OPINION AND ORDER GRANTING MOTION OF COMMONWEALTH CONSTRUCTION CORPORATION, ET AL TO CONVERT CHAPTER 11 CASE TO CHAPTER 7 CASE AND DISMISSING UNITED STATES TRUSTEE’S MOTION TO APPOINT CHAPTER 11 TRUSTEE AS MOOT
This matter is before the Court on the motion of Commonwealth Construction Corporation, Merit Plumbing, Inc., Country Construction, Inc., Transtar Electric, Inc., Active Building Systems, Guardian Insulation, Inc., and Carrier Michigan Co. (collectively the “Moving Creditors”) to convert the chapter 11 bankruptcy case of Citi-Toledo Partners (“Toledo I”) to a case under chapter 7 pursuant to 11 U.S.C. § 1112(b). The United States Trustee (“UST”) has moved for the appointment of a chapter 11 trustee under § 1104. Toledo I has filed objections to the aforementioned motions. Upon consideration of the evidence adduced on the parties’ respective motions, the Court finds that the Moving Creditors’ motion is well taken and should be granted. The Court further finds that the UST’s motion should be dismissed as moot.
FACTS
Toledo I and Citi-Toledo Partners II (collectively the “Toledo Partnerships”) are limited partnerships which were formed in 1990 in order to construct and operate multi-family low income housing units in Maumee, Ohio. The Court shаll hereinafter refer to the properties owned by the Toledo Partnerships collectively as the “Project”.
The Project consists of a 160 unit multifamily apartment complex which is approximately 90% complete. The general partners of Toledo I and Citi-Toledo Partners II (“Toledo II”) are Gary Lefkowitz (“Lefkowitz”) and City Equity Group, Inc. (“CEG”). Lef-kowitz formerly served as the president of CEG.
The Moving Creditors’ claims arose from the construction of the Project. Construction оn the Project began in June 1993. Thereafter, in November of 1993, construction was discontinued when the Toledo Partnerships failed to make payments on the debts incurred on the Project.
Prior Proceedings in This Court
A number of the Moving Creditors filed involuntary chapter 7 petitions against the Toledo Partnerships on December 9, 1993.
The Toledo Partnerships moved to transfer venue of their bankruptcy cases to the
On April 12, 1994 the Court entered a consent order which constituted an order for relief pursuant to § 303 (the “Consent Order”). The Consent Order converted the Toledo Partnerships’ involuntary chapter 7 cases to voluntary bankruptcy cases under chapter 11.
The Consent Order directed the Toledo Partnerships to file statements of financial affairs and schedules of assets and liabilities within 30 days of the entry of the Consent Order. The Consent Order further directed the Toledo Partnerships to appear at a meeting of creditors conducted by the UST pursuant to § 341 and § 521.
Toledo I also sought an additional ex parte extension of time until May 19,1994 to file its bankruptcy schedules.
Proceedings in Other Jurisdictions Involving the Toledo Partnerships’ General Partners
Lefkowitz was indicted in May of 1994 for his alleged fraudulent activities in marketing and managing partnerships in which Lefkow-itz and CEG were general partners during Lefkowitz’s tenure as president of CEG (the “Indictment”).
Certain of the creditors оf CEG (the “Minnesota Creditors”) filed an involuntary bankruptcy petition under chapter 11 in the United States Bankruptcy Court for the District of Minnesota on May 18, 1994 (the “Minnesota Court”). On the same day, the Minnesota Court ordered that a trustee be appointed in CEG’s bankruptcy case (the “Trustee Order”).
However, the Minnesota Court stayed the Trustee Order on May 26, 1994 (the “Stay Order”) in light of a stipulated agreement (the “Management Stipulation”) entered into between the Minnesota Creditors, CEG and Weybridge, Inс. (“Manager”). The Stay Order incorporates both the Management Stipulation and a management agreement entered into between CEG and Manager (the “Management Agreement”).
The Stay Order provides that the Trustee Order will “become fully effective” upon the expiration of the Management Stipulation which expires upon the earlier of 60 days from the date of the Stay Order, termination of the Management Agreement, or a default by the parties to the Mаnagement Stipulation.
