The following is a case update written by Leonard Gumport analyzing a recent case of interest.
In Avery v. Leya Techs., LLC (In re Protoype Eng’g & Mfg.), 2020 Bankr. LEXIS 1775 (Bankr. C.D. Cal. 2020) (“Prototype”) (unpublished), the bankruptcy court ruled that a substantive consolidation claim against a non-debtor entity was a “real property claim” within the meaning of California’s lis pendens statute, Cal. Code Civ. Proc. §§ 405.1-405.61. To review the decision, click here.
Prototype Engineering and Manufacturing, Inc. (“Prototype”) repaired, manufactured, and installed aviation parts and other components for the U.S. Army, Navy, and Air Force. Bahram Bordbar owned and managed Prototype.
On January 15, 2014, an Army Blackhawk helicopter crashed. On September 8, 2014, the deceased co-pilot’s estate and other plaintiffs (the “Crash Victim Claimants”) filed a complaint against Prototype and other aviation industry companies in the Los Angeles Superior Court. On October 8, 2014, several defendants removed that case to the United States District Court for the Central District of California in Case No. 2:14-cv-07793 (the “District Court Action”).
During 2016, the Bordbar Family Trust was formed, and its trustees were Barham Bordbar and his spouse, Malahat Bordbar (collectively, the “Bordbars”). The corpus of the Bordbar Family Trust included two California real properties (the “Real Properties”). At some point, the Bordbars started a new company, Leya Technologies, LLC (“Leya”).
The trial of the District Court Action was scheduled to begin on September 26, 2017. On September 7, 2017, Prototype filed a chapter 7 petition in the United States Bankruptcy Court for the Central District of California in Case No. 2:17-bk-21018 (the “Bankruptcy Case”). A chapter 7 trustee (the “Trustee”) was appointed. During 2017, the Crash Victim Claimants filed proofs of claim for $35 million in the Bankruptcy Case.
On September 6, 2019, the Trustee filed a complaint against the Bordbars, individually and as trustees of Bordbar Family Trust, and against Leya in Adv. No. 2:19-ap-01332 (the “Adversary Proceeding”). On September 24, 2019, the Trustee recorded a lis pendens (the “Lis Pendens”) against each of the Real Properties. In the Lis Pendens, the Trustee alleged that he was asserting a “real property claim affecting” the Real Properties in the Adversary Proceeding.
On September 26, 2019, in the Adversary Proceeding, the Trustee filed a first amended complaint (the “Complaint”), which included avoidance claims and a claim for substantive consolidation. The Complaint alleged that, after the helicopter crash, the Bordbars transferred the Real Properties to the Bordbar Family Trust. The Trustee alleged that the finances of the Bordbars and the Bordbar Family Trust were hopelessly entangled. In the twentieth claim for relief, the Complaint asserted a claim for substantive consolidation nunc pro tunc of the assets and liabilities of the Bordbars, the Bordbar Family Trust, and Leya into Prototype’s estate.
On October 7, 2019, the defendants filed a Rule 12(b)(6) motion to dismiss the Trustee’s Complaint. On December 12, 2019, the bankruptcy court dismissed the substantive consolidation claim without prejudice on the grounds that the Trustee did not give notice to the defendants’ creditors. The bankruptcy court stated that, “if Plaintiff intends to file an amended substantive consolidation claim or motion, he should file it as a separate proceeding so that the creditors of debtor and the nondebtor party defendants need not involve themselves in other claims in this adversary proceeding.” In re Prototype Eng’g & Mfg., 2019 Bankr. LEXIS 4036, *4 (Bankr. C.D. Cal. 2019).
On February 4, 2020, the Crash Victims Claimants filed a complaint in intervention in the Adversary Proceeding. The Crash Victims Claimants’ complaint in intervention did not assert a claim for substantive consolidation.
On February 27, 2020, when the Trustee did not have any substantive consolidation claim on file in the Adversary Proceeding or the Bankruptcy Case, the defendants filed a motion to expunge the Lis Pendens under Cal. Code Civ. Proc. §§ 405.4 and 405.30-405.31. The defendants argued that the Trustee had no real property claim supporting the Lis Pendens. The motion requested attorney’s fees against the Trustee under Cal. Code Civ. Proc. § 405.38.
On March 27, 2020, the Trustee and Crash Victim Claimants jointly filed an opposition to the motion to expunge. The opposition alleged that the Trustee’s substantive consolidation claim was a real property claim and that the claim remained viable. On April 7, 2020, the defendants filed a reply. Among other things, the defendants argued that the Trustee did not then have (and would never have) a substantive consolidation claim in the Adversary Proceeding.
On April 30, 2020, the bankruptcy court conducted a hearing on the motion to expunge. At the hearing, the defendants’ counsel argued that Roman Catholic Archdiocese of San Juan, Puerto Rice v. Acevedo Feliciano, 140 S. Ct. 696 (2020) (“Acevedo”), cast doubt on the authority of bankruptcy courts to enter nunc pro tunc substantive consolidation orders. On July 7, 2020, in Prototype, the bankruptcy court granted in part and denied in part the defendants’ motion to expunge the Lis Pendens. The bankruptcy court denied the motion, without prejudice, to the extent that the defendants sought immediate expungement of the Lis Pendens. The bankruptcy court conditionally granted the motion, ordering that the Lis Pendens would be expunged if the Trustee and the Crash Victim Claimants did not file an amended substantive consolidation claim within 90 days. The bankruptcy court denied the motion to the extent that it sought an award of attorney’s fees against the Trustee.
