IN RE LOS ANGELES TRUST DEED MORTGAGE EXCH

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Docket Number

No. 25393.

Attorney(S)

John E. Glover, Beverly Hills, Cal., for appellant. Tiernan Moneymaker, Los Angeles, Cal., for appellee.

Judges

Herbert Young Cho Choy

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Smart Summary

Factual and Procedural Background

This case arises from the financial dealings of David Farrell, president and principal shareholder of Los Angeles Trust Deed Mortgage Exchange (the Exchange). In late 1958 and early 1959, the Exchange financed several real estate development ventures conducted by Edmund Cantillon and Alvin Rabalais through various legal entities, including a co-partnership named Westport Development Co. and corporations Associate Fundings, Inc. and Brentwood Downs, Inc. The financing arrangement involved loans secured by trust deeds at 10% interest, alongside a separate agreement granting Farrell 50% of the net profits on each tract financed. Seven tracts were financed under this arrangement.

The Exchange was adjudicated bankrupt on December 18, 1960. Cantillon and Rabalais filed claims related to loans on two of the seven tracts in July 1961. In November 1962, trustees for the Exchange acquired Farrell's interest in the profit shares. Subsequently, on July 29, 1966, the trustees filed a counterclaim seeking to dissolve the joint ventures between Cantillon-Rabalais and Farrell and to recover 50% of the profits from the five tracts not covered by Cantillon and Rabalais' claims. The bankruptcy referee ordered dissolution of the joint ventures and payment of the profit shares to the trustees. The district court affirmed this order, and the present appeal followed.

Legal Issues Presented

Whether the bankruptcy referee had summary jurisdiction to hear the trustees' counterclaim concerning the dissolution of joint ventures and recovery of profits from transactions separate from the creditor claims.
Whether Cantillon and Rabalais waived their right to object to the bankruptcy referee's summary jurisdiction by failing to timely object in writing as required by local bankruptcy rules.

Arguments of the Parties

Trustees' Arguments

The trustees argued that the referee properly exercised summary jurisdiction over their counterclaim based on the Supreme Court's decision in Katchen v. Landy, which permits summary jurisdiction to compel surrender of preferences under the Bankruptcy Act.
They urged a broad interpretation of Katchen to include counterclaims arising from transactions separate from the original creditor claims.
The trustees contended that Cantillon and Rabalais waived any objection to summary jurisdiction by failing to file a timely written objection as required by Local Bankruptcy Rule 203.

Cantillon and Rabalais' Arguments

Cantillon and Rabalais contended that the bankruptcy referee lacked jurisdiction over the trustees' counterclaim because it arose from separate transactions unrelated to the creditor claims filed.
They asserted that their oral objection to jurisdiction at a pretrial hearing, followed by an amended answer raising lack of jurisdiction, was timely and sufficient to preserve their objection despite the absence of a prior written objection.
They argued that the local rule's requirement for a written objection should be subject to leave to amend and that the referee granted such leave in this case.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Katchen v. Landy, 382 U.S. 323 (1966)	Confers summary jurisdiction on bankruptcy referees to compel surrender of preferences under § 57g of the Bankruptcy Act.	The court declined to interpret Katchen broadly to allow summary jurisdiction over counterclaims arising from separate transactions unrelated to creditor claims.
Peters v. Lines, 275 F.2d 919 (9th Cir. 1960)	Filing a claim constitutes consent to summary jurisdiction over counterclaims arising from the same transaction as the claim.	The court reaffirmed the distinction that summary jurisdiction applies only when counterclaims arise from the same transaction, not separate ones.
In re Carnell Construction Corp., 424 F.2d 296 (3rd Cir. 1970)	Supports the limitation of bankruptcy referee's summary jurisdiction to claims and counterclaims arising from the same transaction.	Used to support the court's holding that the referee lacked jurisdiction over the trustees' counterclaim on separate transactions.
Katchen v. Landy, 336 F.2d 535 (10th Cir. 1964)	Bankruptcy referee does not have jurisdiction over counterclaims arising out of separate transactions.	Supported the court's refusal to extend summary jurisdiction to the trustees' counterclaim.
Cherno v. Engine Air Service, Inc., 330 F.2d 191 (2d Cir. 1964)	Consistent with limiting summary jurisdiction to related claims and counterclaims.	Reinforced the court's conclusion about jurisdictional limits.
Cline v. Kaplan, 323 U.S. 97 (1944)	Previously allowed formal objections to jurisdiction at any time before final order, leading to procedural inefficiencies.	Congress amended the Bankruptcy Act to require timely objections, which the court applied to the waiver analysis.
In re Perspectron, Inc., 422 F.2d 576 (7th Cir. 1970)	Supports the principle that oral objections to summary jurisdiction may be timely if leave to amend is granted.	Used to justify the court's holding that oral objections followed by amended pleadings satisfy timeliness requirements.
Hall v. Goggin, 148 F.2d 774 (9th Cir. 1945)	Supports liberal allowance of amendments to pleadings.	Referenced in support of the court's approach to waiver and amendment in bankruptcy proceedings.
Honeyman v. Hughes, 156 F.2d 27 (9th Cir. 1946)	Discusses waiver and amendments in procedural context.	Compared with other cases to analyze waiver of jurisdictional objections.

