In re Basil Street Partners, LLC
ORDER GRANTING ALLEGED DEBTOR’S MOTION TO CONVERT AND DIRECTING THE APPOINTMENT OF A CHAPTER 11 TRUSTEE
(Doc. 241, 285)
I. Introduction
On October 19, 2011, four petitioning creditors filed an involuntary bankruptcy petition under chapter 7 of the Bankruptcy Code against the Alleged Debtor.
The Receiver has been assisted in the day-to-day on-site management of the property by The Benchmark Management Company (“Benchmark”). Both the Receiver and Benchmark have continued their pre-petition roles and responsibilities after this case was filed, and, by all accounts, have done an exceptional job in performing their duties and stabilizing the ongoing business conditions at the resort.
As this bankruptcy case unfolded, numerous contested and critical issues arose which delayed the ultimate trial on whether an order for relief should be entered in the involuntary cаse. In due course, and after resolving those issues, the Court scheduled a final evidentiary hearing for June 19, 2012, on the issue of whether an order for relief should be entered under § 303 in the involuntary case. This date was the earliest practicable time, under all the circumstances, for this Court to determine the issues present in this heavily contested petition. See Fed. R. Bankr.P. 1013(a).
On May 31, 2012, merely eighteen days before the trial on the involuntary petition was scheduled to begin, the Alleged Debt- or filed a motion to convert the pending involuntary chapter 7 case to a case under chapter 11 of the Bankruptcy Code (the “Motion to Convert”) (Doc. 241). As with all matters in this case, APL — together with its manager, Jack Antaramian, in an individual capacity — objected to the Motion to Convert. (Doc. 248, 261). APL and Antaramian also filed an emergency motion to appoint a chаpter 11 trustee in the event this Court converted the case to chapter 11. (Doe. 285, 293). To resolve the objection and adjudicate the Motion to Convert, the Court decided to postpone the trial on the order for relief, and instead use the time reserved on June 19, 2012 to conduct a final evidentiary hearing on the Motion to Convert (the “Hearing”) (Doc. 262, 263).
II. Matters Considered at the June 19 Hearing
In conjunction with its Motion to Convert, the Alleged Debtor also filed a Mo
III. The Preliminary Hearing on June 8
That the Court ruled on these various motions at the Hearing should not have come as a surprise to any of the parties in interest. Prior to the Hearing, the Court conducted a preliminary telephonic hearing on June 8, 2012. Counsel for the Alleged Debtor and APL attended and participated in the hearing. During that hearing, the Court advised counsel for the Alleged Debtor and APL that it would be conducting a final evidentiary hearing on the Motion to Convert on June 18, 2012 (which was subsequently re-scheduled one day later to June 19). The Cоurt also advised the Alleged Debtor and APL at that same June 8 hearing that the Hearing on June 19 would be conducted in lieu of the previously scheduled trial on whether an order for relief should be entered in the involuntary chapter 7 case. See Orders at Doc. 262, 263. Finally, the Court indicated at the June 8, 2012 hearing that one of the issues which could be considered at the Hearing on the Motion to Convert was whether a chapter 11 trustee should be appointed in the event that the requested conversion was granted.
The issue of whether a chapter 11 trustee should be appointed upon conversion was expressly addressed by Judge Bernstein in In re Euro-American Lodging Corp.,
IV. Argument & Testimony from the June 19 Hearing
At the Hearing, the Court heard extensive argument regarding both conversion and the propriety of appointing a chapter 11 trustee from counsel for APL and the Alleged Debtor. The Court also heard argument from proposed counsel for the debtor-in-possession (should conversion be granted) and the financial equity sponsor of the Debtor’s proposed plan of reorganization,
The Receiver expressed his support for the requested conversion to chapter 11, and also testified that the case was one that “cries out” for the appointment of a chapter 11 trustee. To justify that statement, the Receiver further testified that the warring factions (namely, APL on one hand and the Alleged Debtor on the other hand) were disruptive to his management of and control over the Debtor’s assets. It appears that representatives from both the Alleged Debtor and APL had prоvided conflicting reports and instructions to the Receiver’s employees, thereby confusing them as to their duties and interfering with the Receiver’s overall control of the property. The Receiver’s sentiment that a chapter 11 trustee would be a welcome addition to this case was echoed by counsel for Benchmark and a number of other creditors.
