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English-Speaking Union v. Johnson

January 15, 2008


The opinion of the court was delivered by: Colleen Kollar-kotelly, United States District Judge


This is an appeal of a ruling made by the United States Bankruptcy Court for the District of Columbia, arising out of Appellant English-Speaking Union's ("ESU") sale of its Washington, D.C. branch headquarters to James and Geraldine Johnson who, before paying ESU its note for part of the building's purchase price, filed for bankruptcy. The narrow issue on appeal is whether the Bankruptcy Court erred by deciding not to equitably subordinate the claim of Elm Company ("Elm"), a creditor, after its counsel testified at trial and, according to ESU (but belied by the record), indicated that Elm had submitted a fraudulently high claim for attorneys' fees to be paid from the bankruptcy proceeds. After thoroughly reviewing the Parties' submissions, case law, statutory authority, and the record as a whole, the Court shall affirm the ruling of the Bankruptcy Court for the reasons that follow.


A. Factual Background

Although the issue presented on appeal is uncomplicated, the underlying facts are not. In 1993, ESU sold a piece of real property located in the District of Columbia to Mr. and Mrs. Johnson (the "debtors").*fn1 See Elm's Br at 2. As part of the sale, ESU took back a note for a portion of the purchase price. Id. at 3. The debtors contemporaneously and subsequently obtained other loans that were secured by deeds of trust on the property, including several held by the Appellee, Elm. Id. 3-4. After the debtors filed for bankruptcy, they sold the property free and clear of its multiple liens pursuant to an order of the Bankruptcy Court, with the liens attaching to the approximately $840,000 in proceeds generated from the sale. Id. at 7. Elm filed a Motion for Summary Judgment seeking to establish, inter alia, the priority of liens on the proceeds. Id. The debtors, and two creditors -- the United States Internal Revenue Service (the "IRS"), and American General Mortgage ("American General") -- opposed the Summary Judgment Motion, but ESU (also a creditor) did not. Id. at 7-8. On August 2, 2001, the Bankruptcy Court issued its decision granting in part and denying in part Elm's Motion for Summary Judgment, which fixed the creditors' competing priorities and found that ESU's deed of trust lien was junior to the deed of trust liens held by Elm and American General. Id. At 8. Following that decision, the liens on the bankruptcy proceeds were subject to the following priorities:

Elm: First Deed of Trust for notes in the amount of $100,000 and $44,000

Elm: Second Deed of Trust for note in the amount of $100,000

American General: Second Deed of Trust for note in the amount of $141,000

ESU: Third Deed of Trust for note in the amount of $335,000

See AR 310-344 (Order and Opinion, No. 99-10076 at 36-38 (Aug. 9, 2001)).*fn2

After the Bankruptcy Court held a pre-trial conference at which ESU failed to appear, all Parties except ESU entered into a Settlement Agreement and filed a Motion to Enter a Settlement Agreement and Notice on September 5, 2001. Elm's Br. at 8-10. The Agreement presumed that the principal balance, interest, and attorneys' fees due to Elm and American General, combined with surcharges, fees, and an IRS lien, consumed all of the proceeds available for distribution.

Id. at 9. Accordingly, there were no proceeds left to be distributed to ESU because of its relatively low priority. Id. On October 29, 2001, the Bankruptcy Court set trial for November 19, 2001. Id. at 10. After seeking several extensions of time to file an objection to the settlement, ESU filed its Objections three days before trial, arguing that Elm's claim should be equitably subordinated for two reasons. Id. at 11; AR 425-433 (Objection of ESU to Proposed Compromise and Settlement at 6-8 (Nov. 13, 2001)) (hereinafter "ESU Objection"). First, ESU questioned the amount of interest Elm was due on its notes. Id. at 430-31. Second, ESU argued that Elm's claim for attorneys' fees was too high because a large portion of those fees were generated pursuant to litigation that was not directly related to collection from the debtors.*fn3 Id. at 431-32. At trial on November 19, 2001, the Bankruptcy Court heard argument and testimony related to ESU's objections.*fn4 Although ESU initially raised its first argument concerning the interest on Elm's notes, see Tr. 53:5 ("[w]e dispute, for example, the interest"), that argument was eventually abandoned by ESU after the Bankruptcy Court made its factual findings with respect to the interest owed. See Tr. 138:20-23 (having calculated the interest due on Elm's notes, the Bankruptcy Court informed ESU that it could examine the "calculations after today's hearing and let the Court know if there was an error," but ESU did not bring any error to the Bankruptcy Court's attention). ESU has not appealed this portion of the Bankruptcy Court's ruling. See ESU's Br. at 1 (limiting the issue on appeal to attorneys' fees).

Regarding Elm's claim for attorneys' fees, the Bankruptcy Court denied ESU's request to equitably subordinate Elm's claim because ESU had not raised that argument in its answer, had not raised it in response to Elm's Motion for Summary Judgment, had not attended the pretrial hearing, and had not submitted a pretrial statement. The Bankruptcy Court did require testimony, however, concerning whether any portion of the attorneys' fees should be disallowed. The Bankruptcy Court sought to determine, in particular, whether there would be any remaining funds to distribute to ESU if Elm could only recover the portion of attorneys' fees that were generated by direct litigation against the debtors (as opposed to any collateral litigation). See Tr. 54:19-23 ("I am going to . . . require them to put on some proof of their claim and let you show me that they are wrong to assert that, at a minimum, the amounts owed are such that it exhausts the funds."). The testimony that followed forms the basis for ESU's instant appeal.

Mr. Hayden, counsel for Elm, presented testimony that approximately $90,000 of pre-petition attorneys' fees were directly attributable to enforcing its notes against the debtors:

Q: And can you estimate for the Court, based on your review of the billing records as well as your knowledge of the proceedings as they have been along, what percentage of [the total legal fees were] actually attributable to collection of the note as opposed to the [collateral litigation]?

A: Yeah . . . directly related, in my view, to enforcing the note, dealing with the [debtors] on the escrow, protracted discovery, dealing with these other litigations, ...

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