Court's Reasoning and Analysis

The court began by examining whether the bankruptcy referee had summary jurisdiction over the trustees' counterclaim involving the dissolution of joint ventures and recovery of profits from five tracts not included in the original creditor claims. Citing Katchen v. Landy, the court acknowledged that summary jurisdiction exists to compel surrender of preferences integral to the allowance or disallowance of claims under the Bankruptcy Act. However, the court declined to extend Katchen to counterclaims arising from separate transactions unrelated to the creditor claims. It emphasized the distinction established in Peters v. Lines that summary jurisdiction applies only when the counterclaim arises from the same transaction as the creditor's claim. The court found that the financing for each tract was treated as a separate transaction and that the trustees' counterclaim concerned five tracts unrelated to the claims filed by Cantillon and Rabalais. Therefore, the referee lacked jurisdiction over the counterclaim.

Next, the court addressed whether Cantillon and Rabalais waived their right to object to the referee's summary jurisdiction by failing to file a timely written objection under Local Bankruptcy Rule 203. The court analyzed the legislative history of § 2, sub. a(7) of the Bankruptcy Act, enacted to prevent forum shopping and require early, explicit objections to jurisdiction. It held that the referee granted leave to amend when Cantillon and Rabalais' counsel made an oral objection at a pretrial hearing shortly after filing an answer without the objection. The court found this oral objection, followed by an amended answer raising lack of jurisdiction, timely and sufficient. It further reasoned that the local rule's requirement for a written objection is subject to leave to amend and that the trustees were not prejudiced by the timing or form of the objection.

Based on these analyses, the court concluded that the bankruptcy referee did not have summary jurisdiction over the trustees' counterclaim arising from separate transactions and that the creditors timely preserved their jurisdictional objection.

Holding and Implications

The court reversed the district court's order and remanded the case.

The direct effect of this decision is that the bankruptcy referee lacked jurisdiction to adjudicate the trustees' counterclaim concerning the dissolution of joint ventures and recovery of profits from transactions separate from the creditor claims filed by Cantillon and Rabalais. Consequently, those issues must be resolved in a plenary action outside the bankruptcy summary proceeding. The court did not establish new precedent beyond clarifying the limits of summary jurisdiction and the standards for timely objection in bankruptcy proceedings.

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IN THE MATTER OF LOS ANGELES TRUST DEED MORTGAGE EXCHANGE, BANKRUPT. ASSOCIATE FUNDINGS, INC., ET AL., RESPONDENTS-APPELLANTS, v. STANLEY A. PHIPPS ET AL., TRUSTEES-APPELLEES.

CHOY, Circuit Judge:

This action stems from certain free-wheeling activities of David Farrell, president and principal shareholder of Los Angeles Trust Deed Mortgage Exchange (Exchange). In late 1958 and early 1959, Exchange financed several ventures of Edmund Cantillon and Alvin Rabalais, who were in the business of developing real property, mostly in Orange County, California.

