In re: Joseph William Sullivan , 522 B.R. 604 ( 2014 )

FILED
DEC 22 2014
SUSAN M. SPRAUL, CLERK
1 U.S. BKCY. APP. PANEL
OF THE NINTH CIRCUIT
2
3 UNITED STATES BANKRUPTCY APPELLATE PANEL
4 OF THE NINTH CIRCUIT
5 In re: ) BAP No. CC-14-1225-TaDKi
)
6 JOSEPH WILLIAM SULLIVAN, ) Bk. No. SA 14-bk-10711-CB
)
7 Debtor. )
______________________________)
8 )
JOSEPH WILLIAM SULLIVAN, )
9 )
Appellant, )
10 )
v. ) OPINION
11 )
WILLIAM HARNISCH; PECONIC )
12 PARTNERS LLC; PECONIC ASSET )
MANAGERS LLC, )
13 )
Appellees. )
14 ______________________________)
15 Argued and Submitted on October 23, 2014
at Malibu, California
16
Filed - December 22, 2014
17
Appeal from the United States Bankruptcy Court
18 for the Central District of California
19 Honorable Catherine E. Bauer, Bankruptcy Judge, Presiding
________________________________
20
21 Appearances: Sean A. O’Keefe of O’Keefe & Associates Law
Corporation, PC argued for Appellant Joseph
22 William Sullivan; Y. David Scharf of Morrison
Cohen LLP argued for Appellees William Harnisch,
23 Peconic Partners LLC, and Peconic Asset Managers
LLC.
24 __________________________________
25
26 Before: TAYLOR, DUNN, and KIRSCHER, Bankruptcy Judges.
27
28
1 TAYLOR, Bankruptcy Judge:
2
3 INTRODUCTION
4 Fifteen days after debtor Joseph Sullivan filed a
5 chapter 111 petition, Appellees, as holders of a large state
6 court judgment and related judgment liens, filed a motion to
7 dismiss the case as a bad faith filing. They contended that the
8 case was a two-party dispute and that Debtor improperly filed
9 solely to delay their collection efforts. They also argued that
10 Debtor lacked any reasonable probability of confirming a chapter
11 11 plan because Appellees would vote against it.
12 Debtor opposed the motion, supported by his declaration and
13 timely filed schedules, statement of financial affairs, and a
14 chapter 11 status report. In the status report, he outlined the
15 events leading to the filing of his petition, including
16 Appellees’ active efforts to execute on their judgment lien and
17 to seize his non-exempt assets, and stated his intent to file a
18 plan within the exclusivity period. The United States Trustee
19 did not file any papers in response to Appellees’ motion but
20 advised the bankruptcy court orally that it did not join in the
21 motion.
22 Notwithstanding the early state of the chapter 11 case and
23 the merely circumstantial nature of Appellees’ evidence, the
24 bankruptcy court granted Appellees’ motion, finding that Debtor
25 filed the case in bad faith without any possibility of confirming
26
1
Unless specified otherwise, all chapter and section
27 references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532, and
all “Rule” references are to the Federal Rules of Bankruptcy
28 Procedure, Rules 1001-9037.
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1 a plan. Then, without considering or determining whether
2 dismissal or conversion of the case would be in the best
3 interests of creditors and the estate, the bankruptcy court
4 dismissed the case. Because we determine that the bankruptcy
5 court’s failure to consider the best interests of creditors and
6 the estate was an abuse of its discretion and further because we
7 determine that its finding of bad faith was in error on this
8 record, we REVERSE.
9 FACTS
10 Debtor filed his bare bones petition for relief under
11 chapter 11 on February 4, 2014. Eight days later he filed2 a
12 Chapter 11 Status Report and supporting declaration.
13 Chapter 11 Status Report
14 In the status report, Debtor presented his version of the
15 prepetition disputes and six years of litigation between Debtor
16 and Appellees in New York and the events immediately leading to
17 the petition. According to Debtor, he was employed until October
18 2008 as the Chief Operating Officer and Chief Compliance Officer
19 of appellees Peconic Partners, LLC and Peconic Asset Managers,
20 LLC (together, “Peconic”). He was also a member of Peconic
21 entitled to share in profits. He described Peconic as an
22 institutional investment manager and registered investment
23 adviser founded by appellee William Harnisch.
24
2
The status report filed as docket 17 on the bankruptcy
25 case electronic docket is not contained in the record provided by
the parties in this appeal. We have exercised our discretion to
26 take judicial notice of documents electronically filed in the
underlying bankruptcy case. See O’Rourke v. Seaboard Sur. Co.
27 (In re E.R. Fegert, Inc.), 887 F.2d 955, 957-58 (9th Cir. 1989);
Atwood v. Chase Manhattan Mortg. Co. (In re Atwood), 293 B.R.
28 227, 233 n.9 (9th Cir. BAP 2003).
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1 Disagreements arose, Debtor’s employment was involuntarily
2 terminated in late 2008, and litigation followed. Although
3 Debtor recited some initial successes at the trial court level,
4 such successes were overturned on appeal and eventually Appellees
5 obtained a judgment of approximately $1.5 million that resolved
6 one of several counterclaims Appellees filed against Debtor. The
7 record contains no evidence that this judgment is
8 nondischargeable; it appears to be based exclusively on contract.
9 Debtor described the judgment as requiring that he repay to
10 Peconic a $1 million advance that Peconic made to him, with
11 interest. The judgment did not fully resolve the state court
12 litigation. Debtor stated that costs to continue litigation plus
13 entry of the judgment rendered him insolvent and that he filed
14 bankruptcy seeking a breathing spell to allow him time either to
15 reorganize his financial affairs through a plan of reorganization
16 or to effect a liquidation through a liquidating plan.
17 Debtor set forth his intent to resolve a tax issue that
18 could provide recovery of over $550,0003 for the estate; to
19 determine if and how to proceed with the remaining New York
20 litigation; and to analyze the costs and benefits to recover as
21 preferential transfers over $70,000 removed from Debtor’s bank
22 accounts by the sheriff as part of Appellees’ collection efforts
23 on the unstayed judgment and to deal with Appellees’ judgment
24
25
26
3
Debtor later increased his estimate of the potential tax
27 recovery to $850,000. When Debtor filed the status report he
already had obtained court approval to retain a CPA to pursue the
28 recovery.
