In re Rexford Properties, LLC, ___BR___, 2016 Westlaw 5416443 (Bankr. C.D.Cal.2016)
In re Rexford Properties, LLC, ___BR___, 2016 Westlaw 5416443 (Bankr. C.D.Cal.2016): A bankruptcy court in California has held that the separate classification of a group of trade creditors in a Chapter 11 plan had to be based on a “legitimate business or economic justification,” but the debtor did not have to show that the special treatment of that group was “critical, essential, or necessary” to the reorganization. [.]
FACTS: A Chapter 11 debtor negotiated a reorganization plan, under which certain of its unsecured creditors (primarily trade creditors) would be separately classified. The members of that class would be paid in full, provided that they promised to continue providing goods and services to the reorganized debtor on terms and conditions that were no less favorable than before the reorganization. Prior to seeking formal plan confirmation, the debtor brought a motion under Federal Rule of Bankruptcy Procedure 3013, seeking an advanced determination that its classification scheme was appropriate.
One of the debtor’s largest unsecured creditors, which was not part of that special class, objected to the motion on the ground that preferential treatment for the class members was not “critical, essential, or necessary” to the reorganization. The debtor argued that as long as the separate classification and the separate treatment were supported by a “legitimate business or economic justification,” the classification scheme was permissible.
REASONING: The court ruled in favor of the debtor but noted that there was no controlling Ninth Circuit authority that was exactly on point. Citing In re Johnston, 21 F.3d 323 (9th Cir. 1994), and In re Barakat, 99 F.3d 1520 (9th Cir. 1996), the court observed that “[s]ubstantially similar claims may be classified separately if there is a ‘legitimate business or economic justification’ for doing so:
The Court concludes that when a plan proposes separate classification of trade vendor claims in order to provide preferential treatment to those claims, a “legitimate business or economic justification” is established when (i) the vendors provide genuine operational or financial benefits to the debtor and (ii) the preferential treatment of vendor claims is reasonably calculated to induce the continued support of those vendors.
The court noted that the higher standard proposed by the objecting party went beyond the language of Barakat, supra:
A legal standard permitting separate classification of substantially similar claims only where the claims are “critical,” “essential,” or “necessary” would go far beyond the requirement of a legitimate business or economic justification. Use of these terms would suggest that separate classification is justified only when it is proven that a debtor’s reorganization will not succeed without it . . . . The requirement of a “legitimate business or economic justification” does not impose such a high bar. If the Ninth Circuit had intended to do so, it certainly would not have held that a legitimate justification would suffice to permit the separate classification of substantially similar claims . . . . Instead, it would have held that such classification is permitted only when necessary to achieve the debtor’s reorganization.
The court also observed that the stricter “necessity” standard would pose evidentiary and procedural problems:
[A] necessity standard would not be practicable. There is no question that when a debtor seeks to provide preferential treatment to a group of otherwise similar claims, it is necessary to separately classify those claims . . . . But how does a debtor show that the preferential treatment (i.e., the premise for the separate classification) is truly necessary (i.e., “inescapable,” “unavoidable,” “compulsory,” “absolutely needed” and “required”)? To meet such a standard-logically speaking- the debtor would need to demonstrate (1) the vendor provides necessary goods and services that are not available from alternative vendors, or that are not otherwise available on terms and conditions that will permit the business to reorganize and (2) the vendor will stop providing those goods and services or favorable terms after confirmation of a plan that does not include the preferential treatment of its claim.
The first proposition is readily capable of proof, but the second proposition is problematic. First, bankruptcy courts do not have a crystal ball. They do not predict what will or will not happen in the future. At best, they make reasoned judgments about the likelihood of future events based on existing circumstances and historical facts . . . . Second, as a matter of proof, it is inherently difficult to establish what a vendor will or will not do in the future. A vendor might be willing to testify that its continued support of the debtor depends on the proposed preferential treatment, but the self-serving nature of the testimony is not likely to yield a satisfying result. Any vendor asked whether preferential treatment of its prepetition claim is a prerequisite to its future support of the debtor is likely to say “yes.” And even if this were not the case, the debtor would face a substantial (perhaps insurmountable) burden in soliciting and presenting the testimony of potentially dozens or hundreds of vendors to demonstrate that the proposed treatment, in each instance, is necessary (i.e., “inescapable,” “unavoidable,” “compulsory,” “absolutely needed” and “required”) to obtain the continued support of those vendors.
