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Reed v. Nathan

United States District Court, E.D. Michigan, Southern Division

October 6, 2016

GREGORY J. REED et al., Appellants,
v.
KENNETH A. NATHAN Appellee.

          OPINION AND ORDER AFFIRMING BANKRUPTCY COURT'S JANUARY 4, 2016, AMENDED ORDER REQUIRING TURNOVER OF ASSETS

          MATTHEW F. LEITMAN UNITED STATES DISTRICT JUDGE

         In 1996, Debtor-Appellant Gregory Reed (“Reed”) and two other individuals established Appellant Keeper of the Word Foundation (“KWF”) to purchase and preserve documents of historical significance. While Reed's intentions were laudable, his operation of KWF's finances was not. For many years, Reed comingled his personal assets with those of KWF in order to shield his assets from his many creditors, used assets that supposedly belonged to KWF for his own purposes, and treated KWF as his personal “piggy bank.” In 2014, Reed filed for personal bankruptcy under Chapter 7 of the Bankruptcy Code (the “Bankruptcy Proceeding”). The Bankruptcy Court appointed Appellee Kenneth Nathan (the “Trustee”) as the Trustee of Reed's bankruptcy estate (the “Estate”). During the course of the Bankruptcy Proceeding, the Trustee filed a motion seeking an order that required KWF to turn over assets that it claimed to own (the “Turnover Motion”). The Trustee alleged that the assets in question were, in fact, assets of the Estate. The Bankruptcy Court held several days of hearings on the Turnover Motion, concluded that nearly all of the assets in dispute did belong to the Estate, and entered a final order that required KWF to turn over the bulk of these assets to the Trustee (the “Final Turnover Order”).[1]

         In this appeal, Reed and KWF urge the Court to vacate the Final Turnover Order. They argue that (1) the Bankruptcy Court lacked jurisdiction to enter the Final Turnover Order; (2) the Bankruptcy Court erred by adjudicating the turnover proceedings in the context of a contested motion rather than in an adversary proceeding; and (3) the Bankruptcy Court deprived KWF of its Seventh Amendment right to a jury trial. The Court disagrees.

         The Bankruptcy Court did precisely what it had to do in order to properly administer the Estate. And it did what bankruptcy commissioners, referees, and judges have been doing with Supreme Court approval for well over seventy-five years. The Bankruptcy Court did not exceed its statutory jurisdiction, violate Article III of, or the Seventh Amendment to, the United States Constitution, or cause KWF any cognizable prejudice. Accordingly, for the reasons explained in detail below, the Court AFFIRMS the Final Turnover Order.

         I

         Reed is a licensed attorney who lives in Detroit, Michigan. (Final Turnover Order, Bankruptcy Proceeding Dkt. #344 at 2, citing 11/2/2015 Hearing Tr., Bankruptcy Proceeding Dkt. #296 at 21-22, 52.) “In the early 1990's, [] Reed became interested in purchasing documents and writings which he believed to have historical significance.” (Id. at 3.) In 1996, Reed and two other individuals incorporated KWF as a non-profit organization in order “to collect and preserve records, relics, and other things of historical interest” such as “papers, memoirs, and memorabilia.” (KWF Articles of Incorporation, Bankruptcy Proceeding Dkt. #167 at Ex. 2.) “Since at least 2012, Reed has had sole control over the financial affairs of KWF.” (Final Turnover Order, Bankruptcy Proceeding Dkt. #344 at 27, citing 10/7/2015 Hearing Tr., Bankruptcy Proceeding Dkt. #257 at 118-120 and KWF Trial Exhibit 1, Bankruptcy Proceeding Dkt. ## 195-1 - 195-7.)

         On August 28, 2014, Reed filed the Bankruptcy Proceeding.[2] (See Bankruptcy Proceeding, Dkt. #1.) On February 27, 2015, the Trustee initiated a related adversary proceeding in the Bankruptcy Court against KWF and five other Defendants (the “Adversary Proceeding”).[3] (See Adversary Proceeding, Dkt. #1.) The Trustee's First Amended Complaint in the Adversary Proceeding alleged that Reed fraudulently conveyed certain real and personal property to KWF “for the purpose of defrauding Reed's creditors.” (First. Am. Compl., Adversary Proceeding Dkt. #50 at 2.) The Trustee sought “a judgment avoiding and recovering the property transferred [to KWF] in the Fraudulent Transfers, or the value thereof, from [KWF] for the benefit of the [] Estate.” (Id. at 19-20.)

