USCA1 Opinion
January 27, 1993 UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT
____________________
No. 92-1379
IN RE SPM MANUFACTURING CORPORATION,
Debtor.
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OFFICIAL, UNSECURED CREDITORS' COMMITTEE,
Appellant,
v.
PETER M. STERN, CHAPTER 7 TRUSTEE
OF SPM MANUFACTURING CORPORATION,
Appellee,
and
ROBERT and FRANCES SHAINE,
Appellees.
____________________
ERRATA SHEET
The opinion of this court issued on January 21, 1993, is
amended as follows:
On page 20, last line of footnote 8, replace "note 11." with
"note 13."
January 21, 1993 UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT
____________________
No. 92-1379
IN RE SPM MANUFACTURING CORPORATION,
Debtor.
______
OFFICIAL, UNSECURED CREDITORS' COMMITTEE,
Appellant,
v.
PETER M. STERN, CHAPTER 7 TRUSTEE
OF SPM MANUFACTURING CORPORATION,
Appellee,
and
ROBERT and FRANCES SHAINE,
Appellees.
____________________
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Frank H. Freedman, U.S. District Judge]
___________________
____________________
Before
Torruella, Circuit Judge,
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Campbell, Senior Circuit Judge,
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and Brody,* District Judge.
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William C. Penkethman with whom David J. Noonan and Kamberg,
______________________ ________________ ________
Berman, P.C. were on brief for appellant.
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Peter M. Stern with whom Cynthia J. Gagne and Law Office of
_______________ _________________ ______________
Peter M. Stern were on brief for appellee Peter M. Stern, Chapter 7
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Trustee of SPM Manufacturing Corporation.
J. Daniel Marr with whom Hamblett & Kerrigan P.A. was on brief
_______________ _________________________
for appellees Robert and Frances Shaine.
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____________________
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*Of the District of Maine, sitting by designation.
CAMPBELL, Senior Circuit Judge. The district court
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affirmed a bankruptcy court order which compelled a secured
creditor to pay to the debtor's estate a portion of the
proceeds it had received in satisfaction of its allowed
secured claim. The bankruptcy court's order contravened an
agreement between the secured creditor and the general,
unsecured creditors to share in the proceeds from the
former's secured interest. The bankruptcy court believed,
and the district court agreed, that such an agreement
violated Bankruptcy Code policy. Appellant, the Official
Unsecured Creditors' Committee which entered the agreement on
behalf of the general, unsecured creditors, argues that the
bankruptcy court's order to pay over the disputed funds to
the estate was an error of law. We agree with appellant, and
so reverse the district court judgment, vacate the order in
part and remand to the bankruptcy court.
I. BACKGROUND
I. BACKGROUND
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Debtor SPM Manufacturing Corporation ("SPM" or
"Debtor"), a family-owned manufacturer of photo albums and
related products based in Springfield, Massachusetts, filed a
voluntary petition for relief under Chapter 11 of the United
States Bankruptcy Code ("Code") on April 3, 1989, in the
United States Bankruptcy Court for the District of
Massachusetts. See 11 U.S.C. 1101 et seq. SPM management
___ _______
continued to operate the company as a debtor in possession
("DIP") pursuant to 11 U.S.C. 1101(1) and 1107. Appellee
Robert Shaine continued to serve as president of SPM and was
an unsecured "insider" creditor. Appellee Frances Shaine
continued on as chair of the board of SPM, in addition to
being a stockholder and having responsibility for the general
administrative functions of SPM.
Appellant Official Unsecured Creditors' Committee
("Committee") was appointed by the bankruptcy court pursuant
to 11 U.S.C. 1102(a) on April 13, 1989. When SPM filed for
bankruptcy protection, the company owed approximately $5.5
million to the general, unsecured creditors represented by
the Committee, including International Paper Company and
other suppliers.1 Approximately $9 million was owed to
Citizens Savings Bank ("Citizens" or "Bank"), which held a
perfected, first security interest in all of SPM's assets
except certain real estate. Unsecured debts that had
priority under section 507(a) of the Code, 11 U.S.C.
507(a), consisted primarily of a tax claim of approximately
$750,000 held by the Internal Revenue Service ("I.R.S.") for
unpaid withholding taxes. The Shaines are personally liable
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1. For simplicity, this opinion uses only the approximate
value of the various claims against the Debtor. The exact
amounts of these claims are not at issue in this appeal.
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for whatever portion of that tax claim is not paid out of the
estate.2
Chapter 11 proceedings to reorganize SPM were
contentious and unproductive. Though the DIP filed a plan
for reorganization in September 1989, later amended in
November 1989, the plan was never confirmed. The Committee
decided at about the same time that reorganization under
current management was unfeasible, but that a liquidation of
SPM's assets would leave nothing for any creditor besides
Citizens, whose secured claim exceeded the value of its
collateral (substantially all of SPM's assets).
Consequently, the Committee began discussions with Citizens
about cooperating in the bankruptcy proceedings to maximize
the value of SPM's assets and provide some return to the
general, unsecured creditors.
On October 12, 1989, the Committee and Citizens
executed the agreement ("Agreement") which is the subject of
this appeal. The Agreement recites the opinion of Citizens
and the Committee that, "through their mutual cooperation . .
. in order to maximize recovery on their respective debts it
is in their mutual interest to enter into this Agreement."
The contract explicitly states that the Committee negotiated
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2. Other creditors not relevant to this appeal are various
"insiders" and Heritage Bank for Savings, which held a valid
first mortgage on real estate owned by SPM in Holyoke,
Massachusetts.
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and executed the Agreement on behalf of the general,
unsecured creditors, "[e]xclusive of the Internal Revenue
Service and potential 'insider' creditors."
Citizens and the Committee agreed to cooperate in
the following manner: (1) to "take all actions reasonably
necessary, including, without limitation, initiation of
motions and filing of other pleadings in the Proceeding, to
replace Debtor's current CEO with [a] New Manager"; (2) "to
work together to formulate a joint plan of reorganization";
and (3) to "negotiate with one another in good faith to reach
mutually acceptable agreements" with respect to a number of
details of the joint plan for reorganization.
