497 B.R. 448
Bankr. E.D. Pa.2013Background
- Debtor Joseph Grasso’s Chapter 11 case: Madison Capital (joined by Katz initially) moved to convert to Chapter 7 under 11 U.S.C. § 1112(b); court had already appointed a Chapter 11 trustee.
- Trustee’s investigation uncovered undisclosed entities, unauthorized postpetition transfers, and sales of three antique automobiles whose sale proceeds were not accounted for.
- Trustee found postpetition diversions and receipts (including three large payments from Curtis Investors) not reported in operating reports and identified substantial postpetition personal and business expenditures funded with estate assets.
- Estate was administratively insolvent with significant negative cash flow and mounting professional fees; any reorganization relied on unproven outside financing from debtor’s friends/family.
- At the hearing Madison relied on documentary evidence; debtor did not testify or produce corroborating evidence of funding; trustee conceded additional information was needed and could not substantiate plan feasibility.
Issues
| Issue | Plaintiff's Argument (Madison) | Defendant's Argument (Debtor / Trustee / Bancorp) | Held |
|---|---|---|---|
| Whether "cause" exists under § 1112(b)(4)(A) (substantial or continuing loss/diminution) | Postpetition unauthorized transfers, unaccounted sales, diversion of receipts, and ongoing negative cash flow prove continuing diminution | Debtor/Trustee contested likelihood of conversion being best for creditors; argued likelihood of plan confirmation | Court held Madison proved cause: unauthorized transfers, diversion, and administrative insolvency establish substantial/diminution and lack of rehabilitation likelihood |
| Whether Debtor/Trustee met burden under § 1112(b)(2) to show unusual circumstances and reasonable likelihood of plan confirmation | N/A (Madison is movant) | Debtor/Trustee argued reorganization could yield greater creditor recovery (e.g., alleged tenancy by entirety; going-concern value of related entities) | Court held Debtor/Trustee failed to identify unusual circumstances or produce evidence; alleged entireties ownership conflicted with documents and nondebtor entity network showed siphoning, not value preservation |
| Feasibility of a Chapter 11 plan (§ 1129(a)(11)) | N/A | Debtor/Trustee claimed outside financing from friends/family would make plan feasible | Court held feasibility unproven: no evidence of commitments, amounts, terms, or ability to fund ongoing operations or administrative claims; plan thus not reasonably likely to be confirmed |
| Good faith and treatment of impaired claimants (§§ 1129(a)(3), 1129(b)) | N/A | Debtor/Trustee asserted unsecured creditors could fare better under Chapter 11 | Court found debtor misconduct (nondisclosure, transfers) undermined good-faith requirement and unsecured creditor opposition (e.g., Madison) made cramdown unlikely; no reasonable likelihood of confirmation |
Key Cases Cited
- In re Dr. R.C. Samanta Roy Institute of Science Technology, Inc., [citation="465 F. App'x 93"] (3d Cir. 2011) (discusses burden-shifting under § 1112(b))
- In re American Capital Equipment, LLC, 688 F.3d 145 (3d Cir. 2012) (conversion analysis and rehabilitation inquiry)
- In re Ramreddy, Inc., 440 B.R. 103 (Bankr. E.D. Pa. 2009) (factors and burden in conversion decisions)
- Fidelity Deposit & Discount Bank v. Domiano (In re Domiano), 442 B.R. 97 (Bankr. M.D. Pa. 2010) (unusual circumstances and need for concrete proof to resist conversion)
- In re FRGR Managing Member LLC, 419 B.R. 576 (Bankr. S.D.N.Y. 2009) (establishing both diminution and absence of rehabilitation under § 1112(b)(4)(A))
- In re DCNC North Carolina I, LLC, 407 B.R. 651 (Bankr. E.D. Pa. 2009) (burden where plan depends on outside financing)
- In re Orbit Petroleum, Inc., 395 B.R. 145 (Bankr. D.N.M. 2008) (unusual circumstances concept and when conversion/dismissal is inappropriate)