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In Re: Death Row Records, Inc v. R. Todd Neilson

March 21, 2012

IN RE: DEATH ROW RECORDS, INC., DEBTOR. JOHN CHIANG, CONTROLLER FOR THE STATE OF CALIFORNIA, APPELLANT,
v.
R. TODD NEILSON, CHAPTER 7 TRUSTEE, APPELLEE.



Appeal from the United States Bankruptcy Court for the Central District of California Honorable Vincent P. Zurzolo, Bankruptcy Judge, Presiding Bk. No. 06-11205 Adv. No. 10-02574

SUSAN M SPRAUL, CLERK U.S. BKCY. APP. PANEL OF THE NINTH CIRCUIT

MEMORANDUM*fn1

Argued and Submitted on November 16, 2011 at Pasadena, California

Filed - March 21, 2012

Before: HOLLOWELL, PAPPAS and PERRIS*fn2 , Bankruptcy Judges.

I. INTRODUCTION

In this interlocutory appeal, the California State Controller ("Controller") seeks the reversal of an order certifying a nationwide class of chapter 7*fn3 trustees who did, could have, or might in the future make a claim for their respective debtor's funds that escheated to the State of California prepetition. For the reasons given below, we REVERSE the bankruptcy court's certification of the class action and REMAND the matter to the bankruptcy court to issue a certification order solely under Civil Rules 23(a) and 23(b)(2), and which narrows the scope of the certified class action by eliminating claims for interest damages and claims for willful violation of the automatic stay.

II. FACTS

A. The Bankruptcy Case

In April 2006, Death Row Records, Inc. ("DRR") and Marion "Suge" Knight, Jr. ("Knight") each filed voluntary petitions for relief under chapter 11. In July 2006, appellee R. Todd Neilson ("Neilson") was appointed the chapter 11 trustee for the DRR estate. In January 2009, the Knight estate was consolidated with the DRR estate (the consolidated estates comprise the "Debtor"), 1 with Neilson acting as the chapter 11 trustee. In November 2009, 2 the Debtor's case was converted to chapter 7. Neilson was 3 appointed the chapter 7 trustee ("Trustee").

B. Trustee's Escheat Claim

5 In March 2009, the Trustee filed a claim with the Controller 6 on behalf of the Debtor seeking a return of the Debtor's money 7 that had escheated to the State of California ("California") 8 under California's Unclaimed Property Law (the "UPL"), Cal. Civ. 9 Proc. Code ("CCP") § 1500, et. seq. On May 26, 2010, the 10 Controller's office issued a letter to the Trustee ("Letter"), 11 which granted in part and denied in part the Trustee's claim. 12 The Letter explained that the Controller denied thirteen of the 13 sixteen claims asserted by the Trustee on the basis that it was 14 "the long-standing position of this office that once unclaimed 15 property has escheated to California, it is not subject to claims 16 by bankruptcy trustees claiming on behalf of a bankruptcy estate 17 or debtor."

18 The Letter explained that because thirteen of the accounts 19 had escheated before the bankruptcy petitions were filed, legal 20 and equitable title to the accounts vested in California. The 21 Letter acknowledged that the former owner of the accounts could 22 divest California of title by filing a verified claim under the 23 procedures set forth in the UPL, but until such a claim was 24 filed, verified and approved, "such property would not be 25 belonging or owed to such property or entity (debtor)." The 26 Letter stated that because that procedure had not occurred 27 prepetition, "the property is not part of bankruptcy estate as 28 defined in 11 U.S.C. § 541."

The Letter continued:

In addition, a trustee acts on behalf of the bankruptcy estate, not the debtor. For purposes of claiming 3 escheated property, "owner" means the person who had legal right to property prior to its escheat 4 (California Code of Civil Procedures Section 1540; subdivision (d)). Once the property vests in the State 5 of California, only the former owner can claim the property. As a result, it does not appear that the 6 bankruptcy estate, or its trustee, had a legal right to the property before it escheated to the State of 7 California. Consequently, because title to the property sought vested in the State of California, and 8 is not, therefore, property of the debtor, these funds held by the state under the Unclaimed Property Law are 9 not subject to a claim by a bankruptcy trustee. 10 The total amount of the claims denied was $10,166.44.

