Opinion
Case No. 01-14080-SSM.
April 30, 2002
Jeffrey M. Sherman, Esquire, O'Rourke Cundra, Washington, DC, Counsel for the debtor.
Dwight Yellen, Esquire, Ballon, Stoll, Bader Nadler, P.C., New York, NY, Counsel for the respondents.
Kevin M. O'Donnell, Esquire, Henry O'Donnell, P.C., Fairfax, VA, Local counsel for the respondents.
Thomas Porter, Value Consultants, Springfield, VA, Chapter 11 trustee.
William S. Taylor, Esquire, Fairfax, VA, Counsel for the Official Committee of Unsecured Creditors.
MEMORANDUM OPINION
Before the court is a motion filed by the debtor on January 10, 2002, for an order holding 23 named individuals and entities (collectively "the respondents") in contempt of court for violating the automatic stay by commencing a lawsuit against various insiders and affiliates of the debtor. A hearing was held in open court on March 19, 2002, at which the debtor and the respondents were present by counsel, as were the United States Trustee and the Official Committee of Unsecured Creditors. The chapter 11 trustee was present in person.
The respondents are Bruce Klein, William Lee, Neil Moody, Valhalla Investment Partners, John Greenshields, Wall Street Digest Defined Benefit Plan, Donald and Joy Rowe, Tim Olson, David Toner, William Kennedy, Patrick Parcells, Robert Ladone, Ladone Leather, Alan Milton, Mantis, LLC, Michael Edgecombe, Geofco Holdings, Stewart Dauman and Karen Zimmerman, Because Corp., Sharon Moody, and Pinnacle Communications.
After hearing the argument of the parties, the court took the matter under advisement. Both the debtor and the respondent submitted post-hearing memoranda which were helpful to the court in clarifying the issues. On April 29, 2002, the court ruled from the bench that the respondents would be held in contempt for violating the automatic stay by attempting to exercise control over certain causes of action belonging to the bankruptcy estate. An order was entered the same date reflecting the court's ruling and imposing prospective sanctions in the event the respondents failed to purge themselves of contempt. The purpose of this memorandum opinion is to supplement the bench ruling by setting forth in writing the reasons for the court's determination.
Background
Collective Communications Corporation is a New Jersey corporation with its principal place of business in Virginia. It filed a voluntary petition for reorganization under chapter 11 of the Bankruptcy Code in this court on October 22, 2001. For a period of approximately three months, the debtor remained in possession of its estate; however, on February 11, 2002, the court directed that a chapter 11 trustee be appointed. Thomas R. Porter was subsequently appointed and has qualified as trustee of the chapter 11 estate. A plan of reorganization has not yet been proposed.
On December 7, 2001 (some six weeks after the chapter 11 filing), the respondents filed a civil action in the United States District Court for the District of New Jersey against 13 defendants seeking to recover damages arising from investments they had made in the debtor. Klein et al. v. Autek Corporation et al., No. 01 cv 5751 (FSH). The debtor is not a named defendant, but the defendants include its chief executive officer, Atul Chowdhry; his wife, Sunita Chowdhry; and his nephew, Neil Chowdhry. Other defendants include four company officers and employees, a subsidiary corporation (Collective Wireless, Inc.), two affiliated corporations (Autek Inc., and Apsaira, Inc.), as well as an attorney, Stephen M. Rosenberg, and Mr. Rosenberg's present and former law firms.
The complaint, which is pleaded in five counts, seeks damages in excess of $6 million under a variety of theories. These include engaging in a pattern of racketeering activities (specifically, mail fraud and wire fraud) in violation of the Racketeer Influenced and Corrupt Organizations Act, violation of the Securities and Exchange Act of 1934, common law fraud, breach by Atul Chowdhry (aided and abetted by the other defendants) of the fiduciary duty owed to shareholders, and malpractice by the attorney and the law firms.
Essentially, the complaint alleges that the debtor was formed to develop and market a wireless two-way secure communications system between corporate offices and mobile "smart" personal digital devices in the field. According to the complaint, the debtor owned the intellectual property rights for a portion of the system but had only a license for the crucial customer billing component of the system. The complaint alleges, however, that in soliciting investors, Mr. Chowdhry and the other defendants misrepresented that the debtor owned all of the intellectual property embodied in the systems and furthermore that the debtor had only approximately $250,000.00 of debt. It is further alleged that the debtor actually owed the licensor of the billing subsystem, TATA Infotech, Inc., some $600,000.00; that Mr. Chowdhry used a defunct corporation, Autek Corporation, as a vehicle for billing the debtor for nonexistent services purportedly provided by his wife and nephew; and that after the respondents had invested $2,005,000.00 in the debtor, the defendants then drained the debtor of cash, organized a successor corporation, Apsaira, Inc., to purchase the debtor's assets, and caused the debtor to file a bad-faith bankruptcy petition.