Citizens and the Committee also agreed to share
whatever proceeds they received as a result of the
reorganization or liquidation of the Debtor. Section 2.4 of
the Agreement specified the terms of the "sharing
arrangement":
Any and all net proceeds of the
sale, refinancing or other disposition of
the assets of SPM and also North American
Album Corporation or any other entity
whose assets are subject to Citizens'
security interest (net proceeds is
defined as those proceeds remaining after
payment of administrative expenses as so
defined by 11 U.S.C. 503, specifically
including attorney's fees and expenses
incurred by the Committee and by
Citizens) received by Citizens and/or the
Creditors' Committee from Debtor's
operations in whatever form said proceeds
make [sic] take (including proceeds from
the operation of any successor entity's
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business) or from the sale or disposition
of the Debtor's or a successor's assets
and/or stock shall be divided between
Citizens and the Creditors' Committee as
follows:
1. The first $3,000,000 of such
proceeds shall be shared 90% to Citizens
and 10% to the Creditors' Committee . .
.;
2. The second $3,000,000 shall be
shared by citizens [sic] and the
Creditors' Committee with 80% going to
Citizens and 20% to the Creditors'
Committee;
3. The next $3,000,000 shall be
shared 70% to Citizens and 30% to the
Creditors' Committee;
4. The next $3,000,000 shall be
shared 60% to Citizens and 40% to the
Creditors' Committee; and
5. All proceeds in excess of
$12,000,000 shall go to the Creditor's
Committee.
The Agreement contained a standard savings clause which
provided that "[i]n the event of any term or provision hereof
is invalid or unenforceable [the] remainder of this Agreement
shall be valid and enforceable to the extent permitted by
law."
Thereafter, the Committee and the Bank filed
numerous motions, both independently and jointly, seeking
unsuccessfully a change in SPM's management, a grant of
relief from the automatic stay for Citizens, the appointment
of a Chapter 11 trustee, and conversion of the case from
Chapter 11 to Chapter 7. At a motion hearing in December
1989, the Agreement was filed with the court as an exhibit.
The court expressed concern about the Agreement's sharing
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provision, characterizing it as a "tax-avoidance" scheme.3
However, at no time during the reorganization proceedings did
any creditor, the Shaines or other interested party4 object
to the mutual promises by Citizens and the Committee to
cooperate during the reorganization proceedings. The court
never formally approved or disapproved the Agreement before
January 1991.
After it became apparent that SPM could not be
successfully reorganized, the bankruptcy court granted a
motion by Citizens on April 16, 1990, to appoint a receiver
with the power to negotiate a sale of all of SPM's assets
pursuant to 11 U.S.C. 363(b). On December 19, 1990, SPM's
assets were sold to Heritage Albums, Inc. for a purchase
price of $5,000,000.00. On December 21, 1990, a previously
entered order went into effect granting Citizens relief from
the automatic stay, see 11 U.S.C. 362, and converting the
___
case into a Chapter 7 liquidation proceeding, see 11 U.S.C.
___
____________________
3. When he first saw the Agreement, the bankruptcy judge
indicated that he thought it might violate section 1129(d),
which prohibits confirmation of a reorganization plan "if the
principal purpose of the plan is the avoidance of taxes." 11
U.S.C. 1129(d). Appellees long ago abandoned the tax-
avoidance argument, probably because the Agreement is not a
"plan" requiring confirmation within the meaning of section
1129 and thus not subject to the requirements of section
1129(d).
4. Appellee Stern was not appointed as the Chapter 7
trustee until December 1990.
-8-
1112(b). After conversion to Chapter 7, appellee Trustee
Stern was appointed. See 11 U.S.C. 701(a).
___
On December 24, 1990, the Committee and Citizens
filed a joint motion for "Entry of Order Requiring Delivery
of Proceeds and Requiring Expedited Determination" which
requested distribution of the sale proceeds to Citizens. The
motion recited that the entire amount was subject to
Citizens' security interest pursuant to 11 U.S.C. 506 and
announced that, after receiving the $5 million and paying
various administrative fees, "Citizens will distribute a
portion of the net proceeds to Kamberg, Berman, P.C.
[Committee's counsel] in accordance with its October 12, 1989
agreement with the Committee." At a hearing before the
bankruptcy court on January 3, 1991, the Debtor and the
Shaines objected to the motion, arguing that the Agreement
distributed proceeds to general, unsecured creditors ahead of
the priority tax creditors in violation of the statutory
scheme for distribution. See 11 U.S.C. 724-726. Citizens
___
and the Committee responded that the $5 million belonged to
Citizens and that the Bank had a right to share its proceeds
with the Committee without paying the I.R.S. or other
creditors first. The bankruptcy court granted
Citizens' and the Committee's motion to the extent it
requested satisfaction of Citizens' allowed secured claim for
$5 million, but rejected the motion to the extent it
-9-
requested approval of the Agreement's sharing provision.5
The bankruptcy judge explained that he viewed the Agreement
as a form of proceeds distribution which did not comply with
the Code.
I am not approving any distribution
that is not in accordance with the
priority of the bankruptcy code, and I
think I made that abundantly clear a long
time ago. I'm not going to have the
bankruptcy code, have an end-run around
it in this court. The law sets out
certain priorities, and your committee
has absolutely no authority to short-
circuit those priorities, and I want to
make that clear.
Furthermore, the bankruptcy court explained, the Committee
has a duty to the bankruptcy estate.
I rule that the committee, although
it certainly had authority to negotiate
something for the benefit of the
bankruptcy estate, that authority was
just that, for the benefit of the entire
bankruptcy estate, and the committee had
no authority, never thought it had and
if it did [ask for court approval], it
would not have been given it to
negotiate something for the benefit of
some sets of creditors of the bankruptcy
estate.
It is perfectly true that without
the agreement the bankruptcy estate would
get nothing, but once the committee was
in operation it had to, it's required by
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5. On its face, the motion by Citizens and the Committee
does not request approval of the Agreement. However, during
the motion hearing, counsel for Citizens requested the court
to order the Chapter 7 trustee to oversee the distribution of
proceeds to the general, unsecured creditors. The court
treated this request as part of the motion and refused to
grant it. We consider the mechanics of the proceeds
distribution infra in Part III.
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-10-
law, to act for the benefit of the entire
estate . . . .