C. The Class Action

12 On August 25, 2010, the Trustee filed a complaint commencing 13 a class action against the Controller: 14 (1) for turnover of the class members' and the Debtor's 15 property and for an accounting pursuant to § 543; 16 (2) for turnover of property under § 542; 17 (3) for wrongful denial of claims under CCP § 1540; 18 (4) to avoid and recover unjust enrichment; 19 (5) for willful violation of the automatic stay; 20 (6) for declaratory relief seeking a determination that 21 debtors' property that escheats to California prepetition is 22 property of the class members' respective bankruptcy estates 23 subject to the exclusive control of the debtors' respective 24 bankruptcy estates' trustees; and, 25 (7) for injunctive relief enjoining the Controller from 26 continuing to deny claims made by bankruptcy trustees on behalf 27 of their estates.

The complaint sought turnover under § 542 and/or § 543 of 2 the amount of escheated funds plus interest and actual damages on 3 the stay violation claim, including costs and attorneys' fees 4 incurred in bringing the class action. The Trustee filed and 5 served a First Amended Complaint (the "Class Action") on 6 September 8, 2010, asserting the identical claims for relief.

D. Controller's Motion To Dismiss

On October 29, 2010, the Controller filed a Motion to 9 Dismiss under Rules 7012 and 7019 ("MTD"), asserting that the 10 Eleventh Amendment barred the Class Action, the bankruptcy court 11 lacked jurisdiction under 28 U.S.C. §§ 1334 and 157, and the 12 Trustee lacked authority under the Bankruptcy Code to file the 13 Class Action.

14 On January 3, 2011, the bankruptcy court issued an order 15 ("Dismissal Order") that dismissed the Trustee's CCP § 1540 and 16 unjust enrichment claims. In its Dismissal Order, the bankruptcy 17 court denied the balance of the MTD because the bankruptcy court 18 determined it had jurisdiction over the claims alleging 19 violations of the Bankruptcy Code.

20 The Controller did not seek leave to appeal the Dismissal 21 Order. On February 24, 2011, the Controller filed an answer 22 denying all the Trustee's allegations. The Controller asserted 23 lack of subject matter jurisdiction as an affirmative defense on 24 the grounds of: sovereign immunity, lack of jurisdiction under 25 28 U.S.C. §§ 1334 and 157, mootness, and that the Class Action 26 was not a core proceeding. The Controller also asserted as an 27 affirmative defense that the Trustee could not satisfy Civil 28 Rule 23 requirements for class certification (made applicable in 1 bankruptcy adversary proceedings by Rule 7023) and lacked 2 standing to act as the class representative.

E. Class Certification

4 In December 2010, the Trustee filed a motion for: (1) class 5 certification; (2) appointment of the Trustee as the class 6 representative; (3) permanent appointment of class counsel; and 7 (4) approval of the form of class notice (the "Certification 8 Motion"). The Controller filed an opposition ("Opposition"). 9 The Opposition challenged class certification under Civil 10 Rule 23, the definition of the class ("Class"), and the 11 definition of the Class claims ("Claims"). The Controller did 12 not, however, raise sovereign immunity or other subject matter 13 jurisdiction challenges previously raised in the MTD. 14 At a March 10, 2011 hearing on the Certification Motion, the 15 bankruptcy court granted the motion and made oral findings 16 concerning the elements of Civil Rule 23(a) and (b) finding that:

(1) numerosity was satisfied because the number of chapter 7 18 trustees in California and nationwide would be difficult to 19 manage absent a class action;

(2) commonality was satisfied because the Claims bear the 21 same or sufficient number of characteristics in common, so "that 22 it makes sense" to have them litigated in a Class Action;

23 (3) typicality of injury was satisfied by the Letter, which 24 referred to the long standing position of the Controller that 25 trustees could not make claims for debtors' escheated property; 26 and,

1 (4) adequacy of representation was met because there is no 2 conflict of interest between the Debtor's interest and the Class' 3 interest in having the Trustee pursue the Class Action.

4 The bankruptcy court also found that the issues were clearly 5 defined as required by Civil Rule 23(b) because it was a narrow 6 class where common questions of law and fact predominate. 7 On April 8, 2011, the bankruptcy court issued an order 8 ("Class Certification Order") certifying the Class Action and 9 appointing the Trustee as Class representative. The Class 10 Certification Order also appointed Class counsel and approved the 11 form of the Class Action notice, which included an "opt out" 12 provision that would permit members to elect to be excluded from 13 the Class.

