When is the Failure to Respond in Litigation Excusable?

AbsenceOfEvidence

The chapter 7 bankruptcy trustee of Canopy Financial, Inc., a former health care transaction software company based in Chicago, is seeking to recover more than $90 million of funds that were misappropriated by its co-founders, one of whom committed suicide and the other who is serving a 13-year prison sentence for fraud. Background about the fraud can be found here, and some of the details about the $50 million in assets the trustee has recovered to date can be found in the recent Seventh Circuit opinion in the Canopy case here.

As discussed by the Seventh Circuit, one of the businesses in the trustee’s sights is Buddha Entertainment, LLC, which operates nightclubs, including TAO in Las Vegas’ Venetian Hotel and Casino. In his complaint, the trustee alleged that the co-founders spent more than $80,000 of Canopy’s money at TAO during several visits. The trustee alleged that these were fraudulent conveyances under federal bankruptcy law and Illinois’s version of the Uniform Fraudulent Transfer Act. Some previous posts from this blog discussing the elements of fraudulent transfers under Illinois law can be found here and here.

The issue in the most recent Seventh Circuit opinion, however, is not as to the substance of the trustee’s complaint of whether the fraudulent transfers were recoverable, but rather, a procedural one, as the party being sued failed to respond initially and was defaulted. The Seventh Circuit outlines in its opinion the equitable standard for evaluating such neglect, before finding that the party in this case failed to meet its burden of demonstrating such neglect. [FN1]

Mysteriously, Buddha did not respond to the trustee’s complaint or motion for default, and the bankruptcy judge entered a default judgment against Buddha requiring it to disgorge the amounts it had received from Canopy. Each of these pleadings was sent to Buddha’s registered agent for service.

It was only after the trustee began to collect from Buddha’s assets in Nevada that at last Buddha responded. It then filed a motion seeking relief from the judgment under the rule of civil procedure which permits relief from a judgment that depends on “mistake, inadvertence, surprise or excusable neglect.” [FN2]

Before the Bankruptcy Court, Buddha argued that it had not received any of the trustee’s filings and that the failure to respond therefore was “excusable neglect” under the federal rule.

The Bankruptcy Court denied the motion, stating that good cause is not shown by the allegation that a registered agent failed to submit pleadings to its principal. It found that as an agent’s acts and omissions usually are attributed to its principal, a litigant is responsible for the acts of its registered agent. The District Court affirmed.

On appeal before the Seventh Circuit, Buddha asked the appeals court to find the bankruptcy judge’s ruling in error on the grounds that despite its agent’s alleged proper failure to forward pleadings, that fact in itself was not dispositive of whether that failure was “excusable.” Instead, it pointed to the equitable standard set forth in the U.S. Supreme Court’s Pioneer Investment Services decision [FN3] and adopted by the Seventh Circuit [FN4], for the proposition that that an attorney’s negligence in meeting a filing deadline could be “excusable neglect” for the purpose of Rule 60(b)(1). Buddha argued that what is true for lawyers must be true for other agents.

The Seventh Circuit noted however that Buddha failed to bring this case to the attention of the bankruptcy judge. More critically, it observed that Pioneer describes excusable neglect as an equitable standard that requires the court to take “account of all relevant circumstances surrounding the party’s omission.” [FN5] The federal appeals court found the most telling thing about the record was its “thinness,” and that Buddha provided no evidence from the registered agent it hired to accept service, as to the circumstances of the alleged errors.

The Seventh Circuit outlined at least 8 things that could have happened, but noted that the record did not address any of the possibilities. It therefore held that Buddha did not carry out their burden of both production and persuasion as to demonstrating whether their neglect in responding was “excusable,” and affirmed the rulings of the lower courts.

The scenarios outlined by the federal appeals court provide guidance as to the quantum of evidence needed for a party asking to be excused of its neglect in a motion to vacate a judgment. Assuming there is no other legal bar to the argument, a party asking to be excused of its neglect will need to be prepared to present some detailed evidence of the reason for that neglect.

[FN1] In re Canopy Financial, Inc., 708 F.3d 934, No. 12-3239 (7th Cir. February 28, 2013).

[FN2] Fed. R. Bankr. P. 9024 (incorporating Fed. R. Civ. P. 60(b)).

[FN3] Pioneer Investment Services Co. v. Brunswick Associates L.P., 507 U.S. 380 (1993).

[FN4] Robb v. Norfolk & Western Ry., 122 F.3d 354 (7th Cir. 1997).

[FN5] Canopy, supra FN1 at 5.

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