Opinion
Case No. 10-04338-PB7
04-27-2012
In re ARIES ASSOCIATES, INC., Debtor.
WRITTEN DECISION - NOT FOR PUBLICATION
ORDER ON MOTION FOR ORDER
APPROVING SALE OF ESTATE
ASSETS AND SETTLEMENT
The Trustee in this case seeks approval of a sale of estate assets to, and settlement with, creditor/litigant L-3 Services, Inc., and related parties (L-3). Dr. Conrad and parties related to him (Conrad Parties) oppose the motion on several grounds, but primarily on the ground that the Aries Associates, Inc., (Aries) estate does not own the assets to be sold. After consideration of the voluminous record and the argument at the hearing, the Court finds that the position now taken by the Conrad Parties is not supported by competent and admissible evidence. The Court also holds that the sales price, which was tested by extensive notice and the opportunity of overbid, is reasonable. Finally, the Court holds that the sale and settlement are proposed in good faith under § 363(m). Accordingly, and for the reasons discussed below, the Court grants the Trustee's motion and approves the proposed sale and settlement.
MOTION
The Trustee proposes to sell the bankruptcy estate's rights, title and interest in and to certain assets particularly described in the Asset Purchase Agreement between L-3 and the Trustee (the APA). In particular, L-3 proposes to buy all of the estate's right, title and interest in and to certain intellectual property which is the subject of the ongoing litigation between L-3 and Aries ("Intellectual Property"). In addition, L-3 proposes to purchase certain equipment ("Included Equipment"), documents ("Purchased Documents"), and causes of action (collectively, the "Assets"). The proposed sales price is $150,000 and was subject to overbid. The proposed sale is free and clear of liens.
The Conrad Parties object primarily on the ground that the Assets were not owned by Aries, and hence are not assets of the Aries bankruptcy estate. Rather, argue the Conrad Parties, Aries holds a conditional, non-exclusive right to use the Assets and its ownership is conditional on repayment to Conrad and Cole of $1.8 million, which has not occurred. In a word, the Trustee has nothing to sell.
Oppositions have been filed on behalf of Dr. Conrad, Dr. Cole and Aries. The Trustee argues that the Aries Trustee alone has standing to take a position on behalf of Aries. Since the objections are nearly identical and overruled, the Court need not determine whether the Aries opposition was properly filed.
BACKGROUND
Since January of 2009 Aries and L-3 have been engaged in litigation in district court over ownership of certain decontamination technology (the "CDCA Litigation"). Generally speaking, Aries contends that its principal, Dr. Conrad, created the decontamination technology for chemical and biological weapons which he eventually called "AeROS," and that at least as of the date of the complaint, that technology was owned by Aries:
ARIES is the owner of certain patents, trademarks, and trade secrets protecting ideas and technology used in chemical and biological decontamination systems ... ARIES is the owner of certain patents, trademarks, and trade secrets protecting its AeROS... technologies used in chemical and biological decontamination systems.Corrected First Amended Complaint, L-3's Request for Judicial Notice (RJN) Ex. 3 at 2:13-20. In the CDCA Litigation, Aries, through Dr. Conrad, contended that development of what would become the AeROS technology began with Dr. Conrad's work at Chromagen, Inc., and that in March, 2005, he and Dr. Cole formed Aries and assigned to it all rights in the Chromagen technology. See L-3's RJN Ex. 4. In the March 2, 2009, Declaration of Michael J. Conrad, PH.D., in Support of Aries Associates, Inc.'s Motion for Preliminary Injunction, he reiterated under oath:
Pursuant to a secured credit agreement dated March 29, 2005, Chromagen assigned certain intellectual property rights, including patents, trademarks and tradeSee L-3's RJN Ex. 2 at 6:26-7:3.
secrets, to my wife Dr. Cole, and me. We, in turn, assigned these rights to ARIES. To acquire Chromagen's intellectual property, ARIES agreed to assume responsibility for certain Chromagen debts of approximately $2.7 million.
L-3, on the other hand, has contended that the technology was created while Dr. Conrad was working for L-3 under "Work for Hire Contracts" and thus belongs to L-3. This battle was being waged in the CDCA Litigation when this bankruptcy case was filed.
On March 18, 2010 Aries filed its chapter 7 petition. Debtor scheduled the Intellectual Property as an asset of the estate. The Trustee was able to negotiate a sale of the assets of the Aries bankruptcy estate, including the AeROS technology and the claims against L-3 asserted in the CDCA Litigation, to L-3, approval of which the Trustee seeks in the present Motion.
