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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


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 "Class Action").

  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 interstate commerce.
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 157(d).*fn2 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. at 755.

  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 omitted).

  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.


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