Bankruptcy

(Ryan, U.S. Bankruptcy Judge)

While California law governs whether and to what extent a transfer of property is voidable by a bankruptcy trustee, the value of the avoided transfer, and therefore the recovery, is governed by ' 550(a) of the Bankruptcy Code, and California law will not affect that valuation.

A debtor filed a voluntary Chapter 7 petition. On Dec. 1, 2005, the plaintiff/bankruptcy trustee filed a complaint to avoid the transfer three years earlier of the debtor's interest in a piece of real property and to recover the value of that interest. The trustee alleged specifically that the transfer was avoidable as a fraudulent transfer pursuant to ' 544 of the Bankruptcy Code and that the value of the property was recoverable pursuant to ' 550 of the Bankruptcy Code. (Once a trustee demonstrates the right to avoid a transfer, the trustee must then establish the amount of recovery pursuant to ' 550(a).) (References here are to the Bankruptcy Code (the Code), 11 U.S.C. ” 101-1330, prior to its amendment by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub.L. 109-8, 119 Stat. 23, because this case was filed before the Act's effective date (Oct. 17, 2005).) Defendant moved for summary adjudication that plaintiff's recovery should be limited to the value of the 'asset' as defined by ” 3439.01 et seq. of the California Civil Code (Civil Code) ' in other words, that recovery should be limited to the non-exempt net equity in the property at the time of the transfer and should not include the increase in value to that property since the transfer. Plaintiff opposed and filed a cross-motion for summary adjudication to recover the current value of the property.

Following a hearing, the judge took the matter under submission to determine if applicable California law limits a bankruptcy trustee's recovery under ' 550 of the Code. The judge noted that the interplay between the Code and California fraudulent conveyance law was 'far from settled.'

After what he described as 'a plain reading' of ” 549 and 550, and California Civil Code ” 3439 et seq., relevant case law, and general principles of bankruptcy law, the judge concluded that plaintiff may recover the current fair market value of any equity in the property. The judge noted first that, in general, a bankruptcy trustee may avoid a transfer if a creditor holding an allowed claim could avoid the transfer under applicable state law. See 11 U.S.C. ' 544(b). However, under controlling California fraudulent conveyance law, e.g., ” 3439.01, 3439.04 and 3439.07, a creditor cannot avoid the transfer in its entirety but may do so only as to that portion of the property not encumbered by a valid lien or exempt under non-bankruptcy law. As such, transfer of property that is fully encumbered and/or exempt is not voidable as a fraudulent transfer. See Consolidated Pioneer Mortg. Entities v. San Diego Sav. & Loan (In re Consolidated Pioneer Mortg. Entities), 1999 WL 23156, *1 (9^th Cir. 1999) ('[P]roperty encumbered by a valid security interest is not recoverable under California law.'). Emphasizing that ' 550(a) does not permit a trustee to recover more than is avoidable under ' 544(b) and California law, defendant argued that plaintiff trustee's recovery should be limited to the debtor's equity interest in the property at the time of the transfer. However, the judge held that while California law governs whether and to what extent a transfer of property is voidable, the value of the avoided transfer ' and therefore the recovery ' is governed by ' 550(a), irrespective of any recovery limitations imposed by California law.

Unfortunately, the Code neither defines 'value' nor indicates at what time 'value' is to be determined. The judge therefore turned to case law and other statutory guidance. He found that at least two courts had recognized that a bankruptcy trustee is entitled to recover the 'greater of the value of the transferred property at the transfer date or the value at the time of the recovery.' 5 L. King, Collier on Bankruptcy ' 550.02[3] (15th ed. rev.2001); see also Langhorne v. Warmus (In re American Way Serv. Corp.) 229 B.R. 496, 530-31 (Bankr.S.D.Fla1999) ('[W]hen the property has appreciated, the trustee is entitled to recover the property itself, or the value of the property at the time of judgment'); Govaert v. B.R.E. Holding Co., Inc.(In re Blitstein, 105 B.R. 133, 137 (Bankr.S.D.Fla.1989) ('[T]he Trustee is entitled to at least a money judgment in the amount of the greater of the value at the time of the transfer; or the value at the time of recovery less the value of improvements made.').

The judge found this result was consistent with the purpose of ' 550: to restore the estate to the position it would have occupied had the property not been transferred. Moreover, a trustee typically has the ability to recover the property transferred, which would allow the estate to benefit from any appreciation. (When this occurs, ' 550(e) entitles a good faith transferee to a lien to secure the lesser of the cost of any improvements or an increase in value attributable to those improvements, demonstrating Congress' intent that any appreciation not attributable to the actions of a good faith transferee (such as capital improvements on the property) inure to the benefit of the estate.)

In accordance with these findings, it was held that the plaintiff could avoid the transfer of debtor's interest in the property to the extent it involved the transfer of unencumbered, non-exempt equity, and, under ' 550(a), that plaintiff could recover for the estate the property transferred or the current fair market value of the asset, less the cost or value of improvements.

