Opinion
Case No. 04-00769-B11.
April 17, 2006
ORDER ON MOTION TO APPROVE SETTLEMENT
This matter came on for evidentiary hearing on the debtor's motion to approve a settlement debtor reached with two creditors who asserted the first and second secured positions on the debtor's real property. Those creditors are Dynamic Finance Corporation and Angela C. Sabella, respectively. Angela Sabella is president of Dynamic Finance, as well as its parent, Dynamic Holdings, and of its affiliates.
The debtor is a limited liability company which owned a piece of land in Temecula, California, which was over 40 acres in size. The debtor's manager is William Johnson, who holds his interest in the debtor through his and his wife's wholly owned company, Shining city, Inc. Shining City holds 55% of the debtor.
This case was commenced as an involuntary bankruptcy, and the filing was not contested. The avowed purpose was to prevent the foreclosure on the land for the benefit of the petitioning secured creditor. The land was subsequently sold, yielding net proceeds in excess of $17 million. Subsequently, debtor brought a motion to settle with four levels of secured creditors, which was opposed. By written order, the court determined there were several issues which required an evidentiary hearing. Discovery was undertaken, and the hearing has been held.
The Court has subject matter jurisdiction over the proceeding pursuant to 28 U.S.C. § 1334 and General Order No. 312-D of the United States District Court for the Southern District of California. This is a core proceeding under 28 U.S.C. 157 (b) (2) (B), (O).
The standard for assessing whether to approve a settlement agreement was set in a case called In re A C Properties, 784 F.2d 1377 (9th Cir. 1986). There, the court wrote:
It is clear that there must be more than a mere good faith negotiation of a settlement by the trustee in order for the bankruptcy court to affirm a compromise agreement. The court must also find that the compromise is fair and equitable [Citation omitted.]
In determining the fairness, reasonableness and adequacy of a proposed settlement agreement, the court must consider:
(a) The probability of success in the litigation; (b) the difficulties, if any, to be encountered in the matter of collection; (c) the complexity of the litigation involved, and the expense, inconvenience and delay necessarily attending it; (d) the paramount interest of the creditors and a proper deference to their reasonable views in the premises.
[Citation omitted.] . . .
The trustee, as the party proposing the compromise, has the burden of persuading the bankruptcy court that the compromise is fair and equitable and should be approved.
In In re JMS Automotive Rebuilders, Inc., 2002 WL 32817517 (C.D. CA. 202), the court elaborated on each of the elements of the A C Properties test. In explaining "the probability of success" prong, the court wrote:
[T]he court must ascertain whether the bankruptcy estate would be likely to succeed on the merits of the subject controversy. [Citation omitted.] The court is responsible for determining the estate's litigation risk, and then determining whether the amount tendered in settlement is commensurate to that litigation risk. Id. However, the court's ultimate obligation is to "canvass" the above-mentioned issues and see whether the settlement falls below the lowest point in the range of reasonableness. [Citation omitted.] The court should not conduct a minitrial as to the merits of the compromised claims and defenses absent a showing of necessity.
Turning to another prong of the test, the court stated:
For purposes of determining the complexity of litigation, the court is required to determine whether pursuing the controversy on its merits would produce a sufficient net benefit to the estate. [Citation omitted.] Items to consider in determining the complexity of the case are: (1) likely burden on the trial court and the parties; (2) likely amount of administrative — expense claims; (3) and other factors which would reduce the real value of any collected judgment in comparison to the in-hand present value of the settlement.
Background
There are at least seven trust deeds securing creditors' interests against the net sale proceeds from the real estate. They are Dynamic's claim number 16, Ms. Sabella's claim number 14, the Suprunuks claim, the Clifford Douglas claim, and the claim of the Brees and South Temecula Gateway (STG). In addition, there is Dynamic's claim number 15. In the original settlement motion, the debtor sought to compromise all the above claims except that of the Brees and STG, who objected. Following the court's order on the first motion, a second settlement motion was filed, addressing only Dynamic's claim 16 and Sabella's claim 14. That is the motion which was the subject of the evidentiary hearing.
The gist of the settlement is that Dynamic has agreed to settle for about $1.3 million less than the full face amount of its claim. The debtor is candid in pointing out that approximately $800,000 of that $1.3 million is default-rate interest, which could be avoided in a confirmed plan. The Dynamic claim, including default interest, exceeds $15 million. In compromise, Dynamic would agree to a first priority secured claim of $14,297,500, plus interest at 10% on the unpaid principal balance of $3,797,500 (the court previously allowed a paydown of $10.5 million to slow the interest added to the debt).
