Court Opinion

ID: 3034810
Source: CourtListenerOpinion
Date Created: 2015-10-13 22:51:38.209357+00
Date Added: 2024-06-11T08:12:31.097012
License: Public Domain

United States Bankruptcy Appellate Panel
                        FOR THE EIGHTH CIRCUIT

                                  ______

                              No. 03-6082ND
                                  ______

In re:                                *
                                      *
North Star Management, LP; North      *
Star Management, LLP                  *
                                      *
      Debtors                         *
                                      *
Michael J. Farrell, Chapter 7 Trustee *      Appeal from the United States
                                      * Bankruptcy Court for the
      Plaintiff-Appellee              *      District of North Dakota
                                      *
             v.                       *
                                      *
American Executive Management, Inc.; *
                                      *
      Defendant-Appellant             *
                                      *
Countryside Partners, LLC             *
                                      *
      Defendant-Appellee              *
                                      *

                                  ______

                         Submitted: March 25, 2004
                            Filed: May 4, 2004
                                  ______

Before KRESSEL, Chief Judge, DREHER, and MAHONEY, Bankruptcy Judges.
                                ______

KRESSEL, Chief Judge.
      American Executive Management appeals from an order of the bankruptcy
court granting judgment to the trustee. We reverse.

                                 BACKGROUND
       The debtors owned and operated a hotel in Bismarck, North Dakota. On
February 14, 2001, the debtors filed for bankruptcy relief under Chapter 11. On
March 21, 2001, the debtors moved the bankruptcy court to employ American
Executive Management, a hotel management company, to manage the hotel. On April
6, 2001, the bankruptcy court approved the employment of American Executive
Management. The bankruptcy court’s order provided that the terms of the
employment would be substantially the terms as set forth in the Management
Agreement, the contract between the debtors and American Executive Management.
The order also provided that the fees charged by American Executive Management
would be ordinary and necessary expenses of the business, thus payable from cash
collateral, and paid in accordance with the Management Agreement.

      On April 9, 2001, American Executive Management took possession of the
hotel and began providing on-site management. On this date, the business bank
account of the debtors had a balance of $85,093.85, but the debtors and American
Executive Management agreed that Eide Bailly, LLP, the firm that handled the
accounting prior to American Executive Management’s involvement, would continue
to handle the accounting and reporting for the month of April. American Executive
Management was not aware of any restriction on the debtors’ use of the money in the
account.

       When American Executive Management took over management of the debtors’
hotel, the debtors’ account was renamed the “credit card account” and used to isolate
credit card payments and to make the audit trail more definite. American Executive
Management authorized a certain number of its employees to access the debtors’
account and also opened four new bank accounts in its name. The debtors’ funds were

                                         2
not transferred to the new accounts until April 25, 2001, the date American Executive
Management took exclusive supervision, direction, and control over the operation of
the hotel. American Executive Management did not provide a surety bond1 as
required by the Management Agreement.

       Pursuant to the Management Agreement2 Sanjay Patel, the managing partner
of the Debtors, was prohibited from accessing the accounts. Nevertheless on May 6,
2001, Donald Boos, American Executive Management’s president, became aware that
Patel had withdrawn $36,000 from the credit card account on May 5, 2001. The
withdrawal resulted in an overdraft, and the bank contacted Boos. Boos in turn
contacted Patel and the debtors’ attorney. The next day, Patel obtained a cashier’s
check and replaced the money taken from the account. Patel again wrongfully
withdrew money from the account on the following dates:

             May 11, 2001    $5,941.26
             May 11, 2001    $495.75
             May 21, 2001    $12,416.14
             May 21, 2001    $5,942.50
             May 24, 2001    $3,681.75
             May 30, 2001    $4,252

     Before the debtors filed their petitions, Countryside had foreclosed its
mortgage on the hotel. It took legal possession of the hotel on May 8, 2001, the date

      1
       The Management Agreement required that American Executive Management
maintain a surety bond in an amount not less than $1,000,000 or other amount as
required by the United States Trustee or the court.
      2
       The Management Agreement mandated that the debtor in possession was to
have no right to draw upon or use such funds except in accordance with, or upon
termination of, the Agreement.
                                          3
the period of redemption expired. Countryside, however, did not obtain physical
possession of the hotel until June 8, 2001. At the end of the redemption period, there
was a balance of $17,128.59 in the debtors’ account. In June of 2001, after receiving
a bank statement and after American Executive Management’s employment was
terminated, Boos was made aware of Patel’s additional unauthorized transactions.

