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In Re D.J. Christie, Inc., 11-40764 (Bankr. D. Kan. May, 17, 2013) Doc. 246
SIGNED this 17th day of May, 2013.
Designated for on-line distribution but not print publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
D.J. CHRISTIE, INC.,
CASE NO. 11-40764
MEMORANDUM OPINION AND JUDGMENT
APPROVING COMPROMISE AND SETTLEMENT
The matter before the Court is the Motion of D.J. Christie, Inc. to Approve
Compromise and Settlement (Motion)1 of the disputes between (1) the Christie Parties,
comprised of Debtor, David J. Christie, and Alexander Glenn, and (2) Alan E. Meyer and
John R. Pratt. Christie, Glenn, Meyer, and Pratt support the Motion.2 Washington
1 Dkt. 212.
2 Dkt. 219 and 220.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 1 of 31
International Insurance Company (Washington) filed a limited objection.3 Liberty Bank,
F.S.B. (Liberty) objected to the settlement.4 Following a hearing,5 the Motion was placed
under advisement.6 Supplemental briefs were requested and filed.7 Having carefully
considered the Motion, the pleadings in support and in opposition, the record in this case
and the related adversary proceeding, and the oral arguments of counsel, the Court is now
ready to rule. For the following reasons, the proposed compromise and settlement is
approved, subject to the conditions stated below.
FINDINGS OF FACT.
The origin of the disputes in this case is a failed joint venture to build The Bluffs,
an apartment project in Junction City, Kansas. It resulted in a damage action, Alan E.
Meyer, et al. v. David J. Christie, et al., Case no. 07-2230, United States District Court
for the District of Kansas (the Federal Litigation). There are least two related bankruptcy
filings, this case, In re D.J. Christie, Inc., and In re The Bluffs, LLC, Case no. 09-11978,
3 Dkt. 218.
4 Dkt. 217.
5 Debtor appeared by Tom R. Barnes II of Stumbo Hanson, LLP. Christie and Glenn appeared by
Bruce J. Woner and Justin W. Whitney of Woner, Glenn, Reeder & Girard, P.A. Washington appeared
by Carol Z. Smith of Gilliland & Hayes, P.A. Meyer and Pratt appeared by Kenneth N. Hickox, Jr., and
Robert M. Millimet of Bickel & Brewer. Liberty appeared by Gordon Gee and David E. Shay of
Seigfreid Bingham, P.C.
6 This Court has jurisdiction pursuant to 28 U.S.C. §§ 157(a) and 1334(a) and (b), and the
Standing Order 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 July
10, 1984. There is no objection to venue or jurisdiction over the parties.
7 Dkt. 233, 236, & 237.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 2 of 31
pending in the Wichita division of this Court. Broadly speaking, the subject of the
settlement is satisfaction of the judgment entered in the Federal Litigation in favor of the
plaintiffs, Meyer and Pratt.
The Federal Litigation was filed in 2007. By letter agreement dated March 1,
2009, Meyer and Pratt entered into a contingent fee agreement with Bickel & Brewer, a
law firm located in Dallas, Texas, for representation in the litigation. On May 22, 2009,
at the conclusion of a nine-day trial, a nine-person jury returned its verdict in favor of the
plaintiffs, and on September 8, 2009, the District Court issued a judgment in favor of
Meyer and Pratt and against the Christie Parties for, among other things, actual damages
totaling approximately $7,170,000, punitive damages totaling $100, post-judgment
interest, and costs (Initial Federal Judgment).
A notice of appeal was filed. On January 12, 2010, the District Court granted a
stay against execution on the Initial Federal Judgment pending appeal, but only upon the
deposit of a supersedeas bond in the amount of $1.125 million. On January 15, 2010, a
copy of Supersedeas Bond No. 90713678 issued by Washington was filed with the
District Court. On appeal, the Tenth Circuit affirmed the jury’s joint venture lost profits
damages award and the Court’s punitive damages award to Meyer and Pratt in the total
amount of $7,170,703, as well as the joint and several liability of the Christie Parties for
that amount. The mandate issued on April 25, 2011.
8 In its objection, dkt. 218, Washington says the number of the Bond is 90713617, but a copy of
the Bond attached as Exhibit N to the complaint in Adversary no. 11-7043 shows the number is actually
Case 11-40764 Doc# 246 Filed 05/17/13 Page 3 of 31
Creditors of Meyer obtained substantial interests in the judgment entered in his
favor. In June 2010, Meyer assigned payment interests in the judgment in the total
amount of $723,508.71 to certain third-party creditors, and filed copies of the
assignments in the District Court case (Payment Assignments).
Liberty Bank obtained two judgments against Meyer in Iowa state court, the first
on June 30, 2010, and the second on September 15, 2010. Liberty Bank thereafter
registered those judgments in the District Court of Johnson County, Kansas, on April 13,
2011, and filed a Kansas state court garnishment action against Christie and Debtor on
May 13, 2011 (the Johnson County Proceedings). Liberty Bank served a garnishment
order against Christie on May 16, 2011, and one against Debtor on May 19, 2011.
Christie and Debtor answered on May 31, 2011, asserting they had no liability because
the Initial Federal Judgment, the basis of their liability to Meyer, was not final and
because of offset. Liberty Bank thereafter filed a proof of claim against Debtor based on
the garnishment order served on Debtor.
On April 29, 2011, and May 2, 4, and 18, 2011, after the Tenth Circuit issued its
mandate, the Christie Parties acquired assignments of judgments entered in Iowa courts
against Meyer, Pratt, and others on six dates in 2010 (Iowa Judgments). At the time of
their acquisition by the Christie Parties, the total amount owed on the Iowa Judgments
On May 19, 2011, Debtor, Christie, and Glenn registered all but one of the Iowa
Judgments in the District Court of Dickinson County, Kansas. The excluded judgment
Case 11-40764 Doc# 246 Filed 05/17/13 Page 4 of 31
was registered in Dickinson County on June 3, 2011. Also on May 19, 2011, one of the
Iowa Judgments in the approximate amount of $3 million was registered in the District
Court of Jackson County, Missouri. Garnishment actions against Meyer and Pratt were
instituted with respect to each registered judgment in Dickinson County, Kansas, and in
Jackson County, Missouri (the Dickinson County Proceedings and the Jackson County,
On May 20, 2011, Debtor D.J. Christie, Inc., commenced this Chapter 11 case.
Debtor’s schedules reported the following: Real property valued at $40,000; personal
property valued at $5,000, plus interests of unknown values in the bond provided by
Washington, potential legal malpractice claims, and an interest in the Iowa Judgments
against Meyer and Pratt, valued at $7.5 million; no secured or priority claims; unsecured
claims of $930,005.49, the largest of which was a claim for $866,505.49 held by Christie,
an insider; and one unexpired lease of office space. The Initial Federal Judgment was
listed as a disputed claim owed to Meyer and Pratt because of Debtor’s position that it
was more than offset by Meyer and Pratt’s liability on the Iowa Judgments. In essence,
Debtor has no meaningful liabilities and no assets which are not related to the Initial
Federal Judgment. As subsequent proceedings have confirmed, the Chapter 11 case was
filed for the purpose of resolving Debtor’s (and Christie’s and Glenn’s) liability to Meyer
On June 15, 2011, after the bankruptcy stay was modified, the Initial Federal
Judgment was amended in accord with the mandate issued by the Tenth Circuit, and the
Case 11-40764 Doc# 246 Filed 05/17/13 Page 5 of 31
amended Federal Judgment was entered in favor of Meyer and Pratt against Debtor,
Christie, and Glenn in the amount of $7,170,603.00, plus $100 in punitive damages, plus
post-judgment interest. The Initial Federal Judgment as amended is hereafter referred to
as the Federal Judgment.
On June 29 and August 5, 2011, Debtor, Christie, and Glenn served Missouri state
court garnishment orders on Washington, seeking to recover the supersedeas bond funds
in partial satisfaction of the Iowa Judgments.
On July 29, 2011, Debtor commenced an adversary proceeding against Meyer,
Pratt, Christie, Glenn, and Washington (Adversary Proceeding).9 Debtor alleges it is
entitled to an offset of its liability on the Federal Judgment based on the Iowa
Judgments.10 Christie and Glenn answered Debtor’s complaint, and filed a similar offset
crossclaim against Meyer and Pratt based on the Iowa Judgments. On January 9, 2012,
the Court granted Liberty’s motion to intervene in the Adversary Proceeding based upon
Liberty’s position that the Christie Parties’ assertion that they may offset their liability on
the Federal Judgment against the Iowa Judgments impacts Liberty’s garnishment liens
against Christie and Debtor since those liens are based on Christie’s and Debtor’s liability
to Meyer under the Federal Judgment. On January 17, 2012, Meyer and Pratt filed
counterclaims against Debtor and crossclaims against Christie and Glenn for, among
9 Adversary no. 11-7043, dkt. 1.
10 A “judgment grid” listing the Iowa Judgments and the Federal Judgment is filed in Adv. no. 117043,
Case 11-40764 Doc# 246 Filed 05/17/13 Page 6 of 31
other things, a declaration that the Christie Parties are not entitled to an offset based on
the Iowa Judgments. Contentious discovery on the offset issue has commenced.
On March 23, 2012, a Complaint for Interpleader11 was filed by the liquidating
trustee of the Bluffs, LLC (Interpleader Proceeding). It recites that a sale order was
entered in the Bluffs’s bankruptcy directing the liquidating trustee to distribute proceeds
from the sale of assets one-half to J.C. Investment, LLC, and one-half to Meyer and Pratt.
But subsequent to the sale order, the liquidating trustee was served with garnishment
orders from the District Court of Dickinson County, Kansas, where the Iowa Judgments
had been filed, on behalf of Christie, Glenn, and Debtor seeking to garnish all funds to be
paid to Meyer and Pratt. The Complaint further alleges that the liquidating trustee is
holding $884,168.36 which is subject to the competing claims of the Christie Parties,
Meyer, and Pratt. Leave to proceed was granted, and the funds are on deposit with the
Clerk of the Bankruptcy Court.
The Christie Parties, Meyer, and Pratt have also been involved in seven lawsuits
filed in Platte County, Missouri (Platte County Proceedings). No one has suggested any
details about these suits should affect the Court’s decision here.
Effective December 6, 2012, Meyer, Pratt, and the Christie Parties agreed to the
Settlement Agreement which is the subject of the Motion. Liberty is not a party to the
settlement and was excluded from the settlement negotiations. The Settlement
11 Adversary case no. 12-7016, dkt. 1.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 7 of 31
Agreement constitutes a full and final compromise and settlement of all claims and
liabilities among the parties due and owing in connection with the Adversary Proceeding,
the Federal Litigation, the Bluffs Bankruptcy, the D.J. Christie, Inc., Bankruptcy, the
Interpleader Proceeding, the Dickinson County Proceedings, the Platte County
Proceedings, the Jackson County, Missouri, Proceeding, and the Johnson County
Proceedings. The monetary matters settled are the liability of Debtor, Christie, and Glenn
to Meyer and Pratt under the Federal Judgment and the liability of Meyer and Pratt to the
Christie Parties under the Iowa Judgments. These matters are the central issues in the
Adversary Proceeding. Under the Settlement Agreement, as consideration for all the
agreements and releases, the settling parties agree that the Iowa Judgments will be offset
in full against the Federal Judgment and the Christie Parties agree to pay Meyer and Pratt
$1.825 million in cash, which includes release of the interpleaded funds of approximately
$884,000. The Court has been advised that the additional required cash will be provided
by Christie, apparently obtained through a loan secured by a mortgage on his exempt
Kansas residence. The Court has also been advised that the distribution of the cash will
be approximately $1 million to Bickel & Brewer, approximately $411,000 in partial
satisfaction of the Payment Assignments, and approximately $411,000 to Pratt.12
Although approval of the Settlement Agreement would not encompass approval of this
distribution, the Court surmises that the proposed distribution is an important part of the
12 See dkt. 237at 3, n. 2 (as to distribution of funds).
Case 11-40764 Doc# 246 Filed 05/17/13 Page 8 of 31
agreement and will analyze it as if it were included in the proposed Settlement
A. STANDARDS FOR APPROVAL OF SETTLEMENTS.
Federal Rule of Bankruptcy Procedure 9019(a) provides that “[o]n motion by the
trustee and after notice and a hearing, the court may approve a compromise or
settlement.” Debtor, as a debtor-in-possession under Chapter 11, generally has the rights
and powers of a trustee,13 including the right to move for approval of a compromise and
settlement under Rule 9019. The Motion was filed on February 6, 2013. The Debtor also
filed a motion to shorten the time for notice, which was granted the next day. The Court
ordered objections to be filed by February 19, 2013, and, if any were filed, a hearing
would be held on February 25, 2013. Service was made on those listed on Debtor’s
matrix. Liberty and Washington filed objections, so a hearing was held. The Court heard
arguments of counsel; no evidence was offered.
“In order to approve a settlement, the court must determine that it is fair and
equitable.”14 The court does not substitute its judgment for that of the trustee, but rather,
should “without conducting a trial or deciding the numerous questions of law and fact,
‘canvass the issues and see whether the settlement fall[s] below the lowest point in the
13 See 11 U.S.C. § 1107(a).
14 8 William L. Norton, Jr., and William L. Norton III, Norton Bankruptcy Law & Practice 3d,
§ 167:2 at 167-6 (Thomson Reuters/West 2012).
Case 11-40764 Doc# 246 Filed 05/17/13 Page 9 of 31
range of reasonableness.’”15 “The decision of a bankruptcy court to approve a settlement
must be ‘an informed one based upon an objective evaluation of developed facts.’”16 The
factors to evaluate include “the probable success of the underlying litigation on the
merits, the possible difficulty in collection of a judgment, the complexity and expense of
the litigation, and the interests of creditors in deference to their reasonable views.”17
These standards are applied to settlements of claims held by the estate and also to claims
against the estate.18 The proponent of the settlement has the burden of persuading the
court that it should be approved.19
B. THE SETTLEMENT AGREEMENT IS FAIR AND EQUITABLE.
The proposed settlement is fair when considered in light of the probability of
success on the merits. The claim against the estate being settled is the Federal Judgment
of approximately $7,170,000 held by Meyer and Pratt against Debtor, Christie, and
Glenn, entered after the Tenth Circuit Court of Appeals affirmed the jury trial judgment
in part. The judgment is final. There is no likelihood that Debtor’s liability on the
judgment would be reduced if the claim were not settled. Christie and Glenn, who are
15 In re Tennol Energy Co., 127 B.R. 820, 828 (Bankr. E.D. Tenn. 1991) (quoting Anaconda-
Ericsson, Inc., v., Hessen (In re Teltronics Servs.), 762 F.2d 185, 189 (2nd Cir. 1985), which was quoting
Cosoff v. Rodman (In re W.T. Grant Co.), 699 F.2d 599, 608 (2d Cir. 1983)).
16 In re Kopexa Realty Venture Co., 213 B. R. 1020, 1022 (10th Cir. BAP 1997) (quoting Reiss v.
Hagmann, 881 F.2d 890, 892 (10th Cir. 1989)).
18 Will v. Northwestern University (In re Nutraquest, Inc.), 434 F.3d 639, 644-45 (3rd Cir. 2006).
19 Tennol Energy, 127 B.R. at 828.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 10 of 31
jointly liable, are not in bankruptcy, yet during the pendency of this case, Meyer and Pratt
have not attempted execution against them.
The settlement proposes to satisfy the Federal Judgment of approximately
$7,170,000 against Debtor by (1) offset of all the Iowa judgments against Meyer and Pratt
held by the Christie Parties, (2) application of the approximately $884,000 held in the
court registry, which is proceeds from the Bluffs bankruptcy, and (3) payment of
approximately $981,000 in cash obtained from a mortgage on Christie’s exempt property.
Since the face value of the Iowa Judgments held by the estate is approximately
$9,312,000, the settlement incorporates a significant discount on the value of these assets.
The complexity of litigating the offset issue supports the settlement. The parties
have been litigating the estate’s right to set the Iowa judgments off against its liability on
the Federal Judgment for almost two years. In addition to the present parties to the
Adversary Proceeding, Debtor seeks to add additional parties claiming an interest in the
Federal Judgment. As to the merits of the right to offset, the Christie Parties report to the
Court that there is little precedent and the prevailing party would be largely dependent
upon the equitable discretion of the deciding court.20 Pratt filed a motion to withdraw
reference of the Adversary Proceeding to preserve his right to jury trial. Although the
District Court adopted this Court’s recommendation that withdrawal be delayed,21 the full
resolution of the offset issue in the Adversary Proceeding would most likely be made
20 Dkt. 219 at 3.
21 Adv. no. 11-7043, dkt. 82.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 11 of 31
more complex by withdrawal of reference and a jury trial on at least some issues.
The difficulty in satisfaction of the Iowa Judgments also supports the settlement.
There is no indication that either Meyer or Pratt have any assets with which they could
satisfy the Iowa Judgments, rendering the judgments essentially worthless as an estate
asset. Their greatest value is as an offset against the estate’s liability on the Federal
The distribution of the settlement funds to be deposited to the Bickel & Brewer
trust account is reasonable. The first $1 million is to be paid to Bickel & Brewer, the
holders of claims against Meyer and Pratt for at least 40% of the recovery on the
approximately $7 million Federal Judgment, which would be approximately $2.8 million.
The amount being applied to the fees is 40% of only a $2.5 million payment, representing
a significant compromise of the claim for fees. The remaining $822,0000 of the funds is
being divided one-half to Meyer and one-half to Pratt, the joint holders of the Federal
Judgment. Meyer’s share is being distributed to the holders of Payment Assignments in
the original amount of approximately $724,000.
The interests of creditors are not harmed by the settlement. Meyer, Pratt, and
Christie are the only significant creditors of the estate. They are parties to the Settlement
Agreement and support its approval. No creditors have objected to the settlement.
Washington, which is not a creditor, objects only in part and the settling parties have
agreed to the changes in the settlement that Washington requests. The only other
objecting part is Liberty, but it also is not a creditor of Debtor. Based upon the foregoing,
Case 11-40764 Doc# 246 Filed 05/17/13 Page 12 of 31
the Court finds that each of the four factors generally considered when evaluating a
proposed settlement are satisfied. Next, the Court must examine the two objections to
C. WASHINGTON’S OBJECTION DOES NOT PRECLUDE APPROVAL
OF THE SETTLEMENT AGREEMENT.
