UNITED STATES BANKRUPTCY APPELLATE PANEL OF THE NINTH CIRCUIT
July 29, 2010
IN RE: LAURENCE R. NICHOLSON AND JOYCE V. NICHOLSON, DEBTORS. KAREN TYNER; APPLIED SCIENCE, INC., APPELLANTS,
LAURENCE R. NICHOLSON; JOYCE V. NICHOLSON, APPELLEES.
Appeal from the United States Bankruptcy Court for the Eastern District of California Hon. Robert S. Bardwil, Bankruptcy Judge, Presiding Bk. No. 09-24547
The opinion of the court was delivered by: Kwan, Bankruptcy Judge:
SUSAN M SPRAUL, CLERK U.S. BKCY. APP. PANEL OF THE NINTH CIRCUIT
A M E N D E D
Argued on May 18, 2010 at San Francisco, California
Submitted on June 29, 2010
Original Opinion Filed - July 16, 2010
Amended Opinion Filed - July 29, 2010
Before: KWAN*fn1 , PAPPAS and JURY, Bankruptcy Judges.
Chapter 7 debtors, Laurence R. Nicholson and Joyce V. 4 Nicholson amended their bankruptcy schedules to claim an 5 exemption in shares of stock in Applied Science, Inc. ("ASI"). 6 The trustee objected to the amendment on the ground that the 7 debtors had claimed the exemption in bad faith. Karen Tyner, 8 who had joined in the trustee's objection, and ASI appeal the 9 bankruptcy court's order overruling the objection and denying 10 the appellants' request for an evidentiary hearing.*fn2 We hold 11 that the bankruptcy court did not abuse its discretion by not 12 conducting an evidentiary hearing. We VACATE the bankruptcy 13 court's order, however, and REMAND for further proceedings, 14 because the bankruptcy court required the appellants to prove 15 bad faith by the incorrect standard of "clear and convincing 16 evidence."
A. The Debtors' Claim of Exemption and the Trustee's Sale of the ASI Stock
Laurence R. Nicholson and Cliff Tyner were 50/50 owners of 21 ASI, which manufactures whole blood collection devices for blood 22 donation centers. In January 2009, Cliff Tyner passed away, and 23 his widow, Karen Tyner, became executor of his estate, inherited 24 his interest in ASI, and became chairperson of ASI's board of 1 directors. At that time, ASI's revenues had been falling since 2 2005 and it had more liabilities than assets.
3 On March 16, 2009, the debtors filed a voluntary petition 4 under Chapter 7 of the Bankruptcy Code.*fn3 On Schedule B 5 (Personal Property) of the petition, the debtors listed the 6 value of their 25 shares in ASI (50% ownership) as $0.00, 7 described the asset as "worthless" and commented that the 8 company had more liabilities ($860,726) than assets ($468,711).
9 The debtors did not claim the shares as exempt property on 10 Schedule C (Property Claimed as Exempt) of the petition. At the 11 § 341(a) meeting of creditors, Nicholson testified that the 12 shares had "no value" because "the corporation owes a 13 considerable amount of money." One day after concluding the 14 meeting of creditors, the chapter 7 trustee, Thomas A. Aceituno, 15 filed a report of no distribution in the case. Tyner filed an 16 objection to the no distribution report, asserting that 17 Nicholson was commissioning an appraisal of ASI and that the 18 shares may have value. The trustee then withdrew the report.
19 On July 28, 2009, the trustee filed a motion seeking the 20 bankruptcy court's approval of a sale of the shares free and 21 clear of liens to Tyner, subject to overbids, for $5,000. On 22 the same day, the debtors amended their bankruptcy schedules to 23 list the value of their ASI shares as $19,949 and to claim the 24 entire amount as exempt under California Code of Civil Procedure ("CCP") § 703.140(b)(5). Three days later, on July 31, 2009, 2 the debtors again amended their schedules to list the value of 3 shares as $0.00, but increased the amount of the exemption in 4 the shares to $22,024 (by adding the amount of $2,075 as exempt 5 under CCP § 703.140(b)(6)). On August 4, 2009, the debtors 6 filed an objection to the proposed sale of the shares, asserting 7 that the initial bid of $5,000 must be increased by the amount 8 of their claimed exemption of $22,024.
On August 19, 2009, the bankruptcy court approved the 10 trustee's proposed sale of the shares for $25,949, free and 11 clear of liens, to Rostrevor Partners, LLC, the successful 12 overbidder at the sale hearing. The sale order provided that 13 the trustee was to hold a portion of the sale proceeds totaling 14 $19,949, the amount of the exemption claimed by the debtors, in 15 a separate account until the trustee's objection to the 16 exemption was resolved. On August 20, 2009, ASI appointed 17 Rostrevor Partners' managing member as its president and CEO and 18 terminated Nicholson's employment.
B. The Trustee's Objection to the Debtors' Claim of Exemption
On August 12, 2009, the trustee filed a timely objection to 21 the debtors' claim of exemption in the shares. He contended 22 that "[t]he amendment was obviously filed as a result of the 23 offer to acquire the stock which I had arranged despite the 24 Debtors' repeated representations that the Stock was 25 'worthless.'" Tyner joined in the trustee's objection, 26 asserting that the debtors had claimed the exemption in bad 27 faith.
