KSB

14-21588 Hall (Doc. # 136)

In Re Hall, 14-21588 (Bankr. D. Kan. Nov. 19, 2014) Doc. # 136

PDFClick here for the pdf document.


SO ORDERED.
SIGNED this 19th day of November, 2014.

 

Designated for print publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS


In re:
LEON FRANCIS HALL, CASE NO. 14-21588
CHAPTER 11
DEBTOR.

MEMORANDUM OPINION AND ORDER GRANTING DEBTOR'S
APPLICATION FOR ENGAGEMENT OF COUNSEL WITH MODIFICATIONS

On July 8, 2014, one day following the filing of the petition in this Chapter 11
case, Debtor Leon Hall filed his Application by Debtor for the Engagement of Counsel.
In it he sought approval of employment of Eron Law, P.A. under 11 U.S.C. § 327,1
effective November 1, 2013, on a contingency fee basis under § 328(a), or alternatively at
the rate of $450 per hour. Leo Hall, a creditor and father of the Debtor, and the United

1 Future references to Title 11 in the text shall be by the section number only.

Case 14-21588 Doc# 136 Filed 11/19/14 Page 1 of 18


States Trustee filed objections. An evidentiary hearing was held on October 22, 2014.
The Debtor appeared in person and by his counsel David Eron, of Eron Law. The United
States Trustee appeared by Joyce Owen. Creditor Leo Hall appeared by Christopher W.
O’Brian of Brown, Dengler & O'Brian LLC, but did not actively participate in the
hearing. There were no other appearances. The Court has jurisdiction.2

The United States Trustee argued in its objection that Eron Law is not
disinterested, as required for appointment under § 327, because it has a claim for
approximately 140 hours of prepetition services, and that the cure is for Eron Law to
become disinterested by waiver of its claim. As to the terms of appointment, the United
States Trustee argued whatever compensation is approved, that it not be under § 328,
which would severely limit the Court’s future ability to review the fees to be awarded.
The United States Trustee opposed approval of a contingency based fee and suggested
that if the Court approves the employment of Eron Law, it should be at the firm's
customary hourly rate, with the total fee being subject to review under the reasonableness
standard of § 330. In his brief, Leo Hall argues that Eron Law should be compensated on

2 This Court has jurisdiction pursuant to 28 U.S.C. § 157(a) and §§ 1334(a) and (b) and the Amended
Standing Order of Reference of the United States District Court for the District of Kansas that exercised
authority conferred by § 157(a) to refer to the District’s Bankruptcy judges all matters under the Bankruptcy
Code and all proceedings arising under the Code or arising in or related to a case under the Code, effective
June 24, 2013. D. Kan. Standing Order 13-1, printed in D. Kan. Rules of Practice and Procedure at 168
(March 2014). An application to approve the employment of counsel is a core proceeding which this Court
may hear and determine as provided in 28 U.S.C.§ 157(b)(2)(A). There is no objection to venue or
jurisdiction over the parties.

2

Case 14-21588 Doc# 136 Filed 11/19/14 Page 2 of 18


an hourly basis normally charged by Chapter 11 counsel in Wichita, Kansas, where Eron
Law’s office is located.3
BACKGROUND FACTS.

Debtor Leon Hall is a farmer. Farming is all that he knows. Until recently, when
he became estranged from his father, Debtor farmed with his father, Leo Hall. Currently
Debtor is employed part time helping out the farmer who is leasing Debtor’s farmland.
Debtor suffers from several medical conditions which limit his earning ability. He does
not earn enough to pay his living expenses. In the past, Debtor's father provided funds for
Debtor's legal expenses, but this source of funding became unavailable when Debtor and
his father became estranged.

Mr. Eron, the managing partner of Eron Law, has been representing Debtor since
December 2012. At that time, Debtor was upset about the family acrimony and the advice
he was receiving from his attorneys who were beholden to his father. Debtor had filed a
Chapter 12 case in 2010. The case was unsuccessful and eventually dismissed. But in
2012, the Debtor’s former bankruptcy counsel was advising that a new bankruptcy should
be filed. Mr. Eron accepted the representation, even though he knew that Debtor had no
source of funds to pay fees.

Eron Law became convinced that Debtor would benefit from the filing of a Chapter
11 case. Eron Law and Debtor executed the Chapter 11 Legal Services Agreement, dated

3 This case was filed in the Kansas City, Kansas division of the Federal Bankruptcy Court for the
District of Kansas, where the customary fees are significantly higher than in Wichita.

3

Case 14-21588 Doc# 136 Filed 11/19/14 Page 3 of 18


November 6, 2013, which is the subject of the application for appointment. It provides for
fees in the amount of 10% of the gross proceeds from all sales of estate assets, subject to
the approval of the employment by the Bankruptcy Court. After executing the Legal
Services Agreement, significant investigation and prefiling estate planning were
undertaken. The representation also included advising Debtor's divorce counsel regarding
the division of assets and assisting Debtor’s criminal counsel in negotiating a settlement of
a potential criminal prosecution. Further details of the representation are discussed below.

Debtor filed a voluntary petition under Chapter 11 on July 7, 2014. Debtor remains
in possession of the estate. Since Debtor is not conducting farming operations, this will be
a liquidating case. Debtor’s primary asset is 9.5 quarter sections of farmland located in
Stafford County, Kansas valued at approximately $5 million, subject to approximately
$4,350,000 in recorded mortgage liabilities. Sale of the real property will result in
significant capital gain tax liability. Personal property is valued at approximately
$300,000, but is fully encumbered. Debtor’s largest secured creditor is his father, who
holds a claim of approximately $1.8 million.4 There are over 100 creditors. Unsecured
claims are approximately $6 million.

Even though the estate appears insolvent, Mr. Eron’s goal is to sell the estate assets
in a manner which will allow significant distributions to unsecured creditors. Eron Law
has the expertise and skill to undertake this representation. Mr. Eron's representation of

4 Doc. 8, 8. (Application by Debtor for the Engagement of Counsel) Debtor’s schedules include
different values, which may be the nondisputed portions of the claims.

4

Case 14-21588 Doc# 136 Filed 11/19/14 Page 4 of 18


Debtor to date evidences compassion, diligence, and creativity. But several factors make
the representation of Debtor difficult and undesirable. Debtor relies upon these details of
the representation to argue that this case is unique and warrants approval of employment
under § 328 on the basis of a contingency fee calculated to be 10% of the estate's gross
proceeds of sale.

To reach his desired outcome of the case, Mr. Eron will have to overcome
significant obstacles. The first is deep seated family strife, involving Debtor’s father and
sister, complicated by his mother’s death in 2013. Much of Mr. Eron’s optimism of
achieving a good outcome is predicated upon his ability to successfully negotiate
settlements with Debtor’s father.

The second obstacle is maximizing the return from disposition of the farmland. Mr.
Eron’s investigation shows the possibility that several of the recorded mortgages on the
farmland have been paid off. Lien avoidance actions will be necessary to realize this
possibility. Mr. Eron has also identified issues about the extent of a prior judgment lien.
There are issues about the ownership of irrigation equipment. In addition, Debtor has a
low tax basis in the property and the potential of a large tax liability upon sale.

Third, the relationship between Debtor and his father while farming for many years
gives rise to the question of whether they were operating a partnership. Mr. Eron proposes
to use the existence of a partnership to both reduce the claims against the estate and to
recover funds for the estate. He reasons that if Debtor and his father were farming as
partners, Debtor may have less than 100% liability for the claims arising from the farming

5

Case 14-21588 Doc# 136 Filed 11/19/14 Page 5 of 18


operation. Mr. Eron is also investigating whether a claim for rent exists against Debtor’s
father for his use of a portion of Debtor’s farmland. There is also the potential for a legal
malpractice action against Debtor’s former counsel.

The undesirability of the case arises from the expectation that the representation
will require significant time coupled with the risk that the estate will be administratively
insolvent and unable to pay fees, or even expenses. In addition, even if Mr. Eron’s plans
to maximize the value of the estate are successful, any payment of attorney fees will be
substantially delayed. Eron Law has already represented Debtor for over a year without
compensation. Such delay in payment causes significant disruption for Eron Law, which
is essentially a solo practice.

When filing the application, Mr. Eron estimated that after all sales are completed,
gross compensation under the 10% contingency fee arrangement would be $500,000. This
amount includes reimbursement of all costs advanced, estimated to be $50,000, resulting
in net estimated compensation of $450,000. Mr. Eron stated that he initially anticipated
that the total time devoted to the case would be 540 hours, resulting in a fee of
approximately $850 per hour. Mr. Eron’s standard hourly rate is $225 per hour for
bankruptcy cases. By the time of oral argument on the application, Mr. Eron
acknowledged that his estimate of the time required was much too low.
DISCUSSION.

A. The appointment of Eron Law is not precluded because the law firm holds a
claim for prepetition services which has not been waived.
6

Case 14-21588 Doc# 136 Filed 11/19/14 Page 6 of 18


The United States Trustee’s first argument is that the employment of Eron Law is
precluded because the firm is not disinterested as required for employment. Section
327(a), employment of professional persons, provides, "Except as otherwise provided in
this section, the trustee, with the court’s approval, may employ one or more attorneys . . .
that do not hold or represent an interest adverse to the estate, and that are disinterested
persons, to represent or assist the trustee in carrying out the trustee’s duties under this
title." Under § 1107, a debtor in possession generally has all the powers of a trustee, and
therefore may employ an attorney under § 327(a). Section 101(14)(A) defines a
disinterested person to mean a person that “is not a creditor, an equity security holder, or
an insider.”

Debtor’s application states that “Eron Law has spent approximately 140 hours as of
the Petition Date devoted exclusively to Debtor’s case during the eight months preceding
this application.”5 At trial the evidence established that Mr. Eron first provided legal
services to Debtor relating to his financial affairs in December 2012. Matters included
review of Debtor’s 2010 bankruptcy and current financial issues, providing assistance in
settling property matters in Debtor’s pending divorce, and assisting in negotiating
settlement of Debtor’s criminal charges which could have resulted in incarceration,
thereby making Debtor unavailable for personal participation in a potential bankruptcy.
At least by early November, the representation included evaluation and planning for a

5 Doc. 8, 5.
7


Case 14-21588 Doc# 136 Filed 11/19/14 Page 7 of 18


Chapter 11 filing. The Legal Services Agreement between Debtor and Eron Law, P.A. is
dated November 6, 2013. On that date, Mr. Eron’s time sheets show an office conference
with Debtor regarding Chapter 11 and other matters. The first time entry for preparing
schedules was in February 2014. Debtor’s divorce was finalized on May 15, 2014, and
thereafter increasing amounts of time were devoted to preparation of the bankruptcy filing.
The bankruptcy petition was filed on July 7, 2014. Other than a small payment of $800 to
$1000, Eron Law has not been paid for any of the services provided and has waived any
claim for services prior to November 6, 2013.

The United States Trustee claims that because Eron Law has not waived its claim
for services between November 6, 2013 and July 7, 2014, Eron Law is not disinterested
and the requested appointment is precluded by §§ 327(a) and 101(14)(A). This position is
supported by a literal reading of the statutes. Cases cited by the United States Trustee
support the position that an attorney holding a prepetition claim for services is not
disinterested and cannot be appointed unless the claim is waived.6 Neither the Debtor nor
Leo Hall cite cases addressing the disinterestedness question.

6 E.g., In re Boot Hill Biofuels, LLC, 2009 WL 982192 (Bankr. D. Kan. March 27, 2009) (Judge
Nugent held that a law firm was not disinterested as required by § 327(a) because it was an involuntary gap
creditor under § 502 and it would be disqualified unless it disclosed and waived those fees); United States
Trustee v. Price Waterhouse, 19 F.3d 138 (3rd Cir. 1994) (clear and unambiguous language of code
prohibited debtor in possession from employing former accountant, who was one of the 20 largest creditors,
to assist in performing duties in case); In re Estes, 57 B.R. 158 (Bankr N.D. Ala. 1986) (employment of
attorney whose law firm held a claim against the estate was improper in Chapter 11 case).

8

Case 14-21588 Doc# 136 Filed 11/19/14 Page 8 of 18


The Court’s research reveals that some courts decline to apply the definition of
disinterested person literally, as urged by the United States Trustee. In Martin, 7 the First
Circuit, after noting that § 327(a) would at first blush “seem to foreclose the employment
of an attorney who is in any respect a ‘creditor’”, found “such a literalistic reading defies
common sense and must be discarded as grossly overbroad.”8 It reasoned that

to interpret the law in such an inelastic way would virtually
eliminate any possibility of legal assistance for a debtor in
possession, except under a cash-and-carry arrangement or on a
pro bono basis. It stands to reason that the statutory mosaic
must, at least, be read to exclude as a “creditor” a lawyer, not
previously owed back fees or other indebtedness, who is
authorized by the court to represent a debtor in connection
with reorganization proceedings—notwithstanding that the
lawyer will almost instantaneously become a creditor of the
estate with regard to the charges endemic to current and future
representation.9

A bankruptcy court has observed that “most courts have concluded that performance of
customary prepetition bankruptcy services, i.e., preliminary work routinely undertaken to
facilitate an upcoming bankruptcy filing, does not make the attorney a creditor under §
101(13) and will not serve to disqualify an otherwise eligible attorney from appointment
under § 327(a) absent the presence of other disqualifying factors.”10 A respected
commentator states, “[e]ven courts that adhere to the per se rule have held that

7 In re Martin, 817 F.2d 175 (1st Cir. 1987).
8 Id. at 180.
9 Id.
10 In re Watson, 94 B.R. 111, 114 (Bankr. S.D. Ohio 1988).


9

Case 14-21588 Doc# 136 Filed 11/19/14 Page 9 of 18


professionals holding claims for services rendered prior to the commencement of the
chapter 11 case are not thereby barred from representing the debtor in possession if the
services were rendered in preparation for the bankruptcy filing.”11

The Court agrees with the more liberal construction of the disinterestedness
requirement. The evidence, including the testimony and the Court’s examination of Mr.
Eron’s time entries for the prepetition time period, convince the Court that the services
were rendered in preparation of the bankruptcy filing and Eron Law should be considered
disinterested for purposes of appointment under § 327.

B. The Court rejects the request that the appointment be under § 328 on a
contingency basis.
Debtor argues that the employment of Eron Law should be under § 328 “because of
the substantial risk of non-payment if sales are not consummated, and the further risk of an
‘ex post facto’ attempt by other parties to reduce the appropriate fee based upon
subsequent facts not presently known.”12 The United States Trustee argues that if Eron
Law is employed, compensation should be determined under §330 rather than § 328.