         KWF filed a motion to dismiss the First Amended Complaint on March 30, 2015. (See Adversary Proceeding Dkt. #21.) It also demanded a jury trial on the claims raised in the First Amended Complaint. (See Adversary Proceeding Dkt. #25.) Finally, KWF filed a motion to withdraw the reference to the Bankruptcy Court and requested that the claims in the First Amended Complaint be adjudicated in district court. (See Adversary Proceeding Dkt. #65.)

         During the initial phases of the Adversary Proceeding, the Trustee came to believe that many of the assets that were the subject of the fraudulent transfer claim actually belonged to Reed. The Trustee then changed his approach. Instead of seeking to obtain the assets through the fraudulent conveyance claim in the Adversary Proceeding, the Trustee attempted to acquire the assets by filing the Turnover Motion in the underlying Bankruptcy Proceeding.[4] In the Turnover Motion, the Trustee sought an order to compel KWF to surrender “[a]ny and all [of its] assets” (hereinafter, the “Turnover Assets”). (See Bankruptcy Proceeding Dkt. #149 at 1-2.) The Trustee filed the Turnover Motion under 11 U.S.C. § 542(a) (“Section 542(a)”), a statute that requires an entity “in possession, custody, or control” of property belonging to a bankruptcy estate to “deliver” that property to the estate's trustee “unless such property is of inconsequential value or benefit to the estate.” 11 U.S.C. § 542(a). KWF filed a response to the Turnover Motion on July 6, 2015. (See Bankruptcy Proceeding Dkt. #167.)

         The Bankruptcy Court held an initial hearing on the Turnover Motion on July 21, 2015. The court heard legal arguments from counsel at that hearing but did not take testimony. “At the conclusion of the hearing, the [Bankruptcy] Court issued a preliminary ruling that there were already pleadings in the record from which the [c]ourt could conclude” that some of the property in question belonged to the Estate. (Final Turnover Order, Bankruptcy Proceeding Dkt. #344 at 14.)

         The Bankruptcy Court then scheduled an evidentiary hearing to determine “whether any of the assets held by KWF, or allegedly held by KWF [i.e., the Turnover Assets], were property of the [] [E]state.” (Id.) The parties took vastly different positions on that issue. KWF acknowledged that Reed had once owned some of the Turnover Assets, but it insisted that it lawfully acquired those assets in 2004 when Reed assigned all of his property to KWF (the “Purported Assignment”). KWF further argued that the Turnover Assets should not be deemed part of the Estate because it (KWF) had a truly separate existence from Reed. The Trustee countered that that the Turnover Assets belonged to the Estate because Reed had extensively comingled his assets and personal financial affairs with those of KWF.

         The Bankruptcy Court conducted the evidentiary hearing over three days in the Fall of 2015. During this hearing, the Bankruptcy Court allowed the Trustee and KWF to examine witnesses, introduce evidence, and present legal argument. At the conclusion of the evidentiary hearing, the Bankruptcy Court allowed each party to file a post-hearing brief.

         On December 17, 2015, the Bankruptcy Court entered the Final Turnover Order and held that the Turnover Assets were part of the Estate. (See Final Turnover Order, Bankruptcy Proceeding Dkt. ## 344, 345.) In its decision, the Bankruptcy Court addressed KWF's claims that it owned the Turnover Assets by virtue of the Purported Assignment and its claimed separate existence from Reed. The court determined that notwithstanding the Purported Assignment and KWF's formal legal status as an independent entity, the Turnover Assets were properly considered part of the Estate because Reed had comprehensively comingled his financial affairs with those of KWF and had maintained control of assets that supposedly belonged to KWF. (See Final Turnover Order, Bankruptcy Proceeding Dkt. #344 at 31-32.) The court highlighted many examples of Reed comingling his financial affairs with those of KWF, maintaining control over KWF's purported assets, or both:

