McKenna v. Offical Committee of Unsecured Creditors

Filing 12

MEMORANDUM AND ORDER re 2 Bankruptcy Appeal. Appellant McKenna's appeal is denied and the order of the bankruptcy court is affirmed. So Ordered by Chief Judge Mary M. Lisi on 5/31/2011. (Duhamel, John)

UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF RHODE ISLAND

In re:

KEVEN A. MCKENNA, P.C.,
Appellant,
v.

C.A. No. 10-472 ML

OFFICIAL COMMITTEE OF UNSECURED
CREDITORS,
Appellee.

MEMORANDUM AND ORDER
This matter is before the Court on the appeal of Keven A. McKenna, P.e., ("Appellant")
a Chapter 11 debtor-in-possession, from an order entered by the bankruptcy court, sua sponte,
appointing a Chapter 11 trustee. For the reasons set forth below, the appeal is denied and the
order of the bankruptcy court is affirmed.
Background
Appellant is a law firm wholly owned by attorney Keven A. McKenna. Appellant filed a
voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code on January
25,2010. Appellant remained in possession and control of its assets and affairs and operated its
business as a debtor in possession from January 2010 until November 2010.
On September 17,2010, the Official Committee of Unsecured Creditors of Keven A.
McKenna, P.C. ("Appellee") filed a motion, pursuant to 11 U.S.C. § 1112(b), seeking the
conversion of Appellant's Chapter 11 reorganization case to a liquidation case under Chapter 7.

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On October 26,2010, the bankruptcy court held a hearing on the motion. At the conclusion of
the hearing, the bankruptcy judge informed the parties that he would take the matter under
advisement and would issue a decision at a later date. On November 18,2010, the bankruptcy
court issued a written order. The motion to convert was denied without prejudice but, based on
the "totality of the circumstances of [the] case, notably the recalcitrance and the conduct of the
equity stakeholder Keven A. McKenna," the bankruptcy court, "sua sponte and pursuant to 11
U.S.C. [s]ection 1104(a)(3)" appointed a Chapter 11 trustee. In re McKenna, P.C., 10-bk-l0256
(Bankr. D.R.I. 2010) (Docket # 196) (emphasis added).
Jurisdiction and Standard of Review
"The district courts of the United States shall have jurisdiction to hear appeals" from the
"final judgments, orders, and decrees" ofa bankruptcy court. 28 U.S.C. § 158(a)(I). Both
parties agree that the order appointing a Chapter 11 trustee is a final order. See generally Ritchie
Special Credit Investments, Ltd. v. United States Trustee, 620 F.3d 847,852 (8th Cir. 2010)
(joining the majority of circuits that have considered the issue and concluding that the bankruptcy
court's appointment of a trustee is a final order).] This Court therefore has jurisdiction over this
appeal.
"On intermediate appeal to a district court, a final order of the bankruptcy court is subject
to the same familiar standards of review normally employed in direct appeals to the courts of
appeals in civil cases generally. The district court accepts all bankruptcy court findings of fact

]Although the First Circuit has not directly addressed the issue of whether an order of a bankruptcy court
appointing a Chapter 11 trustee is a final order pursuant to 28 U.S.C. § 158, the First Circuit has held that the
appointment of a Chapter 11 trustee by a district court is a final order. In re Plaza de Diego Shopping Center, Inc.,
911 F.2d 820 (1st Cir. 1990).

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unless clearly erroneous, but reviews rulings oflaw de novo." In re LaRouche, 969 F.2d 1299,
1301 (1st Cir. 1992) (internal quotation marks and citation omitted).
Analysis
11 U.S.C. § 1112(b)(I) provides that "[e]xcept as provided in ... section 1104(a)(3), on
request of a party in interest, and after notice and a hearing ... the court shall convert a case
under this chapter to a case under chapter 7 or dismiss a case under this chapter, whichever is in
the best interest of creditors and the estate, if the movant establishes cause." 11 U.S.C. §
1112(b)(1 ) (emphasis added).2 Section 1112(b)(4) includes a list of examples of "cause." Id. at
(A)-(P). Courts have wide discretion in determining what constitutes cause. In re Products
International Co., 395 B.R. 101 (Bankr. D. Ariz. 2008). "Although the language of section
1112(b) provides a list of possible circumstances for 'cause,' this is not an exhaustive list, and in
fact the court is not limited to the enumerated grounds for making its determination of some
cause." In re Gonic Realty Trust, 909 F.2d 624,626 (1st Cir. 1990) (internal quotation marks
and citation omitted); In re Products, 395 B.R. at 109 (list in § 1112(b)(4) is usually viewed as
"illustrative rather than exhaustive, and the [c ]000 should consider other factors as they arise,
and use its equitable powers to reach the appropriate result in individual cases") (internal
quotation marks and citation omitted). Thus, in determining cause under § 1112(b), the

