National Farm Financial Corporation v. PSM Holding Corporation

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MEMORANDUM DECISION RE REQUEST
FOR PRELIMINARY INJUNCTION 	-1-
UNITED STATES BANKRUPTCY COURT
FOR THE NORTHERN DISTRICT OF CALIFORNIA
In re
NATIONAL FARM FINANCIAL
CORPORATION, a California
corporation,
Debtor.
NATIONAL FARM FINANCIAL
CORPORATION, a California
corporation,
Plaintiff,
vs.
PSM HOLDING CORP., a New York
corporation,
Defendant.
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Case No. 07-31580 TEC
Chapter 11
Adv. Proc. No. 07-3134 TC
MEMORANDUM DECISION RE DEBTOR’S REQUEST FOR PRELIMINARY INJUNCTION
Debtor National Farm Financial Corporation (Debtor) is a
holding company that owns all of the shares of Business Alliance
Insurance Company (BAIC), an operating insurance carrier. 	Debtor’s
shares are held by the Chao Family Trust. 	Larry and Julie Chao are
the trustees, and are also husband and wife. 	The trust can take
Signed and Filed: January 18, 2008
________________________________________
THOMAS E. CARLSON
U.S. Bankruptcy Judge
________________________________________
Entered on Docket
January 18, 2008
GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
Case: 07-03134 Doc# 28 Filed: 01/18/08 Entered: 01/18/08 13:45:44 Page 1 of 9

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28 	1 All statutory references are to the United State Bankruptcy
Code, Title 11, United States Code, unless otherwise noted.
MEMORANDUM DECISION RE REQUEST
FOR PRELIMINARY INJUNCTION 	-2-
action only upon the approval of both trustees. 	Larry Chao is
president and CEO of both Debtor and BAIC.
Debtor entered a written contract to sell its BAIC shares to
PSM Holding Corp. (PSM). 	When Debtor refused to close the sale,
PSM sued Debtor, BAIC, and Larry Chao in the Central District of
California. 	After a 15-day jury trial, the district court awarded
PSM a $43 million judgment against Debtor, Larry Chao, and BAIC
(the Judgment). 	The district court reduced the Judgment to $40
million, but otherwise denied defendants’ post-trial motions.
Unable to post a bond to stay the Judgment pending appeal,
Debtor filed a chapter 11 petition on December 5, 2007. 	Larry Chao
filed a chapter 11 petition on January 7, 2008. 	Because it is an
insurance company, BAIC is not eligible for relief under the
Bankruptcy Code. 	§ 109(b)(2). 1 	In the present proceeding, Debtor
seeks to have this court enjoin PSM from enforcing the Judgment
against BAIC, on the basis that such enforcement would unduly
interfere with Debtor’s ability to reorganize.
Prior decisions authorize a bankruptcy court to enjoin
creditor action against the chapter 11 debtor’s subsidiary that is
itself unable to seek bankruptcy protection because it is an
insurance company. 	See, e.g., In re Equity Funding Corp. of
America, 396 F.Supp. 1266 (C.D. Cal. 1975). 	Whether such relief is
appropriate turns upon application of the familiar four-part test
for injunctive relief:
Case: 07-03134 Doc# 28 Filed: 01/18/08 Entered: 01/18/08 13:45:44 Page 2 of 9

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MEMORANDUM DECISION RE REQUEST
FOR PRELIMINARY INJUNCTION 	-3-
(1) a strong likelihood of success on the merits, (2) the
possibility of irreparable injury to plaintiff if
preliminary relief is not granted, (3) a balance of
hardships favoring the plaintiff, and (4) advancement of
the public interest (in certain cases). 	Alternatively, a
court may grant the injunction if the plaintiff
demonstrates either a combination of probable success on
the merits and the possibility of irreparable injury or
that serious questions are raised and the balance of
hardships tips sharply in his favor.
Soldius Networks, Inc. v. Excel Innovations, Inc. (In re Excel
Innovations, Inc.), 502 F.3d 1086, 1093 (9th Cir. 2007)
(parentheses and italics in original). 	In this particular context,
the likelihood of prevailing on the merits refers to the likelihood
that Debtor will be able to confirm a plan of reorganization.
This chapter 11 is in substance a two-party case between PSM
and Debtor. 	Debtor scheduled only two claims. 	The first is the
$40 million Judgment. 	The other is a $300,000 claim by the
attorneys who represented Debtor in the PSM litigation. 	Both are
general unsecured claims. 	Debtor states that Julie Chao also
asserts a claim for the harm to her beneficial interest in the
family trust caused by the acts of the officers and directors that
gave rise to the Judgment.
A. 	Likelihood of Confirming a Plan
Debtor has not shown a strong likelihood of confirming a plan.
Debtor can confirm a plan in which its shareholders retain an
interest in the BAIA shares only if general unsecured creditors
accept the plan. 	§ 1129(b)(2)(B). 	A plan cannot be confirmed over
the objection of PSM, because it holds more than one-third of the
general unsecured claims. 	§ 1126(c). 	Debtor asserts that it will
be able to confirm a plan by subordinating the Judgment to the
claims of Julie Chao and the attorneys under section 510 of the
Case: 07-03134 Doc# 28 Filed: 01/18/08 Entered: 01/18/08 13:45:44 Page 3 of 9

