The following is a case update written by Reno Fernandez, a bankruptcy appellate specialist with California Appellate Law Group, LLP, analyzing a recent decision of interest:
On April 27, 2023, the U.S. Court of Appeals for the Seventh Circuit issued an opinion adopting the preponderance-of-the-evidence standard for turnover actions under Bankruptcy Code § 542. In re Dordevic, 67 F.4th 372 (7th Cir. 2023).
To view the opinion, click here.
Shogher Zargaryan designed specialized machinery to produce medical syringes and sought to build a factory. She and her family looked for an investor and, on a cruise, they met the Debtor, Jelina Dordevic. The Debtor transferred $773,250 to help pay for construction in exchange for a 50% stake in the business, namely PHMX LLC, but she requested that it be held in the name of her mother, Jorgovanka Dordevic. The Debtor later testified that this was to avoid problems with immigration authorities, which had charged her with immigration fraud for trying to obtain permanent residency through a sham marriage.
The Debtor filed a petition for relief under chapter 7 of the Bankruptcy Code, and the Chapter 7 Trustee sued the Debtor’s mother for turnover of her 50% interest in PHMX under Bankruptcy Code § 542. A trial was held over three days.
At trial, the Debtor’s mother and the Debtor’s former romantic and business partner, Nikola Zaric, testified inconsistently that either the mother or Zaric owned the 50% interest in PHMX. Jorgovanka (whose first name is used for clarity and not from disrespect) testified that she contributed $112,000, but there was no evidence the funds were actually received and used on the project. Zaric testified that the Debtor owed him $800,000 and that her payment of $773,250 for construction costs was on account of her indebtedness to him.
The bankruptcy court credited the testimony Shogher and her family, which showed that they solicited and receive an investment from the Debtor, not from her mother or Zaric. Expressly applying a preponderance-of-the-evidence standard, the bankruptcy court entered judgment for the Trustee.
The Debtor’s mother took an appeal to district court, arguing that the bankruptcy court should have required proof by clear and convincing evidence. The district court affirmed, and Jorgovanka further appealed to the Seventh Circuit.
The Seventh Circuit affirmed, holding that the preponderance-of-the-evidence standard applies to turnover actions. The court began by reviewing the prevailing practice under the Bankruptcy Act of 1898. Under the Act, a judge-made procedure for “summary turnover” was used to obtain turnover of estate assets. Summary turnover required proof by clear and convincing evidence.
Jorgavonka argued that the clear-and-convincing-evidence standard continues to apply notwithstanding the Act’s repeal and replacement by the Bankruptcy Code. The Seventh Circuit remarked that neither it nor the U.S. Supreme Court has resolved the issue.
The Seventh Circuit noted that, after Grogan v. Garner, 498 U.S. 279 (1991), in the absence of an express or implied standard of proof, the presumptive standard of proof is proof by a preponderance of the evidence. More fundamentally, Grogan teaches that the preponderance-of-the-evidence standard applies unless “particularly important individual interests or rights are at stake.” Id. at 280–81.
Under the Act, such important interests and rights were at stake in summary turnover proceedings. Specifically, the Act imposed heavy penalties, including criminal fines, imprisonment, or both.
By contrast, turnover under the Bankruptcy Code involves only money, for the most part. Accordingly, the Seventh Circuit determined that there are no “quasi-liberty” interests at stake that would support a clear-and-convincing-evidence standard.
The court then reviewed the evidence thoroughly and found more than enough to constitute a preponderance of the evidence. Therefore, the Seventh Circuit affirmed.
There is another interesting aspect to this opinion. Specifically, all three courts framed the issue of equitable ownership as whether Jorgovanka served as the Debtor’s “nominee” under federal common law. (The Seventh Circuit noted that state law may apply but that no party opposed the application of federal common law.)
Being a nominee requires proof of five elements, including that the property was placed in the name of the nominee in anticipation of collection. The Seventh Circuit’s discussion of this element is surprisingly short. The court noted that the Debtor omitted her mother’s 50% interest in PHMX from her schedules, but this is not surprising given the Debtor’s contention that the business belonged to her mother. The court also noted that the Debtor omitted the $800,000 debt to Zaric from her schedules, which is also not surprising given that the validity of the debt is questionable.
These grounds appear somewhat circular. Then again, the court also noted, in passing, that the Debtor could not account for a missing fleet of trucks.
This review was written by Reno Fernandez, a bankruptcy appellate specialist with California Appellate Law Group, LLP, a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.