FILED MAR 11 2020

ORDERED PUBLISHED SUSAN M. SPRAUL, CLERK U.S. BKCY. APP. PANEL OF THE NINTH CIRCUIT

UNITED STATES BANKRUPTCY APPELLATE PANEL OF THE NINTH CIRCUIT

In re: BAP No. CC-19-1118-LGTa

TEINA MARI LIONETTI, Bk. No. 8:15-bk-10705-TA

Debtor. Adv. No. 8:15-bk-01257-TA

TEINA MARI LIONETTI,

Appellant,

v. OPINION

LAW OFFICES OF STEVEN H. MARCUS,

Appellee.

Argued and Submitted on January 30, 2020 at Pasadena, California

Filed – March 11, 2020

Appeal from the United States Bankruptcy Court for the Central District of California

Honorable Theodor Albert, Bankruptcy Judge, Presiding Appearances: Matthew G. Bouslog of Gibson, Dunn & Crutcher LLP argued for appellant; Shai S. Oved of The Law Offices of Shai Oved argued for appellee.

Before: LAFFERTY, GAN, and TAYLOR, Bankruptcy Judges.

LAFFERTY, Bankruptcy Judge:

INTRODUCTION

In 2011 Appellant Teina Lionetti hired Appellee Law Offices of

Steven A. Marcus (the “Marcus Firm”) to represent her in divorce

proceedings. Ms. Lionetti informed the Marcus Firm at the time of hiring

that she had limited means. She signed an engagement letter granting the

Marcus Firm a charging lien on any recovery in the divorce proceeding.

During the Marcus Firm’s representation of her, Ms. Lionetti informed the

firm she was considering bankruptcy, and she in fact consulted with

bankruptcy counsel.

In 2014, the family law court entered a Qualified Domestic Relations

Order that awarded Ms. Lionetti her ex-husband’s 401(k) worth over

$270,000. Those funds were transferred to Ms. Lionetti and deposited into

her retirement account. By then, she owed the Marcus Firm approximately

$150,000. She terminated the Marcus Firm’s representation without paying

those fees.

2 After Ms. Lionetti filed a chapter 71 petition in 2015, the Marcus Firm

filed a complaint seeking a declaration of nondischargeability of the

outstanding fees under § 523(a)(2)(A) and a declaration that its charging

lien was valid. The bankruptcy court granted summary judgment for

Ms. Lionetti, finding that the charging lien was not valid and that the

nondischargeability claim failed as a matter of law. Ms. Lionetti then

moved for an award of attorney’s fees under § 523(d), which the

bankruptcy court denied.

Both orders were appealed to the United States District Court for the

District of California (“District Court”). The District Court affirmed the

bankruptcy court’s grant of summary judgment but remanded the denial of

the fee award for the bankruptcy court to apply the correct standard.

On remand, the bankruptcy court again denied the fee award,

finding that the Marcus Firm had been substantially justified in pursuing

its nondischargeability claim.

We REVERSE.

FACTUAL BACKGROUND

In early 2011, Ms. Lionetti was referred to the Marcus Firm in

connection with her divorce proceeding, and she met with attorney Steven

1 Unless specified otherwise, all chapter and section references are to the Bankruptcy Code,

, and all “Rule” references are to the Federal Rules of Bankruptcy Procedure.

3 Marcus at his office. During that meeting, Ms. Lionetti explained that she

had limited income and resources with which to pay the Marcus Firm’s

legal fees, noting that she was making only $9.25 per hour and working

approximately 25 hours per week. Ms. Lionetti also explained that she had

outstanding debts that included approximately $50,000 owed to her prior

attorney. She told Mr. Marcus that her ex-husband owed her over $150,000

in spousal support, child support, property taxes, health coverage, and

other reimbursements. She stated that she believed her ex-husband had

funds in a 401(k) account and other assets to which she believed she was

entitled.

Mr. Marcus presented Ms. Lionetti with an engagement letter that set

out the terms of the Marcus Firm’s representation of Ms. Lionetti in her

divorce proceeding. The engagement letter purported to grant a charging

lien to the Marcus Firm with respect to any recovery in the divorce

proceeding. During the same meeting, without leaving the Marcus Firm’s

offices, and without having the chance to obtain independent legal advice,

Ms. Lionetti signed the engagement letter and paid a $10,000 retainer fee,

using three separate credit cards.

