Dionne v. Muscarella

United States Court of Appeals,

Eleventh Circuit.

Nos. 96-6845, 96-6846.

In Re: XYZ OPTIONS, INC., Debtor.

Donald DIONNE, as Trustee of the Estate of XYZ Options, Inc., Plaintiff-Appellant,

v.

W. Leo KEATING, Defendant-Appellee.

In Re: XYZ OPTIONS, INC., Debtor.

Donald DIONNE, as Trustee of the Estate of XYZ Options, Inc., Plaintiff-Appellant,

v.

Scott M. SPANGLER, Jean G. Spangler, The Scott M. Spangler Charitable Trust, Defendants-
Appellees.

Sept. 15, 1998.

Appeals from the United States District Court for the Northern District of Alabama. (No. CV-95-
AR-329-W), William M. Acker, Jr., Judge.

Before ANDERSON and BLACK, Circuit Judges, and MOORE*, Senior District Judge.

ANDERSON, Circuit Judge:

We must determine in this appeal whether a bankruptcy court can look behind a prior consent

judgment and whether there are genuine issues of material fact with respect to actual or constructive

fraud against creditors. Plaintiff-Appellant Donald Dionne ("Trustee") is the trustee for the

bankruptcy estate of XYZ Options, Inc. ("XYZ"). The Trustee sued Defendants-Appellees, Scott

M. Spangler, Jean G. Spangler, and the Scott M. Spangler Charitable Remainder Unitrust ("Spangler

*
Honorable John H. Moore, II, Senior U.S. District Judge for the Middle District of Florida,
sitting by designation.
entities"),1 asserting fraudulent transfer and preference claims under 11 U.S.C. §§ 547 and 548.2 The

United States District Court for the Northern District of Alabama removed the case from the

Bankruptcy Court pursuant to 28 U.S.C. § 157(d).

The Spanglers filed a Motion for Partial Summary Judgment. Defendant W. Leo Keating

("Keating") also filed a Motion for Summary Judgment. In separate orders, the district court granted

summary judgment in part in favor of the Spangler entities and Keating. The district court entered

final judgment pursuant to Fed.R.Civ.P. 54(b). The Trustee filed a timely Notice of Appeal as to

both orders of summary judgment.

I. THE RELEVANT FACTS AND COURSE OF PROCEEDINGS3

The Debtor, XYZ, was owned by William Muscarella and Richard Kendrick.4 In 1988, XYZ

entered into a contract with Machinery Trade Company ("Machinery Trade"), whereby XYZ agreed

to build a plant in Iraq to manufacture carbide cutting tools. The total amount of the contract price

was approximately $14,000,000. In order to secure payment and XYZ's performance, the contract

required both Machinery Trade and XYZ to post letters of credit in favor of each other. The contract

required Machinery Trade to pay a down payment of approximately $1,400,000 and post a letter of

credit in an amount equal to the amount due XYZ under the contract. The contract also required that

1
See infra n.5, noting that our use of the name, the Spangler entities, also sometimes includes
First Phoenix Capital, a corporation controlled by Scott Spangler.
2
Although Defendant-Appellee W. Leo Keating was not named in the initial complaint of
April 28, 1994, he was named as a defendant in a later amended and restated complaint.
3
In the summary judgment posture of this case, we state the facts with reasonable inferences
drawn in favor of Appellant.
4
In July of 1993, Richard Kendrick died and his wife was named executrix of his estate.
Before the major transfers involved in this case, his interest in XYZ was conveyed to
Muscarella.

2
XYZ post two letters of credit: one letter as a performance bond for approximately $400,000 and

another letter of approximately $1,400,000 to ensure that Machinery Trade could recover the down

payment in the event of a default by XYZ.

Muscarella and Kendrick, however, were unable to come up with the required letters of

credit because of insufficient assets. They wanted to use the down payment due them from

Machinery Trade as collateral, but they could not do so because the letters of credit were a

prerequisite to their receipt of this money. In search of financial assistance, XYZ approached Scott

M. Spangler, the principal of First Phoenix Capital ("First Phoenix"), for help.5 First Phoenix and

XYZ reached an agreement ("joint agreement") whereby First Phoenix agreed to arrange financing

for the two letters of credit and lend XYZ $400,000 in working capital for the project. XYZ agreed

to repay First Phoenix for any draws made on the letters of credit and signed a note for the amount

of the letters of credit plus the working capital loan. The joint agreement also provided that XYZ

would use funds received from the Machinery Trade contract to collateralize the letters of credit and

eventually remove First Phoenix from the deal. In addition, the transaction provided a base fee of

$400,000, payable to First Phoenix, which could increase or decrease depending upon how quickly

XYZ could collateralize the letters of credit issued in favor of Machinery Trade.

Machinery Trade caused the issuance of its letter of credit which was confirmed by Banco

Nazionale del Lavoro ("BNL"). First Phoenix obtained both of its letters of credit through Northern

Trust Bank of Arizona ("Northern Trust"), with Bank of America International as the originating

5
Because Scott Spangler controlled First Phoenix during the relevant times, we include First
Phoenix in our reference in the opinion to the Spangler entities.

3
bank. These two letters of credit in favor of Machinery Trade were posted to Rafidain Bank in Iraq.

Spangler signed two promissory notes in order to secure the two Northern Trust letters of credit.

Pursuant to the joint agreement with First Phoenix, a closing was held in Texas in October

1988. To secure payment of its note to First Phoenix, XYZ executed an assignment which assigned

to First Phoenix the proceeds of the BNL letter of credit. Muscarella brought the BNL letter of

credit to this meeting in Texas. While Muscarella laid the letter of credit down on the table,

Spangler did not take physical possession of it. Apparently, it was the understanding of the parties

that XYZ would retain possession of the BNL letter of credit in order to make credit arrangements

with suppliers and shippers.6

In November 1988, following the issuance of the required letters of credit, Machinery Trade

paid to XYZ the down payment of approximately $1,400,000. After the down payment money was

deposited into the joint account of First Phoenix and XYZ, Spangler directed Northern Trust to

remove $1,000,000 from the joint account to open a certificate of deposit in the names of First

Phoenix and XYZ. First Phoenix then released the remaining $400,000 from the down payment for

XYZ's use as working capital.

