November 14, 2016
Sections 542 and 543—Turnover of Property of the Estate (2016)
By Bruce Grohsgal* and Gregory J. Flasser**
Section 542 of the Bankruptcy Code generally requires a noncustodial entity who has possession, custody, or control of property of the estate that the trustee may use, sell, or lease under § 363, or that the debtor may exempt under § 522, to deliver to the trustee the property or the value of the property, and to account for such property.1 Section 543 similarly requires a custodian with knowledge of the commencement of the case to deliver such property and the proceeds of such property to the trustee and account for such property.2 This paper reports on opinions regarding turnover published since the 2015 update.3
Jurisdiction and Authority — Generally
Bankruptcy jurisdiction is essentially in rem, based on the district court’s exclusive jurisdiction over all property, wherever located, of the debtor’s estate.4 The court’s jurisdiction begins on the filing of the bankruptcy case and for most purposes ends when the property is transferred from the estate or revests in the debtor5 or the case is dismissed.6 The bankruptcy court stands in the district court’s shoes with respect to its jurisdiction over estate property, by virtue of the standing order of reference from its district court, and has exclusive jurisdiction over property of the debtor’s estate.7
The statutory framework for this jurisdiction is set forth in 28 U.S.C.A. § 157. Section 157(b) gives bankruptcy judges the statutory authority to enter final judgments on certain “core” matters arising under or arising in the bankruptcy case. “Core” matters expressly include “orders to turn over property of the estate.”8
Under § 157, a bankruptcy judge does not have authority to enter a final judgment on a matter that is not core but is merely “related to” the bankruptcy case. A ubiquitous example of a non-core action is a suit by a debtor to recover a disputed prepetition account receivable. The bankruptcy judge may hear a non-core, “related to” matter, but it cannot enter final judgment on it unless the district court has referred the matter to the bankruptcy court and the parties have consented to the bankruptcy court’s authority to enter final judgment. Absent such referral and consent, the bankruptcy judge may only submit its proposed findings of fact and conclusions of law to the district court. The district judge following its de novo consideration of both the facts and the law, then enters or declines to enter the final judgment.9
It follows from this jurisdictional foundation that a turnover action with respect to estate property is a core proceeding, and the jurisdictional statute that governs bankruptcy proceedings expressly so provides.10
The Supreme Court threw this statutory regime into Constitutional chaos when it issued its 2011 opinion in Stern v. Marshall.11 Stern held that because the bankruptcy courts are established under Article I rather than Article III of the Constitution, and bankruptcy judges do not have lifetime tenure as required for Article III judges, that a bankruptcy judge may have statutory authority but not the Constitutional authority to enter a final order on some matters defined as “core” in § 157(b). The Supreme Court would later describe this type of proceeding as “a so-called ‘Stern claim,’ that is, ‘a claim designated for final adjudication in the bankruptcy court as a statutory matter, but prohibited from proceeding in that way as a constitutional matter.’”12
The true characterization of any specific turnover claim for jurisdictional purposes was problematic before Stern, and has become more so since that case was decided. The bankruptcy court’s authority to enter a final judgment on the turnover count of a complaint depends entirely on whether the turnover action involves a straightforward surrender of estate property, or is more properly characterized as another kind of dispute, such as a prepetition contract claim, that is only “related to” the bankruptcy case. Only in the former case can the bankruptcy court enter final judgment. Accordingly turnover complaints continue to be closely scrutinized, especially in the wake of the Supreme Court’s Stern decision.
The court in Dynamic Drywall, Inc. v. McPherson Contractors, Inc. confronted this recurring issue. The Chapter 11 debtor sued for turnover based on its allegation that the defendant had converted miscellaneous equipment belonging to the debtor. The defendant moved to withdraw the reference so that the district court rather than the bankruptcy court would decide the litigation. The bankruptcy court concluded that the Chapter 11 debtor’s claims were not for turnover, but were merely “non-core state law claims, including the state law conversion claim.”13 Accordingly, the bankruptcy court recommended that the district court withdraw the reference with respect to the litigation. The district court accepted the bankruptcy court’s recommendation and withdrew the reference.14
The same result was reached in In re Garrison. Garrison, the Chapter 11 debtor, sued HSBC for turnover, alleging breach of contract and fiduciary duty against HSBC, claiming that HSBC withheld payment of “co-investment” distributions. HSBC moved to withdraw the reference. Garrison converted his case to Chapter 7, and the Chapter 7 trustee did not oppose HSBC’s motion.15 The court found that Garrison’s claims arose “not out of his bankruptcy or the resolution of the claims process but out of a contractual relationship between HSBC” and Capital Group, the beneficial sole owner of which was Garrison. The court found that the claims did not arise out of Garrison’s bankruptcy, and though resolution of the claims might affect the bankruptcy case, this fact did “not sanction their adjudication in bankruptcy court absent the consent of HSBC.” Therefore, the court granted HSBC’s motion to withdraw the reference.”16
Suits on a debtor’s prepetition accounts receivable generally are not core and thus, absent the parties’ consent, the bankruptcy court does not have authority to enter final judgment on such claims. The debtor in In re SurfaceMax, Inc. entered into a prepetition subcontract with Precision. The subcontract authorized Precision to submit any dispute under the subcontract to arbitration. The debtor filed a Chapter 11 bankruptcy petition and sued Precision for amounts owing under the subcontract, seeking turnover of those amounts and of personal property. The debtor’s case was converted to Chapter 7.17 Precision sought arbitration of the debtor’s claims.18
The SurfaceMax court noted that in a bankruptcy proceeding, “courts look to the “core” or ‘non-core’ nature of the underlying claim in determining whether to enforce an arbitration provision.”19 The court stated that a principal purpose of the Bankruptcy Code is to resolve disputes over the debtor’s assets and obligations in one forum, rather than by piecemeal litigation and conflicting judgments.20
The court held that the debtor’s claim for turnover of accounts receivable that arose pre-petition under state law was not core. The claim for turnover of the personal property, in contrast, was core. Nevertheless, in the interest of efficiently adjudicating all claims between the parties, the court also referred the debtor’s claim for turnover of the personal property to arbitration, reasoning that “[e]xtracting this claim from the remainder of the Complaint would prevent the arbitrator from squaring all claims between the parties and determining a liquidated amount owed either by Precision or the Debtor.” The court stayed the adversary proceeding until the arbitration was completed.21
Alter ego and corporate veil piercing actions pose special jurisdictional problems. The bankruptcy judge has jurisdiction and authority over property of the estate. But if the debtor secreted or otherwise transferred estate property to an alter ego or similar entity, is the property still estate property subject to turnover, or is all that remains a state law claim for recovery?
The bankruptcy court in In re Tolomeo cited Stern in concluding that a turnover claim based on alter ego and veil-piercing claims was not constitutionally core (though Stern did not involve either of those legal doctrines).
In Tolomeo the assignees of potential bankruptcy estate claims sued the Chapter 7 debtor’s spouse and corporations owned solely by his spouse, seeking a declaration that the spouse’s and corporations’ assets were property of debtor’s bankruptcy estate. In support, the plaintiffs asserted that the defendants were alter egos of debtor, and requested that the court pierce the veil of the corporate defendants and direct turnover of defendants’ assets to trustee. The assignees filed a motion for judgment on the pleadings.22
The Tolomeo court noted that, though turnover orders are statutorily defined as core matters pursuant to 28 U.S.C.A. § 157(b)(2)(E), alter ego and veil-piercing under Stern are not issues that “stem[ ] from the bankruptcy itself or would necessarily be resolved in the claims allowance process.”23 Nor had the defendants consented to the court’s jurisdiction and authority. The court treated the claims as non-core and stated that it would issue make proposed findings of fact and conclusions of law on the questions of alter ego and veil-piercing for de novo review by the district court.24 The court further ruled that it would address the plaintiffs’ turnover request after the district court’s entry of a final order adjudicating the alter ego and veil-piercing issues, as appropriate.25 The court then, after an extensive analysis, recommended that district court find, under Illinois law, that corporations owned solely by debtor’s spouse were the alter egos of debtor and that their corporate veils should be pierced.26
By comparison, the bankruptcy court in In re Roussos perfunctorily stated that it had “jurisdiction pursuant to 28 U.S.C. §§ 157 and 1334 and General Order No. 13-05 of the U.S. District Court for the Central District of California” over turnover and other claims involving alter egos and fraud on the court.27 At issue in Roussos was whether a 21-year old bankruptcy sale of two properties could be set aside for fraud on the court under Fed.R.Civ.P. 60(d)(3).28 The bankruptcy court that approved the sale relied upon declarations submitted by the Roussos brothers in their individual Chapter 11 cases, which falsely stated that the sale was an arms-length transaction, that neither brother held any interest in companies purchasing the properties, and that the properties were over-encumbered.29 The court ruled that, assuming the allegations in the complaint were true, the properties remained property of the estate and as a result “the estate was never divested of its interest in the Properties.”30 The court declined to dismiss the turnover count.31
See also Comu v. King Louie Min., LLC and In re Raymond discussed in § VII below.
Jurisdiction after Chapter 11 Plan Confirmation
The bankruptcy court in In re Wellesley Realty Associates, LLC held that § 542(a) is “inapplicable” once property has revested in the reorganized debtor pursuant to a Chapter 11 plan “because there is no longer a trustee (or debtor-in-possession) to whom property can be delivered and the estate cannot benefit.”32
Sovereign Immunity
Another area in which difficulties persist is where a turnover proceeding implicates the sovereign immunity from suit of the federal government or a state under the 11th Amendment pursuant to Seminole Tribe of Fla. v. Florida and its progeny.33 Neither the bankruptcy court nor the district court has jurisdiction if the defendant is a sovereign that has not consented to suit or agreed in the plan of the Constitutional Convention or by later joining the federal union not to assert a sovereign immunity defense in a bankruptcy proceeding.34
The Chapter 7 trustee in In re Sann brought an adversary proceeding to compel turnover of certain funds from defendants. The turnover defendants made a counterclaim against the Chapter 7 trustee alleging that the complaint “was presented for the improper purpose of coercing Defendants to deliver funds” which the Chapter 7 trustee was not yet entitled to receive under district court orders. The turnover defendants also filed a third-party complaint against the Department of Justice (DOJ) and the United States Trustee, seeking to hold them liable under the Equal Access to Justice Act (EAJA) and on agency theory for reasonable attorney fees and costs that the defendants had incurred. The DOJ and the U.S. Trustee moved to dismiss third-party complaint.35 The bankruptcy court granted the motion, finding that the defendants/third-party plaintiffs had failed to show an unequivocally expressed waiver of sovereign immunity, and holding that the federal defendants were immune from suit under the United States’ sovereign immunity.36
The authors are not aware of any significant published opinions since last year’s Annual Survey addressing the issues of preemption in connection with turnover actions.
