All Blog Posts Archives - Gupta Evans and Ayres

GEA’s Demand Letter to Union Bank Secures Release of Erroneous Loan

June 10, 2022/in All Blog Posts/by John Ahn

Gupta Evans & Ayres was successfully able to secure a release of a bank loan that was erroneously accounted for as due when the bank had previously discharged the loan years prior. All it took was a simple and effective demand letter, saving our client time and money.

Our client obtained a $50,000 loan from Union Bank in early February 2006. A little over ten years later, Union Bank sent our client a notice of cancellation stating that the remaining balance on the loan had been discharged. Shortly thereafter and to fulfill IRS requirements, Union Bank sent our client a 1099-C Form titled “Combined Tax Statement for Year 2016” which stated and confirmed that the loan had indeed been discharged. Relying on this 1099-C Form, our client promptly paid the taxes on the discharged debt to the IRS.

Around mid-June of 2020, our client sought to secure a loan to purchase real estate and performed a title search. Much to our client’s surprise, the preliminary report included the 2006 loan for $50,000. To sort out this confusion, our client contacted Union Bank directly multiple times requesting access to our client’s bank records and any records of communications or correspondence between our client and Union Bank. However, and unsurprisingly, Union Bank’s representatives’ responses had largely been the same—that the Loan was still showing as due.

GEA stepped in and drafted a demand letter to Union Bank which included documents sent by Union Bank themselves telling our client that the 2006 loan had been discharged, and alluded to Union Bank’s potential violations of the Rosenthal Act given the inaccurate accounting on the loan and Union Bank’s inaction in investigating the errors. In response, Union Bank agreed to release and reconvey the deed of trust on the loan, fully clearing the 2006 loan from our client’s name. As a result, our client was able to freely secure the mortgage loan he was seeking and avoid potential litigation costs and expenses.

Gupta Evans and Ayres Confirms One of the First Contested Subchapter 5 Bankruptcies in the Southern District of California. In re: Eminent Cycles, LLC

June 10, 2022/in All Blog Posts/by The Gupta Evans & Ayres Team

On February 3, 2022, the Subchapter 5 plan for Eminent Cycles, LLC (Case #21-01006-CL11 filed in the Southern District of California) was confirmed over objection from the main secured creditor. The Debtor in this instance had financing ready but could not move forward because the secured creditor’s interest was substantially more than the value of the company.

In a highly contested Chapter 11, the Debtor’s plan effectuated a cramdown of the primary secured creditor allowing the company to continue operations as a going concern while forcing the creditors to restructure their liabilities. The valuation of the business was contested in addition to the plan, however, the Court ultimately held that the plan was proposed in good faith and was in the best interests of the creditors.

There are couple take aways from this process. First and foremost, despite the attempt to streamline the Subchapter 5 process, a Subchapter 5 is still very expensive. A contested Subchapter 5 bankruptcy is much more than a glorified Chapter 13 and debtor’s counsel should plan on a budget that respects the time that it will take to get a plan to completion.

Second, you can confirm a Subchapter 5 without a consenting class of creditors if the plan is fair and equitable. There are two major additions to the code that make a Subchapter 5 easier to confirm than a traditional Chapter 11. The abolition of the absolute priority rule for Subchapter 5 bankruptcies allows access to a restructuring under Chapter 11 that previously was not available to most small businesses. While we did not need that rule in our case, the other major addition which we were able leverage allows a plan to be confirmed without a consenting class of as long as the plan does not discriminate unfairly and is fair and equitable. (11 USC 1191(b))

We are not aware of any specific contested cases that were approved prior to ours, but the UST’s office said there may be another one out there. In any case, if you have any questions or concerns about your Subchapter 5 whether it is a creditor or a debtor matter, we’d be happy to look at it for you and get you some guidance.

Ajay Gupta and Chris S. Evans Obtain Six-Figure Jury Verdict For Client in Property Dispute

June 10, 2022/in All Blog Posts/by The Gupta Evans & Ayres Team

Gupta Evans and Ayres is proud to announce they were able to secure another resounding victory and six-figure verdict for their client after over four years of litigation and a hard-fought jury trial in San Diego County.

GEA represented a purchaser of a home in Oceanside that the purchaser later discovered to be littered with an assortment of undisclosed defects and faulty repairs. The Firm began representing the client in early 2017, which would begin what would become a marathon of litigation and include a litany of hotly contested issues, complete with extensive discovery and motion practice (and, of course, a global pandemic). Although the case concluded as a trial between a buyer and seller of residential real estate, the case began with three times the parties and several cross-complaints and competing defenses, all of which had to be resolved before trial.

