Court Opinion

ID: 4208264
Source: CourtListenerOpinion
Date Created: 2017-10-02 17:00:35.833314+00
Date Added: 2024-06-11T07:47:14.140772
License: Public Domain

NOT PRECEDENTIAL

               UNITED STATES COURT OF APPEALS
                    FOR THE THIRD CIRCUIT
                         _____________

                             No. 16-1865
                            _____________

              In re: LINDA MERRITT a/k/a Lyn Merritt,
                                              Debtor

                          LINDA MERRITT,
                                 Appellant

                                   v.

       CHESHIRE LAND PRESERVATION TRUST; JOHN DOE;
MICHAEL PELET; MID ATLANTIC FARM CREDIT, A.C.A.; KURT HEYMAN

                            _____________

                             No. 16-1866
                            _____________

              In re: LINDA MERRITT a/k/a Lyn Merritt,
                                              Debtor

                          LINDA MERRITT,
                                 Appellant

                                   v.

             R&R CAPITAL LLC; FTP CAPITAL LLC;
           KURT HEYMAN; PANDORA FARMS, LLC;
      GRAYS FERRY PROPERTIES, LLC; MERRITT LAND, LLC;
             BUCK AND DOE RUN VALLEY FARMS
                      ______________

             On Appeal from the United States District Court
                for the Eastern District of Pennsylvania
            (D.C. Civ. Nos. 2:15-cv-01854 & 2:15-cv-01855)
                 District Judge: Hon. Gerald J. Pappert
                                     ______________

                      Submitted Under Third Circuit L.A.R. 34.1(a)
                                     June 9, 2017
                                  ______________

           Before: CHAGARES, VANASKIE, and FUENTES, Circuit Judges

                                 (Filed: October 2, 2017)
                                     ______________

                                        OPINION*
                                     ______________

VANASKIE, Circuit Judge.

       Debtor-Appellant Linda Merritt filed for Chapter 13 bankruptcy after defending a

series of lawsuits by a former business partner, Appellee R&R Capital LLC. During the

ensuing bankruptcy proceedings, Merritt proposed to the Trustee several adversary

actions intended to avoid certain transfers of assets to R&R and Appellee Cheshire Land

Preservation Trust. After the Trustee decided not to pursue those actions, Merritt filed

two adversary actions on her own behalf and sought to compel the Trustee to substitute,

join, or ratify her complaints. When the Bankruptcy Court declined to compel the

Trustee, R&R and Cheshire filed motions to dismiss the respective adversary actions

filed by Merritt. The Bankruptcy Court dismissed both actions, declining to grant Merritt

derivative standing to pursue the claims and alternatively finding that Merritt had failed

to state an avoidance claim. On review, the District Court affirmed for the same reasons.

       *
        This disposition is not an opinion of the full Court and pursuant to I.O.P. 5.7
does not constitute binding precedent.

                                             2
We will affirm on the ground that Merritt lacked derivative standing to pursue the

adversary actions.

                                             I.
       Linda Merritt and R&R Capital LLC formed a number of jointly-operated limited

liability companies (“the LLCs”) between 2003 and 2004. Merritt was appointed the

managing member of the LLCs, through which Merritt and R&R invested in commercial

real estate and thoroughbred horses. The relationship between Merritt and R&R soured

several years later, and R&R initiated six lawsuits in four separate jurisdictions seeking,

among other things, to remove Merritt as the managing member of the LLCs.

       In one such case before the Eastern District of Pennsylvania,1 R&R sought

rescission and replevin of a sale of horses against Merritt, alleging that she had

fraudulently induced R&R into agreeing to the transaction. After a bench trial, the

district court found in favor of R&R on the rescission and replevin claims, and the court

ordered Merritt to refund the purchase price.

       While this Pennsylvania litigation was progressing, R&R sent Merritt notice of her

removal as manager of the LLCs for cause under the companies’ operating agreements.

R&R accompanied this notice with a lawsuit in the Delaware Court of Chancery seeking

a declaration that Merritt was properly removed as manager and member of the LLCs.

By declaratory judgment, the Court of Chancery affirmed that Merritt had been removed

as manager for cause.

       1
         R&R Capital, LLC v. Merritt, 632 F. Supp. 2d 462, 479–80 (E.D. Pa. 2009),
aff’d, 426 F. App’x 85 (3d Cir. 2011).
                                              3
       In the wake of Merritt’s removal, Kurt Heyman was appointed by the Delaware

court as the receiver for the LLCs in their liquidation and dissolution. Heyman had the

LLCs’ properties evaluated and appraised. One such property—a 90-acre tract of land

located on Apple Grove Road in East and West Marlborough Townships, Pennsylvania,

and purchased for $1.3 million—was appraised at $3.2 million. Despite the appraisal,

Heyman was unable to dispose of the Apple Grove property by private sale, purportedly

because of the state of the real estate market in 2009. Heyman instead held a public

auction in 2010 to sell the Apple Grove property, and Cheshire Land Preservation Fund’s

$1.1 million bid was the highest received. Because this bid did not satisfy the mortgage

on the property held by MidAtlantic Farm Credit, Heyman convinced Cheshire to

purchase the property post-auction for $1.25 million, an amount that narrowly exceeded

the outstanding mortgage.

