By order of the Bankruptcy Appellate Panel, the precedential effect

of this decision is limited to the case and parties pursuant to 6th

Cir. BAP LBR 8013-1(b). See also 6th Cir. BAP LBR 8010-1(c).

File Name: 05b0001n.06

BANKRUPTCY APPELLATE PANEL OF THE SIXTH CIRCUIT

In re: HAVEN, INC., )

)

Debtor. )

 )

)

PORTER DRYWALL CO. INC., )

)

Appellant, )

)

v. ) No. 04-8058

)

HAVEN, INC., OHIO SAVINGS BANK, and )

OFFICIAL COMMITTEE OF UNSECURED )

CREDITORS OF HAVEN, INC., )

)

Appellees. )

 )

Appeal from the United States Bankruptcy Court

for the Southern District of Ohio, Eastern Division

Case No. 02-65940

 Argued: February 2, 2005

 Decided and Filed: April 7, 2005

Before: COOPER, LATTA, and WHIPPLE, Bankruptcy Appellate Panel Judges.

__________________

COUNSEL

ARGUED: Robert J. Morje, Columbus, Ohio, for Appellant. Guy R. Humphrey, CHESTER,

WILLCOX & SAXBE, Columbus, Ohio, for Appellees. ON BRIEF: Robert J. Morje, Columbus,

Ohio, for Appellant. Guy R. Humphrey, CHESTER, WILLCOX & SAXBE, Columbus, Ohio,

Yvette A. Cox, BAILEY & CAVALIERI, Columbus, Ohio, Susan L. Rhiel, RHIEL &

ASSOCIATES, Columbus, Ohio, for Appellees. 
2

 

OPINION

 

MARY ANN WHIPPLE, Bankruptcy Appellate Panel Judge. Porter Drywall Co. Inc.

(“Porter”) appeals an order approving a compromise between Debtor, Haven, Inc. (“Haven”) and

Ohio Savings Bank (“OSB”). The settlement related to an adversary proceeding Haven brought

against OSB and Porter seeking to avoid OSB’s mortgage on the sale proceeds of certain real

property. Pursuant to the bankruptcy court’s order approving the compromise, only Haven and

OSB received the proceeds of sale. Although Porter also held a lien on the proceeds, it was not a

party to the compromise and objected to its approval. For the reasons that follow, the Panel

concludes that the order on appeal should be REVERSED.

I. ISSUE ON APPEAL

The issue presented is whether the bankruptcy court abused its discretion when it approved

the compromise between Haven and OSB over Porter’s objection.

II. JURISDICTION AND STANDARD OF REVIEW

A bankruptcy court’s order approving a compromise is “final,” Lockwood v. Snookies, Inc.

(In re F.D.R. Hickory House, Inc.), 60 F.3d 724, 726 (11th Cir. 1995), and may, therefore, be

appealed as of right. 28 U.S.C. § 158(a)(1). The United States District Court for the Southern

District of Ohio has authorized appeals to the Bankruptcy Appellate Panel, and neither party has

timely elected to have this appeal heard by the district court. 28 U.S.C. §§ 158(b)(6), (c)(1).

Accordingly, the Panel has jurisdiction to decide this appeal.

A bankruptcy court’s decision “authorizing the trustee in bankruptcy to enter into a compromise of creditors' claims rests in the sound discretion of the [bankruptcy] judge. A reviewing
3

court will not disturb or set aside such a compromise unless it obviously achieves such an unjust

result as to amount to an abuse of discretion.” Mach. Terminals, Inc. v. Woodward (In re AlbertHarris, Inc.), 313 F.2d 447, 449 (6th Cir. 1963) (citations omitted). “Although our review of the

bankruptcy court's approval of a compromise is only for an abuse of the discretion accorded the

bankruptcy judge, the bankruptcy court is charged with an affirmative obligation to apprise itself

‘of all facts necessary to evaluate the settlement and make an “informed and independent judgment”’

as to whether the compromise is fair and equitable.” Bard v. Sicherman (In re Bard), 49 Fed. Appx.