       During its tenure as manager of the hotel, American Executive Management
paid itself the following fees and expenses3:

             May 1, 2001 $3,000.00
             May 7, 2001 3,500.00
             May 7, 2001 4,430.00
             May 7, 2001 1,218.20
             May 7, 2001 598.91
             May 7, 2001 620.97
             May 22, 2001 224.23
             June 1, 2001 4,343.62
             June 5, 2001 697.07
             June 5, 2001 253.66
             June 5, 2001 301.95
             June 8, 2001 180.65
             TOTAL       19,369.26

American Executive Management did not file an application with the bankruptcy
court for authorization of these payments.

      3
        The Management Agreement required the debtors to pay American Executive
Management the following: a management fee equal to four and one-half percent of
gross revenues, payable monthly on the first day of each month; a base management
fee of no less than $3,500 per month; an accounting fee equal to seven dollars per
room per month; a commencement fee in the amount of $3,000; a yearly incentive
management fee equal to ten percent of net operating income, in excess of $550,000
up to $650,000 and fifteen percent of net operating income in excess of $650,000;
reimbursement of costs and expenses.
                                          4
        In August of 2001, the United States Trustee appointed J.W. Associates as
examiner in order to conduct an investigation into the accounts of the debtors. The
examiner submitted a report indicating that Sanjay Patel, the managing partner of the
debtors, removed approximately $87,535.12 from an account of the debtors during
the month of May 2001 without authorization or sufficient documentation. The bulk
of this money was paid or transferred to Patel after the commencement of the Chapter
11 case but prior to the conversion to Chapter 7 and the appointment of Michael J.
Farrell as the trustee on September 18, 2001.

       The trustee brought an adversary proceeding against Patel and others to recover
the unauthorized post petition transfers. On August 29, 2002, a judgment was entered
in favor of the trustee for $82,935.12. After reviewing documents in connection with
the administration of the debtors’ cases, the trustee concluded that the unauthorized
transfers from the debtors’ account occurred during American Executive
Management’s period of management of the hotel, which was from April 9 through
June 8, 2001. As a result, the trustee commenced this adversary proceeding on
October 11, 2002. The trustee sought a $102,304.38 judgment against American
Executive Management for its breach of its contractual and fiduciary duties to ensure
that estate funds were not dissipated by unauthorized individuals and to provide a
bond to the estate, and for the fees and expenses American Executive Management
paid itself for managing the debtors’ hotel. The trustee also sought a determination
of the competing claims, if any, of the trustee and Countryside Partners to rents and
profits.

       On March 27, 2003, American Executive Management filed a verified answer
and a cross claim against Countryside. American Executive Management requested
that the complaint be dismissed and asserted it was entitled to damages in an amount
exceeding $20,000 because of the estate’s termination of its contract. American
Executive Management also argued that it was entitled to income Countryside

                                          5
received after the termination of its contract because that income was generated by
the hotel during American Executive’s management.

       On April 2, 2003, Countryside filed an answer and a counterclaim, seeking a
determination of the allocation of rents and profits belonging to the bankruptcy estate
as well as those belonging to Countryside for its ownership of the hotel from May 8,
2001 to June 8, 2001. Countryside sought a judgment against American Executive
Management for hotel rents and profits received by that company in the amount of
$177,184.71 minus reasonable expenses. Prior to the August 2003 trial, the trustee
and Countryside reached an agreement regarding rents and profits received for the use
of the hotel property prior to and after May 8, 2001. Countryside and the estate agreed
that they would share any recovered rents and profits equally, and the estate also
would receive $100,000 from Countryside to release the estate’s claim to any
ownership interest in and recovery of property.