During the divorce proceeding, Ms. Lionetti advised Mr. Marcus that

she was considering bankruptcy, and Mr. Marcus provided her with a

referral for bankruptcy counsel. Ms. Lionetti also expressed concern about

the mounting legal fees being incurred and the fact that she had not

4 received any material recovery from her ex-husband since the divorce was

filed.

In January 2014, the family law court determined that the

ex-husband’s 401(k) holding $272,278.98 was Ms. Lionetti’s sole and

separate property. A few months later, the funds from the 401(k) were

transferred to Ms. Lionetti and placed into an individual retirement

account for her benefit. At that point, Ms. Lionetti owed the Marcus Firm

approximately $150,000. A few months later, Ms. Lionetti terminated the

Marcus Firm’s representation without paying the outstanding fees.

In February 2015, Ms. Lionetti filed a chapter 7 bankruptcy petition.

The Marcus Firm timely filed an adversary complaint against her, seeking a

declaration that the debt she owed to it was nondischargeable under

§ 523(a)(2)(A) and that the Marcus Firm held an enforceable charging lien

against the 401(k).2

In August 2017, Ms. Lionetti moved for summary judgment, which

the bankruptcy court granted, dismissing all claims against her. The

bankruptcy court concluded that the purported charging lien provided for

in the engagement letter was void under Rule 3-300 of the California Rules

of Professional Conduct because the Marcus Firm had not provided Ms.

Lionetti with a reasonable opportunity to seek the advice of independent

counsel regarding the lien. The bankruptcy court also concluded that the

2 The Marcus Firm also sought its fees and costs in prosecuting its claims.

5 Marcus Firm had failed to provide sufficient evidence to support the

nondischargeability claim. Specifically, the court found that the Marcus

Firm had failed to provide evidence that Ms. Lionetti did not intend to

perform her obligations when she signed the engagement letter. The

bankruptcy court noted that, in his deposition, Mr. Marcus had been

unable to provide any specific details as to dates or circumstances of other

purported misrepresentations. The court also found that the Marcus Firm

had failed to show it justifiably relied on Ms. Lionetti’s promise to pay

because she had informed Mr. Marcus that she had limited income and

resources, outstanding debts, and was considering bankruptcy. The Marcus

Firm appealed the dismissal to the District Court, which affirmed.

In the meantime, Ms. Lionetti filed a motion seeking an award of

$80,000 in attorney’s fees under § 523(d). The bankruptcy court denied the

motion, finding that it could not determine on the record before it that

there was no substantial justification for the nondischargeability action.

Ms. Lionetti appealed the denial of her motion to the District Court, which

reversed and remanded because it was unclear whether the bankruptcy

court had improperly placed the burden on Ms. Lionetti to show that the

Marcus Firm’s lawsuit lacked substantial justification.

On remand, the bankruptcy court requested briefing and, after a

hearing, once again denied the motion for fees. The court concluded that,

despite having lost on summary judgment, the Marcus Firm had

6 demonstrated that it had substantial justification for pursuing the

nondischargeability claim. The court stated that the Marcus Firm’s factual

allegations—that Ms. Lionetti allowed the Marcus Firm to work for years

knowing that the fee would never be paid in the end—plausibly fit into the

definition of “false pretenses,” i.e., a series of events, activities, or

communications which, when considered collectively, create a false and

misleading set of circumstances that induce the creditor to extend credit to

the debtor. The court also noted that the concept of actual fraud has been

evolving, citing Husky International Electronics, Inc. v. Ritz,

(2016), in which the Supreme Court held that actual fraud under

§ 523(a)(2)(A) may include not only false representations but also

fraudulent conveyance schemes. The bankruptcy court also found that

there were no special circumstances that would make the fee award unjust

and that the amount of fees requested, $80,000, was reasonable.

Ms. Lionetti timely appealed.

JURISDICTION

The bankruptcy court had jurisdiction under

and

157(b)(1) and (b)(2)(I). We have jurisdiction under

.