The motion before the court seeks an order "extending the automatic stay" to the named defendants in the lawsuit, and holding the respondents in civil contempt for violating the automatic stay both by bringing suit against parties "who have a unitary interest" with the debtor and by suing on claims that belong to the bankruptcy estate. The respondents admit filing the lawsuit with knowledge of the bankruptcy but argue that any extension of the automatic stay to non-debtor parties can be accomplished only by adversary proceeding, not by motion, and would not be warranted in any event. They further deny that the lawsuit seeks to recover on causes of action belonging to the bankruptcy estate and argue that the various allegations in the complaint that might support such a broad reading were included simply to demonstrate the full contours of the fraud. At oral argument, the debtor essentially conceded that an adversary proceeding would be required to extend the automatic stay to parties other than the debtor. However, the debtor continues to vigorously assert that the New Jersey lawsuit is a prohibited attempt to prosecute causes of action that belong to the bankruptcy estate.
Discussion A.
The filing of a bankruptcy petition creates a broad stay of various actions against the debtor, its property, and property of the bankruptcy estate. § 362(a), Bankruptcy Code. Among the acts so stayed are "the commencement . . . of a judicial . . . action or proceeding . . . to recover a claim against the debtor that arose before the commencement of the [bankruptcy] case" and "any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate." §§ 362(a)(1) and (3), Bankruptcy Code (emphasis added). Violation of the automatic stay may be punished as a contempt of court. Burd v. Walters, 868 F.2d 665 (4th Cir. 1989). Additionally, § 362(h), Bankruptcy Code, gives a debtor a right of action for damages, including punitive damages, resulting from a willful violation of the stay. Budget Service Co. v. Better Homes of Va., Inc., 804 F.2d 289, 292 (4th Cir. 1986). Where a party has actual knowledge of a bankruptcy, and despite such knowledge intentionally undertakes actions that violate the stay, the party's ignorance of the legal effect of the stay is no defense to a resulting motion to find the party in civil contempt, although it may have a mitigating effect on the sanctions adjudged. In re Peterkin, 102 B.R. 50, 53-54 (Bankr. E.D.N.C. 1989).
B.
As noted, part of the relief requested by the debtor is a ruling "extending" the automatic stay to Mr. Chowdhry and to the various other parties identified with the debtor. The general rule is that the automatic stay applies only to actions against the debtor and does not prohibit suits against third parties, such as guarantors, who may be liable with the debtor on a claim. Credit Alliance Corp. v. Williams (In re Penn Hook Coal Co.), 851 F.2d 119 (4th Cir. 1988). There is authority in this Circuit, however, for extending the automatic stay to non-debtor parties whose interests are so entwined with those of the debtor that suits against them could be regarded as a suit or claim against the debtor itself. A.H. Robins Co., Inc. v. Piccinin, 788 F.2d 994 (4th Cir. 1986). However, the court agrees with the respondents that the proper procedure for extending the automatic stay beyond its literal terms is by an action for an injunction, which requires the bringing of an adversary proceeding. Fed.R.Bankr.P. 7001. Until an injunction has been entered prohibiting suits against insider or affiliated parties, there would be no basis for a finding of contempt simply because such parties have been sued. Accordingly, the present motion, to the extent it is predicated on an alleged violation of § 362(a)(1), Bankruptcy Code, must be denied without prejudice to the trustee's or the debtor's right to file an action for injunctive relief.
The court expresses no view as to the merits of such an action on the present facts, but simply notes that extension of the automatic stay to non-debtor parties is an extraordinary remedy and one which is not routinely or lightly granted.
C.
That leaves the much more difficult issue of whether the lawsuit constitutes a prohibited attempt to "exercise control" over causes of action that belong to the debtor by asserting those causes of action for the individual benefit of the respondents. The chief difficulty arises because many of the factual allegations of the complaint would support a variety of causes of action, including many that belong to the bankruptcy estate. For example, it is alleged that funds belonging to the debtor were used to pay fraudulent invoices of Autek. It is also alleged that Mr. Chowdhry and the other defendants set up Apsaira to carry on the debtor's business; that the debtor's top-level employees have gone to work for Apsaira in violation of non-compete agreements; that Mr. Chowdhry and the other top-level employees have solicited the debtor's customers; and that the chapter 11 petition was filed in bad faith.
In this connection, there can be little doubt that any cause of action to recover funds fraudulently transferred to Autek (and subsequently to Mr. Chowdhry, his wife, and his nephew) belongs to the bankruptcy estate. There can also be little doubt that any cause of action to recover damages for violation of the non-compete agreement, or to recover the value of any property transferred to Apsaira for less than reasonably equivalent value, or in an effort to hinder, delay, or defraud creditors, likewise belongs to the bankruptcy estate. Finally, there can be little doubt that only this court has jurisdiction to determine whether the chapter 11 petition was filed in bad faith or to award damages predicated on a bad-faith filing.
As the respondents point out, however, the complaint, although it grouses and grumbles about fraudulent conveyances and the like, does not in literal terms plead a cause of action for fraudulent conveyance or for violation of a non-compete agreement. While the factual allegations of the complaint are far-ranging and are obviously intended to paint the defendants in as unflattering a light as possible, the first three counts of the complaint, read narrowly, simply seek damages for having been fraudulently induced to invest in the debtor. The damages sought are not measured by the amount of the allegedly fraudulent transfers or the lost billings or even by the diminution in the value of the respondents' stock and debentures. Rather, the suit simply seeks recovery of the amounts the respondents invested in the debtor. For that reason, the court concludes that the first three causes of action, read literally, plead claims that are personal to the plaintiffs and do not belong to the bankruptcy estate.
