United States District Court, S.D. New York
July 1, 2004.
In Re: RECOTON CORPORATION, et al., Debtors.
The opinion of the court was delivered by: DENISE COTE, District Judge
OPINION AND ORDER
On March 1, 2004, the Official Committee of Unsecured Creditors
(the "Committee") of the Recoton Corporation and others (the
"Debtors") brought a motion in the Bankruptcy Court of this
district seeking an order under Sections 1103 and 1109(b) of the
Bankruptcy Code and Rules 2004 and 9016 of the Federal Rules of
Bankruptcy Procedure authorizing the issuance of subpoenas for
the production of documents and the oral examination of witnesses
(the "Discovery Motion"). The Discovery Motion was opposed by four of the Debtors' former directors and officers, Robert L.
Borchardt, Stuart Mont, Arnold Kezsbom and Tracy Clark
(collectively, the "Former D&Os"). On April 13, the Hon. Allan L.
Gropper granted the Committee's Discovery Motion. See In re
Recoton Corp., 307 B.R. 751 (Bankr. S.D.N.Y. 2004).
On May 5, 2004, this Court denied the motion of the Former D&Os
for an emergency stay of the discovery. The Former D&Os now bring
this motion to (1) withdraw the reference to the Bankruptcy Court
of the Discovery Motion, and (2) transfer venue of the Discovery
Motion to the Middle District of Florida. For the reasons cited
below, the motion to withdraw is denied.
On April 8, 2003, the Debtors filed voluntary petitions for
relief under Chapter 11 in the Bankruptcy Court for the Southern
District of New York; two weeks later the Committee was appointed
by the United States Trustee in these cases. In June and July of
that year, six complaints were filed in the Middle District of
Florida against certain of the Debtors' present and/or former
officers and directors, alleging securities fraud in violation of
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934.
The class actions were consolidated on September 29, 2003 (the
After interviewing former employees of the Debtors, the Committee undertook an investigation into the existence of
potential causes of action against the Former D&Os, as well as
potential defenses against the multiple proofs of claim filed by
the Former D&Os against the Debtors. To facilitate that
investigation, on March 1, 2004, the Committee filed the
Discovery Motion pursuant to Bankruptcy Rule 2004. The Discovery
Motion sought documents and testimony from certain former and
current officers and directors of the Debtors, including the
Former D&Os. On March 23, Judge Gropper held a hearing on the
motion, and indicated that he would likely grant the discovery
sought by the Committee.
Following Judge Gropper's prediction, the Former D&Os asked him
to stay any order permitting the Rule 2004 discovery so as to
allow the Former D&Os to move to withdraw the reference to the
Bankruptcy Court. On April 13, Judge Gropper issued a
fifteen-page decision granting the Discovery Motion, and denying
the stay. See In re Recoton, 307 B.R. at 761. Judge Gropper
noted that the Committee had agreed to be governed by a
protective order prohibiting use of the information gathered
through Rule 2004 discovery for any purpose other than the
bankruptcy proceeding, and specifically prohibiting its
disclosure to the plaintiffs in the Class Action. Id. at 756.
The protective order was entered on April 14. On April 23, the
Bankruptcy Court entered an order consistent with its decision in
In re Recoton. No appeal was taken by the Former D&Os and the order became final
on May 3.
Meanwhile, on March 29, the Former D&Os filed in this Court the
motion to withdraw the reference insofar as it relates to the
Discovery Motion, and to transfer that motion to the Florida
court presiding over the Class Action. By letter dated April 29,
the Former D&Os requested a conference with this Court in order
to obtain an emergency stay of the discovery. At a conference
held on May 5, this Court denied the Former D&Os' application to
stay the Bankruptcy Court order permitting
Rule 2004 discovery.*fn1 Also on May 5, the Bankruptcy Court approved
the Debtors' plan of liquidation (the "Plan"). The Plan provides
that a liquidating trust will "step into the shoes" of the
Committee in pursuing the Rule 2004 discovery against the Former
D&Os. An order confirming the Plan was entered the next day.
In support of the instant motion, the Former D&Os rely on the
same arguments they previously articulated to the Bankruptcy
Court in opposition to the Discovery Motion. Specifically, the
Former D&Os argue that (i) Rule 2004 discovery is an
impermissible attempt to obtain discovery relating to upcoming
litigation certain to be brought by the Committee; and (ii)
Rule 2004 discovery would deny the Former D&Os, as defendants in the Class Action, the discovery protections of the Private Securities
Litigation Reform Act ("PSLRA"), Pub.L. No. 104-67, 109 Stat.
737 (1995) (codified in part at 15 U.S.C. § 77z-1, 78u), and the
Securities Litigation Uniform Standards Act ("SLUSA"), Pub.L.
No. 105-353, 112 Stat. 3227 (1998) (codified in scattered
sections of Title 15 of the United States Code).
