Hower, John v. Molding Systems ( 2006 )

In the
United States Court of Appeals
For the Seventh Circuit
____________
No. 05-1889
JOHN HOWER,
Plaintiff-Appellant,
v.
MOLDING SYSTEMS ENGINEERING CORP.,
Defendant-Appellee.
____________
Appeal from the United States District Court
for the Southern District of Illinois.
No. 04-502-MJR—Michael J. Reagan, Judge.
____________
ARGUED DECEMBER 9, 2005—DECIDED APRIL 19, 2006
____________
Before FLAUM, Chief Judge, RIPPLE and WILLIAMS, Circuit
Judges.
WILLIAMS, Circuit Judge. Creditor-appellant John Hower
moved to stay the sale of the debtor’s assets in this bank-
ruptcy proceeding. The bankruptcy court denied the motion
on its merits and Hower appealed to the district court. That
court dismissed the appeal as moot because the sale had
already taken place, and because we agree with that
decision, we affirm the ruling of the district court.
2 No. 05-1889
I. BACKGROUND
In September of 2003, creditor-appellant John Hower won
an Illinois state court judgment in excess of $500,000
against debtor-appellee Molding Systems Engineering
Corporation (“Molding”). A few weeks later, Molding filed a
voluntary petition for Chapter 11 bankruptcy protection.
Molding filed a motion in the bankruptcy court to sell
certain of its assets free and clear of liens and claims,
including Hower’s judgment creditor claim. This motion
requested that Molding’s assets be sold to Molding Services
of Illinois (“MSI”), a new corporation owned and led by the
same pair of individuals who owned and ran the now-
bankrupt Molding. Put simply, Molding and MSI share the
same president and the same majority shareholder. Hower
objected to the motion on several grounds, including the
argument that it was not filed in good faith, but rather was
an attempt to continue in business under a different name
while avoiding Hower’s claim. At the hearing on that
motion, the bankruptcy judge gave Hower the opportunity
to try to locate competing bidders for the assets within 30
days. Unable to locate any other bidder within the 30-day
period, Hower filed his own bid for the assets, offering to
assume Molding’s debts.
At the next hearing, MSI and Molding’s secured creditors
presented numerous arguments supporting MSI’s bid as the
superior bid. The bankruptcy trustee stated that he did not
share Hower’s objection to the MSI bid. MSI’s lawyer
explained that while Molding and MSI shared the same
president and same major shareholder, the corporations
were meaningfully distinct entities because MSI had
obtained $250,000 in operating funds which it could use to
keep the business functioning, whereas Molding had assets
of five dollars. Two secured creditors (banks) who were
owed several hundred thousand dollars by Molding noted
that they strongly supported the MSI sale because they
believed that MSI’s infusion of cash would keep the busi-
No. 05-1889 3
ness operating, while there was no indication that Hower
had enough funds to meet the payroll. Additionally, Hower’s
offer to assume Molding’s debts carried no weight with
these creditors because he had not contacted them or given
them any assurance that he could actually bear those
debts.1 Following the presentation of these arguments, the
bankruptcy judge orally granted the motion for sale to MSI
and denied Hower’s motion to buy.
On June 7, 2004, the bankruptcy court entered a written
sale order authorizing the MSI sale, explicitly finding
that MSI was a good-faith purchaser and stating that,
notwithstanding Federal Rules of Bankruptcy Procedure
6004(g) and 6006(d), the order would take effect immedi-
ately and “shall not be stayed.” On June 15, Hower filed a
motion to stay the sale. On June 16, the judge denied this
motion on the merits, explaining that a rapid sale was in
the best interests of the creditors. On June 17, Hower
appealed that denial to the district court. On June 24,
Molding filed a Report of Sale stating that the sale of assets
to MSI had closed on June 8, the day after the sale order
was entered. In light of the completed sale, the district
court denied Hower’s appeal as moot. This appeal followed.
II. ANALYSIS
A. Hower’s appeal from the sale order to the district
court was moot.
