A recent case shows the potential for interplay between the law of mortgages and bankruptcy.

In that case, Piedmont Capital Mgmt. v. McElfish, No. B316372 (Cal. Ct. App. Aug. 24, 2023), the borrower purchased a home in 2006, acquiring a first deed of trust from one lender, and a home equity line of credit (HELOC) from a second. For convenience, in mortgage parlance, the first loan constitutes the first (or senior) mortgage, while the HELOC constitutes a second mortgage. The HELOC had a 30-year maturity (2036). It also gave the lender the option to accelerate the loan and ask for all past due amounts, which was renewed as each successive month’s payment became due.

The buyer began to experience financial difficulty a few years later, and in or around 2011 and 2012, he stopped paying on the first mortgage and the HELOC, respectively. The holder of the first mortgage foreclosed in 2012, apparently by trustee’s sale. The HELOC was unsatisfied by the sale.

Had the homeowner chosen to file Chapter 7 bankruptcy after the first lender foreclosed, the debt owed to the HELOC lender likely could have been discharged. Again, this is because the collateral was gone. The HELOC was a classic unsecured debt. The homeowner could still likely do so, even after the Court of Appeal’s intervention, because bankruptcy is federal law, and is a different statutory scheme which answers to a different sovereign, i.e., the Federal government.

Instead, the homeowner embarked on four years of litigation, which included the Court of Appeal. The trial court held that 1) the four-year statute of limitations for written contracts applied, 2) that the homeowner had made his last payment in or about 2012, and that therefore, 3) the 2019 lawsuit was time-barred.

Enter the Court of Appeal, which reviewed the HELOC agreement. That Court decided that each monthly payment that came due constituted not only an opportunity to pay the regular monthly amount, but each successive monthly failure to pay gave the HELOC lender the option to accelerate the loan (the “acceleration clause”) and ask for all past due amounts. Because the contract called for monthly payments until 2036, and each successive month gave the HELOC lender the option to invoke the acceleration clause, the lender’s time to seek all past due payment was not even close to running out. There was no bar of the statute of limitations, for amounts that could be demanded up until 2036.

Consumer bankruptcy (“Chapter 7”) has as its goal the liquidation of unsecured debt. The moment that the borrower’s home was foreclosed and taken by the holder of the first mortgage, the security (collateral) for the HELOC was gone. The HELOC  became an unsecured debt. A Chapter 7 could have discharged (cancelled) the debt.

As of the time of the Court of Appeal’s decision, the homeowner still owed the HELOC payments. Effective bankruptcy counsel could, however, show him another option that could protect his remaining estate.



Under Recent Law, Even Debts Based on Alleged Malicious Conduct Can be Discharged.

Under Recent Law, Even Debts Based on Alleged Malicious Conduct Can be Discharged.

In 2019, Congress passed the Small Business Reorganization Act of 2019 (“SBRA”), whose Subchapter V specifically allowed small businesses to reorganize, discharge certain debts, and pay back a portion of other debts over a 3- or 5-year period. This latter aspect is similar to the standard Chapter 11 employed for large organizations, such as General Motors, the Los Angeles Dodgers baseball club, or the recent reorganizations of cryptocurrency firms Voyager, Celsius, and FTX.
In the Subchapter V bankruptcy, the debtor proposes the plan of reorganization, and the court has the option to cram it down the creditors’ throats (assuming that the Court believes that the plan is objectively fair). This is called a “non-consensual plan of reorganization” in Subchapter V.
In an interesting twist, however, where the court approves the small business’s nonconsensual plan of reorganization, the SBRA allows small enterprises to discharge their debts, even where the creditor alleges debts that stem from fraud, breach of fiduciary duty, tax fraud, malicious conduct, or any other exception to discharge stated under 11 USC Sec. 523(a).
In other words, the exceptions to discharge (debts that cannot be cancelled) stated in 11 USC Sec. 523 (a) do not apply to small business, where the court approves the nonconsensual plan of reorganization.
This may lead to harsh results. For example, in a recent case, the creditor who claimed she was injured by the company’s malicious conduct found her claim to barred, or “discharged.” As a result of the explicit language of the SBRA, her claim was effectively cancelled. The court explained that, if Congress had intended a different result in such a case, it would have said so in the law.

In re Off-Spec Solutions, LLC (Kristina Jayn Lafferty v. Off-Spec Solutions LLC, et al)
BAP ID-23-1020-GCB; Adv. No. 22-06020-NGH (Ninth Circuit Court of Appeals, Bankruptcy Appellate Panel; Appeal from the Bankruptcy Court for the District of Idaho; Filed July 6, 2023)


Fraudulent Transfer: Bankruptcy Court Combines California and Federal Statutes, and Allows Trustee to Undo a Fraudulent Sale

Fraudulent Transfer: Bankruptcy Court Combines California and Federal Statutes, and Allows Trustee to Undo a Fraudulent Sale

In 2010, a California property developer, Momentum, signed a contract to have an oil well drilled on its real estate. About 2 years into the drilling, in 2012, Momentum, transferred the property to a related but separate entity, Pyramid, for 55¢, without notifying the drilling company. The drilling company apparently did not strike oil, because Momentum sued for breach of contract in 2014, even though it no longer owned the land (an obvious legal contradiction).

Momentum lost at trial (possibly for lack of standing, i.e., it no longer owned the land, and hence, the contract), and a judgment for the drilling company was entered in May 2018 (less than seven years after the 55¢ transfer).

Momentum promptly (June 2018) filed for Chapter 7 (liquidation) bankruptcy, saying that it had no assets.

