In re: Douglas E. Palermo

Citation: Not availableDocket: 11-848-cv (L)

Court: Court of Appeals for the Second Circuit; January 6, 2014; Federal Appellate Court

Original Court Document: View Document

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The United States Court of Appeals for the Second Circuit addressed an appeal involving Douglas E. Palermo's bankruptcy case. David R. Kittay, the appointed trustee, claimed that Joseph Korff had received fraudulent transfers from Palermo prior to his Chapter 7 bankruptcy filing. Korff contested the timeliness of the complaint and the district court's award of prejudgment interest, arguing that the complaint was filed outside the limitations period and that the court did not justify its interest rate application.

The appellate court determined that the bankruptcy court effectively severed the claims, making the refiled complaint against Korff timely. However, it vacated the prejudgment interest award, remanding the case for the district court to either exercise its discretion regarding the interest calculation or clarify its reasoning if it had already done so. The court affirmed the district court's judgment in part, vacated it in part, and instructed further proceedings consistent with its opinion.

Debtor Douglas Palermo, a self-employed real estate consultant, filed for Chapter 7 bankruptcy on October 14, 2005, in the Southern District of New York. David Kittay was appointed as trustee on January 23, 2006, after the initial trustee's death. On October 12, 2007, shortly before the statute of limitations expired, Kittay initiated proceedings against Joseph Korff and others, alleging they received fraudulent transfers from Palermo before his bankruptcy, in violation of New York's Debtor and Creditor Law (DCL) Sections 273-276. After the Bankruptcy Court identified misjoinders among parties and claims, Kittay amended the complaint on January 7, 2008, dropping all but Palermo and subsequently refiled against separate groups of defendants. 

In August 2008, Korff sought to withdraw the reference from the Bankruptcy Court, resulting in the case being transferred to the District Court. Under 11 U.S.C. § 544(b)(1), a bankruptcy trustee can void transfers voidable under applicable state law, including fraudulent conveyance statutes. Kittay claimed Korff received fraudulent transfers as defined by DCL Sections 273-276, which outline constructive fraud and actual fraud. Constructive fraud occurs when a transfer is made without fair consideration and meets certain conditions, such as the transferor's insolvency or impending inability to pay debts. Section 276 addresses actual fraud, stating any conveyance made with the intent to defraud creditors is fraudulent. 

At trial, evidence revealed Palermo arranged to assign Korff $300,000 from a real estate deal fee in July 2004. Palermo's testimony about Korff's services was vague, while Korff's accounts were inconsistent, claiming entitlement to the fee based on participation in the transaction and implying repayment for undocumented loans to Palermo.

Palermo testified that Korff earned the fee, which was intended to settle prior debts. On October 19, 2010, shortly before trial, Korff sought to dismiss the complaint based on the statute of limitations, but the district court rejected this, citing equitable tolling that preserved Kittay's filing. The jury ruled in favor of Kittay on all counts. Post-trial, Korff filed for judgment notwithstanding the verdict and a new trial, both of which were denied. Korff subsequently requested reconsideration of the dismissal motion, which the court also denied on February 7, 2011. Korff contends that the court erred by not granting his request for judgment as a matter of law, asserting that the jury instructions were flawed, the complaint was untimely, equitable tolling was misapplied, and prejudgment interest was awarded without justification. The document addresses the timeliness of the complaint, noting that the filing period ended on October 14, 2007, but Kittay initiated action in Bankruptcy Court two days prior. Although Kittay's filing seemed late, the Bankruptcy Court's proceedings indicated that the initial complaint's timeliness ensured the subsequent filing was also timely. The court confirmed that the statute of limitations would not be an issue due to the original complaint's timely nature, allowing for separate adversary proceedings to be filed by January 7, 2008.

The court directed that once new complaints are filed, a consent order should terminate the initial adversary proceeding while ensuring that the new complaints relate back to the filing date of the initial complaint. Counsel for Kittay intended to amend the existing complaint to solely address Mr. Palermo, thereby avoiding the costs of initiating a new action. The court agreed that the initial action would not be terminated but rather amended to pertain only to one set of defendants. On January 7, 2008, Kittay filed an amended complaint that effectively dismissed all defendants except Palermo and filed separate complaints against the remaining defendants, without obtaining prior consent.

The amended complaint against Korff referenced a ruling by Judge Hardin regarding the statute of limitations, asserting that the filing date for additional proceedings would relate back to the original filing. No motions regarding timeliness were made until October 19, 2010, when Korff attempted to dismiss the complaint as untimely. Kittay argued for equitable tolling. During oral arguments, neither party provided transcripts from previous proceedings. The court reserved its decision and later denied the motion to dismiss, deeming equitable tolling appropriate. Korff's counsel raised hearsay objections, after which Kittay's counsel indicated readiness to produce the transcript, claiming consistency with the original complaint's timeliness allegations. 

