Brandon v. Sherwood et al
ORDER that the Bankruptcy Court's Order awarding judgment in favor of Trustee Christy L. Brandon, and against Michael J. Sherwood, and Michael J. Sherwood, P.C. for the sum of $53,532.00 is AFFIRMED. IT IS FURTHER ORDERED that the Bankruptcy Court's judgment is AFFIRMED in all other respects. Signed by Judge Dana L. Christensen on 10/17/2017. (ASG)
IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MONTANA
OCT 1 7 2017
Clerk, U.S Courts
District Of Montana
STEVEN VINCENT SANN,
Christy L. Brandon,
Plaintiff and Appellee,
MICHAEL J. SHERWOOD and Michael
J. Sherwood, P.C.,
Defendant and Appellant.
Appellant Michael J. Sherwood ("Sherwood") and his law firm Michael J.
Sherwood, P.C. (together "Appellants") appeal the judgment entered against them
by the United States Bankruptcy Court for the District of Montana1 in favor of the
Plaintiff/Trustee Christy L. Brandon ("Trustee") for the Chapter 7 estate of Steven
Sann ("Sann"). The Trustee brings this action to collect $53,532 in funds
transferred to Sann from an IOLTA trust held by Sherwood on Sann's behalf.
At the time of this proceeding, the Hon. Chief Judge Ralph B. Kirscher was still on the
bench. He recently retired and is succeeded by the Hon. Benjamin P. Hursh, Chief Judge.
These funds were subject to an asset freeze, though Sann retained an allowance of
$17 ,844 for living and business expenses. The funds at issue are three monthly
draws, distributed after the case was converted under Chapter 7 of the Bankruptcy
Code. The Trustee contends that the funds were property of the estate, and the
Chapter 7 conversion prohibited Sherwood from making these transfers.
Appellants argue these transfers were proper because the IOLTA trust was not
property of the estate subject to the bankruptcy proceedings. Judge Kirscher
determined the funds were estate property, improperly transferred, and entered
judgment in favor of the Trustee. This appeal follows. This Court has jurisdiction
over this appeal under 28 U.S.C. § 158(a)(l). For the reasons stated below, this
Court affirms Judge Kirscher's ruling.
This case arises from the juncture of a civil action against Sann by the
Federal Trade Commission ("FTC") and Sann's subsequent bankruptcy. On
January 8, 2013, the FTC filed a civil complaint against Sann and his related
business operations seeking injunctive and equitable relief. The Complaint
alleged Sann had engaged in deceptive business practices referred to as
Judge Kirscher provided a thorough factual background of this case in his Memorandum
of Decision. (Doc. 1-3.) As such, this Court will only repeat the facts necessary to understand
"cramming;" the unauthorized addition of charges onto a consumer's monthly
telephone bill, in violation of 15 U.S.C. § 45(a). The Complaint alleged the
scheme netted profits of more than $26 million, and cost consumers more than $70
The Court entered a Stipulated Preliminary Injunction ("SPI") freezing
Sann's assets pending the outcome of the FTC litigation. The SPI had a carve-out
provision allowing Sann to receive $17 ,844 per month to pay his mortgage,
personal and business expenses. Sann's attorney, Appellant Michael J. Sherwood,
received permission from the FTC to take possession of $648,352.20 from the sale
of an apartment complex and distribute monthly draws from these funds.
Sherwood placed the proceeds in an IOLTA trust and began issuing the monthly
draws in November 2014.
Unrelated to the FTC litigation, Sann and his wife, Terry Sann, filed for
bankruptcy under Chapter 11 in late September 2014. As residents ofNevada,
they filed in Las Vegas. On the bankruptcy schedules the Sanns listed numerous
accounts, including one ending in 6474. They included the money held in the
IOLTA trust, claimed no exemptions, and listed the SPI's allowance of $17,844.
On the Statement of Financial Affairs, the Sanns listed the pending FTC action.
In December, the FTC successfully transferred the case to the District of
Montana, and Sherwood became involved in the bankruptcy case as well. In
March, the United States Trustee filed a motion to convert the bankruptcy case
under Chapter 7. The FTC joined the motion to convert, while the Sanns opposed
it. At a hearing, the FTC's counsel stated that if a trustee were appointed to
oversee all assets, the FTC would stipulate to Sann's request to modify the freeze.
