In re: Bruce Elieff

Citation: Not availableDocket: CC-21-1081-SFL

Court: United States Bankruptcy Appellate Panel for the Ninth Circuit; March 21, 2022; Us Bankruptcy; United States Bankruptcy Court

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Todd Kurtin appeals a summary judgment from the bankruptcy court that subordinated his claim and lien rights against debtor Bruce Elieff under 11 U.S.C. § 510(b). The court clarified that the subordination applies to both Kurtin's claim for damages and his prepetition judgment liens. The appellate panel affirmed the bankruptcy court's ruling, stating that Kurtin’s claim stems from the purchase or sale of a security, necessitating subordination under the statute.

Kurtin and Elieff were equal partners in various real estate ventures starting in the early 1990s, using different business structures (corporations, LLCs, and limited partnerships) collectively referred to as "Joint Entities." The nature of their relationship is debated; Kurtin described it as an “equal general partnership” based on an oral agreement, while acknowledging they operated through the Joint Entities they jointly owned.

Their partnership deteriorated in the late 1990s, leading to litigation in 2003 where Kurtin sued Elieff for multiple claims, including breach of contract and fraud. Elieff counter-sued with similar allegations. This litigation, termed the “First Lawsuit,” resulted in a Settlement Agreement in 2005 following mediation.

The Settlement Agreement resolved existing disputes between Kurtin and Elieff while terminating their business relationship. Kurtin was required to transfer his interests in the Joint Entities to Elieff, who agreed to indemnify Kurtin for liabilities related to those entities. In exchange, Kurtin was to receive a total of $48.8 million in "Settlement Payments," structured in four installments: $21 million by August 19, 2005; $1.8 million by January 2, 2006; $13.1 million by June 30, 2006; and $12.9 million by December 31, 2006. Elieff and the Joint Entities were jointly liable for the first payment, while only the Joint Entities were responsible for the others. The Agreement did not specify how much of the payments related to Kurtin’s claims or the sale of his interest, indicating that the resolution and buyout were indivisible.

Paragraph 14 granted Kurtin a security interest in the Joint Entities' projects to ensure payment of the Settlement Payments and prohibited Elieff from taking distributions that would hinder those payments. When the Joint Entities defaulted on the third and fourth payments, Kurtin sought a judgment for the shortfall but was denied because the entities were not parties in the initial lawsuit. He then pursued arbitration, which resulted in the arbitrator amending the Agreement to allow Kurtin to compel Elieff to transfer his interests in the Joint Entities if payments were not cured by June 30, 2007. However, Kurtin did not enforce this amendment, suspecting the entities lacked sufficient assets to cover the shortfall. Instead, he filed a lawsuit against Elieff and the Joint Entities in December 2007, focusing on a breach of contract claim relevant to the appeal.

Kurtin alleged that Elieff violated paragraph 14 of the Settlement Agreement by taking distributions from Joint Entities that hindered the required settlement payments. In May 2010, a jury found Elieff liable for this breach, awarding Kurtin $24,411,433.86, leading to a judgment against Elieff. Following a series of appeals, in February 2020, the court issued a fifth amended judgment for $33,892,117.62 based on Elieff's breach of the distribution restriction. Kurtin recorded judgment abstracts against Elieff and two of his entities, deemed alter egos, before Elieff filed for bankruptcy.

In October 2019, Elieff, along with Morse Properties, LLC, and 4627 Camden, LLC, filed chapter 11 petitions. Three additional related entities followed in February 2020. The bankruptcy court consolidated these cases in June 2020, appointing a chapter 11 trustee, and later converted the case to chapter 7 in September 2020, with Howard Ehrenberg as trustee. Elieff's amended schedules revealed approximately $13 million in real estate, $260,000 in personal property, and $97 million in secured debt, including $35 million owed to Kurtin.

Soon after filing for bankruptcy, Elieff initiated an adversary proceeding against Kurtin, filing a second amended complaint in December 2019 that included subordination claims under § 510(b), requests for transfer of judgment liens under § 510(c)(2), and avoidance claims. Kurtin moved to dismiss the complaint in January 2020, while Elieff responded with a summary judgment motion in February 2020. The bankruptcy court dismissed some avoidance claims but not those related to § 510(b). It ruled that § 510(c)(2) claims for transferring judgment liens did not apply to claims subordinated under § 510(b). The court allowed time for discovery before rescheduling the summary judgment hearing, which occurred after the case conversion, with the chapter 7 trustee now acting as plaintiff.