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1 lien recorded against Debtor’s New York residence.4 Debtor also
2 stated his intent to file a plan and disclosure statement within
3 the 120 day exclusivity period.
4 Debtor described his primary assets as consisting of: a 50%
5 interest in a residence owned in New York with his wife, with a
6 market value of approximately $700,000 and subject to a mortgage
7 and Appellees’ judicial lien (combined total of $2.2 million);
8 two 401K retirement accounts he claimed as fully exempt; and
9 three vehicles owned free and clear, which he intended to claim
10 as partially exempt. He estimated the total value of his assets
11 at $749,002, exclusive of the potential tax refunds, a possible
12 employment performance bonus, and pending claims against
13 Appellees. Exclusive of the judgment, Debtor estimated total
14 unsecured claims of $217,296.
15 Six days after filing the status report, Debtor filed his
16 schedules and statement of financial affairs.
17 Schedules and Statement of Financial Condition
18 The Debtor’s summary of schedules reflects $350,000 in real
19 property assets and $397,985 in personal property assets for
20 total assets of $747,985; secured debt of $2,007,347; unsecured
21 claims of $231,036; and total liabilities of $2,238,383, which
22 Debtor identified as primarily business debt, not consumer debt.
23 Debtor’s secured debt consisted of a $498,151 mortgage secured by
24 the New York residence and the $1,509,195 judgment. His
25 scheduled unsecured debt consisted of $52,208 on four credit
26
27 4
Appellees filed the judgment with the New York County
Clerk 89 days prior to the petition date, and Debtor did not post
28 a bond to stop their collection efforts.
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1 cards; $73,192 owed to three different law firms; $600 in
2 membership dues; $27.00 in unpaid utilities; and $105,000 in
3 personal loans from two individuals (Gerard Sullivan and Thomas
4 Sullivan, apparently members of Debtor’s family).
5 In his statement of financial affairs, among other things,
6 Debtor disclosed $875,000 in gross income in 2013 which included
7 $675,000 that he described as a gross settlement amount; $242,639
8 in IRA distributions taken in the two years preceding bankruptcy;
9 $249,000 paid to the IRS and Franchise Tax Board in November
10 2013; the pending litigation in New York and related entry of a
11 sister state judgment in California in November 2013; and
12 multiple restraining orders, account restrictions, and apparent
13 levies on behalf of Appellees in the two months preceding the
14 bankruptcy filing. Debtor also disclosed legal retainers of
15 $222,543 paid in the one year pre-filing, $98,000 of which was
16 paid by Gerard, Joseph, or Thomas Sullivan. Of the retainers
17 paid, $42,049 was for fees incurred pre-petition.
18 The day after Debtor filed his schedules and statement of
19 financial affairs, Appellees filed their motion seeking dismissal
20 of the case.
21 The Motion to Dismiss
22 Appellees’ motion5 sought dismissal of the case under § 1112
23 on the stated grounds that: (1) Debtor filed the petition in bad
24 faith – to “delay, hinder or interfere with enforcement” of
25 Appellees’ judgment; (2) Debtor had “no reasonable probability of
26
5
Appellees’ only support for the motion was a declaration
27 that authenticated and attached documents consisting primarily of
documents filed by the parties at various stages of the six years
28 of litigation in New York.
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1 confirming a Chapter 11 plan”; and (3) the filing was a
2 “strategic move in a two-party dispute.” Motion, Dkt. #38 at
3 6:6-9. Appellees supplied no evidence in support of their
4 contentions beyond a request that the bankruptcy court take
5 judicial notice of the record in the New York litigation which
6 documented their litigation victory but failed to evidence either
7 a judgment that would be nondischargeable or any kind of
8 inappropriate litigation conduct by Debtor.
9 Lack of a confirmable plan
10 Appellees argued that Debtor’s chapter 11 case must be
11 dismissed based on the lack of any reasonable likelihood that
12 Debtor could propose a confirmable plan of reorganization. They
13 argued that they would not consent to any plan that proposed less
14 than 100% payment on unsecured creditors’ claims.
15 Two-party dispute and timing of petition6
16 Appellees also contended that Debtor’s case represented a
17 typical two-party dispute and that through the bankruptcy case
18 Debtor sought to collaterally attack final rulings in New York.
19 They argued that Peconic was the creditor most impacted by any
20
21 6
For the balance of their arguments, and the factors
identified and analyzed, Appellees relied on Marshall v. Marshall
22 (In re Marshall), 721 F.3d 1032, 1048 (9th Cir. 2013) (in
considering bad faith as cause for dismissal, courts “may
23 consider any factors which evidence ‘an intent to abuse the
judicial process and the purposes of the reorganization
24 provisions.’”); Leavitt v. Soto (In re Leavitt), 171 F.3d 1219,
1225 (9th Cir. 1999) (dismissal with prejudice of chapter 13 case
25 for bad faith requires consideration of whether debtor
misrepresented facts or manipulated the Bankruptcy Code, debtor’s
26 history of filings and dismissals, whether debtor “only intended
to defeat state court litigation,” whether egregious behavior is
27 present); and Ellsworth v. Lifescape Med. Assocs.
(In re Ellsworth), 455 B.R. 904, 917-18 (9th Cir. BAP 2011)
28 (same).
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1 proposed plan and that the New York forum, not the bankruptcy
2 court, would best and adequately protect all parties and assure a
3 just and equitable result. Appellees made no attempt to explain
4 how the New York forum would protect anyone other than Appellees.
5 Misrepresentations/manipulation
6 As additional indication of Debtor’s alleged bad faith,
7 Appellees asserted that Debtor was less than forthright in his
8 filings in the bankruptcy case. In support, Appellees contended
9 that Debtor’s characterization of his debts as primarily business
10 debts, rather than consumer debts, was improper. Appellees
11 argued that the judgment debt was for repayment of funds Debtor
12 borrowed for personal or family purposes, that Debtor
13 mischaracterized this debt as a tax advance, and that the related
14 legal fees also were not business expenses. They provided no
15 case law support for their argument regarding characterization of
16 Debtor’s debts. Appellees also argued that Debtor lacked
17 substantial unsecured debt and that this suggested that Debtor
18 was abusing the system.