Section 330, Compensation of officers, is the generally applicable fee statute. It
provides, subject to § 328, for the award of “reasonable compensation for actual, necessary
services rendered by the . . . attorney” and “reimbursement for actual, necessary
expenses.” In the absence of preapproval under § 328, Eron Law's fees would be reviewed

11 7 Collier on Bankruptcy, ¶ 1107.04[3][b] at 1107-16 (Alan N. Resnick & Henry J. Sommer eds.-inchief,
16th ed. 2014).
12 Doc. 8, 3.
10

Case 14-21588 Doc# 136 Filed 11/19/14 Page 10 of 18


at the conclusion of the case under the § 330 reasonableness standard.13 In the Tenth

Circuit, reasonableness is determined under the adjusted lodestar approach, which takes

into account each of the factors stated in § 330(a)(3) plus additional relevant factors as

identified in Johnson v. Georgia Highway Express. 14

Section 328, under which Eron Law seeks approval of a contingency fee, provides:

The trustee, . . . with the court’s approval, may employ
or authorize the employment of a professional person under
section 327 . . . on any reasonable terms and conditions of
employment, including on a retainer, on an hourly basis, on a
fixed or percentage fee basis, or on a contingent fee basis.
Notwithstanding such terms and conditions, the court may
allow compensation different from the compensation provided
under such terms and conditions after the conclusion of such
employment, if such terms and conditions prove to have been
improvident in light of developments not capable of being
anticipated at the time of the fixing of such terms and
conditions.

Therefore, when evaluating an employment agreement under § 328, the Court makes a

reasonableness examination of the proposed terms and conditions. If the employment is

approved under § 328, the court may not later switch to § 330 to award fees.15 The

standard for review of fees under an agreement approved under § 328 “is that of

improvidence ‘in light of developments not capable of being anticipated at the time of the

13 In re Circle K Corp., 279 F.3d 669, 671 (9th Cir. 2002).

14 Market Center East Retail Property, Inc. v. Barak Lurie (In re Market Center East Retail Property,
Inc.), 730 F.3d 1239, 1247 (10th Cir. 2013), referring to Johnson v. Georgia Highway Exp., Inc., 488 F.2d
714 (5th Cir. 1974).

15 In re Airspect Air, Inc., 288 B.R. 464, 470 (6th Cir. BAP 2003) rev’d on other grounds 385 F.3d
915 (6th Cir. 2004).

11

Case 14-21588 Doc# 136 Filed 11/19/14 Page 11 of 18


fixing of such terms and conditions.’”16 The court may not revisit its prior determination

of reasonableness of the compensation arrangement unless and until it determines that the

pre-approved terms and conditions were “improvident in light of developments not

capable of being anticipated at the time" of approval.17 This is a “high hurdle to clear.”18

For example, when special litigation counsel’s contingency fee arrangement had been pre-

approved under § 328, the bankruptcy court could not reduce the fee award "simply

because the size and scope of a settlement had not actually been anticipated, [since] it does

not follow that it was incapable of anticipation."19

In this case, the application seeks approval of employment under the November 6,

2013, Legal Services Agreement between Eron Law and Debtor. As to fees it provides:

The Firm agrees to accept this case on a contingency fee basis.
The fees described hereafter will be accepted to cover all work
performed by the Firm in your chapter 11 case, or any
proceedings related to your chapter 11 case. The Firm will
earn fees only upon the sale of assets owned by you. The Firm
agrees to accept a fee equal to 10% of any assets sold by you
or the chapter 11 estate, whether sold during your chapter 11
estate pursuant to 11 U.S.C. §363, through a chapter 11 plan,
any combination thereof, or any substitute therefore. The sales
price shall be calculated on the gross amount of any sale,
regardless of any other fees or secured debts that must be paid
out of the sale proceeds. The Firm agrees that it will be

16 Id. at 471, quoting 11 U.S.C. § 328(a).
17 In re Federal Mogul-Global, Inc., 348 F.3d 390, 396-97 (3rd Cir. 2003), cited with approval in In


re Market Center East Retail Property, Inc., 730 F.3d at 1246, n. 5.
18 Riker, Danzig, Scherer, Hyland & Peretti v. Offical Comm. of Unsecured Creditors (In re Smart

World Technologies, LLC.), 552 F.3d 228, 235 (2nd Cir. 2009).
19 Id.

12

Case 14-21588 Doc# 136 Filed 11/19/14 Page 12 of 18


responsible to take appropriate action to seek recovery of any
earned fees through surcharge or pro rata mechanisms in the
event that sale proceeds are insufficient to pay all necessary
costs, fees, and encumbrances. . . .

COSTS AND EXPENSES. Costs and expenses advanced or
paid by the Firm on behalf of you will be paid by the firm and
included in the contingency fee identified above.

A substantial portion of Mr. Eron’s testimony and the expert opinion report offered
by Eron Law was directed at supporting the position that a contingency fee should be
approved because of the complexity of this case. As stated in the background facts, the
complexity is the result of obstacles which will need to be overcome to reach Mr. Eron’s
desired outcome for the case. Also, the case is undesirable because of the risk of
administrative insolvency and the delay in payment, even if there are sufficient assets.

The Court finds that the issues in this case make it difficult, but not unique. Many
Chapter 11 cases have their roots in entrenched family malfunction. The successful
outcome of many cases depend upon lien avoidance, favorable handling of tax liabilities,
and attempting to shift liability for claims to non-debtors. Debtor’s evidence, although
indicating that reasonable compensation may be higher than in Chapter 11 cases having
similar assets, does not convince the Court that a contingency fee arrangement is
reasonable.

In addition, the contingency fee arrangement proposed by the Debtor does not
present a solution to the problem that in Chapter 11 cases counsel often undertake
representation knowing that there is a significant likelihood of inadequate assets to pay

13

Case 14-21588 Doc# 136 Filed 11/19/14 Page 13 of 18


counsel’s administrative claim for fees. As this Court has frequently said, Chapter 11
cases are hourly contingency fee cases. Unless a contingency fee based upon the sale of
assets includes a method for priming the interests of secured creditors and other lien
holders, which the Eron Legal Services Agreement does not include, the award of the
contingency fee, like the award of an hourly fee, is dependent upon the ability of the estate
to pay administrative expenses. The provision in the proposed Legal Services Agreement
whereby “[t]he Firm agrees that it will be responsible to take appropriate action to seek
recovery of any earned fees through surcharge or pro rata mechanisms in the event the sale
proceeds are insufficient to pay all necessary costs, fees, and encumbrances”20 does not
solve this problem. Rather, it raises the undesirable potential of litigation between counsel
for the debtor-in-possession and lien holders on fee issues.

The Court accepts Mr. Eron’s arguments that this case includes factors which
would justify a contingency fee in other litigation, such as personal injury cases. The
Debtor has no source of funds to pay fees and expenses, costs will be substantial,
representation will require many hours of work over several years, and even then a
successful out come (in this case, an administratively solvent estate) is uncertain. But this
is not a tort case. The interests of creditors must be considered. Counsel for the debtor in
possession has significant duties in addition to the sale of assets. To approve a fee based
solely upon the gross value of assets sold, could have the inappropriate effect of causing

20 Doc. 8, 17.
14


Case 14-21588 Doc# 136 Filed 11/19/14 Page 14 of 18


counsel to focus on asset sales, to the detriment of alternative methods of administering the
assets and of other estate issues not involving asset sales, such as recovery of preferential
payments. A conflict of interest could arise. The Court, the United States Trustee, and the
Debtor have not found any cases where employment of bankruptcy counsel for the debtor
in possession was approved on a contingency basis. The cases which approve such
arrangements are for appointment of special counsel for limited purposes.21 The facts of
this case are not so compelling that the Court wishes to "plow new ground" and approve a
contingency fee for a debtor in possession under § 328.

The Court also declines to approve employment of Eron Law under § 328 at an
hourly rate, as requested in Debtor’s application, if the Court does not approve the
contingency fee agreement. Representation of the Debtor in this case involves so many
unknowns that it impossible for the Court at this stage of the proceedings to determine
what issues may arise. There are multiple foreseeable outcomes. On one hand, this case
could be concluded quickly with excellent results if a settlement beneficial to the estate is
soon reached with Leo Hall. On the other hand, if Leo Hall determines to fully litigate all
issues or if the tax issues cannot be resolved, the case could be lengthy and the outcome
less desirable. Because a compensation agreement once approved under § 328 can be
adjusted only if such terms and conditions prove to have been improvident in light of

21 E.g., In re Smart World Technologies, LLC, 552 F.3d 288 (2nd Cir. 2009) (appointment of special
litigation counsel to defend adversary complaint regarding price to be paid for Chapter 11 debtor’s assets);
In re Barron, 225 F.3d 583 (5th Cir. 2000) (employment by chapter 7 trustee of counsel to pursue preferential
transfer or fraudulent transfer proceeding on a continency fee basis).

15

Case 14-21588 Doc# 136 Filed 11/19/14 Page 15 of 18


developments not capable of being anticipated at the time of the fixing of such terms and
conditions, such approval would deprive the Court of the ability to review the
reasonableness of the compensation at the completion of the case.

C. Because of the difficulty of this case, as discussed above, the Court will
approve the employment of Eron Law under § 327 at the hourly rate of $450.
As this Court has previously said,
A bankruptcy court has “‘wide discretion’ to authorize
many types of fee arrangements” for professionals whose
employment is approved under § 327. . . . “[A] Bankruptcy
Court need not approve or reject an application as presented
but may approve an application with modified terms that the
Court finds necessary to render the proposed employment


reasonable.” 22
For the reasons stated above, the Court will not approve employment of Eron Law under §
327 on either a contingency fee basis or an hourly fee basis under § 328. However, it will
approve employment under § 327, at the rate of $ 450 per hour for Mr. Eron’s time, the
rate he requested in the employment application. The Court will approve employment of
other attorneys and non-attorneys affiliated with Eron Law at the firm’s customary rates.
Eron Law will continue to advance costs. The final fee award will be subject o the
reasonableness standard of § 330.

Mr. Eron’s rate is substantially higher than his customary rate for Chapter 11 debtor
work. It is not, however, substantially higher than fees charged for Chapter 11 debtor
work by some lawyers practicing in the United States Bankruptcy Court for the District of

22 In re Brooke Corp., 2013 WL 6782877 (D. Kan. Case 08-22786, Dec. 20, 2013) (citations omitted)
16

Case 14-21588 Doc# 136 Filed 11/19/14 Page 16 of 18


Kansas, the district in which this case was filed. In the Court’s experience, lawyer’s fees
are market driven. Among the factors that effect the market are competition for the work,
the perceived skill of the lawyer, the actual skill of the lawyer, the availability of the
lawyer to do the work to the exclusion of other work, overhead, and the risk of nonpayment.
The Court believes that Leon Hall would be unable to find a lawyer with the
requisite skills needed to have a reasonable chance of achieving a satisfactory result for
Leon Hall at a significantly lower hourly rate. Approving an hourly rate higher than Eron
Law’s customary fees is appropriate given the complexity of this case, the professional
skill and diligence demonstrated in the Eron Law’s representation of Debtor to date, and
the undesirable aspects of the representation. The Court will therefore approve
engagement of counsel under § 327 at the foregoing hourly rates, subject to the
reasonableness standard of § 330.

CONCLUSION.

For the foregoing reasons, the Court denies the Debtor’s application to employ
Eron Law under § 327, based upon the terms of the November 6, 2013 Legal Services
Agreement being approved under § 328. The Court however will approve employment of
Eron Law under § 327 based upon a revised employment agreement in which
compensation is based upon the hourly rates set forth above. Total compensation shall be
subject to the reasonableness standard of § 330. Such appointment shall to retroactive to
the case filing date of July 7, 2014, if a revised employment application incorporating a fee

17

Case 14-21588 Doc# 136 Filed 11/19/14 Page 17 of 18


agreement consistent with this opinion is filed within 14 days of the entry of this
Memorandum and Order.

The foregoing constitute Findings of Fact and Conclusions of Law under Rules
7052 and 9014(c) of the Federal Rules of Bankruptcy Procedure which make Rule 52(a) of
the Federal Rules of Civil Procedure applicable to this matter. The order based on this
ruling stated above will become effective when it is entered on the docket for this case, as
provided by Federal Rule of Bankruptcy Procedure 9021.

IT IS SO ORDERED.
###


18

Case 14-21588 Doc# 136 Filed 11/19/14 Page 18 of 18

13-22462 Tucker Brothers L.L.C (Doc. # 202)

In Re Tucker Brothers L.L.C, 13-22462 (Bankr. D. Kan. Nov. 14, 2014) Doc. # 202

PDFClick here for the pdf document.


SO ORDERED.
SIGNED this 13th day of November, 2014.

 

For on-line use only; not for print publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS


In re:
CASE NO. 13-22462
TUCKER BROTHERS, L.L.C., CHAPTER 12
DEBTOR.

MEMORANDUM OPINION AND JUDGMENT
DETERMINING VALUE OF BANK'S REAL PROPERTY COLLATERAL AND
DENYING CONFIRMATION OF DEBTOR'S FOURTH AMENDED PLAN


On October 2, 2014, an evidentiary hearing was held on valuation of Debtor’s real
property and confirmation of Debtor/Farmer’s Fourth Amended Plan of Reorganization

Case 13-22462 Doc# 202 Filed 11/13/14 Page 1 of 19


(Plan),1 to which creditor Farmers State Bank, Blue Mound, Kansas objected.2 Debtor
appeared by counsel William L. Needler of William L. Needer and Associates, Ltd., and
by its manager, Thomas J. Tucker. Farmers State Bank appeared by counsel Bruce
Woner and Patricia A. Reeder, of Woner, Glenn, Reeder & Girard, P.A. and Lonnie
Sprague, its executive vice president. After hearing the evidence, the Court took the
matter under advisement.3 For the reasons stated below, the Court finds for purposes of
the Plan that Debtor’s real property should be valued at $1,740,405 and denies
confirmation of Debtor’s Plan.

BACKGROUND FACTS.

Debtor Tucker Brothers, L.L.C. filed a voluntary petition for relief under Chapter
12 on September 19, 2013. Thomas J. Tucker, aged 64, is the managing member of
Debtor. The other member is Thomas’s brother, who is 14 months older. Debtor engages
in agricultural pursuits primarily by raising and marketing livestock and offspring on land

1 Doc. 165. The Court notes that after the hearing, Debtor filed his First Modification of
Debtor/Farmer’s Fourth Amended Plan Pursuant to 11 USC § 1223 of the Bankruptcy Code
(doc. 196). The Court will not consider these modifications. They were filed after the record
was closed and the objection to the Plan taken under advisement.

2 Doc. 169.

3 This Court has jurisdiction pursuant to 28 U.S.C. § 157(a) and §§ 1334(a) and (b) and
the Amended Standing Order of Reference of the United States District Court for the District of
Kansas that exercised authority conferred by § 157(a) to refer to the District’s Bankruptcy judges
all matters under the Bankruptcy Code and all proceedings arising under the Code or arising in
or related to a case under the Code, effective June 24, 2013. D. Kan. Standing Order 13-1,
printed in D. Kan. Rules of Practice and Procedure at 168 (March 2014). Allowance of claims
and confirmation of plans are core proceedings which this Court may hear and determine as
provided in 28 U.S.C. § 157(b)(2)(B) and (L). There is no objection to venue or jurisdiction
over the parties.