       Meanwhile, in the ongoing Delaware litigation, the Court of Chancery ordered a

freeze on the bank accounts of the LLCs in response to evidence that Merritt was

continuing to withdraw funds. Heyman, as receiver, sought a contempt order alleging

that Merritt was frustrating his ability to wind up the LLCs’ affairs. The Court of

Chancery found Merritt in contempt after her violation of several previous orders. The

contempt order, among other penalties, removed Merritt as a member of all the

companies in receivership and stripped her of any entitlement to the distribution of the

assets of those companies at the conclusion of their dissolution and winding up. (App.

806–09.) Merritt contested the contempt order, but the Court of Chancery dismissed her

                                             4
claims. Her appeal to the Delaware Supreme Court was unsuccessful, and the United

States Supreme Court denied her petition for a writ of certiorari.

       After Merritt’s challenges to the contempt order concluded, Merritt filed a

voluntary bankruptcy petition under Chapter 13. As the bankruptcy proceeded, Merritt

proposed two adversary complaints to the Chapter 13 Trustee, one seeking to avoid the

transfer of the Apple Grove property to Cheshire, and the other challenging Heyman’s

transfer of $5 million in assets of the LLCs to R&R for less than equivalent value. When

the Trustee did not take action, Merritt filed her own adversary complaints against

Cheshire and R&R. The Cheshire complaint sought to avoid Heyman’s sale of the Apple

Grove property under § 548(a)(1)(B) of the Bankruptcy Code. The R&R complaint

alleged that the transfers of assets to R&R resulting from the Delaware contempt order

were a fraudulent conveyance under § 548.

       Merritt next filed a motion to compel the Trustee to substitute, join, or ratify her

complaints against Cheshire and R&R, or else abandon the claims and grant Merritt

derivative standing to prosecute the actions. The Bankruptcy Court denied this motion

after an emergency hearing. Both Cheshire and R&R then moved to dismiss Merritt’s

claims against them on the basis that she lacked standing. Merritt also moved for leave to

amend the complaint. The Bankruptcy Court granted Cheshire’s motion to dismiss,

explaining that Merritt did not have derivative standing to pursue a § 548 claim and had

failed to state a claim because she did not hold an interest in the Apple Grove property

when it was transferred. For the same reasons, the Court held that any amendment of the

complaint would be futile. The following day, the Bankruptcy Court granted R&R’s

                                              5
motion to dismiss and denied Merritt’s motion for leave to amend, referring to its

reasoning in granting Cheshire’s motion the day before. Merritt appealed the Bankruptcy

Court’s decisions to the District Court, which affirmed the orders below.

       Merritt now appeals the District Court’s orders affirming the motions to dismiss,

and the cases have been consolidated for appeal.

                                             II.

       The Bankruptcy Court had jurisdiction over this matter pursuant to 28 U.S.C.

§ 157(b)(1) and § 1334. The District Court had jurisdiction pursuant to 28 U.S.C.

§ 158(a). We have appellate jurisdiction under 28 U.S.C. § 158(d) and § 1291. We

exercise the same standard of review as the District Court, “review[ing] the bankruptcy

court’s legal determinations de novo, its factual findings for clear error and its exercise of

discretion for abuse thereof.” In re Trans World Airlines, Inc., 145 F.3d 124, 130–31 (3d

Cir. 1998).

                                             III.

       We begin and end our analysis with the issue of derivative standing.

Traditionally, the avoidance powers under 11 U.S.C. § 548 belong exclusively to the

trustee. In re Knapper, 407 F.3d 573, 583 (3d Cir. 2005). But we have previously

recognized that a bankruptcy court may, in certain situations, authorize an action based

on derivative standing under the court’s equitable powers “when the Bankruptcy Code’s

envisioned scheme breaks down.” In re Weyandt, 544 F. App’x 107, 110 (3d Cir. 2013)

(citing Official Comm. of Unsecured Creditors of Cybergenics Corp. v. Chinery, 330

F.3d 548, 553 (3d Cir. 2003) (en banc)). For example, “derivative standing is a prudent

                                              6
way for bankruptcy courts to remedy lapses in a trustee’s execution of its fiduciary duty.”

Cybergenics, 330 F.3d at 572. Nonetheless, such scenarios are uncommon, and

“derivative standing is the exception rather than the rule.” In re Balt. Emergency Servs.

II, Corp., 432 F.3d 557, 562 (4th Cir. 2005).

