which states that, “[t]he trustee is entitled to only a single satisfaction under subsection (a) of this section.” (Emphasis added.) Thus, if Ms. Whitlock returned the funds to the debtor prepetition, the trustee had not received a prior recovery under Section 550(a) to trigger the single-recovery rule.

The appellate court concluded that the word “satisfaction” used in Section 550(d) “presupposes an obligation.” If Ms. Whitlock returned the funds in question, she satisfied her obligation leaving no right of action for the trustee to pursue in an avoidance action.

Similarly, the appellate court rejected an argument that all prior cases reviewing this issue were distinguishable as they found that the recovery by a trustee would have resulted in a windfall for the bankruptcy estates. Here, the estate never received the funds in question as they were spent by the debtor prepetition. The DeBerry court responded that the debtor’s decision to fritter his funds away prepetition was not relevant to the trustee’s subsequent fraudulent transfer claims against Ms. Whitlock. After all, the debtor could have dissipated the funds in question whether or not they had ever been transferred to Ms. Whitlock.

The Court of Appeals acknowledged in a footnote that the bankruptcy court never decided whether the transfers to Mrs. DeBerry and MBC amounted to a return of funds to the debtor and left the issue for the bankruptcy court to resolve on remand.

Author’s Comments:

The appellate court’s opinion appears to reach the correct result, as the lower courts’ rulings in favor of the trustee appear counter-intuitive on their face. As the appellate court notes, the trial court’s ruling contradicted all other decisions in cases where the issue arose, raising questions as to what motivated the lower court to rule in the trustee’s favor and the district court to affirm that decision.

It is entirely possible that the lower court’s ruling relied on facts and legal arguments that were not fully discussed in the appellate court’s decision. However, barring such explanation, it is hard to imagine a state of the law where a transferee of a fraudulent transfer who returned the funds prepetition could be required to repay the funds a second time pursuant to an avoidance action brought in the transferor’s subsequent bankruptcy case. After all, what were the bankruptcy estate’s damages if Ms. Whitlock indeed returned the funds in question to the debtor prepetition?

These materials were written by Uzzi O. Raanan, a partner at Danning, Gill, Israel & Krasnoff, LLP, located in Los Angeles, California, who is a member of the ad hoc group and the representative from the Business Law Section (BLS) to the CLA’s Board of Representatives. Editorial contributions were made by the Honorable Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), also a member of the ad hoc group. Thomas Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomas Reuters.

Best regards,
Insolvency Law Committee

Co-Chair
Kyra E. Andrassy
Smiley Wang-Ekvall, LLP
kandrassy@swelawfirm.com

Co-Chair
Gary B. Rudolph
Sullivan Hill Rez & Engel, APLC
rudolph@sullivanhill.com

Co-Vice Chair
Michael W. Davis
Brutzkus Gubner Rozansky Seror Weber LLP
mdavis@bg.law

Co-Vice Chair
Michael J. Gomez
Frandzel Robins Bloom & Csato, L.C.
mgomez@frandzel.com

By Sonia Singh and Zev Shechtman

In Mission Product Holding, Inc. v. Tempnology, LLC, resolving a circuit split, the Supreme Court determined that a licensor’s choice to reject an executory trademark license agreement under 11 U.S.C. § 365(a) functions as a breach of contract, not a rescission.  The decision established an important precedent in the interpretation of executory contracts under the Bankruptcy Code.