528, 530 (6th Cir. 2002) (quoting LaSalle Nat’l Bank v. Holland (In re Am. Reserve Corp.), 841 F.2d

159, 162-63 (7th Cir. 1987) (quoting Protective Comm. for Indep. Stockholders of TMT Trailer

Ferry, Inc. v. Anderson, 390 U.S. 414, 424, 88 S. Ct. 1157 (1968), and citing Martin v. Kane (In re

A & C Props.), 784 F.2d 1377, 1380-81 (9th Cir. 1986))); accord, e.g., Fishell v. Soltow (In re

Fishell), 47 F.3d 1168 (6th Cir. 1995) (unreported table decision) (quoting TMT Trailer Ferry, 390

U.S. at 424-25); Reynolds v. Comm’r, 861 F.2d 469, 473 (6th Cir. 1988) (citing Am. Reserve Corp.,

841 F.2d at 162-63), available at 1995 WL 66622, at **3. Generally, a court “abuses its discretion

only when it relies upon clearly erroneous findings of fact or when it improperly applies the law or

uses an erroneous legal standard.” Fleischut v. Nixon Detroit Diesel, Inc., 859 F.2d 26, 30 (6th Cir.

1988). “‘The purpose of a compromise agreement is to allow the trustee and the creditors to avoid

the expenses and burdens associated with litigating sharply contested and dubious claims . . . . The

law favors compromise and not litigation for its own sake, . . . and as long as the bankruptcy court

amply considered the various factors that determined the reasonableness of the compromise, the

court's decision must be affirmed.’” Fishell, 1995 WL 66622, at **2 (quoting A & C Props., 784

F.2d at 1380-81).

III. FACTS

On or about March 9, 2001, Haven executed a mortgage in favor of OSB with respect to

certain real property located in the Sage Creek Subdivision in Delaware County, Ohio (the

“Property”). The mortgage was properly signed, witnessed, and notarized but, when the mortgage

was recorded on March 30, 2001, the signature page from the Construction Loan Agreement

between Haven and OSB was attached in lieu of the mortgage’s signature page. That page did not
4

bear the signatures of witnesses or a notarial acknowledgment. On or about June 6, 2002, Haven

executed a mortgage on the Property in favor of Porter, which was recorded on June 10, 2002. At

some point, Daryl Glover, doing business as Q & T Stucco and Stone (“Glover”), filed a notice

asserting a mechanic’s lien on the Property.

On December 2, 2002, Haven filed a voluntary petition for relief under Chapter 11 of the

Bankruptcy Code. On March 10, 2003, the bankruptcy court entered an order approving the sale

of the Property free and clear of liens, claims, and encumbrances, with liens, claims, and

encumbrances to transfer to the sale proceeds. The Property was sold, and the net proceeds (after

the payment of real estate taxes, recording fees, and other closing and settlement costs) were

$335,729.18, which funds were placed in an attorney’s escrow account. The balance of OSB’s mortgage loan as of February 3, 2003, was $308,841.59. The balance of Porter’s mortgage loan as of

April 1, 2002, was $20,122.50.

On March 20, 2003, Haven filed a complaint against OSB, Porter, and Glover, seeking to

avoid OSB’s mortgage on the Property, alleging an improper acknowledgment. The complaint

sought to preserve the avoided mortgage for the benefit of the estate, so that the other defendants’

interests in the Property would be subordinate to that of the debtor in possession as successor to

OSB. On June 26, 2003, Haven filed a motion for summary judgment and, on July 23, 2003, it filed

an amended motion for summary judgment and OSB filed a cross-motion for summary judgment.

