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In re Racing Services

July 2, 2009

IN RE: RACING SERVICES, INC., DEBTOR.
KIP M. KALER, CHAPTER 7 TRUSTEE, APPELLANT,
v.
SUSAN BALA, APPELLEE.



Appeal from the United States Bankruptcy Appellate Panel for the Eighth Circuit.

The opinion of the court was delivered by: Loken, Chief Judge

Submitted: February 13, 2009

Before LOKEN, Chief Judge, MELLOY and BENTON, Circuit Judges.

Racing Services, Inc. ("RSI"), provided simulcast (simultaneous broadcast) services to licensed off-track betting operators in North Dakota. RSI and Susan Bala, its president and sole shareholder, were indicted for federal gambling and money laundering violations. RSI petitioned for bankruptcy protection, and Kip M. Kaler was subsequently appointed as Chapter 7 bankruptcy Trustee. A jury convicted RSI and Bala in the criminal case. The district court sentenced Bala and entered forfeiture judgments against Bala and RSI. With their appeal in the criminal case pending, Bala filed a Chapter 7 administrative expense claim seeking $110,218.54 in post-petition rent for Fargo office space owned by Bala and leased to RSI. After a hearing, the bankruptcy court allowed the claim but subordinated it to "all other allowed claims pursuant to 11 U.S.C. § 510(c)(1)." We will refer to this ruling as the "Subordination Order." The Eighth Circuit Bankruptcy Appellate Panel ("BAP") affirmed. In re Racing Servs., Inc., 340 B.R. 73 (B.A.P. 8th Cir. 2006).

In March 2007, we reversed the criminal convictions and forfeiture judgments. United States v. Bala, 489 F.3d 334 (8th Cir. 2007). Bala then filed and the bankruptcy court granted a motion to vacate the Subordination Order under Rule 60(b)(5) of the Federal Rules of Civil Procedure, made applicable to bankruptcy cases by Bankruptcy Rule 9024. The Trustee and the State of North Dakota, a substantial RSI creditor, appealed. Again the BAP affirmed. In re Racing Servs., Inc., 386 B.R. 751 (B.A.P. 8th Cir. 2008). The Trustee appeals. We affirm.

I.

Administrative claims for post-petition services to a bankruptcy estate have first priority when the assets of the estate are distributed to creditors. 11 U.S.C. §§ 503(b)(1)(A), 507(a)(1). However, § 510(c)(1) of the Bankruptcy Code authorizes the bankruptcy court to subordinate an allowed administrative claim to other claims "under principles of equitable subordination." Equitable subordination requires proof of inequitable conduct by the claimant that injured other creditors or conferred an unfair advantage. In re Bellanca Aircraft Corp., 850 F.2d 1275, 1282 (8th Cir. 1988). Fraud, illegality, and breach of fiduciary duty are misconduct that justifies equitable subordination. See Id. at 1282 & n.13; In re Missionary Baptist Found. of Am., Inc., 712 F.2d 206, 212 (5th Cir.1983). In the Subordination Order, the bankruptcy court subordinated Bala's administrative claim to all other creditor claims because -

In causing RSI to engage in illegal activities resulting in its criminal convictions, Bala breached her fiduciary duty to RSI and engaged in unfair conduct. . . . Bala's use of the debtor to perpetuate criminal violations of federal gaming laws . . . resulted in the possible forfeiture of all of RSI's assets to the United States, and but for Bala's involvement of RSI in her criminal schemes, RSI likely would not have ended up in bankruptcy. Bala's involvement of RSI in illegal activity clearly injured RSI's creditors.

On appeal, the BAP agreed. 340 B.R. at 76-77.

After an argument hearing on Bala's Rule 60(b)(5) motion, the bankruptcy court granted relief and vacated its equitable subordination ruling because "the now nonexistent criminal conviction" had been critical to that ruling. The court declined the Trustee's request to reopen the matter to consider other evidence of inequitable conduct, observing that "whatever debt [Bala] had, she's more than paid it." The BAP affirmed, concluding that the Rule 60(b)(5) motion was proper and finding no abuse of discretion because, in equitably subordinating Bala's administrative claim, both the bankruptcy court and the BAP had "relied wholly on the Criminal Orders to satisfy the first two elements of equitable subordination." 386 B.R. at 754-55.

II.

Bankruptcy court rulings under Rule 60(b) are reviewed for abuse of discretion. In re Kirwan, 164 F.3d 1175, 1177 (8th Cir. 1999). Here, the Trustee argues that Rule 60(b)(5) did not authorize the relief granted by the bankruptcy court, and therefore the BAP erred in reviewing the bankruptcy court's ruling for abuse of discretion, rather than de novo. "Nothing turns on this argument because a . . . court by definition abuses its discretion when it makes an error of law." Prudential Ins. Co. of Am. v. Nat'l Park Med. Ctr., Inc., 413 F.3d 897, 903 (8th Cir. 2005) (quotations omitted). Thus, we construe this argument as confirming that the Trustee does not appeal the bankruptcy court's exercise of its discretion. The only issue is whether the court had legal authority to exercise that discretion.

Rule 60(b)(5) authorizes relief from a final order if the order (i) "has been satisfied, released or discharged," (ii) "is based on an earlier judgment that has been reversed or vacated," or (iii) "applying it prospectively is no longer equitable."*fn1 The Trustee argues that relief may not be granted under clause (ii) of Rule 60(b)(5) because the Subordination Order was not, in the words of various cases and treatises, "based on the prior judgment in the sense of claim or issue preclusion." 11 Wright, Miller & Kane, Federal Practice and Procedure: Civil 2d § 2863, at 334-35 (1995); see 12 Moore's Federal Practice § 60.46[1] (2009)("based on" means "the first judgment has claim or issue preclusion effects on the second"). With Rule 60(b)(5) relief unavailable, the bankruptcy court could grant relief after the criminal conviction and forfeiture judgments were reversed only under Rule 60(b)(2), which applies to "newly discovered evidence." But Bala's motion to vacate was filed more than one year after entry of the Subordination Order, so a Rule 60(b)(2) motion was time-barred. See Rule 60(c)(1). Therefore, the Trustee concludes, Rule 60(b) relief was unauthorized. Like the BAP, we disagree.

Clause (ii) of Rule 60(b)(5) has received little judicial attention and analysis. All agree that clause (ii) is not a broad ...


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