Grant, Konvalinka & Harrison v. McKenzie et al

Filing 27

MEMORANDUM with order to follow.Signed by District Judge Curtis L Collier on 10/2/2012. (AWH, )

UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF TENNESSEE
AT CHATTANOOGA
IN RE:
STEVE A. MCKENZIE
Debtor

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1:11-cv-192
1:11-cv-274
1:12-cv-025
Chief Judge Curtis L. Collier

MEMORANDUM
Before the Court are appeals from two orders issued by the United States Bankruptcy Court
for the Eastern District of Tennessee (Rucker, J.). The appeals were consolidated because they arise
from common questions of law and fact.1 The first order denied in part a motion for relief from the
automatic stay and abandonment of collateral filed by Appellant Grant, Konvalinka & Harrison, P.C.
(“Appellant” or “GKH”) (Case No. 1:11-cv-192, Court File No. 2-2 (the “May 27, 2011 Order”)).
In ruling on Appellant’s motion for relief, the bankruptcy court took under advisement several of
the issues raised by Appellant. The second order addressed those outstanding issues (Case No. 1:12cv-025, Court File No. 1-36 (the “December 9, 2011 Order”)). The Appellees in this case are Steve
A. McKenzie, the debtor in the bankruptcy action (“Mr. McKenzie” or the “debtor”), and Trustee
C. Kenneth Still (“Trustee”) (“Appellees”). The Court held oral arguments on April 18, 2012.
Attorneys for all of the relevant parties were present and argued their positions before the Court.
After giving careful consideration to the parties’ arguments, the relevant case law, and the

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Case No. 1:12-cv-25 was consolidated with Case No. 1:11-cv-192 because the Court
determined the issues raised in both appeals pertained to the bankruptcy court’s decision on
Appellant’s motion for relief from the automatic stay. Case No. 1:11-cv-274, however, was opened
in error. The parties’ intent was to supplement the record by filing additional documents in Case No.
1:11-cv-192, but those documents were instead filed as a new case. On October 14, 2011, the Court
issued an order clarifying that Case No. 1:11-cv-274 was not a new appeal. The Court consolidated
the two cases so the documents in Case No. 1:11-cv-274 would be associated with Case No. 1:11cv-192.

evidentiary record, the Court AFFIRMS the bankruptcy court’s orders dated May 27, 2011 and
December 9, 2011, which are the subject of the appeals in Case Nos. 1:11-cv-192, 1:11-cv-274, and
1:12-cv-025. Because no further matters remain for adjudication, the Clerk of Court is directed to
CLOSE these cases.

I.

RELEVANT FACTUAL AND PROCEDURAL BACKGROUND2
This case began as an involuntary Chapter 7 bankruptcy action filed against debtor Steve A.

McKenzie on November 11, 2008, in the United States Bankruptcy Court for the Eastern District
of Tennessee. The Chapter 7 bankruptcy was refiled as a voluntary Chapter 11 bankruptcy, and the
two cases were later consolidated. All of the events discussed below arise from this consolidated
bankruptcy matter.
On April 27, 2009, Appellant Grant, Konvalinka & Harrison, P.C. filed a proof of claim as
a secured creditor of Mr. McKenzie. On February 7, 2011, Mr. McKenzie filed an objection to
GKH’s proof of claim because there were no attachments to the claim and because Mr. McKenzie
believed the amount was too great. On February 9, 2011, GKH amended its proof of claim and
attached documents showing a security interest in certain real estate and membership interests
owned by Mr. McKenzie. On March 7, 2011, GKH filed a “Motion for Relief from Stay and
Abandonment of Membership Interests and/or Stock Interests.” The bankruptcy court set a hearing
for March 17, 2011, to take up Appellant’s motion.
Trustee Kenneth C. Still filed a motion to continue the hearing, which the bankruptcy court

2

The factual background comes from information in the documents and exhibits filed by the
parties unless otherwise noted.
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granted over GKH’s objection. The bankruptcy court’s order stated that the preliminary hearing
required by statute would now be consolidated with the final hearing on GKH’s motion for relief.
The new hearing was set for May 4, 2011. On April 29, 2011, the bankruptcy court again entered
an order continuing the final hearing until May 18, 2011. GKH’s motion for relief was heard on May
18, 2011. On May 20, 2011, the bankruptcy court entered an order taking GKH’s motion under
advisement and, in light of “compelling circumstances,” further extended the automatic stay and
continued the hearing until May 24, 2011, the date on which the court stated it would deliver its
opinion. On May 27, 2011, the final order was issued granting in part and denying in part GKH’s
motion for relief (the “May 27, 2011 Order”). The motion for relief was denied with respect to the
debtor’s membership interests in Cleveland Auto Mall, LLC, Spectrum Health Operations, LLC, and
the “Exit 20” entities. The court also declared the automatic stay would remain in effect with respect
to all of the pledged interests until further order of the court.
On June 10, 2011, GKH filed a precautionary motion for leave to appeal the bankruptcy
court’s May 27, 2011 Order. This Court granted GKH’s motion for leave to appeal on January 12,
2012, taking into account the bankruptcy court’s decision on December 9, 2011 (the “December 9,
2011 Order”) that addressed several matters the court had previously taken under advisement in the
May 27, 2011 Order. GKH seeks reversal of the bankruptcy court’s orders denying in part GKH’s
motion for relief from the automatic stay and abandonment of collateral. GKH also requests that the
automatic stay be terminated.

