Johnson, In re
| Citation | 518 F.2d 246 |
| Decision Date | 19 June 1975 |
| Docket Number | Nos. 74-1373,74-1374,s. 74-1373 |
| Parties | In the Matter of Roy M. JOHNSON, Debtor. Otey JOHNSON, Individually and as Trustee, et al., Appellants, v. Gordon D. CLARK et al., Appellees. The FIRST NATIONAL BANK AND TRUST COMPANY OF MUSKOGEE (Trustee in Succession ofthe Roy M. Johnson Trust), Appellant, v. Gordon D. CLARK et al., Appellees. |
| Court | U.S. Court of Appeals — Tenth Circuit |
Andrew Wilcoxen, of Wilcoxen, Lunn, Mayes & Cate, Muskogee, Okl., for appellants Johnson and others.
A. Carl Robinson, of Robinson, Summers & Locke, Muskogee, Okl., for appellant The First Natl. Bank and Trust Co. of Muskogee, Trustee in Succession.
J. D. DeBois, of DeBois, Peck & Sherrill, Duncan, Okl., and Henry W. Simon, Sr., of Simon & Simon, Fort Worth, Tex. (O. L. Peck, Jr. of DeBois, Peck & Sherrill, Duncan, Okl., and John W. Hughes of Simon & Simon, Fort Worth, Tex., on the brief), for appellee Gordon D. Clark.
Before LEWIS, Chief Judge, and BREITENSTEIN and DOYLE, Circuit Judges.
The main issue presented is whether the trustee of a creditors trust established pursuant to Chapter XII of the Bankruptcy Act is to be surcharged for substantial losses to the trust, which losses resulted from defalcations of the bookkeeper; the losses amounted to about $50,000 and occurred during a period starting in 1960 and continuing to 1969.
Appellee Clark was the trustee who hired Billingsley, the bookkeeper. The latter received all of the income of the trust and had absolute control over all expenditures. Notwithstanding that the embezzlements and the fraudulent peculations were regularly carried out, the trustee failed to check on the bookkeeper's work and never discovered the losses. Finally, accountants, while preparing income tax returns, accidentally became aware of the wrongdoing.
In an action by the beneficiaries seeking to surcharge the trustee for the deficiencies in his accounts, the trial court denied relief. The beneficiaries and creditors have appealed.
Following the filing of a petition for a Chapter XII arrangement by Roy Johnson on August 5, 1958, the United States District Court for the Eastern District of Oklahoma approved the proposed arrangement and confirmed the same on May 11, 1960. At that time, Clark was appointed trustee. The arrangement required the trustee to continue the business, submit a profit and loss statement each month, pay the income from mortgaged property to secured creditors and to pay the remaining income to the unsecured creditors. In 1961 the court ordered the trustee to submit annual audits to the court and creditors. In practice these did not involve a detailed investigation and did not reveal the facts.
As of November 1962, the working interests of the trust had been sold, the secured creditors had been paid and the trust retained only passive royalty interests. Distributions to the unsecured creditors were made on July 31, 1962, August 15, 1962, September 11, 1963 and July 31, 1968. The resulting reduction of debt amounted to approximately 30%.
Besides being trustee Clark, who was a geologist, operated his own business and a partnership with his father. All were conducted in the same office. Billingsley, the embezzling bookkeeper and the secretary, performed services for all three businesses.
The undisputed evidence showed that Clark filed the monthly statements and the annual reports, sending copies to the creditors. However, no hearings were ever held on the sufficiency of these nor was action taken by the court giving approval to them. At the same time, neither the creditors nor the residuary beneficiaries objected.
The annual reports were unaudited. They were prepared by the accountants from figures given by Billingsley. It was not until 1969 that these accountants discovered some discrepancy leading to further investigation and revelation that Billingsley had been embezzling money of the trust from its inception. He had both altered and forged checks on a regular basis. For example, not infrequently he raised his salary checks by $1,000. His other practice was to convert royalty checks payable to the trust. He would endorse them on behalf of the trust and then make deposits in his personal account. All of these defalcations totaled over $50,000.
After discovery of the wrongdoing, Clark dismissed Billingsley, enjoined him from disposing of his property and proceeded to get a judgment against him. After this, Billingsley's assets were sold and the proceeds were deposited in court. The trustee also obtained permission to sue the Exchange National Bank and Trust Company of Ardmore. 1 This was the bank which had received trust checks deposited in the account of Billingsley.
