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In re Kreisler

October 17, 2006

IN RE: BARRY B. KREISLER, DEBTOR,
AND MARSHA ERENBERG, DEBTOR.
GARLIN MORTGAGE CORP., APPELLANT,
v.
BARRY B. KREISLER, ET AL., APPELLEES.



USBC Case Nos. 02 B 21934 & 02 B 21935.

The opinion of the court was delivered by: Judge Robert W. Gettleman

Hon. John H. Squires

MEMORANDUM OPINION AND ORDER

Appellant Garlin Mortgage Corp. ("Garlin") appeals from a final order of the United States Bankruptcy Court for the Northern District of Illinois equitably subordinating Garlin's entire secured claim to that of all unsecured creditors. The bankruptcy court had jurisdiction pursuant to 28 U.S.C. § 1334(b) and 28 U.S.C. § 157(a), because the action arises under Title XI of the United States Code and arises in and is related to Chapter 7 cases In re: Barry B. Kreisler, 02 B 21934 and In re: Marsha D. Erenberg, 02 B 21935. This court has jurisdiction pursuant to 28 U.S.C. § 158(a)(1). This court reviews the bankruptcy court's findings of facts under a clearly erroneous standard. Conclusion of law are reviewed de novo. Mungo v. Taylor, 355 F.3d 969, 974 (7th Cir. 2004).

The bankruptcy court issued a 28 page opinion concluding that Garlin's secured claim should be equitably subordinated under 11 U.S.C. § 510(c) to the claims of the unsecured creditors for two reasons: (1) Garlin engaged in inequitable conduct; and (2) Garlin failed to comply with Fed. R. Bank. P. 3001(a)(2). Garlin does not challenge the bankruptcy court's factual findings, only the court's application of those facts to the law. Because this court agrees with the bankruptcy court's conclusion that Garlin's inequitable conduct warrants equitable subordination, it need not reach Garlin's challenge regarding Rule 3001. For the reasons set forth below, the decision of the bankruptcy court is affirmed.

FACTS

Prior to filing for bankruptcy protection, Barry Kreisler ("Barry") and Marsha Erenberg ("Marsha") together owned a limited liability corporation named K&E, L.L.C. ("K&E"). Barry owned 60% and Marsha 40%. K&E, in turn, owned 94.5% of two properties on North Western Avenue in Chicago, Illinois, consisting of two commercial condominium units and three parking spaces (the "Western Avenue Properties"). Barry owned the remaining 5.5 % interest in those properties.

The Western Avenue Properties were encumbered by three mortgage liens. The first was held by Uptown National Bank of Chicago, now know as Bridgeview Bank Group ("Bridgeview Bank"). The second was a mortgage executed by Barry in favor of his mother, Francis Kreisler, to secure a note in the amount of $200,000. The Francis Kreisler mortgage encumbered only Barry's undivided 5.5% interest in the Western Avenue Properties.

Barry also owned a 30% interest in Montana/Ashland L.L.C. ("Montana/Ashland"), a limited liability corporation of which Marsha was a member. On May 22, 2001, Montana/Ashland executed two mortgage notes in favor of Community Bank of Ravenswood ("Community Bank") in the sums of $800,000 and $996,000, for the purpose of acquiring and developing property on North Ashland Avenue in Chicago (the "Ashland Property"). Community Bank received a security interest in the Ashland Property, and the third mortgage on the Western Avenue Property. The junior mortgage on the Western Avenue Property was executed by K&E.

Montana/Ashland defaulted on the notes. Community Bank took a deed in lieu of foreclosure, sold the Ashland Property for $950,000, and applied the proceeds against the outstanding balances due under the notes. The remaining collateral securing the debt to Community Bank under the notes was the Western Avenue Property as a result of the third mortgage.

Barry and Marsha each filed voluntary petitions under Chapter 11 on June 5, 2002. The bankruptcy court ordered the cases to be jointly administered but not substantively consolidated. Both cases were subsequently converted to Chapter 7 and a trustee was appointed. Community Bank filed proofs of claims in the amount of $892,289.99 in each case. At the time of the bankruptcy filings, Barry's assets included a 62.2% ownership interest in the Western Avenue Properties. Marsha owned the remaining 37.8% interest.

On June 3, 2003, Barry created Garlin for the sole purpose of purchasing Community Bank's notes and junior mortgage on the Western Avenue Properties. The principals of Garlin were Linda Horowitz ("Linda"), Barry's sister, and Gary Schnier ("Gary"), Marsha's close friend. Linda was the president and secretary and on the board of directors. Gary was the vice-president, treasurer and assistant secretary. Neither provided any capital to Garlin, nor performed any duties as officers and/or directors, nor were involved in the formation of the corporation. Both were unaware of any actions taken by Garlin during its existence. Both testified that Barry performed all those tasks on behalf of Garlin.

Garlin held no meetings and conducted no business until October 2003. From March through October, however, Barry and Marsha, through Garlin, attempted to enter into an agreement with Community Bank to acquire its notes and mortgage. Toward that end, Barry sent numerous letters to Community Bank and copied Marsha.

Garlin held its first director's meeting on October 1, 2003. Barry attended and drafted the corporate minutes. On October 16, Garlin passed a corporate resolution to: (1) acquire the notes and mortgages from Community Bank for $16,500; (2) hire Barry to serve as its counsel for that transaction; and (3) borrow funds from K&E Investment, Inc. (another corporation controlled by Barry) to complete the acquisition of the mortgage and notes. Barry was to earn a contingent fee of $3,500 once Garlin acquired Community Bank's notes and mortgage and the Western Avenue Property was sold at foreclosure. Garlin borrowed ...


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