The U.S. Bankruptcy Court for the Southern District of Florida recently held that a bankruptcy debtor’s Chapter 11 proceeding should not be dismissed as filed in bad faith to delay or avoid foreclosure, but could not confirm the debtor’s proposed plan to lease its commercial property asset to a business that generates income from medical marijuana.

A copy of the opinion is available at:  Link to Opinion.

A limited liability company (“debtor”) owned 48.8 percent of a commercial property in Miami Beach, Florida (the “commercial property”) that was secured by a mortgage held by a commercial bank (“lender”) that had a long-standing relationship with the debtor.

The debtor and its affiliates filed a state court lawsuit raising several lender liability claims against the lender.  The lender later filed two cases against the debtor, its affiliates and guarantors to collect on some of the loans. The three cases involving three loans –all secured by the commercial property — were eventually consolidated.

The state court entered summary judgment in favor of the lender in the amount of $667,113.17 and ordered the sale of the commercial property. The commercial property was redeemed prior to the foreclosure sale. Final summary judgment as to the remaining issues in the consolidated lawsuit was rendered in the lender’s favor and affirmed by a state appellate court.

After a second appeal of the final judgment awarding lender attorney fees in an amount of $841,099.03 was affirmed, the state court set a foreclosure sale.  The night before the sale, the debtor removed the state court case to federal court, which cancelled the foreclosure sale. Soon thereafter, the case was remanded to the state court and a second foreclosure sale was set.

On the eve of the second, and subsequent third foreclosure sale dates, the debtor twice removed the case to federal court, thereby cancelling the sale.  Following remand of its third failed attempt at removal, the debtor was enjoined from any further removal of the state court case.

After several other emergency motions to delay the foreclosure sale were denied, the debtor filed its Chapter 11 bankruptcy petition on Oct. 4, 2016, the day before the rescheduled foreclosure sale.

Shortly thereafter, the lender filed a motion to dismiss the bankruptcy petition pursuant to 11 U.S.C. §1112(b)(1) alleging that it was filed in bad faith, citing the debtor’s repeated attempts to stop the foreclosure sale by improperly remanding the action to federal court.

Prior to the hearing on the lender’s motion to dismiss, the debtor filed a plan of reorganization and disclosure statement, which proposed, among other things, to rent space in the commercial property to a business that generates income from medical marijuana.

At the hearing on the motion to dismiss, the Court was unpersuaded by the debtor’s argument that the timing of its filing was actually a result of the debtor acting without advice of bankruptcy counsel, because the debtor’s principal is a lawyer, who was responsible for filings in the previous suits and co-author of some of the pleadings filed in the bankruptcy.

Citing potential issues with the plan to lease the commercial property to a business that generates income from medical marijuana — including the fact that the commercial property was not listed as one of the seven licensed dispensing organizations approved in Florida to dispense low-THC cannabis and medical cannabis — the bankruptcy court ordered the debtor to file an amended plan that better addressed the plan’s structure and either did not depend on marijuana as an income source, or briefed the issue if the amended plan was going to rely on marijuana income.

The first amended plan filed by the debtor still relied upon income generated from medical marijuana to make plan payments, including payments to the lender tied to the amount of income generated from the marijuana business.  The debtor and lender subsequently filed their supplemental briefs on the marijuana issue.

The lender argued the bankruptcy action was filed in bad faith.  When determining whether a Chapter 11 case should be dismissed as a bad faith filing, the court must consider factors that evidence “an intent to abuse the judicial process and the purposes of the reorganization provisions,” such as “when there is no realistic possibility of an effective reorganization and it is evident that the debtor seeks merely to delay or frustrate the legitimate efforts of secured creditors to enforce their rights.” lbany Partners, Ltd. v. Westbrook (In re Albany Partners, Ltd.), 749 F.2d 670, 674 (11th Cir. 1984).

