In the Matter of Los Angeles Trust Deed & Mortgage Exchange,bankrupt.associate Fundings, Inc., et al., Respondents-appellants, v. Stanley A. Phipps et al., Trustees-appellees, 464 F.2d 1136 (9th Cir. 1967)

This action stems from certain freewheeling activities of David Farrell, president and principal shareholder of Los Angeles Trust Deed & Mortgage Exchange (Exchange). In late 1958 and early 1959, Exchange financed several ventures of Edmund Cantillon and Alvin Rabalais, who were in the business of developing real property, mostly in Orange County, California.

Cantillon and Rabalais operated via different legal entities-sometimes as a co-partnership under the name, Westport Development Co. (Westport), sometimes through either of two corporations, Associate Fundings, Inc. (Associate) or Brentwood Downs, Inc. (Brentwood). They negotiated an arrangement with Farrell whereby Exchange would loan funds at 10% interest to one or more of the Cantillon-Rabalais legal entities, with trust deeds as security. In addition, Farrell personally was to receive 50% of the net profits on each tract financed by Exchange. During 1958 and 1959, Exchange financed development of seven tracts under this arrangement. In every situation, the secured loan with 10% interest was set forth in one document and the agreement to share profits with Farrell was set forth in another.

On December 18, 1960, Exchange was adjudicated bankrupt. In July 1961, Cantillon and Rabalais filed with the bankruptcy referee two claims related to loans on two of the seven tracts. On July 29, 1966, the trustees, after acquiring both Farrell's and Exchange's interests,¹  filed a counterclaim, praying that the referee dissolve the Cantillon-Rabalais "joint ventures" with Farrell and order payment to the trustees of 50% of the profits earned on the five tracts which were not included in the claims filed by Cantillon and Rabalais. Based upon certain documents, an audit of the profits on the five tracts and a stipulation of facts, the referee ordered the joint ventures to be dissolved and ordered Westport, Associate and Brentwood to turn over 50% of the net profits on the tracts. The district judge affirmed the order and this appeal followed.

I. Filing Claims as a Basis for Summary Jurisdiction on

Counterclaim.

The trustees contend that the referee correctly exercised summary jurisdiction over their counterclaim, based upon Katchen v. Landy, 382 U.S. 323, 86 S. Ct. 467, 15 L. Ed. 2d 391 (1966), wherein the Supreme Court held that "the [Bankruptcy] Act does confer summary jurisdiction to compel a claimant to surrender preferences that under Sec. 57, sub. g would require disallowance of the claim." 382 U.S. at 335, 86 S. Ct. 476. The trustees would have us interpret Katchen broadly to confer summary jurisdiction to determine counterclaims based on transactions which are separate²  from the subject matter of creditors' claims. We decline to interpret Katchen in such a broad manner.

The Court emphasized in Katchen that an objection to a claim under Sec. 57g is "part and parcel of the allowance process" 382 U.S. at 330, 86 S. Ct. at 473, and as such subject to the jurisdiction of the bankruptcy referee. Also, as "part of the process of allowance and disallowance of claims, it is triable in equity." 382 U.S. at 336, 86 S. Ct. at 476, and thus no right to jury trial exists.³ 

After a review of the language of the Bankruptcy Act and the underlying policies, we believe that the referee had no jurisdiction over a counterclaim, unrelated to the transaction upon which a creditor's claim is based. The Act does not make counterclaims a subject of objection to a claim. In Peters v. Lines, 275 F.2d 919 (9th Cir. 1960), this circuit ruled that the filing of a claim constitutes a consent to summary jurisdiction of the referee and enables the referee to render affirmative relief on a trustee's counterclaim arising out of the same transaction as a claim submitted by the creditor. Settlement of the transaction itself had already been tendered to the referee. Thus, in "submitting one side of a controversy for resolution logic dictates that the entire controversy should be open for resolution." 275 F.2d at 925. The distinction between such a case and an unconnected counterclaim was carefully noted. 275 F.2d at 925, fn. 6.

The trustees have not persuaded us that Katchen requires that we abandon the distinction we established in Peters. That the referee lacked jurisdiction over the trustees' counterclaim may be expressed in affirmative terms: Cantillon and Rabalais, i. e., their legal entities, had a right to have their interests in the dispute (stemming from the five unrelated transactions) adjudicated in a plenary action rather than in a bankruptcy proceeding. See 2 Collier on Bankruptcy p 23.08, pp. 530-531. Therefore, we hold that the bankruptcy referee did not have summary jurisdiction over the trustees' application for dissolution of the Cantillon-Rabalais joint ventures.⁴  Financing of these five tracts was separate from the transaction that constituted the subject matter of the Cantillon-Rabalais claims.