2

Case 13-22462 Doc# 202 Filed 11/13/14 Page 2 of 19


it owns in Bourbon County, Kansas. Debtor’s Schedule A lists 1060 acres of farmland in
Bourbon County, Kansas valued at $1,250,000. Schedule B lists cash, vehicles, animals,
inventory, farming equipment, and supplies valued at $41,230. Farmers State Bank
(Bank) is the only secured creditor listed of Schedule D. Bank’s claim is listed at
$1,570,000, with $320,000 of the claim unsecured. Schedule E, creditors holding
unsecured priority claims, lists Bourbon County’s tax claim of $10,667.22. One
unsecured creditor, holding a claim of $152,069.99, is listed on Schedule F. No
executory contracts or unexpired leases are scheduled. The equity holders of Debtor are
listed as co-debtors.

On January 3, 2014, Bank filed a secured proof of claim for $1,598,855.90,
comprised of principal, interest, and attorney fees and expenses. Debtor and Bank
stipulated that the amount of Bank’s claim as stated in its proof of claim is the amount
owing by Debtor to Bank on the date of filing. The parties also agree that the Bank’s
claim is secured by: (1) approximately 1061 acres of real estate in Bourbon County,
Kansas; and (2) all of Debtor’s personal property, including equipment and livestock.

Debtor’s Plan classifies claims and places Bank’s secured claim in Class C. It then
bifurcates the claim into two claims: (1) a “real estate claim” in the amount of
$1,450,000, secured by Bank’s first mortgage lien on farmland; and (2) a “personal
property claim” of $50,731.47 secured by the Bank’s security interest in personal
property. Debtor’s plan proposes that it retain all of the assets, both real and personal, that

3

Case 13-22462 Doc# 202 Filed 11/13/14 Page 3 of 19


it owned on the date it petitioned for relief. Debtor’s Plan proposes to pay the “real estate
claim” as follows:

Year 1 (Oct. 30, 2015) $20,949.00

Year 2 (Oct. 30, 2016) $20,949.00

Year 3 (Oct. 30, 2017) $20,949.00

Years 4 through 17 $86,417.46

Year 18 balloon4
The payments in years one through three are characterized as adequate protection
payments in the amount of “reasonable customary rent for this type of land in this Kansas
location.”5 For these three years, there is no payment of principle6 or interest on the “real
estate claim” and no accrual of interest. The payments in years 4 through 17 are
payments of principle and interest on a debt of $1,450,000 amortized over 30 years at

4.25 per cent. During years one through three Debtor plans to purchase a total of 100
cows from Mark Snelson for $125,000 and proposes to grant the Bank a security interest
in the cows as they are purchased. Debtor’s Plan includes as an expense $5,000 per year
for replacement cows starting in the second year.
4 The Court believes the balloon would be in the amount of $944,242.25, using Debtor’s
amended amortization schedule.

5 Doc. 165, 6-7.

6 Doc. 193, amended exh. D to Plan. But see Plan (doc. 165, 7) stating, “Additionally,
starting the 4th year under the Plan, the secured claim of $1,450,000 on the land, less the
Adequate Protection Payments previously paid under the Plan, shall be paid at the “Till Rate” of
4.25% amortized over 30 years.”

4

Case 13-22462 Doc# 202 Filed 11/13/14 Page 4 of 19


The “personal property claim” is in the amount of $50,731.47. Payments are
$4,970.52 per year, commencing on October 30, 2015, with a balloon in 10 years. The
payments are calculated based upon a 15 year amortization period at 5.25 percent interest.

Bank objects to confirmation on multiple grounds. The most significant
objections, which were the focus of the evidence at the confirmation hearing, are: under
valuation of the Bank’s “real estate claim;” failure to meet the requirements of §
1225(a)(5)(B) with respect to the payments on the “real estate claim”and the “personal
property claim;” failure to meet the feasability requirement of § 1225(a)(6); and
improperly seeking to retain causes of action.
DISCUSSION.

The treatment of secured claims in a Chapter 12 plan is addressed by § 1225(a)(5).
It provides three alternatives: (1) acceptance by the secured creditor; (2) cram down; and

(3) surrender of the collateral to the secured creditor. In the Plan, Tucker Brothers seeks
to cram down both the “real estate claim” and the “personal property claim.” A plan
which crams down an allowed secured claim can be approved over the objection of the
secured creditor if:
(B)(i) the plan provides that the holder of such claim retain
the lien securing such claim; and

 (ii) the value, as of the effective date of the plan, of
property to be distributed by the trustee or the debtor under
the plan on account of such claim is not less that the allowed
amount of such claim;7
7 11 U.S.C. § 1225(a)(5).
5


Case 13-22462 Doc# 202 Filed 11/13/14 Page 5 of 19


This section “requires the bankruptcy court to determine the amount of the creditor’s
allowed secured claim and whether the proposed payment stream has a present value that
is equal to the allowed secured claim.”8 The Chapter 12 debtor has the burden of
establishing all elements necessary for confirmation.9

A. The Plan does not satisfy § 1225(a)(5)(B)(ii) because the Plan uses an incorrect
value for the amount of Bank’s allowed secured claim.
The first step in analyzing whether a secured claim can be crammed down is the
determination of the amount of the allowed secured claim. The amount of an allowed
secured claim is the amount of the allowed claim, or the value of the collateral securing
the claim, whichever is less.10

The parties have stipulated that the amount of Bank’s claim on the date of filing
was $1,598,855.90 and agree that the claim is secured by Debtor’s real and personal
property, including equipment, machinery, hay, and livestock. Debtor’s Plan is
predicated on a total allowed secured claim of $1,500,731.47, divided into the
$50,731.47 secured “personal property claim” and the $1,450,000 secured “real property
claim,” leaving an unsecured claim of $98,124.43. Bank objects, claiming that its
allowed claim as of October 1, 2014 is $1,719,279.60,11 comprised of the amount owed

8 First Nat’l Bank of Durango v. Woods (In re Woods), 465 B.R. 196, 204 (10th Cir. BAP
2012) rev’d on other grounds In re Woods, 743 F.3d 689 (10th Cir. 2014).
9 In re Ames, 973 F.2d 849, 851 (10th Cir. 1992).
10 11 U.S.C. §§ 501 and 506.
11 Doc. 185, 3.
6

Case 13-22462 Doc# 202 Filed 11/13/14 Page 6 of 19


on the petition date plus post petition interest at the contract rate, attorneys fees, and
costs, and that claim is fully secured by Debtor’s personal property, valued in the Plan at
$50,731.47, and by Debtor’s the real property, which the Bank contends has a value of
$1,815,000.12

At trial, the parties each presented an appraisal expert who testified in support of
their respective valuations of the real property. Debtor’s expert, Dennis Totman, is a
certified residential appraiser. He testified that in his opinion, Debtor’s 883.74 acre tract
of contiguous grazing land had a value of $1,211,000 as of April 18, 2014.13 As to the
land value, the appraisal used the comparable sales approach, but it adopted the county
appraiser’s $70,000 valuation of out buildings on this tract. Because the mineral rights
are not owned by the Debtor, Mr. Totman testified that he reduced by $300 per acre the
value determined through the comparable sales method using similar tracts which
included mineral rights. When the value of the outbuildings is deducted from the
appraised value, the result is a value of $1,291.10 per acre. Mr. Totman separately
appraised two smaller tracts, comprised of 178.1 total acres, at $239,000, or $1,341.94 per
acre. His total appraised value for Debtor’s real property was $1,450,000.

Bank’s appraisal, prepared by Joshua Adamson of Martens Appraisal, was more
detailed. Mr. Adamson appraised the land value of 865.35 acres (the entire large tract
without the 20 acres on which the outbuildings are located) to be $1,340,000 using the

12 Exh. 1-A, § 1-3 and Exh. 1-B, § 1-3.
13 Doc. 167, 4.
7


Case 13-22462 Doc# 202 Filed 11/13/14 Page 7 of 19


direct capitalization approach and to be $1,320,000 using the sales comparison approach.
These values were reconciled to be $1,330,000 or $1,536.95 per acre.14 The sales
comparison method expressly adjusted values of comparables based upon whether land
was used for pasture or crops. No adjustment was made for Debtor’s lack of ownership
of mineral rights. The appraisal separately valued the 20 acres on which the outbuildings
are located, using the depreciated replacement cost method for the improvements, valued
at $144,595,15 and $1,525 per acre for the 20 acres of land, rounded to $30,000, for a
rounded total value of $175,000. The Martens appraisal valued the approximately 885
acre tract, including the outbuilding, at $1,505,000. Independent appraisals were
conducted for the remainder of the land, comprised of an east south parcel of 152.28 acres
and a noncontiguous east north parcel of 25.98 acres.16 The income approach and the
sales comparison approaches were used for both parcels, which after reconciliation
resulted in values of $60,000 for the “east north tract” and $250,000 for the “east south
tract.” According to the Martens appraisal, the value of Debtor’s real property as of April
28, 2014 is $1,815,000.

Except in one respect, the Court finds Bank’s appraisal to be more credible. Mr.
Adamson, who prepared the Martens appraisal, is a licensed commercial appraiser,
whereas Mr. Totman retained by Debtor is a licensed residential appraiser. The Martens

14 Exh. 1-A, § 1-3.

15 Exh. 1-A, § 7-6.

16 Exh. 1-B.

8

Case 13-22462 Doc# 202 Filed 11/13/14 Page 8 of 19


appraisal used two appraisal methods, whereas the Totman appraisal relied exclusively
upon the comparable sales method. When using the comparable sales approach, the
Martens appraisal used more current sales and expressly adjusted for the differing uses of
the land. The Court rejects Mr. Totman’s deduction of $300 per acre because the mineral
rights do not run with the approximately 884 acre tract. The Court finds credible the
testimony of Mr. Adamson that such a deduction is not appropriate, since there is no gas,
oil, or mining activity in the area. When that adjustment is restored to the Totman
appraisal, the value per acre for the approximately 885 acre tract (without considering the
value of the outbuildings) is $1,591 per acre. Bank’s per acre value for the same land is
$1,537 per acre. However, the Court rejects Bank’s appraisal of $144,595 for the
improvements. Rather, the Court adopts the County appraiser’s value of $70,000, which
was adopted by Mr. Totman. A value significantly lower than the Martens’ depreciated
cost value is also supported by Tom Tucker’s testimony, who testified that in his opinion
the outbuildings were not worth even $70,000. For these reasons, the Court concludes
that the value of the approximately 885 acre tract as of April 2014 was $1,430,405,
calculated by reducing the Martens’ appraised value of $1,505,000 by $74,595 (the
reduction in value of the outbuildings resulting from substituting the county’s $70,000
appraised value for the Martens’ depreciated cost value of $144,595).

For similar reasons the Court adopts that the Martens’ appraised value for the

152.28 and 25.98 acre tracts. That appraisal used both the income and market comparison
methods. The Martens comparable sales were more recent than those used by Totman.
9

Case 13-22462 Doc# 202 Filed 11/13/14 Page 9 of 19


This factor is important in the current market where prices have risen in the last few
years. Also, the details of the Martens appraisals more accurately reflect the fact that the
“north east tract” was exclusively grass/pasture land, whereas the “south east tract” has 29
acres of dry crop land with the remainder native grass.

The Court therefore concludes that the value of Debtor’s real property for purposes
of the Plan should be $1,740,405, comprised of $1,430,405 for the approximately 883
acre tract (including the out buildings), $60,000 for the north tract, and $250,000 for the
south tract.

Because the Bank did not object to Debtor’s $50,731.47 valuation of the personal
property collateral and there was no evidence on that value, the Court will use this value
when evaluating the Plan. For purposes of the Plan, the total value of collateral securing
Bank’s claim is therefore $1,791,136.47.

Bank filed a proof of claim for $1,598,855.90, secured by Debtor’s real and
personal property. Debtor did not object, so the claim is deemed allowed.17 Under §
506(a)(1) , “[a]n allowed claim of a creditor secured by a lien on property in which the
estate has an interest . . . is a secured claim to the extent of the value of such creditor’s
interest in the estate’s interest in such property.”18 Since the value of the collateral,
$1,791,136.47 exceeds the value of the claim, Bank’s entire claim as of the date of filing
is an allowed secured claim.

17 11 U.S.C. § 502(a).
18 11 U.S.C. § 506(a)(1).
10


Case 13-22462 Doc# 202 Filed 11/13/14 Page 10 of 19


Further, Bank’s allowed secured claim may be increased under § 506(b), which
provides:
To the extent that an allowed secured claim is secured by
property the value of which . . . is greater than the amount of
such claim, there shall be allowed to the holder of such claim,
interest on such claim, and any reasonable fees, costs, or
charges provided for under the agreement or State statute

under which such claim arose.19
Bank has filed two applications for allowance of post petition interest, fees, and expenses.
The first, for the period September 19, 2013 to July 31, 2014, relying on provisions of the
loan documents and attached billing statements, prays for allowance of post petition
interest of $53,615.39 and attorney fees and expenses of $44,767.22.20 The Debtor filed
an objection but did not contest the allegation that such addition to the allowed claim is
provided for in the loan documents. The Bank’s second application, for the period of
August 1, 2014 through October 1, 2014, seeks interest of $10,552.87 and fees and
expenses of $8,617.43.21 The total of the additional amounts which Bank prays be added
to the allowed secured claim is $117,552.91.

No hearing has been held on Bank’s motions, but it is likely that all or a
significant portion of the requested postpetition claim will be allowed. This would

19 11 U.S.C. § 506(b).

20 Doc. 158.

21 Doc. 187.

11

Case 13-22462 Doc# 202 Filed 11/13/14 Page 11 of 19


increase Bank’s allowed secured claim to approximately $1,716,400,22 as of October 1,
2014.

The Plan is predicated upon Bank’s allowed secured claim being $1,300,731.47,
the sum of the “personal property claim” of $50,731.47 and the “real estate claim” of
$1,250,000. This is not the correct amount. Even if Bank’s motions for post petition
interest and expenses were denied in total, which is highly unlikely, Bank’s allowed
secured claim would $1,598,855.90, the stipulated amount of Bank’s claim as of the date
of filing. The Plan does not attempt to and does not succeed in distributing to Bank
property having a value, as of the effective date of the Plan, on account of Bank’s allowed
secured claim, in an amount not less than the allowed amount of such claim, as required
by § 1225(a)(5)(B)(ii).

B. Even if the amount of Bank’s allowed secured claim were $1,300,731.47, the sum
of the “personal property claim” of $50,731.47 and the “real estate claim” of
$1,250,000, Bank’s claims addressed by the Plan, confirmation would be denied.
1. The value of the property to be distributed with respect to the “real estate
claim” is less than the allowed claim, using Debtor’s valuation and therefore §
1225(a)(5)(B)(ii) is not satisfied.
The most glaring deficiency in the Plan’s treatment of the “real estate claim” is the
delay in payment of principal and interest until year four of the plan. During the first
three years, Bank is to receive adequate protection payments, measured by the rental

22 In its trial brief, Bank states the total claim is $1,719,279.60, as of October 1, 2014
(doc. 185, 3).

12

Case 13-22462 Doc# 202 Filed 11/13/14 Page 12 of 19


value of the collateral. These payments are not credited against either interest or
principal, and there is no interest accrual.

