The Seventh Circuit wrote an opinion to explain why the “clear and convincing” standard of proof for a turnover action that prevailed under the former Bankruptcy Act was replaced by a “preponderance of the evidence” standard on adoption of the Bankruptcy Code in 1978.
The mother of a chapter 7 debtor held undisputed, legal ownership of 50% of an evidently valuable, privately owned corporation. The trustee commenced a turnover action against the mother under Sections 541 and 542, alleging that the mother was only a nominee and that the daughter-debtor was the equitable owner of the half-interest in the corporation.
Bankruptcy Judge Donald R. Cassling of Chicago held a three-day trial and ruled in favor of the trustee, finding that the trustee had shown by a preponderance of the evidence that the daughter-debtor was the equitable owner.
The district court affirmed, and so did Circuit Judge Michael B. Brennan in an opinion on April 27.
Who Has the Burden of Proof?
On appeal, the mother contended that Judge Cassling should have employed the standard of “clear and convincing” evidence before ordering turnover. The mother cited cases to that effect under the former Bankruptcy Act, which was superseded by the Bankruptcy Code in 1978.
Before delving into the proper standard of proof, Judge Brennan recited the rules governing burden-shifting in turnover actions. He said that the trustee has the initial burden to make a prima facie case for turnover. Then, the defendant must show reason for going forward, but the ultimate burden of persuasion remains with the trustee.
While federal law determines what is property of the estate, interests in property are controlled by state law, in the absence of controlling federal law.
The Standard Under the Prior Bankruptcy Act
Judge Brennan explained that turnover was a judicially created summary proceeding under the Bankruptcy Act. He said it “was created to effectuate the Bankruptcy Act, which imposed criminal sanctions” for concealing and obstructing the collection of estate assets.
“Given the background of criminal sanctions,” Judge Brennan said, “courts imposed a stringent clear and convincing evidence standard, like the one imposed in a case of fraud in a court of equity.”
The Standard Changes Under the Code
Judge Brennan said that the Bankruptcy Code “no longer includes criminal sanctions.” He therefore said that the rule under the Bankruptcy Act “at best . . . provides only guidance as to the new statutory framework.”
For authority on today’s standard governing turnovers, he took counsel from Grogan v. Garner, 498 U.S. 279 (1991), which dealt with dischargeability of a debt for actual fraud. In Grogan, he explained how the Supreme Court held that “the presumptive standard of proof under [the Bankruptcy Code] is the preponderance standard governing civil actions generally[,] . . . in the absence of an express or implied standard of proof in the Bankruptcy Code.”
Judge Brennan said that “the Supreme Court’s reasoning applies just as well to turnovers under Sections 542 and 541.”
Like Section 523(a)(2)(A) in Grogan, Judge Brennan said that Sections 541 and 542 do not prescribe a standard of proof. He concluded that the “imposition of a higher standard no longer exists in the Bankruptcy Code.”
Next, Judge Brennan inquired as to whether there were individual interests requiring a higher standard of proof. In the case on appeal, he saw “no particularly important individual interests” on the question of the ownership of property. The case, he said, was only about money.
“Without statutory direction to favor one interest over another,” Judge Brennan held, “the default preponderance of evidence standard governs for Section 542 turnovers unless the estate’s theory for property turnover prescribes a heightened standard.”
Looking into Section 542, Judge Brennan said:
Congress did not express a policy that a nominee titleholder’s interest overcomes a creditor’s or another third party’s interest. With congressional silence on the issue, we presume the relevant interests are in parity.
Still, Judge Brennan said that “a question remains as to whether the estate’s nominee theory for turnover requires a higher standard of proof than preponderance.”
Citing the Second, Ninth and Eleventh Circuits and the Collier treatise, Judge Brennan concluded that “courts have uniformly held — albeit in different contexts — that a preponderance standard applies in determining nomineeship.”
Affirming Bankruptcy Judge Cassling, Judge Brennan held that “the bankruptcy court applied the correct standard” of preponderance of the evidence.
The Seventh Circuit wrote an opinion to explain why the “clear and convincing” standard of proof for a turnover action that prevailed under the former Bankruptcy Act was replaced by a “preponderance of the evidence” standard on adoption of the Bankruptcy Code in 1978.
The mother of a chapter 7 debtor held undisputed, legal ownership of 50% of an evidently valuable, privately owned corporation. The trustee commenced a turnover action against the mother under Sections 541 and 542, alleging that the mother was only a nominee and that the daughter-debtor was the equitable owner of the half-interest in the corporation.
Bankruptcy Judge Donald R. Cassling of Chicago held a three-day trial and ruled in favor of the trustee, finding that the trustee had shown by a preponderance of the evidence that the daughter-debtor was the equitable owner.
The district court affirmed, and so did Circuit Judge Michael B. Brennan in an opinion on April 27.