II. Consent to Summary Jurisdiction by Waiver of Right to

Object.

Ordinarily, a challenge to summary jurisdiction in bankruptcy must be asserted by a creditor to the referee at an early stage in the proceedings. Otherwise, the creditor is deemed to have waived the right; he is deemed to have consented to the summary jurisdiction. See 2 Collier on Bankruptcy, p 23.08, pp. 536-547.

Section 2, sub. a(7) of the Bankruptcy Act, 11 U.S.C. § 11(a) (7), the source of the consent jurisdiction, provides:

". . . and where in a controversy arising in a proceeding under this Act an adverse party does not interpose objection to the summary jurisdiction of the court of bankruptcy, by answer or motion filed before the expiration of the time prescribed by law or rule of court or fixed or extended by order of court for the filing of an answer to the petition, motion or other pleading to which he is adverse, he shall be deemed to have consented to such jurisdiction;"

The trustees contend that Cantillon and Rabalais waived this right by failing to object to summary jurisdiction in a timely manner. We disagree.

On October 7, 1966, at the request of the trustees, the referee in bankruptcy held a hearing to "pre-try" the controversy and "narrow the issues." At that time, counsel for Cantillon and Rabalais filed an answer which raised several defenses not including lack of summary jurisdiction. However, counsel made oral objection to the jurisdiction of the referee.⁵  An amended answer was filed on February 8, 1967, raising the additional defense of lack of jurisdiction.

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Rule 12(h) of the Federal Rules of Civil Procedure provides that all defenses-including lack of personal jurisdiction-not raised by preliminary motion or by answer are waived, with certain exceptions not applicable here. The waiver rule is modified by liberal allowances for leave to amend under Rule 15(a).

Fairly read, we believe that the colloquy quoted in the margin indicates that the referee granted leave to amend, when counsel for Cantillon and Rabalais orally objected to summary jurisdiction at the pretrial hearing. However, the Federal Rules of Civil Procedure are applicable to bankruptcy proceedings only insofar as they do not contradict other special bankruptcy rules.⁶  It is therefore necessary to examine what has historically been a very thorny problem for bankruptcy practitioners, the courts and Congress.

Congress adopted Sec. 2, sub. a(7) of the Bankruptcy Act in 1952⁷  in order to modify the rule of Cline v. Kaplan, 323 U.S. 97, 65 S. Ct. 155, 89 L. Ed. 97 (1944), that an adverse party could object to the summary jurisdiction of a bankruptcy referee so long as the objection was "formal" and was made at any time before the entry of a final order in the proceeding.⁸ 

The trustees contend that Cantillon and Rabalais waived the right to object to summary jurisdiction because they did not comply with Local Bankruptcy Rule 203 of the United States District Court (C.D. Cal.), which provides:

"A respondent desiring to contest a summary proceeding against him, shall serve and file not less than two (2) days before the hearing a written answer, objection or other responsive pleading which shall be verified if it sets up matters of fact."

We are thus faced with the issue of whether the local rule's requirement of a written objection is subject to leave to amend. We hold that it is.

The legislative history of Sec. 2, sub. a(7) clearly indicates that Congress passed the provision to deter forum shopping by adverse claimants, by requiring that an objection to summary jurisdiction of the bankruptcy referee be made in an explicit manner at an early stage in the proceedings. The section specifically states that the time for a written objection may be "extended by order of the court." This authorizes the bankruptcy referee to grant leave to amend when an oral objection is so made as to leave little doubt about the basis of the objection and at a time when the opposing party has not incurred substantial costs by proceeding in more than one forum. Accord: In re Perspectron, Inc., 422 F.2d 576 (7th Cir. 1970); Cf. Hall v. Goggin, 148 F.2d 774 (9th Cir. 1945); 2 Collier on Bankruptcy, p 23.08 P. 546, n. 53. Compare Honeyman v. Hughes, 156 F.2d 27 (9th Cir. 1946).

Here, counsel for Cantillon and Rabalais made his oral objection to summary jurisdiction at a pretrial hearing only minutes after filing an answer which did not raise the objection. The objection was just as timely as if it had been in the answer. The trustees were not misled. Leave to amend was wholly appropriate in such circumstances.

III. Conclusion.

In sum, the bankruptcy referee did not have summary jurisdiction over the legal entities of Messrs. Cantillon and Rabalais. The trustees' counterclaim stemming from separate transactions was not within the referee's jurisdiction, and the creditors raised this defense in a timely manner.

Reversed and remanded.