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Shaia v. Malone

United States District Court, E.D. Virginia, Richmond Division

September 21, 2017

HARRY SHAIA, JR., Trustee,
v.
RUSSELL H. MALONE, III, Movant.

          MEMORANDUM OPINION

          M. Hannah Lauck United States District Judge

         This matter comes before the Court on the Motion for Withdrawal of the Reference filed by Debtor Russell H. Malone, III ("Malone" or "Debtor"), Malone Family Holdings, LLC ("MFH"), 10200 W.B. Associates, LLC, Stony Point, LLC, MH Futures, LLC, Debtor's wife, Anne Elizabeth "Beth" Malone ("Ms. Malone"), and Debtor's son, Russell H. Malone, IV ("Russell") (collectively, the "Defendants"). (ECF No. 1.) Defendants seek permissive withdrawal of the adversary proceeding initiated when Trustee Harry Shaia, Jr., ("Trustee") filed a two-count complaint against Defendants in the underlying bankruptcy action. Trustee opposes the withdrawal. The Court exercises jurisdiction pursuant to 28 U.S.C. § 157(d).[1]

         The parties fully briefed the matter in the Bankruptcy Court, and the Court dispenses with oral argument because the materials before it adequately present the facts and legal contentions, and argument would not aid the decisional process. The matter is ripe for disposition. For the reasons that follow, the Court will deny the Motion for Withdrawal of the Reference and remand the case to the Bankruptcy Court.

         I. Factual and Procedural Background[2]

         A. Procedural Background

         On June 3, 2014, Malone, faced with a sizable judgment against him, filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code. On April 7, 2015, the case was converted to a proceeding under Chapter 7, and the Trustee was appointed the next day. On December 6, 2016, after conducting extensive investigation into the estate property, the Trustee initiated an adversary action against Defendants by filing a Complaint in the Bankruptcy Court (the "Trustee Complaint"). The Trustee Complaint asserts two causes of action: (1) "Alter Ego/Reverse Veil Piercing"; and, (2) "Substantive Consolidation.[3]" (Trustee Compl. 37, 39.) On January 5, 2017, Defendants moved to withdraw the adversary proceeding initiated by the Trustee Complaint to this Court. The Trustee opposed the withdrawal, and the parties fully briefed the matter in the Bankruptcy Court.

         B. Allegations in the Trustee Complaint

         The Trustee filed the Trustee Complaint against Malone, Ms. Malone, their son, Russell, and the following five LLCs (collectively, the "LLCs"):

1) Malone Family Holdings ("MFH"), a Virginia LLC created in March 2011, with its principal place of business at 10200 West Broad Street, Richmond, Virginia. At the time MFH was created, Malone and Ms. Malone held 99.3% of the membership interests in MFH.
2) 10200 WB Associates, LLC ("10200 WBA"), a Virginia LLC with its principal place of business also at 10200 West Broad Street, Richmond, Virginia. Malone and Ms. Malone held 100% of the membership interests in 10200 WBA until they assigned all interest in 10200 WBA to MFH in March 2011.
3) Stony Point, LLC ("Stony Point"), a Virginia LLC with its principal place of business also at 10200 West Broad Street, Richmond, Virginia. Malone and Ms. Malone held 100% of the membership interests in Stony Point until they assigned all interest in Stony Point to MFH in March 2011.
4) Dickens Creek Farm, LLC ("DCF"), a Virginia LLC organized in 1998. Malone and Ms. Malone held 100% of the membership interests in DCF until they assigned all interest in DCF to MFH in March 2011.
5) MH Futures, LLC ("MH Futures"), a Virginia LLC organized in 2009. Malone and Ms. Malone held 100% of the membership interests in MH Futures until they assigned all interest in MH Futures to MFH in March 2011.

         In sum, MFH was created in March 2011, at which time Malone and Ms. Malone transferred their 100% ownerships in 10200 WBA, Stony Point, DCF, and MH Futures to MFH. They then held a 99.3% ownership interest in MFH.[4] Malone manages each of the LLCs.