Washington’s objection presents no obstacle to approval. It was filed “for the sole
purpose of ensuring that the issues pertaining to Washington in the related cases . . . are
sufficiently addressed to provide for the discharge and exoneration of the Supersedeas
Bond that has been issued by Washington.”22 To this end, Washington requested that any
order approving the Settlement include the following requirements:
1. That Meyer and Pratt file a satisfaction of the Federal Judgment
in the Federal Litigation which expressly provides that the bond is released;
2. That the Christie Parties file a pleading releasing the
garnishments that have been issued by the Jackson County, Missouri, court
3. That the parties release any claims they may have against
Washington or to the proceeds of the bond; and
4. That Debtor file an amended Schedule B omitting the bond as
personal property it owns.23
At the hearing on the Motion, the parties to the Settlement Agreement stated they had no
objection to these requested terms. The Court finds the terms to be appropriate.
D. LIBERTY’S OBJECTION DOES NOT PRECLUDE APPROVAL OF
THE SETTLEMENT AGREEMENT.
1. Liberty’s objection and the responses of the Christie Parties.
22 Dkt. 218 at 1.
23 Id. at 3-4 (paraphrased by the Court).
Case 11-40764 Doc# 246 Filed 05/17/13 Page 13 of 31
The objection of Liberty Bank is more complex. Liberty contends that approval of
the Settlement Agreement should be denied “because the settling parties seek to use the
proposed Settlement Agreement to evade lawful obligations owed to Liberty Bank and to
extend the terms of the proposed Settlement Agreement beyond the parties to that
agreement and to actions pending in other courts.”24 Liberty also contends the Settlement
Agreement violates provisions of the Bankruptcy Code.
Liberty argues that the settling parties are purporting to determine Liberty’s rights
against Debtor in the bankruptcy case and against Christie in the Johnson County
Proceedings. This position is based upon the Settlement Agreement provisions stating
that the settling parties are resolving all claims among the settling parties relating to
certain litigation, defined to include the Johnson County Proceedings in which Liberty
issued its garnishments against Debtor and Christie. Liberty further argues that the
Settlement Agreement wrongfully fails to account for its rights as a garnishee of Debtor
and Christie since, while the Settlement Agreement provides for the payment of cash for
the benefit of Meyer by the transfer of funds to the trust account of his counsel, the
agreement does not recognize Liberty’s interest in those funds. Liberty contends its rights
are also being impaired by the agreement of the settling parties to “offset in full the Iowa
Judgments and the Federal Judgment” and the stipulation that “the Christie Parties
acquired a valid setoff defense to the Federal Judgment at the moment the Christie Parties
24 Dkt. 217 at 1.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 14 of 31
acquired the Iowa Judgments.”25
In response to Liberty’s objection, the Debtor, Christie, and Glenn argue that
(1) Liberty’s claim against Debtor does not deserve protection because it is contingent
and (2) Liberty’s noncontingent rights are against Meyer, and these rights are not
affected by the Settlement.26 Meyer and Pratt argue that Meyer will receive no funds
from the Settlement, since the funds are subject to the lien of Bickel & Brewer and
Meyer’s assignments of his interest in the Federal Judgment, all of which have claims
against Meyer’s interest that are superior to Liberty’s claim.27 They further assert that the
Settlement does not purport to determine Liberty’s rights.
2. Approval of the Settlement Agreement must be denied if Liberty’s
interests are impaired.
The Court will examine each of Liberty’s arguments. It must do so in light of the
principle that “parties who choose to resolve litigation through settlement may not
dispose of the claims of a third party.”28 “A ‘settlement’ between only two parties to a
multi-party lawsuit is not a settlement, and the procedure to approve a compromise under
Fed. R. Bankr. P. 9019(a) cannot be used to impose an injunction on the non-settling
25 Id. at 3-4 (quoting Settlement Agreement at 5).
26 Dkt. 219 at 4-5.
27 Dkt. 220 at 9-15.
28 Local No. 93 v. City of Cleveland, 478 U.S. 501, 529 (1986).
Case 11-40764 Doc# 246 Filed 05/17/13 Page 15 of 31
3. Since the Court predicts that a Kansas appellate court would hold
that Liberty’s garnishments did not create a lien in Meyer’s interest in the
Federal Judgment, Liberty’s objections are rejected.
The ground for all of Liberty’s objections to the substance of the Settlement
Agreement is the premise that by virtue of the garnishment of Debtor and Christie,
Liberty holds liens in the consideration to be paid to Meyer for release of the Federal
Judgment. Evaluation of Liberty’s objections must therefore start with determining
whether Liberty holds such liens.
The factual basis for the liens is uncontroverted. Liberty holds judgments entered
against Meyer in Iowa for approximately $800,000, which it registered in the District
Court of Johnson County, Kansas. In May 2011, Liberty served garnishment orders on
Debtor and Christie to collect the judgments. By virtue of such garnishments, Liberty
claims an interest in any funds owed by Debtor or Christie to Meyer. The answers of
both Debtor and Christie to the garnishments assert that nothing is owed to Meyer on the
basis of setoff and because the Federal Judgment was not final when the garnishments
There are three key persons involved in a garnishment: A judgment creditor
(garnishor), in this case Liberty; the judgment debtor who owes money to the judgment
creditor, in this case Meyer; and the garnishee, who holds money owed to the judgment
29 Overton’s, Inc., v. Interstate Fire & Casualty Ins. Co. (In re Sportstuff, Inc.), 430 B.R. 170, 181
(8th Cir. BAP 2010).
Case 11-40764 Doc# 246 Filed 05/17/13 Page 16 of 31
debtor, in this case Debtor and Christie.30 As the garnishor under Kansas law, Liberty
obtained an interest in “all . . . credits and indebtedness due from the garnishee to the
judgment debtor at the time of service of the order” and those becoming due between the
time the order is served and the time the garnishee answers the garnishment order.31 In
other words, “[t]he effect of an order of garnishment is to attach those credits and
indebtedness due from the garnishee to the defendant at the time of service of the order
and those becoming due between the time of serving the order of garnishment and the
time of filing the answer of the garnishee.”32 The garnishment does not reach
indebtedness which is unmatured and contingent when the garnishee’s answer is filed.33
There are no Kansas appellate decisions addressing whether a judgment is
sufficiently final for garnishment after an appeal is decided but before the judgment is
modified and entered as directed by the appellate court. But the Kansas Supreme Court
has held that the garnishment of an insurance company to pay a personal injury judgment
is premature where the order was served while the judgment was on appeal, even though
no supersedeas bond had been posted, since the insurance policy required a final
30 See LSF Franchise REO I, LLC, v. Emporia Restaurants, Inc., 283 Kan. 13, 20, 152 P.3d 34,
31 K.S.A. 60-732 (c)(1) and (2).
32 Curiel v. Quinn, 17 Kan. App. 2d 125, 129, 832 P.2d 1206, 1209 (1992), (quoting Washburn v.
Andrew, 209 Kan. 436, 438-39, 496 P.2d 1367, 1369 (1972)). See also LSF Franchise REO, 283 Kan. at
23, 152 P.3d at 42 (“Implicit in the statute’s language is a requirement that, in order for property to be
garnished, it must first be actually owned by or owed to the judgment debtor.”).
33 Curiel v. Quinn, 17 Kan. App. 2d at 129.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 17 of 31
judgment as a condition of liability.34 The Kansas Court of Appeals has held that an order
of garnishment to reach monthly payments due under a property settlement agreement
reached those payments due between the time the garnishment was served and the date of
the answer but not those due thereafter, which were unmatured and contingent when the
answer was filed.35
Liberty served its garnishment order against Christie on May 16, 2011, and against
Debtor on May 19, 2011. Both garnishees answered on May 31, 2011, denying they
owed Meyer any money because of their right to offset and because the Federal Judgment
was not final. As of May 31, 2011, the Initial Federal Judgment had been entered,
execution of the judgment had been stayed pending appeal, and the mandate of the Tenth
Circuit affirming the judgment in part had been issued, but the amended Federal
Judgment was not entered by the District Court until June 15, 2011.
The Court finds that the answers of Debtor and Christie asserting the non-finality
of the Federal Judgment state a valid defense to the garnishments. For purposes of the
Kansas garnishment statutes, as of the date of the initiation of the garnishment
proceedings and the date of the answers, there was no debt owed to Meyer by either
Debtor or Christie. Meyer could not have executed on the Federal Judgment. The Court
predicts that a Kansas appellate court would hold that for purposes of garnishment, as of
May 16, 19, and 31, 2011, the Federal Judgment debt was unmatured and not subject to
34 Lechleitner v. Cummings, 160 Kan. 453, 457-60, 163 P.2d 423 (1945).
35 Curiel v. Quinn, 17 Kan. App.2d at 127-29, 832 P.2d at 1206.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 18 of 31
garnishment36 — that on those dates the liability of Debtor and Christie to Meyer did not
satisfy the Kansas statutory requirement of an “indebtedness due” or “indebtedness
The Court therefore holds that Liberty has no interest in either Debtor’s or
Christie’s obligations to Meyer under the Federal Judgment. All of Liberty’s objections
to the substance of the Settlement Agreement are predicated on its claimed garnishment
liens. Since that predicate is erroneous, the Court rejects Liberty’s objections.
4. Alternatively, if Liberty holds garnishment liens in the funds owed
to Meyer under the Federal Judgment, those liens are inferior to the liens of
Bickel & Brewer and Meyer’s assignees.
a. Analysis of priority of liens.
Alternatively, the Kansas Supreme Court could find the Federal Judgment was
sufficiently final on May 16, 19, and 31, 2011, for garnishment liens to attach to Debtor’s
and Christie’s obligations to Meyer thereunder. The Tenth Circuit had entered its
mandate on April 25, 2011, so there was no doubt that liability would exist. The question
would then become whether those garnishment liens would have priority over Bickel &
Brewer’s attorney lien or the interests of Meyer’s assignees.
36 There is no evidence in the record that Liberty requested or obtained an order in the
garnishment proceedings to protect its priority by imposing a stay until execution on the Federal
Judgment was no longer stayed. See Shawn v. 1776 Corp., 787 P.2d 183 (Colo. App. 1989) (Holding
under Colorado law, garnishment court did not err in ordering stay of garnishment proceedings which
were initiated while garnishee’s judgment rights were subject to stay of execution. Order relieved
garnishor from having to constantly monitor outcome of garnishee’s appeal to determine proper time to
re-institute garnishment proceedings and preserved garnishor’s priority.).
37 See K.S.A. 60-732 (c)(1) and (2).
Case 11-40764 Doc# 246 Filed 05/17/13 Page 19 of 31
Bickel & Brewer’s attorney lien is governed by Texas law. Under Texas law, an
attorney lien created by a contingent fee agreement does not attach until the contingency
is satisfied.38 “Once the contingency occurs, the attorney has a lien on the judgment or
settlement securing his services, and ‘an attorney’s lien is paramount to the rights of the
parties in the suit, and is superior to other liens on the money or property involved,
subsequent in point of time.’”39 But it is unclear under Texas law when the contingency
occurs.40 At a minimum “the contingency cannot occur before the judgment is affirmed
on appeal or when the time for filing an appeal has lapsed.”41
Meyer and Pratt contend that the contingency was removed on April 25, 2011,
when the mandate was issued by the Tenth Circuit. For purposes of determining the
priority of liens, assuming that Liberty’s garnishment liens attached in May 2011, the
Court agrees. If the entry of the mandate rendered the debts owed to Meyer sufficiently
mature to support garnishments under Kansas law, the Court finds it only reasonable that
the Federal Judgment was sufficiently final for the attachment of the attorney lien. Since
the entry of the mandate on April 25, 2011, predates the garnishments, Liberty’s liens
would be inferior to that of Bickel & Brewer.
The other competing interests in the Federal Judgment arise from Payment
38 Marré v. United States, 117 F.3d 297, 308 (5th Cir. 1997) (citing In re Willis,143 B.R. 428, 431
(Bankr. E.D. Tex. 1992)).
39 Id. (quoting Willis, 143 B.R. at 432).
40 Marré v. United States, 117 F.3d at 308, n. 19.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 20 of 31
Assignments granted by Meyer to certain third-party creditors in June 2010 in the
aggregate amount of $723,508.712. In response to Liberty’s objection to the Settlement
Agreement,42 Meyer and Pratt argue that the validity and priority of the Payment
Assignments are controlled by Iowa law, that under Iowa law an assignment of a right in
the thing assigned is absolute and entitled to priority as of the date of the assignment, and
that Iowa law permits the assignment of rights in a judgment that may be recovered in a
pending action or a future judgment.43 Under this analysis, the Payment Assignments
granted interests in the Federal Judgment that are superior to any interest of Liberty.
Liberty has not contested this analysis.44 For purposes of determining the priority of liens
assuming that Liberty’s garnishments were effective, the Court will regard the Payment
Assignments as granting interests in the Federal Judgment as of June 2010, before the
attachment of the lien of Liberty, if any, and the lien of Bickel & Brewer.
To summarize, the Court rules that if Liberty holds garnishment liens in funds
payable to Meyer under the Federal Judgment, its liens are inferior to the interests of the
Payment Assignments and the attorney lien of Bickel & Brewer.
b. Analysis of Liberty’s objections, as the holder of third-priority liens
in Debtor’s obligations under the Federal Judgment.
42 Dkt. 220 at 13-14.
43 Dkt. 220 at 13-14.
44 The Christie Parties also do not challenge this analysis in their documents addressing the
Settlement Agreement. However, it should be noted that in a proposed amended complaint attached to a
pending motion for leave to amend the Adversary Complaint (Adv. No. 11-7043, dkt. 106-1 at 10), the
Christie Parties do allege that at least some of the Payment Assignments should be set aside. Presumably,
if the Settlement Agreement is not approved, these allegations will be pursued.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 21 of 31
(i). Liberty does not have a superior interest in the funds being
paid to the Bickel & Brewer trust account under the Settlement
The Court first considers whether the Settlement Agreement deprives Liberty of
funds being paid for the benefit of Meyer to which it is entitled as the garnishor of Debtor
or Christie. At the request of the Court, Liberty filed a supplemental brief45 addressing its
claimed right in the settlement funds, the $1.825 million being paid to Bickel & Brewer’s
trust account. It argues that because under the Settlement Agreement the Federal
Judgment is satisfied by offset, the funds being paid are not in satisfaction of the Federal
Judgment, but are payments under the Settlement Agreement, to which it has first priority
rights. As to the lien of Meyer and Pratt’s counsel, Liberty’s priority is alleged to arise
because counsel’s right to payment under the Settlement Agreement is contingent until it
is approved by the Bankruptcy Court, and under Texas law, which applies to the attorney
lien claim, the lien does not attach until the contingency is removed. As to the holders of
the Payment Assignments, who will also receive a portion of the payment, priority is
alleged because the assignments are only of Meyer’s interest in the Federal Judgment,
which does not include the funds being paid under the Settlement Agreement.
The Court rejects these arguments. The funds being paid under the Settlement
Agreement are a portion of the consideration for compromise of the Federal Judgment.
The “offset in full” language means the Iowa Judgments are fully satisfied by offset. The
45 Dkt. 233.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 22 of 31
consideration for the compromise of the Federal Judgment is that offset, plus the other
consideration stated, including the $1.825 million payment. Meyer and Pratt’s
supplemental brief states, “the Settlement Agreement itself unambiguously and expressly
establishes that the settling parties’ intent is to provide remuneration to Meyer and Pratt
because of, and in order to compromise the Christie Parties’ liability on, the Judgment.”46
Liberty’s argument rests exclusively upon an erroneous construction of the Settlement
Agreement. The Court therefore finds that Liberty has no interest in the settlement funds
under the theory presented.
Although Liberty in its supplemental brief did not address the question whether it
has a superior interest in the settlement funds assuming they are consideration for
satisfaction of the Federal Judgment, the Court will address this question. Assuming
Liberty’s garnishments of Debtor and Christie were valid, Liberty would have an interest
in payments made by either of these parties in satisfaction of the Federal Judgment. The
payments under the Settlement Agreement are comprised of approximately $884,000
from the proceeds of the sale of the Bluffs and $941,000 contributed by Christie. Those
funds are to be distributed as follows: approximately $1 million to Bickel & Brewer,
$411,000 in partial satisfaction of the Payment Assignments, and approximately $411,000
The Court finds that Liberty, assuming valid garnishments, nevertheless does not
46 Dkt. 237 at 13.
47 Dkt. 237 at 5 (as to distribution of funds).
Case 11-40764 Doc# 246 Filed 05/17/13 Page 23 of 31
have a claim to these funds that is sufficient to deny approval of the Settlement
Agreement. First, neither Debtor nor Christie have any interest in the interpleaded funds
which the Bluff’s bankruptcy judge had ordered should be distributed to Meyer and
Pratt.48 The Debtor’s and Christie’s only claim to the interpleaded funds arises from the
Dickinson County garnishments in aid of collection of the Iowa Judgments. But, since
Debtor and Christie have agreed in the Settlement Agreement that the Iowa Judgments are
offset in full against the Federal Judgment, those garnishments are of no force and effect.
As to the funds provided by Christie (approximately $941,000) for payment on the
Federal Judgment, Liberty’s garnishment of Christie’s indebtedness to Meyer attached.
But it was third in priority, after the attorney lien and the Payment Assignments. The
settling parties (including Meyer) have agreed that Meyer is not entitled to any of the
funds, since there is nothing left for him after the payment of the attorney lien and partial
payment of the Payment Assignments. As discussed above, the Court finds that the
negotiated values assigned to the interests that are superior to Liberty’s interest are just
and reasonable. They consume all of the funds which would otherwise be paid to Meyer.
Liberty’s interest in Christie’s payment of his liability to Meyer under the Federal
Judgment has no value and is therefore not impaired by the settlement.
(ii). The Settlement Agreement does not improperly impact
Liberty’s rights in the Johnson County Proceedings.