       In this Circuit, derivative standing has not yet been applied in the context of a

Chapter 13 bankruptcy. Merritt nevertheless urges us to extend derivative standing to

Chapter 13 debtors to pursue avoidance actions. But we need not decide the question in

this case because the specific circumstances do not warrant derivative standing even if it

were available to Chapter 13 debtors.

       In Weyandt, a case in which a Chapter 13 debtor argued that she was improperly

denied derivative standing to pursue an avoidance action, we explained that the debtor

was required to demonstrate that derivative standing was appropriate in her case because

the Trustee failed to carry out its duties in declining to initiate an avoidance action

directly. 544 F. App’x at 110; see, e.g., Cybergenics, 330 F.3d at 559–76. Regarding

this requirement, we cited a Sixth Circuit decision, In re Gibson Grp., Inc., which

observed that “perhaps the most important prerequisite to derivative standing is that [the

party with authority to act under the Bankruptcy Code] has abused its discretion in failing

to avoid a preferential or fraudulent transfer.” 66 F.3d 1436, 1442 (6th Cir. 1995).

       In this case, Merritt has not demonstrated that the Trustee failed to carry out his

duties or had abused his discretion in declining to pursue her proposed avoidance claims.

Based on the Trustees’ testimony at the motion to compel hearing, the Bankruptcy Court

observed that

                                                7
       (1) Merritt did not request that [the Trustee] file the adversary complaints
       until shortly before the expiration of the two-year statute of limitations, and
       he had insufficient time to conduct a reasonable investigation into the long
       background of the various litigations and sign the complaints in compliance
       with [Federal Rule of Bankruptcy Procedure] 9011; (2) [the Trustee] knew
       that Cheshire and R&R Capital had, at the very least, a colorable defense in
       rebutting Merritt’s claims; (3) Merritt Land—not Merritt herself—owned
       the Apple Grove Property; (4) the Contempt Order extinguished any right
       Merritt had to the proceeds from the sale of any of the Entities’ properties,
       including the Apple Grove Property; and (5) Heyman auctioned the Apple
       Grove Property “under the auspices of the Chancery Court” for “reasonably
       equivalent value.”

(App. 32–33.) Given these circumstances, both the Bankruptcy Court and the District

Court concluded that the Trustee did not violate any fiduciary duty.

       In particular, the Bankruptcy Court and District Court focused heavily on the

timing of Merritt’s proposed adversary actions. They noted that Merritt sent the draft

complaints to the Trustee only three weeks before the statute of limitations was to expire

and provided no explanation for her delay. This forced the Trustee to attempt to

familiarize himself with a maze of litigation across multiple jurisdictions in order to

determine whether he should pursue the claims and represent to the Bankruptcy Court

that each claim was non-frivolous under penalty of sanctions. Even beyond Merritt’s

delay, the Trustee could reasonably conclude that Merritt acted fraudulently in light of

the Pennsylvania ruling and the Delaware contempt order, such that the avoidance

complaints would be rebutted. The Trustee could also reasonably believe that the sale of

the Apple Grove property satisfied § 548’s “reasonably equivalent value” requirement

because the price negotiations had yielded a price above the outstanding mortgage and in

excess of the highest bid at auction.

                                              8
       Merritt argues that, despite these findings, pursuing the avoidance actions would

have been best for the estate. But this line of reasoning assumes that these claims will

succeed. The Trustee was placed in a position where he was required to determine

whether the claims were frivolous or meritorious in a very short period of time. He did

not abuse his discretion in deciding not to pursue them, given the circumstances above,

regardless of the potential benefit to the estate of a successful outcome. This is not an

example of the “Bankruptcy Code’s envisioned scheme break[ing] down.” Weyandt, 544

F. App’x at 110.

       We further disagree with Merritt’s assertion that, because she mentioned her

pending adversary actions in her confirmed Chapter 13 plan and neither Cheshire nor

R&R objected, they have waived their ability to challenge her standing to pursue those

actions. Derivative standing is an application of the bankruptcy courts’ equitable powers,

Cybergenics, 330 F.3d at 568, and a debtor cannot confer derivative standing upon him or

herself by simply by noting in the plan that an adversary action has been filed. Merritt’s

Chapter 13 plan states that, as a matter of fact, Merritt was pursuing the adversary

proceedings. Cheshire and R&R cannot be held to have forfeited their ability to

challenge Merritt’s standing for failing to object to a true statement. Rather, they

properly pursued their challenge by way of motions to dismiss in the adversary actions.

       Thus, we find that Merritt was not inappropriately denied derivative standing to

pursue her avoidance claims, and dismissal was proper under Federal Rule of Civil

Procedure 12(b)(1). Since Merritt lacks standing, we need not address the sufficiency of

her avoidance claim under § 548.

                                             9
                                          IV.

      For the foregoing reasons, we will affirm the March 10, 2016 orders of the District

Court affirming the March 25 and 26, 2015 orders of the Bankruptcy Court.

                                          10