Kitchen v. Fund Recovery Servs., LLC (In re Argon Credit LLC)

634 B.R. 770

IN RE ARGON CREDIT LLC, Debtor.

Latonya D. Kitchen and Karensa Hutchens, Plaintiffs,

v.Fund Recovery Services, LLC, Defendant.

Case No. 16-39654

Adv. Proc. No. 21-00048

United States Bankruptcy Court, N.D. Illinois, Eastern Division.

Signed December 8, 2021

Jeffrey Wilens, Lakeshore Law Center, Yorba Linda, CA, for Plaintiffs.

Peter J. Roberts, Cozen O'Connor, Chicago, IL, for Defendant.

MEMORANDUM OPINION

Honorable Deborah L. Thorne, United States Bankruptcy Judge

Latonya Kitchen and Karensa Hutchens (together, "Plaintiffs") seek restitution from defendant Fund Recovery Services, LLC ("FRS") under California law. In the motion before the court, FRS asks the court to dismiss Plaintiffs’ amended complaint for lack of subject matter jurisdiction or, alternatively, to abstain from hearing the dispute. Specifically, FRS argues that subject matter jurisdiction lapsed when the Trustee abandoned a portfolio of consumer loans including the loans extended to Plaintiffs by Argon Credit LLC and Argon X, LLC (together, "Argon" or the "Debtors"). As explained below, however, resolution of the dispute between Plaintiffs and FRS affects the size of FRS's unsecured claim, which in turn has a potential effect on the size of distributions to the Debtors’ other unsecured creditors. For that reason, and notwithstanding the abandonment of the loan portfolio, the court retains subject matter jurisdiction to hear the dispute as a noncore proceeding related to the Debtors’ bankruptcy cases. In the absence of compelling reasons to abstain, the court does not abstain from exercising its jurisdiction. Therefore, FRS's motion is denied.

FACTUAL BACKGROUND

In 2015 and 2016, Argon's affiliate entered into consumer loan agreements with California residents, including Plaintiffs.¹ Argon X financed these consumer loans by borrowing under a loan and security agreement ("LSA") that gave its lender a security interest in the consumer loan receivables and a parent guarantee from Argon Credit. That secured lender subsequently assigned all rights and remedies under the LSA and the guarantee—and its interest in the consumer loan receivables—to another entity, which subsequently assigned them to FRS.

In December 2016, the Debtors filed voluntary petitions for chapter 11 relief under the United States Bankruptcy Code.² FRS's undisputed proofs of claim establish its $37.3 million claim against Argon X—secured by an estimated $25.6 million of consumer loan receivables as of May 2017—under the LSA and its contingent, unsecured claim against Argon Credit under the parent guarantee. Due to the Debtors’ inability to adequately protect FRS's property interest in the consumer loan receivables, the court modified the automatic stay and entered an order allowing FRS to collect on the consumer loans and apply amounts collected against its secured claim. See Dkt. No. 129.

True to its name, FRS proceeded to recover funds amounting to several thousand dollars from Plaintiffs and at least $3 million from other California residents. In response to FRS's collection efforts, Plaintiffs obtained legal counsel and began pursuing remedies against FRS. The automatic stay was modified again to allow Plaintiffs and others to pursue arbitration against FRS in California, as required by the consumer loan agreements. See Dkt. Nos. 327, 359. When FRS refused to pay the arbitration fees or otherwise participate, the American Arbitration Association closed the arbitration cases. That led to the present adversary proceeding, which commenced on March 18, 2021. At that time, the Trustee estimated that the loan portfolio had no value, that Argon X effectively had no other assets and that Argon Credit had approximately $1.6 million in unencumbered assets. See Dkt. No. 549; Related Dkt. No. 46. Plaintiffs’ amended complaint in this adversary proceeding alleged that the consumer loans on which FRS had collected were either partially or entirely void under California law. On September 2, 2021, FRS's initial motion to dismiss the amended complaint was granted in part and denied in part, leaving two state law causes of action—and Plaintiffs’ plea for restitution and declaratory and injunctive relief—pending before the court in this proceeding. See Adv. Dkt. No. 27.

Then, on the Trustee's motion and after notice and a hearing, the court authorized the Trustee to abandon the loan portfolio including Plaintiffs’ loans. See Dkt. Nos. 552-554. According to the Trustee, the loan portfolio was "of inconsequential value and benefit to the estate," especially in light of the "burdensome" legal costs associated with responding to the amended complaint. 11 U.S.C. § 554(a). Collections on the loans in the portfolio had slowed drastically—from an average of approximately $400,000 per month in 2017 to approximately $25,000 per month in the first nine months of 2021. Dkt. No. 552. Having collected less than $9 million from consumers in four years, FRS itself valued the loan portfolio at only $1.3 million in October 2021. See id. ; Adv. Dkt. 13. On these facts, the court endorsed the Trustee's assessment that it was "highly unlikely" that the loan portfolio would ever yield proceeds in excess of the $28.3 million still owing to FRS. Dkt. No. 552. After the abandonment became effective on October 10, 2021, FRS moved to dismiss the amended adversary complaint for lack of subject matter jurisdiction.