48 See In re The Bluffs, LLC, Case no. 09-11978, Dkt. 648 at 2-4; see also Adv. no. 12-7016, Dkt.
1 at 3-4.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 24 of 31
The Court next considers whether the Settlement Agreement improperly impacts
Liberty’s rights in the Johnson County Proceedings. The Settlement Agreement purports
to release all parties to the agreement — Debtor, Christie, Glenn, Meyer, and Pratt —
from liability, to resolve all issues for all time, and to enjoin any attempt by any party in
the Johnson County litigation “to collect from any of the other parties therein any
obligation arising from or related to the subject matter of” the Johnson County litigation.49
The Settlement Agreement injunction does not apply to Liberty, since it is not a
party to the agreement. Liberty asserts that the Johnson County District Court entered
orders against Christie which have not been satisfied.50 Future consideration of these
orders by the Johnson County District Court is not enjoined as part of the settlement.
Likewise, Liberty’s rights to enforce its judgments against Meyer are not enjoined.
But the Settlement Agreement does resolve all liability of Debtor and Christie to
Meyer, and therefore, Liberty as garnishor of Debtor and Christie will be unable to
recover its judgments against Meyer from Debtor and Christie as garnishees. Liberty
understandably objects that its rights are determined by an agreement to which it is not a
party. But Liberty has provided no authority that parties may not resolve their respective
obligations by agreement even though that resolution may impact a garnishor.
Contrary to Liberty’s objection, the nature of garnishment dictates that a
garnishor’s rights may be altered. Liberty as garnishor stepped into the shoes of its debtor
49 Dkt. 212-1 at 5.
50 Dkt. 217 at 8-10.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 25 of 31
(Meyer), taking only what he could enforce.51 Liberty obtained no right to interfere with
the relationship between the defendant (Meyer) and the garnishees (Debtor and Christie).
“Proceedings in garnishment do not change the legal
relations and rights existing between the defendant and the
garnishee, nor place the plaintiff in a more favorable position
for the enforcement of a claim against the garnishee than
would be the defendant in an action brought by him for the
same cause; nor can any one be held in such proceedings to
the payment of a liability which the defendant could not
himself enforce because of existing equities and set-offs.”52
Liberty’s objection that the Settlement Agreement impermissibly alters its rights in the
Johnson County Proceedings is rejected.
(iii). The stipulation in the Settlement Agreement that all the
Iowa Judgments have been offset against the Federal Judgment
does not improperly impact Liberty’s interests.
Next, the Court considers whether the portion of the Settlement Agreement
stipulating that all the Iowa Judgments have been fully offset against the Federal
Judgment improperly impacts Liberty’s interests. When arguing that it does, Liberty
contends that its garnishment of Christie was effective before the Christie Parties’
acquisition of at least of one of the Iowa Judgments, so that “the total of the amounts of
the Iowa Judgments against Meyer that had been assigned to the Christie Parties was less
51 LSF Franchise, 283 Kan. at 21-22, 152 P.3d at 41-42.
52 Harpster v. Reynolds, 215 Kan. 327, 330, 524 P.2d 212 (1974) (quoting Kansas Investment Co.
v. Jones, 2 Kan. App. 638, syl. ¶ 1, 42 P. 935 (1895)); see also Curiel v. Quinn, 17 Kan. App.2d at 129,
832 P.2d at 1209 (quoting Harpster’s quotation of Kansas Investment Co. v. Jones syl. ¶ 1).
Case 11-40764 Doc# 246 Filed 05/17/13 Page 26 of 31
than the amount of the Federal Judgment owed by the Christie Parties to Meyer.”53 The
last assignment of the Iowa Judgments occurred on May 18, 2011.54 Liberty’s
garnishments were served on May 16 and 19, 2011, and the answers were filed on May
31, 2011, after the assignment of the final Iowa Judgment. Liberty is claiming that
because of the garnishment, its rights to the funds owed on the Federal Judgment cannot
be offset against the last of the assigned Iowa Judgments. No supporting authority is
The Court again rejects Liberty’s argument as conflicting with general principles
of garnishment. As noted above, Liberty as garnishor obtained no right to interfere with
the relationship between the defendant (Meyer) and the garnishees (Debtor and Christie).
They agreed to the offset in full. Further, the statutory recognition of the offset defense55
does not limit the claims that can be offset to those which existed on the date of service of
the garnishment, or even the date of the answer. The last Iowa assignment occurred
before the answer date. The Settlement Agreement’s consideration of all of the assigned
Iowa Judgments as available for offset is therefore consistent with the defense that Debtor
and Christie could assert in Liberty’s garnishment proceedings.
c. Approval of the Settlement Agreement will not be withheld because
it allegedly violates portions of the Bankruptcy Code.
53 Dkt. 233 at 11.
54 See Dkt. 220 at 7.
55 K.S.A. 60-719.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 27 of 31
Liberty also contends that the Settlement Agreement should not be approved
because Debtor has breached its statutory obligations under the Bankruptcy Code in three
respects: it has failed to provide adequate protection under § 363 in conjunction with the
sale of assets outside the ordinary course; it has submitted a de facto plan of
reorganization without following the procedures under § 1129; and it has violated its
statutory duty to act for the benefit of the estate by agreeing to a settlement for the benefit
of the individual interests of Christie. The Court rejects these arguments under the unique
circumstances of this case.
When arguing that it is entitled to adequate protection under § 363(e), Liberty fails
to identify the property interest of the estate which is purportedly being used, sold, or
leased by Debtor. Assuming that Liberty’s attempted garnishment of Debtor was
effective, the interest in which Liberty acquired an interest was Debtor’s obligation to
Meyer under the Federal Judgment. That obligation constitutes a claim against the estate
by Meyer, not an estate property interest subject to use, sale, or lease under § 363(e). The
adequate protection provisions of § 363 are not applicable. If one considers the lien as
attaching to the consideration paid to Meyer on the Federal Judgment, adequate
protection still is not required. As discussed above, the consideration provided by Debtor
was offset of the Iowa Judgments. When viewed as property of the estate, the Iowa
Judgments had no value because they could not be collected from Meyer or Pratt. The
cash payment from the sale of the Bluffs and the funds contributed by Christie are not
property of the estate.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 28 of 31
The Court finds that the Settlement Agreement is not a de facto plan of
reorganization for which approval is sought without fulfilling the applicable procedural
protections and adhering to the absolute priority rule. The Settlement Agreement resolves
the adversary proceeding and thereby satisfies the claims of Meyer and Pratt against the
estate. But except for the offset of the Iowa Judgments, no distribution of estate property
is involved. The estate property applied to the claims of Meyer and Pratt would have no
value to the creditors of the estate who are not parties to the Settlement Agreement. The
competing claims at issue are those asserting interests in the proceeds of Meyer’s rights in
the Federal Judgment, not claims that are against the estate.
Finally, the Court finds that Debtor has not violated its debtor-in-possession
obligations. Liberty argues that Debtor has abandoned its role as a fiduciary to represent
the individual interests of Christie by absolving him of the consequences of allegedly
contemptuous actions in the Johnson County garnishment proceedings. But as previously
discussed, the injunction included in the Settlement Agreement cannot be construed to
preclude Liberty from seeking relief in the Johnson County Proceedings for the alleged
The Court approves the Settlement Agreement as fair and equitable, subject to the
1. That Meyer and Pratt file a satisfaction of the Federal Judgment in the Federal
Case 11-40764 Doc# 246 Filed 05/17/13 Page 29 of 31
Litigation which expressly provides that Supersedeas Bond No. 907136756 (Bond) issued
by Washington is discharged and exonerated;
2. That the Christie Parties file a pleading releasing the garnishments that have
been issued against Washington in the Jackson County, Missouri, Circuit Court Case no.
1116-CV-13164 (11-EXEC-6844 and 11-EXEC-7710);
3. That the Christie Parties and Meyer and Pratt release any claims they may have
against Washington or to the proceeds of the Bond;
4. That Debtor file an amended Schedule B omitting the Bond as personal
property it owns; and
5. That the Settlement Agreement shall be construed not to enjoin proceedings by
Liberty Bank in Johnson County District Court Case nos. 11-CV-3218 and 11-CV-3216
seeking to recover its judgments against Meyer, except to the extent that such proceedings
are a collateral attack upon the Settlement Agreement, which finally determines the rights
and obligations of Meyer, Christie, and Debtor with respect to the Federal Judgment, the
Iowa Judgments, and all other matters addressed therein.
The foregoing constitutes 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. Based on those findings
56 As noted earlier, in its objection, Washington gave 90713617 as the number of the Bond, but a
copy of the Bond attached to the complaint in Adv. 11-7043 shows the number is actually 9071367.
Case 11-40764 Doc# 246 Filed 05/17/13 Page 30 of 31
and conclusions, judgment is hereby entered granting the Motion of D.J. Christie, Inc., to
Approve Compromise and Settlement. As provided by Bankruptcy Rule 9021, this
judgment will become effective when entered on the docket under Bankruptcy Rule 5003.
IT IS SO ORDERED.
# # #
Case 11-40764 Doc# 246 Filed 05/17/13 Page 31 of 31
- Category: Judge Somers
- Published on 07 May 2013
- Written by Judge Somers
- Hits: 77
In Re Murphy, 12-20434 (Bankr. D. Kan. May 3, 2013) Doc. # 29
SIGNED this 2nd day of May, 2013.
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
DEBORAH LYNN MURPHY, CASE NO. 12-20434
MEMORANDUM OPINION DENYING DEBTOR'S MOTION
FOR DETERMINATION THAT CERTAIN PERSONAL PROPERTY
OWNED BY DEBTOR IS NOT SUBJECT TO ANY SECURITY INTEREST
On September 21, 2012, the Court heard arguments on Debtor's Motion for Order
Determining that Certain Personal Property Owned by the Debtor is not Subject to any
Security Interest, or, in the Alternative, Granting Debtor's Request to Redeem Property
(Motion).1 Debtor appeared by Patrick E. Henderson. Capital One, the creditor claiming
a security interest and opposing the Motion, appeared by Michael Berman. The Court
issued an oral ruling from the bench finding that the personal property in issue is subject
1 Dkt. 13.
Case 12-20434 Doc# 29-1 Filed 05/02/13 Page 1 of 8
to a security interest and stating that the Court would prepare a written order
incorporating by reference the oral findings of fact and conclusions of law. Such an order
was prepared and signed on September 24, 2012. It stated:
After hearing the statements of counsel and carefully
considered (sic) the briefs of the parties, the Court, ruling
from the bench, held that, under the terms of the Best Buy
credit card agreement and the facts of this case, the security
interest attached to the items purchased and was automatically
perfected because the items are consumer goods under Article
9 of the Uniform Commercial Code. The Court stated on the
record its Findings of Fact and Conclusions of Law, which are
incorporated herein by this reference. If the Court's oral
findings and rulings are transcribed, the Court orders that the
draft transcription be submitted to the Court for the purpose of
making technical corrections, including incorporation of
correct names, punctuation, paragraphing, quotations,
footnotes, and legal citations.2
This order was not a final order because, as stated in the order, the Court made no ruling
on Debtor’s alternative request to redeem personal property and the Motion remains
pending for determination of that issue. Proceedings for an interlocutory appeal have not
On April 8, 2013, Bankruptcy Judge Berger, sitting in Kansas City, signed a
memorandum opinion and order in In re Cunningham, case no. 12-20662, ruling under
facts indistinguishable from those before the Court in this case, that no security interest
attached to consumer goods purchased using a Best Buy credit card. There are now
conflicting decisions on this issue in the same division of the United States Bankruptcy
2 Dkt. 25.
Case 12-20434 Doc# 29-1 Filed 05/02/13 Page 2 of 8
Court for the District of Kansas. I am filing this memorandum expressly stating the
analysis and findings of fact and conclusions of law orally stated at the conclusion of
arguments, supplemented by reference to Cunningham, as I believe the bar is best served
by having the analysis that led to the oral ruling set out in a written opinion.
FINDINGS OF FACT.
On May 23, 2012, Debtor filed her motion asserting that four items of personal
property are not subject to a purchase money security interest (PMSI) as claimed by
creditor Capital One. The property is four items of electronics purchased from Best Buy
using a Best Buy credit card. Debtor claims the value of the property is $50.00, not
$1,613.30, the amount of Capital One's claim.3 According to Debtor, there is no PMSI
because the description of the collateral in the alleged security agreement is not
sufficiently specific. HSBC, the original holder of the debt, has sold its claim to Capital
One. Capital One asserts that it has an automatically perfected PMSI under the terms of
the Debtor’s agreements with Best Buy and the value is approximately $1,200.00, but if
Debtor redeems she should be required to pay the balance of Capital One's claim in the
approximate amount of $1,613.00.4
The Best Buy credit Application, signed by Debtor, provides: “You grant the Bank
a purchase money security interest in the goods purchased on your Account.” It also
provides: “you agree to the terms and conditions of the Cardholder Agreement and
3 Dkt. 13.
4 Dkt. 15.
Case 12-20434 Doc# 29-1 Filed 05/02/13 Page 3 of 8
Disclosure Statement which shall be sent to you with the Card.” That Cardholder
Agreement includes a full paragraph about security, which includes the statement, “you
grant us a purchase money security interest in the goods purchased with your Card . . ..”
Capital One has provided copies of the sales receipts for the four items, but they do not
incorporate the terms of the Application or the Cardholder Agreement. There is no
security agreement provision on the receipts.
The question is whether the security interest attached to the four items; if it
attached, perfection was automatic since the goods are consumer goods. The condition
for attachment which is in issue requires that the Debtor has authenticated a security
agreement that provides a description of the collateral.5 The sufficiency of descriptions of
collateral is addressed by K.S.A. 84-9-108 (2012 Supp.), which provides in part:
(a) Sufficiency of description. Except as otherwise provided
in subsections (c), (d), and (e), a description of personal or
real property is sufficient, whether or not it is specific, if it
reasonably identifies what is described.
(b) Examples of reasonable identification. Except as
otherwise provided in subsection (d), a description of
collateral reasonably identifies the collateral if it identifies the
(1) Specific listing;
(3) except as otherwise provided in subsection
(e), a type of collateral defined in the uniform
5 K.S.A. 84-9-203(b)(3)(A) (2012 Supp.).
Case 12-20434 Doc# 29-1 Filed 05/02/13 Page 4 of 8
(5) computational or allocational formula or
(6) except as otherwise provided in subsection
(c), any other method, if the identity of the collateral is objectively
. . .
(e) When description by type insufficient. A description only
by type of collateral defined in the uniform commercial code
is an insufficient description of:
(1) A commercial tort claim; or
(2) in a consumer transaction, consumer goods,
a security entitlement, a securities account, or a
Debtor contends that describing the collateral as “goods purchased on your Account”
does not comply with K.S.A. 84-9-108. The argument is that since the sale was a
consumer transaction, subsection (e)(2) applies and was violated because it prohibits
description by type of collateral and, in the Debtor’s view, “goods purchased” is a type of
collateral. Debtor contends that the security agreement must describe the specific goods
purchased, such as TV or VCR.
Debtor's proposed construction of K.S.A. 84-9-108(e)(2) is not correct. The
“description by type” not permitted for consumer goods is the “types” of collateral
defined in the UCC, such as accounts, chattel paper, consumer goods, deposit accounts
equipment, general intangibles, and so forth. “Goods purchased on your Account” is not
a “type of collateral defined in the uniform commercial code.” The purpose of the
collateral description in the security agreement is to define the security interest as
between the parties; unlike a financing statement, the purpose of a security agreement is
Case 12-20434 Doc# 29-1 Filed 05/02/13 Page 5 of 8
not to give notice to third parties.6 The description “goods purchased on your Account”
adequately defines the collateral between the Debtor and the holder of the account.
This case is nearly identical to In re Ziluck, 7 which held debtors consumer goods
purchased using a Radio Shack credit card were subject to security interests granted by
the Radio Shack Account and Security Agreement signed by the debtor describing the
collateral as “all merchandise charged to your Account.” The court rejected the debtor’s
argument that the description of the collateral was insufficient, finding that it “reasonably
identifies the property subject to the security interest - namely any property purchased
with the subject credit card.” Ziluck is identified as correctly decided in Barkley Clark’s
treatise on Article 9, which states, “it is always possible for the issuer [of a credit card] to
retain a security interest in items purchased with the credit card, so long as the credit card
application includes security agreement language.”8
Research conducted before the hearing revealed one case reaching a contrary
result, In re Shirel.9 In that case, the Bankruptcy Judge held that the description of
collateral as “all merchandise purchased with the credit card” in a credit card form from
an appliance center was insufficient for a security interest to attach to a refrigerator
6 Maxl Sales Co. v. Critiques, Inc., 796 F.2d 1293, 1298 (10th Cir. 1986).
7 139 B.R. 44 (S.D. Fla. 1992).
8 Barkely Clark and Barbara Clark, The Law of Secured Transactions under the Uniform
Commercial Code ¶ 12.02(A.S. Pratt 2012).
9 251 B.R. 157 (Bankr. W.D. Okla. 2000).
Case 12-20434 Doc# 29-1 Filed 05/02/13 Page 6 of 8
purchased using the card. I believe he erroneously found the purpose of the security
agreement was to give notice to third parties of the items which are subject to the security
interest. Inquiry notice to third parities is the function of a financing statement, which is
not required for a PMSI in consumer goods. When evaluating the sufficiency of the
description, the Shirel court then focused only on the phrase “all merchandise,” ignoring
the phrase “purchased with the credit card,” and found the phrase “all merchandise”
imprecise. The Ziluck case was cited in a footnote as reaching a contrary result, but it
was rejected since it was not decided under Oklahoma law or by the Tenth Circuit.
As stated above, the Cunningham decision also reaches a contrary result.
Although the facts in Cunningham are indistinguishable from those in this case and the
issue presented was identical, analysis focused upon construction of the three documents
involved in each sale transaction, rather than on the UCC requirements for description of
collateral. The Court concluded that "[a]n enforceable security agreement has never
existed between these parties as to the" consumer goods purchased from Best Buy
because “[t]he type of collateral referenced in the ‘goods purchased on your Account’
contained in the original Application is not sufficiently descriptive to allow attachment
and enforceability under K.S.A. 84-9-108(e) and K.S.A. 84-9-203(b)(3)(A).” This Court
respectfully disagrees. As discussed above, it is my conclusion that the description of the
goods in the Application and the Cardholder Agreement is sufficient under K.S.A. 84-9108(
e) and the security interest therefore attached under K.S.A. 84-9-203(b)(3)(A).