In accordance with its ruling at the hearing, the
bankruptcy court issued a Disbursement Order on January 8,
1991, ordering the following:
1. Citizens is the holder of a valid,
perfected and enforceable first security
interest in all assets of the Debtor
excepting only the real estate owned by
the Debtor;
2. Citizens has a first priority lien
and security interest in all of the post-
petition accounts receivable and
inventory of the Debtor;
3. Citizens' claim is allowed as a
secured claim in the amount of
$5,000,000.00, with the remainder allowed
as an unsecured claim;
4. The net cash proceeds from the sale
of the Debtor's assets held by Goldstein
& Manello [Debtor's counsel], after
payment of its fee and expenses and the
fee and expenses of Kamberg, Berman P.C.
[the Committee's counsel], shall be paid
over to Citizens by Goldstein & Manello
in partial satisfaction of Citizens'
claim.
5. Citizens shall pay from the net cash
proceeds paid over to it by Goldstein &
Manello as aforesaid such fees of the
Examiner and any other party as shall be
approved by order of this court after
notice and hearing.6
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6. Citizens had previously agreed to the payment of
counsel's fees and other administrative expenses from the
sale proceeds; it had included paragraphs four and five in
its proposed order attached to the joint motion.
-11-
Although the court acknowledged that Citizens' allowed
secured claim was $5 million, paragraph six compelled
Citizens to pay part of that amount to the Chapter 7 trustee
for distribution to other creditors:
6. After payment of all fees, Citizens
shall compute the amount due to the
Committee under the agreement of October
12, 1989 between Citizens and the
Committee. Citizens shall then pay such
amount to the trustee in bankruptcy of
SPM Manufacturing Corporation, who shall
administer the same in accordance with
the provisions of the Bankruptcy Code
including the Code's provisions
concerning priority for tax claims.
The effect of paragraph six of the order is to deprive the
general, unsecured creditors of any amount they would have
received under the Agreement and to benefit the I.R.S., the
other priority creditors, and the Shaines who, as principals
of SPM, would be personally liable for the underlying tax
obligations.
Citizens and the Committee made timely objections
to the order and appealed to the United States District Court
for the District of Massachusetts. Trustee Stern and the
Shaines appeared as appellees, and the funds were placed in
escrow pending outcome of the appeal. The district court
affirmed the bankruptcy court order, reasoning that it was a
proper exercise of the bankruptcy court's equitable powers
under section 105(a) of the Code. "[T]he Disbursement Order
furthers the legislative distribution scheme in Chapter 7
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cases and [] the Sharing Agreement, in its original form,
thwarts that scheme." The district court explained that, in
accordance with the Code and Massachusetts contract law, the
bankruptcy court "reformed" the Agreement to comply with the
distribution scheme of the Code.
The Committee filed a timely appeal from the
district court's order. The Bank, conceding that the funds
in escrow belong either to the Committee or to the estate,
does not join the appeal. This court has jurisdiction over
this appeal pursuant to 28 U.S.C. 158(d).
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II. DISCUSSION
II. DISCUSSION
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The facts are essentially undisputed. The issue on
appeal is whether the bankruptcy court erred as a matter of
law in ordering Citizens to pay to the Trustee that portion
of the Bank's secured interest which, according to the terms
of the Agreement, was due to the Committee. In an appeal
from district court review of a bankruptcy court order, the
court of appeals independently reviews the bankruptcy court's
decision, applying the clearly erroneous standard to findings
of fact and de novo review to conclusions of law. In re
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LaRoche, 969 F.2d 1299, 1301 (1st Cir. 1992); In re G.S.F.
_______ ____________
Corp., 938 F.2d 1467, 1474 (1st Cir. 1991). Where the
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language of a contract is unambiguous, the bankruptcy court's
interpretation of it is subject to de novo review. In re
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Sublett, 895 F.2d 1381, 1384 (11th Cir. 1990). No special
_______
deference is owed to the district court's determinations. In
__
re G.S.F. Corp., 938 F.2d at 1474.
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Appellees argue that the order was a proper
exercise of the bankruptcy court's equitable powers under
section 105(a) of the Code. The bankruptcy court has the
equitable power "to issue any order, process, or judgment
that is necessary or appropriate to carry out provisions" of
the Code. 11 U.S.C. 105(a). However, "whatever equitable
powers remain in the bankruptcy courts must and can only be
exercised within the confines of the Bankruptcy Code."
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Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 206 (1988)
________________________ ______
(unanimous decision); see also In re Plaza de Diego Shopping
________ _____________________________
Ctr., Inc., 911 F.2d 820, 830-31 (1st Cir. 1990) ("[T]he
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bankruptcy court's equitable discretion is limited and cannot
be used in a manner inconsistent with the commands of the
Bankruptcy Code."). That is, the bankruptcy court has no
equitable power to deprive creditors of rights or remedies
available to them under the Code. See Norwest Bank, 485 U.S.
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at 206-07; In re Grissom, 955 F.2d 1440, 1449 n.8 (11th Cir.
_____________
1992). Nor does section 105(a) authorize courts to create
substantive rights that are otherwise unavailable under the
Code, or to expand the contractual obligations of parties.
United States v. Pepperman, 976 F.2d 123, 131 (3d Cir. 1992);
_____________ _________
United States v. Sutton, 786 F.2d 1305 (5th Cir. 1986).
_____________ ______
Appellees portray the bankruptcy court's order as a
mere "reform" of the Agreement. In their view, the court
simply substituted the bankruptcy estate for the Committee as
the proper beneficiary of the sharing provision of the
Agreement. Appellant responds that transferring the
contractual right to receive payment from one party to a
third party goes beyond mere "reform." The question now
before us is whether an order compelling Citizens to pay to
the estate from monies realized under its secured interest
the amount required by the Agreement to be paid to the
Committee is within the equitable powers of the bankruptcy
-15-
court.7 Because section 105(a) is not a source of
substantive rights, the bankruptcy court's order was
legitimate only to the extent that some other provision of
the Code or other applicable law entitled the estate to
receive the disputed funds. See In re Morristown & Erie R.R.
___ ____________________________
Co., 885 F.2d 98, 100 (3d Cir. 1989).