The Sabella claim is asserted to be in excess of $1.7 million. She would agree to a second priority secured claim in the amount of $1,315,000 plus 10% interest on that amount after February 1, 2006.
The net sale proceeds from the real property were $17,659,100.31. Debtor's Schedule D listed total secured claims against the property as $21,400,000, only $2,000,000 of which was disputed (that is the claim of the Brees, objecting parties here). Not listed was what has become known as Dynamic's claim 15. So, not all undisputed secured creditors would get paid in full if the debtor's schedules are accurate, unless the senior secured creditors are willing to leave something on the table for them.
When the first settlement motion was filed, the debtor calculated that the settlement agreements reached with Dynamic, Sabella, the Suprunuks, and Clifford Douglas would leave $1,027,581 to pay junior secured creditors (not including the Brees) and unsecured creditors. That number has since been eroded by intervening interest and attorney fee accruals, as reflected by the revised settlement figures. Under the current proposal, Dynamic's unpaid principal balance increased almost $700,000, from $3,100,000 to $3,797,500, presumably for nine months of interest on the unpaid balance, plus attorneys fees. The proposed unpaid compromised balance on the Sabella loan increased from $1,200,000 to $1,315,000 over the same nine months. A ballpark subtraction of those amounts from the remaining net proceeds would leave approximately $2,000,000 to address the scheduled $2,000,000 claim of the Brees (to which the debtor has objected), the $1,200,000 claim of Clifford Douglas, the $2,000,000 claim of the Suprunuks, and $300,000 of junior secured claims, as well as $467,000 of scheduled unsecured creditors. Ahead of them are the administrative claims of the debtor's bankruptcy professionals.
Very much related to the question of what will be gained for creditors is the question of why the debtor would agree to this compromise, and why Dynamic and Sabella would agree to compromise their claims in favor of junior secured and unsecured creditors. Are the probability of success and litigation risk the only factors, or at least the predominant ones? The objecting parties argue they are not.
As noted, the manager of the debtor is William Johnson. Mr. Johnson has had multiple business dealings with Dr. Chambers, the Suprunuks, Dynamic Finance, Angela Sabella, and Isaac Lei. He testified he or entities he is involved with have borrowed "tens of millions of dollars" from Dynamic over a period of years. He also testified he and his wife have millions of dollars of personal guarantees outstanding on loans made by Dynamic. The objecting parties have characterized him as "an economic captive" of Dynamic and Ms. Sabella. At the same time, there are multiple state court lawsuits among the parties concerning their respective interests in various projects, or obligations issued by those projects.
One example of the foregoing brought out by the objecting parties is the debtor's apparent settlement of the $50,000 claim of Issac Lei. Apparently, the proof of claim was reviewed and submitted by counsel for Dynamic and Sabella. However, it was filed about two months after the claims bar date. The debtor's initial position was to not allow the claim at all. Evidence adduced at the hearing indicated the debtor agreed to allow the late-filed claim at $45,000. Then it was brought out that the original claim had failed to credit $7,500 Mr. Lei had received, so the claim was overstated from the outset.
In the context of a motion to approve a proposed compromise, it is not the Court's function to make findings of fact, or conclusions of law. But the Court is charged with determining whether the proponent of the settlement has met its burden of showing the settlement is fair and equitable, as A C Properties directs. The objecting parties have argued the settlement cannot meet the test because the person making the decisions for the debtor, William Johnson, has so many other obligations involving the same parties, as to whom he should be at arm's length. The Court has been sensitive to that concern for some time, as reflected in its November, 2005 written order. The circumstances and interrelations clearly call for heightened scrutiny, but they do not mean that a legitimate settlement could not be reached that benefits junior creditors. The question remains whether the proposed settlement is in the zone of reasonableness.
Discussion
Again, in the context of the instant motion, it is not the Court's role to make findings of facts and conclusions of law, notwithstanding that a lengthy evidentiary hearing has been held. And the Court will not do so. As a separate matter, counsel for Dynamic and Ms. Sabella have advised the Court that the settlement is a package, and if either part fails to meet the A C Properties test, the whole settlement fails.
Sabella's Claim 14
The Sabella claim has a lot of convoluted history. The central issue, however, will be whether Ms. Sabella acquired the promissory note on which it is based as a holder in due course pursuant to California Commercial Code § 3302. In order to answer that question for purposes of the instant motion, the Court will review its understanding of the history of the obligation on which Ms. Sabella relies.
