In re Augustine Pena, III (9th Cir.)

The following is a case update written by Uzzi O. Raanan, a partner at Danning, Gill, Israel & Krasnoff, LLP, analyzing a recent decision of interest:

The Ninth Circuit Court of Appeals holds that real property rents collected by a Chapter 7 trustee, declined by secured creditors, and turned over to the bankruptcy court’s registry as unclaimed funds were not abandoned and therefore remain property of the bankruptcy estate, despite no efforts by anyone to reopen the case and use the funds to pay unsecured creditors. In re Augustine Pena, III 2020 WL 5268523 (9th Cir. Sept. 4, 2020).

To read to full opinion, click here.

FACTS

This case presents a bizarre set of facts leading to an unusual result.

In April 2012 (Petition Date), Augustine Pena III (Debtor) filed for bankruptcy under Chapter 11. At the time the case was filed, Debtor owned 29 rental properties. In June 2012, the bankruptcy court sua sponte converted the case to Chapter 7, due to Debtor’s unauthorized use of cash collateral. Debtor appealed the conversion to the district court and ultimately the Ninth Circuit Court of Appeals. The conversion was affirmed.

Following her appointment, the Chapter 7 trustee (Trustee) sought to abandon Debtor’s real properties, which apparently had no equity. Had that occurred, the properties would have reverted to the Debtor and been subject to either foreclosure or other arrangements with secured creditors. As there were apparently no other assets, the case would have been closed with no distribution to creditors.

The bankruptcy court, however, ruled that while Debtor’s appeals of the conversion were pending it lacked jurisdiction to grant either relief from stay or abandonment. Instead, it authorized the Trustee to manage the rental properties and collect rents. After Debtor exhausted his appeals, the Trustee abandoned the real properties to Debtor and shortly thereafter ceased collecting rents.

The rents collected by the Trustee related to fully encumbered properties and she treated the rents as cash collateral of the respective secured creditors. The Trustee attempted to pay the rents in question to secured creditors on several occasions. When the checks were not cashed, she paid $51,777.03 in rent proceeds into the bankruptcy court’s registry under 11 U.S.C. section 347(a), which states,

Ninety days after the final distribution under section 726, 1194, 1226, or 1326 of this title in a case under chapter 7, subchapter V of chapter 11, 12, or 13 [1] of this title, as the case may be, the trustee shall stop payment on any check remaining unpaid, and any remaining property of the estate shall be paid into the court and disposed of under chapter 129 of title 28.

Though the Trustee “administered” the rents on behalf of secured creditors, she filed a “no asset” report and distributed no funds to unsecured creditors. There were no objections to the Trustee’s Final Account and the case was closed on December 27, 2016.

On March 1, 2018, Debtor filed an application seeking to recover the unclaimed rents without also seeking to reopen the bankruptcy case. Debtor argued that none of his secured creditors could establish entitlement to the unclaimed funds because the real properties for which the rents were collected were either foreclosed upon or Debtor was now current on paying the remaining mortgages. Debtor argued that because the Trustee abandoned the rental properties the properties and their rent proceeds should be treated as though no bankruptcy case had been filed. This, he argued, means that he was entitled to claim the rents in question. Debtor apparently served the application on the secured creditors, United States Trustee, and interested unsecured creditors. No objections were filed with the bankruptcy court.

Despite the lack of opposition, the bankruptcy court denied Debtor’s application. It held that the Trustee properly deposited the rents into the court’s registry under Section 347(a). It further found that secured creditors who declined the rents had five years to claim the funds, after which they will escheat to the United States under 28 U.S.C. section 2042.

The bankruptcy court concluded that between Debtor and his bankruptcy estate the latter was entitled to the rents because the funds were never specifically abandoned by the Trustee. The court noted that the rents were separate assets of the estate under Section 541(a)(6), which Debtor’s unsecured creditors were entitled to claim if secured creditors did not.

Debtor appealed to the Bankruptcy Appellate Panel (BAP), which affirmed the bankruptcy court in a published opinion. See In re Augustine Pena, III, 600 B.R. 415 (B.A.P. 9^th Cir. 2019). It found that the Trustee properly administered the rental properties and rents as property of the bankruptcy estate. During her management of the rental properties, the Trustee sent some of the rents she collected to secured creditors with no objection from the Debtor. It concluded that when the secured creditors failed to cash rent checks remaining after the rental properties were abandoned, the Trustee properly deposited the rents with the court’s registry under Section 347(a).

Acknowledging that the secured creditors may no longer have rights to the unclaimed rents, the BAP held that the funds were not abandoned by the Trustee and therefore remain property of Debtor’s estate.

The BAP agreed that generally when an estate asset is abandoned, “the debtor’s interest in the property is restored nunc pro tunc as of the filing of the bankruptcy petition.” quoting Catalano v. C.I.R., 279 F.3d 682, 685 (9^th Cir. 2002). While it suggested in a footnote that this rule is not absolute and can give way in unjust situations such as this case, it did not discuss any unjust conditions existing here. Rather, it ultimately relied on the argument that the Trustee’s abandonment of the rental properties did not affect abandonment of the unclaimed rents.

Debtor appealed to the Ninth Circuit Court of Appeals (Court), which affirmed the two prior rulings.