___
Appellees argue that the order was authorized on
three different grounds: (1) the Agreement attempted to
distribute property not in accordance with the priorities and
distribution scheme of Code sections 507 and 726; (2) the
Committee had a duty to negotiate on behalf of all creditors,
not just the general, unsecured creditors; and (3) the
Agreement altered the balance of power in the Chapter 11
reorganization proceedings. We consider each argument
separately.
A. Distribution Scheme of the Code
A. Distribution Scheme of the Code
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Appellees argue that allowing the general,
unsecured creditors to receive money under the Agreement
while priority tax creditors receive nothing would conflict
with the statutory scheme for distribution of bankruptcy
estate property. See 11 U.S.C. 507, 726. Thus, they
___
____________________
7. The parties in their briefs assume that the amount owed
to the Committee under the Agreement would be approximately
$700,000. However, the actual amount could be less due to
payment of administrative fees and expenses prior to
distribution of the proceeds. This is not a matter for us to
resolve.
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contend, the bankruptcy court properly acted in equity to
prevent a violation of the Code's distribution scheme.
Section 726 provides, in relevant part, that:
[P]roperty of the estate shall be
distributed
(1) first, in payment of claims of
the kind specified in, and in the order
specified in, section 507 of the title;
(2) second, in payment of any
allowed unsecured claim, other than a
claim of a kind specified in paragraph
(1), (3), or (4) of this subsection,
proof of which is [timely filed.]
11 U.S.C. 726(a). Section 507 of the Code identifies those
expenses and claims which have priority over other claims,
including administrative expenses allowed under section
503(b), claims for wages, and unsecured tax claims. See 11
___
U.S.C. 507(a)(1), (3), (7).
However, the distribution scheme of section 726
(and, by implication, the priorities of section 507) does not
come into play until all valid liens on the property are
satisfied. See United States v. Speers, 382 U.S. 266, 269
___ _____________ ______
n.3 (1965); Goggin v. Division of Labor Law Enforcement, 336
______ __________________________________
U.S. 118, 126-127 (1949). If a lien is perfected and not
otherwise invalidated by law, it must be satisfied out of the
assets it encumbers before any proceeds of the assets are
available to unsecured claimants, including those having
priority (such as priority tax creditors). In re Darnell,
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834 F.2d 1263, 1265 (6th Cir. 1987). Citizens held a valid
lien on all of the SPM assets; these were sold for $5
-17-
million. The bankruptcy court allowed Citizens' secured
claim in that amount. Clearly, then, absent the order, the
entire $5 million belonged to Citizens in satisfaction of its
lien, leaving nothing for the estate to distribute to the
other creditors, including the I.R.S. The bankruptcy court's
order forced Citizens to transfer to the estate a portion of
its own $5 million notwithstanding the court's recognition of
Citizens' right to receive that sum in full.
Because Citizens' secured claim absorbed all of
SPM's assets, there was nothing left for any other creditor
in this case. Ordinarily, in such circumstances, the
distributional priorities of sections 726 and 507 would have
been mooted. Appellees defend the outcome below on the
ground that the Agreement improperly syphoned proceeds to the
general, unsecured creditors "at the expense of priority
creditors." However, it is hard to see how the priority
creditors lost anything owed them given the fact there would
have been nothing left for the priority creditors after the
$5 million was distributed to Citizens. The "syphoning" of
the money to general, unsecured creditors came entirely from
the $5 million belonging to Citizens, to which no one else
had any claim of right under the Bankruptcy Code.
Appellees point to the Agreement's sharing formula
and ask how the parties could contemplate sharing over $12
million when Citizens' claim was worth only $9 million. The
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Agreement, it is said, could not contemplate dividing
property that did not belong to the parties to the contract.
But appellees' assertion is based on a misreading of the
Agreement. The Agreement merely states that Citizens and the
general, unsecured creditors will pool whatever they received
____ ________
from the bankruptcy estate (either in a reorganization or
liquidation) and will then divide the pooled funds among
themselves. Any sharing between Citizens and the general,
unsecured creditors was to occur after distribution of the
_____
estate property, having no effect whatever on the bankruptcy
distributions to other creditors.
This crucial fact remains true under any scenario.
When the Agreement was signed in October 1989, the value of a
reorganized or liquidated SPM was unknown. Assume a
liquidation would have produced $15 million after payment of
the various administrative expenses. If that had happened,
the first $9 million would have gone to Citizens in
satisfaction of its lien, and the rest of the money would
have been distributed pursuant to section 726 (assuming the
case had already been converted to Chapter 7). Hence, the
next $800,000 or so would have been distributed to the I.R.S.
and other priority creditors, and the remaining $5.2 million
would have gone to the general, unsecured creditors in
virtual satisfaction of their $5.5 million claim, leaving
nothing for "insiders" and other subordinated creditors. By
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its terms, the sharing formula in the Agreement is to take
effect only after a proper distribution under the Code.
Citizens and the Committee would have pooled only their own
bankruptcy dividends for a combined $14.2 million and then
split this sum according to the Agreement's formula.
Distributions to the I.R.S. and all other creditors under
section 726 would be unaffected. Under any set of
assumptions, then, the Agreement does not distribute property
of the estate "at the expense of" priority creditors nor does
it violate the distribution scheme of section 726 or the
priorities of section 507.
Appellees argue, in the alternative, that the
Agreement conflicts with the spirit of the Code's
distribution scheme, under which priority creditors always
get paid in full before general, unsecured creditors receive
anything. Appellees contend that Congress never wanted
unsecured creditors especially creditors represented by
the official creditors' committee to be able to
"circumvent" this scheme by negotiating with secured
creditors to increase the return received for their claims
against the debtor. Appellees' theory, however, goes beyond
anything appearing expressly or by implication in the Code.
Section 726 and the other Code provisions governing
priorities of creditors apply only to distributions of
property of the estate. The Code does not govern the rights
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of creditors to transfer or receive nonestate property.
While the debtor and the trustee are not allowed to pay
nonpriority creditors ahead of priority creditors, see King
___ ____
v. United States, 379 U.S. 329 (1964), creditors are
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generally free to do whatever they wish with the bankruptcy
dividends they receive, including to share them with other
creditors. Cf. In re Allegheny Int'l, Inc., 100 B.R. 241,
___ ____________________________
243 (Bankr. W.D. Pa. 1988) (remarking that the Code "does not
permit a debtor to pay its pre-petition debts to suppliers,
at a discount or otherwise, before confirmation of the plan,
but it appears to allow third parties to purchase the claims
of those suppliers").