On August 17, 2009, the debtors amended their schedules for 2 the third time, listing the value of the shares as $25,000 on 3 Schedule B, but eliminating the additional $2,075 they had 4 claimed as exempt on Schedule C.
On September 16, 2009, the debtors filed an opposition to 6 the trustee's objection to their claim of exemption, contending 7 that they had honestly claimed that ASI had no value when they 8 filed the petition. The debtors argued that the company's sales 9 had dramatically increased in late June and early July 2009 due 10 primarily to Nicholson's sales efforts, and particularly from 11 his developing relationship with Pall Medical, a large medical 12 company. The debtors did not serve their opposition to the 13 trustee's objection on Tyner or her counsel.
In her reply to the debtors' opposition, filed on September 15 25, 2009, Tyner asserted that Nicholson knew of Pall Medical's 16 interest in ASI no later than April 2009. At that time, she 17 contended, Nicholson made an offer to purchase her shares while 18 commissioning a "bogus" no-value appraisal to support his claim 19 that they were worthless. She also asserted that Nicholson 20 delayed finalizing a deal with Pall Medical to avoid having to 21 disclose the negotiations in the bankruptcy case.
In support of her reply, Tyner submitted an unsigned 23 document, dated April 27, 2009, that appeared to be an offer 24 from ASI to purchase Tyner's shares based on mandatory buyout 25 provisions in Cliff Tyner's employment agreement with ASI for:
26 (a) $250; (b) 4% of ASI's total sales of the "HemoFlow 27 200/300/400" devices through March 31, 2012 to the extent that 28 new product sales totaled at least $25,000 per month; (c) accord 5 1 and satisfaction of an alleged overpayment of income draws from 2 ASI to Cliff Tyner vis-a-vis Nicholson; and (d) ASI's promise to 3 use its best efforts to reduce any offsets of the buyout amount 4 from Cliff Tyner's personal guarantees of ASI's debts. The 5 document stated that ASI was currently "under water" in value, 6 but that "a distribution agreement has been proposed with Pall 7 Medical" and that "[i]f Pall is interested, some form of buyout 8 may be negotiated between ASI and Pall."
9 Tyner also submitted a sheet of typewritten notes 10 ("Notes"), which Nicholson purportedly wrote around July 3, 2009 11 after a discussion with his attorney and which was allegedly 12 discovered among ASI's files. The Notes stated:
13 Play [Tyner's] objection low. . . . Do not push Tyner to withdraw [it], as this may 14 constitute [bankruptcy] fraud. If we know that the present value of the shares is worth 15 something, . . . then the court may say we conspired to conceal the value that the 16 trustee should have known. Quiet is the word. . . . Obtain [a] short 1 page valuation 17 (in the works) and submit [it] to [the] [t]rustee and Tyner. . . . Shows that value 18 is in my knowledge, not the company. Too much information may cause the trustee to dig 19 deeper and find out about the Pall discussions. . . . We cannot negotiate any 20 deal with Pall until after the August 5 hearing, and we cannot close the deal until 21 after September 16.
22 A single handwritten word, "CONFIDENTIAL," appeared on the 23 Notes. Tyner attempted to prove the handwriting was Nicholson's 24 by attaching a series of signed checks for purposes of 25 comparison. She did not, however, submit a declaration to 26 authenticate the Notes or the checks.
27 On September 30, 2009, the bankruptcy court held a hearing 28 on the trustee's objection to the debtor's claim of exemption.
1 At the hearing, the debtors objected to the Notes as 2 inadmissible because the document lacked foundation. Tyner, 3 through her counsel, contended that she did not submit a 4 declaration to authenticate the Notes because the debtors did 5 not serve her with the opposition and because she expected to be 6 able to cross-examine Nicholson at the hearing as to whether he 7 wrote the Notes. The bankruptcy court denied Tyner's request to 8 cross-examine Nicholson, ruling that it could not hold an 9 evidentiary hearing because she had not filed the required 10 notice that the parties disputed a material fact. The 11 bankruptcy court also ruled, however, that the parties could 12 file supplemental evidence and that it would then take the 13 matter under submission.
14 The trustee timely filed supplemental evidence. Some of 15 this evidence appears to link the Notes to Nicholson in several 16 ways. Other evidence suggested that ASI had begun to develop a 17 relationship with Pall Medical as early as April. The trustee 18 submitted a printout of an e-mail allegedly from Nicholson to 19 Pall Medical, dated March 6, 2009, in which Nicholson 20 purportedly "propose[d] that Pall become the ASI sales 21 representative in Europe and for the American Red Cross" because 22 he had "just found out that there will be a large tender issued 23 in Europe in early April." The evidence also contained an 24 unsigned document, dated April 2, 2009, that apparently explored 25 issues in establishing a distribution relationship between both 26 companies.
As part of their supplemental evidence, the debtors 28 submitted an appraisal of ASI, which valued the company as "$0 1 (Zero)" as of March 31, 2009. The appraiser based this 2 valuation on a combination of a negative total average adjusted 3 net income over the last three years and total net assets of 4 negative $502,923. The appellants did not contest this 5 appraisal.
C. The Bankruptcy Court's Ruling
On October 22, 2009, the bankruptcy court filed an order 8 overruling the trustee's objection to the debtors' exemption.
