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IN RE WORLDCOM

August 4, 2006

IN RE WORLDCOM, INC., ET AL. REORGANIZED DEBTORS
ALAN M. GRAYSON, APPELLANT,
v.
WORLDCOM, INC., ET AL. APPELLEES.



The opinion of the court was delivered by: Robert P. Patterson, Jr., U.S.D.J.

OPINION AND ORDER

Appellant Alan Grayson ("Grayson") appeals from a June 20, 2005 Order of the Bankruptcy Court ("Order") denying his February 25, 2004 Motion for an Order Declaring the Automatic Stay Inapplicable or, in the Alternative, Lifting the Automatic Stay in the WorldCom, Inc. ("WorldCom") bankruptcy proceedings. Grayson seeks to pursue a qui tam action on behalf of the State of California, filed under seal on February 8, 2002, in the Superior Court of California, County of Sacramento, to recover from the Debtors "breakage," the unused portion of prepaid calling cards, which he claims had escheated to the State. Grayson Br. at 1-2.

I. BACKGROUND

WorldCom and its subsidiaries commenced Chapter 11 cases in the United States Bankruptcy Court for the Southern District of New York on July 21, 2002. Appellee's Counter Designation on Appeal ("WorldCom Record") Ex. C at 3. By order dated October 29, 2002, the Bankruptcy Court established January 23, 2003 as the bar date for filing proofs of claim.. Id. Ex. A at 2.

On October 31, 2003, the Bankruptcy Court entered an order ("Confirmation Order") confirming the Debtors' Modified Second Amended Joint Plan of Reorganization ("Plan"). WorldCom Record, Ex. D. The Plan included an injunction which enjoins the commencement or continuation of an action to enforce, attach, collect or recover any debt against the Debtors on or after the Plan's effective date (April 20, 2004). Plan, Id. at Attach. 1, § 10.04.

On December 11, 2003, over ten months after the bar date, the California Attorney General declined to intervene in the Grayson action in the California court, and that action was unsealed. Grayson then filed a First Amended Complaint charging the Defendants violated California's Unclaimed Property Law and False Claims Act by failing to report and pay unused balances on prepaid calling cards. Grayson Bankr. Motion, Grayson Designation on Appeal ("Grayson Record") App. A, at 6; WorldCom Br. at 4.*fn1 Grayson's proposed Second Amended Complaint, dated February 23, 2004, named Defendants and alleged they violated the California Unclaimed Property Law, Cal. Civ. Proc. Code § 1530-32, as well as the California False Claims Act, Cal. Gov't Code § 12650-55, by knowingly and willfully failing to report and pay or deliver "breakage" to the State Controller; and that Defendants' "past and continuing failure to pay or deliver" the "breakage" to the State Controller violated California's Unfair Competition Act, Cal. Bus. & Prof. Code § 17200. Proposed Second Am. Comp. ¶¶ 2-4, Grayson Record App. A, Attach. A. In his proposed Second Amended Complaint, breakage is defined as follows: "Owners often do not use some of the calling card prepayment. This is called 'breakage.'" Id.

At no time did Grayson file or attempt to file a proof of claim in the Debtors' chapter 11 cases. May 24, 2005 Bankr. Hearing Tr. ("May 24, 2005 Tr.") at 8.

On January 17, 2003, the State of California did file a timely proof of claim for $5,167,254 in debts allegedly owed by Debtors under the California Unclaimed Property Law, but did not include Grayson's claims, as noted by the Bankruptcy Court. Proof of Claim, WorldCom Record, Ex. I at Ex. A; May 24, 2005 Tr. at 7-9. That proof of claim does not include any allegations that the Debtors owed additional amounts to California as a result of pre-paid calling card breakage, although under qui tam procedures California would have had notice of these claims as of the complaint's filing in February, 2002. Id.

On February 26, 2004, Grayson filed a motion in the Bankruptcy Court seeking a declaration that the automatic stay was inapplicable to the Grayson Action, or, in the alternative, requesting that the automatic stay be lifted to allow Grayson to proceed against the Debtors in state court ("Grayson Bankr. Motion"). Grayson Record, Ex. A. On April 2, 2004, the Debtors filed an objection to the motion. Grayson Record, App. B. The Bankruptcy Court held a hearing on the motion on May 4, 2004, two weeks after the effective date of the Plan, April 20, 2004. May 4, 2004 Tr.

On May 24, 2005, the Bankruptcy Court denied Grayson's motion in an oral decision read into the record. May 24, 2005 Tr.*fn2 On June 20, 2005, the Bankruptcy Court entered an order denying Grayson's motion for the reasons previously stated on the record. June 20, 2005 Order, WorldCom Record Ex. H.

