ERNEST M. ROBLES, Bankruptcy Judge.
The Court conducted a hearing on the Motion for Summary Adjudication filed by the Chapter 7 Trustee on January 24, 2018, at 10:00 a.m.
On December 7, 2010, creditors commenced an involuntary petition against EPD Investment Co., LLC ("EPD"). The Court entered an Order for Relief on February 9, 2011. On February 1, 2012, Jerrold S. Pressman ("Pressman") filed a voluntary Chapter 7 petition. On June 4, 2012, the bankruptcy cases of EPD and Pressman (collectively, the "Debtors") were substantively consolidated.
Pursuant to the operative Fourth Amended Complaint (the "Complaint") [Doc. No. 234] against John C. Kirkland and Poshow Ann Kirkland as Trustee of the Bright Conscience Trust Dated September 9, 2009 (the "BC Trust"), the Chapter 7 Trustee (the "Trustee") seeks to (1) disallow or equitably subordinate proofs of claim filed by the BC Trust and (2) avoid allegedly fraudulent transfers from the Debtors to Mr. Kirkland and the BC Trust.
The allegations of the Complaint are as follows: Between the 1970s and June 27, 2003, EPD Investment Co. was an unincorporated sole proprietorship run by Pressman. Complaint at ¶ 12. On June 27, 2003, EPD was formed as a California limited liability company to provide corporate protection and to satisfy Mr. Pressman's goal of retirement. Id. Upon EPD's formation in 2003, the EPD sole proprietorship's assets and liabilities were transferred from Mr. Pressman to EPD. Id. At all times, the members and managers of EPD were Mr. Pressman and his son, Keith Pressman ("Keith"). Id.
EPD operated as a Ponzi scheme since its formation in 2003. Id. at ¶ 24. Between 2003 and mid-2009, EPD repaid existing creditors by using funds from new creditors. Id. EPD was balance sheet insolvent from at least December 2003, according to its tax returns, and has never been profitable. Id. at ¶¶ 20-21. Many of EPD's creditors mistakenly believed that EPD owned substantial real property assets in Tennessee, Mississippi, and elsewhere, when in fact EPD owned no real property. Id. at ¶ 16. Instead, EPD owned promissory notes secured by Mr. Pressman's assets, and it was Mr. Pressman who held an ownership interest in entities owning property in Tennessee, Mississippi, and elsewhere. Id.
In mid-2009, EPD could not pay creditors because the companies Mr. Pressman partially owned lacked sufficient operating cash flow, and because EPD was no longer receiving cash infusions from new investors. Id. at ¶ 25.
Mr. Kirkland was outside counsel for the Mr. Pressman, EPD, and other business entities owned by the Mr. Pressman. Id. at ¶ 28. Mr. Kirkland invested and/or loaned in excess of $150,000 of his personal funds to EPD (Mr. Kirkland's "EPD Interests"). Id. at ¶ 29. In September 2009, after EPD had ceased making payments to most creditors, Mr. Kirkland assigned his EPD Interests to the BC Trust (his family trust), and/or to his wife Poshow Ann Kirkland as Trustee of the BC Trust, through a Notice of Assignment. The Notice of Assignment provides: "Notice is hereby given that all rights of John C. Kirkland under all such Loan Documents have been sold, transferred, and assigned to the Bright Conscience Trust Dated September 9, 2009." Id.
The BC Trust took the assignment subject to all claims and defenses of Mr. Kirkland, and did not take the assignment in good faith or for adequate consideration. Id. On September 11, 2009, the BC Trust filed and/or recorded a UCC-1 financing statement as to all assets of the Debtors. Id. On May 5, 2010, the BC Trust filed and/or recorded an amendment to the UCC-1 financing statement, which provided that "[t]his amendment is to clarify and confirm that the prior grant of security did not include the stock of North Hills Industrial Park, Inc., a California S-Corporation." Id.
