Scattered Corporatio v. William Nea ( 2010 )

In the
United States Court of Appeals
For the Seventh Circuit
Nos. 09-3079, 09-3177
IN RE:
S OUTH B EACH S ECURITIES, INC.,
Debtor.
A PPEAL OF:
S CATTERED C ORPORATION, INC., AND
S OUTH B EACH S ECURITIES, INC.,
Appellants.
Appeals from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 08 C 1135—Joan Humphrey Lefkow, Judge.
A RGUED F EBRUARY 19, 2010—D ECIDED M AY 19, 2010
Before P OSNER, F LAUM, and W OOD , Circuit Judges.
P OSNER, Circuit Judge. A corporation called South Beach
Securities filed a petition under Chapter 11 of the Bank-
ruptcy Code and submitted a plan of reorganization. The
bankruptcy judge refused to confirm the plan and dis-
missed the bankruptcy proceeding. In re South Beach
Securities, Inc., 376 B.R. 881 (Bankr. N.D. Ill. 2007). South
2 Nos. 09-3079, 09-3177
Beach and its only creditor, Scattered Corporation, ap-
pealed to the district court, which affirmed. 421 B.R. 456
(N.D. Ill. 2009). Scattered and South Beach now appeal to
us but South Beach has adopted Scattered's brief and
makes no separate arguments.
Led by Leon A. Greenblatt III—a “character” if ever there
was one, see Gary Washburn & Kim Barker, “Randolph
Tower Running Up a Tab: City Says Owner Faces a Hefty
Bill,” Chicago Tribune, Mar. 20, 2001, p. 1; Greg Burns,
“Scattered’s Chief Buoyed by SEC Victory: Greenblatt
Pursues Suit Against Chicago Exchange,” Chicago Tribune,
Nov. 15, 1998, p. 1; Burns, “The ‘Bad Boys’ of Chi-
cago Arbitrage,” Business Week Archives, Aug. 5,
1996, www.businessweek.com/1996/32/b34876.htm (visited
Feb. 19, 2010)—Scattered achieved notoriety some years
ago by selling short more shares of LTV than existed. We
held that this tactic did not violate the securities laws.
Sullivan & Long, Inc. v. Scattered Corp., 47 F.3d 857 (7th
Cir. 1995). But the Chicago Stock Exchange, of which
Scattered was a member, took a dimmer view of
Scattered’s conduct, accusing it of fraud and precipitating
litigation eventually resolved in the company’s favor
but not before it had been driven out of the securities
business. In re Scattered Corp., 53 S.E.C. 948 (1998); “Scat-
tered Corp. Finally Ends Its Long Battle with CHX with
Settlement Vindicating Firm’s Position,” Securities Week,
Apr. 19, 1999; “Scattered Sells CHX Seat and Exits Securi-
ties Industry,” Securities Week, Dec. 8, 1997; “SEC Grants
Scattered Partial Stay in CHX Finding of Firm’s Fraud
and Manipulation,” Securities Week, May 19, 1997. What
it does now is unclear.
Nos. 09-3079, 09-3177 3
South Beach, the debtor in the bankruptcy proceeding,
also is controlled by Greenblatt. It is not participating
actively in this appeal (it has merely, as we said, adopted
Scattered's brief), but the U.S. Trustee—a Department of
Justice official whose role is to be a watchdog in bank-
ruptcy proceedings, 28 U.S.C. § 586(a)(3)—is. He opposed
the confirmation of the plan of reorganization in the
bankruptcy court and the district court and defends
their rulings in this court. He argues that the only
purpose of South Beach’s declaration of bankruptcy, and
of the plan of reorganization, is to avoid taxes, and a plan
of reorganization cannot be confirmed “if the principal
purpose of the plan is the avoidance of taxes.” 11 U.S.C.
§ 1129(d). The U.S. Trustee’s role was especially important
in this case because the bankruptcy was nonadversarial,
and, indeed, as we shall see, phony. Were it not for
his participation, Scattered would have no opponent in
this court.
Scattered argues that the U.S. Trustee is not authorized
to object to a plan of reorganization on the ground that
the plan's primary purpose is to avoid taxes. And
indeed it is not obvious that the U.S. Trustee’s writ runs to
policing against tax evasion—one might think the proper
watchdog would be the Internal Revenue Service, which
could have objected to confirmation of the plan at the
outset, or could step in later by invoking section 269 of the
tax code (discussed below) when and if a party to the
bankruptcy proceeding claimed a tax benefit. 26 C.F.R.
