Horace Fox v. Julia Hathaway

In the

United States Court of Appeals

For the Seventh Circuit

____________________

No. 17-2354

IN RE:

CHICAGO MANAGEMENT CONSULTING GROUP, INC.,

Debtor.

HORACE FOX, as Chapter 7 Trustee for

the Estate of Chicago Management

Consulting Group, Inc.,

Plaintiff-Appellee,

v.

JULIA HATHAWAY,

Defendant-Appellant.

____________________

Appeal from the United States District Court for the

Northern District of Illinois, Eastern Division.

No. 15 C 8917 — Jorge L. Alonso, Judge.

____________________

ARGUED SEPTEMBER 28, 2018 — DECIDED JULY 10, 2019

____________________

Before RIPPLE, SYKES, and SCUDDER, Circuit Judges.

SYKES, Circuit Judge. Frank Novak tragically took his own

life in February 2012. He left his company, Chicago

2 No. 17-2354

Management Consulting Group, Inc., to his close friend

Debra Comess. She was not in a position to manage the

struggling firm, so she initiated bankruptcy proceedings

almost immediately after Novak’s death.

The Chapter 7 Trustee discovered numerous transfers

from Chicago Management Consulting Group’s coffers to

Comess and Julia Hathaway—another Novak companion

who ran a small yoga studio. Believing the transfers to be

fraudulent under the Bankruptcy Code, the Trustee sought

to reclaim their value for the Estate. After a bench trial, the

bankruptcy judge ruled that the transfers to Comess and

Hathaway were voidable on grounds of actual and

constructive fraud and imposed sanctions on Hathaway for

discovery lapses. The district court affirmed.

Comess settled her case; this appeal concerns the trans-

fers to Hathaway. She launches several arguments. First, she

contends that the bankruptcy judge committed clear error by

ignoring one of the Trustee’s trial exhibits when evaluating

the company’s financial health. Second, she challenges the

bankruptcy judge’s finding that the company did not receive

reasonably equivalent value in return for its transfers. Third,

she argues that the company did not have “creditors” under

the Illinois Uniform Fraudulent Transfer Act (“IUFTA” or

“the Act”) at the time of the transfers. Finally, Hathaway

vigorously disputes the sanctions ruling.

We affirm. As a preliminary matter, Hathaway failed to

comply with multiple rules of appellate procedure. On the

merits, our review of a bankruptcy court’s factual findings is

constrained; we reverse only for clear error. Not one of

Hathaway’s arguments meets this high bar. The bankruptcy

judge was amply justified when he concluded that the

No. 17-2354 3

company was insolvent, the transfers to Hathaway were

gratuitous, and the company had creditors under the Act.

And we see no reason to disturb the imposition of discovery

sanctions.

I. Background

Novak was the sole shareholder of Chicago Management

Consulting Group, an information-technology consulting

firm he started in 1997. His primary client was BP America.

By 2008 the company’s solvency was questionable. In

February 2012 Novak committed suicide, leaving his com-

pany to his good friend Debra Comess. She was not

equipped to run the firm, so she initiated bankruptcy pro-

ceedings, filing a voluntary Chapter 7 petition in the North-

ern District of Illinois on May 2, 2012.

For four years prior to the bankruptcy filing, Comess and

Julia Hathaway, another close friend of Novak’s, had re-

ceived significant payments from the company, though they

were not employees. Hathaway alone received $45,400.81

between 2008 and 2012. Hathaway runs a small yoga studio,

and her email correspondence with Novak during this

period suggests that the payments were personal, not pro-

fessional. The emails document Hathaway’s repeated re-

quests for gifts and payments and Novak’s expressions of

affection for her and willing acquiescence in her requests.

Trustee Horace Fox brought an avoidance action target-

ing the transfers to Comess and Hathaway. He later moved

for sanctions against Hathaway alleging dilatory behavior

during discovery.

The bankruptcy judge determined that the women had

indeed received money from Chicago Management Consult-

4 No. 17-2354

ing Group and that Novak typically failed to record the

transactions. The judge also found that the company was

insolvent at the time of the transfers, relying on an account-

ing expert’s report introduced by the Trustee. The judge

rejected Hathaway’s argument that a list of gross receivables

proffered by the Trustee refuted the expert’s conclusion.