According to Dr. Chambers, Chambers Family Trust loaned the debtor $600,000 to aid in acquiring the real estate. Dr. Chambers was the managing member of the debtor, and Shining City and the Suprunuks were the other members. In return for the loan, the Chambers Family Trust received a promissory note for $600,000 and collateral in the form of a trust deed on the property. Dr. Chambers testified he did not know if the note provided for interest or what the due date was, although he probably signed the note on behalf of North Plaza at the time. The whereabouts of that note are unknown.
Dr. Chambers testified that Mr. Johnson wanted to borrow money against North Plaza's land. Dr. Chambers did not want to subordinate to a new lender, so it appears an agreement was reached. In November, 1997 Dr. Chambers executed a full reconveyance of the Family Trust's interest in the 1996 trust deed securing the $600,000 loan. Then, on or about January 28, 1998 Dr. Chambers, as manager of North Plaza, executed a promissory note to the Chambers Family Trust for $739,064.07. The note was to be secured by a deed of trust. This note is at the center of the Sabella claim.
A Short Form Deed of Trust was prepared at some point, and dated January 28, 1998 — the same date as the date of making of the note. However, the signature of Dr. Chambers as manager of North Plaza was not notarized until October 21, 1998, and the trust deed was not recorded until October 23, 1998, almost ten months after the making of the note. It is quite relevant that in between January and October, 1998 Dynamic made its loan to North Plaza of $4,400,000 and acquired its first position deed of trust. Testimony indicated that Dynamic would only loan money on real estate if it received a first position trust deed as collateral.
On the same date, October 23, 1998 there was also recorded an assignment of the January 28, 1998 deed of trust to an entity named B C Lake Villas, LLC, managed by Mr. Johnson. The assignment indicated that while the North Plaza trust deed was dated January 28, 1998 it was recorded "concurrently herewith". Because it was not recorded until October 23, it was junior in priority to Dynamic's first position. The Court does not know if Dynamic was informed of North Plaza's obligation under the note, but no title report would have shown it at the time because nothing concerning it was recorded.
Dr. Chambers wrote a memo he signed, and Mr. Johnson countersigned, dated October 21, 1998 in which he states:
I am hereby, as manager of North Plaza LLC, executing a note for $739,064.97 to myself as trustee of Chambers Family Trust dated 3/3/92. Further as trustee I am assigning this note to BC Lake Villas LLC and delivering it to you as manager. This is in exchange for a note in similar amount from BC Lake Villas LLC to me as trustee which is expected to be paid on November 15, 1998.
With the effect of confusing the reader, the memo continued:
There is still outstanding a 1996 note for $600,000 from North Plaza, LLC to me as trustee which is to provide protection until BC Lake Villas LLC makes the expected payment in November. Until that event that 1996 note is to be paid instead of the current $739,064.97 note by North Plaza LLC, and is to be covered by the latter's deed of trust. Upon receipt of the expected payment from BC Lake Villas LLC I am to cancel the $600,000 note.
The memo referenced that its contents were in accordance with an assignment Dr. Chambers had prepared, and the Suprunuks had signed. That assignment explained in much greater detail the claimed origins of the $739.064.07 note. It stated that the original $600,000 note bore interest at 14%, and was due January 16, 1998. Thereafter, the assignment recites, the note principal was increased by $25,681.07 for additional loans by the Chambers Family Trust. Then it recites that the interest on the adjusted note, when added to the outstanding principal, brought the total to $739,064.07 as of November 5, 1997. Then, the Agreement portion of the document recited:
A Chambers Family Trust 3/3/92 hereby assigns to BC Lake Villas, LP any and all interest and property rights in the note to it from North Plaza, LLC originally dated July 16, 1996 except to the extent that the principal and interest on the BC Lake Villas note to Chambers Family Trust dated November 5, 1997 remains unpaid.
Still on October 23, 1998, BC Lake Villas recorded the assignment of the North Plaza January 28, 1998 deed of trust to Iraj Ameri, dba Corporate Funding. The assignment was executed by William Johnson as manager of BC Lake Villas. Then, on December 10, 1998 Ameri reassigned the January 28, 1998 North Plaza trust deed back to BC Lake Villas, LLC. Then the trust deed was assigned by BC Lake Villas to the Goldbergs and Ameri as collateral. That assignment was also recorded December 10. Mr. Johnson testified that BC Villas held the North Plaza-to-Chambers note and needed to get money out of it. So they borrowed from the Goldbergs and assigned them the North Plaza note and trust deed.
