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IN RE SUPREMA SPECIALTIES

United States District Court, S.D. New York


August 25, 2005.

IN RE: SUPREMA SPECIALTIES, INC., et al., Debtors. HARLEYSVILLE WORCESTER MUTUAL INSURANCE COMPANY and LUMBERMENS MUTUAL CASUALTY INSURANCE COMPANY, Appellants,
v.
KENNETH P. SILVERMAN, ESQ., The Chapter 7 Trustee of the Estate of Suprema Specialties, Inc., et al., Appellee.

The opinion of the court was delivered by: THOMAS GRIESA, Senior District Judge

OPINION

Appellants Harleysville Worcester and Lumbermens appeal from a December 1, 2004 Order by Judge Blackshear of the Bankruptcy Court approving a settlement between the Trustee and two insurance companies. Appellee Kenneth Silverman, the Chapter 7 Trustee of Suprema Specialties, Inc., et al., moves to dismiss the appeal.

The motion is denied.

  BACKGROUND

  Suprema Specialties, Inc., et al., ("Suprema") was a manufacturer of all-natural, gourmet Italian cheeses. Suprema's stock was publicly-traded. Suprema filed for bankruptcy in early 2002 following the discovery of a massive accounting fraud.

  This accounting fraud occurred from 1996 to 2002. Members of Suprema's management team and three principals of Suprema's largest customers arranged sham transactions between Suprema and those companies. The sham transactions were so numerous that around $700 million, or approximately 87%, of Suprema's sales over that time period were either fictitious or inflated. At least one member of Suprema's management team, along with three others, later pled guilty to criminal charges of securities fraud and bank fraud.

  Suprema filed for bankruptcy under Chapter 11 on February 24, 2002. On March 20, 2002 the Bankruptcy Court converted the case to liquidation proceedings pursuant to Chapter 7, and appointed Silverman as the Trustee.

  Appellants

  Appellants are creditors of Suprema, and have claims totalling $3,882,571.19. They filed their proofs of claim in the Bankruptcy Court on August 2, 2002. Appellants provided Suprema with a Bond in the amount of $5.1 million to secure prompt payment to New York milk dealers, as is required under New York's Agriculture and Markets Law § 258-b. Suprema purchased milk in order to manufacture various cheese products. In early February 2002, Appellants learned of the fraud, or at least of the investigation of such fraud. Appellants wrote to Suprema asserting that under the contracts governing the Bond, Suprema was obligated to release them from any liability under the Bond. Appellants demanded such a release by February 12, 2002. Suprema never complied, and continued to purchase milk during the weeks proceeding the bankruptcy filing. Suprema failed to pay roughly $3.8 million to New York milk dealers, for which Appellants were ultimately liable under the Bond. It is that amount which they now seek from Suprema.

  Appellants have also pursued state common law claims against certain of Suprema's former directors. Appellants sought to recover the roughly $3.8 million, as well as legal fees, from the former directors as a result of their negligence in failing to detect and prevent the misappropriation or conversion of corporate assets. That lawsuit was brought in the New Jersey Superior Court, Bergen County, captioned Harleysville Worcester Insurance Company and Lumbermens Mutual Casualty Company v. Mark Cocchiola, et al., docket no. BER-L-6229-02, but was voluntarily dismissed without prejudice pursuant to an agreement between Appellants and Suprema. The agreement resulted from the Government's seizure of Suprema's books and records, which apparently made discovery almost impossible. The parties also agreed to toll the statute of limitations until those records become available. At that time, Appellants apparently intend to pursue their claims against the former directors.

  Other Pending Actions

  There is also a class action brought by Suprema shareholders pending against certain of Suprema's directors, officers, and employees in the United States District Court for the District of New Jersey captioned In re Suprema Specialties, Inc., Securities Litigation, No. 02-168. The class action was dismissed by the District Court, and an appeal is currently pending before the Third Circuit.

  The Insurance Policies

  Suprema maintained three directors and officers liability insurance policies (the "D&O Policies"). The D&O Policies covered Suprema as the "Named Entity" as well as certain "Insured Persons", who were officers and directors of Suprema. The first policy was an Executive and Organization Liability Insurance Policy with National Union Fire Insurance Co. in the amount of $7.5 million (the "Primary Policy"). The second was an Excess Directors and Officers Liability Insurance Policy with Royal Indemnity Company (the "First Excess Policy") in the amount of $7.5 million in excess of the amount covered by the Primary Policy. The third was an Excess Insurance Policy with National Union Fire Insurance Co. in the amount of $10 million in excess of the amount covered by the Primary Policy and the First Excess Policy.

  On January 21, 2004 the Trustee commenced ten insider adversary proceedings in the Bankruptcy Court against insiders and officers and directors of Suprema. Those proceedings seek to recover damages for, among other things, breaches of fiduciary duty, aiding and abetting breaches of fiduciary duty, waste, mismanagement, and fraudulent conveyances.

  In a letter dated April 8, 2004, National Union advised those directors and officers that it was entitled to rescind the D&O Policies because they were issued in reliance on materially false and misleading representations by the insureds. National Union specifically alleged that, in deciding to issue the policies, it had relied on the 10Ks, 10Qs, and 8Ks filed by Suprema with the SEC. National Union concluded that since those forms materially mistated Suprema's financial condition, it was entitled to rescind the policies.

