In re Stockbridge Funding Corp.

• Decision Date: 08 October 1992
• Docket Number: Adv. No. 91-5923A.,Bankruptcy No. 91 B 10069
• Citation: 145 BR 797
• Parties: In re STOCKBRIDGE FUNDING CORP., Debtor. STOCKSCHLAEDER & McDONALD, ESQS., Paul F. Stockschlaeder, Mary K. Stockschlaeder, Gilbert Spitzer and Jerome Spitzer, Plaintiffs, v. David R. KITTAY, as Trustee for the Estate of Debtor, and Irwin Birnbaum, Defendants.
• Court: U.S. Bankruptcy Court — Southern District of New York

145 B.R. 797 (1992)

In re STOCKBRIDGE FUNDING CORP., Debtor STOCKSCHLAEDER & McDONALD, ESQS., Paul F. Stockschlaeder, Mary K. Stockschlaeder, Gilbert Spitzer and Jerome Spitzer, Plaintiffs, v. David R. KITTAY, as Trustee for the Estate of Debtor, and Irwin Birnbaum, Defendants.

Bankruptcy No. 91 B 10069, Adv. No. 91-5923A.

United States Bankruptcy Court, S.D. New York.

October 8, 1992.

COPYRIGHT MATERIAL OMITTED

H. Karasik of Sherman, Citron & Karasik, New York City, for Paul F. Stockschlaeder, Mary K. Stockschlaeder, Stockschlaeder & McDonald, Esqs., Gilbert Spitzer and Jerome Spitzer ("the Spitzers"), (collectively, "plaintiffs").

D. Kittay of David R. Kittay, P.C., New York City, for David R. Kittay as trustee for debtor ("trustee").

M. Foreman of Proskauer Rose Goetz & Mendelsohn, New York City, for Irwin Birnbaum ("Birnbaum").

AMENDED MEMORANDUM OF DECISION OF MOTION FOR CONTEMPT AND VIOLATION OF STAY

FRANCIS G. CONRAD, Bankruptcy Judge.^*

The following Memorandum of Decision¹ addresses two issues within the above adversary proceeding, namely whether civil contempt sanctions should be levied against Plaintiffs and whether Plaintiffs intentionally recorded mortgage assignments in violation of the automatic stay. We hold in favor of Trustee on both issues.

Creditors of Stockbridge Funding Corporation ("Stockbridge") filed an involuntary petition against the Debtor on January 4, 1991. 11 U.S.C. § 101 et seq. On March 1, 1991, the case was converted to Chapter 11, and Mr. Kittay was appointed Chapter 11 Trustee. On June 18, 1991, Plaintiffs filed a petition for declaratory judgment concerning the validity, extent, and priority of liens on real property. Plaintiffs also request that we determine whether the relevant mortgages² are estate property under 11 U.S.C. § 541(d). In his answer to the complaint, Trustee alleged counterclaims and has now moved for civil contempt and sanctions. This Memorandum of Decision resolves only the legal and factual issues raised in Trustee's two counterclaims.

FACTUAL BACKGROUND

Like a two-faced Janus, Stockbridge Funding Corporation practiced its mortgage banking trade in two vastly different worlds. On the one hand, as a purveyor in the legitimate secondary mortgage market, Stockbridge sold mortgages to institutional investors, including banks, savings and loans, and pension funds. When these sales were finalized, Stockbridge no longer serviced the mortgages, and had no further rights or responsibilities with respect to the mortgages or the investors. This aspect of Stockbridge's business is not at issue here.

On the other hand, certain Stockbridge employees were also engaged in fraud and bad business practices that ultimately led to the financial ruin of numerous small investors. Operating primarily in the Polish immigrant communities of New York and New Jersey, Stockbridge solicited investors with so-called guaranteed returns in the secondary mortgage market. In newspaper and television ads targeted at the Polish community, Stockbridge promised risk-free investments with each investor's funds secured by mortgage assignments. In reliance on these and other promises, individual investors tendered cash to Stockbridge. Most if not all of these investors were of modest sophistication.³

When an investor invested money in Stockbridge, the investor and Stockbridge entered into an Investor's Agreement. The Investor's Agreement provided that the investor would be assigned a mortgage that Stockbridge had obtained in lending money to a borrower. Each agreement provided that the investor would be assigned a mortgage that would be recorded at Stockbridge's expense. When an Investor's Agreement was entered into, Stockbridge retained all of the rights of ownership of the assigned mortgage. According to each agreement, the investor bore no risk of loss on the assigned mortgage, relying instead on the Stockbridge guarantee of their investment.

Like the promises of a western snake oil salesperson, however, the enticements were too good to be true. Many small investors received little if any return on their investment in Stockbridge. Only 14% of all investors were actually assigned mortgages that were eventually recorded. Moreover, a substantial number of these investors were assigned loans that were either in default or whose value did not secure each investor's initial cash contribution.

