In re Cohen

MEMORANDUM DECISION ON "ISSUE 5" REGARDING THE CHARACTERIZATION OF PROFESSIONAL CLAIMS AS COMMUNITY OR SEPARATE DEBTS

NEIL W. BASON, Bankruptcy Judge.

I. INTRODUCTION

The general rule is that, although the community marital estate is liable for any debt incurred by either spouse before or during marriage, any debts incurred after spouses are living separate and apart are their separate debts. In this case some divorce attorneys and other professionals, who represented Ms. Cohen after she separated from the Debtor, argue on Ms. Cohen's behalf for an exception to this rule. They have not established any such exception, and the claims that they filed will be disallowed.

In contrast, a prima facie showing has been made that certain other fees by some of the Debtor's professionals were incurred in protecting the community estate post-separation, and the Debtor has cited authority that costs of protecting of the community estate are chargeable to that estate. No party in interest has overcome that prima facie showing, so those claims will be allowed as community claims.

II. BACKGROUND

A scheduling order (dkt. 394) established various discreet issues to be litigated in this case. Issue 5 in that order is:

[W]hether any of the claims asserted by the Debtor's or [Ms. Cohen's] professionals or any other creditor against the Debtor's estate are "community claims" as defined in 11 U.S.C. § 101(7) or are the Debtor's or [Ms. Cohen's] separate debts payable from property other than of the kind identified in 11 U.S.C. § 541(a)(2) and the allowed amount of such claims. [Dkt. 394 at 4:24-28]

Issue 5 was bifurcated at a status conference on June 25, 2014, and this memorandum decision addresses only the characterization of the professionals' claims (as community or separate claims). In other words, this decision does not address other claims, nor the dollar amount of any claims.

The professionals' claims are as follows:

Professionals retained by Ms. Cohen

Professionals retained by the Debtor

After further briefing (now including dkt. 428, 429, 430, 431, 491, 492, 493, 510, 512), and arguments on July 31, 2004, both Issue 5 and a related issue ("Issue 1") were taken under submission. A memorandum decision on Issue 1 was entered on November 13, 2014 (dkt. 692, the "Issue 1 Decision") and, as argued by the Committee and the Debtor, the Issue 1 Decision largely foreshadows the outcome of this Issue 5 decision. Nevertheless, this court has refrained from issuing this decision, mainly in the hope of encouraging settlement.

Unfortunately, the parties' numerous mediation sessions to date have been unsuccessful. Meanwhile the Debtor and the Committee have resolved a number of other issues, including a settlement with One West Bank N.A., and have achieved progress on liquidating certain assets in order to fund that settlement. It appears that issuing this decision now will aid the parties in moving forward with a plan of reorganization.

III. JURISDICTION, AUTHORITY, AND VENUE

This court has the jurisdiction and authority to issue a final order on the characterization of the professionals' claims, for the reasons set forth in the Issue 1 Decision (dkt. 692 at 5:23-12:8). Venue is also proper.

The Committee and the Debtor have objected to the standing of Ms. Cohen's professionals to assert the claims and arguments at issue. Those objections are overruled.

Ms. Cohen's professionals filed, or should be deemed to have filed, their claims on behalf of Ms. Cohen ( see claim nos. 9, 10, 16, 17, and dkt. 492 at 6:1-8:8, 493 at 10:1-11:28). Alternatively, if it were necessary, the professionals could amend the claims to make it explicit that such claims are asserted on behalf of Ms. Cohen, and such amended claims would relate back to the date on which the claims originally were filed. See Rule 15(c) (incorporated by Rule 7015, as applicable in this court's discretion under Rule 9016(c)).

On a related issue, it is true that Ms. Cohen is the real party in interest. But she has acquiesced in her professionals' assertion of these claims, presumably because under nonbankruptcy law the professionals would be entitled to seek payment of their fees out of any distributions to her. Therefore, again, the professionals are deemed to be acting on her behalf.

For all of these reasons, neither the claims nor the arguments asserted by the professionals will be rejected on grounds of standing or the real party in interest doctrine.

