Delannoy v. Woodlawn Colonial, L.P. (In re Delannoy) (9th Cir. Unpublished)

The following is a case update by Ed Hays of Marshack Hays LLC of a recent case of interest:

SUMMARY

In Delannoy v. Woodlawn Colonial, L.P. (In re Delannoy), 2020 U.S. App. LEXIS 34671 (9th Cir. Nov. 3, 2020), the U.S. Court of Appeals for the Ninth Circuit held that a debtor’s prebankruptcy appeal of an adverse judgment becomes property of the estate which a chapter 7 trustee may sell or settle. Although the Ninth Circuit has not yet issued a precedential ruling on the issue, this unpublished decision is the first by the Ninth Circuit and another in a series of BAP and bankruptcy court holdings that have concluded that defensive appellate rights are property.

To read the full decision, click here.

FACTS AND PROCEDURAL HISTORY

The state court entered a judgment for conversion against the debtor for more than $936,000. The judgment included findings that the debtor acted with fraud and malice and included a punitive damages component. The debtor appealed.

Before the Court of Appeal rendered a decision, the debtor filed a voluntary chapter 7 petition. The judgment constituted over 80% of creditor claims in the bankruptcy. The judgment creditor filed a complaint to except the judgment from discharge under Bankruptcy Code sections 523(a)(2), (4), and (6).

The chapter 7 trustee filed a motion to sell the defensive appellate rights. At the auction, the judgment creditor outbid the debtor and purchased the appellate rights for $10,000. The debtor appealed the order, and he was initially granted a temporary stay. The bankruptcy court thereafter denied the debtor’s motion to continue the stay, and the trustee successfully closed the sale transaction with the judgment creditor. The judgment creditor then dismissed the state court appeal of the underlying state court judgment.

The BAP affirmed the sale order which—due to the findings of fraud and malice—would presumably have collateral estoppel (issue preclusive) effect in the nondischargeability proceeding. The Ninth Circuit likewise affirmed.

REASONING

The Ninth Circuit BAP has established that defensive appellate rights become property of the estate which the chapter 7 trustee can sell or settle. In re McCarthy, 2008 WL 8448338, at *16 (9th Cir. BAP Feb. 19, 2008), In re Fridman,  2016 WL 3961303, at *7 (9th Cir. BAP, July 15, 2016) (“The right to appeal a state court judgment is property that is part of a debtor’s estate.”); see also In re Bouzaglou,  2018 WL 4062299, at *4, 7 (9th Cir. BAP, Aug. 13, 2018) (holding that defensive appellate rights were property of a Chapter 7 bankruptcy case), aff’d, 803 F. App’x 147 (9th Cir. 2020); In re Mozer, 302 B.R. 892, 896 (C.D.Cal.2003) [“[t]he right to appeal is valuable in nature and is the property of the bankruptcy estate under California’s broad concept of property rights” and “all of the Debtors’ appellate rights, including the Defensive Appellate Rights, are saleable by the Trustee”]. The Panel acknowledged (in a footnote) that “[n]o party contests that [debtor’s] defensive appeal rights are a species of property that may be transferred under California law, and we therefore assume that point for purposes of this appeal.” 

The Panel reasoned that a sale of a claim to the opposing party must be analyzed as both a sale and compromise, citing Simantob v. Claims Prosecutor, LLC (In re Lahijani), 325 B.R. 282 (9th Cir. BAP 2005). To satisfy Federal Rule of Bankruptcy Procedure 9019, “the compromise must be ‘fair and equitable’ in light of the odds of [debtor] winning his appeal, the complexity and costs of continued litigation, and the interests of creditors.”

Because the sale of the appeal to the judgment creditor had the effect of sealing the debtor’s fate in the section 523 action, the Panel noted: “[w]e agree that a sale of defensive appellate rights raises special concerns, particularly if the appeal has substantial merit that could wipe out a significant claim against the estate, thereby benefitting both the debtor and other creditors” and “[a]dditional concerns are presented where, as here, the adverse judgment being appealed by the debtor contains fraud and malice findings that the judgment creditor could seek to use to support a potential claim that the judgment debt is non-dischargeable, thereby impeding the debtor’s ability to obtain a fresh start.” Notwithstanding these concerns, the Panel found that the bankruptcy court’s findings that debtor failed to make any substantial showing that the appeal would have merit and that the debtor’s chances of prevailing were a “longshot,” supported affirming the order. The Panel also concluded that the estate’s lack of significant other assets supported affirming the sale so that the estate’s other assets were not consumed litigating a longshot. As such, the “trustee acted in good faith and with a proper purpose, that the settlement of the appeal was fair and equitable, and that the sale and settlement were in the best interest of creditors.”

AUTHOR’S COMMENTARY

In the conclusion, the court noted that the Ninth Circuit had not yet decided the issue of defensive appellate rights becoming property that is controlled by a chapter 7 trustee in a published decision: “we agree with the BAP’s observation that “[t]he circumstances presented in this appeal make it a poor candidate for exploring the outer boundaries of the trustee’s right to sell defensive appeal rights,” and our ruling in this case is not an endorsement of that practice in any other context.” That said, no federal court in the Ninth Circuit has yet concluded that such appellate rights are not property of the estate. See, Fridman, supra. To date, at least two circuits have concluded that defensive appellate rights are estate property. See, Martin v. Monumental Life Ins. Co., 240 F.3d 223, 232 (3rd Cir. 2001) (“The right to appeal is part of the debtors’ estates,” citing 11 U.S.C. 541(a)); Croft v. Lowry (In re Croft), 737 F.3d 372 (5th Cir. 2013) [establishing the methodology for determining the potential value of a defensive appeal: the probability of success on appeal multiplied by the expected decrease in liability].

Chapter 7 trustees regularly settle defensive appeals which is absolutely something that counsel for a potential debtor needs to caution debtors prior to bankruptcy. In one recent case, a chapter 7 trustee sold the debtor’s appellate rights for $250,000 and a reduction of the claim. In another case, a debtor was sanctioned for violating the automatic stay by filing pleadings in an appeal post-petition. That said, most chapter 7 trustees are sensitive to selling or settling an appeal which leaves the debtor subject to a Section 523 judgment. As such, good practice advises contacting the trustee after the filing with both a suggestion for how debtor proposes to fund prosecution of an appeal and a letter from appellate counsel regarding the merits of the appeal.

These materials were written by Ed Hays of Marshack Hays LLC, in Irvine, California (ehays@marshackhays.com). Editorial contributions were provided by Maggie E. Schroedter of Higgs Fletcher & Mack, LLP, in San Diego, California (schroedterm@higgslaw.com). Mr. Hays and Ms. Schroedter are members of the Insolvency Law Committee.