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December 13, 2019 Dear constituency list members of the Insolvency Law Committee: On August 23, 2019, President Trump signed the Small Business Reorganization Act of 2019 (“SBRA”) into law. The SBRA is scheduled to take effect on February 19, 2020. Generally, the SBRA does two things. First, it creates a new subchapter within chapter 11 for “small business debtor reorganization” cases. These changes to the Bankruptcy Code are summarized in an ILC e-Bulletin prepared by former ILC Chair Robert Harris. You can read his e-bulletin here. Second, the SBRA amends 11 U.S.C. § 547(b) and 28 U.S.C. § 1409(b) to curb perceived abuses by trustees of their ability to avoid and recover preferential transfers. The amendment to section 547(b) of the Bankruptcy Code forces a trustee (or a debtor in possession, committee, or other person exercising the rights of a trustee) to evaluate the transferee’s potential defenses before filing suit. The amendment to section 1409(b) of the Judicial Code – which deals with venue of certain bankruptcy proceedings – purports to force the plaintiff to file the suit in the preference defendant’s home district if the plaintiff is seeking to recover less than $25,000. This e-bulletin addresses these two changes. Genesis of Amendments to 11 U.S.C. § 547(b) and 28 U.S.C. § 1409(b) The House Judiciary Committee’s report on H.R. 3311 states that the SBRA was largely derived from recommendations developed by the National Bankruptcy Conference (“NBC”) and the American Bankruptcy Institute (“ABI”). The revisions to 11 U.S.C. § 547(b) and 28 U.S.C. § 1409(b) appear to have derived from a 2014 report of the ABI’s Commission to Study the Reform of Chapter 11 (the “ABI Report”). Thus, the ABI Report is helpful to an understanding of the amendments affecting (or purporting to effect) preference claims. Amendment to 11 U.S.C. § 547(b) Section 547(b) provides that, except as provided in section 547(c) and (i), “the trustee may avoid any [preferential] transfer of an interest of the debtor in property.” A plaintiff has the burden of proving the avoidability of the transfer under section 547(b), and a defendant has the burden of proving the nonavoidability of the transfer under section 547(c). 11 U.S.C. § 547(g). The ABI Report sought to address concerns that trustees pursue preference actions with little diligence and without regard to the merits of the claims. The Commission rejected several proposals, including one that would have created a presumption in favor of the creditor that the prepetition transfer was made in the ordinary course of business, which the plaintiff could rebut as part of its prima facie case. The Commission ultimately determined that codifying a standard that requires plaintiffs to perform reasonable due diligence and make good faith efforts to evaluate the merits of preference claims was a reasonable compromise. In line with the Commission’s recommendation, the SBRA amends section 547(b) to provide that “the trustee may, based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses under subsection (c), avoid any [preferential] transfer of an interest of the debtor in property.” Arguably, this language creates two new elements that must be established to prevail on a preference claim. As a matter of statutory construction, the word “and” signifies that the first new element (due diligence) is distinct from the second (consideration of potential affirmative defenses). Otherwise, Congress would have used the word “including” instead of the conjunctive “and.” First, before filing the complaint, the plaintiff must conduct “reasonable due diligence in the circumstances of the case.” It is unclear what this first element entails. For example, can a plaintiff rely on the Statement of Financial Affairs or the debtor’s accounting software, or must the plaintiff independently review bank records and copies of checks to confirm the information? Is the plaintiff required to review invoices to confirm that a transfer was made to or for the benefit of a creditor, or for or on account of an antecedent debt? Second, the plaintiff must take the defendant’s affirmative defenses into account. This is the primary purpose of the amendment to section 547(b). Quite simply, the plaintiff must conduct at least some analysis of a transferee’s “contemporaneous exchange,” “ordinary course” and “new value” defenses (as well as other potential defenses). Some commentators predict that a plaintiff’s due diligence and analysis of defenses will start with a demand letter, requesting either (a) repayment or (b) information and documentation supporting statutory defenses. In this regard, it is noteworthy that the ABI Report contained the following recommendation: “The trustee should be precluded from issuing a demand letter to, or filing a complaint against, any party for an alleged claim under section 547 unless . . . .” Thus, at least in the eyes of the ABI Commission, plaintiffs should conduct their due diligence and analysis before making any demands. It also is important to note that the new elements appear in section 547(b). This means that they must be (a) adequately pled and (b) proven at trial. What happens if a plaintiff files a slam-dunk preference claim to which the defendant has no legitimate defense, but the court determines that the plaintiff failed to perform reasonable due diligence and/or attempt to determine ahead of time whether a defense existed? Arguably, the plaintiff should lose. Another dilemma exists because preference claims, and potential defenses, are often evaluated by the plaintiff’s attorneys and accountants. Will the analyses and advice given by attorneys and accountants to the plaintiff be discoverable? Further, will the submission