Dodson v. Huff ( 2000 )

UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
No. 99-50205
consolidated with No. 99-50206
IN RE LEWIS SMYTH, III,
Debtor,
_________________________________________________
W. PATRICK DODSON,
Appellant,
VERSUS
KEN HUFF, Trustee,
Appellee.
Appeal from the United States District Court
For the Western District of Texas
March 27, 2000
Before HIGGINBOTHAM and PARKER, Circuit Judges and JACK, District
Judge*.
ROBERT M. PARKER, Circuit Judge.
W. Patrick Dodson appeals the order of the district court
affirming the bankruptcy court’s Final Decree. In a consolidated
action, Dodson appeals the district court’s order dismissing for
lack of jurisdiction his challenge to the bankruptcy court’s order
approving the Trustee’s application to retain counsel for appeal.
*
District Judge of the Southern District of Texas, sitting by
designation.
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We affirm the district court in both matters.
I. FACTS AND PROCEDURAL HISTORY
In August of 1991, Dodson and other creditors filed an
involuntary Chapter 7 bankruptcy, later converted to a Chapter 11
reorganization, against Lewis Smyth, III, a real estate developer
and investor. In November 1992, the bankruptcy court approved a
reorganization plan and appointed Ken Huff trustee. With
permission of the bankruptcy court, Huff, a certified public
accountant, employed himself as accountant for the estate. This
suit involves the question of what, if any, personal liability Huff
incurred in his capacity as Trustee for damages to the estate
caused by various alleged errors in the estate’s tax returns.
On February 18, 1997, the Trustee filed an application for
final decree seeking to close the case and a motion for final
payment of his commission. Dodson objected to both motions,
identifying various alleged errors in the Trustee’s handling of the
estate’s federal income taxes. Dodson urged the bankruptcy court
to deny the Trustee’s request for a final decree until Huff filed
amended tax returns to reclaim the estate’s disputed taxes.
In June 1997, at the hearing on his objections, Dodson
expanded his claims to allege additional errors in the Trustee’s
handling of the estate’s taxes and to assert that the Trustee
should be required to personally reimburse the estate for damages
occasioned by his errors in preparing the tax returns. At the
conclusion of the hearing, the bankruptcy court found that, while
Huff had made errors in handling the taxes, those errors should be
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balanced against concessions Huff had obtained from the IRS on
other issues, with the result that the “the estate [was] probably
as well off as it would have been had someone else handled it in a
very meticulous fashion.” Nevertheless, because of the Trustee’s
admitted oversight in failing to file the estate’s 1994 tax return
on time, the court denied his final application for commission.
The bankruptcy court then entered a final decree and Dobson
appealed to the district court.
In July 1997, the Trustee filed a motion seeking to retain the
law firm of Jeffers & Banack, Inc. to represent him on appeal,
which the bankruptcy court granted. In August 1997, Dodson
objected to the appointment and requested a hearing. Dodson argued
that the employment of counsel was inappropriate because it
provided no benefit to the estate and because the law firm selected
had a disqualifying conflict of interest. The bankruptcy court
overruled the objections and reaffirmed its approval of the
Trustee’s counsel for appeal.
The district court, noting a split in circuit law and the
absence of controlling Fifth Circuit precedent concerning the
standard of care necessary to establish a trustee’s personal
liability for damages to a bankruptcy estate, first determined that
a trustee may not be held personally liable to a bankruptcy estate
for damages resulting from simple negligence. Alternatively, the
district court held that, even assuming that a trustee can be held
personally liable based on simple negligence, there is insufficient
evidence in this record to support a finding that the Trustee was
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negligent, with the exception of the penalty incurred for the
Trustee’s late filing of the estate’s 1994 tax return. The
district court noted that the Trustee had admitted this error and
agreed to forego his application for final payment of commission in
his capacity as Trustee, and any final fees due for his services as
accountant. Those amounts would have totaled approximately $4,400,
slightly less than the amount of the penalty for the late filing.
Thus, the district court found that Dodson substantially prevailed
on this issue in bankruptcy court. To the extent the bankruptcy
court did not hold the Trustee personally liable for the
difference, the district court held that it did not abuse its
discretion.
Next, the district court rejected Dodson’s argument that the
case should be reopened and the Trustee required to file amended
tax returns on behalf of the estate. Taking into consideration the
fact that continued litigation of the tax issues would add
administrative costs to the estate and would entail some risk of
greater net tax liability, the district court affirmed the
bankruptcy court’s final decree that closed the case. This ruling
is not challenged on appeal.
Finally, the district court found that the bankruptcy court’s
order approving the Trustee’s application to retain appellant
counsel was interlocutory, and consequently dismissed the appeal of
that order for lack of jurisdiction.