California Law Governs Property Transfer Avoidability, But Not Valuation

In re Brun

'- B.R. ”, 2007 WL 455874 (Bkrtcy.C.D.Cal.,2/5/2007)

(Ryan, U.S. Bankruptcy Judge)

While California law governs whether and to what extent a transfer of property is voidable by a bankruptcy trustee, the value of the avoided transfer, and therefore the recovery, is governed by ' 550(a) of the Bankruptcy Code, and California law will not affect that valuation.

A debtor filed a voluntary Chapter 7 petition. On Dec. 1, 2005, the plaintiff/bankruptcy trustee filed a complaint to avoid the transfer three years earlier of the debtor's interest in a piece of real property and to recover the value of that interest. The trustee alleged specifically that the transfer was avoidable as a fraudulent transfer pursuant to ' 544 of the Bankruptcy Code and that the value of the property was recoverable pursuant to ' 550 of the Bankruptcy Code. (Once a trustee demonstrates the right to avoid a transfer, the trustee must then establish the amount of recovery pursuant to ' 550(a).) (References here are to the Bankruptcy Code (the Code), 11 U.S.C. ” 101-1330, prior to its amendment by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub.L. 109-8, 119 Stat. 23, because this case was filed before the Act's effective date (Oct. 17, 2005).) Defendant moved for summary adjudication that plaintiff's recovery should be limited to the value of the 'asset' as defined by ” 3439.01 et seq. of the California Civil Code (Civil Code) ' in other words, that recovery should be limited to the non-exempt net equity in the property at the time of the transfer and should not include the increase in value to that property since the transfer. Plaintiff opposed and filed a cross-motion for summary adjudication to recover the current value of the property.

Following a hearing, the judge took the matter under submission to determine if applicable California law limits a bankruptcy trustee's recovery under ' 550 of the Code. The judge noted that the interplay between the Code and California fraudulent conveyance law was 'far from settled.'

After what he described as 'a plain reading' of ” 549 and 550, and California Civil Code ” 3439 et seq., relevant case law, and general principles of bankruptcy law, the judge concluded that plaintiff may recover the current fair market value of any equity in the property. The judge noted first that, in general, a bankruptcy trustee may avoid a transfer if a creditor holding an allowed claim could avoid the transfer under applicable state law. See 11 U.S.C. ' 544(b). However, under controlling California fraudulent conveyance law, e.g., ” 3439.01, 3439.04 and 3439.07, a creditor cannot avoid the transfer in its entirety but may do so only as to that portion of the property not encumbered by a valid lien or exempt under non-bankruptcy law. As such, transfer of property that is fully encumbered and/or exempt is not voidable as a fraudulent transfer. See Consolidated Pioneer Mortg. Entities v. San Diego Sav. & Loan (In re Consolidated Pioneer Mortg. Entities), 1999 WL 23156, *1 (9^th Cir. 1999) ('[P]roperty encumbered by a valid security interest is not recoverable under California law.'). Emphasizing that ' 550(a) does not permit a trustee to recover more than is avoidable under ' 544(b) and California law, defendant argued that plaintiff trustee's recovery should be limited to the debtor's equity interest in the property at the time of the transfer. However, the judge held that while California law governs whether and to what extent a transfer of property is voidable, the value of the avoided transfer ' and therefore the recovery ' is governed by ' 550(a), irrespective of any recovery limitations imposed by California law.

Unfortunately, the Code neither defines 'value' nor indicates at what time 'value' is to be determined. The judge therefore turned to case law and other statutory guidance. He found that at least two courts had recognized that a bankruptcy trustee is entitled to recover the 'greater of the value of the transferred property at the transfer date or the value at the time of the recovery.' 5 L. King, Collier on Bankruptcy ' 550.02[3] (15th ed. rev.2001); see also Langhorne v. Warmus (In re American Way Serv. Corp.) 229 B.R. 496, 530-31 (Bankr.S.D.Fla1999) ('[W]hen the property has appreciated, the trustee is entitled to recover the property itself, or the value of the property at the time of judgment'); Govaert v. B.R.E. Holding Co., Inc.(In re Blitstein, 105 B.R. 133, 137 (Bankr.S.D.Fla.1989) ('[T]he Trustee is entitled to at least a money judgment in the amount of the greater of the value at the time of the transfer; or the value at the time of recovery less the value of improvements made.').

The judge found this result was consistent with the purpose of ' 550: to restore the estate to the position it would have occupied had the property not been transferred. Moreover, a trustee typically has the ability to recover the property transferred, which would allow the estate to benefit from any appreciation. (When this occurs, ' 550(e) entitles a good faith transferee to a lien to secure the lesser of the cost of any improvements or an increase in value attributable to those improvements, demonstrating Congress' intent that any appreciation not attributable to the actions of a good faith transferee (such as capital improvements on the property) inure to the benefit of the estate.)

In accordance with these findings, it was held that the plaintiff could avoid the transfer of debtor's interest in the property to the extent it involved the transfer of unencumbered, non-exempt equity, and, under ' 550(a), that plaintiff could recover for the estate the property transferred or the current fair market value of the asset, less the cost or value of improvements.