. While KWF claimed to own a personal residence on Burns Street in Detroit where Reed lived (the “Burns Property”), title to the Burns Property was always in Reed's name. (See Final Turnover Order, Bankruptcy Proceeding Dkt. #344 at 24.) Moreover, Reed granted a mortgage on the Burns Property as security for a loan to him personally and deducted from his personal tax obligations the property taxes paid on that property. (See id.)
. In August 2013, Reed sold books belonging to KWF to Glen Horowitz Bookseller, Inc. for $15, 000, and Reed had that money deposited into a KWF checking account. (See id.) Reed then used those funds “to pay [his] personal expenses.” (Id.)
. “[P]ayments for the sale of [other] books by KWF were deposited into a KWF bank account and then used to pay [Reed's] personal expenses.” (Id. at 26.)
. In March 2014, “Reed sold a letter from Martin Luther King to Rosa Parks” for $65, 000. (Id. at 25-26.) Reed “testified that the letter came from the inventory of the [KWF], ” but bank statements established that the funds from the sale of the letter “were used to pay Mr. Reed's personal expenses, specifically his mortgage, his car payment, his utility bills, and his credit card bills.” (Id. at 26; internal quotation marks omitted.)
. Reed had his Social Security income deposited into KWF bank accounts and then used those accounts “to pay all, or most of, his personal expenses, including the mortgage on the Burns Property, utilities, credit cards, and [his] Lexus car payment.” (Id. at 27-28.)
. In 2014, Reed settled a civil lawsuit to which KWF was not a party, had settlement funds owed to him “deposited in a KWF bank account, ” and he then used those funds “either to benefit himself or to pay [his] preferred creditors.” (Id. at 30.)
. Reed “has always maintained [personal] control of the memorabilia he has collected [in KWF's name] over the years, and has used it to generate revenue for himself, not for the benefit of KWF.” (Id. at 25; emphasis added.) . Reed hid from the Trustee assets that KWF was required to produce for inspection. (See id.) . “Reed's control of the finances of KWF made it possible for Reed to use KWF's bank accounts as his own.” (Id. at 31.)
. Finally, Reed caused KWF to execute a promissory note as security for a $110, 000 loan even though the borrowed funds were “used for some other purpose than to benefit KWF.” (Id. at 28-29.)

         From this evidence, the Bankruptcy Court determined that Reed “used KWF as his personal piggy bank” and had “comingled his financial affairs with those of KWF to the point where [he] treat[ed] all of KWF's assets as his own.” (Id. at 31-32.) The court therefore held that the Turnover Assets were properly deemed property of the Estate. (See Id. at 32.)

         The Bankruptcy Court entered the Final Turnover Order on December 17, 2015. (See Bankruptcy Proceeding at Dkt. ## 344, 345.) KWF timely filed its appeal of the Final Turnover Order in this Court on December 28, 2015. (See ECF #1.)

         II

         A federal district court has jurisdiction to hear appeals - and an aggrieved litigant may appeal as of right - from “final judgments, orders, and decrees” of a bankruptcy court. 28 U.S.C. § 158(a)(1). The Court reviews the Bankruptcy Court's legal conclusions de novo and its findings of fact for clear error. See In re Dilworth, 560 F.3d 562, 563 (6th Cir. 2009). “On an appeal the district court or bankruptcy appellate panel may affirm, modify, or reverse a bankruptcy judge's judgment, order, or decree or remand with instructions for further proceedings.” Fed.R.Bankr.P. 8013.

         III

         A

         “The only way to fully comprehend federal bankruptcy jurisdiction - including the current assignment of adjudicatory authority to non-Article III bankruptcy judges - is to understand the history of federal bankruptcy jurisdiction.” Ralph Brubaker, A ‘Summary' Statutory and Constitutional Theory of Bankruptcy Judges' Core Jurisdiction After Stern v. Marshall, 86 Amer. Bankr. L.J. 121, 122 (2012).[5] That history is an important guidepost in assessing the limits of bankruptcy court jurisdiction because the Supreme Court has “offered no comprehensive rule for application across all cases.” In re Renewable Energy Dev. Corp., 792 F.3d 1274, 1279-80 (10th Cir. 2015).

