Sheila M. Gowan, Chapter 11 Trustee For Dreier LLP v. HSBC MORTGAGE CORPORATION (USA) et al

UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
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In re: 	:
: 	Chapter 11
DREIER LLP, 	: 	Case No. 08-15051 (SMB)
:
Debtor. 	:
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SHEILA M. GOWAN, Chapter 11 Trustee of the 	:
Estate of DREIER LLP, 	:
:
Plaintiff, 	:
:
-- against -- 	: 	Adv. Proc. No. 10-5456 (SMB)
:
HSBC MORTGAGE CORPORATION (USA), 	:
et al. 	:
:
:
:
Defendants. 	:
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MEMORANDUM DECISION GRANTING
MOTION TO DISMISS CROSS-CLAIM
A P P E A R A N C E S:
SILVERMANACAMPORA LLP
Attorneys for Defendants Ka Wing Yuen and Jeannie Yuen
100 Jericho Quadrangle, Suite 300
Jericho, New York 11753
Anthony C. Acampora, Esq.
David J. Mahoney, Esq.
Gayle S. Gerson, Esq.
Of Counsel
RIKER DANZIG SCHERER HYLAND & PERRETTI LLP
Attorneys for Defendant PHH Mortgage Corporation
500 Fifth Avenue, 49th Floor
New York, New York 10110
Anthony J. Sylvester, Esq.
Jonathan P. Vuotto, Esq.
Thomas P. Sheridan, Esq.
Of Counsel
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STUART M. BERNSTEIN
United States Bankruptcy Judge:
Sheila M. Gowan, the chapter 11 trustee of Dreier LLP (the “Trustee”) commenced this
adversary proceeding to avoid and recover certain transfers made by the debtor in connection
with the sale of an apartment by defendants Ka Wing Yuen and Jeannie Yuen to an affiliate of
Marc S. Dreier (“Marc”). One of the defendants, PHH Mortgage Corporation d/b/a Mortgage
Service Center (“PHH”), cross-claimed for contribution and/or indemnity against the Yuens.
The Yuens moved to dismiss the cross-claim, and their motion to dismiss is granted for the
reasons that follow.
BACKGROUND
The facts are not in dispute. The Yuens owned a condominium apartment located at 151
East 58th Street in Manhattan (the “Apartment”). On or about March 16, 2005, they borrowed
$1 million from Merrill Lynch Credit Corporation (“MLCC”), (Amended Answer, Affirmative
Defenses and Cross-Claims of Defendant PHH Mortgage Corporation, dated Aug. 1, 2012
(“Cross-Claim”), at ¶¶ 5-6, 1 Ex. A (the “Note”) (ECF Doc. # 122)), and pledged the Apartment
as security for the loan. (Id. at ¶ 7, Ex. B (the “Mortgage”).) PHH was responsible for servicing
MLCC’s loan to the Yuens. (Id. at ¶ 9.)
On or about May 8, 2007, the Yuens entered into a contract (the “Contract”) to sell the
Apartment to Marc.2 (Id. at ¶ 10.) Marc subsequently assigned his interest in the Contract to his
1 	The paragraph citations to the Cross-Claim refer to the numbered paragraphs beginning on page 8.
2 A copy of the Contract is annexed as Exhibit 2 to the Affidavit of Wing Fong in Opposition to Motion to
Strike Exhibits A, B, and D from the Motion to Dismiss Complaint as Against Douglas Elliman, LLC. d/b/a
Prudential Douglas Elliman and in Further Support of the Motion to Dismiss Pursuant to Federal Rules of Civil
Procedure 8 and 12 and Bankruptcy Rules 7008 and 7012, sworn to July 14, 2011 (ECF Doc. # 49).
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wholly-owned affiliate, MSD Beacon LLC (“MSD”). (Id. at ¶ 11). On or about July 24, 2007,
the Yuens, Marc and MSD closed on the sale of the Apartment. (Id. at ¶ 12.) After the closing,
PHH received a check in the amount of $1,017,390.72 as repayment of the Note, (id. at ¶ 13),
and PHH used that money to satisfy the Yuens’ obligations to MLCC under the Note and
Mortgage. (Id. at ¶ 17.)
