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The Security National Bank of Sioux City, IA v. Vera T. Welte Testamentary Trust

Summarizing by Amir Shachmurove


Case Type:
Case Status:
BAP No. CC-22-1152-LSC and BAP No. CC-22-1153-LSC (9th Circuit, May 23,2023) Not Published
The bankruptcy court properly granted the defendants' motion to dismiss a complaint under Rule 12(b)(6) because the debtor/plaintiff had participated with the defendants in the illegal conduct that served as the basis for the adversary proceeding. Thus, the in pari delicto doctrine prevents a court from aiding one party to a wrongful action from recovering from another party to the wrongful act.
Procedural context:
The bankruptcy court (1) dismissed, under Rule 12(b)(6), a debtor/plaintiff's complaint against defendants who had purchased property from the bankruptcy estate of a company that the debtor owned and (2) granted the defendants' Rule 11 motion. The debtor/plaintiff appealed.
David C. Kwok, the debtor and plaintiff, owned a company called Shorb DCE, LLC. Shorb owned 1oo% of the equity interests in an apartment building. Shorb filed a chapter 11 petition in 2017. Later that year, Shorb's case was converted to chapter 7. Shorb's chapter 7 trustee moved to sell the interest in the apartment building. James Quan and Zhong Qui Li (the "Buyers") were the only bidders, and the bankruptcy court approved the sale. The property had significant equity. Unknown to Shorb's chapter 7 trustee, the Buyers had signed a $150,000 note (the "Secret Note") payable to Kwok or his girlfriend. The Secret Note was payable 45 days after the close of escrow on the property. The Buyers, however, never paid anything to Kwok or his girlfriend on the Secret Note. Less than a year after Shorb's interest in the apartment building was sold, Kwon filed a chapter 13 petition. The case was subsequently converted to chapter 7. Kwok's chapter 7 trustee obtained an order in the Shorb bankruptcy case to disburse the surplus funds. The Shorb trustee paid $468,508.51 to the Kwok trustee. The Kwok trustee began work to close the case when Kwok's bankruptcy trustee disclosed the existence of the Secret Note. Kwok's attorney never amended Kwok's schedules to add the Secret Note. The Kwok trustee then sued the Buyers to recover on the Secret Note and to set aside the sale of Shorb's interests in the apartment building. The Kwok trustee moved to abandon the Secret Note and the litigation against the Buyers, forecasting a 100% dividend to unsecured creditors. The bankruptcy court granted the trustee's motion. Kwok substituted himself in the litigation as plaintiff and filed an amended complaint alleging that the Buyers suggested the Secret Note at a time when Kwon was recovering from a severe heart attack and was not aware that the Shorb bankruptcy case had been converted from a chapter 11 to a chapter 7 case. The Buyers moved to dismiss Kwok's amended complaint under Rule 12(b)(6), arguing lack of consideration for the Secret Note, that Kwon had no direct interest in the apartment building, that certain claims were time-barred, and that Kwon was barred from recovery by the in pari delicto doctrine. The Buyers also sent a Rule 11 letter to Kwok. Kwok filed a one-paragraph response to the Rule 12(b)(6) motion and did not meaningfully contest any of the Buyers' arguments or attach a proposed third amended complaint. Kwon filed a three-paragraph response to the Buyers' Rule 11 motion.
LAFFERTY, SPRAKER, and CORBIT, Bankruptcy Judges

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