§ 1.269-3(e). And there are objections based on the text of
the Bankruptcy Code to the U.S. Trustee’s playing the
role of tax watchdog in bankruptcy proceedings, though
not compelling objections.
4 Nos. 09-3079, 09-3177
The Code permits only a “party in interest that is a
governmental unit” to oppose a plan of reorganization on
the ground that the plan’s primary purpose is to beat
taxes. 11 U.S.C. § 1129(d); In re Trans Max Technologies,
Inc., 349 B.R. 80, 91 (Bankr. D. Nev. 2006); 7 Collier
on Bankruptcy ¶ 1129.07, p. 1129-176 (Alan N. Resnick &
Henry J. Sommer eds., 16th ed. 2009). A U.S. Trustee
is deemed not to be “a governmental unit” only “while
serving as a trustee in a” bankruptcy case. 11 U.S.C.
§ 101(27). The U.S. Trustee is not the trustee in bankruptcy
in this case. There is no trustee; South Beach is a debtor
in possession. The Ninth Circuit has ruled, however, that
the U.S. Trustee can never be “a governmental unit,” even
when not serving as a trustee in bankruptcy. Balser v.
Department of Justice, 327 F.3d 903, 908 (9th Cir. 2003). In so
ruling, the court overlooked section 101(27) of the Bank-
ruptcy Code, the section we just quoted that makes
clear that the U.S. Trustee is not a governmental unit
only when he is acting as a trustee in bankruptcy.
Balser was not actually addressing the question whether
the U.S. Trustee is authorized by 11 U.S.C. § 1129(d) to
participate in a bankruptcy. Yet In re Trans Max Technolo-
gies, Inc., supra, 349 B.R. at 91, relied on Balser to con-
clude that the U.S. Trustee was not authorized—while
questioning the oversight that had led the Ninth Circuit
to that erroneous conclusion. Id. at 91 n. 12.
But there is another ground on which to question
the U.S. Trustee’s authority to challenge the plan of
reorganization. Remember that only a “party in interest that
is a governmental unit” (emphasis added) can object to a
plan on tax grounds. Now it is true that the term “party in
Nos. 09-3079, 09-3177 5
interest” is defined nonexclusively as “including the
debtor, the trustee, a creditors’ committee, an equity
security holders’ committee, a creditor, an equity security
holder, or any indenture trustee.” 11 U.S.C. § 1109(b)
(emphasis added). The U.S. Trustee is not excluded. And
anyway “all this section means is that anyone who has
a legally protected interest that could be affected by a
bankruptcy proceeding is entitled to assert that interest
with respect to any issue to which it pertains.” In re James
Wilson Associates, 965 F.2d 160, 169 (7th Cir. 1992). This
implies that the U.S. Trustee can be a “party in interest”
when he seeks to protect the rules and procedures of
bankruptcy, over which he is the congressionally
ordained watchdog—he has a statutory interest in making
sure that bankruptcy law isn’t abused.
But elsewhere in the Code “party in interest” and
“United States trustee” are treated disjunctively. See, e.g.,
11 U.S.C. § 707(b)(1) (“after notice and a hearing, the
court, on its own motion or on a motion by the United
States trustee, trustee . . . or any party in interest . . .”); id.,
§ 1104 (“on request of a party in interest or the United
States trustee”). Yet when we turn to section 307 of the
Code we discover that “the United States trustee may raise
and may appear and be heard on any issue in any case or
proceeding under this title.” This language, exactly
parallel to the authority granted parties in interest by
section 1109(b) (“a party in interest . . . may raise and may
appear and be heard on any issue in a case under this
chapter”), suggests that the U.S. Trustee can object to
a plan of reorganization after all, in his role as guardian of
6 Nos. 09-3079, 09-3177
the public interest in bankruptcy proceedings. See, e.g. In
re United Artists Theatre Co., 315 F.3d 217, 225 (3d Cir. 2003).
The public has an interest in limiting the use of bankruptcy
to the purposes for which it is intended rather than permit-
ting it to be used as a vehicle by which solvent firms can
beat taxes. Courts often have deemed the U.S. Trustee to be
a “party in interest” in related contexts. E.g., In re A-1 Trash
Pickup, Inc., 802 F.2d 774 (4th Cir. 1986) (moving for
conversion or dismissal of Chapter 11 case); In re Miles, 330
B.R. 848, 849-51 (Bankr. M.D. Ga. 2004) (moving for
dismissal or transfer of case because of improper venue).
The statute is a mishmash but the view that the U.S.
