The following is a case update written by Michael W. Davis of DTO Law, regarding a recent case of interest.
In In re Bral, 622 B.R. 737(9th Cir. BAP 2020), the U.S. Bankruptcy Appellate Panel for the Ninth Circuit affirmed a bankruptcy court’s ruling sustaining a debtor’s objection to a proof of claim on the grounds that federal law preempts any state law claim for damages arising from a bad faith bankruptcy filing. The bankruptcy court held, and the BAP affirmed, that federal preemption determines not only jurisdiction, but also the relief available to claimants asserting damages as a result of a bad faith bankruptcy filing. To view the memorandum, click here.
Debtor John Jean Bral (“Bral”) and Barry Beitler (“Beitler”) formed Ocean View Medical Investors, LLC (“Ocean View”) in 2005. Ocean View’s sole asset was an office building located in Newport Beach, California. In late 2005, Ocean View obtained a $4.75 million loan from First Regional Bank, secured by the office building. The loan was guaranteed by Bral and Beitler. In 2012, the loan went into default. In 2014, Steward Financial, LLC (“Steward”), an entity owned by Beitler, acquired the loan and guaranties from First Regional Bank. Steward subsequently scheduled a nonjudicial foreclosure sale to occur in late 2014 (the “First Sale”).
On the morning of the First Sale, Bral, as a co-manager of Ocean View (and apparently with the consent of all the members except Beitler), caused it to file a chapter 11 petition. Due to an apparent lack of notice to the foreclosure trustee, the First Sale nonetheless proceeded, and Steward was the successful bidder at the auction with a $3 million credit bid. After learning of Ocean View’s bankruptcy, the foreclosure trustee vacated the First Sale. Beitler, also as co-manager of Ocean View, moved to dismiss the bankruptcy case on the grounds that Bral lacked the authority to put Ocean View into a voluntary bankruptcy case without Beitler’s approval. The bankruptcy court ultimately granted the motion and dismissed Ocean View’s bankruptcy case. Thereafter, a second foreclosure sale was held and Steward again purchased the property, this time over competing bidders, with an increased credit bid of $4.1 million (the “Second Sale”).
After completion of the Second Sale, Steward filed a complaint in the Superior Court of California, County of Orange, asserting that it was harmed by Bral when he caused Ocean View’s case to be filed (in bad faith) because Steward ultimately had to pay $1.1 million more for the property at the Second Sale. Steward alleged that Bral was responsible for the increased purchase price because Ocean View’s bankruptcy filing constituted an abuse of the bankruptcy process by Bral and a tortious interference with Steward’s contractual rights to foreclose.
Bral subsequently filed an individual chapter 11 bankruptcy. Steward filed two proofs of claim, the first based on the same claims it asserted in the Orange County case (the “First Claim”), and the second based upon Bral’s remaining liability under his guaranty. Bral objected to the First Claim on two grounds. First, that Steward could not maintain a state law claim against him in connection with the bankruptcy filing because any such claim was barred by preemption. Second, that Steward’s claim was barred by the “economic loss rule,” because the difference in the sales price between the two foreclosure sales did not cause Steward to suffer any legally cognizable harm or damages. Steward, in turn, argued that a prior decision of the U.S. Court of Appeals for the Ninth Circuit, Davis v. Yageo Corp., 481 F.3d 661 (9th Cir. 2007) (“Davis”), limited the scope of preemption to conduct that occurred during Bral’s bankruptcy (and not Ocean View’s) and Steward sought relief for Bral’s misconduct which occurred prior to the petition date of his individual case. Steward also argued that the legally cognizable harm to Steward was the reduction of Bral’s liability under his guaranty in the amount of $1.1 million (the difference between the sales price at the First Sale and the Second Sale).
The bankruptcy court agreed with Bral and disallowed the First Claim. On appeal, the BAP affirmed.
The BAP addressed two questions: did the bankruptcy court correctly disallow the First Claim based on preemption and did it correctly conclude that Steward had not asserted any legally cognizable harm?