       In its October 10, 2003 order, Farrell v. American Executive Management, Inc.,
305 B.R. 312 (Bankr.D.N.D. 2003), the bankruptcy court found the following: (1)
American Executive Management was a professional person for the purposes of 11
U.S.C. § 327, and did not comply with the requirements of 11 U.S.C. § 330 and as a
result the $19,369.26 it paid itself must be disgorged; (2) American Executive
Management’s failure to protect the estate from misappropriations by Patel after May
5, 2001 was negligent and constituted a breach of its fiduciary duty to the estate, and
as a result it was liable for the $82,935.12 misappropriated by Patel; (3) American
Executive Management materially breached the Management Agreement by failing
to obtain a bond as required by that agreement, and by failing to prevent Patel from
having access to the accounts. The bankruptcy court granted the trustee judgment in
the total amount of $102,304.38 against American Executive Management.

      As a result of the settlement agreement between Countryside and the estate, the
bankruptcy court found that the issue of competing claims of the estate and

                                          6
Countryside had been resolved, and therefore dismissed all claims, counterclaims, and
cross claims other than trustee’s complaint against American Executive Management.
American Executive Management appeals from the part of the October 10, 2003 order
that awards a money judgment to the trustee and against American Executive
Management. None of the parties have appealed from that part of the order dismissing
all other claims.

                              STANDARD OF REVIEW
       On appeal, we review the bankruptcy court’s findings of fact for clear error.
Fed.R.Bankr.P. 8013; First Nat’l Bank of Olathe v. Pontow, 111 F.3d 604, 609 (8th
Cir. 1997); Christians v. Crystal Evangelical Free Church (In re Young), 82 F.3d
1407, 1413 (8th Cir. 1996); Hartford Life and Accident Ins. Co. v. Henricksen (In re
Henricksen), 227 B.R. 759 (B.A.P. 8th Cir. 2002). We review conclusions of law de
novo. Blackwell v. Lurie (In re Popkin & Stern), 223 F.3d 764, 765 (8th Cir. 2000);
Wendover Fin. Servs. v. Hervey (In re Hervey), 252 B.R. 763, 765 (B.A.P. 8th Cir.
2000). A finding of fact will not be reversed as clearly erroneous unless the reviewing
court is left with a definite and firm conviction that a mistake has been committed.
Wintz v. American Freightways, Inc. (In re Wintz), 230 B.R. 840, 844 (B.A.P. 8th Cir.
1999) (citing Waugh v. Eldridge (In re Waugh) 95 F.3d 706, 711 (8th Cir. 1996)).

                                       DISCUSSION
      WAS AMERICAN EXECUTIVE MANAGEMENT A PROFESSIONAL
                                         PERSON?
        Although the parties argue much about whether American Executive
Management was a professional person or not, we need not address this issue nor
decide in the abstract whether a hotel management company is a professional person.
It is the law of this case that it is a professional person. 11 U.S.C. § 327(a) requires
a debtor to obtain court approval in order to employ a professional person. In re
Bartley Lindsay Co., 120 B.R. 507, 511 (Bankr.D.Minn. 1990). The Bankruptcy Code
provides no definition of “professional persons” but the term has regularly been

                                           7
accepted to mean persons who play a central role in the administration of the
proceedings. DOLA Intern. Corp. v. Bordlemay (In re DOLA Intern. Corp.), 88 B.R.
950, 954 (Bankr.D.Minn. 1988).

      The debtors, citing 11 U.S.C. § 327 for authority in its motion, treated
American Executive Management as a professional person when it applied for court
approval for American Executive Management’s employment. In the Management
Agreement, American Executive Management acknowledged its status as a
professional under the Bankruptcy Code. Likewise, the bankruptcy court treated
American Executive Management as a professional person when it had a hearing on
the matter and granted the debtors’ motion to approve its employment. The order
approving retention also carved out payment to it, along with other professionals in
the case. We think it is too late to dispute that American Executive Management is
a professional person. Thus, for purposes of this opinion, we assume American
Executive Management is a professional person.