19 Other indicators of bad faith
20 Appellees also argued that Debtor’s failure to pay anything
21 toward the judgment prior to filing bankruptcy showed Debtor’s
22 bad faith. Finally, Appellees also contended that they would get
23 nothing under a plan by Debtor, there was no business to be
24 preserved, there were no jobs to be saved – and, thus, that there
25 was no proper purpose for Debtor’s case. Appellees failed to
26 explain how their business preservation arguments squared with
27 the fact that this is an individual chapter 11 case.
28
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1 Conversion to chapter 7 not a proper option
2 Based on Appellees’ conclusion that Debtor’s debts were
3 primarily consumer debts, Appellees argued that a presumption of
4 abuse would arise under § 707(b) if Debtor were to seek
5 conversion of his case to chapter 7. Therefore, Appellees
6 summarily concluded, conversion to chapter 7 was not an option.
7 Appellees provided no case law to support this conclusion.
8 Debtor’s Opposition
9 Debtor opposed the motion and supported the opposition with
10 his declaration. Debtor described himself as a 57-year-old
11 resident of Seal Beach, California, employed as an investment
12 executive at a salary of $200,000 per annum.
13 Relying on the legal standard identified by the Ninth
14 Circuit in Idaho Dep’t of Lands v. Arnold (In re Arnold), 806
15 F.2d 937, 939 (9th Cir. 1986),7 and citing In re Marshall, 298
16 B.R. 670, 680-81 (Bankr. C.D. Cal. 2003), Debtor argued that the
17 “good faith inquiry ‘is essentially directed to two questions:
18 (1) whether the debtor is trying to abuse the bankruptcy process
19 and invoke the automatic stay for improper purposes; and (2)
20 whether the debtor is really in need of reorganization.’”
21 Opposition, Dkt. #68 at 14:13-16. Debtor stated that he was
22 forced to file bankruptcy to obtain a breathing spell from
23 Appellees’ aggressive collection efforts and that he filed with
24
7
Debtor provided the following quote from the Ninth
25 Circuit’s decision in In re Arnold: “The existence of good faith
depends on an amalgam of factors and not upon a specific fact.
26 The bankruptcy court should examine the debtor’s financial
status, motives, and the local economic environment. . . . Good
27 faith is lacking only when the debtor’s actions are a clear abuse
of the bankruptcy process.” 806 F.2d at 939 (internal citations
28 omitted). Opposition, Dkt. #68 at 14:9-11.
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1 the intent to prepare a fair and equitable plan of
2 reorganization. He argued that he was hopelessly insolvent both
3 from a balance sheet perspective and from his inability to pay
4 debts as they became due in light of the accrual of 9% interest
5 on the judgment ($150,000 annually) compared to his current
6 before-tax annual salary of $200,000. Debtor also argued that
7 through the bankruptcy filing he sought to preserve the home he
8 owned in New York with his wife.
9 As to Appellees’ specific allegations of bad faith factors,
10 Debtor responded as follows:
11 Plan confirmability
12 Debtor primarily argued that consideration of confirmability
13 of a plan not yet filed was premature and placed an improper
14 burden on him at such an early stage of the case. Debtor argued
15 that despite Appellees’ contention that they will thwart any plan
16 the Debtor files, “[f]requently even the most obstreperous of
17 creditor ultimately finds common ground with the debtor later in
18 the case.” Opposition, Dkt #68 at 15:1-2. In addition, Debtor
19 argued that ample law existed to justify separately classifying
20 the Appellees’ claim given their particular characteristics,
21 including receipt of a preferential transfer within 90 days prior
22 to the petition.8
23 Two-party dispute
24 Debtor argued that the bankruptcy case involved over
25
26 8
In a footnote in the opposition, Debtor alleged that
Peconic filed a transcript of the judgment with the Clerk of
27 Nassau County, New York, on January 17, 2014, which resulted in
the creation of a lien in favor of Peconic on the residence in
28 New York owned by the Debtor with his wife.
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1 $400,000 in other claims and thus, factually, did not constitute
2 a two-party dispute. As to Appellees’ collateral attack
3 argument, Debtor argued that he did not seek to defeat the
4 validity of the judgment in the bankruptcy court, but would treat
5 the judgment under the plan in accordance with the Bankruptcy
6 Code, including distributions and appropriate discharge of any
7 unpaid balance, “[u]nless and until the New York Judgment is
8 vacated in the course of a continuation of the New York Action.”
9 Id. at 18:10-11.
10 Alleged misrepresentations and the conversion option
11 Debtor argued that he properly categorized his case as a
12 non-consumer case. Because the debt resulted from a judgment on
13 a business dispute between employer and employee, Debtor argued
14 it had no consumer attributes. Thus, Debtor argued that
15 chapter 7 was clearly an option.
16 Other alleged bad faith indicators
17 Debtor argued that Appellees were wrong to contend that
18 Debtor had the ability to pay the judgment, especially in light
19 of the accruing interest.
20 Other arguments
21 Debtor finally argued that the Supreme Court’s decision in
22 Toibb v. Radloff, 501 U.S. 157 (1991), specifically held that an
23 individual is eligible to reorganize under chapter 11 despite the
24 lack of any ongoing business. Further, Debtor argued that his
25 filing was consistent with the objectives of the Bankruptcy Abuse
26 Prevention and Consumer Protection Action (“BAPCPA”): “to channel
27 individuals with higher levels of income and larger balance
28 sheets into Chapter 13, or Chapter 11.” Id. at 21:20-21. He
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1 acknowledged in his opposition that § 1115, added by BAPCPA,
2 brings an individual chapter 11 debtor’s post-petition income
3 into the estate, and that § 1129(a)(15), also added under BAPCPA,
4 requires that he commit five years of projected disposable net
5 income to his plan effort.