  In response to that letter, on June 15, 2004 the Trustee initiated an adversary proceeding against National Union, Royal Indemnity, and the ten defendants named in the January 21, 2004 action. The Trustee sought a declaratory judgment that (1) the D&O Policies and the proceeds thereof are the property, in whole or part, of the Debtor's estate; (2) as property of the Debtor's estate, the D&O Policies may not be rescinded other than through a proceeding in the Bankruptcy Court in which the Court grants permission to rescind the D&O Policies; (3) there is no legal or factual basis for rescinding the D&O Policies; (4) the claims asserted in the Class Action and Special Situations Actions are covered by the D&O Policies; and (5) the claims asserted in the Insider Adversary Proceedings are covered by the D&O Policies. National Union and Royal Indemnity asserted counterclaims seeking the rescission of the D&O Policies.

  The Trustee, National Union, and Royal Indemnity then entered into negotiations in an attempt to resolve the issues raised in the Trustee's declaratory judgment action. Following the negotiations, the Trustee, National Union, and Royal Indemnity agreed to rescind ab initio the D&O Policies in exchange for (1) a payment of nearly $7.5 million from National Union to the Trustee, and (2) a payment of $6.4 million from Royal Indemnity to the Trustee. The amount to be paid by National Union and Royal Indemnity to the Trustee is roughly 86 times greater than the amount of premiums that Suprema paid for the D&O Policies.

  Pursuant to Rule 9019(a) of the Federal Rules of Bankruptcy Procedure, the Trustee moved for an order approving the settlement. Several of the directors and officers filed timely objections. Appellants did not file any objection, written or otherwise, at that time. On November 22, 2004 the Bankruptcy Court held a hearing regarding the Trustee's motion to approve the settlement. Appellants did not appear at that hearing. The hearing was continued to November 23, and then further continued to December 1, 2004.

  At that hearing, the Court heard the objections raised by various parties, including three former Suprema directors — Randolph Acosta, Paul DeSocio, and Barry Rutcofsky ("the Acosta group"). Following argument on the settlement motion, Bankruptcy Judge Blackshear overruled the remaining objections, granted the Trustee's motion, and approved the settlement.

  The Instant Appeal

  Appellants filed their notice of appeal on December 10, 2004. On December 20, 2004 Appellants filed their Designation of Items to be Included in the Record on Appeal and Statement of Issues to be presented on Appeal. In a letter to the Court dated January 28, 2005, Appellants requested an extension of time to file their opening brief. The Court approved that request by endorsement on February 4, 2005 and gave Appellants until March 3 to file their opening brief. Following a second extension of time, Appellants filed their opening brief on March 18, 2005. Appellants claim that the D&O Policies provide coverage for any "actual or alleged breach of duty, neglect, error, misstatement, misleading statement, omission, or act . . . with respect to any Executive of an Organization, by such Executive in his or her capacity as such or any matter claimed against such Executive solely by reason of his or her status as such." Appellants also claim that the D&O Policies include a priority of payments provision that bars payment to the Debtor's estate until after payment of all other covered claims against the Insured Individuals. They argue that the settlement nullifies the D&O Policies' priority-of-payment provisions, which granted Appellants priority over the Debtor's estate as to any payments for claims covered by the D&O Policies. Under their theory, the Trustee's rescission of the D&O Policies in return for a payment to the Debtor's estate is merely a means of evading the priority-of-payment provisions and allowing the Debtor's estate to receive an amount of money that is essentially the bulk of the insurance proceeds.

  The Acosta group also filed a notice of appeal from the Bankruptcy Court's order, and moved in that court for a stay pending appeal pursuant to Rule 8005 of the Federal Rules of Bankruptcy Procedure. The Bankruptcy Court denied their application for a stay. However, on January 19, 2005 District Judge Casey reversed the Bankruptcy Court and granted a stay. In re Suprema Specialties, Inc., M-47 (RCC). The appeal by the Acosta group has now been assigned to the undersigned judge. DISCUSSION

  The Trustee raises two arguments as to why the appeal should be dismissed: (1) Appellants failed to make any objection in the Bankruptcy Court; and (2) the appeal is moot because the Bankruptcy Court's order has not been stayed.

  Appellants' Failure to Raise the Issue in the Bankruptcy Court

  The court has not found a case in point on the first of the above issues. However, in resolving this issue the court starts with the fact that Appellants are parties to the bankruptcy. The argument that they now seek to raise on appeal was raised in the Bankruptcy Court by other parties in a comparable position and was decided against those parties by the Bankruptcy Court.

  In the view of this court, there is discretion to allow a party join in a Bankruptcy Appeal under these circumstances to protect that party's interests. The court will therefore exercise its discretion and allow Appellants to join the other parties in their appeal of this issue.

  The Failure to Seek a Stay

  Appellants did not seek a stay of the Bankruptcy Court's order. At times, such a failure can moot an appeal. However, the Acosta group sought and obtained a stay of the disbursement of the settlement proceeds. Therefore, it appears that the entirety of the settlement proceeds is currently held by the Trustee. This court can, if it later rules in Appellants' favor on merits, return the parties to the status quo ante by reversing the Bankruptcy Court's approval of the stipulation and ordering the return of the settlement proceeds to National Union and Royal Indemnity. Thus, the appeal is not moot. See In re Burger Boys, Inc., 94 F.3d 755, 760 (2d Cir. 1996).

  CONCLUSION

  The Trustee's motion to dismiss the appeal is denied.

  SO ORDERED.

20050825

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