Finally, after over four years of litigation, and a seven-day jury trial before Judge Blaine Bowman in the North County branch of San Diego Superior Court, the Firm established that the sellers of the home were liable to the client-buyer for breach of contract, fraud (intentional and negligent misrepresentation) and engaging in work as an unlicensed contractor. After establishing such liability, the jury returned a six-figure verdict in favor of the firm’s client.

As the prevailing party at trial, the Firm was then also able to succeed on a post-judgment motion for attorneys’ fees and costs incurred by their client throughout the course of the litigation, in part by successfully arguing the “intertwinement” of the tort and contract causes of action.

After resolving claims against parties other than the seller pre-trial, and upon the successful jury verdict and attorneys’ fees motion, the client was granted a total award of approximately $540,000, inclusive of punitive damages. Congratulations to trial counsel Ajay Gupta and Chris S. Evans for bringing this case across the finish line and obtaining a victory for the Firm’s client!

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

May 3, 2022/in All Blog Posts, Bankruptcy/by Dylan Contreras

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

May 3, 2022/in All Blog Posts, Bankruptcy/by Dylan Contreras

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

May 3, 2022/in All Blog Posts, Bankruptcy/by Dylan Contreras

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.

Prior Publication Does Not Always Bar Trade Secret Protection

April 21, 2022/in All Blog Posts/by John Ahn

Does a published algorithm bar trade secret protection of that algorithm? The answer is not as simple as it seems. Earlier this year, the Federal Circuit in Masimo Corp. held that the prior publication by a third party of trade secret information does not bar trade secret information. Masimo Corp. v. True Wearables, Inc., No. 2021-2146, 2022 U.S. App. LEXIS 1923, at *17 (Fed. Cir. Jan. 24, 2022). This seems counter intuitive given that one of the requirements of a protectable trade secret is that the information to be protected is not generally known to the public. 18 U.S.C. § 1839; Cal Civ Code § 3426.1.

This blog will explore the topic of whether prior publication of information by a third party bars trade secret protection.

I recently posted a blog article about where I discussed the laws around trade secrets generally. To recap:

Trade secrets are defined under 18 U.S.C. § 1839[1] and Cal Civ Code § 3426.1[2]. Boiled down, three things must be true for the information you seek to protect:

Derives independent economic value;
Not generally known to the public;
Reasonable measures were taken to keep the information secret.

Case Background

In Masimo Corp., Masimo Corporation and Ceracor Labortories, Inc. (collectively, “Masimo”) sued True Wearables, Inc. (“True Wearables”) and Dr. Marcelo Lamego for trade secret misappropriation. Specifically, Masimo alleged that Dr. Lamego misappropriated the trade secret known as “TSS”. TSS is related to Masimo’s proprietary algorithm used to solve optimization problems surrounding oximeters[3]. Masimo’s TSS uses a simple linear algebraic equation: “SpHb = Ax + By + Cz . . .,” where x, y, and z are absorption measurements (e.g., wavelength readouts) from the oximeter and A, B, and C are coefficients which relay important information to the user. Masimo Corp. at 2.

Dr. Lamego was employed at Ceracor Laboratories, Inc. before leaving and founding True Wearables. Id. at 3. Dr. Lamego the “Oxxiom device” and later received a notice of allowance for a patent for the Oxxiom device. Id. Masimo sued True Wearables in district court, moving for preliminary injunction on trade secret claims arguing that the provisional application upon which the nonprovisional application claims priority[4] disclosed a variation of the TSS algorithm, which would eventually become public knowledge. Id.

The district court followed CUTSA definition of a trade secret mentioned above. True Wearables argued that the TSS algorithm was “generally known” by the public because it was previously published in a conference paper by the Institute of Electrical and Electronics Engineers (“IEEE”). Id. at 7. Specifically, the IEEE paper disclosed “an algorithm equivalent to the TSS and that has been cited over 1,200 times.” Id. True Wearables also presented expert testimony stating that “variants of the TSS have appeared in statistics textbooks since the early 1960s” and “an algorithm equivalent to the TSS was ‘widely known and widely used by the statistics community’” prior to the lawsuit. Id. at 8. The district court ruled that at best, the publications could be a basis for determining that the TSS was readily ascertainable. Id. (citing Masimo Corp. v. True Wearables, Inc., No. SACV 18-2001 JVS (JDEx), 2021 U.S. Dist. LEXIS 88038, at *13 (C.D. Cal. Apr. 28, 2021)).