6 Appellees’ Reply
7 On reply, Appellees responded that although they believed
8 Debtor was capable of paying all his debts, Debtor’s allegation
9 that he was insolvent established his inability to present a
10 confirmable plan, and thus the case should be dismissed.9
11 Appellees argued that the case was simple: Debtor “lives a lavish
12 lifestyle” and “filed this case in order to maintain his current
13 level of spending,” and concluded that, therefore, the case “does
14 not belong in bankruptcy.” Reply, Dkt. #77 at 9:7-14.
15 The bankruptcy court’s findings and conclusion
16 The hearing on the motion was set concurrently with Debtor’s
17 applications to employ two law firms, his motion for approval of
18 his budget, and a chapter 11 scheduling and management
19 conference. The bankruptcy court heard argument on the
20 Appellees’ motion first. Counsel for the United States Trustee,
21 who appeared but did not otherwise participate in the arguments,
22 advised the bankruptcy court that the United States Trustee did
23 not join in the motion. After oral argument by the parties, and
24
25 9
Appellees also argued against Debtor’s contention that
Appellees’ judgment appropriately could be separately classified
26 and presented their assessment of Debtor’s legitimate debts and
his inability to appropriately identify an impaired class capable
27 of accepting a plan over Appellees’ objection. And Appellees
argued that Debtor’s arguments that his debts are not consumer
28 debts were unsupportable.
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1 without allowing testimony or other additional evidence, the
2 bankruptcy court took the motion under submission and continued
3 the other hearings. Shortly thereafter, it issued its written
4 Statement of Decision and a separate order dismissing the case.
5 In the Statement of Decision the bankruptcy court held that
6 the bankruptcy case was not filed in good faith. It stated that
7 “[t]he existence of good faith depends on an amalgam of factors
8 and not upon a specific fact,” criticizing Debtor’s argument that
9 his subjective good faith in filing the case was important.
10 Statement of Decision, Dkt. #93 at 2 n.1 (citing In re Arnold,
11 806 F.2d at 939). It identified as the appropriate test:
12 “whether a debtor is attempting to unreasonably deter and harass
13 creditors or attempting to effect a speedy, efficient
14 reorganization on a feasible basis.” Id. (again citing
15 In re Arnold, along with In re Marsch, 36 F.3d at 828).
16 The bankruptcy court then specifically found that: “It is
17 obvious that Debtor’s sole purpose for filing bankruptcy was to
18 stop Peconic from collecting on its judgment.” Id. at 3:1-3. As
19 supporting facts it stated that the case was a two-party dispute
20 filed after six years of litigation, only 89 days after judgment
21 was entered against the Debtor, and when Peconic had just begun
22 collection efforts.
23 In addition, the bankruptcy court found that “a confirmable
24 plan of reorganization is not possible since Peconic (by far the
25 largest unsecured creditor), has indicated that it will vote
26 against any plan of reorganization that does not propose to pay
27 unsecured creditors 100 percent of their claims.” Id. at 2. The
28 bankruptcy court referred to Debtor’s estimation in the bare
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1 bones petition that there would be no funds available for
2 distribution to unsecured creditors; and it concluded that Debtor
3 could not artificially impair his mortgage lender because there
4 was no unsecured portion to impair.
5 The Debtor timely filed a notice of appeal to the BAP and an
6 emergency motion with the bankruptcy court for stay pending
7 appeal, which was denied. Debtor thereafter filed a motion with
8 the BAP for a stay pending appeal, which a motions panel granted.
9 JURISDICTION
10 The bankruptcy court had jurisdiction pursuant to 28 U.S.C.
11 §§ 1334 and 157(b)(2)(A). We have jurisdiction under 28 U.S.C.
12 § 158.
13 ISSUES
14 Whether the bankruptcy court abused its discretion when it
15 dismissed the bankruptcy case.
16 STANDARD OF REVIEW
17 We review the bankruptcy court’s decision to dismiss a case
18 under an abuse of discretion standard. Leavitt v. Soto
19 (In re Leavitt), 171 F.3d 1219, 1223 (9th Cir. 1999). We apply a
20 two-part test to determine whether the bankruptcy court abused
21 its discretion. United States v. Hinkson, 585 F.3d 1247, 1261-62
22 (9th Cir. 2009) (en banc). First, we consider de novo whether
23 the bankruptcy court applied the correct legal standard to the
24 relief requested. Id. Then, we review the bankruptcy court’s
25 fact findings for clear error. Id. at 1262 & n.20. See also
26 Eisen v. Curry (In re Eisen), 14 F.3d 469, 470 (9th Cir. 1994)
27 (the bankruptcy court’s finding of “bad faith” is reviewed for
28 clear error); St. Paul Self Storage Ltd. P’ship v. Port Auth.
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1 (In re St. Paul Self Storage Ltd. P’ship), 185 B.R. 580, 582 (9th
2 Cir. BAP 1995) (same). We must affirm the bankruptcy court’s
3 fact findings unless we conclude that they are illogical,
4 implausible, or without support in the record. Hinkson, 585 F.3d
5 at 1262. We may view a factual determination as clearly
6 erroneous if it was without adequate evidentiary support or was
7 induced by an erroneous view of the law. Wall St. Plaza, LLC v.
8 JSJF Corp. (In re JSJF Corp.), 344 B.R. 94, 99 (9th Cir. BAP
9 2006).
10 DISCUSSION
11 The bankruptcy court dismissed Debtor’s case as a bad faith
12 filing based on two primary determinations: (1) its factual
13 finding that the case was a two-party dispute and that Debtor’s
14 sole purpose in filing was to stop Appellees’ collection efforts;
15 and (2) its legal conclusion that Debtor could not propose a
16 confirmable plan. These determinations are not supported
17 adequately by the record. Alternatively, the bankruptcy court
18 abused its discretion by dismissing the case without considering
19 whether conversion or dismissal would be in the best interests of
20 all creditors and the estate.