2As noted above, the hearing on the motion to convert was on October 26, 2010, and the bankruptcy court
issued its decision on November 18,2010. Appellant filed this appeal in November 2010 and the parties briefs were
filed in March 2011. Sections 1112 and 1104 were amended on December 22, 2010. See Bankruptcy Technical
Corrections Act of 2010, Pub. L. 111-327, 124 Stat. 3557 (Dec. 22, 2010). "As a self-described technical
amendment, the [amendments] apply to cases pending and thereafter filed." In re Landmark Atlantic Hess Farm,
LLC, No. 10-24656-DK, 2011 WL 831724 at *3 n.14 (Bankr. D. Md. March 3, 2011); In re TP, Inc., No.1 0-015948-SWH, 2011 WL 1549453 (Bankr. E.D.N.C. April 21, 2011). This Court, however, applies the language of the
statutory provisions pre-December 22,2010, because (I) this is an appeal; (2) the hearing on the motion to convert
and the bankruptcy court's decision occurred before the technical amendments; (3) the parties concentrate on the
pre-amendment statutory provisions in their papers; and (4) the Court's decision is the same under either the pre or
post-amendment version of the statutes.

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bankruptcy court "may consider other factors as they arise and use its powers to reach appropriate
results in individual cases." In re Gonic Realty Trust, 909 F.2d at 626. One ground, however, is
sufficient, standing alone, to establish cause under the statute. In re Reagan, 403 RR. 614
(RA.P. 8th Cir. 2009), affd, 374 F. App'x 683 (8th Cir. 2010); 7 Alan N. Resnik, Collier on
Bankruptcy § 1112.04[5] (16th ed. 2011) ("[i]f one of the enumerated examples of cause set forth
in section 1112(b)(4) is proven by the movant by a preponderance of the evidence, the court must
find that [the] movant has established cause").
Section 1112(b)(1) requires the bankruptcy court to engage in a three-step analysis: (1)
the court must first determine if the movant has demonstrated that cause has been shown by a
preponderance of the evidence; (2) if cause has been demonstrated, the court must ascertain
whether unusual circumstances exist to prevent conversion or dismissaV and (3) if no such
unusual circumstances exist, the court must convert or dismiss. In re Modanlo, 413 B.R. 262
(Bankr. D. Md. 2009). "Thus, if cause has been demonstrated ... the court must ascertain
whether the best interest of creditors and the estate are served by granting or denying the
motion." Id. at 271. Once cause is established, the bankruptcy court has broad discretion to
determine whether conversion or dismissal is in the best interest of creditors and the estate.
Gilroyv. Ameriguest Mortgage Co., BAP NH 07-054, BKR 06-10786-MWV, 2008 WL
4531982 (RA.P. 1st Cir. 2008).
Section 1104(a)(3) provides that at
any time after the commencement of the case but before confirmation of plan, on

3The statutory scheme does not define "unusual circumstances," however the "phrase contemplates
conditions that are not common in Chapter II cases." In re Products, 395 B.R. at 109. The record does not reflect
any unusual circumstances in this case.

