In re Salamon, ___F.3d___, 2017 Westlaw 1404194 (9th Cir. 2017)
SUMMARY: In re Salamon, ___F.3d___, 2017 Westlaw 1404194 (9th Cir. 2017: The Ninth Circuit holds that when a vendor’s nonrecourse junior purchase money lien is extinguished by a senior creditor’s postpetition nonjudicial foreclosure sale, the “foreclosed-out” vendor could not assert a deficiency claim under Bankruptcy Code 11 USC §1111(b), even though the lien was in existence on the day the bankruptcy petition was filed. A creditor making the so-called “1111(b)” election is very rare in Chapter 11 bankruptcy cases, the only chapter where “1111(b)) elections are allowed. Now it will be even more rare.
The insolvency section of the California state bar, by Professor Dan Schector, has written a detailed analysis of the Salamon decision, as follows:
FACTS: A vendor of real property held a note secured by a junior purchase money trust deed on a parcel of commercial real estate. Following the vendor’s bankruptcy, his Chapter 7 trustee succeeded to the bankrupt vendor’s rights under the purchase money note and the junior deed of trust.
Later, the purchasers (the debtors under the note and deed of trust) filed their own Chapter 11 petition. The vendor’s trustee filed a secured proof of claim in the purchasers’ bankruptcy case.
The bank holding the senior lien on the apartment building was later granted relief from the automatic stay to conduct a nonjudicial foreclosure sale.
Under California law, the foreclosure sale automatically extinguished the vendor’s junior purchase money deed of trust. The vendor’s trustee filed an amended proof of claim in the purchasers’ bankruptcy case, seeking the unpaid balance.
When the purchasers objected to that claim, the vendor’s trustee argued that under 11 U.S.C.A. §1111(b)(1), he had the right to elect to be treated as an unsecured creditor because he held the purchasers’ nonrecourse note.
(Although the opinion does not explain why the vendor’s claim was nonrecourse, the vendor was barred from obtaining a deficiency judgment against the purchasers under Calif. Code of Civil Procedure §580b(a)(2).)
The bankruptcy court ruled in favor of the purchasers, the Ninth Circuit BAP affirmed, and so did the Ninth Circuit.
REASONING: On appeal, the vendor’s trustee argued that as of the date of the purchasers’ bankruptcy petition, he qualified under §1111(b)(1) because he held a nonrecourse claim against the purchasers, secured by a lien on the real property, even though that lien was later extinguished by the senior lender’s foreclosure. He reasoned that §1111(b) expressly incorporates §502(b), which requires that the nature of his claim had to be determined “as of the date of the filing of the petition.”
The court rejected that reasoning, distinguishing between the amount of the claim and its secured status: “Under §502, what must be determined as of the date of the filing of the petition is the amount of the claim.” Placing primary reliance on In re Tampa Bay Associates, Ltd., 864 F.2d 47 (5th Cir. 1989), the court held in favor of the purchasers:
[W]e hold that §1111(b)’s requirement that a creditor hold a “claim secured by a lien on the property of the estate” means that if a creditor’s claim, for any reason, ceases to be secured by a lien on property of the estate, the creditor can no longer transform a non-recourse claim into a recourse claim.
AUTHOR’S COMMENT: Although there is little chance that the trustee will seek certiorari (perhaps because the amount in controversy may not justify the expense), I think that the court reached the wrong result and misconstrued §502(b). Other than Tampa Bay (which I criticize below), there is no authority holding that any date other than the petition date would control the determination of the claim.
When Congress wants to depart from the petition date in the evaluation of a secured claim, it does so explicitly, as it did in § 506(a)(1), which controls the treatment of oversecured creditors: “Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest.”
There is no such exception to §502 in §1111(b).
Second, even without reference to §502, §1111(b) itself defines the circumstances under which the statute does not apply, and there are only two exceptions to the general rule:
(b)(1)(A) A claim secured by a lien on property of the estate shall be allowed or disallowed under section 502 of this title the same as if the holder of such claim had recourse against the debtor on account of such claim, whether or not such holder has such recourse, unless-
(i) the class of which such claim is a part elects, by at least two-thirds in amount and more than half in number of allowed claims of such class, application of paragraph (2) of this subsection; or
(ii) such holder does not have such recourse and such property is sold under section 363 of this title or is to be sold under the plan.
Focusing particularly on §1111(b)(1)(A)(ii), note that Congress specifically carved out two types of post-petition sales for special treatment: either a sale under § 363, or a sale under the plan. When it drafted that provision, Congress was obviously aware of post-petition foreclosure sales, yet foreclosure sales were excluded from that exception. See, e.g., Silvers v. Sony Pictures Entertainment, Inc., 402 F.3d 881, 887 (9th Cir. 2005): “[W]hen a statute designates certain persons, things, or manners of operation, all omissions should be understood as exclusions.” The Salamon court did not discuss the significance of the structure of §1111(b)(1)(A)(ii).
