M.A.R. DESIGNS & CONSTRUCTION, INC.
MEMORANDUM OPINION
In this subchapter V proceeding, M.A.R. Designs & Construction, Inc. proposed a liquidating plan in which the Debtor would remove itself as debtor in possession under
I. BACKGROUND
- On January 1, 2023, (the “Petition Date“) M.A.R. Designs & Construction, Inc. (“Debtor“) filed for bankruptcy protection under Title 11 of the Bankruptcy Code1 initiating the bankruptcy case (“Bankruptcy case“). The Debtor‘s president and sole shareholder is Mario Rodriguez (“Mr. Rodriguez“).2
- On January 25, 2023, the Debtor filed an Amended Voluntary Petition to elect to proceed under Subchapter V of Chapter 11.3
- On January 31, 2023, Brendon Singh was appointed as the Subchapter V Trustee4 (“Subchapter V Trustee“).
- On February 9, 2023, the Court held its initial status conference and entered an Order instructing Debtor to, among other things, “provide proof of insurance of all assets to the UST listing the UST as a party of notice,” and to file its plan no later than April 3, 2023.5
- On April 3, 2023, Debtor timely filed its plan of reorganization (“Plan“).6
- On April 17, 18, and 21, 2023, 5 objections (“Objections“) were filed by Alejandro Moreno, Sierra Title of Hidalgo County, Inc. (“Sierra Title“), Nicolas Gomez, Daniel Cuevas, and Maria Cuevas,7 in opposition to the Plan.
- On April 24, 2023, Debtor modified its Plan8 (“First Amended Plan“) to address some of the Objections.
- On April 25, 2023, additional objections were filed by Comack Investments, LP, and Title Resources Guaranty Company (“Objections to the First Amended Plan“), in opposition to the First Amended Plan.9
- On April 30, 2023, Debtor filed its Second Amended Plan, (“Second Amended Plan“)10 to address some the Objections to the First Amended Plan.
- On May 1, 2023, additional objections were filed by Comack Investments, LP, and the United States
Trustee (“Objections to the Second Amended Plan“), in opposition to the Second Amended Plan.11 - On May 8, 2023, Comack Investments, LLC (“Comack“) filed a secured proof of claim in the amount of $360,689.3412 (“Comack POC“).
- On May 19, 2023, Debtor filed its Third Amended Plan13 (“Third Amended Plan“), to address some of the Objections to the Second Amended Plan.
- On June 7, and 8, 2023, John King, Sierra Title, Maria Cuevas, Daniel Cuevas, and Nicolas Gomez, filed objections in opposition to the Third Amended Plan14 (“Objections to the Third Amended Plan“)
- On June 9, 2023, the United States Trustee (“UST“) filed its “Objection Of The United States Trustee (“UST“) To Debtor‘s Amended Plan Of Reorganization Dated May 19, 2023”15 (“UST‘s Objection“).
- On June 12, 2023, Debtor filed its Fourth Amended Plan16 (“Fourth Amended Plan“).
- On June 15, 2023, UST filed its “Motion to Convert Case from Chapter 11 to Chapter 7”17 (“UST Motion to Convert“).
- On June 15, 2023, the Court held an initial hearing on the Fourth Amended Plan18
- On June 29, 2023, Debtor filed its Fifth Amended Plan19 (“Fifth Amended Plan“). The Fifth Amended Plan proposes: (1) removing the debtor-in-possession, (2) liquidating the estate with use of a liquidating trust, (3) the Subchapter V Trustee serving as both the Subchapter V trustee and the liquidating trustee, (4) and lists Chapter 5 causes of action for the trustee to pursue against Mayberry Crossing LLC, Mario Rodriguez, Brenda Gonzales, and Toldos, LLC20 (“Causes of Action“).
- On July 10, 2023, Sierra Title filed its “Sierra Title Of Hidalgo County, Inc. and John King, Trustee‘s Objection To Confirmation Of Third Amended Chapter 11 Plan (Relates To ECF #300)”21 (“Sierra Title Plan Objection“).
- On July 13, 2023, Comack filed its “Comack Investments, LLC‘s Expedited Motion To Dismiss With Prejudice Or Convert” (“Comack‘s Motion to Convert or Dismiss“).22
- On July 17, 2023, Comack filed its “Comack Investments, LLC‘s Objection To Confirmation Of Third Amended Chapter 11 Plan [Doc #300]” (“Comack‘s Objection“).23
- On July 20, 2023, Copesa LLC, Carolos Lozano Gonzalez, Adrian Gonzalez, and Kelvin Construction
LLC filed objections to the Fifth Amended Plan24 (“Objections to the Fifth Amended Plan“). - On July 20, 2023, the UST filed its “Supplemental Objection Of The United States Trustee To Debtor‘s Amended Plan Of Liquidation Dated June 29, 2023“.25 (“UST Supplemental Objection“).
