CIVIL NO. 5:05-CV-145, BANKR. CASE 94-21308, ADVERSARY NO. 02-0001.
May 17, 2008
Pending before this Court is an appeal of a judgment issued by the United States Bankruptcy Court. Louise Andrews appeals the decision to equitably subordinate her claim and the decision not to equitably subordinate Cadleway Properties' (Cadle) claim. Cadle appeals the decision to allow Louise Andrew's claim.
STANDARD OF REVIEW
In a bankruptcy appeal, the district court reviews findings of fact for clear error and issues of law de novo. Fed.R.Bankr.P. 8013; Wells Fargo Bank of Texas N.A. v Sommers (In re Amco Ins.), 444 F.3d 690, 694 (5th Cir. 2006), citing Total Minatome Corp. v. Jack/Wade Drilling, Inc. (In re Jack/Wade Drilling Inc.), 258 F.3d 385, 387 (5th Cir. 2001). A fact finding constitutes clear error "when although there is evidence to support it, the reviewing court on the entire evidence is left with a firm and definite conviction that a mistake has been committed." In re Missionary Baptist Foundation of America, 712 F.2d 206, 209 (5th Cir. 1983) (citing United States v. United States Gypsum Co., 333 U.S. 364, 395 (1948)). However, "[w]hen a finding of fact is premised on an improper legal standard, or a proper one improperly applied, that finding loses the insulation of the clearly erroneous rule." Id. (citingSmith v. Hightower, 693 F.2d 359 (5th Cir. 1982)).
ANALYSIS Cadle's Claim
The bankruptcy court did not err in refusing to equitably subordinate Cadle's claim. Ms. Andrews had argued that Cadle's litigation tactics were sufficiently vexatious to warrant equitable subordination of Cadle's claim. In denying equitable subordination, the bankruptcy court held that Cadle was not an insider, that Ms. Andrews therefore had a substantial burden to show sufficiently egregious conduct, and that, while Cadle's tactics might have been "overly aggressive," they were not sufficiently vexatious and for Cadle's own advantage to justify equitable subordination. Memorandum Opinion at 14, 18.
If the debtor is an individual, an "insider" is either a relative of the debtor, a partnership in which a debtor is a general partner, a general partner of the debtor, or a corporation in which the debtor is a director, officer, or person in control. 11 U.S.C. 101(31) (2004). The bankruptcy court found no evidence that Cadle qualified as any of these. Ms. Andrews asserts that Cadle became an "insider" after its attorney was appointed a special counsel to the Trustee. At most, this is an argument that Cadle became a fiduciary as to the estate. Ms. Andrews would still have the burden of proving conduct warranting equitable subordination.
It is unclear whether vexatious litigation tactics alone may qualify as grounds for equitable subordination in the Fifth Circuit, where equitable subordination is only used sparingly. In re Fabricators, Inc., 926 F.2d 1458, 1464 (5th Cir. 1991). The claimant must have engaged in inequitable conduct which resulted in injury to other creditors or an unfair advantage to the claimant, and equitable subordination may not be inconsistent with the provisions of the Bankruptcy Code. In re Mobile Steel Co., 563 F.2d 692,700 (5th Cir. 1977). Equitable subordination has primarily been limited to three categories: "(1) when the fiduciary of a debtor misuses his position to the disadvantage of other creditors; (2) when a third party controls the debtor to the disadvantage of other creditors; and (3) when a third party actually defrauds other creditors." In re United States Abatement Corp., 39 F.3d 556, 561 (5th Cir. 1994). In arguing that a claim can be equitably subordinated for vexatious litigation tactics, Ms. Andrews relies first onCiticorp Venture Capital, Inc., Ltd. v. Committee of Creditors Holding Unsecured Claims. 323 F.3d 228 (3rd Cir. 2003). In that case, a director of a bankrupt company, an insider, attempted to purchase, at a discount and without disclosure, assets of the bankrupt corporation in order to gain a significant profit at the expense of other creditors. See id. at 231. That scenario would fall into the first Mobile Steel Category, and is not the same as the situation in this case. Here, as the bankruptcy court noted, Cadle was not an insider, and its actions appear to be directed towards increasing the entire value of the estate, thus benefitting all creditors rather than just improving its own position.
Among the allegedly vexatious litigation tactics cited by Ms. Andrews are that Cadle's counsel represented both the Trustee and Cadle at the same time, disregarding a conflict of interest; that Cadle gained "leverage" over its counsel, forcing him to work on a contingent basis, thus prolonging Cadle's pursuit of the Andrews by making the pursuit inexpensive for Cadle; that Cadle attempted to use its counsel to purchase claims from the Trustee for significantly less than it demanded to settle them; and that Cadle irrationally pursued and appealed various claims.
The bankruptcy court considered each of these grounds and held that Ms. Andrews had not met her high burden of proving misconduct. With regard to the double representation, testimony in the record reflected that Cadle's counsel only served as special counsel to the Trustee on the fraudulent transfers issue in the bankruptcy case. The general counsel for the Trustee testified that, on that issue, he viewed Cadle's interests and those of the Trustee as being aligned, not in conflict. Trial Transcript, Vol. I, Day 1, p. 31. He also stated that he did not think that the representation of Cadle's counsel had been inadequate. Id. at p. 77. The special counsel was also court-approved, and there is no evidence to suggest that the representation was not fully disclosed. As the bankruptcy court pointed out, there is also no evidence to suggest that Cadle's objections and appeals were only made possible because of Cadle's counsel's position as special counsel. Based on this evidence, the bankruptcy court's findings were not clearly erroneous.
