571 F.3d 108 (1st Cir. 2009), 08-1690, Braunstein v. McCabe

Docket Nº:08-1690, 08-1691.
Citation:571 F.3d 108
Opinion Judge:LYNCH, Chief Judge.
Party Name:Joseph BRAUNSTEIN, Chapter 7 Trustee of TMG Holdings, LLC and of Edwin A. McCabe, Plaintiff, Appellee/Cross-Appellant, v. Edwin A. McCABE; Karren K. McCabe, Defendants, Appellants/Cross-Appellees, v. Craig J. Ziady, Fourth-Party Defendant, Appellee, Dann Ocean Towing, Inc., Defendant.
Attorney:Joseph H. Reinhardt for appellants/cross-appellees. Mark W. Corner with whom Riemer & Braunstein LLP was on brief for appellee/cross-appellant Joseph Braunstein and appellee Craig J. Ziady.
Judge Panel:Before LYNCH, Chief Judge, TORRUELLA and LIPEZ, Circuit Judges.
Case Date:June 26, 2009
Court:United States Courts of Appeals, Court of Appeals for the First Circuit

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571 F.3d 108 (1st Cir. 2009)

Joseph BRAUNSTEIN, Chapter 7 Trustee of TMG Holdings, LLC and of Edwin A. McCabe, Plaintiff, Appellee/Cross-Appellant,


Edwin A. McCABE; Karren K. McCabe, Defendants, Appellants/Cross-Appellees,


Craig J. Ziady, Fourth-Party Defendant, Appellee,

Dann Ocean Towing, Inc., Defendant.

Nos. 08-1690, 08-1691.

United States Court of Appeals, First Circuit

June 26, 2009

Heard April 7, 2009.

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Joseph H. Reinhardt for appellants/cross-appellees.

Mark W. Corner with whom Riemer & Braunstein LLP was on brief for appellee/cross-appellant Joseph Braunstein and appellee Craig J. Ziady.

Before LYNCH, Chief Judge, TORRUELLA and LIPEZ, Circuit Judges.

LYNCH, Chief Judge.

This appeal requires us to address several issues of first impression in bankruptcy law in this circuit. The first is whether there is a jury trial right under the Seventh Amendment in actions by trustees to compel the turnover of property to the estate under 11 U.S.C. § 542. The second concerns what is meant by the " ordinary course of business" of a debtor for purposes of 11 U.S.C. § 363, which allows trustees to make ordinary expenditures necessary for the operation of a business without involvement of the bankruptcy court. The third concerns whether a cause of action for negligent misrepresentation is stated by the debtors against the trustee's counsel.

The appeal arises from two actions brought by the trustee, Joseph Braunstein, concerning the assets of the estate in bankruptcy of a former lawyer, Edwin McCabe (whom we shall call " McCabe" ), his wife Karren, and various entities they controlled. The trustee filed a turnover complaint to obtain $77,572.69 in insurance proceeds which had been paid to McCabe in settlement of claims arising from wake damage a maritime towing company caused to the luxury houseboat on which the McCabes lived, and which was owned by the estate.

The McCabes appeal from both the district court's denial of their jury trial demand and from the $30,262.69 amount the court ordered turned over, on the ground the court used the wrong legal standard and used incorrect information about the balance in their bank account. The trustee cross-appeals and argues the court used the wrong legal standard for " ordinary course of business" and that the turnover amount is too small.

A separate issue is raised by the McCabes' appeal from the district court's dismissal of their attempt to sue an attorney representing the trustee, for negligent misrepresentation, in an admiralty action the trustee brought against the towing company. That admiralty action is not otherwise relevant to this appeal; a jury heard the case and found in favor of the towing company.

The turnover action arose after McCabe, operating the estate as debtor-in-possession, expended estate funds in a way that actually decreased the value of the estate's primary asset, the houseboat. Contrary to the district court, we hold that McCabe did not make these expenditures within the ordinary course of business. We reverse and remand on that issue. We affirm the court's denial of a jury trial on the turnover claim and its dismissal of the claim against the attorney working with the trustee.


The McCabes lived on the houseboat, the Esperaunce, which was berthed in Charlestown, Massachusetts. It was owned by a limited liability company named TMG Holdings, LLC, (" Holdings" ). The Esperaunce was Holdings' sole asset. Holdings was managed and 99% of its shares were owned by The McCabe Group, a professional corporation through which McCabe and others provided legal services. McCabe was the sole shareholder

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in The McCabe Group and held a 1% share in Holdings. Holdings chartered the Esperaunce to The McCabe Group, which in turn subchartered the boat to the McCabes. The McCabe Group and McCabe each filed for bankruptcy on September 3, 2003, and Holdings filed on February 20, 2004. McCabe functioned as debtor-in-possession in all three cases, which were Chapter 11 filings.