of evidence regarding the plaintiff’s due diligence and analysis of defenses waive privilege regarding such matters? Amendment to 28 U.S.C. § 1409(b) Section 1334(b) of title 28 provides that district courts have original, non-exclusive jurisdiction over bankruptcy proceedings. That section divides bankruptcy proceedings into three categories: (1) proceedings “arising under” the Bankruptcy Code, (2) proceedings “arising in” cases under the Bankruptcy Code, and (3) proceedings “related to” cases under the Bankruptcy Code. Section 1409 of title 28 dictates where these three types of bankruptcy proceedings may be filed. Section 1409(a) sets forth the general rule: Except as provided elsewhere in the statute, “a proceeding arising under title 11 or arising in or related to a case under title 11 may be commenced in the district court in which such case is pending.” Thus, the general rule applies to all three categories of proceedings. Section 1409(b) establishes some exceptions: Except as provided in subsection (d) of this section, a trustee in a case under title 11 may commence a proceeding arising in or related to such case to recover a money judgment of or property worth less than $1,375 or a consumer debt of less than $20,450, or a debt (excluding a consumer debt) against a noninsider of less than $13,650, only in the district court for the district in which the defendant resides. This exception applies only to two of the three categories of proceedings. Proceedings “arising under” the Bankruptcy Code are not included within section 1409(b). BAPCPA’s legislative history strongly suggests that the $13,650 threshold (which was originally $10,000 but adjusts upward every three years) was intended to apply to preference actions. Commentators recognized at the time that Congress was trying to stop the practice of filing small preference actions against defendants who have no connection to the district in which the bankruptcy case is pending. Many courts and commentators also pointed out that Congress made a mistake when it added the phrase italicized above. Preference actions fall within the first category of proceedings listed in section 1409(a) – those “arising under” the Bankruptcy Code. But the exceptions in 1409(b) apply only to the other two categories of proceedings. Therefore, Congress tried to impose a $10,000 threshold on preference actions by inserting language into a statute that does not actually apply to preference actions. Even if section 1409(b) applied to proceedings “arising under” the Bankruptcy Code, it still is not clear that the threshold would apply to preference actions. Section 547(b) allows a trustee to avoid a transfer. Section 550 allows the trustee to recover the property transferred or the value thereof. Arguably, an action to avoid a transfer and recover property (or its value) is not an action “to recover . . . a [non-consumer] debt.” This problem has persisted for over 13 years. In fact, just this year the ILC published an e-bulletin discussing Klein v. ODS Technologies, LP (In re J & J Chemical, Inc.), Adv. No. 18-08029-JDP (Bankr. D. Idaho Jan. 11, 2019), in which the bankruptcy court reiterated that section 1409(b) does not apply to claims “arising under” the Bankruptcy Code. The ABI Report recognized the problem. The Commission recommended that section 1409(b) be amended to (i) clarify that the small claims venue provision applies to preference actions, and (ii) increase the threshold to $50,000. The SBRA provided Congress a perfect opportunity to fix its prior mistake. Congress could have created a new section 1409(f) to deal specifically with preference actions. Or it could have revised section 1409(b) to provide that all of the exceptions in that subsection apply to proceedings “arising under” the Bankruptcy Code. Or Congress could have revised section 1409(b) to expressly say that it covers preference actions (but no other “arising under” actions). The SBRA does none of these things. It simply increases the current $13,650 threshold to $25,000 (subject to periodic increases based on the Consumer Price Index). It is unclear why Congress did not follow the ABI Commission’s recommendation to clarify that the non-consumer debt threshold in section 1409(b) applies to preference actions. What is clear is that Congress thinks that the provision already applies to preference actions. This is reflected by the House Judiciary Committee’s report: The bill also includes two provisions . . . pertaining to preferential transfers. . . . The second provision concerns the venue where such preferential transfer actions may be commenced. Current law requires this type of action to be commenced in the district where the defendant resides if the amount sought to be recovered by the action is less than $13,650. H.R. 3311 would increase this monetary limit to $25,000. As a result, even after the SBRA, courts still will be required to make a choice. Follow the plain language of the statute? Or read the statute consistent with the clear intent of Congress? These materials were written by former ILC Chair John N. Tedford, IV, of Danning, Gill, Israel & Krasnoff, LLP, in Los Angeles, California (jtedford@DanningGill.com). Editorial contributions were provided by Robert G. Harris, a partner in the Silicon Valley bankruptcy law firm Binder & Malter, LLP (rob@bindermalter.com). Thank you for your continued support of the Committee. Best regards, Insolvency Law Committee Co-Chair Kyra E. Andrassy Smiley Wang-Ekvall, LLP kandrassy@swelawfirm.com Co-Chair Gary B. Rudolph Sullivan Hill Rez & Engel, APLC rudolph@sullivanhill.com Co-Vice Chair Michael W. Davis Brutzkus Gubner Rozansky Seror Weber LLP mdavis@bg.law Co-Vice Chair Michael J. Gomez Frandzel Robins Bloom & Csato, L.C. mgomez@frandzel.com

