Creditor Successfully Opens Default and Keeps Preferential Payments

In April 2003, the Debtors filed a Chapter 13 petition. The Debtors' attorney sent the creditor bank two letters requesting a return of preferential payments, which the Debtors intended to use to fund their Chapter 13 plan. The letters were sent to the address used by the creditor for receiving payments. The creditor did not respond to the letters and in December 2005, the debtors filed a complaint against the creditor, seeking return of the pre-petition payments.

According to the proof of service, the complaint was also served at the creditor's payment center. The complaint did not reach the creditor's legal department and, therefore, the legal department did not respond to the complaint by filing an answer. Once the time to answer the complaint expired, the Debtors applied to the clerk of the court for entry of default, a preliminary step in obtaining a judgment against a defaulting party. After a default is entered by the clerk, the petitioning party may then request the court enter a judgment in its favor, based upon the default.

The creditor received notice of the entry of default and referred it to Becket & Lee to attempt to obtain relief from the default. B&L partner Bill Becket's review of the case suggested two procedural defects. First, service of the complaint appeared improper, and second, the complaint was not filed within the applicable statute of limitations. As such, if the default were opened, the suit would likely be dismissed as having not been timely filed. Therefore, on behalf of the creditor, Becket & Lee filed a motion to set aside the default.

The bankruptcy court agreed with Mr. Becket's analysis. It first discussed the standard for relief from a judgment entered by default, holding, "Where timely relief is sought from a default judgment and the movant has a meritorious defense, doubt, if any, should be resolved in favor of the motion to set aside the judgment." Here, a default judgment had not been entered at the time Mr. Becket requested relief from the entry of default. Thus, the standard for setting aside the clerk's entry of default is even more liberal and requires only "good cause," which, according to the court, is to be more broadly construed than the specific grounds for opening a default judgment.

In either case, however, a primary consideration for the court is whether the movant has a meritorious defense should the default be set aside. Here, the court relied on both the due process issue, and on the statute of limitations defense, in finding "good cause" to open the default.

Regarding service of the complaint, the court noted that the fact that the bank did not respond to two letters sent to the payment address should have made the debtor's attorney question whether the bank was receiving the letters. Second, the court ruled that service on a payment address was inadequate to meet the standard that it be "reasonably calculated ... to apprise interested parties of the pendency of the action." Moreover, the court specifically noted that, "With today's technology, it is easy enough to find the service address of record, or the agent for service of process, for most any business entity."

Noting the probable success of the statue of limitations defense raised by Mr. Becket, the court set aside the default. The bank will now likely keep the over $22,000 in payments it received prior to the Debtors' filing.
In re Kellenbeck, Bankruptcy No.03-23527 (Bankr. E. D. Ca. 2003)