Whether an appeal was properly dismissed as moot is a
legal question; thus, our review of the district court’s ruling
is de novo. Higgason v. Farley, 83 F.3d 807 (7th Cir. 1996).
The district court ruled that Hower’s appeal was moot
1
MSI also offered the affidavits of Molding’s president and
second shareholder stating that MSI’s bid was fair and required
by exigent circumstances, but those affidavits were later
stricken as inadmissible, so we do not consider them here.
4 No. 05-1889
because the disputed sale had already taken place. This is
correct. The Bankruptcy Code provides that absent a stay
of sale, appeals of orders authorizing asset sales do not
affect the validity of sales to entities that purchased the
assets in good faith. 11 U.S.C. § 363(m). In the absence of a
stay pending appeal, the good-faith sale of a debtor’s assets
is final. The Code strongly favors finality because the
protection of good-faith purchasers maximizes the value of
the assets for sale, which benefits both debtors and credi-
tors. In re CGI Indus., Inc., 27 F.3d 296, 299 (7th Cir. 1994).
Here, there is no question that no stay was entered, that
the bankruptcy court made an explicit finding of good faith,
and that the sale took place. Therefore, the appeal is moot,
because the sale is final and this court is powerless to
provide Hower the remedy he seeks. Id.B. The bankruptcy court’s refusal to stay the sale
was not an abuse of discretion.
Although we have found that the appeal is moot, we
will address Hower’s argument that this court may evaluate
the correctness of the underlying sale order because of the
bankruptcy court’s alleged errors regarding the issuance of
a stay and the finding of good faith. In other words, he
complains that improper circumstances and wrongful
actions by the bankruptcy court led to the improper sale
that mooted his claim. These underlying arguments fail on
the merits.
Federal Rule of Bankruptcy Procedure 6004(g) provides
that orders authorizing the sale of debtors’ assets are
automatically subject to a ten-day stay unless the court
orders otherwise. We review a bankruptcy court’s decision
to lift an automatic stay for abuse of discretion. In re Meyer
Med. Physicians Group, Ltd., 385 F.3d 1039, 1041 (7th Cir.
2004). Here, the court explicitly ordered otherwise and
declined to reconsider its decision eight days later when
No. 05-1889 5
Hower moved for a stay. “[B]ankruptcy courts face a
difficult task in weighing the competing interests implicated
by upset bids . . . [T]hey must be accorded maximum
discretion in striking an appropriate balance.” Corporate
Assets, Inc. v. Paloian, 368 F.3d 761, 770 (7th Cir. 2004).
Given the unusually exigent circumstances of this case—the
debtor had five dollars in its coffers, it had dozens of full-
time employees and a payroll to meet, and the purchaser
offered to make $250,000 available to keep operations
going—the judge acted within his discretion in expediting
the purchase, particularly in light of the trustee’s and the
secured creditors’ approval of the sale and Hower’ slim
chance of prevailing on appeal. Hower’s equitable point that
the lack of a stay effectively denied him the opportunity to
appeal the court’s decision carries some force, but this
circumstance is contemplated by the Code’s preference for
finality in sale orders and the broad discretion it provides
judges to deny stays pending appeal. Therefore, it was not
an abuse of discretion for the bankruptcy judge to prioritize
the debtor’s ability to operate over Hower’s right to pursue
an appeal.
C. The bankruptcy court’s determination of good
faith was not clearly erroneous.
Although a good-faith sale of a debtor’s assets is unaf-
fected by a later challenge to or revocation of the sale
authorization, asset sales may be challenged after the fact
if there was collusion, fraud, or the sale otherwise mani-
fested bad faith. In re Andy Frain Servs., Inc, 798 F.2d 1113(7th Cir. 1986). Good faith is a factual finding and reviewed
for clear error. In re Smith, 286 F.3d 461, 464 (7th Cir.
