United States District Court, D. Colorado
ORDER REVERSING BANKRUPTCY COURT'S ORDER
CHRISTINE M. ARGUELLO UNITED STATES DISTRICT JUDGE.
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
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.
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.
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.
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”).
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(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
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.
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. (Rec. at 596.)
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 for making a substantial contribution to
the Chapter 7 case as an administrative claim.
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.
STANDARD OF REVIEW
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.
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).
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.
11 U.S.C. § 502(f) GAP PERIOD CLAIM
(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 ...