In re Ben Franklin Retail Stores, Inc.

• Decision Date: 13 October 1998
• Docket Number: 96 B 19489,Adversary No. 7 A 1339.,Bankruptcy No. 96 B 19482,96 B 19501 and 96 B 19497,96 B 19494,96 B 19493
• Parties: In re BEN FRANKLIN RETAIL STORES, INC., et al. Jay A. STEINBERG, et al., Plaintiffs, v. Robert A. KENDIG, David Brainard, Abbey J. Butler, Melvyn J. Estrin, Harvey A. Fain, Alfred H. Kingon, William A. Lemer and C. Wayne Pyrant, Defendants.
• Court: United States Bankruptcy Courts. Seventh Circuit. U.S. Bankruptcy Court — Northern District of Illinois

225 B.R. 646 (1998)

In re BEN FRANKLIN RETAIL STORES, INC., et al.

Jay A. STEINBERG, et al., Plaintiffs, v. Robert A. KENDIG, David Brainard, Abbey J. Butler, Melvyn J. Estrin, Harvey A. Fain, Alfred H. Kingon, William A. Lemer and C. Wayne Pyrant, Defendants.

Bankruptcy Nos. 96 B 19482, 96 B 19489, 96 B 19493, 96 B 19494, 96 B 19501 and 96 B 19497, Adversary No. 7 A 1339.

United States Bankruptcy Court, N.D. Illinois, Eastern Division.

October 13, 1998.

COPYRIGHT MATERIAL OMITTED

Jay Steinberg, Trustee.

Stephen Garcia, Hopkins & Sutter, Chicago, IL, for trustee.

Gerald Saltarelli, Butler, Rubin, Saltarelli & Boyd, Chicago, IL, for Richard Krubeck.

Peter B. Schaeffer, Chicago, IL, for David Brainard.

Peter Robert Sonderby, Davis & Campbell, Chicago, IL, for Curtis Pryant.

Leland Hutchinson, Jr., Freeborn & Peters, Chicago, IL, for Remaining Defendants.

Memorandum Opinion

RONALD BARLIANT, Bankruptcy Judge.

INTRODUCTION

Some of the Debtors' unsecured creditors assigned their causes of action against the Debtors' officers and directors to the Chapter 7 Trustee. He, on behalf of the bankruptcy estates and as assignee of those claims, filed this adversary proceeding charging those officers and directors with breach of fiduciary duties and negligence. The Defendants¹ seek to dismiss the Trustee's Second Amended Adversary Complaint on the grounds that (1) the Trustee lacks standing to assert the assigned claims because they are claims solely belonging to the creditors, (2) the directors are shielded from liability by the certificate of incorporation, and (3) the complaint fails to state a claim for relief.² This Court now holds that the Trustee has standing to assert the assigned claims, and those claims are not barred by the certificate of incorporation, but his complaint must be dismissed because it fails to state a claim upon which relief may be granted.

BACKGROUND

The Debtors are all Delaware corporations formerly in the wholesale and retail variety and craft business. They are a holding company (Ben Franklin Retail Stores, Inc.) and its operating subsidiaries that either owned and operated, or franchised and supplied, Ben Franklin and similar stores around the country. The Defendants were the Debtors' officers and directors, except C. Wayne Pyrant, who was an officer, but not a director. They are accused of wrongfully prolonging the Debtors' corporate lives beyond the point of insolvency by misrepresenting the true value of the Debtors' accounts receivable. Specifically, they "refreshed" or redated the due dates of millions of dollars of receivables to make it appear that they were current when, in fact, they were seriously past due. As a result, receivables that should have been written down were recorded at full value. Based on that overvaluation, the Defendants induced creditors to lend money and supply inventory and other value to the Debtors, even after the Debtors were insolvent. Creditors were harmed because the Debtors sank deeper into insolvency as their liabilities grew.

The Debtors filed for chapter 11 bankruptcy relief on July 26, 1996, but the attempted reorganization failed and the Debtors converted their cases to chapter 7 on June 24, 1997. After the conversion, certain unsecured creditors assigned their claims against the Defendants to the Chapter 7 Trustee.³ The Trustee, as assignee of those claims, alleges that the Defendants are liable for the losses suffered by creditors on two theories. First, the Defendants, as officers and directors of the Debtors while the Debtors were "in the vicinity of insolvency," owed fiduciary duties of care to creditors. The Defendants breached those duties by redating the receivables, misrepresenting the Debtors' financial condition and prolonging the Debtors' corporate lives beyond insolvency. Second, that conduct constituted negligence.

DISCUSSION

The Trustee Has Standing to Assert the Assigned Claims of the Unsecured Creditors

The Defendants argue that the Trustee lacks standing to sue on the assigned claims of the unsecured creditors. They assert that these claims are specific to the unsecured creditors and, as such, the Trustee may not pursue them, notwithstanding the assignments. The Trustee believes that nothing in the bankruptcy code prevents him from bringing these claims and that he has a duty to marshal the Debtors' property for the benefit of the estates.

