Estate of Townsend v. Shumaker, Loop & Kendrick, LLP (In re Fundamental Long Term Care, Inc.)

IN RE: FUNDAMENTAL LONG TERM CARE, INC., Debtor.

ESTATE OF ARLENE TOWNSEND, ESTATE OF ELVIRA NUNZIATA,

ESTATE OF JAMES HENRY JONES, ESTATE OF JOSEPH WEBB,

ESTATE OF OPAL LEE SASSER,

and ESTATE OF JUANITA JACKSON, Appellants, v. SHUMAKER, LOOP & KENDRICK, LLP, Appellee.

Case No. 8:19-cv-2176-T-33

Bankr. No. 8:11-bk-22258-MGW

UNITED STATES DISTRICT COURT MIDDLE DISTRICT OF FLORIDA TAMPA DIVISION

February 27, 2020

ORDER

This cause is before the Court on appeal from the United States Bankruptcy Court for the Middle District of Florida. Appellants, Estate of Arlene Townsend, Estate of Elvira Nunziata, Estate of James Henry Jones, Estate of Joseph Webb, Estate of Opal Lee Sasser, and Estate of Juanita Jackson (the Estates), are probate estates of six deceased nursing-home residents and are creditors of Debtor, Fundamental Long Term Care, Inc. (Fundamental). In the context of Fundamental's Chapter 7 bankruptcy proceeding, the Estates seek review of the Bankruptcy Court's Order denying the Motion to Disqualify Steven M. Berman, Esquire and Shumaker, Loop & Kendrick, LLP (Shumaker) as Counsel to the Chapter 7 Trustee Nunc Pro Tunc and for Disgorgement of Compensation. (Disqualification Order)¹ (Doc. # 11-52). The appeal is fully briefed,² see (Doc. ## 19, 25, 26), and is ripe for review. For the reasons that follow, the Court affirms the Bankruptcy Court's Disqualification Order except to the extent that the Bankruptcy Court found no violation of Rule 2014. The Bankruptcy Court's finding of no violation of Rule 2014 is vacated and the case is remanded back to the Bankruptcy Court for further proceedings consistent with this Order.

I. Background

Prior to 2006, Trans Health Care, Inc. (THI) owned a number of subsidiaries that operated nursing homes throughout the United States. (Doc. # 11-52 at 3). Trans Health Management, Inc. (THMI) provided administrative support forthe nursing homes. (Id.). Beginning in 2004 and continuing to 2009, the Estates filed a series of wrongful-death actions against THI and THMI. (Id. at 4). The suits collectively resulted in $1 billion in empty-chair judgments against the nursing home network. In re Fundamental Long Term Care, Inc., 873 F.3d 1325, 1329 (11th Cir. 2017). THMI was a wholly owned subsidiary of Fundamental. (Doc. # 11-52 at 4). This Chapter 7 involuntary bankruptcy case followed.

As the Bankruptcy Court found:

To administer [Fundamental's] estate, the Trustee began investigating and pursuing potential fraudulent transfer, alter ego, and other related claims arising out of an alleged prepetition "bust-out" scheme. According to the Trustee, THI's corporate parent and its primary shareholder had first conspired to allow THI's two primary secured lenders to loot THI and THMI in order to repay approximately $75 million in loans. Then, THMI's assets had been transferred to a number of entities and individuals known as the "Fundamental Entities" for far less than their fair market value. Finally, to complete the alleged bust-out scheme, THMIs remaining shell had been transferred to the Debtor, which was created for the sole purpose of acquiring THMI's liabilities, and THI was permitted to go out of business before being put into a state court receivership.

(Doc. # 11-52 at 4-5) (citation omitted).

To assist in litigation in the bankruptcy case, the Chapter 7 Trustee filed an application for appointment of Steve Berman, Esquire, of the Shumaker law firm, as specialcounsel pursuant to 11 U.S.C. § 327(a), which was granted by the Bankruptcy Court, without objection, on June 5, 2012. (Doc. # 9-52). In connection with his application to be appointed special counsel, Berman submitted a declaration of disinterestedness pursuant to Rule 2014. (Doc. # 9-49 at 5-7). Several amendments were made to his disclosures, with the last—the one primarily at issue—being made May 4, 2018. (Doc. # 10-575).

While the Trustee's investigation was underway, the Estates were pursuing nearly identical claims in state court. (Doc. # 11-52 at 5). Ultimately, the actions were consolidated in one proceeding—the Trustee, the creditor Estates, and the targets—in the Bankruptcy Court to resolve any issues of fraudulent transfer, alter ego, and other related claims. (Id.). The initial complaint in the adversary proceeding asserted 22 counts against seventeen defendants. (Id. at 6). The matter was tried over a two-week period in 2014. (Id.). Following the trial, the Bankruptcy Court announced its tentative findings and conclusions and ordered a mediation that resulted in two compromises totaling nearly $20 million. (Id.). The Trustee also brought a separate adversary proceeding against THI through its Receiver, and the claims were settled for $700,000. (Id.). Additionally, otheradversary proceedings resulted in settlements of $1.25 million and $6.5 million. (Id. at 7).

