Scott, In re
| Decision Date | 26 March 1999 |
| Docket Number | No. 97-2062,97-2062 |
| Citation | 172 F.3d 959 |
| Parties | , Bankr. L. Rep. P 77,915 In the Matter of Richard E. SCOTT, Debtor. Ronald R. Peterson, Plaintiff-Appellant, v. Richard E. Scott, Defendant-Appellee. In the Matter of Douglas W. Scott, Debtor. Ronald R. Peterson, Plaintiff-Appellant, v. Douglas W. Scott, Defendant-Appellee. In the Matter of Douglas H. Scott, Debtor. Ronald R. Peterson, Plaintiff-Appellant, v. Douglas H. Scott, Defendant-Appellee. |
| Court | U.S. Court of Appeals — Seventh Circuit |
Timothy J. Chorvat (argued), Jenner & Block, Chicago, IL, for Appellant.
Richard E. Scott, pro se.
Douglas W. Scott, pro se.
Douglas H. Scott, pro se.
Michael K. Desmond, Chicago, IL, U.S. Trustee, Office of the United States Trustee, Peoria, IL, Sandra T. Rasnak, Office of the United States Trustee, Chicago, IL, for Amicus Curiae U.S. Trustee.
Richard M. Bendix, Jr., Bret A. Rappaport, Malcolm M. Gaynor (argued), Schwartz, Cooper, Greenberger & Krauss, Chicago, IL, for Amicus Curiae Bret A. Rappaport.
Before CUDAHY, MANION and EVANS, Circuit Judges.
The United States Trustee appointed Ronald R. Peterson bankruptcy trustee for the bankruptcies of Richard Scott, Douglas W. Scott, and Douglas H. Scott. Peterson brought an adversary complaint against them, seeking a denial of the discharge of their debts. The complaint alleged that the Scotts intentionally concealed their assets, and failed to keep and preserve adequate financial information. The bankruptcy court found against the trustee, and the district court affirmed. We conclude that the lower courts did not apply the correct legal standards to Peterson's claims, and therefore we reverse and remand for further proceedings consistent with this opinion.
Douglas H. Scott brought his son Richard Scott into his real estate investment business in 1969. In 1974, Douglas W. Scott, also Douglas H.'s son, joined the business. They primarily invested in single family homes, but they also acquired apartment buildings and office buildings, and later they branched out into horse breeding and film production. As they acquired properties and other investment opportunities, and solicited investors to help fund their investment purchases, they set up partnerships, limited partnerships, and corporations to hold and manage these assets. By the mid-1980s, the Scotts controlled more than 70 corporations, partnerships or limited partnerships (the "business entities"). The Scotts charged their investors a sizeable fee for managing these investments: at least 26% of the initial investment, plus about 5% per year in management fees. This money was paid to IRE Services, Inc., a corporation set up by the Scotts to manage the numerous corporations and partnerships.
The investments made by the Scotts' business entities generally yielded a net operating loss every year--the expenses, interest, and depreciation from the investments exceeded the current revenue generated each year. These losses could then be used to offset the investors' income for tax purposes. And, at least in theory, the real estate and other holdings were appreciating in value every year, so when the properties were sold, the investors would make a profit.
Unfortunately for the Scotts, and their investors, President Reagan proposed substantial tax changes in 1984 (enacted in 1986) which eliminated investors' ability to use passive investment losses to offset income derived from employment. Also, inflation came down from its highs in the late 1970s to single-digit levels. This had the effect of reducing, and in some cases reversing, the rate of appreciation of real estate. (The Scotts had forecasted inflation to remain at 10% per year.) Finally, many of the Scotts' investments were in Oklahoma and other areas hard hit by the collapse in oil prices occurring in the mid-1980s. Because of these changes, investors stopped putting new money into the Scotts' investments, causing insufficient cash flow to cover mortgage payments, expenses and other financial demands. About 50 of the Scotts' business entities filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code (11 U.S.C. § 1101 et seq.) (reorganization). But not all Scott entities filed for bankruptcy, notably IRE Services, Inc.
