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IN RE SULLIVAN & LODGE

United States District Court, Northern District of California


August 19, 2003

IN RE: SULLIVAN & LODGE, INC., DEBTOR

The opinion of the court was delivered by: Charles Breyer, District Judge

ORDER VACATING BANKRUPTCY COURT'S RULING ON MOTION TO COMPEL ABANDONMENT
This matter is before this Court on appeal from the United States Bankruptcy Court. Appellant seeks an order from this Court vacating the bankruptcy court's order granting debtor's motion to compel abandonment of certain legal causes of action.

BACKGROUND

The debtor corporation is a producer of bottled water sold under the Cobb Mountain and Forest Lake labels. Debtor believes that its financial troubles result at least in part from unfair competition and false advertising by other players in the bottled-water market. Accordingly, debtor retained the law firms of Jaret & Jaret ("Jaret") and Lieff Cabraser ("Lieff") as special counsel to pursue legal action against its competitors. These two firms are referred to collectively herein as "Special Counsel."

Two days after debtor signed an engagement letter in April 1999, Special Counsel filed a consumer class action against debtor's competitors. Roughly one month later, Special Counsel filed suit on behalf of the estate. [ Page 2]

Although the estate ultimately obtained settlements totaling $1.2 million, the principals came to believe that Special Counsel's representation of the estate was compromised by a conflict of interest. They opposed Special Counsel's request for compensation on this basis. Finding that Special Counsel "failed to insure that Sullivan & Lodge received the undivided loyalty and commitment from them that it was entitled to receive," the bankruptcy court held that "[n]othing less than a complete forfeiture of all fees would be just in this case." The bankruptcy court denied a motion for reconsideration, and Special Counsel appealed. The district court affirmed the bankruptcy court's ruling.

Debtor's principals believe that they have legitimate affirmative causes of action against Special Counsel stemming from the conflict of interest. Although the principals encouraged the trustee to pursue these claims, the trustee declined to do so. The principals then filed a motion in the bankruptcy court to compel the trustee to abandon the claims to the corporation.

The trustee did not oppose the motion. Special Counsel, however, did file opposition. They based their opposition on the fact that they had offered to purchase the putative claims for $30,000. In their view, this offer rendered the claims unsuitable for abandonment under 11 U.S.C. § 554, which permits abandonment of estate property when that property is either "burdensome to the estate" or "of inconsequential value and benefit to the estate." In response, the principals argued that Special Counsel did not have standing to oppose the motion.

The bankruptcy court granted the motion to compel abandonment. At the hearing on the motion, the court explained its reasoning in the following terms:

Well, as I said before, most of the time we're interested in maximizing the estate, 99.9 percent of the time. But occasionally the situation arises where justice is better served by letting people who really feel-I mean it's obvious that Sullivan and Lodge, the moving parties here, they obviously have strong feelings about what happened. And it just seems fair and just under all the circumstances to let them prosecute that, even though I understand that the estate could be $30,000 richer if they didn't. . . .
[U]nder the unique circumstances presented here and in the absence of any objections by the estate's representative, the motion to abandon is granted. [ Page 3]
The court did not express an opinion on whether Special Counsel had legal standing to oppose the motion.

This appeal is limited to the bankruptcy court's ruling on the motion to compel abandonment. For purposes of the appeal, the Court will assume that the estate has a valid affirmative cause of action against Special Counsel. The only question for this Court is whether the motion to compel abandonment of that cause of action was properly granted.

STANDARD OF REVIEW

"Once a bankruptcy court has determined whether `the factual predicates for abandonment . . . are present, the court's decision to authorize or deny abandonment is reviewed for an abuse of discretion." In re Viet Vu, 245 B.R. 644, 647 (B.A.P. 9th Cir. 2000) (quoting In re Johnston, 49 F.3d 538, 540 (9th Cir. 1995)). "A court abuses its discretion if its decision is `based on an erroneous conclusion of law or when the record contains no evidence on which [the bankruptcy court] could have based [the] decision [to authorize abandonment].'" Id. (quoting In re Windmill Farms. Inc., 841 F.2d 1467, 1472 (9th Cir. 1988)).

