In re Husting Land & Development, Inc.
| Decision Date | 22 November 2000 |
| Docket Number | No. 97-20309 JAB.,97-20309 JAB. |
| Citation | 255 BR 772 |
| Court | U.S. Bankruptcy Court — District of Utah |
| Parties | In re HUSTING LAND & DEVELOPMENT, INC., Reorganized Debtor. |
COPYRIGHT MATERIAL OMITTED
Steven F. Allred, Steven F. Allred, P.C., Orem, UT, Duane H. Gillman, McDowell & Gillman, P.C., Salt Lake City, UT, for R.A. McKell Excavating, Inc.
R. Kimball Mosier, Parsons Davies Kinghorn & Peters, Salt Lake City, UT, for Chapter 11 Trustee.
F. Wayne Elggren, Neilson, Elggren, Durkin & Co., Salt Lake City, UT, for Chapter 11 Trustee.
George W. Pratt, Adam S. Affleck, Jones, Waldo, Holbrook & McDonough, Salt Lake City, UT, for Webb Family Trust.
Daniel E. Garrison, Michael R. Johnson, Snell & Wilmer, Salt Lake City, UT, for Construct Tech, Inc.
Peter Kuhn, Salt Lake City, UT, for United States Trustee.
This is a contested matter arising from the application for allowance of administrative expense filed by R.A. McKell Excavating, Inc. (RAM) in the Chapter 11 case of Husting Land & Development, Inc. (Husting). The issue presented is whether or not the administrative expense claim of RAM is allowable as a post-petition debt incurred in the ordinary course of business pursuant to 11 U.S.C. § 364(a).1 During a two-day evidentiary hearing, RAM presented evidence in support of its argument that the debt owed to it for infrastructure improvements made to Husting's real estate development was incurred in the ordinary course of business. In so doing, RAM offered, and the Court excluded, certain expert testimony on the basis that the failure to prove the reliability of the expert's methodology precluded the Court from considering his opinion as to whether the debt was incurred in the ordinary course of business. Upon careful consideration of the remaining evidence, the pleadings and arguments, and upon an independent analysis of applicable law, the Court concludes that, applying the creditor expectations/vertical dimension test, the debt incurred by Husting was not in the ordinary course of its business and, accordingly, RAM's claim cannot be allowed as an administrative expense of the estate under § 503(b)(1).
Husting was incorporated in 1994 for the purpose of developing a sixty-one acre, three-phase, sixty-nine lot residential subdivision in Draper, Utah, commonly known as Galena Hills. The purchase price of the real estate, which was in excess of $1,075,000, was subordinated by the seller to a $1,500,000 development loan. In connection with the development of the Galena Hills project, Husting was required by Draper City and the Salt Lake County Sewer Improvement District to post cash escrow bonds (the Escrow Accounts) in the aggregate amount of approximately $612,000 to ensure payment to all persons supplying labor, services, equipment, or material to the Galena Hills project. Husting could obtain incremental release of funds in the Escrow Accounts to pay for improvements once the municipalities had approved the installation of various phases of the infrastructure.
Adjacent to Galena Hills was another subdivision development project, Parkway Estates, owned by John Holmes Construction, Inc. and Holmes Mesa Construction, Inc. (Holmes Mesa). Because Galena Hills required access through the Parkway Estates property, and Galena Hills and Parkway Estates shared common areas and roadways, it was necessary to install certain improvements and utilities that would benefit both subdivisions. Thus, Husting and Holmes Mesa entered into an Adjoining Subdivisions Agreement in which Husting agreed to complete certain improvements on Parkway Estates, and Holmes Mesa agreed to reimburse Husting on a pro rata basis for its construction expenses. The Adjoining Subdivisions Agreement provided that reimbursement funds would not be paid to Husting until twenty-four months after final inspection and approval of construction by various municipalities, and then only if certain other conditions were met.