II.

STANDARD OF REVIEW
The district court has appellate jurisdiction to hear appeals from final judgments and orders

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of the bankruptcy court pursuant to 28 U.S.C. § 158(a)(1). The bankruptcy court’s factual findings
are reviewed for clear error and its conclusions of law are reviewed de novo. In re Behlke, 358 F.3d
429, 433 (6th Cir. 2004). A finding of fact is considered clearly erroneous if “the reviewing court
on the entire evidence is left with the definite and firm conviction that a mistake has been
committed.” Heights Cmty. Cong. v. Hilltop Realty, Inc., 774 F.2d 135, 140 (6th Cir. 1985).
The denial of a motion for relief from the automatic stay is reviewed for an abuse of
discretion because it is an equitable determination. AmeriCredit Fin. Servs., Inc. v. Nichols (In re
Nichols), 440 F.3d 850, 856 (6th Cir. 2006). A decision on the application of equitable tolling is
reviewed de novo when the facts that underlie the equitable tolling are undisputed and is reviewed
under the abuse of discretion standard when the facts are in dispute. Chavez v. Carranza, 559 F.3d
486, 493 (6th Cir. 2009) (citing Cook v. Comm’r of Soc. Sec., 480 F.3d 432, 435 (6th Cir. 2007)).

III.

DISCUSSION
A.

Did the bankruptcy court improperly extend the automatic stay beyond the time
allowed in 11 U.S.C. § 362(e)?

GKH’s first argument on appeal is that the bankruptcy court improperly extended the
automatic stay in contravention of 11 U.S.C. § 362(e). GKH claims the bankruptcy court failed to
hold a preliminary hearing as required by 11 U.S.C. § 362(e)(1) and lacked sufficient grounds to
extend the stay beyond the sixty-day time limit provided by 11 U.S.C. § 362(e)(2). The Trustee,
however, disputes GKH’s argument because he claims GKH is relying upon the wrong Code
provision when discussing the preliminary hearing requirement. The Trustee also contends the
bankruptcy court had good cause for extending the stay.
Title 11, Section 362 of the United States Code outlines the procedures a bankruptcy court
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should follow when deciding whether to grant or deny relief from the automatic stay. Section 362(e)
reads as follows:
(e)(1) Thirty days after a request . . . for relief from the stay . . ., such stay is
terminated with respect to the party in interest making such request, unless the court,
after notice and a hearing, orders such stay continued in effect pending the
conclusion of, or as a result of, a final hearing and determination under subsection
(d) of this section. A hearing under this subsection may be a preliminary hearing, or
may be consolidated with the final hearing under subsection (d) of this section. The
court shall order such stay continued . . . pending the conclusion of the final hearing
. . . if there is a reasonable likelihood that the party opposing relief from such stay
will prevail . . . .
(2) Notwithstanding paragraph (1), in a case under chapter 7, 11, or 13 in which
the debtor is an individual, the stay under subsection (a) shall terminate on the date
that is 60 days after a request is made by a party in interest under subsection (d),
unless—
(A) a final decision is rendered by the court during the 60-day period
beginning on the date of the request; or
(B) such 60-day period is extended—
(I) by agreement of all parties in interest; or
(ii) by the court for such specific period of time as the court finds is
required for good cause, as described in findings made by the court.
11 U.S.C. § 362(e).
As a preliminary matter, 11 U.S.C. § 362(e)(2) is the proper provision to apply based on the
facts of the case. Mr. McKenzie is an individual and his case was filed as a consolidated Chapter 7
and Chapter 11 bankruptcy action. Because 11 U.S.C. § 362(e)(2) was the correct provision for the
court to apply, GKH’s arguments that the bankruptcy court failed to hold a preliminary hearing and
make findings regarding the need to consolidate the preliminary and final hearings are without merit.
Section 362(e)(2) imposes no such requirement on the court.
GKH’s second argument is that, even under 11 U.S.C. § 362(e)(2), the bankruptcy court
lacked good cause or compelling circumstances to extend the hearing date beyond the sixty-day time