According to the testimony, the BC Lake Villas property sold in March, 1999, although there were not enough proceeds to pay all secured creditors in full. Dr. Chambers received $450,000 in cash, and a promissory note from Shining City, Inc. for $385,000. The theory appears to be that the $600,000 North Plaza-to-Chambers note of 1996 was extinguished by BC Lake Villas' payment to Dr. Chambers, and that the January 28, 1998 note for $739,064.07 became the property of BC Lake Villas in exchange for its own note and trust deed, although when that might have happened is confusing in light of the Assignment and Agreement referenced in Dr. Chamber's memo.
The evidence at the hearing indicated that Ms. Sabella was interested in acquiring the second trust deed position, and note, from BC Lake Villas as early as February, 1999. Memos were introduced indicating the note now reflected a loan of $833,000, had an 8% interest rate and a June 30, 1999 due date, and that Mr. Johnson held the note. Subsequently, the transaction was structured as a loan from Ms. Sabella to the Johnsons, individually, in the amount of $617,256.79. That loan was reflected in a note dated May 26, 1999. The security offered by Mr. Johnson was the "Chambers note" and trust deed. Notwithstanding that the $617,256 note was made by the Johnsons, individually, the last page (p. 6) purports to be signed by Mr. Johnson for BC Lake Villas, LLC, as well as separately by he and his wife. BC Lake Villas is nowhere identified as a borrower on the note.
The proceeds of the Sabella loan to the Johnsons were disbursed on behalf of Sabella to the Goldbergs and Ameri, who were the senior assignees on the "Chambers note", presumably to buy them out. In addition, $75,000 was disbursed to Peter Suprunuk, and over $26,000 to the Johnsons. Actual disbursements totalled $518,353.70 on a loan for $617,256.79, which apparently included prepaid interest and a reserve of $30,000 for an RV park project. For that, Ms. Sabella became the assignee of the "Chambers note" for $739,064.07 plus accrued interest, and received an assignment of the second trust deed as collateral. At least one way of looking at the transaction is that Mr. Johnson bought out the obligations to the Goldbergs and Ameri with the proceeds of his loan from Ms. Sabella, and assigned his successor position to her, although the actual assignments came directly from the Goldbergs and Ameri to her.
When Ms. Sabella received the assignments from the Goldbergs and Ameri, all she could obtain is what they held, which was the right to repayment of the debts owed to them by BC Lake Villas, secured by the "Chambers note" and trust deed. It appears that BC Lake Villas was the owner of the "Chambers note", having exchanged its own obligation for it, and had pledged it, and the supporting trust deed, as collateral for repayment of the loans made by the Goldbergs. When and how Ms. Sabella became the owner of the "Chambers note", or other circumstances which would authorize her to enforce its terms, was not made clear during the hearing. So far as appears from the record, the note and trust deed remain as collateral for the Johnsons' performance under the terms of the $617,256.79 loan.
Assuming, without deciding, that Ms. Sabella somehow does have the right to enforce against the North Plaza estate the terms of the "Chambers note", it is of concern that it will be because of some ostensible default by the Johnsons under their loan, for which the note is collateral. If North Plaza pays the obligation, it may relieve the Johnsons of their obligation on that loan, or put North Plaza in the position of having to pursue its own manager if it somehow may become subrogated. More troubling is that Mr. Johnson is the manager of the debtor asking this Court to approve the settlement. It is also troubling that the terms of the settlements also include releases. The debtor has not explained how, if at all, it can recover for the benefit of the estate any such obligation to which it may become subrogated, much less whether the releases would or would not impact its ability to recover.
Based on the foregoing, the Court concludes that the debtor has not carried its burden of demonstrating that the proposed settlement is within the zone of reasonableness, and should therefore be denied, without prejudice, at least in part because it has not been shown that Ms. Sabella "owns" the "Chambers note" such that she can enforce it against the North Plaza estate.
Assuming she crossed that threshold, then the Court would get to the issue raised at the outset — whether she is a holder in due course. Section 3302 of the California Commercial Code provides in relevant part:
(a) . . . "holder in due course" means the holder of an instrument if both of the following apply:
(1) The instrument when issued or negotiated to the holder does not bear such apparent evidence of forgery or alteration or is not otherwise so irregular or incomplete as to call into question its authenticity.
(2) The holder took the instrument (A) for value, (B) in good faith, (C) without notice that the instrument is overdue or has been dishonored or that there is an uncured default with respect to payment of another instrument issued as part of the same series, (D) without notice that the instrument contains an unauthorized signature or has been altered, (E) without notice of any claim to the instrument described in Section 3306, and (F) without notice that any party has a defense or claim in recoupment described in subdivision (a) of Section 3305.
