Lehal Realty Associates, In re, 100

• Decision Date: 27 November 1996
• Docket Number: No. 100,D,100
• Citation: 101 F.3d 272
• Parties: , 29 Bankr.Ct.Dec. 1326, Bankr. L. Rep. P 77,185 In re LEHAL REALTY ASSOCIATES, Debtor. George LEBOVITS, a principal and equity holder of Lehal Realty Associates, Debtor-Appellant, v. John F. SCHEFFEL, as Trustee of Lehal Realty Associates, Trustee-Appellee. ocket 96-5007.
• Court: U.S. Court of Appeals — Second Circuit

Page 272

101 F.3d 272

65 USLW 2438, 29 Bankr.Ct.Dec. 1326,

Bankr. L. Rep. P 77,185

In re LEHAL REALTY ASSOCIATES, Debtor George LEBOVITS, a principal and equity holder of Lehal Realty Associates, Debtor-Appellant, v. John F. SCHEFFEL, as Trustee of Lehal Realty Associates Trustee-Appellee.

No. 100, Docket 96-5007.

United States Court of Appeals Second Circuit.

Argued Sept. 5, 1996.

Decided Nov. 27, 1996.

Harvey S. Barr, Spring Valley, NY (Barr & Rosenbaum, LLP, Elizabeth A. Haas, on the brief), for Debtor-Appellant.

Richard L. Magro, White Plains, NY (Voute, Lohrfink, Magro and Collins, of counsel), for Trustee-Appellee.

Before: FEINBERG, CARDAMONE and McLAUGHLIN, Circuit Judges.

FEINBERG, Circuit Judge:

George Lebovits, a 75% general partner in debtor Lehal Realty Associates (Lehal), appeals from an order of the United States District Court for the Southern District of New York, Charles L. Brieant, J. The order enjoined the prosecution of a pending action brought by Lebovits and his partner in a New York State court against appellee John F. Scheffel, Esq., the debtor's trustee in bankruptcy, for breach of fiduciary duty. The action had been brought without the permission of the bankruptcy court. The principal issue before us is whether Judge Brieant erred in granting the injunction. We hold that, on the record before us, he did not. For reasons set forth below, we affirm the order of the district court.

I. Facts and Proceedings Below

In February 1989, an involuntary Chapter 11 petition in bankruptcy was filed against Lehal in the Southern District. Appellee Scheffel (the Trustee) was appointed trustee of the debtor in August 1989. Thereafter, Bankruptcy Judge Howard J. Schwartzberg approved a plan of reorganization that contemplated the liquidation of the debtor's only significant asset, a parcel of real estate located in Rockland County, New York. The property was sold at public auction for $7,600,000.

New York State imposes a tax of 10% (the Gains Tax) on profits from the sale of real property, calculated by subtracting from the sale price an amount equal to the price that the seller paid to acquire the property plus the value of certain capital improvements. N.Y. Tax Law Art. 31B, § 1441 et seq. (McKinney 1987). In order to record a deed transferring property selling for more than a specified minimum amount (concededly exceeded here), the law requires the transferor either to pay the Gains Tax or to obtain a waiver from the New York State Department of Taxation and Finance (the State).

The State computed the gain subject to tax on the proposed sale to be $6,463,288.50, with a total tax due of $646,328.85. The Trustee had apparently unsuccessfully taken the position with the State that some five million dollars in capital improvements should have been included in the debtor's cost basis in calculating the amount of Gains Tax due (the basis argument). Pursuant to authority granted by the bankruptcy court and in order to consummate the sale of the real property, the Trustee paid the tax in February 1990. However, he did so under protest, reserving his right to commence proceedings to recover the funds.

In July 1990, in an unrelated case, Bankruptcy Judge Tina L. Brozman of the Southern District held that a debtor's sale of real property pursuant to an approved plan of reorganization was exempt from the Gains Tax as a "stamp tax or similar tax" under § 1146(c) of the Bankruptcy Code. 11 U.S.C. § 1146(c). ¹ In re 995 Fifth Ave. Assoc., L.P., 116 B.R. 384 (Bankr.S.D.N.Y.1990).

Relying on that decision, the Trustee filed with the State in November 1990 a claim for refund of the Gains Tax he had paid. The claim asserted that, pursuant to § 1146(c), the transfer was exempt from the Gains Tax. It does not appear that the Trustee also raised the basis argument.

The State rejected the claim in a letter dated May 13, 1991. The State disagreed with the Trustee's interpretation of § 1146(c), and relied on an earlier bankruptcy court decision for the proposition that the Gains Tax was not a stamp tax or similar tax under § 1146(c). In re Jacoby-Bender, Inc., 40 B.R. 10 (Bankr.E.D.N.Y.1984), aff'd. 758 F.2d 840 (2d Cir.1985). The State's letter stated:

In accordance with Section 1445.2 of the Tax Law, this determination shall be final and irrevocable unless claimant within ninety (90) days files with [sic] a request for Conciliation Conference with the Bureau of Conciliation and Mediation Services or a Petition for Tax Appeals Hearing with the Division of Tax Appeals. The enclosed Form TA-9.1 explains this procedure.

