First Premier Capital LLC v. Republic Bank (In Re Equipment Acquisition Resources Inc.) , 692 F.3d 558 ( 2012 )

In the
United States Court of Appeals
For the Seventh Circuit
No. 11-3905
IN R E:
E QUIPMENT A CQUISITION R ESOURCES INC.,
Debtor.
F IRST P REMIER C APITAL LLC n/k/a C OMMEND
C APITAL LLC,
Appellant,
v.
R EPUBLIC B ANK OF C HICAGO and W ILLIAM A. B RANDT, JR.,
acting solely in his capacity as Plan Administrator for
Equipment Acquisition Resources Inc.,
Appellees.
Appeal from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 11 C 6249—Elaine E. Bucklo, Judge.
A RGUED M AY 24, 2012—D ECIDED A UGUST 9, 2012
Before C UDAHY, K ANNE, and H AMILTON, Circuit Judges.
C UDAHY, Circuit Judge. This is a case about the ap-
proval of a settlement plan that could potentially prej-
2 No. 11-3905
udice the litigation stance of a third party. Equipment
Acquisition Resources, Inc. (EAR) was a corporation
engaged in the sales and service of semiconductor manu-
facturing equipment. EAR defrauded various creditors
in what was apparently a Ponzi scheme. The com-
pany’s illegal activity included tricking banks into fi-
nancing non-existent or grossly overvalued equipment
and pledging certain pieces of equipment multiple times
to different creditors. After the fraud was discovered,
EAR filed for bankruptcy. As the Chief Restructuring
Officer, William A. Brandt decided to abandon a portion
of EAR’s assets; then, acting as the plan administrator,
he undertook litigation on behalf of the company to pay
its unsecured creditors. First Premier Bank is EAR’s
largest creditor. First Premier is concerned that another
creditor, Republic Bank of Chicago (Republic), is working
in concert with Brandt to enlarge Republic’s secured
interest in EAR’s assets.
The present case concerns five equipment leases
running between EAR and Alliance Commercial Cap-
ital (Alliance) that granted Alliance a secured interest
in EAR’s equipment. Alliance filed UCC financing state-
ments with the Illinois Secretary of State perfecting its
security interests in the leases and other personal property.
Shortly thereafter, Alliance assigned all five leases to
Republic Bank of Chicago. Republic and EAR amended
the leases, providing that EAR would pay down part of
the leases (approximately $4.6 million), EAR would give
a blanket security interest in all its assets to Republic
and Republic would forebear on claims it had against
No. 11-3905 3
EAR. However, the amendment had a typographical
error (a “typo”), incorrectly giving Republic a security
interest in Republic’s own assets, rather than EAR’s
assets. Republic filed UCC financing statements
claiming to have a blanket lien on EAR’s assets.
EAR’s fraud against its creditors was eventually discov-
ered and Brandt was appointed as the company’s Chief
Restructuring Officer. Upon learning that the equipment
stored by EAR was both grossly overvalued and subject
to multiple liens, Brandt decided to abandon the EAR
Estate’s interest in that equipment. The abandoned equip-
ment was auctioned. Based on its understanding that it
has a blanket lien on EAR’s assets, Republic claims the
largest share of the auction proceeds. The matter is cur-
rently being litigated in the Circuit Court of Cook County,
Illinois, by nearly all of EAR’s creditors (“the Cook
County Litigation”). First Premier is a party in that suit.
After abandoning its interest in the equipment, EAR
began to pursue its litigation plan. EAR filed an ad-
versary action against its outside auditors, VonLehman
& Company and Brian Malthouse, in Bankruptcy Court
for accounting malpractice as a result of their failure
to recognize EAR’s fraudulent dealings. EAR earlier
tried to settle this case and bar creditors from pursuing
claims against the outside auditors, but, due to the ob-
jections of the creditors, the bankruptcy court denied
this request. Subsequently, as EAR continued to pur-
sue its litigation plan, it filed an adversary action
against Republic. EAR sought to avoid and recover the
$4.6 million transfer to Republic that occurred as part of
4 No. 11-3905
the lease modification agreement. Additionally, EAR
sought declaratory relief against Republic’s blanket lien
claim and an injunction preventing Republic from suing
the auditors.
