James J Joseph Chapter 7 Trustee v. Madray

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FILED

| FOR PUBLICATION | | #-2"

Z
ORT ea
3 Deputy Clerk
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8 UNITED STATES BANKRUPTCY COURT en ae
cputy Clerk
i) CENTRAL DISTRICT OF CALIFORNIA
10
11} In re Case No. SA 05-18954 JR
12 | DONALD J. BRUN, Adv. No. SA 05-01622 JR
13 Debtor. Chapter 7
14
JAMES J. JOSEPH, Chapter 7 Trustee,
15
Plaintiff, MEMORANDUM OPINION
16
vs.
17
EVA MADRAY,
18 Date: December 13, 2006
Defendants. Time: 3:30 P.M.
19 Place: Courtroom 5A
20 Ir. INTRODUCTION
21 On December 1, 2005, James J. Joseph (“Plaintiff”), the

22 | chapter 7 trustee, commenced an adversary proceeding against Eva
23 ||Madray (“Defendant”) to recover the value of Donald J. Brun'‘s

24 || (“Debtor”} interest in real property located at 356 “Y” Place,
25 | Laguna Beach, California (the “Property”}. On November 6, 2006,
26 || Defendant moved for summary adjudication that Plaintiff's

27 || recovery is limited to the value of the “asset” as

28 || defined by §§ 3439.01 et seg. of the California Civil Code

AUTHENTIGATED
U.S. GOVERNMENT
INFORMAWION

IPO.

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("Civil Code”), that is the non-exempt net equity in the Property
at the time of the transfer. Plaintiff opposed and filed a
cross-moticon for summary adjudication to recover the current
value of the Property. Following a hearing on December 13, 2006,
I took the matter under submission to determine if applicable
California law limits Plaintiff’s recovery under § 550 of the
Bankruptcy Code.’

It. JURISDICTION

I have jurisdiction over this matter under 28 U.S.C.

§ 157(b) (1). This is a core proceeding under 28 U.S.C. §§ 157
(b) (2) (A), (F), (0).
III. STATEMENT OF FACTS

On August 10, 1998, Debtor acquired the Property. On April
24, 2002, Debtor executed a grant deed (the “Deed”) transferring
his interest in the Property to Defendant. The Deed was recorded
the next day.

On October 12, 2005, Debtor filed a voluntary chapter 7
petition. On December 1, 2005, Plaintiff filed a complaint (the
“Complaint”} to avoid the transfer of Debtor’s interest in the
Property and recover the value of that interest. In the
Complaint, Plaintiff alleged that the transfer of the Property to
Defendant (the “Transfer”) is avoidable as a fraudulent transfer

pursuant to § 544 of the Code and §§ 3439.01 et seg. of the Civil

1 Unless otherwise indicated, all chapter, section, and rule
references are to the Bankruptcy Code (the “Code”), 11 U.S.C.
§§ 101-1330, prior to its amendment by the Bankruptcy Abuse
Prevention and Consumer Protection Act of 2005 (the “Act”), Pub.
L. 109-8, 119 Stat. 23, because this case was filed before the
Act's effective date (October 17, 2005), and to the Federal Rules
of Bankruptcy Procedure (the “Rules”), Rules 1001-9036.

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Code, and that the value of the Property is recoverable pursuant
to Civil Code §§ 3439.05 and 3439.07.* Plaintiff prays for a
judgment against Defendant for the total present-day market value
of the property transferred.

On November 6, 2006, Defendant filed a motion (the “Motion”)
for summary adjudication that Plaintiff‘s recovery is limited to
the value of the “asset” as defined by Civil Code §§ 3439.01 et
seg., that is the non-exempt net equity in the Property at the
time of the Transfer. Plaintiff opposed and filed a cross-motion
for summary adjudication that his recovery is not limited by
California law. Plaintiff argues that once the Transfer is
determined to be avoidable pursuant to § 544(b) and § 3439.04, he
can recover the Property or the current fair market value of the
equity in the Property, including any appreciation, pursuant to
§ 550(a), regardless of the limitations imposed by §§ 3439 et
seq. Following a hearing on December 13, 2006, I took the
matter under submission to determine whether Plaintiff’s recovery
igs limited to the amount of non-exempt net equity in the Property
at the time of the Transfer.

