Memorandum Decision re Reformation of Modification of Deed of Trust

Choi v. Bank of China - Memorandum Decision
             
        Original Filed
February 26, 2001
 
   
UNITED STATES BANKRUPTCY COURT

NORTHERN DISTRICT OF CALIFORNIA

       
In re

DENNIS C. T. CHOI,
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Bankruptcy Case
No. 00-30939DM
Debtor.

 

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Chapter 11

DENNIS C. T. CHOI and DEBBIE CHOI,

Plaintiffs.
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Adversary Proceeding
No. 00-3138DM
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BANK OF CHINA, a foreign corporation,

Defendant.

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MEMORANDUM DECISION

I. Introduction

In this matter plaintiffs Dennis C. T. Choi ("Choi") and his wife, Debbie Choi (together, "the Chois"), seek to limit the secured claim on their family residence held by defendant Bank of China ("Bank") to $2 million, representing only a small portion of the Chois' liability to Bank on account of personal guarantees ("the Guarantees") given by them for loans made to a related corporation, Nature's Farm Products, Inc. ("NFP"). Bank relies on a 1997 restructuring of the underlying debt and the security documents pertaining to the Guarantees, and contends that the entire liability under the Guarantees is secured at least up to the full value of the Residence.

The Chois also contend that Bank is liable to them for the breach of an implied covenant of good faith and fair dealing, entitling them to general and punitive damages. Bank, in addition to various defenses on the merits of the Chois' claims, contends that this is a non-core matter and, in addition, that this court lacks jurisdiction to enter judgment against it because it is a foreign sovereign.

For the reasons stated below, the court concludes that the court has jurisdiction to adjudicate this matter; that this matter involves both core proceedings and non-core proceedings, on the latter of which this court cannot enter a final adjudication, but that the relief granted to the Chois herein does not involve non-core proceedings; that the Chois are entitled to reformation of the document that purports to modify their secured obligations to Bank; that Bank's lien on their home is limited to no more than $2 million as a secured claim; and that Bank is not liable to the Chois for any damages but the Chois are entitled to recover their reasonable attorneys' fees and costs.

II. Procedural History

On or about November 4, 1999, Bank began non-judicial foreclosure proceedings against the Chois' family residence at 350 West Santa Inez Avenue, Hillsborough, California (the "Residence"). A trustee's sale was scheduled for April 17, 2000. In March, 2000, NFP filed a lender liability action against Bank in the United States District Court for the Northern District of California (Case No. C-2000-0721), in which the Chois joined later that month. On or about March 30, 2000, NFP and the Chois filed a motion for a temporary restraining order seeking to prevent Bank from foreclosing on the Residence. That motion was heard on April 13, 2000, and orally denied.

On April 14, 2000, Choi filed a voluntary petition under Chapter 11 of the Bankruptcy Code. On May 5, 2000, Bank filed a motion for relief from the automatic stay. A preliminary hearing on that motion was held on May 25, 2000, at which the parties disputed the value of the Residence, the Chois' good faith, and the validity and amount of Bank's lien. The matter ultimately came to a trial on the valuation and good faith issues. On June 27, 2000, the Chois filed their Complaint For Reformation And Damages (the "Complaint"). Bank thereupon moved to dismiss the Complaint, primarily based upon the parol evidence rule of Cal. Code Civ. Proc. ("CCP") § 1856(a). In making that motion Bank did not question the jurisdiction of this court to enter a final judgment in the matter.

By Order Denying Motion To Dismiss Complaint ("the Order Denying Motion") filed on August 29, 2000, the court denied Bank's motion to dismiss the Complaint, concluding, in essence, that the action does not amount to an attempt to rescind the entire encumbrance on their home, but merely seeks to reform a modification of the security document that eliminated a $2 million ceiling on Bank's secured claim. Meanwhile, on August 4, 2000, Bank filed proofs of secured and unsecured claims in the amounts of $24,172,766.68 and $4,682,794.12, respectively.

Thereafter, Bank filed its First Amended Answer to the Complaint on October 18, 2000 and the matter came on for trial beginning on October 30, 2000. The last day of trial was November 27, 2000. The Chois appeared and were represented at trial by Steven C. Finley, Esq.; Bank appeared and was represented by Robert P. Pringle, Esq. and James J. Ostertag, Esq.

III. Discussion1

Choi is one of the principal shareholders of NFP, a California corporation engaged in the importation and wholesale distribution of canned food products. NFP has had a borrowing relationship with Bank since 1985. It was and is a substantial customer of Bank and Choi was regarded as a very important client of it. In May, 1996 NFP was the borrower under a revolving line of credit facility with Bank in the maximum aggregate amount of $22 million (the "1996 Credit"). Bank held various guarantees, some of which were secured. The Guarantees at issue in this litigation are secured by a deed of trust on the Residence. The June 25, 1996 Deed of Trust ("Deed of Trust") given by the Chois as trustors to Bank (through its New York branch) as beneficiary contains a limitation to the effect that the Deed of Trust is for the purpose of securing "... payment of the indebtedness owed by [NFP] under the [NFP-Bank loan documents] ... in the principal sum up to TWO MILLION and 00/100 ($2,000,00.00) DOLLARS...."2

The 1996 Credit had an expiration date of May 15, 1997. In the fall of 1996, NFP experienced business reverses due to problems with its supply of wholesale food products. Also in the fall of 1996 it transferred $2 million to an affiliate, Nature's Farm Products (Chile) S.A. ("NFP-Chile"). That transfer from NFP to NFP-Chile was done without the knowledge of Bank.

At all times material to the dispute between the Chois and Bank, the key representatives of Bank that Choi and NFP dealt with were: Zhu ZhiCheng ("Zhu"), the then general manager of Bank's New York branch with overall responsibility for loans; Jai Shu Luo ("Luo"), Bank's New York branch deputy general manager; Pin Tai ("Tai"), Bank's New York branch assistant general manager; and Peggy Chan ("Chan"), Bank's New York branch credit officer.

