A district judge in New York declined to adopt the Ninth Circuit’s Ybarra doctrine allowing the revival of discharged claims, in the process reversing a bankruptcy court decision handed down in the aftermath of the chapter 11 liquidation of Residential Capital LLC, once the mortgage-servicing affiliate of Ally Financial Inc.
In 2005, the Ninth Circuit held in Ybarra that a counterclaim, otherwise discharged, would revive if the debtor were to initiate a lawsuit on a claim that seemingly had been resolved. In an opinion entered on Sept. 21, District Judge John G. Koeltl held that Ybarra — “not rooted in statutory interpretation but policy considerations” — was contrary to controlling Second Circuit authority.
ResCap implemented a chapter 11 plan in December 2013 and then sued dozens of mortgage-loan originators, mostly in district court in Minnesota, alleging breach of contract and indemnification for selling mortgages that violated underwriting standards. About a half dozen defendants, who had not filed proofs of claim in ResCap’s bankruptcy, asserted counterclaims alleging that ResCap was liable for their attorneys’ fees as a consequence of ResCap’s own breach of the same contracts.
ResCap filed a motion in bankruptcy court in New York asking the judge to enjoin the mortgage originators from prosecuting their counterclaims, contending they were discharged by confirmation of the chapter 11 plan. ResCap nonetheless conceded that the defendants could use their claims for attorneys’ fees in defense or setoff.
The bankruptcy judge denied the motion late last year, relying on the notion from Ybarra that the counterclaims were revived because ResCap sued after the plan’s consummation.
The mortgage originators appealed and won.
Of apparent significance, Judge Koeltl said that ResCap’s disclosure statement and plan supplement said that the liquidating trust would file suits against mortgage originators for breaches of warranties and representations in selling mortgages that ResCap subsequently securitized. Some of the appellants were even mentioned by name in ResCap’s pre-confirmation filings.
The defendants all had notice of ResCap’s bankruptcy but did not file proofs of claim. ResCap had sued them after the plan became effective.
For Judge Koeltl, the Second Circuit’s 2009 post-Ybarra decision in Ogle was controlling. He understood the case to mean that a pre-bankruptcy contractual provision for attorneys’ fees is a contingent claim that must be filed to avoid discharge. Ogle, he said, required reversing the bankruptcy court.
In Ybarra, the Ninth Circuit held that a debtor who voluntarily “returns to the fray” in the process revives counterclaims that otherwise were discharged. Judge Koeltl said there is no statutory basis for Ybarra. He also said he was bound by Ogle and the general principle that exceptions to discharge are narrowly construed. He said that the bankruptcy court had not cited Ogle.
Judge Koeltl insinuated that the Ninth Circuit itself narrowed Ybarra in a decision this month that might be read as meaning that the doctrine only applies if a dispute, settled during bankruptcy, erupted once again after discharge.