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STATE OF MAINE
DEPARTMENT OF THE ATTORNEY GENERAL
6 STATE HOUSE STATION
October 17, 1996
Samuel A. Wilkinson, Clerk
United States Bankruptcy Court
537 Congress St., 2nd Fl.
Portland, Maine 04101
Re: In re: Catherine Duffy Petit, Case No. 93-20821
Dear Mr. Wilkinson:
Enclosed for filing in the above-entitled action please find Maine's Objection to Proposed Settlement, Exhibits to Maine's Objection to Proposed Settlement, Sylvia Paine Affidavit, and Laurence Paine Affidavit.
Thank you for your attention to this matter.
Very truly yours,
Assistant Attorney General
cc: Service List
UNITED STATES BANKRUPTCY COURT
CERTIFICATE OF SERVICE
I hereby certify that on October 18, 1996, 1 mailed a copy of the Maine's Objection to Proposed Settlement, Exhibits to Maine's Objection to Proposed Settlement, Sylvia Paine Affidavit, and Laurence Paine Affidavit, to the parties or their counsel listed below, by United States Mail, first-class, postage prepaid, and I hereby certify that on October 17, 1996, I served by Federal Express for those marked with an asterisk, or by hand for those marked with two asterisks, addressed as follows:
**Stephen G. Morrell, Esq.
Eaton, Peabody, Bradford & Veague
167 Park Row, P.O. Box 9
Brunswick, ME 04011
Patrick G. Waters, Esq.
92 State St.
Boston, MA 02109
Looney & Grossman
101 Arch St.
Boston, MA 02110
Gerard F. Kelly, Esq.
U.S. Trustee
527 Congress St., Room 302
Portland, Maine 04101
Gordon & Wise
101 Federal St.
Boston, MA 02110-1844
*Joseph S.U. Bodoff, Esq.
Hinckley, Allen & Snyder
One Financial Center
Boston, MA 02111-2625
Joseph V. O'Connell
The Pilot Group
400 Commercial St.
Portland, ME 04112
Zbigniew J. Kurlanski, Esq.
P.O. Box 46
Exchange St.
U. Charles Remmel, Esq.
Kelly, Remmel & Zimmerman
53 Exchange St.
P.O. Box 597
Portland, ME 04112-0597
John G. Connor, Esq.
415 Congress St., Suite 304
Portland, ME 04101
Jeffrey A. Thaler, Esq.
Berman & Simmons
129 Lisbon St.
P.O. Box 961
Lewiston, ME
**Richard Poulos, Esq.
Poulos & Campbell
183 Middle St.
Portland, ME 04112
James F. Moeller, Esq.
Woodman & Edmands
231 Main St.
P.O. Box 468
Biddeford, ME 04005-0468
*Judge Arthur N. Votolato, Jr.
U.S. Bankruptcy Court
Federal Center
380 Westminster Mall
Providence, RI 02903
PETER I. BRANN
Assistant Attorney General
UNITED STATES BANKRUPTCY COURT
TO PROPOSED SETTLEMENT
The court solicited the input of the State of Maine and the Securities Administrator (collectively, "Maine") at a recent status conference in the above-captioned matter. Based upon its on-going state court litigation against Paul Richard ("Richard") and others, and based on the on-going illegal securities sales within the last two months of Paul Richard and the debtor, Catherine Duffy Petit ("Petit"), Maine objects to the Amended Application to Compromise Adversary Proceeding and to Sell Assets, dated September 23, 1996 ("proposed settlement"), between Richard and the bankruptcy trustee ("trustee"). Maine submits this brief in support of its objection.
BACKGROUND
In order to place Maine's objection in perspective, we describe in some detail Maine's on-going state court litigation, the trustee's awareness of that litigation, and th~ on-going securities sales of Richard and Petit.
Maine's State Court Litigation. On March 26, 1996, Maine filed a state court lawsuit against Richard and others, entitled State V. HER, Inc., Docket No. CV-96-134 (Me. Super. Ct., Ken. Cty.) ("state lawsuit"). State's Exhibit 1.1 In the state lawsuit, Maine alleged that Richard and others had illegally sold securities for approximately $685,000 to 13 investors, and that they had engaged in fraud to sell the securities.
