Chapter 420, Part III: Pause for Good Cause – In re Hacienda Cracks the Door Open for Cannabis Chapter 11 Bankruptcies in Ninth Circuit.

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In a previous article, I discussed the ultimately doomed effort by United Cannabis, a cannabis-affiliated company, to maintain its chapter 11 bankruptcy petition in the face of the Bankruptcy Court for the District of Colorado’s sua sponte challenge on the basis of the plan requiring administration of federally illegal cannabis activity. Although that case did seem to further shut the door to cannabis businesses seeking the protections of bankruptcy, at least in the Tenth Circuit, it also indirectly highlighted the growing gap in treatment of bankruptcy cases between the Ninth Circuit and others. In a recent case, In re The Hacienda Company, LLC, No. 2:22-bk-15163-NB, 2023 Bankr. LEXIS 2359 (Bankr. C.D. Cal. Sept. 20, 2023), the Ninth Circuit has doubled down on its liberal treatment of cannabis bankruptcy cases. Specifically, Bankruptcy Judge Neil W. Bason of the Central District confirmed the debtor’s chapter 11 plan of reorganization and denied the U.S. Trustee’s motion to dismiss the petition on the grounds that federally illegal cannabis activity was funding the reorganization.

Debtor in the case, the Hacienda Company, was at one point an active California cannabis cultivator and distributor. However, it fell on hard times in 2021 and sold its assets to Lowell Farms, Inc., a Canadian, company, in exchange for shares of Lowell Farms stock. Eventually, Hacienda declared bankruptcy and proposed, as part of its plan of reorganization, to sell off the Lowell Farms shares and distribute the proceeds to its creditors.

The U.S. Trustee objected, and filed a motion to dismiss under section 1112(b) of the bankruptcy code, which prohibits the confirmation of any plan of reorganization for “cause.” Although “cause” under section 1112(b) has somewhat of a malleable definition, the U.S. Trustee argued that good cause was present because Hacienda was still (technically) involved in federally illegal cannabis business activities—specifically, a “conspiracy” to violate the Controlled Substances Act via its assets-for-stock transaction with Lowell Farms.[1]

Judge Bason disagreed, denying the U.S. Trustee’s motion to dismiss and, in a companion order, confirming the plan of reorganization over the U.S. Trustee’s objections. The court’s reasoning, put briefly, was that evidence of illegal activity by a debtor as part of a proposed plan of reorganization does not, ipso facto, mandate dismissal. Specifically, the court pointed out that Congress did not explicitly list “illegal activity” as one of the grounds for “cause” under section 1112(b). It also pointed out several famous examples of confirmed plans of reorganization where past or ongoing illegal activity was present—such as the Enron and PG&E bankruptcies. Lastly, the court also pointed out that the plan it was approving resulted in the same remedy that would have resulted had the debtor been criminally prosecuted under anti-money laundering statutes: liquidation of the assets for the benefit of creditors.

The court went a step further, and also held that even if there was “cause” for dismissal arising from the illegal activity, the “unusual circumstances” exception of section 1112(b)(2) would also justify denial of the motion to dismiss. The court applied the two-part test for “unusual circumstances,” finding first that there were unusual circumstances such that dismissal was not in the best interests of creditors because dismissal would mean that the debtor’s shares in Lowell Farms would sit on the shelf rather than be liquidated to pay the unsecured creditors. The court then found the plan also met the second prong of the unusual circumstances test in that (1) the plan could be confirmed in a reasonable amount of time and (2) that the resulting ability to pay off the debtor’s creditors in full provided “reasonable justification” for the liquidation of the Lowell Farms stock and would also cure any residual illegal activity by eliminating the last cannabis-connected asset of the company.

Implications and Takeaways

The holding in Hacienda should embolden both cannabis businesses and their service providers in that it has left the door to bankruptcy protection slightly ajar. Of course, the unique factual circumstances of this case likely limit its applicability, but it is notable for the court’s noting that illegal activity—read: involvement in cannabis business—does not automatically disqualify a business from bankruptcy protection and the ability to reorganize under chapter 11. Other would-be cannabis debtors that are winding down their operations, but may have other assets, such as intellectual property, they may want to parlay into another venture will likely take advantage of this rather liberal reading of the Bankruptcy Code. That said, for other cannabis businesses, the juice may not be worth the squeeze in terms of the barriers to entry for bankruptcy, and may elect to pursue dissolution or receivership under state law, as has been the trend.

Aside from Hacienda’s impact on its own terms, it further highlights a growing divide between Bankruptcy Courts inside of different circuits, specifically regarding the application of section 1112(b) for dismissal or conversion of chapter 11 petitions and section 1129(a) for chapter 11 plan confirmation.

As you may recall from my prior article, there is a circuit split between the Ninth Circuit on one hand, and Sixth and Tenth Circuits on the other, regarding the interpretation of section 1129(a)(3). That particular subsection requires that, for a plan of reorganization to be confirmed, that it must be “proposed in good faith and not by any means forbidden by law.” The Ninth Circuit, in Garvin v. Cook Investments NW, SPNWY, LLC, 922 F.3d 1031 (9th Cir. 2019), interpreted this clause to mean that the plan must be “proposed . . . not by any means forbidden by law,” not that the plan itself must not contain any illegal activity. The Hacienda court followed this precedent in its order confirming the debtor’s plan. In re Hacienda Co., LLC, 2023 Bankr. LEXIS 2359, at *7-9. In contrast, the Sixth and Tenth Circuits have taken the opposite view and looked at the substantive terms of the plan and, specifically, whether the debtor’s plan consists of any ongoing involvement with federally illegal cannabis business, to determine whether it meets the requirements of section 1129(a)(3). See, e.g., In re Basrah Custom Design, Inc., 600 B.R. 368, 381 n.38 (Bankr. E.D. Mich. 2019); In re Way to Grow, Inc., 610 B.R. 338, 345-47 & n.3 (D. Colo. 2019). Practically speaking, this means that cannabis businesses can have plans confirmed in the Ninth Circuit, but because of the federally illegal nature of their business, the Sixth and Tenth Circuits prevent plan confirmation because the illegal activity prevents a finding that the plans are proposed “in good faith.”

Apart from reinforcing this split, Hacienda answers a lingering question from Garvin. As liberal as the Garvin court was in confirming the plan of reorganization, the court did note that opponents of cannabis business chapter 11 plans could always invoke the section 1112(b) to dismiss the bankruptcy, even if it meets the “proposal” requirements for confirmation under 1129(a), specifically invoking the “gross mismanagement” prong of “cause” for dismissal under that subsection. Garvin, 922 F.3d at 1036. The Hacienda court noted that illegal activity might constitute “gross mismanagement” in the abstract, and impliedly found that the illegal activity by the debtor was not gross mismanagement, although it does not appear that the U.S. Trustee argued that point. One can assume that the relatively “clean” nature of the plan to liquidate the Lowell Farms shares to pay off the creditors left little room for a mismanagement argument. More significantly, the Hacienda court has shown that to constitute cause for dismissal under 1112(b), a movant must show that the illegal activity provides cause for some other reason than its own illegal status. This furthers the divide between the Ninth and Sixth Circuits; although the United Cannabis court did not explicitly say why it was finding good cause under 1112(b) to dismiss the debtor’s petition, one can presume that the “illegal activity” rationale played a role in the good cause finding.

In short, Hacienda’s holding has made the bankruptcy courts of the Ninth Circuit friendlier to cannabis businesses on the issues of cause for dismissal and plan confirmation. Until federal legalization happens, these circuit splits will likely deepen, and is perhaps predictable, if not appropriate, that bankruptcy courts located in the Pacific region—historically the vanguard in cannabis legalization—are providing a more hospitable environment for cannabis business debtors.

[1] Significantly, the U.S. Trustee and Court noted that although Lowell Farms was wholly legal in Canada, including its public trading on the Canadian Stock Exchange, it likely had operations in the United States that violated federal law.

Are Private Student Loans Dischargeable in Bankruptcy Court? An In-Depth Examination of Each Sub-Section of Section 523 (a)(8) of the Bankruptcy Code—Part III

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This is a three-part article that explores whether private student loans are excepted from discharge under Section 523 (a)(8) of the Bankruptcy Code. Section 523 (a)(8) includes three categories of non-dischargeable student loan debt. Part I of the blog article discussed Section 523 (a)(8)(A)(i) and can be accessed here. Part II of the blog article discussed Section 523 (a)(8)(A)(ii) and can be accessed here.  This is Part III of the blog article and explores the last category of non-dischargeable student loan debt, Section 523 (a)(8)(B).  

Section 523 (a)(8)(B) — “Qualified Education Loan”

The last non-dischargeable exception states that “any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986 incurred by a debtor who is an individual” is non-dischargeable unless repaying the debt would impose an undue hardship on the debtor and their dependents.  11 U.S.C.S. 523 § (a)(8)(B) (emphasis added).  Section 523 (a)(8) leads the reader through a statutory trail and, therefore, requires a detailed explanation of each section mentioned in the statute.