14 The Class Certification Order defined the Class as: 15 all bankruptcy trustees who previously filed, could have filed, or will file in the future, claims with the 16 State of California on behalf of the bankruptcy estates of debtors whose property escheated to the State of 17 California prior to the filing of the bankruptcy petitions commencing their respective bankruptcy cases, 18 and which claims were rejected by the Controller on the grounds that such [escheated] property is not property 19 of the bankruptcy estates . . . and/or that the trustees lack authority to file bankruptcy claims under 20 CCP Section 1540.

F. Controller's Motion For Leave To Appeal

On April 21, 2011, the Controller filed a Motion For Leave 23 to Appeal the Class Certification Order and a Notice of Appeal. 24 On April 26, 2011, a BAP panel ("Panel") issued a briefing order. 25 In its brief, the Controller argued that appeal should be 26 permitted so that the Class Certification Order, as well as the 27 sovereign immunity and 28 U.S.C. § 1334 jurisdictional arguments 28 raised in the MTD, could be reviewed. The Trustee's opposition argued that the Controller had waived his sovereign immunity argument by not seeking to appeal the MTD. On June 15, 2011, the Panel issued an order granting leave to appeal. That order is silent on the scope of the appeal. On September 1, 2011, the Panel issued an order granting a Stay Pending Appeal.

III. JURISDICTION

The Controller challenges the bankruptcy court's subject matter jurisdiction. To the extent that the challenge is not sustained, the bankruptcy court had jurisdiction under 28 U.S.C. §§ 1334(a) and 157(a), (b)(1) and (B)(2)(A), (B), (G) and (O). We have jurisdiction under 28 U.S.C. § 158(a)(3) and the Panel's June 15, 2011 order granting leave to appeal.

IV. ISSUES

1. Did the bankruptcy court have subject matter jurisdiction over the Class Action?*fn4

2. Did the bankruptcy court err in certifying the Class?

V. STANDARD OF REVIEW

We review findings of fact for clear error and issues of law de novo. Litton Loan Serv'g, LP v. Garvida (In re Garvida), 347 B.R. 697, 703 (9th Cir. BAP 2006). A bankruptcy court's determination of its subject matter jurisdiction is reviewed de 1 novo. Sea Hawk Seafoods, Inc. v. Alaska (In re Valdez Fisheries 2 Dev. Ass'n, Inc.), 439 F.3d 545, 547 (9th Cir. 2006).

The 3 existence of sovereign immunity is a question of law reviewed de 4 novo. Del Campo v. Kennedy, 517 F.3d 1070, 1075 (9th Cir. 2008); 5 Emp't Dev. Dep't. of Cal. v. Joseph (In re HPA Assocs.), 191 B.R. 6 167, 171 (9th Cir. BAP 1995). We review issues of standing de 7 novo. La Asociacion de Trabajadores de Lake Forest v. City of 8 Lake Forest, 624 F.3d 1083, 1087 (9th Cir. 2010).

9 We review an order on class certification under Civil 10 Rule 23 for an abuse of discretion. Vinole v. Countrywide Home 11 Loans, Inc., 571 F.3d 935, 939 (9th Cir. 2009). As the Ninth 12 Circuit noted, appellate review is limited: 13 to whether the [court] correctly selected and applied [Civil] Rule 23's criteria. An abuse of discretion 14 occurs when the [court], in making a discretionary ruling, relies upon an improper factor, omits 15 consideration of a factor entitled to substantial weight, or mulls the correct mix of factors but makes a 16 clear error of judgment in assaying them.

17 Id. (citing Parra v. Bashas', Inc., 536 F.3d 975, 977-78 (9th 18 Cir. 2008). To the extent that a ruling on a Civil Rule 23 19 requirement is supported by a finding of fact, that finding is 20 reviewed for clear error. Wolin v. Jaguar Land Rover N. Am., 21 LLC, 617 F.3d 1168, 1171-72 (9th Cir. 2010). A factual finding 22 is clearly erroneous if it is illogical, implausible, or without 23 support in inferences that can be drawn ...


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