CLA Article – IN RE LICUP, 2023 WL 2134975, (B.A.P. 9TH CIR. FEB. 21, 2023)

[Previously published on California Lawyers Association website, written by Joshua Scheer]

Dear constituency list members of the Insolvency Law Committee, the following is a case update written by Joshua Scheer, a partner at Scheer Law Group, LLP analyzing a recent case of interest:

SUMMARY

The Ninth Circuit Bankruptcy Appellate Panel (“BAP”) affirmed a non-dischargeable judgment where the creditor did not receive notice of the bankruptcy in time to file a proof of claim in a chapter 7 asset case.  The incorrect address in the petition and lack of actual notice resulted in a non-dischargeable judgment for the full claim amount, not just the amount that the creditor would have received had it filed a timely proof of claim.  The BAP determined that 11 U.S.C. § 523(a)(3)(A) (“§ 523(a)(3)(A)”) was “plain and unambiguous” and did not allow for any equitable exceptions.  Essentially, even if the debtor’s mistake was innocent, lack of actual notice of the petition results in the entire debt being non-dischargeable under § 523(a)(3)(A) if the creditor did not have notice or actual knowledge of the case in time to timely file a proof of claim.  While the result may seem harsh, the BAP’s reasoning is sound. In re Licup, 2023 WL 2134975, (B.A.P. 9th Cir. Feb. 21, 2023).

To read the full published decision: click here.

FACTS

Christine Castro (“Castro”) leased commercial property from Jefferson Avenue Temecula, LLC (“Jefferson”).  In 2012, Jefferson filed an unlawful detainer against Castro and obtained a state court judgment for $31,786.29 (“State Court Judgment”).

In 2014, Castro and her husband Edwin Licup (collectively “Debtors”) filed a joint chapter 7 petition (“Bankruptcy”).  The Debtors scheduled Jefferson as an unsecured creditor with only a $3,100 claim relating to the State Court Judgment.  Debtors listed Jefferson’s former legal counsel as the address for service.  However, Debtors incorrectly, and inadvertently, used “Sun Valley, CA” as the city for Jefferson’s counsel, instead of “Tarzana, CA”.[1]

The chapter 7 trustee notified creditors of a deadline to file proofs of claim. However, given the incorrect address listed in the petition, Jefferson did not receive notice of the Bankruptcy or of the deadline to file a proof of claim.  Allowed claims received a 5.5% distribution.

In 2021, seven years after the chapter 7 distribution, Jefferson filed an adversary complaint to hold the entire State Court Judgment non-dischargeable under 11 U.S.C § 523(a)(3)(A), alleging a lack of actual notice of the petition and the proof of claim deadline.  In defense, the Debtors focused primarily on the amount of distribution Jefferson should be entitled to, if any.  The Debtors argued that Jefferson should only receive the $1,614.74 it would have received had it filed a timely proof of claim.  According to the Debtors, the statute was designed to protect a creditor’s right to participate in whatever actual distributions occurred; it did not entitle a creditor to non-discharge of the entire debt, which would be a windfall in situations where only a small distribution occurred.

Importantly, the Debtors admitted that Jefferson did not have notice or knowledge of the petition.  This satisfied the requirements of § 523(a)(3)(A). The Court granted Jefferson’s summary judgment motion, finding that there were no material facts in dispute and that the lack of “notice” or “actual knowledge” of the petition mandated a judgment in favor of Jefferson.

According to the Bankruptcy Court, the only legal issue was whether the entire State Court Judgment should be non-dischargeable or only the amount that would have been paid had there been a timely proof of claim.  The Bankruptcy Court held that § 523(a)(3)(A) was clear on its face that it excepts the entire amount of a debt, not just a portion.  The entire State Court Judgment amount was non-dischargeable and enforceable to the extent enforceable under state law.[2]

BAP RULING AND REASONING

In an unpublished decision, the BAP affirmed the Bankruptcy Court’s ruling.  The BAP’s focus was narrow and its reasoning straightforward.  11 U.S.C. § 523(a)(3)(A) is clear that when a debtor fails to properly schedule or list a debt and the creditor does not have “notice or actual knowledge” of the case in time to file a proof of claim (as occurred here), the debt is not discharged.  The term “debt” is defined in § 101(12) as “liability on a claim,” not a portion of the claim, but the debt itself.  The BAP reasoned that if Congress had intended to only except from discharge a pro rata portion of the debt, it could have done so.

Debtors argued that only the amount Jefferson would have received had it timely filed a proof of claim should be excepted from discharge under § 523(a)(3)(A).  According to the BAP, the Debtors’ interpretation of the statute provides no incentive to ensure proper scheduling or notice to creditors.  A debtor could simply omit a creditor with its only risk being payment of a pro-rata portion, at some later date, and only if the creditor finds out about the bankruptcy and distribution.