- On July 26, 2023, Debtor filed its “Response to UST‘s Motion to Convert Case.”26
- On July 27, 2023, Debtor filed its “Response to Comack Investments, LLC‘s Expedited Motion to Dismiss With Prejudice Or Convert.”27
- On July 31, 2023, and August 3, 2023, the Court held a hearing on the Fifth Amended Plan,28 (collectively, “Hearing“) now issues its instant Memorandum Opinion.
II. JURISDICTION, VENUE, AND CONSTITUTIONAL AUTHORITY
This Court holds jurisdiction pursuant to
This Court may only hear a case in which venue is proper.33
This Court must evaluate whether it has constitutional authority to enter a final order in this case. While bankruptcy
III. ANALYSIS
Pending before the Court are three matters: (B) UST‘s Motion to Convert, (C) Comack‘s Motion to Dismiss or Convert, (D) confirmation of Debtor‘s Fifth Amended Plan and Objections filed in Opposition to Debtor‘s Fifth Amended Plan. The Court will consider each in turn.
A. Standard to Convert or Dismiss Under 11 U.S.C. § 1112(b)
Section 1112(b)(1) states that the court shall dismiss or convert a chapter 11 case for cause, whichever is in the best interest of creditors and the estate, unless the court determines that the appointment of a trustee or an examiner under § 1104 is in the best interests of the estate.39 Because § 1104 does not apply in a subchapter V case,40 this Court has no power to appoint a chapter 11 trustee or an examiner in this case. Therefore, this Court is restricted to converting or dismissing this case under § 1112(b).
The Code defines “cause” for purposes of § 1112(b) with a non-exhaustive enumerated list including, in pertinent part: (A) substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation; (B) gross mismanagement of the estate;
The moving party bears the burden of proving cause by a preponderance of the evidence.44 Even if this Court finds cause, however, this Court must abstain from converting the case to chapter 7 if “the court finds and specifically identifies unusual circumstances establishing that converting or dismissing the case is not in the best interests of creditors and the estate” and the debtor or another party in interest establishes: (1) that there is a reasonable likelihood of plan confirmation; and (2) that the grounds for converting or dismissing the case include an act or omission of the debtor other than under § 1112(b)(4)(A).45
The Court will now consider UST‘s Motion to Convert.
B. UST‘s Motion to Convert
The UST argues that cause exists to convert Debtor‘s Bankruptcy Case to chapter 7 pursuant to §§ 1112(b)(4)(A), (B), (C), (E), (H) and (J). The Court will consider each in turn.
1. Whether cause exists to convert under § 1112(b)(4)(A)
First, UST argues that causes exists to convert pursuant to § 1112(b)(4)(A).46 To establish cause under § 1112(b)(4)(A), the moving party must show that there is both (a) a substantial or continuing loss to or diminution of the estate and (b) the absence of a reasonable likelihood of rehabilitation.47 The loss may be substantial or continuing; it need not be both.48 If the loss is sufficiently large given the financial circumstances of the debtor as to materially negatively impact the bankruptcy estate an interest of creditors, the loss is substantial.49 The Court will consider each factor in turn.
When examining the movant‘s evidence for loss or diminution, courts must look beyond a debtor‘s financial statements and make a full evaluation of the present condition of the estate.50 The situation presented to the court may be tolerable under the circumstances, but the loss or diminution “should not continue . . . beyond the point at which reorganization no longer remains realistic.”51 The alleged loss can either be “sufficiently large given the financial circumstances of the debtor as to materially negatively impact the bankruptcy estate and interest of the creditors” or can be an ongoing issue, such as negative cash flow.52 Post petition administrative expenses and lack of ongoing operations that cause negative cash flow can be sufficient to establish a substantial or continuing loss to or diminution of the estate.53 When considering whether there is a substantial or continuing loss to or diminution of the estate, the Court must consider the individual circumstances of the Debtor.54 Negative cash flow and an inability to pay current expenses can satisfy the diminution of the estate for purposes of § 1112(b).55 In the context of a debtor who has ceased business operations and liquidated virtually all of its assets, any negative cash flow, including that resulting only from administrative expenses, effectively comes straight from the pockets of creditors and is sufficient to satisfy the first element of § 1112(b)(1).56
UST does not raise a substantial loss argument but instead argues that the estate is being diminished.57 UST asserts that the estate is being diminished because Debtor will not have operational funds to engage in real estate development activities and, as a result, there will be insufficient cashflow to justify Debtor remaining in Chapter 11.58
Debtor concedes that its Fifth Amended Plan does not contemplate continued operations from the Debtor.59 Debtor does, however, note in response that its Fifth Amended Plan contemplates collecting $3,600 in rent monthly over the life of the plan, which would be sufficient to satisfy administrative expenses and simultaneously, result in a higher return for creditors outside of a Chapter 7.60
UST speculates that the estate will be diminished because Debtor‘s plan calls for liquidation.61 The mere fact that Debtor‘s plan is a liquidating plan is insufficient to find diminution of the estate.62 Debtor not
Because UST has failed to show that there is a substantial loss or diminution to the estate, the Court need not consider if there is a substantial likelihood of rehabilitation.
