DAVEY v. EDMONDS (1988)

The Real Estate Commissioner of the State of California appeals from the “Order[s] Directing Payment from the Recovery Account of the Real Estate Fund” entered in favor of John and Lyndi Davey.

A state-owned Real Estate Fund, operated by the Department of Real Estate and financed from real estate license fees, contains a Recovery Account which is available to compensate those fleeced by licensed real estate brokers and salespersons.  (See Bus. & Prof.Code, §§ 10450 et seq.;   10471 et seq.) ¹  Under provisions enacted in 1985 and operative in 1987, to recover from the fund, the victim must first obtain against the licensee a “final judgment ․ based upon the defendant's fraud, misrepresentation, or deceit, made with intent to defraud, or conversion of trust funds arising directly out of any transaction ․ in which the defendant, while licensed ․, performed acts for which that license was required․”  (Id., § 10471, subd. (a).)  The victim can recover up to $20,000 of “the amount unpaid on the judgment which represents an actual and direct loss to the claimant in the transaction.”  (Id., §§ 10471, subd. (a), 10474, subd. (c).)

If the Department denies a victim's application for reimbursement from the Recovery Account, he may apply to the court that rendered the judgment for an order directing payment out of the Recovery Account.  (Id., § 10472, subd. (a).)  The claimant is required to describe his efforts to satisfy the judgment from the judgment debtors' assets;  to represent that he has “diligently pursued” collection efforts against judgment debtors and all other persons liable to him in the transaction;  and to state under penalty of perjury that he prosecuted the action “conscientiously and in good faith” against any potential defendant who reasonably appeared capable of responding in damages.   (Id., § 10471, subds. (c)(5), (7)(D), (E).)

The instant case is governed by former sections 10471 and 10472, which required the claimant to have “made all reasonable searches and inquiries to ascertain whether the judgment debtor is possessed of real or personal property or other assets, liable to be sold or applied in satisfaction of the judgment”;  to have “taken all necessary action and proceedings for the realization thereof”;  and to have “diligently pursued his remedies against all the judgment debtors and all other persons liable to him in the transaction.”   The difference in terminology, however, is not material to the issue presented here.

After making a payment from the fund, the Department of Real Estate is subrogated to the victim's rights against the licensee.  (Id., § 10479.)   The Department also is required to suspend the judgment debtor's license and to require reimbursement of the Recovery Account before reinstating the license.   (Id., § 10475.)

Not infrequently, however, the licensee obtains a discharge in bankruptcy of the victim's claim against him.  (See 11 U.S.C. §§ 727(b), 1141(d)(1)(A), 1328.)   Such a discharge also terminates the licensee's liability on the Department's subrogation claim, except to the extent section 10475 may legitimately provide otherwise.²

However, a debt is not discharged in chapter 7 or 11 bankruptcy cases if the creditor to whom it is owed requests and obtains a determination by the United States Bankruptcy Court that the debt is one for obtaining money, property, services, or credit by false pretenses, by a false representation, or by actual fraud, or one for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.  (11 U.S.C. §§ 523(a)(2)(A), (a)(4), (c).)   In a chapter 13 bankruptcy case even these debts are discharged, unless the debtor has obtained a so-called hardship discharge after failing to complete payments under his plan.  (11 U.S.C. §§ 523(a), 1328(a), (b), (c)(2).)

The decisions of our courts of appeal are divided, at least facially, over the question whether a victim must secure a bankruptcy court determination of nondischargeability as a prerequisite to resort to the Recovery Account.  (See Armenta v. Edmonds (1988) 201 Cal.App.3d 464, 247 Cal.Rptr. 204;  Rogers v. Edmonds (1988) 200 Cal.App.3d 1237, 248 Cal.Rptr. 15.)   Unfortunately our Supreme Court denied review in each of these appeals as well as in a third case where it merely ordered the opinion not be published in the Official Reports.   (Zambrano v. Real Estate Com'r of State (1988) 201 Cal.App.3d 720, 247 Cal.Rptr. 214.)

The Department's position, of course, is that the claimant must do so, for discharge, at a minimum, destroys the Department's opportunity to seek prompt replenishment of the Recovery Account by immediately enforcing its right of subrogation against the licensee.

The present case was decided in the municipal court and appealed to the superior court.   Upon Rule 63 certification, we transferred it here in order to express our views on the subject as well as to afford our Supreme Court another opportunity to resolve any conflict that may exist, should it choose to do so.