At the same time Maine filed suit, it filed a motion for a temporary restraining order and a motion for a preliminary injunction. In conjunction with that motion, it submitted an affidavit from investigator/examiner of the Securities Division, Judy Dorsey ("Dorsey"). State's Exhibit 2. According to Dorsey, On October 23, 1995, she spoke with Richard:
[Richard] acknowledged that several individuals had invested in HER, Inc., with a promise of getting a percentage return on their investment. In response to this information, I told Mr. Richard to stop soliciting and selling interests in HER, Inc., and, among other things, requested a letter stating that no further sales would occur.
Id. at 1. On October 24, 1995, one of the other defendants sent Dorsey a fax, with a copy to Richard, confirming that the defendants would not sell additional securities:
On behalf of HER, Inc., I would like to confirm that we agree not to continue to solicit/sell investments in this corporation until the concerns you have raised relative to the securities issue have been resolved to your satisfaction.
For the court's convenience the referenced State's Exhibits to Maine's objection to Richard Settlement. This court may also take judicial notice of these materials pursuant to Fed. R. Evid. 201(b). See, e.g., Kowaiski V. Gagne1 914 F.2d 299, 305 (1st Cir. 1990) ("It is well accepted that federal courts may take judicial notice of proceedings in other courts if those proceedings have relevance to the matters at hand.") (citations omitted); E.L Du Pont de Nemours & Co. V. Cullen, 791 F.2d 5, 7 (1st Cir. 1986) (Breyer, J.) (First Circuit may properly take judicial notice of pleading from another court included in appendix on appeal); American Glue & Resin, Inc. V. Air Products & Chemicals, Inc., 835 F. Supp. 36, 40-11 (D. Mass. 1990) (collecting cases permitting judicial notice when pleadings from other cases properly submitted to court); Holbrook V. Andersen Corp., 130 F.R.D. 516, 520 n.3 (D. Me. 1990) (district court may properly take judicial notice of pleading from "adjunct court").
Id. at 2; State's Exhibit 3. Subsequently, on December 30, 1995, Dorsey, the Securities Administrator and the Supervisor of Enforcement met with Richard, explained the registration requirements of the Revised Maine Securities Act ("Securities Act"), and informed him that they believed he had violated the Securities Act. State's Exhibit 2 at 2. Immediately prior to filing suit, Dorsey learned that Richard and others had continued to sell unregistered securities. Id.
On March 28, 1996, the Maine Superior Court (Cole, C.J.) granted Maine's motion for a temporary restraining order. State's Exhibit 4. The court enjoined Richard and the other defendants "from selling unregistered securities" (id. at 2) based on the defendants' clear violations of the Securities Act:
[I]t appears to this Court that immediate and irreparable injury, loss and damage [will] result to the plaintiffs and the public in that the defendants are continuing to sell unregistered securities in violation of 32 M.R.S.A. § 10401 and in violation of their agreement with the Securities Administrator to cease selling unregistered securities.
Further, because of the clear nature of these violations and the fact that the defendants have been warned on several occasions about the violations but has chosen to ignore these warnings, the State's likelihood of success on the merits appears high and a balancing of the interests clearly lays in favor of granting a temporary restraining order.
State's Exhibit 4 at 1.
On May 2, 1996, the court (Atwood, J.) held a testimonial hearing on Maine's motion for a preliminary in injunction. On May 31; 1996, the court granted the motion, finding that Richard and the other defendants "have violated and are continuing to violate 32 M.R.S.A. § 10401 through the sale of unregistered securities which results in injury to the plaintiffs and the public as set forth in the plaintiffs' complaint." State's Exhibit 5 at 1. Once again, the court enjoined Richard and the other defendants "from selling unregistered securities." Id.
Furthermore, the court ordered the defendants to provide an accounting "within 10 calendar days of the date of this order." Id. Richard and the other defendants, however, did not submit the court-ordered accounting.2 Likewise, defendant HER, Inc. did not respond to Maine's document request. Accordingly, on June 10, 1996, Maine filed a motion to compel and impose sanctions against HER, Inc. and its counsel (who also represents Richard), State's Exhibit 6, and, on June 18, 1996, Maine filed a motion for civil contempt against Richard and the other defendants, which made plain that the defendants were subject to the preliminary injunction, notwithstanding the interlocutory appeal filed by defendants Richard and HER, Inc. State's Exhibit 7.
Following the filing of these motions, on August 8, 1996, defendant David Hall finally obtained counsel and submitted an accounting under oath to the court. State's Exhibit 8. On September 17, 1996, David Hall submitted a supplemental accounting to the court. State's Exhibit 9. According to David Hall's two accountings, he sold securities to 18 investors in which "I gave the check to Paul Richard. I have no knowledge of what Mr. Richard did with those funds." These securities sales in which David Hall turned the money over to Paul Richa?d total $540,791.14. See Stat~'s Exhibits 8, 9.