Accordingly, the Court finds that cause does not exist to convert pursuant to § 1112(b)(4)(A).
The Court will next consider if cause exists to convert or dismiss pursuant to § 1112(b)(4)(B).
2. Whether cause exists to convert pursuant to § 1112(b)(4)(B)
Next, the UST asserts that cause to convert exists pursuant to § 1112(b)(4)(B).66 Section 1112(b)(4)(B) provides that gross mismanagement of the estate is cause for dismissal or conversion.67 Analysis under § 1112(b)(4)(B) focuses solely on the post-petition management of the estate and does not include mismanagement of the pre-petition debtor.68 Therefore, the Court considers only the post-petition conduct of Debtor as debtor-in-possession.69
A debtor-in-possession is vested with significant power under the Bankruptcy Code and that power comes with certain responsibilities.70 A debtor in possession owes a fiduciary duty to its creditors.71 Gross mismanagement is a breach of that duty.72 Assertions that a Debtor made unauthorized disbursements to insiders, professionals, and pre-petition unsecured creditors is not gross mismanagement, absent a showing that those disbursements are property of the estate pursuant to § 1186.73 Simple mismanagement is insufficient for a finding of gross mismanagement of the estate.74 Simple misconduct can collectively demonstrate gross mismanagement of the estate.75
a. Failure to collect rent owed to the estate
First, UST argues that Mr. Rodriguez‘s failure to collect rents belonging to the Debtor constitutes gross mismanagement of the estate.77 Courts have held that failing to make any attempt to collect rent owed to the estate without providing a compelling reason for not doing so constitutes gross mismanagement.78
Here, the Court received testimony from Mr. Rodriguez that he has not been collecting rents from four apartments located on Lot 22 Hacienda Santa Lucia, a 4 plex in Pharr, Texas, (“Apartments“) owned by the Debtor.79 When questioned, Mr. Rodriguez provided inconsistent and unsatisfactory testimony as to why these rent proceeds were being collected by a third party, Pedro Aguirre, as opposed to the Debtor.80 Mr. Rodriguez also provided inconsistent testimony suggesting that these rent proceeds may have been used to pay off the personal debts of Mr. Rodriguez rather than being remitted to the Debtor‘s estate.81 Mr. Rodriguez‘s testimony is ultimately irrelevant and this Court gives it no weight. The Court notes that the Apartments are listed on Debtor‘s schedules and are property of the estate.82 Thus, pursuant to
No efforts have been made to collect these payments on behalf of the Debtor, and this rent income was not disclosed as property of the estate on Debtor‘s monthly operating reports.84 While Mr. Rodriguez suggests that once Debtor‘s Fifth Amended Plan is confirmed Debtor would begin receiving these rents beginning in September 2023, he provides no satisfactory explanation as to why they have not been collected up to this point.85
As such, the Court finds that Debtor‘s failure to collect the apartment rents constitutes gross mismanagement of the estate.
b. Inaccurate Monthly Operating Reports
Second, UST asserts that Mr. Rodriguez grossly mismanaged the estate
Simple mismanagement is insufficient for a finding of gross mismanagement of the estate.91 However, numerous inaccuracies in Debtor‘s MORS can demonstrate gross mismanagement when paired misconduct that leaves the Court and all parties in interest with an inaccurate picture of Debtor‘s financial condition.92 The Court finds that the inaccuracies of Debtor‘s MORs supplements a finding of gross mismanagement here.
As such, the Court finds that Debtor‘s inaccurate MORs contribute to a finding of gross mismanagement of the estate here.93
c. Debtor‘s Promissory Note with Mr. Rodriguez
Third, UST asserts that Mr. Rodriguez grossly mismanaged the estate by violating his fiduciary duty to Debtor‘s creditors when negotiating the terms of a loan Mr. Rodriguez received from Debtor.94 The Debtor asserts the loan was made pre-petition and therefore is not demonstrative of gross mismanagement of the estate.95
As discussed, gross mismanagement focuses solely on post-petition conduct.96 Mr. Rodriguez testified that the loan was made pre-petition and the promissory note was made to provide certainty to the Court and creditors as to the accuracy of Debtor‘s accounts receivable.97
Debtor‘s amended Schedule A acknowledged the debt as existing prior to the bankruptcy98 and UST does not dispute this fact.99
As such, absent evidence to the contrary, the Court finds that this loan was provided pre-petition and therefore does not arise to gross mismanagement of the estate.