The Eleventh Circuit in Phoenix Piccadilly, Ltd. v. Life Insurance Co. of Virginia (In re Phoenix Piccadilly, Ltd.), 849 F.2d 1393 (11th Cir. 1988), listed a number of subjective factors in determining whether a dismissal for bad faith is appropriate. The factors include whether:

(i) The Debtor only has one asset, . . .;

(ii) The Debtor has few unsecured creditors whose claims are small in relation to the claims of the Secured Creditors;

(iii) The Debtor has few employees;

(iv) The Property is the subject of a foreclosure action as a result of arrearages on the debt;

(v) The Debtor’s financial problems involve essentially a dispute between the Debtor and the Secured Creditors which can be resolved in the pending State Court Action; and

(vi) The timing of the Debtor’s filing evidences an intent to delay or frustrate the legitimate efforts of the Debtor’s secured creditors to enforce their rights.

Phoenix Piccadilly, 849 F.2d at 1384-95.

Here, the debtor’s sole asset was the commercial property (and leases relating thereto) and the debtor had no employees.  Although eight other unsecured creditors placed undisputed, non-insider, non-priority claims totaling $631,987.00, the bankruptcy court concluded that it was clear the debtor filed for Chapter 11 bankruptcy to avoid a foreclosure of the commercial property and liability against the lender and various guarantors.

Next, the bankruptcy court considered whether the debtor had the ability to reorganize itself.

The debtor argued that it would be able to prove feasibility at confirmation, as the proposed tenant had applied for both state and federal approval to cultivate and sell marijuana.  The lender argued that its approval was unlikely due to the commercial property’s proximity to a school and a synagogue.

Citing rulings in several other jurisdictions that declined to confirm bankruptcy plans funded by federally illegal income derived from marijuana cultivation and sale, the Court noted that in each of those cases, the marijuana source of funding was legal under the relevant state law.  See In re Rent-Rite Super Kegs W. Ltd., 484 B.R. 799, 809 (Bankr. D. Colo. 2012);  In re Jerry L. Johnson, 532 B.R. 53 (Bankr. W.D. Mich. 2015);  In re Arenas, 535 B.R. 845 (10th Cir. B.A.P. 2015).

Here, the issue was whether or not the proposed tenant would be approved under federal law to manufacture or sell marijuana.  Because only the University of Mississippi has ever received approval by the federal government to grow and cultivate medical marijuana, the Court reasoned that it was highly unlikely that the debtor and prospective tenant would receive approval from the federal government.

The Court concluded that (i) the debtor cannot rid itself of the taint of the bad faith filing (See In re Natural Land Corp., 825 F. 2d at 296; Albany Partners, 749 F.2d at 670); (ii) the amended plan was based on an enterprise illegal under federal law, and the debtor cannot satisfy the requirements of 11 U.S.C.§1129(a)(3), and; (iii) the amended plan was highly speculative and failed to meet the standards of effective reorganization established by the Supreme Court of the United States that “there must be ‘a reasonable possibility of a successful reorganization within a reasonable time.”  United Savings Ass’n of Texas v. Timbers of Inwood Forest, 484 U.S. 365, 376 (1988).

The Court noted that the case was found to be ripe for dismissal for bad faith, due to the amounts of non-insider unsecured debt, but the lender’s motion to dismiss was denied in the best interest of the unsecured creditors.

However, the Court reasoned that the same factors warranted relief from the automatic stay as to the lender. See Natural Land Corp., 825 F. 2d at 296.  Accordingly, (i) the lender’s motion to dismiss was denied, with the debtor ordered to file a plan that does not rely upon marijuana as a source of income within 14 days or face conversion to a Chapter 7 filing, and; (ii) the lender was granted relief from the stay to continue the foreclosure action and set a foreclosure sale date no earlier than 75 days to be cancelled if the debtor’s amended plan is confirmed, or at the earliest date allowed under state law should the debtor fail to file a plan within 14 days.