IN THE UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF TEXAS

FORT WORTH DIVISION

IN RE: §

§ Bankruptcy Case No.

TONY R. GRESHAM and BELINDA J. § 05-40662-DML-7

GRESHAM, husband and wife, §

§ Adversary No. 05-04068-DML

Debtors. §

______________________________ §

§

WM. CAMERON & CO., a Georgia §

corporation doing business as §

CAMERON ASHLEY BUILDING §

PRODUCTS, §

§

Plaintiff/Appellant, §

§ District Court Case

VS. § NO. 4:06-CV-008-A

§

TONY R. GRESHAM and BELINDA J. §

GRESHAM, husband and wife, §

§

Defendants/Appellees. §

MEMORANDUM OPINION

and

ORDER

Since leave was granted on May 26, 2006, to appeal from the

December 15, 2005, order of the bankruptcy court denying the

motion of Wm. Cameron & Co. d/b/a Cameron Ashley Building

Products ("Cameron") for approval of a proposed compromise

between Cameron and the debtors, Cameron has filed its brief on

appeal, the United States Trustee has filed a responsive brief,

and debtors, Tony R. Gresham and Belinda J. Gresham, have filed a

document stating that they "stand neutral because of the unusual

position they are in as parties to this appeal." Reply by

Defs./Appellees at 2. The court has concluded that the ruling of

the bankruptcy court in the December 15, 2005, order should be

 

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reversed, and that the matter should be remanded to the

bankruptcy court for further proceedings.

I.

Issues Presented

For a recitation of the background facts and a statement of

the tentative views of the court on the issues Cameron defined in

its motion for leave as the ones it would present on appeal, the

court incorporates by reference the contents of the memorandum

opinion and order the court signed in this case on May 26, 2006.

The court interprets the thrust of the issues Cameron presents on

appeal to be as follows:

(1) The bankruptcy court did not consider all of the

factors that should be considered in determining whether the

proposed settlement should be approved, but, instead,

rejected the proposed settlement for the sole reason that it

benefitted only Cameron and not the bankruptcy estate and

creditors other than Cameron. 

(2) The bankruptcy court abused its discretion in

declining to approve the settlement.

The court views these issues to present questions of law, with

the consequence that the ruling of the bankruptcy court is

subject to a de novo review. 

 

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II.

Analysis

A. The Standard for Approval Applied by the Bankruptcy

Court is too Restrictive.

The reason given by the bankruptcy court in the December 15,

2005, order denying Cameron's motion suggests that the bankruptcy

court concluded that it had no authority to approve the proposed

settlement solely because the only benefit to the bankruptcy

estate and the other creditors would be withdrawal of Cameron's

claim against the estate. R. at 4-5. The bankruptcy court

indicated that no settlement of Cameron's adversary proceeding

would be approved unless the settlement would be beneficial to

all creditors. Id. at 5. The court is concerned that the

bankruptcy court took an inappropriately restrictive view of the

circumstances when the bankruptcy court can, and should, approve

settlement of an objection to a debtor's discharge brought

pursuant to 11 U.S.C. § 727(a), whether or not joined with a

claim pursuant to 11 U.S.C. § 523(a) challenging dischargeability

of the debt. 

B. The Three Standards that Other Courts have Applied.

As the court noted on page 13 of the May 26 Memorandum

Opinion and Order, the bankruptcy court's view of the limits of

the bankruptcy court's discretion in determining whether to

approve a settlement of the kind presented by Cameron has

respectable judicial precedent. See, e.g., In re de Armond, 240

B.R. 51, 60 (Bankr. C.D. Cal. 1999). Indeed, some of the court 

 

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decisions stand for the proposition that a proposed compromise

that includes as one of its elements withdrawal of objections to

discharge should, invariably, be disapproved as being in

contravention of public policy. This was the holding in In re

Moore, in which the court explained:

Discharge, the principal objective of a chapter 7

debtor, is a statutory right involving public policy

considerations. It is not a proper subject for

contractual negotiation. . . .

. . . Because it involves questions of public

policy previously determined by the Congress, a

discharge in bankruptcy is not an appropriate element

of a quid pro quo. Tying withdrawal of objections to

discharge to the settlement of other actions is

contrary to public policy. Under no circumstances, not

even where the intent is innocent, may a debtor

purchase a repose from objections to discharge. A

discharge in bankruptcy depends on the debtor's

conduct; it is not an object of bargain.

. . . the court declines to approve the compromise

on the basis that withdrawal of the objections to

discharge as an element of the compromise contravenes

public policy.

50 B.R. 661, 664 (Bankr. E.D. Tenn. 1985) (footnote omitted). 

Similar results were reached in In re Delco, 327 B.R. 491 (Bankr.