The Court converted the case under Chapter 7, appointing Brandon as the
Trustee. From the date of conversion, Sann was no longer entitled to draws from
the IOLTA trust. Sherwood was sent official notice of the conversion, but stated
he "was not up to speed on bankruptcy law" at the time. (Doc. 3 at 9.)
The day following the Trustee's appointment, Sherwood sent Sann a check
for $17 ,844. Sherwood made two further transfers, on June 2 and July 1.
During this time, Sherwood was advised not to continue paying the monthly
draws. In mid-May, Sherwood received an email from the Sanns's Nevada
bankruptcy attorney, Samuel A. Schwartz ("Schwartz"), stating they should
attempt to carve-out funds for Sann's FTC defense, but that "[otherwise], [he did
not] believe there [was] a basis to object to the Chapter 7 trustee holding the
funds." (Doc. 3 at 10.) Sherwood testified that the Sanns's Montana bankruptcy
attorney, James A. Patten ("Patten"), told him not to make any further transfers
from the trust. Sherwood did not share Patten's opinions, and continued to send
the monthly draws, fearing he would be held in contempt if he failed to comply
with the SPI.
In early June, the Trustee sent Sherwood a demand to tum over the
remaining funds in the IOLTA trust. In mid-June, the Trustee sent Sherwood a
demand letter stating that the trust funds were property of the estate. Sherwood
disagreed that the funds were property the estate, and informed the Trustee he
would continue to pay the monthly draws according to the SPI. The Trustee then
filed a motion for turnover in the bankruptcy case. While the motion was pending,
the Trustee filed a Complaint against Sherwood citing violations of 11 U.S.C. §§
542 and 543. As a result of the litigation, coupled with advice from Patten,
Sherwood decided not to issue the August 1 payment.
On August 4, the Bankruptcy Court granted the Trustee's motion for
turnover, ordering Sann to transfer to the Trustee all funds in the IOLTA trust as
of the date of conversion, which was April 29. This demand included the request
for $626.05 from account 6474. In addition, the Bankruptcy Court ordered the
turnover of $53,532 for the three disbursements paid by Sherwood after
conversion, deeming these funds property of the bankruptcy estate.
Sann complied in part, turning over $80,248.75 from account 6474. The
Trustee credited that transfer against her demand, including account 6474. The
Trustee did not apply any of the funds towards the $53,532.
As a result of the Bankruptcy Court's order and a related hearing, Sherwood
mailed the remaining funds, $487,756.20, to the Trustee and asked the Trustee to
dismiss the adversary proceeding. The Trustee declined, seeking to enforce the
$53,532 against Sherwood under§ 542(a). Trial was conducted and judgment was
entered for the Trustee.
When considering an appeal from a bankruptcy court, a district court applies
the same standard of a review that a circuit court would use in reviewing a
decision of a district court. See Ford v. Baro.ff (in re Barofj), 105 F.3d 439, 441
(9th Cir. 1997). A district court reviews a bankruptcy court's legal conclusions de
novo and factual findings for clear error. In re Leavitt, 171 F.3d 1219, 1222 (9th
Cir. 1999) (citations omitted). Mixed questions of fact and law are reviewed de
novo. Miller v. United States, 363 F.3d 999, 1004 (9th Cir. 2004). While the
determination to award equitable relief is reviewed for abuse of discretion.
Traxler v. Multnomah Cty., 596 F.3d 1007, 1014, n.4 (9th Cir. 2010); King v.
Stanton (Jn re Stanton), 38 B.R. 746, 751 (B.A.P. 9th Cir. 1984).
Appellants raise two issues on appeal and argue that Judge Kirscher erred
by (1) finding that the $53,532 transferred from the IOLTA trust was property of
the bankruptcy estate and not exempted; and (2) rejecting Appellant's equitable
defense of double recovery upon finding that Sherwood failed to heed the
warnings of the Bankruptcy Court and bankruptcy counsel instructing him to cease
distributing the monthly draws. This Court will address these issues in that order.
Property of the Bankruptcy Estate
The commencement of a bankruptcy case creates an estate as a matter of
law. 11 U.S.C. § 541(a). The estate is comprised of"all legal or equitable
interests of the debtor ... wherever located and by whomever held." Id. Estate
property is broadly construed and includes "[a]ny interest in property that the
estate acquires after the commencement of the case." § 541(a)(7); United States v.