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period allowed by statute. On April 29, 2011, the court issued an order stating it would need to
continue the hearing beyond the 60-day time limit until May 18, 2011, due to “compelling
circumstances.” The bankruptcy court provided a detailed explanation for why there was good cause
to delay the proceeding. Among other reasons, the Trustee needed to resolve issues pertaining to the
employment of counsel before the bankruptcy court proceeded to the merits of GKH’s motion and
held a hearing. Although GKH contends these issues should have been addressed in a more timely
manner, the Trustee avers GKH played a role in the timing. According to the Trustee, these issues
arose because he was forced to seek new counsel approximately two weeks before GKH’s motion
for relief was filed. The Trustee claims he had to do so because GKH sued his former counsel for
malicious prosecution and abuse of process. As an aside, the Trustee notes that the actual delay in
the proceedings only lasted approximately twelve days.
Based on the evidence in the record, the bankruptcy court had good cause to delay its final
decision and extend the automatic stay. This decision was within the bankruptcy court’s discretion,
and the bankruptcy court properly made its decision in accordance with the requirements of §
362(e). The bankruptcy court also adequately explained its reasoning and showed there were
compelling reasons the proceedings should be delayed. Thus, the bankruptcy court did not err when
it extended the automatic stay.
B.

Did the bankruptcy court err in concluding GKH had not satisfied its burden
of proof under 11 U.S.C. § 362(d)(2)?

GKH’s second argument is that the bankruptcy court erred when it concluded GKH did not
satisfy its burden of proof under 11 U.S.C. § 362(d)(2). A court can grant relief from the automatic
stay under either § 362(d)(1) or (d)(2) if requested by a party in interest and after notice and a
hearing. Section 362(d)(1) allows the court to grant relief “for cause, including the lack of adequate
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protection of an interest in property of such party in interest.” Section 362(d)(2), in contrast,
provides that a court can grant relief from the stay with respect to property if “(A) the debtor does
not have an equity in such property; and (B) such property is not necessary to an effective
reorganization.” The party requesting relief under either provision has the burden of proof on “the
issue of the debtor’s equity in property”; the party opposing the requested relief carries the burden
of proof on all other issues. 11 U.S.C. § 362(g). Equity is defined as “the value, above all secured
claims against the property, that can be realized from the sale of the property for the benefit of the
unsecured creditors.” Stephens Indus., Inc. v. McClung, 789 F.2d 386, 392 (6th Cir.1986) (quoting
Pistole v. Mellor (In re Mellor), 734 F.2d 1396, 1400 (9th Cir.1984)).
GKH contends it met its burden of proof as the party requesting relief and the bankruptcy
court erred when it made GKH establish that the debtor, Mr. McKenzie, had the ability to transfer
his membership interests to GKH. The parties entered into a stipulation with the bankruptcy court
that stated the following: “to the extent the court determines GKH has a valid security interest in any
property of the debtor, the parties stipulate that the debtor does not have any equity in such
property.” GKH claims the very language of this stipulation demonstrates that Mr. McKenzie lacked
equity in the property at issue. Therefore, GKH argues its burden was immediately satisfied and the
Trustee carried the burden of proof on all other issues. Absent any proof regarding the need for
reorganization, GKH contends the stay should have been lifted.
GKH, however, has mischaracterized the nature of the parties’ stipulation. The stipulation
regarding equity only applied “to the extent the court determines GKH has a valid security interest
in any property of the debtor.” Thus, the real issue is who carried the burden of proof in showing
there was a valid security interest in Mr. McKenzie’s property. No courts in this circuit have

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explicitly discussed who carries this burden of proof in the context of 11 U.S.C. §362(d)(2). The
issue, however, has been addressed by bankruptcy courts in other jurisdictions. For example, in In
re Dahlquist, 34 B.R. 476 (Bankr. D. S.D. 1983), the bankruptcy court had to determine whether the
creditor bank was entitled to relief from the automatic stay. In discussing the relevant law, the court
explained that, under either § 362(d)(1) or § 362(d)(2), “a creditor must establish the validity and
perfection of its security interest and the amount of the debt and other allowable costs secured by
its secured claim and must carry the ultimate burden of proof with respect to equity.” Id. at 481.
Many other courts have interpreted the law in a similar manner. See In re Swift, No. 07B 12787,
2009 WL 535986, at *3 (Bankr. N.D. Ill. Feb. 19, 2009) (noting the creditor has the burden of
establishing “the existence, the validity, and the perfection of its secured claim against the real
property”); see also In re Borchers, 45 B.R. 69, 71 (N.D. Iowa 1984); United Companies Fin. Corp.
v. Brantley, 6 B.R. 178, 184 (Bankr. N.D. Fla. 1980). GKH cites one case that stands for a contrary
proposition. In In re Johnson, 422 B.R. 183 (Bankr. E.D. Ark. 2010), the bankruptcy court placed
the initial burden of proof on the Trustee to show that the creditor did not have a perfected security
interest. In re Johnson stands as an anomaly, however, against the larger backdrop of cases that have
placed this burden on the creditor, especially given that the court in In re Johnson failed to cite to
any case law on this issue and offered no explanation for why it was applying this standard.
Also noteworthy is the fact that bankruptcy courts in this circuit have discussed the moving
party’s burden of proof with respect to motions for relief brought pursuant to § 362(d)(1). Although
§ 362(d)(1) only applies to requests for relief from the stay “for cause,” the case law in this area is
instructive for courts attempting to determine who carries the burden under § 362(d)(2). Under §
362(d)(1), the party seeking relief from the stay carries the burden of at least establishing a prima

