KSB

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

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

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

 

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


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

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


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

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


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

BACKGROUND FACTS.

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

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

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

4 Doc. 81.

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

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

5 Doc. 112 at 1.

6 Doc. 129-1, exh. A.

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

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in Kansas until July 1, 2014.

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

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

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


K.S.A. 17-7307(a), which requires foreign corporations to register to do business in the state, much as
K.S.A. 17-76,126(a) does for limited liability companies).
10 Id., 24 Kan App. 2d at 378, 946 P.2d at 1010.
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the dismissal with prejudice and remanded with directions to dismiss the counterclaim
without prejudice, but noted that Ledar bore the risk that the statue of limitations might
run before it was properly registered. The court stated:

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

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

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


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

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

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

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


348 (1949); 6A Charles Alan Wright, Arthur R. Miller & Mary Jane Kane, Federal Practice and
Procedure, § 1542 at 469 (2010).
17 See Doc. 27 at 10 (Debtor’s Schedule F, listing Eagle Woods as an unsecured nonpriority
creditor).
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of capacity under Kansas law, resulting from its failure to register as a foreign limited
liability company as of the time it filed its proof of claim and continuing until after the
claims bar date in bankruptcy court, requires a finding that Eagle Woods lacked the
capacity to file its proof of claim.

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

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

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

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

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

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

Bankruptcy Rule 7017 also applies in contested matters.

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

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

Prepetition, Tudor Oaks Limited Partnership obtained a judgment against debtor

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

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

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

court rejected this argument, stating:

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

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

For these reasons it is quite evident that while Tudor

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

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

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

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

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

22 Id. at 276-277.

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

24 Id. at 511.

25 Id. at 512.

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

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

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

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

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

CONCLUSION.

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

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

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

IT IS SO ORDERED.
# # #


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13-22232 Rock (Doc. # 43)

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

PDFClick here for the pdf document.


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

 

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


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

OPINION DENYING DEBTOR’S REQUEST FOR ATTORNEY FEES

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

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


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

Facts

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

7See Beaumont, 586 F.3d at 781.
8Peterson Distributing, 82 F.3d at 960 (quoting University Medical Ctr. v. Sullivan (In re
University Medical Ctr.), 973 F.2d 1065, 1081 (3d Cir.1992)).
9Peterson Distributing, 82 F.3d at 960.
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UHCSB that this case cannot be distinguished from In re Beaumont10 on any relevant
basis. In Beaumont, the Tenth Circuit held that the Department of Veteran Affairs (VA)
did not violate either the automatic stay or the discharge injunction by reducing the
debtor’s ongoing benefits under a VA disability program in order to recover a prepetition
overpayment of benefits, even though it continued with the reduction after the debtor filed
bankruptcy and after he received a discharge. The debtor was a disabled veteran who had
been receiving disability benefits for eight years when he was given a large probate
distribution. Pursuant to federal statutes, the debtor’s VA benefits were subject to being
reduced if he received any payments from any other source, including an inheritance.
After learning of the inheritance, the VA advised the debtor that it had determined the
probate distribution had made him ineligible for his VA benefits for a period of time,
which meant he had received an overpayment of $18,448 in benefits, and that the VA
intended to collect that amount by offsetting his future disability payments, as was
expressly permitted by statute. The debtor responded by filing for bankruptcy relief, and
the VA continued to offset his benefits during the bankruptcy proceeding and after he
received a discharge. The debtor contended this conduct violated the automatic stay and
the discharge injunction. The Tenth Circuit disagreed.

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

10586 F.3d 776.
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obligation to pay benefits was and is contingent upon
Plaintiff’s financial situation, his annual income, and his
responsibility to keep the Defendant informed of his financial
situation. Plaintiff’s inheritance had the effect of reducing the
amount of benefits he could receive from the Defendant.
Therefore, Plaintiff’s inheritance was directly related to or
intertwined with the amount of benefits Defendant was
obligated to pay to him, and the resulting overpayment of
benefits. It is unlawful for Plaintiff to keep any overpayments
so long as the Defendant, through its own administrative
procedures, has properly determined the amount of
overpayment and properly considered Plaintiff’s disagreement
with that determination. The Court believes that it would be
inequitable for the Plaintiff to receive his inheritance,
continue to receive benefits as if his income was zero, then be
able to discharge in bankruptcy the overpayments once it was
determined that he had been overpaid.11

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

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

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

determined she had been overpaid.