Iv. DISCUSSION

“Section 544(b) of the Bankruptcy Code permits the Trustee

to stand in the shoes of a creditor to assert any state law

claims that a creditor may have.” Kupetz v. Wolf, 845 F.2d 842,

2 Plaintiff and Defendant correctly recognize that, as
discussed in further detail below, Plaintiff's recovery is
governed by Code § 550, and not Civil Code §§ 3439.05 and
3439.07. Therefore, as requested by the parties, I will
determine whether applicable California law limits Plaintiff's
recovery under § 550. However, Plaintiff is advised to amend the
Complaint to assert his recovery claim under the proper statute.

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845 (9th Cir. 1988). Specifically, § 544 of the Code provides
that “the trustee may avoid any transfer of an interest of the
debtor in property .. . that is voidable under applicable law by
a creditor holding an [allowable] unsecured claim... .” 11
U.S.C. § 544(b).

Under California law, an unsecured creditor may avoid a
fraudulent “transfer” to the extent necessary to satisfy the
creditor's claim.? See CaL. CIv. CopE §§ 3439.04, 3439.07. To the
extent a transfer is voidable, the moving creditor may recover a
judgment for the value of the “asset” transferred at the time of
the transfer, or the amount necessary to satisfy the creditor's
claim, whichever is less. Id. § 3439.08. A “transfer”, as
defined by California law, “means every mode, direct or indirect,
absolute or conditional, voluntary or involuntary, of disposing
of or parting with an asset or an interest in an asset, and

includes payment of money, release, lease, and creation of a lien

3” transfer is fraudulent if the debtor made the transfer
or incurred the obligation as follows:

(1) With actual intent to hinder, delay, or
defraud any creditor of the debtor.

(2) Without receiving a reasonably equivalent
value in exchange for the transfer or
obligation, and the debtor either

(A) Was engaged or was about to engage ina
business or a transaction for which the
remaining assets of the debtor were
unreasonably small in relation to the
business or transaction.

(B) Intended to incur, or believed or
reasonably should have believed that he or
she would incur, debts beyond his or her
ability to pay as they became due.

Cau. Civ. CopE § 3439.04(a).

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or other encumbrance.” Id. § 3439.01 (emphasis added). An
“asset” means unencumbered, non-exempt equity in property of a
debtor.* Id. Therefore, a creditor may avoid a debtor’s
fraudulent disposition of the unencumbered, non-exempt value in
property to the extent of its claim.

Once a trustee demonstrates the right to avoid a transfer,

“[the] trustee must then establish the amount of recovery”

pursuant to § 550(a). See Acequia, Inc. v. Clinton (In re
Acequia, Inc.), 34 F.3d 800, 809 (9th Cir. 1994) (emphasis in
original). Section 550 provides in relevant part that:

[T]o the extent that a transfer is avoided
under section 544, 545, 547, 548, 549,
553(b), or 724(a) of this title, the trustee
may recover, for the benefit of the estate,
the property transferred, or, if the court so
orders, the value of such property, from

(1) the initial transferee of such transfer
or the entity for whose benefit such transfer
was made; or

(2} any immediate or mediate transferee of
such initial transferee.

11 U.S.C. § 550(a)(1)-(2). Put simply, § 550 identifies the
parties liable for repayment of the avoided or avoidable

transfer, and empowers the trustee to recover the property

* Section 3439.01 provides in relevant part that:

(a) "Asset" means property of a debtor, but
the term does not include, the following:
(1) Property to the extent it is encumbered
by a valid lien.

(2) Property to the extent it is generally
exempt under nonbankruptcy law.

(3) An interest in property held in tenancy
by the entireties to the extent it is not
subject to process by a creditor holding a
claim against only one tenant.

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transferred or its value for the benefit of the estate. See

Crafts Plus+, Inc. v. Foothill Capital Corp. (In re Crafts

Plus+), 220 B.R. 331, 334 (Bankr. W.D. Tex. 1998). Furthermore,
§ 550 “enunciates the separation between the concepts of avoiding
a transfer and recovering from the transferee.” H.R. Rep. No. 95-
595, at 375 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6331; Ss.
Rep. No. 95-989, at 90 (1978) reprinted in 1978 U.8.C.C.A.N. 5787,
5876.