IV. DISCUSSION

A. Professionals retained by Ms. Cohen

The arguments of the Committee and the Debtor are persuasive (as articulated in dkt. 510, 512). As this court previously held in the Issue 1 Decision, the general rule is that claims can only be asserted against the community estate if the debt was incurred (by either spouse) before or during marriage, not afterwards. Alternatively, assuming for the sake of discussion that California law were to attempt to change the character of such claims after the filing of a bankruptcy petition or attempt to modify the priorities in bankruptcy (neither of which it does), that attempt would be preempted by federal bankruptcy law. See Issue 1 Decision (dkt. 692) at 13:1-14:28, 22:25-25:17.

1. California law

Some of Ms. Cohen's professionals argue that attorney fees are different from all other debts, and that post-separation attorney fees incurred by Ms. Cohen should be treated as community claims. They cite various portions of the California Family Code that permit either spouse to use community property to pay their reasonable attorney fees incurred in the divorce proceedings. But that temporary authority to use community property is analogous to an advance, out of the anticipated share of community property to be distributed to the spouse after the payment of creditors. See dkt. 510 at 7:19-8:10.

As stated in the debtor's brief:

The fact that a party is permitted to use community property does not make the obligation a debt for which community property is liable. Nor does the fact that the party is allowed to use separate property make the obligation a separate debt. Otherwise, the character of the debt would be determined by the source of funds used to pay it. This could never be the rule. [Dkt. 512 at 7:7-8.]

Ms. Cohen's professionals also cite portions of the California Family Code that authorize "need based" and "sanction based" allocations between spouses. See Committee Brief (dkt. 510) at 4:22-6:25. Nothing in those statutes even suggests, let alone establishes, an exception to the general rule in California Family Code § 910 that only makes the community estate liable for debts incurred "before or during marriage."

Put differently, the professionals, standing in the shoes of Ms. Cohen, confuse the issue of allocation of debts as between spouses with classification of debts as either community or separate. Either spouse can use community property to pay reasonable divorce attorney fees, subject to later equalization. Divorce attorney fees also can be allocated as between the spouses. But none of that changes the fact that when Ms. Cohen incurred debts to her divorce attorneys post-separation, they were incurred as her separate debts, not community debts.

Likewise, the authorities cited by Ms. Cohen in favor allowing of the professionals' claims to be paid out of the community estate only authorize such distributions as a method of allocating those claims between the spouses. At most, divorce attorney fees sometimes might be "treated" as if they were community debts in the limited sense that, after payment of all community claims, the attorney fees may be deducted from community assets prior to equal division and distribution of the remainder to the spouses. See Committee Brief (dkt. 510) at 9:19-22.

For all of these reasons, California law does not support the arguments of Ms. Cohen's professionals that their separate claims against her should be recharacterized as community claims against the bankruptcy estate. The claims will be disallowed on this basis.

2. Bankruptcy law

Alternatively, supposing for the sake of discussion that Ms. Cohen could have charged the community estate for her post-separation attorney fees under California law, any such ability to charge community property terminated once this bankruptcy case was commenced, because the Bankruptcy Code now governs the priorities of distribution. This is highlighted by the fact that, as conceded in the briefs filed by two of her professionals, they must "stand in the shoes" of Ms. Cohen to make any claims, and any right to fees is "derivative" of any rights she has to be awarded fees. Dkt. 492, 7:6-7; dkt. 493 at 11:12-13. As a matter of bankruptcy law (and as explained in the Issue 1 Decision), creditors' claims have priority over any distribution to Ms. Cohen, and that priority applies to her attempt to obtain reimbursement for her divorce professionals' fees. As stated by the Bankruptcy Appellate Panel for the Ninth Circuit:

Frequently, a bankruptcy case is commenced by one spouse during the pendency of a dissolution or divorce proceeding. The bankruptcy petition terminates the jurisdiction of the divorce or dissolution court over, at least, the non-exempt assets of the spouses until all creditors are paid in full. The jurisdiction of the bankruptcy court is exclusive.... [ In re Teel, 34 B.R. 762, 764 (9th Cir. BAP 1983) (emphasis added).]