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

unfortunate ongoing health problems and financial condition should convince the Court

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

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

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

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

11 Id. at 781.

8

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


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

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

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

13739 F.2d 870 (1984).

9

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


action violated the automatic stay, saying,

Social welfare payments, such as social security, are statutory

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

payments is to provide income to qualifying individuals. Although the

paying agency can ordinarily recover overpayments, just as creditors can

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

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

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

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

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

14Id. at 876.
10


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


Conclusion

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

11

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

10-06225 Redmond, Brooke Trustee v. Brooke Holdings, Inc. et al (Doc. # 228)

Redmond, Brooke Trustee v. Brooke Holdings, Inc. et al, 10-06225 (Bankr. D. Kan. Sep. 12, 2014) Doc. # 228

PDFClick here for the pdf document.


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

 

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


In Re:

BROOKE CORPORATION, et al.,
DEBTORS.

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

PLAINTIFF,

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

 DEFENDANTS.

CASE NO. 08-22786
CHAPTER 7

ADV. NO. 10-6225

MEMORANDUM OPINION AND ORDER GRANTING
DEFENDANTS STEVEN AND WANDA SCHMIDT’S MOTION TO
FILE AMENDED (SUPPLEMENTAL) ANSWER TO COMPLAINT,
AND ALLOWING THE TRUSTEE ADDITIONAL TIME FOR DISCOVERY


Case 10-06225 Doc# 228 Filed 09/12/14 Page 1 of 6


In this action, the Trustee seeks to avoid allegedly preferential transfers and
constructively fraudulent conveyances made by Debtor Brooke Corporation (Brooke
Corp) to Defendant Brooke Holdings, Inc. (BHI) and to recover part of those avoided
transfers from Defendants Steven and Wanda Schmidt (the Schmidts) under 11 U.S.C.
§ 550 as subsequent transferees of BHI. The Schmidts request leave of the Court under
Federal Rule of Bankruptcy Procedure 7015 to file an amended answer asserting the goodfaith-
transferee defense of § 550(b)(1).1 The Trustee opposes the motion.2 Argument was
held on June 18, 2014. For the reasons stated below, the Court grants the motion.3

PROCEDURAL BACKGROUND.

The complaint was filed on October 26, 2010. The Schmidts’ original answer was
filed on May 2, 2011. It did not assert a defense under § 550(b)(1). On August 13, 2013,
the Schmidts’ present counsel entered his appearance. Pursuant to the scheduling order,
the deadline for the parties to amend their pleadings expired two days later. After several
extensions of time, discovery closed on April 3, 2014, and on the same day, the Trustee
filed his motion for summary judgment against the Schmidts and BHI. On May 16, 2014,

1 The Schmidts appear by J. Michael Morris of Klenda Austerman LLC.

2 The Trustee appears by Michael D. Fielding of Husch Blackwell LLP.

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

2

Case 10-06225 Doc# 228 Filed 09/12/14 Page 2 of 6


the due date for the Schmidts to respond to the motion for summary judgment, the
Schmidts filed their motion for leave to amend their answer.

The Schmidts seek to amend their answer to add the following paragraph:

115. Steven R. and Wanda R. Schmidt further assert
that they are immediate or mediate transferees of the initial
transferee (BHI), and that any funds transferred to them from
BHI as alleged in the Complaint were taken for value, in good
faith, and without knowledge of the voidability of any transfer
avoided. The trustee may, therefore, have no recovery from
them pursuant to 11 USC § 550(b)(1).
The Schmidts argue that no prejudice will result to the Trustee by the amendment since he
had actual notice of the defense and has conducted discovery on it. The Trustee opposes
the motion. He responds that the Schmidts have not shown any cause to amend the
scheduling order that set the deadline to amend pleadings. He also argues that the
Schmidts unduly delayed in seeking the amendment, that he would be prejudiced by the
amendment, and that the amendment, if allowed, would be futile.