When Bank and NFP entered into the 1996 Credit, the approximate available equity (behind senior liens) in the Residence available to secure the Deed of Trust was $2 million. The parties dispute, and the court need not resolve, whether the $2 Million Cap was based upon this equity or based upon varying amounts of secured guarantees given by the Chois and other shareholders of NFP.3Regardless of the origins of the $2 Million Cap, by the fall of 1996 property values in the San Francisco Bay Area had increased and the Residence was no exception.

Zhu understood that because the Guarantees were not limited by the $2 Million Cap, all of the Chois' assets, including the full value of Residence, would be available to satisfy the Chois' debts to Bank.4 However, he acknowledged that no written or verbal agreement to that effect existed and that, if tested, the $2 Million Cap would have applied to the Deed of Trust.

In September, 1996, Zhu visited Choi at the Residence. During the course of that visit Choi commented on the increased value in the Residence and offered that if there was not enough value in the Residence to discharge NFP's liabilities, he would "work like a slave" in order to fulfill his obligations to Bank. This comment by him was not inconsistent with his exposure to the full amount of the NFP debt under the 1996 Credit via the Guarantees. Indeed, as noted, whatever equity existed in the Residence would stand for the Chois' debts, including any unsecured portion of the Guarantees.

At around the same time Zhu learned of the transfer of $2 million from NFP to NFP-Chile. He was very upset about that transaction and admonished Choi for it. Choi apologized for what had been done without Zhu's knowledge. Also in the fall of 1996 Bank's head offices in Beijing desired, and Zhu, Luo, Tai and Chan all knew that Bank desired to eliminate the $2 Million Cap.

In January, 1997, Choi approached Bank in New York about restructuring NFP's $22 million 1996 Credit. Chan and Luo thereafter confirmed that meeting by delivering to NFP, through Choi as its president, a letter of January 23, 1997, summarizing tentative terms and conditions regarding restructuring of the 1996 Credit. In general, the $22 million credit line was to be split into a $17 million revolving line of credit and a $5 million term loan. Of significance to the present dispute, the security, documentation and terms and conditions of the 1996 Credit were to remain unchanged. As of January, 1997, neither of the Chois had any knowledge that Bank desired to remove the $2 Million Cap. While Bank contends that Zhu and Choi had a discussion as early as September, 1996, wherein Choi acknowledged that all of the value in the Residence was available to meet his obligations to Bank, there was no specific indication that Bank mentioned or required removal of the $2 Million Cap, nor that the Chois or either of them were willing to remove it. Rather, Choi's own exposure on the Guarantees is completely consistent with his recognition that if NFP failed, essentially all of the value of the Residence would be available to meet the obligations to Bank.

In early 1997, Choi had several meetings with Chan and Tai to discuss the terms and conditions of the restructuring of the 1996 Credit. At no time did Choi discuss with Tai, Chan or anyone else at Bank the removal of the $2 Million Cap.

Zhu directed representatives of Bank to travel to the Bay Area in the spring of 1997 to determine whether there had been increases in the values of various properties available to constitute additional collateral, including the Residence, to secure NFP's debt to Bank. Choi was aware of the visit, as he met with those representatives, but he was not informed of the Bank's intentions to estimate the value of the Residence.

Chan and Luo signed and delivered to Choi, as president of NFP, a letter of April 2, 1997 (the "April 2 Conditional Commitment Letter"), indicating that Bank had approved the request to restructure the $22 million 1996 Credit under certain terms and conditions. Immediately following the opening paragraph appear the words "Conditional Nature Of Commitment Letter." Zhu testified that the April 2 Conditional Commitment Letter was made conditional because Bank needed the help of its attorneys to eliminate the $2 Million Cap. Following that caption, the letter recites that the terms and conditions of the restructuring do not become effective, and Bank is not bound by them, until a formal agreement and related documents are signed and all conditions precedent are fulfilled. Under a caption "Security And Support" the unconditional continuing personal guaranties for $22 million from the Chois and others are noted, as is the Deed of Trust for $2 million on the Residence. Later in the letter appear fourteen enumerated "Conditions Precedent" and eight enumerated "New Terms And Conditions." No enumerated Condition Precedent nor any enumerated New Term or Condition indicates the removal of the $2 Million Cap. Thus, removal of the $2 Million Cap was not stated as a condition precedent to the new financing, nor a feature of it.

It was Bank's practice to negotiate transactions such as credit restructuring directly with borrowers, and to involve their own attorneys only in the preparation of documents. In this transaction Bank's attorneys, both in New York and California, dealt only with Bank; they had no direct communication with NFP, Choi, or any of their attorneys. In April, 1997, after Bank's head offices indicated a willingness to approve a restructuring of the 1996 Credit only upon removal of any limitations on security available to them, including removal of the $2 Million Cap, Bank's California attorneys commented in writing to Chan about the $2 Million Cap. Specifically, they reported that the more usual practice is to have a deed of trust secure an entire obligation, regardless of the actual value of the property, thus allowing the lender in its sole discretion to resort to each property in any order. Bank did not communicate this possible scenario to NFP or the Chois.

Bank's attorneys did not advise Bank, nor is it the law, that there is any legal requirement that deeds of trust or other encumbrances be unlimited in their nature; in fact, the contrary is true. The $2 Million Cap does not violate any provision of California law.

