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In re Maui Industrial Loan & Finance Co.

United States District Court, D. Hawaii

January 30, 2018

In the Matter of MAUI INDUSTRIAL LOAN & FINANCE CO., Debtor,
DANE S. FIELD, Trustee, Appellee. RNI-NV LIMITED PARTNERSHIP, Appellant,




         Appellant RNI-NV Limited Partnership (“RNI”) appeals the bankruptcy court's July 31, 2017 “Final Judgment as to Trustee's Objection to RNI-NV Limited Partnership's Claim (POC#21).” RNI asks the Court to overturn the bankruptcy court's decision disallowing its claim against the estate of chapter 7 debtor Maui Industrial Loan and Finance Company, Inc. (“MFC”). In the proceedings below, the bankruptcy court sustained the Trustee's Objection to RNI's Claim, based in part, on the bankruptcy court's prior determination in a 2010 Adversary Proceeding between these parties that RNI does not have a valid restitution claim.

         RNI argues that the bankruptcy court erred both procedurally and on the merits when it sustained the Trustee's Objection and proceeded by contested matter. Although the Court agrees that the bankruptcy court should have proceeded by adversary proceeding, rather than by contested matter, given that the Trustee's Objection included a request for subordination, such error was harmless under the particular circumstances presented because RNI suffered no prejudice. With respect to the substance of the claim, the bankruptcy court did not err when it precluded RNI from asserting a restitution claim, in view of its prior determination of that same issue in a 2010 Adversary Proceeding. Nor did the bankruptcy court err in disallowing RNI's Claim pursuant to 11 U.S.C. § 502(b)(1), notwithstanding RNI's repayment of its liability to the estate under Section 502(d). AFFIRMED.


         MFC was a nondepository financial services loan company that was authorized to make loans, but not authorized to accept deposits from the public under state law. Lloyd Kimura controlled MFC and caused it to “borrow” money from investors in exchange for promised returns, and to repay the loans and make the promised returns largely with funds borrowed from subsequent investors. In a federal plea agreement, Mr. Kimura admitted that he operated MFC as a Ponzi scheme for approximately twenty-three years. See United States v. Kimura, Case No. 10-CR-00890 (D. Haw.), Dkt. No. 8 (1/5/11 Mem. of Plea Agreement). After a state regulator ordered MFC to cease doing business, MFC and Kimura commenced separate bankruptcy cases in 2010. See Mem. of Decision on Tr.'s Mot. for Instructions, filed Sept. 7, 2017, attached as Ex. 3 to MFC Opening Br., Dkt. No. 6.[1]

         I. Bankruptcy Proceedings

         In 1999, RNI paid $1, 000, 000 for forty percent of the stock in MFC, but did not obtain approval from the State Division of Financial Institutions before completing the stock purchase. In 2007, when RNI sought to withdraw its investment in MFC, the parties entered into a stock repurchase agreement on October 8, 2007, in which MFC promised to pay RNI a total of $2, 500, 000 in installments. MFC paid $1, 040, 000 on the repurchase agreement before defaulting. RNI then sued MFC in state court and judgment was entered in RNI's favor on November 4, 2009 (Civil No. 09-0037).

         MFC filed for bankruptcy under Chapter 7 on January 28, 2010. Two bankruptcy proceedings are relevant to this appeal. First, the Trustee successfully brought an adversary proceeding against RNI seeking to recover the $1, 040, 000 that MFC paid to it (Adv. Pro. No. 10-90069). Second, on April 1, 2010, in the Chapter 7 proceedings below (Bankr. No. 10-00235), RNI filed Proof of Claim No. 21 (from Claims Registry) for $1, 938, 186.97, which the bankruptcy court disallowed upon the Trustee's Objection and which is the subject of the present appeal. See Dkt. No. 7-2 (4/1/2010 POC No. 21).

         A. Adversary Proceeding (Adv. Pro. No. 10-90069)

         The Adversary Proceeding was an avoidance action brought by the Trustee to recover the amounts paid by MFC to RNI under the stock repurchase agreement. The complaint in the Adversary Proceeding alleged four counts: (1) violation of the Hawaii Business Corporations Act, HRS § 414-111(c) (Count I); (2) violation of the Hawaii Uniform Fraudulent Transfer Act, HRS Chapter 651C (Count II); (3) 11 U.S.C. § 548 (Count III); and (4) transferee liability pursuant to 11 U.S.C. § 550 (Count IV). The bankruptcy judge granted the Trustee's motion for summary judgment on Counts I, II, and IV in a May 16, 2011 Memorandum of Decision, and on June 1, 2011, the parties stipulated to dismiss Count III. On May 27, 2011, RNI filed a Notice of Appeal of the May 16, 2011 Decision. The district court dismissed the appeal for lack of jurisdiction, and the Ninth Circuit affirmed. See Field v. RNI-NV (In re Maui Indus., Loan & Fin. Co., Inc.), 2011 WL 1870289 (Bankr. D. Haw. 2011), appeal dismissed, 2011WL 6012039 (D. Haw.), recon. denied, 2012 WL 667759 (D. Haw.), aff'd, 583 Fed.Appx. 636 (9th Cir. July 14, 2014).