Analysis

Although True Wearables cited various cases that “display in a single publication of an alleged trade secret in its entirety is conclusive evidence that it is generally known”, the Federal Circuit found those cases to be distinguishable because the cited cases involved either (a) disclosure in an unrelated field or (b) disclosure was authorized by the owner of the trade secret thereby extinguishing trade secret protection. Masimo Corp. at 10. The Federal Circuit stated that the mere fact that the trade secret has been published “does not necessarily compel a finding that the information cannot maintain its status as a trade secret for a party in an entirely different field from the one to which the publication was addressed.” Id. at 12.

The true downfall for True Wearables’ argument was that the algorithm or variants of the algorithm were published to the statistics community, which the Federal Circuit deemed to be far enough removed to be considered unrelated to the medical field. Just because those in the statistics community were aware of the algorithm does not necessarily mean that the algorithm would be generally known by “entities who develop noninvasive blood content detectors” such that said entities could derive economic value from the disclosure. Id. at 13. For example, if the algorithm was disclosed to the healthcare community at large, True Wearables may have had a stronger argument that TSS was “generally known.” However, the Federal Circuit found this to not be the case.

Takeaway

Although the case is ongoing, the distinction in whether “publication” is damning towards trade secret protection is worth noting. Here, the inquiry shifted to whether the publication in an unrelated field is far enough removed such that those in the relevant field would not be able to obtain economic benefit of the disclosure. While the Masimo Corp. ruling might seem surprising on its face, the Federal Circuit’s line of reasoning is not completely unfamiliar. Interestingly enough, the logic here—although not completely parallel—seems to be consistent with the rules around other areas of intellectual property. For instance, two trademarks can exist simultaneously in unrelated fields. Also, a patent publication is not prima facie prior art if the publication exists in an unrelated field and there is no motivation to combine. At the end of the day, the Federal Circuit is affirming its stance that determinations of the prongs of trade secret protection is fact intensive as seen in Masimo Corp. It is important to note that despite the preliminary injunction granted in favor of Masimo, True Wearables may still succeed on the merits as the case moves forward. Masimo Corp. is certainly a case worth keeping an eye on.

[1] (3) the term “trade secret” means all forms and types of financial, business, scientific, technical, economic, or engineering information, including patterns, plans, compilations, program devices, formulas, designs, prototypes, methods, techniques, processes, procedures, programs, or codes, whether tangible or intangible, and whether or how stored, compiled, or memorialized physically, electronically, graphically, photographically, or in writing if—(A) the owner thereof has taken reasonable measures to keep such information secret; and (B) the information derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable through proper means by, another person who can obtain economic value from the disclosure or use of the information.

[2] According to the California Trade Secrets Act (“CUTSA”) (d) “Trade secret” means information, including a formula, pattern, compilation, program, device, method, technique, or process, that: (1) Derives independent economic value, actual or potential, from not being generally known to the public or to other persons who can obtain economic value from its disclosure or use; and (2) Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

[3] Without going into the specifics, oximeters are basically LED emitting fingertip sensors used to measure the concentration of total hemoglobin, i.e., blood oxygen levels, in a patient.

[4] Fun fact: a provisional application allows applicants to basically make adjustments to the application for one year while securing an earlier filing date. Applicants can then file a nonprovisional application—which is more or less the completed version of the provisional application—and claim the benefit or “priority” of the earlier filing date of provisional application. In other words, the nonprovisional application would then be considered to have been filed at on the date the provisional application was filed. The priority/filing date is important because the U.S. moved from a “first to invent” filing system to a “first to file” system. This means that whoever files first rather than invents first will generally be awarded the patent. For example, if two applicants filed a patent application for the same or similar invention, the applicant with the earlier filing date will generally be the one to be awarded the patent.

California Supreme Court Says Lenders Owe No Duty of Care in Loan Modification Negotiations

March 8, 2022/in All Blog Posts/by Jake Ayres

The 2008 financial and foreclosure crisis—in addition to immiserating a generation of homeowners—led to an explosion in litigation against lenders and loan servicers by aggrieved owners. Because of the volume of these cases and the diversity of approaches by the plaintiffs, a split of authority between the various Districts of the California Court of Appeal on a key issue developed: do lenders owe a duty of care in reviewing and processing loan modification applications?

On March 7, 2022, in a unanimous, landmark (and whopping, 54-page) majority opinion authored by Chief Justice Cantil-Sakauye, the California Supreme Court answered that question with a resounding “no.” In Sheen v. Wells Fargo, the Justices held that “lender[s] [do not] owe borrowers a tort duty sounding in general negligence principles to . . . ‘process, review and respond carefully and completely to a borrower’s loan modification application,’ such that upon a breach of this duty the lender may be liable for the borrower’s [solely] economic losses.” (Slip Op. at 2.) On June 1, the Court denied Sheen’s petition for rehearing, effectively finalizing the Court’s decision.