Unknown to the individual investor, Stockbridge in fact became a classic Ponzi scheme in which senior investors were paid their "guaranteed" return with money provided by new investors, rather than as a return on the prior investment.⁴ Stockbridge managed to function and to pay interest as long as new investors provided cash and senior investors rolled-over interest income. When the number of new investors dwindled, Stockbridge was unable to pay senior investors their guaranteed returns. Without new money to pay old debts, Stockbridge's house of cards collapsed.⁵

Overwhelming evidence shows that Stockbridge did not comply with the vast majority of its contractual obligations to individual investors. Stockbridge did not maintain a separate trust account for investor funds but instead commingled investor funds for use as working capital.⁶

The relation between Stockbridge and the Spitzers was articulated in several agreements executed in 1990 and 1991. The Spitzers, like Stockbridge, were represented by Stockschlaeder & McDonald.⁷ Under the Warehouse Agreement⁸, the Spitzers provided a $300,000 revolving line of credit to Stockbridge.⁹ This line of credit provided Stockbridge with interim financing until mortgage assignments could be sold to institutional investors. The agreement also provided that the Spitzers would receive assignments in three Stockbridge mortgages as security for their warehousing loan to Stockbridge.¹⁰ According in the Warehouse Agreement, Stockbridge retained the right to repurchase the three mortgages. To further protect Spitzers' interest, Stockschlaeder & McDonald filed a financing statement in the New York County Registrar's Office and the New York Secretary of State's office.

Stockschlaeder & McDonald held the Spitzers' interests in the three mortgages under an escrow agreement. The agreement stated that the assignment of mortgages from Stockbridge to the Spitzers "shall be held in escrow by the Disbursement Account Administrator (Stockschlaeder & McDonald) until a mortgage loan is purchased by the Institutional investor which committed to purchase the said Mortgage Loan".¹¹ With full and complete knowledge of Stockbridge's bankruptcy, Stockschlaeder & McDonald released the assignments from escrow to the Spitzers directly, thereby defeating Stockbridge's right under the Warehouse Agreement to repurchase or sell the mortgages to another institutional investor.¹² In an attempt to protect their clients' interests, Stockschlaeder & McDonald then recorded the Spitzers' assignments in the real property records. Plaintiffs readily admit that the recordations occurred postpetition.

Trustee cites the following events in support of the counterclaim for contempt sanctions. On February 1, 1991, we signed an order to show cause why Stockschlaeder & McDonald should not turn over documents in the firm's possession relating to the debtor's business. On March 1, 1991, a hearing was held on the show cause order.

At the hearing on March 1, 1991, Trustee argued that he was legally entitled to discovery of the documents to the documents in Stockschlaeder & McDonald's possession under 11 U.S.C. § 542(e) and that the documents were essential to the administration of the estate. We agreed. In open court, we ordered Stockschlaeder & McDonald immediately to turn over all files within its possession relating to Stockbridge's business to Trustee. Given Trustee's clear statutory authority to see and possess the documents, we stated that if the firm did not turn over to Trustee all such files in its possession by 6:00 P.M. on March 4, 1991, we would hold the firm in contempt of court. To further enforce our order and to eliminate all doubt as to our intentions, we stated for the record that we would order Stockschlaeder & McDonald to pay contempt sanctions of $10,000 for each day it did not comply. Although not articulated in the record, it was our clear understanding that failure to obtain the records would seriously impede Trustee's investigation of the case. The stated amount was to ensure obedience to our order.

On March 7, 1991, we issued a written order directing Stockschlaeder & McDonald to turn over the files. The last of the files in question were given to Trustee on April 14, 1992. Some 407 days after the first order, Stockschlaeder & McDonald turned over what appeared to be the remaining documents.

Stockschlaeder & McDonald offer several arguments why the documents were not turned over to Trustee. First, Stockschlaeder & McDonald argues that the March 7, 1992, order does not mention "turn over" expressly and instead only requires that Stockschlaeder and McDonald "grant access" to the files in issue. Stockschlaeder & McDonald therefore did not believe themselves obligated to deliver the files to Trustee. Second, Stockschlaeder & McDonald contends that when this court ordered the firm to turn over the files, Stockschlaeder & McDonald was under the impression that the court meant only a limited number of litigation files, rather than all files within Stockschlaeder's possession that related to the business of the debtor. Third, the firm argues that Trustee should have conducted a Rule 2004 examination to obtain the information, rather than requesting documents within the Stockschlaeder & McDonald's possession. Stockschlaeder & McDonald also asserts that some documents were privileged as confidential communications between the firm and its clients, the Spitzers. For the reasons expressed below, we reject their arguments in their entirety.

DISCUSSION

We are faced with two...