The following is a case update written by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), with the summary of the Corbett-Smith case written by Ed Hays of Marshack Hays LLP in Irvine, California, analyzing a recent decision of interest:
A Bankruptcy Court in the Eastern District of New York recently held that a litigation finance company did not hold an effective assignment of a debtor’s interest in settlement proceeds that did not exist on the petition date nor did it have a secured claim, even in funds subject to debtor’s exemption. In re Reviss, No. 19-44155, 2021 WL 1821873 (Bankr. E.D. N.Y. May 6, 2021). To view the opinion, click here.
Debtor Vladimir Reviss was injured in an automobile accident and filed a personal injury action in January 2019, well before he filed his chapter 7 petition in July 2019. Prior to the bankruptcy he entered into a series of agreements (the Agreements) with Green Tree Case Funding under which Green Tree advanced to the Debtor a total of $20,000 in exchange for a promise to pay it that sum, plus origination fees and interest at 3.5 percent per month from the proceeds of the litigation, as fixed by judgment or settlement. He owed them nothing if there was no recovery. The Agreements purported to create an assignment of the proceeds. They acknowledged that the transactions were not assignments of part of the Debtor’s personal injury claim, but rather assignments of a portion of the proceeds of that claim.
Debtor scheduled his personal injury claim on Schedule A/B and claimed the applicable federal personal injury exemption and wild card exemption in the cause of action, for a total exemption of $39,000. Green Tree filed a proof of claim, asserting (1) that it held an assignment of the proceeds which therefore would not become part of the bankruptcy estate and (2) that it had a secured claim in the same proceeds. The chapter 7 trustee hired litigation counsel and quickly settled the case for $75,000. The trustee then filed a motion seeking to settle the case and disburse funds equal to the claimed exemption to the Debtor. He also filed a motion to reclassify Green Tree’s claim to an unsecured claim, for both motions relying on authority from the Eastern District of New York Bankruptcy Court, In re Andrade, Nos. 10-42877, 07-46595, 2010 WL 5347535 (Bankr. E.D. NY. Dec. 21, 2010).
Green Tree opposed both motions, claiming it was entitled to be paid in full from the Debtor’s exempt funds, relying on the assignments in the Agreements and also asserting again that its claim was secured by an equitable lien on the proceeds. Prior to the Court’s ruling, the trustee and Green Tree struck a deal which would have allowed about $10,000 to be uncontested property of the estate in exchange for the trustee taking no further position on Green Tree’s opposition. Despite this agreement, the Court overruled Green Tree’s opposition and granted the motion to disburse the exempt funds to the Debtor. It essentially ruled that Green Tree had no effective assignment of the proceeds and also did not have a secured claim.
To start, the Court observed that under both common law and New York state law going back to 1882, a personal injury cause of action cannot be assigned. However, New York law does permit assignment of the proceeds of a personal injury claim, which explains the carefully crafted language in the Agreements. But this alone did not resolve the issue when a bankruptcy petition was filed before any proceeds were available. Citing again long-standing New York law as well as Andrade, the Court observed that “the assignment of the future proceeds of a lawsuit operates as a future lien which only comes into existence when a judgment is entered” and that lien “does not relate back to the date of the assignment”. Id., at * 2. Therefore, because the lawsuit was settled post petition, Green Tree had at most an equitable lien, with no legal right to the funds. The Court also rejected an argument that Green Tree had a constructive trust in the funds, as such a remedy required bad faith by the Debtor and no bad faith was asserted here.
Having determined under settled law that Green Tree had no legal assignment nor perfected secured claim in future proceeds on the petition date, the Court then applied the strong arm powers of the trustee. As a hypothetical lien creditor, the trustee would have a superior legal interest in the settlement proceeds as against any equitable lien or otherwise unperfected interest held by a creditor or third party. In other words, the estate’s interest in the funds trumped any equitable claim of Green Tree. Since no one had objected to the Debtor’s claim of exemption, he was entitled to payment from the estate funds of the exempt sum. Green Tree had, at most, a general unsecured claim.
Although this decision might come as a shock to some litigation finance companies, the outcome was totally predictable, at least in New York and under common law. The principles applied by the Court – that a personal injury claim could not be assigned, that the assignment of future proceeds of a lawsuit only becomes a lien when the proceeds come into existence, and that the lien does not relate back to the assignment – were noncontroversial law in New York for more than 100 years prior to Andrade. In fact, Andrade itself cites to a series of cases from as long ago as the 1880’s and reaffirmed in the 1930’s by New York courts. Moreover, bankruptcy courts in New York adopted these principles in reported cases for the past 20 years. Those principles made what would occur when a bankruptcy petition was filed prior to settlement or judgment entirely predictable. The legal interest of the Debtor in the outcome of the litigation became property of the bankruptcy estate, subject to any valid exemption claimed by the Debtor. The estate’s interest in the funds would cut off any equitable or unperfected claims as a result of the trustee standing in the shoes of the hypothetical lien creditor. None of this reasoning is unique and certainly none of it is new, at least in New York. One tact for litigation finance companies might be to provide in the Agreements a choice of law of a different state where the outcome might not be so negative. (The choice of law in the pertinent Agreements was New Jersey; the Court observed that both parties had ignored that choice and cited New York law but also noted the outcome would have been the same in New Jersey.) Another tactic would be to make certain that settlements occurred quickly so no bankruptcy could intervene. However, any interference in the litigation strategy by the finance companies might be considered champerty.
