Question: Unauthorized Transfers of Receivership Property: Void, Voidable or Ok?

Answer: In a recent unpublished bankruptcy appellate panel decision (In Re Domum Locis, LLC, 2015 WL 4697747 (9th Cir. BAP 2015)), the BAP reversed the bankruptcy court’s published decision in which the bankruptcy court held that a transfer of property in receivership by the defendant without permission of the receivership court, was void. In Re Domum Locis, LLC, 521 B.R. 661 (Bankr. C.D. Cal. 2014). The bankruptcy court’s decision was discussed in the Winter/Spring 2015 issue of Receivership News.

To refresh the reader’s recollection, an individual had borrowed $9,000,000 and secured the loan with a deeds 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 then filed a chapter 11 bankruptcy. The debtor LLC then filed a motion to use “cash collateral” (the rents). The bank opposed the motion and filed a motion for relief from the automatic stay and to excuse the receiver from having to turn over the properties to the new debtor. 11 U.S.C. §543(b). The case turned on the legal issue of whether the transfer of the properties 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 estate, subject to the bank or receiver suing to set aside the transfers, if possible, or bringing a contempt motion against the individual, in state court, for violating the receivership court’s order.

The bankruptcy court pointed out that, although the question of whether property claimed by the debtor is “property of the estate” is a federal question to be decided under 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 the property as of the commencement of the case. The court, therefore, was required to look to California law to see whether the debtor had any interest in the properties when the case commenced. The bankruptcy court cited a number of California cases, including two California Supreme Court cases, that state property subject to a receivership is held in custodia legis (in the custody of the court). Based on this concept, the bankruptcy court held only the receivership court could 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. As a result, the bankruptcy court held that the properties were not assets of the LLC’s bankruptcy estate, that they remained in the receivership estate subject to the receiver’s control, and, therefore, that the debtor had no assets.

The BAP reversed for a number of reasons. First, citing the California Supreme Court in North v. Cecil B. DeMille Prods., Inc., 2 Cal 2d 55, 57-58 (1934), the BAP pointed out that a receiver pendente lite is appointed to take possession of property pending final judgment in a case and only obtains possession of the property by order of the court. “The title to the property is not changed by the receiver’s appointment. The receiver acquires no title, but only the right of possession as an officer of the court. The title remains in those in whom it was vested when the appointment was made.” The receiver and the receivership court obtain equitable title to the property, because the property is held in equitable trust for those whom the court ultimately decides are entitled. The BAP held that the fact that the property is in custodia legis does not change this analysis, and it specifically found that the bankruptcy court’s interpretation of application of the in custodia legis doctrine was “overly broad in the context of the receivership proceedings over the properties.”

The BAP also pointed out that the bankruptcy court’s decision that the transfer was void is inconsistent with California law as explained in Mercantile Trust Code of San Francisco v. Sunset Road Oil Co., 50 Cal. App. 45, 498-499 (1920). In that case, the court distinguished between receiverships that were for the benefit of one creditor (such as a foreclosing bank) and receiverships that were for the benefit of all creditors. It held that transfers without leave of court would only be void if the receivership was for the benefit of all creditors. The bankruptcy court had characterized the reasoning in Mercantile Trust as “unsound” and rejected it, in part, because the case had not been cited by any other California court and because the court did not believe the reasoning was persuasive in drawing a distinction between receiverships for the benefit of one creditor and all creditors. The BAP disagreed.

The BAP stated, citing Cal. Probate Code §10260, that California had enacted certain legislation that provides that a sale is not sufficient to transfer title, in certain situations, without a court order confirming the sale and that there are no such statutory restrictions on property in receivership. But this analogy is flawed. Cal. Code of Civ. Proc. §568.5 provides: “A receiver may, pursuant to an order of the court, sell real or personal property in the receiver’s possession…[but that] The sale is not final until confirmed by the court.” That is really no different from the Probate Code section the BAP cites. Further, both Civ. Proc. §568.5 and Probate Code §10260 are really irrelevant to the analysis because one deals with sales by a receiver, the other by an executor or personal representative, not transfers by another person having an interest in the property.

Based on these distinctions, the BAP held that the mere existence of the receivership did not make the transfer void as a matter of law. The BAP acknowledged that the receivership court could vacate the sale because the sale was made in violation of the receivership court’s order but, because the debtor held a legal title to the property, the property constituted property of the bankruptcy estate irrespective of the property being in receivership. Property of the estate is defined very broadly under the Bankruptcy Code and includes “all legal or equitable interests of the debtor in property as of the commencement of the case.” 11 U.S.C. §541(a)(1). The BAP did, however, affirm the bankrupt court’s granting of relief from the automatic stay to allow the bank’s return to the receivership court to have the receivership court determine whether the transfer of the properties should be voided; which the BAP felt would give the state court the opportunity “to resolve completely difficult and unsettled issues of California state law.”

