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In Re: Laurence R. Nicholson and Joyce V. Nicholson v. Laurence R. Nicholson

July 29, 2010

IN RE: LAURENCE R. NICHOLSON AND JOYCE V. NICHOLSON, DEBTORS. KAREN TYNER; APPLIED SCIENCE, INC., APPELLANTS,
v.
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

OPINION

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."

I. FACTS

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.

25

26

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 ...


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