During the course of the Hearing, in connection with the potential appointment of a chapter 11 trustee, an issue arose as to the interrelatedness of the Debtor and its proposed plan sponsor/financier, Gulf-water. The Court accepted the stipulation entered into between counsel for Gulfwa-ter and APL as to the ownership interests of Gulfwater. In sum, Gulfwater is owned as follows: 1% by Basil Investors, LLC, which is, in turn, owned by three individuals, namely (i) Fred Pezeshkan; (ii) Iraj Zand; and (in) Raymоnd Sehayek (collectively, “PZS”); and 99% by Gulfwater Investments, LLC, which, in turn, is ultimately owned in trust by family members of PZS. Pezeshkan, Zand, and Sehayek are the same individuals who ultimately own and control the Alleged Debtor. Thus, while Gulfwater is technically a distinct legal entity from the Alleged Debtor, the ultimate beneficial interest holders are essentially aligned with the Debtor. This fact gives the Court concerns about the potential — if not actual — conflicts of interests that could arise in this case that may prevent the Debtor, as a debtor-in-possession, from faithfully discharging its fiduciary duties to the estate.
V. Issues Presented
Among the legal issues raised in connection with the Hearing were: (i) whether conversion should be granted; (ii) if conversion were granted, whether an order for relief would be entered in the chapter 7 involuntary case prior to conversion; (iii) what role the Receiver and Benchmаrk would have with respect to the continued operations of the resort property and the Debtor’s assets if the case were converted; and (iv) whether the Court should appoint a chapter 11 trustee if the case were converted. These issues are addressed below.
VI. Legal Analysis
A. Conversion under § 706
The Alleged Debtor filed its Motion to Convert pursuant to § 706(a) of the Bankruptcy Code. While the plain text and legislative history of that section appear to provide a debtor with an absolute right to convert a case, including an involuntary case, to one under another chapter, the United States Supreme Court has added a judicial gloss to a debtor’s right of conversion based on the language contained in § 706(d). See Marrama v. Citizens Bank of Massachusetts,
For purposes of denying a debtor’s request to convert a case to chapter 11, “cause” can exist to deny such relief if the objecting party establishes by a preponderance of the evidence
1. “Cause” under § 1112(b)(J¡.) Factors
APL argues that “cause” exists to deny the Alleged Debtor’s Motion to Convert under § 1112(b)(4)(A). That section defines “cause” as “substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation” (emphasis supplied). Both prongs of this subsection must be proven. See, e.g., In re Khan,
In this case, APL’s argument that there is no reasonable likelihood of rehabilitation misses the mark insofar as APL appears to be arguing that the Debtor could not comply with the confirmation requirements of § 1129. Here, Gulfwa-ter’s proposed $5 million equity infusion into the Debtor’s business, including Gulf-water’s initial $1 million good faith deposit (Doc. 267), coupled with the framework of a proposed plan, are sufficient to persuade the Court that the Debtor’s business prospects warrant the continuance of its reorganization effort. The Court declines APL’s invitation to turn the conversion hearing into a confirmation hearing, and concludes that APL has not met its burden of establishing “cause” under § 1112(b)(4)(A).
Likewise, APL’s arguments for “cause” under § 1112(b)(4)(B) are also unavailing. The statute requires “gross
Finally, the Court rejects APL’s contention that § 1112(b)(4)(J) or (M) аpply to this case. Subsection (J) relates to a debt- or’s failure to comply with the time periods prescribed by the Court for filing or confirming a plan. Similarly, subsection (M) relates to a debtor’s inability to substantially consummate a confirmed plan. Here, at the time of the Hearing, no such time periods had even been established because the case had not yet been converted. Thus, APL’s arguments under these subsections are premature.