Section 221 (d)(1) of the Internal Revenue Code (“IRC”) states that a “qualified education loan” is any indebtedness incurred by the taxpayer solely to pay for “qualified higher education expenses.” The term “qualified higher education expenses” in Section 221 (d)(1) of the IRC means any expenses used to fund the student’s education, such as tuition, books, supplies, room and board, and other related expenses.  See 26 U.S.C.S. § 221 referring to 20 U.S.C.S. § 1087ll.    Moreover, the “qualified higher education[al] expenses” must be directed towards an “Eligible Educational Institution.” See 26 U.S.C.S. § 221 referring to 26 U.S.C.S. § 25A.    Whether private, non-profit, or government-funded, most accredited universities are “Eligible Educational Institutions.”[i] 

Despite the complexity of Section 523 (a)(8)(B), Bankruptcy Courts throughout the country appear to agree that Section 523 (a)(8)(B) encompasses private student loans.  For instance, in Conti v. Arrowood Indem. Co. (In re Conti), 982 F.3d 445 (6th Cir. 2020), the debtor received loans from CitiBank to fund her college education and then later sought to discharge the private debt through a Chapter 7 bankruptcy.  There was no dispute that the loan proceeds were for the debtor, the debtor was an eligible student when she incurred the debt, and the loan funds were directed to an accredited institution.  The sole issue on appeal was whether the overall purpose of the loan was to fund the debtor’s education.  See In re Conti, 982 F.3d at 446-47. 

The Circuit Court held that the purpose of the loan proceeds can be “centrally discerned from the lender’s agreement with the borrower.” Id. at 448-49.  The Circuit Court found that the promissory notes explicitly stated that the loan was for educational expenses at the named institution and even specified that the loan proceeds were intended to pay for the debtor’s tuition.  Id.    Accordingly, the Appellate Court held that the private student loan was a “qualified education loan” and, thus, was non-dischargeable under Section 523 (a)(8)(B).

The Bankruptcy Court in the District of Alaska reached a similar conclusion in the case of Rizor v. Acapita Educ. Fin.    Corp.    (In re Rizor), 553 B.R. 144 (Bankr. D. Alaska 2016).  In that case, the debtor took out a private student loan to fund his attendance at a private, for-profit veterinary school located in Grenada.    Unlike In Re Conti, the primary issue was whether the veterinary school was an eligible educational institution (“EEI”).  In re Rizor, 553 B.R. 144.  The Bankruptcy Court held that the institution was an EEI because Section 1002 of the U.S. Education Code provided a carve-out for specific, off-shore veterinary schools. Id.

At first blush, Section 523 (a)(8)(B) appears to provide a safe haven for private student loans.  However, it is important to note that Section 523 (a)(8)(B) is extremely dense and statutorily driven.  Part III of article only touched on this subsection’s most important and relevant parts.  The cases cited above offer guidance to Bankruptcy Courts on the innerworkings of Section 523 (a)(8)(B), but do not flush out each moving-part of this exception.  Needless to say, wise attorneys on both sides of the aisle will continue to uncover other legal issues that will undoubtedly make this subsection more difficult to navigate.

 Conclusion

This three-part blog article touched on each non-dischargeable student loan debt category in Section 523 (a)(8) of the Bankruptcy Code.    Part I of the blog article, which can be accessed here, focused on Section 523 (a)(8)(A)(i) and concluded that the term “funded” takes on many definitions, depending on the type of loan program at play.    Part II of the blog article can be accessed here and was focused on Section 523 (a)(8)(A)(ii), which does not provide a safe haven for private lenders.  There appears to be a consensus amongst the Circuit Courts that Section 523 (a)(8)(A)(ii) is not focused on loans at all; instead, the sub-section is aimed at non-conditional grants, such as stipends and scholarships.   Part III of the article was discussed above and examined the intricate statutory trail created by Section 523 (a)(8)(B) of the Code.

Analyzing all three non-dischargeable exceptions under Section 523 (a)(8), it appears that private student loans are non-dischargeable in two instances.  Under Section 523 (a)(8)(A)(i), a private student loan is excepted from discharge if a non-profit entity was part of a loan program that facilitates loans to students in need of financial assistance, and the non-profit entity guaranteed the loan or purchased the loan from the original lender.  Section 523 (a)(8)(B) is also a safe haven for private lenders.  The threshold issue under Section 523 (a)(8)(B) is that the private student loan must be a “qualified education loan,” which requires the proponent to jump through multiple statutory hurdles.   

This is Part III of a three-part blog article. Part I of this three-part blog article can be accessed by clicking on this link. Part II of this blog article can be accessed by clicking on this link.

[i] The IRS website specifically states: Eligible Educational Institutions “include[] most accredited public, non-profit and privately-owned–for-profit postsecondary institutions.”

https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit/eligible-educational-inst#:~:text=An%20eligible%20educational%20institution%20is,the%20U.S.%20Department%20of%20Education.

Are Private Student Loans Dischargeable in Bankruptcy Court? An In-Depth Examination of Each Sub-Section of Section 523 (a)(8) of the Bankruptcy Code—Part II

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This is a three-part article that explores whether private student loans are excepted from discharge under Section 523 (a)(8) of the Bankruptcy Code. Section 523 (a)(8) includes three categories of non-dischargeable student loan debt. Part I of the blog article discussed Section 523 (a)(8)(A)(i) and can be accessed here. This is Part II of the blog article and discusses Section 523 (a)(8)(A)(ii). Part III of the blog article explores the last category of non-dischargeable student loan debt, Section 523 (a)(8)(B) and can be accessed here.

Section 523 (a)(8)(A)(ii)—What is an “educational benefit”?

The text of Section 523 (a)(8)(A)(ii) (hereinafter “(A)(ii)”) states that an “obligation to repay funds received as an educational benefit, scholarship, or stipend” is non-dischargeable unless repaying the debt would impose an undue hardship on the debtor and the debtor’s dependents.

When determining whether private student loans fall under (A)(ii), Bankruptcy Courts are confronted with two issues.  The Bankruptcy Court must first determine whether the debtor actually received funds from the private lender for educational purposes.  The second prong of the analysis requires a determination of whether the private student loan debt is an “educational benefit, scholarship, or stipend.” 11 U.S.C.S. § 528 (a)(8).  Nearly all private lenders and loan servicers attempt to couch private student loans under the term “educational benefit” and avoid arguing that a private student loan is a scholarship or stipend.  The primary reason is that the terms “stipend” and “scholarship” “signify granting, not borrowing” and generally do not need to be repaid by the debtor, whereas a loan must be repaid.  McDaniel v. Navient Sols. LLC (In re McDaniel), 973 F.3d 1083, 1094 (10th Cir. 2020).  On the other hand, the term “educational benefit” is much broader and leaves room for arguing that private student loans confer an educational benefit on the debtor.  See Crocker v. Navient Sols., L.L.C. (In re Crocker), 941 F.3d 206, 219 (5th Cir. 2019) (“[t]he key phrase, “educational benefit,” is the broadest”).  As a result, the second prong hinges on the Bankruptcy Court’s interpretation of “educational benefit.”

The first element—whether the debtor actually received funds—was discussed in two cases originating in the Ninth Circuit.  In the case of In re Kashikar, the Bankruptcy Court held that the term “funds received” means “cash advanced to or on behalf of the debtor.” Kashikar v. Turnstile Capital Mgmt., LLC (In re Kashikar),567 B.R. 160, 166 (Bankr.9th Cir. 2017) (citations omitted).  The Bankruptcy Court found that the debtor “received the funds” when the private lender disbursed the loan proceeds directly to the institution because the funds were dedicated towards paying for the student’s education. Id at 166-67.

In comparison, a debtor does not receive funds when the educational institution gives the debtor a tuition credit in which the institution agrees to be paid at a later date.  In Inst. of Imaginal Studies v. Christoff (In re Christoff), 527 B.R. 624 (B.A.P. 9th Cir. 2015), the institution offered the debtor $6,000 of financial aid in the form of a tuition credit.  Id. at 625-26.  The debtor was required to repay the credit upon completing her course work. Id.  The Bankruptcy Appellate Panel for the Ninth Circuit found that the institution agreed to discount the student’s tuition by $6,000 for a limited time and agreed to be paid the credit at a later date. Id. at 633-35.  There was no cash advanced to or on behalf of the debtor, nor were any funds exchanged between the student, the institution, or a lender.  Id. Therefore, the Bankruptcy Appellate Panel discharged the student loan debt because the Court found that the debtor did not “actually receive funds.” In summary, in order to satisfy the first prong of the (A)(ii) analysis, the lender must direct the loan proceeds to the debtor or the educational institution.

Before turning to the case law on the second issue, it is important to provide some background information.  Navient Solutions, LLC (“Navient”) is a nationwide student loan servicing corporation and is the adverse creditor in the cases described below.  In each case, Navient argued that the term “educational benefit” was broad enough to encompass private student loans.  The Court of Appeals for the Second, Fifth, Ninth, and Tenth Circuits (the “Circuit Courts”) disagreed and concluded that private student loans do not fall under the umbrella of an “educational benefit” and, as a result, are not excepted from discharge under (A)(ii).

Each Circuit Court started its analysis by examining the statutory text of Section 523 (a)(8).  The Circuit Courts noted that the term “loan” was included in Section 523 (A)(i) and (8)(B)—the other two exceptions in Section 523 (a)(8)—but was omitted from Section 523 (8)(A)(ii).  The Fifth Circuit, in In re Crocker, observed that “Congress sandwiched subsection (A)(ii), which does not mention loans at least by name, between two subsections that explicitly do,” which indicates that “educational benefits are not loans.” In re Crocker, 941 F.3d at 219.  The Second Circuit in Homaidan v. Sallie Mae, Inc. 2021 U.S. App.  LEXIS 20934, at *10 (2d Cir. July 15, 2021, No. 20-1981) reached a similar conclusion and found that the “term “loan” is used several times in Section 523 (8)(A) but is absent from § 523 (a)(8)(A)(ii), signaling that the omission was intentional.”  The Circuit Courts held that the omission of the word “loan” from (A)(ii) suggested that Congress’ intended to create a category of student debts that were not incurred through private or federal loans.  