In its memorandum decision filed the same day, the bankruptcy 10 court, citing Martinson v. Michael (In re Michael), 163 F.3d 11 526, 529 (9th Cir. 1998), stated that it would overrule the 12 objection based on its finding that the appellants had failed to 13 present "clear and convincing" evidence that the debtors had 14 acted in bad faith in claiming the exemption in the shares.
The bankruptcy court concluded that the debtors were honest 16 in initially claiming that the shares had no value. The 17 bankruptcy court observed that Nicholson's communications with 18 Pall Medical in March and April 2009 were "preliminary 19 negotiations" that did "not make for a valuable contractual 20 right." The bankruptcy court also stated that the April 27, 21 2009 buyout proposal for Cliff Tyner's shares "reflected the 22 speculative nature of the Pall Medical relationship" because it 23 only provided for a nominal initial payment, which was to be 24 augmented by a percentage of ASI sales payable only if a sales 25 threshold of $25,000 per month was met.
The bankruptcy court gave "little evidentiary weight" to 27 the Notes, finding that Tyner had not laid a sufficient 28 foundation for the admission of the document. The bankruptcy 8 1 court also concluded that, even if the document was genuine, it 2 did not prove bad faith. "At most," the bankruptcy court 3 stated, "the document reflects Nicholson's belief that ASI had 4 value and his desire that the trustee not learn of the Pall 5 Medical discussions." The bankruptcy court further stated that 6 if Nicholson had written the document, he would have done so on 7 or around July 3, 2009, which would have "reveal[ed] nothing 8 about debtors' assessment of ASI's value on March 16, 2009, but 9 rather [was] consistent with [his] testimony that ASI's 10 prospects improved in late June ." Also observing that 11 "[t]he bad faith exception to Rule 1009(a) regulates bad-faith 12 acts, not thoughts," the bankruptcy court noted that the debtors 13 had first amended their schedules in July 2009 to reflect this 14 change in value only after ASI's prospects improved in June 15 2009.
16 Finally, the bankruptcy court rejected the trustee's 17 assertion that the debtors had claimed an exemption in the 18 shares to prevent their sale. The bankruptcy court reasoned 19 that mere delay in claiming exemptions does not prove bad faith, 20 and that "once the debtors realized the shares had value, they 21 had every right to use their exemption claims in an attempt to 22 capture that value."
23 ASI and Tyner timely appealed the bankruptcy court's order. 24 After hearing oral arguments on appeal, we ordered the parties 25 to submit additional briefing on whether the bankruptcy court 26 applied the correct burden of proof to the trustee's objection.
The bankruptcy court had jurisdiction under 28 U.S.C. 3 §§ 1334 and 157(b)(2)(A) and (B). We have jurisdiction under 4 28 U.S.C. § 158(a).
A. Whether the bankruptcy court applied the correct burden of 7 proof to the trustee's objection to the debtors' claim of 8 exemption.
B. Whether the bankruptcy court's factual findings in 10 overruling the trustee's objection were clearly erroneous.
C. Whether the bankruptcy court abused its discretion by not conducting an evidentiary hearing.
IV. STANDARD OF REVIEW
A. We review, de novo, whether the bankruptcy court applied 15 the correct burden of proof to the trustee's objection. See 16 Molski v. Foley Estates Vineyard and Winery, LLC, 531 F.3d 1043, 17 1046 (9th Cir. 2008)(trial court's allocation of the burden of 18 proof is reviewed de novo). De novo review means considering 19 the matter "anew, as if no decision had been rendered below."
20 United States v. Silverman, 861 F.2d 571, 576 (9th Cir. 1988). 21 B. We review the bankruptcy court's factual findings in 22 overruling the trustee's objection for clear error. See Arnold 23 v. Gill (In re Arnold), 252 B.R. 778, 784 (9th Cir. BAP 2000) 24 ("[T]he issue of a debtor's intent [in claiming exemptions] is a 25 question of fact reviewed under the clearly erroneous 26 standard.").
C. We review the bankruptcy court's decision not to conduct an 28 evidentiary hearing for abuse of discretion. See Khachikyan v. 10 1 Hahn (In re Khachikyan), 335 B.R. 121, 128 (9th Cir. BAP 2005).
In applying an abuse of discretion test, we first "determine de 3 novo whether the [bankruptcy] court identified the correct legal 4 rule to apply to the relief requested." United States v. 5 Hinkson, 585 F.3d 1247, 1262 (9th Cir. 2009). If the bankruptcy 6 court identified the correct legal rule, the court abused its 7 discretion if its "application of the correct legal standard [to 8 the facts] was (1) 'illogical,' (2) 'implausible,' or (3) 9 without 'support in inferences that may be drawn from the facts 10 in the record.'" Id., (quoting Anderson v. City of Bessemer 11 City, N.C., 470 U.S. 564, 577 (1985)).