Federal Rule of Bankruptcy Procedure 7001(1)37 includes in the list relief requiring the commencement of an adversary proceeding, “a proceeding to recover money or property, other than a proceeding to compel the debtor to deliver property to the trustee.” Thus a request for turnover of estate property from a debtor,38 and a turnover action for recorded information under § 542(e),39 may be brought by motion, while Rule 7001(1) requires an action for turnover of property that is not a document, against a third party who is not the debtor, under
§ 542(a) and (b) and § 543(a) to be commenced by an adversary proceeding.40
Courts nonetheless have granted turnover relief sought by motion against a third party. In In re Cypress Health Systems Florida, Inc. the bankruptcy court determined that a $50,000 escrow held by a title company was property of the debtor’s estate and ordered it to be turned over on the debtor in possession’s motion.41
Further, many courts have held that § 542(a) is “self-effectuating.” The Ninth Circuit Bankruptcy Appellate Panel (BAP) in In re Cinevision International, Inc. reiterated its view that: “It has long been the determination of this panel that the turnover provisions of the Bankruptcy Code are to be self-effectuating, subjecting to sanctions a party that willfully fails to comply.”42 A party who does not seek the bankruptcy courts guidance, and unilaterally decides that it does need not turn over the property, does so at the risk that it will be assessed damages or will be sanctioned for violating the automatic stay.43
The California bankruptcy court in In re Perry held that a party that had repossessed the Chapter 7 debtor’s car prepetition had the affirmative duty to end its possession once it learned of the bankruptcy case and that since the car was exempt property, “turnover to the Debtor was appropriate.”44
A party’s obligation to turn over property under § 542(a) is further subject to the “good faith” exception, set forth in § XI below.
A debtor in possession, whether under Chapter 11 or Chapter 13,45 and a Chapter 7 or 11 trustee, each has standing to bring an action under Code § 542.46 Most courts have held that a Chapter 7 debtor — whose property is under the authority of the trustee — lacks standing.
In Perry, the debtor’s auto lender had repossessed his car, but had not yet sold it when the debtor commenced his Chapter 7 case a week later. The lender subsequently obtained relief from the stay and sold the car. The bankruptcy court ultimately concluded that the debtor, who was representing himself, had exempted the car. The Perry court found “puzzling” the provision of § 542(a) requiring the turnover of exempt property “where it is the chapter 7 debtor who is seeking turnover from a creditor.” Accordingly, the court noted, some courts have held that a Chapter 7 debtor has standing.47 The Ninth Circuit BAP had reached the opposite conclusion, though, and the Perry court felt itself bound by it.48
The party seeking turnover has the burden of proof,49 and “must prove that the subject property constitutes property of the estate and that the defendant is in possession of that property.”50
The trustee in In re Auld filed motions to extend the deadline for filing a complaint to deny the debtor’s discharge and for the turnover of property. The bankruptcy court ruled that the trustee was required “to describe with particularity the property or documents to be turned over.” Because the trustee had sought discovery, or been specific in his requests, his motion for an order directing turnover was denied.51
An exception stated by the bankruptcy court in In re Tate is the debtor’s burden to raise the issue of the inconsequential value of the property as an affirmative defense.52
Presumptions regarding ownership interests in property may shift the burden of proof. In In re Shapphire, one spouse had transferred property that was titled in her name to the debtor prepetition. Her spouse alleged that the property belonged to both spouses as community property. Under California law, the owner of the legal title to property is presumed to be the owner of the full beneficial title. This presumption can only be rebutted by clear and convincing proof.53 The bankruptcy court ruled that the challenging spouses’ uncorroborated testimony was insufficient to rebut this presumption.54
Generally — Property of the Estate
“It is crucial to the trustee’s claim that the asset to be turned over is property of the estate.”55
Property rights generally are determined by state law.56 If under the applicable state law, the debtor has no interest in the property turnover of which is sought, then the court will deny turnover.
Courts have struggled with cases involving disputed title. The bankruptcy court in In re Nurses’ Registry and Home Health Corporation recently weighed in, holding that a trustee or debtor in possession has a cause of action for turnover even if title is in dispute and needs to be determined as part of the litigation.57
But the bankruptcy court in In re Soundview Elite Ltd. reached the contrary determination. The Chapter 11 trustee in Soundview filed a complaint by which she sought, among other things, turnover of the net value of the debtor’s investment in its non-debtor subsidiary — which was effectively everything that the subsidiary would have after payment to its creditors, since the debtor was the sole shareholder in the subsidiary.58 The court stated that “the turnover power can be improperly invoked, especially when it is used as a Trojan Horse for bringing garden variety contract claims; when the property in question is not already property of the estate; or when the turnover statute is used to recover assets with disputed title when the estate’s claim of ownership is legitimately debatable. It is well established that the turnover power may not be used for such purposes.”59 The court ruled that though the matter was close, and the defendant’s defenses were largely frivolous (and the court could not even find that they were bona fide), the court could not determine that the cash or property to be delivered to the debtor was “already estate property,” or that the debtor’s rights was “yet equivalent to recovery of a fixed sum, or tantamount to substituting one kind of asset for another.”60 The court denied the trustee’s motion for summary judgment of the turnover count.61
In re Fraterfood Service, Inc. required application of the Puerto Rico law. The debtor constructed a building and other improvements on its leasehold. The debtor subsequently filed its Chapter 11 case, rejected the lease, and filed a complaint seeking payment of $1.5M from the landlord for the value of the building and improvements and alleging that the landlord had violated the automatic stay by retaining possession of the building and improvements.62 The landlord moved to dismiss the complaint and sought Bankruptcy Rule 9011 sanctions against the debtor and its counsel.63
The debtor responded that the landlord was obligated to turn over the property under
§ 542(a).64 The court extensively analyzed the applicable law of the Commonwealth of Puerto Rico, and determined that the debtor in its complaint failed to establish that the debtor had an interest in the building and improvements. The court dismissed the debtor’s complaint.65
The Fraterfood court also found that the debtor’s counsel’s filing the complaint constituted “dilatory litigation” the purpose of which was forestall payment to the landlord of the postpetition rent that had accrued prior to the debtor’s rejection of the lease. The court granted the landlord’s motion for sanctions in part, ordering the debtor’s counsel to pay the landlord’s legal costs, expenses and fees.66
A mere damage claim generally is not determined to be estate property subject to turnover. The Chapter 11 trustee in In re The Vaughan Company, Realtors, a real estate brokerage company, sued a competitor and several individuals for the defendants’ “alleged improper relocation of certain real estate brokers” who had worked at the debtor to the competitor, and “the subsequent relisting” of the debtor’s real estate listings with the new firm. The trustee sought, among other things, turnover of the commissions received on the sales of the re-listed properties. The defendants moved to dismiss. 67
The court ruled that the commissions were not property of the estate. “Property such as commissions to be recovered for the estate becomes property of the estate only if and when recovered.” Even if the trustee had sought to recover the commissions as a voidable post-petition transfer under § 549 or otherwise (which she had not), or prevail on her claim that the listings were wrongfully transferred, the commissions themselves would “never become property of VCR’s bankruptcy estate” and thus the trustee could not obtain relief under § 542(a). “A damages award in the amount of the Commissions does not make the Commissions themselves property of the estate” and the trustee’s claim under § 542(a) was “not facially plausible.”68
See also In re Shapphire Resources, LLC discussed in § VI above.
The Property Must be Property That the Debtor May Use, Lease, Sell or Exempt
Property that the Debtor May Use, Lease of Sell
The property, to be subject to turnover, must be property that the debtor may use, lease or sell under section 363, which generally means that it is property of the estate under Code § 541.69
Property that the Debtor May Exempt
The application of the turnover provisions to property asserted by the debtor to be exempt is somewhat peculiar, since the debtor’s exemption would appear to put the exempt property beyond a trustee’s reach even though § 542 requires turnover to the trustee of property that the debtor may exempt.
Courts nonetheless often deny a trustee’s request for turnover of property, if the debtor has claimed a proper exemption (see e.g., In re Perry discussed in § II above),70 and conversely grant the trustee’s motion for turnover from the debtor if the property is not exempt.
Types of Property Interests Subject to Turnover
Several opinions in the last year have made the threshold determination of whether the property sought was estate property, with respect to myriad types of property interests, as set forth in the following subsections of this § VII.
Accounts Receivable
The court in In re SurfaceMax, Inc. (discussed in II above) followed the general rule that an action to obtain payment on an account receivable — though actionable — is not a turnover proceeding.71
Alimony
The bankruptcy court in In re Millette determined that alimony is a property interest and not a personal right under New Hampshire law, and thus was property of the estate.72
Alter Ego Claims
The trustee in Comu v. King Louie Min., LLC alleged that Comu concealed his ownership of Green Automotive Company, Inc., “using, inter alia, his undisclosed, de facto ownership and control of The Barclay Group, Inc. (‘TBG’) to hold his Green Auto Stock and thereby avoid detection.” The trustee sought turnover of all prepetition assets, including the Green Auto Stock and any proceeds collected from the disposition of those assets.73
The bankruptcy court concluded that “TBG was indeed Comu’s alter ego, and that, therefore, any pre-petition shares of the Green Auto Stock owned by TBG should have been turned over to the Trustee pursuant to 11 U.S.C. § 542(a).” The court found that Comu had furthered an “elaborate scheme to dissipate TBG’s Green Auto Stock—and collect millions of dollars in cash proceeds—that should have been available to his creditors.” The court further found value of the stock to be $5,858,788, which reflected the “actual cash proceeds from the sale of Green Auto stock.”74
The district court held that the bankruptcy court had authority to order parties to turn over property subject to their control, which should have been included in the bankruptcy estate, and affirmed the monetary judgment in favor of the trustee pursuant to § 542(a).75
The bankruptcy court in In re Raymond held that control, “even pervasive control, without more, is not a sufficient basis for a court to ignore corporate formalities,” and dismissed the trustee’s alter ego claims.76
See also In re Tolomeo and In re Roussos discussed in § II above,
Avoidable Transfers
Avoided transfers are subject to turnover, but the courts continue to divide on the question of whether a transfer that is merely avoidable is subject to turnover.
The Chapter 7 trustee in In re Bruner sought turnover of a fee paid postpetition to the debtor’s criminal defense counsel. The debtor’s elderly mother wire-transferred the funds to defendant defense counsel, and the parties hotly disputed whether the debtor was “the true source of the transferred funds.” In the court’s view the parties had missed a more fundamental point, that: “turnover can only be used to demand return of estate property to the Trustee, not to avoid transfers of what was estate property.”77 The court reasoned that when the debtor “voluntarily surrendered her own title to the money, the estate lost whatever interest it had in the money.” Even though the trustee offered substantial evidence that the $50,000 was the debtor’s money and thus may have been estate property before its transfer, the trustee did not avoid the unauthorized postpetition transfer. Thus, no evidence the trustee had adduced could prove that the $50,000 fee, having been transferred from the estate, was estate property and the fee was not subject to turnover.78
But in In re Roussos, also discussed in § II above, the court ruled that the transfer of estate property pursuant to a court order under § 363(b) but in fraud on the court “never divested of its interest in the Properties” and declined to dismiss the turnover count.79
See also In re Tolomeo discussed in § II above.
