In Re 68 West 127 Street, LLC
MEMORANDUM OPINION ON MOTION OF THE BANK OF NEW YORK AS TRUSTEE FOR RELIEF FROM THE AUTOMATIC STAY
The debtor and debtor in possession (“Debtor”) filed its chapter 11 petition on the morning of the day that its only asset, an empty, derelict residential building in Harlem, was scheduled to be sold at judicial foreclosure. The Bank of New York, as Trustee (“BONY”), requested relief from the automatic stay under section 362(a) of the Bankruptcy Code to resume
BONY contends that the automatic stay should be lifted under section 362(d)(1) of the Code because the Debtor sought relief under the Bankruptcy Code in bad faith. BONY also contends that relief from the automatic stay should be granted under section 362(d)(2) of the Code because the Debtor has no equity in the building and it is not necessary to an effective reorganization under chapter 11.
Many, if not all, of the factors frequently cited as indicia of a debtor’s bad faith are present. However, the Debtor has carried its burden on the key issue. The Debtor is working within chapter ll’s constraints, having reasonably established that it can effectively reorganize in a reasonable time, and, therefore, is not misusing chapter 11 merely to frustrate its secured creditor. Consequently, the delay imposed by the automatic stay is justified and BONY’s motion is denied.
FACTS
The facts are almost exclusively based on affidavits and exhibits submitted by the parties.
On July 22, 1999 Quenna Moore, then the building’s owner, issued a $252,000 note and first mortgage on the building to an entity that later assigned the note and mortgage to BONY. Following Ms. Moore’s default on the note, the Supreme Court of the State of New York granted BONY’s motion for summary judgment in BONY’s foreclosure proceeding on November 13, 2001 and on April 22, 2002 issued a judgment of foreclosure and sale. BONY scheduled the foreclosure sale for July 10, 2002, but the Debtor, by then the owner of the building, filed its chapter 11 petition that morning.
Ms. Moore had sold the building to the Debtor shortly before the scheduled foreclosure sale, without BONY’s knowledge. Parties facing foreclosure sometimes make such transfers to related entities in a not very subtle attempt to facilitate their control of property by muddying title. The Debtor’s principals are not related to or affiliated with Ms. Moore, however, and the July 2, 2002 transfer to the Debtor does not appear to have been undertaken to shield Ms. Moore or her other assets or otherwise to harm BONY. Ms. Moore’s note to BONY is full recourse, and the assignment did not relieve her of any liability. 1 BONY nevertheless has taken no action to collect from Ms. Moore, and BONY acknowledged that it was not prejudiced by her transfer to the Debtor, or by the Debtor’s day-of-foreclosure filing, for that matter, with the exception of the resulting delay imposed by the automatic stay and the cost of seeking relief under section 362(d) of the Bankruptcy Code. BONY acknowledged that had the building not been transferred, it is likely that Ms. Moore also could have filed a bankruptcy petition that would have stayed the foreclosure sale.
BONY offered no evidence of the value of the building other than agreeing with the Debtor’s submissions that the Debtor has no equity in the collateral: that is, BONY admitted that the value of the building is less than the amount of its prepetition claim.
2
The Debtor’s sched
Although the building has apparently been empty for years, and the Debtor has no income, the Debtor wants to rehabilitate the building, having experience in this area. In the past three years Mr. Enbar has been involved in the purchase of at least eight properties in Harlem.
The Debtor has consistently proposed to pay BONY, from capital contributions and refinancing, what the Debtor asserts is the fair value of BONY’s mortgage. Soon after buying the building, the Debtor offered to pay BONY $250,369, which the parties agree is the outstanding principal balance of the note, in satisfaction of the judgment. Receiving no response, on July 8 and 9, 2002 the Debtor made additional proposals to BONY, ultimately increasing its offer to $301,000. After the chapter 11 filing, the Debtor reiterated this proposal, but BONY apparently did not address it, except by filing its lift-stay motion.
