The following is a case update written by Robert G. Harris of the Silicon Valley bankruptcy boutique, Binder & Malter, LLP, analyzing a recent decision of interest:
In In re Martinez (Otte v. Naviscent) 2021 WL 66306 (N.D. Cal. 1/7/21) United States District Court for the Northern District of California upheld on appeal from the United States Bankruptcy Court for the Northern District of California (a) an order finding a Temporary Protective Order (“TPO”) and Writ of Attachment lien securing the claim of a victim of embezzlement, issued without a statutorily required undertaking, is voidable as an act that exceeded the Superior Court’s jurisdiction, but was not void, in that it was not an act beyond that Court’s fundamental jurisdiction, and (b) a judgment avoiding as a fraudulent conveyance the granting of a deed of trust given by the debtor to hinder or delay the holder of the TPO/Writ of Attachment lien. Significantly, the District Court also upheld under California Penal Code section 496 a substantial award of attorneys’ fees for prosecuting the embezzlement pre- and post-petition.
Appellant and debtor Leeanna Martinez (“Martinez”) worked as an independent contractor, performing bookkeeping services for several clients. Martinez was a bookkeeper for Naviscent, LLC (“Naviscent”) and Michael Otte (“Otte”), a contractor and former corrections officer.
In March 2018, Otte discovered that Martinez had embezzled from him an amount he believed to be $38,000. Otte pursued settlement efforts with Martinez and convinced Martinez’s husband to withdraw cash from a bank account and repay a portion of what was owed to Otte.
Naviscent investigated Martinez. Martinez admitted to embezzling from Naviscent in a recorded interview during a meeting with Naviscent’s representatives. Naviscent brought an action against Martinez in Santa Clara Superior Court. On April 24, 2018, the Superior Court issued a Temporary Protective Order (“TPO”), which prohibited Martinez from transferring any interest in any of her real or personal property without requiring an undertaking. The court also set a hearing on Naviscent’s request for a Right to Attach Order (“RTAO”) and Writ of Attachment.
On April 30, 2018, shortly after Naviscent filed its complaint against Martinez, Otte and Martinez reached a settlement agreement. The agreement required Martinez to pay Otte $300,000 in the form of a promissory note, secured by a deed of trust against her home. The deed of trust was recorded with the county on May 16, 2018, a few weeks after Naviscent had served Martinez with the TPO.
Earlier, on May 3, 2018, Naviscent recorded a lis pendens in the county where Martinez’s home was located. At Martinez’s request, the Superior Court continued the hearing on Naviscent’s writ application to June 19, 2018 and extended the TPO. Before the hearing, Naviscent learned that Martinez and Otte entered a settlement agreement and that Martinez executed a promissory note and deed of trust encumbering her home to Otte. Naviscent filed an ex parte application for an order to show cause (“OSC”) re contempt for Martinez’s violation of the TPO and for a right to attach order. The court set a hearing for the OSC and reset the hearing for the application for the right to attach order per Martinez’s request.
Martinez did not challenge the validity of the TPO before or during the hearing. On June 28, 2018, the court granted Naviscent’s writ application and issued right to attach order (“RTAO”); a writ of attachment (“Writ”) was issued, served and recorded on June 29, 2018.
Otte claimed that, at the time he signed the settlement agreement, he reviewed a title report for the Martinez property that did not indicate any TPOs, writs, or lis pendens in favor of Naviscent. Otte also testified that that he learned of Naviscent’s state court action against Martinez only after he signed the settlement agreement with Martinez and did not know of Naviscent’s TPO or Writ against Martinez until May 31, 2018—almost two weeks after Otte recorded the deed of trust against Martinez’s property.
Martinez’s communications with Otte displayed her preference that Otte receive any available money before Naviscent. Among other things, upon learning of Naviscent’s state court action against her, Martinez informed Otte via text message that she would tell George Papazian, Naviscent’s principal, that she had signed an agreement with Otte. In another communication with Otte, Martinez said of Naviscent’s CEO:
Now he’s really going to have to work to get his money. I’m signing legal separation papers today so Rene [Martinez’s husband] is protected. My estate will have to go through probate. It will be months or more before the house can even be sold. It may go into foreclosure first. He is the one who will be royally screwed.
Naviscent alleged that Otte and Martinez shared a special relationship and that her agreeing to a settlement with Otte was achieved while she was insolvent, suggesting an intent to at least delay Naviscent’s claim and likely an intent to hinder Naviscent’s claim.
Martinez filed for Chapter 13 bankruptcy on August 22, 2018, 98 days after the Otte deed of trust was recorded and within 90 days of issuance of Naviscent’s Writ (but more than 90 days after the issuance of the TPO, to which the Writ of Attachment lien related back).
Martinez sold her residence with court approval and all proceeds were ordered held by her counsel pending further order of the court.