Although Richard and one of the other defendants filed an interlocutory appeal from the preliminary injunction order, which is currently pending, no defendant sought a stay of the preliminary injunction order. Pursuant to M.R. Civ. P.62(a), an interlocutory (or final) injunction is not stayed during the pendency of an appeal.Meanwhile, Richard and the other defendants continued to stonewall. Maine's motion for civil contempt against all of the defendants was considered at a hearing on August 5, 1996 (attended by both Richard and his counsel), whereupon Superior Court Justice Atwood recused himself at the request of Richard's counsel. Maine had served subpoenas seeking the bank records of a number of Petit's affiliates, including Richard. Richard, among others, filed motions to quash the subpoenas, which have not yet been heard by the Superior Court. See, e.g., State's Exhibit 10 (Richard's motion to quash, dated August 20, 1996).
On August 22, 1996, the court (Calkins, I.) considered Maine's motion to compel and motion for civil contempt. Both Richard and his counsel attended that hearing. The court granted Maine's motion to compel, imposed sanctions, and ordered defendant HER, Inc. to produce the requested documents within 10 days. State's Exhibit 11. In conjunction with Maine's motion for contempt, after the court specifically instructed Richard that he was subject to the terms of the preliminary injunction, defendants Richard and HER, Inc. agreed to produce the accounting within 10 days.3 State's Exhibit 12.
On September 4, 1996, defendants Richard and HER, Inc. filed a motion for a protective order to prevent Maine from complying this court's order to provide the trustee with information concerning its investigation into the illegal securities sales
Defendant Steven Hall has never answered the complaint or provided an accounting. Just pri9r to the contempt hearing he requested and obtained an enlargement of time to respond based on alleged medical problems (claimed to be "severe stress under litigation"). The court granted his request for an enlargement, and recently, has been granted a third and final extension to October 18, 1996, to answer the complaint and produce an accounting.
of Richard and others. State's Exhibit 13. In his motion, Richard makes plain that he hopes to prevent the trustee (and presumably this court) from discovering the results of Maine's on-going investigation of illegal securities sales. Id. Both Maine and the trustee have filed briefs in opposition to that motion, which is still pending.
Also on September 4, 1996, defendants Richard and HER, Inc. responded to Maine's document request and submitted a sworn accounting (which they also recently filed with the court m accordance with the preliminary injunction order). State's Exhibit 14. Although woefully inadequate,4 it nevertheless provides a glimpse of the extent of Richard's illegal securities sales in Maine.
According to Richards' sworn accounting, he has "liabilities" of $334,437.53, and HER, Inc. has "liabilities" of $644,860.18. As the Maine Superior Court has found, these "liabilities" are simply the product of illegal securities sales. Id. Since the promissory notes submitted by Richard in his accounting demonstrate on their face that Richard signed the notes on behalf of HER, Inc. as its treasurer, Richard is liable not only for the sales he has acknowledged ($334,437.53), but he is also liable for the sales of HER, Inc. ($644,860.18). Cf. 32 M.R.S.A. §§ 10201(2) (1988), 10602(3) (Supp. 1995) (strict liability for sales of unregistered securities and secondary strict liability for sales of others). Thus, according to Richard's own-partial-accounting, he has liabilities of $979,297.71 from illegal securities sales.
Maine is currently preparing a renewed motion for sanctions and a renewed motion for civil contempt against defendants Richard and HER, Inc.Richard did not include in his sworn accounting numerous securities sales described in defendant David Hall's accounting, and did not include in his sworn accounting the several million dollars of securities sales he and others made on behalf of Petit. In other words, even Richard's accounting of nearly $1,000,000 in illegal securities sales vastly understates the scope of his violation of Maine's securities laws.
Trustee's Awareness Of Maine's State Court Litigation. The trustee has been kept apprised of Maine's on-going state court litigation, and thus is aware of David Hall's accounting of over $500,000 in illegal securities sales in which he then turned over the proceeds to Richard, is aware of Richard's accounting of nearly $1,000,000 in illegal securities sales, and is aware of millions of dollars of other illegal securities sales by Richard, Petit, and others. Moreover, a result of this court's prior order, the trustee is aware of substantial evidence that Richard, Petit, and others have illegally sold millions of dollars of securities in Maine during the last three years.