Lease or Disguised Financing
The trustee in In re Hunt sought turnover of certain equipment from the debtor. The debtor objected, asserting that the property was subject to a finance lease with Shephard under Idaho law, pursuant to the terms of which Shephard was the owner of the property until the debtor completed payments to him.80 The court held that the transaction between the debtor and Shephard was a disguised financing and security interest, and thus that the debtor had an ownership interest in the equipment. As a result, the equipment was property of the estate and the court ordered turnover to the trustee.81
Proceeds and Escrows
If property of the estate, subject to turnover, was first sold, then the sale proceeds are subject to turnover. Conversely if the property is not property of the estate, then the proceeds are not subject to turnover.
If the property sold was subject to a valid and perfected lien, then the holder of the lien is entitled to the proceeds in payment of its claim, prior to any payment to estate. In In re Spence the debtor’s boat slip was sold at sheriff’s sale. The bankruptcy court found that the condominium association’s execution and levy against a boat slip were valid and that it thus held a judgment lien against the proceeds, in the amount of $37,138. The court ordered payment of $37,138 to the association and the turnover of the balance of the proceeds to the Chapter 7 trustee.82
The debtor in In re Morev entered into an agreement with a creditor, Keeler, prepetition. Under the agreement, the debtor assigned his liquor license to Keeler, who agreed to “make maximum effort to sell the license, to recoup $68,000” which represented the amount that the debtor owed to the Keeler “for the purchase of the liquor license, plus legal costs.” Keeler opened an escrow with an escrow company to accomplish the sale, the liquor license was sold, and the sale proceeds were deposited in escrow with the escrow company.83
The debtor filed his Chapter 7 petition and the trustee sought turnover of the escrowed funds. The court held that it is “well settled in the Ninth Circuit that where a seller of a liquor license becomes a debtor in a bankruptcy case after the license is sold, but before the proceeds are distributed from escrow, the proceeds become property of the bankruptcy estate and must be distributed in accordance with the bankruptcy priority scheme … while a state, as the creator of a liquor license, may validly impose conditions on its transferability for the state’s own benefit, it may not, consistently with paramount federal law, impose conditions which discriminate in favor of particular classes of creditors.”84
The escrow company argued that Keeler was entitled to the proceeds, because the debtor had assigned the liquor license to Keeler. The court held that the assignment was neither an outright transfer of, nor a grant of a security interest in, the liquor license. The assignment “was at most a grant by Debtor to Keeler of control of the license for the sole purpose of allowing Keeler to sell the license and to control (not own) the proceeds,” and ordered turnover of the proceeds.85
In In re Cypress Health Systems Florida, Inc. Partner’s Healthcare signed a letter of intent prepetition for the purchase of assets of the debtor and paid a $50,000 deposit to the title company. The sale never closed. The debtor filed its Chapter 11 petition and sought turnover of the $50,000 deposit.86
Partner’s Healthcare argued first that the debtor did not schedule the escrow as an asset, and thus had no interest in the funds. The court rejected this argument perfunctorily. Partners Healthcare next argued that the debtor failed to negotiate the sale in good faith. The court found that the letter of intent contained express terms regarding ownership and disposition of the escrow, including that the escrow “would revert permanently to the possession and control” of the debtor under certain circumstances, which the court found had occurred. The court ordered turnover.87
Property of Others
Bankruptcy Code § 541(d) “excludes from the bankruptcy estate the equitable interest in any property in which the debtor holds, as of the commencement of the case, only legal title and not an equitable interest.
The bankruptcy court in In re Raymond held that property co-owned with one’s spouse, though, is subject to turnover because pursuant to § 363(h) it can be sold and under § 363(j) the proceeds can distributed to the joint owners in accordance with their respective ownership interests.88
Spendthrift and Discretionary Trusts
Section 541(c)(2) of the Code provides that: a “restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title,” and thus “recognizes the enforceability of spendthrift provisions in trusts where the debtor is a beneficiary of a spendthrift trust.”89
The court in Safanda v. Castellano determined that, under the law of the three states that might apply, “discretionary trusts, like spendthrift provisions, validly restrict the transfer of a beneficiary’s interest.” The debtor’s beneficial interest in the trust at issue was “subject to a valid nonbankruptcy restriction on transfer.” It thus “fell within the scope of § 541(c)(2)” and was excluded from her bankruptcy estate.90
Substantive Consolidation
Substantive consolidation is a doctrine by which a bankruptcy court may pool the assets and liabilities of two or more related entities. Courts most often have substantively consolidated two or more debtors, typically because the debtors’ assets and liabilities are so commingled that it would be impossible or prohibitively expensive to disentangle their financial affairs. A court more rarely may substantively consolidate a debtor with a nondebtor. The bankruptcy court in In re Raymond citing approvingly another bankruptcy court decision that stated that: “Substantive consolidation is essentially a complex turnover proceeding because the debtor is asking the nondebtor affiliated entity to bring into the estate assets in which the debtor asserts an inseparable interest.” But the Raymond court dismissed the trustee’s substantive consolidation claim.91
The bankruptcy court in In re Tate followed the majority rule that the party from whom turnover is sought under § 542(a) must be “in possession, custody, or control, during the case, of the property,”92 that is, at some point “during the case,” if the turnover action is to succeed.93
The trustee in Matter of Home Casual LLC sought turnover of a bank account. The bankruptcy court found that “it suffices to note that there is no proof that there were funds in the account on the date of the bankruptcy which would be subject to turnover,” and thus there was no basis on which to compel an accounting.94
Deliver to the Trustee Property or the Value of Such Property
The person in possession, custody or control of the property “during the case” has the duty under§ 542(a) to “deliver to the trustee, and account for, such property or the value of such property.”95 Most courts hold that “during the case” means at any time during the pendency of the bankruptcy case, and not solely at the time the turnover proceeding is commenced.96 Further, if the property has been spent, transferred or otherwise dissipated that person in most cases remains obligated to turn over its value.
The bankruptcy court in Comu v. King Louie Min., LLC found that the debtor had concealed from the trustee certain stock that he owned and had failed to turn over that stock to the trustee. The court ordered the debtor to turn over the value of the stock.97
The debtor in In re Tate received an arbitration award, $110,873 of which was non-exempt property of his estate. The bankruptcy court ordered turnover of that part of the award, shortly after which Tate notified the trustee that he had spent the money on living expenses and “therefore would be unable to comply” with the court’s order.98
Tate then proceeded to try the patience of the court. Six months entry of the turnover order, the court found Tate in civil contempt. Seven months later, “after various efforts failed to coerce Tate’s compliance,” the district court at the bankruptcy court’s request issued an arrest warrant. Tate turned himself in, and was released conditioned on his appearance before the bankruptcy court to explain the whereabouts of the money. At the hearing though, “he failed to provide any additional information as to the disposition of the Arbitration Award. The court ordered Tate held in custody until he either turned over or accounted for the money, and scheduled a second hearing 48 hours later “to provide Tate an opportunity to do so.”99
Tate remained unmoved, reasserting his prior testimony that he had used the money for living expenses, including $78,542 that was withdrawn from his account when the account was closed. Following the hearing, the court gave Tate numerous deadlines and opportunities to comply, none of which were complete or satisfactory.100
Resignedly, the court acknowledged that a year-and-a-half of its “efforts to coerce Tate’s compliance” had “produced limited tangible benefits for creditors.” No matter the personal cost or risk, Tate remained unwilling to fully comply. The court transmitted a record of Tate’s actions in the case to the United States Attorney “for the purpose of considering various criminal charges.” The court tiredly conceded that a criminal prosecution would not provide creditors with any further monetary benefit. However, a monetary judgment, while Tate appeared to still be working, would “at least provide the Trustee an opportunity to recover the remaining portion of the Arbitration Award for the benefit of the creditors, rather than continue a game of cat and mouse with Tate.” Accordingly, the court entered judgment against Tate in the $91,290 value of the estate’s $110,873 share of the arbitration award.101
See also In re Spence discussed in § VII above (ordering payment of $37,138 of proceeds from the sale of the debtor’s boat slip to the judgment lien creditor, and the turnover of the balance of the proceeds to the Chapter 7 trustee).102
Notwithstanding the textual directive in § 542(a), “[n]umerous courts have recognized an equitable defense of double satisfaction in the context of a turnover action,” and the bankruptcy court In re Noram Resources, Inc. denied part of the trustee’s turnover claim because it would have constituted such an “impermissible double recovery.”103
Action for Accounting
Section 542(a) also requires an entity to account for property subject to turnover.104 The court in In re Vaughan Company, Realtors held that though the trustee had failed to state a claim under § 542, she nonetheless was “not precluded from seeking an accounting or from requesting copies of the listing agreements and closing statements under the Rule of Civil Procedure governing pre-trial discovery.”105
See also In re Tate discussed in this § VIII above.