On November 15, 1985, each Scott filed for bankruptcy under Chapter 11 of the Bankruptcy Code. 1 By filing under Chapter 11, the debtors became debtors-in-possession, authorized to continue operating their businesses while preparing a plan of reorganization, to be approved by their creditors. See 11 U.S.C. §§ 1107 & 1108. 2 This plan, and an accompanying disclosure statement, would be reviewed and approved by the bankruptcy court and then circulated to all creditors. Id. at §§ 1121 & 1129. Upon approval of the plan by the creditors, it would become a binding contract between the debtors and the creditors. See, e.g., S.N.A. Nut Co. v. Tulare Nut Co. (In re S.N.A. Nut Co.), 197 B.R. 642, 647 (Bkrtcy.N.D.Ill.1996); accord, Gibbons v. Gardner ( In re Alton R. Co.), 159 F.2d 200, 207 (7th Cir.1947) (Bankruptcy Act).
At the time that the Scotts filed their initial bankruptcy petitions, they did not file their bankruptcy schedules and statements of financial affairs, despite the clear mandate of Rule 1007(c) of the Federal Rules of Bankruptcy Procedure that schedules be filed at the time of filing the petition. About seven months later the debtors finally filed their bankruptcy schedules, in which they revealed that they owned interests in over 70 business entities. However, they identified neither their respective ownership interests in these entities nor the value of their interests in these entities. Schedule B of their bankruptcy schedules stated that "[i]n addition, [the debtors have] a limited partner interest in various partnerships both in and out of Chapter 11 proceedings the value of which can not be determined at this time." Bankruptcy law requires that debtors list their assets and place a numerical figure representing the value of the assets. See 11 U.S.C. § 521(1); In re Bell, 179 B.R. 129, 130 (Bankr.E.D.Wis.1995) () (citing In re Wenande, 107 B.R. 770, 772 (Bankr.D.Wyo.1989)).
On July 25, 1988, the Scotts filed proposed reorganization plans with the bankruptcy court, and circulated the plans to interested creditors. These plans stated that the unsecured creditors, who were owed as much as $14 million, would receive $25,000 to be divided pro rata among all of the unsecured creditors. Furthermore, the balance of the unsecured debt would be discharged, and the Scotts would retain their interests in the business entities free and clear of any prepetition unsecured debt.
Almost nine months later, on March 28, 1989, the debtors filed with the bankruptcy court three virtually identical proposed disclosure statements. These disclosure statements lumped all of the interests in the business entities into a single line. The Scotts valued their combined interests in all of the entities at $142,000: $60,000 for each of the interests of Richard and Douglas H., and $22,000 for Douglas W.'s interest. The disclosure statements did not explain how these figures were derived.
A few creditors objected to these disclosure statements, and the debtors filed another disclosure statement, the First Amended Disclosure Statement, roughly a month later. This disclosure statement, however, contained the same information with regard to the business entities. Moreover, the Scotts refused to produce any records regarding their interests in the corporations or partnerships not in bankruptcy.
Finally, in November 1989, the bankruptcy court ordered the Scotts to turn over their records regarding the business entities not in bankruptcy. A week later, the Scotts circulated a Second Amended Disclosure Statement revealing their interest in Burr Oaks Associates, a partnership not in bankruptcy at that time. (The Scotts did not file this disclosure statement with the bankruptcy court.) Burr Oaks Associates was owned by two partnerships, Group B and Group G partnerships. The general partners of these partnerships were the Scotts themselves and also IRE, Incorporated, a corporation wholly owned by the Scotts. The effect of this arrangement, both legally and practically, was that Burr Oaks Associates was owned by the Scotts (through their ownership interests in Groups B & G) 3 and controlled by the Scotts (as general partners and officers of the general partner of Groups B & G).
The Second Amended Disclosure Statement revealed that Burr Oaks Associates received about $480,000 in cash in early 1989, and had invested the money in high risk bonds, also called debentures. Receipt of this money occurred just before Richard Scott appeared to testify at the meeting of creditors mandated by § 341 of the Bankruptcy Code. It is uncontested that Richard did not reveal the existence of this asset at his § 341 meeting of creditors; he contends that he was not asked about it, and did not have a duty to disclose it.
In January 1990, about three months after the Second Amended Disclosure Statement was circulated among the creditors, the U.S. Trustee asked the bankruptcy court to remove the Scotts as debtors-in-possession and to appoint a trustee to supervise the bankruptcies. See 11 U.S.C. § 1104. The U.S. Trustee alleged that the debtors had been dilatory about fulfilling their duties as debtors-in-possession, had engaged in gross mismanagement of their business interests, and had engaged in dishonest and fraudulent behavior before and during their tenure as debtors-in-possession. The bankruptcy court granted the motion of the U.S. Trustee, and appointed Peterson Chapter 11 Trustee for all three bankruptcies.
Trustee Peterson then retained Craig Elson, a forensic accountant who specializes...
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