         Consulting the parameters of bankruptcy court jurisdiction that prevailed under the Bankruptcy Act of 1898 (the “1898 Act”) is especially helpful in delineating the limits of modern bankruptcy court jurisdiction. Justices of the Supreme Court and leading bankruptcy scholars have recently drawn upon those parameters as they have wrestled with the extent to which Article III of the United States Constitution limits modern bankruptcy court jurisdiction. See, e.g., Wellness Intern. Network, Ltd. v. Sharif, __ U.S. __, 135 S.Ct. 1932, 1952-54 (2015) (Roberts, C.J. dissenting[6]); id. at 1967-68 (Thomas, J., dissenting); Brubaker, 86 Amer. Bankr. L. J. at 122. And they have suggested that Article III does not limit a modern bankruptcy court's jurisdiction to enter a final order in a matter that would have fallen within the historical summary jurisdiction of bankruptcy courts. See Sharif, 135 S.Ct. at 1952-54 (Roberts, C.J., dissenting); Brubaker, 86 Amer. Bankr. L. J. at 122.

         The practice under the 1898 Act also sheds important light on the statutory jurisdiction of modern bankruptcy courts to enter final orders. The Supreme Court “will not read the Bankruptcy Code to erode past bankruptcy practice absent a clear indication that Congress intended such a departure.” Hamilton v. Lanning, 560 U.S. 505, 517 (2010), and as explained below, Congress gave no “clear indication” in the Code that it intended to subtract from the historical jurisdiction bankruptcy courts have long enjoyed. On the contrary, Congress' objective is to “giv[e] bankruptcy courts as much core jurisdiction as is constitutionally permissible.” Brubaker, 86 Am. Bankr. L.J. at 124, 128.

         To be sure, under current Supreme Court precedent, questions of modern bankruptcy court jurisdiction generally - and the specific jurisdictional questions currently before this Court - cannot be answered solely by looking to past practice. But in trying to understand whether a bankruptcy court exceeded its jurisdiction in entering a particular final order, it makes good sense to begin by determining whether the challenged order would have fallen with the historical jurisdiction of bankruptcy courts to enter final orders. So this Court begins with that question as it wrestles with the ultimate inquiry of whether the Bankruptcy Court lacked jurisdiction to enter the Final Turnover Order.

         B

         “At its most basic level, bankruptcy is ‘an adjudication of interests claimed in a res, '” and in order to adjudicate those interests, a bankruptcy court must first determine the parameters of the res. Sharif, 135 S.Ct. at 1952 (Roberts, C.J. dissenting) (quoting Katchen v. Landy, 382 U.S. 323, 329 (1966)). Indeed, “[d]efining what constitutes the estate is the necessary starting point of every bankruptcy; a court cannot divide up the estate without first knowing what's in it.” Id. That is precisely why “[i]dentifying property that constitutes the estate has long been a central feature of bankruptcy adjudication.” Id. (discussing the historical authority of English bankruptcy commissioners).

         But bankruptcy courts have not had unlimited authority to determine that property belongs to a bankruptcy estate. The extent of their power to bring property within the estate has turned, in large part, on whether the property was in the actual or constructive possession of the debtor - and thus the bankruptcy court[7]- at the time the debtor filed for bankruptcy. Where the debtor did possess the property, the bankruptcy courts have been permitted to adjudicate all disputes concerning title to the property - including claims of ownership by third parties - and to order that the property be surrendered to the estate.

         The practice under the 1898 Act illustrates these broad historical powers of bankruptcy courts. Under that Act, “bankruptcy referees had authority to exercise ‘summary' jurisdiction over certain claims, while other claims could only be adjudicated in ‘plenary' proceedings before an Article III district court.” Id. (citing Executive Benefits Ins. Agency v. Arkison, 573 U.S. __, 134 S.Ct. 2165, 2170 (2014)). A bankruptcy referee's summary jurisdiction under the 1898 Act included the “power … to adjudicate, without consent, controversies concerning the title to property of which [the court] had possession.” Taubel-Scott-Kitzmiller Co. v. Fox, 264 U.S. 426, 432-33 (1924). Stated another way, “if the property were in the custody of the bankruptcy court or its officer, any controversy raised by an adverse claimant setting up a title to or lien upon it might be determined on summary proceedings in the bankruptcy court, and would fall within the jurisdiction of the referee.” Weidhorn v. Levy, 253 U.S. 268, 271-72 (1920) (emphasis added).

