IN RE CORPORATE LEISURE EVENT PRODUCTIONS (Bankr.D.Ariz. 2006)

351 B.R. 724

No. 06-bk-01797-PHX-RJH.United States Bankruptcy Court, D. Arizona.
September 5, 2006.

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Michael P. Anthony, Carson, Messinger, Elliott et al., Scott T. Ashby, Squire, Sanders

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Dempsey, L.L.P., James B. Ball, Poli Ball, P.L.C., Paul A. Conant, Thomson Conant PLC, Joshua B. Mayes, Galbut and Hunter, PC, James F. Polese, Polese, Pietzsch, Williams Nolan, PA, Phoenix, AZ, for Creditors.

Michael W. Carmel, Michael W. Carmel, Ltd., Phoenix, AZ, for Debtor.

Alan A. Meda, Stinson, Morrison, Hecker LLP, Robert J. Miller, Bryan Cave, LLP, Phoenix, AZ, for Interested Party.

Larry Lee Watson, Office of the U.S. Trustee, Phoenix, AZ, for U.S. Trustee.

AMENDED OPINION DENYING RECEIVER’S FIRST MOTION TO DISMISS
RANDOLPH J. HAINES, Bankruptcy Judge.

The issue here is who, if anyone, may file a Chapter 11 petition for a Debtor after a state court has appointed a Receiver for the debtor, enjoined the Debtor from filing a bankruptcy petition, and removed the Debtor’s corporate officers and directors. The Court concludes that federal bankruptcy law preempts state law and remains available to an eligible debtor and its constituents notwithstanding creditors’ use of state law remedies in an attempt to bar the bankruptcy courthouse door.

The Court denied the Receiver’s first motion to dismiss by minute entry entered on the docket on June 28, 2006 and now issues this opinion to explain the Court’s reasoning.

Background Facts
Various creditors[1] filed state court actions asserting that they had been defrauded by the Debtor and twelve other related corporate entities.[2] The cases were consolidated before

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Judge Timothy Ryan, Maricopa County Superior Court. On May 8, 2006 Judge Ryan appointed Peter S. Davis as Receiver for thirteen or fourteen entities.[3] The receivership order authorized the Receiver to remove “any director, officer, independent contractor, employee or agent of any of the Receivership

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Defendants, from control of, management of, or participation in, the affairs of the Receivership Defendants.” It enjoined the Receivership Defendants[4] from doing any act to interfere with the Receiver’s custody and management of the receivership assets, and specifically enjoined them from filing “any petition on behalf of the Receivership Defendants for relief under the United States Bankruptcy Code . . . without prior permission from this Court.”

The Receiver has concluded that the Debtors had obtained more than $44 million from the creditors/investors in a Ponzi scheme, whereby new investors’ funds were used to repay prior investors while no real business was being conducted to generate new funds. The Debtor admits that it “had never fully established the validity of its economic model,” which involved raising investor funds to cover the expenses of concert promotion, and that this failure resulted in the business being “operated like a Ponzi-scheme.”

The Receiver’s efforts to marshal the receivership assets resulted in acrimony between the parties. The Receiver asserts that Mr. Nozicka and Mr. Galyon were uncooperative

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and lied about the location and/or ownership of various assets, while the Debtors claim the Receiver’s efforts were “high-handed” and resulted in the destruction of the value of an operating restaurant and big screen televisions and electronics equipment.

Mr. Galyon signed and filed a Chapter 11 petition for the first Galyon entity on June 8, 2006[5] and filed petitions for the other Galyon entities between then and June 14, 2006. Also on June 14, the Receiver removed Mr. Galyon and Mr. Nozicka from their positions as officers, directors and managers of all of the Receivership Defendants. Mr. Nozicka filed bankruptcy petitions for the Nozicka entities on June 16. The Debtors also promptly removed the receivership actions to bankruptcy court.

On June 19, 2006 the Receiver filed his first motion to dismiss these cases, based solely on the argument that Messrs. Galyon and Nozicka were not authorized to file these petitions.[6]

Legal Analysis
There is no dispute that these entities are eligible to be Debtors under Bankruptcy Code §§ 109 and 301.[7] There is no dispute that all filings required by the Bankruptcy Code to commence these bankruptcy cases have been filed.

The only dispute, at least on the present motion, is who is authorized to take this

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action on behalf of the Debtors. Ordinarily, this would be an intracorporate dispute with some officers, directors or shareholders objecting to bankruptcy relief and asserting that some other shareholder, officer or director lacked sufficient corporate authority to make the filing. There is

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apparently no such intracorporate dispute here. Rather, the dispute as to existence of corporate authority is raised by creditors, who prefer the remedy they have in state court over a bankruptcy remedy.