DISCUSSION.
Two bankruptcy procedural rules are applicable, Rule 7016 and Rule 7015. Rule
7016 adopts Civil Rule 16, Pretrial Conferences; Scheduling; Management. Subsection

(b) of Rule 16 addresses scheduling, and subsection (b)(4) addresses modification of a
scheduling order. It provides: “(4) Modifying a Schedule. A schedule may be modified
only for good cause and with the judge’s consent.” Rule 7015 adopts Civil Rule 15,
Amended and Supplemental Pleadings. Subsection (a) of Rule 15 provides:
(a) Amendments Before Trial.
3

Case 10-06225 Doc# 228 Filed 09/12/14 Page 3 of 6


(1) Amending as a Matter of Course. A party may amend its
pleadings once as a matter of course within:
(A) 21 days after serving it, or
(B) if the pleading is one to which a responsive pleading is
required, 21 days after service of a responsive pleading or 21
days after service of a motion under Rule 12(b), (e), or (f),
whichever is earlier.
(2) Other Amendments. In all other cases, a party may amend its
pleading only with the opposing party’s written consent or the court’s
leave. The court should freely give leave when justice so requires.
Of the two rules, Rule 16 sets the more stringent standard, authorizing amendment of the
scheduling order only for “good cause.” Rule 15 provides that leave to amend pleadings
should be freely given when justice so requires. “Refusing leave to amend is generally
only justified upon a showing of undue delay, undue prejudice to the opposing party, bad
faith or dilatory motive, failure to cure deficiencies by amendments previously allowed, or
futility of amendment.”4

Three factors combine to convince the Court that the amendment should be allowed
under these standards. First, the affirmative defense of § 550(b)(1) is essential to the
Schmidts’ defense. Absent the ability to assert the defense, the Schmidts will be strictly
liable to the Trustee if they are subsequent transferees of funds BHI received in an avoided
transfer from Brooke Corp. Second, the Court finds that the Trustee had notice that the
Schmidts intended to rely upon the defense, even though it was not alleged in their answer.
At argument on the Schmidts’ motion, although the Trustee stated he could find no

4 Frank v. U.S. West, Inc., 3 F.3d 1357, 1365 (10th Cir.1993).
4


Case 10-06225 Doc# 228 Filed 09/12/14 Page 4 of 6


correspondence regarding the defense, he did not dispute having notice that the Schmidts
would assert the defense. Questions posed to the Schmidts in depositions taken by the
Trustee include those relevant to the defense. Third, the deadlines established in the
scheduling order in this case for matters other than the filing of amended pleadings have
been extended numerous times upon the request of the Trustee.

The Court therefore finds that there is cause to amend the scheduling order as
requested by the Schmidts. The Court finds no bad faith or dilatory conduct of the
Schmidts. The assertion of the Schmidts’ counsel, who did not prepare the initial answer,
that he believed the defense had been alleged until he received and reviewed the Trustee’s
motion for summary judgment is credible. As set forth in the Court’s separate
memorandum opinion and order denying the Trustee’s motion for summary judgment, the
Court finds that allowing the amendment will not be futile.

Any prejudice to the Trustee that might result from the amendment can be avoided
by allowing the Trustee to engage in any additional discovery which he deems appropriate
in light of this ruling allowing the § 550(b)(1) defense. The Court therefore extends the
discovery deadline for the Trustee to 60 days after the entry of this memorandum opinion
and order for the sole purpose of developing facts related to the §550(b)(1) defense. The
Schmidts may not conduct additional discovery.

The Schmidts’ motion for leave to amend their answer to add the paragraph as
stated in their motion is granted. The Trustee is granted 60 days from the entry of this
order to conduct additional discovery relevant to the newly-added affirmative defense.

5

Case 10-06225 Doc# 228 Filed 09/12/14 Page 5 of 6


IT IS SO ORDERED.

# # #

6

Case 10-06225 Doc# 228 Filed 09/12/14 Page 6 of 6

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

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

PDFClick here for the pdf document.


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

 

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


In Re:

BROOKE CORPORATION, et al.,
DEBTORS.

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

PLAINTIFF,

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

DEFENDANTS.

CASE NO. 08-22786
CHAPTER 7

ADV. NO. 10-6225

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


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


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

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


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

3 Doc. 176.

4 Doc. 215.

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

2

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


Schmidts.

UNCONTROVERTED FACTS.
Procedural History.

