QUESTION: I am a receiver and I have just learned that the defendant purported to sell property I am receiver over. I contacted counsel for the defendant and for the buyer and demanded that the property be returned to me. The buyer’s attorney said his client would not reconvey the property, that the sale was good, and that I should bring a contempt action against the defendant if the defendant violated my order of appointment by selling the property. Is this correct?

ANSWER: A recent case, In Re Domun Locis LLC, 521 B.R. 661 (Bankr. C.D. Cal. 2014), decided by bankruptcy Judge Kwan, dealt with the very receivership issue of whether a transfer of receivership estate assets, without the receivership court’s approval, was void or merely voidable. The facts are not unusual. An individual borrowed a significant sum ($9,000,000) and secured the loan with a deed of trust on three income-producing properties. The borrower defaulted and the bank had a receiver appointed over the properties. The individual then formed an LLC (in which he was the 100% owner), conveyed the properties to the LLC, and filed a chapter 11 bankruptcy. The debtor LLC then filed a motion to use “cash collateral” (the rents), and the bank filed a motion for relief from the automatic stay and to excuse the receiver from having to turn over the property to the new debtor. 11 U.S.C. §543(d). The case turned on the legal issue of whether the transfer of the property to the LLC was void or voidable. If void, the new debtor had no assets because the properties remained in the individual’s name and in the receivership. If voidable, the properties would be property of the LLC’s bankruptcy’s estate, subject to the bank or the receiver having to sue to set aside the transfers, if possible, or only being able to bring a contempt motion against the individual in state court for violating the receivership court’s order.

In the Domun Locis case, Judge Kwan first pointed out that although the question whether an interest claimed by the debtor is “property of the estate” is a federal question to be decided by federal law, bankruptcy courts must look to state law to determine whether and to what extent the debtor has any legal or equitable interest in property as of the commencement of the case. The court, therefore, was required to look to the California law to see whether the debtor had any interest in the properties when the case commenced. Citing a number of California Supreme Court cases, including Pacific Railway Co. v. Wade, 91 Cal. 449 (1891) and Tapscott v. Lion, 103 Cal. 297 (1894), the court held that California has long recognized that properties subject to a court appointed receivership are held in custodia legis, that is, in the custody of the court. Following this concept, California courts have held that, therefore, only the receivership court may authorize a transfer or encumbrance of such property, and any attempt to transfer an interest in property that is held in custodia legis is void and ineffective. Accordingly, Judge Kwan held that the properties were not assets or property of the debtor’s bankruptcy estate and remained in the receivership estate, under the receiver’s custody and control, and that, therefore, the debtor had no assets.

The decision in Domun Locis is correct and significant. It can be used to stop defendants from playing games when a receiver is appointed over their property. Additionally, the case has value to address the situation when a receiver gets a call from the defendant or the plaintiff telling the receiver that the case is over because the defendant has sold the property that was in dispute and has worked out a deal with or paid the plaintiff. As Domun Locis indicates, any such sale, without approval of the receivership court, is void, and unless and until receivership court approval of any such sale is obtained, the receivership continues.