Mr. Kirkland was aware that EPD operated as a Ponzi scheme. In 2005, Mr. Kirkland drafted letters to the California Franchise Tax Board which stated, among other things, that EPD's liabilities exceeded its assets, that EPD had negative cash flow, and that EPD required additional investment just to break even. Id. at ¶ 30(b)(i). Despite knowing that EPD operated as a Ponzi scheme, Mr. Kirkland took actions for the benefit of the BC Trust and to the detriment of EPD's other creditors, including:
On December 12, 2011, the BC Trust filed three proofs of claim in the bankruptcy case, all in the amount of $2.672 million. Id. at ¶ 39. On February 15, 2013, the BC Trust filed a proof of claim in Mr. Pressman's bankruptcy case—which has now been substantively consolidated with the EPD case—in the amount of $3.529 million. Id. All Proofs of Claim are secured claims, and were executed by Poshow Ann Kirkland as Trustee of the BC Trust. Id.
The BC Trust is the assignee of Mr. Kirkland's EPD Interests and the BC Trust's Proofs of Claim are based on the assignment of Mr. Kirkland's EPD Interests. Id. at ¶ 40. The BC Trust did not separately invest or loan funds to the Debtors; its rights are based solely on the assignment of Mr. Kirkland's EPD Interests, which assignment was orchestrated by Mr. Kirkland while he was counsel for Mr. Pressman and EPD. Id.
Mr. Kirkland engaged in inequitable conduct in his representation of EPD, as set forth above. The BC Trust, as Mr. Kirkland's assignee, stands in his shoes and took the assignment of the EPD Interests subject to Mr. Kirkland's actions. Accordingly, the BC Trust's claims should be disallowed or equitably subordinated. Id. at ¶ 42-47.
Prior to the filing of the petition, the Debtors made transfers to the BC Trust evidenced by the liens in favor of the BC Trust. The transfer to the BC Trust is avoidable as actually fraudulent pursuant to § 544 (applying California Civil Code §§ 3439.04(a) and 3439.07) and § 548(a)(1)(A). The transfer is avoidable as constructively fraudulent pursuant to § 544 (applying California Civil Code §§ 3439.04(b), 3439.05, and 3439.07) because it was made without the Debtors receiving reasonably equivalent value at a time when the Debtors were (1) insolvent or (2) were engaged in a business or transaction for which any property remaining was an unreasonably small capital or (3) intended to incur debts beyond their ability to pay. For the same reasons, the transfer is avoidable as constructively fraudulent pursuant to § 548(a)(1)(B).
Prior to the filing of the petition, the Debtors made transfers for the benefit of Mr. Kirkland and the BC Trust by issuing checks to a Union Bank account. Those transfers are avoidable as intentionally fraudulent pursuant to § 544 (applying California Civil Code §§ 3439.04(a) and 3439.07) and § 548(a)(1)(A). Those transfers are avoidable as constructively fraudulent pursuant to § 544 (applying California Civil Code §§ 3439.04(b), 3439.05, and 3439.07) and § 548(a)(1)(B).
All the avoidable transfers are recoverable pursuant to § 550(a)(1).
The Trustee moves to disallow the proofs of claim filed by the BC Trust on the grounds that the BC Trust has not established the claims' prima facie validity. The Trustee next argues that even if the claim is valid, any security interest held by the BC Trust could extend to only a small portion of the proceeds collected by the Trustee. The Trustee asserts that the BC Trust's pre-petition security interest cannot extend, as a matter of law, to amounts recovered by the Trustee through the exercise of his avoidance powers. The Trustee further asserts that the interest rate claimed by the BC Trust is usurious in California and is therefore unenforceable.
In the alternative, the Trustee asserts that the BC Trust's claims should be equitably subordinated. The Trustee asserts that the BC Trust took the assignment of Mr. Kirkland's EPD Interests subject to all rights and liabilities of Mr. Kirkland. The Trustee maintains that Mr. Kirkland engaged in inequitable conduct in connection with his representation of EPD. On this basis, the Trustee maintains that equitable subordination of the BC Trust's claim is appropriate.
