In re Medley, No. 23-60014, 2024 WL 49806 (9th Cir. Jan. 4, 2024)

The following is a case update written by Hale Andrew Antico, Chief Counsel of Antico Law Firm, analyzing In re Medley, No. 23-60014, 2024 WL 49806 (9th Cir. Jan. 4, 2024), a recent case of interest:

SUMMARY

In In re Medley, the United States Court of Appeals for the Ninth Circuit affirmed the ruling of the Ninth Circuit Bankruptcy Appellate Panel (“BAP”) affirming a contempt order for willful violation of the automatic stay. The bankruptcy court entered the contempt order against an alleged factoring company, which the court found to be a lender, and therefore a creditor subject to the automatic stay.

To read the decision, click here.

FACTS

Jill Medley (“Debtor”) is a licensed real estate broker who listed for sale a property in Lake Elsinore, CA. In March 2019, the owner accepted an offer to purchase the property. Relying upon this pending sale and commission of approximately $47,000, Debtor entered into a contract with Precision Business Consulting, LLC (“Precision”), pursuant to which Debtor assigned the commission to Precision for an immediate advance of approximately $35,000. Debtor would also receive an additional $7,000 at the purchase funding date. Debtor granted Precision a security interest in the commission, all future commissions, as well as Debtor’s personal residence. Debtor was obligated to assign replacement commissions to Precision and assumed all risk if the Lake Elsinore sale failed to close.

And that is exactly what happened: the sale did not close. In March 2020, Debtor withdrew the listing and the next day filed a Chapter 13 bankruptcy petition. Precision filed a proof of claim, stating that it held a secured claim for over $53,000. Precision signed the proof of claim as a “Creditor.”

Debtor objected to Precision’s claim on grounds that it was a general unsecured claim. In response, Precision argued that it was not a lender but rather just a factoring company and “[f]actors don’t lend money.” It further claimed that it had a security interest because it secured its purchase of the receivable with a UCC filing.

Meanwhile, Debtor revealed that she re-listed the same property postpetition with an anticipated commission of $75,000. Precision made demands on the Debtor, the seller, the escrow company, and other clients of Debtor who sought to sell their properties. Precision did not seek relief from the automatic stay.

Debtor then sought an Order to Show Cause why Precision shouldn’t be held in contempt for violating the automatic stay under 11 U.S.C. § 362(k). Precision’s response was that it wasn’t a lender whose collateral included the commission, but instead was a factor that owned a portion of the commission. Precision reasoned that because the commission was Precision’s property and not Debtor’s, the commission was not property of Debtor’s bankruptcy estate. As a factor, Precision was merely protecting its own asset purchased prepetition and could not have violated the automatic stay.

The bankruptcy court held an evidentiary hearing. In part due to Precision’s admissions that it was a creditor, the bankruptcy court found that Precision was not a factor, but rather a secured creditor, subject to the automatic stay. The bankruptcy court ruled that the contract between Debtor and Precision was a disguised finance agreement and not a purchase agreement.

Having found Precision as a lender and secured creditor, the bankruptcy court ruled that the Precision willfully violated the automatic stay and awarded Debtor sanctions of $20,000.

Precision appealed to the BAP, which affirmed the ruling of the bankruptcy court. Precision appealed to the Court of Appeals, which also affirmed.

REASONING

The Ninth Circuit began by a review of the test for whether a transaction is a sale or a loan, and found that the standard is “the transfer of risk should be a primary factor to which a court looks.” Medley, at *1, citing S&H Packing & Sales Co. v. Tanimura Distrib. Inc., 883 F.3d 797, 802 (9th Cir. 2018) (en banc).

In assessing who held the risk, the court noted that the agreement between Debtor and Precision provided that the Debtor accepted full liability if the deal failed, and she alone bore the risk of the transaction. The Ninth Circuit also noted that Precision held a security interest in Debtor’s account receivables and her residence, and that Precision admitted its claim was secured by a perfected UCC filing. The court concluded that the transaction was a loan disguised as a sale, and Precision was subject to the automatic stay.

The Ninth Circuit also concluded that Precision willfully violated the stay and that sanctions were warranted.

Finally, the Ninth Circuit considered Precision’s argument that the commission was Precision’s property as of the petition date and that its communications to the Debtor and Debtor’s clients with real estate were merely an attempt to retain its property. Relying upon City of Chicago v. Fulton, 594 U.S. 154 (2021), which requires that creditors maintain the status quo once a bankruptcy is filed, the court noted that Medley possessed the advance she received from Precision as of the petition date, and Precision’s acts to collect the debt were protected by the stay.

In sum, the Ninth Circuit concluded that because Precision was a lender and took actions postpetition to collect on a debt, it violated the automatic stay; the Circuit affirmed the ruling of the BAP.

AUTHOR’S COMMENTARY

If it looks like a loan, walks like a loan, and quacks like a loan, then it is not a factor.

The Ninth Circuit correctly shut down an effort to create a loophole in the section 362(a) stay with what both courts called a “sale in disguise.” Had the decision had gone the other way, any creditor could claim that it is not a lender, but merely a factoring company not subject to the stay.  

Also, the Ninth Circuit got it right when it declined the invitation to broaden the Fulton holding beyond prepetition possession. Affirmative acts of collection which purportedly maintain the status quo are very different from passive retention. The Ninth Circuit was correct in upholding and protecting the automatic stay from erosion on both counts.

One lesson for attorneys representing both debtors and creditors is to not simply take a creditor’s word for it that it is merely a factoring company exempt from the automatic stay. When confronted with this type of transaction, counsel should remember the S&H Packing & Sales test to determine if the risk transferred from debtor to the company. If not, it is not a factoring company, but instead just a run-of-the-mill lender and creditor.

It could appear that the Debtor did not have clean hands. She received the advance from Precision, filed bankruptcy, and obtained sanctions for the violation of the automatic stay. After the case was dismissed, the Debtor also received the full commission. This can feel like an unfair result with unjust enrichment. Debtors should use the bankruptcy process and automatic stay as a shield, and not a sword. It is not clear that this happened here.

However, despite Debtor’s actions, the creditor should have simply admitted it was a lender/creditor subject to the stay, and filed a motion for turnover or sought some other remedy. Instead, it tried to be too clever and ended up footing the bill.

These materials were written by Hale Andrew Antico, Chief Counsel of Antico Law Firm, representing consumer debtors in the Central District of California, and President of the Central District Consumer Bankruptcy Attorneys Association, with editorial contributions by Maggie Schroedter, Partner, Robberson Schroedter LLP.