New Bankruptcy Opinion: IN RE TRI-STATE FINANCIAL, LLC – Court of Appeals, 8th Circuit, 2014

In re: Tri-State Financial, LLC, doing business as North Country Ethanol Debtor,

Thomas D. Stalnaker, Trustee, Plaintiff-Appellee,

v.

George Allison; Frank Cernik; Phyllis Cernik; Chris Daniel; Amy Daniel; Distefano Family LTD Partnership, Defendants-Appellants.

Mark E. Ehrhart; Robert G. Griffin; John Hoich; Denise Hoich, Defendants.

Timothy Jackes; James G. Jandrain;, Defendants-Appellants.

American Interstate Bank, Defendant.

George Kramer; Bernie Marquardt Defendants-Appellants.

Radio Engineering Industries, Inc.; Joseph Vacanti, Trustee of The Joseph and Cynthia Vacanti Trust, Defendants.

Centris Federal Credit Union, Defendant-Appellee,

Centris Federal Credit Union Counterclaim and Cross-Claim Plaintiff-Appellee,

v.

Thomas D. Stalnaker, Trustee Counterclaim Defendant-Appellee,

George Allison; Frank Cernik; Phyllis Cernik; Chris Daniel; Amy Daniel; Distefano Family LTD Partnership Cross-Claim Defendants-Appellants.

Mark E. Ehrhart; Robert G. Griffin; John Hoich; Denise Hoich Cross-Claim Defendants.

Timothy Jackes; James G. Jandrain; George Kramer; Bernie Marquardt Cross-Claim Defendants-Appellants.

Radio Engineering Industries, Inc.; Joseph Vacanti, Trustee of The Joseph and Cynthia Vacanti Trust Cross-Claim Defendants.

In re: Tri-State Financial, LLC, doing business as North Country Ethanol Debtor,

Thomas D. Stalnaker, Trustee, Plaintiff,

v.

George Allison, Jr.; Frank Cernik; Phyllis Cernik; Chris Daniel; Amy Daniel; Distefano Family LTD Partnership; Mark E. Ehrhart; Robert G. Griffin; John Hoich; Denise Hoich; Timothy Jackes; James G. Jandrain; American Interstate Bank; George Kramer; Bernie Marquardt, Defendants.

Radio Engineering Industries, Inc., Defendant-Appellant.

Joseph Vacanti, Trustee of The Joseph and Cynthia Vacanti Trust, Defendants.

Centris Federal Credit Union, Defendant-Appellee,

Centris Federal Credit Union Counterclaim and Cross-Claim Plaintiff-Appellee,

v.

Thomas D. Stalnaker, Trustee Counter-Claim Defendant.

George Allison; Frank Cernik; Phyllis Cernik; Chris Daniel; Amy Daniel; Distefano Family LTD Partnership; Mark E. Ehrhart; Robert G. Griffin; John Hoich; Denise Hoich; Timothy Jackes; James G. Jandrain; George Kramer; Bernie Marquardt Cross-Claim Defendants.

Radio Engineering Industries, Inc. Cross-Claim Defendant-Appellant.

Joseph Vacanti, Trustee of The Joseph and Cynthia Vacanti Trust Cross-Claim Defendant.

In re: Tri-State Financial, LLC, doing business as North Country Ethanol Debtor,

Thomas D. Stalnaker, Trustee, Plaintiff,

v.

George Allison; Frank Cernik; Phyllis Cernik; Chris Daniel; Amy Daniel; Distefano Family LTD Partnership; Mark E. Ehrhart; Robert G. Griffin, Defendants.

John Hoich; Denise Hoich, Defendants-Appellants.

Timothy Jackes; James G. Jandrain; American Interstate Bank; George Kramer; Bernie Marquardt; Radio Engineering Industries, Inc.; Joseph Vacanti, Trustee of The Joseph and Cynthia Vacanti Trust, Defendants.

Centris Federal Credit Union, Defendant-Appellee,

Centris Federal Credit Union Counterclaim and Cross-Claim Plaintiff-Appellee,

v.

Thomas D. Stalnaker, Trustee Counterclaim Defendant.

George Allison; Frank Cernik; Phyllis Cernik; Chris Daniel; Amy Daniel; Distefano Family LTD Partnership; Mark E. Ehrhart; Robert G. Griffin Cross-Claim Defendants.

John Hoich; Denise Hoich Cross-Claim Defendants-Appellants.

Timothy Jackes; James G. Jandrain; George Kramer; Bernie Marquardt; Radio Engineering Industries, Inc.; Joseph Vacanti, Trustee of The Joseph and Cynthia Vacanti Trust Cross-Claim Defendants.

In re: Tri-State Financial, LLC, doing business as North Country Ethanol Debtor,

Thomas D. Stalnaker, Trustee, Plaintiff-Appellee,

v.

George Allison; Frank Cernik; Phyllis Cernik; Chris Daniel; Amy Daniel; Distefano Family LTD Partnership; Mark E. Ehrhart; Robert G. Griffin; John Hoich; Denise Hoich; Timothy Jackes; James G. Jandrain, Defendants.

American Interstate Bank, Defendant-Appellant.

George Kramer; Bernie Marquardt; Radio Engineering Industries, Inc.; Joseph Vacanti, Trustee of The Joseph and Cynthia Vacanti Trust, Defendants.

Centris Federal Credit Union, Defendant-Appellee,

Centris Federal Credit Union Counterclaim and Cross-Claim Plaintiff,

v.

Thomas D. Stalnaker, Trustee Counterclaim Defendant.

George Allison; Frank Cernik; Phyllis Cernik; Chris Daniel; Amy Daniel; Distefano Family LTD Partnership; Mark E. Ehrhart; Robert G. Griffin; John Hoich; Denise Hoich; Timothy Jackes; James G. Jandrain; George Kramer; Bernie Marquardt; Radio Engineering Industries, Inc.; Joseph Vacanti, Trustee of The Joseph and Cynthia Vacanti Trust Cross-Claim Defendants.

Nos. 14-6018, 14-6019, 14-6020, 14-6025

United States Court of Appeals, Eighth Circuit.

Submitted: August 27, 2014.
Filed: October 23, 2014.

Before KRESSEL, SCHERMER, and NAIL, Bankruptcy Judges.

NAIL, Bankruptcy Judge.

James G. Jandrain, Distefano Family Ltd. Partnership, George Allison, Jr., Frank and Phyllis Cernik, Chris and Amy Daniel, Timothy Jackes, George Kramer, and Bernie Marquardt (collectively, “Jandrain, et al.”) appeal the May 22, 2014 judgment of the bankruptcy court determining certain funds were property of the bankruptcy estate, awarding Trustee Thomas D. Stalnaker certain fees and expenses, and surcharging those fees and expenses against the funds the bankruptcy court determined were property of the bankruptcy estate. Radio Engineering Industries, Inc. (“REI”), John Hoich and Denise Hoich, and American Interstate Bancorporation (“American Interstate”) each separately appeal the same judgment. We reverse and remand for further proceedings consistent with this opinion.

BACKGROUND

In June and July 2003, a group of investors referred to as “the Omaha Group” transferred $2,000,000.00 to Tri-State Financial, LLC. Over the following year, Tri-State Financial transferred $793,654.42 of those funds to Tri-State Ethanol Company, LLC, which was in chapter 11 bankruptcy in the District of South Dakota, and $1,190,000.00 of those funds to one of Tri-State Ethanol’s vendors.

In July 2004, Tri-State Ethanol’s case was converted to chapter 7, and John S. Lovald was appointed chapter 7 trustee. Tri-State Financial filed a request for payment of an administrative expense and a proof of claim seeking recovery of both the $793,654.42 and the $1,190,000.00. In July 2006, Lovald paid Tri-State Financial the $793,654.42. Tri-State Financial distributed the entire sum to the Omaha Group.

In November 2008, Tri-State Financial filed a petition for relief under chapter 11 of the bankruptcy code. In January 2009, Stalnaker was appointed chapter 11 trustee. Sometime thereafter, Lovald paid Stalnaker the $1,190,000.00.

In September 2010, Stalnaker filed an adversary proceeding to determine ownership of the $1,190,000.00. Stalnaker claimed the funds were property of the bankruptcy estate. Centris Federal Credit Union (“Centris”) agreed the funds were property of the bankruptcy estate, but it claimed the funds were subject to its blanket security interest in Tri-State Financial’s assets. Jandrain, et al. claimed the funds were held in trust by Tri-State Financial and were thus not property of the estate. The matter was tried, and on February 13, 2013, the bankruptcy court entered an order: (1) determining the funds were not property of the bankruptcy estate; (2) determining the bankruptcy estate was entitled to be reimbursed both for the legal fees and expenses it incurred in litigating and eventually settling with Lovald and for the attorney fees, costs, and expenses it incurred in the adversary proceeding; and (3) outlining the procedure for Stalnaker to request reimbursement for those fees, costs, and expenses.

Stalnaker requested $35,944.45 for the legal fees and expenses the bankruptcy estate incurred in litigating and eventually settling with Lovald and $61,886.90 for the attorney fees, costs, and expenses the bankruptcy estate incurred in the adversary proceeding. No party in interest objected to the amounts requested or to the $35,944.45 being surcharged against the $1,190,000.00. However, several parties in interest, including Jandrain, et al., objected to the $61,886.90 being surcharged against the $1,190,000.00. The matter was heard, and on May 21, 2013, the bankruptcy court entered an order allowing the amounts requested and surcharging both amounts against the $1,190,000.00.

On that same date, the bankruptcy court entered a judgment incorporating the terms of its February 13, 2013 and May 21, 2013 orders. [1] Stalnaker and Centris timely filed a notice of appeal. Jandrain, et al. timely filed a notice of cross-appeal.

On appeal, the parties identified a plethora of issues they believed were presented by the appeal and the cross-appeal. We boiled those issues down to two: (1) whether the bankruptcy court erred in concluding the $1,190,000.00 was not property of the bankruptcy estate; and (2) whether the bankruptcy court erred in surcharging Stalnaker’s attorney fees, costs, and expenses against the $1,190,000.00. After reviewing the record and considering the parties’ arguments, we determined any consideration of either issue would have been premature.

In their post-trial brief, Stalnaker and Centris argued, inter alia, “[Tri-State Financial] is judicially estopped from having any intent or position imputed upon it other than the [$1,190,000.00] belong[s] to [Tri-State Financial].” Stalnaker and Centris also argued a “sweeping release” executed in August 2006 by all but two members of the Omaha Group-Jandrain and Radio Engineering Industries, Inc.-“includes any claimed obligation of [Tri-State Financial] to turn over the [$1,190,000.00] to [those parties.]” Finally, Stalnaker and Centris argued the Omaha Group “should be estopped from asserting ownership to the [$1,190,000.00].” Both the bankruptcy court’s February 13, 2013 order and its May 21, 2013 order are silent with respect to these arguments.

We could, perhaps, interpret the bankruptcy court’s silence as an implicit rejection of Stalnaker and Centris’s arguments and render an opinion on that basis. However, we believe the better course is to afford the bankruptcy court an opportunity to consider those arguments, if it did not in fact do so, and explain its reasoning for accepting or rejecting them.

Stalnaker v. Allison (In re Tri-State Financial, LLC), 512 B.R. 209, 211-12 (B.A.P. 8th Cir. 2014) (“Stalnaker I”) . We therefore reversed and remanded the matter for further proceedings. Id. at 212.

On remand, the bankruptcy court [2] reconsidered its earlier ruling, and on May 22, 2014, it entered an order determining the $1,190,000.00 was in fact property of the bankruptcy estate and was subject to Centris’s blanket security interest. The bankruptcy court’s order specifically left unaffected its May 21, 2013 order awarding Stalnaker $35,944.45 for the legal fees and expenses the bankruptcy estate incurred in litigating and eventually settling with Lovald and $61,886.90 for the attorney fees, costs, and expenses it incurred in the adversary proceeding and surcharging both amounts against the $1,190,000.00.

On that same date, the bankruptcy court entered a judgment incorporating the terms of its May 22, 2014 and May 21, 2013 orders. [3] Jandrain, et al., REI, the Hoiches, and American Interstate each timely filed a notice of appeal.

STANDARD OF REVIEW

We review the bankruptcy court’s findings of fact for clear error and its legal conclusions de novo. Islamov v. Ungar (In re Ungar), 633 F.3d 675, 678-79 (8th Cir. 2011) .

DISCUSSION

The parties again identify a plethora of issues they believe are presented by the several appeals. Those issues may be condensed and restated as follows: (1) whether the bankruptcy court exceeded its mandate on remand; (2) whether the bankruptcy court disregarded the law of the case; (3) whether the bankruptcy court failed to comply with Fed.R.Civ.P. 63 and Fed.R.Bankr.P. 9028; (4) whether the bankruptcy court erred in concluding the $1,190,000.00 was property of the bankruptcy estate; and (5) whether the bankruptcy court erred in surcharging Stalnaker’s attorney fees, costs, and expenses against the $1,190,000.00.

With respect to the first issue, Jandrain, et al. argue in reconsidering its earlier ruling that the $1,190,000.00 was not property of the estate, the bankruptcy court failed to follow our mandate on remand. We disagree.

The question of whether the bankruptcy court exceeded our mandate is a question of law and is thus subject to de novo review. Gourley v. Usery (In re Usery), 242 B.R. 450, 456 (B.A.P. 8th Cir. 1999) (citation therein), aff’d 242 F.3d 378 (8th Cir. 2000).

When a case has been decided . . . on appeal and remanded, every question decided by the appellate court, whether expressly or by necessary implication, is finally settled and determined, thus creating a mandate for the lower court. The mandate of the appellate court is completely controlling as to all matters within its compass, but on remand the trial court is free to pass upon any issue that was not expressly or impliedly disposed of on appeal.

Id. at 457 (citations omitted) (first emphasis in original; remaining emphasis added).

In Stalnaker I, we did not address-much less expressly or impliedly dispose of-either of the issues framed by the parties to that appeal. To the contrary, we stated unambiguously “any consideration of either issue is premature.” Stalnaker, 512 B.R. at 211 . Consequently, on remand, the bankruptcy court was free to pass upon those issues.

With respect to the second issue, Jandrain, et al. and REI argue in reconsidering its earlier ruling that the $1,190,000.00 was not property of the estate, the bankruptcy court disregarded the law of the case. Again, we disagree.

Under the law-of-the-case doctrine, “when a court decides upon a rule of law, that decision should continue to govern the same issues in subsequent stages in the same case.” Alexander v. Jensen-Carter, 711 F.3d 905, 909 (8th Cir. 2013) (citations therein). The doctrine “applies to both appellate decisions and [trial] court decisions that have not been appealed.” Id. (citation therein).

It is this latter point that precludes application of the law-of-the-case doctrine in this case. The bankruptcy court’s earlier decision was appealed. On remand, “[a] lower court is not bound by its own earlier rulings unless explicitly or implicitly adopted by the appellate court.” Usery, 242 B.R. at 457 (citations therein). In remanding the matter, we did not explicitly or implicitly adopt any of the bankruptcy court’s rulings. Consequently, the bankruptcy court was not bound by its earlier rulings. And this is so, even though the case was transferred to a different judge around the time of our remand. Id. at n.7 (citation therein).

With respect to the third issue, American Interstate argues following the retirement of the bankruptcy judge originally assigned to this case, the bankruptcy court did not comply with Fed.R.Civ.P. 63 and Fed.R.Bankr.P. 9028. We agree.

Pursuant to Rule 63,

If a judge conducting a hearing or trial is unable to proceed, any other judge may proceed upon certifying familiarity with the record and determining that the case may be completed without prejudice to the parties. In a hearing or a nonjury trial, the successor judge must, at a party’s request, recall any witness whose testimony is material and disputed and who is available to testify again without undue burden. The successor judge may also recall any other witness.

Fed.R.Civ.P. 63. [4]

In this case, the bankruptcy court did not certify familiarity with the record and determine the case could be completed without prejudice to the parties before entering its judgment. The bankruptcy court’s familiarity with the record is abundantly demonstrated by its detailed recitation of the facts in its decision. However, without the requisite certification, there is no suggestion that the parties had any reason to believe a decision was imminent and the time within which they might exercise their right under Rule 63 and Rule 9028 to ask the bankruptcy court to recall witnesses whose testimony was material and disputed was passing. [5] Under the circumstances, we will remand the matter to allow the bankruptcy court to comply with Rule 63 and Rule 9028.

In reaching this conclusion, we are mindful of the opinion of the Eighth Circuit Court of Appeals in Higginbotham v. The Corner Stone Bank (In re Higginbotham), 917 F.2d 1130 (8th Cir. 1990), in which the court of appeals recognized the possibility that a party could waive its rights under Rule 9028. However, in that case, the court of appeals was considering an earlier version of Rule 9028 that did not require the bankruptcy court to certify familiarity with the record or afford the parties an opportunity to ask the bankruptcy court to recall any witnesses. That earlier version, as quoted by the court of appeals, provided:

If by reason of death, sickness or other disability, a judge before whom an involuntary petition or an adversary proceeding has been tried or a hearing conducted is unable to perform the duties to be performed by the court under these rules after a verdict is returned, or findings of fact and conclusions of law or a memorandum is filed, then any other judge regularly sitting in or assigned to the court in which the trial or hearing was conducted may perform those duties; but if the other judge is satisfied that he cannot perform those duties because he did not preside or for any other reason, he may in his discretion grant a new trial.

Id. at 1131-32 (without emphasis in original).

Moreover, in that case, the party complaining about the bankruptcy court’s failure to comply with Rule 9028 had sought affirmative relief from the successor judge, thereby demonstrating, at least implicitly, “a willingness to accept that judge’s authority to decide the case.” Id. at 1133. In this case, Centris filed a motion asking the bankruptcy court to accept briefs summarizing the parties’ respective positions regarding the issues of estoppel and release discussed in Stalnaker I. Thus, Centris might be said to have implicitly demonstrated a willingness to accept the bankruptcy court’s authority to decide the case on the record it inherited. However, the same cannot be said about American Interstate or any of the other parties.