   PAYMENT OF AMERICAN EXECUTIVE MANAGEMENT’S FEES AND
                                    EXPENSES
       While 11 U.S.C. §§ 330 and 331 contemplate the disbursement of fees to a
professional after compliance with those sections, nothing in those sections prohibit
the bankruptcy court from authorizing a professional person to be paid its fees on an
ongoing basis with the actual application and allowance of those fees to come later.
Under 11 U.S.C. §328, which authorizes the employment of professionals on any
reasonable terms and conditions including retainers, application procedures whereby
the professionals may be paid each month without prior court approval of billing
statements are permissible. See In re ACT Mfg., Inc., 281 B.R. 468 (Bankr.D.Mass.
2002); In re Mariner Post-Acute Network, Inc., 257 B.R. 723 (Bankr.D.Del. 2000);
Matter of Dandy Lion Inns of America, 120 B.R. 1015, 1017 (Bankr.D.Neb. 1990).
This is exactly what occurred in this case. In its April 6, 2001 order approving the
employment of American Executive Management, the bankruptcy court stated that

                                         8
the terms of the employment would be substantially the terms as set forth in the
Management Agreement. In that agreement, the debtors agreed to pay American
Executive Management a management fee equal to four and one-half percent of gross
revenues, payable monthly on the first day of each month, in addition to
reimbursement for costs and expenses.

                            DISGORGEMENT OF FEES
       We believe the bankruptcy court properly exercised its discretion in the
employment order to allow American Executive Management to be paid in
accordance with its management agreement. Therefore, we think it was an error for
the bankruptcy court to order American Executive Management to disgorge its fees
simply for failing to comply with 11 U.S.C. §§ 330 and 331. We note, however, that
the fees paid to American Executive Management still remain subject to being
approved under § 330, and eventually on its own initiative or by a date set by the
bankruptcy court, American Executive Management will have to file an application
and have its fees allowed. To the extent that, at that time, the bankruptcy court does
not allow its fees, the excess would be subject to disgorgement.

                      MATERIAL BREACH OF CONTRACT
      It is undisputed that American Executive Management failed to obtain a surety
bond in an amount no less than $1,000,000, as required by the Management
Agreement. The bankruptcy court, however, concluded that the bond would not
provide coverage for the money Patel wrongfully withdrew. If the bond would not
have provided any coverage, then the failure to provide the bond did not affect or
damage the debtors, the estate, or the trustee in any way. Thus, American Executive
Management’s breach of the Management Agreement was not material.

      In addition, section 7.01 of the Management Agreement required American
Executive Management to create a special account in which the debtors had no right
to draw upon or use. This provision deals primarily with the obligations and rights of

                                          9
the debtors, not of American Executive Management. However, to the extent this
provision of the Management Agreement imposed any obligation on American
Executive Management, it complied with the contract by creating an account that the
debtors had no right to draw upon or use. The fact that Patel somehow convinced the
bank to give him money from the account does not indicate any breach of the contract
by American Executive Management.

                         BREACH OF FIDUCIARY DUTY
       The parties argue much about whether or not American Executive Management
was a fiduciary. We need not decide this issue because we conclude that even if
American Executive Management was a fiduciary, it did not breach its fiduciary duty
for the same reasons we conclude it did not breach its contract. A fiduciary is not a
guarantor. The duty imposed on fiduciaries requires them to exercise due care and use
the care that an ordinary, prudent person would use under the same circumstances.
See Gearhart Indus., Inc. v. Smith Int’l, Inc., 741 F.2d 707, 719-720 (5th Cir. 1984);
In re Gaubert, 149 B.R. 819, 828 (Bankr.E.D.Tex. 1992). American Executive
Management complied with the Management Agreement and took ordinary, careful
steps regarding the account. It was the bank and Patel who undermined American
Executive Management’s attempts to prohibit the debtors’ access to the account. The
fact that Patel wrongfully withdrew the money within the account does not indicate
that American Executive Management breached its fiduciary duties.

                                 CONCLUSION
     Because we believe the bankruptcy court erred in ordering the disgorgement
of American Executive Management’s fees and entering a money judgment for the
amount of money withdrawn by Patel, we reverse that part of the bankruptcy court’s
judgment granting judgment in favor of the plaintiff and against American Executive
Management.

                                         10