Howard v. Fidelity & Deposit Co.

                                   United States Court of Appeals,

                                              Fifth Circuit.

                                             No. 95-31137.

                       In the Matter of ROYALE AIRLINES, INC., Debtor.

                                             Nov. 4, 1996.

Appeal from the United States District Court for the Western District of Louisiana.

Before REYNALDO G. GARZA, DeMOSS and PARKER, Circuit Judges.

        ROBERT M. PARKER, Circuit Judge:

        The Appellants, Gene Howard and Commercial National Bank appeal the judgment of the

bankruptcy court granting Appellee, Fidelity and Deposit Company of Maryland's, motion for

summary judgment as to its liability as surety for former trustee Jerry Bass. The Appellants

contended that Bass failed to pursue preference actions before they prescribed causing financial loss

to the Appellants. The bankruptcy court based its ruling on two grounds: first, that Commercial

National Bank gained possession of the right to pursue preference claims, and second, based on the

facts of the case, the doctrine of in pari delicto warranted a finding of no liability. The district court

found that the doctrine of in pari delicto barred Commercial National Bank's recovery, and affirmed

the bankruptcy court. Although we find that the bankruptcy court erroneously applied the doctrine

of in pari delicto, given the particular egregious facts of this case, we affirm, finding that Commercial

National Bank implicitly consented to Bass' actions as trustee.

                                     FACTUAL BACKGROUND

        Royale Airlines, Inc. ("Royale" or "Debtor") filed a voluntary petition for bankruptcy under

Chapter 11 of the Bankruptcy Code on September 9, 1987. Royale named Commercial National

Bank ("CNB") as its principal creditor, having a secured claim in excess of seven and a half million

dollars. Immediately prior to and during the early stages of the Royale bankruptcy, CNB sought to

improve its collateral position. On October 19, 1987, CNB obtained from the bankruptcy court a

"Final Order" which provided that Royale's pre-petition and post-petition debt to CNB be secured


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in favor of CNB by way of a super-priority lien.1 This order gave CNB a mortgage over all property

that existed at the time of filing or that would exist in the future. To reduce Royale's debt to CNB,

after property was abandoned to Royale, Royale would then convey the property by partial dation

to CNB. CNB would then liquidate the property.

          Royale continued to lose money in Chapter 11, and a plan of reorganization had not been

confirmed by December 1988. On December 23, 1988, the Airline Pilots Association International

filed a motion to appoint a custodian for Royale or to have a trustee appointed. Thereafter, on

January 23, 1989, CNB filed a "Motion to Lift Stay under Section 362" and the bankruptcy court on

January 30, 1989 signed an order granting CNB's motion.2 This Order gave CNB the right to take

possession of all assets over which it had a mortgage. Subsequently, the United States Trustee filed

a motion requesting the bankruptcy court to appoint a trustee, or alternatively, to convert Royale's

bankruptcy to a Chapter 7 case. On February 28, 1989, the bankruptcy court entered an order

converting the Royale bankruptcy to a Chapter 7 case. In addition, Jerry Bass ("Bass") was

appointed as interim trustee and became the permanent trustee on July 10, 1989.

          During the Chapter 7 proceedings, CNB continued to collect and liquidate the property of the

Royale estate. On November 12, 1991, Jerry Bass resigned as trustee. The United States Trustee


   1
  The bankruptcy court's order provided that Royale's debt to CNB be secured in favor of
CNB, by:

                 all of the property of the estate of [Royale], including without limitation all
                 property of the estate as it existed on the date [Royale] filed its petition, and all
                 property of the estate acquired, created or generated in any manner whatsoever by
                 the estate after the date [Royale] filed its petition....
   2
       The January 30, 1989 order signed by the bankruptcy court states:

                 IT IS ORDERED that the stay of 11 U.S.C. § 362 be modified to allow CNB to
                 take possession and control of the property of the estate and the property of the
                 Debtor which is the subject of [CNB's] mortgages and to secure, preserve, and
                 protect same pending further order of this Court relating to the collateral.... CNB
                 may exercise those rights in its discretion deemed necessary by it to secure,
                 preserve, and protect the property of the estate and the property of the Debtor that
                 serves as collateral for CNB's loans with powers similar to those granted a keeper
                 under LSA-R.S. 9:5138.