Three months after receipt of the down payment, Spangler sought a release of the personal

assets he had pledged to Northern Trust to secure the two letters of credit in favor of Machinery

Trade. In order to do this, First Phoenix and XYZ executed a Third Party Security Agreement

granting Northern Trust a security interest in the $1,000,000 certificate of deposit. In addition, XYZ

6
The question of when and whether First Phoenix held a security interest in the BNL letter of
credit is the subject of a companion case, No. 96-7035. The opinion in that case is published
simultaneously with this opinion. In November 1993, First Phoenix took possession of the letter
of credit and perfected a security interest in the letter of credit.

4
signed a Loan Agreement providing that Northern Trust would first liquidate the $1,000,000

certificate of deposit to satisfy any liability under the letters of credit before turning to Spangler.

As a result, Northern Trust released its security interest in Spangler's personal assets.

Performance on the construction project began in early 1989, and Machinery Trade made

regular progress payments through the BNL letter of credit. Pursuant to the contract, XYZ would

submit a draw to BNL requesting payment for work performed or materials shipped to Iraq. BNL

would fund the draw directly to the joint account of First Phoenix and XYZ at Northern Trust.

In the fall of 1989, Spangler discovered that Muscarella, through a business entity named

TRU-MET, had acquired ownership of Carbitech, a subcontractor on the Iraqi contract, using money

XYZ received from the contract with Machinery Trade. As part of the venture, Muscarella caused

XYZ to guarantee TRU-MET's payment of the purchase price. Contending that this activity violated

the terms of the joint agreement, Spangler had his attorney draft a Waiver & Assignment, which

Muscarella and Kendrick signed. Pursuant to the Waiver & Agreement, First Phoenix agreed to

waive the breach, and XYZ agreed to assign and transfer a certain interest in the $1,000,000

certificate of deposit to First Phoenix. The Waiver & Agreement gave First Phoenix permission to

use the proceeds of the certificate of deposit under specified conditions, but XYZ retained a residual

interest in the certificate of deposit.

In November 1989, BNL stopped making payments to XYZ and filed a declaratory judgment

action in federal court in Atlanta stating that it was no longer liable under the BNL letter of credit.

XYZ counterclaimed asserting that BNL had breached the terms of the BNL letter of credit by

5
refusing to honor XYZ's draws.7 Because XYZ had assigned to First Phoenix an interest in the BNL

letter of credit, First Phoenix filed a notice of interest and moved to intervene in the action.

On August 2, 1990, Iraq invaded Kuwait. On that same day, Rafidain Bank made a pay or

extend demand to Bank of America International in connection with the two Northern Trust letters

of credit in favor of Machinery Trade; Bank of America International made a similar demand on

Northern Trust. In August 1990, XYZ and First Phoenix filed suit in Houston, Texas to enjoin Bank

of America International and Northern Trust from releasing funds to Rafidain Bank. XYZ and First

Phoenix succeeded in obtaining a preliminary injunction preventing Rafidain from drawing against

Bank of America International and Bank of America International from drawing on the Northern

Trust letters of credit.

With the contract between Machinery Trade and XYZ at an impasse, XYZ was without a

source of income and had difficulty meeting its financial obligations. Accordingly, TRU-MET was

unable to make payments on the purchase of Carbitech's stock. The sellers of the Carbitech stock

called on XYZ's guarantee and eventually filed suit in Indiana. In April 1992, the former Carbitech

shareholders obtained a default judgment of approximately $1,700,000 against XYZ.

On January 4, 1993, XYZ filed a cross-claim against First Phoenix in the Houston litigation,

alleging that the joint venture agreement was usurious, and claiming ownership of the certificate of

deposit. First Phoenix, in defense, asserted that the money due under the joint venture agreement

was a profit and not interest and, as a result, Texas usury law did not apply.

7
After BNL refused to make payment on the letter of credit, XYZ and Machinery Trade
arranged for XYZ to receive payments through the Iraqi embassy in Washington, D.C.. XYZ
received over $3,000,000 through this embassy.

6
 Largely in response to the cross-claim in Houston, First Phoenix filed suit in federal court

in Phoenix, Arizona against XYZ seeking a declaratory judgment to have the court determine that

the payments due under the joint agreement were not usurious but were in fact a joint venture profit.

First Phoenix also sought a money judgment of $966,000 for this joint venture profit and expenses

incurred by First Phoenix.

On July 21, 1993, the district court in the Atlanta litigation entered a Memorandum Opinion

finding in favor of XYZ against BNL in an amount exceeding $2,000,000. XYZ filed a motion to

amend the judgment to add pre-judgment interest. That motion remained pending for several

months.

In November 1993, XYZ and the Spangler entities met to discuss settlement. Spangler wrote

out an outline of a deal and faxed it to XYZ's attorney. This draft of the deal provided that the

Spangler entities would receive $1,200,000, which would come out of the expected judgment against

BNL in the Atlanta litigation. However, the parties met again a few days later. For reasons that are

not adequately explained in the record evidence, the parties finally agreed to settle upon terms much

more favorable to the Spangler entities.

In implementing the settlement agreement, the parties entered into a consent judgment in the

Arizona litigation in favor of the Spangler entities and against XYZ. The judgment was in an amount

of approximately $2,300,000, including interest.8 The amount of the Arizona consent judgment was

virtually identical to the amount (net after attorneys' fees) which XYZ would receive from the

judgment against BNL in the Atlanta litigation. Pursuant to the settlement, this $2,300,000 was

transferred to the Spangler entities in satisfaction of the Arizona consent judgment. The subsequent

8
In this opinion, we refer to this as the Arizona consent judgment.

7
implementation of the settlement agreement was somewhat different from the settlement agreement,

and was extremely complicated, complex, and convoluted.

A fact finder could reasonably conclude from this summary judgment record that after full

implementation of the settlement agreement, XYZ was left with virtually no assets, having given

up the following assets: (a) the approximately $2,300,000 that it netted after attorneys' fees from

the judgment against BNL in the Atlanta litigation; (b) XYZ's remaining interest in the $1,000,000

certificate of deposit; (c) real estate which it had owned, subject to a bank mortgage; and (d) a

usury claim against the Spangler entities which it had been asserting in the Houston litigation and

the Arizona litigation, both of which were settled as part of the settlement agreement.