Case 12-20434 Doc# 29-1 Filed 05/02/13 Page 7 of 8
For the foregoing reasons, the Court denies the portion of Debtor’s Motion seeking
a determination that Capital One’s security interest did not attach to the consumer goods
purchased with Debtor’s Best Buy credit card. The security interest granted in the
Application attached when the goods were purchased using the Best Buy credit card and
was automatically perfected.
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.
IT IS SO ORDERED.
Case 12-20434 Doc# 29-1 Filed 05/02/13 Page 8 of 8
- Category: Judge Somers
- Published on 04 April 2013
- Written by Judge Somers
- Hits: 127
In Re Creason, 09-22647 (Bankr. D. Kan. Apr. 3, 2013) Doc. # 125
SIGNED this 2nd day of April, 2013.
Designated for on-line use but not print publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
ROGER ALLEN CREASON and CASE NO. 09-22647
PATRICIA GALE CREASON, CHAPTER 13
MEMORANDUM OPINION AND JUDGMENT
REGARDING TURNOVER OF ESTATE’S INTEREST IN
DEBTORS’ INTEREST IN GMC, LLC, AND
THE TRUSTEE’S OBJECTION TO GMC, LLC’S PROOF OF CLAIM
On September 20, 2012, the Court held an evidentiary hearing on two related
substantive matters: (1) The Chapter 13 Trustee’s objection to claim number 9 filed by
GMC, LLC (GMC);1 and (2) the Chapter 13 Trustee’s motion for turnover of the interest
of Debtors Roger Allen Creason and Patricia Gale Creason (Debtors) in GMC, comprised
1 Dkt. 28.
Case 09-22647 Doc# 125 Filed 04/02/13 Page 1 of 15
of proceeds of the liquidation of GMC.2 The Court has jurisdiction.3 Resolution of both
matters turns upon two matters: (1) the amount of GMC’s claim against Debtors as
guarantors of the obligations of Johnson County Drywall Supply, Inc. (Drywall), to
GMC; and (2) Debtors’ claim, as holders of one-third of the GMC membership interests,
in the proceeds of the liquidation of GMC’s assets. Having carefully considered the
evidence, the exhibits, the arguments and briefs of counsel, the Court holds that Debtors’
interest in GMC is $189,681.00, that GMC has a claim for $151,679.61 secured by
Debtors’ membership interest, and that the Trustee is entitled to turnover of $38,001.39,
the difference between the value of Debtors’ interest and Debtors’ liability.
FINDINGS OF FACT.
Debtors Roger and Patricia Creason are the sole owners of the stock of Drywall.
Drywall conducted its business on real property owned by GMC. Debtors also are the
owners of an undivided 1/3 interest in GMC.4 Two other individuals, Frank A. Glorioso
and William L. Morris, are also holders of undivided 1/3 interests in GMC. Until
2 Dkt. 57.
3 This Court has jurisdiction pursuant to 28 U.S.C. §§ 157(a) and 1334(a) and (b), and the
Standing Order 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 July
10, 1984. An objection to a proof of claim and a motion for turnover are core proceedings which this
Court may hear and determine as provided in 28 U.S.C. § 157(b)(2). There is no objection to venue or
jurisdiction over the parties.
4 Debtors’ interest in GMC is titled in the name of the Roger A. Creason and Patricia A. Creason
Revocable Trust. The distinction between Debtors and their trust is not material to the issues before the
Court and will be ignored.
Case 09-22647 Doc# 125 Filed 04/02/13 Page 2 of 15
December 2007, Glorioso and Morris were also owners of Drywall stock, although they
had retired in approximately 2002.
On March 31, 2006, Drywall entered into a written lease with GMC. On
December 27, 2007, in conjunction with Glorioso and Morris’s entering into an
agreement for redemption of their Drywall stock, Drywall and GMC entered into an
amendment extending the lease for an additional thirty-three months. On the same date,
Debtors entered into a guaranty in favor of GMC, Glorioso, and Morris, personally
guarantying Drywall’s obligations to GMC under the lease as amended. Debtors agreed
to secure their personal guaranty by a pledge of their interest in GMC, and executed a
security agreement and a pledge agreement to accomplish this result. Also on that date,
Roger Creason, Gloriso, and Morris executed an amendment to the GMC operating
agreement providing that the rental income paid to GMC by Drywall would be distributed
on an equal basis to Glorioso and Morris for 48 months from January 1, 2008, and that
Roger Creason would not be entitled to receive any portion of such rental income.
On August 17, 2009, Debtors filed for protection under Chapter 13, and Drywall
filed for protection under Chapter 7. Drywall closed its business. Steve Rebein, the
Chapter 7 Trustee of Drywall, sold all of Drywall’s assets and vacated the leased
premises. The lease with GMC was rejected.
W.H. Griffin (Trustee) was appointed Chapter 13 Trustee in this bankruptcy.
Debtors’ Schedule B lists a 1/3 interest in GMC, estimated to have a value of $225,000.
On December 8, 2009, GMC filed a proof of claim for $66,600.75, which was amended
Case 09-22647 Doc# 125 Filed 04/02/13 Page 3 of 15
on April 30, 2012, to a secured claim of $221,600 for “breach of lease/guarantee.” On
January 26, 2010, the Trustee objected to GMC's proof of claim, stating it should not be
allowed because it “will be paid upon liquidation of Debtor’s interest in GMC, LLC.”5
On March 31, 2011, GMC sold its last asset, the premises leased to Drywall, for net
proceeds of $569,045.19. On April 5, 2011, the Trustee filed the motion for turnover of
Debtors’ interest in the sale proceeds.
Trial on the motion for turnover was combined with trial on the objection to
GMC’s proof of claim. At trial, GMC contended that Debtors’ debt to GMC based upon
their guaranty of the debts of Drywall and their share of GMC’s expenses exceeded their
interest in the sale proceeds, so that the Trustee’s motion should be denied. The Trustee
and Debtors contend that Debtors are owed $65,935 by GMC. Debtors claim their
interest in GMC’s assets exceeds their liability to GMC based upon: (1) a challenge to
some of the elements of GMC’s claim against them; and (2) a proposed construction of
the rent allocation provision in the amended operating agreement that would make it not
applicable to Debtors’ liability under the guaranty.
GMC is being liquidated, and its only remaining asset is the net proceeds from the
sale of its real property. There is no dispute that Debtors, as the owners of a one-third
5 Dkt. 28.
Case 09-22647 Doc# 125 Filed 04/02/13 Page 4 of 15
interest in GMC, are entitled to $$189,681.00, which is one-third of $569,045.19,6 the net
proceeds from the sale of GMC’s real property. The controversy is about the amounts
which should be offset from Debtors’ share for two general categories of claims:
(1) Debtors’ liability to GMC as guarantors of Drywall’s lease obligations; and
(2) Debtors’ liability for expenses of GMC.
A. Debtors’ Liability as Guarantors of Drywall’s Obligations under the GMC
1. Debtors Personally Guarantied Drywall’s Lease Payments.
The guaranty unconditionally obligates Debtors to pay all amounts owing to GMC
under the lease between GMC and Drywall. When Drywall filed for bankruptcy relief, it
rejected the lease with GMC, the lease was terminated, and GMC as lessor became
entitled to damages. Debtors do not contest their liability for GMC’s damage claim, but
they do challenge the amount of that liability.
2. Drywall’s Liability to GMC Is Determined by State Law, Subject to the
Cap of 11 U.S.C. § 502(b)(6).
As stated above, Drywall, the lessee of GMC’s property, filed for relief under
Chapter 7. The lease was not assumed and was terminated. GMC asserts it was damaged
by Drywall’s termination of the lease. Under 11 U.S.C. § 502(b)(6), a lessor’s damage
claim is subject to a cap — it is disallowed to the extent that —
6 The Court is aware that 569,045.19 divided by 3 is actually 189,681.73, but the parties have not
concerned themselves with the extra 73 cents, and the Court will follow their lead.
Case 09-22647 Doc# 125 Filed 04/02/13 Page 5 of 15
(6) if such claim is the claim of a lessor for damages resulting
from the termination of a lease of real property, such claim
(A) the rent reserved by such lease, without
acceleration, for the greater of one year, or 15 percent,
not to exceed three years, of the remaining term of
such lease, following the earlier of —
(i) the date of the filing of the petition; and
(ii) the date on which such lessor repossessed,
or the lessee surrendered, the leased property; plus
(B) any unpaid rent due under such lease, without
acceleration, on the earlier of such dates.
“In determining the landlord’s claim for rejection of a lease, the court should first
calculate the amount of the claim under applicable state law without application of any
bankruptcy limitation and then apply the cap under Code § 502(b)(6).”7
The Tenth Circuit has not addressed the meaning of “rent reserved by such lease”
under § 502(b)(6)(A), which defines the amount of the cap that is applicable in this case.
A leading test for determining the rent reserved was formulated by the Bankruptcy
Appellate Panel for the Ninth Circuit in McSheridan. 8 After thoroughly reviewing the
case law, the McSheridan court adopted the following three-part test for finding that a
charge constitutes “rent reserved,” which this Court finds to have been well reasoned.
1) The charge must: (a) be designated as “rent” or
“additional rent” in the lease; or (b) be provided as the
tenant’s/lessee’s obligation in the lease;
7 3 William L. Norton, Jr., and William L. Norton III, Norton Bankruptcy Law & Practice 3d,
§ 48:36 at p. 48-94 (Thomson Reuters/West 2012).
8 Kuske v. McSheridan (In re McSheridan), 184 B.R. 91 (9th Cir. BAP 1995), overruled in part on
other grounds Saddleback Valley Cmty. Church v. El Toro Materials Co. (In re El Toro Materials Co.),
504 F.3d 978, 981-82 (9th Cir. 2007).
Case 09-22647 Doc# 125 Filed 04/02/13 Page 6 of 15
2) The charge must be related to the value of the
property or the lease thereon; and
3) [T]he charge must be properly classifiable as rent
because it is a fixed, regular or periodic charge.9
One of the cases cited was Rose’s Stores, 10 a decision of the Bankruptcy Court for the
Eastern District of North Carolina which had adopted a two-part test. That test requires
that “the charge must be provided for in the lease as the tenant’s obligation, though it
need not be denominated as rent,” and “the charge must be related to ‘the value of the
property and the value of the lease thereon.’”11 Under this test, charges “generally related
to the tenant’s use of the premises rather than to the value of the property or the leasehold
estate,” such as general maintenance and utilities, “should not be included in the
§ 502(b)(6) calculation.”12
Under § 502(b)(6), all of the damages claimed to have resulted from the
termination of the lease are subject to the cap, and claims for such damages in excess of
the cap are not allowed. However, a claim for rent due prepetition not resulting from the
termination is not subject to the cap.13 When presenting its damage claim in GMC exhibit
402, GMC states that its claim for expenses related to the breach of the lease are “Limited
to One Year Period Following Bankruptcy Filing.” GMC has thereby correctly
9 Id. at 99-100.
10 In re Rose’s Stores, Inc., 179 B.R. 789 (Bankr. E.D.N.C. 1995).
11 Id. at 791 (quoting In re Heck’s Inc., 123 B.R. 544, 546 (Bankr. S.D. W.Va. 1992)).
12 179 B.R. at 791.
13 11 U.S.C. § 502(b)(6)(B).
Case 09-22647 Doc# 125 Filed 04/02/13 Page 7 of 15
acknowledged the applicability of the cap to Debtors’ liability as the guarantors of
Drywall’s lease obligations.14
At trial, GMC claimed that $196,949.4115 is owed as damages by Debtors for
termination of the lease. GMC’s claim is comprised of the following elements:
Lease payments for one year - Sept. 2009 to August 2010 $100,000.00
Real estate taxes (for 2008 through August 2010) 52,740.16
Legal and accounting 8,740.22
Building management 20,146.50
Debtors do not challenge the first four elements of these amounts claimed under state law.
Although they do challenge the last three elements, for the reasons explained below, the
Court need not determine if these amounts are owed under state law. The Court will
therefore apply the § 502(b)(6)(A) cap to the total damages GMC claims, $196,949.41.
The Court next determines the amount of “rent reserved” for purposes of the
§ 502(b)(6)(A) cap.16 The lease between Drywall and GMC obligates Drywall to pay a
base “rent” plus “additional rent,” defined to be “all charges required to be paid by Tenant
14 See In re Episode USA, Inc., 202 B.R. 691, 695-96 (Bankr. S.D.N.Y. 1996) (holding
§ 502(b)(6) applies to debtor-guarantors).
15 In its exhibit 402 admitted at trial, GMC claimed termination damages of $201,449.41, which
included total taxes of $57,240.16. In its post-trial brief, dkt. 113 at 4, GMC acknowledged that it made
an error in the amount of taxes by transposing two numbers and the correct amount of taxes is
$52,740.16, which makes the total claim $196,949.41.
16 In this case, all of the elements of the damage claim are amounts owed under the lease, so the
determination of the cap requires examination of the elements of the damage claim. In other
circumstances, the damages for termination could be measured in a different manner, such as profits lost
when, after the termination, the premises were leased to a third party.
Case 09-22647 Doc# 125 Filed 04/02/13 Page 8 of 15
under this Lease.”17 The additional charges which were the responsibility of Drywall
under the lease included utilities, taxes, maintenance and repair costs, insurance costs, and
legal costs, including attorney fees. Thus, all of the elements claimed by GMC satisfy the
first part of the McSheridan test. But only some of the elements satisfy the second part of
the test that they be related to the value of the real property or the lease. The elements of
monthly rent, taxes, and insurance satisfy this requirement, but the claims for utilities,
maintenance/mowing/repair, and building management relate to Drywall’s occupancy of
the premises, not to the value of the lease. In addition, the utilities,
maintenance/mowing/repair, and building management elements, as well as the charge for
legal and accounting expenses, do not satisfy the third part of the test because they are not
fixed, regular, or periodic payments due the landlord. GMC claims interest on past-due
payments, but interest, although provided for by the lease, is not the type of expense
included in the McSheridan test. Therefore, the Court concludes that only the claims for
one year of rent, taxes, and insurance are included in the cap on termination damages
imposed by § 502(b)(6)(A).
There is no dispute that the rent included in the cap is $100,000, the rent for one
year following termination of the lease. There is also no dispute that $5,995.75 is the
correct amount for insurance. Although the parties agree that the total taxes for the period
2008 through August 2010 are $52,740.16,18 a portion of this amount must be excluded
17 Exh. 403.
18 Dkt. 113 at 4; dkt. 111 at 4.
Case 09-22647 Doc# 125 Filed 04/02/13 Page 9 of 15
from the cap since it is for periods outside of the one-year period between September
2009 and August 2010. Only those taxes owed by Drywall during the year immediately
following termination may be included in the cap. They are the taxes owed by Drywall
on December 20, 2009, for the first half of the 2010 taxes ($12,410.81)19 and a pro rata
share of the second half of the 2010 taxes, stated to be $4,136.94,20 for a total of
$16,547.75. To the extent that the taxes Drywall owed to GMC under the lease include
taxes due before Drywall filed for bankruptcy relief,21 they are a prepetition claim not
subject to the § 502(b)(6)(A) cap.
To summarize, GMC claims $196,949.41 for expenses related to termination of the
lease. Under § 502(b)(6)(A), the amount of these damages is capped at the amounts due
during one year following the termination for base rent ($100,000), taxes ($16,547.75),
and insurance premiums ($5.995.75). The remaining elements of the damage claim are
disallowed because of the cap,22 with the exception of the taxes which were due
19 Exh. 402.
21 The testimony at trial was that the second half of the 2008 taxes was past due when Drywall
filed for relief (Tr. 83, l. 20 to 84, l. 4), yet the damage calculation as shown as exhibit 402 includes taxes
for all of 2008 and both halves of 2009. It is impossible for the Court to determine from the record the
correct allocation of the total taxes claimed to the categories of those due prepetition, those due within
one year of termination of the lease, and those due thereafter.
22 In a post-trial brief, Debtors and the Trustee assert that the following adjustments should be
made to GMC’s claim: a $4,500 reduction in taxes because of a transposition of numbers; a $7,611.42
reduction in attorney fees which were not itemized; $3,273.66 for maintenance/mowing/repairs; and
$20,146.50 for building management. Since the Court finds that none of the elements, except the taxes,
can be recovered because of the cap, the Court does not rule on these objections. In its post-trial brief,
dkt. 113 at 4, GMC acknowledged that it made an error in the amount of taxes claimed by transposing
two numbers, and the correct amount is $52,740.16.
Case 09-22647 Doc# 125 Filed 04/02/13 Page 10 of 15
prepetition. The excluded elements total $38,213.50, so the total recovery under Debtors’
guaranty of Drywall’s prepetition obligations under the lease and for damages for
termination is $158,735.91. During the Drywall bankruptcy, the Chapter 7 Trustee paid
GMC $10,000 rent for the time the leased premises were occupied. GMC proposes that
Debtors be given credit for this payment,23 thereby reducing their obligation to
B. The Claim for Expenses of GMC.
In addition to Debtors’ liability as guarantors of Drywall’s lease obligations, GMC
also claims Debtors are liable, as one-third owners of GMC, for certain expenses of
GMC. The expenses total $8,831.11, for such matters as insurance, appraisals, surveying,
and building maintenance not attributable to termination of the lease. Debtors did not
challenge this portion of GMC’s claim.24 Debtors’ obligation for one-third of the
expenses is $2,943.70, an amount which should be offset from the value of their interest.
C. Calculation of the Proper Division of Assets.
The primary dispute in calculating the division of assets is whether the lease
termination damages (comprised primarily of rent for one year) is an asset of GMC to be
allocated equally to each of the three co-owners, or whether that asset should be allocated
23 Exh. 401-A.
24 Debtors and the Trustee in their post-trial brief (dkt. 111) contend most of these expenses
should be disallowed as not covered by the guaranty. The Court agrees that they are not within the
guarantied liabilities of Drywall. But because GMC is not claiming these expenses under the guaranty,
this does not provide a defense.