The court went on to hold, however, that although the class of trade creditors, taken as a whole, qualified under the “legitimate business or economic justification” test, a few of the claimants included by the debtor in the class of trade creditors had to be excluded because the debtor had not presented sufficient evidence to show justification as to those particular creditors.
After determining that the separate classification of the trade creditors was justifiable, the court then ruled that those creditors would qualify as “impaired” for purposes of the cramdown provisions in the Bankruptcy Code, which require that at least one “impaired class” consent to the plan. The court noted that under In re L & J Anaheim Assocs., 995 F.2d 940 (9th Cir. 1993), any alteration of a creditor’s rights constitutes “impairment,” even if the value of the rights is enhanced:
The proposed Trade Class described in the present motion is clearly “impaired” within the meaning of section 1124. Under the proposed treatment of the Trade Class claims, the holders of trade claims will be provided payment equal to 100% of the allowed amount of their claims, but as a condition to such treatment they will be required to agree to continue providing goods and services to [the debtor] on terms and conditions no less favorable than currently provided. The imposition of this condition is an alteration of the rights of the holders of the claims in the Trade Class, even if the treatment overall results in full payment.
COMMENT OF ATTORNEY MARCH: Don’t count on higher courts agreeing with this decision. It guts the Bankruptcy Code’s classification scheme if creditors of same priority can be separately classified
For discussions of recent opinions involving related issues, see 2014-08 Comm. Fin. News. NL 17, New Value Chapter 11 Plan Requires Genuine Market Test, Lender’s Deficiency Claim Cannot Be Gerrymandered Where Guarantor is Insolvent, and Artificial Impairment Cannot Be Abusive; and 2012 Comm. Fin. News. 19, When Secured Lender Holds Non-Debtor Guarantees, Lender’s Unsecured Deficiency Claim May Be Separately Classified, Thus Enabling Debtor to Confirm Cramdown Plan Using a Separate Class of Impaired Consenting Unsecured Creditors.
[this case discussion, but NOT attorney March’s above comment, is from the California State Bar Insolvency Law Committee e-newsletter of 1/30/17}
Ho vs. ReconTrust Co., NA, 2016 Westlaw 6091564 (9th Cir. 2016)
SUMMARY: Ho vs. ReconTrust Co., NA, 2016 Westlaw 6091564 (9th Cir. 2016): Ninth Circuit Court of Appeals held that a foreclosure trustee’s notice of default sent to a borrower was not an attempt to collect a debt for purposes of the FDCPA.
FACTS: A consumer defaulted on her home loan. Acting on behalf of the lender, the trustee sent her a notice of default (“NOD”), in anticipation of foreclosure. The notice stated that she owed approximately $20,000 and that she “may have the legal right to bring [her] account in good standing by paying all of [her] past due payments.” The NOD also stated that the home “may be sold without any court action.” The trustee then recorded a notice of sale.
Borrower sued lender under the Fair Debt Collection Practices Act (“FDCPA”), stating that the NOD had misrepresented the amount of the debt. The district court granted the trustee’s motion to dismiss, and the Ninth Circuit affirmed.
REASONING: In a 2 to 1 opinion written by Judge Kozinski, the court reasoned that the trustee was simply seeking to proceed with the foreclosure in compliance with California law and was not attempting to collect a debt:
[The trustee] would only be liable if it attempted to collect money from [the borrower]. And this it did not do, directly or otherwise. The object of a nonjudicial foreclosure is to retake and resell the security, not to collect money from the borrower. California law does not allow for a deficiency judgment following non-judicial foreclosure. This means that the foreclosure extinguishes the entire debt even if it results in a recovery of less than the amount of the debt . . . . Thus, actions taken to facilitate a non-judicial foreclosure, such as sending the notice of default and notice of sale, are not attempts to collect “debt” as that term is defined by the FDCPA.
