In Precision Bus. Consulting v. Medley (In re Medley), No. 6:20-BK-11768-SY, 2023 WL 1960799, at *1 (B.A.P. 9th Cir. Feb. 13, 2023)

The following is a case update written by Matthew Resnik analyzing a recent case of interest, In Precision Bus. Consulting v. Medley (In re Medley), No. 6:20-BK-11768-SY, 2023 WL 1960799, at *1 (B.A.P. 9th Cir. Feb. 13, 2023) (“Medley”).

SUMMARY

In Medley, the United States Bankruptcy Appellate Panel for the Ninth Circuit (“BAP”) affirmed the bankruptcy court’s decision that a factoring agreement created a loan in favor of Precision secured by the debtor’s real estate sales commissions, and that Precision was not a “factor” that owned the debtor’s right to receive the commission. As such, the BAP found no error in the bankruptcy court’s decision that the creditor’s attempt to collect the real estate sales commission from the debtor violated the automatic stay and that the alleged factored commissions were indeed property of the estate. 

As Shakespeare wrote, “[T]hat which we call a rose, [b]y any other name would smell as sweet.” William Shakespeare, Romeo and Juliet, act 2, sc. 2. The BAP’s conclusion – that the agreement between the parties was not actually a disguised sale but was more akin to a loan – affirms the proposition that substance governs, and not name, label or form. 

To read the full published decision: click here.

FACTS

Background

The debtor, Jill Medley (“Debtor”), is a licensed real estate broker. She executed a series of agreements with Precision Business Consulting LLC (“Precision”) whereby Precision advanced funds (“Advance”) based on the anticipated recovery of a commission by Medley at the close of escrow. Medley would receive an advance equal to 75% of the expected commission from a sale of property (“Park” and/or “Park Sale”). The commissions were assigned to Precision, as well as additional security interests in commissions unrelated to the Advance. Some additional collateral included a UCC filing, a deed of trust on Medley’s residence and additional replacement commissions should the anticipated commission on the Park Sale fall through. The Park Sale subsequently fell out of escrow and Park had no immediate intention to relist the property for sale.            

Chapter 13 Filing

The day after Park withdrew the sale listing, Debtor filed a chapter 13 petition. She did not list Precision as a creditor. However, she listed an affiliated business, Escrow Cash Advance, LLC, as holding an unsecured claim (arising from a separate transaction) and included Escrow Cash Advance on the mailing list at the same address as Precision. Medley, at *3.

Precision filed a proof of claim contending that it held a secured claim of $53,405.32. The proof of claim indicated an 18% annual interest rate and included a handwritten notation claiming “default interest” totaling nearly $6,000. Mr. Cooper, on behalf of Precision, signed the proof of claim and checked the box indicating “I am the creditor.” Id., at *3. Debtor filed an objection to Precision’s claim, arguing the Precision held only a general unsecured claim. In response, Precision insisted that it was not a lender; rather, it was “a factoring company that purchases receivables . . . . Factors don’t loan money.” Id., at *2. Additionally, Precision argued that its claim was secured as a result of the UCC filing. Precision never filed a motion for relief from stay while the Chapter 13 case was open. Precision continued its collection efforts following the filing of the petition.

The bankruptcy proceeding was later dismissed. The Park property was subsequently relisted and sold, and Debtor received the full commission without any deductions.

Order to Show Cause

Debtor filed an Order to Show Cause (“OSC”) against Precision alleging that collection efforts, including contacting Park directly and demanding payment postpetition, violated the automatic stay under 11 U.S.C. § 362(k). The Debtor requested that the bankruptcy court impose civil contempt sanctions of $20,000 for violation of a court order. Id., at *5. Precision opposed the motion, arguing it did not violate the stay because it merely was protecting an asset it owned and had purchased prepetition.

At the OSC hearing, the bankruptcy court asked Debtor if she wished to pursue the remedy for a stay violation under § 362(k), which would require an adversary, or under § 105, which would impose on the bankruptcy court the order to show cause. Debtor informed the Court that she would file an adversary, but “she evidently changed her mind because she did not commence an adversary proceeding; rather, she merely refiled a substantially similar motion.” Id. at *5. The bankruptcy court granted the OSC and reserved the right to impose sanctions.

In opposition, Precision failed to address Debtor’s failure to commence an adversary proceeding. Precision defended its actions and reiterated that it was a “factor” and therefore the commissions and collection were not property of the estate. Debtor argued that under the “transfer of risk” test, Precision was a secured creditor. The bankruptcy court set the case for an evidentiary hearing.

