Belofsky & Belofsky v. Leighton Holdings

In the
United States Court of Appeals
For the Seventh Circuit
Nos. 99-1749 & 99-1803
In the Matter of:
Kids Creek Partners, L.P.,
Debtor.
Appeals of:
David R. Herzog, Trustee, and Belofsky
& Belofsky, P.C. (formerly known as
David A. Belofsky & Associates, P.C.),
Special Counsel for the Trustee
Appeals from the United States District Court for the
Northern District of Illinois, Eastern Division.
No. 98 C 3852 (94 B 23947)--Charles P. Kocoras, Judge.
Argued November 29, 1999--Decided January 10, 2000
Before Bauer, Easterbrook, and Evans, Circuit Judges.
Easterbrook, Circuit Judge. When Kids Creek
Partners entered bankruptcy, its only valuable
asset was an option to acquire a 450-acre parcel
of land at a bargain price. In November 1994 Kids
Creek reached an agreement that would result in
the profitable sale of one part of the parcel to
the County of Grand Traverse, Michigan, and
Munson Healthcare. The buyers threatened to call
off the deal unless Kids Creek conveyed
unencumbered title by the end of the year, which
it could do only by persuading Leighton Holdings,
Ltd., to release a mortgage Leighton held on the
entire parcel. Leighton was unwilling to do this
until its debt had been repaid; Kids Creek could
not pay until it had exercised the option and
sold the land, which it could not do without
Leighton’s cooperation--for even if the
bankruptcy court had the power to approve the
exercise of the option and a sale free from
Leighton’s lien, see 11 U.S.C. sec.363(f)(3), the
lien extended to other interests that could not
be so readily cleared. And Kids Creek did not
want to handle the transaction the most obvious
way--repaying Leighton out of the profits of the
sale--because it contemplated suit against
Leighton on a lender-liability theory and feared
that it might have trouble collecting a judgment
rendered years later. (Leighton is a Cayman
Islands corporation that does not maintain
substantial assets in the United States.)
At the very last moment, on December 30, 1994,
Leighton and Kids Creek (through David Herzog,
its Interim Trustee) struck a bargain. Kids Creek
would exercise the option and immediately
reconvey the land to the buyers for about $2.9
million; this would produce the $2.1 million
needed to repay Leighton, which would release its
liens; Leighton would provide Kids Creek with a
letter of credit to assure satisfaction of any
judgment Kids Creek might secure against
Leighton. Bankruptcy Judge Schmetterer entered a
lengthy order providing for the purchase and
conveyance of the property, payment of the debt,
release of the liens, and posting of the letter
of credit. A handwritten addendum (initialed by
Judge Schmetterer) provides:
If the Trustee initiates such a lawsuit
and [Leighton] prevails, then [Leighton]
shall have an allowed super-priority
administrative claim, prior to the claim
of any holder of a claim otherwise
allowable under section 507(a) of the
Bankruptcy Code, for (a) all costs and
fees associated with the issuance of the
letter of credit; (b) all legal fees and
expenses incurred in the defense of the
lawsuit; (c) all other fees and expenses
reasonably incurred in connection with the
collection of [Leighton’s] claim; and (d)
any and all funds previously drawn by the
Trustee under the letter of credit,
together with interest at [Leighton’s]
contractual default rate.
The deal closed, leaving Kids Creek with
approximately $500,000 in cash to satisfy
creditors other than Leighton. (The surplus was
less than $800,000, because Kids Creek had to pay
the seller of the land.) Instead of paying its
debts, Kids Creek (through Herzog, by then the
permanent Trustee) decided to use the money to
fund a suit (technically an adversary proceeding
in the bankruptcy) against Leighton, which
prevailed after a lengthy battle. Herzog v.
Leighton Holdings, Ltd., 212 B.R. 898 (Bankr.
N.D. Ill. 1997), affirmed, 239 B.R. 497 (N.D.