In response to the Motion the Conrad Parties now argue that Aries does not own the Intellectual Property or any of the Assets. Rather, contend the Conrad Parties, Aries has a mere "conditional assignment" of the technology which is contingent upon payment to Conrad and Cole of the obligations assumed from Chromagen. They also argue that to the extent Aries owns the property, it is subject to a first-priority security interest in favor of the Conrads and that the Conrads were given a right of first refusal.
As in the CDCA Litigation, Dr. Conrad and Dr. Cole are referred to collectively as the Conrads.
DISCUSSION
The Trustee moves to sell under § 363(b)(1) which, under certain circumstances, authorizes a trustee to sell "property of the estate." The Conrad Parties' primary objection to the sale is that the Assets, particularly the Intellectual Property, are not property of the Aries bankruptcy estate. Rather, assert the Conrad Parties, the transfer from Chromagen to Aries was conditional on the payment of the Conrads' $1.8 million claim. Further, any transfer from Chromagen to Aries was subject to a first priority security interest in favor of the Conrads. Thus, Chromagen and/or the Conrads own the beneficial interest in the Intellectual Property and other Assets, and the Aries estate has nothing to sell.
Before allowing a Trustee to sell assets of the estate, the Court must find that the estate owns the property to be sold. In re Popp, 323 B.R. 260 (9th Cir.BAP 2005); In re Rodeo Canyon, 362 F.3d 603 (9th Cir. 2004). Aries' Schedules, attested to under penalty of perjury by Dr. Conrad, state that Aries owns all of the Assets. The Trustee is entitled to rely on a debtor's schedules. Hebbring v. U.S. Trustee, 463 F.3d 902, 908-09 (9th Cir. 2006).
A party asserting a competing interest in property to be sold under § 363 has the burden of proof on the issue of the validity, priority, or extent of such interest. 11 U.S.C. § 363(p)(2). The sole evidence upon which the Conrad Parties base their assertion that Aries does not own the beneficial interest in the Intellectual Property is a document entitled "Secured Debt Agreement" dated July 5, 2006 (SDA) and the declarations of Drs. Conrad and Cole based thereon.
The Trustee and L-3 object to the admission of the SDA asserting the "best evidence rule." The original of the SDA, a signed copy of which first surfaced in connection with the Motion, has not been produced.
The Federal Rules of Evidence (FRE) govern evidentiary matters in bankruptcy cases. FRE 101; Fed.R.Bankr.P. 9017. Under the Federal Rules of Evidence, a party seeking to prove the content of a writing must normally produce the original writing. FRE 1002 provides:
An original writing, recording, or photograph is required in order to prove its content unless these rules or a federal statute provides otherwise.
As intimated, FRE 1002 is qualified by other rules of evidence which permit a duplicate or other secondary evidence to be introduced to prove the content of a writing. See, e.g., FRE 1003 (exception for duplicates); 1005 (exception for public records); 1006 (exception for summaries); 1007 (exception for party admissions).
In the case at hand, the Conrad Parties have not produced the original SDA. Rather, the Conrad Parties rely upon a purported duplicate of the SDA. FRE 1003 governs the admissibility of duplicates and provides:
A duplicate is admissible to the same extent as the original unless a genuine question is raised about the original's authenticity or
the circumstances make it unfair to admit the duplicate.
Weinstein's Federal Evidence treatise discusses the rationale behind the best evidence rule:
1. Secondary evidence, whether parol testimony or copies, is susceptible to both human and mechanical error. The rule, therefore, enhances the probability of accuracy.6 Jack B. Weinstein & Margaret A. Berger, Weinstein's Federal Evidence § 1002.03 (2d ed.1997) cited in In re Porras, 224 B.R. 367 (Bankr.W.D.Tex. 1998). Where there is a possibility of fraud in the circumstances surrounding the execution of a writing, the reliability of the duplicate is impaired and the court may insist on the original if the opponent demands it. Id. at § 1003.03.
2. The rule promotes the prevention of fraud because it allows the parties to examine documents for any defects or alterations, and it dampens any desire to color testimony as to the contents of documents, since any testimony is subject to immediate corroboration.
3. The appearance of the original may furnish information as to its authenticity and significance that may be lacking in a copy.
In the present case the Court finds not only that a genuine question has been raised about the authenticity of the SDA, but also that the circumstances make it unfair to admit the supposed duplicate SDA proffered by the Conrad Parties.
The Conrad Parties contend that the SDA was created and executed in July 2006 in connection with the assignment of the Intellectual Property and other assets from Chromagen to Aries. The Trustee and L-3 suspect that the SDA was created more recently in an effort to derail the proposed sale to L-3.
Dr. Conrad explains that though they exercised their right under the SCA to obtain the Chromagen assets in April 2005, the Conrads agreed to defer transfer of ownership to permit Chromagen to resolve certain litigation, which did not occur until March 2006.
