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In re S.M. Acquisition Co.

August 7, 2006

IN RE: S.M. ACQUISITION CO., D/B/A STYLEMASTER, INC., DEBTOR,
MATRIX IV, INC., APPELLANT,
v.
AMERICAN NATIONAL BANK AND TRUST COMPANY OF CHICAGO, APPELLEE.



The opinion of the court was delivered by: Marvin E. Aspen United States District Judge

MEMORANDUM ORDER AND OPINION

Matrix IV, Inc. ("Matrix") appeals several decisions of the United States Bankruptcy Court for the Northern District of Illinois regarding the equitable subordination and recharacterization affirmative defenses it asserted in the underlying adversary proceeding. Specifically, Matrix claims the bankruptcy court erred by (1) ordering it on November 14, 2002 to file a more definite statement setting forth facts in support of its affirmative defense; (2) striking those defenses pursuant to Rule 12(f) on December 20, 2002; and (3) entering an October 31, 2005 memorandum inconsistent with our remand order of September 12, 2005. For the reasons set forth below, we reverse the dismissal of the recharacterization defense and remand the matter to the bankruptcy court for consideration of that particular affirmative defense. We affirm the bankruptcy court's order striking the equitable subordination defense.

PROCEDURAL BACKGROUND*fn1

S.M. Acquisition Co., d/b/a Stylemaster, Inc. ("Stylemaster") filed a petition for bankruptcy relief under Chapter 11 on March 18, 2002. American National Bank and Trust Company of Chicago (the "Bank") brought a related adversary proceeding against Matrix in which the Bank sought a declaration that its lien on certain Stylemaster property was superior to the liens asserted by Matrix. On August 4, 2003, following a bench trial, the bankruptcy court entered judgment in the Bank's favor. See In re S.M. Acquisition Co., 296 B.R. 452 (Bankr. N.D. Ill. 2003) ("Stylemaster I"). Matrix appealed that judgment to our court, as well as the bankruptcy court's earlier decision to strike Matrix's eighth affirmative defense. In an April 29, 2004 order, we remanded the action to the bankruptcy court on a specific issue and refrained from ruling on other arguments raised in that appeal. See In re S.M. Acquisition Co., No. 03 C 7072, 2004 WL 1151575 (N.D. Ill. April 29, 2004) ("Stylemaster II"). On January 13, 2005, the bankruptcy court issued additional findings of fact and conclusions of law supporting its original judgment in the Bank's favor. See In re S.M. Acquisition Co., 319 B.R. 553 (Bankr. N.D. Ill. 2005) ("Stylemaster III").

Matrix then appealed the bankruptcy court's findings and conclusions upon the remand. By order of September 12, 2005, we affirmed the bankruptcy court's original and additional findings and conclusions, as well as challenged evidentiary and discovery rulings. See In re S.M. Acquisition Co., Nos. 03 C 7072, 05 C 1037, slip op. at 2, 36-37 (N.D. Ill. Sept. 12, 2005) ("Stylemaster IV"). We also remanded the case to the bankruptcy court for the limited purpose of entering a memorandum opinion and order on Matrix's eighth affirmative defense. Id. We did so because the bankruptcy court stated in its January 13, 2005 order that it prepared a memorandum opinion in April 2003 on that issue, but no opinion had been handed down. See Stylemaster III, 319 B.R. at 555 n.2. On October 31, 2005, the bankruptcy court entered its memorandum, concluding that Matrix's equitable subordination and recharacterization affirmative defenses were legally insufficient and dismissing them with prejudice. See In re S.M. Acquisition Co., 332 B.R. 346, 356-357 (Bankr. N.D. Ill. 2005) ("Stylemaster V").

At this juncture, Matrix objects to the bankruptcy court's orders requiring it to file a more definite statement of facts supporting these two affirmative defenses and its dismissal of those defenses. (Matrix Brief at 2, 12-13.) See Stylemaster V, 332 B.R. at 356-357; In re S.M. Acquisition Co., No. 02 B 10723, No. 02 A 00283, Tr. of Excerpt (B) of Proc. at 10-11 (Bankr. N.D. Ill. Dec. 20, 2002) (orally granting the Bank's motion to strike eighth affirmative defense) [Adversary Proc. Docket No. 229]; In re S.M. Acquisition Co., No. 02 B 10723, No. 02 A 00283, Minute Order (Bankr. N.D. Ill. Nov. 14, 2002) (ordering Matrix to "file more definite statement of facts . . . by November 18, 2002") (hereinafter "MDS Order") [Adversary Proc. Docket No. 116]. Matrix further claims that the court exceeded our September 12 mandate by issuing an opinion written (at least in part) after April 2003 and relying on evidentiary support outside the pleadings. (Matrix Brief at 2, 14-18.) The Bank opposes Matrix's appeal and defends the bankruptcy court's decisions.

