In re Hunter
This matter coming before the court on February 6, 2019 on the Debtor's Motion to Convert this case from Chapter 7 to Chapter 11 (the "Motion"). At the hearing, Thomas W. Waldrep, Jr. and John R. Van Swearingen appeared on behalf of the Debtor, Ellis B. Drew, III appeared on behalf of Mountain Commerce Bank ("MCB"), Kiah T. Ford IV appeared on behalf of Todd O'Gara and Wanu Water, Inc. ("Wanu"), Robert E. Price, Jr. appeared on behalf of the Bankruptcy Administrator, and C. Edwin Allman, III, the Chapter 7 trustee, also appeared. Having considered the Motion and all other matters of record, including those incorporated through judicial notice, the evidence presented at the hearing, and the arguments of counsel, the court finds and concludes as follows:
BACKGROUND
The Debtor filed a voluntary petition for relief under Chapter 7 of the Bankruptcy Code on October 17, 2018 (the "Petition Date"), and C. Edwin Allman, III was appointed to serve as Chapter 7 trustee (the "Trustee"). On the Petition Date the Debtor, who holds an MBA from Wake Forest University, was earning income as an independent contractor with a three-month contract with Musubu, a local technology company, in the amount of $ 12,500.00 per month. His original Schedule I showed household income of $ 15,500.00, and original schedule J showed expenses of $ 14,759.31, leaving net income in the amount of $ 740.69. The Schedule I indicated that the Debtor did not expect any increase or decrease in income within a year. Shortly after the Petition Date, the Debtor was offered a position as a director
The Debtor's schedules and statement show that prior to obtaining employment with Musubu, the Debtor had been in severe financial distress for a number of years. His Statement of Financial Affairs ("SOFA") lists gross income of $ 9,259.00 for 2018 as of the Petition Date, and $ 14,122.0 for 2016.
Also on his Schedule A/B, the Debtor lists a civil action pending in the United States District Court for the Middle District of North Carolina, Case No. 15-CV-1050 styled Gregory Hunter and Hunter Family Capital, LLC v. Mountain Commerce Bank and Bobby A. Brown (the "Civil Case") which the Debtor valued at $ 3,000,000.00.
On December 13, 2018, the Trustee filed a Motion for Approval of Settlement of Disputed Claim against MCB and Bobby A. Brown (Docket No. 21) seeking approval of a proposed settlement of the Debtor's claims in the Civil Case for the sum of $ 150,000.00 along with subordination of MCB's claim in the bankruptcy case. This settlement would not affect the Hunter Family Capital claim against MCB. In response, the Debtor has filed the Motion seeking to convert to Chapter 11. His stated intent is twofold: (1) he wishes to incorporate his postpetition income into his bankruptcy estate
DISCUSSION
Section 706 of the Bankruptcy Code provides in relevant part
(a) The debtor may convert a case under this chapter to a case under chapter 11, 12, or 13 of this title at any time, ifthe case has not been converted under section 1112, 1208, or 1307 of this title. Any waiver of the right to convert a case under this subsection is unenforceable.
....
(d) Notwithstanding any other provision of this section, a case may not be converted to a case under another chapter of this title unless the debtor may be a debtor under such chapter.