The Management Agreement expressly provides that “[t]he actions of Manager ... shall be solely as agent for [CEG], and Manager does not assume any fiduciary relationship with or for [CEG]”. See Management Contract, at p. 1, para. 1.2. Further, the Stay Order states that the Manager is not “deemed to be a custodian, trustee, marshall, or other officer of the court within the meaning of 18 U.S.C. § 154”.
Notwithstanding the fact that the Manager is not liable as a fiduciary of CEG’s estate, thе Management Stipulation provides that the Manager “[will] have, consistent with the Management Contract, the right to make all decisions with respect to the operations of [CEG and certain entities controlled by CEG]”. See Management Stipulation, at p. 7, para 4. The Management Agreement delegates substantially all of the CEG’s fiduciary duties to the Manager. See Management Agreement, p. 4-5, para. 4.4. Included within the Manager’s duties is the task of “directpng] and instruct[ing] counsel for [CEG] and other professionals employed by [CEG]”. See Management Agreement, at p. 3, para. 4.1(e).
Testimony at the Hearing on the Instant Motions
At the hearing, Kenneth Minnichiello (“Minnichiello”), president of Commonwealth Construction Corporation, testified that his company managed the construction work performed on the Project in accordance with a contract between the parties.
Minnichiello testified that, although the Toledo Partnerships experienced cash flow difficulties in July of 1993, his company continued to construct approximately 40% of the Projеct in reliance upon misrepresentations by CEG that CEG had sufficient funds to complete construction on the Project.
Minnichiello testified that Commonwealth has been required to furnish a security guard
The Moving Creditors also presented the testimony of Michael Jacobson (“Jacobson”) who is employed with CED Construction, Inc. (“CCI”), a company which specializes in developing and constructing multi-family housing projects ranging in size from 100 units to 500 units. A number of CCI’s properties have been allocated low income housing tax credits. Although Jacobson testified that he has only recently been employed by CCI, Jacobson has been a member of the Michigan Bar for approximately 30 years and has specialized in the area of real estate transactions.
According to Jacobson, the low income housing tax credit is an income tax credit awarded by state agencies for multi-family low income housing properties based upon an allocation formula determined by such state agencies. The amount of the low income housing tax credit (“Credits”) awarded represents a function of several factors including the cost of constructing such low income housing. Jacobson testified that the amount of financing available for low income housing tax credit properties is typically lower than that available for conventional properties because the rents which may be charged for low income housing tax credit properties are generally lower than for conventional prоperties.
Jacobson testified that, preliminarily, he estimated the value of the Project’s real estate would be “at least” equal to the aggregate book value of the real estate listed in Toledo I and Toledo II’s bankruptcy schedules if the Project could obtain Credits.
Although Jacobson testified that a developer in Ohio is by no means guaranteed an allocation of Credits, he stated that the Project could potentially generate $500,000-$600,000 in Credits. Jaсobson testified that the Project’s market value could be substantially lower if the Project could not obtain an allocation of Credits. Indeed, Jacobson testified that if Credits should not be available for the Project, the value of the Project could be less than the total costs of construction for the Project.
Jacobson testified that the Credits which had been allocated to the Toledo Partnerships expired on December 31, 1993. The parties do not dispute this fact.
Jacobson also testified that in order to obtain an allocation of Credits for 1994, an application must be filed by a developer with the State of Ohio on or before September 1, 1994. Jacobson testified that if an allocation of Credits was not obtained for the Project in 1994, the next available opportunity for a developer to obtain Credits for the Project would be in May, 1995.
Jacobson testified that, generally, the value of a real estаte property is impaired the longer it remains idle. In Jacobson’s view, such properties typically require a period of “rehabilitation”.
CEG provided the testimony of Bruce Mallory (“Mallory”) a principal of Business Consultants, Inc. which has been appointed to represent CEG’s creditors in the Minnesota Court. Mallory testified that, in light of the fact that he has only recently been retained to represent the creditors in CEG’s bankruptcy case, he has no knowledge as to whether CEG is paying real estate taxes for the Toledo Partnerships or as to the location of the Toledo Partnerships’ bank accounts.