Consistent with the foregoing advice, Bank's California attorneys prepared various items of loan documentation, including a Modification Of Deed Of Trust (the "Modification") in respect of the Residence. The Modification contained preamble recitals reflecting the Deed of Trust given by the Chois to Bank in connection with the 1996 Credit, referred to the restructuring of the credit facility, and provided for various specific modifications to the Deed of Trust. An unnumbered paragraph entitled "For The Purpose Of Securing" that appeared in the Deed of Trust was deleted and replaced by language in the Modification that purported to secure payment of the entire indebtedness owed by NFP to Bank and subject to the Guarantees. Thus, the $2 Million Cap was eliminated not by specific reference, but by deletion of the entire section of the Deed of Trust in which it was contained, and replacement of a different series of subparagraphs.

Chan acknowledged that eliminating the $2 Million Cap without notifying the Chois was a departure from the normal practice of obtaining the agreement of any borrower when conditions such as these are changed.

Choi believed that the April 2 Conditional Commitment Letter was the agreement he had with Bank, based in part upon a long and good relationship he and NFP had with Bank and further upon his trust in Zhu as his banker. Choi received voluminous documentation on or about April 28, 1997, which documentation included the $17 million revolving credit facility and a $5 million term loan (set forth in the Amended Credit Agreement) from Bank to NFP (collectively, with all related documentation, the "1997 Credit"), and the Modification. Although Choi had experience in buying at least four parcels of real estate between 1978 and 1987, and is generally able to read simple English language documents, he did not read them in detail and did not forward them to his or NFP's counsel. It was NFP's practice to have its counsel review documents of this nature yet for some unexplained reason, both in connection with the 1996 Credit and the 1997 Credit, Bank required NFP and the Chois to sign a letter that recited that they had chosen not to be represented by an attorney. When confronted with the large number of documents Bank wanted signed, Choi asked for more time to have the attorneys review them. Both Chan and Zhu assured him that the documents were needed right away and that the terms and conditions were the same as recited in the April 2 Conditional Commitment Letter. In reliance on those representations, and with no contrary understandings to the effect of those documents, Choi signed them.

Apart from the Modification and the other related loan documents pertaining to the 1997 Credit, Choi, as president of NFP, was asked to sign Closing Instructions addressed to Commonwealth Land Title Company. A set of those Closing Instructions was executed as late as May 22, 1997, thus indicating that Choi may have had more time to review the documents than he testified at trial. But having additional time is irrelevant, as Choi believed that the April 2 Conditional Commitment Letter was the agreement, and because he relied on Zhu's and Chan's assurances. In any event Choi signed those later Closing Instructions solely in his capacity as president of NFP; neither he nor his wife, Debbie Choi, signed in their individual capacities. Of equal importance, the Closing Instructions insofar as they pertain to the Residence are ambiguous. Under a provision entitled "Insuring Priority" the title policy to be issued to Bank was to insure the Deed of Trust as modified by the Modification "securing a principal amount of up to $22.0 million...." In the very next subparagraph, however, following the caption "Amount Of Insurance," the figure $2 million appears.

When the Chois signed the Modification they did not realize that the effect was to remove the $2 Million Cap. Only in November, 1999, when Bank declared a notice of default and commenced foreclosure against the Residence did the Chois first learn that the $2 Million Cap was gone.

Apart from all that, Bank contends that the Chois knew of the Modification and the effect it would have on encumbrances against the Residence. Bank's entire case rests on an alleged telephone conversation between Luo and Choi in April, 1997. Preliminarily, Luo testified under oath in the district court action that to his knowledge, personnel of Bank disclosed all terms and conditions of the Modification to Choi. That statement lacks the specificity to permit a finding that the Chois were informed that the $2 Million Cap was being removed. Further, Luo's testimony is not credible, in part because he has also testified that Bank's California lawyers told him that California law required that the $2 Million Cap would be removed, a fact that was neither established by any other evidence nor, as noted, is accurate as a matter of law. Further, Luo's recollection about the disputed telephone conversation with Choi in April, 1997 is very vague. He made no notations about it; he could not confirm whether Choi had already received the loan documents pertaining to the 1997 Credit; he offered no specifics as to the date of the telephone conversation; and he merely testified that he told Choi about the written advice from Bank's California counsel "... about the requirement of the removal of the upper limit for the security amount on the real properties and I remembered his answer that he, in any case, all my properties have been mortgaged to your bank." Since the attorney's letter only commented on the usual practice, and not whether elimination of the $2 Million Cap was required by law, Luo's recollections of what was said on the alleged phone call are imprecise and unreliable. Also, as previously noted in the conversations between Zhu and Choi in September, 1996, Choi had reason to believe that all of the equity in his properties was available to cover his liability on the Guarantees; in actual fact, Luo's testimony that Choi said all of his properties had been mortgaged to the Bank was not accurate.5

His statement to the effect that he told Choi that the lawyers wanted the $2 Million Cap removed is equally unbelievable since Zhu, Luo's superior, made it abundantly clear the decision to eliminate the $2 Million Cap was that of the Bank, and not the decision of the attorneys. In sum, Choi did not learn from Luo that Bank intended to remove the $2 Million Cap.

IV. Issues

A. Does this court have jurisdiction to adjudicate these matters?

B. Is this a core proceeding?

C. Are the Chois entitled to equitable relief by way of reformation of the Modification?

D. Are the Chois entitled to damages, and if so, are they entitled to punitive damages?

E. Are the Chois entitled to their attorneys' fees.

V. Analysis

A. This court has jurisdiction to adjudicate these matters.

Bank is a corporation organized under the laws of the Peoples Republic of China, wholly owned by the government of the Peoples Republic of China, and doing business in the United States with branches in New York and California. Bank claims that jurisdiction to enter a judgment in these matters rests exclusively with the United States District Court under the Foreign Sovereign Immunities Act ("FSIA"), 28 U.S.C. §§ 1330, 1603-1610. According to Bank, this court can only "hear preliminary discovery matters" and enter proposed findings of fact and conclusions of law.6

Bank did not raise FSIA in its twenty-nine affirmative defenses, nor in its motion to dismiss the Complaint, nor in the proceedings in connection with that motion, nor in time to save the Chois from briefing the core/non-core issues discussed below. Bank raised FSIA for the first time on the first day of trial, in a supplemental trial brief. Moreover, although Bank's proofs of claim state that it "neither expressly nor impliedly consents to the jurisdiction of the Bankruptcy Court" Bank did not cite FSIA in those proofs of claim and Bank has never filed a motion with the United States District Court to withdraw the reference to this court under 28 U.S.C. § 157(d). Bank had every opportunity to raise FSIA sooner, and understood that its claims and the Chois' claims or counterclaims against Bank both arose from the same transaction or occurrence.