With respect to post–1987 claims, the issue appears to have been resolved by recent statutory amendment.   Section 10471, subdivision (c)(7)(F), added in 1987, requires that the claimant represent that the licensee's debt has not been discharged in bankruptcy or, if a bankruptcy case is pending, that the bankruptcy court has already declared the debt nondischargeable.³  Nonetheless, there may be many pending older claims, such as the ones now before us, which are not directly subject to this requirement.   To resolve such cases requires interpreting and applying the earlier statutes.

Any ambiguous language in these legislative enactments is to be construed liberally in favor of the claimant in order to carry out their goal of providing a pool of funds through which fraud losses can be shifted from victims to licensees as a class.

Both before and after their 1985 revamping, the statutes required, through divers phrases, that the claimant diligently pursue his remedies against the licensee and other persons who might be liable to him.   It is conceivable that prior to the 1987 amendment of section 10471, there may have been instances in which an assetless licensee was so destitute that a declaration of nondischargeability from the bankruptcy court would have been a useless document.   If so, to insist that the already injured party should have expended further funds in so vain an endeavor would serve only to diminish even the limited recovery currently available to him.   Nonetheless, in most cases consideration for the Department's potential interest as a subrogee would necessitate that such a minimal effort be undertaken.

In this regard we note that the legislative declaration accompanying the 1987 amendment's express requirement that claimants protect their judgments from discharge, points out that “An independent study completed for the Department of Real Estate has determined that, based upon anticipated future program revenues and claims, the Real Estate Recovery Program is now insolvent.”   It also mentions with disapproval the conduct of claimants “who have employed judicial procedures designed solely to assure access to the Recovery Account.”  (Stats.1987, ch. 535, § 1(c), (d).)

Consequently, it would be difficult, indeed, to regard this amendment as merely declarative of existing law.   To the contrary, as previously noted, section 10475 has long provided that a discharge in bankruptcy does not relieve a licensee of his obligation to make restitution to the Recovery Account, a declaration which certainly suggests that in some instances, at least, it was contemplated that a fraud victim might receive compensation from the state fund even though the licensee's indebtedness was discharged in bankruptcy.  (See fn. 2, supra.)

Turning to the facts of the case before us, we conclude the claimants failed to establish they had exercised the requisite reasonable diligence.   They candidly informed the bankruptcy court they intended “to ask the state court for an order directing payment of any judgment obtained against Debtor out of [the Recovery Account] rather than seek to enforce any judgment against Debtor or his spouse.”  (Emphasis added.)

In addition, although they filed a complaint in the bankruptcy case to determine the nondischargeability of the licensee's debt to them, the claimants apparently did not pursue it and offered no explanation for their failure to do so.   That is, their debtor had obtained his discharge in bankruptcy in January 1985, and they presented no evidence that they had before that time investigated or evaluated his financial prospects in such a fashion as would have justified their counsel's conclusional argument that a post-bankruptcy effort to collect a nondischarged debt would have been futile.

In fact, at the hearing in March 1986, at which the presently challenged order was made, the licensee testified he had earned approximately $2,500 in January and $1,000 in February, and that although he did not own a car he “rented” one, which he used in his business, for $234 per month.   Perhaps for this reason, the claimants in their brief take the extreme position that the licensee's discharge in bankruptcy is itself sufficient “to totally satisfy the proof” required that they made all reasonable searches and took all necessary steps to enforce their judgment against him.

Accordingly, plaintiffs' claim against the Recovery Account cannot be sustained.   The purpose of the statutory diligence requirement is twofold:  first, to conserve the state fund's resources by requiring the victim to pursue the fund only as a last resort;  and second, to protect the potential interests of the Department as subrogee, to the benefit of other future claimants who might otherwise face an insolvent Recovery Account.   Claimants' conduct here was in derogation of both these goals.

Our disposition of this primary issue moots the claimants' cross-appeal challenging the trial court's exclusion of their legal fees from the amount of their reimbursement, a claim which would have been unavailing in any event.   (Acebo v. Real Estate Education etc. Fund (1984) 155 Cal.App.3d 907, 202 Cal.Rptr. 518.)

Our analysis, we recognize, is not entirely consistent with that expounded in either Armenta v. Edmonds, supra, 201 Cal.App.3d 464, 247 Cal.Rptr. 204, or Rogers v. Edmonds, supra, 200 Cal.App.3d 1237, 248 Cal.Rptr. 15.

