[COLUMN] Trustee & debtor mutually dismiss adversary claims for $1M

THE client’s company filed for Chapter 7 relief as it was bankrupt. It had two warehouses and rent for one was $15,000 a month, the other $20,000 a month.

The original business started 12 years ago when the client had a partner. They imported merchandise from Asia and distributed them here in the USA. For eight years, business was good. In the 9th year, the business started deteriorating with sales going down about 40%. The partner decided he wanted to split up and not do the business anymore. The client then bought off the partner and paid him a lump sum amount for the inventory. The client then set up an LLC to take over the business.

The first year of operations were breakeven. The second year of operations had some profit. Overseas suppliers were shipping merchandise with extended credit to the LLC. In the third year, it appeared that there was too much competition, and losses were being incurred monthly. The LLC could not pay the rent for two warehouses, so it stopped paying rent on the bigger warehouse and consolidated inventory in the smaller warehouse. The landlord for the bigger warehouse sued the LLC for unpaid rent of $240,000.

In year three, the LLC could not pay its suppliers on time despite extended credit, so the client as the company’s CEO decided to return all unpaid merchandise to suppliers. Let’s just end this here because it gets a little complicated what happens next.

I represent the LLC in its Chapter 7 petition. Since the merchandise was returned to suppliers, the LLC no longer had any inventory, or if it did, inventory was negligible.

The client testified at several hearings with the Chapter 7 trustee that the LLC did not have inventory, which was the truth. And what is the reason why it no longer had inventory? Because the LLC could not pay the suppliers and so the LLC returned the entire inventory to unpaid suppliers. Well and good. That’s the truth anyway.

However, it doesn’t end there. It’s a long story. First, the client attempted by himself, without me or other counsel, to respond to the 2004 exam conducted by the trustee. This is a deposition where the trustee’s lawyer gets to ask the client anything that he wants and needs to so he can understand what happened to the inventory. The problem is that the tax returns for year three show that there is about $1M of inventory while the client has testified that there is no inventory. So what is really going on? I’m out of the picture at that point because the client did not retain me for the 2004 exam. Second, at the same time that the trustee subpoena’s client for the 2004 exam, the trustee also filed an adversary case against the client, as an individual, to recover some amounts that he thinks were preferential payments made by the LLC to the client. The amount is not big. But it’s just a preferential payment action that involves a small amount, less than $50,000.

After the deposition, the trustee then amends the adversary against the client alleging that the client had concealed the $1M inventory, and he wants the $1M back in cash from the client. Whoa, now that’s a pretty big claim! So now the client hires me again the represent him in the adversary. The trustee throws everything against the client, including the kitchen sink, in the amended complaint, which now sounds like a criminal case with all kinds of conspiracies perpetrated by the client to hide the $1M inventory from the trustee.

This is a simple Chapter 7 case that has exploded into a very complicated legal case! In short, the trustee has actually accused the client of committing a crime by hiding $1M of inventory.

In the client’s answer to the amended complaint, we include a counterclaim against the trustee for $1M. So now that issues have joined, the trustee and client are suing each other for $1M, with the trustee accusing the client of having committed several crimes.

This case was litigated for two years and finally ended with parties, the trustee and client dismissing their claims against each other. It’s a mutual dismissal of the adversary claims. The settlement was arrived at after a one-day settlement conference with the help of a very experienced mediator who was a Federal Bankruptcy judge who had just retired. She was most helpful in the resolution of the case and I wish to give her our thanks for all her help and insight to resolve this case amicably. We were prepared to go to trial in case the mediation failed. But the Judge did point out some weaknesses in the documentary evidence. At trial, I had no idea how the trial court would rule.

The client had lots of documentary evidence to prove his case, but at the same time, there were discrepancies in the tax returns.

I believe there was divine intervention through the judge because she really saw both sides of the argument impartially.

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Lawrence Bautista Yang specializes in Bankruptcy, Business, Real Estate and Civil Litigation and has successfully represented more than five thousand clients in California. Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 20274 Carrey Road, Walnut, CA 91789 or 1000 S. Fremont Ave., Mailstop 58, Building A-10 South, Suite 10042, Alhambra, CA 91803.

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