The bankruptcy court did not decide the summary judgment motions. Instead, on March 24,

2004, Haven filed a motion for approval of a compromise with OSB. The settlement, as interpreted

by the parties, provides for the bankruptcy estate to receive the first $120,000 of the sale proceeds

with the balance to be disbursed to OSB up to the balance of its mortgage and then to Porter up to

the balance of its mortgage and then to Glover. The settlement further provides that “OSB does not

anticipate that there will be any proceeds remaining after paying $120,000.00 to the Bankruptcy

Estate and paying the balance of its Mortgage Loan.” On April 12, 2004, Porter filed a memorandum

in opposition to the motion for approval of the compromise, asserting that it was not a party to the

settlement and that its mortgage had priority over both OSB and the bankruptcy estate.
5

The bankruptcy court conducted a hearing on approval of the compromise on June 7, 2004,

at which the Official Committee of Unsecured Creditors (the “Committee”) supported the

settlement. The court did not make any oral findings of fact or conclusions of law but, on June 30,

2004, it entered an order approving the settlement, which found that “the Compromise is in the best

interests of the Debtor’s creditors and its bankruptcy estate and is fair and equitable.” Porter timely

filed a notice of appeal on July 7, 2004. The bankruptcy court denied a stay pending appeal on

August 2, 2004, and the proceeds of the Property have now been disbursed in accordance with the

settlement according to Haven’s and Porter’s attorneys’ statements at oral argument before the

Panel.

IV. DISCUSSION

Rule 9019(a) of the Federal Rules of Bankruptcy Procedure provides: “On motion by the

trustee and after notice and a hearing, the court may approve a compromise and settlement.” A

Chapter 11 debtor in possession has all of the rights, powers and duties of a trustee. 11 U.S.C.

§ 1102. The rule offers no guidance on the criteria to be used in evaluating whether a compromise

and settlement should be approved. The Sixth Circuit has held, however, that “[t]he bankruptcy

court . . . is obligated to weigh all conflicting interests in deciding whether the compromise is ‘fair

and equitable,’ considering such factors as the probability of success on the merits, the complexity

and expense of litigation, and the reasonable views of creditors.” Bauer v. Commerce Union Bank,

859 F.2d 438, 441 (6th Cir. 1988); accord, e.g., Bard v. Sicherman (In re Bard), 49 Fed. Appx. 528,

530 (6th Cir. 2002); Reynolds v. Comm’r, 861 F.2d 469, 473 (6th Cir. 1988) (citing Protective

Comm. of Indep. Stockholders for TMT Trailer Ferry, Inc. v. Anderson, 390 U.S. 414, 424, 88 S. Ct.

1157 (1968)). More explicit guidance may be found in the unreported opinion in the Bard case:

The United States Supreme Court has instructed bankruptcy courts engaged

in making such determinations to “form an educated estimate of the complexity,

expense, and likely duration of such litigation, the possible difficulties of collecting

on any judgment which might be obtained, and all other factors relevant to a full and

fair assessment of the wisdom of the proposed compromise.” The federal courts of

appeal have in turn implemented this directive by considering:
6

(a) The probability of success in the litigation; (b) the difficulties, if

any, to be encountered in the matter of collection; (c) the complexity

of the litigation involved, and the expense, inconvenience and delay

necessarily attending it; (d) the paramount interest of the creditors

and a proper deference to their reasonable views in the premises.

Bard, 49 Fed. Appx. at 530 (quoting TMT Trailer Ferry, 390 U.S. at 424, and citing Drexel v.

Loomis, 35 F.2d 800, 806 (8th Cir. 1929)) (other citations omitted); accord, e.g., Fishell v. Soltow

(In re Fishell), 47 F.3d 1168 (6th Cir. 1995) (unreported table opinion) (quoting Martin v. Kane (In

re A & C Props.), 784 F.2d 1377, 1381 (9th Cir. 1986)), available at 1995 WL 66622, at **3. As

for the analysis and findings of fact required, a panel of the Sixth Circuit has adopted the procedure

mandated by the Seventh Circuit:

“A bankruptcy judge need not hold a mini-trial or write an extensive opinion every

time he approves or disapproves a settlement. The judge need only apprise himself

of the relevant facts and law so that he can make an informed and intelligent

decision, and set out the reasons for his decision. The judge may make either written

or oral findings; form is not important, so long as the findings show the reviewing

court that the judge properly exercised his discretion.”