It is clear that without the assignments the Trustee would not have standing to pursue claims that belong to the creditors.⁴ As the Seventh Circuit stated in Steinberg v. Buczynski, 40 F.3d 890, 893 (7th Cir.1994):

The Trustee is confined to enforcing entitlements of the corporation. He has no right to enforce entitlements of a creditor. He represents the unsecured creditors of the corporation; and in that sense when he is suing on behalf of the corporation he is really suing on behalf of the creditors of the corporation. But there is a difference between a creditor\'s interest in the claims of the corporation against a third party, which are enforced by the trustee, and the creditor\'s own direct — not derivative — claim against the third party, which only the creditor himself can enforce.

Under Bankruptcy Code § 541(a)(7)⁵, however, "the commencement of a case . . . creates an estate comprised of among other property . . . any interest in property that the estate acquires after the commencement of the case." 11 U.S.C. § 541(a)(7). The assignments effectively turned the unsecured creditors' causes of action into property of the estates and the Trustee has a duty to marshal those assets for the benefit of the estates. See Koch Refining v. Farmers Union Central Exchange, Inc., 831 F.2d 1339, 1342-1343 (7th Cir.1987).

The Defendants cite a number of cases to support their arguments that property of the estate is determined as of the commencement of the bankruptcy case, that the assignments cannot confer standing on the Trustee and that the assigned claims are not assets of the estates. The Defendants, however, make no mention of § 541(a)(7). Their vigorous arguments that under § 541(a)(1) property of the estate is determined as of the date of bankruptcy is obviously not pertinent to property acquired under § 541(a)(7), which, by its terms, includes as property of the estate, assets acquired "after the commencement of the case."

Section 541(a) defines the property that comprises the estate in seven subsections. The first one, § 541(a)(1), includes "all legal or equitable interests of the debtor in property as of the commencement of the case." (Emphasis added.) The Defendants' focus on the moment the cases were commenced as if subsection (a)(1) were all there is to § 541. In so doing they duplicate the mistake made by the district court reversed in In re Wilson, 694 F.2d 236, 238 (11th Cir.1982):

We also find that the district court\'s emphasis on defining the estate as of the date the case was commenced carries little weight, since the general timing restriction of section 541(a) applies to subsections 541(a)(1) and (a)(2) but not to section 541(a)(7). The property of the estate, including property added to the estate after commencement of the proceeding under subsections 541(a)(3) through (a)(7), is "property of the estate". . . .

The Defendants do cite Barnes v. Schatzkin, 215 A.D. 10, 212 N.Y.S. 536 (N.Y.App. Div.1925), aff'd, 242 N.Y. 555, 152 N.E. 424 (N.Y.1926), which held that assigned claims could not confer standing on a trustee because the claims were not assets of the debtor prior to the bankruptcy. But the dissent, relying on an opinion by Judge Learned Hand, demonstrated the majority's error: the claims were assigned for the benefit of the estate and the bankruptcy act then in effect contained no provision preventing the trustee from receiving assets for the benefit of the estate.⁶ Even if the New York court's majority opinion were otherwise persuasive, the inclusion of § 541(a)(7) in the current bankruptcy code effectively overrules Barnes.⁷

Williams v. California 1st Bank, 859 F.2d 664 (9th Cir.1988), does involve assignments of claims in a case under the bankruptcy code. In Williams, however, the assignments were much different from those upon which the Trustee is relying here. The Williams assignments did not provide that the proceeds of any recovery would go to the estate and be distributed to creditors pro rata, according to the priories established by the bankruptcy code. Rather, the proceeds, after payment of the trustee and legal fees, were to go to the assigning creditors; non-assigning creditors would get nothing. As the Ninth Circuit correctly characterized the arrangement,

the assignments notwithstanding, the investors plainly remain the real parties in interest in these actions. The Trustee and the estate will recoup only administrative costs from a favorable judgment; the investor-assignors receive the bulk of any recovery. In reality, then, the creditors have assigned their claims only for purposes of bringing suit. As a result, the Trustee, as in Caplin, is attempting to "collect money not owed to the estate."

859 F.2d, at 666, quoting and citing Caplin v. Marine Midland Grace Trust Co. of N.Y., 406 U.S. 416, 92 S.Ct. 1678, 32 L.Ed.2d 195 (1972).⁸ In this case, the estates are the real parties in interest, and any proceeds will come into the estates, to be distributed in accordance with the bankruptcy code.

Finally, in their reply brief, the Defendants take a few weak swipes at the assignments themselves: that the assignments do not clearly transfer the claims to the Debtors' estates; that the assignments reflect that "good and valuable" consideration came from the estate but there was no court approval under § 363 and Bankruptcy Rule 9019; and that the "attorney-in-fact" language suggests that the Trustee may have a conflict of interest between his duties to the estate and his duties to the assignors.

First, the assignments are to "Jay A....