Questions of fact surround the Arizona consent judgment entered into by the parties in favor

of the Spangler entities in an amount of approximately $2,300,000. The fact finder could reasonably

find that the full $2,300,000 did not in fact go to the Spangler entities, but rather that $550,000 went

to either a corporation controlled by Muscarella's mother or to the benefit of Muscarella's business

interests.9 In addition, a fact finder could reasonably find that the $1,000,000 certificate of deposit

(subject to any lien of Northern Trust) also ended up in the possession of a corporation owned by

Muscarella's mother. The record does not adequately explain why Muscarella, or friends or family

of Muscarella, were permitted to receive any of the assets.

9
It is clear that the Spangler entities ended up with $1,500,000 in the Scott M. Spangler
Charitable Remainder Unitrust. There are issues of fact with respect to part or all of another
$250,000. But what is significant for this opinion is that the fact finder might reasonably find
that the Spangler entities ended up with at least $550,000 less than the full $2,300,000, and that
this $550,000 was diverted to a corporation owned by Muscarella's mother or to persons or
organizations benefitting Muscarella personally, to the exclusion of XYZ's creditors. There is
evidence that the $550,000 passed through Keating's possession, and that Keating retained
approximately $10,000.

8
II. ISSUES

We first address whether the district court sitting in bankruptcy can entertain the Trustee's

challenge to the Arizona consent judgment. This is a legal issue which we review de novo.

Next, we address the issues of actual and constructive fraud. Under 11 U.S.C. § 548, there

are two types of fraudulent transfer claims: actual fraud and constructive fraud. We address each

in turn, first the issue of actual fraud and then the issue of constructive fraud. In the summary

judgment posture of this case, summary judgment is appropriate when evidence in the summary

judgment record gives rise to no genuine issue of material fact and the moving party is entitled to

judgment as a matter of law. We review the district court's grant of summary judgment de novo and

apply the same standards as the district court.

Finally, we address the district court's granting of Keating's motion for summary judgment.

III. DISCUSSION

A. THE ARIZONA CONSENT JUDGMENT

The primary transfer challenged by the Trustee's fraudulent transfer claim is the $2,300,000

which XYZ transferred to the Spangler entities in satisfaction of the Arizona consent judgment in

federal court. The Spangler entities argue that this transfer is shielded by the Arizona consent

judgment in favor of the Spangler entities and against XYZ. In other words, they argue that a

bankruptcy court is powerless to look behind the Arizona consent judgment. The district court

rejected this argument of the Spangler entities, as do we.

In Pepper v. Litton, 308 U.S. 295, 60 S.Ct. 238, 84 L.Ed. 281 (1939), the Supreme Court

rejected a claim of res judicata and sustained the power of a bankruptcy court to look behind a

9
previous state court judgment. Emphasizing the broad equitable powers of bankruptcy courts, the

Court stated:

[A] bankruptcy court has full power to inquire into the validity of any claim asserted against
the estate and to disallow it if it is ascertained to be without lawful existence. And the mere
fact that a claim has been reduced to judgment does not prevent such an inquiry. As the
merger of a claim into a judgment does not change its nature so far as provability is
concerned, so the court may look behind the judgment to determine the essential nature of
the liability for purposes of proof and allowance.... And the bankruptcy trustee may
collaterally attack a judgment offered as a claim against the estate for the purpose of showing
that it was obtained by collusion of the parties....

Id. at 305-06, 60 S.Ct. at 244-45 (citations omitted). In that case, Litton, the controlling stockholder

of the bankrupt corporation, caused the bankrupt to confess judgment in favor of Litton, thus giving

Litton a judgment lien against the bankrupt for amounts alleged to have been for past unpaid salary.

Id. at 297, 60 S.Ct. at 240. The bankruptcy court found "a planned and fraudulent scheme," id. at

312, 60 S.Ct. at 248, and found that the lien (or confessed judgment) and subsequent transfer of

property to Litton pursuant thereto were but steps "in a general fraudulent plan ... designed to defeat

creditors." Id. The effect of the Supreme Court's holding in Pepper v. Litton affirmed the power of

the bankruptcy court to look behind the consent judgment which Litton had caused his corporation

to confess in his own favor under the circumstances there, which included "collusion of the parties."

Id. at 306, 60 S.Ct. at 245.10

10
In Pepper v. Litton, the consent judgment referred to in the text above was entered into in
state court before the bankruptcy, and the trustee in bankruptcy was obviously not a party. The
Court in Pepper v. Litton also focused on subsequent litigation, in which the trustee in
bankruptcy himself became a party in a subsequent phase of the state court litigation, i.e., when
the trustee in bankruptcy later moved in state court to set aside the Litton consent judgment.
Pepper, 308 U.S. at 299, 60 S.Ct. at 241. Even though the trustee in bankruptcy had himself
attempted to set aside the Litton consent judgment in the state court, the Supreme Court rejected
the claim of res judicata. However, that holding must be viewed in light of Heiser v. Woodruff,
327 U.S. 726, 66 S.Ct. 853, 90 L.Ed. 970 (1946), in which the Court held generally that res
judicata applies in bankruptcy proceedings. In Heiser, the trustee in bankruptcy had himself

10
 The Second Circuit, in Margolis v. Nazareth Fair Grounds & Farmers Mkt., 249 F.2d 221

(2d Cir.1957), followed the foregoing rule of Pepper v. Litton and held that the broad equity powers

of a bankruptcy court empowered it to look behind a previous judgment to determine the essential

nature of the liability and to disregard such a judgment if obtained by collusion. Margolis, 249 F.2d

at 223-24 (following and quoting from Pepper v. Litton ). Under the circumstances of that case,

which were similar to Pepper v. Litton, the Second Circuit rejected the res judicata defense. Id. at

224. See Coleman v. Alcock, 272 F.2d 618 (5th Cir.1959)11 (rejecting a res judicata defense to a

fraudulent transfer claim of a trustee in bankruptcy and holding that the trustee was not bound by

a previous state court judgment merely because the bankrupt was a party, thus implying that the

trustee could challenge the previous judgment); see also Kelleran v. Andrijevic, 825 F.2d 692, 694

been a party in the previous litigation culminating in the previous judgment claimed to be res
judicata. In that previous litigation to which the trustee in bankruptcy was a party, the claim of
fraud was presented by the trustee to set aside the prior judgment, id. at 730, 66 S.Ct. at 855, and
was "fully heard, and the contested issue ... decided against him." Id. at 733, 66 S.Ct. at 856.
Recognizing that the trustee in bankruptcy in Pepper v. Litton had also moved in state court to
set aside the Litton judgment, and that the Pepper v. Litton court had nevertheless rejected res
judicata, the Court in Heiser distinguished Pepper v. Litton, pointing out that in Pepper v. Litton
"the issue which the bankruptcy court later considered was not an issue in the trial of the cause in
the state court and could not be adjudicated there." Heiser, 327 U.S. at 738-39 n. *, 66 S.Ct. at
858-59 n. *.