DISCUSSION

I. Standing

"Only those persons who are directly and adversely affected pecuniarily by an order of the bankruptcy court have been held to have standing to appeal that order." Matter of Fondiller, 707 F.2d 441, 442 (9th Cir. 1983). Whether Special Counsel has standing to bring this appeal, therefore, depends on whether the law firms have a direct pecuniary interest in the bankruptcy court's ruling.

The Ninth Circuit applies a "person aggrieved" test to determine appellate standing.

This test

exists to fill the need for an explicit limitation on standing to appeal in bankruptcy proceedings. This need springs from the nature of bankruptcy litigation which almost always involves the interests of persons who are not formally parties to the litigation. In the course of administration of the bankruptcy estate disputes arise in which numerous persons are to some degree interested. Efficient judicial administration requires that appellate review be limited to those persons whose interests are directly affected. [ Page 4]
Fondiller, 707 F.2d at 443 (citations omitted). In Fondiller, the order at issue authorized the bankruptcy estate to retain counsel to bring legal action against the appellant. According to the Ninth Circuit, "appellant's only demonstrable interest in the order [was] as a potential party defendant in an adversary proceeding. . . . The order did not diminish her property, increase her burdens, or detrimentally affect her rights." Id. The court thus held that the appellant was not a "person aggrieved," and therefore lacked standing to appeal.

Like the appellant in Fondiller, Special Counsel's primary interest in the bankruptcy court's ruling is "as [] potential party defendant[s] in an adversary proceeding." Absent more, this interest does not render either law firm a "person aggrieved" for standing purposes.

Special Counsel also claim to have standing as post-petition creditors of the estate because they have not been paid for the legal services they rendered. Cf. In re P.R.T.C., Inc., 177 F.3d 774, 778 (9th Cir. 1999) (creditor has standing to object to court order transferring legal claims out of the estate). The reason they have not been paid, of course, is because the bankruptcy court denied their request for compensation based on its determination that their legal representation was compromised by a conflict of interest. That ruling was reaffirmed on a motion for reconsideration and then on appeal to the district court. Presently, however, both firms have appeals pending in the Ninth Circuit on the issue of their entitlement to fees from the estate. As such, the law firms' status as creditors has not been finally determined.

Separately, appellant Jaret & Jaret argues that it has standing to object to the order compelling abandonment because it is a pre-petition creditor. While it appears from the record that there is some question as to whether Jaret is a net creditor or debtor of the estate at this time, the Court will assume without finding that the firm is in a net creditor position. Accordingly, the merits of the appeal will be considered below.

II. Scheduling Requirement

Special Counsel argue that debtor was required to list its potential legal claims against Special Counsel as assets on the schedules it filed with the bankruptcy court. However, the cases cited by Special Counsel in support of this proposition involved property that was [ Page 5]

abandoned by operation of law pursuant to section 554(c), not abandonments ordered by courts in response to motions from interested parties pursuant to 554(a) or (b). The consideration's supporting strict adherence to the scheduling requirement before assets will be transferred out of an estate by operation of law carry much less force when abandonment is requested by a party and the merits of the request considered by a court after notice and a hearing. See, e.g., King v. Harry, 131 F. Supp. 252, 254 (D.D.C. 1955) ("The bankrupt has certain obligations to fulfill and his creditors, already losers, are at least entitled to notice before their property is taken. For this reason, . . . a bankrupt must exercise great care to schedule his assets . . . properly."). Accordingly, these cases have only limited relevance to the issue now before the Court.

Special Counsel point out that Federal Rule of Bankruptcy Procedure 1019(5)(C)(i) requires a debtor to file a schedule listing property acquired post-petition when a Chapter 11 case is converted to Chapter 7. In this case, conversion occurred in March 2000. Special Counsel argue that debtor's potential causes of action arose in mid-1999, when debtor first became aware that Special Counsel had filed the consumer class action, and thus should have been scheduled at the time of conversion. However, debtor suffered no injury-and hence had no standing to sue-until the claims against debtor's competitors were resolved and the effect, if any, of the purported conflict of interest became apparent. Since settlement did not occur until at least May 2001, debtor was not required to schedule its potential claims against Special Counsel when the bankruptcy case was converted to Chapter 7 in 2000.

To the extent that Special Counsel seek reversal of the bankruptcy court's order on the grounds that the abandoned causes of action are barred by judicial estoppel, that argument should be tested in the context of litigation over those claims, not on a motion to abandon.