Debtor characterizes this treatment as negative amortization - instead of reducing
the debt by the payment of interest and principal during the first three years, the debt is
increasing by the accrual of interest. A more detailed explanation is the following by the
Ninth Circuit Court of Appeals:

Negative amortization refers to “a provision wherein part or
all of the interest on a secured claim is not paid currently but
instead is deferred and allowed to accrue,” with the accrued
interest added to the principal and paid when income is
higher. The extent of negative amortization depends upon the
difference between the “accrual rate,” or the overall rate of
interest to be paid on a claim, and the “pay rate,” or the rate of
interest to be paid on a monthly basis. Even when a debtor
defers payments of interest on its debt obligation, the deferred
amount can be capitalized at a rate of interest which enables
the deferred amount to equal the present value of the
creditor’s allowed secured claim.23

Whether negative amortization is permissible under the fair and equitable standard
applicable to Chapter 11 plans is determined on a case by case basis by consideration of
ten enumerated factors.24 Some of the factors which the Ninth Circuit identified for
consideration are: “Is the amount and length of the proposed deferral reasonable; Is the
ratio of debt to value satisfactory throughout the plan; Are the debtor’s financial
projections reasonable . . . ; What is the nature of the collateral, and is the value of the

23 Great Western Bank v. Sierra Woods Group, 953 F.2d 1174, 1176 (9th Cir. 1992),
quoting In re Club Associates, 107 B.R. 385, 398 (Bankr. N.D. Ga. 1989).
24 Id., 1178.
13

Case 13-22462 Doc# 202 Filed 11/13/14 Page 13 of 19


collateral appreciating, depreciating, or stable; . . . ; and Are there adequate safeguards to
protect the secured creditor against plan failure.”25 The Ninth Circuit BAP relied on these
factors when affirming a bankruptcy court’s confirmation of a Chapter 12 plan that
included a 21-month partial deferral on interest, where the creditor was oversecured and
the loan-to-value ratio would increase only slightly, from 71% to 75%.26 A bankruptcy
court in the Ninth Circuit held that a Chapter 12 plan satisfied the requirements of §
1225(a)(5) where the secured creditors would receive partial interest payments during the
first four years, the deferred interest would be accumulated, and the total accumulated
sum including the principal would be amortized over the remaining 16 years.27

In this case, Debtor’s negative amortization does not satisfy § 1225(a)(5). The
annual interest on $1,250,000 at 4.25% is $53,125. Unlike the forgoing negative
amortization plans which were confirmed, during the first three years of this Plan, no
interest is paid. The amount of the deferral is not reasonable. The deferred interest is not
capitalized. This alone is fatal to the proposal. In addition, because Debtor has no equity
in the farm property, the accruing interest obligation, if capitalized would be unsecured.
In effect the Plan provides for Bank to make an interest free, unsecured loan for three
years.

25 Id.

26 Miller v. Nauman (In re Nauman), 213 B.R. 355, 362-64 (9th Cir. BAP 1997).

27 In re Big Hook Land & Cattle Co., 81 B.R. 1001, 1006 (Bankr. D. Mont. 1988).

14

Case 13-22462 Doc# 202 Filed 11/13/14 Page 14 of 19


The Court rejects Debtor’s suggestion that granting Bank a security interest in
cows to be purchased during the first three Plan years and the adequate protection rent to
be paid during those years cure any defect. Granting Bank a lien in the cows to be
purchased under the Plan would provide an additional $37,500 in collateral each per year.
But providing collateral each year valued at almost $20,000 less than the accruing annual
interest still leaves a negative amortization plan where Debtor has no equity in the
collateral. Likewise, if the $20,949 adequate protection payments are considered partial
interest payments, the negative amortization aspect of the Plan would require denial of
confirmation. There would be deferred interest of approximately $35,000 per year,
without any provision that it be added to the principal and without an equity cushion.

2. The payment periods for both the “real estate claim” and the “personal
property claim” were not shown to be appropriate under the circumstances of this
case.
Debtor has not sustained his burden of proof to show that the payment periods are
appropriate.28 “When contemplating a plan’s repayment period, a court may consider the
length of the underlying note and the creditor’s customary repayment periods for similar
loans.”29 The annual Plan payments on the “real estate claim” are calculated at 4.25%
interest over 30 years, with a balloon payment after 15 installments, which installments
do not start until year four of the Plan. The annual Plan payments on the “personal
property claim” are calculated at 4.25% interest over 15 years, with a balloon in 10 years.

28 Bank does not challenge the 4.25% interest rate.
29 In re Woods, 465 B.R. at 208.
15


Case 13-22462 Doc# 202 Filed 11/13/14 Page 15 of 19


All of Bank’s notes with Debtor, including the real estate note, are for a period of one
year or less. The Plan if confirmed would significantly change Bank’s expectations when
making the loans. Debtor has provided no evidence that the Plan payment periods are
customary for similar loans.

3. The Debtor has not shown that the Plan to be feasible.
Before confirming a plan, § 1225(a)(6) requires the Court to find that “the debtor
will be able to make all payments under the plan and to comply with the plan.” “In order
to satisfy the feasability test, it will be necessary for the debtor to submit sufficient
evidence with regard to the debtor’s projected income and expenses to enable the court to
determine that the debtor can make all of the payments called for by the plan.”30 The
Court is not satisfied as to the feasability of the Plan.

Although the Plan is predicated upon Debtor changing the focus of his farming
operations from raising of horses to raising of cows, in which he had engaged in the past,
little evidence was presented about Debtor’s historical success in the projected operations
or to otherwise support in the income and expense projections in the Plan, particularly in
light of the volatility of the prices of live stock and feed.

More importantly, Debtor provided no testimony as to the feasability of payment
of the projected balloon payments. The managing member of Debtor is 64 years old, and

30 8 Collier on Bankruptcy ¶ 1225.02[5] at 1225-10 (Alan N. Resnick & Henry J. Sommer
eds.-in-chief, 16th ed. 2014).

16

Case 13-22462 Doc# 202 Filed 11/13/14 Page 16 of 19


the other member is 14 months older. Refinancing of the “personal property claim” in ten
years could be problematical since both members will be almost 75 years old, the value of
livestock is difficult to predict, and the equipment will have further depreciated. The
“real property claim” balloon will mature in approximately 20 years, when the members
will be in their mid eighties. Absent considerable appreciation in the value of the farm
land, Debtor will have little equity. The Court has no basis on which to find a reasonable
expectation that the balloon payments, required by the Plan, can be refinanced when they
become due.

4. The Plan’s provision for retention of a § 510(c) equitable subordination
cause of action as to Bank’s claim will not be approved.
Bank objects to Debtor’s inclusion of the following as a general provision of the
Plan:
Nothing in this Plan, including any prior classification or
treatment of the holders of a claim of any type, shall prevent
this Debtor/Farmer from bringing any actions at any time
under Section 510(c) of the Bankruptcy Code against any

Creditor secured or unsecured.31
Under § 510(c), the court, under principles of equitable subordination based upon
wrongful conduct of the claimant, may subordinate all or part of an allowed claim to all or
part of another allowed claim or subordinate all or part of an allowed interest to all or part

31 Doc. 165, 12.

17

Case 13-22462 Doc# 202 Filed 11/13/14 Page 17 of 19


of another interest.32 Such subordination is limited to reordering the priority of claims to
ensure fairness in the bankruptcy process as a whole.33

Bank’s objection is that Debtor may interpret the forgoing provision of the Plan to
provide a basis for Debtor to attempt to subordinate Bank’s claim after confirmation of a
Plan which provides for payment of that claim. The Court agrees that preservation of
such an action would be inappropriate. Generally, the confirmation of a Chapter 12 plan
binds Debtor and creditors to the plan provisions. “The order of confirmation acts as a
res judicata determination of all matters dealt with by the plan.”34 Although an order of
confirmation may specifically preserve certain matters open to future determination, in
order for such provisions not to conflict with the binding effect of the plan, they must be
limited to those matters not necessary to confirmation.35

In this case, the amount of Bank’s secured claim and the priority of the liens
securing that claim are central to the confirmation of any proposed Plan. Bank is the only
secured creditor, and whether that claim can be crammed down is the primary hurdle to
confirmation. In addition, Debtor has stipulated the Bank’s proof of claim accurately

32 3 William L. Norton, Jr., and William L. Norton III, Norton Bankruptcy Law &
Practice 3d, § 53:3 at 58-8 (Thomson Reuters/West 2014).

33 Id.

34 8 Collier on Bankruptcy ¶ 1227.01[1] at 1227-2.
35 See In re Buchholz, 224 B.R. 13, 25-26 (Bankr. D.N.J. 1998).
18


Case 13-22462 Doc# 202 Filed 11/13/14 Page 18 of 19


states the status of the claim as of the date of filing. If Debtor wishes to attempt to
subordinate Bank’s claim in any respect, it must do so before, not after, confirmation.

CONCLUSION.

The Court finds that Debtor’s real property should be valued at $1,740,405 and
denies confirmation of Debtor’s Plan. Debtor shall have 35 days from the date of entry of
this order to file an amended plan consistent with the above holdings. .

The foregoing constitute Findings of Fact and Conclusions of Law under Rules
7052 and 9014(c) of the Federal Rules of Bankruptcy Procedure which make Rule 52(a)
of the Federal Rules of Civil Procedure applicable to this matter.
JUDGMENT.

Judgment is hereby entered determining the value of Debtor’s real property for
purposes of plan confirmation is $1,740,405 and denying confirmation of
Debtor/Farmer’s Fourth Amended Plan of Reorganization. The judgment based on this
ruling will become effective when it is entered on the docket for this case, as provided by
Federal Rule of Bankruptcy Procedure 9021.

IT IS SO ORDERED.
###


19

Case 13-22462 Doc# 202 Filed 11/13/14 Page 19 of 19

13-22232 Rock (Doc. # 43)

In Re Rock, 13-22232 (Bankr. D. Kan. Oct. 7, 2014) Doc. # 43

PDFClick here for the pdf document.


SO ORDERED.
SIGNED this 6th day of October, 2014.

 

Opinion Designated for Electronic Use, But Not for Print Publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS


In re:
AMELIA LUE ROCK,
DEBTOR.
CASE NO. 13-22232-13
CHAPTER 13

OPINION DENYING DEBTOR’S REQUEST FOR ATTORNEY FEES

This matter is before the Court for a ruling following a hearing on August 28,
2014, on the Debtor’s request for sanctions against UnitedHealthcare Specialty Benefits,
LLC (UHCSB), for alleged violations of the automatic stay. The Debtor appears by
counsel Sarah A. Sypher of Sypher Law Group, LLC. UHCSB appears by counsel
Michael D. Fielding of Husch Blackwell LLP and Eric S. Goldstein of Shipman &
Goodwin LLP. The Court has reviewed the relevant pleadings and heard the arguments
of counsel, and is now ready to rule. At this point, the question is whether the doctrine of

Case 13-22232 Doc# 43 Filed 10/06/14 Page 1 of 11


recoupment provides UHCSB a defense to actions it took that would otherwise constitute
violations of the automatic stay imposed by § 362(a) of the Bankruptcy Code. As
explained below, the Court concludes UHCSB properly withheld money from
postpetition disability benefits it owed the Debtor in order to recoup an overpayment of
the benefits that had been made to the Debtor before she filed bankruptcy. Consequently,
UHCSB did not violate the automatic stay, and is not liable to the Debtor for attorney fees
she incurred in trying to get UHCSB to stop the withholding and refund the money it
withheld postpetition.

Facts

Before April 2010, the Debtor was working as a nurse for the State of Kansas in
the psychiatric ward of a hospital. In 2010, she was injured by a patient in a way that led
to back surgery. By April 2010, she was no longer able to work and began receiving
long-term disability benefits under a plan sponsored by the Kansas Public Employees
Retirement System. UHCSB administers the plan for KPERS. The plan called for the
Debtor’s benefits to be reduced to the extent she received income from certain other
sources, including workers’ compensation benefits. The plan gave the administrator the
right to recover any overpayments, and to determine the method by which repayment
would be made. In 2011, the Debtor received a workers’ compensation award of $7,300.
Under the plan, that amount was treated as an overpayment of her disability benefits, and
in accordance with the plan, UHCSB reduced the Debtor’s future benefits by $100 per
month in order to recoup that overpayment from her.

2

Case 13-22232 Doc# 43 Filed 10/06/14 Page 2 of 11


Between 2011 and 2013, the Debtor developed additional health problems that she
attributes to her work injury, including diabetes and a heart condition. She needs several
medications in order to stay alive. The monthly withholding from her disability benefits
has made it more difficult for her to pay her rent and purchase her necessary medicine.
By August 2014, she was approximately 60 years old.

In August 2013, the Debtor filed a Chapter 13 bankruptcy petition. Her attorney
assumed UHCSB would stop the $100 per month withholding, and included that
assumption in drafting the Debtor’s Chapter 13 plan. The plan was confirmed in October
2013. Despite receiving actual notice of the Debtor’s bankruptcy filing, UHCSB
continued to withhold $100 per month from her disability payments to continue
recovering the overpayment from her.

The Debtor’s attorney contacted UHCSB and at first was advised the withholding
would stop, but later was told it would continue. Eventually, an attorney for UHCSB
advised her that the company believed the monthly withholding was in the nature of
recoupment and therefore not prohibited by the automatic stay, providing citations to a
number of cases concerning recoupment. On June 11, 2014, the Debtor filed a motion
asking the Court to compel UHCSB to turn over to the Debtor all the money it had
withheld postpetition, to impose a sanction against UHCSB for violating the automatic
stay by continuing to withhold $100 per month from her benefits after she filed
bankruptcy, and to require UHCSB to pay her $1,500 in attorney fees as an additional
sanction under § 362(k)(1). In a response filed on July 11, 2014, UHCSB continued to

3

Case 13-22232 Doc# 43 Filed 10/06/14 Page 3 of 11


assert the monthly withholding was a permissible recoupment that did not violate the stay.
Nevertheless, it advised that KPERS had voluntarily agreed to stop withholding any
money from the Debtor’s future disability benefits, to waive the remaining balance owed
on the prepetition overpayment (approximately $4,120), and to refund the $800 that had
been withheld since the Debtor filed bankruptcy.