         The bankruptcy court determined that the pre-petition transfers violated the Hawaii Business Corporations Act, in part, because at a time when it was insolvent, MFC made “distributions” to RNI, which under Hawaii law, are defined as “[a] direct or indirect transfer of money or other property (except its own shares) or incurrence of indebtedness by a corporation to or for the benefit of its shareholders in respect of any of its shares.” Mem. of Decision at 6, filed May 16, 2011, Dkt. No. 7-31 (quoting HRS § 414-3). The bankruptcy court explained that RNI's restitution claim was also not warranted because “granting RNI a restitution claim would unjustly give RNI greater rights than it bargained for. RNI's restitution claim, if granted, would put RNI on a par with [MFC]'s unsecured creditors, even though RNI agreed to buy stock, which is subordinate to creditor claims.” Id. at 7. The bankruptcy court reasoned that “[a]llowing RNI to elevate its rights to equal status with unsecured creditors would be unfair to [MFC]'s other creditors.” Id. (citing Durette v. Aloha Plastic Recycling, Inc., 105 Hawai‘i 490, 503, 100 P.3d 60, 73 (2004) (recognizing that restitution is equitable in nature, guided by the goal of preventing injustice)). The bankruptcy court further determined that “a party that has engaged in wrongful conduct in connection with the transaction is not entitled to restitution, ” citing RNI's failure “to obtain regulatory approval before acquiring shares of [MFC].” Id. at 7. The bankruptcy court concluded that the Trustee was entitled to avoid the stock repurchase agreement, the related promissory note, and the payments from MFC to RNI under HRS § 414-111(c). Id. at 8.

         Additionally, because there was no dispute that RNI did not give reasonably equivalent value in exchange for the $1, 040, 000 in transfers received from MFC, that the transfers occurred within a four-year reach-back period, or that RNI did not prove that it took the transfers in good faith, the bankruptcy court found the transfers were avoidable by the Trustee under the Hawaii Uniform Fraudulent Transfer Act, HRS § 651-4C(a). Id. at 9-10. Finally, the bankruptcy court concluded that the Trustee was entitled to recover from RNI the $1, 040, 000 in transfers under 11 U.S.C. § 550, and awarded the Trustee pre-judgment interest at ten percent per annum from the date on which the transfers were made. Id. at 11.

         Following RNI's unsuccessful appeals to the district court and the Ninth Circuit, the Trustee executed on RNI's appeal bond and, on September 11, 2014, filed a Satisfaction of Judgment for the $1, 428, 324.90 that RNI paid back to the estate in the avoidance action. Dkt. No. 7-44 (9/11/2014 Satisfaction of Judgment in Adv. Pro. No. 10-90069); Dkt. No. 7-6 (8/7/14 Notice of Receipt of Payment on Judgment in Adv. Pro. No. 10-90069).

         B. RNI's Claim And Trustee's Objection (Bankr. No. 10-00235)

         In the MFC Chapter 7 case, RNI filed its Proof of Claim No. 21 (“Claim”) in the amount of $1, 938, 186.97 on April 1, 2010. Dkt. No. 7-2. On August 2, 2011, while the contemporaneous Adversary Proceeding was pending, the Trustee scheduled RNI's Claim at $0. Dkt. No. 7-4 at 6 (8/2/11 Mot. to Approve Procedure for Bifurcation of Unsecured Claims Filed by Ponzi Scheme Investors).[2]

         On April 25, 2017, the Trustee filed a Motion for Instructions as to Distribution Rights of Creditors Filing Claims (“Motion for Instructions”), seeking clarification from the bankruptcy court on the procedure for disbursing approximately $8, 000, 000 in estate funds to creditors, of which $6, 000, 000 was designated for timely “Class A” restitution claims under 11 U.S.C. § 726(a)(2). Dkt. No. 7-7. The Motion for Instructions sought guidance as to how the Trustee was to distribute the balance of estate funds-whether to first pay untimely claims (Section 726(a)(3)) or “Class B” claims (lost investment/lost profit). Id. at 2-3. Exhibits A through C to the Trustee's Motion for Instructions proposed classification and distribution of the estate funds to three types of creditors based on their classes of recovery: “Class A” (timely restitution claims); “Class B” (timely lost profit claims); and untimely, as-yet unbifurcated claims. Because RNI's Claim for $1, 938, 186.97 was neither scheduled in Exhibits A though C nor addressed in the Motion for Instructions, RNI filed an Objection to the Trustee's Motion for Instructions on May 19, 2017, demanding that its Claim be classified “in Exhibit A [Class A claims], as a timely filed proof of claim, ” either “for $1, 938, 186.97 or $1, 728, 831.00, the amount of the appeal bond paid over to the Trustee.” Dkt. No. 7-8 at 2, 5. RNI argued that “[u]nder § 502(d), after RNI had posted an appeal bond . . . and the Trustee filed his Satisfaction of Judgment on September 14, 2014, RNI's proof of claim was reinstated and allowed to participate in the distribution of the estate funds, unless the Trustee filed a formal objection.” Id. at 8.

