Phillip Kelly v. David Armstrong

United States Court of Appeals
FOR THE EIGHTH CIRCUIT
___________
No. 96-4267
___________
Phillip Kelly, Trustee, *
*
Plaintiff/Appellant, *
*
v. *
*
David Armstrong, Hannah Armstrong, *
*
Defendants/Appellees, *
*
Theodore F. Armstrong, *
*
Defendant, *
* Appeal from the United States
Omaha State Bank, * District Court for the District
* of Nebraska.
Defendant/Appellee, *
*
Lynn Terry, Special Administrator for *
the Estate of Theodore F. Armstrong, *
deceased, David Armstrong, Special *
Administrator for the Estate of *
Theodore F. Armstrong, deceased, *
*
Appellees. *
___________
Submitted: September 11, 1997
Filed: April 1, 1998
___________
Before RICHARD S. ARNOLD, Chief Judge, FLOYD R. GIBSON, and BEAM, Circuit
Judges.
___________
BEAM, Circuit Judge.
Phillip Kelly, trustee of David and Hannah Armstrong's bankruptcy
estate, brought this action under 11 U.S.C. § 548(a), alleging both actual
and constructive fraud and seeking to set aside four pre-bankruptcy
transfers: (1) the sale of David's stock in a family ranching corporation
to his father, Theodore; (2) the sale of the Armstrongs' home to Theodore;
(3) David's pledge of stock as collateral on loans issued by Omaha State
Bank; and (4) David and Hannah's pledge of several vehicles as additional
collateral on the loans. A jury returned a verdict against Kelly on all
four claims. The district court denied his motions for a new trial and for
judgment as a matter of law, and Kelly appeals. We affirm in part, reverse
in part, and remand for a new trial.
I. BACKGROUND
This eleven-year-old case comes to us with a long and complex
history. See Abbott Bank-Hemingford v. Armstrong, 931 F.2d 1233 (8th Cir.
1991) (Armstrong I); Abbott Bank-Hemingford v. Armstrong, 44 F.3d 665 (8th
Cir. 1995) (Armstrong II). The facts giving rise to the Armstrong
bankruptcy saga are fully recited in our opinion in Armstrong I. Here, we
offer only those facts directly relevant to the instant appeal.
In October of 1986, shortly before declaring bankruptcy, David and
Hannah Armstrong transferred property in a circumspect series of
transactions. First, David transferred 1800 shares and the majority
interest in Maverick Land and Cattle Company (Maverick), a closely held
corporation in which he and his father, Theodore, were the sole
shareholders, to Theodore for $79,920. Next, in exchange for a pledge by
Theodore of over $600,000 worth of securities, Omaha State Bank increased
-2-
Maverick's credit line from $200,000 to $600,000. Maverick borrowed
against the new credit line to repay Theodore $157,700, in partial
satisfaction of an outstanding debt. Soon thereafter, Theodore purchased
David and Hannah's residence for that exact amount.
David then pledged his remaining shares of Maverick to Omaha State
Bank as additional security on the credit extension. David and Hannah also
pledged several of their vehicles to secure the loan, although Omaha State
Bank neither required nor requested that they do so. Finally, with the
proceeds from the sale of their house, David and Hannah purchased annuities
that were exempt from execution under Nebraska law.1 See Neb. Rev. Stat.
§ 44-371 (Reissue 1984).
David and Hannah Armstrong filed their bankruptcy petition on December
31, 1986. As a result of the foregoing transactions, virtually all of
their assets were encumbered to the benefit of Omaha State Bank and to the
detriment of all other creditors. The Chairman of the Board of Omaha State
Bank, Marvin Schmid, was a personal friend of Theodore's, and Schmid's
former law partner has represented Theodore,2 David, and Hannah throughout
these proceedings.
One of the disadvantaged creditors, the Abbott Bank-Hemingford,
formerly known as the Bank of Hemingford, (Bank) asked the bankruptcy court
to disallow the exemption for the annuities on the grounds that the
Armstrongs had acquired them in a fraudulent transaction. The court denied
the Bank's motion, because it found no "extrinsic evidence of fraud" with
respect to that transaction. The Bank then moved the court to deny the
Armstrongs' discharge in bankruptcy, based on the fact that they had
1
Nebraska law has been amended to limit the value of exempt annuities to
$10,000. See Neb. Rev. Stat. § 44-371 (Reissue 1988).