A hearing on the Debtor’s motion was held on August 28, 2014. In light of
KPERS’s decision to waive the balance of the overpayment and to refund the money that
had been withheld postpetition, the only outstanding relief the Debtor was seeking was
for UHCSB to pay her attorney fees. The Court told the parties the only issue it had to
decide was whether UHCSB had violated the automatic stay. There was no question that
the company thought it had the absolute right to continue the monthly withholding
without getting stay relief. If that was wrong, the Court stated that a reasonable attorney
fee was the only sanction the Court would impose.
Discussion

Ordinarily, any postpetition efforts a creditor takes to recover a prepetition
obligation from a debtor are violations of the automatic stay imposed by § 362(a) unless
the creditor first obtains relief from the stay. The Debtor sensibly suggests that even if
UHCSB’s actions were proper recoupment, the company should at least have asked this
Court to confirm that fact by asking for stay relief, instead of relying solely on its own
determination. A leading bankruptcy treatise says that courts are split on the question

4

Case 13-22232 Doc# 43 Filed 10/06/14 Page 4 of 11


whether the automatic stay applies to bar or restrain a legitimate right of recoupment.1
However, assuming for the moment that UHCSB had a valid right to recoup the
overpayment, binding Tenth Circuit precedent prohibits this Court from ruling that
UHCSB was required to seek stay relief before it continued to withhold the $100 from the
Debtor’s monthly benefit payment.2

At least within the Tenth Circuit, the doctrine of recoupment is a well-established
exception to the automatic stay, as well as to the discharge injunction imposed by
§ 524(a).3 Recoupment originated as an equitable rule of joinder, allowing adjudication
in one suit of two claims that the common law had required to be brought separately.4
“Under recoupment, a defendant could meet a plaintiff’s claim with a countervailing
claim that arose ‘out of the same transaction.’”5 In bankruptcy, “‘[r]ecoupment’ is an
equitable doctrine . . . that allows one party to a transaction to withhold funds due another

15 Collier on Bankruptcy, ¶ 553.10 at 553-93 (Alan N. Resnick & Henry J. Sommer, eds.-inchief,
16th ed. 2014).

2Beaumont v. Dept. of Veteran Affairs (In re Beaumont), 586 F.3d 776, 781 (10th Cir. 2009) (“If
the recoupment doctrine applies, then there is no ‘debt’ or ‘claim’ here as defined in the Bankruptcy
Code, and [the party who exercised recoupment rights] has not violated the automatic stay nor the
discharge injunction”).

3See id., 586 F.3d at 781; In re Lunt, 477 B.R. 812, 818-19 (Bankr. D. Kan. 2012), aff’d 500 B.R.
9 (D. Kan. 2013); see also Ahsland Petroleum Co. v. Appel (In re B&L Oil Co.), 782 F.2d 155, 159 (10th
Cir. 1986) (“The general principle is that a petition for bankruptcy operates as a ‘cleavage’ in time; but
the recoupment doctrine has traditionally operated as an exception to the rule that applies to other
debts.”).

4Ashland Petroleum Co. v. Appel (In re B & L Oil Co.), 782 F.2d 155, 157 (10th Cir. 1986).

5Id. (citing J. Moore, 3 Moore’s Federal Practice, ¶ 13.02 at 13-13, n. 1 (2d ed. 1985) and 20 Am.
Jur. 2d Counterclaim, Recoupment, and Setoff, §§ 16-18 (1965)).

5

Case 13-22232 Doc# 43 Filed 10/06/14 Page 5 of 11


party where the debts arise out of the same transaction. In other words, the doctrine
‘allows a creditor to recover a pre-petition debt out of payments owed to the debtor postpetition.’”
6

Whether UHCSB’s postpetition withholding from the Debtor’s disability benefits
was protected by the recoupment doctrine depends on whether the Debtor’s obligation to
repay the benefits overpayment arose out of the “same transaction” as her right to receive
continuing disability benefits.7 This means that “both debts must arise out of a single
integrated transaction so that it would be inequitable for the debtor to enjoy the benefits
of that transaction without also meeting [the debtor’s] obligations.”8 The Court must
examine the equities of the case, and determine whether the Debtor’s claim for ongoing
disability benefits and UHCSB’s claim to recover the prepetition overpayment of benefits
“are so closely intertwined that allowing the debtor to escape [her] obligation would be
inequitable notwithstanding the Bankruptcy Code’s tenet that all unsecured creditors
share equally in the debtor’s estate.”9

After considering the equities here, the Court concludes it must agree with

6Beaumont, 586 F.3d at 780 (quoting Conoco, Inc., v. Styler (In re Peterson Distributing, Inc.),
82 F.3d 956, 959 (10th Cir. 1996), and City of Fort Collins v. Gonzales (In re Gonzales), 298 B.R. 771
(Bankr. D. Colo. 2003)).

7See Beaumont, 586 F.3d at 781.
8Peterson Distributing, 82 F.3d at 960 (quoting University Medical Ctr. v. Sullivan (In re
University Medical Ctr.), 973 F.2d 1065, 1081 (3d Cir.1992)).
9Peterson Distributing, 82 F.3d at 960.
6

Case 13-22232 Doc# 43 Filed 10/06/14 Page 6 of 11


UHCSB that this case cannot be distinguished from In re Beaumont10 on any relevant
basis. In Beaumont, the Tenth Circuit held that the Department of Veteran Affairs (VA)
did not violate either the automatic stay or the discharge injunction by reducing the
debtor’s ongoing benefits under a VA disability program in order to recover a prepetition
overpayment of benefits, even though it continued with the reduction after the debtor filed
bankruptcy and after he received a discharge. The debtor was a disabled veteran who had
been receiving disability benefits for eight years when he was given a large probate
distribution. Pursuant to federal statutes, the debtor’s VA benefits were subject to being
reduced if he received any payments from any other source, including an inheritance.
After learning of the inheritance, the VA advised the debtor that it had determined the
probate distribution had made him ineligible for his VA benefits for a period of time,
which meant he had received an overpayment of $18,448 in benefits, and that the VA
intended to collect that amount by offsetting his future disability payments, as was
expressly permitted by statute. The debtor responded by filing for bankruptcy relief, and
the VA continued to offset his benefits during the bankruptcy proceeding and after he
received a discharge. The debtor contended this conduct violated the automatic stay and
the discharge injunction. The Tenth Circuit disagreed.

This Court finds that the obligations of both parties did
arise from the “same transaction.” [Plaintiff-debtor’s] claim
for and award of pension benefits generated the [Defendant
VA’s] obligation to pay those benefits. The Defendant’s

10586 F.3d 776.
7


Case 13-22232 Doc# 43 Filed 10/06/14 Page 7 of 11


obligation to pay benefits was and is contingent upon
Plaintiff’s financial situation, his annual income, and his
responsibility to keep the Defendant informed of his financial
situation. Plaintiff’s inheritance had the effect of reducing the
amount of benefits he could receive from the Defendant.
Therefore, Plaintiff’s inheritance was directly related to or
intertwined with the amount of benefits Defendant was
obligated to pay to him, and the resulting overpayment of
benefits. It is unlawful for Plaintiff to keep any overpayments
so long as the Defendant, through its own administrative
procedures, has properly determined the amount of
overpayment and properly considered Plaintiff’s disagreement
with that determination. The Court believes that it would be
inequitable for the Plaintiff to receive his inheritance,
continue to receive benefits as if his income was zero, then be
able to discharge in bankruptcy the overpayments once it was
determined that he had been overpaid.11

The same can be said in this case: It would be inequitable for the Debtor to receive her

workers’ compensation award, continue to receive disability benefits as if she had not

received the award, then be able to discharge in bankruptcy the overpayment once it was

determined she had been overpaid.

Pointing to the equitable nature of the recoupment doctrine, the Debtor argues her

unfortunate ongoing health problems and financial condition should convince the Court

not to condone UHCSB’s efforts to recoup the overpayment of disability benefits she

received. But the Court does not understand the 10th Circuit and other courts applying

recoupment to mean the availability of the doctrine ever depends on its impact on the

debtor based on anything about the debtor other than the direct relationship between the

11 Id. at 781.

8

Case 13-22232 Doc# 43 Filed 10/06/14 Page 8 of 11


prepetition obligation the creditor wants to recoup and the postpetition benefit the creditor
will be providing to the debtor. Instead, the equities to be considered are whether the
debtor’s postpetition benefits are so intertwined with the overpayment or other obligation
the debtor incurred that allowing the debtor to continue to receive those benefits without
meeting the obligation would be inequitable, or whether it would be unfair for the party
providing the postpetition benefits to recover on the related prepetition obligation when
the debtor’s other creditors are not being made whole.12 The Debtor has cited no case
where a court ruled that anything else about the debtor’s circumstances precluded a party
from exercising an otherwise proper right to recoup an obligation the debtor incurred
before filing bankruptcy, and this Court has found none. While the Court feels sympathy
for the Debtor’s health and financial problems, the recoupment doctrine allows no room
for such considerations to affect its application.

The Court did find one case relying on an equitable consideration that might be
viewed as involving the debtor’s unfortunate financial circumstances, the Third Circuit’s
decision in Lee v. Schweiker. 13 In that case, after the debtor filed bankruptcy, the Social
Security Administration continued to reduce her monthly old-age benefits in order to
recover a prepetition overpayment of those benefits. The Third Circuit ruled the SSA’s

12See, e.g., Conoco v. Styler (In re Peterson Distributing, Inc.), 82 F.3d 956, 959-63 (10th Cir.
1996) (denying recoupment); Davidovich v. Welton (In re Davidovich), 901 F.3d 1533, 1537 (10th Cir.
1990) (allowing recoupment of one obligation but not another); B&L Oil, 782 F.2d at 159 (allowing
recoupment).

13739 F.2d 870 (1984).

9

Case 13-22232 Doc# 43 Filed 10/06/14 Page 9 of 11


action violated the automatic stay, saying,

Social welfare payments, such as social security, are statutory

“entitlements” rather than contractual rights. The purpose of these

payments is to provide income to qualifying individuals. Although the

paying agency can ordinarily recover overpayments, just as creditors can

ordinarily obtain payment from a debtor’s future income, the Bankruptcy

Code protects a debtor’s future income from such claims once a petition has

been filed, and the SSA violated the automatic stay in continuing to

withhold part of [the debtor’s] benefits after she had filed her petition.14
Benefits paid to a debtor based on being unable to work could similarly be viewed as
social welfare payments, which suggests the Third Circuit might apply a similar rule to
disability payments like those the Debtor is receiving in this case. But the Tenth Circuit’s
Beaumont decision, dealing with VA disability benefits, makes clear this Court cannot
rely on the social welfare aspect of the benefits involved in this case to conclude that the
recoupment doctrine did not protect UHCSB’s postpetition recovery of the prepetition
overpayment the Debtor received.

Under the circumstances of this case, the Court concludes UHCSB was entitled to
recoup the prepetition overpayment that resulted when the Debtor received her workers’
compensation award from the postpetition payments it owed the Debtor under the KPERS
long-term disability plan. Consequently, UHCSB did not violate the automatic stay by
deducting $100 per month from the postpetition benefits it paid the Debtor, and is
therefore cannot be liable to her for the attorney fees she incurred trying to get the
deductions stopped.

14Id. at 876.
10


Case 13-22232 Doc# 43 Filed 10/06/14 Page 10 of 11


Conclusion

For the reasons stated, the Court denies the Debtor’s request that UHCSB be
ordered to pay her attorney fees.
# # #

11

Case 13-22232 Doc# 43 Filed 10/06/14 Page 11 of 11

13-21483 Flex Financial Holding Company (Doc. # 199)

In Re Flex Financial Holding Company, 13-21483 (Bankr. D. Kan. Oct. 29, 2014) Doc. # 199

PDFClick here for the pdf document.


SO ORDERED.
SIGNED this 28th day of October, 2014.

 

Designated for print publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS


In re:
FLEX FINANCIAL HOLDING CASE NO. 13-21483
COMPANY, CHAPTER 11
DEBTOR.

MEMORANDUM OPINION AND ORDER DENYING
DEBTOR’S OBJECTION TO THE CLAIM OF EAGLE WOODS, LLC (CLAIM NO. 15)
BASED UPON EAGLE WOODS, LLC’S FAILURE TO REGISTER TO
DO BUSINESS IN KANSAS


On February 13, 2014, Eagle Woods, LLC, a Missouri limited liability company
(Eagle Woods), filed a timely proof of claim for Debtor’s alleged breach of a lease of real
property located in Olathe, Kansas.1 Debtor Flex Financial Holding Company (Flex)
objected.2 Among other things, Flex raised the question of law whether the claim must be

1 Proof of claim no. 15.
2 Doc. 112.


Case 13-21483 Doc# 199 Filed 10/28/14 Page 1 of 12


disallowed because Eagle Woods was not registered to do business in Kansas at the time
it filed the proof of claim and did not so register until after the expiration of the claims bar
date. Eagle Woods responded to the objection. The Court requested and received
additional briefs. Oral arguments were heard. For the reasons stated below, the Court
finds that the proof of claim will not be disallowed because of Eagle Woods’ delay in
registering to do business in Kansas.

BACKGROUND FACTS.

The relevant facts are undisputed. Eagle Woods is a limited liability company
organized under the laws of Missouri. In 2006, Eagle Woods, as landlord, entered into a
ten-year lease with Flex, as tenant, of premises located in Olathe, Kansas. In 2012, Eagle
Woods sued Flex in Johnson County, Kansas District Court for delinquent rent.3

Flex filed a voluntary petition under Chapter 11 on June 10, 2013. A claims bar
date of February 28, 2014, was ordered.4 On February 13, 2014, Eagle Woods filed its
proof of claim, asserting a nonpriority unsecured claim in the amount of $1,340,614.91,
arising from Debtor’s alleged prepetition breach of the lease. On June 10, 2014, Debtor
filed its response, objecting to the claim on legal and factual bases. The legal basis was
that (1) Eagle Woods owns income-producing property in Kansas, (2) Eagle Woods was
doing business in Kansas, (3) Eagle Woods had not registered to do business in Kansas,

(4) Kansas law bars actions by unregistered foreign companies doing business in Kansas,
3 Doc. 28 at 3 (Statement of Financial Affairs).

4 Doc. 81.

2

Case 13-21483 Doc# 199 Filed 10/28/14 Page 2 of 12


(5) Eagle Woods was not authorized to do business in Kansas at any time before the
expiration of the claims bar date, and (6) under 11 U.S.C. § 502(b)(1) and § 558, Debtor
shall have the benefit of any defenses available to Debtor under these facts.5
On July 1, 2014, Eagle Woods registered with the Kansas Secretary of State as a
foreign limited liability company authorized to do business in the state.6 Eagle Woods
thereafter responded to the objection, arguing in part that it has met all the requirements
of Kansas law that are necessary to obtain authority to do business in Kansas, retroactive
to January 2006, preceding the date of the lease, and also has authority to prosecute its
bankruptcy claim and, if the automatic stay were lifted, to pursue the state court litigation.
DISCUSSION.

Eagle Woods is a limited liability company organized under the laws of the State
of Missouri and is therefore considered a foreign limited liability company under Kansas
law. The parties agree that by owning and renting Kansas real estate, Eagle Woods was
doing business in Kansas. As a foreign limited liability company, Eagle Woods was
subject to K.S.A. 17-76,126, a “closed-door” statute, and could not “maintain any action,
suit or proceeding in the state of Kansas until it . . . registered in this state and . . . paid to
the state all fees and penalties for the years, or parts thereof, during which it did business
in the state without having registered.”7 Eagle Woods was not registered to do business

5 Doc. 112 at 1.

6 Doc. 129-1, exh. A.

7 K.S.A. 17-76,126(a).

3

Case 13-21483 Doc# 199 Filed 10/28/14 Page 3 of 12


in Kansas until July 1, 2014.

