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Amalia Mazzolin, As Trustee of the Amalia Mazzolin 1998 v. Lehman Brothers Real Estate Fund Iii

January 25, 2012

AMALIA MAZZOLIN, AS TRUSTEE OF THE AMALIA MAZZOLIN 1998 TRUST B, AND THE MAZZOLIN FAMILY LIMITED PARTNERSHIP, AN ILLINOIS LIMITED PARTNERSHIP, PLAINTIFFS,
v.
LEHMAN BROTHERS REAL ESTATE FUND III, L.P. A DELAWARE LIMITED PARTNERSHIP, DEFENDANT.



The opinion of the court was delivered by: Rebecca R. Pallmeyer United States District Judge

Judge Rebecca R. Pallmeyer

MEMORANDUM OPINION AND ORDER

Plaintiffs, a trustee and an Illinois limited partnership, originally filed this action in the Circuit Court of Cook County seeking rescission of their subscription agreements for partnership interests in the defendant-partnership, Lehman Brothers Real Estate Fund III, L.P. ("LBREF"). Plaintiffs allege that they made their decision to invest in what they thought were portfolios of promising real estate holdings based on false and misleading information furnished by the Defendant in a private placement memorandum, in violation of Illinois law. Defendant removed the case to this court, arguing that jurisdiction is proper because this case is "related to" the Chapter 11 bankruptcy of Lehman Brothers Holdings Inc. ("LBH"). The parties filed cross-motions: Defendant sought venue transfer to the United States District Court for the Southern District of New York; Plaintiffs asked this court to remand the case to state court, arguing that removal was improper. On September 23, 2011, this court issued an order directing Defendant to show cause within fourteen days why Plaintiffs' motion to remand should not be granted.

On October 7, 2011, Defendant filed its response to this court's show cause order. That same day, the court stayed its September 23 remand order to allow consideration of the Defendant's submissions. For the reasons stated below, Defendants have not satisfied the court that this case was properly removed. The court therefore orders this case remanded to state court.

BACKGROUND

This opinion assumes familiarity with the facts set forth in this court's previous disposition. See Mazzolin v. Lehman Bros. Real Estate Fund III, L.P., 11 C 953, 2011 WL 4435649 (N.D. Ill. Sept. 23, 2011). In that opinion, the court explained its conclusion that Defendant had not established jurisdiction under the Seventh Circuit's more limited definition of "related to" federal jurisdiction pursuant to 28 U.S.C. §§ 1452(a) and 1334(b). The court observed that Defendant's factual assertions appeared to conflict with the language of LBREF's partnership agreement, which lists Lehman Brothers Real Estate Associates III, L.P. ("LBREA")-not LBH, as Defendant contended-as LBREF's general partner. Id. at *2. As a result, Defendant had not shown how LBREF's unspecified relationship with LBH stood to affect the property in LBH's estate. Id. at *4. The court also rejected Defendant's argument that LBH's "economic stake" in LBREF was sufficient to establish federal jurisdiction, concluding that such an interpretation would extend federal bankruptcy jurisdiction to any claim by a third party against a non-debtor in which the debtor has an investment interest. Id.

The court also rejected Defendant's argument that an insurance policy covering LBREF and owned by LBH is sufficient to establish federal bankruptcy jurisdiction. The court noted that LBREF had not filed a copy of the insurance agreement itself. Without that document, the argument that a judgment against LBREF would affect property in LBH's estate was too speculative to overcome the presumption in favor of Plaintiffs' choice of forum. Id.

Defendant's response to the show cause order provides additional evidence concerning the Venture Capital Asset Protection Policy. Defendant continues to withhold the insurance policy itself; according to Defendant, the policy addresses situations not relevant in this case, and releasing the policy in a public filing "could influence the formulation of claims unrelated to the instant action." (Def.'s Resp. to Ct.'s Request to Show Cause that Remand is Not Appropriate (hereinafter "Def.'s Resp.") ¶ 2 n.1.) Instead, Defendant submitted a letter from Stephen Davidson, attorney for the firm representing the claims manager for Vigilant Insurance Company, the issuer of the policy. (Letter from Stephen P. Davidson to Rick Lusk of 8/11/11, Ex. 2 to Def.'s Resp.) The letter identifies LBH as the insured and confirms coverage and the advancement of defense costs for this litigation, subject to Vigilant's reservation of rights. (Id. at 1.) Davidson's letter states that LBREF "meets the definition of Organization" under the policy and confirms that pursuant to the "'Organization Liability Coverage Endorsement,' Vigilant agreed to pay on behalf of the Organization all Loss for which the Organization becomes legally obligated to pay on account of any Claim for a Wrongful Act, subject to other Policy terms and conditions." (Id. at 2-3.)