II. ANALYSIS
A. Standard of review
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A bankruptcy court’s findings of fact are subject to the
clearly erroneous standard of review and conclusions of law are
reviewed de novo. See Matter of Sadkin, 36 F.3d 473, 475 (5th Cir.
1994). When the district court has affirmed the bankruptcy court’s
findings, this standard is strictly applied, and reversal is
appropriate only when there is a firm conviction that error has
been committed. See id.
B. Standard of Care Required of Bankruptcy Trustee
A bankruptcy trustee is charged with the duty to “collect and
reduce to money the property of the estate for which such trustee
serves, and close such estate as expeditiously as is compatible
with the best interests of parties in interest.” 11 U.S.C. §
704(1)(1994). That duty includes the filing of tax returns on
behalf of the estate. See 11 U.S.C. § 704(8)(1994). However, the
Bankruptcy Code is silent on the standard of care required of a
trustee performing those duties and on what is to be done if the
trustee breaches that standard of care. See In re Hutchinson
(Yadkin Valley Bank & Trust Co. v. McGee), 5 F.3d 750, 752 (4th
Cir. 1993). The Supreme Court has held that a trustee should be
“surcharged” – that is, held personally liable – for willfully and
deliberately breaching his fiduciary duty of loyalty. See Mosser
v. Darrow, 341 U.S. 267, 272-73 (1951). The Mosser Court did not
address a trustee’s personal liability with regard to negligent
actions. See id. at 272 (“We see no room for operation of the
principles of negligence in a case in which conduct has been
knowingly authorized. This is not a case of a trustee betrayed by
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those he had grounds to believe were trustworthy, for these
employees did exactly what it was agreed by the trustee that they
should do.”).
Following Mosser, a circuit split developed on the question of
the proper standard of care to which a trustee should be held. A
number of Circuit Courts of Appeals have adopted the intentional
and deliberate standard, holding that a trustee in bankruptcy
should not be held personally liable unless he acts willfully and
deliberately in violation of his fiduciary duties. See, e.g., In
re Chicago Pacific Corp., 773 F.2d 909, 915 (7th Cir. 1985); Ford
Motor Credit Co. v. Weaver, 680 F.2d 451, 461-62 (6th Cir. 1982);
Sherr v. Winkler, 552 F.2d 1367, 1375 (10th Cir. 1977). On the
other hand, In re Cochise College Park, Inc., 703 F.2d 1339, 1357
(9th Cir. 1983), imposes liability upon a trustee for mere
negligence. Here, the district court concluded that the proper
standard is gross negligence, an intermediate position articulated
in the well-reasoned In re J.F.D. Enterprises, Inc., 223 B.R. 610
(Bankr. D. Mass. 1998), aff’d, 236 B.R. 112 (Bankr. D. Mass. 1999).
We agree.
In 1997, the Final Report of the National Bankruptcy Review
Committee described the state of the law on the trustee standard of
care question as a “crazy quilt” of decisions. See Nat’l Bankr.
Review Comm’n Final Report § 3.3.2 at 859 (1997). The Commission
observed that the difficulty arose from conflicting policy
considerations; too little protection might expose a trustee to
excessive personal liability and dissuade capable people from
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becoming trustees, while too much protection would jeopardize the
goal of responsible estate management. See id. at 860-61. The
Commission ended by recommending the adoption of a gross negligence
standard for Chapter 7, 12 and 13 trustees, and tying a Chapter 11
trustee to the standard of care applicable to officers and
directors of a corporation in the state in which the Chapter 11
case is pending. See id.
In order to properly balance the opposing policy concerns
identified by the Commission, we must consider the nature of a
trustee’s duties. The requirement that a trustee maintain
disinterestedness often results in the selection of trustees who
have limited historical knowledge of the debtor’s business or prior
understanding of the industry in which the business is operated.
See J.F.D. Enterprises, Inc., 223 B.R. 610, 628 (Bankr. D. Mass.
1998). In addition, the trustee must make enormously complex
decisions within tight time constraints and without the assistance
of -- in fact, in the face of opposition or hostility from – both
secured and unsecured creditors. See id.
After considering the policy goals, the Commission’s
recommendations and the nature of the trustee’s duties, we conclude
that trustees should not be subjected to personal liability unless
they are found to have acted with gross negligence. See id. Gross
negligence has been defined as:
The intentional failure to perform a manifest duty in
reckless disregard of the consequences . . . . It is an
act or omission respecting legal duty of an aggravated
character as distinguished from a mere failure to
exercise ordinary care. It amounts to indifference to
present legal duty and to utter forgetfulness of legal
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obligations so far as other persons may be affected.
Black’s Law Dictionary at 1033 (6th ed. 1990). “This standard of
care strikes the proper balance between the difficulties of the
task assumed by trustees and the need to protect the interest of
creditors and other parties in the bankruptcy case.” See J.F.D.