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

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

3

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


as the deadline for filing dispositive motions.

Relationship of Defendants.

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

Brooke Corp Loan Repayments and Dividend Payments to BHI.

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

6 Doc. 176-4 at 4.

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

4

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


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

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

BHI Transfers to the Schmidts.

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

Avoidance of Transfers from Brooke to BHI.

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

5

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


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

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

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

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

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


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


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

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

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

7

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


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

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

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

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


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

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


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

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

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

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

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


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


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

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

16 Id., § 2741 at 412.

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


18 Id.

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


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


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

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

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

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

20 Doc. 189 at 5.
11


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


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

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

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

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

12

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


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

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

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

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

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

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

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


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

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

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

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

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

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


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

14

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


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

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

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

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

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

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

15

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


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

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

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

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

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

35 Id., § 68.

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

16

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


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

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

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

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

37 Id. at 743-44.

17

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


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

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

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

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


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

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


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

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

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

IT IS SO ORDERED.
# # #


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

13-06094 Rajala, Chapter 7 Trustee v. National Association of Postal Supervisors Branch (Doc. # 46)

13-06094 Rajala, Chapter 7 Trustee v. National Association of Postal Supervisors Branch (Bankr. D. Kan. Jul. 11, 2014) Doc. # 46

PDFClick here for the pdf document.


 

SO ORDERED.
SIGNED this 11th day of July, 2014.

 

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


In Re:

ROSEMARY ANN KROUSE,
DEBTOR.

ERIC C. RAJALA, Chapter 7 Trustee,
PLAINTIFF,

v.
NATIONAL ASSOCIATION OF
POSTAL SUPERVISORS BRANCH 458,
DEFENDANT.

CASE NO. 13-20356
CHAPTER 7

ADV. NO. 13-6094

MEMORANDUM OPINION AND ORDER
GRANTING THE PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT AND
DENYING THE DEFENDANT'S MOTION FOR SUMMARY JUDGMENT


In this adversary proceeding, Plaintiff Eric C. Rajala, Chapter 7 Trustee (Trustee),
seeks to avoid under 11 U.S.C. § 548(a)(1)(B) and recover under § 550(a) a transfer of

Case 13-06094 Doc# 46 Filed 07/11/14 Page 1 of 13


$15,000 made by Debtor to Defendant National Association of Postal Supervisors Branch
458 (NAPS) immediately before the filing of Debtor’s bankruptcy petition. Both the
Trustee and NAPS have moved for summary judgment. The relevant facts are
uncontroverted. The motions present the legal question whether the Trustee may avoid as
a fraudulent transfer a prepetition payment of funds which Debtor could have claimed as
exempt if the transfer had not been made. For the reasons examined below, the Court
concludes that the Trustee may avoid such a transfer. The Court has jurisdiction.1

UNCONTROVERTED FACTS.

Debtor signed her voluntary petition under Chapter 7 on February 15, 2013, and
her counsel filed it on February 20, 2013, at 3:03 pm. One of the assets listed on Debtor’s
Schedule B is “life insurance proceeds US Bank” valued at $147,000.

On February 8, 2013, Debtor received a check from the Office of Federal
Employee’s Group Life Insurance for $147,670.77, representing the proceeds of Debtor’s
claim for life insurance arising from the death of her husband on December 31, 2012. On
February 8, 2013, Debtor deposited the check into her US Bank savings account. On the
morning of February 20, 2013, before the petition was filed, Debtor purchased two

1 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 Amended Standing Order of Reference of the United States
District Court for the District of Kansas that exercised authority conferred by § 157(a) to refer to the
District’s bankruptcy judges all matters under the Bankruptcy Code and all proceedings arising under the
Code or arising in or related to a case under the Code, effective June 24, 2013. D. Kan. Standing Order
13-1, printed in D. Kan. Rules of Practice and Procedure at 168 (March 2014). 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)(H). There is no objection to venue or jurisdiction over the parties.