Thus, there were two holdings in Pepper v. Litton. The holding with respect to
the subsequent state court litigation to which the trustee was a party has been clarified by
Heiser, as explained in this footnote. On the other hand, nothing in Heiser undermines
the Pepper v. Litton holding with respect to the original Litton consent judgment to
which the trustee was not a party. This is the holding to which we refer in this opinion as
the rule of Pepper v. Litton. Later in this opinion, we explain more fully why Heiser
does not undermine this holding.
11
In Bonner v. City of Prichard, 661 F.2d 1206 (11th Cir.1981) (en banc), this court adopted
as binding precedent all of the decisions of the former Fifth Circuit handed down prior to the
close of business on September 30, 1981. Id. at 1209.

11
(2d Cir.1987) (stating that "[b]ankruptcy courts may look beyond a state court default judgment

where the judgment was procured by collusion or fraud"); In re Beck-Rumbaugh Assoc., Inc., 103

B.R. 628, 633-34 (Bankr.E.D.Pa.1989) (finding that, in light of Pepper v. Litton and its progeny, the

bankruptcy court could look behind a state court consent judgment that was entered into collusively

so as to deprive another creditor of its lawful stake in the proceeds of the debtor); In re Fill, 82 B.R.

200, 217-18 (citing Pepper v. Litton and holding that the bankruptcy court was not precluded from

setting aside the judgment because of res judicata, and further noting that the judgment was

"collusive and laced with fraud") (Bankr.S.D.N.Y.1987). The instant case fits comfortably within

the rule of Pepper v. Litton and its progeny. As we discuss below in this opinion, there is ample

evidence in this summary judgment record giving rise to genuine issues of fact with respect to

whether the Arizona consent judgment was taken as part of a scheme of fraud and collusion not only

on the part of XYZ and Muscarella, but also on the part of the Spangler entities. Following the rule

of Pepper v. Litton and its progeny, we hold that the district court in this case, sitting in bankruptcy,

properly entertained the Trustee's challenge to the Arizona consent judgment.12

Our holding in this regard is explained not only by the foregoing precedent, but also by the

following reasoning. The Arizona consent judgment was not binding upon the Trustee. The Trustee

represents the rights of the creditors of XYZ who were not parties to the Arizona consent judgment

and whose interests were not represented by XYZ, which was a party to that judgment.13 With

12
With respect to this issue, the parties have not argued that the law of any state should
govern, and have cited only federal cases. Having litigated the issue as a matter of federal law
and having presented no choice of law issue to this court, we accept the implied concession that
federal law governs. We note also that the Arizona consent judgment was in a federal court.
13
Indeed, as discussed below, the summary judgment evidence creates a genuine issue of fact
with respect to whether XYZ was intending to hinder, delay, or defraud the very creditors that

12
respect to the Arizona consent judgment, the Trustee was not in privity with XYZ. See Fill, 82 B.R.

at 217. In circumstances somewhat similar to those in the instant case, the former Fifth Circuit in

Coleman v. Alcock, supra, held that a trustee in bankruptcy is not bound, either by res judicata or

collateral estoppel, by an in personam judgment in prior litigation in which the bankrupt was a party.

The court held:

[W]e are of the view that the Trustee is not bound, either on res judicata or judicial collateral
estoppel, by the prior state court proceedings. The Trustee is, of course, a successor of the
Bankrupt for many purposes. But he is much more both in the extraordinary rights with
which the Bankruptcy Act invests him, and as a general representative of the creditors.
Unless he intervenes and takes on the role of an active litigant subjecting himself thereby to
the usual incidents of such action, he is not bound by the judgment merely because the
Bankrupt was a party defendant in the prior litigation.

Coleman, 272 F.2d at 621-22 (footnote omitted). The decision in Coleman does not elaborate on

the circumstances under which the trustee in bankruptcy will be deemed not to be in privity with the

debtor, and thus not bound by a prior judgment involving the debtor. Nor need we elaborate in the

instant case beyond the circumstances here. As will be demonstrated in the discussion below, the

fact finder in the instant case could reasonably find that the Arizona consent judgment was part of

a collusive scheme on the part of XYZ and the Spangler entities to hinder, delay, or defraud

creditors. Thus, we need hold in the instant case, and we do hold, only that the Trustee in

bankruptcy would not be in privity with XYZ, with respect to the Arizona consent judgment, where

that judgment was obtained as part of a collusive scheme on the part of XYZ and the Spangler

entities to hinder, delay, or defraud creditors.

This holding is consistent with Heiser v. Woodruff, 327 U.S. 726, 66 S.Ct. 853, 90 L.Ed. 970

(1946), in which the Supreme Court clarified its prior decision in Pepper v. Litton. After holding

the Trustee represents.

13
generally that res judicata is applicable in bankruptcy proceedings, the Court discussed Pepper v.

Litton and said:

Undoubtedly, since the bankruptcy act authorizes a proof of claim based on a judgment, such
a proof may be assailed in the bankruptcy court on the ground that the purported judgment
is not a judgment because of want of jurisdiction of the court which rendered it over the
persons of the parties or the subject matter of the suit or because it was procured by fraud
of a party. Pepper v. Litton, supra, 308 U.S. at 306, 60 S.Ct. at 245, 84 L.Ed. 281; Chandler
v. Thompson, 120 F. 940 (7th Cir.1902); In re Continental Engine Co., 234 F. 58 (7th
Cir.1916); In re Stucky Trucking & Rigging Co., 243 F. 287 (D.N.J. 1917); In re Rubin, 24
F.2d 289 (7th Cir.1928).