Evidentiary hearing

At the evidentiary hearing, Debtor testified that Precision aggressively pursued the commissions and insisted that she was “borrowing funds from the future, that I could pay back soon as one of my properties sold, and I identified which property that would be.” Id., at *7. Precision argued it was merely trying to preserve Precision’s legal rights as a factor to the commission and insisted that Medley “stole the money”. Precision adamantly disputed it was a lender, yet also insisted it was a secured creditor.

The bankruptcy court issued an extensive written ruling. The court agreed with the Debtor that under the “transfer of risk” test, Precision was a secured creditor and did not own the commission as a “factor”. Precision received notice of the bankruptcy and rejected Precision’s argument that their collection efforts were solely based on their understanding of being a “factor”. The bankruptcy court ultimately found that Precision was a secured creditor subject to the automatic stay and the transaction was actually in substance a “disguised financing agreement.” Id., at *8. 

Although the Court wished it could award a larger sanction, the bankruptcy court found that the OSC limited the requested remedy to Debtor’s attorneys’ fees. The bankruptcy court found that Precision willfully violated the automatic stay under 11 U.S.C. § 362(k) and ordered Debtor sanctions in the form of her attorney’s fees and costs in the amount of $20,000. Id., at *9.

Precision timely appealed. The BAP affirmed. 

REASONING

Form over substance. Beware lest you lose the substance by grasping at the shadow AESOP’S FABLES, The Dog and the Shadow (The Harvard Classics 1909).

The BAP reasoned that Precision drafted the applicable agreement, under which Precision would advance funds to Debtor in exchange for the promise of repayment which was secured by collateral. The BAP first analyzed Precision’s argument – that it owned the right to receive a portion of the commission despite the agreement having the protections of a promissory note. The BAP defined “factoring” by quoting Black’s Law Dictionary: “Factoring” is described as “[t]he buying of accounts receivable at a discount. The price is discounted because the factor (who buys them) assumes the risk of delay in collection and loss on the accounts receivable.” Produce Pay, Inc. v. FVF Distribs. Inc., 468 F.Supp.3d 1304, 1309 n.3 (S.D. Cal. 2020) (quoting Black’s Law Dictionary 612 (7th ed. 1999)), at *11 (B.A.P. 9th Cir. Feb. 13, 2023)

The BAP agreed with the bankruptcy court that the “the legal consequences of a transaction are based on its economic substance rather than its form.” Medley, at *11. The BAP reasoned that, consistent with California precedent, the agreement contained the hallmarks of a secured lending agreement, rather than a discrete purchase of an asset. Furthermore, the BAP noted that Precision’s conduct and admissions supported the bankruptcy court’s finding that the transaction was a loan in substance. “It repeatedly identified itself as a secured creditor, including in its proof of claim. The proof of claim also demanded 18% interest on the debt. At trial, Mr. Cooper insisted that he would ‘stipulate’ that Precision is a secured creditor.” Id., at *14. Despite Precision’s attempt to label the transaction as a sale, the BAP found that the substance of the agreement was not consistent with a pure sale arrangement of an asset. 

The BAP held: “Based on these factors, the bankruptcy court did not err when it found that the agreement was not a true sale, but rather a secured loan, and that the right to receive the commission was property of the bankruptcy estate protected by the automatic stay.” Id., at *15.

Adversary required where there is a Contested Matter

Precision argued on appeal that the bankruptcy court should have required Debtor to commence an adversary proceeding under Rule 7001(2) because the dispute involved the characterization of debt. The BAP admitted that this argument exposed some confusion in the record. However, the BAP overcame this misunderstanding by conducting a two step analysis:

First, Precision did not request an adversary proceeding. Rather, because it remained silent on this issue, the BAP found that Precision had “waived this point of error.” Medley, at *16.

Second, the Ninth Circuit utilizes the Munoz factors to determine whether the error was harmless. “We are to consider whether:

(1) the material facts were few and undisputed,

(2) the dispositive issues were pure questions of law,

(3) neither party expressed any discontent with the contested matter procedures the bankruptcy court utilized, and

(4) this Panel was “satisfied that neither the factual record nor the quality of the presentation of the arguments would have been materially different had there been an adversary proceeding.”

Id., at *16-17, quoting Ruvacalba v. Munoz (In re Munoz), 287 B.R. 546, 550 (9th Cir. BAP 2002).

The BAP came down hard on Precision and found harmless error, primarily due to the laissez faire attitude of Precision during the trial phase for the evidentiary ruling.  “Given that Precision did not participate in the joint pretrial stipulation, ignored the court’s orders, and was unprepared for the evidentiary hearing, an adversary proceeding would not have changed the outcome.” Medley, at*17.