In Prototype, the bankruptcy court stated:“Whether a substantive consolidation claim may be a ‘real property claim’ supporting a [lis pendens] under California law is apparently an issue of first impression.” Id., at *18. In deciding that issue, the bankruptcy court considered: (1) the text of California’s lis pendens statute, Cal. Code Civ. Proc. §§ 405.1-405.61; (2) the interpretation of that statute in Kirkeby v. Superior Court, 33 Cal.4th 642 (2004) (“Kirkeby”); and (3) the law of substantive consolidation, particularly as stated in Alexander v. Compton (In re Bonham), 229 F.3d 750 (9th Cir. 2000) (“Bonham”).
Under Cal. Code Civ. Proc. § 405.2, a lis pendens is a “notice of the pendency of an action in which a real property claim is alleged.” Cal. Code Civ. Proc. § 405.4 defines a “real property claim” as “the cause or causes of action in a pleading which would, if meritorious, affect . . . title to, or the right to possession of, specific real property . . . .” In Kirkeby, the California Supreme Court held that a cause of action to avoid a fraudulent transfer was a “real property claim” within the meaning of Cal. Code Civ. Proc. § 405.4. Kirkeby left “unresolved” whether a claim to impose a constructive trust or equitable lien was a “real property claim” that would support a lis pendens. Prototype, at *22. Kirkeby “directs courts applying the California expungement statutes to proceed with a demurrer-like analysis of the noticing party’s pleading.” Prototyope, at *27.
A demurrer-like analysis of the Trustee’s previously asserted substantive consolidation claim showed that it was a “real property claim” as defined in Cal. Code Civ. Proc. § 405.4. Substantive consolidation is an uncodified, equitable doctrine that allows bankruptcy courts to combine the assets and liabilities of separate and distinct (but related) entities into a single pool as though they belonged to a single entity. Prototype, at *31. Under the doctrine of substantive consolidation as delineated in Bonham, the property of a substantively consolidated non-debtor becomes property of the debtor’s bankruptcy estate. Prototype, at *34. An order granting substantive consolidation of the assets of the defendants in the Adversary Proceeding would affect their title to, or right of possession, of the Real Properties. Id. at *28-*29. A substantive consolidation order “therefore affects title to and possession of those assets.” Id. at *34. The Trustee’s substantive consolidation claim was “more akin” to a fraudulent transfer claim than a claim to impose a constructive trust or equitable lien. Id. at *19.
The prior dismissal of the Trustee’s substantive consolidation claim did not require immediate expungement of the Lis Pendens, as the dismissal was without prejudice and the bankruptcy court had not set a deadline for the Trustee to assert an amended substantive consolidation claim. Prototype, at *45. The bankruptcy court found that expunging the Lis Pendens before reaching the merits of the Trustee’s substantive consolidation claim would be premature. Ninety days was a reasonable time to permit the Trustee and the Crash Victim Claimants to undertake discovery and to identify the creditors of the defendants. The bankruptcy court ordered that the Lis Pendens would be expunged if the Trustee and Crash Victim Claimants failed to file an amended substantive consolidation claim within 90 days. Id. at *45-*46.
The bankruptcy court declined to award of attorney’s fees against the Trustee for recording the Lis Pendens. Cal. Code Civ. Proc. § 405.38 provides for an award of attorney’s fees against a party who records a lis pendens without substantial justification. The Trustee had substantial justification for asserting that his substantive consolidation claim was a real property claim. Prototype, at *49-*50.
The defendants’ argument that Acedevo precludes nunc pro tunc substantive consolidation was not ripe for decision. It would be premature for the bankruptcy court to issue an advisory opinion on the merits of any to-be-filed amended substantive consolidation claim. Prototype, at *53-*54.
In Prototype, the defendants did not challenge the Trustee’s Lis Pendens under Cal. Code Civ. Proc. § 405.32, which requires a court to expunge a lis pendens “if the claimant has not established by a preponderance of the evidence the probable validity of the real property claim.” Prototype, at *31 n.11. A party should not record a lis pendens unless it has sufficient evidence to show the probable validity of the asserted real property claim. The bankruptcy court’s ruling in Prototype did not preclude the defendants from subsequently challenging the probable validity of the Trustee’s amended substantive consolidation claim. The Trustee did not subsequently file an amended substantive consolidation claim. Instead, on March 30, 2021, the bankruptcy court entered an order approving a settlement among the parties.
Prototype left for another day the issue of whether Acedevo precludes bankruptcy courts from granting substantive consolidation nunc pro tunc. More than 40 years since the enactment of the Bankruptcy Code, the United States Supreme Court has not decided whether the Code permits bankruptcy courts to order substantive consolidation, nunc pro tunc or otherwise. In Bank of Am., N.A. v. CD-04, Inc. (In re Owner Mgmt. Serv., LLC), 530 B.R. 711 (Bankr. C.D. Cal. 2015), affirmed sub nom., OMS, LLC v. Bank of Am., N.A., 2015 U.S. Dist. LEXIS 152622 (C.D. Cal. 2015), the bankruptcy court ruled that substantive consolidation remains “an independent equitable remedy that the bankruptcy court may impose under appropriate circumstances.” Id., 530 B.R. 723.
These materials were written by Leonard L. Gumport of Gumport Law Firm, PC in Pasadena (firstname.lastname@example.org). Editorial contributions were provided by Jessica M. Simon, Ballard Spahr LLP (email@example.com).