This dispute is not governed by the Bankruptcy Code. Indeed, the complaining creditors and their Receiver cannot point to any provision of the Bankruptcy Code that has even allegedly been violated by these filings. But while intracorporate disputes would ordinarily be governed by the law of the state of incorporation, this particular kind of creditor-driven intracorporate dispute is governed instead by federal common law, as will be seen.

Much of the history of bankruptcy law deals with efforts by creditors to escape bankruptcy court jurisdiction or to enforce remedies provided by state law that are unavailable under bankruptcy law. Before this country had a federal bankruptcy law, a debtor who had been discharged by one state’s insolvency law remained at risk that creditors could send him to debtor’s prison in another state, if he ventured there. It was to put an end to this practice that the Constitution conferred on Congress the unique uniform bankruptcy power.[8] Once Congress exercises that power it preempts and supersedes all state bankruptcy and insolvency laws[9] and other state law remedies that might interfere with the uniform federal bankruptcy system.[10]

The paramount and exclusive federal jurisdiction in this regard was noted early on by the great equity jurist, Justice Story. Construing a bankruptcy statute that contained no automatic stay, Justice Story concluded that Congress intended to vest bankruptcy courts with

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jurisdiction to “suspend or control all proceedings in the state courts”:

It is farther objected that, if the jurisdiction of the District Court is as broad and comprehensive as the terms of the [Bankruptcy Act of 1841] justify according to the interpretation here insisted on, it operates or may operate to suspend or control all proceedings in the state courts either then pending or thereafter to be brought by any creditor or person having any adverse interest to enforce his rights or obtain remedial redress against the bankrupt or his assets after the bankruptcy. We entertain no doubt that, under the provisions of the 6th section of the act, the District

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Court does possess full jurisdiction to suspend or control such proceedings in the state courts, not by acting on the courts, over which it possesses no authority; but by acting on the parties through the instrumentality of an injunction or other remedial proceedings in equity upon due application made by the assignee and a proper case being laid before the court requiring such interference. . . . Similar proceedings have been instituted in England in cases of bankruptcy; and they were without doubt in the contemplation of Congress as indispensable to the practical working of the bankrupt system.
. . . .
. . . Congress did not intend to trust the working of the bankrupt system solely to the state courts of twenty-six states, which were independent of any control by the general government, and were under no obligations to carry the system into effect. The judicial power of the United States is, by the Constitution, competent to all such purposes; and Congress, by the act, intended to secure the complete administration of the whole system in its own courts, as it constitutionally might do.[11]

As Justice Story there noted, the Bankruptcy Act of 1841 did not specifically authorize bankruptcy courts to enjoin state courts, and in fact the Judiciary Act of 1793 expressly prohibited federal courts from enjoining state courts. Consequently if a state court first acquired jurisdiction over a debtor’s assets such as through a receivership, a subsequent bankruptcy court arguably could not reach them.[12] That is virtually identical to the kind of race to the courthouse that the creditors here claim to have won. But Congress closed this loophole in the Bankruptcy Act of 1867, in which Congress for the first time amended the Judiciary Act of 1793 to expressly permit federal district courts sitting in bankruptcy to stay proceedings in

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state courts.[13]

Of course the current Bankruptcy Code goes even further, not only by making the stay automatic, statutory and specifically applicable to government entities,[14] but also by specifically requiring receivers to turn over receivership property to bankruptcy trustees and debtors in possession.[15]

Given this background, it is not surprising that all courts to have addressed the precise issue after 1867 — a creditor’s argument that a receivership order removes authority for a debtor or its corporate constituents to file a bankruptcy case — have concluded that state court receivership orders cannot bar debtors from resorting to the exclusive bankruptcy court jurisdiction. Even prior to the Chandler Act (which contained the first corporate reorganization provisions), the Sixth Circuit so concluded even though the corporate debtor had consented to the receivership that had been pending for over two years and even though the state court “has issued the usual injunction against inference.” “[T]he pendency of a receivership does not ordinarily prevent the filing of a

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voluntary petition.”[16] That concise conclusion appears to be good law today and, in the absence of any statutory language or controlling case law to the contrary, is dispositive here.[17]

Ten years later, the Sixth Circuit reached the same conclusion when the receivership order specifically enjoined the debtor’s directors, officers and stockholders “from