Though § 707(a) gives a debtor broad authority to convert, the Supreme Court has interpreted § 707(d) to limit a debtor's right to convert a Chapter 7 case to a case under Chapter 13. Marrama v. Citizens Bank of Mass. ,
Though Marrama addresses a Chapter 7 debtor's conversion to Chapter 13, courts have found its analysis applicable where a Chapter 7 debtor seeks to convert to Chapter 11, reasoning that § 1112(b) serves the same purpose as § 1307(c). In re Woodruff,
Here, the Respondents point to a substantial or continuing loss to the estate along with the absence of a reasonable likelihood of rehabilitation,
Section 1112(b)(4)(A)
Section 1112(b)(4)(A) provides that cause exists to dismiss or convert a case if the movant establishes both (1) substantial or continuing loss to or diminution of the estate post-petition, and (2) the absence of a reasonable likelihood of rehabilitation. Under the first prong, substantial or continuing loss to or diminution of the estate, the "loss or decline in value must be either substantial or continuing, but need not be both." In re Paterno,
Rehabilitation is a more demanding standard than reorganization, and is defined by whether the debtor will be able to reestablish his business on a firm, sound basis ... Where a debtor proposes a plan of pure liquidation, there is no likelihood of rehabilitation. Thus, rehabilitation depends upon establishing a cash flow from which current obligations can be satisfied. This prospect must be premised on objective facts, not merely speculative data, and is determined by the Court based on evidence presented at the hearing.
In re Paterno ,
Two cases in which courts have allowed a Chapter 7 debtor to convert to a Chapter 11 case and have analyzed the conversion request pursuant to § 1112(b)(4)(A) are instructive. In In re Basil Street Partners, LLC , the court found that the second prong of § 1112(b)(4)(A) could not be proven by an objecting creditor when an entity related to the involuntary Chapter 7 corporate debtor proposed a $ 5 million equity infusion to the debtor's business. In re Basil St. Partners, LLC ,
Cases in which courts have found cause under § 1112(b)(4)(A) to deny a motion to convert a Chapter 7 case to Chapter 11 are similarly instructive. In In re Woodruff , a voluntary Chapter 7 debtor requested conversion to a Chapter 11 after inheritance of stock valued at $ 120,000.00. In re Woodruff ,
Similarly in Braunstein v. Waller , the district court affirmed the bankruptcy court's denial of a voluntary Chapter 7 debtor's motion to convert to Chapter 11 that was filed after the Chapter 7 trustee filed a motion to approve bid procedures of certain property. Braunstein v. Waller , No.
In In re Gordon , the 80-year old Chapter 7 debtor had drafted a four-year plan which provided for her to sell her assets, and that upon such sale, her creditors would be paid in full. In re Gordon , No. 312-09605,
In the present case, the Debtor offered extensive testimony in conjunction with a "liquidation analysis" that he had prepared comparing his Chapter 7 with a hypothetical Chapter 11. The Debtor calculates that unsecured creditors would recover 18 cents on the dollar in a Chapter 7, but no less than 51 cents on the dollar through a Chapter 11 plan.
The Debtor also presented an overview of the basis for the claims he asserts in his Civil Case, as well as expert witness reports and various exhibits that could be used to support his claims. As for damages, the Debtor asserts that he and Hunter Family Capital could be awarded as much as $ 3,000,000.00. In response, the Respondents pointed out significant weaknesses in the Debtor's claims in the Civil Case. MCB estimates that even in the event the Debtor is successful, the damage award would be less than $ 100,000.00. The Debtor admitted that while he included damages for Hunter Family Capital in his analysis, he was not familiar with Hunter Family Capital's basis for damages as he had not "looked at it in a while."
While the parties agree on little, the court finds that the following basic facts were established at the hearing,
- The Debtor established that he currently has monthly gross income of $ 12,916.00. His latest Amended Schedule J shows a proposed budget should his case be converted to Chapter 11. Because he has not yet adopted this budget, the net income as reflected on his latest Amended Schedule J is speculative.
- Debtor's counsel in the Civil Case, Kevin Cartledge and Spilman Thomas & Battle, have agreed to waive their prepetition claims in the amount of $ 187,429.92 against the Debtor if they are allowed to represent him going forward for a 40% contingency fee.
- MCB asserts a claim against the Debtor based on a promissory note in the amount of approximately $ 490,000.00. The Debtor listed this claim (in the amount of $ 500,000.00) as disputed on his schedules.
- Whether the Debtor will be successful in the Civil Case, and whether any damages will be awarded if the Debtor is successful, is speculative.