Shumaker's employment as special counsel began in June 2012 and continued until December 2015 when the firm filed a motion to withdraw. At that point, its involvement in litigation on behalf of the Trustee had essentially concluded with a compromise of administrative expenses that included payment to Shumaker of $5,620,148.48. (Id. at 7-8). On December 22, 2015, the Bankruptcy Court granted Shumaker's motion to withdraw as litigation counsel. (Id. at 8).

Two and a half years later, on June 4, 2018, the Estates filed a motion to disqualify Shumaker and to disgorge all past and future compensation to Shumaker. (Doc. # 10-577). The Bankruptcy Court denied the motion in a 28-page opinion on August 21, 2019 (Doc. # 11-52), and this appeal followed.

The issues on appeal are whether Shumaker should have been disqualified and its compensation disgorged (1) for holding interests allegedly adverse to the bankruptcy estate and (2) in failing to disclose certain connections it had to entities involved in the bankruptcy litigation. These are two separate issues, and courts in this Circuit and others have recognized that a professional's obligation to disclose connections is far broader than what is required fordisqualification. In re Gulf Coast Orthopedic Ctr., 265 B.R. 318, 323 (Bankr. M.D. Fla. 2001) ("Under the Rule the applicant and the professional must disclose all connections, not merely those which rise to the level of conflict."); In re Matco Elecs. Grp., Inc., 383 B.R. 848, 852 (Bankr. N.D.N.Y. 2008) (explaining that the "level of disclosure outlined in the Rule is mandatory, whether or not that disclosure would unearth a conflict of interest"). Additionally, the Estates raise a due process challenge claiming that the Bankruptcy Court deprived them of due process by denying them a hearing on the motion and the opportunity to conduct discovery.

Section 327(a) of the Bankruptcy Code provides the basic authorization for the retention of professionals by the trustee:

Except as otherwise provided in this section, the trustee, with the court's approval, may employ one or more attorneys, accountants, appraisers, auctioneers, or other professional persons, that do not hold or represent an interest adverse to the estate, and that are disinterested persons, to represent or assist the trustee in carrying out the trustee's duties under this title.

11 U.S.C. § 327(a). "Fed. R. Bankr. P. 2014 requires that a professional seeking employment in a bankruptcy case submit a 'verified statement . . . setting forth the person's connections' to the debtor, creditors and any other party ininterest." In re Leslie Fay Companies, Inc., 175 B.R. 525, 533 (Bankr. S.D.N.Y. 1994) (quoting Fed. R. Bankr. P. 2014).

A. Shumaker's Disclosures

With the application for his appointment, Berman submitted a declaration of disinterestedness pursuant to Rule 2014 on June 1, 2012. (Doc. # 9-49 at 5-7). The initial Berman declaration included the following representations:

The [Shumaker] Firm does not have any connection to or any interest materially adverse to the Debtor, any of the Debtor's affiliated businesses, any business or entity which may be considered an insider of the Debtor, the Trustee, the Debtor's creditors, any party in interest, their respective attorneys or accountants, the United States Trustee, or the employees of the Office of the United States Trustee, except as further disclosed herein.

. . .

No member of the Firm presently represents or otherwise works for any creditor, general partner, lessor, lessee, party to an executory contract of the Debtor or any of its affiliated entities or businesses, or person otherwise adverse or potentially adverse to the Debtor, on any matter, whether such representation is related or unrelated to the Debtor or the estate.

(Doc. # 9-49 at ¶¶ 5, 12). The only connection disclosed in the initial declaration was that a Shumaker partner is married to an attorney in the employ of the Office of the United States Trustee, but the partner does not practice in the bankruptcy area and was not involved in the case in any way. (Id. at ¶ 6). On March 22, 2013, a supplemental disclosureidentified Shumaker's employment of an outside contract attorney from California. (Doc. # 10-584).

On February 6, 2014, Berman again amended his disclosures, this time to identify Shumaker's relationship with General Electric:

The [Shumaker] Firm does not have any connection to or any interest materially adverse to the Debtor, any of the Debtor's affiliated businesses, any business or entity which may be considered an insider of the Debtor, including Trans Health Management, Inc. ("THMI"), the Trustee, the Debtor's creditors, any party in interest, their respective attorneys or accountants, the United States Trustee, or the employees of the Office of the United States Trustee, other than a long since concluded prior representation of General Electric Company and General Electric Supply Company on completely unrelated matters.

(Doc. # 9-512 at ¶ 4). Shumaker was permitted to withdraw as litigation counsel on December 23, 2015, and the order permitting withdrawal acknowledged that Shumaker may...