In re Flanagan

• Decision Date: 09 October 2007
• Docket Number: Docket No. 06-0731-bk(XAP).,Docket No. 04-5638-bk(L).
• Citation: 503 F.3d 171
• Parties: In re Charles Atwood FLANAGAN. Cadle Co., D.A.N. Joint Venture, L.P., Appellants-Cross-Appellees, v. Bonnie C. Mangan, Trustee. Charles Atwood Flanagan, John C. Flanagan, Appellees-Cross-Appellants, U.S. Trustee, Trustee.
• Court: U.S. Court of Appeals — Second Circuit

503 F.3d 171

In re Charles Atwood FLANAGAN.

Cadle Co., D.A.N. Joint Venture, L.P., Appellants-Cross-Appellees, v. Bonnie C. Mangan, Trustee. Charles Atwood Flanagan, John C. Flanagan, Appellees-Cross-Appellants, U.S. Trustee, Trustee.

Docket No. 04-5638-bk(L).

Docket No. 06-0731-bk(XAP).

United States Court of Appeals, Second Circuit.

Argued September 14, 2006.

Decided: October 9, 2007.

Edward C. Taiman, Jr., Sabia, Taiman, Moskey, Albano & Shea, LLC, Hartford, Connecticut, for Appellants-Cross-Appellees.

Joseph L. Rini, New Haven, Connecticut, for Appellee-Cross-Appellant John C. Flanagan.

James C. Graham, Pepe & Hazard, LLP, Hartford, Connecticut, for Appellee-Cross-Appellant Bonnie C. Mangan, Trustee.

Before: CARDAMONE, MINER, and STRAUB, Circuit Judges.

CARDAMONE, Circuit Judge:

This appeal arises from two separate but related adversary bankruptcy proceedings that we will describe in a moment. Charles A. Flanagan (debtor) filed a petition under Chapter 11 of the U.S. Bankruptcy Code, 11 U.S.C. § 101 et seq., for bankruptcy relief in the United States Bankruptcy Court for the District of Connecticut (Dabrowski, B.J.) on February 17, 1999. While debtor-in-possession under Chapter 11, Flanagan instituted the first adversary proceeding (Preference Action) in the bankruptcy court against Cadle Company to avoid and recover for the bankrupt estate a $99,542.87 payment he had made to Cadle Company. Following the conversion of Flanagan's Chapter 11 case to one under Chapter 7, Bonnie C. Mangan was appointed trustee of Flanagan's bankrupt estate and substituted as party plaintiff in the Preference Action.

Cadle Company and D.A.N. Joint Venture, L.P. (collectively Cadle Creditors or appellants) then brought a second separate adversary proceeding (Constructive Trust Action) seeking a declaratory judgment and the imposition of a constructive trust over certain securities that Flanagan owned prior to the bankruptcy filing. In two memorandum decisions issued on May 22, 2003, the bankruptcy court denied the equitable relief requested by the Cadle Creditors and ruled the trustee could avoid the payment from Flanagan to Cadle only to the extent of $14,542.87. The bankruptcy court went on to hold that the payment was partially protected from avoidance by the earmarking doctrine. Following a motion for reconsideration, the bankruptcy court affirmed its original decisions on July 3, 2003. Both parties appealed. The United States District Court for the District of Connecticut (Arterton, J.) affirmed the decisions of the bankruptcy court on September 30, 2004.

As Sir Walter Scott observed "Oh, what a tangled web we weave, when first we practise to deceive." Marmion, Canto VI, Stanza 17 (1808). Such well describes the circumstances of the debtor's conduct revealed by the record in the appeal before us. Fortunately, these tangled facts were carefully sorted out in the bankruptcy court in its decisions and in the district court's September 30, 2004 decision affirming the judgment of the bankruptcy court. We now in turn affirm the judgment of the district court.

BACKGROUND

The facts of this case were laid out in detail by the district court in Cadle Co. v. Mangan, 316 B.R. 11, 14-17 (D.Conn. 2004). Nonetheless, for purposes of clarity and analysis, we include a summary of those facts relevant to the disposition of this appeal.

Prior to Flanagan's bankruptcy filing of February 17, 1999, the Cadle Creditors obtained several money judgments against Flanagan in federal and state court. Most significant for our purposes is a judgment obtained by Cadle against Flanagan on March 20, 1997 in the United States District Court for the District of Connecticut (Covello, J.) in the amount of $90,747.87 (federal judgment). Among Flanagan's assets at the time of the federal judgment was a 50 percent equity interest in Thompson & Peck, Inc. and Flanagan/Prymus Insurance Group, Inc. (collectively Thompson & Peck), valued in excess of $100,000. Flanagan had possession of the Thompson & Peck stock certificates at the time of the federal judgment in March 1997. In September 1997 he transferred the certificates to Socrates Babacas as security for loans made by Babacas to him in the amount of $85,000 (Babacas loan).

