Mid-West Case Report (Opportunity Finance, LLC, v. Kelley)

Opportunity Finance, LLC, v. Kelley, 822 F.3d 451 (8th Cir. 2016)

The United States Court of Appeals for the Eighth Circuit ( “Eighth Circuit”)‑held that (i)‑the district court did not abuse its discretion in declining to estop the trustee from arguing that lenders were not “persons aggrieved” with standing to appeal the bankruptcy court’s substantive consolidation order, (ii)‑the “persons aggrieved” doctrine remained valid and would not be reconsidered by the court and (iii)‑the district court did not err in dismissing lenders under the “persons aggrieved” doctrine.

Thomas Petters (“Petters”), a person ultimately convicted of wire fraud, mail fraud, conspiracy and money laundering, conducted a multi‑billion‑dollar Ponzi scheme using the Petters Company Inc. (“PCI”)‑and eight associated special‑purpose entities (“SPEs”).  To fund PCI, Petters used the SPEs, which held illusory accounts receivable and had no appreciable assets entering bankruptcy.  PCI also served as a holding company for several of the SPEs.  Two groups of lenders made loans directly to certain SPEs and another group of lenders made loans to the first group of lenders (“Lenders”).  Each Lender was a net winner in the Ponzi scheme.

PCI and the SPEs were placed into receivership.  Subsequently, PCI and the SPEs filed for bankruptcy protection under Chapter 11 (“Chapter 11”)‑of the United States Bankruptcy Code (“Bankruptcy Code”)‑in the United States Bankruptcy Court for the District of Minnesota (“Bankruptcy Court”)‑and Douglas Kelley was named as trustee (“Trustee”).

The Bankruptcy Court:

During the Chapter 11 case, the Trustee filed avoidance actions against the Lenders seeking a claw‑back of funds for the bankruptcy estates.  The Trustee alleged that the SPEs wrongfully transferred funds to the Lenders.  If the Lenders were found liable in the avoidance actions, then the Lenders could file proofs of claim in the Chapter 11 case.  However, the Lenders did not file proofs of claim in the Chapter 11 case.  The Trustee, with the support of the unsecured creditors committee, also moved for substantive consolidation of the bankruptcy estates of PCI and the SPEs.  The Lenders, along with nonparty Elistone Fund (“Elistone”)‑objected to the consolidation.  The Bankruptcy Court granted the Trustee’s motion for substantive consolidation finding that PCI and the SPEs were interrelated and had engaged in “massive commingling and the erosion of corporate boundaries”.  The Lenders and Elistone appealed the consolidation.  The Trustee then moved to certify the appeals directly to the Eighth Circuit, which was denied.  Subsequently, the Trustee moved to dismiss the appeals arguing that the Lenders did not have standing as “persons aggrieved” to appeal the Bankruptcy Court’s order.  The Lenders responded stating that (i)‑the Trustee was estopped from objecting to their standing because he expressly stated in his certification motion that the District Court had jurisdiction to hear the appeals and (ii)‑they were persons aggrieved.

The District Court:

The District Court of the State of Minnesota (“District Court”)‑dismissed the appeals and held that (i)‑the Trustee was not estopped and (ii)‑the Lenders were not “persons aggrieved”.  The Lenders subsequently appealed.

The Eighth Circuit:

Before the Eighth Circuit, the Lenders argued that (i)‑the Trustee should be estopped from asserting they lacked standing to appeal since the Trustee, in the certification motion, stated that the District Court had jurisdiction over the pending appeal, (ii)‑even if the Trustee is not estopped, the “persons aggrieved” doctrine invalidly restricts their ability to appeal bankruptcy orders and (iii)‑they were “persons aggrieved” because the substantive consolidation (1)‑diminished their property by increasing the Trustee’s potential recovery against them and decreased the value of their contingent claims and (2)‑impaired their rights by precluding potential affirmative defenses in the trustee’s avoidance actions.

In a split decision, the Eighth Circuit affirmed the District Court’s ruling and held that the District Court did not abuse its discretion in declining to estop the Trustee’s arguments that the Lenders lacked standing and invoking the persons aggrieved doctrine.  In addressing the Lenders’ argument that the Trustee should be estopped from arguing the lack of standing, the Eighth Circuit noted that the Trustee’s statement that the District Court had jurisdiction under 28 U.S.C. §§158(a)‑and 1334 is not clearly inconsistent with the Trustee’s later position that the Lenders are not parties aggrieved.  The Eighth Circuit reasoned that there is nothing inconsistent with arguing that, based on the finality of the Bankruptcy Court’s order, the District Court has jurisdiction over the appeal, and later arguing, because the Lenders did not have standing to appeal, that the appeal should be dismissed.  The Eighth Circuit then addressed the Lenders’ argument that even if the Trustee is not estopped, the “persons aggrieved” doctrine invalidly restricts their ability to appeal bankruptcy court orders because the doctrine is no longer valid after the 1978 amendments removed explicit references to the doctrine in the Bankruptcy Code.   In rejecting this argument, the Eight Circuit noted that it has long applied the “persons aggrieved” doctrine and previously held that the “persons aggrieved” doctrine survives the 1978 amendments to the Bankruptcy Code.  Finally, the Eighth Circuit addressed the Lenders’ arguments that they qualify as persons aggrieved” because the substantive consolidation would diminish their property by increasing the Trustee’s potential recovery against them and decrease the value of their contingent claims and impair their affirmative defenses in the avoidance actions.  The Eight Circuit rejected the first prong of the argument finding that, when analyzing “persons aggrieved”, the doctrine limits standing to persons with a financial stake in the bankruptcy court’s order – meaning they were directly and adversely affected pecuniarily by the order.  The Eighth Circuit noted that the possibility of harm does not satisfy the “persons aggrieved” standard.  Examining the case at hand, the Eighth Circuit noted that any potential pecuniary harm to the Lenders is indirect because several steps must happen before the lenders suffer a pecuniary harm.  Namely, the Trustee must prevail in the avoidance actions, the Lenders must pay the judgment in full and then the Lenders must file a valid proof of claim against the consolidated bankruptcy estate.  The Eighth Circuit also rejected the second prong of the argument finding that the elimination of a good faith defense does not, by itself, make a party a person aggrieved.  Accordingly, the Eighth Circuit affirmed the District Court finding that the District Court did not err in dismissing the Lenders under the persons aggrieved doctrine.