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facie case that it holds a valid security interest. See In re Cambridge Woodbridge Apartments, LLC,
292 B.R. 832 (Bankr. N.D. Ohio 2003). In In re Cambridge Woodbridge Apartments, LLC, the
moving party could establish its prima facie case by showing “(1) a demonstration of a debt owing
from the debtor to [the creditor]; (2) a valid security interest possessed by [the creditor] that secures
the debt; and (3) a decline in the value of the collateral securing the debt combined with [the]
debtor’s failure to provide adequate protection of [the creditor’s] interest.” Id. at 841 (quoting In re
Howery, 275 B.R. 852, 854 (Bankr. S.D. Ohio 2002)). The burden then shifts to the debtor to prove
the creditor is adequately protected. Id. The allocation of the burdens of proof set out in § 362(g)
applies to both § 362(d)(1) and (d)(2). Therefore, the discussion in In re Cambridge Woodbridge
Apartments, LLC, regarding the moving party’s burden under § 362(d)(1) shows that, implicit within
the determination of the debtor’s equity in the property, is the need to also determine whether the
creditor possessed a valid security interest. The case also shows that the party with the burden of
proof in establishing the debtor’s equity in the property is also the party responsible for establishing
that the creditor possessed a valid security interest.
Hence, the law in this circuit pertaining to § 362(d)(1) supports an interpretation of §
362(d)(2) requiring, at a minimum, the creditor must establish a prima facie case showing a valid
security interest possessed by the creditor. Moreover, case law in other jurisdictions supports the
even broader interpretation that the creditor bears the ultimate burden of proof on the issue of
whether the debtor has equity in the property, and the issue of whether the creditor has a valid
security interest is a necessary part of that analysis. Given that GKH failed to submit operating
agreements for the entities as requested by the bankruptcy court, with the exception of Cleveland
Auto Mall, LLC, and offered no other proof on the matter other than the stipulation, the Court

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concludes the bankruptcy court did not err when it determined GKH failed to satisfy its burden of
proof.
C.

Did the bankruptcy court err in concluding there was not a valid transfer of Mr.
McKenzie’s membership interest in Cleveland Auto Mall, LLC (“CAM”)?

Next, GKH contends the bankruptcy court improperly denied GKH’s motion for relief with
respect to the membership interest in Cleveland Auto Mall, LLC (“CAM”). In the May 27, 2011
Order, the bankruptcy court concluded GKH’s security interest did not attach in CAM because GKH
did not carry its burden of showing (1) the debtor had rights in the pledged interest that would enable
him to convey the entire interest without the consent of Mr. Nelson E. Bowers II, the other member
of the limited liability company or (2) consent had actually been obtained. GKH, however, claims
it established the existence of a valid transfer because it offered proof that Mr. Bowers had
consented to the transfer in accordance with Tennessee law and the CAM operating agreement.
The Operating Agreement reads as follows:
(a) General Prohibition. Each member agrees that he or she will not sell,
transfer, assign, give away, bequeath, grant a security interest in, encumber, pledge,
or in any way alienate all or any portion of his, her or its Membership Interest,
whether now or hereafter acquired, or any right or interest therein, whether
voluntarily, by operation law, by gift, or otherwise, without the prior written consent
of the Board, except for a transfer that meets the requirements of this agreement.
...
(b) Effect of Prohibited Transfer. Any transfer or acquisition of all or any
portion of a Membership Interest in violation of Subsection (a) of this section shall
be null and void and shall not operate to transfer any interest or title to the
Membership Interest to the purported transferee. This restriction shall be effective
against persons without actual knowledge of this restriction. The restrictions set forth
in this article are deemed to be reasonable restrictions against the acquisition of a
Membership Interest by persons whose interests may be inimical to that of the
Company or other Members. Any transfer of a Membership Interest occurring as a
result of the operation of law including without limitation, Section 48-218-101 of the
Act shall not dissolve the Company, nor entitle or empower the transferee to become
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a Member, to exercise any governance rights, or to receive any notices from the
Company, except as expressly required by the Act and this agreement.
(Operating Agreement, Section 8.1(a),(b)).
Based on the evidence in the record, the Court agrees with the bankruptcy court’s analysis
and conclusions. First, GKH did not satisfy its burden in showing Mr. McKenzie had rights in the
pledged interest that would enable him to convey the entire interest without Mr. Bowers’ consent.
As noted above, the language in the CAM Operating Agreement makes clear that an interest in CAM
cannot be transferred without the prior written consent of the other members.
Moreover, the “Act” referenced in the agreement is understood to be the Tennessee Limited
Liability Company Act, Tenn. Code Ann. §§ 48-201-101 et seq. (See Operating Agreement, Section
1.1). The Tennessee Limited Liability Company Act allows parties to impose restrictions on the
transfer of a member’s interests. In particular, § 48-218-102 requires consent from all members
when assigning governance rights, unless the rights are being transferred to another member or the
parties have stated differently in the operating agreement or articles. Section 48-218-101 allows
parties to include restrictions on the assignment of financial rights in the operating agreement.
Unless the restriction is “manifestly unreasonable,” it can be enforced against the owner of the
financial rights that are restricted.3 Id. Therefore, under Tennessee corporate law, the restrictions
imposed in the operating agreement are enforceable.
Second, there is insufficient evidence to establish prior consent was obtained to transfer Mr.
McKenzie’s rights in CAM. CAM only had two members: Mr McKenzie and Mr. Bowers. Mr.
Bowers had an opportunity to testify at the hearing on GKH’s motion for relief on May 24, 2011,