Next, UST asserts that Mr. Rodriguez grossly mismanaged the estate by making a $80,000 post-petition payment to International Bank of Commerce (“IBC“) on account of pre-petition debt with estate assets and without Court approval.100 Debtor contends that the payment was not made with estate assets.101
For this $80,000 payment to IBC to constitute gross mismanagement, UST must show that it was made with estate assets.102 When asked about this transaction, Mr. Rodriguez mentioned that IBC was a previous creditor of the Debtor, and that the payment needed to be made to prevent an adverse action from being taken against the Debtor.103 When asked about how he obtained the funds for this payment, he suggested that the funds used to make the $80,000 payment were a “gift from a friend” and not from estate assets.104 The Court gives this testimony little weight. However, as discussed, for an expenditure to constitute gross mismanagement the movant must demonstrate that the payment was made using estate funds.105 Here, UST failed to show that the $80,000 paid to IBC were made from estate assets.106
As such, the Court finds that the UST has failed to carry its burden to demonstrate the payment made by Mr. Rodriguez to IBC constitutes gross mismanagement of the estate.
e. Providing Insurance for Property not owned by the Debtor
Last, the UST asserts the insurance provided by the Debtor was misleading and constitutes gross mismanagement of the estate.107
Debtor provided UST proof of insurance on January 23, 2023, for property located at 4508 Blue Bird Ave., 2302 Corales St., and 2513 May Dr.,108 that did not belong to the bankruptcy estate.109 While testifying, Mr. Rodriguez admitted to providing such insurance and using money received as “gifts” to pay the premiums, but noted that he was initially mistaken about whether Debtor owned those properties and later amended Debtor‘s schedule during bankruptcy to reflect that Debtor did not actually own those insured properties.110 The UST asserts that this conduct constitutes gross mismanagement of the estate.111
Similar to the inaccurate MORs discussed supra, misconduct that leaves the Court and all parties in interest with an inaccurate picture of Debtor‘s financial condition can contribute to a finding of gross mismanagement.112 Providing the UST with insurance for property not owned by the Debtor paints an inaccurate
In sum, Debtor‘s failure to collect rents owed to the estate, Debtor‘s inaccurate MORs, and Debtor providing insurance for non-estate property, collectively is sufficient to find cause to convert or dismiss Debtor‘s case for gross mismanagement pursuant to § 1112(b)(4)(B).113
Accordingly, the Court finds pursuant to § 1112(b)(4)(B) that Debtor has grossly mismanaged the estate.
The Court will next consider if cause exists to convert or dismiss pursuant to § 1112(b)(4)(C).
3. Whether cause exists to convert pursuant to § 1112(b)(4)(C)
UST asserts that cause exists because Debtor has failed to maintain insurance on its real property.114
Section 1112(b)(4)(C) provides that cause includes “failure to maintain appropriate insurance that poses a risk to the estate or to the public.”115 Section 1112(b)(4)(C) is designed to safeguard against a debtor‘s failure to maintain proper insurance that exposes the estate to liabilities that threaten creditors’ recoveries, the stability of the bankrupt entity, or the public generally.116 When a debtor owns real property with structures, § 1112(b)(4)(C) requires that the debtor maintain casualty and liability insurance to protect the estate and the public.117
Here, UST requested that Debtor provide proof of insurance of “all assets” and the Court ordered that by March 2, 2023, Debtor must “provide proof of insurance on all assets to the U.S.T. listing the UST as a party of notice.”118 Debtor concedes that Debtor has failed to insure its properties even now, more than five months after the date specified in this Court‘s order.119 Debtor claims to have obtained insurance on some property, but concedes that it has failed to insure all property due to lack of funds because it has been unable to sell properties in the face of UST‘s objections.120
Debtor‘s reasoning is ultimately irrelevant and without merit. Debtor has had a more than ample opportunity to obtain liability and property insurance and has failed to do so. An inability to pay is not an
Accordingly, the Court finds cause to dismiss or convert pursuant to § 1112(b)(4)(C).
The Court will next consider if cause exists to convert or dismiss pursuant to § 1112(b)(4)(E).