In this case, borrower Kwang Sheen took out a second and third mortgage with Wells Fargo on his home in Los Angeles. Sheen eventually missed payments on both loans and Wells Fargo began foreclosure proceedings, scheduling a trustee’s sale for February 2010. In January of 2010, Sheen, through his representative, contacted Wells Fargo and applied for a loan modification in an attempt to stave off foreclosure. A week after his application for modification, Wells Fargo cancelled the trustee’s sale set for February. Wells Fargo never got back to Sheen directly about the loan modification requests, but did get a set of letters related to the two loans from Wells Fargo in March of 2010, which informed him the loans had been charged off and the balance accelerated. Sheen interpreted these letters to mean that the loans had been modified to become unsecured such that there would be no foreclosure on his property. However, as it turned out, Sheen’s interpretation of the letters was incorrect, and both loans remained secured as Wells Fargo went to the market with the distressed loans.

In November of 2010, Wells Fargo sold the second loan to a third party, and that loan eventually ended up in the hands of Mirabella Investment Group, LLC (“Mirabella,” a client of Gupta Evans & Ayres who prevailed against Sheen on summary judgment, plaintiff’s appeal of which is pending the resolution of the Wells Fargo appeal). In 2014, Mirabella foreclosed on the property and it was sold at a foreclosure sale. Sheen’s lawsuit followed, wherein he brought causes of action for intentional infliction of emotional distress, unfair competition (section 17200), and—most critically—negligence. The California Court of Appeal held summarily dispatched the emotional distress and unfair competition claims, and, in the bulk of the opinion, held that Wells Fargo owed no duty of care to Sheen in processing his loan modification requests, relying on the “economic loss rule” which states that parties to a contract (or a contract negotiation) do not owe each other a duty not to cause purely economic losses that do not arise from the violation of an independent duty. Sheen v. Wells Fargo, 38 Cal. App. 5th 346 (2019). In so doing, the Court of Appeal explicitly noted that “[t]he issue of whether a tort duty exists for mortgage modification has divided California courts for years” and that “[t]he California Supreme Court has yet to resolve this division.” Id. at 348. Picking up the thrown-down gauntlet, the California Supreme Court granted review.

Like the Court of Appeal, the California Supreme Court used economic loss rule as its primary rationale, which provides that a party to a contract cannot recover in tort for purely economic damages—“i.e., pecuniary losses unaccompanied by property damage or personal injury” (Slip Op. at 2.)—unless the plaintiff can show a breach of a duty arising independent of the contract between the parties. Robinson Helicopter v. Dana Corp., 34 Cal. 4th 979, 992-93 (2004). The court relied heavily on this principle in deciding not to impose a duty on lenders, noting the underlying rationale of the rule is to “‘prevent the erosion of contract doctrines by the use of tort law to work around them.’” (Slip. Op. at 15 (quoting Restatement, §3 at p. 2).) The court reasoned that loan modification is just a renegotiation of an existing contract, wherein the lender is attempting to find a way to best enforce and protect the rights established by the original contract. (Id. at 17-18, 23.)

After noting that its approach was consistent with the majority of other jurisdictions (id. at 19-22), the court dispensed with plaintiff’s legal counterarguments. In particular, the court noted that the economic loss rule is not limited to loan origination, but also modification because of its relation to the original contract between the parties. (Id. at 23.) The court also stated that the oft-cited factors from Biakanja v. Irving, 49 Cal.2d 647 (1958)—used to impose a duty of care in certain situations—do not apply when the parties are in contractual privity. (Id. at 37.)

Lastly, and perhaps most importantly, the court rejected plaintiff’s policy arguments. The court did recognize the underlying merit in plaintiff’s contention that the bargaining power in loan modification negotiations are lopsided in favor of lenders and servicers (who may have incentives to promote foreclosure and discourage modification), but ultimately stated that it was the role of the Legislature to strike the balance between those competing costs and benefits. (Id. at 46-55.) The court was not shy about prodding the Legislature to act to address the concerns raised by plaintiff about home loan modification negotiations, stating that “should it choose to the Legislature can both prescribe whether a lender must act ‘reasonably’ and (in some detail, if it chooses) what constitutes ‘reasonable’ behavior within this sphere.” (Id. at 55.) Justice Liu, in his concurring opinion, was more pointed: “[W]hether the mortgage market and affected communities would benefit from manipulative practices and ‘bargaining or information asymmetries’ . . . continues to be ripe for legislative consideration.” (Id. at 11 (Liu, J., concurring).) This open signaling from the California Supreme Court could spur the Legislature to act to address the concerns raised by both plaintiff and the court.

