United States District Court, D. Montana, Missoula Division
In re STEVEN VINCENT SANN, Debtor.
MICHAEL J. SHERWOOD and Michael J. Sherwood, P.C., Defendant and Appellant. Christy L. Brandon, Plaintiff and Appellee,
L. CHRISTENSEN, CHIEF JUDGE
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 Montana 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
Sarin's behalf. 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)(1). For the reasons stated below, this Court
affirms Judge Kirscher's ruling.
case arises from the juncture of a civil action against Sann
by the Federal Trade Commission ("FTC") and
Sarin'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 "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
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.
to the FTC litigation, Sann and his wife, Terry Sann, filed
for bankruptcy under Chapter 11 in late September 2014. As
residents of Nevada, 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.
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 Sarins
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 Sarin's request to modify the freeze.
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.)
following the Trustee's appointment, Sherwood sent Sann a
check for $17, 844. Sherwood made two further transfers, on
June 2 and July 1.
this time, Sherwood was advised not to continue paying the
monthly draws. In mid-May, Sherwood received an email from
the Sarins's Nevada bankruptcy attorney, Samuel A.
Schwartz ("Schwartz"), stating they should attempt
to carve-out funds for Sarin'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 Sarins'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
early June, the Trustee sent Sherwood a demand to turn 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.
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.
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.
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.
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.
SeeFordv. Baroff(in reBaroff), 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 (In re
Stanton), 38 B.R. 746, 751 (B.A.P. 9th Cir. 1984).
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
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 (In re Bialac), 712 F.2d 426, 431 (9th Cir.
1983). This includes property to which the debtor has a
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 ERISA approved
pension plans. Patterson v. Shumate, 504 U.S. 753,
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 Sarin'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).
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 ...