Citicorp Venture Capital, Ltd. v. Committee of Creditors Holding Unsecured Claims

Opinions of the United
2003 Decisions States Court of Appeals
for the Third Circuit

3-19-2003

Citicorp Venture Cap v. Comm Creditors
Precedential or Non-Precedential: Precedential

Docket 02-1815

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 PRECEDENTIAL

Filed March 19, 2003

UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT

Nos. 02-1815, 02-1905

CITICORP VENTURE CAPITAL, LTD., a New York
Corporation,
Appellant No. 02-1815
v.
COMMITTEE OF CREDITORS HOLDING UNSECURED
CLAIMS, AND COMMITTEE OF CREDITORS HOLDING
UNSECURED CLAIMS AS ESTATE REPRESENTATIVE OF
PAPERCRAFT CORPORATION

CITICORP VENTURE CAPITAL, LTD., a New York
Corporation,
v.
COMMITTEE OF CREDITORS HOLDING UNSECURED
CLAIMS, AND COMMITTEE OF CREDITORS HOLDING
UNSECURED CLAIMS AS ESTATE REPRESENTATIVE OF
PAPERCRAFT CORPORATION
Appellant No. 02-1905

APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE WESTERN DISTRICT OF PENNSYLVANIA
(D.C. No. 00-cv-02181)
District Judge: The Honorable Robert J. Cindrich
 2

Argued December 16, 2002
BEFORE: NYGAARD, ALITO, and RENDELL,
Circuit Judges.

(Filed March 19, 2003)

Lawrence J. Slattery, Esq. (Argued)
Morgan, Lewis & Bockius
101 Park Avenue
New York, NY 10178
Amy M. Tonti, Esq.
Reed Smith
435 Sixth Avenue
Pittsburgh, PA 15219
Counsel for Appellant/Cross
Appellee
Philip E. Beard, Esq.
Stonecipher, Cunningham, Beard
& Schmitt
125 First Avenue
Pittsburgh, PA 15222
Stephen M. Ray, Esq. (Argued)
Stutman, Treister & Glatt
3699 Wilshire Boulevard, Suite 900
Los Angeles, CA 90010
Counsel for Appellee/Cross
Appellant

OPINION OF THE COURT

NYGAARD, Circuit Judge:
This case arises out of the Chapter 11 filing of Papercraft
Corporation and the subsequent litigation. Here, in our
second review of determinations made by the Bankruptcy
Court and the District Court, we must assess justifications
for the subordination of several of Citicorp Venture
 3

Capital’s (“CVC”) claims, and we must evaluate the
accompanying calculations. First, CVC argues that the
District Court erroneously upheld the Bankruptcy Court’s
subordination of certain administrative costs and
professional fees. Second, CVC contends that the District
Court erroneously upheld the Bankruptcy Court’s
subordination of CVC’s claim by an additional amount
incurred during a delay in the plan process. Third, CVC
asserts that the finding that CVC made a profit on its note
purchases is error. Finally, in a cross appeal, the
Committee of Creditors Holding Unsecured Claims and
Committee of Creditors Holding Unsecured Claims as
Estate Representative of Papercraft Corporation (the
“Committee”) argues that the District Court erred in
reducing the Bankruptcy Court’s equitable subordination
remedy on account of lost interest income. We hold that the
“American Rule” should not be applied to the subordination
of the administrative and professional costs, and that the
District Court’s findings are not clearly erroneous. We will
affirm.

I. Background
In 1991, an informal committee of Papercraft creditors
and Papercraft agreed to a restructuring plan known as the
“BDK plan,” which was to be filed in conjunction with a
voluntary Chapter 11 petition. The creditors’ claims against
Papercraft would be converted into “BDK units,” consisting
of stock and bonds issued by the new venture, in
proportion to an estimated value of such units. Papercraft’s
directors, including CVC, approved the BDK plan, and the
Chapter 11 petition and the BDK plan were filed.
The Committee commenced litigation, alleging that CVC,
while an insider and fiduciary of Papercraft, attempted to
take control of Papercraft’s assets and reap significant
profit at the expense of other creditors by withdrawing its
support for the BDK plan and offering a competing plan,
secretly purchasing $60,849,299.10 in claims against
Papercraft for the discounted amount of $10,553,541.88,
and delaying confirmation of the original plan. The
Committee asserted that because CVC breached its
fiduciary duty to Papercraft and Papercraft’s creditors by
 4

