Opinion
Case No. 95-12006-AM
October 31, 1995
James A. Bialec, Esquire, Richard C. Deering and Assocs., Alexandria, VA, for debtor
Brian F. Kenney, Esquire, Miles Stockbridge, P.C., Fairfax, VA, for Capital Commercial
MEMORANDUM OPINION AND ORDER
Before the court is (a) the motion of Capital Commercial Properties, Inc. filed August 22, 1995 for civil contempt sanctions against Quan Duc Trinh; (b) the show cause order dated September 25, 1995, against Quan Duc Trinh for failure to comply with the consent order entered in Contested Matter No. 95-610 granting relief from the automatic stay and for failing to appear at a prior hearing in response to a subpoena; (c) the show cause order dated September 12, 1995, against Quan Duc Trinh for failure to attend the Section 341 meeting of creditors after this case was converted from chapter 11 to chapter 7; and (d) the show cause order, also dated September 12, 1995, against Quan Duc Trinh for failing to file monthly financial reports for the period the debtor was in chapter 11 or to account for $10,000.00 paid to the debtor post-petition. An evidentiary hearing was held on October 24, 1995 at which Quan Duc Trinh was present in person and represented by counsel. At the conclusion of the hearing, the court took the matters under advisement.
Facts
The debtor, Webster Management Investment Company, filed a voluntary chapter 11 petition in this court on May 10, 1995. Its president and sole shareholder is Quan Duc Trinh ("Trinh"). The debtor's business was the subleasing of approximately 7,500 square feet of commercial retail space in the Rex Mini-Mall in Falls Church, Virginia, to various small businesses. The prime lease for the space was between the debtor and Capital Commercial Properties, Inc. ("Capital Commercial").
The debtor filed its chapter 11 petition after Capital Commercial had obtained a judgment for possession in the state court based on the debtor's defaults in payment of the rent on the prime lease. The landlord promptly filed a motion for relief from the automatic stay, and a hearing was held on June 5, 1995. At the conclusion of the evidentiary hearing, but before the court announced its decision, the parties entered into a settlement under which Capital Commercial would pay the debtor in possession $10,000.00 and would be entitled to immediate possession of the premises and to set off its security deposit against the rent due. The debtor would be entitled to retain the rents already received for months prior to June; all other rents would belong to the landlord.
On June 5, 1995 (the day of the relief from stay hearing), a Consent Order Conditioning Rights of Debtor in Possession was routinely entered in this case on the joint motion of the debtor in possession and the United States Trustee. The order, which was endorsed by counsel for the debtor, provided in relevant part as follows:
2. Except as otherwise agreed to by the United States Trustee in writing, the debtor shall close the bank accounts presently maintained, and all funds on deposit shall be transferred to the appropriate Debtor in Possession Account as hereinafter set forth. * * *
3. The debtor in possession shall immediately open a new bank account in such federally insured depository as the debtor may select. The account shall be opened in the name of the debtor and designated "Debtor in Possession Account," and all income derived by the debtor in possession shall be deposited therein.
* * *
8. The debtor shall not pay or satisfy out of the money or assets of the estate any creditor for any debt which was incurred prior to the filing of the Petition or which could be dealt with or affected under the Plan to be proposed herein, except upon Order of the Court.
After notice to creditors, an order approving the settlement with Capital Commercial and granting relief from the automatic stay was entered by this court on June 23, 1995. The debtor subsequently moved to dismiss its case. The United States Trustee objected, primarily because the debtor in possession had never filed adequate schedules or monthly financial reports. The court, after considering the contentions of the parties, denied the motion to dismiss and on August 8, 1995, ordered the case converted to chapter 7. Additionally, on August 21, 1995, this court, on motion of the United States Trustee, entered an order containing, among other provisions, the following:
ORDERED, that the president of the Debtor, Quan Trinh, is hereby directed to file with the Court, and copies to the United States Trustee and the Chapter 7 trustee, all Chapter 11 operating reports, from the time the case was filed until the case was converted to Chapter 11, with all attached bank statements and canceled checks within twenty days of the entry of this order; and it is further,
ORDERED, that the president of the Debtor, Quan Trinh, is hereby directed to file with the Court and copies to the United States Trustee and Chapter 7 trustee, a written and full accounting of the $10,000 received by the Debtor from Capital Commercial Properties, Inc., within twenty days of the entry of this order;
An interim trustee was appointed and a Section 341 meeting of creditors in the converted case was scheduled for September 7, 1995. Trinh did not appear at the meeting of creditors. After a hearing before this court on the United States Trustee's motion for sanctions, a new date for the meeting of creditors was scheduled for October 19, 1995. Trinh appeared at that meeting and answered questions but did not produce any financial records.