The Circuit Courts’ analysis continued and they defined the term “educational benefit” as used in (A)(ii).  Because the term was left undefined by Congress, the Circuit Courts applied the statutory canon of noscitur a sociss.  The cannon helps Bankruptcy Courts define a vague word included in a list by examining the other terms surrounding the disputed word.   See Homaidan, 2021 U.S. App.  LEXIS 20934 at *13 (“the meaning of doubtful terms or phrases may be determined by reference to their relationship with other associated words or phrases”) quoting United States v. Dauray, 215 F.3d 257 (2d Cir. 2000) see also In re Crocker, 941 F.3d 206, 218-219 (“noscitur a sociis. . . . tells us that statutory words are often known by the company they keep”).

To repeat, the text of (A)(ii) is: “obligation to repay funds received as an educational benefit, scholarship, or stipend.” 11 U.S.C.S. § 523 (8)(A)(ii).  The Fifth Circuit found that when a student receives a stipend or scholarship, he is not required to repay the entity that awarded him the stipend or scholarship.  As the Tenth Circuit succinctly put it, a “stipend. . . .is a fixed and regular payment, such as a salary, and a scholarship. . . .is a grant of financial aid to a student,” and both do not normally need to be repaid.” In re McDaniel, 973 F.3d at 1097.  Similarly, the word “benefit,” as used in “educational benefit,” implies a payment, gift, or service, that does not need to be repaid.  Id.  

The Circuit Courts’ interpretation of “benefit,” “scholarship,” and “benefit” indicate that (A)(ii) was narrowly tailored to except from discharge “conditional grants” that are required to be repaid if certain service obligations are not satisfied.  See In re McDaniel, 973 F.3d at 1102 (the common quality linking together the items in the statutory phrase “educational benefit, scholarship, or stipend” is that they can all naturally be read to describe “conditional payments”) (citations omitted).  The Circuit Courts further noted that the primary distinction between loans and conditional payments is that loans—whether private or federally backed—require repayment at a specific date by the debtor. In re Crocker, 941 F.3d at 219-221. In comparison, conditional grants must only be repaid if the debtor does not fulfill its responsibilities under the grant.  Id. Thus, the Circuit Courts found that under the doctrine of noscitur a sociss, the term “educational benefit” means “educational funds that a student receives in exchange for agreeing to perform services in the future.” In re McDaniel, 973 F.3d at 1096.   

The Second Circuit stated that an educational benefit could be a military program in which the government pays for the student’s tuition in exchange for the student working for the military for a limited time.  See Homaidan, No. 20-1981, 2021 U.S. App. LEXIS 20934, at *15.  If the student fails to fulfill their obligation, they incur an obligation to repay the funds the military dedicated towards the debtor’s educational benefit.  Id.

The Circuit Courts rejected Navient’s argument that educational benefits encompass private student loans.  The Circuit Courts held that if Navient’s interpretation were correct, (A)(ii) would become a catch-all provision that would consume all loans of any type, which would render Section 523 (A)(i) and (8)(B) superfluous and meaningless.  See e.g., Homaidan, No. 20-1981, 2021 U.S. App. LEXIS 20934, at *11 (“Navient’s broad reading. . . .would draw virtually all student loans within the scope of § 523(a)(8)(A)(ii)”, which would “swallow up” the other sub-section of Section 523 (a)(8)). The Tenth Circuit was a little harsher in its ruling: “no normal speaker of English . . . in the circumstances [ ] would say that student loans are obligations to repay funds received as an educational benefit. . . .likewise[,] no normal speaker of English would say that mortgages are housing benefits or that automobile loans qualify as transportation benefits.” In re McDaniel, 973 F.3d at 1096-97.

In conclusion, the growing trend is that a private student loan is not an educational benefit.  The primary reason, among many others, is that if “educational benefit” was defined to include loans, the remaining sub-sections of Section 523 (a)(8) would become superfluous and meaningless.  Moreover, the words surrounding the term “educational benefit” indicate that (A)(ii) is focused on debts that are incurred as a result of conditional grants, which the Circuit Courts agree are not loans, whether private or otherwise.  As a result, it appears that it is safe to say that private student loans are not excepted from discharge under Section 523 (a)(8)(A)(ii).

This is Part II of a three-part blog article. Part I of this three-part blog article can be accessed by clicking on this link. Part III of this blog article can be accessed by clicking on this link.

Are Private Student Loans Dischargeable in Bankruptcy Court? An In-Depth Examination of Each Sub-Section of Section 523 (a)(8) of the Bankruptcy Code—Part I

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In the United States, student loans have exceeded $1.6 trillion, making student loans a central focus amongst Chapter 7 and 13 debtors. Student loans facilitated or guaranteed by the U.S. government or a non-profit institution are non-dischargeable in bankruptcy court, pursuant to Section 523 (a)(8) of the Bankruptcy Code. A non-dischargeable debt means that the debtor must still repay the debt even after successful Chapter 13 or 7 bankruptcy. The only exception to this iron-clad rule is if the debtor shows that repayment would “impose an undue hardship on the debtor and the debtor’s dependents.” 11 U.S.C.S. § 528 (a)(8).

A common question is whether private student loans facilitated by private lenders—such as, Sallie Mae and Chase Bank—are afforded the same non-dischargeable protections as federal and non-profit student loans. In other words, do private student loans fall under Section 523 (a)(8) of the Code and require a showing of undue hardship to discharge the student debt? This three-part blog article explores each of the three sub-sections of Section 523 (a)(8) and explains how, under certain circumstances, private student loans are also a non-dischargeable debt, absent a showing of undue hardship by the debtor.

A Quick Primer on Section 523 (a)(8) & The Undue Hardship Test

Section 523(a)(8) of the Code is titled “Exceptions from Discharge” and specifies three types of student loan debts that remain with a debtor after a successful bankruptcy case:

(A)(i) an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or

(A) (ii) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or

(B) any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual.

Whether private or federally backed, bankruptcy courts will not discharge the debt if the student loan fits into one of the three categories described above.  The only exception is if the debtor presents evidence that repaying the debt would result in an “undue hardship on the debtor and the debtor’s dependents.” 11 U.S.C.S. § 523 (a)(8) (emphasis added).

The Second Circuit Court of Appeals developed a legal standard to determine whether a debtor would suffer an undue hardship if required to repay the student debt.  See Brunner v. New York State Higher Educ. Servs.  Corp. 831 F.2d 395, 396 (2d Cir. 1987).  The Brunner Test includes three factors, and the debtor must prove that each factor weighs in their favor.  The three factors are: (1) the debtor cannot maintain, based on current income, a minimal standard of living for herself and her dependents; (2) additional circumstances exist that indicate the debtor’s current living condition will persist for a significant period of time; and (3) the debtor has made a good faith effort to repay the debt.  See Brunner 831 F.2d at 396.  Nearly all bankruptcy courts throughout the U.S. apply some form of the Brunner Test when confronted with a debtor that seeks to discharge student loan debt.

The Ninth Circuit Court of Appeals in United Student Aid Funds v. Pena (In re Pena), 155 F.3d 1108 (9th Cir. 1998) applied the Brunner Test and discharged the student loan debt.  In In re Pena, a middle-aged married couple filed for bankruptcy relief and sought to discharge the student loan debt that the husband incurred to attend trade school.  The debtors presented evidence that the husband’s certificate was useless and did not help him find better employment or increase his salary.  To make matters worse, the wife suffered from depression, bipolar disorder, schizophrenia, and other mental ailments that prevented her from retaining a job for longer than six months.  Further, the debtors’ age and limited education indicated that their living situation would not improve.  The Ninth Circuit found that the debtors—living on a monthly income of approximately $1,700—could not maintain a “minimal standard of living.”  The Circuit Court held that it would be impossible for the debtors to repay the debt without resorting to homelessness.  As a result, the 9th Circuit Court found that the debtors satisfied the “undue hardship test” and discharged the student loan debt.

Bankruptcy Courts throughout the U.S. rarely discharge student loan debt unless the facts of the case are similar—or worse than—In re Pena, which has made the Brunner Test an extremely difficult standard to satisfy.  Commercial lenders often argue that private student loan debts also fall under Section 523 (a)(8) of the Bankruptcy Code and, as a result, are nondischagabe absent a showing of undue hardship by the debtor.

The remaining part of this article focuses on analyzing each of the three sub-sections of 523 (a)(8) in the context of private student loan debts.  The first part of this three-part article focuses on Section 523 (a)(8)(A)(i).  The second and third segments discuss Section 523 (a)(8)(A)(ii) and Section 523 (a)(8)(B), respectively.

Section 523 (a)(8)(A)(i)—What does the term “program funded” mean?

Section 523 (a)(8)(A)(i) (hereinafter “AI”) is the first sub-section of Section 523 (a)(8). The text of AI states that a debt incurred by an “an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or non-profit institution” is non-dischargeable. 

The second use of the word “or” separates AI into two clauses.  There are two notable distinctions between the two clauses.  The first distinction is that the first clause is limited to “loans,” whereas “the second clause of AI concerns loan programs, [not] particular loans.” In re O’Brien 318 B.R. 258, 262 (S.D.N.Y. 2004) (emphasis added) (citations omitted). The other notable difference is that the first clause is limited to loans by a “governmental unit,” and the second clause includes governmental units and non-profit institutions.

These two distinctions indicate that private student loans are excepted from discharge under the second clause of AI (and not the first clause) if: (1) the loan was made under a “loan program” and (2) the program is “funded” by a non-profit institution.  See In re Hammarstrom 95 B.R. 160, 165 (Bankr.N.D.Cal. 1989) (“[f]irst, the loan must be made pursuant to a “program” for providing educational loans.  Second, that program must be “funded” at least in part by a non-profit organization”).