Section 542(a) does not require turnover of “property that is of inconsequential value or benefit to the estate.”106
The bankruptcy court in In re Shapphire Resources, LLC found that, “given the nature of the Property, its renovation to be used as a home for the developmentally disabled, and its ability to generate income …, and that no party has argued that the Property is of inconsequential value or benefit to the estate, the debtor in possession who was seeking turnover had “shown, by a preponderance of the evidence, that the Property [was] not of inconsequential value or benefit to the estate.”107
The bankruptcy court in In re Noram Resources, Inc., also discussed in § VIII above, noted that “an essential element of a turnover action is that the estate property in question must have consequential value.” The court went on to state that, if the defendants, “through settling claims rightfully owned by the estates, impacted the prosecution of the subsequent lawsuits, then the claims would have consequential value” to the estate. The evidentiary record in the court’s view did “demonstrate such an impact, although it may have been minimal.”108
Bankruptcy Code § 542(b) provides that, subject to the exceptions in § 542(c) and (d) and to offset under § 553, “an entity that owes a debt that is property of the estate and that is matured, payable on demand, or payable on order, shall pay such debt to, or on the order of, the trustee.”109
The “matured debt” does not need to be evidenced by a promissory note. In In re MF Global Inc. the debtor’s customer had opened an investment trading account with the debtor prepetition pursuant to the terms of a Customer Agreement. The Customer Agreement gave the debtor “various rights, including, without limitation, the right to declare” the customer “in default without declaring a margin call and the right to liquidate his account without affording him prior notice.”110
The debtor attempted to contact the customer several times on May 6, 2010, during a severe market downturn, to notify the customer of a margin call. An email sent by the debtor toward the end of the day informed the customer that unless he paid the margin call the debtor would liquidate his account. By the end of the next day the debtor had completely liquidated the account.111
The customer sued the debtor prepetition. The litigation was stayed by the bankruptcy filing. The customer did not seek relief from the stay. The customer filed a $545,000 claim in the bankruptcy case.112
The trustee did not seek affirmative relief under § 542(a), but sought only a determination that the customer’s account was in deficit for the purpose of temporarily disallowing the customer’s claim under § 502(d).113 The court found that the trustee had established that the customer was “unconditionally liable” to the debtor for the debit balance of his account the debt was matured under § 542(b) and thus that the debt was estate property under § 541(a).114 The court held that the trustee thus had made a prima facie showing that the debit balance was subject to turnover and sustained the trustee’s objection to the customer’s claim under section 502(d) of the Code.115
But a mere contract dispute is not a “matured debt.” The bankruptcy court in In re NanoDynamics, Inc. “readily dismisse[d]” the trustee’s § 542 turnover action. Section 542 “has no utility to collect a ‘debt’ that has yet to be determined to be ‘property of the estate’ because, for example, there neither has been a determination of liability on an obligation, nor identification of a source of payment (or other satisfaction) to which a debtor has a right of ownership or possession.”116
The court in In re Soundview Elite Ltd., also discussed in § VII above, noted that “section 542(b) can be used to monetize estate assets such as notes or accounts receivable that are already property of the estate.”117 But “[u]nlike the entitlement to payment on an account receivable or a promissory note, which is simply to be converted into cash,” the debtor did “not yet own the redemption proceeds, and its entitlement” was “not yet equivalent to recovery of a fixed sum, or tantamount to substituting one kind of asset for another.”118
The debtor in In re Pantazelos filed a complaint against her former bankruptcy counsel seeking recovery of attorney’s fees paid for legal services rendered in her two earlier bankruptcy cases, both of which were bankruptcy cases dismissed.119 The defendant moved to dismiss the debtor’s suit. The bankruptcy court stated that turnover is a remedy to obtain what is acknowledged to be property of the estate, and “cannot be used as a tool to acquire property the debtor did not have a right to possess or use at the commencement of a case.” The debtor, in the court’s view, had put “the cart before the horse.”120 She did not allege a “debt” that was “clearly her property and simply not in her possession. Rather, the debtor alleged that the defendant obtained the money improperly, “alluding to possible fraud.” The court nonetheless determined that the facts, taken in the light most favorable to the debtor, established a plausible claim for common law fraud. The court held that it was not bound by the debtor’s mischaracterization of her legal theory, and denied the defendant’s motion to dismiss.121
In In re Harrelson the debtor similarly alleged that her former bankruptcy counsel and debt relief agency “took the Plaintiff’s money and failed to perform under the terms of the Agreement, failed to negotiate the settlement of the credit card debts, [and] failed to prevent further collection efforts by the creditors, including lawsuits filed against the Plaintiff …” The bankruptcy court characterized the debtor’s claim as “a quintessential allegation for breach of contract” and not a matured debt payable on demand, and noted that there appeared to be a dispute as to as to whether the debtor still had legal title to the fees that she paid to the defendants.122 The agreement among the parties required the submission of disputes to arbitration.123 The court rejected the objections to enforcement of the clause and ruled that the “turnover” claim “must be submitted to arbitration.”124
The bankruptcy court in In re 11 East 36th LLC stated that it is settled law that turnover cannot be used to liquidate contract disputes. It was clear, on the face of the complaint, that the plaintiff was attempting by one count of the complaint to liquidate a disputed debt.125 The court agreed that the plaintiff had failed to state a cause of action and dismissed that count of the complaint.126
the authors are not aware of any significant published opinions since last year’s Annual Survey addressing issues in connection with the “good faith” exception to turnover actions.
Bankruptcy Code § 542(e) provides that “[s]ubject to any applicable privilege, after notice and a hearing, the court may order an attorney, accountant, or other person that holds recorded information … relating to the debtor’s property or financial affairs, to turn over or disclose such recorded information to the trustee.”127
In In re Auld, the bankruptcy court denied the Chapter 7 trustee’s motion for turnover pursuant to § 542, stating that to obtain an order to turn over property or recorded information, the trustee must show: (a) that the property to be turned over is property of the bankruptcy estate and the recorded information relates to property of the estate; and (b) that the property and recorded information are in the Debtor’s possession or under his control at the time the turnover motion was filed.128 The trustee’s motion in Auld requested turnover of (i) copies of the debtor’s mortgage loan or credit applications given to obtain the present mortgage against the debtor’s property; (ii) copies of loan documents and copy of the title to a 2009 Harley-Davidson motorcycle; (iii) copies of the debtor’s prepared and filed 2015 tax returns upon filing and turnover of the estate’s portion of any and all 2015 refunds immediately upon receipt; (iv) copies of titles to a 2004 and/or 2002 GMC Yukon; (v) an explanation concerning the disposition of property awarded to the debtor in his most recent divorce decree; and (vi) information concerning any life insurance policy that the debtor owned and was required by his divorce decree to maintain.
In denying the turnover motion, the Auld court analyzed each request in turn. First, the motion did not clearly identify the loan applications for the property, establish that they were in the debtor’s possession, or indicate why they were relevant. The court noted that applications that were several years old would be of questionable relevance. Second, the motion did not clearly identify or establish the relevance of the loan documents sought with respect to the motorcycle, and did not establish that those documents or the title to the motorcycle were in the debtor’s possession. The noted that since the motorcycle was scheduled subject to the lien of the secured creditor, the title most likely was being held by the lender. Third, with regard to the tax return request, the court declined to issue an order to turnover paperwork that did not yet exist. Fourth, the court found that the GMC Yukon and been exempted by the debtor and thus was no longer an asset of the estate, and the court declined to order the turnover of a document that did not relate to property of the estate. Fifth, in response to the request for an explanation concerning the award in the divorce decree, the court stated there is no legal basis to enter an order directing the debtor to provide “explanations” because an explanation is neither property of the estate nor recorded information subject to turnover. Finally, with respect to the request for information concerning life insurance policies, the court reiterated that “information” is not property or recorded information that is subject to turnover.129
In In re Allegro Law LLC, the bankruptcy court entered a default judgment against the defendants in the amount of $103 million, in part because the plaintiff offered a “mountain of evidence” in support of his claim that the defendants defrauded a large number of individuals, but also as a result of the defendants’ poor conduct (including their refusal to show up at the trial and refusal to turnover recorded information).130 The court found that the defendant, Timothy McCallan had perpetrated fraud on a massive scale by promising customers that their debts would be either paid or settled. Instead, McCallan siphoned off the money into companies controlled or closely associated to him.131 McCallan used a number of lawyers including Keith Nelms to perpetuate his scheme. Allegro Financial and Allegro Law (“Allegro”) were entities controlled by McCallan and fronted by Nelms as a law firm.132 Nelms superficially hired McCallan and AmeriCorp and Seton (also controlled by McCallan) to handle processing for Allegro. When the State of Alabama placed Allegro in receivership, Nelms and Allegro each filed Chapter 7 bankruptcy petitions.133
The Chapter 7 trustee of the Allegro bankruptcies filed suit against McCallan, AmeriCorp and Seton seeking, among other things, turnover of property of the estate. The trustee had learned that Nelms and Allegro did not keep their own business records, but rather the records were kept by AmeriCorp in an electronic form.134 The defendants disregarded two discovery orders which required them to produce the database and to allow the trustee access to the database. Though the court denied the trustee’s request for default judgment, it held the defendants in contempt and again ordered them to produce the requested database.135 The defendants eventually produced the data stored on a CD, but their production was facially deficient because they did not provide the trustee with actual access to the computer servers. The defendants later tried to cover this deficiency by claiming (falsely as it later turned out) that the servers had been deactivated and that access to the servers was not technologically possible.136 Three years into the Chapter 7 cases, the defendants finally granted the trustee access to the servers, but by then the damage had been done. The trustee then filed a third motion for sanctions, asserting that he was unable to make distributions to creditors of the Allegro bankruptcy estate due to the defendants’ “stonewalling” on discovery, and that he had incurred various fees during the time. The court granted the trustee’s motion in the amount of $999,457.95, stating the “proceedings were delayed by several years as a result of the Defendants’ well-documented obstructionist tactics.”137
Bankruptcy Code § 543138 is entitled “Turnover of Property by a Custodian” and is the parallel to § 542. The party from whom the turnover is sought must be a custodian for § 543 to apply. A “custodian” is defined in Code § 101(11) as:
Subsections 543(a) and (b) provide that:
Subsection 543(c)(2) provides that the court, after notice and a hearing, shall -
Subsection 543(d)(1) provides that after notice and hearing, the bankruptcy court -
In In re Joseph and David Johnsman Limited Partnership, a secured lender of the Chapter 12 debtor obtain relief from the automatic stay from the bankruptcy court and an order of possession from the state court. The lender, instead of proceeding under the state court order, permitted the debtor to sell the collateral, which consisted of equipment and livestock, to Egbert. Egbert paid the purchase price, which was remitted to the lender on account of the debt. The debtor subsequently brought an adversary proceeding against Egbert, alleging that Egbert was a custodian under § 543(b) and seeking an accounting and turnover.143 Egbert sought summary judgment based on his assertion that he did not fall within the definition of custodian under § 101(11)(C).144 He clearly was not a court-appointed trustee or receiver of the debtor’s property or an agent or assignee under a general assignment for the purpose of administration of such property within the meaning of § 101(11)(C).145 The court found that the livestock and equipment were transferred to Egbert “for his own use and advantage or profit forever,” that the Bills of Sale included “no language in indicating that the transfers were for the purpose of administration of the property” for the benefit of the debtor’s creditors, and that the debtor’s reliance on allegations in the complaint that Egbert had orally agreed to take possession of the equipment and livestock for the general benefit of the estate, without more, was “insufficient” to defeat the motion for summary judgment.146 The court agreed with Egbert and held that he was not a “custodian.”