Enterprises, 223 B.R. at 628.
C. Evidence of Huff’s Gross Negligence
The district court held that, with the exception of the fees
incurred for late filing of tax returns, there was insufficient
evidence in the record to support a finding that the Trustee was
even negligent, much less grossly negligent. This finding was not
clearly erroneous.
1. N.L. River Ranch Partnership
Dodson contends that Huff had a duty to abandon to the Debtor
the estate’s partnership interest in N.L. River Ranch in the Spring
of 1993 because the estate had a negative partnership capital
account balance in that asset. Dodson argues that the estate
incurred $15,000 in tax liability in 1994 because the Trustee
failed to abandon the asset. The district court noted that whether
a trustee can abandon property in order to shift tax liabilities is
subject to dispute. See 15 COLLIER ON BANKRUPTCY ¶ TX2.06[2](L. King
15th ed. rev. 1999). Moreover, the evidence on this question
consists solely of two statements contained in testimony by
Jennifer Rothe, a CPA who gave expert opinion testimony concerning
the estate’s income tax during the hearing on Dodson’s objections
to the Trustee’s application for Final Decree. Specifically, Rothe
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said that she understood that a certain adjustment to the estate’s
capital gain figure was due to the negative capital in N.L. River
Ranch and resulted in approximately $15,000 in additional tax.
However, she went on to testify that “I don’t have a copy of that
K-1, so I can’t verify that.” No other testimony or documents –
not even the relevant tax returns – were introduced to support
Dodson’s allegations. We therefore conclude that the district
court’s finding that there was insufficient evidence to support
this allegation was not clearly erroneous.
2. Failure to Deduct Payments Made to Barbara Smyth
At the time this case commenced, Barbara Smyth was the wife of
Debtor, Lewis Smyth, III. Ms. Smyth agreed to relinquish any claim
to the assets of the bankruptcy estate in exchange for periodic
payments. A $12,000 payment to Ms. Smyth was allowed as a
deduction on the estate’s 1996 tax return. Dodson complains that
previous payments to Ms. Smyth were not taken as deductions and the
estate incurred $19,150 in taxes that could have been avoided if
the Trustee had properly categorized the payments. However, the
Trustee testified that he attempted to deduct the earlier payments,
but that the Internal Revenue Service disallowed the deductions.
Further, Rothe testified that she did not have enough information
to give an opinion about the deductibility of the payments to Ms.
Smyth. The district court’s conclusion that the Trustee was not
negligent in regard to these deductions was not error.
3. Penalty for Understatement and Underpayment of Taxes
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Dodson alleges that the IRS assessed $1,208 in penalties
against the estate for underpayment of estimated tax and $11,097.97
in penalties and interest for understating the taxes due in 1995.
Both of these disputes apparently arose from the timing of the
sale of the estate’s interest in Bull Domingo, which was slated to
close in 1995, but did not close until 1996. The record contains
evidence that the estate received various interim payments, the
taxability of which could not be determined until the Trustee
received further documentation in 1996. The district court’s
finding that the penalties were not due to the Trustee’s
negligence, but to matters beyond his control, was not clearly
erroneous.
4. Penalties for Late Filing of Income Tax Returns
Dodson alleges that the estate incurred penalties of $4,906.57
for filing 1993 and 1994 federal income tax returns late. At the
hearing, the Trustee conceded that Dodson was correct and agreed to
forego over $4,400 in Trustee and accountant fees. We agree with
the district court’s finding that Dodson substantially prevailed on
this issue in bankruptcy court and, to the extent that the Trustee
was not held liable for the difference, the bankruptcy court did
not abuse its discretion. We also note that in actuality the
sanction imposed against the Trustee, if subjected to close
scrutiny, would in all likelihood be founded only in simple
negligence. However, since the Trustee agreed to the sanction, we
see no reason to disturb the status quo.
Based on the foregoing, we affirm the Final Decree.
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D. Order approving employment of attorneys for appeal
Orders appointing counsel under the Bankruptcy Code are
interlocutory and are not generally considered final and
appealable. In re American Cabinets & Woodcrafting Corp. (American
Cabinets & Woodcrafting Corp v. Polito Enter., Inc.), 159 B.R. 969,
971 (M.D. Fla. 1993). Further, Dodson did not seek or receive
leave of court to appeal the order. Consequently, we affirm the
district court’s dismissal of this consolidated appeal for lack of
jurisdiction.
III. CONCLUSION
The entry of Final Decree is AFFIRMED. The dismissal of
Dodson’s challenge to the bankruptcy court’s approval of employment
of counsel for appeal is AFFIRMED.
AFFIRMED.
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