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request of a party in interest or the United States trustee, and after notice and a
hearing, the court shall order the appointment of a trustee ... if grounds exist to
convert or dismiss the case under section 1112, but the court determines that the
appointment of a trustee or an examiner is in the best interests of creditors and the
estate.
11 U.S.C. § 1104(a)(3) (emphasis added). When read together, §§ 1112(b)(I) and 1104(a)(3)
require a court to consider three alternatives. In re Products, 395 B.R. at 108. "If cause has been
shown by the moving party, the [c]ourt must consider whether to dismiss the case, convert the
case to one under Chapter 7, or appoint a Chapter 11 trustee, whichever results in the best
interest of creditors." Id.; see also In re LG Motors, Inc., 422 B.R. 110 (Bankr. N.D. Ill. 2009) (§
1104(a)(3) gives the court discretion to appoint a trustee instead of converting or dismissing the
case if the court determines the appointment is in the best interest of the creditors and the estate);
7 Collier on Bankruptcy § 1112.04[7] (once cause has been shown, instead of either conversion
or dismissal, a court may appoint a trustee if such appointment is in the best interest of the
creditors and the estate); see also In re Keith, No. 10-61722-11,2010 WL 3835003 at *6 (Bankr.
D. Mont. Sept. 29,2010) (when § 1104(a)(3) and § 1112(b) are read together "it seems clear that
the court must appoint a Chapter 11 trustee rather than convert or dismiss the case if section
1104(a)(3) applies") (internal quotation marks and citation omitted) (emphasis in original)). The
court determines which approach is appropriate based upon the record. In re Products, 395 B.R.
101.
Appellant argues that the bankruptcy court erred when it appointed a Chapter 11 trustee
(1) without a motion by an interested party or by the United States Trustee; (2) without notice
and a hearing; and (3) without making fact findings supporting a cause determination or a
determination that appointing a trustee was in the best interest of the creditors of the estate.

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Appellee contends that (1) the bankruptcy court acted in accord with the bankruptcy code; (2)
Appellant received adequate notice and hearing; and (3) the bankruptcy court had adequate
grounds to find cause under § 1112(b) and that the appointment of the trustee was in the best
interest of all creditors pursuant to § 1104(a)(3).
The Court begins with Appellant's argument that the bankruptcy court's order is flawed
because there was no motion by an interested party or the United States Trustee to appoint a
Chapter 11 trustee. Section 1104(a)(3) provides that "on request of a party in interest or the
United States trustee" the bankruptcy court may appoint a Chapter 11 trustee. 11 U.S.C. §
1104(a)(3). Although there was no motion before the bankruptcy court to appoint a Chapter 11
trustee, the absence of such a motion does not render the bankruptcy court's order infirm.
No provision of [the bankruptcy code] providing for the raising of an issue by a
party in interest shall be construed to preclude the court from, sua sponte, taking
any action or making any determination necessary or appropriate to enforce or
implement court orders or rules, or to prevent an abuse of process.

II U.S.C. § 105(a). "The provision entitling a United States trustee or party to make ... a
request [to appoint a Chapter II trustee pursuant to 1104(a)] does not preclude the court from
doing so sua sponte...." In re Bibo, Inc., 76 F.3d 256,258 (9th Cir. 1996) (acknowledging the
court's sua sponte power pursuant to 11 U.S.c. § 105(a)); see also In re ROPT Ltd. Partnership,
209 B.R.144, 149 (RA.P. 1st Cir. 1997) (citing In re Bibo for the proposition that
"notwithstanding § 1104(a)'s language limiting appointment of a trustee in Chapter 11 case ...
[a] bankruptcy court [is] permitted pursuant to § 105 to sua sponte appoint trustee");
see generally In re Pedro Abich, Inc., 165 RR. 5, 8 (D.P.R. 1994) (§ 105 "overrides" the party in
interest and trustee language in § 1112(b) and allows court to act on its own initiative). The