In his decision from the bench, Bankruptcy Judge Gonzalez held that 1) under California Law, "breakage" is not unused and unclaimed property of the consumer and thus does not escheat to the state; 2) Grayson's claims did not fall under the exception to the automatic stay of 11 U.S.C. § 362, applicable to interference with a state's exercise of its "police and regulatory power;" and 4) the Eleventh Amendment grant of sovereign immunity to the states is not applicable to Grayson's qui tam case on California's behalf; and 4) Grayson's action is barred by the Plan Injunction, and that Grayson had not provided sufficient justification to lift the Plan Injunction.

Grayson filed a notice of appeal from the Bankruptcy Court's decision with this Court on June 20, 2005, and filed a brief on August 4, 2005.

II. DISCUSSION

A. Standard of Review

This Court reviews the Bankruptcy Court's findings of fact under a clearly erroneous standard and conclusions of law de novo. See Fed. R. Bankr. P. 8013; National Union Fire Ins. Co. v. Bonnanzio (In re Bonnanzio), 91 F.3d 296, 300 (2d Cir. 1996).

The decision to grant or deny relief from the automatic stay or, by analogy, the Plan Injunction,*fn3 is reviewed for abuse of discretion. In re Sonnax Indus., 907 F.2d 1280, 1286 (2d Cir. 1990). The Bankruptcy Court's decision should not be disturbed on appeal where the record shows that court considered the appropriate factors for determining whether cause for relief from the stay exists. See Id. at 1288 (affirming denial of relief because court considered the appropriate factors.)

B. The Bankruptcy Court's Findings on "Breakage"

Judge Gonzalez found that Grayson was making a claim for the value on prepaid calling cards when the holder does not use all the value on the card. May 24, 2005 Tr. at 4. Judge Gonzalez also found that the terms of Debtors' tariff and Prepaid Service Agreement, which Grayson admitted governed the cards, prohibited the refund for activated or partially used calling cards, and that those terms provide that Consumers pay a fee in advance for the right to use Debtors' telecommunication services. Id. at 4-5. Therefore, Judge Gonzalez held, the only property held by the Debtors is the remaining amount of fees paid upfront which had become non-refundable after activation upon the first use of the calling card. Id. at 5.

Judge Gonzalez's conclusion is a legal conclusion based on facts presented to him, (as conceded in Grayson's Brief at 17), and therefore these factual conclusions are subject to a clearly erroneous standard of review. Grayson does not show that the Bankruptcy Court erred in its conclusion.

Grayson concedes that until July 31, 2001, Debtors' relationships with customers were governed by tariffs filed with the State and Federal Communications Commission and after that date, by contract. Grayson Br. at 9-11; see Grayson Record App. C. Grayson quotes language from these documents,*fn4 such as the Tariff's promise that Debtors will "honor all unactivated cards for reimbursement"*fn5 or "Minutes never expire," to support his argument that Debtors offered refunds, which now must escheat to the state. Grayson Br. at 9-11. The very language that Grayson quotes, however, does not support his conclusion. Rather this language expressly supports the Bankruptcy Court's conclusions that only completely unused cards were eligible for any refunds promised by Debtors (but see n. 5 and discussion in the following paragraph), and that it is calling card minutes, not cash, that is due to the Debtors' customers.

Grayson also argues that Judge Gonzalez misinterpreted the claim in his "Complaint"*fn6 when he found that "Mr. Grayson's action only involves partially used cards which are not entitled to a refund or reimbursement for the unused portion of the card." Grayson Br. at 17; May 24, 2005 Hearing at 5. Grayson argues that there is "no such language in the Complaint" to suggest that Grayson wished to limit "the allegations to partially used cards." Grayson Br. at 17. The language in Grayson's Proposed Second Amended Complaint discussing "breakage," (which he defines as occurring when owners "do not use some of the calling card prepayment") is ambiguous. See Proposed Second Amended Complaint; Grayson Bankr. Motion Att. A, Grayson Record App. A. However, the language in the Tariff that Grayson cites for support of his argument that the Debtors offer refunds for "unactivated [sic] cards" (Grayson Br. at 9, citing Tariff No. 1, Grayson Record, Ex. C, Attached as Ex. B, at § C 3.264) and that Debtors have wrongfully withheld "unused prepayments [from] the Controller" (Grayson Br. at 17) is inconsistent with his claim, since the Tariff states only that "MCI will honor all unactivated [sic] cards for reimbursement up to November 8, 1996" and that after November 8, 1996, "MCI shall no longer reimburse customers for unactivated [sic] cards that are returned to MCI." Tariff No. 1 at § C 3.264. Grayson does not demonstrate that the Bankruptcy Court erred in concluding that WorldCom customers had no property interest in the balances of totally as well as partially unused cards, and that "the only property in question is the property of the Debtors and not property of the State of California . . . ." May 24, 2005 Tr. at 5.

The conclusions of the Bankruptcy Court are consistent with the opinions of the Superior Court of California, Sacramento County, which has twice dismissed the Grayson action for failure to state a claim, holding that the California Unclaimed Property Law does not apply to breakage. See California ex rel. Grayson, No. 02 AS 00790 (Cal. Super. Dec. 10, 2004), and California ex ...


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