Ill. 1999). Judge Schmetterer summed up:
Plaintiff complains that the [real estate
development] project was doomed by the
refusal of Leighton as lender to fund the
last advance involved in a series of
loans. But the evidence showed that the
project failed due to mismanagement,
breach of contractual obligations owed by
Debtor to the lender, a lower offered sale
price than was hoped for, and [a] capital
gains tax problem, among other reasons not
caused by Defendants. If the final loan
advance had been extended, the project
still would have failed, and there were
ample contractual grounds to deny the
final funding.
212 B.R. at 904. Having kept its part of the
bargain by maintaining the letter of credit
throughout the litigation, Leighton called on
Kids Creek to reimburse its costs and attorneys’
fees. As a practical matter this meant turning
over the estate’s remaining assets. But Trustee
Herzog and the law firm he hired to prosecute the
suit (Belofsky & Belofsky, P.C.) contended that
their bills should be paid instead. By this time,
all thought of distributing anything to Kids
Creek’s original creditors and investors had
evaporated; Herzog had devoted all of the
estate’s assets to the doomed suit against
Leighton. Herzog and the Belofsky firm contended
that the deal with Leighton in 1994 is invalid
because the Code does not allow such a super-
priority administrative claim.
Judge Schmetterer was not amused by this
belated attempt to turn a business arrangement
into the equivalent of a gift by Leighton to its
adversaries. He ordered the estate’s remaining
assets distributed to Leighton, leaving Herzog
and the Belofsky firm without compensation for
their services. 220 B.R. 963 (Bankr. N.D. Ill.
1998). (In a later order, the bankruptcy judge
required Herzog and the law firm to disgorge all
interim fees they had received. 236 B.R. 871
(Bankr. N.D. Ill. 1999).) Because Leighton’s
claim substantially exceeds the estate’s
remaining assets, Judge Schmetterer did not have
any occasion to conduct a close analysis of its
claim; even the lowest estimate of reasonable
attorneys’ fees exceeds what is available for
distribution. District Judge Kocoras affirmed,
233 B.R. 409 (N.D. Ill. 1999), holding that
Herzog and the Belofsky firm are estopped to
contest the validity of the 1994 super-priority
order. Other creditors might be entitled to
object, for they did not receive notice of the
December 30 proceeding at which the order was
entered. But Herzog negotiated and approved the
order, and the law firm undertook the
representation with knowledge of it. They are in
no position to complain, the judge held. And of
course no one else has appeared to protest;
unsecured creditors (and the original partners)
know that their claims are worthless and have no
interest in the dispute among administrative
claimants.
Herzog and the Belofsky firm devote much of
their appeal to semantic quibbles. Why, it was
the Interim Trustee and his Counsel who approved
the deal in 1994, they say. Neither the Interim
Trustee nor his Counsel is a claimant today.
Rather it is the Trustee and the estate’s Special
Counsel who seek payment. That the Trustee and
the Interim Trustee are the same person, and that
the Interim Trustee’s lawyer later joined the
Belofsky firm, are dismissed as mere details. Yet
if arrangements to which an interim trustee gave
consent may be avoided as soon as the permanent
trustee is appointed, then contracts with debtors
in bankruptcy would be worthless, and estates in
bankruptcy would be worse off. No one wants to
transact with an entity that may repudiate its
promise. Once an interim trustee has (with
judicial approval) made a bargain on behalf of an
estate in bankruptcy, then the estate is bound.
Replacing one trustee with another may change who
speaks for the estate in the future, but it does
not alter the estate’s obligations. As for the
fact that the Special Counsel was appointed after
the 1994 arrangement: a lawyer takes his client
as he finds it. If the estate lacks the assets to
pay for the legal services, then the lawyer has
agreed to work on contingent fee. That was Kids
Creek’s situation when Belofsky & Belofsky signed
on as Special Counsel in 1995. If the estate sued
Leighton and won, then the Belofsky firm could
expect full compensation; but if it sued and
lost, then the firm had to expect little or no
compensation, because Leighton would have first
claim. This is an ordinary transaction for the
plaintiffs’ bar, and the firm must accept the
consequences.
