Every once in a while, we encounter a case that forces us to ponder the potential breadth of the bankruptcy discharge. In re Lombard Flats, LLC, a Northern District of California case from March 23, 2016, is such a case. In short, the court held that an alter ego claim against a Chapter 11 debtor that is based on pre-petition facts and claims is included in the bankruptcy discharge by operation of § 1141(d) and § 524(a). As an aside, we almost missed the second most interesting aspect of Lombard Flats: Its connection to 1990s pop culture and the genesis of reality television! Enjoy.
Lombard Flats started out as a typical Chapter 11 case. The debtor’s principal asset was a “three flat” apartment building in San Francisco located at 949-953 Lombard Street. My colleague Dave tells me that Wikipedia told him that 949 Lombard Street is none other than the location used by the cast of 1994’s “The Real World: San Francisco” (i.e., the Pedro and Puck season). Located in the Russian Hill neighborhood, it’s one block east of the “most crooked street in the world.” Apparently, a tipped candle caused the building to burn in 2000, with $2 million in damage. Mr. Eng, the debtor’s principal, owned the property from 1985 to 2009, at which point he transferred the building to Lombard Flats.
But back to the bankruptcy (which, since you are reading this blog, is probably more important to you anyway). The debtor’s plan proposed to pay the major secured creditor in full and pay the remainder of the debtor’s income to another secured creditor. The remaining creditors were unsecured and were discharged under the plan. The bankruptcy court confirmed the plan on July 19, 2010, entered the final decree on May 23, 2011, and closed the case on June 3, 2011. However, in 2013, Cheuk Yan, with his son Demas Yan as his attorney, sued Lombard Flats, Mr. Eng, Mr. Eng’s relatives, and their closely-held companies in state court.
Specifically, Mr. Yan sought to collect on at least 3 promissory notes that Mr. Eng had issued to Mr. Yan. He also asserted that Mr. Eng had fraudulently conveyed the apartment building to Lombard Flats after issuing the notes, liened-up the building with debt, and then caused the bankruptcy filing. Mr. Yan obtained a default judgment. However, Lombard Flats moved the bankruptcy court for an order of contempt on the theory that the claim against Lombard Flats violated the discharge injunction. Granting the motion, the bankruptcy court ordered Mr. Yan and his son (the attorney) to vacate the default judgment or face contempt.
In apparent response to the order of contempt, Mr. Yan transferred his claim against Mr. Eng and Lombard Flats to Legal Recovery, LLC. His son then filed a second action against Mr. Eng and Lombard Flats on behalf of Legal Recovery. In the second action, Legal Recovery asserted breach of contract and fraudulent transfer allegations against Mr. Eng, only, but also alleged that Lombard Flats was an alter ego of Mr. Eng. Therefore, Legal Recovery sought joint and several recovery from Mr. Eng and Lombard Flats. Of course, the debtor filed, and the bankruptcy court granted, another motion for contempt. Specifically, the court found Demas Yan in contempt and ordered him to pay Lombard Flats’ attorneys’ fees.
Mr. Yan appealed to the district court on two, intertwined grounds. First, he argued that the bankruptcy court lacked subject matter jurisdiction to order the dismissal of the state court action against the debtor based on the alter ego doctrine. Second, he argued that the alter ego claim was not included in Lombard Flats’ discharge. The first argument depended on that second argument. That is, if the alter ego allegation was not included in the discharge, then the bankruptcy court would have no ability to enforce the discharge injunction of 11 U.S.C. § 524(a)(2) on account of that claim.
District Court Decision
The district court started with 11 U.S.C. § 524(a). Under that section, a discharge “voids any judgment” as to “a determination of the personal liability of the debtor with respect to any debt” and “operates as an injunction against” the collection of “any such debt as the personal liability of the debtor.” This pairs nicely with the language of § 1141(d)(1), which states that an order confirming the Chapter 11 plan “discharges the debtor from any debt that arose before the date of such confirmation . . . whether or not (i) a proof of the claim based on such debt is filed or deemed filed under Section 501 of this title; (ii) such claim is allowed under Section 502 of this title; or (iii) the holder of such claim has accepted the plan.”
The district court then considered whether an alter ego theory is a “claim” subject to discharge. The familiar definition of “claim” in § 101(5) is that a claim is a “right to payment,” including “disputed” and “equitable” rights as well as “rights to an equitable remedy for breach of performance if such breach gives rise to a right to payment.” We would point out that, although the court did not articulate the connection between a “debt” and a “claim,” § 101(12) defines “debt” as “liability on a claim.”
The district court dismissed the fact that the alter ego does not create an independent cause of action against the debtor by noting, correctly, that § 101(5)’s definition focuses on whether a “right to payment” arises, not whether a cause of action is available. That is true whether the “right to payment” is a legal cause of action, an equitable remedy, or a disputed allegation. Thus, “characterizing the alter ego theory as a ‘judgment collection remedy,’ rather than a claim for substantive relief, does not escape enforcement of the discharge.”
Mr. Yan’s final attempt at escaping the discharge was to argue that the alter ego claim was not established pre-petition. For discharge purposes, though, a claim arises at the time of the events giving rise to the claim, not at the time that the plaintiff is first able to file suit on the claim. As the court points out, under the Ninth Circuit’s “fair contemplation” test, “a claim arises when a claimant can fairly or reasonably contemplate the claim’s existence even if a cause of action has not yet accrued under nonbankruptcy law.”
The district court also pointed out that a contingent claim for breach of contract arises at the time of contracting, not at the time of breach. Thus, even without the breach of contract, a contingent claim for breach of contract against Mr. Eng was fairly contemplated pre-petition. Because the contractual relationship, the breach of that contract by Mr. Eng, and the facts that formed the basis for the alter ego claim all occurred pre-petition, the alter ego claim was fairly contemplated and, thus, discharged under § 524.
In determining when the alter ego claim arose, the district court addressed Mr. Yan’s reliance on In re Conseco Life Ins., 2005 WL 2203150 (C.D. Cal. Apr. 13, 2005). Whereas the Conseco plaintiffs alleged post-petition conduct that supported an alter ego claim and a breach of contract against a post-confirmation entity, Mr. Yan’s allegations all involved pre-petition conduct by Mr. Eng and Lombard Flats. Therefore, the alter ego claim was fairly contemplated pre-petition.
While straightforward and unsurprising, the district court’s analysis serves as an excellent reminder that the bankruptcy discharge is very broad. The district court’s focus on the discharge of any “right to payment” under § 101(5) reemphasizes, to us at least, that the discharge received in bankruptcy eliminates a creditor’s “right to payment” regardless of how the creditor attempts to style that right in an attempt to avoid the discharge injunction. While basic, this injunction forms the heart of the Bankruptcy Code and is worthy of periodic review. Lombard Flats does so in a worthwhile manner, with a nostalgic backstory to boot.