Several months later, Brandt submitted a Motion to
Approve Settlement Pursuant to Rule 9019 of the Fed-
eral Rules of Bankruptcy Procedure with Republic (the
“Settlement Motion”) to end the EAR-Republic adversary
action. The settlement called for a continuation of the
two parties’ suits against auditor VonLehman, a divvy
of any proceeds from those suits and a retroactive modi-
fication of the earlier Republic blanket lien transfer to
correct the typo to reflect that Republic has a blanket
lien on EAR’s assets rather than Republic’s.
First Premier objected to this settlement, arguing
that (1) EAR and Republic could not, under In re Martin
Grinding & Machine Works, Inc., 793 F.2d 592 (7th Cir.
1986), retroactively reform a fatal defect in the earlier
lease amendment; (2) Republic was attempting to bolster
its case in the Cook County Litigation in violation of
Brandt’s duty to EAR’s creditors; and (3) the Settlement
Motion did not provide an analysis indicating that the
settlement was in the best interests of the creditors.
The bankruptcy court approved the Settlement Motion,
finding that reformation of the lease was at least possible
and that the settlement would avoid expensive litiga-
tion for the estate. The court specifically noted that its
approval order was not intended to resolve whether
Republic in fact had a lien on the assets involved in the
Cook County Litigation. Then First Premier appealed to
No. 11-3905 5
the district court. The district court affirmed: distinguish-
ing Martin Grinding, and finding that EAR could have
potentially suffered an adverse judgment had EAR not
entered into the settlement with Republic. First Premier
appeals.
The district court had jurisdiction pursuant to 28 U.S.C.
§ 158(a)(1). This court has jurisdiction under 28 U.S.C.
§ 1291. We review a district court’s approval of a settle-
ment for abuse of discretion.1
I.
Republic’s original lease amendments contain typo-
graphical errors relating to the collateral securing an
interest in Republic’s assets rather than EAR’s. Section 9-203
of the Uniform Commercial Code (UCC) provides that “[a]
security interest attaches to collateral when it becomes
enforceable against the debtor with respect to the col-
lateral.” 810 Ill. Comp. Stat. 5/9-203(a) (2009). This interest
will be enforceable against third parties with respect to
the collateral if the “debtor has authenticated a
security agreement that provides a description of the
collateral.” 5/9-203(b)(3)(A) “A security interest attaches
1
We reject First Premier’s argument that the Settlement
Approval Order was actually an appeal from a claim objection.
First Premier’s objection to the Settlement Motion did not
state that it was making an objection to Republic’s claim.
Further, as will be made clear below, the Settlement Motion
did not award Republic a secured claim, so a challenge to
such a motion may not properly be interpreted as an objection
to a claim.
6 No. 11-3905
only if a signed security agreement properly describes
collateral.” In re Sarah Michaels, Inc., 358 B.R. 366, 377
(Bankr. N.D. Ill. 2007). These typographical errors in the
description of the collateral created a large problem for
Republic, which feared its supposed secured interest
would not attach. As part of the settlement agreement,
the parties agree to reform the lease agreement to
correct this error.
First Premier argues that Martin Grinding precludes
the reformation proposed by Republic and therefore the
bankruptcy court erred in approving the settlement.
However, First Premier misunderstands the legal
posture of the bankruptcy court and the application of
the holding of Martin Grinding.