21 Section 1112(b)(1) provides in relevant part that “. . . the
22 court shall convert a case under this chapter to a case under
23 chapter 7 or dismiss a case under this chapter, whichever is in
24 the best interests of creditors and the estate, for cause
25 . . . .” 11 U.S.C. § 1112(b)(1). If cause is established, the
26 decision whether to convert or dismiss the case falls within the
27 sound discretion of the court. Mitan v. Duval (In re Mitan),
28 573 F.3d 237, 247 (6th Cir. 2009); Nelson v. Meyer
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1 (In re Nelson), 343 B.R. 671, 675 (9th Cir. BAP 2006) (chapter 13
2 case). And, if a bankruptcy court determines that there is cause
3 to convert or dismiss, it must also: (1) decide whether
4 dismissal, conversion, or the appointment of a trustee or
5 examiner is in the best interests of creditors and the estate;
6 and (2) identify whether there are unusual circumstances that
7 establish that dismissal or conversion is not in the best
8 interests of creditors and the estate. § 1112(b)(1), (b)(2); and
9 see Shulkin Hutton, Inc., P.S. v. Treiger (In re Owens), 552 F.3d
10 958, 961 (9th Cir. 2009) (“the court must consider the interests
11 of all of the creditors”); In re Prods. Int’l Co., 395 B.R. 101,
12 107 (Bankr. D. Ariz. 2008).
13 A. The bankruptcy court abused its discretion when it failed to
consider whether conversion or dismissal was in the best
14 interests of all creditors and the estate.
15 We determine as a preliminary matter that even if we
16 determine that the bankruptcy court’s findings of bad faith and
17 plan futility were not in error, the bankruptcy court abused its
18 discretion by failing to consider whether conversion or dismissal
19 was in the best interests of all creditors and the estate. We
20 also determine that on the current record this error was not
21 harmless. We begin here because clarification on this point
22 provides guidance in our analysis of the bankruptcy court’s other
23 determinations.
24 Appellees argue on appeal that dismissal was in the best
25 interests of creditors and that Debtor waived any contrary
26 argument because he did not raise it in his opposition to the
27 motion. We disagree. In the motion and opposition the parties
28 both argued as to whether chapter 7 was an available option for
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1 the Debtor.10 And regardless of the parties’ arguments, the
2 bankruptcy court had an independent obligation under § 1112 to
3 consider what would happen to all creditors on dismissal and, in
4 light of its analysis, whether dismissal or conversion would be
5 in the best interest of all creditors, not just the largest and
6 most vocal creditor. See In re Owens, 552 F.3d at 961 (agreeing
7 with the Fourth Circuit that “when deciding between dismissal and
8 conversion under 11 U.S.C. § 1112(b), ‘the court must consider
9 the interest of all of the creditors.’”) (quoting Rollex Corp. v.
10 Assoc. Materials (In re Superior Siding & Window, Inc.), 14 F.3d
11 240, 243 (4th Cir. 1994)).
12 When determining the best interest of the creditors under
13 § 1112(b), the Code’s fundamental policy of achieving equality
14 among creditors must be a factor considered, “and it is not
15 served by merely tallying the votes of the unsecured creditors
16 and yielding to the majority interest.” In re Superior Siding &
17 Window, Inc., 14 F.3d at 243; and see In re Graphic Trade
18 Bindery, Inc., 2012 Bankr. LEXIS 1598 at *17 (Bankr. D. Md.
19 Apr. 12, 2012) (“the mere fact that a section 1112(b) motion
20 seeks only conversion is no bar to dismissal if the court
21 determines that dismissal is in the best interest of the
22 creditors and the estate. The opposite is also true. The task
23 of the bankruptcy court is to determine which option is the
24 better choice.”).
25
10
Both sides focused their arguments, however, on whether
26 Debtor’s case would be subject to dismissal as an abuse pursuant
to § 707(b) due to Debtor’s income level and the nature of his
27 debts. Appellees argued that Debtor mischaracterized his
consumer debts as primarily business debts; Debtor argued to the
28 contrary.
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1 While we acknowledge that unsecured creditors did not take a
2 position here, it is notable that the United States Trustee made
3 clear that it did not support dismissal.
4 Based on our reading of the hearing transcript, it appears
5 that the bankruptcy court may have believed that its limited task
6 was to grant or deny the relief requested by Appellees –
7 dismissal. The bankruptcy court was not so limited. It had at
8 least three options available to it: let Debtor try to propose a
9 plan; convert the case to chapter 7; or dismiss it, as Appellees
10 requested. When considering these options, the bankruptcy court
11 was required to consider the unrefuted evidence that:
12 (1) Appellees had judgment liens and immediate collection
13 abilities superior to all of Debtor’s unsecured creditors upon
14 dismissal of the case; (2) Appellees’ judgment liens, however,
15 were subject to attack as preferences; (3) there was no evidence
16 that creditors other than Appellees had any avenue for prompt or
17 meaningful payment outside a bankruptcy case; (4) recovery of the
18 tax refund would be enhanced in either a chapter 11 or chapter 7
19 case; and (5) dismissal as a result of these factors was far less
20 advantageous than conversion for all creditors of the estate
21 other than Appellees. This was not harmless error.
22 We cannot determine from the record whether the bankruptcy
23 court believed that § 707(b) barred conversion to chapter 7, but
24 the Appellees certainly argued that this was the case. We
25 disagree; § 707(b) abuse analysis did not bar conversion on this
26 record.
27
28
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1 There is a substantial body of decisional law11 focusing on
2 the applicability of § 707(b) when a debtor seeks to voluntarily
3 convert a chapter 13 case to chapter 7 – and the courts are split
4 as to whether conversion under these facts is appropriate. We
5 located only one case discussing a debtor’s attempt to
6 voluntarily convert a chapter 11 case to chapter 7. See
7 In re Traub, 140 B.R. 286 (Bankr. D.N.M. 1992). We located no
8 case authority, and the parties cited none, addressing the
9 applicability of § 707(b) abuse analysis to chapter 7 cases
10 converted involuntarily from chapter 11. Dismissal under
11 § 707(b), however, requires the exercise of the bankruptcy
12 court’s discretion; the statute states that the bankruptcy court
13 “may” dismiss - dismissal is not required.
14 Further, the bankruptcy court’s ability to rely on § 707(b)
15 for dismissal requires a determination that the Debtor’s debts
16 were primarily consumer. Suffice it to say that this question
17 is, at best for Appellees, an open one.