The court also seemingly overruled contrary precedent in a sweeping footnote (id. at 55 n.12), but did not delve into the details of the prior cases from the Court of Appeal that did find duties of care applicable to lenders. One of the handful of cases that did find a duty of care and was heavily relied upon by plaintiffs—Alvarez v. BAC Home Loans Servicing, L.P., 228 Cal. App. 4th 941 (2014)—was addressed in Justice Jenkins’ concurring opinion, wherein he fell on his sword and addressed his participation in that case’s opinion. In short, Justice Jenkins seemed to admit that he, along with the rest of the majority in Alvarez, misapplied the Biakanja factors and overlooked the fact that that analysis only applies where the parties are not in contractual privity. (Id. at 2 (Jenkins, J., concurring).)

In granting review and deciding against the existence of a duty, the California Supreme Court has spoken clearly about the lack of a lender’s duty to process, review, and respond to loan modification—avoiding a potential instantaneous sea change in the allocation of risk and liability between lenders and borrowers. However, at the same time, the Court has also, in asserting its inability to make law on the subject from the bench, laid the groundwork for potential Legislative action. Finally, although the court seemingly has spoken with an intent to close the book on this issue in the judicial sphere, given the passing remarks made by the concurring Justices pointing out the items not conclusively addressed by the majority opinion (id. at 3-5 (Liu, J. concurring); id. at 2-3 (Jenkins, J., concurring)), lender litigants can reasonably expect that borrower plaintiffs will continue to jam their proverbial feet in the door.

Which State’s Law Governs? Domesticating Out-of-State Judgments in California

January 19, 2022/in All Blog Posts/by John Ahn

I ran into an interesting legal question regarding the collection of out-of-state judgments: when an out-of-state judgement is domesticated in California, which state’s law controls? Let’s say a creditor secured a judgment against one spouse outside of California in another community property state, but that state’s community property laws prevented the married couple’s community property from being encumbered by the judgment. The rub is that the couple also own property in California. Can the creditor secure a lien against the California property by domesticating the judgment in California?

California Sister State Money Judgments Act and Domesticating Judgments

The California Sister State Money Judgments Act, Code Civ Proc section 1710 deals with sister state judgments and domesticating judgments in California, which states: “Except as otherwise provided in this chapter, a judgment entered pursuant to this chapter shall have the same effect as an original money judgment of the court and may be enforced or satisfied in like manner.” Code Civ Proc § 1710.35. Courts have taken the plain language of section 1710.35 and determined that the legislative intent of the “[a]ct was not intended to alter any substantive rights or defenses which would otherwise be available to a judgment debtor or a judgment creditor in this state.” Washoe Dev. Co. v. Irving Sav. Ass’n, 47 Cal.App.4th 1518, 1524 (1996); see also Kahn v. Berman,198 Cal. App. 3d 1499, 1505-1507 (1988).

In Washoe, a judgment was entered in Nevada and then renewed by court order, which revealed that Respondents had money due from Appellants remaining. 47 Cal.App.4th at 1521. Respondents obtained a judgment in California (domesticated judgment) to recover the remaining amount through the sister-state judgment process under Code Civ Proc section 1710. Id. There was an issue raised regarding whether the California judgment was unenforceable in light of conflicting Nevada law. Id. at 1523. However, the court in Washoe determined that defenses against sister-state judgment enforcement cannot be asserted because “the court rendering the judgment had fundamental jurisdiction”, which in this case, was California. Id. at 1524.

In light of Washoe and section 1710 of the California Sister State Money Judgments Act, the answer seems relatively straightforward. However, not all community property states are created equal, and will sometimes conflict with one another in terms of whether the community property can be encumbered by a judgment lien. For instance, Ariz. Rev. Stat. (“A.R.S.”) section 25-214 states that binding community property for “[a]ny transaction of guaranty, indemnity or suretyship” requires a joinder of both spouses. Ariz Rev. Stat. § 25-214. This effectively prevents the creditor in the situation supra from securing a lien on any of the couple’s community property. However, California has no such rule. In fact, California’s Code of Civil Procedure states that “[a]ll property of the judgment debtor is subject to enforcement of a money judgment.” Code Civ. Proc., § 695.010. This begs the question: if the creditor decides to domesticate the Arizona judgment in California, will the creditor be able to secure a lien on the community property located in California?

