In the Matter of: Mortgages Ltd.

A bankruptcy court may not disregard statements in a pleading in regards to an agreement made between two parties unless the court finds that the agreement was made in bad faith.

As a private real estate lender in Arizona, Mortgages Ltd. raised money from investors to lend for certain real estate purchasers. Eventually, Mortgages Ltd. filed for Chapter 11 bankruptcy and was restructured through a “confirmed bankruptcy plan.” The appellee, ML Manager LLC (“ML Manager”), managed Mortgages Ltd.’s portfolio and sought to sell some of the loans in the portfolio. However, a group of “pass through” investors, Rev Op Group, objected to the sales and moved for cross-declaratory judgment to “resolve ML Manager’s powers regarding Mortgages Ltd.’s portfolio.” The bankruptcy court held that the Rev Op Group had executed an agreement with ML Manager that was irrevocable under Arizona law. ML Manager thus moved to dismiss the appeal as equitably moot; but, the Ninth Circuit determined that the appeal was not equitably moot because Rev Op Group diligently sought the stay. Further, the panel “could fashion effective relief because modification of the declaratory judgment would not inequitably affect innocent third parties.” Additionally, the panel determined that on remand, the bankruptcy court could adequately devise an equitable remedy to the injured party. Ultimately, the panel determined that the bankruptcy court erred in its conclusion that the agreement between Rev Op Group and ML Manager was irrevocable under Arizona law. The panel found in Rev Op Group’s answer that the investors did not sign any type of documentation that included the agency agreement. The panel further held that “under the federal pleading rules, a court cannot disregard statements in a pleading unless the court specifically determines that the statement was made in bad faith under Federal Rule of Civil Procedure 11, or should be struck under Rule 12(f).” REVERSED AND REMANDED.