In these circumstances Bank has waived and is estopped to assert any rights it may have had as a "foreign state" to contest the bankruptcy court's jurisdiction over the Chois claims or counterclaims. Phoenix Consulting Inc. v. Republic of Angola, 216 F.3d 36, 39 (D.C. Cir. 2000) ("if the sovereign makes a ‘conscious decision to take part in the litigation,' then it must assert its immunity under the FSIA either before or in its responsive pleading"); cf. Alpha Therapeutic Corp. v. Nippon Hoso Kyokai, 199 F.3d 1078, 1085-86 (9th Cir. 1999) (declining to find waiver where FSIA was raised three months after filing answer, but defendant successfully moved to dismiss based on FSIA), opinion withdrawn pursuant to parties' stipulation, ___ F.3d ___, 2001 WL 28095 (9th Cir. 2001). See also In re Lazar (Schulman v. State of California), ___ F.3d ___, 2001 WL 29160, text accompanying nn. 9-14 (9th Cir. 2001) (sovereign immunity can be waived, and where arm of state files proofs of claim state waives Eleventh Amendment immunity regarding counterclaims arising from same transaction or occurrence). Contra Resolution Trust Corp. v. Miramon, 935 F.Supp. 838, 841 & n.2 (E.D. La. 1996) (sovereign immunity not subject to waiver or estoppel).

B. These matters are core proceedings.

Bankruptcy courts may hear non-core proceedings but absent the parties' consent they are limited to submitting proposed findings of fact and conclusions of law to the district court. 28 U.S.C. § 157(c). The terms "core" and "non-core" are not defined in the Bankruptcy Code. Section 157(b)(2) of Title 28 recites a partial list of core proceedings. However, that statutory provision is subject to limitations under the United States Constitution. In Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50, 102 S.Ct. 2858, 73 L.Ed.2d 598 (1982), "the Supreme Court held that the portion of the Bankruptcy Act of 1978 which allowed a bankruptcy court to entertain and decide a state law contract claim over the objection of one of the parties violated Article III of the United States Constitution." Piombo Corp. v. Castlerock Properties (In re Castlerock Properties), 781 F.2d 159, 160 n.1 (9th Cir. 1986).

The Chois' Complaint alleged that this is a core proceeding, citing 28 U.S.C. § 157(b)(2)(A) and (O), the "catch all" provisions of that statute. Bank denied that this was a core proceeding in its Answer, its First Amended Answer, and its trial brief. The Chois then filed a supplemental trial brief on the issue, adding citations to 28 U.S.C. § 157(b)(2)(G) (relief from automatic stay) and (K) (validity and extent of liens), and arguing that this proceeding is core because it involves allowance or disallowance of a claim against the estate (§ 157(b)(2)(B)). Both parties' briefs only refer to the "reformation claim," but it is unclear whether this is a shorthand for the entire Complaint or just the first claim for relief. Regardless of the parties' intent, this court will consider how their arguments apply to both claims for relief.

1. The first claim for relief is core

The Complaint's first claim for relief seeks reformation of the Modification on grounds of fraud or mistake. This essentially seeks to determine the validity and extent of Bank's lien, and is therefore a core proceeding under 28 U.S.C. § 157(b)(2)(K). Spartan Mills v. Bank of America Illinois, 112 F.3d 1251, 1256 (4th Cir. 1997), cert. denied, 522 US 969, 118 S.Ct. 417, 139 L.Ed.2d 319 (1997); John Hancock Mutual Life Ins. Co. v. Watson (In re Kincaid), 917 F.2d 1162, 1165 (9th Cir. 1990); Diversified Mortgage Co., Inc. v. Gold (In re Gold), 247 B.R. 574, 577 (Bankr. D. Mass. 2000) (adversary proceeding for reformation of mortgages was core proceeding to determine validity, priority, or extent of liens).

In addition, determining whether to award attorneys' fees is sufficiently part of this proceeding that it is also treated as a core proceeding. United States v. Yochum (In re Yochum), 89 F.3d 661, 669-670 (9th Cir. 1996) (award of attorneys' fees emanated from bankruptcy proceedings and it "makes common sense" to construe that award as core proceeding because bankruptcy court was most familiar with case and attorneys).

2. The second claim for relief is also core

The Complaint's second claim for relief is for compensatory and general damages for breach of the implied covenant of good faith and fair dealing. Although this court decides below that no such damages should be awarded, this court must determine whether that decision should be by way of final or proposed findings of fact and conclusions of law.

As noted, the Chois assert that this is a core proceeding under the "catch all" provisions 28 U.S.C. § 557(b)(2)(A) and (O). However, the Ninth Circuit Court of Appeals has ruled that these provisions do not encompass "state law contract claims that do not specifically fall within the categories of core proceedings enumerated in 28 U.S.C. § 157(b)(2)(B)-(N)." Castlerock, 781 F.2d at 162.

The Chois also assert that this is a core proceeding because it was filed in response to Bank's motion for relief from the automatic stay. Paragraph (G) of 28 U.S.C. § 157(b)(2) defines core proceedings as including "motions to terminate, annul, or modify the automatic stay." However, the creditor in Castlerock had filed a motion for relief from the automatic stay, and that did not prevent the Castlerock court from deciding that the proceeding was non-core. Id. at 160. Filing a motion for relief from the automatic stay is analogous, in this context, to appearing for a limited purpose without consenting to jurisdiction. Therefore, this court is not persuaded that this is a core proceeding under paragraph (G).