On December 15, 2010, the Trustee commenced this adversary proceeding against the
various parties, including the Yuens and PHH, that received transfers in connection with the sale
and renovation of the Apartment.3 According to the Trustee, the source of those transfers was a
Dreier LLP bank account. (First Amended Complaint, dated June 17, 2011, at ¶ 19 (ECF Doc. #
41).) The Trustee contends that Dreier LLP did not receive any benefit from the transfers, the
transfers were fraudulent, and they should be avoided and recovered for the benefit of the Dreier
LLP estate. (Id. at ¶¶ 1, 20.) PHH filed the Cross-Claim asserting that because it used the
transfer it received to satisfy the Note and Mortgage to MLCC on behalf of the Yuens, the Yuens
should either indemnify or provide contribution to PHH for any sums recovered by the Trustee
from PHH. (Cross-Claim at ¶¶ 21, 27.) The Trustee eventually settled with the Yuens and
dismissed the claims asserted against them.
The Yuens have moved to dismiss PHH’s cross-claims on two grounds. First, they argue
that this Court lacks subject matter jurisdiction over the issues of indemnification and
contribution between PHH and the Yuens. Second, even if jurisdiction exists, PHH does not
3 	The other defendants included HSBC Mortgage Corporation (USA), Prudential Douglas Elliman, Corcoran
Group Eastside, Inc., First American Title Insurance Company, First American Title Agency, Inc., Michael
Braverman Design and NY Landmark Construction Corp.
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have a contractual or common law right to indemnification or contribution. PHH takes the
contrary view on both points.
DISCUSSION
A. 	Subject Matter Jurisdiction
When considering a motion to dismiss for lack of subject matter jurisdiction under FED.
R. CIV. P. 12(b)(1), a court must accept the material factual allegations in the complaint as true,
but need not draw inferences favorable to the plaintiff. J.S. v. Attica Cent. Schs., 386 F.3d 107,
110 (2d Cir. 2004), cert. denied, 544 U.S. 968 (2005); Shipping Fin. Servs. Corp. v. Drakos, 140
F.3d 129, 131 (2d Cir. 1998). A court may also consider materials outside of the pleadings to
resolve any jurisdictional disputes, but cannot rely on conclusory or hearsay evidence. J.S., 386
F.3d at 110; Zappia Middle East Constr. Co. v. Emirate of Abu Dhabi, 215 F.3d 247, 253 (2d
Cir. 2000). The party asserting that the court has subject matter jurisdiction bears the burden of
proving it. Robinson v. Overseas Military Sales Corp., 21 F.3d 502, 507 (2d Cir. 1994); Truong
v. Litman, No. 06 Civ. 1431(SHS), 2006 WL 3408573, at *3 (S.D.N.Y. Nov. 22, 2006), aff’d,
312 Fed. Appx. 377 (2d Cir. 2009). Where the court “relies solely on the pleadings and
supporting affidavits, the plaintiff need only make a prima facie showing of jurisdiction.”
Robinson, 21 F.3d at 507; accord CutCo. Indus., Inc. v. Naughton, 806 F.2d 361, 364 (2d Cir.
1986).
Consideration of the bankruptcy court’s subject matter jurisdiction begins with 28 U.S.C.
§ 1334. Subsection (a) grants the district court exclusive jurisdiction over bankruptcy cases.
Subsection (b) grants the district court “original but not exclusive jurisdiction of all civil
proceedings arising under title 11, or arising in or related to cases under title 11.” The district
court may refer its bankruptcy jurisdiction to the bankruptcy court. 28 U.S.C. § 157(a). The
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United States District Court for the Southern District of New York has referred its bankruptcy
jurisdiction to this Court pursuant to its Amended Standing Order of Reference, 12 Misc. 00032
(S.D.N.Y. Jan. 31, 2012).
Proceedings that arise under title 11 or arise in a case under title 11 correspond to the
Court’s “core” jurisdiction. See 28 U.S.C. § 157(b)(1) (“Bankruptcy judges may hear and
determine . . . all core proceedings arising under title 11, or arising in a case under title 11 . . . .”);
Wood v. Wood (In re Wood), 825 F.2d 90, 96 (5th Cir. 1987) (“[S]ection 157 apparently equates
core proceedings with the categories of ‘arising under’ and ‘arising in’ proceedings.”).