The bankruptcy put the 55¢ sale in the spotlight. A “fraudulent transfer” is defined as a conveyance intentionally done to deprive creditors of the asset, or a transfer for less than reasonable value, which is made when the debtor is insolvent, or which transfer renders the debtor insolvent. 11 US Code Sec. 548 (a)(1)(A)-(B); Uniform Voidable Transactions Act, § 4(a), at 19.

The bankruptcy Trustee (Diane Weil) discovered the relationship between Momentum and Pyramid, and sued to undo the land deal, as a transfer intended to frustrate creditors. This is an interesting argument, because Momentum sued the drilling company, and not the other way around. The Trustee could have reasoned that the common ownership and management of Pyramid and Momentum was suspicious, and the 2012 transfer could render a countersuit against Momentum meaningless.  

The bankruptcy court allowed the Trustee’s suit. California’s Universal Voidable Transactions Act (Civil Code Sec. 3439.09) has a 7-year statute of repose (the maximum time to sue for a wrongful act, even where the other party has not been harmed), and Bankruptcy Code Sec. 546 extends for 2 years the Trustee’s ability to sue on any fraud claim that exists at the time the bankruptcy is filed.  

In this case,

1) Momentum in 2012 sold the property to its sister entity, Pyramid, for 55 cents without notifying the oil driller;

2) Momentum became liable for the fraudulent transfer in May 2018, when it lost the Superior Court case against the driller;

3) Momentum filed for Chapter 7 bankruptcy in June 2018;

4) Because California’s 7-year statute of repose for the fraudulent transfer had not expired when Momentum filed for bankruptcy in 2018, the bankruptcy Trustee had an additional 2 years (a maximum of 7 + 2 years) to begin fraud proceedings in the bankruptcy court, with intent to undo the sale and take control of the property, under 11 USC Sec. 546.

The Trustee began her fraudulent transfer proceedings against Momentum and Pyramid in 2019, pursuant to California law. The bankruptcy court held that the Trustee’s action was timely, and the Bankruptcy Appellate Panel affirmed.


WEIL v. PYRAMID CENTER, INC. (IN RE MOMENTUM DEV. LLC), 649 B.R. 33 (9th Circuit Bankruptcy Appellate Panel; Filed March 2, 2023)  



What Could Go Wrong?

What Could Go Wrong?



Suppose you find yourself in this situation. You’ve been involved in litigation for months against a party you believe defrauded you out of thousands of dollars. After protracted legal proceedings, your judge finally sets a trial date. You are finally going to have your day in court against this person.

But shortly before you go to trial, you receive a tip that your defendant has filed for bankruptcy. And not only that, but you also find out that this person filed for bankruptcy a couple of years ago, in the middle of your case, and did not tell you or your judge. And not only that, but you also find out that the person received a discharge (cancellation of all pre-bankruptcy unsecured debt), and that the trustee determined that the person had no assets. The bankruptcy case is CLOSED.

No problem. You think that, because you have a trial date, all you have to do is go before your state court judge and plead your case for fraud. Surely, your state court judge can grant you relief, and force this fraudulent, thieving defendant to pay you your damages.

What could possibly go wrong? Unfortunately, a lot.

Because the case has closed, there is no more “automatic stay” of 11 USC Sec. 362. There is, however, a “discharge injunction” 11 USC Sec. 524(a), which means that creditors are barred from attempting to collect discharged debts.

Furthermore, the Bankruptcy Court has exclusive jurisdiction over the question of whether these discharged debts are related to fraud. 11 USC Sec. 524 (a)(2), (4) & (6); Grogan v. Garner, 498 U.S. 279, 284 n. 10, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991); Aldrich v. Imbrogno (In re Aldrich), 34 B.R. 776, 779 (9th Cir. B.A.P.1983), cited in Ackerman v. Eber (In re Eber) 687 F.3d 1123 (9th Cir. 2012).

Based on these authorities, you will likely seek to file a dischargeability complaint under 11 USC Sec. 524 (a)(2), (4) or (6), in the Bankruptcy Court; or an action to revoke the discharge under 11 USC Sec. 727 (d), for example, if there are multiple false statements or multiple examples of deception in the defendant/debtor’s bankruptcy papers, such that it appears that the discharge itself was obtained through fraud.

Additionally, the US Supreme Court has ruled that if the Plaintiff or Plaintiff’s attorney is well-versed in bankruptcy law, the failure to observe the discharge injunction (in this case, failure to seek a ruling on fraud in the bankruptcy court) is considered much more knowing and culpable. Taggart v. Lorenzen, 139 S. Ct. 1795 (2019) [Slip Opinion, p. 7]. In other words, to paraphrase a line from Michael Mann’s film, The Insider, “The more you know, the worse (the contempt sanction) gets.”

The point is that you want your client to have the maximum ability to seek a ruling on the defendant’s alleged fraud in State Court. This, however, must await a ruling from the Bankruptcy Court in this regard, and any attempt to circumvent the Bankruptcy Court could easily backfire and be very costly.



Where debtors claimed “100% Fair Market Value” of their home as protected by the Homestead Exemption, and there was no timely objection by the US Trustee, then the claim of exemption protected the full amount of money generated by the sale of the home, after payment to the mortgage lender, even though the “FMV” number claimed was over the allowable limit.

In re Masingale (9th Circuit Bankruptcy Appellate Panel) 644 B.R. 530, Opinion of Farris J.

Filed November 2, 2022.

Pin It on Pinterest

Call Now ButtonCall Now