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In re Carbide Cutoff Inc.

decided: March 25, 1983.

IN THE MATTER OF CARBIDE CUTOFF, INC.; APPEAL OF SPECIAL {Q}COUNSEL{/Q} TO THE TRUSTEE


Appeal from the United States District Court for the Northern District of Illinois. No. 81 C 20126 -- Stanley J. Roszkowski, Judge.

Pell, Bauer and Timbers,*fn* Circuit Judges.

Author: Timbers

TIMBERS, Circuit Judge.

This appeal arises from an unusual factual scenario in which the bankruptcy court approved a Trustee's application to permit counsel for a group of unsecured trade creditors to litigate as Special Counsel to the Trustee certain of the estate's claims. After the bankruptcy court subsequently approved an application to compromise the estate's claims, the Special Counsel (appellant on the instant appeal) appealed to the district court from the order of the bankruptcy court approving the compromise application. Without reaching the merits of the Special Counsel's appeal, the district court dismissed the appeal for lack of standing on the part of the Special Counsel.

We find that the record is unclear with respect to the scope of the Special Counsel's authority. We therefore vacate the order appealed from and remand the case to the district court with instructions in turn to remand the case to the bankruptcy court for clarification consistent with this opinion. We further instruct the district court in due course to rule upon the merits of the Special Counsel's claim that the bankruptcy court's approval of the compromise application was an abuse of discretion.

I.

Carbide Cutoff, Inc. (Carbide) is an Illinois corporation which was engaged in the manufacture and sharpening of specially designed steel cutting saws and blades. It was founded in 1975. As a result of serious financial difficulties which occurred in 1979, Carbide arranged for its principal creditor -- American National Bank and Trust Company (Bank) of Rockford, Illinois -- to obtain in early 1980 additional security for an outstanding loan.*fn1 In addition, Carbide's President and its Chairman of the Board of Directors arranged for Alpha Sierra Corporation (Alpha Sierra), a Michigan corporation wholly owned by Carbide's President and Chairman, to purchase Carbide's assets in exchange for Alpha Sierra's assumption of Carbide's indebtedness to the Bank. On February 27, 1980, Carbide sent a bulk sale notice to its creditors announcing the impending sale of assets to Alpha Sierra.

Prior to consummation of the sale of assets, an unsecured creditor, J.M. Grimstad, Inc. (Grimstad), filed an involuntary bankruptcy petition on March 7, 1980 against Carbide.*fn2 Grimstad was represented by Randall E. Crocker, Esq. (Crocker), whose law firm subsequently was appointed Special Counsel to the Trustee by the bankruptcy court.*fn3 Grimstad initially obtained a TRO blocking the sale of assets to Alpha Sierra. The TRO expired and the transfer of assets was consummated on March 19. No interruption occurred in the operation of Carbide's principal plant at Rockford, Illinois. After the sale of assets, the plant was operated as a subsidiary of Alpha Sierra.

On April 4, the bankruptcy court entered an order adjudging Carbide insolvent. The Chapter VII proceedings continued after the bulk sale to Alpha Sierra, although the estate had been stripped of its principal assets. Craig McGuire (McGuire or Trustee) of Polo, Illinois, was appointed by the bankruptcy court as Trustee of Carbide's estate. During the summer of 1980, McGuire conducted several Bankruptcy Rule 205 examinations. To the dismay of the general trade creditors, however, it appeared that McGuire chose not to pursue vigorously the estate's colorable claims against the Bank and Alpha Sierra. For example, although Crocker urged McGuire to commence and action against the Bank and Alpha Sierra to set aside the preferential security interests granted to the Bank and to avoid the sale of assets to Alpha Sierra as an unauthorized post-petition transfer (a first step toward reclaiming the assets), 11 U.S.C. § 549 (Supp. II 1978), McGuire rejected Crocker's recommendation.

On August 9, McGuire did avoid the transfer to Alpha Sierra, but failed to take any further action to collect Carbide's assets. Instead, McGuire filed an application on October 9 to compromise the estate's claims against the Bank and Alpha Sierra. This first proposed compromise provided that the estate would receive $35,000 and that the Bank and Alpha Sierra would release any claims they had against the estate. In return, the estate agreed to release its claims against the Bank and Alpha Sierra. On November 10, McGuire petitioned to withdraw this application to compromise, after a number of unsecured creditors protested. The bankruptcy court granted McGuire's petition to withdraw the application.

Alpha Sierra then commenced an action against McGuire seeking a declaratory judgment that the sale of assets transaction was valid. According to appellant on the instant appeal, McGuire failed to inform Carbide's trade creditors of this declaratory judgment action and filed an answer improperly admitting material allegations contained in Alpha Sierra's complaint.

Subsequently, on March 9, 1981, McGuire filed a second application to compromise, proposing terms substantially similar to those in the prior application.*fn4 This renewed effort by the Trustee to compromise the estate's potential claims triggered an application on March 26 by a group of twelve trade creditors represented by Crocker*fn5 requesting the removal of McGuire as Trustee, 11 U.S.C. § 324 (Supp. II 1978), or, alternatively, the appointment of a Special Counsel to pursue in the Trustee's name the estate's claims against the Bank and Alpha Sierra.*fn6

After a hearing before the bankruptcy court on the second compromise application, the bankruptcy court on April 13 entered an order denying the application. The bankruptcy court did not rule, however, on the trade creditors' application to remove the Trustee. Instead, the parties stipulated that McGuire would remain as Trustee and Crocker's law firm would act as Special Counsel to the Trustee to prosecute in the Trustee's name the estate's claims against the Bank and Alpha Sierra.

The bankruptcy court subsequently formalized this arrangement with respect to the appointment of Crocker's firm as Special Counsel in an order entered May 1, 1981 captioned "Order Authorizing Employment of Special Counsel."*fn7 According to appellant, it was agreed among the parties that Ronald R. Peterson, Esq. and his law firm would "assist" the Special Counsel, ...


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