Court Opinion

ID: 3047234
Source: CourtListenerOpinion
Date Created: 2015-10-13 23:21:08.060382+00
Date Added: 2024-06-11T07:38:08.897764
License: Public Domain

United States Court of Appeals
                            FOR THE EIGHTH CIRCUIT
                                     ___________

                                     No. 08-2067
                                     ___________

In re: Racing Services, Inc.,                    *
                                                 *
               Debtor.                           *
------------------------------------------------ *
Kip M. Kaler, Chapter 7 Trustee,                 *
                                                 * Appeal from the United States
               Appellant,                        * Bankruptcy Appellate Panel
                                                 * for the Eighth Circuit.
        v.                                       *
                                                 *
Susan Bala,                                      *
                                                 *
               Appellee.                         *
                                          ___________

                                Submitted: February 13, 2009
                                   Filed: July 2, 2009
                                    ___________

Before LOKEN, Chief Judge, MELLOY and BENTON, Circuit Judges.
                              ___________

LOKEN, Chief Judge.

       Racing Services, Inc. (“RSI”), provided simulcast (simultaneous broadcast)
services to licensed off-track betting operators in North Dakota. RSI and Susan Bala,
its president and sole shareholder, were indicted for federal gambling and money
laundering violations. RSI petitioned for bankruptcy protection, and Kip M. Kaler
was subsequently appointed as Chapter 7 bankruptcy Trustee. A jury convicted RSI
and Bala in the criminal case. The district court sentenced Bala and entered forfeiture
judgments against Bala and RSI. With their appeal in the criminal case pending, Bala
filed a Chapter 7 administrative expense claim seeking $110,218.54 in post-petition
rent for Fargo office space owned by Bala and leased to RSI. After a hearing, the
bankruptcy court allowed the claim but subordinated it to “all other allowed claims
pursuant to 11 U.S.C. § 510(c)(1).” We will refer to this ruling as the “Subordination
Order.” The Eighth Circuit Bankruptcy Appellate Panel (“BAP”) affirmed. In re
Racing Servs., Inc., 340 B.R. 73 (B.A.P. 8th Cir. 2006).

      In March 2007, we reversed the criminal convictions and forfeiture judgments.
United States v. Bala, 489 F.3d 334 (8th Cir. 2007). Bala then filed and the
bankruptcy court granted a motion to vacate the Subordination Order under Rule
60(b)(5) of the Federal Rules of Civil Procedure, made applicable to bankruptcy cases
by Bankruptcy Rule 9024. The Trustee and the State of North Dakota, a substantial
RSI creditor, appealed. Again the BAP affirmed. In re Racing Servs., Inc., 386 B.R.
751 (B.A.P. 8th Cir. 2008). The Trustee appeals. We affirm.

                                           I.

       Administrative claims for post-petition services to a bankruptcy estate have first
priority when the assets of the estate are distributed to creditors. 11 U.S.C.
§§ 503(b)(1)(A), 507(a)(1). However, § 510(c)(1) of the Bankruptcy Code authorizes
the bankruptcy court to subordinate an allowed administrative claim to other claims
“under principles of equitable subordination.” Equitable subordination requires proof
of inequitable conduct by the claimant that injured other creditors or conferred an
unfair advantage. In re Bellanca Aircraft Corp., 850 F.2d 1275, 1282 (8th Cir. 1988).
Fraud, illegality, and breach of fiduciary duty are misconduct that justifies equitable
subordination. See Id. at 1282 & n.13; In re Missionary Baptist Found. of Am., Inc.,
712 F.2d 206, 212 (5th Cir.1983). In the Subordination Order, the bankruptcy court
subordinated Bala’s administrative claim to all other creditor claims because -

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      In causing RSI to engage in illegal activities resulting in its criminal
      convictions, Bala breached her fiduciary duty to RSI and engaged in
      unfair conduct. . . . Bala’s use of the debtor to perpetuate criminal
      violations of federal gaming laws . . . resulted in the possible forfeiture
      of all of RSI’s assets to the United States, and but for Bala’s involvement
      of RSI in her criminal schemes, RSI likely would not have ended up in
      bankruptcy. Bala’s involvement of RSI in illegal activity clearly injured
      RSI’s creditors.

On appeal, the BAP agreed. 340 B.R. at 76-77.