Generally, a core proceeding is one that invokes a substantive right under title 11, or could only
arise in the context of a bankruptcy case. Binder v. Price Waterhouse & Co., LLP (In re Resorts
Int’l, Inc.), 372 F.3d 154, 162-63 (3d Cir. 2004); Wood, 825 F.2d at 96-97; Liberty Mut. Ins. Co.
v. Lone Star Indus., Inc., 313 B.R. 9, 16 (D. Conn. 2004).
A proceeding is “related to” a case under title 11, and falls within its non-core
jurisdiction,4 if the outcome might have a “conceivable effect” on the estate. Publicker Indus.
Inc. v. United States (In re Cuyahoga Equip. Corp.), 980 F.2d 110, 114 (2d Cir. 1992); see U.S.
Brass Corp. v. Travelers Ins. Group, Inc. (In re U.S. Brass Corp.), 301 F.3d 296, 304 (5th Cir.
2002); Pacor, Inc. v. Higgins (In re Pacor, Inc.), 743 F.2d 984, 994 (3d Cir. 1984), overruled on
other grounds by Things Remembered, Inc. v. Petrarca, 516 U.S. 124 (1995). Thus, “[a]n action
is related to bankruptcy if the outcome could alter the debtor’s rights, liabilities, options, or
freedom of action (either positively or negatively) and which in any way impacts upon the
handling and administration of the bankrupt estate.” Pacor, 743 F.2d at 994; accord Beebe Int’l,
4 	“Related to” proceedings correspond to the Court’s non-core jurisdiction. Resorts Int’l, 372 F.3d at 162;
see Wood, 825 F.2d at 97.
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Inc. v. French Am. Banking Corp. (In re Wedtech Corp.), 72 B.R. 313, 315-16 (Bankr. S.D.N.Y.
1987). Conversely, the bankruptcy court lacks “related to” jurisdiction over proceedings that
have no effect on the debtor’s estate. Celotex Corp. v. Edwards, 514 U.S. 300, 308 n.6 (1995).
PHH contends that the cross-claims may have a “conceivable effect” on the bankruptcy
case in two ways. First, they may alter the identity of creditors, the amount of claims against the
estate and the amount of any recovery on behalf of the estate. (Defendant PHH Mortgage
Corporation’s Memorandum of Law in Opposition to Defendants Ka Wing Yuen and Jeannie
Yuens’ Motion to Dismiss PHH Mortgage Corporation’s Amended Cross-Claims, dated
Sept. 18, 2012, at 1, 6 (ECF Doc. # 125).) Specifically,
[I]f PHH prevails on its Cross-Claims, PHH would not be a creditor of the
Debtor’s estate, but the Yuens would have been. If PHH does not prevail on its
Cross-Claims, PHH will be a creditor of the estate (and but for the settlement, the
Yuens would have been, in a different amount).
(Id. at 6) (footnote omitted.) Second, the cross-claims may enhance the prospects for settlement
because cross-claimants may be more willing to settle for a discount with a trustee and seek
indemnification if such claims are in the case. (Id. at 6-7.) Conversely, “[i]f such cross-claims
are not in the case, the parties may forego settlement discussions and put more effort into their
defense, resulting in greater costs to the estate and altering the amount of any recovery.” (Id. at
7.)
The Court concludes that it lacks “related to” jurisdiction over the cross-claims. Beyond
a conclusory statement, PHH has not explained how the outcome of its cross-claims against the
Yuens will affect the identity of the creditors or the amount that the estate might recover or
distribute. It speculates that if it prevails, the Yuens will become creditors of the estate, but if it
loses, it will be a creditor of the estate. PHH does not cite any authority for this proposition, but
appears to be relying on 11 U.S.C. § 502(h), which provides:
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A claim arising from the recovery of property under section 522, 550, or 553 of
this title shall be determined, and shall be allowed under subsection (a), (b), or (c)
of this section, or disallowed under subsection (d) or (e) of this section, the same
as if such claim had arisen before the date of the filing of the petition.