The more relevant statutory provisions are paragraphs (B) and (C) of 28 U.S.C. § 157(b)(2). Paragraph (B) concerns "allowance or disallowance of claims against the estate." Paragraph (C) concerns "counterclaims by the estate against persons filing claims against the estate." Although the Chois do not cite paragraph (C) both they and Bank focus heavily on Castlerock, which was decided under paragraph (C). Moreover, the distinction between "claims" and "counterclaims" is blurred in this case7 and, as further discussed below, this court will treat paragraphs (B) and (C) as two sides of the same coin.

In Castlerock the Ninth Circuit determined that paragraph (C) did not apply for two reasons. First, the Ninth Circuit stated that the creditor "would not have filed [its] Proof of Claim if the bankruptcy court had declined jurisdiction over the counterclaims" and therefore "it seems unfair under the facts of this case to categorize the counterclaims as falling within this provision." Id. at 161-162. The facts in Castlerock are initially similar: the creditor in Castlerock was the plaintiff in a pending state court action; the debtor filed state law counterclaims; and the bankruptcy court elected, over the creditor's objection, to try those matters in the bankruptcy court. However, this court cannot find that Bank "would not have filed" its proofs of claim but for the Chois' Complaint – to the contrary, Bank had to file its proofs of claim to protect its potentially very large unsecured claim. Therefore, Castlerock's first ground for ruling the counterclaims non-core is inapplicable.

Second, Castlerock held that "the apparent broad reading that can be given to § 157(b)(2) should be tempered by the Marathon decision." In particular:

This circuit has interpreted Marathon as depriving the bankruptcy court of jurisdiction "to make final determinations in matters that could have been brought in a district court or a state court."

Castlerock, 781 F.2d at 162, quoting Lucas v. Thomas (In re Thomas), 765 F.2d 926, 929 n.3 (9th Cir. 1985).

This test would appear to make the Chois' second claim for relief a non-core proceeding, because that claim was in fact brought in the district court. However, the Ninth Circuit recognized what it called "well-settled law that a creditor consents to jurisdiction over related counterclaims by filing a proof of claim." Castlerock, 781 F.2d at 162 (emphasis added). See also In re Levoy and Aikens (United States v. Levoy), 182 BR 827 (9th Cir. BAP 1995) (by filing proofs of claim, United States submitted to bankruptcy court jurisdiction over counterclaims, citing Langenkamp v. Culp, 498 US 42, and other cases involving waivers by filing proofs of claim).

The Ninth Circuit's focus on "related counterclaims" echoes a line of similar cases. See Kaiser Steel Corp. v. Frates (In re Kaiser Steel Corp.), 95 BR 782, 788-789 (Bankr. D. Colo. 1989) (citing cases, and noting split in authority whether counterclaims must be "compulsory"), aff'd, 109 BR 968 (DC Colo.), appeal dismissed, mandamus granted as to jury right in some of consolidated appeals, 911 F.2d 380 (10th Cir. 1990). In fact, as the Supreme Court has pointed out, counterclaims are often "part and parcel" of determining claims. Katchen v. Landy, 382 US 323, 330; 86 S.Ct. 467, 473; 15 L.Ed.2d 391 (1966). See Taubman Western Assoc's, No. 2 v. Beugen (In re Beugen), 81 BR 994, 1000 (Bankr. N.D. Cal. 1988) (Carlson, J.) (Katchen is "still good law"), citing Commodity Futures Trading Com'n v. Schor, 478 US 833, 853; 106 S.Ct. 3245, 3258; 92 L.Ed.2d 675 (1986). See also 1 Collier on Bankruptcy ¶ 3.02[3][d] (15th Ed., L. King Ed., through Dec. 2000), text accompanying n. 54 ("it seems probable that the filing of a proof of claim subjects the claimant to core treatment only if the counterclaim involves the same subject matter as the proof of claim [or involves avoiding powers].").

There is some authority that it matters whether the "counterclaim" is filed before or after the creditor files its proof of claim. However, this court believes the better analysis focuses on whether the creditor would have filed a proof of claim but for the bankruptcy court's adjudication of the issues and how closely the claims and counterclaims are related. Compare Sun West Distributors, Inc. v. Grumman Energy Systems Co. (In re Sun West Distributors, Inc.), 69 BR 861 (Bankr. S.D. Cal. 1987) (implying that sequence does matter), and Annotation, Action for Breach of Contract as Core Proceeding in Bankruptcy Under 28 U.S.C.A. § 157(B) (1995 & Supp. Through 2000), § 2 ("Virtually all of the courts which have addressed the issue whether adversary proceedings on behalf of the estate of the debtor for breach of contract in which the defendants counterclaim against the estate have held that such proceedings are not core proceedings under 28 U.S.C.A. § 157(b) ..., though there are a few cases to the contrary ...."), with Kaiser Steel, 95 BR at 788 (explicitly rejecting sequence of claims and counterclaims as a basis for determining core and non-core) and Beugen, 81 BR at 1000 ("Numerous courts have held that a claim and a counterclaim arising out of the same transaction comprise a single legal controversy that should not be divided.").