In In re 4522 Kateuua Ave, EEC, the court granted the motion for turnover.147 In that case, the debtor had commenced its Chapter 11 case four months after forecl
I. INTRODUCTION
Section 542 of the Bankruptcy Code generally requires a noncustodial entity who has possession, custody, or control of property of the estate that the trustee may use, sell, or lease under § 363, or that the debtor may exempt under § 522, to deliver to the trustee the property or the value of the property, and to account for such property.1 Section 543 similarly requires a custodian with knowledge of the commencement of the case to deliver such property and the proceeds of such property to the trustee and account for such property.2 This paper reports on opinions regarding turnover published since the 2015 update.3
II. JURISDICTION AND AUTHORITY OF THE BANKRUPTCY COURTS
Jurisdiction and Authority — Generally
Bankruptcy jurisdiction is essentially in rem, based on the district court’s exclusive jurisdiction over all property, wherever located, of the debtor’s estate.4 The court’s jurisdiction begins on the filing of the bankruptcy case and for most purposes ends when the property is transferred from the estate or revests in the debtor5 or the case is dismissed.6 The bankruptcy court stands in the district court’s shoes with respect to its jurisdiction over estate property, by virtue of the standing order of reference from its district court, and has exclusive jurisdiction over property of the debtor’s estate.7
The statutory framework for this jurisdiction is set forth in 28 U.S.C.A. § 157. Section 157(b) gives bankruptcy judges the statutory authority to enter final judgments on certain “core” matters arising under or arising in the bankruptcy case. “Core” matters expressly include “orders to turn over property of the estate.”8
Under § 157, a bankruptcy judge does not have authority to enter a final judgment on a matter that is not core but is merely “related to” the bankruptcy case. A ubiquitous example of a non-core action is a suit by a debtor to recover a disputed prepetition account receivable. The bankruptcy judge may hear a non-core, “related to” matter, but it cannot enter final judgment on it unless the district court has referred the matter to the bankruptcy court and the parties have consented to the bankruptcy court’s authority to enter final judgment. Absent such referral and consent, the bankruptcy judge may only submit its proposed findings of fact and conclusions of law to the district court. The district judge following its de novo consideration of both the facts and the law, then enters or declines to enter the final judgment.9
It follows from this jurisdictional foundation that a turnover action with respect to estate property is a core proceeding, and the jurisdictional statute that governs bankruptcy proceedings expressly so provides.10
The Supreme Court threw this statutory regime into Constitutional chaos when it issued its 2011 opinion in Stern v. Marshall.11 Stern held that because the bankruptcy courts are established under Article I rather than Article III of the Constitution, and bankruptcy judges do not have lifetime tenure as required for Article III judges, that a bankruptcy judge may have statutory authority but not the Constitutional authority to enter a final order on some matters defined as “core” in § 157(b). The Supreme Court would later describe this type of proceeding as “a so-called ‘Stern claim,’ that is, ‘a claim designated for final adjudication in the bankruptcy court as a statutory matter, but prohibited from proceeding in that way as a constitutional matter.’”12
The true characterization of any specific turnover claim for jurisdictional purposes was problematic before Stern, and has become more so since that case was decided. The bankruptcy court’s authority to enter a final judgment on the turnover count of a complaint depends entirely on whether the turnover action involves a straightforward surrender of estate property, or is more properly characterized as another kind of dispute, such as a prepetition contract claim, that is only “related to” the bankruptcy case. Only in the former case can the bankruptcy court enter final judgment. Accordingly turnover complaints continue to be closely scrutinized, especially in the wake of the Supreme Court’s Stern decision.
The court in Dynamic Drywall, Inc. v. McPherson Contractors, Inc. confronted this recurring issue. The Chapter 11 debtor sued for turnover based on its allegation that the defendant had converted miscellaneous equipment belonging to the debtor. The defendant moved to withdraw the reference so that the district court rather than the bankruptcy court would decide the litigation. The bankruptcy court concluded that the Chapter 11 debtor’s claims were not for turnover, but were merely “non-core state law claims, including the state law conversion claim.”13 Accordingly, the bankruptcy court recommended that the district court withdraw the reference with respect to the litigation. The district court accepted the bankruptcy court’s recommendation and withdrew the reference.14
The same result was reached in In re Garrison. Garrison, the Chapter 11 debtor, sued HSBC for turnover, alleging breach of contract and fiduciary duty against HSBC, claiming that HSBC withheld payment of “co-investment” distributions. HSBC moved to withdraw the reference. Garrison converted his case to Chapter 7, and the Chapter 7 trustee did not oppose HSBC’s motion.15 The court found that Garrison’s claims arose “not out of his bankruptcy or the resolution of the claims process but out of a contractual relationship between HSBC” and Capital Group, the beneficial sole owner of which was Garrison. The court found that the claims did not arise out of Garrison’s bankruptcy, and though resolution of the claims might affect the bankruptcy case, this fact did “not sanction their adjudication in bankruptcy court absent the consent of HSBC.” Therefore, the court granted HSBC’s motion to withdraw the reference.”16
Suits on a debtor’s prepetition accounts receivable generally are not core and thus, absent the parties’ consent, the bankruptcy court does not have authority to enter final judgment on such claims. The debtor in In re SurfaceMax, Inc. entered into a prepetition subcontract with Precision. The subcontract authorized Precision to submit any dispute under the subcontract to arbitration. The debtor filed a Chapter 11 bankruptcy petition and sued Precision for amounts owing under the subcontract, seeking turnover of those amounts and of personal property. The debtor’s case was converted to Chapter 7.17 Precision sought arbitration of the debtor’s claims.18
The SurfaceMax court noted that in a bankruptcy proceeding, “courts look to the “core” or ‘non-core’ nature of the underlying claim in determining whether to enforce an arbitration provision.”19 The court stated that a principal purpose of the Bankruptcy Code is to resolve disputes over the debtor’s assets and obligations in one forum, rather than by piecemeal litigation and conflicting judgments.20
The court held that the debtor’s claim for turnover of accounts receivable that arose pre-petition under state law was not core. The claim for turnover of the personal property, in contrast, was core. Nevertheless, in the interest of efficiently adjudicating all claims between the parties, the court also referred the debtor’s claim for turnover of the personal property to arbitration, reasoning that “[e]xtracting this claim from the remainder of the Complaint would prevent the arbitrator from squaring all claims between the parties and determining a liquidated amount owed either by Precision or the Debtor.” The court stayed the adversary proceeding until the arbitration was completed.21
Alter ego and corporate veil piercing actions pose special jurisdictional problems. The bankruptcy judge has jurisdiction and authority over property of the estate. But if the debtor secreted or otherwise transferred estate property to an alter ego or similar entity, is the property still estate property subject to turnover, or is all that remains a state law claim for recovery?
The bankruptcy court in In re Tolomeo cited Stern in concluding that a turnover claim based on alter ego and veil-piercing claims was not constitutionally core (though Stern did not involve either of those legal doctrines).
In Tolomeo the assignees of potential bankruptcy estate claims sued the Chapter 7 debtor’s spouse and corporations owned solely by his spouse, seeking a declaration that the spouse’s and corporations’ assets were property of debtor’s bankruptcy estate. In support, the plaintiffs asserted that the defendants were alter egos of debtor, and requested that the court pierce the veil of the corporate defendants and direct turnover of defendants’ assets to trustee. The assignees filed a motion for judgment on the pleadings.22
The Tolomeo court noted that, though turnover orders are statutorily defined as core matters pursuant to 28 U.S.C.A. § 157(b)(2)(E), alter ego and veil-piercing under Stern are not issues that “stem[ ] from the bankruptcy itself or would necessarily be resolved in the claims allowance process.”23 Nor had the defendants consented to the court’s jurisdiction and authority. The court treated the claims as non-core and stated that it would issue make proposed findings of fact and conclusions of law on the questions of alter ego and veil-piercing for de novo review by the district court.24 The court further ruled that it would address the plaintiffs’ turnover request after the district court’s entry of a final order adjudicating the alter ego and veil-piercing issues, as appropriate.25 The court then, after an extensive analysis, recommended that district court find, under Illinois law, that corporations owned solely by debtor’s spouse were the alter egos of debtor and that their corporate veils should be pierced.26
By comparison, the bankruptcy court in In re Roussos perfunctorily stated that it had “jurisdiction pursuant to 28 U.S.C. §§ 157 and 1334 and General Order No. 13-05 of the U.S. District Court for the Central District of California” over turnover and other claims involving alter egos and fraud on the court.27 At issue in Roussos was whether a 21-year old bankruptcy sale of two properties could be set aside for fraud on the court under Fed.R.Civ.P. 60(d)(3).28 The bankruptcy court that approved the sale relied upon declarations submitted by the Roussos brothers in their individual Chapter 11 cases, which falsely stated that the sale was an arms-length transaction, that neither brother held any interest in companies purchasing the properties, and that the properties were over-encumbered.29 The court ruled that, assuming the allegations in the complaint were true, the properties remained property of the estate and as a result “the estate was never divested of its interest in the Properties.”30 The court declined to dismiss the turnover count.31
See also Comu v. King Louie Min., LLC and In re Raymond discussed in § VII below.
Jurisdiction after Chapter 11 Plan Confirmation
The bankruptcy court in In re Wellesley Realty Associates, LLC held that § 542(a) is “inapplicable” once property has revested in the reorganized debtor pursuant to a Chapter 11 plan “because there is no longer a trustee (or debtor-in-possession) to whom property can be delivered and the estate cannot benefit.”32
Sovereign Immunity
Another area in which difficulties persist is where a turnover proceeding implicates the sovereign immunity from suit of the federal government or a state under the 11th Amendment pursuant to Seminole Tribe of Fla. v. Florida and its progeny.33 Neither the bankruptcy court nor the district court has jurisdiction if the defendant is a sovereign that has not consented to suit or agreed in the plan of the Constitutional Convention or by later joining the federal union not to assert a sovereign immunity defense in a bankruptcy proceeding.34
The Chapter 7 trustee in In re Sann brought an adversary proceeding to compel turnover of certain funds from defendants. The turnover defendants made a counterclaim against the Chapter 7 trustee alleging that the complaint “was presented for the improper purpose of coercing Defendants to deliver funds” which the Chapter 7 trustee was not yet entitled to receive under district court orders. The turnover defendants also filed a third-party complaint against the Department of Justice (DOJ) and the United States Trustee, seeking to hold them liable under the Equal Access to Justice Act (EAJA) and on agency theory for reasonable attorney fees and costs that the defendants had incurred. The DOJ and the U.S. Trustee moved to dismiss third-party complaint.35 The bankruptcy court granted the motion, finding that the defendants/third-party plaintiffs had failed to show an unequivocally expressed waiver of sovereign immunity, and holding that the federal defendants were immune from suit under the United States’ sovereign immunity.36
III. PREEMPTION OF STATE LAW BY THE BANKRUPTCY CODE; PREEMPTION OF THE BANKRUPTCY CODE BY OTHER FEDERAL LAW
The authors are not aware of any significant published opinions since last year’s Annual Survey addressing the issues of preemption in connection with turnover actions.
IV. FORM OF ACTION/SERVICE
Federal Rule of Bankruptcy Procedure 7001(1)37 includes in the list relief requiring the commencement of an adversary proceeding, “a proceeding to recover money or property, other than a proceeding to compel the debtor to deliver property to the trustee.” Thus a request for turnover of estate property from a debtor,38 and a turnover action for recorded information under § 542(e),39 may be brought by motion, while Rule 7001(1) requires an action for turnover of property that is not a document, against a third party who is not the debtor, under
§ 542(a) and (b) and § 543(a) to be commenced by an adversary proceeding.40
Courts nonetheless have granted turnover relief sought by motion against a third party. In In re Cypress Health Systems Florida, Inc. the bankruptcy court determined that a $50,000 escrow held by a title company was property of the debtor’s estate and ordered it to be turned over on the debtor in possession’s motion.41
Further, many courts have held that § 542(a) is “self-effectuating.” The Ninth Circuit Bankruptcy Appellate Panel (BAP) in In re Cinevision International, Inc. reiterated its view that: “It has long been the determination of this panel that the turnover provisions of the Bankruptcy Code are to be self-effectuating, subjecting to sanctions a party that willfully fails to comply.”42 A party who does not seek the bankruptcy courts guidance, and unilaterally decides that it does need not turn over the property, does so at the risk that it will be assessed damages or will be sanctioned for violating the automatic stay.43
The California bankruptcy court in In re Perry held that a party that had repossessed the Chapter 7 debtor’s car prepetition had the affirmative duty to end its possession once it learned of the bankruptcy case and that since the car was exempt property, “turnover to the Debtor was appropriate.”44
A party’s obligation to turn over property under § 542(a) is further subject to the “good faith” exception, set forth in § XI below.