N.D. Ga. 2005); In re Levine, 287 B.R. 683 (Bankr. E.D. Mich.

2002); In re Smith, 207 B.R. 177 (Bankr. N.D. Ind. 1997); In re

Wilson, 196 B.R. 777 (Bankr. N.D. Ohio 1996); In re Vickers, 176

B.R. 287 (Bankr. N.D. Ga. 1994) (applying the absolute

prohibition against compromise rule to an attempt by the trustee

to compromise a § 727 claim, but suggesting that a different rule

might apply if a creditor had brought the claim and was seeking

approval of a compromise, at 290).

 

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Other courts have concluded that dismissal of a § 727

objection to discharge pursuant to a compromise between the

debtor and the creditor, or trustee, who filed the objection is

permissible so long as there is a full disclosure to all

interested parties, with the right to oppose the proposed

dismissal and with the right to continue prosecution of the

objection to discharge if one or more of the interested parties

does oppose the dismissal. This line of cases includes In re

Taylor, 190 B.R. 413 (Bankr. D. Colo 1995); In re Vickers, 176

B.R. at 290 (indicating that the court may well approve a

compromise of a § 727 claim brought by a creditor "where the

trustee and other creditors are notified and given the

opportunity to take up the discharge action but fail to do so");

In re Marston, 141 B.R. 767 (Bankr. M.D. Fla. 1992); In re Short,

60 B.R. 951 (Bankr. M.D. La. 1986); In re Margolin, 135 B.R. 671

(Bankr. D. Colo. 1992). In Short, the court gave the following

rationale for this view:

Since Rule 7041 [of the Federal Rules of

Bankruptcy Procedure] requires that the trustee receive

notice of the dismissal of a complaint to deny the

debtor's discharge and since the rule also allows the

Court to set terms and conditions that it deems proper,

the Court will require a notice to all creditors and

parties in interest of the motion to dismiss. The

notice will further state that the complaint will be

dismissed unless, within 20 days, a creditor other

interested party requests to be substituted as

plaintiff and/or objects to the dismissal. It will

also state the advantage that the Debtor is providing

in exchange for the plaintiff's motion to dismiss. 

This condition of full disclosure will provide all

interested parties with the right to object to the

dismissal and with the right to continue prosecution of

the complaint to deny the Debtor's discharge if they 

 

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wish to do so. If no creditor cares to pursue and if

the trustee does not wish to pursue denial of a

discharge, the Court can see no authority to deny the

dismissal and no way to achieve the prosecution of the

case.

60 B.R. at 953. 

The line of cases mentioned in the immediately preceding

paragraph assumes that the bankruptcy court has the authority to

allow another creditor or the trustee to be substituted for the

original plaintiff in a § 727 proceeding. There are cases

holding that an intervention or substitution of parties in a

§ 727 adversary proceeding after the deadline for filing an

objection to discharge is unauthorized. See In re Chalasani, 92

F.3d 1300 (2d Cir. 1996); In re Stout, 262 B.R. 862 (Bankr. D.

Colo. 2001). This court disagrees with the reasoning of the

Chalasani line of cases on that subject. There does not appear

to be a logical reason why a bankruptcy court cannot substitute

one creditor, or the trustee, for a plaintiff/creditor in a § 727

proceeding if the latter fails or refuses to go forward. A

number of the court opinions that discuss the subjects under

consideration in this memorandum opinion emphasize that a § 727

proceeding is for the benefit of the entire bankruptcy estate and

all creditors. See, e.g., In re de Armond, 240 B.R. at 55; In re

Joseph, 121 B.R. 679, 682 (Bankr. N.D.N.Y. 1990); In re

Drenckhahn, 77 B.R. 697, 701 (Bankr. D. Minn. 1987); In re Moore,

50 B.R. at 663-64. If the action is for the benefit of all

creditors and the trustee, logically any of them could be

substituted as a plaintiff. Cases that have approved

 

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substitution of the trustee or a creditor for the plaintiff in a

§ 727 adversary proceeding include In re Lindsey, 208 B.R. 169,

170 (Bankr. E.D. Ark. 1997); In re Joseph, 121 B.R. at 683; In re

Nicolosi, 86 B.R. 882, 888-89 (Bankr. W.D. La. 1988); In re

Short, 60 B.R. at 953. The court agrees with the conclusion

those courts expressly or impliedly reached that a substitution

of the trustee or creditor for a plaintiff/creditor who has

initiated a § 727 proceeding is authorized and proper. In In re

Margolin the court explained that a way to address the 

tension between vindication of the public interest in

upholding the policies behind § 727, and the public

interest in fostering the peaceful, just, speedy and

inexpensive resolution of disputes, is to (1) provide

notice and full disclosure of the terms of such

agreements between the original complaining creditor

and debtor to all parties in interest; and (2) to allow

other creditors and/or the trustee to intervene or be

substituted for the original complaining creditor in

order to prosecute the § 727 complaint.

