Dodson v. Huff

• Court: Court of Appeals for the Fifth Circuit
• Decided: March 27, 2000
• Docket: 99-50206
• Status: Published

Opinion

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

No. 99-50205 consolidated with No. 99-50206

IN RE LEWIS SMYTH, III, Debtor, _________________________________________________

W. PATRICK DODSON,

Appellant,

VERSUS

KEN HUFF, Trustee,

Appellee.

Appeal from the United States District Court For the Western District of Texas March 27, 2000

Before HIGGINBOTHAM and PARKER, Circuit Judges and JACK, District Judge*.

ROBERT M. PARKER, Circuit Judge.

W. Patrick Dodson appeals the order of the district court

affirming the bankruptcy court’s Final Decree. In a consolidated

action, Dodson appeals the district court’s order dismissing for

lack of jurisdiction his challenge to the bankruptcy court’s order

approving the Trustee’s application to retain counsel for appeal.

* District Judge of the Southern District of Texas, sitting by designation.

1 We affirm the district court in both matters.

I. FACTS AND PROCEDURAL HISTORY

In August of 1991, Dodson and other creditors filed an

involuntary Chapter 7 bankruptcy, later converted to a Chapter 11

reorganization, against Lewis Smyth, III, a real estate developer

and investor. In November 1992, the bankruptcy court approved a

reorganization plan and appointed Ken Huff trustee. With

permission of the bankruptcy court, Huff, a certified public

accountant, employed himself as accountant for the estate. This

suit involves the question of what, if any, personal liability Huff

incurred in his capacity as Trustee for damages to the estate

caused by various alleged errors in the estate’s tax returns.

On February 18, 1997, the Trustee filed an application for

final decree seeking to close the case and a motion for final

payment of his commission. Dodson objected to both motions,

identifying various alleged errors in the Trustee’s handling of the

estate’s federal income taxes. Dodson urged the bankruptcy court

to deny the Trustee’s request for a final decree until Huff filed

amended tax returns to reclaim the estate’s disputed taxes.

In June 1997, at the hearing on his objections, Dodson

expanded his claims to allege additional errors in the Trustee’s

handling of the estate’s taxes and to assert that the Trustee

should be required to personally reimburse the estate for damages

occasioned by his errors in preparing the tax returns. At the

conclusion of the hearing, the bankruptcy court found that, while

Huff had made errors in handling the taxes, those errors should be

2 balanced against concessions Huff had obtained from the IRS on

other issues, with the result that the “the estate [was] probably

as well off as it would have been had someone else handled it in a

very meticulous fashion.” Nevertheless, because of the Trustee’s

admitted oversight in failing to file the estate’s 1994 tax return

on time, the court denied his final application for commission.

The bankruptcy court then entered a final decree and Dobson

appealed to the district court.

In July 1997, the Trustee filed a motion seeking to retain the

law firm of Jeffers & Banack, Inc. to represent him on appeal,

which the bankruptcy court granted. In August 1997, Dodson

objected to the appointment and requested a hearing. Dodson argued

that the employment of counsel was inappropriate because it

provided no benefit to the estate and because the law firm selected

had a disqualifying conflict of interest. The bankruptcy court

overruled the objections and reaffirmed its approval of the

Trustee’s counsel for appeal.

The district court, noting a split in circuit law and the

absence of controlling Fifth Circuit precedent concerning the

standard of care necessary to establish a trustee’s personal

liability for damages to a bankruptcy estate, first determined that

a trustee may not be held personally liable to a bankruptcy estate

for damages resulting from simple negligence. Alternatively, the

district court held that, even assuming that a trustee can be held

personally liable based on simple negligence, there is insufficient

evidence in this record to support a finding that the Trustee was

3 negligent, with the exception of the penalty incurred for the

Trustee’s late filing of the estate’s 1994 tax return. The

district court noted that the Trustee had admitted this error and

agreed to forego his application for final payment of commission in

his capacity as Trustee, and any final fees due for his services as

accountant. Those amounts would have totaled approximately $4,400,

slightly less than the amount of the penalty for the late filing.

Thus, the district court found that Dodson substantially prevailed

on this issue in bankruptcy court. To the extent the bankruptcy

court did not hold the Trustee personally liable for the

difference, the district court held that it did not abuse its

discretion.

Next, the district court rejected Dodson’s argument that the

case should be reopened and the Trustee required to file amended

tax returns on behalf of the estate. Taking into consideration the

fact that continued litigation of the tax issues would add

administrative costs to the estate and would entail some risk of

greater net tax liability, the district court affirmed the

bankruptcy court’s final decree that closed the case. This ruling

is not challenged on appeal.

Finally, the district court found that the bankruptcy court’s

order approving the Trustee’s application to retain appellant

counsel was interlocutory, and consequently dismissed the appeal of

that order for lack of jurisdiction.