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MEMORANDUM DECISION RE REQUEST
FOR PRELIMINARY INJUNCTION 	-4-
Bankruptcy Code. 	As explained below, Debtor’s theory is
unsupported by law.
Debtor first argues that the Judgment should be subordinated
under section 510(b), because it arises out of the purchase of a
security of Debtor or an affiliate of Debtor. 	While the Judgment
did arise out of Debtor’s breach of contract to sell the shares of
its affiliate BAIA, section 510(b) does not require subordination
to the creditors of Debtor. 	The statute requires a claim arising
from the purchase of BAIA shares to be given the same priority as
the BAIA shares themselves. 	The BAIA shares are not
subordinated to Debtor’s creditors because to Debtor they represent
an asset, like a vehicle or a building. 	Each of the cases relied
upon by Debtor involves the very different circumstance in which
the claimant had purchased shares of the debtor itself. 	In that
circumstance, section 510(b) requires subordination to creditors of
the debtor, to prevent parties who bargained only for an equity
stake in debtor from elevating themselves to parity with creditors
who justly expected to be paid in full before equity holders
received any value. 	American Broadcasting Systems, Inc. v. Nugent
(In re Betacom of Phoenix, Inc.), 240 F.3d 823, 828-31 (9th Cir.
2001); Falcon Capital Corp. Shareholders v. Osborne (In re THC
Financial Corp.), 679 F.2d 784, 785-87 (9th Cir. 1982). 	In the
present case, the language and purpose of section 510(b) relate
only to whether the Judgment is subordinated to the claims of
creditors of BAIA. 	Because BAIA is not entitled to seek bankruptcy
protection, the claims of those creditors are not before this
court.
Case: 07-03134 Doc# 28 Filed: 01/18/08 Entered: 01/18/08 13:45:44 Page 4 of 9

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MEMORANDUM DECISION RE REQUEST
FOR PRELIMINARY INJUNCTION 	-5-
Debtor next argues that the Judgment should be subordinated to
Julie Chao’s claim, pursuant to section 510(c) of the Bankruptcy
Code. 	This argument is predicated on the assumption that the
Judgment is subject to rescission, because the contract upon which
it is based was not approved by Debtor’s shareholders, as required
by California Corporations Code section 1001.
From this premise, Debtor first contends that the Judgment
should be subordinated, because payment of the claim would violate
a statute. 	La Grand Steel Products Co. v. Goldberg (In re Poole,
McGonigle & Dick, Inc.), 796 F.2d 318, 322-24 (9th Cir.), amended
by 804 F.2d 576 (9th Cir. 1986). 	That decision does not support
subordination in the present case. 	The statute in question in
Poole prohibited the repurchase of shares by an insolvent
corporation. 	Subordination in that circumstance served the same
purpose cited by the cases interpreting section 510(b): to prevent
a party that bargained only for an equity position from elevating
itself to parity with creditors. 	Id. at 323. 	Debtor cites no
authority for the proposition that failure to secure the
shareholders’ approval of a contract vitiates a money judgment for
breach of that contract. 	The Solorza decision holds only that a
sale not approved by shareholders is not void, because the
shareholders may later decide to ratify it. 	Solorza v. Park Water
Co., 86 Cal.App.2d 653 (1948). 	Section 208(b) of the Corporations
Code suggests that lack of required shareholder approval does not
relieve the corporation from monetary liability under a contract.
That section provides that a contract made by an officer with
actual or apparent authority binds the corporation, “except as the
board’s authority is limited by law other than this division. . .
Case: 07-03134 Doc# 28 Filed: 01/18/08 Entered: 01/18/08 13:45:44 Page 5 of 9