ANALYSIS

In a bankruptcy appeal, we examine the bankruptcy court's factual findings for clear error and its legal conclusions de novo. See Hoseman v. Weinschneider, 322 F.3d 468, 473 (7th Cir. 2003); Meyer v. Rigdon, 36 F.3d 1375, 1378 (7th Cir.1994); United Air Lines, Inc. v. HSBC Bank USA, 322 B.R. 347, 350 (N.D. Ill. 2005); Outboard Marine Corp. v. Moglia, 278 B.R. 778, 782 (N.D. Ill. 2002). De novo review requires us to make an independent examination of the bankruptcy court's judgment without giving deference to that court's analysis or conclusions. We also review de novo mixed questions of fact and law. See In re Rovell, 232 B.R. 381, 386 (N.D. Ill. 1998). With these standards in mind, we consider each of Matrix's arguments in turn.

A. The Bankruptcy Court's MDS Order

Matrix first articulated its equitable subordination defense on September 12, 2002 in response to the Bank's motion for summary judgment in the underlying adversary proceeding. (See Matrix Memo. in Resp. & Obj. to Mot. Summ. J. ("MSJ") ¶¶ 26-32 [Adversary Proc. Docket No. 58].) At that time, Matrix argued that its tool and die lien was superior to the Bank's security interest in the relevant Stylemaster molds. (Id. ¶¶ 1-6.) Moreover, it alleged that the Bank colluded "with the fraudulent conduct of Stylemaster" and its president, Martha Williams, leading to Matrix's crippling losses. (Id. ¶ 31.) As further support for its argument, Matrix claimed that the Bank, among other things: (1) extended credit to Stylemaster despite its insolvency; (2) intentionally refused to act on its knowledge of Matrix liens; (3) entered into a "sweetheart settlement" with Stylemaster guarantors and amended that agreement to impair the equitable subordination defense; and (4) enlisted its counsel in efforts to "supercede Matrix'[s] liens and obfuscat[e]" collusive acts. (Id. ¶ 21.) Based on this "collusive conduct by the Bank," Matrix requested "an order equitably subordinating any interest the Bank may have in the Stylemaster molds in Matrix'[s] possession" and a denial of the Bank's motion for summary judgment. (Id. ¶ 32.)

The bankruptcy court subsequently denied the parties' cross-motions for summary judgment, and Matrix initiated additional discovery to investigate and support its equitable subordination argument. In response, the Bank filed a motion in limine on November 12, 2002, correctly observing that Matrix had not formally plead this affirmative defense and seeking to bar the related discovery, which it claimed Matrix underhandedly served to further its separate RICO action against Stylemaster. (See Bank Mot. In Limine ¶¶ 3-5, 10 [Adversary Proc. Docket No. 112].)

As a result, on November 14, the bankruptcy court ordered Matrix "to file [the] affirmative defense of equitable subordination asserted by it in defense of [the Bank's] summary judgment motion." See MDS Order. The court also ordered Matrix to file a more definite statement of facts in support of that affirmative defense by November 18, 2002. Id. In light of the impending formal addition of the affirmative defense, the court informed the parties that the Bank's motion in limine would be treated as a motion to strike and set a briefing schedule. Id. Matrix complied with the court's order, filing its affirmative defense*fn2 and more definite statement of facts on November 18.

As a legal conclusion, we review the bankruptcy court's MDS Order de novo. A court may order a party to file a more definite statement where the original pleading is "so vague or ambiguous that [the opposing] party cannot reasonably be required to frame" a response and thus, the claim does not satisfy the liberal notice pleading requirement of Rule 8(a). Fed. R. Civ. P. 12(e) (applicable to adversary proceedings under Fed. R. Bankr. P. 7012(b)). In addition, a court may require a more definite statement for claims alleging fraud or mistake, which must be pled with particularity. Fed. R. Civ. P. 9(b). Although Rule 12(e) issues are typically raised by motion, a court has the discretion to order a more definite statement sua sponte with appropriate notice and as needed, particularly where designed to "keep the case moving." See, e.g., Bennett v. Schmidt, 153 F.3d 516, 518 (7th Cir. 1998).

Matrix contends that it adequately pled its equitable subordination affirmative defense, which had been discussed in the summary judgment briefing. It also objects to the bankruptcy court's sua sponte MDS Order, which required a more definite statement even before reviewing the affirmative defense pleading. (Matrix Brief at 12-14.) The Bank alleges that because the equitable subordination defense ...


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