The chief concern of the chapter 7 trustee, the United States Trustee, and Capital Commercial may be simply stated: what happened to the $10,000.00 paid by Capital Commercial in settlement of the relief from stay motion? Payment was by a check in the amount of $10,000.00 payable to Webster Management Investment Company, Debtor in Possession, and was received by Trinh on or about June 16, 1995. Trinh deposited the check in the debtor's pre-petition checking account and did not deposit it in a debtor in possession account — indeed, no debtor in possession account had ever been set up. Of the $10,000.00 received, $8,996.00 was paid to Washington Work, Incorporated ("Washington Work"), a company in which Trinh owned a 50% interest, on account of a pre-petition debt. Trinh testified he believed the Washington Work debt was secured by a valid security interest in the debtor's accounts receivable. The disposition of the remaining $1,004.00 is unexplained.
The debt is listed on the debtor's schedules in the amount of $80,000.00 and is evidenced by a document, prepared on the letterhead of Washington Work, entitled "Promissory Note" dated December 21, 1994. The document recited that the debtor had borrowed $80,000.00 from Washington Work "during the period from June 1, 1991 through December 21, 1994" and that the debtor promised to repay that amount to Washington Work at its Washington, D.C. address with "interest at the rate of zero percent (0%) per annum" and with payments to be made "at the convenience of both parties."
The promissory note recited: "This is a secured debt. Washington Work Inc. will be entitle [sic] to file a UCC filing on this debt in the State of Virginia." Evidence was introduced that Washington Work filed a financing statement with the Virginia State Corporation Commission on May 11, 1995 (one day after the chapter 11 filing).
Discussion
This court has jurisdiction of this controversy under 28 U.S.C. § 1334 and 157(a) and the general order of reference entered by the United States District Court for the Eastern District of Virginia on August 15, 1984. Under § 105(a), Bankruptcy Code, this court has the authority to "issue any order, process, or judgment that is necessary or appropriate" to carry out the provisions of the Bankruptcy Code and to hold parties in civil contempt for violation of its orders. Burd v. Walters (In re Walters), 868 F.2d 665, 669 (4th Cir. 1989). Although matters concerning the administration of the estate are normally "core" proceedings under 28 U.S.C. § 157(b)(2)(A), contempt proceedings, even in aid of the court's jurisdiction over the administration of the estate, have some of the characteristics of a non-core proceeding in that a bankruptcy judge's finding of civil contempt is subject to de novo review by a United States District Judge.
Under F.R.Bankr.P. 9020(c), if a hearing before a bankruptcy judge results in a finding of contempt, the order of contempt must be served on the person or entity named in the order and "shall be effective 10 days after service of the order and shall have the same force and effect as an order of the district court unless, within the 10 day period, the entity named therein serves and files objections prepared in the manner provided in Rule 9033(b)." If objections are filed, the contempt order is reviewed "as provided" in F.R.Bankr.P. 9033, which governs the review of non-core proceedings and requires the district judge to "make a de novo review upon the record or, after additional evidence, of any portion of the bankruptcy judge's findings of fact or conclusions of law to which specific written objection has been made . . ."
Counsel for Capital Commercial advised the court that the debtor had furnished an affidavit concerning rents as required by the consent order and that the subpoena requiring Trinh's appearance at the prior hearing had not been served on him personally, but rather on a family member. On that basis, Capital Commercial moved to withdraw its motion for sanctions against Trinh and to dismiss the show cause order that had been issued at its request. Accordingly, the court will treat the motion as withdrawn and will dismiss the order to show cause dated September 25, 1995. Additionally, since Trinh appeared and submitted to examination at the rescheduled meeting of creditors held on October 19, 1995, the court will dismiss the show cause order seeking to hold him in contempt for failure to appear at the earlier meeting of creditors.