Whiting Pools, 462 U.S. 198, 204-05 (1983). Thus, property "is not outside of
[the estate's] reach because it is novel or contingent or enjoyment must be
postponed." Harsh Investment Corp. v. Bialac (Jn re Bialac), 712 F.2d 426, 431
(9th Cir. 1983). This includes property to which the debtor has a future interest.
The policy of the Bankruptcy Code is to promote inclusion to maximize a
creditor's distributions. In re McCullogh, 259 B.R. 509, 518 (Bankr. D.R.I. 2001).
However, property can be excluded from the estate under various provisions.
Section 541 (c)(2) is such a provision and exempts valid state spendthrift trusts and
BRISA approved pension plans. Patterson v. Shumate, 504 U.S. 753, 760 (1992).
Appellants argue that the $648,352.20 recovered from the sale of an
apartment complex owned 99% by Sann is subject to exclusion from the
bankruptcy estate under § 541 (c)(2). They argue the exclusion applies because the
property was held in an IOLTA trust on Sann's behalf, and like spendthrift trusts,
the SPI's asset freeze placed a restriction on those funds. Judge Kirscher
disagreed and determined the property was not exempted and fell under the broad
scope and plain meaning of§ 541(a).
On appeal, this Court is asked to consider whether the SPI created a valid
spendthrift trust, precluding the bankruptcy court from exercising jurisdiction over
those funds. For the reasons cited below, Judge Kirscher's ruling is affirmed.
The IOLTA funds were included within the broad scope of
This Court concludes that the three distributions totaling $53,532 fall within
the meaning and scope of "property of the estate." 11 U.S.C. § 541(a). Section
541 (a) provides the "estate is comprised of all of the following property, wherever
located and by whomever held: ... all legal or equitable interests of the debtor in
property as of the commencement of the case." Id. Property is broadly construed,
includes future interest, and contingent property rights. Harsh Investment Corp.,
712 F.2d at 431.
The rights maintained by Sann in the IOLTA trust fall within the plain
meaning of estate property within the Bankruptcy Code. The funds were obtained
from the sale of an apartment complex owned 99% by Sann. They were held in an
IOLTA trust on Sann's behalf with the FTC's consent. This Court placed the
funds under an asset freeze to preserve the status quo while the FTC action was
pending. Pursuant to the SPI, Sann maintained a right to monthly draws for living
expenses. These draws are not per se excluded from the definition of estate
property because they were held by Sherwood and not yet deposited into Sann' s
bank account. For these reasons, this Court finds that the monthly draws fall
within the broad definition of estate property for the purposes of § 541 (a), unless
an exception applies.
The IOL TA funds are included in the estate because the SPI
does not constitute a valid spendthrift trust
Section 541 (c)(2) excludes from the estate an interest in a plan or trust that
contains a transfer on restriction enforceable under nonbankruptcy law. Patterson
v. Shumate, 504 U.S. at 758. This exclusion is narrow, as the exceptions listed in
§ 522(d)(l)(E) includes a broader set of exceptions, including stock payments,
profitsharing, annuity, and other such accumulated interests reasonably necessary
for the support of the debtor and dependants. Id. In Patterson v. Shumate, the
Supreme Court expanded the coverage of§ 541 (c)(2) holding that the phrase
"nonbankruptcy law" applied to both state and federal law, and that an BRISA
approved pension plan containing an anti-alienation provision fell within its
purview. Id. at 760.
Though the Court decided the issue by looking to the statute's plain
meaning, it noted important policy justifications, including Congress's intent to
protect benefits that an employee has worked for and counted upon. Id. at 764-65
(quoting Nachman Corp. v. Pension Benefit Guar. Corp., 446 U.S. 359, 375
Thus, under Patterson, the SPI is exempted from the estate only if it forms
(1) a valid trust or plan, that (2) contains a restriction on transfer, that is (3)
enforceable under state or federal nonbankruptcy law. Id. at 759. Even if met, the
Ninth Circuit has instructed that§ 541(c)(2) is permissive, not mandatory, and
thus a debtor may relinquish his or her right to exclude property by failing to
schedule it or failing to raise the issue before the bankruptcy court. In re Rains,
428 F.3d 893, 905-06 (9th Cir. 2005) (stating§ 541(c)(2) is "permissive not
mandatory"); In re Amerson, 839 F.3d 1290, 1299 (10th Cir. 2016) (finding that
the debtor's inclusion of property on her bankruptcy schedules and failure to argue
for the application of§ 541(c)(2) resulted in the interest becoming part of her
bankruptcy estate.) The debtor bears the burden of demonstrating the exemption
has been met. In re Adams, 302 B.R. 535, 540 (B.A.P. 6th Cir. 2003).