In this case, the proceeds of the sale of SPM's
assets pursuant to 11 U.S.C. 363 were property of the
estate and thus the Code governed their use and distribution.
However, once the court lifted the automatic stay and ordered
those proceeds distributed to Citizens in proper satisfaction
of its lien, that money became the property of Citizens, not
of the estate. Appellees concede that the bankruptcy court
has no authority to control how Citizens disposes of the
proceeds once it receives them. There is nothing in the Code
forbidding Citizens to have voluntarily paid part of these
monies to some or all of the general, unsecured creditors
after the bankruptcy proceedings finished.
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Thus, appellees' argument reduces to contending
that although a secured creditor is free to share its
proceeds with nonpriority creditors after bankruptcy
proceedings have concluded, it may not enter into a contract
during bankruptcy in which it promises to do the same thing.
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Again, appellees' argument lacks statutory support for it
confuses estate property and nonestate property. The
parties' agreement to share the proceeds could be seen as a
partial assignment by Citizens and the general, unsecured
creditors of their rights to receive bankruptcy dividends.8
See David Gray Carlson, A Theory of Contractual Debt
___ ________________________________
Subordination and Lien Priority, 38 Vand. L. Rev. 975, 996-
________________________________
1004 (1985). A right to receive payment is freely
transferable and assignable in Massachusetts without the
consent of the debtor and without affecting the debtor's
obligation to pay the underlying debt. See Mass. Gen. L. ch.
___
106, 9-318; Graves Equipment, Inc. v. M. DeMatteo Constr.
_______________________ ____________________
Co., 397 Mass. 110, 489 N.E.2d 1010, 1012 (1986) ("Section 9-
___
318(1)(a) incorporates the common law rule that an assignee
of contract rights stands in the shoes of the assignor . . .
."). The Agreement did not affect estate property, i.e., the
sale proceeds, but only concerned the contacting parties'
claims against the estate, i.e., their rights to be paid by
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____________________
8. We do not decide exactly how to categorize the Agreement
because that issue is not necessary to our decision. See
___
infra note 13.
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the estate. We find no support in the Code for banning this
type of contractual assignment in all cases.
Appellees suggest the policy of the Code is that,
regardless of the source of the payments, nonpriority
creditors should never receive a return on their claims if
priority creditors receive nothing. This theory of Code
policy is directly contradicted by the fact that nonpriority
creditors routinely receive payment from third parties for
their claims without interference by the bankruptcy court.
Unsecured creditors often sell their claims to third parties,
e.g., for 30 cents on the dollar, in order to avoid the
uncertainty and delay of bankruptcy proceedings. See Chaim
___
J. Fortgang & Thomas Moers Mayer, Trading Claims and Taking
__________________________
Control of Corporations in Chapter 11, 12 Cardozo L. Rev. 1,
______________________________________
2-3 (1990). The Code does not speak to the validity of claim
transfers, and the Bankruptcy Rules provide only procedures
for the filing of notice required for a transferee to be
recognized as the holder of the claim. See Bankr. Rule
___
3001(e)9; In re Odd Lot Trading, Inc. 115 B.R. 97, 100
______________________________
____________________
9. Bankruptcy Rule 3001(e)(2) sets out the procedures for
transfers of claims other than for security after proof of
the claim is filed:
If a claim other than one based on a
publicly traded note, bond, or debenture
has been transferred other than for
security after the proof of claim has
been filed, evidence of the transfer
shall be filed by the transferee. The
clerk shall immediately notify the
-23-
(Bankr. N.D. Ohio 1990); Fortgang & Mayer, Trading Claims, at
______________
____________________
alleged transferor by mail . . . . If
the alleged transferor files a timely
objection and the court finds, after
notice and a hearing, that the claim has
been transferred other than for security,
it shall enter an order substituting the
transferee for the transferor. If a
timely objection is not filed by the
alleged transferor, the transferee shall
be substituted for the transferor.
Bankr.Rule 3001(e)(2).
Prior to 1991, some courts interpreted Rule 3001 as
authorization for courts "to monitor the manner in which
claims are transferred or assigned and thereby prevent, inter
alia, the improper proliferation of claims, wrongdoing and
inequitable conduct." In re Ionosphere Clubs, Inc., 119 B.R.
____________________________
440, 443 (Bankr. S.D.N.Y. 1990). Rule 3001(e) was amended in
1991 to restrict the bankruptcy court's power to inspect the
terms of such transfers. See In re Odd Lot Trading, Inc.,
___ _____________________________
115 B.R. 97, 100-01 (Bankr. N.D. Ohio 1990). Transfers are
no longer required to be unconditional and assignees do not
have to submit to the bankruptcy court the terms of the
transfer for its approval. Consequently, under the amended
rule, the bankruptcy court cannot disapprove the transfer
because of its terms, e.g., inadequate consideration. The
1991 Advisory Committee Note explains that:
Subdivision (e) is amended to limit the
court's role to the adjudication of
disputes regarding the transfer of
claims. . . . If a claim has been
transferred other than for security after
a proof of claim has been filed, the
transferee is substituted for the
transferor. In that event, the clerk
should note the transfer without the need
for court approval. If a timely
objection is filed, the court's role is
to determine whether a transfer has been
made that is enforceable under
nonbankruptcy law. This rule is not
intended either to encourage or
discourage postpetition transfers of
claims . . . .
Bankr. Rule 3001, Advisory Committee Notes, 1991 Amendment.
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19-25. The circumstances in which claims transfers are
expressly said to be invalid are limited. For example, the
purchasing of claims by an affiliate or insider of the debtor
for the sole purpose of blocking the confirmation of
competing plans may constitute "bad faith" for the purposes
of section 1126(e), 11 U.S.C. 1126(e). See In re Applegate
___ _______________
Property, Ltd., 133 B.R. 827, 834-35 (Bankr. W.D. Tex. 1991).