- If the Debtor converts to Chapter 11, the Debtor will incur administrative expenses. Neither the Debtor's latest Amended Schedule J nor his Chapter 11 liquidation analysis include an amount for Chapter 11 administrative expenses.
The Debtor asks to convert to Chapter 11 so that he can regain control of the Civil Case and withdraw from the settlement agreement. Conversion will, in effect, result in the immediate loss of $ 150,000.00 from the estate as well as the loss of MCB's agreement that it will not participate in the dividend available to creditors from these funds. The court finds that the loss of the Trustee's settlement agreement is a substantial post-petition loss to the estate, and that the first prong has been met.
Turning to the second prong, absence of a reasonable likelihood of rehabilitation, it is this issue that goes to the heart of the Debtor's motion to convert. With the Trustee's settlement agreement, the estate will have $ 150,000.00 in funds available for
As set forth above, neither the Debtor's net income nor the value that he places on the Civil Case are based on objective data; these figures are based on speculation and therefore do not support a finding of a reasonable likelihood of rehabilitation. Looking at his net income, not only is the figure speculative, it is clear that the Debtor has not given proper consideration to the costs of a Chapter 11, such as quarterly fees, attorney's fees, and litigation costs. As the Trustee bluntly points out, if the litigation is resolved unfavorably, there is no way the Chapter 11 can continue-fees will outpace any small net monthly income the Debtor might have. The court must agree.
Similarly, even according to the Debtor's own analysis, the amount of his claim against MCB is speculative. This court will not delve into the relative merits of the Civil Case other than to conclude that continuation of the litigation subjects the Debtor's creditors to substantial risk. The Debtor asserts that even in a "worst-case scenario" in which the claim against MCB resolves with no benefit to the estate, a Chapter 11 would still yield a slightly higher return to unsecured creditors than the Chapter 7. Unfortunately, as pointed out by the Respondents, the Debtor fails to include amounts for either MCB's $ 490,000.00 claim or a claim on behalf of Wanu. As an independent party with a fiduciary duty to liquidate the property of the estate in a manner that is in best interest of the parties in interest, the Trustee is in a better position to objectively weigh the risks and benefits than the Debtor, who has been embroiled in the litigation for years.
In summary, the immediate loss that the estate would suffer from withdrawal of the settlement agreement is a loss from which it appears unlikely that the estate could ever recover. To the extent that the Debtor purports to be seeking rehabilitation, the court cannot find that it is reasonably likely he would succeed in that endeavor. The Debtor's contention that he desires to contribute his net monthly income to his creditors through a Chapter 11 plan is discounted by the court due to the relatively insignificant increase in income since the Petition Date, $ 416.00, and his admission that he has not yet attempted to adhere to his proposed budget. The Debtor's core motive for conversion is not rehabilitation, but to regain control of the Civil Case so he can continue to litigate. Given the substantial loss the estate would suffer upon conversion and repudiation of the settlement agreement and the absence of a reasonable likelihood of rehabilitation the court finds cause under § 1112(b)(4)(A).