Finally, I believe that the court’s reliance on Tampa Bay, supra, may have been misplaced, for a couple of reasons. First, that case is factually distinguishable: it involved a creditor who itself had conducted a post-petition foreclosure and had later invoked §1111. That is very different from the present case, in which a junior creditor’s lien was extinguished by a senior creditor’s post-petition foreclosure. The destruction of the creditor’s lien in Tampa Bay resulted from a self-inflicted post-petition wound. The vendor’s lien in the present case was destroyed by someone else’s post-petition behavior.
More significantly, the reasoning in Tampa Bay is suspect. The court there held that post-petition foreclosure sales are implicitly encompassed within the”§363″ exception to § 1111(b) because foreclosure sales are “similar” to sales under § 363. The linchpin of the Tampa Bay policy-based analogy is that in both foreclosure sales and § 363 sales, “the creditor in each instance is allowed the opportunity to preserve the benefit of its bargain with the debtor by purchasing its collateral at a sale, with a credit offset allowed for any bid up to the full amount of the debt.”
That may be true of a creditor who conducts a foreclosure, as in Tampa Bay, but it is not true of a junior creditor bidding at a senior lender’s foreclosure sale. Under California law, a sold-out junior lien holder cannot submit a credit bid at a senior creditor’s foreclosure sale. See, e.g., Nomellini Const. Co. v. Modesto Sav. & Loan Ass’n, 275 Cal. App. 2d 114, 116, 79 Cal. Rptr. 717, 719 (3d Dist. 1969): “[W]here the sale is held pursuant to a power of sale in a trust deed …, and the bid is made by a junior lienholder who proposes to use the claimed balance of the junior paper as a part of the bid, the bid should be rejected by the trustee.”
It is also worth noting that the Tampa Bay court cited §502 and yet failed to focus on the language in § 502(b) requiring the court to “determine the amount of such claim …as of the date of the filing of the petition …” For all of these reasons, Tampa Bay was a badly-flawed opinion and does not merit the Ninth Circuit’s reliance on it.
The Salamon court’s decision to rely on post-petition events for purposes of §1111(b) is at odds with other Ninth Circuit authority holding that the petition date is generally controlling in a bankruptcy case. For example, see In re LCO Enterprises, 12 F.3d 938, 941 (9th Cir. 1993), a preference action:
[T]he amount and priority of an unsecured creditor’s claim is fixed on the date of the filing of the petition. Similarly, on the date of the filing, a secured creditor’s claim is fixed in amount, the value of the security as of that date can be ascertained and the claim will be either fully or partially secured.
Ironically, the LCO court then went on to carve out an ad hoc exception to the “petition date” rule where a lease had been assumed by the estate post-petition; but in In re Tenderloin Health, 849 F.3d 1231 (9th Cir. 2017), the Ninth Circuit recently limited LCO to its facts and reaffirmed the primacy of the “petition date” rule in the context of preferences.
My point is not that LCO and Tenderloin are controlling but that the petition date should usually be viewed as a watershed moment, unless there is a clear statutory mandate to depart from that rule. (For a more thorough discussion of Tenderloin, see 2017-11 Comm. Fin. News. NL 22, Debt Repayment Was Preferential Because Under “Hypothetical Liquidation” Rule, Other Funds Deposited by Debtor Could Have Been Avoided as Hypothetically Preferential.)
From a policy standpoint, haven’t sold-out junior vendors suffered enough, without also depriving them of the ability to invoke §1111(b)? In the context of a commercial development, what is the reason for such harsh treatment? The purchaser of the property, the bankrupt debtor, gets to enjoy a “heads I win, tails you lose” bargain, at least in a state (like California) that forbids most commercial vendors from obtaining recourse from the purchaser. If the property is a success, the purchaser enjoys the upside. If the property is a failure, the vendor loses its junior lien and now loses all hope of recourse, even after the debtor files a bankruptcy petition.
Given the overall dearth of authority on point, this issue apparently does not arise very frequently, so we may have to wait a long time before the Supreme Court untangles this statutory problem. For a discussion of the Bankruptcy Appellate Panel’s opinion in this case, see 2015-16 Comm. Fin. News. NL 33, Vendor Holding Nonrecourse Purchase Money Paper Cannot Assert Deficiency Claim Under § 1111(b) After Junior Lien is Extinguished by Senior Creditor’s Post-Petition Nonjudicial Foreclosure Sale.