327 U.S. at 736, 66 S.Ct. at 857-58. Thus, Heiser recognized and reaffirmed the rule of Pepper v.

Litton, as described earlier in this opinion14—that res judicata does not preclude a bankruptcy court

from looking behind even a claim which has been reduced to a judgment against the bankrupt where

"the purported judgment is not a judgment ... because it was procured by fraud...." Heiser, 327 U.S.

at 736, 66 S.Ct. at 858. Where a prior judgment against the bankrupt was procured as part of a

collusive scheme to hinder, delay, or defraud creditors, as in Pepper v. Litton and as the fact finder

might find in the instant case, res judicata does not preclude inquiry by the bankruptcy court. This

reading of Heiser is reinforced by the other cases which Heiser cites for this proposition. For

example, in Chandler v. Thompson, 120 F. 940 (7th Cir.1902), the court rejected a claim of res

judicata under circumstances indistinguishable from the instant case. There, appellee had obtained

a consent judgment against the bankrupt before the bankruptcy. After bankruptcy, appellee filed a

claim against the bankrupt estate based on the consent judgment. Another judgment creditor and

the trustee in bankruptcy objected to appellee's claim; in defense, appellee argued that res judicata

14
See supra n. 10.

14
precluded the bankruptcy court from impeaching the prior consent judgment. In rejecting appellee's

argument, the Seventh Circuit held:

The averments, in the petition, of fraud and collusion are inartistically drawn. They show
in substance, however, that no real debt underlay the judgments, but that the judgments were
entered in pursuance of a scheme (to which both judgment creditor and judgment debtor
were parties) to hinder, delay, and defraud certain claimants, in the collection of claims
pending against [the bankrupt].

The case, thus presented, is not that of an attack collaterally upon the judgments by the
parties thereto, or their privies. It is the case of an attack by the trustee of third persons,
strangers to the judgment, whose rights and interests would be injuriously affected, if the
judgments were allowed to stand proved as claims. As to such persons, a judgment procured
through the collusion of the parties thereto, and founded upon no real debt, is to be treated
as void, and open to collateral attack....

Chandler, 120 F. at 941. To the same effect, see In re Continental Engine Co., 234 F. 58 (7th

Cir.1916); In re Stucky Trucking & Rigging Co., 243 F. 287 (D.C.N.J.1917).15

15
Although some subsequent cases have narrowly construed the passage in Heiser which
acknowledges that bankruptcy courts have the power to look behind a previous judgment where
the judgment was procured by fraud, none of those cases have involved a prior judgment
obtained as part of a collusive scheme to hinder, delay, or defraud creditors. Because the very
cases cited by Heiser—Pepper v. Litton, Chandler v. Thompson, In re Continental Engine Co.,
and In re Stucky Trucking & Rigging Co.—affirmed the authority of a bankruptcy court to look
behind a prior judgment obtained as part of a collusive scheme to hinder, delay, or defraud
creditors, we are confident that the fraudulently procured judgment contemplated by Heiser
includes fraud of such nature, and therefore includes the fraud in the instant case. Moreover, the
fraud in the instant case fits comfortably within the description of the necessary fraud in one of
the leading cases amongst the progeny of Heiser. In Browning v. Navarro, 826 F.2d 335 (5th
Cir.1987), the Fifth Circuit discussed Heiser and the circumstances which would warrant
disregarding res judicata. The court stated:

[The party challenging the prior judgment] must demonstrate that the judgment
was obtained as the result of a scheme or collusion that is designed to influence
corruptly the proceedings, or to inhibit the ability of an adverse party to fully
present his case or defense, and which has the effect of foreclosing to him the
opportunity to have a fair and complete trial.

Browning, 826 F.2d at 345. Where a prior consent judgment was obtained as part of a
collusive scheme to hinder, delay, or defraud other creditors, as the fact finder might

15
 Thus, we conclude that Heiser reaffirms the rule of Pepper v. Litton as described above in

this opinion. We also conclude that the instant case fits comfortably within the rule of Pepper v.

Litton and its progeny. Moreover, the rule of Pepper v. Litton and its application in this case

comports with sound common sense. We see no reason why one creditor of a bankrupt should be

able to escape the usual scrutiny with respect to fraudulent transfers merely because that creditor's

claim was reduced to a judgment prior to the bankruptcy, where the trustee in bankruptcy was not

a party and its interests were not represented, but rather where the prior judgment was obtained by

parties antagonistic to the trustee's interests as part of a collusive scheme to hinder, delay, or defraud

other creditors. For the foregoing reasons, we conclude that both precedent and reason support our

conclusion rejecting the res judicata argument of the Spangler entities based upon the Arizona

consent judgment. On remand, the district court can properly look behind that judgment upon the

appropriate showing of fraud and collusion.

B. ACTUAL FRAUD

We turn next to the issue of actual fraud. The district court held that the Trustee had failed

to create a genuine issue of material fact, and granted summary judgment in favor of the Spangler

entities. The Trustee asserts that the district court did not apply the proper "badges of fraud"

analysis. Because proof of "actual intent to hinder, delay, or defraud" creditors, pursuant to 11

U.S.C. § 548, may rarely be accomplished by direct proof, the Trustee argues that courts may infer

fraudulent conduct from the circumstantial evidence and the surrounding circumstances of the

transactions. We agree with the Trustee. In determining whether the circumstantial evidence

reasonably find on remand in the instant case, the fraud falls comfortably within the Fifth
Circuit's description.