Although Castlerock has sometimes been interpreted as relying on the sequence of "claim" and "counterclaim" (e.g., Kaiser Steel, 95 BR at 788) a close reading shows otherwise. In Castlerock the Ninth Circuit noted that the bankruptcy court had already treated the proceeding as core over the creditor's objections, and therefore the creditor's filing of a proof of claim was effectively non-consensual. Castlerock, 781 F.2d at 162 ("Castlerock cites no case in which the filing of the proof of claim followed the bankruptcy court's assertion of jurisdiction over the counterclaims despite objections from the creditor.") (Emphasis added.). The Ninth Circuit explained that the purpose of treating the filing of a proof of claim as consent to counterclaims is "to prevent a bankruptcy trustee from having to split a cause of action by defending against the claim in the summary proceedings and then seeking affirmative relief in a plenary suit." Castlerock, 781 F.2d at 162 (quotation marks and citation omitted). What the Ninth Circuit rejected has been called "jurisdiction by ambush": "forcing the creditor to file a proof of claim as a defensive maneuver, thereby conferring jurisdiction on the bankruptcy court." Castlerock, 781 F.2d at 162-163, citing Dexter v. Gilbert (Matter of Kirchoff Frozen Foods, Inc.), 496 F.2d 84, 86 (9th Cir.1974). The Ninth Circuit explained what it means to file a claim for "defensive" purposes in Kirchoff: "Only if the [creditors'] claim of right to retain the funds were resolved adversely to them would it become necessary for them to claim against the bankrupt estate as creditors." Kirchoff, 496 F.2d at 86.

Those facts are inapplicable in this case. Bank did not have to file a proof of claim "as a defensive maneuver" – Bank asserted there was no equity in the Residence and it filed a multi-million dollar unsecured claim, as well as a secured claim. The existence of those claims does not depend on the second claim for relief being "resolved adversely" to Bank. Moreover, the policy identified in Castlerock would be undermined if the second claim for relief were classified as non-core: then the Chois would have to "split their cause of action" because their second claim for relief constitutes not only a claim against Bank but also a possible set-off to Bank's secured claim and hence a defense to Bank's assertion that there is no equity in the Residence. In fact, Bank's own nineteenth affirmative defense is for setoff Finally, Bank did not move the district court to withdraw the reference to this court, and that is another reason why splitting this case between two courts at this late stage is inappropriate.

In sum, Bank filed its proofs of claim voluntarily and this court cannot find that Bank would have declined to file those claims but for the presence of the second cause of action before this court; the Chois' second claim for relief is "part and parcel" of the process of allowing or disallowing Bank's secured and unsecured claims; the second claim for relief and Bank's asserted claims would each be compulsory counterclaims against the other outside of bankruptcy; and designating the second claim for relief as non-core would force the Chois to "split" their second claim for relief. For all of these reasons, this court rules that the Chois' second claim for relief is a core proceeding under the facts of this case. See Durkin v. Benedor Corp. (In re G.I. Industries, Inc.), 204 F.3d 1276, 1279-80 (9th Cir. 2000) (core proceeding included not only determination of proof of claim itself but also determination of validity of underlying agreements between parties based on alleged lack of mutual intent between parties and lack of consideration).

C. The Chois are entitled to rescind the Modification and therefore reform their obligations under the Deed of Trust.

In the Order Denying Motion the court set forth the legal principles on which it permitted the Chois to take this matter to trial. As stated therein, whether they could prove their allegations would be determined as a factual matter. No purpose would be served by restating the legal theories the court left open for the Chois to apply. Rather, the following will demonstrate how the application of those theories to the established facts leads the court to reach the result that it does.

1. Absence Of Fraud

In their trial brief the Chois set forth the well-known elements of fraud that must be established to justify reformation of the Modification under Cal. Civ. Code § 3399. It is sufficient to focus only on the third element, intent to induce or deceive, to demonstrate that the Chois may not prevail on this theory. They have the burden to prove, but did not prove, that Bank or any of its representatives set out on a course of action that resulted in execution of the Modification with the intent to trick or deceive the Chois. In fact, any such willful intent is completely negated by the fact that the 1997 Credit documents themselves do exactly what Bank wanted to do, namely restructure NFP's debt and remove the $2 Million Cap. If the Chois were tricked, they had ample opportunity to learn that it was about to happen and how such events would affect them.

The Chois no doubt contend that it is precisely the failure of Bank, and in particular Zhu, Luo and Chan to point out the legal effect of the Modification, that establishes fraud. The court is convinced that the mere showing of a failure to disclose, in light of the sequence of events that did in fact provide the Chois with ample opportunity to understand the documents, negates any inference of actual intent to deceive. No such proof can be found from the evidence submitted.

2. Unilateral Mistake

As noted in the Order Denying Motion, the parol evidence rule of CCP § 1856(a), does not prevent the Chois from proving that they did not read the Modification as a result of their unilateral mistake under circumstances the Bank knew or suspected to be present.8 However, the Chois' burden is high: the courts have generally required clear and convincing proof, or something more than a preponderance of the evidence. Messner v. Mallory, 107 Cal. App. 2d 377, 381 (1951) (unilateral mistake); California Trust Co. v. Cohn, 9 Cal. App. 2d 33, 40 (1935) (same); Bernstein v. Pavich (In re Pavich), 191 BR 838, 845 (Bankr. E.D. Cal. 1996) (mutual mistake).

"Clear and convincing" proof "demands a high probability" but "falls well short of what is required for a criminal conviction." 1 Witkin, Cal. Evid. 4th § 38 (2000) (emphasis in original), citing BAJI (8th ed.), No. 2.62; Cal. Evid. Code §§ 115 and 502; Mattco Forge v. Arthur Young & Co., 52 Cal. App. 4th 820, 848, 849 (1997). The evidence must be of such convincing force that it demonstrates, in contrast to the opposing evidence, a high probability of the truth of the facts for which it is offered as proof. BAJI (8th ed.) No. 2.62.

Based upon the relationship of NFP and the Chois to Bank, the evolution of the credit transactions from May, 1996 to May 1997, the language of the April 2 Conditional Commitment Letter, and the assurances that the loan documentation (which included the Modification) were consistent with the terms and conditions of the April 2 Conditional Commitment Letter, the evidence is clear, and the court is convinced, that Bank knew or suspected that the Chois were unwittingly and unknowingly removing the $2 Million Cap by signing the Modification, and that such action was material in connection with their relationship with Bank.