"When a debtor files a Chapter 7 bankruptcy petition, all 14 of the debtor's assets become property of the bankruptcy estate, 15 see 11 U.S.C. § 541, subject to the debtor's right to reclaim 16 certain property as 'exempt,' § 522(l)." Schwab v. Reilly, 2010 17 WL 2400094, at *4 (U.S. June 17, 2010). "The Bankruptcy Code 18 specifies the types of property debtors may exempt, § 522(b), as 19 well as the maximum value of the exemptions a debtor may claim 20 in certain assets, § 522(d)." Id. "Section 522(b) allow[s a 21 debtor] to choose the exemptions afforded by state law or the 22 federal exemptions listed in § 522(d)." Taylor v. Freeland & 23 Kronz, 503 U.S. 638, 642 (1992). "Section 522(l) states the 24 procedure for claiming exemptions and objecting to claimed 25 exemptions as follows: 'The debtor shall file a list of 26 property that the debtor claims as exempt under subsection (b) 27 of this section. . . Unless a party in interest objects, the 28 property claimed as exempt on such list is exempt.'" Id.
Here, the chapter 7 trustee objected to the debtors' 2 amendment of the schedules claiming an exemption on the ground 3 of bad faith. Federal Rule of Bankruptcy Procedure 1009(a) 4 provides: "A voluntary petition, list, schedule, or statement 5 may be amended by the debtor as a matter of course at any time 6 before the case is closed." Fed. R. Bankr. P. 1009(a). "No 7 court approval is required for an amendment, which is liberally 8 allowed." In re Michael, 163 F.3d at 529, citing In re Doan, 9 672 F.2d 831, 833 (11th Cir. 1982). "Whether [debtors may] 10 amend their schedules post-petition," however, "is separate from 11 the question whether the exemption [itself is] allowable." Id., 12 citing In re Sandoval, 103 F.3d 20, 22 (5th Cir. 1997). 13 We reject the debtors' argument that bankruptcy courts have 14 no authority to disallow exemptions claimed in bad faith.
Section 522(l) of the Bankruptcy Code and Rule 4003(b) of the 16 Federal Rules of Bankruptcy Procedure permit a party in interest 17 to object to a debtor's claim of exemption. Further, the 18 Supreme Court has recognized the "broad authority granted to 19 bankruptcy judges," pursuant to § 105(a) of the Bankruptcy Code, 20 "to take appropriate action in response to fraudulent conduct by 21 the atypical litigant who has demonstrated that he is not 22 entitled to the relief available to the typical debtor."
Marrama v. Citizens Bank of Massachusetts, 549 U.S. 365, 374-75 24 (2007); see also Latman v. Burdette, 366 F.3d 774, 784-86 (9th 25 Cir. 2004)(recognizing inherent powers of bankruptcy courts to 26 equitably surcharge a debtor's exemption to protect integrity of 27 the bankruptcy process and to ensure debtor does not exempt 28 amount greater than allowed under Bankruptcy Code despite lack 12 1 of express Code provision for equitable surcharge of 2 exemptions). In Andermahr v. Barrus (In re Andermahr), the 3 panel adopted the rule of the Eleventh Circuit in In re Doan 4 that a bankruptcy court may disallow a claim of exemption on a 5 showing of "bad faith by the debtor or prejudice to creditors."
30 B.R. 532, 533 (9th Cir. BAP 1983), citing In re Doan, 672 7 F.2d at 833. The Ninth Circuit also adopted the rule stated in 8 Doan. See In re Michael, 163 F.3d at 529, citing In re Doan, 9 672 F.2d at 833.
A. The Bankruptcy Court did not Apply the Correct Burden of 11 Proof to the Trustee's Objection.
Rule 4003(c) of the Federal Rules of Bankruptcy Procedure 13 provides that, if a party in interest timely objects, "the 14 objecting party has the burden of proving that the exemptions 15 are not properly claimed." An exemption is "presumptively 16 valid" and the objecting party, therefore, has the burden of 17 producing enough evidence to rebut that presumption. Carter v. 18 Anderson (In re Carter), 182 F.3d 1027, 1029 n.3 (9th Cir. 19 1999). Even if this burden is met, the burden of persuasion 20 remains on the objecting party. Id.
21 The Bankruptcy Code and Bankruptcy Rules do not indicate 22 what is the appropriate burden of persuasion for disallowing a 23 claim of exemption. The Ninth Circuit has not defined this 24 burden. The panel has, outside of the bad faith context, 25 applied the ordinary "preponderance of the evidence" standard. 26 See Kelley v. Locke (In re Kelley), 300 B.R. 11, 16-17 (9th Cir. 27 BAP 2003). "Proof by the preponderance of the evidence means 28 that it is sufficient to persuade the finder of fact that the 13 1 proposition is more likely true than not." United States v. 2 Arnold & Baker Farms (In re Arnold & Baker Farms), 177 B.R. 648, 3 654 (9th Cir. BAP 1994).
The debtors argue that "clear and convincing" evidence of 5 bad faith is necessary to disallow a claim of exemption on that 6 basis. "Clear and convincing evidence is a higher standard 7 requiring a high probability of success." Id. The debtors make 8 several arguments in support of this position.
9 First, the debtors argue that the panel adopted the "clear 10 and convincing" standard for resolving objections to exemptions 11 for bad faith in Magallanes v. Williams (In re Magallanes), 96 12 B.R. 253 (9th Cir. BAP 1988), and that the Ninth Circuit, by 13 citing Magallanes in Martinson v. Michael (In re Michael), 163 14 F.3d 526 (9th Cir. 1998), did the same. Therefore, they argue, 15 the bankruptcy court correctly relied on Michael in applying 16 this standard. Each of these contentions is incorrect.