Bankruptcy Courts often find that the first element is satisfied if a non-profit entity is part of a program that facilitates the student loan to the debtor.  For example, in Hemar Service Corp., Inc. v. Pilcher 149 B.R. 595 (Bankr.9th Cir. 1993), the debtor received student loans from a loan program funded by multiple non-profit and for-profit entities.  The Bankruptcy Court found that the creditor satisfied the first element because a non-profit entity that was a member of a loan program that provided educational loans to students in need of financial assistance. See Pilcher 149 B.R. at 598.  The first element is very easy to satisfy and, as a result, Bankruptcy Courts often overlook or do not analyze the first prong of the AI analysis.

Turning to the second element, the Bankruptcy Court in In re Hammarstrom held that the term “funded” means a non-profit institution that “plays any meaningful part in providing funds” to the loan program. In re Hammarstrom, 95 B.R. at 165.  Bankruptcy Courts consistently rely on In re Hammarstrom because it was one of the first bankruptcy cases to define the term “funded” as used in the second clause of AI.  However, Bankruptcy Courts are divided on what constitutes “funding” a loan program.  Some Bankruptcy Courts have held that a non-profit institution funds a loan program when it purchases the notes made under the loan program from a private, commercial lender.

For instance, in In re Hammarstrom, the non-profit entity and a private lender entered into an agreement wherein the private lender would execute the notes with the debtors and loan money directly to the students.  After the lender disbursed the loan proceeds, the non-profit entity would immediately purchase the notes from the lender and would become a creditor of the debtors.  The Bankruptcy Court found that the loan program structure made the commercial lender nothing more than an agent for the non-profit entity to help it advance loans for post-secondary education.  The Bankruptcy Court concluded that the non-profit entity funded the loan program because it purchased all of the notes under the program from the original lender and relieved the lender from its duties and obligations under the same.

The Court of Appeals for the Third and Eighth Circuits came to a similar conclusion but required non-profit entities to participate in the loan program.  In the case of Sears v. EduCap, Inc. (In re Sears) 393 B.R. 678 (Bankr.W.D.Mo. 2008) the non-profit entity prepared the loan documents, marketed the loans, processed the loan applications, and facilitated the disbursement of proceeds from the private lender to the student.  The Bankruptcy Court found that the non-profit lender funded the program because it exercised “plenary control” over the loan program and was required to purchase the loans (at one point or another), regardless of whether the loan was current or in default.  See In re Sears, 393 B.R. at 681. Similarly, in Johnson v. Access Grp., Inc. (In re Johnson), Nos.  1:05-bk-00666MDF, 1:05-ap-00162, 2008 Bankr. LEXIS 3325, at *10 (Bankr. M.D. Pa. Dec. 3, 2008), the Bankruptcy Court for the District of Pennsylvania found that the non-profit institution “funded” the loan program because it (1) agreed to purchase the loan prior to the loan being made to the debtor, (2) the non-profit entity administered the program that facilitated the student loans, and (3) the non-profit entity guaranteed the loan while it was held by the private lender.

The Court of Appeals in the First, Second, Seventh, and Ninth Circuits have encountered different loan programs and, as a result, have reached different conclusions from the other Circuit Courts. The Court of Appeals in the First, Second, Seventh, and Ninth Circuits held that a non-profit entity “funds” the loan program if it guarantees the note and repays the debt to the lender upon the debtor’s default.  These Circuit Courts found that without the guarantees from the non-profit entities, private lenders would not participate in the loan programs.

The Second Circuit Court of Appeals in O’Brien v. First Marblehead Educ. Res., Inc. (In re O’Brien), 419 F.3d 104 (2d Cir. 2005) specifically held that a non-profit entity was “clearly devoting some of its financial resources to supporting the program” by guaranteeing all notes made under the loan program.  The Second Circuit Appellate Court was persuaded by the fact that after the debtor defaulted under the note, the non-profit entity fulfilled its obligations and immediately repaid the debt to the private lender, including all interest, fees, and costs.  Bankruptcy Courts throughout the country have reached similar conclusions. See e.g., In re Duits, No. 14-05277-RLM-13, 2020 Bankr. LEXIS 138, at *5 (Bankr. S.D. Ind. Jan. 15, 2020) (“the non-profit’s guaranty helps fund a program because it encourages a lender to extend credit that may not be otherwise available”); see also Educ. Res. Inst. Inc. v. Taratuska (In re Taratuska) (D.Mass. Aug. 25, 2008, No. 07-11938-RCL) 2008 U.S.Dist.LEXIS 93206, at *18 (the non-profit funded the loan program because it guaranteed the loan, paid the loan upon default, and presented evidence that it “maintained money in segregated reserves to support its guaranteed obligations, thus devoting financial resources to the loan program”).

The cases described above signify that the term “funded” takes on many definitions, depending on the non-profit’s obligations and duties in the loan program.  The Court of Appeals for the First, Second, Seventh, and Ninth Circuits found that a non-profit institution “funds” the loan program when it guarantees the loan and repays the loan proceeds to the lender upon the debtor’s default.  On the other hand, a non-profit entity “funds” the loan program when it purchases the note from the lender (see e.g., In re Hammarstrom, 95 B.R. 160) and manages the loan program.  See e.g., In re Sears 393 B.R. 678.

In conclusion, the case law interpreting AI illustrates that Bankruptcy Courts are willing to employ numerous definitions of the term “funded” in order to find that private student loans that are facilitated through loan programs are excepted from discharge under Section 523 (a)(8)(A)(i). 

This is Part I of a three-part blog article. Part II of this three-part blog article can be accessed by clicking on this link. Part III of this blog article can be accessed by clicking on this link.

Debtor’s Motion to Dismiss v. Creditor’s Motion to Convert In Chapter 13—The 9th Circuit’s Ruling in In Re Nichols

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On September 1, 2021, the Ninth Circuit issued its ruling in the case of In Re Nichols. The Circuit Court held that a debtor has an absolute right—without exception—to dismiss his Chapter 13 bankruptcy case under Section 1307 (b) of the Bankruptcy Code. In reaching its holding, the Ninth Circuit departed from an established precedent that when the bankruptcy court is confronted with a debtor’s motion to dismiss under Section 1307 (b) on the one hand, and a creditor’s motion to convert under Section 1307 (c) on the other, the court may convert the case from Chapter 13 to a Chapter 7 proceeding if there is evidence of bad faith or abuse of the bankruptcy process by the debtor. In Re Nichols is a significant and impactful holding in the Ninth Circuit because it informs all bankruptcy practitioners and creditors that even when a debtor has abused the bankruptcy process and engaged in bad faith, the debtor may escape the consequences of his actions by filing a motion to dismiss, which, according to In re Nichols, the court must grant.

The Relevant Statutes & Prior Law

The relevant statutes are Sections 1307 (b) and (c) of the Bankruptcy Code. Section 1307 (b) states in pertinent part:

On request of the Debtor at any time, if the case has not been converted under section 706, 1112, or 1208 of this title, the court shall dismiss a case under this chapter. Any waiver of the right to dismiss under this subsection is unenforceable.

(emphasis added).

In comparison, Section 1307 (c) of the Code states:

Except as provided in subsection (f) of this section, on request of a party in interest or the United States trustee and after notice and a hearing, the court may convert a case under this chapter to a case under chapter 7 of this title or may dismiss a case under this chapter, whichever is in the best interests of creditors and the estate, for cause, including— [omitted].

(emphasis added).

The prior leading case on this subject was Marrama v. Citizens Bank, 549 U.S. 365 (2007) (“Marrama”). In Marrama, the primary question was whether a debtor’s bad-faith conduct permitted the bankruptcy court to deny the debtor’s motion to convert from a Chapter 7 to a Chapter 13 bankruptcy under Section 706 (a) of the Bankruptcy Code. The paradox was that Section 706 (a) granted the debtor a one-time unqualified right to convert from a Chapter 7 to a Chapter 13; however, Section 706 (d) specified that the debtor’s absolute right was conditioned on his ability to qualify as a debtor under Chapter 13.[1]

The Supreme Court first pointed out that Section 1307 (c) permitted the bankruptcy court to dismiss or convert a Chapter 13 case “for cause,” which encompasses a debtor that engaged in bad faith or abused the bankruptcy process. The Supreme Court reaffirmed that bankruptcy courts are courts of equity and have “broad authority . . . to take any action necessary or appropriate ‘to prevent an abuse of the process.’” Id. at 1111-12 (quoting 11 U.S.C. § 105 (a)). Armed with the expansive powers of Section 105 (a), the Supreme Court bridged the gap between Sections 706 (d) and 1307 (c). The Court held that when a debtor engages in bad faith conduct or abuses the bankruptcy process, the debtor is not a qualified debtor under Chapter 13 and thus, cannot satisfy the requirements of Section 706 (d).

Many courts throughout the country, including the Ninth Circuit, interpreted Marrama to hold that Section 105 (a) permitted bankruptcy courts to abrogate the absolute rights of debtors when there is evidence that the debtor engaged in fraud, bad faith, or abused the bankruptcy process. The expansive interpretation of Marrama paved the way for the Ninth Circuit’s holding in Rosson v. Fitzgerald (In re Rosson), 545 F.3d 764, 777 (Ninth Cir. 2008) (“Rosson”) and other cases throughout the country.