         The forty-page Trustee Complaint details myriad interwoven financial transactions within and among the LLCs, Malone, Ms. Malone, and Russell. The Trustee Complaint alleges that

through his use of various alter ego companies, the Debtor assigned, redirected, and reallocated any property, compensation, or gain to which he was entitled, to entities which he controls, thereby hiding them from his creditors. In reality, however, the Debtor retained complete dominion, control, and full beneficial use of all this property and proceeds for himself, Anne Elizabeth Jones Malone (his wife) and Russell H. Malone, IV (his son).

(Trustee Compl. 1.)

         In his Complaint, the Trustee contends that "[e]ven a cursory examination of the financial records leads to the inevitable conclusion that, given the rampant commingling of funds over a period of several years, the LLCs are hopelessly intertwined and should be consolidated into a single estate with that of the Individual Defendants." (Id. at 21.) The Trustee charges that Malone, Ms. Malone, and Russell all used MFH "as if it were a personal bank account." (Id at 34.) The Trustee Complaint outlines the distribution of significant amounts of money to Malone that are inconsistent with the lesser amount of income Malone reported in the underlying bankruptcy action. In sum, the Trustee asserts that "the Debtor, and the Debtor alone, dominated the [LLCs] in all aspects, " meaning that the LLCs amount to alter egos of Malone that should be consolidated into the underlying bankruptcy action.

         The Trustee Complaint asserts two counts against all defendants:

Count I: "Alter Ego/Reverse Veil Piercing" - Malone used "the corporate form of the [LLCs] to evade [his, Ms. Malone's, and Russell's] personal obligations, perpetrate fraud, and commit injustice on [his, Ms. Malone's, and Russell's] creditors" (the "Alter Ego Count"), (id. at 37-39); and,
Count II: "Substantive Consolidation" - Because "there exists a substantial identify of interests between the Debtor and the other Defendants, " Malone's estates should be substantively consolidated "with that of the other Defendants" (the "Substantive Consolidation Count"), (id. at 39).

         The Trustee seeks, inter alia: (1) "A declaration that the [LLCs] are alter egos of [Malone, Ms. Malone, and Russell, ] and liable for" Malone's debts; and, (2) "Substantive consolidation of the estates of the Debtor and the other Defendants." (Id. at 40.)

         II. Analysis

         A. Legal Standard for Withdrawal of Reference

         Pursuant to 28 U.S.C. § 1334, the district courts have "original and exclusive jurisdiction of all cases" under the Bankruptcy Code. 28 U.S.C. § 1334(a). District courts may refer all bankruptcy matters to bankruptcy judges, 28 U.S.C. § 157(a), [5] as this District has done since 1984. See In the Matter of: The Administration of the Bankruptcy Courts and Reference of Bankruptcy Cases and Proceedings to the Bankruptcy Judges of this District (E.D. Va. August 15, 1984) (Order). The district court retains the power, however, to "withdraw ... any proceeding referred" to the bankruptcy court, and decide the matter itself. 28 U.S.C. § 157(d). A party who seeks district court determination of a matter filed in an underlying bankruptcy action may, as Defendants have here, file a motion to withdraw the reference. The burden of demonstrating the appropriateness of withdrawal-whether mandatory or discretionary-rests with the movant. See In re U.S. Airways Grp., Inc., 296 B.R. 673, 677 (E.D. Va. 2003).

         Bankruptcy law provides two avenues by which a district court can order a case withdrawn from the bankruptcy court: mandatory withdrawal or permissive withdrawal. 28 U.S.C. § 157(d).[6]

         1. Mandatory Withdrawal

         Mandatory withdrawal occurs when "resolution of the proceeding requires consideration of both title 11 and other laws of the United States regulating organizations or activities affecting interstate commerce." Neither party suggests that the Motion for Withdrawal of the Reference invokes this option.

         2. Discretion ...


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