16
supports an inference of fraudulent intent, courts should look to the existence of certain badges of

fraud.16 See In re Sherman, 67 F.3d 1348, 1353-54 (8th Cir.1995); In re Acequia, Inc., 34 F.3d 800,

805-06 (9th Cir.1994); FDIC v. Anchor Properties, 13 F.3d 27, 32 (1st Cir.1994); In re Brantz, 106

B.R. 62, 67 (Bankr.E.D.Pa.1989). In Sherman, the court stated that fraudulent conduct may be

inferred from the circumstances following a transfer. Sherman, 67 F.3d at 1353. In determining

whether the circumstantial evidence is sufficient to establish fraudulent intent, the court should

investigate the transfer for the existence of badges of fraud.17 These badges of fraud include:

(1) The transfer was to an insider;

(2) The debtor retained possession or control of the property transferred after the transfer;

16
Both parties acknowledge that courts should look to the badges of fraud in analyzing actual
fraud pursuant to § 548(a)(1). The Spangler entities contend, however, that this court does not
have to reach a badges of fraud inquiry. The Spangler entities argue that a legitimate business
purpose successfully rebuts any showing of actual fraud. See In re Sherman, 67 F.3d 1348, 1354
(8th Cir.1995) (stating that badges of fraud are sufficient to establish actual fraudulent intent,
"absent significantly clear evidence of a legitimate supervening purpose."). The basis for this
assertion centers on the legitimacy of First Phoenix's claim to the BNL letter of credit. The
Spangler entities contend that it was a reasonable business decision for XYZ to turn the entire
proceeds from the Atlanta litigation over to First Phoenix because XYZ had no hope of dealing
with its other creditors while First Phoenix stood waiting at its front door. However, in light of
the circumstances of this case, we conclude that the Spanglers have not shown evidence of a
legitimate business purpose sufficient to overcome the reasonable inferences of fraud. In
addition to the inferences of fraud discussed below, at the time of the settlement negotiations, the
Spanglers' security interest was not perfected because XYZ had retained possession of the BNL
letter of credit. See infra n.20. Thus, the validity and priority of the Spangler security interest
was vulnerable. As we will discuss in greater detail, the structure of the settlement agreement
left XYZ with almost no assets. Furthermore, assets originally slotted for creditors were
funneled off for other uses.
17
Although the presence of one specific "badge" will not be sufficient to establish fraudulent
intent, the "confluence of several can constitute conclusive evidence of an actual intent to
defraud." Sherman, 67 F.3d at 1354 (quoting Max Sugarman Funeral Home, Inc. v. A.D.B.
Investors, 926 F.2d 1248, 1254 (1st Cir.1991)); see also In re Kranich, 53 B.R. 821
(Bankr.M.D.Fla.1985).

17
 (3) The transfer was disclosed or concealed;

(4) Before the transfer was made the debtor had been sued or threatened with suit;

(5) The transfer was of substantially all the debtor's assets;

(6) The debtor absconded;

(7) The debtor removed or concealed assets;

(8) The value of the consideration received by the debtor was reasonably equivalent to the
value of the asset transferred;

(9) The debtor was insolvent or became insolvent shortly after the transfer was made;

(10) The transfer occurred shortly before or shortly after a substantial debt was incurred;
and

(11) The debtor transferred the essential assets of the business to a lienor who transferred the
assets to an insider of the debtor.

Alabama Code, § 8-9A-4(b)(Supp.1996); see also Arizona Revised Statutes, § 44-1004(b)(1990).18

After a careful review of the briefs and the summary judgment record, and after oral

argument, we readily conclude that the evidence adduced creates genuine issues of material fact as

to whether or not there was an actual intent to hinder, delay, or defraud creditors. We find genuine

issues of fact with respect to actual fraud on the part of XYZ and its principal, Muscarella, and also

on the part of the Spangler entities.

In this opinion, we focus on the transfer of the approximately $2,300,000 (proceeds from the

BNL letter of credit, which the Atlanta judgment awarded to XYZ) by XYZ to the Spangler entities.

18
The parties acknowledge that the appropriate analysis of actual fraudulent intent under §
548(a) would look to the badges of fraud. The parties also assume the applicability of the badges
of fraud itemized in the text, which are substantially the same under the laws of Alabama and
Arizona. Thus, this appeal presents no choice of law issues.

18
Our focus is on the initial $2,300,000 transfer19 to the Spangler entities in satisfaction of the Arizona

consent judgment, and on the subsequent flow of this money pursuant to the implementation of the

settlement agreement.

We turn our attention first to the evidence suggesting that Muscarella and the Spangler

entities fixed the amount of the Arizona consent judgment in favor of the Spangler entities at

approximately $2,300,000, notwithstanding the fact that all parties intended at the time that the

Spangler entities would actually receive a substantially lesser sum, with the balance thereof to be

diverted primarily to Muscarella personally or to persons or family designated by him. Evidence

to the foregoing effect includes: (a) the affidavit filed by the Spangler entities in the Atlanta

litigation indicating that the Spangler entities were owed approximately $1,250,000, approximately

6 months before the Arizona consent judgment; (b) a draft of the settlement agreement, reflecting

the status of the settlement negotiations just a few days before the final settlement agreement was

19
There is evidence that virtually all of the assets of XYZ were dissipated as a result of the
settlement agreement between Muscarella, as owner of XYZ, and the Spangler entities. Thus,
other assets that a fact finder might deem to have been transferred, in addition to the $2,300,000
include:

(a) XYZ's potential interest in the $1,000,000 certification of deposit, to the extent
of the excess of same over any potential liability to Northern Trust. This certificate of
deposit was lost to XYZ as a result of the implementation of the settlement agreement;

(b) Real estate which XYZ had at one time owned, subject to a bank mortgage;
and

(c) The usury claims which XYZ was asserting against the Spangler entities both
in the Houston litigation and in the Arizona litigation. The Trustee asserts that a fact
finder could find that the usury claim had the potential of eliminating or reducing
substantially the value of any claim the Spangler entities had against XYZ. The usury
claim was abandoned as part of the settlement agreement which dismissed the Houston
litigation, and finalized the Arizona litigation with the Arizona consent judgment.

19
reached, indicating that the Spangler entities were owed $1,200,000, and the testimony of

Muscarella that during the negotiations leading up to the Arizona consent judgment the Spangler

entities only claimed they were owed $1,250,000; (c) the testimony of Muscarella that the Arizona

consent judgment was intended to be in the precise amount of the Atlanta judgment, despite the fact

that Muscarella did not know whether XYZ owed the Spangler entities anything close to $2,000,000

at the time; and (d) most importantly, in the actual disbursement of the monies as part of the

implementation of the settlement agreement, the fact that the Spangler entities actually ended up

with substantially less than the $2,300,000 amount of the consent judgment, with approximately

$550,000 (plus the $1,000,000 certificate of deposit) being diverted either to Muscarella personally

or to persons or family designated by him. Based on the foregoing evidence, the fact finder could

reasonably find that Muscarella, in control of XYZ, and the Spangler entities artificially inflated the

amount of the Arizona consent judgment, notwithstanding the intent on the part of all parties that

the Spangler entities would actually end up with a substantially lesser amount and that $550,000

would be diverted to either a corporation owned by Muscarella's mother or to persons or

organizations benefitting Muscarella's business interests, to the exclusion of XYZ's creditors.