August 16, 2019

Dear constituency list members of the Insolvency Law Committee, the following is a case update analyzing a recent case of interest:

SUMMARY

In Hugger v. Warfield (In re Hugger), 2019 WL 1594017 (9th Cir. BAP Apr. 5, 2019), the U.S. Bankruptcy Appellate Panel of the Ninth Circuit (the “BAP”) affirmed an order denying a chapter 7 debtor’s request that the bankruptcy court vacate his own discharge and dismiss his case because he had filed the case too soon to discharge $40,000 of taxes. To read the full unpublished decision, click here.

FACTS

In September 2015, Anthony Hugger (the “Debtor”) filed tax returns for seven years ranging from 2001 through 2012. For those years, he owed approximately $40,000 in taxes. On January 9, 2017, the Debtor filed a chapter 7 petition. On May 9, 2017, the U.S. Bankruptcy Court for the District of Arizona (the “Bankruptcy Court”) entered the Debtor’s discharge. A few days later, the case was closed as a no-asset case.

The timing of the filing of the bankruptcy case is important because, under Section 523(a) of the Bankruptcy Code, an individual’s discharge does not discharge “any debt (1) for a tax . . . (B) with respect to which a return . . . (ii) was filed or given after the date on which such return . . . was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition.” Thus, if an untimely return is filed within two years prepetition, the tax with respect to which the return was filed will not be discharged.

Presumably after the case was closed, the Debtor discovered that he had filed his petition too early. To discharge the $40,000 in taxes, he should have waited to file his petition until two years after he filed the returns.

In September 2017, the Debtor filed a motion to vacate the discharge and dismiss the case. He contended that he had filed for bankruptcy only to deal with his tax obligations (his unsecured non-tax debts totaled $569) and, therefore, he had not been granted a fresh start. He also argued that the Bankruptcy Court had the equitable authority to grant relief under section 105 of the Bankruptcy Code.

The chapter 7 trustee and the Arizona Department of Revenue (“ADOR”) opposed the motion. They argued, among other things, that a debtor lacks standing to revoke his or her own discharge. ADOR also argued that the Debtor failed to show that dismissing the chapter 7 case would not prejudice creditors.

At the hearing on the motion, the Debtor’s counsel admitted that he made a mistake by filing the Debtor’s case too early. He acknowledged that the purpose of the motion was to allow the Debtor to file a new chapter 7 case to discharge the taxes. He argued that the Bankruptcy Court could grant the motion under Federal Rule of Civil Procedure (“FRCP”) 60, made applicable by Federal Rule of Bankruptcy Procedure 9024.

The Bankruptcy Court denied the motion. On appeal, the BAP affirmed.

REASONING

The Debtor apparently conceded on appeal that: (a) he lacked standing to revoke his own discharge under section 727(d); and (b) the Bankruptcy Court lacked equitable power under section 105(a) to revoke a discharge on request of a debtor. Therefore, the BAP examined whether the Bankruptcy Court abused its discretion when it denied the Debtor’s request for relief under FRCP 60.

The Debtor argued that relief was warranted under FRCP 60(b)(1) – “mistake, inadvertence, surprise, or excusable neglect.” However, the BAP stated that FRCP 60(b)(1) may not be used to remedy attorney error. The BAP further stated that a chapter 7 debtor seeking to dismiss his case has the burden to show that doing so will not result in “legal prejudice” to creditors. The BAP then rejected the Debtor’s argument that the taxing authorities would not be prejudiced by dismissal of the case since they could still attempt to collect the taxes until such time that the Debtor files a new chapter 7 petition.

The BAP also examined whether relief would be appropriate under FRCP 60(b)(6) – “any other reason that justifies relief.” Although the Debtor urged the BAP to adopt the analysis in In re Estrada, 568 B.R. 533 (Bankr. C.D. Cal. 2017), which vacated a debtor’s discharge under FRCP 60(b)(6), in that case the debtor proposed to convert his case to chapter 13 to pay creditors in full through a plan. In contrast, the BAP noted, in this case the Debtor was seeking relief to discharge his taxes, not pay them.