Following the filing of Maine's lawsuit, the trustee sought from this court an ex parte order to conduct examinations of the Maine Bureau of Banking, pursuant to Bankruptcy Rule 2004. On May 10, 1996, this court granted that motion, but denied the request to seal the record. Nevertheless, based on this court's finding concerning "the allegedly sensitive nature of the information sought ?o be obtained, and on account of the Debtor's demonstrated propensity to hinder and delay all discovery in this case" (emphasis in original), this court specifically ordered the trustee not to provide information obtained from Maine to Petit or her "affiliated parties," which includes Richard.
As a result of this order, Maine has turned over to the trustee copies of all of investment-related documents, such as agreements and promissory notes, as it received them from investors. According to the notes in the trustee's possession, Richard himself issued notes with a face value of $1,584,289.50. These notes represent a total investment of $849,246.43. We observe that these investments purport to sell to investors Richard's interest in the Key Bank litigation-an interest he only can obtain if this court approves the proposed settlement.
As we told the trustee previously, see, e.g., State's Exhibit 25, to investors, Richard's involvement extends far beyond simply issuing notes to investors. Of the millions of dollars of notes that we provided to the trustee, which were issued by Petit, HER, Inc., Litigation Resources (Richard's new company), and others, Richard was involved in transactions involving $1,978,265.71. Id.
Furthermore, as a result of this court's order, we provided the trustee with copies of 47 different notes signed by Petit beginning in 1993, purporting to pay investors extraordinary returns based on their investment of millions of dollars. The face value of these notes totals $4,210,751.08.
Although the trustee blandly reports that it is "apparent that large sums of money have been collected by the parties to this settlement from persons who are
5 Many of the attachments in this letter have already been included previously as State's Exhibits. Accordingly, we only included in State's Exhibit 15 the attachments had not been included previously as State's Exhibits.
not; parties to: this proceeding[,]" Proposed Settlement at 6, the trustee does not appear to be particularly concerned the apparent and enormous bankruptcy (and state law) violations of Petit and Richard. On the contrary, we are not aware of any serious investigation conducted by the trustee into these apparent bankruptcy and state law violations.
Likewise, we are not aware of any action taken by the trustee in the face of Petit's apparent actions in direct contravention of her sworn testimony in proceedings before this court. Rather, the trustee simply notes that Petit "maintains that her signatures on the notes * * * were signed in blank and in bulk and were delivered to the holders thereof without her authority." Proposed Settlement at 14. Since the draft proposed settlement telefaxed to us on August 16, 1996, noted instead that Petit "maintains her signatures on the notes * * * are not authentic and were delivered to the holders thereof without her authority, see Draft Proposed Settlement at 15, one would have thought that the trustee would have conducted further investigation or examination of Petit under oath before proceeding with the proposed settlement.6
Furthermore, prior to the trustee's filing of the proposed settlement, Maine reminded him of the substantial evidence of the apparent bankruptcy and state law violations of Petit and Richard. On September 5, 1996, we sent him a letter, together
For the court's convenience, we attach to this brief a copy of the draft proposed settlement telefaxed to us on August 16, 1996. It should be noted that the trustee did not provide us until he filed the final proposed settlement agreement with the agreement signed by Paul Richard and Joseph O'Donnell on August 8, 1996, which would have made clear that the "draft" proposed settlement was, in fact, a fait accompli.
with the David Hall and Paul Richard accountings described above. State's Exhibit 15. Thus, prior to filing the proposed settlement, the trustee had in his possession notes signed by Petit and Richard representing millions of dollars, and had sworn accountings signed by defendants in the state lawsuit in which Richard had received directly or indirectly over a million dollars in investments.
As we reminded the trustee, Richard has never revealed any other source of income other than these illegal securities sales. Id. Furthermore, we explained that Richard (and Petit) had previously used the cloak of secrecy in order to further their securities fraud, thus raising troubling questions about the trustee's apparent acquiescence in Richard's attempt to hide the identity of the investor who provide the $70,000. Id. In a similar vein, we reminded the trustee that Petit and Richard had previously use imprimatur of various court orders, such as a confidentiality order, in order to give their scheme a patina of legitimacy. Id.
Thus, at the time the trustee filed the proposed settlement on September 23, 1996, he had before him substantial evidence that Petit and Richard had committed millions of dollars of securities fraud, and that their only responses to these allegations were either blanket denials or silence. In our view, the trustee was obligated under those circumstances to do more than simply close his eyes to these allegations, file the proposed settlement, and suggest that it was the responsibility of Maine or the court to uncover and prove an on-going fraud. See Proposed Settlement at 16.