ISSUE

Whether the bankruptcy court abused its discretion in denying Ms.

Lionetti’s request for attorney’s fees under § 523(d).

7 STANDARD OF REVIEW

We review the bankruptcy court’s order granting or denying

attorneys’ fees under § 523(d) for abuse of discretion. Heritage Pac. Fin. LLC

v. Machuca (In re Machuca),

(9th Cir. BAP 2012)(citing First

Card v. Hunt (In re Hunt),

(9th Cir. 2001)).

Under the abuse of discretion standard, we first “determine de novo

whether the [bankruptcy] court identified the correct legal rule to apply to

the relief requested.” United States v. Hinkson,

(9th Cir.

2009) (en banc). If the bankruptcy court identified the correct legal rule, we

then determine under the clearly erroneous standard whether its factual

findings and its application of the relevant law were illogical, implausible,

or without support in inferences that may be drawn from the facts in the

record.

DISCUSSION

A. Legal Standard for § 523(d) Fee Awards

Section 523(d) permits a debtor who successfully defends a

nondischargeability action under § 523(a)(2) to recover attorney’s fees from

the plaintiff creditor under certain circumstances. Specifically, the statute

provides:

If a creditor requests a determination of dischargeability of a consumer debt under subsection (a)(2) of this section, and such debt is discharged, the court shall grant judgment in favor of the debtor for the costs of, and a reasonable attorney’s fee for,

8 the proceeding if the court finds that the position of the creditor was not substantially justified, except that the court shall not award such costs and fees if special circumstances would make the award unjust.

To prevail on a motion for attorney’s fees under § 523(d), a debtor

must prove three elements: (1) the creditor requested a determination of

the dischargeability of the debt; (2) the debt is a consumer debt; and (3) the

debt was discharged. Stine v. Flynn (In re Stine),

(9th Cir.

BAP 2000), aff’d,

(9th Cir. 2001). If the debtor establishes

these elements, the burden then shifts to the creditor to prove that its

actions were substantially justified. Id. The creditor must show that it had

substantial justification for the pursuit of the discharge litigation at all

stages of the litigation. Heritage Pac. Fin., LLC v. Montano (In re Montano),

(9th Cir. BAP 2013).

The parties do not dispute that Ms. Lionetti established the threshold

requirements for entitlement to fees under § 523(d). And the Marcus Firm

did not cross-appeal the bankruptcy court’s findings that the amount of

fees requested was reasonable and that there were no special circumstances

that would make an award of fees unjust. Therefore, the sole issue

presented in this appeal is whether the Marcus Firm met its burden to

show that it was substantially justified in pursuing its § 523(a)(2) claim.

The “substantially justified” standard requires that a claim have a

reasonable basis both in law and in fact. In re Hunt,

(citing

9 Pierce v. Underwood,

(1988)). A “novel but reasonable”

legal theory or a legal theory subject to a split of non-binding authority

may serve as bases for concluding that a claim is substantially justified. In

re Machuca,

. But a creditor cannot show substantial

justification for pursing a legally plausible § 523(a)(2) claim if it fails to

provide evidence to prove an essential element of the claim. See In re

Montano,

(“Since the bankruptcy court concluded that

Heritage had not proven actual reliance, an essential element to prove for

an exception to discharge under 523(a)(2)(B), . . . it follows that Heritage

did not show that its position was substantially justified.”)

Although the initial conditions set out by § 523(d) are straightforward

and direct, i.e., that the debtor has prevailed in an action seeking

nondischargeability of a consumer debt under § 523(a)(2), the last

condition–the court finding that “the position of the creditor was not

substantially justified”–has proven difficult to interpret and apply.

As an initial matter, the language “substantially justified” is not

defined in this section, nor anywhere else in the Code. This language

emanates from the Equal Access to Justice Act (“EAJA”). See In re Hunt,

(noting that the standard for a fee award under § 523(d) was

modeled on the EAJA, citing legislative history). The “reasonable basis in

law and fact” standard articulated by the Supreme Court in the EAJA

context has been used by courts applying § 523(d). See, e.g., In re Machuca,

10

. But while these references are helpful, they are not entirely

apt–the EAJA is not used regularly in bankruptcy proceedings, nor do most

of its non-bankruptcy applications involve actions based on alleged fraud.