4. Whether cause exists to convert pursuant to § 1112(b)(4)(E)
The UST asserts that cause exists because Debtor has failed to comply with this Court‘s Status Conference Order.122
The protection a debtor receives under the Bankruptcy Code comes with an obligation to strictly abide by the bankruptcy court‘s orders.123 Section 1112(b)(4)(E) embodies that principle.124 Cause to convert pursuant to § 1112(b)(4)(E) exists if a debtor fails to comply with a single order; a pattern of non-compliance is not required by the statute.125 Nor does § 1112(b)(4)(E) require a debtor‘s non-compliance to be willful, in bad faith, or fraudulent.126
As discussed supra, this Court ordered Debtor to “provide proof of insurance on all assets to the U.S.T. listing the UST as a party of notice” no later than March 2, 2023.127 Debtor failed to provide proof of insurance to the UST by that deadline, and even five months after the deadline was still unable to insure all of Debtor‘s real property. Debtor‘s only explanation for this was an inability to pay for the insurance.128 However, as discussed, a failure to comply with an order of this Court need not be willful, in bad faith, or fraudulent. Thus, even taking Debtor‘s assertion at face value, Debtor‘s failure to maintain insurance on its real property in contravention of this Court‘s order constitutes cause under § 1112(b)(4)(E).
Accordingly, the Court finds that cause exists under § 1112(b)(4)(E) for conversion or dismissal.
The Court will next consider if cause exists to convert or dismiss pursuant to § 1112(b)(4)(H).
5. Whether cause exists to convert pursuant to § 1112(b)(4)(H)
The UST asserts that cause exists because Debtor has failed to timely provide information requested by the UST.129
Section 1112(b)(4)(H) provides that cause exists to convert or dismiss for “failure timely to provide information or
As discussed supra, the UST requested that Debtor provide proof of insurance of all assets and to list the U.S. Trustee as a party of notice in the insurance policy.132 Mr. Rodriguez has admitted that proof of insurance was provided to the UST for properties that were not owned by the Debtor.133 Some insurance was provided that purported to insure at least two of the apartments in a four plex owned by Debtor, but proof of the other apartments being insured was not provided to the UST.134
The Debtor has also untimely and more recently failed to submit Monthly Operating Reports.135 The Debtor filed its May Operating Report on July 31, 2023, and has not submitted operating reports for any of the months that followed.136 Debtor did not provide an excuse for failure to file these reports.137 Failing to provide accurate MORs is cause for conversion or dismissal.138 The Court finds that failing to provide proof of insurance and failing to timely submit its MORs as reasonably requested by the UST constitutes cause to convert or dismiss under § 1112(b)(4)(H).
Accordingly, the Court finds cause for conversion or dismissal pursuant to § 1112(b)(4)(H).
The Court will next consider if cause exists to convert or dismiss pursuant to § 1112(b)(4)(J).
6. Whether cause exists to convert pursuant to § 1112(b)(4)(J)
The UST asserts that Debtor has delayed confirming a plan, “defeat[ing] the purpose of a Subchapter V reorganization, increasing the costs of administrative expenses and reducing repayment to creditors.”139 Debtor denies causing any delay in plan confirmation.140
Section 1112(b)(4)(J) may provide relief where a debtor fails “to make meaningful and substantive progress toward the confirmation of a plan within the time periods fixed by the Bankruptcy Code and any court orders[.]”141
The UST cites In re Double H Transportation LLC in support of its position that Debtor has failed to make meaningful progress towards confirmation of a plan.142 In Double H Transportation, the district court affirmed an order converting a case
Bankruptcy courts are given a great deal of discretion to say when enough is enough.145
The Debtor in this case has proposed six alternative Chapter 11 plans.146 However, the number of amendments made to an initial plan, by itself, is not dispositive on whether the debtor has failed to make meaningful and substantive progress towards confirmation.147
Accordingly, the Court finds that cause does not exist to convert or dismiss under
The Court will next consider if cause exists to convert or dismiss for lack of good faith.
7. Whether cause exists to convert for lack of good faith
The UST asserts that cause exists to convert for lack of good faith.149
As this Court stated in In re Zamora-Quezada, “[w]hilst [
Thus, courts should employ a totality of the circumstances approach when considering a lack of good faith.154
The UST asserts the following as proof of bad faith of the Debtor: (a) Debtor‘s involvement in various fraudulent real estate transactions executed through its President, Mr. Rodriguez, who pled guilty in state court to four counts of fraud regarding releases of liens of Commack,158 (b) claims filed by creditors against the Debtor alleging fraud,159 (c) Debtor‘s failure to schedule certain liabilities against the estate,160 (d) lack of cash flow of the business,161 (e) that Mr. Rodriguez is the Debtor‘s only employee,162 (f) Debtor‘s failure to accurately present information on Debtor‘s Monthly Operating Reports,163 (g) Debtor‘s failure to timely and file past-due Monthly Operating Reports,164 (h) Debtor‘s failure to show an arms-length negotiation regarding Mr. Rodriguez‘s interest-free loan and promissory note,165 (i) Debtor‘s failure to show an arms-length negotiation regarding Mr. Rodriguez‘s negotiations and interest-free promissory note with Mayberry Crossing LLC,166 (j) Mr. Rodriguez filing for personal bankruptcy shortly after signing the promissory note with Debtor,167 and (k) providing the UST proof of insurance for property not owned by the Debtor.168
The Court will consider each factor in turn.