At the preliminary hearing, the Debtor stated that it would continue to try to pay BONY the value of BONY’s interest in the building by filing a “new value” chapter 11 plan in which its principals would buy the building for its fair value, the cash purchase price satisfying administrative, priority and secured claims including BONY’s first mortgage claim.
Before the final hearing, the Debtor filed such a new value plan, under which the Debtor’s principals would pay $175,000 into the estate and either guarantee a new $175,000 first mortgage loan or pay another $175,000 into the estate themselves if such loan cannot be obtained. With that $350,000, the Debtor would pay the handful of administrative and priority claims (except for one voluntarily reduced priority claim) and secured claims (including tax liens), with $250,000 going to satisfy BONY’s secured claim based on the asserted value of its first mortgage interest. Thus, the plan would seek a valuation of BONY’s first mortgage interest under section 506(a) of the Bankruptcy Code at $250,000. The plan provides for no recovery by the Debtor’s few unsecured creditors.
At the final hearing, the Debtor agreed to terminate its exclusive periods under section 1121 of the Bankruptcy Code or otherwise to satisfy the requirement of
Bank of Am. Nat’l Trust and Sav. Assn. v. 203 N. LaSalle St. P’ship,
Also at the final hearing, the Court conditioned the continuation of the automatic stay on the Debtor’s prompt submission of an executed commitment by one or more of its principals to fund the plan. This the Debtor did by filing an affidavit by Steven Kamhi agreeing to pay $175,000 as provided in the plan as well as committing to guarantee or underwrite the additional $175,000. Attached as an exhibit to Mr.
DISCUSSION
BONY seeks relief under section 362(d)(1) of the Bankruptcy Code for cause. 3 BONY does not assert that its interest in the building is not adequately protected. BONY does not contend that the building is declining in value. It also does not challenge the Debtor’s assertion that the building is secure from vandalism. (At the final hearing the United States Trustee, who took no position on BONY’s motion, confirmed receipt of satisfactory evidence of continued insurance on the building, as well as stated that the Debtor has timely filed its schedules and operating reports.) Instead, the cause alleged by BONY under section 362(d)(1) is the Debt- or’s alleged bad faith in seeking relief under chapter 11.
BONY also requests that the automatic stay be lifted under section 362(d)(2) of the Bankruptcy Code, asserting that the Debt- or has no equity in the building and that the building is not necessary for an effective reorganization. 4
Given the building at issue and the time between the start of the bankruptcy case and the final hearing on BONY’s motion, the Court also considered whether the stay should be lifted under section 362(d)(3) of the Bankruptcy Code, which provides in relevant part that relief from the automatic stay of an act against “single asset real estate” by a creditor secured thereby shall be granted unless, not later than the 90 days after the start of the bankruptcy case or such later date as the Court may determine for cause, the debtor has filed a plan of reorganization that has a reasonable possibility of being confirmed within a reasonable time. 5
The Debtor responds that, although it has no equity in the building, the building is necessary for its effective reorganization, which it can effectively and promptly accomplish under its proposed chapter 11 plan. The Debtor therefore contends that it is pursuing its rights under the Bankruptcy Code in good faith.
Summary
While in the light of the various “bad faith factors” discussed below BONY has established a
prima facie
case for stay relief,
see Sonnax Indus. v. Tri Component Prods. Corp. (In re Sonnax Indus., Inc.),
Bad Faith as “Cause” Under Section 362(d)(1)
Although not expressly stated in section 362(d)(1), it is well established that a debtor’s bad faith constitutes “cause” for relief from the automatic stay under that section.
In re AMC Realty Corp.,
Courts often list numerous factors indicating a debtor’s bad faith, which “are not substantively different from each other” whether used in the context of a motion to dismiss the underlying bankruptcy case under section 1112(b) of the Bankruptcy Code or a motion for relief from the automatic stay under section 362(d)(1).