V. STANDING
A debtor in possession, whether under Chapter 11 or Chapter 13,45 and a Chapter 7 or 11 trustee, each has standing to bring an action under Code § 542.46 Most courts have held that a Chapter 7 debtor — whose property is under the authority of the trustee — lacks standing.
In Perry, the debtor’s auto lender had repossessed his car, but had not yet sold it when the debtor commenced his Chapter 7 case a week later. The lender subsequently obtained relief from the stay and sold the car. The bankruptcy court ultimately concluded that the debtor, who was representing himself, had exempted the car. The Perry court found “puzzling” the provision of § 542(a) requiring the turnover of exempt property “where it is the chapter 7 debtor who is seeking turnover from a creditor.” Accordingly, the court noted, some courts have held that a Chapter 7 debtor has standing.47 The Ninth Circuit BAP had reached the opposite conclusion, though, and the Perry court felt itself bound by it.48
VI. BURDEN OF PROOF
The party seeking turnover has the burden of proof,49 and “must prove that the subject property constitutes property of the estate and that the defendant is in possession of that property.”50
The trustee in In re Auld filed motions to extend the deadline for filing a complaint to deny the debtor’s discharge and for the turnover of property. The bankruptcy court ruled that the trustee was required “to describe with particularity the property or documents to be turned over.” Because the trustee had sought discovery, or been specific in his requests, his motion for an order directing turnover was denied.51
An exception stated by the bankruptcy court in In re Tate is the debtor’s burden to raise the issue of the inconsequential value of the property as an affirmative defense.52
Presumptions regarding ownership interests in property may shift the burden of proof. In In re Shapphire, one spouse had transferred property that was titled in her name to the debtor prepetition. Her spouse alleged that the property belonged to both spouses as community property. Under California law, the owner of the legal title to property is presumed to be the owner of the full beneficial title. This presumption can only be rebutted by clear and convincing proof.53 The bankruptcy court ruled that the challenging spouses’ uncorroborated testimony was insufficient to rebut this presumption.54
VII. SECTION 542(a)—PROPERTY OF THE ESTATE THAT THE DEBTOR MAY USE, LEASE, SELL, OR EXEMPT
Generally — Property of the Estate
“It is crucial to the trustee’s claim that the asset to be turned over is property of the estate.”55
Property rights generally are determined by state law.56 If under the applicable state law, the debtor has no interest in the property turnover of which is sought, then the court will deny turnover.
Courts have struggled with cases involving disputed title. The bankruptcy court in In re Nurses’ Registry and Home Health Corporation recently weighed in, holding that a trustee or debtor in possession has a cause of action for turnover even if title is in dispute and needs to be determined as part of the litigation.57
But the bankruptcy court in In re Soundview Elite Ltd. reached the contrary determination. The Chapter 11 trustee in Soundview filed a complaint by which she sought, among other things, turnover of the net value of the debtor’s investment in its non-debtor subsidiary — which was effectively everything that the subsidiary would have after payment to its creditors, since the debtor was the sole shareholder in the subsidiary.58 The court stated that “the turnover power can be improperly invoked, especially when it is used as a Trojan Horse for bringing garden variety contract claims; when the property in question is not already property of the estate; or when the turnover statute is used to recover assets with disputed title when the estate’s claim of ownership is legitimately debatable. It is well established that the turnover power may not be used for such purposes.”59 The court ruled that though the matter was close, and the defendant’s defenses were largely frivolous (and the court could not even find that they were bona fide), the court could not determine that the cash or property to be delivered to the debtor was “already estate property,” or that the debtor’s rights was “yet equivalent to recovery of a fixed sum, or tantamount to substituting one kind of asset for another.”60 The court denied the trustee’s motion for summary judgment of the turnover count.61
In re Fraterfood Service, Inc. required application of the Puerto Rico law. The debtor constructed a building and other improvements on its leasehold. The debtor subsequently filed its Chapter 11 case, rejected the lease, and filed a complaint seeking payment of $1.5M from the landlord for the value of the building and improvements and alleging that the landlord had violated the automatic stay by retaining possession of the building and improvements.62 The landlord moved to dismiss the complaint and sought Bankruptcy Rule 9011 sanctions against the debtor and its counsel.63
The debtor responded that the landlord was obligated to turn over the property under
§ 542(a).64 The court extensively analyzed the applicable law of the Commonwealth of Puerto Rico, and determined that the debtor in its complaint failed to establish that the debtor had an interest in the building and improvements. The court dismissed the debtor’s complaint.65
The Fraterfood court also found that the debtor’s counsel’s filing the complaint constituted “dilatory litigation” the purpose of which was forestall payment to the landlord of the postpetition rent that had accrued prior to the debtor’s rejection of the lease. The court granted the landlord’s motion for sanctions in part, ordering the debtor’s counsel to pay the landlord’s legal costs, expenses and fees.66
A mere damage claim generally is not determined to be estate property subject to turnover. The Chapter 11 trustee in In re The Vaughan Company, Realtors, a real estate brokerage company, sued a competitor and several individuals for the defendants’ “alleged improper relocation of certain real estate brokers” who had worked at the debtor to the competitor, and “the subsequent relisting” of the debtor’s real estate listings with the new firm. The trustee sought, among other things, turnover of the commissions received on the sales of the re-listed properties. The defendants moved to dismiss. 67
The court ruled that the commissions were not property of the estate. “Property such as commissions to be recovered for the estate becomes property of the estate only if and when recovered.” Even if the trustee had sought to recover the commissions as a voidable post-petition transfer under § 549 or otherwise (which she had not), or prevail on her claim that the listings were wrongfully transferred, the commissions themselves would “never become property of VCR’s bankruptcy estate” and thus the trustee could not obtain relief under § 542(a). “A damages award in the amount of the Commissions does not make the Commissions themselves property of the estate” and the trustee’s claim under § 542(a) was “not facially plausible.”68
See also In re Shapphire Resources, LLC discussed in § VI above.
The Property Must be Property That the Debtor May Use, Lease, Sell or Exempt
Property that the Debtor May Use, Lease of Sell
The property, to be subject to turnover, must be property that the debtor may use, lease or sell under section 363, which generally means that it is property of the estate under Code § 541.69
Property that the Debtor May Exempt
The application of the turnover provisions to property asserted by the debtor to be exempt is somewhat peculiar, since the debtor’s exemption would appear to put the exempt property beyond a trustee’s reach even though § 542 requires turnover to the trustee of property that the debtor may exempt.
Courts nonetheless often deny a trustee’s request for turnover of property, if the debtor has claimed a proper exemption (see e.g., In re Perry discussed in § II above),70 and conversely grant the trustee’s motion for turnover from the debtor if the property is not exempt.
Types of Property Interests Subject to Turnover
Several opinions in the last year have made the threshold determination of whether the property sought was estate property, with respect to myriad types of property interests, as set forth in the following subsections of this § VII.
Accounts Receivable
The court in In re SurfaceMax, Inc. (discussed in II above) followed the general rule that an action to obtain payment on an account receivable — though actionable — is not a turnover proceeding.71
Alimony
The bankruptcy court in In re Millette determined that alimony is a property interest and not a personal right under New Hampshire law, and thus was property of the estate.72
Alter Ego Claims
The trustee in Comu v. King Louie Min., LLC alleged that Comu concealed his ownership of Green Automotive Company, Inc., “using, inter alia, his undisclosed, de facto ownership and control of The Barclay Group, Inc. (‘TBG’) to hold his Green Auto Stock and thereby avoid detection.” The trustee sought turnover of all prepetition assets, including the Green Auto Stock and any proceeds collected from the disposition of those assets.73
The bankruptcy court concluded that “TBG was indeed Comu’s alter ego, and that, therefore, any pre-petition shares of the Green Auto Stock owned by TBG should have been turned over to the Trustee pursuant to 11 U.S.C. § 542(a).” The court found that Comu had furthered an “elaborate scheme to dissipate TBG’s Green Auto Stock—and collect millions of dollars in cash proceeds—that should have been available to his creditors.” The court further found value of the stock to be $5,858,788, which reflected the “actual cash proceeds from the sale of Green Auto stock.”74
The district court held that the bankruptcy court had authority to order parties to turn over property subject to their control, which should have been included in the bankruptcy estate, and affirmed the monetary judgment in favor of the trustee pursuant to § 542(a).75
The bankruptcy court in In re Raymond held that control, “even pervasive control, without more, is not a sufficient basis for a court to ignore corporate formalities,” and dismissed the trustee’s alter ego claims.76
See also In re Tolomeo and In re Roussos discussed in § II above,
Avoidable Transfers
Avoided transfers are subject to turnover, but the courts continue to divide on the question of whether a transfer that is merely avoidable is subject to turnover.
The Chapter 7 trustee in In re Bruner sought turnover of a fee paid postpetition to the debtor’s criminal defense counsel. The debtor’s elderly mother wire-transferred the funds to defendant defense counsel, and the parties hotly disputed whether the debtor was “the true source of the transferred funds.” In the court’s view the parties had missed a more fundamental point, that: “turnover can only be used to demand return of estate property to the Trustee, not to avoid transfers of what was estate property.”77 The court reasoned that when the debtor “voluntarily surrendered her own title to the money, the estate lost whatever interest it had in the money.” Even though the trustee offered substantial evidence that the $50,000 was the debtor’s money and thus may have been estate property before its transfer, the trustee did not avoid the unauthorized postpetition transfer. Thus, no evidence the trustee had adduced could prove that the $50,000 fee, having been transferred from the estate, was estate property and the fee was not subject to turnover.78
But in In re Roussos, also discussed in § II above, the court ruled that the transfer of estate property pursuant to a court order under § 363(b) but in fraud on the court “never divested of its interest in the Properties” and declined to dismiss the turnover count.79
See also In re Tolomeo discussed in § II above.
Lease or Disguised Financing
The trustee in In re Hunt sought turnover of certain equipment from the debtor. The debtor objected, asserting that the property was subject to a finance lease with Shephard under Idaho law, pursuant to the terms of which Shephard was the owner of the property until the debtor completed payments to him.80 The court held that the transaction between the debtor and Shephard was a disguised financing and security interest, and thus that the debtor had an ownership interest in the equipment. As a result, the equipment was property of the estate and the court ordered turnover to the trustee.81
Proceeds and Escrows
If property of the estate, subject to turnover, was first sold, then the sale proceeds are subject to turnover. Conversely if the property is not property of the estate, then the proceeds are not subject to turnover.