We are also mindful of the opinion of the Eighth Circuit Court of Appeals in Littleton v. Pilot Travel Centers, LLC, 568 F.3d 641 (8th Cir. 2009), in which the court of appeals stated a party who does not make a Rule 63 request to recall witnesses “has no right to sit back and await decision of the case before objecting to the procedure.” Id. at 648 (quoting Higginbotham, 917 F.2d at 1133 ). However, we cannot tell from that opinion whether the successor judge in that case made the requisite certification.

In any event, in this case, American Interstate cannot be said to have sat back and awaited a decision before objecting to the procedure, because, as noted above, there is no suggestion the parties had any reason to believe a decision was imminent. There is likewise no suggestion there was any “procedure” to which American Interstate might have objected. The bankruptcy court simply entered its judgment, at which point it was too late for American Interstate-or any other party-to object.

In light of our decision to remand this matter, we do not reach the remaining issues. We are not expressly or impliedly disposing of those remaining issues, and on remand the bankruptcy court is again free to pass upon them. Likewise, we are not explicitly or implicitly adopting any of the bankruptcy court’s rulings regarding those remaining issues, and on remand the bankruptcy court is still not bound by its earlier rulings regarding them.

CONCLUSION

For the foregoing reasons, we again reverse and remand for further proceedings consistent with this opinion.

[1] According to the judgment, the amounts awarded were $35,944.45 and $61,286.90.

[2] In January 2014, while Stalnaker I was still pending, the bankruptcy judge originally assigned to this case retired. In February 2014, the case was assigned to a different judge.

[3] According to the judgment, the amounts awarded were $35,944.45 and $61,286.90.

[4] Rule 63 applies in bankruptcy cases. Fed.R.Bankr.P. 9028.

[5] No other party to this appeal responded to American Interstate’s argument regarding Rule 63 and Rule 9028. In any event, the record in this case is voluminous, and the parties could reasonably have expected it would take some time for the bankruptcy court to familiarize itself with the record.

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New Bankruptcy Opinion: IN RE CONEX HOLDINGS, LLC – Bankr. Court, D. Delaware, 2014

In re: CONEX HOLDINGS, LLC, et al., Chapter 7, Debtors.

CHARLES A. STANZIALE, JR., in his capacity as the Chapter 7 Trustee of Conex Holdings, LLC, Conex International, LLC, and Advantage Blasting & Coating, Inc., Plaintiff,

v.

COPPERCOM, INC., Defendant.

Case No. 11-10501(CSS), Adv. Proc. No. 13-50939(CSS).

United States Bankruptcy Court, D. Delaware.

October 23, 2014.

William E. Chipman, Jr., Mark D. Olivere, COUSINS CHIPMAN & BROWN, LLP, Wilmington, DE, and Bruce S. Sperling, Robert D. Cheifetz, Eamon P. Kelly, SPERLING & SLATER, P.C., Chicago, IL, Counsel to Defendant.

Katharine L. Mayer, McCARTER & ENGLISH, LLP, Wilmington, DE, and Charles A. Stanziale, Jr., Jeffrey T. Testa, Michael J. Reynolds, Newark, NJ, Counsel to Plaintiff, Charles A. Stanziale, Jr., Chapter 7 Trustee.

OPINION [1]

CHRISTOPHER S. SNOTCHI, Bankruptcy Judge.

INTRODUCTION

Charles A. Stanziale, Jr., Chapter 7 Trustee (the “Trustee”) for Conex Holdings, LLC (“Holdings”), Conex International, LLC (“Conex”), and Advantage Blasting & Coating, Inc. (“ABC” and together with Holdings and Conex, the “Debtors”) filed a complaint [2] against their parent company CopperCom, Inc. (“CopperCom” or the “Defendant”) (i) seeking turnover of property pursuant to Bankruptcy Code Section 542, (ii) alleging breach of the implied covenant of good faith and fair dealing, (iii) alleging unjust enrichment, and (iv) seeking avoidance and recovery of transfers pursuant to Bankruptcy Code Sections 549 and 550, respectively. As the parent company of the Debtors, CopperCom filed consolidated federal income tax returns that included Conex, Holdings, and ABC (the “CopperCom Group”). The Trustee’s claims rely on allegations concerning CopperCom’s use and retention of net operating losses (“NOLs”) and the federal income tax benefits derived therefrom.

CopperCom moves to dismiss the Complaint in its entirety (the “Motion to Dismiss”). For the reasons set forth below, the Court will grant with prejudice the Motion to Dismiss Count I for turnover of an alleged $2.559 million receivable due to Conex from CopperCom for use of Conex’s 2008 NOL. The Court will grant without prejudice the Motion to Dismiss Count II for breach of the implied covenant of good faith and fair dealing, Count III for unjust enrichment, Count IV for avoidance of transfers pursuant to Bankruptcy Code Section 549, and Count V for recovery and preservation of any transfers avoided pursuant to Bankruptcy Code Section 550. The Trustee has not pleaded adequate facts in support of his claims; however, the Court grants the Trustee leave to amend the Complaint within twenty-eight (28) days of the issuance of this opinion to adequately plead facts to support Counts II, III, IV, and V.

JURISDICTION

This Court has jurisdiction over this adversary proceeding pursuant to 28 U.S.C. §§ 157 and 1334. Venue is proper in this District pursuant to 28 U.S.C. §§ 1408 and 1409. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(1) and (b)(2)(A),(E), and (O). The Court has the judicial authority to enter a final order.

STATEMENT OF FACTS

A. Procedural Background

On February 20, 2011 (the “Petition Date”), Wells Fargo Bank, N.A., Bank of Montreal, and The Prudential Insurance Company of America filed involuntary petitions for relief against the Debtors. [3] On February 24, 2011, the Court entered an order for relief under Chapter 7 of the Bankruptcy Code with respect to the Debtors’ cases. [4] On February 24, 2011, the Office of the United States Trustee for the District of Delaware appointed Charles A. Stanziale, Jr. as the Chapter 7 Trustee of the Debtors’ estates. [5] On March 11, 2011, the Court entered an order providing for the joint administration of the Debtors’ cases. [6]

On April 22, 2013, the Trustee initiated an adversary proceeding against the Debtors’ parent company, CopperCom, for turnover of an open receivable due to Conex arising from the Defendant’s use of Conex’s 2008 NOL and the tax benefit derived therefrom; breach of the implied covenant of good faith and fair dealing based on the Defendant’s breach of an (alleged) implied-in-fact tax allocation agreement (the “TAA”) relating to the Defendant’s use of the tax benefit derived from Conex’s 2009-2011 NOLs; or, in the alternative, unjust enrichment for the retention and utilization of Conex’s 2009-2011 NOLs; and for avoidance and recovery of the value of the Debtors’ 2010-2011 NOLs to the extent the NOLs were used by the CopperCom Group in its consolidated federal income tax returns filed for those years. [7] The Defendant filed the Motion to Dismiss, [8] the Trustee filed an objection, [9] and the Defendant filed a reply brief. [10] Briefing is complete and the matter is ripe for decision.

B. Parties

CopperCom, a subsidiary of Heico Holding, Inc. (“Heico”), is a Florida corporation with its principal place of business in Florida. [11] Holdings is a Delaware limited liability company with its principal place of business in Illinois and an acquisition company of Heico. [12] CopperCom owns 100% of all interests in Holdings. [13] Conex is a Texas limited liability company with its principal place of business in Texas. [14] Holdings owns 100% of all interests in Conex. [15] ABC is a corporation organized under the laws of the State of Texas with its principal place of business in Texas. [16] CopperCom, as designee of Heico, holds more than 80% of the common shares of ABC. [17]

On August 7, 2008, Conex International, Corp., predecessor-in-interest to Conex, changed its form and structure so as to sell itself to Heico. Conex converted to a limited liability company and changed its name from Conex International Corp. to Conex International, LLC. On that date, Conex was a wholly owned subsidiary of Conex Holdings, Inc. On August 8, 2008, Conex Holdings, Inc. transferred to Holdings, a special purpose LLC created to facilitate the acquisition, its interests in Conex and ABC.

On or about September 19, 2009, CopperCom and its subsidiaries filed a 2008 federal income tax return (“2008 Consolidated Tax Return”). [18] The first tax year that Holdings, Conex, and ABC were included in the CopperCom Group’s consolidated tax return was for the year ending December 31, 2008. [19] Holdings and Conex were treated as disregarded entities for federal income tax purposes, and CopperCom, as the single member of the disregarded entities, was treated as directly holding Holdings’ and Conex’s assets and liabilities. [20]

C. Factual Background

1. Facts Relevant to the Utilization of Conex’s 2008 NOL and the Recordation of the Receivable Due to Conex from CopperCom

For the year ending December 31, 2008, CopperCom, as the Debtors’ parent company, included the Debtors in the 2008 Consolidated Tax Return. [21] Conex’s pre-tax book loss for the post-acquisition stub period (August 9, 2008 to December 31, 2008) was $7.797 million. CopperCom used Conex’s 2008 NOL in the 2008 Consolidated Tax Return to reduce the taxable income of the profitable members of the CopperCom Group. The estimated income tax benefit derived by the CopperCom Group for the use of Conex’s 2008 NOL was $2,644,171.41. [22]

The tax benefit to CopperCom was recorded in Conex’s General Ledger Account as a federal income tax expense with an offsetting entry in the same amount described as “Due From Parent Company.” As a result of certain year-end adjustments, the tax benefit amount originally accrued was reduced. Conex’s audited statement of earnings for the period from August 8, 2008 to December 31, 2008 reflects Conex’s loss before income taxes being reduced to $7.256 million. Conex’s General Ledger Account reflects a receivable due Conex from CopperCom of $2,559,369.81 (the “Receivable”) as of December 31, 2008.

The Receivable due Conex from CopperCom’s use of Conex’s 2008 NOL is reflected in an audit report prepared by Deloitte & Touche LLP for the year ending December 31, 2008 (the “2008 Audit Report”). [23] The 2008 Audit Report identifies the Receivable due Conex from CopperCom and provides in relevant part: “In addition . . ., a tax benefit to be derived from the Parent [CopperCom] for federal income taxes of $2,559[,000] has been recorded in other long-term liabilities.” [24] Similarly, the Debtors’ 2009 draft audited consolidated financial statements reflect the Receivable due Conex from CopperCom on the Debtors’ balance sheet as of December 31, 2009. The 2009 consolidated financial statement provides that “the tax benefit to be derived from the Parent [CopperCom] for federal income taxes of $2.559 million has been recorded in other long-term liabilities in 2008 and remains recorded as of December 31, 2009.” [25]

Conex’s management-prepared financial statements for the year ending December 31, 2010 also reflect the Receivable due from CopperCom. Conex’s balance sheet as of December 31, 2010 reflects the Receivable as due and owing in its balance sheet asset account. The Receivable was never paid and remains due and owing to Conex.

2. Facts Relevant to the Utilization of Conex’s 2009, 2010, and Subsequent Years’ NOLs

For 2009, Conex reported a book loss before taxes of approximately $160.7 million and a taxable loss of approximately $22.8 million. The CopperCom Group reported a consolidated book loss of approximately $149 million and a taxable loss of approximately $19.3 million. The profitable members of the CopperCom Group utilized $7,367,751 of Conex’s taxable loss to offset the profitable members taxable income resulting in a tax savings of $2,505,035.

The Trustee asserts that the General Ledger Accounts demonstrate that Conex was recording a reduction to its federal income tax expense on a monthly basis based on the accrued benefit it was expecting to derive from the utilization of its 2009 NOL by the profitable members of the CopperCom Group and recording the benefit as an increase in the receivable due from CopperCom. Conex recorded an increase in its receivable due from CopperCom on a monthly basis throughout 2009 and through March 2010. Conex’s 2009 General Ledger Account reflects a monthly addition to the balance of the receivable due Conex from CopperCom throughout 2009 and also contains an offsetting entry. The Trustee alleges that the description “FIT Benefit” provided in the General Ledger for the increase in the receivable account means “Federal Income Tax Benefit.”

The aggregate of the 2009 monthly tax benefits recorded as a receivable due to Conex from CopperCom was reversed by a single audit entry reflected in the 2009 General Ledger which purports to be recorded on December 31, 2009. The Trustee believes, however, that this entry was in fact actually recorded in April 2010, because Conex’s 2010 General Ledger Account No. 17150 does not reflect the reversal being recorded until April 13, 2010.

LEGAL DISCUSSION

A. Motion to Dismiss Standard

The Defendant seeks dismissal of the action on the grounds that the Trustee has failed to state a claim for which relief can be granted. This motion, under Rule 12(b)(6), [26] tests the sufficiency of factual allegations pleaded in the Plaintiff’s complaint. [27] With the Supreme Court’s decisions in Bell Atlantic Corp. v. Twombly [28] and Ashcroft v. Iqbal, [29] “pleading standards have seemingly shifted from simple notice pleading to a more heightened form of pleading, requiring a plaintiff to plead more than the possibility of relief to survive a motion to dismiss.” [30]

In Iqbal, the Supreme Court makes clear that the Twombly “facial plausibility” pleading requirement applies to all civil suits in the federal courts. [31] “Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements” are insufficient to survive motions to dismiss. [32] Rather, “all civil complaints must now set out sufficient factual matter to show that the claim is facially plausible.” [33] A claim is facially plausible “when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” [34] Determining whether a complaint is “facially plausible” is “a context-specific task that requires the reviewing court to draw on its judicial experience and common sense. [35] But where the well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct, the complaint has alleged, but not effectively shown, that the pleader is entitled to relief.” [36]

After Iqbal, the Third Circuit has instructed this Court to “conduct a two-part analysis. First, the factual and legal elements of a claim should be separated. The [court] must accept all of the complaint’s well-pleaded facts as true, but may disregard any legal conclusions.” [37] The court “must then determine whether the facts alleged in the complaint are sufficient to show that the plaintiff has a plausible claim for relief.” [38] The Third Circuit has further instructed that “[s]ome claims will demand relatively more factual detail to satisfy this standard, while others require less.” [39]

B. Net Operating Losses

The claims asserted in this adversary proceeding concern the Defendant’s use of NOLs generated by Conex in federal income tax returns filed by the Defendant. The Internal Revenue Code (“I.R.C.”) rules govern the use of NOLs:

NOLs occur when a corporation’s operating losses exceed income. In such instances, corporate taxpayers are entitled to deduct NOL carryovers and NOL carrybacks in determining their taxable income in each taxable year. Carrying back NOLs for that purpose entitles the taxpayer to a refund of taxes attributable to the prior year’s income offset by the carryback. When carrying back NOLs, the taxpayer must first apply the NOLs to the oldest tax year to which it is permitted to carry back NOLs and in which it had reported income. The taxpayer’s income for a given tax return year could be reduced to zero if the NOLs carried back are large enough to cancel out income entirely for that year. [40]

Under IRS regulations during the periods relevant to this dispute, NOLs incurred by Conex could be carried back three years and could also be carried forward for fifteen taxable years. [41] Each of the Trustee’s claims involves CopperCom’s use of Conex’s (alleged) NOLs as discussed below.

C. Count I: Turnover of Estate Property under 11 U.S.C. § 542

Section 542 provides the cause of action for turnover, which requires an entity in possession of property of the estate to deliver the property, or value thereof, to the trustee. [42] A properly pleaded complaint asserting a claim for turnover must allege an undisputed right to recover the claimed debt. [43] Turnover is not appropriate where there is a legitimate dispute over ownership of the property. [44]

The Defendant argues that Count I should be dismissed because the Trustee has failed to allege that the Receivable is the undisputed property of Conex. In support, the Defendant contends that federal income tax law treats Conex as a disregarded entity for federal income tax purposes, and as a result, all of Conex’s income and losses passed through to the Defendant as the parent of Conex. Therefore, Conex’s NOLs for the tax years of 2008-2011 were deemed to be the losses of the Defendant for federal income tax purposes, and neither the NOLs nor the tax benefits derived therefrom are property of Conex’s estate.

The Trustee alleges that “[a]s single member LLCs, both Conex and Holdings were treated as `disregarded entities’ for federal income tax purposes. Under these circumstances, Coppercom, as owner of the disregarded entities, was treated as holding directly each entity’s assets and liabilities.” [45] Conversely, the Trustee also alleges that the Receivable due to Conex results from the Defendant’s use of Conex’s 2008 NOL.

On the Petition Date, a bankruptcy estate was created to hold “all legal or equitable interests of the debtor in property as of the commencement of the case.” [46] The Petition Date sets a “date of cleavage” and “establishes the moment at which the parties’ respective rights in property must be determined.” [47] The scope of an estate’s property interests is broad. [48]

Estate property includes all of a debtor’s rights and expectancies and is a concept that “has been construed most generously and an interest is not outside its reach because it is novel or contingent or because enjoyment must be postponed.” Segal v. Rochelle, 382 U.S. 375, 379 (1966) ; see also, e.g., 11 U.S.C. § 541(c)(1)(A) (providing that assets become estate property notwithstanding any provision of nonbankruptcy law that would prevent their being liquidated or transferred by the debtor); H.R. REP. No. 95-595, at 175-76 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6136 (making clear that “property of the estate” includes all “contingent interests and future interests, whether or not transferable by the debtor”). [49]

“In fact, every conceivable interest of the debtor, future, nonpossessory, contingent, speculative, and derivative, is within the reach of [section] 541.” [50]

A single member limited liability company (“SMLLC”) “may elect to be classified as an association taxable as a corporation or to be disregarded as a separate entity, resulting in passthrough taxation of its sole member.” [51] If the SMLLC does not elect to be classified as an association, it is treated as a disregarded entity. [52] As a disregarded entity, the SMLLC’s assets, liabilities, income items, and deduction items will be treated as owned, owed, received, and incurred directly by its owner. [53] The result is that the member is treated as “personally engaging in the transactions engaged in” by the SMLLC. [54]

The allegations show that Conex’s claim to the Receivable is not undisputed because, on the one hand, the Trustee alleges that Holdings’ and Conex’s assets and liabilities (including tax benefits related to NOLs) were treated as held directly by the Defendant for federal income tax purposes, and on the other hand, alleges that the Receivable is due and owing to Conex.