18 Finally, we are aware of individual chapter 11 cases
19 converted to chapter 7 by court order after either failure by
20 debtors to achieve plan confirmation timely or as a result of
21 default under confirmed chapter 11 plans – none of which involved
22 “means test” or § 707(b) abuse consideration. We located nothing
23 in the record before the bankruptcy court to support a conclusion
24 that Debtor’s chapter 11 case would not be eligible for
25 conversion to chapter 7 in the event Debtor was not able to
26
11
For an interesting survey of the majority, minority, and
27 hybrid approaches, see Anna Haugen, James C. Eidson and Amir
Shachmurove, Should § 707(b) Apply in Chapter 7 Cases Converted
28 from Chapter 13?, 33-APR Am. Bankr. Inst. J. 48 (2014).
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1 confirm a plan because Appellees ultimately prevailed in a plan
2 objection based on their veto under § 1129(a)(8).
3 The bankruptcy court here failed to consider whether
4 dismissal or conversion was in the best interests of the
5 creditors and the estate. Conversion was and is a viable option
6 even if § 707(b) is applicable. And given the facts in the
7 record currently before us, we cannot conclude that the
8 bankruptcy court’s failure to consider conversion was harmless
9 error. The evidence strongly suggests that conversion is in the
10 best interest of all creditors other than Appellees. Thus, the
11 bankruptcy court erred in this regard.
12
B. The bankruptcy court erred when it found the Debtor filed
13 this case not in good faith.
14 The bankruptcy court has broad discretion in determining
15 what constitutes “cause” under section 1112(b). See Chu v.
16 Syntron Bioresearch, Inc. (In re Chu), 253 B.R. 92, 95 (S.D. Cal.
17 2000). The movant bears the burden of establishing by a
18 preponderance of the evidence that cause exists. StellarOne Bank
19 v. Lakewatch LLC (In re Park), 436 B.R. 811, 815 (Bankr. W.D. Va.
20 2010). Because good faith is required in the commencement and
21 prosecution of a chapter 11 case, “the lack thereof constitutes
22 ‘cause’ for dismissal under § 1112(b)(1).” In re Mense, 509 B.R.
23 269, 276 (Bankr. C.D. Cal. 2014) (citing In re Marsch, 36 F.3d at
24 828 (“Although section 1112(b) does not expressly require that
25 cases be filed in ‘good faith,’ courts have overwhelmingly held
26 that a lack of good faith in filing a Chapter 11 petition
27 establishes cause for dismissal.”)). “The good faith requirement
28 ‘deter[s] filings that seek to achieve objectives outside the
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1 legitimate scope of the bankruptcy laws.’” Id.
2 The bankruptcy court found that the bankruptcy case was a
3 two-party dispute with no possibility of plan confirmation and
4 was filed for the sole purpose of stopping Appellees’ collection
5 on their judgment. The limited record then before the bankruptcy
6 court in the early stages of the case does not support these
7 findings and conclusions.
8 1. The bankruptcy court erred by finding Debtor’s sole and
bad faith purpose was to stop Appellees’ collection
9 efforts.
10 It is well recognized that the automatic stay under § 362,
11 activated upon filing a bankruptcy petition (with some exceptions
12 not applicable here), is intended to provide debtors in
13 bankruptcy with a breathing spell from their creditors’
14 collection actions. And it is not unusual to encounter a
15 chapter 11 case filed “because of the crushing weight of a
16 judgment.” In re Marshall, 298 B.R. at 683. If, however, a
17 debtor seeks to use a chapter 11 filing to “unreasonably deter
18 and harass creditors,” such a filing lacks good faith.
19 In re Marsch, 36 F.3d at 828.
20 The bankruptcy court here found that Debtor filed his
21 chapter 11 case solely to stop Appellees’ collection efforts and
22 concluded that this constituted bad faith. The bankruptcy court
23 made no finding that stopping Appellees’ collection efforts was
24 unreasonable or was intended to harass Appellees, however, and we
25 find no support in the record for such inferences.
26 Based on Debtor’s schedules and statement of financial
27 affairs, for at least the two years preceding the bankruptcy
28 filing, Debtor supplemented his salary with substantial
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1 withdrawals from retirement accounts, credit cards, and
2 significant loans from family members. Then two months before
3 filing, Appellees commenced aggressive collection efforts,
4 freezing or levying against bank and brokerage accounts. The
5 Debtor concurrently continued to incur substantial legal fees.
6 As stated in Debtor’s declaration in opposition to the motion,
7 which was not disputed by any evidence submitted by Appellees,
8 the litigation costs, entry of the judgment, and unpaid legal
9 bills left him insolvent. Appellees’ contrary argument that
10 Debtor was solvent and could and should have paid Appellees’
11 judgment is not supported by the record.
12 At oral argument, the bankruptcy court expressed its
13 disbelief12 in assertions by Debtor that he was financially
14 strapped prepetition, when he had a house in New York that he
15 planned to keep and three high-end vehicles – unlike the people
16 the bankruptcy court was “used to” – “people who literally are
17 living in homeless shelters.” Hr’g Tr. (Apr. 9, 2014) at
18 17:22-23. The bankruptcy court directed argument away from
19 Debtor’s alleged insolvency,13 as a “non-issue.” Id. at 15:17.
20 As articulated by the Ninth Circuit, however, when assessing a
21 debtor’s good faith the bankruptcy court “should examine the
22 debtor’s financial status [and] motives. . . .” In re Arnold,
23
12
The bankruptcy court told Debtor’s counsel “don’t tell
24 me this gentleman is impoverished, please.” Hr’g Tr. (Apr. 9,
2014) at 18:10-11.
25
13
Nonetheless Debtor’s counsel advised the bankruptcy
26 court that Debtor moved to California, not because he wanted to
be 2,000 miles away from his wife, but because he had to do so
27 for employment. His wife remained in New York as a cancer
survivor who had a network of people and medical caregivers
28 supporting her there.