Pursuant to 28 U.S.C. § 157(a), all Chapter 11 cases are
automatically referred to this district's bankruptcy judges. A
party can move to withdraw the reference to the Bankruptcy Court
pursuant to 28 U.S.C. § 157(d) ("Section 157(d)"), which states:
The district court may withdraw, in whole or in
part, any case or proceeding referred under this
section, on its own motion or on timely motion of any
party, for cause shown. The district court shall,
on timely motion of a party, so withdraw a
proceeding if the court determines that resolution
of the proceeding requires consideration of both
title 11 and other laws of the United States
regulating organizations or activities affecting
28 U.S.C. § 157(d) (emphasis supplied). The Former D&Os argue
that the reference of the Discovery Motion should be withdrawn
under either the mandatory or permissive standard of Section
A. Mandatory Withdrawal
The Former D&Os assert that the reference must be withdrawn due
to the complexity of the issues presented in the Discovery
Motion. According to the Former D&Os, consideration of the
Discovery Motion requires the Bankruptcy Court to "resolve the
conflict between the freedom from discovery to which [the Former
D&Os] are entitled under the PSLRA and SLUSA, and the broad
discovery seemingly permitted by Bankruptcy Rule 2004."*fn3
Mandatory withdrawal under Section 157(d) is narrowly applied,
and is appropriate only when "substantial and material potential
conflicts exist between non-bankruptcy federal laws and Title
11." In re Keene Corp., 182 B.R. 379, 382 (Bankr. S.D.N.Y.
1995) (citation omitted). Mandatory withdrawal is required when
resolution of the matter calls for the bankruptcy judge to "engage in significant interpretation, as opposed to simple
application," of federal non-bankruptcy statutes. City of New
York v. Exxon Corp., 932 F.2d 1020, 1026 (2d Cir. 1991).
Mandatory withdrawal pursuant to Section 157(d) is not
compelled in this case. By applying the unambiguous and plain
language of the federal non-bankruptcy statutes at issue here,
Judge Gropper correctly concluded that the Discovery Motion is
not governed by and not in conflict with either the PSLRA or
SLUSA.*fn4 See In re Recoton, 307 B.R. at 759.
The Class Action is brought on behalf of the Debtors'
shareholders and alleges securities fraud. The Discovery Motion
is not seeking information to pursue securities fraud claims on
behalf of purchasers and sellers of the Debtors' securities.
Instead, it seeks information to assist the Debtors in potential
claims they may have against their former and current officers
and directors, and to resist claims those individuals have filed against the estates. Rule 2004 discovery is available, among
other reasons, to assist parties in determining whether
wrongdoing has occurred. It may precede the filing of an
adversary proceeding but is "not generally permitted once an
adversary proceeding has been filed." In re Recoton, 307 B.R.
If the existence of a related securities fraud action which
is hardly unusual were sufficient to bar or delay
Rule 2004 discovery, the rights of creditors and debtors would be impaired
and the efficient administration of bankruptcy cases
impeded.*fn5 Although Judge Gropper considered the
provisions of the PSLRA and SLUSA in determining the
appropriateness of the Committee's Discovery Motion, their
inapplicability to Rule 2004 was sufficiently clear and
unambiguous that he was not required to and he did not resort to
any "significant interpretation" of federal non-bankruptcy
statutes in doing so. Permissive Withdrawal
The Former D&Os alternatively argue that permissive withdrawal
of the reference under Section 157(d) is justified. The Former
D&Os contend that there is "an obvious and substantial overlap in
the facts, transactions, and issues involved in the Consolidated
Class Action and the discovery sought (and claims likely to be
asserted)" by the Committee. They further maintain that
"considerations of justice, judicial economy, and consistent
adjudication" all justify withdrawal of the reference.
As previously stated, a district court may withdraw a reference
to the Bankruptcy Court, "in whole or in part, . . . for cause
shown." 28 U.S.C. § 157(d). While Section 157(d) does not define
"cause," the Second Circuit has identified a number of relevant
factors, including "whether the claim or proceeding is core or
non-core, whether it is legal or equitable, and considerations of
efficiency, prevention of forum shopping, and uniformity in the
administration of bankruptcy law." Orion Pictures Corp. v.
Showtime Networks, Inc., 4 F.3d 1095, 1101 (2d Cir. 1993); see
also In re Burger Boys, Inc., 94 F.3d 755, 762 (2d Cir. 1996).
The threshold inquiry in evaluating a request for permissive
withdrawal is whether the claim is core or non-core, "since it is
upon this issue that questions of efficiency and uniformity will
turn." In re Orion, 4 F.3d at 1101. Courts have generally held that withdrawing the reference of a core matter is inappropriate
"given that the bankruptcy court generally will be more familiar
with the facts and issues." Id. See, e.g., Michaelesco v.