In Opposition, Defendants contend that (1) the BC Trust's claims cannot be equitably subordinated because the Trustee has already recovered damages on account of the conduct giving rise to the claim for equitable subordination; (2) that any claims for inequitable conduct against Mr. Kirkland have been released in connection with the Trustee's settlement of claims against law firms at which Mr. Kirkland worked; (3) that the Trustee cannot reach the assets of the BC Trust because it is an irrevocable trust; (4) that genuine issues exist as to the amount of interest to which the BC Trust is entitled to receive on account of its claim; and (5) that the Trustee is barred from asserting that the BC Trust's lien cannot extend to assets of the estate collected by the Trustee, because the Trustee failed to adequately plead these issues in the Complaint.
In Reply to Defendants' Opposition, the Trustee asserts that Defendants raise only legal arguments and have failed to show any genuine dispute as to an issue of material fact that precludes the entry of summary adjudication. The Trustee rejects the Defendants' contention that the claims for inequitable conduct against Mr. Kirkland have been released, contending that Mr. Kirkland selectively quotes the release provisions of the settlement agreements out of context. The Trustee maintains that the irrevocability of the BC Trust does not defeat his claim for equitable subordination, because the equitable subordination claim does not seek to reach the assets of the BC Trust but rather to subordinate the claim to the claims of other creditors.
At the outset, the Court notes that certain of the issues relevant to this matter are addressed in the Report and Recommendation that the Court has transmitted to the District Court in connection with the Trustee's Motion for Summary Adjudication as to the second, third, and sixth claims for relief. To the extent those issues are not restated herein, they are incorporated by reference.
Summary adjudication is appropriate "if the movant shows that there is no genuine dispute as to any material facts and the movant is entitled to judgment as a matter of law." Civil Rule 56 (made applicable to these proceedings by Bankruptcy Rule 7056). The moving party has the burden of establishing the absence of a genuine issue of material fact and that it is entitled to judgment as a matter of law. Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986). "[S]ummary judgment will not lie if the dispute about a material fact is "genuine," that is, if the evidence is such that a reasonable jury could return a verdict for the nonmoving party." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). "A fact is `material' only if it might affect the outcome of the case[.]" Fresno Motors, LLC v. Mercedes Benz USA, LLC, 771 F.3d 1119, 1125 (9th Cir. 2014). If the moving party shows the absence of a genuine issue of material fact, the nonmoving party must "go beyond the pleadings and by her own affidavits, or by the `depositions, answers to interrogatories, and admissions on file,' designate `specific facts showing that there is a genuine issue for trial.'" Celotex, 477 U.S. at 324 (quoting Fed. R. Civ. P. 56(e)). The court is "required to view all facts and draw all reasonable inferences in favor of the nonmoving party" when reviewing the Motion. Brosseau v. Haugen, 543 U.S. 194, 195 n.2 (2004).
There is no genuine dispute as to the following facts. Mr. Kirkland invested in EPD in late 2007. In September 2009, Mr. Kirkland assigned his claims against the Debtors to the BC Trust. The BC Trust did not separately invest in or loan money to the Debtors, and did not pay Mr. Kirkland anything in exchange for the assignment.
On December 12, 2011, Poshow Kirkland filed Proofs of Claim Nos. 171, 235, and 236 on behalf of the BC Trust. Claim 171, 235, and 236 each list an amount owed of $2,672,000, as purportedly secured claims. On February 15, 2013, Poshow Kirkland filed Proof of Claim No. 13 in the consolidated case of Mr. Pressman. Claim 13 lists an amount owed of $3,529,000, as a secured claim. Claim 13 is the same as Claims 171, 235, and 236, but includes additional interest.
Ms. Kirkland has not amended any of the claims to include documentation or an itemization of claimed interest.
There is no dispute that the four claims are duplicative. The Court will disallow the duplicative proofs of claim and focus its analysis on whether the BC Trust is entitled to a single claim on account of the assignment of Mr. Kirkland's EPD Interests.
