Indian Motocycle Associates III Ltd. Partnership v. Massachusetts Housing Finance Agency

• Decision Date: 02 August 1995
• Docket Number: No. 94-2233,94-2233
• Citation: 66 F.3d 1246
• Parties: , Bankr. L. Rep. P 76,672 INDIAN MOTOCYCLE ASSOCIATES III LIMITED PARTNERSHIP, Appellant, v. MASSACHUSETTS HOUSING FINANCE AGENCY, Appellee. . Heard
• Court: U.S. Court of Appeals — First Circuit

Page 1246

66 F.3d 1246

27 Bankr.Ct.Dec. 1230, Bankr. L. Rep. P 76,672

INDIAN MOTOCYCLE ASSOCIATES III LIMITED PARTNERSHIP, Appellant, v. MASSACHUSETTS HOUSING FINANCE AGENCY, Appellee.

No. 94-2233.

United States Court of Appeals, First Circuit.

Heard Aug. 2, 1995.

Decided Oct. 2, 1995.

Paul R. Salvage, with whom Susan Luttrell Burns and Bacon & Wilson, P.C., Springfield, MA, were on brief, for appellant.

Kevin C. Maynard, with whom Mark D. Cress and Bulkley, Richardson and Gelinas, Springfield, MA, were on brief, for appellee.

Before TORRUELLA, Chief Judge, CYR and STAHL, Circuit Judges.

CYR, Circuit Judge.

Indian Motocycle Associates III Limited Partnership, a chapter 7 debtor, appeals from a district court order reversing a bankruptcy court decision denying appellee Massachusetts Housing Finance Agency's ("MHFA") motion to compel the chapter 7 debtor to restore diverted cash collateral to the chapter 7 estate. We vacate the district court order and remand to the bankruptcy court for further proceedings.

I BACKGROUND

A. The Regulatory Agreement

In 1987, MHFA loaned Indian Motocycle Associates Limited Partnership ("Indian Motocycle") $8.6 million to develop low-income housing in Springfield, Massachusetts [hereinafter: "the Project"]. Under a program authorized by the National Housing Act ("NHA"), 12 U.S.C. Secs. 1701, 1709, 1715k et seq. (1994); 24 C.F.R. Sec. 250.1 (1994), the United States Department of Housing and Urban Development ("HUD") coinsured the non-recourse mortgage loan. ¹ In order to qualify for HUD coinsurance, Indian Motocycle signed a "Regulatory Agreement," obligating it to comply with pertinent HUD regulations and conditions whereby the individual Indian Motocycle partners assumed personal liability "for funds or property of the Project which come into their hands and which they are not entitled to retain; and ... for their own acts and deeds or acts and deeds of their authorized agents that are in violation of the provisions of this Agreement." The Regulatory Agreement is incorporated into the mortgage by express reference.

In addition to conveying a first mortgage on all real property belonging to the Project, Indian Motocycle assigned all its Project leases, rents, profits and income to MHFA "for the purpose of discharging the [note]." See Mortgage p 4; 12 U.S.C. Sec. 1715k(d)(2)(A). MHFA in turn authorized Indian Motocycle to collect and apply Project rents to enumerated purposes, including loan repayments and "reasonable expenses necessary to the operation and maintenance of the Project." Regulatory Agreement p 3(b). Indian Motocycle's right to collect Project rents terminated upon default. See Mortgage p 4. In the event the debtor were to breach the Regulatory Agreement, MHFA or HUD would be entitled to seek specific performance, injunctive relief, or the appointment of a receiver for the Project. See Regulatory Agreement pp 17-18. The mortgage and Regulatory Agreement were duly recorded by MHFA.

In 1989, Indian Motocycle transferred its ownership interest in the Project to Indian Motocycle Associates III Limited Partnership, which assumed the MHFA note and

                mortgage;  in August 1992, it defaulted.  MHFA promptly tendered notice of default but took no immediate steps to acquire possession of the Project (as by foreclosure) or the rents (as by appointment of a receiver).  Meanwhile, Indian Motocycle Associates III Limited Partnership had withdrawn $65,000 from the rents on deposit in the Project operating accounts, with which, inter alia, it retained counsel in contemplation of the commencement of a voluntary chapter 11 proceeding ($35,000 retainer) and an accountant (Coopers & Lybrand) to prepare a prepetition audit of the Project ($20,000). 2  On December 15, 1992, following these disbursements, Indian Motocycle Associates III Limited Partnership (hereinafter:  "debtor") filed its chapter 11 petition and continued to operate the Project as a debtor in possession. 3  Pursuant to the Regulatory Agreement, MHFA filed a motion to compel the debtor "to restore [the $65,000 in cash collateral] improperly diverted from the [chapter 11] estate in violation of Title II of the [NHA]." 4
                

B. The Bankruptcy Court Decision

The bankruptcy court ruled that the unauthorized prepetition transfer of MHFA cash collateral to retain chapter 11 counsel violated the Regulatory Agreement. In re Indian Motocycle Assocs. III Ltd. Partnership, 161 B.R. 865, 867-68 (Bankr.D.Mass.1994). ⁵ The court nonetheless denied the motion to compel the debtor to restore the $65,000 to MHFA, noting that Regulatory Agreement violations by the debtor were "irrelevant," given that the motion to compel purported to assert MHFA's legal rights against the debtor only and that no adversary proceeding had yet been commenced against the debtor's general partners, attorneys or accountants, the transferees in possession. Id. at 868.