This Court is not persuaded that Appellants have met their burden to prove
this exception applies. Undoubtably, the SPI's asset freeze places a restriction on
funds held in the IOLTA trust. Undoubtably, the SPI is enforced under federal
law, 15 U.S.C. § 53(b). Appellants's claim fails then on the first of§ 541(c)(2)'s
requirements: the SPI does not create a valid trust under state or federal law.
It is obvious, yet worth noting, that the SPI is not an BRISA approved
pension plan. Nor is there any case law to support the contention that the SPI
creates a trust under federal statute 15 U.S.C. § 53(b). Section 53(b) provides for
temporary restraining orders and preliminary injunctions when the FTC has reason
to believe that a person or entity is violating or about to violate any provision of
law enforced by the FTC. There is nothing in the statute that discusses an
intention to create a trust. By its terms § 53(b)(2) is limited to temporary relief in
the form of a temporary restraining order or preliminary injunction.
Sherwood argues that the SPI is exempted from the estate because the
FTC's complaint contains allegations that the proceeds were fraudulently
obtained. However, the FTC's mere allegations do not carry the weight of a final
judgment. In issuing the SPI, this Court determined that the FTC was likely to
succeed in its action. However, this is not a final ruling on whether the funds were
fraudulently obtained. Accordingly, the Bankruptcy Court retained jurisdiction.
This Court specifically declined to take any stance on whether the funds were
fraudulently obtained, and informed Sherwood of that at a hearing in response to
Sann's request to modify the SPI. Sherwood acknowledge that the assets
"wouldn't be property of the estate ifthe FTC prevailed." (Doc. 3 at 6-7.) At the
time of the transfers, the FTC had not prevailed. This Court concludes the
allegation of fraud did not deprive the Bankruptcy Court of jurisdiction.
Having examined the SPI, coupled with the absence of any authority that §
53(b) satisfies the requirements of§ 541 (c)(2) as instructed by Patterson, this
Court concludes that the SPI does not create a valid trust under federal law, nor is
there any justification for its exemption under federal law. Thus, the IOLTA funds
are only exempt from the estate if the SPI creates a valid spendthrift trust under
Spendthrift trust provisions are valid in Montana. Lundgren v. Hoglund,
711 P .2d 809, 810 ( 1985). The Montana Uniform Trust Code recognizes three
valid ways to create a trust, and describes them in § 72-38-401. Of the prescribed
methods, only subsection (2) is applicable here: a "declaration by the owner of
property that the owner holds identifiable property as trustee." Montana Code
Ann.§ 72-38-401(2). The following statute, instructs the requirements for
creation, which include intent to create a trust. Mont. Code Ann. § 72-38-402(2).
Under Montana law, the party asserting the existence of a trust must prove so by
"clear, unmistakable, satisfactory and convincing evidence." New Hope Lutheran
Ministry v. Faith Lutheran Church of Great Falls, Inc., 328 P.3d 586, 600 (2014).
Looking to the language in the SPI, there is nothing which can be
reasonably interpreted as a declaration by Sann that he intends to hold the
$648,352.20 in trust for himself or the FTC. There is even less evidence that the
FTC consented to Sann's holding the property as a trustee on their behalf. Instead,
the FTC made every attempt to limit Sann's exercise of control over his assets. In
regards to Sherwood's holding the $648,352.20, the FTC explained "the funds are
in Mr. Sherwood's account because the FTC insisted that they be deposited
somewhere more secure .... But under the allowance provision, the carve-out
from the asset freeze ... Mr. Sann is allowed to withdraw funds from any account
that he owns or controls to cover his allowance but only to the extent of the
allowance amount." (Doc. 4-25 at 41.)