The Trustee did not follow either course suggested in the letter. Instead, in June 1991 he commenced an adversary proceeding in the bankruptcy court against the State to recover the Gains Tax already paid.

The Trustee's complaint in the adversary proceeding contained two causes of action: the first raised the stamp tax exemption argument, and the second the basis argument. In October 1991, Bankruptcy Judge Schwartzberg concluded that he had the authority to determine the amount or legality of the Gains Tax pursuant to 11 U.S.C. § 505, but had no authority to compel the State to refund any portion of the tax because the State had not waived its Eleventh Amendment right of sovereign immunity. In re Lehal Realty Associates, 133 B.R. 9 (Bankr.S.D.N.Y.1991). On this view, the bankruptcy judge did not reach the merits of the Trustee's basis argument.

In December 1991, the Trustee filed an administrative tax appeal with the State from its denial in May 1991 of his refund claim. The Trustee and the State thereafter stipulated to adjourn the administrative appeal until this court decided an already argued appeal growing out of Bankruptcy Judge Brozman's decision in 995 Fifth Avenue. ² Our opinion in that case was issued in April 1992. We held that the Gains Tax is not a stamp tax or similar tax for purposes of 11 U.S.C. § 1146(c), and that a trustee in bankruptcy therefore must pay it. 963 F.2d 503. Certiorari in 995 Fifth Ave. was denied in October 1992. 506 U.S. 947, 113 S.Ct. 395, 121 L.Ed.2d 302.

Thereafter, the Trustee applied to the bankruptcy court for permission to abandon the pending administrative tax appeal. Judge Schwartzberg granted the relief, but by separate order dated April 6, 1993, permitted Lebovits and his partner ³ to continue the administrative appeal in place of the Trustee. Lebovits did so, but was denied relief by the State because of the Trustee's earlier failure to file a timely administrative appeal within the 90-day period that began with the State's denial of the refund in May 1991.

In response to this adverse decision and without obtaining the permission of the bankruptcy court, Lebovits in January 1995 filed an action in state court (the State Court Action) against the Trustee and his law firm. The complaint alleged, among other things that the Trustee's failure to file a timely administrative tax appeal constituted "negligence and malpractice" in breach of his "fiduciary duty." The State Court Action seeks to hold the Trustee personally liable for the amount of the Gains Tax refund to which Lebovits alleges Lehal was entitled. The Trustee appeared in the suit and issue was joined.

In May 1995, the Trustee filed a Final Report with the bankruptcy court. He also simultaneously requested that he be discharged from his obligations as trustee, and that the bankruptcy court enjoin continuation of the State Court Action against him. After a hearing in the bankruptcy court, Bankruptcy Judge John J. Connelly ⁴ issued an order closing the debtor's Chapter 11 case and discharging the Trustee from his duties, but refusing to enjoin the State Court Action against him. The judge was aware that Lebovits had not sought permission of the bankruptcy court to sue the Trustee in state court but stated that, if necessary, he would grant such permission retroactively.

The Trustee appealed Bankruptcy Judge Connelly's decision to the district court. Judge Brieant affirmed the bankruptcy court's discharge of the Trustee, but reversed that court in part by enjoining Lebovits from pursuing the State Court Action. The judge reasoned that proceedings against a Trustee for alleged breach of duty in connection with the administration of the estate should be heard in the bankruptcy court or, if necessary to preserve the right to a trial by jury, in the district court. Judge Brieant also noted that

Judge Connelly stated on the record that if the Bankruptcy Court's approval would be necessary to bring the state proceeding, he would retroactively grant such approval. Because of the important interest the Bankruptcy Court and this Court has in overseeing and correcting the conduct of its officers, this Court concludes that any such approval in this case would have been an abuse of judicial discretion.

This appeal followed.

II. Discussion

Appellant Lebovits offers us a number of reasons why Judge Brieant erred in refusing to allow the State Court Action to proceed. Unsurprisingly, the Trustee defends Judge Brieant's order.

Lebovits argues in general terms that a bankruptcy trustee owes a fiduciary duty to all parties in interest and that such a trustee can be held personally responsible for breach of that duty. The Trustee concedes the former proposition, but argues that because he was acting within his authority and was administering and liquidating the estate rather than carrying out its business, he cannot be held personally liable. As will be seen below, the Trustee's argument overstates his case in light of In re Gorski, 766 F.2d 723 (2d Cir.1985).

Lebovits also argues that a bankruptcy court does not have exclusive jurisdiction over suits against a trustee for breach of duty. While that may be true in some circumstances, it does not mean that the bankruptcy court or the district court in this case did not have jurisdiction to decide whether to allow the State Court Action to...