In Magallanes, the panel stated that "bad faith must be 18 established by clear and convincing evidence." 96 B.R. at 256. 19 The panel reasoned that "[t]his standard allows the party 20 alleging bad faith an opportunity to prove his or her claim, but 21 also implements the policy of liberally allowing the debtors to 22 amend their exemption claims in order to enhance their fresh 23 start." Id., citing Brown v. Sachs (In re Brown), 56 B.R. 954, 24 958 (Bankr. E.D. Mich. 1986). This discussion, however, was 25 dicta because it was "not necessary to the decision and thus 26 [has] no binding or precedential impact in the present case."
27 Export Group v. Reef Industries, Inc., 54 F.3d 1466, 1471-72 1 (9th Cir. 1995), citing inter alia Black's Law Dictionary 454 2 (6th ed. 1990)(defining "dictum" as "an observation or remark 3 . . . not necessarily involved in the case or essential to its 4 determination") and Wainwright v. Witt, 469 U.S. 412, 422 5 (1985). The discussion was not essential to the panel's 6 decision in Magallanes because it did not review whether the 7 bankruptcy court applied the correct burden of proof. Instead, 8 the panel held that the bankruptcy court had not made a factual 9 determination as to the appropriateness of the amended schedules 10 when the bankruptcy court disallowed the debtor's amended claim 11 of a homestead exemption because of its prior order disallowing 12 his original exemptions for his failure to appear at a scheduled 13 trial. In re Magallanes, 96 B.R. at 256. Therefore, the panel 14 remanded for the bankruptcy court to make factual findings on 15 whether the debtor had claimed the exemption in bad faith. Id.
16 The Ninth Circuit's discussion of the issue in Michael was 17 also dicta. In Michael, the Ninth Circuit affirmed the panel's 18 reversal of the bankruptcy court's holding that the debtors 19 could not amend their bankruptcy schedules to claim a homestead 20 exemption more than a year after the petition date. 163 F.3d at 21 528-29. Citing the panel's opinion in Magallanes, the Ninth 22 Circuit observed that the trustee had not objected to the 23 amendment for bad faith. Id. at 529. Because of this, neither 24 the Ninth Circuit nor the panel had an opportunity in Michael 25 to reach the issue of whether the bankruptcy court had applied 26 the correct burden of proof.
27 After Michael, the panel in Arnold observed that "[i]t is 28 not entirely clear whether bad faith or prejudice [in claiming exemptions] must be shown by a 'preponderance of the evidence' or 'clear and convincing' evidence." 252 B.R. at 784.*fn4 The panel in Arnold suggested that the Supreme Court may have answered this question in Grogan v. Garner, 498 U.S. 279 (1991). Id. In Grogan, the Supreme Court held that a party in interest must prove, by a "preponderance of the evidence," that a debt should be excepted from discharge under 11 U.S.C. § 523.
498 U.S. at 291. Finding that the statute and its legislative history did not indicate the appropriate burden of proof, the Court stated that "[t]his silence is inconsistent with the view that Congress intended to require a special, heightened standard of proof." Id. at 286. "Because the preponderance-of-the- evidence standard results in a roughly equal allocation of the risk of error between litigants," the Court continued, "we presume that this standard is applicable in civil actions between private litigants unless 'particularly important individual interests or rights are at stake.'" Id. (citation omitted). The Court held that a debtor's interest in a discharge was not important enough to rebut this presumption, because "a debtor has no constitutional or 'fundamental' right to a discharge in bankruptcy." Id. The Court also rejected the argument that "the clear-and-convincing standard" is "required to effectuate the 'fresh start' policy of the Bankruptcy Code." Id.
The Ninth Circuit has not addressed whether Grogan has 2 determined the burden of proving that an exemption is claimed in 3 bad faith. We are persuaded that Grogan has for the following 4 reasons. First, because Congress is silent, under Grogan we 5 must presume that exemptions may be disallowed for bad faith by 6 a "preponderance of the evidence." If the right to a discharge 7 was not important enough to rebut this presumption in Grogan, 8 neither is the right to an exemption, because it is not a 9 constitutional or "fundamental" right. Rather, allowance of 10 exemptions in bankruptcy is a matter of congressional 11 authorization under the Bankruptcy Code. See Schwab v. Reilly 12 at *4. Second, under Grogan, a higher standard is not necessary 13 to protect the "fresh start" purpose of the exemption statutes.
See id., at *11 ("exemptions in bankruptcy cases are part and 15 parcel of the fundamental bankruptcy concept of a 'fresh 16 start'")(internal quotation marks omitted). We find no support 17 for the debtors' contention that the Grogan Court limited its 18 reasoning to the facts of that case. Accordingly, following 19 Grogan, we reject the argument that "the clear-and-convincing 20 standard" is "required to effectuate the 'fresh start' policy of 21 the Bankruptcy Code." 498 U.S. at 286.
The Tenth Circuit's decision in Gillman v. Ford (In re 23 Ford), 492 F.3d 1148 (10th Cir. 2007) supports our conclusion 24 that Grogan controls the burden of proof. In Ford, the 25 bankruptcy court held that there was "clear and convincing" 26 evidence that a debtor had amended her schedules to claim an 27 exemption in pending litigation in bad faith. Id. at 1153-54.
The Tenth Circuit affirmed the bankruptcy court's ruling, but adopted the "preponderance of the evidence" standard instead.