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GKH does not argue the restriction is “manifestly unreasonable.” In fact, section 8.1(b) of
the operating agreement even states the restrictions are “deemed to be reasonable.”
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and he claimed there was consent to the transfer that became effective “as of October 13 and
October 24, 2008.” He could not, however, recall when the consent was actually executed. As a
result, the bankruptcy court could not find Bowers’ undated written consent had been agreed to prior
to the transfer of the security interest to CAM or even prior to the filing of this bankruptcy action.
In support of its decision, the bankruptcy court cited two cases that--while not having
identical facts to this one--are still relevant. The Court agrees with the bankruptcy court’s analysis.
In In re Weiss, 376 B.R. 867 (Bankr. N.D. Ill. 2007), creditors sought relief from the automatic stay
so they could foreclose on the Chapter 11 debtor’s interests in certain partnerships and limited
liability companies. The creditors argued the debtor had assigned his interests as collateral in the
pledge agreement. However, the operating and partnership agreements governing the companies
restricted the transfer of interests without the express written consent of the other members, partners,
and interest holders. At issue was whether the creditors held perfected security interests in the
debtor’s interests based on the pledge agreement. The bankruptcy court ultimately decided the
debtor’s assignment of his interest under the pledge agreement was invalid. Although the court’s
analysis in In re Weiss was based on Illinois law, it is still relevant to the circumstances of this case
because, like Illinois law, Tennessee law allows parties to restrict the transfer of membership
interests for certain types of companies. See also Condo v. Connors, 2010 WL 2105926 (Colo. Ct.
App. 2010), cert. granted, 2011 WL 882684 (Colo. Sup. Ct. Mar. 14, 2011) (determining the
assignment of interest in the case violated the limited liability company operating agreement, which
restricted the assignment of membership interests). Notably, although GKH argues the above cases
are distinguishable, GKH fails to offer any case law in support of its own position.
Finally, GKH raises several alternative arguments for why the bankruptcy court erred. For

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example, GKH contends that, even if Bowers did not give prior consent (an argument it does not
concede), Bowers’ subsequent waiver was sufficient. GKH also contends Mr. Bowers did not
consider it a breach of the operating agreement that Mr. McKenzie assigned his membership interest
in entities where McKenzie and Bowers were the only members. Although Mr. Bowers may have
later expressed these views, the Court is still bound by the terms of the operating agreement and the
relevant statutes in determining whether Mr. McKenzie’s security interest can be assigned. GKH
also attempts to shift the burden to the Trustee pursuant to 11 U.S.C. § 362(g) to show that the
untimely consent of Mr. Bowers was invalid and the Trustee failed to introduce evidence on this
issue. However, as noted in the previous section, GKH had the burden of proof of establishing it had
a valid security interest in CAM. Implicit in this burden is the need to also show Mr. McKenzie had
the necessary consent to transfer his membership interests to GKH.
Accordingly, because GKH did not demonstrate there was a valid transfer of Mr.
McKenzie’s membership interest in CAM under the relevant corporate law, the bankruptcy court
did not err in reaching its decision.4
D.

Did the bankruptcy court err in deciding the Trustee could defensively use his
status and powers of avoidance even though the statute of limitations had run?

GKH’s fourth argument is that the bankruptcy court improperly allowed the Trustee to use
his status and powers of avoidance defensively even though the statute of limitations had expired.
Pursuant to 11 U.S.C. § 544(a) and (b), a trustee receives the status of a hypothetical lien creditor