Rather, we understand that the trustee "is a representative of the San Juan Hotel Corp., 71 B.R. 413, 417 (D.P.R. 1987) (operating trustee), rev'd in part on other grounds, 847 F.2d 931(1st Cir. 1988); see also Industries, Inc., 725 F.2d 880, 888 (2d Cir. 1984) (Friendly, J.) Bankruptcy after all, an officer of the court") (citation omitted).
When persons, such as trustees, perform duties in the administration of bankrupt estates, they act as officers of the court, not as private persons. As such, trustees are held to high fiduciary standards of conduct.
Matter of Topco, Inc., 894 F.2d 727, 739 (5th Cir. 1990) (Goldberg, J.) (citation omitted).7
Following the filing of the proposed settlement, we have sought unsuccessfully to obtain the identity of the unnamed source of the $70,000, and we have sought unsuccessfully to obtain the documents relating to this investment. On October 10, 1996, we asked the trustee to provide us with this information, and to provide us with the information in his possession that satisfied him that Richard was proceeding in good faith. State's Exhibit 16. The trustee's response has been silence.8 Given Richard's track record, this refusal to identify the source of the $70,000 should raises red flags for the court, if not the trustee.
7
1t should also be noted that "bankruptcy estates should not be administered for the sole or primary benefit of the professionals appointed to administer such estates." In re Khan's Corp.' 184 B.R. 398, 401 Bankr. S.D. Fla. 1995) (citations omitted).We likewise have sought this information from Richard. State's Exhibit 17. Today, his counsel informed us that he did not yet know who would be providing the money, but hoped to know by early next week, and, at that time, would set up a meeting for us to interview the prospective investor.
The court should also be aware of another recent development in this matter. In this court's order dated May 10, 1996, Petit and her "affiliated parties," which includes Richard, were "restrained and enjoined from interfering in any manner with the investigations" of the trustee or Maine. Nevertheless, Richard last week served corporate deposition subpoenas on the Maine Bureau of Banking and on the Attorney General's Office, for which we shortly will file a motion to quash. Although the trustee suggested that we might want to file a motion to quash, the trustee has given no indication that he would support such a motion a quash or thought that there was anything unseemly about this proposed discovery. We are troubled by the trustee's willingness to sit on sidelines while Richard seeks to violate this court's order and seeks court approval for a fraudulent scheme.
Petit And Richard's On-Going Violations. In addition to the millions of dollars of apparent state law (and bankruptcy) violations, there now is substantial evidence that Catherine Petit and Paul Richard, working together, are continuing to commit state law (and bankruptcy) violations, and, as we feared, intend to hijack the authority of this court in order to further their fraudulent scheme.
Last week, Sylvia and Lawrence Paine contacted the Attorney General's Office concerning their investments in Petit's lawsuit. This week, we were able to meet with them and to obtain their extensive documentation concerning their dealings with Petit and her affiliates during the last two years.
Sylvia and Lawrence Paine are 74 and 88 years old, respectively, and he is in ill health, thus making it unable for them to travel to Portland for the hearing on the proposed settlement. Sylvia Paine Affidavit ¶ 2; Lawrence Paine Affidavit ¶ 2. We therefore submit their affidavits in conjunction with this objection.
Between October 1994 and July 1995, the Paines invested a total of $285,000 in Petit's lawsuit against Key Bank. Sylvia Paine Affidavit ¶¶ 4-13; Lawrence Paine Affidavit ¶¶ 4-15. In their seven different investments, they noted on their checks that the money was for the "Petit litigation," and in all but one case, they received agreements signed by Petit (and witnessed by Thomas Blackburn). See State's Exhibits 18-30.
Between October 1994 and July 1995, the Paines were solicited by Armand Pelletier, Donald Shields, and Thomas Blackburn, each of whom represented that they were working on behalf of Petit. See Sylvia Paine Affidavit ¶¶ 4-13; Lawrence Paine Affidavit ¶¶ 4-15. The Paines agreed to invest in the Petit litigation as a result of serious misrepresentations:
Mr. Pelletier repeatedly stated then and later that this lawsuit was a sure thing and that there was no way we could lose our money. He explained that although the suit was on-going, there was an escrow fund that had something like $14,000,000 to pay people when the case ended. Thus, even if Mrs. Petit lost the suit, we were promised that we would get our money back from the escrow fund. Mr. Pelletier said that Key Bank was certain to settle the suit, and he stated, if not then, certainly later, that the case was just about to settle.