True Conflict Test

In Gaughan v. First Cmty. Bank (In re Miller), 517 B.R. 145, 152 (D.Ariz. 2014), a judgment was entered against the husband Larry Miller and not his wife, Kari Miller, in Arizona. 517 B.R. at 147. The judgment was later domesticated in California, and the Arizona District Court determined that Arizona laws should apply under the principles of full faith and credit. Id. at 155. However, the Ninth Circuit reversed this decision in First Cmty. Bank v. Gaughan (In re Miller), 853 F.3d 508, 519 (9th Cir. 2017).

The Ninth Circuit drilled down on this issue of conflicting statutes due to the presence of a choice-of-law provision and applied a three-prong test based on Kearney v. Salomon Smith Barney, Inc., 39 Cal. 4th 95, 111-12 (2006). 853 F.3d at 516. In determining which state’s law applies, they analyzed three questions: (1) does relevant law vary between the potentially affected jurisdictions?; (2) If there is a difference in law, does a true conflict exist such that “each of the states involved has a legitimate but conflicting interest in applying its own law[?]”; (3) If there is a true conflict, “which state’s interest would be more impaired if its policy were subordinated to the policy of the other state[?]” Id.; see also Kearny, 39 Cal. 4th at 111-12.

On paper, there seems to be a “true conflict” between the Arizona and California community property laws—applying Arizona law would mean the community property is exempt or protected from encumbrance, while applying California law would mean the community property can be encumbered. This is exactly what the court in Gaughan concluded prior to the Ninth Circuit’s reversal. However, the Ninth Circuit held that the differences in the two statutes did not necessarily compel the conclusion that a true conflict existed. In re Miller, 853 F.3d at 516. Instead, the “existence of such a conflict turns on whether the circumstances of the case implicate the policies underlying the ostensibly conflicting laws.” Id. at 517.

The Ninth Circuit dove deeper in light of this finding and analyzed the true purpose of each state’s ostensibly conflicting rules to see whether a true conflict actually existed. In doing so, the Ninth Circuit relied on Hamada v. Valley National Bank, 27 Ariz. App. 433 (1976). In Hamada, the Appellees Valley National Bank secured a judgment against the Appellants Hajime and Toshiko Hamada, a married couple. Id. at 436. However, Toshiko Hamada, Hajime’s wife, did not sign the promissory note on which the judgment was based. Id. The Arizona Court of Appeals explained that “[t]he husband, as a member of the community, has no power under the law without the knowledge and consent of his wife, to use community assets to guarantee the payment of a debt of a stranger to the community, it deriving no benefit therefrom.” Id. Therefore, the “policy underlying Arizona’s dual-signature requirement is to ensure that a spouse who lacks knowledge of, and does not acquiesce to, a guaranty is not bound.” In re Miller, 853 F.3d at 516.

Given that the Millers in In re Miller did not defend on the ground that Kari Miller lacked knowledge or acquiescence to justify her lack of signature on the guaranty, A.R.S. § 25-214 was not invoked and therefore, there was no true conflict between California and Arizona law. Id. at 518. Further, because there was no true conflict, the Ninth Circuit determined that California had a compelling interest in applying its law, one of which is “fostering the growth of commercial activities that require ready access to credit—a policy that would be undermined by limiting the ability of California creditors to enforce obligations for activities undertaken in California and made subject to the operation of California law by consent of the parties.” Id.

In light of the Ninth Circuit’s ruling in In re Miller, if the creditors in the hypothetical supra were to domesticate the out-of-state judgment in California and there are differences in the two states’ statutes, this might trigger the three-prong analysis to determine whether a true conflict actually exists. However, even if the analysis is triggered, it would probably be prudent to assume Washoe and California’s procedural laws would be controlling.

Author: John Ahn

When is a Broker Entitled to his Commission Fee – An Examination of the ‘Procuring Cause’ Requirement in California

January 19, 2022/in All Blog Posts, Corporate Litigation, Real Estate/by Dylan Contreras

Most, if not all, California real estate brokers (and agents) earn a living by helping people buy and sell homes. Brokers are often paid on a commission basis, usually 2%-3% of the sales price, and do not enjoy the luxury of a steady, bi-weekly paycheck. Given the “feast or famine” nature of the industry, brokers often find themselves in a commission fee dispute with another broker or their client.

In California, a real estate broker earns his commission fee when he produces a “ready, willing, and able” buyer to purchase the property. The broker must also be the “procuring cause” in effectuating the sale. Most brokers, agents, and lawyers are familiar with the former requirement—we have all heard that phrase before. However, the “procuring cause” element is often overlooked and misunderstood amongst real estate professionals. Although the California Association of Realtors (“C.A.R.”) has released helpful guidelines and even included these requirements in its model rules, confusion remains as to what “procuring cause” means. This blog article fills that void by exploring California’s case law on the ‘procuring cause’ requirement.