In February 1996, Husting entered into a Development Agreement with Construct Tech, in which Construct Tech agreed to provide excavation and construction services for the Galena Hills project, including storm drains, sewer, curb and gutter, sidewalk and street improvements. Construction on Galena Hills and the adjoining Parkway Estates subdivision was to begin in April of 1996. However, Construct Tech did not actually break ground on the project until June of that year. From its inception, the relationship between Husting and Construct Tech was fraught with problems and disagreements. Husting's sole shareholder and president, Leon Harward (Harward), provided uncontroverted testimony that Construct Tech's work was incomplete, substandard and defective. Ultimately, in November of 1996, Hustings terminated its contract with Construct Tech.
As a result of difficulties encountered with Construct Tech, the Galena Hills project was seriously behind schedule and Husting was unable to meet payment obligations on its construction financing. On January 14, 1997, Husting, as debtor-in-possession, filed its voluntary petition for relief under Chapter 11. At the time of its Chapter 11 filing, Husting's intention for reorganization was to complete necessary subdivision improvements to Galena Hills and then sell the improved lots to pay secured and unsecured creditors.
In February 1997, Harward and Rick McKell (McKell), President of RAM, visited the Galena Hills site to assess the work necessary to correct defects in the excavation and construction work and complete the project. At the site, McKell observed open trenches, pipelines that were not backfilled, lidless manholes and a number of other deficiencies. After further discussion between the parties, Harward invited RAM to bid on the project. RAM's bid proposal, for work on sewer, water, storm drain, irrigation and site work, totaled $258,191.40. In April 1997, Husting and RAM entered into a post-petition agreement (Construction Agreement), whereby RAM agreed to correct the defective work performed pre-petition by Construct Tech and to complete the remaining work on Phase II of the Galena Hills and Parkway Estates projects on a time and materials basis. The Construction Agreement provides as follows:
RAM Exhibit 11, Construction Agreement at ¶¶ 2 and 3.
Prior to entering into the Construction Agreement, RAM was aware that Husting had filed for relief under Chapter 11 and understood that the only present sources of payment for its work was the approximate $612,000 in the Escrow Accounts established pursuant to the bonds with Draper City and the Salt Lake County Sewer District. However, Harward also led McKell to believe that other sources of payment existed, included the Adjoining Subdivisions Agreement, and funds from Castle Homes, L.L.C., a third-party investor that purportedly intended to purchase and build homes on the lots once the underground and surface improvements had been completed by RAM,2 and to otherwise invest in Husting in some fashion.3 Husting did not obtain Court approval for incurring post-petition unsecured debt under the terms of the Construction Agreement.
Shortly after RAM began working on the Galena Hills and Parkway Estates projects, it became apparent that neither McKell nor Husting had realized the scope of corrective work that would have to be done. Indeed, rather than simply correcting Construct Tech's deficiencies, most of the culinary and sanitary water lines and systems previously installed had to be completely removed and replaced. As a result, the invoices RAM submitted to Husting over the next several months on a time and materials basis exceeded his original bid proposal and the amounts held in the Escrow Accounts. Finally, in November of 1997, RAM ceased performing under the Construction Agreement because Husting and/or third parties had failed to pay past-due invoices and because further payment or funding from the Escrow Accounts, the Adjoining Subdivisions Agreement and third-party investors appeared unlikely to materialize in the near future. In the seven months between May and November of 1997, RAM invoiced $969,633.08 to Husting for materials and labor supplied for performing corrective work and making improvements to the Galena Hills and Parkway Estates projects. During the same period, Husting paid RAM $371,640.57 with funds obtained through partial release of funds in the Escrow Accounts.
In April 1998, three months after the Trustee was appointed in the Husting Chapter 11 case upon Husting's own motion, RAM filed a Motion for Allowance of Administrative Expense (Motion) in which it claimed $648,444.77 in principal and interest as of January 15, 1998. The Trustee and various creditors objected to RAM's Motion. Hearing on the Motion was continued several times at RAM's request. In the interim, a plan of reorganization proposed by the Trustee was confirmed under which the Court retained jurisdiction...
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