Under Bankruptcy Rule 3001(f), a proof of claim executed and filed in accordance with the Bankruptcy Rules constitutes prima facie evidence of the validity and amount of the claim. To overcome the presumption of validity created by a timely-filed proof of claim, an objecting party must do one of the following: (1) object based on legal grounds and provide a memorandum of points and authorities setting forth the legal basis for the objection; or (2) object based on a factual ground and provide sufficient evidence (usually in the form of declarations under penalty of perjury) to create triable issues of fact. In re G.I. Indus., Inc., 204 F.3d 1276, 1280 (9th Cir. BAP 2000); In re Medina, 205 B.R. 216, 222 (9th Cir. BAP 1996); In re Hemingway Transport, Inc., 993 F.2d 915, 925 (1st Cir. 1993). Upon objection, a proof of claim provides "some evidence as to its validity and amount" and is "strong enough to carry over a mere formal objection without more." See Lundell v. Anchor Constr. Spec., Inc., 223 F.3d 1035, 1039 (9th Cir. 2000) (citing In re Holm, 931 F.2d 620, 623 (9th Cir. 1991)). An objecting party bears the burden and must "show facts tending to defeat the claim by probative force equal to that of the allegations of the proofs of claim themselves." Holm, 931 F.2d at 623. When the objector has shown enough evidence to negate one or more facts in the proof of claim, the burden shifts back to the claimant to prove the validity of the claim by a preponderance of evidence. See Lundell, 223 F.3d at 1039 (citation omitted).
The claim itself does not contain documentation substantiating the amounts claimed, and Ms. Kirkland's deposition testimony showed that she possessed only a rudimentary understanding of the basis for the claim:
Poshow Kirkland Deposition Transcript [Doc. No. 262, Ex. 12] at 40:14-41:12.
As this litigation has progressed, Mr. Kirkland has supplied some additional evidence with respect to funds that he loaned to EPD (Mr. Kirkland subsequently assigned EPD's alleged obligation to him to the BC Trust). However, the evidence supplied is insufficient to substantiate the BC Trust's contention that it is owed $2,672,000 on account of amounts loaned by Mr. Kirkland.
In support of the BC Trust's claim, Defendants point to the declaration of Ruben J. Moreno, who worked as an account manager for EPD. Mr. Moreno contends that Mr. Kirkland loaned EPD $2,071,608.23 between September 2007 and October 2009. According to Mr. Moreno, the total balance owed the BC Trust, including interest, was $2,927,376.20 as of December 2010. Mr. Moreno asserts that, based on a default interest rate of 24%, the BC Trust is owed $14,381,715.78 as of December 2017. Mr. Kirkland also testifies as to the amounts that he loaned EPD between September 2007 and October 2009.
The Court finds that the testimony of Mr. Moreno and Mr. Kirkland is insufficient to create a genuine dispute as to the issue of how much Mr. Kirkland loaned EPD. Mr. Moreno's testimony cannot create a genuine issue because it contradicts his deposition testimony. "The general rule in the Ninth Circuit is that a party cannot create an issue of fact by an affidavit contradicting his prior deposition testimony. This sham affidavit rule prevents a party who has been examined at length on deposition from rais[ing] an issue of fact simply by submitting an affidavit contradicting his own prior testimony, which would greatly diminish the utility of summary judgment as a procedure for screening out sham issues of fact." Yeager v. Bowlin, 693 F.3d 1076, 1080 (9th Cir. 2012) (internal citations and quotation marks omitted).
At his deposition, Mr. Moreno stated that he had never heard of the BC Trust and that he did not know whether the BC Trust had ever invested funds with EPD. Mr. Moreno did recall that Mr. Kirkland had invested funds with EPD, but he did not know how much Mr. Kirkland had invested. Mr. Moreno further testified that he had sent Mr. Kirkland an accounting of the funds that Mr. Kirkland had invested with EPD. However, Mr. Moreno testified that he obtained this information from Mr. Pressman:
Moreno Deposition Transcript 37-39.
Mr. Moreno's declaration testimony is fundamentally inconsistent with his deposition testimony. In his declaration filed in support of Defendants' Opposition to the Trustee's Motion for Summary Adjudication, Mr. Moreno states:
Moreno Decl. [Doc. No. 307] at ¶ 2.