         On June 1, 2017, the Trustee did object, filing an Objection to RNI's Claim on the bankruptcy court's local form (hib3007-1), asserting that the Claim should be disallowed in its entirety. Dkt. No. 7-11 (Objection to Claim). The Trustee's Objection argued that RNI's Claim was unenforceable against the estate by operation of collateral estoppel or issue preclusion, in light of the issues already adjudicated by the courts in the Adversary Proceeding. In the alternative, the Trustee asserted that any “allowed claim” that RNI may have must be subordinated to the lowest priority under Section 510(b), or alternatively, equitably subordinated under Section 510(c), or alternatively, subordinated to a “Class B” claim. Dkt. No. 7-11 at 15.

         RNI opposed the Trustee's Objection as both procedurally improper and substantively without merit. RNI first asked the bankruptcy court to dismiss the Trustee's Objection on procedural grounds because the Trustee combined its Objection to the Claim with another demand for relief-subordination-which is not permitted under Federal Rule of Bankruptcy Procedure 3007(b) and Local Bankruptcy Rule 3007-1(d). According to RNI, when an objection is accompanied by a subordination request, such relief must be sought in a separate adversary proceeding. Dkt. No. 7-12.[3]

         In reply, the Trustee emphasized that he only sought subordination of the Claim in the alternative and argued that RNI identified no prejudice that it would suffer should the bankruptcy court proceed by way of contested matter. According to the Trustee, there were no remaining issues of factual or legal dispute regarding subordination, since all such issues had previously been determined in the Adversary Proceeding. Dkt. No. 7-13 at 4-5. The Trustee also maintained that RNI did not have a restitution claim because the bankruptcy court previously determined in the Adversary Proceeding that RNI was a shareholder, not an MFC investor, and that MFC made “distributions” to RNI. Moreover, the Trustee asserted that RNI's Claim was not “restored” pursuant to Section 502(d); rather, its Claim was merely “reinstated” when RNI paid the judgment against it and was then an “allowed claim, ” subject to the Trustee's Objection. Id. at 7-8.

         II. Bankruptcy Court Order And Judgement

         The matter was fully briefed, and the bankruptcy court held a hearing on the Trustee's Objection on July 10, 2017. Dkt. No. 7-21 (7/10/17 Hrg. Tr.). On July 27, 2017, the bankruptcy court entered its Order Sustaining Objection to Claim, determining that RNI's Claim should be disallowed. Dkt. No. 7-15 (7/27/17 Order). With respect to the procedural issue, the bankruptcy court rejected RNI's request to dismiss the Trustee's Objection, and noted that:

RNI argues that the proper procedure to subordinate under § 510(b) is to initiate an adversary proceeding. However, the judgment in the prior adversary proceeding determined all issues that are necessary to determine § 510(b) subordination, so it would be useless to initiate another proceeding because RNI would lose. However, equitable subordination under § 510(c) would bring in to play factors that were not involved in the prior adversary proceeding.

7/27/17 Order at 4 n.7. With respect to the merits of the Trustee's Objection, the bankruptcy court recounted the prior determination in the Adversary Proceeding in which the Trustee-

brought an avoidance action against RNI to recover the roughly $1.4 million that the debtor paid to RNI pursuant to the judgment in the state court breach of contract action for the remaining debt owed under the stock repurchase agreement. I issued a judgment avoiding the transfer and ordering RNI to return the money to the bankruptcy estate. I found that the stock repurchase agreement was illegal and that RNI had no restitution claim against the debtor.

7/27/17 Order at 2 (footnotes omitted). The bankruptcy court then evaluated RNI's current Claim in light of the prior rulings in the Adversary Proceeding, and concluded that the issues previously adjudicated precluded re-litigation of RNI's Claim for restitution:

The issue previously alleged in the avoidance litigation is identical to the issue raised in this claim objection-whether RNI has a restitution claim for its original $1, 000, 000.00 contribution to the debtor. The debtor and RNI already presented arguments on this issue in the avoidance action and I made a final ruling that RNI did not have a restitution claim. RNI appealed to the U.S. District Court but the appeal was dismissed for lack of jurisdiction (RNI failed to timely file a notice of appeal) and the Ninth Circuit affirmed the dismissal. Thus, the issue was actually litigated and adjudicated. Finally, the determination that RNI's purchase of the debtor's stock was illegal was critical to the avoidance action. RNI argued, as a defense to the avoidance claim, that it had a restitution claim against the debtor, and that the satisfaction of that claim was value given in ...

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