a. Mr. Rodriguez‘s State Court Fraud Convictions
The UST asserts that Mr. Rodriguez‘s state court fraud convictions regarding fraudulent property transfers formerly belonging to Debtor constitute evidence of bad faith.169 Mr. Rodriguez conceded that he had pled guilty to fraud.170
A Debtor‘s improper pre-petition conduct can serve as indicia of bad faith.
As such, the Court finds that the fraudulent acts of Mr. Rodriguez, Debtor‘s president, contributes toward a finding of bad faith.174
b. Claims filed against the Debtor alleging fraud
The UST asserts that claims against the Debtor alleging fraud are proof of Debtor‘s bad faith.175 Citing
UST is mistaken about the effect of
Thus, the Court agrees with Debtor and finds that Debtor not objecting to proofs of claims alleging fraud before confirmation is not demonstrative of Debtor‘s alleged bad conduct.
As such, the Court does not find this factor as indicative of bad faith.
c. Debtor‘s failure to schedule certain liabilities against the estate
Failure to disclose information on a bankruptcy schedule constitutes bad faith conduct.182 The UST asserts that Debtor‘s failure to schedule contingent claims belonging to Alejandra Rios, Sanjera Valencia, and Ann Falcon (“Undisclosed Creditors“) against the estate demonstrates bad faith.183
As such, the Court finds Debtor‘s intentional failure to schedule these claims as indicative of bad faith.
d. Debtor‘s lack of cash flow
UST asserts that Debtor‘s lack of cash flow is indicative of bad faith.189 Little or no cash flow, or a source of income to sustain a reorganization can be indicative of bad faith.190 As discussed supra, and as evidenced by Debtor‘s MORs, Debtor has little to no cash flow.191
As such, the Court finds Debtor‘s lack of cash flow to be indicative of bad faith.192
e. Mr. Rodriguez is the Debtor‘s only employee
UST asserts that because there are no jobs or employees to protect here, Debtor‘s principal being the only employee is indicative of bad faith.193 Debtor concedes that he is Debtor‘s only employee.194
Employing few or zero employees other than its principals can be indicative of bad faith195 because, inter alia, the purpose of Chapter 11 is to protect a debtor‘s employees and not just its principals.196 Here, Debtor‘s petition identifies Mr. Rodriguez as both its president and sole shareholder and lists no other employees.197
f. Debtor‘s failure to accurately present information on Debtor‘s Monthly Operating Reports
The UST asserts that Debtor has failed to accurately present information on its monthly operating reports.199 Specifically, UST asserts that Debtor has not been disclosing payments made by third parties on behalf of the Debtor or the rent income being generated from the apartments located at a 4 plex in Pharr, Texas owned by the Debtor.200
Pursuant to
When questioned, Mr. Rodriguez conceded that box fifteen on Debtor‘s March, April, and May MORs were incorrectly marked “no” when he did in fact receive gifts from third parties on behalf of the Debtor.”203 Mr. Rodriguez did not provide an explanation for why the rent income was not disclosed on Debtor‘s MORS.204
As such, this Court finds that pursuant to
g. Debtor‘s failure to timely file MORs
The UST asserts that the Debtor has failed to file a monthly operating report for June.205 Failing to file MORs is a violation of a debtor‘s fiduciary obligation under the Code and is indicative of bad faith.206 The Debtor filed their May Operating Report on July 31, 2023, and has not submitted MORs for any of the months that followed.207 Debtor did not provide an excuse for failure to provide these reports.208
As such, the Court finds that Debtor‘s failure to file MORs timely is indicative of bad faith.
h. Debtor‘s failure to show an arms-length negotiation regarding Mr. Rodriguez‘s interest-free loan and promissory note
The UST asserts that Debtor‘s promissory note was negotiated unfavorably, and that Mr. Rodriguez taking out a loan for personal reasons is indicative of bad faith.209 Debtor replies that the loan was
UST cites no authority indicating that a principal and sole shareholder taking a loan from their business in the past is indicative of bad faith. Merely reaffirming an existing debt is different from actively taking money post-petition from the Debtor or renegotiating terms of a loan. The Court finds that merely having a loan from the Debtor and reaffirming its existence for the benefit of creditors does not demonstrate bad faith here.
