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In re South Beach Securities

May 19, 2010


Appeals from the United States District Court for the Northern District of Illinois, Eastern Division. No. 08 C 1135-Joan Humphrey Lefkow, Judge.

The opinion of the court was delivered by: Posner, Circuit Judge.


Before POSNER, FLAUM, and WOOD, Circuit Judges.

A corporation called South Beach Securities filed a petition under Chapter 11 of the Bankruptcy Code and submitted a plan of reorganization. The bankruptcy judge refused to confirm the plan and dismissed the bankruptcy proceeding. In re South Beach Securities, Inc.,376 B.R. 881 (Bankr. N.D. Ill. 2007). South Beach and its only creditor, Scattered Corporation, ap-pealed to the district court, which affirmed. 421 B.R. 456 (N.D. Ill. 2009). Scattered and South Beach now appeal to us but South Beach has adopted Scattered's brief and makes no separate arguments.

Led by Leon A. Greenblatt III-a "character" if ever there was one, see Gary Washburn & Kim Barker, "Randolph Tower Running Up a Tab: City Says Owner Faces a Hefty Bill," Chicago Tribune, Mar. 20, 2001, p. 1; Greg Burns, "Scattered's Chief Buoyed by SEC Victory: Greenblatt Pursues Suit Against Chicago Exchange," Chicago Tribune, Nov. 15, 1998, p. 1; Burns, "The 'Bad Boys' of Chicago Arbitrage," Business Week Archives, Aug. 5, 1996, (visited Feb. 19, 2010)-Scattered achieved notoriety some years ago by selling short more shares of LTV than existed. We held that this tactic did not violate the securities laws. Sullivan & Long, Inc. v. Scattered Corp., 47 F.3d 857 (7th Cir. 1995). But the Chicago Stock Exchange, of which Scattered was a member, took a dimmer view of Scattered's conduct, accusing it of fraud and precipitating litigation eventually resolved in the company's favor but not before it had been driven out of the securities business. In re Scattered Corp., 53 S.E.C. 948 (1998); "Scattered Corp. Finally Ends Its Long Battle with CHX with Settlement Vindicating Firm's Position," Securities Week, Apr. 19, 1999; "Scattered Sells CHX Seat and Exits Securi-ties Industry," Securities Week, Dec. 8, 1997; "SEC Grants Scattered Partial Stay in CHX Finding of Firm's Fraud and Manipulation," Securities Week, May 19, 1997. What it does now is unclear.

South Beach, the debtor in the bankruptcy proceeding, also is controlled by Greenblatt. It is not participating actively in this appeal (it has merely, as we said, adopted Scattered's brief), but the U.S. Trustee-a Department of Justice official whose role is to be a watchdog in bankruptcy proceedings, 28 U.S.C. § 586(a)(3)-is. He opposed the confirmation of the plan of reorganization in the bankruptcy court and the district court and defends their rulings in this court. He argues that the only purpose of South Beach's declaration of bankruptcy, and of the plan of reorganization, is to avoid taxes, and a plan of reorganization cannot be confirmed "if the principal purpose of the plan is the avoidance of taxes." 11 U.S.C. § 1129(d). The U.S. Trustee's role was especially important in this case because the bankruptcy was non-adversarial, and, indeed, as we shall see, phony. Were it not for his participation, Scattered would have no opponent in this court.

Scattered argues that the U.S. Trustee is not authorized to object to a plan of reorganization on the ground that the plan's primary purpose is to avoid taxes. And indeed it is not obvious that the U.S. Trustee's writ runs to policing against tax evasion-one might think the proper watchdog would be the Internal Revenue Service, which could have objected to confirmation of the plan at the outset, or could step in later by invoking section 269 of the tax code (discussed below) when and if a party to the bankruptcy proceeding claimed a tax benefit. 26 C.F.R. § 1.269-3(e). And there are objections based on the text of the Bankruptcy Code to the U.S. Trustee's playing the role of tax watchdog in bankruptcy proceedings, though not compelling objections.

The Code permits only a "party in interest that is a governmental unit" to oppose a plan of reorganization on the ground that the plan's primary purpose is to beat taxes. 11 U.S.C. § 1129(d); In re Trans Max Technologies, Inc., 349 B.R. 80, 91 (Bankr. D. Nev. 2006); 7 Collier on Bankruptcy ¶ 1129.07, p. 1129-176 (Alan N. Resnick & Henry J. Sommer eds., 16th ed. 2009). A U.S. Trustee is deemed not to be "a governmental unit" only "while serving as a trustee in a" bankruptcy case. 11 U.S.C. § 101(27). The U.S. Trustee is not the trustee in bankruptcy in this case. There is no trustee; South Beach is a debtor in possession. The Ninth Circuit has ruled, however, that the U.S. Trustee can never be "a governmental unit," even when not serving as a trustee in bankruptcy. Balser v. Department of Justice, 327 F.3d 903, 908 (9th Cir. 2003). In so ruling, the court overlooked section 101(27) of the Bankruptcy Code, the section we just quoted that makes clear that the U.S. Trustee is not a governmental unit only when he is acting as a trustee in bankruptcy. Balser was not actually addressing the question whether the U.S. Trustee is authorized by 11 U.S.C. § 1129(d) to participate in a bankruptcy. Yet In re Trans Max Technologies, Inc., supra, 349 B.R. at 91, relied on Balser to conclude that the U.S. Trustee was not authorized-while questioning the oversight that had led the Ninth Circuit to that erroneous conclusion. Id. at 91 n. 12.

