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In re HealthTrio, Inc.

United States District Court, D. Colorado

March 31, 2019

IN RE HEALTHTRIO, INC.,
v.
DENNIS W. SCRUGGS, Appellee. DAVID E. LEWIS, TRUSTEE, Appellant,

          ORDER REVERSING BANKRUPTCY COURT'S ORDER

          CHRISTINE M. ARGUELLO UNITED STATES DISTRICT JUDGE.

         This matter is before the Court on Chapter 7 Trustee David E. Lewis's (“the Trustee”) appeal of the Bankruptcy Court's Order, entered on January 24, 2018, in case No. 09-34404. Dennis W. Scruggs (“Respondent”) opposes the appeal. The Court has jurisdiction under 28 U.S.C. § 158(a)(1). For the following reasons, the Order of the Bankruptcy Court is reversed.

         I. QUESTIONS PRESENTED

         The Bankruptcy Court awarded two claims in favor of Respondent, which form the basis of the instant appeal. Accordingly, the Court will consider:

1. Whether the Bankruptcy Court erred when, pursuant to 11 U.S.C. § 502(f), it compensated Respondent for services Respondent provided to Debtor HT Inc. during the gap period; and 2. Whether the Bankruptcy Court erred when it allowed, in this Chapter 7 case, Respondent's substantial contribution administrative claim pursuant to 11 U.S.C. § 503(b)(3)(D).

         II. BACKGROUND[1]

         The Debtor in this case is Health Trio Inc. (“Debtor HT Inc.”) which developed and licensed software used by health insurance companies to administer claims. “Over the years, ” however, Dr. Malik Hasan, the founder and majority shareholder of Debtor HT Inc., “engaged in a scheme to manipulate HT Inc.'s assets and defraud creditors.” (Rec. at 585.) Between 2000 and 2005, Hasan made cash contributions in the approximate amount of $16.8 million to Debtor HT Inc. None of these contributions were approved by the Board of Directors of Debtor HT Inc., nor did Hasan obtain any collateral to secure repayment of these funds. Nonetheless, at a December 2005 board meeting, the Board approved the issuance of promissory notes and a security agreement, which pledged all of Debtor HT Inc.'s assets as collateral to secure repayment of all of Hasan's monetary contributions.

         Respondent is a certified public accountant who was originally employed as the chief financial officer of Debtor HT Inc. Respondent began his employment in July 2004, and his salary was $122, 500 per year. His duties from July 2004 through February 2009 included “managing cash receipts and disbursements, performing financial and tax accounting and reporting, managing Debtor HT Inc.'s contracts and routinely interfacing with attorneys on Debtor HT Inc.'s litigation.” (Id. at 586.) Respondent signed the promissory notes and the security agreement as an officer of Debtor HT Inc.

         In 2007, Immedient Corporation-one of the three petitioning creditors against Debtor HT Inc.-obtained a judgment against Debtor HT Inc. Subsequently, Hasan demanded to be repaid for the contributions he had made to Debtor HT Inc. Hasan sued Debtor HT Inc. on the security agreement and promissory notes, and Debtor HT Inc. did not defend itself in the lawsuit. Accordingly, Hasan obtained a default judgment in the amount of $21.79 million. Respondent signed both an affidavit in support of Hasan's judgment and an assignment of assets to Hasan, and Debtor HT Inc. surrendered all of its assets to Hasan. “When questioned about signing the insider foreclosure documents, [Respondent] testified he was an accountant, not a lawyer, and as an employee of HT Inc., he did what he was told.” (Id. at 587.) Thereafter, Hasan formed a new entity called Health Trio LLC (“HT LLC”).

         Hasan purchased Debtor HT Inc.'s assets at a foreclosure sale and transferred the assets and Debtor HT Inc.'s business to HT LLC.

Most of HT Inc.'s employees began working for HT LLC as of October 1, 2007, including [Respondent] as CFO. HT LLC operated the exact same business as HT Inc. [Respondent] testified he was never terminated and never resigned as CFO of HT Inc. and that he was the only officer of HT Inc. after August 2007. . . . [Respondent] was hired by Hasan as HT LLC's CFO from October 1, 2007 until January 2010, at the same salary he was paid by HT Inc.

(Id.) Thus, Respondent testified that he had two CFO positions from October 2007[2](Supp. Rec. at 116) until January 2010: one for HT LLC at his regular salary and one for HT Inc. “for which he was not compensated.” (Rec. at 587.)

         Respondent testified that he “became concerned about his potential liability and future due to the involuntary petition litigation.” (Id.) As a result, Respondent sought, inter alia, an indemnification agreement from Hasan regarding Respondent's activities as an officer, director, and shareholder of Debtor HT Inc. Respondent further testified that, when Hasan refused Respondent's requests, he resigned from his paid position at HT LLC-but not his unpaid position at Debtor HT Inc.-in January 2010. The Court notes that Respondent's resignation from HT LLC did not occur until more than ten months after the involuntary Chapter 7 petition was filed against Debtor HT Inc. The Court also notes that during the gap period, even after he resigned his CFO position at HT LLC, Respondent continued to collect revenues received by Debtor HT Inc. which he delivered to Hasan, resisted the involuntary petition, and helped conceal the fact that Debtor HT Inc. had ceased operations in 2007.

