Business Law

In re Brown

The following is a recent case update:

Summary

In In re Brown, 606 B.R. 40 (9th Cir. BAP 2019), the U.S Bankruptcy Appellate Panel for the Ninth Circuit held, as a matter of first impression, that the time to commence an action on a state law claim was continuously tolled after the debtors received their bankruptcy discharge pursuant to a state statute suspending the limitations period while the commencement of an action is stayed by injunction or statutory prohibition.  The BAP accordingly affirmed the bankruptcy court’s order overruling the debtor’s objection to the claim as untimely.  A copy of the opinion can be viewed here.

Facts

In 2012, the debtors commenced their bankruptcy case by filing a voluntary Chapter 7 petition. Because of an apparent lack of assets, the bankruptcy court’s notice of the bankruptcy filing instructed creditors not to file proofs of claim.  Within a few months, the Chapter 7 trustee issued his final report stating that there were no assets to distribute.  As such, the debtors received their discharge, and the case was closed.  About four and a half years later, in 2017, the debtors moved to reopen their case based on their recent discovery of a potential prepetition personal injury or product liability cause of action.  The bankruptcy court entered an order reopening the case.  A new chapter 7 trustee was appointed, and the court issued a notice advising creditors that assets for distribution had been found and setting a claims bar date for creditors to file proofs of claim.  The appellee, MOMA Funding LLC, timely filed a proof of claim with the bankruptcy court. The debtors objected to the proof of claim as being barred by the applicable statute of limitations.

The debtors conceded that their bankruptcy case intervened before the statute of limitations period expired on MOMA’s claim under California law, and that the limitations period was tolled while the automatic stay prohibited MOMA from instituting a collection action on its claim under California Code of Civil Procedure (“CCP”) section 356, which suspends statutes of limitations during periods when an injunction or statute prohibits commencement of an action.  However, the debtors argued that the limitations period began to run again upon the closing of their case and therefore it had expired before their bankruptcy case was reopened in 2017.  The debtors maintained that the discharge injunction did not cause a further suspension of the limitations period under CCP section 356, and that MOMA should have nominally sued them on the debt solely for the purpose of preserving its rights before the statute of limitations expired.  

After holding a hearing, the bankruptcy court entered an order overruling the debtors’ objection and allowing the claim.  The bankruptcy court explained that, pursuant to CCP section 356, the discharge injunction suspended the applicable limitations period. The bankruptcy court found the debtors’ argument that the discharge injunction did not toll the statute of limitations was unsupported by any persuasive authority and was at odds with the plain language of the statute.  The debtors timely appealed, and the BAP affirmed the bankruptcy court on appeal.

Reasoning

The BAP began its analysis with Bankruptcy Code section 108(c), which provides that if a limitations period for bringing a claim against the debtor has not expired prepetition under applicable nonbankruptcy law, then the time to bring such claim does not expire until the later of “(1) the end of such period, including any suspension of such period occurring on or after the commencement of the case; or (2) 30 days after notice of the termination or expiration of the stay under section 362, 922, 1201, or 1301 of this title, as the case may be with respect to such claim.”  11 U.S.C. § 108(c); see also Rogers v. Corrosion Prods., Inc., 42 F.3d 292, 297 (5th Cir. 1995).

The BAP rejected the debtors’ argument that the limitations period on the creditor’s claim began to run again when the bankruptcy court closed the bankruptcy case, thereby terminating the automatic stay.  Instead, the BAP focused on section 108(c)(1) and agreed with the creditor that the statute of limitations never restarted because the creditor was enjoined from pursuing the debtors after entry of the debtors’ discharge, and that the discharge injunction continued to toll the limitations period under CCP section 356.  Section 356 provides: “When the commencement of an action is stayed by injunction or statutory prohibition, the time of the continuance of the injunction or prohibition is not part of the time limited for the commencement of the action.”  The BAP noted that, pursuant to Bankruptcy Code section 524(a)(2), the bankruptcy discharge “operates as an injunction against the commencement or continuation of an action . . . to collect, recover or offset any such debt as a personal liability of the debtor.”  Thus, the BAP determined that the discharge injunction fell squarely within the “injunction or statutory prohibition” language of CCP section 356.