The declaration testimony implies that Mr. Moreno had the ability to independently obtain information regarding EPD's accounts. By contrast, the deposition testimony shows that Mr. Moreno was able to determine how much Mr. Kirkland had loaned EPD only after consulting with Mr. Pressman. In this respect, Mr. Moreno's deposition testimony is materially inconsistent with his declaration testimony. As noted previously, a party cannot create an issue of fact by submitting declaration testimony inconsistent with that party's deposition testimony. Mr. Moreno's deposition testimony shows that he lacked personal knowledge of the amount that Mr. Kirkland loaned EPD—Mr. Moreno had to obtain the information from Mr. Pressman. The Court finds that the inconsistent declaration testimony, in which Mr. Moreno asserts that he does have personal knowledge of the amounts loaned by Mr. Kirkland, is inadmissible as a result of its inconsistency with the deposition testimony. Consequently, Mr. Moreno's declaration testimony cannot create a genuine dispute regarding the issue of how much Mr. Kirkland loaned to EPD.
Mr. Kirkland also submits declaration testimony asserting that he loaned EPD $2,071,608.23 between September 2007 and October 2009. However, Mr. Kirkland does not provide any evidence substantiating the alleged loans. He does not provide any information regarding the methods of transfer or the originating or receiving bank account. He does not attach copies of checks or wire transfers. Mr. Kirkland's conclusory statements do not create a genuine issue of material fact. See F.T.C. v. Publ'g Clearing House, Inc., 104 F.3d 1168, 1171 (9th Cir. 1997), as amended (Apr. 11, 1997) ("A conclusory, self-serving affidavit, lacking detailed facts and any supporting evidence, is insufficient to create a genuine issue of material fact.").
Based on the report of the Trustee's expert witness Thomas Jeremiassen, the Court finds that there is no genuine dispute that Mr. Kirkland's net investment with EPD was no more than $1,116,755.41. See Doc. No. 267 at 26. This consists of a total of $1,221,608.23 that EPD received from Mr. Kirkland, less $104,852.82 in mortgage payments that EPD made on Mr. Kirkland's home. Id.
The Trustee argues that $600,000 of the funds transmitted by Mr. Kirkland to EPD should not be deemed to be an investment, because those funds were booked to a revenue account entitled "Consulting & Professional Fees." However, Mr. Kirkland testifies that he had no knowledge of how EPD booked the funds that he transmitted. Accordingly, the Court cannot find that there is no genuine dispute as to the characterization of the $600,000 in funds.
As set forth in greater detail below, the Court finds that although the BC Trust holds an allowed claim in the amount of $1,116,755.41 on account of funds that Mr. Kirkland loaned to EPD, the BC Trust's security interest cannot attach to the vast majority of the proceeds that have been collected by the Trustee. Further, the Court finds that to the extent the BC Trust's claim does attach to proceeds held by the estate, the Trustee is entitled to prevail upon his claim for equitable subordination.
The primary sources of the funds held by the estate are as follows (amounts listed below exceed the estate's cash on hand because fees have already been paid to professionals):
As a matter of law, even if BC Trust held a security interest, it could not extend to the proceeds collected by the Trustee through the settlements set forth in ¶¶ 1-3.
As a matter of law, the funds collected by the Trustee in connection with the settlement of avoidance actions are not subject to any lien asserted by BCT. In McGoldrick v. Juice Farms, Inc. (In re Ludford Fruit Prod., Inc.), 99 B.R. 18, 24-25 (Bankr. C.D. Cal. 1989), the court rejected a creditor's contention that it held a security interest in the recoveries obtained by the Trustee through the exercise of his avoidance powers:
Ludford Fruit, 99 B.R. at 24-25.
The BC Trust cites In re Figearo, 79 B.R. 914, 918 (Bankr. D. Nev. 1987) for the proposition that proceeds collected in connection with the Trustee's avoiding powers may be subject to a creditor's security interest. The Court declines to follow Figearo, which is contrary to Ludford Fruit. The leading treatise, Collier on Bankruptcy, is consistent with Ludford Fruit:
5-552 Collier on Bankruptcy ¶ 552.02 (16th ed. 2017).
The Court further notes that Figearo is contrary to the weight of authority and has not been followed by more recent cases. See, e.g., Official Committee of Unsecured Creditors v. UMB Bank, NA et al. (In re Residential Capital, LLC), 497 B.R. 403, 414 (Bankr. S.D.N.Y. 2013) (declining to follow Figearo; holding that the Trustee's avoidance power claims "must be considered after-acquired property belonging to the estate"; and holding that "because the Debtor does not own the right to pursue a fraudulent transfer action in bankruptcy (since that action belongs to the trustee post-petition under section 554(b)), the Debtor could not have encumbered or assigned that right prepetition").