         The gap period between the time the involuntary petition was filed and the entry of the order for relief lasted from February 18, 2009, until May 5, 2012. Respondent testified that, after he resigned his paid position with HT LLC in January 2010, “he remained CFO of HT Inc. during and after the Gap Period until the Trustee was appointed in December 2012.” (Id. at 588.) Respondent asserts:

The ordinary course of business or financial affairs of HT Inc. during the Gap Period was to wind down HT Inc.'s operations, and his services as an officer of HT Inc. are compensable as a Gap Period claim. [Respondent] asserts he could have left HT Inc. and let the “chips fall, ” to the detriment of HT Inc. and ultimately the HT Inc. bankruptcy estate.

(Id.) Despite Respondent's admission on cross-examination by the Trustee that “the only benefit to the Debtor [HT Inc.] . . . during this gap period . . . [was] that Dr. Hassan was continuing to receive money on his security interest [which] reduced the amount that was owed to him on the secured claim, ” (Supp. Rec. at 222), the Bankruptcy Court found that Respondent “provided routine CFO services to HT Inc. in the Gap Period . . . for the benefit of HT Inc ..... ”, and awarded Respondent $46, 959.[3] (Rec. at 596.)

         Additionally, the Bankruptcy Court found that Respondent “provided a substantial contribution to the chapter 7 bankruptcy estate in the post-petition period by conferring an actual, direct and demonstrable benefit to the estate in supporting the trustee's litigation claims.” (Id.) Specifically, Respondent provided a “six-inch three-ring binder litigation notebook for use in the investigation and prosecution of two adversary proceedings, ” which ultimately settled for a combined total of $1, 225, 000. (Id. at 589.) The notebook was a product of Respondent's efforts during the gap period to catalogue, identify, maintain, and preserve documents that could eventually be relevant to subsequent litigation.

The notebook was a “roadmap” for the Trustee. [Respondent] actively assisted the Trustee's counsel in formulating and prosecuting the . . . complaints [in the adversary proceedings]. The complaints were detailed and comprehensive, containing numerous claims for relief. [Respondent] had frequent meetings, located documents, answered questions, was deposed several times, and responded to e-mails with two sets of litigation counsel retained by the Trustee. He estimated he spent 750 hours in this category after the order for relief.

(Id.) Therefore, the Bankruptcy Court awarded Respondent $23, 250[4] for making a substantial contribution to the Chapter 7 case as an administrative claim.

         On February 2, 2018, the Trustee initiated the instant appeal arguing that the Bankruptcy Court erred in granting Respondent's gap period claim and awarding Respondent funds for his contribution to the Chapter 7 case. Respondent filed a Response (Doc. # 13) on May 11, 2018, and the Trustee filed a Reply (Doc. # 14) on May 23, 2018.

         III. STANDARD OF REVIEW

         This Court reviews the Bankruptcy Court's legal determinations de novo. See In re Baldwin, 593 F.3d 1155, 1159 (10th Cir. 2010). The Court also reviews de novo mixed questions of law and fact that primarily involve legal issues. See In re Wes Dor Inc., 996 F.2d 237 (10th Cir. 1993). The Bankruptcy Court's factual findings are reviewed for clear error. See In re Johnson, 477 B.R. 156, 168 (10th Cir. BAP 2012). If a “lower court's factual findings are premised on improper legal standards or on proper ones improperly applied, they are not entitled to the protection of the clearly erroneous standard, but are subject to de novo review.” Id.

         In the instant case, there are no disputed factual issues. Therefore, because the Trustee's appeal is premised on his argument that the Bankruptcy Court improperly applied the law, the Court will review the Bankruptcy Court's decision de novo. In re Chernushin, 584 B.R. 567, 570 (D. Colo. 2018), aff'd, 911 F.3d 1265 (10th Cir. 2018) (citing In re Baldwin, 593 F.3d at 1159).

         IV. DISCUSSION

         The Trustee raises a number of issues related to the Bankruptcy Court's allowance of the gap period claim under 11 U.S.C. § 502(f) and the Bankruptcy Court's allowance of the administrative expense claim under 11 U.S.C. § 503(b). The Court will consider each claim in turn.

         A. 11 U.S.C. § 502(f) GAP PERIOD CLAIM

         Section 502(f) provides:

(f) In an involuntary case, a claim arising in the ordinary course of the debtor's business or financial affairs after the commencement of the case but before the earlier of the appointment of a trustee and the order for relief shall be determined as of the date such claim arises, and shall be allowed under subsection (a), (b), or (c) of this section or disallowed under subsection (d) or (e) of this ...

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