Mr. Pelletier did not describe any risks in this investment. On the contrary, every time he described the investment, he was adamant that Mrs. Petit was going to win her lawsuit and that we couldn't lose money. Indeed, no one ever told us about any risks in this investment. Mr. Pelletier did not tell us about any prior settlement in Mrs. Petit's lawsuit. He did not tell us that parts of Mrs. Petit's suit against Key Bank had been dismissed. He did not tell us anything about Mrs. Petit's bankruptcy.
Sylvia Paine Affidavit ¶¶ 6-7; see also id. ¶¶ 9-13 (other misrepresentations).
On January 27, 1996, the Paines met with Petit and Pelletier. Sylvia Paine Affidavit ¶ 16. Petit described her lawsuit against Key Bank in glowing terms and told them that she could not lose. Id.
In April 1996, Richard called Sylvia Paine and told her that he was working with Petit and wanted to meet. Sylvia Paine Affidavit ¶ 17. It should be noted that this is after the Securities Division had warned Richard that he had been illegally selling securities, after Richard's associate, Steven Hall, had informed the Securities Division that they would not sell securities, and after the Maine Superior Court had issued a temporary restraining order enjoining Richard and others from selling securities.
On July 15, 1996, Petit and Richard came to the Paine's home again to discuss their investment in the Petit litigation. Sylvia Paine Affidavit ¶¶ 19-21. Petit again described her litigation in glowing terms. Id. Significantly, they also told the Paines that Richard had purchased the Petit litigation, and may have said something to the effect that this had something to do with the bankruptcy. Id. For her part, Petit told them that the bankruptcy was behind her (and had been the fault of Pelletier and Shields). Id.
On August 8, 1996--the very day that the trustee signed the agreement with Richard to sell him part of the Petit litigation for $7O,OOO - Petit and Greg O'Halloran went to the Paine's home to discuss her litigation against Key Bank and to ask for more money. Sylvia Paine Affidavit ¶¶ 22-27. The details of this meeting confirm our darkest suspicions about the proposed settlement.
Petit brought an easel and charts, and made another tour de force presentation concerning her litigation against Key Bank. Id. She admitted to them that she had received "only" $50,000 from the Paine's prior investments, and dismissed the other investments as frauds. Id. The Paines were very anxious to have her honor her prior agreements (which we note she had obviously acknowledged in prior meetings). Id.
O'Halloran then began to press the Paines very hard for $25,000 that they had to have by the following Monday in order to keep the Petit lawsuit going. Id. At that moment, Petit announced that she shouldn't be present while they were discussing the money, and went to the car to wait. Id. In any event, O'Halloran went out to the car to clear with Petit the terms of the new agreement reached with the Paines (which included honoring the Paines' prior agreements). Id.
On August 9, 1996, Richard and O'Halloran went to the Paines' home to provide the paperwork and get the $25,000, but the terms of the agreement needed further modification. Sylvia Paine Affidavit ¶ 28. It should be noted that Richard is soliciting this money not only immediately after he signed the agreement with the trustee, but also less than week after the first hearing on Maine's motion for civil contempt for violating the terms of the preliminary injunction.
On Sunday, August 11, 1996, Richard and O'Halloran returned to pick up the $25,000 that they convinced the Paines they had to have by the next day. Sylvia Paine Affidavit ¶ 29; Laurence Paine Affidavit ¶ 19. Apparently secure in his view that this court would simply rubberstamp the proposed settlement, Richard "hereby represents that he is the owner of various lawsuits [sic] regarding Catherine Petit." Id. (quoting State's Exhibits 31-32). We now turn to that issue.
ARGUMENT
The trustee seeks to sell the lion's share of what Petit daims is the largest asset in the estate, namely, her lawsuit against Key Bank and the related malpractice claims stemming from that lawsuit. The Bankruptcy Code provides that "[t]he trustee, after notice and a hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate." 11 U.S.C. § 363(b)(1). "Good faith" is an integral consideration in such a sale:
The reversal or modification on appeal of an authorization under [11 U.S.C. § 363(b)] * * * of a sale or lease of property does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such * * * sale or lease were stayed pending appeal.