2002). Hower’s argument that MSI was not a good-faith
purchaser is predicated on the fact that it is an insider
corporation formed by the same two individuals who
controlled Molding. Superficially, this argument has appeal,
6 No. 05-1889
as there may be something suspect in the officers and
shareholders of a debtor company forming a new corpora-
tion to buy the assets of the debtor they previously misman-
aged. In other words, the facts in this case could
be interpreted as allowing the former president and share-
holder of Molding to shed undesired debt and repurchase
core assets at a discount. But in order to encourage insol-
vent debtors to continue operating and generating revenue
for the creditors, bankruptcy debtors are permitted to do
exactly that, provided that the insider involvement is
disclosed at the beginning of the proceedings. See, e.g., In re
Firstmark Corp., 46 F.3d 653, 656 (7th Cir. 1995) (citing
with approval the district court’s statement that “sale of a
debtor’s property to an insider is subject to close scrutiny.
However, it is not bad faith per se” and only constitutes bad
faith if there is a breach of the duty of full disclosure). And
there is good reason for allowing such transactions. That is,
the failure of a company may be due to adverse market
conditions—rather than flagrant mismanagement—and the
former officers may be in the best position to make use of
the assets and formulate a successful future business
model. As a result, there may be circumstances where an
effective repurchase of assets is the most efficient business
outcome. The approval of the trustee and secured creditors
here suggests that this is such a case.
Hower points out that Molding and MSI failed to sub-
mit admissible evidence demonstrating that the sale
occurred in good faith. That may be so, but Hower likewise
fails to support his allegation of bad faith with documents,
testimony, personal knowledge, or anything other than the
accusation that this was an insider sale. While the Bank-
ruptcy Code neither defines good faith nor states how it
is to be established, this court has placed the burden on the
party alleging bad faith or seeking reconsideration of a
good-faith finding. See, e.g., In re Andy Frain Servs., Inc,
798 F.2d at 1125 (“Although Wilson presents a number of
No. 05-1889 7
reasons why we should find bad faith, none of them are
persuasive”); see also Katten v. Bailey, No. 95-C-2720,
1995 U.S. Dist. LEXIS 14431, at *17 (N.D. Ill. Oct. 2, 1995)
(applying Andy Frain and concluding that “upon appear-
ing before the Bankruptcy Court, the plaintiff-appellants
were required to establish by a preponderance of the
evidence that Edward Fox was not a good faith purchaser”).
In the absence of any admissible evidence of bad faith, we
cannot say that it was clear error for the bankruptcy judge
to conclude that the sale occurred in good faith.
Hower’s final arguments merit only the briefest discus-
sion. He argues that there was no evidence that the par-
ties closed on the sale before the appeal was filed, but a
Report of Sale was in fact filed describing the closing.
Hower offered no evidence to contradict that document, and
the bankruptcy court was perfectly entitled to accept it as
valid. Hower’s argument that Federal Rule of Civil Proce-
dure 62(a) controls his right to a stay pending appeal is
simply wrong; the applicable rule in this matter is Federal
Rule of Bankruptcy Procedure 6004(g), discussed above.
Hower’s complaint appears to be driven by the under-
standable grievance that the debtors here are legally
evading payment of his judgment.2 But the very existence
of bankruptcy courts contemplates that sometimes unse-
cured creditors will fail to collect all or part of their legiti-
mate claims. The task of the court is to relieve an honest
debtor’s burden and apportion the loss equitably and
efficiently, not to ensure that every creditor gets his due. 1
BANKR. DESK GUIDE § 1.5 (2005).
2
The validity of Hower’s claim is in question, although that issue
is not before us at the moment. A parallel proceeding is currently
addressing the question of whether his failure to declare his claim
against Molding as an asset in his own pro se personal bankruptcy
judicially estops him from pursuing collection of that judgment.
8 No. 05-1889
III. CONCLUSION
For the foregoing reasons, we AFFIRM the ruling of the
district court.
A true Copy:
Teste:
________________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-02-C-0072—4-19-06