Ready, Willing, and Able – A Brief Summary

Under California law, a broker has satisfied the ready, willing, and able requirement when he has produced a buyer willing to purchase the property for the price and terms specified by the seller. (See Steve Schmidt & Co. v. Berry (1986) 183 Cal.App.3d 1299, 1305-06.) The buyer doesn’t need to make an offer to purchase the home, but an offer does indicate that the buyer is ready and willing to buy the home. (See Martin v. Culver Enterprises, Inc. (1966) 239 Cal.App.2d 925, 929.) In addition, the prospective purchaser must have the financial capability to purchase the property, such as the necessary capital, or is pre-approved for a home loan. (See Steve Schmidt, 183 Cal.App.3d at 1305-1306.).

In Steve Schmidt, the broker satisfied the ready, willing, and able requirement because the buyer possessed sufficient funds to purchase the property or, at a minimum, could obtain a loan to finance the transaction. In comparison, in Park v. First American Title Co. (2011) 201 Cal.App.4th 1418, 1426, the buyer was unable to purchase the property, which meant that the broker was not entitled to his commission fee. The buyer did not produce any evidence that indicated he had the financial capability to close the transaction, such as pay stubs and bank statements, nor had he been pre-approved for a home loan. The main takeaway is that a broker satisfies this first requirement if the buyer is serious about purchasing the property and has the financial wherewithal to do so.

Procuring Cause Requirement

The National Association of Realtors (“N.A.R.”) defines procuring cause as the “uninterrupted series of casual events, which results in the successful transaction.” C.A.R. has adopted N.A.R.’s definition and baked the procuring cause requirement into its Multiple Listing Services Rules (“M.L.S. Rules”). M.L.S. Rule 7.13 states that a buyer’s-broker’s offer is accepted by the selling broker “by procuring a buyer which ultimately results in the creation of a sales or lease contract.” The N.A.R.’s and M.L.S.’s respective definitions of procuring cause derive from the century-old landmark case of Sessions v. Pacific Improvement Co. (1922) 57 Cal.App. 1.

In Sessions, the plaintiff-broker was employed by the defendant-seller for the sole purpose of selling a shipping yard located near the San Francisco Bay. The plaintiff-broker completed all of the due diligence associated with the sale, such as obtaining the necessary maps and surveys and obtaining a permit to dredge the shipping yard, among other things. After the plaintiff-broker left his employ with the defendant-seller, he provided tract maps to the parties and even helped resolve a drainage issue on the shipping yard. The defendant-seller ultimately closed the transaction at the $1 million purchase price plaintiff-broker had previously proposed; however, the plaintiff-broker was not paid his commission fee.

In reviewing these facts, the California Supreme Court issued the ironclad rule that California Courts rely on to this day: a broker is entitled to his commission fee when he “set[s] in motion a chain of events, which, without a break in their continuity, cause the buyer and seller to come to terms as the proximate result of his peculiar activities.” (Sessions, 57 Cal.App. at 20.) The Supreme Court found that the plaintiff broker was an integral part of the sale because he had “performed the most effective and. . . .hardest and most expensive part of the whole undertaking.” (Id. at 32.) The Court concluded that the plaintiff-broker was entitled to his commission fee for his efforts in helping effectuate the sale of the shipping yard. (Id.)

Although Sessions was decided during the roaring twenties, California Courts have continuously relied on the case. For example, in Duffy v. Campbell (1967) 250 Cal.App.2d 662, the plaintiff-broker was the seller’s agent. The plaintiff-broker introduced the buyer to the seller, negotiated the sales price and contract terms, and even opened an escrow account for the parties. During the escrow period, the buyer and seller held a meeting at the exclusion of the plaintiff-broker and reduced the sale’s price by the amount of the broker’s commission fee. In addition, the parties conveniently closed the sale of the home after the last day the broker could claim a commission fee under the listing agreement.

The Court held that the plaintiff-broker was the procuring cause in effectuating the sale. (See generally Duffy, 250 Cal.App.2d at 665-57.) Akin to Sessions, the plaintiff-broker did all of the heavy lifting. He introduced the parties, negotiated the sales price, and even opened an escrow account for the parties. (Id.) The fact that the parties amended the agreement, principally to exclude the plaintiff-broker from the transaction, did not preclude the plaintiff-broker from collecting his commission fee. (Id. at 668.)

Although Sessions and Duffy may provide a sigh of relief to a broker currently involved in a commission fee dispute, it is important to examine cases in which the Court found that the complaining broker was not the procuring cause.

