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Creditor Loses Bankruptcy Settlement Challenge

By Robyn Hagan Cain on January 11, 2012 | Last updated on March 21, 2019

The Seventh Circuit Court of Appeals ruled last week that a bankruptcy court did not err in approving a bankruptcy settlement that allotted a portion of the proceeds from a property sale to pay the insolvent company’s bankruptcy attorneys.

Holly Marine Towing, Inc. was a Chicago company that owned and operated a tug boat service on Lake Michigan. The company filed for Chapter 11 bankruptcy on January 8, 2007, and the bankruptcy court converted the case to a Chapter 7 liquidation bankruptcy the following year. A trustee was appointed to manage the estate’s assets and pay off creditors.

During the proceedings, a dispute arose over the sale of property at 9320 South Ewing Avenue (Ewing property) in Chicago, the site at which Holly Marine operated its business. Several competing claims to the Ewing property surfaced.

Holly Marine's principals, Glenn Dawson and Holly Headland, were going through a divorce, and each sought to establish ownership interests in the property. Dawson and Headland reached a settlement that divided up the proceeds from the sale of the Ewing property. Headland and Dawson each received 25 percent, while the bankruptcy estate received the other 50 percent through its trustee. Dawson and Headland paid Holly Marine's bankruptcy attorneys, Bauch & Michaels, LLC (Bauch), a total of $65,000 from their personal share of the proceeds as part of the agreement.

Scouler & Company, LLC, a financial services firm and a creditor of the bankruptcy estate that provided financial consulting services to Holly Marine during the Chapter 11 bankruptcy proceedings, challenged the court's order approving the bankruptcy settlement on the grounds that the $65,000 payout to Bauch should have been distributed to it and other Chapter 11 creditors.

When a Chapter 11 case is converted to a Chapter 7 liquidation bankruptcy, Chapter 7 administrative creditors -- those who provided administrative services to the estate during the Chapter 7 proceedings -- take priority over the Chapter 11 administrative creditors.

If there are not enough funds to pay all Chapter 11 administrative claims, the leftover value of the estate is distributed to these Chapter 11 creditors on a pro rata basis, but such distributions under the priority scheme apply only to the "property of the estate."

Here, the district court ruled that the Bauch payment was not property of the estate. Finding no clear error in the district's court's determination that the distribution to Bauch involved non-estate assets, the Seventh Circuit Court of Appeals upheld the bankruptcy settlement.

Before you challenge a bankruptcy settlement on behalf of a creditor, make sure that the distributions that you are contesting are property of the bankruptcy estate instead of non-estate assets.

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