Trustee can be a party in interest makes better sense, as
this case illustrates; we’ll see that the case really needed
a watchdog, and we cannot see what would be gained
by everyone having to wait for the Internal Revenue
Service to take action against Greenblatt’s tax shenanigans.
The IRS did receive a copy of the plan and didn’t object to
it, but may have thought that since it could always disal-
low the deductions later if the plan got confirmed and
since it isn’t in the business of preventing abuse of bank-
ruptcy per se, there was no need for it to intervene in the
bankruptcy.
And even if the U.S. Trustee was not a party in interest,
the bankruptcy or district court, since it can hardly be
thought required to approve an unlawful plan of reorgani-
zation, need not turn a deaf ear when the U.S. Trustee,
or anyone else for that matter, argues the plan’s unlaw-
fulness. If in doing so the U.S. Trustee is acting ultra
vires, as we very much doubt, his superiors in the Justice
Nos. 09-3079, 09-3177 7
Department can rein him in; but even if he should be
thought an officious intermeddler, this would not autho-
rize Scattered to flout bankruptcy law. Congress has
authorized the federal courts to “issue any order, process,
or judgment that is necessary or appropriate to carry
out the provisions of this title [the Bankruptcy Code],” and,
even more pointedly, has declared that “no provision of
this title providing for the raising of an issue by a party in
interest shall be construed to preclude the court from, sua
sponte, taking any action or making any determination
necessary or appropriate to enforce or implement court
orders or rules, or to prevent an abuse of process.” 11
U.S.C. § 105(a). Consistent with this language, bankruptcy
judges have considered issues of tax avoidance on their
own initiative. In re Hartman Material Handling Systems, Inc.,
141 B.R. 802, 808-09 and n. 10 (Bankr. S.D.N.Y. 1992); In re
Maxim Industries, Inc., 22 B.R. 611 (Bankr. D. Mass. 1982); cf.
In re Economy Cast Stone Co., 16 B.R. 647, 650 (Bankr. E.D.
Va. 1981). As Hartman explained, “this Court cannot fairly
consider plan confirmation . . . and ignore the obvious tax
avoidance question. Congress has given the bankruptcy
courts the responsibility for determining whether a reorga-
nization plan is proper, including tax considerations.” 141
B.R. at 809.
And given the breadth of the statutory definition of
“party in interest,” how can the U.S. Trustee have standing
to make motions and be heard in bankruptcy cases (as he
is expressly authorized to do, 11 U.S.C. §§ 307, 707(b)(1)) if
he has no “interest” in such cases? We conclude that he is
a party in interest, and come at last to the merits of the
appeal.
8 Nos. 09-3079, 09-3177
South Beach was once a registered securities bro-
ker/dealer, but by the time it declared bankruptcy it had
become a shell. It had no employees or business activities,
and its only “assets” were net operating losses. These are
better described as potential assets, because they can
sometimes, but by no means always, as we’re about to
see, be set off against taxable income and thus reduce a
company’s taxes. 26 U.S.C. § 172; United Dominion Indus-
tries, Inc. v. United States, 532 U.S. 822, 825 (2001); In re
Comdisco, Inc., 434 F.3d 963, 965 (7th Cir. 2006); In re
Harvard Industries, Inc., 568 F.3d 444, 445-46 n. 2 (3d Cir.
2009); 1 Boris I. Bittker & James S. Eustice, Federal Income
Taxation of Corporations and Shareholders, ¶ 5.03[4], p. 5-17
(7th ed. 2009). We don’t know how South Beach came
to have these losses; its only recent activity was preparing
its bankruptcy filing.
South Beach is wholly owned by NOLA, LLC, which
has no business operations either; its sole asset is the
stock of South Beach. NOLA, a limited liability company,
has three members. One is Greenblatt’s father; the others
are the fathers of Scattered’s other two officers and direc-
tors. NOLA is managed by a company named Teletech
whose president and sole employee at the relevant time
was Greenblatt and whose sole function is to manage
NOLA. Through Teletech, and thus through NOLA,
Greenblatt controls South Beach.
In 2001 Greenblatt directed another corporation that
he controls, Loop Corporation, to lend South Beach
$2.2 million for five years at an annual interest rate of
12 percent. He then had South Beach lend NOLA
Nos. 09-3079, 09-3177 9
$3.2 million. The purpose of the loan to NOLA was to
enable it to purchase the stock of a company called
Health Risk Management, Inc (HRM). We do not know
where South Beach obtained $1 million to make up the
difference between the $2.2 million that it received from
Loop and the $3.2 million that it lent to NOLA. It may
have had assets left over from its time as a broker/dealer;
as we said, it has no assets now other than net operating
losses.
