Appeal from the United States Bankruptcy Court for the Central District of California Hon. Robin L. Riblet, Bankruptcy Judge, Presiding. Bk. No. ND 09-12110-RR.
The opinion of the court was delivered by: Montali, Bankruptcy Judge
Argued and Submitted on March 19, 2010 at Pasadena, California
Before: MONTALI, PAPPAS and BRANDT,*fn1 Bankruptcy Judges.
In this decision we revisit the heightened duty of a bankruptcy court to make an independent analysis and evaluation in the all too familiar situation of a trustee in bankruptcy selling to a defendant the estate's causes of action against that defendant. Our conclusion that such an analysis and evaluation should have been made in this case is bolstered by recent United States Supreme Court precedent reminding bankruptcy judges of their duty to make the inquiry regardless of the manner in which the parties have presented them with the question.
Debtor-Appellant, Frances Michael Fitzgerald ("Fitzgerald") appeals an order of the bankruptcy court authorizing the chapter 7*fn2 trustee-Appellee's ("Trustee") sale of certain assets of Fitzgerald's estate to Appellee, the John Leldon Gray Trust (the "Trust," collectively with Trustee, "Appellees"). For the foregoing reasons, we REVERSE the sale order.*fn3
A. Prepetition Background
Fitzgerald, a/k/a Michael Ninn, formed N Worx Media, Inc. ("NWM"), a company that owned and distributed adult films directed, edited, and produced by Fitzgerald. In June 2007, John Gray ("Gray"), as trustee of the Trust, approached Fitzgerald with a proposal to create a new corporation that would market and distribute Fitzgerald's library of films, and finance the production of future adult films. One month later, Fitzgerald and the Trust formed Ninn Worx SR, Inc. ("NWSR"), with Fitzgerald contributing to NWSR his 100% interest in NWM in exchange for $1,000 and a 49% interest in NWSR. The Trust owned the remaining 51% interest. Fitzgerald was appointed chief executive officer of NWSR, and continued to work as a film director.
The collaboration was short-lived. Fitzgerald was relieved of his duties as chief executive officer of NWSR on or around May 30, 2008. Relations between Fitzgerald and Gray further deteriorated and in August, 2008, NWSR sued Fitzgerald in Los Angeles County Superior Court for breach of fiduciary duty, tortious interference, and violation of the California Business and Professions Code ("State Court Action"). Fitzgerald filed a cross-complaint against NWSR, Gray, the Trust, and other third parties. NWSR demurred. Fitzgerald responded by filing an amended cross-complaint alleging ten causes of action, praying for damages of at least $1 million for each claim. NWSR again demurred. On February 25, 2009, the state court sustained the demurrer to eight of Fitzgerald's causes of action, granting him leave to amend all eight, and overruled the demurrer with respect to two causes of action: conversion and accounting. On or around March 17, 2009, Tim Riley ("Riley"), new counsel for Fitzgerald in the State Court Action, filed a second amended cross-complaint alleging various cross-claims (the "Cross-Claims") to which NWSR filed a demurrer and a motion to strike.
B. Postpetition Background
Assisted by bankruptcy attorney Elva Wallace ("Wallace"), Fitzgerald filed a chapter 7 petition on June 2, 2009. He did not list the Cross-Claims in his schedules, and valued his 49% interest in NWSR at $0.00. The section 341 meeting of creditors was scheduled for July 27, 2009. On June 22, 2009, NWSR filed in state court a Notice of Stay of Proceedings due to Fitzgerald's bankruptcy filing.
On July 13, 2009, Fitzgerald moved to dismiss his bankruptcy case so he could continue to negotiate a settlement of the State Court Action.*fn4 After some docketing and other procedural errors, Wallace eventually set Fitzgerald's dismissal motion for hearing on September 8, 2009.
On August 25, 2009, NWSR and Trustee filed their combined opposition to Fitzgerald's motion to dismiss, opposing it on both substantive and procedural grounds. Substantively, the opposition noted that an asset sale to Gray (as trustee of the Trust) was in the works, which would bring to the estate approximately $60,000 to pay unsecured claims that totaled just over $40,000.
On August 28, 2009, Trustee filed an ex parte motion requesting a continuance of the September 8 dismissal hearing because he was unable to attend, and because he opposed dismissal prior to the pending asset sale, which he expected to occur sometime around September 28, 2009. For reasons unknown, the bankruptcy court did not act on Trustee's continuance motion, and the hearing went as Wallace had scheduled on September 8. The only party to appear at the hearing was NWSR, through counsel.
On September 11, 2009, the bankruptcy court entered an order denying Fitzgerald's motion to dismiss for his failure to serve all creditors.
On August 31, 2009, Trustee filed and served a motion to sell to the Trust (1) Fitzgerald's 49% interest in NWSR, and (2) Fitzgerald's Cross-Claims "for up to $60,000" ("Sale Motion"). The $60,000 figure was the aggregate of filed, unsecured claims of approximately $40,000, plus expected administrative fees and expenses.
Trustee asserted that the proposed sale was in the best interest of the estate because, based on the sale price and the amount of unsecured claims, unsecured creditors would likely be paid in full. He further asserted the proposed sale was fair and reasonable considering that Fitzgerald's 49% interest (which Fitzgerald valued at $0.00) had no value to anyone other than the Trust because distributions to NWSR shareholders were subordinate to its $2 million debt, which, under its current financial situation, was unlikely to be paid in the foreseeable future. With respect to the Cross-Claims, Trustee offered no analysis regarding their value or the costs of litigation, but stated that the sale obviated the need for Trustee to prosecute and defend them. Finally, although Trustee asserted in the Sale Motion that the proposed sale was entered into in good faith, he did not seek a "good faith" finding under section 363(m) or present any evidence of the Trust's good faith.*fn5 Trustee set the sale hearing for September 23, 2009.
Just two days prior to the sale hearing, Fitzgerald filed an amended schedule B, which changed the value of his 49% interest in NWSR from $0.00 to $5.5 million and, for the first time, identified an interest in 137 films with a value of $1.5 million. Again, Fitzgerald did not list the Cross-Claims. He also filed an amended schedule F, which now indicated that unsecured claims totaled $784,366.87.*fn6
The sale hearing went forward on September 23, 2009. No written opposition was filed but Wallace and Riley, appearing for Fitzgerald and his life partner, Suzette Rowe ("Rowe"), attempted orally to oppose it.
Initially, the bankruptcy court granted the Sale Motion because Fitzgerald failed to file any written opposition, and Local Bankruptcy Rule 9013-1(h) of the Central District of California deems such silence as consent. In response, Wallace stated that Fitzgerald favored the sale if Trustee were selling the assets for "full value," but she needed a two-week continuance to file an opposition, which she failed to file previously because she was out of town. Wallace further stated that on September 22, 2009, she filed two unsecured claims against the estate, one for $550,000 on behalf of Rowe's mother, who had lent Fitzgerald money for a home, and one for $192,000 on behalf of Riley, for his attorneys fees ...