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Lebron v. Mechem Financial

argued: March 1, 1994.


On Appeal From the United States District Court For the Western District of Pennsylvania. (D.C. Civil Action No. 93-00067E).

Before: Stapleton and Scirica, Circuit Judges, and Van Antwerpen, District Judge*fn*

Author: Stapleton


STAPLETON, Circuit Judge:

Pursuant to 11 U.S.C. §§ 503(b)(3) and (b)(4) (1988), the bankruptcy court awarded W. James Scott ("Scott"), a creditor and former officer and director of the debtor, Mechem Financial, Inc. ("Mechem"), reimbursement of expenses incurred in connection with activities that the court felt "substantially contributed" to Mechem's estate. Most of Scott's efforts were aimed at exposing the fact that Mechem's officers and directors were engaged in fraudulent activity. The bankruptcy court's award was appealed by three other creditors of the estate, Michael Q. Lebron, Michael C. Lebron, and Anthony Lebron ("the Lebrons"). The district court reversed, holding that some of Scott's expenses were incurred either before the chapter 11 petition was filed or after the case was converted to chapter 7, and that §§ 503(b)(3) and (b)(4) do not authorize recovery of expenses incurred during these periods. The district court further held that Scott could not recover the expenses he incurred while the chapter 11 proceedings were pending because he was acting solely for his own benefit, thus making any benefit to the estate purely incidental. Finally, the court held that the bankruptcy court's award was inequitable because Scott was an insider in the corporation that was committing the fraud. Scott appeals the judgment of the district court. We will reverse and remand for further proceedings.


Mechem was founded in 1986 to manage pre-need funeral trust funds for individuals and to provide these individuals with funeral goods and services to be paid for with the funds in trust. The funds were advanced from the participating individuals to Mechem through funeral directors. Scott was one of the three initial members of Mechem's board of directors as well as a minority shareholder. In addition, Scott was a funeral director who had entrusted Mechem with funds under pre-need contracts executed by his customers. A second board member, John R. Copple ("Copple"), served as the President of Mechem, and controlled the day-to-day operations of the corporation. Soon after Mechem was organized, Scott began to sense that Copple was not disclosing to him information regarding Mechem financial matters and investments. Then, in October 1987, Copple and the third member of the board of directors removed Scott as an officer and director of Mechem.

After his removal, Scott apparently made several requests of Copple for financial information about Mechem, but Copple refused these requests. Therefore, in 1988, Scott filed a complaint in mandamus against Mechem in the Court of Common Pleas of Erie County, Pennsylvania, seeking to exercise his rights under Pennsylvania law as a shareholder to examine Mechem's books. During the discovery phase of this action, Scott became aware that Copple had misappropriated millions of dollars of pre-need funeral trust fund monies for personal use, much of which was used to purchase rare coins controlled by Copple. In light of this information, Scott, in February 1990, filed a complaint in equity in the Court of Common Pleas of Erie County, Pennsylvania, against Mechem, its officers, directors, and majority shareholders, and certain holders of trust funds. He sought appointment of a custodian to prevent further mismanagement and fraud, a complete and accurate accounting of the assets held by Mechem, an injunction against the disbursement or transfer of pre-need trust funds, and a declaration that certain issues and transfers of corporate stock were void. Scott accompanied this complaint with an affidavit that detailed alleged acts of mismanagement and self-dealing by Copple in his capacity as president of Mechem.

According to the bankruptcy court, the walls began to close in on Copple at this point. On March 6, 1990, a common pleas court ordered Mechem and, specifically, Copple, to file before March 12, 1990, inventories of all assets, investments, and accounts held by Mechem or Copple personally. Because neither Mechem nor Copple filed a satisfactory inventory, Scott promptly moved to compel compliance with the court's order. On March 19, 1990, the common pleas court entered an additional order directing Mechem and Copple to file by March 26, 1990, inventories and more detailed supporting information.

Copple reacted to the court's order by causing Mechem to file a chapter 11 petition on March 23, 1990. Scott immediately filed in the bankruptcy court for the appointment of a trustee, for an expedited accounting, and for partial relief from a stay. The bankruptcy court granted Scott's motion on March 28, 1990, and a trustee was appointed on that same day. Scott then gave the trustee all of the information that he had gathered during his pre-bankruptcy petition legal actions against Mechem and Copple. The bankruptcy court found that this information "contributed to the trustee's report of investigation filed promptly with [the] Court on April 24, 1990 identifying various assets and summarizing the history of questionable financial transactions between [Mechem] and [Copple and affiliates and corporations under Copple's control.]" B.Op. at 6.

The trustee recommended that the proceedings be converted to chapter 7, which the bankruptcy court did on May 23, 1990. During the liquidation process, the trustee collected cash in the amount of $460,000. The trustee also brought numerous adversary proceedings against Copple and his wife, which resulted in the turnover of additional property to the estate. Finally, the trustee obtained a judgment against Copple for $4,009,645, and against Copple and his wife for $1,307,567. According to the trustee, unless the Copples successfully appeal these awards, another $400,000 to $700,000 will be collected upon the liquidation of their personal assets. Despite the collection and liquidation efforts, the unsecured creditors of Mechem will incur losses.

Scott, pursuant to §§ 503(b)(3) and (b)(4), applied to the bankruptcy court for reimbursement of the expenses he had incurred in connection with the Mechem legal actions and his participation in the chapter 11 and chapter 7 proceedings. Specifically, Scott requested $48,805.12 as reimbursement for attorney fees and $10,207.88 as reimbursement for general expenses. These amounts represented expenses incurred before, during, and after Mechem entered the chapter 11 proceedings. The bankruptcy court awarded Scott his requested reimbursements in full. In justification of this award, the court made the following findings:

The information gathered by Scott in his prosecution of matters against the Debtor was critical to the Court in making an immediate determination to appoint a Trustee and critical to the Trustee in making a prompt investigation and report to the Court which resulted in conversion of this case to Chapter 7. Scott's information also assisted the Trustee in the subsequent collection of assets for the benefit of creditors of the estate.

Scott's efforts were more than just a passing benefit to the estate. The efforts of Scott were a substantial contribution in assisting the Trustee to carry out his responsibilities. Scott's efforts far exceeded those which he was obligated to perform. . . .

We find that all of Scott's efforts for which he incurred fees and expenses both prepetition and postpetition resulted in a direct benefit and were a substantial contribution to the estate. Any fees and expenses which Scott incurred prepetition substantially contributed to the administration of the Debtor's estate postpetition. Thus, there is ...

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