Martin Grinding involved the inadvertent omission
of specific classes of collateral from the security agree-
ment. There, the creditor loaned funds to the debtor in
exchange for a security interest in the debtor’s machinery,
equipment, furniture, fixtures, inventory and accounts
receivable. 793 F.2d at 593. Although the parties did
not include “inventory” or “accounts receivable” in the
description of the collateral in the security agreement,
the missing items were included in other loan docu-
ments. Id. at 593-94. However this court held that even
though the parties made a mutual mistake and parol
evidence supported their claimed intent to include the
omitted items, the unambiguous security agreement, as
written, controlled. Id. at 597-98. Accordingly, the creditor
did not hold a security interest in inventory or accounts
receivable. Id. at 598. This court noted that this strict
No. 11-3905 7
outcome promotes confidence in the written terms of
secured transactions and allows subsequent creditors
to rely on the contents of security interest documents. Id.
at 596-97. Martin Grinding stands for the notion that
parol evidence may not alter an unambiguous secured
transaction.
However, with respect to the present case there has
been no ruling on the issue of reformation: here, the
bankruptcy court merely noted that reformation was
perhaps possible. The bankruptcy court did not issue
a “precise determ ination of likely outcom es,”
precisely because doing so would defeat the purpose of
compromising the claim. Instead, the bankruptcy court
needed only to consider the possibility of an adverse
outcome for the estate in litigation with Republic.
There are several differences between Martin Grinding
and the instant case indicating that a positive outcome
for EAR in its Republic litigation is not guaranteed.
Further, the present case does not involve the omission
of a class of collateral in a security agreement, as in
Martin Grinding, but instead involves a typo as to the
source of collateral in a lease modification agreement in
the context of a settlement. In fact, unlike the agreement
in Martin Grinding the typo here renders the description
of the collateral in the modification agreement between
Republic and EAR completely ineffective. The agreement
at issue in Martin Grinding unambiguously secured cer-
tain collateral; it listed several classes of collateral that
constituted security, only “inventory” and “accounts
receivable” were omitted from this description. 793 F.2d
8 No. 11-3905
at 593. Despite these two missing classes of collateral,
the agreement was still effective—it still made sense
and successfully conferred a security interest in the
listed classes of collateral to the other party. On the
other hand, the security interest clause in the modifica-
tion agreement between Republic and EAR is not effec-
tive. This clause purports to indicate that EAR has the
authority to grant a security interest in property it does
not own, and that this security interest is conveyed
from Republic to Republic. Not only is this conveyance
impossible, it does not make sense, and unlike the agree-
ment in Martin Grinding it cannot stand on its own as
an unambiguous conveyance.
It is also worth noting that the Martin Grinding court
specifically relied on the fact that the agreement at issue
there was unambiguous. Id. at 595. Consequently, it
never determined whether an ambiguous security agree-
ment could be reformed to correct an error, which is
the issue at hand.
Further, there are public documents reflecting the
understanding between EAR and Republic to the effect
that Republic indeed has a blanket security interest. In
contrast, the parties in Martin Grinding disagreed as to
the scope of the creditor’s security interest. There the
creditor sought to challenge with parol evidence the
debtor’s understanding of the unambiguous security
agreement. 793 F.2d at 593-94. The court in Martin
Grinding made it clear that the reason it was not allowing
parol evidence to enlarge the security agreement was to
prevent confusion—to ensure that subsequent creditors
No. 11-3905 9
had adequate notice of what was at stake. Id. at 596-97.
Here there is much less chance that reformation
would lead to creditor confusion. EAR and Republic
agree that the typo in the original modification agree-
ment was contrary to the intent of the contracting
parties, and all other public documents support this
understanding.
Finally, and perhaps most importantly, Martin Grinding
does not deal with a Rule 9019 settlement. Martin
Grinding is a contest between a creditor and a debtor. The
case here is not so simple. Given the different context
of Martin Grinding, there is no direct parallel between
the two cases. The context precludes any clear applica-
tion of one case to the other.
