In re Kenneth Allen Knight Trust

• Decision Date: 13 September 2002
• Docket Number: No. 00-5530.,00-5530.
• Citation: 303 F.3d 671
• Parties: In re KENNETH ALLEN KNIGHT TRUST, Debtor. Angela Lynn Brady-Morris; Denise Michele Brady, Plaintiffs-Appellants, v. J. Baxter Schilling, Trustee, Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

303 F.3d 671

In re KENNETH ALLEN KNIGHT TRUST, Debtor.

Angela Lynn Brady-Morris; Denise Michele Brady, Plaintiffs-Appellants, v. J. Baxter Schilling, Trustee, Defendant-Appellee.

No. 00-5530.

United States Court of Appeals, Sixth Circuit.

Argued: February 1, 2002.

Decided and Filed: September 13, 2002.

COPYRIGHT MATERIAL OMITTED

Harry Bernard O'Donnell, IV (argued and briefed), Louisville, KY, for Appellants.

J. Baxter Schilling (argued and briefed), Louisville, KY, for Appellee.

Before SUHRHEINRICH, SILER, and BATCHELDER, Circuit Judges.

OPINION

BATCHELDER, Circuit Judge.

Plaintiffs-Appellants Angela Brady-Morris and Denise Brady ("Brady's daughters") appeal the district court's judgment affirming the bankruptcy court's declaration that the debtor Kenneth Allen Knight Trust ("Trust") is a "business trust" and therefore entitled to bankruptcy protection. Brady's daughters argue that the bankruptcy court applied the wrong law and should instead have used either Kentucky's definition of "business trust," or an alternate definition taken from federal case law. Finding no merit to their claims, we affirm.

Statement of Facts

On June 5, 1991, the Trust filed a voluntary petition under Chapter 11 of the Bankruptcy Code. After reviewing the background of the case, the bankruptcy court converted it into a Chapter 7 case; the court also consolidated it with three other related cases and appointed as trustee the Appellee J. Baxter Schilling. The bankruptcy court subsequently issued a memorandum opinion in which it made a number of factual findings and, on the basis of these findings, concluded that the Trust was a "business trust." This conclusion was important because it meant that the Trust qualified as a debtor under the Code, since family trusts — which the Trust here would otherwise be — are not eligible for bankruptcy treatment, but business trusts are: only a "person" can be a debtor under the Bankruptcy Code, 11 U.S.C. § 109; the term "person" includes individuals, partnerships, and corporations, id. § 101(41); and the definition of "corporation" includes "business trusts," id. § 101(9)(A)(v). The Bankruptcy Code does not define "business trust," however, and federal courts have generally either looked to state law for a definition, or have created their own.

Brady's daughters wanted the litigation between the Trust and its potential creditors to take place outside the bankruptcy court, so they appealed the decision. On appeal, the district court initially found the Trust to be a family trust and consequently not entitled to bankruptcy protection, but upon the Trustee's motion to reconsider, the court made independent factual findings — outside those of the bankruptcy court — and concluded that the Trust was in substance Brady's personal property and hence subject to the Bankruptcy Code.

Brady's daughters again appealed, and we reversed in a per curiam unpublished opinion: Brady v. Schilling (In re Kenneth Allen Knight Trust), 121 F.3d 708, 1997 WL 415318 (6th Cir. July 22, 1997). We found, first, that the district court had exceeded its scope of review when it made independent factual findings, and that if the bankruptcy court's factual findings had been indeterminate, the district court should have remanded for further factual findings. Id., at *3. We next considered the merits of the bankruptcy court's conclusion that the Trust was a business trust. Because, as we noted, "[c]ourts have not adopted a uniform definition of business trust for purposes of the Bankruptcy Code," and this circuit had not spoken on the issue, we had to choose which of several available definitions we would adopt. Id. We chose a version of the test articulated in In re Treasure Island Land Trust, 2 B.R. 332 (Bankr.M.D.Fla.1980) — quoting several sentences from the case, and restating the definition in a slightly altered form. Brady, 1997 WL 415318, at *4. But because that definition required a fact-specific finding about the primary purpose of the Trust, and because the bankruptcy court had not made such a finding, we remanded the case to the bankruptcy court for further findings of fact. Id. On remand the bankruptcy court added new findings to those it had previously made, and found as follows.