The prospect of having property repossessed may, of course, be an inducement to pay off a debt. But that inducement exists by virtue of the lien, regardless of whether foreclosure proceedings actually commence. The fear of having your car impounded may induce you to pay off a stack of accumulated parking tickets, but that doesn’t make the guy with the tow truck a debt collector.
The court acknowledged that its result was contrary to those of two other circuit court decisions, Glazer v. Chase Home Fin. LLC, 704 F.3d 453 (6th Cir. 2013), and Wilson v. Draper & Goldberg, P.L.L.C., 443 F.3d 373 (4th Cir. 2006). The court was particularly critical of the Glazer opinion:
The Sixth Circuit’s decision in Glazer rests entirely on the premise that”the ultimate purpose of foreclosure is the payment of money . . . .” But the FDCPA defines debt as an “obligation of a consumer to pay money . . . .”Following a trustee’s sale, the trustee collects money from the home’s purchaser, not from the original borrower. Because the money collected from a trustee’s sale is not money owed by a consumer, it isn’t “debt” as defined by the FDCPA.
The court carefully limited the scope of its opinion:
We do not hold that the FDCPA intended to exclude all entities whose principal purpose is to enforce security interests. If entities that enforce security interests engage in activities that constitute debt collection, they are debt collectors. We hold only that the enforcement of security interests is not always debt collection.
Later, the court invoked the underlying policy of the FDCPA to explain why the NOD was not a request for payment:
The notices at issue in our case didn’t request payment from [the borrower]. They merely informed [her] that the foreclosure process had begun, explained the foreclosure timeline, apprised her of her rights and stated that she could contact [the lender] . . . if she wished to make a payment. These notices were designed to protect the debtor. They are entirely different from the harassing communications that the FDCPA was meant to stamp out.
There was a strong and lengthy dissent by Judge Korman, arguing that the weight of authority supported the application of the FDCPA to the foreclosure trustee.
COMMENT: Less than two weeks before the decision in Ho was issued, the Fourth Circuit reaffirmed its holding in Wilson, supra, in McCray vs. Federal Home Loan Mortgage Corp., 2016 Westlaw 5864509 (4th Cir.). (For a discussion of McCray, see 2016 Commercial Finance Newsletter – – , Lender and Law Firm Seeking Foreclosure Are “Debt Collectors” Under FDCPA.) There is now an irreconcilable circuit split that requires Supreme Court review. I predict that certiorari will be granted in both of these cases and that the Supreme Court will agree with the Fourth Circuit.
I think that the Court will reason that one purpose of the NOD is to collect the debt. The mailing of an NOD tells the borrower that she has to pay up or else. Yes, it is true that the NOD does not expressly say “you must pay.” But it does say “if you do not pay, bad things will happen,” which is essentially the same thing. To use an ancient maxim in a new context, an NOD is as good as a wink.
I am certainly not saying that every NOD constitutes a violation of the FDCPA; the statute is violated only when a creditor engages in specific types of misconduct. But a creditor who violates the statute should not be able to hide behind the fact that the misbehavior was coupled with an effort to foreclose.
The counterargument, as articulated by Judge Kozinski, is that it would interfere with the foreclosure process, a creature of state law, to expose lenders to federal liability under the FDCPA. That is true, but I think that argument is overbroad. Many commercial transactions are governed by state law, often with a federal overlay, so that the creditor must comply with both sets of laws. That is the nature of federalism. See, e.g., Arizona v. United States, —U.S. —-, 132 S.Ct. 2492, 2500, 183 L.Ed.2d 351 (2012): “Federalism, central to the constitutional design, adopts the principle that both the National and State Governments have elements of sovereignty the other is bound to respect.”
Whether or not the Supreme Court overturns the Ninth Circuit on this issue, I am compelled to add that Judge Kozinski’s writing is always a pleasure to read. His prose is so clear and so refreshingly informal that his meaning shines through. Very few other judges are such powerful writers; Judges Posner and Easterbrook of the Seventh Circuit are in the same elite class. [as reported California State Bar Business Law Section Insolvency e-newsletter of 1/25/17]