Mortgage Lender Services, Inc. v. 2408 I Street, Sacramento, CA 95816

Opinion

1 2 3 4 5 6 7 8 UNITED STATES DISTRICT COURT 9 EASTERN DISTRICT OF CALIFORNIA 10 11 MORTGAGE LENDER SERVICES, No. 2:19-cv-02568-MCE-KJN INC, 12 Plaintiff, 13 MEMORANDUM AND ORDER v. 14 2408 I STREET and 2407 J STREET, 15 SACRAMENTO, CA 95816, et al., 16 Defendants. 17

18 19 The United States is a potential claimant to some $1,403,648.33 in funds 20 interpleaded by Plaintiff Mortgage Lender Services, Inc., (“Plaintiff”) with the Sacramento 21 County Superior Court on November 18, 2019. The government removed the state 22 action to this Court on December 19, 2019, invoking federal question jurisdiction on 23 grounds that the United States is a party. The government now moves for summary 24 judgment under Federal Rule of Civil Procedure 56,1 arguing that it is entitled as a matter 25 of law to recoup unpaid federal tax liabilities of a potential claimant to the funds, Roger 26 /// 27 1 All further references to “Rule” or “Rules” are to the Federal Rules of Civil Procedure unless 28 otherwise noted. 1 Duke. As set forth below, that Motion, as well as a cross-motion in opposition filed by 2 yet another claimant, are DENIED.2 ECF Nos. 8 and 13. 3 4 5 BACKGROUND 6 7 In September 2012, the O Street Partners, LLC, (“OSP”) executed a promissory 8 note secured by a Deed of Trust in order to purchase real property located at 2408 I 9 Street and 2407 J Street (“the properties”). The beneficiary of the Deed of Trust, the 10 1988 Orredre Revocable Trust UDT dated April 26, 1988 (“the Trust) had loaned OSP 11 some $4.2 million to purchase the properties. Members of the Orredre family were also 12 the majority stakeholders in OSP. Roger Duke along with Paula and Samuel Downing 13 originally had minority interests. 14 Following what appears to have been a dispute over control over OSP, the Trust 15 initiated foreclosure proceedings against OSP after, at least according to Duke, it 16 improperly refused to refinance the loan and drained OSP of the cash necessary to keep 17 the loan current. The properties were subsequently sold for some $6.2 million and the 18 Trust received some $4,652,466.24 to satisfy the promissory note. That left surplus 19 cash from the sale in the sum of $1,407,533.76, which after payment of trustee’s fees, 20 expenses and a filing fee yielded a net surplus of $1,403,648.33. Because both Roger 21 Duke and OSP itself claimed entitlement to those proceeds, and since there were other 22 potential claimants to the funds as well, Plaintiff decided to interplead the funds by filing 23 a Petition for Distribution Regarding Unresolved Claims with the state court on 24 November 18, 2019. It deposited the surplus proceeds that same day. 25 By Order and Notice of Hearing issued December 15, 2019 (Ex. B to Pl.’s Notice 26 of Removal, ECF No. 1-2, p. 133-17), the state court granted Plaintiff’s request to be 27 2 Having determined that oral argument would not be of material assistance, the Court ordered this 28 matter submitted on the briefs in accordance with E.D. Local Rule 230(g). 1 discharged from the proceedings upon interpleading the funds. At the same time, the 2 state court set a deadline of January 30, 2020, for any potential claimant to submit a 3 claim against the proceeds prior to a hearing to be held on February 28, 2020 as to 4 disposition of the funds. 