Ms. Cohen is only entitled to an allocation of whatever community property remains after payment of creditors. Neither she nor her professionals have shown any basis to elevate her separate liability to her divorce professionals for post-separation fees into a community claim that must be paid pro rata with debts incurred during the marriage. Thus, her professionals' claims (on her behalf) will be disallowed on this alternative ground.

B. Professionals retained by the Debtor

Divorce fees are one thing, and professional fees incurred to protect the community estate are another. The Debtor has argued persuasively that, under California law, the attorney fees of Bryan Cave, LLP were incurred to represent the community estate's interests in litigation and therefore are themselves community debts. See dkt. 512 at 3:19-5:4; In re Marriage of Hirsch, 211 Cal.App.3d 104 (1989). Likewise, under the Bankruptcy Code, the Bryan Cave claim (no. 15) appears to qualify as a community claim for bankruptcy purposes. See generally Issue 1 Decision (dkt. 692) at 13:1-14:2. No party in interest has cited any contrary authority. Accordingly, the claim of Bryan Cave will be allowed as a community claim.

The Saavedra claim (no. 14) appears to be based on the same litigation as the Bryan Cave claim, and appears to be allowable as a community claim for the same reasons. Again, no contrary authority has been cited.

The Committee (dkt. 429 at 8:8-14) and Ms. Cohen (dkt. 431 at 3:18) have objected to the Gursey claim (claim no. 18). Those fees appear to have been incurred for forensic accounting services on behalf of the Debtor in his divorce, and therefore are subject to the same objections as the claims of Ms. Cohen's professionals. Gursey and the Debtor have not cited any contrary authority. Accordingly, the Gursey claim will be disallowed as a community claim - no objection has been made to the allowance of that claim as separate liability of the Debtor, so it will be allowed to that limited extent.

Ms. Cohen has objected (dkt. 431 at 2:23-28) that the scheduled claims of several persons, who appear to be professionals, are likewise separate liabilities of the Debtor Those include claims on behalf of: Dr. Armen Hekmati; G.L. Howard Accountant; Hochman Salkin Rettig Toscher & Perez; Jaffe & Clemens; and The Udinsky Group. See Bankruptcy Schedule F (dkt. 39 at PDF pp. 18-30). No response has been received by those claimants, and the proof of service attached to Ms. Cohen's amended objection (dkt. 431) includes each of them, so these objections are sustained and the claims are disallowed to the extent that they are asserted as community claims, and allowed (pursuant to § 1111(a)) as separate liabilities of the Debtor.

The Committee has also objected to the scheduled claim of Jaffe & Clemens (dkt. 429 at 4:1-7), asserting that it appears to be a claim for a separate liability of the Debtor, and its objection was served on that claimant ( id. at PDF p. 16). No response appears on the docket, and for this alternative reason this claim is disallowed to the extent that it is asserted as a community claim, and allowed as a separate liability of the Debtor.

V. CONCLUSION

The claims filed by Ms. Cohen's professionals (claim nos. 9, 10, 16, 17) will be disallowed as community claims (and will be treated as assertions, on behalf of Ms. Cohen, that she should receive a greater allocation of whatever assets might remain after paying creditors' claims, which is an issue for another day). The following claims will be disallowed as community claims, but allowed as a separate liability of the Debtor: filed claim (no. 18) of Gursey, and the scheduled claims of Dr. Armen Hekmati; G.L. Howard Accountant; Hochman Salkin Rettig Toscher & Perez; Jaffe & Clemens; and The Udinsky Group. The claims filed by Bryan Cave (no. 15) and Saavedra (no. 14) will be allowed as community claims.

No proposed orders implementing the foregoing rulings should be lodged at this time. As with the Issue 1 Decision, it appears appropriate to defer entry of any such orders so as to give all parties in interest at least a short "breathing spell" before having to litigate appeals. In fact, it may be appropriate to defer entry of any such orders until a plan of reorganization is confirmed, so that the confirmation order and all related rulings can be appealed at the same time. That issue, and any other procedural issues, can be addressed as needed at future status conferences.