On November 13, 2018, Naviscent filed an adversary proceeding in bankruptcy court against Otte and sought a declaration that: (1) Otte’s deed of trust was invalid; and (2) Naviscent’s TPO had priority over Otte’s deed of trust. Naviscent later amended its complaint to add causes of action for avoidance of Otte’s deed of trust and actual and constructive fraud.
On December 27, 2018, Martinez filed an adversary proceeding against Naviscent, alleging for the first time that Naviscent’s TPO and Writ were void because it had not posted an undertaking.
On March 19, 2019, Otte filed his own adversary proceeding against Naviscent, seeking declaratory relief, and alleging that: (1) Naviscent’s TPO and Writ were void; (2) Naviscent’s claim, if it existed, was subordinate to Otte’s deed of trust; and (3) Naviscent had failed to establish the amount of its claim against Martinez. Otte argued that Naviscent did not qualify for a Writ, the state court extended the TPO without noticed motions, and Naviscent did not post an undertaking. Naviscent asserted a variety of affirmative defenses and argued that Otte’s settlement agreement, promissory note, and deed of trust were unenforceable.
On March 5, 2019, the court denied Martinez’s motion for summary judgment on her claim and held that the Writ was voidable but not void. Martinez moved to alter or amend the order denying summary judgment. Although the parties had each brought motions before the bankruptcy court to allow the Superior Court to make further findings regarding the validity of the TPO and Writ, the parties stipulated to allow the bankruptcy court to resolve the question of whether Naviscent’s Writ remained valid, and the court directed the parties to file supplemental briefing on that issue as part of the motion to alter or amend the judgment. The bankruptcy court also invited Otte and Rene Martinez (Martinez’s husband), who were parties in interest but not parties to the adversary proceeding, to file briefs on the motion to alter or amend. Neither did so. In a memorandum decision denying Martinez’s motion to alter or amend the judgment, the bankruptcy court on September 6, 2019 affirmed its prior ruling that Naviscent’s TPO and Writ were voidable, not void, and held that the doctrine of laches barred Martinez from voiding the TPO and Writ. This decision was binding on all parties, including Otte.
Judgment After Trial
The bankruptcy court consolidated the adversary proceedings between Naviscent and Otte for trial. After a two-day trial, the judge concluded that: (1) Naviscent established an allowed secured claim of $734,000, plus interest and attorneys’ fees and costs; (2) Otte established a nonpriority unsecured claim in the amount of $300,000; and (3) Martinez demonstrated an intent to hinder or delay Naviscent’s recovery when she transferred to Otte the promissory note secured by a deed of trust against her home, thereby rendering Martinez’s grant of a security interest to Otte “avoided.” The court also found, based on the law of the case doctrine, that her rulings on summary judgment in Martinez v. Naviscent precluded Otte’s challenges to Naviscent’s Writ.
Martinez appealed the bankruptcy court’s Order Denying Motion for Summary Judgment, its subsequent Order Denying Motion to Alter or Amend Judgment, its Order Granting Summary Judgment, and the Judgment entered pursuant thereto. Martinez sought reversal of these orders and a ruling that Naviscent’s TPO and Writ were void ab initio.
Otte appealed the judgment after trial and sought reversal, reinstatement of his secured claim, and limitation of Naviscent’s claim to $265,257.61.
California Code of Civil Procedure Section 489.210 requires that “[b]efore issuance of a writ of attachment, [or] a temporary protective order . . ., the plaintiff shall file an undertaking to pay the defendant any amount the defendant may recover for any wrongful attachment by the plaintiff in the action.” Cal. Code Civ. P. § 489.210. The Superior Court issued the TPO and RTAO without the box for a bond checked. It is undisputed the Naviscent did not post a bond.
The central issue appealed was whether the TPO and RTAO were void or merely voidable. Appellants relied on Vershbow v. Reiner, 231 Cal. App. 3d 879 (1991) for the proposition that the issuance of the TPO and the Writ were void and not voidable. Naviscent relied on People v. Am. Contractors Indem. Co., 33 Cal. 4th 653 (2004), arguing that the two orders issued were instead voidable.
The bankruptcy court declined to apply Vershbow because “American Contractors expands the analysis set forth in Vershbow to require an analysis of whether an invalid act is void or voidable.” The bankruptcy court relied on American Contractors, a decision by the California Supreme Court issued thirteen years after Vershbow, that distinguished between trial court actions for which the court lacked fundamental jurisdiction and trial court actions that simply exceeded the court’s jurisdiction. Without fundamental jurisdiction to hear or determine a case, due to an absence of authority over the parties or the subject matter, any ensuing judgment will be void ab initio. If instead a court acts contrary to authority conferred upon it by statute, its act or judgment is merely voidable.