11 U.S.C. § 363(m) (emphasis added).
Although section 363(m) is directed towards appeals, the bankruptcy court, in the first instance, should make an express determination that the purchaser is acting in good faith. See In re Abbott Dairies of Pennsylvania, Inc., 788 F.2d 143, 149-50 (3d Cir. 1986). In evaluating this issue, contrary to the implication of the trustee in the proposed settlement, see Proposed Settlement at 16, it is not incumbent upon others, such as Maine, to come forward with evidence to prove that this transaction is not in good faith. Quite the contrary, the burden is on the proponent, here the trustee, to prove that a sale out of the ordinary course of business should be approved under section 363(b). See, e.g., In re Ionosphere Clubs, Inc., 100 B.R. 670, 675 (Bankr. S.D.N.Y. 1989) (Lifland, B.J.) (citing In re Lionel Corp., 722 F.2d 1063, 1071 (2d Cir. 1983)). Thus, the trustee bears the burden of proof on the issue of "good faith." In re Wilde Horse Enterprises, lnc., 136 B.R. 830, 841 (Bankr. C.D. Cal. 1991) (citations omitted).
Furthermore, "[a] sale of substantially all of the debtor's property outside the ordinary course of business *** must be closely scrutinized." Id. (citation omitted). This is particularly true here where the purchaser is an insider. See id. at 842 ("not bad faith per se for an insider to purchase property from an estate"); In re Abbott Dairies of Pennsylvania, Inc., 788 F.2d at 149 (sale to insider "ripe for collusion and interested dealing"); Wolverton v. Shell Oil Co., 442 F.2d 666, 669 (9th Cir. 1971):
[I]t is still true that a sale to the bankrupt, especially when it is of an asset such as a cause of action of unknown but potentially great value, as here, offers opportunities for skullduggery that make it suspect.
(Citation omitted).
In this regard, the trustee must provide the court and other interested parties "with sufficient information to allow them to take a position on the proposed sale." In re Wilde Horse Enterprises, Inc., 136 B.R. at 842 (citation omitted); see also In re Savage Industries, Inc., 43 F.3d 714, 720 (1st Cit. 1994) (Cyr, j.) ("[n]otice is the cornerstone underpinning Bankruptcy Code procedure").
In this case, the trustee has not provided any substantive information about its reasoning for proposing this sale. For example, although Petit and Richard, and others acting on their behalf, have repeatedly informed investors that they expect to recover millions of dollars from the Key Bank litigation, the trustee's willingness to accept a $70,000 for most of the interest in that litigation obviously indicates a different view. There is, however, no explanation in the proposed settlement of his assessment of the probability of success. See Jeffrey V. Desmond, 70 F.3d 183, 185 (1st Cir. 1995) (issues to consider in approving compromise under Bankruptcy Rule 9019(a)). Similarly, there is no explanation in the proposed settlement of his assessment of the complexity of the litigation involved, and the expense and delay attending it. Id.
This is significant because it speaks directly to issue of the on-going fraud being committed by Petit and Richard. If the Key Bank litigation is worth millions, then the trustee is significantly selling this asset to an insider at a substantial discount, which is improper under the authorities cited above. On the other hand, if the Key Bank litigation is worth nothing, then it is equally unconscionable to sell this asset to someone like Richard, who has been selling this asset for years without owning it and selling it based on gross misrepresentations concerning its value.
Likewise, the cost of pursuing the Key Bank litigation also directly bears on the on-going fraud being committed by Petit and Richard. If it will cost up to $600,000 to prosecute these claims, as Petit asserted in her Fifth Amended Disclosure Statement, dated September 18, 1995, then Petit and Richard will be required far more than $70,000 in order to transform this asset in the multi-million dollar bonanza they have been representing to investors for years. If it will cost little or nothing to prosecute these claims, then the trustee has again significantly undervalued this asset and Petit and Richard have engaged in a massive fraud by raising millions of dollars with the claim that they needed the money to pay lawyers (who had been prosecuting the litigation based on contingency agreements). In sum, the trustee has provided virtually no information to permit the court to make a reasoned assessment of the proposed settlement.
In any event, this court should not approve the proposed settlement because it is being financed by a continuing fraud and because it will give Petit and Richard the means to commit further fraud. It is beyond debate that "'good faith'' purchaser status is precluded by, inter alia, fraud[.]" In re Mark Bell Furniture Warehouse, Inc., 992 F.2d 7, 8 (1st Cir. 1993) (citations omitted); see also In re WPR V-TV, Inc., 983 F.2d
336 (1st Cir. 1993) ("finding of fraud or mistake not necessary when 'compelling equities"' require vacation of confirmation of sale) (quotation and footnote omitted).