Moving on, the judge ruled that the company did not re-

ceive reasonably equivalent value in exchange for its trans-

fers to Hathaway. He based this finding on evidence of

Novak’s close personal relationship with her, his habit of

paying for her personal expenses on demand, the lack of

evidence that Hathaway performed any work for the com-

pany, the irregularity and vagueness of her apparently

hastily prepared invoices, and the inconsistency of those

invoices with the company’s bank records.

The judge concluded that the transfers were voidable as

actually and constructively fraudulent under 11 U.S.C. § 548

and the IUFTA. The latter applied via § 544(b)(1) of the Code

because the Trustee had established that the consulting firm

had “at least one [unsecured] creditor” at the time of the

conveyances—the Internal Revenue Service—and that an

unpaid credit-card company counted as another.

The judge took a cautious approach to the Trustee’s mo-

tion for discovery sanctions. He declined to impose sanc-

tions for Hathaway’s failure to respond to interrogatories

and produce tax returns. And although Hathaway was slow

to turn over certain emails despite multiple discovery or-

ders, the judge was satisfied that she had generally complied

and that much of the delay was caused by her email service

provider. Finally, the judge considered a set of emails that

Hathaway unquestionably possessed but failed to produce.

No. 17-2354 5

He found that those emails were improperly omitted but

that they contained no relevant information. In the end, the

judge determined that sanctions were appropriate only to

the extent that Hathaway’s delay and failure to comply with

court orders caused the Trustee to expend additional time

and resources litigating the recurring discovery disputes. He

ordered “payment of the [T]rustee’s attorney fees and

expenses reasonably incurred in pursuing the discovery

matters.” The judge later entered judgment against

Hathaway for the fraudulent conveyances in the amount of

$45,400.81 and imposed $11,187.25 in discovery sanctions.

Hathaway appealed to the district court under 28 U.S.C.

§ 158(a)(1). The district judge affirmed across the board. He

discerned no clear error in the bankruptcy judge’s finding

that Chicago Management Consulting Group was insolvent.

He was unimpressed by Hathaway’s attempts to contradict

the finding that the company had not received value for its

transfers. Nor did he see fit to question the bankruptcy

court’s identification of unsecured creditors for § 544(b)

purposes. On the issue of discovery sanctions, he deferred to

the bankruptcy judge’s broad discretion and found no

reason to set aside the award.

II. Discussion

Hathaway’s appeal repeats the arguments she raised in

district court. We note at the outset that she did not ap-

proach this appeal with the seriousness our rules demand.

She failed to provide an adequate record to facilitate our

review. Because she claims that several of the bankruptcy

court’s factual findings were unsupported by the evidence, it

was her responsibility to “include in the record a transcript

of all evidence relevant to that finding or conclusion.” FED.

6 No. 17-2354

R. APP. P. 10(b)(2); see also FED. R. BANKR. P. 8009(b)(5).

Relevant evidence “generally … include[s] a complete

transcript of the trial along with the exhibits properly admit-

ted into evidence.” LaFollette v. Savage, 63 F.3d 540, 544 (7th

Cir. 1995).

The most glaring omission is the expert report upon

which the bankruptcy court based its insolvency ruling. That

report, compiled by Trustee’s expert Lois West, was not

delivered to us until after oral argument.1 Frustratingly,

Hathaway has been on notice of this deficiency since the

district judge noted the absence of the West report from the

record. Comess v. Fox (In re Chi. Mgmt. Consulting Grp., Inc.),

569 B.R. 722, 728 n.7 (N.D. Ill. 2017). So we’re left to interpret

a portion of the West report’s raw data reproduced in

Hathaway’s appellate brief. Finally, Hathaway’s appendix is

incomplete under our circuit rules. It includes only the

district judge’s opinion, not the bankruptcy judge’s opinion.

See 7TH CIR. R. 30(b)(2).

These serious errors could justify dismissal. See Tapley v.