After the trial commenced, Korff sought reconsideration of the equitable tolling decision. The district court reviewed the bankruptcy court transcripts and concluded that consent was only necessary if the initial adversary proceeding was terminated, not if the complaint was simply amended. The court reaffirmed its decision to toll the statute of limitations based on Kittay's timely initiation of the initial adversary proceeding and the absence of prejudice to the defendant. It also held the complaint was timely under the relation back provision of Federal Rule of Civil Procedure 15(c). Korff appealed these determinations. The analysis concluded that Federal Rule of Civil Procedure 21 provides a sufficient basis for affirming the district court's decision, as it allows for the addition or dropping of parties and specifies that misjoinder is not grounds for dismissal in bankruptcy adversary proceedings.

Federal Rule of Civil Procedure 21 allows bankruptcy courts to address misjoinder by severing claims or dropping parties but explicitly prohibits dismissal of the entire action due to misjoinder. Dismissal is considered an extreme sanction and is not warranted; instead, severance or dismissal of only the improper party is appropriate if it does not prejudice significant rights. The bankruptcy court's initial directive to dismiss the complaint and require separate filings was inconsistent with Rule 7021. Had the court ordered severance, the complaint would have remained timely, as it would relate back to the original filing date of October 12, 2007. Unlike a dismissal without prejudice, which resets the statute of limitations, a severed claim continues under the original filing, provided it was filed within the limitations period.

Although the bankruptcy court did not explicitly invoke Rule 7021, its intent to sever was clear from its statements regarding the misjoinder and the necessity for separate proceedings. The court suggested that claims were misjoined and that refiled complaints would remain timely, indicating that it aimed for the claims to proceed separately. The record supports the conclusion that the bankruptcy court effectively executed a severance under Rule 7021, which Korff’s argument against misjoinder does not undermine. The court's assurances about the refiled complaints being timely contradict any claim that Korff was simply dropped as a party rather than having claims severed against him.

A dismissal without prejudice after October 14, 2007, would effectively act as a dismissal with prejudice due to the statute of limitations barring any refiling. The bankruptcy court intended for all claims to continue, opting to sever rather than dismiss parties. This intention is supported by the district court's conclusion that a consent order was only necessary if the original action were entirely dismissed. The bankruptcy court showed no dissatisfaction when the newly severed complaints were subsequently refiled without a consent order, indicating that a consent requirement was not imposed. Consequently, the bankruptcy court executed a de facto Rule 7021 severance, and the district court correctly refused to dismiss the complaint as untimely.

Regarding prejudgment interest, the district court awarded $177,090.41 against Korff, calculated at a statutory rate of nine percent per annum from July 29, 2004, based on Kittay's motion for prejudgment interest. The decision to grant such interest lies within the district court’s discretion and is not easily overturned unless there is an abuse of that discretion. Kittay claimed entitlement to prejudgment interest from the date of the fraudulent transfer, while Korff contended it was entirely discretionary and should be calculated from the adversary proceeding's commencement at the federal rate. The treatment of prejudgment interest in avoidance and recovery actions under federal bankruptcy law remains unresolved in the circuit, with different courts applying either federal or state law based on the nature of the claims. Since this action is based on New York substantive law, the interest rate is governed by New York law.

In Goldman Sachs Execution, Clearing, L.P. v. The Official Unsecured Creditors’ Committee, the court determined that federal bankruptcy cases should apply the federal interest rate. However, the district court awarded interest based on New York law, specifically referencing N.Y. C.P.L.R. 5004, which allows for interest to be recovered in breach of contract cases or in situations involving property interference, but grants discretion to the court in equitable actions. The court found that Kittay's action, aimed at benefitting creditors without a contractual basis, was equitable in nature, allowing the district court discretion in awarding prejudgment interest.

The decision noted a lack of clarity from the district court regarding whether it recognized its discretionary power in awarding prejudgment interest at New York's statutory rate of 9 percent. The court emphasized the need for the district court to explain its reasoning regarding the exercise of discretion in the interest award. Additionally, there was an indication that the district court might have had authority to award prejudgment interest under federal law, which would also provide discretion regarding the rate and timing.

The conclusion affirmed the district court's decision not to dismiss the complaint and its application of state law for the interest award but mandated a remand for the district court to clarify its discretion in awarding interest and to articulate its reasoning. The judgment was partially affirmed, partially vacated, and remanded.