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Ungaretti & Harris LLP v. Steinberg

March 5, 2008


The opinion of the court was delivered by: Matthew F. Kennelly, District Judge


This bankruptcy appeal arises from an adversary proceeding that is part of the bankruptcy of Resource Technology Corporation ("RTC"). Plaintiff-appellant Ungaretti & Harris, LLP ("Ungaretti") served as counsel to the Chapter 11 trustee of RTC's estate before the case was converted to a Chapter 7 liquidation. In late 2006, defendant-appellee Jay Steinberg, RTC's Chapter 7 trustee, sought the bankruptcy court's approval for a settlement that he had reached with Ungaretti concerning its claims to certain funds in the possession of the Chapter 7 estate. The bankruptcy court denied approval and gave the parties a week to file motions for summary judgment. Steinberg's ensuing motion for judgment on the pleadings was granted in January 2007. Ungaretti now appeals from the bankruptcy court's denial of approval for the Steinberg-Ungaretti settlement and its grant of judgment on the pleadings for the Chapter 7 estate, as well as its denial of Ungaretti's request for a preliminary injunction barring disbursement of certain funds held by Steinberg. For the reasons set forth below, the Court affirms the bankruptcy court's rulings.

I. Background

A. The RTC Bankruptcy Case and Ungaretti's Adversary Proceeding

The background of the RTC bankruptcy case, ably described by the bankruptcy court in its December 4, 2006 opinion, Ungaretti & Harris LLP v. Steinberg (In re Resource Tech. Corp.), 356 B.R. 435, 438-43 (Bankr. N.D. Ill. 2006), is summarized below.

RTC's business involved removing methane gas from landfills and, where possible, selling the gas or converting it to usable energy. In November 1999, RTC was made the subject of an involuntary bankruptcy proceeding. It consented to entry of an order for relief in January 2000.

RTC's principal secured creditors, at all relevant times, have been a group including Leon Greenblatt, Banco Panamericano, Chiplease, Inc., and other related entities (collectively, "the Lenders"). The Lenders, who include controlling persons of RTC, provided RTC's debtor-in-possession financing, secured by a lien on nearly all of its assets.

RTC operated as a debtor in possession until August 2003. At that point, problems with its management, including unauthorized payments to professionals and failures to file timely operating reports, led to the appointment of Gregg Szilagyi, an attorney then employed by Ungaretti, as the Chapter 11 trustee. Szilagyi administered the RTC estate for about two years, with Ungaretti as his counsel.

In June 2005, Szilagyi and the Lenders reached an agreement ("the Szilagyi-Lender settlement"), one byproduct of which is at the core of the adversary proceeding and this appeal.

This settlement provided that Szilagyi would pursue a motion to dismiss the RTC bankruptcy case, suspend any action affecting the Lenders' collateral pending a ruling on the motion to dismiss, seek dismissal of an injunctive proceeding Szilagyi had brought against the Lenders' lien enforcement activities, and file a timely notice of appeal with respect to an order entered against RTC in another adversary proceeding. In return, the Lenders agreed to pay $2 million in satisfaction of claims that Ungaretti asserted under section 506(c) of the Bankruptcy Code as compensation for preserving the Lenders' collateral. The Lenders transferred $1.5 million of this amount ("the Lender Funds") to Ungaretti when the Szilagyi-Lender settlement was executed, even though the settlement was not to become effective until the bankruptcy court approved it.

Two days after the Szilagyi-Lender settlement's execution, Szilagyi filed a motion seeking approval of the settlement and dismissal of the bankruptcy case. The motion generated objections from creditors other than the Lenders, and a hearing on the motion was held on September 19-20, 2005. During the hearing, the bankruptcy court expressed the view that any recovery on the section 506(c) claim asserted by Szilagyi and Ungaretti would belong to the RTC estate, so that the provision of the settlement calling for payment directly to Ungaretti could not be approved. In response, Szilagyi withdrew his request for approval of the settlement.

Also at the hearing, the bankruptcy court found problems that required further bankruptcy administration, notably Ungaretti's receipt of roughly $376,000 from the RTC estate without court authorization. (The bankruptcy court had made Ungaretti's compensation for its work as Szilagyi's counsel "subject to the court's subsequent approval as part of the normal interim fee application process approximately every 120 days"-approval Ungaretti did not seek until twenty-two months after it began collecting payments for its work. In re Resource Tech. Corp., 356 B.R. at 444 n.1.) On September 21, 2005, the court entered an order denying Szilagyi's motion for approval of the Szilagyi-Lender settlement "to the extent not withdrawn" and entered another order converting the case to Chapter 7. Steinberg was appointed Chapter 7 trustee. Thereafter, Ungaretti voluntarily transferred the Lender Funds to Steinberg's counsel, to be held in escrow. Ungaretti, the Lenders, and the Chapter 7 estate all continued to assert claims on the Lender Funds.