The FTC continually sought to limit Sann's control over his assets by
inserting itself in the bankruptcy proceedings. After Sann filed for bankruptcy in
Nevada, it was the FTC who petitioned to move the case to the District of
Montana where litigation in the FTC case was underway. It was also the FTC who
petitioned the Bankruptcy Court to convert the case under Chapter 7, fearing the
diminution of the estate by Sann's monthly draws and by diversion of funds used
to pay attorney fees. The FTC was willing to stipulate to the modification of the
asset freeze requested by Sann, so long as a trustee was appointed to administer
the assets. This conduct does not suggest any intent to elect Sann as trustee, but
rather to limit any exercise of his control over the assets. Accordingly, this Court
cannot find that Sherwood has demonstrated the existence of a spendthrift trust
under Montana law by "clear, unmistakable, satisfactory and convincing
Consequently, Appellant's argument that the $53,532 is excluded from the
estate under§ 541(c)(2) is without merit. Having so decided, there is no reason
for the Court to determine whether Sann waived his right by failing to exempt the
IOL TA funds on his amended bankruptcy schedules.
Equitable Relief Under Double Recovery
Next, the Court is asked to consider whether the Trustee's adversary action
against Appellants for $53,532 constitutes more than a "single satisfaction" under
11 U.S.C. § 550(c). Double recovery occurs when a trustee attempts to recover the
same asset twice. In re Newman, 487 B.R. 193, 201 (B.A.P. 9th Cir. 2013).
Though the Trustee argues that there are no equitable defenses to a trustee's
demand for turnover other than those enumerated in§ 542(a)3, Ninth Circuit dicta
in Newman left open the possibility that a debtor could seek refuge in a defense of
double recovery. Id. ("If a trustee sought a double recovery, the party from whom
the second recovery was sought could raise as an equitable defense to turnover
that the bank account constituted effectively a single asset, and the trustee should
not be able to recover the same asset twice.")
Taking this guidance, the Court will examine whether the Appellants are
entitled to an equitable defense of double recovery. The Court concludes that (1)
Appellants remain liable to pay the trustee $53,532 and this is not a double
recovery, and (2) the Bankruptcy Court did not abuse its discretion by deciding
The Trustee cites Helms v. Roti (In re Roti), 271 B.R. 281, 292 (Banla. N.D. Ill. 2002);
Boyer v. Davis (In re US.A. Diversified Prod., Inc.), 193 B.R. 868, 879 (Banla. N.D. Ill. 1995)
("[l]f an entity in possession of estate property receives notice of the bankruptcy filing but
nonetheless transfer the property to an entity other than the trustee, it does so at its peril.")
that Appellants had not exhibited sufficient equity to warrant relief from the
Appellants are liable for $53,532
Section 542(a) permits a trustee to demand the turnover of funds held by
someone other than the debtor or to "account for ... the value of such property
unless the property is of inconsequential value or benefit to the estate." Id. The
Ninth Circuit determined that this section permits a trustee to seek recovery of
estate property "against everyone who may have had control over property of the
estate at some point after the petition was filed." In re Newman, 487 B.R. at 199.
The Court reasoned that to restrict recovery only to property currently possessed
would allow "the possessor of property of the debtor [to] thwart the demand
simply by transferring the property to someone else." Id. at 199-20. Section
542(a) permits the trustee to demand turnover of all funds held in the debtor's
account as of the date of conversion.
In Newman, the Ninth Circuit adopted the holding of an unpublished court
opinion in deciding that a trustee is not relieved of liability because funds are no
longer accessible. Id. at 200 (citing to Rynda v. Thompsen (In re Rynda), 2012
WL 603657, at *3 (B.A.P. 9th Jan. 30, 2012)). The debtor claimed she could not
comply with the trustee's turnover demand because she had already spent her tax
return. Rynda, 2012 WL 603657, at *3. On appeal, the Ninth Circuit determined
that her statutory obligation "to deliver to the trustee and account for such property
or its value [remained]. ... [This] requirement was not waived because the debtor
no longer possessed the property." Id. at 200.
Following Newman, this Court concludes that Appellants are not relieved of
the responsibility to tum over demanded funds. Their liability extends to
compensate the trustee for the full amount demanded; in this case, $541,288, the
amount left in the account at the date of conversion. Whiting Pools, 462 U.S. at
204-06 (concluding that a debtor is required to deliver to the Trustee all property
possessed at the time of conversion to a Chapter 7 proceeding).
Appellants argue that they are absolved of responsibility to turn over any
additional funds, because Sann's previous payment of $80,248.75 contains the
missing $53,532. They urge the Court to apply tracing methods to determine
whether the money recovered by the Trustee included the outstanding balance.