The opinion in Rogers focused entirely on the nonretroactivity of the 1987 amendment to section 10471 and the policy of liberality in applying remedial statutes.   Of course, it is possible that because the factual record there demonstrated complete compliance, its authors found it unnecessary to address the claimant's long-standing statutory obligation diligently to pursue his remedies against the debtor.

Armenta, on the other hand, simply held the statutory prerequisite of “a final judgment” against the licensee was unfilled if he obtained a discharge in bankruptcy, since under bankruptcy law the discharge “voids any judgment” against the bankrupt.

This would appear to be too expansive a reading of section 524(a)(1) of the Bankruptcy Code.   That provision states a discharge “voids any judgment ․ to the extent that such judgment is a determination of the personal liability of the debtor with respect to any debt discharged․”  The words “to the extent that” are more than a graceful connective phrase.   They are used repeatedly in the Bankruptcy Code to delineate the extent to which a rule operates and beyond which it does not.⁴  Section 524(a)(1) of the Bankruptcy Code thus invalidates the judgment only “to the extent that,” i.e., “insofar as,” it adjudges the debtor personally liable for the discharged debt.   It does not purport to invalidate the judgment for the collateral purposes of establishing the facts essential thereto ⁵ or satisfying a state's statutory requirement that a claim be reduced to judgment before the creditor resorts to his remedy against the state fund.  (Accord, Rogers v. Edmonds, supra, 200 Cal.App.3d at p. 1241, 248 Cal.Rptr. 15;  see In re Fasse, supra, 40 B.R. 198, 200;  Matter of McGraw (Bankr.W.D.Wis.1982) 18 B.R. 140, 143.)   In addition, section 524(a)(1) should be read in pari materia with section 524(a)(2), which enjoins any act to collect a discharged debt “as a personal liability of the debtor.”   This discharge injunction would not prohibit pursuit of the claim against the Recovery Fund.

Despite these observations, we do not regard the judgment in Armenta as necessarily incorrect.   There, although the claimants had obtained “a default judgment against a licensed real estate agent based upon allegations of fraud,” the bankruptcy court had subsequently “ruled in favor of the agent and discharged the debt.”

The order directing payment from the Recovery Account is reversed, with directions to deny plaintiffs' application for such an order.   Each party will bear its own costs.

FOOTNOTES

1.   All further code references are to the Business and Professions Code unless otherwise indicated.

2.   Section 10475 provides:  “Should the commissioner pay from the Recovery Account any amount in settlement of a claim or toward satisfaction of a judgment against a licensed broker or salesperson, the license of the broker or salesperson shall be automatically suspended upon the date of payment from the Recovery Account.   No broker or salesperson shall be granted reinstatement until he or she has repaid in full, plus interest at the prevailing legal rate applicable to a judgment rendered in any court of this state, the amount paid from the Recovery Account on his or her account.   A discharge in bankruptcy shall not relieve a person from the penalties and disabilities provided in this chapter.”The extent to which this provision may conflict with sections 524(a)(2) and 525(a) of the Bankruptcy Code is an issue not before us.  (See In re Fasse (Bankr.D.Colo.1984) 40 B.R. 198, 200–201.)

3.   Since section 10471 requires that the application contain such a representation, and section 10472.1, subdivision (b) demands that the claimant “establish compliance with” section 10471, it seems clear the claimant must prove—not merely “represent”—that the bankruptcy court has determined nondischargeability.We note in passing that this amendment would seem to erect an insurmountable obstacle to claimants in the event the licensee seeks a chapter 13 discharge, which encompasses even fraud debts.  (See p. ––––, supra.)

4.   See, e.g., 11 U.S.C. §§ 346(j)(3), (6), (7)(A), 361(1), (2), 362(b)(3), 363(d), 502(b), (e)(1), 506(a), (b), (d), 507(a)(3)(B), (a)(4)(B), (a)(5), (a)(6), 509(a), (b), 522(f), (g), (h), 523(a)(5), 545, 547(c)(1), (2), (3)(A), (4), 548(c), 550(a).

5.   In the Recovery Account proceeding, though the Department is entitled to relitigate these facts, they are binding on the claimant and the licensee.  (Secs. 10473, 10473.1.)

GATES, Associate Justice.

COMPTON, Acting P.J., and FUKUTO, J., concur.