Loop then sold to Scattered, for $100,000, the
$2.2 million loan that it had made to South Beach. This
made Scattered a creditor of South Beach, because South
Beach was Loop’s debtor and now Scattered had stepped
into Loop’s shoes. Scattered claims to be owed $3.3 million
by South Beach, though it has not explained why the
$2.2 million loan that it bought from Loop should give it
a $3.3 million claim against South Beach, the debtor on
that loan; conceivably the explanation is the high
interest rate.
Greenblatt is an officer and director of Scattered, along
with the sons of NOLA’s other owners, and it appears
that he negotiated all the transactions relating to this
case both with and on behalf of South Beach. He
also signed South Beach’s Chapter 11 petition. All the com-
panies that we have mentioned except HRM have the
same office address. It is apparent that Greenblatt caused
Scattered to become South Beach’s creditor and caused
South Beach to declare bankruptcy.
South Beach’s bankruptcy filings list, as its sole asset, the
stock in HRM, and assign to that stock a value of zero.
10 Nos. 09-3079, 09-3177
How South Beach ended up with HRM’s stock, which it
had lent NOLA the money to buy, is unexplained, but it
confirms the obvious: all these companies are controlled
by Greenblatt.
NOLA, having used the money it borrowed from South
Beach to buy stock in HRM that became worthless, and
having no other assets, went broke too, just like South
Beach. Its bankruptcy proceeding began at the same time
as South Beach’s, but is not before us.
South Beach did not list its net operating losses as an
asset. But its disclosure statement, consistent with the
requirement that material tax consequences be described
in it, does state that the purpose of the bankruptcy is to
monetize South Beach’s net operating losses. (Amend-
ments made to the Bankruptcy Code in 2005—which
don’t apply to this case, filed in April 2005—make this
disclosure requirement explicit. 11 U.S.C. § 1125(a)(1);
5 Bankruptcy Service, Lawyer’s Edition § 44:353 (2010). But
the requirement has been held to be implicit in the pre-2005
version of section 1125 applicable to this case. See Hall
v. Vance, 887 F.2d 1041, 1043 (10th Cir. 1989); In re
Metrocraft Publishing Services, Inc., 39 B.R. 567, 571 (Bankr.
N.D. Ga. 1984).)
The plan of reorganization proposed by South Beach and
turned down by the bankruptcy judge and the district
judge would have given Scattered all the stock of South
Beach. A court can’t confirm a plan of reorganization,
however, unless the owners of at least one class of “im-
paired claims” (a term broadly defined to encompass
claims altered by the plan, 11 U.S.C. § 1124; In re Wabash
Valley Power Ass’n, Inc., 72 F.3d 1305, 1321 (7th Cir. 1995);
Nos. 09-3079, 09-3177 11
In re L & J Anaheim Associates, 995 F.2d 940, 942-43 (9th Cir.
1993); W. Homer Drake, Jr. & Christopher S. Strickland,
Chapter 11 Reorganizations § 12:14, pp. 627-28 (2d ed. 2009)),
other than “an insider” member of the class, vote to
approve it, 11 U.S.C. § 1129(a)(10), and also unless either
the owners of all other classes of impaired claims accept
the plan, or the other conditions in that subsection for a
cramdown (approval of a plan over the objection of one
or some of the creditors) are met. 11 U.S.C. §§ 1129(a)(8),
(b). A class of claims is deemed to have accepted a
plan if creditors (other than the insiders that section
1129(a)(10) excludes from the eligible voters for a plan)
vote for it who own at least two-thirds in amount, and
more than a half in number, of allowed claims of the
class. 11 U.S.C. § 1126(c). Scattered voted for the plan;
South Beach had no other creditors; we defer the ques-
tion whether in the absence of other creditors Scat-
tered’s consent was effective.
Had the plan been confirmed, Scattered, as sole creditor
of the debtor, would have ended up owning South
Beach’s net operating losses. South Beach could not have
offset those losses against its own income since it has
no income or assets (aside from the potential assets con-
sisting of the losses themselves) and no prospects of
obtaining any; it is not engaged in any business or invest-
ment activities and in fact is defunct, though it remains
a corporation in good standing. Consistent with the law
of Mississippi (where it is incorporated) for maintaining
its corporate status in the absence of an agreement by
the shareholders to eliminate the board of directors,
South Beach has a single director. Miss. Code Ann. §§ 79-4-
12 Nos. 09-3079, 09-3177
8.01(a), -8.03(b). He is unpaid and inactive, since he
does nothing. But he does have, Greenblatt testified, “a
beating heart,” and no more is required.