______________
An assigned claim may be limited if the assignment involves a
breach of fiduciary duty or fraud and the breach of duty or
fraud enables the assignee to acquire the claim for
inadequate consideration. In re Executive Office Centers,
________________________________
Inc., 96 B.R. 642, 649 (Bankr. E.D. La. 1988). However,
____
absent some effect on the administration of the estate or
diminution of estate property, neither the Code nor the Rules
prohibit or discourage creditors from receiving cash from
nondebtors in exchange for their claims.
While the Agreement in this case might not be
categorized as a "transfer" under Rule 3001(e),10 the
____________________
10. We do not decide whether the Agreement in this case
constitutes a "transfer" of claim subject to the requirements
of Rule 3001 because appellees did not raise this issue.
Even if notice of the Agreement should have been but was not
filed with the court, that failure would not authorize the
bankruptcy court to void or alter the Agreement. Failure to
file notice of a transfer under Rule 3001(e) only affects the
standing of the transferee as a "creditor" and thus the duty
of the trustee to make payment on the claim to the
transferee. See Bankr. Rule 3001(e); In re FRG, Inc., 124
___ ________________
B.R. 653, 656-57 (Bankr. E.D. Pa. 1991); In re Oxford Royal
___________________
Mushroom Prods., Inc., 93 B.R. 390, 397 (Bankr. E.D. Pa.
______________________
1988).
-25-
financial outcomes produced by the Agreement and by outright
claim transfers are analogous. If the general, unsecured
creditors in this case had sold their claims to Citizens (or
another third party) for cash, e.g., for ten cents on the
dollar, after all was said and done the priority creditors
would have received nothing and the general, unsecured
creditors would have received approximately $550,000 (10% of
their $5.5 million total claim). The bankruptcy court would
have had no authority to prevent the general, unsecured
creditors from transferring their claims. In comparison,
under the Agreement's sharing arrangement the general,
unsecured creditors would receive, under the parties'
calculations, see note 7, approximately $700,000 (about 12.5%
___
of their claims) while priority creditors receive nothing.
Given authority in the Bankruptcy Code and Rules to permit
outright transfers resulting in general, unsecured creditors
receiving some money for their claims, we see nothing to
prohibit the same result if produced by a partial assignment
or sharing of claims such as accomplished by the Agreement in
this case.
Because Code provisions governing priorities and
distribution of estate property gave the estate no right to
share in proceeds from Citizens' secured claim, the
bankruptcy court derived no right under those same provisions
-26-
to order Citizens to pay a portion of its own claim proceeds
to the estate.
B. No Fiduciary Duty to the Estate
B. No Fiduciary Duty to the Estate
_______________________________
Appellees argue that the bankruptcy court had the
equitable power to order Citizens to pay to the estate the
amount due to the Committee under the Agreement because, as
the bankruptcy court ruled:
[T]he committee, although it certainly
had authority to negotiate something for
the benefit of the bankruptcy estate,
that authority was just that, for the
benefit of the entire bankruptcy estate,
and the committee had no authority . . .
to negotiate something for the benefit of
some sets of creditors of the bankruptcy
estate.
Appellees do not contest the bankruptcy court's ruling that
the Committee had the general power to enter contracts. The
Code expressly authorizes a committee to "perform such other
services as are in the interest of those represented." 11
U.S.C. 1103(c)(5). Appellees also concede that the
Committee's appointment pursuant to 11 U.S.C. 1102(a)
charged it only with representation of the general, unsecured
creditors (not with representation of the I.R.S. or other
priority creditors). Nevertheless, they contend, any
agreement negotiated by the Committee should have been
negotiated to benefit the estate as a whole and thus any
contractual right to receive payment from Citizens rightfully
belongs to the estate.
-27-
We do not accept this contention, as it seems based
on the erroneous assumption that the Official Unsecured
Creditors' Committee is a fiduciary for the estate as a
whole. While a creditors' committee and its members must act
in accordance with the provisions of the Bankruptcy Code and
with proper regard for the bankruptcy court, the committee is
a fiduciary for those whom it represents, not for the debtor
or the estate generally. In re Microboard Processing, Inc.,
__________________________________
95 B.R. 283, 285 (Bankr. D. Conn. 1989); In re Johns-Manville
____________________
Corp., 60 B.R. 842, 853 (S.D.N.Y.), rev'd on other grounds,
_____ _______________________
801 F.2d 60 (2d Cir. 1986). Thus the committee's fiduciary
duty, as such, runs to the parties or class it represents.
Markey v. Orr, No. G89-40886, 1990 U.S. Dist. LEXIS 3005 at
______ ___
*9-*10 (W.D. Mich. 1990); Pension Benefit Guar. Corp. v.
____________________________
Pincus, Verlin, Hahn, Reich & Goldstein P.C., 42 B.R. 960,
______________________________________________
963 (E.D. Pa. 1984); Microboard, 95 B.R. at 285; Johns-
__________ ______
Mansville, 60 B.R. at 853. It is charged with pursuing
_________
whatever lawful course best serves the interests of the class
of creditors represented. In re Seaescape Cruises, Ltd., 131
_____________________________
B.R. 241, 243 (Bankr. S.D. Fla. 1991).
In this case, the Committee reasonably determined
that entering into the Agreement with Citizens was in the
best interests of the class it represented, to wit, the
__ ___
general, unsecured creditors. No general, unsecured creditor
objected to the Committee's decision, see In re Seaescape
___ ________________
-28-
Cruises, 131 B.R. at 243-44, nor have appellees offered any
_______
evidence or reason for us to believe that the represented
class would have been better off had the Committee not acted
as it did. The contrary appears true. Although the Shaines
and the Debtor may have preferred a less active committee,
and one more sympathetic to them, an effective creditors'
committee must sometimes be adversarial if it is to fulfill
its role in a Chapter 11 case. In re Seaescape Cruises, 131
_______________________
B.R. at 243; In re Daig Corp., 17 B.R. 41, 43 (Bankr. D.
__________________
Minn. 1981).
The creditors' committee is not merely a
conduit through whom the debtor speaks to
and negotiates with creditors generally.
On the contrary, it is purposely intended
to represent the necessarily different
interests and concerns of the creditors
it represents. It must necessarily be
adversarial in a sense, though its
relation with the debtor may be
supportive and friendly. There is simply
no other entity established by the Code
to guard those interests. The committee
as the sum of its members is not intended
to be merely an arbiter but a partisan
which will aid, assist, and monitor the
debtor pursuant to its own self-interest.