Case 09-22647 Doc# 125 Filed 04/02/13 Page 11 of 15
only to Glorioso and Morris under the terms of the amended operating agreement. As
stated above, the amendment to the operating agreement states that for the period of 48
months from January 1, 2008, “rental income paid to the Company [GMC] by Johnson
County Drywall” shall be divided equally between Glorioso and Morris, and Roger
Creason “shall not be entitled to receive a portion of such rental income” during that
Roger Creason admits he signed the amendment to the operating agreement, but he
and the Trustee contend that the amounts owed under Debtors’ guaranty of Drywall’s
obligation to GMC are not rental income for purposes of the amendment. They argue that
the amendment applies only to rents paid by Drywall to GMC and that payments made by
a third party, such as Debtors, for termination damages are not covered. Reliance is
placed upon the principle of Kansas law that contracts are “enforced according to their
plain, general, and common meaning in order to insure the intentions of the parties are
enforced.”25 They contend that because the amendment is complete and unambiguous,
the Court must determine the intent of the parties from “the four corners” of the
amendment, “without regard to extrinsic or parole evidence.”26
25 Dkt. 111 at 3-4 (quoting Bunnell Farms Co. v. Samuel Gary, Jr. & Assocs., 30 Kan. App. 2d
739, 741-42, 47 P.3d 804, 806 (2002), which was quoting Hall v. JFW, Inc., 20 Kan. App. 2d 845, 848,
893 P.2d 837 (1995)).
26 Id. at 4 (quoting Bettis v. Hall, 852 F. Supp. 2d 1325, 1334 (D. Kan. 2012), which was quoting
Kay–Cee Enter., Inc. v. Amoco Oil Co., 45 F. Supp. 2d 840, 843 (D. Kan. 1999)).
Case 09-22647 Doc# 125 Filed 04/02/13 Page 12 of 15
GMC responds that Debtors’ argument fails for two reasons. First, there is no
language in the amendment stating that payment only from Drywall is to be divided
between Morris and Glorioso. Second, it argues that adopting Debtors’ interpretation
would reward them for the breach of Drywall’s obligation to pay rent. It points out that
the amendment and the guaranty were executed in conjunction with the agreement for
redemption of Glorioso’s and Morris’s stock in Drywall (resulting in Debtors becoming
the sole owners of Drywall) and the grant to Drywall of an option to purchase the real
property leased by GMC. According to GMC, Debtors’ giving up their claim to one-third
of the rent for 48 months was part of the consideration for these benefits. GMC presented
evidence that the allocation of rent solely to Glorioso and Morris was suggested in a draft
redemption agreement presented by Debtors, which included the proposal that “[m]onthly
rent shall remain the same, but it shall be distributed by GMC, LLC to only Glorioso and
Morris.”27 Reviewers of the proposal suggested that this allocation be removed from the
agreement so it would not be construed as additional consideration for the stock, which
would make it subject to income taxation.28
The Court finds GMC’s arguments more persuasive. Debtors’ obligations under
the guaranty are in satisfaction of Drywall’s liability for termination of the lease. The
amount owed is calculated by reference to the rent owed under the lease. The
circumstances of the amendment to the operating agreement evidence that Glorioso and
27 Exh. 415 at 4.
28 Id at 1.
Case 09-22647 Doc# 125 Filed 04/02/13 Page 13 of 15
Morris, but not Debtors, were to benefit from the value of the lease. The allocation stated
in the amendment to the operating agreement is applicable to “rental income”; the phrase
“paid to the Company by Johnson County Drywall Supply” defines the applicable lease,
but does not serve to limit the rental income so allocated to that paid directly by Drywall,
as opposed to on Drywall’s behalf.
D. Calculation of the Estate’s Interest in GMC’s Assets.
GMC’s claim against Debtors as guarantors is secured by Debtors’ GMC
membership interest. It is therefore appropriate to offset the amount owed to GMC by
Debtors against Debtors’ share of the liquidation assets, which are the net proceeds from
the sale of GMC’s real property. Likewise, GMC’s claim for expenses is an obligation of
Debtors as holders of an interest in GMC, and is properly offset against the net proceeds
from the sale of GMC’s real property.
The Court therefore holds that the estate’s interest is calculated as follows:
One-third interest in net proceeds from sale $189,681.00
Less obligations under guaranty ($148,735.91)
Less one-third of GMC’s expenses (2,943.70)
Total owed to Debtors from sale proceeds $38,001.39.
For the forgoing reasons, the Court holds that GMC has a claim against Debtors
for $151,679.61, secured by Debtors’ one-third interest in GMC, which has a value of
Case 09-22647 Doc# 125 Filed 04/02/13 Page 14 of 15
$189,681.00. The Trustee’s turnover motion is granted as to $38,001.39, the value of
Debtors’ interest after the offset of GMC’s claim.
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 is hereby entered sustaining the Trustee’s objection to GMC’s proof of
claim. The Court holds that GMC has a secured claim for $151,679.61, payable by offset
against $189,681.00, the value of Debtors’ membership interest in GMC.
Judgment is hereby entered sustaining the Trustee’s motion for turnover. The
Court holds that GMC shall turn over $38,001.39, the difference between the value of
Debtors’ membership interest in GMC and the amount owed by Debtors to GMC.
IT IS SO ORDERED.
# # #
Case 09-22647 Doc# 125 Filed 04/02/13 Page 15 of 15
- Category: Judge Somers
- Published on 11 April 2013
- Written by Judge Somers
- Hits: 142
Cherry et al v. Neuschafer, 11-05103 (Bankr. D. Kan. Apr. 10, 2013) Doc. # 64
SIGNED this 10th day of April, 2013.
Designated for on-line use but not print publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
JOHN CHARLES NEUSCHAFER and
AUDREY LANE NEUSCHAFER,
ANDREW CHERRY and
JOHN CHARLES NEUSCHAFER,
CASE NO. 11-10282
ADV. NO. 11-05103
MEMORANDUM OPINION AND ORDER GRANTING IN PART
PLAINTIFFS’ COMPLAINT FOR EXCEPTION FROM DISCHARGE
Case 11-05103 Doc# 64 Filed 04/10/13 Page 1 of 22
Plaintiffs Andrew and Pamela Cherry (Plaintiffs or Cherrys) seek a determination
under 11 U.S.C. §§ 523(a)(2)(A) and (a)(6)1 that under the doctrine of issue preclusion
Defendant John C. Neuschafer’s (Debtor) obligation to them under a Georgia state court
judgment for fraud in the inducement, violation of the Georgia RICO statute, punitive
damages, attorneys fees, costs, and interest is nondischargeable.2 Following denial of
Plaintiff’s motion for summary judgment,3 trial was held on February 19, 2013. For the
following reasons, the Court grants the compliant in part and holds that Plaintiffs’
judgment against Debtor for fraud in the inducement is excepted from discharge under §
523(a)(2)(A), but otherwise denies the complaint.
FINDINGS OF FACT.
By complaint filed on May 9, 2006, in the Superior Court of Gwinnett County,
Georgia (the Georgia Litigation),4 the Cherrys brought suit against Integrity Funding
Group, LLC (Integrity), Cornerstone Investment Funds, LLC (Cornerstone), John C.
Neuschafer, and Andrew J. Taulbee. The Georgia Litigation arose from a contract for the
1 Future references to Title 11 in the text shall be to the section only.
2 This Court has jurisdiction over the parties and the subject matter pursuant to 28 U.S.C. §§
157(a) and 1334(a) and (b), and the Standing Order 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 July 10, 1984. Furthermore, this Court may hear and finally adjudicate
this matter because it is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(I). There is no objection to
venue or jurisdiction over the parties.
3 Dkt. 46.
4 Andrew and Pamela Cherry v. Integrity Funding Group, LLC., et al, Civil Action No. 06A04817-
10, Superior Court of Gwinnett County, Ga.
Case 11-05103 Doc# 64 Filed 04/10/13 Page 2 of 22
sale of the Cherrys’ home to Integrity and the Cherrys’ lease from Integrity, with option
to purchase, of a replacement residence. The claims alleged included breach of contract,
fraud, specific performance, violation of Georgia Fair Business Practice Act, and
violation of the Georgia Racketeer Influenced and Corrupt Organizations Act (Georgia
RICO). Debtor was not a member of Integrity, but was a member and the manger of
defendant Cornerstone, which was a member of Integrity. Jury trial was demanded.
The complaint was personally served on Debtor at his residence, 2737 Tarva Place,
Duluth, Ga., the address stated in the compliant. This is the address of the home formerly
owed by the Cherrys; Debtor moved to this property in early April, 2005. Debtor
appeared in the action by an attorney and filed an answer and a counterclaim. On March
30, 2007, an order was entered granting the motion of Debtor’s attorney to withdraw.
Debtor knew of the withdrawal. In the notice of withdrawal, prepared by Debtor’s
counsel, Debtor’s address is stated to be 951 Fernbank Lane, Dacula, GA. Debtor
testified he had lived at the Dacula address, but had moved by the time he retained his
trial counsel, to whom he gave his correct address on Tarva Place in Duluth, GA.
Debtor testified that after the withdrawal of his attorney he did not hire an
attorney, but did consult with his brother-in-law, who is an attorney. They agreed that no
entry of appearance would be made and that Debtor was to notify his brother-in-law in
the event of a trial. Debtor monitored the litigation every month or two by reviewing the
court’s on-line system, which had the information commonly found on a docket sheet.
The record contains a copy of the docket sheet, but Debtor testified that it was not the
Case 11-05103 Doc# 64 Filed 04/10/13 Page 3 of 22
same information as was available on-line, since there are approximately 60 entries
between March 30, 2007 and March 13, 2008, on the docket sheet which Debtor states
were, at least for the most part, not in the information available on-line at the times he
electronically checked the status of the Georgia Litigation.
The docket sheet entry for March 13, 2008 states “dismissal order.” Debtor saw
this entry and understood it to mean that the case against him was dismissed. He
thereafter stopped checking the litigation status on-line. The entry immediately preceding
the “dismissal order” entry states “2/19/2008 - notice of stay in bankruptcy - re taulbee,
andrew judson & taulbee tiffany jones.” The entry immediately following the “dismissal
order”entry states, “05/15/2008 - order - re bankruptcy/case reopened.” Debtor did not
see this entry.
After the withdrawal of his counsel, Debtor received no mailings and no notices
concerning the litigation. Debtor testified that he lived at 2737 Tarva Place, Duluth, GA
on the date of service of the complaint, moved to 3289 Swampwillow Ct., Jefferson, GA
in April 2007, moved to 135 Bill Rutedge Road, Winder, GA in April 2009, and moved to
Kansas in July, 2009. The Fernbank address is the address listed for Debtor, as well as
Integrity, on the Georgia docket sheet included in this record. There is no evidence
whether the Debtor’s address stated on the docket sheet was changed during the pendency
of the Georgia Litigation.
After the dischargeability complaint was filed, Debtor visited Georgia and
reviewed the court file. He found a large envelope postmarked March 27, 2008,
Case 11-05103 Doc# 64 Filed 04/10/13 Page 4 of 22
addressed to him at 951 Fernbank Lane, Dacula, GA and marked “UNDELIVERABLE
AS ADDRESSED NO FORWARDING ORDER ON FILE.” The contents of the
envelope were not present. There is no entry on the docket sheet for March 27, 2008.
The entries immediately before and after that date are the March 13, 2008 “dismissal
order” and the May 15, 2008 “order - re bankruptcy/case reopened.” Plaintiffs’ Georgia
counsel’s uncontroverted testimony is that the returned envelope did not contain notice of
the trial date, because the envelope was sent several months before the July 22, 2008 trial
date and such notices are generally sent approximately 30 days before trial.
As previously stated, a jury trial was requested. The scheduled events portion of
the docket sheet includes two entries for “Calendar Call - Jury,” one dated February 25,
20085 and one dated April 21, 2008. It next entry is “bench trial” for July 22, 2008.
There is no entry on the docket sheet showing the giving of notice of the trial setting. It is
uncontroverted that Debtor did not receive mail notice and had no actual notice of the
Trial to the court was held on July 22, 2008. Cherrys’ counsel, Kevin Pratt, and
Andrew Cherry appeared. Debtor testified that he would have appeared for trial if he had
received notice. The docket sheet simply states “07/25/2008-judgment.”6 The trial
5 The copy of the docket sheet in the record is cut off, so the last digit of the year of the February
25 entry date is missing, but the Court believes the year is 2008, based upon other entries in the docket.
6 Exh. 1.
Case 11-05103 Doc# 64 Filed 04/10/13 Page 5 of 22
resulted in a judgment against Debtor filed on July 25, 2008,7 which was amended to
correct a scrivener's error on December 10, 2008.8 The amended judgment (Georgia
Judgment) provides in part:
The Plaintiff presented evidence that the Defendants made
material mistatements when entering into a lease purchase
agreement to sell the Plaintiffs real property, and when entering
into the agreement the Defendants had a present intention not to
perform. The evidence presented supports a finding that
Defendants Integrity and Neuschafer committed Fraud in the
inducement. The facts relevant to this finding include that the
Defendants made material representations to the Plaintiffs
regarding the purchase of their home and the purchase of a
replacement home. The Defendants stated that they would place
the Plaintiffs in a home under a lease purchase agreement, that the
Plaintiff’s would be provided a credit on the closing of the
purchase of the replacement property in the amount of $30,300.00,
plus $1000.00 for 24 months. In reliance on the statements by the
Defendants, the Plaintiff sold Neuschafer the Plaintiffs’ then
current residence, and moved into the new home presented by the
Defendants under the lease purchase agreement. In further reliance
on the agreement to purchase the home, the Plaintiff’s paid for
improvements to be made on the leased property at the cost of
$13,757.00. When the Plaintiff’s attempted to purchase the new
home pursuant to the agreement, it was discovered that the
Defendant Neuschafer did not own the home and that the home
was owned by Defendant Taulbee as a straw buyer. It is also
shown by the record in this case that the Defendant Taulbee
received payment from Defendant Neuschafer for the purchase of
Based on these facts, Judgment in the amount of
$67,757.00 in favor of the Plaintiff’s and against Integrity Funding
Group, LLC and Neuschafer, jointly and severally, for Fraud in the
7 Exh. 4.
8 Exh. 5.
Case 11-05103 Doc# 64 Filed 04/10/13 Page 6 of 22
Inducement is hereby entered.9
The court also found in favor of the Cherrys on the Fair Business Practices Act claim. It
awarded $54,300.00 in damages, which was "merged into the Fraud Judgment."10
As to the Georgia RICO claim, the Georgia court found in part:
This Court finds that the act of participating in a scheme to
commit Mortgage Fraud in the procurement of two separate
loans used to facilitate the purchase of the home that was to
be sold to the Plaintiffs is a sufficient predicate act to
constitute a violation of Georgia Racketeer Influenced and
Corrupt Organizations Act (RICO). . . . this Court finds that
the actual damages caused to the Plaintiff by the Defendants
actions is $355,000.00. Based on the specific finding of facts
that the Defendants conduct was intentional and wanton, this
Court further holds that the award of punitive damages in
favor of the Plaintiffs and against Defendants Integrity and
Neuschafer in the amount of $100,000.00 is appropriate.
Moreover, as the Georgia RICO expressly provides that any
person injured by reason of a violation of the Act shall have a
cause of action for three times the actual damages sustained,
and where appropriate, punitive damages. The facts clearly
indicate that it is highly appropriate that the actual damages
and punitive damages in this case be tripled. 11
Attorneys fees and costs were also assessed against the defendants. The total judgment
therefore was stated as follows:
a) The principal amount of $67,757.00 for Fraud in the
Inducement and Violation of the Fair Busienss [sic] Practices Act;
b) The principal amount of $1,065,000.00 ($355,000 tripled)
9 Id. at 1-2.
10 Id. at 2.
11 Id. at 2-3.
Case 11-05103 Doc# 64 Filed 04/10/13 Page 7 of 22
for Violation of Georgia RICO;
c) Punitive damages in the amount of $300,000.00 ($100,000
d) $19,500.00 Attorneys fees;
e) $130.00 Court Cost
f) Post judgment interest at 8%.12
Debtor did not learn of the judgment until after he moved to Kansas, when through
service of process, he learned that the Georgia judgment had been registered in this state.
The Cherrys’ Georgia trial counsel, Kevin Pratt, testified by deposition, which had
been taken by telephone. When testifying, he referred only to documents which had been
provided by Plaintiffs’ counsel; he had not reviewed his file, did not have his file present,
and had not reviewed the court file. In a written report, about which he testified, Mr.
The dockets for cases in this jurisdiction do not reflect notices
sent for trials. This is because the practice of our state court is
to have the judge directly give notice to the litigants of trial
settings. If a trial notice is returned undeliverable the Judges
office makes a note that the notice was returned.
Consequently, although the court docket does not reflect a
trial notice, it also does not reflect that the notice sent by the
judge was returned undeliverable.13
Mr. Pratt testified that it would be extremely rare to get more than 30 days advance notice
of a trial setting, and he did not know what would have been in the returned envelope
addressed to Debtor postmarked March 27, 2008. Mr. Pratt stated in his statement that he
12 Id. at 3.
13 Exh. 15, 63.
Case 11-05103 Doc# 64 Filed 04/10/13 Page 8 of 22
received notice of the July, 2008 trial in the “normal and customary manner.”14 He
testified that the notice would have been received no more than 30 days in advance of the
trial date, would have been calendared, but the notice itself was not retained.
A. Plaintiffs’ nondischageability complaint.
In this adversary proceeding, the Cherrys seek a determination that their judgment
against Debtor entered in the Georgia Litigation is nondischargeable under §§
523(a)(2)(A) and/or 523(a)(6). They rely upon the doctrine of issue preclusion, also
referred to as collateral estoppel. That doctrine “prevents a party that has lost the battle
over an issue in one lawsuit from relitigating that same issue in another lawsuit.”15 It
applies in discharge litigation under § 523.16
B. What portions of the Georgia Judgment are eligible for preclusive effect as
to the § 523(b)(2)(A) exception to discharge?
