Business Law

Harkey v. Grobstein (In re Point Ctr. Fin., Inc.) (9th Cir.)

The following is a case update written by Adam A. Lewis, Senior Counsel at Morrison & Foerster LLP, analyzing a recent decision of interest:

SUMMARY

In Harkey v. Grobstein (In re Point Ctr. Fin., Inc.), 957 F.3d 990 (9th Cir. 2020), the U.S. Court of Appeals for the Ninth Circuit affirmed an order authorizing a chapter 7 trustee to assume an operating agreement between the debtor and a limited liability company and to exercise management rights over the LLC following the trustee’s election by a majority of the LLC’s members. The Ninth Circuit ruled that the bankruptcy court was within its authority in confirming the trustee’s election as manager. The Ninth Circuit further ruled, alternatively, that the bankruptcy court validly extended under Fed. R. Bankr. P. 9006(b)(1) the previously expired deadline under 11 U.S.C. § 365(d)(1) for the trustee to assume the operating agreement. To review the opinion, click here.

FACTS

Prior to filing bankruptcy, Point Center Financial, Inc. (PCF) originated and serviced loans by private investors. When loans defaulted, PCF foreclosed on the properties securing the loans, and generally placed the foreclosed properties in LLCs and converted the investors’ interests into membership interests in the LLCs. One of those LLCs was Dillon Avenue 44, LLC (Dillon). Its operating agreement entitled Dillon’s manager, PCF, to a management fee.

On February 19, 2013, PCF filed a petition under chapter 11. Later that year, a chapter 11 trustee was appointed. When the case was converted to chapter 7, the trustee became the chapter 7 trustee. Bankruptcy Code section 365(d)(1) permits a bankruptcy court to extend the 60-day statutory deadline to assume or reject executory contracts in chapter 7 cases by motion made within original deadline. The trustee timely obtained such an extension to February 28, 2014.  PCF’s former principal, Harkey, told the trustee that there was no sale of Dillon’s property on the horizon, and the trustee allowed the extended deadline to pass without taking action to assume Dillon’s operating agreement.  

Over two years later, the trustee learned that there had been a potential sale when Harkey had stated otherwise. The trustee then got a majority of Dillon’s members to elect him manager (in his capacity as the PCF estate’s trustee), and, on May 31, 2016, the trustee moved the bankruptcy court to authorize his exercising management rights over Dillon based on his election as Dillon’s manager.  In the alternative, relying on Fed. R. Bankr. P. 9006(b)(1), the trustee asked the bankruptcy court to extend the previously expired deadline to assume or reject Dillon’s operating agreement. The trustee also sought authority to assume that agreement, and asserted excusable neglect for his delay, alleging that he had relied on Harkey’s misrepresentations.

Dillon’s members did not appear at the hearing, an omission they later claimed was due to their alleged misconception that nothing was at stake for them. On June 19, 2016, the bankruptcy court issued an order granting both parts of the trustee’s motion. The trustee subsequently sold Dillon’s real estate, and distributed the proceeds to creditors, PCF, and Dillon members. 

Without obtaining a stay, Harkey and at least some of the Dillon members appealed the appointment and extension/assumption orders to the district court, claiming that the bankruptcy court lacked jurisdiction to approve the appointment of the trustee as manager and the power to extend the statutory deadline of Section 365(d)(1) after the expiration of its previous timely extension. The trustee contended that the appellants lacked standing because they were not aggrieved parties and that the appeal was in any case equitably moot because of what had transpired since the entry of the appealed order.  On October 9, 2018, the district court affirmed the bankruptcy court. The appellants then appealed to the Ninth Court, which affirmed on April 29, 2020.  

REASONING

The Ninth Court rejected the trustee’s argument that the appellants lacked standing because they were not “financially aggrieved,” the bankruptcy law test for standing.  The appellants were aggrieved even though they did get some money from the sale, because they did not get as much as they would have but for the payment of the management fee.  After concluding that appellants had appellate standing, the Court’s majority declined to address the trustee’s argument that the appeal was equitably moot. Instead, the majority addressed the merits and ruled in the trustee’s favor, while the third judge dissented from the ruling on the merits but concurred in the result on the grounds that the appeal was equitably moot.