The question in this case is what is the impact of Eagle Woods’ failure to register
in Kansas until July 1, 2014, after it filed its proof of claim and after expiration of the
claims bar date. The Court will first examine the impact of the delay in registration under
Kansas law. It will then consider whether that delay (1) provides a defense under 11

U.S.C. § 502(b)(1) or § 5588 to the merits of the claim when asserted in bankruptcy court,
or (2) precludes this Court from considering the proof of claim under bankruptcy law.
The relationship under Kansas law between the statue of limitations and the
dismissal of a counterclaim asserted by a foreign corporation that had done business in
the state without registering with the state for a lack of capacity arising from the failure to
register was noted in Corco. 9 Ledar Transport, Inc., appealed from the dismissal with
prejudice of its counterclaim against Corco, Inc., on the basis that Ledar was a foreign
corporation doing business in Kansas without registering with the Secretary of State. The
Kansas Court of Appeals held noncompliance with the registration requirement meant
that Ledar could not at the time maintain the counterclaim, but also noted that “[s]tates
with similar statutes generally hold that compliance after an action is begun is sufficient
to enable a corporation to maintain an action.”10 The appellate court therefore reversed

8 Future references in the text to Title 11 shall be to the section number only.
9 Corco, Inc., v. Ledar Transport, Inc., 24 Kan. App. 2d 377, 946 P.2d 1009 (1997) (involving


K.S.A. 17-7307(a), which requires foreign corporations to register to do business in the state, much as
K.S.A. 17-76,126(a) does for limited liability companies).
10 Id., 24 Kan App. 2d at 378, 946 P.2d at 1010.
4


Case 13-21483 Doc# 199 Filed 10/28/14 Page 4 of 12


the dismissal with prejudice and remanded with directions to dismiss the counterclaim
without prejudice, but noted that Ledar bore the risk that the statue of limitations might
run before it was properly registered. The court stated:

Under the facts of this case, the proper remedy was to
dismiss Ledar’s counterclaim without prejudice rather than
with prejudice. This would give Ledar the opportunity to
comply with the statutes and then reassert its claim against
Corco. On the other hand, it would also leave the risk that the
statue of limitations might run against Ledar.11

Corco was cited in Haile Group, LLC, 12 an unpublished opinion of the Kansas
Court of Appeals, and the only Kansas appellate court decision construing the limited
liability company “closed-door” statute. Haile, organized under the laws of Florida, sued
the City of Lenexa, claiming it was entitled to compensation for work performed on a city
project. After trial to the court, judgment was entered in favor of the City. Haile
appealed claiming, among other things, that the trial court erred in concluding that Haile
lacked capacity or standing to maintain the action because it was not registered as a
foreign limited liability company as required by K.S.A. 17-76,126. Citing Corco, the
court noted that “[n]oncompliance with the registration statutes at the outset of an action
is not fatal to a plaintiff’s claim.”13 Further, the court observed that “Haile’s failure to
register as a foreign limited liability company only implicates its capacity to sue, not its

11 Id., 24 Kan. App. 2d at 379, 946 P.2d at 1010.
12 Haile Group, LLC .v City of Lenexa, 242 P.3d 1281, 2010 WL 4977221 (Kan. App. 2010).
13 Id. at *3.


5

Case 13-21483 Doc# 199 Filed 10/28/14 Page 5 of 12


standing to sue.”14 The court of appeals held that the district court therefore should have
dismissed “Haile’s action without prejudice to give Haile reasonable time to comply with
the registration statutes and refile the action.”15

In this case, Eagle Woods sued Flex in Johnson County District Court before it
registered in Kansas as a foreign limited liability company. It therefore lacked capacity to
bring the suit; in other words, it had no personal right to litigate16 in Johnson County
District Court. But assuming that the state court litigation against Debtor was not stayed
by the bankruptcy filing, when Eagle Woods registered on July 1, 2014, that defect would
have been cured, since counsel for both parties acknowledged at oral argument that the
Kansas five-year statute of limitations applicable to the enforcement of written contracts
had not run by July 1, 2014. Hence, the delay in registration would not have provided a
defense to Flex if Eagle Woods’ claim were being litigated in state court. To the extent
that Eagle Woods’ claim against Debtor in bankruptcy court is determined under state
law, the delay in registration does not provide a defense under § 502(b)(1) or § 558.

Turning to bankruptcy law, Eagle Woods is a creditor of Debtor17 and therefore is
entitled to file a proof of claim under § 501. The question is whether Eagle Woods’ lack

14 Id. at *5.
15 Id. at *7 (emphasis supplied).
16 See Toklan Royalty Corp. v. Panhandle Eastern Pipe Line Co., 168 Kan. 259, 268, 212 P.2d


348 (1949); 6A Charles Alan Wright, Arthur R. Miller & Mary Jane Kane, Federal Practice and
Procedure, § 1542 at 469 (2010).
17 See Doc. 27 at 10 (Debtor’s Schedule F, listing Eagle Woods as an unsecured nonpriority
creditor).
6

Case 13-21483 Doc# 199 Filed 10/28/14 Page 6 of 12


of capacity under Kansas law, resulting from its failure to register as a foreign limited
liability company as of the time it filed its proof of claim and continuing until after the
claims bar date in bankruptcy court, requires a finding that Eagle Woods lacked the
capacity to file its proof of claim.

For the following reasons, the Court finds that federal rules of procedure govern
the capacity of entities in bankruptcy court litigation, and under those rules, Eagle Woods
has the capacity to engage in claims litigation. Federal Rule of Bankruptcy Procedure
701718 provides that Federal Rule of Civil Procedure 17,19 which addresses real party in
interest, capacity, and related matters, applies in adversary proceedings. Subsection (b) of
Civil Rule 17 provides:

(b) Capacity to Sue or Be Sued. Capacity to sue or
be sued is determined as follows:
(1) for an individual who is not acting in a
representative capacity, by the law of the individual’s
domicile;
(2) for a corporation, by the law under which it was
organized; and
(3) for all other parties, by the law of the state where
the court is located, except that:
(A) a partnership or other unincorporated
association with no such capacity under that
state’s law may sue or be sued in its common
name to enforce a substantive right existing
under the Unites States Constitution or laws;
and
(B) 28 U.S.C. §§ 754 and 959(a) govern the
capacity of a receiver appointed by a United
18 Fed. R. Bankr. P. 7017. Future references in the text shall be to Bankruptcy Rule.

19 Fed. R. Civ. P. 17. Future references in the text shall be to Civil Rule.

7

Case 13-21483 Doc# 199 Filed 10/28/14 Page 7 of 12


States court to sue or be sued in a United States
court.

Debtor’s objection to Eagle Woods’ proof of claim gave rise to a contested matter under

Bankruptcy Rule 9014.20 Subsection (c) of Bankruptcy Rule 9014 provides that

Bankruptcy Rule 7017 also applies in contested matters.

The capacity of a limited partnership organized under Ontario law to bring a

dischargeability complaint in a bankruptcy court in Florida was at issue in Cochrane. 21

Prepetition, Tudor Oaks Limited Partnership obtained a judgment against debtor

Cochrane in Minnesota. Tudor Oaks filed a dischargeability complaint in Cochrane’s

Chapter 7 case, and the debtor responded with a motion to dismiss, premised in part on a

lack of capacity because Tudor Oaks was not registered to do business in Florida. The

court rejected this argument, stating:

While it is without dispute that F.R.B.P. 7017(b), as
adopted by F.R. Civ. P. 17(b) provides that the capacity of a
corporation to sue or to be sued shall be determined by the
law under which it was organized[, a]n important exception to
this Rule is [a prior version of what is now F.R. Civ. P.
17(b)(3)(A)].

The suit pending before this Court is an enforcement of
a right granted by Congress to a creditor to obtain a
determination of the dischargeability of a particular debt. The
jurisdiction to make such a determination is exclusively
within the competence of the Bankruptcy Court where the
case filed by Debtor is pending.

For these reasons it is quite evident that while Tudor

20 3 William L. Norton, Jr., and William L. Norton III, Norton Bankruptcy Law & Practice 3d,
§ 48:27 at 48-78 (Thomson Reuters 2014).

21 Tudor Oaks Ltd. P’ship v. Cochrane (In re Cochrane), 273 B.R. 272 (Bankr. M.D. Fla. 2001).

8

Case 13-21483 Doc# 199 Filed 10/28/14 Page 8 of 12


Oaks Limited Partnership may not have the capacity to pursue
a legal action in courts of this State [Florida], it certainly has
an absolute right to do so in the Federal Bankruptcy Court.22

In Fantastik, 23 a bankruptcy court sitting in Nevada held “that federal law applies
in determining capacity to bring and maintain an adversary proceeding to determine the
allowance or disallowance of a claim in the bankruptcy court.”24 It therefore rejected the
defendants’ contention that litigation against the debtor seeking actual and punitive
damages should be dismissed because the plaintiff, an Oklahoma corporation, had been
doing business in Nevada without qualifying to do so under Nevada law, and therefore
could not commence, maintain, or defend any action in the Nevada state courts. It noted
that a plaintiff in bankruptcy claims litigation has no choice of forums. “It would be
patently inequitable to deny a creditor access to the bankruptcy court to adjudicate a claim
simply because that creditor could not bring that action in the courts of the state in which
the bankruptcy court sits.”25 The authorities relied upon by the Fantastik court included
Civil Rule 17 and Bankruptcy Rule 7017, as applicable to corporations in claims
litigation.

Bankruptcy Rules 9014(c) and 7017, which adopt Civil Rule 17, require the Court
to hold that Eagle Woods has the capacity to engage in litigation of its claim against Flex,

22 Id. at 276-277.

23 Dollar Saver Stores, Inc., v. Brown (In re Fantastik, Inc.), 49 B.R. 510 (Bankr. D. Nev. 1985).

24 Id. at 511.

25 Id. at 512.

9

Case 13-21483 Doc# 199 Filed 10/28/14 Page 9 of 12


even though it was not registered to do business as a foreign limited liability company
until after the claims bar date. Civil Rule 17 does not expressly address the capacity of a
limited liability company. Such a company is not an individual, so subsection (b)(1),
selecting the law of the individual’s domicile, does not apply. Subsection 17(b)(2)
applies to a corporation, selecting the law under which the corporation was organized.
Although a limited liability company has some characteristics of a corporation,
corporations and limited liability companies are distinct entities under Kansas and other
states’ laws. Subsection 17(b)(2) therefore does not apply to Eagle Woods.26 Civil Rule
17(b)(3) states the general rule that the capacity of parties that are not individuals or
corporations is determined “by the law of the state where the court is located.” Numerous
federal courts other than bankruptcy courts have held that Federal Rule 17(b)(3) guides
the capacity inquiry for limited liability companies.27 Under this general rule, the law of
Kansas would apply to the capacity of Eagle Woods and bar further proceedings to prove
its claim, since Eagle Woods did not obtain capacity under Kansas law until July 1, 2014,
after the bar date, which was not tolled by the delay in registration.

But for parties whose capacity is determined by Civil Rule 17(b)(3), including
limited liability companies, there are two exceptions to the application of the law of the

26 The Court observes that if Eagle Woods were considered a corporation under Rule 17, it would
have capacity, since there is no evidence that it lacks capacity under Missouri law.

27 In re Dairy Farmers of Am., Inc., Cheese Antitrust Litig., 767 F. Supp. 2d 880, 892 (N.D. Ill.
2011); Merry Gentleman, LLC, v. George and Leona Prods., Inc., 2014 WL 3810998 at *2, (N.D. Ill.
2014) (collecting cases).

10

Case 13-21483 Doc# 199 Filed 10/28/14 Page 10 of 12


state where the federal court is located. The first applies in this case. It provides that an
entity to which Civil Rule 17(b)(3) applies and which has no capacity under the law of the
state where the court is located may nevertheless sue or be sued in its common name to
enforce a substantive right under the laws of the United States. As discussed above, this
provision has been held applicable to a dischargeability proceeding filed by a foreign
limited partnership.28 It also “has enabled a partnership or other unincorporated
association to sue and be sued in a federal court under the Fair Labor Standards Act,
National Labor Relations Act, Labor Management Relations Act, the antitrust laws,
patent laws, Emergency Price Control Act, War Labor Disputes Act, Capehart Act,
Securities Exchange Act, Railway Labor Act, Federal Arbitration Act, as well as other
federal statutes.”29 The Bankruptcy Code is a part of the laws of the United States. It
gives a holder of a claim against a debtor the substantive right to file a proof of claim and
gives the debtor the right to object to the claim. A claim holder has no ability to choose
the court in which the claim will be asserted — it must be filed in the court in which the
debtor’s bankruptcy case is pending. Allowing a limited liability company claim holder
that is not authorized to do business under the law of the state where that bankruptcy
court is located to assert its claim there promotes the jurisdiction of the bankruptcy court
to adjudicate all claims against the debtor’s bankruptcy estate.

CONCLUSION.

28 In re Cochrane, 273 B.R. at 276-277.

29 6A Federal Practice and Procedure, § 1564 at 630-32.

11

Case 13-21483 Doc# 199 Filed 10/28/14 Page 11 of 12


For the foregoing reasons the Court holds the failure of Eagle Woods, a Missouri
limited liability company, to register to do business in Kansas until after the expiration of
the date for filing proofs of claim does not provide (1) a defense to the claim under state
law, or (2) a basis to disallow the claim under bankruptcy law for lack of capacity. The
Debtor’s objection to Eagle Woods’ claim on the ground the company did not register to
do business in Kansas until July 1, 2014, which was after the date Eagle Woods filed its
proof of claim and after the claims bar date, is denied.

IT IS SO ORDERED.
# # #


12

Case 13-21483 Doc# 199 Filed 10/28/14 Page 12 of 12

10-06225 Redmond, Brooke Trustee v. Brooke Holdings, Inc. et al (Doc. # 230)

Redmond, Brooke Trustee v. Brooke Holdings, Inc. et al, 10-06225 (Bankr. D. Kan. Sep. 12, 2014) Doc. # 230

PDFClick here for the pdf document.


SO ORDERED.
SIGNED this 12th day of September, 2014.

 

Opinion Designated for Print and On-Line Publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS


In Re:

BROOKE CORPORATION, et al.,
DEBTORS.

CHRISTOPHER J. REDMOND,
Chapter 7 Trustee of Brooke
Corporation, Brooke Capital
Corporation, and Brooke Investments,
Inc.,

PLAINTIFF,

v.
BROOKE HOLDINGS, INC., et al.,

DEFENDANTS.