Outside of bankruptcy, South Beach’s net operating
losses could be used to obtain a tax benefit only if the
company received a capital infusion that enabled it to
obtain income against which to offset the losses, or if its
assets (other than the net operating losses) were
acquired by a company that had income or assets. For
the general rule is that taxpayers may not transfer net
operating losses to other taxpayers. In re Luster, 981 F.2d
277, 278-79 (7th Cir. 1992); IRS Private Letter Ruling
9622026 (May 31, 1996). If the plan of reorganization were
approved, Scattered would become the owner of South
Beach and, wanting to extract a tax benefit from South
Beach’s net operating losses, would transfer capital to
South Beach to enable that company to generate
income against which to offset the net operating losses.
The result would be to shield income of Scattered from
federal tax, because South Beach’s income would be
Scattered’s income since Scattered would be South
Beach’s sole owner.
Consistent with the general rule that we just men-
tioned, both the Internal Revenue Code and the judge-
made tax doctrine of “substance over form” (on which
see, e.g., Gregory v. Helvering, 293 U.S. 465 (1935); In re
Comdisco, Inc., supra, 434 F.3d at 965; Yosha v.
Commissioner, 861 F.2d 494, 497 (7th Cir. 1988); In re CM
Holdings, Inc., 301 F.3d 96, 102 (3d Cir. 2002); Stewart v.
Commissioner, 714 F.2d 977, 987-88 (9th Cir. 1983))
Nos. 09-3079, 09-3177 13
impose limitations on using the purchase of a company
as the basis for deducting the company’s net operating
losses from the purchaser’s taxable income. (Comdisco
applied the doctrine to a net operating loss.) If, for exam-
ple, the owner of the corporation that has the losses
sells his stock, the corporation is not permitted to offset
those losses against its future income by more than the
income the corporation would have earned if its owner-
ship had not changed and it had invested its capital in tax-
exempt bonds. 26 U.S.C. § 382(a); Garber Industries, Inc. v.
Commissioner, 435 F.3d 555, 557 (5th Cir. 2006); 2 Bittker
& Eustice, supra, ¶¶ 14.42[3], 14.44[1][b], pp. 14-63, 14-92
to 14-93. That rule is designed to minimize the tax incen-
tive for the change in ownership, lest the change confer a
tax benefit on someone (the buyer) other than the previous
owner, who had borne the brunt of the net operating
losses.
But the statute treats family members (spouses, children,
grandchildren, parents) as a single owner, corporations
as being owned by their shareholders, and trusts as
being owned by their beneficiaries, 26 U.S.C. §§ 318(a)(1),
(a)(2)(B), 382(l)(3)(A); 26 C.F.R. §§ 1.382-2T(h)(2), (6), 2
Bittker & Eustice, supra, ¶ 14.43[2][d], pp. 14-71 to 14-72,
and these attribution rules might allow the purchase
by Scattered of South Beach without triggering the ap-
plication of section 382(a), though the record is too
sketchy for us to be confident of that conclusion.
Corporations in Chapter 11 bankruptcy, moreover, are
allowed to match net operating losses against income
beyond what is permitted by section 382(a) if immedi-
ately after the reorganization the debtor’s shareholders
14 Nos. 09-3079, 09-3177
and its “qualified creditors” (which include creditors, like
Scattered, who have held debt for at least 18 months
prior to the filing of the bankruptcy proceeding) own at
least half the stock by virtue of their prior status. 26 U.S.C.
§ 382(l)(5); 2 Bittker & Eustice, supra, ¶ 14.44[6], pp. 14-102
to 14-106. The thinking behind section 382(l)(5) is that
in bankruptcy the creditors rather than the shareholders
are the true owners of the corporation, so there’s no
real ownership change when the creditors receive the
stock of the corporation. 7 Mertens Law of Federal Income
Taxation, § 29:158 (2010). Consistent with this thinking,
the statute imposes certain restrictions on the deduction
of net operating losses. See 26 U.S.C. § 382(l)(5)(B); 7
Mertens, supra, § 29:158; 2 Bittker & Eustice, supra, ¶
14.44[6][a], p. 14-103. But we needn’t get into these; we
can just assume that Scattered’s plan is not vulnerable
under section 382.