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bankruptcy court was authorized to sua sponte appoint a Chapter 11 trustee. 4
Appellant next argues that it was not granted notice of, or a hearing on, the appointment
of a trustee. Both 11 U.S.c. § 1112(b) and § 1104(a)(3) include the language "after notice and a
hearing." See id. The phrase "after notice and a hearing" is defined in the bankruptcy code as
"notice as is appropriate in the particular circumstances, and such opportunity for a hearing as is
appropriate in the particular circumstances...." 11 U.S.C. § 102 (1)(A). It is undisputed that
Appellant received notice of and a hearing on the motion to convert. Thus, the prospect of the
appointment of a trustee was not wholly unknown to Appellant. In its memorandum of law in
support of the motion to convert, Appellee requested that the bankruptcy court convert the matter
to a Chapter 7 proceeding and "order the immediate appointment of a Chapter 7 trustee."
Memorandum of Law in Support of Motion to Convert at 9, In re McKenna, P.C., 10-bk-10256
(Bankr. D.R.I. 2010) (Docket # 156-1). Section 1112(b) also warns of the possibility ofthe
appointment of a Chapter 11 trustee by its specific reference to § 11 04(a)(3). Additionally, had
the bankruptcy judge determined that the matter should be converted to a Chapter 7 proceeding, a
trustee would have been appointed to administer the estate.
Promptly after the order for relief under [Chapter 7], the United States trustee
shall appoint one disinterested person that is a member of the panel of private
trustees ... or that is serving as trustee in the case immediately before the order
for relief under this Chapter to serve as interim trustee in the case."
11 U.S.C. § 701(a)(l) (emphasis added). Conversion ofa Chapter 11 case to a Chapter 7 case

4Appellant argues that Cournoyer v. Town of Lincoln, 790 F.2d 971, 972 n.1 (l st Cir. 1986), stands for the
proposition that in "a Chapter II case, a trustee can only be appointed upon the request of a party in interest or the
United States Trustee." Id. What Appellant fails to comprehend, however, is that Cournoyer was decided several
months before the 1986 amendments to the bankruptcy code which, among other things, added the sua sponte
provision in § lOS. See In re Starmark Clinics, LP, 388 B.R. 729 (Bankr. S.D. Texas 2008); l l i also 11 U.S.C. §
lOS; Pub. L. No. 99-554,100 Stat. 3088.

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"constitutes an order for relief under the chapter to which the case is converted ...." 11 U.S.C.
§ 348(a); see also Ohio v. Kovacs, 469 U.S. 274, 285 n.12 (1985) (trustee is "appointed promptly
in Chapter 7 cases"); In re C.W. Mining Co., 636 F.3d 1257, 1261 (RA.P. 10th Cir. 2011)
("interim trustee is appointed 'promptly' after a Chapter 7 order for relief is granted ... and
eventually, a permanent trustee ... is installed for the duration of the bankruptcy"); see generally
In re EI Legado De Chi Chi Rodriguez Golf, No. 08-08321 BKT, 2010 WL 1924439 at *2
(Bankr. D.P.R. May 12,2010) (Chapter 7 and Chapter 11 trustee have "similar powers and
duties"). In essence, Appellee moved for the appointment of a trustee by moving to convert.
This Court concludes that Appellant received the appropriate notice of, and a hearing on, the
prospect of the appointment of a trustee under the circumstances.
Last, Appellant contends that the bankruptcy court erred by not making fact findings to
support a "cause" determination under § 1112(b) or a determination that appointing a Chapter 11
trustee was in the best interest of the creditors. Appellant argues that the record did not reflect
clear and convincing evidence that a Chapter 11 trustee was necessary under the circumstances.
The preponderance standard applies to a cause determination pursuant to § 1112(b). In re
Woodbrook Associates, 19 F.3d 312 (7th Cir. 1994); In re EI Legado, 2010 WL 1924439; In re
Babayoff, 445 RR. 64 (Bankr. E.D.N.Y. 2011); In re Westgate Properties, Ltd., 432 B.R. 720,
723 (Bankr. N.D. Ohio 2010) ("where action under § 1112 is brought, movant bears burden of
proving by preponderance of evidence that cause exists"). On the other hand, it appears that the
clear and convincing standard applies to the appointment of a trustee pursuant to § 1104. In re
G-I Holdings, Inc., 385 F.3d 313 (3d Cir. 2004); In re Berwick Black Cattle Co., 405 RR. 907
(Bankr. C.D. TIL 2009) (party seeking appointment has burden of proof and it "appears that the

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majority applies a clear and convincing standard ... while the minority uses a preponderance of
the evidence standard") (citations omitted).s "[C]ourts in the First Circuit have not directly
determined what evidentiary standard to apply when determining" the burden under § 1104.
Tradex Corp. v. Morse, 339 B.R. 823, 827, 830 (D. Mass. 2006) (concluding that a court "need
find the factual predicates - 'cause' or the best interest of the relevant parties - by only a
preponderance of the evidence. Clear and convincing evidence is not required."). The Court
need not decide which standard applies because, in this case, the facts adduced at the hearing
were largely uncontested and they would support a finding under either standard.