Defendant also submitted an affidavit from the recipient of that letter, Rick Lusk of LBH's Insurance Risk Management division. (Lusk Aff., Ex. 1 to Def.'s Resp.) The affidavit explains that based on his "personal knowledge and on due investigation," he understands the policy to identify "only the specific fund platform limited partnership entity," in this case Lehman Brothers Real Estate Partners III, L.P., "with the idea that, coverage would then extend above, laterally, and below the fund platform limited partnership entity." (Id. ¶¶ 1, 7.) Under this rationale, LBREF is covered under the policy's extension of coverage to "any feeder fund, parallel fund, employee fund or co-investment fund of any pooled investment vehicle identified." (Id. ¶ 7) Lusk further declares that "[a]s LBREF III properly draws upon the VCAP Policy in connection with this action, an asset of the Lehman Brothers estate is financially affected as the policy is depleted." (Id. ¶ 9.) Notably, neither the letter nor the affidavit state that the policy covers LBH for claims of indemnity that might be brought against it due to its relationship with the affiliated organizations that are covered by the policy. At any rate, any liability that might flow to LBH remains speculative because Defendant has not yet explained the relationship between LBH and LBREF.

DISCUSSION

As the court noted in its previous disposition, federal bankruptcy jurisdiction extends to "all civil proceedings arising under [the federal Bankruptcy Code], or arising in or related to cases under [the Bankruptcy Code]." 28 U.S.C. § 1334(b) (emphasis added). The Seventh Circuit has "interpreted 'related to' jurisdiction narrowly 'out of respect for Article III' . . . as well as to prevent the expansion of federal jurisdiction over disputes that are best resolved by state courts." In re FedPak Sys., Inc., 80 F.3d 207, 214 (7th Cir. 1996) (quoting Home Ins. Co. v. Cooper & Cooper, Ltd., 889 F.2d 746, 749 (7th Cir. 1989)). Specifically, a case is "related to" a bankruptcy proceeding when the resolution of the case is "likely to affect the debtor's estate." In re Heath, 115 F.3d 521, 524 (7th Cir. 1997). "The party seeking removal has the burden of establishing federal jurisdiction, and federal courts should interpret the removal statute narrowly, resolving any doubt in favor of the plaintiff's choice of forum in state court." Schur v. L.A. Weight Loss Ctrs., Inc., 577 F.3d 752, 758 (7th Cir. 2009).

Defendant contends that because the insurance policy issued to LBH will be used to fund the litigation and pay any resulting damages, this litigation affects the debtor's estate by depleting the funds available under the policy. Defendant sees support for this argument in this court's observation that "it is well-established that 'insurance contracts in which the debtor has an interest at the time the petition is filed constitute property of the estate.'" Mazzolin, 2011 WL 4435649, at *4 (quoting In re Stinnett, 465 F.3d 309, 312 (7th Cir. 2006)). Insurance policies are indeed property of the debtor's estate. It does not follow, however, that proceeds of those policies are also property of the estate.

LBH, the debtor, purportedly owns the insurance policy, but the proceeds of the policy appear to be for the benefit of affiliated partnerships like LBREF, a separate legal entity. In this respect, the facts of this case are most analogous to cases where a debtor-corporation has purchased insurance policies providing liability coverage to directors and officers. In In re marchFIRST, Inc., for example, several shareholders of an internet consulting and information technology company had sued certain of its directors and officers, alleging violations of federal securities laws. 288 B.R. 526, 528-29 (Bankr. N.D. Ill. 2002). The directors and officers were covered by an insurance policy maintained by the company totaling $50 million, a policy which also provided indemnification coverage to the company. Id. Once the company filed for Chapter 11 bankruptcy, the Trustee, who also brought suit against the directors and officers, sought to enjoin the shareholders' suit as a violation of the automatic stay, arguing that the proceeds of the insurance policy was property of the estate. Id. at 529. The bankruptcy court, however, rejected the Trustee's argument:

There is no question that the policies themselves are estate property. There is authority to support the argument that the proceeds of a directors' and officers' liability insurance policy are also property of a corporate debtor's estate. In re Minoco [Grp.] of Cos., Ltd., 799 F.2d 517 (9th Cir. 1986); In re Sacred Heart Hosp. of Norristown, 182 B.R. 413 (Bankr. E.D. Pa. 1995); In re Circle K Corp., 121 B.R. 257 (Bankr. D. Ariz. 1990). There is also authority to the contrary. In re Louisiana World Exposition, 832 F.2d 1391 (5th Cir. ...


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