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There is a genuine question as to the authenticity of the SDA. First, there is the fact that this document, ostensibly created in 2006, has not surfaced in the extensive discovery and litigation between the Conrad Parties and L-3 which has been ongoing since January 6, 2009. Not only has the SDA not appeared, but the Conrad Parties have identified no other document or correspondence which refers to the SDA in the numerous pages of documents produced. As noted above, in the CDCA Litigation Dr. Conrad declared that the assets were transferred from Chromagen to Aries "[p]ursuant to a secured credit agreement . . .." He made no mention of the SDA.
The Conrad Parties argue that Aries' $1.8 million obligation to the Conrads is supported by many other documents. This indeed appears to be the case. However, neither the fact of" nor the amount of the obligation is in question. Rather, it is the newly raised assertion of a security interest in favor of the Conrads and a beneficial interest in favor of Chromagen for which there is no evidence other than the copy of the SDA.
Second, the position taken by the Conrad Parties in reliance upon the SDA is completely inconsistent with the position they have taken for the last several years in the CDCA Litigation and in this bankruptcy case.
As noted above, in its complaint in the CDCA Litigation, Aries alleged:
ARIES is the owner of certain patents, trademarks, and trade secrets protecting ideas and technology used in chemical and biological decontamination systems . . . ARIES is the owner of certain patents, trademarks, and trade secrets protecting its AeROS . . . technologies . . ..In the CDCA Litigation, Aries, through Dr. Conrad, contended that development of what would become the AeROS technology began with Dr. Conrad's work at Chromagen, Inc., and that in March, 2005, he and Dr. Cole formed Aries and assigned to it all rights in the Chromagen technology. See L-3's RJN Ex. 4. In the March 2, 2009, Declaration of Michael J. Conrad, Ph.D., in Support of Aries Associates, Inc.'s Motion for Preliminary Injunction, he reiterated under oath:
Pursuant to a secured credit agreement dated March 29, 2005, Chromagen assigned certain intellectual property rights, including patents, trademarks and trade secrets, to my wife Dr. Cole, and me. We, in turn, assigned these rights to ARIES. To acquire Chromagen's intellectual property, ARIES agreed to assume responsibility for certain Chromagen debts of approximately $2.7 million.See L-3's RJN Ex. 2 at 6:26-7:3.
The Conrad Parties took the same position in connection with the bankruptcy case. Dr. Conrad signed the Aries petition which provided "I declare under penalty of perjury that the information provided in this petition is true and correct, and that I have been authorized to file this petition on behalf of the debtor." In Schedule B - Personal Property, Aries listed "three patents, a US patent application and a foreign patent application." In Schedule D - Creditors Holding Secured Claims, Debtor listed no secured claims. In Schedule F - Creditors Holding Unsecured Nonpriority Claims, Debtor listed Dr. Conrad and Dr. Cole with an unsecured claim for "Loans" in the amount of $800,000.00 and Dr. Conrad with an unsecured claim for "Loans and money owing" in the amount of $1,800,000.00. In Schedule G - Executory Contracts and Unexpired Leases, Debtor listed only the office lease with Rexford Industrial. Dr. Conrad signed the Declaration Concerning Aries' Schedules as President of the Debtor again declaring under penalty of perjury that the schedules "are true and correct to the best of my knowledge, information, and belief."
In the Statement of Financial Affairs under the heading "Property held for another person," Aries listed only "Two fogging machines belonging to Curtis Dyna-Fog." As with the schedules, Dr. Conrad signed a declaration under penalty of perjury that the statement of financial affairs was true and correct to the best of his knowledge, information and belief.
Finally, on March 17, 2010, Dr. Conrad signed a Declaration Re: Electronic Filing of Petition, Schedules & Statements in which he declared "that the information I have given my attorney and the information provided in he electronically filed petition, statements, and schedules is true and correct."
Neither the Schedules nor Statement of Financial Affairs have been amended. At the hearing counsel for the Conrads attempted to justify the numerous allegations that the Intellectual Property was owned by Aries on the ground that it made no difference - Aries' and the Conrads' interests were aligned. The Court finds the argument strained with respect to the CDCA Litigation, and completely inapplicable to the statements made in the bankruptcy case. In the bankruptcy case on the question of ownership of the Intellectual Property the positions of Aries and the Conrads were in no ways aligned. In the Schedules as filed, the Conrads were equity holders with at most a hope of a reversionary interest if all creditors were paid in full. Under the newly alleged arrangement under the SDA, the Conrads would either be secured creditors or the beneficial owners of the Intellectual Property.