As such, the Court does not find this factor as indicative of bad faith.
i. Debtor‘s failure to show an arms-length negotiation regarding Mr. Rodriguez‘s negotiations and interest-free promissory note with Mayberry Crossing LLC
The UST similarly asserts that Mr. Rodriguez failed to negotiate with Mayberry Crossing LLC (“Mayberry Crossing“) in good faith with regards to a $397,000.00 loan made to Mayberry Crossing by the Debtor.212 Mr. Rodriguez testified that Mayberry Crossing was owned by a friend of his wife, and that the interest free loan was given years ago to help the friend‘s business, but he had the promissory note made post-petition merely to provide more confidence that the loan would be repaid.213 The UST has offered no evidence disputing Mr. Rodriguez‘s testimony.
As mentioned supra, reaffirming an existing debt is different from actively taking money post-petition from the Debtor or renegotiating unfavorable terms of a loan. The loan was made from Mr. Rodriguez in his role as principal and sole shareholder prior to the bankruptcy, and UST has not cited any authority demonstrating that providing an interest free loan to another company pre-petition shows bad faith.214
As such, the Court does not find this factor as indicative of bad faith.
j. Mr. Rodriguez filing for personal bankruptcy shortly before signing a promissory note with Debtor
UST asserts that Mr. Rodriguez filing a personal Chapter 11 bankruptcy for himself after creating the promissory note demonstrates a conflict of interest and bad faith.215 UST argues Mr. Rodriguez‘s bankruptcy frustrates collection efforts against him for Debtor‘s account receivables, and the representations made to the Court as to when Debtor will collect these funds are proof of bad faith.216 Mr. Rodriguez filed for Chapter 11 on July 3, 2023;217 however, Mr. Rodriguez‘s petition was struck on August 18, 2023, for failure to take a pre-petition credit counseling course pursuant to
As such, USTs argument is moot.
The UST asserts, that Debtor provided the UST with insurance for properties that do not belong to the estate.219 As the Court discussed supra, Debtor providing this insurance to the UST for properties not belonging to the estate is misleading. The Court finds this conduct is indicative of bad faith.220
In sum, the Court finds the following factors as indicative of bad faith: (a) Mr. Rodriguez‘s State Court Fraud Convictions; (c) Debtor‘s failure to schedule certain liabilities against the estate; (d) Debtor‘s lack of cash flow; (e) Mr. Rodriguez is the Debtor‘s only employee; (f) Debtor‘s failure to accurately present information on Debtor‘s MORs; (g) Debtor‘s failure to timely file MORs; and (k) Providing the UST proof of insurance for property not owned by the Debtor.
Accordingly, having weighed the totality of the circumstances, the Court finds Debtor has operated in bad faith and cause exists to convert or dismiss pursuant to
Having found that there is cause to convert or dismiss, the Court will now determine whether there are unusual circumstances that converting or dismissing the case is not in the best interest of creditors and the estate.
8. Whether unusual circumstances establish that converting or dismissing this case is not in the best interest of creditors and the estate
The court may not convert a case under this chapter to a case under chapter 7 or dismiss a case under this chapter if the court finds and specifically identifies unusual circumstances establishing that converting or dismissing the case is not in the best interests of creditors and the estate, and the debtor or any other party in interest establishes that—
(A) there is a reasonable likelihood that a plan will be confirmed within the timeframes established in
sections 1121(e) and1129(e) of this title, or if such sections do not apply, within a reasonable period of time; and(B) the grounds for converting or dismissing the case include an act or omission of the debtor other than under
paragraph (4)(A) —(i) for which there exists a reasonable justification for the act or omission; and
(ii) that will be cured within a reasonable period of time fixed by the court.221
The phrase “unusual circumstances” is not defined in the Bankruptcy Code, but “the word ‘unusual’ contemplates facts that are not common to Chapter 11 cases generally.”222 Determining whether unusual circumstances exist is a fact intensive inquiry.223 Once cause has been shown, the Debtor has the burden to specifically identify “unusual circumstances establishing that converting or dismissing the case is not in the best interest of creditors or the estate.”224 Bankruptcy
Debtor has not alleged any unusual circumstances justifying why this case should not be converted other than a bald unsupported assertion that its Subchapter V liquidation plan would leave creditors better off than in a Chapter 7 liquidation, and that proceeding under its plan would lower costs overall.227 None the less, the Court will briefly consider each in turn.
a. Whether Debtor‘s liquidation plan would leave creditors better off
First, Debtor asserts that confirming its plan would provide creditors a larger dividend than in a Chapter 7 liquidation.228 However, Debtor‘s first argument merely illustrates a requirement of confirming a plan under Subchapter V, that holders of a claim must “receive or retain under the plan...a value...not less than the amount the holder would so receive or retain if the debtor were liquidated under chapter 7 of this title....” 229 Furthermore, Debtor fails to provide evidence or cite any authority demonstrating that a Subchapter V plan providing a greater dividend than a Chapter 7 constitutes unusual circumstances.