Of course, § 523(d) does not come into play unless and until the

creditor’s challenge to dischargeability has been unsuccessful. And the

mere fact of having lost on the nondischargeability claim, even in some

instances on a motion for summary judgment, does not require a finding of

no substantial justification. Id. Rather, the statute requires that the trial

court evaluate whether the “position” of the creditor was substantially

justified, which strongly suggests that the standard applies to something

considerably more amorphous than the ultimate persuasive power of the

facts adduced or arguments presented. In other words, an inquiry about

substantial justification usually requires a sort of weighing of the creditor’s

view of the facts or its premises rather than its failure ultimately to prevail.

This task is made more difficult because proving fraud almost always

relies, in part, on the use of inferences. See Gertsch v. Johnson & Johnson, Fin.

Corp. (In re Gertsch),

(9th Cir. BAP 1999) (intent to

deceive can be inferred from the totality of the circumstances, including

reckless disregard for the truth); Tallant v. Kaufman (In re Tallant),

(9th Cir. BAP 1998) (intent may be inferred from the totality of the

circumstances). But while the use of inferences in a fraud action is

appropriate to establish an element of the claim that is unlikely to be

11 admitted and is not otherwise subject to objective verification, e.g., the

fraudulent intent of the defendant, it is not normally appropriate to use

inferences to prove other elements of the claim that are subject to objective

verification. Stated differently, while it may be necessary to utilize

inferences to establish some elements of a fraud claim, to have “substance,”

a fraud claim must emanate from some objective facts that would

demonstrate a misrepresentation or deceptive act, knowledge of the

deception by the defendant, reliance, and harm. The attempt to use

inferences (or inferences on inferences) to establish multiple–or all–of the

predicates for a fraud claim inappropriately equates a sense of overall

inequity with substantial justification.

Requiring at least some objective factual basis for a fraud claim

comports with the most fundamental meaning of the phrase “substantially

justified” as interpreted by the Supreme Court (i.e., having a reasonable

basis in law and fact). But the simpler and more fundamental meaning of

“substantially justified,” i.e., presenting or offering something of substance,

as opposed to surmise, may provide the answer to the inquiry whether a

position falls within the standard. It does here.

The Marcus Firm did not offer any objective factual basis for a

§ 523(a)(2)(A) claim that would have supported a finding that its claim was

substantially justified. Rather, it asserts that the “totality of the

circumstances” (including the notion that it was unfair for the Marcus Firm

12 to have accrued substantial fees in successfully representing Ms. Lionetti in

her divorce and to go unpaid) shows substantial justification for its claim.

This assertion attempts to turn the inquiry concerning “substance” into an

exercise in sifting through miasmas of alleged inequities, and is far from

the standard of substantial justification that § 523(d) ought to require.

B. The bankruptcy court erred in its application of the “substantially justified” standard.

To prevail on its nondischargeability claim under § 523(a)(2)(A), the

Marcus Firm would have had to prove, by a preponderance of the

evidence:

(1) misrepresentation, fraudulent omission or deceptive conduct by the debtor; (2) knowledge of the falsity or deceptiveness of his statement or conduct; (3) an intent to deceive; (4) justifiable reliance by the creditor on the debtor’s statement or conduct; and (5) damage to the creditor proximately caused by its reliance on the debtor’s statement or conduct.

Turtle Rock Meadows Homeowners Ass’n v. Slyman (In re Slyman),

(9th Cir. 2000). To the extent the Marcus Firm asserted that the

fraud at issue was a fraudulent omission, it needed to show that the

omitted fact was material and that Ms. Lionetti had a duty to disclose. See

Apte v. Japra, M.D., F.A.C.C., Inc. (In re Apte),

(9th Cir.

1996). If those elements were proven, the reliance and causation elements

would be deemed established without needing to be separately proven.

13 In its complaint, the Marcus Firm appeared to rely solely on a fraud

in the inducement theory, i.e., that Ms. Lionetti did not intend to pay the

Marcus Firm at the time she signed the engagement letter. Later, in its

opposition to Ms. Lionetti’s motion for summary judgment, the Marcus

Firm posited two alternative theories in support of its nondischargeability

claim: (1) a fraudulent conveyance scheme; and (2) fraudulent omissions.