Because the Trustee has alleged that Conex and Holdings were disregarded entities for federal income tax purposes, federal income tax law indicates that the Defendant directly held Conex’s assets and liabilities, which included any tax benefits or liabilities derived from its operating losses in 2008. Section 542 is a remedy available to debtors to obtain what is acknowledged to be property of the bankruptcy estate, [55] and the Trustee has failed to allege an undisputed right to recover the Receivable. Indeed, the I.R.C. precludes the Trustee from pleading this undisputed right to the Receivable—and thus a turnover claim—because Conex’s NOLs and the right to use them passed through by operation of federal income tax law to the Defendant. [56] Any tax benefits derived from the Defendant’s use of Conex’s NOLs inured solely to the benefit of the Defendant as Conex’s single member. [57] Based on the facts alleged in the Complaint and the inferences reasonably drawn therefrom, Count I fails to state a claim upon which relief can be granted. The Court will dismiss the Trustee’s turnover claim with prejudice. [58]

D. Count II: Breach of the Implied Covenant of Good Faith and Fair Dealing with Respect to the CopperCom Group’s Use of Conex’s 2009-2011 NOLs

Delaware courts have “recognized the occasional necessity of implying contract terms to ensure the parties’ reasonable expectations are fulfilled.” [59] The “implied covenant of good faith and fair dealing is recognized only where a contract is silent as to the issue in dispute.” [60] To state a claim for breach of the implied covenant of good faith and fair dealing, a party “must allege (i) a specific implied contractual obligation, (ii) a breach of that obligation by the defendant, and (iii) resulting damage to the plaintiff.” [61]

Absent a contractual provision dictating a standard of conduct, there is no legal difference between breaches of contract made in bad faith and breaches of contract not made in bad faith. Both are simply breaches of the express terms of the contract. [62]

“The doctrine thus operates only in that narrow band of cases where the contract as a whole speaks sufficiently to suggest an obligation and point to a result, but does not speak directly enough to provide an explicit answer.” [63] “The covenant is best understood as a way of implying terms in the agreement, whether employed to analyze unanticipated developments or to fill gaps in the contract’s provisions.” [64]

The Defendant argues that Count II should be dismissed because (i) there is no free-standing cause of action for breach of the implied covenant of good faith and fair dealing pursuant to Delaware law, [65] (ii) the Court cannot imply or infer an obligation by the Defendant to pay Conex for use of the NOLs when allocation of Conex’s losses are addressed in the Operating Agreement, (iii) the Trustee fails to allege that Conex could have reasonably expected payment for the use of the NOLs, and (iv) there is no rational reason to require the Defendant to pay for tax savings resulting from Conex’s NOLs.

Count II for breach of the implied covenant of good faith and fair dealing alleges that the Defendant breached the covenant by failing to reimburse Conex for the amount of tax savings ($2,505,035) realized for the 2009-2011 tax years and by unilaterally rescinding the TAA in April 2010, thereby frustrating the purpose of the TAA.

The Court will consider the Operating Agreements of Conex and Holdings annexed to the Motion to Dismiss and still treat the matter under the Fed. R. Civ. P. 12(b)(6) standard because the Operating Agreements fall within the Third Circuit’s “integral exception” doctrine. [66] The Operating Agreements are integral to the Complaint and explicitly relied on by the Trustee because the Trustee alleges that Conex and Holdings are single member LLCs and were treated as disregarded entities for federal income tax purposes. [67] This information is contained in the Conex Operating Agreement and the Holdings Operating Agreement, which provide that the 100% interest member of Conex is Holdings and the 100% interest member of Holdings is CopperCom, respectively. [68] Sections 8.2 of the Conex Operating Agreement and Holdings Operating Agreement both provide that “[e]xcept as otherwise required by applicable provisions of tax law, Company taxable income and loss shall be allocated to the Member in proportion to its Percentage Interest.” [69]

Notwithstanding the Operating Agreements, the Trustee’s claim for breach of the implied covenant is premised on the existence of the (alleged) implied-in-fact TAA that the Trustee seeks to establish through the parties’ course of performance. The Trustee argues that Conex’s practice of recording the tax benefit derived from the utilization of its 2009 and 2010 NOL on a monthly basis suggests that it was following a protocol whereby CopperCom would pay to Conex the amount by which Conex’s NOLs reduced the CopperCom Group’s consolidated tax liability. The Trustee further argues that CopperCom’s reversal of the accounting entries indicating a receivable due to Conex for use of its NOLs constituted “arbitrary or unreasonable conduct which ha[d] the effect of preventing [Conex] from receiving the fruits” of the TAA. [70]

Taking all of the allegations in the Complaint as true, the Trustee has failed to allege sufficient facts to support a claim for breach of the implied covenant of good faith and fair dealing because the Operating Agreements and federal income tax law permit the exact conduct of which the Trustee complains. [71] The Trustee alleges, and the Operating Agreements show, that Conex’s single member is Holdings, and in turn, Holdings’ single member is CopperCom. As discussed supra, for federal income tax purposes, the Defendant was treated as directly holding Conex’s assets and liabilities, including NOLs and the tax benefits derived therefrom, because of Conex’s status as a disregarded entity. The terms of the Operating Agreement control and federal income tax law provides the Defendant with the right to use Conex’s NOLs and the related federal income tax benefits to offset the CopperCom groups taxable income.

To the extent the Trustee relies on the existence of the (alleged) implied-in-fact TAA for this claim, the Trustee has failed to allege sufficient facts plausibly establishing the agreement. A valid contract exists when “(1) the parties intended that the contract would bind them, (2) the terms of the contract are sufficiently definite, and (3) the parties exchange legal consideration.” [72] An implied-in-fact contract “is one inferred from the conduct of the parties, though not expressed in words. The parties’ intent and mutual assent to an implied-in-fact contract is proved through conduct rather than words.” [73]

The only allegations to support the existence of the TAA are that Conex carried on its books and records an open and due receivable arising from the Defendant’s use of the tax benefits derived from Conex’s 2009-2011 NOLs, and that the Defendant made an entry in its general ledger offsetting the receivables due to Conex. The Trustee failed to plead facts plausibly show the parties’ intent and mutual assent to bind them to contract. [74] The Court will dismiss Count II of the complaint without prejudice. The Trustee may amend the Complaint to allege additional facts consistent with this Opinion.

E. Count III: Unjust Enrichment

Unjust enrichment is “`the unjust retention of a benefit to the loss of another, or the retention of money or property of another against the fundamental principles of justice or equity and good conscience.'” [75] The elements of unjust enrichment are: (1) an enrichment, (2) an impoverishment, (3) a relation between the enrichment and impoverishment, (4) the absence of a justification, and (5) the absence of a remedy provided by law. [76]

The Defendant argues that Count III should be dismissed because the Trustee has failed to plausibly allege facts establishing a claim for unjust enrichment, specifically that the Defendant’s retention and use of Conex’s 2009, 2010, and 2011 NOLs resulted in an impoverishment to Conex. In support, the Defendant asserts that the Trustee has failed to allege that Conex had prior income or expected future income and would have been able to use the NOLs to enhance the estate.

The Trustee alleges that Conex’s 2009, 2010, and 2011 NOLs are property of the estate, and the Defendant was unjustly enriched by demanding and procuring the benefit of Conex’s tax losses. As a result, the Defendant and other profitable members of the consolidated tax group received a substantial benefit at Conex’s expense. The Trustee urges the Court to deny the Motion to Dismiss because, at this stage in the pleading, the Trustee “is entitled to the benefit of discovery to prove” his claims. [77]

Relevant provisions of the I.R.C. require the CopperCom Group’s profitable members carry each year’s NOLs back the statutorily mandated number of years. [78] If the NOLs were exhausted after the carryback, there was nothing left to carry over. [79] The I.R.C. allows the carryover of NOLs against future taxable income to the extent the NOLs are not extinguished when carrying them back against prior taxable income. The CopperCom Group would have lost the NOLs had it not used them because the I.R.S. would have deemed the NOLs to have been carried back. [80] Further, nothing in the I.R.C. or Treasury Regulations requires members of a consolidated group to compensate the group, the parent, or any other member for the incurrence of income or loss that may generate either a tax liability or benefit for the group. [81]

Taking all of the allegations in the Complaint as true, the Trustee has failed to allege sufficient facts to support a claim for unjust enrichment. The complaint does not allege that Conex had prior or current taxable income that could have been offset by carrying back the NOLs. The complaint does not allege that Conex realized taxable income at any time prior to the bankruptcy, and therefore could have carried the NOLs back or forward to reduce that taxable income. The Trustee does not allege that Conex has any prospect for future income. Conex is in a chapter 7 liquidation and no longer operates. The Trustee has failed to allege that the Defendant’s use and retention of Conex’s NOLs resulted in an impoverishment to Conex. The Court will dismiss Count III without prejudice. The Trustee may amend the Complaint to allege additional facts consistent with this Opinion.

F. Counts IV and V: Avoidance of Transfers Pursuant to 11 U.S.C. Section 549 and Recovery and Preservation of the Transfers Pursuant to 11 U.S.C. Section 550

Pursuant to Section 549, a chapter 7 trustee may avoid: (1) a transfer, (2) of property of the bankruptcy estate, (3) that occurs after the commencement of the bankruptcy case, and (4) that was not authorized by any provision of the Bankruptcy Code or by order of the bankruptcy court. [82] Section 550 provides that “to the extent that a transfer is avoided under section . . . 549 . . . of this title, the trustee may recover . . . the property transferred . . . from the initial transferee of such transfer or the entity for whose benefit such transfer was made.” [83]

Count IV asserts a claim for avoidance to the extent the Debtors transferred any of their 2010 or 2011 tax losses to the Defendant for utilization in the consolidated federal income tax filings for 2010 and 2011. Count V asserts a claim for recovery and preservation of the transfers asserted in Count IV.

The Defendant argues that Count IV, and thus Count V, should be dismissed because there was no transfer within the meaning of the Bankruptcy Code. In support, the Defendant contends that the 2010 and 2011 NOLs were never Conex’s property because it was a disregarded entity for federal income tax purposes. And as a disregarded entity, there was never a transfer of the NOLs from Conex to the Defendant within the meaning of the Bankruptcy Code because the Defendant was treated as holding directly the NOLs.

The Trustee argues that Section 549 does not require the debtor to affirmatively act in order to constitute a transfer of property. [84] The Trustee argues that the 2010 and 2011 NOLs are property of Conex’s estate.

The Defendant filed consolidated federal tax returns for the CopperCom Group in accordance with the I.R.C. In doing so, the Defendant was required to apply the CopperCom Group’s consolidated NOLs, and the Defendant as the parent of the CopperCom Group, was responsible for filing the consolidated federal income tax return and paying any federal income tax due on behalf of all group members regardless of whether the Defendant and Conex entered into a TAA. [85]

The CopperCom Group’s consolidated tax return reflects the income and losses of the CopperCom Group as a single entity, even though the individual members, including Conex, had to first calculate its taxable income in the same manner as if it were filing its own federal tax return. [86] The Defendant, as the parent of the CopperCom Group, did not have discretion as to whether to take NOLs from its group members, rather the manner in which NOLs were consolidated and applied is mandated by the I.R.C. and corresponding regulations. [87]

Assuming, arguendo, that the parties entered into the TAA, the Debtors would necessarily calculate hypothetical stand-alone NOLs in order to file a consolidated tax return. [88] These hypothetical stand-alone NOLs are not “property of the debtor because they [are] a legal fiction.” [89] Here, the receivables listed on Conex’s books and records appear to be calculations to determine Conex’s individual NOLs so that the Defendant could determine the CopperCom Group’s consolidated NOLs for the consolidated federal income tax return. No actual transfer as contemplated by the Bankruptcy Code occurred when the Defendant applied Conex’s NOLs to the calculation of income tax due from the CopperCom Group because those NOLs were held directly by the Defendant for purposes of federal income tax law. [90] And, as explained, supra, the Trustee fails to allege that the NOLs had value to Conex. Therefore, the policy behind avoidance actions is not implicated. [91] The Court will dismiss Count IV without prejudice. Likewise, the Court will dismiss Count V without prejudice. The Trustee may amend the Complaint to allege additional facts consistent with this Opinion.

G. Leave to Replead

The Trustee requests that the Court allow leave to file an amended complaint in the event that the Court concludes that more factual detail is needed or the claims are insufficient in some manner. [92]

Federal Rule of Civil Procedure 15(a), as made applicable to adversary actions pursuant to Federal Rule of Bankruptcy Procedure 7015, provides that “leave [to amend] shall be freely given when justice so requires.” The Court grants the Trustee leave to replead with respect to Counts II, III, IV, and V—those dismissed without prejudice.

CONCLUSION

For the foregoing reasons, the Motion to Dismiss Count I will be granted with prejudice and the Motion to Dismiss Counts II, III, IV, and V will be granted without prejudice. The Court grants the Trustee leave to amend the Complaint within twenty-eight (28) days of the issuance of this Opinion. An order will be issued.

[1] “The court is not required to state findings or conclusions when ruling on a motion under Rule 12 . . . .” Fed R. Bankr. P. 7052(a)(3). Accordingly, the Court herein makes no findings of fact and conclusions of law pursuant to Rule 7052 of the Federal Rules of Bankruptcy Procedure.

[2] Adv. Pro. No. 13-50939, D.I. 1 (“Complaint”). Unless otherwise noted, all references to the docket are for Adv. Pro. No. 13-50939.

[3] Del. Bankr. No. 11-10501, D.I. 1.

[4] Del. Bankr. No. 11-10501, D.I. 21.

[5] Del. Bankr. No. 11-10501, D.I. 25.

[6] Del. Bankr. No. 11-10501, D.I. 46.

[7] Complaint at ¶¶ 1, 46-68.

[8] D.I. 15 (“Motion to Dismiss”).

[9] D.I. 21 (“Opposition”), p. 19.

[10] D.I. 25 (“Reply”).

[11] Complaint at ¶ 10.

[12] Id. at ¶ 7.

[13] Id.

[14] Id. at ¶ 8.

[15] Id.

[16] Id. at ¶ 9.

[17] Id.

[18] Id. at ¶ 27.

[19] Id.

[20] Id.

[21] Id. at ¶ 30.

[22] Id. The Trustee multiplies Conex’s $7.797 million pre-tax book loss by the effective tax rate of 34% to determine the estimated tax benefit amount. Id. at ¶ 32 n.3.

[23] The 2008 Audit Report provides in relevant part:

The Company [Holdings, Conex and ABC] files a consolidated federal income tax return with the Parent [CopperCom]. The benefit for federal income taxes recorded in the consolidated financial statements represents the allocated benefit to be derived from the Parent without regard to the lower marginal tax rates which may be retained by the Parent.

The Company is a member of a group of companies that file a consolidated income tax return. As a member of that group, the tax benefit has been allocated to the Company as if the Company were a separate tax payer. As a result of the allocation of the tax benefit, the Company has recorded a receivable from the Parent [CopperCom], which is recorded in other long-term liabilities on the accompanying consolidated balance sheet.

Id. at ¶¶ 34-35.

[24] Id.

[25] Id.

[26] Rule 7012(b) of the Federal Rules of Bankruptcy Procedure incorporates Rule 12(b)(6) of the Federal Rules of Civil Procedure in adversary proceedings.

[27] Kost v. Kozakiewicz, 1 F.3d 176, 183 (3d Cir. 1993) (“The pleader is required to set forth sufficient information to outline the elements of his claim or to permit inferences to be drawn that these elements exist.” (citations omitted)).

[28] 550 U.S. 544 (2007).

[29] 556 U.S. 662 (2009).

[30] Fowler v. UPMC Shadyside, 578 F.3d 203, 210 (3d Cir. 2009) .

[31] See Fowler, 578 F.3d at 210 .

[32] Iqbal, 556 U.S. at 678 . See also Sands v. McCormick, 502 F.3d 263, 268 (3d Cir. 2007) (“[A] court need not credit a plaintiff’s `bald assertions’ or `legal conclusions’ when deciding a motion to dismiss.” (quotations omitted)); Bartow v. Cambridge Springs SCI, 285 Fed. Appx. 862, 863 (3d Cir. 2008) (“While facts must be accepted as alleged, this does not automatically extend to bald assertions, subjective characterizations, or legal conclusions.” (quotations omitted)).

[33] Fowler, 578 F.3d at 210 (internal quotations omitted).

[34] Iqbal, 556 U.S. at 678 .

[35] Id. at 679.

[36] Id. (citations and internal quotations omitted).

[37] Fowler, 578 F.3d at 210-11 ; Iqbal, 556 U.S. at 679 (“When there are well-pleaded factual allegations, a court should assume their veracity and then determine whether they plausibly give rise to an entitlement to relief.”); Carino v. Stefan, 376 F.3d 156, 159 (3d Cir. 2004) . The Court may also consider documents attached as exhibits to the complaint, any documents incorporated into the complaint by reference, and matters of the public record. In re Fruehauf Trail Corp., 250 B.R. 168, 183 (Bankr. D. Del. 2000) (citing PBGC v. White, 998 F.2d 1192, 1196 (3d Cir. 1993) ); see also Sands, 502 F.3d at 268 . Yet “if the allegations of [the] complaint are contradicted by documents made a part thereof, the document controls and the Court need not accept as true the allegations of the complaint.” Sierra Invs., LLC v. SHC, Inc. (In re SHC, Inc.), 329 B.R. 438, 442 (Bankr. D. Del. 2005) (quoting ESI, Inc. v. Coastal Power Prod. Co., 13 F. Supp. 2d 495, 497 (S.D.N.Y. 1998) ).