       After an argument hearing on Bala’s Rule 60(b)(5) motion, the bankruptcy
court granted relief and vacated its equitable subordination ruling because “the now
nonexistent criminal conviction” had been critical to that ruling. The court declined
the Trustee’s request to reopen the matter to consider other evidence of inequitable
conduct, observing that “whatever debt [Bala] had, she’s more than paid it.” The BAP
affirmed, concluding that the Rule 60(b)(5) motion was proper and finding no abuse
of discretion because, in equitably subordinating Bala’s administrative claim, both the
bankruptcy court and the BAP had “relied wholly on the Criminal Orders to satisfy
the first two elements of equitable subordination.” 386 B.R. at 754-55.

                                          II.

       Bankruptcy court rulings under Rule 60(b) are reviewed for abuse of discretion.
In re Kirwan, 164 F.3d 1175, 1177 (8th Cir. 1999). Here, the Trustee argues that Rule
60(b)(5) did not authorize the relief granted by the bankruptcy court, and therefore the
BAP erred in reviewing the bankruptcy court’s ruling for abuse of discretion, rather
than de novo. “Nothing turns on this argument because a . . . court by definition
abuses its discretion when it makes an error of law.” Prudential Ins. Co. of Am. v.
Nat’l Park Med. Ctr., Inc., 413 F.3d 897, 903 (8th Cir. 2005) (quotations omitted).
Thus, we construe this argument as confirming that the Trustee does not appeal the

                                          -3-
bankruptcy court’s exercise of its discretion. The only issue is whether the court had
legal authority to exercise that discretion.

       Rule 60(b)(5) authorizes relief from a final order if the order (i) “has been
satisfied, released or discharged,” (ii) “is based on an earlier judgment that has been
reversed or vacated,” or (iii) “applying it prospectively is no longer equitable.”1 The
Trustee argues that relief may not be granted under clause (ii) of Rule 60(b)(5)
because the Subordination Order was not, in the words of various cases and treatises,
“based on the prior judgment in the sense of claim or issue preclusion.” 11 Wright,
Miller & Kane, Federal Practice and Procedure: Civil 2d § 2863, at 334-35 (1995); see
12 Moore’s Federal Practice § 60.46[1] (2009) (“based on” means “the first judgment
has claim or issue preclusion effects on the second”). With Rule 60(b)(5) relief
unavailable, the bankruptcy court could grant relief after the criminal conviction and
forfeiture judgments were reversed only under Rule 60(b)(2), which applies to “newly
discovered evidence.” But Bala’s motion to vacate was filed more than one year after
entry of the Subordination Order, so a Rule 60(b)(2) motion was time-barred. See
Rule 60(c)(1). Therefore, the Trustee concludes, Rule 60(b) relief was unauthorized.
Like the BAP, we disagree.

      Clause (ii) of Rule 60(b)(5) has received little judicial attention and analysis.
All agree that clause (ii) is not a broad exception to principles of finality:

           Rule 60(b)(5) does not provide a basis for relief when one
      judgment relies on an earlier judgment merely as legal precedent and that

      1
        Neither party addressed whether the BAP’s affirmance was a final order
conferring appellate jurisdiction under 28 U.S.C. § 158(d). Though the Chapter 7
proceedings continue and we may raise this jurisdictional issue sua sponte, we see no
reason to doubt that the order in question was appealable. See In re Flight Transp.
Corp. Sec. Litig., 874 F.2d 576, 580 (8th Cir. 1989) (definitive ruling on whether a
party is entitled to administrative expenses falls within the collateral order doctrine).

                                          -4-
      legal precedent is subsequently set aside or overturned. A change in the
      law following a judgment does not merit relief under Rule 60(b)(5).

12 Moore’s Federal Practice at § 60.46[2], citing cases from four other circuits. That
principle is clear, but it is harder to define when clause (ii) does apply. Many cases,
like the above-quoted treatises, have cross-referenced the law of issue and claim
preclusion. See Schwartz v. United States, 976 F.2d 213, 217 (4th Cir. 1992), cert.
denied, 507 U.S. 919 (1993); Klein v. United States, 880 F.2d 250, 258 n.10 (10th Cir.
1989); Tomlin v. McDaniel, 865 F.2d 209, 210-11 (9th Cir. 1989); Harris v. Martin,
834 F.2d 361, 364 (3d Cir. 1987). Other cases have held that a decision was “based
on” a prior judgment only if the prior judgment was “a necessary element of the
decision, giving rise, for example, to the cause of action or a successful defense.”
Lubben v. Selective Serv. Sys. Local Bd. No. 27, 453 F.2d 645, 650 (1st Cir.1972);
accord Bailey v. Ryan Stevedoring Co., 894 F.2d 157, 160 (5th Cir.), cert. denied, 498
U.S. 829 (1990); De Filippis v. United States, 567 F.2d 341, 343 n.4 (7th Cir. 1977),
overruled on other grounds, United States v. Chicago, 663 F.2d 1354 (7th Cir. 1981).