         The possession that gave rise to a bankruptcy court's broad summary jurisdiction did “not” have “to be actual.” Id. “Constructive possession [was] sufficient.” Id. And such possession “exist[ed]” in a number of circumstances, including, where the debtor had “control” over it at that time (constructive possession). Weidhorn, 253 U.S. at 271-72 (internal citations omitted) (bankruptcy court did not have actual or constructive possession over property which would have given rise to summary jurisdiction because debtor did not have “possession or control” over property”).[8]

         Under limited circumstances, a bankruptcy court was even deemed to have constructive possession of - and thus summary jurisdiction over - property held by a third party. Such constructive possession existed where the debtor's estate had a claim to the property and where third party's “claim [to the property was] colorable only.” Taubel-Scott-Kitzmiller Co. 264 U.S. at 432-33. Constructive possession did not exist where the third party in possession raised a “substantial adverse” claim to the property. In re Wiltse Bros. Corp., 357 F.2d 190, 193 (6th Cir. 1966) (“General principles establish that where the actual or constructive possession is in a third person, the Bankruptcy Court only has jurisdiction when it determines that the property is not held under a substantial adverse claim”).

         Importantly, bankruptcy courts retained jurisdiction to determine whether a third party raised a merely “colorable” claim to property (in which case the bankruptcy court had constructive possession of the property and summary jurisdiction to resolve competing claims to it) or a “substantial adverse” claim (in which case the bankruptcy court lacked constructive possession and could not summarily decide claims with respect to that property). As the Supreme Court explained, a bankruptcy court was empowered to “conclude, where it lack[ed] actual possession, that the physical possession held by some other persons [was] of such a nature that the property [was] constructively within the possession of the court.” Taubel-Scott-Kitzmiller, 264 U.S. at 434. In other words, the Supreme Court reserved to the bankruptcy court “the power and the duty” to determine whether a third party's claim to property was a “substantial adverse” one or a “merely colorable” one. Cline v. Kaplan, 323 U.S. 97, 99 (1944).

         In Harrison v. Chamberlain, 271 U.S. 191, 194-95 (1926), the Supreme Court provided bankruptcy courts with “the test to be applied in determining whether an adverse claim is substantial or merely colorable.” Under this test, a third party's claim “is to be deemed of a substantial character when the claimant's contention discloses a contested matter of right, involving some fair doubt and reasonable room for controversy, in matters either of fact or law; and is not to be held merely colorable unless the preliminary inquiry shows that it is so unsubstantial and obviously insufficient, either in fact or law, as to be plainly without color of merit, and a mere pretense.” Id. (quotation omitted).

         C

         In Sampsell v. Imperial Paper & Color Corp., 313 U.S. 215 (1941), the Supreme Court applied the above-described rules to determine whether a bankruptcy court had summary jurisdiction to declare that property titled to an affiliate of the debtor belonged to the debtor's bankruptcy estate. Sampsell involved a debtor named Wilbur Downey (“Downey”). Prior to 1936, Downey “had engaged in business, unincorporated, and had incurred a debt to the predecessor of Standard Coated Products Corporation of approximately $104, 000.” Sampsell, 313 U.S. at 215. In June of 1936, Downey formed a corporation, transferred his personal stock to the corporation, and thereafter conducted business in the name of the corporation. See Id. In 1938, Downey “was adjudged a voluntary bankrupt, ” and during the bankruptcy proceedings, the assigned bankruptcy referee ordered Downey and the corporation to show cause “why the assets of the corporation should not be marshalled for the benefit of the creditors of the bankrupt estate and administered by the trustee.” Id. at 216. The referee held a hearing, found that the corporation was a mere “sham and a cloak” designed to preserve assets for Downey's family, and entered a final order declaring “that the property of the corporation was property of the bankrupt estate and that it be administered for the benefit of creditors.” Id. at 217.

         The Supreme Court held that there was “no question but that the jurisdiction of the bankruptcy court was properly exercised by summary proceedings.” Id. at 218. The court explained that a mere alter ego of the debtor is in no position to make a “substantial adverse” claim to property that would deprive a bankruptcy court of constructive possession - and thus summary jurisdiction - over the property under “the rule of Taubel-Scott-Kitzmiller Co. [supra]”:

The legal existence of the affiliated corporation does not per se give it standing to ...

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