The court acknowledges that the April 2 Conditional Commitment Letter is exactly that, a conditional commitment. But the course of dealing of the parties encouraged Choi's reliance on its terms and, more importantly, by stating that the loan would not become effective until the conditions precedent had been fulfilled, Bank strongly implied the only conditions were those stated. Not one of those conditions or the new terms described in the letter relate in any way to the $2 Million Cap.9 Moreover, the Modification itself says nothing in its recitals or text about the $2 Million Cap, and only by a careful comparison of the Modification and the Deed of Trust could Choi have discovered that the $2 Million Cap was being eliminated. Finally, although Section 7.10 of the 1997 Credit attempts to evade the rule that ambiguities are construed against the drafter, that attempt is both factually and legally ineffective. Factually, that section says "all parties being represented by legal counsel," which is directly contrary to the letter Bank had the Chois sign saying they were not represented by legal counsel. Legally, it would not be enough even were Bank to show that the parties were in equal bargaining positions – there must be "evidence the actual provision in dispute was jointly drafted." Vons Companies, Inc. v. United States Fire Ins. Co., 78 Cal.App.4th 52, 58 (2000), as modified, review denied. There is no evidence the documents eliminating the $2 Million Cap was jointly drafted.

When a contract is reformed on grounds of unilateral mistake, the contract which was intended by the party acting under that unilateral mistake is the contract of the parties (provided no third parties are prejudiced thereby). See Cal. Civ. Code Section 3399; Stare v. Tate, 21 Cal. App. 3d 432, 438-439; 98 Cal. Rptr. 264, 268 (1971); Eagle Indem. Co. v. Industrial Accident Commission, 92 Cal. App. 2d 222, 229; 206 P.2d 877, 881 (1949); Hanlon v. Western Loan & Bldg. Co., 46 Cal.App.2d 580, 603; 116 P.2d 465, 478 (1941) (reformation of deed). Here, no third parties were or will be prejudiced. The Modification shall be reformed so as to reinstate the $2 Million Cap.10

D. The Chois are not entitled to general or punitive damages.

As stated above, the court is not satisfied that Bank is guilty of fraud. Rather, it appears that the worst that can be said about Bank's practices is that they were careless. The failure to include in the April 2 Conditional Commitment Letter that the $2 Million Cap would be removed does not amount to a breach of any covenant of good faith or fair dealing. This is so for the same reason that Bank will not be held liable for fraud.

E. The Chois are entitled to reasonable attorneys' fees.

Bank claims there is no right to attorneys' fees under the terms of the parties' agreements. Bank's twelfth affirmative defense cites CCP § 1021, which states:

Except as attorney's fees are specifically provided for by statute, the measure and mode of compensation of attorneys and counselors at law is left to the agreement, express or implied, of the parties; but parties to actions or proceedings are entitled to their costs, as hereinafter provided. [Emphasis added.]

California Civil Code ("Civil Code"), Section 1717(a), provides in relevant part:

(a) In any action on a contract, where the contract specifically provides that attorney's fees and costs, which are incurred to enforce that contract, shall be awarded either to one of the parties or to the prevailing party, then the party who is determined to be the party prevailing on the contract, whether he or she is the party specified in the contract or not, shall be entitled to reasonable attorney's fees in addition to other costs.

Section 7.13 of the 1997 Credit provides, in full:

7.13 Legal Expenses and Fees

In the event that Bank employs attorneys to remedy, prevent or obtain release from a breach or default of this Agreement or the loan documents arising out of a breach or default of this Agreement or the loan documents or in connection with or contesting the validity of this Agreement or the loan documents,{11} any of the terms and covenants and provisions and all condition {sic} hereof or thereof or any of the matters referred {to?} herein or therein or in connection with any bankruptcy or postjudgment proceeding, Bank shall be entitled to be reimbursed for all of its attorneys{'} fees, whether or not suit is filed and including without limitation those incurred in each and every action, suit or proceeding including all appeals and petitions therefrom and all fees and costs incurred by Bank in the event that Bank obtain the {sic} judgment in connection of {sic} the enforcement and interpretation of this Agreement or the loan documents {then?} Bank shall be entitled to recover from Borrower and each {sic}, all costs and expenses incurred in connection with the enforcement of such, including, without limitation, attorneys{'} fees, whether incurred prior to or after the entry of the judgment. The provision of this subsection is {sic} severable from the other provisions of the Agreement and shall survive the entry of judgment referred to herein and shall not be deemed merged into any judgment. {Emphasis added.}

Bank makes no argument on the attorneys' fee issue other than citing CCP § 1021. Presumably Bank is suggesting that the policy of mutuality embodied in Civil Code § 1717(a) applies only to actions to "enforce" a contract, and therefore does not apply to the Chois' action, which could be characterized as one "in connection with" or "contesting the validity of" the Modification. However, California courts have interpreted Section 1717 to apply where plaintiff's action successfully challenges "the enforceability" of the contract, or in this case a portion thereof. Star Pacific Investments, Inc. v. Oro Hills Ranch, Inc., 121 Cal. App. 3d 447, 460 (1981). Like the attorneys' fee provision in this case, the one in Oro Hills arguably was broader than "enforcement": it required payment of attorneys' fees "in any action or proceeding in which Beneficiary {Oro Hills} or Trustee may appear, and in any suit brought by Beneficiary to foreclose this Deed." Id. at 459.

The Oro Hills court emphasized the statutory purpose of "mutuality" and that if the deed of trust beneficiary therein had prevailed it certainly would have sought attorneys' fees. Id. at 459-460. The same is true of Bank, which prayed for attorneys' fees in its Answer and First Amended Answer. See Wagner v. Benson, 101 Cal.App.3d 27, 36-37; 161 Cal.Rptr. 516, 522 (1980) (emphasizing mutuality of remedy); Nevin v. Salk, 45 Cal.App.3d 331, 338-340; 119 Cal.Rptr. 370, 374-375 (1975) (same).