2. “Bad Faith” Conduct under Marra-ma and its Progeny
With respect to the alleged bad faith conduct of the Debtor, in order to successfully oppose conversion, objecting creditors must demonstrate bad faith conduct that is “atypical” or “extraordinary.” See Marrama,
However, in light of the vague parameters of what may constitute “bad faith,” other courts have found bad faith to exist notwithstanding the absence of the type of fraudulent concealment present in Marra-ma. For example, in In re Euro-American, a single petitioning creditor filed an involuntary petition against the alleged debtor. In an effort to defeat the petition and have it dismissed on numerosity grounds under § 303(b), the debtor padded the number of creditors. See In re Euro-American,
Other courts have likewise stated that conversion to chapter 11 is appropriate, notwithstanding the existence of bad faith conduct on the part of the debtor, where the debtor has a viable business which can
In this case, APL has made much to do about the Alleged Debtor’s conduct in defending against the involuntary petition. The Alleged Debtor has indeed opposed the involuntary petition at every turn, including by filing a motion to dismiss, which the Court ultimately denied. (Doc. 108). However, the Court is unwilling to find that exercising one’s legal rights to controvert an involuntary petition is the standard by which bad faith should be measured. While the Alleged Debtor was ultimately unsuccessful in its effort to have the petition dismissed, it did not engage in the type of “extraordinary” conduct that would be necessary to deny conversion. Furthermore, even if the Court were tо find that the Alleged Debtor had engaged in the requisite level of “bad faith” conduct that could warrant a denial of its Motion to Convert, there are a number of other creditors in addition to APL who would be much better served by the continued operation of the Alleged Debtor’s property. Under the circumstances, chapter 11 provides the best pathway for potential recovery for unsecured creditors, especially given the fact that liquidation of the Alleged Debtor’s assets under chapter 7 would benefit only the secured creditors whose expressed intention all along has been to credit bid for assets of the estate. See Transcript from January 18, 2012 hearing (Doc. 110, Part 5, p. 8,11.12-25; p. 9,11.1-25).
Accordingly, the Court finds that APL and Jack Antaramian, individually, have failed to carry their burden of demonstrating “cause” under Marrama and its progeny. As a result, the Motion to Cоnvert is GRANTED, and the objection filed by APL (Doc. 248), and joined in by Jack Antaramian, individually (Doc. 261), is OVERRULED.
B. Continued Service of the Receiver and Benchmark
Throughout the course of the proceedings on the Motion to Convert, the Debtor has conceded, including in its Motion to Excuse Turnover (Doc. 270), that in the event conversion is granted, the Debtor would not seek to displace or remove the Receiver or terminate the services of Benchmark.
Section 543(d) of the Bankruptcy Code authorizes the Court to keep a pre-petition “custodian,” which, by definition, includes the Receiver in this case, in place upon the filing of the bankruptcy petition. See also In re Statepark Bldg. Group, Ltd.,
In accordance with § 543(d) and the foregoing case law, the Court hereby expressly orders that the Receiver and Benchmark shall remain in place until further order of this Court. This portion of the Court’s Order is intended to prevent the occurrence of an event of default under the post-petition loan facility and related loan documents, such that the post-petition
Accоrdingly, the Motion to Excuse Turnover is GRANTED. The limited objections filed by Family Access Exchange (Doc. 278) and Benchmark (Doc. 279) are OVERRULED as moot.
C. No Order for Relief Will be Entered in the Involuntary Chapter 7 Case
APL argues that an order for relief should be entered in the involuntary chapter 7 case prior to the case being converted. See Doc. 284, pp. 10-11. The Court rejects this argument. It is axiomatic that only a single order for relief is entered in any given bankruptcy case. In re Clinton,
Bеcause the Alleged Debtor’s decision to convert its case to chapter 11 effectively mooted all pending issues related to the involuntary chapter 7 proceeding, the Court need not make the necessary determination under § 303(h)(1) on whether an order for relief should be entered in the chapter 7 case. This Order effectuates the conversion of the case to one under chapter 11, and constitutes an order for relief under § 348(a). All issues that were pending in the involuntary chapter 7 case pertaining to the merits under § 303(h)(1) are now moot. See In re Technical Fabricators,
D. Appointment of Chapter 11 Trustee: § 1101
Having granted conversion, the Court was left with a decision at the Hearing as to whether to appoint a chapter 11 trustee, or whether to postpone that decision to a later date. Specifically, counsel for the Alleged Debtor articulated due process concerns, essentially arguing that § 1104(a), which governs the appointment of a chapter 11 trustee, requires “notice and a hearing” and that no such notice — or at least insufficient notice of the Court’s intention to possibly appoint a chapter 11 trustee — had been provided. Debtor’s counsel also objected to the appointment of a trustee on substantive grounds, arguing that upon conversion, “nothing would change.” The Debtor acknowledged that the Receiver would remain in complete control of the Debtor’s cash and other assets, and that Benchmark would remain in charge of the daily on-site operations of the resort property. Accordingly, Debtor contended, the status quo would be pre
1. Due Process Concerns
Section 1104(a) does require notice and a hearing before a trustee can be appointed. However, under the rules of construction of the Bankruptcy Code contained in § 102, which apply to all seсtions of the Code, the phrase “after notice and a hearing” means “after such notice as is appropriate in the particular circumstances, and such opportunity for a hearing as is appropriate in the particular circumstances.” 11 U.S.C. § 102(1)(A). This definition informs of an underlying policy that certain bankruptcy eases, by necessity, must be handled expeditiously. It also provides flexibility in an atmosphere in which bankruptcy courts are often faced with urgent matters that require hearings to be scheduled on short notice. In re Casco Bay Lines, Inc.,
In fact, notice has even been held to be sufficient when such notice was provided for the first time during the course of an ongoing hearing. See In re Bibo, Inc.,
In contrast to In re Bibo, the Court in this case placed the parties on notice— eleven days prior to the Hearing — of the possibility that a chapter 11 trustee could be appointed. Under the foregoing case law, that time period is not so short or inadequate as to constitute a violation of due process rights. Moreover, the Alleged Debtor was permitted to cross-examine the Receiver, the only witness called at the Hearing, whose uncontroverted testimony played a pivotal role in the Court’s decision to appoint a trustee. The Court is satisfied that the Alleged Debtor knew of the potential to appoint a chapter 11 trustee and had a meaningful opportunity to be heard on that issue.
