Sergent v. McKinstry

• Decision Date: 21 March 2012
• Docket Number: Civil Nos. 11–129–ART, 11–133–ART.
• Citation: 472 B.R. 387
• Court: U.S. District Court — Eastern District of Kentucky
• Parties: Harold E. SERGENT, Appellant, v. Taft A. McKINSTRY, as Trustee of the BD Unsecured Creditors Trust, et al., Appellees. Taft A. McKinstry, as Trustee of the BD Unsecured Creditors Trust, Petitioner, v. Harold E. Sergent, et al., Respondents.

472 B.R. 387

Harold E. SERGENT, Appellant,
v.
Taft A. McKINSTRY, as Trustee of the BD Unsecured Creditors Trust, et al., Appellees.
Taft A. McKinstry, as Trustee of the BD Unsecured Creditors Trust, Petitioner,
v.
Harold E. Sergent, et al., Respondents.

Civil Nos. 11–129–ART, 11–133–ART.

United States District Court,
E.D. Kentucky,
Southern Division,
Pikeville.

March 21, 2012.

[472 B.R. 390]

Jay S. Geller, Jeremy R. Fischer, Paul McDonald, Bernstein, Shur, Sawyer & Nelson, P.A., Portland, ME, for Appellant.

Logan E. Johnson, Schiffer Odom Hicks & Johnson, PLLC, Houston, TX, David B. Goroff, Geoffrey S. Goodman, Foley & Lardner, LLP, John C. Goodchild, III, Kevin B. Dreher, Morgan, Lewis & Bockius, LLP, Chicago, IL, Ellen Arvin Kennedy, Grahmn Morgan, Dinsmore & Shohl LLP, Jay Edward Ingle, Mary Elisabeth Naumann, Jackson Kelly PLLC, Lexington, KY, for Appellees.

MEMORANDUM OPINION & ORDER
AMUL R. THAPAR, District Judge.

Location matters. When King Leonidas and the Greeks chose to make their stand at Thermopylae, the narrow mountain pass “largely neutralize[d]” the Persians' strong cavalry and enabled the Greek force to inflict massive casualties on a Persian army more than twenty times its size. See Ben Dupré, Where History Was Made: Landmarks of World History from Thermopylae to Ground Zero 11–12 (2009). During the American Revolutionary War, the militia fought from behind hills and trees rather than in the open field, employing guerilla tactics to turn the strength of the British line formations into a weakness. See generally Mark V. Kwasny, Washington's Partisan War, 1775–1783, chs. 4–5 (1998). By choosing their battlefields, these armies shaped the rules of engagement.

[472 B.R. 391]

The same is often true in litigation. Although Sergent's appeal and the Plaintiff's motion to withdraw raise complex and novel issues, they distill to a single question: where should this litigation take place? The Bankruptcy Court should not have abstained from hearing the claims against Sergent, and the Plaintiff is entitled to a jury trial on her claims. Yet because the motion to withdraw is premature, the parties must stay in Bankruptcy Court until the case is trial-ready.

BACKGROUND A. The Underlying Bankruptcy

Any coal mining case that does not mention black diamonds “would be a much duller affair” than Hamlet without the prince. Cinkovitch v. Thistle Coal Co., 143 Iowa 595, 121 N.W. 1036, 1038 (Iowa 1909). History makes clear that two factors earned coal its nickname: value and durability. In the United States, coal spurred the building of the nation's first railways and helped lay the foundations for the beginning of the Industrial Revolution. Albert Sidney Bolles, Industrial History of the United States 710 (Henry Bill Publishing 3d ed. 1878). Near the end of the nineteenth century, the value of coal mined in the nation was “equal to that of all the gold, silver, and iron produced.” Id. at 704. America's “diadem of economic wealth” continued to sparkle with black diamonds into the twentieth century, In re Hudak's Estate, 383 Pa. 278, 118 A.2d 577, 584 (1955) (Musmanno, J., dissenting), and coal continued its “industrial supremacy,” Frederick Robert Worts, Modern Industrial History 158 (1919).

Harold Sergent was probably trying to dig up similarly auspicious prospects by naming his coal company after the black diamond. After all, Sergent and James Campbell founded the Black Diamond Mining Company and its seven affiliates (collectively, “Black Diamond”) to buy promising but undeveloped coal assets in Floyd County, Kentucky, and turn a profit. Compl., McKinstry v. Sergent, 442 B.R. 567 (E.D.Ky.2011) (Pikeville No. 10–110–ART), R. 1–1 at 10 ¶ 11. After putting up some of his own money, Sergent turned to a consortium of lenders, led by CIT Capital USA, Inc., to finance the purchase of these assets. Id. at 11 ¶ 12.