After the initial filings, on December 18, 2003, the Esperaunce was damaged by the wake of a tugboat owned by Dann Ocean Towing. The McCabes filed a claim with Dann's insurance company, which was settled for $95,230.95 on December 8, 2004. Under the settlement agreement, $17,658.26 was earmarked for alternate living arrangements for the McCabes while $77,572.69 was for damage to the Esperaunce. The trustee does not dispute that the $17,658.26 belonged to the McCabes. While McCabe was the debtor-in-possession, he did not open a separate account in that capacity. Rather, he commingled the insurance funds with the funds in his and his wife's personal account. The McCabes deposited all of the insurance proceeds into that account, which was held in Karren's name.

Without notifying the bankruptcy court or seeking its approval, the McCabes arranged to have work done on the Esperaunce from the insurance proceeds. They spent $47,310 to have the boat towed to a marina in Gloucester, Massachusetts on October 30, 2004 and to have initial repair work conducted. That work consisted of dismantling or demolishing portions of the boat. The record shows that this work was done to repair the wake damage, to enable refurbishment of the houseboat's structure in order to address water damage that predated the wake incident, and to make structural improvements to the boat. Despite the wake damage, the McCabes had continued to live on the houseboat while they settled their claim with the insurer. The work actually done and paid for decreased the value of the boat.

On February 16, 2005, the petitions for Holdings and McCabe were converted to Chapter 7 liquidations and Braunstein was appointed trustee (he had been appointed interim trustee in The McCabe Group's case on November 5, 2004). McCabe ordered a halt to the repair work on February 16 and Braunstein took possession of the Esperaunce.

Braunstein received an offer to purchase the Esperaunce. On October 26, 2005, before the sale was finalized, attorney Craig J. Ziady, the trustee's counsel, emailed McCabe. He told McCabe about the offer and wrote that if Braunstein " decides to move forward, there will be a sale motion, with the customary counter-offer procedures, etc., of which you will certainly be provided notice." In November 2005, Braunstein conducted, with bankruptcy court approval, a sale of the boat for $42,000. The McCabes were not given notice as attorney Ziady had represented. They concede they were not actually entitled to notice because they did not file an appearance and request for notice. See Fed. R. Bankr.P. 9010.

Braunstein filed a complaint against the McCabes in bankruptcy court on February 28, 2005 requesting, under 11 U.S.C. § 542, a turnover and accounting of estate property in the McCabes' possession, " including but not limited to certain insurance settlement proceeds obtained by McCabe and Karren McCabe post-petition and without bankruptcy court approval," as well as a restraining order to prevent the McCabes from spending any more estate funds. No claim was made of fraudulent transfer. The McCabes asserted counterclaims alleging Braunstein initiated the adversary

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proceeding in bad faith and was in breach of his fiduciary duty as trustee. They also answered the turnover claim and demanded a jury trial on it.

On May 23, 2006, Braunstein sued Dann, the owner of the boat that caused the wake damage, for negligence in federal district court in Massachusetts under the court's admiralty jurisdiction. Dann brought a third-party claim for indemnification against the McCabes. The McCabes counterclaimed against Braunstein, alleging conversion and breach of fiduciary duty, and filed a fourth-party complaint against attorney Ziady for negligent misrepresentation based on his failure to give them notice of the sale of the Esperaunce. On motion of the parties, the district court consolidated the negligence claim in admiralty and the turnover claims in bankruptcy on December 12, 2006.

Attorney Ziady moved to dismiss the fourth-party complaint against him on December 28, 2006. At the motion hearing, the court stated it would dismiss because attorney Ziady owed no legal duty to the McCabes, and on February 13, 2007, it entered an electronic order granting the motion.1 The McCabes moved for reconsideration, arguing that the existence of a legal duty is not an element of a negligent misrepresentation claim. They also sought leave to amend their fourth-party complaint to assert a claim against attorney Ziady for promissory estoppel.2 The court denied the motion on February 28, 2007.

On January 3, 2008, the court entered an order denying the McCabes' jury trial demand in the turnover case. The negligence case was tried first under the court's admiralty jurisdiction. On January 10, the jury entered a verdict in favor of Dann on Braunstein's negligence complaint against the company. It concluded that McCabe had acted as Holdings' authorized agent in settling with Dann and that the Holdings estate therefore did not have a claim against Dann that Braunstein could assert.

The court held a bench trial on the turnover claim immediately after the conclusion of the negligence case. At the trial, McCabe testified that Holdings, the owner of the boat, " was not in business" and that " there were no operations of Holdings." The repairs were meant to " enhance" the value of the houseboat, and there was a significant amount of work to be done not covered by the insurance.

The reason for the repair of the houseboat, McCabe testified, was that he and his...

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