. . . .

. . . Although it is preferable that these matters be addressed in the

Bankruptcy Court's opinion, “[i]f, indeed, the record contain[s] adequate facts to

support the decision of the trial court to approve the proposed compromises, a

reviewing court would be properly reluctant to attack that action solely because the

court failed adequately to set forth its reasons or the evidence on which they were

based.”

Fishell, 1995 WL 66622, at **3 (quoting LaSalle Nat’l Bank v. Holland (In re Am. Reserve Corp.),

841 F.2d 159, 163 (7th Cir. 1987); TMT Trailer Ferry, 390 U.S. at 437).

Although the bankruptcy court in this case did make a determination on the ultimate issue

that “the Compromise is in the best interests of the Debtor’s creditors and its bankruptcy estate and
1

 At the time the OSB mortgage was signed and recorded, Section 5301.01 also required the

signatures of two witnesses, but Section 5301.234 of the Ohio Revised Code (which has been

invalidated as violative of the Ohio constitution, In re Nowak, 820 N.E.2d 335 (Ohio 2004); Kovacs

v. First Union Home Equity Bank (In re Huffman), 369 F.3d 972 (6th Cir. 2004)) purported to negate

that requirement. In any event, OSB’s mortgage was properly witnessed, but the mortgage signature

page, containing the witnesses’ signatures as well as the acknowledgment, was replaced by the

signature page from the Construction Loan Agreement when the instrument was recorded.

7

is fair and equitable under the factors set forth in Drexel v. Loomis,” the order approving the

compromise does not make any specific findings of fact regarding any of those four factors.

Moreover, the bankruptcy court made no oral findings of fact at the hearing on approval of the

compromise. Thus, the Panel must determine if “the record contain[s] adequate facts to support the

decision of the trial court.” Id.

As for the first prong of the Drexel test, the risk that OSB would prevail in the adversary

proceeding does indicate the prudence of a compromise. Ohio law permits the recordation of

instruments only if they are “properly executed.” Ohio Rev. Code § 5301.25(A). Thus, “an

improperly executed mortgage does not put a subsequent bona fide purchaser on constructive

notice.” Simon v. Chase Manhattan Bank (In re Zaptocky), 250 F.3d 1020, 1028 (6th Cir. 2001).

A trustee or debtor in possession is by statute a bona fide purchaser “without regard to any

knowledge.” 11 U.S.C. § 544(a)(3). Accordingly, an improperly executed Ohio mortgage is

avoidable under § 544(a) of the Bankruptcy Code. E.g., Suhar v. Burns (In re Burns), 322 F.3d 421,

427 (6th Cir. 2003) (citing Zaptocky, 250 F.3d at 1027-28). Under Ohio law, the mortgagor’s

signing of a mortgage “shall be acknowledged by the . . . mortgagor . . . before a judge or clerk of

a county of record in this state, or a county auditor, county engineer, notary public, or mayor.” Ohio

Rev. Code § 5301.01(A).1

 An improperly notarized instrument is “improperly executed” within the

meaning of Section 5301.25(A) of the Ohio Revised Code, Mortgage Elec. Registration Sys. v.