Chambers, 840 F.3d 370, 375 (7th Cir. 2016) (explaining that

we may dismiss an appeal when the appellant has “ample

opportunity to correct” a deficiency in the record and fails to

do so); see also Urso v. United States, 72 F.3d 59, 61 (7th Cir.

1995) (“[We] decline[] to entertain [an] appeal[] when the

appellant does not file a required appendix.”). We neverthe-

less choose to reach the merits, where Hathaway fares no

better.

1Following oral argument, Hathaway moved to supplement the record

with a copy of the West report. We denied that motion.

No. 17-2354 7

A. Insolvency Analysis

We apply “de novo review for the bankruptcy court’s con-

clusions of law and clear error review for its findings of

fact.” First Weber Grp., Inc. v. Horsfall, 738 F.3d 767, 776 (7th

Cir. 2013). Demonstrating clear error is no mean feat. “When

there are two permissible views of the evidence, the …

choice between them cannot be clearly erroneous.” Dexia

Crédit Local v. Rogan, 629 F.3d 612, 628 (7th Cir. 2010). We

will not reverse the court’s factual findings without a “defi-

nite and firm conviction” that it erred. Unsecured Creditors

Comm. of Sparrer Sausage Co. v. Jason’s Foods, Inc., 826 F.3d

388, 393 (7th Cir. 2016).

The Trustee’s fraudulent-transfer claims rest on 11 U.S.C.

§ 548 and the IUFTA, 740 ILL. COMP. STAT. 160/5 (2010). Each

statute has actual- and constructive-fraud provisions. Actual

fraud under § 548 can be proven by circumstantial evidence,

including the size of the transfer in relation to the debtor’s

assets. Frierdich v. Mottaz (In re Frierdich), 294 F.3d 864, 869–

70 (7th Cir. 2002). The IUFTA considers insolvency to be a

“badge” of actual fraud. § 160/5(b)(9). Under the construc-

tive-fraud component of § 548, a trustee can avoid any

transfer for which the debtor “received less than a reasona-

bly equivalent value in exchange for such transfer or obliga-

tion[] and was insolvent on the date that such transfer was

made or such obligation was incurred.” § 548(a)(1)(B); accord

§ 160/5. Thus, whether Chicago Management Consulting

Group was insolvent when Novak transferred funds to

Hathaway was a crucial issue for the bankruptcy court.

Under federal and state fraudulent-transfer law, a debtor

is insolvent if it has “a balance sheet on which liabilities

exceed assets.” See Baldi v. Samuel Son & Co., Ltd., 548 F.3d

8 No. 17-2354

579, 581 (7th Cir. 2008); Grochocinski v. Zeigler (In re Zeigler),

320 B.R. 362, 379 (Bankr. N.D. Ill. 2005); see also 11 U.S.C.

§ 101(32)(A) (defining “insolvent”); 740 ILL. COMP. STAT.

160/3(a) (same). If a willing buyer would not purchase the

debtor’s combined assets and liabilities, the debtor is insol-

vent. Covey v. Commercial Nat’l Bank of Peoria, 960 F.2d 657,

660 (7th Cir. 1992). A trustee doesn’t need to show insolven-

cy on the precise day of the transfer. If he can demonstrate

that the debtor was insolvent at points before and after the

transfer, it’s up to the transferee to rebut the presumption of

insolvency in between. Baldi, 548 F.3d at 581.

Relying on the West report, the bankruptcy judge found

that the company was insolvent during the relevant period.

Lois West, a trained accountant, analyzed records kept by

Novak using QuickBooks accounting software. According to

the judge, the data clearly showed that the company’s

liabilities exceeded its assets when the transfers were made.

As we’ve noted, Hathaway included only a partial reproduc-

tion of the report in her appellate submission. Even based on

her version of events, West calculated a negative valuation

for the company at every six-month interval between

June 30, 2008, and December 31, 2011. Thus, so long as the

bankruptcy judge accepted the veracity of the QuickBooks

data and the reliability of West’s methods, a finding of

insolvency was inevitable.