[38] Fowler, 578 F.3d at 211 (internal quotations omitted).

[39] In re Ins. Brokerage Antitrust Litig., 618 F.3d 300, 361 (3d Cir. 2010) .

[40] In re Marvel Ent. Grp., Inc., 273 B.R. 58, 64 (3d Cir. 2002) (internal citations omitted).

[41] 26 U.S.C. § 172.

[42] 11 U.S.C. § 542(a).

[43] In re Hechinger Investment Co. of Delaware, Inc., 282 B.R. 149, 162 (Bankr. D. Del. 2002) .

[44] Giuliano v. Fairfield Health Care Centers Limited P’ship (In re Lexington Healthcare Grp., Inc.), 363 B.R. 713, 716 (Bankr. D. Del. 2007).

[45] Complaint at ¶ 26.

[46] 11 U.S.C. § 541(a)(1).

[47] In re IndyMac Bancorp, Inc., 2:08-BK-21752-BB, 2012 WL 1037481, *12 (Bankr. C.D. Cal. Mar. 29, 2012).

[48] Id. (citing United States v. Whiting Pools, Inc., 462 U.S. 198, 204 (1983) and In re Central Ark. Broad. Co., 68 F.3d 213, 214 (8th Cir. 1995) ).

[49] Id.

[50] Matter of Yonikus, 996 F.2d 866, 869 (7th Cir. 1993) (citations omitted).

[51] Kandi v. U.S., 2006 WL 83463, *2 (W.D. Wash. Jan. 11, 2006) (citing 26 C.F.R. § 301.7701-3(a)). For federal income tax purposes, an eligible entity, such as a single member LLC, can elect to be classified as an association, and thus a corporation under 26 C.F.R. § 301.7701-2(b)(2), or a partnership, or disregarded as an entity separate from its owner. 26 C.F.R. § 3307.7701-3(a).

[52] 26 C.F.R. § 301.7701-3(b)(1)(ii); see Kandi, 2006 WL 83463 at *2 .

[53] 26 C.F.R. § 301.7701-2(c)(2)(i). A business entity that has a single owner and is not a corporation, such as a single member LLC, is disregarded as an entity separate from its owner. Id. “Under federal tax law, a single-member LLC that does not make an election is a disregarded entity—a tax nothing.” Markell Co., Inc. v. C.I.R., 107 T.C.M. 1447 n.12 (2014) (citing 26 C.F.R. § 301.7701-3(b)(1)(ii)). 26 C.F.R. § 301.7701-2(a).

[54] Markell Co., Inc. v. C.I.R., 107 T.C.M. 1447 n.12 (2014) (citing 26 C.F.R. § 301.7701-3(b)(1)(ii)). “A significant amount of case law has emerged in determining ownership of tax refunds between parents and their subsidiaries arising from consolidated tax returns filed on behalf of the group.” In re Vineyard Nat. Bancorp, 2013 WL 1867987, *7 (Bankr.C.D.Cal. May 3, 2013). Several courts have held that NOLs are property of a debtor’s estate in the context of a tax allocation agreement, see, e.g., In re Prudential Lines Inc., 928 F.2d 565 (2d Cir. 1991), however those cases are distinguishable because they involved tax-paying C-corporations, not single member LLCs that have not elected to be taxed as corporations.

[55] Hechinger, 282 B.R. at 161-62 (quoting In re Asousa P’ship., 264 B.R. 376, 384 (Bankr. E.D. Pa. 2001) ).

[56] In re Majestic Star Casino, LLC, 716 F.3d 736, 759 (3d Cir. 2013) (quoting ( Official Comm. Of Unsecured Creditors of Forman Enters., Inc. v. Forman (In re Forman Enters., Inc.), 281 B.R. 600, 612 (Bankr. W.D. Pa. 2002) (“Any tax benefits resulting from the NOL and the right to use it inure solely to the benefit of . . . shareholders and would not be available to satisfy claims of the corporation’s creditors.”). The debtor in Majestic Star Casino was an S-corporation. Federal income tax law provides that an S-corporation, like a SMLLC, is a disregarded entity and is not taxed on its income. See 26 U.S.C. § 1363(a).

[57] Majestic Star Casino, 716 F.3d at 759 .

[58] The Trustee clarifies Count I in his Opposition: “The Trustee also does not dispute that Defendant, as the sole member of Holding LLC, the parent of Conex, had control over the utilization of Conex’s NOLs. But, those facts are not relevant in this dispute.” Opposition, pp. 19-20. Rather, the Trustee argues that the Defendant and Conex from entered into the TAA as evidenced by the parties’ course of performance recordation of the Receivable. Id. These allegations are made in the Opposition, not in the Complaint, and do not make the claim any more plausible. In substance, the Trustee argues that the Defendant’s breach of the TAA by not delivering the Receivable to Conex creates an undisputed right to the Receivable. On these grounds, the Trustee has also failed to allege a claim upon which relief can be granted because the Trustee “cannot use the turnover provisions to liquidate contract disputes or otherwise demand assets whose title is in dispute.” U.S. v. Inslaw, Inc., 932 F.2d 1467, 1472 (D.C. Cir. 1991) ; see also In re Charter Co., 913 F.2d 1575, 1579 (11th Cir. 1990) ; In re Satelco, Inc., 58 B.R. 781, 786 (Bankr. N.D. Tex. 1986) ; In re Chick Smith Ford, Inc., 46 B.R. 515, 518 (Bankr. M.D. Fla. 1985) ; In re FLR Co., 58 B.R. 632 (Bankr. W.D. Pa. 1985) .

[59] Dunlap v. State Farm Fire & Cas. Co., 878 A.2d 434, 442 (Del. 2005) (citations and internal quotations omitted). See also AQSR India Private, Ltd. v. Bureau Veritas Holdings, Inc., C.A. No. 4021-VCS, 2009 WL 1707910, at *11 (Del. Ch. June 16, 2009) .

[60] AQSR India Private, Ltd. v. Bureau Veritas Holdings, Inc., C.A. No. 4021-VCS, 2009 WL 1707910, at *11 (Del. Ch. June 16, 2009) .

[61] Kelly v. Blum, 2010 WL 629850, at *13 (Del. Ch. Feb. 24, 2010) .

[62] AQSR India Private, Ltd. v. Bureau Veritas Holdings, Inc., C.A. No. 4021-VCS, 2009 WL 1707910, at *11 (Del. Ch. June 16, 2009) (citations omitted). See 17A Am.Jur.2d Contracts § 712 (“[A]llegations of malicious, knowing, wanton and willful behavior do not give rise to a separate tort action where no wrongful conduct, except the breach of contract, is asserted.”).

[63] Airborne Health, Inc. v. Squid Soap, LP, 984 A.2d 126, 146 (Del. Ch. 2009) .

[64] Dunlap v. State Farm Fire and Cas. Co., 878 A.2d 434, 441 (Del. 2005) .

[65] The Defendant contends that “[u]nder the Operating Agreement, Delaware law applies to claims against CopperCom.” Motion to Dismiss at p. 13 n.8. The Trustee applies Delaware law. Opposition at p. 27 n.10. Section 16.2 of Conex’s Operating Agreement provides that Texas law governs, whereas Section 14.2 of Holdings’s Operating Agreement provides that Delaware law governs. Motion to Dismiss, Exhs. A-B. Conex is a Texas corporation, Holdings is a Delaware corporation, and CopperCom is a Delaware corporations.

[66] In re Mervyn’s Holdings, LLC, 426 B.R. 488, 496 (Bankr. D. Del. 2010) ; see also In re Burlington Coat Factory Securities Lit., 114 F.3d 1410, 1426 (3d Cir. 1997) (noting that an exception to the general rule that a court may not consider matters extraneous to the pleadings is that a “document integral to or explicitly relied upon in the complaint” may be considered “without converting the motion [to dismiss] into one for summary judgment”) (quoting Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1220 (3d Cir. 1996) . The Trustee is presumably on notice of the Operating Agreements by virtue of being the trustee of the Debtors’ estates. See Burlington Coat, 114 F.3d at 1426 (“[T]he rationale underlying this exception is that the primary problem raised by looking to documents outside the complaint—lack of notice to the plaintiff—is dissipated.”).

[67] Indeed, the Trustee alleges:

Both Conex and Holdings are single member limited liability companies (“LLCs”) with Conex wholly owned by Holdings, and Holdings wholly owned by CopperCom. As single member LLCs, Both Conex and Holdings were treated as “disregarded entities” for federal income tax purposes. Under these circumstances, CopperCom, as owner of the disregarded entities, was treated as holding directly each entity’s assets and liabilities.

Complaint at ¶¶ 25-27.

[68] Id.

[69] Motion to Dismiss, Exhs. A-B.

[70] Dunlap v. State Farm Fire and Cas. Co., 878 A.2d 434, 442 (Del. 2005) (citing Wilgus v. Salt Pond Inv. Co., 498 A.2d 151, 159 (Del. Ch. 1985) (construing Restatement § 205)).

[71] Dunlap, 878 A.2d at 441 . “Existing contract terms control, however, such that implied good faith cannot be used to circumvent the parties’ bargain, or to create a `free-floating duty . . . unattached to the underlying legal document.'” Id. (quoting Glenfed Financial Corp., Commercial Finance Div. v. Penick Corp., 647 A.2d 852, 858 (N.J. 1994) .

[72] Osborn v. Kemp, 991 A.2d 1153, 1158 (Del. 2010) .

[73] Capital Management Co. v. Brown, 813 A.2d 1094, 1098 (Del. 2002) (internal citations omitted). The Supreme Court has defined an implied-in-fact contract as one “founded upon a meeting of the minds, which, although not embodied in an express contract, is inferred, as a fact, from conduct of the parties showing, in the light of the surrounding circumstances, their tacit understanding.” Baltimore & Ohio R.R. Co. v. United States, 261 U.S. 592, 597 (1923) .

[74] The Trustee made certain allegations with respect to the parties’ intent in his Opposition; however these allegations were not made in the Complaint, and the Court will not consider them. The Opposition includes exhibits annexed thereto totaling almost 600 pages including tax returns, accounting guidelines, and the declaration of Bernard W. Costich. Pursuant to this Court’s Order dated May 16, 2011 [Del. Bankr. No. 11-10501, D.I. 99], the Trustee retained Crowe Horwath LLP (“Crowe”) as his accountants. Mr. Costich is the partner-in-charge at Crowe’s New York City Office’s Bankruptcy and Insolvency Practice. Adv. Pro. No. 13-50939, D.I. 22, Declaration of Bernard W. Costich (the “Costich Declaration”), ¶¶2-3. The Costich Declaration describes and asserts that Heico directed the Defendant to reimburse Conex for utilization the tax benefits derived from Conex’s NOLs. Id. at ¶¶ 7-23. However, the Court will not consider allegations in the Opposition that are not made in the Complaint. “It is axiomatic that the complaint may not be amended by the briefs in opposition to a motion to dismiss.” Frederico v. Home Depot, 507 F.3d 188, 202 (3d Cir. 2007) .

[75] MCG Capital Corp. v. Maginn, 2010 WL 1782271, at *24 (Del. Ch. May 5, 2010) (quoting Schock v. Nash, 732 A.2d 217, 232 (Del. 1999) ).

[76] Jackson Nat. Life Ins. Co. v. Kennedy, 741 A.2d 377, 393 (Del. Ch. 1999) .

[77] Opposition at p. 31. The Trustee relies on In re Forman Enters., Inc., 273 B.R. 408 (Bankr. W.D. Pa. 2002), to support the unjust enrichment claim. The shareholder-defendants in Forman argued, as the Defendant does in this instance, that the net operating losses did not have value to the debtor because the debtor (an S-Corporation in Forman) did not pay taxes. Id. at 412. The Forman Court reasoned that “whether the NOL had any value for debtor misses the point . . . . The NOL might be viewed as providing a substantial benefit for defendants which debtor conferred on them as a result of their own course of conduct and which would be unconscionable for them to retain.” Id. (emphasis in original).

[78] 26 U.S.C. § 172.

[79] White Metal Rolling, 222 B.R. at 426.

[80] Marvel, 273 B.R. 58 (citing 26 C.F.R. §§ 1.1502-2; 1.1502-11; 1.1502-12; 1.1502-21A).

[81] Id. at 65. Nonetheless, it is not uncommon for members of a consolidated group to provide for the allocation of these liabilities and benefits among themselves by entering into tax sharing agreements. Id.

The NOL had value only to the extent that the subsidiary could use it to offset future income or bargain with other members of the affiliated group for its use. Since the subsidiary was undergoing liquidation, the NOL had no carryover value because the subsidiary had no prospect of future income. Further, the subsidiary had no bargaining leverage because it had consented to the filing of the consolidated return and the governing regulations, and the use of the NOLs was presumably consistent with those rules.

Id. at 425 (citing Jump v. Manchester Life & Cas. Management Corp., 579 F.2d 449, 453-54 (8th Cir. 1978) .

[82] 11 U.S.C. § 549.

[83] 11 U.S.C. § 550.

[84] Opposition at pp. 30-31; see Forman, 273 B.R. at 416 (“Nowhere is there any indication in the Bankruptcy Code that action, as opposed to inaction, by a debtor is required for there to be a transfer.”).

[85] In re Marvel Ent. Grp., Inc., 273 B.R. 58, 84 (D. Del. 2002) (citing 26 C.F.R. §§ 1.1502-6). “No agreement entered into by one or more members of the group with any other member of such group or with any other person shall in any case have the effect of reducing the liability prescribed under this section.” 26 C.F.R. §§ 1.1502-6.

[86] 26 C.F.R. §§ 1.1502-11; 1.1502-12.

[87] Marvel, 273 B.R. at 84 ; see also White Metal Rolling, 222 B.R. at 424 (“the parent has no discretion; the consolidated NOL is applied to prior years in the statutorily mandated order, and then carried forward only if that prior years’ consolidated income does not fully absorb it.”)

[88] Marvel, 273 B.R. at 85 .

[89] Id.

[90] Id.; see also United Dominion Indus. v. U.S., 532 U.S. 822 (2003) (concept of separate NOLs for individual members of a consolidated tax group does not exist).

[91] White Metal Rolling, 222 B.R. at 427 (“[I]f the debtor transfers property that would not have been available for distribution to his creditors in a bankruptcy proceeding, the policy behind the avoidance power is not implicated.”) (citing Begier v. Internal Revenue Serv., 496 U.S. 53, 58 (1990) ). “This is consistent with the longstanding rule that a creditor cannot recover transferred property if the property could not have been used to satisfy the creditor’s claim.” Id.; see, e.g., Bryce v. National City Bank, 93 F.2d 300, 302 (2d Cir. 1937) .

[92] Opposition at p.7.

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New Bankruptcy Opinion: IN THE MATTER OF ARCAPITA BANK BSC (C) – Bankr. Court, SD New York, 2014

In the Matter of: ARCAPITA BANK B.S.C.(C), et al, Debtors.

Case Nos. 12-11076-Shl.

United States Bankruptcy Court, S.D. New York.

September 30, 2014.

BY: EVAN R. FLECK, ESQ., NICHOLAS C. KAMPHAUS, ESQ., MILBANK, TWEED, HADLEY & McCLOY LLP, New York, NY, Attorneys for the Reorganized Debtors.

BY: TALLY M. WIENER, ESQ., LAW OFFICES OF TALLY M. WIENER, New York, NY, Attorney for Captain Hani Alsohaibi.

SEAN H. LANE, Bankruptcy Judge.

Before the Court is an application that is styled objection of Captain Hani Alsohaibi to the proposed diversion of funds by and for the benefit of First Islamic Investment Bank B.S.C./Arcapita Bank B.S.C. affiliates and successors and reservation of rights. It goes on to request a hearing concerning the “administrative insolvency” of The First Islamic Investment Bank B.S.C./Arcapita Bank B.S.C. affiliates and successors. It’s found at Docket No. 1979.

I also have before me an opposition by the reorganized debtors to that application, as well as a reply that was filed on the docket.

The objection complains of the alleged proposed diversion of funds. It says that Arcapita seeks relief from payment obligations owing under a Murabaha agreement among Arcapita Investment Holding Limited, Goldman Sachs International, and other entities. It goes on to say that Arcapita seeks a waiver from Goldman to divert $5 million that it would otherwise be obligated to pay to service its loan. It goes on to complain that Arcapita is administratively insolvent. And all of these statements need to be understood in the context of the current posture of this case and so some background is in order.

The debtors’ assets here primarily consisted of investments in operating companies and other portfolio assets, including interests in joint ventures. Approximately 70 percent of the debtors’ investments related to operating companies or other portfolio assets in which the debtors held directly or indirectly only minority equity interests. The balance of the debtors’ investments related to operating companies and other portfolio assets in which the debtors held directly or indirectly 50 percent or more of the interests.

The plan of reorganization in this case that was put before the Court and ultimately confirmed proposed to establish a New Cayman Islands holding company, New Arcapita Topco, to own and control a series of newly formed intermediate holdings companies and subsidiaries, the new holding companies.

The plan provided that the new holding companies would own directly or indirectly 100 percent of the debtors’ assets, and in exchange for their allowed claims the majority of the debtors’ unsecured creditors would receive a pro rata share of the new Sharia-compliant Sukuk facility, substantially all of the equity of the new holding companies and certain warrants issued by New Arcapita Topco.

The reorganized Arcapita Group, with the assistance of AIM Group Ltd., would wind down its operations. Reorganized Arcapita Group would make distributions from the exits of investments which would occur in a manner and at a time that maximized returns and would be consistent with the terms of the cooperation agreement, as that term is used in the plan.

The business plan provided for the retention of AIM, which was a newly formed investment management company, to manage the investment assets on a day-to-day basis.

These are only the top level details of the plan which are set forth in far more detail in the confirmation order and the plan, but are provided here only to give some general sense of what happened in the case.