2
Theodore Armstrong died on May 19, 1997. As Special Administrators for his
estate, Lynn Terry and David Armstrong were substituted for him in this appeal.
-3-
transferred property with the intent to hinder, delay, or defraud their
creditors. The court found that the Armstrongs had acted with fraudulent
intent, and granted the Bank's motion. The district court affirmed both
conclusions, and we affirmed on appeal. See Armstrong I, 931 F.2d at 1237.
Subsequently,3 Phillip Kelly, the trustee of the Armstrongs'
bankruptcy estate, filed this action in district court, seeking to set
aside each of the following transactions: the sale of David's Maverick
stock to Theodore; the sale of the Armstrongs' house to Theodore; David's
pledge of his remaining Maverick stock to Omaha State Bank; David and
Hannah's pledge of vehicles to Omaha State Bank. On each of his claims,
the jury found against Kelly. Kelly now appeals the section 548(a)(1)
actual fraud claims as to all four transfers and all defendants, and the
section 548(a)(2) constructive fraud claim with respect to David's pledge
of stock to Omaha State Bank, asserting several points of error.
II. DISCUSSION
A. Collateral Estoppel
Kelly asserts that the Armstrongs are precluded from relitigating the
issue of fraudulent intent because the bankruptcy court made an earlier
finding that they transferred property with intent to hinder, delay, or
defraud their creditors. We do not agree that the bankruptcy finding is
controlling in this case.
3
In the interim, the Armstrongs also objected to the Bank's million dollar claim
against their estate. They argued that the claim was extinguished by the Bank's failure
to give proper notice of the sale of $950 worth of hay and equipment. The bankruptcy
court found in favor of the Armstrongs and the district court affirmed. We reversed on
appeal, because we concluded that collateral estoppel from our holding in Armstrong
I barred the lower courts' finding. See Armstrong II, 44 F.3d at 665.
-4-
The doctrine of collateral estoppel "has the dual purpose of
protecting litigants from the burden of relitigating an identical issue .
. . and of promoting judicial economy by preventing needless litigation."
Parklane Hosiery Co. v. Shore, 439 U.S. 322, 326 (1979). Four requirements
must be met before a finding in a previous case is conclusive: (1) the
issue must be identical to that involved in the prior proceeding; (2) the
issue must have been actually litigated; (3) the issue must have been
determined by a valid and final judgment; and (4) the determination must
have been essential to the judgment. See Farmland Indus., Inc. v. Morrison-
Quirk Grain Corp., 987 F.2d 1335, 1339 (8th Cir. 1993).
The issue decided in the discharge proceeding is different from the
issue presented in this case. The bankruptcy court denied the Armstrongs'
discharge because it found that they had acted with intent to hinder, delay,
or defraud their creditors. That finding refers to the Armstrongs' conduct
in the administration of their estate generally. The only conclusion that
necessarily follows from the bankruptcy court's finding is that, at some
point during the activity preceding the filing of the bankruptcy petition,
the Armstrongs' behavior indicated an intent to hinder, delay, or defraud
their creditors. This case involves four distinct transactions, and the
issue is whether any of them, individually, involved fraudulent intent.
That question is not answered by the bankruptcy court's general finding.
Moreover, even if we were to determine that the issues are sufficiently
similar, we still could not justify the use of issue preclusion against
Theodore or Omaha State Bank, neither of whom were parties to the discharge
litigation, and neither of whom had any opportunity to litigate the issue
decided in that case. Accordingly, none of the defendants in this case can
be collaterally estopped from litigating the issue of the Armstrongs' intent
in making the contested transfers.
B. Burden of Proof
Kelly argues that the district court erred in failing to instruct the
jury that, if it were to find multiple badges of fraud with regard to any
transfer, the burden would shift
-5-
to the defendants to establish a legitimate supervening purpose for making
that transfer. The district court instructed the jury that it could "give
the presence or absence of [badges of fraud] such weight as [the jury
thought] the[ir] presence or absence deserve[d]." Kelly contends that the
common law of fraudulent conveyances shifts the burden of both production
and persuasion to the defendants once multiple badges of fraud have been
established, and furthermore, that Federal Rule of Evidence 3014 should not
be applied to change this allocation of burdens. We agree.