II. ANALYSIS

A. Standard of review

4 A bankruptcy court’s findings of fact are subject to the

clearly erroneous standard of review and conclusions of law are

reviewed de novo. See Matter of Sadkin, 36 F.3d 473, 475 (5th Cir.

1994). When the district court has affirmed the bankruptcy court’s

findings, this standard is strictly applied, and reversal is

appropriate only when there is a firm conviction that error has

been committed. See id.

B. Standard of Care Required of Bankruptcy Trustee

A bankruptcy trustee is charged with the duty to “collect and

reduce to money the property of the estate for which such trustee

serves, and close such estate as expeditiously as is compatible

with the best interests of parties in interest.” 11 U.S.C. §

704(1)(1994). That duty includes the filing of tax returns on

behalf of the estate. See 11 U.S.C. § 704(8)(1994). However, the

Bankruptcy Code is silent on the standard of care required of a

trustee performing those duties and on what is to be done if the

trustee breaches that standard of care. See In re Hutchinson

(Yadkin Valley Bank & Trust Co. v. McGee), 5 F.3d 750, 752 (4th

Cir. 1993). The Supreme Court has held that a trustee should be

“surcharged” – that is, held personally liable – for willfully and

deliberately breaching his fiduciary duty of loyalty. See Mosser

v. Darrow, 341 U.S. 267, 272-73 (1951). The Mosser Court did not

address a trustee’s personal liability with regard to negligent

actions. See id. at 272 (“We see no room for operation of the

principles of negligence in a case in which conduct has been

knowingly authorized. This is not a case of a trustee betrayed by

5 those he had grounds to believe were trustworthy, for these

employees did exactly what it was agreed by the trustee that they

should do.”).

Following Mosser, a circuit split developed on the question of

the proper standard of care to which a trustee should be held. A

number of Circuit Courts of Appeals have adopted the intentional

and deliberate standard, holding that a trustee in bankruptcy

should not be held personally liable unless he acts willfully and

deliberately in violation of his fiduciary duties. See, e.g., In

re Chicago Pacific Corp., 773 F.2d 909, 915 (7th Cir. 1985); Ford

Motor Credit Co. v. Weaver, 680 F.2d 451, 461-62 (6th Cir. 1982);

Sherr v. Winkler, 552 F.2d 1367, 1375 (10th Cir. 1977). On the

other hand, In re Cochise College Park, Inc., 703 F.2d 1339, 1357

(9th Cir. 1983), imposes liability upon a trustee for mere

negligence. Here, the district court concluded that the proper

standard is gross negligence, an intermediate position articulated

in the well-reasoned In re J.F.D. Enterprises, Inc., 223 B.R. 610

(Bankr. D. Mass. 1998), aff’d, 236 B.R. 112 (Bankr. D. Mass. 1999).

We agree.

In 1997, the Final Report of the National Bankruptcy Review

Committee described the state of the law on the trustee standard of

care question as a “crazy quilt” of decisions. See Nat’l Bankr.

Review Comm’n Final Report § 3.3.2 at 859 (1997). The Commission

observed that the difficulty arose from conflicting policy

considerations; too little protection might expose a trustee to

excessive personal liability and dissuade capable people from

6 becoming trustees, while too much protection would jeopardize the

goal of responsible estate management. See id. at 860-61. The

Commission ended by recommending the adoption of a gross negligence

standard for Chapter 7, 12 and 13 trustees, and tying a Chapter 11

trustee to the standard of care applicable to officers and

directors of a corporation in the state in which the Chapter 11

case is pending. See id.

In order to properly balance the opposing policy concerns

identified by the Commission, we must consider the nature of a

trustee’s duties. The requirement that a trustee maintain

disinterestedness often results in the selection of trustees who

have limited historical knowledge of the debtor’s business or prior

understanding of the industry in which the business is operated.

See J.F.D. Enterprises, Inc., 223 B.R. 610, 628 (Bankr. D. Mass.

1998). In addition, the trustee must make enormously complex

decisions within tight time constraints and without the assistance

of -- in fact, in the face of opposition or hostility from – both

secured and unsecured creditors. See id.

After considering the policy goals, the Commission’s

recommendations and the nature of the trustee’s duties, we conclude

that trustees should not be subjected to personal liability unless

they are found to have acted with gross negligence. See id. Gross

negligence has been defined as:

The intentional failure to perform a manifest duty in reckless disregard of the consequences . . . . It is an act or omission respecting legal duty of an aggravated character as distinguished from a mere failure to exercise ordinary care. It amounts to indifference to present legal duty and to utter forgetfulness of legal

7 obligations so far as other persons may be affected.