The Trust was created in 1978 by James Brady (Brady), who named it after his nephew Kenneth Allen Knight and designated that nephew as the Trust's settlor. Knight purportedly paid a token $10 into the Trust (for which he was reimbursed by Brady), and thus began and ended Knight's personal involvement in the Trust. The Trust's beneficiaries were Brady and, secondarily, his daughters, Angela and Michele Brady — the Appellants here. Brady, however, was also the trustee (with one co-trustee, at first), and he had virtually total control of the Trust, including the authority to manage its assets.

The Trust owned two principal assets: Brady's personal residence ("Residence"), and 100% of the stock of KAK Holdings, Inc. The Residence was acquired by the Trust in two stages. The first 50% of the legal title to the Residence was transferred to the Trust by deed dated April 26, 1982. The second 50% was deeded to the Trust in April of 1986 from Brady's former wife, Anna Brady; Brady had acquired her 50% interest for $125,000, under the terms of their divorce decree.

KAK Holdings, Inc., the Trust's other principal asset, owned four subsidiary corporations ("Subsidiaries"): KAK Real Estate, Inc., Investment Advisors, Inc., Ralliana, Inc., and Direct Participation, Inc. KAK Real Estate, in turn, owned various real estate investments, including Brady's vacation home in Beaver Creek, Colorado. Investment Advisors owned a condominium in the same city. Ralliana, Inc. was the general partner of a limited partnership that owned and operated various Rally's fast food franchises. Direct Participation owned interests in restaurants and other corporations.

The Trust's incomplete checking records indicated that most if not all of the Subsidiaries' financial activities were conducted through the Trust and its bank accounts. Occasionally, the Trust would obtain "financing" for the Subsidiaries from a Maryland bank, via an illegal method: the Trust would claim to own assets that in fact belonged to an entirely different trust, owned by one Richard Thurman. When Thurman found out what Brady was doing, he filed suit against Brady, the Trust, and other related entities. Brady subsequently filed the voluntary Chapter 11 petition for bankruptcy that led to the present litigation.

After making these supplemented factual findings on remand, the bankruptcy court applied the test we had adopted in the first appeal and found the Trust to be a business trust: Brady was the principal beneficiary; he was the primary trustee (along with a trust company and, later, one of his daughters); he alone directed the Trust's business activities; he alone could remove other trustees; the other residual beneficiaries would forfeit their interest under the Trust if they sued Brady over how he operated the Trust; though both of the 50% transfers of the Residence were ostensibly "gifts" to the Trust, there was no evidence that Brady filed any gift tax returns, or that the Trust did anything with the residence, and "[t]he record clearly shows that Brady treated these transfers, at best, as contributions of capital to his KAK Trust business entity"; Brady did not disclose to his original co-trustee the first 50% transfer of the Residence; the Residence was the only non-business asset the Trust ever owned; Brady's gift of the Residence was no indication of a non-business purpose, because he "routinely titled real estate, which he used personally, in his business entities" (for example, KAK Real Estate owned his vacation home in Colorado); "most, if not all financial activities of [the Trust's] Subsidiaries were conducted through KAK Trust and its bank accounts"; and Brady treated the Trust just as he treated his other business entities. The bankruptcy court concluded that "it is clear that James Brady created this trust solely for his benefit and was in actuality the settlor/grantor of the KAK trust," and that "it is beyond dispute that the KAK Trust was intended to operate as a `holding company' for James Brady's various business enterprises"; thus the bankruptcy court found that "the sole purpose of the KAK Trust, from its inception, was to be an entity through which James Brady could conduct his business affairs."

Brady's daughters again appealed to the district court, which affirmed the bankruptcy court. This time the facts were no longer in dispute, and the issue was whether the bankruptcy court had applied the correct definition of "business trust." Brady's daughters asserted that the bankruptcy court erred because it should have adopted a definition of "business trust" from Kentucky law or from Morrissey v. Commissioner of Internal Revenue, 296 U.S. 344, 56 S.Ct. 289, 80 L.Ed. 263 (1935), and argued that under these alternate definitions the Trust was not a business trust. The district court chose not to evaluate the merits of their choice-of-law claim and instead held fast to our earlier definition. In the district court's words,

[f]ortunately for the Bankruptcy Court and this reviewing court — though perhaps unfortunately for the Brady daughters — the Court of Appeals provided clear and specific guidance to accompany its remand of this case. Accepting the arguments presented by the Brady daughters would require that we disregard that guidance, and we must decline the invitation to do so.

The district court concluded that since the bankruptcy court had obediently followed the Court of Appeals' instructions — both in making findings of fact and in making findings of law — "its conclusion is unassailable." Except by Brady's daughters, who now appeal.

Analysis

In a case which comes to us from the bankruptcy court by way of an appeal from a decision of a district court, we...