Keeping Tabs on the Ninth Circuit
June 18, 2020 - This Week at the Ninth

This Week at The Ninth: Erie And Exculpation

This Week at The Ninth:  Erie And Exculpation

This week, the Ninth Circuit (quite reasonably) relied on the state courts to resolve a number of open legal questions, certifying two questions to state high courts and issuing an en banc opinion based on the Montana Supreme Court’s resolution of a third. Here, we focus on two cases the Court decided without such assistance. In the first, the Court held that whether equitable restitution is an available remedy for a state-law claim in federal court is a matter of federal rather than state law. In the second, the Court held that the Bankruptcy Code permits exculpation clauses that release parties from liability for their conduct in bankruptcy proceedings.

The Court holds that federal courts must apply federal equitable principles to claims for equitable restitution under state law and thus may not award equitable restitution under California’s Unfair Competition Law (“UCL”) and Consumers Legal Remedies Act (“CLRA”) when an adequate legal remedy exists.

Panel: Judges Lucero (CA10), Callahan, and Bade, with Judge Bade writing the opinion.

Key Highlight: “Pursuant to Erie Railroad Co. v. Tompkins, 304 U.S. 64 (1938), and Guaranty Trust Co. of New York v. York, 326 U.S. 99 (1945), we hold that federal courts must apply equitable principles derived from federal common law to claims for equitable restitution under California’s [UCL] and [CLRA].”

Background: Plaintiff Kathleen Sonner, on behalf of herself and a putative class, sued Premier Nutrition for allegedly falsely advertising that its “Joint Juice” product improves joint comfort, in violation of California’s UCL and CLRA. Although Sonner originally sought $32 million as either legal damages or equitable restitution, she voluntarily dismissed the claim for legal damages shortly before trial in order to secure a bench trial rather than a jury trial. She thus sought the $32 million solely as equitable restitution. The district court then dismissed Sonner’s complaint without leave to amend. It held that, under California law, Sonner could not obtain equitable restitution unless a plain, adequate and complete remedy at law was unavailable, a requirement she could not satisfy.

Result: The Ninth Circuit affirmed the district court’s dismissal of the complaint, but on different grounds. Rather than apply California law on equitable remedies—which Sonner claimed the California legislature had abrogated—the Court held that federal courts must apply federal common law equitable principles to claims for equitable restitution, even when those claims arise under state law. Relying on the Supreme Court’s decision in Guaranty Trust Co. of New York v. York, 326 U.S. 99 (1945), the Court explained that “state law can neither broaden nor restrain a federal court’s power to issue equitable relief.”

The Court acknowledged that, under Erie Railroad Co. v. Tompkins, 304 U.S. 64 (1938), federal courts must apply state substantive law when exercising diversity jurisdiction and that to identify whether a law is substantive or procedural the Court generally applies an “outcome determinative test.” But, the Court stressed, “the ‘outcome’ of this litigation is not our ‘only consideration’” when applying Erie, “as we must also balance the policies underlying the state and federal laws.” Here, the Court concluded, the federal “principle precluding courts from awarding equitable relief when an adequate legal remedy exists implicates the well-established federal policy of safeguarding the constitutional right to a trial by jury in federal court.” Because Sonner could have sought the same relief as legal damages, she could not show that an adequate remedy at law was unavailable, and her complaint was therefore properly dismissed. Finally, the Court held, because Sonner had voluntarily dismissed her claim for damages after a warning from the district court that further amendment would not be allowed, the district court did not abuse its discretion in denying her leave to amend to add her legal damages claim back into the complaint.

The Ninth Circuit reiterates its rejection of the equitable mootness theory on which the district court relied, but nevertheless affirms on the ground that the Bankruptcy Code does not prohibit exculpation clauses that release third parties from liability for negligence relating to the bankruptcy proceedings.

Panel: Judges Paez, Berzon, and Bybee, with Judge Berzon writing the opinion.

Key Highlight: “We remanded to the district court with instructions to consider the merits of Blixseth’s challenge to the Clause. But on remand, the district court did not rule on the merits of Blixseth’s challenge to the Clause. Instead, it dismissed Blixseth’s challenge on the ground that it was barred by equitable mootness.”

Background: Timothy Blixseth had big plans for the Yellowstone Club, an “exclusive ski and golf community” based in Big Sky, Montana. He borrowed $375 million from Credit Suisse and others to finance a global expansion of the enterprise. But after a few years of setbacks and a divorce that left Blixseth’s wife as indirect owner of the business, the Yellowstone Club entered Chapter 11 bankruptcy. The proceedings were contentious, with much of the litigation focusing on proposed reorganization plan’s “exculpation clause,” a contractual provision releasing certain non-debtors from liability for acts or omissions arising out of the Chapter 11 proceedings. The district court had rejected Blixeth’s challenge to the bankruptcy court’s order clarifying that clause, holding that he lacked standing. In a prior appeal, the Ninth Circuit reversed, holding both that Blixseth had standing and that his objection was not equitably moot. But on remand, the district court dismissed Blixseth’s claim on the ground that it was equitably moot.

Result: The Ninth Circuit affirmed. The Court first resolved a threshold procedural issue. The Court had asked Blixseth to show cause why the appeal should not be dismissed after it learned the parties had possibly reached a settlement. His response was incomplete: he moved to dismiss two parties with whom he had settled, but he did not address the status of his dispute with Credit Suisse until a month and a half after the Court’s deadline. While the Court noted that it has the power to dismiss appeals in such situations, it declined to do so. Because Credit Suisse had not been prejudiced by the delay, Blixseth had at least partially responded to the order, and dismissal is a harsh remedy, the Court stayed its hand.

Next, the Court succinctly addressed the ground on which the district court had rejected Blixseth’s challenge to the reorganization plan: equitable mootness. The Ninth Circuit saw no need to get into the details of the doctrine because it had already decided the precise issue in Blixseth’s prior appeal. That determination was now the “law of the case,” and it prohibited both the district court and the Ninth Circuit from revisiting the issue. In any event, the Court continued, its prior decision remained sound: Blixseth’s challenge was not equitably moot because invalidating the exculpation clause would not destroy the entire reorganization plan.

Finally, the Court reached the merits of Blixseth’s objection that, in releasing Credit Suisse from liability, the exculpation clause was overbroad. Under the Bankruptcy Code, “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.” 11 U.S.C. § 524(e). Blixseth contended that the reorganization plan violated that statutory provision by releasing Credit Suisse from liability for negligence relating to the bankruptcy proceedings. The Court disagreed, reasoning that the exculpation clause was narrow, relating only to the process of plan approval. The statute, by contrast, merely “confines the debt that may be discharged to the ‘debt of the debtor’—and not the obligations of third parties for that debt.” Because the exculpation clause was therefore valid, the Court affirmed. “Perhaps,” it declared, “we have reached the end of this matter.”