If the property sold was subject to a valid and perfected lien, then the holder of the lien is entitled to the proceeds in payment of its claim, prior to any payment to estate. In In re Spence the debtor’s boat slip was sold at sheriff’s sale. The bankruptcy court found that the condominium association’s execution and levy against a boat slip were valid and that it thus held a judgment lien against the proceeds, in the amount of $37,138. The court ordered payment of $37,138 to the association and the turnover of the balance of the proceeds to the Chapter 7 trustee.82
The debtor in In re Morev entered into an agreement with a creditor, Keeler, prepetition. Under the agreement, the debtor assigned his liquor license to Keeler, who agreed to “make maximum effort to sell the license, to recoup $68,000” which represented the amount that the debtor owed to the Keeler “for the purchase of the liquor license, plus legal costs.” Keeler opened an escrow with an escrow company to accomplish the sale, the liquor license was sold, and the sale proceeds were deposited in escrow with the escrow company.83
The debtor filed his Chapter 7 petition and the trustee sought turnover of the escrowed funds. The court held that it is “well settled in the Ninth Circuit that where a seller of a liquor license becomes a debtor in a bankruptcy case after the license is sold, but before the proceeds are distributed from escrow, the proceeds become property of the bankruptcy estate and must be distributed in accordance with the bankruptcy priority scheme … while a state, as the creator of a liquor license, may validly impose conditions on its transferability for the state’s own benefit, it may not, consistently with paramount federal law, impose conditions which discriminate in favor of particular classes of creditors.”84
The escrow company argued that Keeler was entitled to the proceeds, because the debtor had assigned the liquor license to Keeler. The court held that the assignment was neither an outright transfer of, nor a grant of a security interest in, the liquor license. The assignment “was at most a grant by Debtor to Keeler of control of the license for the sole purpose of allowing Keeler to sell the license and to control (not own) the proceeds,” and ordered turnover of the proceeds.85
In In re Cypress Health Systems Florida, Inc. Partner’s Healthcare signed a letter of intent prepetition for the purchase of assets of the debtor and paid a $50,000 deposit to the title company. The sale never closed. The debtor filed its Chapter 11 petition and sought turnover of the $50,000 deposit.86
Partner’s Healthcare argued first that the debtor did not schedule the escrow as an asset, and thus had no interest in the funds. The court rejected this argument perfunctorily. Partners Healthcare next argued that the debtor failed to negotiate the sale in good faith. The court found that the letter of intent contained express terms regarding ownership and disposition of the escrow, including that the escrow “would revert permanently to the possession and control” of the debtor under certain circumstances, which the court found had occurred. The court ordered turnover.87
Property of Others
Bankruptcy Code § 541(d) “excludes from the bankruptcy estate the equitable interest in any property in which the debtor holds, as of the commencement of the case, only legal title and not an equitable interest.
The bankruptcy court in In re Raymond held that property co-owned with one’s spouse, though, is subject to turnover because pursuant to § 363(h) it can be sold and under § 363(j) the proceeds can distributed to the joint owners in accordance with their respective ownership interests.88
Spendthrift and Discretionary Trusts
Section 541(c)(2) of the Code provides that: a “restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title,” and thus “recognizes the enforceability of spendthrift provisions in trusts where the debtor is a beneficiary of a spendthrift trust.”89
The court in Safanda v. Castellano determined that, under the law of the three states that might apply, “discretionary trusts, like spendthrift provisions, validly restrict the transfer of a beneficiary’s interest.” The debtor’s beneficial interest in the trust at issue was “subject to a valid nonbankruptcy restriction on transfer.” It thus “fell within the scope of § 541(c)(2)” and was excluded from her bankruptcy estate.90
Substantive Consolidation
Substantive consolidation is a doctrine by which a bankruptcy court may pool the assets and liabilities of two or more related entities. Courts most often have substantively consolidated two or more debtors, typically because the debtors’ assets and liabilities are so commingled that it would be impossible or prohibitively expensive to disentangle their financial affairs. A court more rarely may substantively consolidate a debtor with a nondebtor. The bankruptcy court in In re Raymond citing approvingly another bankruptcy court decision that stated that: “Substantive consolidation is essentially a complex turnover proceeding because the debtor is asking the nondebtor affiliated entity to bring into the estate assets in which the debtor asserts an inseparable interest.” But the Raymond court dismissed the trustee’s substantive consolidation claim.91
VIII. SECTION 542(a)—DELIVER TO THE TRUSTEE AND ACCOUNT FOR THE PROPERTY OR THE VALUE OF SUCH PROPERTY IN POSSESSION, CUSTODY, OR CONTROL DURING THE CASE OF THE ENTITY, OTHER THAN A CUSTODIAN, FROM WHOM TURNOVER IS SOUGHT
The bankruptcy court in In re Tate followed the majority rule that the party from whom turnover is sought under § 542(a) must be “in possession, custody, or control, during the case, of the property,”92 that is, at some point “during the case,” if the turnover action is to succeed.93
The trustee in Matter of Home Casual LLC sought turnover of a bank account. The bankruptcy court found that “it suffices to note that there is no proof that there were funds in the account on the date of the bankruptcy which would be subject to turnover,” and thus there was no basis on which to compel an accounting.94
Deliver to the Trustee Property or the Value of Such Property
The person in possession, custody or control of the property “during the case” has the duty under§ 542(a) to “deliver to the trustee, and account for, such property or the value of such property.”95 Most courts hold that “during the case” means at any time during the pendency of the bankruptcy case, and not solely at the time the turnover proceeding is commenced.96 Further, if the property has been spent, transferred or otherwise dissipated that person in most cases remains obligated to turn over its value.
The bankruptcy court in Comu v. King Louie Min., LLC found that the debtor had concealed from the trustee certain stock that he owned and had failed to turn over that stock to the trustee. The court ordered the debtor to turn over the value of the stock.97
The debtor in In re Tate received an arbitration award, $110,873 of which was non-exempt property of his estate. The bankruptcy court ordered turnover of that part of the award, shortly after which Tate notified the trustee that he had spent the money on living expenses and “therefore would be unable to comply” with the court’s order.98
Tate then proceeded to try the patience of the court. Six months entry of the turnover order, the court found Tate in civil contempt. Seven months later, “after various efforts failed to coerce Tate’s compliance,” the district court at the bankruptcy court’s request issued an arrest warrant. Tate turned himself in, and was released conditioned on his appearance before the bankruptcy court to explain the whereabouts of the money. At the hearing though, “he failed to provide any additional information as to the disposition of the Arbitration Award. The court ordered Tate held in custody until he either turned over or accounted for the money, and scheduled a second hearing 48 hours later “to provide Tate an opportunity to do so.”99
Tate remained unmoved, reasserting his prior testimony that he had used the money for living expenses, including $78,542 that was withdrawn from his account when the account was closed. Following the hearing, the court gave Tate numerous deadlines and opportunities to comply, none of which were complete or satisfactory.100
Resignedly, the court acknowledged that a year-and-a-half of its “efforts to coerce Tate’s compliance” had “produced limited tangible benefits for creditors.” No matter the personal cost or risk, Tate remained unwilling to fully comply. The court transmitted a record of Tate’s actions in the case to the United States Attorney “for the purpose of considering various criminal charges.” The court tiredly conceded that a criminal prosecution would not provide creditors with any further monetary benefit. However, a monetary judgment, while Tate appeared to still be working, would “at least provide the Trustee an opportunity to recover the remaining portion of the Arbitration Award for the benefit of the creditors, rather than continue a game of cat and mouse with Tate.” Accordingly, the court entered judgment against Tate in the $91,290 value of the estate’s $110,873 share of the arbitration award.101
See also In re Spence discussed in § VII above (ordering payment of $37,138 of proceeds from the sale of the debtor’s boat slip to the judgment lien creditor, and the turnover of the balance of the proceeds to the Chapter 7 trustee).102
Notwithstanding the textual directive in § 542(a), “[n]umerous courts have recognized an equitable defense of double satisfaction in the context of a turnover action,” and the bankruptcy court In re Noram Resources, Inc. denied part of the trustee’s turnover claim because it would have constituted such an “impermissible double recovery.”103
Action for Accounting
Section 542(a) also requires an entity to account for property subject to turnover.104 The court in In re Vaughan Company, Realtors held that though the trustee had failed to state a claim under § 542, she nonetheless was “not precluded from seeking an accounting or from requesting copies of the listing agreements and closing statements under the Rule of Civil Procedure governing pre-trial discovery.”105
See also In re Tate discussed in this § VIII above.