We also conclude that there is evidence from which a fact finder could reasonably find that

the above-mentioned artificial inflation of the amount of the Arizona consent judgment was intended

by Muscarella and the Spangler entities as part of a collusive scheme to hinder, delay, or defraud

the creditors of XYZ. The following evidence would support such a finding:

(a) Shortly before the finalization of the settlement agreement, Birenbaum, one of the

attorneys for the Spangler entities, wrote a letter to Scott Spangler noting that Spangler had told the

attorneys that one of the arguments that Muscarella intended to use in negotiating with his creditors

20
was that the Spangler entities had a first-priority security interest in the proceeds of the BNL letter

of credit, and, consequently, that the other creditors of XYZ could ultimately receive little or nothing

even after the Atlanta litigation was resolved. The letter also noted Muscarella's request that the

settlement agreement be structured so as to ensure the priority security interest of the Spangler

entities. The letter also noted that the Spangler entities were certainly taking the position that they

had a first-priority security interest in the BNL letter of credit, but acknowledged that it did not

appear that the Spangler entities would be entitled to all of the proceeds, then estimated to be

approximately $2,100,000, thus possibly leaving a significant portion for the other creditors.

Finally, the letter noted the possibility that the security interest of the Spangler entities might be

successfully attacked. With regard to the latter, the evidence in this record indicates that possession

of the BNL letter of credit was not delivered to the Spangler entities until late November 1993,

shortly after the date of the Birenbaum letter. During the settlement negotiations, the fact that the

Spangler entities did not have possession of the letter of credit was known to both sides, and both

sides thus were aware of the legal vulnerability of the Spangler security interest.20

(b) Muscarella testified in his deposition that he needed to have the Spangler lien remain in

place so that he could use it as leverage in negotiating with other XYZ creditors. He had advised

Spangler of this.

20
In the companion case, No. 96-7035, this court has held that the Spanglers' security interest
in the BNL letter of credit first became perfected in late November 1993, on the date the
Spangler entities took possession of the BNL letter of credit. The opinion in No. 96-7035 is
being published simultaneously with this opinion.

21
 (c) Muscarella's attorney, Chamberlin, testified in deposition that he had discussed with

Muscarella the need to make sure that the Spangler entities had a lien on the BNL letter of credit

proceeds before settlement negotiations.

(d) Shortly after the foregoing, XYZ, in November 1993, delivered possession of the BNL

letter of credit to the Spangler entities, thus perfecting the security interest of the Spangler entities.

(e) If the fact finder concludes that the Arizona consent judgment was in fact artificially

inflated, that in itself would add support for a finding of intent on the part of Muscarella, XYZ, and

the Spangler entities to hinder, delay, or defraud creditors, at least in the absence of other credible

explanation. In other words, the most reasonable explanation for artificially inflating the amount

of the judgment may be an intent to use the judgment as a shield to make assets unavailable to other

creditors of XYZ.

(f) Finally, the fact finder could reasonably find that, of the $2,300,000 initially transferred

to the Spangler entities, at least $550,000 was ultimately diverted to Muscarella's mother's

corporation or otherwise for Muscarella's benefit. The fact finder could reasonably find that this

diversion, and also the transfer of the $1,000,000 certificate of deposit which ended up in

Muscarella's mother's corporation, occurred with the knowledge and participation, not only of

Muscarella, but also of the Spangler entities.

On the basis of all the evidence, the fact finder could reasonably find that the Arizona

consent judgment was artificially inflated with the intent on the part of the parties to use the

judgment as a shield against creditors to protect the diversion of funds to Muscarella, or persons or

family influenced by him.

22
 Looking at the foregoing evidence through the prism of the badges of fraud, we readily

conclude that a reasonable trier of fact could find that most of the badges of fraud are established

by the evidence in the summary judgment record. We turn first to discuss the eighth badge of fraud,

i.e., the issue of whether or not the value of the consideration received by the debtor, XYZ, was

reasonably equivalent to the value of the assets transferred. The primary asset transferred by XYZ

was the approximately $2,300,000 representing the proceeds of the BNL letter of credit which were

awarded to XYZ by the district court in Atlanta.21 The primary value received by XYZ was the

satisfaction of the consent judgment in the Arizona litigation.22 The Spangler entities argue that their

claims, which were thus settled, greatly exceeded the $2,300,000 received, and thus amounted to

equivalent value. We readily conclude that a reasonable fact finder might find otherwise.23 Thus,

we conclude that the fact finder could reasonably find the existence of the eighth badge of fraud.

There is ample evidence from which a reasonable fact finder could find that the transfers in

connection with the implementation of the settlement agreement transferred substantially all of the

debtor's assets, and left the debtor insolvent, thus satisfying the fifth and ninth badge of fraud. With

21
See supra n. 19 (listing other assets that a reasonable fact finder may find were transferred
by XYZ as a result of the settlement agreement and ensuing transactions).
22
Also settled were any claims by the Spangler entities against XYZ in the Atlanta litigation
and the Houston litigation.
23
As is often the case when genuine issues of material fact preclude summary judgment, it is
true that the Spangler entities have adduced evidence from which a jury might find equivalent
value. However, they have not persuaded us that they had claims equaling or exceeding a
realistically perceived value of $2,300,000, thus eliminating genuine issues of fact in this regard.
This is especially true in light of the ample evidence suggesting that the Spangler entities never
intended to receive the full $2,300,000. Moreover, there are genuine issues of material fact as to
the realistic value of several of the Spangler claims. For example, there is very little evidence
that the Spangler entities realistically perceived that they had a viable claim for $875,531 for any
remaining liability on the Northern Trust letters of credit. The evidence suggests that those
letters of credit were amply collateralized by the $1,000,000 certificate of deposit.

23
respect to the fourth badge of fraud, it might reasonably be found that the debtor, XYZ, was subject

to judgments and threatened suits by creditors immediately before the transfer.