In re AMC Realty,
The Second Circuit has summarized such factors as follows:
1. the debtor has only one asset;
2. the debtor has few unsecured creditors, whose claims are small in relation to those of the secured creditors;
3. the debtor’s one asset is the subject of a foreclosure action as a result of arrearages or default on the debt;
4. the debtor’s financial condition is, in essence a two party dispute between the debtor and secured creditors which can be resolved in the pending state foreclosure action;
5. the timing of the debtor’s filing evidences an intent to delay or frustrate the legitimate efforts of the debtor’s secured creditors to enforce their rights;
6. the debtor has little or no cash flow;
7. the debtor can’t meet current expenses including the payment of personal property and real estate taxes; and
8. the debtor has no employees.
In re C-TC 9th Ave. P’ship,
The courts repeatedly caution, however, not to apply such factors mechanically.
Id.
at 629 (citing numerous cases for the proposition that “[t]he existence of ‘bad faith’ depends not on any one specific factor but on a combination of factors determined after careful examination of the facts of the particular debtor’s case”);
see also In re Willows of Coventry Ltd. P’ship,
Lists of such factors, then, ultimately do no more than assist the exercise of discretion in deciding when a debtor has improperly invoked the Bankruptcy Code, or is improperly hiding behind the automatic stay to speculate with the creditor’s collateral, because it is not able, or not trying, to confirm a chapter 11 plan.
See C-TC 9th Ave. P’ship,
Keeping the primary focus on the permissible uses of the Bankruptcy Code is important because, taken out of context, the exercise of certain rights under the Code that are perfectly legitimate may appear hurtful, even malicious, yet the exercise of a statutory right or remedy should rarely, if ever, be said to be in bad faith. As stated by Judge Fox in
In re Clinton Centrifuge, Inc.,
In engrafting the good faith requirement into the Code, courts must be careful not to upset the delicate balance of interests fashioned by Congress under chapter 11. Moreover, to the extent that the concept of good faith exists independent of other Code provisions (such as adequate protection), courts must be vigilant to apply this concept in ways consistent with the legislative policy decisions embodied in these other [Code] enactments. Thus, in evaluating a debtor’s good faith, the court’s only inquiry is to determine whether the debtor seeks to abuse the bankruptcy law by employing it for a purpose for which it was not intended. When a debtor is motivated by plausible, legitimate reorganization (or liquidation) purposes and not solely or predominantly by the mere desire to prevent foreclosure or hinder creditors, bad faith is not present in a chapter 11 case.
The Supreme Court has consistently applied the plain language of the Bankruptcy Code even when the result might appear inequitable in a non-bankruptcy setting, including when such result might violate one or more of the bad faith factors listed above.
See, e.g., Toibb v. Radloff,
Moreover, notwithstanding the routinely cited bad faith factor of an eve-of-foreclosure bankruptcy filing, apparently no court has applied that factor in isolation to find bad faith. Indeed, several courts have observed that resort to bankruptcy to stave off foreclosure is consistent with bankruptcy’s goals of preserving going concerns and maximizing value: 8
Filing a bankruptcy petition with the intent to frustrate creditors does not by itself establish an absence of intent to seek rehabilitation. Indeed, because a major purpose behind our bankruptcy laws is to afford a debtor some breathing room from creditors, it is almost inevitable that creditors will, in some sense be “frustrated” when their debtor files a bankruptcy petition. In reality, there is a considerable gap between delaying creditors, on the eve of foreclosure and the concept of abuse of judicial purpose.
In re Cohoes Indust. Terminal,
Similar observations may be made about other commonly listed bad faith factors.
See, e.g., In re Kingston Square Assocs.,
214 B.R.
713, 734, 736-37
(Bankr.S.D.N.Y.1997) (eve-of-foreclosure filing was not in bad faith, despite circumvention of “bankruptcy remote” board structure imposed by primary, secured creditor, because bankruptcy preserved value for handful of unsecured creditors and debtor’s limited partners);
In re Foundry of Barrington P’ship,
It may be argued in response that the Bankruptcy Code expressly limits the potentially invidious effects of its own provisions by incorporating a non-specific “for cause” standard in sections 362(d)(1) and 1112(b). However, the cases discussed above highlight that the presence of “bad faith factors” should, at most, only heighten one’s sensitivity to the possibility that a creditor is entitled to relief from the automatic stay. (It is not even a question of shifting the burden of persuasion to the debtor, as might be the case under section 1112(b), because the debtor already has that burden, with the exception of the issue of its equity in the collateral, under section 362(g) of the Code, although the presence of several bad faith factors can establish the creditor’s
prima facie
case.