engaging in such self-dealing, CVC’s claims should be
equitably subordinated pursuant to § 510(c) of the
Bankruptcy Code, 11 U.S.C. § 510(c).
The Bankruptcy Court issued an October 12, 1995,
Memorandum Opinion and Order, finding that CVC’s
purchases at a discount, without disclosure, while an
insider, constituted breaches of CVC’s fiduciary duty to
Papercraft and its creditors. In re Papercraft Corp., 187 B.R.
486, 498-99 (Bankr. W.D. Pa. 1995). The Bankruptcy Court
limited CVC’s allowed claim to the $10,553,541.88 price,
and held that further subordination of CVC’s claims
pursuant to the principles of equitable subordination
codified at 11 U.S.C. § 510(c) was not appropriate because
the Bankruptcy Court was already limiting CVC’s allowed
claim to the amount it paid for such claim. Id. at 501-02.
On appeal, the District Court affirmed the Bankruptcy
Court’s factual findings that CVC breached its fiduciary
duties, acted inequitably, caused injury to Papercraft and
its creditors and gained an unfair advantage. In re
Papercraft Corp., 211 B.R. 813 (W.D. Pa. 1997). However,
the District Court remanded the case to the Bankruptcy
Court for a further finding on the amount CVC’s claims
should be subordinated beyond the amount paid for such
claims, if at all, pursuant to the principles of equitable
subordination. Id. at 827. Both parties appealed.
We affirmed the District Court’s opinion, finding that
CVC violated its fiduciary duty in a number of significant
respects and that CVC’s misconduct caused harm justifying
subordination. In re Papercraft Corp., 160 F.3d 982, 988-90
(3d Cir. 1998). We explicitly stated that the findings of fact
“make this a paradigm of inequitable conduct by a fiduciary
as that concept has been developed in the case law, and we
believe that further elaboration is not required.” Id. at 987.
We explained that,
Further subordination may be appropriate, but only if
supported by findings that justify the remedy chosen
by reference to equitable principles. . . . While the
bankruptcy court held, with record support, that the
delay between the filing of the petition and the filing of
the disclosure statement was not attributable to CVC’s
 5

machinations, it made no similar finding with respect
to the period of delay between the filing of the
disclosure statement and confirmation of the BDK
plan. Moreover, while the bankruptcy court found “no
evidence that CVC engaged in conduct designed to
delay the plan process,” if CVC’s pursuit of its own
interest in fact resulted in delay of the confirmation, we
do not read that finding as inconsistent with
subordination based on injury resulting from that
delay. On remand, the bankruptcy court should
consider whether the record supports the proposition
that non-selling creditors suffered loss as a result of a
delay in confirmation caused by CVC advocacy of its
competing plan and objections to the BDK plan.
Id. at 991-92. Our mandate to the Bankruptcy Court was
clear: determine whether the record supports the additional
subordination of CVC’s claims.
On remand, the Bankruptcy Court found three kinds of
economic harm to non-selling noteholder creditors: (1) the
quantifiable monetary harm that resulted from the delay in
confirming the plan; (2) the harm that resulted from the
uncertainty over the amount of CVC’s claim distribution;
and (3) the harm that resulted from the delay in fully
implementing the confirmed 1991 plan that can be
measured by the professional fees and expenses of three
courts and five proceedings. In re Papercraft Corp., 247 B.R.
625, 628 (Bankr. W.D. Pa. Apr. 20, 2000). The Bankruptcy
Court held, therefore, that CVC’s recovery would be further
subordinated by (1) $1,248,000 for additional
administrative expenses incurred during the four-month
delay; (2) $956,250 for interest and dividends lost by
creditors during the delay; and (3) $2,974,373.15 for
professional fees and expenses incurred and/or paid by the
Estate or BDK through April 30, 2000.1 In re Papercraft
Corp., 253 B.R. 385, 390 (Bankr. W.D. Pa. Sep. 21, 2000).

1. The Bankruptcy Court also held that CVC’s recovery would be further
subordinated by $4,750 in United States Trustee fees incurred and/or
paid by the Papercraft bankruptcy estate from the date of confirmation
through May 2, 2000. 247 B.R. at 630.
 6

The District Court affirmed the Bankruptcy Court’s
decision, except that it reduced the lost interest income
component of the subordination from $956,250 to
$50,123.45. Memorandum Order at 36. CVC filed a timely
appeal.