135 B.R. at 673. 

As the Margolin court noted, a public-interest factor that

must be considered in determining whether a compromise that

contemplates dismissal of a § 727 proceeding should be approved

is the policy favoring settlement. The court deciding In re Hass

explained that:

Consensual resolution of litigation has been

favored in the law from time immemorial, whether by the

parties themselves, or through mediation or other

techniques of dispute resolution. Settlements in

discharge and dischargeability litigation are no less

favored.

. . . .

 

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. . . [A] per se prohibition on compromise of

Section 727(a) actions is entirely inconsistent with

Bankruptcy Rule 7041, the time-honored judicial policy

which favors consensual dispute resolution, and the

right which a plaintiff always has to decline to

continue prosecuting a claim.

273 B.R. 45, 50, 54 (Bankr. S.D.N.Y. 2002) (citation omitted).

Other court decisions involving a proposed dismissal of a § 727

objection to discharge that have paid significant attention to

the policy favoring settlement include In re Hayden, 246 B.R.

795, 799 (Bankr. D.S.C. 1999); In re Bates, 211 B.R. 338, 343

(Bankr. D. Minn. 1997); In re Mavrode, 205 B.R. 716, 719 (Bankr.

D.N.J. 1997).

The public interest in favor of settlement has played a

significant role in the development of the line of cases that

constitute the majority view, i.e., that settlement of a § 727

claim can, and should, be approved when the terms of the

settlement are fair and equitable and in the best interest of the

estate. See In re Hass, 273 B.R. at 50; In re Hayden, 246 B.R.

at 799; In re Mavrode, 205 B.R. at 719, 721-22. This majority

view is, of course, consistent with the directive of Rule 7041 of

the Federal Rules of Bankruptcy Procedure that "a complaint

objecting to the debtor's discharge shall not be dismissed at the

plaintiff's instance without notice to the trustee, the United

States trustee, and such other persons as the court may direct,

and only on order of the court containing terms and conditions

which the court deems proper." 

 

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The facts that the § 727 claim is combined with a § 523

claim, and the proposed settlement contemplates a ruling

favorable to the objecting creditor on the § 523 claim and

dismissal of the § 727 claim, do not prevent application of the

rule that a settlement should be approved if it is fair and

equitable and in the best interest of the estate. See, e.g., In

re Hass, where the court reasoned that:

Indeed, where a creditor settles a Section 523(a) claim

and also seeks dismissal of his Section 727(a) claim

(as was approved in In re Joseph, In re Margolin and In

re Hayden), it may be inferred that the dismissal was

at least in part a quid pro quo of the settlement. But

that does not bar a creditor from settling his Section

523(a) claim and abandoning his Section 727(a) claim

(which he has no further incentive to prosecute),

because other creditors and the Chapter 7 trustee will

receive full disclosure and an opportunity to prosecute

the Section 727(a) claim through the mechanism of

Bankruptcy Rule 7041.

273 B.R. at 56 (footnote omitted); and:

Finally, contrary to the Chapter 7 Trustee's

argument, there is no impropriety in confronting a

debtor with a non-frivolous, potentially viable Section

727(a) claim whether or not it puts the debtor under

pressure to settle the Section 523(a) claim. Litigants

are frequently confronted with the leverage that is

explicit in the potential adverse consequences of an

adverse judgment. A strong, viable claim may well

compel a settlement whereas a claim that the defendant

knows to be weak or frivolous should have little or no

coercive effect. The coercion comes not from the

assertion of a fair claim but from the debtor's own

conduct which gave rise to the claim. Accordingly, a

plaintiff need not show that the Section 727(a) claim

 

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is meritless in order that the compromise of the

Section 523(a) action be approved.

Id. at 57.

C. Factors to be Considered in Determining Whether to

Approve a Proposed Compromise of a § 727 Claim.

The court agrees with the majority view. Approval, vel non,

of the compromise in the instant action should be based on a

determination of whether the compromise is fair and equitable and

in the best interest of the estate. Some of the factors the

court decisions have suggested should be considered in making

that determination are the following:

(a) The strong policy favoring consensual dispute

resolution in bankruptcy litigation must be considered. Supra at

7-8.

(b) The potential success of the § 727 claim should be

considered. However, Cameron will not be obligated to show that

the § 727 claim is meritless in order to obtain approval of the

compromise. In re Hass, 273 B.R. at 57.

(c) The complexity, expense, inconvenience, and delay

attendant pursuit of the § 727 claim should be considered. In re

Mavrode, 205 B.R. at 721. 