For this reason, courts have held that the amount of the
trustee's recovery should not be limited by the amount of the
creditor's claim. See Acequia, 34 F.3d at 809; see also Decker

v. Voisenat (In re Serrato), 214 B.R. 219, 232 (Bankr. N.D. Cal.

1997); Stalnaker v. DLC, Ltd. (In re DLC, Ltd.), 295 B.R. 593,

607 (8th Cir. BAP 2003) (holding that a trustee may recover the
entire transfer, as opposed to only the amount necessary to
satisfy the creditors’ claims). In Acegquia, the debtor in
possession commenced an action to recover, as fraudulent under §
544(b) and Idaho law, certain pre-petition transfers by the
debtor's shareholder, Clinton. Acequia, 34 F.3d at 804. The
magistrate judge determined that the subject transfers were
fraudulent, “[h]owever, reasoning that Acequia's avoidance rights
under section 544(b) derive from those of its unsecured
creditors, . . . limited the corporation’s section 544 (b)
recovery to the total amount of unsecured claims against the
bankruptcy estate.” Id. at 807. On appeal, the Ninth Circuit
yuled that the magistrate judge erred by imposing this cap on the
debtor’s § 544(b) recovery. Id. at 809. In reaching its

decision, the Ninth Circuit emphasized the separation between the

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concepts of avoiding a transfer and recovery from a transferee.
Id. Consequently, the trustee may avoid a fraudulent transfer in
excess of the amount of the unsecured creditors’ claims where the
recovery will accrue “for the benefit of the estate.” Id. 809-
11; see also Voisenat, 214 B.R. at 231-32 (holding that the
limitation imposed by Civil Code § 3439.07, expressly limiting
the avoidance of a transfer to the extent necessary to satisfy
the creditor’s claim, did not limit the trustee’s recovery in
bankruptcy) .

However, courts in the Ninth Circuit have not been entirely
consistent regarding the impact of the recovery limitations
imposed by §§ 3439 et seq. on actions to avoid and recover
pursuant to §§ 544(b) and 550(a). In Decker v. Tramiel (In re
JTS Corp.), 2006 WL 2844581, *5 (N.D. Cal. 2006) (slip copy), the
trustee commenced an adversary proceeding to avoid the debtor’s
sale of certain real property for $10,000,000 pursuant to
§ 544(b) and California law. Id. at *2. While the bankruptcy
court concluded that the sale was fraudulent, it reduced the
amount of the transferee’s liability by the amount he paid to the
debtor pursuant to § 3439.08(d).5 The trustee appealed, arguing
that the bankruptcy court’s calculation of liability was
erroneous. The trustee argued that once the avoidability of the

transfer is determined pursuant to state law, the amount of the

5 Section 3439.07 provides that a creditor, subject to the
limitations in § 3439.08, may obtain avoidance of a fraudulent
transfer to the extent necessary to satisfy the creditor’s claim.
Section 3439.08(d) provides that “[n]otwithstanding voidability
of a transfer .. . a good faith transferee . .. is entitled, to
the extent of the value given the debtor for the transfer ...a
reduction in the amount of the liability on the judgment.”

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transfer is determined pursuant to § 550{a), and that any limit
on liability imposed by state law should be disregarded. The
district court disagreed. Specifically, the district court found
persuasive the fact that two other courts had “assumed that state
law setoff provisions like the one at issue are swept into 11
U.S.C. § 544(b) along with provisions defining a fraudulent
conveyance.” Id. at *5. Moreover, the court stated that while

§ 3439.08 is a limit on liability rather than on avoidability,
“the statutory provision authorizing avoidance states expressly
that a creditor may obtain avoidance ‘subject to the limitations
in Section 3439.08.'" Id, Therefore, the court held that the
bankruptcy court properly permitted the transferee to set off the
value he gave for the real property at issue. Id.

As can be seen from the above discussion, the interplay
between the Code and California fraudulent conveyance law is far
from settled. The parties have not cited, and I have not
discovered any cases specifically deciding the issue here.
Nonetheless, a plain reading of §§ 549 and 550, and Civil Code
§§ 3439 et seq., relevant case law, and general principles of
bankruptcy law support the conclusion that Plaintiff may recover
the current fair market value of any equity in the Property.