The Absence of Good Faith
The Fourth Circuit has held that filing in good faith is an implicit requirement in seeking relief under the Bankruptcy Code, and that the absence of good faith can constitute cause for dismissal. Carolin Corp. v. Miller ,
Here, the court has already found the absence of a reasonable likelihood of rehabilitation and finds that its analysis on that issue goes to objective futility. In re Rain Tree Healthcare of Winston-Salem, LLC ,
Turning to the subjective inquiry, in considering the totality of the circumstances, courts look for various indicia and patterns that might suggest bad faith though "there is no single factor that will necessarily lead to a finding of bad faith." Carolin ,
The Debtor admits that he did not disclose on his SOFA a gratuitous transfer of 30% of his membership interest in Hunter Family Capital to his three children within two years of the Petition Date. At the hearing, he explained that he did not know the transfer had been within two years. This explanation is not sufficient. In exchange for a fresh start, the Bankruptcy Code requires debtors to provide accurate, honest, and complete information on their schedules and statements. The Debtor's apparent failure to review his financial records not does excuse him from this requirement. Also, the Debtor did not disclose a conveyance made on May 14, 2018 to his parents in the form of a second deed of trust on his home to secure a debt he owed to them dating from 2017, and he overstated the amount of the debt, listing it as $ 90,000.00 instead of $ 39,000.00. While the Debtor explained that he did not understand that the deed of trust was a transfer, this explanation carries little weight in light of the Debtor's education and professional experience, as well as the fact that the Debtor was represented by sophisticated bankruptcy counsel who assisted him with the preparation and filing of his schedules and SOFA. The Trustee indicates that the Debtor has now provided him with corrected information and has diligently responded to any of his requests for information. While not all of the points brought out by the Respondents are given credence in the absence of specific evidence, it remains of concern to the court that the Debtor's amended schedules and his SOFA have not corrected these particular misstatements and omissions, and that some of these inaccuracies revolve around
Of further concern is the Debtor's attempt to exercise control over and interfere with property of the estate. Upon the filing of the bankruptcy petition, the Debtor's interest in the Civil Case vested in the bankruptcy estate to be administered by the Trustee.
[T]his court does not intend to issue an order on the summary judgment motion until some time following the February 6, 2019 [bankruptcy court] hearing. While counsel for Plaintiffs may be correct that a favorable opinion and order on summary judgment 'could dramatically affect the outcome of the motion to approve any agreement to settle in the bankruptcy matter,' (Doc. 66 at 2), an unfavorable ruling could correspondingly undermine any agreement between the Trustee and Defendants.
In his response in support of his Motion (Docket No. 67), the Debtor counters that he did not file the pleading in the Civil Case individually, that it was filed on behalf of Hunter Family Capital. Moreover, the Debtor asserts that the pleading was informational only. At the hearing, Mr. Cartledge testified that he acted under the direction of Mr. Waldrep. As to these explanations, the court can only note that the pleading in question, Docket No. 66 filed in the Civil Case, clearly begins "NOW COME Plaintiffs Gregory Hunter and Hunter Family Capital, LLC (collectively, the 'Plaintiffs')...." and it concludes with a "request" that the court enter a memorandum opinion on summary judgment without delay.
And so, the Debtor argues that he has provided explanations for any issues with his schedules and statements, as well as his attempt to usurp control of estate property from the Trustee, and that the record does not reflect the type of bad faith conduct that has previously disqualified Chapter 7 debtors from converting their cases in this district. In In re Southern , the bankruptcy court denied a Chapter 7 debtor's motion to convert to Chapter 13 after finding that the debtor had failed to disclose assets and transfers on his schedules and statements, was untruthful at his § 341 meeting, and intentionally hid an asset in an effort to defraud creditors. In re Southern , No. 10-50713,
Finally, there is a question as to whether the Debtor's primary motive for conversion-to stop the settlement agreement-is in and of itself indicative of bad faith. See In re Ordonez , No. BR 10-37596,
Courts have found that using Chapter 11 to speculate that a single asset will provide a "one-shot profit" at the creditor's risk is an impermissible purpose and indicates bad faith. Carolin,
The Debtor's bankruptcy process began with his decision to file his Chapter 7 petition and statements and schedules disclosing his assets, liabilities, and financial transactions. He filed his voluntary Chapter 7 petition listing one significant nonexempt asset of value, his claim against MCB, to be administered by the Chapter 7 Trustee. When the Trustee negotiated a settlement agreement to liquidate this primary asset of the estate, the Debtor filed the Motion and interfered in the Civil Case, risking the value of the asset to the detriment of his creditors. The Debtor's business decision several years ago to develop East Coast Wings franchises in Tennessee shows that he took a risk to leave his employment at Oppenheimer to embark on that venture. As a result of taking that risk he has incurred substantial unsecured debts. Now, the Debtor is asking that the court allow him to take another risk-that of converting his case, repudiating the Trustee's proposed settlement with MCB, and going forward with his lawsuit
CONCLUSION
Based upon the foregoing, the court finds that Respondents have shown by a preponderance of the evidence that cause exists under § 1112(b). A separate order denying the Motion will be entered.
