The U.S. Bankruptcy Appellate Panel for the Eight Circuit recently applied the "conceivable effect" test in holding that a bankruptcy court lacked jurisdiction over a state law fraud claim raised by a third-party regarding the validity of a lender's lien, and therefore, declined to consider the issue on appeal.
In so ruling, the Panel ruled that the state law fraud claim did not invoke "arising under" or "arising in" jurisdiction of the bankruptcy court because the state law fraud claim was not created or determined by the Bankruptcy Code, and could exist outside of bankruptcy.
A copy of the opinion is available at: Link to Opinion
Debtors were farmers and ranchers who purchased 880 acres of land in North Dakota under a contract for deed. Debtors lived on 160 acres of the parcel ("Home Parcel") which was later sold to defendant ranchers ("Ranchers").
Debtors borrowed nearly $400,000 from lender ("Lender") to pay their operating expenses under eight separate loans, two of which were secured. In March 2016, Lender approved short term loan extensions for Debtors in exchange for them providing a security interest in additional real estate.
Debtors executed eight promissory notes and loan modification agreements, as well as a mortgage to secure payment of the notes. Although the legal description of the mortgage included the Home Parcel, Ranchers owned the Home Parcel at the time the mortgage was executed. On April 5, 2016, Ranchers conveyed the Home Parcel back to Debtors because they believe it would help them qualify for an operating loan. The mortgage was recorded the same day.
However, once Debtors discovered Lender would not loan any more funds, they conveyed the Home Parcel back to Ranchers on April 7, 2016. At that time, the Home Parcel was already encumbered by Lender's mortgage.
Debtors later filed a voluntary petition for relief under Chapter 12 of the Bankruptcy Code and an adversary proceeding naming Ranchers and Lender as defendants. In their answer, Ranchers asked the bankruptcy court to invalidate Lender's lien on the Home Parcel based on a state law fraud claim.
The bankruptcy court entered judgment in the adversary proceeding for Lender and against Debtors. In doing so, it examined North Dakota law with reference to the transfer of the Home Parcel to Debtors and the grant of the mortgage to Lender, and stated that Debtors did not meet their burden of showing actual fraud. As a result, Lender was found to have a valid and enforceable mortgage lien against the Home Parcel.
The bankruptcy case was later converted to Chapter 7. Thereafter, the bankruptcy court denied a motion to reconsider the judgment in the adversary proceeding. Debtors, Ranchers, and the Chapter 7 Trustee ("Trustee") appealed the judgment in the adversary proceeding and the denial of the motion to reconsider.
Initially, the Panel granted Lender's motion to dismiss Debtors' appeal based on lack of standing, and held that the Trustee's appeal because it was untimely. However, Lender's request to dismiss Ranchers' appeal was denied.
On appeal, Ranchers challenged the bankruptcy court's judgment against Debtors in favor of Lender by arguing state law fraud and sought a determination as to whether Lender held a valid lien on the Home Parcel.
The Panel first explained that Ranchers failed to assert a cross-claim or counterclaim in the adversary proceeding regarding the validity of Lender's lien on the Home Parcel, and therefore, it would not consider a matter that was not properly brought before the bankruptcy court.
Nevertheless, to the extent the Ranchers did assert a claim regarding the validity of the lien below, the Panel found that the bankruptcy court had no jurisdiction over the dispute between Ranchers and Lender. The Panel noted that bankruptcy courts have "original but not exclusive jurisdiction of all civil proceedings arising under title 11, or arising in or related to cases under title 11." See 28 U.S.C. § 1334(b); 28 U.S.C. § 157(a). The Panel then explained that the Eighth Circuit uses the "conceivable effect" test to determine the existence of "related to" jurisdiction for non-core proceedings.
Under this test, courts consider whether the outcome of the civil proceeding would conceivably have any effect on the estate being administered in the bankruptcy. In other words, "[a]n action is related to bankruptcy if the outcome could alter the debtor's rights, liabilities, options, or freedom of action ... and which in any way impacts upon the handling and administration of the bankruptcy estate. Dogpatch Props., Inc. v. Dogpatch U.S.A., Inc. (In re Dogpatch U.S.A., Inc.), 810 F.2d 782, 786 (8th Cir. 1987) (quoting Pacor, Inc. v. Higgins, 743 F.2d 984, 994 (3d Cir. 1984), overruled on other grounds by Things Remembered, Inc. v. Petrarca, 516 U.S. 124, 129 (1995)).
The Panel further explained that "related to" jurisdiction is broad but has limits, and therefore, "bankruptcy courts have no jurisdiction over proceedings that have no effect on the estate of the debtor." Celotex Corp. v. Edwards, 514 U.S. 300, 308 n.6 (1995)).
Applying the "conceivable effect" test, the Panel determined that Ranchers' claim involved a state law fraud dispute between Lender and Ranchers, both non-debtors, concerning property that was not part of the bankruptcy estate. Indeed, the transfer of the Home Parcel to Ranchers was completed prior to the filing of debtors' petition. Thus, the outcome of the dispute would not have an effect on the bankruptcy estate.
Further, the Panel noted that when questioned on the issue of jurisdiction at oral argument, the parties were unable to satisfactorily explain how the outcome of the dispute between Ranchers and Lender could have a conceivable effect on the bankruptcy estate.
Thus, the Panel found that it could not consider the merits of Ranchers and Lenders dispute because the bankruptcy court would not have had jurisdiction. Accordingly, the Panel remanded the case to the bankruptcy court with instructions to dismiss Ranchers' claim regarding the validity of Lender's lien against the Home Parcel.
Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Admitted to practice law in Illinois
Alabama | California | Florida | Georgia | Illinois | Indiana | Massachusetts | New Jersey | New York | Ohio | Pennsylvania | Texas | Washington, DC | Wisconsin
NOTICE: We do not send unsolicited emails. If you received this email in error, or if you wish to be removed from our update distribution list, please simply reply to this email and state your intention. Thank you.
Our updates and webinar presentations are available on the internet, in searchable format, at:
Financial Services Law Updates
The Consumer Financial Services Blog™
California Finance Law Developments