AUTHOR’S COMMENTARY

An easy takeaway from Hugger is that a debtor’s attorney needs to evaluate whether a bankruptcy filing actually will accomplish the debtor’s goal(s). If the goal is to discharge a debt, make sure the debt is actually dischargeable.

In that regard, even if the Bankruptcy Court granted the motion and the Debtor had filed a new chapter 7 petition, it is not certain that the taxes would be discharged. In this circuit, late-filed Form 1040s and state equivalents are not “returns” for purposes of section 523(a)(1)(B) if they do not represent “an honest and reasonable attempt to satisfy the requirements of the tax law.” See Smith v. U.S. (In re Smith), 828 F.3d 1094 (9th Cir. 2016); U.S. v. Hatton (In re Hatton), 220 F.3d 1057 (9th Cir. 2000). A “belated acceptance of responsibility” is not an honest and reasonable attempt to comply with the tax code. Smith, 828 F.3d at 1097. Thus, under current Ninth Circuit law, it is very possible that: (a) the Debtor’s late tax filings would not qualify as “returns”; and (b) the taxes never would be discharged because they are taxes “with respect to which a return, or equivalent report or notice . . . was not filed or given.” See 11 U.S.C. § 523(a)(1)(B)(i). Smith and a similar BAP decision, U.S. v. Martin (In re Martin), 542 B.R. 479 (9th Cir. BAP 2015), were the subject of an ILC e-Bulletin published on October 26, 2016.

Finally, a curious fact, not noted in the BAP’s decision, is that the Debtor commenced his case by filing an emergency petition – i.e., a petition without schedules, statement of financial affairs (“SOFA”), or other required documents. After obtaining an extension, the Debtor filed his schedules and other documents 24 days after the petition date, and he did not file a completed SOFA until 77 days after the petition date. The Debtor must have had a reason for filing his petition when he did – possibly related to an IRS garnishment referred to in the SOFA – and likely benefitted from the automatic stay that took immediate effect. Thus, while the Debtor may not have fully received a “fresh start,” he probably did achieve some respite by filing for bankruptcy when he did.

These materials were written by John N. Tedford, IV, of Danning, Gill, Diamond & Kollitz, LLP, in Los Angeles (jtedford@dgdk.com). Editorial contributions were provided by Jessica Mickelsen Simon of Hemar, Rousso & Heald, LLP in Encino, California.

Thank you for your continued support of the Committee.

Best regards,
Insolvency Law Committee

Co-Chair
Marcus O. Colabianchi
Duane Morris LLP
MColabianchi@duanmorris.com

Co-Chair
Rebecca J. Winthrop
Norton Rose Fulbright US LLP
rebecca.winthrop@nortonrosefulbright.com

Co-Vice Chair
Kyra E. Andrassy
Smiley Wang-Ekvall, LLC
kandrassy@swelawfirm.com

Co-Vice Chair
Gary B. Rudolph
Sullivan Hill Rez & Engel, APLC
rudolph@sullivanhill.com

June 24, 2019

Dear constituency list members of the Insolvency Law Committee, the following is a case update.

Summary

In Easley v. Collection Serv. of Nev., 910 F.3d 1286 (9th Cir. 2018), the United States Court of Appeals for the Ninth Circuit (the “Ninth Circuit”) expanded the holding in In re Schwartz-Tallard, 803 F. 3d 1095 (9th Cir. 2015) (en banc), to mean that debtors are entitled to recover appellate attorneys’ fees when successfully challenging an initial award of fees and costs awarded to them under section 362(k) for a willful violation of the automatic stay, not only when defending such award. To read the full published decision, click here.

Facts

Appellants, chapter 13 debtors (“Debtors”), scheduled a hospital as a general unsecured creditor in the amount of $3,535, but the debt had previously been assigned to appellee Collection Service of Nevada (“Appellee”). Unaware of the bankruptcy, Appellee pursued collection of the debt. Appellee eventually initiated garnishment of one of the Debtors’ wages, prompting Debtors’ counsel to demand a stop to the garnishment in light of the bankruptcy. Wages were garnished four times before Appellee caused the employer and constable to stop garnishing.