There remains the second show cause order of September 12, 1995, issued at the request of the United States Trustee. The United States Trustee (now joined by Capital Commercial and the chapter 7 trustee) seeks an order from this court holding Trinh in civil contempt and imposing monetary sanctions, in the form of a $10,000.00 fine payable to the estate, for Trinh's action in paying the $8,996.00 to Washington Work, Inc. and in failing to provide information with respect to the disposition of the remaining $1,004.00.
It is clear, as a legal matter, that the deposit of the $10,000.00 into the debtor's pre-petition bank account rather than into a debtor in possession account, and the payment of $8,996.00 of those funds to Washington Work on account of a pre-petition claim, were both highly improper. Trinh admitted at the October 24, 1995 hearing that he had been advised at an initial meeting with a representative of the Office of the United States Trustee shortly after the chapter 11 case was filed of the requirement to open a debtor in possession account. That requirement was also explicitly set forth in the Consent Order Conditioning Rights of Debtor in Possession entered June 5, 1995, approximately 11 days prior to the receipt by Trinh of the $10,000.00 check from Capital Commercial. The only explanation offered by Trinh for the failure to open a debtor in possession account was that he felt it was unnecessary because he expected the chapter 11 case to be dismissed in light of the settlement with Capital Commercial.
With respect to Washington Work, Trinh testified that he thought he could make the payment because the debt was secured by the debtor's accounts receivable. However, the Consent Order Conditioning Rights of Debtor in Possession clearly prohibits payment of any prepetition debt except with court approval or as part of a confirmed chapter 11 plan — there is no exception for secured debts. Putting to one side the issue of whether its security interest was properly perfected under state law, the fact remains that the security interest of Washington Work was presumptively voidable under § 547 of the Bankruptcy Code as a preference. The security interest was granted on account of an antecedent pre-petition debt incurred over more than a three year period; was perfected, if at all, more than 10 days after the debt was incurred; and was perfected within the one-year "insider" preference period. Even though it is common in chapter 11 cases for debtors to continue to make regular payments on account of secured debts such as vehicle loans and mortgages, such "adequate protection" payments require court approval under F.R.Bankr.P. 4001(d) after notice to creditors and an opportunity to object. Furthermore, the payment to Washington Work in this case was by no stretch of the imagination a payment in the regular course of business. The promissory note had no payment schedule and recited that repayment would be made "at the convenience of both parties." The only apparent reason for the timing of the payment to Washington Work was that the debtor's business operations were about to cease.
Capital Commercial points out that evidence was offered only of filing with the Virginia State Corporation Commission, and that no evidence was offered to show compliance with the requirement of § 8.9-401(c), Va. Code Ann., for filing with the Clerk of the Circuit Court for the city or county where the debtor carried on its business. Trinh testified that the accountant who would have had copies of the filed financing statements was on vacation and that he (Trinh) was therefore unable to produce at the hearing all the documents that might exist. If in fact the security interest was not properly perfected by local filing, the chapter 7 trustee's "strong arm" avoiding powers under § 544 of the Bankruptcy Code would allow him to avoid the security interest, particularly where the filing with the State Corporation Commission did not occur until after the debtor filed its chapter 11 petition and was prohibited by the automatic stay. § 362(a)(4), Bankruptcy Code (bankruptcy filing operates as automatic stay of "any act to . . . perfect . . . any lien against property of the estate.") Since it appears that the security interest is independently voidable as an insider preference, and since it does not appear that Trinh has ready access to the documents that would resolve the perfection issue, the court expressly makes no finding on the issue of perfection.