Shefts, 303 B.R. 249, 252 (Bankr. D. Conn. 2004); In re Iridium
Operating LLC, 285 B.R. 822, 834-835 (Bankr. S.D.N.Y. 2002);
Bambu Sales, Inc. v. Stern, No. 98 Civ. 1952 (NG), 1998 WL
760335, *3 (E.D.N.Y. 1998).
Section 157(b)(2) sets forth a non-exhaustive list of
categories of core proceedings, which includes "`(A) matters
concerning the administration of the estate," "(B) allowance or
disallowance of claims against the estate," and "(O) other
proceedings affecting the liquidation of the assets of the
estate." 28 U.S.C. § 157(b)(2). Whether a proceeding is core
should be given a "broad interpretation." United States Lines,
Inc. v. American Steamship Owners Mutual Protection and Indemnity
Assoc., Inc., 197 F.3d 631, 637 (2d Cir. 1999) (citation
omitted); see also Resolution Trust Corp. v. Best Products
Co., Inc., 68 F.3d 26, 31 (2d Cir. 1995) (noting that sponsors
of the 1984 Bankruptcy Code revisions "repeatedly said that 95
percent of the proceedings brought before the bankruptcy judges
would be core proceedings"). Thus, a proceeding is core if it is
"unique to or uniquely affected by the bankruptcy proceedings,"
or if it "directly affect[s] a core bankruptcy function." In re
Petrie Retail, Inc., 304 F.3d 223, 229 (2d Cir. 2002) (citation omitted). See also In re Manville Forest Products Corp.,
896 F.2d 1384, 1389 (2d Cir. 1990). Stated differently, a core
proceeding is "an action that has as its foundation the creation,
recognition, or adjudication of rights which would not exist
independent of a bankruptcy environment." In re Manshul Const.
Corp., 225 B.R. 41, 45 (Bankr. S.D.N.Y. 1998) (citation
The discovery sought by the Committee pursuant to Rule 2004 is
properly characterized as a core proceeding. The Committee seeks
to use the Bankruptcy Code's discovery provision to investigate
potential causes of action against the Former D&Os, as well as
the Debtors' potential defenses against the claims filed by the
Former D&Os. In other words, the Committee seeks to use
Rule 2004 discovery to advance the administration of the estate, the
resolution of claims, and the liquidation of the estate, all of
which are core functions under 28 U.S.C. § 157(b)(2)(A), (B), and
(O). See In re Drexel Burnham Lambert Group, Inc., 123 B.R. 702,
704 n. 1 (Bankr. S.D.N.Y. 1991) (Rule 2004 discovery is a
core proceeding); In re Ecam Publications, Inc., 131 B.R. 556,
561 (Bankr. S.D.N.Y. 1991) (same). See also In re Manville, 896
F.2d at 1390 ("the majority of courts . . . have held that
proceedings to determine the allowance and disallowance of claims
against the estate are core").
Withdrawal of the reference is also inappropriate under the
remaining factors articulated by the Second Circuit in Orion, which "fall under the broad umbrella of interests of efficiency
and uniformity." See In re Enron Corp., No. 04 Civ. 2527
(SHS), 2004 WL 1197243, *4 (S.D.N.Y. May 28, 2004) (citing
Orion, 4 F.3d at 1101). As the Second Circuit recently
confirmed in describing the Bankruptcy Code's broad removal
provision, "Congress intended to grant comprehensive jurisdiction
to bankruptcy courts so that they might deal efficiently and
expeditiously with all matters connected with the bankruptcy
estate." California Public Employees' Retirement System v.
WorldCom, Inc., 368 F.3d 86, 103 (2d Cir. 2004) (citation
omitted) (emphasis added by WorldCom).
Withdrawing the reference to the Bankruptcy Court of the
Discovery Motion and transferring it to the Middle District of
Florida clearly would undermine judicial efficiency and may lead
to inconsistent applications of bankruptcy law. The Florida court
presides over the Class Action, a lawsuit brought by the Debtors'
shareholders under federal securities laws. The Discovery Motion
was brought in a bankruptcy proceeding being heard in this
district and is governed by the Bankruptcy Code. It would be an
inefficient use of judicial resources to withdraw from an
experienced bankruptcy judge a motion brought pursuant to the
federal rules in bankruptcy that is addressed to the discovery of
evidence to pursue and defend claims that may be or have been
filed in a pending bankruptcy proceeding in order to transfer the
motion to a Florida district judge presiding over a securities law action in which the claims that will be affected
by this discovery have not and never will be filed.
This motion is a naked attempt at forum shopping. The Former
D&Os did not appeal Judge Gropper's decision within the required
time period, and now seek to transfer the Discovery Motion to
another court in the hope of finding an audience more receptive
to their arguments.
For the reasons stated above, the motion to withdraw the
reference of the Official Committee of Unsecured Creditors'
Rule 2004 discovery motion, and to transfer venue over the motion to
the Middle District of Florida, is denied.