Debtors brought a contempt motion against Appellee. The bankruptcy court granted the motion and awarded $1,295 in damages and $1,277 in attorneys’ fees and costs. Debtors appealed the award to the district court on the grounds that the bankruptcy court erred in failing to account for several days of attorneys’ fees incurred in connection with remedying the stay violation. The district court affirmed the damage award, but remanded to the bankruptcy court to re-review the award of legal fees in light of the Ninth Circuit’s then-recent ruling in In re Schwartz-Tallard, 803 F.3d 1095 (9th Cir. 2015) (en banc), holding that a debtor is entitled to additional attorneys’ fees for defending an appeal of an award of damages for violation of the automatic stay. After remand from the district court, the bankruptcy court awarded additional attorneys’ fees for the prosecution of the underlying motion, but refused to grant an award for fees and costs incurred on the appeal to the district court because Debtors had already sought a similar award from district court and that request remained pending.

The district court denied the Debtors’ motion for attorneys’ fees and costs on appeal based on a failure to file adequate points and authorities as required under local rules or, alternatively, based on its reading of Schwartz-Tallard. The district court held that Schwartz-Tallard only supports payments of attorneys’ fees and costs under section 362(k) for defending a sanctions award on appeal, but not for prosecuting the appeal to challenge the judgment or order. The Ninth Circuit reversed on both grounds.

Reasoning

First, procedurally, the Ninth Circuit found that the district court abused its discretion when it determined that the points and authorities filed by Debtors were inadequate. It found, contrary to the district court, that Debtors provided sufficient information to support Debtors’ factual contentions.

Second, the Ninth Circuit reversed on substantive grounds. Section 362(k)(1) provides that:

an individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages

11 U.S.C. § 362(k)(1).

The court explained that prior to Schwartz-Tallard, the court interpreted section 362(k)(1) as “limiting attorneys’ fees and costs awards to those incurred in stopping a stay violation.” Sternberg v. Johnston, 595 F.3d 937, 947 (9th Cir. 2010) (emphasis added). In Schwartz-Tallard, the court overruled Sternberg. Schwartz-Tallard made it clear that attorneys’ fees for “prosecuting an action for damages” under section 362(k) are recoverable. While the district court found that the holding of Schwartz-Tallard was limited to awarding fees for defense of an appeal of attorneys’ fees, in its reversal the Ninth Circuit clarified that attorneys’ fees may also be awarded for debtors’ successful prosecution of an appeal of an award of damages under section 362(k). The court reiterated its reasoning in Schwartz-Tallard that the award of attorneys’ fees for prosecuting an action for damages is consistent with the intent of Congress to provide appropriate means and incentives for debtors to pursue actions for violations of the automatic stay. Further, the court found that its ruling is consistent with its prior decisions on other fee-shifting statutes granting awards of attorneys’ fees for successfully challenging an initial judgment. The Ninth Circuit also reasoned that section 362(k) is critically important to debtors in bankruptcy who typically do not have the resources to hire private counsel and, thus, section 362(k) should be interpreted as seeking to make debtors whole (as if the violation never occurred), if possible.

Author’s Commentary

The decision in Easley serves as a reminder that the financial consequences for a violation of the automatic stay may be severe. Appellee appears to have been owed less than $4,000, caused less than $1,300 in actual damages, but might be required to pay tens of thousands of dollars to the Debtors because it did not act swiftly enough to stop the stay violation and, apparently, refused to return the money that was garnished. Prudent creditors should exercise caution with debtors who have filed for bankruptcy protection, seek relief from stay when in doubt, and quickly end any stay violations and reverse any adverse consequences that resulted from their actions. Otherwise, where creditors willfully violated the automatic stay, they should be prepared to settle and pay quickly to avoid incurring additional losses. Vigilant debtors and their attorneys should also take note that, under the combined precedents of Schwartz-Tallard and Easley, the law is increasingly on their side when it comes to recovering attorneys’ fees and costs incurred in successful appeals of rulings under section 362(k), whether they are defending or challenging the decision on appeal.

These materials were written by Zev M. Shechtman, of Danning, Gill, Diamond & Kollitz, LLP, in Los Angeles (zshechtman@dgdk.com), with editorial contributions from ILC members Michael W. Davis of Brutzkus Gubner Offices in Woodland Hills. (mdavis@bg.law), and Hon. Meredith A. Jury (ret.).

Best regards,
Insolvency Law Committee

Co-Chair
Marcus O. Colabianchi
Duane Morris LLP
mcolabianchi@duanemorris.com

Co-Chair
Rebecca J. Winthrop
Norton Rose Fulbright US LLP
rebecca.winthrop@nortonrosefulbright.com

Co-Vice Chair
Kyra E. Andrassy
Smiley Wang-Ekvall, LLP
kandrassy@swelawfirm.com

Co-Vice Chair
Gary B. Rudolph
Sullivan Hill Rez & Engel, APLC
rudolph@sullivanhill.com

March 18, 2019

Dear constituency list members of the Insolvency Law Committee, the following is a recent case update.