JURISDICTION

The court has subject matter jurisdiction to hear this proceeding under 28 U.S.C. § 1334(b). For the reasons discussed below, this is "a proceeding related to a case under title 11." 28 U.S.C. § 157(c).³ Consequently, while the court "may hear [the] proceeding" and "submit proposed findings of fact and conclusions of law to the district court," it may not, without the consent of all parties, "determine" the proceeding or enter "any final order or judgment." Id .

Regarding the court's authority to rule on the motion presented, no party disputes that "the court has jurisdiction to determine its jurisdiction." Gladney v. Pendleton Corr. Facility , 302 F.3d 773, 775 (7th Cir.2002). Venue is proper in the Northern District of Illinois, Eastern Division pursuant to 28 U.S.C. § 1409(a).

DISCUSSION

The Seventh Circuit's decision in Bush v. United States , 939 F.3d 839 (7th Cir. 2019), has three lessons that inform the court's response to FRS's motion to dismiss: (I) "related-to jurisdiction must be assessed at the outset of the dispute, and it is satisfied when the resolution has a potential effect on other creditors;" (II) Matter of Xonics, Inc. , 813 F.2d 127 (7th Cir. 1987), remains good law; and (III) 28 U.S.C. § 1334(c)(1) provides grounds to abstain from exercising related-to jurisdiction. Bush , 939 F.3d at 846.

I. At the outset of the dispute, this adversary proceeding was related to Argon's bankruptcy cases

Like all federal courts, bankruptcy courts’ subject matter jurisdiction is grounded in statute. Celotex Corp. v. Edwards , 514 U.S. 300, 307, 115 S.Ct. 1493, 131 L.Ed.2d 403 (1995). 28 U.S.C. § 1334(b) grants district courts "original but not exclusive jurisdiction of all civil proceedings arising under title 11, or arising in or related to cases under title 11."⁴ This statutory language (i.e., "arising under," "arising in," and "related to") limits the kinds of proceedings over which bankruptcy courts can exercise subject matter jurisdiction. Only related-to jurisdiction is relevant here.⁵

A proceeding is "related to" a bankruptcy case if it affects "the amount of property for distribution or the allocation of property among creditors." Matter of FedPak Sys., Inc. , 80 F.3d 207, 214 (7th Cir. 1996) (quoting Xonics , 813 F.2d at 131 ). See also Celotex , 514 U.S. at 308 n. 6, 115 S.Ct. 1493 ; In re Robert Plan Corp. , 777 F.3d 594, 597 (2nd Cir. 2015) ("The standard for "related to" jurisdiction is whether the outcome of the proceeding could conceivably have any effect upon the debtors’ estate being administered.") (quotations omitted). For example, when chapter 7 debtors Donald and Kimberly Bush asked a bankruptcy court to determine the size of a tax penalty they owed the IRS, the IRS argued that the bankruptcy court had no jurisdiction to do so because the determination would not affect distributions to other creditors. In re Bush , 2015 WL 12516007, at *2 (Bankr. S.D. Ind. Aug. 14, 2015). After all claims had been filed, it turned out that the tax penalty was subordinate to more liabilities than the Bushes’ assets could cover, so the size of the penalty could make no difference to the Bushes or their other creditors. Bush , 939 F.3d at 845. Earlier in the case, however, it was not certain that "a decision could not have affected the allocation of assets among the creditors with outstanding claims." Id . On that basis, the Seventh Circuit eventually held that the bankruptcy court had jurisdiction to determine the penalty because at the time it was asked to do so, that determination had "a potential effect on other creditors." Bush , 939 F.3d at 846. Together, Bush and Celotex confirm that "jurisdictional issues must be resolved ex ante , not in light of how things turn out." Id .

At the time Plaintiffs filed their initial complaint against FRS, the resolution of the dispute affected the allocation of assets to other unsecured creditors. To see this, recall that the dispute affects whether FRS gets to keep the $3 million it has already collected from California residents.⁶ If FRS wins the dispute, the loans it collected on are valid, so it gets to keep the $3 million already collected and assert a roughly $28.3 million unsecured claim against Argon Credit under the guarantee. On the other hand, if Plaintiffs win the dispute, all California loans in the portfolio are partially or entirely void, so FRS may have to give back some or all of the $3 million already collected from California residents—if that occurs, the size of FRS's unsecured claim against Argon Credit increases. Therefore,...