Id. at 1154, 1157. Discussing Grogan, the Ford court analogized 3 that the "discharge of debt under § 523 is analytically similar 4 to obtaining an exemption in bankruptcy - in each case, the 5 debtor is seeking a preference vis-a-vis creditors that will be 6 sustained absent bad faith on the part of the debtor." Id. at 7 1154. The Tenth Circuit also observed that the "preponderance 8 of the evidence" standard "reflects a fair balance between [the 9 creditor's interest in recovering full payment of debts and the 10 debtor's interest in a fresh start]" equally in exemption 11 proceedings as in dischargeability actions. Id. at 1154-55.
Our conclusion is also reinforced by the panel's 13 observation in Arnold that having different standards for 14 exemption proceedings and dischargeability actions would create 15 "seemingly anomolous results" after Grogan. 252 B.R. at 784 16 n.10. For example, as the panel stated, a bankruptcy court may 17 allow a debtor's exemption under the higher standard, but deny 18 the same debtor a discharge under the lower one. Id. Following 19 Arnold, we now conclude that a uniform standard will achieve a 20 consistent balance between debtors' and creditors' interests and 21 will avoid such anomolous results.
"Courts [after Grogan] are split over the question of 23 whether bad faith or prejudice must be established by a 24 preponderance of the evidence or by clear and convincing 25 evidence." In re Rolland, 317 B.R. 402, 415 n.19 (Bankr. C.D. 26 Cal. 2004) (collecting cases). Courts in this circuit, however, 27 have universally applied the "preponderance of the evidence" 28 standard. See, e.g., id.; In re Reardon, 403 B.R. 822, 830 18 1 (Bankr. D. Mont. 2009). Moreover, although the Seventh Circuit 2 applied the higher standard in In re Yonikus, 996 F.2d 866, 872 3 (7th Cir. 1993), that court offered no explanation for doing so. 4 Id. (though citing In re Brown, 56 B.R. at 958).
Second, the debtors argue that the "clear and convincing" 6 standard is necessary to avoid infringing on exemption rights 7 created under California law. We disagree. As the Supreme 8 Court has recognized, bankruptcy exemptions are authorized and 9 regulated by Congress in § 522 of the Bankruptcy Code. See 10 Schwab v. Reilly, at *5. Although state law may control the 11 "nature and extent" of state law exemptions, subject to the 12 limitations set forth in the Bankruptcy Code, "the manner in 13 which such exemptions are to be claimed, set apart, and awarded, 14 is regulated and determined by the federal courts, as a matter 15 of procedure in the course of bankruptcy administration, as to 16 which they are not bound or limited by state decisions or 17 statutes." In re Moore, 274 F. 645, 648 (E.D. Mich. 1921); see 18 also Raleigh v. Illinois Dep't of Revenue, 530 U.S. 15, 21 19 (2000) ("Congress of course may do what it likes with 20 entitlements in bankruptcy"). Because Congress has regulated 21 the allowance of exemptions in bankruptcy, the Code and Rules 22 may alter burdens of proof relating to exemptions, even if those 23 burdens are part of the "substantive" right under state law. 24 See Raleigh v. Illinois Dep't of Revenue, 530 U.S. at 21-22 and 25 n.2. In implementing the provisions of § 522(l), Rule 4003(c) 26 places the burden of proof on the objecting party, see Fed. R. 27 Bankr. P. 4003, Advisory Committee Note ("This rule is derived from § 522(l) of the Code").*fn5 Bankruptcy courts may, in turn, define that burden because of their "equitable powers to adjust rights between creditors." Raleigh v. Illinois Dep't of Revenue, 530 U.S. at 24; see also Thomas E. Plank, The Erie Doctrine and Bankruptcy, 79 Notre Dame L. Rev. 633, 679-80 (2004).
Third, the debtors argue that the appellants waived their right to contest this issue by failing to raise it on appeal. We are mindful that, "[a]bsent exceptional circumstances, this court generally will not consider arguments raised for the first time on appeal." See United Student Funds, Inc. v. Wylie (In re Wylie), 349 B.R. 204, 213 (9th Cir. BAP 2006). However, "unlike a legal argument that is forfeited below, we are not obligated to apply an erroneous evidentiary standard." In re Ford, 492 F.3d at 1154 n.6. Moreover, we cannot, as the panel did in Arnold, avoid deciding this issue because, as we explain below, the bankruptcy court could have reached a different result if it had applied a lower standard of proof.
For these reasons, as the panel suggested in Arnold, we hold that a party objecting to a debtor's claim of exemption must prove bad faith by a "preponderance of the evidence" and 2 not by "clear and convincing" evidence.
B. The Bankruptcy Court could have Found, by a Preponderance 4 of the Evidence, that the Debtors Claimed the Exemption in Bad 5 Faith.
6 "Bad faith [in claiming exemptions] is determined by an 7 examination of the 'totality of the circumstances.'" In re 8 Rolland, 317 B.R. at 414. "Concealment of assets is the usual 9 ground for a finding of 'bad faith.'" Id. at 415, citing In re 10 Arnold, 252 B.R. at 785. However, "a debtor's intentional and 11 deliberate delay in amending an exemption for the purpose of 12 gaining an economic or tactical advantage at the expense of 13 creditors and the estate [also] constitutes 'bad faith.'" Id. 14 at 416.