According to the Plaintiff's complaint, the following events then ensued. While in charge of Black Diamond, Sergent engaged in self-dealing and mismanaged the company. Id. at 24 ¶ 54. In 2006, he caused Black Diamond to enter a Consulting & Sales Agreement with another company that Sergent founded, Global Energy Holdings, LLC. Id. at 11 ¶ 13. Under this agreement, Black Diamond appointed Sergent and Global Energy as its exclusive agents for selling coal and paid them $0.25 per ton of coal that Black Diamond mined or sold, with a minimum monthly payment of $30,000. Consulting & Sales Agreement, McKinstry v. Sergent ( In re Black Diamond Mining, LLC ), No. 11–07010–JMS (Bankr. E.D. Ky. 2008) [hereinafter “ Adversary Proceeding ”], R. 19–1 at 3 ¶¶ 6–7. Not long afterwards, Black Diamond, under Sergent's direction, entered a Royalty Agreement with one of its lenders, CIT Capital. Compl., McKinstry, 442 B.R. 567 (No. 10–110), R. 1–1 at 12 ¶ 15. In exchange for financing the purchase of the Floyd County coal assets, Black Diamond agreed to pay royalties of $0.05 per ton to CIT Capital and $0.04 per ton to Sergent and Campbell. Royalty Fee Agreement, Adversary Proceeding, R. 19–2 at 2–3 ¶¶ 2–3. These agreements allegedly created a conflict of interest for Sergent. He was caught between his incentive to maximize his personal income by selling as much coal as possible regardless of whether Black Diamond would profit

[472 B.R. 392]

and Black Diamond's interest to “sell only as much coal as it could profitably mine.” Compl., McKinstry, 442 B.R. 567 (Pikeville No. 10–110–ART), R. 1–1 at 12 ¶ 16.

Succumbing to the incentive to produce or sell as much coal as possible, Sergent committed Black Diamond to long-term Supply Contracts with coal purchasers to sell more coal than Black Diamond could produce from its own mines. Id. at 12–13 ¶ 17. To make up the shortfall between the amount it could produce and the amount it was obligated to sell, Black Diamond purchased the difference on the spot market. Id. Of course, this strategy was profitable so long as the price of purchasing coal on the spot market remained less than the selling price under the Supply Contracts, which topped out at about $52 per ton. Id. at 13 ¶ 18.

Although successful for the first two years, this strategy turned out to be a disastrous gamble when coal prices surpassed the $52 break-even point. Id. Concerned about the company's continued ability to satisfy its liabilities, CIT Capital insisted that Black Diamond hire Alvarez & Marsal North America, LLC (“A & M”) as a financial advisor. Id. at 14 ¶ 23. But this was all for naught. The spot market price of coal continued to rise, and Black Diamond was unable to restructure the Supply Contracts. Id. at 14 ¶ 22; see also Appellant's Br., Sergent v. McKinstry, Pikeville No. 11–129–ART (E.D. Ky. 2011), R. 7 at 13. By early 2008, the spot market price of coal reached $70 to $80 per ton, which meant that Black Diamond lost $20 to $30 for each ton of coal it bought to satisfy its contractual obligations. Compl., McKinstry, 442 B.R. 567 (Pikeville No. 10–110–ART), R. 1–1 at 13–14 ¶ 21.

With their borrower's liabilities rapidly outstripping its assets, Black Diamond's lenders needed a new plan of attack. In February 2008, CIT Capital and the other lenders turned to the Chapter 11 bankruptcy process with the hope of reorganizing Black Diamond as a profitable company. The lenders filed involuntary petitions to drag Black Diamond and its seven subsidiaries into bankruptcy. See, e.g., Chapter 11 Involuntary Pet., In re Black Diamond Mining Co., No. 08–70066–JMS (Bankr. E.D. Ky. 2008) [hereinafter “ Underlying Bankruptcy ”], R. 1.

Up to this point, Black Diamond had not lived up to a name suggesting value and durability. Rather, once in bankruptcy, Black Diamond's name was more akin to the ski symbol indicating the need for expertise before continuing downhill. The Bankruptcy Court had to decide what kind of experts were needed to reorganize Black Diamond and help pull it back from the brink of financial collapse. For their part, CIT Capital and the other lenders moved for the appointment of a bankruptcy trustee to manage Black Diamond's estate. Mot. Appoint Trustee, Underlying Bankruptcy, R. 2. But rather than engage in a prolonged fight over the appointment of a trustee, the parties agreed to create a new senior management position within Black Diamond—Chief Restructuring Officer (“CRO”)—and to appoint a specialist in turnaround management from A & M to this position. CRO Order, id., R. 56. Accordingly, the Bankruptcy Court authorized Black Diamond to hire an A & M employee, Ira Genser, as its CRO. Id. at 2. Because Genser was not a court-appointed trustee under the Bankruptcy Code, CIT Capital withdrew its motion for a trustee, but reserved the ability to renew it in the future. Id. at 6 (ordering that CIT Capital's motion to appoint a Chapter 11 trustee is “withdrawn, without prejudice”).

The Bankruptcy Court gave Genser, as CRO, all of the powers necessary to run and restructure Black Diamond, including the power to hire and fire employees.

[472 B.R. 393]

Id. at 2–4 (listing all of the CRO's powers). So Genser hired his A & M colleague, Larry Tate, as Black Diamond's Chief Financial Officer (“CFO”). Engagement Letter, McKinstry, Pikeville No. 11–133–ART, R. 2 Ex. 3 ¶ 1.a(ii). Consistent with the requirements of the CRO Order, Black Diamond and A & M entered into a court-approved Engagement Letter that described the relationship between Black Diamond and A & M. This Engagement Letter detailed the scope of A & M's turnaround management services, Genser's hiring as CRO, and Tate's hiring as CFO. See generally id.; see also Underlying Bankruptcy, R. 439 (order approving Engagement Letter).

After A & M took over Black Diamond's day-to-day management, the Bankruptcy Court authorized Black Diamond to reject the Consulting & Sales Agreement and the Royalty Agreement that caused Black Diamond's financial troubles. Id., R. 407. Unhappy that he would not receive payments promised to him under these agreements, Sergent filed proofs...