Alarmex Holdings, LLC v. Gowan (In re Dreier LLP)

527 B.R. 126

In re DREIER LLP, Debtor.

Alarmex Holdings, LLC, Appellant

v.Sheila M. Gowan, Chapter 11 Trustee for Dreier LLP, Appellee.

No. 14 Civ. 2353PAE.

United States District Court, S.D. New York.

Signed Aug. 6, 2014.

Eric B. Fisher, Dickstein Shapiro LLP, Howard D. Ressler, Kensington & Ressler, New York, NY, for Appellee.

David J. Sack, Feder, Kaszovitz LLP, Murray L. Skala, Feder, Kaszovitz, Isaacson, Weber & Skala, New York, NY, for Appellant.

OPINION & ORDER

PAUL A. ENGELMAYER, District Judge.

Alarmex Holdings, LLC (“Alarmex”) appeals from the February 14, 2014 Order of the United States Bankruptcy Court for the Southern District of New York (Bernstein, J.) (“Order”), issued in the Chapter 11 bankruptcy case of the law firm Dreier LLP, In re: Dreier LLP, No. 08–15051(SMB) (the “Dreier LLP bankruptcy”). That Order granted an objection by the Chapter 11 Trustee, Sheila M. Gowan (“Gowan” or the “Trustee”), and reclassified Alarmex's Claim No. 393 (the “Alarmex claim”) as a general unsecured claim on the Dreier LLP bankruptcy estate.

Alarmex appeals on two grounds: First, because Dreier LLP was supposed to hold the funds at issue in escrow, Alarmex asserts that it is entitled to a secured, priority claim, pursuant to 11 U.S.C. § 506(a)(1). Such a priority claim would entitle Alarmex to be paid ahead of the estate's other creditors. Alternatively, Alarmex asserts that the bankruptcy court should have imposed a constructive trust over the estate's property for Alarmex's benefit.

For the reasons that follow, the bankruptcy court's Order is vacated and the case remanded for further factual development.

I. Background¹

The facts underlying the Dreier LLP fraud and bankruptcy have been set out in detail in several prior decisions in this District. See, e.g., United States v. Dreier, 682 F.Supp.2d 417, 422 (S.D.N.Y.2010) (“Dreier I ” ); United States v. Dreier, No. 09 Cr. 085(JSR), 2010 WL 1223087 (S.D.N.Y. Mar. 24, 2010) (“Dreier II ” ); In re Dreier LLP, 429 B.R. 112, 117–19 (Bankr.S.D.N.Y.2010) (“Dreier III ” ); In re Dreier LLP, No. 10 Civ. 4758(DAB), 2010 WL 3835179 (S.D.N.Y. Sept. 10, 2010) (“Dreier IV ” ); In re Dreier LLP, 452 B.R. 391 (Bankr.S.D.N.Y.2011) (“Dreier V ” ).

The Court assumes familiarity with these decisions and sets out here only the facts most germane to this appeal.

A. Dreier's Fraud Scheme

Dreier LLP was a law firm based in New York City that employed some 300 people. Dreier III, 429 B.R. at 118. Marc S. Dreier (“Dreier”) was the firm's sole equity partner. Id. Between 2004 and 2008, Dreier ran a Ponzi scheme, selling fraudulent promissory notes to hedge funds and individual investors (the “note fraud scheme”); Dreier stole approximately $700 million via this scheme. Id. Virtually all of Dreier's fraud proceeds were deposited into a specific LLP attorney trust account held at JP Morgan Chase bearing the last four digits “5966” (the “5966 account”). See Dkt. 1712 (“Trustee's Objection”) ¶ 8. Dreier used this account to pay principal, interest, and fees to the investors in the Ponzi scheme, to “fund his lifestyle,” and to subsidize his law firm's operations. Dreier III, 429 B.R. at 118. He also deposited client funds into the same account. Id. Therefore, although the 5966 account was titled an “escrow” or “attorney trust” account, it is undisputed that Dreier commingled operating revenues from his law firm, funds from his clients, and investments from his note fraud victims in that account. Trustee's Objection ¶ 9.

On December 7, 2008, Dreier was indicted in this District and arrested. Id. at ¶ 3; Dreier III, 429 B.R. at 118. On December 8, 2008, the Securities and Exchange Commission (the “SEC”) filed a civil complaint alleging that Dreier had violated the securities laws of the United States. Dreier IV, 2010 WL 3835179, at *2. “Two days later, the Honorable Miriam G. Cedarbaum of this District appointed a receiver for Dreier's assets (the ‘Receiver’) and temporarily restrained the assets of Dreier and his law firm, Dreier LLP.” Id. On December 16, 2008 (the “petition date”), the Receiver commenced a voluntary Chapter 11 proceeding on behalf of Dreier LLP; appellee Gowan was appointed as the chapter 11 trustee of the Dreier LLP estate. Id. ; Trustee's Objection ¶ 5.

On March 17, 2009, Dreier pled guilty before the Honorable Jed S. Rakoff to charges of conspiracy, securities fraud, wire fraud, and money laundering. See United States v. Dreier, No. 09 Cr. 85 (JSR). On July 13, 2009, Judge Rakoff signed an Order of Forfeiture/Preliminary Order of Forfeiture as to Specific Properties, which ordered Dreier to forfeit, inter alia, “property constituting or derived from proceeds obtained as a result of the fraud offenses ... and property traceable to such property.” Id. Dkt. 85 (the “Preliminary Forfeiture Order”). Specific properties forfeited included “[a]ny and all funds in [the 5966 Account] held at JP Morgan Chase in the name of Dreier LLP.”² Preliminary Forfeiture Order, Schedule A, Item 13.