Under the totality of the circumstances, the bankruptcy 16 court could have found, by a "preponderance of the evidence," 17 that the debtors concealed the value of the shares from the 18 trustee. The bankruptcy court could have found that the debtors 19 did not honestly believe, as they had testified, that the shares 20 were worthless. The March 6, 2009 e-mail proposal and the April 21 2, 2009 agreement suggest that Nicholson was already negotiating 22 a deal with Pall Medical on the petition date. Pall Medical was 23 apparently a multi-billion dollar company that would procure 24 sales for ASI throughout Europe and to the Red Cross. This 25 relationship was, therefore, expected to produce a dramatic 26 increase in revenues. Nicholson attested, in his opposition to 27 the trustee's objection, that the deal with Pall Medical would 28 "easily push total sales for this fiscal year in excess of 21 1 $1Million [sic], more than double last year's sales." Also, 2 Nicholson's April 27, 2009 buyout offer to have ASI purchase 3 Tyner's shares was made only six weeks after the petition date.
"[A]n offer to purchase an asset would normally constitute 5 strong evidence of the asset's value, even if there is only one 6 such offer." Grueneich v. Doeling (In re Grueneich), 400 B.R. 7 680, 687 (8th Cir. BAP 2009). Although the bankruptcy court 8 found that the consideration for the buyout was "speculative," 9 the court could have found that, by a preponderance of the 10 evidence, the debtors did not believe that the shares were 11 worthless as of the petition date because such a lucrative deal 12 was on the horizon.
The bankruptcy court gave little weight to the debtors' 14 beliefs or motives, opining that "[t]he bad faith exception to 15 Rule 1009(a) regulates bad-faith acts, not thoughts." However, 16 a debtor's subjective intent is an important, although not 17 determinative, factor in determining bad faith. Marsch v. 18 Marsch (In re Marsch), 36 F.3d 825, 828 (9th Cir. 1994).
We recognize that bad faith beliefs and motives are, as a 20 matter of law, insufficient. In Grueneich, the debtor amended 21 his schedules to claim an exemption in stock that he had valued 22 at $0. 400 B.R. at 682. The Eighth Circuit BAP held that the 23 bankruptcy court clearly erred in sustaining the trustee's 24 objection to the amendment. Id. at 687. The Eighth Circuit BAP 25 reasoned that there was no evidence, other than a recent 26 purchase offer, that the debtor did not honestly believe that 27 the stock had no value or that anyone was misled by the 28 schedules. Id. The Eighth Circuit BAP also noted that the 22 1 bankruptcy court did not allow the debtor to present evidence 2 that the company's liabilities exceeded its assets and that the 3 prospective buyer's motive was questionable. Id. Here, as in 4 Grueneich, the appellants submitted an uncontested appraisal 5 showing that ASI was underwater and had a purchase offer from an 6 insider that may not, therefore, be reliable evidence of value.
Here, however, unlike in Grueneich, the bankruptcy court 8 could have found that the debtors misled the trustee by 9 testifying that the stock was worthless. The trustee likely 10 would have abandoned the shares if Tyner had not objected 11 because the debtors did not amend their schedules until the same 12 day that the trustee noticed them for sale. Also, it is 13 apparently undisputed that Nicholson did not want Tyner to 14 acquire full control of ASI. Although mere delay in claiming 15 exemptions is insufficient evidence of bad faith, In re Arnold, 16 252 B.R. at 786, this delay, therefore, may have been a 17 deliberate attempt by Nicholson to gain an economic or tactical 18 advantage at the expense of his creditors. Nevertheless, we 19 leave it to the bankruptcy court to weigh the evidence again in 20 the first instance under the correct standard of proof.
C. The Bankruptcy Court did not Abuse its Discretion by not 22 Setting an Evidentiary Hearing.
23 The Fifth Amendment's requirement of due process applies in 24 bankruptcy proceedings. Gonzalez-Ruiz v. Doral Financial Corp. 25 (In re Gonzalez-Ruiz), 341 B.R. 371, 381 (1st Cir. BAP 2006). 26 Section 102(1)(A) of the Bankruptcy Code defines the phrase, 27 "after notice and a hearing" as "such notice as is appropriate 1 in the particular circumstances, and such opportunity for a 2 hearing as is appropriate in the particular circumstances."
3 11 U.S.C. § 102(1)(A). Therefore, "[t]he concept of 'notice and 4 a hearing' is a flexible one," In re Gonzalez-Ruiz, 341 B.R. at 5 381, citing Credit-Alliance Corp. v. Dunning-Ray Insurance 6 Agency, Inc. (In re Blumer), 66 B.R. 109, 113 (9th Cir. BAP 7 1986), aff'd, 826 F.2d 1069 (9th Cir. 1987). "The bankruptcy 8 judge has considerable, albeit not unlimited, discretion in 9 determining if the notice and a hearing requirement has been 10 satisfied." Id.
11 Likewise, Rule 43(c) of the Federal Rules of Civil 12 Procedure, which is applicable to contested matters under Rule 13 9017 of the Federal Rules of Bankruptcy Procedure, provides: 14 "When a motion relies on facts outside the record, the court may 15 hear the matter on affidavits or may hear it wholly or partly on 16 oral testimony or on depositions." Under this rule, bankruptcy 17 courts have "wide discretion" in deciding whether to take oral 18 testimony at an evidentiary hearing. United Commercial 19 Insurance Service, Inc. v. Paymaster Corp., 962 F.2d 853, 858 20 (9th Cir. 1992); accord Garner v. Shier (In re Garner), 246 B.R. 21 617, 624 (9th Cir. BAP 2000).