As to the first question (preemption), the BAP recognized that the Ninth Circuit has held “on a number of occasions . . . that the Bankruptcy Code and Rules completely preempt state law causes of action and remedies arising from the act of filing a bankruptcy.” Bral, 622 B.R. at 743. The BAP relied on the “sweeping scope” of Miles v. Okun (In re Miles), 430 F.3d 1083 (9th Cir. 2005) (“Miles”); MSR Expl., Ltd. v. Meridian Oil, Inc., 74 F.3d 910 (9th Cir. 1996) (“MSR”); and Gonzales v. Parks, 830 F.2d 1033 (9th Cir. 1987) (“Gonzales”) to conclude that: (i) Congress had expressed a policy of providing that federal courts (and not state courts) should decide what penalties apply in connection with the alleged misuse of the bankruptcy process (Miles at 1089) and allowing state court remedies for wrongful bankruptcy filings would interfere with the bankruptcy process (Miles at 1090); (ii) the Bankruptcy Code completely preempts state law malicious prosecution cases for conduct in bankruptcy proceedings (MSR at 912-13); and (iii) causes of action for abuse of process relating to wrongfully filed bankruptcies are also preempted by the Bankruptcy Code (Gonzales at 1036). The BAP ultimately concluded that together, Miles, MSR, and Gonzales recognize a “a comprehensive federal scheme and a dominant federal interest in maintaining complete control over the bankruptcy process” including claims relating to wrongful filings. Bral, 622 B.R. at 745.
The BAP rejected Steward’s arguments that Davis compelled a different result. Davis involved prepetition breach of fiduciary duty claims asserted on the basis that a company’s directors engaged in self-dealing when they authorized the entity debtor’s bankruptcy filing. Steward asserted that its claims against Bral were similar in posture to the breach of fiduciary duty claims in Davis and were not preempted as the claims were based on Bral’s conduct that occurred prior to his individual case. The BAP disagreed. The BAP stated that Steward overlooked that Bral’s at-issue conduct did occur in the context of a bankruptcy case, Ocean View’s dismissed Chapter 11 filing. So, the BAP reasoned, “[Steward] does not assert prepetition state law causes of action divorced from the Bankruptcy Code. Rather, its claims arose from Ocean View’s initial bankruptcy filing itself. As such, they are ‘completely preempted’ by the Bankruptcy Code.” Id. at 747. The BAP focused on the fact that the gravamen of Steward’s claims were damages arising from pleadings filed and pursued in a bankruptcy proceeding.
As to the second question (damages), the BAP also affirmed the bankruptcy court’s holding that Steward had failed to allege cognizable damages. The BAP reasoned that Steward “received everything it was entitled to receive” in connection with the Second Sale. Id. at 748. Further, that the increased value of the property was to Steward’s benefit rather than its detriment. The BAP stated plainly that the “diminished guaranty claim does not even make sense” because Steward could not be harmed when it received more value for its collateral in the Second Sale than it did through the First Sale. Id.
Stay tuned for an update as Steward is appealing the BAP’s ruling (Ninth Circuit Case No. 21-60004), and we will likely find out whether the Ninth Circuit agrees with Steward’s argument that Davis compels a different result here.
Given the holdings of Miles, MSR, and Gonzales, it does appear that the BAP was on solid ground when it reasoned that the First Claim asserted damages based upon documents filed and prosecuted in a bankruptcy case and is therefore preempted. It also appears that Steward’s asserted damages are based upon its desire to maximize its claim against Bral rather than an effort to ensure complete recovery (perhaps because of animus between Bral and Beitler). Otherwise, Steward might have been relieved by the increased value of its recovered collateral, as it lessened Steward’s unsecured claim in Bral’s bankruptcy.
These materials were authored by ILC member Michael W. Davis, of DTO Law (firstname.lastname@example.org), with editorial contributions from ILC member Meredith King, of Higgs Fletcher & Mack.