2. Merits of the Appointment of the Chapter 11 Trustee
In the context of an appointment of a chapter 11 trustee, a full evidentiary hearing is not required, as courts enjoy wide discretion under § 1104(a)(2) to appoint a trustee. In re William A. Smith Constr. Co., Inc.,
The. Court found the Receiver’s testimony to be convincing. The Receiver has a wealth of experience in this field, having served as a receiver on over 150 occasions. The Receiver also has been involved in many bankruptcy cases over the course of his career. He is knowledgeаble about the local business community and well-respected by its members. The Receiver has been in control of the particular resort property owned by the Alleged Debtor and the property’s operations for nearly two years. The Court finds the Receiver’s overall impressions about this case — and, specifically, the potential benefit that a chapter 11 trustee would bring to the case — to be extremely credible.
The Receiver testified that the warring factions in this case have been disruptive to his and his employees’ efforts to operate the property. The Receiver also described a recent sequence of events in which his authority to vote on behalf of a block of 300 voting interests/owners at the resort, including the commercial component of the property (the ownershiр of which remains in dispute), has been challenged by a lawyer from the Alleged Debtor’s counsel’s current law firm (i.e., a colleague of the Alleged Debtor’s current bankruptcy counsel). This challenge concerns the Court, because it suggests that if the Alleged Debtor were allowed to operate as a debt- or-in-possession, it may simply forgo voting on behalf of the commercial component in a manner beneficial to the estate, as the Receiver has attempted to do. The fact that a lawyer from the Alleged Debtor’s own law firm has challenged the Receiver’s voting authority implicates conflicts of interest between the Debtor’s own agenda and its fiduciary duties to the estate as a debtor-in-possession.
Finally, the Court notes that the proposed plan sponsor, Gulfwater, is also owned both directly and indirectly by PZS and their family members. While Gulfwa-ter has characterized its projected $5 million loan as a capital/equity infusion (as opposed to a loan/new indebtedness), the similarity in the ownership structure between the Debtor and Gulfwater gives the Court pause for concern. Gulfwater may be a perfеctly acceptable investor or lender for infusing badly needed capital into the Debtor’s operations to help facilitate its reorganization effort. The Court’s concerns are not so much focused on the motivations of Gulfwater for sponsoring a plan, but rather on the decision of whether to enter into an agreement with Gulfwater, in the first instance, is in the best interest of creditors and the estate. The Court believes that this decision is best left to a disinterested trustee performing the duties enumerated under § 1106(a), instead of a debtor-in-possession that is controlled by one of two warring factions seeking to oust the other from maintaining ownership and/or control of the resort.
Underlying the Court’s concern is its observation that both factions have exhibited a willingness throughout this case to spend seemingly limitless sums on attorneys’ fees in order to prolong their litigation in the hope of gaining the upper hand for ownership or control of the Debtor. A chapter 11 trustee comes with none of the attendant biases of the warring factions. A trustee can investigate Gulfwater’s sponsored plan and offer of capital/equity infusion, independent of the existence of any interests that might be considered adverse to the estate. And, if necessary, a trustee could solicit and evaluate other plans, formulate her own plan, decide whether it is desirable to continue the business operations altogether (or, alternatively, liquidate assets), recommend conversion of the case back to chapter 7, and otherwise manage the affairs of the Debtor, including deciding whether to object to claims or to pursue causes of actions available to the estate. In other words, the Court is not convinced, based on the totality of circumstances presented, that these important fiduciary duties will be performed as expected without the intervention of a disinterested trustee.