The evidence before the court is insufficient to show, and the court does not find, that Trinh had actual knowledge that Washington Work's security interest was not properly perfected. The evidence does show, however, that Trinh either had actual knowledge of, or was recklessly indifferent to, the limitation on payment of prepetition claims by a chapter 11 debtor in possession and the requirement for the closing of pre-petition bank accounts and depositing all funds received post-petition in the debtor in possession account. The fact that he thought the chapter 11 case would be dismissed does not excuse his failure to comply with the terms of the Consent Order Conditioning Rights of Debtor in Possession. A chapter 11 debtor has no automatic right to dismiss its case, and until the case was dismissed, the debtor in possession continued in its fiduciary role. Additionally, notwithstanding the order entered by this court on August 21, 1995, requiring Trinh to file operating reports for the period the debtor was in chapter 11 and to account for the $10,000 received from Capital Commercial, Trinh has never satisfactorily accounted for the portion of the $10,000 not paid to Washington Work. Trinh did not produce any accounting records at the rescheduled meeting of creditors. When he appeared at the hearing on October 24, 1995, he produced a jumble of disorganized documents that he asserted were the business's records. These had not been previously furnished to the chapter 7 trustee or the United States Trustee and were not in any form which would have permitted ready review at the hearing. Accordingly, neither the court, the chapter 7 trustee, nor the United States Trustee could determine how the $1,004 had been spent.
"[O]n request of a party in interest or the United States trustee, and after notice and a hearing, the court may convert a case under this chapter to a case under chapter 7 of this title or may dismiss a case under this chapter, whichever is in the best interest of creditors and the estate, for cause. . . ." § 1112(b), Bankruptcy Code (emphasis added).
"[A] debtor in possession shall have all of the rights, other than the right to compensation under section 330 of this title, and powers, and shall perform all the functions and duties . . . of a trustee serving in a case under this chapter." § 1107(a), Bankruptcy Code. Under § 1106(a)(1), which incorporates § 704(2), these functions include the duty to "be accountable for all property received."
The court concludes, therefore, that Trinh's actions in failing to open a debtor in possession account, depositing the $10,000 received from Capital Commercial in a non-debtor in possession account, paying the $8,996 to Washington Work without court approval, and failing to satisfactorily account for the remaining $1,004 were undertaken by him either in knowing violation or in reckless disregard of his fiduciary responsibilities as representative of the debtor in possession and of the obligations imposed by the Consent Order Conditioning Rights of Debtor in Possession and the August 21, 1995 order. The bankruptcy estate has clearly been damaged in the amount of the $10,000 that would otherwise have been available to pay the claims of creditors in this case. The court concludes, therefore, that the appropriate sanction for Trinh's willful or reckless failure to comply with the terms of the Consent Order Conditioning Rights of Debtor in Possession and the August 21, 1995, order is an award of damages payable to the chapter 7 trustee in the amount of the funds lost as a result of Trinh's defalcation. See, Better Homes of Va., Inc. v. Budget Service Co., 52 B.R. 426, 431 (E.D.Va. 1985) ("Civil contempt orders are, by their nature, remedial or coercive.") (Upholding bankruptcy court's award of actual damages incurred by debtor in possession as sanction for creditor's violation of automatic stay).
The entry of this order shall not affect the chapter 7 trustee's right to pursue any other available remedy for the recovery of such funds, including, but not limited to, a preference or other avoidance action against Washington Work.
ORDER
For the foregoing reasons, which constitute the court's findings of fact and conclusions of law under F.R.Bankr.P. 7052, it is
ORDERED and ADJUDGED:
1. The motion of Capital Commercial filed August 22, 1995, for civil contempt sanctions against Quan Duc Trinh is dismissed as having been withdrawn.
2. The order to show cause dated September 25, 1995, issued on application of Capital Commercial (docket item #84), is dismissed.
3. The order to show cause dated September 12, 1995, issued on application of the United States Trustee (docket item # 70), is dismissed.
4. Quan Duc Trinh is found to be in civil contempt of this court's Consent Order Conditioning Rights of Debtor in Possession and of this court's order of August 21, requiring the debtor to account for the $10,000 received from Capital Commercial and shall pay to the chapter 7 trustee, Richard A. Bartl, as a sanction for such civil contempt, damages of $10,000.00 within 30 days of the entry of this order.
5. The clerk shall mail a copy of this Memorandum Opinion and Order to Quan Duc Trinh by certified mail and in addition shall mail copies by first-class mail to counsel for the debtor, the chapter 7 trustee, the United States Trustee, and counsel for Capital Commercial. Pursuant to F.R.Bankr.P. 9020(c), this order shall be effective 10 days after service on Quan Duc Trinh unless, within such 10 day period, Quan Duc Trinh serves and files objections in the manner provided in F.R.Bankr.P. 9033(b).