In his order, the bankruptcy judge summarized his findings supporting the appointment of
a Chapter 11 trustee as follows: "based upon the totality of the circumstances of this case,
notably the recalcitrance and the conduct of the equity stakeholder Keven A. McKenna...." In
re McKenna, P.C., lO-bk-10256 (Docket # 196-1) (emphasis added). At the hearing on the
motion to convert, Appellant readily admitted that Appellant had "continually, albeit late,
supplied the Court with ... documents" and that "there [had] been failures to comply with prior
orders of the [c]ourt ...." October 26,2010, Hearing Transcript at 72, 110 (emphasis added).6

In fact, the bankruptcy judge observed:
[W]hat's wrong with following the rules and filing a motion for an extension of
time? I know you run out of those at some point. But instead ofjust using up
your goodwill with everybody by blowing off ... these deadlines, it gets to be
kind of an uncomfortable bed to sleep in, but the Debtor made the bed. And that,

SThe Court acknowledges that the appointment of a Chapter 11 trustee has been described as an
"extraordinary" act. Tradex Corp. v. Morse, 339 B.R. 823, 828 (D. Mass. 2006).

6.rhe bankruptcy court sanctioned Appellant for its failure to comply with deadlines in a scheduling order.
In re McKenna, P .C., 10-10256 (Docket ## 154, 180). The court, however, deferred assigning a dollar amount to
the sanctions until a later date. See id.

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you know, that-let's face it. That's one of the main reasons we're here today is
just recalcitrance ....
Id. at 112 (emphasis added). Counsel for Appellant admitted that he had not petitioned the
bankruptcy court for an extension of any deadline "because [he was] trying to get the documents
together and filed." Id. at 56. He further explained that some of the reasons for not getting
documents to the bankruptcy court on a timely basis was a result of miscommunication between
he and Mr. McKenna, counsel's time spent on related matters in Rhode Island Superior Court,
and because counsel had been "trying to get things done more accurately than we have in terms
oftimeliness." Id. at 115. Counsel for Appellant explained to the bankruptcy court that it
"seem[ed] with every day there's ... a new fire to put out." Id. at 64. The bankruptcy court
aptly found, however, that the "problem is the need to stop ... obstructionism [and] footdragging," id. at 74, to which counsel for Appellant replied, "that's ... a fair comment, Judge."
Id. at 75. The record clearly supports a fmding of "cause" under § 1112(b). See 11 U.S.C. §
1112(b)(4)(E) (cause includes "failure to comply with an order of the court").7 As a result, the
Court need go no further. See In re Reagan, 403 B.R. 614 (one ground, standing alone, is
sufficient to show cause).
In addition to Appellant's cavalier attitude towards court orders, the record also reflects

that Appellant, as debtor in possession, repeatedly overdrew its bank accounts. At the hearing on
the motion to convert, Mr. McKenna did not dispute that he bounced approximately two dozen
checks and incurred bank fees of approximately $1,300. Mr. McKenna testified that the checks

7It appears that Appellant argues that II U.S.C. § 1112(b)(2) applies and excuses the cause shown. The
Court finds that § 1112(b)(2) does not apply because, among other reasons, the record does not reflect that there
"exists a reasonable justification" for Appellant's violations of court orders. See II U .S.C. § 1112(b)(2)(B)(i).

