In-Possession. Hari Ram, Inc. v. Magnolia Portfolio, LLC (In re Hari Ram, Inc.)

• Decision Date: 05 March 2014
• Docket Number: No. 1:13–bk–06524MDF.,1:13–bk–06524MDF.
• Citation: 507 B.R. 114
• Parties: In re HARI RAM, INC., Debtor–in–Possession. Hari Ram, Inc., Movant v. Magnolia Portfolio, LLC, Respondent.
• Court: U.S. Bankruptcy Court — Middle District of Pennsylvania

507 B.R. 114

In re HARI RAM, INC., Debtor–in–Possession.Hari Ram, Inc., Movant

v.Magnolia Portfolio, LLC, Respondent.

No. 1:13–bk–06524MDF.

United States Bankruptcy Court, M.D. Pennsylvania.

Signed March 5, 2014.

Henry W. Van Eck, Mette, Evans, & Woodside, Harrisburg, PA, for Debtor.

OPINION

MARY D. FRANCE, Chief Judge.

Before the Court is the motion of Hari Ram, Inc., (“Debtor”) for the use of cash collateral (the “Motion”). Debtor concedes that Magnolia Portfolio, LLC (“Magnolia”) holds a mortgage and is perfected by an assignment of rents and a UCC financing statement. Debtor asserts, however, that the hotel room revenues are property of the estate and that it has offered to provide adequate protection for Magnolia's interest in Debtor's assets. Conversely, Magnolia objects to Debtor's use of its cash collateral because, either (1) Debtor's interest in the hotel room revenues was terminated before the petition was filed or, alternatively, (2) Debtor is unable to adequately protect Magnolia's security interest. For the reasons set forth below, the Court finds that even if Debtor retains an interest in the cash collateral, it is unable to provide adequate protection to Magnolia's interests. Thus the motion to use cash collateral will be denied ¹

I. BACKGROUND

Debtor is the owner and operator of a hotel located at 350 Bent Creek Boulevard, Mechanicsburg, Pennsylvania, (the “Mechanicsburg Hotel”). Magnolia was not the original lender, but acquired its position through an assignment by Orrstown Bank (“Orrstown”). In 2001, Debtor executed a promissory note in the principal amount of $2,669,000 secured by a mortgage (“First Mortgage”) and an assignment of rents (“First Rent Assignment”) (collectively “First Mortgage Documents”) to finance the construction of the Mechanicsburg Hotel. The First Mortgage Documents were recorded in the Recorder of Deeds Office of Cumberland County, Pennsylvania. Debtor also executed a Commercial Security Agreement granting Orrstown a security interest in various personal property including furniture, fixtures, equipment, accounts receivable, inventory, general intangibles, rents, and “payments.” Ex. B3. The security interest in personal property was perfected by the filing of a UCC financing statement with the Commonwealth.² Neither the First Mortgage Documents nor the Commercial Security Agreement includes provisions for the collateralization of future advances.

Under the terms of the First Mortgage, Debtor granted to Orrstown “right, title, and interest in and to the [Mechanicsburg Hotel], together with all ... improvements and fixtures ... equipment ... and other articles of personal property, and ... all present and future rents, revenues, income,issues, royalties, profits and other benefits derived from the [Mechanicsburg Hotel].” Ex. M–2. Additionally, Debtor was required “to pay to Lender all amounts secured by [the First Mortgage Documents] as they become due, and ... strictly perform all of [Debtor's] obligations under [the First Mortgage Documents].” Ex. M–2. The First Rent Assignment created a “continuing security interest in all of [Debtor's] rights, title, and interest in and to the Rents from the [Mechanicsburg Hotel], under which “Rents” were defined as “all rents, revenues, income, issues, profits and proceeds from the [Mechanicsburg Hotel]....” Ex. M–3. The First Rent Assignment provided that it was given “to secure (1) payment of the indebtedness and (2) performance of any and all obligations of [Debtor] under the Note, this assignment, and the related documents.” Ex. M–3. The First Rent Assignment authorized Debtor to control and manage the Mechanicsburg Hotel and to collect “the Rent,” but it also authorized Orrstown to “send notices to any and all tenants of the [Mechanicsburg Hotel] advising them of the [First Rent ]Assignment and directing all Rents to be paid directly to [Orrstown] or [Orrstown's] agent.” Ex. M–3.