Notably, the BAP, in following prior BAP precedent, reasoned that it had previously found the language of § 523(a)(3)(A) to be “clear and unambiguous” in In re Mahakian, 529 B.R. 268, 276 (B.A.P. 9th Cir. 2015).[3]  Consistent with its prior ruling, the BAP held that “equitable exceptions” did not apply to § 523(a)(3) where the language was clear on its face. The court has no power to disregard the plain language of the statute.

AUTHOR’S COMMENTS

The BAP’s non-precedential opinion is not controversial: equitable exceptions cannot be read into a statute, such as 11 U.S.C. § 523(a)(3)(A), where the language is clear on its face.  However, counsel should understand that an omitted or incorrectly scheduled claim does not automatically result in a non-dischargeable debt.

For example, 11 U.S.C. § 523(a)(3)(A) only applies where a proof of claim would have been required for distribution in the first place.  If Licup had been a “no asset” case where a proof of claim deadline was never set, it would have likely resulted in the Jefferson debt being discharged entirely.  The case must be an asset case, where the proof of claim deadline has passed in order for the statute to apply. The Licup panel distinguished the case before it from In re Nielsen, 383 F.3d 922, 926 (9th Cir. 2004) and In re Beezley, 994 F.2d 1433 (9th Cir.1993), two cases in which the 9^th Circuit had held that certain omitted debts were discharged despite a lack of notice of the petition, because no claims bar date had been set in either case.

Moreover, for § 523(a)(3)(A) to result in a non-dischargeable debt, the creditor must not have received actual notice in time to file a timely proof of claim. The ruling in Licup would have presumably been different if Jefferson had received notice of the case.  How much notice is sufficient remains an open question.

In addition, § 523(a)(3)(A) incorporates 11 U.S.C. § 521(a) (Debtor’s duties).Finally, § 523(a)(3)(A) is not the only bankruptcy code section governing omitted or late filed claims.  A creditor may file a late claim prior to distribution pursuant to 11 U.S.C. § 501(a) (Filing proofs of claims or interests) and request distribution under 11 U.S.C. § 726(a)(2)(C) (Permitting late filed claims).  A creditor may also seek to revoke the debtor’s discharge under 11 U.S.C. § 727(d) (Time period for seeking revocation of discharge).  In these scenarios “good faith” and “equity” are part of the court’s analysis.  However, these remedies are separate and apart from § 523(a)(3)(A).

Licup does leave some questions unanswered.  § 523(a)(3)(A) refers to “notice or actual knowledge” of the case (not the bar date).  Presumably then, a creditor’s constructive notice of the bankruptcy case renders the section inoperative.  What constitutes constructive notice of a bankruptcy case?  Also, how much time is enough to file a timely claim?  A month?  A week?  A day?  Does it depend on the sophistication or resources of the creditor?  How should debtor’s counsel advise a client who failed to schedule a creditor in a case in which a bar date has been set?  Would it be unethically misleading for debtor’s counsel to tell a “naïve” creditor with § 523(a)(3)(A) rights that debtor received a discharge and offer to settle the claim?  What rights does a creditor have in this scenario?  What if a “Notice of Asset Case” containing a claims bar date is served, but ultimately no distribution is made (i.e., the case turns out to be a no asset case)?  Can a debtor in such a case move to have the claims bar date notice “withdrawn” nunc pro tunc to avoid the potential inequitable consequences of § 523(a)(3)(A) in a no-asset case with a bar date?

The ruling in Licup holding is narrow, but significant: § 523(a)(3)(A) precludes even a good faith debtor from discharging a debt if the creditor does not receive notice or have actual knowledge of the case in time to file a proof of claim before the claims bar date.

These materials were written by ILC committee member Joshua Scheer, of Scheer Law Group, LLP in Aliso Viejo, CA ([email protected]).  Editorial contributions were provided by Marc A. Lieberman of FLP Law Group, LLP in Los Angeles, CA ([email protected]). 

[1] Tarzana and Sun Valley are suburban neighborhoods in the City of Los Angeles. They have different ZIP and are about 15 miles apart.

[2] There were questions as to the enforceability of the State Court Judgment as to both Debtors and even as to Castro individually as the State Court Judgment was entered against “Christina Castro, LLC”.  However, the court declined to rule on these state law issues and directed the parties to address them in state court.  Instead, it focused its ruling only on whether the debt itself was non-dischargeable under § 523(a)(3)(A).

[3] In Mahakian, the debtor attempted to assert that a late filed proof of claim filed by the debtor, where the creditor had been previously omitted, should not be discharged.  The debtor in Mahakian argued that the omission was due to the debtor’s “excusable neglect” in failing to include the creditor in the petition and in filing the late claim.