II. Jurisdiction and Standard of Review
The District Court had subject matter jurisdiction over
the appeal below pursuant to 28 U.S.C. § 158(a) and
appellate jurisdiction in accordance with Local Bankruptcy
Appellate Rule 8007.1. We have jurisdiction pursuant to 28
U.S.C. §§ 158(d) and 1291.
We exercise plenary review over legal determinations of a
district court sitting as an appellate court in a bankruptcy
proceeding. Fellheimer, Eichen & Braverman, P.C. v. Charter
Techs., Inc., 57 F.3d 1215, 1223 (3d Cir. 1995). We may
only overturn factual findings, however, if they are “clearly
erroneous.” Id; Fed. R. Bankr. P. 8013. We must accept the
District Court’s factual findings “unless they are ‘completely
devoid of a credible evidentiary basis or bear[ ] no rational
relationship to the supporting data.’ ” Moody v. Security
Pac. Bus. Credit, Inc., 971 F.2d 1056, 1063 (3d Cir. 1992)
(citation omitted).

III. Discussion
First, CVC argues that the Bankruptcy Court violated the
American Rule by subordinating the attorneys’ fees. We
disagree.
The expression of the American Rule is found in Alyeska
Pipeline Service Co. v. Wilderness Soc’y, where the Supreme
Court explained that, “[i]n the United States, the prevailing
litigant is ordinarily not entitled to collect a reasonable
attorneys’ fee from the loser.” 421 U.S. 240, 247 (1975).
There are, however, numerous exceptions to this rule. An
element of all American Rule exceptions is a determination
that the litigant “prevailed” and should be awarded
attorneys’ fees. For example, 42 U.S.C. § 1988 was enacted
with the express intent of negating the effect of the Alyeska
decision in statutory civil rights cases. 1976 U.S.C.C.A.N.
 7

5908-09 (“[T]he purpose of this amendment is to remedy
anomalous gaps in our civil rights laws created by the
United States Supreme Court’s recent decision in Alyeska
Pipeline . . . .”). Under § 1988, a party must show it
“prevailed” in the underlying action.
The District Court affirmed the Bankruptcy Court’s
subordination of attorneys’ fees, explaining:
The Committee is not asking for the payment of
attorneys’ fees as such. The fees and expenses at issue
depleted funds that otherwise would have been
available to creditors but for CVC’s misconduct in
breaching its fiduciary duty. To ensure the distribution
creditors should have received absent CVC’s
misconduct, it is necessary to restore the Estate’s
funds ‘by subordinating CVC’s share of distribution by
the amount of fees and expenses incurred by
professionals who are to be paid from estate assets
that would not have been incurred but for CVC’s
breach of its fiduciary duty.’
In re Papercraft Corp., Memorandum Order *11 (W.D. Pa.
February 20, 2002). We agree with the District Court’s
logic.
In the exercise of its powers as a court of equity, the
bankruptcy court may subordinate claims for cause,
applying traditional principles of equitable subordination.
11 U.S.C. § 510(c); Pepper v. Litton, 308 U.S. 295, 307-11
(1939); Taylor v. Standard Gas & Elec. Co., 306 U.S. 307,
322 (1939); see also Comstock v. Group of Institutional
Investors, 335 U.S. 211, 229 (1948) (narrowing the
application of equitable subordination to situations in
which bad faith by the claimant is found). Although § 510(c)
codifies the doctrine of equitable subordination, it does not
detail the requirements of such subordination. Instead, it
merely states that the doctrine is to be applied “under the
principles of equitable subordination,” and the legislative
history states that Congress intended that the courts
develop these principles. 124 Cong. Rec. 32,398 (1978)
(statement of co-sponsor Rep. Edwards); 124 Cong. Rec.
33,998 (statement of co-sponsor Sen. DeConcini); Burden v.
United States, 917 F.2d 115, 118 (3d Cir. 1990).
 8