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1 806 F.2d at 939. Here, the bankruptcy court’s disinclination to
2 examine the Debtor’s financial status beyond his possession of a
3 home in New York and three admittedly valuable vehicles
4 contributed to its erroneous conclusion.14
5 Debtor’s petition, filed within 8915 days of perfection of
6 Appellees’ judgment lien, not only appropriately provided Debtor
7 a breathing spell,16 it laid the ground work for another key goal
8 underlying the bankruptcy process, leveling the playing field for
9 other creditors of the estate. See In re Superior Siding &
10 Window, Inc., 14 F.3d at 243. Appellees appear to have obtained
11 their judgment lien within the preference period. Not
12 surprisingly, Appellees argued that they would be better off if
13 allowed to pursue collection on their judgment outside of the
14 bankruptcy case – absent the bankruptcy filing, Appellees would
15 have a substantial advantage over other creditors.
16 In addition, Debtor stated his clear intention to save
17 equity in the New York home, where his wife lived, and his desire
18 for orderly liquidation of assets if he could not propose a
19 confirmable plan. The record does not evidence that the
20
21 14
As recently discussed by the Ninth Circuit, “bankruptcy
law must apply equally to the rich and poor alike, fulfilling the
22 Constitution’s requirement that Congress establish ‘uniform laws
on the subject of bankruptcies throughout the United States.’”
23 Hawkins v. Franchise Tax Bd. of Cal., 769 F.3d 662, 669 (9th Cir.
2014).
24
15
The record is not fully developed as to the mechanism by
25 which Appellees obtained lienholder status; it appears
undisputed, however, that Debtor’s filing on February 4, 2014,
26 put Appellees’ lien status within the 90-day preference period.
27 16
At the hearing on the motion, Debtor’s counsel argued
that the breathing spell benefit of the automatic stay was
28 negated here by Appellees’ quickly filed motion.
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1 bankruptcy court considered either of these goals. But both
2 goals are legitimate reasons to file bankruptcy. See Warner v.
3 Universal Guardian Corp. (In re Warner), 30 B.R. 528, 529 (9th
4 Cir. BAP 1983) (nothing in the Code prohibits the use of chapter
5 11 by debtors seeking to save their family home from
6 foreclosure); and In re Soundview Elite, Ltd., 503 B.R. 571, 580
7 (Bankr. S.D.N.Y. 2014) (“[I]t is not bad faith to file a chapter
8 11 petition for the purpose of a more orderly liquidation.”).
9 And although Debtor had not filed a proposed plan as of the
10 hearing on the motion, Debtor argued that through the chapter 11
11 bankruptcy process he intended to seek recovery of as much as
12 $850,000 on overpayment of taxes.
13 All the evidence before the bankruptcy court indicated that
14 Debtor had significant financial need for protection under the
15 Bankruptcy Code. No evidence was presented from which the
16 bankruptcy court could infer that Debtor intended to unreasonably
17 deter or harass Appellees or any of his other creditors.
18 2. The existence of disputes between Debtor and Appellees
does not render the case a two-party dispute filed in
19 bad faith.
20 “Petitions in bankruptcy arising out of a two-party dispute
21 do not per se constitute a bad-faith filing by the debtors.”
22 In re Stolrow’s, Inc., 84 B.R. 167, 171 (9th Cir. BAP 1988).
23 Courts that find bad faith based on two-party disputes do so
24 where “it is an apparent two-party dispute that can be resolved
25 outside of the Bankruptcy Court’s jurisdiction.” Oasis at Wild
26 Horse Ranch, LLC v. Sholes (In re Oasis at Wild Horse Ranch,
27 LLC), 2011 Bankr. LEXIS 4314 at *29 (9th Cir. BAP Aug. 26, 2011)
28 (emphasis added) (citing N. Cent. Dev. Co. v. Landmark Capital
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1 Co. (In re Landmark Capital Co.), 27 B.R. 273, 279 (D. Ariz.
2 1983)); and see St. Paul Self Storage Ltd. P’ship, 185 B.R. at
3 583 (debtor’s only significant asset was a claim against one
4 creditor set to be tried in state court and bankruptcy court
5 supervision of debtor’s liquidation was not necessary to protect
6 other creditors). Typical bad faith two-party dispute cases may
7 involve delays on the eve of trial (litigation tactics), forum
8 shopping, new-debtor syndrome (special purpose entities), repeat
9 filers, and repeatedly delayed foreclosure sales. There are no
10 such common indicators here.
11 The evidence before the bankruptcy court established that
12 the parties were involved in six years of litigation in state
13 court prior to the petition date; Debtor was using exempt assets,
14 family loans, and credit card debt to fund the litigation and his
15 expenses; and Appellees started to aggressively collect on their
16 judgment. With assets of approximately $750,000 versus the
17 $1.5 million judgment, and interest accruing at 9% on the
18 judgment versus Debtor’s annual salary of $200,000, Debtor was
19 balance sheet and cash flow insolvent before considering living
20 expenses and other significant debt. Such numbers do not support
21 the bankruptcy court’s implicit determination that resolution
22 outside the bankruptcy court was preferable or even possible.
23 This was not a case where Appellees offered any kind of
24 settlement or any resolution of the judgment other than Debtor’s
25 full liquidation. Nor does the evidence support a conclusion
26 that the bankruptcy filing did not provide important protection
27 to other legitimate creditors by leveling the playing field.
28 “Good faith is lacking only when the debtor’s actions are a clear
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1 abuse of the bankruptcy process.” In re Arnold, 806 F.2d at 939.
2 Keeping the Appellees from seizing all liquid assets ahead of
3 other creditors and bringing preferential transfers back into the
4 estate for the benefit of all creditors not only do not
5 constitute abuses of the bankruptcy process, they achieve primary
6 goals of the bankruptcy process. Nor did Appellees present any
7 evidence to support an inference that Debtor sought to have the
8 bankruptcy court act as an appellate court in connection with the
9 pending state court matters or to shift to the bankruptcy court
10 the decision making on claims in the state court litigation.
11 During oral argument on the motion, the bankruptcy court
12 repeatedly stated that Debtor had one creditor. Appellees argued
13 that Debtor’s scheduled debts were insignificant and questionable
14 – Appellees were most affected by the filing, and, implicitly, of
15 singular importance. To the contrary, Debtor’s schedules, which
16 the bankruptcy court acknowledged having reviewed, establish the
17 existence of significant debt owed to credit card companies,
18 attorneys, and family members. The bankruptcy court had no
19 evidence before it from which it could appropriately infer that
20 any of such debt was not legitimate. Nor did any evidence exist
21 to dispute Debtor’s contention that the interest accrual on the
22 judgment alone made his financial survival outside of bankruptcy
23 impossible. To conclude otherwise was not supported by the
24 record.