The BAP was not persuaded by the debtors’ contention that the discharge injunction is limited to actions seeking to impose personal liability on a debtor, and that it is not broad enough to trigger CCP section 356, because the creditor could have commenced an action nominally naming the debtors for some purpose other than collecting or enforcing the debt as a personal liability.  Indeed, the BAP found “nonsensical” the debtors’ reliance on cases permitting debtors to be nominally named in lawsuits without violating the discharge injunction for the sole purpose of pursuing a collateral source of recovery, such as insurance or other third party funds.  The BAP noted that the only source of recovery here was the bankruptcy estate.  Thus, in order to comply with the statute of limitations (if not suspended), the creditor would have needed to commence an action to collect or enforce the debt, which action was specifically enjoined by Bankruptcy Code section 524. 

In addition to finding the debtors’ legal arguments unpersuasive, the BAP noted that finding in favor of the debtors would also yield an unjust result.  This is because it would essentially reward the debtors for failing to disclose all their assets, including the litigation claims.  The BAP pointed out that if the debtors had timely disclosed their litigation claim on their initial bankruptcy schedules, as they were required to do under Section 521, then the bankruptcy court would have instructed creditors to file claims, and the creditor here presumably would have filed a claim by the bar date, thus mooting the statute of limitations issue.  Thus the BAP concluded that finding in favor of the debtors would effectively reward the debtors for failing to carry out their legal duties, and that would be contrary to basic notions of justice.

Author Commentary

While a matter of first impression, the BAP’s ruling is solid on both legal and policy grounds.  As the decision recognizes, finding that the discharge injunction does not toll the statute of limitations under CCP section 356 would invite all sorts of mischief in the reporting of undisclosed assets by debtors.  Unscrupulous debtors could, for example, file “no asset” cases resulting in creditors not filing proofs of claim, but later amend their schedules to list previously undisclosed assets after the statute of limitations had expired, thereby preventing the creditors from sharing in proceeds from such newly disclosed assets. 

In a lengthy footnote, the BAPalso suggested alternative grounds for the creditor’s claim to be deemed timely even in the absence of a tolling statute such as CCP section 356 (thereby perhaps protecting creditors in jurisdictions outside California without such statutory protections).  Such an argument is premised on the statute of limitations being measured as of the petition date, rather than when a creditor’s proof of claim is filed.  In support of this position, the BAP cited its prior decision in BAC Home Loans Servicing, LP v. Abdelgadir (In re Abdelgadir), 455 B.R. 896, 901 (9th Cir. BAP 2011) (“[a]s of the petition date, the estate is created and creditors’ rights are fixed as much as possible.”)  The BAP further noted that pursuant to Bankruptcy Code section 502(b), the amount of a creditor’s claim is determined as of the petition date.  See Cadle Co. v. Mangan (In re Flanagan), 503 F.3d 171, 179 (2d Cir. 2007) (“A plain reading of [section 502(b)] thus suggests that the bankruptcy court should determine whether a creditor’s claim is enforceable against the debtor as of the date the bankruptcy petition was filed.”).  The BAP also pointed out that courts limit the bankruptcy estate’s defenses to claims under Bankruptcy Code section 558—which provides the estate with “any defense available to the debtor”—to prepetition defenses that the debtor may have had outside of bankruptcy.  See In re Parrott Broad. Ltd. P’ship, Case No. 10-40017-JDP, 2013 WL 3230345, at *7 (Bankr. D. Idaho June 26, 2013) (“These defenses are limited to ‘pre-petition defenses to a cause of action that would have been applicable to a debtor if no bankruptcy case had been filed.’”) (citing Reed v. City of Arlington, 650 F.3d 571, 575 (5th Cir. 2011)).  However, the BAP acknowledged that discussion of such matters was dicta, as neither the bankruptcy court nor the parties had raised these issues. 

These materials were prepared by ILC member Gary M. Kaplan, a partner at Farella Braun + Martel LLP in San Francisco (gkaplan@fbm.com), with editorial contributions from ILC member M. Douglas Flahaut, a partner at Arent Fox LLP in Los Angeles (douglas.flahaut@arentfox.com). 

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