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IRS scuttles proposed settlement

Where a proposed settlement would pay an unsecured creditor ahead of the Internal Revenue Service, which was a senior creditor, it violated the Bankruptcy Code’s priority schemes and was denied.

Background

In August of 2017, River House Enterprises LC obtained an arbitration award against the debtor, Tovan Construction Inc., and had that award confirmed in state court. In an attempt to collect on that award, River House filed suit against the debtor, Michael A. Pancione, the debtor designee and a principal of the debtor and Tovan Enterprises Inc., or TEI, and TEI in the Loudoun County Circuit Court, alleging that Pancione formed TEI for the purpose of diverting the debtor’s assets to TEI in order to evade the debtor’s creditors.

On July 24, 2019, the debtor filed a chapter 7 petition. Following the debtor’s bankruptcy filing and imposition of the automatic stay, River House sought relief from the stay to continue prosecuting the Loudoun claims in state court. The trustee opposed stay relief, arguing that the Loudoun claims were property of the estate and that River House therefore lacked standing to prosecute those claims. The stay relief motion has essentially been held in abeyance pending resolution of the instant motion.

In addition to the River House claim and other claims filed in the case, the IRS holds claims totaling $385,872.95, all of which are secured by federal tax liens. At least $112,242.21 of these claims are priority claims. None of these claims have been objected to.

The trustee now seeks to approval to approve a settlement. The settlement provides for payments by Pancione and TEI to the estate and River House, mutual releases and a bar order. The IRS filed an objection to the settlement, asserting that it violates the Bankruptcy Code’s priority schemes and improperly attempts to bar the IRS from asserting future claims.

Analysis

The main dispute is whether the settlement, which provides for (i) payment of $110,000 by Pancione and TEI to the estate, (ii) payment of $70,000 by Pancione and TEI to River House, (iii) mutual releases between the parties and (iv) a bar order to give effect to the mutual releases, violates the Bankruptcy Code’s priority schemes by paying $70,000 to River House, a general unsecured creditor, ahead of the IRS’ secured and priority claims.

The trustee contends that the Bankruptcy Code’s priority scheme only applies if the Loudoun claims are property of the estate. The trustee argues that because the dispute over who owns the Loudoun claims is being settled—in other words, because the trustee and River House say there is a cloud over title to the Loudoun claims—that the Bankruptcy Code’s priority scheme does not apply to settlement of that dispute.

The trustee seeks to characterize this as a settlement of the dispute over who owns the Loudoun claims. The court declines to adopt the trustee’s description of the settlement and instead will look to the settlement’s substance to determine its true nature. At core, the trustee is settling alleged fraudulent transfers between the debtor, Pancione and TEI. Because fraudulent transfers harm the entire estate, not individual creditors, these causes of action, particularly in light of the bankruptcy filing, are property of the estate.

River House may assert that it holds a separate conspiracy claim against the non-debtor entities, but in reality, River House is using the conspiracy claim to further prosecute fraudulent transfer theories in an attempt to recover on the arbitration award against the debtor. To the extent that River House had any conspiracy claim separate and apart from estate property (and separate and apart from any fraudulent transfer litigation related to the debtor), the trustee has no standing to settle that claim and the court declines to exercise jurisdiction over that claim, to the extent it even could.

In any event, given that the settlement purports to settle estate claims, the distributions provided for by the settlement are proceeds of property of the estate and therefore must adhere to the Code’s priority schemes. Because the proposed settlement seeks to pay River House, an unsecured creditor, $70,000 while the IRS, a senior creditor, does not receive payment in full, the court finds that the settlement is not “fair and equitable” because it violates the Bankruptcy Code’s priority schemes.

Trustee’s motion to approve settlement denied.

In re: Tovan Construction Inc., No. 19-12423, March 31, 2021. EDVA Bankr. at Alexandria (Kindred). VLW No. 021-4-003. 5 pp.

VLW 021-4-003