2

Case 13-06094 Doc# 46 Filed 07/11/14 Page 2 of 13


cashier’s checks from US Bank for a total of $67,350. One cashier’s check, in the
amount of $51,750, was made payable to Wanda O’Brien for payment of Debtor’s
husband’s debt to Ms. O’Brien. Debtor delivered the check to Ms. O’Brien, who
deposited it into her US Bank checking account on February 20, 2013, at 11:45 a.m.,
several hours before Debtor’s petition was filed. The second cashier’s check, in the
amount of $15,600, was made payable to NAPS for payment of Debtor’s husband’s debt
to NAPS. Debtor delivered the check to NAPS, which deposited it into its Brotherhood
Bank checking account on February 20, 2013, at 2:30 p.m., approximately one-half hour
before Debtor’s petition was filed. Neither the transfer to Wanda O’Brien nor the transfer
to NAPS was disclosed by Debtor in her schedules or statement of financial affairs filed
on February 20, 2013. As a result of the purchases of the cashiers’ checks, when
Debtor’s petition was filed at 3:03 p.m. on February 20, 2013, she had in her US Bank
account net life insurance proceeds of $80,320.77.

On her Schedule C, Debtor claimed $147,000 to be exempt under K.S.A. 602313(
a)(7). The Trustee objected to the exemption of the portion of the life insurance
proceeds which had been transferred prepetition. The Court sustained the objection and
ruled that the exemption is limited to $80,320.77, the amount of the life insurance
proceeds in Debtor’s possession when the Chapter 7 petition was filed.

Debtor’s schedules showed $153,301 owed to creditors, real property valued at

3


Case 13-06094 Doc# 46 Filed 07/11/14 Page 3 of 13


$60,690 (subject to a secured claim of $52,514),2 and personal property valued at
$152,556, comprised primarily of the $147,000 life insurance proceeds,3 only $80,320.77
of which was in her possession. After investigation, the Trustee determined that as of the
filing date, Debtor’s nonexempt property consisted of nonexempt funds in her bank
accounts of $1,219.26 and a 1994 Ford Van 150 Econoline having a fair value of $750.4
In its reply brief filed out of time,5 NAPS states that the amount owed to Debtor’s
creditors and the value of Debtor’s nonexempt assets are controverted, but provides
nothing of evidentiary value in support. The Court will therefore regard as
uncontroverted that on the date Debtor filed her petition, she owed her creditors $153,301
and had non-exempt property valued at $1,969.26.

DISCUSSION.

The Trustee seeks to avoid the payment to NAPS under § 548(a)(1)(B). It

provides:

(a)(1) The trustee may avoid any transfer . . . of an

interest of the debtor in property . . . that was made . . . on or

within 2 years before the date of filing of the petition, if the

debtor voluntarily or involuntarily —

. . .

(B)(i) received less than a reasonably equivalent value

in exchange for such transfer . . . ; and

2 Case no. 13-20356, Doc. 1 at 7, Schedule A.
3 Id. at 8-12, Schedule B.
4 Doc. 37 at 5.
5 Doc. 38 (filed on May 29, 2014, more than 21 days after the Trustee filed a memorandum in


support of his motion for summary judgment on April 25, 2014).
4

Case 13-06094 Doc# 46 Filed 07/11/14 Page 4 of 13


(ii) (I) was insolvent on the date that such transfer was
made . . . , or became insolvent as a result of such transfer.
This subsection allows a bankruptcy trustee to set aside constructively fraudulent
transfers — transfers which are not “infected by actual fraud”6 but are made by insolvent
debtors.
It permits avoidance if the trustee can establish (1) that the
debtor had an interest in property; (2) that a transfer of that
interest occurred within [two years] of the filing of the
bankruptcy petition; (3) that the debtor was insolvent at the
time of the transfer or became insolvent as a result thereof;
and (4) that the debtor received ‘less than a reasonably
equivalent value in exchange for such transfer.’7

The uncontroverted facts establish these elements. On February 20, 2013, Debtor
delivered a cashier’s check in the amount of $15,600 to NAPS to pay the debt of her late
husband to NAPS. The funds used to purchase the cashier’s check were proceeds of life
insurance paid to Debtor which had been deposited in a segregated account. NAPS
deposited the check into its checking account on February 20, 2013, at 2:30 pm,
approximately one-half hour before Debtor’s petition was filed. The facts therefore
establish that Debtor made a transfer of an interest in her property to NAPS, that the
transfer occurred less than two years prepetition, and that Debtor received less than a
reasonably equivalent value in exchange, since the debt was owed by Debtor’s late
husband, not by Debtor. Further, the facts establish that Debtor was insolvent on the date

6 BFP v. Resolution Trust Corp., 511 U.S. 531, 535 (1994).
7 Id.


5

Case 13-06094 Doc# 46 Filed 07/11/14 Page 5 of 13


of the transfer because Debtor’s debts then exceeded the value of all her nonexempt
property.