With respect to the fraudulent conveyance theory, the Marcus Firm

alleged that after Ms. Lionetti granted the Marcus Firm a charging lien on

any recovery from the divorce proceeding, she later sought and received

counseling from two bankruptcy attorneys, her accountant, and her son-in-

law, an attorney with Gibson, Dunn & Crutcher LLP, the firm that

represented her in the nondischargeability proceeding (and now represents

her in this appeal).3 Then, after the family law court awarded the 401(k) to

Ms. Lionetti, she refused to endorse the check to the Marcus Firm for

payment as promised in the engagement letter and thereafter terminated

the firm’s services. The Marcus Firm argued that these facts could be

interpreted only one way–as evidence that Ms. Lionetti “knew exactly what

she was doing and why, and its adverse impact upon Plaintiff’s ability to

enforce and collect his [sic] fees, all the while continuing to accept the

benefit of Plaintiff’s services which resulted in the delivery of more than

3 According to Ms. Lionetti’s supplemental declaration in support of her motion for summary judgment, she denied having been counseled by her son-in-law.

14 $272,278.98 into her hands.” Although not clearly articulated, the Marcus

Firm seemed to argue that the referenced events constituted a transfer

scheme designed to hinder the collection of a debt. As for justifiable

reliance, the Marcus Firm argued that it relied on Ms. Lionetti’s

representation in the engagement letter that she intended to pay the

amounts due regardless of whether the firm’s efforts were successful.

Alternatively, under its fraudulent omission theory, the Marcus Firm

argued that Ms. Lionetti fraudulently failed to disclose at the time she

signed the engagement letter that she had no intention of authorizing the

firm to sign the 401(k) check in payment of its fees if doing so would result

in adverse tax consequences to her, and subsequently fraudulently failed to

disclose that in 2012 she had consulted with the above-mentioned

attorneys.

Supporting its opposition to summary judgment were the

declarations of Steven H. Marcus and Louis J. Esbin, counsel for the Marcus

Firm. Mr. Marcus testified, in relevant part, that although Ms. Lionetti was

billed each month, she never asked the firm to stop its representation and

instead “begged” Mr. Marcus to remain as counsel, and “repeatedly

assured me that she would pay our fees from the proceeds since there was

no other source available to her and she knew that she owed us these

funds.” For this assertion, Mr. Marcus cited an email from Ms. Lionetti

dated January 15, 2013, to her accountant, which included a copy of a

15 proposed email to Mr. Marcus. There was no proof such an email was ever

sent to Mr. Marcus, but even if there were, the email itself contains no

assurance of payment. In short, Mr. Marcus provided no specifics as to the

dates, times, or places of any purported assurances of payment, nor did he

cite any other evidence pointing to a fraudulent intent on Ms. Lionetti’s

part.4

As found by the bankruptcy court–and affirmed by the District

Court–the Marcus Firm did not proffer any evidence that Ms. Lionetti did

not intend to pay the firm when she signed the engagement letter, and, in

fact, Ms. Lionetti’s payment of the $10,000 retainer negated any inference

that she lacked such intent. The District Court also affirmed the bankruptcy

court’s rejection of the fraudulent conveyance theory as applied to the

transfer of the 401(k) funds into Ms. Lionetti’s retirement account because

the undisputed facts showed that no funds were transferred to a third

party.

The Marcus Firm does not dispute these findings, nor could it, given

that it did not appeal the District Court’s decision. See In re Machuca,

(creditor could not attack final judgment on summary

4 In his declaration, Mr. Esbin authenticated various attached documents, including the referenced email and others obtained from Ms. Lionetti in discovery. Those emails corroborate the allegation that Ms. Lionetti sought the advice of bankruptcy counsel in late 2012 or early 2013. Although those emails show that Ms. Lionetti intended to ask bankruptcy counsel about how the Marcus Firm’s fees would be treated in bankruptcy, there was no suggestion of any fraudulent scheme or intent.