CASE NO. 08-22786
CHAPTER 7

ADV. NO. 10-6225

MEMORANDUM OPINION AND ORDER
DENYING THE TRUSTEE’S MOTION FOR SUMMARY JUDGMENT
AGAINST DEFENDANTS STEVEN AND WANDA SCHMIDT


Case 10-06225 Doc# 230 Filed 09/12/14 Page 1 of 19


In this action, the Trustee seeks to avoid allegedly preferential transfers and
constructively fraudulent conveyances made by Debtor Brooke Corporation (Brooke
Corp) to Defendant Brooke Holdings, Inc. (BHI), and to recover part of those avoided
transfers from Defendants Steven and Wanda Schmidt (the Schmidts)1 under 11 U.S.C.
§ 550,2 as subsequent transferees of BHI. The Trustee moved for summary judgment
against BHI and the Schmidts.3 BHI did not respond to the motion, and a default judgment
was entered finding that $5,100,800 in loan payments Brooke Corp made to BHI are
avoidable as preferential transfers under § 547(b) and that $13,143,980.77 in dividend
payments Brooke Corp made to BHI after December 31, 2004, are avoidable as
constructively fraudulent conveyances under §§ 544 and 548.4 This opinion therefore
addresses only the motion for summary judgment against the Schmidts.5 For the reasons
discussed below, the Court finds the Trustee is not entitled to judgment as a matter of law
based upon the uncontroverted facts presented and therefore denies the motion as to the

1 The Complaint also seeks recovery from other individuals, but the Trustee’s actions against
them have been dismissed.


2 All subsequent references to title 11 in the text shall be to the section number only.

3 Doc. 176.

4 Doc. 215.

5 This Court has jurisdiction pursuant to 28 U.S.C. §§ 157(a) and 1334(a) and (b), and the
Amended Standing Order of Reference of the United States District Court for the District of Kansas that
exercised authority conferred by § 157(a) to refer to the District’s bankruptcy judges all matters under the
Bankruptcy Code and all proceedings arising under the Code or arising in or related to a case under the
Code, effective June 24, 2013. D. Kan. Standing Order 13-1, printed in D. Kan. Rules of Practice and
Procedure at 168 (March 2014). Efforts to avoid or recover preferences and fraudulent conveyances are
core proceedings which this Court may hear and determine as provided in 28 U.S.C. § 157(b)(2)(F) and
(H). There is no objection to venue or jurisdiction over the parties.

2

Case 10-06225 Doc# 230 Filed 09/12/14 Page 2 of 19


Schmidts.

UNCONTROVERTED FACTS.
Procedural History.

Brooke Corp and Brooke Capital filed for bankruptcy on October 28, 2008. On
October 6, 2010, the Trustee filed his Complaint against the defendants in this adversary
action. The Complaint sought avoidance of preferential transfers under § 547 (Count I);
avoidance of constructively fraudulent conveyances under § 548 and K.S.A. 33-204 and
33-205 (Count II); recovery of avoided transfers under § 550 (Count III); and disallowance
of several proofs of claim under § 502(d) (Count IV). Initially, there were 13 defendants.
Of these, eight have been dismissed with prejudice, and the claims against two more were
terminated. This leaves BHI and the Schmidts, the parties against whom the Trustee
moved for summary judgment. Defendant BHI failed to respond to the motion for
summary judgment, and the order granting the Trustee a default judgment was entered on
July 10, 2014.

The pretrial order set deadlines for discovery, including the production of reports
from expert witnesses. The Trustee retained experts and provided three reports: Expert
Report of R. Larry Johnson Regarding Insolvency of Brooke Corporation; Expert Report
of R. Larry Johnson Regarding Insolvency of Brooke Holdings, Inc.; and Expert Report of
Kent E. Barrett Regarding Brooke Holdings, Inc. Cash Flows (BHI Cash Flow Report).
The Schmidts did not serve any expert reports and did not request any documents relied
upon by the Trustee’s experts. Discovery closed on April 3, 2014. April 21, 2014, was set

3

Case 10-06225 Doc# 230 Filed 09/12/14 Page 3 of 19


as the deadline for filing dispositive motions.

Relationship of Defendants.

Defendant BHI was incorporated in the State of Kansas as a privately-owned
company used primarily to hold stock of Brooke Corp.6 BHI is an insider of the Debtors.
Approximately 74% of BHI was owned by Robert Orr, 22% by his brother, Leland Orr,
and 4% by other Orr family members.7 Robert Orr always held himself out as the person
in charge of BHI. Robert Orr also served as the CEO of Brooke Corp from 1986 through
October 1, 2007. Robert Orr served as the Chairman of Brooke Corp’s Board of Directors
from 1991 through September 17, 2008, and resigned from that Board in October 2008. In
2007 and 2008, Robert Orr held various officer positions with Brooke Capital. Defendant
Wanda R. Schmidt is Robert Orr’s mother-in-law. Defendant Steven Schmidt is Wanda
Schmidt’s son and the brother-in-law of Robert Orr.

Brooke Corp Loan Repayments and Dividend Payments to BHI.

In May 2007, BHI began borrowing from First United Bank of Frankfort, Illinois,
and loaning the proceeds to Brooke Corp. From December 18, 2007, through July 16,
2008, BHI loaned Brooke Corp a total of $6.1 million. Brooke Corp repaid BHI a total of

6 Doc. 176-4 at 4.

7 Doc. 176-1 at 6, ¶ 10 (supported by BHI Cash Flow Report, Doc. 176-6 at 3, which relied on
SEC complaint filed May 4, 2011, in District of Kansas). The Schmidts controverted this statement by
referring to a 1992 document which shows Robert Orr’s ownership to be approximately 39%. The Court
finds that the Schmidts’ have not effectively controverted the Trustee’s statement of fact, since the date of
the Schmidts’ document is almost 19 years before the SEC complaint was filed, and fifteen years before
the events at issue in this proceeding took place. Further, the exact percentages of ownership are not
material to the issues before the Court.

4

Case 10-06225 Doc# 230 Filed 09/12/14 Page 4 of 19


$5,100,800 between February 14, 2008, and September 4, 2008.

From November 24, 2004, to the date that Brooke Corp filed for bankruptcy relief,
Brooke Corp paid dividends to BHI totaling $13,737,194. In this proceeding, BHI has not
contended that the dividends were paid on account of any antecedent debt.

BHI Transfers to the Schmidts.

Wanda Schmidt received two checks from BHI: one for $87,168.50, dated
December 26, 2007, and one for $75,300, dated December 31, 2007. Of this $162,468.50
paid to Wanda Schmidt, $75,300 was for the redemption of her BHI common stock, and
the remainder was for the redemption of her BHI preferred stock. The two checks did not
clear the BHI bank account until February 26, 2008. Steven Schmidt received two checks
from BHI: one for $180,000, dated December 31, 2007, and one for $180,000, dated
February 22, 2008. This $360,000 paid to Steven Schmidt was for the repurchase of his
BHI stock. Steven Schmidt deposited both checks into his bank account on February 22,
2008, and they cleared BHI’s bank account on February 25, 2008. The Schmidts do not
controvert the conclusions of the BHI Cash Flow Report that of the $162,468.50 paid by
BHI to Wanda Schmidt, $115,840 (71.3%) came from Brooke Corp dividends, and that of
the $360,000 paid by BHI to Steven Schmidt, $252,000 (70%) came from Brooke Corp
dividends.

Avoidance of Transfers from Brooke to BHI.

On July 10, 2014, an Order Granting Trustee’s Motion for Default Judgment

5

Case 10-06225 Doc# 230 Filed 09/12/14 Page 5 of 19


Against Defendant Brooke Holdings, Inc. was entered.8 The judgment holds:

(1) $5,100,800 in loan payments that Brooke Corp made to BHI are avoidable as
preferential transfers under § 547(b); (2) $13,143,980.77 in dividend payments that
Brooke Corp made to BHI are avoidable as constructively fraudulent conveyances under
§ 544 of the Bankruptcy Code (through K.S.A. 33-204(a)(2) and 33-205(a)) and
§ 548(a)(1)(B); and (3) pursuant to § 550 and K.S.A. 33-207, the Trustee may recover the
$5,100,800 and $13,143,980.77 in avoidable transfers from BHI.
DISCUSSION

The Schmidts Have Not Effectively Controverted the Trustee’s Statement of Facts
Regarding the Insolvency of Brooke Corp and BHI (Paragraphs 16-20).

The Trustee’s memorandum in support of his motion includes the following
statements regarding the insolvency of Brooke Corp and BHI. The statements are
supported by reference to expert reports, copies of which are attached to the memorandum.

16. Brooke Corp’s assets consisted primarily of its
investments in its operating subsidiaries, approximately 8090%
of which was its investments in Brooke Capital and
Aleritas. Brooke Capital was continuously insolvent from
November 1, 2004 through the Petition Date. . . .
17. After establishing liabilities for loan impairments
and writing off intangible assets, Aleritas had substantial
negative equity and was continuously insolvent since at least
December 31, 2004.
18. Given the insolvency of Aleritas and Brooke
Capital, coupled with Brooke Corp’s numerous unrecorded
8 Doc. 215.
6


Case 10-06225 Doc# 230 Filed 09/12/14 Page 6 of 19


liabilities, Brooke Corp was insolvent since at least December
31, 2004.

19. Defendant BHI’s solvency was dependent on the
value of its investment in Brooke Corp common stock, since
its other assets and liabilities consisted primarily of amounts
borrowed from third parties to fund loans to Brooke Corp and
other related parties.
20. As noted above, Brooke Corp was insolvent since
at least December 31, 2004. Thus, after eliminating the value
of BHI’s investment in Brooke Corp stock and amounts
receivable from Brooke Corp due to Brooke Corp’s
insolvency, BHI had substantial negative equity. Accordingly,
BHI was also insolvent since at least December 31, 2004.9
When responding to the Trustee’s motion, the Schmidts state:

4. ¶s 16-18 are contested. The Schmidts have no
information as to Brooke Corp’s solvency at any given time.
They also have no information as to the methodology
employed by the trustee’s expert. The report, as attached to
the summary judgment motion, is for the most part no more
than conclusions. The report also contradicts the market, as
Brooke Corp. was a publicly traded company during the
applicable time period with a positive per share price.
Moreover, given the amount involved in this adversary action,
as to the Schmidts, they simply cannot afford to independently
hire their own experts. However, they understand that there
are other actions pending in which Brooke Corp.’s solvency is
at issue and will be/are contested with countering experts. See
Argument, Part 1, below. Also, the Claimholder’s Response
includes significant materials contesting the trustee’s experts
as to insolvency.
5. ¶s 19-20 are contested. Again, the premise for these
¶s is that BHI was insolvent because Brooke Corp. was
9 Doc. 176-1 at 7-8.

7

Case 10-06225 Doc# 230 Filed 09/12/14 Page 7 of 19


insolvent. See Response to ¶s 16-18 above.10

The Schmidts’ response to ¶¶ 16-20 of the Trustee’s statement of facts is not
sufficient to show a genuine dispute as to the facts stated. Rule 56(c)(1) provides that a
party asserting that a fact is “genuinely disputed must support the assertion by: (A) citing
to particular parts of materials in the record.” A local rule applicable to proceedings
before this Court states, “All facts on which a motion or opposition is based must be
presented by affidavit, declaration under penalty of perjury, and/or relevant portions of
pleadings, depositions, answers to interrogatories, and responses to requests for
admissions.”11 The Schmidts cite no particular portions of the record in support of their
assertions. The Schmidts’ refer to the “Claimholder’s Response,” but that response has
been stricken from the record.12 Rather than providing facts which would be admissible in
evidence to controvert the Trustee’s statements, the Schmidts state they “have no
information as to Brooke Corp’s solvency at any given time.”13

The matters stated in the Trustee’s ¶¶ 16-20 will be considered uncontroverted for
purposes of the motion for summary judgment. As noted by the Trustee, these facts have
reduced relevancy since BHI failed to respond to the motion for summary judgment and a

10 Doc. 189 at 2.
11 D. Kan. Rule 56.1(d).
12 The Claimholder’s Response is Doc. 186. It is a response to the Trustee’s motion for summary


judgment that was filed by a nonparty, Robert D. Orr, who purchased BHI’s claim against Brooke Corp.
The response was stricken from the record by Doc. 208.
13 Doc. 189 at 2.
8

Case 10-06225 Doc# 230 Filed 09/12/14 Page 8 of 19


default judgment avoiding the challenged transfers to it has been entered. The insolvency
of neither Brooke Corp nor BHI is an element of the Trustee’s claims against the
Schmidts. Nevertheless, BHI’s insolvency is not totally irrelevant, as it is a factor in the
Trustee’s argument that the Schmidts did not give value for the funds in issue.

The Court Will Not Delay Ruling on the Summary Judgment Motion Based on the
Schmidts’ Assertion that Facts to Controvert Paragraphs 16-20 of the Trustee’s
Statement of Facts Are Unavailable to Them.

The Schmidts argue that their inability to controvert the Trustee’s statement of facts
regarding the solvency of Brooke Corp and BHI provides grounds to delay ruling on the
motion under Rule 56(d), which provides:

(d) When Facts are Unavailable to the Nonmovant.
If a nonmovant shows by affidavit or declaration that, for
specified reasons, it cannot present facts essential to justify its
opposition, the court may:

(1) defer considering the motion or deny it;
(2) allow time to obtain affidavits or declarations or to
take discovery; or
(3) issue any other appropriate order.
The rule was amended in 2010 and subdivision (d) “carrie[d] forward without substantial
change the provisions of former subdivision (f),”14 so earlier authorities referring to
subdivision (f) now apply to subdivision (d). “The purpose of subdivision (f) is to provide
an additional safeguard against improvident or premature grant of summary judgment.”15
“One of the most common reasons offered under Rule 56(f) for being unable to present
14 Fed. R. Civ. P. 56, Advisory Committee Notes to 2010 Amendments.
15 10B Charles Alan Wright, Arthur R. Miller & Mary Jane Kane, Federal Practice and
Procedure, § 2740 at 402 (3rd ed. 1998).
9


Case 10-06225 Doc# 230 Filed 09/12/14 Page 9 of 19


specific facts in opposition to a summary-judgment motion is insufficient time or
opportunity to engage in discovery.”16 In the Tenth Circuit, “a party seeking to defer a
ruling on summary judgment under Rule 56(f) must provide an affidavit ‘explain[ing] why
facts precluding summary judgment cannot be presented.’”17 The affidavit should identify
“(1) ‘the probable facts not available,’ (2) why those facts cannot be presented currently,

(3) ‘what steps have been taken to obtain these facts,’ and (4) ‘how additional time will
enable [the party] to’ obtain those facts and rebut the motion for summary judgment.”18
Justifications for not taking discovery based on a lack of funds have not been successful.19
In this case, discovery has been closed. The Schmidts have not designated any
experts or conducted any discovery to determine the details of the expert opinions offered
by the Trustee. The Schmidts describe no steps which they have taken to refute the
allegations of insolvency and do not explain how additional time will enable them to
obtain the needed facts. The declaration submitted to support the Rule 56(d) defense
states merely that neither the declarant, Steven Schmidt, nor his mother, Wanda Schmidt,
can afford to pay significantly more to defend against the Trustee’s Complaint, and that
the fees of a forensic accountant would be substantial and beyond their ability to pay. The

16 Id., § 2741 at 412.

17 Valley Forge Ins. Co. v. Health Care Mgmt. Partners, Ltd., 616 F.3d 1086, 1096 (10th Cir.
2010) (quoting Comm. for the First Amendment v. Campbell, 962 F.2d 1517, 1522 (10th Cir. 1992)).