5 On December 19, 2019, just four days after issuance of the state court order, the 6 United States removed the matter to federal court. There accordingly had been no 7 disposition in state court as to the competing claimants prior to removal. The 8 United States has nonetheless moved for summary judgment on grounds that it is 9 entitled to recover Roger Duke’s unpaid federal tax liability from the proceeds even 10 though Duke’s entitlement to those proceeds vis-à-vis any other claimants has yet to be 11 established. OSP, not surprisingly, opposes the government’s motion as premature at 12 this juncture yet also claims that it should be entitled to the proceeds as a matter of law 13 to the exclusion of other claimants. 14 15 ANALYSIS 16 17 The Court begins by considering the procedural status of this matter. Plaintiff, as 18 a stakeholder holding funds or property to which conflicting claims may be made, is 19 entitled to protect itself from multiple liability, by requiring potential claimants to litigate 20 between themselves who is entitled to the funds or property. In federal court, that is 21 accomplished by commencing an action in interpleader. See, e.g., Cripps v. Life Ins. Co. 22 of N. Am., 980 F.2d 1261, 1265 (9th Cir. 1992). An interpleader action entails a two- 23 stage process. “‘First, the court determines the propriety of interpleading the adverse 24 claimants and relieving the stakeholder from liability. The second stage involves an 25 adjudication of the adverse claims of the defendant claimants.’” Metro. Life Ins. Co. v. 26 Billini, 2007 WL 4209405 at *2 (E.D. Cal. 2007) (quoting First Interstate Bank of Or. v. 27 U.S., 891 F. Supp. 543, 546 (D. Or. 1995)). 28 Here, Plaintiff began the two-step process by filing a Petition in state court under 1 California Civil Code § 2924j(c) on November 18, 2019. ECF No. 1-1, p.3. That statute 2 permits a Trustee, following a Trustee’s Sale, to deposit any funds remaining after the 3 obligations secured by the Deed of Trust have been satisfied, should entitlement to 4 those funds be disputed. As indicated above, Plaintiff deposited the sum of 5 $1,403,648.33 with the state court concurrently with the filing of its Petition. That 6 deposit, which corresponds with the first step of federal interpleader practice, permitted 7 the state court to discharge Plaintiff of any further responsibility for disbursement of the 8 sale proceeds, and it did so by its order of December 13, 2019. ECF No. 1-2, p. 133. 9 Then, under California Civil Code § 2924(d), the state court was required to hold a 10 hearing after notice to potential claimants, after which the deposited funds would be 11 distributed to any and all claimants entitled thereto. The state court’s order of 12 December 13, 2019 did just that by setting a hearing for February 28, 2020. That 13 corresponds to the second stage of federal interpleader practice. 14 Because the United States removed the case to this Court on December 19, 15 2019, the second stage in the interpleader process has not yet been completed.3 Even 16 though any entitlement to the disputed funds thus remains unresolved, the United States 17 has moved for summary judgment, claiming that because Roger Duke owns 12.5 18 percent of OSP, the government is accordingly entitled to satisfy its $189,883.40 claim 19 for Mr. Duke’s personal unpaid federal tax liability out of his share of the remaining 20 proceeds.4 21 The government’s motion is premature, at best. OSP, for its part, claims that it 22 continues to operate as a legal entity and has numerous financial obligations, including 23 significant outstanding bills from vendors and debt owed to commercial banks which 24