The Court does not agree that the $80,248.75 necessarily contained the
missing $53,532, nor that applying tracing methods to account 6474 concludes the
issue favorable for Appellants. On his bankruptcy schedules Sann listed numerous
checking accounts, including accounts ending in 6474, 7212, 7204, 4740, 1045,
7818, 1045, 5789, 3847, 7809, 1031and6505. Account 6474 was used as the
primary account for personal monthly expenses, and Sann deposited the monthly
draws into this account. Terry Sann testified that in mid-July she used money in
account 64 74 to catch up on mortgage payments. On August 4, 2015 the Trustee
had still not received the remaining assets as of conversion, and sent a demand
specifying the amounts owed by account. In total, the Trustee requested:
$78,400.00 from the IRS tax refund;
$38,269.53 from the DIP account;
$626.05 from Account 6474;
$10,510.92 from Account 1045;
$48, 580.74 from Account 7212;
$50,145.23 from the Euro Pacific Account;
The funds held in Account Nos. 7818, 6505, 5789. 3847,
7809 and 1031 as of the date of conversion (April 29, 2015).
$53,532.00, which consists of three months or draws (May,
June and July) taken from the Sherwood IOLTA Trust
Account, post-petition, which funds are property of the
(Doc. 4-59 at 3-4.)
Only $626.05 was requested from account 6474. On August 3 and 12, Sann
made several transfers into account 6474 from other accounts, totaling $34,980.49.
Additionally, money from a tax return was deposited into 6474. On August 12,
Sann transferred $10,000 from 6474 into 7204. On August 13, Sann complied
with the demand in part, wiring $80,248.75 from account 6474. The Trustee
credited that transfer against the amounts for which she had demanded, including
account numbers ending in 6474, 1045, 7212, and 4740. When asked how she
credited the monies, she said in accordance with her duties to maximize
allocations to the creditors.
When Appellants applied tracing principals to demonstrate that the
$80,248.75 contained the $53,532.00, they only traced money into account 6474.
This approach is misleading. In the months after the date of conversion, Sann
freely transferred money across the accounts. While the Trustee was entitled to,
and demanded roughly $226,532.47, she received only $80,248.75. Though the
payment originated from 6474, she had demanded only $624.05 from that account,
and used the funds to credit the others.
Appellants argue that simple math necessitates the conclusion that the
August 12 transfer included the $53,532 because the money withdrawn from 6474
is less than the amount transferred by Sherwood. Appellants cite In re Belmont,
claiming the case instructs that double recovery is not analyzed vis-a-vis the total
amount collected, but rather by asking whether the funds transferred by Sherwood
were recovered by the Trustee. 551 B.R. 723 (Bankr. E.D.N.Y. 2016).
"It is well settled that until finally paid, litigants may look to multiple
parties to recover the same loss." Id. at 732. Appellants's reliance on Belmonte is
inapposite. In Belmonte, the trustee of a Chapter 7 estate brought an adversary
action against the defendants who received $250,000 after the debtor's postconversion transfer of estate property. Id. at 725. The debtors took out a second
mortgage on their home and used the proceeds to pay the defendants. Id. at 731.
The court decided that there was no evidence of double recovery, even though the
trustee had successfully avoided the second mortgage, because the trustee had not
yet recovered $250,000. Id. at 732.
Similarly, this Court concludes that there is no evidence of double recovery,
because the Trustee has not yet fulfilled a single recovery of the assets demanded.
The Bankruptcy Court did not abuse its discretion by finding
Sherwood ineligible for equitable relief
The Bankruptcy Court determined that its equitable powers must yield to
express statutory commands. Law v. Siegel,_ U.S._, 134 S.Ct. 1188,
1194-1195 (2014); San Rafael Baking Co. v. N Cal. Bakery Drivers Sec. Fund (Jn
re San Rafael Baking Co.), 219 B.R. 860, 866 (B.A.P. 9th 1998) (stating
"bankruptcy courts are courts of equity but must follow the law and cannot ignore
express statutory commands.") Notwithstanding that the Bankruptcy Court
determined§ 542(a) an express statutory command, the Bankruptcy Court further
concluded that Sherwood failed to demonstrate sufficient equity to warrant the
Bankruptcy Court's relief. "He who seeks equity must do equity." Gardenhire v.