25 3. Appellees’ stated intention not to accept a less-than-100%-
plan by Debtor, alone, does not support a conclusion that
26 Debtor filed the case in bad faith.
27 The bankruptcy court also found that Debtor could not
28 propose a confirmable plan because Appellees argued they would
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1 vote against it. Many are the judgment creditors who gnash their
2 teeth (metaphorical or otherwise) in chagrin when their
3 collection campaign is stayed by a bankruptcy filing. Only
4 slightly less frequent are the immediate post-filing threats that
5 no quarter will be given. Such jeremiads, however, are not a
6 sufficient basis for a universal conclusion of plan futility.
7 And they certainly do not unequivocally establish the debtor’s
8 bad faith. Economic considerations and rationality often result
9 in resolution.
10 Here, the Appellees’ statements must be taken in context.
11 Debtor had not filed a plan, and Appellees, apparently, had not
12 had time to compare their possible treatment under a plan with
13 the certainly less favorable treatment in a chapter 7 case. It
14 is indeed possible that Appellees would elect chapter 7,
15 notwithstanding that they lose the opportunity to obtain any
16 access to Debtor’s post-petition income. It is further possible
17 that the tax refunds will not be more easily collected in a
18 chapter 11 case such that this factor does not support a
19 continuation in chapter 11. And it is certainly possible that
20 the Debtor will try to take advantage of his creditors rather
21 than dealing with them forthrightly as he promises. But the
22 possibility that the Appellees will not act in their economic
23 best interest, when the choice is correctly presented as not
24 being limited to dismissal or chapter 11, or that the Debtor will
25 act in a manner inconsistent with the only evidence before the
26 bankruptcy court, do not equate to bad faith. Here, the only
27 evidence is not supportive of bad faith and only suggestive of
28 plan futility. Indeed, it is worth noting that the Appellees’
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1 stated unwillingness to ever support Debtor’s plan was not
2 supported by declaratory evidence of any type. It is possible
3 that this is a reasoned response that would retain rationality
4 even if conversion is the alternative, but on this record it is
5 illogical to so assume.
6 Moreover, nothing in the record indicates that Debtor was
7 aware that Appellees would take such a position when he filed his
8 petition. And when the bankruptcy court ruled on the motion,
9 Debtor had not filed a proposed plan at all.17 In essence, the
10 bankruptcy court concluded, based on a very scant record, that
11 Debtor could neither propose the 100% plan Appellees demanded,
12 negotiate a consensual resolution, or cram down a lesser payout
13 plan.18 Such determinations were premature.
14
17
At oral argument, the bankruptcy court heard the Debtor
15 to suggest that he would artificially impair the secured lender
on the New York property to obtain an impaired class to vote in
16 favor of a future plan. The bankruptcy court included in its
findings, however, that the “New York property is worth more than
17 what is owed to the secured lender, so there is no unsecured
portion to impair.” Statement of Decision at 2. We were unable
18 to find support in the record for this finding. Debtor scheduled
50% of the estimated value of the New York residence as property
19 of the estate due to his nonfiling wife’s joint interest, but it
is not clear from the schedules whether Debtor likewise scheduled
20 50% of the mortgage debt against the property or 100%. Nor did
we locate any evidence regarding the status of payments to the
21 mortgage lender or whether Debtor’s nonfiling spouse contributed
to the mortgage payments or had independent assets or income.
22
18
The bankruptcy court referred to an estimate contained
23 in Debtor’s petition itself that no funds would be available for
distribution after exempt property and administrative claims. In
24 his appellate opening brief, Debtor undertook to explain in a
footnote that the “no distribution” box in the emergency
25 petition, as referred to by the bankruptcy court, was checked
automatically by the software system used by counsel. As the
26 bankruptcy court acknowledged at oral argument on the motion that
it had reviewed the schedules and other documents on the docket,
27 which necessarily included Debtor’s multiple declarations, we
conclude that reliance on a checked box on the bare bones
28 (continued...)
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1 We note that Debtor acknowledged that his postpetition
2 earnings and net disposable income are available in a chapter 11
3 plan. Under § 502 of the Code, Appellees would not be entitled
4 to the 9% interest on their judgment postpetition,19 reducing the
5 amount required to be paid from Debtor’s not-insubstantial
6 $200,000 annual salary. Debtor proposed to seek a large recovery
7 from the IRS to contribute to plan payments. And Debtor’s
8 schedules disclosed not-insignificant amounts of exempt assets
9 that the Debtor could, if so inclined, commit to a chapter 11
10 plan payout. Such possibilities were neither discussed nor
11 considered nor given adequate time for development.
12 Although it is well within a bankruptcy court’s decision-
13 making authority to determine facial non-confirmability of a
14 proposed plan (such as when considering a motion for approval of
15 a filed disclosure statement20), determining the facial non-
16 confirmability of an unfiled plan so early in the case and absent
17 a fully developed record is not supportable. See Can-Alta
18 Props., Ltd. v. State Sav. Mortg. Co. (In re Can-Alta Properties,
19 Ltd.), 87 B.R. 89, 92-93 (9th Cir. BAP 1988) (lifting of the
20 automatic stay based on bad faith, where the court lacked
21 evidence of confirmability or feasibility of a plan and afforded
22
23 18
(...continued)
petition was insufficient grounds for the bankruptcy court to
24 conclude no plan could be confirmed.
25 19
Section 502(b)(2) provides for the disallowance of a
claim to the extent that “such claim is for unmatured interest.”
26
20
See e.g., In re Main St. AC, Inc., 234 B.R. 771, 775
27 (Bankr. N.D. Cal. 1999) (a court may disapprove of a disclosure
statement if the plan to which it refers could not possibly be
28 confirmed).
- 29 -
1 no opportunity for the debtor to amend the then existing plan to
2 respond to the court’s concerns, constituted an abuse of
3 discretion).
4 CONCLUSION
5 Based on the foregoing, we REVERSE.
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