The plan was confirmed and a confirmation order entered on June 17, 2013, the effective date of that plan was September 17, 2013.

Given all of these facts, the Court is going to deny the application before it for relief.

Although the application is styled as an objection to a proposed course of action by the reorganized debtors, in fact there’s no current request that has been made by the reorganized debtors to this Court to do anything. In fact, the Arcapita case has been confirmed, so this objection is talking about obligations of a reorganized debtor that is not in bankruptcy court. In fact, the reorganized debtors explain that the injunctive relief requested by the objector here is to prevent RA Holdco 2 LLC and its co-obligors under a court-approved exit financing from obtaining a waiver of certain terms.

The reorganized debtors state, and I agree, that this is an agreement between private parties, neither of whom is in bankruptcy, and so the action here does not require court approval.

There’s some reference by the objector here that the terms of the exit financing documents must be honored. So, for example, the objector cites to paragraph 10(b)(iii)(B) of the final order approving the exit financing that says certain modifications require court approval such as those that “increase the commitments or the rate of profit or fees payable thereunder,” and that’s discussed at the reply at page 11. But there’s been no showing that the waiver of the condition at issue here in any way triggers that requirement or any other obligation under the exit financing.

In fact what appears to be at issue is a request to waive a prepayment, that is an ability to not have to honor one particular condition, but which in fact would change nothing else in the obligation. So what it essentially does is channel funds to the reorganized debtors to use as they see fit, which the reorganized debtors note is something that is being done in the business judgment of the reorganized debtor and does not require court approval.

There’s been some discussion in the papers about the financial health of the reorganized debtors. I don’t need to resolve this issue to rule on the application that is in front of me, but I do think it is important to note that the reorganized debtors strongly disagree with the views of Captain Hani Alsohaibi on that subject. On this topic, they note three things.

One is that the reorganized debtors sought and obtained 100 percent consent of the applicable lenders for the waiver of certain aspects of the prepayment provision of the exit facility; second, they note that it increased, from their point of view, liquidity for the reorganized debtors between asset sales; and third, that from their point of view they’re doing better than projections set forth in the disclosure statement.

There’s also a request here to take down, so to speak, a particular website, www.arcapita.com, and to mandate that the case administration website should be kept up to date.

As the reorganized debtors note, the website for Arcapita was transferred to the AIM Group Ltd. as part of the plan and there has been nothing identified to this Court that’s in the confirmation order or the plan that has been violated regarding the use of the website or any other aspect relating to the website, including the maintenance of the case administration website. Nothing has been identified to me as violating the terms of any court order or matter approved by the Court. So, that deals with the issues going forward.

To the extent that the application seeks to revisit any terms of the confirmation order I’m going to deny that request. A bankruptcy court’s order of confirmation is treated as a final judgment with res judicata effect. See In re Indesco International, Inc., 354 B.R. 660, 664 (Bankr. S.D.N.Y. 2006) . “Any attempt by the parties or those in privity with them to relitigate any of the matters that were raised or could have been raised therein is barred under the doctrine of res judicata.” Sure-Snap Corporation v. State Street Bank & Trust Co., 948 F.2d 869, 873 (2d Cir. 1991) .

Courts have considered confirmation of a plan in a Chapter 11 proceeding to be an event comparable to the entry of a final judgment in ordinary civil litigation. See Silverman v. Tracar, S.A., 255 F.3d 87, 92 (2d Cir. 2001) .

So for all those reasons given the record in front of me on the application as well as the record of the case, and that is the plan confirmation and the terms of that plan, I’m going to reject the application.

With all that said I’d ask that the reorganized debtors submit a proposed order addressing the pending application and just make it clear that it’s being denied for the reasons stated on the record at the hearing.

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New Bankruptcy Opinion: IN RE TIN CROSS VINEYARDS, LLC – Bankr. Court, ND California, 2014

In re TIN CROSS VINEYARDS, LLC, Debtor(s).

No. 14-11160.

United States Bankruptcy Court, N.D. California.

October 24, 2014.

Memorandum re Form of Order

ALAN JAROSLOVSKY, Bankruptcy Judge.

The court’s approval of the order entered in this administratively consolidated case on October 22, 2014, Docket Number 81, was made due to the court’s mistake and neglect. The order was signed in violation of B.L.R. 6004-1(d), which requires the court to identify with specificity each and every lien and interest to be sold free and clear of. Likewise, B.L.R. 6006-1(a) requires specificity as to rejected executory contracts.

To the extent it is ever proper to issue an order precluding unknown future plaintiffs from asserting successor liability, it is not appropriate in this case and was not intended by the court.

The court apologizes to any party inconvenienced by the court’s lack of diligence in reviewing the October 22 order before signing it.

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New Bankruptcy Opinion: IN RE PMC MARKETING CORP. – Bankr. Court, D. Puerto Rico, 2014

IN RE: PMC MARKETING CORP, Chapter 7, Debtor(s),

NOREEN WISCOVITCH RENTAS CHAPTER 7 TRUSTEE, Plaintiff,

v.

MUNICIPIO DE PONCE, Defendant(s).

Case No. 09-02048, Adversary No. 12-00137.

United States Bankruptcy Court, D. Puerto Rico.

October 23, 2014.

OPINION AND ORDER

BRIAN K. TESTER, Bankruptcy Judge.

Before this Court is Plaintiff’s Amended Motion for Summary Judgment filed on July 16, 2014 [Dkt. No. 23]. This Motion was unopposed by the Defendant despite receiving notice. [1] For the reasons set forth below, the Plaintiff’s Motion for Summary Judgment is GRANTED.

Summary judgment is appropriate where “the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.” Fed. R. Civ. P. 56(a). “A dispute is genuine if the evidence about the fact is such that a reasonable jury could resolve the point in the favor of the non-moving party. A fact is material if it has the potential of determining the outcome of the litigation.” Patco Constr. Co. v. People’s United Bank, 684 F.3d 197, 206-07 (1st Cir. 2012) .

Federal Rule of Civil Procedure 56 does not embrace default judgment principles. [2] Even when a motion for summary judgment is unopposed, the court is not relieved of its duty to decide whether the movant is entitled to judgment as a matter of law. Likewise, the court must still assess whether the moving party has fulfilled its burden of demonstrating that there is no genuine issue of material fact. In an unopposed motion for summary judgment, the court is still obliged to consider the motion on its merits, in light of the record as constituted, in order to determine whether judgment would be legally appropriate. Aguiar-Carrasquillo v. Agosto-Alicea, 445 F.3d 19 (1st Cir.2006) . Entry of a summary judgment motion as unopposed does not automatically give rise to a grant of summary judgment. Instead, “the district court [is] still obliged to consider the motion on its merits, in light of the record as constituted, in order to determine whether judgment would be legally appropriate.” Mullen v. St. Paul Fire and Marine Ins. Co., 972 F.2d 446, 452 (1st Cir.1992) . “Even when faced with an unopposed motion for summary judgment, a court still has the obligation to test the undisputed facts in the crucible of the applicable law in order to ascertain whether judgment is warranted.” Mendez v. Banco Popular de Puerto Rico, 900 F.2d 4, 7 (1st Cir.1990) ; Fed.R.Civ.P. 56(e)); Pico Vidal v. Ruiz Alvarado, 377 B.R. 788 (D.P.R., 2007) .

It is well-settled that “before granting an unopposed summary judgment motion, the court must inquire whether the moving party has met its burden to demonstrate undisputed facts entitling it to summary judgment as a matter of law.” Lopez v. Corporacion Azucarera de Puerto Rico, 938 F.2d 1510, 1517 (1st Cir.1991) . Accordingly, we emphasize that courts “in considering a motion for summary judgment, must review the motion, even if unopposed, and determine from what it has before it whether the moving party is entitled to summary judgment as a matter of law.” Custer v. Pan Am. Life Ins. Co., 12 F.3d 410, 416 (4th Cir.1993) .

After reviewing the Plaintiff’s arguments, and the relevant law, this Court determines that there is no triable issue as to any material facts and that the moving party is entitled to judgment as a matter of law. The court concludes after a review of the documents provided by Plaintiff that she has met her burden in terms of producing adequate affirmative evidence. There is no controversy in the case — the payment was to a creditor, on account of an antecedent debt, during the preference period, while the Debtor was insolvent and the payments would allow the creditor to receive more than under a Chapter 7. Therefore, pursuant to 11 U.S.C. § 547, Defendant, Municipio de Ponce, received preferential transfers in the amount of $9,389.51. Clerk to enter Judgment.

SO ORDERED

[1] The court refers Defendant to PR LBR 5005-4(g).

[2] Federal Rule of Civil Procedure 55 is the basic procedure to be followed when there is a default in the course of litigation. It tracks the ancient common law axiom that a default is an admission of all well-pleaded allegations against the defaulting party. See generally B. Finberg, Annotation, Necessity of Taking Proof as to Liability Against Defaulting Defendant, 8 A.L.R.3d 1070 (1966). Other default provisions embrace that same philosophy. See, e.g., Fed.R.Civ.P. 4(a) (failure to appear and defend in response to a summons “will result in a judgment by default against the defendant for the relief demanded in the complaint”); cf. Fed.R.Civ.P. 16(f) (failure to attend pretrial conference); Fed.R.Civ.P. 37(b)(2)(C) (failure to obey discovery orders). Motions for summary judgment, however, lack these ancient common law roots. See generally John A. Bauman, The Evolution of the Summary Judgment Procedure: An Essay Commemorating the Centennial Anniversary of Keating’s Act, 31 Ind. L.J. 329 (1956). They are governed by Rule 56 under which the failure to respond to the motion does not alone discharge the burdens imposed on a moving party. Vermont Teddy Bear Company, Inc. v. 1-800 Beargram Company, 373 F.3d 241 (2nd Cir.2004) .

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New Bankruptcy Opinion: IN RE MILLER AUTOMOTIVE GROUP, INC. – Bankr. Court, WD Missouri, 2014

IN RE: MILLER AUTOMOTIVE GROUP, INC. f/k/a MILLER CHRYSLER DODGE JEEP, Debtor.

Case No. 13-20027-DRD-11.

United States Bankruptcy Court, W.D. Missouri, Central Division.

October 24, 2014.

MEMORANDUM OPINION

DENNIS R. DOW, Bankruptcy Judge.

Two matters are before this Court: 1) the Final Application of Attorneys for Debtor for Fee Allowance and Reimbursement of Costs (the “Fee Application”) filed by William L. Needler and Associates, Ltd. (individually, “Needler”), and 2) the Motion for the Examination and Disgorgement of Fees Paid to William L. Needler and for the Imposition of Sanctions (the “Motion”) filed by the United States Trustee (the “Trustee”). This is a core proceeding under 28 U.S.C. §157(b)(2)(A) over which the Court has jurisdiction pursuant to 28 U.S.C. §§1334(b), 157(a) and (b)(1). For the reasons set forth below, the Court denies Needler’s request for the allowance of fees and reimbursement of costs, and grants the Trustee’s Motion.

I. FACTUAL AND PROCEDURAL BACKGROUND

Miller Automotive Group, Inc. (the “Debtor”) held the franchise from Chrysler Corporation (“Chrysler”) granting it the right to sell and service Chrysler, Dodge, Ram and Jeep vehicles as a factory dealer. The dealership was run by David Miller as general manager, and his wife, Gloria Miller, as office manager. On January 11, 2013, the Debtor filed its voluntary petition under Chapter 11. Days later, the Debtor filed an application to employ Needler as its attorney. Needler reported in his Disclosure of Compensation (“Rule 2016 Disclosure”) that he had been paid a pre-petition retainer of $8,000 (the “Retainer”). Over the Trustee’s objection, the Court authorized Needler’s employment with the caveat that his fees would be carefully scrutinized.

As part of the first day motions, Needler sought the Court’s approval to employ Chad Gutschow (“Gutschow”), a broker who had worked with the Debtor pre-petition to sell the dealership’s assets. The Trustee objected to the employment, citing “significant connections” between Gutschow and Needler that were undisclosed. Needler subsequently withdrew the application to employ Gutschow.

The Debtor filed a Chapter 11 Plan (the “Plan”) shortly after the petition date, but the Court was unable to consider it because it lacked a disclosure statement. The Debtor also filed a motion to use cash collateral (the “Cash Collateral Motion”); the Court denied it without prejudice primarily on the grounds that the financial information on which the Cash Collateral Motion was based was unreliable. Immediately after the decision was handed down, Needler filed an Emergency Motion to Withdraw the Reference to the United States District Court. That motion was denied.

In February, 2013, the two largest creditors of the Debtor filed motions for relief from the automatic stay: Ally Financial Inc. (“Ally) to foreclose its security interest against the Debtor’s vehicles and other collateral, and Chrysler Group LLC (“Chrysler”) to terminate certain sales and service agreements. Both motions were set for hearing, but in the interim, the Debtor filed its motion to dismiss the case. Ally’s motion was subsequently granted and Chrysler’s was granted in part.

An Order granting the dismissal motion was entered in April, 2013, and the case was closed. The Trustee sought to reopen the case to seek a determination of the reasonableness of the Debtor’s attorney’s fees, and the motion to reopen was granted. Needler’s fee application along with this Motion followed. [1]

II. EVALUATION OF COMPENSATION AND DISGORGEMENT

A. Reasonableness of Fees

The Bankruptcy Code provides a framework for evaluating the appropriateness of professional fees. Section §329(b) authorizes the court to examine the reasonableness of a debtor’s attorney’s fees and, if such compensation exceeds the reasonable value of the services rendered, the court may order the return of any payment made, to the extent excessive. This statute allows the court sua sponte to regulate attorneys who seem to have charged debtors excessive fees, and is aimed at preventing overreaching by a debtor’s attorney. In re Zepecki, 258 B.R. 719, 725 (8th Cir. BAP 2001). The decision to reduce fees under §329 is within the sound discretion of the bankruptcy court. In re Sullivan’s Jewelry, Inc., 226 B.R. 624, 627 (8th Cir. 1998), citing In re Coones Ranch, 7 F.3d 740, 744 (8th Cir. 1993) .

Section 330(a) provides that in determining the amount of reasonable compensation, the court shall consider the nature, the extent, and the value of such services, taking into account all relevant factors, including whether the professional has demonstrated skill and experience in the bankruptcy field. It provides further that the court shall not allow compensation for services that were not “reasonably likely to benefit the debtor’s estate. . . .” 11 U.S.C. §330(a)(4)(A)(ii)(I). The attorney seeking compensation bears the burden of proving entitlement to all fees and expenses requested. In re Kula, 213 B.R. 729, 736 (8th Cir. BAP 1997). This burden is not to be taken lightly given that every dollar expended on legal fees results in a dollar less that is available for distribution to the creditors. In re Ulrich, 2014 WL 4385691 (Bankr. E.D. Mich. Sept. 5, 2014)(citations omitted).

A bankruptcy court does not determine the reasonableness of an attorney’s requested compensation through hindsight. The Bankruptcy Code requires only that the services in question had the reasonable likelihood of benefiting the estate at the time they were provided, not that they actually did provide a benefit. In re Blue Stone Real Estate, 487 B.R. 573, 577 (Bankr. M.D. Fla. 2013) . The court must make this determination in an objective manner, making sufficient factual findings, on the record, on which to base its decision. In re Ahead Communications Systems, Inc., 395 B.R. 512, 517 (D. Conn. 2008) .

The fact that the Chapter 11 plan was ultimately not confirmed does not, by itself, bar recovery of compensation for services performed in the reorganization case. In re American Metallurgical Products Co., Inc., 228 B.R. 146, 159 (Bankr. W.D. Pa. 1998) . The court in In re Jefsaba, Inc., 172 B.R. 786, 799 (Bankr. W.D. Pa. 1994), explained the standard this way:

[W]e do not conclude that only successful actions may be compensated under §330. To the contrary, so long as there was a reasonable chance of success which outweighed the cost in pursuing the action, the fees relating thereto are compensable. Moreover, professionals must often perform significant work in making the determination whether a particular course of action could be successful. Such services are also compensable so long as, at the outset, it was not clear that success was remote.

See also In re Kohl, 95 F. 3d 713, 714 (8th Cir. 1996) (fees may be denied when counsel should have realized that reorganization was not feasible); In re Crown Oil, Inc., 257 B.R. 531, 542 (Bankr. D. Mont. 2000 (counsel worsened creditors’ position by attempting to reorganize debtor when reorganization was clearly not feasible) ; In re Central Florida Metal Fabrication, Inc., 207 B.R. 742, 751 (Bankr. N.D.Fla. 1997) (“If attorneys are not guarantors of the results in bankruptcy cases, they may not remain ostrich like and ignore the reality of a case crumbling about them.”)(citations omitted).

There is ample precedent for denying all compensation to an attorney for failure to provide value to the estate. In In re Spicklemier, 469 B.R. 903 (Bankr. D. Nev. 2012), for example, the court ordered pursuant to §329 that the debtor’s attorney disgorge all monies paid by the debtor because “the work counsel performed for the Debtors in this case reflects a lack of competence and diligence that does not deserve to be compensated.” Id. at 914. The attorney initially filed a case for which the debtors were ineligible. The case was ultimately dismissed. The attorney then filed a motion for reconsideration, but failed to appear at the hearing. He also filed pleadings without citing any legal authority, and appeared at hearings unprepared. The court found that the reasonable value of his services was zero. See also In re Sullivan’s Jewelry, Inc., 226 B.R. 624 (8th Cir. BAP 1998)(legal fees reduced to zero because debtor’s attorney rendered services that benefitted debtor’s insiders instead of the estate).

The Trustee takes the position that the services provided by Needler were of no benefit to the estate and, therefore, Needler should be denied all fees requested and be ordered to disgorge all fees received. The Court agrees. The record indicates that Needler not only failed to provide a benefit, but took actions that were detrimental to the Debtor and the estate.