Comm 'r (Jn re Gardenhire), 20 F.3d 1145, 1152, n.11 (9th Cir. 2000).
When reviewing a bankruptcy court's denial of equitable relief, the court
will reverse only upon finding arbitrary or capricious reasoning. Pankratz Lumber
Co. v. F.E.R.C., 824 F.2d 774, 780 (9th Cir. 1987). This Court does not find the
Bankruptcy Court abused its discretion.
The Bankruptcy Court decided that Sherwood had failed to heed the
warnings of the Trustee, the FTC and Sann's other bankruptcy attorneys,
instructing him to discontinue the monthly draws. Appellants argue this finding
was erroneous, and that Sherwood ceased the transfers as soon as the Bankruptcy
Court instructed him to do so.
This Court is unpersuaded and concludes that any confusion regarding the
status of the monthly draws should have been resolved at least prior to the June
transfer. On April 29, the Bankruptcy Court converted the case under Chapter 7
and assigned Brandon as the trustee. On May 1, the Trustee sent Sherwood notice
of conversion, which he did not receive until May 5. In addition to representing
Sann in the FTC defense, Sherwood was also appointed as bankruptcy counsel.
Sherwood stated he did not receive actual knowledge of conversion until
May 5, as he had not signed up to receive electronic notice. He did not open the
Trustee's letter right away because he was "busy with other matters." (Doc. 3 at
9.) Sherwood also stated he was unfamiliar with bankruptcy law at the time of
conversion. Sherwood issued the monthly draw on May 1. When he received
notice of the conversion on May 5 he did not attempt to stop payment. This check
was not deposited until May 29.
In mid-May, the Trustee filed a motion in the FTC action to be substituted
in place of Sann for all matters implicating the estate property, based on her status
after the Chapter 7 conversion. Sherwood was Sann's attorney in the FTC action
as well. The FTC wrote a memorandum of law and filed it with this Court, writing
that "all of debtor's frozen assets are property of the estate, and that the debtor had
no authority to use estate property." (Doc. 3 at 10.) Yet, Sherwood asserts that he
continued the transfers through June and July because he needed the FTC's
consent before he would disregard the SPI.
Also in mid-May, Sann's Nevada bankruptcy attorney copied Sherwood in
an email discussing strategy in light of the Trustee's turnover demand. Schwartz
thought they should try to argue for a carve-out from the frozen trust funds for
Sann's defense in the FTC action, with the balance going to the estate. "Otherwise,
I do not believe there is a basis to object to the Chapter 7 trustee holding the
funds." Id. Sherwood asserts this email did not provide notice to discontinue the
transfers because he was merely copied in the email and it was not directed to him.
After the May transfer, Sherwood made two further transfers to Sann. He
stated that he discussed his options with various counsel and did an "intense
amount of research." (Doc. 3 at 11.) From this, he concluded that it would be
acceptable to continue the transfer and wait to see what the court did. He stated
that he feared this Court might hold him in contempt if he failed to comply with
the SPI. He stated that as of June he began to have concern that the Debtor might
get into trouble for holding the monthly draws, but he had no sense that he himself
might be held responsible. Sherwood made an ill-informed decision to "wait and
see" instead of seeking clarification by interpleading.
For these reasons, This Court concludes that the Bankruptcy Court did not
abuse its discretion by finding Sherwood's actions did not warrant equitable relief.
Upon a de novo review of the Bankruptcy Court's legal conclusions, the
Court determines that the Bankruptcy Court's order awarding judgment in favor of
Trustee Christy L. Brandon, and against Michael J. Sherwood and Michael J.
Sherwood, P.C. for the sum of$53,532.00 was based on legal grounds within the
contemplation of the Bankruptcy Code and on factual findings that are not clearly
erroneous. Further, the Bankruptcy Court did not abuse its discretion by failing to
award equitable relief based on factual findings that are neither arbitrary nor
IT IS ORDERED that the Bankruptcy Court's Order awarding judgment in
favor of Trustee Christy L. Brandon, and against Michael J. Sherwood, and
Michael J. Sherwood, P.C. for the sum of $53,532.00 is AFFIRMED.
IT IS FURTHER ORDERED that the Bankruptcy Court's judgment is
AFFIRMED in all other respects.
DATED this l1
~ay of October, 2017.
Dana L. Christensen, Chief Judge
United States District Court
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