In re Paterno
MEMORANDUM OPINION AND ORDER
THIS MATTER сame before the Court for hearing on May 22, 2014, after due and proper notice, upon Motion by ArborOne FLCA (“ArborOne”) to Convert Chapter 11 Case to Chapter 7 pursuant to 11 U.S.C. § 1112 and Federal Rules of Bankruptcy Procedure 1017, 9013, and 9014. Appearing before the Court was James White and Michelle Walker, counsel for Charles Franсis Paterno, Jr. and Jacquelyn Nye Paterno (collectively, the “Debtors”); Christine Myatt, counsel for Arbo-rOne; and Robert E. Price, Jr. on behalf of the Bankruptcy Administrator’s office. The male Debtor, Charles Francis Pater-
I. PRE-PETITION BACKGROUND
Beginning in the early 2000s, Mr. Pater-no became actively involved in the promotion of autoclaved aerated concrete (“AAC”), a thermally insulating lightweight concrete-based product used for internal and external construction. As a substantial shareholder in Carolina AAC, LLC (“Carolina AAC”) and Carolina AAC Development, LLC (“Carolina AAC Development”), Mr. Paterno initiated construction on an AAC plant in South Carolina in 2010. Funding for this construction was provided primarily by ArborOne through the purchase of bonds. Specifically, on November 30, 2010, Carolina AAC made, executed, and delivered a series of Senior Secured Private Placement Taxable Bonds, Series 2010A, in the aggregate principal amount of $6,361,200.00, and a series of Senior Secured Taxable Private Placеment Bonds, Series 2010B, in the aggregate principal amount of $706,800.00 pursuant to a Trust Indenture dated November 1, 2010, wherein Carolina AAC agreed to issue and ArborOne agreed to purchase the bonds. On that same date, Carolina AAC Development similarly made, executed, and delivered a series of Senior Secured Private Placement Taxable Bonds, Series 2010A, in the aggregate principal amount of $3,033,000.00, and a series of Senior Secured Taxable Private Placement Bonds, Series 2010B, in the aggregate principal amount of $337,000.00 pursuant to a Trust Indenture dated November 1, 2010, wherein Carolina AAC Development agreed to issue and ArborOne agreed to purchase the bonds. The bonds purchased by Arbo-rOne for both companies totaled $10,438,000.00.
To secure payment on these bonds, Carolina AAC Development provided Arbo-rOne with a mortgage and security agreement against real property located in Marlboro County, South Carolina and Marion County, South Carolinа. Arbo-rOne further received and recorded a lien against all assets of Carolina AAC Development, Carolina AAC, and Lide Smith Farms, and an Assignment of Leases and Rents on December 1, 2010. For further security, the Debtors each absolutely and unconditionally guaranteed to ArborOne the due and punctual payment of all liabilities and obligations of Carolina AAC and Carolina AAC Development.
Unfortunately, after almost two years of construction, the general contractor for the South Carolina plant committed suicide and construction ceased. Construction on the plant has not resumed to date. Following the general contractor’s death, Ar-borOne declared the entire balance under the bonds to be immediately due and payable, and announced that the bonds were in default. It is disputed as to what amount, if any, the surety paid on the bonds following their default and whether any amount remains due from the surety.
On July 12, 2013, ArborOne commenced two legal procеedings against the Debtors in the Superior Court of Orange County, North Carolina. The first case asserted a claim for the outstanding balance owed under the Carolina AAC Bonds and Guaranties. The second case asserted a claim for the outstanding balance owed under the Carolina AAC Development Bonds and Guarantiеs. On January 23, 2014, the Superior Court entered an Amended Order Granting Plaintiffs Motion for Summary Judgment Against Defendants Nunc Pro
In light of these judgments, the Debtors liquidated approximately $433,000.00 of stocks pre-petition, and Mr. Paterno requested early disbursements from his two lifetime pensions with Sonoco Products Company. These pensions provide Mr. Paterno with approximately $6,600.00 per month in income. However, despite the Debtors’ attempts to work with ArborOne to pay the debt, ArbоrOne commenced foreclosure proceedings against Carolina AAC, Carolina AAC Development, and Lide Smith Farms. The foreclosure sales are scheduled to be held June 10, 2014 and June 16, 2014.
II. THE BANKR UPTCY FILING
The Debtors filed a petition for relief under Chapter 11 of the Bankruptcy Code on March 14, 2014. As of this date, the sum owed by the Debtors to ArbоrOne as guarantors was $11,124,072.98 exclusive of costs and attorney’s fees. According to the Debtors’ Schedule I, Mr. Paterno is currently self-employed and receives $6,383.64 from his pension and $3,000.00 as a consulting and management fee from Carolina AAC. Although Mr. Paterno has a consulting services contract with Carolina AAC for $15,000.00 per month, he lаst received a consulting fee in early March 2014. Mr. Paterno deferred his remaining fees due to Carolina AAC’s lack of funding, and is owed approximately $1,500,000.00 from the company to date. Mr. Paterno’s wife is currently unemployed, and their monthly net income is $1,092.81.
On April 29, 2014, before any monthly operating reports had been submitted, Ar-borOne filed а Motion to Convert Chapter 11 Case to Chapter 7. In support of this motion, ArborOne argues that the Debtors have no reasonable likelihood of rehabilitation, and that there is substantial or continuing loss to the estate. ArborOne premises this argument on the Debtors’ Schedules of Assets, Statement of Financial Affairs, and other documents filed with the Court.