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preparing or in any way aiding the institution of reorganization proceedings on behalf of the debtor corporation in the District Court without the consent of such state court.”[18] That court concluded that such a state court restraining order erroneously “denied to the appellee, its directors, stockholders and attorneys, access to the federal courts, thus depriving them of their constitutional right to relief under Sec. 77B of the Bankruptcy Act,” citing the Uniform Bankruptcy Power of the Constitution.[19] Shortly thereafter, the District Court for the Southern District of New York reached the same conclusion: “The appointment by a state court of a permanent receiver with full power to act for the corporation does not affect the right of directors to act on behalf of a corporation in federal bankruptcy proceedings.”[20]
Other courts have reached the same conclusion under the current Bankruptcy Code.[21] The only cases to the contrary appear to arise when there is a purely intracorporate dispute (rather than a dispute with creditors) as to who has the

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authority to file,[22] or where the debtor is “ineligible for debtor

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status” under the Bankruptcy Code.[23]

It is of course true that bankruptcy courts generally look to state law to determine who is authorized to file a voluntary petition for a corporation, partnership or other kind of organizational entity. This rule, however, derives not from the language of the Bankruptcy Code (or its predecessor Bankruptcy Act), but rather from federal common law[24] in the absence of statutory directive. The Bankruptcy Code neither specifies who has authority to file a corporate petition nor requires that state law be the exclusive source of any such authority.[25]

Just as obviously, however, there is a federal common law exception to this reliance on state law when the state law is in the form of a receivership order that attempts to preclude any of the original constituents of the organizational entity from filing a petition on its behalf, in order to maintain the state court remedy that has been obtained by creditors. It makes no difference whether the corporate officers and directors were actually removed by the receiver or the receivership order merely enjoins their interference or filing of a petition.[26] In either case,

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state law withdraws their authority to file for bankruptcy relief and yet in both cases the unanimous federal common law holds that they are nevertheless entitled to do so. Much of this common law predates the drafting and adoption of the Bankruptcy Code, so Congress must be assumed to have incorporated it when it drafted the Code.

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Indeed, Congress did expressly incorporate this common law when the Chandler Act of 1938 made explicit that a bankruptcy case would ordinarily supersede a state receivership and that a state receiver would ordinarily be required to turn over the estate assets to a debtor in possession or trustee. Bankruptcy Act § 2a(21) is the predecessor to the Code’s § 543. As explained by the then-leading authority, “its provisions enact what was already established by prior case law,” and this “codification of the bankruptcy court’s powers as to superseded receiverships, general assignments and similar proceedings is a desirable change, removing possible controversies and conflicts as to jurisdiction.”[27] The legislative history expressly recognized that there was nothing in the Bankruptcy Act of 1898 that required receivers to be divested of property when the debtor is thrown into bankruptcy, but “the courts have supplied the gap and the bill codifies that result.”[28] The fact that Congress granted such express relief notwithstanding that receivership orders generally included the “usual injunction against inference”[29] necessarily implies that Congress intended such state law not to control who may petition for bankruptcy relief.

Nor is it any answer to say that that analysis should not apply here because this

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Receiver did have authority to file for the receivership entities.[30] Congress obviously intended bankruptcy relief to be available for the benefit of many of the constituents of a business entity, including not only the creditor interests but also the equity interests and perhaps those of employees and customers as well.[31] While bankruptcy case law generally refers to state law to determine who has eligibility to file the petition, it unanimously refuses to do so (in the absence of an intracorporate dispute) when state law has provided a creditor’s remedy to vest that authority in a receiver.

Finally, it is clear that Congress did not intend a bright-line rule to govern these issues either way. Even though the ordinary rule is that receivers must turn over estate property to a debtor in possession or trustee, Code § 543(b), the bankruptcy courts have discretion to waive that requirement if the interests of creditors would be better served by continuing the receiver in possession. Code § 543(d)(1). And although the existence of bankruptcy jurisdiction may be undeniable, bankruptcy courts nevertheless have discretion to abstain or suspend proceedings if “the interests of creditors and the debtor would

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be better served.” Code § 305(a)(1). As the Supreme Court held in resolving a somewhat similar conflict between two federal statutes, “[t]he bankruptcy court is a court of equity and, in making this determination it is in a very real sense balancing the equities.”[32] The express powers to excuse turnover or abstain provide ample authority to balance the equities based on the facts of each individual case, and provide a more sensible and fact-based resolution than any bright-line test of corporate authority or race to the courthouse could provide. That is obviously the remedy Congress preferred and dictated, rather than the simple race to the courthouse on which the Receiver and

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creditors rely.

For these reasons, the Receiver’s first motion to dismiss should be denied, without prejudice to its second motion to dismiss, its motion to excuse turnover (or the Debtor’s motion for turnover) and its motion to abstain or suspend.