The court concluded the hearing and took the matter under submission. Kurtin subsequently filed a Civil Rule 56(d) motion for additional discovery, arguing that the rights and obligations under the Settlement Agreement were largely unrelated to his transfer of interests in the Joint Entities to Elieff. He sought to allocate the Settlement Payments, claiming that if the Joint Entities' value was less than Elieff’s first $21 million Settlement Payment, then the subsequent Settlement Payments would not pertain to securities transactions. However, Kurtin did not assert that the payments were allocable or provide evidence to support this claim. Furthermore, he did not demonstrate that the first Settlement Payment was specifically tied to his interest transfer.

In January 2021, the bankruptcy court granted summary judgment on the § 510(b) claims, determining that the Settlement Agreement involved the purchase and sale of Elieff’s affiliates' securities. The court emphasized that Kurtin's obligation to transfer his interests was central to the Settlement Agreement, thus applying § 510(b) regardless of whether all agreement aspects directly related to securities transactions. The court also denied Kurtin's supplemental Civil Rule 56(d) request, stating that any potential allocation of Settlement Payments would not present a material fact issue to prevent summary judgment. The court clarified that a nexus between the claim and securities transactions sufficed for § 510 relief.

Following the memorandum decision, both parties sought clarification on whether subordination applied solely to Kurtin’s “claim” or also to his judgment liens. After a hearing, the court ruled that Kurtin’s liens were included under the term “claim” in § 510(b), resulting in their subordination on the same grounds as his claim. On April 5, 2021, the court issued a final judgment on Ehrenberg’s § 510(b) subordination claims, and Kurtin appealed in a timely manner.

Jurisdiction over the case is established under 28 U.S.C. § 1334 and § 157(b)(2)(A) and (O), with appellate jurisdiction under 28 U.S.C. § 158. Key issues include whether the bankruptcy court erred in granting summary judgment in favor of Ehrenberg, properly construed § 510(b), abused its discretion in denying Kurtin’s supplemental Civil Rule 56(d) motion, and abused its discretion in excluding certain evidence from Kurtin. The standard of review for summary judgment is de novo, assessing facts favorably for the nonmoving party to determine if there are any genuine material disputes. The bankruptcy court's interpretation of the Code also undergoes de novo review. The denial of a Civil Rule 56(d) motion and the exclusion of evidence are reviewed for abuse of discretion, defined as applying an incorrect legal standard or making illogical factual findings.

Kurtin's claim for breach of the Settlement Agreement is encompassed by § 510(b), which requires the subordination of claims arising from the purchase or sale of securities to ensure creditors are prioritized over equity holders. The Ninth Circuit interprets § 510(b) broadly, holding that claims "arise from" securities transactions when there is a causal relationship. The case is compared to Tristar Esperanza Properties, LLC, where a creditor's claim related to a member's interest in a limited liability company was subordinated under § 510(b). The Ninth Circuit affirmed the bankruptcy court's decision in that case, dismissing arguments that the claim’s status as a judgment excluded it from § 510(b) provisions.

Kurtin's claim stems from a failed Settlement Agreement in which he relinquished his interests in Joint Entities, valued at millions of dollars. The primary benefit he received was the right to Settlement Payments, while paragraph 14 of the agreement restricted Elieff's access to distributions from the Joint Entities to protect the funds necessary for these payments. This established a direct causal link between Kurtin’s claim and the conveyance of his equity interests. The bankruptcy court correctly applied § 510(b) to Kurtin’s claim, rejecting his arguments against this application. 

Kurtin cited Khan v. Barton to assert that his claim arose from Elieff’s misconduct post-settlement and was unrelated to the sale of securities. In Khan, the Ninth Circuit acknowledged a broad interpretation of § 510(b) but noted it does not cover all transactions related to stock. Unlike in Khan, where the debtor's actions were disconnected from the original stock purchase, Kurtin's claim is directly tied to his divestment of interests under the Settlement Agreement. The purpose of the distribution restriction was to secure funds for Kurtin’s Settlement Payments, thus linking his claim to the breach of the Settlement Agreement and triggering subordination under § 510(b).