In Rosson, the bankruptcy court ordered the debtor to deposit his arbitration award with the Chapter 13 Trustee to fund his reorganization plan. The debtor failed to do so, and the bankruptcy court moved, sua sponte, to convert the case to a Chapter 7 proceeding. Before the bankruptcy court entered its final order, the debtor filed a motion to dismiss, pursuant to Section 1307 (b). The bankruptcy court denied the debtor’s motion, and the debtor appealed.

Relying on Marrama, the Ninth Circuit held there was no analytical distinction between a debtor’s dismissal rights under Section 1307 (b) and a debtor’s right to convert from a Chapter 7 to a Chapter 13 under Section 706 (a). In other words, the same limitations imposed on a debtor’s right to convert from a Chapter 7 to a Chapter 13 under Section 706 (a) and (d) applied with equal force to a debtor’s right to dismiss his Chapter 13 case under Section 1307 (b). The Ninth Circuit held that the debtor’s “right of voluntary dismissal under Section 1307 (b) is not absolute but is qualified by the authority of a bankruptcy court to deny dismissal on the grounds of bad-faith conduct or to prevent an abuse of process.” Id. at 774. Based on this line of reasoning, the Ninth Circuit affirmed the bankruptcy court’s ruling.

Rosson bolstered the broad interpretation of Marrama and was cited by numerous bankruptcy courts in the Ninth Circuit and elsewhere. See In re Brown, 547 B.R. 846, 853 (Bankr. S.D. Cal. 2016) (“under § 1307 (c), where bad faith is present, the court decides how the case is to proceed, if at all, in the interests of the creditors rather than of the debtor”); see also In re Armstrong (Bankr. E.D.N.Y. 2009) 408 B.R. 559, 569 (same).

The New Law – In Re Nichols & Law v. Seigel

Similar to Rosson, the primary question in Nichols v. Marana Stockyard & Livestock Mkt., Inc. (In re Nichols) (Ninth Cir. Sep. 1, 2021, No. 20-60043) 2021 U.S. App. LEXIS 26366 (“Nichols”) was whether there was an implied exception to the debtor’s right to dismiss its Chapter 13 bankruptcy under Section 1307 (b) of the Bankruptcy Code. The Ninth Circuit held that there was no such exception and overruled its prior decision in Rosson. In reaching its decision, the Ninth Circuit relied heavily on the Supreme Court’s holding in Law v. Siegel 571 U.S. 415 (2014) (“Law”).

In Law, the trustee expended over $500,000 in attorneys’ fees in an adversary proceeding against the debtor. The trustee alleged the debtor fraudulently created a second position lien on his property to preserve his equity in the same. The bankruptcy court found in favor of the trustee. At the conclusion of the proceeding, the bankruptcy court granted the trustee’s motion to surcharge the entirety of the debtor’s homestead exemption to pay for the trustee’s attorneys’ fees. Section 522 (k) of the Bankruptcy Code states that funds safeguarded by the homestead exemption cannot be used to pay for administrative expenses.

In a unanimous decision, the Supreme Court held that Section 105 (a) “does not allow the bankruptcy court to override explicit mandates of other sections of the Bankruptcy Code.” Id. at 11. The Supreme Court found that the lower court “exceeded [the] limits of its authority under Section 105 (a) by surcharging the debtor’s entire homestead exemption,” which the Court found was a clear violation of Section 522 (k) of the Bankruptcy Code. The Supreme Court then turned its attention to clarifying its ruling in Marrama.

Writing for the Supreme Court, the late Justice Scalia wrote that Marrama stands for the limited proposition that courts may use, as a supplement to Section 706 (d), their equitable powers under Section 105 (a) to deny a debtor’s motion to convert from a Chapter 7 to a Chapter 13. The Supreme Court reasoned that Section 105 (a) was only relevant to the holding in Marrama because it allowed the Court to avoid the “procedural niceties” of granting the 706 (a) motion to convert, then dismissing or converting the case pursuant to Section 1307 (c) due to the debtor’s bad faith.  More bluntly put, Section 105 (a) and its application in Marrama “did not endorse . . . the view that equitable considerations permit a bankruptcy court to contravene express provisions of the Code.” Id. at 426.

In Nichols, the Ninth Circuit found that Law rejected the broad sweeping language in Marrama that the Circuit Court relied upon to reach its decision in Rosson. The Ninth Court held that Rosson was no longer good law because Law made clear that even when there is evidence of bad faith, the bankruptcy court cannot utilize its equitable powers under Section 105 (a) to override the debtor’s absolute right to dismiss under Section 1307 (b) of the Bankruptcy Code.

Because Law overruled Rosson, the Ninth Circuit revisited the actual text of Section 1307 (b), which states in pertinent part: “on request of the debtor at any time . . . the court shall dismiss the case under any chapter.” [emphasis added]. The term “shall” “creates an obligation impervious to judicial discretion” and mandates action by the court. Id. at 13. Finding no other exception to Section 1307 (b), the Circuit Court held that Lawoverruled Rosson and that, in the Ninth Circuit, the debtor has an unqualified right to dismiss their Chapter 13 case at any time.

The holdings in Nichols and Law are significant and impactful for all bankruptcy practitioners. For Nichols, it is clear that the debtor has an absolute right to dismiss their case at any time—without exception. On the other hand, Law is entirely expansive. The holding in Law teaches us that the bankruptcy court’s equitable powers under Section 105 (a) are limited. The bankruptcy courts cannot explore the equities of the case when interpreting a statute that uses the terms “shall” or “must”; but, instead, the bankruptcy court must strictly comply with the Bankruptcy Code and, essentially, turn a blind eye to the realities of the case and circumstances. Only time will tell whether Nichols and Law further the spirit of the Bankruptcy Code and provide equal protection to debtors and creditors in bankruptcy court.

[1] Section 706 of the Bankruptcy Code states in pertinent part:

(a) The Debtor may convert a case under this chapter to a case under chapter 11, 12, or 13 of this title at any time, if the case has not been converted under section 1112, 1208, or 1307 of this title. Any waiver of the right to convert a case under this subsection is unenforceable.

(d) Notwithstanding any other provision of this section, a case may not be converted to a case under another chapter of this title unless the Debtor may be a debtor under such chapter.

Author: Dylan Contreras

Famous Bankruptcy Cases

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As Bankruptcy LItigation attorneys, we see people from all walks of life whose circumstances have caused them to need bankruptcy protection. We work with companies who are seeking to be made whole in cases where their debtor has declared bankruptcy and we support business owners and individuals whose cases are bankruptcy adjacent, meaning that the filing of Chapters 11 or 7 has tangentially affected the shared financial interests of our clients.

At Gupta Evans and Ayres, we pride ourselves on knowing quite a bit about bankruptcy filings, but we did not know quite how many celebrities have filed for bankruptcy. The one on this list that was most surprising? Ulysses S. Grant, though his bankruptcy filing is not related to his statue being toppled in San Francisco in 2020, it was the result of other bouts of poor judgement on his part.

Here is a list of some of the most surprising celebrities to have filed for bankruptcy throughout modern history (Grant is the outlier).

cyndi lauper 1980s 1

Cindy Lauper: Before she Wanted to Have Fun, her band went bankrupt. She made a hasty and stable recovery.

t pain

T-Pain declared bankruptcy in the 90’s after out-of-control spending. He recently appeared on and won the Masked Singer and his finances seem to be on the mend.

larry King 1

Before LArry King sat in front of the colorful iconic dots and hosted his famous talk show he was accused of stealing $5K from his business partner. The charges didn’t stick but the stigma did and he declared bankruptcy in the late ’70’s.

burt

Burt Reynolds lost a fortune over his career partly due to an expensive divorce and all those toupees. He declared bankruptcy in the 90s but went on to make such cult favorites as Boogie Nights. He was still active in the movie industry until his death.

nick cage

Nicholas Cage doesn’t just make movies in VEgas, he lives life on the edge. After wild spending and unpaid tax bills Cage declared bankruptcy in the early 200’s. He seems to be managing just fine now with an estimated net worth of over $20 million.

mike Tyson

Mike Tyson has made some questionable choices (face tatoos, tigers, ears…) but poor spending choices and a pricey divorce caused the fighter to file for bankruptcy in the early 2000’s. He has since founded a marijuana company in California and seems to be solvent once again.

Looking at the retrospective of celebrities who have weathered bankruptcy may cause those of us touched by Chapter 7 or 11 filings to cringe more than the average person. The truth is, it’s no laughing matter. While bankruptcy filings can be strategic tools to protect assets in dire circumstances, those same filings can reserve funds from those who are owed money. At Gupta Evans and Ayres, we are bankruptcy litigation experts. The intricacies of filings are our forte. If you or someone you trust is impacted by bankruptcy, don’t hesitate to reach out.

Want to see how we work? READ ON…

Chapter 420, Part II: Closing the Book on Cannabis-Adjacent Bankruptcy

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In a previous article, I discussed the potential impacts of a then-forthcoming decision in the case of In re United Cannabis Corporation, which had the potential to widen access to federal bankruptcy relief to cannabis-adjacent hemp businesses. 

However, the In re United Cannabis case ended not with a bang, but with a whimper.  On January 12, 2021, after approximately eight months of consideration, Bankruptcy Judge Joseph G. Rosania, Jr. of the District of Colorado issued a one-page ruling dismissing[1] the bankruptcy petition “pursuant to 11 U.S.C. § 1112(b) and . . . finding good cause.”  In so doing, he snuffed out any hope that the District of Colorado could become a hub for hemp businesses that dabble in cannabis to successfully pursue chapter 11 bankruptcy. 