The doctrine of equitable subordination is remedial, and
the goal “ ‘is to undo or to offset any inequality in the claim
position of a creditor that will produce injustice or
unfairness to other creditors in terms of the bankruptcy
results.’ ” Burden, 917 F.2d at 117 (citation omitted); see
also In re Papercraft Corp., 160 F.3d 982, 991 (3d Cir.
1998) (stating that the purpose of equitable subordination
is “to compensate in a manner that will permit a . . .
remedy to the injury that has been suffered by those
[creditors] who will benefit from the subordination”). “ ‘[T]he
bankruptcy court has the power to sift the circumstances
surrounding any claim to see that injustice or unfairness is
not done in the administration of the bankrupt estate.’ ”
Burden, 917 F.2d at 117 (quoting Pepper, 308 U.S. at 307-
08). The inequitable conduct may arise out of any unfair
act by the creditor as long as the conduct affects the
bankruptcy results of the other creditors. Matter of Mobile
Steel Co., 563 F.2d 692, 700 (5th Cir. 1997). Because
equitable subordination is remedial rather than penal, a
claim should be equitably subordinated only to the extent
necessary to offset the harm suffered by the debtor and its
creditors as a result of the inequitable conduct. Mobile
Steel, 563 F.2d at 701. A New York bankruptcy court has
eloquently stated:
The remedy of equitable subordination must remain
sufficiently flexible to deal with manifest injustice
resulting from the violation of the rules of fair play
. . . . ‘where ingenuity spawns unprecedented vagaries
of unfairness, [bankruptcy courts] should not decline
to recognize their marks, nor hesitate to turn the
twilight for [offending claimants] into a new dawn for
other creditors.’
In re Teltronics Servs., Inc., 29 B.R. 139, 172 (Bankr.
E.D.N.Y. 1983) (citations omitted). We hold that because
the Bankruptcy Court subordinated attorneys’ fees
pursuant to its equitable powers, the American Rule is not
implicated. The Bankruptcy Court did not award a money
judgment for attorneys’ fees to penalize CVC. Rather, the
Bankruptcy Court analyzed the record facts, found specific
damages, and used its equitable powers to return the non-
selling creditors to the position they would have been in
had CVC not acted inequitably.
 9

We directed the Bankruptcy Court to make findings as to
the amount of CVC’s claims that should be subordinated
pursuant to the principles of equitable subordination, and
to identify specific harm resulting from CVC’s wrongdoing.
In re Papercraft Corp., 160 F.3d at 991. The Bankruptcy
Court did so, and concluded that CVC’s inequitable
conduct justifies subordination of attorneys’ fees. We hold
that the finding is not clearly erroneous.
At trial, the Bankruptcy Court stated that “none of these
litigation costs would have been incurred” but for CVC’s
inequitable conduct, 5 app. at 1364, and that “some
reasonable litigation costs may actually be a direct
consequence of CVC’s activities in this case.” 5 app. at
1365. The Bankruptcy Court found that, but for CVC’s
inequitable conduct, the Committee would not have
incurred such substantial fees and costs. In re Papercraft
Corp., 247 B.R. at 628; 28 app. at 8004-05. The
Bankruptcy Court analyzed the depletion of available funds
in the reorganized entity, and determined that the economic
harm is directly attributable to CVC’s inequitable actions.
In re Papercraft Corp., 247 B.R. at 628; 29 app. 8326. The
Bankruptcy Court also found that the fees and costs
related to the litigation were a “third type of economic harm
caused by CVC’s undisclosed claims purchasing.” In re
Papercraft Corp., 247 B.R. at 631. The amount of attorneys’
fees does not include all litigation costs of the Committee.
Rather, more than $700,000 is deducted from the
attorneys’ fee award for fees and costs that are unrelated to
CVC’s inequitable conduct. 29 app. 8211-48.
CVC’s inequitable conduct includes repeatedly litigating
issues that were decided against it by our earlier decision,
as well as earlier decisions of the District Court and the
Bankruptcy Court. For example, in this case, CVC has
incessantly relitigated the issue of whether it profited from
its illegal claims trading, even though this issue had
already been decided against it in the District Court, and
reviewed by us. In re Papercraft Corp., 165 B.R. 980, 983-
84 (Bankr. W.D. Pa. 1994); In re Papercraft Corp., 187 B.R.
486, 492, 498-99 (Bankr. W.D. Pa. 1995); In re Papercraft
Corp., 211 B.R. 813, 825 n.12 (W.D. Pa. 1997); In re
Papercraft Corp., 160 F.3d 982, 990-91 (3d Cir. 1998). Also,
 10