From the very beginning, Needler caused the Debtor to incur unnecessary legal fees. Needler filed the initial petition naming Miller Chrysler Dodge, Inc. as Debtor. No such corporate entity exists. The Trustee brought this error to Needler’s attention, but he took no action to correct it. The Trustee was forced to file a motion to dismiss the case for ineligibility, and Needler ultimately filed an Amended Petition to reflect the corrected corporate name.

As the Trustee points out, Needler was unable to obtain a final order authorizing the Debtor’s use of cash collateral. According to Mrs. Miller, Needler never advised her what the Debtor needed to prove in order to use cash collateral, nor did he review the projections she prepared to determine if they were feasible or accurate. In denying the Debtor’s Cash Collateral Motion, the Court all but handed Needler a list of the documentation necessary to meet the Debtor’s burden of proof, namely, accurate and reliable sales and expense projections. Needler ignored the Court’s directive, and instead, filed a motion to withdraw the reference to the District Court. It was swiftly denied.

Needler argues that withdrawal of the reference was appropriate because issues had been raised implicating the Dealer Day in Court Act, [2] that resolution of these issues would require the Court to give consideration to both Title 11 and laws regulating activities affecting interstate commerce and that withdrawal of the reference would be mandatory under these circumstances under 28 U.S.C. § 157(d). The Act provides that a dealer may sue to recover damages due to the failure of the manufacturer to act in good faith in terminating the dealer’s franchise. The record does not support Needler’s argument. Chrysler did not terminate or fail to renew the Debtor’s franchise, so the Act does not apply. Secondly, no such claims were raised in any pleading then pending before the Court. Third, even had they been, withdrawal of reference would have been mandatory only as to such claims or proceedings, not the entire case or even the cash collateral motion. Finally, Needler assumes that even if such claims had been raised, they would have required the kind of material and substantial consideration of the Dealer Day in Court Act which would have made withdrawal of the reference mandatory, and this has not been demonstrated.

Needler also disputes the Trustee’s charge that the withdrawal motion was purely “forum shopping.” His denial belies the facts. In an email dated February 17, 2013, Needler relayed the following to the Debtors: “We got very rough treatment on February 12, 2013 from Judge Dow. He denied all further Use of Cash Collateral. We decided, since he was so against us, that all we can do is to go to the U.S. District Court. We have filed a Motion to Withdraw the Reference and have gone directly to the U.S. District Court. . . . Hopefully we will have more luck here.” Mr. Robert Ball, the Debtor’s local counsel, testified that he told Needler that he did not think filing the motion to withdraw the reference was a good idea “because the Court didn’t deny your application entirely, he denied it without prejudice to its refiling, so there’s no need to go anywhere else.” Tr. p. 174, line 25, p. 175, lines 1, 2. [3] Even the District Court recognized Needler’s action as an exercise in futility: “In large measure, Debtor seeks withdrawal as part of an effort to persuade a different judge to do what the Bankruptcy Court has already declined to do — a classic case of forum shopping. . . . It is also worth noting that Debtor cites no authority suggesting withdrawal of the reference is justified in these circumstances. . . .” Order Denying Emergency Motion to Withdraw Reference, Case No. 13-4041-CV-C-ODS, United States District Court for the Western District of Missouri, March 11, 2013. Filing the motion was simply a tactic employed by Needler to delay the bankruptcy proceeding and charge additional fees.

Needler was unable to propose a viable reorganization Plan and have it considered by the Court because the one he filed was not accompanied by the required disclosure statement. Again, the Trustee and the Court made Needler aware of this deficiency, but he took no action to remedy it. He was also unable to secure a floor plan financing arrangement for the Debtor so it could continue its operations, the initial goal of the bankruptcy filing. There is no evidence that Needler made any efforts to accomplish that on behalf of the Debtor. In terms of the alternate goal, to sell the dealership, Needler failed in that regard as well. He never filed another motion to employ a broker after he withdrew the one to employ Gutschow. Although the Debtors eventually did sell the dealership, the sale occurred over six months after the case was closed and Needler had nothing to do with it whatsoever.

The case was ultimately dismissed at the insistence of the Millers. Needler asserts that the case was dismissed because the Debtor’s projections proved to be unreliable, and the Debtor had “some unknown pending transactions” which required the dismissal. The Court finds Needler’s reasons disingenuous in light of the evidence. Mrs. Miller testified that Needler’s lack of professionalism and results drove the decision: “Our rationale was because he [Needler] failed to obtain the objective to which he said that he was going to do. We felt we couldn’t trust him. We saw how he operated and he was very unorganized. Just in my opinion, he was incompetent, completely incompetent. . . . We had no faith in that he even knew what he was doing.” Tr. p. 135, line 25, pp. 136, 1-11.

Even if this Court were to determine the appropriate compensation for Needler based on the specific entries on his fee application, a substantial portion of his fees would not be approved. Specifically, Needler would most certainly be denied fees and expenses attributed to his preparation of the motion to withdraw the reference, and his attempted collection of attorney’s fees in state court. In addition, fees associated with actions he took after the case was dismissed would be stricken. In the unlikely event that, after deducting those amounts, the Court determined that Needler was entitled to any compensation, it would be limited to $17,000. As noted below, Needler failed to enter into a written fee agreement with the Debtor, and that was the amount he verbally represented would be sufficient for his retention. The very fact that Needler requested fees that are clearly not compensable is an indication of his bad faith.

While the evidence establishes the absence of an actual benefit to the Debtor’s estate resulting from Needler’s services, the critical question is whether those services were reasonably likely to benefit the estate. That is, did Needler recognize, or should Needler have recognized from the outset or even when the case was pending that little or no hope of a Chapter 11 reorganization existed? The answer is a resounding “yes.”

Needler admitted that he was well aware of the Debtor’s operational struggles and low inventory, as well as its inability to obtain new financing to satisfy the substantial debt owed to Ally. Gutschow stated in his Declaration in support of the Debtor’s motion to employ him (before it was withdrawn) that he had pursued the financing option since mid-December 2012 and did not believe that he could obtain a new floor line for the Debtor given the current economic conditions. Needler was also aware that Gutschow’s employment as a broker would be problematic, telling Mr. Miller that his connection with Gutschow “might not look good.” In addition, he knew that pursuing a withdrawal of the reference with respect to securing the use of cash collateral was risky.

The record reflects that a minimum amount of effort and investigation and awareness on Needler’s part would have confirmed that reorganization was not a viable option for the Debtor. After considering the evidence presented at the hearing on the Cash Collateral Motion, the Court spelled it out for Needler:

[F]irst of all, with respect to the sale of the dealership itself . . . the debtor has been trying to sell this for 11 months. There is no sale pending. There is no broker employed. . . . And there are substantial questions about the projections of income and expenses. . . . [I]n 30 days, approximately, the debtor has sold one vehicle, perhaps two vehicles. This debtor is just not a viable entity. . . . The debtor has no mechanism for financing new cars. . . . [A]mounts were being paid without authorization to use Ally’s cash collateral to pay pre-petition debts, which the Court had not authorized. And I’m troubled by that. . . . [T]here’s no motion pending before me at present to either dismiss or convert the case . . . So the Court does nothing more than [deny the Motion to Use Cash Collateral as presented].

Several months and many thousands of dollars later, Needler was still “working the Chapter 11 case” despite the Court’s assessment that the Debtor was not a viable entity.

Mr. Needler argued at the hearing on this Motion that his fees were justified because the bankruptcy filing succeeded in protecting the Debtor’s assets. There was no evidence, however, that Chrysler intended to cancel the franchise or that the franchise was otherwise in imminent danger. Furthermore, applying Needler’s logic would lead to absurd results. If filing a bankruptcy petition, thereby triggering the automatic stay, was all it took to justify the payment of attorney’s fees, then even an attorney who filed a petition in bad faith would be entitled to compensation.

In short, the Court finds that Needler not only failed to provide any actual value to the Debtor’s estate, but that his services were not reasonably likely to do so. It is apparent that his only success was stringing along a case that should never have been filed in the first place. For these reasons, this Court denies Needler’s request for compensation.

B. Non-Disclosure

The Trustee asserts that Needler’s fee request should be denied because his Rule 2016 Disclosure and application for employment were willfully misleading in that they suggested that the Retainer was paid by the Debtor. In fact, it was paid by the Millers’ daughter, an equity holder of the Debtor. Needler contends that “there was no secret” as to the source of his Retainer because he disclosed it in answer to Question No. 9 in the Debtor’s Statement of Affairs (“SOFA”). The Trustee also argues that Needler was obligated to disclose that Gutschow was a client of his in a pending bankruptcy case, and that their relationship presented a conflict of interest. Needler countered that he did, in fact, disclose the nature of their relationship, and that it posed no conflict of interest. The Court finds Needler’s disclosures problematic in several respects.

Section 329 requires the attorney to “file with the court a statement of the compensation paid or agreed to be paid, . . . and the source of such compensation.” Likewise, Rule 2016(a) requires the attorney to file an application that includes “a statement as to what payments have theretofore been made or promised. . ., [and] the source of the compensation so paid or promised.”

The disclosure requirements of §329 are mandatory, not permissive. In re Cook, 223 B.R. 782, 790 (10th Cir. BAP 1998)(citations omitted). The purpose of the disclosure is to allow any party in interest to make an independent judgment about the effect on the estate of any given payment. In re Rio Valley Motors Company, LLC, 2007 WL 2492685, *2 (Bankr. D.N.M. 2007). When a professional fails to file a sufficiently detailed disclosure, even if the failure is merely negligent or inadvertent, the court and parties in interest are not provided the information they need to judge whether the Code’s standards are being met. In re Smitty’s Truck Stop, Inc., 210 B.R. 844, 849 (10th Cir. BAP 1997).

Regarding the source of the Retainer, the Court rejects Needler’s position that the response in the SOFA was sufficient to comply with Bankruptcy Rules 2014 and 2016. In the first place, the “disclosure” was made in the wrong document. The SOFA is not Needler’s disclosure, but rather the Debtor’s, a snapshot of the Debtor’s financial position. Needler should have disclosed the source of the payment he received in his own Disclosure of Compensation. That is precisely its purpose. Moreover, the SOFA was filed two weeks after Needler filed his Rule 2016 Disclosure and therefore, the Court considered Needler’s employment application without complete and accurate information. As the court stated in Smitty’s Truck Stop, Inc., 210 B.R. at 849, “It is not the Court’s job to search through the record to find all relevant facts relating to an attorney’s employment. It is counsel’s [or applicant's] duty to provide the court with the information necessary to determine whether to appoint counsel.”

Secondly, Needler’s Disclosure simply states that he was “paid the total sum of $8,000.00 which included the filing fee of $1,213.00 and a Pro Hac Vice Fee of $100.00 along with a retainer of $6,687.00. The balance of $13,313 which is unpaid remains due on the retainer of $20,000.00.” The source of the payment is conspicuously absent. The SOFA simply states that the payment was “[f]rom a 3rd Party Not a Creditor.” It is apparent from the record and from other bankruptcy cases in which Needler served as Debtor’s counsel that advising clients to have a third party pay the retainer was his modus operandi. In an e-mail to Mrs. Miller, Needler wrote: “Please expedite wire transfer to BB&T of $17,000 advanced for retainer and costs as soon as possible. This money should be from 3rd parties, NOT CREDITORS OF THE BUSINESS.” Needler is all too familiar with this wording and the ramifications of substituting it for the true source. He used virtually identical language in at least one other case of which this Court is aware, and was admonished by the court then: “This is not sufficient. A `person not a Creditor’ is too vague a description to allow a party in interest to make at least an initial determination about the identity of the payor or the relationship of the payor to the debtor, the estate or the professional.” Rio Valley Motors Company, 2007 WL 2492685, at *2. As a result, Needler’s employment was not approved.

Finally, the importance of naming the source of the Retainer is underscored by the fact that the Miller’s daughter is part owner of the Debtor. Her equity interest in the Debtor makes her an interested party. Since it is conceivable that she could have asserted a claim against the Debtor, a potential conflict of interest exists.

Turning to Needler’s connection to Gutschow, the Court acknowledges that Needler disclosed their relationship, but once again, finds the location and substance of that disclosure troubling. Needler states in his Sworn Declaration in support of the Debtor’s Application to Employ Attorney that “he confirmed a Chapter 11 in Nebraska . . . on 2/15/2011 for one Chad Gutschow, who was then employed by TGAG L.L.C. and who the Applicant will be proposing as an individual Consultant to sell the Franchise and assets under this Debtor’s Plan. . . .” He neglected to add that the case was still pending. There is no mention of it in the motion prepared by Needler to approve Gutschow as the Debtor’s exclusive broker, nor in Gutschow’s Declaration in support of that motion. In fact, Gutshow affirmatively states that he has “no `adverse interest’ which would prevent his employment and that he and CLG Automotive are entirely `disinterested persons’ as these terms from the Bankruptcy Code have been explained to this Declarant. . . .” In the interest of full disclosure, Needler should have described their connection in the Debtor’s motion to approve Gutshow and instructed Gutschow to do the same in his Declaration. [4]

A bankruptcy court is well within its discretion to deny an attorney all fees and expenses, including prepetition fees, for failing to meet the disclosure requirements set forth in §329 of the Code and Bankruptcy Rules 2014 and 2016, and there is an abundance of cases to demonstrate that. In In re Park-Helena Corp., 63 F. 3d 877 (9th Cir. 1995), for example, the disclosures filed by the debtor’s attorneys stated that they received a retainer “paid by the Debtor” when in reality the payment came from the personal checking account of the debtor’s president. That fact was only revealed after the debtor’s major creditor objected to the attorneys’ fee request. Moreover, the attorneys failed to disclose that the president was a party in interest because he held an equity interest in the debtor and his payment was credited against his indebtedness to the debtor. The bankruptcy court found that the attorneys had violated the disclosure rules on two counts — by failing to disclose the source of the retainer, and that the president paid it out of his personal account. The court denied their request for fees and the district court affirmed. On appeal, the attorneys argued that the distinction between the president and the debtor was one of form over substance. The Ninth Circuit rejected that argument and affirmed the order of the bankruptcy court. See also Jacques H. Geisenberger, Jr., P.C. v. DeAngelis, 2011 WL 4458779 (M.D. Pa. Sept. 23, 2011)(affirming bankruptcy court’s decision ordering full disgorgement of prepetition fees for violation of disclosure requirements); In re Chatkhan, 496 B.R. 687 (Bankr. E.D.N.Y. 2012) (law firm’s failure to disclose prepetition retainer or the date it was drawn down in payment warranted denial of all compensation); In re Bartmann, 320 B.R. 725 (Bankr. N.D. Okla. 2004) (attorney’s disregard for disclosure requirements and lack of candor justified order requiring him to disgorge undisclosed compensation).

Needler challenges the Court’s authority to order him to disgorge a retainer paid by a third party. It is well-settled, however, that a bankruptcy court may order the disgorgement to the estate of attorney’s fees paid by a third party when is established that the payments constituted distributions that would have otherwise accrued to the debtor’s estate. In re W.T. Mayfield Sons Trucking Co., Inc., 225 B.R. 818, 827 (Bankr. N.D.Ga. 1998) . The general rule is that, notwithstanding an ultimate third party owner of the funds, a retainer is held in trust for the debtor’s estate to the extent it is utilized to compensate the estate’s attorney. The prevailing view was articulated by the court in In re Stevenson, 2011 WL 2413172, *5 (Bankr. D. Ariz. June 9, 2011):

[N]otwithstanding an ultimate third party owner of the funds, the retainer is held in trust for Debtor’s estate to the extent it is utilized to compensate the estate’s attorney. The estate, therefore, has an equitable interest in the trust funds. Property of the estate includes any legal or equitable interests of the debtor in property as of the commencement of the case.

For all of the reasons set forth above, the Court concludes that Needler failed to satisfy the disclosure requirements of the Bankruptcy Code and Bankruptcy Rules. This constitutes additional grounds for denying his requested fees and ordering him to disgorge the Retainer.

III. IMPOSITION OF SANCTIONS

Section 105 gives bankruptcy courts broad power to implement the provision of the Bankruptcy Code and to prevent an abuse of the bankruptcy process, which includes the power to sanction counsel. See In re Clink (Gargula v. Bisges), 2013 WL 1741945, *5 (Bankr. W.D. Mo. April 23, 2013), citing In re Triepke, 2012 WL 12299524 (Bankr. W.D. Mo. April 12, 2012). Bankruptcy courts also possess inherent authority to regulate the practice of attorneys who appear before them and to sanction abusive litigation practices. Law v. Siegel, 2014 WL 813702, *5 (Mar. 4, 2014)(citations omitted); In re Nguyen, 447 B.R. 268, 280 (9th Cir. BAP 2011)(en banc)(citations omitted). “This power is broad enough in scope, and includes the power to impose monetary sanctions, as well as to `control admission to its bar and to discipline attorneys who appear before it.” In re Burnett, 450 B.R. 116, 132 (Bankr. E.D.Ark. 2011) (citations omitted). See also In re Steward, Case No. 11-46399-705 (Bankr. E.D.Mo. 2011), Memorandum Opinion and Order, June 10, 2014 (attorneys who filed a petition knowing it contained false representations and who used non-attorney staff to provide legal advice were suspended from practicing before the U.S. Bankruptcy Court for a one-year period).

Bankruptcy Rule 9011 gives bankruptcy courts additional authority to impose an appropriate sanction for attorney misconduct. The sanction must be limited to what is sufficient to deter repetition of conduct in violation of the Rule, or comparable conduct by others similarly situated. Fed. R. Bankr. P. 9011(c)(2). See, e.g., In re Spickelmier, 469 B.R. 903 (Bankr. D. Nev. 2012) (to deter the filing of frivolous and redundant pleadings in the future, and protect unsuspecting clients, court ordered attorney to disgorge all fees and complete CLE courses).