IX. UNLESS SUCH PROPERTY IS OF INCONSEQUENTIAL VALUE OR BENEFIT TO THE ESTATE
Section 542(a) does not require turnover of “property that is of inconsequential value or benefit to the estate.”106
The bankruptcy court in In re Shapphire Resources, LLC found that, “given the nature of the Property, its renovation to be used as a home for the developmentally disabled, and its ability to generate income …, and that no party has argued that the Property is of inconsequential value or benefit to the estate, the debtor in possession who was seeking turnover had “shown, by a preponderance of the evidence, that the Property [was] not of inconsequential value or benefit to the estate.”107
The bankruptcy court in In re Noram Resources, Inc., also discussed in § VIII above, noted that “an essential element of a turnover action is that the estate property in question must have consequential value.” The court went on to state that, if the defendants, “through settling claims rightfully owned by the estates, impacted the prosecution of the subsequent lawsuits, then the claims would have consequential value” to the estate. The evidentiary record in the court’s view did “demonstrate such an impact, although it may have been minimal.”108
X. SECTION 542(b)—DEBTS MATURED OR PAYABLE ON DEMAND OR ORDER BUT § 542 NOT AVAILABLE TO LIQUIDATE DISPUTED CONTRACT CLAIMS
Bankruptcy Code § 542(b) provides that, subject to the exceptions in § 542(c) and (d) and to offset under § 553, “an entity that owes a debt that is property of the estate and that is matured, payable on demand, or payable on order, shall pay such debt to, or on the order of, the trustee.”109
The “matured debt” does not need to be evidenced by a promissory note. In In re MF Global Inc. the debtor’s customer had opened an investment trading account with the debtor prepetition pursuant to the terms of a Customer Agreement. The Customer Agreement gave the debtor “various rights, including, without limitation, the right to declare” the customer “in default without declaring a margin call and the right to liquidate his account without affording him prior notice.”110
The debtor attempted to contact the customer several times on May 6, 2010, during a severe market downturn, to notify the customer of a margin call. An email sent by the debtor toward the end of the day informed the customer that unless he paid the margin call the debtor would liquidate his account. By the end of the next day the debtor had completely liquidated the account.111
The customer sued the debtor prepetition. The litigation was stayed by the bankruptcy filing. The customer did not seek relief from the stay. The customer filed a $545,000 claim in the bankruptcy case.112
The trustee did not seek affirmative relief under § 542(a), but sought only a determination that the customer’s account was in deficit for the purpose of temporarily disallowing the customer’s claim under § 502(d).113 The court found that the trustee had established that the customer was “unconditionally liable” to the debtor for the debit balance of his account the debt was matured under § 542(b) and thus that the debt was estate property under § 541(a).114 The court held that the trustee thus had made a prima facie showing that the debit balance was subject to turnover and sustained the trustee’s objection to the customer’s claim under section 502(d) of the Code.115
But a mere contract dispute is not a “matured debt.” The bankruptcy court in In re NanoDynamics, Inc. “readily dismisse[d]” the trustee’s § 542 turnover action. Section 542 “has no utility to collect a ‘debt’ that has yet to be determined to be ‘property of the estate’ because, for example, there neither has been a determination of liability on an obligation, nor identification of a source of payment (or other satisfaction) to which a debtor has a right of ownership or possession.”116
The court in In re Soundview Elite Ltd., also discussed in § VII above, noted that “section 542(b) can be used to monetize estate assets such as notes or accounts receivable that are already property of the estate.”117 But “[u]nlike the entitlement to payment on an account receivable or a promissory note, which is simply to be converted into cash,” the debtor did “not yet own the redemption proceeds, and its entitlement” was “not yet equivalent to recovery of a fixed sum, or tantamount to substituting one kind of asset for another.”118
The debtor in In re Pantazelos filed a complaint against her former bankruptcy counsel seeking recovery of attorney’s fees paid for legal services rendered in her two earlier bankruptcy cases, both of which were bankruptcy cases dismissed.119 The defendant moved to dismiss the debtor’s suit. The bankruptcy court stated that turnover is a remedy to obtain what is acknowledged to be property of the estate, and “cannot be used as a tool to acquire property the debtor did not have a right to possess or use at the commencement of a case.” The debtor, in the court’s view, had put “the cart before the horse.”120 She did not allege a “debt” that was “clearly her property and simply not in her possession. Rather, the debtor alleged that the defendant obtained the money improperly, “alluding to possible fraud.” The court nonetheless determined that the facts, taken in the light most favorable to the debtor, established a plausible claim for common law fraud. The court held that it was not bound by the debtor’s mischaracterization of her legal theory, and denied the defendant’s motion to dismiss.121
In In re Harrelson the debtor similarly alleged that her former bankruptcy counsel and debt relief agency “took the Plaintiff’s money and failed to perform under the terms of the Agreement, failed to negotiate the settlement of the credit card debts, [and] failed to prevent further collection efforts by the creditors, including lawsuits filed against the Plaintiff …” The bankruptcy court characterized the debtor’s claim as “a quintessential allegation for breach of contract” and not a matured debt payable on demand, and noted that there appeared to be a dispute as to as to whether the debtor still had legal title to the fees that she paid to the defendants.122 The agreement among the parties required the submission of disputes to arbitration.123 The court rejected the objections to enforcement of the clause and ruled that the “turnover” claim “must be submitted to arbitration.”124
The bankruptcy court in In re 11 East 36th LLC stated that it is settled law that turnover cannot be used to liquidate contract disputes. It was clear, on the face of the complaint, that the plaintiff was attempting by one count of the complaint to liquidate a disputed debt.125 The court agreed that the plaintiff had failed to state a cause of action and dismissed that count of the complaint.126
XI. SECTION 542(c)—THE “GOOD FAITH” EXCEPTION TO TURNOVER
the authors are not aware of any significant published opinions since last year’s Annual Survey addressing issues in connection with the “good faith” exception to turnover actions.
XII. SECTION 542(e)—OBLIGATION TO TURN OVER RECORDED INFORMATION
Bankruptcy Code § 542(e) provides that “[s]ubject to any applicable privilege, after notice and a hearing, the court may order an attorney, accountant, or other person that holds recorded information … relating to the debtor’s property or financial affairs, to turn over or disclose such recorded information to the trustee.”127
In In re Auld, the bankruptcy court denied the Chapter 7 trustee’s motion for turnover pursuant to § 542, stating that to obtain an order to turn over property or recorded information, the trustee must show: (a) that the property to be turned over is property of the bankruptcy estate and the recorded information relates to property of the estate; and (b) that the property and recorded information are in the Debtor’s possession or under his control at the time the turnover motion was filed.128 The trustee’s motion in Auld requested turnover of (i) copies of the debtor’s mortgage loan or credit applications given to obtain the present mortgage against the debtor’s property; (ii) copies of loan documents and copy of the title to a 2009 Harley-Davidson motorcycle; (iii) copies of the debtor’s prepared and filed 2015 tax returns upon filing and turnover of the estate’s portion of any and all 2015 refunds immediately upon receipt; (iv) copies of titles to a 2004 and/or 2002 GMC Yukon; (v) an explanation concerning the disposition of property awarded to the debtor in his most recent divorce decree; and (vi) information concerning any life insurance policy that the debtor owned and was required by his divorce decree to maintain.
In denying the turnover motion, the Auld court analyzed each request in turn. First, the motion did not clearly identify the loan applications for the property, establish that they were in the debtor’s possession, or indicate why they were relevant. The court noted that applications that were several years old would be of questionable relevance. Second, the motion did not clearly identify or establish the relevance of the loan documents sought with respect to the motorcycle, and did not establish that those documents or the title to the motorcycle were in the debtor’s possession. The noted that since the motorcycle was scheduled subject to the lien of the secured creditor, the title most likely was being held by the lender. Third, with regard to the tax return request, the court declined to issue an order to turnover paperwork that did not yet exist. Fourth, the court found that the GMC Yukon and been exempted by the debtor and thus was no longer an asset of the estate, and the court declined to order the turnover of a document that did not relate to property of the estate. Fifth, in response to the request for an explanation concerning the award in the divorce decree, the court stated there is no legal basis to enter an order directing the debtor to provide “explanations” because an explanation is neither property of the estate nor recorded information subject to turnover. Finally, with respect to the request for information concerning life insurance policies, the court reiterated that “information” is not property or recorded information that is subject to turnover.129
In In re Allegro Law LLC, the bankruptcy court entered a default judgment against the defendants in the amount of $103 million, in part because the plaintiff offered a “mountain of evidence” in support of his claim that the defendants defrauded a large number of individuals, but also as a result of the defendants’ poor conduct (including their refusal to show up at the trial and refusal to turnover recorded information).130 The court found that the defendant, Timothy McCallan had perpetrated fraud on a massive scale by promising customers that their debts would be either paid or settled. Instead, McCallan siphoned off the money into companies controlled or closely associated to him.131 McCallan used a number of lawyers including Keith Nelms to perpetuate his scheme. Allegro Financial and Allegro Law (“Allegro”) were entities controlled by McCallan and fronted by Nelms as a law firm.132 Nelms superficially hired McCallan and AmeriCorp and Seton (also controlled by McCallan) to handle processing for Allegro. When the State of Alabama placed Allegro in receivership, Nelms and Allegro each filed Chapter 7 bankruptcy petitions.133
The Chapter 7 trustee of the Allegro bankruptcies filed suit against McCallan, AmeriCorp and Seton seeking, among other things, turnover of property of the estate. The trustee had learned that Nelms and Allegro did not keep their own business records, but rather the records were kept by AmeriCorp in an electronic form.134 The defendants disregarded two discovery orders which required them to produce the database and to allow the trustee access to the database. Though the court denied the trustee’s request for default judgment, it held the defendants in contempt and again ordered them to produce the requested database.135 The defendants eventually produced the data stored on a CD, but their production was facially deficient because they did not provide the trustee with actual access to the computer servers. The defendants later tried to cover this deficiency by claiming (falsely as it later turned out) that the servers had been deactivated and that access to the servers was not technologically possible.136 Three years into the Chapter 7 cases, the defendants finally granted the trustee access to the servers, but by then the damage had been done. The trustee then filed a third motion for sanctions, asserting that he was unable to make distributions to creditors of the Allegro bankruptcy estate due to the defendants’ “stonewalling” on discovery, and that he had incurred various fees during the time. The court granted the trustee’s motion in the amount of $999,457.95, stating the “proceedings were delayed by several years as a result of the Defendants’ well-documented obstructionist tactics.”137
XIII. SECTION 543—TURNOVER OF PROPERTY BY A CUSTODIAN
Bankruptcy Code § 543138 is entitled “Turnover of Property by a Custodian” and is the parallel to § 542. The party from whom the turnover is sought must be a custodian for § 543 to apply. A “custodian” is defined in Code § 101(11) as:
(A) receiver or trustee of any of the property of the debtor, appointed in a case or proceeding not under this title;
(B) assignee under a general assignment for the benefit of the debtor’s creditors; or
(C) trustee, receiver, or agent under applicable law, or under a contract, that is appointed or authorized to take charge of property of the debtor for the purpose of enforcing a lien against such property, or for the purpose of general administration of such property for the benefit of the debtor’s creditors.139
Subsections 543(a) and (b) provide that:
(a) A custodian with knowledge of the commencement of a case under this title concerning the debtor may not make any disbursement from, or take any action in the administration of, property of the debtor, proceeds, product, offspring, rents, or profits of such property, or property of the estate, in the possession, custody, or control of such custodian, except such action as is necessary to preserve such property.
(b) A custodian shall—
(1) deliver to the trustee any property of the debtor held by or transferred to such custodian, or proceeds, product, offspring, rents, or profits of such property, that is in such custodian’s possession, custody, or control on the date that such custodian acquires knowledge of the commencement of the case; and
(2) file an accounting of any property of the debtor, or proceeds, product, offspring, rents, or profits of such property, that, at any time, came into the possession, custody, or control of such custodian.140
Subsection 543(c)(2) provides that the court, after notice and a hearing, shall -
(2) provide for the payment of reasonable compensation for services rendered and costs and expenses incurred by such custodian.141
Subsection 543(d)(1) provides that after notice and hearing, the bankruptcy court -
(1) May excuse compliance with subsection (a), (b), or (c) of this section if the interests of creditors and, if the debtor is not insolvent, of equity security holders would be better served by permitting a custodian to continue in possession, custody, or control of such property.142
In In re Joseph and David Johnsman Limited Partnership, a secured lender of the Chapter 12 debtor obtain relief from the automatic stay from the bankruptcy court and an order of possession from the state court. The lender, instead of proceeding under the state court order, permitted the debtor to sell the collateral, which consisted of equipment and livestock, to Egbert. Egbert paid the purchase price, which was remitted to the lender on account of the debt. The debtor subsequently brought an adversary proceeding against Egbert, alleging that Egbert was a custodian under § 543(b) and seeking an accounting and turnover.143 Egbert sought summary judgment based on his assertion that he did not fall within the definition of custodian under § 101(11)(C).144 He clearly was not a court-appointed trustee or receiver of the debtor’s property or an agent or assignee under a general assignment for the purpose of administration of such property within the meaning of § 101(11)(C).145 The court found that the livestock and equipment were transferred to Egbert “for his own use and advantage or profit forever,” that the Bills of Sale included “no language in indicating that the transfers were for the purpose of administration of the property” for the benefit of the debtor’s creditors, and that the debtor’s reliance on allegations in the complaint that Egbert had orally agreed to take possession of the equipment and livestock for the general benefit of the estate, without more, was “insufficient” to defeat the motion for summary judgment.146 The court agreed with Egbert and held that he was not a “custodian.”
In In re 4522 Kateuua Ave, EEC, the court granted the motion for turnover.147 In that case, the debtor had commenced its Chapter 11 case four months after forecl