In re Fmo Associates II, LLC

• Decision Date: 13 February 2009
• Docket Number: No. 808-76102-reg.,808-76102-reg.
• Citation: 402 B.R. 546
• Parties: In re FMO ASSOCIATES II, LLC, Debtor.
• Court: U.S. Bankruptcy Court — Eastern District of New York

Page 546

402 B.R. 546

In re FMO ASSOCIATES II, LLC, Debtor.

No. 808-76102-reg.

United States Bankruptcy Court, E.D. New York.

February 13, 2009.

Kenneth A. Reynolds, McBreen & Kopko, Jericho, NY, for Debtor.

MEMORANDUM DECISION

ROBERT E. GROSSMAN, Bankruptcy Judge.

Before the Court is a motion by FMO Associates II, LLC (the "Debtor") to convert its Chapter 7 case to a case under Chapter 11 pursuant to 11 U.S.C. § 706. The Debtor urges the Court to grant the motion arguing that it has not acted in bad faith and is therefore eligible to be a debtor under Chapter 11. The Chapter 7 Trustee, Kenneth Kirschenbaum, opposes the motion, arguing that conversion of the Debtor's case to a case under Chapter 11 would serve no purpose. The Trustee also argues due to the particular circumstances regarding the conduct of the Debtor before and during the pendency of the instant Chapter 7 case the Debtor has forfeited its right to convert the case to a case under Chapter 11. The Court finds the Supreme Court's recent decision In re Marrama v. Citizens Bank, 549 U.S. 365, 127 S.Ct. 1105, 166 L.Ed.2d 956 (2007), instructive in this case. Based on the totality of the circumstances, the Debtor's conduct does not rise to the requisite level of bad faith and thus the Debtor is eligible to be a debtor under Chapter 11. Accordingly, the Court grants the Debtor's motion.

Facts

On October 31, 2008 (the "Petition Date"), the Debtor filed a voluntary petition for relief under Chapter 7 of the Bankruptcy Code. Kenneth Kirschenbaum was appointed Interim Trustee on October 31, 2008 (the "Trustee"). The petition was filed without any schedules, statement of financial affairs or corporate resolution authorizing the filing. The Debtor owns an undeveloped parcel of land zoned for commercial use located in Bay Shore, New York (the "Property"). The Property consists of two separate tax lots, one of which constitutes approximately 90% of the Property. The Property is encumbered by a first mortgage held by Anthony Pirrera and ASPA Management Corp. (the "First Mortgagee"), which is security for a note in the original principal amount of $540,000. Prior to the date the petition was filed, the First Mortgagee had commenced a foreclosure action with respect to the Property. On August 25, 2008, a judgment of foreclosure was entered in favor of the First Mortgagee in the amount of $553,655.40. The Property is also encumbered by a second mortgage held by Alfred Giordano, in the outstanding amount of approximately $82,000. In addition to these two mortgages, the Property is encumbered by tax liens held by Suffolk County in the approximate amount of $38,000.

During the year prior to the Petition Date, the Debtor had marketed the Property for sale and retained Michael Salgo, Esq. as its real estate counsel to represent the Debtor in its efforts to sell the Property. Based on the offers the Debtor had received for the Property prepetition, the Debtor's principal believed that the value of the Property was less than the total amounts owed under the two mortgages and the tax lien.

At a point in time subsequent to the Petition Date the Trustee received from the Debtor's counsel schedules and the statement of financial affairs. However, these documents were not filed with the Court.¹ According to the Trustee, the schedules listed the value of the Property at less than the total amount of mortgages and liens encumbering the Property.

On November 17, 2008, the First Mortgagee filed a motion to vacate the automatic stay to permit the First Mortgagee to continue with the foreclosure against the Property. According to the affidavit in support of the motion, the value of the Property was estimated to be between $500,000 and $600,000 pursuant to an appraisal conducted for the First Mortgagee. The motion to vacate the stay was served on the Chapter 7 Trustee, the Debtor and counsel to the Debtor. The motion was granted unopposed at a hearing held on December 15, 2008. An order vacating the stay was entered on the Court's docket on December 17, 2008.

On January 19, 2009, the Debtor filed with the Court schedules and the statement of financial affairs. In the schedules, the value of the Property is listed as $770,000 and the total amount of liens on the Property is listed at $710,000. On January 22, 2009, the Debtor filed the instant motion to convert to Chapter 11 (the "Motion"). In the Motion, the Debtor revealed to the Court for the first time that the Debtor had entered into a contract of sale of the larger lot for $740,000. This exceeds the amount of the scheduled liens against the Property. Under the terms of the sale the Debtor would retain the smaller lot, which would be unencumbered. According to the Debtor, this remaining lot is worth approximately $30,000.