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The bankruptcy court acknowledges GKH’s interest has attached to the CAM member
interest under § 47-9-408 despite GKH not showing that its assignment could overcome the
applicable corporate restrictions. However, for the reasons discussed in the sections that follow, the
Court still cannot grant the relief requested by GKH because, even if those interests were perfected,
the trustee properly used his avoidance powers to defeat GKH’s motion.
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at the commencement of an action and can thereafter exercise his avoidance powers. However, the
Bankruptcy Code imposes a timeframe within which the trustee may file an adversary action under
§ 544. As stated in 11 U.S.C. § 546(a):
An action proceeding under section 544, 545, 547, 548, or 553 of this title
may not be commenced after the earlier of–
(1) the later of–
(A) 2 years after the entry of the order for relief; or
(B) 1 year after the appointment or election of the first trustee under
section 702, 1104, 1163, 1202, or 1302 of this title if such appointment or such
election occurs before the expiration of the period specified in subparagraph (A); or
(2) the time the case is closed or dismissed.
11 U.S.C. § 546(a). In light of § 546(a)(1), the Trustee had two years after the entry of the January
21, 2009 order for relief to assert a claim to invalidate, subordinate, or avoid GKH’s security
interest.
It is undisputed that the Trustee failed to assert a claim to invalidate, subordinate, or avoid GKH’s
security interest before the statute of limitations expired on January 21, 2011.
The Trustee, however, claims he was not bound by the statute of limitations provided in §
546(a)(1). Although the Trustee offers several reasons, on appeal, the Court will focus on the
primary issue in contention--that is, whether the Trustee could use his right or power to “avoid”
defensively under 11 U.S.C. § 544(a) without regard to the two year statute of limitations in order
to oppose a motion for relief from the automatic stay. The bankruptcy court properly observed there
is a split of authority on the issue. The majority view, which was adopted by the bankruptcy court
and is referenced by the Trustee on appeal, is best represented by In the Matter of Mid Atlantic
Fund, Inc., 60 B.R. 604 (Bankr. S.D.N.Y. 1986).
In Mid Atlantic Fund, the creditors were assigned a purchase money note and mortgage as
collateral security for the payment of a prior judgment against the debtor. A Chapter 7 petition was
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filed against the debtor soon thereafter. The trustee informed the creditors their security interest was
unperfected and stated he would, using his avoidance power, commence an adversary proceeding
against them if they sought to enforce the security interest. The trustee did not commence an
adversary proceeding within the applicable statute of limitations or the time extension agreed to by
the parties per stipulation. After this period ended, the creditors demanded that the trustee make an
accounting and turn over the monies he had received as payment for the note and mortgage. When
he did not respond, the creditors filed a reclamation motion before the bankruptcy court, which the
trustee opposed.
Although the bankruptcy court ultimately denied the creditors’ reclamation motion, the court
gave great consideration to the creditors’ arguments, especially their contention that the trustee was
barred from using his avoidance powers because the statute of limitations had expired. The court,
however, observed the trustee had not brought an avoidance action but rather was acting defensively
pursuant to § 502(d). The court explained “[t]he purpose of Code § 502(d) is to preclude entities
which have received voidable transfers from sharing in the distribution of the assets of the estate
unless and until the voidable transfer has been returned to the estate.” Id. at 609. The court further
noted that § 502(d) states the court “shall disallow” the claim at issue and imposes no time limit on
when the trustee must object. Id. at 610. Among other things, the court notes that courts have
commonly allowed the defensive use of barred claims outside the bankruptcy context. Id. The court
also clarified that the trustee could not use his powers to seek additional recovery; instead he was
limited to only “offsetting the claim asserted by the creditor.” Id. at 611. The court finally noted that
“[w]hen Code § 502(d) is used to disallow the claim of a secured creditor, the lien of the creditor
becomes void.” Id.

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Since Mid Atlantic Fund, a number of courts have applied these principles in the context of
various types of bankruptcy proceedings. In re American Pie, 361 B.R. 318 (Bankr. D. Mass. 2007)
(citing In re McLean Indus., Inc., 196 B.R. 670, 676 (S.D.N.Y. 2007)). See In re KF Dairies, Inc.,
143 B.R. 734, 736 (9th Cir. BAP 1992); In re Stoecker, 143 B.R. 118, 131 (Bankr. N.D. Ill. 1992),
aff’d, 143 B.R. 879 (N.D. Ill. 1992); In re Chase & Sanborn Corp., 124 B.R. 368, 370 (Bankr. S.D.
Fla. 1991); In re Minichello, 120 B.R. 17, 19 (Bankr. M.D. Pa. 1990)); see also In re America West
Airlines, Inc., 217 F.3d 1161 (9th Cir. 2000); In re Cushman Bakery, 526 F.2d 23 (1st Cir. 1975),
cert denied, 425 U.S. 937 (1976).
The minority view, which is supported by GKH, essentially states that a trustee cannot
defensively use his avoidance powers once the statute of limitations has expired. A commonly cited
case expressing this view is In the Marketing Assocs. of America, Inc., 122 B.R. 367 (Bankr. E.D.
Mo. 1991). In Marketing Associates, the trustee in a Chapter 11 bankruptcy objected to a creditor’s
proof of claim. The trustee alleged the creditor may have received certain preferential transfers.
However, at no point, did he file an adversary proceeding to avoid the alleged preferential transfers.
After the statute of limitations had expired for the trustee bringing an adversary proceeding pursuant
to § 546(a)(1), the trustee sought to use § 502(d) to avoid the transfers. The court rejected the
conclusions of the court in Mid Atlantic, noting that “it is implicit [in § 502(d)] that no preference
is avoidable if the action is not brought within the time limits prescribed by § 526(a)(1). Id. at 369.
The court also observed that allowing a trustee to proceed under § 502(d) after the statute of
limitations had passed was a “procedural windfall.” Id. Although the court agreed with the purpose
of § 502(d) as explained by the court in Mid Atlantic, it nonetheless reached a different conclusion.
The court determined the trustees in both Mid Atlantic and the case before it “failed to bring a timely