Even though all the elements of a constructively fraudulent transfer are present,
NAPS contends that the Trustee may not avoid the transfer because the funds transferred
were exempt proceeds of life insurance. NAPS argues, “Because the life insurance
proceeds received by the Debtor were exemptible property and not subject to the attacks
of creditors, the payment to NAPS could not be fraudulent as a matter of law under
§ 548(a).”8 NAPS relies on cases holding that a trustee cannot avoid such a transfer under
§ 548(a)(1)(A) because a transfer of exempt property cannot be made with the actual
intent to hinder, delay, or defraud creditors,9 and cases reasoning that to permit avoidance
“would allow the Debtor’s creditors to indirectly, through the trustee, defeat the Debtor’s
state law exemption . . . when they could not do this acting on their own.”10

The Trustee’s response is two fold.11 First, he contends that NAPS is in effect

8 Doc. 35 at 5.

9 Kepler v. Weis (In re Weis), 92 B.R. 816, 822-23 (Bankr. W.D. Wis. 1988) (transfer of exempt
property could not be avoided under § 548(a)(1) as a matter of law because transfer could not have been
made with actual intent to hinder, delay, or defraud creditors); Malone v. Short (In re Short), 188 B.R.
857 (Bankr. M.D. Fla. 1995) (transfer of homestead that was exempt at the time of transfer cannot be
avoided under § 548(a)(1) as having been made with the intent to hinder, delay, or defraud creditors).
After these cases were decided, § 548(a) was amended and § 548(a)(1) was redesignated as
§ 548(a)(1)(A). See Religious Liberty and Charitable Donation Protection Act of 1998, Pub. L. No. 105183,
§ 3(a), 112 Stat. 517 (1998), reprinted in App. F, Pt. 41(o), Collier on Bankruptcy, App. Pt. 41(o)(ii)
at App. Pt. 41-255 (Alan N. Resnick & Henry J. Sommer, eds.-in-chief, 16th ed. 2012).

10 Doc. 35 at 6 (citing Jarboe v. Treiber (In re Treiber), 92 B.R. 930, 933-34 (Bankr. N.D. Okl.
1988), Silagy v. Marzilli (In re Hunter), 2008 WL 2076750, *2 (Bankr. N.D. Ohio May 15, 2008); and
Rutledge v. Johansen, 270 F.2d 881, 882-83 (10th Cir. 1959)).

11 See doc. 37.

6

Case 13-06094 Doc# 46 Filed 07/11/14 Page 6 of 13


asserting Debtor’s exemption rights, that such rights are personal to Debtor, and NAPS is
therefore precluded from asserting that the exempt nature of the transferred funds bars the
Trustee’s complaint. For this position, the Trustee relies upon an unpublished decision of
the Tenth Circuit BAP.12 Second, the Trustee argues that the Court should reject those
decisions holding that Debtor’s prepetition transfer of exemptible property cannot be
avoided. The Trustee relies on case law13 and §§ 522(g)(1), 541(a)(1), and 522(b)(1) and
(b)(3).

NAPS has failed to address the Trustee’s first argument,14 but both parties have
fully briefed the question whether prepetition transfers of exemptible property are
amenable to avoidance and recovery actions by bankruptcy trustees. The Court will
resolve this case on its merits by ruling on this issue, rather than on the issue of NAPS’s
standing to assert Debtor’s exemption rights.

One of the cases cited by NAPS in support of its position that transfers of
exemptible property cannot be the object of avoidance actions is Rutledge, 15 a 1959
decision of the Tenth Circuit Court of Appeals, which would be very persuasive in this

12 Morris v. First Nat’l Bank and Trust (In re Taylor), 1998 WL 123027 (10th Cir. BAP March
19, 1998).

13 Id.; Tavenner v. Smoot, 257 F.3d 401 (4th Cir. 2001).

14 NAPS filed its own motion for summary judgment and brief in support (doc. 35) but failed to
timely reply to the Trustee’s response to NAPS’s motion and cross-motion for summary judgment (doc.
37). NAPS’s out-of-time reply (doc. 38) does not address Taylor, the case relied upon by the Trustee for
the proposition that NAPS is precluded from asserting the exempt nature of the funds.