       The Trustee argues that the Subordination Order was not “based on” the
criminal conviction and forfeiture judgments because subordination was not “required
by” the preclusive effect of those judgments, nor were those judgments a “necessary
element” of the equitable subordination remedy. We agree that, in the first
proceeding, the Trustee used the conviction and forfeiture judgments “as probative
evidence” of inequitable conduct that injured creditors, rather than as judgments
whose collateral estoppel effect precluded litigation of the equitable subordination
issue. Morse v. Comm’r, 419 F.3d 829, 833 (8th Cir. 2005). But the Subordination
Order was in fact “based on” those prior judgments, in that they provided conclusive
proof of inequitable conduct and injury to creditors, and those judgments could not
be impeached or collaterally attacked until reversed by this court. As reversal did not
occur until relief under Rule 60(b)(2) was time-barred, the BAP concluded that Rule
60(b)(5) relief should be available.

                                         -5-
       There are a few cases suggesting that clause (ii) may be applied beyond the four
corners of issue or claim preclusion, but we acknowledge that this situation does not
fit neatly within the prior authorities construing and applying clause (ii). See Bagley
v. Comm’r, 121 F.3d 393, 395 n.4 (8th Cir. 1997) (district court could likely use Rule
60(b)(5) to reinstate invasion-of-privacy award dismissed as duplicative of libel
award, if the libel claim ultimately failed); Werner v. Carbo, 731 F.2d 204, 207 (4th
Cir. 1984) (relief available under clause (ii) if judgment sought to be vacated was
entered simultaneously with the prior judgment even if res judicata or collateral
estoppel were not applied). We conclude that we need not decide whether clause (ii)
reaches this situation because relief was available under clause (iii) of Rule 60(b)(5),
which authorized relief if “applying [the Subordination Order] prospectively is no
longer equitable.”

       An order has “prospective application” within the meaning of clause (iii) if “it
is executory or involves the supervision of changing conduct or conditions.” Twelve
John Does v. District of Columbia, 841 F.2d 1133, 1139 (D.C. Cir. 1988) (quotations
omitted). This subpart of Rule 60(b)(5) “encompasses the traditional power of a court
of equity to modify its decree in light of changed circumstances.” Frew ex rel. Frew
v. Hawkins, 540 U.S. 431, 441 (2004).

       The Trustee’s briefs largely ignored this issue, simply asserting that clause (iii)
does not apply because “the subordination would not be considered a prospective
judgment.” We disagree. Bankruptcy courts are courts of equity, and subordination
is an equitable remedy. Farmers Bank of Clinton, Mo. v. Julian, 383 F.2d 314, 322
(8th Cir.), cert. denied, 389 U.S. 1021 (1967). The Subordination Order had a
prospective application -- it governed future distributions of the bankruptcy estate’s
assets to RSI creditors.2 In Kirwan, we held that Rule 60(b) authorized the bankruptcy

      2
       Only this prospective application was affected by the Rule 60(b)(5) relief
granted. If Bala had sought an order requiring repayment of prior distributions that
were based on the Subordination Order, the equities would have been significantly

                                           -6-
court to reconsider a prior order whose prospective application would inequitably
preclude lifting the automatic stay of a creditor’s fraud action. 164 F.3d at 1177-78.
In In re Hendrix, 986 F.2d 195, 196-99 (7th Cir. 1993), the Seventh Circuit held that
Rule 60(b)(5) authorized the bankruptcy court to modify the inequitable prospective
effects of its discharge order. Consistent with these authorities, we conclude the
bankruptcy court had equitable discretion to modify the prospective application of the
Subordination Order under clause (iii) of Rule 60(b)(5).

     The judgment of the Bankruptcy Appellate Panel is affirmed. The Trustee’s
motion to supplement the record is denied.
                      ______________________________

different, though relief from the prior Order might still have been appropriate.

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