Herzog and the Belofsky firm advance many
reasons why, in their view, even their personal
consent should not be enough to validate
Leighton’s super-priority claim. The district
court found these arguments wanting; we find them
irrelevant, because, once Herzog failed to appeal
from the December 30 order, all claims that could
have been raised at that time were forfeited. If
the December 30 order was a final decision,
appealable to the district court under 28 U.S.C.
sec.158(a), then failure to take a timely appeal
puts that order beyond review. The district judge
thought that the order was not final because its
full effects could not be known until later:
whether the estate would sue Leighton, and if so
whether Leighton would prevail, and if it
prevailed the amount of its super-priority claim,
all depended on events that postdated the order.
That’s true enough, but why does it render the
order non-final?
Think of a judgment in a quiet-title action:
the judge decrees that A has a life interest in
the property, with remainder to B and C in that
order. C could appeal immediately, contending
that he should be superior to B-- even though B
may predecease A, so that the sequence between B
and C turns out not to matter. An order in a
declaratory judgment action concerning insurance
coverage requiring Insurer to indemnify Insured
if it should lose an underlying tort suit is
appealable, even though Insured may win the suit.
An order specifying that Insurer must provide
coverage (i.e., that a policy is valid) is
appealable even though Insured may never suffer
a casualty and even though, if it does, the
nature of the casualty and the amount of the loss
are variable. Coverage itself has value; indeed,
coverage is a property right, valuable to someone
who fears that a bad event may happen. A judgment
that A must indemnify B if a described event
occurs--a standard disposition of a declaratory-
judgment action about the scope or validity of an
insurance policy-- is final and appealable when
entered. The order of December 30 is similar; it
gives Leighton assurance that if a specified
event occurs, then indemnity will be forthcoming.
Provision for indemnity is the kind of order that
would be final in a stand-alone suit outside of
bankruptcy.
Orders of the form "if X, then Y" are common in
litigation. They are routinely treated as
immediately appealable, so that the nature of the
property rights these orders determine may be
respected; indeed it would be absurd to say that
the finality of such a judgment depends not on
when it is entered, but on when (if at all) event
X occurs. The decision of December 30, 1994, is
an "if-then" order: if Leighton is sued and
prevails, then its expenses are treated as a
super-priority administrative claim. Such an
order is final, and appealable, if an order
establishing a creditor’s priority is generally
appealable even though the amount of the claim,
and its value given other creditors’ claims,
remain to be determined. And a priority-fixing
order is indeed treated as final under sec.158.
See, e.g., In re Morse Electric Co., 805 F.2d 262
(7th Cir. 1986).
Perhaps the trustee could reply that an if-then
disposition is not final when the additional
contingencies occur in the same litigation. See
McMunn v. Hertz, 791 F.2d 88, 90 (7th Cir. 1986);
In re Lytton’s, 832 F.2d 395, 399-400 (7th Cir.
1988); State Street Bank v. Brockrim, 87 F.3d
1487 (1st Cir. 1996). But bankruptcy comprises
many disparate proceedings that would not be a
single case in ordinary litigation and are not
lumped together to determine finality. That’s the
essential conclusion of Morse Electric. The
super-priority order was entered as part of the
core bankruptcy proceeding; the claim by the
Trustee against Leighton was an adversary
proceeding that for our purposes might as well
have been a separate suit. The best way to
understand the proceedings, we think, is that
Leighton sought and obtained in the core
bankruptcy case an indemnity agreement whose full
effect depended on the outcome of a separate
adversary proceeding. Because the decision in the
core case finally determined Leighton’s priority,
it was appealable under the rationale of Morse
Electric.