Ms. Sabella testified that she relied on her broker, Isaac Lei, for all the work and due diligence on this transaction because she was focused on resolving a matter in Utah. It appears by her testimony that Mr. Lei was acting as her agent in the transaction, and she is chargeable with his knowledge. It does not appear she can insulate herself as a holder in due course by delegating.
According to a February 25, 1999 memo from Mr. Lei to Ms. Sabella, it seems they understood the second trust deed on North Plaza secured an $833,000 obligation. By a similar memo dated April 28, 1999 Mr. Lei still thinks it is an $833,000 obligation, and that Mr. Johnson holds the note. He also understood the loan was due June 30, and that Johnson was asking Dr. Chambers, as a manager of North Plaza, for a 90 day extension. Importantly, Mr. Lei understood the note had an 8% interest rate. The same memo reflects that Mr. Lei understood the Goldbergs held the $833,000 note and trust deed as collateral for a loan that was past due as of March 19, 1999.
The real issue arose when Mr. Lei received a copy of the "Chambers note" because virtually nothing about it resembled what he had understood it to be. The face amount of the note was $739,064.07, not $833,000. The second line of the note had typed in: "On or before January 12, 1999," followed by the preprinted words "after date, for value received, I/we promise to pay . . ." That language indicates a one year due date because interest was to commence January 12, 1998. The rate of interest provided was 13%. Then, typed in after the preprinted words "interest payable" were the words "and principal payable on June 12, 1999." The word "June" had been altered by someone putting white-out or correcting tape over whatever was under it, and then writing the word "June". So Mr. Lei was faced with information that showed the note was at variance with what he had understood its interest rate to be, and it had at least two possible due dates neither of which were what he expected. Moreover, the later one, June 12, was clearly an alteration, and was for an unusual period of time, 17 months, as distinct from the one year set out elsewhere in the note. Interestingly, Dr. Chambers testified those are his initials near the correction to "June", and he assumes he must have put them there when the correction was made.
There were other changes on the note, such as the change to one digit of the year of the date of the Chambers Family Trust. In addition, the date then did not match the date of the Chambers Family Trust in the assignment of the note to BC Lake Villas. The Court is not persuaded the latter changes were ones Mr. Lei should necessarily have observed. However, the former give rise to much greater concern. Section 3103 of the California Commercial Code defines "Good Faith" to mean "honesty in fact and the observance of reasonable commercial standards of fair dealing." Mr. Lei is an experienced broker. He had been communicating with others, including Ms. Sabella, about his understanding of the contents of the note. Then he saw the note, and little, if anything, resembled what he understood and expected — not the amount, not the due date, and most notably, not the interest rate. There is an irony of sorts involved because Ms. Sabella testified she likely would not have been interested in the note if it carried only an 8% interest rate. Yet that is what Mr. Lei told her in a memo. Instead, the rate of interest on the face of the note was 13% which, under the circumstances, should have been a red flag for Mr. Lei 1) if he thought it was supposed to be 8%; and 2) because he knew the rate was usurious unless the note was somehow exempted from the usury provisions. Notwithstanding those facts, there was no testimony of any effort to ascertain whether the note was exempt. With facts like that staring him in the face, he cannot play ostrich. Almost nothing about the note was what he expected, and the Court is inclined to think that "reasonable commercial standards" would require some effort to reconcile the due date and the interest rate, and whether the note was exempt from the usury law.
In sum, because of the tangle of interrelations, the Court is unable to ascertain whether the proposed settlement package was the product of good faith negotiation. The Court is persuaded that no sufficient showing has been made that Ms. Sabella would succeed in establishing a right to receive the face amount of the Chambers note plus interest accrued at 13% because there is no sufficient showing that she took the note as a holder in due course, assuming she owns it as distinct from holding it as an assignment of collateral on an obligation. The Court recognizes that litigation of the Sabella claim will delay distribution and, if she does prevail, will cost the estate accrued interest, which would further erode what was left for junior creditors, not to mention administrative claims.
In the last analysis, at least for purposes of the present motion, the debtor as the proponent, has the burden of persuading the Court that the proposed settlement is fair and equitable, and should be approved. It has not done so.
Because Dynamic and Ms. Sabella have stated that the settlement proposal is a package, denial of the motion as to Ms. Sabella's claim effectively constitutes a denial of the motion as to Dynamic, as well. Therefore, the Court need not separately address the objections to settlement of Dynamic's claim.
Accordingly, and for the foregoing reasons, the debtor's motion to improve its settlement with Dynamic and Ms. Sabella shall be, and hereby is, denied.
IT IS SO ORDERED.