In December 2005, Steinberg sought to terminate the Lenders' claim to the Lender Funds through a new motion to approve the Szilagyi-Lender settlement. Steinberg argued that Szilagyi had done all that was required of him under the settlement agreement and that the agreement would be enforceable upon the court's approval. Steinberg contended, however, that he, as Szilagyi's successor, should obtain the benefits of the settlement for RTC's Chapter 7 estate. The bankruptcy court granted the motion, but the Lenders responded by seeking to vacate approval of the settlement.

In February 2006, Steinberg sought the bankruptcy court's approval for a new settlement with the Lenders ("the Steinberg-Lender settlement") designed, among other things, to settle the question of the Lender Funds by placing them with the Chapter 7 estate, with the Lenders waiving any claims to the funds. In March 2006, the bankruptcy court approved the Steinberg-Lender settlement; the Lenders' motion to vacate the court's approval of the Szilagyi-Lender settlement was withdrawn as moot. The Steinberg-Lender settlement thus effectively superseded the earlier Szilagyi-Lender settlement. Pursuant to the Steinberg-Lender settlement, the bankruptcy court entered an order authorizing Steinberg's counsel "to distribute $1.5 million of the funds held in escrow relating to the Settlement Agreement to Steinberg for the benefit of the Estate" on March 28, 2006.

In response to these developments, Ungaretti in April 2006 filed the adversary proceeding from which this appeal arises. Ungaretti sought injunctive relief and turnover of the Lender Funds, asserting three grounds for claiming the funds. First, Ungaretti contended that because its services provided the basis for the section 506(c) claim created by the Szilagyi-Lender settlement, it was entitled to the Lender Funds as a section 506(c) recovery. Second, Ungaretti contended it was entitled to the imposition of a constructive trust on the Lender Funds for unpaid trustee fees and attorneys' fees. Third, Ungaretti asserted it had a claim in quantum meruit for its services that entitled it to the Lender Funds. Along with its adversary complaint, Ungaretti filed a motion for preliminary injunction to prevent Steinberg from expending the Lender Funds.

Before the bankruptcy court could enter a ruling on the motion for preliminary injunction or the pending fee applications of Szilagyi and Ungaretti, Steinberg proposed yet another settlement (the "Steinberg-Ungaretti settlement"). Under the agreement, Ungaretti and Szilagyi would waive their claims to the Lender Funds. In exchange, the Chapter 7 RTC estate was to pay roughly $250,000 to Ungaretti for its work as Szilagyi's counsel and for "transition services" that benefitted Steinberg's Chapter 7 administration. Ungaretti was also to receive an allowed Chapter 11 administrative claim of roughly $1.8 million and a waiver of the estate's claim for disgorgement of the unauthorized payments Ungaretti had received from the RTC Chapter 11 estate. Szilagyi was to receive an allowed Chapter 11 administrative claim in the amount of $250,000. The Lenders opposed Steinberg's motion to approve the settlement.

B. The Bankruptcy Court's December 4, 2006 Order

In an order dated December 4, 2006, the bankruptcy court denied approval for the Steinberg-Ungaretti settlement. The bankruptcy court reasoned that the consideration Ungaretti would receive under the settlement was not in the best interests of the Chapter 7 RTC estate under section 363 of the Bankruptcy Code and In re Telesphere Communications, Inc., 179 B.R. 544, 552 (Bankr. N.D. Ill. 1994). Specifically, the bankruptcy court concluded the net cash payment to Ungaretti was outside the range of reasonable litigation outcomes because Ungaretti had no serious chance of prevailing on its claim to the Lender Funds. In contrast, the estate was "very likely [to] succeed" in its claim for disgorgement of the unauthorized payments because the estate lacked the resources to pay its Chapter 7 administrative expenses, which section 726(b) of the Bankruptcy Code places ahead of Chapter 11 administrative claims in cases such as this one. In re Resource Tech. Corp., 356 B.R. at 443.

None of Ungaretti's three bases for asserting a claim to the Lender Funds "ha[d] any likelihood of success," the bankruptcy court concluded. Id. at 444. Ungaretti's argument that the funds were a section 506(c) surcharge against the Lenders' collateral failed because Ungaretti was not awarded the funds pursuant to a bankruptcy trustee's request, as required by Hartford Underwriters Ins. Co. v. Union Planters Bank, 530 U.S. 1, 9 (2000)-and in any event, a section 506(c) surcharge recovery cannot properly be paid to an ...

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