On August 27, 2010, Judge Rakoff issued a Final Order of Forfeiture, which, in relevant part, was identical to the Preliminary Forfeiture Order. See id. Dkt. 156 (the “Final Forfeiture Order”).

B. The Alarmex Claim

In December 2006, about two years before Dreier was arrested, CJ Apparel Group, LLC (“CJ Apparel”) agreed to purchase assets from Alarmex. Dreier LLP represented CJ Apparel in connection with that purchase. Dkt. 1810.

On December 22, 2006, the parties entered into an Asset Purchase Agreement to consummate the sale. Dkt. 1811 (Declaration of Jonathan Honig (“Honig Decl.”)) Ex. 1 (“APA”). Pursuant to ¶ 3. 1(b) of the APA, $500,000 was withheld from the $10 million purchase price and provided to Dreier LLP, the “Escrowee,” to be held in escrow. See APA ¶ 3.1(b) (purchaser shall pay “to the Escrowee, an aggregate of $500,000 to an account designated by Escrowee, to be maintained in accordance with the terms of Article 12 of this Agreement (the ‘Escrow Amount’ )”). Under ¶ 10.6 of the APA, an additional $300,000 was placed in escrow for “holdback” purposes, for a total of $800,000. The APA defined Dreier LLP's role as “Escrowee” or “escrow agent,” as follows:

The Escrowee shall hold the Escrow Amount in escrow in a segregated bank account at JP Morgan Chase for the Escrow Period and in accordance with the terms of this Agreement. Escrowee shall hold the Escrow Amount in an interest-bearing account for the benefit of the Parties. If interest is held for the benefit of the Parties, it shall be paid to the Party entitled to the Escrow Amount and the Party receiving the interest shall pay any income taxes thereon. The Social Security or Federal Identification numbers of the Parties shall be furnished to Escrowee upon request.

APA ¶ 13.1.

As of July 12, 2007, slightly more than $600,000 of the escrow funds had been distributed to the parties. See Trustee's Objection Ex. A, Attachment 2. Including the interest that had accrued in the seven months since the purchase agreement, the total amount remaining in escrow as of July 12, 2007 was $200,991.87. Id.

As noted, Dreier was indicted and arrested on December 7, 2008, and the voluntary Chapter 11 proceeding on behalf of Dreier LLP commenced on December 16, 2008.

On March 27, 2009, shortly before the “bar date” of March 31, 2009, Alarmex filed claim No. 393 against the Dreier LLP bankruptcy estate.³ Trustee's Objection ¶ 13; id. Ex. A. In its claim, Alarmex asserted that it was owed $200,991.87 by the estate, and that it was entitled to be paid on a secured basis ahead of other creditors. Trustee's Objection Ex. A.

On November 6, 2013, the Trustee objected to Alarmex's claim. Dkt. 1712. The Trustee asserted, inter alia, that she was unable to locate, within the accounts held by Dreier and/or Dreier LLP in JP Morgan Chase, any segregated sub-account designated as having belonged to Alarmex or CJ Apparel. The Trustee concluded, on that basis, that the funds at issue must have been deposited into the 5966 account. Id. Ex. B (the Declaration of Sheila Gowan (“Gowan Decl.”)) ¶¶ 6, 7. On January 16, 2014, Alarmex filed an opposition to the Trustee's Objection. Dkt. 1810.

On February 11, 2014, the bankruptcy court heard argument and, then, on the record, granted the Trustee's objection. Specifically, the bankruptcy court held as follows:

First of all is you [i.e., Alarmex] have no secured claim. To the extent you're saying that you were secured by the property that was stolen from you [,] that money—any money in the account as of the petition date[—]was forfeited to the United States, and under forfeiture law it was never property of the estate.

So to the extent you have a secured claim, and I don't think you do, you have it in property, which isn't property of the estate, which is not a secured claim in bankruptcy.

Second for the reasons I stated in the—in connection with the GSO settlement in my decision I would not be inclined to permit you to trace in a Ponzi scheme case or impose a constructive trust even if you could trace the money into the account of the estate, which you can't.

Dkt. 1864 (“Feb. 11, 2014 Tr.”) at 13–14.

On February 14, 2014, the bankruptcy court issued an Order, in which, for the “reasons stated on the record of the Hearing,” it “recharacterized” the Alarmex claim as a “general unsecured claim.” Dkt. 1852. On February 25, 2014, Alarmex filed a timely Notice of Appeal. Dkt. 1865.

On April 3, 2014, Alarmex's appeal was filed in this Court. In re: Dreier, No. 14 Civ. 2353(PAE) (S.D.N.Y. filed Apr. 3, 2014), Dkt. 1. On May 12, 2014, Alarmex submitted its memorandum of law in support of its appeal. Id. Dkt. 7 (“Alarmex Br.”). On May 27, 2014, the Trustee submitted an opposition brief. Id. Dkt. 9 (“Trustee Br.”). On June 10, 2014, Alarmex filed a reply brief. Id. Dkt. 10 (“Alarmex Reply Br.”).

II. Applicable Legal Standards

Under Rule 8013 of the Federal Rules of Bankruptcy Procedure, this Court “may affirm, modify, or reverse [the] bankruptcy judge's judgment, order, or...