Funds recovered by the Trustee in connection with the settlement of the Trustee's claims against two of Mr. Kirkland's former law firms cannot be subject to any security interest of the BC Trust. The Trustee asserted claims against Luce Forward Hamilton & Scripps LLP ("Luce Forward") for the avoidance and recovery of transfers pursuant to §§ 544, 547, 548, and 550, as well as claims for professional negligence, legal malpractice, and breach of fiduciary duty. The Trustee settled those claims for a payment of $750,000.
As discussed above, claims based upon the Trustee's avoiding powers are not subject to a prepetition creditor's lien, pursuant to § 552(a). The Trustee's claims against Luce Forward for professional negligence and legal malpractice arose from Mr. Kirkland's misconduct while he was employed at Luce Forward. The BC Trust, as Mr. Kirkland's assignee, does not hold a security interest in the proceeds of a settlement that resulted from Mr. Kirkland's misconduct.
The Trustee asserted claims against Greenberg Traurig LLP and Greenberg Traurig PA ("Greenberg Traurig") for the avoidance and recovery of transfers pursuant to §§ 544, 547, 548, and 550, as well as claims for professional negligence, legal malpractice, and breach of fiduciary duty. The Trustee settled those claims for a payment of $500,000. Similar to the settlement with Luce Forward, the settlement with Greenberg Traurig arose in connection with Mr. Kirkland's misconduct while he was employed at Greenberg Traurig. The settlement with Greenberg Traurig, like the settlement with Luce Forward, is not subject to a prepetition creditor's lien.
The Trustee recovered $3,615,817.85 in connection with a settlement with Robert Geringer. The settlement was based on payments made by Mr. Geringer for the purchase of stock in NHIP.
The BC Trust points to a UCC financing statement recorded in September 2009 in support of its contention that it holds a security interest in NHIP's stock, and therefore a security interest in the proceeds of the settlement with Mr. Geringer. The BC Trust ignores the fact that an amended UCC-3 financing statement was subsequently recorded that provides: "This amendment is to clarify and confirm that the prior grant of security did not include the stock of North Hills Industrial Park, Inc., [NHIP] a California S-Corporation."
Lisa Underkoffler, Mr. Kirkland's secretary, filed the amended UCC-3 on May 5, 2010. Doc. No. 262 at Ex. 18 (document produced by National Corporate Research, Ltd., establishing that the UCC-3 was filed by Ms. Underkoffler). Ms. Underkoffler testified that she would not have filed the UCC-3 absent Mr. Kirkland's authorization.
Mr. Kirkland states that he never consented to the filing of the amended financing statement, was never told about the amended financing statement, and contends that the amended financing statement was filed at a time when he was out of the country and had limited communication with his office. Doc. No. 304 at ¶ 28.
The Court finds that at the time Ms. Underkoffler filed the UCC-3, she was an agent of Mr. Kirkland acting within the scope of her authority. As a result, Mr. Kirkland is bound by Ms. Underkoffler's filing of the UCC-3. See Cal. Civ. Code § 2330; Official Committee of Unsecured Creditors v. City Nat. Bank, N.A., 2011 WL 1832963, at *5 (N.D. Cal. 2011) ("It is well established that a principal is bound by the acts of an agent acting within the scope of the agent's authority."). Being bound by the acts of his agent Ms. Underkoffler, Mr. Kirkland cannot create a genuine dispute of material fact by testifying that he did not consent to the filing of the UCC-3.
The only proceeds as to which the BC Trust's alleged security interest could conceivably attach are the $54,588.53 that the Trustee obtained from the sale of stock in Ice Skating Enterprises, Inc. and the $50,000 that the Trustee obtained on account of Mr. Pressman's stock ownership interested in Sidecreek Development, Inc.