In re Daig Corp., 17 B.R. at 43. We conclude, therefore,
_________________
that the bankruptcy court erred as a matter of law insofar as
it felt that the Committee was under a particular duty to
negotiate the sharing provision of the Agreement for the
benefit of the estate as a whole.
C. Balance of Power in Reorganization Proceedings
C. Balance of Power in Reorganization Proceedings
______________________________________________
-29-
Appellees contend that the bankruptcy court's order
equitably prevented Citizens and the Committee from forming
an alliance which would destroy the "balance of power"
allegedly created by the Code, especially sections 507 and
1129. The Agreement between Citizens and the Committee,
appellees argue, frustrated SPM's attempts to reorganize and,
if similar agreements are permitted in future cases, could
create "chaos" and "free for alls" in reorganization
proceedings.
The first part of appellees' argument that the
Agreement actually prevented the Debtor in this case from
successfully reorganizing was not timely raised below and
we do not, therefore, consider it. Issues not raised in the
bankruptcy court are ordinarily not considered for the first
time on appeal. In re LaRoche, 969 F.2d 1299, 1305 (1st Cir.
_____________
1992); In re Burgess, 955 F.2d 134, 136 n.2 (1st Cir. 1992);
_____________
Liakas v. Creditors' Committee of Deja Vu, Inc., 780 F.2d
______ _______________________________________
176, 179 (1st Cir. 1986). This principle applies to cases
where, as here, a party attempts to justify a bankruptcy
court order with a theory not raised before or considered by
the bankruptcy court. In re Sun Runner Marine, Inc., 945
_______________________________
F.2d 1089, 1095 (9th Cir. 1991). Though the Shaines knew of
the Agreement's existence since December 1989, they never
complained to the bankruptcy court about Citizens' and the
Committee's joining of forces during the reorganization
-30-
proceedings; they raised questions only about the
distribution of Citizens' proceeds to nonpriority creditors.
The bankruptcy court gave no indication in its findings and
rulings that it was bothered by that aspect of the Agreement.
Not until oral argument before the district court hearing on
this appeal did the Shaines and the Trustee invoke the
alleged negative effects on reorganization of the Citizens-
Committee alliance.
It is true that, in the interest of justice,
parties are sometimes permitted to offer unraised alternative
rationales for affirming a judgment. See, e.g., In re
___ ____ ______
Killebrew, 888 F.2d 1516, 1521 (5th Cir. 1989). But
_________
appellees' contention here that the Agreement disrupted the
Debtor's reorganization proceedings is essentially a factual
issue requiring findings of fact not now contained in the
record before us. The bankruptcy court, not the district
court or court of appeals, is the only tribunal equipped to
make evidentiary findings on relevant factual matters such as
whether the parties acted in bad faith, whether the parties
intended to frustrate attempts to reorganize the Debtor, and
whether the parties' actions actually prevented the Debtor
from successfully reorganizing. See Bankruptcy Rules 7052,
___
8013; In re Sublett, 895 F.2d at 1384. We are in no position
_____________
to ascertain by ourselves whether the Agreement, in fact,
interfered unjustifiably with the reorganization proceedings.
-31-
See In re Sun Runner Marine, 945 F.2d at 1095 ("We do not
___ ________________________
know what legal standard the bankruptcy court would have
applied, or whether the bankruptcy court would have found
facts warranting [the parties' requested order], had that
issue been presented to it.")
We respond briefly to appellees' warning that if
this agreement stands, creditors in the future will form
alliances to defeat attempts to reorganize, extort higher
payouts from debtors, and generally create chaos in Chapter
11. Our focus is necessarily on the particular agreement
before us, to see whether it conflicts with the
reorganization provisions of Chapter 11 and whether the
record supports appellees' portrait of the dire effects of
giving effect to such a contract. Insofar as we can see, the
parties' promises made in the Agreement were well within
their rights under the Bankruptcy Code: they agreed to move
the bankruptcy court to replace the Debtor's current
management, see 11 U.S.C. 1104(a),(b), and to propose a
___
plan of reorganization, see 11 U.S.C. 1121(c). The record
___
shows that, in addition to the joint motions contemplated by
the Agreement, the parties moved for conversion of the case
to Chapter 7. This action was allowed by 11 U.S.C.
1112(b). We see no indication in the Agreement that Citizens
and the Committee agreed to vote for or against any
particular plans, a restriction which could raise charges of
-32-
bad faith. See 11 U.S.C. 1126(e); Young v. Higbee Co., 324
___ _____ __________
U.S. 204, 210-11 (1945). Appellees have not pointed to any
other Code provision implicated by the parties' cooperative
efforts. Looking at the ones mentioned, we cannot find
support for appellees' assertion that this agreement
conflicts with any policy in favor of reorganizations
manifested by Chapter 11.
As for future cases, we note that the bankruptcy
court always retains the power to monitor and control the
tenor of reorganization proceedings. If the unsecured
creditors' committee fails to be properly representative of
the unsecured creditors, any party in interest can move to
have the committee reconstituted. See 11 U.S.C.
___
1102(a)(2); In re Daig Corp., 17 B.R. at 42. If an entity's
_________________
acceptance or rejection of a plan is not made in good faith,
or was not solicited or procured in good faith, the court can
disqualify that vote. See 11 U.S.C. 1126(e). The good
___
faith requirement bars creditors from casting their votes
from ulterior motives, such as coercing a higher payment from
the debtor's estate, pure malice, and advancing the interests
of a competing business. In re Federal Support Co., 859 F.2d
_________________________
17, 19 (4th Cir. 1988). The record contains no evidence that
Citizens and the Committee harbored any such sinister
designs.
-33-
Appellees assert that creditors should not do
anything to alter the usual divergence of interests between
secured and unsecured creditors. While secured creditors
might generally prefer liquidation and unsecured creditors
might generally support reorganization, the Code surely does
not require them to take such positions. No two creditors
have identical interests, see In re Microboard Processing,
___ _____________________________
Inc., 95 B.R. at 285, and the Code implicitly recognizes that
____
fact by providing a procedural framework for handling the
various divergent interests of the parties to a bankruptcy.