SUMMARY

On January 16, 2019, the California Supreme Court granted the request of the U.S. Court of Appeals for the Ninth Circuit to decide questions of California law relevant to the Ninth Circuit’s determination of Brace v. Speier (In re Brace), No. 17-60032 (9th Cir.). The question presented by the Ninth Circuit is whether the “form of title” presumption in California Evidence Code section 662 overcomes the presumption in California Family Code section 760 that all property acquired by a married person during marriage is community property.

To read the Ninth Circuit’s Order Certifying Question to the Supreme Court of California, click here.

BACKGROUND

Clifford and Ahn Brace were married in 1972. In the late 1970s, they purchased a home in Redlands. At some point they also purchased a rental property in San Bernardino. They took title to each property as “husband and wife as joint tenants.”

In 2011, Mr. Brace filed for bankruptcy. After some preliminary legal issues were resolved, the bankruptcy court needed to decide whether the bankruptcy estate owned 100%, or just 50%, of each property. In 2015, the bankruptcy court entered a judgment in favor of the chapter 7 trustee determining that the properties were community property and, therefore, entirely property of the bankruptcy estate. See 11 U.S.C. § 541(a)(2). In a published decision, the U.S. Bankruptcy Appellate Panel of the Ninth Circuit affirmed. Brace v. Speier (In re Brace), 566 B.R. 13 (9th Cir. BAP 2017). The BAP’s decision was the subject of an ILC e-Bulletin authored by Michael W. Davis and published on October 16, 2017.

QUESTIONS PRESENTED TO THE CALIFORNIA SUPREME COURT

In California, there is a statutory presumption that property acquired by a married person during the marriage while domiciled in California is community property. See Cal. Fam. Code § 760. By written agreement, spouses can “transmute” community property into separate property of either spouse. See Cal. Fam. Code §§ 850-853.

Separately, California’s Evidence Code contains a series of presumptions which dictate which party has the initial burden of providing evidence or proving certain facts. Evidence Code section 662 provides that “[t]he owner of the legal title to property is presumed to be the owner of the full beneficial title.” This is sometimes referred to as the “title presumption.”

In 2003, the Ninth Circuit held that the community property presumption is rebutted when spouses acquire real property from a third party as joint tenants, and that there is a rebuttable presumption that “‘where the deed names the spouses as joint tenants . . . the property [is] in fact held in joint tenancy.’” Hanf v. Summers (In re Summers), 332 F.3d 1240, 1243-44 (9th Cir. 2003) (quoting Hansen v. Hansen, 233 Cal.App.2d 575, 594 (1965)). The Ninth Circuit also held that California’s transmutation statutes do not apply to transactions in which spouses acquire property from third parties because there is “no interspousal transaction requiring satisfaction of the statutory formalities.” Id. at 1245.

The second holding of Summers was expressly rejected by the California Supreme Court in Marriage of Valli, 58 Cal.4th 1396 (2014). In that case, a husband used community property funds to purchase an insurance policy on his life, naming his wife as the policy’s owner and beneficiary. Later, in divorce proceedings, the husband asserted that the policy was community property. The California Supreme Court agreed, because the husband had not made, joined in, consented to, or accepted a written, express declaration that the character or ownership of the insurance policy was being changed from community property to the wife’s separate property. The court expressly stated that the title presumption “does not apply when it conflicts with the transmutation statutes.” Valli, 58 Cal.4th at 1406.

The ultimate issue in Brace is whether the debtor’s act of taking title to the real properties as a joint tenant with his spouse rebuts the community property presumption or qualifies as an effective transmutation. To assist in addressing this issue, the Ninth Circuit certified the following question to the California Supreme Court:

Does the form of title presumption set forth in section 662 of the California Evidence Code overcome the community property presumption set forth in section 760 of the California Family Code in Chapter 7 bankruptcy cases where: (1) the debtor husband and non-debtor wife acquire property from a third party as joint tenants; (2) the deed to that property conveys the property at issue to the debtor husband and non-debtor wife as joint tenants; and (3) the interests of the debtor and non-debtor spouse are aligned against the trustee of the bankruptcy estate?