Section 269(a)(1) of the Internal Revenue Code, however,
which overlaps the doctrine of substance over form and
imposes restrictions on obtaining tax benefits from net
operating losses beyond the restrictions imposed by
section 382, disallows deductions and other tax benefits,
including net operating losses, 7 Mertens, supra, § 38:97,
when the principal purpose of acquiring corporate
control, or of certain other intercorporate transactions, on
which the claim of benefits is based is to avoid tax. To
preserve the tax benefits of the transaction the taxpayer
must demonstrate that business reasons unrelated to
tax avoidance were the primary purpose of the transaction.
The attribution rules of 26 U.S.C. § 318 don’t apply to
section 269; for section 318 applies only when expressly
Nos. 09-3079, 09-3177 15
made applicable to other provisions in subchapter C of
the tax code, and it hasn’t been made expressly
applicable to section 269, which anyway is not in
subchapter C. But a beneficial owner of a company is
deemed to control it for section 269 purposes; so if he
subsequently becomes its legal owner, there is no acquisi-
tion of corporate control and so the change in ownership
does not trigger the restrictions imposed by the section.
See Ach v. Commissioner, 358 F.2d 342, 345-46 (6th Cir.
1966); Rev. Rul. 70-638 (1970); IRS Field Service Advisory
200202057 (Jan. 11, 2002); 7 Mertens, supra, § 38:89 n. 5.
Greenblatt may be the beneficial owner of both
Scattered and South Beach, though this is uncertain, since
Scattered is owned by two other companies and a trust
set up for Greenblatt’s father and children, while South
Beach is owned by NOLA, which is owned by Green-
blatt’s father and the fathers of the two other directors.
But because the attribution rules of section 318 don’t
apply to section 269, the ownership of South Beach can’t be
ascribed to Scattered even if Greenblatt is the beneficial
owner of both corporations; and since Scattered therefore
is not the beneficial owner of South Beach, its acquisition
of South Beach can’t escape the bar of section 269(a)(1).
Brick Milling Co. v. Commissioner, T.C. Memo 1963-305; IRS
Rev. Rul. 80-46 (Feb. 25, 1980); 2 Bittker & Eustice, supra,
¶ 14.41[3][d], p. 14-51.
So it looks as if the plan of reorganization, even if
approved, wouldn’t confer the tax benefit that Green-
blatt sought. But that doesn’t affect whether the plan
was rightly rejected; for South Beach’s disclosure state-
16 Nos. 09-3079, 09-3177
ment suggests no purpose other than to beat taxes, and
we know that a plan of reorganization may not be con-
firmed if that is its principal purpose, whether or not the
purpose will actually be accomplished or will be nixed
later by the Internal Revenue Service. The object of bank-
ruptcy is to adjust the rights of the creditors of a bankrupt
company; it is not to allow a solvent company to try
to lighten its tax burden.
The plan of reorganization also had to be rejected on the
closely related ground that it hadn’t been proposed in
good faith. 11 U.S.C. § 1129(a)(3). To be in good faith a
plan of reorganization must have a true purpose and fact-
based hope of either “preserving [a] going concern” or
“maximizing property available to satisfy creditors.” Bank
of America National Trust & Savings Ass’n v. 203 North
LaSalle Street Partnership, 526 U.S. 434, 453 (1999); see also
In re Madison Hotel Associates, 749 F.2d 410, 425 (7th Cir.
1984). At the onset of the series of transactions among
Greenblatt’s puppet firms, South Beach was solvent. At
the end it was insolvent as a result of having been
directed by Greenblatt to borrow money from another
Greenblatt company, money that South Beach could not
repay to Scattered (the company controlled by Green-
blatt to which the loan had been assigned), because
South Beach had lent the borrowed money to NOLA,
which went broke. The series of transactions set the
stage for Scattered, as sole creditor of a bankrupt firm, to
acquire South Beach in a Chapter 11 reorganization. There
were no outside creditors. Their absence, and thus the
absence of any real debt or real creditors, shows that
this case doesn’t belong in bankruptcy court. In re
Nos. 09-3079, 09-3177 17
Coastal Cable TV, Inc., 709 F.2d 762, 764-65 (1st Cir. 1983);
Furness v. Lilienfield, 35 B.R. 1006, 1012 (D. Md. 1983);
In re Stern, 50 B.R. 285, 288 (Bankr. E.D.N.Y. 1985); In re
Setzer, 47 B.R. 340, 346 (Bankr. E.D.N.Y. 1985); In re
Maxim Industries, Inc., supra, 22 B.R. at 613.
Scattered contends that there was another motive for
the bankruptcy besides the tax motive, and that was to
shield South Beach from suits. The argument is bogus.