Black’s Law Dictionary at 1033 (6th ed. 1990). “This standard of

care strikes the proper balance between the difficulties of the

task assumed by trustees and the need to protect the interest of

creditors and other parties in the bankruptcy case.” See J.F.D.

Enterprises, 223 B.R. at 628.

C. Evidence of Huff’s Gross Negligence

The district court held that, with the exception of the fees

incurred for late filing of tax returns, there was insufficient

evidence in the record to support a finding that the Trustee was

even negligent, much less grossly negligent. This finding was not

clearly erroneous.

1. N.L. River Ranch Partnership

Dodson contends that Huff had a duty to abandon to the Debtor

the estate’s partnership interest in N.L. River Ranch in the Spring

of 1993 because the estate had a negative partnership capital

account balance in that asset. Dodson argues that the estate

incurred $15,000 in tax liability in 1994 because the Trustee

failed to abandon the asset. The district court noted that whether

a trustee can abandon property in order to shift tax liabilities is

subject to dispute. See 15 COLLIER ON BANKRUPTCY ¶ TX2.06[2](L. King

15th ed. rev. 1999). Moreover, the evidence on this question

consists solely of two statements contained in testimony by

Jennifer Rothe, a CPA who gave expert opinion testimony concerning

the estate’s income tax during the hearing on Dodson’s objections

to the Trustee’s application for Final Decree. Specifically, Rothe

8 said that she understood that a certain adjustment to the estate’s

capital gain figure was due to the negative capital in N.L. River

Ranch and resulted in approximately $15,000 in additional tax.

However, she went on to testify that “I don’t have a copy of that

K-1, so I can’t verify that.” No other testimony or documents –

not even the relevant tax returns – were introduced to support

Dodson’s allegations. We therefore conclude that the district

court’s finding that there was insufficient evidence to support

this allegation was not clearly erroneous.

2. Failure to Deduct Payments Made to Barbara Smyth

At the time this case commenced, Barbara Smyth was the wife of

Debtor, Lewis Smyth, III. Ms. Smyth agreed to relinquish any claim

to the assets of the bankruptcy estate in exchange for periodic

payments. A $12,000 payment to Ms. Smyth was allowed as a

deduction on the estate’s 1996 tax return. Dodson complains that

previous payments to Ms. Smyth were not taken as deductions and the

estate incurred $19,150 in taxes that could have been avoided if

the Trustee had properly categorized the payments. However, the

Trustee testified that he attempted to deduct the earlier payments,

but that the Internal Revenue Service disallowed the deductions.

Further, Rothe testified that she did not have enough information

to give an opinion about the deductibility of the payments to Ms.

Smyth. The district court’s conclusion that the Trustee was not

negligent in regard to these deductions was not error.

3. Penalty for Understatement and Underpayment of Taxes

9 Dodson alleges that the IRS assessed $1,208 in penalties

against the estate for underpayment of estimated tax and $11,097.97

in penalties and interest for understating the taxes due in 1995.

Both of these disputes apparently arose from the timing of the

sale of the estate’s interest in Bull Domingo, which was slated to

close in 1995, but did not close until 1996. The record contains

evidence that the estate received various interim payments, the

taxability of which could not be determined until the Trustee

received further documentation in 1996. The district court’s

finding that the penalties were not due to the Trustee’s

negligence, but to matters beyond his control, was not clearly

erroneous.

4. Penalties for Late Filing of Income Tax Returns

Dodson alleges that the estate incurred penalties of $4,906.57

for filing 1993 and 1994 federal income tax returns late. At the

hearing, the Trustee conceded that Dodson was correct and agreed to

forego over $4,400 in Trustee and accountant fees. We agree with

the district court’s finding that Dodson substantially prevailed on

this issue in bankruptcy court and, to the extent that the Trustee

was not held liable for the difference, the bankruptcy court did

not abuse its discretion. We also note that in actuality the

sanction imposed against the Trustee, if subjected to close

scrutiny, would in all likelihood be founded only in simple

negligence. However, since the Trustee agreed to the sanction, we

see no reason to disturb the status quo.

Based on the foregoing, we affirm the Final Decree.

10 D. Order approving employment of attorneys for appeal

Orders appointing counsel under the Bankruptcy Code are

interlocutory and are not generally considered final and

appealable. In re American Cabinets & Woodcrafting Corp. (American

Cabinets & Woodcrafting Corp v. Polito Enter., Inc.), 159 B.R. 969,

971 (M.D. Fla. 1993). Further, Dodson did not seek or receive

leave of court to appeal the order. Consequently, we affirm the

district court’s dismissal of this consolidated appeal for lack of

jurisdiction.

III. CONCLUSION

The entry of Final Decree is AFFIRMED. The dismissal of

Dodson’s challenge to the bankruptcy court’s approval of employment

of counsel for appeal is AFFIRMED.

AFFIRMED.