Cantillon and Rabalais operated via different legal entities — sometimes as a co-partnership under the name, Westport Development Co. (Westport), sometimes through either of two corporations, Associate Fundings, Inc. (Associate) or Brentwood Downs, Inc. (Brentwood). They negotiated an arrangement with Farrell whereby Exchange would loan funds at 10% interest to one or more of the Cantillon-Rabalais legal entities, with trust deeds as security. In addition, Farrell personally was to receive 50% of the net profits on each tract financed by Exchange. During 1958 and 1959, Exchange financed development of seven tracts under this arrangement. In every situation, the secured loan with 10% interest was set forth in one document and the agreement to share profits with Farrell was set forth in another.

On December 18, 1960, Exchange was adjudicated bankrupt. In July 1961, Cantillon and Rabalais filed with the bankruptcy referee two claims related to loans on two of the seven tracts. On July 29, 1966, the trustees, after acquiring both Farrell's and Exchange's interests, filed a counterclaim, praying that the referee dissolve the Cantillon-Rabalais "joint ventures" with Farrell and order payment to the trustees of 50% of the profits earned on the five tracts which were not included in the claims filed by Cantillon and Rabalais. Based upon certain documents, an audit of the profits on the five tracts and a stipulation of facts, the referee ordered the joint ventures to be dissolved and ordered Westport, Associate and Brentwood to turn over 50% of the net profits on the tracts. The district judge affirmed the order and this appeal followed.

In November, 1962, trustees for Exchange acquired Farrell's interest in 50% of the profits of the ventures. This was the result of a compromise of a controversy between the trustees on the one hand and Farrell, his wife and various Farrell entities on the other hand. The controversy was also occasioned by the divorce of Farrell and his wife. The agreement was embodied in an order of compromise, which consolidated the holdings of Farrell and Exchange under the auspices of the trustees in bankruptcy.

I. Filing Claims as a Basis for Summary Jurisdiction on Counterclaim.

The trustees contend that the referee correctly exercised summary jurisdiction over their counterclaim, based upon Katchen v. Landy, 382 U.S. 323, 86 S.Ct. 467, 15 L.Ed.2d 391 (1966), wherein the Supreme Court held that "the [Bankruptcy] Act does confer summary jurisdiction to compel a claimant to surrender preferences that under § 57, sub. g would require disallowance of the claim." 382 U.S. at 335, 86 S.Ct. 476. The trustees would have us interpret Katchen broadly to confer summary jurisdiction to determine counterclaims based on transactions which are separate from the subject matter of creditors' claims. We decline to interpret Katchen in such a broad manner.

Although the contracts for each tract were identical and later ones were routinely executed without further negotiation, the referee found that the parties treated the financing for each tract as a separate transaction. The determination is not "clearly erroneous" and we abide by it in this appeal.

The Court emphasized in Katchen that an objection to a claim under § 57g is "part and parcel of the allowance process" 382 U.S. at 330, 86 S.Ct. at 473, and as such subject to the jurisdiction of the bankruptcy referee. Also, as "part of the process of allowance and disallowance of claims, it is triable in equity." 382 U.S. at 336, 86 S.Ct. at 476, and thus no right to jury trial exists.

The Supreme Court did not consider in Katchen the issue presented by the instant case. At the court of appeals level, the Tenth Circuit ruled that a bankruptcy referee does not have jurisdiction to hear counterclaims arising out of separate transactions. Katchen v. Landy, 336 F.2d 535 (10th Cir. 1964). Unfortunately, the trustee did not appeal this aspect of the court of appeals' decision. Katchen v. Landy, 382 U.S. 323, 326, 86 S.Ct. 467, 15 L.Ed.2d 391 (1966).

After a review of the language of the Bankruptcy Act and the underlying policies, we believe that the referee had no jurisdiction over a counterclaim, unrelated to the transaction upon which a creditor's claim is based. The Act does not make counterclaims a subject of objection to a claim. In Peters v. Lines, 275 F.2d 919 (9th Cir. 1960), this circuit ruled that the filing of a claim constitutes a consent to summary jurisdiction of the referee and enables the referee to render affirmative relief on a trustee's counterclaim arising out of the same transaction as a claim submitted by the creditor. Settlement of the transaction itself had already been tendered to the referee. Thus, in "submitting one side of a controversy for resolution logic dictates that the entire controversy should be open for resolution." 275 F.2d at 925. The distinction between such a case and an unconnected counterclaim was carefully noted. 275 F.2d at 925, fn. 6.