The record in this case is replete with examples of Needler’s violations of not only the Bankruptcy Code, Bankruptcy Rules, and Local Rules, but basic tenets of legal representation as well. Needler routinely failed to inform his client about pleadings he filed and responses thereto. At the hearing on the Motion, the Millers testified to that effect. For example, Needler never advised them that he had filed an application to employ Gutschow or that the Trustee had filed an objection to it. Needler attempted to counter that by establishing that his office had, in fact, e-mailed or faxed pleadings to the Debtor. Needler misses the point. Service of a pleading after it has been filed is not tantamount to discussing the pleading beforehand, soliciting a client’s input, and obtaining authorization to file it.

It is evident that Needler failed to perform a reasonable investigation into the facts contained in Debtor’s petition since it named a non-existent debtor. Because his signature constituted a certification that he had no knowledge after an inquiry that the information was incorrect, Needler violated his duty under §707(b)(4). He also filed other documents and pleadings that are indicative of his lack of diligence: the Plan was filed without a disclosure statement, the financial information supporting the use of cash collateral was unreliable, and the motion to withdraw of the reference was unsubstantiated.

Needler engaged in forum-shopping. As noted previously, he told the Debtor’s representatives that he filed the motion to withdraw the reference because it was “all we can do,” even though this Court denied the Cash Collateral Motion without prejudice to refile it. The District Court concluded that Needler had no legal basis to withdraw the reference.

Needler failed to enter into a written fee arrangement with the Debtor, and misled the Millers as to the amount that they were expected to pay. At the hearing on the Motion, Mrs. Miller testified as follows:

Q: And what was your understanding, based on your conversations with Mr. Needler concerning the compensation that was to be paid to him?

A: That he needed $8,000 up front and the full retainer was 17 total.

Q: Did you understand or have any discussions with Mr. Needler about him billing on an hourly basis?

A: No.

Q: To the best of your knowledge, did you or anyone at Miller Automotive sign a fee or an engagement letter with Mr. Needler concerning his fees?

A: No.

Tr. p. 106, lines 6-17.

Needler instructed his client to pay the Retainer from funds provided by a third party, and then failed to disclose the true identity of the payor, a co-owner of the Debtor. He acted deliberately in total disregard of a prior court’s admonition that designating the payor as a “Third Party” was insufficient. Furthermore, Mrs. Miller testified that the payor (the Millers’ daughter) obtained the funds for the Retainer from the Debtor and, more importantly, that Needler was aware of that. Tr. p. 124, lines 11-25.

Needler failed to disclose the conflict of interest that existed because of his attorney/client relationship with Gutschow. Because the bankruptcy case in which Needler represented a company affiliated with Gutschow was still pending when Needler sought to employ him as the Debtor’s broker, it was incumbent upon Needler to make an accurate and proper disclosure.

Needler failed to comply with the Local Rules regarding electronic filing. Specifically, he failed to secure the original signature of the Debtor’s representative on documents filed in the case as required by W.D. Mo. Bankr. Ct. ECF Administrative Procedures, Section II.D. The record reflects that Needler opted instead to procure the signatures by facsimile, and that most often, he sent only the signature page to the Millers rather than the entire document. According to the Trustee, Needler has never been able to produce the original of his application for employment, yet another violation of this Local Rule.

Needler failed to communicate effectively with the Debtor, both in terms of adequately explaining the bankruptcy process and the attendant risks, and in terms of professional behavior. Mrs. Miller testified that the first time she and her husband met Needler in person was at the initial hearing on cash collateral. She also recounted that Needler had not explained the mechanics of the use of cash collateral or the concept of adequate protection. In addition, after the Cash Collateral Motion was denied, he never discussed with her the potential of filing an amended motion with different projections. Rather, he “felt there was a way to go around it and go to a higher court. . . .” Tr. p. 118, lines 24, 25.

Needler’s interactions with the Debtor’s representatives were deplorable. In Mr. Miller’s words: “And he would call the dealership and just yell at everyone if we weren’t there to take the call immediately. . . . [W]e were bullied the whole time. Finally, it got to where my wife wouldn’t even talk to him because he just yelled and screamed. And then finally he yelled and screamed at me and I just finally said this is enough.” Tr. p. 55, lines 13-18. Mrs. Miller echoed that: “He would scream. He was a bully. . . . [H]onestly, I was scared to death every time the phone would ring.” Tr. p. 136, lines 7-13.

If this were an isolated case, the infractions cited above would be more than sufficient to justify the imposition of sanctions. This is not an isolated case, however. A search of published opinions involving Needler as pro hac vice counsel to Chapter 11 debtors revealed a pattern of professional misconduct, procedural non-compliance, and ethical violations. The following is merely a sampling. It is noteworthy that these cases span a wide chronological and geographical range.

In re TCI Limited, 769 F. 2d 441 (7th Cir. 1985) — Needler’s firm filed unjustified and unsubstantiated pleadings, even after the court offered the firm an opportunity to supplement the record. The district court awarded costs and fees of litigation to the defendants and against Needler. The Seventh Circuit affirmed.

In re Grimes, 115 B.R 639 (Bankr. D.S.D. 1990) — Needler’s fees were found to be excessive. “The [c]ourt’s blind approval of this inflated amount and expenses would be tantamount in condoning pillage and plunder of the debtors’ estate.” Needler was ordered to disgorge approximately one-third of his retainer. Note that the retainer was paid by the debtors’ relative with funds provided by the debtors.

In re Grantham Brothers, 922 F.2d 1438 (9th Cir. 1991) — The bankruptcy court imposed sanctions against Needler for Bankruptcy Rule 9011 violations and the district court affirmed. The Ninth Circuit affirmed based on an improper and frivolous filing that was intended to delay the bankruptcy proceeding and increase the cost of litigation.

In re Enrose Farms, Inc., 1999 WL 33486711 (Bankr. D. Idaho March 9, 1999) — The bankruptcy court imposed sanctions against Needler for failing to adequately investigate facts prior to commencing suit, to substantiate his claims, and to communicate with opposing counsel. Needler was found “guilty of unprofessional conduct in failing to do even a minimum of inquiry into the merits of their claims. . . .” He also “admitted no wrong, and attempted to blame others for the outcome of the case,” and used stalling tactics. Needler and his local co-counsel were sanctioned the total amount of $20,000.

In re Big Mac Marine, Inc., 326 B.R. 150 (8th Cir. BAP 2005) — Needler was disqualified by the bankruptcy court from serving as debtor’s attorney because of an actual conflict of interest and denied fees incurred prior to the disqualification order. The Eighth Circuit affirmed.

In re Rio Valley Motors Company, LLC, 2007 WL 2492685 (Bankr. D.N.M. Aug. 29, 2007) — Needler identified the payor of his retainer as “Third Party” and “a person not a Creditor.” The court ruled that the disclosure was insufficient, and denied Needler’s employment.

In re Incredible Auto Sales LLC, 2007 WL 3226835 (Bankr. D. Mont. Oct. 30, 2007) — Needler failed to timely file an application to employ a professional, used unreliable valuations to secure the use of cash collateral, filed “a wholly inadequate disclosure statement” and “disgraceful pleadings,” and “never took the time to perform even the most basic professional obligations.” Needler’s “disregard for the [c]ourt’s Local Rules and procedure was evidenced throughout this case. . . .” Needler admitted that he knew, at the inception of this case, that it would end up in Chapter 7. The court ordered the disgorgement of a portion of his fees and denied the interim fee requested.

In re TGAG LLC, Case No. 12-82354-TLS, U.S. Bankruptcy Court for the District of Nebraska — The trustee and the debtor objected to Needler’s interim fee application on the grounds that the fees requested were unreasonable and excessive. The bankruptcy court reduced the fee amount to half of the amount Needler requested. [5]

Only six months ago, Needler appeared before another Bankruptcy Judge in this District. In In re Metten Management Innovation, LLC, Case No. 13-50244, Needler failed to disclose the source of his retainer, filed documents and pleadings containing errors and inconsistencies, failed to comply with Local Rules regarding required verifications, used questionable practices to obtain his client’s signature on pleadings, filed a plan that was “patently unconfirmable” and a disclosure statement that was deficient, was unavailable for several hearings, willfully failed to amend certain pleadings despite agreeing to do so in open court, displayed a “cavalier” attitude, and filed cases that “should never have been filed.” Judge Cynthia Norton denied his application for employment nunc pro tunc, denied his application for compensation, and ordered Needler to disgorge the sum of $7,574 to the trustee.

As detailed throughout this Opinion, good cause has been shown to suspend Needler from the privilege of practicing law. He has shown little respect for this Court or his clients. He has flagrantly disregarded his duties as an officer of the Court and has intentionally violated the requirements imposed by the Bankruptcy Code and Rules. Rulings from numerous courts over the years have not served to deter Needler’s behavior. Accordingly, the Court orders that Needler be suspended from practicing before the United States Bankruptcy Court for the Western District of Missouri, effective immediately.

IV. CONCLUSION

The record in this case demonstrates that Needler did not meet his burden of proving that the compensation he requested was reasonable. To the contrary, the evidence showed that his services provided no value to the Debtor’s estate and that Needler knew, or should have known, that they were not reasonably likely to do so. To borrow the words of another court, “Were there ever a time to use `fail’ as the contemporary vernacular permits, it is now, and in reference to this deplorable display of legal representation: it was an epic fail.” [6] For those reasons, the Court denies Needler’s request for compensation set forth in his Fee Application.

In addition, the Court grants the Trustee’s Motion for the disgorgement of fees and imposition of sanctions. Needler failed to properly disclose and identify the source of his Retainer as required by the Bankruptcy Code and Rules. As a result, the Court orders that Needler disgorge the amount of $6,687 (the Retainer less fees) to the Trustee.

Finally, based on the abundance of evidence before it, the Court imposes the sanction of suspension pursuant to §105 and Bankruptcy Rule 9011. The Court orders that, effective immediately, Needler is suspended indefinitely from the privilege to practice before the United States Bankruptcy Court for the Western District of Missouri. The purpose of this non-monetary sanction is to deter future misconduct on the part of Needler and others similarly situated.

[1] Mr. and Mrs. Miller also filed an objection to professional fees on the grounds that Needler “utterly failed to achieve any of the objectives for which the Debtor retained him,” communicated abysmally with them, and “continuously undermined the authority of the Court and the U.S. Trustee.”

[2] 15 U.S.C. §§1221, et seq.

[3] All citations to a Transcript refer to the Hearing on the Motion held on July 22, 2014.

[4] While the Court agrees with the Trustee that Needler’s “disclosure” of his connection to Gutschow was inadequate, the point is moot because Needler eventually withdrew his motion to employ Gutschow. The Trustee also spent a considerable time arguing at the hearing on the Motion that Gutschow’s continued efforts to sell the Debtor’s dealership after the withdrawal were improper. The Court disagrees. The Millers testified that their expectation was always that Gutschow would be paid a commission from the purchaser, not the estate. Further testimony confirmed that this payment arrangement was standard in the industry.

[5] This is the case in which Gutschow was involved.

[6] In re Spickelmier, 469 B.R. at 906 .

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New Bankruptcy Opinion: IN RE 412 BOARDWALK, INC. – Bankr. Court, MD Florida, 2014

In re 412 Boardwalk, Inc. and 422 Boardwalk, Inc., Chapter 11, Debtors.

Case No. 3:14-bk-01847-JAF, Jointly administered with Case No. 3:14-bk-01848-JAF.

United States Bankruptcy Court, M.D. Florida, Jacksonville Division.

October 24, 2014.

FINDINGS OF FACT AND CONCLUSIONS OF LAW

JERRY A. FUNK, Bankruptcy Judge.

This case is before the Court upon Creditor’s, ARS Investors I LP-2011-1 Jax, Motion for Relief from the Automatic Stay (Doc. 23) [1] , to which Debtors, 412 Boardwalk, Inc. and 422 Boardwalk, Inc., filed a Response. (Doc. 61). The Creditor also filed a Motion to Dismiss Debtors’ Jointly Administered Chapter 11 Cases (the “Motion to Dismiss”) (Doc. 55), to which Debtors filed a Response (Doc. 60). The Court held a hearing on the Motions on August 1, 2014, after which the parties filed their respective briefs (Docs. 63, 64). The Court, having heard the testimony and examined the evidence presented, having observed the candor and demeanor of the witnesses, and having considered the arguments of counsel, makes the following Findings of Fact and Conclusions of Law.

Findings of Fact

412 Boardwalk, Inc. (“412 Boardwalk”) is a for-profit Florida corporation that owns commercial property located at 412 1st Street North in Jacksonville Beach, Florida (the “412 Property”). The 412 Property consists of a 13,983 square foot site improved with a 8,997 square foot restaurant and bar, The Pier Cantina and Sandbar (the “Restaurant”). 422 Boardwalk, Inc. (“422 Boardwalk”), is also a for profit Florida corporation that owns two lots in Jacksonville Beach (the “422 Property”). [2] The 422 Property consists of a 28,695 square foot site minimally improved with a surface parking lot and is located at 422 1st Street North, Jacksonville Beach, Florida 32250; the 422 Property is immediately adjacent to 412 Property. In addition, both Properties are oceanfront properties.

The Properties are located in the Central Business District of Jacksonville Beach and are surrounded by commercial uses, bars, nightclubs and restaurants. Specifically, the property directly north is improved with a public surface parking lot for the pier. The property directly west is improved with a public surface parking lot and the Ritz Lounge. The property directly south is improved with a commercial building, which has changed tenancy over the years, but is generally occupied as a bar or nightclub. Thus, the Properties are well suited for commercial or mixed use because of their size, zoning, proximity to commercial uses and heavy pedestrian and vehicular traffic as well as adjacent land uses, and other physical and functional features.

The Properties were purchased for a future development as oceanfront properties. At the time the 412 Property was acquired, it consisted of a single, two story, commercial building; the building was leased to a tenant, a computer company, which unfortunately left after the economy faltered. Any efforts to sell or lease the building were unsuccessful and the building was vacant for over a year. In 2010, Debtors’ principal, Chris Hionides (the “Principal”), was approach by three entrepreneurs, Benjamin Porter, Richard Trendel and Luis Cuevas (the “Entrepreneurs”), with a business opportunity. The Entrepreneurs proposed to renovate the building to operate a restaurant. The Principal and the Entrepreneurs invested approximately $1 million, including the Principal’s personal investment of $350,000.00, to complete renovations. As part of the renovation effort, the parking lots located on the 422 Property were improved and the 422 Property now serves as a parking lot for the Restaurant’s customers.

In August of 2010, the Properties were leased to the current tenant, Peerless Brands, LLC (“Peerless”), the operator of the Restaurant for a period of ten years. [3] Pursuant to the lease agreement, Peerless pays $12,000.00 per month, to Debtors to rent the Properties. While negotiating the rental rate for the Properties, the Entrepreneurs and the Principal considered the investment of the parties to renovate the building and concluded that, under the circumstances, a rate of $12,000.00 per month constituted a fair rental rate. Upon completion of the renovations, Peerless took possession of the Properties. The Principal is a minority (25%) owner of Peerless, but he does not participate in its operations or its finances. The venture has apparently been successful and the Restaurant generates a profit. The Principal receives $12,000.00 per month in distributions for his share in Peerless.

The Properties are encumbered by two mortgages. Specifically, Debtors executed a Consolidated Payment Note (the “First Note”) in the principal amount of $2,610,401.00, which consolidated Debtors’ previous notes. The First Note is secured by a mortgage encumbering the Properties. The monthly payment on the First Note, prior to the Creditor’s notice of default, was $16,820.00 including 6% interest in the amount of $12,175.00. Debtors also executed the Corrective Mortgage Modification and Extension Agreement (the “Second Note”) in the principal amount of $493,887.00, which is secured by another mortgage encumbering the Properties. The monthly payment on the Second Note, prior to the Creditor’s notice of default, was $3,380.00 including 4.25% interest in the amount of $1,665.00.

Despite the Restaurant’s success, Debtors struggle financially. Pursuant to its 2012 income tax return, 412 Boardwalk reported $112,209.00 in gross rents while its expenses totaled $198,648.00 generating a loss in the amount of $86,439.00. The 2013 income tax return disclosed that 412 Boardwalk received income from gross rents in the amount of $149,430.00 while its expenses totaled $523,445.00 generating a $374,015.00 loss. Nevertheless, the Principal was able to make the payments on both Notes. In fact, the Principal made payments on the Notes even when Debtors generated no income in previous years. The Principal explained that he was able to make these payments because Debtors received “capital infusions” from his individual funds and from funds of his other “affiliated companies.” Unfortunately, as his financial flexibility has diminished, the Principal chose not to pay property taxes for the Properties. It is undisputed that Debtors’ failure to pay any sums they are required to pay constitutes an event of default upon which Creditor may accelerate the debt and foreclose the mortgages.

In 2011, the Notes were sold by a traditional lender to Creditor, a non-traditional lender, who purchases mortgages secured by, primarily, “distressed assets.” At some point in time, Creditor obtained other notes secured by mortgages on several other properties controlled by the Principal. During 2013, Creditor prompted the Principal about Debtors’ delinquent property taxes, and the parties started negotiating a resolution of the issue. The Principal was led to believe that Creditor would advance Debtors’ delinquent property taxes and Debtors would sign a short term note for the tax advancements. Creditor made a payment in the amount of approximately $365,000.00 to cover the outstanding property taxes for 2009 and 2010 for the Properties. The Principal paid delinquent property taxes for 2011. In July of 2013, Creditor, through a notice of default, demanded that Debtors reimburse it for the payment of the 2009 and 2010 property taxes plus accrued interest and attorney’s fees in a lump sum. The Principal testified that at that time Creditor also requested payment of property taxes on several properties securing other notes belonging to Creditor and gave him 10 days to comply with its request. The Principal requested a 30-day extension, but he was unsuccessful. Creditor also approached tenants who were renting several of the Principal’s properties, informed them that the Principal would lose his properties and requested that tenants make rental payments directly to Creditor. This action created panic among tenants. Upon the expiration of the ten-day period, Creditor accelerated the Notes’ balances. Specifically, Creditor imposed a default interest of 25% on the First Note and 18% on the Second Note. Creditor also initiated a foreclosure action against both Properties and the state court concluded that Debtors failed to show cause as to why a final judgment of foreclosure should not be entered. However, the final judgment of foreclosure has not been entered. The Principal entered into negotiations with Creditor to forbear from foreclosing on the Properties and other properties, which proved to be slow and unsuccessful.