As such, this argument fails.
b. The Subchapter V trustee‘s specialized knowledge
Debtor also asserts that the Subchapter V trustee has specialized knowledge of the innerworkings of this case, which constitutes unusual circumstances justifying remaining in Chapter 11.230 Debtor contends that the Subchapter V Trustee has developed specialized institutional knowledge of the Debtor over the seven months the Bankruptcy Case has been pending, and thus is better positioned to liquidate the estate than a new Chapter 7 trustee.231 This is reflected in Debtor‘s liquidation analysis, and assumes that the liquidating trustee would do due diligence in appraising and selling real estate, and a Chapter 7 Trustee would only sell debtor‘s real estate according to its “par” or apparent value.232
The Court finds Debtor‘s argument to be without merit. A Subchapter V trustee is appointed in every case where the Debtor has elected to proceed under Subchapter V.233 In each of those cases the trustee has statutory duties including, inter alia, being accountable for all property received,234 examining proofs of claims and objecting as proper,235 being present at
Thus, the Court must decide whether this case should be converted or dismissed.
9. Whether this Court should convert this case to Chapter 7 or dismiss this case
Upon finding cause, a court must decide whether conversion or dismissal is in the best interest of the creditors and the estate.239 There is no bright line test to determine whether conversion or dismissal is in the best interest of creditors and the estate.240 The Court has broad discretion to determine whether conversion or dismissal is in the best interests of the creditors and the estate.241
Here, UST recommends conversion because [t]here appear to be valuable real estate assets and potential claims under Chapter 5 that could provide a meaningful recovery to the bankruptcy estate.242 Comack incorporates the UST‘s motion by reference, but requests either conversion or dismissal, asserting that Debtor‘s bad faith warrants denying the Debtor bankruptcy protection: “[g]iven the Debtor‘s owner‘s criminal conduct perpetuated on the [c]reditors and the widespread distrust of Mario Rodriguez, any property sales should only be conducted by the Chapter 7 Trustee.”243
The best interest of the estate ultimately turns on whether its economic value is greater in or out of bankruptcy.244 Here the Debtor has 25 properties that can be sold to generate a recovery for the creditors.245 There has been inconsistent testimony regarding the value of Debtor‘s estate and whether Debtor would pursue its chapter 5 causes of action.246 Both these facts indicate greater economic value being produced in bankruptcy rather than outside of bankruptcy.
Further, the Court finds based on the numerous findings of bad faith and gross mismanagement of the estate by the Debtor, that a Chapter 7 trustee would be better positioned to investigate and effectively liquidate the numerous pieces of real estate owned by Debtor.247 Further, a common
Accordingly, UST‘s Motion to Convert is granted. Furthermore, this Court finds that converting this case to Chapter 7 is in the best interests of creditors and the estate.
The Court next considers Comack‘s Motion to Convert or Dismiss.
C. Comack‘s Motion to Dismiss or Convert
In its Motion to Convert or Dismiss, Comack asserts that Debtor‘s bankruptcy case should be dismissed with prejudice because it was filed in bad faith.250 Alternatively, Comack asserts that Debtor‘s bankruptcy case should be converted to Chapter 7 because Debtor is liquidating rather than reorganizing.251 Comack joined the United States Trustee‘s Motion to Convert, and requested the Court dismiss this case with prejudice as being filed in bad faith.252
For all of the reasons discussed supra, the Court similarly finds that Comack has met its burden to demonstrate cause to convert or dismiss for bad faith behavior committed by the Debtor during the pendency of this case. Also as discussed supra, the Court finds that conversion is in the best interests of creditors and the estate.
Accordingly, Comack‘s Motion is granted and, as discussed supra, this case will be converted to Chapter 7.
D. Confirmation and related objections
On June 29, 2023, Debtor filed its Fifth Amended Plan and now seeks confirmation from this Court. However, since this Court has already found cause to convert this case to Chapter 7, Debtor‘s Fifth Amended Plan253 is not confirmed. Similarly, Sierra Title Plan Objection,254 Comack‘s Objection,255 the Objections to the Fifth Amended Plan,256 and the UST Supplemental Objection,257 are also overruled as moot.
Accordingly, confirmation of Debtor‘s Fifth Amended Plan is denied, and all Objections thereto, are overruled as moot.
IV. CONCLUSION
An order consistent with this Memorandum Opinion will be entered on the docket simultaneously herewith.
SIGNED September 22, 2023
Eduardo V. Rodriguez
Chief United States Bankruptcy Judge