The trustees have not persuaded us that Katchen requires that we abandon the distinction we established in Peters. That the referee lacked jurisdiction over the trustees' counterclaim may be expressed in affirmative terms: Cantillon and Rabalais, i. e., their legal entities, had a right to have their interests in the dispute (stemming from the five unrelated transactions) adjudicated in a plenary action rather than in a bankruptcy proceeding. See 2 Collier on Bankruptcy ¶ 23.08[1], pp. 530-531. Therefore, we hold that the bankruptcy referee did not have summary jurisdiction over the trustees' application for dissolution of the Cantillon-Rabalais joint ventures. Financing of these five tracts was separate from the transaction that constituted the subject matter of the Cantillon-Rabalais claims.

Accord: In re Carnell Construction Corp., 424 F.2d 296 (3rd Cir. 1970); Katchen v. Landy, 336 F.2d 535 (10th Cir. 1964); Cherno v. Engine Air Service, Inc., 330 F.2d 191 (2d Cir. 1964).

II. Consent to Summary Jurisdiction by Waiver of Right to Object.

Ordinarily, a challenge to summary jurisdiction in bankruptcy must be asserted by a creditor to the referee at an early stage in the proceedings. Otherwise, the creditor is deemed to have waived the right; he is deemed to have consented to the summary jurisdiction. See 2 Collier on Bankruptcy, ¶ 23.08[4], pp. 536-547.

Section 2, sub. a(7) of the Bankruptcy Act, 11 U.S.C. § 11(a) (7), the source of the consent jurisdiction, provides:

". . . and where in a controversy arising in a proceeding under this Act an adverse party does not interpose objection to the summary jurisdiction of the court of bankruptcy, by answer or motion filed before the expiration of the time prescribed by law or rule of court or fixed or extended by order of court for the filing of an answer to the petition, motion or other pleading to which he is adverse, he shall be deemed to have consented to such jurisdiction;"

The trustees contend that Cantillon and Rabalais waived this right by failing to object to summary jurisdiction in a timely manner. We disagree.

On October 7, 1966, at the request of the trustees, the referee in bankruptcy held a hearing to "pre-try" the controversy and "narrow the issues." At that time, counsel for Cantillon and Rabalais filed an answer which raised several defenses not including lack of summary jurisdiction. However, counsel made oral objection to the jurisdiction of the referee. An amended answer was filed on February 8, 1967, raising the additional defense of lack of jurisdiction.

MR. MONEYMAKER [Counsel for Trustees]: I don't believe there is any objection to jurisdiction.
THE REFEREE: They are going about, in any event, raising that objection.
MR. GLOVER [Counsel for Cantillon and Rabalai]s: We are certainly raising it now, and we have raised it before [on discovery].
. . . .
MR. GLOVER: . . . We are certainly objecting to the — you pointed out that it hasn't been pleaded. We objected when we were here before on the same theory, that this was a matter for the Trustee to file an action on if he wants to enforce these contracts.
That is our objection, good or bad.
THE REFEREE: I suggest you file a supplement to your response and set up any objection to jurisdiction.
Now, we will see how far we can go on this pretrial.
After discussing other matters, the referee mentioned the jurisdiction objection again.

THE REFEREE: Apparently there is no dispute that there are then a number of contracts covering a number of tracts, and maybe you can reach a stipulation that these are the terms in all of them, setting forth any language which is agreeable to both of you. It will save an awful lot of trouble; and all of this is without prejudice to your objection to jurisdiction.

Rule 12(h) of the Federal Rules of Civil Procedure provides that all defenses — including lack of personal jurisdiction — not raised by preliminary motion or by answer are waived, with certain exceptions not applicable here. The waiver rule is modified by liberal allowances for leave to amend under Rule 15(a).

Fairly read, we believe that the colloquy quoted in the margin indicates that the referee granted leave to amend, when counsel for Cantillon and Rabalais orally objected to summary jurisdiction at the pretrial hearing. However, the Federal Rules of Civil Procedure are applicable to bankruptcy proceedings only insofar as they do not contradict other special bankruptcy rules. It is therefore necessary to examine what has historically been a very thorny problem for bankruptcy practitioners, the courts and Congress.