25 3 Following removal, this Court issued, on April 21, 2020, its own Order (ECF No. 17) transferring the deposited surplus proceeds here and discharging Plaintiff from any further liability for disbursing those funds, such that Plaintiff’s status is only that of a nominal party excused from any further participation in 26 the proceedings. That confirms that the first stage of the interpleader process has been completed, leaving only the second phase adjudicating the competing claims to be accomplished. 27

4 Assuming a 12.5 percent share of the surplus funds held in interpleader, Mr. Duke would 28 hypothetically be entitled to some $175,941.72 of those funds. 1 exceeds $1,800,000, a sum in excess of the disputed sales proceeds now held in 2 interpleader. Importantly, as OSP points out, its own Operating Agreement, at 3 Article XII, Paragraph 12.1, provides as follows: 4 Distributions of Available Cash of the Company shall be made to the Members only after all operating expenses have 5 been paid in full and adequate reserves have been established, all as determined in the discretion of the 6 Manager . . . . 7 OSP Operating Agreement, Ex. 1 to OSP’s Opp., ECF No. 13. 8 That provision is consistent with the California Corporations Code, which provides 9 at § 17704.05(a) that “[a] limited liability company shall not make a distribution if after the 10 distribution. . . the limited liability company would not be able to pay its debts as they 11 become due… “ Accordingly, OSP maintains that, in light of its other claimed debts, 12 excess funds in interpleader cannot be deemed a distribution so as to satisfy Mr. Duke’s 13 own unpaid personal tax liability.5 Therefore, OSP maintains that the government’s 14 Motion for Summary Judgment must fail. 15 The Court agrees. Until the issue of who is entitled to the deposited proceeds has 16 been resolved through the second stage of the interpleader process, which has not yet 17 occurred, whether or not the government can satisfy Mr. Duke’s tax obligations out of his 18 potential share cannot possibly be determined. The same logic applies to OSP’s own 19 cross-motion for summary judgment, made in the course of opposing the United States’ 20 Motion. OSP’s Opp. and Cross Motion, ECF No. 13. The Court cannot rule out the 21 possibility that some part of the interpleaded funds may inure to Mr. Duke’s benefits so 22 as to be subject to governmental seizure at this juncture, again since who is entitled to 23 the proceeds has simply not been established. 24 Tellingly, the government’s own reply papers appear to concede the infirmities of

25 5 To further complicate matters, the parties also dispute just who is entitled to manage OSP at this juncture. While Roger Duke agreed to relinquish control in that regard, he claims he did so based on an 26 agreement with OSP that was breached and is accordingly void. The Orradre Trust has also submitted an Opposition to the United States’ Motion maintaining that John Orradre, and not Roger Duke, is the current 27 manager of OSP. Decl. of John Orradre, ECF No. 15-2, ¶ 2. Like the OSP Opposition itself, however, the Orradre papers confirm OSP’s allegedly outstanding indebtedness of some $1.8 million, as well as the fact 28 that no distributions have been made to OSP members since the foreclosure sale. Id. at ¶ 3. WwOAOW 2.497 VV VOUVINY LU INGIN MVVULTICEI LO PUM VVVslicy rayet vvulivV

1 || its Motion for Summary Judgment at this stage of the proceedings. According to the 2 | Reply, “the United States maintains that this court should order the release of 12.5 % of 3 | the interpleaded funds to the United States absent further proof that O Street Partners 4 | has legitimate debts that would preclude any such distribution.” Reply, ECF No. 16, 5 |} 2:10-12. (emphasis added). Just as significantly, the Reply continues: 6 In order to ensure a lawful and equitable distribution of the interpleaded funds, the United States believes that the proper 7 course of action is to order any claimants on O Street Partners to file a claim in this matter that demonstrates to this 8 Court that the alleged debts referenced in the Oppositions are legitimate debts that must be paid before distributions. 9 Absent this showing, the United States’ Motion for Summary 40 Judgment must be granted. The United States believes that requiring all claims against 11 the funds, including alleged debts to be filed in this action, the Court will ensure a just distribution of those funds, and avoid 12 the risk of fraud. 13 Id. at 5:2-6. 14 In the Court’s view, this amounts to a concession that summary judgment is an 15 || unviable option unless and until competing claims to the interpleaded funds have been 16 || resolved. Consequently, any request for summary judgment at this point is premature. 17 18 CONCLUSION 19 20 Based on the foregoing, the United States’ Motion for Summary Judgment (ECF 21 || No. 8) is DENIED, as is OSP’s Cross Motion for Summary Judgment incorporated within 22 | its Opposition to the government’s Motion at ECF No. 13. By separate Minute Order, the 23 | Court will schedule a Status Conference at which time the further disposition of this 24 | matter will be addressed. 25 IT |S SO ORDERED. 26 | Dated: May 29, 2020 27 28 MORRISON C. ENGLAND, J UNITED STATES DISTRI