15 270 F.2d 881.

7

Case 13-06094 Doc# 46 Filed 07/11/14 Page 7 of 13


case if it were still good law. In Rutledge, the bankruptcy trustee brought an action to
recover exempt homestead property that the debtor had transferred to a creditor for an
antecedent debt within four months preceding bankruptcy. The trial court found that all
elements of a voidable preference were present but held the transfer could not be avoided
because the property transferred was exempt under Oklahoma law. On appeal by the
trustee, the Tenth Circuit affirmed, applying the “textbook law . . . that ‘a transfer of
exempt property of a debtor, though it is to a creditor and to apply to an antecedent
indebtedness, does not give rise to a voidable preference.’”16 The Circuit noted that the
rule was “grounded in the legal concept that property exempt by law remains in the
bankrupt, does not pass to the trustee, and the bankrupt’s disposition of it prior to
bankruptcy is therefore of no concern to the trustee or the creditors he represents.”17 To
allow the avoidance of the preferential payment “would deny to the bankrupt the right to
accomplish before bankruptcy that which he could clearly do after bankruptcy. Surely, if
a bankrupt is entitled to have exempt property of which he is seized at the time of filing of
the bankruptcy set apart from the bankruptcy estate, he is entitled to make a valid transfer
of it prior to the date of the filing.”18 The Rutledge view has been referred to as the “no
harm, no foul” doctrine.19 Courts have applied the doctrine not only in preference actions

16 Id. at 882 (quoting Remington on Bankruptcy, Vol. 4, § 1678).
17 Id.
18 Id.
19 E.g., Tavenner v. Smoot, 257 F.3d at 406.


8

Case 13-06094 Doc# 46 Filed 07/11/14 Page 8 of 13


but also in actions to recover fraudulent conveyances of exempt property.20

This Court finds Rutledge not to be applicable. Since 1959, when Rutledge was
decided, the Bankruptcy Act that was then in effect has been repealed, and replaced with
the current Bankruptcy Code, enacted in 1978. An analysis of the Code shows the
invalidity of the “no harm, no foul” doctrine under current law. Contrary to the rationale
of Rutledge, § 541 now defines property of the estate to include all property of the debtor,
including property which the debtor may exempt. The estate also includes any interest in
property which the trustee recovers under § 550, which provides that to the extent a
transfer is avoided under §§ 544, 545, 547, 548, 553(b) or 724(a), the trustee may recover
such property or its value for the benefit of the estate. Section 522(g) allows the debtor to
exempt property so recovered by the trustee to the extent such property could have been
exempted if it had not been transferred, providing that the transfer was not a voluntary
transfer by the debtor and the debtor did not conceal such property. If transfers of
potentially exempt property could not be recovered by the trustee, no purpose would be
served by § 522(g). Under the Code, the avoidance of a debtor’s voluntary transfer of
property which the debtor could have exempted now augments the estate for the benefit
of all creditors. A voluntary transfer is in effect a waiver of the right to exempt the
property. In addition, under the Code, potentially exempt property may become available

20 Malone v. Short (In re Short), 188 B.R. 857, 859-60 (Bankr. M.D. Fla. 1995) (transfer of
homestead that was exempt at the time of transfer cannot be avoided as having been made with the intent
to hinder, delay, or defraud creditors); Kapila v. Fornabaio (In re Fornabaio), 187 B.R. 780, 782 (Bankr.

S.D. Fla. 1995) (although debtor transferred exempt property for less than reasonably equivalent value
when insolvent, the transfer could not be avoided by trustee).
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to creditors if the debtor fails to assert the exemption. The label “no harm, no foul” is
now a misnomer; to disallow avoidance may result in the diminution of the estate and be
contrary to the goal of making an equitable distribution to creditors.

