A Subchapter V trustee in Orlando, Fla., was removed for an undisclosed conflict of interest, denied compensation, and ordered to disgorge what he had been paid, but he was not removed from his other trusteeships.
In her August 17 opinion, Bankruptcy Judge Lori V. Vaughan said that the Subchapter V trustee had been “openly and actively adverse to the Debtor” since the “beginning of the case.” She said that the “very intent and purpose of [the] SBRA is thwarted when the trustee is conflicted, as he was in this case.”
The Subchapter V trustee in Judge Vaughan’s case is also a chapter 7 panel trustee. The office of the U.S. Trustee in the Middle District of Florida declined to say whether the office would or would not appoint that individual in new chapter 7 cases.
The ‘Sub V’ Trustee for the LLC
The debtor was a limited liability corporation that owned two parcels of real estate. The debtor claimed that the properties were worth between $1.3 million and $1.5 million. The secured lender with a $1 million claim was “likely over-secured,” Judge Vaughan said.
Before bankruptcy, the secured lender had begun foreclosure and obtained an order from state court directing that rental income be paid to the lender. The debtor then filed a chapter 11 petition under Subchapter V, and the U.S. Trustee appointed the Subchapter V trustee, whom we shall refer to as the trustee.
The trustee filed a statement saying that he was “disinterested” as defined in Section 101(14).
The debtor filed a plan promising to pay all creditors in full.
In papers along with the petition, the debtor disclosed that its owner was another corporation that a husband and wife owned as tenants by the entireties. The papers also disclosed that the husband was the manager of the corporate owner.
The Conflict
Before the debtor’s bankruptcy, a small airline had also filed a chapter 11 petition before another judge in Florida. The husband had signed the petition as the airline’s chairman of the board. Three months before the real estate owner’s bankruptcy, the trustee appeared in the airline’s bankruptcy as counsel for a creditor with two $25 million unsecured claims for alleged misappropriation of trade secrets.
Before the airline’s bankruptcy, the creditor had sued the airline and the husband individually in federal district court.
As counsel for the creditor of the airline debtor, the trustee had filed a motion to modify the automatic stay. The bankruptcy court permitted the suit to proceed in district court against the husband but not against the airline.
The airline confirmed a chapter 11 plan. The husband remained in the airline’s management and became the trustee of the airline’s liquidation trust.
Judge Vaughan characterized the trustee as having “actively represented” the creditor in the airline case and “appeared in most hearings.”
While the trustee was representing his client in the airline case, Judge Vaughan said that “the Trustee simultaneously served as the subchapter V trustee in this case. The Trustee pursued an active role in this case — usually adversarial to the Debtor and indirectly to [the husband].”
Judge Vaughan recounted how the trustee on two occasions moved for dismissal of the real estate owner’s chapter 11 case, taking sides with the secured creditor. In at least one trial, the trustee examined the husband and introduced documents into evidence.
The trustee sought dismissal on the grounds that the debtor was a single-asset debtor not eligible for relief in Subchapter V. Judge Vaughan ruled against the trustee and allowed the case to proceed under Subchapter V.
In addition, the trustee opposed confirmation of the debtor’s plan, contending that the bankruptcy was a two-party dispute that should be dismissed for a bad-faith filing. The trustee filed a final application for about $12,000 in compensation.
The debtor responded in part by claiming that the trustee was not disinterested.
In sum, Judge Vaughan was confronted with a disputed confirmation hearing and a motion to remove the trustee for a conflict rendering him not disinterested.
The Rule on Disinterest
The outcome turned on Section 101(14)(C), which defines a disinterested person as someone who
does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor, or for any other reason.
Judge Vaughan overruled the trustee’s principal argument attempting to explain why he was disinterested.
The trustee contended that the husband did not own the debtor. Rather, the debtor was owned by another corporation in which the husband’s ownership interest was as a tenant by the entireties. Because the husband allegedly had no individual interest in the Subchapter V debtor, the trustee contended that he was not an equity security holder referenced in Section 101(14)(C).
Judge Vaughan rejected the argument, calling it “overly simple and strictly technical.” She said that trustees must avoid even the appearance of impropriety and be divested of “‘any scintilla of personal interest which might be reflected in his decisions concerning estate matters,’” quoting Matter of Codesco, Inc., 18 B.R. 997, 999 (Bankr. S.D.N.Y. 1982).
The trustee’s arguments, Judge Vaughan said,
ignore the substance of his conflict and the purpose of the disinterested person requirement. [The husband] is an owner and manager of the Debtor, even if his interest is indirect. For purposes of disinterest, the concern is whether the person holds an interest in the entity as equity and not the form of ownership. [The husband] has an interest in [the debtor’s corporate owner] and is directly impacted by its success or failure even if he and [his wife] hold the interest as tenants by the entireties.