18 Id.

19 10B Fed. Prac. & Pro., § 2741 at 436 (citing Grimm v. Westinghouse Elec. Corp., 300 F.
Supp. 984, 991 (N.D. Cal. 1969); Dale Hilton, Inc., v. Triangle Publ’ns, Inc., 27 F.R.D. 468, 476


(S.D.N.Y. 1961)).
10
Case 10-06225 Doc# 230 Filed 09/12/14 Page 10 of 19


Schmidts ask for a delay in ruling on the summary judgment motion not for the purpose of
conducting their own discovery, but because there are other adversary proceedings “where
the Brooke Corp. insolvency will be contested with the assistance of expert testimony.”20

For several reasons, the Court rejects the Schmidts’ argument as a basis for
delaying a ruling on the summary judgment motion. First, the Schmidts recite no efforts
on their part to join with the defendants in the cited cases in the retention of experts.
Second, it is highly possible that the other proceedings will be settled and not proceed to
trial. Third, because judgment has been entered on the avoidance claims against BHI, the
insolvency of Brooke Corp and BHI are not elements of the remaining claims. Fourth, the
Schmidts have made no argument that a ruling on the solvency of Brooke Corp in the
other cases would have a preclusive effect in this case.

The Court declines to delay resolution of the Trustee’s summary judgment motion
until after a determination is made in other adversary proceedings of Brooke Corp’s
solvency.
The Trustee’s Summary Judgment Motion Is Denied.

Section 550(a)(1) allows the Trustee to recover for the benefit of the estate any
transfer which is avoidable under §§ 544, 547, and 548 from the initial transferee.
Judgment was entered under this subsection against BHI as the initial transferee of the
Brooke Corp loan repayments of $5,100,800 and dividend payments of $13,143,980.77.

20 Doc. 189 at 5.
11


Case 10-06225 Doc# 230 Filed 09/12/14 Page 11 of 19


But that judgment has not been satisfied, and the Trustee has no expectation of recovering
from BHI. The Trustee therefore seeks a judgment against the Schmidts under
§ 550(a)(2), which allows the Trustee to recover the avoided transfers from “any
immediate or mediate transferee of such initial transferee.”

The uncontroverted facts establish that in February 2008, BHI transferred $360,000
to Steven Schmidt and $162,468.50 to Wanda Schmidt in order to redeem their stock in
BHI. Of the monies paid to Steven Schmidt, $252,000 is traceable to the avoidable
transfers that BHI received from Brooke Corp. Of the monies paid to Wanda Schmidt,
$115,840 is traceable to the avoided transfers that BHI received from Brooke Corp. As to
the traceable funds, the Schmidts are transferees of BHI, the initial transferee from Brooke
Corp. They are therefore liable to the Trustee under § 550(a)(2), unless they are within the
protection afforded by § 550(b). That subsection provides:

(b) The Trustee may not recover under section (a)(2) of
this section from —
(1) a transferee that takes for value, including
satisfaction or securing of a present or antecedent debt, in good
faith, and without knowledge of the voidability of the transfer
avoided; or
(2) any immediate or mediate good faith transferee of
such transfer.
“The policy underlying the ‘good faith’ defense . . . is to protect certain innocent
purchasers from challenges to the underlying transfer.”21 The focus is on the transaction

21 Enron Corp. v. Avenue Special Situations Fund II, LP, (In re Enron), 333 B.R. 205, 233
(Bankr. S.D.N.Y. 2005); see also Bonded Financial Servs., Inc., v. European Amer. Bank, 838 F.2d 890,
897 (7th Cir. 1988) (Transferees covered by § 550(b) receive protection because requiring them to

12

Case 10-06225 Doc# 230 Filed 09/12/14 Page 12 of 19


between the initial and the subsequent transferee.22 The subsection provides an affirmative
defense, and the transferee relying on the defense has the burden of proof.23

The Trustee asserts that the Schmidts are not protected by § 550(b)(1) for two
reasons: (1) they did not allege the defense in their answer; and (2) they did not give value
for the transfers from BHI. When the Trustee raised the first of these objections in his
memorandum in support of summary judgment, the Schmidts responded with a motion to
amend their answer to add the defense, to which the Trustee objected. By separate order,
the Court has allowed the Schmidts to amend their answer. The Trustee’s first assertion is
therefore rejected.

The Trustee’s second assertion presents a difficult legal question — does the fact
that BHI was insolvent when the transfers were made to the Schmidts in exchange for their
stock in BHI establish as a matter of law that the Schmidts did not give value for the
transfers? Courts disagree about the meaning of “value” as used in § 550(b)(1). Some
courts hold that “value” is consideration sufficient to support a contract24 — that there is
no requirement for the value of the property received from the earlier transferee to be

monitor how their transferors obtained the property transferred would be impractical, and exposing them
to risk on account of earlier problems affecting the property would make commerce harder to conduct.).

22 Bonded Financial, 838 F.2d at 897; Lewis v. Zermano (In re Stevinson), 194 B.R. 509, 512-13,

D. Colo. 1996); Bakst v. Sawran (In re Sawran), 359 B.R. 348, 354-55 (Bankr. S.D. Fla. 2007).
23 Rodgers v. Monaghan Co. (In re Laguna Beach Motors, Inc.), 159 B.R. 562, 566 (Bankr. C.D.
Cal. 1993).
24 In re Enron, 333 B.R. at 236; Baldi v. Lynch (In re McCook Metals, L.L.C.), 319 B.R. 570, 590

n. 15 (Bankr. N.D. Ill. 2005).
13
Case 10-06225 Doc# 230 Filed 09/12/14 Page 13 of 19


reasonably equivalent to the value of the property given by the subsequent transferee.25
Other courts find that “value” requires a measure of equivalence, such as fair market value
or reasonably equivalent value.26 The Schmidts argue the Court should adopt the first
view, and the Trustee urges the adoption of the second view.

The Court finds those cases not requiring a measure of equivalence are better
reasoned. Section 550(b) contains no equivalence language; it requires only “value.” If
Congress intended to require equivalence, one would expect it to have said so, as it did in
other Code sections. As stated by one court,

[The omission of equivalence language in § 550(b)(1)] is
significant because Congress knows how to impose an
equivalence standard when it wants to. Section 549(c) of the
Code, for example, requires a transferee to have paid “present
fair equivalent value” to sustain a defense to an action to
recover a post-petition transfer. Similarly, section
548(a)(1)(B) renders fraudulent certain transfers received for
“less than a reasonably equivalent value.” When Congress
uses language in one part of a statute and omits it in another,
the omission is presumed to be intentional.27

This analysis is supported by the legislative history. The 1973 Report of the Commission
on the Bankruptcy Laws of the United States explained the proposal which became

25 Anderson v. SunTrust Mortgage, Inc. (In re Judd), 471 B.R. 830, 847 (D.S.C. 2012); CLC
Creditors’ Grantor Trust v. Howard Savings Bank (In re Commercial Loan Corp.), 396 B.R. 730, 743-44
(Bankr. N.D. Ill. 2008); Williams v. Mortillaro (In re Resource, Recycling & Remediation, Inc.), 314 B.R.
62, 70 (Bankr. W.D. Pa. 2004); Coleman v. Home Savings Ass’n (In re Coleman), 21 B.R. 832, 836
(Bankr. S.D. Tex. 1982).

26 Brown v. Harris (In re Auxano, Inc.), 96 B.R. 957, 965 (Bankr. W.D. Mo. 1989) (fair market
value); In re Laguna Beach Motors, 159 B.R. at 568 (reasonably equivalent value).


27 In re Commercial Loan Corp., 396 B.R. at 744.

14

Case 10-06225 Doc# 230 Filed 09/12/14 Page 14 of 19


§ 550(b) in part as follows: “Subdivision (b) states the liability, if any, of subsequent
transferees. If the subsequent transferee gives value in good faith, regardless of the
amount or whether present or past consideration, he is protected.”28 The cases relied upon
by the Trustee that interpret “value” to mean “fair market value” or “reasonably equivalent
value” are contrary to the legislative intent.

The absence of an equivalence standard is also supported by the purpose of
§ 550(b).29 It provides a defense similar to one available to purchasers of goods. Under
Article 2 of the Uniform Commercial Code, “a person with voidable title has power to
transfer a good title to a good faith purchaser for value.”30 The definition of “value”
includes “any consideration sufficient to support a simple contract”;31 there is no
equivalence requirement. Under Kansas law, a similar rule also applies to certain real
property transactions: in order for a grantee under a quitclaim deed to take advantage of
the recording laws and be considered a good faith purchaser for value, the consideration

28 Report of the Commission on the Bankruptcy Laws of the United States, H.R. Doc. No. 93-137,
93rd Cong. 1st Sess., Part II, Proposed Statutory Changes, § 4-609, n. 4 (1973), reprinted in App., Vol. B,
Collier on Bankruptcy, App. Pt 4(c) at p. App. Pt. 4-753.

29 The case relied upon by the Trustee for the proposition that “value” in § 550(b)(1) means “fair
market value” does so based upon the rationale that the purpose of § 550 is to preserve the assets of the
estate. In re Auxano, Inc., 96 B.R. at 965. But in this Court’s opinion, that rationale is misdirected.
Although the purpose of § 550 in general is preserving assets of the estate, the purpose of § 550(b)(1),
which imposes the requirement of “value,” is to provide protection to subsequent transferees of avoided
transfers. That protective purpose is fulfilled by construing “value” in subsection (b)(1) not to impose an
equivalence standard.

30 K.S.A. 84-2-403(1).

31 K.S.A. 2013 Supp. 84-1-204(4).

15

Case 10-06225 Doc# 230 Filed 09/12/14 Page 15 of 19


paid must have been valuable (not nominal), but it need not have been full or adequate.32
Furthermore, the Restatement (Third) of Restitution and Unjust Enrichment, which has
been followed by the Kansas appellate courts,33 recognizes being a purchaser for value
without notice as an affirmative defense to liability on restitution claims against the
property that would have been valid if the property had remained in the hands of the
grantor.34 When defining “value,” the Restatement says, in part: “Except as otherwise
provided by statue, a purchaser gives value for rights if they are acquired (a) in exchange
for present value, excluding nominal consideration.”35

The Trustee contends that because BHI was insolvent when the Schmidts received
the funds from BHI that are traceable to the avoided transfers from Brooke Corp to BHI,
summary judgment should be granted in his favor. The Schmidts respond by asserting that
stock of even an insolvent company may have value. They cite Commercial Loan36 in
support. In that case, four banks were stockholders of the debtor, Commercial Loan
Corporation (CLC), which was controlled by Hueser. Starting in 2001, Hueser began
purchasing all of the stock of CLC from the banks using CLC funds that had been
transferred to WK Financial, a corporation controlled by Hueser. CLC filed for Chapter

32 Morris v. Wicks, 81 Kan. 790, 791-94, 106 P.1048 (1910) (consideration of $1 was nominal).

33 Uhlmann v. Richardson, 48 Kan. App.2d 1, 7-12, 287 P.3d 287 (2012).

34 Restatement (Third) of Restitution and Unjust Enrichment, § 66 (2011).

35 Id., § 68.

36 In re Commercial Loan Corp., 396 B.R. 730.

16

Case 10-06225 Doc# 230 Filed 09/12/14 Page 16 of 19


11 bankruptcy relief in 2004, and a liquidating plan proposed by creditors was confirmed.
A liquidating trust created by the plan sued to recover the funds used to purchase the stock
from the banks. The banks moved for summary judgment. As to the value element of the
banks’ good-faith-transferee defense under § 550(b)(1), the court held that “value” did not
include any equivalence element and that the stock purchased by Hueser had value even
though CLC was insolvent. The court stated:

The stock was “value” because it constituted consideration
sufficient to support a simple contract. The Trust argues that
the stock had no value because CLC was insolvent at the time
of the sales, but stock in a corporation may have value even
though the corporation is insolvent (in the “balance sheet”
sense that its liabilities exceed its assets). The banks
established a prima facie case on the “value” element by
showing they gave up their stock. If CLC’s insolvency meant
the stock had no value, it was the Trust’s obligation to adduce
evidence showing as much. No evidence has been offered.37

The Commercial Loan court therefore found for the transferees on the value issue because
of the trust’s failure to provide evidence other than the fact of CLC’s insolvency.

The question in this case is whether “value” was given when the Schmidts
surrendered their BHI stock for redemption even though it has now been established that
BHI was insolvent at the time of the redemption. The Court finds Commercial Loan to be
instructive and rejects the Trustee’s argument that the statement in Commercial Loan that
the stock of an insolvent entity may have value is not good law. It is true, as argued by the

37 Id. at 743-44.

17

Case 10-06225 Doc# 230 Filed 09/12/14 Page 17 of 19


Trustee, that Commercial Loan relied upon Wabash Valley Power, 38 a 1995 Seventh
Circuit decision which that circuit recently noted has been abrogated in part by subsequent
Supreme Court decisions.39 But Wabash Valley addressed the value of the stock of an
insolvent corporation for purposes of the absolute priority rule, not § 550(b)(1). The Court
finds the general proposition that it is possible for the stock of an insolvent corporation to
have value for purposes of § 550(b)(1) to be reasonable. Nothing in § 550 requires the
adoption of a balance-sheet test for the value of stock transferred to the issuer for
redemption. For example, such stock could have value because of control issues or
because solvency is on the horizon.

The Court also finds the rationale of the bona-fide-payee defense of the
Restatement (Third) of Restitution and Unjust Enrichment to be helpful. It defines the
innocent-cash-payee defense by providing, in part, that “[a] payee without notice takes
payment free of a restitution claim to which it would otherwise be subject, but only to the
extent that (a) the payee accepts the funds in satisfaction or reduction of the payee’s valid
claim as creditor of the payor or of another person.”40 Under this definition, the defense is
not available to the recipient of a gift or a payment on an illegal contract, such as a

38 In re Wabash Valley Power Assoc., 72 F.3d 1305, 1318 (7th Cir. 1995).

39 In re Castleton Plaza, LP, 707 F.3d 821, 823-24 (7th Cir. 2013) (Wabash Valley abrogated to
extent it suggested that despite absolute priority rule, equity owners of Chapter 11 debtor could retain
their interests by contributing new value to debtor pursuant to reorganization plan without engaging in
competitive bidding for those interests).


40 Restatement (Third) of Restitution and Unjust Enrichment, § 67.

18

Case 10-06225 Doc# 230 Filed 09/12/14 Page 18 of 19


gambling obligation, because they are not valid claims against the payor.41 The Trustee
has not presented facts or argument showing that the redemption of the Schmidts’ stock in
BHI was either a gift or an illegal contract.

In this case, as in Commercial Loan, the Trustee has proven that BHI was insolvent,
not that the Schmidts gave no value for the transfers. The Trustee may ultimately prove
that the Schmidts gave no value, but at the summary judgment phase of this litigation, the
Court is unwilling to conclude that the Schmidts cannot prevail on the good-faithtransferee
defense premised solely on the fact of BHI’s insolvency. Although this fact will
undoubtedly make it more difficult for the Schmidts to prove the stock had value at the
time their stock was redeemed, it does not conclusively establish that the stock had no
value at that time.
CONCLUSION.

For the foregoing reasons, the Court denies the Trustee’s motion for summary
judgment against Defendants Steven and Wanda Schmidt.

IT IS SO ORDERED.
# # #


41 Id., Illustrations 2 & 11.
19
Case 10-06225 Doc# 230 Filed 09/12/14 Page 19 of 19

You are here: Home