in the briefs filed with the Bankruptcy Court on remand, 29
app. 8133-87, CVC attempted to relitigate that it did not
usurp a corporate opportunity, even though all three courts
had already found against CVC on this issue in previous In
re Papercraft Corp. decisions. 160 F.3d at 987-88; 211 B.R.
at 820, 824-26; 187 B.R. at 498-99. Finally, CVC’s
collateral proceedings, for which CVC only had standing
because it illegally purchased claims against Papercraft,
were aimed at preventing the reorganized debtor from
engaging in a value-enhancing sale transaction, and
depleted monies that would have otherwise been available
to the creditors. 29 app. 8216-17, 8245-46.
The Bankruptcy Court also determined that the
testimony of CVC’s representatives during the litigation was
not credible. In re Papercraft, 187 B.R. at 493 n.3 (finding
that all other credible testimony and evidence shows that
the testimony of CVC’s Saleem Muqaddam is false); id. at
497 (dismissing the testimony of CVC’s William Comfort,
which contradicted other evidence); id. (disbelieving
testimony of Muqaddam). Each of these instances of
inequitable conduct resulted in legal fees and costs that
decreased the funds available the non-selling creditors.
The Bankruptcy Court spent a substantial amount of
time and effort considering the narrow issue of whether to
include the professional fees and expenses in the
subordination, 28 app. 8004-05; 29 app. 8288-335, and
ruled on the issue in two written opinions. In re Papercraft
Corp., 247 B.R. at 631; In re Papercraft Corp., 253 B.R. at
387-90. We conclude that the Bankruptcy Court found
facts sufficient to establish the egregious conduct
warranting subordination of CVC’s claims, and those facts
are not clearly erroneous. Although the pursuit of one’s
legal rights may not be grounds for equitable
subordination, protracted and unjustified litigation tactics
that harm the estate by causing it to incur fees may justify
subordination. The Bankruptcy Court has been involved in
overseeing this litigation for a decade and has had the best
opportunity to observe first hand CVC’s conduct and
evaluate its motives. We are hard-pressed to disagree with
its determinations based on the extensive record and
proceedings before it, and its obvious familiarity with what
we previously termed CVC’s “machinations.”
 11

We reject CVC’s other two arguments, as well as the
Committee’s argument on cross-appeal.
First, we conclude that the District Court did not err by
holding that CVC was responsible for all fees incurred
during a delay in the plan process. In our previous
decision, we indicated that CVC’s actions could have led to
the delay in the BDK Plan’s confirmation:
Without limiting the inquiry of the bankruptcy court in
any way, we note that there is evidence which would
support a finding that the non-selling Papercraft
creditors suffered injury from CVC’s attempt to control
the reorganization. . . . [I]f CVC’s pursuit of its own
interest in fact resulted in delay in the confirmation,
we do not read that finding as inconsistent with
subordination based on injury resulting from that
delay.
In re Papercraft, 160 F.3d at 991-92. The Bankruptcy Court
evaluated the evidence, and found ample support to
establish that CVC’s conduct delayed the plan process by at
least four months, and that CVC’s intent was to benefit
itself over and above other creditors to whom it owed a
fiduciary duty not to self-deal. In re Papercraft, 247 B.R. at
628. We have determined that the Bankruptcy Court’s
findings are not clear error.
Second, we conclude that the District Court did not err
by affirming the Bankruptcy Court’s calculation of CVC’s
profit. CVC argues that because it could only have realized
a profit on the claim purchases if the cash equivalent of the
BDK Units that it could receive under the BDK Plan
exceeded the $10.5 million that CVC paid for the claims,
the calculation must be the fair market value of those BDK
Units. More than sufficient evidence demonstrates that the
Bankruptcy Court did not err by valuing CVC’s profit based
on the reorganization value at the time of the BDK Plan
confirmation. All of the creditors, including CVC, were to
receive BDK Units on an equal basis, determined by their
proportional share of interests in the reorganized entity,
and we uphold the District Court’s affirmation of the
Bankruptcy Court’s calculations.
 12

Finally, the Committee argues that the District Court
erred by reducing the subordination on account of lost
interest income from $956,250 to $50,123. This argument
is meritless. Because there was a four-month delay in the
issuance of the debt securities, the Bankruptcy Court came
to the $965,250 figure by multiplying the $239,062 in
monthly interest on all the debt securities by four. The
District Court correctly noted that the securities were ten-
year notes, which would provide the Committee ten years of
interest regardless of when they were issued. Mem. Order
(Feb. 20, 2002), at 24-25. We therefore conclude that the
District Court did not err by calculating the lost interest by
a four-month delay of the ten years of interest.
For the foregoing reasons, we will affirm the judgment of
the District Court.

A True Copy:
Teste:

Clerk of the United States Court of Appeals
for the Third Circuit