Judge Vaughan went on to say that the husband’s equity interest was “directly impacted,” even if his ownership was as a tenant by the entireties. Moreover, Florida law provides that each tenant “hold the entire property.”
In short, indirect ownership “does not change the result,” Judge Vaughan said. “Simply put, an attorney who is adverse to the Debtor’s principal in another case cannot serve as the subchapter V trustee.”
“The Trustee’s representation of [the creditor] in the [airline] bankruptcy makes him materially adverse to an equity security holder — [the husband] — meaning he is not a disinterested person.”
The Role of a Subchapter V Trustee
Judge Vaughan continued by elucidating the unique role of a Subchapter V trustee and what appears to be a heightened need for disinterestedness.
A Subchapter V trustee “plays a different” role from other trustees and “is the only trustee directed to ‘facilitate the development of a consensual plan,’” Judge Vaughan said. [Emphasis in original.] By comparison, other trustees typically come in conflict with debtors and creditors.
Judge Vaughan pointed to the handbook for Subchapter V trustees, which says that a “principal duty” of a Subchapter V trustee is to facilitate a consensual plan. She divined that a Subchapter V trustee should be “less adversarial” and “act[] more like a mediator than an adversary.”
By comparison, Judge Vaughan said that the trustee “was openly and actively adverse” to the debtor from “the beginning of the Debtor’s case.” She said that the trustee took several positions adverse to the debtor, even though the plan proposed paying all claims in full.
Judge Vaughan summed up:
Instead of trying to bring the parties together — to facilitate a consensual plan — the Trustee has spent his time thwarting the Debtor’s efforts to reorganize and taking the side of the secured creditor. This is not the role of a subchapter V trustee.
Judge Vaughan concluded that the trustee’s actions were “at odds with his duties under Section 1183.” She deduced “that this is due to the Trustee’s existing adverse relationship” with the husband.
Denial of All Compensation
Judge Vaughan found cause to remove the trustee because he was not disinterested and held “a material adverse interest against the equity security holder in this case.” She therefore removed him as trustee in the case.
In view of the conflict, Judge Vaughan found that the trustee’s “fees were not reasonable or necessary” and were “not reasonably likely to benefit the Debtor’s estate.” They “only hindered the process,” she said.
Judge Vaughan denied any fees sought by the trustee and ordered disgorgement of fees he already had been paid.
Judge Vaughan abated consideration of confirmation of the debtor’s plan pending a review of the case by a new Subchapter V trustee.
Trustee Not Removed Across the Board
According to a government website, the trustee is a chapter 7 panel trustee in the Middle District of Florida, thus invoking Section 324(b). Whenever a trustee has been removed “in a case under this title,” the section provides that “such trustee . . . shall thereby be removed in all other cases under this title in which such trustee or examiner is then serving unless the court orders otherwise.”
The following day, the U.S. Trustee filed a motion for clarification, asking Judge Vaughan to say whether the trustee should be removed in all cases. Judge Vaughan responded by entering an order stating that the trustee was not removed in other cases.
Commentary
“This is the most blatant conflict of interest I could imagine” John K. Olson told ABI. “I cannot imagine how the former trustee could have argued with a straight face that he was disinterested — or how the U.S. Trustee could have allowed the trustee to proceed.”
Mr. Olson was a bankruptcy judge who retired after serving a term on the bench in Fort Lauderdale, Fla.
ABI asked the office of the U.S. Trustee in Orlando to comment on why the U.S. Trustee had not taken a position on the alleged conflict of interest and whether the office intends to appoint the trustee in new chapter 7 cases. The office responded by saying, “The USTP respectfully declines to comment.”
Prof. Nancy Rapoport said that the opinion “is important for two reasons: It’s a great analysis of disinterestedness generally, and it ties in the special role of a Subchapter V trustee.” Prof. Rapoport is the Garman Turner Gordon Professor of Law at the Univ. of Nevada at Las Vegas William S. Boyd School of Law and an expert on ethics in bankruptcy cases.
A Subchapter V trustee in Orlando, Fla., was removed for an undisclosed conflict of interest, denied compensation, and ordered to disgorge what he had been paid, but he was not removed from his other trusteeships.
In her August 17 opinion, Bankruptcy Judge Lori V. Vaughan said that the chapter 13 trustee had been “openly and actively adverse to the Debtor” since the “beginning of the case.” She said that the “very intent and purpose of [the] SBRA is thwarted when the trustee is conflicted, as he was in this case.”
The Subchapter V trustee in Judge Vaughan’s case is also a chapter 7 panel trustee. The office of the U.S. Trustee in the Middle District of Florida declined to say whether the office would or would not appoint that individual in new chapter 7 cases.