Odita, 822 N.E.2d 821, 825 (Ohio Ct. App. 2004); Majestic Homes, Inc. v. Figgers, No. 3831, 1985

WL 3998, at *2 (Ohio Ct. App. Nov. 27, 1985), and is thus avoidable under § 544(a) of the

Bankruptcy Code.
8

The parties stipulated that OSB’s mortgage was properly executed in the sense that it was

properly signed, witnessed, and notarized. Nevertheless, the instrument actually submitted for

recordation did not show that it was properly executed because the signature page attached to the

mortgage did not contain the signatures of witnesses or a notarial acknowledgment. There does not

appear to be any Ohio decision addressing whether a mortgage not reflecting the acknowledgment

may be recorded even though the mortgage was actually acknowledged: if the courts of Ohio would

hold that the omission makes it improper to record the mortgage, the consequences would likely be

the same as if OSB’s mortgage had not been notarized at all and Haven would prevail; if Ohio law

permits the recordation of the instrument without the acknowledgment (so long as the execution of

the instrument was acknowledged), OSB would prevail.

Turning to the other factors to be considered in determining whether to approve a

compromise, as the adversary proceeding relates to the disposition of the proceeds of the sale of the

Property and the funds were then held in escrow, the collection of any judgment presented no

difficulties. The adversary proceeding was not complex. Moreover, because Haven and OSB had

filed cross-motions for summary judgment and those motions had been fully briefed, the prosecution

of the litigation to its conclusion would involve little or no additional “expense, inconvenience and

delay.” See Martinson v. Michael (In re Michael), 183 B.R. 230, 239 (Bankr. D. Mont. 1995)

(denying approval of settlement where trustee was “almost certain to prevail,” trustee’s victory could

be enforced by selling property, and material facts were uncontroverted, law had already been

researched, and litigation was “near its end”).

As for “the paramount interest of the creditors and a proper deference to their reasonable

views in the premises,” Bard, 49 Fed. Appx. at 530, the Committee supported the settlement. But

the court must also consider the interests of secured creditors, including the defendants in the

adversary proceeding. Pursuant to the compromise, the proceeds of the Property have been completely disbursed to Haven and OSB when Porter holds, at a minimum, a second priority interest in

the funds, and the adversary proceeding in which Porter asserted those rights has been dismissed

with prejudice. Clearly, the compromise was not in Porter’s interests.
9

Moreover, Ohio law dictates that, if Haven were to prevail in avoiding OSB’s mortgage as

improperly executed, Porter’s mortgage would move into first position under Ohio law; and § 551

of the Bankruptcy Code does not change that result. Section 551 provides that “[a]ny transfer

avoided under section . . . 544 . . . of this title . . . is preserved for the benefit of the estate but only

with respect to property of the estate.” The statute “puts the estate in the shoes of the creditor whose

lien is avoided. It does nothing to enhance (or detract from) the rights of that creditor viz-a-viz other

creditors.” Carvell v. Bank One, Lafayette, N.A. (In re Carvell), 222 B.R. 178, 180 (B.A.P. 1st Cir.

1998). Section 551 thus “prevents junior lienors from improving their position at the expense of the

estate when a senior lien is avoided,” id. (quoting H.R. Rep. No. 95-595, at 376 (1977); S. Rep. No.

95-989, at 91 (1978)), but does not confer on a trustee any greater rights than were held by the

secured creditor prior to the avoidance, e.g., Barnett Bank of S. Fla., N.A. v. Weitzner (In re

Kavolchyck), 164 B.R. 1018, 1024 (S.D. Fla. 1994); Connelly v. Marine Midland Bank, N.A., 61

B.R. 748, 750 (W.D.N.Y. 1986); Walker v. Elam (In re Fowler), 201 B.R. 771, 781 (Bankr. E.D.

Tenn. 1996); Tenn. Mach. Co. v. Appalachian Energy Indus., Inc. (In re Appalachian Energy Indus.,

Inc.), 25 B.R. 515, 517 (Bankr. M.D. Tenn. 1982). Accordingly, these and other cases hold that,

when a trustee avoids an unperfected security interest, he or she steps into the shoes of the creditor

and so holds an unperfected security interest, which is subordinate to later, perfected security

interests.