The position taken in the Aries Schedules and Statement of Financial Affairs is consistent with the position taken by Dr. Conrad in his personal bankruptcy case. In his Schedule B, Dr. Conrad included under "Accounts receivable," "Money owing by Aries Associates, Inc. for patent licenses. Face amount approx. $1,800,000." The entry was amended to "Money owing by ARIES Associates, Inc. for patent and patent application assignments. Face amount approx. $1,800,000." However, in neither version is there an indication the claim is secured or that Dr. Conrad asserted a beneficial interest in the underlying Intellectual Property. Conrad's Schedule B also provided "Mr. Conrad may have rights intellectual property formerly owned by Chromagen, Inc. as a result of the corporate dissolution of that company," but the specific Intellectual Property, including AeROS, was not scheduled. Dr. Conrad scheduled no executory contracts. Nor was any putative asset in the form of a security interest, as required to be disclosed by a debtor.
In support of the joint opposition filed by Dr. Conrad and Dr. Cole, Dr. Cole declared:
Pursuant to the Secured Debt Agreement, ARIES agreed to assume Chromagen, Inc.'s unpaid debt that was owed to my husband and me in the principal amount of $1.8 Million in exchange for the transfer of ownership of certain consumable assets ... and the grant of a license and/or conditional assignment to ARIES for certain intellectual property assets identified therein. (Dr. Conrad and Dr. Cole are referred to collectively as the CONRADS in the Secured Debt Agreement). According to the Secured Debt Agreement, the CONRADS were granted a first-priority security interest in these assets. No ownership rights were granted to ARIES in these intellectual property assets.As noted above, however, this is entirely inconsistent with the schedules in this case as well and in the personal case of Dr. Conrad as well as with the behavior of Drs. Conrad and Cole in both bankruptcy cases. Aries' schedules, which were signed by Dr. Conrad, included the Intellectual Property with no indication that anyone else had any interest therein. The same is true of Aries' Statement of Financial Affairs. Neither Dr. Cole nor Dr. Conrad were scheduled as secured creditors, and neither filed proofs of claim.
The recent appearance of the SDA, combined with the numerous statements of the Conrad Parties which are contrary to the terms now asserted based thereon raise a genuine question as to the authenticity of the SDA.
The Court also finds that the circumstances of the case render it unfair to allow the Conrad Parties to rely on the SDA. The Conrad Parties assert that the SDA was created over 5 years ago in 2006. As noted, the Trustee and L-3 suspect that the SDA was created far more recently in response to the proposed sale. Had the original been produced, the parties could conduct forensic inspections of the ink and paper from which the origination date might have been established. It would be unfair for the Court to accept the duplicate and the Conrad Parties' bare assertion of its age in a circumstance where the Trustee and L-3 could not test the theory.
The only evidence proffered in support of the Conrad Parties' argument that Aries does not own the Assets is the SDA and the declarations of Drs. Conrad and Cole based solely thereon. Since the SDA will not be admitted under FRE 1002 & 1003, the Conrad Parties have not met their burden under 11 U.S.C. § 363(p)(2).
The Conrad Parties also argue that the sales price is insufficient. However, the sale was widely publicized and noticed and was subject to overbid, and neither the objecting parties nor anyone else submitted one. A public auction subject to overbid is an acceptable and common method of determining the market value of assets. In re Abbotts Dairies of Penn., Inc., 788 F.2d 143, 149 (3d. Cir. 1986). Notice of the sale was published and the parties most likely to be interested in the assets, including the Conrads, received notice of the proposed sale and an opportunity to overbid. The Conrad Parties submitted neither an overbid nor evidence of the value of the Assets. As counsel for the Trustee declared, Dr. Conrad had stated that he believed the patents had no value due to the cost of litigating with L-3 and others. The Court finds the sales price is fair and reasonable.
Likewise, there is no evidence that the deal struck between L-3 and the Trustee was other than a good faith arm's length deal. The Trustee has declared that the sales price and settlement were the result of negotiations with L-3, and the Court has no evidence or cause to discount that testimony.
The same is true of the Included Equipment. Aries' Schedules included office equipment at the Roselle St. address, lab and development equipment at the Roselle St. address, and inventory and supplies. Furthermore, as additional evidence that Aries owned the equipment, Aries had depreciated the equipment for tax purposes.
CONCLUSION
For all of the foregoing reasons, the Court grants the Trustee's Motion and approves the sale of the Assets to L-3 and the related settlement. Counsel for the Trustee or L-3 shall submit an order consistent herewith within thirty (30) days of the entry of this Order.
IT IS SO ORDERED.
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PETER W. BOWIE, Chief Judge
United States Bankruptcy Court