Here, Plaintiff seeks to avoid the transfer of Debtor's
interest in the Property to Defendant via the Deed. Plaintiff
may avoid the Transfer if a creditor holding an allowed claim
could avoid the Transfer under applicable state law. See 11
U.S.C. § 544(b). Under controlling California fraudulent
conveyance law, e.g. §§ 3439.01, 3439.04, and 3439.07, a creditor

could not avoid the Transfer in its entirety. Rather, a creditor

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is permitted to avoid only a “transfer”. A “transfer” is the
disposition of an “asset”, which excludes property encumbered by
a valid lien or exempt under non-bankruptcy law. As such,
property that is fully encumbered and/or exempt is not voidable

as a fraudulent transfer. See Consolidated Pioneer Mortq.

Entities v. San Diego Sav. & Loan (In re Consolidated Pioneer

Mortq. Entities), 1999 WL 23156, *1 (9th Cir. 1999) (“[BP] roperty

encumbered by a valid security interest is not recoverable under
California law.”). Accordingly, Plaintiff, standing in the shoes
of a creditor proceeding under California law, is entitled to
avoid the Transfer only to the extent that Debtor disposed of
unencumbered, non-exempt property with the intent to defraud, or
while insolvent. See Kendall v. Turner (In re Turner), 335 B.R.
140, 145 (Bankr. N.D. Cal. 2005) (stating that under California
law, only the transfer of the “asset” is avoided).

Based on the above analysis, Defendant argues that
Plaintiff's recovery is limited to Debtor’s equity interest in
the Property at the time of the Transfer. Defendant emphasizes
that § 550(a) does not permit Plaintiff to recover more than is
avoidable under § 544(b) and California law. Defendant is
correct that a trustee's recovery may be made only “to the extent
the transfer is avoided.” See 110U.S.cC. § 550(a). However, a
trustee may recover, for the benefit of the estate, the property
transferred or its value. Accordingly, while Plaintiff can avoid
the Transfer only to the extent Debtor transferred equity in the
Property, Plaintiff may recover the “value” of that equity
interest pursuant to § 550{a).

The Code neither defines “value” nor indicates at what time

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“value” is to be determined. See Hirsch v. Steinber In re

Colonial Realty Co.), 226 B.R. 513, 525 (Bankr. D. Conn. 1998).

Typically, courts equate “value” with the fair market value of
the subject property at the time of the transfer. See Hirsch,

226 B.R. at 525; see also Salven v. Munday (In re Kemmer), 265

B.R. 224, 235 (Bankr. E.D. Cal. 2001); Tramiel, 2006 WL 2844581,
*6. This is especially true where the property depreciated in
value after the transfer, or was not in the possession of the

§ 550 defendant. See Hirsch, 226 B.R. at 525; see also First

Software Corp. v. Computers Assoc. Int’l. (In re First Software

Corp.), 107 B.R. 417, 423 (D. Mass 1989); Hall v. Arthur Young &
Co. (In re Computer Universe, Inc.), 58 B.R. 28, 32 (Bankr. M.D.

Fla. 1986); 5 L. King, Collier on Bankruptcy § 550.02[3] (15th
ed. rev. 2001).

At least two courts have recognized that the trustee is
entitled to recover the “greater of the value of the transferred
property at the transfer date or the value at the time of the
recovery.” Collier on Bankruptcy, supra, { 550.02[3]; see also

Langhorne v. Warmus (In re American Way Serv. Corp.), 229 B.R.

496, 530-31 (Bankr. $.D. Fla. 1999) (“[(W]hen the property has
appreciated, the trustee is entitled to recover the property
itself, or the value of the property at the time of judgment”);

Govaert v. B.R.E. Holding Co., Inc. (In re Blitstein), 105 B.R.