16

Section 547 preference complaint, and are forever barred from so doing.” Id. at 370.
There are courts that have followed an approach similar to that espoused in Marketing
Associates to ultimately decide a trustee cannot use his powers under § 502(d) defensively after the
relevant time period has passed. See, e.g., In re West, 474 B.R. 191, 202-03 (Bankr. N.D. Miss.
2012); In re IFS Fin. Corp., No. 02-39553, 2008 WL 4533713 (Bankr. S.D. Texas Oct. 2, 2008). But
see In re KF Dairies, Inc., 143 B.R. 734, 736-37 (B.A.P. 9th Cir. 1992) (stating Marketing
Associates’ “criticism of Mid Atlantic was misplaced” and that “[a]pplication of the time-bar to
objections based on section 502(d) would undercut the statutory language, the purpose of the
bankruptcy code, and the general rule that statutory time-bars are inapplicable to matters of defense,
where no affirmative relief is sought”). After considering the relevant law, the Court concludes there
is no reason to depart from the view applied in the majority of jurisdictions and by the bankruptcy
court in this action. In using his avoidance powers pursuant to § 502(d), the Trustee sought to fulfill
the purposes of this section of the Bankruptcy Code and achieve the most equal distribution possible
under the circumstances. Although the instant case differs in some respects from Mid Atlantic Fund
in that, among other things, the Trustee here did not file an objection to the creditor’s motion for
relief, those differences are minimal. Of particular significance is the fact that the Trustee was not
attempting to seek additional recovery. Instead, he merely sought to use his status and avoidance
powers defensively to prevent GKH from obtaining relief with respect to security interests believed
to be preferential transfers. As noted in Mid Atlantic Fund and its progeny, a trustee, when acting
defensively pursuant to § 502(d), can use his avoidance powers even after the statute of limitations
has expired. Accordingly, the Court concludes the bankruptcy court did not err when it decided
likewise.

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E.

Did the bankruptcy court err when it equitably tolled the statute of limitations?

As its final argument, GKH contends the bankruptcy court erred in concluding that the
statute of limitations in § 546(a) should be equitably tolled. The Trustee had originally argued the
statute of limitations should be equitably tolled as an alternative to his argument that he should be
able to use his status and avoidance powers defensively to defeat GKH’s claim.
“Strictly defined, equitable tolling is [t]he doctrine that the statute of limitations will not bar
a claim if the plaintiff, despite diligent efforts, did not discover the injury until after the limitations
period had expired.” Newton v. Wells Fargo Fin., Inc. (In re Dill), No. 07-3125, 2008 WL 2357237,
at *3 (Bankr. E.D. Tenn. 2008) (quoting Tapia-Martinez v. Gonzales, 482 F.3d 417, 422 (6th Cir.
2007)). When determining whether to apply the equitable tolling doctrine, courts often consider the
following factors: “(1) lack of actual notice of filing requirement; (2) lack of constructive knowledge
of filing requirement; (3) diligence in pursuing one’s rights; (4) absence of prejudice to the
defendant; and (5) a plaintiff’s reasonableness in remaining ignorant of the notice requirement.” Id.
(citing Nardei v. Maughan (In re Maughan), 340 F.3d 337, 344 (6th Cir. 2003)). However, even
after taking these factors into account, the decision to equitably toll the statute of limitations should
be made on a case-by-case basis. Id. (citing Graham-Humphreys v. Memphis Brooks Museum of Art,
Inc., 209 F.3d 552, 561 (6th Cir. 2000)); see Cook v. Stegall, 295 F.3d 517, 521 (6th Cir. 2002)
(citation omitted).
Courts can consider any number of other factors when deciding whether the statute of
limitations should be equitably tolled. See, e.g., Vana v. Mallinckrodt Med., Inc., 70 F.3d 116 (6th
Cir. 1995) (noting the Sixth Circuit had found the equitable tolling doctrine applicable where an
employer’s affirmative representations had caused the plaintiff to delay filing a claim and that the