On its face, § 502(h) gives a pre-petition claim to a fraudulent transferee where the
trustee recovers the transfer under § 550. Section 502(h) is based on the principle of fraudulent
transfer law that the return of a fraudulent transfer restores the parties to the status quo. In re
Best Prods. Co., 168 B.R. 35, 57-58 (Bankr. S.D.N.Y. 1994) (quoting 1 GERARD GLENN,
FRAUDULENT CONVEYANCES & PREFERENCES § 260a, at 446-47 (1940)). The rule of restoration
only applies, however, where the transferee gave consideration for the avoided transfer. In that
circumstance, the return of the transfer entitles the transferee to the return of the consideration it
paid, and the Bankruptcy Code gives the transferee an allowable unsecured claim in the amount
of that consideration. But if the transferee did not give any consideration for the fraudulent
transfer, there is nothing to reinstate, and the return of the fraudulently transferred funds does not
give rise to an allowable claim. See id. at 58; see also 4 ALAN RESNICK & HENRY J. SOMMER,
COLLIER ON BANKRUPTCY ¶ 502.09[2], at 502-72 (16th ed. 2012) (“The amount of the claim
allowable under this section [§ 502(h)] is not the value of the property recovered but rather the
value of the consideration paid by the transferee for the property recovered.”) Otherwise, a thief
forced to return stolen property to the trustee would have a claim against the estate for the value
of what he stole.
PHH does not allege that it gave any consideration to Dreier LLP in exchange for the
payment that Dreier LLP made at the closing.5 Because it gave no consideration to Dreier LLP,
5 	PHH’s Tenth Affirmative Defense alleges that the Trustee’s claims are barred because Dreier LLP, as
Marc’s alter ego, directly benefitted from the transfers alleged in the Complaint. The statement is conclusory,
unsupported by any factual allegations pertaining to the alter ego relationship.
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the return of fraudulently transferred funds would not reinstate a valid claim, and if PHH filed
such a claim, it would be subject to disallowance under 11 U.S.C. § 502(b)(1) (disallowing
claims that are unenforceable under applicable law). A fortiori, the Yuens would not have a
claim against the estate for any sums paid to PHH in connection with its claim for contribution
and indemnity because the receipt of those payments by PHH would not constitute “the recovery
of property under section 522, 550, or 553” of the Bankruptcy Code.
The Court also rejects the argument that “related to” jurisdiction exists based on the
speculation that the Trustee or PHH will be more willing to settle their claims if the Court hears
the cross-claims. PHH’s jurisdictional theory would authorize a bankruptcy court to exercise
jurisdiction over all manner of disputes between parties in a multi-party lawsuit, including those
having nothing to do with the debtor, if the centralization of disputes in a single forum would be
more likely to lead to a settlement. It comes as no surprise that PHH cites no supporting
authority for its jurisdictional theory. Beyond that, the Court’s conclusion that it lacks
jurisdiction over the cross-claims does not make the cross-claims go away; it merely requires
PHH to litigate those claims in a different forum. Whatever settlement value the cross-claims
may have would not be affected by the Court’s inability to hear them.
B. 	Supplemental Jurisdiction
PHH next contends that even if the Court lacks “related to” jurisdiction over the cross-
claims, it has supplemental jurisdiction under 28 U.S.C. § 1367. Section 1367(a) provides in
pertinent part:
Except as provided in subsections (b) and (c) or as expressly provided
otherwise by Federal statute, in any civil action of which the district courts have
original jurisdiction, the district courts shall have supplemental jurisdiction over
all other claims that are so related to claims in the action within such original
jurisdiction that they form part of the same case or controversy under Article III
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of the United States Constitution. Such supplemental jurisdiction shall include
claims that involve the joinder or intervention of additional parties.
Thus, where a district court has original jurisdiction over some claims in a civil action, it
may exercise supplemental jurisdiction over additional claims that are part of the same case or
controversy. Exxon Mobile Corp. v. Allapattah Servs., Inc., 545 U.S. 546, 549 (2005). 	“There
is a serious question whether the supplemental jurisdiction statute is applicable to the jurisdiction
exercisable by bankruptcy judges.” 16 DANIEL R. COQUILLETTE ET AL., M OORE ’ S FEDERAL
PRACTICE § 106.05[10], at 106.34.2(1) (3rd ed. 2012) [hereinafter M OORE ’ S ]; compare Sasson v.