Following passage of the Bankruptcy Act in 1938, the Supreme Court promulgated General Orders, effective February 3, 1939. General Order 37 provides:

"In proceedings under the Act the Rules of Civil Procedure for the District Courts of the United States shall, in so far as they are not inconsistent with the Act or with these general orders, be followed as nearly as may be, * * *"

See 1 Collier on Bankruptcy, ¶ 2.81, P. 390.40.

Congress adopted § 2, sub. a(7) of the Bankruptcy Act in 1952 in order to modify the rule of Cline v. Kaplan, 323 U.S. 97, 65 S.Ct. 155, 89 L.Ed. 97 (1944), that an adverse party could object to the summary jurisdiction of a bankruptcy referee so long as the objection was "formal" and was made at any time before the entry of a final order in the proceeding.

Pub.L. 456 (S. 2234), 82d Cong., 2d Sess.

See 2 Collier on Bankruptcy, ¶ 23.08[4], pp. 543-545. The drawbacks of Cline were stated in a House Report as follows:

". . . This holding has unsettled sound procedure and an expeditious administration in bankruptcy. A respondent may now proceed on the merits and gamble on a favorable decision. When he perceives or fears that the decision will be against him on the merits, he may interpose his formal objection to jurisdiction at any time before the entry of the order, and, should his objection be sustained, the summary proceedings must be dismissed. In such event, the trustee is required to relitigate the issues in a plenary action.

"The proposed amendment is intended to overcome this unsatisfactory situation and is keyed to rule 12(h) of the Federal Rules of Civil Procedure, which requires the timely interposition of an objection to jurisdiction and, if not so made, the defense is deemed waived." House Report No. 2320 on S. 2234, 2d Sess. 4 (1952).

See also Sloan, "Procedural Effect of the 1952 Amendment to Sec. 2, sub. a(7) of the Bankruptcy Act," 28 J. of Nat'l Ass'n of Ref. 32 (1954), cited in 2 Collier on Bankruptcy, ¶ 23.08[4], p. 545, n. 48.

The trustees contend that Cantillon and Rabalais waived the right to object to summary jurisdiction because they did not comply with Local Bankruptcy Rule 203 of the United States District Court (C.D.Cal.), which provides:

"A respondent desiring to contest a summary proceeding against him, shall serve and file not less than two (2) days before the hearing a written answer, objection or other responsive pleading which shall be verified if it sets up matters of fact."

We are thus faced with the issue of whether the local rule's requirement of a written objection is subject to leave to amend. We hold that it is.

The legislative history of § 2, sub. a(7) clearly indicates that Congress passed the provision to deter forum shopping by adverse claimants, by requiring that an objection to summary jurisdiction of the bankruptcy referee be made in an explicit manner at an early stage in the proceedings. The section specifically states that the time for a written objection may be "extended by order of the court." This authorizes the bankruptcy referee to grant leave to amend when an oral objection is so made as to leave little doubt about the basis of the objection and at a time when the opposing party has not incurred substantial costs by proceeding in more than one forum. Accord: In re Perspectron, Inc., 422 F.2d 576 (7th Cir. 1970); Cf. Hall v. Goggin, 148 F.2d 774 (9th Cir. 1945); 2 Collier on Bankruptcy, ¶ 23.08[4] p. 546, n. 53. Compare Honeyman v. Hughes, 156 F.2d 27 (9th Cir. 1946).

Here, counsel for Cantillon and Rabalais made his oral objection to summary jurisdiction at a pretrial hearing only minutes after filing an answer which did not raise the objection. The objection was just as timely as if it had been in the answer. The trustees were not misled. Leave to amend was wholly appropriate in such circumstances.

III. Conclusion.

In sum, the bankruptcy referee did not have summary jurisdiction over the legal entities of Messrs. Cantillon and Rabalais. The trustees' counterclaim stemming from separate transactions was not within the referee's jurisdiction, and the creditors raised this defense in a timely manner.

Reversed and remanded.