South Beach’s bankruptcy schedule listed no claims other
than Scattered’s, and the deliberate omission of creditors
from the list submitted by the debtor is unlawful and is
grounds for dismissal of the bankruptcy proceeding. 11
U.S.C. §§ 521(a)(1), 1112(e); In re Seaman, 340 B.R. 698, 702-
03 (Bankr. E.D.N.Y. 2006); see also In re Haga, 131 B.R. 320,
325-26 (Bankr. W.D. Tex. 1991). Scattered argues that
bankruptcy would shield South Beach from being sued
by creditors of its parent, NOLA, such as Wachovia,
Prudential Securities, and the bankruptcy trustee of MJK
Clearing, Inc., rather than by its “own” creditors. But
creditors in bankruptcy include anyone who has a claim
against the debtor, which is defined broadly as any right
to payment; it needn’t be a claim arising from a con-
tractual relation with the debtor. 11 U.S.C. §§ 101(5), (10);
Johnson v. Home State Bank, 501 U.S. 78, 83-84 (1991); Fogel
v. Zell, 221 F.3d 955, 960 (7th Cir. 2000); In re WorldCom,
Inc., 546 F.3d 211, 216 (2d Cir. 2008). And it’s odd to think
that South Beach would ever be the target of a suit, since
it’s a shell. It does have the net operating losses, but
we cannot see how they could be used by a judgment
creditor to obtain a tax benefit, for that would be at the
18 Nos. 09-3079, 09-3177
expense of the Treasury Department rather than of the
wrongdoer.
Greenblatt’s other enterprises are targets of a number
of suits, see, e.g., Wachovia Securities, LLC v. Neuhauser,
No. 04 C 3082, 2004 WL 2526390 (N.D. Ill. Nov. 5, 2004);
In re MJK Clearing, Inc., 408 F.3d 512 (8th Cir. 2005); In
re MJK Clearing, Inc., 241 F.R.D. 491 (N.D. Ill. 2007),
unsurprisingly given Greenblatt’s well-earned reputation
for sailing close to the wind; and if he transferred money
from Scattered to South Beach to take advantage of the
latter’s net operating losses, South Beach might become
a secondary target of the suits. In the 2007 MJK Clearing
case, the trustee in bankruptcy sought an order that
NOLA turn over to him its stock in South Beach. But
Scattered is not about to fund South Beach so that it can
pay judgments. It will receive no capital infusion from
Scattered unless and until it has emerged from bankruptcy.
Bankruptcy is therefore not required for the protection of
South Beach from litigation—not to mention the fact that
to make a firm that one controls insolvent in order to make
it judgment proof, or to otherwise shield assets from
judgment creditors, is not a proper invocation of bank-
ruptcy law. See Shapiro v. Wilgus, 287 U.S. 348, 355 (1932)
(Cardozo, J.); 7 Collier on Bankruptcy, supra, ¶ 1112.07; see
also In re 15375 Memorial Corp., 589 F.3d 605, 625-26 (3d Cir.
2009); In re Dixie Broadcasting, Inc., 871 F.2d 1023, 1026-
28 (11th Cir. 1989).
The bankruptcy judge and the district judge had still
another ground for denying confirmation of the pro-
posed plan of reorganization, illustrating what a travesty
Nos. 09-3079, 09-3177 19
this bankruptcy proceeding is: South Beach’s sole
creditor—Scattered—is an insider of South Beach. Re-
member that a plan of reorganization can’t be con-
firmed unless “at least one class of claims that is impaired
under the plan has accepted the plan, determined without
including any acceptance of the plan by any insider.”
11 U.S.C. § 1129(a)(10). The only claim alleged to be
impaired by the plan is Scattered’s claim to the money it
is owed by virtue of having bought Loop’s loan to South
Beach. Scattered voted to accept the plan but was an
insider of the debtor when it did so, because Greenblatt
controls South Beach, Loop, and Scattered. And while
“insider” includes a “person in control of the debtor,” 11
U.S.C. § 101(31)(B)(iii), it is not limited to such persons;
it includes any entity so closely related to the debtor as to
“suggest that any transactions were not conducted at arm’s
length.” In re Winstar Communications, Inc., 554 F.3d 382,
396-97 (3d Cir. 2009); see also In re Krehl, 86 F.3d 737, 742-
43 (7th Cir. 1996); In re U.S. Medical, Inc., 531 F.3d 1272,
1277-78 and n. 5 (10th Cir. 2008); In re AFI Holding, Inc., 355
F.R. 139, 152-53 (B.A.P. 9th Cir. 2006). That condition
obviously is satisfied here.