The trust had been intended at the time of its creation to continue for 10 years. Therefore, on April 28, 1970, the trustee sought an extension of time in order to pursue the Billingsley recovery. In conjunction with this, however, he requested an order allowing liquidation of the assets and termination of the trust. The beneficiaries and some of the creditors objected to this. As a result a hearing was held in October in which the court directed the trustee to file a preliminary final accounting. Soon thereafter, in January 1971, the objecting creditors and beneficiaries applied to the court to surcharge the trustee for the deficiencies attributable to Billingsley and also for alleged excessive administrative expenses. In addition, a request was made that the trustee be denied the additional compensation which the plan would have given to him. 2
Following another hearing in February the court continued the arrangement for a year. The court also ordered Clark to file a final report. Delay of the surcharge determination was also ordered.
On March 1, 1971, the First National Bank and Trust Company of Muskogee succeeded Clark as trustee, and as the plaintiff in the suit against the Exchange National Bank. At the trial of this matter in February 1972 the trustee Bank prevailed.
A hearing on Clark's final report and motion for discharge was held in August 1971. After that, the case was taken under advisement, and on November 21, 1972, Judge Langley entered an order surcharging Clark in the amount of $157,185.99. However, on January 2, 1973, this order of surcharge was vacated. Another hearing was held on April 24. Following this briefs were submitted, but before a decision could be made Judge Langley died. The case was then tried by Judge Daugherty on the record. This trial was held on April 19, 1974, at which time oral arguments were made, and soon thereafter, on May 3, 1974, Judge Daugherty entered the present order which is now being reviewed in which he denied the surcharge and approved the final account of Clark.
The trial court ruled:
1) That the judgment allowing the estate to recover against the Exchange National Bank somehow barred or prevented a surcharge in these proceedings. The court's reasoning was that the creditors and beneficiaries were barred from asserting a position inconsistent with that maintained in the prior proceeding;
2) The court was uncertain as to whether a reasonably prudent person could have detected Billingsley's conversions;
3) The court refused to surcharge for excessive administrative costs on the ground that it felt unable to conclude improper management by Clark warranting surcharge;
4) The court felt that the objectors were barred because of their failure to object to the reports which were filed regularly. The ruling was that they had either ratified or acquiesced;
5) The beneficiaries and creditors were barred by laches. They had not objected and thus it would be unfair to surcharge the trustee after passage of the years involved;
6) The court held that the misuse of the telephone and the making of gifts out of trust funds was de minimis;
7) The accounting expenses and legal expenses occasioned by the substantial losses to the trust were not chargeable under the totality of the facts; finally, the crowning blow was the court's ruling that the trustee was entitled to his 15% of the residue of the estate. All of these rulings are challenged on this appeal.
The standard applicable to the surcharge of a bankruptcy trustee is negligence. This was established in the case of Mosser v. Darrow, 341 U.S. 267, 71 S.Ct. 680, 95 L.Ed. 927 (1951). As in the case at bar, the trustee there did not make any personal profit. His wrongdoing consisted of allowing key employees to profit personally by trading in securities of the subsidiaries of the debtor corporation. Darrow was appointed reorganization trustee in 1935 for the common law trusts. Johnson and Kulp were employed by the trustee. They had been promoters of the subsidiaries of the common law trusts which were being reorganized. Their employment agreement allowed them to trade in securities of the subsidiaries. They would often acquire bonds and then sell them at a profit to the trustee, and in some instances they had purchased bonds from people who had intended to offer them to the trustee for purchase. During eight years of trusteeship Darrow filed but one account for one of the debtors. Following an SEC investigation, Darrow resigned and filed his final account which was objected to. The Supreme Court pointed out that the reorganization trustee is a representative of the court. The trusteeship, the Court said, is "serious business and is not to be undertaken lightly." The Court further said that the doing of forbidden acts calls for the sanction of personal liability. The Supreme Court further said that the responsibility could have been avoided if the questionable practice had been submitted to the court for its approval, in which case a notice would have been given to creditors and interested parties or by making reports at regular intervals (in this instance the trustee failed to report). Thus, this case...
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