In order to stop the accrual of the default rate of interest on both Notes and to preserve his property, the Principal filed bankruptcy petitions on behalf of Debtors on April 18, 2014. Pursuant to Schedule E, 412 Boardwalk has four unsecured creditors: 1) the Florida Department of Revenue with a claim of $816.45; 2) the Principal with a claim of $542,015.17 [4] ; 3) Styles Construction with a claim of $17,000.00; and 4) Triple S. Fire Protection with a claim of $22,000.00 totaling $581,015.17. 422 Boardwalk has no unsecured creditors. Creditor claims that, as of the Petition Date, Debtors owe $3,741,912.71 [5] ; the Principal is certain this amount is inaccurate. For the purposes of the Motions for Relief from the Automatic Stay, the Court concludes that, as of the Petition Date, Debtors owed Creditor $3,741,912.71. Furthermore, the property taxes for 2012 and 2013 for the Properties in the amount of $182,000.00 remain unpaid. [6]

On June 9, 2014, the Court entered an Interim Order Granting Debtor’s Motion for Authority to Use Cash Collateral and ordered 412 Boardwalk to pay adequate protection payments to Creditor. Thereafter, Creditor received: 1) $25,680.00 on June 11, 2014, and 2) $11,564.00 on July 7, 2014. Creditor has been receiving rent payments from Peerless prior to the Petition Date. For instance in March of 2014, before Debtors filed their respective petitions, Creditor received $12,840.00. Furthermore, prior to the hearing, the Principal signed an Assignment of Economic Interests assigning his interests and benefits, including distributions from Peerless, to Debtors so that an additional $12,000.00 per month is available to assist Debtors in funding their plan of reorganization. Lastly, to the extent rental income generated by the Properties and Peerless’ monetary distributions are insufficient, the Principal testified he is willing to make capital contributions to fund payments and any operating shortfalls.

Conclusions of Law

Upon filing a petition for bankruptcy, an automatic stay is imposed. In re Laurent, 208 Fed.Appx. 724, 724 (11th Cir. 2006). Section 362(d), which sets forth the grounds for granting relief from the automatic stay, provides:

On request of a party in interest and after notice and a hearing, the court shall grant relief from the stay provided under subsection (a) of this section, such as by terminating, annulling, modifying, or conditioning such stay —

(1) for cause, including the lack of adequate protection of an interest in property of such party in interest;

(2) with respect to a stay of an act against property under subsection (a) of this section, if —

(A) the debtor does not have an equity in such property; and

(B) such property is not necessary to an effective reorganization.

11 U.S.C. § 362(d). “[T]he Court must lift the stay if the movant prevails under either of the two grounds.” In re Elmira Litho, Inc., 174 B.R. 892, 900 (Bankr. S.D.N.Y. 1994) . Here, Creditor seeks relief pursuant to §§ 362(d)(1) and 362(d)(2). The Court will address Creditor’s claims in turn.

Creditor’s Claim Under § 362(d)(1)

A movant seeking relief from the automatic stay under § 362(d)(1) “must demonstrate a factual and legal right to the relief that it seeks.” In re Elmira Litho, Inc., 174 B.R. at 902 . In other words, the party seeking relief from the automatic stay must establish a prima facie case of cause for relief. In re George, 315 B.R. 624, 628 (Bankr. S.D. Ga. 2004) . Absent such showing, relief from the effect of the stay will be denied. In re Bogdanovich, 292 F.3d 104, 110 (2d. Cir. 2002) . Because “cause” is not further defined in the Bankruptcy Code, relief from the stay for cause is a discretionary determination made on a case-by-case basis. Laguna Assocs. Ltd. P’ship, 30 F.3d 734, 737 (6th Cir. 1994). A petition filed in bad faith justifies granting relief from the automatic stay. In re Dixie Broad., Inc., 871 F.2d 1023, 1026 (11th Cir. 1989) (citing In re Natural Land Corp., 825 F.2d 296 (11th Cir. 1987) ). There is no particular test for determining whether a debtor has filed a petition in bad faith and courts may consider any factors which evidence “an intent to abuse the judicial process and the purposes of the reorganization provisions or, in particular, factors which evidence that the petition was filed to delay or frustrate the legitimate efforts of secured creditors to enforce their rights.” [7] In re Phoenix Piccadilly, Ltd., 849 F.2d 1393, 1394 (11th Cir. 1988) (internal quotations omitted).

Debtors concede and the Court recognizes that certain of the objective bad faith factors considered by the Eleventh Circuit in Phoenix Piccadilly are present in the instant case. Specifically, each Debtor has only one asset, the Properties subject to a foreclosure action as a result of the nonpayment of property taxes, and Debtors have no employees. 412 Boardwalk has few unsecured creditors whose claims are relatively small compared to the claims of the secured creditors and 422 Boardwalk has none. It is also undisputed that Debtors’ financial problems arose when Debtors elected not to pay property taxes which constituted a default on the Notes. However, the Court agrees with Debtors’ argument that the appearance of some of the objective bad faith factors from Phoenix Piccadilly cannot be determinative in any given case, as virtually every reorganization case in the current market exhibits certain of the Phoenix Piccadilly factors. Also, the Court does not overlook the fact that Debtors have been timely paying mortgage payments for years even when they had no income. The Court must also consider the fact that the Principal and the Entrepreneurs invested approximately $1 million to improve the value of the Properties and to create an opportunity for Debtors to generate income. Debtors’ choice of not paying property taxes is unacceptable and cannot be condoned. However, Creditor utilized a questionable method to compel the Principal to pay the outstanding taxes by ambushing him with a demand for payment of the Properties’ outstanding taxes together with payment of other outstanding property taxes on many other properties controlled by the Principal and gave him ten days to cure these defaults. Otherwise, Creditor threatened it would accelerate several notes. In addition, Creditor rejected Principal’s request for a thirty-day extension. The Principal believes that if he had thirty days, he would be able to come up with the amount sufficient to cover the outstanding property taxes on the Properties. Furthermore, the Court notes that the Principal in good faith engaged in an eight-month-long negotiation on behalf of Debtors to resolve the financial issues while Creditor was accruing default interest on the Notes. Once the prolonged negotiations proved unsuccessful, the Principal sought protection under the Bankruptcy Code. The Court finds that the circumstances of this case do not establish the petitions were filed in bad faith. The Court also finds Creditor failed to establish that the current adequate protection payments are insufficient to protect Creditor’s interest or that it would suffer irreparable injury, loss or damage if the stay is not lifted. [8] For this reason, the Court denies Creditor’s request to lift the stay on this ground.

Creditor’s Claim Under § 362(d)(2)

To obtain relief from the stay under § 362(d)(2), a debtor must have no equity in the property and the property must not be necessary to an effective reorganization. In re Lamelas, No. 12-26067-AJC, 2013 WL 324028 at *5 (Bankr. S.D. Fla. Jan. 28, 2013). “Both parts must be satisfied before relief can be granted.” In re Moulton, 393 B.R. 752, 766 (Bankr. N.D. Ala. 2008) . The Movant has the burden of demonstrating that a debtor has no equity, and the debtor has the burden of demonstrating that the property is necessary to an effective reorganization. In re Lamelas, 2013 WL 324028 at *2.

The Court need not conduct a thorough analysis of whether there is equity in the Properties because the Court finds that the Properties are necessary for an effective reorganization. The Properties are the primary source of Debtors’ income, which stems from the lease with Peerless and Peerless’ distributions. Thus, Peerless’ continued successful operation of the Restaurant on the Properties is key to the reorganization of the Debtors. Thus, the Motions for Relief from the Automatic Stay will be denied.

Creditor’s Claim Under 11 U.S.C. § 1112

Section 1112(b)(1) provides that the court shall dismiss a case under Chapter 11 for cause. Section 1112(b)(4) sets forth a nonexhaustive list of grounds that may constitute “cause” for dismissal. [9] In re Schultz, 436 B.R. 170, 174 (Bankr. M.D. Fla. 2010) . “[T]he determination of cause under § 1112(b) is `subject to judicial discretion under the circumstances of each case.'” In re Albany Partners, Ltd., 749 F.2d 670, 674 (11th Cir. 1984) (quoting In the Matter of Nancant, 8 B.R. 1005 (Bankr. D. Mass. 1981) ). The burden rests with the moving party to establish “cause” for dismissal. In re Schultz, 436 B.R. at 174 . “In evaluating a § 1112(b) motion to dismiss, all doubts are to be resolved in favor of a debtor.” In re Chris-Marine U.S.A., Inc., 262 B.R. 118, 124 (Bankr. M.D. Fla. 2001) . “Additionally, a court should be reluctant to dismiss a case or to grant relief that will effectively end any chance for reorganization when confirmation, the natural end of the carefully designed Chapter 11 process, looms soon in the future.” Id. at 125.

Here, Creditor claims that the cases should be dismissed for three reasons: 1) the petitions were filed in bad faith; 2) there is substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation; and 3) Debtors have grossly mismanaged the estate. (Doc. 55 at 8). The Court will address Creditor’s contentions in turn.

Debtor’s Good Faith

A case should be dismissed for cause if the petition was not filed in good faith. In re Albany Partners, Ltd., 749 F.2d 670, 674 (11th Cir. 1984) . What amounts to bad faith is the same for both proceedings on a motion to dismiss and a motion for relief from the automatic stay. Phoenix Piccadilly, 849 F.2d at 1394 . For the reasons stated above, the Court finds that Debtors filed their respective petitions in good faith.

Substantial or Continuing Loss to or Diminution of the Estate and the Absence of a Reasonable Likelihood of Rehabilitation

To determine if there is a continuing loss to or diminution of the estate, the court must look beyond financial statements and fully evaluate the present condition of the debtor’s estate. In re Motel Props., Inc., 314 B.R. 889, 894 (Bankr. S.D. Ga. 2004) . Negative cash flow and an inability to pay current expenses as they come due can satisfy the continuing loss to or diminution of the estate standard for purposes of § 1112(b). In re Gateway Access Solutions, Inc., 374 B.R. 556, 564 (Bankr. M.D. Pa. 2007) . Section 1112(b)(4)(A) “is written in the conjunctive; therefore, it requires both a loss to or diminution of the estate and an absence of a reasonable likelihood of rehabilitation.” In re Motel Props., Inc., 314 B.R. at 895 . Creditor claims that Debtors have failed to pay property taxes and that they cannot show they are capable of paying those taxes from their only source of income, $12,000.00 per month from their rental agreement. Debtors claim that Creditor made tax payments for the property taxes due for 2009 and 2010 while Debtors paid the property taxes for 2011. Debtors further claim that the 2012 and 2013 taxes will be paid over sixty months at the statutory interest rate pursuant to Debtors’ plan of reorganization and that amounts for future property tax obligations, which are not yet due, will be set aside from post-petition revenues.

Debtors also established at the hearing that they have alternative sources of income. Specifically, the Principal assigned his financial interest from Peerless to Debtors in the amount of $12,000.00 per month and the Principal testified he was willing to make capital contributions to cover any operating shortfalls of Debtors to fund any post-confirmation obligations. Therefore, the Court finds that there is no continuous loss to or diminution of the estate and there is no need to address whether there is an absence of a reasonable likelihood of rehabilitation at this time. The Court will deny the Motion to Dismiss on this ground.

Gross Mismanagement of the Estate

The example of [cause provided in § 1112](b)(4)(B) focuses on the management of the estate and not on the debtor. 3 Collier on Bankruptcy ¶ 1112.04[5][c], p. 1112-15 (16th ed. 2013). However, “[t]he inquiry cannot include mismanagement by the debtor prior to the bankruptcy filing.” Id.; see also In re Sunnyland Farms, Inc., No. 14-10231 TA, 2014 WL 4443491 at *4 (Bankr. D.N.M. Sept. 9, 2014) (stating “[u]npaid prepetition taxes are not relevant in the cause analysis” while discussing § 1112(b)(4)(I)); In re Rent-Rite Super Kegs West Ltd., 484 B.R. 799, 809 (Bankr. D. Colo. 2012) (pre-petition gross mismanagement is not cause under § 1112(b)(4)(B) because the estate is a post-petition entity).

Creditor claims that Debtors’ failure to pay property taxes for years 2009, 2010, 2012 and 2013 evidences Debtors have grossly mismanaged the estate. It is undisputed that Debtors owe significant property taxes to the Duval County Tax Collector. Debtors claim that their plan of reorganization will provide for payment of the outstanding prepetition property taxes over a sixty (60) month period post-confirmation. (Doc. 61 at 5). Since the bankruptcy proceedings began, Debtors have drafted and filed a plan of reorganization and have maintained property insurance. Debtors have also been paying adequate protection payments to Creditor pursuant to the Court’s order. There is no evidence of mismanagement, let alone gross mismanagement, post-petition.

For this reason, the Court will deny the Motion to Dismiss and will enter separate orders consistent with these Findings of Fact and Conclusions of Law.

[1] Creditor also filed a Motion for Relief from the Automatic Stay (Doc. 20) in In re 422 Boardwalk, Inc., Case No. 3:14-bk-01848-JAF, which has been jointly administered with case In re 412 Boardwalk, Inc., Case No, 3:14-bk-01847 since June 2, 2014. This Motion is almost identical to the Motion for Relief from the Automatic Stay (Doc. 23) filed in In re 412 Boardwalk, Inc., Case No, 3:14-bk-01847.

[2] The term “Properties” in this Order refers to both the 412 Property and the 422 Property.

[3] While the lease agreement provides it was entered into between Peerless and 412 Boardwalk, Debtors established that the parties to the agreement intended the 422 Property to be used by Peerless as parking for the Restaurant.

[4] Even though the Principal testified he does not receive any salary from the Debtors and that there are not any outstanding notes between himself and the Debtors, the evidence established he paid himself $45,150.00 from the Debtors’ funds during the period from April 1, 2013, to April 1, 2014. (Creditor’s Ex. 9). The Principal, at the hearing, was unable to explain why he paid himself such an amount.

[5] As Debtors indicated in their post-hearing brief, Creditor’s debt was scheduled as disputed and as of the date of the hearing, Creditor had not filed proofs of claim. (Doc. 64 at 1).

[6] Debtors claim that their plan of reorganization will provide for payment of the property taxes over a sixty month period post-confirmation. (Doc. 61 at 5).

[7] The factors include the following inquiries: (1) Is there a realistic possibility of an effective reorganization? (2) Does the debtor only possess a few assets? (3) Does the debtor only have a few unsecured creditors whose claims are small in relation to the claims of secured creditors? (4) Does the debtor have few employees? (5) Is the debtor’s property subject to a foreclosure action as a result of arrearages on the debt? (6) Do the debtor’s financial problems involve essentially a dispute between the debtor and the secured creditors which can be resolved in a pending state court action? and (7) Does the timing of the debtor’s filing evidence an intent to delay or frustrate the legitimate efforts of the debtor’s secured creditors to enforce their rights? Phoenix Piccadilly, 849 F.2d at 1394 ; In re Natural Land Corp., 825 F.2d at 298 . The “list of factors is not exhaustive; nor is there any single factor that will necessarily lead to a finding of bad faith.” Natural Land Corp., 825 F.2d at 298 .

[8] In the Motion to Lift the Automatic Stay, Creditor claims that the value of its lien is declining as a result of the non-payment of the debt, plus the accrual of interest and additional costs and expenses incurred by Creditor in an attempt to protect its security interest. (Doc. 23 at 8). Creditor claims it has not received adequate protection, but Debtors established Creditor has been receiving adequate protection payments. (Doc. 23 at 9). Creditor claims that its hardship outweighs any potential prejudice to Debtors or their estate. (Doc. 23 at 8). However, Creditor failed to specify to what extent, if any, monthly adequate protection payments paid by Debtors fail to cover “accrual of interest and additional costs and expenses.” (Doc. 23 at 8). The Court will not perform any independent calculations to determine if Creditor’s assertion is accurate.

[9] Section 1112(b)(4) provides as follows:

For purposes of this subsection, the term `cause’ includes —

(A) substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation;

(B) gross mismanagement of the estate;

(C) failure to maintain appropriate insurance that poses a risk to the estate or to the public;

(D) unauthorized use of cash collateral substantially harmful to 1 or more creditors;

(E) failure to comply with an order of the court;

(F) unexcused failure to satisfy timely any filing or reporting requirement established by this title or by any rule applicable to a case under this chapter;

(G) failure to attend the meeting of creditors convened under section 341(a) or an examination ordered under rule 2004 of the Federal Rules of Bankruptcy Procedure without good cause shown by the debtor;

(H) failure timely to provide information or attend meetings reasonably requested by the United States trustee (or the bankruptcy administrator, if any);

(I) failure timely to pay taxes owed after the date of the order for relief or to file tax returns due after the date of the order for relief;

(J) failure to file a disclosure statement, or to file or confirm a plan, within the time fixed by this title or by order of the court;

(K) failure to pay any fees or charges required under chapter 123 of title 28;

(L) revocation of an order of confirmation under section 1144;

(M) inability to effectuate substantial consummation of a confirmed plan;

(N) material default by the debtor with respect to a confirmed plan;

(O) termination of a confirmed plan by reason of the occurrence of a condition specified in the plan; and

(P) failure of the debtor to pay any domestic support obligation that first becomes payable after the date of the filing of the petition.

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Because it was designed by experienced restructuring professionals and is chapter 11 specific in focus, Chapter 11 Dockets is optimized for the unique needs of bankruptcy practitioners.

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