Cadle's attempts to locate assets with which to satisfy its federal judgment focused principally upon Flanagan's equity interest in Thompson & Peck. In March 1998 Cadle subpoenaed Flanagan to appear before Judge Covello for an examination of the debtor and for Flanagan to produce, inter alia, "[a]ll documents and communications related to or evidencing any interest which [Flanagan] may hold in Thompson & Peck, Inc." Flanagan appeared for the hearing but did not produce any documents that would reveal his interest in Thompson & Peck. On March 12, 1998 Cadle made a motion for a turnover order commanding Flanagan to "turn over all evidence of . . . ownership and/or other interest in Thompson & Peck . . . including any and all stock certificates in [his] possession, under [his] control and/or available to [him]." The turnover order was granted by the district court on April 13, 1998 and upheld on reconsideration.

Despite this court order, Flanagan persistently failed to comply with its instructions. Consequently, on November 16, 1998 a hearing was held at which Flanagan was ordered to show cause why he should not be held in contempt for his failure to comply with the court's turnover order. At the conclusion of the hearing, Judge Covello found Flanagan had willfully and intentionally not complied with the turnover order and ordered him committed to the Bureau of Prisons until he complied. The execution of the contempt order was stayed and a hearing scheduled a week later to allow Flanagan one final opportunity to comply.

When Flanagan's father, John Flanagan, learned that his son was facing contempt sanctions, he lent him $100,222.87 for the purpose of satisfying the federal judgment (family loan). John Flanagan had never loaned money to his son before and did so on this occasion only to prevent Charles Flanagan from being imprisoned and to protect the family's reputation. The family loan was secured by the debtor's equity interest in Thompson & Peck and Flanagan arranged for Babacas to deliver the stock certificates to his father's home. Immediately upon receipt of the family loan, Flanagan delivered the funds to his lawyer so that the federal judgment could be satisfied. On November 20, 1998 Flanagan's attorney deposited the funds into the registry of the district court and Cadle received payment on December 3, 1998 (Payment).

Following Flanagan's bankruptcy and the filing of the Preference Action to avoid and recover the Payment as a preferential transfer under 11 U.S.C. § 547, the Cadle Creditors mounted a two-pronged defense. In the Preference Action and in the Constructive Trust Action instituted by appellants, the Cadle Creditors sought the imposition of a constructive trust over the Thompson & Peck stock for their benefit. Appellants argued it was solely because of Flanagan's wrongful concealment of his equity interest in Thompson & Peck that they had been unable to execute upon the stock and secure the federal judgment and other judgments they had obtained prior to the 90-day preference period. Thus, they sought the imposition of a constructive trust over the Thompson & Peck stock to restore them to the secured position they would have occupied absent Flanagan's misconduct. The Cadle Creditors asserted the Payment did not improve their position relative to other creditors (as required by 11 U.S.C. § 547(b)(6)) because, due to their constructive possession of the Thompson & Peck stock, the Cadle Creditors possessed a fully secured lien in the stock prior to the preference period.

The second prong of the Cadle Creditors' defense against the Preference Action was their argument that the family loan funds had been earmarked by John Flanagan for the sole and specific purpose of satisfying the federal judgment against his son. Accordingly, they maintained that the family loan funds had never constituted an "interest of the debtor in property" as required by § 547(b).

The bankruptcy court resolved the Preference Action and the Constructive Trust Action in two decisions issued on May 22, 2003. Both decisions were upheld on reconsideration and a modified opinion was issued in the Preference Action on July 3, 2003. In response to Cadle's constructive trust claim, the bankruptcy court found the imposition of a trust inappropriate in the circumstances. It noted the Cadle Creditors possessed "only an expectation of the potential fruits of execution [on the stock]," and concluded that a constructive trust should not be imposed to "protect property rights which may or may not have become vested and indefeasible."

The bankruptcy court also ruled the Payment was partially protected from avoidance by the earmarking doctrine because the family loan was made for the sole and specific purpose of enabling Flanagan to satisfy the federal judgment. But the bankruptcy court further held that "even though the transaction fits the earmarking defense insofar as it replaced one creditor (Cadle) with another ([John] Flanagan), the substitution of a secured for an unsecured obligation attenuates that defense because, and to the extent, it caused a diminution to Flanagan's personal estate." As a consequence, the bankruptcy court entered judgment in favor of the trustee to avoid the transfer but only to the extent of $14,542.87, an amount equal to the difference between the family loan and the Babacas loan whose security interest had been supplanted.

The Preference Action and the Constructive Trust Action were consolidated on appeal to the district court. On September 30, 2004 Judge Arterton of the United States District Court for the District of Connecticut affirmed the decisions of the bankruptcy court. The Cadle Creditors appealed, and the...