The court affirmed the subordination of shareholders’ claims regarding the debtor-corporation’s breach of the stock purchase agreement, emphasizing that the nature of the claims, which sought recovery of equity investment, was more significant than the timing of the alleged breach. Kurtin argued that the Settlement Agreement's consideration could not be divided into securities-related and non-securities-related components. He contended that although some Settlement Payments compensated him for selling his interests in Joint Entities, they also covered non-sale damages, thus falling outside the scope of § 510(b). Specifically, Kurtin claimed the first $21 million Settlement Payment fully compensated the securities sale and argued that subsequent unpaid amounts could not be linked to his securities sale under § 510(b). However, he failed to provide evidence that the Settlement Payments were intended to be apportioned in the parties' contract. The Settlement Agreement's language indicated a lack of purpose distinction among the payments, and the court found no support in the record for treating the payments as severable. Kurtin's references to case law did not substantiate his claims, as they did not support the apportionment of damages arising from a single indivisible contract. Under California law, without a contractual basis for apportioning consideration, the contract remains indivisible, making it impermissible to separate the Settlement Payments. The court concluded that no portion of the purchase price could be designated specifically for the stock or other interests involved.

Kurtin did not demonstrate a genuine dispute regarding the Settlement Agreement's allowance for allocating Settlement Payments between securities-related and non-securities-related damages. The breach of paragraph 14 was directly tied to the obligation of making Settlement Payments linked to the sale of his securities. Kurtin anticipated receiving payments from funds protected by paragraph 14, making all Settlement Payments integral to the securities sale. His attempt to separate part of his claim from the securities sale was unsuccessful, as the bankruptcy court correctly concluded that his claim for breach of paragraph 14 was inherently related to the sale of his interests in the Joint Entities, in accordance with § 510(b). The court noted that § 510(b) does not require claims to arise solely from securities transactions, thus affirming the broad application of the statute.

Kurtin argued that the bankruptcy court misapplied § 510(b) to his judgment liens, asserting that it only affects claims and not liens, and that his secured claim should maintain its priority. However, the bankruptcy court’s interpretation aligns with § 510(b)'s purpose of preventing equity investors from having equal standing with creditors, regardless of the nature of their claims. The statute encompasses both secured and unsecured claims, and Kurtin's view that liens are excluded contradicts established legal interpretations, including the Supreme Court's ruling in Johnson v. Home State Bank, which recognized that "claims" under the Code include mortgage liens. Thus, the entirety of a claim, along with its associated in rem rights, is subject to subordination under § 510(b).

A creditor’s right to foreclose on a mortgage persists through bankruptcy, as established in Long v. Bullard and further clarified in Johnson v. Home State Bank. Johnson differentiates between two aspects of a secured claim: personal liability, which can be discharged in bankruptcy, and in rem liability, which remains intact. Only the in personam action against the debtor is extinguished by a bankruptcy discharge, while the in rem action remains unaffected.

Section 510(b) mandates the subordination of claims for damages from securities sales, encompassing Kurtin’s entire “right to payment,” whether personal or in rem. This means that Kurtin cannot collect any payment until unsecured creditors are fully compensated, despite retaining his secured claim; subordination simply ranks it below unsecured creditors' interests. If unsecured creditors are unpaid, Kurtin’s judgment liens are effectively worthless. 

Kurtin’s interpretation of “claim” under § 510(b) would undermine the statute’s intent to prioritize unsecured creditors, allowing a former equity investor to elevate their lien rights improperly. Judicial precedent, such as Tristar, supports that obtaining a judgment does not exempt claims from § 510(b), reinforcing that Kurtin cannot collect damages until unsecured creditors are satisfied.

Kurtin argues that the interpretation of § 510(b) conflicts with other provisions of the Bankruptcy Code, specifically §§ 725 and 510(c). He believes that subordination only pertains to the distribution of the estate’s property under § 726 and does not affect his liens, which he asserts maintain their prepetition priority and must be disposed of in accordance with § 725. However, the statutory framework indicates that satisfaction of Kurtin’s claims, regardless of their nature, is contingent upon the full payment of other claims first.

Kurtin argues that there is a significant distinction between the estate's distribution under § 726, which incorporates § 510, and the disposition of encumbered property under § 725, which does not reference § 510. He incorrectly relies on § 725, which pertains to the distribution of estate property as outlined in Czyzewski v. Jevic Holding Corp., emphasizing that Chapter 7 liquidations must adhere to a specific order of asset distribution. Section 725 grants bankruptcy courts broad authority to manage dispositions of estate property affected by third-party interests or liens and is subject to the subordination mandates of § 510(b).