The appellants argued that the bankruptcy court lacked jurisdiction of the election of the trustee as manager of Dillon.  They further argued that Dillon’s operating agreement, when the trustee sought to assume it, no longer was estate property. They argued that, because the operating agreement no longer was estate property, the bankruptcy court lacked jurisdiction under 28 U.S.C. § 1334(e)(1), granting jurisdiction of all property of a bankruptcy estate. On the election issue, the Court said that there is ample authority for bankruptcy courts to approve such an election, citing as an exampleIn re Walter, 83 B.R. 14, 17 (9th Cir. BAP 1988). On the issue of whether the bankruptcy court lacked jurisdiction because the rejected operating agreement was no longer property of the estate, the short answer was Mission Prod. Holdings, Inc. v. Tempnology, LLC, 587 U.S. __, 139 S. Ct. 1652, 1661, 203 L.Ed.2d 876 (2019), which ruled that rejection of an executory agreement merely constitutes a breach, not a termination. The operating agreement was, therefore, still estate property.  The Ninth Circuit added that, in any event, there also was “related to” and “arising under” jurisdiction under 28 U.S.C. § 1334(b).

Getting to the heart of the case, the Court reasoned that, although Section 365(d)(1) only allows for an extension of its deadline by a motion made within that statutory deadline, the trustee and the bankruptcy court did not rely on that provision.  Instead, they employed Rule 9006(b)(1).  By its express terms, Rule 9006(b)(1) permits extension of a deadline set by a “notice  . . . or order” (emphasis added) if either the motion is made within the governing deadline of the notice or order at issue or is made on the grounds of excusable neglect after the deadline has expired.  Relying on Rule 9006(b)(1)’s permission to extend a governing deadline set by a prior order – in this case the original Section 365(d)(1) extension order – the bankruptcy court properly found excusable neglect in that the trustee failed to act before the originally-extended deadline expired due to Harkey’s misrepresentation. 

AUTHOR’S COMMENTS

The Court’s analysis of the jurisdictional issues was correct.  Moreover, the decision reaches the “right” result because it prevented Dillon’s members and Harkey from a windfall benefit from Harkey’s misrepresentation.  The trustee benefitted by reaping the fee mandated by the operating agreement, but that is an outcome the members risked in the first instance by voting him in as manager even after the extended deadline.  Moreover, creditors of PCF were paid through the sale, and even the Dillon members received some money, though less than they might have because of the manager’s fee.

Whether the Court correctly concluded that the bankruptcy court could extend the expired extended deadline 2 ½ years later is a thornier issue.  The question is whether a bankruptcy court has the power to extend a statutory deadline beyond what is expressly permitted by the statute, in contrast to extending deadlines originally set by a notice or order.  In other words, do statutory deadlines (even as extended as expressly permitted in the statute itself via a court order) have more gravitas than deadlines set in the first instance solely on the authority of a court order or rule such that courts cannot alter them beyond what the statute expressly permits? In a partial dissent, the third member of the Court agreed with the majority on the jurisdiction issue, but thought that Rule 9006(b)(1) did not permit the bankruptcy court to further extend the statutory deadline of Section 365(d)(1). That judge concurred in the result but would have relied instead on the equitable mootness theory that the majority sidelined. 

Perhaps there were remedies other than Rule 9006(b)(1) that would have averted a windfall occasioned by Harkey’s fraud without infringing on the statutory deadline, doctrines that might apply in other circumstances.  One example of a possible remedy is the equitable mootness ground urged by the trustee and on relied on by the partial dissent.  There may be other remedies that can avoid untoward results in the occasional case without compromising the sanctity of statutory deadlines.

The majority and dissenting opinions in Point Center raise this broader issue: Can Rule 9006(b)(1) be utilized to vitiate other statutory deadlines if there has been an intervening order extending time? For example, in chapter 11, under Bankruptcy Code section 365(d)(2), the debtor generally has until confirmation of a plan to assume or reject agreements. Under Section 365(d)(4), the debtor initially has only 120 days for a nonresidential lease to the debtor/lessee.  Under the terms of the statute itself, the 120 days can be extended by a timely motion or motions, but only for another 90 days total.  Beyond that, a debtor can obtain a further extension only with the landlord’s consent.  Suppose a debtor gets a 90-day extension.  Can the debtor get a further extension without the landlord’s consent under Rule 9006(b)(1) on the grounds that the debtor seeks an extension set not by the statute but by the prior order?  It looks like the same conceptual problem as in Point Center

These materials were authored by Adam A. Lewis, Senior Counsel at Morrision & Foerster, LLP.  Editorial contributions were made by Leonard Gumport of Gumport Law Firm PC.

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