The first question to ask when applying the doctrine of issue preclusion in this case
is whether the issues in the dischargeability litigation are the same as those in the Georgia
Litigation. Subsection § 524(a)(2)(A) excepts from discharge debts “for money, property,
services . . . to the extent obtained by false pretenses, a false representation, or actual
fraud.” To establish an exception to discharge for fraud, the creditor must prove: “1) the
14 Id. at 64.
15 Melnor, Inc. v. Corey (In re Corey), 583 F.3d 1249, 1251 (10th Cir. 2009).
16 Grogan v. Garner, 498 U.S. 279, 284-85 (1991).
Case 11-05103 Doc# 64 Filed 04/10/13 Page 9 of 22
debtor knowingly committed actual fraud or false pretenses, or made a false
representation or willful misrepresentation; 2) that the debtor had the intent to deceive the
creditor; and 3) that the creditor relied upon the debtor’s representation."17 In addition,
the creditor’s reliance must have been justifiable,18 and the debtor’s non-financial
misrepresentation must be the proximate cause of the debt in issue.19
The first element of the Georgia Judgment is damages of $67,757.00, plus post
judgment interest at the rate of 8% per year, for fraud in the inducement. Under Georgia
law, the elements for a fraud claim are: “(1) a false representation made by the defendant;
(2) which the defendant knew was false; (3) made with an intent to deceive the plaintiff;
(4) justifiable and detrimental reliance by the plaintiff on such representation and (5)
damages suffered by the plaintiff as a result.”20 The Georgia Judgment states the
evidence supports findings that Debtor made “material mistatements when entering into a
lease purchase agreement,”21 that when entering into the agreement he had “a present
intention not to perform,”22 that Cherrys relied on the misstatements, and that Cherrys
17 State of Missouri v. Audley (In re Audley), 275 B.R. 383, 388 (10th Cir. BAP 2002), citing
Fowler Bros. v. Young (In re Young), 91 F.3d 1367, 1373 (10th Cir. 1996).
19 In re Giovanni, 324 B.R. 586, 594 (E.D. Va. 2005).
20 Hebbard v. Camacho (In re Camacho), 411 B.R. 496, 505 (Bankr. S.D. Ga. 2009), citing
Crawford v. Williams, 258 Ga. 806, 806, 375 S.E.2d 223, 224 (1989) and other Georgia cases.
21 Exh. 5, 1.
Case 11-05103 Doc# 64 Filed 04/10/13 Page 10 of 22
were injured. These findings are the same as required for the exception to discharge
under § 523(a)(2)(A).
Since the judgment for Violation of the Fair Business Practices Act is “merged
into the Fraud Judgment,”23 the Court will not separately consider this portion of the
The Georgia Judgment also includes finding that Debtor violated the Georgia Civil
RICO statute causing damages of $355,000.00, that the conduct causing the damages was
intentional and wanton such that an award of punitive damages of $100,000.00 was
appropriate, and under RICO statute these damages should be tripled, resulting in a
judgment for $1,065,000.00 and punitive damages of $300,000.00. Plaintiffs contend that
this entire judgment is nondischargeable under Cohen, 24 a Supreme Court decision
holding that the discharge exception for actual fraud prevents the discharge of all liability
arising from the debtor’s fraud, including triple damages assessed on account of fraud
under state law as well as attorney fees and costs.
Under the Georgia civil RICO statute,25 a person injured by reason of any violation
of the activities prohibited by O.C.G.A. 16-14-4 has a cause of action for three times the
actual damages sustained and, where appropriate, punitive damages. Georgia Code 1614-
4 declares “[i]t is unlawful for any person, through a pattern of racketeering activity . .
23 Exh. 5, 2.
24 Cohen v. De La Cruz, 523 U.S. 213 (1998).
25 O.C.G.A. 16-14-6.
Case 11-05103 Doc# 64 Filed 04/10/13 Page 11 of 22
. to acquire or maintain, . . . any interest in or control of any enterprise, real property, or
personal property of any nature, including money.” Pattern of racketeering activity
includes “[e]ngaging in at least two acts of racketeering activity in furtherance of one or
more incidents, schemes, or transactions that have the same or similar intents, results,
accomplices, victims, or methods of commission . . ..”26 “‘Racketeering activity’ means
to commit . . . any crime which is chargeable by indictment” under a very long list of
Georgia statutes, commonly called predicate acts.27 The predicate acts for Debtor’s RICO
liability are violations of the Georgia residential mortgage fraud statute, which provides
A person commits the offense of residential mortgage
fraud when, with the intent to defraud, such person:
(1) Knowingly makes any deliberate misstatement,
misrepresentation, or omission during the mortgage lending
process with the intention that it be relied on by a mortgage
lender, borrower, or any other party to the mortgage lending
As stated above, to except the RICO judgment from discharge under §523(a)(2)(A)
under the doctrine of issue preclusion, the Plaintiffs must show that the RICO judgment
was supported by findings which included the elements of misrepresentation, knowledge
of falsity, intent to defraud, justifiable reliance, and resulting damage. The Georgia
26 O.C.G.A. 16-14-3(8)(a)).
28 O.C.G.A. 16-8-102.
Case 11-05103 Doc# 64 Filed 04/10/13 Page 12 of 22
Judgment includes the following as findings of fact to support the judgment for violation
of the mortgage fraud statute:
The facts support that the Defendants [Debtor and Integrity
Funding Group, LLC] combined to arrange for the
procurement of two separate loans to purchase real property,
and that the Defendants participated in outside of closing
transactions that were not disclosed to the lenders. This Court
finds that the act of participating in a scheme to commit
Mortgage Fraud in the procurement of two separate loans
used to facilitate the purchase of the home that was to be sold
to the Plaintiffs is a sufficient predicate act to constitute a
violation of ... RICO. As such the Defendants Integrity and
Neuschafer are liable for all of the damages proximately
caused by the acts. Based on the entire transaction involving
the sale of a principal residence at a discounted price on the
promise and misstatements of Neuschafer, and the fact that
Neuschafer had a present intention not to perform his
obligations under the agreement, this Court finds that the
actual damages caused to the Plaintiff by the Defendants
actions is $355,000.00.29
Thus, the Debtor’s liability under civil RICO is predicated upon
misrepresentations made in the procurement of two separate loans and failure to make
disclosures to lenders. It is crucial that these misrepresentations were made to lenders, not
to the Plaintiffs. The unspecified lenders presumably provided credit to Debtor or a co
defendant based upon the fraud and failure to disclose. If the lenders had pursued Debtor
for fraud and obtained a judgment, that judgment probably would have included the
elements for the exception from discharge under § 523(a)(2)(A) as findings of fact. But
the RICO judgment does not impose liability on Debtor based upon these elements. The
29 Exh. 5, 2.
Case 11-05103 Doc# 64 Filed 04/10/13 Page 13 of 22
misrepresentations which are the basis for the RICO judgment were not made to
Plaintiffs. There is no finding that Plaintiffs relied upon the misrepresentations made to
lenders. There is no finding that the misrepresentations made to lenders were the
proximate cause of the damages awarded to Plaintiffs on the RICO claim. Rather than
being awarded damages for property obtained by Debtor as a result of misrepresentations
made to lenders, Plaintiffs were awarded RICO damages based upon the “entire
transaction” and the fact that Debtor “had a present intention not to perform his
obligations under the agreement,” meaning the agreement to purchase a home which was
to be sold to the Plaintiffs.30 The judgment for fraud in the inducement awards damages
resulting from breach of the agreement. The Court therefore concludes that issue
preclusion is not available to bar the Debtor’s discharge under § 523(a)(2)(A) for his
liability for the RICO portion of the Georgia Judgment.
C. What portions of the Georgia Judgment are eligible for preclusive effect as
to the § 523(a)(6) exception to discharge?
Section 523(a)(6) excepts from discharge any debt “for willful and malicious
injury by the debtor to another entity or to the property of another entity.” It “generally
relates to torts and not to contracts,”31 but a breach of contract which is both willful and
30 Exh. 5, 2.
31 4 Colliers on Bankruptcy ¶ 523.12 (Alan N. Resnick & Henry J. Sommer eds.-in-chief, 16th
ed. rev. 2012).
Case 11-05103 Doc# 64 Filed 04/10/13 Page 14 of 22
malicious can be excepted from discharge under the section.32 To fall within the
exception, the injury must have been both willful and malicious. An injury is malicious
when it is without just cause or excuse.33 “[T]he focus of the ‘malicious’ inquiry is on the
debtor’s actual knowledge or the reasonable foreseeability that his conduct will result in
injury to the creditor.”34 “‘Willful’ conduct is conduct that is volitional and deliberate
and over which the debtor exercises meaningful control, as opposed to unintentional or
None of the elements of the Georgia Judgment include findings that Plaintiffs’
injury resulted from conduct which was both willful and malicious. The fraud in the
inducement judgment relies upon evidence that Debtor made material misstatements and
had no intention of preforming when entering into the agreement with Plaintiffs. There is
no mention of either willfulness or maliciousness. Issue preclusion is not applicable to
Plaintiffs’ claim of exception of the fraud in the inducement judgment from discharge
under § 523(a)(6).
With respect to the punitive damage portion of the RICO claim, the Georgia court
found Debtor’s conduct was “intentional and wanton.” Although one could argue that
intentional and wanton conduct satisfies the willful requirement, there is absolutely no
32 Texas v. Walker, 142 F.3d 813, 823-24 (5th Cir. 1998), cited with approval in Sanders v.
Vaughn (In re Sanders), 210 F.3d 390, 2000 WL 328136 (10th Cir. 2000) (unpublished disposition).
33 4 Colliers on Bankruptcy at ¶ 523.12.
34 C.I.T. Financial Serv., Inc. v. Posta (In re Posta), 866 F.2d 364, 367 (10th Cir. 1989).
Case 11-05103 Doc# 64 Filed 04/10/13 Page 15 of 22
finding relating to maliciousness. The judgment is silent as to the whether the Debtor had
actual knowledge or reasonable foreseeability that his conduct would result in injury to
the Cherrys. Since maliciousness is required to except the RICO judgment from
discharge under § 523(a)(6), Plaintiffs’ reliance on issue preclusion to except the RICO
judgment from discharge is rejected.
D. Should the Georgia Judgment be denied preclusive effect because Debtor
did not receive notice of the trial?
When denying Plaintiffs’ motion for summary judgment the Court examined
applicability of the doctrine of issue preclusion to the fraud in the inducement portion of
the Georgia Judgment. It stated:36
“When the issue previously litigated was litigated under state
law, a bankruptcy court will apply the law of collateral
estoppel of the relevant state.”37 Under Georgia law, a party
may only assert the doctrine of collateral estoppel against a
party to a prior proceeding if the issue was (1) raised in a
prior proceeding, (2) actually litigated and decided, and (3)
necessary to final judgment.38 A default judgment satisfies
the requirement that the judgment be on the merits.39
The Georgia Litigation with respect to the fraud judgment
satisfies the forgoing elements for issue preclusion. But the
Court is concerned that there are no uncontroverted facts
showing that Debtor knowingly allowed what appears to be
equivalent to a default judgment to be entered against him.
36 Dkt. 46, 6-7.
37 4 Collier on Bankruptcy at § 523.06; see 28 U.S.C §1738.
38 In re Camacho, 411 B.R. at 501, citing Boozer v. Higdon, 252 Ga. 276, 313 S.E.2d 100, 102
39 Spooner v. Deere Credit, Inc., 244 Ga. App. 681, 682, 536 S.E.2d 581, 582 (2000).
Case 11-05103 Doc# 64 Filed 04/10/13 Page 16 of 22
Further, there is nothing in the portion of the record of the
Georgia Litigation before this Court showing that Debtor,
who was pro se, had notice of the hearing which resulted in
the judgment. Some bankruptcy decisions applying Georgia
issue preclusion law have added the requirement that “the
party against whom preclusion is asserted must have had a
‘full and fair opportunity’ to litigate.”40 But this element does
not appear to have been expressly adopted by the Georgia
courts. However, the Georgia courts do follow the
Restatement (Second) of Judgments.41 In § 28, the
restatement addresses exceptions to the general rule of issue
preclusion.42 One of these exceptions is that the party “did
not have an adequate opportunity or incentive to obtain a full
and fair adjudication in the initial action.” The comments to
this provision of the restatement caution that such a “refusal
to give the first judgment preclusive effect should not occur
without a compelling showing of unfairness,” but confirm that
a court has discretion to deny preclusive effect to assure “fair
administration of preclusion doctrine.”43 The Court finds that
a more complete record of the Georgia Litigation is required
before it can be certain that this case is not one of those rare
circumstances where preclusive effect should be denied
because of lack of opportunity to obtain a full and fair
adjudication in the Georgia Litigation. Summary judgment
for nondischageability of the fraud judgment is therefore
The trial has provided the Court with a more complete record of the Georgia
Litigation. Debtor was served with the complaint, retained counsel, filed an answer and
counterclaim, and participated in the litigation from August 9, 2006 through March 30,
40 In re Camacho, 411 B.R. at 503.
41 Kent v. Kent, 265 Ga. 211, 212, 452 S.E.2d 764, 765 (1995) (citing Restatement (Second) of
Judgments § 27(1982)).
42 Restatement (Second) of Judgments § 28 (1982).
43 Id., comment j.
Case 11-05103 Doc# 64 Filed 04/10/13 Page 17 of 22
2007, when his counsel withdrew. Thereafter, Debtor monitored the case through the online
information provided by the court; he stopped monitoring the case after reading the
docket entry for March 13, 2008, which stated “dismissal order.” He either did not read
or did not find significant the entry immediately preceding the March 13, 2008 entry,
dated February 19, 2008 stating “notice of stay in bankruptcy - re taulbee, andrew judson
& taulbee, tiffany jones.” Debtor interpreted March 13, 2008 “dismissal order” entry to
mean that the entire case was dismissed, but took no action to verify his interpretation.
The Court’s primary concern is that Debtor did not receive notice of the July, 2008
trial setting.44 Plaintiffs’ Georgia counsel testified that he received notice of the setting
by mail approximately 30 days before trial and similar notice would have been sent to
Debtor at his address as shown in the Court records. There is no evidence or other reason
for this Court to conclude that notice was not attempted.45 It is required by O.C.G.A. 911-
40(c). As to service, O.C.G.A. 9-11-5 provides that service upon a party shall be made
by mailing to the person to be served at the person’s last known address and that service
is complete upon mailing. Debtor’s last known address as stated on the docket sheet in
evidence was 951 Fernbank Lane, Dacula, GA. Debtor’s non-receipt of notice is fully
44 The parties did not offer evidence to explain how a case for jury trial was requested and for
which jury calendar call was last stated on the docket sheet on April 21, 2008, came to be heard by a
judge on July 22, 2008.
45 The record includes a copy of a large envelope (without the contents) mailed by the Georgia
court to Debtor at the address stated on the docket sheet mailed first class on March 27, 2008 and returned
as undeliverable as addressed and no forwarding address provided. Plaintiffs’ Georgia counsel’s
uncontroverted testimony is that this envelope did contain notice of the trial, because it was sent several
months before the July 22, 2008 trial date and such notices are generally sent approximately 30 days
Case 11-05103 Doc# 64 Filed 04/10/13 Page 18 of 22
explained by the fact that this was not Debtor’s correct address in July, 2008. Debtor had
not resided at the Dacula address since at least April, 2005, so there is not reason to
believe that mail sent to that address would have been forwarded to Debtor. There is no
evidence when the address error occurred. Debtor’s residence was correctly stated in the
complaint, and he was served at that address. The address on the docket sheet is the same
as that stated in the withdrawal pleadings filed by Debtor’s attorney. Despite the
continuation of the litigation during the year intervening between withdrawal of his
counsel and the dismissal entry, Debtor testified that he received no notices and was not
served with any court documents. Nevertheless, Debtor made no inquiries concerning the
litigation and made no attempt to assure that the record included his correct address.
Under Georgia law, a litigant’s failure to receive notice of trial is not a basis to set aside a
judgment when the lack of notice is the result of the defendant’s own failure to advise the
court of his correct address.46
The Court finds that there is not a compelling showing of unfairness which would
preclude Plaintiffs’ reliance on the doctrine of issue preclusion. Debtor knowingly did
not participate in the Georgia Litigation after the withdrawal of his counsel and took no
46 Sterling Motor Freight Co., Inc. v. Wendt, 156 Ga. App. 516, 517, 275 S.E.2d 101, 103 (1980)
(where defendant was aware that case was pending and ready for trial, defendant himself discharged his
attorneys, and defendant made it impossible to be reached by moving out or state and leaving no
forwarding address, defendant could not complain that trial proceeded in his absence); Stewart v.
Williams, 164 Ga. App. 117, 296 S.E.2d 416 (1982) (default judgment not set aside where defendant did
not have actual notice of trial but clerk of the court testified that notice by mail was provided); cf. Shelton
v. Rodgers, 160 Ga. App. 910, 288 S.E.2d 619 (1982) (default set aside where defendant did not receive
notice of trial because jury trial notice was sent by clerk to defendant’s former address after his counsel
had withdrawn and supplied clerk with defendant’s current address).
Case 11-05103 Doc# 64 Filed 04/10/13 Page 19 of 22
action to verify his understanding that he was no longer at risk of judgment after the
March 13, 2008 dismissal order. Even if, as Debtor testified, he was not aware that the
Georgia Court misstated his address on the docket sheet, a person acting diligently to
protect his interests would have made inquiry when he had not received any notices after
the withdrawal of his counsel. The lack of notice of trial, although not solely Debtor’s
fault, could have been avoided if Debtor had been more attentive to his affairs. The result
was a significant judgment which Debtor has not sought to have set aside.
Plaintiffs have provided the Court with citations to Bankruptcy court decisions
applying Georgia law of issue preclusion in dischargeability litigation which fully support
the Court’s holding that issue preclusion applies in this case. Debtor, on the other hand,
has provided no case law supporting his position on the issue preclusion question.
Camcho47 is a case cited by Plaintiffs. In Camcho, as in this case, debtor participated in
the early stages of fraud litigation through counsel, requested his counsel to withdraw, did
not appear for trial, and had fraud judgment entered against him. The court held that
issue preclusion applied under Georgia law. The court found that the full and fair
opportunity element of issue preclusion was in effect a due process requirement, which is
an unspoken element of collateral estoppel, and that due process was accorded debtor.
“Debtor knew about the case, had the opportunity to litigate, and did so for a time. He
then decided not to participate for practical reasons, but not a reason which suggest that
47 In re Camacho, 411 B.R. at 496. Additional Georgia Bankruptcy Court decisions cited by
Plaintiffs are: In re Whelan, 236 B.R. 495 (Bankr. N.D. Ga. 1999) modified 245 B.R. 698 (N.D. Ga.