In its decision, the BAP downplays the bankruptcy court’s citation to a number of California authorities, and federal authorities, which the bankruptcy court asserted hold that attempts to sell or transfer property held in custodial legis are ineffective, including Pacific Railway Co. v. Wade, 91 Cal. 449 (1891); Tapscott v. Lyon, 103 Cal. 297 (1894); Withington v. Shay, 47 Cal. App. 2d 69 (1941) and North v. Evans, 1 Cal. App. 2d 64 (1934). The BAP only addressed the language in Pacific Railway Co. v. Wade which states: “No sale can take place, no debt can be paid, no contract can be made, which does not receive the sanction of the court,” stating that language only means the receiver cannot take such action without court approval.

So, should the superior court find the transfer of the properties void, voidable, or ok? The BAP is correct in stating that the appointment of a receiver does not change legal title to property placed in receivership and that all the receiver gets is equitable title. That does not mean, however, that a defendant in a receivership case can transfer property in the court’s custody. By having possession and equitable title to the property, the court can, for example, sell the property, through its receiver, to a third party even though the court does not have a legal title. It can authorize the transfer of the property by transferring equitable title and by issuing, in effect, an injunction preventing interference with the new buyer’s ownership[1]. This happens all the time. Whether the defendant retains legal title, therefore, does not answer the question of whether the transfer of property in custodia legis is void or voidable.

Two analogous situations highlight the problem with California law in this area. For example, if the bank asserted that the transfer of the property to the LLC was a violation of an injunction issued by the receivership court (because the appointing order also enjoins interference with the receiver’s possession and control), would the transfer in violation of that injunction be void or voidable? A long line of California cases hold that a sale of real property in violation of an injunction is voidable, but not void. Bagley v. Ward, 37 Cal. 121 (1869); American Trust Co. v. de Albergaria, 123 Cal. App. 76 (1932); Warburton v. Kieferle, 135 Cal. App. 2d 278 (1955). Whereas, on the other hand, if the bank asserted that the defendant transferred title to the property with the “actual intent to hinder delay or defraud” the bank and hence, the transfer was a voidable transfer under California law[2], California law is clear that the transfer would be void, not merely voidable. In Re Cass, 476 B.R. 602, 614 (Bankr. S.D. Cal. 2012), aff’d 606 Fed. Appx. 318 (9th Cir. 2015), citing Swinford v. Rodgers, 23 Cal. 233, 235-236 (1893) (“[T]he law is well settled, that a conveyance made with intent to defraud creditors is void…”). As can be seen, therefore, whether the transfer is void or merely voidable appears to depend on legal theory advanced to deal with the unauthorized transfer. Not a satisfying situation.

The bankruptcy court’s decision that any transfer of receivership property without permission of the receivership court is void is much cleaner and, of course, much preferred by receivers. However, the BAP’s opinion that the transfer is only voidable makes sense, given that the receiver and the receivership court do not obtain legal title simply by placing the property in receivership and the law that transfers in violation of injunctions also are only voidable, not void. Whether this ultimately turns out to be the law in California will depend on what happens in the superior court and any appellate decision or in the 9th Circuit where the appeal of the BAP decision is currently pending.

[1]  SEC v. American Capital Investments, Inc., 98 F. 3d 1133, 1144 (9th Cir. 1996), abrogated on other grounds, 523 U.S. 83, 93-94 (1998) (“Clark also teaches that a receiver’s sales do not even purport to convey ‘legal’ title, but rather ‘good,’ equitable title enforced by an injunction against suit. See 2 Clark on Receivers §§ 342, 344, 482(a), 487, 489, 491.

When a court of equity orders property in its custody to be sold, the court itself as vendor confirms the title in the purchaser. Neither the court nor [the receiver] gives a legal title to the purchaser because neither the court nor its officer has legal title to give.... A court of equity acts by a process of injunction against the owner and against the parties to the suit and protects the purchaser against interference and assures him a quiet title and quiet enjoyment.”).

[2]  Effective January 1, 2016 California’s Uniform Fraudulent Transfer Act was amended and became the Uniform Voidable Transactions Act. Among other things, the word “fraudulent” was excised from the statute and replaced with the word “voidable.”

This alert is intended to note current legal trends in commercial lending and risk management issues. No alert should be construed as representing advice on specific, individual legal matters, but rather as an overview of the subject discussed. Your questions and comments are always welcome. Please do not hesitate to contact me at pdavidson@ecjlaw.com or (310) 281-6363 to further discuss this alert or to answer any questions.