DISCUSSION
WHETHER THE CREDITORS HAVE ESTABLISHED “CAUSE” TO CONVERT OR DISMISS TOLEDO I’S CHAPTER 11 CASE
Applicable Statute
Section 1112(b) provides, in pertinent part, that:
on request of a party in interest or the United States trustee, and after notice and a hearing, the court may convert a case under this chapter to a case under chapter 7 of this title or may dismiss a case underthis chapter, whichever is in the best interest of creditors and the estate, for cause, including—
(1) continuing loss to or diminution of the estate and absence of a reasonable likelihood of rehabilitation!;.]
Burden of Proof
The Moving Creditors bear the burden of proof on their motion by the preponderance of the evidence.
In re A-K Enterprises, Inc.,
The Timing of the Creditors’ Motion
Preliminarily, Toledo I argues that a court may not convert or dismiss a bankruptcy case prior to the expiration of the period during which the debtor has the exclusive right to file a plan. The Court disagrees.
See In re Woodbrook Assoc.,
Continuing Loss to or Diminution of the Estate and Absence of a Reasonable Likelihood of Rehabilitation
The Court finds that the continuing diminution of the estate and the absence of a reasonable likelihood of rehabilitation of Toledo I represents “cause” for conversion or dismissal under § 1112(b).
See In re Johnston,
Section 1112(b)(1) contemplates a “twofold” inquiry into whether there has been a “continuing diminution of the estate and absence of a reasonable likelihood of rehabilitation.”
In re Photo Promotion Associates, Inc.,
First, the Court finds that there has been a diminution of the estate. “All that need be found is that the estate is suffering some diminution in value”.
In re Kanterman,
Second, the Court finds that Toledo I does not have a “reasonable likelihood of rehabilitation”.
See Clarkson,
Toledo I does not have any employees. Nor does Toledo I have any operating income which could be utilized to pay expenses such as real estate taxes. In addition, Toledo I has not demonstrated an ability to fund completion of the Project.
Furthermore, Toledo I has allowed the Project’s Credits to expire. Toledo I did not provide any evidence at the hearing indicating that it would be able to obtain Credits in the future.
Lastly, although the Bankruptcy Code contemplates liquidating plans of reorganization in certain circumstances, the Court cannot equate the determination of whether Toledo I possesses a reasonable likelihood of rehabilitation with Toledo I’s ability to effectuate a liquidating plan. C.f. § 1141(d)(3)(A) (stating that a debtor does nоt receive a discharge where “[a] plan provides for the liquidation of all or substantially all of the property of the estate”).
Conversion or Dismissal for Bad Faith
“It is well-settled that even though Chapter 11 does not expressly so state, bad faith may serve as a ground for dismissal of a petition.”
Michigan Nat’l Bank v. Charfoos (In re Charfoos),
At the hearing, Toledo I argued that its prepetition conduct is irrelevant to this Court’s analysis of whether “cause” exists to convert or dismiss Toledo I’s chapter 11 case. Similarly, Toledo I argued that its postpеtition conduct during the time that Lefkowitz was in control of CEG is irrelevant to this Court’s analysis under § 1112(b). On the contrary, however, the Sixth Circuit stated in
Charfoos
that “ ‘no list is exhaustive of all the conceivable factors that could be relevant in analyzing a particular debtor’s good faith’ ”.
Charfoos,
The Court finds Minnichiello’s testimony that CEG misrepresented its ability to obtain funds to complete the Project to be probative as to Toledo I’s lack of good faith.
Moreover, Toledo I’s unexcused failure to file its bankruptcy schedules until June 7, 1994, two days before the hearing on this matter, evinces bad faith.
See Finstrom v. Huisinga,
Significantly, as the Moving Creditors noted at the hearing, the Toledo Partnerships caused to be recorded a deed from Toledo I to Toledo II on January 21, 1994. This deed conveyed substantially all of the real estate securing Toledo II’s mortgage debt. The fact that this deed was recorded is not indicated on Toledo I’s statement of affаirs. Nor have the Toledo Partnerships provided any
Further, the Court cannot condone Toledo I’s failure to file an operating statement with the UST. As the cоurt noted in In re Berryhill,
[t]imely and accurate financial disclosure is the life blood of the Chapter 11 process. Monthly operating reports are much more than busy work imposed upon a Chapter 11 debtor for no reason other than to require it to do something. They are the means by which creditors can monitor a debtor’s post-petition operations. In re Chesmid Park Corp.,45 B.R. 153 , 159 (Bankr.E.D.Va.1984). As such, their filing is very high on the list of fiduciary obligations imposed upon a debtor in possession. In re McClure,69 B.R. 282 , 290 (Bankr.N.D.Ind.1987).