22 An evidentiary hearing is generally appropriate when there 23 are disputed and material factual issues that the bankruptcy 24 court cannot readily determine from the record. Thus, if a 25 contested matter in a bankruptcy case "cannot be decided without 26 resolving a disputed material issue of fact, an evidentiary 27 hearing must be held at which testimony of witnesses is taken in 28 the same manner as testimony is taken in an adversary proceeding 24 1 or at trial in a district court civil case." Fed. R. Bankr. P. 2 9014, Advisory Committee Note to 2002 Amendment. This advisory 3 committee note "makes clear that this requirement is intended to 4 require a trial when there is a genuine factual dispute." In re 5 Khachikyan, 335 B.R. at 126 and n.4.
6 However, "[n]othing in [Rule 9014(d)] prohibits a court 7 from resolving any matter that is submitted on affidavits by 8 agreement of the parties." Fed. R. Bankr. P. 9014, Advisory 9 Committee Note to 2002 Amendment. Therefore, "[w]here the 10 parties do not request an evidentiary hearing or the core facts 11 are not disputed, the bankruptcy court is authorized to 12 determine contested matters . . . on the pleadings and arguments 13 of the parties, drawing necessary inferences from the record." 14 In re Gonzalez-Ruiz, 341 B.R. at 381.
15 Rule 9014(e) requires bankruptcy courts to "provide 16 procedures that enable parties to ascertain at a reasonable time 17 before any scheduled hearing whether the hearing will be an 18 evidentiary hearing at which witnesses may testify." The 19 Eastern District of California has, accordingly, promulgated a 20 local rule that provides:
21 If the moving party does not consent to the Court's resolution of disputed material 22 factual issues pursuant to FRCivP 43(e), the moving party shall file and serve, within 23 the time required for a reply, a separate statement identifying each disputed material 24 factual issue. . . . Failure to file the separate statement shall be construed as 25 consent to resolution of the motion and all disputed material factual issues pursuant to 26 FRCivP 43(e).
Bankr. E.D. Cal. R. 9014-1(f)(1)(iii).
We quickly dispense with the appellants' claim that this 2 local rule, on its face, denied them due process of law. "The 3 three-part test for the validity of a local bankruptcy rule is: 4 (1) whether it is consistent with Acts of Congress and the 5 Federal Rules of Bankruptcy Procedure; (2) whether it is more 6 than merely duplicative of such statutes and rules; and (3) 7 whether it prohibits or limits the use of the Official Forms." 8 In re Garner, 246 B.R. at 624, citing Fed. R. Bankr. P. 9 9029(a)(1). Local Rule 9014-1(f)(1)(ii) easily satisfies each 10 of these requirements. First, the rule obeys Rule 9014(e)'s 11 directive by providing procedures that allow parties to request 12 an evidentiary hearing. Second, the local rule supplements the 13 Federal Rule because that Rule expressly does not provide such 14 procedures. Third, the local rule does not prohibit or limit 15 the use of the Official Forms.
We also reject the appellants' argument that the bankruptcy 17 court applied the local rule in a manner that deprived them of 18 due process. "A local rule imposing a requirement of form shall 19 not be enforced in a manner that causes a party to lose rights 20 because of a non-willful failure to comply with the requirement."
21 Fed. R. Bankr. P. 9029(a)(2). However, the bankruptcy court 22 appropriately interpreted the appellants' non-compliance with 23 the notice requirement as consent to let the matter rest on the 24 record alone. Although Tyner was not served with the debtors' 25 opposition to the trustee's objection to the claimed exemption, 26 she, along with the trustee who was served with the opposition, 27 could have filed the notice of disputed material factual 28 issue(s) with the reply, or at any time thereafter.
Further, even if the appellants had complied with the rule, 2 the bankruptcy court did not abuse its discretion. Bad faith is 3 a "highly factual determination" but does not generally require 4 an evidentiary hearing. C-TC 9th Ave. Partnership v. Norton Co. 5 (In re C-TC 9th Ave. Partnership), 113 F.3d 1304, 1312 (9th Cir. 6 1997). The appellants argue that whether Nicholson wrote the 7 Notes was a material and disputed fact. However, the appellants 8 had every opportunity to prove this fact without Nicholson's 9 testimony. They retained the full range of rights to discovery 10 in this contested matter, see In re Khachikyan, 335 B.R. at 126, 11 and were even permitted to supplement the record with 12 declarations and other evidence. Thus, the bankruptcy court was 13 able to determine this disputed fact from the record alone.
Again, however, since we remand this matter for further 15 proceedings, the bankruptcy court may, in the exercise of its 16 discretion, determine whether an evidentiary hearing is 17 appropriate.
Because we conclude that the bankruptcy court applied the 22 incorrect burden of proof to the trustee's objection to the 23 debtors' claim of exemption, we VACATE the bankruptcy court's 24 order overruling the trustee's objection and REMAND this matter 25 for further proceedings consistent with this opinion.