Notes
Since the Debtor affirmatively indicated on his Schedule I that he expected his present income to continue, it appears that the Debtor had been offered long-term employment with Musubu prior to the Petition Date.
The employment income as listed on the Debtor's SOFA does not match the Debtor's testimony at the February 6 hearing. The Debtor testified that he had a three-month employment contract at $ 12,500.00/month starting in August 2018. He also testified that he taught a 30-day course in 2017 at the Wake Forest University business school. The Debtor lists only $ 9,259.00 for year-to-date employment income in 2018 as of the October Petition Date. The Debtor lists no employment income for 2017.
Hunter Family LLC should have been listed as Hunter Family Capital, LLC.
At the February 6 hearing the Debtor clarified that he valued his individual claim against MCB and the Hunter Family Capital claim against MCB together for a total of $ 3,000,000.00. The Debtor did not list the federal court case but a state court case in Forsyth Superior Court, Case No. 15 CVS 6949 with a value of $ 3,000,000.00 in his Schedule A/B.
This is the same entity listed in Debtor's Schedule A/B as Kingsley Investment Group, LLC.
The Debtor originally owned a 50% interest in Hunter Family Capital, but transferred 30% of his interest (15% of Hunter Family Capital) to his children within two years prior to the Petition Date. In addition, it was stipulated at the February 6 hearing that due to missed capital calls in Kingsley Investments, the Hunter Family Capital percentage ownership in Kingsley has decreased, but the amount of such decrease is uncertain.
Although the Debtor claims he wants to convert to include his postpetition income into his bankruptcy estate, he did not file his Amended Schedules I and J until January 4, 2019, showing $ 1,156.69 in net monthly household income, along with the Motion, two months after he started his full-time job with Musubu and three weeks after the Trustee filed the Motion for Approval of Settlement.
Todd O'Gara and Wanu Water, Inc. are listed on Debtor's Schedule E/F with the amount of the claim listed as unknown and are plaintiffs in a lawsuit against the Debtor, O'Gara et al. v. Hunter, 18-CV-00825, pending in the United States District Court for the Middle District of North Carolina, asserting claims for tortious interference with business relations, tortious interference with contract, negligent misrepresentation, violation of unfair competition laws, libel, and civil conspiracy. They have also filed an adversary proceeding, O'Gara et al. v. Hunter, Ad. Proc. No. 18-6036, requesting a determination that their claims are nondischargeable.
MCB is listed on Debtor's Schedule E/F with a disputed claim in the amount of $ 500,000.00 based on a promissory note.
Neither the Debtor's Chapter 7 liquidation analysis nor his Chapter 11 liquidation analysis comply with the priority scheme set forth in the Bankruptcy Code.
The Debtor's prosecution of his Civil Case relies in part on expert witness reports and testimony. The Debtor's experts are listed as a prepetition creditors on his schedules. The Debtor contends that these experts are willing to waive their substantial prepetition fees. But there is no indication that these experts would also waive their fees for providing expert testimony at the trial.
The Debtor argues that he can increase his net income as shown on his proposed Amended Schedule J by "tightening his belt." It is clear from the Debtor's statements and schedules that he has been in severe financial distress for a number of years. The court finds it difficult to fathom that the Debtor has not already tightened his belt to the extent he is willing and able to do so.
At the Debtor's request, this court has taken judicial notice of the matters of record in the Civil Case.
The Debtor's litigation counsel for the Civil Case supports the Motion, but in the event of success, would have the advantage of having a Chapter 11 administrative claim due to the contingency fee arrangement rather than a prepetition, general unsecured claim.