The Ivanhoe Rule: Double Recovery Is Not Permitted, But (A/K/A Limitation-On-Dividend Approach Meets Reduction-Of-Claim Approach)

In re Del Biaggio, 496 B.R. 600 (Bankr. N.D. Cal. 2012) -

The creditors committee objected to proofs of claim filed by a group of unsecured lenders who had received partial payment from a non-debtor co-obligor, arguing that the claims should be reduced by the payments. If you bet that the creditors committee would prevail, you would lose.

The debtor borrowed $39.25 million from a group of lenders. The loans were supposed to be secured by a pledge of stock owned by the debtor and held by a broker-dealer. In fact, the debtor did not own the stock, although at his behest an employee of the broker-dealer fabricated documentation to show ownership. Both the debtor and the broker-dealer employee were convicted of securities fraud; and the lenders sued the broker-dealer, asserting negligence with respect to the employee. The parties settled, and the broker-dealer paid $6.9 million to the lenders.

The lenders filed proofs of claim in the debtor's bankruptcy asserting claims for the full balance of the loan without deducting the payment. The creditors committee objected, arguing that the claims must be reduced by the amount already paid by the broker-dealer (the Reduction-of-Claim Approach), while the lenders asserted they did not have to take the payment into account unless the dividend received in the bankruptcy would result in more than a full recovery (the Limitation-of-Dividend Approach).

Relying on an old pre-Bankruptcy Code Supreme Court case - Ivanhoe Bldg. & Loan v. Orr, 295 U.S. 243, 55 Sup. Ct. 685, 79 L. Ed. 1419 (1935) - the bankruptcy court sided with the lenders. In Ivanhoe, the debtor owed $10,740, which was also secured by real property owned by a third party. (The debtor originally owned the property, and transferred it subject to the mortgage securing the debt.) Prior to the bankruptcy, the creditor foreclosed the mortgage and acquired the property with a credit bid of $100.

The debtor's bankruptcy trustee argued that the debtor was entitled to offset the value of the foreclosed property ($9,000) rather than the $100 bid against the loan amount. The bankruptcy court, district court and court of appeals agreed with the trustee. However, the Supreme Court reversed: (1) the debtor was entitled to a credit of only $100, and (2) the credit would not reduce the creditor's unsecured claims unless failure to do so would allow the creditor to recover from all sources more than the full amount of the claim.

This analysis implicitly takes...