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Nelson v. Welch

October 12, 2010


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


In this action, before this court on remand from the court of appeals, plaintiff William G. Nelson, IV, a former director and minority shareholder of Repository Technologies, Inc. "(RTI"), has sued RTI's former bankruptcy counsel, defendants David K. Welch and Crane, Heyman, Simon, Welch & Clar, alleging what purport to be state-law claims for conspiracy to help RTI's majority shareholders breach their fiduciary duties to RTI's shareholders and creditors, and tortious interference with contract. Defendants have moved to dismiss the complaint for failure to state a claim pursuant to Fed. R. Civ. P. 12(b)(6). For the reasons that follow, the motion is granted.


This case is one of a number of lawsuits arising out of RTI's bankruptcy. As described by the Seventh Circuit, "the parties interested in these disputes and their lawyers have been on a litigation death march since April 2006." In re Repository Tech. Inc, , 601 F.3d 710, 713 (7th Cir. 2010). Hopefully (but not likely), that trek will end here. A full explanation of all the litigation surrounding and arising from RTI's bankruptcy is set forth in the Seventh Circuit opinion (id. at 714-16), and is summarized here to explain the posture of the case as it comes to this court.

RTI marketed, supplied and maintained software. It was losing money between 2000 and 2004, at which time it became clear that its existing line of credit with its principal secured lender, West Suburban Bank, was insufficient to meet its business expenses. Plaintiff, a minority shareholder and member of RTI's Board, offered to finance RTI's operations. On August 30, 2002, RTI executed a revolving credit note with plaintiff providing for a maximum credit amount of $500,000. Plaintiff received a security interest in all of RTI's assets, which he subordinated to the Bank's security interest. On December 19, 2003, RTI's Board (without plaintiff's participation) authorized an increase in the credit line to $1.5 million. No new loan documents or security agreements were executed.

By May 28, 2004, plaintiff had advanced approximately $1.74 million to finance RTI's operations. At that time plaintiff stopped advancing money, but did suspend RTI's obligation to pay interest, telling RTI's president E. James Emerson that he did not expect to be repaid until RTI was "no longer in trouble." Eventually, however, plaintiff began to believe that RTI's controlling shareholders, Emerson and his wife, were overpaying themselves and their children, so he took steps to call in his debt. On April 4, 2006 (while still a member of RTI's Board), plaintiff paid off the $126,484 balance due on the Bank's loan, thereby elevating himself to RTI's sole secured creditor. He did not inform RTI of that maneuver. He then resigned as a director and sent Emerson a notice of default demanding RTI pay $509,687 in overdue interest to avoid an event of default.

Unable to pay, Emerson and RTI consulted with defendants, who prepared and on April 25, 2006 filed a petition for Chapter 11 reorganization. Plaintiff filed a proof of secured claim of $2.4 million. See 11 U.S.C. § 501(a). To effectuate its plan of reorganization, RTI filed an adversary action against plaintiff, seeking to re-characterize plaintiff's debt as equity and then to subject plaintiff's interest in RTI to equitable subordination. 11 U.S.C. § 510(c)(1).

The bankruptcy court concluded that there were disputed issues of fact, combined the adversary and bankruptcy actions, and conducted a trial. On February 13, 2007, the bankruptcy court entered judgment in the adversary action, re-characterizing $240,000 of plaintiff's debt as equity but completely denying RTI's claim for equitable subordination, leaving plaintiff with a secured claim of approximately $1.8 million.

Having been unable to obtain full re-characterization and equitable subordination, RTI conceded that it could not offer a confirmable plan for Chapter 11 reorganization. The bankruptcy court then entered an order dismissing the bankruptcy case. That order, and the adversary judgment, referred to the court's findings of fact and conclusions of law in which the court rejected plaintiff's alternate motion to dismiss the bankruptcy case as having been filed in bad faith. Specifically, the bankruptcy court concluded that the "filing of this bankruptcy was a rational reaction to [plaintiff's] actions, and was partially successful. Therefore, the bankruptcy cannot be held to be in bad faith." In re Repository Technologies Inc., 363 B.R. 868, 816 (Bkrtcy. N.D. Ill. 2007).

That same day, immediately after the bankruptcy was dismissed, plaintiff sued RTI in federal district court seeking damages for RTI's breach of the loan agreement. The following day, Judge Coar, to whom that case was assigned, granted plaintiff's motion for a temporary restraining order freezing all of RTI's assets. Just prior to the freeze, however, RTI had paid the instant defendants $100,000 as fees for representing RTI in the bankruptcy. The district court appointed a receiver to operate RTI's business to protect plaintiff's interests in the RTI assets. On March 20, 2007, plaintiff conducted a Uniform Commercial Code ("U.C.C.") sale of RTI's assets to himself for $475,00, and all RTI's assets were transferred to plaintiff. On June 7, 2007, the court approved the receiver's final report on the sale and liquidation, and plaintiff dropped his remaining claims.

During this time frame plaintiff also appealed the bankruptcy court's judgment in the adversary proceeding to the district court. On January 15, 2008, Judge St. Eve, to whom that appeal had been assigned, affirmed all of the bankruptcy court's factual findings and legal conclusions. In re Repository Tech. Inc., 381 B.R. 852 (N.D. Ill. 2008). Judge St. Eve also denied plaintiff's motion to strike as dictum the bankruptcy court's finding that RTI had not filed the bankruptcy in bad faith.

On July 11, 2007, plaintiff filed the instant complaint in the Circuit Court of Cook County, Illinois, alleging that defendants: (1) conspired with the Emersons to use the RTI Chapter 11 case to enrich themselves; (2) tortuously interfered with plaintiff's loan contract with RTI; and (3) abused the bankruptcy process.*fn1 Defendants removed the case to the district court and it was assigned to Judge Kocoras. Plaintiff promptly dropped his abuse of bankruptcy process claim and sought remand to the state court. Judge Kocoras denied that motion, concluding that the court had "arising in" jurisdiction under 28 U.S.C. § 1334(b) because the remaining claims all revolved around plaintiff's assertion that defendants engaged in abuse of the bankruptcy process.

While the instant case was pending before Judge Kocoras, Judge St. Eve affirmed the judgment in the adversary proceeding. On February 8, 2008, Judge Kocoras concluded that Judge St. Eve's decision affirming the bankruptcy court's finding that RTI had not filed the Chapter 11 petition in bad faith, precluded plaintiff's abuse of the bankruptcy process claim and dismissed that claim with prejudice. Defendants then moved to dismiss the remaining claims arguing that Judge Kocoras had already held that the entire complaint was based on the abuse of bankruptcy process allegations. Judge Kocoras concluded that plaintiff's state-law claims stemmed "from events that happened outside the bankruptcy context" and declined to exercise supplemental jurisdiction over those claims under 28 U.S.C. § 1367(c)(3), and remanded those claims to the state court.

Defendants appealed Judge Kocoras' decision not to exercise supplemental jurisdiction over the state law claims, arguing that because the district court's dismissal of the abuse of the bankruptcy process claim was dispositive of the state-law claims, Judge Kocoras should have retained supplemental jurisdiction and dismissed those claims as well. Plaintiff did not appeal the dismissal of the abuse of the bankruptcy process claim. He did, however, appeal Judge St. Eve's affirmance of the bankruptcy court's decision in the adversary action, arguing that the bankruptcy court erred in partially re-characterizing his loans as equity and requesting that the court of appeals strike as dictum the bankruptcy court's finding that RTI did not ...

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