The fifth cause of action, as noted, is a malpractice claim against attorney Stephen M. Rosenberg and the two law firms he belonged to during the period in question. It is predicated on the allegation that Mr. Rosenberg was representing respondent Klein at the same time that he was representing Mr. Chowdhry and the debtor. The gist of the action is the violation of Mr. Rosenberg's duty properly to give Mr. Klein good legal advice and to protect his interests. Whether that duty would extend to the other plaintiffs on the ground that Mr. Klein was in turn advising them is an interesting question. However, it is not one which this court need resolve, since in any event the claim for bad legal advice to Mr. Klein does not belong to the bankruptcy estate.
The fourth count is much more problematical. As noted, it pleads a breach of the fiduciary duty owed by Mr. Chowdhry to shareholders. Thus, even though the damages claimed by the respondents are measured by the amount of their investment, the specific breaches alleged in the complaint would affect the interest of all shareholders. Such causes of action clearly belong to the corporation. "The overwhelming majority rule is that an action for injuries to a corporation cannot be maintained by a shareholder on an individual basis and must be brought derivatively." Simmons v. Miller, 261 Va. 561, 573, 544 S.E.2d 666, 674 (2001). The reasons for this rule are that
(1) it prevents a multiplicity of lawsuits by shareholders; (2) it protects corporate creditors by putting the proceeds of the recovery back in the corporation; (3) it protects the interests of all shareholders by increasing the value of their shares, instead of allowing a recovery by one shareholder to prejudice the rights of others not a party to the suit; and (4) it adequately compensates the injured shareholder by increasing the value of his shares.
Simmons, 261 Va. at 574, 544 S.E.2d at 674; see also Strasenburgh v. Straubmuller, 146 N.J. 527, 551-52, 683 A.2d 818, 830 (1996) ("Claims for breach of fiduciary duty on the part of directors will also be generally regarded as derivative claims unless the injury to shares is distinct"). Derivative claims belong to the bankruptcy estate and may not be asserted by shareholders except with permission of the bankruptcy court. Accordingly, the court agrees that the commencement of the suit was a prohibited attempt to exercise control over property of the bankruptcy estate.
Since the New Jersey and Virginia rules appear to be the same, the court need not reach the issue of whether New Jersey or Virginia law applies.
Additionally, it seems clear that any claims against Autek and Apsaira, regardless of how pleaded, are property of the bankruptcy estate. See National American Ins. Co. v. Ruppert Landscaping Co., Inc., 187 F.3d 439 (4th Cir. 1999). At bottom, the claims against Autek, no matter how artfully pleaded, are necessarily grounded on a theory of fraudulent conveyance. Similarly, any claims against Apsaira are necessarily grounded on theories either of fraudulent conveyance or successor liability. In Ruppert, the Fourth Circuit noted that "[i]f a cause of action is part of the estate of the bankrupt then the trustee alone has standing to bring that claim." Id. at 441. The court went on to hold that claims grounded on theories of successor liability, tortious interference with contract, and statutory and common law conspiracy against a company that had purchased debtor's assets prepetition had the "same underlying focus" as, and were "so similar in object and purpose" to, a potential fraudulent conveyance action by the chapter 7 trustee under § 548, Bankruptcy Code, that such claims could not be brought until abandoned by the trustee. Id.
D.
In summary, then, the court determines that the cause of action for breach of fiduciary duty, and the causes of action, however pleaded, against Autek and Apsaira, belong to the bankruptcy estate. Those causes of action have not been abandoned by the trustee, nor did the respondents obtain authorization from the court to pursue them on behalf of the bankruptcy estate. Accordingly, the court concludes that the prosecution of those particular claims by the respondents constituted an attempt to exercise control over property of the estate in violation of § 362(a)(3), Bankruptcy Code. As noted, the respondents had actual knowledge of the bankruptcy case at the time they filed the lawsuit. For that reason the court adjudged the respondents in civil contempt for willfully violating the automatic stay.
The respondents may purge themselves of contempt by promptly dismissing the fourth cause of action as well as all claims against Autek and Apsaira. Such dismissal is without prejudice, since the claims in question might ultimately be abandoned by the trustee. The court has considered whether monetary sanctions are appropriate. Aside from whatever counsel fees may have been incurred in the bringing of the contempt motion, the debtor has not at this point suffered any compensable loss by reason of the stay violation. Once the contempt motion was filed, the respondents agreed to the entry of an order extending the time to file an answer in the New Jersey action until this court made a ruling. Additionally, the debtor has prevailed only in part. For that reason the court does not find monetary sanctions appropriate with respect to past violations of the stay. However, the court does find that prospective (i.e., coercive) sanctions in the amount of $1,000.00 per week are appropriate to ensure that the respondents promptly purged themselves of contempt by dismissing the offensive claims.
A separate order has been entered consistent with this opinion.