Because the ruling does not provide any substantive reasoning for the decision, industry observers are left to speculate.  One can only assume that the court found the evidence offered by the U.S. Trustee—namely, that the debtor was not nearly as removed from the cannabis arena as it purported to be based on the debtor’s website and marketing materials—credible enough to justify dismissal on the grounds that a plan of reorganization could not be untainted by federally illegal cannabis money.  In so doing, the court left the fundamental question of how the 2018 Farm Bill’s legalization of hemp affects the availability of bankruptcy to businesses that have toes in both the cannabis and hemp pools.  For the time being, the safer route—and the route perhaps favored by conventional wisdom—for businesses is to completely segregate their cannabis and hemp businesses, both on a practical and corporate/legal level.

The Bankruptcy Court for the District of Colorado’s declination to decide the issue raised by Way to Grow only illuminates other quirks in the current state of affairs for bankruptcy in the cannabis context.  In particular, the ruling in United Cannabis displays the tension between how different bankruptcy courts have construed section 1112 vis-à-vis section 1129(a)(3). 

Section 1129(a)(3) provides that a bankruptcy plan shall only be confirmed where, inter alia, “[t]he plan has been proposed in good faith and not by any means forbidden by law.”  On its face, this statute would seem to preclude plans funded by federally illegal cannabis, given that those funds would be derived from a “means forbidden by law.”  However, the Ninth Circuit disagreed in Garvin v. Cook Investments NW, SPNWY, LLC, 922 F.3d 1031 (9th Cir. 2019).  In that case, the Ninth Circuit affirmed the Bankruptcy Court for the Western District of Washington’s confirmation of a chapter 11 plan for reorganization over the U.S. Trustee’s objection that one of the debtors was renting real property to a cannabis growing operation.  Id.  The Ninth Circuit parsed the language of section 1129(a)(3) quite narrowly, holding that that subsection “directs bankruptcy courts to policy the means of a reorganization plan’s proposal, not its substantive provisions.”  Id.at 1033.  The Ninth Circuit applied that interpretation to the case at bar, and found that although income funneled into the plan would ultimately be derived from a federally illegal source—the cannabis grower tenant—that had no bearing on whether the plan had been proposed in good faith.  See id. at 1035-36.  Importantly, the Ninth Circuit refused to rule on the argument that section 1112(b) mandated dismissal of the petition, concluding that “the Trustee waived the argument by failing to renew its motion to dismiss” after the Bankruptcy Court’s initial dismissal of a previous motion to dismiss with leave to renew at the plan confirmation hearing.  Id. at 1033-34.

This literal interpretation of section 1129(a)(3) has been explicitly criticized in courts within other circuits.  Indeed, the Bankruptcy Court for the Eastern District of Michigan sharply critiqued Garvin in dicta for its de facto affirmation of illegal conduct pursuant to a bankruptcy plan:

This Court does not necessarily agree with the Garvin court’s holding about § 1112(a)(3).  And, respectfully, one might reasonably question whether the Garvin court should have refused to decide the § 1112(b) dismissal issue.  That refusal, on waiver grounds, arguably is questionable, because it allowed the affirmance, by a federal court, of the confirmation of a Chapter 11 plan under which a debtor would continue to violate federal criminal law under the [Controlled Substances Act].

In re Basrah Custom Design, Inc., 600 B.R. 368, 381 n.38 (Bankr. E.D. Mich. 2019).

Moreover, the District Court of Colorado in In re Way to Grow, the very case that seemingly left the door open for United Cannabis in the first place, also criticized Garvin for unduly focusing on the “means forbidden by law” clause of section 1129(a)(3), rather than the “good faith” portion of the same.  610 B.R. 338. 

As a result, there is an embryonic circuit split on the issue of interpreting section 1129(a)(3) as applied to cannabis business petitioners, with the Ninth Circuit in the minority and the Sixth and Tenth Circuits in the presumptive majority. 

As fascinating as this may be on an academic level, for businesses in the cannabis industry, this circuit split will likely have little bearing on the ultimate issue of whether businesses that dabble in cannabis can obtain the benefits of federal bankruptcy.  Reason being, section 1129(a)(3) is just one ground for dismissal on the basis of illegality.  Garvin itself noted in its final paragraphs that there are plenty of other reasons to dismiss cannabis bankruptcies—not the least of which is section 1112(b).  Garvin, 922 F.3d at 1036.  Indeed, running an illegal business as part of a bankruptcy plan could conceivably run afoul of any number of the listed bases for “cause” under section 1112(b)(4), including but not limited to the “gross mismanagement of the estate” prong name checked by the court in Garvin. 

The unceremonious dismissal of the petition in United Cannabis raises more questions than answers.  Unless and until cannabis is descheduled, or some other form of federal reform occurs, the Bankruptcy Courts will be left to continue to battle it out over interpretations of section 1129(a)(3), comfortable in the knowledge that section 1112 provides a backstop for dismissing cannabis-funded petitions and plans.  However, the issue raised in United Cannabis—whether a company that has cannabis-derived revenue can have a chapter 11 plan approved if the plan doesn’t require that revenue—remains tantalizingly unanswered for now.  

[1] Curiously, the court styled the order as one “granting” the U.S. Trustee’s “Motion to Dismiss Chapter 11 Cases pursuant to 11 U.S.C. § 1112(b).”  However, the U.S. Trustee never filed a Motion to Dismiss.  Rather, the U.S. Trustee filed a response to the court’s own Order to Show Cause why the petition should not be dismissed—although, that response did raise section 1112(b) as a reason for dismissing the case. 

Webinar: COVID-19 – Impact and Options for SoCal Businesses

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As the COVID-19 pandemic has surged upwards, our practice has seen a dramatic uptick in the number of calls we’ve been receiving from business owners, including landlords, tenants and lenders, who are all grappling with issues never before seen and seeking answers to questions they have never faced before. In an effort to educate the community and businesses about what we’re seeing in San Diego, we put together a panel on Covid-19 impact and options for a Webinar. 

The Webinar was held April 1st, 2020 and featured the following panelists:

Ajay Gupta, Founder of Gupta Evans and Associates.
Attorney Ajay Gupta is a certified bankruptcy specialist and has been working on real estate and bankruptcy matter since 2005. He represents both debtors and creditors in state and federal bankruptcy court on a host of matters from secured transactions, to landlord-tenant disputes, to complex bankruptcy matters.
Sam Brotman, Founder of Brotman Law.
Attorney Sam Brotman’spractice primarily centers on all aspects of tax litigation and criminal/civil tax controversies in front of the Internal Revenue Service, Franchise Tax Board, Employment Development Department, California Department of Tax and Fee Administration, and various other state/local tax agencies.
Randy Newman, Founder Total Lender Solutions
Attorney Randy Newman is the founder of Total Lender Solutions which operates as the foreclosure trustee for numerous lenders across the country. Randy works primarily as an agent for lenders where there is a default on a loan and foreclosure is imminent
Jon Fleming, Receiver at Legacy Receivers.
Jon Fleming’spractice focuses primarily on receiverships and asset management. As an asset manager, Jon manages a number of housing units and is on the front line of many of the new eviction rules and issues. As a receiver, Jon is frequently called in to manage secured assets where there has been a default by a secured borrower.
Sean O'Neill advisor at US Bank.
Sean O’Neill
Vice President | Relationship Manager
Emerging Business Group | U.S. Bank Business Banking
sean.oneill@usbank.com

Please feel free to reach out to any of us with your questions or concerns. I’d again like to thank the panelists for sharing their knowledge and making this Webinar a success.

Small Businesses and Covid-19 on March 30, 2020

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Two weeks ago today, I was standing in front of Judge Styn in San Diego Superior Court expecting to get a one-week bench trial underway.  This was after we had waived our jury the prior Friday when San Diego had suspended jury trials due to the Coronavirus.  Judge Styn is 79 years old and the San Diego Courts were shut down the following day.  For most of us, we’ve only been living with the impact of this virus for just two weeks, but for small businesses, so much has changed over those two weeks.  

This article attempts to provide some resources for small businesses and individuals as we all navigate this global health crisis.  Things are changing rapidly, but this article is current as of today and has a lot of useful information for small businesses. 

We are in the middle of what is going to be a very difficult time for small businesses.  With a focus on bankruptcy and real estate, our practice has been busy with calls from business owners (landlords, tenants, lenders) who are all grappling with issues never before seen and seeking answers to questions they have never faced before. On the Debtor side, the early calls focus on companies that were mostly on very unstable ground before they got to us.  COVID-19 is the proverbial straw that broke the camel’s back for these companies.  For creditors and landlords, the preliminary calls have not yet been defaults, but, rather, game plans for work arounds and updates for new laws concerning evictions and foreclosures. 

The biggest impact of the Coronavirus is to retail businesses and restaurants.  At a fundamental level, 90% of retailers are shut down completely and fast food is the only restaurant that can even operate in this environment.  Retailers employ 15.6 million people in this country while and another 16 million are in retail.  Together, they make up approximately 20% of the workforce of this country.  The vast majority of those people are currently unemployed and there are many looming questions as to whether those businesses are going to be able to survive the downturn. 

It goes without saying that we are in the early stages and any fallout will largely depend on how long this process takes.  California’s “Stay At Home” order issued by Governor Newsom was issued on March 19, 2020 and, as of the date of this writing, all signs suggest that it will be in place through the end of April, at least; but there is a huge difference between six weeks and 12 weeks in terms of the economics of this situation and the impact it will have on businesses and business owners alike.  

As the crisis further develops, new orders, mandates and regulations will likely be issued, and we will try and update you with these as they are released.  The hope for businesses is that California can strive to stay ahead of the fallout and provide as much as clarity on the situation, for better or worse, as the matter unfolds.