As explained above, OSB’s mortgage may be avoidable by Haven, which (as the debtor in

possession) has the status of a bona fide purchaser without notice. However, § 5301.25(A) of the

Ohio Revised Code provides that an improperly executed mortgage is unenforceable only against

one without “knowledge of the existence of the instrument.“ The courts of some states interpret

similar statutes to hold that subsequent lienholders have actual knowledge by virtue of the fact that

the prior mortgage was, in fact, recorded, albeit improperly. See, e.g., Rogan v. America’s

Wholesale Lender (In re Vance), 99 Fed. Appx. 25 (6th Cir. 2004) (discussing State St. Bank &

Trust Co. v. Heck’s, Inc., 963 S.W.2d 626, 630 (Ky. 1998)). However, the courts of Ohio hold that

a defectively executed mortgage gives neither constructive nor actual notice: “A defectively

executed mortgage is not entitled to record, and even if it is recorded, the defective mortgage is

treated as though it has not been recorded.” Odita, 822 N.E.2d at 825 (citation omitted); accord,
10

e.g., Priority Mtg. & Inv. Co. v. Flesariu, 2 Ohio Law Abs. 760 (Ohio Ct. App. 1924); see Figgers,

1985 WL 3998, at *2. The Ohio Court of Appeals in Odita also addressed the policy considerations

behind the Ohio rule:

It would seem that, as a matter of principle, a defectively executed mortgage

should be superior to a subsequent legal interest if the subsequent legal interest was

acquired with notice of the prior defectively executed mortgage. However, “[w]hile

this is the rule in many jurisdictions, the rule is otherwise in Ohio because of the

recording statutes.” Notwithstanding, with property rights it is not necessarily that

the outcome be the best outcome possible in each case; only that the outcome

necessarily be consistent across every case so as to provide reliability and predictability. . . .

Therefore, although this court recognizes that the current ruling may seem

intuitively unfair or inequitable to some observers, because there exists a significant

line of authority finding such, we follow these precedents based upon stare decisis

and to lend stability to future property transactions.

Odita, 822 N.E.2d at 828-29 (citations omitted).

These cases were decided by intermediate appellate courts, but they rely on several decisions

of the Ohio Supreme Court. In the Denison case, the Supreme Court held that “[a] defectively

executed mortgage when recorded does not establish a lien with priority over subsequently recorded

mortgages properly executed.” Citizens National Bank v. Denison, 133 N.E.2d 329, 333 (Ohio

1956). As the Odita court explained:

Although the particular facts in Citizens Natl. Bank concern constructive notice, the

court does not indicate anywhere in its decision that actual notice by the subsequent

mortgagee is an exception to its holding that the recording of a defectively executed

mortgage does not establish a lien with priority over subsequently recorded

mortgages properly executed.

Odita, 822 N.E.2d at 826. In Langmede v. Weaver, the court summarized several earlier decisions,

then concluded:
11

These cases, and others that might be cited, have indisputably established the

principle that a recorded mortgage which lacks some requisite of legal execution is

not available for any purpose against a third person who subsequently acquires the

title to or an interest in or a lien upon the property, and that notice by him at the time,

either actual or constructive, or both, however complete it may be, of the existence

and record of such mortgage, imparts no value or officacy [sic] to it.

Langmede v. Weaver, 60 N.E. 992, 997 (Ohio 1901). Likewise, in Strang v. Beach, the court held:

Under the express and peculiar phraseology of these statutes, a series of

authoritative decisions have [sic] been made in this State, holding that such

mortgages only as were signed, sealed, witnessed and acknowledged in accordance

with the provisions of the first section of the act first above referred to, were entitled

to be recorded, or could be recognized as having been delivered for record or recorded; and that none but mortgages so executed and delivered for record, or

recorded, could have any effect whatsoever, either at law or in equity, as to third

parties, whether such third parties had notice of the defectively executed or

unrecorded mortgage or not.

Strang v. Beach, 11 Ohio St. 283, 288 (1860).