We recall that acceptance by a class of claims requires
approval by two-thirds (in amount) and more than one-
half (in number) of the claimants, excluding insiders. 11
U.S.C. §§ 1126(c), 1129(a)(10). With Scattered excluded
because of its insider status, there are no eligible voters.
The exclusion of insiders in deciding whether a plan
has been accepted by impaired creditors is intended to
prevent conflicts of interest that can arise when a
20 Nos. 09-3079, 09-3177
creditor has substantial influence over the debtor
beyond what is implicit in being a creditor. See In re U.S.
Medical, Inc., supra, 531 F.3d at 1277-78; In re Friedman, 126
B.R. 63, 69-70 (B.A.P. 9th Cir. 1991). It brakes cramdowns
by ensuring that some disinterested creditors have ap-
proved the plan. See, e.g., In re Combustion Engineering,
Inc., 391 F.3d 190, 243-44 (3d Cir. 2004); In re Windsor on
the River Associates, Ltd., 7 F.3d 127, 131 (8th Cir. 1993);
7 Collier on Bankruptcy, supra, ¶ 1129.02[10][a], p. 1129-50
and n. 178. This cannot be a concern in the present case,
however, because the only creditor is an insider. There is
no risk of collusion between an insider creditor and the
debtor at the expense of other creditors, and that takes
the case out of the intended scope of section 1129(a)(10),
though not out of the approval requirement. But even
though the purpose of section 1129(a)(10) is not engaged
here, the fact that only insiders are involved or in-
terested in the bankruptcy (apart from the U.S. Trustee!)
helps show why this bankruptcy doesn’t serve the pur-
poses of bankruptcy law—and why no alternative plan is
conceivable. For while the question presented by the
appeal is whether the plan tendered by South Beach
should have been confirmed, the bankruptcy judge was
right to dismiss the bankruptcy proceeding rather than
give South Beach (realistically, Scattered) a chance
to propose an alternative plan. No confirmable alterna-
tive plan is conceivable. See 11 U.S.C. § 1112(b); In re
Hedquist, 450 F.3d 801, 804 (8th Cir. 2006); In re American
Capital Equipment, Inc., 405 B.R. 415, 426-27 (Bankr. W.D.
Pa. 2009); 7 Collier on Bankruptcy, supra, ¶¶ 1112.04[5][a],
[c], 1112.07, pp. 1112-23 to 1112-24, 1112-26, 1112-49
to 1112-62.
Nos. 09-3079, 09-3177 21
It is true that at an earlier stage of the bankruptcy
proceeding the district court reversed the bankruptcy
judge’s ruling that the petition for bankruptcy had been
filed in bad faith and should therefore be dismissed. The
reversal was not necessarily error, because all the facts
were not yet before the bankruptcy court or the district
court. Scattered’s argument that the district court’s
finding that the petition had not been filed in bad faith
is “law of the case” and cannot be reexamined by us is
frivolous, because the doctrine of law of the case limits
reexamination of a ruling in an earlier stage of a litiga-
tion by the same court, not by a higher court. Lujan v.
National Wildlife Federation, 497 U.S. 871, 881 n. 1 (1990);
Higginbotham v. Baxter Int’l, Inc., 495 F.3d 753, 761 (7th
Cir. 2007). And anyway the doctrine doesn’t bar reex-
amination of a ruling even by the same court if there is
a compelling reason for reexamination, Agostini v. Felton,
521 U.S. 203, 236 (1997); Santamarina v. Sears, Roebuck & Co.,
466 F.3d 570, 571-72 (7th Cir. 2006), as there was here
because the facts brought out in the confirmation hearing
showed that the bankruptcy had been filed in bad faith.
Greenblatt’s evasive and at times incredible testimony,
and his orchestration of a scheme aimed at a palpable
misuse of bankruptcy, raise serious ethical and perhaps
legal concerns. The appeal to the district court and now to
our court was frivolous, and we invite the U.S. Trustee to
consider applying for sanctions against Scattered and
South Beach, Greenblatt, the appellants’ law firms, and the
firms’ lawyers who worked on the case, for misconduct in
the bankruptcy and district courts. And we order the
appellants, and the law firms and lawyers that appeared
22 Nos. 09-3079, 09-3177
for them in this court, to show cause why they should not
be sanctioned for their conduct here.
A FFIRMED AND S HOW-C AUSE O RDER ISSUED .
5-19-10