In an action under 11 U.S.C. § 548(a)(1), it is unlikely that a
trustee will be able to present adequate direct evidence to establish the
debtor's intent to defraud creditors. See In re Acequia, Inc., 34 F.3d 800,
805-06 (9th Cir. 1994). Therefore, courts look for common indicia, or
badges of fraud, which have frequently bespoken fraudulent intent in the
past. Some badges of fraud are: (1) actual or threatened litigation
against the debtor; (2) a transfer of all or substantially all of the
debtor's property; (3) insolvency on the part of the debtor; (4) a special
relationship between the debtor and the transferee; and (5) retention of the
property by the debtor after the transfer. See, e.g., Max Sugarman Funeral
Home, Inc. v. A.D.B. Investors, 926 F.2d 1248, 1254 (1st Cir. 1991); see
also In re Sherman, 67 F.3d 1348, 1354 (8th Cir. 1995) (listing badges of
fraud in a fraudulent conveyance case governed by Missouri law). Once a
trustee establishes a confluence of several badges of fraud, the trustee is
entitled to a presumption of fraudulent intent. See Acequia, 34 F.3d at
806; In re Bateman, 646 F.2d 1220, 1223 (8th Cir. 1981). In such cases,
"the burden shifts to the transferee to prove some 'legitimate supervening
purpose' for the transfers at issue." Acequia, 34 F.3d at 806.
4
Rule 301 provides that "a presumption imposes on the party against whom it is
directed the burden of going forward with evidence to rebut or meet the presumption,
but does not shift to such party the burden of proof in the sense of the risk of
nonpersuasion, which remains throughout the trial upon the party on whom it was
originally cast."
-6-
Federal Rule of Evidence 301 states that a presumption imposes upon
a party against whom it is directed the burden of production, or going
forward with the evidence, but does not shift the burden of proof, or
persuasion. Long-standing principles of substantive law regarding
presumptions, however, will often trump the provisions of Rule 301. See,
e.g., James v. River Parishes Co., 686 F.2d 1129, 1133 (5th Cir. 1982)
(stating that "th[e] inference or presumption of negligence [on an admiralty
law issue] . . . is not governed by Rule 301 . . . [but] is determined, as
a matter of substantive law, in light of the considerations that prompted
its adoption"). We have explained in previous cases that, upon a showing
of multiple badges of fraud, "'[t]he burden which shifts . . . is not a
burden of going forward with the evidence requiring the bankrupt to explain
away natural inferences, but a burden of proving that he has not committed
the objectionable acts with which he has been charged.'" Bateman, 646 F.2d
at 1223 n.4 (quoting Shainman v. Shear's of Affton, Inc., 387 F.2d 33, 37
(8th Cir. 1967)).
The instruction given by the district court—that badges of fraud, if
found, could be given whatever weight the jury thought they warranted—could
potentially have resulted in the jury's improper allocation of the burden
of proof. As the case was submitted, the jury was free to return a verdict
in favor of the defendants, despite finding the existence of multiple badges
of fraud and disbelieving the defendants' explanations for the transfers.
The district court's failure to instruct the jury properly regarding the
burden of proof constitutes reversible error. See American Eagle Ins. Co.
v. Thompson, 85 F.3d 327, 332 (8th Cir. 1996). Therefore, the four actual
fraud claims under section 548(a)(1) must be remanded for a new trial.
We have considered the other issues raised by Kelly, including the
district court's denial of his motion for judgment as a matter of law on his
constructive fraud claim under section 548(a)(2), and we conclude that they
are without merit. Accordingly, we affirm the judgment of the district
court in all other respects.
-7-
III. CONCLUSION
For the foregoing reasons, the judgment of the district court is
affirmed in part, reversed in part, and remanded for a new trial.
A true copy.
ATTEST:
CLERK, U.S. COURT OF APPEALS, EIGHTH CIRCUIT.
-8-