16 judgment through a § 523(d) proceeding). Instead, it argues that the totality

of the circumstances provided a reasonable factual basis for its pursuit of

the nondischargeability claim. But the Marcus Firm points to no evidence

that would support a nondischargeability claim under any of the proffered

theories.5 Nor has our review of the record suggested a reasonable factual

basis for such a claim.

In its ruling after remand, although the court acknowledged the

correct standard–that the plaintiff must show that it had a reasonable legal

and factual basis for its claim–the bankruptcy court focused almost entirely

on whether the Marcus Firm had posited a a reasonable legal theory for its

claim, i.e., false pretenses or a fraudulent conveyance scheme. The

bankruptcy court did not analyze with specificity whether there was any

reasonable factual basis for the Marcus Firm to believe that it could

establish the elements of a § 523(a)(2)(A) claim under those theories. There

was no specific evidence of misrepresentation, fraudulent omission, or

fraudulent intent before the court, and the court cited no objective evidence

that would have supported, either directly or by inference, a false pretenses

5 The Marcus Firm states in its appellate brief that it “incorporates its former briefs on remand as though set forth at length.” However, we need not consider arguments not specifically and distinctly made in a party’s appellate brief. Price v. Lehtinen (In re Lehtinen),

(9th Cir. BAP 2005), aff’d,

(9th Cir. 2009). See also Monsanto Co. v. Scruggs,

(Fed. Cir. 2006) (Under Fed. R. App. P. 28 [which sets forth briefing requirements and is substantively identical to Rule 8014], arguments are not properly raised by incorporating them by reference from a summary judgment memorandum.).

17 or fraudulent conveyance scheme theory.

Additionally, there was no evidence that would have supported the

conclusion that the Marcus Firm justifiably relied on any representations

made by Ms. Lionetti. Given that the firm was indisputably aware of Ms.

Lionetti’s financial circumstances, the only reasonable inference to be

drawn from the evidence was that the Marcus Firm relied on its charging

lien in continuing to provide legal services.

C. There is no policy reason to limit the application of § 523(d) to situations involving consumer finance companies.

We note finally that the attempt by the Marcus Firm to argue against

application of § 523(d) because this case is not a “third party credit card

transaction” or a “typical one-sided battle against [a consumer debtor]”

lacks merit. As an initial matter, nothing in the statute or the case law

indicates that such a limitation on application of § 523(d) was contemplated

by Congress or is appropriate. In fact, far from falling outside the intended

scope of the statute, this case provides a prime example of the dilemma a

consumer debtor confronts when a creditor initiates a nondischargeability

action--i.e., the challenge of mounting--and financing--an effective defense

on what is typically a fact-intensive, and therefore potentially quite

expensive, matter. The Marcus Firm does not dispute that Ms. Lionetti’s

counsel reasonably incurred the $80,000 sought via the § 523(d) motion in

the successful effort to defend against its claim of nondischargeability (and

18 that the firm actually incurred sums greatly in excess of those sought in the

§ 523(d) motion throughout this long and contentious matter), or that the

firm could not reasonably expect to collect such a fee from Ms. Lionetti.

Absent the good fortune of obtaining what would essentially be a pro bono

representation, a consumer debtor will typically lack the ability personally

to fund such a defense. Thus, the possibility of a § 523(d) award may

provide a debtor’s only chance for attracting an attorney and obtaining an

appropriate and vigorous defense. Moreover, where the creditor asserting

nondischargeability is a law firm, the deterrent effect of § 523(d) may be

especially important. The potential cost of such litigation, in and of itself,

may in many cases cause appropriate restraint by potential plaintiff-

creditors. But a law firm can pursue the litigation without significant out of

pocket costs. Without the deterrent of § 523(d), a law firm may be much

more likely to pursue questionable litigation in an attempt to obtain a

settlement in a weak or meritless case.

CONCLUSION

Although the bankruptcy court identified the correct legal rule in

denying Ms. Lionetti’s motion for fees, the court did not properly apply

that rule, as it identified nothing in the record from which it could have

determined that the Marcus Firm had a reasonable factual basis for its

nondischargeability claim; it thus abused its discretion in denying the fee

motion.

Accordingly, we REVERSE.

19