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served as trustee until Gene Howard ("Howard") was appointed as successor trustee on May 29,

1992. On March 22, 1993, the Royale bankruptcy was closed leaving an unpaid debt to CNB of over

two million dollars. CNB brought this action hoping to recover damages from Bass and his surety,

Fidelity and Deposit Company of Maryland, for Bass' alleged failure to timely institute preference

actions.3

                                     PROCEEDINGS BELOW

        In the adversary proceeding, CNB and Howard alleged that Bass, the former trustee, failed

to pursue the bankruptcy estate's preference actions before they prescribed causing financial loss to

CNB. There were two sureties guaranteeing Bass' performance as trustee, Travelers Indemnity

Company and Fidelity and Deposit Company of Maryland ("Fidelity"). Both sureties were granted

summary judgment in their favor by the bankruptcy court after the court found that CNB was

mutually and equally at fault with Bass in allowing preference actions to prescribe without any action

being taken. CNB appealed the bankruptcy court's grant of summary judgment for Fidelity and

Deposit Company of Maryland.

        The bankruptcy court also ruled that the preference actions of the Royale estate were never

abandoned and that, although the law was unclear, CNB gained possession of the right to pursue

Royale's preferential transfers and director and officer claims by virtue of the lift stay order dated

January 30, 1989. The court found that the right to pursue the preference actions was possessed by

CNB, not Bass. The bankruptcy court took judicial notice of the fact that CNB controlled the case

and dominated the trustee's actions to such an extent that it had a duty to preserve these assets. CNB

dominated the Royale estate from the commencement under Chapter 11 and thereafter following the

conversion to Chapter 7. Therefore, the bankruptcy court found that CNB possessed a duty to

prosecute these claims. The court also found that Bass shared a concurrent duty with CNB to pursue

   3
    On October 28, 1993, Howard filed a motion to reopen the Royale bankruptcy in order to
bring the current adversary proceeding. However, Howard had assigned all remaining causes of
action to CNB in October 1992. CNB reassigned three percent (3%) of its alleged claim back to
Howard in November 1993, thus allowing both CNB and Howard to pursue the adversary action
together.

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the preference actions.

        The bankruptcy court reached the legal conclusion that any breach of the duty to investigate

and pursue preference actions did not occur until the prescription date for filing preference claims or

any other claim had passed. Based on this determination and the bankruptcy court's findings that

CNB dominated Bass' actions to such an extent that if CNB wanted preference actions pursued it

could have pes and that Bass was not removed as trustee but resigned, the court found that CNB

breached its duty to preserve or pursue the preference actions in question. Consequently, the court

held the equitable doctrine of in pari delicto barred CNB's claims. The bankruptcy court also

implicitly found that Bass breached his duties owed to the estate.

        The district court affirmed the bankruptcy court's denial of CNB's claims, although it

disagreed with one of the reasons relied on by the bankruptcy court. In particular, the district court

found that CNB was mutually at fault with Bass and that the doctrine of in pari delicto barred any

recovery by CNB. The district court likewise found that CNB dominated the Royale estate from

commencement of the case, as well as after the conversion to Chapter 7. However, the district court

disagreed with the bankruptcy court's finding that the right to pursue the preference action had been

transferred to CNB. The district court stated that it was not certain that the bankruptcy court had

the power to transfer that right, but even if it did, the transfer had to be explicit and that neither the

original 1987 financing order nor the January 30, 1989 lift stay order specifically transferred the right

to bring preference actions to CNB. CNB timely filed its appeal.