With regard to the alleged "leverage" by Cadle over its attorney and the effect of the fee arrangement on the representation, the bankruptcy judge held that Ms. Andrews had failed to produce sufficient evidence. Ms. Andrews alleged unspecified "leverage" based solely on the fact that Cadle's attorney represented Cadle on a contingent basis. The bankruptcy court's finding that this evidence was insufficient was not error.
With regard to Cadle's attempt to purchase the claims for significantly less than it later demanded in settlement, the bankruptcy court noted that Cadle "never demanded more than [it] was owed," and "had no duty to settle at a discount." Memorandum Opinion at 16-17. Cadle had a legal right to attempt to purchase the claims, and it could justifiably demand full payment as a settlement. In addition, Ms. Andrews produced no evidence of specific damage to the estate based on this conduct. The bankruptcy court's refusal to equitably subordinate on this bases was not clear error.
Ms. Andrews asserts several times that Cadle threatened the Trustee with suit if he settled the case for less than Cadle's preferred settlement amount. However, the only evidence produced was a letter which made no explicit threats. Memorandum Opinion at 17. The letter did state that Ms. Andrews might sue Cadle for malicious prosecution under certain circumstances, and that Cadle would expect the Trustee, in his official and personal capacity, to defend it and hold it harmless for damages, but the bankruptcy court found this evidence insufficient to qualify as a "threat." Id. That finding was not clear error.
Ms. Andrews makes several allegations of abuse of the judicial process. First, she alleges that Cadle filed a groundless motion to recuse Bankruptcy Judge Schmidt and that witness Dan Cadle alleged bias and incompetence on the part of bankruptcy judges, particularly Bankruptcy Judge Leal, in his deposition. She alleges that these actions indicated disrespect of the judiciary.
Dan Cadle's comments on bias and incompetence came in response to questions by Ms. Andrews' attorneys. The bankruptcy court refused to penalize Cadle for Dan Cadle's truthful response to questions in a deposition. See Memorandum Opinion at 16. This Court agrees with the bankruptcy court that "it cannot be appropriate to penalize a citizen for responding to a deposition question with his unfortunate view of the facts." Memorandum Opinion at 16. This decision did not constitute error.
Finally, Ms. Andrews argues that Cadle should be equitably subordinated for prosecuting claims it did not own, including filing and appealing a second lawsuit in the Western District of Texas without permission. Ms. Andrews alleges the following multi-part scheme. First, Cadle's counsel, acting as special counsel, persuaded the Trustee and the court to authorize the sale of a RICO claim against the Andrews. Cadle then filed a new RICO suit in the Western District of Texas, though the same claims were already pending in the original bankruptcy proceeding. In the new suit, Cadle named one of the Andrews' attorneys as a party, but did not disclose this fact until its counsel (still special counsel for the Trustee) arrived at a court-ordered settlement mediation. Naming an attorney as a party torpedoed the Trustee's attempt to settle in mediation, and the estate was forced to trial. In the meantime, Bankruptcy Judge Leal revoked the order authorizing the sale of the RICO claim to Cadle. However, Cadle continued to prosecute and appeal that claim as if it owned it until the suit was finally dismissed. This alleged scheme thus resulted in a five-year delay. Id. at 46.
The bankruptcy judge viewed Cadle's behavior as the company's aggressive pursuit of remedies that would benefit the estate as a whole. See Memorandum Opinion at 16-17. His interpretation of the facts was different from that of Ms. Andrews. This Court cannot say that the bankruptcy court's interpretation was clearly erroneous.
Ms. Andrews argues that the bankruptcy court improperly excluded evidence that established the full extent of Cadle's misuse of the judicial system. Specifically, the bankruptcy court excluded evidence of a Texas arrest warrant for Dan Cadle concerning Cadle's debt collection practices, published opinions condemning Cadle's use of claim switching to mislead parties in bankruptcy about the ownership of claims, contempt orders of other courts concerning Cadle's litigation practices, and additional evidence about the recusal of various bankruptcy judges in this case. See Trial Transcript, Vol. II, Day 2, p. 6-30, 34-36, 40, 63-64. The bankruptcy judge excluded this evidence on relevancy grounds. See id. A trial court's exclusion of evidence, when questioned on appeal, is reviewed for abuse of discretion. United States v. Pace, 10 F.3d 1106, 1115 (5th Cir. 1993). Most of the contested evidence offered by Ms. Andrews on this point dealt with conduct by Cadle in other bankruptcy cases, introduced to show bad actions by Cadle in this case. The bankruptcy court's decision to exclude was not an abuse of discretion. Excluding additional evidence about Cadle's efforts to recuse bankruptcy judges in this case also was not an abuse of discretion, since the fact that Cadle had sought to have them recused was already in record. In sum, the bankruptcy judge properly refused to equitably subordinate Cadle's claim.
The bankruptcy court allowed Louise Andrews' claim, but equitably subordinated it. In equitably subordinating Andrews' claim, it appears that the bankruptcy court based its decision, in part, on matters that were outside the pleadings and outside the trial record. It is unclear whether the bankruptcy court's consideration of these matters affected the bankruptcy court's decision to equitably subordinate Ms. Andrews' claim. This issue is remanded to the bankruptcy court for reconsideration.
Appellant Andrews argues that the Trustee's settlement of claims moots this appeal. This issue was not brought before the bankruptcy court, since the settlement appeal was still pending at the time of the bankruptcy court's decision. On remand, the bankruptcy court should also comment on the effect of the settlement on this case.
The decision not to equitably subordinate Cadle's claim is AFFIRMED. The decision to equitably subordinate Andrews' claim is REMANDED. This Court also asks the bankruptcy court to comment on the effect of the Trustee's settlement of claims on the instant case.