2000); and In re Hooks, 238 B.R. 880 (Bankr. S.D. Ga. 1999).
Case 11-05103 Doc# 64 Filed 04/10/13 Page 20 of 22
due process was not accorded him.”48 An opportunity to participate is not negated by the
“decision to disregard or avoid that opportunity.”49
The Court therefore holds that issue preclusion applies to Plaintiffs’ contention
that discharge of the Georgia Judgment of $67,757.00 for fraud in the inducement is
barred under § 523(a)(2)(A), but not under § 523(a)(6). The amount excepted from
discharge includes all liability arising from the fraud in the inducement.50 The Court
therefore holds that amount excepted from discharge includes post-judgment interest on
$67,757.00 at 8% per year from the date of the judgment to February 14, 2011, the date of
Debtor’s filing for bankruptcy relief. The Georgia Judgment includes $19,500.00 for
attorneys fees and $130.00 court costs, but because there are no findings that these
amounts are recoverable as part of the liability for fraud in the inducement, they are not
included in the amount excepted from discharge. The Georgia Judgment for RICO
damages is not excepted from discharge based upon issue preclusion because that portion
of the Georgia Judgment does not reflect the elements required for exceptions to
discharge under §§ 523(a)(2)(A) or (a)(6).
The foregoing constitute Findings of Fact and Conclusions of Law under Rule
7052 of the Federal Rules of Bankruptcy Procedure which makes Rule 52(a) of the
48 Id. at 503.
49 Id., citing In re Hooks, 238 B.R. 880, 86-87 (Bankr. S. D. Ga. 1999).
50 Cohen v. De La Cruz, 523 U.S. at 213.
Case 11-05103 Doc# 64 Filed 04/10/13 Page 21 of 22
Federal Rules of Civil Procedure applicable to this proceeding. A judgment based upon
this ruling will be entered on a separate document as required by Federal Rule of
Bankruptcy Procedure 7058 which makes Federal Rule of Civil Procedure 58 applicable
to this proceeding.
IT IS SO ORDERED.
Case 11-05103 Doc# 64 Filed 04/10/13 Page 22 of 22
- Category: Judge Somers
- Published on 20 March 2013
- Written by Judge Somers
- Hits: 232
Redmond, Trustee v. NCMIC Finance Corp, 12-06043 (Bankr. D. Kan. Mar. 13, 2013) Doc. # 37
SIGNED this 13th day of March, 2013.
Designated for print publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
BROOKE CORPORATION, et al.,
CHRISTOPHER J. REDMOND,
Chapter 7 Trustee of Brooke
Corporation, Brooke Capital
Corporation (f/k/a Brooke Franchise
Corporation), and Brooke Investments,
NCMIC FINANCE CORPORATION,
CASE NO. 08-22786
ADV. NO. 12-6043
MEMORANDUM OPINION AND ORDER
GRANTING NCMIC FINANCE CORPORATION’S
MOTION FOR SUMMARY JUDGMENT ON COUNT V
Case 12-06043 Doc# 37 Filed 03/13/13 Page 1 of 23
In Counts IV and V of the Complaint, Plaintiff Christopher J. Redmond, Chapter 7
Trustee (Trustee) of Debtors Brooke Corporation, Brooke Capital Corporation, and
Brooke Investments, Inc., seeks to avoid allegedly fraudulent transfers made by the
Debtors and to recover the value thereof from NCMIC Finance Corporation (NCMIC).
NCMIC moves for summary judgment under Federal Rule of Civil Procedure 56, made
applicable to this proceeding by Federal Rule of Bankruptcy Procedure 7056, on Count V
of the Complaint. The motion presents the question whether, under the facts alleged in
the Complaint, NCMIC is “an entity for whose benefit” the allegedly fraudulent transfers
were made, within the meaning of 11 U.S.C. § 550(a)(1).1 After carefully considering the
pleadings and the oral arguments of counsel,2 the Court finds that summary judgment on
Count V should be granted.
THE COURT WILL REGARD THE MOTION AS ONE FOR SUMMARY
Before reaching the merits, the Court must decide whether the motion should be
regarded as one for summary judgment under Rule 56 or as one for judgment on the
pleadings under Rule 12. NCMIC filed the motion under Rule 56 before any discovery
was completed and relied almost exclusively upon the allegations of the Complaint. In
response, the Trustee contended that the motion should be considered as one for judgment
on the pleadings under Rule 12(c) and presented additional allegations from the
1 Future references to Title 11 in the text shall be to the section number only.
2 The Trustee appears by Michael D. Fielding of Husch Blackwell LLP. NCMIC appears by Paul
D. Sinclair of Polsinelli Shughart PC.
Case 12-06043 Doc# 37 Filed 03/13/13 Page 2 of 23
Complaint. But, recognizing that the Court could consider the motion as one for
summary judgment as presented by NCMIC, the Trustee also included additional
statements of allegedly uncontroverted facts supported by copies of the contracts which
determined the relevant relationships between Brooke, its franchisees, Aleritas (who
loaned money to the franchisees), and NCMIC, who purchased interests in the Aleritas
As urged by the Trustee, because NCMIC relies upon the allegations of the
Complaint (with the exception of paragraph 23 of the statement of uncontroverted facts,
which the Court finds to be irrelevant), the motion could be regarded as one for judgment
on the pleadings under Rule 12(c). However, NCMIC characterizes the motion as one for
summary judgment, and when responding to the motion, the Trustee provided facts not
included in the Complaint, to be considered if the Court treats the motion under Rule 56.
Rule 12(d) provides that if, on a motion under Rule 12(b)(6) or 12(c), matters outside the
pleadings are presented to and are not excluded by the court, the motion must be treated
as one under Rule 56. The Court wishes to consider the contracts submitted by the
Trustee in his response to NCMIC’s motion and therefore will treat the motion under
The Court will therefore apply the well-known standards for ruling on motions for
summary judgment. Contrary to the Trustee’s argument, the decision to treat the motion
under Rule 56 rather than Rule 12 does not impact the applicable standard as “the
Case 12-06043 Doc# 37 Filed 03/13/13 Page 3 of 23
standard applied by the court appears to be identical under” either Rule 12(c) or Rule 56.3
Since the issue presented is the construction of § 550 in light of the uncontroverted facts
regarding the conduct of Brooke’s franchise business, summary judgment is appropriate if
NCMIC is entitled to judgment as a matter of law.4
This ruling that the motion shall be governed by Rule 56 makes it necessary for the
Court to consider NCMIC’s objections to the Trustee’s additional statements of fact.
NCMIC objects to the additional statements from the Complaint on the grounds they are
irrelevant and were not submitted in compliance with Rule 56. The Court overrules these
objections. It finds the statements from the Complaint are relevant to understanding
Brooke’s franchise operations, and they are not controverted by NCMIC. The additional
portions of the Complaint would clearly be properly before the Court if the Court were
proceeding under Rule 12. Also, under Rule 56(c)(3), the Court could consider the
additional allegations from the Complaint even if they had not been cited by either of the
parties. The Court will therefore consider the additional allegations as providing a fuller
background for understanding the allegations of the Complaint on which NCMIC relies,
and the transactions in issue.
NCMIC also objects to the Trustee’s statements of fact discussing the contracts,
copies of which are attached to the Trustee’s response. Those contracts, alleged to be
3 5C Charles Alan Wright & Arthur R. Miller, Federal Practice and Procedure: Civil, § 1369 at
261-62 (3rd ed. 2004).
4 Rule 56(a); Celotex Corp. v. Catrett, 477 U.S. 317, 322 (1986); note: in 2010, the “entitled to
judgment” language was moved from subdivision (c) to (a).
Case 12-06043 Doc# 37 Filed 03/13/13 Page 4 of 23
representative of many others, are a franchise agreement, a promissory note between
Aleritas and a franchisee, a security agreement executed in conjunction with the note, a
collateral preservation agreement, and a participation agreement. NCMIC contends the
statements are not submitted in accord with the requirements of Rule 56. This objection
is well founded. The Trustee did not support his discussion by affidavit, deposition
testimony, or other materials of evidentiary value. Those purported statements of fact
will be stricken. However, because, as NCMIC has acknowledged, the contract
documents speak for themselves, the documents will be considered.
THE UNCONTROVERTED FACTS.
Although there are many unknown or disputed issues of fact about the very large
numbers of transfers which the Trustee seeks to avoid, the motion presents only a
question of law about the construction of § 550(a)(1). This determination can be made
based upon the facts as alleged in the Complaint and as shown in the contract documents.
They are as follows.
The Brooke group of companies was involved in many aspects of insurance and
insurance-related businesses, including a network of insurance franchisees and agents.
The parent company was Debtor Brooke Corporation (Brooke Corp.). Debtor Brooke
Capital Corporation (Brooke Capital), a majority-owned subsidiary of Brooke Corp.,
owned 100% of Debtor Brooke Investments, Inc. The three Brooke Debtors will be
referred to collectively as Debtors. Another relevant majority-owned subsidiary of
Brooke Corp. was non-debtor Brooke Credit Corporation, d/b/a Aleritas Capital
Case 12-06043 Doc# 37 Filed 03/13/13 Page 5 of 23
Corporation (Aleritas). Aleritas was engaged in lending money to Brooke franchisees
and other insurance agents.
Defendant NCMIC, which began its relationship with Brooke in 1998, initially
fulfilled a “warehouse” financing role for Brooke agency franchise loans, holding the
loans until they were securitized or sold to community banks. Later, NCMIC provided
other services and purchased various participation interests in loans which Aleritas made
to Brooke agents.
Brooke conducted its insurance business through a network of franchise and
company-owned locations. The franchise agreement provided by the Trustee is
representative of the arrangements. Brooke Capital acted as franchisor. Pursuant to the
franchise agreements, the franchisees agreed to pay franchise fees and to provide Brooke
a percentage (usually 15%) of their sales commissions going forward. In return, Brooke
agreed to provide ongoing franchise services throughout the life of the franchise
relationship, including, but not limited to, “cash managements services” such as billing
and collecting insurance premiums, remitting premiums to the respective carriers,
receiving and allocating commission revenues, and receiving and processing agency-
related bills (including bills relating to rent, utilities, advertising, service providers, etc.).
Brooke controlled most of the cash flows for its franchise agencies. Its business practice
was to pay most of the rent and other operating expenses for its agents, including loan
payments, and to charge those payments (along with the percentage of ongoing
Case 12-06043 Doc# 37 Filed 03/13/13 Page 6 of 23
commission revenues and recurring franchise fees) to the agents’ monthly statements as
offsets to the commission revenues earned.
When franchise agencies were acquired, the acquisition costs, the franchise fees,
and, often, additional working capital would typically be financed through Brookes’
lending subsidiary, Aleritas. Each loan was evidenced by a promissory note, such as the
one provided by the Trustee, and under the terms of a commercial security agreement,
was secured by all of the assets of the franchisee. In conjunction with each loan, Brooke
Capital and Aleritas entered into a Collateral Preservation Agreement, under which
Brooke Capital would provide services to franchisees to assure that they continued in
business, thereby preserving the value of Aleritas’ collateral. After Aleritas made loans
to franchisees, it would sell the loans in one of two ways: (1) by selling participation
interests in the individual loans to local banks or investors; or (2) by bundling loans and
selling them as part of securitizations.
Under the terms of the participation agreements, Defendant NCMIC purchased
various participation interests in Brooke franchisee/agent loans originated by Aleritas.
Aleritas continued to service the loans after selling them to NCMIC. Aleritas repurchased
some participation interests from NCMIC; some loans remain outstanding and are owed
by the franchisees/agents.
Brooke was under “tremendous pressure” for all the loans to perform because its
business model depended on a continuous stream of willing buyers for its loans. But a
large number of Brooke franchisees either underperformed or completely failed to
Case 12-06043 Doc# 37 Filed 03/13/13 Page 7 of 23
perform in the months preceding the Debtors’ bankruptcy filings. The Trustee alleged
that when a franchisee underperformed or had insufficient commission income to cover
its loan payments, Brooke Capital transferred its own funds to Aleritas, which, acting as a
mere conduit, made monthly loan payments that the underperforming or non-performing
agents owed on the various participated loans. The Trustee estimates that the total
amount of money transferred by Brooke Capital (via Aleritas) to NCMIC for payments on
loans which NCMIC owned in whole or in part was $5,682,083.97 (NCMIC Loan
Payments). With respect to the Brooke franchisees whose loans were held at least in part
by NCMIC, the Trustee alleges that Brooke Capital paid expenses (Operating Expense
Transfers) totaling $22,306,633.62. The Trustee alleges that Brooke Capital also paid
loan obligations of these Brooke franchisees to lenders other than NCMIC (Other Lender
Transfers) totaling $17,005,570.89.
Details concerning these transfers are shown in Exhibit 1 to the Complaint. In 211
pages, it sets forth with respect to each loan in which NCMIC held a participation
interest, the related agency number and the relevant transfers. The first 41 pages cover 41
agencies, so the total number of agencies is estimated to be 211. Each page contains
about 25 transfers, so the total number of transfers in issue is approximately 5,275.5 The
information is detailed. For example, for agency number 801, the exhibit reflects that it
operated from two locations, and was obligated on Aleritas loan number 3694 for
5 The exhibit lists the transfers by month but does not reveal whether each monthly amount is
itself comprised of more than one transfer.
Case 12-06043 Doc# 37 Filed 03/13/13 Page 8 of 23
$476,044, in which NCMIC purchased an interest on December 28, 2004. For each of the
25 months between January 15, 2005, and January 15, 2007, the exhibit shows the agency
revenue, franchise fee, adjusted revenue, net revenue, loan payments, net cash flow,
Operating Expense Transfers, Other Loan Transfers, and NCMIC Loan Payments. In just
one month, January 2005, the transfers on behalf of agency 801 for the three categories of
transfers which the Trustee seeks to recover are alleged to total $116,072.73, comprised
of $76,607.00 for Operating Expense Transfers, $35,144.75 for Other Lender Transfers,
and $4,320.98 for NCMIC Loan Payments.
Count IV of the Complaint alleges that the NCMIC Loan Payments totaling
$5,682,083.97 were transferred by Brooke Capital to NCMIC (via Aleritas) and were
constructively fraudulent transfers under §§ 544 and 548(a)(1)(B) of the Bankruptcy
Code and under K.S.A. 33-204(a)(2)6 and 33-205(a). Recovery from NCMIC is sought
under Bankruptcy § 550 and K.S.A. 33-207, as the initial transferee or a subsequent
transferee. In Count V, the Trustee alleges that the Operating Expense Transfers totaling
$22,306,633.62 and the Other Lender Transfers totaling $17,005,570.89 were likewise
constructively fraudulent transfers under §§ 544 and 548(a)(1)(B) of the Bankruptcy
Code and under K.S.A. 33-204(a)(2)7 and 33-205(a). It is alleged that even though the
payments were made to third parties, these transfers may be recovered from NCMIC
6 The Complaint actually gives 33-204(2) — which does not exist — as the statute number, but
clearly intends to cite 33-204(a)(2).
7 Again the statute number is given as 33-204(2) instead of 33-204(a)(2).
Case 12-06043 Doc# 37 Filed 03/13/13 Page 9 of 23
under Bankruptcy § 550 and K.S.A. 33-2078 because NCMIC benefitted from the
transfers. NCMIC seeks summary judgment on Count V, but not on Count IV. The
Trustee acknowledged at oral argument that Count V is an alternative to Count IV, since
the total recovery from NCMIC under Counts IV and V is capped at $5,682,083.97.
A. The Positions of the Parties.
In Count V, the Trustee contends, assuming the Operating Expense Transfers and
the Other Lender Transfers are set aside as fraudulent, that they may be recovered from
NCMIC as a “transfer beneficiary” under § 550(a)(1) since it was “the entity for whose
benefit such transfer was made.” The Complaint alleges the payment of the franchisees’
expenses benefitted NCMIC “because it enabled the agents to continue operating and
thereby preserved the underlying collateral value which secured” NCMIC’s loans and
“because, in certain instances, it enabled underperforming agencies to become profitable
and thereby continue making monthly loan payments to NCMIC without additional
‘subsidization’ by Brooke Capital.”9 At oral argument, counsel for the Trustee
unequivocally stated that the theory of recovery under Count V is that the transfers
benefitted NCMIC in three respects: (1) the collateral for the participated loans held by
8 Despite the allegation that the transfers may be recovered under K.S.A. 33-207, the Trustee did
not raise this state law remedy in response to NCMIC’s motion for summary judgment. The Court finds
that reliance on K.S.A. 33-207 to support a right to relief against NCMIC under Count V has been
9 Dkt. 1, Complaint ¶103.
Case 12-06043 Doc# 37 Filed 03/13/13 Page 10 of 23
NCMIC remained viable and intact; (2) NCMIC continued to get loan payments because
the franchisees continued in business; and (3) NCMIC was paid face value by Aleritas
when it repurchased some participation interests while the loans were performing and not
in default. NCMIC responds that as a matter of law the Trustee cannot recover from it as
a transfer beneficiary because: (1) the Trustee has not avoided, and cannot now avoid
(because of the statute of limitations), the transfers made to the initial transferees; and
(2) NCMIC is not “the entity for whose benefit such transfer was made” under
B. NCMIC Is Not Entitled to Summary Judgment on the Theory that the
Trustee Has Not Avoided the Transfers.
The Court finds that NCMIC’s first argument is without merit. NCMIC argues,
based upon the decision of the Tenth Circuit Court of Appeals in Slack-Horner, 10 that the
Trustee may not recover the transfers from NCMIC because he has not avoided the
transfers from Brooke to the third parties. NCMIC also argues that any such avoidance
action would now be time barred.
In Slack-Horner, as a result of the debtor’s failure to pay property taxes, the taxes
became a lien on the debtor’s real property. The lien was sold at a public sale to Simons.