But there is another ground on which to question the U.S. Trustee's authority to challenge the plan of reorganization. Remember that only a "party in interest that is a governmental unit" (emphasis added) can object to a plan on tax grounds. Now it is true that the term "party in interest" is defined nonexclusively as "including the debtor, the trustee, a creditors' committee, an equity security holders' committee, a creditor, an equity security holder, or any indenture trustee." 11 U.S.C. § 1109(b) (emphasis added). The U.S. Trustee is not excluded. And anyway "all this section means is that anyone who has a legally protected interest that could be affected by a bankruptcy proceeding is entitled to assert that interest with respect to any issue to which it pertains." In re James Wilson Associates, 965 F.2d 160, 169 (7th Cir. 1992). This implies that the U.S. Trustee can be a "party in interest" when he seeks to protect the rules and procedures of bankruptcy, over which he is the congressionally ordained watchdog-he has a statutory interest in making sure that bankruptcy law isn't abused.

But elsewhere in the Code "party in interest" and "United States trustee" are treated disjunctively. See, e.g., 11 U.S.C. § 707(b)(1) ("after notice and a hearing, the court, on its own motion or on a motion by the United States trustee, trustee . . . or any party in interest . . ."); id., § 1104 ("on request of a party in interest or the United States trustee"). Yet when we turn to section 307 of the Code we discover that "the United States trustee may raise and may appear and be heard on any issue in any case or proceeding under this title." This language, exactly parallel to the authority granted parties in interest by section 1109(b) ("a party in interest . . . may raise and may appear and be heard on any issue in a case under this chapter"), suggests that the U.S. Trustee can object to a plan of reorganization after all, in his role as guardian of the public interest in bankruptcy proceedings. See, e.g. In re United Artists Theatre Co., 315 F.3d 217, 225 (3d Cir. 2003). The public has an interest in limiting the use of bankruptcy to the purposes for which it is intended rather than permitting it to be used as a vehicle by which solvent firms can beat taxes. Courts often have deemed the U.S. Trustee to be a "party in interest" in related contexts. E.g., In re A-1 Trash Pickup, Inc., 802 F.2d 774 (4th Cir. 1986) (moving for conversion or dismissal of Chapter 11 case); In re Miles, 330 B.R. 848, 849-51 (Bankr. M.D. Ga. 2004) (moving for dismissal or transfer of case because of improper venue).

The statute is a mishmash but the view that the U.S. Trustee can be a party in interest makes better sense, as this case illustrates; we'll see that the case really needed a watchdog, and we cannot see what would be gained by everyone having to wait for the Internal Revenue Service to take action against Greenblatt's tax shenanigans. The IRS did receive a copy of the plan and didn't object to it, but may have thought that since it could always disallow the deductions later if the plan got confirmed and since it isn't in the business of preventing abuse of bankruptcy per se, there was no need for it to intervene in the bankruptcy.

And even if the U.S. Trustee was not a party in interest, the bankruptcy or district court, since it can hardly be thought required to approve an unlawful plan of reorganization, need not turn a deaf ear when the U.S. Trustee, or anyone else for that matter, argues the plan's unlawfulness. If in doing so the U.S. Trustee is acting ultra vires, as we very much doubt, his superiors in the Justice Department can rein him in; but even if he should be thought an officious intermeddler, this would not authorize Scattered to flout bankruptcy law. Congress has authorized the federal courts to "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title [the Bankruptcy Code]," and, even more pointedly, has declared that "no provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process." 11 U.S.C. § 105(a). Consistent with this language, bankruptcy judges have considered issues of tax avoidance on their own initiative. In re Hartman Material Handling Systems, Inc., 141 B.R. 802, 808-09 and n. 10 (Bankr. S.D.N.Y. 1992); In re Maxim Industries, Inc., 22 B.R. 611 (Bankr. D. Mass. 1982); cf. In re Economy Cast Stone Co., 16 B.R. 647, 650 (Bankr. E.D. Va. 1981). As Hartman explained, "this Court cannot fairly consider plan confirmation . . . and ignore the obvious tax avoidance question. Congress has given the bankruptcy courts the responsibility for determining whether a reorganization plan is proper, including tax considerations." 141 B.R. at 809.

And given the breadth of the statutory definition of "party in interest," how can the U.S. Trustee have standing to make motions and be heard in bankruptcy cases (as he is expressly authorized to do, 11 U.S.C. §§ 307, 707(b)(1)) if he has no "interest" in such cases? We conclude that he is a party in interest, and come at last to the merits of the appeal.

South Beach was once a registered securities broker/dealer, but by the time it declared bankruptcy it had become a shell. It had no employees or business activities, and its only "assets" were net operating losses. These are better described as potential assets, because they can sometimes, but by no means always, as we're about to see, be set off against taxable income and thus reduce a company's taxes. 26 U.S.C. § 172; United Dominion Indus-tries, Inc. v. United States, 532 U.S. 822, 825 (2001); In re Comdisco, Inc., 434 F.3d 963, 965 (7th Cir. 2006); In re Harvard Industries, Inc., 568 F.3d 444, 445-46 n. 2 (3d Cir. 2009); 1 Boris I. Bittker & James S. Eustice, Federal Income Taxation of ...

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