Kwok v. Zhong Qiu Li (In re Kwok)

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In re: DAVID C. KWOK, Debtor.

DAVID C. KWOK, Appellant, v. ZHONG QIU LI; JAMES QUAN, Appellees.

Adv. No. 2:22-ap-01026-BR

Nos. CC-22-1152-LSC, CC-22-1153-LSC

Bk. No. 2:18-bk-23346-BR

United States Bankruptcy Appellate Panel of the Ninth Circuit

May 23, 2023

NOT FOR PUBLICATION

Appeal from the United States Bankruptcy Court for the Central District of California Barry Russell, Bankruptcy Judge Presiding

Before: LAFFERTY, SPRAKER, and CORBIT, Bankruptcy Judges.

MEMORANDUM ^[*]

INTRODUCTION

David C. Kwok appeals the bankruptcy court's orders dismissing his adversary complaint against appellees and imposing Rule 9011 sanctions.^[1] We agree that the complaint was properly dismissed and that sanctions were appropriate. However, because the record is insufficient to permit us to determine whether the amount of the sanctions was appropriate, we REMAND for further proceedings as set forth below.

FACTS

A. The Shorb bankruptcy and asset sale

Kwok is the sole member of Shorb DCE, LLC ("Shorb"). In 2017, Shorb filed a chapter 11 petition. The case was converted to chapter 7 on August 30, 2017. Thereafter, the bankruptcy court approved the chapter 7 trustee's ("Shorb Trustee") motion to sell Shorb's primary asset, a 100% ownership interest in an 11-unit apartment building in Alhambra, California (the "Property") for $2,450,000, subject to overbid. The Property had significant equity. James Quan and Zhong Qiu Li (the "Buyers" and "Appellees") were the only bidders, and the bankruptcy court approved the sale to them. The sale closed December 11, 2017.

Unbeknownst to the Shorb Trustee or the bankruptcy court, shortly before the Buyers entered into the purchase agreement for the Property, they signed a promissory note payable to Kwok or Elke L. Coffey (Kwok's girlfriend) in the amount of $150,000 (the "Secret Note"). The unsecured Secret Note (as more fully explained below) states that it is valid upon completion of the Buyers' purchase of the Property and is due in full 45 days after the close of escrow on the Property. The Buyers, however, never paid any amount to Kwok or Coffey on the Secret Note.

B. The Kwok bankruptcy

Kwok filed a chapter 13 petition in November 2018. The case was converted to chapter 7 a few months later. Kwok scheduled as his primary asset a 100% membership interest in Shorb, but he did not disclose the amount owed to him from the Secret Note, nor did he disclose it to the chapter 7 trustee ("Kwok Trustee") until January 2022.

In July 2019, the Kwok Trustee obtained an order in the Shorb bankruptcy authorizing the distribution of surplus funds from the Shorb estate directly to the Kwok Trustee. After the Shorb Trustee's final report was approved, he paid $468,508.51 to the Kwok Trustee from the Shorb estate.

While the Kwok Trustee was preparing his final report, Kwok's bankruptcy counsel informed him of the existence of the Secret Note. Kwok's counsel provided a copy of the Secret Note and advised that an amendment to Kwok's bankruptcy schedules would be filed to add the Secret Note, but this was never done.

C. The adversary proceeding

In January 2022, the Kwok Trustee filed the adversary proceeding against the Buyers that is the subject of this appeal.^[2] The complaint alleged claims for: (1) breach of a written contract based on Buyers' failure to pay the Secret Note; (2) avoidance of the sale of the Shorb Property under § 363(n) or alternatively for damages, including punitive damages; and (3) turnover of the Property under § 542.

The Kwok Trustee also moved in the main case to abandon the Secret Note and the adversary proceeding on the ground that, even without those assets, he expected to be able to make a 100% distribution to creditors plus a small surplus distribution to Kwok. Accordingly, he did not believe it worthwhile to pursue the estate's claims against the Buyers due to the increased administrative expenses that would be necessary to pursue those claims. The bankruptcy court granted the motion to abandon.

Thereafter, Kwok substituted himself in as plaintiff in the adversary proceeding. Kwok then filed a second amended complaint ("SAC") which contained the same claims as alleged in the original complaint, plus a fourth claim for financial elder abuse under California Welfare and Institutions Code § 15610.30.