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MEMORANDUM DECISION RE REQUEST
FOR PRELIMINARY INJUNCTION 	-6-
.” 	Sections 208 and 1001 are both in Division 1 of the
Corporations Code. 	Thus, any failure to comply with section 1001
is not a limitation imposed by law “other than this division.”
Furthermore, subsection (a) of section 208 suggests that the
shareholder’s remedies are to sue to enjoin closing of the sale, or
to sue the responsible officers and directors for breach of duty.
Debtor contends that subordination is also appropriate under
section 510(c), because PSM engaged in improper litigation tactics
by not joining Julie Chao as a party in the district court action.
Debtor cites no authority for this contention. 	Furthermore, to the
extent that Debtor has any standing to raise this issue, Debtor has
not explained why it did not do so in the district court. 	It is
also worthy of note that the district court permitted PSM to argue
that “NFFC was not handled by the Chaos in such a way as to be
considered a separate legal entity from BAIC” and stated “it is up
to the jury to determine whether Mr. Chao’s signature on the
[contract] is sufficient to bind BAIC and NFFC and himself.”
Fineman Decl., Exh. E at 9:18-20; 8:21-23.
The one claim that would appear to be subject to subordination
is that of Julie Chao. 	Because she holds (indirectly) only an
equity interest in Debtor, any claim for damage to that equity
interest must be subordinated to the claims of Debtor’s creditors.
See Betacom, supra, 240 F.3d at 828-31.
It is clear from the above that PSM holds more than one-third
in amount (indeed virtually all) of the general unsecured claims
against Debtor, and that PSM can therefore block confirmation of
any plan that provides for Debtor’s shareholders to retain any
Case: 07-03134 Doc# 28 Filed: 01/18/08 Entered: 01/18/08 13:45:44 Page 6 of 9

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MEMORANDUM DECISION RE REQUEST
FOR PRELIMINARY INJUNCTION 	-7-
interest in the shares of BAIC. 	§ 1129(b)(2)(B). 	Thus, Debtor has
not shown a strong likelihood of confirming a plan.
B. 	Balance of Hardships
Nor has Debtor shown that the balance of hardships tips
sharply in its favor. 	Debtor’s most legitimate interest is in
having some effective remedy if the Judgment is reversed. 	Debtor
seeks to do so by staying all enforcement of the Judgment during
what may be a protracted appeal. 	There are alternate remedies that
would not deny PSM all benefits of its Judgment, and at the same
time would preserve for Debtor an effective remedy should it
prevail on appeal. 	This court, for instance, could condition
relief from stay permitting PSM to hold and vote the shares of BAIA
on PSM’s not transferring those shares, or seizing or transferring
assets of BAIC out of the ordinary course of business, pending the
outcome of the appeal. 	It is unlikely that BAIA itself would be
dismembered in such a setting. 	The duty of the Insurance
Commissioner to protect BAIA’s policyholders to a large extent
requires the protection of BAIA itself. 	If there arises some
specific threat to the continued viability of BAIA, this court can
always revisit whether the broad injunctive relief presently sought
is appropriate. 	Debtor’s desire to keep control of BAIA during the
appeal does not outweigh PSM’s interest in enjoying the profits of
BAIA during that period.
C. Irreparable Harm and Public Interrest
This court assumes without deciding that Debtor has no
adequate legal remedy and may suffer irreparable harm if injunctive
Case: 07-03134 Doc# 28 Filed: 01/18/08 Entered: 01/18/08 13:45:44 Page 7 of 9

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MEMORANDUM DECISION RE REQUEST
FOR PRELIMINARY INJUNCTION 	-8-
relief is not granted. 	It appears that public policy
considerations are neutral. 	The relevant public interest to be
protected is that of the policy holders of BAIC, and they will be
protected by the Insurance Commissioner.
CONCLUSION
Because Debtor has not shown a likelihood of prevailing on the
merits, or that the balance of hardships justifies the long-term
imposition of the broad relief presently sought, such relief will
be granted only on a temporary basis. 	Thus, the temporary
restraining order entered on December 6, 2007 will remain in effect
through February 8, 2008 or until a further order is entered,
whichever comes first. 	The court will hold a status conference
regarding this action on January 28, 2008 at 10:30 a.m. 	The court
respectfully requests counsel for the Insurance Commissioner to
attend and participate.
**END OF MEMORANDUM DECISION**
Case: 07-03134 Doc# 28 Filed: 01/18/08 Entered: 01/18/08 13:45:44 Page 8 of 9

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Court Service List
Robert A. Julian, Esq.
Krista M. Enns, Esq.
Law Offices of Winston and Strawn LLP
101 California Street, 39th Floor
San Francisco, CA 94111
Thomas R. Kreller, Esq.
Milbank, Tweed, Hadley & McCloy
601 South Figueroa Street, 30th Floor
Los Angeles, CA 90017
Case: 07-03134 Doc# 28 Filed: 01/18/08 Entered: 01/18/08 13:45:44 Page 9 of 9