                                             DISCUSSION

        Pursuant to the bankruptcy appellat e process, the Court of Appeals is the second level of

appellate review. Nonetheless, we review a bankruptcy court's grant of summary judgment de novo.

In re Southmark Corp., 88 F.3d 311, 314 (5th Cir.1996). Accordingly, all fact questions are viewed

in the light most favorable to the nonmovant. Summary Judgment is proper when no issue of material

fact exists and the moving party is entitled to judgment as a matter of law. Id.; FED.R.CIV.P. 56(c).

         The equitable defense of in pari delicto, which means "in equal fault", is based on the


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common law notion that a plaintiff's recovery may be barred by his own wrongful conduct. Bateman

Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 306, 105 S.Ct. 2622, 2626, 86 L.Ed.2d 215

(1985). The Supreme Court in Bateman Eichler, set forth a two part test applying this doctrine to

bar private causes of action in securities cases. The Bateman Eichler test provides that an action

"may be barred on the grounds of the plaintiff's own culpability only where (1) as a direct result of

his actions, the plaintiff bears at least substantial responsibility for the violations he seeks to redress,

and (2) preclusion of suit would not significantly interfere with the effective enforcement of the ...

laws and protection of the ... public." Bateman Eichler, 472 U.S. at 310-11, 105 S.Ct. at 2629. The

first prong of the test sets forth the essential elements of the doctrine, while the second prong

embodies the doctrine's traditional requirement that public policy implications be carefully considered

before the defense is allowed. Pinter v. Dahl, 486 U.S. 622, 633, 108 S.Ct. 2063, 2071, 100 L.Ed.2d

658 (1988). Courts have expanded the defense's application to those situations where the plaintiff

bore at least substantially equal responsibility for his injury and where the plaintiff has participated

in some of "the same sort of wrongdoi ng" as the defendants. Id. at 307, 105 S.Ct. 2627, citing,

Perma Life Mufflers, Inc. v. International Parts Corp., 392 U.S. 134, 138, 88 S.Ct. 1981, 1984, 20

L.Ed.2d 982 (1968).

        Under the first prong of the Bateman Eichler test, a plaintiff cannot recover where, as a result

of his own actions, the plaintiff bears at least substantially equal responsibility for the underlying

wrongdoing of which he is complaining. Thus, in determining whether the bankruptcy court properly

applied the doctrine of in pari delicto, we must first consider whether it was settled that CNB had

a duty to bring the preference actions despite Bass' inactions. CNB argues that the bankruptcy court,

as well as the district court, improperly found that CNB and Bass had equivalent duties to bring the

preference actions and that both parties were equally at fault without providing a reasonable basis for

any fault by CNB. Fidelity contends that the bankruptcy court correctly applied the doctrine after

it found that CNB breached its duty to preserve or pursue the preference actions and thus it was

equally at fault with Bass as trustee. We find CNB's argument persuasive.


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        The bankruptcy court in making its ruling noted that "it is unsettled law whether such a

transfer [of the right to pursue preference actions] can take place...."4 We need not resolve this

question in order to decide the issue before us. The bankruptcy court further found that "in view of

the fact that it is this court's opinion that [CNB] had possession of these claims ... it is also this court's

opinion that [CNB] had a duty to prosecute these claims." However, it is clear that the bankruptcy

court's January 30, 1989 Final Order did not specifically state that CNB had possession nor the duty

to prosecute these claims. Because the law is admittedly unsettled on the ability to assign preference

actions, and as noted by the district court, the bankruptcy court in its Final Order did not specifically

transfer these act ions to CNB, any determination that CNB had a concurrent legal duty to pursue

those claims is at best speculative. Additionally, the bankruptcy court's ruling is insupportable to

demonstrate the plaintiff bore substantially equal responsibility to pursue the avoidance actions.

Therefore, there can be no finding of equivalent fault, a requisite element to support the defense of

in pari delicto. Thus, the first prong of the Bateman Eichler test is not satisfied. Accordingly, we

find the bankruptcy court erroneously applied the defense of in pari delicto predicated on the finding

that CNB was equally at fault for not pursuing the preference actions when it was unknown whether

CNB had a legal duty to act and, therefore, the bankruptcy court erred in granting summary judgment

on such grounds.