In the SAC, Kwok alleged that while Shorb was still in chapter 11, he hired a broker to list the Property himself, but about six weeks into the Shorb case, Kwok suffered a severe heart attack and was subsequently in and out of the hospital for several months and taking painkillers and antibiotics. It was during this period that the Shorb case was converted to chapter 7, but Kwok alleges that he was unaware of this until a few weeks after the conversion and believed he was entitled to sell the Property as a debtor-in-possession.

Kwok further alleged that during this time, the Buyers approached him to express an interest in purchasing the Property. According to the complaint, they convinced Kwok not to market the Property or involve his broker further. Instead, they devised a plan to purchase the Property for $2,450,000. To ensure Kwok's cooperation, Buyers offered an additional $150,000 in the form of a note payable directly to Kwok. They also allegedly promised to allow Kwok to keep an existing apartment he occupied in the Property for two years or until he recovered. Kwok also alleged that Buyers advised him that if he did not do the deal, he would get nothing from the bankruptcy. He alleged that he relied on the Buyers' advice, but, had he known the true facts, he would have requested the broker take an active role in marketing the Property, and he would not have agreed to the deal with the Buyers.

The allegations continue: After the sale closed in December 2017, the Buyers took possession of the Property and permitted Kwok to remain in his unit until April 2018, when the Buyers presented Kwok with a three-day notice to quit. When Kwok asked Li about the payment of the note, Li "walked away saying she did not understand anything about it."

Turning to the specific claims, the SAC alleges that: (1) the Buyers breached the parties' contract by not paying anything on the Secret Note, and Kwok is entitled to recover damages of $150,000 plus interest and attorneys' fees; (2) the sale of the Property should be avoided under § 363(n) or damages of $1.3 million plus punitive damages should be awarded because the sale price for the Property was controlled by an agreement among potential bidders at the sale, including the Buyers; (3) the Property should be turned over to Kwok pursuant to § 542 because it is property of the estate that has been abandoned; and (4) the Buyers are liable for financial elder abuse. The financial elder abuse claim alleged that, at the time of the negotiations between the parties, Kwok was over the age of 65 and was impaired due to his health condition, and he relied on the advice of the Buyers, who fraudulently induced him to sell the Property at less than market value, which Kwok alleged was $3,750,000. He alleged that the Buyers' conduct was willful, predatory, callous, and fraudulent.

The Buyers filed a motion to dismiss the SAC under Civil Rule 12(b)(6) for failure to state a claim upon which relief may be granted. With respect to the first claim for relief for breach of contract, they argued that the Secret Note lacked consideration; specifically, alleging that the Secret Note was given in exchange for Kwok's cooperation with the sale of the Property, but Kwok did not own the Property. The Buyers argued in the alternative that even if a contract were formed, it was void as against public policy because Kwok had breached his fiduciary duties to the Shorb bankruptcy estate.

With respect to the § 363(n) claim for relief, the Buyers argued that the SAC did not allege all the elements required for such a claim, and the one-year statute of limitations had expired.

As to the third claim for relief under § 542, the Buyers argued that this claim must fail because neither the Secret Note nor the Property were property of the Kwok bankruptcy estate.

Finally, with respect to the financial elder abuse claim for relief, the Buyers argued that the SAC did not allege sufficient facts to establish the necessary elements of such a claim because there was no allegation that Kwok's property was taken (the Property belonged to Shorb); Kwok was judicially estopped and lacked standing to bring the claim because he did not list it on his bankruptcy schedules; and the claim was time-barred due to the four-year statute of limitations given that Kwok admitted in the SAC that he was advised as of August 31, 2017 that the sale was required to go through the bankruptcy court.

The Buyers also argued that all four claims for relief were barred by the doctrine of in pari delicto because Kwok admitted in the SAC that he agreed to the Secret Note to obtain funds "outside of escrow" and he did not disclose the Secret Note to either the Shorb Trustee or the Kwok Trustee.

After complying with the safe harbor provisions of Rule 9011 by sending a letter and a proposed motion for sanctions under Rule 9011 to Kwok explaining why his claims were baseless, the Buyers filed the motion for sanctions, concurrent with the motion to dismiss, arguing that the claims in the SAC were frivolous and noting that Kwok had failed to withdraw the SAC despite being given the statutory 21-day opportunity to do so.

Kwok filed a one paragraph response to the Civil Rule 12(b)(6) motion requesting leave to file a third amended complaint but he did not contest in any meaningful way the arguments set forth in the motion, nor did he include a proposed amended complaint nor otherwise...