A reasonable fact finder could also find that the first, second, seventh, and eleventh badges

of fraud are satisfied. All deal with retention of possession or control by the debtor or insiders.

There is ample evidence from which it could reasonably be found that essential assets of the debtor,

XYZ, were transferred to a lienor, the Spangler entities, who then transferred assets to an insider.

For example, the fact finder could reasonably find that $550,000, plus XYZ's residual interest in the

$1,000,000 certificate of deposit, ended up in the hands of insider Muscarella, or persons or family

controlled by him.

Finally, there are reasonable inferences in this summary judgment record from which it might

reasonably be found that the third badge of fraud is satisfied, namely, that the transfer was

concealed. The fact finder might reasonably infer, from the fact that the implementation of the

settlement agreement was delayed approximately 90 days, that there was an intent to conceal the

transfer for a sufficient length of time until the bankruptcy preference period expired. Moreover,

an intent to conceal might reasonably be inferred from the complex and convoluted nature of the

transfers by which the settlement agreement was implemented. While it is true that mere complexity

would not give rise to an inference of fraud or intent to conceal, in this case, the record wholly fails

to provide any reasonable explanation for a considerable number of the convoluted transactions

involved.

After careful consideration of the evidence discussed above in light of the badges of fraud,

we readily conclude that there is ample evidence from which a fact finder could reasonably find an

24
actual intent on the part of both the debtor, XYZ, and the Spangler entities to hinder, delay, or

defraud creditors.24 The district court's contrary conclusion was error.

C. CONSTRUCTIVE FRAUD

In addition to actual fraud, the Trustee also argues that the transfer of the $2,300,000 BNL

proceeds to the Spangler entities was constructively fraudulent, pursuant to 11 U.S.C. § 548(a). The

elements of a claim of constructive fraud under § 548(a) are that: (1) the debtor had an interest in

property; (2) the transfer of that interest occurred within one year of the bankruptcy petition; (3)

the debtor was insolvent at the time of the transfer or became insolvent as a result thereof; and (4)

the debtor received less than reasonably equivalent value in exchange for such transfer. Finding that

24
It is true that there is also evidence in the record on the basis of which a fact finder could
find that the Spangler entities were innocent dupes with respect to the fraud on creditors. There
is evidence that the plan for settlement originally contemplated that the $550,000 (which
ultimately found its way into the pockets of Muscarella personally or persons or family
designated by him) would ultimately benefit creditors of XYZ. The plan apparently
contemplated that XYZ could use the $550,000 to fund a new letter of credit to be substituted for
the two Northern Trust letters of credit, which in turn would free up for XYZ's use the
$1,000,000 certificate of deposit which had collateralized the two Northern Trust letters of
credit. There is some evidence that this original plan was intended to make available to XYZ
that $1,000,000 for the benefit of XYZ's other creditors. While a fact finder might find the
Spangler entities innocent on the basis of the foregoing evidence, several reasons persuade us
that there remain genuine issues of fact with respect to the innocence of the Spangler entities.
The foregoing original plan was not followed in the implementation of the settlement agreement.
The $550,000 did not end up at the disposal of XYZ, nor did the $1,000,000 certificate of
deposit. To the contrary, the $550,000 and the $1,000,000 certificate of deposit ended up in
possession of a corporation owned by Muscarella's mother. Although the record does not
explain how or why Muscarella's mother's corporation was permitted to swoop in and pocket
such substantial assets, nevertheless this is what happened. There is evidence on the basis of
which a fact finder could reasonably find that this occurred with the knowledge and participation
not only of Muscarella, but also of the Spangler entities. Moreover, there is no adequate
explanation in the record for the fact that the Arizona consent judgment may have been
artificially inflated, thus leaving the reasonable inference that there was an intent on the part of
Muscarella, XYZ, and the Spangler entities to use the consent judgment as a shield against other
creditors. Thus, genuine issues of material fact remain with respect to actual fraud on the part of
Muscarella, XYZ, and the Spangler entities.

25
the Spangler entities did not deny any of the first three elements, the district court addressed only

the issue of reasonably equivalent value. The district court rejected the Trustee's argument and

determined that no genuine issue of fact existed as to whether or not XYZ had received reasonably

equivalent value in exchange for the transfer of the BNL judgment proceeds to First Phoenix.

In our above discussion of the badges of fraud, we have already determined that there are

genuine issues of material fact on the issue of reasonably equivalent value. We need not discuss the

issue again. The fact finder could reasonably find all four elements of constructive fraud. The

district court's contrary conclusion was error.

D. KEATING'S MOTION FOR SUMMARY JUDGMENT

The district court granted Keating's motion for summary judgment and dismissed the action

as against Keating. The district court had already granted summary judgment in favor of the

Spangler entities, holding that they had given equivalent value for XYZ's transfer of the $2,300,000

BNL proceeds. The Trustee's claim against Keating was based on the allegation that Keating was

at least a temporary recipient of a portion of the $2,300,000, pursuant to one of the convoluted

transactions which followed XYZ's initial transfer of the $2,300,000 to the Spangler entities. In

granting summary judgment in favor of Keating, the district court reasoned as follows: because the

court had already ruled that XYZ had no further interest in the $2,300,000, it followed that neither

XYZ nor its Trustee in bankruptcy had any interest in the subsequent transfers to other entities.

26
 Our holding today, reversing the district court's grant of summary judgment in favor of the

Spangler entities, nullifies the reasoning of the district court in its ruling in favor of Keating.

Accordingly, we also reverse the district court's grant of summary judgment in favor of Keating.25

IV. CONCLUSION

For the foregoing reasons, we reject the argument of the Spangler entities that the Trustee's

challenge to the $2,300,000 is shielded by the Arizona consent judgment, and we conclude that there

are genuine issues of material fact with respect to actual fraud and constructive fraud. We reverse

the district court's grant of summary judgment in favor of the Spangler entities, and we reverse the

district court's grant of summary judgment in favor of Keating. We remand this case for further

proceedings not inconsistent with this opinion.

REVERSED AND REMANDED.

25
Anticipating a possible reversal of the district court's grant of summary judgment in favor of
the Spangler entities, Keating makes alternative arguments in support of the judgment in his
favor. We decline to address the alternative arguments, preferring that they be addressed in the
first instance by the district court.

27