Under § 1104(a)(2), the Court is required to appoint a trustee if such appointment is in the best interest of creditors, any equity security holders, and other interests of the estate. In making its deter
In addition to the concerns expressed above, the Receiver implored the Court at the Hearing to appoint a trustee, noting that the case “cries out” for one. The property manager and creditors who attended the Hearing were likewise unanimous in their support for a trustee. In light of (i) the lack of confidence in the Debtor expressed at the Hearing by both the creditor body and the neutral Receiver, and (ii) the potential for conflicts of interest to arise and for fiduciary duties to be ignorеd, the Court finds that the appointment of a disinterested chapter 11 trustee whose allegiance to the estate is unassailable would best serve the interests of creditors and the estate.
Furthermore, the Court agrees with Judge Bernstein’s analysis in In re Euro-American that the termination of exclusivity may actually be a positive development insofar as other parties are permitted to file a competing plan, thereby fostering an atmosphere of competition that may prove beneficial to all parties involved. In re Euro-American,
That the parties have been embroiled in these hotly contested, heavily litigated and expensive disputes for years on end — exhausting the limited resources of both the state and federal court systems — brings the Court to its final point. In In re United States Mineral Products Co.,
VII. Conclusion
For the reasons stated above, as well as the reasons stated orally on the record at the Hearing, which constitutes the findings of facts and conclusions of law, pursuant to Rule 7052 of the Federal Rules of Bankruptcy Procedure, and the decision of the Court on any issue not addressed in this Order, it is hereby
It is further ORDERED that APL’s Chapter 11 Trustee Motion (Doc. 285) is GRANTED in that a chapter 11 trustee will be appointed. The United States Trustee is forthwith directed to appoint a chapter 11 trustee in this case.
It is further ORDERED that the Debt- or’s Motion to Excuse Turnover (Doc. 270) is GRANTED. The Receiver (or the “Property Manager,” as that term is defined in the post-petition loan agreement) shall continue to remain in control, possession, operation, and management of the “Project,” as that term is defined in the post-petition loan agreement. Further, the Receiver or “Property Manager” shall retain control over all disbursements of funds of and from the bankruptcy estate, until further Order of this Court.
It is further ORDERED that the objections filed at Doe. 248 and Doc. 261 in opposition to the Motion to Convert are OVERRULED, and the limited objections filed at Doc. 278 and Doc. 279 are OVERRULED as moot.
DONE AND ORDERED.
Notes
. The term "Alleged Debtor” is used to refer to a debtor in an involuntary case prior to the entry of an order for relief. In this case, prior to this Court’s June 19, 2012 ruling granting the Alleged Debtor’s motion to convert its case to chapter 11, no order for relief had been entered in the involuntary chapter 7 case. Upon conversion to chapter 11, however, the Court refers to the Alleged Debtor simply as the "Debtor.”
. Throughout the case, the parties have referred to the development as consisting of two main parcels: the "East Parcel” and the "West Parcel.” On the West Parcel lies the hotel, which overlooks the marina. The commercial component, which consists of a number of retail stores known as The Shoppes at Naples Bay Resort, sits on the ground level of the hotel. The East Parcel houses the condominium units and clubhouse and its related amenities, including the pools, fitness center, and tennis courts.
. One of the disputes that arose in this case was the extent of the resort property that wаs actually owned by the Alleged Debtor. This issue arose in the context of the post-petition financing provided by Family Access Exchange, LLC, pursuant to § 364. The parties disagreed as to whether the Alleged Debtor or a different, non-debtor entity known as Knightsbridge Partners of Naples, LLC ("Knightsbridge”) owned the commercial component of the property, and thus whether the Alleged Debtor could pledge the commercial component as collateral for its loan from Family Access Exchange. The parties were able to fashion language acceptable to the lender that postponed the resolution of this issue to a later date. However, this issue remains unresolved, and the Receiver testified that this pending dispute has caused problems, as detailed later in this opinion, concerning the voting rights that can be exercised on behalf of the owner of the commercial component of the resort property.
. Doc. 248, 261, 278, 279.
. The Alleged Debtor filed an unofficial proposed plan of reorganization as an exhibit to its Motion to Convert.
. See In re Eugene Alexander, Inc.,