During the bankruptcy court proceedings, MHFA had relied on case law to the effect that a debtor's unauthorized prepetition disbursement of rents securing an NHA-insured loan warrants postpetition relief compelling the debtor and/or its attorneys to restore the encumbered funds to the debtor estate. Id. The bankruptcy court reasoned, however, that the requested relief would undermine the Bankruptcy Code distribution scheme by entitling $65,000 of the HUD/MHFA unsecured claim against the chapter 11 estate to "super priority" status.

On intermediate appeal, the district court reversed and remanded to the bankruptcy court for entry of an order compelling the "[d]ebtor to restore the distributions diverted from the estate." Massachusetts Hous. Fin. Agency v. Indian Motocycle Assocs. III Ltd. Partnership (In re Indian Motocycle Assocs. III Ltd. Partnership), 174 B.R. 351, 357-58 (D.Mass.1994) (citing Bankruptcy Code Sec. 105(a), 11 U.S.C. Sec. 105(a) (empowering the court to "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title")).

II DISCUSSION

The debtor contends that the bankruptcy court correctly determined that it lacked authority under Bankruptcy Code Sec. 105(a) to order a chapter 11 debtor--even one who concedes that it improperly diverted a secured creditor's collateral shortly before filing

its chapter 11 petition--to return the collateral (or its monetary equivalent) to the chapter 11 estate. The debtor argues that it no longer retained a property "interest" in, or control over, the diverted collateral on the date it filed its chapter 11 petition and, accordingly, the collateral never became property of the chapter 11 estate amenable to administration. See Bankruptcy Code Sec. 541(a)(1), (6), 11 U.S.C. Sec. 541(a)(1), (6) (providing that estate is comprised of "all legal or equitable interests of the debtor in property as of the commencement of the case," including "rents ... from [real] property of the estate") (emphasis added). Further, the debtor says, its diversion of the encumbered rents did not alter the amount of MHFA's claim against the debtor estate, which remained the balance outstanding on the note at the date of the chapter 11 petition. Finally, the debtor argues that the bankruptcy court correctly declined to follow those courts which have ordered chapter 11 debtors in possession to restore to the debtor estate diverted NHA-encumbered rents, see infra Section II.A.2, since those cases did not involve a non-federal agency like MHFA, nor did those courts cite to legislative history indicating that Congress intended that NHA policy override the debtor protection policy underlying the Bankruptcy Code, including the right to utilize monies in the debtor's possession to fund prepetition retainers of chapter 11 counsel.

A. Injunctive Relief

We review challenged rulings of law by the district court de novo and contested findings of fact by the bankruptcy court for clear error. See In re LaRoche, 969 F.2d 1299, 1301 (1st Cir.1992). ⁶ A bankruptcy court's decision granting or denying injunctive relief pursuant to Bankruptcy Code Sec. 105(a) is reviewed only for abuse of discretion. See, e.g., Western Auto Supply Co. v. Savage Arms, Inc. (In re Savage Arms, Inc.), 43 F.3d 714, 719 n. 8 (1st Cir.1994). "Four principal factors govern the appropriateness of permanent injunctive relief: (1) whether the plaintiff has prevailed on the merits; (2) whether the plaintiff will suffer irreparable injury absent injunctive relief; (3) whether the harm to the plaintiff outweighs any harm threatened by the injunction; and (4) whether the public interest will be adversely affected by the injunction." Id. The present appeal implicates only the first two factors.

1. Injury

Although the bankruptcy court ruled that the debtor's prepetition transfer of MHFA's cash collateral constituted a conversion, it concluded that injunctive relief was unwarranted since the amount owed MHFA by the chapter 11 estate remained the same. To the extent this ruling suggests that MHFA sustained no cognizable injury, we disagree. Since there is no indication that MHFA's claim was over-secured, the conversion by the debtor of the $65,000 cash collateral reduced MHFA's secured claim by that amount, leaving MHFA with an unsecured claim for $65,000. See Bankruptcy Code Sec. 506(a), (b), 11 U.S.C. Sec. 506(a), (b); see also id. Sec. 541(a)(6) ("Such estate is comprised of ... [p]roceeds, product, offspring, rents, or profits of or from property of the estate [viz., the Project]") (emphasis added).

The advantage to holding a secured claim to these rents in the chapter 11 proceeding is not to be underestimated. Since the rents constituted "cash collateral" securing the MHFA note, id. Sec. 363(a) ("cash collateral" includes "cash ... whenever acquired in which the estate and an entity other than the estate have an interest and includes Nevertheless, we do not think the bankruptcy court ruling should be interpreted simply as a determination that secured NHA...