In sum, debtor's failure to schedule its potential causes of action against Special Counsel is not grounds for reversal of the bankruptcy court's order. [ Page 6]

III. Section 554

Section 554(a) of the Bankruptcy Code states that "[a]fter notice and a hearing, the trustee may abandon any property of the estate that is burdensome to the estate or that is of inconsequential value and benefit to the estate." Section 554(b) provides that "[o]n request of a party in interest and after notice and a hearing, the court may order the trustee to abandon any property of the estate that is burdensome to the estate or that is of inconsequential value and benefit to the estate." Under either subsection, abandonment is proper only when the party seeking abandonment can establish that the property at issue is burdensome or of inconsequential value and benefit to the estate. See Viet Vu, 245 B.R. at 647. When the trustee requests or does not oppose a motion to compel abandonment, the court must "focus . . . upon the reasons underlying the trustee's determination and affirm a decision which reflects a business judgment made in good faith, upon a reasonable basis and within the scope of his authority under the Code." In re Wilson, 94 B.R. 886, 888 (E.D. Va. Bankr. 1989) (citations and internal quotation marks omitted).

The principals argue that abandonment was proper in this case because the trustee declined to pursue the causes of action, rendering them valueless to the estate. This argument puts the cart before the horse. Claims do not become valueless for section 554 purposes because a trustee declines to pursue them; rather, a trustee may decline to pursue a claim if that claim has no value. Thus, while "a trustee is not compelled to accept any offer to purchase, solely because `some recovery is better than none at all,'" neither may he "simply ignore a significant offer." In re Moore, 110 B.R. 924, 928 (C.D. Cal. Bankr. 1990). Charged with the duty of maximizing the value of the estate, see Commodity Futures Trading Comm'n v. Weintraub, 471 U.S. 343, 352 (1985), a trustee may abandon a cause of action only when he deems its value to be less than the cost of asserting it. See Hanover Ins. Co. v. Tyco Indus., Inc., 500 F.2d 654, 657 (3d Cir. 1974); see also In re K.C. Mach. & Tool Co., 816 F.2d 238, 246 (6th Cir. 1987) ("Abandonment should not be ordered where the benefit of administering the asset exceeds the cost of doing so."). [ Page 7]

The record in this case indicates that the bankruptcy court based its decision to grant the motion to compel abandonment in large part on the fact that the trustee did not oppose abandonment The court did not make an independent inquiry into the value of the cause of action to the estate, nor did it investigate the basis for the trustee's non opposition to abandonment. Accordingly, abandonment was compelled without the requisite showing that the asset in question was of inconsequential value and benefit to the estate, and without ascertaining that the trustee's determination to that effect "reflect[ed] a business judgment made in good faith, upon a reasonable basis and within the scope of his authority under the Code." Wilson, 94 B.R. at 888.

That the potential causes of action were not entirely without value is clear from the fact that Special Counsel offered to purchase them for $30,000. Although the trustee was under no obligation to accept Special Counsel's opening bid, neither was the trustee free simply to ignore the offer. See Moore, 110 B.R. at 928 ("[I]f consideration is offered for a cause of action, then the cases are clear that the trustee must take affirmative action to resolve the matter."). The trustee's apparent failure even to explore the potential upside of a sale to Special Counsel is fundamentally inconsistent with the conclusion that the decision not to pursue the claims was made in the exercise of the trustee's sound business judgment. See id.; cf. Wilson, 94 B.R. at 892 (authorizing abandonment where trustee consented only on condition that estate would receive 35% of any profit arising from the causes of action).

In the absence of sound reasons supporting the trustee's decision to abandon, the bankruptcy court's reliance for its decision on the trustee's non opposition to the motion was improper. Since the other evidence in the record does not permit the conclusion that the causes of action against Special Counsel were of inconsequential value and benefit to the estate, abandonment pursuant to section 554(b) should not have been compelled.

CONCLUSION

For the reasons stated above, the order of the bankruptcy court granting debtor's motion to compel abandonment is hereby VACATED. The case is remanded to the [ Page 8]

bankruptcy court to determine whether the trustee's consent to abandonment reflected sound business judgment consistent with the requirements of 11 U.S.C. § 554.

IT IS SO ORDERED. [ Page 1]

20030819

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