In re Reuter

• Decision Date: 31 January 2011
• Docket Number: 10–6069.,BAP Nos. 10–6043
• Citation: 443 B.R. 427
• Parties: In re Nathan Paul REUTER, Debtor.Nathan Paul Reuter, Debtor–Appellantv.Tana S. Cutcliff; James A. Fields; James D. Fields; Joshua P. Haeflinger; LaDonna S. Henderson, as Trustee for LaDonna S. Henderson Living Trust; Patricia A. Reitz, as Trustee for Frances L. Reitz Trust; Terry J. Schippers; James D. Teegarden II; Michael S. Trom, Movants–Appellees.In re Nathan Paul Reuter, Debtor.Tana S. Cutcliff; James A. Fields; James D. Fields; Joshua P. Haeflinger; LaDonna S. Henderson, as Trustee for LaDonna S. Henderson Living Trust; Patricia A. Reitz, as Trustee for Frances L. Reitz Trust; Terry J. Schippers; James D. Teegarden II; Michael S. Trom, Plaintiffs–Appelleesv.Nathan Paul Reuter, Defendant–Appellant.
• Court: U.S. Bankruptcy Appellate Panel, Eighth Circuit

443 B.R. 427

In re Nathan Paul REUTER, Debtor.Nathan Paul Reuter, Debtor–Appellant

v.Tana S. Cutcliff; James A. Fields; James D. Fields; Joshua P. Haeflinger; LaDonna S. Henderson, as Trustee for LaDonna S. Henderson Living Trust; Patricia A. Reitz, as Trustee for Frances L. Reitz Trust; Terry J. Schippers; James D. Teegarden II; Michael S. Trom, Movants–Appellees.In re Nathan Paul Reuter, Debtor.Tana S. Cutcliff; James A. Fields; James D. Fields; Joshua P. Haeflinger; LaDonna S. Henderson, as Trustee for LaDonna S. Henderson Living Trust; Patricia A. Reitz, as Trustee for Frances L. Reitz Trust; Terry J. Schippers; James D. Teegarden II; Michael S. Trom, Plaintiffs–Appellees

v.Nathan Paul Reuter, Defendant–Appellant.

BAP Nos. 10–6043

10–6069.

United States Bankruptcy Appellate Panel of the Eighth Circuit.

Submitted: Jan. 11, 2011.Decided: Jan. 31, 2011.

James F.B. Daniels, argued, Kansas City, MO, for appellant.David Gregory Brown, argued, Columbia, MO, for appellee.Before KRESSEL, Chief Judge, SALADINO, and NAIL, Bankruptcy Judges.SALADINO, Bankruptcy Judge.

The debtor appeals from orders of the bankruptcy court¹ denying confirmation of his Chapter 11 plan, granting the creditors' motion to convert the case to Chapter 7, and entering judgment in favor of the creditors on certain dischargeability claims raised in an adversary proceeding.For the reasons stated below, we affirm.

I.Background

Mr. Reuter, the debtor, was a founding member of Vertical Group, LLC, a financial services company in Columbia, Missouri.The company handled mortgages, insurance, and investments.Mr. Reuter's expertise was in mortgages, but he induced clients, including the appellees here, to invest funds through the company in late 2004 and early 2005.The investments did not go well—evidently, all of the investors lost their investments.²In May 2005, the State of Missouri filed a civil suit against Vertical Group, LLC, and its officers, members, and/or directors, including Mr. Reuter, for, inter alia, selling unregistered securities and misrepresenting the nature of certain financial instruments they sold to investors other than the Cutcliff group of creditors (however, there is one investor common to both groups).Mr. Reuter entered into a consent judgment with the Missouri Attorney General in September 2008, permanently enjoining him from selling, attempting to sell, or acting as an agent or advisor regarding the sale of investments, securities, or financial instruments, and assessing a civil penalty of $10,000.00 against him, with payment of $5,000.00 of that penalty suspended.One of the company's principals—Daryl Brown—was convicted in federal court in 2008 of seven counts of wire fraud, two counts of causing interstate travel in execution of a scheme to defraud, three counts of engaging in monetary transactions in criminally derived property, and one count of conspiracy to commit money laundering, all of which garnered him a sentence of 180 months in prison.

In June 2006, Ms. Cutcliff and a number of other Vertical clients filed a civil suit in federal court in the Western District of Missouri against Mr. Reuter and Vertical Group, LLC, alleging violation of the Racketeer Influenced and Corrupt Organizations Act(“RICO”), conspiracy, violation of the Federal Securities Act, violation of the Missouri Securities Act, breach of fiduciary duty, violation of the Missouri Merchandising Practices Act, and fraudulent inducement.In July 2007, Mr. Reuter filed a Chapter 11 bankruptcy petition, which stayed the civil lawsuit.In his bankruptcy schedules, he listed the plaintiffs as holding contingent, unliquidated, and disputed claims totaling more than $2.9 million.Ms. Cutcliff and the eight other plaintiffs then filed an adversary proceeding alleging that Mr. Reuter operated a Ponzi scheme, objecting to dischargeability under 11 U.S.C. § 523(a)(2), (a)(4), (a)(6), and (a)(19) and objecting to discharge under 11 U.S.C. § 727(a)(3), (a)(4), and (a)(5).³

Because many of the issues in the adversary proceeding were similar to the same group of aggrieved investors' objection to the debtor's plan, both matters were tried simultaneously.In March 2010, the Cutcliff group of creditors moved to convert the case to a Chapter 7.In April 2010, the court issued an opinion denying confirmation of the plan and entering judgment in the creditors' favor regarding the non-dischargeability of the debts under § 523(a)(2)(A)(false representation and false pretense) and (a)(19)(fraud and securities law violations).In May 2010, the court granted the motion to convert.

