Even if it may not prevail, a debtor’s objection to the claim of a dominant unsecured creditor can prevent that creditor from voting for the election of a hand-picked chapter 7 trustee, as shown in an opinion by Bankruptcy Judge Elizabeth L. Gunn of Washington, D.C.
Judge Gunn’s September 23 opinion doubles as a handbook laying out the procedures for ruling on the validity of a contested election of a chapter 7 trustee. As Judge Gunn said, “Chapter 7 trustee elections are rare.”
On the eve of foreclosure, the corporate debtor filed a chapter 11 petition. The secured lender was evidently in league with the dominant unsecured creditors.
The debtor in possession initiated an adversary proceeding against the dominant unsecured creditors, which together held 75% of the unsecured claims. The complaint made allegations of fraud, seeking damages and rescission of the underlying contract.
About three months later, the bankruptcy court modified the automatic stay, allowing the lender to foreclose. On motion by the dominant unsecured creditors, the bankruptcy court converted the case to chapter 7. An interim trustee was appointed.
The dominant unsecured creditors filed proofs of claim. At a meeting of creditors, they sought the election of a trustee under Section 702. The U.S. Trustee presided over the ensuing election, where the dominant unsecured creditors voted for their favored candidate, whom we shall call the elected trustee.
The principals of the debtor objected to the removal of the interim trustee and challenged the voting eligibility of the dominant unsecured creditors. Unable to certify the election of the elected trustee, the U.S. Trustee filed a report with Judge Gunn outlining the election and the objections.
Judge Gunn decided that the dominant unsecured creditors were ineligible to vote and were thus ineligible to request an election. No valid election having been held, she ruled that the interim trustee would continue as the permanent trustee.
Judge Gunn began by laying out the standards for voting eligibility under Section 702(a). A creditor may vote only if the creditor (1) has an “allowable, undisputed, fixed, liquidated, unsecured claim;” (2) does not have “an interest materially adverse . . . to the interest of creditors entitled to such distribution,” and (3) is not an insider. In addition, Bankruptcy Rule 2003(b) also requires a voting creditor to have filed a claim.
Of course, the principals were ineligible to vote, although they held unsecured claims. The dominant unsecured creditors contended that the principals were also barred from objecting to the election.
Judge Gunn observed that the Bankruptcy Code does not say who may dispute an election. She allowed the principals to object to the election, because there was “no doubt that they are interested parties as managing members and equity holders of the Debtor.”
Next, Judge Gunn dealt with the eligibility of the dominant creditors to vote.
The dominant creditors were seemingly eligible to call for a vote because they held far more than 20% of the amount of eligible claims required by Section 702(a).
Still, the dominant creditors would be ineligible to vote if they held an “interest materially adverse,” a term not defined in the statute. In that regard, a trustee elected by creditors would take over prosecution of the adversary proceeding against the dominant creditors.
By “actually controlling a choice of a trustee,” Judge Gunn said that the dominant creditors “may enhance their recovery or subvert the post-election administrative process.”
If the dominant creditors could vote, Judge Gunn said,
they would be able to handpick the trustee and their opponent in the adversary proceeding. This undoubtedly creates a conflict of interest between the estate and the [dominant] Creditors.
Pursuing the issue further, Judge Gunn said that a trustee’s success in the adversary proceeding could “drastically reduce” the pool of unsecured claims. She therefore held that the dominant creditors did not meet the requirements of Section 702(a)(2) and were ineligible to vote.
Given that the dominant creditors were ineligible to vote, they likewise were not entitled to request an election under Section 702(b). Thus, no valid election was held, allowing the interim trustee to continue as the permanent trustee.
Observation
A footnote by Judge Gunn is noteworthy.
She said that the elected trustee was a “panel” chapter 7 trustee in the district and that his “qualification, professionalism, and ethics are not in question.”
In other words, electing a panel trustee does not allow a creditor to vote who is otherwise ineligible in view of an adverse interest.
Even if it may not prevail, a debtor’s objection to the claim of a dominant unsecured creditor can prevent that creditor from voting for the election of a hand-picked chapter 7 trustee, as shown in an opinion by Bankruptcy Judge Elizabeth L. Gunn of Washington, D.C.
Judge Gunn’s September 23 opinion doubles as a handbook laying out the procedures for ruling on the validity of a contested election of a chapter 7 trustee. As Judge Gunn said, “Chapter 7 trustee elections are rare.”
On the eve of foreclosure, the corporate debtor filed a chapter 11 petition. The secured lender was evidently in league with the dominant unsecured creditors.
The debtor in possession initiated an adversary proceeding against the dominant unsecured creditors, which together held 75% of the unsecured claims. The complaint made allegations of fraud, seeking damages and rescission of the underlying contract.
About three months later, the bankruptcy court modified the automatic stay, allowing the lender to foreclose. On motion by the dominant unsecured creditors, the bankruptcy court converted the case to chapter 7. An interim trustee was appointed.