See Elizabeth Warren, Bankruptcy Policy, 54 U. Chi. L. Rev.
___ _________________
775, 785-89 (1987); see also Elizabeth Warren & Jay Lawrence
________
Westbrook, The Law of Debtors and Creditors 427-35 (2d ed.
__________________________________
1991). While unsecured creditors may sometimes share common
objectives with the debtor and current management, they are
not required to rubber stamp the proposals of the debtor nor
to support the retention of current management. See In re
___ _____
Federal Support Co., 859 F.2d at 19 ("It is well settled []
___________________
that good faith in casting a vote does not require of the
creditor a selfless disinterest.") The duty of the unsecured
creditors' committee to pursue the best interests of the
unsecured creditors requires different outcomes in different
situations, and may entail entering contracts regarding
reorganization plans, see, e.g., In re Donlevy's Inc., 111
___ ____ _____________________
B.R. 1, 2 (Bankr. D. Mass. 1990), recommending rejection of a
-34-
debtor's plan of reorganization, or filing motions to convert
a Chapter 11 case to Chapter 7, see, e.g., In re Seaescape
___ ____ _______________
Cruises, Ltd., 131 B.R. at 243. For the reasons discussed,
_____________
we do not think that the bankruptcy court's order was
justified as a means to enforce the rules or policies spelled
out in Chapter 11.11
D. Other Arguments
D. Other Arguments
_______________
We briefly dispose of the parties' other arguments.
We reject appellees' argument that Citizens, by agreeing to
share some of its bankruptcy proceeds with the Committee,
"carved out" or "divested itself" of a portion of its lien
and thus the court "simply used its equitable powers to
determine who best was entitled to receive this carved out
portion" of Citizens' claim. This argument is untenable
because no appeal was taken from the bankruptcy court's
express ruling that Citizens, pursuant to its $5 million
allowed secured claim, was entitled to receive the entire
sale proceeds. Furthermore, under Massachusetts law a valid
assignment of a debt does not divest the claim of its
priority or alter the debtor's obligation to pay the debt;
____________________
11. Even, indeed, if an alliance of the type reflected in
the Agreement were believed to contravene bankruptcy
policies, the remedy ordering Citizens to pay out to the
estate funds it had agreed to pay to the Committee would
seem questionable. If the Agreement violated public policy,
the more usual remedy would be to declare it invalid and
unenforceable rather than to enforce it, out of Citizens'
pocket, in favor of a nonparty to the Agreement.
-35-
the assignee steps into the shoes of the assignor for the
portion of the claim assigned.12 See Mass. Gen. L. ch.
___
106, 9-302(2); Grise v. White, 355 Mass. 698, 247 N.E.2d
_____ _____
385, 388 (1969).
Because the bankruptcy court's order compelling
Citizens to pay the estate from the proceeds of its security
interest was not authorized by section 105(a), we need not
consider the Committee's argument that section 510(a), 11
U.S.C. 510(a), required the bankruptcy court to give effect
to the Agreement as a subordination agreement.13 And
because the Agreement did not conflict with federal
bankruptcy policy, there is no need to resolve the parties'
dispute as to when and to what extent courts may, under
Massachusetts law, reform contracts which violate public
policy.
III. CONCLUSION
III. CONCLUSION
__________
____________________
12. We assume, for the moment, that the Agreement could be
characterized as a partial assignment of the parties' claims.
As explained infra note 13, the issue of how to characterize
_____
the Agreement is not before us.
13. How to categorize the Agreement is no simple question.
It has attributes of both a partial assignment and a
subordination agreement. See generally David Gray Carlson, A
_____________ _
Theory of Contractual Debt Subordination and Lien Priority,
____________________________________________________________
38 Vand. L. Rev. 975 (1985) (discussing the characteristics
of and enforceability of various types of subordination and
assignment agreements in bankruptcy). Even if it cannot be
deemed a subordination agreement for purposes of enforcement
pursuant to 11 U.S.C. 510(a), the question on appeal is not
whether the Agreement is valid and enforceable, but whether
the bankruptcy court had authority under the Code to issue
its order.
-36-
For the reasons discussed above, we hold that the
bankruptcy court erred as a matter of law in ordering
Citizens to pay to the Trustee the amount due to the
Committee under the Agreement. Accordingly, we reverse the
judgment of the district court and vacate paragraph six of
the bankruptcy court's Disbursement Order of January 8, 1991.
No question is raised in this appeal as to whether
the Agreement is binding on Citizens and the Committee.
Indeed, Citizens previously expressed, at hearings before the
bankruptcy court and the district court, its complete
willingness to abide by its obligation under the Agreement to
pay the Committee the agreed share of the sale proceeds. At
the hearing on January 3, 1991, counsel for Citizens
requested the court to order the Chapter 7 Trustee to oversee
the distribution of the proceeds to the general, unsecured
creditors. Appellees Robert and Frances Shaine point out in
their appellate brief that the mechanics of distributing
these proceeds to the general, unsecured creditors were not
made clear in the Agreement, nor did the bankruptcy court
decide how the proceeds should be handled.
Consequently, having reversed the bankruptcy
court's order, we remand to the bankruptcy court to determine
whether to allow Citizens' motion to have the Trustee
administer the distribution of the funds due to the general,
-37-
unsecured creditors under the Agreement. Appellant has not
pointed to any basis in the Code for authorizing, let alone
requiring, the bankruptcy court or Trustee to administer a
distribution of nonestate funds pursuant to a private
agreement. However, because we lack a complete record and
because the precise issue was not appealed, we leave it up to
the bankruptcy court to decide, in the first instance,
whether to order the Trustee (rather than Citizens) to
administer the distribution, and to determine the allocation
of any related administrative expenses. If the bankruptcy
court determines that the Trustee should not oversee
distribution, or if Citizens withdraws its motion for the
Trustee to administer the funds, then the bankruptcy court
shall distribute the funds in escrow, including accrued
interest, to Citizens subject to any proper administrative
charges or other obligations.
The district court judgment is reversed, the
___________________________________________________
bankruptcy court order is vacated in part, and the matter is
_____________________________________________________________
remanded for further proceedings not inconsistent herewith.
____________________________________________________________
Costs to appellant.
__________________
-38-