Hathaway argues that the judge committed clear error

when he chose to credit the West report rather than Trustee

Exhibit 32. That document is simply a list of dollar figures

labeled “Receivables from BP According to deposits and

wire transfers to Acct xx 7854.” Its attractiveness to

Hathaway is obvious: Exhibit 32 shows over $2.6 million in

No. 17-2354 9

accounts receivable over the crucial 2008–2012 period.

Seizing the chance to cast doubt on the West report,

Hathaway adds the receivables from Exhibit 32, subtracts

liabilities, and proclaims that the company was in the black.

Exhibit 32 is not the panacea Hathaway makes it out to

be. As the judge explained, its figures don’t rebut West’s

topline finding of insolvency. Indeed, the receivables listed

in Exhibit 32 are wholly consistent with West’s conclusion.

When the company’s contractors performed work for BP,

they generated accounts payable to themselves in addition to

accounts receivable for the company. So a significant portion

of the incoming cash from BP was offset by the company’s

obligations to its contractors. Because the West report con-

sidered “all three accounting categories—accounts receiva-

ble, cash, and accounts payable,” it offered the most

complete picture of the company’s solvency. Even account-

ing for outstanding receivables generated by company

contractors, the firm’s liabilities exceeded its net asset value.

Hathaway asks us to add gross receivables to the West

report’s asset figures to generate a new valuation for the

company. But only net receivables are relevant. Hathaway

advanced these same arguments in the bankruptcy and

district courts, to no avail. She offers nothing new to support

her position. In sum, she hasn’t come close to showing clear

error.

B. Reasonably Equivalent Value

Hathaway also challenges the bankruptcy judge’s finding

that the company did not receive reasonably equivalent

value for its transfers. Under both § 548 and the IUFTA, a

debtor’s failure to receive value is a necessary element of

10 No. 17-2354

constructive fraud. Leibowitz v. Parkway Bank & Tr. Co. (In re

Image Worldwide, Ltd.), 139 F.3d 574, 577 (7th Cir. 1998)

(explaining that cases applying the no-value requirement of

§ 548 can be used to evaluate the same question under the

Act). Courts consider “the fair market value of what was

transferred and received, whether the transaction took place

at arm’s length, and the good faith of the transferee.” Smith

v. SIPI, LLC (In re Smith), 811 F.3d 228, 240 (7th Cir. 2016).

Whether value was given is a question of fact reviewed only

for clear error. In re Image Worldwide, 139 F.3d at 576.

Hathaway argues that she provided labor value com-

mensurate with the money she received from the firm. She

cites her education, work experience, and one line of the trial

transcript in which she mentions consulting work she did for

the company. She also directs our attention to a set of self-

prepared invoices, which she claims provide the requisite

documentation of her work. But as the courts below ob-

served, her invoices are strikingly brief and inconsistent.

And they conflict with Hathaway’s own testimony, in which

she stated that she billed the company by recording out-of-

pocket expenses, hours worked, and her hourly rate. The

invoices offer vague descriptors like “Workshop Prepara-

tion” and “Management Consulting” but make no attempt at

itemization. Nor do they match the company’s bank records.

The invoices are simply not compelling. It’s clear why the

bankruptcy court placed so little stock in them.

The bankruptcy judge cited plenty of evidence beyond

the invoices to support his conclusion that the transfers were

gratuitous. Novak evidently had no qualms about spending

considerable sums on Hathaway with no obvious connection

to professional services. To illustrate: On October 13, 2009,

No. 17-2354 11

Hathaway demanded reimbursement for $119.10 in personal

cosmetic expenses. “I adore you,” Novak replied. About

three weeks later, a check for that precise amount was paid

by the company to Hathaway. This exchange was no outlier;

Novak satisfied repeated requests for personal gifts from

flowers to perfume. He even outfitted her yoga studio with

mats and other equipment.

Hathaway acknowledges the pattern of gratuitous

spending but argues that she always viewed those expendi-

tures as gifts from Novak personally, not from the company.

But Hathaway’s description of her state of mind, while not

entirely irrelevant, doesn’t impeach the judge’s conclusion

nearly enough to show clear error.