When the debtor failed to timely redeem, Simons received a treasurer’s deed. The debtor
filed for relief within one year, and the trustee brought an action alleging that the transfer
of the property to Simons was voidable as a fraudulent conveyance. Both the bankruptcy
10 Weinman v. Simons (In re Slack-Horner Foundries Co.), 971 F.2d 577, 580 (10th Cir. 1992).
Case 12-06043 Doc# 37 Filed 03/13/13 Page 11 of 23
court and the district court found the trustee could not avoid the transfer. On appeal, the
Tenth Circuit affirmed. Contrary to the trustee’s characterization of the transfer to be
avoided as being between the debtor and Simons, the Tenth Circuit held that the debtor’s
interest was transferred from the debtor to the state at the public sale and the state then
transferred the state’s interest to Simons. Therefore the state was the initial transferee
under the § 550, and Simons was considered an immediate transferee of the initial
transferee. The Tenth Circuit then held that although § 550 authorized the trustee in
certain circumstances to recover the value of the property transferred from either the
initial transferee or a subsequent transferee, “in order to recover from a subsequent
transferee the trustee must first have the transfer of the debtor’s interest to the initial
transferee avoided under §548.”11 Since the trustee had made no attempt to have the
transfer from the debtor to the state avoided, the trustee could not demonstrate any basis
for recovering the property from Simons. Slack-Horner therefore stands for the rule that
avoidance of the initial transfer is necessary before the transfer can be recovered from a
But Slack-Horner does not apply to this case. There are three categories of
persons from whom recovery can be made under § 550(a): (1) the initial transferee;
(2) the party for whose benefit the transfer was made; and (3) any immediate or mediate
transferee of the initial transferee (subsequent transferees). Slack-Horner applies to
11 Id. at 580.
Case 12-06043 Doc# 37 Filed 03/13/13 Page 12 of 23
subsequent transferees. In this case, the Trustee seeks to recover the transfers from
NCMIC as a transfer beneficiary, not as a subsequent transferee. The Court declines to
extend Slack-Horner to transfer beneficiaries. As this Court has previously observed,
Slack-Horner is a minority position, and the argument that it was wrongly decided is
attractive.12 Further, the Trustee is not seeking to recover from NCMIC without an
adjudication that the transfers are avoidable; in Count V, the Trustee seeks both to avoid
the transfers as fraudulent transfers and to recover from NCMIC.
C. NCMIC Is Entitled to Summary Judgment Because as a Matter of Law
NCMIC Is Not a Transfer Beneficiary.
NCMIC’s next argument, that as a matter of law, it is not a transfer beneficiary of
the third-party payments, has merit.
The phrase “the entity for whose benefit the transfer was made” is ambiguous.
Must the transferor intend to confer a benefit on the transferee? What type of benefit
must be received? How directly must it be related to the avoided transfer? The Code
does not define the conditions for transfer-beneficiary liability, there is no relevant
legislative history, and the liability of a person for whose benefit the transfer was made
had not been codified in prior bankruptcy law. Nevertheless, prior to enactment of the
Code, “[c]ourts . . . permitted trustees to recover from nontransferees who had received
12 Reiderer v. Logan Wildlife Corp. (In re Brooke Corp.), 443 B.R. 847, 853-55 (Bankr. D. Kan.
Case 12-06043 Doc# 37 Filed 03/13/13 Page 13 of 23
the actual benefit of the transfers.”13 Preference recovery was permitted “from
guarantors, sureties, or indorsers of notes even though such parties were not transferees
and had not taken any action to procure payment to the holder of the debt.”14 As to
fraudulent transfers, courts allowed recovery from benefitted parties, but courts “applying
pre-Code law steadfastly rejected attempts by bankruptcy trustees to impose liability on
parties merely because they had conspired with, or aided and abetted, the debtor.”15
Mack v. Newton, 16 a 1984 Fifth Circuit Court of Appeals decision, is an example.
The case concerned the financing of a dairy cattle operation, Dairyland Inc. The trustee
alleged that two principals of Dairyland and Equico, a lender to Dairyland and Dairy
Cows, another business controlled by the Dairyland principals, were liable for the
fraudulent transfer of Dairyland cows mortgaged to Equico where the proceeds were not
applied to the Dairyland secured debt. A jury found in favor of the trustee. On appeal,
the Fifth Circuit considered the right of the trustee to recover the value of the fraudulent
transfers from the principals and Equico. The court started its analysis by stating the
general rule under the Act that “one who did not actually receive any part of the property
fraudulently transferred . . . will not be liable for its value, even though he may have
13 Larry Chek and Vernon O. Teofan, The Identity and Liability of the Entity for Whose Benefit a
Transfer Is Made Under Section 550(a): An Alternative to the Rorschach Test, 4 J. Bankr. L. & Prac. 145,
15 Id. at 151.
16 Mack v. Newton, 737 F.2d 1343 (5th Cir. 1984).
Case 12-06043 Doc# 37 Filed 03/13/13 Page 14 of 23
participated or conspired in the making of the fraudulent transfer.”17 It approvingly
quoted the following rationale for this rule from the Ninth Circuit’s decision in Elliott:
The purpose of those sections of the Bankruptcy Act
which are here relevant is clearly to preserve the assets of the
bankrupt; they are not intended to render civilly liable all
persons who may have contributed in some way to the
dissipation of those assets. The Act carefully speaks of
conveyances of property as being ‘null and void,’ and
authorizes suit by the trustee to ‘reclaim and recover such
property or collect its value.’ The actions legislated against
are not ‘prohibited’; those persons whose actions are rendered
‘null and void’ are not made ‘liable’; and terms such as
‘damages’ are not used. The legislative theory is cancellation,
not the creation of liability for the consequences of a wrongful
It then noted that there is “an exception to the general Elliott rule for those cases in which
a person does not actually directly receive the transferred property, but nevertheless
indirectly receives it or receives its proceeds or value.”19 Applying these considerations
to the Dairyland transfers, the court affirmed a judgment against the principals and
Equico with respect to 188 cows mortgaged to Equico which were transferred from
Dairyland to Dairy Cows and thereafter sold by Dairy Cows to third parties, with the
proceeds going to Equico and being applied to Dairy Cows’, rather than Dairyland’s,
debt. However, it reversed the judgment as to 275 Dairyland cows mortgaged to Equico
17 Id. at 1357.
18 Elliott v. Glushon, 390 F.3d 514, 516 (9th Cir. 1967); quoted in Mack v. Newton, 737 F.2d at
19 737 F.2d at 1358.
Case 12-06043 Doc# 37 Filed 03/13/13 Page 15 of 23
which were sold at auction to third parties by Dairyland for cash which was deposited in
the Dairyland bank account and used in its operations, rather than to pay its debt to
Equico. The Fifth Circuit rejected the trustee’s argument that although the defendants did
not receive the proceeds, they “received a benefit from the fact that these funds helped
Dairyland continue to operate.”20 It stated:
[S]uch a benefit does not suffice to take the situation out of
the Elliott rule. . . . The exceptions are essentially consistent
with this “disgorging” approach: one must return what one
has wrongfully received. The Trustees’s theory is
inconsistent with this: it is based on an incidental,
unquantifiable, and remote benefit bearing no necessary
correspondence to the value of the property transferred or
received. Hence it essentially is no more than “the creation of
liability for the consequences of a wrongful act.”21
The enactment of § 550(a)(1) of the Bankruptcy Code codified the concept that
one who benefitted from an avoided transfer may be liable to the estate, even though the
person or entity was not the recipient of the transferred property. The archetypical
example of an “entity for whose benefit such transfer was made” occurs where the debtor
pays its creditor and thereby reduces the personal liability of a guarantor of the debt.22
Even though the guarantor does not receive the payment, the guarantor gets the benefit of
the transfer because the guarantor’s liability has been extinguished by the payment.
20 Id. at 1359.
21 Id. at 1359-1360.
22 E.g., Bonded Fin. Servs., Inc. v. European Am. Bank, 838 F.2d 890, 895 (7th Cir. 1988); Terry
v. Meredith (In re Meredith), 527 F.3d 372, 375 (4th Cir. 2008); Reily v. Kapila (In re International
Mgmt. Assocs.), 399 F.3d 1288, 1292 (11th Cir. 2005).
Case 12-06043 Doc# 37 Filed 03/13/13 Page 16 of 23
“[N]othing in the text of § 550(a)(1) limits ‘the entity for whose benefit’ the transfer was
made only to a debtor or guarantor.”23
The issue here is to determine and apply the criteria for liability of a transfer
beneficiary under § 550(a)(1). There are no Tenth Circuit Court of Appeals or
Bankruptcy Appellate Panel decisions construing “the entity for whose benefit such
transfer was made” as used in § 550(a)(1). Both the Trustee and NCMIC direct the Court
to the McCook decision, which rejects intent to benefit as sufficient for transfer
beneficiary liability, and holds that “transfer beneficiary status depends on three aspects
of the ‘benefit’: (1) it must actually have been received by the beneficiary; (2) it must be
quantifiable; and (3) it must be accessible to the beneficiary.”24 The disgorgement-based
understanding of recovery, as discussed in Mack, is the basis for each of these three
elements. When requiring an actual benefit and not merely intent to benefit, the McCook
decision cited Mack and agreed with the observation of commentators that “fraudulent
transfer recovery is a form of disgorgement, so that no recovery can be had from parties
who participated in a fraudulent transfer but did not benefit from it.”25 The requirement
23 Meredith at 375; see also Citicorp N. Am., Inc. v. Official Comm. of Unsecured Creditors (In re
TOUSA, Inc.), 680 F.3d 1298, 1313 (11th Cir. 2012) (reduced liability of guarantor when debt is paid is
“not the only circumstance that can give rise to ‘for whose benefit’ liability”).
24 Baldi v. Lynch (In re McCook Metals, L.L.C.), 319 B.R. 570, 590 (Bankr. N.D. Ill. 2005).
When presenting its written arguments, NCMIC contended that debtor intent to benefit the transfer
beneficiary was also a necessary element. Dkt. 17 at 16-27. But at oral argument, NCMIC’s counsel did
not pursue that position and stated that upon further examination of the case law, he no longer understood
intent to benefit to be a necessary element. The Court therefore does not address the relevance of intent.
25 Id. at 591 (citing Chek and Teofan, The Identity and Liability of the Entity for Whose Benefit a
Transfer Is Made, 4 J. Bankr. L. & Prac. at 169).
Case 12-06043 Doc# 37 Filed 03/13/13 Page 17 of 23
that the benefit be quantifiable was described as a “corollary to the disgorgement-based
requirement . . . . A merely theoretical benefit is not sufficient since it would not be
subject to disgorgement.”26 Likewise the accessible benefit requirement follows from the
disgorgement-based requirement, since “[e]ven if a quantifiable benefit is actually
received, it could not fairly be disgorged if the beneficiary never had access to it.”27
Turning to the facts before it, the bankruptcy court held that debtor McCook’s transfer to
another entity of the debtor’s contractual right to acquire a smelter, in an attempt to
protect this asset from the reach of McCook’s creditors, was a fraudulent transfer. As to
recovery, it applied the foregoing three criteria and held that Lynch, a man who controlled
both McCook and the transferee, was liable as the entity for whose benefit the transfer
was made. The court reasoned that Lynch received an actual benefit (his share of the
value of the assets on the date of transfer); that the benefit was quantifiable (since
testimony established a value of $11.1 million for the smelter); and that the value was
accessible (through Lynch’s control of the transferee).
As stated above, the Trustee’s theory of recovery is that NCMIC benefitted from
Brooke Capital’s transfers in three respects: (1) the collateral for the participated loans
held by NCMIC remained viable and intact; (2) NCMIC continued to get loan payments
because the franchisees continued in business; and (3) NCMIC was paid face value when
Aleritas repurchased some participation interests while the loans were performing and not
26 Id. at 591.
27 Id. at 592.
Case 12-06043 Doc# 37 Filed 03/13/13 Page 18 of 23
in default. In support of its summary judgment motion, NCMIC argues that the benefit
allegations do not satisfy the McCook criteria. It contends that the Trustee’s “‘continuing
operations’ theory is based upon an alleged benefit to [NCMIC] that was, at best,
theoretical and amorphous” and that to the extent NCMIC benefitted at all, the benefit is
“neither quantifiable nor accessible” by NCMIC.28 The Trustee responds that the
transfers benefitted NCMIC because they “enabled NCMIC to continue receiving its
monthly loan payments because the other creditors did not take actions that would cause
the agency to cease operating.”29 According to the Trustee, the actual benefit is therefore
the monthly loan payments, which are both quantifiable and directly accessible because
they were received by NCMIC.
The Court will therefore examine each of the McCook aspects of benefit. The first
question is whether NCMIC actually received a benefit. This must be answered in light
of the disgorgement-based understanding of recovery of fraudulent transfers from those
benefitting from the transfer. The words “such transfer” in the phrase “the entity for
whose benefit such transfer was made” refers to the transfer avoided as a fraudulent
conveyance. Therefore, the benefit actually received must flow from the initial transfer
which is avoided.30 Here the transfers which the Trustee seeks to avoid are thousands of
28 Dkt. 17 at 24.
29 Dkt. 18 at 33-34. When making this argument in his written submission, the Trustee focuses
exclusively upon examination of a situation where an agency has sufficient funds to pay NCMIC’s loan
payments, but has insufficient revenues to make its other monthly payments. This is considered later in
30 Bonded Fin. Servs., 838 F.2d at 896.
Case 12-06043 Doc# 37 Filed 03/13/13 Page 19 of 23
transfers to creditors of hundreds of franchisees, whose loans from Aleritas were held by
NCMIC. The Trustee does not argue that NCMIC received a benefit from any single
transfer; he argues that the benefit derives from the cumulative effect of many transfers to
creditors of a franchisee. Under § 550(a)(1), it is the franchisees who benefitted from
“such transfers,” since as to each transfer, their liability to their creditors was diminished.
But under the Trustee’s continuation of business theory, NCMIC did not receive an actual
benefit from “such transfers” — the alleged benefit is a secondary result of the benefit to
the franchisees/agents. Also, under the Trustee’s continuation of business theory, the
second McCook requirement, that the benefit be quantifiable, is not satisfied.
Continuation of the franchisees/agents’ businesses is a theoretical and amorphous benefit
to which a monetary value related to the avoided transfers cannot be assigned. Likewise,
the benefit of continued operation of the franchises was not accessible to NCMIC. It
would not be fair to disgorge the transfers from NCMIC which benefitted, if at all, only
indirectly from the cumulative effect of the transfers.
In the Trustee’s brief opposing summary judgment, rather than relying upon the
general allegation that the benefit to NCMIC was the continuation of the
franchisees/agents’ businesses, as alleged in the Complaint and repeated at oral argument,
the Trustee focuses upon a more specific situation which he contends would satisfy each
of the McCook requirements. He states:
To illustrate the “indirect benefit” that NCMIC
received it is necessary to consider a situation where an agent
generates sufficient revenues to make its monthly loan
Case 12-06043 Doc# 37 Filed 03/13/13 Page 20 of 23
payments to NCMIC but has insufficient monies to pays its
remaining monthly obligations (including operating expenses
and monies owed to other lenders). In that scenario, Brooke’s
payments to the third-parties created a direct benefit to
NCMIC because [they] enabled NCMIC to continue receiving
its monthly loan payments because the other creditors did not
take actions that would cause the agency to cease operating.
Thus, the first element of the McCook decision is met —
NCMIC received an actual benefit (i.e., its monthly loan
payments) from the revenues generated by the
agent/franchisee. Moreover, the monthly loan payment was
quantifiable and it was directly accessible because it was
received by NCMIC (thereby satisfying the second and third
elements of the McCook decision).31
In a footnote to this explanation, the Trustee makes the argument that summary judgment
should not be granted because discovery is required. He states:
Quantifying the exact dollar amount of that benefit
necessarily requires a fact intensive, in-depth loan-by-loan
review which will depend upon the monthly loan payments to
NCMIC as well other monies that Brooke paid to third-parties
on behalf of each agent/franchisee. Additionally, this will
require a review of all monies received by NCMIC with
respect to each loan (including monthly loan payments as well
as monies from the sale of any participated interests). This in-
depth, loan-by-loan review cannot be completed without
discovery which the Trustee has already commenced.32
The Court finds that this scenario does not change the foregoing analysis that the
Trustee’s claim alleged in Count V does not satisfy the McCook requirements or provide
a basis to deny summary judgment because there are material facts in dispute. Recovery
from NCMIC under the scenario presented relies upon the aggregate effect of the
31Dkt. 18 at 33-34.
32 Id. at 34, n. 10.
Case 12-06043 Doc# 37 Filed 03/13/13 Page 21 of 23
allegedly fraudulent transfers to third-party creditors of the franchisees/agents. The
Trustee does not suggest that he would conduct discovery on a transfer-by-transfer basis.
And even if such an analysis were made, the making of a loan payment to NCMIC by an
agent/franchisee whose other creditors were paid would be the result of that
agent/franchisee’s independent decision to pay NCMIC; the third-party payments would
have made such payment possible but there would be no direct relationship between the
transfers and the payment to NCMIC. The alleged benefit to NCMIC would not “derive
directly from the transfer”33 and would bear “no necessary correspondence to the value of
the property transferred or received.”34 As stated by the Trustee, the transfers would have
simply “enabled” the payments to NCMIC. To adopt the Trustee’s theory would
dramatically expand the scope of § 550(a)(1) liable parties beyond those against whom
the disgorgement-based theory of recovery is applicable.
For the foregoing reasons, the Court finds that, assuming the Operating Expense
Transfers and the Other Lender Transfers from Brooke Capital to third-party creditors of
the franchisees/agents who were liable on the notes in which NCMIC held participation
interests are avoidable as fraudulent transfers, NCMIC is not liable to the Trustee under
§ 550(a)(1) as an entity for whose benefit such transfers were made. There are no
33 Turner v. Phoenix Fin., LLC (In re Imageset, Inc.), 299 B.R. 709, 718 (Bankr. D. Me. 2003)
(citing Bonded Fin. Servs., 838 F.2d at 896).
34 Mack v. Newton, 737 F.2d at 1360.
Case 12-06043 Doc# 37 Filed 03/13/13 Page 22 of 23
material facts in controversy, and NCMIC is entitled to judgment as a matter of law on
Count V of the Complaint.
The foregoing constitutes Findings of Fact and Conclusions of Law under Rule
7052 of the Federal Rules of Bankruptcy Procedure which makes Rule 52(a) of the
Federal Rules of Civil Procedure applicable to this proceeding.
IT IS SO ORDERED.
# # #
Case 12-06043 Doc# 37 Filed 03/13/13 Page 23 of 23