In re Berryhill,
In addition, Toledo I has failed to provide the UST with proof of liability insurance. Toledo I’s failure to provide the UST with such information hampers efforts by the UST in monitoring the estate. More importantly, if Toledo I has, in fact, failed to obtain insurance, such failure subjects the estate to potential liability for personal injuries incurred at the Project.
Despite the fact that Toledo I agreed to appear at a § 341 meeting conducted by the UST under the terms of the Consent Order, Toledo I has failed to submit to such an examination during the period subsequent to entry of an order for relief.
See In re Chandler,
The Court shares the UST’s concerns with Toledo I’s delegation of substantially all of its fiduciary duties to the Manager in light of the fact that the Manager does not bear the responsibilities of a fiduciary to this estate.
C.f. In re William A. Smith Constr. Co.,
Toledo I’s citation of
In re Cardinal Industries, Inc.
is unavailing. In
In re Cardinal Indus., Inc.,
the bankruptcy court appointed an operating trustee which trustee served as general partner in a number of limited partnerships.
See In re Cardinal Indus., Inc.,
WHETHER TO CONVERT OR DISMISS TOLEDO I’S BANKRUPTCY CASE
The Court finds that conversion of Toledo I’s bankruptcy case is warranted.
Moreover, the fact that creditors will likely enjoy greater rights in bankruptcy court than they would enjoy in stаte court militates in favor of conversion. As the court stated in In re Staff Inv. Co.,
[a] chapter 7 trustee has a veritable arsenal of bankruptcy and nonbankruptcy rights. The trustee’s basic bankruptcy avoiding powers may bear fruit. [Additionally,] [t]he trustee has a claim, based on federal law, against each of the general partners for any insufficiency of assets to pay liabilities.”
In re Staff Inv. Co.,
Furthermore, in circumstances where a debtor has faded in performing its fiduciary duties, conversion rather than dismissal is warranted.
See In re Sal Caruso Cheese, Inc.,
Most importantly, the Court finds that conversion to chapter 7 will maximize the value of the estate available to creditors. Even if the Moving Creditors had favored dismissal, the above considerations mandate conversion of Toledo I’s case.
In light of the foregoing, it is therefore
ORDERED that the Moving Creditors’ motion to convert Toledo I’s chapter 11 bankruptcy case to a case under chapter 7 be, and it hereby is, granted. It is further
ORDERED that the United States Trustee’s motion to appoint a trustee be, and it hereby is, dismissed as moot. It is further
ORDERED that, pursuant to 11 U.S.C. § 348(a), the conversion of this bankruptcy case to a bankruptcy case under chapter 7 constitutes an Order for Relief under Chapter 7 in the bankruptcy ease of Toledo I. It is further,
ORDERED that pursuant to § 348(c) and 11 U.S.C. § 342, the Clerk of this Court shall give “such notice as is appropriate of an Order for Relief in a case under this Title.” It is further
ORDERED that, pursuant to Bankruptcy Rules 1019(2) and 2002(f)(4), the Clerk of this Court shall give notice of the entry of this Order of conversion. It is further,
ORDERED that, pursuant to Bankruptcy Rule 1019(5), CEG shall forthwith turn over to the Interim Chapter 7 Trustee, all records and property of the estate in its possession or control. It is further,
ORDERED that Toledo I, by its general partners CEG and Lefkowitz, prepare and file in this Court, within 30 days of the date of this Order, a separate schedule listing unpaid obligations incurred after the filing оf the petition under Chapter 11, including the amounts owing, the creditors’ names and their addresses or places of business, including matrix, and a statement of all contracts, executory in whole or in part, assumed or entered into after the filing of the petition, together with a final report and account showing all receipts and disbursements of funds, in accordance with Rule 1019(5), Rules of Bankruptcy Procedure. It is further
ORDERED that CEG and Lefkowitz shall each file with the Court statements of their individual assets and liabilities within 30 days from the date of this Order pursuant to Bankruptcy Rule 1007(g).