On April 30, 2014, the Debtors filed their first monthly operating report for the period of March 14, 2014 through March 31, 2014. This operating report showed a total income of $0.00 and total expenses of $3,587.13. At the start of the month, the Debtors had $7,924.17 in cash on hand, and they had $4,337.04 at the end of the month. As a result, their first monthly report reflected a cash loss in the amount of $3,587.13. The Debtors’ second monthly operating report was timely filed on May 21, 2014, the day before the hearing on the motion to convert. This document reported monthly income of $14,403.62 and expenses of $12,404.45. Cash on hand at the start of the month totaled $4,337.04 and increased to $6,336.21 by the end of the month. The Debtors’ net income for the month was $1,999.17.
At the May 22, 2014 hearing, Mr. Pater-no testified to his background in AAC, his future job prospects, his wife’s education and teaching history, his monthly expenses, and his aggressive efforts to find a “white knight” investor for Carolina AAC. Mr. Paterno informed the Court that as of May 22, 2014, there had been no cash infusions into Carolina AAC for approximately eight weeks, and the company was operating with only one employee who had deferred his last two paychecks. Mr. Pa-terno stated that even if he did not receive his projected monthly $3,000.00 consulting
III. LEGAL ANALYSIS
ArborOne seeks conversion of this case to Chapter 7 for “cause” pursuant to 11 U.S.C. § 1112(b)(4)(A). Subject to limited exceptions, § 1112(b)(1) provides that “the court shall cоnvert a case under this chapter to a chapter 7 or dismiss a case ... whichever is in the best interests of creditors and the estate, for cause” unless appointment of a Chapter 11 trustee is in the best interest of creditors and the estate. 11 U.S.C. § 1112(b)(1) (2013) (emphasis added). In determining whether “cause” exists, the court must conduct a fact-spеcific inquiry of the debtor’s post-petition circumstances, and may exercise its discretion. In re Creekside Sr. Apartments, L.P.,
Specifically, pursuant to § 1112(b)(4)(A), cause exists to dismiss or convert a case if the movant establishes (1) “substantial or continuing loss to or diminution of the estate” post-petition, and (2) the “absence of a reasonable likelihood of rehabilitation.” 11 U.S.C. § 1112(b)(4)(A). This is a two-fold inquiry, and the party seeking conversion bears the burden of proof by a preponderance of the evidence. In re Modanlo,
A. Substantial or Continuing Loss to or Diminution of the Estate
The first prong requires the Court to determine whether, post-petition, there has been a substantial or continuing loss to or diminution of the estate. 11 U.S.C. § 1112(b)(4)(A); In re Landmark Atlantic Hess Farm, LLC,
The Bankruptcy Court for the Middle District of Pennsylvania, for example, converted a case to Chapter 7 where the debtor’s seven monthly operating reports shоwed a sharp decline in the debtor’s cash position. In re Gateway Access Solutions, Inc.,
Comрarably, the Bankruptcy Court for the Western District of Virginia found cause to convert or dismiss the case where the aggregate picture painted by the operating reports was “bleak.” In re Park,
In contrast, however, the Bankruptcy Court for the Eastern District of North
In the present case, the Debtors have filed only two monthly operating reports and have been in bankruptcy less than three months. Although the first monthly operating report showed an income of $0.00, this report was only for a sixteen-day period and excluded Mr. Pa-terno’s pension payment for the month of March. While the net income listed on their first monthly operating report was negative, the Debtors had positive net income of $1,999.17 for the second monthly operating report, with total income being $14,403.62. The Debtors’ cash on hand as of April 30, 2014, was $6,336.21.
Despite these positive figures, ArborOne argues that the Debtors failed to obtain employment for the past two years, liquidated approximately $433,000.00 of stock, survived solely on credit card debt, and failed to pay their tax liability. These events, however, all occurred pre-petition and are therefore irrelevant to the current inquiry. The record reflects that the Debtors have not sold any assets or incurred any credit card debt since the petition date. ArborOne’s argument is premised solely on the Debtors’ Schedules of Assets, monthly operating reports, and Statement of Financial Affairs. ArborOne does not dispute the accuracy of these documents and did not present any additional evidence at the hearing. Therefore, the court finds that ArborOne has failed to show any substantial or continuing post-petition loss to the estate. The first prong required for conversion is not satisfiеd.
B. Reasonable Likelihood of Rehabilitation
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. In re Creekside Sr. Apartments, L.P.,
In the present case, the Court need not reach this second prong of the test as ArborOne has failed to meet its burden to show a substantial or continuing loss to the estate. The conjunctive phrasing of § 1112(b)(4)(A) therefore precludes Arbo-rOne’s argument on rehabilitation. The Court merely notes that while ArborOne’s motion to convert relies heavily upon the argument that the rehabilitation of Carolina AAC and Carolina AAC Development appears unlikely, Mr. and Mrs. Paterno are the debtors in this case, not Carolina AAC and Carolina AAC Development.
IV. CONCLUSION
Based on the foregoing, it is therefore ORDERED that ArborOne’s motion to convert is denied without prejudice.
SO ORDERED.
Notes
. Section 1112(b)(3) requires the Court to commence a hearing upon a motion to convert or dismiss made by a party in interest within thirty days of the filing of the motion and render its decision on the motion no more than fifteen days after the commencement of the hearing, unless the movant agrees otherwise or compelling circumstances exist. 11 U.S.C. § 1112(b)(3) (2013).