Who Gets to Keep the Money: Sometimes Procedural Arguments Can Matter as Much as Substantive Arguments

Allison v. Centris Fed. Credit Union (In re Tri-State Financial, LLC), 885 F.3d 528 (8th Cir. 2018) –

A Chapter 11 trustee brought a proceeding to determine ownership of ~$1.2 million. Initially the bankruptcy court held that the funds were not property of the bankruptcy estate. After an appeal, a remand, a change in judges, a new opinion, and further appeals, the case ended up before the Eighth Circuit. In addition to the substantive issue, the procedural issues relating to the extent to which a judge may revisit decisions made earlier in the case became a focal point.

After another debtor (TSE) filed a Chapter 11 bankruptcy, a group of investors formed a new entity (TSF) solely to finance TSE’s operations until a plan could be approved. The group transferred $2 million to TSF, which in turn transferred ~$800,000 to TSE and $1.19 million to one of TSE’s vendors. TSF subsequently filed a Chapter 11 bankruptcy.

The TSF Chapter 11 trustee was able to recover $1.19 million from TSE, but the investor group contended that the funds were not part of the TSF bankruptcy estate and demanded return of the funds. So, the trustee brought a proceeding seeking determination of ownership of the funds.

The investor group claimed that TSF was merely holding the funds in trust. On the other hand, the trustee and a secured creditor claimed that the investors had released any claims they might have had to the funds, and they were a judicially estopped from claiming any interest.

Representatives of the investors group testified that when they transferred the funds to TSF they understood that the funds would be held in trust. In contrast, a forensic accountant expressed the opinion that the funds should be treated as equity. The bankruptcy judge found that TSF held the funds in trust, and thus they were not part of the bankruptcy estate.

On appeal the Bankruptcy Appellate Panel (BAP) reversed and remanded since the bankruptcy judge had not addressed the claims release or judicial estoppel issues. The BAP did not reach the issue of ownership of the funds since it considered it was premature.

On remand the case was reassigned to another judge since the original judge had retired. The new judge found that it was more likely than not that the $2 million was originally intended as a capital contribution to TSF. But later after TSE’s plan is not approved, the funds were treated as a loan. Thus, discounting the witness testimony as self-serving and relying primarily on documentary evidence, the judge held that the funds were loan proceeds and part of the bankruptcy estate.

The case then made another round to the BAP and back on procedural grounds. The investors argued that the new judge should not have revisited the original factual findings. They claimed that by doing so the judge exceeded the mandate on remand and violated the law of the case doctrine. They also contended that the judge failed to comply with federal rules applicable to a successor judge which require the successor judge to certify familiarity with the record and to provide an opportunity to recall witnesses.

Although the BAP rejected the first argument, it remanded to permit the new judge to comply with the procedures required in the case of a successor judge. On remand an order was entered with the required certification and the parties were given an opportunity to identify any witnesses they wished to recall. Once again, the investors appealed, this time to the district court – which affirmed. Onward and upward to the Eighth Circuit.

The Eighth Circuit began by addressing the procedural issues. When a case has been appealed and remanded, everything decided at the appellate level – both expressly and by implication – is finally settled, creating a mandate for the lower court. However, the lower court is free to address matters that were not disposed of on appeal.

Under the law of the case doctrine, once a rule of law is decided, that decision continues to govern for the rest of the case. However, when there is an appeal and remand, the lower court is bound by its prior decisions only to the extent that they were adopted explicitly or implicitly by the appellate court. Since the BAP did not adopt the findings that the funds were held in trust, the successor judge was entitled to revisit the issue.

On the substantive issue, bankruptcy courts look to state law to determine the nature and extent of a debtor’s interest in property. Under applicable state law, the creation of a trust and its terms must be established by clear and convincing evidence. This means “evidence which produces in the trier of fact a firm belief or conviction about the existence of a fact to be proved.”

Although there was some evidence in the record that indicated the funds were to be held in trust, there was other evidence that the funds were not held in trust. There was no documentary evidence referencing a trust, defining duties of the trustee, or identifying TSF as a trustee. Instead there was evidence that the funds were initially intended to be a capital contribution, and then later treated as a loan.

In addition, when TSF filed a claim in TSE’s bankruptcy, it filed in its own name as opposed to as a trustee on behalf of the investors. None of the investors objected to TSF’s claim, and none of the investors filed individual claims. Accordingly, the successor judge’s findings were not clearly erroneous, and the district court was affirmed.

This case is a reminder that procedural matters are important. You may not be able to reach the substantive issues if procedural requirements are not satisfied.

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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