"Typically, 'good faith' involves, the integrity of the purchaser in the course of conduct at the sales proceedings." Matter of Perona Bothers, Inc., 186 B.R. 833, 839 (D.N.J. 1995) (citation omitted); see also In re Wilde Horse Enterprises, lnc., 136 B.R. at 842 ('Good faith' encompasses fair value, and further speaks to the integrity of the transaction."). In short, "traditional equitable principles" govern whether the proposed settlement is in "good faith" and should be approved. In re- Abbott Dairies -of Pennsylvania, Inc., 788 F.2d at 147 (citations omitted). Applying these standards, it is plain that the trustee has not-and cannot-satisfy his burden of proof that the purchaser is acting in good faith.
It is gilding the lily to again relate Richard's repeated violations of Maine's securities laws. Suffice to say, when his only known source of income is illegally selling securities-approximately $1,000,000 by his own admission-and when he continues to sell such securities after being warned not to do so, after promising not do so, after being enjoined, and after Maine files a contempt motion, and, finally, even after he signs the proposed settlement with the trustee to purchase the asset he has been selling for years, this is not someone who is acting in good faith.
Furthermore, this court should not, and indeed cannot, approve this transaction in the face of 28 U.S.C. § 959(b), which requires the trustee to conduct the debtor's business in accordance to valid state laws, such as Maine's securities laws. This case bears numerous similarities to In re White Crane Trading Co., 170 B.R. 694 (Bankr. E.D. Cal. 1994). In that case, on a motion by the trustee (who refused to ignore consumer fraud when it came to his attention) and the California Attorney General, the court vacated a prior order permitting a sale pursuant to 28 U.S.C. § 959(b) on the grounds that order was being used to violate California's consumer protection laws.
As that court noted, section 959(b) "stands for the uncontroversial proposition trustee must carry out his duties in conformity with state law." id. (quotation that a omitted).
Valid state consumer protection and deceptive trade practice laws qualify as valid laws of the State in which such property is situated for purposes of section 959, which applies to debtors who continue to sell goods in the retail marketplace.
***
The purpose of bankruptcy is not to permit debtors and nondebtors to wrest competitive advantage by exempting themselves from the myriad of laws that regulate business. Bankruptcy does not grant the debtor a license to eliminate the marginal cost generated by compliance with valid state laws that constrain nonbankrupt competitors. The Congress has thus required that every debtor in possession and bankruptcy trustee manage and operate the debtor's property in compliance with state laws-good, bad, and indifferent-that apply outside of bankruptcy.
Id. (footnote omitted).
Because the trustee and Richard have not yet even disclosed the identity of the investor, much less the manner in which the transaction is structured, they certainly cannot demonstrate that this is not simply another, illegal sale of securities. Likewise, they do not even to attempt to prove that the source of this largesse is not some earlier fraud, say, like the fraud perpetuated on the Paines on the day Richard signed his agreement with the trustee.
Moreover, even if the trustee could somehow demonstrate that this transaction is legitimate (unlike the millions of dollars of prior transactions), that would not change the outcome because finally selling to Richard an asset he has been selling for years is simply giving him the means to commit further fraud. This is particularly true since Petit, Richard, and others have misrepresented prior court orders in an effort to give their scheme an air of respectability. See, e.g., State's Exhibit 15 (misusing the Superior Court's confidentiality order to silence another victim).
A judge's order approving a transaction cloaks the transaction with the prestige of the court. After such a cachet is conferred, it is susceptible of abuse. * * * Permitting a merchant to trumpet court authorization amounts to entrusting the court's prestige to the care and custody of the merchant.
In re White Crane Trading Co., 170 B.R. at 704. This court should not be a party to the on-going fraud being committed by Catherine Duffy Petit and Paul Richard. It should reject the proposed settlement.
CONCLUSION
Based upon the foregoing, the State of Maine and the Securities Administrator request that this court reject the proposed settlement.
Dated: October 17, 1996 Respectfully submitted,
Augusta, Maine
ANDREW KETTERER
Attorney General
PETER J. BRANN
(Me. Bar No.274)
LINDA J. CONTI
(Me. Bar No.2173)
Assistant Attorneys General
Six State House Station
Augusta, Maine 04333
(207) 626-8800
Attorneys for State of Maine and Securities Administrator
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