A.The adversary proceeding

In addition to holding the debtor liable under § 523(a)(2)(A) for his own fraud, the court also held him vicariously liable under that section for the fraud of his business associate, Daryl Brown.The court noted an open question with regard to the Eighth Circuit's legal interpretation of attributing vicarious liability to an otherwise innocent partner and whether a creditor has to show more than the mere existence of an agent-principal relationship before the agent's fraud may be imputed to the debtor-principal, but ruled that under the evidence presented by the creditors, at a minimum the debtor and Mr. Brown acted as partners and the debtor could be held liable for Mr. Brown's fraud.Moreover, the court ruled that the debtor willfully ignored the myriad warning signs about Mr. Brown and his activities and either knew or should have known of Mr. Brown's fraud.

In considering the § 523(a)(19) cause of action, the court recognized divergent opinions as to the import of the 2005 Bankruptcy Abuse Prevention and Consumer Protection Actamendments to § 523(a)(19) and whether a bankruptcy court has jurisdiction to render a determination of liability for securities law violations or whether the court may only decide the dischargeability of a liability determination made in a non-bankruptcy forum.The court ruled in this case that Mr. Reuter had consented to the bankruptcy court's jurisdiction to determine liability as well as dischargeability on the basis of the consent judgment he executed with the Missouri Attorney General during the pendency of the bankruptcy case, which specifically stated that the creditors' claims for monetary relief would be fully determined and adjudicated by the bankruptcy court.

The court then found that the debtor was subject to a private cause of action by the creditors under the Missouri Securities Act of 2003 and was liable for his direct violations of securities law, although he was not subject to liability under the federal Securities Exchange Act of 1934 as a “controlling person” for the securities violations of others.

The court performed its damages calculations under two separate measures of damages: common law damages stemming from the debtor's “direct and vicarious fraudulent representations and false pretenses,” and statutory damages for his securities violations under the Missouri statutory code.The amount of actual damages was the principal amount of each plaintiff's investment.That also was the amount of the statutory damages.No consequential damages were awarded.The court awarded punitive damages based on “egregious” evidence of the debtor's recklessness and indifference to the creditors.The court adopted the debtor's calculation of double the actual damages, as used in his plan, for the appropriate amount of punitive damages.

The court also awarded attorneys' fees to the five creditors who were found to hold valid claims for the debtor's violation of Missouri securities laws.

B.Denial of plan confirmation

In his plan, Mr. Reuter proposed to liquidate his partial ownership/stock interests in three title companies and pay the net proceeds to the Cutcliff group of creditors pro rata in full payment and satisfaction of their claims, plus make 60 monthly payments to them which “would be equal to the difference of all other property to be distributed under the Plan to the holders of claims and Debtor's projected disposable income.”The Cutcliff creditors objected to the plan on the grounds that it was not proposed in good faith under 11 U.S.C. § 1129(a)(3), it was not feasible under 11 U.S.C. § 1129(a)(11), and it was not in the best interest of creditors under 11 U.S.C. § 1129(a)(7).

The court held that bad faith was evident from the totality of the circumstances of the case: namely, that a larger purpose for the debtor's bankruptcy filing was to lessen the effects of the Cutcliff group's litigation rather than to reorganize his financially troubled business enterprises.Moreover, he had no debt other than the Cutcliff group's claims, he failed to report the value of certain assets and a particular source of income, and he appeared to the court to be purposely under-employed.The court also surmised that, prior to filing bankruptcy, he structured all of his assets to shield them from creditors.In finding a lack of good faith, the court said,

[T]he Debtor's admitted motivation for seeking chapter 11 relief suggests that his Plan was proposed not with the intention of satisfying Plaintiffs' claims to the greatest extent possible, but with the intention of avoiding payment of those claims to the greatest extent possible, and the meager repayment percentage proposed by the Debtor's plan supports this conclusion.Such a purpose is the antithesis of good faith and not consistent with the spirit and purpose of Chapter 11.

Mem. Op. of Apr. 14, 2010, at 67.

In addition to bad faith, the court found the plan lacked feasibility.Mr. Reuter expected to have disposable income of $100.00 each month, which was insufficient to cover his proposed payment of the Missouri Attorney General's fine, much less any administrative expenses of the case or any of the Cutcliff creditors' claims.

The issue on the best interest of creditors test was whether the debtor's assets, which were held in revocable trusts owned by him...