There is another reason why the order of
December 30 was final. The super-priority clause
is part of a comprehensive order that includes a
direction to exercise the option, sell the
property, and distribute the proceeds in a
particular way. Usually we ask whether a decision
is "final," not whether an isolated passage
standing alone would be final. The administrative
super-priority cannot be divorced from the sale,
for it is a condition of the sale. If an order
approving a sale of property from an estate in
bankruptcy is final, then any dispute about the
conditions attached to the sale must be appealed
at the same time. It would undermine the validity
of the interests transferred by the sale to allow
an appeal about the conditions to be deferred. So
all we need to decide is the basic question: is
an order approving the sale of assets from an
estate in bankruptcy final under sec.158? The
answer is yes. In re Gould, 977 F.2d 1038 (7th
Cir. 1992); In re Met-L-Wood Corp., 861 F.2d 1012
(7th Cir. 1988); In re Sax, 796 F.2d 994 (7th
Cir. 1986).
Requiring an immediate appeal makes good sense.
How could estates in bankruptcy reach beneficial
arrangements for the sale of their assets if
terms and conditions crucial to the transaction
could be reopened years later? Only a fool would
deal with the estate under those circumstances,
and the estate’s inability to make conclusive
arrangements would reduce the amount available
for distribution to creditors. Thus we do not ask
whether the super-priority order was authorized
by the Code, or whether the use of the power to
create such interests (if that power exists) was
prudently exercised here; nor do we ask whether
some equitable principle prevents Herzog and the
Belofsky firm from welching on their promise.
Instead we hold that once the period for appeal
expired early in 1995, any party who had notice
of the December 30 order was forever barred from
questioning its terms. That the Interim Trustee
agreed to the order, and therefore could not
appeal because he was not aggrieved by it, does
not permit a later appeal; it shows instead that
the Trustee simply had to live with it, rather
than wage what amounts to a collateral attack
after losing the adversary action against
Leighton.
Events since the expiration of the time for
appeal may create separate controversies. Just as
a declaratory judgment resolving an insurance
coverage issue would not be conclusive on a later
dispute about the valuation of the casualty, so
the order of December 30, 1994, would not be
conclusive on a dispute about the reasonableness
of Leighton’s fees and costs. As we have
mentioned, the assets available for distribution
are less than any amount that would be deemed
reasonable, so no dispute of this kind has
arisen. But the Belofsky firm does contend that
it is entitled to keep $2,500 that it received as
a sanction in the adversary proceeding. The
bankruptcy judge ordered Cecil McNab, one of the
defendants in the adversary proceeding, to pay
$2,500 to the law firm as a sanction under Fed.
R. Civ. P. 37(a)(4)(A) (applied to bankruptcy
cases by Fed. R. Bankr. P. 7037). If the award
was property of the Kids Creek estate, then it
must be turned over for the benefit of other
administrative creditors. This is what the
bankruptcy judge and the district judge
concluded. But if the money never became Kids
Creek’s property, then the turnover order was
mistaken.
Rule 37(a)(4)(A) provides that "the court shall,
after affording an opportunity to be heard,
require the party or deponent whose conduct
necessitated the motion [to compel] . . . to pay
to the moving party the reasonable expenses
incurred in making the motion, including
attorney’s fees" (emphasis added). Payment is to
"the moving party"--which is to say the litigant,
for a law firm is an agent, not a "party" to the
case. This is the norm; fees awarded under fee-
shifting statutes belong to the litigant, not the
lawyer, though the litigant may agree by contract
to pass them on to the lawyer. See Central States
Pension Fund v. Central Cartage Co., 76 F.3d 114
(7th Cir. 1996). Here the moving party was the
bankruptcy estate of Kids Creek, so the award is
property of the estate under 11 U.S.C. sec.541.
Any agreement by the estate to remit those funds
to its law firm is subject to the claims of other
creditors, and Leighton holds a higher priority.
Affirmed