18

rationale behind the doctrine was to ensure “that a defendant [not be] permitted to escape liability
by engaging in misconduct that prevents the plaintiff from filing his or her claim on time”).
However, as a general rule, the equitable tolling doctrine should be applied sparingly. Cook, 295
F.3d at 521.
The bankruptcy court acknowledged in the December 9, 2011 Order that it probably would
not have tolled the statute of limitations if the decision had been based solely upon the five-factor
test discussed in In re Dill. Among other things, the bankruptcy court noted that the Trustee is
extremely experienced in these matters and that he could not legitimately feign ignorance of the
notice and filing requirements. The Trustee also could have exercised greater diligence. For
example, the court notes counsel for the Trustee, Mr. Leroy, mistakenly believed GKH’s only
collateral was real estate. This was true despite schedules indicating Mr. McKenzie owned a number
of interests and ran a variety of businesses. The court also noted the Trustee failed to act upon the
“London email.” The London email was sent from the debtor’s executive assistant at SAM
Management Company, LLC to Jack London, a member of the Trustee’s accounting firm. The email
included several attachments relevant to the matters at hand, and the bankruptcy court acknowledges
Mr. Leroy failed to give them sufficient consideration or act upon them.5 Therefore, contrary to
GKH’s arguments at the hearing before this Court, the bankruptcy court did consider the Trustee’s
actions in deciding whether equitable tolling was appropriate. However, after reflecting upon these
matters, the bankruptcy court ultimately concluded equitable tolling was appropriate because it
found GKH had made affirmative misrepresentations in the record.

5

At the hearing before this Court, GKH offered other examples where the Trustee allegedly
failed to exercise due diligence.
19

Although the parties vigorously dispute the facts at issue, the bankruptcy court did not abuse
its discretion in deciding to equitably toll the statute of limitations. The bankruptcy court carefully
detailed in the December 9, 2011 Order several reasons that equitable tolling was appropriate in
spite of the Trustee’s lack of diligence. In particular, based on the court’s findings of fact, the
bankruptcy court received testimony from Kyle Weems, the attorney who filed the Chapter 11 action
on behalf of Mr. McKenzie, that the transfer of the pledged interests from Mr. McKenzie to GKH
were not disclosed on the schedules. Moreover, GKH did not disclose its security interest in the
pledged interests when it filed its proof of claim on April 27, 2009. According to the bankruptcy
court, this information was not disclosed in the record until GKH filed an amended claim on
February 9, 2011, which was approximately two weeks after the statute of limitations expired for
the Trustee to filed an avoidance action. The court also notes that GKH did not file the amended
claim until after the debtor filed an objection to the original claim.
The bankruptcy court offers several other examples in its opinion regarding how GKH’s
actions were misleading. For example, with respect to the sale of TIPCO, a corporation in which
both Mr. McKenzie and Mr. Bowers had an interest, Mr. John Anderson, member and director of
GKH, was involved in preparing the sale motion on behalf of Mr. Bowers. The sale motion,
however, was signed alleging there were no other liens on the interests. In subsequent proceedings,
the bankruptcy court notes that various parties associated with GKH testified in a manner that left
the court with the impression GKH had no interest in the transaction.6 The court questioned

6

One illustration that stood out in the bankruptcy court’s opinion was its discussion of the
hearing on May 25, 2011, pertaining to the sale motion of TIPCO. The court notes that John
Konvalinka made a limited appearance on behalf of Mr. Bowers. The Court notes:
“When asked about whether his firm owned any interest in the two entities, Mr.
Konvalinka responded that he was not aware that it did. Exhibit 11, John Konvalinka
20

members of GKH at a hearing in October 2011, directly asking why GKH had not earlier asserted
its liens. The general consensus among those testifying was that GKH was not required to make a
disclosure of the security interest in those proceedings. While the bankruptcy court acknowledged
that several of the proceedings or matters did not require GKH to make an affirmative disclosure,
taken as a whole, GKH had “opportunities to correct the affirmative misrepresentations that had
been made” but did not.
Although some facts are disputed, the Court cannot say it is “left with the definite and firm
conviction that a mistake has been committed.” Heights Cmty. Cong. v. Hilltop Realty, Inc., 774
F.2d 135, 140 (6th Cir. 1985). The bankruptcy court has had a unique vantage point throughout the
debtor’s bankruptcy proceedings to engage with the parties, hear testimony, and observe the parties’
conduct in a manner that this Court is not privy to except through written transcripts. As a result,
the bankruptcy court’s assessment of the parties’ conduct is properly given deference, especially
when the court avers a party--here, GKH--made affirmative misrepresentations or engaged in
misleading behavior. Based on the bankruptcy court’s findings of fact, the Court concludes the
bankruptcy court acted in accordance with the law when it decided to equitably toll the statute of
limitations. Moreover, the bankruptcy court identified circumstances warranting tolling in this case
even though the Trustee was not without fault.
Accordingly, the bankruptcy court did not abuse its discretion when it equitably tolled the

Testimony, May 25, 2011, Hearing at 7. A determination of whether this response
was misleading or merely careful depends on whether the listener focuses on the
words any interest or the word own. However the response is interpreted, the
testimony did not leave the court with the impression that GKH itself had any
interest in the transaction before the court.”
(Court File No. 1-35 at 52).
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statute of limitations.

IV.

CONCLUSION
For the foregoing reasons, the Court AFFIRMS the bankruptcy court’s orders dated May

27, 2011 and December 9, 2011, which are the subject of the appeals in Case Nos. 1:11-cv-192,
1:11-cv-274, and 1:12-cv-025.

/s/
CURTIS L. COLLIER
CHIEF UNITED STATES DISTRICT JUDGE

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