The Courts and the Stay at Home Order:  

The San Diego Superior Court closed on March 17th and will continue to be closed through April 3rd.  There will be no jury trials until at least May 22nd and all existing jury trial dates have been continued 60 days.  While certain emergency services are available, it is widely expected that the April 3rd date will be extended for at least another two weeks as San Diego is entering into an acceleration phase for the disease.  This is especially likely as the federal government has now advised that the current social distancing guidelines remain in place through April 30, 2020.

What this means is that the Courts are essentially inaccessible through most of April.  What is already an overburdened system will be backlogged by another 2 months of cases making access to the judicial system that much more difficult and expensive.  

Federal Courts have not yet suspended operations, at least not in the 9th circuit.  Some oral arguments have been postponed, but the Bankruptcy Court has issued an order allowing for telephonic appearances for all oral arguments and a number of orders to allow filings to continue.  In large part because the federal system has transitioned to an electronic system over two decades ago, they appear to have been well positioned to allow for appropriate social distancing without a complete cessation of activity.  

Mortgages and Covid-19:

With 2008 in very recent memory, the federal government and banks are gearing up for a number of missed payments, whether its commercial or residential.  Fannie Mae and Freddie Mac have announced programs for loan forbearance for both residential and commercial mortgages for up to 12 months.  One of the challenges from a borrower’s perspective is determining whether your loan is owned by one these two juggernauts, as the servicing company will differ from the entity listed on the deed of trust that will likely differ from the entity who owns your loan.  

To put things into perspective, the total amount of mortgage debt is estimated at $15.8 Trillion and Fannie and Freddie are estimated to have guaranteed or own somewhere around $4.4 Trillion (See also Bloomberg).  The important thing is that you may be one of the 28 Million loans that may be owned by Fannie or Freddie that may make you eligible for relief.  Below are some links that will help you find out if you have a Fannie Mae or Freddie Mac Loan.

California has also teamed up with the largest banks and about 200 local lenders to provide some relief.  Essentially, if your lender is one of the institutions identified at the link below, the lender will grant a 90-day moratorium on payments for COVID-19 related missed payments. Additionally, any missed payments resulting from COVID-19 will not affect your credit ratings.  There shall also be a 60-day moratorium from these institutions on foreclosures.  A current list of participating lenders and servicing agents is below.

Evictions and Covid-19

There are essentially two main things that will impact evictions in California in the short run.   First, there is the issue of whether the Court will actually be open.  For now, Courts are closed until April 3rd and I’m fully expecting them to remain closed through April 17th.  

More importantly, on March 27th, the state of California has imposed a moratorium on evictions caused by Covid-19 hardships.  That moratorium will be in effect until May 31st.  In short, if a tenant has documentation demonstrating loss of employment or reduction in income due to the COVID-19 pandemic, then the tenant cannot be evicted for nonpayment of rent and the tenant should notify the landlord immediately.  If a tenant falls within this moratorium, the tenant will have an additional six months to pay the unpaid rent.  However, it is important to highlight that this is NOT a moratorium on a tenant’s obligation to pay rent if they are otherwise unaffected by COVID-19. 

This is obviously a developing story and we’ll update you as we learn more. Broadly speaking, any real hardship in this environment can at least in some part be attributed to COVID-19 and, if a tenant’s employment or income has been lost from the hardship and can be documented, then the tenant should be protected under the moratorium.

Summary of the $350 Billion stimulus package:

On Friday, the federal government passed a $2 Trillion stimulus bill.  While large chunks are dedicated to beefing up COVID-19 responses ($275 Billion), maintaining large businesses ($500 Billion), and direct injections to Americans in need ($560 Billion) (See https://howmuch.net/articles/breakdown-coronavirus-2t-economic-stimulus), $350 Billion has been earmarked for loans to small businesses.  

That’s a lot of loans.  The SBA estimates that there are 30 million small businesses in the US, which means this stimulus provides for an average of more than $10,000 per business in the US.  The challenge will clearly be the administration of these loans.  If you’re a small business and your vision for the next 3 – 6 months is cloudy, you need to start the application process right away.  The SBA is notoriously slow at processing applications, and if you wait, you will miss the window.

The details as we understand them are as follows:

  • stablishes and provides funding for forgivable bridge loans;
  • loans will cover from February 15, 2020 and end June 30, 2020;
  • businesses, nonprofits, self-employed individuals, sole proprietorships, and independent contractors with less than 500 employees are eligible;
  • loans are capped at the lesser of $10 million or 2.5 times the total of the applicant’s average monthly payments for payroll costs for 1-year prior to obtaining the loan;
  • proceeds may be used for payroll costs, group health care benefits, employee salaries, commissions, compensation, interest on mortgage obligations, rent, utilities, and interest on debt obligations (approved expenses) incurred before the covered period;
  • no personal guarantees or collateral are required for the loans;
  • the loans are non-recourse so long as the proceeds are used for an approved purpose;
  • any balance remaining on the loan after forgiveness shall be for a 10-year term at an interest rate not greater than 4%;
  • loans may be eligible for forgiveness of indebtedness in an amount equal to the sum of approved expenses incurred during the 8-week period after loan origination;
  • forgiven loan amount may be reduced based upon the number of employees and adjustments in reduced salaries and wages;
  • canceled indebtedness is excluded from gross income;
  • provides additional funding for grants and technical assistance;
  • establishes limits on requirements for employers to provide paid leave; and
  • strengthens unemployment insurance, which could potentially add $600 per week for up to four months on top of what a state would give beneficiaries.

(From https://www.lexology.com/library/detail.aspx?g=e7a31eb2-9263-48ff-94d9-0947a0af8073)

The loans themselves are broken down into two major types, the Paycheck Protection Program (PPP) and the Economic Injury Disaster Loan (EIDL).  Only the PPP is eligible for loan forgiveness based on maintaining a certain number of employees.  The PPP must be applied for through your local bank, while the EIDL must be applied for directly through the SBA.

Matt Garrett, the CEO of TGG Accounting, just did a fantastic webinar on the stimulus package this morning.  As of this email, it’s not up on TGG’s website, but I’m hopeful that it will be soon.  For those looking to take advantage of the stimulus package for small businesses, this video is an excellent resource.  Matt and his team are well ahead of the curve on the stimulus package and we all need to take advantage of their expertise as TGG has been extraordinarily generous in compiling, organizing and sharing their research.  See:  https://tgg-accounting.com/blog/

Other Bankruptcy News:  Chapter 5 Bankruptcy

On February 19th, and, remarkably, completely unrelated to the Coronavirus, the federal government passed a large amendment to the bankruptcy laws that will make bankruptcy more accessible to small businesses.  Welcome, the Chapter 5 bankruptcy.  For practitioners, it is essentially a hybrid between a Chapter 11 and a Chapter 13 bankruptcy and businesses with less than $2.7 Million in secured debt are eligible to file.  

Up until this point, filing a bankruptcy for a small business required a certain level of overhead that made it extraordinarily cost prohibitive for small businesses.  It is extremely difficult to rationalize adding significant legal expense to an already overburdened business in order to justify filing a Chapter 11 bankruptcy and, as a result, it really remained only a nuclear bomb option for most small business debtors.  

The new, Chapter 5 does away with much of the overhead associated with a Chapter 11 including the costs associated with maintaining a creditor’s committee and producing a disclosure statement.  More importantly, the Chapter 5 allows you to “impair” creditors without a vote of those creditors so long as the distribution to them is “feasible”, does not “unfairly discriminate”, and is “fair and equitable”.  Effectively, the Chapter 5 allows for a discharge over the course of time, which, while possible in a Chapter 11, was extremely difficult.

The hardest hit small businesses are retailers and restaurants.  The stay at home orders have effectively shut down most of these businesses.  While many costs in these types of operations are scalable, the two that are not are going to be rent and debt service.

Rent is a particular problem for restaurants and retailers.  Unlike a law firm, who we are learning can function from home or pretty much anywhere, a restaurant or retailer is intimately tied to its location.  What is more difficult is that, under California law, a commercial lease terminates likely at the end of a validly issued notice to pay or quit, not a judgement for possession.  (See In re Windmill Farms.)  What that means is that even in bankruptcy, a lease cannot be reinstated once the notice to pay or quit has expired.

Because of the nature of retail and restaurants and how COVID-19 has impacted this particular group of businesses and the “short fuse” associated with lease terminations, it is likely that we are going to see more Chapter 5 filings over the coming 12 months.

Does The Coronavirus Pandemic Qualify As a Force Majeure Event?

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In the wake of the Coronavirus (COVID-19) pandemic, state and local governments throughout the U.S. have ordered restaurants, bars, and shopping centers to shut down, while businesses that sell essential products can remain open. Due to the pandemic, small and large companies are forced to close their doors and find clever ways to remain competitive in a world where “dining in” is no longer an option. 

As companies prepare for the unknown, they should also ask how this turbulent time will affect their contracts, and more importantly, whether they are still required to perform their contractual obligations during this global health crisis. This article will provide a thorough analysis of the force majeure defense that may excuse a party from performing his or her otherwise required contractual duties.

What is Force Majeure?

Force majeure—which means “superior force” en français—excuses a party’s nonperformance of a given contractual duty when an unanticipated event, such as a pandemic or epidemic, occurs. The force majeure defense is available by statute and the force majeure clause, which is included in many contracts. 

Force Majeure By Statute

Section 1511 of the Cal. Civ. Code provides that a party is excused from a contractual obligation when performance is prevented or delayed by (1) operation of law or (2) an irresistible or superhuman cause. 