The Trustee asserts that he is entitled to surcharge the BC Trust's claim, and that such surcharge vastly exceeds the proceeds as to which the claim could be attach. The Trustee is correct that, pursuant to § 506(c), he is entitled to "recover from property securing an allowed secured claim the reasonable, necessary costs and expenses of preserving, or disposing of, such property to the extent of any benefit to the holder of such claim. . . ." However, such a recovery would be limited to the costs incurred by the Trustee in selling the Ice Skating Enterprises stock and obtaining the distribution on account of Mr. Pressman's Sidecreek Development stock. The Trustee has not furnished any evidence of the amounts incurred to liquidate such property. Instead, the Trustee points only to the attorneys' fees accrued in liquidating all the assets of the estate.
Ultimately, the fact that the BC Trust's claim can attach to a small portion of the proceeds collected by the Trustee is unavailing, as the Court finds that the Trustee is entitled to prevail upon his claim for equitable subordination.
Section 510(c) provides that "the court may under principles of equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim." The subordination of claims based on equitable considerations generally requires three findings: "(1) that the claimant engaged in some type of inequitable conduct, (2) that the misconduct injured creditors or conferred unfair advantage on the claimant, and (3) that subordination would not be inconsistent with the Bankruptcy Code." Henry v. Lehman Comm. Papers, Inc. (In re First All. Mortgage Co.), 471 F.3d 977, 1006 (9th Cir. 2006).
The BC Trust acquired Mr. Kirkland's EPD Interests through an assignment, and therefore remains subject to the rights and liabilities of Mr. Kirkland, including any liability flowing from Mr. Kirkland's inequitable acts prior to assignment. Here, there is no genuine dispute as to the facts establishing that Mr. Kirkland engaged in inequitable conduct sufficient to support equitable subordination.
Mr. Kirkland's conduct was inequitable in significant part because of his status as an insider of EPD. Mr. Kirkland's insider status is established by the fact that Mr. Kirkland was EPD's agent for service of process and served as outside counsel for companies partially owned or controlled by Mr. Pressman, including Plus Lounge Las Vegas LLC, SC Club LP, and Broadway Entertainment Marketing Inc. Even in situations where Mr. Kirkland did not formally represent EPD, he controlled EPD's legal advice and actions. For example, on March 21, 2006, Christopher Austin, an associate at Greenberg Traurig, the law firm at which Mr. Kirkland was then a partner, sent an e-mail to Mr. Kirkland stating:
Doc. No. 262 at Ex. 16 (records produced by Greenberg Traurig LLP).
Mr. Kirkland responded: "Please make the demand on behalf of Plush. I'll have a different lawyer make the demand on behalf of EPD." Id.
Defendants object to the introduction of these e-mails on the grounds that they were not timely submitted and that they are protected by the attorney-client and work-product privileges. Defendants' objections are overruled.
With respect to timely submission, it is true that the e-mails were inadvertently omitted from the exhibits attached to the Trustee's declaration in support of the Motion for Summary Adjudication [Doc. No. 262]. However, that declaration is 2,377 pages long. In addition, the e-mails were included as exhibits to deposition transcripts that were lodged in connection with the Motion. Defendants have had an opportunity to submit additional briefing setting forth their evidentiary objections to the e-mails. Under these circumstances, it would place form over substance to strike the e-mails on timeliness grounds.
The Court rejects Defendants' argument that the e-mails are protected by the attorney-client privilege. The attorney-client privilege "normally extends both to the substance of the client's communication as well as the attorney's advice in response thereto," and also extends "to those papers prepared by an attorney or at an attorney's request for the purpose of advising a client, provided the papers are based on and would tend to reveal the client's confidential communications." Matter of Fischel, 557 F.2d 209, 211 (9th Cir. 1977). However, the privilege does not extend "beyond the substance of the client's confidential communications to the attorney" and "will not conceal everything said and done in connection with an attorney's legal representation of a client in a matter." Id.
The e-mails merely establish that Mr. Kirkland controlled EPD's legal strategy even in situations where he did not formally represent EPD. They do not reveal the substance of confidential communications by either Plush or EPD to Mr. Kirkland. They do not reveal any substantive legal advice given by Mr. Kirkland to either Plush or EPD. Mr. Kirkland's directive to have one attorney send a demand letter on behalf of EPD and have a different attorney send a demand letter on behalf of Plush does not constitute the type of substantive legal advice protected by the privilege. Accordingly, the attorney-client privilege does not apply.
