Ch. 7 Trustee Ousted for Charging Estate for Vacation

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By Stephanie Cumings

Oct. 19 — A bankruptcy trustee who tried to charge the bankruptcy estate for his family vacation to New Orleans failed for a third time to convince a court he shouldn't have been removed.

Judge Patrick E. Higginbotham wasn't convinced that the trustee was denied due process by the removal. The court saw no problem with the bankruptcy court considering the trustee's past indiscretions when deciding to remove him for the New Orleans trip.

Hired Own Firm and Wife

W. Steve Smith was serving as the bankruptcy trustee for IFS Financial Corporation, and he hired his own firm to represent him as trustee, with his wife serving as lead counsel.

His behavior as trustee gave the bankruptcy court pause on more than one occasion. The court at one point found Smith had engaged in “retaliatory litigation,” even though the court said it was a “close call.” The court also suspected Smith was not genuinely soliciting other law firms to serve as counsel in one bankruptcy matter, as the bankruptcy court had instructed, so that Smith's firm could be hired instead.

Five-Day New Orleans Trip

At one point, Smith and his wife were scheduled to argue at a hearing before the Fifth Circuit in New Orleans on a Tuesday, but the couple and their children arrived on Saturday and left on Wednesday. Smith later sought to have some of the expenses from the trip covered by the bankruptcy estate, but he didn't itemize the expenses.

When one of the estate's creditors objected and demanded an itemized list of expenses, Smith specified he wanted a $2,121 reimbursement for a “hotel stay,” with no further breakdown of the expenses, and without mentioning that his wife and children came with him.

Removed From All Cases

The bankruptcy court ultimately found it was inappropriate for Smith to charge the estate for an extended stay in New Orleans for a one-day hearing and ordered Smith to show cause why he shouldn't be removed as trustee. Smith argued he needed the extra time away from distractions to prepare for the hearing, and that he brought his children because he lacked other childcare options. He admitted that he later realized he should have absorbed more of the cost himself rather than charging the estate.

The bankruptcy court found that Smith should be removed from the case and from all his other pending cases. If a trustee is removed for “cause” under Section 324(a) of the Bankruptcy Code, Section 324(b) stipulates that the trustee “shall thereby be removed in all other cases under this title in which such trustee or examiner is then serving unless the court orders otherwise.” The district court affirmed Smith's removal.

Probe in Greater Detail

Smith argued on appeal to the circuit court that he didn't have adequate notice that the bankruptcy court would be considering past “contextual matters” in addition to the New Orleans trip at the hearing on his removal. In addition to the retaliatory litigation and the issue with hiring independent firms, the bankuptcy court also considered an instance in which Smith had challenged a ruling that was beneficial to the bankruptcy estate but detrimental to his own firm.

The circuit court found that the show cause order “expressly invoked these matters as reasons to doubt Smith's fidelity to the estate, which should have alerted him as to their likely importance to the impending hearing.” And even though one of those incidents wasn't specifically mentioned in the order, the court said that the order “alerted Smith that his observance of fiduciary duties generally, including in past cases, would be at issue.”

“Moreover, Smith repeatedly invoked his entire track record in his briefing before the hearing, representing that he had virtually unerringly adhered to his fiduciary obligations in the IFS litigation and other cases,” the court said. The court said that because Smith had “emphasized his record so sweepingly,” he should have “expected that the bankruptcy court might probe it in greater detail.”

Gross Negligence Not Necessary

Smith argued that he shouldn't have been removed unless the bankruptcy court found he acted with “gross negligence,” even though he could point to no court that has adopted this standard. The circuit court said it was “far from clear to our eyes that the gross negligence standard ought to be imported.”

Smith also argued that he shouldn't have been removed without a finding of “actual injury or fraud,” a standard the court said some courts have used. The court refused to adopt any general standard for finding “cause” for removal under Section 324, but found that “Smith's conduct, as determined by the bankruptcy court, justified removal regardless of whether it entailed gross negligence or ‘actual injury or fraud.'”

The court also rejected the argument that Section 324 is unconstitutional on its face because it allows a trustee to be removed from other cases without notice to the courts presiding over those cases or the parties involves. The court said that whether or not there is a set of circumstances in which the law would be unconstitutional is the wrong question. A law is only facially constitutional, the court said, if there is no set of circumstances in which it would be constitutional.

Regardless, the court said Smith couldn't rest his claim on the violation of legal rights of third parties but must instead assert his own rights.

Judges James L. Dennis and Catharina Haynes joined Judge Higginbotham on the three judge panel.

Smith was represented by Shannon Kathleen Dunn and Beth Elaine Watkins of the Law Office of Beth Watkins, San Antonio, Texas.

The appellee creditor was represented by Kell Corrigan Mercer of Husch Blackwell, LLP, Austin, Texas.

To contact the reporter on this story: Stephanie Cumings in Washington at

To contact the editor responsible for this story: Jay Horowitz at

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