Accordingly, under Ohio law, if OSB’s mortgage was improperly executed, it would be

“treated as though it has not been recorded.” Odita, 822 N.E.2d at 825. Under § 551 of the

Bankruptcy Code, Haven, as debtor in possession, would step into the shoes of one holding an

unrecorded mortgage. Under Ohio law, a subsequent, recorded mortgage has priority over an

unrecorded mortgage. Ohio Rev. Code § 5301.23(A). Thus, if Haven were to prevail against OSB

in the adversary proceeding, Porter would have priority to the proceeds of the sale of the Property

and its claim would be satisfied in full. A compromise providing for the sale proceeds to be remitted

first to the Debtor’s estate and then to OSB is not, therefore, “fair and equitable.”

Appellees assert, however, that Porter was not entitled to consideration in connection with

the settlement because it “did not file either a counterclaim or a cross claim in the underlying

Litigation asserting its interests in the Proceeds.” (Brief of Appellee Ohio Savings Bank, at 7.)
12

Appellees cite no authority for the proposition that Porter’s claim to the proceeds constitutes a

compulsory counterclaim or cross-claim that is waived if not raised in the initial answer. Indeed,

Rule 7013 of the Federal Rules of Bankruptcy Procedure expressly provides that a defendant sued

by a debtor in possession “need not state as a counterclaim any claim that the party has against the

debtor, the debtor’s property, or the estate, unless the claim arose after the entry of an order for

relief.” In addition, when a counterclaim is omitted “through oversight, inadvertence, or excusable

neglect, or when justice requires, the pleader may by leave of court set up the counterclaim by

amendment.” Fed. R. Bankr. P. 7013; Fed. R. Civ. P. 13(f). Moreover, while Rule 13 requires that

certain counterclaims be raised in the party’s answer, there is no requirement that any cross-claims

be included. Fed. R. Bankr. P. 7013; Fed. R. Civ. P. 13(a), (g). Porter clearly asserted its claim of

priority in the proceeds in Paragraphs 23 and 24 of its answer (under the heading “Affirmative

Defenses,” Fed. R. Bankr. P. 7008(a); Fed. R. Civ. P. 8(c) (counterclaims mistakenly designated as

defenses must be treated as if there had been a proper designation)) and in greater detail in its

response to Haven’s motion for summary judgment. So Haven and OSB were clearly on notice of

Porter’s claimed interest in the proceeds when they entered into their agreement disposing of the

litigation. And Rule 41(a)(2) of the Federal Rules of Civil Procedure, adopted by Rule 7041 of the

Federal Rules of Bankruptcy Procedure, provides that, where a counterclaim exists, an action shall

not be dismissed over a defendant’s objection unless the counterclaim can remain for independent

adjudication. 

The record does not contain adequate facts to support the decision of the bankruptcy court

approving the compromise between Haven and OSB. First, although there is a genuine legal issue

as to the avoidability of OSB’s mortgage, there is little question regarding the proper distribution

of the proceeds of the sale of the Property if the mortgage is avoided. Second, there is no question

regarding the enforceability of the decision on the merits. Third, the controversy is not complex, and

the pursuit of the adversary proceeding to its conclusion would not involve significant additional

expense, inconvenience, or delay. Fourth, not all of the parties to the proceeding have joined in the

agreement and the interests of the creditor with the most to lose – Porter – have been totally disregarded. OSB correctly characterizes the nature of the dispute as “all or nothing” (Brief of Appellee

Ohio Savings Bank, at 5), but in no event would the bankruptcy estate have priority to the sale
13

proceeds over Porter: if the mortgage is not avoidable, OSB would be in first position and Porter

would be in second position; and, if the mortgage is avoidable, Porter would be in first position and

the estate (or Glover) would be in second position. Accordingly, a settlement allocating the sale

proceeds only between Haven and OSB but not Porter cannot be “fair and equitable.” The

bankruptcy court abused its discretion in approving the agreement.

V. CONCLUSION

For the foregoing reasons, the bankruptcy court’s order approving the compromise is

REVERSED.