The legislative history of the Code fully supports the rejection of the “no harm, no
foul” doctrine. In 1970, Congress created the Commission on the Bankruptcy Laws of
the United States to “study, analyze, evaluate, and recommend changes to the [1898
Bankruptcy] Act.”21 The Commission’s recommendations provided the basic structure of
the new Code that was enacted in 1978. Whereas under the Act, exempt property was not
included in the estate,22 the Commission recommended that the Code should provide for
the estate to include all property of the debtor on the date of filing, including property
which the debtor claims is exempt, and also include property which the trustee recovers
under § 550.23 One of the Commission’s recommendations was to overrule the cases
holding that “a transfer of exempt property cannot be a preference.”24 The report stated:

There is no valid reason supporting the case law that is being
overruled; the mere fact that the property used to prefer a
creditor may be claimed as exempt does not establish a reason
why preference attack is not appropriate. The goals of
equality and avoidance of unwise extensions of credit would
be furthered by allowing preference attack. The only rationale

21 Joint Resolution, Pub. L. 91-354, 84 Stat. 468-469 (July 24, 1970).
22 See Rutledge, 270 F.2d at 882.
23 11 U.S.C. § 541(a)(1) and (3).
24 Report of the Commission on the Bankruptcy Laws of the United States, July 1973, 93d Cong.,


1st Sess., H.R. Doc. 93-137, pt. I, at Ch. 8(E)(3)(c), reprinted in App. B, Pt. 4(c) Collier on Bankruptcy,
at App. Pt. 4-465.
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for the cases is that other creditors are not hurt since they are
not entitled to expect payment or security from exempt
property.25

Although cases decided since the adoption of the Code have not uniformly rejected
the “no harm, no foul” doctrine, the majority of cases has done so.26 In Tavenner 27 the
Fourth Circuit Court of Appeals noted the split of authority but found the “majority
position — that transfers of exemptible property are amenable to avoidance and recovery
actions by bankruptcy trustees — is better reasoned.”28 It did so for two reasons. First,
§ 522(g) anticipates this result, since it permits the debtor under certain circumstances to
exempt property recovered by the trustee. Second, the “no harm, no foul” approach is
misguided. “Under a statutory scheme in which all property is presumed to be part of the
bankruptcy estate, and no property is exempt until such time as the debtor claims an
exemption for it, creditors can be harmed by transfers of potentially exempt property
because it is not a foregone conclusion that such property will be exempt from the
estate.”29 The Tenth Circuit BAP, in an unpublished decision, held that the fact that the

25 Id.

26 Maxwell v. Barounis (In re Swiontek), 376 B.R. 851, 865 n. 8 (Bankr. N.D. Ill. 2007)
(collecting cases). One of the cases cited as adopting the majority view is Redmond v. Tuttle, 698 F.2d
414 (10th Cir. 1983), in which, without mentioning the “no harm, no foul” doctrine, the Tenth Circuit
ruled the debtors’ attempted exemption of property the trustee recovered that they had transferred
prepetition must be denied under § 522(g) because the transfer had been voluntary.

27 257 F.3d 401.

28 Id. at 406.

29 Id. at 407.

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debtors claimed a vehicle as exempt “did not affect the Trustee’s right to avoid the
Bank’s [unperfected] lien under section 544(a).”30 It relied upon §§ 541 and 522b) but
did not cite Rutledge or any cases either accepting or rejecting the “no harm, no foul”
doctrine.

This Court is persuaded that the majority is correct, and prepetition transfers of
property which the debtor could have claimed as exempt are avoidable by the trustee if
the elements of constructively fraudulent transfers under § 548(a)(1)(B) are satisfied. The
construction of §§ 541 and 522(g), together with the accompanying legislative history,
compel this result.

For the foregoing reasons, the Court declines to apply the “no harm, no foul”
doctrine to this action under § 548(a)(1)(B) and holds that the Trustee’s avoidance of
Debtor’s constructively fraudulent transfer to NAPS of $15,000 before she filed her
bankruptcy petition is not precluded because the funds transferred could have been
claimed as exempt if the transfer had not been made. The Trustee’s motion for summary
judgment is therefore granted, and NAPS’s motion for summary judgment is denied. The
Trustee may avoid the transfer to NAPS under § 548(a)(1)(B) and recover the same from
NAPS for the benefit of the estate under § 550(a).

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

30 In re Taylor, 1998 WL 123027 at *2.
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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.
# # #


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