At the hearing on the Motion, counsel to the Debtor stated that the Debtor had solicited offers for the purchase of the Property well prior to the Petition Date and had circulated proposed contracts of sale, but had never expected to receive an offer after the Petition Date. If the Motion is granted, the Debtor intends to file a plan and disclosure statement as well as a request to approve the sale of the Property to the prospective purchaser, subject to higher and better offers. If the sale of the Property is approved and is consummated, there will be sufficient net proceeds to make a payment to unsecured creditors, which the Debtor lists in the total amount of $218,193.89.² In addition, the Debtor will retain for the benefit of the estate the ownership of the smaller lot. The Office of the United States Trustee appeared in support of the Motion on the grounds that it would be in the best interest of creditors to grant such motion and that the Trustee failed to introduce sufficient evidence that the Debtor acted in bad faith during the pendency of the Chapter 7 case. According to the United States Trustee, the Debtor's representation of the events was just as likely to be true as the Trustee's representation of the events, and without any evidence to support his argument, the Trustee's opposition should be overruled. The First Mortgagee also appeared at the hearing and did not oppose the Motion.

The Debtor asserts that it has a right to convert the case to Chapter 11 but for a showing of extreme circumstances. The Debtor argues that so long as the Court does not find that "extreme circumstances" exist which would preclude the granting of such relief, the Court should not interfere with the Debtor's right to seek conversion of its case. The Trustee opposes the motion and argues that the Debtor's right to convert is not absolute and in fact is limited by statute and case law. The Trustee argues that in this case conversion is not appropriate because it would serve no purpose as the Debtor has no "business" to reorganize. The Trustee also argues that under the reasoning set forth in In re Marrama, 549 U.S. 365, 127 S.Ct. 1105 (2007) the Debtor's bad faith conduct while in Chapter 7 provides additional grounds to deny the Debtor's request.

Discussion

Both the Debtor and the Trustee agree that a Chapter 7 debtor does not have an absolute right to convert to Chapter 11. Section 706(a) of the Bankruptcy Code provides that a "debtor may convert a case under this chapter to a case under chapter 11, 12, or 13 of this title at any time, if the case has not been converted under section 1112, 1208, or 1307 of this title". Any waiver of the right to convert a case under this subsection is unenforceable. Courts in this Circuit have recognized that despite the "seemingly absolute language" of this statute, a debtor's right to convert a Chapter 7 case to Chapter 11 under Section 706(a) is not absolute. First, the debtor must file a motion and give notice pursuant to Fed. R. Bankr.P. 1017(f)(2). As the Court in In re Krishnaya recognized, the fact that conversion under Section 706(a) requires a motion suggests that the Court's role in such motion "is more than a meaningless one." 263 B.R. 63, 66 (Bankr. S.D.N.Y.2001). The Debtor has complied with this requirement.

The fundamental question presented in this case is what is the appropriate standard to apply in considering whether to grant or deny the Debtors motion to convert a case from Chapter 7 to a case under Chapter 11, and which party has the burden of persuasion. Recently, the Supreme Court issued a decision regarding whether a Chapter 7 debtor had an absolute right to convert to Chapter 13, and if there is no absolute right, whether the Court could take into consideration the debtor's bad faith conduct during the Chapter 7 case. In In re Marrama, 549 U.S. 365, 127 S.Ct. 1105 (2007), the Supreme Court concluded that the Debtor's right to convert a Chapter 7 case to a case under Chapter 13 is not absolute and is specifically limited by § 706(d) of the Bankruptcy Code, which states that "[n]otwithstanding any other provision of this section, a case may not be converted to a case under another chapter of this title unless the debtor may be a debtor under such chapter." In Marrama, the debtor filed inaccurate statements and schedules which omitted information regarding the true value of an asset of the estate the debtor had transferred to a trust for which he was the sole beneficiary within one year of the filing date. The debtor had admitted that he made the transfer to protect this property from creditors, and then the debtor sought to convert his case to a case under Chapter 13. The Chapter 7 trustee opposed the motion and the bankruptcy court denied the debtor's motion. The Supreme Court affirmed the Bankruptcy Court and concluded that the debtor's bad faith conduct during a Chapter 7 case justified denial of the debtor's motion to convert.

The Supreme Court based its decision on the language of § 706(a), which when read together with § 706(d) of the Bankruptcy Code, limits a debtor's right to convert to a chapter for which the debtor qualifies to be a...