(d) Whether estate funds are to be used in the settlement

is a significant factor. Id.

(e) The court should consider whether one creditor will

benefit from the compromise at the expense of other creditors. 

Id. Relevant to this factor is whether money to be paid by

Cameron will be out of funds of the estate. Id. 

 

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(f) As a corollary to (e) above, if the funds to be paid in

the settlement of the § 523 claim do not come from the estate,

other creditors will not only not be injured by the proposed

settlement, but will benefit from it if there were to be a

dividend from which the plaintiff's claim would be excluded. Id.

(g) If other creditors and the United States Trustee have

been afforded ample time to object to the settlement, and

supplant themselves as plaintiffs in the § 723 action in order to

prosecute it to a conclusion, but choose not to do so, there

would be no further benefit inuring to the bankruptcy estate in

requiring further litigation of the § 727 claim. Id. at 722.

(h) The potential that the § 523 claim is meritorious is

important, so the availability of prima facie evidence to support

the claim should be considered.

III.

Considerations Related to Remand

The United States Trustee has requested that "this Court

remand this matter to the bankruptcy court to reconsider the

approval of the proposed settlement after conducting an

evaluation of the bona fides of Cameron's complaint under 11

U.S.C. § 523." Br. of U.S. Trustee at 17. The court is inclined

to agree that, with the exception of the questions mentioned

below relative to adequacy of the notices and the possible need

to clarify the terms of the settlement agreement, a showing of

 

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In the instant action, the inconsistency between the valuations

used by the debtors in their bankruptcy papers and the valuations used

in the earlier papers submitted to Cameron might well be considered to

create prima facie evidence that false information was furnished.

12

prima facie validity of Cameron's § 523 claim1

 is all that should

be required for debtors and Cameron to gain approval of their

settlement (assuming that no other creditor or the United States

Trustee steps in to prosecute the § 727 claim). In other words,

virtually all of the factors mentioned under subsection C. above

appear, based on the record that already exists, to favor

approval of the compromise.

The court has concern that the notices previously given by

Cameron to the creditors and United States Trustee of the

proposed compromise were not adequate. While perhaps implicit in

the information conveyed by the notices, none of the

notifications expressly stated that an essential ingredient of

the proposed settlement was dismissal of the § 727 claim. The

Notice of Settlement a Request for Cause to be Continued on

Inactive Calendar signed May 26, 2005, stated that "[t]he parties

are preparing and will file a Stipulation for Judgment Regarding

Non-Dischargeability of Debt and a Judgment Denying

Dischargeability in the near future." R. at 27. Notably, there

is no mention of the proposed disposition of the § 727 claim. 

The Motion to Approve Judgment Denying Dischargeability of Debt

and Notice of Hearing signed June 24, 2005, is similarly

inadequate. Id. at 29-30. The same is true of the Stipulation

for Judgment Regarding Non-Dischargeability of Debt, which shows

 

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it was signed June 20, 2005, id. at 42-43, and the Notice of

Hearing on Motion to Approve Judgment Denying Dischargeability of

Debt, which shows it was signed July 1, 2005, id. at 46-47. 

Before proceeding with a hearing on whether the proposed

compromise should be approved, Cameron should be required to give

notice to all creditors and the United States Trustee of the

details of the proposed compromise and of the hearing date. See

In re Mavrode, 205 B.R. at 722. The Notice should specifically

advise that the proposed compromise contemplates dismissal of the

§ 727 claim and that if any creditor or the United States Trustee

wishes to be substituted for, or join with, Cameron in the

prosecution of that claim they should make that fact known to the

bankruptcy court a significant period of time prior to the

hearing date. Id.

Another point to be considered following remand is the

possibility of Cameron and the debtors clarifying the terms of

their settlement before the notification is given to the

creditors and the United States Trustee. From what this court

has learned, there will be no compromise if the § 727 claim is

not dismissed. Thus, if a creditor or the United States Trustee

were to elect to be substituted for, or join with, Cameron in the

prosecution of the § 727 claim, the matter of approval of a

compromise presumably will be moot. The parties will want to

take this contingency into account in clarifying the terms of

their settlement.

 

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Therefore,

The court ORDERS that the order the bankruptcy court signed

December 15, 2005, denying Cameron's Motion to Approve Judgment

Denying Dischargeability of Debt be, and is hereby, reversed, and

the matter of approving a proposed compromise between Cameron and

debtors be, and is hereby, remanded to the bankruptcy court for

further proceedings consistent with this Memorandum Opinion and

Order.

SIGNED October 12, 2006.

 /s/ John McBryde 

JOHN McBRYDE

United States District Judge

 

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