Sanctions for Violation of the Stay

The record supporting the sanctions award is a bit unclear. The bankruptcy court’s written order references the sanctions as “civil contempt sanctions,” which is akin to a § 105 sanction. On the other hand, a § 362k violation is referenced as a “civil sanction. The BAP, however, relied upon the bankruptcy court’s language in its written orders rather than any alleged inconsistent statement made by the judge orally during the evidentiary hearing. As a result, the BAP evaluated the sanction portion of the appeal under § 362(k).

The sanction was determined under the 2015 Schwatrz-Tallard decision, which specifically provides “an individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.” See Am.’s Servicing Co. v. Schwartz-Tallard (In re Schwartz-Tallard), 803 F.3d 1095, 1100 (9th Cir. 2015) (en banc)”. Medley, at *18. The BAP utilized Ninth Circuit precedent as the basis for allowance of actual damages including attorney fees: “In other words, § 362(k) “makes an award of actual damages and attorney’s fees mandatory, and grants bankruptcy courts the discretion to impose punitive damages in appropriate cases.” Ibid.,at *18.

In a footnote, but of significance to the post Fulton backdrop, the BAP reconciled the preservation of status quo versus the active collection of a creditor against a debtor in bankruptcy: “Unlike the City of Chicago, which did nothing, Precision took active steps to collect its debt.” Medley, at *19 n.7. 

Ultimately the BAP found the record adequate to support a finding of sanctions. Specifically, in its written order, the bankruptcy court explained that it was allowing “actual damages incurred by [Ms. Medley] in the form of her attorney’s fees and costs in the amount of $20,000.” In its oral comments, the court stated that it had reviewed the requested fees, considered Precision’s objections, identified improper billing entries that would warrant minor reductions, and ultimately determined that the reasonable total fees exceeded the $20,000 cap. “This explanation is adequate.” Medley, at *21, citing Moreno v. City of Sacramento, 534 F.3d 1106, 1111 (9th Cir. 2008) (holding that the explanation of a fee award “need not be elaborate, but it must be comprehensible”).

The BAP affirmed and found that the bankruptcy court did not err in holding that the commission was subject to the automatic stay, that Precision violated the stay, and the award of $20,000 as compensation for Ms. Medley’s attorneys’ fees was warranted under the record.

AUTHOR’S COMMENTS

Without question, Precision advanced sums of money. It may have called it a Factoring Agreement; however, by all accounts it was structured as a loan. A true factor bears the risk in assuming the collateral which it would ultimately control. In this specific case, the additional requirements to the factoring agreement included not only an interest in the commission for the Park Sale, but other commissions as well. The collateral to secure the advance of funds included other forms of collateral including but not limited to a deed of the trust of the debtor and the filing of a UCC statement. The form of the agreement did not match the substance for which Precision was arguing.

It is not unusual for factors to play a role in bankruptcy and the ultimate success or failure of a reorganization. Oftentimes the parties take for granted the “form” over “substance” in a written agreement – when perhaps the agreement is more likely a loan with the layers of protections a promissory note would utilize. The rationale of the Medley panel provides a rather simple backdrop to what would appear to be transactional and convoluted. The transfer of risk is ultimately a deciding factor.  The contents of the four corners of the documents will be the overriding factor in determining the character of the interest.

Here, the Debtor was subjected to the entire risk and would be fully exposed for the full amount in case of default. Precision bore a calculated indirect risk. However, the Debtor expressly granted Precision a security interest, not only in the commission against which Precision made an advance, but also in all of her present and future accounts receivable along with her residence. Precision identified itself as a secured creditor with an interest rate of 18% as reflected on the proof of claim that was filed. They were not a true factor by any definition.

In essence the Debtor believed she was borrowing funds – with the risk shifting solely to the individual in receipt of the advance (the borrower).  The additional collateral for repayment in case of default provides the hallmark attributes of a loan for repayment.

The BAP was convinced the commission was collateral for repayment but not an asset that transferred to the lender upon the amount being realized. That commission was property of the estate and the subsequent actions of the creditor exposed them to damages including but not limited to attorney fees. This is extremely important when considering the fact that if the opposing party does not object and is not otherwise prejudiced, they will be subject to an adverse sanctions award. 

These materials were written by Matthew Resnik, managing partner at RHM Law LLP located in both the San Fernando Valley and Downtown Los Angeles, California, with editorial assistance by Maggie E. Schroedter of Robberson Schroedter LLP in San Diego, California (maggie@theRSfirm.com).