In Westside Estate Agency, Inc. v. Randall (2016) 6 Cal.App.5th 317, the plaintiff-broker made a $42 million offer for a Bel Air home on behalf of his clients. The offer was rejected, but the plaintiff-broker continued to negotiate and exchange offers with the seller’s broker. After the seller conditionally accepted the plaintiff-broker’s offer, the buyer contacted his attorney for additional advice and told the plaintiff-broker to cancel the deal. The plaintiff-broker did not submit any more offers for the buyer. Three months later, the buyer purchased the property for $1.25 million more than the plaintiff-broker’s original offer and used their attorney as the acting broker. The plaintiff-broker sued, claiming that he was entitled to a commission fee based on the new purchase price.

The Court disagreed and held that the plaintiff-broker “merely put the prospective buyer on track to purchase the property,” which did not entitle him to his commission fee. (Westside Estate Agency, Inc., 6 Cal.App.5th at 331.) The Court found that the plaintiff-broker’s efforts, albeit helpful, were too attenuated from the closing date to award him a commission fee because the transaction closed approximately three months after the buyer told the plaintiff-broker to cancel the deal. Moreover, the buyer purchased the home on different terms than those initially negotiated by the plaintiff-broker. (Id.)

In Schiro v. Parker (1955) 137 Cal.App.2d 503, the Court reached a similar conclusion as Westside Estate Agency, Inc. In Schiro, the property’s listed sale price was $366,000. The plaintiff-broker represented the buyer and submitted two offers at $320,000 and $325,000, both of which the seller rejected. The Plaintiff-broker later learned that the seller was inclined to sell the property for $330,000 or $335,000. The Plaintiff-broker communicated this information to the buyer, but the buyer chose not to submit another offer to the seller. A few weeks later, the buyer met with a separate broker, or the closing-broker, and told him that he thought the “deal was off.” Acting at the buyer’s direction, the closing-broker made two offers to the seller, and the seller accepted the closing-broker’s second offer for $330,000.

Based on these facts, the Court held that the plaintiff-broker was not entitled to his commission fee. The Court focused on the buyer’s state of mind in reaching its decision. The Court was persuaded by the fact that the buyer thought the “deal was off,” and he was, therefore, “free to believe that [plaintiff-broker] was unable to procure an acceptable offer from the seller.” (Schiro 137 Cal.App.2d. at 507-08.)

The holdings in Westside Estate Agency and Schiro teach us the Courts will examine multiple factors when determining whether the complaining broker was the procuring cause in effectuating the sale. In Westside Estate Agency, Inc., the Court focused on the fact that the plaintiff-broker’s efforts were too attenuated from the closing date to be considered the procuring cause. On the other hand, in Schiro, the Court’s relied on the buyer’s beliefs and state of mind concerning the transaction and his relationship with the plaintiff-broker.

There are noticeable factual differences in the case in which the broker was the procuring cause (i.e., Sessions and Duffy) and the cases in which the Court found the broker was not (i.e., Westside Estate Agency, Inc., and Schiro). In Sessions and Duffy, the plaintiff-brokers completed all of the major tasks related to the sale, and their efforts were closely related to the transactions in time and purpose. In comparison, in Westside Estate Agency, Inc. and Schiro, the brokers’ actions were too attenuated from the transaction (i.e., Westside Estate Agency, Inc.) and were not a significant factor or cause of the buyer and seller completing the sale.

The C.A.R. has adopted the case holdings described above and created four categories of factors to guide brokers, arbitrators, and courts in determining whether a broker was the procuring cause in the transaction. The four categories are outlined below:

Connection to the Transaction: These factors focus on who showed the property to the client, made offers on the client’s behalf, the amount of time that elapsed between the intro broker’s efforts and the sale of the property, and the services each competing broker provided. These factors were discussed in Westside Estate Agency, Inc., Sessions, and Duffy.
Buyer’s Choice: This set pertains to the client’s choice between brokers and his/her state of mind as to who was representing them. This factor was central to the holding in Schiro.
Broker’s Conduct: This category relates to the steps the competing brokers took to secure their commission fee and relationship with their clients. In other words, did the closing broker ask the seller if he/she had engaged with another broker? Did the intro-broker know that his/her client was attending open houses on their own? And did the intro-broker tell his client to inform other brokers that he/she was already represented?
Other – Catch-All: This set solely relates to whether any contractual agreements existed between the broker and the client, such as a Buyer-Representation Agreement.

It is important that California real estate brokers and agents keep these factors, as well as the cases discussed above, in mind when negotiating a sales contract on behalf of their client(s). Any ambiguity on who is entitled to a commission fee may negatively impact a broker’s livelihood and result in an arduous and time-consuming litigation process. Contact a California real estate attorney if you or another agent are involved in a commission-fee dispute.

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