This preserves the possibility that a reasonable jurist
might find Martin Grinding to control in an appropriate
circumstance. The basis of EAR’s claim might have been
reformed in litigation. Because it is plausible that the
estate might have lost in the EAR-Republic litigation
and because the settlement otherwise benefitted the
estate, neither the bankruptcy court nor the district court
abused its discretion in approving the settlement.
First Premier argues that the settlement is not in the
best interest of the estate and therefore never should
have been approved. Yet, the bankruptcy court noted
that the settlement “puts to rest what could be very
expensive litigation between [the EAR Estate] and [Repub-
lic].” Brandt’s business judgment appears sound in this
respect—avoiding protracted and expensive litigation
10 No. 11-3905
will protect the payout to unsecured creditors, and the
bankruptcy court acted reasonably to agree.
II.
First Premier argues that the settlement unacceptably
gives Republic an advantage in the Cook County Litiga-
tion. The argument is supported by the fact that the
bankruptcy court’s order does purport to reform the
lease agreements. First Premier is obviously concerned
that Republic will introduce the order as proof of its
claim to a blanket lien on the equipment proceeds at
issue in the Cook County Litigation. At first glance it
may appear that Brandt has settled the EAR Estate’s
differences with Republic by, in effect, awarding
Republic some of First Premier’s money. Indeed, the
EAR Estate no longer has any interest in the abandoned
assets at issue in the Cook County Litigation, furthering
the impression that EAR is settling with someone else’s
money.
Such an outcome would obviously be welcome to
Brandt and Republic and unacceptable to First Premier.
However, the bankruptcy court specifically noted that
it was not reaching the merits of the underlying asset
dispute. “Since it is without prejudice to any of the con-
tentions the parties may raise in other litigation in
other fora in which the state or some other court may
take a different view whether or not the amendments
could be appropriately reformed,” there was no final
determination on the issue of reformation. The text of the
order does not indicate the limited nature of the bank-
No. 11-3905 11
ruptcy court’s approval. Instead, the court noted that
rather than redrafting the order, the parties should
“provide some business to the worthy certified short-
hand reporter. She’d provide a transcript of my oral
findings and conclusions.” The bankruptcy court was
thus interested in moving the proceedings along in the
interest of ensuring that unsecured creditors would be
paid “as quickly as possible.”
It is clear that the bankruptcy court was walking a
very fine line. The court approved the settlement in order
to “get money in the estate as quickly as we can so divi-
dends can be paid under the liquidating plan.” But the
settlement, at Republic’s insistence, contained a retro-
active reformation that if granted could potentially nega-
tively impact the rights of third parties. Rather than
require a renegotiation of the settlement, the bankruptcy
court approved the settlement while creating a record
making it clear that the issue of actual reformation was
not determined. The court’s approval of the settlement
does not award Republic a secured claim but skirts
the issue altogether.
The bankruptcy court’s issuance of an order that con-
tains language purporting to reform the lease agreements
and simultaneously disclaiming the consequences of
that language may be perplexing. However, the represen-
tations of Republic at oral argument that the settlement
will not be used to limit the litigation positions of First
Premier or any other third party are reassuring. The
settlement does not reform the lease modifications. It
merely stands as an agreement between the two parties
12 No. 11-3905
that the lease modification agreements are flawed with
a typo.2 Republic does not claim that this agreement
binds third parties.
Republic agreed at oral argument that First Premier
could not be bound by the settlement’s reformation
language. Further, Republic assured us that any proof
of claim filed in the Cook County Litigation “will not
contain a copy of the [bankruptcy court’]s order or the
transcript or make any reference to it.”
Despite First Premier’s concern about the settlement
agreement between EAR and Republic, it has not been
prejudiced by the agreement in any way. For the fore-
going reasons the district court did not abuse its discre-
tion in affirming the bankruptcy court’s decision and
we affirm.
2
During oral argument Republic indicated that it believed the
settlement could be used as evidence of a mutual mistake of
fact in the original lease amendment. We noted that such an
agreement would seem to have little evidentiary standing
since it constitutes hearsay.
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