A couple of other points: the Debtor did not participate in the briefing or argument. Once the trustee agreed to not argue further against Green Tree’s claim, it was the Court alone that came to this debtor-friendly outcome. Also, the Court did not need to reach whether the advancement of funds was a loan and therefore subject to usury laws. Finally, policy considerations were not in play at all. This was a strictly legal ruling.
The result arguably would have been different under federal law governing equitable liens. Under similar facts, the District Court for the Eastern District of California reached a result that was not as friendly to the debtor. See, In re Corbett-Smith, infra. In Corbett-Smith, debtor was a prison guard and member of the California Correctional Peace Officers Association Benefit Trust Fund (“CCPOA”). As a benefit to its members, CCPOA would advance funds to an injured member in exchange for such member assigning their rights to receive Workers Compensation. Upon receipt of their Workers Compensation benefit, CCPOA would be reimbursed. In this case, however, debtor filed bankruptcy before the Workers Compensation benefits were received. She then took the position that the discharge protected her from having to repay the benefits from her Workers Compensation award. After trial in which the debtor appeared in pro per, the Bankruptcy Court ruled in her favor for reasons never argued by debtor. The Bankruptcy Court held that Workers Compensation benefits could not be assigned until they were received. Cal. Corr. Peace Officers Ass’n Ben. Tr. Fund v. Corbett (In re Corbett), 2016 Bankr. LEXIS 825 (Bankr. E.D. Cal. Mar. 14, 2016). On appeal, the District Court reversed finding that CCPOA had an equitable lien under well-established Ninth Circuit precedence and that the lien was necessary to prevent debtor from receiving a windfall. Cal. Corr. Peace Officers Ass’n Ben. Tr. Fund v. Corbett (In re Corbett), 2017 U.S. Dist. LEXIS 108925 (E.D. Cal. July 11, 2017).
“Generally, an equitable lien is a right, not recognized at law, which a court recognizes and enforces as distinct from strictly legal rights, to have a fund or specific property, or the proceeds, applied in full or in part to the payment of a particular debt or demand.” 53 C.J.S. Liens § 16 (2017). “It is well settled and an agreement to charge, or to assign, or to give security upon, or to affect property not yet in existence . . . creates no legal estate or interest in the things when they afterwards come into existence or are acquired by the promisor, [but] does constitute an equitable lien upon the property so existing or acquired at a subsequent time, which is enforced in the same manner and against the same parties as a lien upon specific things existing and owned by the contracting party at the date of the contract.” 3 Pomeroy’s Equity Jurisprudence § 1236 p. 2472 (1905).
The United States Supreme Court, drawing from the law of equitable liens by agreement, has explained that reimbursement sought from an ERISA plan beneficiary pursuant to a subrogation agreement was equitable relief authorized by ERISA. Sereboff v. Mid Atl. Med. Servs., Inc., 547 U.S. 356, 364-65, 126 S. Ct. 1869, 164 L. Ed. 2d 612 (2006). Sereboff cited “the familiar rule of equity that a contract to convey a specific object even before it is acquired will make the contractor a trustee as soon as he gets title to the thing.” quoting Barnes v. Alexander, 232 U.S. 117, 121, 34 S. Ct. 276, 58 L. Ed. 530 (1914). The Ninth Circuit has held that under Sereboff, there are three criteria to establish an equitable lien:
“First, there must be a promise by the beneficiary to reimburse the fiduciary for benefits paid under the plan in the event of a recovery from a third party. Second, the reimbursement agreement must specifically identify a particular fund, distinct from the beneficiary’s general assets, from which the fiduciary will be reimbursed. Third, the funds specifically identified by the fiduciary must be within the possession and control of the beneficiary.”
Bilyeu v. Morgan Stanley Long Term Disability Plan, 683 F.3d 1083, 1092 (9th Cir. 2012).
Applying the foregoing cases, the Court in Corbett-Smith found that debtor executed an agreement to “repay and hereby assign to [CCPOA] the proceeds of any and all recovery/ies made from any responsible party or insurer to [debtor].” Second, the court found that the agreement sufficiently identified the particular fund from which repayment would be made. Lastly, the court found that debtor had possession and control of the funds because she filed bankruptcy and her Chapter 7 trustee received the funds.
These materials were written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., ret.), with the summary of the Corbett-Smith case written by Ed Hays of Marshack Hays LLP in Irvine, California. Editorial contributions were made by Monique D. Jewett-Brewster, a shareholder with Hopkins & Carley, ALC. The opinions expressed herein are solely those of the authors. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.