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bounced because (1) he represents "low income" individuals and he receives "a lot of bounced
checks," (2) he made the "mistake" of using "excessive accounts," (3) he was using a new
banking "system" and was not "aware of ... new rules" that charged him fees for a bounced
check and, (4) he was using an inefficient payroll processing company. Id. at 93-94.
Mr. McKenna's admissions concerning the bounced checks, at best, demonstrate a lack of
good financial management. "[B]ouncing checks is gross mismanagement." In re Plaza de
Retiro, Inc" 417 B.R. 632,643 (Bankr. D.N.M. 2009) (debtor bounced 9 checks in one month
and 21 in the following month incurring over $1,000 in "unnecessary bank charges"). Mr.
McKenna's conduct in bouncing numerous checks and incurring unnecessary bank fees shows
gross mismanagement and constitutes cause under § 1112(b). See 11 U.S.C. § 1112(b)(4)(B)
(cause includes "gross mismanagement of the estate").
Furthermore, on August 12,2010, the bankruptcy court found that Appellant's disclosure
statement, filed on July 2,2010, was inadequate. The bankruptcy court ordered Appellant to file
an amended disclosure statement no later than September 13, 2010. In Ie McKenna, P.e., 10-bk10256 (Docket # 136). On September 21,2010, some 8 days after the deadline and four days
after the motion to convert was filed, Appellant filed its first amended disclosure statement. Id.
(Docket # 158). At the hearing on the motion to convert, however, Appellee objected to the
amended disclosure statement. Notably, Appellant did not contest Appellee's objection to the
adequacy of the statement. Appellant's counsel admitted that it was not "overly complicated to
put [a disclosure statement] together" and at times he needed to "drone [sic] out [his] client ...."
October 26,2010, Hearing Transcript at 106. The bankruptcy court found that Appellant had not
"come close to submitting a ... an adequate disclosure statement, and, you know, it's been a

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while and it's been contentious...." Id. at 105. Consequently, some ten months after filing the
petition, an accurate disclosure statement had still not been filed.
"The [d]isclosure [s]tatement is an integral component to any petition for the protections
afforded pursuant to the Bankruptcy Code. Timely and accurate financial disclosures is the life
blood of the Chapter 11 process." In re Integrated Pet Foods, Inc., No. 03-33362-DWS, 2004
WL 2252119 at *6 (Bankr. B.D. Pa. Sept. 17,2004) (internal quotation marks and citation
omitted); see also In re Daniels, No. 92-13051-JNF, Adv. No. 93-1332, 1994 WL 470213
(Bankr. D. Mass. April 25, 1994) (after 15 months in reorganization case, inadequacy of
disclosure statement, among other factors, supported conversion). Appellant's failure to file a
disclosure statement within the time set by the Court also constitutes cause under § 1112(b). See
11 U.S.C. § 1112(b)(4)(1) (cause includes "failure to file a disclosure statement ... within the
time fixed by ... order of the court").
As noted above, § 1104(a)(3) also provides, in part, that the appointment of a Chapter 11
trustee must be in the "best interest of creditors and the estate." 11 U.S.C. § 1104(a)(3); see also
In re Sydnor, 431 B.R. 584,600 (Bankr. D. Md. 2010) ("[s]ection 1112 and [s]ection 1104 read
together require the court to make a finding as to what remedy is in the best interest of the
creditors and the estate"). Unfortunately, the bankruptcy code does not define the phrase "best
interests of creditors and the estate." In re Vaughn, 429 B.R. 14 (Bankr. D.N.M. 2010). Implicit
in the bankruptcy court's order, however, was a finding that the appointment of a trustee was in
the best interest of the creditors and the estate. The appointment of a Chapter 11 trustee will
"alleviate concerns about future instances" of Mr. McKenna's recalcitrance, contentiousness,
foot dragging, and "gross mismanagement." See In re TP, Inc., No. 1O-01594-8-SWH, 2011 WL

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1549453 at *4 (Bankr. E.D.N.C. 2011); see also In re Taub, 427 B.R. 208,214 (Bankr. E.D.N.Y.
2010), aff'd, Nos. 10 CV 5717 (RJD), 08 BK 44210 (ESS), 2011 WL 1322390 (E.D.N.Y. March
31, 2011) (appointment of Chapter 11 trustee was in the best interest of creditors and the estate
where case had been marked from the outset by "acrimony, contentiousness," and "distrust"
causing progression toward reorganization to halt); In re United States Mineral Products Co., 105
F. App'x 428,430 (3d Cir. 2004) (bankruptcy court did not abuse discretion by sua sponte
appointing trustee based upon, among other things, "the contentiousness and acrimonious nature
ofthe relationship among the parties, the lack of trust, [and] the lack of progress....").
For the reasons discussed above, Appellant's appeal is denied and the order of the
bankruptcy court is affirmed.

SO ORDERED.
/s/ Mary M. Lisi
MaryM. Lisi
Chief United States District Judge
May 31, 2011.

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