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In Re: Canopy Financial, Inc v. Geneva Seal

April 2, 2012

IN RE: CANOPY FINANCIAL, INC., DEBTOR. GUS PALOIAN, AS CHAPTER 7 TRUSTEE, PLAINTIFF,
v.
GENEVA SEAL, INC., DEFENDANT. GUS PALOIAN, AS CHAPTER 7 TRUSTEE, PLAINTIFF,
v.
LESTER LAMPERT, INC., DEFENDANT.



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

MEMORANDUM OPINION AND ORDER

Gus Paloian, as the Chapter 7 Trustee for Canopy Financial, Inc., has moved to strike the jury demands that Geneva Seal, Inc. and Lester Lampert, Inc. have asserted in the adversary proceedings that Paloian initiated against each of them. For the reasons stated below, the Court denies both motions.

Background

The Court takes the following facts from the parties' submissions in this proceeding and before the bankruptcy court.

Before it filed for bankruptcy, Canopy was a technology company with a five-member board of directors. Geneva Seal and Lester Lampert ("defendants") are jewelry companies. In the years before the petition, two of Canopy's directors, Jeremy Blackburn and Anthony Banas, caused tens of millions of dollars to be fraudulently transferred from Canopy to themselves and third parties, including defendants and other retailers, to purchase large amounts of luxury goods and services. By the time the other board members discovered this conduct, Blackburn and Banas had transferred most of Canopy's funds, leaving it unable to repay the debts they had incurred on its behalf. The two later pled guilty to wire fraud.

On November 25, 2009, Canopy filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code. The bankruptcy court subsequently converted the case to a Chapter 7 proceeding and appointed Paloian as the trustee. On March 26, 2010, Paloian filed a complaint against Blackburn and Banas in bankruptcy court. The bankruptcy court later entered final judgments in favor of Paloian and against Blackburn and Banas, finding each liable for nearly one hundred million dollars.

These adversary proceedings arise out of Paloian's assertion that in the summer of 2009, Blackburn and/or Banas used Canopy funds to purchase $100,000 worth of jewelry from Lester Lampert and $232,175 worth of jewelry from Geneva Seal. Paloian contends that because Canopy's money was used without authorization to purchase property that Canopy never received, and because Canopy was actually insolvent on the date of the transfer, the transfers are fraudulent and Canopy's estate is entitled to a return of the transferred funds.

On October 11, 2011, Paloian filed complaints against both defendants in bankruptcy court. Each defendant filed an answer in which it made a jury demand and stated that it did not consent to a jury trial in the bankruptcy court. The answers also included affirmative defenses in which defendants asserted that they were entitled to "a setoff in the amount of the value of the Jewelry, or in the alternative . . . a return of the Jewelry." See, e.g., Case No. 12 C 147, dkt. no. 9, Ex. A at 33-34. The bankruptcy court entered a pretrial order in both cases, establishing a discovery cut-off date and setting the matter for trial, but it noted that the order was without prejudice to defendants' rights to request withdrawal of the references. On January 19-20, 2012, defendants filed motions asking this Court to withdraw the references of their proceedings to the bankruptcy court on the ground that they did not consent to a trial by jury in bankruptcy court. The Court granted the motions.

Discussion

Paloian has moved to strike defendants' jury demands on the ground that their affirmative defenses are equivalent to having submitted claims against the bankruptcy estate. According to Paloian, defendants have thereby "brought themselves within the equitable jurisdiction of the bankruptcy court" for purposes of resolving not just their affirmative defenses but also Paloian's underlying claims against them. See Matter of Peachtree Lane Assocs., Ltd., 150 F.3d 788, 798 (7th Cir. 1998) (citing Langenkamp v. Culp, 498 U.S. 42, 44-45 (1990)). A creditor who files a proof of claim against a bankruptcy estate is not entitled to a jury trial on that claim. Id. Courts have differed, however, regarding whether defendants who assert their right to a setoff as an affirmative defense maintain their right to a jury trial on debtors' claims against them.

Paloian relies primarily on In re Commercial Financial Services, Inc., 251 B.R. 397 (Bankr. N.D. Okla. 2000), a case in which a debtor in possession filed a complaint seeking to recover the amount due on a note. The defendant filed an answer in which he asserted as an affirmative defense that he "may be owed money by [the debtor] which may be set-off or recouped against any amount that he may owe." Id. at 400. The court observed that bankruptcy court jurisdiction does not extend to traditional state-law causes of action without the consent of the litigants because "Congress lacks constitutional power to grant final adjudicative authority to Article I courts, such as bankruptcy courts, except in connection with federally created -- or 'public' -- rights." Id. at 403 (citing N. Pipeline Const. Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982)); see also Stern v. Marshall, 131 S. Ct. 2594, 2618 (2011) ("Congress may not bypass Article III simply because a proceeding may have some bearing on a bankruptcy case; the question is whether the action at issue stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process.") (emphasis in original). "When a defendant sued by a debtor in possession asserts a claim against the estate, however, the bankruptcy court's equitable jurisdiction to adjust the debtor-creditor relationship is invoked." Commercial Fin. Servs., 251 B.R. at 404.

The court noted that the defense of setoff "is predicated upon the defendant . . . having a 'valid and enforceable' prepetition claim against [the bankruptcy estate]." Id. at 405. The court observed that the defendant's "claim, if proven and allowed, would reduce the recovery [the estate] would obtain for distribution to unsecured creditors." Id. at 406. The court concluded that "[b]y pleading setoff as an affirmative defense, [defendant] is in fact asserting a claim against the estate's right to recover against [defendant], which itself is the property of the estate." Id. at 405 (emphasis in original). Thus, the defendant's assertion of the defense of setoff had invoked the bankruptcy court's jurisdiction and effected a waiver of the right to jury trial on the trustee's claims because the defense amounted to a claim against the estate. Id. at 408 (citing Langenkamp, 498 U.S. at 45).

By contrast, defendants point to In re Concept Clubs, Inc., 154 B.R. 581 (D. Utah 1993). In that case, a bankruptcy trustee sued a company for damages based on breach of an agreement between them and for return of funds the company held. The company asserted that it was entitled to a setoff for the trustee's violations of the agreement and "revenues and property allegedly converted by the Chapter 11 trustee that belonged to" the company. Id. at 583. The court concluded that "setoff raised as an affirmative defense only reduces, or extinguishes, the amount sought by the trustee for the estate" and therefore that "the bankruptcy court's equitable jurisdiction is not required because setoff as a defense does not involve the claims allowance process." Id. at 589 (emphasis in original). Thus, the defendant was entitled to a jury trial on the trustee's claim.

Another judge in this district considered this issue in an adversary action by a debtor to recover unpaid receivables in which the defendant "asserted as an affirmative defense that it [was] entitled to setoffs for liabilities and expenses arising out of products liability and patent infringement cases involving products sold by" the debtor. In re Hedstrom Corp., Nos. 04-38543, 05 C 6888, 2006 WL 1120572, at *1 (N.D. Ill. Apr. 24, 2006). The judge found the holding of Commercial Financial Services more persuasive than that of Concept Clubs. He concluded that whether the debtor "writes [defendant] a check or cancels [defendant's] receivable, the end result is the same: the bankruptcy estate will be significantly diminished." ...


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