The District Court followed the lower court’s analysis, distinguishing Vershbow on its facts. In Vershbow, the court had expressly required the posting of an undertaking; it was the clerk that mistakenly issued the writ without one. By contrast, the Superior Court in the case at bar failed to check the box requiring an undertaking or to specify the amount in the available field on the form. The District Court also distinguished the case at bar from Vershbow because Appellants in the case at bar had failed to challenge Naviscent’s TPO and Writ in the Superior Court, choosing instead to wait until sometime after the bankruptcy case had been filed to do so; in Vershbow the trial court declared the applicant’s Writ void in the same action in which the Writ was issued. The District Court also agreed with the bankruptcy court that the 1932 California Supreme Court decision of Baird v. Smith, 216 Cal. 408 (1932) was not applicable because it dealt with default judgment statutes, which explicitly grant the court clerk authority to enter default judgment. By contrast, the statutes governing attachments do not authorize the clerk to issue a writ of attachment on its own; the clerk’s authority to issue the TPO and Writ is derived solely from the court’s RTAO.
The District Court upheld the bankruptcy court, overruling other, less consequential, challenges to the TPO and Writ, including: (1) the claim that continuances requested by Martinez, granted without a noticed hearing, had been improper; (2) the assertion that the Writ, having been recorded in the 90 days prior to filing, was terminated by Cal. Code Civ. P § 493.030(b) even though the TPO has been issued outside the 90-day period; (3) the TPO and Writ could not be avoided under the Strong Arm clause of Bankruptcy Code section 544 because it was not raised in the complaint filed by Martinez or the summary judgment filings.
Central to the outcome of this case was the bankruptcy court’s unheeded warning to all parties that the doctrine of law of the case applied and that issues decided in one adversary proceeding would be binding on the parties in another. Otte was offered the opportunity to file briefs on Martinez’s summary judgment motion and did not. The District Court upheld the bankruptcy court’ refusal to allow Otte to relitigate whether the TPO and Writ were void rather than voidable at trial, citing United States v. Alexander, 106 F.3d 874, 877 (9th Cir. 1997) and identifying the doctrine as applicable to issues that were “decided explicitly or by necessary implication in the previous disposition” United States v. Lummi Nation, 763 F.3d 1190, 1187 (9th Cir. 2014), and finding the doctrine applicable in bankruptcy cases citing In re GGW Brands, LLC, 2013 WL 6906375, at *16 (Bankr. C.D. Cal. Nov. 15, 2013) (citing In re Pilgrim’s Pride Corp., 442 B.R. 522, 530 (Bankr. N.D. Tex. 2010)).
The District Court also upheld the finding after trial that that Martinez possessed an intent to delay and to hinder, but not an intent to defraud, and the bankruptcy court’s avoidance of the deed of trust granted to Otte as a fraudulent conveyance. The District Court reviewed the lower court’s application of the California Uniform Fraudulent Transfers Act (“CUFTA”) and finding that at least three of the nonexclusive factors known as “badges of fraud” were present in support of the finding of an intent to hinder or delay: (1) the grant of security interest to Otte after Naviscent filed its complaint in state court; (2) a “special relationship” between Martinez and Otte; and (3) Martinez’s “growing and unmanageable insolvency.”
Finally, the District Court reviewed and upheld the findings that Naviscent had established a $734,000 claim over numerous factual challenges. The District Court also upheld, in a unique and detailed ruling, the award of attorneys’ fees for prosecuting the embezzlement case against Martinez under California Penal Code section 496.
The decision to uphold a lien notwithstanding the absence of an undertaking was not reached easily. The facts favored Naviscent. It was the victim of gross financial misconduct by Martinez. Once Martinez’s crimes were discovered, she acted with intent to hinder or delay Naviscent by granting Otte a deed of trust and then filing bankruptcy once that lien had aged beyond attack as a preference. Still, the simple failure to ensure that a $10,000 undertaking was posted was nearly fatal. While the Superior Court issued an order without the box for an undertaking being checked, and the court clerk would not accept a check after the TPO had issued, this case might have ended much sooner and with much less expense had the error been brought to the attention of the Superior Court immediately. Ideally, the TPO could have been amended to allow the undertaking to be posted.
An easily-overlooked aspect of this decision is the upholding of an award of attorneys’ fees and costs for prosecuting embezzlement under California Penal Code section 496 and the District Court’s detailed analysis. Without a contractual basis for including fees in Naviscent’s secured claim, this award (fees of $260,532.50 and costs of $4,669.60) suggests that victims of future crimes may well have a new and powerful tool to recover against criminals who file for bankruptcy.
One final note: had appeal been taken to the 9th Circuit (instead of the matter being settled), it is very possible that the Panel might have certified the issue of whether Naviscent’s lien was voidable or void ab initio for determination by the California Supreme Court under California Rule of Court 8.548. Instead, the matter was settled following a judicially-supervised settlement conference with Naviscent receiving all funds held less Martinez’s homestead exemption. Otte retains his unsecured claim in the Chapter 13 case where the plan is to be confirmed while all adversary proceedings will be dismissed.
These materials were authored by Robert G. Harris of the Silicon Valley bankruptcy boutique, Binder & Malter, LLP with editorial assistance by United States Bankruptcy Judge Meredith Jury (ret.), 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.