         However, our analysis does not end here. In reviewing the record, although we may

conclude that the reasons given by the bankruptcy court do not support summary judgment, this court

is not bound by those grounds art iculated and we may affirm the judgment on any other grounds

supported by the record. See Forsyth v. Barr, 19 F.3d 1527, 1534 n. 12 (5th Cir.), cert. denied, ---

U.S. ----, 115 S.Ct. 195, 130 L.Ed.2d 127 (1994). Therefore, we must proceed to Fidelity's

   4
     See e.g., In re Pearson Industries, Inc., 178 B.R. 753, 762 (Bankr.C.D.Ill.1995) (stating that
a trustee's right to recover preferences cannot be assigned to another entity), In re North Atlantic
Millwork Corp., 155 B.R. 271, 281 (Bankr.D.Mass.1993) (noting that absent the appointment of
a creditor to bring preference actions in a reorganization plan, there is no statutory authority
bestowing that right); In re Professional Inv. Properties of America, 955 F.2d 623, 626 (9th
Cir.), cert. denied, 506 U.S. 818, 113 S.Ct. 63, 121 L.Ed.2d 31 (1992) (permitting assignment of
a trustee's avoidance powers under particular circumstances outside reorganization plan).

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argument that CNB consented to the actions or inactions of Bass thereby precluding CNB from

recovery.

       Fidelity argues that, under the doctrine of consent, CNB's failure to act to preserve the

property of the Royale estate or to object to the actions taken or not taken by Bass as trustee, bars

its recovery in this proceeding. CNB asserts that Fidelity's argument is improperly based on the

assumption that CNB knew that Bass was not going to investigate the preference actions. CNB

contends that it was led to believe that Bass was acting to pursue the preference actions.

        It is well recognized that where a party is found to have by their conduct, either expressly or

impliedly, consented to another party's actions, they are precluded from asserting a claim against that

party for damages they may have suffered. In In re Peckinpaugh, 50 B.R. 865 (Bankr.N.D.Ohio

1985), the bankruptcy court reiterated that "a secured creditor cannot remain silent with knowledge

of the Trustee's actions and not act upon it and t hen be heard that the Trustee made the wrong

decision." Peckinpaugh, 50 B.R. at 869. This aptly describes the course of CNB's conduct in the

case sub judice.

       While the record discloses that CNB did not expressly consent to Bass' actions, the evidence

before us mandates the finding that CNB implicitly consented to the actions of Bass. However, such

consent should not be lightly inferred. In this case, CNB is a legally sophisticated creditor and

exercised complete control over the trustee's actions throughout the bankruptcy. CNB was the

largest creditor of the Debtor initially and throughout the case. The record discloses that CNB had

a close involvement and was in close contact, if not daily contact, with virtually every aspect of the

Debtor's bankruptcy proceedings. CNB worked with the trustee to liquidate the estate's assets. The

bankruptcy court found that at a el discussed the preference matters; thus, CNB was aware of the

preference claims and when those claims would prescribe, yet CNB's conduct shows that whatever

course of action or inaction Bass pursued, CNB did not complain until the filing of this action. In

addition, during the period of time that Bass served as trustee, the record is void of any

documentation to either Bass, the bankruptcy court, or the United States Trustee's Office expressing


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concern over Bass' performance as trustee. Nor did CNB seek to remove Bass as trustee.

Accordingly, this Court finds that based on CNB's conduct during these proceedings, CNB implicitly

consented to the actions or inactions of Bass in his dut ies as trustee of the Debtor. We find the

remaining arguments of CNB to be without merit.

       For the foregoing reasons, we AFFIRM the bankruptcy court's granting of summary judgment

in favor of Fidelity and Deposit Company of Maryland.

       AFFIRMED.




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