In re Yukon Enter., Inc.,
In practice, cases relying on “bad faith” therefore generally hinge on reasons that also would satisfy the specifically listed criteria in sections 362(d)(2) and 362(d)(3) of the Bankruptcy Code, or on several of the specific criteria in sections 1112(b)(1)-(10), as the case may be.
In re Gucci
This substantial overlap with sections 362(d)(2) and 362(d)(3) is especially the case in jurisdictions where “cause” cannot be based simply on the debtor’s subjective intent.
Compare In re Carolin Corp. v. Miller,
Extraordinary circumstances are not present here to override the fact that the Debtor is pursuing a course of action that, as discussed below, has a reasonable possibility of ending in a confirmed chapter 11 plan. Although the Debtor is not currently earning income, it is beyond doubt that restructuring its balance sheet to facilitate the rehabilitation of a derelict residential building is a permissible chapter 11 goal.
See In re Nevada Towers Assocs.,
14 C.B.C (MB) 146 (Bankr.S.D.N.Y.1977) (automatic stay not lifted on incomplete apartment project, where limited partners offered to provide funds to finish construction). As noted, BONY was not harmed by the Debtor’s purchase of the building shortly before the chapter 11 filing.
In re Levinsky,
Effective Reorganization/Successful Reorganization
Having met the good faith standard under section 362(d)(1), the Debtor also has satisfied the similar, if not identical, standards of sections 362(d)(2)(B) and 362(d)(3)(A) of the Bankruptcy Code. Those sections’ references to an “effective reorganization”
9
and a “plan of reorgani
Based on the record, the valuation underlying the Debtor’s plan is credible, as is the assumption that the Debtor’s principals will contribute the contemplated new value. The “new value” plan also is premised on a legal theory under 11 U.S.C. § 1129(b)(2)(B)(ii) and
Case v. Los Angeles Lumber Products Co.,
Accordingly, BONY’s motion is denied. The Court has entered an order consistent with this opinion.
Notes
. Because section 1111(b)(1)(A) of the Bankruptcy Code in essence converts secured non-recourse obligations to recourse obligations, an eve-of-foreclosure transfer to a related single-purpose entity of collateral securing a non-recourse note permits bankruptcy relief for the transferred property while shielding the original obligor’s other assets, in which the obligor may have substantial equity.
. At the final hearing, BONY was not able to establish the total amount owed on the bank
. Section 362(d)(1) provides that "the court shall grant relief from the stay ... for cause, including the lack of adequate protection of an interest in property of such party in interest.”
. Section 362(d)(2) provides that the court shall grant relief from the automatic stay of an act against property "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)(3)(A). The building apparently qualifies as single asset real estate under section 101(5 IB) of the Bankruptcy Code. The Debtor's bankruptcy case began on July 10, 2002 and the parties agreed to adjourn the final hearing on BONY’s motion (BONY having waived its rights under 11 U.S.C. § 362(e) until the date of the hearing) to October 22, 2002, thus bringing section 362(d)(3)’s 90-day period into play. Section 362(d)(3) is not a secured creditor's exclusive remedy in this situation. It does not supersede sections 362(d)(1) and (2).
In re 234
-6
West 22nd St. Corp.,
. Particularly when other parties’ interests are affected, however, the debtor's
motives
in seeking relief under the Bankruptcy Code are less important because the filing is a much for the benefit of creditors and, perhaps, third-party equity holders as the debtor.
In re Johns-Manville Corp.,
. On remand, the court determined that the subsequent chapter 13 case was filed in good faith.
In re Johnson,
.
LaSalle, 526
U.S. at 453,
. As the Debtor’s only asset, the building clearly is necessary for the Debtor’s reorgani-