A mortgagee moved to dismiss a real estate debtor’s chapter 11 case, or in the alternative for relief from the automatic stay. It contended that the debtor filed bankruptcy in bad faith, and that this was a “single asset real estate” case subject to special provisions regarding its entitlement to relief from the stay.
Investors had formed the debtor to purchase assets in a luxury residential development. The original developer was not successful, so the debtor acquired assets for ~$12 million consisting of residential lots and the proceeds of club memberships that it hoped would have a value of more than $20 million. The acquisition was financed in part by its members and in part through bank loans.
Unfortunately there was a prolonged recession that impacted the marketability of the lots and club memberships. The debtor did not sell a single lot, although expenses and debt service continued to mount. After various defaults and negotiations, its primary bank (TCB) began a foreclosure process. The day before the foreclosure sale was scheduled, the debtor filed bankruptcy.
In addition to TCB, the debtor had several other secured creditors, including another bank and the club associated with the development. The club claimed it was owed ~$1.8 million for unpaid dues, maintenance charges, late fees and interest, that was secured by all of the debtor’s lots. The homeowners association also asserted a claim of ~$165,000 for association dues.
The plan of reorganization contemplated that the debtor would sell the lots that it owned over a period of eight years, and that a subset of the current owners would cover cash shortfalls during that time in exchange for new equity interests and an injunction to stop collection on their guaranties.
The court commented that the debtor “never sold a single lot, employed a single person, or erected a single building.” It concluded that the purpose of the bankruptcy was to “hinder and delay creditors’ ability to collect against the guarantors of a failed land speculation investment.”
As a preliminary matter, the court addressed TCB’s contention that this was a single asset real estate (SARE) case. SARE is defined in Section 101(51B) as “real property constituting a single property or project other than residential property with fewer than 4 residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental thereto.”
The only real question was whether the debtor generated substantially all of its gross income from the real property, since its minimal income had come from a sale of memberships, as opposed to operating the property. However, the court decided that “it is appropriate to look at the Debtor’s business model (as originally conceived and as proposed in the Plan) rather than to just look at the past few years to determine whether the seventy-two lots generate substantially all of the gross income of the Debtor.” While acknowledging that it was a close call, the court determined that this was a single asset real estate case.
Before addressing the consequences of classifying the case as a single asset real estate case, the court turned to the motion to dismiss the case as a bad faith filing. The court noted that decisions emphasize the intent to abuse the bankruptcy process. In particular, frustrating legitimate efforts of secured creditors to enforce their rights when there is no realistic possibility of a reorganization supports a finding of bad faith.
The determination is based on a totality of the circumstances, with cases suggesting a series of factors to consider, including those found in the Phoenix Piccadilly, Ltd. v. Lif3e Ins. Co. of Va. (In re Phoenix Piccadilly, Ltrds), 849 F.2d 1393 (11th Circ. 1988). The court decided that the following factors weighed in favor of a bad faith filing: debtor has only one asset (the property at issue), debtor has few employees, property is subject to a foreclosure action as a result of arrearages on the debt, and timing of the filing evidences an intent to delay or frustrate legitimate efforts of the debtor’s secured creditors to enforce their rights. The one factor that was not clearly present in this case was that the debtor’s financial problems is essentially a two party dispute between the debtor and its secured creditor. This case was a little unusual in that the debtor had several different secured creditors with interests at stake.
While the Phoenix Piccadilly factors weighed in favor of a bad faith finding, the court concluded that it also had to explore whether there were any exculpatory considerations. This included a laundry list of factors such as: creditor seeking relief was the seller of the property, the creditor has received significant cash proceeds from debtor’s efforts to sell the property, principals of the debtor made a substantial capital investment, debtor has a specific plan for development, the plan has been substantially implemented prior to bankruptcy, the debtor’s development plan does not depend on additional speculative investments, the debtor’s efforts may result in a windfall to the secured creditors, and the plan does not significantly assign a time for repayment. The court found that a review of these factors reinforced its view that this was a bad faith filing.
The debtor argued that its goal was to maximize value, it “harbors no ‘sinister motive,’” and it needed more time because of the complexity of the case. The court was not persuaded.
The court also considered granting relief based on “substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation.” In this case interest continued to accrue, and the debtor had not sold any assets or collected any of its receivables. (In fact its manager testified that he was not actively trying to collect receivables).
The court also concluded that the proposed plan of reorganization was unlikely to succeed: Interest and homeowner association assessments would continue to be incurred; and although the debtor had sold none of its lots to date, it would have to sell a number of lots at prices sufficiently over the release prices to cover costs. This was unlikely because the release prices would be set based on fair market value. All of which led to the conclusion that the case should be dismissed.
The court also found that TCB would have been entitled to relief from the automatic stay. Since stay relief related to the majority of the debtor’s assets, dismissal was appropriate.
The court made an interesting comment at the end of its decision:
In closing, the Court notes that its finding that this case was filed in bad faith does not mean that the Court has made a finding that the Debtor or its investors have acted unscrupulously in a business sense. To the contrary, the Debtor appears to be managed by and comprised of sophisticated and professional businesspeople. Under the facts and circumstances of this case, however, the Bankruptcy Code’s protections do not extend to the Debtor.
It is easy to forget that a court can make findings with a negative connotation – such as that there has been “bad faith” or a “fraudulent transfer” by a debtor – without concluding that those involved are bad people.