On January 16, 2019, the California Supreme Court granted the Ninth Circuit’s request to decide the question presented. (The Ninth Circuit’s phrasing of the question does not restrict the California Supreme Court’s consideration of the issues involved; the court may restate the question. Cal. R. Ct. 8.548(f)(5).) Briefing in the California Supreme Court is ongoing.

AUTHOR’S COMMENTARY

When spouses purchase a home in California, they usually don’t give much thought as to how title should be held. Historically, spouses have taken title as joint tenants so that, when one spouse dies, the ownership interest of the deceased spouse automatically transfers to the surviving spouse. This “right of survivorship” is convenient because it avoids the need for a probate. But most people don’t realize that if the joint tenancy is given full effect each spouse separately owns a one-half interest in the property and has the power to transfer his or her one-half interest without the other spouse’s consent. Obviously, this is not what most spouses intend when they buy a family home. The Ninth Circuit’s certification reflects how difficult it is to apply Valli in this context.

Assuming that the California Supreme Court does not modify the question presented, I believe that it will rule that the “form of title presumption” does not overcome the “community property presumption.” Family Code section 760 provides that “[e]xcept otherwise provided by statute,” all property acquired by a married person during marriage while domiciled in California is community property. Sections 770 through 853 contain various exceptions to this rule.

Evidence Code section 662 establishes only an evidentiary presumption. “A presumption is not evidence.” Cal. Evid. Code § 660. A presumption affecting the burden of proof (such as section 662) imposes “upon the party against whom it operates the burden of proof as to the nonexistence of the presumed fact.” Cal. Evid. Code § 606. It does this to implement “some public policy other than to facilitate the determination of the particular action in which the presumption is applied . . . such as the policy in favor of . . . the stability of titles to property.” Cal. Evid. Code § 605. Evidence that property was acquired by spouses during marriage, thus implicating Family Code section 760, should be sufficient to overcome the evidentiary presumption. Also, in Valli, the California Supreme Court confirmed that the form of title presumption “does not apply when it conflicts with the transmutation statutes” in Family Code sections 850-853.

The fact that the interests of the debtor and non-debtor spouse are aligned against the trustee should not have any bearing on the outcome. The Ninth Circuit included this fact within the certified question because the appellants seized on a comment in Justice Chin’s concurrence in Valli that language in Family Code section 2581 (which applies in the context of divorce and separate proceedings) “suggests that rules that apply to an action between the spouses to characterize property acquired during the marriage do not necessarily apply to a dispute between a spouse and a third party.” However, since the estate’s rights in property derive directly from the rights held by the debtor on the petition date, the trustee is not truly a third party. See 11 U.S.C. § 541(a). Further, query whether the debtor even has standing to appeal (and thus align himself with his wife against the trustee) given his argument that he has no legal or beneficial interest in his wife’s allegedly separate ownership interest in the property. Indeed, by involving himself in the dispute, the debtor is arguably violating his duty to cooperate with the trustee to enable the trustee to expeditiously administer property of the estate. See 11 U.S.C. §§ 521(a)(3), 704(a).

Regardless of how it answers the Ninth Circuit’s question, the California Supreme Court’s answer will have a significant impact on cases in which only one spouse files for bankruptcy. If the California Supreme Court’s decision formally abrogates the Ninth Circuit’s first holding in Summers, it will confirm that trustees may sell properties held by spouses as joint tenants and, subject to debtors’ exemptions, distribute all of the sale proceeds to creditors. In some cases, the answer will determine whether creditors receive anything at all.

These materials were written by John N. Tedford, IV, of Danning, Gill, Diamond & Kollitz, LLP, in Los Angeles (jtedford@dgdk.com). Editorial contributions were provided by the Hon. Judge Meredith A. Jury (ret.).

Best regards,
Insolvency Law Committee

Co-Chair
Marcus O. Colabianchi
Duane Morris LLP
mcolabianchi@duanemorris.com

Co-Chair
Rebecca J. Winthrop
Norton Rose Fulbright US LLP
rebecca.winthrop@nortonrosefulbright.com

Co-Vice Chair
Kyra E. Andrassy
Smiley Wang-Ekvall, LLP
kandrassy@swelawfirm.com

Co-Vice Chair
Gary B. Rudolph
Sullivan Hill Rez & Engel, APLC
rudolph@sullivanhill.com