Sokoloff, 424 F.3d 864, 869 (9th Cir. 2005) (“[T]he bankruptcy court’s ‘related to’ jurisdiction
also includes the district court’s supplemental jurisdiction pursuant to 28 U.S.C. § 1367 ‘over all
other claims that are so related to claims in the action within [the court’s] original jurisdiction
that they form part of the same case or controversy under Article III of the United States
Constitution.’”) (quoting 28 U.S.C. § 1367(a)), cert. denied, 547 U.S. 1206 (2006); Klein v.
Civale & Trovato, Inc. (In re Lionel Corp.), 29 F.3d 88, 92 (2d Cir. 1994) (stating that the
bankruptcy court had jurisdiction over a dispute between third parties “under principles of
supplemental jurisdiction”) (citing 28 U.S.C. 1367); McCarthy v. Radcliffe (In re Radcliffe), 317
B.R. 581, 590 (Bankr. D. Conn. 2004) (“[T]he Second Circuit Court of Appeals has
interpreted 28 U.S.C. § 1367(a) to confer supplemental jurisdiction (sometimes referred to as
pendent or ancillary jurisdiction) on the bankruptcy courts as well as the district courts.”); with
Walker v. Cadle Co. (In re Walker), 51 F.3d 562, 572 (5th Cir. 1995) (“Because there is no
Congressional statute conferring upon the bankruptcy courts the power to exercise supplemental
jurisdiction, we find no error in the district court’s conclusion that the bankruptcy court did not
have the power to [assert supplemental jurisdiction over claims].”); Enron Corp. v. Citigroup,
Inc. (In re Enron Corp.), 353 B.R. 51, 61 (Bankr. S.D.N.Y. 2006) (“[T]he jurisdictional grant
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in 28 U.S.C. § 1334(b) and 28 U.S.C. § 157, by implication, negates a bankruptcy court’s
exercise of jurisdiction of a supplemental non-federal claim in instances where that claim has no
impact on the bankruptcy estate.”).
The question of the Court’s supplemental jurisdiction should turn on the scope of the
reference from the district court, bearing in mind that a bankruptcy court’s jurisdiction “is
grounded in, and limited by, statute.” Celotex, 514 U.S. at 307. Title 28, section 1334, grants
the district courts “original and exclusive jurisdiction of all cases under title 11,” 28 U.S.C. §
1334(a), and “original but not exclusive jurisdiction of all civil proceedings arising under title 11,
or arising in or related to cases under title 11.” 28 U.S.C. § 1334(b). A district court may refer
its bankruptcy jurisdiction, i.e., its jurisdiction under 28 U.S.C. § 1334(a) and (b), to the
bankruptcy judges in its district, 28 U.S.C. § 157(a), and the United States District Court for the
Southern District of New York has referred its bankruptcy jurisdiction to this Court pursuant to
its Amended Standing Order of Reference, 12 Misc. 00032 (S.D.N.Y. Jan. 31, 2012).
Supplemental jurisdiction, on the other hand, is based on a different statute, and it seems that
“the district court could no more refer its supplemental jurisdiction than it could refer its
copyright, criminal or diversity jurisdiction.” Masterwear Corp. v. Rubin Baum Levin Constant
& Friedman (In re Masterwear Corp.), 241 B.R. 511, 517 n.6 (Bankr. S.D.N.Y. 1999). If the
Court were asked to write on a clean slate it would conclude that it lacks supplemental
jurisdiction for the reasons expressed by the Fifth Circuit Court of Appeals in Walker.
As noted above, however, the Second Circuit Court of Appeals has ruled that a
bankruptcy court may acquire jurisdiction over a dispute between third parties under the
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principles of supplemental jurisdiction. Lionel, 29 F.3d at 92.6 Under the circumstances, the
Court is constrained to conclude it may exercise supplemental jurisdiction over the cross-claims
asserted by PHH against the Yuens because they are so related to the Trustee’s core claim
against PHH (and the Yuens) “that they form part of the same case or controversy under Article
III of the United States Constitution.” 28 U.S.C. § 1367(a).
This does not, however, end the inquiry. A court may decline to exercise its
supplemental jurisdiction as a matter of discretion:
(c) The district courts may decline to exercise supplemental jurisdiction over a
claim under subsection (a) if—
(1) the claim raises a novel or complex issue of State law,
(2) the claim substantially predominates over the claim or claims over which the
district court has original jurisdiction,
(3) the district court has dismissed all claims over which it has original
jurisdiction, or
(4) in exceptional circumstances, there are other compelling reasons for declining
jurisdiction.