For the foregoing reasons, this court is persuaded that an award of attorneys' fees is proper in this case.

VI. Conclusion

The Chois have requested a separate hearing to determine the reasonable amount of their attorneys' fees and costs. Within thirty days of the date of service of this Memorandum Decision, the Chois shall file, serve and set for hearing a motion pursuant to B.L.R. 7007-1 for allowance of their reasonable attorneys' fees and costs, with a declaration attaching detailed time and expense records. The Chois should address whether such award should be set off against Bank's secured or unsecured claims, or should be awarded as a separate judgment against Bank in the Chois' favor.

The Chois are entitled to judgment on their first claim for relief; Bank is entitled to judgment on the Chois' second claim for relief. The Modification shall be reformed so as not to eliminate the $2 Million Cap. The Chois shall be entitled to their reasonable attorneys' fees and costs. Because it is unclear whether those attorneys' fees and costs will be a separate judgment or will reduce Bank's claims, this court will not enter judgment at this time. After resolution of the attorneys' fees issue, the court will enter a final judgment, consistent with this Memorandum Decision and the resolution of the foregoing attorneys' fees issue.

 
Dated: February 26, 2001

__________________________________________
Dennis Montali
United States Bankruptcy Judge

1The following discussion constitutes the court's findings of fact and conclusions of law. Fed. R. Bankr. P. 7052(a). Should any portion of these proceedings be found to be non-core, the findings and conclusions are proposed, subject to Fed. R. Bank. P. 9033. See discussion at V.B, infra.

2Throughout this Memorandum Decision the limitation on Deed of Trust will be referred to as the "$2 Million Cap".

3 In fact, Zhu understood that limitations on secured claims such as the Deed of Trust on the Residence were frequently limited in some areas, such as New York, because borrowers were taxed upon the dollar amount of secured encumbrances.

4 This understanding would be substantially but not precisely correct because of the claims of other unsecured creditors of the Chois and because of any exemption the Chois might claim in the Residence. In addition, the Bank would not protected against other creditors obtaining liens against the Residence.

5 Bank's Second Amended Response to the Chois' Request For Admissions indicates that this vague recollection by Luo is the only proof that anyone on behalf of Bank informed Choi (nobody informed Debbie Choi) that Bank desired the $2 Million Cap eliminated.

6 Bank does not claim immunity from suit under FSIA. In fact, FSIA includes exceptions for foreign instrumentalities that engage in "commercial" as opposed to "regulatory" activities and for "in rem" relief, among other exceptions. See 28 U.S.C. § 1603(d) and (3); § 1605(a)(2) and (4); and Republic of Argentina v. Weltover, Inc., 504 US 607, 614; 112 S.Ct. 2160, 2166; 119 L.Ed.2d 394 (1992). Cf. Gates v. Victor Fine Foods, 54 F.3d 1457, 1463-1465 (9th Cir. 1995) (no jurisdiction because plaintiffs' claims not related to foreign agency's commercial activity), cert. denied sub nom Fletcher's Fine Foods, Ltd. v. Gates, 516 US 869, 116 S.Ct. 187, 133 L.Ed.2d 124 (1995).

Therefore, Bank lacks immunity and under Section 1605(a) jurisdiction is proper in "courts of the United States." Moreover, under Section 1330(a) the "district courts shall have original jurisdiction" over actions against a foreign state.

Bank apparently argues, although it does not explicitly state, that bankruptcy courts are not "courts of the United States," and that although the bankruptcy court is a unit of the district court (See 28 U.S.C. § 151) it may not finally adjudicate claims against Bank. For the reasons stated in the text this court does not reach these issues. But see 28 U.S.C. § 451 (defining "courts of the United States"); Perroton v. Gray (In re Perroton), 958 F.2d 889, 893 (9th Cir. 1992) (for purposes of 28 U.S.C. §§ 451 and 1915(a), bankruptcy court was not among "courts of the United States" and therefore could not waive filing fees), and compare United States v. Yochum (In re Yochum), 89 F.3d 661, 669 (9th Cir. 1996) (bankruptcy courts are "units of the district court" and therefore "courts of the United States" for purposes of award of attorneys' fees under 26 U.S.C. § 7430) and Bedford Computer Corp. v. Israel Aircraft Industries, Ltd. (In re Bedford Computer Corp.), 114 BR 2, 4-5 (Bankr. D. N.H. 1990) (bankruptcy court had jurisdiction under FSIA as "unit" of district court).

7 On the one hand, one could argue that the Chois did not file a "counterclaim" to Bank's claims because the Chois filed their Complaint just over one month before Bank filed its proofs of claim, on August 4, 2000. On the other hand, Bank's motion for relief from the automatic stay was predicated on its claims, making the Complaint in the nature of a "counterclaim."

8 As established in the trial briefs and the undisputed facts, the exception based upon mutual mistake does not apply in this case.

9 The April 2 Conditional Commitment Letter stated that "{u}pon completion of all the required documentation and the satisfaction of the terms and conditions, this credit facility shall become effective." (Emphasis added.) The words "terms and conditions" are not defined, but appear to refer to the enumerated terms and conditions within that letter.

10 Thus, the $2 Million Cap is reimposed to limit the amount of Bank's secured interest in the Residence. No other provisions of the 1997 Credit or the Guarantees are to be affected by this decision.

11 Section 1.1 of the 1997 Credit defines "Loan Documents" as including "the Deeds of Trust as amended by the Modifications, ... the Guaranty, ... and all other agreements, documents and instruments executed and delivered by Borrower to Bank in connection herewith and therewith."


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