REASONING

The Court agreed with the BAP that the Trustee did not abandon the unclaimed rents when she abandoned the rental properties. Because rents are a separate and discrete class of assets under Section 541(a)(6), they had to be abandoned clearly and with notice to creditors. The Court noted that a Trustee cannot abandon property by accident. Here, while the Trustee’s notice of abandonment listed the rental properties it made no mention of rents derived therefrom.

The Court further found that Debtor failed to object to the Trustee’s attempts to distribute rents to secured creditors, filing his motion to recover the unclaimed funds over a year after the case closed. He also failed to object to the Trustee’s Final Account, where the secured creditors were deemed owners of the unclaimed rents.

In the absence of abandonment, the Court concluded that the rents remain property of Debtor’s bankruptcy estate. Debtor would only have an interest in these proceeds after all creditors have been paid in full. The Court rejected Debtor’s argument that the funds will remain in limbo indefinitely, as they will in fact escheat to the U.S. Treasury if left unclaimed for five years. See 28 U.S.C. section 2042.

AUTHOR’S COMMENTS

This case is unusual in that it involves disagreements between a debtor and three courts over ownership of a significant amount of money that none of the estate’s creditors has attempted to claim.

The overarching question in this case is who has a right to the unclaimed funds. The Trustee and three courts concluded that the funds belong to Debtor’s secured creditors, and that the Trustee therefore properly attempted to pay the funds to them. The Court held that when the secured creditors declined the money the Trustee properly deposited the funds in the bankruptcy court’s registry under Section 347(a). However, a question remains whether the funds ever belonged to either the secured creditors or Debtor’s estate.

The Court found that the Trustee’s abandonment of the rental properties did not affect abandonment of rents collected on these properties. However, as the BAP acknowledged, “[u]pon abandonment, the debtor’s interest in the property is restored nunc pro tunc as of the filing of the bankruptcy petition.” Catalano v. C.I.R., 279 F.3d at 685; see Brown v. O’Keefe, 300 U.S. 598, 602 (1937) (holding that “[w]hatever title or inchoate interest may have passed to the trustee was extinguished by relation as of the filing of the petition when the trustee informed the court that the shares were burdensome assets, and was directed by the court to abandon and disclaim them. [Citations.] In such case ‘the title stands as if no assignment had been made.’ [Citations.] A precise analogy is found in the law of gifts and legacies. Acceptance is presumed, but rejection leaves the title by relation as if the gift had not been made.”); Mason v. C.I.R., 646 F. 2d 1309, 1310 (9^th Cir. 1980) (holding that “[w]hen the court grants a trustee’s petition to abandon property in a bankrupt’s estate, any title that was vested in the trustee is extinguished, and the title reverts to the bankrupt, nunc pro tunc”).

Thus, when the Trustee abandoned the rental properties in 2014, the result was that the properties were deemed to have never been assets of the Debtor’s estate. Rather, they remained Debtor’s assets continuously during the case. This suggests that the Trustee had no right to the rents on these properties as of commencement of the case. If true, the rents the Trustee collected after the Petition Date were not assets of the bankruptcy estate. Rather, they belonged to the rental properties’ owner, e.g., the Debtor.

The Court found that the Trustee did not specifically abandon the rents, which are a separate asset from the rental properties. See 11 U.S.C. § 541(a)(6). It therefore concluded that the rents are property of Debtor’s estate to this day. However, while rents “from property of the estate” are an estate asset, here the rents were collected post-petition. Because the rental properties were deemed abandoned as of the Petition Date, and therefore were not property of the estate as of that date, the rents were not collected “from property of the estate.” It would therefore appear that the rents were never an asset of the estate under Section 541.

If the unclaimed rents were indeed never property of the estate, and being that the secured creditors who at one time held liens on the funds have declined to assert their rights, an argument can be made that the funds in question should belong to the Debtor.

The BAP Opinion included reference to Wallace v. Lawrence Warehouse Co., 338 F.2d 392, 394, n. 1 (9^th Cir. 1964), which states,

The ordinary rule is that, when a trustee abandons property of the bankrupt, title reverts to the bankrupt, nunc pro tunc, so that he is treated as having owned it continuously. [Citations.] This is a fiction, and a fiction is but a convenient device, invented by courts to aid them in achieving a just result. It is not a categorical imperative, to be blindly followed to a result that is unjust. The Supreme Court itself had not so followed it. Dushane v. Beall, 1896, 161 U.S. 513, 16 S.Ct. 637, 40 L.Ed. 791; First National Bank of Jacksboro v. Lasater, 1905, 196 U.S. 115, 25 S.Ct. 206, 49 L.Ed. 408. See also In re J. C. Winship Co., 7 Cir., 1903, 120 F. 93, 96.

However, neither the BAP nor the Court relied on Wallace v. Lawrence for the proposition that abandonment should not have applied nunc pro tunc in the present case. Moreover, neither court discussed facts indicating that it would be unjust to apply the general rule recognized by the United States Supreme Court in Brown v. O’Keefe, 300 U.S. at 602.

These materials were written by Uzzi O. Raanan, a partner at Danning, Gill, Israel & Krasnoff, LLP, located in Los Angeles, California, who is a member of the ad hoc group and the representative from the Business Law Section (BLS) to the CLA’s Board of Representatives. Editorial contributions were made by the Honorable Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), also a member of the ad hoc group. 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.