Operation of Law, Cal. Civ. Code 1511 (1)

The broad language of section 1511 (1) invites the question of whether Governor Newsom’s Stay at Home Order renders performance of a contractual obligation illegal, impracticable, or frustrates the underlying purpose for why both parties entered into the contract.  California courts have consistently reinforced the broad language of section 1511. 

For instance, in Indus. Dev. & Land Co. v. Goldschmidt, 56 Cal. App. 507 (1922), the plaintiff entered into a commercial lease agreement that restricted his use of the property to the operation of a liquor business. After Congress passed the Prohibition Amendment, the plaintiff argued that he was excused from paying any further rents because the operation of his business became illegal. The court sided with the plaintiff, finding that the lease agreement became inoperative after the passage of the 18th Amendment, which made performance of his contractual duty illegal. Id at 509.

Likewise, in Johnson v. Atkins, 53 Cal. App. 2d 430 (1942), the court held that a Colombian buyer was not liable for breach of contract because the Colombian government refused to issue the buyer a legal permit to accept a shipment. The court reasoned that had the buyer accepted the goods he would have committed an unlawful act, which justified his nonperformance. Id. at 432.

However, just because an event may fall within the purview of section 1511(1), it does not mean that a party is automatically excused from satisfying their contractual obligations.  There are limits to this rule, and each potential application of section 1511 will require a fact-intensive inquiry of the  circumstances.  

In Dwight v. Callaghan, 53 Cal. App. 132 (1921), for instance, the defendant claimed he could not satisfy his contractual duties because the U.S. government purchased a large quantity of the same materials the defendant needed to satisfy his contractual obligations. The court found that the plaintiff had acquired the same materials from other suppliers such that the government’s interference with defendant’s performance did not render performance impossible; but, instead, just more expensive than the defendant had initially anticipated. Id. at 137.  This case, and the many that came after it, showcases how the concept of force majeure can be misused by parties and how what appears “impossible” to one person is, in reality, just merely more difficult.  In such circumstances, a Court will not permit a party to avoid liability simply because performance is more costly or burdensome than originally anticipated. See Habitat Tr. for Wildlife, Inc. v. City of Rancho Cucamonga, 175 Cal. App. 4th 1306, 1336 (2009).

Turning to the present and the Coronavirus pandemic, it is hard to say how broadly (or narrowly) section 1511 (1) could arguably be applied to excuse performance of contracting parties.  On one hand, whether performance of a given contractual duty will result in a violation of Governor Newsom’s Stay at Home Order thereby making it illegal is unclear.  Police have not begun enforcing the order, by either ordering people to return home or issuing citations (at least at the time of this article).  However, government actions are evolving, and it is reasonable to predict that Governor Newsom may order law enforcement officials to enforce the executive order by way of citations or other means.  On the other hand, by issuing an order that requires individuals to remain at home and “shelter in place,” and that requires months’ long closures of businesses, Governor Newsom’s Order almost certainly prevents, or at the very least delays, performance of certain categories of contractual obligations. If that is the case, then a vast amount of contractual duties will likely be excused.

Irresistible or Superhuman Causes, Cal. Civ. Code 1511 (2)

“Acts of God” encompass the latter section of 1511(2), and excuse a party’s nonperformance if a natural event, like a pandemic, earthquake, or flood occurs that renders performance impossible. In most instances, the court’s ruling will often turn on whether the natural event was unanticipated by the parties at the time of contracting. See Ryan v. Rogers, 96 Cal. 349 (1892). 

For example, in Ryan v. Rogers, 96 Cal. 349 (1892), the defendant pleaded that he was unable to complete his deliveries because heavy rainfall had flooded his usual delivery route. The court found that the defendant knew—before signing the contract—that rainstorms were a common occurrence during that time of year, and defendant’s usual delivery route was often flooded after a heavy rainstorm.  Based on these findings, the court concluded that the flood was not unforeseeable, but expected at some point during the life of the contract and held the defendant liable for breach of contract.  Id. at 353.  

In comparison, the court in Ontario Deciduous Fruit-Growers’ Ass’n v. Cutting Fruit-Packing Co., 134 Cal. 21 (1901) held that a farmer was excused from furnishing specific varieties of fruit because the farmer’s orchards were “so far affected by an extraordinary drought.” Id. at 25. The court concluded that the farmer “[cannot] be made to perform impossibilities” in light of extreme weather conditions that were not contemplated by the parties when they signed the contract. Id. 

Both cases teach us that courts are not willing to excuse a party’s nonperformance just because a natural event, like severe weather, interferes with the party’s performance. The court’s critical inquiry is whether the natural event was foreseeable by the parties when they executed the contract.  If an impediment to a party’s performance is anticipated or foreseeable at the time of contracting, courts take the position that the party concerned about such impediment should draft contract terms to account for such risk or concern.

In closing, the Coronavirus pandemic may on its surface qualify as an “Act of God.”  However, different from the courts’ usual probe, the main question here will be whether the Coronavirus qualifies as a “natural event” for purposes of section 1511 (2).  Some argue that the Coronavirus outbreak is a natural event because we did not intentionally create the virus; rather, it is a natural product of our interactions and actions.  Even if the Coronavirus does not meet the definition of “natural event,” the resulting effects of the pandemic, such as Governor Newsom’s order touched on above, would likely trigger the application of section 1511 to a variety of otherwise required contractual obligations.  Courts throughout California will be forced to answer these questions with no precedent to rely on, as our country has not been confronted with a global health crisis, like this one, before.

Force Majeure By Contract

Before resorting to section 1511, nonperforming parties should first turn to their contract to determine whether a force majeure clause is included in their contract.  Force majeure clauses are worded differently from contract to contract; but, generally, a force majeure clause will excuse a party’s nonperformance (or delay performance) of a given contractual duty when an unanticipated event specified in the clause occurs, rendering performance temporarily impossible. 

The occurrence of an event specified in the force majeure clause does not automatically excuse a party from fulfilling their contractual commitments. Instead, the nonperforming party claiming nonperformance was justified due to an unforeseen event must satisfy two requirements.

The first requirement is the event that caused the party’s nonperformance must have been unforeseeable at the time the parties signed the contract. This requirement is akin to the analysis above regarding section 1511(2) and the holding in Ryan v. Rogers, 96 Cal. 349 (1892).

Second, performance must have been “impracticable” or “impossible” when performance was due, which largely mirrors the analysis of section 1511(1). Specific to force majeure provisions included in a contract, the nonperforming party must demonstrate that performance would cause them to suffer “an extreme loss, expense, difficulty, or injury.” Butler v. Nepple, 54 Cal. 2d 589, 599 (1960). However, a party cannot avoid liability merely because performance was more costly or burdensome than originally anticipated. Id.

In Butler v. Nepple, Nepple breached the contract because the steelworkers’ union went on strike, and he could not obtain the steel needed to satisfy his contractual commitments.  Critical to Nepple’s argument was that the force majeure clause specified that if the steelworkers’ union went on strike, his performance was excused.  Despite the clear language of the force majeure provision, the California Supreme Court disagreed. The court held that Nepple failed to show the other steel manufacturers’ prices were “extreme and unreasonable” based on what he usually paid.  The court concluded that had Nepple satisfied his contractual obligations and obtained the requisite steel, Nepple would have only incurred a “mere increase in expense,” which does not justify a party’s nonperformance of a given contractual duty. Id. 

Force majeure clauses are often overlooked during contract negotiations and are not given the attention they deserve.  As such, businesses and people alike may find that their contracts contain boilerplate force majeure clauses that do not specifically address the Coronavirus pandemic. Whether a force majeure clause covers the current Coronavirus pandemic will not only depend on the exact language of the provision itself (e.g. acts of god, “catch-all” provisions), but also the specific circumstances of the case and to what extent the unforeseen event impacted a party’s performance—was it made impractical, or just more difficult? 

It must be clarified that the defenses described, including the ones by statute, will likely only excuse a party’s performance temporarily.  A party must resume satisfying its contractual obligations if and when it is no longer impossible to do so.  

Protecting Your Legal Interests Right Now

The Coronavirus pandemic has made us question whether we can perform our contractual obligations, whether the other party has the means to perform, and what measures we should take to protect our interests.  Below are some tips that address each of these questions:

Have You Determined That You Cannot Perform Your Contractual Duties?

  • Explore and evaluate other options to complete performance—that is, like Nepple, seek out alternative suppliers, vendors, etc., and determine the added expense of using such alternative options;
  • Communicate your position with the other contracting parties early to make each party aware of the circumstances, and to see whether you can work together to facilitate a resolution. 

Are You Owed Performance?

  • Contact the performing party to ensure that they can or intend to satisfy their contractual obligations during the pandemic. 
  • If the performing party cannot uphold their contractual commitments, then explore other options with the nonperforming party to find a solution, if possible. Courts frown upon non-breaching parties that refuse to work with the nonperforming party during a national crisis. 

Are You Drafting A Contract?

  • Include a force majeure clause that specifies if the Coronavirus makes performance illegal or impossible, then the party is excused from performing its contractual obligations. 
  • Force majeure clauses can also include any events that the parties believe will safeguard their interests. Do not be afraid to add any other language such as national emergency, terrorist attacks, riots, civil unrest, executive orders, etc.

Conclusion

Overall, the discharge of a given contractual duty is a fact-intensive inquiry that is determined on a case-by-case basis.  If you are unsure whether your performance is excused or whether you can hold a party in breach of a contract for failing to perform, then speak to a California attorney for  guidance. 

The materials available at this web site are for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem. Use of and access to this web site or any of the e-mail links contained within the site do not create an attorney-client relationship. The opinions expressed at or through this site are the opinions of the individual author and may not reflect the opinions of the firm or any individual attorney.

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