133, 137 (Bankr. S.D. Fla. 1989) (“[T]he Trustee is entitled to
at least a money judgment in the amount of the greater of the
value at the time of the transfer; or the value at the time of
recovery less the value of improvements made.”). This makes

sense. As noted by Collier, this result is consistent with the

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well-established purpose of § 550, to restore the estate to the
position it would have occupied had the property not been
transferred.* See Collier on Bankruptcy, supra, § 550.02[3].
Moreover, as stated by Plaintiff, a trustee typically has the
ability to recover the property transferred, which would allow
the estate to benefit from any appreciation. Section 550 (e)
demonstrates the intent of Congress that any appreciation not
attributable to the actions of a good faith transferee inure to
the benefit of the estate. Pursuant to § 550(e), a good faith
transferee is entitled to a lien to secure the lesser of the cost
of any improvements, or an increase in value as a result of such
improvements.’ See 11 U.S.C. § 550(e); see also Collier on
Bankruptcy, supra, § 550.02[3].

In sum, while California law governs whether and to what
extent a transfer of property is voidable, the value of the

avoided transfer, and therefore, the recovery is governed by

6 Collier also notes that this result:

serves the equitable underpinnings of
restorative justice by discouraging a “wait
and see” approach by transferee defendants
holding property, such as stock, that may be
subject to wide, rapid swings in value on
account of volatile markets. Likewise, as
noted in the legislative record, ‘a
transferee has an opportunity to benefit by
delay, and there are possibilities for abuse
where the transferred property is
appreciating substantially in value.

Collier on Bankruptcy, supra, § 550.02[3].

7 Improvements include physical additions or alterations to
the property, repairs, the payment of taxes or secured debt, and
preservation of the subject property. See 11 U.S.C. § 550(e).

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§ 550(a), irrespective of any recovery limitations imposed by
California law. Therefore, Plaintiff may avoid the transfer of
Debtor's interest in the Property to the extent it involved the
transfer of unencumbered, non-exempt equity. Under § 550(a}),
Plaintiff may recover the property transferred, e.g. the “asset”,
or the current fair market value of the asset, less the cost or
value of improvements, assuming such recovery is for the benefit
of the estate. This interpretation is consistent with a plain
reading of the Code, the Ninth Circuit’s holding in Acequia, and
the separation of the concepts of avoidance and recovery. To the
extent that the reasoning in Tramiel supports a holding to the
contrary, it is unpersuasive and not binding on this court.
Accordingly, Plaintiff is entitled to summary judgment that he
may recover the current fair market value of the property
transferred for the benefit of the estate.
¥. CONCLUSION

While California law allows Plaintiff to avoid the Transfer
only to the extent that Debtor disposed of unencumbered, non-
exempt property, California law does not limit Plaintiff's
recovery to the value of the “asset” at the time of the Transfer.

Rather, Trustee may recover the appreciated value of the asset,

provided it is for the benefit of the estate. Accordingly,
partial summary judgment is granted for Plaintiff in that
Plaintiff's recovery under §§ 544(b) and 550(a) is the value of
the equity in the Property at the time of the Transfer, plus any
appreciation, less any offset for property improvements.

This memorandum decision shall constitute my findings of

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fact and conclusions of law.

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Dated: February 5,

2007

13

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UNITED STATES BANKRUPTCY COURT
CENTRAL DISTRICT OF CALIFORNIA

In re Case No. SA 05-18954 GR
Adversary No. SA 05-01622 JR

DONALD J. BRUN,
NOTICE OF ENTRY OF ORDER

Debtor.

To:

OFFICE OF THE UNITED STATES TRUSTEE
411 West Fourth Street
Santa Ana, CA 92701-8000

LEONARD M. SHULMAN

Shulman Hodges & Bastian LLP

26632 Towne Centre Drive, Suite 300
Foothill Ranch, CA 92610

THOMAS H. CASEY

Law Offices of Thomas H. Casey, Inc.
22342 Avenida Empresa, Suite 260
Rancho Santa Margarita, CA 92688

You are hereby notified, pursuant to Bankruptcy Rule 9022 that
a judgment or order entitled MEMORANDUM OPINION and ORDER DENYING
DEFENDANT’S MOTION FOR PARTIAL SUMMARY JUDGMENT, AND GRANTING
PLAINTIFF'S CROSS-MOTION FOR PARTIAL SUMMARY JUDGMENT was entered

on FEB 6 7007

I hereby certify that I mailed a copy of this notice to the

above-named persons on FER g 207 .
Dated: FFB 6 2007

JON D. CERETTO
By Tie use

Deputy Clerk