Hathaway invites us to reinterpret the evidence present-

ed at trial, crediting her version of events over the judge’s.

But even if Hathaway’s story is one of “two permissible

views of the evidence”—which we doubt—that is insuffi-

cient to show clear error. Dexia Crédit Local, 629 F.3d at 628.

C. Creditors under the IUFTA

Under 11 U.S.C. § 544(b)(1), trustees can utilize state

fraudulent-conveyance statutes in bankruptcy proceedings.

Section 544(b) enables a trustee to step into the shoes of an

unsecured creditor who existed at the time of the transfer

and vindicate that creditor’s state-law rights. The trustee can

“avoid any transaction of the debtor that would be voidable

by any actual unsecured creditor under state law. The

trustee need not identify the creditor, so long as the unse-

cured creditor exists.” In re Image Worldwide, 139 F.3d at 576–

77 (citation omitted). The bankruptcy judge found that

Chicago Management Consulting Group owed money to the

12 No. 17-2354

IRS and was carrying credit-card debt at the time of the

transfers.

Hathaway points to no evidence contradicting those find-

ings. She doesn’t even challenge the existence of the compa-

ny’s tax obligation or credit-card debt, arguing instead that

those obligations were “nominal” and not “due and paya-

ble.” And if Hathaway wished to challenge the judge’s legal

conclusion that these creditors and their claims qualified

under § 544(b) and triggered the IUFTA, she waived that

argument by failing to develop it. LINC Fin. Corp. v.

Onwuteaka, 129 F.3d 917, 921 (7th Cir. 1997) (“[F]ailure to cite

authorities in support of a particular argument constitutes a

waiver of the issue.”).

D. Discovery Sanctions

We review a bankruptcy court’s imposition of discovery

sanctions for abuse of discretion. Golant v. Levy (In re Golant),

239 F.3d 931, 937 (7th Cir. 2001). We cannot substitute our

own judgment, nor do we require the judge to choose the

least severe sanction. Id. Instead, we ask whether a “reason-

able jurist, apprised of all the circumstances, would have

chosen [the sanction] as proportionate to the infraction.”

Salgado v. Gen. Motors Corp., 150 F.3d 735, 740 (7th Cir. 1998).

Hathaway devotes most of her brief to an attack on the

judge’s sanctions order. She claims the Trustee was unable to

show prejudice stemming from her actions and that oppos-

ing counsel inflated the hours they allegedly spent handling

discovery disputes. She says she ultimately complied with

all discovery orders and blames Google for email production

delays. And she even intimates that the Trustee should be

sanctioned for his attorneys’ conduct.

No. 17-2354 13

The judge did not abuse his discretion. The fees that were

awarded are reasonably related to the Trustee’s efforts to

litigate discovery. Although the judge was eventually con-

vinced that the gaps and delays in Hathaway’s email pro-

duction hadn’t obscured crucial information, the time spent

litigating those matters burdened both the Trustee and the

court. Acting within his broad discretion, the judge conclud-

ed that Hathaway should pay the legal bills incurred by the

Trustee while fighting those discovery battles. And he

attached an itemized breakdown of the fees he awarded—

and did not award. He even cut in half the fees claimed by

one of the Trustee’s attorneys, citing “unnecessary time.”

Discovery sanctions are upheld “so long as [they] could be

considered reasonable.” Collins v. Illinois, 554 F.3d 693, 696

(7th Cir. 2009). These were reasonable sanctions.

E. Rule 38 Sanctions

The Trustee argues that Hathaway should be sanctioned

under Rule 38 of the Federal Rules of Appellate Procedure

for filing a frivolous appeal. But a request for Rule 38 sanc-

tions must be made by separate motion. Berkson v. Gulevsky

(In re Gulevsky), 362 F.3d 961, 964 (7th Cir. 2004). The Trustee

merely requests sanctions in a section of his appellate brief.

As we’ve explained before, a “brief-borne request is not a

separately filed motion.” McDonough v. Royal Caribbean

Cruises, Ltd., 48 F.3d 256, 258 (7th Cir. 1995). We therefore

decline to address the issue.

AFFIRMED