Kurtin's liens, now subordinated to unsecured creditors, hinder the estate's ability to administer its assets under § 363(f). Without evidence that the estate is prepared for final distribution, § 725 merely requires the trustee to dispose of third-party interests before any final distribution under § 726. 

Kurtin contends that § 510(c)(2) suggests the term "claim" in § 510(b) should exclude liens, arguing that Congress distinctly treated "liens" and "claims" in the context of equitable subordination. However, the distinction between lien transfer and lien subordination indicates that once a claim is subordinated, the lien follows automatically. Thus, the lack of a provision in § 510(b) for lien transfer does not imply that Congress intended to exclude liens from subordination under § 510(b). Both lien subordination and lien transfer are distinct remedies, and their coexistence does not undermine the subordination provisions.

Kurtin's arguments regarding the interpretation of 11 U.S.C. § 510(b) and (c) are unpersuasive. The bankruptcy court's interpretation that § 510(b) applies to liens is supported by the traditional treatment of liens in bankruptcy, despite Kurtin's claims that such subordination conflicts with the protections typically afforded to secured creditors under state law. While Kurtin cites cases emphasizing the general resilience of liens in bankruptcy, he overlooks that Congress has the authority to modify lien rights when necessary, as evidenced by various sections within the bankruptcy code that can significantly impact those rights. 

Furthermore, Kurtin’s assertion that applying § 510(b) to his lien rights infringes on his due process rights is circular and lacks merit. He contends that any impact on his lien rights constitutes an unconstitutional taking under the Fifth Amendment. However, the principles established in precedent indicate that when Congress exercises its bankruptcy powers, any limitations on property rights become implicit in the agreements made by the parties, thus preserving due process. Bankruptcy courts possess the authority to subordinate claims and associated lien rights, irrespective of state law. Consequently, the possibility that a bankruptcy court might subordinate claims or liens related to the Settlement Agreement was an inherent aspect of the contract between Kurtin and Elieff, leading to the rejection of Kurtin’s due process violation argument.

Kurtin's liens were not eliminated by the subordination of his secured claim; however, his collateral may be distributed, impacting its availability. He argues that since the court did not avoid his lien, it remains intact and retains its priority, asserting that any distribution of his collateral to other creditors still subjects that property to his lien. The court clarified that while Kurtin's claim was subordinated, his lien status was not entirely negated, resulting in a position junior to unsecured creditors. Consequently, Kurtin’s claim will not receive payment until unsecured creditors are fully satisfied. His arguments regarding lien avoidance were deemed incorrect and did not demonstrate any error in the bankruptcy court's ruling.

Kurtin also challenged the bankruptcy court's denial of his supplemental Civil Rule 56(d) request for further discovery, asserting he needed more time to ascertain the value of components of the Settlement Agreement. The court found this request unjustified, as the Settlement Agreement was indivisible, making the valuation evidence irrelevant to the summary judgment. Kurtin's claims regarding the timing of the sale of his equity interests and their relation to the Joint Entities' debt structure were also deemed insufficient to establish a material issue of fact that would affect the outcome of the litigation. Thus, his need for additional discovery did not meet the required standard to oppose summary judgment.

Creditors existing at the time of Elieff’s bankruptcy filing could not have relied on the equity cushion from his investments in the Joint Entities to extend credit. The rationale for imposing 11 U.S.C. § 510(b) subordination includes two key factors: creditor reliance on the equity cushion and the greater risk of loss that investors assume compared to creditors. The Ninth Circuit emphasizes that the risk allocation rationale is paramount, particularly in cases involving the sale of securities by an affiliate of the debtor. Kurtin's argument, focusing solely on the creditor reliance rationale, is inadequate as it does not affect the risk allocation principle relevant to this case. Furthermore, Kurtin's objections to the exclusion of evidence pertain mainly to his previously discredited attempts to assess the value of Settlement Payments, which the court deemed irrelevant. His declarations regarding his subjective intent in the Settlement Agreement were also found immaterial, as they do not reflect the parties' objective intent. Ultimately, the bankruptcy court did not abuse its discretion in denying Kurtin's supplemental motion or excluding parts of his evidence. The court’s summary judgment in favor of Ehrenberg on the § 510(b) claims and its order subordinating Kurtin’s lien rights and claims were affirmed.