With respect to Defendants' work-product privilege objection, the Court finds that the work-product privilege does not prevent admission of the e-mails solely for the purpose of establishing that Mr. Kirkland controlled EPD's legal strategy even when he did not formally represent EPD. The work-product privilege protects from disclosure "the mental impressions, conclusions, opinions, or legal theories . . . of an attorney or other representative of a party." Upjohn Co. v. United States, 449 U.S. 383, 400. Here, the e-mails are relevant only insofar as they demonstrate that Mr. Kirkland controlled EPD's legal strategy; the specific legal advice Mr. Kirkland rendered is not relevant to this litigation. Therefore, admission of the e-mails for the sole purpose of establishing Mr. Kirkland's control of EPD's legal strategy does not violate the work-product privilege.
Mr. Kirkland's inequitable conduct consisted of facilitating the recordation of the UCC-1 financing statement in favor of the BC Trust, at the same time that EPD was experiencing serious cash flow problems and was not paying its other creditors. These actions inured to the detriment of EPD's other creditors but benefited the BC Trust in favor of Mr. Kirkland's children. The actions were undertaken at a time when EPD was experiencing serious cash flow issues. The recordation of the lien in favor of the BC Trust consisted of substantially all of EPD's remaining assets.
Because the Court finds that the Trustee is entitled to prevail upon his claim for equitable subordination, the Court does not rule upon the amount of interest, if any, to which EPD is entitled. Such a determination is unnecessary given that EPD's claim will be subordinated to all other claims.
Defendants assert various arguments in opposition to the Motion for Summary Adjudication, all of which lack merit.
First, Defendants argue that the Trustee's claims against Mr. Kirkland have been released in connection with settlements entered into between the Trustee and Mr. Kirkland's former law firms. Defendants selectively quote portions of the release provisions out of context. The releases preserved the Trustee's claims against Mr. Kirkland; only the claims against the law firms were released.
Second, Defendants argue that the Trustee may not obtain equitable subordination because he has already recovered amounts in settlements from Mr. Kirkland's prior law firms. The Trustee's settlements with those prior firms were based on avoidance actions and claims for malpractice and breach of fiduciary duty. The instant claims for equitable subordination are not duplicative of claims previously asserted. Defendants' argument lacks merit.
Third, the Trustee's disallowance and equitable subordination claims are not time-barred. Defendants claim that a statute of limitations was somehow triggered based on the date that Mr. Kirkland ceased employment with the law firm Luce Forward. Defendants' position is contrary to the Bankruptcy Code, which permits the Trustee to object to proofs of claim, and provides for the equitable subordination of claims. None of these provisions are subject to a statute of limitations.
Fourth, Defendants assert that the BC Trust has a defense to the Trustee's avoidance claims because the BC Trust qualifies as a holder in due course that took for value and in good faith under Cal. Comm. Code § 3302(a). According to Defendants, the BC Trust took for value because the beneficiaries of the BC Trust are Mr. and Mrs. Kirkland's children, and Mr. and Mrs. Kirkland are required to support their children pursuant to Cal. Fam. Code § 4053(b) and (d).
Defendants do not contest that no money or property of any kind was provided by the BC Trust to Mr. Kirkland in exchange for Mr. Kirkland's assignment of his EPD Interests to the BC Trust. Defendants instead rely upon the novel proposition that the Kirkland's obligation to support their children constitutes "value" within the meaning of Cal. Comm. Code § 3302(a). Defendants do not cite any authority for this proposition, and the Court finds that it lacks merit. The Kirkland's independent statutory obligation to provide for their children cannot serve as a mechanism to enable Defendants to circumvent the Bankruptcy Code's fraudulent transfer provisions. Such a result would make it far too easy for debtors to avoid obligations to their creditors.
Based upon the foregoing, the Court finds that the Trustee is entitled to judgment in his favor on his equitable subordination claim. The findings set forth herein will not become the order of the Court until the District Court acts upon the Report and Recommendation submitted in connection with the Trustee's related motion for summary adjudication with respect to his fraudulent transfer claims.