28 U.S.C. § 1367(c).
The Court declines to exercise its supplemental jurisdiction over the PHH cross-claims
because they raise complex and undecided issues under New York law. See 28 U.S.C. §
1367(c)(1). 	While at least one commentator has concluded that a fraudulent transferee’s right to
contribution or indemnity under New York law is doubtful, see Edward M. Fox & James
Gadsden, Rights of Indemnification and Contribution Among Persons Liable for Fraudulent
6 	In Lionel, the debtor hired a contractor to work on premises that it leased. After the debtor failed to pay for
the construction work, the contractor filed a mechanic’s lien against the landlord’s property. The debtor and the
landlord commenced an adversary proceeding that, among other things, sought an order declaring the mechanics’
lien invalid. Lionel, 29 F.3d at 90. The landlord also asserted a lease-based claim against the debtor arising from its
failure to discharge the lien. Id. at 92.
The Lionel Court ruled that the bankruptcy court had core jurisdiction over the landlord’s claim against the
debtor, and it had supplemental jurisdiction over the landlord’s claim against the contractor. Id.
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Conveyances, 23 SETON HALL L. REV. 1600, 1605-11 (1993), neither party has been able to
locate any direct authority settling the question.7 Furthermore, aside from contribution and
indemnity, PHH might have the right to enforce the Yuens’ original obligation to the extent PHH
was compelled to pay the Trustee. The payment to PHH by Dreier LLP was done at the
direction of the Yuens. PHH had no contractual right to receive any payment from Dreier LLP
or MSD because PHH was not a party to the Contract. Instead, PHH had the contractual right to
receive payment from the Yuens pursuant to the Note.
The Contract nevertheless gave the Yuens the right to re-direct the sales proceeds, stating
that at the closing, “[a]ll checks in payment of the balance of the Purchase Price shall be payable
to the order of the Seller . . . .” (Contract at ¶ 3(b).) The Yuens allocated part of their sales
proceeds to PHH. The payment to PHH satisfied the Yuens’ Note and Mortgage, but because of
the source of those proceeds, PHH may have to return the payments.
This result raises a question that New York law does not appear to answer: where an
obligor uses fraudulently transferred funds to satisfy its own obligation, and its obligee must
thereafter restore the transferred funds to the transferor’s trustee, is the obligor’s debt reinstated?
In other words, does New York law recognize a right similar to Bankruptcy Code § 502(h) in this
situation, and restore the status quo and permit the obligee (PHH) to recover from its obligor (the
Yuens) under the original obligation? Section 502(h) is based on the principle of fraudulent
conveyance law, discussed earlier, that the return of a fraudulent transfer restores the parties to
7 	PHH bases much of its indemnification argument on the principle of unjust enrichment. However, the
rights of PHH and the Yuens, inter se, are governed by the Note and Mortgage. The quasi-contractual remedy of
unjust enrichment does not apply where the parties’ rights are governed by contract. Clark-Fitzpatrick, Inc. v. Long
Island RR. Co., 516 N.E.2d 190, 193 (N.Y. 1987) (“The existence of a valid and enforceable written contract
governing a particular subject matter ordinarily precludes recovery in quasi contract for events arising out of the
same subject matter.”). PHH has not claimed that the Yuens are contractually obligated to provide indemnification.
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the transfer to the status quo. The Yuens were not parties to any fraudulent transfer between
Dreier LLP and PHH, but the same principle of restoration may apply to PHH’s claim against the
Yuens.
The Court has not been able to locate any relevant authorities under New York law.
Given the unsettled nature of New York law on this point, the Court concludes in its discretion
that it should not exercise supplemental jurisdiction over this question, and instead, allow the
New York state courts to pass upon it in the first instance. In summary, the Court concludes that
it lacks “related to” jurisdiction over the Cross-Claims, possesses supplemental jurisdiction over
the Cross-Claims, but declines in its discretion to exercise its supplemental jurisdiction and
dismisses the Cross-Claims. Submit order.
Dated: New York, New York
October 12, 2012
/s/ Stuart M. Bernstein
STUART M. BERNSTEIN
United States Bankruptcy Judge
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