How Mediation Helps Resolve the Unsolvable (In re Zimmer)

Unsolvable? (photo by Marilyn Swanson)

By: Donald L Swanson

The opinion is In re Zimmer, Case No. 17-20543 in the Bankruptcy Court for the Western District of Pennsylvania (issued December 14, 2020, Doc. 452).

The case is a mess—you’ve got to read it to believe it.

Beginning Facts

Daniel and Lucille Morris (the “Morris couple”) are defrauded by their former lawyer.  The lawyer files Chapter 13 bankruptcy, and the Morris couple hold non-dischargeable claims against him.

Daniel Morris, of the Morris couple, is an attorney and is representing the Morris couple in this bankruptcy.

–Contentious Litigation

For many years the Morris couple has been pursuing their former lawyer through the state and federal courts of New York, before he files this bankruptcy. 

The bankruptcy is contentious as well—the Morris couple has filed, for example, “at least 22 requests that the instant bankruptcy case be dismissed.”

The dismissal requests identify a litany of bad acts by the Debtor, including:

  • false statements about the location of his residence;
  • failures to produce documents and information in litigation;
  • failures to list assets in a prior bankruptcy (filed in Southern Florida in 2005);
  • failure to list the Morris couple as creditors in the 2005 Florida bankruptcy (which prevented them from receiving a distribution in that case);
  • failures in the present case to adequately disclose interests in business ventures and transfers of assets; and
  • disclaiming interests in a parent’s estate, which disclaimer was prevented by a state court.

–Other Creditors and Interested Parties

Debtor has other creditors, besides the Morris couple: eight additional creditors are identified in Debtor’s schedules, including the IRS.

Another interested party, the Client Protection Fund of the Bar of Maryland, opposed the dismissal requests because, (i) it had reimbursed the Morris couple for some of their claims against the Debtor, and  (ii) the Debtor has assets available for distribution to creditors.

The Chapter 13 Trustee in the lawyer’s bankruptcy also expresses concerns about Debtor’s good faith and asks that the case be converted to Chapter 7. 

–Potential Settlement

At a hearing on the dueling motions to dismiss and to convert, Debtor’s counsel announces that Debtor, the Morris couple, and the Client Protection Fund had reached a “global” settlement, providing for a structured dismissal of the case and distribution of assets among these three parties only, subject to Bankruptcy Court review.

Upon learning of the “global settlement,” the Chapter 13 Trustee objects and argues that the settlement is not in the best interest of creditors, since other creditors won’t share in any distribution.

So, the Bankruptcy Court continues the hearing until the proposed settlement can be addressed.

–Buyer’s Remorse

Once Debtor’s motion for approval of the settlement is filed, the Morris couple experiences buyer’s remorse and proclaims that the settlement should be rejected because their own acceptance of the settlement was “improvident,” due to Mr. Morris being “ill” when he agreed to the deal. So, the Morris couple renews their dismissal request.

In response, counsel for Debtor and for the Client Protection Fund are outraged and request sanctions against the Morris couple.

–Conversion to Chapter 7

At a subsequent hearing, the Bankruptcy Court declines to approve the settlement or dismiss the case.  Instead, the Court grants the Trustee’s motion and converts the case to Chapter 7.

What follows is the Bankruptcy Judge’s reasoning.

  • The settlement is not in the best interest of creditors—questions abound on whether Debtor’s assets should be preserved for the benefit of all creditors, not merely for the Morris couple and the Client Protection Fund.
  • The conversion issue is this—what’s in the best interest of creditors, or the estate? A pot of money exists, and the question is, who gets it?  Preserving that asset for creditors, generally, is what’s in the best interest of the estate and its creditors.  And so, conversion, not dismissal, is what’s best.
  • Even if Debtor’s actions and bankruptcy filing are not in good faith, the interests of the entire creditor body are better served by conversion to Chapter 7.

Ensuing Litigation

After conversion to Chapter 7:

  • The Chapter 7 trustee intervenes in an adversary Debtor had filed to avoid a lien claimed by the Morris couple on Debtor’s inheritance rights;
  • The Morris couple continues prosecuting their non-dischargeability lawsuit against Debtor;
  • The Client Protection Fund files a declaratory judgment action against the Morris couple and the Chapter 7 Trustee to determine its rights; and
  • The U.S. Trustee sues Debtor to deny his discharge in its entirety.

Debtor choses to not contest dischargeability actions brought by the Morris couple or by the U.S. Trustee—so, he receives no discharge.

Nevertheless, the Morris couple continues filing pleading after pleading in the bankruptcy case.

Mediation to the Rescue

Then, the Bankruptcy Court refers to mediation all open matters between the Morris couple, the Chapter 7 Trustee, and the Client Protection Fund.

The mediation proves successful.  The Chapter 7 Trustee, the Morris couple, and the Client Protection Fund resolve their differences and memorialize their settlement in a written agreement.  The settlement is then approved by the Bankruptcy Court.

The gist of the settlement is that the funds in question (estimated at $80,000) will be turned over to the Chapter 7 Trustee for distribution, under the Bankruptcy Code’s waterfall scheme, as follows:

  1. First, payment of administrative fees and expenses of the Chapter 7 Trustee (capped at $14, 000);
  2. Second, payment of the allowed priority claim of the IRS;
  3. Third, distribution of remaining funds evenly between the Morris couple and the Client Protection Fund; and
  4. Finally, the Morris couple and the Client Protection Fund are free to pursue recovery of their respective and unpaid non-dischargeable claims against Debtor.

Morris Couple Doesn’t Quit

The Morris couple objects to claims of all other creditors.  All claimants, other than the IRS, fail to respond—and their claims are denied. The IRS prevails in opposing the Morris couple’s objection, and its claims are to be paid under the mediated and Court-approved settlement. 

Foreseeing the allowance of the IRS claim, the Morris couple preemptively file their latest Motion to dismiss Debtor’s bankruptcy.  The Chapter 7 Trustee, the Client Protection Fund, the IRS and Debtor, all oppose the Motion. 

At a hearing on the latest Motion to dismiss, Mr. Morris admits that their primary motive for dismissal is their desire to receive payment ahead of (or to the detriment of) the IRS.  The Morris couple’s logic is this:

  • If the case is dismissed, the distribution waterfall mandated by § 726 of the Bankruptcy Code will not apply; and
  • They hold to their motive, despite agreeing to the IRS distributiohn in the mediated and Court-approved settlement agreement.

Bankruptcy Court’s Ruling

Here’s the Court’s central finding on the Morris couple’s latest Motion to dismiss: their arguments are “unconvincing.”  And here is the Court’s rationale:

  • The IRS is to have its priority claim paid in full, under the mediated and Court-approved settlement, unless its distribution is interfered with by dismissal of the bankruptcy;
  • In essence, the Morris couples’ latest Motion to dismiss is a collateral effort to re-write the mediated and Court-approved settlement agreement, to remove any distribution to the IRS; and
  • Such a result is not proper, since the Morris couple has waived any claim to be ahead of the IRS’s distribution rights.

Pressing On

And, of course, the Morris couple filed a Motion (Doc. 456) to reconsider the Bankruptcy Court’s ruling, which Motion was denied on January 22, 2021 (Doc. 468).

But the Morris couple are not to be deterred. They continue make filings in the case, which filings are at Doc. 555 as of this writing.

Conclusion

Yikes!

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