In 2008, Orrstown loaned $5,740,000 to Gurugovind, LLC, (“Gurugovind”) to construct a hotel in Enola, Pennsylvania (the “Enola Hotel”). Orrstown also made a second loan to Gurugovind of $640,000 on the same date. Both loans to Gurugovind were conditioned on the pledge of additional security by Debtor in the form of two mortgages on the Mechanicsburg Hotel (the “Gurugovind Mortgages”) and two further assignments of rent from the Mechanicsburg Hotel (the “Gurugovind Rent Assignments”) (collectively, the “Gurugovind Documents”). The Gurugovind Mortgages included cross collateralization clauses, which state that the mortgages secure:

all obligations, debts and liabilities, plus interest thereon, of either [Debtor] or [Gurugovind] to [Orrstown], or any one or more of them, as well as all claims by [Orrstown] against [Gurugovind] or [Debtor] or any one or more of them, whether now existing or hereafter arising, whether related or unrelated to the purpose of the Note, whether voluntary or otherwise, whether due or not due, direct or indirect, determined or undetermined, absolute or contingent, liquidated or unliquidated, whether [Gurugovind] or [Debtor] may be liable individually or jointly with others, whether obligated as guarantor, surety, accommodation party or otherwise, and whether recover upon such amounts may be or hereafter may become barred by any statute of limitations, and whether the obligation to repay such amounts may be or hereafter may become otherwise unenforceable.

Exs. M–5, M–8. Although Debtor executed the Gurugovind Assignments as separate documents, the Gurugovind Mortgages also provided that Debtor agreed to assign to Orrstown all of its “right, title, and interest in and to all present and future leases of the Property and all Rents from the Property.” Exs. M–5, M–8. Under the terms of the Gurugovind Mortgages, rents are defined as “all present and future rents, revenues, income, issues, royalties, profits, and other benefits derived from the [Mechanicsburg Hotel].” Exs. M–5, M–8. Debtor did not execute the notes executed in connection with the financing of the Enola Hotel, but the Gurugovind Mortgages specify that “[Gurugovind] and [Debtor] shall pay to [Orrstown] all indebtedness secured by [the mortgages] as [they] become due.” Exs. M–5, M–8. “Indebtedness” is described as “all principal, interest, and other amounts, costs and expensespayable” under the promissory notes executed in connection with the two 2008 loans. Exs. M–5, M–8.

It is unclear from the record whether Gurugovind defaulted on the loans before or after the First Mortgage Documents and the Gurugovind Documents were assigned to Magnolia, but on December 13, 2013, Magnolia sent a letter to Debtor asserting that it had defaulted “on a certain loan” and, therefore, Magnolia had elected to collect “proceeds” generated by the Mechanicsburg Hotel. Ex. M–12. In response to this demand for the payment of hotel room revenues, Debtor filed a bankruptcy petition under Chapter 11 of the Bankruptcy Code on December 24, 2013. Among other “first day” motions, Debtor sought permission to use Magnolia's cash collateral. In support of the Motion, Debtor argued that hotel room revenues are personal property and not an interest in real property. In the alternative, Debtor asserted that even if hotel room revenues were determined to be an interest in real property, the Court should find that Debtor's interest in the revenues was not terminated pre-petition and that the revenues are property of the estate. Additionally, Debtor asserted that it is only personally liable to Magnolia under the First Mortgage Documents, which were not in default, and is not personally liable under the Gurugovind Documents. The Court held an expedited hearing on December 30, 2013, after which it entered an interim order authorizing Debtor's use of cash collateral with certain limitations. A final hearing was held on February 4, 2014.

At the final hearing, the parties stipulated that the primary issue was a legal one. Are the hotel revenues an interest in real property, like tenant rents, such that Magnolia's notice to Debtor that all “proceeds” were to be remitted to Magnolia terminated Debtor's interest in the hotel revenues before the petition was filed? Alternatively, are hotel revenues personal property that became property of the estate upon the filing of the petition? If the hotel room revenues were found to be property of the estate, then the parties agreed that the Court was required to determine whether Magnolia's secured interest in cash collateral was adequately protected.

Both parties primarily relied on the exhibits admitted at the hearing in support of their respective positions. Debtor also presented the testimony of Gavin Patel (“Patel”), who testified that he supervises Debtor's financial operations and, working with an accountant, prepared a forecast of Debtor's operations through September 2014. Patel testified that Debtor would be able to service all debt listed in the projections and obtain a positive cash flow by the end of the period. The projections included the debt service on the First Mortgage, but did not include payment of the loans secured by the Gurugovind Mortgages. Because Debtor asserts that it is not personally obligated to Magnolia under the Gurugovind Documents, payments on the Gurugovind obligations were not included as expenses in the nine-month forecast. Debtor also asserted that the First Mortgage is not in default and has never been in default, which Magnolia did not dispute.

In the balance sheet attached to the petition, Debtor states that it has total assets of $2,911,049.72, total liabilities of $1,818,233.07, and total equity of $1,092,626.65. The obligation to Magnolia on the First Mortgage is listed at $1,428,045.38. On its income statement, Debtor reports net income for the period January through November 2013 of $260,490.36. At the hearing, Patel testified that in its forecasted statement of revenue and expenses for January through ...